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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
------------------------
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTER ENDED SEPTEMBER 30, 2002
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
------------------------
COMMISSION FILE NUMBER: 000-22007
------------------------
SOUTHWEST BANCORPORATION OF TEXAS, INC.
(Exact Name of Registrant as Specified in its Charter)
TEXAS 76-0519693
(State or Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification No.)
4400 POST OAK PARKWAY
HOUSTON, TEXAS 77027
(Address of Principal Executive Offices, including zip code)
(713) 235-8800
(Registrant's telephone number, including area code)
------------------------
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes [X] No [ ]
------------------------
There were 33,850,027 shares of the Registrant's Common Stock outstanding
as of the close of business on November 1, 2002.
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SOUTHWEST BANCORPORATION OF TEXAS, INC. AND SUBSIDIARIES
INDEX TO FORM 10-Q
PAGE
----
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Report of Independent Accountants......................... 2
Condensed Consolidated Balance Sheet as of September 30,
2002 and December 31, 2001
(unaudited)............................................ 3
Condensed Consolidated Statement of Income for the Three
and Nine Months Ended September 30, 2002 and 2001
(unaudited)............................................ 4
Condensed Consolidated Statement of Changes in
Shareholders' Equity for the Nine Months Ended
September 30, 2002 (unaudited)......................... 5
Condensed Consolidated Statement of Cash Flows for the
Nine Months Ended September 30, 2002 and 2001
(unaudited)............................................ 6
Notes to Condensed Consolidated Financial Statements
(unaudited)............................................ 7
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations................ 10
Item 3. Quantitative and Qualitative Disclosures About
Market Risk........................................ 29
Item 4. Controls and Procedures............................ 29
PART II. OTHER INFORMATION
Item 1. Legal Proceedings.................................. 30
Item 2. Changes in Securities and Use of Proceeds.......... 30
Item 3. Defaults upon Senior Securities.................... 30
Item 4. Submission of Matters to a Vote of Security
Holders............................................ 30
Item 5. Other Information.................................. 30
Item 6. Exhibits and Reports on Form 8-K................... 30
Signatures.................................................. 31
1
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
REPORT OF INDEPENDENT ACCOUNTANTS
Board of Directors and Shareholders
Southwest Bancorporation of Texas, Inc.:
We have reviewed the accompanying condensed consolidated balance sheet of
Southwest Bancorporation of Texas, Inc. and subsidiaries (the "Company") as of
September 30, 2002, the related condensed consolidated statements of income for
each of the three-month and nine-month periods ended September 30, 2002 and
2001, the condensed consolidated statement of changes in shareholders' equity
for the nine-month period ended September 30, 2002 and the condensed
consolidated statement of cash flows for the nine-month periods ended September
30, 2002 and 2001. These financial statements are the responsibility of the
Company's management.
We conducted our review in accordance with standards established by the
American Institute of Certified Public Accountants. A review of interim
financial information consists principally of applying analytical procedures to
financial data and making inquiries of persons responsible for financial and
accounting matters. It is substantially less in scope than an audit conducted in
accordance with generally accepted auditing standards, the objective of which is
the expression of an opinion regarding the financial statements taken as a
whole. Accordingly, we do not express such an opinion.
Based on our review, we are not aware of any material modifications that
should be made to the accompanying condensed consolidated interim financial
statements for them to be in conformity with accounting principles generally
accepted in the United States of America.
We previously audited in accordance with auditing standards generally
accepted in the United States of America, the consolidated balance sheet as of
December 31, 2001, and the related consolidated statements of income, of changes
in shareholders' equity, and of cash flows for the year then ended (not
presented herein), and in our report dated February 25, 2002 we expressed an
unqualified opinion on those consolidated financial statements. In our opinion,
the information set forth in the accompanying consolidated balance sheet
information as of December 31, 2001, is fairly stated in all material respects
in relation to the consolidated balance sheet from which it has been derived.
/s/ PricewaterhouseCoopers LLP
Houston, Texas
October 29, 2002
2
SOUTHWEST BANCORPORATION OF TEXAS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEET
(UNAUDITED)
SEPTEMBER 30, DECEMBER 31,
2002 2001
-------------- -------------
(DOLLARS IN THOUSANDS, EXCEPT
SHARE AND PER SHARE AMOUNTS)
ASSETS
Cash and due from banks..................................... $ 197,489 $ 272,823
Federal funds sold and other cash equivalents............... 150,124 72,633
---------- ----------
Total cash and cash equivalents........................... 347,613 345,456
Securities -- available for sale............................ 1,254,849 1,068,315
Loans held for sale......................................... 81,874 87,024
Loans held for investment................................... 2,928,547 2,672,458
Allowance for loan losses................................... (34,597) (31,390)
Premises and equipment, net................................. 89,197 59,924
Accrued interest receivable................................. 20,183 20,706
Other assets................................................ 150,791 178,663
---------- ----------
Total assets.............................................. $4,838,457 $4,401,156
========== ==========
LIABILITIES AND SHAREHOLDERS' EQUITY
Deposits:
Demand -- noninterest-bearing............................. $1,115,405 $ 987,752
Demand -- interest-bearing................................ 35,000 38,373
Money market accounts..................................... 1,425,781 1,403,796
Savings................................................... 95,279 86,237
Time, $100 and over....................................... 530,311 554,120
Other time................................................ 373,563 358,355
---------- ----------
Total deposits......................................... 3,575,339 3,428,633
Securities sold under repurchase agreements................. 235,525 358,401
Other borrowings............................................ 568,769 229,578
Accrued interest payable.................................... 1,806 2,562
Other liabilities........................................... 20,949 18,840
---------- ----------
Total liabilities...................................... 4,402,388 4,038,014
---------- ----------
Minority interest in consolidated subsidiary................ 1,503 1,408
---------- ----------
Commitments and contingencies
Shareholders' equity:
Common stock -- $1 par value, 150,000,000 shares
authorized; 33,833,908 issued and outstanding at
September 30, 2002 and 32,924,098 issued and
outstanding at December 31, 2001....................... 33,834 32,924
Additional paid-in capital................................ 87,026 73,388
Retained earnings......................................... 294,841 251,552
Accumulated other comprehensive income.................... 18,865 3,870
---------- ----------
Total shareholders' equity............................. 434,566 361,734
---------- ----------
Total liabilities and shareholders' equity............. $4,838,457 $4,401,156
========== ==========
The accompanying notes are an integral part of the condensed consolidated
financial statements.
3
SOUTHWEST BANCORPORATION OF TEXAS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENT OF INCOME
(UNAUDITED)
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
----------------------- -----------------------
2002 2001 2002 2001
---------- ---------- ---------- ----------
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
Interest income:
Loans.............................................. $45,774 $50,938 $133,923 $158,747
Securities......................................... 15,266 13,256 44,274 39,690
Federal funds sold and other....................... 191 366 568 2,246
------- ------- -------- --------
Total interest income........................... 61,231 64,560 178,765 200,683
------- ------- -------- --------
Interest expense:
Deposits........................................... 12,819 20,688 37,686 69,963
Other borrowings................................... 2,671 3,098 7,971 12,677
------- ------- -------- --------
Total interest expense.......................... 15,490 23,786 45,657 82,640
------- ------- -------- --------
Net interest income............................. 45,741 40,774 133,108 118,043
Provision for loan losses............................ 3,000 2,000 8,750 5,500
------- ------- -------- --------
Net interest income after provision for loan
losses........................................ 42,741 38,774 124,358 112,543
------- ------- -------- --------
Noninterest income:
Service charges on deposit accounts................ 9,198 7,784 27,357 19,564
Investment services................................ 2,371 2,046 7,183 5,441
Other fee income................................... 126 2,992 6,094 8,870
Other operating income............................. 1,673 1,676 5,016 6,296
Gain on sale of loans, net......................... 1,472 432 3,058 2,228
Gain on sale of securities, net.................... 1,680 8 1,682 33
------- ------- -------- --------
Total noninterest income........................ 16,520 14,938 50,390 42,432
------- ------- -------- --------
Noninterest expenses:
Salaries and employee benefits..................... 22,325 19,466 64,785 57,749
Occupancy expense.................................. 5,840 5,624 16,956 15,694
Other operating expenses........................... 9,949 8,528 29,799 24,498
Minority interest.................................. 30 (38) 79 9
------- ------- -------- --------
Total noninterest expenses...................... 38,144 33,580 111,619 97,950
------- ------- -------- --------
Income before income taxes...................... 21,117 20,132 63,129 57,025
Provision for income taxes........................... 6,555 6,460 19,840 18,294
------- ------- -------- --------
Net income...................................... $14,562 $13,672 $ 43,289 $ 38,731
======= ======= ======== ========
Earnings per common share:
Basic........................................... $ 0.43 $ 0.42 $ 1.30 $ 1.18
======= ======= ======== ========
Diluted......................................... $ 0.42 $ 0.40 $ 1.26 $ 1.14
======= ======= ======== ========
The accompanying notes are an integral part of the condensed consolidated
financial statements.
4
SOUTHWEST BANCORPORATION OF TEXAS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS' EQUITY
(UNAUDITED)
ACCUMULATED
COMMON STOCK ADDITIONAL OTHER TOTAL
-------------------- PAID-IN RETAINED COMPREHENSIVE SHAREHOLDERS'
SHARES DOLLARS CAPITAL EARNINGS INCOME EQUITY
---------- ------- ---------- -------- ------------- -------------
(DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
BALANCE, DECEMBER 31, 2001............ 32,924,098 $32,924 $73,388 $251,552 $ 3,870 $361,734
Exercise of stock options........... 747,546 748 13,251 13,999
Issuance of restricted common stock,
net.............................. 162,264 162 (162) --
Deferred compensation
amortization..................... 549 549
Comprehensive income:
Net income for the nine months
ended September 30, 2002....... 43,289 43,289
Net change in unrealized
appreciation on securities
available for sale, net of
deferred taxes of $8,278 and
reclassification of net gains
included in net income of
$955........................... 14,995 14,995
--------
Total comprehensive income....... 58,284
---------- ------- ------- -------- ------- --------
BALANCE, SEPTEMBER 30, 2002........... 33,833,908 $33,834 $87,026 $294,841 $18,865 $434,566
========== ======= ======= ======== ======= ========
The accompanying notes are an integral part of the condensed consolidated
financial statements.
5
SOUTHWEST BANCORPORATION OF TEXAS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS
(UNAUDITED)
NINE MONTHS ENDED
SEPTEMBER 30,
-----------------------
2002 2001
---------- ----------
(DOLLARS IN THOUSANDS)
Cash flows from operating activities:
Net income................................................ $ 43,289 $ 38,731
Adjustments to reconcile net income to net cash provided
by operating activities:
Provision for loan losses............................... 8,750 5,500
Depreciation............................................ 6,715 5,797
Provision for capitalized mortgage servicing rights in
excess of fair value................................... 2,700 --
Realized gain on securities available for sale, net..... (1,682) (33)
Amortization and accretion of securities' premiums and
discounts, net......................................... 3,080 (4)
Amortization of mortgage servicing rights............... 2,833 2,057
Amortization of computer software....................... 2,632 1,895
Other amortization...................................... 549 338
Minority interest in net income of consolidated
subsidiary............................................. 79 9
Gain on sale of loans, net.............................. (3,058) (2,228)
Origination of loans held for sale and mortgage
servicing rights....................................... (126,979) (102,159)
Proceeds from sales of loans............................ 133,623 99,840
Income tax benefit from exercise of stock options....... 6,424 1,842
Decrease in accrued interest receivable, prepaid
expenses and other assets.............................. 17,463 9,442
Increase (decrease) in accrued interest payable and
other liabilities...................................... 1,353 (4,382)
Other, net.............................................. 247 (254)
--------- ---------
Net cash provided by operating activities.......... 98,018 56,391
--------- ---------
Cash flows from investing activities:
Proceeds from maturity and call of securities available
for sale................................................ 21,770 113,757
Principal paydowns of mortgage-backed securities available
for sale................................................ 288,429 113,662
Proceeds from sale of securities available for sale....... 35,904 51,989
Purchase of securities available for sale................. (498,423) (368,217)
Purchase of Federal Reserve Bank stock.................... (242) (845)
Proceeds from redemption of Federal Home Loan Bank
stock................................................... 5,699 10,126
Purchase of Federal Home Loan Bank stock.................. (17,422) --
Net increase in loans held for investment................. (262,613) (214,203)
Purchase of Bank-owned life insurance policies............ -- (50,000)
Purchase of premises and equipment........................ (39,677) (13,200)
Proceeds from sale of premises and equipment.............. 826 1,006
Purchase of mortgage servicing rights..................... (708) (312)
--------- ---------
Net cash used in investing activities.............. (466,457) (356,237)
--------- ---------
Cash flows from financing activities:
Net increase (decrease) in noninterest-bearing demand
deposits................................................ 127,653 (26,797)
Net increase (decrease) in time deposits.................. (8,601) 38,980
Net increase in other interest-bearing deposits........... 27,654 221,076
Net increase (decrease) in securities sold under
repurchase agreements................................... (122,876) 61,718
Net increase (decrease) in other short-term borrowings.... 239,459 (178,732)
Proceeds from long-term borrowings........................ 100,000 --
Payments on long-term borrowings.......................... (268) (247)
Net proceeds from exercise of stock options............... 7,575 1,771
--------- ---------
Net cash provided by financing activities.......... 370,596 117,769
--------- ---------
Net increase (decrease) in cash and cash equivalents........ 2,157 (182,077)
Cash and cash equivalents at beginning of period............ 345,456 411,306
--------- ---------
Cash and cash equivalents at end of period.................. $ 347,613 $ 229,229
========= =========
The accompanying notes are an integral part of the condensed consolidated
financial statements.
6
SOUTHWEST BANCORPORATION OF TEXAS, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)
1. BASIS OF PRESENTATION
The unaudited condensed consolidated financial statements include the
accounts of Southwest Bancorporation of Texas, Inc. (the "Company") and its
direct and indirect wholly-owned subsidiaries, Southwest Holding Delaware, Inc.
(the "Delaware Company"), Southwest Bank of Texas National Association (the
"Bank"), Mitchell Mortgage Company, LLC ("Mitchell"), Fairview, Inc., SWBT
Securities, Inc. and SWBT Insurance Agency, Inc. The consolidated financial
statements also include the accounts of First National Bank of Bay City, a 58%
owned subsidiary of the Delaware Company. All material intercompany accounts and
transactions have been eliminated. In the opinion of management, the unaudited
condensed consolidated financial statements reflect all adjustments, consisting
only of normal and recurring adjustments, necessary for a fair statement of the
Company's consolidated financial position at September 30, 2002 and December 31,
2001, consolidated net income for the three and nine months ended September 30,
2002 and 2001, consolidated cash flows for the nine months ended September 30,
2002 and 2001 and the consolidated changes in shareholders' equity for the nine
months ended September 30, 2002. Interim period results are not necessarily
indicative of results of operations or cash flows for a full-year period.
These financial statements and the notes thereto should be read in
conjunction with the Company's annual report on Form 10-K for the year ended
December 31, 2001.
New Accounting Pronouncements
On June 29, 2001, the Financial Accounting Standards Board approved
Statement of Financial Accounting Standards (SFAS) No. 141, Business
Combinations, and SFAS No. 142, Goodwill and Other Intangible Assets. SFAS No.
141 amends APB Opinion No. 16, Business Combinations, to prohibit use of the
pooling-of-interests (pooling) method of accounting for business combinations
initiated after June 30, 2001 and require the use of purchase accounting.
Goodwill generated from purchase business combinations consummated prior to
the issuance of SFAS No. 142 was amortized on a straight-line basis over 20
years. SFAS No. 142 addresses the initial recognition and measurement of
intangible assets acquired outside a business combination and the recognition
and measurement of goodwill and other intangible assets subsequent to
acquisition. Under the new standard, goodwill and intangible assets deemed to
have indefinite lives are no longer amortized, but instead are tested at least
annually for impairment. The standard was adopted by the Company on January 1,
2002 and the impact of adoption was immaterial.
On October 24, 2002, the Financial Accounting Standards Board approved SFAS
No. 147, Acquisitions of Certain Financial Institutions. SFAS No. 147 amends
previously issued guidance regarding the accounting and reporting for the
acquisition of all or part of a financial institution. The statement also
provides guidance on the accounting for the impairment or disposal of core
deposits and is effective for acquisitions after October 1, 2002.
Reclassifications
Certain previously reported amounts have been reclassified to conform to
the 2002 financial statement presentation. These reclassifications had no effect
on net income or shareholders' equity.
7
SOUTHWEST BANCORPORATION OF TEXAS, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
2. COMPREHENSIVE INCOME
Comprehensive income consists of the following:
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------ ------------------
2002 2001 2002 2001
------- ------- ------- -------
Net income...................................... $14,562 $13,672 $43,289 $38,731
Net change in unrealized appreciation on
securities available for sale, net of tax..... 6,334 9,501 15,950 15,369
Less: reclassification adjustment for gains
included in net income........................ (955) (5) (955) (21)
------- ------- ------- -------
Total comprehensive income...................... $19,941 $23,168 $58,284 $54,079
======= ======= ======= =======
3. MORTGAGE SERVICING RIGHTS
The Company originates, sells and services single family residential
mortgages and commercial mortgages through its ownership of Mitchell. Through
Mitchell, the Company also originates and services residential and commercial
construction loans. The Company periodically evaluates the carrying value of the
mortgage servicing rights in relation to the present value of the estimated
future net servicing revenue based on management's best estimate of remaining
loan lives. Any excess carrying value is recorded as a valuation allowance with
the provision recorded as a component of other fee income in the accompanying
statement of income.
The following table summarizes the changes in capitalized mortgage
servicing rights for the periods indicated:
NINE MONTHS ENDED YEAR ENDED
SEPTEMBER 30, DECEMBER 31,
2002 2001
------------------ ------------
Balance, beginning of period........................... $12,008 $12,334
Originations......................................... 1,564 2,247
Purchases............................................ 708 557
Scheduled amortization............................... (985) (1,087)
Payoff amortization.................................. (1,848) (2,043)
------- -------
Balance before valuation allowance..................... 11,447 12,008
Less: valuation allowance............................ 2,700 --
------- -------
Balance, end of period................................. $ 8,747 $12,008
======= =======
The managed servicing portfolio totaled $1.13 billion at September 30, 2002
and $1.28 billion at December 31, 2001. Capitalized mortgage servicing rights
represent 78 basis points and 94 basis points of the portfolio serviced at
September 30, 2002 and December 31, 2001, respectively.
8
SOUTHWEST BANCORPORATION OF TEXAS, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
4. EARNINGS PER COMMON SHARE
Earnings per common share is computed as follows:
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------- -----------------
2002 2001 2002 2001
-------- -------- ------- -------
Net income..................................... $14,562 $13,672 $43,289 $38,731
======= ======= ======= =======
Divided by average common shares and common
share equivalents:
Average common shares........................ 33,741 32,886 33,350 32,833
Average common shares issuable under the
stock option plan......................... 985 1,197 1,058 1,269
------- ------- ------- -------
Total average common shares and common share
equivalents............................... 34,726 34,083 34,408 34,102
======= ======= ======= =======
Basic earnings per common share................ $ 0.43 $ 0.42 $ 1.30 $ 1.18
======= ======= ======= =======
Diluted earnings per common share.............. $ 0.42 $ 0.40 $ 1.26 $ 1.14
======= ======= ======= =======
Stock options outstanding of 94 and 97 for the three months ended September
30, 2002 and 2001, respectively, and 96 and 88 for the nine months ended
September 30, 2002 and 2001, respectively, have not been included in diluted
earnings per share because to do so would have been antidilutive for the periods
presented. Stock options are antidilutive when the exercise price is higher than
the current market price of the Company's common stock.
5. SEGMENT INFORMATION
The Company has two operating segments: the bank and the mortgage company.
Each segment is managed separately because each business requires different
marketing strategies and each offers different products and services.
The Company evaluates each segment's performance based on the revenue and
expenses from its operations, excluding non-recurring items. Intersegment
financing arrangements are accounted for at current market rates as if they were
with third parties.
Summarized financial information by operating segment for the three and
nine months ended September 30, 2002 and 2001 follows:
THREE MONTHS ENDED SEPTEMBER 30,
---------------------------------------------------------------------------------------------------
2002 2001
------------------------------------------------ ------------------------------------------------
BANK MORTGAGE ELIMINATIONS CONSOLIDATED BANK MORTGAGE ELIMINATIONS CONSOLIDATED
------- -------- ------------ ------------ ------- -------- ------------ ------------
Interest income........ $58,909 $3,816 $(1,494) $61,231 $62,074 $4,671 $(2,185) $64,560
Interest expense....... 15,490 1,494 (1,494) 15,490 23,786 2,185 (2,185) 23,786
------- ------ ------- ------- ------- ------ ------- -------
Net interest income.... 43,419 2,322 -- 45,741 38,288 2,486 -- 40,774
Provision for loan
losses............... 2,918 82 -- 3,000 1,917 83 -- 2,000
Noninterest income..... 17,157 (637) -- 16,520 13,441 1,497 -- 14,938
Noninterest expense.... 35,870 2,274 -- 38,144 31,426 2,154 -- 33,580
------- ------ ------- ------- ------- ------ ------- -------
Income before income
taxes................ $21,788 $ (671) $ -- $21,117 $18,386 $1,746 $ -- $20,132
======= ====== ======= ======= ======= ====== ======= =======
9
SOUTHWEST BANCORPORATION OF TEXAS, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NINE MONTHS ENDED SEPTEMBER 30,
---------------------------------------------------------------------------------------------------------
2002 2001
--------------------------------------------------- ---------------------------------------------------
BANK MORTGAGE ELIMINATIONS CONSOLIDATED BANK MORTGAGE ELIMINATIONS CONSOLIDATED
---------- -------- ------------ ------------ ---------- -------- ------------ ------------
Interest income...... $ 171,543 $ 11,917 $ (4,695) $ 178,765 $ 193,783 $ 15,075 $ (8,175) $ 200,683
Interest expense..... 45,657 4,695 (4,695) 45,657 82,640 8,175 (8,175) 82,640
---------- -------- --------- ---------- ---------- -------- --------- ----------
Net interest
income............. 125,886 7,222 -- 133,108 111,143 6,900 -- 118,043
Provision for loan
losses............. 8,504 246 -- 8,750 5,260 240 -- 5,500
Noninterest income... 48,055 2,335 -- 50,390 37,083 5,349 -- 42,432
Noninterest
expense............ 104,719 6,900 -- 111,619 91,628 6,322 -- 97,950
---------- -------- --------- ---------- ---------- -------- --------- ----------
Income before income
taxes.............. $ 60,718 $ 2,411 $ -- $ 63,129 $ 51,338 $ 5,687 $ -- $ 57,025
========== ======== ========= ========== ========== ======== ========= ==========
Total assets......... $4,815,045 $257,666 $(234,254) $4,838,457 $4,092,042 $271,648 $(253,779) $4,109,911
========== ======== ========= ========== ========== ======== ========= ==========
Intersegment interest was paid to the Bank by the mortgage company in the
amount of $1,494 and $2,185 for the three months ended September 30, 2002 and
2001, respectively. For the nine months ended September 30, 2002 and 2001,
intersegment interest was $4,695 and $8,175, respectively.
Advances from the Bank to the mortgage company of $234,254 and $253,779
were eliminated in consolidation at September 30, 2002 and 2001, respectively.
6. SUBSEQUENT EVENT
On November 1, 2002, the Company completed the sale of its interest in
First National Bank of Bay City, a 58% owned subsidiary of the Delaware Company,
in a cash transaction valued at $2.9 million. The Company will record a pretax
gain of approximately $1.1 million from the proceeds of the sale.
10
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
SPECIAL CAUTIONARY NOTICE REGARDING FORWARD-LOOKING STATEMENTS
Certain of the matters discussed in this document and in documents
incorporated by reference herein, including matters discussed under the caption
"Management's Discussion and Analysis of Financial Condition and Results of
Operations," may constitute forward-looking statements for purposes of the
Securities Act of 1933, as amended, and the Securities Exchange Act of 1934, as
amended, and as such may involve known and unknown risks, uncertainties and
other factors which may cause the actual results, performance or achievements of
the Company to be materially different from future results, performance or
achievements expressed or implied by such forward-looking statements. The words
"expect," "anticipate," "intend," "plan," "believe," "seek," "estimate," and
similar expressions are intended to identify such forward-looking statements.
The Company's actual results may differ materially from the results anticipated
in these forward-looking statements due to a variety of factors, including,
without limitation: (a) the effects of future economic conditions on the Company
and its customers; (b) governmental monetary and fiscal policies, as well as
legislative and regulatory changes; (c) the risks of changes in interest rates
on the level and composition of deposits, loan demand, and the values of loan
collateral, securities and interest rate protection agreements, as well as
interest rate risks; (d) the effects of competition from other commercial banks,
thrifts, mortgage banking firms, consumer finance companies, credit unions,
securities brokerage firms, insurance companies, money market and other mutual
funds and other financial institutions operating in the Company's market area
and elsewhere, together with such competitors offering banking products and
services by mail, telephone, computer and the internet; and (e) the failure of
assumptions underlying the establishment of reserves for loan losses and
estimations of values of collateral and various financial assets and
liabilities. All written or oral forward-looking statements attributable to the
Company are expressly qualified in their entirety by these cautionary
statements.
OVERVIEW
Total assets at September 30, 2002 and December 31, 2001 were $4.84 billion
and $4.40 billion, respectively. Gross loans were $3.01 billion at September 30,
2002, an increase of $250.9 million, or 9%, from $2.76 billion at December 31,
2001. Shareholders' equity was $434.6 million and $361.7 million at September
30, 2002 and December 31, 2001, respectively.
For the nine months ended September 30, 2002, net income was $43.3 million
($1.26 per diluted share) compared to $38.7 million ($1.14 per diluted share)
for the same period in 2001, an increase of 12%. For the three months ended
September 30, 2002, net income was $14.6 million ($0.42 per diluted share)
compared to $13.7 million ($0.40 per diluted share) for the same period in 2001,
an increase of 7%. Return on average assets and return on average shareholders'
equity for the three months ended September 30, 2002 was 1.25% and 13.59%,
respectively, as compared to 1.34% and 15.96% for the three months ended
September 30, 2001. For the nine months ended September 30, 2002, return on
average assets and return on average shareholders' equity was 1.30% and 14.62%,
respectively, as compared to 1.32% and 16.00% for the nine months ended
September 30, 2001. Return on average assets is calculated by dividing
annualized net income by the daily average of total assets. Return on average
shareholders' equity is calculated by dividing annualized net income by the
daily average of common shareholders' equity.
RESULTS OF OPERATIONS
INTEREST INCOME
Interest income for the three months ended September 30, 2002 was $61.2
million, a decrease of $3.3 million, or 5%, from the three months ended
September 30, 2001. This decrease in interest income is due to a decrease in the
average yield on interest-earning assets to 5.83% for the three months ended
September 30, 2002, a decrease of 118 basis points when compared to the same
period in 2001. This decrease is partially offset by a $514.6 million increase
in average interest-earning assets to $4.17 billion for the three months ended
September 30, 2002, a 14% increase from the same period last year. For the nine
months ended
11
September 30, 2002, interest income was $178.8 million, a $21.9 million, or 11%,
decrease from the same period a year ago. This decrease in interest income is
due to a decrease in the average yield on interest-earning assets to 5.95% for
the nine months ended September 30, 2002, a decrease of 165 basis points when
compared to the same period in 2001. This decrease is partially offset by a
$483.6 million increase in average interest-earning assets to $4.01 billion for
the nine months ended September 30, 2002, a 14% increase from the same period
last year.
Interest income on loans decreased $5.2 million to $45.8 million for the
three months ended September 30, 2002. This decrease was due to a 135 basis
point decrease in the average yield on loans to 6.20% for the three months ended
September 30, 2002, compared to 7.55% for the same period last year. This
decrease is partially offset by a $251.5 million increase in average loans
outstanding to $2.93 billion for the three months ended September 30, 2002, a 9%
increase from the same period a year ago.
For the nine months ended September 30, 2002, interest income on loans
decreased 16% to $133.9 million, down from $158.7 million for the same period
last year. This decrease was due to a 187 basis point decrease in the average
yield on loans to 6.29% for the nine months ended September 30, 2002, compared
to 8.16% for the same period last year. This decrease is partially offset by a
$246.8 million increase in average loans outstanding to $2.85 billion for the
nine months ended September 30, 2002, a 9% increase from the same period a year
ago.
Interest income on securities increased $2.0 million to $15.3 million for
the three months ended September 30, 2002. This increase was due to a $267.8
million increase in average securities outstanding to $1.19 billion for the
three months ended September 30, 2002, a 29% increase from the same period a
year ago. This increase is partially offset by a 61 basis point decrease in the
average yield on securities to 5.08% for the three months ended September 30,
2002, compared to 5.69% for the same period last year.
Interest income on securities increased $4.6 million to $44.3 million for
the nine months ended September 30, 2002. This increase was due to a $256.1
million increase in average securities outstanding to $1.12 billion for the nine
months ended September 30, 2002, a 30% increase from the same period a year ago.
This increase is partially offset by an 86 basis point decrease in the average
yield on securities to 5.29% for the nine months ended September 30, 2002,
compared to 6.15% for the same period last year.
INTEREST EXPENSE
Interest expense on deposits and other borrowings for the three months
ended September 30, 2002 was $15.5 million, a decrease of $8.3 million, or 35%,
from the three months ended September 30, 2001. This decrease in interest
expense was attributable to a decrease in the average rate on interest-bearing
liabilities to 1.96% for the period, a decrease of 138 basis points when
compared to the same period in 2001. This decrease is partially offset by a
$310.3 million increase in average interest-bearing liabilities to $3.14 billion
for the three months ended September 30, 2002, an increase of 11% from the same
period last year.
Interest expense on deposits and other borrowings for the nine months ended
September 30, 2002 was $45.7 million, a decrease of $37.0 million, or 45%, from
the nine months ended September 30, 2001. This decrease in interest expense was
attributable to a decrease in the average rate on interest-bearing liabilities
to 1.99% for the period, a decrease of 202 basis points when compared to the
same period in 2001. This decrease is partially offset by a $307.7 million
increase in average interest-bearing liabilities to $3.06 billion for the nine
months ended September 30, 2002, an increase of 12% from the same period last
year.
NET INTEREST INCOME
Net interest income for the three months ended September 30, 2002 was $45.7
million compared to $40.8 million in 2001, an increase of $5.0 million, or 12%.
Growth in average interest-earning assets, primarily loans and securities, was
$514.6 million, or 14%, while yields decreased 118 basis points to 5.83%. Yields
decreased throughout 2001 as the Bank's prime lending rate decreased. The impact
of the growth in average interest-earning assets was partially offset by a
$310.3 million, or 11%, increase in average interest-bearing
12
liabilities, offset by a decrease in the rate paid on interest-bearing
liabilities of 138 basis points to 1.96% in 2002.
For the nine months ended September 30, 2002, net interest income was
$133.1 million compared to $118.0 million in 2001, an increase of $15.1 million,
or 13%. Growth in average interest-earning assets, primarily loans and
securities, was $483.6 million, or 14%, while yields decreased 165 basis points
to 5.95%. The impact of the growth in average interest-earning assets was
partially offset by a $307.7 million, or 11%, increase in average
interest-bearing liabilities, offset by a decrease in the rate paid on
interest-bearing liabilities of 202 basis points to 1.99% in 2002.
For the three months ended September 30, 2002, the net interest margin,
defined as annualized net interest income divided by average interest-earning
assets, decreased to 4.36% compared to 4.43% for the three months ended
September 30, 2001. This decrease resulted from a decrease in the yield on
interest-earning assets of 118 basis points, from 7.01% for the three months
ended September 30, 2001 to 5.83% for the three months ended September 30, 2002.
This decrease in the yield on interest-earning assets was partially offset by a
decrease in the cost of funds of 138 basis points from 3.34% for the three
months ended September 30, 2001 to 1.96% for the three months ended September
30, 2002. For the nine months ended September 30, 2002, the net interest margin
declined to 4.43% compared to 4.47% for the nine months ended September 30,
2001. This decrease resulted from a decrease in the yield on interest-earning
assets of 165 basis points from 7.60% for the nine months ended September 30,
2001 to 5.95% for the nine months ended September 30, 2002. This decrease in the
yield on interest-earning assets was partially offset by a decrease in the cost
of funds of 202 basis points, from 4.01% for the nine months ended September 30,
2001 to 1.99% for the nine months ended September 30, 2002.
13
The following table presents for the periods indicated the total dollar
amount of interest income from average interest-earning assets and the resultant
yields, as well as the interest expense on average interest-bearing liabilities,
expressed both in dollars and rates. No tax equivalent adjustments were made and
all average balances are daily average balances. Nonaccruing loans have been
included in the table as loans carrying a zero yield. The yield on the
securities portfolio is based on average historical cost balances and does not
give effect to changes in fair value that are reflected as a component of
consolidated shareholders' equity.
THREE MONTHS ENDED SEPTEMBER 30,
-------------------------------------------------------------------
2002 2001
-------------------------------- --------------------------------
AVERAGE INTEREST AVERAGE AVERAGE INTEREST AVERAGE
OUTSTANDING EARNED/ YIELD/ OUTSTANDING EARNED/ YIELD/
BALANCE PAID RATE BALANCE PAID RATE
----------- -------- ------- ----------- -------- -------
(DOLLARS IN THOUSANDS)
ASSETS
Interest-earning assets:
Loans.......................... $2,928,311 $45,774 6.20% $2,676,845 $50,938 7.55%
Securities..................... 1,192,252 15,266 5.08 924,501 13,256 5.69
Federal funds sold and other... 46,249 191 1.64 50,826 366 2.86
---------- ------- ---- ---------- ------- ----
Total interest-earning
assets............... 4,166,812 61,231 5.83% 3,652,172 64,560 7.01%
------- ---- ------- ----
Less allowance for loan losses... (34,474) (31,431)
---------- ----------
4,132,338 3,620,741
Noninterest-earning assets....... 474,758 417,962
---------- ----------
Total assets........... $4,607,096 $4,038,703
========== ==========
LIABILITIES AND SHAREHOLDERS' EQUITY
Interest-bearing liabilities:
Money market and savings
deposits.................... $1,561,247 5,325 1.35% $1,509,293 9,747 2.56%
Certificates of deposit........ 964,091 7,494 3.08 918,749 10,941 4.72
Repurchase agreements and
borrowed funds.............. 613,791 2,671 1.73 400,818 3,098 3.07
---------- ------- ---- ---------- ------- ----
Total interest-bearing
liabilities.......... 3,139,129 15,490 1.96% 2,828,860 23,786 3.34%
---------- ------- ---- ---------- ------- ----
Noninterest-bearing liabilities:
Noninterest-bearing demand
deposits.................... 1,016,011 841,680
Other liabilities.............. 26,738 28,219
---------- ----------
Total liabilities...... 4,181,878 3,698,759
---------- ----------
Shareholders' equity............. 425,218 339,944
---------- ----------
Total liabilities and
shareholders'
equity............... $4,607,096 $4,038,703
========== ==========
Net interest income.............. $45,741 $40,774
======= =======
Net interest spread.............. 3.87% 3.67%
==== ====
Net interest margin.............. 4.36% 4.43%
==== ====
14
NINE MONTHS ENDED SEPTEMBER 30,
-------------------------------------------------------------------
2002 2001
-------------------------------- --------------------------------
AVERAGE INTEREST AVERAGE AVERAGE INTEREST AVERAGE
OUTSTANDING EARNED/ YIELD/ OUTSTANDING EARNED/ YIELD/
BALANCE PAID RATE BALANCE PAID RATE
----------- -------- ------- ----------- -------- -------
(DOLLARS IN THOUSANDS)
ASSETS
Interest-earning assets:
Loans........................ $2,848,400 $133,923 6.29% $2,601,558 $158,747 8.16%
Securities................... 1,119,122 44,274 5.29 863,043 39,690 6.15
Federal funds sold and
other..................... 46,514 568 1.63 65,841 2,246 4.56
---------- -------- ---- ---------- -------- ----
Total interest-earning
assets.................. 4,014,036 178,765 5.95% 3,530,442 200,683 7.60%
-------- ---- -------- ----
Less allowance for loan
losses....................... (33,380) (30,126)
---------- ----------
3,980,656 3,500,316
Noninterest-earning assets..... 460,912 422,025
---------- ----------
Total assets.............. $4,441,568 $3,922,341
========== ==========
LIABILITIES AND SHAREHOLDERS' EQUITY
Interest-bearing liabilities:
Money market and savings
deposits.................. $1,514,235 15,650 1.38% $1,436,632 34,182 3.18%
Certificates of deposit...... 937,344 22,036 3.14 893,292 35,781 5.36
Repurchase agreements and
borrowed funds............ 609,736 7,971 1.75 423,690 12,677 4.00
---------- -------- ---- ---------- -------- ----
Total interest-bearing
liabilities............. 3,061,315 45,657 1.99% 2,753,614 82,640 4.01%
---------- -------- ---- ---------- -------- ----
Noninterest-bearing
liabilities:
Noninterest-bearing demand
deposits.................. 958,507 812,275
Other liabilities............ 25,761 32,784
---------- ----------
Total liabilities......... 4,045,583 3,598,673
---------- ----------
Shareholders' equity........... 395,985 323,668
---------- ----------
Total liabilities and
shareholders' equity.... $4,441,568 $3,922,341
========== ==========
Net interest income............ $133,108 $118,043
======== ========
Net interest spread............ 3.96% 3.59%
==== ====
Net interest margin............ 4.43% 4.47%
==== ====
15
The following table presents the dollar amount of changes in interest
income and interest expense for the major components of interest-earning assets
and interest-bearing liabilities and distinguishes between the increase
(decrease) related to outstanding balances and the volatility of interest rates.
For purposes of this table, changes attributable to both rate and volume which
cannot be segregated have been allocated proportionately to the change due to
volume and the change due to rate.
THREE MONTHS ENDED SEPTEMBER 30, NINE MONTHS ENDED SEPTEMBER 30,
--------------------------------- --------------------------------
2002 VS. 2001 2002 VS. 2001
--------------------------------- --------------------------------
INCREASE (DECREASE) INCREASE (DECREASE)
DUE TO DUE TO
--------------------------------- --------------------------------
VOLUME RATE TOTAL VOLUME RATE TOTAL
-------- ---------- --------- -------- --------- ---------
(DOLLARS IN THOUSANDS)
INTEREST-EARNING ASSETS:
Loans............................. $4,785 $ (9,949) $(5,164) $15,062 $(39,886) $(24,824)
Securities........................ 3,839 (1,829) 2,010 11,777 (7,193) 4,584
Federal funds sold and other...... (33) (142) (175) (659) (1,019) (1,678)
------ -------- ------- ------- -------- --------
Total increase (decrease) in
interest income.............. 8,591 (11,920) (3,329) 26,180 (48,098) (21,918)
------ -------- ------- ------- -------- --------
INTEREST-BEARING LIABILITIES:
Money market and savings
deposits........................ 336 (4,758) (4,422) 1,846 (20,378) (18,532)
Certificates of deposit........... 540 (3,987) (3,447) 1,765 (15,510) (13,745)
Repurchase agreements and borrowed
funds........................... 1,646 (2,073) (427) 5,567 (10,273) (4,706)
------ -------- ------- ------- -------- --------
Total increase (decrease) in
interest expense............. 2,522 (10,818) (8,296) 9,178 (46,161) (36,983)
------ -------- ------- ------- -------- --------
Increase (decrease) in net
interest income................. $6,069 $ (1,102) $ 4,967 $17,002 $ (1,937) $ 15,065
====== ======== ======= ======= ======== ========
PROVISION FOR LOAN LOSSES
The provision for loan losses represents the current period credit cost
associated with maintaining an appropriate allowance for credit losses. The loan
loss provision for each period is dependent upon many factors, including loan
growth, net charge-offs, changes in the composition of the loan portfolio,
delinquencies, management's assessment of the quality of the loan portfolio, the
value of the underlying collateral on problem loans and the general economic
conditions in the Company's market area. Periodic fluctuations in the provision
for loan losses result from management's assessment of the adequacy of the
allowance for loan losses. Although no assurance can be given, management
believes that the present allowance for loan losses is adequate; however, actual
loan losses may vary from current estimates.
For the quarter ended September 30, 2002, the methodology used to determine
the provision for loan losses was unchanged from the prior period. The
composition of the Company's loan portfolio remained relatively unchanged from
December 31, 2001 and there was no material change in the lending programs or
terms during the quarter.
The provision for loan losses was $3.0 million for the three months ended
September 30, 2002, as compared to $2.0 million for the three months ended
September 30, 2001. The provision for loan losses was $8.8 million for the nine
months ended September 30, 2002, as compared to $5.5 million for the nine months
ended September 30, 2001. The increase in the provision for loan losses
corresponds to the increase in average loans outstanding and net charge-offs for
the nine months ended September 30, 2002 when compared to the same period last
year.
Net charge-offs were $1.4 million for the three months ended September 30,
2002 and 2001. Of the $1.4 million in net charge-offs for the current period,
$1.0 million is related to one commercial credit. Net
16
charge-offs to average loans was 0.20% for the three months ended September 30,
2002, as compared to 0.22% for the three months ended September 30, 2001. For
the nine months ended September 30, 2002, net charge-offs were $5.5 million, as
compared to $2.5 million for the same period last year. Net charge-offs to
average loans was 0.27% for the nine months ended September 30, 2002, as
compared to 0.13% for the nine months ended September 30, 2001.
In addition to the increase in net charge-offs, changes in general economic
factors were considered when determining the amount of the provision for loan
losses. Some of the factors include the slowing of the national and
international economies, the turbulent performance of the stock market, and the
increase in the local unemployment rate in the current year.
While the Company recognizes that the economic slowdown may adversely
impact its borrowers' financial performance and ultimately their ability to
repay their loans, management continues to be cautiously optimistic about the
key credit indicators from the Company's loan portfolio. While the Company has
experienced an increase in net charge-offs in the current year as a result of
the factors noted above, its net charge-offs to average loans has been below the
average of banks insured by the Federal Deposit Insurance Corporation. (See
"-- Financial Condition -- Loan Review and Allowance for Loan Losses.")
NONINTEREST INCOME
Noninterest income for the three months ended September 30, 2002 was $16.5
million, an increase of $1.6 million, or 11%, from $14.9 million during the
comparable period in 2001. Noninterest income for the nine months ended
September 30, 2002 was $50.4 million, an increase of $8.0 million, or 19%, from
$42.4 million during the comparable period in 2001. The following table shows
the breakout of noninterest income between the bank and the mortgage company for
the periods indicated.
THREE MONTHS ENDED SEPTEMBER 30,
-------------------------------------------------------------
2002 2001
----------------------------- -----------------------------
BANK MORTGAGE COMBINED BANK MORTGAGE COMBINED
------- -------- -------- ------- -------- --------
Service charges on
deposit accounts.... $ 9,198 $ -- $ 9,198 $ 7,784 $ -- $ 7,784
Investment
services............ 2,371 -- 2,371 2,046 -- 2,046
Factoring fee
income.............. 1,133 -- 1,133 1,082 -- 1,082
Loan fee income...... 507 682 1,189 330 688 1,018
Bank-owned life
insurance income.... 1,233 -- 1,233 1,198 -- 1,198
Letters of credit fee
income.............. 386 -- 386 330 -- 330
Mortgage servicing
fees, net of
amortization and
impairment.......... 12 (2,961) (2,949) -- 242 242
Gain on sale of
loans, net.......... 5 1,467 1,472 -- 432 432
Gain on sale of
securities, net..... 1,680 -- 1,680 8 -- 8
Other income......... 632 175 807 663 135 798
------- ------- ------- ------- ------ -------
Total noninterest
income............ $17,157 $ (637) $16,520 $13,441 $1,497 $14,938
======= ======= ======= ======= ====== =======
NINE MONTHS ENDED SEPTEMBER 30,
-------------------------------------------------------------
2002 2001
----------------------------- -----------------------------
BANK MORTGAGE COMBINED BANK MORTGAGE COMBINED
------- -------- -------- ------- -------- --------
Service charges on
deposit accounts.... $27,357 $ -- $27,357 $19,564 $ -- $19,564
Investment
services............ 7,183 -- 7,183 5,441 -- 5,441
Factoring fee
income.............. 3,440 -- 3,440 3,428 -- 3,428
Loan fee income...... 1,154 2,084 3,238 840 1,937 2,777
Bank-owned life
insurance income.... 3,628 -- 3,628 3,288 -- 3,288
Letters of credit fee
income.............. 1,089 -- 1,089 958 -- 958
Mortgage servicing
fees, net of
amortization and
impairment.......... 84 (2,839) (2,755) -- 768 768
Gain on sale of
loans, net.......... 472 2,586 3,058 -- 2,228 2,228
Gain on sale of
securities, net..... 1,682 -- 1,682 33 -- 33
Other income......... 1,966 504 2,470 3,531 416 3,947
------- ------- ------- ------- ------ -------
Total noninterest
income............ $48,055 $ 2,335 $50,390 $37,083 $5,349 $42,432
======= ======= ======= ======= ====== =======
Banking Segment. The largest component of noninterest income is service
charges on deposit accounts, which were $9.2 million for the three months ended
September 30, 2002, an increase of $1.4 million, or 18%,
17
from $7.8 million for the same period last year. Service charges on deposit
accounts were $27.4 million for the nine months ended September 30, 2002, an
increase of $7.8 million, or 40%, from $19.6 million for the same period last
year. Several factors contributed to this growth. First, the Bank's treasury
management group continues to grow, with service charges from commercial
analysis up $927,000, or 26%, for the three months ended September 30, 2002 when
compared to the same period last year. For the nine months ended September 30,
2002, such charges were $13.9 million, an increase of $3.9 million, or 39%, from
$10.0 million for the nine months ended September 30, 2001. This success at
winning new business results from the Company's ability to design custom
cost-effective cash management solutions for middle market and large corporate
customers. Second, net NSF charges on deposit accounts were $3.9 million for the
three months ended September 30, 2002, an increase of $209,000, or 6%, from $3.7
million for the same period last year. Net NSF charges on deposit accounts were
$11.2 million for the nine months ended September 30, 2002, an increase of $2.9
million, or 36%, from $8.2 million for the same period last year. This increase
in NSF charges is primarily due to net fee income on a new deposit product.
Additionally, the total number of deposit accounts grew from 150,972 at
September 30, 2001 to 159,509 at September 30, 2002.
Investment services income was $2.4 million for the three months ended
September 30, 2002 compared to $2.0 million for the same period last year, an
increase of $325,000, or 16%. For the nine months ended September 30, 2002,
investment services income was $7.2 million, an increase of $1.7 million, or
32%, from $5.4 million for the nine months ended September 30, 2001. The
increase in investment services income is attributable to increased investment
sales to commercial and retail customers and to the expanding foreign exchange
department, as well as the addition of several experienced calling officers and
an increase in referrals from the Company's growing customer base.
Gain on sale of loans was $472,000 for the nine months ended September 30,
2002. This gain primarily represents the premium for the sale of the Bank's
credit card portfolio. There were no such transactions in the prior year.
Gain on sale of securities, net, was $1.7 million for the three and nine
months ended September 30, 2002. This gain was recorded on the sale of warrants
and other investment securities with a book value of $34.2 million. There were
no such transactions in the prior year.
Other income was $632,000 for the three months ended September 30, 2002, a
decrease of $31,000, or 5%, from the same period last year. For the nine months
ended September 30, 2002, other income was $2.0 million, a decrease of $1.5
million, or 44%, from $3.5 million for the nine months ended September 30, 2001.
This decrease is partially due to a gain recorded on the sale of Bank assets in
the prior year and to a decrease in income from equity investees.
Mortgage Segment. Gain on sale of loans was $1.5 million for the three
months ended September 30, 2002, an increase of $1.0 million, or 240%, from the
same period last year. For the nine months ended September 30, 2002, gain on
sale of loans was $2.6 million, an increase of $358,000, or 16%, from $2.2
million for the nine months ended September 30, 2001. The increase in the gain
on sale of loans is due to two factors. First, the principal balance of mortgage
loans sold increased to $37.1 million during the three months ended September
30, 2002 compared to $26.6 million during the three months ended September 30,
2001. The principal balance of mortgage loans sold for the nine months ended
September 30, 2002 was $126.7 million compared to $97.6 million for the
comparable period last year. In addition, the mortgage company recorded a gain
of $641,000 ($395,000 net of amortization of capitalized mortgage servicing
rights) on the sale of $130.0 million of mortgage servicing rights on
multi-family loans in the third quarter of 2002. No such transaction was
recorded in the prior year.
Mortgage servicing fees, net of amortization and impairment, were ($3.0)
million for the three months ended September 30, 2002 as compared to $242,000
for the same period last year. For the nine months ended September 30, 2002,
mortgage servicing fees, net of amortization and impairment, were ($2.8) million
as compared to $768,000 for the same period last year. This decrease is
primarily due to a provision for capitalized mortgage servicing rights in excess
of fair value in the amount of $2.7 million in the third quarter of 2002. The
decrease in the fair value of capitalized mortgage servicing rights is a result
of the decline in the 10-year Treasury rate in the third quarter resulting in
historically low mortgage rates and an increase in
18
prepayments of mortgages serviced by the Company. In addition, $246,000 of
capitalized mortgage servicing rights was expensed with the sale of the related
servicing assets discussed above.
NONINTEREST EXPENSES
For the three months ended September 30, 2002, noninterest expenses totaled
$38.1 million, an increase of $4.6 million, or 14%, from $33.6 million during
2001. For the nine months ended September 30, 2002, noninterest expenses totaled
$111.6 million, an increase of $13.7 million, or 14%, from the same period in
2001. The increase in noninterest expenses was primarily due to salaries and
employee benefits and other operating expenses. The efficiency ratio is
calculated by dividing total noninterest expenses by net interest income plus
noninterest income, excluding net security gains (losses). An increase in the
efficiency ratio indicates that more resources are being utilized to generate
the same volume of income while a decrease would indicate a more efficient
allocation of resources. The efficiency ratio was 62.96% for the three months
ended September 30, 2002 compared with 60.28% for the same period last year. For
the nine months ended September 30, 2002, the efficiency ratio was 61.39%
compared with 61.05% for the same period last year. The increase in the
efficiency ratio in 2002 is primarily a result of the write-down of mortgage
servicing rights discussed in "-- Results of Operations -- Noninterest Income"
above.
Salaries and employee benefits for the three months ended September 30,
2002 was $22.3 million, an increase of $2.9 million, or 15%, from the three
months ended September 30, 2001. Salaries and employee benefits was $64.8
million for the nine months ended September 30, 2002, an increase of $7.0
million, or 12%, from $57.7 million for the same period last year. This increase
was due primarily to hiring of additional personnel required to accommodate the
Company's growth. Total end of period employees were 1,506 and 1,388 at
September 30, 2002 and 2001, respectively.
Other operating expenses for the three months ended September 30, 2002 were
$9.9 million, an increase of $1.4 million, or 17%, from the three months ended
September 30, 2001. Other operating expenses were $30.0 million for the nine
months ended September 30, 2002, an increase of $5.3 million, or 22%, from $24.5
million for the same period last year. Major categories within other operating
expenses are professional expenses, computer software amortization expense, and
losses on accounts. Professional expenses increased to $2.3 million for the
three months ended September 30, 2002 from $1.7 million for the comparable
period last year, an increase of $606,000, or 35%. For the nine months ended
September 30, 2002, professional expenses were $6.4 million, an increase of $1.5
million, or 30%, from $4.9 million for the same period last year. This increase
is primarily due to an increase in consulting fees. Computer software
amortization expense increased to $910,000 for the three months ended September
30, 2002 from $706,000 for the comparable period last year, an increase of
$204,000, or 29%. For the nine months ended September 30, 2002, computer
software amortization expense was $2.6 million, an increase of $736,000, or 39%,
from $1.9 million for the same period last year. This increase is due to
amortization of new software related to technology upgrades throughout the
Company. Losses on deposit accounts increased to $972,000 for the three months
ended September 30, 2002 from $376,000 for the comparable period last year, an
increase of $596,000, or 159%. For the nine months ended September 30, 2002,
losses on deposit accounts were $2.8 million, an increase of $1.2 million, or
70%, from $1.7 million for the same period last year. This increase is primarily
due to charge-offs of deposit accounts related to a new deposit product. In
addition, the Company charged off $350,000 and $150,000 in the third and second
quarter of 2002, respectively, related to check kiting.
INCOME TAXES
Income tax expense includes the regular federal income tax at the statutory
rate, plus the income tax component of the Texas franchise tax. The amount of
federal income tax expense is influenced by the amount of taxable income, the
amount of tax-exempt income, the amount of nondeductible interest expense, and
the amount of other nondeductible expenses. Taxable income for the income tax
component of the Texas franchise tax is the federal pre-tax income, plus certain
officers' salaries, less interest income from federal securities. For the three
months ended September 30, 2002, the provision for income taxes was $6.6
million, an increase of $95,000, or 1%, from the $6.5 million provided for the
same period in 2001. For the nine months ended September 30, 2002, income tax
expense was $19.8 million, an increase of $1.5 million, or 8%, from the
19
$18.3 million provided for the same period in 2001. The Company's effective tax
rate was 31% and 32% for the three months ended September 30, 2002 and 2001,
respectively. For the nine months ended September 30, 2002 and 2001, the
Company's effective tax rate was 31% and 32%, respectively.
FINANCIAL CONDITION
LOANS HELD FOR INVESTMENT
Loans held for investment were $2.93 billion at September 30, 2002, an
increase of $256.1 million, or 10%, from $2.67 billion at December 31, 2001.
The following table summarizes the loan portfolio of the Company by type of
loan as of September 30, 2002 and December 31, 2001:
SEPTEMBER 30, 2002 DECEMBER 31, 2001
----------------------- ----------------------
AMOUNT PERCENT AMOUNT PERCENT
------------- ------- ------------ -------
(DOLLARS IN THOUSANDS)
Commercial and industrial.................. $1,143,508 39.04% $1,084,114 40.56%
Real estate:
Construction and land development........ 688,202 23.50 698,423 26.13
1-4 family residential................... 438,878 14.99 344,133 12.88
Commercial owner occupied................ 453,661 15.49 320,336 11.99
Farmland................................. 5,676 0.19 4,854 0.18
Other.................................... 21,281 0.73 25,884 0.97
Consumer................................... 177,341 6.06 194,714 7.29
---------- ------ ---------- ------
Total loans held for investment....... $2,928,547 100.00% $2,672,458 100.00%
========== ====== ========== ======
The primary lending focus of the Company is on small- and medium-sized
commercial, construction and land development, residential mortgage and consumer
loans. The Company offers a variety of commercial lending products including
term loans, lines of credit and equipment financing. A broad range of short- to
medium-term commercial loans, both collateralized and uncollateralized, are made
available to businesses for working capital (including inventory and
receivables), business expansion (including acquisitions of real estate and
improvements) and the purchase of equipment and machinery. The purpose of a
particular loan generally determines its structure.
Generally, the Company's commercial loans are underwritten on the basis of
the borrower's ability to service such debt from cash flow. As a general
practice, the Company takes as collateral a lien on any available real estate,
equipment or other assets and personal guarantees of company owners or project
sponsors. Working capital loans are primarily collateralized by short-term
assets whereas term loans are primarily collateralized by long-term assets.
A substantial portion of the Company's real estate loans consists of loans
collateralized by real estate, other assets and personal guarantees of company
owners or project sponsors. Additionally, a portion of the Company's lending
activity consists of the origination of single-family residential mortgage loans
collateralized by owner-occupied properties located in the Company's primary
market area. The Company offers a variety of mortgage loan products which
generally are amortized over five to 30 years.
Loans collateralized by single-family residential real estate are typically
originated in amounts of no more than 90% of appraised value. The Company
typically requires mortgage title insurance and hazard insurance in the amount
of the loan. Although the contractual loan payment periods for single-family
residential real estate loans are generally for a 15 to 30 year period, such
loans often remain outstanding for significantly shorter periods than their
contractual terms.
The Company originates and purchases residential and commercial mortgage
loans to sell to investors with servicing rights retained. The Company also
provides residential and commercial construction financing
20
to builders and developers and acts as a broker in the origination of
multi-family and commercial real estate loans.
Residential construction financing to builders generally has been
originated in amounts of no more than 80% of appraised value. The Company
requires a mortgage title binder and builder's risk insurance in the amount of
the loan. The contractual loan payment periods for residential construction
loans are generally for a six to twelve month period.
Consumer loans made by the Company include automobile loans, recreational
vehicle loans, boat loans, home improvement loans, personal loans
(collateralized and uncollateralized) and deposit account collateralized loans.
The terms of these loans typically range from 12 to 84 months and vary based
upon the nature of collateral and size of the loan.
The contractual maturity ranges of the commercial and industrial and funded
real estate construction and land development loan portfolio and the amount of
such loans with fixed interest rates and floating interest rates in each
maturity range as of September 30, 2002 are summarized in the following table:
SEPTEMBER 30, 2002
--------------------------------------------------
AFTER ONE
ONE YEAR OR THROUGH AFTER FIVE
LESS FIVE YEARS YEARS TOTAL
----------- ---------- ---------- ----------
(DOLLARS IN THOUSANDS)
Commercial and industrial............... $ 712,047 $359,813 $71,648 $1,143,508
Real estate construction and land
development........................... 432,946 232,059 23,197 688,202
---------- -------- ------- ----------
Total................................... $1,144,993 $591,872 $94,845 $1,831,710
========== ======== ======= ==========
Loans with a fixed interest rate........ $ 463,087 $148,447 $38,515 $ 650,049
Loans with a floating interest rate..... 681,906 443,425 56,330 1,181,661
---------- -------- ------- ----------
Total................................... $1,144,993 $591,872 $94,845 $1,831,710
========== ======== ======= ==========
LOANS HELD FOR SALE
Loans held for sale of $81.9 million at September 30, 2002 decreased from
$87.0 million at December 31, 2001. These loans are carried at the lower of cost
or market and are typically sold to investors within one year of origination.
The market value of these loans is impacted by changes in current interest
rates. An increase in interest rates would result in a decrease in the market
value of these loans while a decrease in interest rates would result in an
increase in the market value of these loans. The business of originating and
selling loans is conducted by the Company's mortgage segment.
LOAN REVIEW AND ALLOWANCE FOR LOAN LOSSES
The Company's loan review procedures include a credit quality assurance
process that begins with approval of lending policies and underwriting
guidelines by the Board of Directors, a loan review department staffed, in part,
with Office of the Comptroller of the Currency experienced personnel, low
individual lending limits for officers, Senior Loan Committee approval for large
credit relationships and a quality control process for loan documentation. The
Company also maintains a monitoring process for credit extensions in excess of
$100,000. The Company performs quarterly concentration analyses based on various
factors such as industries, collateral types, business lines, large credit
sizes, international credit exposure and officer portfolio loads. The Company
has established underwriting guidelines to be followed by its officers. The
Company also monitors its delinquency levels for any negative or adverse trends.
The Company continues to invest in its loan portfolio monitoring system to
enhance its risk management capabilities.
The Company's loan portfolio is well diversified by industry type but is
generally concentrated in the eight county region defined as its primary market
area. Historically, the Houston metropolitan area has been affected both
positively and negatively by conditions in the energy industry. It is estimated
that approximately
21
32% of economic activity currently is related to the upstream energy industry,
down from 69% in 1981. Since the mid 1980's, the economic impact of changes in
the energy industry has been lessened due to the diversification of the Houston
economy driven by growth in such economic entities as the Texas Medical Center,
the Port of Houston, the Johnson Space Center, among others, and government
infrastructure spending to support the population and job growth in the Houston
area. As a result, the economy of the Company's primary market area has become
increasingly affected by changes in the national and international economies.
The Company monitors changes in the level of energy prices, real estate
values, borrower collateral, and the level of local, regional, national, and
international economic activity. Recently, several major employers in the
Houston market have either experienced financial difficulties or reductions in
employment due to changes in the energy trading markets, corporate
consolidations, or political events affecting the global economy. While these
factors are significant, the Company's primary market area has managed to show a
12 month gain of approximately 800 jobs, or less than 0.04 percent of the total
employment base of 2.1 million, as of September 30, 2002. As of September 30,
2002, other than $3.3 million in charge-offs related to four commercial credits,
these events have had no material effect on the Company's loan portfolio. There
can be no assurance, however, the Company's loan portfolio will not become
subject to increasing pressures from deteriorating borrower credit due to
general economic conditions.
The allowance for loan losses is established through a provision for loan
losses based on management's evaluation of risk inherent in the loan portfolio.
The allowance is increased by provisions charged against current earnings and
reduced by net charge-offs. Loans are charged off when they are deemed to be
uncollectible; recoveries are generally recorded only when cash payments are
received. Based on an evaluation of the loan portfolio, management presents a
quarterly analysis of the allowance for loan losses to a committee of the Board
of Directors, indicating any changes in the allowance since the last review and
any recommendations as to adjustments in the allowance. In making its
evaluations, management considers both quantitative and qualitative risk factors
in establishing an allowance for loan losses that it considers to be appropriate
at each reporting period. Quantitative factors include historical charge-off
experience, delinquency and past due trends, changes in collateral values,
changes in energy prices, changes in the level of borrower covenant violations,
the level of nonperforming loans, changes in the risk classification of credits,
growth and concentrations of credit in the loan portfolio, the results of
regulatory and internal loan review examinations, and changes in the loan
portfolio's composition by both industry and by borrower.
Qualitative factors include an evaluation of the economic factors affecting
the Company's primary market area, changes in the type and complexity of credit
extensions, the experience levels of its lending and loan review staff, new
lending products, the age of the loan portfolio, and other factors.
In order to determine the adequacy of the allowance for loan losses,
management performs periodic reviews of the loan portfolio, either individually
or in pools. Generally, commercial and real estate loans are reviewed
individually and consumer and single family residential loans are evaluated in
pools.
A general allowance for loan losses is established based upon (i) the
historical loss experience by loan type; (ii) management's internal grading of
the loans resulting in an allowance based upon the historical loss experience by
grade applied to the outstanding principal balance of the adversely graded
loans; and (iii) certain subjective factors such as economic trends, performance
trends, portfolio age and concentrations of credit. In addition, specific
allowances may be established for loans which management believes require
greater reserves than those allocated based on the above methodology. Future
changes in economic conditions, circumstances, or other factors could cause
management to increase or decrease the allowance for loan losses as necessary.
Management believes that the allowance for loan losses at September 30,
2002 is adequate to cover losses inherent in the portfolio as of such date.
There can be no assurance, however, that the Company will not sustain losses in
future periods, which could be greater than the size of the allowance at
September 30, 2002.
22
The following table presents, for the periods indicated, an analysis of the
allowance for loan losses and other related data:
NINE MONTHS
ENDED YEAR ENDED
SEPTEMBER 30, DECEMBER 31,
2002 2001
------------- ------------
(DOLLARS IN THOUSANDS)
Allowance for loan losses, beginning balance................ $31,390 $28,150
Provision charged against operations........................ 8,750 7,500
Charge-offs:
Commercial and industrial................................. (5,007) (3,663)
Real estate:
Construction and land development...................... (108) (65)
1-4 family residential................................. (60) (171)
Commercial owner occupied.............................. (32) --
Farmland............................................... -- --
Other.................................................. (64) (94)
Consumer.................................................. (776) (1,037)
------- -------
Total charge-offs........................................... (6,047) (5,030)
------- -------
Recoveries:
Commercial and industrial................................. 206 265
Real estate:
Construction and land development...................... -- --
1-4 family residential................................. -- 59
Commercial owner occupied.............................. -- --
Farmland............................................... -- --
Other.................................................. 98 51
Consumer.................................................. 200 395
------- -------
Total recoveries............................................ 504 770
------- -------
Net charge-offs............................................. (5,543) (4,260)
------- -------
Allowance for loan losses, ending balance................... $34,597 $31,390
======= =======
Allowance to period-end loans............................... 1.18% 1.17%
Net charge-offs to average loans............................ 0.27% 0.17%
Allowance to period-end nonperforming loans................. 200.18% 237.82%
23
The following table reflects the distribution of the allowance for loan
losses among various categories of loans for the dates indicated. The Company
has allocated portions of its general allowance for loan losses to cover the
estimated losses inherent in particular risk categories of loans. This
allocation is made for analytical purposes and is not necessarily indicative of
the categories in which future loan losses may occur. The total allowance is
available to absorb losses from any segment of loans.
SEPTEMBER 30, 2002 DECEMBER 31, 2001
--------------------- ---------------------
PERCENT OF PERCENT OF
LOANS TO LOANS TO
AMOUNT TOTAL LOANS AMOUNT TOTAL LOANS
------- ----------- ------- -----------
(DOLLARS IN THOUSANDS)
Balance of allowance for loan losses
applicable to:
Commercial and industrial.................. $13,470 39.04% $13,554 40.56%
Real estate:
Construction and land development........ 6,278 23.50 7,395 26.13
1-4 family residential................... 3,989 14.99 2,695 12.88
Commercial owner occupied................ 6,032 15.49 3,397 11.99
Farmland................................. 42 0.19 34 0.18
Other.................................... 1,583 0.73 1,110 0.97
Consumer................................... 3,203 6.06 3,205 7.29
------- ------ ------- ------
Total allowance for loan losses............ $34,597 100.00% $31,390 100.00%
======= ====== ======= ======
NONPERFORMING ASSETS AND IMPAIRED LOANS
Nonperforming assets, which include nonaccrual loans, accruing loans 90 or
more days past due, restructured loans, and other real estate and foreclosed
property, were $18.1 million at September 30, 2002 compared with $14.2 million
at December 31, 2001. This resulted in a ratio of nonperforming assets to loans
and other real estate of 0.62% and 0.53% at September 30, 2002 and December 31,
2001, respectively. Nonaccrual loans, the largest component of nonperforming
assets, were $14.6 million at September 30, 2002, an increase of $3.6 million
from $11.0 million at December 31, 2001.
The following table presents information regarding nonperforming assets as
of the dates indicated:
SEPTEMBER 30, DECEMBER 31,
2002 2001
------------- ------------
(DOLLARS IN THOUSANDS)
Nonaccrual loans............................................ $14,596 $11,020
Accruing loans 90 or more days past due..................... 2,687 2,179
Other real estate and foreclosed property................... 829 1,037
------- -------
Total nonperforming assets................................ $18,112 $14,236
======= =======
Nonperforming assets to total loans and other real estate... 0.62% 0.53%
Loans on which the accrual of interest has been discontinued are designated
as nonaccrual loans. Loans are designated as nonaccrual when reasonable doubt
exists as to the full collection of interest and principal. When a loan is
placed on nonaccrual status, all interest previously accrued but not collected
is reversed against current period interest income. Income on such loans is then
recognized only to the extent that cash is received and where the future
collection of interest and principal is probable. Interest accruals are resumed
on such loans only when they are brought fully current with respect to interest
and principal and when, in the judgment of management, the loans are estimated
to be fully collectible as to both principal and interest. Gross interest income
on nonaccrual loans that would have been recorded had these loans been
performing as agreed was $842,000 for the nine months ended September 30, 2002.
The Company regularly updates appraisals on loans collateralized by real
estate, particularly those categorized as nonperforming loans and potential
problem loans. In instances where updated appraisals reflect
24
reduced collateral values, an evaluation of the borrower's overall financial
condition is made to determine the need, if any, for possible writedowns or
appropriate additions to the allowance for loan losses.
A loan is considered impaired, based on current information and events, if
management believes 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. A loan is not considered impaired during a period of delay
in payment if the Company expects to collect all amounts due, including interest
past due. An insignificant delay (up to 90 days) or insignificant shortfall in
the amount of payment does not constitute an impairment. If the measure of the
impaired loan is less than the recorded investment in the loan, an impairment is
recognized through the provision for loan losses. All nonaccrual loans and
accruing loans 90 or more days past due are considered impaired at September 30,
2002.
The following is a summary of loans considered to be impaired:
SEPTEMBER 30, DECEMBER 31,
2002 2001
------------- ------------
(DOLLARS IN THOUSANDS)
Impaired loans with no valuation reserve.................... $ -- $ 510
Impaired loans with a valuation reserve..................... 19,721 19,728
------- -------
Total recorded investment in impaired loans............... $19,721 $20,238
======= =======
Valuation allowance related to impaired loans............... $ 2,386 $ 3,749
======= =======
The average recorded investment in impaired loans during the nine months
ended September 30, 2002 and the year ended December 31, 2001 was $18.9 million
and $15.5 million, respectively. Interest income on impaired loans of $262,000
and $425,000 was recognized for cash payments received during the nine months
ended September 30, 2002 and the year ended December 31, 2001, respectively. The
decrease in the valuation allowance related to impaired loans is the result of a
change in the composition of these loans and the recognition of loan losses that
were included in the reserve at December 31, 2001.
SECURITIES
At the date of purchase, the Company classifies debt and equity securities
into one of three categories: held to maturity, trading or available for sale.
At each reporting date, the appropriateness of the classification is reassessed.
Investments in debt securities classified as held to maturity are stated at cost
increased by accretion of discounts and reduced by amortization of premiums,
both computed by the interest method, only if management has the positive intent
and ability to hold those securities to maturity. Securities that are bought and
held principally for the purpose of selling them in the near term are classified
as trading and measured at fair value in the financial statements with
unrealized gains and losses included in earnings. Securities not classified as
either held to maturity or trading are classified as available for sale and
measured at fair value in the financial statements with unrealized gains and
losses reported, net of tax, as a component of accumulated other comprehensive
income (loss) until realized. Gains and losses on sales of securities are
determined using the specific-identification method. The Company has classified
all securities as available for sale at September 30, 2002.
25
The amortized cost and approximate fair value of securities classified as
available for sale is as follows:
SEPTEMBER 30, 2002 DECEMBER 31, 2001
---------------------------------------------- ----------------------------------------------
AMORTIZED GROSS UNREALIZED FAIR AMORTIZED GROSS UNREALIZED FAIR
COST GAIN LOSS VALUE COST GAIN LOSS VALUE
---------- ------- ---------- ---------- ---------- ------- ---------- ----------
(DOLLARS IN THOUSANDS)
AVAILABLE FOR SALE
U.S. Government securities... $ 99,856 $ 1,898 $ -- $ 101,754 $ 50,860 $ 1,294 $ (17) $ 52,137
Mortgage-backed securities... 979,576 22,108 (233) 1,001,451 872,974 8,571 (2,825) 878,720
Municipal securities......... 92,389 5,485 (2) 97,872 85,047 252 (1,524) 83,775
Federal Reserve Bank stock... 4,472 -- -- 4,472 4,230 -- -- 4,230
Federal Home Loan Bank
stock...................... 20,036 -- -- 20,036 7,939 -- -- 7,939
Other securities............. 29,151 113 -- 29,264 41,169 356 (11) 41,514
---------- ------- ----- ---------- ---------- ------- ------- ----------
TOTAL SECURITIES AVAILABLE
FOR SALE................. $1,225,480 $29,604 $(235) $1,254,849 $1,062,219 $10,473 $(4,377) $1,068,315
========== ======= ===== ========== ========== ======= ======= ==========
Securities totaled $1.25 billion at September 30, 2002, an increase of
$186.5 million from $1.07 billion at December 31, 2001. The yield on the
securities portfolio for the nine months ended September 30, 2002 was 5.29%
while the yield was 6.15% for the nine months ended September 30, 2001.
The Company has no mortgage-backed securities that have been issued by
non-agency entities. Included in the Company's mortgage-backed securities at
September 30, 2002 were agency issued collateral mortgage obligations with a
book value of $487.7 million and a fair value of $494.3 million.
At September 30, 2002, $724.0 million of the mortgage-backed securities
held by the Company had final maturities of more than 10 years. At September 30,
2002, approximately $21.9 million of the Company's mortgage-backed securities
earned interest at floating rates and repriced within one year, and accordingly
were less susceptible to declines in value should interest rates increase.
The following table summarizes the contractual maturity of investments and
their weighted average yields at September 30, 2002. The yield on the securities
portfolio is based on average historical cost balances and does not give effect
to changes in fair value that are reflected as a component of other
comprehensive income.
SEPTEMBER 30, 2002
--------------------------------------------------------------------------------------------------
AFTER ONE YEAR AFTER FIVE YEARS
WITHIN BUT WITHIN BUT WITHIN AFTER
ONE YEAR FIVE YEARS TEN YEARS TEN YEARS
----------------- ----------------- ----------------- -----------------
AMORTIZED AMORTIZED AMORTIZED AMORTIZED
COST YIELD COST YIELD COST YIELD COST YIELD TOTAL YIELD
--------- ----- --------- ----- --------- ----- --------- ----- ---------- -----
(DOLLARS IN THOUSANDS)
U.S. Government
securities............... $ 4,104 5.83% $ 81,947 5.15% $ 13,805 5.25% $ -- --% $ 99,856 5.19%
Mortgage-backed
securities............... 3,142 6.09 20,099 6.05 232,290 5.16 724,045 4.99 979,576 5.06
Municipal securities....... 2,215 4.34 8,849 4.55 8,723 4.53 72,602 4.88 92,389 4.80
Federal Reserve Bank
stock.................... 4,472 6.00 -- -- -- -- -- -- 4,472 6.00
Federal Home Loan Bank
stock.................... 20,036 3.00 -- -- -- -- -- -- 20,036 3.00
Other securities........... 25,776 1.73 787 5.98 1,356 3.53 1,232 4.36 29,151 2.04
Federal funds sold......... 126,570 1.57 -- -- -- -- -- -- 126,570 1.57
Securities purchased under
resale agreements........ 20,000 1.60 -- -- -- -- -- -- 20,000 1.60
Interest-bearing
deposits................. 3,554 1.64 -- -- -- -- -- -- 3,554 1.64
-------- ---- -------- ---- -------- ---- -------- ---- ---------- ----
Total investments........ $209,869 2.00% $111,682 5.27% $256,174 5.13% $797,879 4.98% $1,375,604 4.58%
======== ==== ======== ==== ======== ==== ======== ==== ========== ====
26
OTHER ASSETS
Other assets were $150.8 million at September 30, 2002, a decrease of $27.9
million from $178.7 million at December 31, 2001. This decrease is primarily
attributable to decreases in factored receivables. Factored receivables result
from providing operating funds to businesses by converting their accounts
receivable to cash. Factored receivables were $33.3 million at September 30,
2002, a decrease of $21.9 million from $55.2 million at December 31, 2001. This
decrease is due to the seasonal nature of some of the factoring company's
customers.
DEPOSITS
The Company offers a variety of deposit accounts having a wide range of
interest rates and terms. The Company's deposits consist of demand, savings,
interest-bearing demand, money market and time accounts. The Company relies
primarily on customer service, advertising and competitive pricing policies to
attract and retain these deposits. As of September 30, 2002, the Company had
less than one percent of its deposits classified as brokered funds. Deposits
provide the primary source of funding for the Company's lending and investment
activities, and the interest paid for deposits must be managed carefully to
control the level of interest expense.
The Company's ratio of average demand deposits to average total deposits
for the periods ended September 30, 2002 and December 31, 2001, was 29% and 28%,
respectively.
The average daily balances and weighted average rates paid on deposits for
the nine months ended September 30, 2002 and the year ended December 31, 2001,
are presented below:
SEPTEMBER 30, 2002 DECEMBER 31, 2001
------------------- -----------------
AMOUNT RATE AMOUNT RATE
----------- ----- ---------- ----
(DOLLARS IN THOUSANDS)
Interest-bearing demand......................... $ 33,006 0.25% $ 62,510 0.50%
Regular savings................................. 93,384 1.00 81,799 1.58
Premium yield................................... 822,928 1.71 851,951 3.41
Money market savings............................ 564,917 1.04 461,433 2.21
CD's less than $100,000......................... 293,275 3.75 302,885 5.25
CD's $100,000 and over.......................... 566,571 2.73 522,601 4.82
IRA's, QRP's and other.......................... 77,498 3.84 76,336 5.07
---------- ---- ---------- ----
Total interest-bearing deposits............... 2,451,579 3.10% 2,359,515 3.64%
==== ====
Noninterest-bearing deposits.................... 958,507 836,366
---------- ----------
Total deposits................................ $3,410,086 $3,195,881
========== ==========
The following table sets forth the maturity of the Company's time deposits
that are $100,000 or greater as of the dates indicated:
SEPTEMBER 30, DECEMBER 31,
2002 2001
------------- ------------
(DOLLARS IN THOUSANDS)
3 months or less............................................ $297,828 $348,782
Between 3 months and 6 months............................... 58,462 81,457
Between 6 months and 1 year................................. 71,859 75,461
Over 1 year................................................. 102,162 48,420
-------- --------
Total time deposits $100,000 and over..................... $530,311 $554,120
======== ========
27
BORROWINGS
Securities sold under repurchase agreements and short-term borrowings
generally represent borrowings with maturities ranging from one to thirty days.
Short-term borrowings consist of federal funds purchased, treasury, tax and loan
deposits and other bank borrowings. Long-term borrowings generally consist of
borrowings with the Federal Home Loan Bank maturing within one year. Information
relating to these borrowings is summarized as follows:
SEPTEMBER 30, DECEMBER 31,
2002 2001
------------- ------------
(DOLLARS IN THOUSANDS)
Securities sold under repurchase agreements:
Average................................................... $276,054 $270,656
Period-end................................................ 235,525 358,401
Maximum month-end balance during period................... 323,815 358,401
Interest rate:
Average................................................... 1.51% 3.17%
Period-end................................................ 1.55% 2.03%
Long-term borrowings:
Average................................................... $ 20,278 $ 7,565
Period-end................................................ 107,142 7,410
Maximum month-end balance during period................... 107,172 7,717
Interest rate:
Average................................................... 3.77% 7.00%
Period-end................................................ 2.28% 6.96%
Short-term borrowings:
Average................................................... $313,404 $157,630
Period-end................................................ 461,627 222,168
Maximum month-end balance during period................... 501,736 368,792
Interest rate:
Average................................................... 1.83% 3.93%
Period-end................................................ 1.98% 2.12%
LIQUIDITY AND CAPITAL RESOURCES
Liquidity management involves maintaining sufficient cash levels to fund
operations and to meet the requirements of borrowers, depositors, and creditors.
Higher levels of liquidity bear higher corresponding costs, measured in terms of
lower yields on short-term, more liquid earning assets, and higher interest
expense involved in extending liability maturities. Liquid assets include cash
and cash equivalents, loans and securities maturing within one year, and money
market instruments. In addition, the Company holds securities maturing after one
year, which can be sold to meet liquidity needs.
The Company relies primarily on customer deposits, securities sold under
repurchase agreements and shareholders' equity to fund interest-earning assets.
The Federal Home Loan Bank ("FHLB") is also a major source of liquidity for the
Bank. The FHLB allows member banks to borrow against their eligible collateral
to satisfy liquidity requirements.
Maintaining a relatively stable funding base, which is achieved by
diversifying funding sources, competitively pricing deposit products, and
extending the contractual maturity of liabilities, reduces the Company's
exposure to roll over risk on deposits and limits reliance on volatile
short-term purchased funds. Short-term funding needs arise from declines in
deposits or other funding sources, funding of loan commitments and requests for
new loans. The Company's strategy is to fund assets to the maximum extent
possible with core deposits that provide a sizable source of relatively stable
and low-cost funds. Average core
28
deposits funded approximately 71% of total interest-earning assets for the nine
months ended September 30, 2002 and 74% for the same period in 2001.
Management believes the Company has sufficient liquidity to meet all
reasonable borrower, depositor, and creditor needs in the present economic
environment. In addition, the Bank has access to the FHLB for borrowing
purposes. The Company has not received any recommendations from regulatory
authorities that would materially affect liquidity, capital resources or
operations.
The Company's risk-based capital ratios including Leverage Capital, Tier 1
Risk-Based Capital and the Total Risk-Based Capital Ratio were 8.97%, 10.96% and
11.92%, respectively, at September 30, 2002.
CRITICAL ACCOUNTING POLICIES
The Company has established various accounting policies which govern the
application of accounting principles generally accepted in the United States in
the preparation of the Company's financial statements. Certain accounting
policies involve significant judgments and assumptions by management which have
a material impact on the carrying value of assets and liabilities; management
considers such accounting policies to be critical accounting policies. The
judgments and assumptions used by management are based on historical experience
and other factors, which are believed to be reasonable under the circumstances.
Because of the nature of the judgments and assumptions made by management,
actual results could differ from these judgments and estimates that could have a
material impact on the carrying values of assets and liabilities and the results
of operations of the Company. The Company believes the allowance for loan losses
is a critical accounting policy that requires the most significant judgments and
estimates used in the preparation of its condensed consolidated financial
statements. In estimating the allowance for loan losses, management utilizes
historical experience as well as other factors including the effect of changes
in the local real estate market on collateral values, the effect on the loan
portfolio of current economic indicators and their probable impact on borrowers
and increase or decreases in nonperforming and impaired loans. Changes in these
factors may cause management's estimate of the allowance to increase or decrease
and result in adjustments to the Company's provision for loan losses.
OTHER MATTERS
On September 29, 2001, the Financial Accounting Standards Board approved
Statement of Financial Accounting Standards (SFAS) No. 141, Business
Combinations, and SFAS No. 142, Goodwill and Other Intangible Assets. SFAS No.
141 amends APB Opinion No. 16, Business Combinations, to prohibit use of the
pooling-of-interests (pooling) method of accounting for business combinations
initiated after September 30, 2001 and require the use of purchase accounting.
Goodwill generated from purchase business combinations consummated prior to
the issuance of SFAS No. 142 was amortized on a straight-line basis over 20
years. SFAS No. 142 addresses the initial recognition and measurement of
intangible assets acquired outside a business combination and the recognition
and measurement of goodwill and other intangible assets subsequent to
acquisition. Under the new standard, goodwill and intangible assets deemed to
have indefinite lives are no longer amortized, but instead are tested at least
annually for impairment. The standard was adopted by the Company on January 1,
2002 and the impact of adoption was immaterial.
On October 24, 2002, the Financial Accounting Standards Board approved SFAS
No. 147, Acquisitions of Certain Financial Institutions. SFAS No. 147 amends
previously issued guidance regarding the accounting and reporting for the
acquisition of all or part of a financial institution. The statement also
provides guidance on the accounting for the impairment or disposal of core
deposits and is effective for acquisitions after October 1, 2002.
29
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
There have been no material changes since December 31, 2001. See the
Company's Annual Report on Form 10-K, "Item 7. Management's Discussion and
Analysis of Financial Condition and Results of Operations -- Financial
Condition -- Interest Rate Sensitivity and Liquidity."
ITEM 4. CONTROLS AND PROCEDURES
The Company's chief executive officer and chief financial officer have
evaluated the Company's disclosure controls and procedures (as defined in Rule
13a-14(c) and Rule 15d-14(c) under the Exchange Act) as of September 30, 2002
and concluded that those disclosure controls and procedures are effective.
There have been no changes in the Company's internal controls or in other
factors known to the Company that could significantly affect these controls
subsequent to their evaluation, nor any corrective actions with regard to
significant deficiencies and material weaknesses.
While the Company believes that its existing disclosure controls and
procedures have been effective to accomplish these objectives, the Company
intends to continue to examine, refine and formalize its disclosure controls and
procedures and to monitor ongoing developments in this area.
-------------------------
With respect to the unaudited financial information of Southwest
Bancorporation of Texas, Inc. for the three and nine month periods ended
September 30, 2002 and 2001, included in this Form 10-Q, PricewaterhouseCoopers
LLP reported that they have applied limited procedures in accordance with
professional standards for a review of such information. However, their separate
report dated October 29, 2002 appearing herein, states that they did not audit
and they do not express an opinion on that unaudited financial information.
Accordingly, the degree of reliance on their report on such information should
be restricted in light of the limited nature of the review procedures applied.
PricewaterhouseCoopers LLP is not subject to the liability provisions of Section
11 of the Securities Act of 1933 for their report on the unaudited financial
information because that report is not a "report" or a "part" of the
registration statement prepared or certified by PricewaterhouseCoopers LLP
within the meaning of Sections 7 and 11 of the Act.
30
PART II -- OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
None.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
None.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
ITEM 5. OTHER INFORMATION
None.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits:
*10.1 Purchase and Sale Agreement between TCP Renaissance
Partners, L.P. and Southwest Bank of Texas, N.A., dated May
24, 2002.
*15.1 Awareness Letter of PricewaterhouseCoopers LLP.
*99.1 Certification of the Chief Executive Officer Pursuant to 18
U.S.C. Section 1350, Adopted Pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
*99.2 Certification of the Chief Financial Officer Pursuant to 18
U.S.C. Section 1350, Adopted Pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
(b) Reports on Form 8-K:
Two reports on Form 8-K were filed by the Company during the three
months ended September 30, 2002:
(i) A Current Report on Form 8-K dated July 15, 2002 was filed on July
17, 2002; Item 5 and Item 7.
(ii) A Current Report on Form 8-K dated August 15, 2002 was filed on
August 19, 2002; Item 5 and Item 7.
---------------
* Filed herewith
31
SIGNATURES
PURSUANT TO THE REQUIREMENTS OF THE SECURITIES EXCHANGE ACT OF 1934, AS
AMENDED, THIS REPORT HAS BEEN SIGNED BELOW BY THE FOLLOWING PERSONS ON BEHALF OF
THE REGISTRANT AND IN THE CAPACITIES AND ON THE DATES INDICATED.
SIGNATURE TITLE DATE
--------- ----- ----
/s/ PAUL B. MURPHY, JR. Director, President and Chief November 8, 2002
------------------------------------------------ Executive Officer
PAUL B. MURPHY, JR. (Principal Executive Officer)
/s/ RANDALL E. MEYER Executive Vice President, November 8, 2002
------------------------------------------------ and Chief Financial Officer
RANDALL E. MEYER (Principal Financial Officer)
/s/ R. JOHN MCWHORTER Senior Vice President and Controller November 8, 2002
------------------------------------------------ (Principal Accounting Officer)
R. JOHN MCWHORTER
32
I, Paul B. Murphy, Jr., certify that:
1. I have reviewed this quarterly report on Form 10-Q of Southwest
Bancorporation of Texas, Inc.;
2. Based on my knowledge, this quarterly report does not contain any
untrue statement of a material fact or omit to state a material fact necessary
to make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by this
quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities,
particularly during the period in which this quarterly report is being
prepared;
b) evaluated the effectiveness of the registrant's disclosure
controls and procedures as of September 30, 2002 (the "Evaluation Date");
and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors:
a) all significant deficiencies in the design or operation of
internal controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have identified
for the registrant's auditors any material weaknesses in internal controls;
and
b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses.
Dated November 5, 2002
/s/ PAUL B. MURPHY, JR.
--------------------------------------
Paul B. Murphy, Jr.
Director, President and Chief
Executive Officer
33
I, Randall E. Meyer, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Southwest
Bancorporation of Texas, Inc.;
2. Based on my knowledge, this quarterly report does not contain any
untrue statement of a material fact or omit to state a material fact necessary
to make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by this
quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities,
particularly during the period in which this quarterly report is being
prepared;
b) evaluated the effectiveness of the registrant's disclosure
controls and procedures as of September 30, 2002 (the "Evaluation Date");
and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors:
a) all significant deficiencies in the design or operation of
internal controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have identified
for the registrant's auditors any material weaknesses in internal controls;
and
b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses.
Dated November 5, 2002
/s/ RANDALL E. MEYER
--------------------------------------
Randall E. Meyer.
Executive Vice President and Chief
Financial Officer
34
EXHIBIT INDEX
EXHIBIT
NO. DESCRIPTION
------- -----------
*10.1 Purchase and Sale Agreement between TCP Renaissance
Partners, L.P. and Southwest Bank of Texas, N.A., dated May
24, 2002.
*15.1 Awareness Letter of PricewaterhouseCoopers LLP.
*99.1 Certification of the Chief Executive Officer Pursuant to 18
U.S.C. Section 1350, Adopted Pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
*99.2 Certification of the Chief Financial Officer Pursuant to 18
U.S.C. Section 1350, Adopted Pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
---------------
* Filed herewith