1 UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 (Mark One) [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended September 30, 1999 ------------------------------------------------- OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM -------------------- to ----------------------- Commission file number 0-12247 ------------------- SOUTHSIDE BANCSHARES, INC. - -------------------------------------------------------------------------------- (Exact name of registrant as specified in its charter) TEXAS 75-1848732 - ----------------------------------------- --------------------------------- (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 1201 S. Beckham, Tyler, Texas 75701 - ----------------------------------------- --------------------------------- (Address of principal executive offices) (Zip Code) (Registrant's telephone number, including area code) 903-531-7111 ------------- 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 . --- --- The number of shares outstanding of each of the issuer's classes of capital stock, as of the latest practicable date, was 3,894,852 shares of Common Stock, par value $2.50, outstanding at November 4, 1999.
2 PART I. FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS SOUTHSIDE BANCSHARES, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (UNAUDITED) (in thousands, except share amounts) <TABLE> <CAPTION> September 30, December 31, ASSETS 1999 1998 ------------- ------------ <S> <C> <C> Cash and due from banks ........................................................ $ 28,832 $ 41,372 Federal funds sold .......................................................... 15,650 ---------- ---------- Cash and cash equivalents ................................................... 44,482 41,372 Investment securities: Available for sale .......................................................... 154,922 132,447 Held to maturity ............................................................ 3,620 347 ---------- ---------- Total Investment securities ............................................... 158,542 132,794 Mortgage-backed and related securities: Available for sale .......................................................... 365,120 333,194 Held to maturity ............................................................ 5,764 7,810 ---------- ---------- Total Mortgage-backed securities .......................................... 370,884 341,004 Marketable equity securities: Available for sale .......................................................... 18,294 14,171 Loans: Loans, net of unearned discount ............................................. 356,382 319,723 Less: Reserve for loan losses .............................................. (4,264) (3,564) ---------- ---------- Net Loans ................................................................. 352,118 316,159 Premises and equipment, net .................................................... 20,495 19,166 Other real estate owned, net ................................................... 231 195 Interest receivable ............................................................ 6,132 6,065 Deferred tax asset ............................................................. 5,312 Other assets ................................................................... 4,512 5,403 ---------- ---------- TOTAL ASSETS .............................................................. $ 981,002 $ 876,329 ========== ========== </TABLE> <TABLE> <CAPTION> LIABILITIES AND SHAREHOLDERS' EQUITY <S> <C> <C> Deposits: Noninterest bearing ......................................................... $ 158,665 $ 122,440 Interest bearing ............................................................ 401,830 392,594 ---------- ---------- Total Deposits ............................................................ 560,495 515,034 Short-term obligations: Federal funds purchased ..................................................... 4,168 FHLB Dallas advances ........................................................ 181,500 118,000 Other obligations ........................................................... 2,478 1,523 ---------- ---------- Total Short-term obligations ............................................. 183,978 123,691 Long-term obligations: FHLB Dallas advances ........................................................ 170,615 156,027 Guaranteed Preferred Beneficial Interest in the Company's Junior Subordinated Debentures .............................................. 20,000 20,000 ---------- ---------- Total Long-term obligations .............................................. 190,615 176,027 Deferred tax liability ......................................................... 1,184 Other liabilities .............................................................. 8,535 13,980 ---------- ---------- TOTAL LIABILITIES ......................................................... 943,623 829,916 ---------- ---------- Shareholders' equity: Common stock: ($2.50 par, 6,000,000 shares authorized, 3,894,852 and 3,685,775 shares issued and outstanding) ................... 9,737 9,214 Paid-in capital ............................................................. 27,401 24,198 Retained earnings ........................................................... 12,367 11,391 Treasury stock (239,361 and 182,176 shares at cost) ......................... (4,210) (3,158) Accumulated other comprehensive (loss) income ............................... (7,916) 4,768 ---------- ---------- TOTAL SHAREHOLDERS' EQUITY ............................................... 37,379 46,413 ---------- ---------- TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY ............................... $ 981,002 $ 876,329 ========== ========== </TABLE> The accompanying notes are an integral part of these consolidated financial statements. 1
3 SOUTHSIDE BANCSHARES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED) (in thousands, except per share data) <TABLE> <CAPTION> Quarter Ended Nine Months Ended September 30, September 30, ------------------------- ------------------------ 1999 1998 1999 1998 -------- -------- -------- -------- <S> <C> <C> <C> <C> Interest income Loans ................................................... $ 7,174 $ 6,704 $ 20,654 $ 19,424 Investment securities ................................... 2,465 1,440 6,597 3,524 Mortgage-backed and related securities .................. 5,784 3,006 15,845 7,633 Other interest earning assets ........................... 313 175 886 435 -------- -------- -------- -------- Total interest income ............................... 15,736 11,325 43,982 31,016 Interest expense Time and savings deposits ............................... 4,129 3,941 12,121 11,554 Short-term obligations .................................. 2,478 1,359 6,051 2,371 Long-term obligations ................................... 2,711 1,629 8,172 3,313 -------- -------- -------- -------- Total interest expense .............................. 9,318 6,929 26,344 17,238 -------- -------- -------- -------- Net interest income ........................................ 6,418 4,396 17,638 13,778 Provision for loan losses .................................. 375 300 1,028 900 -------- -------- -------- -------- Net interest income after provision for loan losses ........ 6,043 4,096 16,610 12,878 -------- -------- -------- -------- Noninterest income Deposit services ........................................ 1,793 1,343 4,944 3,820 Gain (loss) on securities available for sale ............ (30) 700 274 935 Other ................................................... 524 361 1,578 1,072 -------- -------- -------- -------- Total noninterest income ............................ 2,287 2,404 6,796 5,827 -------- -------- -------- -------- Noninterest expense Salaries and employee benefits .......................... 3,608 2,861 10,157 8,365 Net occupancy expense ................................... 717 621 2,077 1,735 Equipment expense ....................................... 157 111 376 336 Advertising, travel & entertainment ..................... 269 263 903 829 Supplies ................................................ 120 124 366 331 Postage ................................................. 107 86 298 259 Other ................................................... 841 781 2,585 2,306 -------- -------- -------- -------- Total noninterest expense ........................... 5,819 4,847 16,762 14,161 -------- -------- -------- -------- Income before income taxes ................................. 2,511 1,653 6,644 4,544 Provision for income taxes ................................. 537 248 1,301 799 -------- -------- -------- -------- Net Income ................................................. $ 1,974 $ 1,405 $ 5,343 $ 3,745 ======== ======== ======== ======== Earnings Per Common Share-Basic ............................ $ .54 $ .38 $ 1.46 $ 1.01 ======== ======== ======== ======== Earnings Per Common Share-Diluted .......................... $ .52 $ .37 $ 1.41 $ .97 ======== ======== ======== ======== </TABLE> The accompanying notes are an integral part of these consolidated financial statements. 2
4 SOUTHSIDE BANCSHARES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY (UNAUDITED) (in thousands) <TABLE> <CAPTION> Accumulated Other Compre- Compre- Total hensive hensive Share- Income Common Paid in Retained Treasury Income holders' (Loss) Stock Capital Earnings Stock (Loss) Equity -------- -------- -------- -------- -------- ----------- -------- <S> <C> <C> <C> <C> <C> <C> <C> Balance at December 31, 1997 ............. $ $ 8,740 $ 21,290 $ 10,414 $ (1,820) $ 1,322 $ 39,946 Net Income ............................... 3,745 3,745 3,745 Other comprehensive income, net of tax Unrealized gains on securities, net of reclassification adjustment (see disclosure) ........................... 2,707 2,707 2,707 -------- Comprehensive income ..................... $ 6,452 ======== Common stock issued (16,162 shares) ...... 41 225 266 Dividends paid ........................... (1,009) (1,009) Purchase of 51,426 shares of Treasury stock ......................... (1,016) (1,016) Sale of 6,000 shares of Treasury stock ... (22) 60 38 FAS 109 - Incentive Stock Options ........ 42 42 Stock dividend ........................... 421 2,571 (2,992) -------- -------- -------- -------- -------- -------- Balance at September 30, 1998 ............ $ 9,202 $ 24,128 $ 10,136 $ (2,776) $ 4,029 $ 44,719 ======== ======== ======== ======== ======== ======== Disclosure of reclassification amount: Unrealized holding gains arising during period ................................ $ 3,324 Less: reclassification adjustment for gains included in net income .......... 617 -------- Net unrealized gains on securities ....... $ 2,707 ======== Balance at December 31, 1998 ............. $ $ 9,214 $ 24,198 $ 11,391 $ (3,158) $ 4,768 $ 46,413 Net Income ............................... 5,343 5,343 5,343 Other comprehensive loss, net of tax Unrealized losses on securities, net of reclassification adjustment (see disclosure) ........................... (12,684) (12,684) (12,684) -------- Comprehensive loss ....................... $ (7,341) ======== Common stock issued (34,159 shares) ...... 86 288 374 Dividends paid on common stock ........... (1,044) (1,044) Purchase of 57,185 shares of Treasury stock ......................... (1,052) (1,052) FAS 109 - Incentive Stock Options ........ 29 29 Stock dividend ........................... 437 2,886 (3,323) -------- -------- -------- -------- -------- -------- Balance at September 30, 1999 ............ $ 9,737 $ 27,401 $ 12,367 $ (4,210) $ (7,916) $ 37,379 ======== ======== ======== ======== ======== ======== Disclosure of reclassification amount: Unrealized holding losses arising during period ................................ $(12,503) Less: reclassification adjustment for gains included in net income .......... 181 -------- Net unrealized losses on securities ...... $(12,684) ======== </TABLE> The accompanying notes are an integral part of these consolidated financial statements. 3
5 SOUTHSIDE BANCSHARES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOW (UNAUDITED) (in thousands) <TABLE> <CAPTION> Nine Months Ended September 30, ----------------------------- 1999 1998 ---------- ---------- <S> <C> <C> OPERATING ACTIVITIES: Net income .................................................................. $ 5,343 $ 3,745 Adjustments to reconcile net cash provided by operations: Depreciation ............................................................... 1,092 1,056 Amortization of premium .................................................... 4,080 3,891 Accretion of discount and loan fee ......................................... (1,280) (461) Provision for loan losses .................................................. 1,028 900 FAS 109 - incentive stock options .......................................... 29 42 Increase in interest receivable ............................................ (67) (1,312) Decrease (increase) in other receivables and prepaids ...................... 590 (3,029) Decrease (increase) in deferred tax asset .................................. 38 (54) Increase in interest payable ............................................... 568 187 (Gain) loss on sale of assets .............................................. (37) 35 Gain on sale of other real estate owned .................................... (100) (32) Gain on sale of securities available for sale .............................. (274) (935) (Decrease) increase in other payables ...................................... (5,058) 21,375 ---------- ---------- Net cash provided by operating activities ................................ 5,952 25,408 INVESTING ACTIVITIES: Proceeds from sales of investment securities available for sale ............. 69,310 48,783 Proceeds from sales of mortgage-backed securities available for sale ........ 89,209 30,455 Proceeds from maturities of investment securities available for sale ........ 22,909 7,399 Proceeds from maturities of mortgage-backed securities available for sale ... 70,308 48,986 Proceeds from maturities of investment securities held to maturity .......... 347 345 Proceeds from maturities of mortgage-backed securities held to maturity ..... 2,064 4,522 Purchases of investment securities available for sale ....................... (125,288) (87,247) Purchases of mortgage-backed securities available for sale .................. (203,411) (247,657) Purchases of marketable equity securities available for sale ................ (4,123) (7,459) Purchases of investment securities held to maturity ......................... (2,820) Net increase in loans ....................................................... (37,874) (18,025) Purchases of premises and equipment ......................................... (3,051) (1,461) Proceeds from sales of premises and equipment ............................... 667 106 Proceeds from sales of other real estate owned .............................. 296 275 Proceeds from sales of repossessed assets ................................... 956 1,111 ---------- ---------- Net cash used in investing activities .................................... (120,501) (219,867) </TABLE> The accompanying notes are an integral part of these consolidated financial statements. 4
6 SOUTHSIDE BANCSHARES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOW (continued) (UNAUDITED) (in thousands) <TABLE> <CAPTION> Nine Months Ended September 30, ----------------------------- 1999 1998 ---------- ---------- <S> <C> <C> FINANCING ACTIVITIES: Net increase in demand and savings accounts ............................... $ 40,990 $ 5,966 Net increase in certificates of deposit ................................... 4,471 5,040 Proceeds from the issuance of common stock ................................ 374 266 Net (decrease) increase in federal funds purchased ........................ (4,168) 35 Sale of treasury stock .................................................... 38 Purchase of treasury stock ................................................ (1,052) (1,016) Dividends paid ............................................................ (1,044) (1,009) Net increase in FHLB Dallas advances ...................................... 78,088 150,798 Issuance of guaranteed preferred beneficial interest in the Company's junior subordinated debentures ........................... 20,000 ---------- ---------- Net cash provided by financing activities ............................ 117,659 180,118 ---------- ---------- Net increase (decrease) in cash and cash equivalents ....................... 3,110 (14,341) Cash and cash equivalents at beginning of period ........................... 41,372 36,593 ---------- ---------- Cash and cash equivalents at end of period ................................. $ 44,482 $ 22,252 ========== ========== SUPPLEMENTAL DISCLOSURE FOR CASH FLOW INFORMATION: Interest paid ............................................................. $ 25,777 $ 17,051 Income taxes paid ......................................................... $ 1,350 $ 850 SUPPLEMENTAL DISCLOSURES OF NONCASH INVESTING AND FINANCING ACTIVITIES: Acquisition of OREO and other repossessed assets through foreclosure ...... $ 887 $ 1,170 </TABLE> The accompanying notes are an integral part of these consolidated financial statements. 5
7 SOUTHSIDE BANCSHARES, INC. AND SUBSIDIARIES NOTES TO FINANCIAL STATEMENTS 1. Basis of Presentation The consolidated balance sheet as of September 30, 1999, and the related consolidated statements of income, shareholders' equity and cash flow for the nine month period ended September 30, 1999 and 1998 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. 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 the Company's latest report on Form 10-K. 2. Earnings Per Share Earnings per share on a basic and diluted basis as required by Statement of Financial Accounting Standard No. 128, "Earnings Per Share" is calculated as follows (in thousands, except per share amounts): <TABLE> <CAPTION> Nine Months Ended September 30, ------------------------------- 1999 1998 -------------- -------------- <S> <C> <C> Basic net earnings per share Net income $ 5,343 $ 3,745 Weighted average shares outstanding 3,656 3,713 -------------- -------------- $ 1.46 $ 1.01 ============== ============== Diluted net earnings per share Net income $ 5,343 $ 3,745 Weighted average shares outstanding plus assumed conversions 3,776 3,867 -------------- -------------- $ 1.41 $ .97 ============== ============== Calculation of weighted average shares outstanding plus assumed conversions Weighted average shares outstanding 3,656 3,713 Effect of dilutive securities options 120 154 -------------- -------------- 3,776 3,867 ============== ============== </TABLE> 3. Comprehensive Income The components of accumulated comprehensive income (loss) as required by Statement of Financial Accounting Standard No. 130, "Reporting Comprehensive Income" are as follows: <TABLE> <CAPTION> Nine Months Ended September 30, 1999 -------------------------------------- Before-Tax Tax (Expense) Net-of-Tax Amount Benefit Amount ---------- ------------- ---------- <S> <C> <C> <C> Unrealized losses on securities: Unrealized holding losses arising during period $ (18,944) $ 6,441 $ (12,503) Less: reclassification adjustment for gains realized in net income 274 (93) 181 ---------- ---------- ---------- Net unrealized losses (19,218) 6,534 (12,684) ---------- ---------- ---------- Other comprehensive losses $ (19,218) $ 6,534 $ (12,684) ========== ========== ========== </TABLE> 6
8 <TABLE> <CAPTION> Quarter Ended September 30, 1999 ----------------------------------------- Before-Tax Tax (Expense) Net-of-Tax Amount Benefit Amount ----------- ------------- ----------- <S> <C> <C> <C> Unrealized losses on securities: Unrealized holding losses arising during period $ (6,398) $ 2,175 $ (4,223) Less: reclassification adjustment for losses realized in net income (30) 10 (20) ----------- ----------- ----------- Net unrealized losses (6,368) 2,165 (4,203) ----------- ----------- ----------- Other comprehensive losses $ (6,368) $ 2,165 $ (4,203) =========== =========== =========== </TABLE> <TABLE> <CAPTION> Nine Months Ended September 30, 1998 ----------------------------------------- Before-Tax Tax (Expense) Net-of-Tax Amount Benefit Amount ----------- ------------ ----------- <S> <C> <C> <C> Unrealized gains on securities: Unrealized holding gains arising during period $ 5,036 $ (1,712) $ 3,324 Less: reclassification adjustment for gains realized in net income 935 (318) 617 ----------- ----------- ----------- Net unrealized gains 4,101 (1,394) 2,707 ----------- ----------- ----------- Other comprehensive income $ 4,101 $ (1,394) $ 2,707 =========== =========== =========== </TABLE> <TABLE> <CAPTION> Quarter Ended September 30, 1998 ----------------------------------------- Before-Tax Tax (Expense) Net-of-Tax Amount Benefit Amount ----------- ------------ ----------- <S> <C> <C> <C> Unrealized gains on securities: Unrealized holding gains arising during period $ 4,421 $ (1,503) $ 2,918 Less: reclassification adjustment for gains realized in net income 700 (238) 462 ----------- ----------- ----------- Net unrealized gains 3,721 (1,265) 2,456 ----------- ----------- ----------- Other comprehensive income $ 3,721 $ (1,265) $ 2,456 =========== =========== =========== </TABLE> 7
9 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - Quarter and nine months ended September 30, 1999 compared to September 30, 1998. The following is a discussion of the consolidated financial condition, changes in financial condition, and results of operations of Southside Bancshares, Inc. (the "Company"), and should be read and reviewed in conjunction with the financial statements, and the notes thereto, in this presentation and in the Company's latest report on Form 10-K. The Company reported an increase in net income for the quarter and nine months ended September 30, 1999 compared to the same periods in 1998. Net income for the quarter and nine months ended September 30, 1999 was $2.0 million and $5.3 million, as compared to $1.4 million and $3.7 million for the same periods in 1998. Net Interest Income Net interest income for the quarter and nine months ended September 30, 1999 was $6.4 million and $17.6 million, an increase of $2.0 million or 46.0% for the quarter and $3.9 million or 28.0% for the nine months when compared to the same periods in 1998. Average interest earning assets increased $280.6 million or 47.3%, while the net interest spread decreased from 2.6% at September 30, 1998 to 2.3% at September 30, 1999. Beginning in the second quarter of 1998, the Company leveraged the balance sheet to offset the interest expense associated with the Trust Preferred Securities issued and to utilize the additional capital provided. The leverage strategy produced a resulting spread for the leveraged portion of the balance sheet which was significantly less than the Company's previous average. Also impacting net interest income was the significant increase beginning in the second quarter of 1998 of tax free municipal securities. These securities have lower coupons, but reduce federal income tax expense. Interest expense on Trust Preferred Securities was $1.3 million for the nine months ended September 30, 1999 compared to $.6 million for the same period in 1998 due to the fact the securities were not issued until May 18, 1998. During the nine months ended September 30, 1999, Average Loans, funded primarily by the growth in average deposits and average FHLB Dallas advances, increased $30.8 million or 10.2%, compared to the same period in 1998. The average yield on loans decreased from 8.6% at September 30, 1998 to 8.3% at September 30, 1999. Average Securities increased $236.5 million or 83.7% for the nine months ended September 30, 1999 when compared to the same period in 1998. This increase was a direct result of the leverage strategy implemented in 1998. The overall yield on Average Securities increased to 6.2% during the nine months ended September 30, 1999 from 5.9% during the same period in 1998. Interest income from federal funds and other interest earning assets increased $.5 million or 103.7% for the nine months ended September 30, 1999 when compared to the same period in 1998 as a result of the average balance increase of 135.9%. The average yield decreased from 6.0% in 1998 to 5.2% at September 30, 1999 due to lower federal funds rates. Total interest expense increased $9.1 million or 52.8% to $26.3 million during the nine months ended September 30, 1999 as compared to $17.2 million during the same period in 1998. The increase was attributable to an increase in Average Interest Bearing Liabilities of $254.6 million or 51.9% while the average yield remained unchanged at 4.7% from September 30, 1998 to September 30, 1999. Average Interest Bearing Deposits increased $36.4 million or 10.1% while the average rate paid decreased from 4.3% at September 30, 1998 to 4.1% at September 30, 1999. Average Short-term Interest Bearing Liabilities, consisting primarily of FHLB Dallas advances and Federal Funds Purchased, increased $98.5 million or 167.1% as compared to the same period in 1998. This increase reflects a strategically planned increase in balance sheet leverage to achieve certain Asset/Liability Management Committee ("ALCO") objectives. Average Long-term Interest Bearing Liabilities consisting of FHLB Dallas advances increased $109.6 million or 173.6% compared to $63.1 million at September 30, 1998. The advances were obtained from FHLB Dallas as part of the Company's balance sheet leverage strategy and partially to fund long-term 8
10 loans. FHLB Dallas advances are collateralized by FHLB Dallas stock, securities, and nonspecified real estate loans. Average Long Term Junior Subordinated Debentures increased $10.2 million or 103.7% from September 30, 1998 to September 30, 1999 as a result of the issuance of the Preferred Securities. The increase is due to the fact the Junior Subordinated Debentures were not issued until May 18, 1998. 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. SUMMARY OF INTEREST EARNING ASSETS AND INTEREST BEARING LIABILITIES <TABLE> <CAPTION> AVERAGE YIELD OR AVERAGE YIELD OR VOLUME INTEREST RATE PAID VOLUME INTEREST RATE PAID ---------- ---------- ---------- ---------- ---------- ---------- (Dollars in thousands) Nine Months Ended September 30, 1999 Nine Months Ended September 30, 1998 -------------------------------------- ------------------------------------ <S> <C> <C> <C> <C> <C> <C> INTEREST EARNING ASSETS: Loans $ 332,171 $ 20,654 8.3% $ 301,335 $ 19,424 8.6% Investment Securities(1)(2) 163,487 8,164 6.7% 89,102 4,796 7.2% Mortgage-backed Securities(2) 355,651 15,845 6.0% 193,496 7,633 5.3% Other Interest Earning Assets 22,877 886 5.2% 9,697 435 6.0% ---------- ---------- ---------- ---------- TOTAL INTEREST EARNING ASSETS $ 874,186 $ 45,549 7.0% $ 593,630 $ 32,288 7.3% ========== ========== ========== ========== INTEREST BEARING LIABILITIES: Deposits $ 394,795 $ 12,121 4.1% $ 358,432 $ 11,554 4.3% Fed Funds Purchased and Other Interest Bearing Liabilities 7,501 271 4.8% 5,028 207 5.5% Short Term Interest Bearing Liabilities - FHLB Dallas 149,903 5,780 5.2% 53,908 2,164 5.4% Long Term Interest Bearing Liabilities - FHLB Dallas 172,678 6,897 5.3% 63,110 2,690 5.7% Long Term Junior Subordinated Debentures 20,000 1,275 8.5% 9,817 623 8.5% ---------- ---------- ---------- ---------- TOTAL INTEREST BEARING LIABILITIES $ 744,877 $ 26,344 4.7% $ 490,295 $ 17,238 4.7% ========== ========== ---------- ========== ========== ---------- NET INTEREST SPREAD 2.3% 2.6% ========== ========== </TABLE> (1) Interest income includes taxable-equivalent adjustments of $1,567 and $1,272 as of September 30, 1999 and 1998, respectively. (2) For the purpose of calculating the average yield, the average balance of securities is presented at historical cost. Noninterest Income Noninterest income was $6.8 million for the nine months ended September 30, 1999 compared to $5.8 million for the same period in 1998. Deposit services income increased $1.1 million or 29.4% for the nine months ended September 30, 1999 compared to the same period in 1998. Deposit services income increased primarily as a direct result of the overdraft privilege program and also due to increased numbers of deposit accounts and increased deposit activity from September 30, 1998 to September 30, 1999. Other noninterest income increased $.5 million or 47.2% for the nine months ended September 30, 1999 primarily as a result of increases in mortgage servicing release fees income. Gains on sales of securities decreased $.7 million for the nine months ended September 30, 1999 compared to the same period in 1998. During the quarter, short-term municipal securities were sold and were replaced with tax free loans made by the Company's loan department. In addition, short-term U.S. Treasury and agency securities were sold and replaced primarily with premium mortgage backed securities. Sales of securities available for sale were the result of changes in economic conditions as intermediate and long-term interest rates increased over 134 basis points from the lows of last 9
11 fall due to concerns of increased inflation and the rate of growth in the economy. The market value of the available for sale and held to maturity securities portfolio at September 30, 1999 was $547.6 million with a net unrealized loss on that date of $12.0 million. The net unrealized loss is comprised of $13.6 million in unrealized losses and $1.6 million in unrealized gains. Noninterest Expense Noninterest expense was $16.8 million for the nine months ended September 30, 1999, compared to $14.2 million for the same period of 1998, representing an increase of $2.6 million or 18.4%. Salaries and employee benefits increased $1.8 million or 21.4% during the nine months ended September 30, 1999 when compared to the same period in 1998. Direct salary expense and payroll taxes increased $1.2 million as a result of personnel additions for the nine months ended September 30, 1999 when compared to the same period in 1998. Branch expansion combined with normal payroll increases accounted for this increase. Retirement expense increased $.3 million or 56.1% for the nine months ended September 30, 1999 when compared to the same period in 1998. Health insurance expense increased $.3 million or 44.4% for the nine months ended September 30, 1999 when compared to the same period in 1998. Net occupancy expense increased $.3 million or 19.7% for the nine months ended September 30, 1999 compared to the same period in 1998, largely due to higher real estate taxes, depreciation expense and the opening of three new branches in 1998. Other noninterest expense increased $.3 million or 12.1% for the nine months ended September 30, 1999 when compared to the same period in 1998. The increase was due primarily to ATM fees and telephone expense due to added locations. In addition, bank exam and bank analysis fees increased due to bank asset and transaction growth. Also, costs associated with the Company's junior subordinated debentures increased. Provision for Income Taxes The provision for the income tax expense for the nine months ended September 30, 1999 was 19.6% compared to 17.6% for the nine months ended September 30, 1998. The increase is due to higher pretax income. Capital Resources Total shareholders' equity for the Company at September 30, 1999, of $37.4 million was down $9 million from December 31, 1998, and represented 3.8% of total assets at September 30, 1999 compared to 5.3% of total assets at December 31, 1998. Increases to shareholders' equity during the nine months ended September 30, 1999 were net income of $5.3 million, common stock (12,801 shares) issued through dividend reinvestment of $32,000 and $54,000 due to the exercise of 21,358 shares of incentive stock options. Decreases to shareholders' equity consisted of $1.0 million in dividends paid to shareholders, the purchase of 57,185 shares of treasury stock for $1.1 million, and a decrease of $12.7 million in net unrealized gains on securities available for sale. 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 eight percent. The minimum Tier 1 capital to risk-adjusted assets is four percent. The Federal Reserve Board also requires bank holding companies to comply with the minimum leverage ratio guidelines. The leverage ratio is a 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 average of three percent 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 10
12 regulation, that if undertaken, could have a direct material effect on the Bank's financial statements. At September 30, 1999, the Company and Southside Bank exceeded all regulatory minimum capital requirements. The Federal Reserve 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. It is management's intention to maintain the Company's 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 the Company or Southside Bank not exceed earnings for that year. Liquidity and Interest Rate Sensitivity The primary functions of asset/liability management are to assure adequate liquidity and maintain an appropriate balance between interest sensitive earning assets and interest bearing liabilities. Liquidity management involves the ability to meet the cash flow requirements of customers who may be either depositors wanting to withdraw funds or borrowers needing funds to meet their credit needs. 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. Through this process, market value volatility is also a key consideration. Cash, Interest Earning Deposits, Federal Funds Sold and short-term investments with maturities or repricing characteristics of one year or less are the principal sources of asset liquidity. At September 30, 1999, these investments were 21.1% of Total Assets. Historically, the overall liquidity of the Company has been enhanced by a significant aggregate amount of core deposits and by the lack of significant dependence on public fund deposits. Composition of Loans The Company's main objective is to seek attractive lending opportunities in East Texas. Total Average Loans increased $30.8 million or 10.2% from the nine months ended September 30, 1998 to September 30, 1999. The majority of the increase is in Real Estate Loans and Commercial Loans. The increase in Real Estate Loans is due to a stronger real estate market, interest rates and an increased commitment in residential mortgage lending. Commercial Loans increased as a result of commercial growth in the Company's market area. Loan Loss Experience and Reserve for Loan Losses The loan loss reserve is based on the most current review of the loan portfolio at that time. An internal loan review officer of the Company is responsible for an ongoing review of Southside Bank's entire loan portfolio with specific goals set for the volume of loans to be reviewed on an annual basis. A list of loans which are graded as having more than the normal degree of risk associated with them are maintained by the internal loan review officer. This list is updated on a periodic basis but no less than quarterly by the servicing officer in order to properly allocate necessary reserves and keep management informed on the status of attempts to correct the deficiencies noted in the credit. While management is aware of certain risk factors within segments of the loan portfolio, reserve allocations have been made on an individual loan basis. An additional reserve is maintained on the remainder of the portfolio of at risk loans that is based on tracking of the Company's loan losses on loans that have not been previously identified as problems. 11
13 For the third quarter and nine months ended September 30, 1999, loan charge-offs were $230,000 and $547,000 and recoveries were $68,000 and $219,000, respectively, resulting in net charge-offs of $162,000 and $328,000. For the third quarter and nine months ended September 30, 1998, net charge-offs were $255,000 and $685,000, respectively. The decrease in net charge-offs for the nine months ended September 30, 1999 occurred primarily as a result of one commercial loan charge-off in the first quarter of 1998. The remainder was due to the large volume of consumer loan charge-offs in the first quarter of 1998. As a result of these and other factors, the necessary provision expense was estimated at $1.0 million for the nine months ended September 30, 1999. Nonperforming Assets The categories of nonperforming assets consist of delinquent loans over 90 days past due, nonaccrual and restructured loans, other real estate owned and repossessed assets. Delinquent loans over 90 days past due represent loans for which the payment of principal or interest has not been received in a timely manner. The full collection of both the principal and interest is still expected but is being withheld due to negotiation or other items expected to be resolved in the near future. Generally, a loan is categorized as nonaccrual when principal or interest is past due 90 days or more, unless, in the determination of management, the principal and interest on the loan are well secured and in the process of collection. In addition, a loan is placed on nonaccrual when, in the opinion of management, the future collectibility of interest and principal is in serious doubt. When a loan is categorized as nonaccrual, the accrual of interest is discontinued and any remaining accrued interest is reversed in that period; thereafter, interest income is recorded only when actually received. Restructured loans represent loans which have been renegotiated to provide a reduction or deferral of interest or principal because of deterioration in the financial position of the borrowers. Categorization of a loan as nonperforming is not in itself a reliable indicator of potential loan loss. Other factors, such as the value of collateral securing the loan and the financial condition of the borrower must be considered in judgments as to potential loan loss. Other Real Estate Owned (OREO) represents real estate taken in full or partial satisfaction of debts previously contracted. The OREO consists primarily of raw land and oil and gas interests. The Company is actively marketing all properties and none are being held for investment purposes. Total nonperforming assets at September 30, 1999 were $2,366,000, up $364,000 or 18.2% from $2,002,000 at December 31, 1998. From December 31, 1998 to September 30, 1999, nonaccrual loans increased $273,000 or 63.2% to $705,000. At September 30, 1999, nonaccrual loans represented .2% of total loans and 16.5% of reserve for loan losses. Loans 90 days past due or more increased $216,000 or 37.5% to $792,000. The majority of the 90 day past due loans are collateralized by residential dwellings that are primarily owner occupied. Historically, the amount of losses suffered on this type of loan have been significantly less than those on other properties. Other real estate increased $36,000 or 18.5% to $231,000. Restructured loans decreased $74,000 or 15.6% to $399,000. Repossessed assets decreased $87,000 or 26.7%. Expansion During the third quarter of 1999, the Company opened a third full service branch in Longview, Texas. Year 2000 Compliance (Y2K) In May 1997, the Federal Financial Institutions Examination Council ("FFIEC") issued an interagency statement to the chief executive officers of all federally supervised financial institutions regarding Y2K project management awareness. The FFIEC has highly prioritized Y2K compliance in order to avoid major disruptions to the operations of financial institutions and the country's financial systems when the new century results in two digit dates for the year being below the prior year's value. The FFIEC statement provides guidance to financial institutions, providers of data services, and all examining personnel of the federal banking agencies regarding the Y2K issue. The federal banking agencies have been conducting Y2K compliance examinations, and the failure to implement an adequate Y2K program can be identified 12
14 as an unsafe and unsound banking practice. The FDIC has established an examination procedure which contains three categories of ratings: "Satisfactory," "Needs Improvement," and "Unsatisfactory." Institutions that receive a Y2K rating of Unsatisfactory may be subject to formal enforcement action, supervisory agreements, cease and desist orders, civil money penalties, or the appointment of a conservator. In addition, federal banking agencies will be taking into account Y2K compliance programs when reviewing applications and may deny an application based on Y2K related issues. Y2K Issue The Y2K issue concerns the potential impact of historic computer software code that only utilizes two digits to represent the calendar year (e.g. "98" for "1998"). Software so developed, and not corrected, could produce inaccurate or unpredictable results commencing upon January 1, 2000, when current and future dates present a lower two digit year number than dates in the prior century. The Company, similar to most financial services providers, is significantly subject to the potential impact of the Y2K issue due to the nature of financial information. Potential impacts to the Company may arise from software, computer hardware, and other equipment both within the Company's direct control and outside of the Company's ownership, yet with which the Company electronically or operationally interfaces. Financial institution regulators have intensively focused upon Y2K exposures, issuing guidance concerning the responsibilities of senior management and directors. Y2K testing and certification is being addressed as a key safety and soundness issue in conjunction with regulatory exams. In order to address the Y2K issue, the Company developed and implemented a five phase plan divided into the following major components: 1. awareness 2. assessment 3. renovation 4. validation 5. implementation The Company completed all phases of the plan with customer awareness ongoing. Other important segments of the Y2K plan are to identify those loan customers whose possible lack of Y2K preparedness might expose the Bank to financial loss, and to highlight any servicers of purchased loans or securities which might present Y2K operating problems. The Board of Directors established a Y2K subcommittee to monitor progress with achieving and certifying Y2K compliance. In addition, the Company utilized external consulting firms to assist with its Y2K program. The Company's current plan is to continue customer awareness. Following its completion of the assessment phase, the Company determined that a significant portion of its computer hardware and software did not require updating or replacement to achieve Y2K compliance. The Company limited internally generated programmed software coding to correct, as substantially all of the software utilized by the Company is purchased or licensed from external providers. The Company has determined that it has little to no exposure to contingencies related to the Y2K issue for products it has sold. The Company initiated formal communications with all of its significant suppliers and customers to determine the extent to which the Company is vulnerable to those third parties' failure to remediate their own Y2K issues. The Company requested third party vendors represent their products and services to be Y2K compliant and that they have a program to test for that compliance. Significant suppliers have been contacted and where applicable their products successfully tested. All testing, communications and correspondence indicates the necessary levels of concern and planning for their own Y2K readiness. At this time, the Company cannot estimate the additional cost, if any, that might develop in relation to significant suppliers and customers. The Company is prepared to curtail credit availability to customers identified as having material exposure to the Y2K issue. However, the Company's ability to exercise such 13
15 curtailment may be limited by various factors, including existing legal agreements and potential concerns regarding lender liability. The Company developed contingency plans which represent enhancements of the Company's existing business resumption plans to safeguard the Company under various Y2K scenarios. The contingency plans are designed to address critical system failures. The contingency plans include the use of third party service providers, alternative commercial vendors, alternative data security and other contingency service suppliers. The Company's total Y2K estimated project cost, which is based upon currently available information, includes expenses for the review and testing of third parties, including government entities. However, there can be no guarantee that the hardware, software, and systems of such third parties will be without unfavorable Y2K issues and, therefore, not present a material adverse impact upon the Company. Y2K compliance costs incurred to date total approximately $395,000, the majority of which was related to hardware and software acquisitions. This figure does not include the implicit costs associated with the reallocation of internal staff hours to Y2K project related efforts. At this time management currently estimates additional Y2K compliance costs, which are expensed on a current period basis except for fixed asset purchases, at between $40,000 and $90,000. The estimated costs associated with the Y2K project have decreased from the original estimate. The Company's testing indicates less hardware purchases will be required than originally estimated. This range of cost does not include normal ongoing costs for computer hardware (including ATM's) and software that would be replaced in the next year even without the presence of the Y2K issue in conjunction with the Company's ongoing programs for updating and expanding its delivery infrastructure. The aforementioned Y2K project cost estimate may change as the Company progresses in its Y2K program and obtains additional information associated with and conducts further testing concerning third parties. At this time, no significant projects have been delayed as a result of the Company's Y2K effort. Despite the Company's activities in regards to the Y2K issue, there can be no assurance that partial or total systems interruptions or the costs necessary to update hardware and software would not have a material adverse effect upon the Company's business, financial condition, results of operations and business prospects. Forward-Looking Information Certain statements of other than historical fact that are contained in this document and in written material, press releases and oral statements issued by or on behalf of the Company may be considered to be "forward-looking statements" as that term is defined in the Private Securities Litigation Reform Act of 1995. These statements may include words such as "expect," "estimate," "project," "anticipate," "should," "intend," "probability," "risk," "target," "objective" and similar expressions. Forward-looking statements are subject to significant risks and uncertainties and the Company's actual results may differ materially from the results discussed in the forward-looking statements. For example, certain market risk disclosures are dependent on choices about key model characteristics and assumptions and are subject to various limitations. See "Item 2 - Management's Discussion and Analysis of Financial Condition and Results of Operations." By their nature, certain of the market risk disclosures are only estimates and could be materially different from what actually occurs in the future. As a result, actual income gains and losses could materially differ from those that have been estimated. Other factors that could cause actual results to differ materially from forward-looking statements include, but are not limited to general economic conditions, either nationally or in the State of Texas, legislation or regulatory changes which adversely affect the businesses in which the Company is engaged, changes in the interest rate environment which reduce interest margins, significant increases in competition in the banking and financial services industry, changes in consumer spending, borrowing and saving habits, technological changes, the Company's ability to increase market share and control expenses, the effect of compliance with legislation or regulatory changes, the effect of changes in accounting policies and practices and the costs and effects of unanticipated litigation. 14
16 PART II. OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS Not Applicable ITEM 2. CHANGES IN SECURITIES Not Applicable ITEM 3. DEFAULTS UPON SENIOR SECURITIES Not Applicable ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS Not Applicable ITEM 5. OTHER INFORMATION Not Applicable ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits Exhibit No. ------- 27 - Financial Data Schedule for the nine months ended September 30, 1999. (b) Reports on Form 8-K - None 15
17 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. SOUTHSIDE BANCSHARES, INC. (Registrant) BY: /s/ B. G. HARTLEY ---------------------------------------- B. G. Hartley, Chairman of the Board and Chief Executive Officer (Principal Executive Officer) DATE: 11-10-99 ---------------------- /s/ LEE R. GIBSON ---------------------------------------- Lee R. Gibson, Executive Vice President (Principal Financial and Accounting Officer) DATE: 11-10-99 ---------------------- 16
18 EXHIBIT INDEX <TABLE> <CAPTION> EXHIBIT NO DESCRIPTION - ---------- ----------- <S> <C> 27 Financial Data Schedule for the nine months ended September 30, 1999. </TABLE>