UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

Commission file number 0-7674

FIRST FINANCIAL BANKSHARES, INC.

(Exact name of registrant as specified in its charter)

Texas		75-0944023
(State or other jurisdiction of incorporation		(I.R.S. Employer
or organization)		Identification No.)
400 Pine Street, Abilene, Texas		79601
(Address of principal executive offices)		(Zip Code)

TABLE OF CONTENTS

Item		Page
PART I FINANCIAL INFORMATION
1. Financial Statements			3
Consolidated Balance Sheets — Unaudited			4
Consolidated Statements of Earnings — Unaudited			5
Consolidated Statements of Comprehensive Earnings — Unaudited			6
Consolidated Statements of Changes in Shareholders’ Equity — Unaudited			7
Consolidated Statements of Cash Flows — Unaudited			8
Notes to Consolidated Financial Statements — Unaudited			9
2. Management’s Discussion and Analysis of Financial Condition and Results of Operations			20
3. Quantitative and Qualitative Disclosures About Market Risk			41
4. Controls and Procedures			41
PART II OTHER INFORMATION
6. Exhibits			43
Signatures			44
EX-31.1
EX-31.2
EX-32.1
EX-32.2
EX-101 INSTANCE DOCUMENT
EX-101 SCHEMA DOCUMENT
EX-101 CALCULATION LINKBASE DOCUMENT
EX-101 LABELS LINKBASE DOCUMENT
EX-101 PRESENTATION LINKBASE DOCUMENT
EX-101 DEFINITION LINKBASE DOCUMENT

PART I

FINANCIAL INFORMATION

Item 1. Financial Statements.

The consolidated balance sheets of First Financial Bankshares, Inc. (the “Company”) at June 30, 2010 and 2009 and December 31, 2009, the consolidated statements of earnings and comprehensive earnings for the three and six months ended June 30, 2010 and 2009, and changes in shareholders’ equity and cash flows for the six months ended June 30, 2010 and 2009, follow on pages 4 through 8.

FIRST FINANCIAL BANKSHARES, INC. AND SUBSIDIARIES

		June 30,								December 31,
		2010				2009				2009
		(Unaudited)
ASSETS
CASH AND DUE FROM BANKS		$	100,460			$	102,339			$	139,915
FEDERAL FUNDS SOLD			225				26,375				14,290
INTEREST-BEARING DEPOSITS IN BANKS			139,521				17,252				167,336
Total cash and cash equivalents			240,206				145,966				321,541
TRADING SECURITIES, at fair value			—				31,189				—
SECURITIES HELD-TO-MATURITY (fair value of $11,403, $19,746 and $15,674 at June 30, 2010 and 2009 and December 31, 2009, respectively)			11,107				19,278				15,273
SECURITIES AVAILABLE-FOR-SALE, at fair value			1,402,448				1,250,784				1,270,104
LOANS
Held for investment			1,513,671				1,462,885				1,510,046
Held for sale			6,001				16,237				4,323
			1,519,672				1,479,122				1,514,369
Less: Allowance for loan losses			(28,954	)			(23,247	)			(27,612	)
Net loans			1,490,718				1,455,875				1,486,757
BANK PREMISES AND EQUIPMENT, net			66,888				63,807				64,363
INTANGIBLE ASSETS			62,840				63,565				63,152
OTHER ASSETS			61,388				47,071				58,266
Total assets		$	3,335,595			$	3,077,535			$	3,279,456
LIABILITIES AND SHAREHOLDERS’ EQUITY
NONINTEREST-BEARING DEPOSITS		$	782,166			$	741,242			$	836,323
INTEREST-BEARING DEPOSITS			1,924,062				1,731,273				1,848,434
Total deposits			2,706,228				2,472,515				2,684,757
DIVIDENDS PAYABLE			7,088				7,077				7,081
SHORT-TERM BORROWINGS			159,480				176,673				146,094
OTHER LIABILITIES			31,801				32,411				25,822
Total liabilities			2,904,597				2,688,676				2,863,754
COMMITMENTS AND CONTINGENCIES
SHAREHOLDERS’ EQUITY
Common stock — $0.01 par value, authorized 40,000,000 shares; 20,848,421, 20,814,760, and 20,826,431 shares issued at June 30, 2010 and 2009 and December 31, 2009, respectively			208				208				208
Capital surplus			270,087				268,608				269,294
Retained earnings			128,863				102,756				115,123
Treasury stock (shares at cost: 164,965, 160,438 and 162,836 at June 30, 2010 and 2009, and December 31, 2009, respectively)			(4,038	)			(3,671	)			(3,833	)
Deferred compensation			4,038				3,671				3,833
Accumulated other comprehensive earnings			31,840				17,287				31,077
Total shareholders’ equity			430,998				388,859				415,702
Total liabilities and shareholders’ equity		$	3,335,595			$	3,077,535			$	3,279,456

See notes to consolidated financial statements.

FIRST FINANCIAL BANKSHARES, INC. AND SUBSIDIARIES

		Three Months Ended June 30,								Six Months Ended June 30,
		2010				2009				2010				2009
INTEREST INCOME:
Interest and fees on loans		$	22,792			$	22,690			$	45,165			$	45,744
Interest on investment securities:
Taxable			9,237				9,151				18,203				18,806
Exempt from federal income tax			4,676				4,499				9,310				8,627
Interest on trading securities			—				57				—				140
Interest on federal funds sold and interest-bearing deposits in banks			349				71				721				113
Total interest income			37,054				36,468				73,399				73,430
INTEREST EXPENSE:
Interest on deposits			3,463				4,155				6,998				8,932
Other			133				192				297				454
Total interest expense			3,596				4,347				7,295				9,386
Net interest income			33,458				32,121				66,104				64,044
PROVISION FOR LOAN LOSSES			2,973				1,588				4,983				3,348
Net interest income after provision for loan losses			30,485				30,533				61,121				60,696
NONINTEREST INCOME:
Trust fees			2,672				2,126				5,198				4,242
Service charges on deposit accounts			5,293				5,421				10,152				10,562
ATM and credit card fees			2,830				2,427				5,341				4,636
Real estate mortgage operations			857				858				1,417				1,446
Net gain on securities transactions			72				498				72				747
Net gain on sale of student loans			—				—				—				616
Net gain (loss) on sale of foreclosed assets			59				99				70				(59	)
Other			787				691				1,430				1,466
Total noninterest income			12,570				12,120				23,680				23,656
NONINTEREST EXPENSE:
Salaries and employee benefits			12,841				12,241				25,498				24,233
Net occupancy expense			1,561				1,567				3,139				3,187
Equipment expense			1,853				1,968				3,690				3,908
Printing, stationery and supplies			428				465				857				898
FDIC insurance premiums			990				2,305				1,978				3,256
Correspondent bank service charges			181				323				372				635
ATM and interchange expense			756				618				1,529				1,418
Professional and service fees			636				591				1,329				1,337
Amortization of intangible assets			153				216				312				438
Other expenses			4,552				4,064				8,585				7,996
Total noninterest expense			23,951				24,358				47,289				47,306
EARNINGS BEFORE INCOME TAXES			19,104				18,295				37,512				37,046
INCOME TAX EXPENSE			4,906				4,729				9,597				9,776
NET EARNINGS		$	14,198			$	13,566			$	27,915			$	27,270
EARNINGS PER SHARE, BASIC		$	0.68			$	0.65			$	1.34			$	1.31
EARNINGS PER SHARE, ASSUMING DILUTION		$	0.68			$	0.65			$	1.34			$	1.31
DIVIDENDS DECLARED PER SHARE		$	0.34			$	0.34			$	0.68			$	0.68

See notes to consolidated financial statements.

FIRST FINANCIAL BANKSHARES, INC. AND SUBSIDIARIES

		Three Months Ended June 30,								Six Months Ended June 30,
		2010				2009				2010				2009
NET EARNINGS		$	14,198			$	13,566			$	27,915			$	27,270
OTHER ITEMS OF COMPREHENSIVE EARNINGS (LOSS):
Change in unrealized gain on investment securities available-for-sale, before income taxes			(142	)			1,257				1,246				10,650
Reclassification adjustment for realized gains on investment securities included in net earnings, before income tax			(72	)			(498	)			(72	)			(747	)
Total other items of comprehensive earnings (loss)			(214	)			759				1,174				9,903
Income tax benefit (expense) related to other items of comprehensive earnings (loss)			75				(266	)			(411	)			(3,466	)
COMPREHENSIVE EARNINGS		$	14,059			$	14,059			$	28,678			$	33,707

See notes to consolidated financial statements.

FIRST FINANCIAL BANKSHARES, INC. AND SUBSIDIARIES

																														Accumulated
																														Other				Total
		Common Stock								Capital				Retained				Treasury Stock								Deferred				Comprehensive				Shareholders’
		Shares				Amount				Surplus				Earnings				Shares				Amounts				Compensation				Earnings				Equity
Balances at December 31, 2008			20,799,198			$	208			$	268,087			$	89,637				(158,811	)		$	(3,500	)		$	3,500			$	10,850			$	368,782
Net earnings (unaudited)			—				—				—				27,270				—				—				—				—				27,270
Stock issuances (unaudited)			15,562				—				355				—				—				—				—				—				355
Cash dividends declared, $0.68 per share (unaudited)			—				—				—				(14,151	)			—				—				—				—				(14,151	)
Change in unrealized gain (loss) in investment securities available-for-sale, net of related income taxes (unaudited)			—				—				—				—				—				—				—				6,437				6,437
Additional tax benefit related to directors’ deferred compensation plan (unaudited)			—				—				30				—				—				—				—				—				30
Shares purchased in connection with directors’ deferred compensation plan, net (unaudited)			—				—				—				—				(1,627	)			(171	)			171				—				—
Stock option expense (unaudited)			—				—				136				—				—				—				—				—				136
Balances at June 30, 2009 (unaudited)			20,814,760			$	208			$	268,608			$	102,756				(160,438	)		$	(3,671	)		$	3,671			$	17,287			$	388,859
Balances at December 31, 2009			20,826,431			$	208			$	269,294			$	115,123				(162,836	)		$	(3,833	)		$	3,833			$	31,077			$	415,702
Net earnings (unaudited)			—				—				—				27,915				—				—				—				—				27,915
Stock issuances (unaudited)			21,990				—				569				—				—				—				—				—				569
Cash dividends declared, $0.68 per share (unaudited)			—				—				—				(14,175	)			—				—				—				—				(14,175	)
Change in unrealized gain in investment securities available- for-sale, net of related income taxes (unaudited)			—				—				—				—				—				—				—				763				763
Additional tax benefit related to directors’ deferred compensation plan (unaudited)			—				—				30				—				—				—				—				—				30
Shares purchased in connection with directors’ deferred compensation plan, net (unaudited)			—				—				—				—				(2,129	)			(205	)			205				—				—
Stock option expense (unaudited)			—				—				194				—				—				—				—				—				194
Balances at June 30, 2010 (unaudited)			20,848,421			$	208			$	270,087			$	128,863				(164,965	)		$	(4,038	)		$	4,038			$	31,840			$	430,998

See notes to consolidated financial statements.

FIRST FINANCIAL BANKSHARES, INC. AND SUBSIDIARIES

		Six Months Ended June 30,
		2010				2009
CASH FLOWS FROM OPERATING ACTIVITIES:
Net earnings		$	27,915			$	27,270
Adjustments to reconcile net earnings to net cash provided by operating activities:
Depreciation and amortization			3,526				3,898
Provision for loan losses			4,983				3,348
Securities premium amortization (discount accretion), net			2,086				526
Gain on sale of assets, net			(130	)			(1,403	)
Deferred federal income tax benefit			(659	)			(213	)
Trading security activity, net			—				24,802
Loans originated for resale			(57,561	)			(111,949	)
Proceeds from sales of loans held for resale			55,884				150,972
Change in other assets			1,625				4,142
Change in other liabilities			2,396				1,998
Total adjustments			12,150				76,121
Net cash provided by operating activities			40,065				103,391
CASH FLOWS FROM INVESTING ACTIVITIES:
Activity in available-for-sale securities:
Sales			15,018				35,359
Maturities			83,344				111,157
Purchases			(227,495	)			(139,110	)
Activity in held-to-maturity securities — maturities			4,169				4,217
Net decrease (increase) in loans			(15,723	)			44,358
Purchases of bank premises and equipment and computer software			(5,763	)			(1,128	)
Proceeds from sale of other assets			3,791				1,788
Net cash provided by (used in) investing activities			(142,659	)			56,641
CASH FLOWS FROM FINANCING ACTIVITIES:
Net decrease in interest-bearing deposits			(54,157	)			(55,835	)
Net increase (decrease) in noninterest-bearing deposits			75,628				(54,403	)
Net increase (decrease) in short-term borrowings			13,386				(58,926	)
Common stock transactions:
Proceeds from stock issuances			569				355
Dividends paid			(14,167	)			(14,145	)
Net cash provided by (used in) financing activities			21,259				(182,954	)
NET DECREASE IN CASH AND CASH EQUIVALENTS			(81,335	)			(22,922	)
CASH AND CASH EQUIVALENTS, beginning of period			321,541				168,888
CASH AND CASH EQUIVALENTS, end of period		$	240,206			$	145,966
SUPPLEMENTAL INFORMATION AND NONCASH TRANSACTIONS
Interest paid		$	7,357			$	10,016
Federal income tax paid			8,502				10,306
Transfer of loans to foreclosed assets			8,456				2,626
Investment securities purchased but not settled			4,054				9,926

See notes to consolidated financial statements.

FIRST FINANCIAL BANKSHARES, INC. AND SUBSIDIARIES

Note 1 — Basis of Presentation

The consolidated financial statements include the accounts of the Company, a Texas corporation and a financial holding company registered under the Bank Holding Company Act of 1956, or BHCA, and its wholly-owned subsidiaries: First Financial Bankshares of Delaware, Inc.; First Financial Investments of Delaware, Inc.; First Financial Bank, National Association, Abilene, Texas; First Financial Bank, Hereford, Texas; First Financial Bank, National Association, Sweetwater, Texas; First Financial Bank, National Association, Eastland, Texas; First Financial Bank, National Association, Cleburne, Texas; First Financial Bank, National Association, Stephenville, Texas; First Financial Bank, National Association, San Angelo, Texas; First Financial Bank, National Association, Weatherford, Texas; First Financial Bank, National Association, Southlake, Texas; First Financial Bank, National Association, Mineral Wells, Texas; First Technology Services, Inc.; First Financial Trust & Asset Management Company, National Association; First Financial Investments, Inc.; and First Financial Insurance Agency, Inc.

Through our subsidiary banks, we conduct a full-service commercial banking business. Our service centers are located primarily in North Central and West Texas. Including the branches and locations of all our bank subsidiaries, as of June 30, 2010, we had 50 financial centers across Texas, with ten locations in Abilene, two locations in Cleburne, three locations in Stephenville, three locations in Granbury, two locations in San Angelo, three locations in Weatherford, and one location each in Mineral Wells, Hereford, Sweetwater, Eastland, Ranger, Rising Star, Southlake, Aledo, Willow Park, Brock, Alvarado, Burleson, Keller, Trophy Club, Boyd, Bridgeport, Decatur, Roby, Trent, Merkel, Clyde, Moran, Albany, Midlothian, Glen Rose, Odessa and Fort Worth. Our trust subsidiary has six locations in Abilene, San Angelo, Stephenville, Sweetwater, Fort Worth and Odessa, all in Texas.

In the opinion of management, the unaudited consolidated financial statements reflect all adjustments necessary for a fair presentation of the Company’s financial position and unaudited results of operations and should be read in conjunction with the Company’s consolidated financial statements, and notes thereto, for the year ended December 31, 2009. All adjustments were of a normal recurring nature. However, the results of operations for the three and six months ended June 30, 2010, are not necessarily indicative of the results to be expected for the year ending December 31, 2010, due to seasonality, changes in economic conditions and loan credit quality, interest rate fluctuations, regulatory and legislative changes and other factors. Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States (“U.S. GAAP”) have been condensed or omitted under SEC rules and regulations. The Company evaluated subsequent events for potential recognition and/or disclosure through the date the consolidated financial statements were issued.

Goodwill and other intangible assets are evaluated annually for impairment as of the end of the second quarter. No such impairment has been noted in connection with these evaluations.

Note 2 — Earnings Per Share

Basic earnings per common share is computed by dividing net income available to common shareholders by the weighted average number of shares outstanding during the periods presented. In computing diluted earnings per common share for the three and six months ended June 30, 2010 and 2009, the Company assumes that all dilutive outstanding options to purchase common stock have been exercised at the beginning of the period (or the time of issuance, if later). The dilutive effect of the outstanding options is reflected by application of the treasury stock method, whereby the proceeds from the exercised options are assumed to be used to purchase common stock at the average market price during the respective

periods. The weighted average common shares outstanding used in computing basic earnings per common share for the three months ended June 30, 2010 and 2009, were 20,847,735 and 20,809,061 shares respectively. The weighted average common shares outstanding used in computing basic earnings per common share for the six months ended June 30, 2010 and 2009, were 20,841,389 and 20,805,392 shares respectively. The weighted average common shares outstanding used in computing fully diluted earnings per common share for the three months ended June 30, 2010 and 2009, were 20,869,138 and 20,830,965, respectively. The weighted average common shares outstanding used in computing fully diluted earnings per common share for the six months ended June 30, 2010 and 2009, were 20,869,403 and 20,821,782, respectively

Note 3 — Securities

A summary of available-for-sale and held-to-maturity securities is as follows (in thousands):

		June 30, 2010
						Gross				Gross
		Amortized				Unrealized				Unrealized				Estimated
		Cost Basis				Holding Gains				Holding Losses				Fair Value
Securities held-to-maturity:
Obligations of state and political subdivisions		$	10,546			$	286			$	(9	)		$	10,823
Residential mortgage-backed securities			561				19				—				580
Total debt securities held-to-maturity		$	11,107			$	305			$	(9	)		$	11,403
Securities available-for-sale:
U. S. Treasury securities and obligations of U.S. government sponsored-enterprises and agencies		$	341,158			$	10,916			$	—			$	352,074
Obligations of state and political subdivisions			460,466				18,599				(489	)			478,576
Corporate bonds and other			66,361				4,946				—				71,307
Residential mortgage-backed securities			477,432				23,061				(2	)			500,491
Total securities available-for-sale		$	1,345,417			$	57,522			$	(491	)		$	1,402,448

		December 31, 2009
						Gross				Gross
		Amortized				Unrealized				Unrealized				Estimated
		Cost Basis				Holding Gains				Holding Losses				Fair Value
Securities held-to-maturity:
Obligations of state and political subdivisions		$	14,652			$	392			$	(6	)		$	15,038
Residential mortgage-backed securities			621				16				(1	)			636
Total debt securities held-to-maturity		$	15,273			$	408			$	(7	)		$	15,674
Securities available-for-sale:
Obligations of U.S. government sponsored-enterprises and agencies		$	260,018			$	12,050			$	—			$	272,068
Obligations of state and political subdivisions			437,550				18,643				(561	)			455,632
Corporate bonds and other			73,858				5,028				—				78,886
Residential mortgage-backed securities			442,823				20,995				(300	)			463,518
Total securities available-for-sale		$	1,214,249			$	56,716			$	(861	)		$	1,270,104

The Company invests in mortgage-backed securities that have expected maturities that differ from their contractual maturities. These differences arise because borrowers may have the right to call or prepay obligations with or without a prepayment penalty. These securities include collateralized mortgage obligations (CMOs) and other asset backed securities. The expected maturities of these securities at June 30, 2010, were computed by using scheduled amortization of balances and historical prepayment rates. At June 30, 2010 and 2009, the Company did not hold any CMOs that entail higher risks than standard mortgage-backed securities.

The amortized cost and estimated fair value of debt securities at June 30, 2010, by contractual and expected maturity, are shown below (in thousands):

		Held-to-Maturity								Available-for-Sale
		Amortized				Estimated				Amortized				Estimated
		Cost Basis				Fair Value				Cost Basis				Fair Value
Due within one year		$	6,164			$	6,238			$	170,269			$	173,790
Due after one year through five years			4,107				4,319				402,370				419,619
Due after five years through ten years			135				127				248,994				261,559
Due after ten years			140				139				46,352				46,989
Mortgage-backed securities			561				580				477,432				500,491
Total		$	11,107			$	11,403			$	1,345,417			$	1,402,448

During the quarter ended June 30, 2010 and 2009, sales of investment securities that were classified as available-for-sale totaled $11.8 million and $30.0 million, respectively. Gross realized gains from 2010 and 2009 securities sales totaled $72 thousand and $498 thousand, respectively. There were no losses realized on securities sales during these periods. During the six-months ended June 30, 2010 and 2009, sales of investment securities that were classified as available-for-sale totaled $15.0 million and $35.4 million, respectively. Gross realized gains from 2010 and 2009 securities sales totaled $72 thousand and $747 thousand, respectively. There were no losses realized on securities sales during these periods. The specific identification method was used to determine cost in order to compute the realized gains.

The following tables disclose, as of June 30, 2010 and December 31, 2009, our available-for-sale and held-to-maturity securities that have been in a continuous unrealized-loss position for less than 12 months and those that have been in a continuous unrealized-loss position for 12 or more months (in thousands):

		Less than 12 Months								12 Months or Longer								Total
						Unrealized								Unrealized								Unrealized
June 30, 2010		Fair Value				Loss				Fair Value				Loss				Fair Value				Loss
Obligations of state and political subdivisions		$	16,150			$	322			$	4,313			$	176			$	20,463			$	498
Residential mortgage-backed securities			515				2				—				—				515				2
Total		$	16,665			$	324			$	4,313			$	176			$	20,978			$	500

		Less than 12 Months								12 Months or Longer								Total
						Unrealized								Unrealized								Unrealized
December 31, 2009		Fair Value				Loss				Fair Value				Loss				Fair Value				Loss
Obligations of state and political subdivisions		$	21,703			$	428			$	2,798			$	139			$	24,501			$	567
Residential mortgage-backed securities			27,619				300				82				1				27,701				301
Total		$	49,322			$	728			$	2,880			$	140			$	52,202			$	868

The number of investment positions in this unrealized loss position totaled 53 at June 30, 2010. We do not believe these unrealized losses are “other than temporary” as (1) we do not have the intent to sell our securities prior to recovery and/or maturity and (2) it is more likely than not that we will not have to sell our securities prior to recovery and/or maturity. The unrealized losses noted are interest rate related due to the level of interest rates at June 30, 2010 compared to the time of purchase. We have reviewed the ratings of the issuers and have not identified any issues related to the ultimate repayment of principal as a result of credit concerns on these securities. Our mortgage related securities are backed by GNMA, FNMA and FHLMC or are collateralized by securities backed by these agencies.

As of June 30, 2009, trading securities totaled $31.2 million. No amounts were held in trading securities at June 30, 2010 or December 31, 2009. The trading securities portfolio was a government securities money market fund comprised primarily of U.S. government agency securities and repurchase agreements collateralized by U.S. government agency securities. The trading securities were carried at estimated fair value with unrealized gains and losses included in earnings. The Company invested in trading securities in 2008 to improve its yield on daily funds and to lower its exposure on Federal funds. However, due to significantly lower interest rates, the Company has deployed these funds into our investment portfolio and into certificates of deposit at unaffiliated banks.

Securities, carried at approximately $748,511,000 at June 30, 2010, were pledged as collateral for public or trust fund deposits, repurchase agreements and for other purposes required or permitted by law.

Note 4 — Loans And Allowance for Loan Losses

Major classifications of loans are as follows (dollars in thousands):

		June 30,								December 31,
		2010				2009				2009
Commercial, financial and agricultural		$	463,560			$	464,377			$	508,431
Real estate — construction			88,777				104,168				77,711
Real estate — mortgage			791,951				715,211				752,735
Consumer			175,384				195,366				175,492
Total Loans		$	1,519,672			$	1,479,122			$	1,514,369

Included in real estate-mortgage loans above are $6.0 million and $4.3 million, respectively, in loans held for sale at June 30, 2010 and December 31, 2009 in which the carrying amounts approximate fair value. Included in real estate-mortgage and consumer loans above are $4.1 million and $12.1 million, respectively, in loans held for sale at June 30, 2009, in which the carrying amounts approximate fair value.

The Company’s recorded investment in impaired loans and the related valuation allowance are as follows (in thousands):

June 30, 2010								June 30, 2009								December 31, 2009
Recorded				Valuation				Recorded				Valuation				Recorded				Valuation
Investment				Allowance				Investment				Allowance				Investment				Allowance
$	14,240			$	2,780			$	10,242			$	2,495			$	18,540			$	3,340

The allowance for loan losses as of June 30, 2010 and 2009 and December 31, 2009, is presented below. The level of the allowance reflects our periodic evaluation of general economic conditions, the financial condition of our borrowers, the value and liquidity of collateral, delinquencies, prior loan loss experience, and the results of periodic reviews of the portfolio by our independent loan review department and regulatory examiners. Management has evaluated the adequacy of the allowance for loan losses by estimating the probable losses in various categories of the loan portfolio, which are identified below (in thousands):

		June 30,								December 31,
		2010				2009				2009
Allowance for loan losses provided for:
Loans specifically evaluated as impaired		$	2,780			$	2,495			$	3,340
Remaining portfolio			26,174				20,751				24,272
Total allowance for loan losses		$	28,954			$	23,246			$	27,612

Changes in the allowance for loan losses are summarized as follows (in thousands):

		Three Months Ended June 30,								Six Months Ended June 30,
		2010				2009				2010				2009
Balance at beginning of period		$	28,750			$	22,652			$	27,612			$	21,529
Add:
Provision for loan losses			2,973				1,588				4,983				3,348
Loan recoveries			201				232				388				488
Deduct:
Loan charge-offs			(2,970	)			(1,225	)			(4,029	)			(2,118	)
Balance at end of period		$	28,954			$	23,247			$	28,954			$	23,247

Nonaccrual loans still accruing and past due 90 days or more, restructured loans and foreclosed assets are as follows (in thousands, except percentages):

		June 30,								December 31,
		2010				2009				2009
Nonaccrual loans		$	14,240			$	10,242			$	18,540
Loans still accruing and past due 90 days or more			1				72				15
Restructured loans			—				—				—
Foreclosed assets			8,306				3,755				3,533
Total		$	22,547			$	14,069			$	22,088
As a % of total loans and foreclosed assets			1.48	%			0.95	%			1.46	%
As a % of total assets			0.68	%			0.46	%			0.67	%

Certain of our subsidiary banks have established lines of credit with the Federal Home Loan Bank of Dallas to provide liquidity and meet pledging requirements for those customers eligible to have securities pledged to secure certain uninsured deposits. At June 30, 2010, approximately $258,253,000 in loans held by these subsidiaries were subject to blanket liens as security for letters of credit issued under these lines of credit.

Note 5 — Income Taxes

Income tax expense was $4.9 million for the second quarter in 2010 as compared to $4.7 million for the same period in 2009. Our effective tax rates on pretax income were 25.7% and 25.8% for the second quarters of 2010 and 2009, respectively. Income tax expense was $9.6 million for the six months ended June 30, 2010 as compared to $9.8 million for the same period in 2009. Our effective tax rates on pretax income were 25.6% and 26.4% for the six months ended June 30, 2010 and 2009, respectively. The effective tax rates differ from the statutory Federal tax rate of 35% largely due to tax exempt interest income earned on certain investment securities and loans, the deductibility of dividends paid to our employee stock ownership plan and Texas state taxes.

The decreases in the effective tax rates for the second quarter and six-month period ended June 30, 2010 over the same periods in 2009 were largely the result of an increase in tax exempt income.

Note 6 — Stock Based Compensation

The Company grants incentive stock options for a fixed number of shares with an exercise price equal to the fair value of the shares at the date of grant to employees. No stock options have been granted in 2010. In May 2009, the Company granted incentive stock options to purchase 101,600 shares of Company common stock with an exercise price of $50.33 per share. The fair value of the options granted was estimated using the Black-Scholes options pricing model with the following weighted-average assumptions: risk-free interest rate of 3.24%; expected dividend yield of 2.66%; expected life of 5.79 years; and expected volatility of 41.64%.

The Company recorded stock option expense totaling approximately $98 thousand and $71 thousand, respectively, for the three-month periods ended June 30, 2010 and 2009. The Company recorded stock option expense totaling approximately $194 thousand and $136 thousand, respectively, for the six-month periods ended June 30, 2010 and 2009.

The additional disclosure requirements under authoritative accounting guidance have been omitted due to immateriality.

Note 7 — Pension Plan

The Company’s defined benefit pension plan was frozen effective January 1, 2004, whereby no additional years of service will accrue to participants, unless the pension plan is reinstated at a future date. The pension plan covered substantially all of the Company’s employees at the time. The benefits for each employee were based on years of service and a percentage of the employee’s qualifying compensation during the final years of employment. The Company’s funding policy was and is to contribute annually the amount necessary to satisfy the Internal Revenue Service’s funding standards. Contributions to the pension plan, prior to freezing the plan, were intended to provide not only for benefits attributed to service to date but also for those expected to be earned in the future. As a result of the Pension Protection Act of 2006 (the “Protection Act”), the Company will be required to contribute amounts in future years to fund any shortfalls. The Company has evaluated the provisions of the Protection Act as well as the Internal Revenue Service’s funding standards to develop a preliminary plan for funding in future years. The Company made a contribution totaling $1.0 million in March 2010 and $1.4 million in April 2009 and continues to evaluate future funding amounts.

Net periodic benefit costs totaling $100 thousand and $80 thousand were recorded, respectively, for the three months ended June 30, 2010 and 2009. Net periodic benefit costs totaling $200 thousand and $160 thousand were recorded, respectively, for the six months ended June 30, 2010 and 2009.

Note 8 — Recently Issued Authoritative Accounting Guidance

In 2010, the Financial Accounting Standards Board issued authoritative guidance expanding disclosures related to fair value measurements including (i) the amounts of significant transfers of assets or liabilities between Levels 1 and 2 of the fair value hierarchy and the reasons for the transfers, (ii) the reasons for transfers of assets or liabilities in or out of Level 3 of the fair value hierarchy, with significant transfers disclosed separately, (iii) the policy for determining when transfers between levels of the fair value hierarchy are recognized and (iv) for recurring fair value measurements of assets and liabilities in Level 3 of the fair value hierarchy, a gross presentation of information about purchases, sales, issuances and settlements. The new guidance further clarifies that (i) fair value measurement disclosures should be provided for each class of assets and liabilities (rather than major category), which would generally be a subset of assets or liabilities

within a line item in the statement of financial position and (ii) disclosures should be provided about the valuation techniques and inputs used to measure fair value for both recurring and nonrecurring fair value measurements for each class of assets and liabilities included in Levels 2 and 3 of the fair value hierarchy. The disclosures related to the gross presentation of purchases, sales, issuances and settlements of assets and liabilities included in Level 3 of the fair value hierarchy will be required beginning January 1, 2011. The remaining disclosure requirements and clarifications made by the new guidance became effective on January 1, 2010.

In 2010, the FASB issued authoritative guidance that requires entities to provide enhanced disclosures in the financial statements about their loans including credit risk exposures and the allowance for loan losses. While some of the required disclosures are already included in the management discussion and analysis section of our interim and annual filings, the new guidance will require inclusion in the notes to the financial statements. Included in the new guidance are credit quality information, impaired loan information, loan modification information and nonaccrual and past due information. The period-end information will be required to be disclosed for the year ending December 31, 2010 and the activity-related information will be required to be disclosed beginning with the first quarter of 2011. The Company does not expect the adoption of this authoritative guidance to have a significant effect on the financial condition and results of operations.

Note 9 — Fair Value Disclosures

The authoritative accounting guidance for fair value measurements defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants. A fair value measurement assumes that the transaction to sell the asset or transfer the liability occurs in the principal market for the asset or liability or, in the absence of a principal market, the most advantageous market for the asset or liability. The price in the principal (or most advantageous) market used to measure the fair value of the asset or liability shall not be adjusted for transaction costs. An orderly transaction is a transaction that assumes exposure to the market for a period prior to the measurement date to allow for marketing activities that are usual and customary for transactions involving such assets and liabilities; it is not a forced transaction. Market participants are buyers and sellers in the principal market that are (i) independent, (ii) knowledgeable, (iii) able to transact and (iv) willing to transact.

The authoritative accounting guidance requires the use of valuation techniques that are consistent with the market approach, the income approach and/or the cost approach. The market approach uses prices and other relevant information generated by market transactions involving identical or comparable assets and liabilities. The income approach uses valuation techniques to convert future amounts, such as cash flows or earnings, to a single present amount on a discounted basis. The cost approach is based on the amount that currently would be required to replace the service capacity of an asset (replacement costs). Valuation techniques should be consistently applied. Inputs to valuation techniques refer to the assumptions that market participants would use in pricing the asset or liability. Inputs may be observable, meaning those that reflect the assumptions market participants would use in pricing the asset or liability developed based on market data obtained from independent sources, or unobservable, meaning those that reflect the reporting entity’s own assumptions about the assumptions market participants would use in pricing the asset or liability developed based on the best information available in the circumstances. In that regard, the authoritative guidance establishes a fair value hierarchy for valuation inputs that gives the highest priority to quoted prices in active markets for identical assets or liabilities and the lowest priority to unobservable inputs. The fair value hierarchy is as follows:

	•		Level 1 Inputs — Unadjusted quoted prices in active markets for identical assets or liabilities that the reporting entity has the ability to access at the measurement date.
	•		Level 2 Inputs — Inputs other than quoted prices included in Level 1 that are observable for the asset or liability, either directly or indirectly. These include quoted prices for similar assets or liabilities in active markets, quoted prices for identical or similar assets or liabilities in markets that are not active, inputs other than quoted prices that are observable for the asset or liability (for example, interest rates, volatilities, prepayment speeds, loss severities, credit risks and default rates) or inputs that are derived principally from or corroborated by observable market data by correlation or other means. Level 2 investments consist primarily of obligations of U.S. government sponsored enterprises and agencies, obligations of state and municipal subdivisions, corporate bonds and mortgage backed securities.
	•		Level 3 Inputs — Significant unobservable inputs that reflect an entity’s own assumptions that market participants would use in pricing the assets or liabilities.

A description of the valuation methodologies used for assets and liabilities measured at fair value, as well as the general classification of such instruments pursuant to the valuation hierarchy, is set forth below.

In general, fair value is based upon quoted market prices, where available. If such quoted market prices are not available, fair value is based upon internally developed models that primarily use, as inputs, observable market-based parameters. Valuation adjustments may be made to ensure that financial instruments are recorded at fair value. While management believes the Company’s valuation methodologies are appropriate and consistent with other market participants, the use of different methodologies or assumptions to determine the fair value of certain financial instruments could result in a different estimate of fair value at the reporting date.

Securities classified as available-for-sale and trading are reported at fair value utilizing Level 1 and Level 2 inputs. For these securities, the Company obtains fair value measurements from an independent pricing service. The fair value measurements consider observable data that may include dealer quotes, market spreads, cash flows, the United States Treasury (the “Treasury”) yield curve, live trading levels, trade execution data, market consensus prepayments speeds, credit information and the security’s terms and conditions, among other things.

There were no transfers between Level 2 and Level 3 during the quarter and the six-months ended June 30, 2010.

The following table summarizes financial assets and financial liabilities measured at fair value on a recurring basis as of June 30, 2010, segregated by the level of the valuation inputs within the fair value hierarchy utilized to measure fair value (dollars in thousands):

		Level 1				Level 2				Level 3				Total Fair
		Inputs				Inputs				Inputs				Value
Available for sale investment securities:
U. S. Treasury securities and obligations of U. S. government sponsored-enterprises and agencies		$	15,530			$	336,544			$	—			$	352,074
Obligations of state and political subdivisions			10,932				467,644				—				478,576
Corporate bonds			7,066				59,132				—				66,198
Residential mortgage-backed securities			15,247				485,244				—				500,491
Other securities			5,109				—				—				5,109
		$	53,884			$	1,348,564			$	—			$	1,402,448

Certain financial assets and financial liabilities are measured at fair value on a nonrecurring basis, that is, the instruments are not measured at fair value on an ongoing basis but are subject to fair value adjustments in certain circumstances (for example, when there is evidence of impairment). Financial assets and financial liabilities measured at fair value on a non-recurring basis include the following at June 30, 2010:

Impaired Loans — Impaired loans are reported at the fair value of the underlying collateral if repayment is expected solely from the collateral. Collateral values are estimated using Level 3 input based on the discounting of the collateral measured by appraisals. At June 30, 2010, impaired loans with a carrying value of $14.2 million were reduced by specific valuation allowances totaling $2.8 million resulting in a net fair value of $11.4 million, based on Level 3 inputs.

Loans Held for Sale — Loans held for sale are reported at the lower of cost or fair value. In determining whether the fair value of loans held for sale is less than cost when quoted market prices are not available, the Company considers investor commitments/contracts. These loans are considered Level 2 of the fair value hierarchy. At June 30, 2010, the Company’s mortgage loans held for sale were recorded at cost as fair value exceeded cost.

Certain non-financial assets and non-financial liabilities measured at fair value on a recurring and non-recurring basis include other real estate owned, goodwill and other intangible assets and other non-financial long-lived assets. Such amounts were not significant to the Company at June 30, 2010.

The Company is required under authoritative accounting guidance to disclose the estimated fair value of their financial instrument assets and liabilities including those subject to the requirements discussed above. For the Company, as for most financial institutions, substantially all of its assets and liabilities are considered financial instruments, as defined. Many of the Company’s financial instruments, however, lack an available trading market as characterized by a willing buyer and willing seller engaging in an exchange transaction.

The estimated fair value amounts of financial instruments have been determined by the Company using available market information and appropriate valuation methodologies. However, considerable judgment is required to interpret data to develop the estimates of fair value. Accordingly, the estimates presented herein are not necessarily indicative of the amounts the Company could realize in a current market exchange. The use of different market assumptions and/or estimation methodologies may have a material effect on the estimated fair value amounts.

In addition, reasonable comparability between financial institutions may not be likely due to the wide range of permitted valuation techniques and numerous estimates that must be made given the absence of active secondary markets for many of the financial instruments. This lack of uniform valuation methodologies also introduces a greater degree of subjectivity to these estimated fair values.

Financial instruments with stated maturities have been valued using a present value discounted cash flow with a discount rate approximating current market for similar assets and liabilities. Financial instrument liabilities with no stated maturities have an estimated fair value equal to both the amount payable on demand and the carrying value.

The carrying value and the estimated fair value of the Company’s contractual off-balance-sheet unfunded lines of credit, loan commitments and letters of credit, which are generally priced at market at the time of funding, are not material.

The estimated fair values and carrying values of all financial instruments under current authoritative guidance at June 30, 2010 and 2009, were as follows (in thousands):

		June 30,
		2010								2009
		Carrying				Estimated				Carrying				Estimated
		Value				Fair Value				Value				Fair Value
Cash and due from banks		$	100,460			$	100,460			$	102,339			$	102,339
Federal funds sold			225				225				26,375				26,375
Interest-bearing deposits in banks			139,521				139,521				17,252				17,252
Trading securities			—				—				31,189				31,189
Held to maturity securities			11,107				11,403				19,278				19,746
Available for sale securities			1,402,448				1,402,448				1,250,784				1,250,784
Loans			1,490,718				1,492,743				1,455,875				1,446,625
Accrued interest receivable			19,860				19,860				19,619				19,619
Deposits with stated maturities			801,741				803,966				709,066				712,537
Deposits with no stated maturities			1,904,487				1,904,487				1,763,449				1,763,449
Short term borrowings			159,480				159,480				176,673				176,673
Accrued interest payable			1,446				1,446				1,651				1,651

Item 2.		Management’s Discussion and Analysis of Financial Condition and Results of Operations

Forward-Looking Statements

This Form 10-Q contains certain forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. When used in this Form 10-Q, words such as “anticipate,” “believe,” “estimate,” “expect,” “intend,” “predict,” “project,” and similar expressions, as they relate to us or management, identify forward-looking statements. These forward-looking statements are based on information currently available to our management. Actual results could differ materially from those contemplated by the forward-looking statements as a result of certain factors, including, but not limited to, those listed in “Item 1A- Risk Factors” in our Annual Report on Form 10-K and the following:

	•		general economic conditions, including our local and national real estate markets and employment trends;
	•		volatility and disruption in national and international financial markets;
	•		the effects of recent legislative, tax, accounting and regulatory actions and reforms;
	•		political instability;
	•		the ability of the Federal government to deal with the national economic slowdown and the effect of stimulus packages enacted by Congress as well as future stimulus packages, if any;
	•		competition from other financial institutions and financial holding companies;
	•		the effects of and changes in trade, monetary and fiscal policies and laws, including interest rate policies of the Board of Governors of the Federal Reserve System;
	•		changes in the demand for loans;
	•		fluctuations in the value of collateral securing our loan portfolio and in the level of the allowance for loan losses;
	•		the accuracy of our estimates of future loan losses;
	•		the accuracy of our estimates and assumptions regarding the performance of our securities portfolio;
	•		soundness of other financial institutions with which we have transactions;
	•		inflation, interest rate, market and monetary fluctuations;
	•		changes in consumer spending, borrowing and savings habits;
	•		continued increases in FDIC deposit insurance assessments;
	•		our ability to attract deposits;
	•		consequences of continued bank mergers and acquisitions in our market area, resulting in fewer but much larger and stronger competitors;
	•		expansion of operations, including branch openings, new product offerings and expansion into new markets;
	•		acquisitions and integration of acquired businesses; and
	•		acts of God or of war or terrorism.

Such statements reflect the current views of our management with respect to future events and are subject to these and other risks, uncertainties and assumptions relating to our operations, results of operations, growth strategy and liquidity. All subsequent written and oral forward-looking statements attributable to us or persons acting on our behalf are expressly qualified in their entirety by this paragraph. We undertake no obligation to publicly update or otherwise revise any forward-looking statements, whether as a result of new information, future events or otherwise.

Introduction

As a multi-bank financial holding company, we generate most of our revenue from interest on loans and investments, trust fees, and service charges. Our primary source of funding for our loans and investments are deposits held by our subsidiary banks. Our largest expenses are interest on these deposits and salaries and related employee benefits. We usually measure our performance by calculating our return on average assets, return on average equity, our regulatory leverage and risk based capital ratios, and our efficiency ratio, which is calculated by dividing noninterest expense by the sum of net interest income on a tax equivalent basis and noninterest income.

The following discussion of operations and financial condition should be read in conjunction with the financial statements and accompanying footnotes included in Item 1 of this Form 10-Q as well as those included in the Company’s 2009 Annual Report on Form 10-K.

Regulatory Reform and Legislation

Congress and the regulators for financial institutions have proposed and passed significant changes to the laws, rules and regulations governing financial institutions. Most recently, the House of Representatives and Senate passed the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”) which the President has signed. Prior to the Dodd-Frank Act, Congress and the financial institutions regulators made other significant changes affecting many aspects of banking. Those recent actions address many issues including capital, interchange fees, compliance and risk management, debit card overdraft fees, the establishment of a new consumer regulator, healthcare, incentive compensation, expanded disclosures and corporate governance. While many of the new regulations are for financial institutions with assets greater than $10 billion, we expect the new regulations to reduce our revenues and increase our expenses in the future. We are closely monitoring those actions to determine the appropriate response to comply and at the same time minimize the adverse effect on our banks.

Critical Accounting Policies

We prepare consolidated financial statements based on the selection of certain accounting policies, generally accepted accounting principles and customary practices in the banking industry. These policies, in certain areas, require us to make significant estimates and assumptions.

We deem a policy critical if (1) the accounting estimate required us to make assumptions about matters that are highly uncertain at the time we make the accounting estimate; and (2) different estimates that reasonably could have been used in the current period, or changes in the accounting estimate that are reasonably likely to occur from period to period, would have a material impact on the financial statements.

The following discussion addresses (1) our allowance for loan losses and our provision for loan losses and (2) our valuation of securities, which we deem to be our most critical accounting policies. We have other significant accounting policies and continue to evaluate the materiality of their impact on our consolidated financial statements, but we believe these other policies either do not generally require us to make estimates and judgments that are difficult or subjective, or it is less likely they would have a material impact on our reported results for a given period.

Allowance for Loan Losses. The allowance for loan losses is an amount we believe will be adequate to absorb probable losses on existing loans in which full collectibility is unlikely based upon our review and evaluation of the loan portfolio. The allowance for loan losses is increased by charges to income and decreased by charge-offs (net of recoveries).

Our methodology is based on current authoritative accounting guidance, including guidance from the SEC. We also follow the guidance of the “Interagency Policy Statement on the Allowance for Loan and Lease Losses,” issued jointly by the Office of the Comptroller of the Currency (“OCC”), the Federal Reserve Board, the FDIC, the National Credit Union Administration and the Office of Thrift Supervision. We have developed a loan review methodology that includes allowances assigned to certain classified loans, allowances assigned based upon estimated loss factors and qualitative reserves. The level of the allowance reflects our periodic evaluation of general economic conditions, the financial condition of our borrowers, the value and liquidity of collateral, delinquencies, prior loan loss experience, and the results of periodic reviews of the portfolio by our independent loan review department and regulatory examiners.

Our allowance for loan losses is comprised of three elements: (i) specific reserves determined in accordance with current authoritative accounting guidance based on probable losses on specific classified loans; (ii) general reserves determined in accordance with current authoritative accounting guidance that consider historical loss rates; and (iii) a qualitative reserve determined in accordance with current authoritative accounting guidance based upon general economic conditions and other qualitative risk factors both internal and external to the Company. We regularly evaluate our allowance for loan losses to maintain an adequate level to absorb estimated probable loan losses inherent in the loan portfolio. Factors contributing to the determination of specific reserves include the credit-worthiness of the borrower, changes in the value of pledged collateral, and general economic conditions. All classified loans are specifically reviewed and a specific allocation is assigned based on the losses expected to be realized from those loans. For purposes of determining the general reserve, the loan portfolio less cash secured loans, government guaranteed loans and classified loans is multiplied by the Company’s historical loss rates. The qualitative reserves are determined by evaluating such things as current economic conditions and trends, including unemployment, changes in lending staff, policies or procedures, changes in credit concentrations, changes in the trends and severity of problem loans and changes in trends in volume and terms of loans.

Although we believe we use the best information available to make loan loss allowance determinations, future adjustments could be necessary if circumstances or economic conditions differ substantially from the assumptions used in making our initial determinations. A further downturn in the economy and employment could result in increased levels of nonperforming assets and charge-offs, increased loan loss provisions and reductions in income. Additionally, as an integral part of their examination process, bank regulatory agencies periodically review our allowance for loan losses. The bank regulatory agencies could require the recognition of additions to the loan loss allowance based on their judgment of information available to them at the time of their examination.

Accrual of interest is discontinued on a loan when management believes, after considering economic and business conditions and collection efforts, the borrower’s financial condition is such that collection of principal and interest is doubtful or generally if the loan is 90 days past due.

Our policy requires measurement of the allowance for an impaired collateral dependent loan based on the fair value of the collateral. Other loan impairments are measured based on the present value of expected future cash flows or the loan’s observable market price.

Valuation of Securities. The Company records its available-for-sale and trading securities portfolio at fair value.

Fair values of these securities are determined based on methodologies in accordance with current authoritative accounting guidance. Fair values are volatile and may be influenced by a number of factors, including market interest rates, prepayment speeds, discount rates, credit ratings and yield curves. Fair values for investment securities are based on quoted market prices, where available. If quoted market prices are not available, fair values are based on the quoted prices of similar instruments or an estimate of fair value by using a range of fair value estimates in the market place as a result of the illiquid market specific to the type of security.

When the fair value of a security is below its amortized cost, and depending on the length of time the condition exists and the extent the fair value is below amortized cost, additional analysis is performed to determine whether an other-than-temporary impairment condition exists. Available-for-sale and held-to-maturity securities are analyzed quarterly for possible other-than-temporary impairment. The analysis considers (i) whether we have the intent to sell our securities prior to recovery and/or maturity and (ii) whether it is more likely than not that we will have to sell our securities prior to recovery and/or maturity. Often, the information available to conduct these assessments is limited and rapidly changing, making estimates of fair value subject to judgment. If actual information or conditions are different than estimated, the extent of the impairment of the security may be different than previously estimated, which could have a material effect on the Company’s results of operations and financial condition.

Results of Operations

Performance Summary. Net earnings for the second quarter of 2010 were $14.2 million compared to $13.6 million for the same period in 2009, or a 4.66% increase over the same period in 2009. Net earnings for the second quarter of 2010 compared to the same period in 2009 were negatively impacted by an increase in the provision for loan losses of $1.4 million and a decrease in net gain on securities transaction of $426 thousand. The negative impact was offset by a decrease in FDIC insurance premiums of $1.3 million, primarily due to the FDIC special assessment recorded in the second quarter of 2009.

Basic earnings per share for the second quarter of 2010 were $0.68 compared to $0.65 for the the same quarter last year. The return on average assets was 1.70% for the second quarter of 2010, as compared to 1.77% for the same quarter of 2009. The return on average equity was 13.37% for the second quarter of 2010 as compared to 13.98% for the same quarter of 2009.

Net earnings for the six-month period ended June 30, 2010 were $27.9 million, an increase of $645 thousand, or 2.4% compared to net earnings for the six-month period ended June 30, 2009 of $27.3 million. Net earnings for the six months ended June 30, 2010 compared to the same period in 2009 were negatively impacted by (i) a decrease in gain from sale of student loans of $616 thousand, (ii) an increase in the provision for loan losses of $1.6 million and (iii) a decrease in net gain on securities transactions of $675 thousand. The negative impact was offset by a decrease in FDIC insurance premiums of $1.3 million, primarily due to the FDIC special assessment recorded in the six month period of 2009.

Basic earnings per share basis, net earnings were $1.34 for the six-months of 2010 as compared to $1.31 for the same period of 2009. The return on average assets was 1.69% for the six-months of 2010, as compared to 1.76% for the same period of 2009. The return on average equity was 13.33% for the six-months of 2010, as compared to 14.28% for the same period of 2009.

Net Interest Income. Net interest income is the difference between interest income on earning assets and interest expense on liabilities incurred to fund those assets. Our earning assets consist primarily of loans and investment securities. Our liabilities to fund those assets consist primarily of noninterest-bearing and interest-bearing deposits.

Tax-equivalent net interest income was $36.1 million for the second quarter of 2010, as compared to $34.6 million for the same period last year. The increase in 2010 compared to 2009 was largely attributable to an increase in the volume of earning assets. Average earning assets increased $246.1 million for the second quarter of 2010 over the same period in 2009. Average short-term investments and average taxable securities increased $122.0 million and $64.9 million, respectively, for the second quarter of 2010 over the second quarter of 2009. Average interest bearing liabilities increased $172.4 million for the second quarter of 2010, as compared to the same period in 2009. The yield on earning assets decreased 33 basis points, whereas the rate paid on interest-bearing liabilities decreased only 22 basis points in the second quarter of 2010.

Tax-equivalent net interest income was $71.3 million for the first six-month period of 2010, as compared to $68.7 million for the same period last year. The increase in 2010 compared to 2009 was largely attributable to (i) the decrease in the rate paid on interest-bearing liabilities in an amount greater than the decrease in rates earned on interest earning assets and (ii) an increase in the volume of interest earning assets. Average interest earning assets increased $193.6 million for the first six-months of 2010 over the same period in 2009. Average short-term investments and average tax exempt securities increased $154.5 million and $42.2 million, respectively, for the first six-month period of 2010 over the first six-month period of 2009, offsetting a decrease of $21.7 million in average loans. Average interest bearing liabilities increased $121.2 million for the six-month period of 2010, as compared to the same period in 2009. The yield on earning assets decreased 31 basis points, whereas the rate paid on interest-bearing liabilities decreased only 26 basis points in the first six months of 2010, primarily due to the effects of lower interest rates.

Table 1 allocates the change in tax-equivalent net interest income between the amount of change attributable to volume and to rate.

     Table 1 — Changes in Interest Income and Interest Expense (in thousands):

		Three Months Ended June 30, 2010												Six Months Ended June 30, 2010
		Compared to Three Months Ended												Compared to Six Months Ended
		June 30, 2009												June 30, 2009
		Change Attributable to								Total				Change Attributable to								Total
		Volume				Rate				Change				Volume				Rate				Change
Short-term investments		$	590			$	(311	)		$	279			$	1,541			$	(933	)		$	608
Taxable investment securities (1)			675				(647	)			28				392				(1,136	)			(744	)
Tax-exempt investment securities (2)			470				(160	)			310				1,314				(186	)			1,128
Loans (2) (3)			460				(299	)			161				(657	)			181				(476	)
Interest income			2,195				(1,417	)			778				2,590				(2,074	)			516
Interest-bearing deposits			399				(1,091	)			(692	)			750				(2,683	)			(1,933	)
Short-term borrowings			6				(65	)			(59	)			(58	)			(100	)			(158	)
Interest expense			405				(1,156	)			(751	)			692				(2,783	)			(2,091	)
Net interest income		$	1,790			$	(261	)		$	1,529			$	1,898			$	709			$	2,607