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, 2000 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: <TABLE> <CAPTION> Name of each exchange Title of each class on which registered ------------------- --------------------- <S> <C> NONE NONE </TABLE> 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, 2001, 7,499,916 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 March 2, 2001 was $52,226,913. DOCUMENTS INCORPORATED BY REFERENCE Registrant's Proxy Statement to be filed for the Annual Meeting of Shareholders to be held April 19, 2001. (Part III) ================================================================================
2 PART I ITEM 1. BUSINESS GENERAL Southside Bancshares, Inc. (the "Company"), incorporated in Texas in 1982, is a bank holding company for Southside Bank (the "Bank" or "Southside Bank"), headquartered in Tyler, Texas. Tyler has a metropolitan area population of approximately 171,000 and is located approximately 90 miles east of Dallas, Texas and 90 miles west of Shreveport, Louisiana. The Bank has the largest deposit base in the Tyler metropolitan area and is the largest bank based on asset size headquartered in East Texas. At December 31, 2000, the Company had total assets of $1.2 billion, total loans of $481.4 million, deposits of $720.6 million, and shareholders' equity of $51.7 million. The Company had net income of $9.8 million and $7.9 million and diluted earnings per share of $1.24 and $1.00 for the years ended December 31, 2000 and 1999, respectively. The Company has paid a cash dividend every year since 1970. The Bank is a community-focused financial institution that offers a full range of financial services to individuals, businesses and nonprofit organizations in the communities it serves. These services include consumer and commercial loans, deposit accounts, trust services, safe deposit services and brokerage services. The Bank's consumer loan services include 1-4 family residential mortgage loans, home 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, 2000, the Bank's trust department managed approximately $207 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, which at December 31, 2000, had $.9 million in loans outstanding. 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 considers its primary market area to be all of Smith and Gregg Counties in East Texas, and to a lesser extent, portions of adjoining counties. During 1998 and 1999, the Bank opened three branches in Gregg County and one branch in Smith County. The Bank plans to open two additional branches in Lindale and Whitehouse, both in Smith County, which should open during 2001. The Company expects its presence in the Gregg County market area to increase in the future, however, the city of Tyler in Smith County presently represents the Company's primary market area. 1
3 The principal economic activities in the Company's market area include retail, distribution, manufacturing, medical services, education and oil and gas industries. Additionally, Tyler's industry base includes conventions and tourism, as well as retirement relocation. All of these support a growing regional system of medical service, retail and education centers. Tyler is home to several nationally recognized health care systems. Tyler hospitals represent all major specialties and employ over 6,500 individuals. In 1998, Target Stores opened a multi-state distribution center in the greater Tyler area along Interstate 20 that employs over 1,000 workers. The Bank serves its markets through twelve full service branch locations, including seven branches located in grocery stores. The branches are located in and around Tyler and Longview. Several longtime Longview banking veterans joined the Bank to lead the Company in its expansion into the Longview market. 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 four motor bank facilities and Countywide maintains one location. The Bank's customers may also access various banking services through 21 ATMs owned by the Bank and ATMs owned by others, through debit cards, and through the Bank's automated telephone, internet and electronic banking products. These products allow the Bank's customers to apply for loans, access account information and conduct various transactions from their telephones and computers. 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, with the exception of selected municipal loans. Total loans as of December 31, 2000 increased $94.0 million or 24.3% while the average balance was up $93.1 million or 27.3% when compared to 1999. Real estate loans as of December 31, 2000 increased $53.7 million or 23.5% from December 31, 1999. Loans to individuals increased $12.3 million or 15.6% from December 31, 1999 and commercial loans increased $28.0 million or 35.1%. The increase in real estate loans is due to a stronger real estate market and a strong commitment by the Company to residential mortgage lending. Commercial loans increased as a result of commercial growth in the Company's market area. Commercial loans also increased due to the growth of loans made to municipalities in Texas. Loans to individuals increased due to greater penetration in the Company's market area. 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, 2000 was $10 million. The Bank's largest loan relationship at December 31, 2000 was approximately $7.5 million. The average yield on loans for the year ended December 31, 2000 increased to 8.45% from 8.28% for the year ended December 31, 1999. This increase was reflective of the repricing characteristics of the loans and the increase in lending rates during 2000. 2
4 LOAN PORTFOLIO COMPOSITION AND ASSOCIATED RISK The following table sets forth loan totals net of unearned discount by category for the years presented: <TABLE> <CAPTION> December 31, -------------------------------------------------------------- 2000 1999 1998 1997 1996 ---------- ---------- ---------- ---------- ---------- (in thousands) <S> <C> <C> <C> <C> <C> Real Estate Loans: Construction ................... $ 25,108 $ 18,489 $ 10,509 $ 10,299 $ 7,821 1-4 Family Residential ......... 134,672 112,699 93,215 76,243 62,356 Other .......................... 122,665 97,556 68,140 55,802 57,198 Commercial Loans .................. 107,711 79,722 67,977 61,972 51,307 Loans to Individuals .............. 91,279 78,980 79,882 91,719 79,485 ---------- ---------- ---------- ---------- ---------- Total Loans .................... $ 481,435 $ 387,446 $ 319,723 $ 296,035 $ 258,167 ========== ========== ========== ========== ========== </TABLE> 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 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, 2000, the majority of the Company's real estate loans were collateralized by properties located in Smith and Gregg Counties. Of the $282.4 million in real estate loans, $134.7 million or 47.7% represent loans collateralized by residential dwellings that are primarily owner occupied. Historically, the amount of losses suffered on this type of loan has been significantly less than those on other properties. The Company's loan policy requires appraisal prior to funding any real estate loans and also outlines the requirements for appraisals on renewals. Management 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. Real estate loans are divided into three categories: 1-4 Family Residential Mortgage Lending, Construction Loans and Commercial Real Estate Loans. 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 five to 30 years. These loans are typically fully amortizing with monthly payments sufficient to repay the total amount of the loan or amortizing with a balloon feature, typically due in fifteen years or less. The Company reviews information concerning the income, financial condition, employment and credit history when evaluating the creditworthiness of the applicant. 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. At December 31, 2000, these loans totaled $17.9 million. 3
5 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. The Company formed a special lending department during 1998 that makes loans to municipalities and school districts throughout the state of Texas. The majority of the loans to municipalities and school districts have tax pledges which additionally support these loans in addition to collateral. Average loans to municipalities and school districts increased approximately $16.2 million during the year ended December 31, 2000. At December 31, 2000, the Company had Commercial Loans to municipalities and school districts of $31.1 million and Real estate loans to municipalities and school districts of $1.3 million. 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, 2000 was approximately $3.9 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 $52.4 million at December 31, 2000. Additionally, the Company makes loans for a full range of other consumer purposes, which may be secured or unsecured depending on the credit quality and purpose of the loan. At this point, the economy in the Bank's trade territory appears stable. One area of concern is the nationwide personal bankruptcy rate. Management expects this rate 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 levels 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 MATURITIES AND SENSITIVITY TO CHANGES IN INTEREST RATES The following table represents loan maturities and sensitivity to changes in interest rates. The amounts of total loans outstanding at December 31, 2000, 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 ............................... $ 15,736 $ 7,845 $ 1,527 Real Estate Loans-Other .......................... 107,403 126,248 23,686 Commercial Loans ................................. 86,117 20,492 1,102 All Other Loans .................................. 58,204 29,442 3,633 ------------ ---------- ---------- Total Loans ................................ $ 267,460 $ 184,027 $ 29,948 ============ ========== ========== Loans with Maturities After One Year for Which: Interest Rates are Fixed or Predetermined $ 213,346 Interest Rates are Floating or Adjustable $ 24,604 </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. 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, 2000 and 1999, these loans totaled $8.9 million and $8.8 million or 17.2% and 23.3% 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. 5
7 LOAN LOSS EXPERIENCE AND RESERVE FOR LOAN LOSSES The loan loss reserve is based on the most current review of the loan portfolio at that time. Several methods are used to maintain the review in the most current manner. First, the servicing officer has the primary responsibility for updating significant changes in a customer's financial position. Accordingly, each officer prepares status updates on any credit deemed to be experiencing repayment difficulties which, in the officer's opinion, would place the collection of principal or interest in doubt. Second, an internal review officer from the Company is responsible for an ongoing review of the Company's entire loan portfolio with specific goals set for the volume of loans to be reviewed on an annual basis. Independent Bank Services, L.C., a partially owned subsidiary of the Bank, supplements the internal review officer's process by performing additional loans reviews designed to achieve overall goals of penetration. 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. Industry experience shows that a portion of the Company's loans will become delinquent and a portion of the loans will require partial or entire charge-off. Regardless of the underwriting criteria utilized, losses may be experienced as a result of various factors beyond the Company's control, including, among other things, changes in market conditions affecting the value of properties and problems affecting the credit of the borrower. Management's determination of the adequacy of allowance for loan losses is based on various considerations, including an analysis of the risk characteristics of various classifications of loans, previous loan loss experience, specific loans which would have loan loss potential, delinquency trends, estimated fair value of the underlying collateral, current economic conditions, the views of the regulators (who have the authority to require additional reserves), and geographic and industry loan concentration. In addition to maintaining an ongoing review of the loan portfolio, the internal review officer maintains a history of the loans that have been charged-off without first being identified as problems. This history is used to assist in gauging the amount of nonspecifically allocated reserve necessary, in addition to the portion which is specifically allocated by loan. The internal 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, 2000, the Company's review of the loan portfolio indicates that a loan loss reserve of $5.0 million is adequate. 6
8 The following table presents information regarding the average amount of net loans outstanding, changes in the reserve for loan losses, the ratio of net loans charged-off to average loans outstanding, and an allocation of the reserve for loan loss. LOAN LOSS EXPERIENCE AND RESERVE FOR LOAN LOSSES <TABLE> <CAPTION> Years Ended December 31, -------------------------------------------------------------------- 2000 1999 1998 1997 1996 ---------- ---------- ---------- ---------- ---------- (dollars in thousands) <S> <C> <C> <C> <C> <C> Average Net Loans Outstanding .............................. $ 434,559 $ 341,466 $ 304,255 $ 274,577 $ 243,925 ========== ========== ========== ========== ========== Balance of Reserve for Loan Loss at Beginning of Period .... $ 4,575 $ 3,564 $ 3,370 $ 3,249 $ 3,317 ---------- ---------- ---------- ---------- ---------- Loan Charge-Offs: Real Estate-Construction ................................... (15) -- -- -- -- Real Estate-Other .......................................... (14) -- (175) -- -- Commercial Loans ........................................... (522) (114) (405) (525) (70) Loans to Individuals ....................................... (891) (651) (769) (704) (768) ---------- ---------- ---------- ---------- ---------- Total Loan Charge-Offs ..................................... (1,442) (765) (1,349) (1,229) (838) ---------- ---------- ---------- ---------- ---------- Recovery of Loans Previously Charged off: Real Estate-Construction ................................... -- -- -- 10 -- Real Estate-Other .......................................... 34 5 36 14 7 Commercial Loans ........................................... 57 106 90 133 78 Loans to Individuals ....................................... 240 209 202 188 185 ---------- ---------- ---------- ---------- ---------- Total Recovery of Loans Previously Charged-Off ............. 331 320 328 345 270 ---------- ---------- ---------- ---------- ---------- Net Loan Charge-Offs ....................................... (1,111) (445) (1,021) (884) (568) Provision for Loan Loss .................................... 1,569 1,456 1,215 1,005 500 ---------- ---------- ---------- ---------- ---------- Balance at End of Period ................................... $ 5,033 $ 4,575 $ 3,564 $ 3,370 $ 3,249 ========== ========== ========== ========== ========== Ratio of Net Charge-Offs to Average Loans Outstanding ...... .26% .13% .34% .32% .23% ========== ========== ========== ========== ========== </TABLE> Allocation of Reserve for Loan Loss (dollars in thousands): <TABLE> <CAPTION> December 31, ------------------------------------------------------------------------------------------------ 2000 1999 1998 1997 1996 ---------------- ---------------- ---------------- ---------------- ---------------- % 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 .... $ 230 4.6% $ 91 2.0% $ 52 1.5% $ 52 1.5% $ 39 1.2% Real Estate-Other ........... 2,124 42.2% 1,804 39.4% 1,291 36.2% 1,087 32.3% 1,059 32.6% Commercial Loans ............ 1,561 31.0% 1,558 34.1% 1,182 33.2% 1,181 35.0% 1,129 34.7% Loans to Individuals ........ 1,097 21.8% 1,077 23.5% 1,017 28.5% 1,040 30.9% 948 29.2% Unallocated ................. 21 .4% 45 1.0% 22 .6% 10 .3% 74 2.3% ------ ------- ------ ------- ------ ------- ------ ------- ------ ------- Balance at End of Period .... $5,033 100% $4,575 100% $3,564 100% $3,370 100% $3,249 100% ====== ======= ====== ======= ====== ======= ====== ======= ====== ======= </TABLE> See "Consolidated Financial Statements - Note 6. 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 of two real estate properties. The Company is actively marketing the properties and they are not 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 Years Ended December 31, -------------------------------------------------------- 2000 1999 1998 1997 1996 -------- -------- -------- -------- -------- (dollars in thousands) <S> <C> <C> <C> <C> <C> Loans 90 Days Past Due: Real Estate ..................... $ 577 $ 233 $ 412 $ 454 $ 214 Loans to Individuals ............ 43 58 44 232 170 Commercial ...................... 599 48 120 56 88 -------- -------- -------- -------- -------- 1,219 339 576 742 472 -------- -------- -------- -------- -------- Loans on Nonaccrual: Real Estate ..................... 336 2 108 646 Loans to Individuals ............ 216 281 263 177 113 Commercial ...................... 78 422 167 1,059 774 -------- -------- -------- -------- -------- 630 703 432 1,344 1,533 -------- -------- -------- -------- -------- Restructured Loans: Real Estate ..................... 160 178 197 214 230 Loans to Individuals ............ 151 214 222 189 108 Commercial ...................... 78 56 54 32 62 -------- -------- -------- -------- -------- 389 448 473 435 400 -------- -------- -------- -------- -------- Total Nonperforming Loans .......... 2,238 1,490 1,481 2,521 2,405 Other Real Estate Owned ............ 43 140 195 364 273 Repossessed Assets ................. 196 209 326 206 262 -------- -------- -------- -------- -------- Total Nonperforming Assets ......... $ 2,477 $ 1,839 $ 2,002 $ 3,091 $ 2,940 ======== ======== ======== ======== ======== Percentage of Total Assets ......... .22% .18% .23% .54% .61% Percentage of Loans and Leases, Net of Unearned Income .......... .51% .47% .63% 1.04% 1.14% </TABLE> Total nonperforming assets increased $638,000 or 34.7% between December 31, 1999 and December 31, 2000. On January 3, 2001, one loan of $268,000 in the nonperforming asset category, loans 90 days past due, was paid in full. Nonperforming assets as a percentage of assets increased .04% from the previous year and as a percentage of loans increased .04%. 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, 2000 in the opinion of management, the Company had $431,000 of loans identified as potential problem loans. A potential problem loan is a loan where information about possible credit problems of the borrower is known, causing management to have serious doubts about the ability of the borrower to comply with the present loan repayment terms and may result in a future classification of the loan in one of the nonperforming asset categories. 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: <TABLE> <CAPTION> Valuation Carrying Total Allowance Value ------------ ------------ ------------ (in thousands) <S> <C> <C> <C> Real Estate Loans....................... $ 336 $ 32 $ 304 Commercial Loans........................ 78 20 58 Loans to Individuals.................... 216 29 187 ------------ ------------ ------------ Balance at December 31, 2000............ $ 630 $ 81 $ 549 ============ ============ ============ </TABLE> <TABLE> <CAPTION> Valuation Carrying Total Allowance Value ------------ ------------ ------------ (in thousands) <S> <C> <C> <C> Commercial Loans........................ $ 422 $ 225 $ 197 Loans to Individuals.................... 281 44 237 ------------ ------------ ------------ Balance at December 31, 1999............ $ 703 $ 269 $ 434 ============ ============ ============ </TABLE> For the years ended December 31, 2000 and 1999, the average recorded investment in impaired loans was approximately $567,000 and $565,000, respectively. During the years ended December 31, 2000 and 1999, 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 $122,000, $125,000 and $94,000 for the years ended December 31, 2000, 1999 and 1998, respectively. If these loans had been accruing interest at their original contracted rates, related income would have been $138,000, $137,000 and $113,000 for the years ended December 31, 2000, 1999 and 1998, respectively. The following is a summary of the Allowance for Losses on Other Real Estate Owned for the years presented: <TABLE> <CAPTION> Years Ended December 31, -------------------------------- 2000 1999 1998 -------- -------- -------- (in thousands) <S> <C> <C> <C> Balance at beginning of year ......... $ 61 $ 658 $ 672 Acquisition of OREO .............. -- 61 -- Disposition of OREO .............. (61) (658) (14) -------- -------- -------- Balance at end of year ............... $ -- $ 61 $ 658 ======== ======== ======== </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 HTM and are carried at their remaining unpaid principal balance, net of unamortized premiums or unaccreted discounts. Premiums are amortized and discounts are accreted using the level interest yield method over the estimated remaining term of the underlying security. Available for Sale (AFS). Debt and equity securities that will be held for indefinite periods of time, including securities that may be sold in response to changes in market interest or prepayment rates, needs for liquidity and changes in the availability of and the yield of alternative investments are classified as AFS. These assets are carried at market value. Market value is determined using published quotes as of the close of business. Unrealized gains and losses are excluded from earnings and reported net of tax as a separate component of shareholders' equity until realized. Management attempts to deploy investable funds into instruments which are expected to increase the overall return of the portfolio given the current assessment of economic and financial conditions, while maintaining acceptable levels of capital, interest rate and liquidity risk. The following table sets forth the carrying amount of Investment Securities, Mortgage-backed Securities and Marketable Equity Securities at December 31, 2000 and 1999: <TABLE> <CAPTION> December 31, ----------------------------- Available for Sale: 2000 1999 ------------ ------------ (in thousands) <S> <C> <C> U.S. Treasury ............................. $ 6,015 $ 9,467 U.S. Government Agencies................... 3,502 21,168 Mortgage-backed Securities: Direct Govt. Agency Issues.............. 254,667 232,855 Other Private Issues.................... 14,619 40,821 State and Political Subdivisions........... 45,150 55,543 Other Stocks and Bonds..................... 22,336 28,609 ------------ ------------ Total................................ $ 346,289 $ 388,463 ============ ============ </TABLE> <TABLE> <CAPTION> December 31, ----------------------------- Held to Maturity: 2000 1999 ------------ ------------ (in thousands) <S> <C> <C> U.S. Government Agencies.................. $ 39,888 $ 42,871 Mortgage-backed Securities: Direct Govt. Agency Issues............. 67,498 14,967 Other Private Issues................... 75,463 58,931 State and Political Subdivisions.......... 54,994 43,048 Other Stocks and Bonds.................... 9,626 289 ------------ ------------ Total............................... $ 247,469 $ 160,106 ============ ============ </TABLE> The Company invests in mortgage-backed and related securities, including mortgage participation certificates, which are insured or guaranteed by U.S. Government agencies and government sponsored enterprises, and collateralized mortgage obligations and real estate mortgage investment conduits. Mortgage-backed securities (which also are known as mortgage participation certificates or pass-through certificates) represent a participation interest in a pool of single-family or multi-family mortgages, the principal and interest payments on which are passed from the mortgage originators, through intermediaries (generally U.S. 10
12 Government agencies, government sponsored enterprises, and direct whole loans) that pool and repackage the participation interests in the form of securities, to investors such as the Company. U.S. Government agencies and government sponsored enterprises, which guarantee the payment of principal and interest to investors, primarily include the Federal Home Loan Mortgage Corporation, the Federal National Mortgage Association and the Government National Mortgage Association. The whole loans the Company purchases are all AAA rated collateralized mortgage obligations and real estate mortgage investment conduit tranches rated AAA due to credit support and/or insurance coverage. Mortgaged-backed securities typically are issued with stated principal amounts, and the securities are backed by pools of mortgages that have loans with interest rates that are within a range and have varying maturities. The characteristics of the underlying pool of mortgages, i.e., fixed-rate or adjustable-rate, as well as prepayment risk, are passed on to the certificate holder. The term of a mortgaged-backed pass-through security thus approximates the term of the underlying mortgages. The Company's mortgaged-backed derivative securities include collateralized mortgage obligations, which include securities issued by entities which have qualified under the Internal Revenue Code as real estate mortgage investment conduits. Collateralized mortgage obligations and real estate mortgage investment conduits (collectively collateralized mortgage obligations) have been developed in response to investor concerns regarding the uncertainty of cash flows associated with the prepayment option of the underlying mortgagor and are typically issued by governmental agencies, government sponsored enterprises and special purpose entities, such as trusts, corporations or partnerships, established by financial institutions or other similar institutions. A collateralized mortgage obligation can be collateralized by loans or securities which are insured or guaranteed by Federal National Mortgage Association, Federal Home Loan Mortgage Corporation, the Government National Mortgage Association, or whole loans which, in the Company's case, are all rated AAA. In contrast to pass-through mortgage-backed securities, in which cash flow is received pro rata by all security holders, the cash flow from the mortgages underlying a collateralized mortgage obligation is segmented and paid in accordance with a predetermined priority to investors holding various collateralized mortgage obligation classes. By allocating the principal and interest cash flows from the underlying collateral among the separate collateralized mortgage obligation classes, different classes of bonds are created, each with its own stated maturity, estimated average life, coupon rate and prepayment characteristics. Like most fixed-income securities, mortgage-backed and related securities are subject to interest rate risk. However, unlike most fixed-income securities, the mortgage loans underlying a mortgage-backed or related security generally may be prepaid at any time without penalty. The ability to prepay a mortgage loan generally results in significantly increased price and yield volatility (with respect to mortgage-backed and related securities) than is the case with non-callable fixed income securities. Furthermore, mortgage-backed derivative securities often are more sensitive to changes in interest rates and prepayments than traditional mortgage-backed securities and are, therefore, even more volatile. The combined Investment Securities, Mortgage-backed Securities, and Marketable Equity Securities portfolio increased to $593.8 million on December 31, 2000, compared to $548.6 million on December 31, 1999, an increase of $45.2 million or 8.2%. Mortgage-backed Securities increased $64.7 million or 18.6% during 2000 when compared to 1999. State and Political Subdivisions increased $1.6 million or 1.6% during 2000. U.S. Treasury securities decreased during 2000 compared to 1999 by $3.5 million or 36.5%, U.S. Government Agency securities decreased $20.6 million or 32.2% and Other Stocks and Bonds increased $3.1 million or 10.6% in 2000 compared to 1999 due to increased purchases of corporate bonds and increases in FHLB Dallas equity securities. During the first half of 2000, as rates continued to increase, the Company sold securities with an overall lower yield and, in some cases a longer average life and replaced them with securities with higher yields reflective of the interest rate environment at that time. During the second quarter ended June 30, 2000, the Company issued $54.4 million of long-term brokered CD's with one-year call options and additional call options every six months thereafter, until the CD matures. The average yield on these CD's was 8.19% with an average life of 10.8 years. Obtaining this long-term funding enabled the Bank to take advantage of the higher interest rate environment, primarily through the purchase of securities without incurring significant additional interest rate risk. The options associated with these CD's may provide the Bank with valuable balance sheet opportunities in the future. The higher cost associated with these callable CD's will have a negative impact on net interest spread during the next several quarters. In conjunction with the issuance of these long-term brokered CD's, securities were purchased with an overall duration and yield approximately that of the brokered CD's. 11
13 The market value of the Securities portfolio at December 31, 2000 was $599.8 million, which represented a net unrealized gain on that date of $1.0 million. The net unrealized gain was comprised of $13.5 million in unrealized gains and $12.5 million of unrealized losses. Net unrealized gains and losses on AFS securities, which is a component of Shareholders' Equity on the consolidated balance sheet, can fluctuate significantly as a result of changes in interest rates. Because management cannot predict the future direction of interest rates, the effect on Shareholders' Equity in the future cannot be determined; however, this risk is monitored closely through the use of shock tests on the AFS securities portfolio using an array of interest rate assumptions. During the month ended January 31, 2000 and the year ended December 31, 1999, the Company transferred securities totaling $91.7 million and $132.4 million, respectively, from AFS to HTM due to changes in market conditions. Of the total transferred, $21.2 million and $66.3 million were investment securities and $70.5 million and $66.1 million were mortgage-backed securities. The unrealized loss on the securities transferred from AFS to HTM was $2.6 million and $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, 2000 or 1999. On January 1, 2001, the Company adopted Financial Accounting Standards No. 133, "Accounting for Derivative Instruments and Hedging Activities" (FAS133) and Financial Accounting Standards No. 137, "Accounting for Derivative Instruments and Hedging Activities (FAS137). The transition provisions contained in FAS133 provide that at the date of initial application, an entity may transfer any debt security classified as HTM to AFS or trading. Effective January 1, 2001, as part of implementing FAS133 and FAS137, the Company elected to transfer all of its securities out of the HTM category in accordance with FAS133 guidance. Securities transferred on January 1, 2001 and sold during the first quarter ended March 31, 2001, will be accounted for as trading securities. All other securities transferred will be accounted for as AFS securities. The maturities classified according to the sensitivity to changes in interest rates of the December 31, 2000 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 ----------------------------------------------------------------------------- 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 -------- ------- -------- ------- -------- ------- -------- ------- (dollars in thousands) <S> <C> <C> <C> <C> <C> <C> <C> <C> U.S. Treasury ....................... $ 6,015 6.08% $ -- $ -- $ -- U.S. Government Agencies ............ 3,502 6.09% -- -- -- Mortgage-backed Securities .......... 73,413 7.73% 141,503 7.72% 45,820 7.67% 8,550 7.54% State and Political Subdivisions .... 630 7.77% 1,308 8.86% 1,640 7.88% 41,572 7.95% Other Stocks and Bonds .............. 19,974 8.10% 1,139 6.98% 971 7.00% 252 2.79% -------- -------- -------- -------- Total .......................... $103,534 7.65% $143,950 7.72% $ 48,431 7.66% $ 50,374 7.85% ======== ======== ======== ======== </TABLE> <TABLE> <CAPTION> MATURING OR REPRICING ----------------------------------------------------------------------------- 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 -------- ------- -------- ------- -------- ------- -------- ------- (dollars in thousands) <S> <C> <C> <C> <C> <C> <C> <C> <C> U.S. Government Agencies............. $ 12,534 7.28% $ 3,874 6.88% $ 10,023 7.19% $ 13,457 7.66% Mortgage-backed Securities........... 20,619 7.20% 46,044 7.37% 25,464 7.32% 50,834 7.31% State and Political Subdivisions 495 7.15% 1,880 7.27% 2,920 7.73% 49,699 8.12% Other Stocks and Bonds............... 1,991 6.88% 1,479 7.18% -- 6,156 6.55% -------- -------- -------- -------- Total................................ $ 35,639 7.21% $ 53,277 7.33% $ 38,407 7.32% $120,146 7.64% ======== ======== ======== ======== </TABLE> 12
14 DEPOSITS AND BORROWED FUNDS Deposits provide the Company with its primary source of funds. The increase of $133.1 million or 22.6% in Total Deposits during 2000 provided the Company with funds for the growth in loans and a portion of the growth in securities. Time Deposits increased $89.2 million or 34.7% during 2000 compared to 1999. This increase was due in part to $54.4 million of brokered CD's issued during the second quarter ended June 30, 2000. Noninterest Bearing Demand Deposits increased $16.3 million or 10.8% during 2000. Interest Bearing Demand Deposits increased $23.9 million or 15.0% and Saving Deposits increased $3.7 million or 18.4% during 2000. The latter three categories, which are considered the lowest cost deposits, comprised 51.9% of total deposits at December 31, 2000 compared to 56.2% at December 31, 1999. The increase in Total Deposits, not including the brokered CD's issued, was 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 at December 31, 2000 and 1999: <TABLE> <CAPTION> December 31, ----------------------- 2000 1999 ---------- ---------- (in thousands) <S> <C> <C> Noninterest Bearing Demand Deposits .... $ 166,899 $ 150,629 Interest Bearing Demand Deposits ....... 183,383 159,505 Savings Deposits ....................... 24,007 20,282 Time Deposits .......................... 346,316 257,128 ---------- ---------- Total Deposits ................. $ 720,605 $ 587,544 ========== ========== </TABLE> During the year ended December 31, 2000, total time deposits of $100,000 or more increased $63.7 million or 72.8% from December 31, 1999. This increase was due to $54.4 million of brokered CD's issued during the second quarter ended June 30, 2000 and overall bank growth which accounted for an increase of $9.3 million in time certificates of deposit at year ended December 31, 2000, and more than offset the decrease in Public Funds of $1.2 million at December 31, 2000. The table below sets forth the maturity distribution of time deposits of $100,000 or more issued by the Company at December 31, 2000 and 1999: <TABLE> <CAPTION> December 31, 2000 December 31, 1999 --------------------------------- --------------------------------- Time Other Time Other Certificates Time Certificates Time of Deposit Deposits Total of Deposit Deposits Total ------------ -------- --------- ------------ -------- --------- (in thousands) <S> <C> <C> <C> <C> <C> <C> Three months or less................ $ 22,671 $ 377 $ 23,048 $ 29,146 $ 377 $ 29,523 Over three to six months............ 16,603 12,000 28,603 14,345 13,228 27,573 Over six to twelve months........... 27,076 459 27,535 11,377 459 11,836 Over twelve months.................. 71,956 -- 71,956 18,536 -- 18,536 ------------ -------- --------- ------------ -------- --------- Total....................... $ 138,306 $ 12,836 $ 151,142 $ 73,404 $ 14,064 $ 87,468 ============ ======== ========= ============ ======== ========= </TABLE> 13
15 Short-term Obligations, consisting primarily of FHLB Dallas advances and Federal Funds Purchased, decreased $29.8 million or 16.0% during 2000 when compared to 1999. FHLB Dallas advances are collateralized by FHLB Dallas stock, nonspecified real estate loans and securities. <TABLE> <CAPTION> Years Ended December 31, ------------------------------------------------ 2000 1999 1998 ------------- ------------- ------------- (dollars in thousands) <S> <C> <C> <C> Federal Home Loan Bank ("FHLB") Dallas Advances Balance at end of period....................................... $ 148,940 $ 181,222 $ 118,000 Average amount outstanding during the period(1)................ 156,265 155,719 61,734 Maximum amount outstanding during the period................... 188,899 186,500 135,000 Weighted average interest rate during the period(2)............ 6.3% 5.3% 5.3% Interest rate at end of period................................. 6.1% 5.3% 5.0% </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. Long-term Obligations primarily consisting of FHLB Dallas advances and Junior Subordinated Debentures increased $21.9 million during 2000 to $216.6 million or an 11.2% increase when compared to $194.7 million in 1999. The increase is primarily a result of the Company issuing $17.0 million of convertible preferred securities. On November 2, 2000, the Company through its wholly-owned subsidiary, Southside Capital Trust II (the "Trust II Issuer"), sold 1,695,000 cumulative convertible preferred securities at a liquidation amount of $10 per convertible preferred security for an aggregate amount of $16,950,000. These securities have a convertible feature that allows the owner to convert each security to a share of the Company's common stock at a conversion price of $10 per common share. On May 18, 1998, the Company through its wholly-owned subsidiary, Southside Capital Trust (the "Trust Issuer"), sold 2,000,000 Preferred Securities (the "Junior Subordinated Debentures") at a liquidation amount of $10 per Preferred Security for an aggregate amount of $20,000,000. These securities have a distribution rate of 8.50% per annum payable at the end of each calendar quarter. 14
16 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 continued throughout 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. 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 to increase. EMPLOYEES At December 31, 2000, the Company employed approximately 365 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, 2000, were as follows: B. G. Hartley (Age 71), Chairman of the Board and Chief Executive Officer of the Company since 1983. He also serves as Chairman of the Board and Chief Executive Officer of the Company's subsidiary, Southside Bank, having served in these capacities since the Bank's inception in 1960. Sam Dawson (Age 53), 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 68), Vice Chairman of the Board of the Company and the Company's subsidiary, Southside Bank. He joined Southside Bank as a vice president in 1968. Jeryl Story (Age 49), Executive Vice President of the Company. Senior Executive Vice President - Loan Administration, Senior Lending Officer and Director of the Company's subsidiary, Southside Bank, since 1996. He joined Southside Bank in 1979 as an officer in Loan Documentation. Lee R. Gibson (Age 44), Executive Vice President and Chief Financial Officer of the Company and of the Company's subsidiary, Southside Bank. He is also a Director of Southside Bank. He became an officer of the Company in 1985 and of Southside Bank during 1984. All the individuals named above serve in their capacity as officers of the Company and/or Southside Bank at the pleasure of each entities' Board of Directors. 15
17 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. 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 Federal Reserve. The Company and Southside Delaware are required to file annual and other reports with, and furnish information to, the Federal Reserve, which makes periodic inspections of the Company and Southside Delaware. The Bank Holding Company Act provides that a bank holding company must obtain the prior approval of the Federal Reserve for the acquisition of more than five percent of the voting stock or substantially all the assets of any bank or bank holding company. In addition, the Bank Holding Company Act restricts the extension of credit to any bank holding company by its subsidiary bank. The Bank Holding Company Act also provides that, with certain exceptions, a bank holding company may not engage in any activities other than those of banking or managing or controlling banks and other authorized subsidiaries or own or control more than five percent of the voting shares of any company that is not a bank. The Federal Reserve has deemed limited activities to be closely related to banking and therefore permissible for a bank holding company. 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 Financial Services Modernization Act of 1999, which became effective on March 11, 2000, expands the types of activities in which a bank holding company may engage. Subject to various limitations, the Modernization Act generally permits a bank holding company to elect to become a "financial holding company." A financial holding company may affiliate with securities firms and insurance companies and engage in other activities that are "financial in nature." Among the activities that are 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, certain merchant banking activities and activities that the Federal Reserve considers to be closely related to banking. A bank holding company may become a financial holding company under the Modernization Act if each of its subsidiary banks is "well capitalized" under the Federal Deposit Insurance Corporation Improvement Act prompt corrective action provisions, is well managed and has at least a satisfactory rating under the Community Reinvestment Act. In addition, the bank holding company must file a declaration with the Federal Reserve that the bank holding company wishes to become a financial holding company. A bank holding company that falls out of compliance with these requirements may be required to cease engaging in some of its activities. Any bank holding company that does not elect to become a financial holding company remains subject to the current restrictions of the Bank Holding Company Act. In a similar manner, a bank may establish one or more subsidiaries, which subsidiaries may then engage in activities that are financial in nature. However, applicable law and regulation provide that the amount of investment in these activities generally are limited to 45% of the total assets of the bank, and these investments are not aggregated with the bank for determining compliance with capital adequacy guidelines. Further, the transactions between the bank and this type of subsidiary are subject to a number of limitations. Under the Modernization Act, the Federal Reserve serves as the primary "umbrella" regulator of financial holding companies, with supervisory authority over each parent company and limited authority over its subsidiaries. Expanded financial activities of financial holding companies generally will be regulated according to the type of such financial activity: banking activities by banking regulators, securities activities by securities regulators and insurance activities by insurance regulators. The Modernization Act also imposes additional restrictions and heightened disclosure requirements regarding private information collected by financial 16
18 institutions. All implementing regulations under the Modernization Act have not yet become effective in final form, and the Company cannot predict the full sweep of the new legislation and have not yet determined whether it will elect to become a financial holding company. The Federal Reserve has cease-and-desist powers over bank holding companies and their nonbanking subsidiaries where their actions would constitute a serious threat to the safety, soundness or stability of a subsidiary bank. 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 to acquire a bank or bank holding company located in Texas. This type of acquisition may occur only if the Texas bank to be directly or indirectly controlled by the out-of-state bank holding company has existed and continuously operated as a bank for a period of at least five years. In any event, a bank holding company may not own or control banks in Texas the deposits of which would exceed 20% of the total deposits of all federally-insured deposits in Texas. The Company has no present plans to acquire or establish banks outside the State of Texas but have not eliminated the possibility of doing so. The Federal Reserve has promulgated capital adequacy regulations for all bank holding companies with assets in excess of $150 million. The Federal Reserve's capital adequacy regulations are based upon a risk based capital determination, whereby a bank holding company's capital adequacy is determined in light of the risk, both on- and off-balance sheet, contained in the company's assets. Different categories of assets are assigned risk weightings and are counted at a percentage of their book value. The regulations divide capital between Tier 1 capital (core capital) and Tier 2 capital. For a bank holding company, Tier 1 capital consists primarily of common stock, related surplus, noncumulative perpetual preferred stock, minority interests in consolidated subsidiaries and a limited amount of qualifying cumulative preferred securities. Goodwill and certain other intangibles are excluded from Tier 1 capital. Tier 2 capital consists of an amount equal to the allowance for loan and lease losses up to a maximum of 1.25% of risk weighted assets, limited other types of preferred stock not included in Tier 1 capital, hybrid capital instruments and term subordinated debt. Investments in and loans to unconsolidated banking and finance subsidiaries that constitute capital of those subsidiaries are excluded from capital. The sum of Tier 1 and Tier 2 capital constitutes qualifying total capital. The Tier 1 component must comprise at least 50% of qualifying total capital. Every bank holding company has to achieve and maintain a minimum Tier 1 capital ratio of at least 4.0% and a minimum total capital ratio of at least 8.0%. In addition, banks and bank holding companies are required to maintain a minimum leverage ratio of Tier 1 capital to average total consolidated assets (leverage capital ratio) of at least 3.0% for the most highly-rated, financially sound banks and bank holding companies and a minimum leverage ratio of at least 4.0% for all other banks. The Federal Deposit Insurance Corporation and the Federal Reserve define Tier 1 capital for banks in the same manner for both the leverage ratio and the risk-based capital ratio. However, the Federal Reserve defines Tier 1 capital for bank holding companies in a slightly different manner. As of December 31, 2000, the Company's Tier 1 leverage capital ratio was 6.31%. 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. The guidelines also indicate that the Federal Reserve will continue to consider a "Tangible Tier 1 Leverage Ratio" in evaluating proposals for expansion or new activities. The Tangible Tier 1 Leverage Ratio is the ratio of Tier 1 capital, less intangibles not deducted from Tier 1 capital, to quarterly average total assets. As of December 31, 2000, the Federal Reserve had not advised the Company of any specific minimum Tangible Tier 1 Leverage Ratio applicable to the Company. 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 sources of income are dividends paid by the bank. The Company must pay all of its operating expenses from funds received by it from the bank. Therefore, 17
19 shareholders may receive dividends from the Company only to the extent that funds are available after payment of the Company's operating expenses. In addition, in November 1985 the Federal Reserve adopted a policy statement concerning payment of cash dividends, which generally prohibits bank holding companies from paying dividends except out of operating earnings, and the prospective rate of earnings retention appears consistent with the bank holding company's capital needs, asset quality and overall financial condition. THE BANK The bank is subject to various requirements and restrictions under the laws of the United States and the State of Texas, and to regulation, supervision and regular examination by the Texas Department of Banking and the Federal Deposit Insurance Corporation. The Texas Department of Banking and the Federal Deposit Insurance Corporation have the power to enforce compliance with applicable banking statutes and regulations. These requirements and restrictions include requirements to maintain reserves against deposits, restrictions on the nature and amount of loans that may be made and the interest that may be charged thereon and restrictions relating to investments and other activities of the bank. Transactions with Affiliates. The bank may not engage in specified transactions (including, for example, loans) with its affiliates unless the terms and conditions of those 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 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, 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. The bank also 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, these loans must be approved by the bank's board of directors in advance, must be on terms and conditions as favorable to the bank as those available to an unrelated person and are limited in amount. 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 or consumer and penalties to the bank are provided if the bank fails to comply with these laws and regulations. The scope and requirements of these laws and regulations have expanded significantly in recent years. 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 area. If other banks were to establish branch facilities near the Bank or any of its facilities, it is uncertain whether these branch facilities would have a material adverse effect on the business of the Bank. In 1994 Congress adopted the Reigle-Neal Interstate Banking and Branching Efficiency Act of 1994. That statute provides for nationwide interstate banking and branching, subject to certain aging and deposit concentration limits that may be imposed under applicable state laws. Current Texas law permits interstate branching only through acquisition of a financial institution that is at least five 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 with its main office outside of Texas generally cannot branch on a de novo basis into Texas. The new law permits applicable regulatory authorities to approve de novo branching in Texas by institutions located in states that would permit Texas institutions to branch on a de novo basis into those states. The Federal Deposit Insurance Corporation 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 18
20 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 Federal Reserve. Changes in the discount rate on member bank borrowings, control of borrowings, open market operations, the imposition of and changes in reserve requirements against member banks, deposits and assets of foreign branches, the imposition of and changes in reserve requirements against certain borrowings by banks and their affiliates and the placing of limits on interest rates which member banks may pay on time and savings deposits are some of the instruments of monetary policy available to the Federal Reserve. Those monetary policies influence to a significant extent the overall growth of all bank loans, investments and deposits and the interest rates charged on loans or paid on time and savings deposits. The nature of future monetary policies and the effect of such policies on the future business and earnings of the 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. The Federal Deposit Insurance Corporation has the right to prohibit the payment of dividends by the Bank where the payment is deemed to be an unsafe and unsound banking practice. The Bank is also subject to certain restrictions on the payment of dividends as a result of the requirements that it maintain an adequate level of capital in accordance with guidelines promulgated from time to time by the Federal Deposit Insurance Corporation. The exact amount of future dividends on the stock of the Bank will be a function of the profitability of the Bank in general 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 1990, the federal banking regulators promulgated capital adequacy regulations to which all national and state banks, such as the Bank, are subject. These requirements are similar to the Federal Reserve requirements promulgated with respect to bank holding companies discussed previously. Changes in Management. 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 this 30-day period, the applicable federal banking regulatory agency may disapprove of the addition of employment of such director or officer. The Bank is not subject to any such requirements. Enforcement Authority. The federal banking laws also contain civil and criminal penalties available for use by the appropriate regulatory agency against certain "institution-affiliated parties" primarily including management, employees and agents of a financial institution, as well as independent contractors such as attorneys and accountants and others who participate in the conduct of the financial institution's affairs and who caused or are likely to cause more than minimum financial loss to or a significant adverse affect on the institution, who knowingly or recklessly violate a law or regulation, breach a fiduciary duty or engage in unsafe or unsound practices. These practices can include the failure of an institution to timely file required reports or the submission of inaccurate reports. These laws authorize the appropriate banking agency to issue cease and desist orders that may, among other things, require affirmative action to correct any harm resulting from a violation or practice, including restitution, reimbursement, indemnification or guarantees against loss. A financial institution may also be ordered to restrict its growth, dispose of certain assets or take other action as determined by the ordering agency to be appropriate. 19
21 Annual Audits. Every bank with total assets in excess of $500 million, such as the Bank, must have an annual independent audit made of the bank's financial statements by a certified public accountant to verify that the financial statements of the bank are presented in accordance with generally accepted accounting principles and comply with such other disclosure requirements as prescribed by the Federal Deposit Insurance Corporation. Prompt Corrective Action. Banks are subject to restrictions on their activities depending on their level of capital. The Federal Deposit Insurance Corporation's "prompt corrective action" regulations divides banks into five different categories, depending on their level of capital. Under these regulations, a bank is deemed to be "well capitalized" if it has a total risk-based capital ratio of 10% or more, a core capital ratio of six percent or more and a leverage ratio of five percent or more, and if the bank is not subject to an order or capital directive to meet and maintain a certain capital level. Under these regulations, a bank is deemed to be "adequately capitalized" if it has a total risk-based capital ratio of eight percent or more, a core capital ratio of four percent or more and a leverage ratio of four percent or more (unless it receives the highest composite rating at its most recent examination and is not experiencing or anticipating significant growth, in which instance it must maintain a leverage ratio of three percent or more). Under these regulations, a bank is deemed to be "undercapitalized" if it has a total risk-based capital ratio of less than eight percent, a core capital ratio of less than four percent or a leverage ratio of less than four percent. Under these regulations, a bank is deemed to be "significantly undercapitalized" if it has a risk-based capital ratio of less than six percent, a core capital ratio of less than three percent and a leverage ratio of less than three percent. Under such regulations, a bank is deemed to be "critically undercapitalized" if it has a leverage ratio of less than or equal to two percent. In addition, the Federal Deposit Insurance Corporation has the ability to downgrade a bank's classification (but not to "critically undercapitalized") based on other considerations even if the bank meets the capital guidelines. If a state nonmember bank, such as the Bank, is classified as undercapitalized, the bank is required to submit a capital restoration plan to the Federal Deposit Insurance Corporation. An undercapitalized bank is prohibited from increasing its assets, engaging in a new line of business, acquiring any interest in any company or insured depository institution, or opening or acquiring a new branch office, except under certain circumstances, including the acceptance by the Federal Deposit Insurance Corporation of a capital restoration plan for the bank. If a state nonmember bank is classified as undercapitalized, the Federal Deposit Insurance Corporation may take certain actions to correct the capital position of the bank. If a bank is classified as significantly undercapitalized, the Federal Deposit Insurance Corporation would be required to take one or more prompt corrective actions. These actions would include, among other things, requiring sales of new securities to bolster capital, improvements in management, limits on interest rates paid, prohibitions on transactions with affiliates, termination of certain risky activities and restrictions on compensation paid to executive officers. If a bank is classified as critically undercapitalized, the bank must be placed into conservatorship or receivership within 90 days, unless the Federal Deposit Insurance Corporation determines otherwise. The capital classification of a bank affects the frequency of examinations of the bank and impacts the ability of the bank to engage in certain activities and affects the deposit insurance premiums paid by the bank. The Federal Deposit Insurance Corporation is required to conduct a full-scope, on-site examination of every bank at least once every twelve months. An exception to this rule provides that banks that have assets of less than $100 million, are categorized as "well capitalized," were found to be well managed with a composite rating of "outstanding" and have not been subject to a change in control during the last 12 months, need only be examined by the Federal Deposit Insurance Corporation once every 18 months. Banks also may be restricted in their ability to accept brokered deposits, depending on their capital classification. "Well capitalized" banks are permitted to accept brokered deposits, but all banks that are not well capitalized are not permitted to accept such deposits. The Federal Deposit Insurance Corporation may, on a case-by-case basis, permit banks that are adequately capitalized to accept brokered deposits if the Federal Deposit Insurance Corporation determines that acceptance of such deposits would not constitute an unsafe or unsound banking practice with respect to the bank. Risk Based Deposit Insurance Premiums. The Federal Deposit Insurance Corporation assesses insurance premiums on a bank's deposits at a variable rate depending on the probability that the deposit insurance fund will incur a loss with respect to the bank. The Federal Deposit Insurance Corporation determines the deposit insurance assessment rates on the basis of the bank's capital classification and 20
22 supervisory evaluations. Each of these categories has three subcategories, resulting in nine assessment risk classifications. The three subcategories with respect to capital are "well capitalized," "adequately capitalized" and "less than adequately capitalized" (that would include "undercapitalized," "significantly undercapitalized" and "critically undercapitalized" banks). The three subcategories with respect to supervisory concerns are "healthy," "supervisory concern" and "substantial supervisory concern." A bank is deemed "healthy" if it is financially sound with only a few minor weaknesses. A bank is deemed subject to "supervisory concern" if it has weaknesses that, if not corrected, could result in significant deterioration of the bank and increased risk to the Bank Insurance Fund of the Federal Deposit Insurance Corporation. A bank is deemed subject to "substantial supervisory concern" if it poses a substantial probability of loss to the Bank Insurance Fund. Deposit Insurance. The bank's deposits are insured up to $100,000 per insured account by the Bank Insurance Fund. The bank's deposit insurance assessments may increase depending upon the risk category and subcategory, if any, to which the bank is assigned by the Federal Deposit Insurance Corporation. 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 might be enacted or what other regulations might be adopted or the effects thereof. 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, 2000, 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, 2000 were in excess of the minimum requirements. Also see discussion of "Capital Resources" under Item 7. USURY LAWS Texas usury laws limit the rate of interest that may be charged by state banks. Certain Federal laws provide a limited preemption of Texas usury laws. The maximum rate of interest that Southside Bank may charge on direct business loans under Texas law varies between 18% per annum and (i) 28% per annum for business and agricultural loans above $250,000 or (ii) 24% per annum for other direct loans. Texas floating usury ceilings are tied to the 26-week United States Treasury Bill Auction rate. Other ceilings apply to open-end credit card loans and dealer paper purchased by Southside Bank. A Federal statute removes interest ceilings under usury laws for loans by Southside Bank which are secured by first liens on residential real property. ECONOMIC ENVIRONMENT The monetary policies of regulatory authorities, including the FRB, have a significant effect on the operating results of bank holding companies and their subsidiaries. The FRB regulates the national supply of bank credit. Among the means available to the FRB are open market operations in United States Government Securities, changes in the discount rate on member bank borrowings, changes in reserve requirements against member and nonmember bank deposits, and loans and limitations on interest rates which member banks may pay on time or demand deposits. These methods are used in varying combinations to influence overall growth and distribution of bank loans, investments and deposits. Their use may affect interest rates charged on loans or paid for deposits. Also see discussion of "Banking Industry in Texas" above. 21
23 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, accounts payable operations, other support areas and training facilities are located. o Land and building located at 1010 East First Street in Tyler where motor bank facilities are located. o Property and a building 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 and a building on South Broadway Avenue near the South Broadway branch where motor bank facilities are located. o Twenty-one 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 constructed a permanent branch facility complete with motor bank facilities. o Property on U.S. Highway 69 in Lindale, Texas, where the Company will construct a permanent branch facility complete with motor bank facilities. o Property in Whitehouse, Texas, where the Company will construct a permanent branch facility complete with motor bank facilities. The Company completed expansion and remodeling of the operations annex building, located on the property of the bank's headquarters during 2000. 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 was completed during 2000. The Company purchased property in Lindale on Highway 69, north of Interstate 20 on which it plans to build a branch facility with motor bank facilities during 2001. During the second quarter of 2000, the Company received approval from the Federal Deposit Insurance Corporation to open a second full service branch in Lindale. The Company plans to open the Lindale branch in temporary facilities during the first half of 2001. The Company also acquired property in Whitehouse, Texas in southern Smith County on which it plans to begin construction of a full service branch during 2001. 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. 22
24 ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS During the three months ended December 31, 2000, 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 January 1, 1999 to December 31, 2000. During the second quarter of 2000, the Company declared and paid a two for one stock split. During the fourth quarter of 2000, the Company declared and paid a 5% stock dividend. During the third quarter of 1999 and 1998, the Company declared and paid a 5% stock dividend. Stock prices listed below have been adjusted to give retroactive recognition to stock splits and stock dividends. <TABLE> <CAPTION> Year Ended 1st qtr. 2nd qtr. 3rd qtr. 4th qtr. - ----------------------- ------------------- ------------------- ------------------ ------------------ <S> <C> <C> <C> <C> December 31, 2000 $ 8.99 - 7.97 $ 9.45 - 7.93 $ 8.36 - 7.33 $ 8.41 - 6.98 December 31, 1999 $ 9.10 - 7.79 $ 8.28 - 7.71 $ 11.21 - 8.00 $ 11.44 - 8.37 </TABLE> See "Item 7. Capital Resources" for a discussion of the Company's common stock repurchase program. STOCKHOLDERS There were approximately 1,111 holders of record of the Company's common stock, the only class of equity securities currently issued and outstanding, as of February 28, 2001. DIVIDENDS Cash dividends declared and paid were $0.225 per share for the year ended December 31, 2000. Cash dividends declared and paid were $.20 per share for the years ended December 31, 1999 and 1998. Stock dividends of 5% were also declared and paid during each of the years ended December 31, 2000, 1999 and 1998. 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. 23
25 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, 2000. 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. <TABLE> <CAPTION> As of and For the Years Ended December 31, ---------------------------------------------------------------- 2000 1999 1998 1997 1996 ----------- ----------- ----------- ----------- ----------- (in thousands, except per share data) <S> <C> <C> <C> <C> <C> Investment Securities............................ $ 161,285 $ 182,452 $ 132,794 $ 71,835 $ 57,825 =========== =========== =========== =========== =========== Mortgage-backed and Related Securities........... $ 412,247 $ 347,574 $ 341,004 $ 141,413 $ 114,356 =========== =========== =========== =========== =========== Loans, Net of Reserve for Loan Loss.............. $ 476,402 $ 382,871 $ 316,159 $ 292,665 $ 254,918 =========== =========== =========== =========== =========== Total Assets..................................... $ 1,151,881 $ 1,012,565 $ 876,329 $ 571,189 $ 482,755 =========== =========== =========== =========== =========== Deposits......................................... $ 720,605 $ 587,544 $ 515,034 $ 462,674 $ 425,950 =========== =========== =========== =========== =========== Long-term Obligations............................ $ 216,595 $ 194,704 $ 176,027 $ 28,547 $ 9,096 =========== =========== =========== =========== =========== Interest & Deposit Service Income................ $ 83,463 $ 67,468 $ 49,030 $ 39,168 $ 34,593 =========== =========== =========== =========== =========== Net Income....................................... $ 9,825 $ 7,924 $ 5,351 $ 5,006 $ 4,205 =========== =========== =========== =========== =========== Net Income Per Common Share-Basic................ $ 1.29 $ 1.03 $ .69 $ .64 $ .53 =========== =========== =========== =========== =========== Net Income Per Common Share-Diluted.............. $ 1.24 $ 1.00 $ .66 $ .62 $ .52 =========== =========== =========== =========== =========== Cash Dividends Declared Per Common Share......... $ .225 $ .20 $ .20 $ .20 $ .20 =========== =========== =========== =========== =========== </TABLE> 24
26 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, 2000, 1999 and 1998 and financial condition as of December 31, 2000 and 1999. This discussion should be read in conjunction with the financial statements and related notes. All share data has been adjusted to give retroactive recognition to stock splits and stock dividends. 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 $139.3 million or 13.8% to $1.2 billion at December 31, 2000 from $1.0 billion at December 31, 1999. The increase was primarily attributable to a $93.5 million increase in net loans and a $45.2 million increase in the securities portfolio. The securities portfolio totaled $593.8 million at December 31, 2000 compared to $548.6 million at December 31, 1999. At December 31, 2000, net loans were $476.4 million compared to $382.9 million at December 31, 1999. The increase in loans and securities was funded primarily by retail deposit growth. Nonperforming assets at December 31, 2000 totaled $2.5 million, representing 0.22% of total assets, compared to $1.8 million or 0.18% of total assets at December 31, 1999. Nonaccruing loans decreased to $630,000 and the ratio of nonaccruing loans to total loans decreased to 0.13% at December 31, 2000 as compared to $703,000 or 0.18% at December 31, 1999. Real estate owned decreased to $43,000 at December 31, 2000 from $140,000 at December 31, 1999. Loans 90 days past due at December 31, 2000 totaled $1.2 million compared to $.3 million at December 31, 1999, an increase of $.9 million. Deposits increased $133.1 million to $720.6 million at December 31, 2000 from $587.5 million at December 31, 1999. FHLB Dallas advances were $328.6 million at December 31, 2000, a $27.3 million decrease from $355.9 million at December 31, 1999. Short-term FHLB Dallas advances decreased $32.3 million to $148.9 million at December 31, 2000 from $181.2 million at December 31, 1999. Long-term FHLB Dallas advances increased $4.9 million to $179.6 million at December 31, 2000 from $174.7 million at December 31, 1999. Other borrowings at December 31, 2000 and 1999 totaled $44.3 million and $24.8 million, respectively, and at December 31, 2000 consisted of $7.3 million short-term borrowings, $17.0 million of Long-term Junior Subordinated Convertible Debentures and $20.0 million of Long-term Junior Subordinated Debentures. On November 2, 2000, the Company through its wholly-owned subsidiary, Southside Capital Trust II (the "Trust II Issuer"), sold 1,695,000 cumulative convertible preferred securities at a liquidation amount of $10 per convertible preferred security for an aggregate amount of $16,950,000. These securities have a convertible feature that allows the owner to convert each security to a share of the Company's common stock at a conversion price of $10 per common share. 25
27 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, 2000 totaled $51.7 million compared to $37.7 million at December 31, 1999. The increase primarily reflects the net income recorded for the year ended December 31, 2000 and a decrease in the accumulated other comprehensive loss of $6.3 million, partially offset by the repurchase of 94,050 shares of the outstanding stock at an average price of $8.65 per share and the declaration of cash dividends. LEVERAGE STRATEGY In May 1998 the Company implemented a leverage strategy designed to enhance its profitability with acceptable levels of credit, interest rate and liquidity risk. The leverage strategy consists of borrowing long and short-term funds from the Federal Home Loan Bank and investing the funds primarily in mortgage-backed securities, and to a lesser extent, long-term municipal securities. Although mortgage-backed securities often carry lower yields than traditional mortgage loans and other types of loans the Company makes, these securities generally increase the overall quality of the Company's assets by virtue of the securities' underlying insurance or guarantees, are more liquid than individual loans and may be used to collateralize the Company's borrowings or other obligations. While the strategy of investing a substantial portion of the Company's assets in mortgage-backed and municipal securities has resulted in lower interest rate spreads and margins, the Company believes that the lower operating expenses and reduced credit and interest rate risk of this strategy have enhanced its overall profitability. While the Company may increase its leverage to offset interest expense associated with this convertible preferred securities offering, the balance sheet strategy going forward will be to gradually replace a portion of the Company's securities portfolio with higher yielding loans. On the liability side, the Company intends to gradually replace a portion of the short-term Federal Home Loan Bank borrowings with deposits. The intended net result is to increase the Company's net interest spread. Since completing the initial phase of the Company's leverage strategy during the second quarter of 1999, its net interest spread has begun to increase. The leverage strategy is dynamic and requires ongoing management. As interest rates, funding costs and security spreads change, the Company's determination of the proper securities to purchase and funding to obtain must be re-evaluated. RESULTS OF OPERATIONS The Company's results of operations are dependent primarily on net interest income, which is the difference between the income earned on its loan, securities and investment portfolios and its cost of funds, consisting of the interest paid on deposits and borrowings. Results of operations are also affected by the Company's noninterest income, provision for loan losses and noninterest expenses. General economic and competitive conditions, particularly changes in interest rates, 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, 2000 COMPARED TO DECEMBER 31, 1999 OVERVIEW During the year ended December 31, 2000, the Company's net income increased $1.9 million or 24.0% to $9.8 million, from $7.9 million for the same period in 1999. The increase in net income was primarily attributable to an increase in interest income due to a more favorable net interest spread and the growth in earning assets. Noninterest income, not including gains or losses on sales of securities, also grew due to deposit services income. These increases were partially offset by an increase in noninterest expense and losses on sales of securities. Earnings per share of $1.24 represented an increase of $0.24 or 24.0% over the year ended December 31, 1999. 26
28 NET INTEREST INCOME Net interest income is the principal source of a financial institution's earnings stream and represents the difference or spread between interest and fee income generated from interest earning assets and the interest expense paid on deposits and borrowed funds. Fluctuations in interest rates as well as volume and mix changes in interest earning assets and interest bearing liabilities materially impact net interest income. Net interest income for the year ended December 31, 2000 was $29.3 million, an increase of $4.6 million or 18.7% compared to the same period in 1999. Average interest earning assets increased $109.0 million or 12.3%, while the net yield on average earning assets increased from 3.02% at December 31, 1999 to 3.22% at December 31, 2000. As interest rates increased during 1999 and the first half of 2000, the Company's premium mortgage-backed securities increased in yield as prepayment speeds decreased. This increase in yield, along with the increase in average loans, combined to increase the net interest spread. Future increases in the net interest spread will become more difficult due to competition and long-term liabilities purchased at higher rates. During the year ended December 31, 2000, average loans, funded primarily by the growth in average deposits and average Federal Home Loan Bank advances, increased $93.1 million or 27.3%, compared to the same period in 1999. The average yield on loans increased from 8.28% at December 31, 1999 to 8.45% at December 31, 2000, reflective of an overall increase in interest rates. The increase in interest income on Loans of $8.0 million or 28.5% was the result of the increase in Average Loans and average yield on loans during 2000. Average investment and mortgage-backed securities increased $17.8 million or 3.4% for the year ended December 31, 2000 when compared to the same period in 1999. This increase was a direct result of the leverage strategy implemented in 1998. The overall yield on Average Securities increased to 7.35% during the year ended December 31, 2000 from 6.35% during the same period in 1999, due in part to decreased prepayment speeds on mortgage-backed securities which led to decreased amortization expense, combined with a restructuring of a portion of the securities portfolio into higher yielding securities due to higher overall interest rates. Interest income on investment and mortgage-backed securities increased $6.2 million in 2000 or 20.0% compared to 1999 due to the increase in the Average Securities and the increase in the average yield of securities during 2000. Interest income from marketable equity securities, federal funds and other interest earning assets increased $461,000 or 34.6% for the year ended December 31, 2000 when compared to 1999 as a result of higher rates and a special dividend of $304,000 on the Company's FHLB Dallas stock which more than offset the average balance decrease of 7.5%. During the year ended December 31, 2000, the mix of the Company's Interest Earning Assets reflected an increase in Loans compared to the prior year end as Loans averaged 43.5% of Total Average Interest Earning Assets compared to 38.4% during 1999, a direct result of significant loan growth. Securities averaged 56.1% of the total and Other Interest Earning Asset categories averaged 0.4% for December 31, 2000. During 1999 the comparable mix was 60.7% in Securities and 0.9% in the Other Interest Earning Asset categories. Total interest expense increased $10.1 million or 28.1% to $46.1 million during the year ended December 31, 2000 as compared to $36.0 million during the same period in 1999. The increase was attributable to an increase in average interest bearing liabilities of $108.5 million or 14.3% and an increase in the average yield on interest bearing liabilities from 4.75% at December 31, 1999 to 5.33% at December 31, 2000. Average interest bearing deposits increased $95.2 million or 23.8% while the average rate paid increased from 4.13% at December 31, 1999 to 4.81% at December 31, 2000. Average Time Deposits increased $74.3 million or 31.8% while the average rate paid increased 87 basis points. Average Interest Bearing Demand Deposits increased $17.9 million or 12.1% and Average Savings Deposits increased $2.9 million or 15.2%. Average Noninterest Bearing Demand Deposits increased during 2000 $8.4 million or 6.1%. The latter three categories, which are considered the lowest cost deposits, comprised 52.0% of total average deposits during the year ended December 31, 2000 compared to 56.6% during 1999 and 54.2% during 1998. The increase in Average Total Deposits is reflective of overall bank growth, brokered CD issuance, branch expansion and, except for the brokered CD's issued, was the primary source of funding the increase in Average Loans. 27
29 During the second quarter ended June 30, 2000, the Company issued $54.4 million of long-term brokered CD's with one-year call options and additional call options every six months thereafter, until the CD matures. The average yield on these CD's was 8.19% with an average life of 10.8 years. Obtaining this long-term funding should enable the Bank to take advantage of the higher interest rate environment, primarily through the purchase of securities without incurring significant additional interest rate risk. The higher cost associated with these callable CD's will have a negative impact on net interest spread during the next several quarters. The options associated with these CD's may provide the bank with valuable balance sheet opportunities in the future. During the second quarter, the bank introduced a new Platinum Money Market Deposit Account. This account pays a higher rate on larger deposit balances than the bank's other money market account. As deposits shift to the new money market account, the higher interest cost associated with this change will have a negative impact on net interest margin. The bank hopes to attract new deposits due to the competitive rate of this account. While the interest rate on this account is higher than the Company's previous money market account, the interest rate is comparable to and in some cases is lower than the rate for short-term borrowings from the FHLB. As new deposits are obtained, short-term FHLB Dallas funds may be replaced which may offset some of the negative impact on the Bank's net interest margin. The following table sets forth the Company's deposit averages by category for the years ended December 31, 2000, 1999 and 1998: <TABLE> <CAPTION> COMPOSITION OF DEPOSITS Years Ended December 31, --------------------------------------------------------------- 2000 1999 1998 ------------------- ------------------- ------------------- (dollars in thousands) AVG. AVG. AVG. AVG. AVG. AVG. BALANCE YIELD BALANCE YIELD BALANCE YIELD --------- ------- --------- ------- --------- ------- <S> <C> <C> <C> <C> <C> <C> Noninterest Bearing Demand Deposits.............. $ 145,883 N/A $ 137,499 N/A $ 105,779 N/A Interest Bearing Demand Deposits................. 165,790 2.99% 147,878 2.83% 131,006 2.79% Savings Deposits................................. 22,207 2.57% 19,272 2.56% 17,280 2.70% Time Deposits.................................... 307,663 5.95% 233,354 5.08% 214,419 5.30% --------- --------- --------- Total Deposits.............................. $ 641,543 3.72% $ 538,003 3.08% $ 468,484 3.31% ========= ========= ========= </TABLE> Average short-term interest bearing liabilities, consisting primarily of FHLB Dallas advances and federal funds purchased, were $161.2 million, a decrease of $1.1 million or .7% for the year ended December 31, 2000 when compared to the same period in 1999. Average long-term interest bearing liabilities consisting of FHLB Dallas advances increased $12.0 million or 6.8% during the year ended December 31, 2000 as compared to $175.0 million at December 31, 1999. The advances were obtained from the FHLB Dallas as part of the Company's balance sheet leverage strategy and partially to fund long-term loans. FHLB Dallas advances are collateralized by FHLB Dallas stock, securities and nonspecified real estate loans. The Company plans to gradually replace short-term FHLB Dallas advances with deposit growth and long-term FHLB Dallas advances. The Company expects that loan growth should gradually replace a portion of the securities portfolio. Average long-term junior subordinated convertible debentures were $2.4 million for the year ended December 31, 2000 compared to zero for the same period in 1999. The increase is a result of the sale of 1,695,000 Convertible Preferred Securities on November 2, 2000 at a liquidation amount of $10 per Convertible Preferred Security for an aggregate amount of $16,950,000. It has a distribution rate of 8.75% per annum payable at the end of each calendar quarter. This increase in Average Long-term Junior Subordinated Convertible Debentures contributed to the higher average rate paid in 2000 when compared to 1999. Average long term junior subordinated debentures remained the same at $20 million from December 31, 1999 to December 31, 2000. Average long-term and short-term interest bearing liabilities other than deposits increased $13.3 million or 3.7%, a direct result of the Company's leverage strategy and ALCO objectives. This increase contributed to the higher interest expense in 2000, as well as providing the primary source of funding for the increase in average investment, mortgage-backed and marketable equity securities. 28
30 RESULTS OF OPERATIONS The following table presents average balance sheet amounts and average yields for the years ended December 31, 2000, 1999 and 1998. 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, 2000 December 31, 1999 ----------------------------------------- -------------------------------------- AVG. AVG. AVG. AVG. ASSETS BALANCE INTEREST YIELD BALANCE INTEREST YIELD ----------- ----------- ----- ----------- ----------- ----- <S> <C> <C> <C> <C> <C> <C> INTEREST EARNING ASSETS: Loans(1)(2) ......................... $ 434,559 $ 36,733 8.45% $ 341,466 $ 28,290 8.28% Securities: Inv. Sec. (Taxable)(4) .............. 77,971 5,446 6.98% 73,806 4,391 5.95% Inv. Sec. (Tax-Exempt)(3)(4) ........ 88,462 7,147 8.08% 91,084 6,756 7.42% Mortgage-backed Sec.(4) ............. 374,531 27,155 7.25% 358,258 22,080 6.16% Marketable Equity Sec ............... 19,351 1,553 8.03% 17,180 911 5.30% Interest Earning Deposits ........... 964 65 6.74% 2,936 175 5.96% Federal Funds Sold .................. 2,838 176 6.20% 4,914 247 5.03% ----------- ----------- ----------- ----------- Total Interest Earning Assets: ...... 998,676 78,275 7.84% 889,644 62,850 7.06% ----------- ----------- NONINTEREST EARNING ASSETS: Cash and Due From Banks ............. 31,621 29,548 Bank Premises and Equipment ......... 21,952 19,891 Other Assets ........................ 17,815 11,961 Less: Reserve for Loan Loss ....... (4,944) (4,040) ----------- ----------- Total Assets ........................ $ 1,065,120 $ 947,004 =========== =========== LIABILITIES AND SHAREHOLDERS' EQUITY: INTEREST BEARING LIABILITIES: Savings Deposits ................... $ 22,207 570 2.57% $ 19,272 493 2.56% Time Deposits ...................... 307,663 18,307 5.95% 233,354 11,866 5.08% Interest Bearing Demand Deposits ................. 165,790 4,958 2.99% 147,878 4,186 2.83% Short-term Interest Bearing Liabilities ............. 161,162 10,177 6.31% 162,287 8,535 5.26% Long-term Interest Bearing Liabilities-FHLB Dallas ......... 187,011 10,211 5.46% 175,028 9,236 5.28% Long-term Junior Subordinated Convertible Debentures .......... 2,447 214 8.75% -- -- Long-term Junior Subordinated Debentures ......... 20,000 1,700 8.50% 20,000 1,700 8.50% ----------- ----------- ----------- ----------- Total Interest Bearing Liabilities ..................... 866,280 46,137 5.33% 757,819 36,016 4.75% ----------- ----------- NONINTEREST BEARING LIABILITIES: Demand Deposits ..................... 145,883 137,499 Other Liabilities ................... 10,480 9,956 ----------- ------------ Total Liabilities ................... 1,022,643 905,274 SHAREHOLDERS' EQUITY ................ 42,477 41,730 ----------- ------------ TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY ............... $ 1,065,120 $ 947,004 =========== ============ NET INTEREST INCOME ................. $ 32,138 $ 26,834 =========== =========== NET YIELD ON AVERAGE EARNING ASSETS ..................... 3.22% 3.02% ==== ==== <CAPTION> AVERAGE BALANCES AND YIELDS (dollars in thousands) Years Ended ----------------------------------------- December 31, 1998 ----------------------------------------- AVG. AVG. ASSETS BALANCE INTEREST YIELD --------- --------- --------- <S> <C> <C> <C> INTEREST EARNING ASSETS: Loans(1)(2) ......................... $ 304,255 $ 26,059 8.56% Securities: Inv. Sec. (Taxable)(4) .............. 22,974 1,316 5.73% Inv. Sec. (Tax-Exempt)(3)(4) ........ 69,270 5,270 7.61% Mortgage-backed Sec.(4) ............. 226,359 12,116 5.35% Marketable Equity Sec ............... 7,700 449 5.83% Interest Earning Deposits ........... 962 60 6.24% Federal Funds Sold .................. 2,462 137 5.56% --------- --------- Total Interest Earning Assets: ...... 633,982 45,407 7.16% --------- NONINTEREST EARNING ASSETS: Cash and Due From Banks ............. 23,754 Bank Premises and Equipment ......... 17,781 Other Assets ........................ 13,961 Less: Reserve for Loan Loss ....... (3,492) --------- Total Assets ........................ $ 685,986 ========= LIABILITIES AND SHAREHOLDERS' EQUITY: INTEREST BEARING LIABILITIES: Savings Deposits ................... $ 17,280 467 2.70% Time Deposits ...................... 214,419 11,369 5.30% Interest Bearing Demand Deposits ................. 131,006 3,649 2.79% Short-term Interest Bearing Liabilities ............. 66,786 3,513 5.26% Long-term Interest Bearing Liabilities-FHLB Dallas ......... 84,836 4,701 5.54% Long-term Junior Subordinated Convertible Debentures .......... -- -- Long-term Junior Subordinated Debentures ......... 12,383 1,048 8.50% --------- --------- Total Interest Bearing Liabilities ..................... 526,710 24,747 4.70% --------- NONINTEREST BEARING LIABILITIES: Demand Deposits ..................... 105,779 Other Liabilities ................... 10,417 --------- Total Liabilities ................... 642,906 SHAREHOLDERS' EQUITY ................ 43,080 --------- TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY ............... $ 685,986 ========= NET INTEREST INCOME ................. $ 20,660 ========= NET YIELD ON AVERAGE EARNING ASSETS ..................... 3.26% ==== </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 $494, $92 and $8 as of December 31, 2000, 1999 and 1998, respectively. (3) Interest income includes taxable-equivalent adjustments of $2,363, $2,070 and $1,722 as of December 31, 2000, 1999 and 1998, respectively. (4) 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, 2000, 1999 and 1998, loans totaling $630, $703 and $432, 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. 29
31 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, 2000 Compared to 1999 ------------------------------------- Average Average Increase Volume Yield (Decrease) -------- -------- --------- <S> <C> <C> <C> INTEREST INCOME: Loans .............................................. $ 7,882 $ 561 $ 8,443 Investment Securities (Taxable) .................... 258 797 1,055 Investment Securities (Tax-Exempt)(1) .............. (199) 590 391 Mortgage-backed Securities ......................... 1,039 4,036 5,075 Marketable Equity Securities ....................... 96 546 642 Federal Funds Sold ................................. (120) 49 (71) Interest Earning Deposits .......................... (130) 20 (110) -------- -------- -------- Total Interest Income ........................... 8,826 6,599 15,425 -------- -------- -------- INTEREST EXPENSE: Savings Deposits ................................... 75 2 77 Time Deposits ...................................... 5,160 1,281 6,441 Interest Bearing Demand Deposits ................... 561 211 772 Federal Funds Purchased and Other Interest Bearing Liabilities .................... (60) 1,702 1,642 FHLB Dallas Advances ............................... 677 298 975 Long-term Junior Subordinated Convertible Debentures ...................................... 214 -- 214 -------- -------- -------- Total Interest Expense .......................... 6,627 3,494 10,121 -------- -------- -------- Net Interest Earnings .............................. $ 2,199 $ 3,105 $ 5,304 ======== ======== ======== </TABLE> <TABLE> <CAPTION> Years Ended December 31, 1999 Compared to 1998 ------------------------------------- Average Average Increase Volume Yield (Decrease) -------- -------- --------- <S> <C> <C> <C> INTEREST INCOME: Loans .............................................. $ 3,105 $ (874) $ 2,231 Investment Securities (Taxable) .................... 3,022 53 3,075 Investment Securities (Tax-Exempt)(1) .............. 1,621 (135) 1,486 Mortgage-backed Securities ......................... 7,909 2,055 9,964 Marketable Equity Securities ....................... 506 (44) 462 Federal Funds Sold ................................. 124 (14) 110 Interest Earning Deposits .......................... 118 (3) 115 -------- -------- -------- Total Interest Income ........................... 16,405 1,038 17,443 -------- -------- -------- INTEREST EXPENSE: Savings Deposits ................................... 52 (26) 26 Time Deposits ...................................... 1,308 (541) 767 Interest Bearing Demand Deposits ................... 276 (9) 267 Federal Funds Purchased and Other Interest Bearing Liabilities .................... 5,023 (1) 5,022 FHLB Dallas Advances ............................... 4,770 (235) 4,535 Long-term Junior Subordinated Debentures ........... 652 -- 652 -------- -------- -------- Total Interest Expense .......................... 12,081 (812) 11,269 -------- -------- -------- Net Interest Earnings .............................. $ 4,324 $ 1,850 $ 6,174 ======== ======== ======== </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. 30
32 PROVISION FOR LOAN LOSSES The provision for loan losses for the period ended December 31, 2000 was $1.6 million compared to $1.5 million for December 31, 1999. For the year ended December 31, 2000, the Company's subsidiary, Southside Bank, had net charge-offs of loans of $1.1 million, an increase of 149.7% compared to December 31, 1999. For the year ended December 31, 1999, net charge-offs on loans were $445,000. The increase in net charge-offs for 2000 is reflective of the overall growth in the Company's loan portfolio and the low level of net charge-offs for 1999. Net charge-offs for commercial loans and loans to individuals both increased. As of December 31, 2000, the Company's review of the loan portfolio indicates that a loan loss reserve of $5.0 million is adequate. NONINTEREST INCOME Noninterest income consists of revenues generated from a broad range of financial services and activities including fee based services. The following schedule lists the accounts from which noninterest income was derived, gives totals for these accounts for the year ended December 31, 2000 and the comparable year ended December 31, 1999 and indicates the percentage changes: <TABLE> <CAPTION> Years Ended December 31, ----------------------- Percent 2000 1999 Change -------- -------- -------- (dollars in thousands) <S> <C> <C> <C> Deposit services ....................................... $ 8,045 $ 6,780 18.7% (Losses) gains on sales of securities available for sale ........................................... (535) 149 (459.1)% Trust income ........................................... 726 631 15.1% Other .................................................. 1,991 1,672 19.1% -------- -------- Total noninterest income ............................... $ 10,227 $ 9,232 10.8% ======== ======== </TABLE> Total noninterest income for the year ended December 31, 2000 increased 10.8% or $1.0 million compared to 1999. Securities losses increased $684,000 or 459.1% from 1999. Of the $535,000 in net securities losses from the AFS portfolio in 2000, there were $1,553,000 in realized losses and $1,018,000 in realized gains. The Company sold securities out of its AFS portfolio to accomplish Asset Liability Committee and investment portfolio objectives aimed at maximizing the total return of the securities portfolio. Sales of AFS securities were the result of changes in economic conditions and a change in the mix of the securities portfolio. As rates increased during 2000, lower yielding securities were sold and replaced with higher yielding securities. The increase in deposit services income of $1.3 million or 18.7% 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 $95,000 or 15.1% due to growth in the Trust department. Other noninterest income increased $319,000 or 19.1% primarily as a result of increases in credit card income, official check fee income and other fee income. 31
33 NONINTEREST EXPENSE The following schedule lists the accounts which comprise noninterest expense, gives totals for these accounts for the year ended December 31, 2000 and the comparable year ended December 31, 1999 and indicates the percentage changes: <TABLE> <CAPTION> Years Ended December 31, --------------------- Percent 2000 1999 Change -------- -------- -------- (dollars in thousands) <S> <C> <C> <C> Salaries and employee benefits ......... $15,165 $13,427 12.9% Net occupancy expense .................. 3,170 2,842 11.5% Equipment expense ...................... 659 537 22.7% Advertising, travel and entertainment... 1,623 1,322 22.8% Supplies ............................... 563 494 14.0% Postage ................................ 422 419 0.7% Other .................................. 3,852 3,483 10.6% ------- ------- Total noninterest expense ...........,,, $25,454 $22,524 13.0% ======= ======= </TABLE> Noninterest expense for the year ended December 31, 2000 increased $2.9 million or 13.0% when compared to the year ended December 31, 1999. Salaries and employee benefits increased $1.7 million or 12.9% due to several factors. Direct salary expense and payroll taxes increased $1.5 million or 13.2% as a result of overall bank growth and pay increases. Retirement expense decreased $189,000 or 25.3% for the year ended December 31, 2000 due to actuarial assumptions and a higher return on plan assets. Deferred compensation expense decreased $198,000 or 93.9% due to changes in deferred compensation plans expensed during 1999. Health insurance expense increased $634,000 or 55.5% for the year ended December 31, 2000 due to increased health claims expense. Net occupancy expense increased $328,000 or 11.5% for the year ended December 31, 2000 compared to the same period in 1999, largely due to higher real estate taxes and depreciation expense. Equipment expense increased $122,000 or 22.7% for the year ended December 31, 2000 when compared to 1999 due to additional locations. Advertising, travel and entertainment expense increased $301,000 or 22.8% for the year ended December 31, 2000 compared to the same period in 1999 due to an increased advertising budget and additional expenses associated with additional locations and growth in assets. Other expense increased $369,000 or 10.6% during the year ended December 31, 2000 compared to 1999. 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 $2.7 million for the year ended December 31, 2000 and represented a $660,000 or 33.0% increase from the year ended December 31, 1999. The effective tax rate as a percentage of pre-tax income was 21.3% in 2000, 20.2% in 1999 and 18.6% in 1998. The increase in the effective tax rate and income tax expense for 2000 was primarily a result of higher taxable income. 32
34 DECEMBER 31, 1999 COMPARED TO DECEMBER 31, 1998 OVERVIEW Net income for the year ended December 31, 1999 was $7.9 million as compared to $5.3 million for the same period in 1998, an increase of $2.6 million or 48.1%. 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. Earnings per share of $1.00 represented an increase of $0.34, or 51.5% over the year ended December 31, 1998. NET INTEREST INCOME Net interest income increased $5.7 million or 30.3% for the year ended December 31, 1999 compared to the same period in 1998. In May 1998, the Company implemented a leverage strategy designed to enhance profitability with acceptable levels of credit, interest rate and liquidity risk. The leverage strategy consists of borrowing long and short-term funds from the Federal Home Loan Bank and investing the funds in securities. Margin compression resulted during the implementation phase of the leverage strategy. While the Company experienced margin compression during 1998 and 1999, the leverage strategy began to produce additional net income beginning during 1999. 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. 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 Company's leverage strategy. Securities averaged 60.7% of the total and Other Interest Earning Asset categories averaged 0.9% for December 31, 1999. During 1998 the comparable mix was 51.5% in Securities and 0.5% 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 change was a result of overall higher interest rates, decreased prepayment speeds on premium mortgage-backed securities which led 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 average interest earning assets decreased 10 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 8.28% 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. 33
35 Interest income on loans increased $2.1 million or 8.2% compared to 1998 due to 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 primarily 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. Average Time Deposits increased $18.9 million or 8.8% while the average rate paid decreased 22 basis points along with an increase in Average Interest Bearing Demand Deposits of $16.9 million or 12.9% 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 56.6% of total average deposits during the year ended December 31, 1999 compared to 54.2% 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. This increase contributed to the higher interest expense in 1999, as well as providing the primary source of funding for the increase in average investment, mortgage-backed and marketable equity securities. 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 million. The debentures have 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 and 1998 was $1.5 million and $1.2 million, respectively. For the year ended December 31, 1999, the Company's subsidiary, Southside Bank, had net charge-offs of loans of $445,000, 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 indicated that a loan loss reserve of $4.6 million was adequate. NONINTEREST INCOME The following table sets forth the accounts from which noninterest income was derived, gives totals for these accounts for the year ended December 31, 1999 and the comparable year ended December 31, 1998 and indicates the percentage changes: <TABLE> <CAPTION> Years Ended December 31, --------------------- Percent 1999 1998 Change -------- -------- -------- (dollars in thousands) <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> 34
36 Total noninterest income for the year ended December 31, 1999 increased 11.2% or $929,000 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 the AFS portfolio to accomplish Asset/Liability Management Committee objectives of obtaining an acceptable total rate of return on a risk adjusted basis on the securities portfolio. Sales of AFS securities 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 $510,000 or 43.9% primarily as a result of increases in mortgage servicing release fees income of $289,000 and an increase in income from Countywide of $112,000. NONINTEREST EXPENSE The following table sets forth 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 -------- -------- -------- (dollars 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 growth and pay increases. Retirement expense increased $281,000 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 employee stock ownership plan and additional deferred compensation expense incurred during 1999. Health insurance expense increased $247,000 or 27.6% for the year ended December 31, 1999 due to increased health claims. Net occupancy expense increased $472,000 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 $80,000 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. 35
37 Advertising, travel and entertainment expense increased $198,000 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 $67,000 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 $122,000 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, amortization of 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 $776,000 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 and 18.6% in 1998. The increase in the effective tax rate and income tax expense for 1999 was primarily a result of higher taxable 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, 2000, these investments were 15.5% of Total Assets, as compared with 13.0% for December 31, 1999, and 19.2% for December 31, 1998. Liquidity is further provided through the matching, by time period, of rate sensitive interest earning assets with rate sensitive interest bearing liabilities. The Company has three lines of credit for the purchase of federal funds. Two $15.0 million and one $10.0 million unsecured lines of credit have been established with Bank of America, Frost Bank and Texas Independent Bank, respectively. The Asset/Liability Management Committee of the bank closely monitors various liquidity ratios, interest rate spreads and margins, interest rate shock reports and market value of portfolio equity with rates shocked plus and minus 200 basis points to ensure the Company a satisfactory liquidity position. Market value of portfolio equity is defined as the net present value of an institution's existing assets, liabilities and off-balance sheet instruments. Market value of portfolio equity analysis is the general measure used by regulatory authorities for assessing an institution's interest rate risk. The extent to which assets will gain or lose value in relation to the gains or losses of liabilities and/or interest rate contracts determines the appreciation or depreciation in equity on a market-value basis. Such market value analysis is intended to evaluate the impact of immediate and sustained parallel interest-rate shifts of the current yield curve upon the market value of the current balance sheet. In addition, the bank utilizes a simulation model to determine the impact of net interest income under several different interest rate scenarios. By utilizing this technology, the bank attempts to determine changes that need to be made to the asset and liability mixes to minimize the change in net interest income under these various interest rate scenarios. 36
38 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. The interest rate risk inherent in assets and liabilities may be determined by analyzing the extent to which such assets and liabilities are "interest rate sensitive" and by measuring an institution's interest rate sensitivity "gap." An asset or liability is said to be interest rate sensitive within a defined time period if it matures or reprices within that period. The difference or mismatch between the amount of interest earning assets maturing or repricing within a defined period and the amount of interest bearing liabilities maturing or repricing within the same period is defined as the interest rate sensitivity gap. An institution is considered to have a negative gap if the amount of interest bearing liabilities maturing or repricing within a specified time period exceeds the amount of interest earning assets maturing or repricing within the same period. If more interest earning assets than interest bearing liabilities mature or reprice within a specified period, then the institution is considered to have a positive gap. Accordingly, in a rising interest rate environment in an institution with a negative gap, the cost of its rate sensitive liabilities would theoretically rise at a faster pace than the yield on its rate sensitive assets, thereby diminishing future net interest income. In a falling interest rate environment, a negative gap would indicate that the cost of rate sensitive liabilities would decline at a faster pace than the yield on rate sensitive assets and improve net interest income. For an institution with a positive gap, the reverse would be expected. The table on page 40 shows interest sensitivity gaps for four different intervals as of December 31, 2000. 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. 37
39 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 2001 2002 2003 2004 2005 Thereafter Total Value ---------- ---------- --------- --------- ---------- ----------- ----------- ---------- <S> <C> <C> <C> <C> <C> <C> <C> <C> Fixed Rate Loans ......... $ 214,470 $ 90,326 $ 49,733 $ 28,847 $ 15,122 $ 29,318 $ 427,816 $ 426,794 8.29% 8.27% 8.15% 8.05% 8.09% 7.91% 8.22% Adjustable Rate Loans .... 28,385 5,761 1,713 3,227 3,811 10,092 52,989 52,989 10.37% 10.40% 10.49% 9.88% 10.08% 10.78% 10.40% Mortgage-backed Securities ............... 89,151 67,514 51,286 39,017 29,730 135,549 412,247 415,112 7.67% 7.65% 7.64% 7.62% 7.60% 7.42% 7.57% Investments and Other Interest Earning Assets .. 45,737 2,609 4,802 383 1,886 126,690 182,107 185,249 7.40% 7.11% 6.99% 7.70% 8.16% 7.83% 7.69% Total Interest Earning Assets ........... $ 377,743 $ 166,210 $ 107,534 $ 71,474 $ 50,549 $ 301,649 $ 1,075,159 $1,080,144 8.19% 8.07% 7.89% 7.90% 7.95% 7.75% 7.99% Savings Deposits ......... $ 2,400 $ 1,201 $ 1,201 $ 1,201 $ 1,201 $ 16,803 $ 24,007 $ 23,520 2.57% 2.57% 2.57% 2.57% 2.57% 2.57% 2.57% NOW Deposits ............. 10,758 5,379 5,379 5,379 5.379 75,299 107,573 103,973 3.04% 3.04% 3.04% 3.04% 3.04% 3.04% 3.04% Money Market Deposits .... 18,105 6,036 6,036 6,036 6,036 18,106 60,355 61,480 3.38% 3.38% 3.38% 3.38% 3.38% 3.38% 3.38% Platinum Money Market .... 10,819 1,159 1,159 1,159 1,159 -- 15,455 15,856 5.10% 5.10% 5.10% 5.10% 5.10% -- 5.10% Certificates of Deposit .. 226,106 31,356 30,115 6,659 18,401 33,679 346,316 354,699 6.01% 6.10% 6.86% 5.64% 7.32% 8.19% 6.37% FHLB Dallas Advances ..... 149,804 50,820 61,867 13,752 13,666 38,676 328,585 328,063 6.09% 5.68% 5.54% 5.62% 5.97% 6.07% 5.90% Other Borrowings ......... 7,303 -- -- -- -- 36,950 44,253 44,253 4.69% -- -- -- -- 8.61% 7.96% Total Interest Bearing Liabilities ...... $ 425,295 $ 95,951 $ 105,757 $ 34,186 $ 45,842 $ 219,513 $ 926,544 $ 931,844 5.79% 5.48% 5.63% 4.70% 5.72% 5.29% 5.58% </TABLE> 38
40 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%. At December 31, 2000, the contractual maturity of substantially all of the Company's mortgage-backed or related securities was in excess of ten years. The actual maturity of a mortgage-backed or related security is less than its stated maturity due to regular principal payments and prepayments of the underlying mortgages. Prepayments that are faster than anticipated may shorten the life of the security and affect its yield to maturity. The yield to maturity is based upon the interest income and the amortization of any premium or discount related to the security. In accordance with generally accepted accounting principles, premiums and discounts are amortized over the estimated lives of the loans, which decrease and increase interest income, respectively. The prepayment assumptions used to determine the amortization period for premiums and discounts can significantly affect the yield of the mortgage-backed or related security, and these assumptions are reviewed periodically to reflect actual prepayments. Although prepayments of underlying mortgages depend on many factors, including the type of mortgages, the coupon rate, the age of mortgages, the geographical location of the underlying real estate collateralizing the mortgages and general levels of market interest rates, the difference between the interest rates on the underlying mortgages and the prevailing mortgage interest rates generally is the most significant determinant of the rate of prepayments. During periods of falling mortgage interest rates, if the coupon rate of the underlying mortgages exceeds the prevailing market interest rates offered for mortgage loans, refinancing may increase and accelerate the prepayment of the underlying mortgages and the related security. At December 31, 2000, of the $412.2 million of mortgage-backed and related securities held by the Company, an aggregate of $407.3 million were secured by fixed-rate mortgage loans and an aggregate of $4.9 million were secured by adjustable-rate mortgage loans. The Company assumes 70% of savings accounts and transaction accounts at December 31, 2000, are core deposits and are, therefore, expected to roll-off after five years. The Company assumes 30% of Money Market accounts at December 31, 2000 are core deposits and are, therefore, expected to roll-off after five years. The Company does not consider any of its Platinum Money Markets accounts as core deposits. No roll-off rate is applied to certificates of deposit. Fixed maturity deposits reprice at maturity. In evaluating the Company's exposure to interest rate risk, certain limitations inherent in the method of analysis presented in the foregoing table must be considered. For example, although certain assets and liabilities may have similar maturities or periods to repricing, they may react in different degrees to changes in market interest rates. Also, the interest rates on certain types of assets and liabilities may fluctuate in advance of changes in market interest rates, while interest rates on other types may lag behind changes in market rates. Additionally, certain assets, such as adjustable rate mortgages, have features which restrict changes in interest rates, prepayment and early withdrawal levels may deviate significantly from those assumed in calculating the table. Finally, the ability of many borrowers to service their debt may decrease in the event of an interest rate increase. The Company considers all of these factors in monitoring its exposure to interest rate risk. 39
41 The following table sets forth certain information as of December 31, 2000 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) ............................... $ 131,093 $ 136,366 $ 184,028 $ 29,318 $ 480,805 Securities ............................. 67,430 71,743 197,227 257,358 593,758 Other Interest Earning Assets .......... 596 -- -- -- 596 ---------- ---------- ---------- ---------- ---------- Total Rate Sensitive Assets ............ $ 199,119 $ 208,109 $ 381,255 $ 286,676 $1,075,159 ========== ========== ========== ========== ========== Rate Sensitive Liabilities (RSL) Interest Bearing Deposits .............. $ 70,178 $ 198,010 $ 141,631 $ 143,887 $ 553,706 Other Interest Bearing Liabilities ..... 113,205 43,902 140,105 75,626 372,838 ---------- ---------- ---------- ---------- ---------- Total Rate Sensitive Liabilities ....... $ 183,383 $ 241,912 $ 281,736 $ 219,513 $ 926,544 ========== ========== ========== ========== ========== Gap(2) ................................. 15,736 (33,803) 99,519 67,163 148,615 Cumulative Gap ......................... 15,736 (18,067) 81,452 148,615 Cumulative Ratio of RSA to RSL ......... 1.09 0.96 1.12 1.16 1.16 Gap/Total Earning Assets ............... 1.5% (3.1)% 9.3% 6.2% 13.8% </TABLE> - -------------------------------------------------------------------------------- (1) Amount is equal to total loans net of unearned discount less nonaccrual loans at December 31, 2000. (2) Gap equals Total RSA minus Total RSL. The Asset Liability Management Committee of Southside Bank closely monitors the desired gap along with various liquidity ratios to ensure a satisfactory liquidity position for the Company. 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. 40
42 CAPITAL RESOURCES Total Shareholders' Equity at December 31, 2000, of $51.7 million increased 37.2% or $14.0 million from December 31, 1999 and represented 4.5% of total assets at December 31, 2000 compared to 3.7% at December 31, 1999. The increase in the percent of Shareholders' Equity to Total Assets is a result of the decrease in the unrealized losses in the securities portfolio and the increase in net income. Net income for 2000 of $9.8 million was the major contributor to the increase in Shareholders' Equity at December 31, 2000 along with the issuance of $410,000 in common stock (53,964 shares) through the Company's dividend reinvestment plan and incentive stock option plan and a net decrease in unrealized losses of $6.3 million on AFS securities. Decreases to Shareholders' Equity consisted of $1.7 million in dividends paid and the purchase of $813,000 in treasury stock (94,050 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 2000, 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, 2000, that the Bank meets all capital adequacy requirements to which it is subject. 41
43 To be categorized as well capitalized, the Bank must maintain minimum Total risk-based, Tier 1 risk-based, and Tier 1 leverage ratios as set forth in the following table: <TABLE> <CAPTION> To Be Well Capitalized Under For Capital Prompt Corrective Actual Adequacy Purposes Action Provisions ------------------------- ----------------------- ---------------------- Amount Ratio Amount Ratio Amount Ratio ----------- -------- --------- -------- ----------- ------- (dollars in thousands) <S> <C> <C> <C> <C> <C> <C> As of December 31, 2000: Total Capital (to Risk Weighted Assets) Consolidated ........................ $ 94,817 16.63% $ 45,605 8.00% N/A N/A =========== ======== ========= ======== =========== ======= Bank Only ........................... $ 87,495 15.30% $ 45,741 8.00% $ 57,176 10.00% =========== ======== ========= ======== =========== ======= Tier 1 Capital (to Risk Weighted Assets) Consolidated ........................ $ 71,169 12.48% $ 22,802 4.00% N/A N/A =========== ======== ========= ======== =========== ======= Bank Only ........................... $ 82,758 14.47% $ 22,870 4.00% $ 34,306 6.00% =========== ======== ========= ======== =========== ======= Tier 1 Capital (to Average Assets) (1) Consolidated ........................ $ 71,169 6.31% $ 45,148 4.00% N/A N/A =========== ======== ========= ======== =========== ======= Bank Only ........................... $ 82,758 7.33% $ 45,176 4.00% $ 56,470 5.00% =========== ======== ========= ======== =========== ======= As of December 31, 1999: Total Capital (to Risk Weighted Assets) Consolidated ........................ $ 70,611 13.96% $ 40,473 8.00% N/A N/A =========== ======== ========= ======== =========== ======= Bank Only ........................... $ 67,687 13.25% $ 40,864 8.00% $ 51,080 10.00% =========== ======== ========= ======== =========== ======= Tier 1 Capital (to Risk Weighted Assets) Consolidated ........................ $ 61,782 12.21% $ 20,237 4.00% N/A N/A =========== ======== ========= ======== =========== ======= Bank Only ........................... $ 63,343 12.40% $ 20,432 4.00% $ 30,648 6.00% =========== ======== ========= ======== =========== ======= Tier 1 Capital (to Average Assets) (1) Consolidated ........................ $ 61,782 6.20% $ 39,876 4.00% N/A N/A =========== ======== ========= ======== =========== ======= Bank Only ........................... $ 63,343 6.35% $ 39,875 4.00% $ 49,844 5.00% =========== ======== ========= ======== =========== ======= </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, 2000, 1999 and 1998. <TABLE> <CAPTION> Years Ended December 31, ----------------------------- 2000 1999 1998 ----- ----- ----- <S> <C> <C> <C> Percentage of Net Income to: Average Total Assets .......................... .92% .84% .78% Average Shareholders' Equity .................. 23.13% 18.99% 12.42% Percentage of Dividends Declared Per Common Share to Net Income Per Common Share-Basic .... 17.44% 19.42% 28.99% Percentage of Dividends Declared Per Common Share to Net Income Per Common Share-Diluted .. 18.15% 20.00% 30.30% Percentage of Average Shareholders' Equity to Average Total Assets ................ 3.99% 4.41% 6.28% </TABLE> 42
44 OTHER ACCOUNTING ISSUES On June 15, 1998, the Financial Accounting Standards Board (FASB) issued Financial Accounting Standards No. 133, "Accounting for Derivative Instruments and Hedging Activities" (FAS133). FAS133 and its amendments are 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 sheet 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. In June 1999, the Financial Accounting Standards Board issued Financial Accounting Standards No. 137, "Accounting for Derivative Instruments and Hedging Activities (FAS137)-- Deferral of the Effective Date of Financial Accounting Standards No. 133, an Amendment of Financial Accounting Standards Board Statement No. 133," which defers the effective date of Financial Accounting Standards No. 133 from fiscal years beginning after June 15, 1999 to fiscal years beginning after June 15, 2000. Initial application should be as of the beginning of an entity's fiscal quarter; on that date, hedging relationships must be designated and documented pursuant to the provisions of Financial Accounting Standards No. 133, as amended. Earlier application of all of the provisions is encouraged but is permitted only as of the beginning of any fiscal quarter that begins after the issuance date of Financial Accounting Standards No. 133, as amended. Additionally, Financial Accounting Standards No. 133, as amended, should not be applied retroactively to financial statements of prior periods. In June 2000, the Financial Accounting Standards Board issued Financial Accounting Standards No. 138, "Accounting for Derivative Instruments and Hedging Activities, an Amendment of Financial Accounting Standards Board Statement No. 133," which addresses a limited number of issues causing implementation difficulties for numerous entities that apply Financial Accounting Standards No. 133, as amended. Financial Accounting Standards No. 138 amends the accounting and reporting standards of Financial Accounting Standards No. 133, as amended, for certain derivative instruments, certain hedging activities and for decisions made by the Financial Accounting Standards Board relating to the Derivatives Implementation Group process. Management anticipates that adoption of Financial Accounting Standards No. 133, as amended, will not have a significant effect on the Company's results of operations or its financial position, except the HTM securities transferred. On January 1, 2001, the Company adopted FAS133 and FAS137. The transition provisions contained in FAS133 provide that at the date of initial application, an entity may transfer any debt security classified as HTM to AFS or trading. Effective January 1, 2001, as part of implementing FAS133 and FAS137, the Company elected to transfer all of its securities out of the HTM category in accordance with FAS133 guidance. Securities transferred on January 1, 2001 and sold during the first quarter ended March 31, 2001, will be accounted for as trading securities. All other securities transferred will be accounted for as AFS securities. In September 2000, the Financial Accounting Standards Board issued Financial Accounting Standards No. 140, "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities, a replacement of Financial Accounting Standards Board Statement No. 125," which revises the standards for accounting for securitizations and other transfers of financial assets and collateral and requires certain disclosures, but, it carries over most of Financial Accounting Standards No. 125's provisions without reconsideration. The statement is effective for transfers and servicing of financial assets and extinguishments of liabilities occurring after March 31, 2001. It is effective for disclosures about securitizations and collateral and for the recognition and reclassification of collateral for fiscal years ending after December 15, 2000. Management anticipates the adoption of financial Accounting Standards No. 140 will not have a significant effect on the Company's results of operations or its financial position. 43
45 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. 44
46 ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA The information required by this item is set forth in Part IV. ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None. PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT Certain of the information required under this item appears beginning on page 2 of the Company's definitive proxy statement for the Annual Meeting of Shareholders to be held April 19, 2001, and is incorporated herein by reference. ITEM 11. EXECUTIVE COMPENSATION The information required under this item appears beginning on page 7 of the Company's definitive proxy statement for the Annual Meeting of Shareholders to be held April 19, 2001, 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 19, 2001, and is incorporated herein by reference. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS The information required under this item beginning on page 10 of the Company's definitive proxy statement for the Annual Meeting of Shareholders to be held April 19, 2001, 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, 2000 and 1999. Consolidated Statements of Income for the years ended December 31, 2000, 1999 and 1998. Consolidated Statements of Shareholders' Equity for the years ended December 31, 2000, 1999 and 1998. Consolidated Statements of Cash Flow for the years ended December 31, 2000, 1999 and 1998. Notes to Consolidated Financial Statements. 45
47 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 by reference). 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 by reference). 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 by reference). **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 incorporated herein by reference). **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 by reference). **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 by reference). **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 by reference). **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 by reference). **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 by reference). 46
48 **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 (filed as Exhibit 10(f) to the Registrant's Form 10-K for the year ended December 31, 1997, and incorporated herein by reference). *21 - Subsidiaries of the Registrant. *23 - Consent of Independent Accountants. - ---------- * Filed herewith. ** Compensation plan, benefit plan or employment contract or arrangement. (b) Reports on Form 8-K On November 10, 2000, the Company filed Form 8-K reporting Item 5. Other Events, regarding the approval by the board of directors of the Company of a 5% common stock dividend, a $.05 per common share cash dividend and a $.025 per common share special cash dividend. Further, the Company reported the adjustment of the conversion ratio for the Company's convertible trust preferred securities to 1.0 shares of common stock per $10 principal amount of debentures. 47
49 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. SOUTHSIDE BANCSHARES, INC. BY: /s/ B. G. HARTLEY ------------------------------------------ B. G. Hartley, Chairman of the Board and Director (Principal Executive Officer) /s/ LEE R. GIBSON -------------------------------------------- Lee R. Gibson, CPA, Executive Vice President and Chief Financial Officer (Principal Financial and Accounting Officer) DATED: March 1, 2001 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 1, 2001 - ------------------------ and Director (B. G. Hartley) /s/ ROBBIE N. EDMONSON Vice Chairman of the Board March 1, 2001 - ------------------------ and Director (Robbie N. Edmonson) /s/ SAM DAWSON President and Secretary March 1, 2001 - ------------------------ and Director (Sam Dawson) /s/ FRED E. BOSWORTH Director March 1, 2001 - ------------------------ (Fred E. Bosworth) /s/ HERBERT C. BUIE Director March 1, 2001 - ------------------------ (Herbert C. Buie) /s/ ROLLINS CALDWELL Director March 1, 2001 - ------------------------ (Rollins Caldwell) /s/ MICHAEL D. GOLLOB Director March 1, 2001 - ------------------------ (Michael D. Gollob) /s/ W. D. (JOE) NORTON Director March 1, 2001 - ------------------------ (W. D. (Joe) Norton) /s/ PAUL W. POWELL Director March 1, 2001 - ------------------------ (Paul W. Powell) /s/ WILLIAM SHEEHY Director March 1, 2001 - ------------------------ (William Sheehy) </TABLE> 48
50 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, 2000 and 1999, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2000, 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 the 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 March 2, 2001 49
51 SOUTHSIDE BANCSHARES, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (in thousands, except share amounts) <TABLE> <CAPTION> December 31, December 31, 2000 1999 ------------ ------------ ASSETS <S> <C> <C> Cash and due from banks ......................................... $ 38,800 $ 41,131 Investment securities: Available for sale ........................................... 56,777 96,244 Held to maturity ............................................. 104,508 86,208 ----------- ----------- Total Investment securities ................................ 161,285 182,452 Mortgage-backed and related securities: Available for sale ........................................... 269,286 273,676 Held to maturity ............................................. 142,961 73,898 ----------- ----------- Total Mortgage-backed securities and related securities .... 412,247 347,574 Marketable equity securities: Available for sale ........................................... 20,226 18,543 Loans: Loans, net of unearned discount .............................. 481,435 387,446 Less: reserve for loan losses ................................ (5,033) (4,575) ----------- ----------- Net Loans .................................................. 476,402 382,871 Premises and equipment, net ..................................... 25,475 21,306 Other real estate owned, net .................................... 43 140 Interest receivable ............................................. 9,117 7,563 Deferred tax asset .............................................. 2,922 6,244 Other assets .................................................... 5,364 4,741 ----------- ----------- TOTAL ASSETS ............................................... $ 1,151,881 $ 1,012,565 =========== =========== LIABILITIES AND SHAREHOLDERS' EQUITY Deposits: Noninterest bearing .......................................... $ 166,899 $ 150,629 Interest bearing ............................................. 553,706 436,915 ----------- ----------- Total Deposits ............................................. 720,605 587,544 Short-term obligations: Federal funds purchased ...................................... 5,025 75 FHLB Dallas Advances ......................................... 148,940 181,222 Other obligations ............................................ 2,278 4,744 ----------- ----------- Total Short-term obligations ............................... 156,243 186,041 Long-term obligations: FHLB Dallas Advances ......................................... 179,645 174,704 Guaranteed Preferred Beneficial Interest in the Company's Junior Subordinated Convertible Debentures ................ 16,950 -- Guaranteed Preferred Beneficial Interest in the Company's Junior Subordinated Debentures ............................ 20,000 20,000 ----------- ----------- Total Long-term obligations ................................ 216,595 194,704 Other liabilities ............................................... 6,743 6,604 ----------- ----------- TOTAL LIABILITIES .......................................... 1,100,186 974,893 ----------- ----------- Commitments and Contingencies (Note 14 and 15) Shareholders' equity: Common stock: ($1.25 par, 20,000,000 shares authorized, 8,215,135 and 7,798,332 shares issued) ................. 10,269 9,748 Paid-in capital .............................................. 30,226 27,472 Retained earnings ............................................ 19,891 14,583 Treasury stock (606,552 and 512,502 shares at cost) .......... (5,357) (4,544) Accumulated other comprehensive loss ......................... (3,334) (9,587) ----------- ----------- TOTAL SHAREHOLDERS' EQUITY ................................ 51,695 37,672 ----------- ----------- TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY ................ $ 1,151,881 $ 1,012,565 =========== =========== </TABLE> The accompanying notes are an integral part of these consolidated financial statements. 50
52 SOUTHSIDE BANCSHARES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME (in thousands, except per share data) <TABLE> <CAPTION> Years Ended December 31, -------------------------------------- 2000 1999 1998 -------- -------- -------- <S> <C> <C> <C> Interest income Loans ............................................... $ 36,239 $ 28,198 $ 26,051 Investment securities ............................... 10,230 9,077 4,864 Mortgage-backed and related securities .............. 27,155 22,080 12,116 Marketable equity securities ........................ 1,553 911 449 Other interest earning assets ....................... 241 422 197 -------- -------- -------- Total interest income ......................... 75,418 60,688 43,677 -------- -------- -------- Interest expense Deposits ............................................ 23,835 16,545 15,485 Short-term obligations .............................. 10,177 8,535 3,513 Long-term obligations ............................... 12,125 10,936 5,749 -------- -------- -------- Total interest expense ........................ 46,137 36,016 24,747 -------- -------- -------- Net interest income .................................... 29,281 24,672 18,930 Provision for loan losses .............................. 1,569 1,456 1,215 -------- -------- -------- Net interest income after provision for loan losses .... 27,712 23,216 17,715 -------- -------- -------- Noninterest income Deposit services .................................... 8,045 6,780 5,353 (Loss) gain on sales of securities available for sale........................................... (535) 149 1,260 Trust income ........................................ 726 631 528 Other ............................................... 1,991 1,672 1,162 -------- -------- -------- Total noninterest income ...................... 10,227 9,232 8,303 -------- -------- -------- Noninterest expense Salaries and employee benefits ...................... 15,165 13,427 11,318 Net occupancy expense ............................... 3,170 2,842 2,370 Equipment expense ................................... 659 537 457 Advertising, travel & entertainment ................. 1,623 1,322 1,124 Supplies ............................................ 563 494 461 Postage ............................................. 422 419 352 Other ............................................... 3,852 3,483 3,361 -------- -------- -------- Total noninterest expense ..................... 25,454 22,524 19,443 -------- -------- -------- Income before federal tax expense ...................... 12,485 9,924 6,575 -------- -------- -------- Provision (benefit) for federal tax expense Current ............................................. 2,572 2,033 1,496 Deferred ............................................ 88 (33) (272) -------- -------- -------- Total income taxes ............................ 2,660 2,000 1,224 -------- -------- -------- Net Income ............................................. $ 9,825 $ 7,924 $ 5,351 ======== ======== ======== Net Income Per Common Share Basic ............................................... $ 1.29 $ 1.03 $ .69 Diluted ............................................. $ 1.24 $ 1.00 $ .66 </TABLE> The accompanying notes are an integral part of these consolidated financial statements. 51
53 SOUTHSIDE BANCSHARES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY (in thousands, except share amounts) <TABLE> <CAPTION> Compre- hensive Income Common Paid in Retained Treasury (Loss) Stock Capital Earnings Stock --------- -------- --------- ------- -------- <S> <C> <C> <C> <C> <C> Balance at December 31, 1999 ................ $ $ 9,748 $ 27,472 $14,583 $ (4,544) Net Income .................................. 9,825 9,825 Other comprehensive income, net of tax Unrealized gains on securities, net of reclassification adjustment (see disclosure below) ........................ 6,277 Minimum pension liability adjustment ........ (24) --------- Comprehensive income ........................ $ 16,078 ========= Common stock issued (53,964 shares) ......... 67 343 FAS109 - Incentive Stock Options (ISO's) .... 6 Dividends paid on common stock .............. (1,658) Purchase of 94,050 shares of treasury stock ........................... (813) Stock dividend .............................. 454 2,405 (2,859) ------- --------- ------- -------- Balance at December 31, 2000 ................ $10,269 $ 30,226 $19,891 $ (5,357) ======= ========= ======= ======== Disclosure of reclassification amount: Unrealized holding gains arising during period................................... $ 5,924 Less: reclassification adjustment for losses included in net income............ (353) --------- Net unrealized gains on securities.......... $ 6,277 ========= Balance at December 31, 1998................ $ $ 9,214 $ 24,198 $11,391 $ (3,158) Net Income.................................. 7,924 7,924 Other comprehensive loss, net of tax Unrealized losses on securities, net of reclassification adjustment (see disclosure below)........................ (14,352) Minimum pension liability adjustment........ (3) --------- Comprehensive loss.......................... $ (6,431) ========= Common stock issued (77,012 shares)......... 96 360 FAS109 - Incentive Stock Options (ISO's).... 29 Dividends paid on common stock.............. (1,409) Purchase of 148,150 shares of treasury stock........................... (1,386) Stock dividend.............................. 438 2,885 (3,323) ------- --------- ------- -------- Balance at December 31, 1999................ $ 9,748 $ 27,472 $14,583 $ (4,544) ======= ========= ======= ======== 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) ========= <CAPTION> Accumulated Other Compre- Total hensive Shares Income holders' (Loss) Equity ----------- --------- <S> <C> <C> Balance at December 31, 1999 ................ $ (9,587) $ 37,672 Net Income .................................. 9,825 Other comprehensive income, net of tax Unrealized gains on securities, net of reclassification adjustment (see disclosure below) ........................ 6,277 6,277 Minimum pension liability adjustment ........ (24) (24) Comprehensive income ........................ Common stock issued (53,964 shares) ......... 410 FAS109 - Incentive Stock Options (ISO's) .... 6 Dividends paid on common stock .............. (1,658) Purchase of 94,050 shares of treasury stock ........................... (813) Stock dividend .............................. ---------- --------- Balance at December 31, 2000 ................ $ (3,334) $ 51,695 ========== ========= Disclosure of reclassification amount: Unrealized holding gains arising during period................................... Less: reclassification adjustment for losses included in net income............ Net unrealized gains on securities.......... Balance at December 31, 1998................ $ 4,768 $ 46,413 Net Income.................................. 7,924 Other comprehensive loss, net of tax Unrealized losses on securities, net of reclassification adjustment (see disclosure below)........................ (14,352) (14,352) Minimum pension liability adjustment........ (3) (3) Comprehensive loss.......................... Common stock issued (77,012 shares)......... 456 FAS109 - Incentive Stock Options (ISO's).... 29 Dividends paid on common stock.............. (1,409) Purchase of 148,150 shares of treasury stock........................... (1,386) Stock dividend.............................. --------- --------- Balance at December 31, 1999................ $ (9,587) $ 37,672 ========== ========= Disclosure of reclassification amount: Unrealized holding losses arising during period................................... Less: reclassification adjustment for gains included in net income............. Net unrealized losses on securities......... </TABLE> (continued) 52
54 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 Shares 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, 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 (42,320 shares) ..... 53 294 347 FAS109 - Incentive Stock Options (ISO's) 42 42 Dividends paid on common stock .......... (1,359) (1,359) Purchase of 142,852 shares of treasury stock ....................... (1,398) (1,398) Exercise of 12,000 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> The accompanying notes are an integral part of these consolidated financial statements. 53
55 SOUTHSIDE BANCSHARES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOW (in thousands) <TABLE> <CAPTION> Years Ended December 31, ----------------------------------------- 2000 1999 1998 --------- --------- --------- <S> <C> <C> <C> OPERATING ACTIVITIES: Net income .................................................................. $ 9,825 $ 7,924 $ 5,351 Adjustments to reconcile net cash provided by operations: Depreciation .............................................................. 1,699 1,474 1,397 Amortization of premium ................................................... 1,610 4,657 5,229 Accretion of discount and loan fees ....................................... (2,043) (1,774) (660) Provision for loan losses ................................................. 1,569 1,456 1,215 FAS109-Incentive stock options ............................................ 6 29 42 Loss (gain) on sale of securities available for sale ...................... 535 (149) (1,260) Gain on sale of assets .................................................... -- (86) (51) Gain on sale of other real estate owned ................................... (17) (129) (32) Increase in interest receivable ........................................... (1,554) (1,498) (2,147) (Increase) decrease in other assets ....................................... (636) 331 (2,270) Decrease (increase) in deferred tax asset ................................. 100 (33) (87) Increase in interest payable .............................................. 517 702 558 (Decrease) increase in other payables ..................................... (2,880) (4,862) 7,883 --------- --------- --------- Net cash provided by operating activities ............................. 8,731 8,042 15,168 INVESTING ACTIVITIES: Proceeds from sale of investment securities available for sale ............ 87,280 81,700 62,413 Proceeds from sale of mortgage-backed securities available for sale ....... 209,087 111,969 46,515 Proceeds from maturities of investment securities available for sale ...... 6,939 26,093 10,322 Proceeds from maturities of mortgage-backed securities available for sale ............................................................... 38,449 89,702 79,121 Proceeds from maturities of investment securities held to maturity ........ 8,430 3,347 457 Proceeds from maturities of mortgage-backed securities held to maturity ... 4,991 2,357 5,899 Purchases of investment securities available for sale ..................... (73,508) (149,299) (130,138) Purchases of mortgage-backed securities available for sale ................ (308,826) (222,610) (333,304) Purchases of investment securities held to maturity ....................... (3,829) (21,708) -- Purchases of mortgage-backed securities held to maturity .................. (3,110) (2,258) -- Purchases of marketable equity securities available for sale .............. (1,683) (4,372) (10,913) Net increase in loans ..................................................... (96,366) (69,299) (26,521) Purchases of premises and equipment ....................................... (5,868) (4,200) (3,096) Proceeds from sale of premises and equipment .............................. 672 212 Proceeds from sale of repossessed assets .................................. 1,003 1,290 1,617 Proceeds from sale of other real estate owned ............................. 390 356 275 --------- --------- --------- Net cash used in investing activities ................................. (136,621) (156,260) (297,141) </TABLE> (continued) 54
56 SOUTHSIDE BANCSHARES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOW (continued) (in thousands) <TABLE> <CAPTION> Years Ended December 31, ----------------------------------------------- 2000 1999 1998 ----------- ----------- ----------- <S> <C> <C> <C> FINANCING ACTIVITIES: Net increase in demand and savings accounts ......................... $ 43,873 $ 47,765 $ 41,944 Net increase in certificates of deposit ............................. 89,188 24,745 10,416 Proceeds from FHLB Dallas advances .................................. 1,071,180 258,100 404,800 Repayment of FHLB Dallas advances ................................... (1,098,521) (176,201) (188,320) Issuance of guaranteed preferred beneficial interest in the company's junior subordinated debentures ................. -- -- 20,000 Issuance of guaranteed preferred beneficial interest in the company's junior subordinated convertible debentures ..... 16,950 -- -- Net increase (decrease) in federal funds purchased .................. 4,950 (4,093) 284 Proceeds from the issuance of common stock .......................... 410 456 347 Purchase of treasury stock .......................................... (813) (1,386) (1,398) Sale of treasury stock .............................................. -- -- 38 Dividends paid ...................................................... (1,658) (1,409) (1,359) ----------- ----------- ----------- Net cash provided by financing activities ..................... 125,559 147,977 286,752 ----------- ----------- ----------- Net (decrease) increase in cash and cash equivalents ................ (2,331) (241) 4,779 Cash and cash equivalents at beginning of year ...................... 41,131 41,372 36,593 ----------- ----------- ----------- Cash and cash equivalents at end of year ............................ $ 38,800 $ 41,131 $ 41,372 =========== =========== =========== SUPPLEMENTAL DISCLOSURE FOR CASH FLOW INFORMATION: Interest paid ....................................................... $ 45,620 $ 35,315 $ 24,189 Income taxes paid ................................................... $ 2,125 $ 1,725 $ 1,763 SUPPLEMENTAL DISCLOSURES OF NONCASH INVESTING AND FINANCING ACTIVITIES: Acquisition of other real estate owned and other repossessed assets through foreclosure ...................................... $ 1,266 $ 1,131 $ 1,812 </TABLE> The accompanying notes are an integral part of these consolidated financial statements. 55
57 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 2000. 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. 56
58 Securities. The Company uses the specific identification method to determine the basis for computing realized gain or loss. The Company accounts for debt and equity securities as follows: Held to Maturity (HTM). Debt securities that management has the positive intent and ability to hold until maturity are classified as HTM and are carried at their remaining unpaid principal balance, net of unamortized premiums or unaccreted discounts. Premiums are amortized and discounts are accreted using the level interest yield method over the estimated remaining term of the underlying security. Available for Sale (AFS). Debt and equity securities that will be held for indefinite periods of time, including securities that may be sold in response to changes in market interest or prepayment rates, needs for liquidity and changes in the availability of and the yield of alternative investments are classified as AFS. These assets are carried at market value. Market value is determined using published quotes as of the close of business. Unrealized gains and losses are excluded from earnings and reported net of tax in Accumulated Other Comprehensive Income until realized. Premises and Equipment. Bank premises and equipment are stated at cost, net of accumulated depreciation. Depreciation is computed on a straight line basis over the estimated useful lives of the related assets. Useful lives are estimated to be twenty to forty years for premises and three to ten years for equipment. Maintenance and repairs are charged to income as incurred while major improvements and replacements are capitalized. Income Taxes. The Company files a consolidated Federal income tax return. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of changes in tax rates is recognized in income in the period the change occurs. Stock Options. The Company applies the provisions of Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees" and related interpretations, in accounting for its stock-based compensation plans. Under Opinion 25, compensations cost is measured as the excess, if any of the quoted market price of the Company's stock at the date of the grant above the amount an employee must pay to acquire the stock. The Financial Accounting Standards Board (FASB) published Statement of Financial Accounting 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 1998, 1999 and 2000. 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 and its amendments are 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. 57
59 In June 1999, the Financial Accounting Standards Board issued Financial Accounting Standards No. 137, "Accounting for Derivative Instruments and Hedging Activities (FAS137)-- Deferral of the Effective Date of Financial Accounting Standards No. 133, an Amendment of Financial Accounting Standards Board Statement No. 133," which defers the effective date of Financial Accounting Standards No. 133 from fiscal years beginning after June 15, 1999 to fiscal years beginning after June 15, 2000. Initial application should be as of the beginning of an entity's fiscal quarter; on that date, hedging relationships must be designated and documented pursuant to the provisions of Financial Accounting Standards No. 133, as amended. Earlier application of all of the provisions is encouraged but is permitted only as of the beginning of any fiscal quarter that begins after the issuance date of Financial Accounting Standards No. 133, as amended. Additionally, Financial Accounting Standards No. 133, as amended, should not be applied retroactively to financial statements of prior periods. In June 2000, the Financial Accounting Standards Board issued Financial Accounting Standards No. 138, "Accounting for Derivative Instruments and Hedging Activities, an Amendment of Financial Accounting Standards Board Statement No. 133," which addresses a limited number of issues causing implementation difficulties for numerous entities that apply Financial Accounting Standards No. 133, as amended. Financial Accounting Standards No. 138 amends the accounting and reporting standards of Financial Accounting Standards No. 133, as amended, for certain derivative instruments, certain hedging activities and for decisions made by the Financial Accounting Standards Board relating to the Derivatives Implementation Group process. Management anticipates that adoption of Financial Accounting Standards No. 133, as amended, will not have a significant effect on the Company's results of operations or its financial position, except for the HTM securities transferred. On January 1, 2001, the Company adopted FAS133 and FAS137. The transition provisions contained in FAS133 provide that at the date of initial application, an entity may transfer any debt security classified as HTM to AFS or trading. Effective January 1, 2001, as part of implementing FAS133 and FAS137, the Company elected to transfer all of its securities out of the HTM category in accordance with FAS133 guidance. Securities transferred on January 1, 2001 and sold during the first quarter ended March 31, 2001, will be accounted for as trading securities. All other securities transferred will be accounted for as AFS securities. In September 2000, the Financial Accounting Standards Board issued Financial Accounting Standards No. 140, "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities, a replacement of Financial Accounting Standards Board Statement No. 125," which revises the standards for accounting for securitizations and other transfers of financial assets and collateral and requires certain disclosures, but, it carries over most of Financial Accounting Standards No. 125's provisions without reconsideration. The statement is effective for transfers and servicing of financial assets and extinguishments of liabilities occurring after March 31, 2001. It is effective for disclosures about securitizations and collateral and for the recognition and reclassification of collateral for fiscal years ending after December 15, 2000. Management anticipates the adoption of financial Accounting Standards No. 140 will not have a significant effect on the Company's results of operations or on its financial position. General. Certain prior period amounts have been reclassified to conform to current year presentation. 58
60 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 splits and stock dividends and is calculated as follows (in thousands, except per share amounts): <TABLE> <CAPTION> Years Ended December 31, ------------------------------ 2000 1999 1998 ------ ------ ------ <S> <C> <C> <C> Numerator: Net income ..................................... $9,825 $7,924 $5,351 ====== ====== ====== Numerator for net income per common share ...... 9,825 7,924 5,351 Effect of dilutive securities .................. 142 -- -- ------ ------ ------ Numerator for net income per common share - assuming dilution ................. $9,967 $7,924 $5,351 ====== ====== ====== Denominator: Denominator for net income per common share (weighted-average shares outstanding) 7,612 7,675 7,783 Effect of dilutive securities: Stock options ............................. 197 247 298 Convertible debentures .................... 241 -- -- ------ ------ ------ Denominator for net income per common share - assuming dilution ................. 8,050 7,922 8,081 ====== ====== ====== Net income per common share ......................... $ 1.29 $ 1.03 $ .69 Net income per common share - assuming dilution ..... $ 1.24 $ 1.00 $ .66 </TABLE> 59
61 3. COMPREHENSIVE INCOME The components of accumulated comprehensive income (loss) as required by Statement of Financial Accounting Standard No. 130, "Reporting Comprehensive Income" are as follows (in thousands): <TABLE> <CAPTION> Year Ended December 31, 2000 -------------------------------------- Before-Tax Tax (Expense) Net-of-Tax Amount Benefit Amount ---------- ------------- ---------- <S> <C> <C> <C> Unrealized gains on securities: Unrealized holding gains arising during period ..... $ 8,976 $(3,052) $ 5,924 Less: reclassification adjustment for losses realized in net income ......................... (535) 182 (353) ------- ------- ------- Net unrealized gains .............................. 9,511 (3,234) 6,277 Minimum pension liability adjustment .................. (36) 12 (24) ------- ------- ------- Other comprehensive income ............................ $ 9,475 $(3,222) $ 6,253 ======= ======= ======= </TABLE> <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> 4. CASH AND DUE FROM BANKS The Company is required to maintain cash reserve balances with the Federal Reserve Bank. The reserve balances were $4.5 million and $250,000 as of December 31, 2000 and 1999, respectively. 60
62 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, 2000 and 1999 were (in thousands): <TABLE> <CAPTION> AVAILABLE FOR SALE --------------------------------------------------- Gross Gross Estimated December 31, Amortized Unrealized Unrealized Market 2000 Cost Gains Losses Value ---- --------- ---------- ---------- --------- <S> <C> <C> <C> <C> U.S. Treasury ..................... $ 6,001 $ 15 $ 1 $ 6,015 U.S. Government Agencies .......... 3,502 -- -- 3,502 Mortgage-backed Securities: Direct Govt. Agency Issues ...... 250,190 4,598 121 254,667 Other Private Issues ............ 14,170 532 83 14,619 State and Political Subdivisions .. 43,609 1,741 200 45,150 Other Stocks and Bonds ............ 22,327 9 -- 22,336 -------- -------- -------- -------- Total ........................... $339,799 $ 6,895 $ 405 $346,289 ======== ======== ======== ======== </TABLE> <TABLE> <CAPTION> HELD TO MATURITY --------------------------------------------------- Gross Gross Estimated December 31, Amortized Unrealized Unrealized Market 2000 Cost Gains Losses Value ---- --------- ---------- ---------- --------- <S> <C> <C> <C> <C> U.S. Government Agencies .......... $ 39,888 $ 871 $ 212 $ 40,547 Mortgage-backed Securities: Direct Govt. Agency Issues ...... 67,498 2,069 136 69,431 Other Private Issues ............ 75,463 1,182 250 76,395 State and Political Subdivisions .. 54,994 2,353 1 57,346 Other Stocks and Bonds ............ 9,626 131 -- 9,757 -------- -------- -------- -------- Total ........................... $247,469 $ 6,606 $ 599 $253,476 ======== ======== ======== ======== </TABLE> <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> 61
63 Interest income recognized on securities for the years presented: <TABLE> <CAPTION> Years Ended December 31, ---------------------------------- 2000 1999 1998 ------- ------- ------- (in thousands) <S> <C> <C> <C> U.S. Treasury .......................... $ 403 $ 707 $ 562 U.S. Government Agencies ............... 4,197 3,322 614 Mortgage-backed Securities ............. 27,155 22,080 12,116 State and Political Subdivisions ....... 4,913 4,698 3,548 Other Stocks and Bonds ................. 2,270 1,261 589 ------- ------- ------- Total interest income on securities .... $38,938 $32,068 $17,429 ======= ======= ======= </TABLE> During the month ended January 31, 2000 and the year ended December 31, 1999, the Company transferred securities totaling $91.7 million and $132.4 million, respectively, from AFS to HTM due to changes in market conditions. Of the total transferred, $21.2 million and $66.3 million were investment securities and $70.5 million and $66.1 million were mortgage-backed securities. The unrealized loss on the securities transferred from AFS to HTM was $2.6 million and $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, 2000 or 1999. On January 1, 2001, the Company adopted FAS133 and FAS137. The transition provisions contained in FAS133 provide that at the date of initial application, an entity may transfer any debt security classified as HTM to AFS or trading. Effective January 1, 2001, as part of implementing FAS133 and FAS137, the Company elected to transfer all of its securities out of the HTM category in accordance with FAS133 guidance. Securities transferred on January 1, 2001 and sold during the first quarter ended March 31, 2001, will be accounted for as trading securities. All other securities transferred will be accounted for as AFS securities. Of the $535,000 in net securities losses on sales from the AFS portfolio in 2000, there were $1,553,000 in realized losses and $1,018,000 in realized gains. 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. The $1,260,000 in net securities gains on sales from the AFS portfolio in 1998 were comprised of $1,321,000 in realized gains and $61,000 in realized losses. 62
64 The scheduled maturities of AFS and HTM securities as of December 31, 2000 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 .................. $ 27,735 $ 27,759 Due after one year through five years .... 4,709 4,810 Due after five years through ten years ... 2,539 2,611 Due after ten years ...................... 40,456 41,823 -------- -------- 75,439 77,003 Mortgage-backed securities .................. 264,360 269,286 -------- -------- Total ................................. $339,799 $346,289 ======== ======== Held to maturity securities: Due in one year or less .................. $ 2,486 $ 2,489 Due after one year through five years .... 15,194 15,387 Due after five years through ten years ... 12,943 13,013 Due after ten years ...................... 73,885 76,761 -------- -------- 104,508 107,650 Mortgage-backed securities .................. 142,961 145,826 -------- -------- Total ................................. $247,469 $253,476 ======== ======== </TABLE> Investment securities with book values of $343,955,000 and $436,357,000 were pledged as of December 31, 2000 and 1999, respectively, to collateralize FHLB Dallas advances, public and trust deposits or for other purposes as required by law. 63
65 6. LOANS AND RESERVE FOR POSSIBLE LOAN LOSSES Loans in the accompanying consolidated balance sheets are classified as follows: <TABLE> <CAPTION> December 31, December 31, 2000 1999 ------------ ------------ Real Estate Loans: (in thousands) <S> <C> <C> Construction ..................... $ 25,108 $ 18,489 1-4 family residential ........... 134,672 112,699 Other ............................ 122,665 97,556 Commercial loans ..................... 107,737 79,804 Loans to individuals ................. 92,607 82,747 -------- -------- Total loans .......................... 482,789 391,295 Less: Unearned income ........... 1,354 3,849 Reserve for loan losses ... 5,033 4,575 -------- -------- Net loans ................. $476,402 $382,871 ======== ======== </TABLE> The following is a summary of the Reserve for Loan Losses for the years ended December 31, 2000, 1999 and 1998: <TABLE> <CAPTION> Years Ended December 31, ------------------------------ 2000 1999 1998 -------- -------- -------- (in thousands) <S> <C> <C> <C> Balance at beginning of year .............. $ 4,575 $ 3,564 $ 3,370 Provision for loan losses .......... 1,569 1,456 1,215 Loans charged off .................. (1,442) (765) (1,349) Recoveries of loans charged off .... 331 320 328 ------- ------- ------- Balance at end of year .................... $ 5,033 $ 4,575 $ 3,564 ======= ======= ======= </TABLE> Nonaccrual loans at December 31, 2000 and 1999 were $630,000 and $703,000, respectively. Loans with terms modified in troubled debt restructuring at December 31, 2000 and 1999 were $389,000 and $448,000, respectively. For the years ended December 31, 2000 and 1999, the average recorded investment in impaired loans was approximately $567,000 and $565,000, respectively. During the years ended December 31, 2000 and 1999, 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 $122,000, $125,000 and $94,000 for the years ended December 31, 2000, 1999 and 1998, respectively. If these loans had been accruing interest at their original contracted rates, related income would have been $138,000, $137,000 and $113,000 for the years ended December 31, 2000, 1999 and 1998, 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: <TABLE> <CAPTION> Valuation Carrying Total Allowance Value -------- --------- -------- (in thousands) <S> <C> <C> <C> Real Estate.............................. $ 336 $ 32 $ 304 Commercial Loans......................... 78 20 58 Loans to Individuals..................... 216 29 187 -------- -------- -------- Balance at December 31, 2000............. $ 630 $ 81 $ 549 ======== ======== ======== </TABLE> 64
66 <TABLE> <CAPTION> Valuation Carrying Total Allowance Value -------- --------- -------- (in thousands) <S> <C> <C> <C> Commercial Loans......................... $ 422 $ 225 $ 197 Loans to Individuals..................... 281 44 237 -------- -------- -------- Balance at December 31, 1999............. $ 703 $ 269 $ 434 ======== ======== ======== </TABLE> 7. BANK PREMISES AND EQUIPMENT <TABLE> <CAPTION> December 31, December 31, 2000 1999 ------------ ------------ (in thousands) <S> <C> <C> Bank premises ..................... $27,002 $22,347 Furniture and equipment ........... 13,473 12,290 ------- ------- 40,475 34,637 Less accumulated depreciation ..... 15,000 13,331 ------- ------- Total .................... $25,475 $21,306 ======= ======= </TABLE> Depreciation expense was $1,699,000, $1,474,000 and $1,397,000 for the years ended December 31, 2000, 1999 and 1998, respectively. Rent expense was $447,000, $424,000 and $198,000 for the years ended December 31, 2000, 1999 and 1998, respectively. Future minimum rental commitments under noncancelable leases are (in thousands): <TABLE> <S> <C> 2001 $ 270 2002 181 2003 142 2004 27 2005 -- Thereafter -- ------- $ 620 ======= </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: <TABLE> <CAPTION> Years Ended December 31, ------------------------ 2000 1999 1998 ------ ------ ------ (in thousands) <S> <C> <C> <C> Balance at beginning of year ..... $ 61 $ 658 $ 672 Acquisition of OREO .......... 61 Disposition of OREO .......... (61) (658) (14) ----- ----- ----- Balance at end of year ........... $ -- $ 61 $ 658 ===== ===== ===== </TABLE> For the years ended December 31, 2000, 1999 and 1998, income from OREO properties exceeded the provision and other expenses by $2,000, $58,000 and $28,000, respectively. 65
67 9. INTEREST BEARING DEPOSITS <TABLE> <CAPTION> December 31, December 31, 2000 1999 ------------ ------------ (in thousands) <S> <C> <C> Savings deposits ................... $ 24,007 $ 20,282 Money Market demand deposits ....... 60,355 75,278 Platinum Money Market deposits ..... 15,455 -- NOW demand deposits ................ 107,573 84,227 Certificates and other time deposits of $100,000 or more .............. 151,142 87,468 Certificates and other time deposits under $100,000 .......... 195,174 169,660 -------- -------- Total ..................... $553,706 $436,915 ======== ======== </TABLE> For the years ended December 31, 2000, 1999 and 1998, interest expense on time deposits of $100,000 or more was $7,902,000, $3,427,000 and $3,133,000, respectively. At December 31, 2000, the scheduled maturities of certificates and other time deposits are as follows (in thousands): <TABLE> <S> <C> 2001 $ 226,106 2002 31,356 2003 30,115 2004 6,659 2005 and thereafter 52,080 --------- $ 346,316 ========= </TABLE> The aggregate amount of demand deposits that has been reclassified as loans were $950,000 and $870,000 for December 31, 2000 and 1999, respectively. 66
68 10. SHORT-TERM BORROWINGS Information related to short-term borrowings is provided in the table below. <TABLE> <CAPTION> Years Ended December 31, -------------------------------- 2000 1999 1998 -------- -------- -------- (in thousands) <S> <C> <C> <C> Federal funds purchased Balance at end of period ................................. $ 5,025 $ 75 $ 4,168 Average amount outstanding during the period(1) .......... 2,687 4,660 3,700 Maximum amount outstanding during the period ............. 15,325 24,068 25,364 Weighted average interest rate during the period(2) ...... 6.6% 5.1% 5.7% Interest rate at end of period ........................... 6.5% 4.3% 5.1% Securities sold under agreements to repurchase Balance at end of period ................................. $ -- $ -- $ -- Average amount outstanding during the period(1) .......... -- -- 59 Maximum amount outstanding during the period ............. -- -- 7,150 Weighted average interest rate during the period(2) ...... -- -- 5.6% Interest rate at end of period ........................... -- -- -- Federal Home Loan Bank ("FHLB") Dallas Advances Balance at end of period ................................. $148,940 $181,222 $118,000 Average amount outstanding during the period(1) .......... 156,265 155,719 61,734 Maximum amount outstanding during the period ............. 188,899 186,500 135,000 Weighted average interest rate during the period(2) ...... 6.3% 5.3% 5.3% Interest rate at end of period ........................... 6.1% 5.3% 5.0% Treasury tax and loan funds Balance at end of period ................................. $ 2,278 $ 4,744 $ 1,523 Average amount outstanding during the period(1) .......... 2,210 1,908 1,293 Maximum amount outstanding during the period ............. 4,604 4,747 3,154 Weighted average interest rate during the period(2) ...... 5.8% 4.0% 4.2% Interest rate at end of period ........................... 5.8% 4.7% 4.1% </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. 67
69 11. LONG TERM OBLIGATIONS <TABLE> <CAPTION> Years Ended December 31, ---------------------------------- 2000 1999 1998 -------- -------- -------- (in thousands) <S> <C> <C> <C> FHLB Dallas Advances Balance at end of period ................................. $179,645 $174,704 $156,027 Average amount outstanding during the period (1) ......... 187,011 175,028 84,836 Maximum amount outstanding during the period ............. 210,460 174,870 156,238 Weighted average interest rate during the period (2) ..... 5.5% 5.3% 5.5% Interest rate at end of period ........................... 5.7% 5.4% 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. Maturities of fixed rate FHLB Dallas Long-term advances based on scheduled repayments at December 31, 2000 are (in thousands): <TABLE> <CAPTION> Under Due Due Over 2000 1 Year 1-5 Years 6-10 Years 10 Years Total -------- --------- ---------- -------- -------- <S> <C> <C> <C> <C> <C> Total Long-term Obligations......... $ 864 $140,105 $ 37,891 $ 785 $179,645 ======== ======== ======== ======== ======== </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. 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. On November 2, 2000, the Company through its wholly-owned subsidiary, Southside Capital Trust II (the "Trust II Issuer"), sold 1,695,000 cumulative convertible preferred securities at a liquidation amount of $10 per convertible preferred security for an aggregate amount of $16,950,000. These securities have a convertible feature that allows the owner to convert each security to a share of the Company's common stock at a conversion price of $10 per common share. 68
70 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. 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 $3.7 million over a maximum period of fifteen years after retirement or death. Deferred compensation expense was $13,000, $211,000 and $147,000 for the years ended December 31, 2000, 1999 and 1998, 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 $1,451,000, $1,122,000 and $802,000 for the years ended December 31, 2000, 1999 and 1998, respectively. There were six retirees and five retirees participating in the health insurance plan as of December 31, 2000 and 1999, 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 years ended December 31, 2000 and 1999 were $100,000. There were no contributions to the plan for the year ended December 31, 1998. At December 31, 2000 and 1999, 197,260 and 202,919 shares of common stock were owned by the Employee Stock Ownership Plan, respectively. The number of shares have been adjusted as a result of stock splits and stock dividends. These shares are treated as externally held shares for dividend and earnings per share calculations. The Company has an Officers Long-term Disability Income Plan, (the "Disability Plan"), which covers officers of the Company and Southside Bank in the event they become disabled as defined under its terms. Individuals are automatically covered under the plan if they (a) have been elected as an officer, (b) have been an employee of the Company and Southside Bank for three years and (c) receive earnings of $50,000 or more on an annual basis. The Disability Plan provides, among other things, that should a covered individual become totally disabled he would receive 66-2/3%, not to exceed $10,000 per month, of their current salary. The benefits paid out of this plan are limited by the benefits paid to the individual under the terms of other Company sponsored benefit plans. The Company and Southside Bank have a defined benefit pension plan pursuant to which participants are entitled to benefits based on final average monthly compensation and years of credited service determined in accordance with plan provisions. All employees of the Company and Southside Bank who have worked 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 138,899 shares of Southside Bancshares, Inc. stock purchased at fair market value at December 31, 2000 and 1999. The number of shares have been adjusted as a result of stock splits and stock dividends. 69
71 <TABLE> <CAPTION> December 31, December 31, Change in Projected Benefit Obligation 2000 1999 ------------ ------------ (in thousands) <S> <C> <C> Benefit obligation at end of prior year ..... $ 13,548 $ 13,926 Service cost ................................ 679 714 Interest cost ............................... 1,030 957 Actuarial loss (gain) ....................... 488 (1,371) Benefits paid ............................... (634) (604) Expenses paid ............................... -- (74) -------- -------- Benefit obligation at end of year ........ $ 15,111 $ 13,548 ======== ======== </TABLE> <TABLE> <CAPTION> December 31, December 31, Change in Plan Assets 2000 1999 ------------ ------------ (in thousands) <S> <C> <C> Fair value of plan assets at end of prior year ..... $ 14,117 $ 12,113 Actual return ...................................... (123) 1,891 Employer contribution .............................. 485 791 Benefits paid ...................................... (634) (604) Expenses paid ...................................... -- (74) -------- -------- Fair value of plan assets at end of year ........ $ 13,845 $ 14,117 ======== ======== </TABLE> <TABLE> <CAPTION> December 31, December 31, Reconciliation of Funded Status 2000 1999 ------------ ------------ (in thousands) <S> <C> <C> Funded status ....................................... $(1,266) $ 569 Unrecognized net loss (gain) ........................ 729 (1,127) Unrecognized net transition asset ................... (139) (185) ------- ------- Accrued benefit cost ............................. $ (676) $ (743) ======= ======= </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 7.50% and 4.50% and 7.75% and 4.50% at December 31, 2000 and 1999, respectively. The assumed long-term rate of return on plan assets was 9.0% at December 31, 2000 and 1999. Net periodic pension cost for the years ended December 31, 2000, 1999 and 1998 included the following components: <TABLE> <CAPTION> Years Ended December 31, ------------------------------ 2000 1999 1998 -------- -------- -------- (in thousands) <S> <C> <C> <C> Service cost ...................... $ 679 $ 714 $ 578 Interest cost ..................... 1,030 957 856 Expected return on assets ......... (1,245) (1,068) (900) Transition asset recognition ...... (46) (46) (46) Net loss recognition .............. -- 9 9 ------- ------- ------- Net periodic benefit cost ......... $ 418 $ 566 $ 497 ======= ======= ======= </TABLE> 70
72 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. <TABLE> <CAPTION> December 31, December 31, Change in Projected Benefit Obligation 2000 1999 ------------ ------------ (in thousands) <S> <C> <C> Benefit obligation at end of prior year ........... $ 635 $ 405 Service cost ...................................... 3 13 Interest cost ..................................... 35 46 Actuarial (gain) loss ............................. (149) 227 Benefits paid ..................................... (56) (56) ----- ----- Benefit obligation at end of year .............. $ 468 $ 635 ===== ===== </TABLE> <TABLE> <CAPTION> December 31, December 31, Change in Plan Assets 2000 1999 ------------ ------------ (in thousands) <S> <C> <C> Fair value of plan assets at end of prior year ..... $ $ Employer contribution .............................. 56 56 Benefits paid ...................................... (56) (56) ---- ---- Fair value of plan assets at end of year ........ $ -- $ -- ==== ==== </TABLE> <TABLE> <CAPTION> December 31, December 31, Reconciliation of Funded Status 2000 1999 ------------ ------------ (in thousands) <S> <C> <C> Funded status .................................... $(468) $(635) Unrecognized net loss ............................ 106 260 Unrecognized net transition obligation ........... 19 21 ----- ----- Accrued benefit cost ............................. (343) (354) Additional minimum liability ..................... (112) (79) ----- ----- Accrued benefit liability ........................ (455) (433) Intangible asset ................................. 19 21 Accumulated other comprehensive income ........... 93 58 ----- ----- Net amount recognized ............................ $(343) $(354) ===== ===== </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 7.50% and 4.50% and 7.75% and 4.50% at December 31, 2000 and 1999, respectively. The assumed long-term rate of return on plan assets was 9.0% at December 31, 2000 and 1999. Net periodic postretirement benefit cost for the years ended December 31, 2000, 1999 and 1998 includes the following components: <TABLE> <CAPTION> Years Ended December 31, ------------------------ 2000 1999 1998 ---- ---- ---- (in thousands) <S> <C> <C> <C> Service cost .................... $ 3 $ 13 $ -- Interest cost ................... 35 46 28 Transition obligation recognition 3 3 3 Net loss recognition ............ 4 21 -- ---- ---- ---- Net periodic benefit cost ....... $ 45 $ 83 $ 31 ==== ==== ==== </TABLE> 71
73 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, 2000 and 1999, there were 17,688 and 294,435 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 1998, 1999 and 2000. These stock options have contractual terms of 10 years. All options vest on a graded schedule, 20% per year for 5 years, beginning on the first anniversary date of the grant date. In accordance with APB 25, the Company has not recognized any compensation cost for these stock options. A summary of the status of the Company's stock options as of December 31, 2000, 1999 and 1998 and the changes during the year ended on those dates is presented below: <TABLE> <CAPTION> 2000 1999 1998 ------------------------- ------------------------ ------------------------ # 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 .................... 890,012 $ 6.41 788,975 $ 5.90 655,075 $ 5.19 --------- ------ --------- ------ --------- ------ Granted ........................ 279,971 $ 7.39 157,665 $ 8.00 334,983 $ 9.87 --------- ------ --------- ------ --------- ------ Exercised ...................... 9,503 $ 4.42 47,094 $ 2.95 27,059 $ 2.98 --------- ------ --------- ------ --------- ------ Forfeited ...................... 3,224 $ 7.84 9,534 $ 7.98 174,024 $11.33 --------- ------ --------- ------ --------- ------ Expired ........................ -- N/A -- N/A -- N/A --------- ------ --------- ------ --------- ------ Outstanding at end of year ..... 1,157,256 $ 6.65 890,012 $ 6.41 788,975 $ 5.90 --------- ------ --------- ------ --------- ------ Exercisable at end of year ..... 557,034 $ 5.69 405,498 $ 5.22 322,138 $ 4.37 --------- ------ --------- ------ --------- ------ Weighted-average FV of options granted during the year ........................... $ 1.83 $ 2.13 $ 3.18 --------- --------- --------- </TABLE> The fair value of each stock option granted is estimated on the date of grant using the Black-Scholes method of option pricing with the following weighted-average assumptions for grants in 2000, 1999 and 1998, respectively: dividend yield of 2.95%, 2.30%, and 1.37%; risk-free interest rates of 5.95%, 6.05%, and 5.18%; the expected lives of 6 years; the expected volatility is 23.21%. 72
74 The following table summarizes information about stock options outstanding at December 31, 2000: <TABLE> <CAPTION> Options Outstanding Options Exercisable ------------------------------------------- ---------------------------- NUMBER WEIGHTED AVG. NUMBER RANGE OF OUTSTANDING REMAINING WEIGHTED AVG EXERCISABLE WEIGHTED AVG. EXERCISE PRICES AT 12/31/00 CONTR. LIFE EXERCISE PRICE AT 12/31/00 EXERCISE PRICE <S> <C> <C> <C> <C> <C> $ 2.71 to $ 5.88 402,465 4.3 $4.74 366,730 $4.62 $ 7.30 to $ 8.00 754,791 8.3 $7.68 190,304 $7.73 - ---------------- --------- ----- ----- --------- ----- $ 2.71 to $ 8.00 1,157,256 6.9 $6.65 557,034 $5.69 ========= ========= </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 2000, 1999, and 1998 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 12/31/00 12/31/00 12/31/99 12/31/99 12/31/98 12/31/98 -------- -------- -------- -------- -------- -------- <S> <C> <C> <C> <C> <C> <C> FAS123 Charge ............. $ -- $ 330 $ -- $ 316 $ -- $ 184 Net Income ................ $ 9,825 $ 9,495 $ 7,924 $ 7,608 $ 5,351 $ 5,167 Net Income per Common Share-Basic ............ $ 1.29 $ 1.25 $ 1.03 $ .99 $ .69 $ .66 Net Income per Common Share-Diluted .......... $ 1.24 $ 1.20 $ 1.00 $ .96 $ .66 $ .64 </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 $0.225 per share for the year ended December 31, 2000. Cash dividends declared and paid were $0.20 per share for the years ended December 31, 1999 and 1998. Future dividends will depend on the Company's earnings, financial condition and other factors which the Board of Directors of the Company considers to be relevant. The Company's dividend policy requires that any dividend payments made by the Company not exceed consolidated earnings for that year. The Bank is subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Bank's financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank must meet specific capital guidelines that involve quantitative measures of the Bank's assets, liabilities, and certain off-balance-sheet items as calculated under regulatory accounting practices. The Bank's capital amounts and classification are also subject to qualitative judgments by the regulators regarding components, risk weightings, and other factors. 73
75 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, 2000, that the Bank meets all capital adequacy requirements to which it is subject. As of December 31, 2000, 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 ---------- ------- ---------- ------- ---------- ------- As of December 31, 2000: (in thousands) <S> <C> <C> <C> <C> <C> <C> Total Capital (to Risk Weighted Assets) Consolidated............................ $ 94,817 16.63% $ 45,605 8.00% N/A N/A ========== ====== ========== ====== ========== ======= Bank Only............................... $ 87,495 15.30% $ 45,741 8.00% $ 57,176 10.00% ========== ====== ========== ====== ========== ======= Tier 1 Capital (to Risk Weighted Assets) Consolidated............................ $ 71,169 12.48% $ 22,802 4.00% N/A N/A ========== ====== ========== ====== ========== ======= Bank Only............................... $ 82,758 14.47% $ 22,870 4.00% $ 34,306 6.00% ========== ====== ========== ====== ========== ======= Tier 1 Capital (to Average Assets) (1) Consolidated............................ $ 71,169 6.31% $ 45,148 4.00% N/A N/A ========== ====== ========== ====== ========== ======= Bank Only............................... $ 82,758 7.33% $ 45,176 4.00% $ 56,470 5.00% ========== ====== ========== ====== ========== ======= As of December 31, 1999: Total Capital (to Risk Weighted Assets) Consolidated............................ $ 70,611 13.96% $ 40,473 8.00% N/A N/A ========== ====== ========== ====== ========== ======= Bank Only............................... $ 67,687 13.25% $ 40,864 8.00% $ 51,080 10.00% ========== ====== ========== ====== ========== ======= Tier 1 Capital (to Risk Weighted Assets) Consolidated............................ $ 61,782 12.21% $ 20,237 4.00% N/A N/A ========== ====== ========== ====== ========== ======= Bank Only............................... $ 63,343 12.40% $ 20,432 4.00% $ 30,648 6.00% ========== ====== ========== ====== ========== ======= Tier 1 Capital (to Average Assets) (1) Consolidated............................ $ 61,782 6.20% $ 39,876 4.00% N/A N/A ========== ====== ========== ====== ========== ======= Bank Only............................... $ 63,343 6.35% $ 39,875 4.00% $ 49,844 5.00% ========== ====== ========== ====== ========== ======= </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. 74
76 The table below summarizes key equity ratios for the Company for the years ended December 31, 2000, 1999 and 1998. <TABLE> <CAPTION> Years Ended December 31, ---------------------------------- 2000 1999 1998 -------- -------- -------- <S> <C> <C> <C> Percentage of Net Income to: Average Total Assets ............................. .92% .84% .78% Average Shareholders' Equity ..................... 23.13% 18.99% 12.42% Percentage of Dividends Declared Per Common Share to Net Income Per Common Share-Basic ....... 17.44% 19.42% 28.99% Percentage of Dividends Declared Per Common Share to Net Income Per Common Share-Diluted ..... 18.15% 20.00% 30.30% Percentage of Average Shareholders' Equity to Average Total Assets ................... 3.99% 4.41% 6.28% </TABLE> 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, 2000, 44,732 shares were sold under this plan at an average price of $8.24 per share, reflective of other trades at the time of each sale. For the year ended December 31, 1999, 34,296 shares were sold under this plan at an average price of $9.25 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 2000, 94,050 shares of treasury stock were purchased under this plan at a cost of $813,000. During 1999, 148,150 shares of treasury stock were purchased under this plan at a cost of $1,386,000. 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, --------------------------------- 2000 1999 1998 ------- -------- -------- <S> <C> <C> <C> Current tax provision ............................... $ 2,572 $ 2,033 $ 1,496 Deferred tax expense (benefit) ...................... 88 (33) (272) ------- ------- ------- Provision for tax expense charged to operations ..... $ 2,660 $ 2,000 $ 1,224 ======= ======= ======= </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, --------------------------------- 2000 1999 1998 ------- -------- -------- <S> <C> <C> <C> Provision for loan losses............................ $ (431) $ (551) $ (204) Provision for OREO losses............................ -- 202 -- Depreciation......................................... 42 45 (6) Retirement and other benefit plans................... 44 (4) (211) FHLB Dallas Stock dividends.......................... 526 308 149 Other................................................ (93) (33) -- ------- ------- ------- Deferred tax expense (benefit)....................... $ 88 $ (33) $ (272) ======= ======= ======= </TABLE> 75
77 The components of the net deferred tax asset (liability) as of December 31, 2000 and 1999 are summarized below (in thousands): <TABLE> <CAPTION> Assets Liabilities ------- ----------- <S> <C> <C> Allowance for Losses on OREO ........................... $ 101 $ Reserve for Loan Losses ................................ 1,711 Retirement and Other Benefit Plans ..................... 831 Unrealized losses on securities available for sale ..... 1,685 Loan Origination Costs ................................. (88) Premises and Equipment ................................. (292) FHLB Dallas Stock Dividends ............................ (1,128) Other .................................................. 102 ------- ------- Gross deferred tax assets (liabilities) ............. 4,430 (1,508) ------- ------- Net deferred tax asset at December 31, 2000 ...... $ 2,922 ======= </TABLE> <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> A reconciliation of tax at statutory rates and total tax expense is as follows (dollars in thousands): <TABLE> <CAPTION> Years Ended December 31, ------------------------------------------------------------------- 2000 1999 1998 ------------------- ------------------- ------------------- 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 ................... $ 4,245 34.0% $ 3,374 34.0% $ 2,236 34.0% Increase (Decrease) in Taxes from: Tax Exempt Interest ...................... (2,001) (16.0%) (1,661) (16.7%) (1,210) (18.4%) Other Net ................................ 416 3.3% 287 2.9% 198 3.0% ------- ---- ------- ---- ------- ---- Provision for Tax Expense Charged to Operations ............................ $ 2,660 21.3% $ 2,000 20.2% $ 1,224 18.6% ======= ==== ======= ==== ======= ==== </TABLE> 76
78 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, 2000 and 1999. At December 31, 1998, the Company had commitments to purchase $8.3 million 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 $54.2 million and $52.2 million at December 31, 2000 and 1999, respectively. The Company had outstanding standby letters of credit of $406,000 and $259,000 at December 31, 2000 and 1999, 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 47.7% 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. 77
79 19. RELATED PARTY TRANSACTIONS Loan activity of executive officers, directors, and their affiliates for the years ended December 31, 2000 and 1999 were (in thousands): <TABLE> <CAPTION> 2000 1999 -------- -------- <S> <C> <C> Beginning Balance of Loans $ 5,765 $ 6,428 Additional Loans .......... 2,114 2,936 Payments .................. (2,639) (3,599) ------- ------- Ending Balance of Loans ..... $ 5,240 $ 5,765 ======= ======= </TABLE> Other indebtedness of officers and employees as of December 31, 2000 and 1999 was $3,673,000 and $3,031,000, respectively. The Company incurred legal costs of $134,000, $150,000 and $176,000 during the years ended December 31, 2000, 1999 and 1998, respectively, from a law firm of which an outside director of the Company is a partner. The Company paid approximately $69,000, $54,000 and $49,000 in insurance premiums during the years ended December 31, 2000, 1999 and 1998, respectively, to companies of which two outside directors are officers. 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. 78
80 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: <TABLE> <CAPTION> At December 31, 2000 At December 31, 1999 --------------------------- --------------------------- Carrying Carrying Amount Fair Value Amount Fair Value ------------ ------------ ------------ ------------ (in thousands) <S> <C> <C> <C> <C> Financial assets: Cash and due from banks ................ $ 38,800 $ 38,800 $ 41,131 $ 41,131 Investment securities: Available for sale ..................... 56,777 56,777 96,244 96,244 Held to maturity ....................... 104,508 107,650 86,208 84,389 Mortgage-backed and related securities: Available for sale ..................... 269,286 269,286 273,676 273,676 Held to maturity ....................... 142,961 145,826 73,898 71,876 Marketable equity securities: Available for sale ..................... 20,226 20,226 18,543 18,543 Loans, net .................................. 476,402 479,783 382,871 375,411 Financial liabilities: Retail deposits .......................... $ 720,605 $ 693,873 $ 587,544 $ 542,250 Federal funds purchased .................. 5,025 5,025 75 75 FHLB Dallas advances ..................... 328,585 328,063 355,926 348,392 Junior subordinated debentures ........... 20,000 20,000 20,000 20,000 Junior subordinated convertible debentures ........................... 16,950 16,950 -- -- Off-balance sheet liabilities: Commitments to extend credit ............. 47,393 47,393 46,007 46,007 Standby letters of credit ................ 406 406 259 259 Credit card arrangements ................. 6,801 6,801 6,171 6,171 </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. 79
81 21. QUARTERLY FINANCIAL INFORMATION OF REGISTRANT NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (in thousands, except per share data) <TABLE> <CAPTION> 2000 --------------------------------------------------------------- Fourth Third Second First Quarter Quarter Quarter Quarter ------------ ------------ ------------ ------------ <S> <C> <C> <C> <C> Interest income .................................. $ 20,190 $ 19,182 $ 18,513 $ 17,533 Net interest income .............................. 7,232 7,095 7,551 7,403 Income before provision for income taxes ......... 3,180 2,954 3,183 3,168 Provision for income taxes ....................... 628 592 714 726 Net income ....................................... 2,552 2,362 2,469 2,442 Net income per share Basic ........................................ .34 .31 .32 .32 Diluted ...................................... .32 .30 .31 .31 </TABLE> <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 ........................................ .33 .26 .23 .21 Diluted ...................................... .32 .25 .23 .20 </TABLE> 80
82 22. PARENT COMPANY FINANCIAL INFORMATION Condensed financial information for Southside Bancshares, Inc. (parent company only) was as follows: CONDENSED BALANCE SHEETS <TABLE> <CAPTION> December 31, December 31, 2000 1999 ------------ ------------ (in thousands) ASSETS <S> <C> <C> Cash and due from banks ................................................... $ 7,031 $ 2,648 Investment in bank subsidiary at equity in underlying net assets .................................................. 79,476 53,810 Investment in nonbank subsidiary at equity in underlying net assets .................................................. 15 15 Other assets .............................................................. 2,270 1,240 ------------ ------------ TOTAL ASSETS ...................................................... $ 88,792 $ 57,713 ============ ============ LIABILITIES Junior subordinated debentures ............................................ $ 20,000 $ 20,000 Junior subordinated convertible debentures ................................ 16,950 -- Other liabilities ......................................................... 147 41 ------------ ------------ TOTAL LIABILITIES ................................................. 37,097 20,041 ------------ ------------ SHAREHOLDERS' EQUITY Common stock ($1.25 par, 20,000,000 shares authorized: 8,215,135 and 7,798,332 and shares issued) ............................ 10,269 9,748 Paid-in capital ........................................................... 30,226 27,472 Retained earnings ......................................................... 19,891 14,583 Treasury stock (606,552 and 512,502 shares) ............................... (5,357) (4,544) Accumulated other comprehensive loss ...................................... (3,334) (9,587) ------------ ------------ TOTAL SHAREHOLDERS' EQUITY ........................................ 51,695 37,672 ------------ ------------ TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY ........................ $ 88,792 $ 57,713 ============ ============ </TABLE> 81
83 CONDENSED STATEMENTS OF INCOME <TABLE> <CAPTION> Years Ended December 31, ---------------------------------------- 2000 1999 1998 ------------ ------------ ------------ INCOME (in thousands) <S> <C> <C> <C> Dividends from subsidiary ............................. $ -- $ -- $ 586 ------------ ------------ ------------ TOTAL INCOME ..................................... -- -- 586 ------------ ------------ ------------ EXPENSE Interest expense ...................................... 1,914 1,700 1,048 Salaries and employee benefits ........................ 100 100 -- Taxes other than income ............................... -- -- 27 Other ................................................. 382 348 171 ------------ ------------ ------------ TOTAL EXPENSE .................................... 2,396 2,148 1,246 ------------ ------------ ------------ Loss before federal income tax expense ................ (2,396) (2,148) (660) Benefit for federal income tax expense ................ 815 730 424 ------------ ------------ ------------ Loss before equity in undistributed earnings of subsidiaries ........................... (1,581) (1,418) (236) Equity in undistributed earnings of subsidiaries ...... 11,406 9,342 5,587 ------------ ------------ ------------ NET INCOME ....................................... $ 9,825 $ 7,924 $ 5,351 ============ ============ ============ </TABLE> CONDENSED STATEMENTS OF CASH FLOW <TABLE> <CAPTION> Years Ended December 31, ------------------------------------------------ 2000 1999 1998 ------------ ------------ ------------ (in thousands) <S> <C> <C> <C> OPERATING ACTIVITIES: Net Income ............................................... $ 9,825 $ 7,924 $ 5,351 Adjustments to reconcile net income to cash provided by operations: Equity in undistributed earnings of subsidiaries ....... (11,406) (9,342) (5,587) (Increase) decrease in other assets .................... (1,030) 45 (1,283) Decrease (increase) in other liabilities ............... 105 31 (2) ------------ ------------ ------------ Net cash used in operating activities ............. (2,506) (1,342) (1,521) INVESTING ACTIVITIES: Investments in subsidiaries .............................. (8,000) -- (10,000) ------------ ------------ ------------ Net cash used in investing activities ............. (8,000) -- (10,000) FINANCING ACTIVITIES: Purchase of treasury stock ............................... (813) (1,386) (1,398) Proceeds from sale of treasury stock ..................... 38 Proceeds from issuance of common stock ................... 410 456 347 Dividends paid ........................................... (1,658) (1,409) (1,359) Proceeds from the issuance of junior subordinated debentures .............................. -- -- 20,000 Proceeds from the issuance of junior subordinated convertible debentures ............................... 16,950 -- -- ------------ ------------ ------------ Net cash provided by (used in) financing activities....................................... 14,889 (2,339) 17,628 Net increase (decrease) in cash and cash equivalents ..... 4,383 (3,681) 6,107 Cash and cash equivalents at beginning of year ........... 2,648 6,329 222 ------------ ------------ ------------ Cash and cash equivalents at end of year ................. $ 7,031 $ 2,648 $ 6,329 ============ ============ ============ </TABLE> 82
84 INDEX TO EXHIBITS <TABLE> <CAPTION> EXHIBIT NUMBER DESCRIPTION ------- ----------- <S> <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 by reference). 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 by reference). 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 by reference). **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 incorporated herein by reference). **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 by reference). **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 by reference). **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 by reference). **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 by reference). **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 by reference). </TABLE>
85 <TABLE> <S> <C> **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 (filed as Exhibit 10(f) to the Registrant's Form 10-K for the year ended December 31, 1997, and incorporated herein by reference). *21 - Subsidiaries of the Registrant. *23 - Consent of Independent Accountants. </TABLE> - ---------- * Filed herewith. ** Compensation plan, benefit plan or employment contract or arrangement.