1 ================================================================================ UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 Form 10-K (MARK ONE) X ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES --- EXCHANGE ACT OF 1934 FOR THE FISCAL YEAR ENDED DECEMBER 31, 1999 OR TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES --- EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM TO ---- ---- COMMISSION FILE NUMBER 0-12247 Southside Bancshares, Inc. (Exact name of registrant as specified in its charter) TEXAS 75-1848732 (State of incorporation) (I.R.S. Employer Identification No.) 1201 S. BECKHAM AVENUE, TYLER, TEXAS 75701 (Address of Principal Executive Offices) (Zip Code) Registrant's telephone number, including area code: (903) 531-7111 Securities registered pursuant to Section 12(b) of the Act: Name of each exchange Title of each class on which registered ------------------- ------------------- NONE NONE Securities registered pursuant to Section 12(g) of the Act: COMMON STOCK (Title of Class) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YES X NO --- --- Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [X] As of March 2, 2000, 3,636,515 shares of common stock of Southside Bancshares, Inc. were outstanding. The aggregate market value of common stock held by nonaffiliates of the registrant as of February 9, 2000 was $49,510,878. DOCUMENTS INCORPORATED BY REFERENCE Registrant's Proxy Statement to be filed for the Annual Meeting of Shareholders to be held April 20, 2000. (Part III) ================================================================================
2 PART I ITEM 1. BUSINESS GENERAL Southside Bancshares, Inc. (the "Company") is a Texas corporation organized in 1982 that serves as a bank holding company for Southside Bank (the "Bank"), a Texas-chartered bank organized in 1960. The Company owns all of the capital stock of Southside Delaware Financial Corporation, a Delaware corporation ("Southside Delaware"), that in turn owns all of the capital stock of the Bank. The Company and the Bank are headquartered in Tyler, Texas, which 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, which has a population of approximately 171,000, and is the largest independent bank headquartered in East Texas. At December 31, 1999, the Company had total assets of $1.0 billion, loans of $387.4 million, deposits of $587.5 million, and shareholders' equity of $37.7 million. The Bank is a community-focused financial institution that offers a full range of financial services to individuals, businesses and nonprofit organizations in its primary market area. 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 and home improvement loans, automobile loans and other installment loans. The Bank began offering home equity loans in January 1998 when a new Texas law first permitting such loans took effect. 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 and commercial real estate loans. The Bank also offers construction loans primarily for owner-occupied 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 certificate accounts. The Bank's trust services include investment, management, administration and advisory services, primarily for individuals and, to a lesser extent, partnerships and corporations. At December 31, 1999, the Bank's trust department managed approximately $178 million of trust assets. Through its 25% owned securities brokerage affiliate, BSC Securities, L.C., the Bank offers full retail investment services to its customers. In early 1997, the Company formed a consumer finance subsidiary, Countywide Loans, Inc. ("Countywide"), to provide basic financial services such as small loans, check cashing and money orders to individuals. The Bank considers its primary market area to be all of Smith and Gregg Counties, Texas, and, to a lesser extent, portions of adjoining counties. The principal economic activities in the Bank's market area include the retail, distribution, manufacturing, medical services, education and oil and gas industries. The Bank serves this market through twelve full service branch locations, including seven branches located in grocery stores. The branches are located in and around Tyler and Longview. The Company opened three branches in 1998 and 1999 in Longview, Texas, a city located approximately 35 miles east of Tyler in adjoining Gregg County. Two longtime Longview banking veterans have joined the Bank to lead the Company in its expansion into the Longview market area. The Company's television and radio advertising has extended into this market area for several years, providing the Bank name recognition in the Greater Longview area. The Bank also maintains three motor bank facilities, and Countywide maintains one location. The Bank's customers may also access various banking services through 20 automated teller machines ("ATMs") owned by the Bank and ATMs owned by others, through debit cards, and through the Bank's automated telephone, internet and electronic banking products that allow the Bank's customers to apply for loans, access account information and conduct various transactions from their telephones and computers. The Company reported net income of $7.9 million and $5.3 million and diluted earnings per share of $2.10 and $1.39 for the years ended December 31, 1999 and 1998, respectively. The Company instituted a cash dividend in 1970 and has paid dividends each year since that time. 1
3 The Company and the Bank are subject to comprehensive regulation, examination and supervision by the Board of Governors of the Federal Reserve System (the "FRB"), the Texas Department of Banking (the "TDB") and the Federal Depository Insurance Corporation (the "FDIC"), and are subject to numerous laws and regulations relating to the extension of credit and making of loans to individuals. 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. MARKET AREA The Company's market area is primarily Smith and Gregg Counties in East Texas. During 1998 and 1999, the Company opened three branches in Gregg County. While the Gregg County market area is expected to grow during the coming years, at present, Tyler, Texas in Smith County, represents the Company's primary market area. Tyler's industry base is a diverse mix that includes oil and gas, manufacturing, distribution, conventions and tourism, as well as retirement relocation, to name a few. All of these support a growing regional system of medical service, retail and education centers. Tyler is home to several nationally recognized health care systems. Tyler hospitals represent all major specialties and employ several thousand individuals. LENDING ACTIVITIES The Company's main objective is to seek attractive lending opportunities in East Texas, primarily in Smith and Gregg Counties. Substantially all of the Bank's loans are made to borrowers who live in and conduct business in East Texas. Total loans as of December 31, 1999 increased $67.7 million or 21.2% while the average balance was up $37.2 million or 12.2% when compared to 1998. Real estate loans as of December 31, 1999 increased $56.9 million or 33.1% from December 31, 1998. Loans to individuals decreased $.9 million or 1.1% from December 31, 1998 and commercial loans increased $11.7 million or 17.3%. The increase in real estate loans is due to a stronger real estate market and an increased commitment by the Company to residential mortgage lending. Commercial loans increased as a result of commercial growth in the Company's market area. Real estate and commercial loans also increased due to the growth of loans made to municipalities in Texas. Most of the loans to municipalities have tax pledges supporting them in addition to collateral. Average loans to municipalities increased approximately $3.8 million during the year ended December 31, 1999. Loans to individuals decreased due to a decision by management that effective January 2, 1998, the Company exited its indirect dealer loan line of business to concentrate more on direct automobile loans. In the portfolio, loans dependent upon private household income represent a significant concentration. Due to the number of customers involved who work in all sectors of the local economy, the Company believes the risk in this portion of the portfolio is adequately spread throughout the economic community. 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, 1999 was $7.5 million. The Bank's largest loan relationship at December 31, 1999 was approximately $6.8 million. The average yield on loans for the year ended December 31, 1999 decreased to 8.26% from 8.56% for the year ended December 31, 1998. This decrease was reflective of the repricing characteristics of the loans and the decrease in lending rates during 1999 due to competitive pressures, the changing mix of the loan portfolio and a lower average prime rate in 1999 compared to 1998. The U.S. prime interest rate decreased 75 basis points during the latter part of 1998 beginning September 1998. Prime increased 75 basis points during 1999, but did not begin increasing until June 1999, at which time prime increased 25 basis points. The final 25 basis point increase did not occur until November 1999. As a result, the prime rate, which is used as a basis to price numerous loans, was on average lower in 1999 than in 1998. 2
4 LOANS TO AFFILIATED PARTIES In the normal course of business, the Company's subsidiary, Southside Bank, makes loans to certain of the Company's, as well as its own, officers, directors, employees and their related interests. As of December 31, 1999 and 1998, these loans totaled $8.8 million and $9.1 million or 23.3% and 19.6% 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 PORTFOLIO COMPOSITION AND ASSOCIATED RISK For purposes of this discussion, the Company's loans are divided into three categories: Real Estate Loans, Commercial Loans, and Loans to Individuals. REAL ESTATE LOANS Real estate loans are divided into three categories: 1-4 Family Residential Mortgage Lending, Construction Loans and Commercial 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, 1999, the vast majority of the Company's real estate loans were collateralized by properties located in Smith and Gregg Counties. Of the $228.7 million in real estate loans, $112.7 million or 49.3% 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. A significant portion of the remaining real estate loans are collateralized primarily with owner occupied commercial real estate. The Company's loan policy requires appraisal prior to funding any real estate loans and also outlines the requirements for appraisals on renewals. Due to the volume of real estate loans contained in the Company's portfolio which are collateralized by owner occupied properties, and the appraisal and other real estate lending policies in place that indicate the value of the collateral for these loans, management does not consider the potential impact of these loans on the loan loss reserve to be excessive, even though real estate loans constitute the largest percentage of loans outstanding. Management also pursues an aggressive policy of reappraisal on any real estate loan that becomes troubled and potential exposures are recognized and reserved for as soon as they are identified. However, the slow pace of absorption for certain types of properties could adversely affect the volume of nonperforming real estate loans held by the Company. 1-4 Family Residential Mortgage Lending Residential loan originations are generated by the Company's in-house originations staff, marketing efforts, present customers, walk-in customers and referrals from real estate agents, mortgage brokers and builders. The Company focuses its lending efforts primarily on the origination of loans secured by first mortgages on owner-occupied, 1-4 family residences. Substantially all of the Company's 1-4 family residential mortgage originations are secured by properties located in Smith and Gregg Counties, Texas. Historically, the Company has sold a portion of its loan originations to secondary market investors pursuant to ongoing purchase commitments. The Company's fixed rate 1-4 family residential mortgage loans generally have maturities ranging from seven to 30 years. These loans are typically fully amortizing with monthly payments sufficient to repay the total amount of the loan. The Company also makes seven to 30 year amortizing loans with a balloon feature, typically due in fifteen years or less. The Company reviews information concerning the income, financial condition, employment and credit history when evaluating the creditworthiness of the applicant. 3
5 In November 1997, Texas voters approved a change to the Texas Constitution allowing home equity loans. The Company began offering this form of real estate lending beginning January 1, 1998 when the law became effective. The Company has established underwriting and pricing guidelines for this lending area. Construction Loans The Company's construction loans are collateralized by property located primarily in the Company's market area. The Company's emphasis for construction loans is directed toward properties that will be owner occupied. Occasionally, construction loans for projects built on speculation are financed, but these typically have substantial secondary sources of repayment. The Company's construction loans to individuals generally have fixed interest rates during the construction period. Construction loans to individuals are typically made in connection with the granting of the permanent loan on the property. Commercial Real Estate Loans In determining whether to originate commercial real estate loans, the Company generally considers such factors as the financial condition of the borrower and the debt service coverage of the property. Commercial real estate loans are made at both fixed and adjustable interest rates for terms generally up to 20 years. Commercial real estate loans primarily include commercial office buildings, retail, medical and warehouse facilities, hotels and churches. The majority of these loans, with the exception of those for hotels and churches, are collateralized by owner occupied properties. COMMERCIAL LOANS The Company's commercial loans are diversified to meet most business needs. Loan types include short-term working capital loans for inventory and accounts receivable and short and medium-term loans for equipment or other business capital expansion. Management does not consider there to be any material concentration of risk in any one industry type, other than medical, in this loan category since no industry classification represents over 10% of loans. The medical community represents a concentration of risk in the Company's Commercial loan and Commercial Real Estate loan portfolio (see "Market Area"). Risk in the medical community is mitigated because it is spread among multiple practice types and multiple specialties. In its commercial business loan underwriting, the Company assesses the creditworthiness, ability to repay, and the value and liquidity of the collateral being offered. Terms are generally granted commensurate with the useful life of the collateral offered. LOANS TO INDIVIDUALS The Bank is a major consumer lender in its trade territory and has been for many years. The majority of consumer loans outstanding are those secured by vehicles, including the "indirect" vehicle loan portfolio, which at December 31, 1999 was approximately $11.1 million. The indirect vehicle loans on the Company's books were originated through automobile dealers but underwritten directly by the Company using the same underwriting guidelines used for its direct vehicle loans. However, due to market forces that were contributing to declining profit margins on indirect vehicle loans, the Company exited the indirect vehicle loan program effective January 2, 1998 to concentrate on direct vehicle loans. Direct vehicle loans accounted for approximately $62.4 million at December 31, 1999. Additionally, the Company makes loans for a full range of other consumer purposes, which may be secured or unsecured depending on the credit quality and purpose of the loan. Other major categories for the remainder of the portfolio include loans secured by boats and cash or equivalently secured loans. At this point, the economy in the Bank's trade territory appears stable. One area of concern is the high nationwide personal bankruptcy rate. Management expects this trend to have some adverse effect on the Company's net charge-offs. Most of the Company's loans to individuals are collateralized, which management believes will limit the exposure in this area should current bankruptcy trends continue. 4
6 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 greatest weight being given to payment history with the Company, and an assessment of the borrower's ability to meet existing obligations and payments on the proposed loan. Although creditworthiness of the applicant is a primary consideration, the underwriting process also includes a comparison of the value of the collateral, if any, in relation to the proposed loan amount. LOAN PORTFOLIO COMPOSITION The following table sets forth loan totals net of unearned discount by category for the years presented: <TABLE> <CAPTION> December 31, ---------------------------------------------------------------- 1999 1998 1997 1996 1995 ----------- ----------- ----------- ----------- ----------- (in thousands) <S> <C> <C> <C> <C> <C> Real Estate Loans: Construction.............................. $ 18,489 $ 10,509 $ 10,299 $ 7,821 $ 4,558 1-4 Family Residential.................... 112,699 93,215 76,243 62,356 49,909 Other..................................... 97,556 68,140 55,802 57,198 54,436 Commercial Loans............................. 79,722 67,977 61,972 51,307 44,217 Loans to Individuals......................... 78,980 79,882 91,719 79,485 75,658 ----------- ----------- ----------- ----------- ----------- Total Loans............................... $ 387,446 $ 319,723 $ 296,035 $ 258,167 $ 228,778 =========== =========== =========== =========== =========== </TABLE> The following table represents loan maturities and sensitivity to changes in interest rates. The amounts of total loans outstanding at December 31, 1999, 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. <TABLE> <CAPTION> After One Due in One but within After Five Year or Less Five Years Years ---------------- ---------------- ---------------- (in thousands) <S> <C> <C> <C> Construction Loans......................................... $ 14,362 $ 3,674 $ 453 Real Estate Loans-Other.................................... 55,948 93,581 60,726 Commercial Loans........................................... 49,512 21,261 8,949 All Other Loans............................................ 39,133 35,956 3,891 ---------------- ---------------- ---------------- Total Loans.......................................... $ 158,955 $ 154,472 $ 74,019 ================ ================ ================ </TABLE> <TABLE> <S> <C> <C> Loans with Maturities After One Year for Which: Interest Rates are Fixed or Predetermined $ 227,788 Interest Rates are Floating or Adjustable $ 19,489 </TABLE> * The volume of commercial loans due within one year reflects the Company's general policy of limiting such loans to a short-term maturity. Loans are shown net of unearned discount. Nonaccrual loans are reflected in the due after five years column. 5
7 LOAN LOSS EXPERIENCE AND RESERVE FOR LOAN LOSSES The loan loss reserve in place at the end of each year is based on the most current review of the loan portfolio at that time. Several methods are used to maintain the review in the most current manner. First, the servicing officer has the primary responsibility for updating significant changes in a customer's financial position. Accordingly, each officer prepares status updates on any credit deemed to be experiencing repayment difficulties which, in the officer's opinion, would place the collection of principal or interest in doubt. Second, an internal review officer from the Company is responsible for an ongoing review of the Company's entire loan portfolio with specific goals set for the volume of loans to be reviewed on an annual basis. Third, Southside Bank is regulated and examined by the FDIC and/or the Texas Department of Banking on an annual basis. At each review of a credit, a subjective analysis methodology is used to grade the respective loan. Categories of grading vary in severity to include loans which do not appear to have a significant probability of loss at the time of review to grades which indicate a probability that the entire balance of the loan will be uncollectible. If full collection of the loan balance appears unlikely at the time of review, estimates or appraisals of the collateral securing the debt are used to allocate the necessary reserves. A list of loans, which are graded as having more than the normal degree of risk associated with them, is maintained by the internal review officer. This list is updated on a periodic basis, but no less than quarterly by the servicing officer in order to properly allocate necessary reserves and keep management informed on the status of attempts to correct the deficiencies noted in the credit. In addition to maintaining an ongoing review of the loan portfolio, the internal review officer maintains a history of the loans that have been charged-off without first being identified as problems. This history is used to determine the amount of nonspecifically allocated reserve necessary, in addition to the portion which is specifically allocated by loan. The internal review officer also uses the loan portfolio data collected to determine the allocation of reserve for loan loss appropriate for the risk in each of the Company's major loan categories. As of December 31, 1999, the Company's review of the loan portfolio indicates that a loan loss reserve of $4.6 million is adequate. The table on the following page summarizes the average amount of net loans outstanding; changes in the reserve for loan losses arising from loans charged-off and recoveries on loans previously charged-off; additions to the reserve which have been charged to operating expense; the ratio of net loans charged-off to average loans outstanding; and an allocation of the reserve for loan loss. 6
8 LOAN LOSS EXPERIENCE AND RESERVE FOR LOAN LOSSES <TABLE> <CAPTION> Years Ended December 31, -------------------------------------------------------------- 1999 1998 1997 1996 1995 ---------- ---------- ---------- ---------- ---------- (dollars in thousands) <S> <C> <C> <C> <C> <C> Average Net Loans Outstanding.......................... $ 341,466 $ 304,255 $ 274,577 $ 243,925 $ 209,141 ========== ========== ========== ========== ========== Balance of Reserve for Loan Loss at Beginning of Period................................ $ 3,564 $ 3,370 $ 3,249 $ 3,317 $ 3,137 ---------- ---------- ---------- ---------- ---------- Loan Charge-Offs: Real Estate-Construction............................... Real Estate-Other...................................... (175) (36) Commercial Loans....................................... (114) (405) (525) (70) (61) Loans to Individuals................................... (651) (769) (704) (768) (502) ---------- ---------- ---------- ---------- ---------- Total Loan Charge-Offs ................................ (765) (1,349) (1,229) (838) (599) ---------- ---------- ---------- ---------- ---------- Recovery on Loans Previously Charged off: Real Estate-Construction............................... 10 Real Estate-Other...................................... 5 36 14 7 272 Commercial Loans....................................... 106 90 133 78 546 Loans to Individuals................................... 209 202 188 185 261 ---------- ---------- ---------- ---------- ---------- Total Recovery of Loans Previously Charged-Off......... 320 328 345 270 1,079 ---------- ---------- ---------- ---------- ---------- Net Loan (Charge-Offs) Recoveries...................... (445) (1,021) (884) (568) 480 Provision (Credit) for Loan Loss....................... 1,456 1,215 1,005 500 (300) ---------- ---------- ---------- ---------- ---------- Balance at End of Period............................... $ 4,575 $ 3,564 $ 3,370 $ 3,249 $ 3,317 ========== ========== ========== ========== ========== Ratio of Net Charge-Offs (Recoveries) to Average Loans Outstanding....................... .13% .34% .32% .23% (.23%) ========== ========== ========== ========== ========== </TABLE> Allocation of Reserve for Loan Loss (dollars in thousands): <TABLE> <CAPTION> December 31, -------------------------------------------------------------------------------- 1999 1998 1997 1996 1995 -------------- -------------- -------------- --------------- -------------- % of % of % of % of % of Amount Total Amount Total Amount Total Amount Total Amount Total ------- ------ ------ ------- ------- ------ ------- ------- ------- ------ <S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> Real Estate-Construction................ $ 91 2.0% $ 52 1.5% $ 52 1.5% $ 39 1.2% $ 23 .7% Real Estate-Other....................... 1,804 39.4% 1,291 36.2% 1,087 32.3% 1,059 32.6% 1,209 36.4% Commercial Loans........................ 1,558 34.1% 1,182 33.2% 1,181 35.0% 1,129 34.7% 1,059 31.9% Loans to Individuals.................... 1,077 23.5% 1,017 28.5% 1,040 30.9% 948 29.2% 934 28.2% Unallocated............................. 45 1.0% 22 .6% 10 .3% 74 2.3% 92 2.8% ------- ----- ------ ------ ------- ----- ------- ------ ------- ----- Balance at End of Period................ $ 4,575 100% $3,564 100% $ 3,370 100% $ 3,249 100% $3,317 100% ======= ===== ====== ====== ======= ===== ======= ====== ======= ===== </TABLE> See "Consolidated Financial Statements - Note 4. Loans and Reserve for Possible Loan Losses." 7
9 NONPERFORMING ASSETS Nonperforming assets consist of delinquent loans over 90 days past due, nonaccrual loans, other real estate owned and restructured loans. Nonaccrual loans are those loans which are more than 90 days delinquent and collection in full of both the principal and interest is in doubt. Additionally, some loans that are not delinquent may be placed on nonaccrual status due to doubts about full collection of principal or interest. When a loan is categorized as nonaccrual, the accrual of interest is discontinued and the accrued balance is reversed for financial statement purposes. Other Real Estate Owned (OREO) represents real estate taken in full or partial satisfaction of debts previously contracted. The OREO consists primarily of raw land. The Company is actively marketing all properties and none are being held for investment purposes. Restructured loans represent loans which have been renegotiated to provide a reduction or deferral of interest or principal because of deterioration in the financial position of the borrowers. Categorization of a loan as nonperforming is not in itself a reliable indicator of potential loan loss. Other factors, such as the value of collateral securing the loan and the financial condition of the borrower must be considered in judgments as to potential loan loss. The following table of nonperforming assets is classified according to bank regulatory call report guidelines: <TABLE> <CAPTION> NONPERFORMING ASSETS (dollars in thousands) December 31, ----------------------------------------------------------------- 1999 1998 1997 1996 1995 ------------ ------------ ----------- ----------- ------------ <S> <C> <C> <C> <C> <C> Loans 90 Days Past Due: Real Estate.................................. $ 233 $ 412 $ 454 $ 214 $ 266 Loans to Individuals......................... 58 44 232 170 203 Commercial................................... 48 120 56 88 183 ------------ ------------ ----------- ----------- ------------ 339 576 742 472 652 ------------ ------------ ----------- ----------- ------------ Loans on Nonaccrual: Real Estate.................................. 2 108 646 486 Loans to Individuals......................... 281 263 177 113 116 Commercial................................... 422 167 1,059 774 654 ------------ ------------ ----------- ----------- ------------ 703 432 1,344 1,533 1,256 ------------ ------------ ----------- ----------- ------------ Restructured Loans: Real Estate.................................. 178 197 214 230 243 Loans to Individuals......................... 214 222 189 108 49 Commercial................................... 56 54 32 62 44 ------------ ------------ ----------- ----------- ------------ 448 473 435 400 336 ------------ ------------ ----------- ----------- ------------ Total Nonperforming Loans....................... 1,490 1,481 2,521 2,405 2,244 Other Real Estate Owned......................... 140 195 364 273 273 Repossessed Assets.............................. 209 326 206 262 240 ------------ ------------ ----------- ----------- ------------ Total Nonperforming Assets...................... $ 1,839 $ 2,002 $ 3,091 $ 2,940 $ 2,757 ============ ============ =========== =========== ============ Percentage of Total Assets...................... .2% .2% .5% .6% .6% Percentage of Loans and Leases, Net of Unearned Income....................... .5% .6% 1.0% 1.1% 1.2% </TABLE> Total nonperforming assets decreased $163,000 between December 31, 1998 and December 31, 1999. Nonperforming assets as a percentage of assets remained the same as the previous year at .2% and as a percentage of loans decreased .1% to .5%. Nonperforming assets represent a drain on the earning ability of the Company. Earnings losses are due both to the loss of interest income and the costs associated with maintaining the OREO, for taxes, insurance and other operating expenses. In addition to the nonperforming assets, at December 31, 1999 in the opinion of management, the Company had $.2 million 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. 8
10 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 (in thousands): <TABLE> <CAPTION> Valuation Carrying Total Allowance Value ------------ ------------ ------------ <S> <C> <C> <C> Commercial Loans....................................................... $ 422 $ 225 $ 197 Loans to Individuals................................................... 281 44 237 ------------ ------------ ------------ Balance at December 31, 1999........................................... $ 703 $ 269 $ 434 ============ ============ ============ </TABLE> <TABLE> <CAPTION> Valuation Carrying Total Allowance Value ------------ ------------ ------------ <S> <C> <C> <C> Real Estate Loans...................................................... $ 2 $ $ 2 Commercial Loans....................................................... 167 32 135 Loans to Individuals................................................... 263 49 214 ------------ ------------ ------------ Balance at December 31, 1998........................................... $ 432 $ 81 $ 351 ============ ============ ============ </TABLE> For the years ended December 31, 1999 and 1998, the average recorded investment in impaired loans was approximately $565,000 and $665,000, respectively. During the years ended December 31, 1999 and 1998, the amount of interest income reversed on impaired loans placed on nonaccrual and the amount of interest income subsequently recognized on the cash basis was not material. The net amount of interest recognized on loans that were nonaccruing or restructured during the year was $125,000, $94,000 and $110,000 for the years ended December 31, 1999, 1998 and 1997, respectively. If these loans had been accruing interest at their original contracted rates, related income would have been $137,000, $113,000 and $336,000 for the years ended December 31, 1999, 1998 and 1997, respectively. The following is a summary of the Allowance for Losses on Other Real Estate Owned for the years presented (in thousands): <TABLE> <CAPTION> Years Ended December 31, ------------------------------------------------------- 1999 1998 1997 ---------------- ----------------- ---------------- <S> <C> <C> <C> Balance at beginning of year........................... $ 658 $ 672 $ 946 Acquisition of OREO................................ 61 Disposition of OREO................................ (658) (14) (274) ---------------- ----------------- ---------------- Balance at end of year................................. $ 61 $ 658 $ 672 ================ ================= ================ </TABLE> 9
11 SECURITIES ACTIVITY The securities portfolio of the Company plays a primary role in management of the interest rate sensitivity of the Company and, therefore, is managed in the context of the overall balance sheet. The Securities portfolio generates a substantial percentage of the Company's interest income and serves as a necessary source of liquidity. The Company accounts for debt and equity securities as follows: Held to Maturity (HTM). Debt securities that management has the positive intent and ability to hold until maturity are classified as held to maturity 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 available for sale. These assets are carried at market value. Market value is determined using published quotes as of the close of business. Unrealized gains and losses are excluded from earnings and reported net of tax as a separate component of shareholders' equity until realized. Prudent management of the investment securities portfolio serves to optimize portfolio yields. Management attempts to deploy investable funds into instruments which are expected to increase the overall return of the portfolio given the current assessment of economic and financial conditions. Average Securities increased $214 million or 65.6% during the year ended December 31, 1999 compared to 1998. Beginning in the second quarter of 1998 and continuing through the second quarter ended June 30, 1999, the Company leveraged the balance sheet to offset the interest expense associated with the Trust Preferred Securities issued. The leverage strategy consisted of borrowing long and short-term funds from FHLB Dallas and investing the funds primarily in municipal and mortgage-backed securities. This accounted for the increase in Average Securities. The mix of Average Securities between taxable and tax-exempt securities changed to 83.1% taxable and 16.9% tax-exempt for the year ended 1999 from 78.8% taxable and 21.2% tax-exempt for 1998 due to tax considerations. Average Other Interest Earning Assets, consisting primarily of Federal Funds Sold, increased $4.4 million or 129.3% during the year ended December 31, 1999 compared to 1998. The mix of taxable securities reflected a slight decrease in Mortgage-backed Securities. Average Mortgage-backed Securities represented 66.3% of the total securities portfolio for 1999 compared to 69.4% for 1998. The combined Investment Securities, Mortgage-backed Securities, and Marketable Equity Securities portfolio increased to $548.6 million on December 31, 1999, compared to $488.0 million on December 31, 1998, an increase of $60.6 million or 12.4%. Mortgage-backed Securities increased $6.6 million or 1.9% during 1999 when compared to 1998. State and Political Subdivisions increased $8.1 million or 8.9% during 1999. U.S. Treasury securities decreased during 1999 compared to 1998 by $9.7 million or 50.7%, U.S. Government Agency securities increased $42.3 million or 194.8% and Other Stocks and Bonds increased $13.4 million or 86.3% in 1999 compared to 1998 due to increased purchases of corporate bonds and increases in FHLB Dallas equity securities. During 1999 the two to ten year treasury rates increased approximately 170 basis points and the 30 year treasury rate increased 139 basis points. During the first half of 1999, as rates began to increase, the Company sold a portion of its longer term municipal securities and intermediate term mortgage-backed securities and replaced them primarily with premium mortgage-backed collateral pools and agency floaters. As rates continued to increase, the Company purchased additional premium mortgage-backed securities balanced with discount mortgage-backed securities primarily with intermediate term average lives. In the fourth quarter, with rates up significantly, the Company purchased some longer term municipals and U.S. Agency securities balanced with short-term agency securities and premium mortgage-backed securities. 10
12 The market value of the Securities portfolio at December 31, 1999 was $544.7 million, which represented a net unrealized loss on that date of $10.0 million. The net unrealized loss was comprised of $11.2 million in unrealized losses and $1.2 million of unrealized gains. Net unrealized gains and losses on securities available for sale, 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 available for sale securities portfolio using an array of interest rate assumptions. During the year ended December 31, 1999, the Company transferred a total of $132.4 million securities from AFS to HTM due to changes in market conditions and ALCO objectives. Of the total transferred, $66.3 million were investment securities and $66.1 million were mortgage-backed securities. The unrealized loss on the securities transferred from AFS to HTM was $5.6 million, net of tax, at the date of transfer. There were no securities transferred from AFS to HTM during the year ended December 31, 1998. There were no sales from the HTM portfolio during the years ended December 31, 1999 or 1998. The following table sets forth the carrying amount of Investment Securities, Mortgage-backed Securities and Marketable Equity Securities at December 31, 1999 and 1998 (in thousands): <TABLE> <CAPTION> December 31, -------------------------------------------- 1999 1998 ------------------- -------------------- <S> <C> <C> Available for Sale: U.S. Treasury ..................................................... $ 9,467 $ 19,198 U.S. Government Agencies........................................... 21,168 21,377 Mortgage-backed Securities: Direct Govt. Agency Issues...................................... 232,855 229,707 Other Private Issues............................................ 40,821 103,487 State and Political Subdivisions................................... 55,543 90,533 Other Stocks and Bonds............................................. 28,609 15,510 ------------------- -------------------- Total........................................................ $ 388,463 $ 479,812 =================== ==================== </TABLE> <TABLE> <CAPTION> December 31, -------------------------------------------- 1999 1998 ------------------- -------------------- <S> <C> <C> Held to Maturity: U.S. Government Agencies........................................... $ 42,871 $ 347 Mortgage-backed Securities: Direct Govt. Agency Issues...................................... 14,967 7,810 Other Private Issues............................................ 58,931 State and Political Subdivisions................................... 43,048 Other Stocks and Bonds............................................. 289 ------------------- -------------------- Total........................................................ $ 160,106 $ 8,157 =================== ==================== </TABLE> 11
13 The maturities classified according to the sensitivity to changes in interest rates of the December 31, 1999 securities portfolio and the weighted yields are presented below. Tax-exempt obligations are shown on a taxable equivalent basis. Mortgage-backed securities are classified according to repricing frequency and cash flows from street estimates of principal prepayments. <TABLE> <CAPTION> MATURING OR REPRICING ------------------------------------------------------------------------------------- (dollars in thousands) After 1 But After 5 But Within 1 Yr. Within 5 Yrs. Within 10 Yrs After 10 Yrs. ------------------- -------------------- -------------------- -------------------- Available For Sale: Amount Yield Amount Yield Amount Yield Amount Yield ---------- ------- ----------- ------- ----------- ------ ----------- ------- <S> <C> <C> <C> <C> <C> <C> <C> <C> U.S. Treasury........................ $ 8,474 5.54% $ 993 5.24% $ $ U.S. Government Agencies............. 10,244 6.21% 4,965 6.36% 5,959 7.37% Mortgage-backed Securities........... 44,329 7.07% 112,991 7.06% 71,159 6.95% 45,197 6.82% State and Political Subdivisions..... 1,020 8.00% 2,666 8.20% 9,949 7.70% 41,908 7.68% Other Stocks and Bonds............... 19,045 5.01% 3,438 6.46% 6,126 6.12% ---------- ----------- ----------- ----------- Total........................... $ 83,112 6.35% $ 125,053 7.03% $ 87,067 7.06% $ 93,231 7.16% ========== =========== =========== =========== </TABLE> <TABLE> <CAPTION> MATURING OR REPRICING ------------------------------------------------------------------------------------- (dollars in thousands) After 1 But After 5 But Within 1 Yr. Within 5 Yrs. Within 10 Yrs After 10 Yrs. ------------------- -------------------- -------------------- -------------------- Held to Maturity: Amount Yield Amount Yield Amount Yield Amount Yield ---------- ------- ----------- ------- ----------- ------ ----------- ------- <S> <C> <C> <C> <C> <C> <C> <C> <C> U.S. Government Agencies............ $ $ 7,944 6.75% $ 18,009 6.61% $ 16,918 7.53% Mortgage-backed Securities.......... 6,820 6.58% 12,361 6.94% 48,144 6.57% 6,573 6.77% State and Political Subdivisions 450 7.11% 1,415 7.34% 1,400 7.65% 39,783 8.23% Other Stocks and Bonds.............. 289 7.77% ---------- ----------- ----------- ----------- Total............................... $ 7,270 6.61% $ 21,720 6.90% $ 67,553 6.60% $ 63,563 7.89% ========== =========== =========== =========== </TABLE> DEPOSITS AND BORROWED FUNDS Deposits provide the Company with its primary source of funds. The increase of $72.5 million or 14.1% in Total Deposits during 1999 provided the Company with funds for the growth in loans and a portion of the growth in securities. Time Deposits increased $24.0 million or 9.8% during 1999 compared to 1998. Noninterest Bearing Demand Deposits increased $28.2 million or 23% during 1999. Interest Bearing Demand Deposits increased $17.7 million or 13.5% and Saving Deposits increased $2.6 million or 14.9% during 1999. The latter three categories, which are considered the lowest cost deposits, comprised 54.4% of total deposits at December 31, 1999 compared to 52.6% at December 31, 1998. The increase in Total Deposits is reflective of overall bank growth and branch expansion and was the primary source of funding the increase in Loans. The following table sets forth the Company's deposits by category for the years ended December 31, 1999 and 1998: <TABLE> <CAPTION> Years Ended December 31, ------------------------------------------ 1999 1998 ----------------- ------------------ (in thousands) <S> <C> <C> Noninterest Bearing Demand Deposits.................................... $ 150,629 $ 122,440 Interest Bearing Demand Deposits....................................... 148,625 130,940 Savings Deposits....................................................... 20,282 17,649 Time Deposits.......................................................... 268,008 244,005 ----------------- ------------------ Total Deposits................................................. $ 587,544 $ 515,034 ================= ================== </TABLE> During the year ended December 31, 1999, total time deposits of $100,000 or more increased $7.5 million or 8.3% from December 31, 1998. This increase was due to overall bank growth which accounted for an increase of $19.1 million in time certificates of deposit at year ended December 31, 1999, and more than offset the decrease in Public Funds of $11.6 million at December 31, 1999. 12
14 The table below sets forth the maturity distribution of time deposits of $100,000 or more issued by the Company at December 31, 1999 and 1998 (in thousands): <TABLE> <CAPTION> December 31 ,1999 December 31, 1998 ---------------------------------------- ---------------------------------------- Time Other Time Other Certificates Time Certificates Time of Deposit Deposits Total of Deposit Deposits Total ------------- ------------ ------------- ------------ ------------ ------------- <S> <C> <C> <C> <C> <C> <C> Three months or less................ $ 29,146 $ 11,256 $ 40,402 $ 20,201 $ 29,930 $ 50,131 Over three to six months............ 14,345 13,228 27,573 10,201 6,564 16,765 Over six to twelve months........... 11,377 459 11,836 13,560 13,560 Over twelve months.................. 18,536 18,536 10,380 10,380 ------------- ------------ ------------- ------------ ------------ ------------- Total....................... $ 73,404 $ 24,943 $ 98,347 $ 54,342 $ 36,494 $ 90,836 ============= ============ ============= ============ ============ ============= </TABLE> Short-term Obligations, consisting primarily of FHLB Dallas advances and Federal Funds Purchased, increased $62.4 million or 50.4% during 1999 when compared to 1998. This increase reflects a strategically planned increase in balance sheet leverage to achieve certain Asset/Liability Management committee ("ALCO") objectives. Long-term Obligations primarily consisting of FHLB Dallas advances and Junior Subordinated Debentures increased $18.7 million during 1999 to $194.7 million or a 10.6% increase when compared to $176.0 million in 1998. The advances were obtained from FHLB Dallas as part of a strategically planned increase in balance sheet leverage to achieve certain ALCO objectives. FHLB Dallas advances are collateralized by FHLB Dallas stock, nonspecified real estate loans and securities. 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. It has a distribution rate of 8.50% per annum payable at the end of each calendar quarter. THE BANKING INDUSTRY IN TEXAS The banking industry is affected by general economic conditions such as interest rates, inflation, recession, unemployment and other factors beyond the Company's control. During the mid to late 1980's, declining oil prices had an indirect effect on the Company's business, and the deteriorating real estate market caused a significant portion of the increase in the Company's nonperforming assets during that period. During the early 1990's the East Texas economy entered into a recovery and growth period that continues as we enter the year 2000. During the last ten years the East Texas economy has diversified, decreasing the overall impact of declining oil prices, however, the East Texas economy is still affected by the oil industry. One area of concern continues to be the personal bankruptcy rate occurring nationwide and in East Texas. Management expects this trend to have some effect on the Company's net charge-offs. Management of the Company, however, cannot predict whether current economic conditions will improve, remain the same or decline. COMPETITION The activities engaged in by the Company and its subsidiary, Southside Bank, are highly competitive. Financial institutions such as savings and loan associations, credit unions, consumer finance companies, insurance companies, brokerage companies and other financial institutions with varying degrees of regulatory restrictions compete more vigorously for a share of the financial services market. Brokerage companies continue to become more competitive in the financial services arena and pose an ever increasing challenge to banks. Legislative changes also greatly affect the level of competition the Company faces. During 1998 federal legislation allowed credit unions to expand their membership criteria. This allows credit unions to use their expanded membership capabilities combined with tax-free status to compete more fiercely for traditional bank business. Because banks do not enjoy a tax-free status, credit unions will have a competitive advantage. Currently, the Company must compete against some institutions located in East Texas and elsewhere in the Company's service area which have capital resources and legal loan limits substantially in excess of those available to the Company and Southside Bank. The Company expects the competition it faces to continue to increase. 13
15 EMPLOYEES At December 31, 1999, the Company employed approximately 337 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, 1999, were as follows: B. G. Hartley (Age 70), Chairman of the Board of the Company since 1983. He was elected President of the Company in 1982. He also serves as Chairman of the Board and Chief Executive Officer of the Company's subsidiary, Southside Bank, having served in these capacities since the Bank's inception in 1960. Sam Dawson (Age 52), President, Secretary and Director of the Company. President, Chief Operations Officer and Director of the Company's subsidiary, Southside Bank since 1996. He became an officer of the Company in 1982 and of Southside Bank during 1975. Robbie N. Edmonson (Age 67), Vice Chairman of the Board of the Company. He is currently Vice Chairman of the Board and Chief Administrative Officer of the Company's subsidiary, Southside Bank. He joined Southside Bank as a vice president in 1968. Jeryl Story (Age 48), Senior Executive Vice President - Loan Administration, Senior Lending Officer and Director of the Company's subsidiary, Southside Bank, since 1996. He joined Southside Bank in 1979 as an officer in Loan Documentation. Lee R. Gibson (Age 43), Executive Vice President and Chief Financial Officer of the Company and Executive Vice President and Director of the Company's subsidiary, Southside Bank. He became an officer of the Company in 1985 and of Southside Bank during 1984. Titus E. Jones (Age 55), Executive Vice President of the Company's subsidiary, Southside Bank, since 1987. He joined Southside Bank in 1965. Lonny R. Uzzell (Age 46), Executive Vice President of the Company's subsidiary, Southside Bank. He joined Southside Bank in 1981 as an officer in Marketing. H. Andy Wall (Age 59), Executive Vice President of the Company's subsidiary, Southside Bank, since 1984. He joined Southside Bank in 1968 and became an officer in 1969. James F. Deakins (Age 66), Senior Vice President - Loan Review of the Company since 1988. He joined Southside Bank in 1987 as a Vice President in commercial lending. All the individuals named above serve in their capacity as officers of the Company and/or Southside Bank at the pleasure of each entities' Board of Directors. SUPERVISION AND REGULATION Banking is a complex, highly regulated industry. 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 descriptions of and references to the statutes and regulations below are brief summaries and do not purport to be complete. The descriptions are qualified in their entirety by reference to the specific statutes and regulations discussed. 14
16 THE COMPANY As bank holding companies under the Bank Holding Company Act of 1956, as amended (the "BHC Act"), the Company and Southside Delaware are registered with and subject to regulation by the FRB. The Company and Southside Delaware are required to file annual and other reports with, and furnish information to, the FRB, which makes periodic inspections of the Company and Southside Delaware. The BHC Act provides that a bank holding company must obtain the prior approval of the FRB for the acquisition of more than 5% of the voting stock or substantially all the assets of any bank or bank holding company. In addition, the BHC Act restricts the extension of credit to any bank holding company by its subsidiary bank. The BHC Act also provides that, with certain exceptions, a bank holding company may not (i) engage in any activities other than those of banking or managing or controlling banks and other authorized subsidiaries or (ii) own or control more than 5% of the voting shares of any company that is not a bank. The FRB has deemed certain limited activities to be closely related to banking and therefore permissible for a bank holding company to engage in. In approving acquisitions by bank holding companies of banks and companies engaged in banking-related activities, the FRB considers whether the performance of any such activity by an affiliate of the holding company can reasonably be expected to produce benefits to the public, such as greater convenience, increased competition or gains in efficiency, that outweigh such possible adverse effects as undue concentration of resources, decreased or unfair competition, conflicts of interest or unsound banking practices. The FRB 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. 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. Federal banking law generally provides that a bank holding company may acquire or establish banks in any state of the United States, subject to certain aging and deposit concentration limits. In addition, Texas banking laws permit a bank holding company which owns stock of a bank located outside the State of Texas (an "Out-of-State Bank Holding Company") to acquire a bank or bank holding company located in Texas. Such 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, however, 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 FRB has promulgated capital adequacy regulations to which all bank holding companies that have assets in excess of $150 million are subject. The FRB's capital adequacy regulations are based upon a risk based capital determination, whereby a bank holding company's capital adequacy is determined in light of the risk, both on and off-balance sheet, contained in the company's assets. Different categories of assets are assigned risk weightings and, based thereon, are counted at a percentage (from 0% to 100%) 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, noncumulative perpetual preferred stock, related surplus, minority interests in consolidated subsidiaries and a limited amount of qualifying cumulative preferred securities such as the Preferred Securities. Goodwill and certain other intangibles are excluded from Tier 1 capital. Tier 2 capital consists of varying percentages of the reserve for loan losses, all 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. The Tier 1 component must comprise at least 50% of qualifying total capital. The FRB risk-based capital standards contemplate that evaluation of capital adequacy will take account of a wide range of other factors, including overall interest rate exposure; liquidity, funding and market risks; the quality and level of earnings; investment, loan portfolio, and other concentrations of credit; certain risks arising from nontraditional activities; the quality of loans and investments; the effectiveness of loan and investment policies; and management's overall ability to monitor and control financial and operating risks including the risks presented by concentrations of credit and nontraditional activities. In addition, the FRB has established minimum Leverage Ratio (Tier 1 capital to quarterly average total assets) guidelines for bank holding companies and banks. These guidelines provide for a minimum 15
17 Leverage Ratio of 3% for bank holding companies and banks that meet certain specified criteria, including having the highest regulatory rating. All other banking organizations are required to maintain a Leverage Ratio of at least 3% plus an additional cushion of 100 to 200 basis points. 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. Furthermore, the guidelines indicate that the FRB 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, 1999, the FRB had not advised the Company of any specific minimum Tangible Tier 1 Leverage Ratio applicable to it. 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 only significant sources of income are (i) dividends paid by the Bank and (ii) the tax savings, if any, that result from the filing of consolidated income tax returns for the Company, Southside Delaware and the Bank. The Company must pay all of its operating expenses from funds received by it 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. Consistent with its policy regarding bank holding companies serving as a source of financial strength for their subsidiary banks, the FRB has stated that, as a matter of prudent banking, a bank holding company generally should not maintain a rate of cash dividends unless its net income available to common stockholders has been sufficient to fully fund the dividends, and the prospective rate of earnings retention appears consistent with the bank holding company's capital needs, asset quality and overall financial condition. In addition, the Company is subject to certain restrictions on the payment of dividends as a result of the requirement that it maintain an adequate level of capital as described above. The Gramm-Leach-Bliley Act. Traditionally, the activities of bank holding companies have been limited to the business of banking and activities closely related or incidental to banking. The Gramm-Leach-Bliley Act ("Gramm-Leach-Bliley"), enacted on November 12, 1999 with an effective date of March 11, 2000, expands the types of activities in which a bank holding company may engage. Subject to various limitations, Gramm-Leach-Bliley generally permits bank holding companies to elect to become financial holding companies which may affiliate with securities firms and insurance companies and engage in other activities that are financial in nature. Among the activities that will be deemed "financial in nature" are, in addition to traditional lending activities, securities underwriting, dealing in or making a market in securities, sponsoring mutual funds and investment companies, insurance underwriting and agency activities, merchant banking activities, and activities which the FRB considers to be closely related to banking. A bank holding company may become a financial holding company under the new statute if each of its subsidiary banks is well capitalized under the FDICIA 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 FRB that the bank holding company wishes to become a financial holding company. A bank holding company that falls out of compliance with such requirements may be required to cease engaging in certain activities. Any bank holding company that does not elect to become a financial holding company remains subject to the current restrictions of the BHC Act. Under the new legislation, the FRB 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 will generally 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. Gramm-Leach-Bliley also imposes additional restrictions and heightened disclosure requirements regarding private information collected by financial institutions. Implementing regulations under Gramm-Leach-Bliley have not yet been promulgated in final form, and the Company cannot predict the full sweep of the new legislation and has not yet determined whether it will elect to become a financial holding company. 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. Such requirements and restrictions include requirements to maintain reserves against deposits, restrictions 16
18 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. Transactions with Affiliates. With respect to the federal legislation applicable to the Bank, the Federal Reserve Act, as amended by the Competitive Equality Banking Act of 1987, prohibits the Bank from engaging in specified transactions (including, for example, loans) with certain affiliates unless the terms and conditions of such transactions are substantially the same or at least as favorable to the Bank as those prevailing at the time for comparable transactions with or involving other nonaffiliated entities. In the absence of such comparable transactions, any transaction between the Bank and its affiliates must be on terms and under circumstances, including credit standards, that in good faith would be offered or would apply to nonaffiliated companies. In addition, certain transactions, referred to as "covered transactions," between the Bank and its affiliates may not exceed 10% of the Bank's capital and surplus per affiliate and an aggregate of 20% of its capital and surplus for covered transactions with all affiliates. Certain transactions with affiliates, such as loans, also must be secured by collateral of specific types and amounts. Finally, the Bank is prohibited from purchasing low quality assets from an affiliate. Every company under common control with the Bank, including the Company and Southside Delaware, are deemed to be affiliates of the Bank. Loans to Insiders. Federal law also constrains the types and amounts of loans that the Bank may make to its executive officers, directors and principal shareholders. Among other things, such loans must be approved by the Bank's board of directors in advance and must be on terms and conditions as favorable to the Bank as those available to unrelated persons. Regulation of Lending Activities. Loans made by the Bank are also subject to numerous federal and state laws and regulations, including the Truth-In-Lending Act, Federal Consumer Credit Protection Act, 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 and penalties to the Bank are provided for failure of the Bank to comply with such laws and regulations. The scope and requirements of such laws and regulations have expanded significantly in recent years. 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 its market areas. If other banks were to establish branch facilities near the Bank or any of its facilities, it is uncertain whether such branch facilities would have a materially adverse effect on the business of the Bank. The Riegle-Neal Act. In addition, in 1994 Congress adopted the Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 (the "Riegle-Neal Act"). That statute provides for nationwide interstate banking and branching subject to certain aging and deposit covenants. The Riegle-Neal Act authorizes banks to merge across state lines, thereby creating interstate branches. Current Texas law permits interstate branching only through acquisition of a financial institution that is at least 5 years old, and after the acquisition, the resulting institution and its affiliates cannot hold more than 20% of the total deposits in the state. Accordingly, a bank outside the state generally cannot branch on a de novo basis into Texas. The new law permits the TDB to approve de novo branching by state-chartered institutions located in states that would permit Texas institutions to branch on a de novo basis into those states. The statute applies to institutions located in 13 states, but it is possible that, over the next few years, additional states will provide for reciprocity in de novo branching, thereby providing for broader application. The FDIC has adopted regulations under the Riegle-Neal Act to prohibit an out-of-state bank from using the new 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. Governmental Monetary Policies. The commercial banking business is affected not only by general economic conditions but also by the monetary policies of the FRB. 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 FRB. Those monetary policies influence to a significant extent the overall growth of bank loans, investments and deposits and the interest rates charged on loans or paid on time and 17
19 savings deposits. The nature of future monetary policies and the effect of such policies on the future business and earnings of the Bank, therefore, cannot be predicted accurately. 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 of the Company. 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. Additionally, the FDIC has the right to prohibit the payment of dividends by a bank where such 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 and applicable tax rates in effect from year to year. The Bank's ability to pay dividends in the future will directly depend on its future profitability, which cannot be accurately estimated or assured. Capital Adequacy. In 1983, Congress enacted the International Lending Supervision Act, which, among other things, directed the FDIC to establish minimum levels of capital for banks and to require banks to achieve and maintain adequate capital. Pursuant to this authority, the FDIC has promulgated capital adequacy regulations to which all state nonmember banks, such as the Bank, are subject. These requirements are substantially similar to the FRB requirements promulgated with respect to bank holding companies. FIRREA. The Financial Institutions Reform, Recovery and Enforcement Act of 1989 ("FIRREA") includes various provisions that affect or may affect the Bank. Among other matters, FIRREA generally permits bank holding companies to acquire healthy thrifts as well as failed or failing thrifts. FIRREA removed certain cross-marketing prohibitions previously applicable to thrift and bank subsidiaries of a common holding company. Furthermore, a multibank holding company may now be required to indemnify the federal deposit insurance fund against losses it incurs with respect to such company's affiliated banks, which in effect makes a bank holding company's equity investments in healthy bank subsidiaries available to the FDIC to assist such company's failing or failed bank subsidiaries. In addition, pursuant to FIRREA, any depository institution that has been chartered less than two years, is not in compliance with the minimum capital requirements of its primary federal banking regulator or is otherwise in a troubled condition must notify its primary federal banking regulator of the proposed addition of any person to the board of directors or the employment of any person as a senior executive officer of the institution at least 30 days before such addition or employment becomes effective. During such 30-day period, the applicable federal banking regulatory agency may disapprove of the addition or employment of such director or officer. The Bank is not subject to any such requirements. FIRREA also expanded and increased civil and criminal penalties available for use by the appropriate regulatory agency against certain "institution-affiliated parties" primarily including (i) management, employees and agents of a financial institution, as well as (ii) independent contractors such as attorneys and accountants and others who participate in the conduct of the financial institution's affairs and who cause 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. Such practices can include the failure of an institution to timely file required reports or the submission of inaccurate reports. Furthermore, FIRREA authorizes 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, indemnifications 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. FDICIA. The FDIC Improvement Act of 1991 ("FDICIA") made a number of reforms addressing the safety and soundness of the deposit insurance system, supervision of domestic and foreign depository 18
20 institutions, and improvement of accounting standards. This statute also limited deposit insurance coverage, implemented changes in consumer protection laws and provided for least-cost resolution and prompt regulatory action with regard to troubled institutions. FDICIA requires every bank with total assets in excess of $500 million to 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 generally accepted accounting principles and comply with such other disclosure requirements as prescribed by the FDIC. FDICIA also places certain restrictions on activities of banks depending on their level of capital. FDICIA divides banks into five different categories, depending on their level of capital. Under regulations adopted by the FDIC, 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 such 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 such 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 such 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%. A bank may be reclassified to be in a capitalization category that is next below that indicated by its actual capital position (but not to "critically undercapitalized") if it receives a less-than-satisfactory examination rating by its examiners with respect to its asset quality, management, earnings or liquidity that has not been corrected, or it is determined that the bank is in an unsafe or unsound condition or engaged in an unsafe or unsound practice. If a state nonmember bank is classified as undercapitalized, the bank is required to submit a capital restoration plan to the FDIC. Pursuant to FDICIA, 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. Furthermore, 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" or "critically undercapitalized," the FDIC is required to take one or more prompt corrective actions. These actions 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," FDICIA requires the bank to be placed into conservatorship or receivership within 90 days, unless the FDIC determines that other action would better achieve the purposes of FDICIA regarding prompt corrective action with respect to undercapitalized banks. 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. Under FDICIA, the FDIC is required to conduct a full-scope, on-site examination of every bank at least once every twelve months. An exception to this rule provides that banks that (i) have assets of less than $100 million, (ii) are categorized as "well capitalized," (iii) are found to be well managed with a composite rating of "outstanding" and (iv) have not been subject to a change in control during the last twelve months, need only be examined by the FDIC once every eighteen months. Under FDICIA, banks 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. The federal banking agencies have established guidelines, effective August 9, 1995, which prescribe standards for depository institutions relating to internal controls, information systems, internal audit systems, loan documentation, credit underwriting, interest rate exposure, asset growth and management 19
21 compensation. The agencies may require an institution that fails to meet the standards set forth in the guidelines to submit a compliance plan. The agencies are also currently proposing standards for asset quality and earnings. The Company cannot predict what effect such guidelines will have on the Bank. Deposit Insurance. Under the FDIC's risk-based insurance assessment system, each insured bank is placed in one of nine "assessment risk classifications" based on its capital classification and the FDIC's consideration of supervisory evaluations provided by the institution's primary federal regulator. Each insured bank's insurance assessment rate is then determined by the risk category in which it has been classified by the FDIC. There is currently a 27 basis point spread between the highest and lowest assessment rates, so that banks classified as strongest by the FDIC are subject in 2000 to 0% assessment, and banks classified as weakest by the FDIC are subject to an assessment rate of .27%. In addition to its insurance assessment, each insured bank is subject in 2000 to a debt service assessment of $.016 per one hundred dollars of deposits to help recapitalize the Savings Association Insurance Fund of the FDIC. Under these assessment criteria, the Bank is required to pay annual deposit premiums to BIF in the amount of $.016 per hundred dollars of deposits. The Bank's deposit insurance assessments may increase or decrease depending upon the risk assessment classification to which the Bank is assigned by the FDIC. Any increase in insurance assessments could have an adverse effect on the Bank's earnings. Management of the Company and the Bank cannot predict what other legislation or economic and monetary policies of the various regulatory authorities might be enacted or adopted or what other regulations might be adopted or the effects thereof. Future legislation and polices and the effects thereof might have a significant influence on overall growth and distribution of loans, investments and deposits and affect interest rates charged on loans or paid for time and savings deposits. Such legislation and policies have had a significant effect on the operating results of commercial banks in the past and are expected to continue to do so in the future. The foregoing is an attempt to summarize some of the relevant laws, rules and regulations governing banks and bank holding companies but does not purport to be a complete summary of all applicable laws, rules and regulations governing banks and bank holding companies. CAPITAL GUIDELINES Southside Bank is regulated by the TDB and the FDIC. The FDIC requires minimum levels of Tier 1 capital and risk-based capital for FDIC-insured institutions. The FDIC requires a minimum leverage ratio of 3% of adjusted total assets for the highest rated banks. Other banks are required to meet a leverage standard of 4% or more, determined on a case-by-case basis. On December 31, 1999, 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, 1999 were in excess of the minimum requirements. Also see discussion of "Capital Resources" under Item 7. USURY LAWS Texas usury laws limit the rate of interest that may be charged by state banks. Certain Federal laws provide a limited preemption of Texas usury laws. The maximum rate of interest that Southside Bank may charge on direct business loans under Texas law varies between 18% per annum and (i) 28% per annum for business and agricultural loans above $250,000 or (ii) 24% per annum for other direct loans. Texas floating usury ceilings are tied to the 26-week United States Treasury Bill Auction rate. Other ceilings apply to open-end credit card loans and dealer paper purchased by Southside Bank. A Federal statute removes interest ceilings under usury laws for loans by Southside Bank which are secured by first liens on residential real property. 20
22 ECONOMIC ENVIRONMENT The monetary policies of regulatory authorities, including the FRB, have a significant effect on the operating results of bank holding companies and their subsidiaries. The FRB regulates the national supply of bank credit. Among the means available to the FRB are open market operations in United States Government Securities, changes in the discount rate on member bank borrowings, changes in reserve requirements against member and nonmember bank deposits, and loans and limitations on interest rates which member banks may pay on time or demand deposits. These methods are used in varying combinations to influence overall growth and distribution of bank loans, investments and deposits. Their use may affect interest rates charged on loans or paid for deposits. Also see discussion of "Banking Industry in Texas" above. ITEM 2. PROPERTIES Southside Bank owns the following properties: o A two story building in Tyler, Texas, at 1201 South Beckham Avenue and the property adjacent to the main bank building, known as the Southside Bank Annex. These properties house the executive offices of Southside Bancshares, Inc. o Property and a building directly adjacent to the building housing the Southside Bank Annex. The building is referred to as the Operations Annex, where various back office lending and accounts payable operations are located. o Land and building located at 1010 East First Street in Tyler where Motor Bank facilities are located. o 2.21 acres of land located at the intersection of South Broadway Avenue and Grande Boulevard in Tyler. The tract is occupied by Southside Bank's South Broadway branch, which currently provides a full line of banking services. o Property on South Broadway Avenue near the South Broadway branch where Motor Bank facilities are located. o Twenty Automatic Teller Machines (ATM) facilities located throughout Smith and Gregg Counties. o Building located in the downtown square of Tyler which houses Southside Bank's Downtown branch, providing a full line of banking services. o Gentry Parkway branch and Motor Bank facility at 2121 West Gentry Parkway in Tyler. o Property at 2001 Judson Road in Longview, Texas, where the Company will construct a permanent branch facility complete with Motor Bank facilities. The Company completed expansion and remodeling of its annex building, immediately across the parking lot from the bank headquarters during 1999. The Company purchased property in Longview, Texas at 2001 Judson Road during 1998. Construction of a permanent branch facility at this location began during 1999 and is expected to be completed during 2000. The Company began an addition to the operations annex building located on the property of the bank's headquarters during 1999. Completion is anticipated during 2000. The Company has a contingent contract on property in Lindale on Highway 69, north of Interstate 20. The Company plans to build a branch facility with Motor Bank facilities in the near future. 21
23 ITEM 3. LEGAL PROCEEDINGS Southside Bank is party to legal proceedings arising in the normal conduct of business. Management of the Company believes that such litigation is not material to the financial position or results of the operations of the Company or Southside Bank. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS During the three months ended December 31, 1999, there were no meetings, annual or special, of the shareholders of the Company. No matters were submitted to a vote of the shareholders, nor were proxies solicited by management or any other person. PART II ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS MARKET INFORMATION The Company's common stock began trading on the Nasdaq National Market on May 14, 1998 under the symbol "SBSI." Prior to that the Company's common stock was not actively traded on any established public trading market. The high/low prices shown below represent the closing prices on the Nasdaq National Market for the period from May 14, 1998 to December 31, 1999. Prior to May 14, 1998 high/low prices shown below were acquired from shareholders voluntarily advising the transfer agent. Accordingly, the market information is incomplete. However, the per share prices listed below are, to the Company's knowledge, generally representative of transactions for the periods reported. During the third quarter of 1999, 1998 and 1997, the Company declared and paid a 5% stock dividend. Stock prices listed below have been adjusted to give retroactive recognition to stock dividends. <TABLE> <CAPTION> Year Ended 1st qtr. 2nd qtr. 3rd qtr. 4th qtr. - ----------------------- ------------------- ------------------- ------------------ ----------------- <S> <C> <C> <C> <C> December 31, 1999 $ 19.11 - 16.37 $ 17.38 - 16.19 $ 23.54 - 16.80 $ 24.03 - 17.58 December 31, 1998 $ 19.50 - 16.10 $ 26.08 - 19.84 $ 24.50 - 16.19 $ 19.05 - 16.19 </TABLE> See "Item 7. Capital Resources" for a discussion of the Company's common stock repurchase program. STOCKHOLDERS There were approximately 1,103 holders of record of the Company's common stock, the only class of equity securities currently issued and outstanding, as of February 29, 2000. DIVIDENDS Cash dividends declared and paid were $.40 per share for the years ended December 31, 1999, 1998 and 1997. Stock dividends of 5% were also declared and paid during each of the years ended December 31, 1999, 1998 and 1997. 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. 22
24 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, 1999. 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 (in thousands, except per share data). <TABLE> <CAPTION> As of and For the Years Ended December 31, ---------------------------------------------------------------- 1999 1998 1997 1996 1995 ----------- ----------- ----------- ----------- ----------- <S> <C> <C> <C> <C> <C> Investment Securities............................ $ 182,452 $ 132,794 $ 71,835 $ 57,825 $ 76,919 =========== =========== =========== =========== =========== Mortgage-backed and Related Securities........... $ 347,574 $ 341,004 $ 141,413 $ 114,356 $ 99,407 =========== =========== =========== =========== =========== Loans, Net of Reserve for Loan Loss.............. $ 382,871 $ 316,159 $ 292,665 $ 254,918 $ 225,461 =========== =========== =========== =========== =========== Total Assets..................................... $ 1,012,565 $ 876,329 $ 571,189 $ 482,755 $ 448,673 =========== =========== =========== =========== =========== Deposits......................................... $ 587,544 $ 515,034 $ 462,674 $ 425,950 $ 388,308 =========== =========== =========== =========== =========== Long-term Obligations............................ $ 194,704 $ 176,027 $ 28,547 $ 9,096 $ 13,686 =========== =========== =========== =========== =========== Interest & Deposit Service Income................ $ 67,468 $ 49,030 $ 39,168 $ 34,593 $ 32,342 =========== =========== =========== =========== =========== Net Income....................................... $ 7,924 $ 5,351 $ 5,006 $ 4,205 $ 4,532 =========== =========== =========== =========== =========== Net Income Per Common Share-Basic................ $ 2.17 $ 1.44 $ 1.34 $ 1.11 $ 1.21 =========== =========== =========== =========== =========== Net Income Per Common Share-Diluted.............. $ 2.10 $ 1.39 $ 1.30 $ 1.10 $ 1.19 =========== =========== =========== =========== =========== Cash Dividends Declared Per Common Share......... $ .40 $ .40 $ .40 $ .40 $ .35 =========== =========== =========== =========== =========== </TABLE> 23
25 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, 1999, 1998 and 1997 and financial condition as of December 31, 1999 and 1998. 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 dividends. FORWARD-LOOKING INFORMATION Certain statements of other than historical fact that are contained in this document and in written material, press releases and oral statements issued by or on behalf of the Company may be considered to be "forward-looking statements" as that term is defined in the Private Securities Litigation Reform Act of 1995. These statements may include words such as "expect," "estimate," "project," "anticipate," "should," "intend," "probability," "risk," "target," "objective" and similar expressions. Forward-looking statements are subject to significant risks and uncertainties and the Company's actual results may differ materially from the results discussed in the forward-looking statements. For example, certain market risk disclosures are dependent on choices about key model characteristics and assumptions and are subject to various limitations. See "Item 1 - Business" and "Item 7 - Management's Discussion and Analysis of Financial Condition and Results of Operations." By their nature, certain of the market risk disclosures are only estimates and could be materially different from what actually occurs in the future. As a result, actual income gains and losses could materially differ from those that have been estimated. Other factors that could cause actual results to differ materially from forward-looking statements include, but are not limited to general economic conditions, either nationally or in the State of Texas, legislation or regulatory changes which adversely affect the businesses in which the Company is engaged, changes in the interest rate environment which reduce interest margins, significant increases in competition in the banking and financial services industry, changes in consumer spending, borrowing and saving habits, technological changes, the Company's ability to increase market share and control expenses, the effect of compliance with legislation or regulatory changes, the effect of changes in accounting policies and practices and the costs and effects of unanticipated litigation. FINANCIAL CONDITION Total assets increased $136.2 million or 15.5% to $1.0 billion at December 31, 1999 from $876.3 million at December 31, 1998. The increase was primarily attributable to a $66.7 million increase in net loans and a $60.6 million increase in the securities portfolio. The securities portfolio totaled $548.6 million at December 31, 1999 compared to $488.0 million at December 31, 1998. Beginning in the second quarter of 1998 and continuing through the second quarter ended June 30, 1999, the Company leveraged the balance sheet to offset interest expense associated with Trust Preferred Securities issued by the Company during May 1998. The leverage strategy consisted of borrowing long and short-term funds from FHLB Dallas and investing the funds primarily in municipal and mortgage-backed securities. During 1999 the two to ten year treasury rates increased approximately 170 basis points and the 30 year treasury rate increased 139 basis points. During the first half of 1999, as rates began to increase, the Company sold a portion of its longer term municipal securities and intermediate term mortgage-backed securities and replaced them primarily with premium mortgage-backed collateral pools and agency floaters. As rates continued to increase, the Company purchased additional premium mortgage-backed securities balanced with discount mortgage-backed securities primarily with intermediate term average lives. In the fourth quarter, with rates up significantly, the Company purchased some longer term municipals and U.S. Agency securities balanced with short-term agency securities and premium mortgage-backed securities. During the year ended December 31, 1999, the Company transferred a total of $132.4 million securities from AFS to HTM due to changes in market conditions and ALCO objectives. Of the total transferred, $66.3 million were investment securities and $66.1 million were mortgage-backed securities. The unrealized loss on the securities transferred from AFS to HTM was $5.6 million, net of tax, at the date of transfer. There were no securities transferred from AFS to HTM during the year ended December 31, 1998. There were no sales from the HTM portfolio during the years ended December 31, 1999 or 1998. 24
26 At December 31, 1999, net loans were $382.9 million compared to $316.2 million at December 31, 1998. The increase in loans and securities was funded primarily by Federal Home Loan Bank ("FHLB") Dallas advances and retail deposit growth. Nonperforming assets at December 31, 1999 totaled $1.8 million, representing .2% of total assets, compared to $2.0 million or .2% of total assets at December 31, 1998. Nonaccruing loans increased to $.7 million and the ratio of nonaccruing loans to total loans increased to .2% at December 31, 1999 as compared to $.4 million or .1% at December 31, 1998. Real estate owned decreased to $140,000 at December 31, 1999 from $195,000 at December 31, 1998. Deposits increased $72.5 million to $587.5 million at December 31, 1999 from $515.0 million at December 31, 1998. FHLB Dallas advances were $355.9 million at December 31, 1999, an $81.9 million increase from $274.0 million at December 31, 1998. Short-term FHLB Dallas advances increased $63.2 million to $181.2 million at December 31, 1999 from $118.0 million at December 31, 1998. Long-term FHLB Dallas advances increased $18.7 million to $174.7 million at December 31, 1999 from $156.0 million at December 31, 1998. Other borrowings at December 31, 1999 and 1998 totaled $24.8 million and $25.7 million, respectively, and at December 31, 1999 consisted of $4.8 million short-term borrowings and $20.0 million of Long-term Junior Subordinated Debentures. On May 18, 1998, the Company through its wholly-owned subsidiary, Southside Capital Trust (the "Trust Issuer"), sold 2,000,000 Preferred Securities at a liquidation amount of $10 per Preferred Security for an aggregate amount of $20,000,000. It has a distribution rate of 8.50% per annum payable at the end of each calendar quarter. Shareholders' equity at December 31, 1999 totaled $37.7 million compared to $46.4 million at December 31, 1998. The decrease primarily reflects the decrease in the accumulated other comprehensive income of $14.4 million, repurchase of 74,075 shares of the outstanding stock at an average price of $18.70 per share and the declaration of cash dividends partially offset by the net income recorded for the year ended December 31, 1999. 25
27 RESULTS OF OPERATIONS The following table presents average balance sheet amounts and average yields for the years ended December 31, 1999, 1998 and 1997. The information should be reviewed in conjunction with the other financial statements. 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. <TABLE> <CAPTION> AVERAGE BALANCES AND YIELDS (dollars in thousands) Years Ended ------------------------------------------------------------------------------------------- December 31, 1999 December 31, 1998 December 31, 1997 ------------------------------ --------------------------- -------------------------- AVG. AVG. AVG. AVG. AVG. AVG. ASSETS BALANCE INTEREST YIELD BALANCE INTEREST YIELD BALANCE INTEREST YIELD - ------ --------- --------- ---- --------- --------- ---- --------- --------- ---- <S> <C> <C> <C> <C> <C> <C> <C> <C> <C> INTEREST EARNING ASSETS: Loans(1)............................ $ 341,466 $ 28,198 8.26% $ 304,255 $ 26,051 8.56% $ 274,577 $ 23,847 8.68% Securities: Inv. Sec. (Taxable)(3).............. 73,806 4,391 5.95% 22,974 1,316 5.73% 20,294 1,238 6.10% Inv. Sec. (Tax-Exempt)(2)(3)........ 91,084 6,756 7.42% 69,270 5,270 7.61% 38,768 3,049 7.86% Mortgage-backed Sec.(3) ............ 358,258 22,080 6.16% 226,359 12,116 5.35% 120,977 7,729 6.39% Marketable Equity Sec............... 17,180 911 5.30% 7,700 449 5.83% 2,415 129 5.34% Interest Earning Deposits........... 2,936 175 5.96% 962 60 6.24% 602 34 5.65% Federal Funds Sold.................. 4,914 247 5.03% 2,462 137 5.56% 2,285 129 5.65% --------- --------- --------- --------- --------- --------- Total Interest Earning Assets....... 889,644 62,758 7.05% 633,982 45,399 7.16% 459,918 36,155 7.86% --------- --------- --------- NONINTEREST EARNING ASSETS: Cash and Due From Banks............. 29,548 23,754 23,945 Bank Premises and Equipment......... 19,891 17,781 14,693 Other Assets........................ 11,961 13,961 10,518 Less: Reserve for Loan Loss..... (4,040) (3,492) (3,355) --------- --------- --------- Total Assets........................ $ 947,004 $ 685,986 $ 505,719 ========= ========= ========= LIABILITIES AND SHAREHOLDERS' EQUITY: - ------------------------------------- INTEREST BEARING LIABILITIES: Savings Deposits................... $ 19,272 493 2.56% $ 17,280 467 2.70% $ 16,173 446 2.76% Time Deposits...................... 246,110 12,372 5.03% 220,421 11,605 5.26% 206,873 11,000 5.32% Interest Bearing Demand Deposits................. 135,122 3,680 2.72% 125,004 3,413 2.73% 117,496 3,265 2.78% Short-term Interest Bearing Liabilities............. 162,287 8,535 5.26% 66,786 3,513 5.26% 14,222 773 5.44% Long-term Interest Bearing Liabilities-FHLB Dallas......... 175,028 9,236 5.28% 84,836 4,701 5.54% 12,151 721 5.93% Long-term Junior Subordinated Debentures......... 20,000 1,700 8.50% 12,383 1,048 8.50% --------- --------- --------- --------- --------- --------- Total Interest Bearing Liabilities. 757,819 36,016 4.75% 526,710 24,747 4.70% 366,915 16,205 4.42% --------- --------- --------- NONINTEREST BEARING LIABILITIES: Demand Deposits..................... 137,499 105,779 94,005 Other Liabilities................... 9,956 10,417 6,873 --------- --------- --------- Total Liabilities................... 905,274 642,906 467,793 SHAREHOLDERS' EQUITY................ 41,730 43,080 37,926 --------- --------- --------- TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY............... $ 947,004 $ 685,986 $ 505,719 ========= ========= ========= NET INTEREST INCOME................. $ 26,742 $ 20,652 $ 19,950 ========= ========= ========= NET YIELD ON AVERAGE EARNING ASSETS..................... 3.01% 3.26% 4.34% ==== ==== ==== </TABLE> (1) Loans are shown net of unearned discount. Interest on loans includes fees on loans which are not material in amount. (2) Interest income includes taxable-equivalent adjustments of $2,070, $1,722 and $988 as of December 31, 1999, 1998 and 1997, respectively. (3) For the purpose of calculating the average yield, the average balance of securities is presented at historical cost. Note: For the years ended December 31, 1999, 1998 and 1997, loans totaling $703, $432 and $1,344, respectively, were on nonaccrual status. The policy is to reverse previously accrued but unpaid interest on nonaccrual loans; thereafter, interest income is recorded to the extent received when appropriate. 26
28 ANALYSIS OF CHANGES IN INTEREST INCOME AND INTEREST EXPENSE The following tables set forth the dollar amount of increase (decrease) in interest income and interest expense resulting from changes in the volume of interest earning assets and interest bearing liabilities and from changes in yields (in thousands): <TABLE> <CAPTION> Years Ended December 31, 1999 Compared to 1998 ---------------------------------------- Average Average Increase Volume Yield (Decrease) ------------ ----------- ----------- <S> <C> <C> <C> INTEREST INCOME: Loans............................................................... $ 3,098 $ (951) $ 2,147 Investment Securities (Taxable)..................................... 3,022 53 3,075 Investment Securities (Tax-Exempt) (1).............................. 1,621 (135) 1,486 Mortgage-backed Securities.......................................... 8,505 1,459 9,964 Marketable Equity Securities........................................ 499 (37) 462 Federal Funds Sold.................................................. 122 (12) 110 Interest Earning Deposits........................................... 118 (3) 115 ------------ ----------- ----------- Total Interest Income............................................ 16,985 374 17,359 ------------ ----------- ----------- INTEREST EXPENSE: Savings Deposits.................................................... 52 (26) 26 Time Deposits....................................................... 1,253 (486) 767 Interest Bearing Demand Deposits.................................... 276 (9) 267 Federal Funds Purchased and Other Interest Bearing Liabilities..................................... 5,023 (1) 5,022 FHLB Dallas Advances................................................ 4,748 (213) 4,535 Long-term Junior Subordinated Debentures............................ 652 652 ------------ ----------- ----------- Total Interest Expense........................................... 12,004 (735) 11,269 ------------ ----------- ----------- Net Interest Earnings............................................... $ 4,981 $ 1,109 $ 6,090 ============ =========== =========== </TABLE> <TABLE> <CAPTION> Years Ended December 31, 1998 Compared to 1997 ---------------------------------------- Average Average Increase Volume Yield (Decrease) ------------ ----------- ----------- <S> <C> <C> <C> INTEREST INCOME: Loans............................................................... $ 2,545 $ (341) $ 2,204 Investment Securities (Taxable)..................................... 145 (67) 78 Investment Securities (Tax-Exempt) (1).............................. 2,324 (103) 2,221 Mortgage-backed Securities.......................................... 5,812 (1,425) 4,387 Marketable Equity Securities........................................ 307 13 320 Federal Funds Sold.................................................. 10 (2) 8 Interest Earning Deposits........................................... 23 3 26 ------------ ----------- ----------- Total Interest Income............................................ 11,166 (1,922) 9,244 ------------ ----------- ----------- INTEREST EXPENSE: Savings Deposits.................................................... 30 (9) 21 Time Deposits....................................................... 712 (107) 605 Interest Bearing Demand Deposits.................................... 206 (58) 148 Federal Funds Purchased and Other Interest Bearing Liabilities..................................... 2,764 (24) 2,740 FHLB Dallas Advances................................................ 4,024 (44) 3,980 Long-term Junior Subordinated Debentures............................ 1,048 1,048 ------------ ----------- ----------- Total Interest Expense........................................... 8,784 (242) 8,542 ------------ ----------- ----------- Net Interest Earnings............................................... $ 2,382 $ (1,680) $ 702 ============ =========== =========== </TABLE> (1) Interest yields on securities which are nontaxable for Federal Income Tax purposes are presented on a taxable equivalent basis. NOTE: Volume/Yield variances (change in volume times change in yield) have been allocated to amounts attributable to changes in volumes and to changes in yields in proportion to the amounts directly attributable to those changes. 27
29 The Company's results of operations are dependent primarily on net interest income, which is the difference between the income earned on its loan, securities and investment portfolios and its cost of funds, consisting of the interest paid on deposits and borrowings. Results of operations are also affected by the Company's noninterest income, provision for loan losses and noninterest expenses. General economic and competitive conditions, particularly changes in interest rates, 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, 1999 COMPARED TO DECEMBER 31, 1998 OVERVIEW During the year ended December 31, 1999, the Company's net income increased $2.6 million or 48.1% to $7.9 million, from $5.3 million for the same period in 1998. The increase in net income was primarily attributable to an increase in interest income which was partially offset by an increase in noninterest expense and provision for loan losses. The results of operations of the Company are primarily those of the Bank. NET INTEREST INCOME Net interest income is the principal source of a financial institution's earnings stream and represents the difference or spread between interest and fee income generated from interest earning assets and the interest expense paid on deposits and borrowed funds. Fluctuations in interest rates as well as volume and mix changes in interest earning assets and interest bearing liabilities materially impact net interest income. Net interest income increased for the year ended December 31, 1999 $5.7 million or 30.3% compared to the same period in 1998. Beginning during the second quarter of 1998 and continuing into 1999, the Company leveraged the balance sheet to offset the interest expense associated with the Trust Preferred Securities issued. The leverage strategy produced a resulting spread for the leveraged portion of the balance sheet which was significantly less than the Company's previous average. The leverage strategy was fully implemented by the second quarter of 1999. The Company's spread and margin reached its low point during that quarter. Due to the Company's overall balance sheet strategy, which is to replace securities with loan growth and replace FHLB Dallas borrowings with deposits, the spread is expected to increase in future quarters. During the second half of the year ended December 31, 1999, the Company's spread gradually increased. Interest income for the year ended December 31, 1999 increased $17.0 million or 38.9% to $60.7 million compared to the same period in 1998. The increased interest income in 1999 was attributable to the increase in Average Interest Earning Assets during the year which was partially offset by a decrease in the Average Interest rate earned. Average Interest Earning Assets, totaling $889.6 million at December 31, 1999, increased $255.7 million or 40.3% over December 31, 1998 primarily as a result of increases in Average Investment and Mortgage-backed securities, and to a lesser extent, Average Loans. During the year ended December 31, 1999, the mix of the Company's Interest Earning Assets reflected a decrease in Loans compared to the prior year end as Loans averaged 38.4% of Total Average Interest Earning Assets compared to 48.0% during 1998, a direct result of the leverage strategy adopted by the Company. Securities averaged 60.7% of the total and Other Interest Earning Asset categories averaged .9% for December 31, 1999. During 1998 the comparable mix was 51.5% in Securities and .5% in the Other Interest Earning Asset categories. The overall yield on Investment, Mortgage-backed and Marketable Equity securities increased 45 basis points to 6.32% during 1999 compared to the same period in 1998. This was a result of overall higher interest rates, decreased prepayment speeds on premium mortgage-backed securities which lead to decreased amortization expense and an increase for the year ended December 31, 1999 in the average tax-free municipal securities portfolio. The average yield on the Average Interest Earning Assets decreased 11 basis points during the year ended December 31, 1999 as compared to 1998 primarily as a result of the decrease in the average yield on loans and the increase in the overall mix of earning assets with lower yielding securities. The average yield on loans for the year ended December 31, 1999 decreased to 8.26% from 8.56% for the year ended December 31, 1998. This decrease was reflective of the repricing characteristics of the loans and the decrease in lending rates during 1999 due to competitive pressures, the changing mix of the loan portfolio and a lower average prime rate in 1999 compared to 1998. The U.S. prime interest rate decreased 75 basis points during the latter part of 1998 beginning September 28
30 1998. Prime increased 75 basis points during 1999, but did not begin increasing until June 1999, at which time prime increased 25 basis points. The final 25 basis point increase did not occur until November 1999. As a result, the prime rate, which is used as a basis to price numerous loans, was on average lower in 1999 than in 1998. The increase in interest income on Loans of $2.1 million or 8.2% was the result of the increase in Average Loans during 1999 which more than offset the decrease in average yield on loans during 1999. Interest income on securities increased $14.6 million in 1999 or 84.0% compared to 1998 due to the increase in the Average Securities and the increase in the average yield of securities during 1999. The increase in interest expense for the year ended December 31, 1999 of $11.3 million or 45.5% was attributable to an increase in Average Interest Bearing Liabilities of $231.1 million or 43.9% along with the increase in the average rate paid on Interest Bearing Liabilities of 5 basis points. The average rate paid increased due to an average increase in the ratio of the higher interest bearing liabilities during 1999. Average Time Deposits increased $25.7 million or 11.7% while the average rate paid decreased 23 basis points along with an increase in Average Interest Bearing Demand Deposits of $10.1 million or 8.1% and an increase in Average Savings Deposits of $2.0 million or 11.5%. Average Noninterest Bearing Demand Deposits increased during 1999 $31.7 million or 30.0%. The latter three categories, which are considered the lowest cost deposits, comprised 54.3% of total average deposits during the year ended December 31, 1999 compared to 53.0% during 1998 and 52.4% during 1997. The increase in Average Total Deposits is reflective of overall bank growth and branch expansion and was the primary source of funding the increase in Average Loans. Average Long-term and Short-term Interest Bearing Liabilities other than deposits increased $185.7 million or 122.5%, a direct result of the Company's leverage strategy, and contributed to the higher interest expense in 1999 and were the primary source of funding the increase in Average Investment, Mortgage-backed and Marketable Equity securities. The following table sets forth the Company's deposit averages by category for the years ended December 31, 1999, 1998 and 1997: <TABLE> <CAPTION> COMPOSITION OF DEPOSITS (dollars in thousands) Years Ended December 31, ---------------------------------------------------------------- 1999 1998 1997 -------------------- ------------------- -------------------- AVG. AVG. AVG. AVG. AVG. AVG. BALANCE RATE BALANCE RATE BALANCE RATE --------- ----- --------- ---- --------- ----- <S> <C> <C> <C> <C> <C> <C> Noninterest Bearing Demand Deposits.............. $ 137,499 N/A $ 105,779 N/A $ 94,005 N/A Interest Bearing Demand Deposits................. 135,122 2.72% 125,004 2.73% 117,496 2.78% Savings Deposits................................. 19,272 2.56% 17,280 2.70% 16,173 2.76% Time Deposits.................................... 246,110 5.03% 220,421 5.26% 206,873 5.32% --------- --------- --------- Total Deposits.............................. $ 538,003 3.08% $ 468,484 3.31% $ 434,547 3.39% ========= ========= ========= </TABLE> Average Long-term Junior Subordinated Debentures increased $7.6 million or 61.5%, a result of the sale of 2,000,000 Preferred Securities on May 18, 1998 at a liquidation amount of $10 per Preferred Security for an aggregate amount of $20,000,000. It has a distribution rate of 8.50% per annum payable at the end of each calendar quarter. This increase in Average Long-term Junior Subordinated Debentures also contributed to the higher average rate paid in 1999 when compared to 1998. PROVISION FOR LOAN LOSSES The provision for loan losses for December 31, 1999 was $1.5 million compared to $1.2 million for December 31, 1998. For the year ended December 31, 1999, the Company's subsidiary, Southside Bank, had net charge-offs of loans of $.4 million, a decrease of 56.4% compared to December 31, 1998. For the year ended December 31, 1998, net charge-offs on loans were $1.0 million. The decrease in net charge-offs for 1999 is reflective of the overall economy in the Company's primary market area. Net charge-offs for real estate loans, commercial loans and loans to individuals all decreased. As of December 31, 1999, the Company's review of the loan portfolio indicates that a loan loss reserve of $4.6 million is adequate. 29
31 NONINTEREST INCOME Noninterest income is an important source of earnings. The Company intends to maximize noninterest income in the future by looking for new fee income services to provide customers, continuing to review service charge schedules and competitively and profitably pricing those services. The following schedule lists the accounts from which noninterest income was derived, gives totals for these accounts for the year ended December 31, 1999 and the comparable year ended December 31, 1998 and indicates the percentage changes (dollars in thousands): <TABLE> <CAPTION> Years Ended December 31, ----------------------------- Percent 1999 1998 Change ------------- ------------- -------- <S> <C> <C> <C> Deposit services.................................................. $ 6,780 $ 5,353 26.7% Gain on sales of securities available for sale.................... 149 1,260 (88.2%) Trust income...................................................... 631 528 19.5% Other............................................................. 1,672 1,162 43.9% ------------- ------------- Total noninterest income.......................................... $ 9,232 $ 8,303 11.2% ============= ============= </TABLE> Noninterest income consists of revenues generated from a broad range of financial services and activities including fee based services. Total noninterest income for the year ended December 31, 1999 increased 11.2% or $.9 million compared to 1998. Securities gains decreased $1.1 million or 88.2% from 1998. Of the $149,000 in net securities gains from the AFS portfolio in 1999, there were $856,000 in realized gains and $707,000 in realized losses. The Company sold securities out of its AFS portfolio to accomplish Asset Liability Committee (ALCO) and investment portfolio objectives aimed at maximizing the total return of the securities portfolio. Sales of securities available for sale were the result of changes in economic conditions and a change in the mix of the securities portfolio. The increase in deposit services income of $1.4 million or 26.7% was a result of the introduction of a new overdraft privilege program in June 1997 and a new free checking account program introduced during the first quarter of 1999, which increased overdraft fees, increased numbers of deposit accounts and increased deposit activity. Trust income increased $103,000 or 19.5% due to growth in the Trust department. Other noninterest income increased $.5 million or 43.9% primarily as a result of increases in mortgage servicing release fees income of $.3 million and an increase in income from Countywide Finance Company of $.1 million. NONINTEREST EXPENSE The following schedule lists the accounts which comprise noninterest expense, gives totals for these accounts for the year ended December 31, 1999 and the comparable year ended December 31, 1998 and indicates the percentage changes: <TABLE> <CAPTION> Years Ended December 31, ---------------------------- Percent 1999 1998 Change ------------- ------------ --------- (in thousands) <S> <C> <C> <C> Salaries and employee benefits.................................... $ 13,427 $ 11,318 18.6% Net occupancy expense............................................. 2,842 2,370 19.9% Equipment expense................................................. 537 457 17.5% Advertising, travel and entertainment............................. 1,322 1,124 17.6% Supplies.......................................................... 494 461 7.2% Postage........................................................... 419 352 19.0% Other............................................................. 3,483 3,361 3.6% ------------- ------------ Total noninterest expense......................................... $ 22,524 $ 19,443 15.8% ============= ============ </TABLE> Noninterest expense for the year ended December 31, 1999 increased $3.1 million or 15.8% when compared to the year ended December 31, 1998. Salaries and employee benefits increased $2.1 million or 18.6% due to several factors. Direct salary expense and payroll taxes increased $1.6 million or 16.2% as a result of personnel additions to staff the three new branches opened in the second half of 1998, overall bank 30
32 growth and pay increases. Retirement expense increased $.3 million or 41.5% for the year ended December 31, 1999 due to increasing numbers of employees covered by the retirement plan, increased contributions to the Company's ESOP and additional deferred compensation expense incurred during 1999. Health insurance expense increased $.2 million or 27.6% for the year ended December 31, 1999 due to increased health claims expense. Net occupancy expense increased $.5 million or 19.9% for the year ended December 31, 1999 compared to the same period in 1998, largely due to higher real estate taxes, depreciation expense and associated operating costs as a result of the three new branches opened in the second half of 1998. Equipment expense increased $.1 million or 17.5% for the year ended December 31, 1999 when compared to 1998 due to increased equipment usage at the three new branch locations opened in the second half of 1998 and increased equipment costs associated with equipment maintenance. Advertising expense increased $.2 million or 17.6% for the year ended December 31, 1999 compared to the same period in 1998. The increase occurred due to increases in direct advertising during 1999 as a result of the opening of the three new branches in 1998 and new products introduced in 1999. Donations also increased during the year ended December 31, 1999 and are included in this total. Postage expense increased $.1 million or 19.0% for the year ended December 31, 1999 compared to the same period in 1998, largely due to the increased numbers of deposit accounts and increased volume. Other expense increased $.1 million or 3.6% during the year ended December 31, 1999 compared to 1998. The increase was due primarily to ATM fees and telephone expense due to added locations. In addition, bank exam and bank analysis fees increased due to bank asset and transaction growth. Also, costs associated with the Company's junior subordinated debentures increased. INCOME TAXES Income tax expense was $2.0 million for the year ended December 31, 1999 and represented a $.8 million or 63.4% increase from the year ended December 31, 1998. The effective tax rate as a percentage of pre-tax income was 20.2% in 1999, 18.6% in 1998 and 25.2% in 1997. The increase in the effective tax rate and income tax expense for 1999 was primarily a result of higher taxable income. DECEMBER 31, 1998 COMPARED TO DECEMBER 31, 1997 OVERVIEW During the year ended December 31, 1998, the Company's net income increased $.3 million or 6.9% to $5.3 million, from $5.0 million for the same period in 1997. The increase in net income was primarily attributable to an increase in noninterest income which was partially offset by an increase in noninterest expense and provision for loan losses. The results of operations of the Company are primarily those of the Bank. NET INTEREST INCOME Net interest income decreased $32,000 or .2% for the year ended December 31, 1998 compared to the same period in 1997. Interest income for the year ended December 31, 1998 increased $8.5 million or 24.2% to $43.7 million compared to the same period in 1997. The increased interest income in 1998 was attributable to the increase in Average Interest Earning Assets during the year. Average Interest Earning Assets, totaling $634.0 million at December 31, 1998, increased $174.1 million or 37.8% over December 31, 1997 primarily as a result of increases in Average Investment and Mortgage-backed Securities and, to a lesser extent, Average Loans. During the year ended December 31, 1998 the mix of the Company's Interest Earning Assets reflected a decrease in Loans compared to the prior year end as Loans averaged 48.0% of Total Average Interest Earning Assets compared to 59.7% during 1997. Securities averaged 51.5% of the total and Other Interest Earning Asset categories averaged .5% for December 31, 1998. During 1997 the comparable mix was 39.7% in Securities and .6% in the Other Interest Earning Asset categories. The 31
33 average yield on the Average Interest Earning Assets decreased 70 basis points during the year ended December 31, 1998 as compared to 1997 primarily as a result of the decrease in the average yield on securities. The overall yield on Investment and Mortgage-backed securities decreased 79 basis points to 5.87% during 1998 compared to the same period in 1997. This was a result of overall lower interest rates, increased prepayment speeds on premium mortgage-backed securities which lead to increased amortization expense and an increase for the year ended December 31, 1998 in the average tax-free municipal securities portfolio. The increase in interest income on Loans of $2.2 million or 9.2% was the result of the increase in Average Loans during 1998. Interest income on securities increased $6.3 million in 1998 or 56.2% compared to 1997 primarily due to the increase in the Average Securities during 1998. The increase in interest expense for the year ended December 31, 1998 of $8.5 million or 52.7% was attributable to an increase in Average Interest Bearing Liabilities of $159.8 million or 43.6% along with the increase in the average rate paid on Interest Bearing Liabilities of 28 basis points. Average Time Deposits increased $13.5 million or 6.5% while the average rate paid decreased 6 basis points along with an increase in Average Interest Bearing Demand Deposits of $7.5 million or 6.4% and an increase in Average Savings Deposits of $1.1 million or 6.8%. Average Noninterest Bearing Demand Deposits increased during 1998 $11.8 million or 12.5%. The latter three categories, which are considered the lowest cost deposits, comprised 53.0% of total average deposits during the year ended December 31, 1998 compared to 52.4% during 1997 and 52.8% during 1996. The increase in Average Total Deposits is reflective of overall bank growth and branch expansion and was the primary source of funding the increase in Average Loans. Average Long-term and Short-term Interest Bearing Liabilities other than deposits increased $137.6 million or 521.9% which contributed to the higher interest expense in 1998. PROVISION FOR LOAN LOSSES The provision for loan losses for December 31, 1998 and 1997 was $1.2 million and $1.0 million, respectively. For the year ended December 31, 1998, the Company's subsidiary, Southside Bank, had net charge-offs of loans of $1.0 million, an increase of 15.5% compared to December 31, 1997. For the year ended December 31, 1997, net charge-offs on loans were $.9 million. The increase in net charge-offs for 1998 occurred primarily as a result of the increase in loans over the past four years which have grown $118.7 million, $73.3 million of which were real estate loans, and increased bankruptcies which caused the charge-offs for loans to individuals to remain consistent with last year's charge off level. NONINTEREST INCOME Total noninterest income for the year ended December 31, 1998 increased 46.5% or $2.6 million compared to 1997. Securities gains increased $1.0 million or 440.8% from 1997. Of the $1,260,000 in net securities gains from the AFS portfolio in 1998, there were $1,321,000 in realized gains and $61,000 in realized losses. The Company sold securities out of its AFS portfolio to accomplish ALCO and investment portfolio objectives aimed at maximizing the total return of the securities portfolio. The increase in deposit services income of $1.4 million or 33.8% was a result of the introduction of a new overdraft privilege program, increased numbers of deposit accounts and increased deposit activity. Trust income increased $131,000 or 33.0% due to the growth in the Trust Department. Other noninterest income increased $.1 million or 12.3% primarily as a result of increases in mortgage servicing release fees income. NONINTEREST EXPENSE Noninterest expense for the year ended December 31, 1998 increased $2.5 million or 14.9% when compared to the year ended December 31, 1997. Salaries and employee benefits increased $1.4 million or 14.5% due to several factors. Direct salary expense and payroll taxes increased $1.3 million as a result of personnel additions to staff three new branches opened in 1998, overall bank growth and pay increases. Retirement expense decreased $155,000 or 29.5% for the year ended December 31, 1998. Net occupancy expense increased $.3 million or 13.5% for the year ended December 31, 1998 compared to the same period in 1997, largely due to higher real estate taxes, depreciation expense and associated operating costs as a result of three new branches opened in 1998. 32
34 Equipment expense increased $43,000 or 10.4% for the year ended December 31, 1998 when compared to 1997 due to increased equipment usage at three new branch locations opened in 1998 and increased equipment costs associated with equipment maintenance. Advertising expense increased $118,000 or 11.7% for the year ended December 31, 1998 compared to the same period in 1997. The increase occurred due to increases in direct advertising during 1998 as a result of the opening of three new branches in 1998 and new products introduced in 1998. Donations also increased during the year ended December 31, 1998 and are included in this total. Other expense increased $.6 million or 21.8% during the year ended December 31, 1998 compared to 1997. The increase was due primarily to consulting fees paid in relation to the introduction of the overdraft privilege product, increased ATM fees and telephone expense due to added locations. In addition, trust and legal fees increased due to bank asset and transaction growth. INCOME TAXES Income tax expense was $1.2 million for the year ended December 31, 1998 and represented a $.5 million or 27.5% decrease from the year ended December 31, 1997. The decreased income tax expense was primarily a result of lower pre-tax income. MANAGEMENT OF LIQUIDITY Liquidity management involves the ability to convert assets to cash with a minimum of loss. The Company must be capable of meeting its obligations to its customers at any time. This means addressing (1) the immediate cash withdrawal requirements of depositors and other funds providers; (2) the funding requirements of all lines and letters of credit; and (3) the short-term credit needs of customers. Liquidity is provided by short-term investments that can be readily liquidated with a minimum risk of loss. Cash, Interest Earning Deposits, Federal Funds Sold and short-term investments with maturities or repricing characteristics of one year or less continue to be a substantial percentage of total assets. At December 31, 1999, these investments were 13.0% of Total Assets, as compared with 19.2% for December 31, 1998, and 18.7% for December 31, 1997. Liquidity is further provided through the matching, by time period, of rate sensitive interest earning assets with rate sensitive interest bearing liabilities. The Company has three lines of credit for the purchase of federal funds. Two $15.0 million and one $10.0 million unsecured lines of credit have been established with Bank of America, Frost Bank and Texas Independent Bank, respectively. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK The primary objective of monitoring the Company's interest rate sensitivity, or risk, is to provide management the tools necessary to manage the balance sheet to minimize adverse changes in net interest income as a result of changes in the direction and level of interest rates. Federal Reserve Board monetary control efforts, the effects of deregulation and legislative changes have been significant factors affecting the task of managing interest rate sensitivity positions in recent years. Interest rate sensitivity is a function of the repricing characteristics of the Company's portfolio of assets and liabilities. These repricing characteristics are the time frames at which interest earning assets and interest bearing liabilities are subject to changes in interest rates either at repricing or maturity. Sensitivity is measured as the difference between the volume of assets and liabilities in the Company's current portfolio that are subject to repricing in future time periods. The differences are referred to as interest sensitivity gaps and are usually calculated separately for various segments of time and on a cumulative basis. Any excess of assets or liabilities results in an interest sensitivity gap. A positive gap denotes net asset sensitivity and a negative gap represents net liability sensitivity. The table on page 35 shows interest sensitivity gaps for four different intervals as of December 31, 1999. The interest rate risk inherent in assets and liabilities may be determined by analyzing the extent to which such assets and liabilities are "interest rate sensitive" and by measuring an institution's interest rate sensitivity "gap." An asset or liability is said to be interest rate sensitive within a defined time period if it matures or reprices within that period. The difference or mismatch between the amount of interest earning assets maturing or repricing within a defined period and the amount of interest bearing liabilities maturing or repricing within the same period is defined as the interest rate sensitivity gap. An institution is considered to have a negative gap if the amount of interest bearing liabilities maturing or 33
35 repricing within a specified time period exceeds the amount of interest earning assets maturing or repricing within the same period. If more interest earning assets than interest bearing liabilities mature or reprice within a specified period, then the institution is considered to have a positive gap. Accordingly, in a rising interest rate environment in an institution with a negative gap, the cost of its rate sensitive liabilities would theoretically rise at a faster pace than the yield on its rate sensitive assets, thereby diminishing future net interest income. In a falling interest rate environment, a negative gap would indicate that the cost of rate sensitive liabilities would decline at a faster pace than the yield on rate sensitive assets and improve net interest income. For an institution with a positive gap, the reverse would be expected. In an attempt to manage its exposure to changes in interest rates, management closely monitors the Company's exposure to interest rate risk. Management maintains an asset/liability committee which meets regularly and reviews the Company's interest rate risk position and makes recommendations for adjusting this position. In addition, the Board reviews on a monthly basis the Company's asset/liability position. The following table provides information about the Company's financial instruments that are sensitive to changes in interest rates. Except for the effects of prepayments and scheduled principal amortization on mortgage related assets, the table presents principal cash flows and related weighted average interest rates by the contractual term to maturity. Nonaccrual loans are not included in the Loan totals. All instruments are classified as other than trading. <TABLE> <CAPTION> EXPECTED MATURITY DATE (dollars in thousands) Year Ending December 31, ----------------------------------------------------------------------------------------------------- Fair 2000 2001 2002 2003 2004 Thereafter Total Value ---------- ---------- ---------- ---------- ---------- ---------- ---------- ---------- <S> <C> <C> <C> <C> <C> <C> <C> <C> Fixed Rate Loans.......... $ 106,612 $ 58,077 $ 40,006 $ 31,374 $ 25,015 $ 73,316 $ 334,400 $ 323,068 8.52% 8.40% 8.23% 7.95% 7.86% 7.69% 8.18% Adjustable Rate Loans..... 32,854 1,876 4,244 1,453 4,411 7,505 52,343 52,343 9.52% 9.20% 9.60% 9.59% 8.84% 9.44% 9.45% Mortgage-backed Securities................ 46,222 39,185 33,335 28,455 24,377 176,000 347,574 345,553 7.11% 7.08% 7.06% 7.04% 7.01% 6.79% 6.93% Investments and Other Interest Earning Assets... 29,624 9,057 4,803 3,192 4,369 150,585 201,630 199,811 5.31% 6.43% 6.74% 6.61% 7.59% 7.50% 7.10% Total Interest Earning Assets............ $ 215,312 $ 108,195 $ 82,388 $ 64,474 $ 58,172 $ 407,406 $ 935,947 $ 920,775 7.93% 7.77% 7.74% 7.52% 7.56% 7.26% 7.55% Savings Deposits.......... $ 2,704 $ 1,352 $ $ $ $ 16,226 $ 20,282 $ 18,423 2.57% 2.57% 2.57% 2.57% NOW Deposits.............. 9,779 4,890 58,678 73,347 64,661 1.99% 1.99% 1.99% 1.99% Money Market Deposits..... 10,038 5,018 60,222 75,278 73,346 3.38% 3.38% 3.38% 3.38% Certificates of Deposit... 196,307 44,933 16,164 4,301 6,303 268,008 267,765 5.02% 5.66% 5.86% 5.29% 5.46% 5.19% FHLB Dallas Advances...... 182,169 40,864 29,287 36,417 11,409 55,780 355,926 348,392 5.35% 5.02% 5.22% 5.42% 5.34% 5.76% 5.37% Other Borrowings.......... 4,819 20,000 24,819 24,819 4.69% 8.50% 7.76% Total Interest Bearing Liabilities....... $ 405,816 $ 97,057 $ 45,451 $ 40,718 $ 17,712 $ 210,906 $ 817,660 $ 797,406 5.03% 5.04% 5.45% 5.41% 5.38% 4.05% 4.83% </TABLE> 34
36 Residential fixed rate loans are assumed to have annual prepayment rates between 10% and 18% of the portfolio. Commercial and multi-family real estate loans are assumed to prepay at an annualized rate between 6% and 18%. Consumer loans are assumed to prepay at an annualized rate between 6% and 18%. Fixed and adjustable rate mortgage-backed securities, including Collateralized Mortgage Obligations ("CMOs") and Real Estate Mortgage Investment Conduits ("REMICs"), have annual payment assumptions ranging from 10% to 30%. Premium mortgage-backed securities have interest rate risk associated with prepayment of principal. If overall rates trend down, mortgages may prepay faster causing the yield to decline on the premium mortgage-backed securities. If rates increase, mortgages may prepay slower, increasing the yield and average life of premium mortgage-backed securities. The Company assumes 80% of savings accounts, transaction accounts and Money Market accounts at December 31, 1999, are core deposits and are, therefore, expected to roll-off after five years. The remaining savings accounts are assumed to roll-off over the first eighteen months. No roll-off rate is applied to certificates of deposit. Fixed maturity deposits reprice at maturity. In evaluating the Company's exposure to interest rate risk, certain limitations inherent in the method of analysis presented in the foregoing table must be considered. For example, although certain assets and liabilities may have similar maturities or periods to repricing, they may react in different degrees to changes in market interest rates. Also, the interest rates on certain types of assets and liabilities may fluctuate in advance of changes in market interest rates, while interest rates on other types may lag behind changes in market rates. Additionally, certain assets, such as adjustable rate mortgages, have features which restrict changes in interest rates, prepayment and early withdrawal levels may deviate significantly from those assumed in calculating the table. Finally, the ability of many borrowers to service their debt may decrease in the event of an interest rate increase. The Company considers all of these factors in monitoring its exposure to interest rate risk. The following table sets forth certain information as of December 31, 1999 with respect to rate sensitive assets and liabilities and interest sensitivity gap (dollars in thousands): <TABLE> <CAPTION> Rate Sensitive Assets (RSA) 1-3 Mos. 4-12 Mos. 1-5 Yrs. Over 5 Yrs. Total ------------- ----------- ------------ ----------- ------------ <S> <C> <C> <C> <C> <C> Loans(1)................................. $ 88,523 $ 70,432 $ 154,472 $ 73,316 $ 386,743 Securities............................... 46,093 44,289 146,773 311,414 548,569 Other Interest Earning Assets......................... 635 635 ------------- ----------- ------------ ----------- ------------ Total Rate Sensitive Assets.............. $ 135,251 $ 114,721 $ 301,245 $ 384,730 $ 935,947 ============= =========== ============ =========== ============ Rate Sensitive Liabilities (RSL) Interest Bearing Deposits................ $ 85,227 $ 133,601 $ 82,961 $ 135,126 $ 436,915 Other Interest Bearing Liabilities.................... 117,164 69,824 117,977 75,780 380,745 ------------- ----------- ------------ ----------- ------------ Total Rate Sensitive Liabilities......... $ 202,391 $ 203,425 $ 200,938 $ 210,906 $ 817,660 ============= =========== ============ =========== ============ Gap (2).................................. (67,140) (88,704) 100,307 173,824 118,287 Cumulative Gap........................... (67,140) (155,844) (55,537) 118,287 Cumulative Ratio of RSA to RSL................................. .67 .62 .91 1.14 1.14 Gap/Total Earning Assets................. (7.2%) (9.5%) 10.7% 18.6% 12.6% </TABLE> - ------------- (1) Amount is equal to total loans net of unearned discount less nonaccrual loans at December 31, 1999. (2) Gap equals Total RSA minus Total RSL. 35
37 The Asset Liability Management Committee of Southside Bank closely monitors the desired gap along with various liquidity ratios to ensure a satisfactory liquidity position for the Company. Rates have fluctuated several hundred basis points during the last five years. During this time, NOW, MMDA and Savings rates have moved very little. Therefore, when considering rate sensitivity, management does not consider NOW, Savings and MMDA to be one day interest rate sensitive. Management spreads these deposits into several categories from 0 to 10 years for purposes of internal evaluation. As a result of reclassifying these deposits, management considers the Company to be appropriately matched. Management continually evaluates the condition of the economy, the pattern of market interest rates and other economic data to determine the types of investments that should be made and at what maturities. Using this analysis, management from time to time assumes calculated interest sensitivity gap positions to maximize net interest income based upon anticipated movements in the general level of interest rates. Regulatory authorities also monitor the Bank's gap position along with other liquidity ratios. In addition, the Bank utilizes a simulation model to determine the impact of net interest income under several different interest rate scenarios. By utilizing this technology, the Bank can determine changes that need to be made to the asset and liability mixes to minimize the change in net interest income under these various interest rate scenarios. CAPITAL RESOURCES Total Shareholders' Equity at December 31, 1999, of $37.7 million decreased 18.8% or $8.7 million from December 31, 1998 and represented 3.7% of total assets at December 31, 1999 compared to 5.3% at December 31, 1998. The decrease in the percent of Shareholders' Equity to Total Assets is a result of the increase in the unrealized losses in the securities portfolio and the increase in Total Assets. Net income for 1999 of $7.9 million was the major contributor to the increase in Shareholders' Equity at December 31, 1999 along with the issuance of $.5 million in common stock (38,506 shares) through the Company's dividend reinvestment plan and incentive stock option plan. Decreases to Shareholders' Equity consisted of a net increase in unrealized losses of $14.4 million on securities available for sale, $1.4 million in dividends paid and the purchase of $1.4 million in treasury stock (74,075 shares). The Company purchased treasury stock pursuant to a common stock repurchase plan instituted in late 1994. Under the repurchase plan, the Board of Directors establishes, on a quarterly basis, total dollar limitations and price per share for stock to be repurchased. The Board reviews this plan in conjunction with the capital needs of the Company and Southside Bank and may, at its discretion, modify or discontinue the plan. During the third quarter of 1999, the Company issued a 5% stock dividend, which had no net effect on Shareholders' Equity. The Company's dividend policy requires that any cash dividend payments made by the Company not exceed consolidated earnings for that year. Shareholders should not anticipate a continuation of the cash dividend simply because of the implementation of a dividend reinvestment program. The payment of dividends will depend upon future earnings, the financial condition of the Company, and other related factors. The Bank is subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Bank's financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank must meet specific capital guidelines that involve quantitative measures of the Bank's assets, liabilities, and certain off-balance-sheet items as calculated under regulatory accounting practices. The Bank's capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors. Quantitative measures established by regulation to ensure capital adequacy require the Bank to maintain minimum amounts and ratios (set forth in the table below) of Total and Tier 1 capital (as defined in the regulations) to risk-weighted assets (as defined), and of Tier 1 capital (as defined) to average assets (as defined). Management believes, as of December 31, 1999, that the Bank meets all capital adequacy requirements to which it is subject. 36
38 To be categorized as well capitalized, the Bank must maintain minimum Total risk-based, Tier 1 risk-based, and Tier 1 leverage ratios as set forth in the following table: <TABLE> <CAPTION> To Be Well Capitalized Under For Capital Prompt Corrective Actual Adequacy Purposes Action Provisions ----------------------- ---------------------------- ----------------------------- Amount Ratio Amount Ratio Amount Ratio ---------- ------ -------------- ----------- -------------- ------------ <S> <C> <C> <C> <C> <C> <C> As of December 31, 1999: Total Capital (to Risk Weighted Assets)........ $ 70,611 13.96% > or = $40,473 > or = 8.0% > or = $50,592 > or = 10.0% Tier 1 Capital (to Risk Weighted Assets)........ $ 61,782 12.21% > or = $20,237 > or = 4.0% > or = $30,355 > or = 6.0% Tier 1 Capital (to Average Assets) (1).......... $ 61,782 6.20% > or = $39,876 > or = 4.0% > or = $49,845 > or = 5.0% As of December 31, 1998: Total Capital (to Risk Weighted Assets)........ $ 63,962 14.86% > or = $34,435 > or = 8.0% > or = $43,044 > or = 10.0% Tier 1 Capital (to Risk Weighted Assets)........ $ 54,280 12.61% > or = $17,218 > or = 4.0% > or = $25,827 > or = 6.0% Tier 1 Capital (to Average Assets) (1).......... $ 54,280 6.76% > or = $32,108 > or = 4.0% > or = $40,135 > or = 5.0% </TABLE> (1) Refers to quarterly average assets as calculated by bank regulatory agencies. The table below summarizes key equity ratios for the Company for the years ended December 31, 1999, 1998 and 1997. <TABLE> <CAPTION> Years Ended December 31, ----------------------------------- 1999 1998 1997 ------ ------- ------- <S> <C> <C> <C> Percentage of Net Income to: Average Total Assets............................................... .84% .78% .99% Average Shareholders' Equity....................................... 18.99% 12.42% 13.20% Percentage of Dividends Declared Per Common Share to Net Income Per Common Share-Basic......................... 18.43% 27.78% 29.85% Percentage of Dividends Declared Per Common Share to Net Income Per Common Share-Diluted....................... 19.05% 28.78% 30.77% Percentage of Average Shareholders' Equity to Average Total Assets..................................... 4.41% 6.28% 7.50% </TABLE> 37
39 YEAR 2000 (Y2K) ISSUE The Y2K issue concerned the potential impact of historic computer software code that only utilizes two digits to represent the calendar year (e.g. "98" for "1998"). Software so developed, and not corrected, could have produced inaccurate or unpredictable results commencing upon January 1, 2000, when current and future dates present a lower two digit year number than dates in the prior century. The Company, similar to most financial services providers, was significantly subject to the potential impact of the Y2K issue due to the nature of financial information. The Company has passed the primary critical dates and is not aware of any significant Y2K problems affecting the Company or the marketplace. Y2K compliance costs incurred during 1999 and 1998 totaled approximately $395,000, the majority of which was related to hardware and software acquisitions. This figure does not include the implicit costs associated with the reallocation of internal staff hours to Y2K project related efforts. Management currently estimates no additional significant Y2K compliance costs, which are expensed on a current period basis except for fixed asset purchases. OTHER ACCOUNTING ISSUES On June 15, 1998, the Financial Accounting Standards Board (FASB) issued Accounting Standards No. 133, "Accounting for Derivative Instruments and Hedging Activities" (FAS133). FAS133 is effective for all fiscal quarters of all fiscal years beginning after June 15, 2000. FAS133 requires that all derivative instruments be recorded on the balance at their fair value. Changes in the fair value of derivatives are recorded each period in current earnings or other comprehensive income, depending on whether a derivative is designated as part of a hedge transaction and, if it is, the type of hedge transaction. Management of the Company anticipates that the adoption of FAS133 will not have a significant effect on the Company's results of operations or its financial position. EFFECTS OF INFLATION The consolidated financial statements of the Company, and their related notes, have been prepared in accordance with generally accepted accounting principles, that require the measurement of financial position and operating results in terms of historical dollars, without considering the change in the relative purchasing power of money over time and due to inflation. The impact of inflation is reflected in the increased cost of the Company's operations. Unlike many industrial companies, nearly all of the assets and liabilities of the Company are monetary. As a result, interest rates have a greater impact on the Company's performance than do the effects of general levels of inflation. Interest rates do not necessarily move in the same direction or to the same extent as the price of goods and services. 38
40 ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA The information required by this item is set forth in Part IV. ITEM 9. CHANGES AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None. PART III ITEM 10. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS OF THE REGISTRANT Certain of the information required under this item appears beginning on page 2 of the Company's definitive proxy statement for the Annual Meeting of Shareholders to be held April 20, 2000, and is incorporated herein by reference. ITEM 11. EXECUTIVE COMPENSATION The information required under this item appears beginning on page 6 of the Company's definitive proxy statement for the Annual Meeting of Shareholders to be held April 20, 2000, and is incorporated herein by reference. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The information required under this item beginning on page 2 of the Company's definitive proxy statement for the Annual Meeting of Shareholders to be held April 20, 2000, and is incorporated herein by reference. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS The information required under this item beginning on page 11 of the Company's definitive proxy statement for the Annual Meeting of Shareholders to be held April 20, 2000, and is incorporated herein by reference. PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K (a) 1. Financial Statements The following consolidated financial statements of Southside Bancshares, Inc. and its subsidiaries are filed as part of this report. Consolidated Balance Sheets as of December 31, 1999 and 1998. Consolidated Statements of Income for the years ended December 31, 1999, 1998 and 1997. Consolidated Statements of Shareholders' Equity for the years ended December 31, 1999, 1998 and 1997. Consolidated Statements of Cash Flow for the years ended December 31, 1999, 1998 and 1997. Notes to Consolidated Financial Statements. 39
41 2. Financial Statement Schedules All schedules are omitted because they are not applicable or not required, or because the required information is included in the consolidated financial statements or notes thereto. 3. Exhibits Exhibit No. 3 (a)(i) - Articles of Incorporation as amended and in effect on December 31, 1992, of SoBank, Inc. (now named Southside Bancshares, Inc.)(filed as Exhibit 3 to the Registrant's Form 10-K for the year ended December 31, 1992, and incorporated herein). 3 (a)(ii) - Articles of Amendment effective May 9, 1994 to Articles of Incorporation of SoBank, Inc. (now named Southside Bancshares, Inc.) (filed as Exhibit 3(a)(ii) to the Registrant's Form 10-K for the year ended December 31, 1994, and incorporated herein). 3 (b) - Bylaws as amended and in effect on March 23, 1995 of Southside Bancshares, Inc. (filed as Exhibit 3(b) to the Registrant's Form 10-K for the year ended December 31, 1994, and incorporated herein). *, ** 10 (a)(i) - Deferred Compensation Plan for B. G. Hartley effective February 13, 1984, as amended June 28, 1990, December 15, 1994, November 20, 1995 and December 21, 1999 (filed as Exhibit 10(a)(i) to the Registrant's Form 10-K for the year ended December 31, 1999, and filed herewith). ** 10 (a)(ii) - Deferred Compensation Plan for Robbie N. Edmonson effective February 13, 1984, as amended June 28, 1990 and March 16, 1995 (filed as Exhibit 10(a)(ii) to the Registrant's Form 10-K for the year ended December 31, 1995, and incorporated herein). ** 10 (b) - Officers Long-term Disability Income Plan effective June 25, 1990 (filed as Exhibit 10(b) to the Registrant's Form 10-K for the year ended June 30, 1990, and incorporated herein). ** 10 (c) - Retirement Plan Restoration Plan for the subsidiaries of SoBank, Inc. (now named Southside Bancshares, Inc.)(filed as Exhibit 10(c) to the Registrant's Form 10-K for the year ended December 31, 1992, and incorporated herein). ** 10 (d) - Incentive Stock Option Plan effective April 1, 1993 of SoBank, Inc. (now named Southside Bancshares, Inc.) (filed as Exhibit 10(d) to the Registrant's Form 10-K for the year ended December 31, 1994, and incorporated herein). ** 10 (e) - Form of Deferred Compensation Agreements dated June 30, 1994 with each of Titus Jones and Andy Wall as amended November 13, 1995. (filed as Exhibit 10(e) to the Registrant's Form 10-K for the year ended December 31, 1995, and incorporated herein). 40
42 ** 10 (f) - Form of Deferred Compensation Agreements dated June 30, 1994 with each of Sam Dawson, Lee Gibson and Jeryl Story as amended October 15, 1997 and Form of Deferred Compensation Agreement dated October 15, 1997 with Lonny Uzzell. * 21 - Subsidiaries of the Registrant. * 23 - Consent of Independent Accountants. * 27 - Financial Data Schedule for the year ended December 31, 1999. ------------------------ * Filed herewith. ** Compensation plan, benefit plan or employment contract or arrangement. (b) Reports on Form 8-K Registrant did not file any Form 8-K's during the three months ended December 31, 1999. 41
43 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. SOUTHSIDE BANCSHARES, INC. BY: /s/ B. G. HARTLEY ----------------------------------- B. G. Hartley, Chairman of the Board and Director (Principal Executive Officer) /s/ LEE R. GIBSON ----------------------------------- Lee R. Gibson, CPA, Executive Vice President (Principal Financial and Accounting Officer) DATED: March 9, 2000 Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the date indicated. <TABLE> <CAPTION> Signature Title Date --------- ----- ---- <S> <C> <C> /s/ B. G. HARTLEY Chairman of the Board March 9, 2000 - ------------------------------------- and Director (B. G. Hartley) /s/ ROBBIE N. EDMONSON Vice Chairman of the Board March 9, 2000 - ------------------------------------- and Director (Robbie N. Edmonson) /s/ SAM DAWSON President and Secretary March 9, 2000 - ------------------------------------- and Director (Sam Dawson) /s/ FRED E. BOSWORTH Director March 9, 2000 - ------------------------------------- (Fred E. Bosworth) /s/ HERBERT C. BUIE Director March 9, 2000 - ------------------------------------- (Herbert C. Buie) /s/ ROLLINS CALDWELL Director March 9, 2000 - ------------------------------------- (Rollins Caldwell) /s/ MICHAEL D. GOLLOB Director March 9, 2000 - ------------------------------------- (Michael D. Gollob) /s/ W. D. (JOE) NORTON Director March 9, 2000 - ------------------------------------- (W. D. (Joe) Norton) /s/ PAUL W. POWELL Director March 9, 2000 - ------------------------------------- (Paul W. Powell) /s/ WILLIAM SHEEHY Director March 9, 2000 - ------------------------------------- (William Sheehy) </TABLE> 42
44 Report of Independent Accountants To the Shareholders and Board of Directors Southside Bancshares, Inc. In our opinion, the accompanying consolidated balance sheets and the related consolidated statements of income, shareholders' equity and cash flow present fairly, in all material respects, the financial position of Southside Bancshares, Inc. and its subsidiaries at December 31, 1999 and 1998, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1999, in conformity with accounting principles generally accepted in the United States. These financial statements are the responsibility of the Company's management; our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these statements in accordance with auditing standards generally accepted in the United States which require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for the opinion expressed above. /s/ PRICEWATERHOUSECOOPERS LLP PricewaterhouseCoopers LLP Dallas, Texas February 25, 2000 43
45 SOUTHSIDE BANCSHARES, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (in thousands, except share amounts) <TABLE> <CAPTION> December 31, December 31, 1999 1998 -------------- ------------- <S> <C> <C> ASSETS Cash and due from banks........................................................... $ 41,131 $ 41,372 Investment securities: Available for sale............................................................. 96,244 132,447 Held to maturity............................................................... 86,208 347 -------------- ------------- Total Investment securities.................................................. 182,452 132,794 Mortgage-backed and related securities: Available for sale............................................................. 273,676 333,194 Held to maturity............................................................... 73,898 7,810 -------------- ------------- Total Mortgage-backed securities and related securities...................... 347,574 341,004 Marketable equity securities: Available for sale............................................................. 18,543 14,171 Loans: Loans, net of unearned discount................................................ 387,446 319,723 Less: reserve for loan losses.................................................. (4,575) (3,564) -------------- ------------- Net Loans.................................................................... 382,871 316,159 Premises and equipment, net....................................................... 21,306 19,166 Other real estate owned, net...................................................... 140 195 Interest receivable............................................................... 7,563 6,065 Deferred tax asset................................................................ 6,244 Other assets...................................................................... 4,741 5,403 -------------- ------------- TOTAL ASSETS................................................................. $ 1,012,565 $ 876,329 ============== ============= LIABILITIES AND SHAREHOLDERS' EQUITY Deposits: Noninterest bearing............................................................ $ 150,629 $ 122,440 Interest bearing............................................................... 436,915 392,594 -------------- ------------- Total Deposits............................................................... 587,544 515,034 Short-term obligations: Federal funds purchased........................................................ 75 4,168 FHLB Dallas Advances........................................................... 181,222 118,000 Other obligations.............................................................. 4,744 1,523 -------------- ------------- Total Short-term obligations................................................. 186,041 123,691 Long-term obligations: FHLB Dallas Advances........................................................... 174,704 156,027 Guaranteed Preferred Beneficial Interest in the Company's Junior Subordinated Debentures................................................. 20,000 20,000 -------------- ------------- Total Long-term obligations.................................................. 194,704 176,027 Deferred tax liability............................................................ 1,184 Other liabilities................................................................. 6,604 13,980 -------------- ------------- TOTAL LIABILITIES............................................................ 974,893 829,916 -------------- ------------- Commitments and Contingencies (Note 14 and 15) Shareholders' equity: Common stock: ($2.50 par, 6,000,000 shares authorized, 3,899,166 and 3,685,775 shares issued)...................................... 9,748 9,214 Paid-in capital................................................................ 27,472 24,198 Retained earnings.............................................................. 14,583 11,391 Treasury stock (256,251 and 182,176 shares at cost)............................ (4,544) (3,158) Accumulated other comprehensive (loss) income.................................. (9,587) 4,768 -------------- ------------- TOTAL SHAREHOLDERS' EQUITY.................................................. 37,672 46,413 -------------- ------------- TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY.................................. $ 1,012,565 $ 876,329 ============== ============= </TABLE> The accompanying notes are an integral part of these consolidated financial statements. 44
46 SOUTHSIDE BANCSHARES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME (in thousands, except per share data) <TABLE> <CAPTION> Years Ended December 31, ------------------------------------- 1999 1998 1997 ----------- ----------- ---------- <S> <C> <C> <C> Interest income Loans..................................................................... $ 28,198 $ 26,051 $ 23,847 Investment securities..................................................... 9,077 4,864 3,299 Mortgage-backed and related securities.................................... 22,080 12,116 7,729 Marketable equity securities.............................................. 911 449 129 Other interest earning assets............................................. 422 197 163 ----------- ----------- ---------- Total interest income............................................... 60,688 43,677 35,167 ----------- ----------- ---------- Interest expense Deposits.................................................................. 16,545 15,485 14,711 Short-term obligations.................................................... 8,535 3,513 773 Long-term obligations..................................................... 10,936 5,749 721 ------------ ----------- ---------- Total interest expense.............................................. 36,016 24,747 16,205 ----------- ----------- ---------- Net interest income.......................................................... 24,672 18,930 18,962 Provision for loan losses.................................................... 1,456 1,215 1,005 ----------- ----------- ---------- Net interest income after provision for loan losses.......................... 23,216 17,715 17,957 ----------- ----------- ---------- Noninterest income Deposit services.......................................................... 6,780 5,353 4,001 Gain on sales of securities available for sale............................ 149 1,260 233 Trust income.............................................................. 631 528 397 Other..................................................................... 1,672 1,162 1,035 ----------- ----------- ---------- Total noninterest income............................................ 9,232 8,303 5,666 ----------- ----------- ---------- Noninterest expense Salaries and employee benefits............................................ 13,427 11,318 9,889 Net occupancy expense..................................................... 2,842 2,370 2,089 Equipment expense......................................................... 537 457 414 Advertising, travel & entertainment....................................... 1,322 1,124 1,006 Supplies.................................................................. 494 461 440 Postage................................................................... 419 352 331 Other..................................................................... 3,483 3,361 2,759 ----------- ----------- ---------- Total noninterest expense........................................... 22,524 19,443 16,928 ----------- ----------- ---------- Income before federal tax expense............................................ 9,924 6,575 6,695 ----------- ----------- ---------- Provision (benefit) for federal tax expense Current................................................................... 2,033 1,496 1,914 Deferred.................................................................. (33) (272) (225) ----------- ----------- ---------- Total income taxes.................................................. 2,000 1,224 1,689 ----------- ----------- ---------- Net Income................................................................... $ 7,924 $ 5,351 $ 5,006 =========== =========== ========== Net Income Per Common Share Basic..................................................................... $ 2.17 $ 1.44 $ 1.34 Diluted................................................................... $ 2.10 $ 1.39 $ 1.30 </TABLE> The accompanying notes are an integral part of these consolidated financial statements. 45
47 SOUTHSIDE BANCSHARES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY (in thousands, except share amounts) <TABLE> <CAPTION> Accumulated Other Compre- Compre- Total hensive hensive Share- Income Common Paid in Retained Treasury Income holders' (Loss) Stock Capital Earnings Stock (Loss) Equity --------- -------- --------- --------- ---------- ---------- ---------- <S> <C> <C> <C> <C> <C> <C> <C> Balance at December 31, 1998................ $ $ 9,214 $ 24,198 $ 11,391 $ (3,158) $ 4,768 $ 46,413 Net Income.................................. 7,924 7,924 7,924 Other comprehensive loss, net of tax Unrealized losses on securities, net of reclassification adjustment (see disclosure below)........................ (14,352) (14,352) (14,352) Minimum pension liability adjustment........ (3) (3) (3) --------- Comprehensive loss.......................... $ (6,431) ========= Common stock issued (38,506 shares)......... 96 360 456 FAS109 - Incentive Stock Options (ISO's).... 29 29 Dividends paid on common stock.............. (1,409) (1,409) Purchase of 74,075 shares of treasury stock........................... (1,386) (1,386) Stock dividend.............................. 438 2,885 (3,323) -------- --------- --------- ---------- ---------- ---------- Balance at December 31, 1999................ $ 9,748 $ 27,472 $ 14,583 $ (4,544) $ (9,587) $ 37,672 ========= =========- ========== ========= ========= ========= Disclosure of reclassification amount: Unrealized holding losses arising during period................................... $ (14,254) Less: reclassification adjustment for gains included in net income............. 98 --------- Net unrealized losses on securities......... $ (14,352) ========= Balance at December 31, 1997................ $ $ 8,740 $ 21,290 $ 10,414 $ (1,820) $ 1,322 $ 39,946 Net Income.................................. 5,351 5,351 5,351 Other comprehensive income, net of tax Unrealized gains on securities, net of reclassification adjustment (see disclosure below)........................ 3,396 3,396 3,396 Minimum pension liability adjustment........ 50 50 50 --------- Comprehensive income........................ $ 8,797 ========= Common stock issued (21,160 shares)......... 53 294 347 FAS109 - Incentive Stock Options (ISO's).... 42 42 Dividends paid on common stock.............. (1,359) (1,359) Purchase of 71,426 shares of treasury stock........................... (1,398) (1,398) Exercise of 6,000 shares of ISO's........... (22) 60 38 Stock dividend.............................. 421 2,572 (2,993) -------- --------- --------- ---------- ---------- ---------- Balance at December 31, 1998................ $ 9,214 $ 24,198 $ 11,391 $ (3,158) $ 4,768 $ 46,413 ========= =========- ========== ========= ========= ========= Disclosure of reclassification amount: Unrealized holding gains arising during period................................... $ 4,228 Less: reclassification adjustment for gains included in net income............. 832 --------- Net unrealized gains on securities.......... $ 3,396 ========= </TABLE> (continued) 46
48 SOUTHSIDE BANCSHARES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY (continued) (in thousands, except share amounts) <TABLE> <CAPTION> Accumulated Other Compre- Compre- Total hensive hensive Share- Income Common Paid in Retained Treasury Income holders' (Loss) Stock Capital Earnings Stock (Loss) Equity --------- -------- --------- --------- ---------- ---------- ---------- <S> <C> <C> <C> <C> <C> <C> <C> Balance at December 31, 1996................ $ $ 8,290 $ 18,501 $ 9,628 $ (777) $ 842 $ 36,484 Net Income.................................. 5,006 5,006 5,006 Other comprehensive income, net of tax Unrealized gains on securities, net of reclassification adjustment (see disclosure below)........................ 445 445 445 Minimum pension liability adjustment........ 35 35 35 --------- Comprehensive income........................ $ 5,486 ========= Common stock issued (18,430 shares)......... 46 280 326 FAS109 - Incentive Stock Options (ISO's).... 43 43 Dividends paid on common stock.............. (1,316) (1,316) Purchase of 65,464 shares of treasury stock........................... (1,154) (1,154) Exercise of 11,700 shares of ISO's.......... (34) 111 77 Stock dividend.............................. 404 2,466 (2,870) -------- --------- --------- ---------- ---------- ---------- Balance at December 31, 1997................ $ 8,740 $ 21,290 $ 10,414 $ (1,820) $ 1,322 $ 39,946 ========= ========== ========== ========= ========= ========= Disclosure of reclassification amount: Unrealized holding gains arising during period................................... $ 599 Less: reclassification adjustment for gains included in net income............. 154 --------- Net unrealized gains on securities.......... $ 445 ========= </TABLE> The accompanying notes are an integral part of these consolidated financial statements. 47
49 SOUTHSIDE BANCSHARES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOW (in thousands) <TABLE> <CAPTION> Years Ended December 31, ------------------------------------- 1999 1998 1997 ----------- ----------- ---------- <S> <C> <C> <C> OPERATING ACTIVITIES: Net income................................................................... $ 7,924 $ 5,351 $ 5,006 Adjustments to reconcile net cash provided by operations: Depreciation .............................................................. 1,474 1,397 1,215 Amortization of premium.................................................... 4,657 5,229 1,589 Accretion of discount and loan fees........................................ (1,774) (660) (780) Provision for loan losses.................................................. 1,456 1,215 1,005 FAS109-Incentive stock options............................................. 29 42 43 Gain on sale of securities available for sale.............................. (149) (1,260) (233) Gain on sale of assets..................................................... (86) (51) (12) Gain on sale of other real estate owned.................................... (129) (32) Increase in interest receivable............................................ (1,498) (2,147) (618) Decrease (increase) in other assets........................................ 331 (2,270) 923 Increase in deferred tax asset............................................. (33) (87) (225) Increase in interest payable............................................... 702 558 598 (Decrease) increase in other payables...................................... (4,862) 7,883 167 ----------- ----------- ---------- Net cash provided by operating activities.............................. 8,042 15,168 8,678 INVESTING ACTIVITIES: Proceeds from sale of investment securities available for sale............. 81,700 62,413 31,037 Proceeds from sale of mortgage-backed securities available for sale........ 111,969 46,515 37,247 Proceeds from maturities of investment securities available for sale....... 26,093 10,322 16,366 Proceeds from maturities of mortgage-backed securities available for sale.. 89,702 79,121 33,389 Proceeds from maturities of investment securities held to maturity......... 3,347 457 936 Proceeds from maturities of mortgage-backed securities held to maturity.... 2,357 5,899 10,214 Purchases of investment securities available for sale...................... (149,299) (130,138) (61,370) Purchases of mortgage-backed securities available for sale................. (222,610) (333,304) (108,788) Purchases of investment securities held to maturity........................ (21,708) Purchases of mortgage-backed securities held to maturity................... (2,258) Purchases of marketable equity securities available for sale............... (4,372) (10,913) (1,038) Net increase in loans...................................................... (69,299) (26,521) (39,900) Purchases of premises and equipment........................................ (4,200) (3,096) (5,153) Proceeds from sale of premises and equipment............................... 672 212 17 Proceeds from sale of repossessed assets................................... 1,290 1,617 1,015 Proceeds from sale of other real estate owned.............................. 356 275 98 ----------- ----------- ---------- Net cash used in investing activities.................................. (156,260) (297,141) (85,930) </TABLE> (continued) 48
50 SOUTHSIDE BANCSHARES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOW (continued) (in thousands) <TABLE> <CAPTION> Years Ended December 31, ------------------------------------- 1999 1998 1997 ----------- ----------- ---------- <S> <C> <C> <C> FINANCING ACTIVITIES: Net increase in demand and savings accounts................................ $ 47,765 $ 41,944 $ 24,443 Net increase in certificates of deposit.................................... 24,745 10,416 12,281 Proceeds from FHLB advances................................................ 258,100 404,800 58,900 Repayment of FHLB advances................................................. (176,201) (188,320) (10,449) Issuance of guaranteed preferred beneficial interest in the company's junior subordinated debentures......................... 20,000 Net (decrease) increase in federal funds purchased......................... (4,093) 284 (916) Proceeds from the issuance of common stock................................. 456 347 326 Purchase of treasury stock................................................. (1,386) (1,398) (1,154) Sale of treasury stock..................................................... 38 77 Dividends paid............................................................. (1,409) (1,359) (1,316) ----------- ----------- ---------- Net cash provided by financing activities............................ 147,977 286,752 82,192 ----------- ----------- ---------- Net (decrease) increase in cash and cash equivalents....................... (241) 4,779 4,940 Cash and cash equivalents at beginning of year............................. 41,372 36,593 31,653 ----------- ----------- ---------- Cash and cash equivalents at end of year................................... $ 41,131 $ 41,372 $ 36,593 =========== =========== ========== SUPPLEMENTAL DISCLOSURE FOR CASH FLOW INFORMATION: Interest paid.............................................................. $ 35,315 $ 24,189 $ 15,701 Income taxes paid.......................................................... $ 1,725 $ 1,763 $ 1,990 SUPPLEMENTAL DISCLOSURES OF NONCASH INVESTING AND FINANCING ACTIVITIES: Acquisition of other real estate owned and other repossessed assets through foreclosure............................................. $ 1,131 $ 1,812 $ 1,148 </TABLE> The accompanying notes are an integral part of these consolidated financial statements. 49
51 NOTES TO FINANCIAL STATEMENTS Southside Bancshares, Inc. and Subsidiaries 1. SUMMARY OF SIGNIFICANT ACCOUNTING AND REPORTING POLICIES The significant accounting and reporting policies of Southside Bancshares, Inc. (the "Company"), and its wholly owned subsidiaries, Southside Delaware Financial Corporation, Southside Bank (the "Bank") and the nonbank subsidiary, are summarized below. Organization and Basis of Presentation. The consolidated financial statements include the accounts of the Company, Southside Delaware Financial Corporation, Southside Bank and the nonbank subsidiary, which did not conduct any business in 1999. Southside Bank offers a full range of financial services to commercial, industrial, financial and individual customers. All significant intercompany accounts and transactions are eliminated in consolidation. The preparation of these consolidated financial statements in conformity with generally accepted accounting principles requires the use of management's estimates. These estimates are subjective in nature and involve matters of judgment. Actual amounts could differ from these estimates. Cash Equivalents. Cash equivalents, for purposes of reporting cash flow, include cash and amounts due from banks. Loans. All loans are stated at principal outstanding net of unearned income. Interest income on installment loans is recognized primarily using the level yield method. Interest income on other loans is credited to income based primarily on the principal outstanding at contract rates of interest. Loans receivable that management has the intent and ability to hold for the foreseeable future or until maturity or pay-off are reported at their outstanding principal adjusted for any charge-offs, the reserve for loan losses, and any deferred fees or costs on originated loans and unamortized premiums or discounts on purchased loans. A loan is considered impaired, based on current information and events, if it is probable that the Company will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Substantially all of the Company's impaired loans are collateral-dependent, and as such, are measured for impairment based on the fair value of the collateral. Loan Fees. The Company treats loan fees, net of direct costs, as an adjustment to the yield of the related loan over its term. Reserve for Loan Losses. A reserve for loan losses is provided through charges to income in the form of a provision for loan losses. Loans which management believes are uncollectible are charged against this account with subsequent recoveries, if any, credited to the account. The amount of the reserve for loan losses is determined by management's evaluation of the quality and inherent risks in the loan portfolio, economic conditions and other factors which warrant current recognition. Nonaccrual Loans. A loan is placed on nonaccrual when principal or interest is contractually past due 90 days or more unless, in the determination of management, the principal and interest on the loan are well collateralized and in the process of collection. In addition, a loan is placed on nonaccrual when, in the opinion of management, the future collectibility of interest and principal is in serious doubt. When classified as nonaccrual, accrued interest receivable on the loan is reversed and the future accrual of interest is suspended. Payments of contractual interest are recognized as income only to the extent that full recovery of the principal balance of the loan is reasonably certain. Other Real Estate Owned. Other Real Estate Owned includes real estate acquired in full or partial settlement of loan obligations. Other Real Estate Owned is carried at the lower of (1) the recorded amount of the loan for which the foreclosed property previously served as collateral or (2) the fair market value of the property. Prior to foreclosure, the recorded amount of the loan is written down, if necessary, to the appraised fair market value of the real estate to be acquired, less selling costs, by charging the reserve for loan losses. Any subsequent reduction in fair market value is charged to results of operations through the Reserve for Losses on Other Real Estate account. Costs of maintaining and operating foreclosed properties are expensed as incurred. Expenditures to complete or improve foreclosed properties are capitalized only if expected to be recovered; otherwise, they are expensed. 50
52 Securities. The Company uses the specific identification method to determine the basis for computing realized gain or loss. The Company accounts for debt and equity securities as follows: Held to Maturity (HTM). Debt securities that management has the positive intent and ability to hold until maturity are classified as held to maturity 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 available for sale. These assets are carried at market value. Market value is determined using published quotes as of the close of business. Unrealized gains and losses are excluded from earnings and reported net of tax in Accumulated Other Comprehensive Income until realized. Premises and Equipment. Bank premises and equipment are stated at cost, net of accumulated depreciation. Depreciation is computed on a straight line basis over the estimated useful lives of the related assets. Useful lives are estimated to be twenty to forty years for premises and three to ten years for equipment. Maintenance and repairs are charged to income as incurred while major improvements and replacements are capitalized. Income Taxes. The Company files a consolidated Federal income tax return. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of changes in tax rates is recognized in income in the period the change occurs. Stock Options. The Financial Accounting Standards Board (FASB) published Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based Compensation" (FAS123) on January 1, 1996 which encourages, but does not require, companies to recognize compensation expense for grants of stock, stock options and other equity instruments to employees based on new fair value accounting rules. Companies that choose not to adopt the new rules will continue to apply existing rules, but will be required to disclose pro forma net income and earnings per share under the new method. The Company elected to provide the pro forma disclosures for 1997, 1998 and 1999. Recent Accounting Pronouncements. On June 15, 1998, the FASB issued Statement of Financial Accounting Standards No. 133, "Accounting for Derivative Instruments and Hedging Activities" (FAS133). FAS133 is effective for all fiscal quarters of all fiscal years beginning after June 15, 2000. FAS133 requires that all derivative instruments be recorded on the balance at their fair value. Changes in the fair value of derivatives are recorded each period in current earnings or other comprehensive income, depending on whether a derivative is designated as part of a hedge transaction and, if it is, the type of hedge transaction. Management of the Company anticipates that the adoption of FAS133 will not have a significant effect on the Company's results of operations or its financial position. General. Certain prior period amounts have been reclassified to conform to current year presentation. 51
53 2. EARNINGS PER SHARE Earnings per share on a basic and diluted basis as required by Statement of Financial Accounting Standards No. 128, "Earnings Per Share" (FAS128), has been adjusted to give retroactive recognition to stock dividends and is calculated as follows (in thousands, except per share amounts): <TABLE> <CAPTION> Years Ended December 31, ------------------------------------------ 1999 1998 1997 ------------- ------------- ------------- <S> <C> <C> <C> Basic net earnings per share Net income......................................................... $ 7,924 $ 5,351 $ 5,006 Weighted average shares outstanding................................ 3,654 3,706 3,743 ------------- ------------- ------------- $ 2.17 $ 1.44 $ 1.34 ============= ============ ============= Diluted net earnings per share Net income......................................................... $ 7,924 $ 5,351 $ 5,006 Weighted average shares outstanding plus assumed conversions............................................. 3,772 3,848 3,859 ------------- ------------- ------------- $ 2.10 $ 1.39 $ 1.30 ============= ============= ============= Calculation of weighted average shares outstanding plus assumed conversions Weighted average shares outstanding................................ 3,654 3,706 3,743 Effect of dilutive securities options.............................. 118 142 116 ------------- ------------- ------------- 3,772 3,848 3,859 ============= ============= ============= </TABLE> 52
54 3. COMPREHENSIVE INCOME In June 1997, the FASB issued Statement of Financial Accounting Standards No. 130, "Reporting Comprehensive Income" (FAS130). This statement, which the Company adopted January 1, 1998, establishes standards for the reporting and display of comprehensive income and its components in a full set of general-purpose financial statements. The new standard requires that all items that are required to be recognized under generally accepted accounting standards as components of comprehensive income be reported in a financial statement that is displayed with the same prominence as other financial statements. Reclassification of financial statements for earlier periods provided for comparative purposes is required. The components of comprehensive income are as follows: <TABLE> <CAPTION> Year Ended December 31, 1999 -------------------------------------------------- Before-Tax Tax (Expense) Net-of-Tax Amount Benefit Amount --------------- -------------- --------------- <S> <C> <C> <C> Unrealized losses on securities: Unrealized holding losses arising during period...... $ (21,597) $ 7,343 $ (14,254) Less: reclassification adjustment for gains realized in net income........................... 149 (51) 98 --------------- -------------- --------------- Net unrealized losses............................... (21,746) 7,394 (14,352) Minimum pension liability adjustment.................... (5) 2 (3) --------------- -------------- --------------- Other comprehensive loss................................ $ (21,751) $ 7,396 $ (14,355) =============== ============== =============== </TABLE> <TABLE> <CAPTION> Year Ended December 31, 1998 -------------------------------------------------- Before-Tax Tax (Expense) Net-of-Tax Amount Benefit Amount --------------- -------------- --------------- <S> <C> <C> <C> Unrealized gains on securities: Unrealized holding gains arising during period....... $ 6,405 $ (2,177) $ 4,228 Less: reclassification adjustment for gains realized in net income........................... 1,260 (428) 832 --------------- -------------- --------------- Net unrealized gains................................ 5,145 (1,749) 3,396 Minimum pension liability adjustment.................... 76 (26) 50 --------------- -------------- --------------- Other comprehensive income.............................. $ 5,221 $ (1,775) $ 3,446 =============== ============== =============== </TABLE> <TABLE> <CAPTION> Year Ended December 31, 1997 -------------------------------------------------- Before-Tax Tax (Expense) Net-of-Tax Amount Benefit Amount --------------- -------------- --------------- <S> <C> <C> <C> Unrealized gains on securities: Unrealized holding gains arising during period....... $ 907 $ (308) $ 599 Less: reclassification adjustment for gains realized in net income........................... 233 (79) 154 --------------- -------------- --------------- Net unrealized gains................................ 674 (229) 445 Minimum pension liability adjustment.................... 52 (17) 35 --------------- -------------- --------------- Other comprehensive income.............................. $ 726 $ (246) $ 480 =============== ============== =============== </TABLE> 4. CASH AND DUE FROM BANKS The Company is required to maintain cash reserve balances with the Federal Reserve Bank. The reserve balances were $250,000 and $1,223,000 as of December 31, 1999 and 1998, respectively. 53
55 5. INVESTMENT, MORTGAGE-BACKED AND MARKETABLE EQUITY SECURITIES The amortized cost and estimated market value of investment, mortgage-backed and marketable equity securities as of December 31, 1999 and 1998 were (in thousands): <TABLE> <CAPTION> AVAILABLE FOR SALE ------------------------------------------------ Gross Gross Estimated December 31, Amortized Unrealized Unrealized Market 1999 Cost Gains Losses Value --------- ---------- ---------- --------- <S> <C> <C> <C> <C> U.S. Treasury ....................... $ 9,502 $ $ 35 $ 9,467 U.S. Government Agencies ............ 21,430 262 21,168 Mortgage-backed Securities: Direct Govt. Agency Issues ........ 236,240 404 3,789 232,855 Other Private Issues .............. 41,400 144 723 40,821 State and Political Subdivisions .... 57,180 485 2,122 55,543 Other Stocks and Bonds .............. 28,841 2 234 28,609 -------- -------- -------- -------- Total ............................. $394,593 $ 1,035 $ 7,165 $388,463 ======== ======== ======== ======== </TABLE> <TABLE> <CAPTION> HELD TO MATURITY ------------------------------------------------ Gross Gross Estimated December 31, Amortized Unrealized Unrealized Market 1999 Cost Gains Losses Value --------- -------- -------- -------- <S> <C> <C> <C> <C> U.S. Government Agencies ............ $ 42,871 $ 201 $ 873 $ 42,199 Mortgage-backed Securities: Direct Govt. Agency Issues ........ 14,967 21 295 14,693 Other Private Issues .............. 58,931 1,748 57,183 State and Political Subdivisions..... 43,048 1,154 41,894 Other Stocks and Bonds .............. 289 7 296 -------- -------- -------- -------- Total ............................. $160,106 $ 229 $ 4,070 $156,265 ======== ======== ======== ======== </TABLE> <TABLE> <CAPTION> AVAILABLE FOR SALE ------------------------------------------------ Gross Gross Estimated December 31, Amortized Unrealized Unrealized Market 1998 Cost Gains Losses Value --------- -------- -------- -------- <S> <C> <C> <C> <C> U.S. Treasury ....................... $ 19,137 $ 64 $ 3 $ 19,198 U.S. Government Agencies ............ 21,402 16 41 21,377 Mortgage-backed Securities: Direct Govt. Agency Issues ........ 227,804 2,342 439 229,707 Other Private Issues .............. 102,577 1,261 351 103,487 State and Political Subdivisions..... 86,055 4,591 113 90,533 Other Stocks and Bonds .............. 15,484 26 15,510 -------- -------- -------- -------- Total ............................. $472,459 $ 8,300 $ 947 $479,812 ======== ======== ======== ======== </TABLE> <TABLE> <CAPTION> HELD TO MATURITY ------------------------------------------------ Gross Gross Estimated December 31, Amortized Unrealized Unrealized Market 1998 Cost Gains Losses Value --------- -------- -------- -------- <S> <C> <C> <C> <C> U.S. Government Agencies .......... $ 347 $ $ $ 347 Mortgage-backed Securities: Direct Govt. Agency Issues....... 7,810 79 79 7,810 ------ ------ ------ ------ Total ........................... $8,157 $ 79 $ 79 $8,157 ====== ====== ====== ====== </TABLE> 54
56 Interest income recognized on securities for the years presented (in thousands): <TABLE> <CAPTION> Years Ended December 31, ------------------------------- 1999 1998 1997 ------- ------- ------- <S> <C> <C> <C> U.S. Treasury .......................... $ 707 $ 562 $ 461 U.S. Government Agencies ............... 3,322 614 578 Mortgage-backed Securities ............. 22,080 12,116 7,729 State and Political Subdivisions ....... 4,698 3,548 2,067 Other Stocks and Bonds ................. 1,261 589 322 ------- ------- ------- Total interest income on securities .... $32,068 $17,429 $11,157 ======= ======= ======= </TABLE> During the year ended December 31, 1999, the Company transferred a total of $132.4 million securities from AFS to HTM due to changes in market conditions and in connection with certain ALCO goals. Of the total transferred, $66.3 million were investment securities and $66.1 million were mortgage-backed securities. The unrealized loss on the securities transferred from AFS to HTM was $5.6 million, net of tax, at the date of transfer. There were no securities transferred from AFS to HTM during the year ended December 31, 1998. There were no sales from the HTM portfolio during the years ended December 31, 1999 or 1998. Of the $149,000 in net securities gains on sales from the AFS portfolio in 1999, there were $856,000 in realized gains and $707,000 in realized losses. Of the $1,260,000 in net securities gains on sales from the AFS portfolio in 1998, there were $1,321,000 in realized gains and $61,000 in realized losses. The $233,000 in net securities gains on sales from the AFS portfolio in 1997 were comprised of $376,000 in realized gains and $143,000 in realized losses. The scheduled maturities of AFS and HTM securities as of December 31, 1999 are presented below. Mortgage-backed securities are presented in total by category. <TABLE> <CAPTION> Amortized Aggregate Cost Fair Value --------- --------- (in thousands) <S> <C> <C> Available for sale securities: Due in one year or less ................... $ 28,559 $ 28,539 Due after one year through five years ..... 12,070 12,062 Due after five years through ten years .... 15,828 15,908 Due after ten years ....................... 60,496 58,278 --------- --------- 116,953 114,787 Mortgage-backed securities ................... 277,640 273,676 --------- --------- Total .................................. $ 394,593 $ 388,463 ========= ========= Held to maturity securities: Due in one year or less ................... $ 450 $ 450 Due after one year through five years ..... 9,359 9,345 Due after five years through ten years .... 19,409 19,303 Due after ten years ....................... 56,990 55,291 --------- --------- 86,208 84,389 Mortgage-backed securities ................... 73,898 71,876 --------- --------- Total .................................. $ 160,106 $ 156,265 ========= ========= </TABLE> Investment securities with book values of $436,357,000 and $306,409,000 were pledged as of December 31, 1999 and 1998, respectively, to collateralize advances, public and trust deposits or for other purposes as required by law. 55
57 6. LOANS AND RESERVE FOR POSSIBLE LOAN LOSSES Loans in the accompanying consolidated balance sheets are classified as follows (in thousands): <TABLE> <CAPTION> December 31, December 31, 1999 1998 -------- -------- <S> <C> <C> Real Estate Loans: Construction .......................... $ 18,489 $ 10,509 1-4 family residential ................ 112,699 93,215 Other ................................. 97,556 68,140 Commercial loans .......................... 79,804 68,117 Loans to individuals ...................... 82,747 84,059 -------- -------- Total loans ............................... 391,295 324,040 Less: Unearned income ................ 3,849 4,317 Reserve for loan losses ........ 4,575 3,564 -------- -------- Net loans ................................. $382,871 $316,159 ======== ======== </TABLE> The following is a summary of the Reserve for Loan Losses for the years ended December 31, 1999, 1998 and 1997 (in thousands): <TABLE> <CAPTION> Years Ended December 31, --------------------------------- 1999 1998 1997 ------- ------- ------- <S> <C> <C> <C> Balance at beginning of year ............... $ 3,564 $ 3,370 $ 3,249 Provision for loan losses ........... 1,456 1,215 1,005 Loans charged off ................... (765) (1,349) (1,229) Recoveries of loans charged off ..... 320 328 345 ------- ------- ------- Balance at end of year ..................... $ 4,575 $ 3,564 $ 3,370 ======= ======= ======= </TABLE> Nonaccrual loans at December 31, 1999 and 1998 were $703,000 and $432,000, respectively. Loans with terms modified in troubled debt restructuring at December 31, 1999 and 1998 were $448,000 and $473,000, respectively. For the years ended December 31, 1999 and 1998, the average recorded investment in impaired loans was approximately $565,000 and $665,000, respectively. During the years ended December 31, 1999 and 1998, the amount of interest income reversed on impaired loans placed on nonaccrual and the amount of interest income subsequently recognized on the cash basis was not material. The amount of interest recognized on nonaccrual or restructured loans was $125,000, $94,000 and $110,000 for the years ended December 31, 1999, 1998 and 1997, respectively. If these loans had been accruing interest at their original contracted rates, related income would have been $137,000, $113,000 and $336,000 for the years ended December 31, 1999, 1998 and 1997, respectively. 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 (in thousands): <TABLE> <CAPTION> Valuation Carrying Total Allowance Value ----- --------- ----- <S> <C> <C> <C> Commercial Loans ................ $422 $225 $197 Loans to Individuals ............ 281 44 237 ---- ---- ---- Balance at December 31, 1999 .... $703 $269 $434 ==== ==== ==== </TABLE> 56
58 <TABLE> <CAPTION> Valuation Carrying Total Allowance Value ----- --------- -------- <S> <C> <C> <C> Real Estate Loans ............... $ 2 $ $ 2 Commercial Loans ................ 167 32 135 Loans to Individuals ............ 263 49 214 ---- ---- ---- Balance at December 31, 1998 .... $432 $ 81 $351 ==== ==== ==== </TABLE> 7. BANK PREMISES AND EQUIPMENT <TABLE> <CAPTION> December 31, December 31, 1999 1998 ------------ ------------ (in thousands) <S> <C> <C> Bank premises .................... $22,347 $20,675 Furniture and equipment .......... 12,290 10,435 ------- ------- 34,637 31,110 Less accumulated depreciation .... 13,331 11,944 ------- ------- Total ................... $21,306 $19,166 ======= ======= </TABLE> Depreciation expense was $1,474,000, $1,397,000 and $1,215,000 for the years ended December 31, 1999, 1998 and 1997, respectively. Rent expense was $424,000, $198,000 and $159,000 for the years ended December 31, 1999, 1998 and 1997, respectively. Future minimum rental commitments under noncancelable leases are (in thousands): <TABLE> <S> <C> 2000 $ 298 2001 270 2002 181 2003 142 2004 27 Thereafter 0 ----- $ 918 ===== </TABLE> 8. OTHER REAL ESTATE OWNED The following is a summary of the Allowance for Losses on Other Real Estate Owned (OREO) for the periods presented (in thousands): <TABLE> <CAPTION> Years Ended December 31, --------------------------- 1999 1998 1997 ----- ----- ----- <S> <C> <C> <C> Balance at beginning of year .... $ 658 $ 672 $ 946 Acquisition of OREO ......... 61 Disposition of OREO ......... (658) (14) (274) ----- ----- ----- Balance at end of year .......... $ 61 $ 658 $ 672 ===== ===== ===== </TABLE> For the years ended December 31, 1999, 1998 and 1997, income from OREO properties exceeded the provision and other expenses by $58,000, $28,000 and $23,000, respectively. 57
59 9. INTEREST BEARING DEPOSITS <TABLE> <CAPTION> December 31, December 31, 1999 1998 ------------ ------------ (in thousands) <S> <C> <C> Savings deposits ........................ $ 20,282 $ 17,649 Money Market demand deposits ............ 75,278 60,264 NOW demand deposits ..................... 73,347 70,676 Certificates and other time deposits of $100,000 or more ................... 98,347 90,836 Certificates and other time deposits under $100,000 ............... 169,661 153,169 -------- -------- Total .......................... $436,915 $392,594 ======== ======== </TABLE> For the years ended December 31, 1999, 1998 and 1997, interest expense on time deposits of $100,000 or more was $3,805,000, $3,369,000 and $2,922,000, respectively. At December 31, 1999, the scheduled maturities of certificates and other time deposits are as follows (in thousands): <TABLE> <S> <C> 2000 $ 196,307 2001 44,933 2002 16,164 2003 4,301 2004 and thereafter 6,303 ----------- $ 268,008 =========== </TABLE> The aggregate amount of demand deposits that has been reclassified as loans were $.9 million and $.5 million for December 31, 1999 and 1998, respectively. 58
60 10. SHORT-TERM BORROWINGS Information related to short-term borrowings is provided in the table below. <TABLE> <CAPTION> Years Ended December 31, ------------------------------------ 1999 1998 1997 -------- -------- -------- (in thousands) <S> <C> <C> <C> Federal funds purchased Balance at end of period ................................ $ 75 $ 4,168 $ 3,884 Average amount outstanding during the period (1) ........ 4,660 3,700 2,695 Maximum amount outstanding during the period ............ 24,068 25,364 12,384 Weighted average interest rate during the period (2) .... 5.1% 5.7% 5.7% Interest rate at end of period .......................... 4.3% 5.1% 7.8% Securities sold under agreements to repurchase Balance at end of period ................................ $ $ $ Average amount outstanding during the period (1) ........ 59 3,649 Maximum amount outstanding during the period ............ 7,150 13,027 Weighted average interest rate during the period (2) .... 5.6% 5.2% Interest rate at end of period Federal Home Loan Bank ("FHLB") Dallas Advances Balance at end of period ................................ $181,222 $118,000 $ 29,000 Average amount outstanding during the period (1) ........ 155,719 61,734 6,798 Maximum amount outstanding during the period ............ 186,500 135,000 29,000 Weighted average interest rate during the period (2) .... 5.3% 5.3% 5.5% Interest rate at end of period .......................... 5.3% 5.0% 4.9% Treasury tax and loan funds Balance at end of period ................................ $ 4,744 $ 1,523 $ 1,647 Average amount outstanding during the period (1) ........ 1,907 1,293 1,080 Maximum amount outstanding during the period ............ 4,747 3,154 2,850 Weighted average interest rate during the period (2) .... 4.0% 4.2% 5.2% Interest rate at end of period .......................... 4.7% 4.1% 5.3% </TABLE> (1) The average amount outstanding during the period was computed by dividing the total month-end outstanding principal balances by the number of months in the period. (2) The weighted average interest rate during the period was computed by dividing the actual interest expense (annualized) by average balance outstanding during the period. The Company has three lines of credit for the purchase of federal funds. Two $15.0 million and one $10.0 million unsecured lines of credit have been established with Bank of America, Frost Bank and Texas Independent Bank, respectively. 59
61 11. LONG TERM OBLIGATIONS <TABLE> <CAPTION> Years Ended December 31, ------------------------------------ 1999 1998 1997 -------- -------- -------- (in thousands) <S> <C> <C> <C> FHLB Dallas Advances Balance at end of period ................................ $174,704 $156,027 $ 28,547 Average amount outstanding during the period (1) ........ 175,028 84,836 12,151 Maximum amount outstanding during the period ............ 174,870 156,238 28,547 Weighted average interest rate during the period (2) .... 5.3% 5.5% 5.9% Interest rate at end of period .......................... 5.4% 5.3% 6.0% </TABLE> (1) The average amount outstanding during the period was computed by dividing the total month-end outstanding principal balances by the number of months in the period. (2) The weighted average interest rate during the period was computed by dividing the actual interest expense (annualized) by average balance outstanding during the period. Maturities of fixed rate FHLB Dallas Long-term advances based on scheduled repayments at December 31, 1999 are: <TABLE> <CAPTION> Under Due Due Over 1999 1 Year 1-5 Years 6-10 Years 10 Years Total ------------ ------------- ------------ ------------ ------------ <S> <C> <C> <C> <C> <C> Total Long-term Obligations........ $ 947 $ 138,277 $ 35,112 $ 368 $ 174,704 ============ ============= ============ ============ ============ </TABLE> FHLB Dallas advances are collateralized by FHLB Dallas stock, nonspecified real estate loans and mortgage-backed securities. In April 1998, the Company formed a wholly-owned non-banking subsidiary Southside Capital Trust (the "Trust Issuer"). The Trust Issuer was created under the Business Trust Act of Delaware for the sole purpose of issuing and selling Preferred Securities and Common Securities and using proceeds from the sale of the Preferred Securities and Common Securities to acquire Junior Subordinated Debentures (the "Debentures") issued by the Company. Accordingly, the Debentures are the sole assets of the Trust Issuer and payments under the Debentures are the sole revenue of the Trust Issuer. All of the Common Securities are owned by the Company. The Company's obligations under the Debentures and related documents, taken together, constitute a full and unconditional guarantee by the Company of the Trust Issuer's obligations under the Preferred Securities. Although the Debentures are treated as debt of the Company, they currently qualify for Tier 1 capital treatment subject to a limitation that the securities included as Tier 1 capital not exceed 25% of total Tier 1 capital. The Securities are callable by the Company on or about June 30, 2003, or earlier in the event the deduction of related interest for federal income taxes is prohibited, treatment as Tier 1 capital is no longer permitted or certain other contingencies arise. The Preferred Securities must be redeemed upon maturity of the Debentures in year 2028. On May 18, 1998, the Company, through the Trust Issuer, sold 2,000,000 Preferred Securities at a liquidation amount of $10 per Preferred Security for an aggregate amount of $20,000,000. It has a distribution rate of 8.50% per annum payable at the end of each calendar quarter. 60
62 12. EMPLOYEE BENEFITS Southside Bank has a deferred compensation agreement with eight of its executive officers, which generally provides for payment of an aggregate amount of $3.4 million over a maximum period of fifteen years after retirement or death. Deferred compensation expense was $211,000, $147,000 and $43,000 for the years ended December 31, 1999, 1998 and 1997, respectively. The Company provides accident and health insurance for substantially all employees through an insurance program funded by the Company. Health insurance benefits are offered to retired employees who pay a premium based on cost as determined by a third party administrator. Substantially all of the Company's employees may become eligible for those benefits if they reach normal retirement age after fifteen years of employment with the Company. The cost of health care benefits was $1,122,000, $802,000 and $792,000 for the years ended December 31, 1999, 1998 and 1997, respectively. There were five retirees and four retirees participating in the health insurance plan as of December 31, 1999 and 1998, respectively. The Company has an Employee Stock Ownership Plan which covers substantially all employees. Contributions to the plan are at the sole discretion of the Board of Directors. Contributions to the plan for the year ended December 31, 1999 were $100,000. There were no contributions to the plan for the year ended December 31, 1998 and 1997. At December 31, 1999 and 1998, 96,628 and 97,951 shares of common stock were owned by the Employee Stock Ownership Plan, respectively. The number of shares have been adjusted as a result of stock dividends. These shares are treated as externally held shares for dividend and earnings per share calculations. The Company has an Officers Long-term Disability Income Plan, (the "Disability Plan"), which covers officers of the Company and Southside Bank in the event they become disabled as defined under its terms. Individuals are automatically covered under the plan if they (a) have been elected as an officer, (b) have been an employee of the Company and Southside Bank for three years and (c) receive earnings of $50,000 or more on an annual basis. The Disability Plan provides, among other things, under its terms that should a covered individual become totally disabled he would receive 66-2/3%, not to exceed $10,000 per month, of their current salary. The benefits paid out of this plan are limited by the benefits paid to the individual under the terms of other Company sponsored benefit plans. The Company and Southside Bank have a defined benefit pension plan pursuant to which participants are entitled to benefits based on final average monthly compensation and years of credited service determined in accordance with plan provisions. All employees of the Company and Southside Bank who have worked 1000 hours or more in their first twelve months of employment or during any plan year thereafter are eligible to participate. Employees are vested upon the earlier of five years credited service or the employee attaining 60 years of age. Benefits are payable monthly commencing on the later of age 65 or the participant's date of retirement. Eligible participants may retire at reduced benefit levels after reaching age 55. The Company contributes amounts to the pension fund sufficient to satisfy funding requirements of the Employee Retirement Income Security Act. Plan assets included 66,142 shares of Southside Bancshares, Inc. stock purchased at fair market value as of December 31, 1999 and 1998. The number of shares have been adjusted as a result of stock dividends. 61
63 <TABLE> <CAPTION> December 31, December 31, Change in Projected Benefit Obligation 1999 1998 ------------ ------------ (in thousands) <S> <C> <C> Benefit obligation at end of prior year ........... $ 13,926 $ 11,853 Service cost ...................................... 714 578 Interest cost ..................................... 957 856 Actuarial (gain) loss ............................. (1,371) 1,107 Benefits paid ..................................... (604) (468) Expenses paid ..................................... (74) -------- -------- Benefit obligation at end of year .............. $ 13,548 $ 13,926 ======== ======== </TABLE> <TABLE> <CAPTION> December 31, December 31, Change in Plan Assets 1999 1998 ------------ ------------ (in thousands) <S> <C> <C> Fair value of plan assets at end of prior year .... $ 12,113 $ 10,233 Actual return ..................................... 1,891 2,064 Employer contribution ............................. 791 284 Benefits paid ..................................... (604) (468) Expenses paid ..................................... (74) -------- -------- Fair value of plan assets at end of year ....... $ 14,117 $ 12,113 ======== ======== </TABLE> <TABLE> <CAPTION> December 31, December 31, Reconciliation of Funded Status 1999 1998 ------------ ------------ (in thousands) <S> <C> <C> Funded status ..................................... $ 569 $(1,813) Unrecognized net (gain) loss ...................... (1,127) 1,076 Unrecognized net transition asset ................. (185) (231) ------- ------- Accrued benefit cost ........................... $ (743) $ (968) ======= ======= </TABLE> The weighted average discount rate and rate of increase in future compensation levels used in determining actuarial present value of the projected benefit obligation was 7.75% and 4.50% and 6.75% and 4.50% at December 31, 1999 and 1998, respectively. The assumed long-term rate of return on plan assets was 9.0% at December 31, 1999 and 1998. Net periodic pension cost for the years ended December 31, 1999, 1998 and 1997 included the following components (in thousands): <TABLE> <CAPTION> Years Ended December 31, --------------------------------- 1999 1998 1997 ------- ------- ------- <S> <C> <C> <C> Service cost .............................. $ 714 $ 578 $ 510 Interest cost ............................. 957 856 778 Expected return on assets ................. (1,068) (900) (806) Transition asset recognition .............. (46) (46) (46) Net loss recognition ...................... 9 9 ------- ------- ------- Net periodic benefit cost ................. $ 566 $ 497 $ 436 ======= ======= ======= </TABLE> 62
64 The Company has a nonfunded supplemental retirement plan (restoration plan) for its employees whose benefits under the principal retirement plan are reduced because of compensation deferral elections or limitations under federal tax laws. The expense for this plan for the years ended December 31, 1999, 1998 and 1997 was $83,000, $34,000 and $45,000, respectively. <TABLE> <CAPTION> December 31, December 31, Change in Projected Benefit Obligation 1999 1998 ------------ ------------ (in thousands) <S> <C> <C> Benefit obligation at end of prior year .... $ 405 $ 510 Service cost ............................... 13 Interest cost .............................. 46 29 Actuarial loss (gain) ...................... 227 (77) Benefits paid .............................. (56) (57) ----- ----- Benefit obligation at end of year ....... $ 635 $ 405 ===== ===== </TABLE> <TABLE> <CAPTION> December 31, December 31, Change in Plan Assets 1999 1998 ------------ ------------ (in thousands) <S> <C> <C> Fair value of plan assets at end of prior year .... $ $ Employer contribution ............................. 56 57 Benefits paid ..................................... (56) (57) ---- ---- Fair value of plan assets at end of year ....... $ 0 $ 0 ==== ==== </TABLE> <TABLE> <CAPTION> December 31, December 31, Reconciliation of Funded Status 1999 1998 ------------ ------------ (in thousands) <S> <C> <C> Funded status .............................. $(635) $(405) Unrecognized net loss ...................... 260 53 Unrecognized net transition obligation ..... 21 24 ----- ----- Accrued benefit cost ....................... (354) (328) Additional minimum liability ............... (79) (77) ----- ----- Accrued benefit liability .................. (433) (405) Intangible asset ........................... 21 24 Accumulated other comprehensive income ..... 58 53 ----- ----- Net amount recognized ...................... $(354) $(328) ===== ===== </TABLE> The weighted average discount rate and rate of increase in future compensation levels used in determining actuarial present value of the projected benefit obligation was 7.75% and 4.50% and 6.75% and 4.50% at December 31, 1999 and 1998, respectively. The assumed long-term rate of return on plan assets was 9.0% at December 31, 1999 and 1998. Net periodic postretirement benefit cost for the years ended December 31, 1999, 1998 and 1997 includes the following components (in thousands): <TABLE> <CAPTION> Years Ended December 31, ------------------------ 1999 1998 1997 ------ ---- ------- <S> <C> <C> <C> Service cost ......................... $13 $ $ Interest cost ........................ 46 28 37 Transition obligation recognition .... 3 3 3 Net loss recognition ................. 21 3 --- --- --- Net periodic benefit cost ............ $83 $31 $43 === === === </TABLE> 63
65 Incentive Stock Options In April 1993, the Company adopted the Southside Bancshares, Inc. 1993 Incentive Stock Option Plan ("the Plan"), a stock-based incentive compensation plan. The Company applies APB Opinion 25 and related Interpretations in accounting for the Plan and discloses the pro forma information required by FAS123. Under the Plan, the Company is authorized to issue shares of Common Stock pursuant to "Awards" granted in the form of incentive stock options (intended to qualify under Section 422 of the Internal Revenue Code of 1986, as amended). Awards may be granted to selected employees and directors of the Company or any subsidiary. At December 31, 1999 and 1998, there were 140,222 options and 210,757 options available for grant, respectively. The Plan provides that the exercise price of any stock option may not be less than the fair market value of the Common Stock on the date of grant. The Company granted incentive stock options in 1997, 1998 and 1999. These stock options have contractual terms of 10 years. All options vest on a graded schedule, 20% per year for 5 years, beginning on the first anniversary date of the grant date. In accordance with APB 25, the Company has not recognized any compensation cost for these stock options. A summary of the status of the Company's stock options as of December 31, 1999, 1998 and 1997 and the changes during the year ended on those dates is presented below: <TABLE> <CAPTION> - ---------------------------- --------------------------- -------------------------- -------------------------- 1999 1998 1997 - ---------------------------- --------------------------- -------------------------- -------------------------- # SHARES OF WEIGHTED # SHARES OF WEIGHTED # SHARES OF WEIGHTED UNDERLYING AVERAGE UNDERLYING AVERAGE UNDERLYING AVERAGE OPTIONS EXERCISE OPTIONS EXERCISE OPTIONS EXERCISE PRICES PRICES PRICES - ---------------------------- ------------ ------------- ------------ ------------ ------------ ------------ <S> <C> <C> <C> <C> <C> <C> Outstanding at beginning of the year 375,698 $12.38 311,934 $10.90 243,254 $8.88 - ---------------------------- ------------ ------------- ------------ ------------ ------------ ------------ Granted 75,075 $16.79 159,510 $20.73 83,384 $15.33 - ---------------------------- ------------ ------------- ------------ ------------ ------------ ------------ Exercised 22,425 $17.68 12,882 $19.17 13,545 $15.16 - ---------------------------- ------------ ------------- ------------ ------------ ------------ ------------ Forfeited 4,540 $16.75 82,864 $23.80 1,159 $15.33 - ---------------------------- ------------ ------------- ------------ ------------ ------------ ------------ Expired 0 N/A 0 N/A 0 N/A - ---------------------------- ------------ ------------- ------------ ------------ ------------ ------------ Outstanding at end of year 423,808 $13.45 375,698 $12.38 311,934 $10.90 - ---------------------------- ------------ ------------- ------------ ------------ ------------ ------------ Exercisable at end of year 193,094 $14.11 153,414 $13.71 98,004 $10.45 - ---------------------------- ------------ ------------- ------------ ------------ ------------ ------------ Weighted-average FV of options granted during the year $4.78 $6.72 $4.71 - ---------------------------- ------------ ------------- ------------ ------------ ------------ ------------- </TABLE> The fair value of each stock option granted is estimated on the date of grant using the minimum value method of option pricing with the following weighted-average assumptions for grants in 1999, 1998 and 1997, respectively: dividend yield of 2.19%, 1.34%, and 2.25%; risk-free interest rates of 6.05%, 5.18%, and 6.52%; the expected lives of 6 years; the expected volatility is 22.25%. 64
66 The following table summarizes information about stock options outstanding at December 31, 1999: <TABLE> <CAPTION> Options Outstanding Options Exercisable ------------------- ------------------- NUMBER WEIGHTED AVG. NUMBER RANGE OF OUTSTANDING REMAINING WEIGHTED AVG EXERCISABLE WEIGHTED AVG. EXERCISE PRICES AT 12/31/99 CONTR. LIFE EXERCISE PRICE AT 12/31/99 EXERCISE PRICE --------------- ----------- ----------- -------------- ----------- -------------- <S> <C> <C> <C> <C> <C> $ 5.69 to $12.34 195,502 5.30 $ 9.90 147,173 $ 9.38 $ 15.33 to $17.38 228,306 5.70 $10.80 45,921 $ 10.35 ---------------- ------- ---- ------ -------- ------- $ 5.69 to $17.38 423,808 5.50 $10.38 193,094 $ 9.61 </TABLE> Pro Forma Net Income and Net Income Per Common Share Had the compensation cost for the Company's stock-based compensation plans been determined consistent with the requirements of FAS123, the Company's net income and net income per common share for 1999, 1998, and 1997 would approximate the pro forma amounts below (in thousands, except per share amounts, net of taxes): <TABLE> <CAPTION> As Pro As Pro As Pro Reported Forma Reported Forma Reported Forma 12/31/99 12/31/99 12/31/98 12/31/98 12/31/97 12/31/97 ---------- ----------- --------- ---------- --------- ---------- <S> <C> <C> <C> <C> <C> <C> FAS123 Charge....................... $ $ 316 $ $ 184 $ $ 136 Net Income.......................... $ 7,924 $ 7,608 $ 5,351 $ 5,167 $ 5,006 $ 4,870 Net Income per Common Share-Basic...................... $ 2.17 $ 2.08 $ 1.44 $ 1.39 $ 1.34 $ 1.30 Net Income per Common Share-Diluted.................... $ 2.10 $ 2.02 $ 1.39 $ 1.34 $ 1.30 $ 1.26 </TABLE> The effects of applying FAS123 in this pro forma disclosure are not indicative of future amounts. 13. SHAREHOLDERS' EQUITY Cash dividends declared and paid were $.40 per share for the years ended December 31, 1999, 1998 and 1997. Future dividends will depend on the Company's earnings, financial condition and other factors which the Board of Directors of the Company considers to be relevant. The Company's dividend policy requires that any dividend payments made by the Company not exceed consolidated earnings for that year. Retained earnings not available for the payment of dividends at December 31, 1999 were $14.6 million. The Bank is subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Bank's financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank must meet specific capital guidelines that involve quantitative measures of the Bank's assets, liabilities, and certain off-balance-sheet items as calculated under regulatory accounting practices. The Bank's capital amounts and classification are also subject to qualitative judgments by the regulators regarding components, risk weightings, and other factors. Quantitative measures established by regulation to ensure capital adequacy require the Bank to maintain minimum amounts and ratios (set forth in the table below) of Total and Tier 1 capital (as defined in the regulations) to risk-weighted assets (as defined), and of Tier 1 capital (as defined) to average assets (as 65
67 defined). Management believes, as of December 31, 1999, that the Bank meets all capital adequacy requirements to which it is subject. As of December 31, 1999, the most recent notification from the Federal Deposit Insurance Corporation categorized the Bank as well capitalized under the regulatory framework for prompt corrective action. To be categorized as well capitalized the Bank must maintain minimum Total risk-based, Tier 1 risk-based, and Tier 1 leverage ratios as set forth in the table. There are no conditions or events since that notification that management believes have changed the institution's category. <TABLE> <CAPTION> To Be Well Capitalized Under For Capital Prompt Corrective Actual Adequacy Purposes Action Provisions ------------------------ ------------------------- --------------------------------- Amount Ratio Amount Ratio Amount Ratio ----------- -------- ---------- ----------- ----------------- -------------- <S> <C> <C> <C> <C> <C> <C> As of December 31, 1999: Total Capital (to Risk Weighted Assets)........ $ 70,611 13.96% > or = $40,473 > or = 8.0% > or = $ 50,592 > or = 10.0% Tier 1 Capital (to Risk Weighted Assets)........ $ 61,782 12.21% > or = 20,237 > or = 4.0% > or = $ 30,355 > or = 6.0% Tier 1 Capital (to Average Assets) (1).......... $ 61,782 6.20% > or = 39,876 > or = 4.0% > or = $ 49,845 > or = 5.0% As of December 31, 1998: Total Capital (to Risk Weighted Assets)........ $ 63,962 14.86% > or = 34,435 > or = 8.0% > or = $ 43,044 > or = 10.0% Tier 1 Capital (to Risk Weighted Assets)........ $ 54,280 12.61% > or = 17,218 > or = 4.0% > or = $ 25,827 > or = 6.0% Tier 1 Capital (to Average Assets) (1).......... $ 54,280 6.76% > or = 32,108 > or = 4.0% > or = $ 40,135 > or = 5.0% </TABLE> (1) Refers to quarterly average assets as calculated by bank regulatory agencies. Payment of dividends by the Bank is limited under regulation. The amount that can be paid in any calendar year without prior approval of the Bank's regulatory agencies cannot exceed the lesser of net profits (as defined) for that year plus the net profits for the preceding two calendar years, or retained earnings. The table below summarizes key equity ratios for the Company for the years ended December 31, 1999, 1998 and 1997. <TABLE> <CAPTION> Years Ended December 31, ------------------------------------------ 1999 1998 1997 ------------- ------------ ------------ <S> <C> <C> <C> Percentage of Net Income to: Average Total Assets............................................... .84% .78% .99% Average Shareholders' Equity....................................... 18.99% 12.42% 13.20% Percentage of Dividends Declared Per Common Share to Net Income Per Common Share-Basic......................... 18.43% 27.78% 29.85% Percentage of Dividends Declared Per Common Share to Net Income Per Common Share-Diluted....................... 19.05% 28.78% 30.77% Percentage of Average Shareholders' Equity to Average Total Assets..................................... 4.41% 6.28% 7.50% </TABLE> 66
68 14. DIVIDEND REINVESTMENT AND COMMON STOCK REPURCHASE PLAN The Company has a Dividend Reinvestment Plan funded by stock authorized, but not yet issued. Proceeds from the sale of the common stock will be used for general corporate purposes and could be directed to the Company's subsidiaries. For the year ended December 31, 1999, 17,148 shares were sold under this plan at an average price of $18.49 per share, reflective of other trades at the time of each sale. For the year ended December 31, 1998, 15,427 shares were sold under this plan at an average price of $19.74 per share, reflective of other trades at the time of each sale. The Company instituted a Common Stock Repurchase Plan in late 1994. Under the repurchase plan, the Board of Directors establishes, on a quarterly basis, total dollar limitations and price per share for stock to be repurchased. The Board reviews this plan in conjunction with the capital needs of the Company and Southside Bank and may, at its discretion, modify or discontinue the plan. During 1999, 74,075 shares of treasury stock were purchased under this plan at a cost of $1,386,000. During 1998, 71,426 shares of treasury stock were purchased under this plan at a cost of $1,398,000. 15. INCOME TAXES The provisions for federal income taxes included in the accompanying statements of income consist of the following (in thousands): <TABLE> <CAPTION> Years Ended December 31, ----------------------------------------- 1999 1998 1997 ------------ ------------ ------------ <S> <C> <C> <C> Current tax provision.................................................. $ 2,033 $ 1,496 $ 1,914 Deferred tax benefit................................................... (33) (272) (225) ------------ ------------ ------------ Provision for tax expense charged to operations........................ $ 2,000 $ 1,224 $ 1,689 ============ ============ ============ </TABLE> Deferred income taxes result from temporary differences in the recognition of revenues and expenses for tax and book purposes. These differences and the tax effect of each of the major categories are as follows (in thousands): <TABLE> <CAPTION> Years Ended December 31, ----------------------------------------- 1999 1998 1997 ------------ ------------ ------------ <S> <C> <C> <C> Provision for loan losses.............................................. $ (551) $ (204) $ (323) Provision for OREO losses.............................................. 202 83 Depreciation........................................................... 45 (6) 29 Retirement and other benefit plans..................................... (4) (211) (60) FHLB Dallas Stock dividends............................................ 308 149 40 Loan origination costs................................................. 11 Other.................................................................. (33) (5) ------------ ------------ ------------ Deferred tax benefit................................................... $ (33) $ (272) $ (225) ============ ============ ============ </TABLE> 67
69 The components of the net deferred tax asset (liability) as of December 31, 1999 and 1998 are summarized below (in thousands): <TABLE> <CAPTION> Assets Liabilities ------------ ------------ <S> <C> <C> Allowance for Losses on OREO...................................................... $ 101 $ Reserve for Loan Losses........................................................... 1,280 Retirement and Other Benefit Plans................................................ 875 Unrealized losses on securities available for sale................................ 4,919 Loan Origination Costs............................................................ (148) Premises and Equipment............................................................ (250) FHLB Dallas Stock Dividends....................................................... (602) Other............................................................................. 69 ------------ ------------ Gross deferred tax assets (liabilities)........................................ 7,244 (1,000) ------------ ------------ Net deferred tax asset at December 31, 1999................................. $ 6,244 ============ </TABLE> <TABLE> <CAPTION> Assets Liabilities ------------ ------------ <S> <C> <C> Allowance for Losses on OREO...................................................... $ 308 $ Reserve for Loan Losses........................................................... 729 Retirement and Other Benefit Plans................................................ 868 Unrealized gains on securities available for sale................................. (2,474) Loan Origination Costs............................................................ (148) Premises and Equipment............................................................ (187) FHLB Dallas Stock Dividends....................................................... (294) Other............................................................................. 14 ------------ ------------ Gross deferred tax assets (liabilities)........................................ 1,905 (3,089) ------------ ------------ Net deferred tax liability at December 31, 1998............................. $ (1,184) ============ </TABLE> A reconciliation of tax at statutory rates and total tax expense is as follows (dollars in thousands): <TABLE> <CAPTION> Years Ended December 31, --------------------------------------------------------------- 1999 1998 1997 ------------------- ------------------- ------------------- Percent Percent Percent of of of Pre-Tax Pre-Tax Pre-Tax Amount Income Amount Income Amount Income -------- -------- -------- -------- -------- -------- <S> <C> <C> <C> <C> <C> <C> Calculated Tax Expense............................. $ 3,374 34.0% $ 2,236 34.0% $ 2,276 34.0% Increase (Decrease) in Taxes from: Tax Exempt Interest................................ (1,661) (16.7%) (1,210) (18.4%) (706) (10.5%) Other Net.......................................... 287 2.9% 198 3.0% 119 1.7% -------- -------- -------- -------- -------- -------- Provision for Tax Expense Charged to Operations...................................... $ 2,000 20.2% $ 1,224 18.6% $ 1,689 25.2% ======== ======== ======== ======== ======== ======== </TABLE> 68
70 16. COMMITMENTS AND CONTINGENCIES In the normal course of business the Company buys and sells securities. There were no commitments to purchase securities at December 31, 1999. At December 31, 1998, the Company had commitments to purchase $8,294,000 in securities. The Company, or its subsidiaries, is involved with various litigation which resulted in the normal course of business. Management of the Company, after consulting with its legal counsel, believes that any liability resulting from litigation will not have a material effect on the financial position and results of operations and the liquidity of the Company or its subsidiaries. 17. FINANCIAL INSTRUMENTS WITH OFF-BALANCE-SHEET RISK In the normal course of business the Company is a party to certain financial instruments, with off-balance-sheet risk, to meet the financing needs of its customers. These off-balance-sheet instruments include commitments to extend credit and standby letters of credit. These instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount reflected in the financial statements. The contract or notional amounts of these instruments reflect the extent of involvement and exposure to credit loss the Company has in these particular classes of financial instruments. Commitments to extend credit are agreements to lend to a customer provided that the terms established in the contract are met. Commitments generally have fixed expiration dates and may require payment of fees. Since some commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. Standby letters of credit are conditional commitments issued to guarantee the performance of a customer to a third party. These guarantees are primarily issued to support public and private borrowing arrangements. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan commitments to customers. The Company had outstanding unused commitments to extend credit of $52,178,000 and $29,810,000 at December 31, 1999 and 1998, respectively. The Company had outstanding standby letters of credit of $259,000 and $246,000 at December 31, 1999 and 1998, respectively. The Company applies the same credit policies in making commitments and standby letters of credit as it does for on-balance-sheet instruments. The Company evaluates each customer's credit worthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary, upon extension of credit is based on management's credit evaluation of the borrower. Collateral held varies but may include real estate, accounts receivable, inventory, property, plant, and equipment. 18. SIGNIFICANT GROUP CONCENTRATIONS OF CREDIT RISK The economy of the Company's market area, East Texas, is directly tied to the oil and gas industry. Oil prices have had an indirect effect on the Company's business. Although the Company has a diversified loan portfolio, a significant portion of its loans are collateralized by real estate. Repayment of these loans is in part dependent upon the economic conditions in the market area. Part of the risk associated with real estate loans has been mitigated since 49.3% of this group represents loans collateralized by residential dwellings that are primarily owner occupied. Losses on this type of loan have historically been less than those on speculative properties. Many of the remaining real estate loans are collateralized primarily with owner occupied commercial real estate. The Mortgage-backed Securities held by the Company consist solely of Government agency pass-through securities which are either directly or indirectly backed by the full faith and credit of the United States Government. 69
71 19. RELATED PARTY TRANSACTIONS Loan activity of executive officers, directors, and their affiliates for the years ended December 31, 1999 and 1998 were (in thousands): <TABLE> <CAPTION> 1999 1998 ----------------- ---------------- <S> <C> <C> Beginning Balance of Loans.............................................. $ 6,428 $ 6,160 Additional Loans...................................................... 2,936 3,917 Payments.............................................................. (3,599) (3,649) ----------------- ---------------- Ending Balance of Loans................................................. $ 5,765 $ 6,428 ================= ================ </TABLE> Other indebtedness of officers and employees as of December 31, 1999 and 1998 was $3,031,000 and $2,656,000, respectively. The Company incurred legal costs of $150,000, $176,000 and $148,000 during the years ended December 31, 1999, 1998 and 1997, respectively, from a law firm of which an outside director of the Company is a partner. The Company paid approximately $54,000, $49,000 and $55,000 in insurance premiums during the years ended December 31, 1999, 1998 and 1997, respectively, to companies of which two outside directors are officers. During 1999 there were no architectural fees paid to outside directors. The Company paid approximately $5,000 and $50,000 in architectural fees during the years ended December 31, 1998 and 1997, respectively, to a company of which an outside director is an officer. 20. DISCLOSURES ABOUT THE FAIR VALUE OF FINANCIAL INSTRUMENTS Statement of Financial Accounting Standards No. 107, "Disclosures about Fair Value of Financial Instruments" (FAS107), requires disclosure of fair value information about financial instruments, whether or not recognized in the balance sheet, for which it is practicable to estimate that value. In cases where quoted market prices are not available, fair values are based on estimates using present value or other estimation techniques. Those techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. Such techniques and assumptions, as they apply to individual categories of the Company's financial instruments, are as follows: Cash and due from banks: The carrying amounts for cash and due from banks is a reasonable estimate of those assets' fair value. Investment, mortgage-backed and marketable equity securities: Fair values for these securities are based on quoted market prices, where available. If quoted market prices are not available, fair values are based on quoted market prices for similar securities. Loans receivable: For adjustable rate loans that reprice frequently and with no significant change in credit risk, the carrying amounts are a reasonable estimate of those assets' fair value. The fair value of other types of loans is estimated by discounting the future cash flows using the current rates at which similar loans would be made to borrowers with similar credit ratings and for the same remaining maturities. Nonperforming loans are estimated using discounted cash flow analyses or underlying value of the collateral where applicable. Deposit liabilities: The fair value of demand deposits, savings accounts, and certain money market deposits is the amount on demand at the reporting date, that is, the carrying value. Fair values for fixed rate certificates of deposits are estimated using a discounted cash flow calculation that applies interest rates currently being offered for deposits of similar remaining maturities. 70
72 Federal funds purchased and securities sold under agreement to repurchase: Federal funds purchased and securities sold under agreement to repurchase generally have an original term to maturity of one day and thus are considered short-term borrowings. Consequently, their carrying value is a reasonable estimate of fair value. Commitments to extend credit: The carrying amounts of commitments to extend credit and standby letters of credit are a reasonable estimate of those assets' fair value. FHLB Dallas Advances: The fair value of these advances is estimated by discounting the future cash flows using rates at which advances would be made to borrowers with similar credit ratings and for the same remaining maturities. The following table presents the Company's assets, liabilities, and unrecognized financial instruments at both their respective carrying amounts and fair value (dollars in thousands). <TABLE> <CAPTION> At December 31, 1999 At December 31, 1998 -------------------------------- -------------------------------- Carrying Carrying Amount Fair Value Amount Fair Value --------------- --------------- -------------- --------------- <S> <C> <C> <C> <C> Financial assets: Cash and due from banks.................... $ 41,131 $ 41,131 $ 41,372 $ 41,372 Investment securities: Available for sale....................... 96,244 96,244 132,447 132,447 Held to maturity......................... 86,208 84,389 347 347 Mortgage-backed and related securities: Available for sale....................... 273,676 273,676 333,194 333,194 Held to maturity......................... 73,898 71,876 7,810 7,810 Marketable equity securities: Available for sale....................... 18,543 18,543 14,171 14,171 Loans, net.................................... 382,871 375,411 316,159 321,238 Financial liabilities: Retail deposits............................ $ 587,544 $ 542,250 $ 515,034 $ 515,968 Federal funds purchased.................... 75 75 4,168 4,168 FHLB Dallas advances....................... 355,926 348,392 274,027 261,240 Junior subordinated debentures............. 20,000 20,000 20,000 20,000 Off-balance sheet liabilities: Commitments to extend credit............... 46,007 46,007 24,643 24,643 Standby letters of credit.................. 259 259 246 246 Credit card arrangements................... 6,171 6,171 5,167 5,167 </TABLE> As discussed earlier, the fair value estimate of financial instruments for which quoted market prices are unavailable is dependent upon the assumptions used. Consequently, those estimates cannot be substantiated by comparison to independent markets and, in many cases, could not be realized in immediate settlement of the instruments. Accordingly, the aggregate fair value amounts presented in the above fair value table do not necessarily represent the underlying value of the Company. 71
73 21. CONDENSED FINANCIAL INFORMATION OF REGISTRANT NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (in thousands, except per share data) <TABLE> <CAPTION> 1999 ------------------------------------------------------- Fourth Third Second First Quarter Quarter Quarter Quarter ------------ ------------ ------------ ------------ <S> <C> <C> <C> <C> Interest income......................................... $ 16,706 $ 15,736 $ 14,642 $ 13,604 Net interest income..................................... 7,034 6,418 5,871 5,349 Income before provision for income taxes................ 3,280 2,511 2,205 1,928 Provision for income taxes.............................. 699 537 441 323 Net income.............................................. 2,581 1,974 1,764 1,605 Net income per share Basic............................................... .71 .54 .48 .44 Diluted............................................. .69 .52 .47 .42 </TABLE> <TABLE> <CAPTION> 1998 ------------------------------------------------------- Fourth Third Second First Quarter Quarter Quarter Quarter ------------ ------------ ------------ ------------ <S> <C> <C> <C> <C> Interest income......................................... $ 12,661 $ 11,325 $ 10,138 $ 9,553 Net interest income..................................... 5,152 4,396 4,533 4,849 Income before provision for income taxes................ 2,031 1,653 1,330 1,561 Provision for income taxes.............................. 425 248 176 375 Net income.............................................. 1,606 1,405 1,154 1,186 Net income per share Basic............................................... .43 .38 .31 .32 Diluted............................................. .42 .37 .29 .31 </TABLE> 72
74 22. PARENT COMPANY FINANCIAL INFORMATION Condensed financial information for Southside Bancshares, Inc. (parent company only) was as follows (dollars in thousands): CONDENSED BALANCE SHEETS <TABLE> <CAPTION> December 31, December 31, ----------------- ------------------ ASSETS 1999 1998 ----------------- ------------------ <S> <C> <C> Cash and due from banks.................................................... $ 2,648 $ 6,329 Investment in bank subsidiary at equity in underlying net assets................................................... 53,810 58,794 Investment in nonbank subsidiary at equity in underlying net assets................................................... 15 15 Other assets............................................................... 1,240 1,285 ----------------- ------------------ TOTAL ASSETS....................................................... $ 57,713 $ 66,423 ================= ================= LIABILITIES Junior subordinated debentures............................................. $ 20,000 $ 20,000 Other liabilities.......................................................... 41 10 ----------------- ----------------- TOTAL LIABILITIES.................................................. 20,041 20,010 ----------------- ----------------- SHAREHOLDERS' EQUITY Common stock ($2.50 par, 6,000,000 shares authorized: 3,899,166 and 3,685,775 and shares issued)............................. 9,748 9,214 Paid-in capital............................................................ 27,472 24,198 Retained earnings.......................................................... 14,583 11,391 Treasury stock (256,251 and 182,176 shares)................................ (4,544) (3,158) Net unrealized gains on securities available for sale ..................... (9,587) 4,768 ----------------- ----------------- TOTAL SHAREHOLDERS' EQUITY......................................... 37,672 46,413 ----------------- ----------------- TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY......................... $ 57,713 $ 66,423 ================= ================= </TABLE> 73
75 CONDENSED STATEMENTS OF INCOME <TABLE> <CAPTION> Years Ended December 31, ----------------------------------------- 1999 1998 1997 ------------ ------------ ------------ INCOME (in thousands) <S> <C> <C> <C> Dividends from subsidiary.............................................. $ $ 586 $ 2,066 ------------ ------------ ------------ TOTAL INCOME...................................................... 586 2,066 ------------ ------------ ------------ EXPENSE Interest expense....................................................... 1,700 1,048 Salaries and employee benefits......................................... 100 Taxes other than income................................................ 27 41 Other.................................................................. 348 171 70 ------------ ------------ ------------- TOTAL EXPENSE..................................................... 2,148 1,246 111 ------------ ------------ ------------- (Loss) income before federal income tax expense........................ (2,148) (660) 1,955 Benefit for federal income tax expense................................. 730 424 37 ------------ ------------ ------------- (Loss) income before equity in undistributed earnings of subsidiaries............................................ (1,418) (236) 1,992 Equity in undistributed earnings of subsidiaries....................... 9,342 5,587 3,014 ------------ ------------ ------------ NET INCOME........................................................ $ 7,924 $ 5,351 $ 5,006 ============ ============ ============ </TABLE> CONDENSED STATEMENTS OF CASH FLOW <TABLE> <CAPTION> Years Ended December 31, ----------------------------------------- 1999 1998 1997 ------------ ------------ ------------ (in thousands) <S> <C> <C> <C> OPERATING ACTIVITIES: Net Income........................................................... $ 7,924 $ 5,351 $ 5,006 Adjustments to reconcile net income to cash provided by operations: Equity in undistributed earnings of subsidiaries................... (9,342) (5,587) (3,014) (Increase) decrease in other assets................................ 45 (1,283) Decrease in other liabilities...................................... 31 (2) (40) ------------ ------------ ------------ Net cash (used in) provided by operating activities........... (1,342) (1,521) 1,952 INVESTING ACTIVITIES: Investments in subsidiaries.......................................... (10,000) (10) ------------ ------------ ------------ Net cash used in investing activities......................... (10,000) (10) FINANCING ACTIVITIES: Purchase of treasury stock........................................... (1,386) (1,398) (1,154) Proceeds from sale of treasury stock................................. 38 77 Proceeds from issuance of Common Stock............................... 456 347 326 Dividends paid....................................................... (1,409) (1,359) (1,316) Proceeds from the issuance of junior subordinated debentures............................................ 20,000 ------------ ------------ ------------ Net cash provided by (used in) financing activities........... (2,339) 17,628 (2,067) Net increase (decrease) in cash and cash equivalents................. (3,681) 6,107 (125) Cash and cash equivalents at beginning of year....................... 6,329 222 347 ------------ ------------ ------------ Cash and cash equivalents at end of year............................. $ 2,648 $ 6,329 $ 222 ============ ============ ============ </TABLE> 74
76 INDEX TO EXHIBITS <TABLE> <CAPTION> Exhibit No. <S> <C> <C> <C> 3 (a)(i) - Articles of Incorporation as amended and in effect on December 31, 1992, of SoBank, Inc. (now named Southside Bancshares, Inc.)(filed as Exhibit 3 to the Registrant's Form 10-K for the year ended December 31, 1992, and incorporated herein). 3 (a)(ii) - Articles of Amendment effective May 9, 1994 to Articles of Incorporation of SoBank, Inc. (now named Southside Bancshares, Inc.) (filed as Exhibit 3(a)(ii) to the Registrant's Form 10-K for the year ended December 31, 1994, and incorporated herein). 3 (b) - Bylaws as amended and in effect on March 23, 1995 of Southside Bancshares, Inc. (filed as Exhibit 3(b) to the Registrant's Form 10-K for the year ended December 31, 1994, and incorporated herein). *, ** 10 (a)(i) - Deferred Compensation Plan for B. G. Hartley effective February 13, 1984, as amended June 28, 1990, December 15, 1994, November 20, 1995 and December 21, 1999 (filed as Exhibit 10(a)(i) to the Registrant's Form 10-K for the year ended December 31, 1999, and filed herewith). ** 10 (a)(ii) - Deferred Compensation Plan for Robbie N. Edmonson effective February 13, 1984, as amended June 28, 1990 and March 16, 1995 (filed as Exhibit 10(a)(ii) to the Registrant's Form 10-K for the year ended December 31, 1995, and incorporated herein). ** 10 (b) - Officers Long-term Disability Income Plan effective June 25, 1990 (filed as Exhibit 10(b) to the Registrant's Form 10-K for the year ended June 30, 1990, and incorporated herein). ** 10 (c) - Retirement Plan Restoration Plan for the subsidiaries of SoBank, Inc. (now named Southside Bancshares, Inc.)(filed as Exhibit 10(c) to the Registrant's Form 10-K for the year ended December 31, 1992, and incorporated herein). ** 10 (d) - Incentive Stock Option Plan effective April 1, 1993 of SoBank, Inc. (now named Southside Bancshares, Inc.) (filed as Exhibit 10(d) to the Registrant's Form 10-K for the year ended December 31, 1994, and incorporated herein). ** 10 (e) - Form of Deferred Compensation Agreements dated June 30, 1994 with each of Titus Jones and Andy Wall as amended November 13, 1995. (filed as Exhibit 10(e) to the Registrant's Form 10-K for the year ended December 31, 1995, and incorporated herein). ** 10 (f) - Form of Deferred Compensation Agreements dated June 30, 1994 with each of Sam Dawson, Lee Gibson and Jeryl Story as amended October 15, 1997 and Form of Deferred Compensation Agreement dated October 15, 1997 with Lonny Uzzell. * 21 - Subsidiaries of the Registrant. * 23 - Consent of Independent Accountants. * 27 - Financial Data Schedule for the year ended December 31, 1999. - -------------------- * Filed herewith. ** Compensation plan, benefit plan or employment contract or arrangement. </TABLE>