body_10q.htm


 UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C.  20549

Form 10-Q/A
 

     (Mark One)

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

For the quarterly period ended June 30, 2007

OR

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

For the transition period from ____________ to ____________
 
Commission file number 0-12247


SOUTHSIDE BANCSHARES, INC.
(Exact name of registrant as specified in its charter)
 
 
TEXAS
75-1848732
(State or other jurisdiction of
(I.R.S. Employer
incorporation or organization)
Identification No.)
 
 
1201 S. Beckham, Tyler, Texas
75701
 
 
903-531-7111
(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  o .

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer.  See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act.  (Check one):

Large accelerated filer o                     Accelerated filer  x            Non-accelerated filer  o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).  Yes  o .   No  x .

The number of shares of the issuer's common stock, par value $1.25, outstanding as of July 26, 2007 was 13,081,616 shares.


 



TABLE OF CONTENTS


PART I.  FINANCIAL INFORMATION
ITEM 1.  FINANCIAL STATEMENTS
ITEM 2.  MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
ITEM 3.  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
ITEM 4.  CONTROLS AND PROCEDURES
PART II.  OTHER INFORMATION
ITEM 1.  LEGAL PROCEEDINGS
ITEM 1A.  RISK FACTORS
ITEM 2.  UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
ITEM 3.  DEFAULTS UPON SENIOR SECURITIES
ITEM 4.  SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
ITEM 5.  OTHER INFORMATION
ITEM 6.  EXHIBITS
SIGNATURES
Exhibit Index
Certification Pursuant to Section 302
Certification Pursuant to Section 302
Certification Pursuant to Section 906
 
 

 
 
EXPLANATORY NOTE

Southside Bancshares, Inc. (the “Company”) hereby amends the Company’s Quarterly Report on the Form 10-Q for the six months ended June 30, 2007, originally filed with the Securities and Exchange Commission on August 6, 2007.

This amendment is being filed to reflect the restatement of the Company’s Consolidated Statement of Cash Flows, as discussed in Note 2 contained herein, and other information related to such restated financial information. Except for Items 1 and 4 of Part I, no other information included in the original report on Form 10-Q is amended by this Form 10-Q/A.




PART I.   FINANCIAL INFORMATION
ITEM 1.   FINANCIAL STATEMENTS

SOUTHSIDE BANCSHARES, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(UNAUDITED)
(in thousands, except share amounts)
 
 
June 30,
   
December 31,
 
ASSETS
 
2007
   
2006
 
Cash and due from banks
  $
43,762
    $
52,537
 
Interest earning deposits
   
544
     
550
 
Federal funds sold
   
11,850
     
1,925
 
Total cash and cash equivalents
   
56,156
     
55,012
 
Investment securities:
               
Available for sale, at estimated fair value
   
88,566
     
98,952
 
Held to maturity, at cost
   
1,353
     
1,351
 
Mortgage-backed and related securities:
               
Available for sale, at estimated fair value
   
599,326
     
643,164
 
Held to maturity, at cost
   
207,262
     
226,162
 
Federal Home Loan Bank stock, at cost
   
15,540
     
25,614
 
Other investments, at cost
   
881
     
882
 
Loans held for sale
   
5,042
     
3,909
 
Loans:
               
Loans
   
768,739
     
759,147
 
Less:  allowance for loan losses
    (7,367 )     (7,193 )
Net Loans
   
761,372
     
751,954
 
Premises and equipment, net
   
35,268
     
32,641
 
Interest receivable
   
9,921
     
10,110
 
Deferred tax asset
   
10,456
     
8,678
 
Other assets
   
30,633
     
32,547
 
TOTAL ASSETS
  $
1,821,776
    $
1,890,976
 
LIABILITIES AND SHAREHOLDERS' EQUITY
               
Deposits:
               
Noninterest bearing
  $
328,361
    $
325,771
 
Interest bearing
   
1,007,989
     
956,704
 
Total Deposits
   
1,336,350
     
1,282,475
 
Short-term obligations:
               
Federal funds purchased
   
     
5,675
 
FHLB Dallas advances
   
239,826
     
322,241
 
Other obligations
   
1,511
     
1,605
 
Total Short-term obligations
   
241,337
     
329,521
 
Long-term obligations:
               
FHLB Dallas advances
   
89,393
     
129,379
 
Long-term debt
   
20,619
     
20,619
 
Total Long-term obligations
   
110,012
     
149,998
 
Other liabilities
   
18,583
     
18,378
 
TOTAL LIABILITIES
   
1,706,282
     
1,780,372
 
                 
       Off-Balance-Sheet Arrangements, Commitments and Contingencies (Note 10)
               
                 
Shareholders' equity:
               
Common stock:  ($1.25 par, 20,000,000 shares authorized,
               
14,805,225 and 14,075,653 shares issued)
   
18,507
     
17,594
 
Paid-in capital
   
114,462
     
100,736
 
Retained earnings
   
21,392
     
29,648
 
Treasury stock (1,724,857 and 1,718,737 shares at cost)
    (22,983 )     (22,850 )
Accumulated other comprehensive loss
    (15,884 )     (14,524 )
TOTAL SHAREHOLDERS' EQUITY
   
115,494
     
110,604
 
                 
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY
  $
1,821,776
    $
1,890,976
 

The accompanying notes are an integral part of these consolidated financial statements.

1


SOUTHSIDE BANCSHARES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(UNAUDITED)
(in thousands, except per share data)
   
Three Months
   
Six Months
 
   
Ended June 30,
   
Ended June 30,
 
 
 
2007
   
2006
   
2007
   
2006
 
Interest income
 
 
   
 
   
 
   
 
 
Loans
  $
12,733
    $
11,328
    $
25,247
    $
21,956
 
Investment securities – taxable
   
616
     
594
     
1,452
     
1,337
 
Investment securities – tax-exempt
   
505
     
490
     
1,012
     
1,089
 
Mortgage-backed and related securities
   
10,163
     
11,149
     
21,097
     
21,386
 
Federal Home Loan Bank stock and other investments
   
330
     
350
     
700
     
694
 
Other interest earning assets
   
33
     
14
     
69
     
32
 
Total interest income
   
24,380
     
23,925
     
49,577
     
46,494
 
Interest expense
                               
Deposits
   
10,025
     
7,404
     
19,590
     
13,658
 
Short-term obligations
   
2,776
     
4,037
     
6,722
     
7,587
 
Long-term obligations
   
1,518
     
1,947
     
3,178
     
4,143
 
Total interest expense
   
14,319
     
13,388
     
29,490
     
25,388
 
Net interest income
   
10,061
     
10,537
     
20,087
     
21,106
 
Provision for loan losses
   
217
     
448
     
334
     
729
 
Net interest income after provision for loan losses
   
9,844
     
10,089
     
19,753
     
20,377
 
Non interest income
                               
Deposit services
   
4,270
     
3,947
     
8,198
     
7,416
 
Gain on sale of securities available for sale
   
6
     
101
     
435
     
224
 
Gain on sale of loans
   
724
     
469
     
1,069
     
842
 
Trust income
   
576
     
403
     
1,040
     
807
 
Bank owned life insurance income
   
268
     
265
     
532
     
509
 
Other
   
818
     
782
     
1,526
     
1,267
 
Total non interest income
   
6,662
     
5,967
     
12,800
     
11,065
 
Non interest expense
                               
Salaries and employee benefits
   
7,298
     
7,310
     
14,402
     
14,730
 
Occupancy expense
   
1,190
     
1,201
     
2,358
     
2,374
 
Equipment expense
   
242
     
225
     
470
     
428
 
Advertising, travel & entertainment
   
449
     
472
     
870
     
924
 
ATM and debit card expense
   
242
     
275
     
496
     
445
 
Director fees
   
141
     
167
     
268
     
312
 
Supplies
   
188
     
168
     
336
     
352
 
Professional fees
   
240
     
318
     
551
     
633
 
Postage
   
155
     
155
     
303
     
305
 
Telephone and communications
   
193
     
191
     
384
     
354
 
Other
   
1,118
     
1,081
     
2,254
     
2,140
 
Total non interest expense
   
11,456
     
11,563
     
22,692
     
22,997
 
 
                               
Income before income tax expense
   
5,050
     
4,493
     
9,861
     
8,445
 
Provision for income tax expense
   
463
     
950
     
1,511
     
1,674
 
Net Income
  $
4,587
    $
3,543
    $
8,350
    $
6,771
 
Earnings per common share –basic
  $
0.35
    $
0.28
    $
0.64
    $
0.53
 
Earnings per common share –diluted
  $
0.34
    $
0.27
    $
0.62
    $
0.51
 
Dividends declared per common share
  $
0.12
    $
0.11
    $
0.23
    $
0.22
 

The accompanying notes are an integral part of these consolidated financial statements.

2


SOUTHSIDE BANCSHARES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
(UNAUDITED)
(in thousands, except share amounts)

 
 
Compre-hensive
Income
   
Common Stock
   
Paid-in Capital
   
Retained Earnings
   
Treasury Stock
   
Accumulated
Other
Compre-
hensive
Income (Loss)
   
Total Share-holders
Equity
 
                                           
Balance at
December 31, 2005
 
 
    $
16,633
    $
87,962
    $
32,054
    $ (22,850 )   $ (4,509 )   $
109,290
 
Net Income
  $
6,771
                     
6,771
                     
6,771
 
Other comprehensive loss, net of tax
                                                       
Unrealized losses on securities, net of
                                                       
    reclassification   
    adjustment
   (see Note 4)
    (9,167 )                                     (9,167 )     (9,167 )
Comprehensive loss
  $ (2,396 )                                                
Common stock issued (94,803 shares)
           
119
     
714
                             
833
 
Stock compensation expense
                   
14
                             
14
 
Tax benefit of incentive stock options
                   
41
                             
41
 
Dividends paid on common stock
                            (2,626 )                     (2,626 )
Stock dividend
           
728
     
10,978
      (11,706 )                    
 
Balance at June 30, 2006
          $
17,480
    $
99,709
    $
24,493
    $ (22,850 )   $ (13,676 )   $
105,156
 
                                                         
Balance at
December 31, 2006
          $
17,594
    $
100,736
    $
29,648
    $ (22,850 )   $ (14,524 )   $
110,604
 
Net Income
  $
8,350
                     
8,350
                     
8,350
 
Other comprehensive income, net of tax
                                                       
Unrealized losses on securities, net of
                                                       
reclassification adjustment
(see Note 4)
    (1,533 )                                     (1,533 )     (1,533 )
Adjustment to net periodic
                                                       
benefit cost
(see Note 4)
   
173
                                     
173
     
173
 
Comprehensive Income
  $
6,990
                                                 
Common stock issued (108,634 shares)
           
137
     
788
                             
925
 
Stock compensation expense
                   
14
                             
14
 
Tax benefit of incentive stock options
                   
21
                             
21
 
Dividends paid on common stock
                            (2,927 )                     (2,927 )
Purchase of 6,120 shares of common stock
                                    (133 )             (133 )
Stock dividend
           
776
     
12,903
      (13,679 )                    
 
Balance at June 30, 2007
          $
18,507
    $
114,462
    $
21,392
    $ (22,983 )   $ (15,884 )   $
115,494
 
 
The accompanying notes are an integral part of these consolidated financial statements.

3


SOUTHSIDE BANCSHARES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
(in thousands)
   
Six Months Ended
June 30,
 
 
 
2007
   
2006
 
 
 
 
   
(Restated)
 
OPERATING ACTIVITIES:
 
 
   
 
 
Net income
  $
8,350
    $
6,771
 
Adjustments to reconcile net income to net cash provided by operations:
               
Depreciation
   
1,085
     
1,132
 
Amortization of premium
   
2,445
     
3,066
 
Accretion of discount and loan fees
    (1,314 )     (929 )
Provision for loan losses
   
334
     
729
 
Stock compensation expense
   
14
     
14
 
Decrease (increase) in interest receivable
   
189
      (659 )
Decrease in other assets
   
1,585
     
208
 
Net change in deferred taxes
    (1,077 )     (176 )
(Decrease) increase in interest payable
    (134 )    
338
 
(Decrease) increase in other liabilities
    (434 )     3,155  
Increase in loans held for sale
    (1,133 )     (2,839 )
Gain on sale of available for sale securities
    (435 )     (224 )
Gain on sale of assets
   
      (1 )
Loss on sale of other real estate owned
   
1
     
 
Net cash provided by operating activities
   
9,476
     
10,585
 
 
               
INVESTING ACTIVITIES:
               
Proceeds from sales of investment securities available for sale
   
4,953
     
39,197
 
Proceeds from sales of mortgage-backed securities available for sale
   
51,430
     
30,651
 
Proceeds from maturities of investment securities available for sale
   
57,891
     
14,175
 
Proceeds from maturities of mortgage-backed securities available for sale
   
50,874
     
53,060
 
Proceeds from maturities of mortgage-backed securities held to maturity
   
20,596
     
16,683
 
Proceeds from redemption of Federal Home Loan Bank stock
   
10,729
     
2,019
 
Purchases of investment securities available for sale
    (51,789 )     (23,027 )
Purchases of investment securities held to maturity
   
      (1,348 )
Purchases of mortgage-backed securities available for sale
    (60,474 )     (157,067 )
Purchases of mortgage-backed securities held to maturity
    (2,180 )     (41,282 )
Purchases of Federal Home Loan Bank stock and other investments
    (654 )     (657 )
Net increase in loans
    (10,048 )     (45,119 )
Purchases of premises and equipment
    (3,712 )     (933 )
Proceeds from sales of premises and equipment
   
     
1
 
Proceeds from sales of other real estate owned
   
334
     
45
 
Proceeds from sales of repossessed assets
   
191
     
185
 
Net cash provided by (used in) investing activities
   
68,141
      (113,417 )

The accompanying notes are an integral part of these consolidated financial statements.


4


SOUTHSIDE BANCSHARES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (continued)
(UNAUDITED)
(in thousands)
 
 
Six Months Ended
 
 
 
June 30,
 
 
 
2007
 
 
2006
 
FINANCING ACTIVITIES:
 
 
 
 
(Restated)
 
 Net increase in demand and savings accounts
 
 
21,773
 
 
 
5,388
 
 Net increase in certificates of deposit
 
 
31,944
 
 
 
78,801
 
 Net (decrease) increase in federal funds purchased
 
 
(5,675
)
 
 
10,600
 
 Proceeds from FHLB Advances
 
 
2,786,999
 
 
 
3,608,804
 
 Repayment of FHLB Advances
 
 
(2,909,400
)
 
 
(3,603,261
)
 Tax benefit of incentive stock options
 
 
21
 
 
 
41
 
 Purchases of common stock
   
(133
)
   
 
 Proceeds from the issuance of common stock
 
 
925
 
 
 
833
 
 Dividends paid
 
 
(2,927
)
 
 
(2,626
)
      Net cash (used in) provided by financing activities
 
 
(76,473
)
 
 
98,580
 
 
 
 
   
 
 
 
 
Net increase (decrease) in cash and cash equivalents
 
 
1,144
 
 
 
(4,252
)
Cash and cash equivalents at beginning of period
 
 
55,012
 
 
 
51,829
 
Cash and cash equivalents at end of period
 
$
56,156
 
 
$
47,577
 
 
 
 
   
 
 
 
 
SUPPLEMENTAL DISCLOSURES FOR CASH FLOW INFORMATION:
 
 
   
 
 
 
 
 Interest paid
 
$
29,624
 
 
$
25,050
 
 Income taxes paid
 
 
2,000
 
 
 
1,150
 
 
 
 
   
 
 
 
 
SUPPLEMENTAL DISCLOSURES OF NONCASH INVESTING AND FINANCING ACTIVITIES:
 
 
   
 
 
 
 
 Acquisition of other repossessed assets and real estate through foreclosure
 
$
197
 
 
$
957
 
 Payment of 5% stock dividend
 
 
13,679
 
 
 
11,706
 
 Adjustment to pension liability
 
 
(262
)
 
 
 
Unsettled trades to purchase securities
   
(941
)    
 

The accompanying notes are an integral part of these consolidated financial statements



5



SOUTHSIDE BANCSHARES, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS

1.  Basis of Presentation

The term “Company” is used throughout this report to refer to Southside Bancshares, Inc. and its subsidiaries.  The term “Bank” is used to refer to Southside Bank wherever a distinction between Southside Bancshares, Inc. and Southside Bank aids in the understanding of this report.

The consolidated balance sheet as of June 30, 2007, and the related consolidated statements of income, shareholders' equity and cash flows and notes to the financial statements for the three and six month periods ended June 30, 2007 and 2006 are unaudited; in the opinion of management, all adjustments necessary for a fair presentation of such financial statements have been included.  Such adjustments consisted only of normal recurring items.  All significant intercompany accounts and transactions are eliminated in consolidation.  The preparation of these consolidated financial statements in conformity with U.S. generally accepted accounting principles (“GAAP”) requires the use of management’s estimates. These estimates are subjective in nature and involve matters of judgment.  Actual amounts could differ from these estimates.

Interim results are not necessarily indicative of results for a full year.  These financial statements should be read in conjunction with the financial statements and notes thereto in our Annual Report on Form 10-K/A for the year ended December 31, 2006.  All share data has been adjusted to give retroactive recognition to stock splits and stock dividends.  For a description of our significant accounting and reporting policies, refer to Note 1 of the Notes to Financial Statements in our Annual Report on Form 10-K/A for the year ended December 31, 2006.
 

2.  Restatement of the Statement of Cash Flows for the Six Months Ended June 30, 2006

On November 13, 2007, the Company filed a Form 8-K reporting that management concluded that certain cash flows from operating, investing and financing activities were incorrect in several of the Company’s historical Consolidated Statement of Cash Flows. Management amended its Form 10-K for the year ended December 31, 2006, to restate the Consolidated Statement of Cash Flows for the years ended December 31, 2006, 2005 and 2004.

The restatements for the periods described above were caused by the lack of a non-cash adjustment that should have been reflected in the Company's Consolidated Statement of Cash Flows in accordance with Statement of Financial Accounting Standard No. 95, Statement of Cash Flows.  Securities and brokered deposit trades generally settle in cash several days after the contractual trade date, although generally accepted accounting principles require us to recognize trades as of the trade date.  In the accounting periods being restated, the Company failed to recognize those trades that were between the trade date and settlement date, and therefore had not yet been consummated in the exchange of cash.  These unsettled trades historically had been reflected in the Company's Consolidated Statement of Cash Flows as actual cash flows from operating activities, with corresponding activity in cash flows from investing activities for the unsettled securities trades, and a corresponding activity in cash flows from financing activities for the unsettled brokered deposit trades.  These unsettled trades should have instead been reflected as non-cash adjustments and reported in the Supplemental Disclosures of Noncash Investing and Financing Activities.

For all periods restated there was no change in the Company’s Total Cash and Cash Equivalents, Net Increase in Cash and Cash Equivalents, Consolidated Statements of Income, Consolidated Balance Sheets or Consolidated Statements of Changes in Shareholders’ Equity and Comprehensive Income. Accordingly, the Company’s historical revenues, net income, earnings per share, total assets and regulatory capital remain unchanged.

For the six months ended June 30, 2006, there was no adjustment required to be made to cash flows from financing activities as originally reported. The table below reflects the changes made to the Statement of Cash Flows for the six months ended June 30, 2006, to appropriately reflect the impact of unsettled securities transactions that occurred during the six months then ended:

   
For the six months ended
June 30, 2006
 
   
(in thousands)
 
 
 
As Originally
         
As
 
 
 
Reported
   
Adjustment
   
Restated
 
   
 
   
 
   
 
 
(Decrease) increase in other liabilities
  $ (4,378 )   $
7,533
    $
3,155
 
Net cash provided by operating activities
   
3,052
     
7,533
     
10,585
 
                         
Purchases of mortgage-backed securities held to maturity
    (33,749 )     (7,533 )     (41,282 )
Net cash provided by (used) in investing activities
    (105,884 )     (7,533 )     (113,417 )
                         

 
6

 
3.  Earnings Per Share
 
Earnings per share on a basic and diluted basis has been adjusted to give retroactive recognition to stock splits and stock dividends and is calculated as follows (in thousands, except per share amounts):

 
 
Three Months
 
 
Six Months
 
 
 
Ended June 30,
 
 
Ended June 30,
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
2007
 
 
2006
 
 
2007
 
 
2006
 
    Basic Earnings and Shares:
 
 
 
 
 
 
 
 
 
 
 
 
       Net Income
 
$
4,587
 
 
$
3,543
 
 
$
8,350
 
 
$
6,771
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
       Weighted-average basic shares outstanding
 
 
13,035
 
 
 
12,853
 
 
 
13,008
 
 
 
12,830
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
    Basic Earnings Per Share:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
       Net Income
 
$
0.35
 
 
$
0.28
 
 
$
0.64
 
 
$
0.53
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
    Diluted Earnings and Shares:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
       Net Income
 
$
4,587
 
 
$
3,543
 
 
$
8,350
 
 
$
6,771
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
       Weighted-average basic shares outstanding
 
 
13,035
 
 
 
12,853
 
 
 
13,008
 
 
 
12,830
 
       Add:   Stock options
 
 
401
 
 
 
484
 
 
 
421
 
 
 
496
 
       Weighted-average diluted shares outstanding
 
 
13,436
 
 
 
13,337
 
 
 
13,429
 
 
 
13,326
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
    Diluted Earnings Per Share:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
       Net Income
 
$
0.34
 
 
$
0.27
 
 
$
0.62
 
 
$
0.51
 

For the three and six month periods ended June 30, 2007 and 2006, there were no antidilutive options.

7



4.  Comprehensive Income (Loss)

The components of other comprehensive income (loss) are as follows (in thousands):

   
Six Months Ended June 30, 2007
 
 
 
Before-Tax
   
Tax (Expense)
   
Net-of-Tax
 
 
 
Amount
   
Benefit
   
Amount
 
Unrealized losses on securities:
 
 
   
 
   
 
 
Unrealized holding losses arising during period
  $ (1,888 )   $
642
    $ (1,246 )
Less:  reclassification adjustment for gains
                       
  included in net income
   
435
      (148 )    
287
 
Net unrealized losses on securities
    (2,323 )    
790
      (1,533 )
 Adjustment to net periodic benefit cost
   
262
      (89 )    
173
 
Other comprehensive loss
  $ (2,061 )   $
701
    $ (1,360 )


   
Three Months Ended June 30, 2007
 
 
 
Before-Tax
   
Tax (Expense)
   
Net-of-Tax
 
 
 
Amount
   
Benefit
   
Amount
 
Unrealized losses on securities:
 
 
   
 
   
 
 
Unrealized holding losses arising during period
  $ (5,556 )   $
1,889
    $ (3,667 )
Less:  reclassification adjustment for gains
                       
  included in net income
   
6
      (2 )    
4
 
Net unrealized losses on securities
    (5,562 )    
1,891
      (3,671 )
 Adjustment to net periodic benefit cost
   
104
      (35 )    
69
 
Other comprehensive loss
  $ (5,458 )   $
1,856
    $ (3,602 )


   
Six Months Ended June 30, 2006
 
 
 
Before-Tax
   
Tax (Expense)
   
Net-of-Tax
 
 
 
Amount
   
Benefit
   
Amount
 
Unrealized losses on securities:
 
 
             
Unrealized holding losses arising during period
  $ (13,665 )   $
4,646
    $ (9,019 )
Less:  reclassification adjustment for gains
                       
  included in net income
   
224
      (76 )    
148
 
Net unrealized losses on securities
    (13,889 )    
4,722
      (9,167 )
 
                       
Other comprehensive loss
  $ (13,889 )   $
4,722
    $ (9,167 )


   
Three Months Ended June 30, 2006
 
 
 
Before-Tax
   
Tax (Expense)
   
Net-of-Tax
 
 
 
Amount
   
Benefit
   
Amount
 
Unrealized losses on securities:
                 
Unrealized holding losses arising during period
  $ (5,982 )   $
2,034
    $ (3,948 )
Less:  reclassification adjustment for gains
                       
  included in net income
   
101
      (34 )    
67
 
Net unrealized losses on securities
    (6,083 )    
2,068
      (4,015 )
 
                       
Other comprehensive loss
  $ (6,083 )   $
2,068
    $ (4,015 )


8


5.  Securities

The amortized cost and estimated market value of investment and mortgage-backed securities as of June 30, 2007 and December 31, 2006, are reflected in the tables below (in thousands):

       
   
June 30, 2007
 
AVAILABLE FOR SALE:
 
Amortized Cost
   
Gross Unrealized Gains
   
Gross Unrealized Losses
   
Estimated Market Value
 
Investment Securities:
                       
   U.S. Treasury
  $
18,157
    $
    $
1,051
    $
17,106
 
   Government Sponsored Enterprise Debentures
   
8,999
     
     
2
     
8,997
 
   State and Political Subdivisions
   
54,361
     
1,077
     
480
     
54,958
 
   Other Stocks and Bonds
   
7,591
     
9
     
95
     
7,505
 
Mortgage-backed Securities:
                               
   U.S. Government Agencies
   
73,596
     
274
     
1,669
     
72,201
 
   Government Sponsored Enterprises
   
527,797
     
896
     
8,196
     
520,497
 
   Other Private Issues
   
6,711
     
39
     
122
     
6,628
 
Total
  $
697,212
    $
2,295
    $
11,615
    $
687,892
 

HELD TO MATURITY:
                       
Investment Securities:
                       
   Other Stocks and Bonds
  $
1,353
    $
14
    $
    $
1,367
 
Mortgage-backed Securities:
                               
   U.S. Government Agencies
   
28,228
     
     
621
     
27,607
 
   Government Sponsored Enterprises
   
179,034
     
44
     
3,485
     
175,593
 
Total
  $
208,615
    $
58
    $
4,106
    $
204,567
 

       
   
December 31, 2006
 
AVAILABLE FOR SALE:
 
Amortized Cost
   
Gross Unrealized Gains
   
Gross Unrealized Losses
   
Estimated Market Value
 
Investment Securities:
                       
   U.S. Treasury
  $
27,104
    $
    $
721
    $
26,383
 
   Government Sponsored Enterprise Debentures
   
9,923
     
     
     
9,923
 
   State and Political Subdivisions
   
54,037
     
1,488
     
390
     
55,135
 
   Other Stocks and Bonds
   
7,611
     
12
     
112
     
7,511
 
Mortgage-backed Securities:
                               
   U.S. Government Agencies
   
72,183
     
425
     
1,209
     
71,399
 
   Government Sponsored Enterprises
   
570,777
     
1,250
     
7,377
     
564,650
 
   Other Private Issues
   
7,190
     
20
     
95
     
7,115
 
Total
  $
748,825
    $
3,195
    $
9,904
    $
742,116
 

HELD TO MATURITY:
                       
Investment Securities:
                       
   Other Stocks and Bonds
  $
1,351
    $
7
    $
16
    $
1,342
 
Mortgage-backed Securities:
                               
   U.S. Government Agencies
   
30,788
     
     
407
     
30,381
 
   Government Sponsored Enterprises
   
195,374
     
97
     
3,104
     
192,367
 
Total
  $
227,513
    $
104
    $
3,527
    $
224,090
 
 
The Bank concluded that, based on the creditworthiness of the issuer, the unrealized loss on each security in the above table represents a temporary impairment and does not require adjustment to the carrying amount of any of the individual securities. Additionally, the Bank has the ability and the intent to hold such securities through recovery of the unrealized losses.

Investment and mortgage-backed securities with book values of $322.9 million at June 30, 2007 and $454.6 million at December 31, 2006 were pledged to collateralize FHLB advances, public funds, trust deposits, repurchase agreements and for other purposes, as required or permitted by law.
9



6.  Loans and Allowance for Probable Loan Losses

The following table sets forth loan totals by category for the periods presented (in thousands):


 
 
At
   
At
 
 
 
June 30,
   
December 31,
 
 
 
2007
   
2006
 
 
 
 
       
Real Estate Loans:
 
 
   
 
 
   Construction
  $
46,876
    $
39,588
 
   1-4 Family Residential
   
223,996
     
227,354
 
   Other
   
177,918
     
181,047
 
Commercial Loans
   
125,609
     
118,962
 
Municipal Loans
   
110,416
     
106,155
 
Loans to Individuals
   
83,924
     
86,041
 
Total Loans
  $
768,739
    $
759,147
 

The summaries of the Allowance for Loan Losses are as follows (in thousands):

 
 
Three Months
Ended June 30,
 
 
Six Months
Ended June 30,
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
2007
 
 
2006
 
 
2007
 
 
2006
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Balance at beginning of period
 
$
7,261
 
 
$
7,193
 
 
$
7,193
 
 
$
7,090
 
Provision for loan losses
 
 
217
 
 
 
448
 
 
 
334
 
 
 
729
 
Loans charged off
 
 
(616
)
 
 
(744
)
 
 
(1,209
)
 
 
(1,447
)
Recoveries of loans charged off
 
 
505
 
 
 
449
 
 
 
1,049
 
 
 
974
 
Balance at end of period
 
$
7,367
 
 
$
7,346
 
 
$
7,367
 
 
$
7,346
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 


10



7.  Employee Benefit Plans

The components of net periodic benefit cost are as follows (in thousands):

 
 
Six Months Ended June 30,
 
 
 
Defined Benefit
 
 
 
 
 
 
 
 
 
Pension Plan
 
 
Restoration Plan
 
 
 
2007
 
 
2006
 
 
2007
 
 
2006
 
Service cost
 
$
665
 
 
$
669
 
 
$
31
 
 
$
34
 
Interest cost
 
 
1,156
 
 
 
1,095
 
 
 
84
 
 
 
92
 
Expected return on assets
 
 
(1,264
)
 
 
(1,162
)
 
 
 
 
 
 
Transition obligation recognition
 
 
 
 
 
 
 
 
1
 
 
 
1
 
Net loss recognition
 
 
241
 
 
 
392
 
 
 
42
 
 
 
90
 
Prior service credit amortization
 
 
(21
)
 
 
(21
)
 
 
(1
)
 
 
(1
)
Net periodic benefit cost
 
$
777
 
 
$
973
 
 
$
157
 
 
$
216
 

 
 
Three Months Ended June 30,
 
 
 
Defined Benefit
 
 
 
 
 
 
 
 
 
Pension Plan
 
 
Restoration Plan
 
 
 
2007
 
 
2006
 
 
2007
 
 
2006
 
Service cost
 
$
356
 
 
$
347
 
 
$
16
 
 
$
16
 
Interest cost
 
 
566
 
 
 
548
 
 
 
39
 
 
 
43
 
Expected return on assets
 
 
(631
)
 
 
(581
)
 
 
 
 
 
 
Transition obligation recognition
 
 
 
 
 
 
 
 
 
 
 
 
Net loss recognition
 
 
105
 
 
 
203
 
 
 
10
 
 
 
40
 
Prior service credit amortization
 
 
(11
)
 
 
(21
)
 
 
 
 
 
(1
)
Net periodic benefit cost
 
$
385
 
 
$
496
 
 
$
65
 
 
$
98
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 

Employer Contributions

We previously disclosed in our financial statements for the year ended December 31, 2006, that we expected to contribute $3.0 million to our defined benefit pension plan and $88,000 to our post retirement benefit plan in 2007.  As of June 30, 2007, we had contributed $3.0 million to the defined benefit pension plan, and $40,000 of contributions had been made to the post retirement benefit plan.

11



8.  Incentive Stock Options

In April 1993, we adopted the Southside Bancshares, Inc. 1993 Incentive Stock Option Plan ("the ISO Plan"), a stock-based incentive compensation plan.  The ISO Plan expired March 31, 2003.  Prior to January 1, 2006, we applied APB Opinion 25 and related Interpretations in accounting for the ISO Plan and disclosed the pro forma information required by SFAS 123 and SFAS 148.  There was no compensation expense recognized for the stock options prior to January 1, 2006.

A summary of the status of our nonvested shares as of June 30, 2007 is as follows:

 
 
Six Months Ended
June 30, 2007
 
 
 
Number of Options
 
 
Weighted Average Grant-Date Fair Value
 
Nonvested at beginning of the period
 
 
12,257
 
 
$
4.91
 
Vested
 
 
(6,127
)
 
$
4.91
 
Cancelled
   
(383
)
 
$
4.91
 
Nonvested at end of period
 
 
5,747
 
 
$
4.91
 

For the three and six months ended June 30, 2007 and 2006, we recorded approximately $7,000 and $14,000, respectively, of stock-based compensation expense.  As of June 30, 2007 and 2006, there was $20,000 and $47,000, respectively, of total unrecognized compensation cost related to the ISO Plan for nonvested options granted in March 2003.  The cost is expected to be recognized over a weighted-average period of 9 months.

The fair value of each stock option granted is estimated on the date of grant using the Black-Scholes method of option pricing with the following weighted-average assumptions for grants in 2003:  dividend yield of 1.93%; risk-free interest rate of 4.93%; expected life of 6 years; and expected volatility of 28.90%.

Under the ISO Plan, we were authorized to issue shares of common stock pursuant to "Awards" granted in the form of incentive stock options (intended to qualify under Section 422 of the Internal Revenue Code of 1986, as amended).  Before the ISO Plan expired, awards were granted to selected employees and directors.  No stock options have been available for grant under the ISO Plan since its expiration in March 2003.  Currently, we do not offer share-based payment programs to our employees.

The ISO Plan provided that the exercise price of any stock option not be less than the fair market value of the common stock on the date of grant.  The outstanding stock options have contractual terms of 10 years.  All options vest on a graded schedule, 20% per year for 5 years, beginning on the first anniversary date of the grant date.

A summary of the status of our stock options as of June 30, 2007 and the changes during the six months ended on those dates is presented below:

 
 
Number of Options
   
Weighted Average Exercise Prices
   
Weighted Average
Remaining Contract Life (Years)
   
Aggregate Intrinsic Value
(in thousands)
 
Outstanding at December 31, 2006
   
604,281
    $
5.76
             
Exercised
    (90,601 )   $
5.43
             
Cancelled
    (383 )   $
12.61
             
Outstanding at June 30, 2007
   
513,297
    $
5.82
     
2.60
    $
8,278
 
Exercisable at June 30, 2007
   
507,550
    $
5.74
     
2.56
    $
8,226
 

The total intrinsic value (i.e., the amount by which the fair value of the underlying common stock exceeds the exercise price of a stock option on exercise date) of stock options exercised during the six months ended June 30, 2007 and 2006 were $1.5 million and $1.1 million, respectively.

Cash received from stock option exercises for the six months ended June 30, 2007 and 2006 was $360,000 and $396,000, respectively.  The tax benefit realized for the deductions related to the stock option exercises were $21,000 and $41,000 for the six months ended June 30, 2007 and 2006, respectively.

12

9.  Accounting Pronouncements

Statements of Financial Accounting Standards

SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities, including an amendment of FASB Statement No. 115.”  SFAS 159, issued by the Financial Accounting Standards Board (“FASB”) in February 2007, allows entities to irrevocably elect fair value as the initial and subsequent measurement attribute for certain financial assets and financial liabilities that are not otherwise required to be measured at fair value, with changes in fair value recognized in earnings as they occur.  SFAS 159 also requires entities to report those financial assets and financial liabilities measured at fair value in a manner that separates those reported fair values from the carrying amounts of similar assets and liabilities measured using another measurement attribute on the face of the statement of financial position.  Lastly, SFAS 159 establishes presentation and disclosure requirements designed to improve comparability between entities that elect different measurement attributes for similar assets and liabilities.  SFAS 159 is effective for fiscal years beginning after November 15, 2007, with early adoption permitted if an entity also early adopts the provisions of SFAS 157.  We intend to adopt SFAS 159 on January 1, 2008.  We have not yet determined if, or to what extent, we will elect to use the fair value option to value our financial assets and liabilities or the impact that the implementation of SFAS 159 will have on our consolidated financial statements.

SFAS No. 157, “Fair Value Measurements.” SFAS 157 defines fair value, establishes a framework for measuring fair value in GAAP, and expands disclosures about fair value measurements. SFAS 157 is effective for us on January 1, 2008 and is not expected to have a material impact on our consolidated financial statements.

SFAS No. 155, “Accounting for Certain Hybrid Financial Instruments — an amendment of FASB Statements No. 133 and 140.” SFAS 155 amends SFAS 133, “Accounting for Derivative Instruments and Hedging Activities” and SFAS 140, “Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities.” SFAS 155 permits, but does not require, fair value accounting for hybrid financial instruments that contain an embedded derivative that would otherwise require bifurcation in accordance with SFAS 133.  SFAS 155 also eliminated the temporary exemption for interests in securitized financial assets provided for by SFAS 133, Derivatives Implementation Group (“DIG”) Issue D1, “Application of Statement 133 to Beneficial Interests in Securitized Financial Assets.” However, in January 2007, the FASB issued interpretive guidance in SFAS 133, DIG Issue B40, “Application of Paragraph 13(b) to Securitized Interests in Prepayable Financial Assets.” In DIG Issue B40, the FASB concluded that a securitized interest in prepayable financial assets was not subject to the bifurcation requirements of SFAS 155 provided that the interest met both the following criteria: (1) the right to accelerate the settlement of the securitized interest cannot be controlled by the investor; and (2) the securitized interest itself does not contain an embedded derivative for which bifurcation would be required other than an embedded derivative that results solely from the embedded call options in the underlying financial assets. The guidance in DIG Issue B40 is effective upon the adoption of SFAS 155. SFAS 155 was effective for all financial instruments acquired or issued after December 31, 2006 as well as to those hybrid financial instruments that had been previously bifurcated under SFAS 133. The adoption of SFAS 155 did not have a material impact on our consolidated financial statements.

Emerging Issues Task Force Consensuses

In September 2006, the Emerging Issues Task Force (“EITF”) reached a final consensus on Issue 06-4, “Accounting for Deferred Compensation and Postretirement Benefit Aspects of Endorsement Split-Dollar Life Insurance Arrangements.”  EITF 06-4 requires that for a split-dollar life insurance arrangement, an employer should recognize a liability for future benefits in accordance with SFAS 106, “Employers' Accounting for Postretirement Benefits Other Than Pensions.”  Under the guidance, the purchase of an endorsement type policy does not constitute a settlement since the policy does not qualify as nonparticipating because the policyholders are subject to the favorable and unfavorable experience of the insurance company.  EITF 06-4 is effective for fiscal years beginning after December 15, 2007.  We are currently assessing the impact of the adoption of EITF 06-4 on our consolidated financial statements.

In September 2006, the EITF reached a final consensus on Issue 06-5, “Accounting for Purchases of Life Insurance.”  EITF 06-5 provides guidance on FASB Technical Bulletin No. 85-4, “Accounting for Purchases of Life Insurance.”  Under the guidance, the policyholder should consider any additional amounts included in the contractual terms of the policy in determining the amount that could be realized under the insurance contract.  In addition, the policyholder should also determine the amount that could be realized under the life insurance contract assuming the surrender of an individual-life by individual-life policy.  EITF 06-5 was effective for fiscal years beginning after December 15, 2006.  The adoption of EITF 06-5 did not have a material impact on our consolidated financial statements.

13



Financial Accounting Standards Board Staff Positions and Interpretations

FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes, an interpretation of FASB Statement 109.” FASB Interpretation No. 48 (“FIN 48”) prescribes a recognition threshold and a measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. Benefits from tax positions should be recognized in the financial statements only when it is more likely than not that the tax position will be sustained upon examination by the appropriate taxing authority that would have full knowledge of all relevant information. A tax position that meets the more-likely-than-not recognition threshold is measured at the largest amount of benefit that is greater than fifty percent likely of being realized upon ultimate settlement. Tax positions that previously failed to meet the more-likely-than-not recognition threshold should be recognized in the first subsequent financial reporting period in which that threshold is met. Previously recognized tax positions that no longer meet the more-likely-than-not recognition threshold should be derecognized in the first subsequent financial reporting period in which that threshold is no longer met. Interpretation 48 also provides guidance on the accounting for and disclosure of unrecognized tax benefits, interest and penalties.

We adopted the provisions of FIN 48 on January 1, 2007. As of the date of adoption, we had no unrecognized tax benefits and thus had accrued no interest or penalties on such benefits.  At adoption, we did not anticipate a significant increase in unrecognized tax benefits during the subsequent 12 months.  As of January 1, 2007, our 2003 through 2006 tax years were open to examination by the Internal Revenue Service and state taxing jurisdictions. There were no material changes in these items during the current quarter.  While we typically do not incur significant interest or penalties on income tax liabilities, it is our policy to classify such amounts as interest expense and miscellaneous expense, respectively. We did not change our policy on classification of interest and penalties upon adoption of FIN 48.

10.  Off-Balance-Sheet Arrangements, Commitments and Contingencies

Financial Instruments with Off-Balance-Sheet-Risk. In the normal course of business, we are a party to certain financial instruments, with off-balance-sheet risk, to meet the financing needs of our customers.  These off-balance-sheet instruments include commitments to extend credit and standby letters of credit.  These instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount reflected in the financial statements.  The contract or notional amounts of these instruments reflect the extent of involvement and exposure to credit loss we have in these particular classes of financial instruments.

Commitments to extend credit are agreements to lend to a customer provided that the terms established in the contract are met.  Commitments generally have fixed expiration dates and may require payment of fees.  Since some commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements.  Standby letters of credit are conditional commitments issued to guarantee the performance of a customer to a third party.  These guarantees are primarily issued to support public and private borrowing arrangements.  The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan commitments to customers.

We had outstanding unused commitments to extend credit of $118.0 million and $99.5 million at June 30, 2007 and 2006, respectively.  Each commitment has a maturity date and the commitment expires on that date with the exception of credit card and ready reserve commitments, which have no stated maturity date.  Unused commitments for credit card and ready reserve at June 30, 2007 and 2006 were $9.3 million and $7.9 million, respectively, and are reflected in the due after one year category.  We had outstanding standby letters of credit of $3.9 million and $3.6 million at June 30, 2007 and 2006, respectively.

The scheduled maturities of unused commitments as of June 30, 2007 and 2006 were as follows (in thousands):
 
 
June 30,
 
 
 
2007
 
 
2006
 
Unused commitments:
 
 
 
 
 
 
Due in one year or less
 
$
87,271
 
 
$
57,812
 
Due after one year
 
 
30,691
 
 
 
41,697
 
Total
 
$
117,962
 
 
$
99,509
 
 
 
 
 
 
 
 
 
 
We apply the same credit policies in making commitments and standby letters of credit as we do for on-balance-sheet instruments.  We evaluate each customer's credit worthiness on a case-by-case basis.  The amount of collateral obtained, if deemed necessary, upon extension of credit is based on management's credit evaluation of the borrower.  Collateral held varies but may include cash or cash equivalents, negotiable instruments, real estate, accounts receivable, inventory and property, plant, and equipment.

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Lease Commitments. We lease certain branch facilities and office equipment under operating leases.  It is expected that certain leases will be renewed or equipment replaced with new leased equipment as these leases expire.

Securities. In the normal course of business we buy and sell securities.  There were $941,000 of unsettled trades to purchase and no unsettled trades to sell securities at June 30, 2007.  At December 31, 2006, there were no unsettled trades to purchase or sell securities.

Litigation. We are subject to litigation in the normal course of business.  Management, after consulting with our legal counsel, believes that any liability resulting from litigation will not have a material effect on our financial position and results of operations or our liquidity.


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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following is a discussion of the consolidated financial condition, changes in financial condition, and results of our operations, and should be read and reviewed in conjunction with the financial statements, and the notes thereto, in this presentation and in our Annual Report on Form 10-K/A for the year ended December 31, 2006.

We reported an increase in net income for the three months and six months ended June 30, 2007 compared to the same periods in 2006.  Net income for the three and six months ended June 30, 2007 was $4.6 million and $8.4 million, respectively, compared to $3.5 million and $6.8 million, respectively, for the same periods in 2006.

All share data has been adjusted to give retroactive recognition to stock splits and stock dividends.

Forward Looking Statements

Certain statements of other than historical fact that are contained in this document and in written material, press releases and oral statements issued by or on behalf of Southside Bancshares, Inc., a bank holding company, may be considered to be “forward-looking statements” within the meaning of and subject to the protections of the Private Securities Litigation Reform Act of 1995.  These forward-looking statements are not guarantees of future performance, nor should they be relied upon as representing management’s views as of any subsequent date.  These statements may include words such as "expect," "estimate," "project," "anticipate," “appear,” "believe," "could," "should," "may," "intend," "probability," "risk," "target," "objective," “plans,” “potential,” and similar expressions.  Forward-looking statements are statements with respect to our beliefs, plans, expectations, objectives, goals, anticipations, assumptions, estimates, intentions and future performance, and are subject to significant known and unknown risks and uncertainties, which could cause our actual results to differ materially from the results discussed in the forward-looking statements.  For example, discussions of the effect of our expansion, trends in asset quality and earnings from growth, and certain market risk disclosures are based upon information presently available to management and are dependent on choices about key model characteristics and assumptions and are subject to various limitations.  By their nature, certain of the market risk disclosures are only estimates and could be materially different from what actually occurs in the future.  As a result, actual income gains and losses could materially differ from those that have been estimated.  Other factors that could cause actual results to differ materially from forward-looking statements include, but are not limited to, the following:

 
·
general economic conditions, either globally, nationally, in the State of Texas, or in the specific markets
 
in which we operate;
 
·
legislation, regulatory changes or changes in monetary or fiscal policy that adversely affect the businesses in which we are engaged;
 
·
adverse changes in the status or financial condition of the Government Sponsored Enterprises (the “GSEs”) impacting the GSEs’ guarantees or ability to pay or issue debt;
 
·
economic or other disruptions caused by acts of terrorism in the United States, Europe or other areas;
 
·
changes in the interest rate yield curve such as flat, inverted or steep yield curves, or changes in the interest rate environment that impact interest margins and may impact prepayments on the mortgage-backed securities portfolio;
 
·
unexpected outcomes of existing or new litigation involving us;
 
·
changes impacting the leverage strategy;
 
·
significant increases in competition in the banking and financial services industry;
 
·
changes in consumer spending, borrowing and saving habits;
 
·
technological changes;
 
·
our ability to increase market share and control expenses;
 
·
the effect of changes in federal or state tax laws;
 
·
the effect of compliance with legislation or regulatory changes;
 
·
the effect of changes in accounting policies and practices;
 
·
the costs and effects of unanticipated litigation;
 
·
risks of mergers and acquisitions including the related time and cost of implementing transactions and the potential failure to achieve expected gains, revenue growth or expense savings; and
 
·
failure of assumptions underlying allowance for loan losses and other estimates.

Additional information concerning us and our business, including additional factors that could materially affect our financial results, is included in our filings with the Securities and Exchange Commission.  All written or oral forward-looking statements made by us or attributable to us are expressly qualified by this cautionary notice.  We disclaim any obligation to update any factors or to announce publicly the result of revisions to any of the forward-looking statements included herein to reflect future events or developments.

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Critical Accounting Estimates

Our accounting and reporting estimates conform with accounting principles generally accepted in the United States and general practices within the financial services industry.  The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes.  Actual results could differ from those estimates.  We consider our critical accounting policies to include the following:

Allowance for Losses on Loans.  The allowance for losses on loans represents management’s best estimate of probable losses inherent in the existing loan portfolio.  The allowance for losses on loans is increased by the provision for losses on loans charged to expense and reduced by loans charged-off, net of recoveries.  The provision for losses on loans is determined based on our assessment of several factors:  reviews and evaluations of specific loans, changes in the nature and volume of the loan portfolio, and current economic conditions and the related impact on specific borrowers and industry groups, historical loan loss experience, the level of classified and nonperforming loans and the results of regulatory examinations.

The loan loss allowance is based on the most current review of the loan portfolio.  The servicing officer has the primary responsibility for updating significant changes in a customer's financial position.  Each officer prepares status updates on any credit deemed to be experiencing repayment difficulties which, in the officer's opinion, would place the collection of principal or interest in doubt.  Our internal loan review department is responsible for an ongoing review of our loan portfolio with specific goals set for the loans to be reviewed on an annual basis.

At each review, a subjective analysis methodology is used to grade the respective loan.  Categories of grading vary in severity from loans that do not appear to have a significant probability of loss at the time of review to loans that indicate a probability that the entire balance of the loan will be uncollectible.  If full collection of the loan balance appears unlikely at the time of review, estimates or appraisals of the collateral securing the debt are used to allocate the necessary allowances.  The internal loan review department maintains a list of all loans or loan relationships that are graded as having more than the normal degree of risk associated with them.  This list for loans or loan relationships of $50,000 or more is updated on a periodic basis in order to properly allocate necessary allowance and keep management informed on the status of attempts to correct the deficiencies noted with respect to the loan.

Loans are considered impaired if, based on current information and events, it is probable that we will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement.  The measurement of impaired loans is generally based on the present value of expected future cash flows discounted at the historical effective interest rate stipulated in the loan agreement, except that all collateral-dependent loans are measured for impairment based on fair value of the collateral.  In measuring the fair value of the collateral, we use assumptions, such as discount rates, and methodologies, such as comparison to the recent selling price of similar assets, consistent with those that would be utilized by unrelated third parties performing a valuation.

Changes in the financial condition of individual borrowers, economic conditions, historical loss experience and the conditions of the various markets in which collateral may be sold may all affect the required level of the allowance for losses on loans and the associated provision for loan losses.

As of June 30, 2007, our review of the loan portfolio indicated that a loan loss allowance of $7.4 million was adequate to cover probable losses in the portfolio.

Refer to Part II, “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations - Loan Loss Experience and Allowance for Loan Losses” and “Note 1 – Summary of Significant Accounting and Reporting Policies” of the Notes to Consolidated Financial Statements in our Annual Report on Form 10-K/A for the year ended December 31, 2006 for a detailed description of our estimation process and methodology related to the allowance for loan losses.


Estimation of Fair Value. The estimation of fair value is significant to a number of our assets and liabilities.  GAAP requires disclosure of the fair value of financial instruments as a part of the notes to the consolidated financial statements.  Fair values are volatile and may be influenced by a number of factors, including market interest rates, prepayment speeds, discount rates and the shape of yield curves.

Fair values for most investment and mortgage-backed securities are based on quoted market prices, where available.  If quoted market prices are not available, fair values are based on the quoted prices of similar instruments.  The fair value of fixed rate loans is estimated by discounting the future cash flows using the current rates at which similar loans would be made to borrowers with similar credit ratings and for the same remaining
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 maturities.  Nonperforming loans are estimated using discounted cash flow analyses or underlying value of the collateral where applicable.  Fair values for fixed rate certificates of deposits are estimated using a discounted cash flow calculation that applies interest rates currently being offered for deposits of similar remaining maturities. The fair value of Federal Home Loan Bank (“FHLB”) advances is estimated by discounting the future cash flows using rates at which advances would be made to borrowers with similar credit ratings and for the same remaining maturities.  The fair values of other real estate owned (“OREO”) are typically determined based on appraisals by third parties, less estimated costs to sell, and recorded at the lower of cost or fair value.

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

Defined Benefit Pension Plan. The plan obligations and related assets of the defined benefit pension plan (the “Plan”) are presented in “Note 13 – Employee Benefits” of the Notes to Consolidated Financial Statements in our Annual Report on Form 10-K/A for the year ended December 31, 2006.  Plan assets, which consist primarily of marketable equity and debt instruments, are valued using market quotations.  Plan obligations and the annual pension expense are determined by independent actuaries and through the use of a number of assumptions.  Key assumptions in measuring the plan obligations include the discount rate, the rate of salary increases and the estimated future return on plan assets.  In determining the discount rate, we utilized a cash flow matching analysis to determine a range of appropriate discount rates for our defined benefit pension and restoration plans.  In developing the cash flow matching analysis, we constructed a portfolio of high quality non-callable bonds (rated AA- or better) to match as close as possible the timing of future benefit payments of the plans at December 31, 2006.  Based on this cash flow matching analysis, we were able to determine an appropriate discount rate.

Salary increase assumptions are based upon historical experience and our anticipated future actions.  The expected long-term rate of return assumption reflects the average return expected based on the investment strategies and asset allocation on the assets invested to provide for the Plan’s liabilities.  We considered broad equity and bond indices, long-term return projections, and actual long-term historical Plan performance when evaluating the expected long-term rate of return assumption.  At June 30, 2007, the weighted-average actuarial assumptions of the Plan were: a discount rate of 6.05%; a long-term rate of return on plan assets of 7.50%; and assumed salary increases of 4.50%.  Material changes in pension benefit costs may occur in the future due to changes in these assumptions.  Future annual amounts could be impacted by changes in the number of plan participants, changes in the level of benefits provided, changes in the discount rates, changes in the expected long-term rate of return, changes in the level of contributions to the Plan and other factors.

Off-Balance-Sheet Arrangements, Commitments and Contingencies

Details of our off-balance-sheet arrangements, commitments and contingencies as of June 30, 2007 and 2006, are included in “Note 10 – Off-Balance-Sheet Arrangements, Commitments and Contingencies” in the accompanying Notes to Financial Statements included in this report.

Leverage Strategy

We utilize wholesale funding and securities to enhance our profitability and balance sheet composition by determining acceptable levels of credit, interest rate and liquidity risk consistent with prudent capital management.  The leverage strategy consists of borrowing a combination of long and short-term funds from the FHLB and issuing brokered CDs. These funds are invested primarily in mortgage-backed securities, and to a lesser extent, long-term municipal securities.  Although mortgage-backed securities often carry lower yields than traditional mortgage loans and other types of loans we make, these securities generally increase the overall quality of our assets because of underlying insurance or guarantees, are more liquid than individual loans and may be used to collateralize our borrowings or other obligations.  While the strategy of investing a substantial portion of our assets in mortgage-backed and municipal securities has resulted in lower interest rate spreads and margins, we believe that the lower operating expenses and reduced credit risk combined with the managed interest rate risk of this strategy have enhanced our overall profitability over the last several years.  At this time, we utilize the leverage strategy with the goal of enhancing overall profitability by maximizing the use of our capital.

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Risks associated with the asset structure we maintain include a lower net interest rate spread and margin when compared to our peers, changes in the slope of the yield curve, which can reduce our net interest rate spread and margin, increased interest rate risk, the length of interest rate cycles, and the unpredictable nature of mortgage-backed securities prepayments.  See “Item 1A.  Risk Factors – Risks Related to our Business” in our Annual Report on Form 10-K/A for the year ended December 31, 2006.  During 2006, the interest rate yield curve inverted.  An inverted yield curve is defined as shorter term interest rates at a higher level than longer term interest rates.  During the quarter ended June 30, 2007, longer term interest rates increased faster than shorter term interest rates and at June 30, 2007, the U. S. Treasury yield curve was no longer inverted.  Should the yield curve invert again, our net interest margin and spread could decrease.  Our asset structure, net interest spread and net interest margin require an increase in the need to monitor our interest rate risk.  An additional risk is the change in market value of the AFS securities portfolio as a result of changes in interest rates.  Significant increases in interest rates, especially long-term interest rates, could adversely impact the market value of the AFS securities portfolio which could also significantly impact our equity capital.  Due to the unpredictable nature of mortgage-backed securities prepayments, the length of interest rate cycles, and the slope of the interest rate yield curve, net interest income could fluctuate more than simulated under the scenarios modeled by our Asset/Liability Committee (“ALCO”) and described under “Item 3.  Quantitative and Qualitative Disclosures about Market Risk” in this report.

The management of the securities portfolio as a percent of earning assets is guided by changes in our overall loan and deposit levels combined with changes in our wholesale funding levels.  If adequate quality loan growth is not available to achieve our goal of enhancing profitability by maximizing the use of capital, as described above, then we could purchase additional securities, if appropriate, which could cause securities as a percentage of earning assets to increase.  Should we determine that increasing the securities portfolio or replacing the current securities maturities and principal payments is not an efficient use of capital, we could adjust the level of securities through proceeds from maturities, principal payments on mortgage-backed securities or sales.  During the quarter ended June 30, 2007, our loan growth was less than desired but due to the yield curve, we determined a slight decrease in the securities portfolio as a percentage of total assets was appropriate.  At June 30, 2007, the securities portfolio as a percentage of total assets decreased to 50.1% from 50.7% at March 31, 2007 and 52.7% at December 31, 2006.  The current interest rate environment is more investment friendly and changes to the securities portfolio as a percent of earning assets will be guided by changes in our loan and deposit levels during the third quarter of 2007.  During the first six months of 2007, we reduced our investment and mortgage-backed securities approximately $70.5 million as investment and mortgage-backed securities excluding the net unrealized loss on available for sale securities decreased from $976.3 million at December 31, 2006 to $905.8 million at June 30, 2007.  Our strategy will be reevaluated as market conditions warrant. The leverage strategy is dynamic and requires ongoing management.  As interest rates, yield curves, mortgage-backed securities prepayments, funding costs and security spreads change, our determination of the proper types and maturities of securities to own, proper amount of securities to own and funding needs and funding sources will continue to be reevaluated.

With respect to liabilities, we will continue to utilize a combination of FHLB advances and deposits to achieve our strategy of minimizing cost while achieving overall interest rate risk objectives as well as the liability management objectives of the ALCO.  The FHLB funding and the brokered CDs represent wholesale funding sources.  Our FHLB borrowings at June 30, 2007 decreased 27.1%, or $122.4 million, to $329.2 million from $451.6 million at December 31, 2006 as a result of the decrease in the securities portfolio and an increase in deposits in excess of loan growth.  During the second quarter ended June 30, 2007, FHLB borrowings decreased $24.5 million due to an increase in deposits in excess of loan growth.  During the quarter and six months ended June 30, 2007, we did not issue any additional callable brokered CDs.  At June 30, 2007, our callable brokered CDs totaled $123.4 million.  These brokered CDs have maturities from approximately 1 to 4.5 years and have calls that we control, all of which are currently six months or less.   During the last twelve months we utilized long-term brokered CDs to a greater extent than long-term FHLB funding because the brokered CDs better matched overall ALCO objectives by protecting Southside Bank with fixed rates should interest rates increase, while providing Southside Bank options to call the funding should interest rates decrease.  Our wholesale funding policy currently allows maximum brokered CDs of $150 million; however, this amount could be increased to match changes in ALCO objectives.  The potential higher interest expense and lack of customer loyalty are risks associated with the use of brokered CDs.  Due to the non-brokered deposit growth and the decrease in FHLB borrowings during the quarter and six months ended June 30, 2007, our total wholesale funding as a percentage of deposits, not including brokered CDs, decreased to 37.3% at June 30, 2007, from 40.2% at March 31, 2007, and 49.6% at December 31, 2006, reflective of our strategy to deleverage during these periods.

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Net Interest Income

Net interest income is the difference between interest income earned on assets (loans and investments) and interest expense due on our funding sources (deposits and borrowings) during a particular period.

Net interest income for the six months ended June 30, 2007 was $20.1 million, a decrease of $1.0 million, or 4.8%, when compared to the same period in 2006.  Average interest earning assets increased $9.9 million, or 0.6%, to $1.73 billion, while the net interest spread decreased from 1.99% for the six months ended June 30, 2006 to 1.68% for the same period in 2007 and the net interest margin decreased from 2.67% for the six months ended June 30, 2006 to 2.52% for the same period in 2007.  Net interest income decreased as a result of decreases in our net interest spread and net interest margin during the six months of 2007 when compared to the same period in 2006, which more than offset the increase in our average interest earning assets.

For the three months ended June 30, 2007, when compared to the same period in 2006, net interest income decreased $476,000, or 4.5%, to $10.1 million, primarily as a result of a decrease in our net interest margin and spread and a decrease in our average earning assets.  For the three months ended June 30, 2007, when compared to the same period in 2006, average interest earning assets decreased $51.3 million, or 2.9%, to $1.69 billion, and the net interest margin and net interest spread decreased to 2.57% and 1.71%, respectively, from 2.61% and 1.90%, respectively.  The decrease in our net interest margin and net interest spread was due primarily to the increase in short-term funding costs during the three months ended June 30, 2007 when compared to the same period in 2006.  Future changes in interest rates or the yield curve could influence our net interest margin and net interest spread during future quarters.  Future changes in interest rates could also impact prepayment speeds on our mortgage-backed securities, which could influence our net interest margin and net interest spread during future quarters.

During the six months ended June 30, 2007, average loans, funded by the growth in average deposits, increased $62.3 million, or 8.8%, to $767.2 million, compared to $704.8 million for the same period in 2006.  The average yield on loans increased from 6.57% for the six months ended June 30, 2006 to 6.90% for the six months ended June 30, 2007.  For the three months ended June 30, 2007, average loans increased $53.3 million, or 7.5%, to $768.7 million, compared to $715.4 million for the same period in 2006.  The average yield on loans increased from 6.62% for the three months ended June 30, 2006 to 6.91% for the three months ended June 30, 2007.  The increase in interest income on loans of $3.3 million, or 15.0%, to $25.2 million for the six months ended June 30, 2007, when compared to $22.0 million for the same period in 2006, and the increase in interest income on loans of $1.4 million, or 12.4%, to $12.7 million for the three months ended June 30, 2007, when compared to $11.3 million for the same period in 2006 was the result of an increase in average loans and the average yield.  The rate at which loan yields are increasing has been partially impacted by repricing characteristics of the loans, interest rates at the time the loans repriced, and the competitive loan pricing environment.  Due to the competitive loan pricing environment, we anticipate that we may be required to continue to offer lower interest rate loans that compete with those offered by other financial institutions in order to retain quality loan relationships.  Offering lower interest rate loans could impact the overall loan yield and, therefore profitability.

Average investment and mortgage-backed securities decreased $45.5 million, or 4.6%, to $933.4 million, for the six months ended June 30, 2007, when compared to $978.9 million for the same period in 2006.  This decrease was the result of implementing a strategy designed to reduce our overall leverage.  The overall yield on average investment and mortgage-backed securities increased to 5.18% during the six months ended June 30, 2007, from 5.01% during the same period in 2006.  Interest income on investment and mortgage-backed securities for the six months ended June 30, 2007 decreased $251,000, or 1.1%, to $23.6 million compared to $23.8 million for the same period in 2006.  For the three months ended June 30, 2007, average investment and mortgage-backed securities decreased $94.7 million, or 9.6%, to $895.4 million, when compared to $990.0 million for the same period in 2006, which is also reflective of the strategy to reduce our balance sheet leverage during that time.  The overall yield on average investment and mortgage-backed securities increased to 5.15% during the three months ended June 30, 2007, from 5.05% during the same period in 2006.  Interest income from investment and mortgage-backed securities decreased $949,000, or 7.8%, to $11.3 million for the three months ended June 30, 2007, compared to $12.2 million for the same period in 2006.  The decrease in interest income for the three and six month periods ending June 30, 2007 was due to the decrease in the average balance which more than offset the increase in the average yield.  The increase in the average yield primarily reflects decreased prepayment rates on mortgage-backed securities, which led to decreased amortization expense, combined with reinvestment of proceeds from lower-yielding matured securities into higher yielding securities due to the overall higher interest rate environment.  The overall higher interest rate environment during 2007 when compared to 2006 contributed to a decrease in residential mortgage refinancing nationwide and in our market area.  The decrease in prepayments on mortgage loans combined with a previous restructuring of the securities portfolio reduced overall amortization expense which contributed to the increase in interest income.  A return to lower long-term interest rate levels similar to that experienced in May and June of 2003 could impact our net interest margin in the future due to increased prepayments and repricing.

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Average FHLB stock and other investments decreased $7.5 million, or 25.9%, to $21.5 million, for the six months ended June 30, 2007 when compared to $29.1 million for the same period in 2006 due to the decrease in FHLB Dallas advances.  The average yield of FHLB stock and other investments increased to 6.56% for the six months ended June 30, 2007, when compared to 4.82% for the same period in 2006 due to the higher average short-term interest rates.  Interest income from our FHLB stock and other investments increased $6,000, or 0.9%, to $700,000 for the six months ended June 30, 2007, when compared to $694,000 for the same period in 2006 due to increases in the average yield which more than offset the decrease in average balance.  For the three months ended June 30, 2007, average FHLB stock and other investments decreased $10.7 million, or 37.6%, to $17.8 million, when compared to $28.5 million for the same period in 2006.  For the three months ended June 30, 2007, interest income from FHLB stock and other investments decreased $20,000, or 5.7%, to $330,000, when compared to $350,000 for the same period in 2006 as a result of the decrease in the average balance which more than offset the increase in the average yield from 4.92% in 2006 to 7.45% in 2007.

Average federal funds sold and other interest earning assets increased $1.3 million, or 94.4%, to $2.7 million, for the six months ended June 30, 2007, when compared to $1.4 million for the same period in 2006.  Interest income from federal funds sold and other interest earning assets increased $37,000, or 115.6%, for the six months ended June 30, 2007, when compared to the same period in 2006, as a result of the increase in the average balance and yield from 4.66% in 2006 to 5.17% in 2007, which was due to the higher average short-term interest rates.  Average federal funds sold and other interest earning assets increased $1.1 million, or 82.4%, to $2.5 million, for the three months ended June 30, 2007, when compared to $1.4 million for the same period in 2006.  Interest income from federal funds sold and other interest earning assets increased $19,000, or 135.7%, for the three months ended June 30, 2007, when compared to the same period in 2006, as a result of the increase in the average balance and the average yield from 4.10% in 2006 to 5.31% in 2007.

Total interest expense increased $4.1 million, or 16.2%, to $29.5 million during the six months ended June 30, 2007 as compared to $25.4 million during the same period in 2006.  The increase was primarily attributable to an increase in the average yield on interest bearing liabilities from 3.65% for the six months ended June 30, 2006 to 4.28% for the six months ended June 30, 2007.  Average interest bearing liabilities decreased $11.3 million, or 0.8%, for the six months ended June 30, 2007 as compared to the same period in 2006.  For the three months ended June 30, 2007, total interest expense increased $931,000, or 7.0%, to $14.3 million, compared to $13.4 million for the same period in 2006 primarily as a result of an increase in the average yield on interest bearing liabilities.  Average interest bearing liabilities decreased $73.4 million, or 5.2%, while the average yield on interest bearing liabilities increased from 3.79% for the three month period ended June 30, 2006 to 4.27% for the three month period ended June 30, 2007.

Average interest bearing deposits increased $143.3 million, or 17.0%, to $985.1 million during the six months ended June 30, 2007, when compared to $841.9 million for the same period in 2006, and the average rate paid increased from 3.27% for the six month period ended June 30, 2006 to 4.01% for the same period in 2007.  For the three months ended June 30, 2007, average interest bearing deposits increased $131.0 million, or 15.1%, when compared to the same period in 2006 and the average rate paid increased from 3.43% for the three month period ended June 30, 2006 to 4.03% for the three month period ended June 30, 2007.  The largest increase in average interest bearing deposits resulted from the issuance of callable brokered CDs.  The remaining increase in our average total deposits is the result of overall bank growth and branch expansion.  Interest expense for interest bearing deposits for the three and six months ended June 30, 2007 increased $2.6 million, or 35.4%, and $5.9 million, or 43.4%, when compared to the same periods in 2006 due to the increase in the average balance and yield.

Average short-term interest bearing liabilities, consisting primarily of FHLB advances and federal funds purchased, decreased $88.3 million, or 23.9%, to $280.7 million for the six months ended June 30, 2007, when compared to $369.0 million for the same period in 2006.  Interest expense associated with short-term interest bearing liabilities decreased $865,000, or 11.4%, and the average rate paid increased 68 basis points to 4.83% for the six month period ended June 30, 2007 when compared to 4.15% for the same period in 2006.  For the three months ended June 30, 2007, average short-term interest bearing liabilities decreased $146.7 million, or 38.8%, when compared to the same period in 2006.  Interest expense associated with short-term interest bearing liabilities decreased $1.3 million, or 31.2%, while the average rate paid increased 52 basis points to 4.80% for the three month period ended June 30, 2007 when compared to 4.28% for the same period in 2006.  The decrease in the interest expense for the three and six month periods ended June 30, 2007 when compared to 2006 was due to the decrease in the average balance for short-term interest bearing liabilities which more than offset the increase in the average yield.

21



Average long-term interest bearing liabilities consisting of FHLB advances decreased $66.2 million, or 39.0%, during the six months ended June 30, 2007 to $103.5 million as compared to $169.7 million for the six month period ending June 30, 2006.  The decrease in the average long-term FHLB advances occurred primarily as a result of long-term FHLB advances moving into the short-term FHLB advances category combined with the increase in the use of brokered CDs to better match ALCO objectives.  Interest expense associated with long-term FHLB advances decreased $1.0 million, or 30.7%, while the average rate paid increased 55 basis points to 4.52% for the six months ended June 30, 2007 when compared to 3.97% for the same period in 2006.  For the three months ended June 30, 2007, long-term interest bearing liabilities decreased $57.7 million, or 38.0%, when compared to the same period in 2006.  Interest expense associated with long-term FHLB advances decreased $448,000, or 29.2%, and the average rate paid increased 58 basis points to 4.63% for the three month period ended June 30, 2007 when compared to 4.05% for the same period in 2006.  The decrease in interest expense was due to the decrease in the average balance of long-term interest bearing liabilities more than offsetting the increase in the average rate paid.  FHLB advances are collateralized by FHLB stock, securities and nonspecific real estate loans.

Average long-term debt, consisting entirely of our junior subordinated debentures issued in 2003 in connection with the issuance of trust preferred securities by our subsidiary Southside Statutory Trust III, was $20.6 million for the three and six months ended June 30, 2007 and 2006.  Interest expense increased $62,000, or 7.8%, to $860,000 for the six months ended June 30, 2007 when compared to $798,000 for the same period in 2006 as a result of the increase in three-month LIBOR due to higher short-term interest rates during 2007 when compared to 2006.  Interest expense increased $19,000, or 4.6%, to $432,000 for the three months ended June 30, 2007 when compared to $413,000 for the same period in 2006.  The long-term debt adjusts quarterly at a rate equal to three-month LIBOR plus 294 basis points.


22


RESULTS OF OPERATIONS

The analysis below shows average interest earning assets and interest bearing liabilities together with the average yield on the interest earning assets and the average cost of the interest bearing liabilities.

   
AVERAGE BALANCES AND YIELDS
 
   
(dollars in thousands)
 
   
(unaudited)
 
 
 
Six Months Ended
 
   
June 30, 2007
   
June 30, 2006
 
   
AVG BALANCE
   
INTEREST
   
AVG YIELD
   
AVG BALANCE
   
INTEREST
   
AVG YIELD
 
ASSETS
 
 
   
 
   
 
   
 
   
 
   
 
 
INTEREST EARNING ASSETS:
 
 
   
 
   
 
   
 
   
 
   
 
 
Loans(1) (2)
  $
767,168
    $
26,259
      6.90 %   $
704,827
    $
22,952
      6.57 %
Loans Held For Sale
   
3,884
     
96
      4.98 %    
4,645
     
117
      5.08 %
Securities:
                                               
Investment Securities (Taxable)(4)
   
59,374
     
1,452
      4.93 %    
59,593
     
1,337
      4.52 %
Investment Securities (Tax-Exempt)(3)(4)
   
40,893
     
1,449
      7.15 %    
44,994
     
1,591
      7.13 %
Mortgage-backed and
Related Securities (4)
   
833,161
     
21,097
      5.11 %    
874,318
     
21,386
      4.93 %
Total Securities
   
933,428
     
23,998
      5.18 %    
978,905
     
24,314
      5.01 %
Federal Home Loan Bank stock and other investments, at cost
   
21,517
     
700
      6.56 %    
29,056
     
694
      4.82 %
Interest Earning Deposits
   
551
     
17
      6.22 %    
691
     
17
      4.96 %
Federal Funds Sold
   
2,140
     
52
      4.90 %    
693
     
15
      4.36 %
Total Interest Earning Assets
   
1,728,688
     
51,122
      5.96 %    
1,718,817
     
48,109
      5.64 %
NONINTEREST EARNING ASSETS:
                                               
Cash and Due From Banks
   
42,669
                     
45,926
                 
Bank Premises and Equipment
   
33,952
                     
33,534
                 
Other Assets
   
43,359
                     
41,854
                 
Less:  Allowance for Loan Loss
    (7,298 )                     (7,139 )                
Total Assets
  $
1,841,370
                    $
1,832,992
                 
LIABILITIES AND SHAREHOLDERS’ EQUITY
                                               
INTEREST BEARING LIABILITIES:
                                               
Savings Deposits
  $
51,815
     
334
      1.30 %   $
50,663
     
312
      1.24 %
Time Deposits
   
540,684
     
13,072
      4.88 %    
433,362
     
8,827
      4.11 %
Interest Bearing Demand Deposits
   
392,614
     
6,184
      3.18 %    
357,837
     
4,519
      2.55 %
Total Interest Bearing Deposits
   
985,113
     
19,590
      4.01 %    
841,862
     
13,658
      3.27 %
Short-term Interest Bearing Liabilities
   
280,657
     
6,722
      4.83 %    
368,963
     
7,587
      4.15 %
Long-term Interest Bearing Liabilities – FHLB Dallas
   
103,515
     
2,318
      4.52 %    
169,749
     
3,345
      3.97 %
Long-term Debt (5)
   
20,619
     
860
      8.30 %    
20,619
     
798
      7.70 %
Total Interest Bearing Liabilities
   
1,389,904
     
29,490
      4.28 %    
1,401,193
     
25,388
      3.65 %
NONINTEREST BEARING LIABILITIES:
                                               
Demand Deposits
   
318,189
                     
311,844
                 
Other Liabilities
   
18,692
                     
11,014
                 
Total Liabilities
   
1,726,785
                     
1,724,051
                 
SHAREHOLDERS’ EQUITY
   
114,585
                     
108,941
                 
Total Liabilities and Shareholders’ Equity
  $
1,841,370
                    $
1,832,992
                 
NET INTEREST INCOME
          $
21,632
                    $
22,721
         
NET YIELD ON AVERAGE EARNING ASSETS
                    2.52 %                     2.67 %
NET INTEREST SPREAD
                    1.68 %                     1.99 %

(1)  Interest on loans includes fees on loans that are not material in amount.
(2)  Interest income includes taxable-equivalent adjustments of $1,108 and $1,113 for the six months ended June 30, 2007 and 2006, respectively.
(3)  Interest income includes taxable-equivalent adjustments of $437 and $502 for the six months ended June 30, 2007 and 2006, respectively.
(4)  For the purpose of calculating the average yield, the average balance of securities is presented at historical cost.
(5)  Represents junior subordinated debentures issued by Southside Bancshares, Inc. to Southside Statutory Trust III in connection with the
       issuance by Southside Statutory Trust III of $20 million of trust preferred securities.
 
 
Note: As of June 30, 2007 and 2006, loans totaling $1,637 and $1,424, respectively, were on nonaccrual status.  The policy is to reverse previously accrued but unpaid interest on nonaccrual loans; thereafter, interest income is recorded to the extent received when appropriate.
 

23



   
AVERAGE BALANCES AND YIELDS
 
   
(dollars in thousands)
 
   
(unaudited)
 
 
 
Three Months Ended
 
   
June 30, 2007
   
June 30, 2006
 
   
AVG BALANCE
   
INTEREST
   
AVG YIELD
   
AVG BALANCE
   
INTEREST
   
AVG YIELD
 
ASSETS
 
 
   
 
   
 
   
 
   
 
   
 
 
INTEREST EARNING ASSETS:
 
 
   
 
   
 
   
 
   
 
   
 
 
Loans(1) (2)
  $
768,744
    $
13,238
      6.91 %   $
715,423
    $
11,816
      6.62 %
Loans Held For Sale
   
4,458
     
55
      4.95 %    
4,826
     
64
      5.32 %
Securities:
                                               
Investment Securities (Taxable)(4)
   
50,584
     
616
      4.88 %    
51,840
     
594
      4.60 %
Investment Securities (Tax-Exempt)(3)(4)
   
40,747
     
726
      7.15 %    
40,557
     
720
      7.12 %
Mortgage-backed and
Related Securities (4)
   
804,026
     
10,163
      5.07 %    
897,645
     
11,149
      4.98 %
Total Securities
   
895,357
     
11,505
      5.15 %    
990,042
     
12,463
      5.05 %
Federal Home Loan Bank stock and other investments, at cost
   
17,778
     
330
      7.45 %    
28,507
     
350
      4.92 %
Interest Earning Deposits
   
550
     
10
      7.29 %    
825
     
8
      3.89 %
Federal Funds Sold
   
1,945
     
23
      4.74 %    
543
     
6
      4.43 %
Total Interest Earning Assets
   
1,688,832
     
25,161
      5.98 %    
1,740,166
     
24,707
      5.69 %
NONINTEREST EARNING ASSETS:
                                               
Cash and Due From Banks
   
40,259
                     
43,345
                 
Bank Premises and Equipment
   
35,342
                     
33,549
                 
Other Assets
   
42,910
                     
39,442
                 
Less:  Allowance for Loan Loss
    (7,360 )                     (7,200 )                
Total Assets
  $
1,799,983
                    $
1,849,302
                 
LIABILITIES AND SHAREHOLDERS’ EQUITY
                                               
INTEREST BEARING LIABILITIES:
                                               
Savings Deposits
  $
52,454
     
170
      1.30 %   $
51,402
     
165
      1.29 %
Time Deposits
   
548,969
     
6,711
      4.90 %    
460,139
     
4,897
      4.27 %
Interest Bearing Demand Deposits
   
395,653
     
3,144
      3.19 %    
354,549
     
2,342
      2.65 %
Total Interest Bearing Deposits
   
997,076
     
10,025
      4.03 %    
866,090
     
7,404
      3.43 %
Short-term Interest Bearing Liabilities
   
231,818
     
2,776
      4.80 %    
378,536
     
4,037
      4.28 %
Long-term Interest Bearing Liabilities – FHLB Dallas
   
94,082
     
1,086
      4.63 %    
151,794
     
1,534
      4.05 %
Long-term Debt (5)
   
20,619
     
432
      8.29 %    
20,619
     
413
      7.92 %
Total Interest Bearing Liabilities
   
1,343,595
     
14,319
      4.27 %    
1,417,039
     
13,388
      3.79 %
NONINTEREST BEARING LIABILITIES:
                                               
Demand Deposits
   
320,966
                     
313,422
                 
Other Liabilities
   
18,927
                     
11,958
                 
Total Liabilities
   
1,683,488
                     
1,742,419
                 
SHAREHOLDERS’ EQUITY
   
116,495
                     
106,883
                 
Total Liabilities and Shareholders’ Equity
  $
1,799,983
                    $
1,849,302
                 
NET INTEREST INCOME
          $
10,842
                    $
11,319
         
NET YIELD ON AVERAGE EARNING ASSETS
                    2.57 %                     2.61 %
NET INTEREST SPREAD
                    1.71 %                     1.90 %

(1)  Interest on loans includes fees on loans that are not material in amount.
(2)  Interest income includes taxable-equivalent adjustments of $560 and $552 for the three months ended June 30, 2007 and 2006, respectively.
(3)  Interest income includes taxable-equivalent adjustments of $221 and $230 for the three months ended June 30, 2007 and 2006, respectively.
(4)  For the purpose of calculating the average yield, the average balance of securities is presented at historical cost.
(5)  Represents junior subordinated debentures issued by Southside Bancshares, Inc. to Southside Statutory Trust III in connection with the
       issuance by Southside Statutory Trust III of $20 million of trust preferred securities.
 
 
Note: As of June 30, 2007 and 2006, loans totaling $1,637 and $1,424, respectively, were on nonaccrual status.  The policy is to reverse previously accrued but unpaid interest on nonaccrual loans; thereafter, interest income is recorded to the extent received when appropriate.


24



Noninterest Income
 
 
We earn noninterest income from a variety of sources which include deposit related fees such as ATM, overdraft, and check processing fees.  In addition, we earn income from the sale of loans and securities, trust services, bank owned life insurance (“BOLI”), brokerage services, and other fee generating programs that we either provide or participate in.

Noninterest income was $12.8 million for the six months ended June 30, 2007 compared to $11.1 million for the same period in 2006, an increase of $1.7 million, or 15.7%.  For the three months ended June 30, 2007, noninterest income was $6.7 million, compared to $6.0 million for the same period in 2006, an increase of $695,000, or 11.6%.  During the six months ended June 30, 2007, we had gains on the sale of AFS securities of $435,000 compared to gains of $224,000 for the same period in 2006.  Gains on the sale of AFS securities for the three months ended June 30, 2007 were $6,000 compared to $101,000 for the same period in 2006.  The market value of the AFS securities portfolio at June 30, 2007 was $687.9 million with a net unrealized loss on that date of $9.3 million.  The net unrealized loss is comprised of $11.6 million in unrealized losses and $2.3 million in unrealized gains.  The market value of the HTM securities portfolio at June 30, 2007 was $204.6 million with a net unrealized loss on that date of $4.0 million.  The net unrealized loss is comprised of $4.1 million in unrealized losses and $58,000 in unrealized gains.  During the six months ended June 30, 2007 we sold securities out of our AFS portfolio as a result of the inverted yield curve, low volatility and tight credit spreads with the primary objective of decreasing the overall securities portfolio.  

Deposit services income increased $323,000, or 8.2%, and $782,000, or 10.5%, for the three and six months ended June 30, 2007, respectively, when compared to the same periods in 2006, primarily as a result of increases in overdraft income, increased numbers of deposit accounts and an increase in debit card income.

Trust income increased $173,000, or 42.9%, and $233,000, or 28.9%, for the three and six months ended June 30, 2007, respectively, when compared to the same periods in 2006 due to growth experienced in our trust department.

Gain on sale of loans increased $255,000, or 54.4%, and $227,000, or 27.0%, for the three and six months ended June 30, 2007, respectively, when compared to the same periods in 2006.  The increase was due to an increase in premiums on student loans sold when compared to the same period in 2006.  

Other noninterest income increased $36,000, or 4.6%, and $259,000, or 20.4%, for the three and six months ended June 30, 2007, respectively, when compared to the same periods in 2006.  The increases for the three and six month periods ended June 30, 2007 were primarily a result of increases in brokerage services income, credit card fee income, and Mastercard income which was offset by decreases in other recoveries, including a recovery of a loss from 2005 on a check of $150,000 received during the second quarter of 2006.

Noninterest Expense

We incur numerous types of noninterest expenses associated with the operation of our various business activities, the largest of which are salaries and employee benefits.  In addition, we incur numerous other expenses, the largest of which are detailed in the consolidated statements of income.

Noninterest expense was $11.5 million and $22.7 million for the three and six months ended June 30, 2007, respectively, compared to $11.6 million and $23.0 million for the same periods in 2006, respectively, representing decreases of $107,000, or 0.9%, and $305,000, or 1.3%, respectively.

Salaries and employee benefits expense decreased $12,000, or 0.2%, and $328,000, or 2.2%, during the three and six months ended June 30, 2007, respectively, when compared to the same periods in 2006.  Direct salary expense and payroll taxes decreased $83,000, or 1.4%, and $198,000, or 1.6%, for the three and six months ended June 30, 2007, respectively, when compared to the same periods in 2006.  These decreases were the result of department managers completing an evaluation of work flow in their respective departments during the third quarter of 2006, with the primary objective of identifying any opportunities to increase productivity primarily through the use of technology investments with less personnel expense.  In certain departments the evaluations identified the ability to utilize part-time employees to better staff for peak customer transaction times in lieu of full-time employees.  In addition, management is utilizing productivity gains to not fill certain vacancies created by normal attrition.  The combination of these initiatives resulted in salary and employee benefit expense savings and improved productivity gains.  

25



Retirement expense, included in salary and benefits, decreased $166,000, or 26.5%, and $303,000, or 24.2%, for the three and six months ended June 30, 2007, respectively, when compared to the same periods in 2006, primarily as a result of the amendments to the Plan and the changes in the actuarial assumptions used to determine net periodic pension costs for 2007 when compared to 2006.  Specifically, the assumed long-term rate of return was reduced to 7.50% and the assumed discount rate was increased to 6.05%.  We will continue to evaluate the assumed long-term rate of return and the discount rate to determine if either should be changed in the future.  If either of these assumptions were decreased, the cost and funding required for the retirement plan could increase.  

Health and life insurance expense, included in salary and benefits, increased $238,000, or 38.2%, and $174,000, or 13.8%, for the three and six months ended June 30, 2007, respectively, when compared to the same periods in 2006 due to increased health claims expense.  We have a self-insured health plan that is supplemented with stop loss insurance policies.  Health insurance costs are rising nationwide and these costs may continue to increase during the remainder of 2007.

ATM and debit card expense decreased $33,000, or 12.0%, for the three months ended June 30, 2007, and increased $51,000, or 11.5%, for the six months ended June 30, 2007, respectively, compared to the same periods in 2006.  The decrease for the three months ended June 30, 2007 as compared to the same period in 2006 was the result of the implementation of the new billing system from our service provider during the second quarter of 2006.  The increase for the six months ended June 30, 2007 as compared to the same period in 2006, was primarily due to an increase in combined use of ATM and debit cards and point of sale activity.

Director fees decreased $26,000, or 15.6%, and $44,000, or 14.1%, for the three and six months ended June 30, 2007, respectively, compared to the same periods in 2006 due to a decrease in the number of directors.

Professional fees decreased $78,000, or 24.5%, and $82,000, or 13.0%, for the three and six months ended June 30, 2007, respectively, compared to the same periods in 2006.  The decrease occurred primarily due to a decrease in legal fees associated with legal matters and litigation resulting from the normal course of business.

Other expense increased $37,000, or 3.4%, and $114,000, or 5.3%, for the three and six months ended June 30, 2007, respectively, compared to the same periods in 2006.  The increase occurred primarily due to increases in bank exam fees, bank analysis fees, brokerage services expense and student loan origination and lender fee expense.

Income Taxes

Pre-tax income for the three and six months ended June 30, 2007 was $5.1 million and $9.9 million, respectively, compared to $4.5 million and $8.4 million, respectively, for the same periods in 2006.

Income tax expense was $463,000 and $1.5 million for the three and six months ended June 30, 2007, respectively, compared to $950,000 and $1.7 million for the three and six months ended June 30, 2006, respectively.  The effective tax rate as a percentage of pre-tax income was 9.2% and 15.3% for the three and six months ended June 30, 2007, respectively, compared to 21.1% and 19.8% for the three and six months ended June 30, 2006, respectively.  

The decrease in the effective tax rate and income tax expense for 2007 was due to a one-time state tax credit resulting from a change in Texas tax law during the quarter ended June 30, 2007, related to the new margin tax.  The state tax credit was $770,000, which was partially offset by an increase in our estimated margin tax of $109,000, net of tax.  Excluding the effect of the state tax credit and estimated margin tax, the effective tax rate for the three and six months ended June 30, 2007, would have been 22.3% and 22.0%, respectively.

Our current estimated alternative minimum tax position has been reduced to less than $100,000.  We believe the remaining alternative minimum tax position is reversible in the future and no valuation allowance against the related deferred tax asset is deemed necessary at this time.  We continue to review the appropriate level of tax-free income so as to minimize any alternative minimum tax position in the future.

26



Capital Resources

Our total shareholders' equity at June 30, 2007, was $115.5 million, representing an increase of $4.9  million from December 31, 2006, and represented 6.3% of total assets at June 30, 2007 compared to 5.8% of total assets at December 31, 2006.  

Increases to shareholders’ equity consisted of net income of $8.4 million and the issuance of $925,000 in common stock (108,634 shares) through our incentive stock option and dividend reinvestment plans, which more than offset an increase in accumulated other comprehensive loss of $1.4 million, and $2.9 million in dividends paid.

Under the Federal Reserve Board's risk-based capital guidelines for bank holding companies, the minimum ratio of total capital to risk-adjusted assets (including certain off-balance sheet items, such as standby letters of credit) is currently 8%.  The minimum Tier 1 capital to risk-adjusted assets is 4%.  Our $20 million of trust preferred securities issued by our subsidiary, Southside Statutory Trust III, is considered Tier 1 capital by the Federal Reserve Board.  The Federal Reserve Board also requires bank holding companies to comply with the minimum leverage ratio guidelines.  The leverage ratio is the ratio of bank holding company's Tier 1 capital to its total consolidated quarterly average assets, less goodwill and certain other intangible assets.  The guidelines require a minimum leverage ratio of 4% for bank holding companies that meet certain specified criteria.  Failure to meet minimum capital regulations can initiate certain mandatory and possibly additional discretionary actions by regulators, which could have a material adverse effect on our financial condition and results of operations.  Management believes that, as of June 30, 2007, we met all capital adequacy requirements to which we were subject.  

The Federal Deposit Insurance Act requires bank regulatory agencies to take "prompt corrective action" with respect to FDIC-insured depository institutions that do not meet minimum capital requirements.  A depository institution's treatment for purposes of the prompt corrective action provisions will depend on how its capital levels compare to various capital measures and certain other factors, as established by regulation.  Prompt corrective action and other discretionary actions could have a material effect on our financial condition and results of operation.

It is management's intention to maintain our capital at a level acceptable to all regulatory authorities and future dividend payments will be determined accordingly.  Regulatory authorities require that any dividend payments made by either us or Southside Bank not exceed earnings for that year.  Shareholders should not anticipate a continuation of the cash dividend simply because of the existence of a dividend reinvestment program.  The payment of dividends is at the discretion of our board of directors and will depend upon future earnings, our financial condition, and other related factors.

27



To be categorized as well capitalized, we must maintain minimum Total risk-based, Tier 1 risk-based, and Tier 1 leverage ratios as set forth in the following table:

 
 
Actual
   
For Capital
Adequacy Purposes
   
To Be Well Capitalized Under Prompt Corrective Actions Provisions
 
 
 
Amount
   
Ratio
   
Amount
   
Ratio
   
Amount
   
Ratio
 
As of June 30, 2007:
 
(dollars in thousands)
 
                                     
Total Capital (to Risk Weighted Assets)
 
 
   
 
   
 
   
 
   
 
   
 
 
Consolidated
  $
158,503
      18.54 %   $
68,387
      8.00 %  
N/A
   
N/A
 
Bank Only
  $
151,064
      17.67 %   $
68,385
      8.00 %   $
85,481
      10.00 %
                                                 
Tier 1 Capital (to Risk Weighted Assets)
                                               
Consolidated
  $
151,136
      17.68 %   $
34,193
      4.00 %  
N/A
   
N/A
 
Bank Only
  $
143,697
      16.81 %   $
34,193
      4.00 %   $
51,289
      6.00 %
                                                 
Tier 1 Capital (to Average Assets) (1)
                                               
Consolidated
  $
151,136
      8.41 %   $
71,924
      4.00 %  
N/A
   
N/A
 
Bank Only
  $
143,697
      7.99 %   $
71,896
      4.00 %   $
89,870
      5.00 %
                                                 
As of June 30, 2006:
                                               
                                                 
Total Capital (to Risk Weighted Assets)
                                               
Consolidated
  $
145,506
      17.60 %   $
66,141
      8.00 %  
N/A
   
N/A
 
Bank Only
  $
140,251
      16.98 %   $
66,090
      8.00 %   $
82,612
      10.00 %
                                                 
Tier 1 Capital (to Risk Weighted Assets)
                                               
Consolidated
  $
138,160
      16.71 %   $
33,070
      4.00 %  
N/A
   
N/A
 
Bank Only
  $
132,905
      16.09 %   $
33,045
      4.00 %   $
49,567
      6.00 %
                                                 
Tier 1 Capital (to Average Assets) (1)
                                               
Consolidated
  $
138,160
      7.44 %   $
74,290
      4.00 %  
N/A
   
N/A
 
Bank Only
  $
132,905
      7.16 %   $
74,262
      4.00 %   $
92,827
      5.00 %

(1) Refers to quarterly average assets as calculated by bank regulatory agencies.

Liquidity and Interest Rate Sensitivity

Liquidity management involves our ability to convert assets to cash with a minimum of loss to enable us to meet our obligations to our customers at any time.  This means addressing: (1) the immediate cash withdrawal requirements of depositors and other funds providers; (2) the funding requirements of all lines and letters of credit; and (3) the short-term credit needs of customers.  Liquidity is provided by short-term investments that can be readily liquidated with a minimum risk of loss.  Cash, interest earning deposits, federal funds sold and short-term investments with maturities or repricing characteristics of one year or less continue to be a substantial percentage of total assets.  At June 30, 2007, these investments were 14.7% of total assets compared to 15.2% at June 30, 2006.  Liquidity is further provided through the matching, by time period, of rate sensitive interest earning assets with rate sensitive interest bearing liabilities.  We have three lines of credit for the purchase of overnight federal funds at prevailing rates.  Two $15.0 million and one $10.0 million unsecured lines of credit have been established with Bank of America, Frost Bank and TIB - The Independent BankersBank, respectively.  At June 30, 2007, the amount of additional funding we could obtain from FHLB using our unpledged securities at FHLB was approximately $440.0 million, net of FHLB stock purchases required.  We have obtained a $12.0 million letter of credit from FHLB as collateral for a portion of our public fund deposits.

28

Interest rate sensitivity management seeks to avoid fluctuating net interest margins and to enhance consistent growth of new interest income through periods of changing interest rates.  The ALCO closely monitors various liquidity ratios, interest rate spreads and margins, interest rate simulation tests utilizing various interest rate scenarios including immediate shocks and market value of portfolio equity (“MVPE”) with interest rates immediately shocked plus and minus 200 basis points to assist in determining our overall interest rate risk and adequacy of the liquidity position.  In addition, the ALCO utilizes a simulation model to determine the impact of net interest income of several different interest rate scenarios.  By utilizing this technology, we can determine changes that need to be made to the asset and liability mixes to minimize the change in net interest income under these various interest rate scenarios.

Composition of Loans

One of our main objectives is to seek attractive lending opportunities in Texas, primarily in the counties in which we operate.  Substantially all of our loans are made to borrowers who live in and conduct business in the counties in Texas in which we operate, with the exception of municipal loans.  Municipal loans are made to municipalities, school districts and colleges primarily throughout the state of Texas.  We look forward to the possibility that our loan growth will continue to accelerate in the future as we work to identify and develop additional markets and strategies to expand our lending territory.

The following table sets forth loan totals by category for the periods presented (in thousands):

 
 
At
   
At
   
At
 
 
 
June 30,
   
December 31,
   
June 30,
 
 
 
2007
   
2006
   
2006
 
 
 
 
         
 
 
Real Estate Loans:
 
 
   
 
   
 
 
   Construction
  $
46,876
    $
39,588
    $
33,084
 
   1-4 Family Residential
   
223,996
     
227,354
     
222,332
 
   Other
   
177,918
     
181,047
     
173,776
 
Commercial Loans
   
125,609
     
118,962
     
104,623
 
Municipal Loans
   
110,416
     
106,155
     
105,316
 
Loans to Individuals
   
83,924
     
86,041
     
84,793
 
Total Loans
  $
768,739
    $
759,147
    $
723,924
 

Construction loans increased $7.3 million, or 18.4%, to $46.9 million for the six month period ended June 30, 2007 from $39.6 million at December 31, 2006, and $13.8 million, or 41.7%, from $33.1 million at June 30, 2006. Commercial loans increased $6.6 million, or 5.6%, to $125.6 million for the six month period ended June 30, 2007 from $119.0 million at December 31, 2006, and $21.0 million, or 20.1%, from $104.6 million at June 30, 2006.  Municipal loans increased $4.3 million, or 4.0%, to $110.4 million for the six month period ended June 30, 2007 from $106.2 million at December 31, 2006, and $5.1 million, or 4.8%, from $105.3 million at June 30, 2006.

Our 1-4 family residential mortgage loans decreased $3.4 million, or 1.5%, to $224.0 million for the six month period ended June 30, 2007 from $227.4 million at December 31, 2006, and increased $1.7 million, or 0.7%, from $222.3 million at June 30, 2006.  Commercial real estate loans decreased $3.1 million, or 1.7% to $177.9 million for the six month period ended June 30, 2007 from $181.0 million at December 31, 2006, and increased $4.1 million, or 2.4%, from $173.8 million at June 30, 2006.  Loans to individuals decreased $2.1 million, or 2.5% to $83.9 million for the six month period ended June 30, 2007 from $86.0 million at December 31, 2006, and $869,000, or 1.0%, from $84.8 million at June 30, 2006.  


29



Loan Loss Experience and Allowance for Loan Losses

The loan loss allowance is based on the most current review of the loan portfolio.  Several methods are used to maintain the review in the most current manner.  First, the servicing officer has the primary responsibility for updating significant changes in a customer's financial position.  Accordingly, each officer prepares status updates on any credit deemed to be experiencing repayment difficulties that, in the officer's opinion, would place the collection of principal or interest in doubt.  Second, our internal loan review department is responsible for an ongoing review of our loan portfolio with specific goals set for the loans to be reviewed on an annual basis.

At each review, a subjective analysis methodology is used to grade the respective loan.  Categories of grading vary in severity from loans that do not appear to have a significant probability of loss at the time of review to loans that indicate a probability that the entire balance of the loan will be uncollectible.  If full collection of the loan balance appears unlikely at the time of review, estimates or appraisals of the collateral securing the debt are used to allocate the necessary allowances.  The internal loan review department maintains a list of all loans or loan relationships that are graded as having more than the normal degree of risk associated with them.  This list for loan and loan relationships of $50,000 or more is updated on a periodic basis in order to properly allocate necessary allowances and keep management informed on the status of attempts to correct the deficiencies noted with respect to the loan.

Industry experience shows that a portion of our loans will become delinquent and a portion of the loans will require partial or entire charge-off.  Regardless of the underwriting criteria utilized, losses may be experienced as a result of various factors beyond our control, including, among other things, changes in market conditions affecting the value of properties used as collateral for loans and problems affecting the credit of the borrower and the ability of the borrower to make payments on the loan.  Our determination of the adequacy of allowance for loan losses is based on various considerations, including an analysis of the risk characteristics of various classifications of loans, previous loan loss experience, specific loans that would have loan loss potential, delinquency trends, estimated fair value of the underlying collateral, current economic conditions, the views of the bank regulators (who have the authority to require additional allowances), and geographic and industry loan concentration.

As of June 30, 2007, our review of the loan portfolio indicated that a loan loss allowance of $7.4 million was adequate to cover probable losses in the portfolio.

For the three and six months ended June 30, 2007, loan charge-offs were $616,000 and $1.2 million and recoveries were $505,000 and $1.0 million, resulting in net charge-offs of $111,000 and $160,000, respectively.  For the three and six months ended June 30, 2006, loan charge-offs were $744,000 and $1.4 million and recoveries were $449,000 and $974,000, resulting in net charge-offs of $295,000 and $473,000, respectively.  The necessary provision expense was estimated at $217,000 and $334,000 for the three and six months ended June 30, 2007, respectively.

Nonperforming Assets

Nonperforming assets consist of delinquent loans 90 days or more past due, nonaccrual loans, OREO, repossessed assets and restructured loans.  Nonaccrual loans are those loans which are 90 days or more delinquent and collection in full of both the principal and interest is in doubt.  Additionally, some loans that are not delinquent may be placed on nonaccrual status due to doubts about full collection of principal or interest.  When a loan is categorized as nonaccrual, the accrual of interest is discontinued and the accrued balance is reversed for financial statement purposes.  Restructured loans represent loans that have been renegotiated to provide a reduction or deferral of interest or principal because of deterioration in the financial position of the borrowers.  Categorization of a loan as nonperforming is not in itself a reliable indicator of potential loan loss.  Other factors, such as the value of collateral securing the loan and the financial condition of the borrower must be considered in judgments as to potential loan loss.  OREO represents real estate taken in full or partial satisfaction of debts previously contracted.  The dollar amount of OREO is based on a current valuation of the OREO at the time it is recorded on our books, net of estimated selling costs.  Updated valuations are obtained as needed and any additional impairments are recognized.


30



The following table sets forth nonperforming assets for the periods presented (in thousands):
 

 
 
At
 
 
At
 
 
At
 
 
 
June 30,
 
 
December 31,
 
 
June 30,
 
 
 
2007
 
 
2006
 
 
2006
 
 
 
 
 
 
 
 
 
 
 
 
Nonaccrual loans
 
$
1,637
 
 
$
1,333
 
 
$
1,424
 
Loans 90 days past due
 
 
408
 
 
 
128
 
 
 
692
 
Restructured loans
 
 
179
 
 
 
220
 
 
 
239
 
Other real estate owned
 
 
23
 
 
 
351
 
 
 
841
 
Repossessed assets
   
77
     
78
     
41
 
Total Nonperforming Assets
 
$
2,324
   
$
2,110
   
$
3,237
 

Total nonperforming assets at June 30, 2007 were $2.3 million, an increase of $214,000, or 10.1%, from $2.1 million at December 31, 2006 and a decrease of $913,000, or 28.2%, from $3.2 million at June 30, 2006.  From December 31, 2006 to June 30, 2007, nonaccrual loans increased $304,000, or 22.8%, to $1.6 million and from June 30, 2006, increased $213,000, or 15.0%.  Of the total at June 30, 2007, 18.0% are residential real estate loans, 46.3% are commercial real estate loans, 11.1% are commercial loans, 23.8% are loans to individuals and 0.8% are construction loans.  OREO decreased $328,000, or 93.4%, to $23,000 at June 30, 2007 from $351,000 at December 31, 2006 and decreased $818,000, or 97.3%, from $841,000 at June 30, 2006.  The primary decrease in OREO resulted from the sale of one residential dwelling during the first quarter of 2007, which comprised approximately 90% of OREO at December 31, 2006.  Total OREO at June 30, 2007 consist of one residential dwelling.  We actively market all properties and none are held for investment purposes.  Loans 90 days or more past due increased $280,000, or 218.8%, to $408,000 at June 30, 2007 from $128,000 at December 31, 2006 and decreased $284,000, or 41.0%, from $692,000 at June 30, 2006.  Repossessed assets decreased $1,000, or 1.3%, to $77,000 at June 30, 2007 from $78,000 at December 31, 2006 and increased $36,000, or 87.8%, from $41,000 at June 30, 2006.  Approximately $51,000 of the repossessed assets at June 30, 2007 represented two loans with an SBA guarantee of 85.0%.  Restructured loans decreased $41,000, or 18.6%, to $179,000 at June 30, 2007 from $220,000 at December 31, 2006 and decreased $60,000, or 25.1%, from $239,000 at June 30, 2006.

Expansion

We opened our sixth full service grocery store branch in our largest market area, the city of Tyler, in Smith County in July 2007.

On May 17, 2007, we announced that we had entered into a definitive agreement with Fort Worth Bancshares, Inc., the bank holding company of Fort Worth National Bank, that provides for the merger of Fort Worth Bancshares, Inc. into a wholly-owned subsidiary of Southside Bancshares, Inc.  The merger has been approved by the Federal Reserve Board, but consummation of the merger is still subject to the approval of the shareholders of Fort Worth Bancshares, Inc. and other customary closing conditions.  The merger is expected to be consummated in the third quarter of 2007.

This merger expands our presence in Texas into the Fort Worth, Arlington and Austin markets in Tarrant and Travis Counties.  The expansion will make the Tarrant County market our second largest lending market and third largest deposit market.  We will retain the Fort Worth National Bank charter and continue to operate Fort Worth National Bank under that name.  The bank has two branches in Fort Worth, one branch in adjoining Arlington and a loan production office in Austin.  Under the terms of the definitive agreement, the all cash transaction is valued at $36.5 million, based on a purchase price of $52.00 per share of Fort Worth Bancshares, Inc. common stock, subject to customary closing adjustments.

Accounting Pronouncements

See “Note 9 - Accounting Pronouncements” in our financial statements included in this report.

31



ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

In the banking industry, a major risk exposure is changing interest rates.  The primary objective of monitoring our interest rate sensitivity, or risk, is to provide management the tools necessary to manage the balance sheet to minimize adverse changes in net interest income as a result of changes in the direction and level of interest rates.  Federal Reserve Board monetary control efforts, the effects of deregulation and legislative changes have been significant factors affecting the task of managing interest rate sensitivity positions in recent years.

In an attempt to manage our exposure to changes in interest rates, management closely monitors our exposure to interest rate risk through our ALCO.  Our ALCO meets regularly and reviews our interest rate risk position and makes recommendations to our board for adjusting this position.  In addition, our board reviews our asset/liability position on a monthly basis.  We primarily use two methods for measuring and analyzing interest rate risk:  Net income simulation analysis and MVPE modeling.  Through these simulations we attempt to estimate the impact on net interest income of a 200 basis point parallel shift in the yield curve.  Our policy guidelines seek to limit the estimated change in net interest income to 10 percent of forecasted net interest income over the succeeding 12 months and 200 basis point parallel rate shock.  Our policy guidelines limit the change in market value of equity in a 200 basis point parallel rate shock to 20 percent of the base case.  The results of the valuation analysis as of June 30, 2007 were within policy guidelines for all scenarios except for the immediate down 200 basis point shock scenario, which reflected net interest income would increase approximately 11%.  Due to the level of our interest bearing demand and savings deposit rates at June 30, 2007, some of these rates cannot move down 200 basis points.  As part of the overall assumptions, certain assets and liabilities have been given reasonable floors.  This type of simulation analysis requires numerous assumptions including but not limited to changes in balance sheet mix, prepayment rates on mortgage-related assets and fixed rate loans, cash flows and repricings of all financial instruments, changes in volumes and pricing, future shapes of the yield curve, relationship of market interest rates to each other (basis risk), credit spread and deposit sensitivity.  Assumptions are based on management’s best estimates but may not accurately reflect actual results under certain changes in interest rates.


32



The following table provides information about our financial instruments that are sensitive to changes in interest rates.  Except for the effects of prepayments and scheduled principal amortization on fixed rate loans and mortgage-backed securities, the table presents principal cash flows and related weighted average interest rates by the contractual term to maturity.  Adjustable rate student loans totaling $3.2 million are classified in the one year category.  Callable FHLB Advances are presented based on contractual maturity.  Callable brokered CDs are presented based on contractual maturity.  Loans held for sale totaling $5.0 million are classified in the one-year category.  Nonaccrual loans totaling $1.6 million are not included in total loans.  All instruments are classified as other than trading.

   
EXPECTED MATURITY DATE
 
   
(dollars in thousands)
 
   
Twelve Months Ending June 30, 2007
 
 
 
 
   
 
   
 
   
 
   
 
   
 
   
 
   
Fair
 
 
 
2008
   
2009
   
2010
   
2011
   
2012
   
Thereafter
   
Total
   
Value
 
Loans:
 
 
   
 
   
 
   
 
   
 
   
 
   
 
   
 
 
Fixed Rate
  $
199,669
    $
92,291
    $
51,125
    $
32,158
    $
20,107
    $
108,030
    $
503,380
    $
497,547
 
 
    6.88 %     6.78 %     6.70 %     6.63 %     6.48 %     5.72 %     6.56 %        
Adjustable Rate
   
58,066
     
18,173
     
8,828
     
7,817
     
3,995
     
171,885
     
268,764
     
268,764
 
 
    8.36 %     7.94 %     8.26 %     8.16 %     8.29 %     6.65 %     7.23 %        
Mortgage-backed
                                                               
Securities:
                                                               
Fixed Rate
   
183,801
     
186,089
     
154,461
     
109,180
     
69,297
     
103,760
     
806,588
     
802,526
 
 
    5.27 %     5.05 %     5.01 %     5.06 %     5.00 %     4.75 %     5.05 %        
Investments and Other Interest Earning Assets:
                                                               
Fixed Rate
   
40,898
     
1,690
     
3,250
     
3,470
     
3,330
     
60,189
     
112,827
     
112,841
 
 
    5.19 %     6.08 %     6.64 %     6.66 %     6.10 %     6.04 %     5.77 %        
Adjustable Rate
   
     
     
     
     
     
5,907
     
5,907
     
5,907
 
 
   
     
     
     
     
      7.06 %     7.06 %        
Total Interest
                                                               
Earning Assets
  $
482,434
    $
298,243
    $
217,664
    $
152,625
    $
96,729
    $
449,771
    $
1,697,466
    $
1,687,585
 
 
    6.30 %     5.77 %     5.56 %     5.59 %     5.48 %     5.91 %     5.90 %        
Savings Deposits
  $
5,264
    $
2,632
    $
2,632
    $
2,632
    $
2,632
    $
36,846
    $
52,638
    $
52,638
 
 
    1.31 %     1.31 %     1.31 %     1.31 %     1.31 %     1.31 %     1.31 %        
NOW Deposits
   
95,473
     
5,229
     
5,229
     
5,229
     
5,229
     
73,210
     
189,599
     
189,599
 
 
    4.63 %     0.85 %     0.85 %     0.85 %     0.85 %     0.85 %     2.75 %        
Money Market Deposits
   
24,873
     
8,290
     
8,290
     
8,290
     
8,290
     
24,872
     
82,905
     
82,905
 
 
    3.12 %     3.12 %     3.12 %     3.12 %     3.12 %     3.12 %     3.12 %        
Platinum Money Market
   
70,984
     
10,775
     
10,775
     
10,775
     
10,775
     
12,676
     
126,760
     
126,760
 
 
    3.95 %     3.95 %     3.95 %     3.95 %     3.95 %     3.95 %     3.95 %        
Certificates of Deposit
   
385,901
     
40,764
     
41,016
     
31,435
     
56,824
     
147
     
556,087
     
553,991
 
 
    4.87 %     4.71 %     5.00 %     5.24 %     5.44 %     4.34 %     4.95 %        
FHLB Advances
   
225,432
     
43,649
     
36,811
     
18,171
     
1,099
     
4,057
     
329,219
     
327,061
 
 
    4.81 %     4.69 %     4.65 %     5.20 %     4.99 %     5.14 %     4.80 %        
Other Borrowings
   
1,511
     
     
     
     
     
20,619
     
22,130
     
22,130
 
 
    5.10 %    
     
     
     
      8.30 %     8.08 %        
Total Interest
                                                               
Bearing Liabilities
  $
809,438
    $
111,339
    $
104,753
    $
76,532
    $
84,849
    $
172,427
    $
1,359,338
    $
1,355,084
 
 
    4.67 %     4.25 %     4.32 %     4.38 %     4.61 %     2.50 %     4.31 %        



33



Residential fixed rate loans are assumed to have annual prepayment rates between 7% and 35% of the portfolio.  Residential adjustable rate loans are assumed to have annual prepayment rates between 12% and 50%.  Commercial and multi-family real estate loans are assumed to prepay at an annualized rate between 8% and 40%.  Consumer loans are assumed to prepay at an annualized rate between 8% and 30%.  Commercial loans are assumed to prepay at an annual rate between 8% and 45%.  Municipal loans are assumed to prepay at an annual rate between 6% and 18%.  Fixed rate mortgage-backed securities, including Collateralized Mortgage Obligations ("CMOs") and Real Estate Mortgage Investment Conduits ("REMICs"), have annual payment assumptions ranging from 6% to 50%.  At June 30, 2007, the contractual maturity of substantially all of our mortgage-backed or related securities was in excess of ten years.  The actual maturity of a mortgage-backed or related security is less than its stated maturity due to regular principal payments and prepayments of the underlying mortgages.  Prepayments that are faster than anticipated may shorten the life of the security and affect its yield to maturity.  The yield to maturity is based upon the interest income and the amortization of any premium or accretion of any discount related to the security.  In accordance with GAAP, premiums and discounts are amortized or accreted over the estimated lives of the loans, which decrease and increase interest income, respectively.  The prepayment assumptions used to determine the amortization period for premiums and discounts can significantly affect the yield of the mortgage-backed or related security, and these assumptions are reviewed periodically to reflect actual prepayments.  Although prepayments of underlying mortgages depend on many factors, including the type of mortgages, the coupon rate, the age of mortgages, the geographical location of the underlying real estate collateralizing the mortgages and general levels of market interest rates, the difference between the interest rates on the underlying mortgages and the prevailing mortgage interest rates generally is the most significant determinant of the rate of prepayments.  During periods of falling mortgage interest rates, if the coupon rate of the underlying mortgages exceeds the prevailing market interest rates offered for mortgage loans, refinancing may increase and accelerate the prepayment of the underlying mortgages and the related security.  At June 30, 2007, 100% of the mortgage-backed and related securities we held were secured by fixed-rate mortgage loans.

We assume 70% of savings accounts and non public fund transaction accounts at June 30, 2007, are core deposits and are, therefore, expected to mature after five years.  All public fund transaction accounts are assumed to mature within one year.  We assume 30% of money market accounts at June 30, 2007 are core deposits and are, therefore, expected to mature after five years.  We assume 10% of our platinum money market accounts are core deposits and are, therefore, expected to mature after five years.  Fixed maturity deposits reprice at maturity.

In evaluating our exposure to interest rate risk, certain limitations inherent in the method of analysis presented in the foregoing table must be considered.  For example, although certain assets and liabilities may have similar maturities or periods to repricing, they may react in different degrees to changes in market interest rates.  Also, the interest rates on certain types of assets and liabilities may fluctuate in advance of changes in market interest rates, while interest rates on other types may lag behind changes in market rates.  Certain assets, such as adjustable rate mortgages, have features which restrict changes in interest rates.  Prepayment and early withdrawal levels associated with mortgage-backed securities may deviate significantly from those assumed in calculating the table.  Finally, the ability of many borrowers to service their debt may decrease in the event of an interest rate increase.  We consider all of these factors in monitoring our exposure to interest rate risk.

ITEM 4. CONTROLS AND PROCEDURES
 
Background of Restatement and Material Weakness in Internal Control Over Financial Reporting

In the third quarter of 2007 we identified that certain cash flows from operating, investing and financing activities were incorrect in several of the Company's historical Consolidated Statement of Cash Flows which resulted in the need to restate the Company's consolidated financial statements for the years ended December 31, 2006, 2005 and 2004 and each of the quarters of 2006 as more fully described in Note 2, to the consolidated financial statements included in this Form 10-Q/A.  The Company subsequently determined the following material weakness existed as of December 31, 2006 and through June 30, 2007:

A material weakness is a deficiency, or a combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of the Company's annual or interim financial statements will not be prevented or detected on a timely basis.

The Company did not maintain effective internal control over financial reporting relating to the accurate presentation and disclosure of cash flows in accordance with accounting principles generally accepted in the United States of America. Specifically, the Company did not maintain effective controls to accurately reflect the non-cash effects of unsettled securities transactions within the statement of cash flows and in the proper accounting periods. This control deficiency resulted in misstatements of operating, investing and financing cash flows resulting in the restatement of the Company's consolidated financial statements for the years ended December 31, 2006, 2005 and 2004 and each of the quarters of 2006.  Additionally, this control deficiency could result in misstatement of the consolidated statement of cash flows and disclosures that would result in a material misstatement of the consolidated financial statements that would not be prevented or detected.  Accordingly, management determined that this control deficiency constituted a material weakness.

34


Evaluation of Disclosure Controls and Procedures
 
Our Chief Executive Officer ("CEO") and our Chief Financial Officer ("CFO") undertook an evaluation of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934, as amended) as of the end of the period covered by this report, in connection with the filing of the Quarterly Report on Form 10-Q/A.  The Company maintains disclosure controls and procedures that are designed to ensure that information required to be disclosed in the reports it files under the Securities and Exchange Act of 1934, as amended, is recorded, processed, summarized and reported within the time periods specified in the Commission’s rules and forms.  Such controls include those designed to ensure that information is accumulated and communicated to management, including the CEO and CFO, as appropriate to allow timely decisions regarding required disclosure.  Based upon that evaluation, in connection with the restatement of the Company’s Consolidated Financial Statements, described in Note 2 to the June 30, 2007 consolidated financial statements, and as a result of the material weakness described above, our CEO and our CFO have concluded that our disclosure controls and procedures were not effective as of June 30, 2007.

Changes in Internal Control Over Financial Reporting
 
No changes were made to the Company’s internal control over financial reporting during the three months ended June 30, 2007, that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

Plan for Remediation of Material Weakness in Internal Control Over Financial Reporting

To remediate the material weakness described above and to enhance our internal control over financial reporting, management plans to supplement its existing cash flow controls with the following additional controls:
·  
Management and oversight controls to review and approve the statement of cash flows, in particular non-cash items
·  
Designing specific processes and controls to identify and monitor non-cash items, specifically unsettled trades



35



PART II. OTHER INFORMATION

ITEM 1.                   LEGAL PROCEEDINGS

We are a party to legal proceedings arising in the normal course of business.  Management believes that at June 30, 2007 such litigation is not material to our financial position or results of operations.

ITEM 1A.                   RISK FACTORS

Information regarding risk factors appears in “Item 2.  Management’s Discussion and Analysis of Financial Condition and Results of Operations - Forward Looking Statements” of this Form 10-Q/A and in Part I — “Item 1A Risk Factors” in our Annual Report on Form 10-K/A for the year ended December 31, 2006. There have been no material changes from the risk factors previously disclosed in our Annual Report on Form 10-K/A.

ITEM 2.                   UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

The following table provides information with respect to purchases made by or on our behalf or any “affiliated purchaser” (as defined in Rule 10b-18(a)(3) under the Securities Exchange Act of 1934), of our common stock during the three months ended June 30, 2007.

 
 
Total Number
of Shares Purchased
 
Average Price Paid Per Share
 
Total Number of Shares Purchased as Part of Publicly Announced Plan
 
Maximum Number of Shares That May Yet Be Purchased Under the Plan at the End of the Period
April 1, 2007 to April 30, 2007
 
 
$
 
 
 
May 1, 2007 to May 31, 2007
 
6,120
(1)
$
21.56
 
   
June 1, 2007 to June 30, 2007
 
 
$
 
   
Total
 
6,120
 
$
21.56
 
 
 

(1)  Repurchase of shares made in connection with the exercise of certain employee stock options.


ITEM 3.                   DEFAULTS UPON SENIOR SECURITIES

Not Applicable

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

 
(a)
An annual meeting of shareholders was held on April 19, 2007.

 
(b)
The election of three directors (terms expiring at the 2010 Annual Meeting) were as follows:

   FOR        WITHHELD
Alton Cade                                            9,091,763       306,918
B. G. Hartley                                          9,090,750       307,931
Paul W. Powell                                      9,017,862       380,819

 
The other directors, whose terms of office continued after the annual meeting, are: Sam Dawson, Melvin B. Lovelady, William Sheehy, Herbert C. Buie, Robbie N. Edmonson, Michael D. Gollob, and Joe Norton.

ITEM 5.                   OTHER INFORMATION

Not Applicable


36



ITEM 6EXHIBITS

Exhibit
   No.   
 
  3 (a)(i)     -
 
Articles of Incorporation as amended and in effect on December 31, 1992, of SoBank, Inc. (now
 
named Southside Bancshares, Inc.)(filed as Exhibit 3 to the Registrant's Form 10-K for the year
 
ended December 31, 1992, (commission file number 000-12247) and incorporated herein by
 
reference).

 
  3 (a)(ii)    -
 
Articles of Amendment effective May 9, 1994 to Articles of Incorporation of SoBank, Inc. (now
 
named Southside Bancshares, Inc.) (filed as Exhibit 3(a)(ii) to the Registrant’s Form 10-K for the
 
year ended December 31, 1994, (commission file number 000-12247) and incorporated herein by
 
reference).

 
  3 (b)              -
 
Amended and Restated Bylaws of Southside Bancshares,
 
Inc. (filed as Exhibit 3(b) to the Registrant’s Form 8-K, filed June 28, 2006, and incorporated
 
herein by reference).

*  31.1     -           Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
*  31.2     -           Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
** 32        -           Certification Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

                         .
*  Filed herewith.
**The certifications attached as Exhibit 32 accompany this quarterly Report on Form 10-Q/A and are
“furnished” to the Commission pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 and shall
not be deemed “filed” by us for purposes of Section 18 of the Securities Exchange Act of 1934, as
amended.
37

 
 
 
SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this amended report to be signed on its behalf by the undersigned thereunto duly authorized.
 

 
SOUTHSIDE BANCSHARES, INC.
 
    
 
 
 
BY:
/s/LEE R. GIBSON
 
 
Lee R. Gibson, Executive Vice President
 
 
and Chief Financial Officer (Principal Financial
 
 
and Accounting Officer)
 
 
 
 
DATE: November 15, 2007
 


38

 
Exhibit Index

 
     Exhibit
    Number                                Description
 
 
       31.1
Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
       31.2
Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
       32
Certification Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
 
  39