UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q (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, 2002 ------------------------------------------------ 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 July 31, 2002 was 7,909,017 shares of Common Stock, par value $1.25.
PART I. FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS SOUTHSIDE BANCSHARES, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (UNAUDITED) (in thousands, except share amounts) <Table> <Caption> ASSETS June 30, December 31, 2002 2001 ------------ ------------ <S> <C> <C> Cash and due from banks .............................................................. $ 45,345 $ 52,681 Investment securities available for sale ............................................. 147,686 158,818 Mortgage-backed and related securities available for sale ............................ 484,808 454,078 Marketable equity securities available for sale ...................................... 22,067 21,287 Loans: Loans, net of unearned discount ................................................... 552,363 537,898 Less: Reserve for loan losses .................................................... (5,971) (5,926) ------------ ------------ Net Loans ....................................................................... 546,392 531,972 Premises and equipment, net .......................................................... 30,636 27,748 Interest receivable .................................................................. 9,075 8,622 Other assets ......................................................................... 21,772 21,531 ------------ ------------ TOTAL ASSETS .................................................................... $ 1,307,781 $ 1,276,737 ============ ============ LIABILITIES AND SHAREHOLDERS' EQUITY Deposits: Noninterest bearing ............................................................... $ 191,468 $ 171,802 Interest bearing .................................................................. 597,374 586,152 ------------ ------------ Total Deposits .................................................................. 788,842 757,954 Short-term obligations: Federal funds purchased ........................................................... 15,100 25,900 FHLB Dallas advances .............................................................. 136,120 114,177 Other obligations ................................................................. 2,500 2,500 ------------ ------------ Total Short-term obligations ................................................... 153,720 142,577 Long-term obligations: FHLB Dallas advances .............................................................. 233,594 260,713 Junior subordinated debentures .................................................... 20,000 20,000 Junior subordinated convertible debentures ........................................ 15,070 16,950 ------------ ------------ Total Long-term obligations .................................................... 268,664 297,663 Deferred tax liability ............................................................... 1,772 1,634 Other liabilities .................................................................... 21,424 8,324 ------------ ------------ TOTAL LIABILITIES ............................................................... 1,234,422 1,208,152 ------------ ------------ Shareholders' equity: Common stock: ($1.25 par, 20,000,000 shares authorized, 9,017,101 and 8,733,297 shares issued) ............................................ 11,271 10,917 Paid-in capital ................................................................... 37,385 35,195 Retained earnings ................................................................. 30,000 25,133 Treasury stock (1,143,177 and 920,577 shares at cost) ............................. (11,883) (8,511) Accumulated other comprehensive income ............................................ 6,586 5,851 ------------ ------------ TOTAL SHAREHOLDERS' EQUITY ..................................................... 73,359 68,585 ------------ ------------ TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY ..................................... $ 1,307,781 $ 1,276,737 ============ ============ </Table> 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) <Table> <Caption> Quarter Ended June 30, Six Months Ended June 30, ----------------------- ------------------------- 2002 2001 2002 2001 --------- --------- --------- --------- <S> <C> <C> <C> <C> Interest income Loans ............................................ $ 9,433 $ 10,526 $ 19,024 $ 20,646 Investment securities ............................ 1,765 1,591 3,639 3,583 Mortgage-backed and related securities ........... 6,130 7,709 11,987 15,646 Other interest earning assets .................... 181 250 368 611 --------- --------- --------- --------- Total interest income ........................ 17,509 20,076 35,018 40,486 Interest expense Deposits ......................................... 4,100 6,739 8,383 14,004 Short-term obligations ........................... 1,468 1,878 2,671 4,001 Long-term obligations ............................ 3,500 3,878 7,486 7,584 --------- --------- --------- --------- Total interest expense ....................... 9,068 12,495 18,540 25,589 --------- --------- --------- --------- Net interest income ................................. 8,441 7,581 16,478 14,897 Provision for loan losses ........................... 601 300 1,051 760 --------- --------- --------- --------- Net interest income after provision for loan losses . 7,840 7,281 15,427 14,137 --------- --------- --------- --------- Noninterest income Deposit services ................................. 2,643 2,323 5,123 4,550 Gain on sales of securities available for sale ... 799 509 1,043 2,317 Trust income ..................................... 227 222 481 446 Other ............................................ 1,015 557 1,860 964 --------- --------- --------- --------- Total noninterest income ..................... 4,684 3,611 8,507 8,277 --------- --------- --------- --------- Noninterest expense Salaries and employee benefits ................... 5,342 4,569 10,607 8,637 Net occupancy expense ............................ 978 822 1,915 1,611 Equipment expense ................................ 141 186 325 369 Advertising, travel & entertainment .............. 482 479 878 912 Supplies ......................................... 178 171 366 326 Professional fees ................................ 184 192 331 318 Other ............................................ 1,309 1,216 2,538 2,318 --------- --------- --------- --------- Total noninterest expense .................... 8,614 7,635 16,960 14,491 --------- --------- --------- --------- Income before federal tax expense ................... 3,910 3,257 6,974 7,923 Provision for federal tax expense ................... 549 679 847 1,861 --------- --------- --------- --------- Income before cumulative effect of change in accounting principle ........................... 3,361 2,578 6,127 6,062 Cumulative effect of change in accounting principle, net of tax ............................. -- -- -- (994) --------- --------- --------- --------- Net Income .......................................... $ 3,361 $ 2,578 $ 6,127 $ 5,068 ========= ========= ========= ========= Earnings Per Common Share: Basic: Income before cumulative effect of change in accounting principle ........................... $ 0.43 $ 0.33 $ 0.78 $ 0.77 Cumulative effect of change in accounting principle, net of tax ............................. -- -- -- (0.13) --------- --------- --------- --------- Net income ..................................... $ 0.43 $ 0.33 $ 0.78 $ 0.64 ========= ========= ========= ========= Diluted: Income before cumulative effect of change in accounting principle ........................... $ 0.35 $ 0.29 $ 0.65 $ 0.66 Cumulative effect of change in accounting principle, net of tax ............................... -- -- -- (0.10) --------- --------- --------- --------- Net income ..................................... $ 0.35 $ 0.29 $ 0.65 $ 0.56 ========= ========= ========= ========= </Table> 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 per share amounts) <Table> <Caption> Accumulated Other Compre- Total Compre- hensive Share- hensive Common Paid in Retained Treasury Income holders' Income Stock Capital Earnings Stock (Loss) Equity ------- --------- --------- --------- --------- --------- --------- <S> <C> <C> <C> <C> <C> <C> <C> Balance at December 31, 2001................ $ $ 10,917 $ 35,195 $ 25,133 $ (8,511) $ 5,851 $ 68,585 Net Income.................................. 6,127 6,127 6,127 Other comprehensive income, net of tax Unrealized gains on securities, net of reclassification adjustment (see Note 3). 735 735 735 ------- Comprehensive income........................ $ 6,862 ======= Common stock issued (283,804 shares)........ 354 2,082 2,436 Dividends paid on common stock.............. (1,260) (1,260) Purchase of 222,600 shares of Treasury stock............................ (3,372) (3,372) Tax benefit of incentive stock options...... 108 108 --------- --------- --------- --------- --------- --------- Balance at June 30, 2002.................... $ 11,271 $ 37,385 $ 30,000 $ (11,883) $ 6,586 $ 73,359 ========= ========= ========= ========= ========= ========= Balance at December 31, 2000................ $ $ 10,269 $ 30,226 $ 19,891 $ (5,357) $ (3,334) $ 51,695 Net Income.................................. 5,068 5,068 5,068 Other comprehensive income, net of tax Unrealized gains on securities, net of reclassification adjustment (see Note 3). 7,060 7,060 7,060 ------- Comprehensive income........................ $12,128 ======= Common stock issued (63,186 shares)......... 79 283 362 Dividends paid on common stock.............. (895) (895) Purchase of 223,500 shares of Treasury stock............................ (2,059) (2,059) Tax benefit of incentive stock options...... 50 50 --------- --------- --------- --------- --------- --------- Balance at June 30, 2001.................... $ 10,348 $ 30,559 $ 24,064 $ (7,416) $ 3,726 $ 61,281 ========= ========= ========= ========= ========= ========= </Table> The accompanying notes are an integral part of these consolidated financial statements. 3
SOUTHSIDE BANCSHARES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOW (UNAUDITED) (in thousands) <Table> <Caption> Six Months Ended June 30, ------------------------ 2002 2001 --------- --------- <S> <C> <C> OPERATING ACTIVITIES: Net income ................................................................ $ 6,127 $ 5,068 Adjustments to reconcile net cash provided by operations: Depreciation ............................................................. 1,135 936 Amortization of premium .................................................. 4,882 2,882 Accretion of discount and loan fees ...................................... (203) (945) Provision for loan losses ................................................ 1,051 760 Tax benefit of incentive stock options ................................... 108 50 (Increase) decrease in interest receivable ............................... (453) 472 Decrease (increase) in other assets ...................................... 568 (1,310) Increase in deferred tax asset ........................................... (241) (225) (Decrease) increase in interest payable .................................. (357) 208 Increase in other liabilities ............................................ 13,457 14,312 Gain on sales of premises and equipment .................................. (12) (12) Gain on sales of other real estate owned ................................. (28) (4) Gain on sales of securities .............................................. (1,043) (2,317) Cumulative effect of change in accounting principle ...................... -- 994 Proceeds from sales of trading securities ................................ -- 99,595 --------- --------- Net cash provided by operating activities .............................. 24,991 120,464 INVESTING ACTIVITIES: Proceeds from sales of investment securities available for sale ........... 68,860 47,360 Proceeds from sales of mortgage-backed securities available for sale ...... 66,527 57,930 Proceeds from maturities of investment securities available for sale ...... 7,515 46,219 Proceeds from maturities of mortgage-backed securities available for sale . 112,645 69,516 Purchases of investment securities available for sale ..................... (63,620) (98,812) Purchases of mortgage-backed securities available for sale ................ (214,047) (251,062) Purchases of marketable equity securities available for sale .............. (780) (547) Net increase in loans ..................................................... (17,308) (28,939) Purchases of premises and equipment ....................................... (4,030) (1,082) Proceeds from sales of premises and equipment ............................. 19 26 Proceeds from sales of other real estate owned ............................ 79 12 Proceeds from sales of repossessed assets ................................. 977 579 --------- --------- Net cash used in investing activities .................................. (43,163) (158,800) </Table> The accompanying notes are an integral part of these consolidated financial statements. 4
SOUTHSIDE BANCSHARES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOW (continued) (UNAUDITED) (in thousands) <Table> <Caption> Six Months Ended June 30, ---------------------------- 2002 2001 ----------- ----------- <S> <C> <C> FINANCING ACTIVITIES: Net increase in demand and savings accounts ................................. $ 20,520 $ 617 Net increase (decrease) in certificates of deposit .......................... 10,368 (14,565) Net decrease in federal funds purchased ..................................... (10,800) (4,050) Net (decrease) increase in FHLB Dallas advances ............................. (5,176) 55,251 Net decrease in junior subordinated convertible dentures .................... (1,880) -- Proceeds from the issuance of common stock .................................. 2,436 362 Purchase of treasury stock .................................................. (3,372) (2,059) Dividends paid .............................................................. (1,260) (895) ----------- ----------- Net cash provided by financing activities .............................. 10,836 34,661 Net decrease in cash and cash equivalents .................................... (7,336) (3,675) Cash and cash equivalents at beginning of period ............................. 52,681 38,800 ----------- ----------- Cash and cash equivalents at end of period ................................... $ 45,345 $ 35,125 =========== =========== SUPPLEMENTAL DISCLOSURE FOR CASH FLOW INFORMATION: Interest paid ............................................................... $ 18,897 $ 25,381 Income taxes paid ........................................................... $ 1,000 $ 1,125 SUPPLEMENTAL DISCLOSURES OF NONCASH INVESTING AND FINANCING ACTIVITIES: Acquisition of other repossessed assets and real estate through foreclosure . $ 1,837 $ 545 Transfer of held to maturity securities to trading securities ............... $ -- $ 99,792 </Table> 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 consolidated balance sheet as of June 30, 2002, and the related consolidated statements of income, shareholders' equity and cash flow for the quarter and six-month periods ended June 30, 2002 and 2001 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. All share data has been adjusted to give retroactive recognition to stock splits and stock dividends. 2. 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): <Table> <Caption> Quarter Ended June 30, Six Months Ended June 30, ----------------------- ---------- ---------- 2002 2001 2002 2001 --------- --------- --------- --------- <S> <C> <C> <C> <C> Basic Earnings and Shares: Income before cumulative effect of accounting change ............ $ 3,361 $ 2,578 $ 6,127 $ 6,062 Cumulative effect of change in accounting principle, net of tax . -- -- -- (994) --------- --------- --------- --------- Net income ...................................................... $ 3,361 $ 2,578 $ 6,127 $ 5,068 ========= ========= ========= ========= Weighted-average basic shares outstanding ....................... 7,926 7,810 7,865 7,873 Basic Earnings Per Share: Income before cumulative effect of accounting change ............ $ 0.43 $ 0.33 $ 0.78 $ 0.77 Cumulative effect of change in accounting principle, net of tax . -- -- -- (0.13) --------- --------- --------- --------- Net income ...................................................... $ 0.43 $ 0.33 $ 0.78 $ 0.64 ========= ========= ========= ========= Diluted Earnings and Shares: Income before cumulative effect of accounting change ............ $ 3,361 $ 2,578 $ 6,127 $ 6,062 Add: Applicable dividend on convertible debentures .............. 218 244 462 489 --------- --------- --------- --------- Adjusted net income ............................................. 3,579 2,822 6,589 6,551 Cumulative effect of change in accounting principle, net of tax . -- -- -- (994) --------- --------- --------- --------- Net income ...................................................... $ 3,579 $ 2,822 $ 6,589 $ 5,557 ========= ========= ========= ========= Weighted-average basic shares outstanding ....................... 7,926 7,810 7,865 7,873 Add: Stock options .............................................. 602 345 579 322 Convertible debentures ..................................... 1,599 1,780 1,688 1,780 --------- --------- --------- --------- Weighted-average diluted shares outstanding ..................... 10,127 9,935 10,132 9,975 ========= ========= ========= ========= Diluted Earnings Per Share: Income before cumulative effect of accounting change ............ $ 0.35 $ 0.29 $ 0.65 $ 0.66 Cumulative effect of change in accounting principle, net of tax . -- -- -- (0.10) --------- --------- --------- --------- Net income ...................................................... $ 0.35 $ 0.29 $ 0.65 $ 0.56 ========= ========= ========= ========= </Table> The accompanying notes are an integral part of these consolidated financial statements. 6
3. Comprehensive Income The components of accumulated comprehensive income are as follows: <Table> <Caption> Six Months Ended June 30, 2002 -------------------------------------------------- Before-Tax Tax (Expense) Net-of-Tax Amount Benefit Amount ------------- ------------- ------------- <S> <C> <C> <C> Unrealized gains on securities: Unrealized holding gains arising during period ... $ 2,157 $ (733) $ 1,424 Less: reclassification adjustment for gains included in net income ...................... 1,043 (354) 689 ------------- ------------- ------------- Net unrealized gains on securities .............. 1,114 (379) 735 ------------- ------------- ------------- Other comprehensive income .......................... $ 1,114 $ (379) $ 735 ============= ============= ============= </Table> <Table> <Caption> Quarter Ended June 30, 2002 -------------------------------------------------- Before-Tax Tax (Expense) Net-of-Tax Amount Benefit Amount ------------- ------------- ------------- <S> <C> <C> <C> Unrealized gains on securities: Unrealized holding gains arising during period ... $ 3,779 $ (1,284) $ 2,495 Less: reclassification adjustment for gains included in net income ...................... 799 (271) 528 ------------- ------------- ------------- Net unrealized gains on securities .............. 2,980 (1,013) 1,967 ------------- ------------- ------------- Other comprehensive income .......................... $ 2,980 $ (1,013) $ 1,967 ============= ============= ============= </Table> <Table> <Caption> Six Months Ended June 30, 2001 -------------------------------------------------- Before-Tax Tax (Expense) Net-of-Tax Amount Benefit Amount ------------- ------------- ------------- <S> <C> <C> <C> Unrealized gains on securities: Unrealized holding gains arising during period ... $ 11,508 $ (3,913) $ 7,595 Less: reclassification adjustment for gains included in net income ....................... 2,317 (788) 1,529 ------------- ------------- ------------- Net unrealized gains on securities .............. 9,191 (3,125) 6,066 Less: cumulative effect of change in accounting principle ........................ (1,506) 512 (994) ------------- ------------- ------------- Other comprehensive income .......................... $ 10,697 $ (3,637) $ 7,060 ============= ============= ============= </Table> <Table> <Caption> Quarter Ended June 30, 2001 -------------------------------------------------- Before-Tax Tax (Expense) Net-of-Tax Amount Benefit Amount ------------- ------------- ------------- <S> <C> <C> <C> Unrealized gains on securities: Unrealized holding gains arising during period ... $ 1,050 $ (357) $ 693 Less: reclassification adjustment for gains included in net income ....................... 509 (173) 336 ------------- ------------- ------------- Net unrealized gains on securities .............. 541 (184) 357 ------------- ------------- ------------- Other comprehensive income .......................... $ 541 $ (184) $ 357 ============= ============= ============= </Table> 7
4. Accounting Pronouncements In June 2001, the Financial Accounting Standards Board issued Statement of Financial Accounting Standard No. 141 "Business Combinations" (FAS 141) and Statement of Financial Accounting Standard No. 142 "Goodwill and Other Intangible Assets" (FAS 142). FAS 141 requires all business combinations initiated after June 30, 2001 to be accounted for using the purchase method. Under FAS 142, goodwill and intangible assets with indefinite lives are no longer amortized but are reviewed annually (or more frequently if impairment indicators arise) for impairment. Separable intangible assets that are not deemed to have indefinite lives will continue to be amortized over their useful lives (but with no maximum life). The amortization provisions of FAS 142 apply to goodwill and intangible assets acquired after June 30, 2001. With respect to goodwill and intangible assets acquired prior to July 1, 2001, the Company was required to adopt FAS 142 effective January 1, 2002. The adoption of this new accounting pronouncement did not have a material impact on the Company's consolidated financial position or results of operations. In June 2001, the Financial Accounting Standards Board issued Financial Accounting Standard No. 143, "Accounting for Asset Retirement Obligations" (FAS 143). FAS 143 requires liability recognition for retirement obligations associated with tangible long-lived assets. The obligations included within the scope of FAS 143 are those for which a company faces a legal obligation for settlement. The initial measurement of the asset retirement obligation is to be at fair value. The asset retirement cost equal to the fair value of the retirement obligation is to be capitalized as part of the cost of the related long-lived asset and amortized to expense over the useful life of the asset. FAS 143 is effective for all fiscal years beginning after June 15, 2002. The Company does not believe that FAS 143 will have a material impact on its consolidated financial statements. In August 2001, the Financial Accounting Standards Board issued Statement of Financial Accounting Standard No. 144, "Accounting for the Impairment and Disposal of Long-lived Assets" (FAS 144). This statement addresses financial accounting and reporting for the impairment or disposal of long-lived assets. FAS 144 supercedes FAS 121, "Accounting for the Impairment of Long-lived Assets and for Long-lived Assets to be Disposed of" and the accounting and reporting provisions of Accounting Principles Board ("APB") Opinion No. 30, "Reporting the Results of Operations - Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions," for the disposal of a segment of the business previously defined in that opinion. FAS 144 also amends Accounting Research Bulletin No. 51, "Consolidated Financial Statements" to eliminate the exception to consolidation for a subsidiary for which control is likely to be temporary. The Company does not believe that FAS 144 will have a material impact on its consolidated financial statements. In April 2002, the Financial Accounting Standards Board issued Statement of Financial Accounting Standard No. 145, "Rescission of FAS 4, 44, and 64, Amendment of FAS 13, and Technical Corrections" (FAS 145). This statement updates, clarifies and simplifies existing accounting pronouncements with respect to the accounting for gains and losses from the extinguishments of debt. FAS 4 required all gains and losses from extinguishments of debt to be aggregated and, if material, classified as an extraordinary item, net of related tax effect. As a result of the rescission of FAS 4, the criteria in APB Opinion No. 30 will now be used to classify those gains and losses. The provisions of this statement are applicable to transactions occurring after May 15, 2002. The Company does not believe that FAS 145 will have a material impact on its consolidated financial statements. In June 2002, the Financial Accounting Standards Board issued Statement of Financial Accounting Standard No. 146, "Accounting for Costs Associated with Exit or Disposal Activities" (FAS 146). This Statement addresses financial accounting and reporting for costs associated with exit or disposal activities and nullifies Emerging Issues Task Force (EITF) Issue No. 94-3, "Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring)." The principal difference between this Statement and Issue 94-3 relates to its requirements for recognition of a liability for a cost associated with an exit or disposal activity. This Statement requires that a liability for a cost associated with an exit or disposal activity be recognized when the liability is incurred. Under Issue 94-3, a liability for an exit cost as defined in Issue 94-3 was recognized at the date of an entity's commitment to an exit plan. A fundamental conclusion reached by the Board in this Statement is that an entity's commitment to a plan, by itself, does not create a present obligation to others that meets the definition of a liability. Therefore, this Statement eliminates the definition and requirements for recognition of exit costs in Issue 94-3. This Statement also establishes that fair value is the objective for initial measurement of the liability. The provisions of this Statement are effective for exit or disposal activities that are initiated after December 31, 2002, with early application encouraged. The Company does not believe that FAS 146 will have a material impact on its consolidated financial statements. 8
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - Six months ended June 30, 2002 compared to June 30, 2001. 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 six months ended June 30, 2002 compared to the same period in 2001. Net income for the quarter and six months ended June 30, 2002 was $3.4 million and $6.1 million compared to $2.6 million and $5.1 million for the same period in 2001. All share data has been adjusted to give retroactive recognition to stock splits and stock dividends. Forward-Looking Information Certain statements of other than historical fact that are contained in this document and in written material, press releases and oral statements issued by or on behalf of the Company may be considered to be "forward-looking statements" as that term is defined in the Private Securities Litigation Reform Act of 1995. These statements may include words such as "expect," "estimate," "project," "anticipate," "should," "intend," "probability," "risk," "target," "objective" and similar expressions. Forward-looking statements are subject to significant risks and uncertainties and the Company's actual results may differ materially from the results discussed in the forward-looking statements. For example, certain market risk disclosures are dependent on choices about key model characteristics and assumptions and are subject to various limitations. See "Item 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 and may impact prepayments on the mortgage-backed securities portfolio, changes effecting the leverage strategy, 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. Net Interest Income Net interest income for the six months ended June 30, 2002 was $16.5 million, an increase of $1.6 million or 10.6% for the six months when compared to the same period in 2001. Average interest earning assets increased $58.5 million or 5.2%, while the net interest spread increased from 2.14% at June 30, 2001 to 2.66% at June 30, 2002 and the net margin increased from 2.93% at June 30, 2001 to 3.17% at June 30, 2002. The increase in net interest spread and margin is primarily a result of the decrease in interest expense on the brokered Certificates of Deposit (CD's) called during the first six months of 2001. During the six months ended June 30, 2002, Average Loans, funded primarily by the growth in average deposits and average FHLB Dallas advances, increased $44.8 million or 9.1%, compared to the same period in 2001. The average yield on loans decreased from 8.59% at June 30, 2001 to 7.37% at June 30, 2002 reflective of the overall decrease in interest rates during the year. Average Securities increased $13.3 million or 2.2% for the six months ended June 30, 2002 when compared to the same period in 2001. This increase was a direct result of the leverage strategy implemented in 1998. The overall yield on Average Securities decreased to 5.58% during the six months ended June 30, 2002 from 6.76% during the same period in 2001. The decrease is reflective of overall lower interest rates, increased prepayment speeds on mortgage-backed securities which led to increased amortization expense and a restructuring of a portion of the securities portfolio in an effort to lower duration. Income from equity securities, interest income from federal funds and other interest earning assets decreased $243,000 or 39.8% for the six months ended June 30, 2002 when compared to 2001 as a result of the decrease in the 9
average yield from 5.13% in 2001 to 3.04% at June 30, 2002, due to lower interest rates. Total interest expense decreased $7.0 million or 27.5% to $18.5 million during the six months ended June 30, 2002 as compared to $25.6 million during the same period in 2001. The decrease was attributable to a decrease in the average yield on interest bearing liabilities from 5.40% at June 30, 2001 to 3.69% at June 30, 2002. Average Interest Bearing Deposits increased $37.7 million or 6.9% while the average rate paid decreased from 5.14% at June 30, 2001 to 2.88% at June 30, 2002, which is due in part to the call of the higher cost long-term brokered CDs during 2001. During March 2001, the Company notified CD holders that $24.6 million of brokered CDs were being called April 12, 2001. The Company recorded $195,000 of additional interest expense associated with the call of the CDs during the first quarter ended March 31, 2001. During April 2001, the Company notified CD holders that the remaining $30.0 million of brokered CDs would be called May 24, 2001. An additional $357,000 of expense was incurred during the second quarter ending June 30, 2001, associated with the call of the brokered CDs. These CDs were replaced with long-term advances from the FHLB at an average rate of approximately 5.40% and an average life of approximately 4.9 years. The Company's current policy allows for a maximum of $100 million in brokered CDs. The potential of higher interest cost and lack of customer loyalty are risks associated with the use of brokered CDs. At June 30, 2002 and December 31, 2001, the Company had no brokered CDs and brokered CDs represented zero percent of deposits Average Short-term Interest Bearing Liabilities, consisting primarily of FHLB Dallas advances and Federal Funds Purchased, decreased $4.0 million or 2.4% as compared to the same period in 2001. Average Long-term Interest Bearing Liabilities consisting of FHLB Dallas advances increased $25.0 million or 12.1% compared to $206.1 million at June 30, 2001. The advances were obtained from FHLB Dallas as part of the Company's balance sheet leverage strategy and partially to fund long-term loans. FHLB Dallas advances are collateralized by FHLB Dallas stock, securities and nonspecified real estate loans. The Company has adopted a balance sheet strategy going forward in which it will attempt to gradually reduce Federal Home Loan Bank borrowings as a percentage of deposits. On the asset side, the Company will attempt to gradually reduce the securities portfolio as a percentage of earning assets. The leverage strategy the Company has in place is designed to enhance net income and shareholder return with as minimal interest rate risk as possible. The leverage strategy is dynamic in nature and requires continuous management as the Company's balance sheet changes and the interest rate environment changes. The Company does not maintain the leverage strategy for any other reason at this time. One of the risks associated with the asset structure the Company maintains is a lower net interest rate spread and margin when compared to peers. This asset structure, spread and margin increases the need to monitor the Company's interest rate risk. Average Long-Term Junior Subordinated Convertible Debentures decreased from $17.0 million at June 30, 2001 to $16.1 million at June 30, 2002. During the six months ended June 30, 2002, 187,994 convertible trust preferred shares were converted into 197,393 shares of the Company's common stock. During the second quarter ended June 30, 2002, 183,494 convertible trust preferred shares were converted into 192,668 shares of the Company's common stock. Subsequent to June 30, 2002, an additional 29,200 convertible trust preferred shares were converted into 30,660 shares of the Company's common stock. The total convertible trust preferred shares converted to date represents 12.8% of the convertible trust preferred issue. Average Long Term Junior Subordinated Debentures remained the same at $20 million from June 30, 2001 to June 30, 2002. 10
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. <Table> <Caption> SUMMARY OF INTEREST EARNING ASSETS AND INTEREST BEARING LIABILITIES -------------------------------------------------------------------------------------------- AVERAGE AVERAGE AVERAGE AVERAGE BALANCE INTEREST YIELD BALANCE INTEREST YIELD -------------------------------------------------------------------------------------------- (dollars in thousands) Six Months Ended June 30, 2002 Six Months Ended June 30, 2001 ---------------------------------------------- ----------------------------------------- <S> <C> <C> <C> <C> <C> <C> INTEREST EARNING ASSETS: Loans(1)(2) $ 539,408 $ 19,714 7.37% $ 494,581 $ 21,071 8.59% Investment Securities(3)(4) 154,400 5,019 6.56% 129,672 4,519 7.03% Mortgage-backed Securities(4) 460,090 11,987 5.25% 471,560 15,646 6.69% Other Interest Earning Assets 24,412 368 3.04% 24,014 611 5.13% ------------ ------------ ------------ ------------ TOTAL INTEREST EARNING ASSETS 1,178,310 37,088 6.35% 1,119,827 41,847 7.54% ------------ ------------ NONINTEREST EARNING ASSETS: Cash and Due from Banks 35,202 34,633 Bank Premises and Equipment 29,445 25,474 Other Assets 39,276 17,504 Less: Reserve for Loan Loss (6,069) (5,374) ------------ ------------ TOTAL ASSETS $ 1,276,164 $ 1,192,064 ============ ============ INTEREST BEARING LIABILITIES: Deposits $ 587,672 8,383 2.88% $ 549,952 14,004 5.14% Fed Funds Purchased and Other Interest Bearing Liabilities 4,083 39 1.93% 4,931 122 4.99% Short Term Interest Bearing Liabilities - FHLB Dallas 154,618 2,632 3.43% 157,743 3,879 4.96% Long Term Interest Bearing Liabilities - FHLB Dallas 231,138 5,937 5.18% 206,135 5,992 5.86% Long Term Junior Subordinated Convertible Debentures 16,077 699 8.70% 16,950 742 8.75% Long Term Junior Subordinated Debentures 20,000 850 8.50% 20,000 850 8.50% ------------ ------------ ------------ ------------ TOTAL INTEREST BEARING LIABILITIES 1,013,588 18,540 3.69% 955,711 25,589 5.40% ------------ ------------ NONINTEREST BEARING LIABILITIES Demand Deposits 179,279 163,028 Other Liabilities 11,463 14,673 ------------ ------------ Total Liabilities 1,204,330 1,133,412 SHAREHOLDERS' EQUITY 71,834 58,652 ------------ ------------ TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 1,276,164 $ 1,192,064 ============ ============ NET INTEREST INCOME $ 18,548 $ 16,258 ============ ============ NET MARGIN ON AVERAGE EARNING ASSETS 3.17% 2.93% ======= ======= NET INTEREST SPREAD 2.66% 2.14% ======= ======= </Table> (1) Loans are shown net of unearned discount. Interest on loans includes fees on loans which are not material in amount. (2) Interest income includes taxable-equivalent adjustments of $690 and $425 as of June 30, 2002 and 2001, respectively. (3) Interest income includes taxable-equivalent adjustments of $1,380 and $936 as of June 30, 2002 and 2001, respectively. (4) For the purpose of calculating the average yield, the average balance of securities is presented at historical cost. 11
Noninterest Income Noninterest income was $8.5 million for the six months ended June 30, 2002 compared to $8.3 million for the same period in 2001. Deposit services income increased $573,000 or 12.6% for the six months ended June 30, 2002. 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 June 30, 2001 to June 30, 2002. Other noninterest income increased $896,000 or 92.9% for the six months ended June 30, 2002 primarily as a result of increases in bank owned life insurance income and mortgage servicing release fee income. During the six months ended June 30, 2002, the Company had gains on the sale of securities of $1.0 million compared to $2.3 million for the same period in 2001. The Company sold available for sale securities during 2002 to restructure a portion of the securities portfolio. On January 1, 2001, the Company adopted Financial Accounting Standard No. 133, "Accounting for Derivative Instruments and Hedging Activities," (FAS 133). As allowed by FAS 133, at the date of initial application of this statement, the Company transferred held to maturity securities with an amortized cost of $155.2 million into the available for sale category. In addition, the Company transferred held to maturity securities with an amortized cost of $99.8 million and a market value of $98.3 million into the trading category. The effect of adopting FAS 133 is shown as a cumulative effect of a change in accounting principle and reduced net income by $994,000 (net of taxes) during the first quarter of 2001. The Company sold the securities transferred into the trading category along with previously existing available for sale securities which resulted in realized gains of $1.8 million or an after tax gain of $1.2 million. These separate transactions allowed the Company to reposition the investment portfolio while having a positive impact of $302,000 or $199,000 (net of taxes) on consolidated net income for the first quarter of 2001. The market value of the entire securities portfolio at June 30, 2002 was $654.6 million with a net unrealized gain on that date of $10.2 million. The net unrealized gain is comprised of $10.9 million in unrealized gains and $0.7 million in unrealized losses. Noninterest Expense Noninterest expense was $17.0 million for the six months ended June 30, 2002, compared to $14.5 million for the same period of 2001, representing an increase of $2.5 million or 17.0%. Salaries and employee benefits increased $2.0 million or 22.8% during the six months ended June 30, 2002 when compared to the same period in 2001. The Company has opened five new branches during this time period. These openings combined with normal payroll increases and higher benefit costs were the primary reasons for the increase. Direct salary expense and payroll taxes increased $1.6 million or 22.1% as a result of personnel additions for the six months ended June 30, 2002 when compared to the same period in 2001. Branch expansion combined with normal payroll increases accounted for this increase. Retirement expense increased $226,000 or 35.4% for the six months ended June 30, 2002 when compared to the same period in 2001, primarily as a result of the increase in the number of participants, level of performance of retirement plan assets and actuarial assumptions. Health insurance expense increased $191,000 or 19.7% for the six months ended June 30, 2002 when compared to the same period in 2001. The Company has a self-insured health plan which is supplemented with stop loss insurance policies. During the six month period ended June 30, 2002, the Company experienced higher costs associated with this plan. Net occupancy expense increased $304,000 or 18.9% for the six months ended June 30, 2002 compared to the same period in 2001, largely due to branch expansion, higher real estate taxes and depreciation expense. Other expense increased $220,000 or 9.5% for the six months ended June 30, 2002 compared to the same period in 2001 primarily due to increases in vehicle expense, bank analysis fees and collection fee expense. Provision for Income Taxes The provision for the income tax expense for the six months ended June 30, 2002 was 12.1% compared to 23.5% for the six months ended June 30, 2001. The decrease in the effective tax rate and income tax expense is due to the increase in tax free income for the six months ended June 30, 2002 when compared to the six months ended June 30, 2001. The Company expects its tax free income as a percentage of total income to gradually begin to decrease which should gradually increase the Company's effective tax rate. 12
Capital Resources Total shareholders' equity for the Company at June 30, 2002, of $73.4 million was up $4.8 million from December 31, 2001, and represented 5.61% of total assets at June 30, 2002 compared to 5.37% of total assets at December 31, 2001. Increases to shareholders' equity during the six months ended June 30, 2002 were net income of $6.1 million and common stock (283,804 shares) issued primarily through the conversion of convertible trust preferred shares and the Company's dividend reinvestment and incentive stock option plans of $2.4 million and an increase of $735,000 in net unrealized gains on securities available for sale. Decreases to shareholders' equity consisted of $1.3 million in dividends paid to shareholders and the purchase of 222,600 shares of the Company's common stock for $3.4 million. 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. A portion of the $20 million trust preferred securities is considered Tier 1 capital by the Federal Reserve Bank. 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 four 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 regulation, that if undertaken, could have a direct material effect on the Bank's financial statements. At June 30, 2002, the Company and the 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 the Bank not exceed earnings for that year. Liquidity and Interest Rate Sensitivity Liquidity management involves the ability to convert assets to cash with a minimum of loss. The Company must be capable of meeting its obligations to its customers at any time. This means addressing (1) the immediate cash withdrawal requirements of depositors and other funds providers; (2) the funding requirements of all lines and letters of credit; and (3) the short-term credit needs of customers. Liquidity is provided by short-term investments that can be readily liquidated with a minimum risk of loss. Cash, Interest Earning Deposits, Federal Funds Sold and short-term investments with maturities or repricing characteristics of one year or less continue to be a substantial percentage of total assets. At June 30, 2002, these investments were 21.8% of Total Assets. Liquidity is further provided through the matching, by time period, of rate sensitive interest earning assets with rate sensitive interest bearing liabilities. The Company has three lines of credit for the purchase of federal funds. Two $15.0 million and one $10.0 million unsecured lines of credit have been established with Bank of America, Frost Bank and Texas Independent Bank, respectively. 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. The Asset Liability Management Committee of the Bank closely monitors various liquidity ratios, interest rate spreads and margins, interest rate shock reports and market value of portfolio equity (MVPE) with rates shocked plus and minus 200 basis points to ensure a satisfactory liquidity position for the Company. In addition, the Bank utilizes a simulation model to determine the impact of net interest income under several different interest rate scenarios. By utilizing this technology, the Bank can determine changes that need to be made to the asset and liability mixes to minimize the change in net interest income under these various interest rate scenarios. On November 2, 2000, the Company through its wholly owned subsidiary, Southside Capital Trust II, (the "junior subordinated convertible issuer"), sold 1,695,000 cumulative convertible preferred securities (the "junior subordinated convertible debentures") at a liquidation amount of $10 per convertible preferred security for an aggregate amount of $16,950,000. These securities have a convertible feature that allows the owner to convert each security to a share of 13
the Company's common stock at a conversion price of $9.52 per common share. The debentures have a distribution rate of 8.75% per annum payable at the end of each calendar quarter. The proceeds received by the Company from the Trust II Issuer continues to be used for general corporate purposes, including, but not limited to, capital contributions to the Bank to support growth, for working capital, the repurchase of shares of the Company's common stock and acquisitions by the Company. Composition of Loans The Company's main objective is to seek attractive lending opportunities in East Texas and adjoining counties. Total Average Loans increased $44.8 million or 9.1% from the six months ended June 30, 2001 to June 30, 2002. The majority of the increase is in loans to municipalities and school districts. The increase in Municipal Loans is due to a strong commitment in municipal lending. 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 the 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. For the second quarter and six months ended June 30, 2002, loan charge-offs were $828,000 and $1,172,000 and recoveries were $60,000 and $166,000, respectively, resulting in net charge-offs of $768,000 and $1,006,000. For the second quarter and six months ended June 30, 2001, loan charge-offs were $409,000 and $607,000 and recoveries were $297,000 and $436,000, respectively, resulting in net charge-offs of $112,000 and $171,000. Net charge-offs increased for the six months ended June 30, 2002 due to increases in the loan portfolio over the last three to four years and slight changes in the economic conditions of the market area. As a result of this and other factors, the necessary provision expense was estimated at $1.1 million for the six months ended June 30, 2002. 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. Total nonperforming assets at June 30, 2002 were $3.6 million, up $1.2 million or 49.4% from $2.4 million at December 31, 2001. Other real estate increased $942,000 or 1,449.2% to $1.0 million from December 31, 2001 to 14
June 30, 2002. Of this total, 54% consist of five residential dwellings, 28% is the construction of a residential dwelling and 18% is a commercial building. The Company is actively marketing all properties and none are being held for investment purposes. From December 31, 2001 to June 30, 2002, nonaccrual loans increased $644,000 or 71.9% to $1.5 million. Of this total, 19% are construction and land development loans, 18% are residential real estate loans, 8% are commercial real estate loans, 31% are commercial loans and 24% are loans to individuals. Loans 90 days past due or more decreased $265,000 or 28.0% to $680,000. Restructured loans decreased $3,000 or 1.1% to $ 280,000. Repossessed assets decreased $132,000 or 62.0% to $81,000. Expansion During the first six months of 2002 the Company opened five new full service branches. Two of the branches are located in Whitehouse, two in Tyler and one in Longview. Four of the full service branches are located in grocery stores. Accounting Pronouncements In June 2001, the Financial Accounting Standards Board issued Statement of Financial Accounting Standard No. 141 "Business Combinations" (FAS 141) and Statement of Financial Accounting Standard No. 142 "Goodwill and Other Intangible Assets" (FAS 142). FAS 141 requires all business combinations initiated after June 30, 2001 to be accounted for using the purchase method. Under FAS 142, goodwill and intangible assets with indefinite lives are no longer amortized but are reviewed annually (or more frequently if impairment indicators arise) for impairment. Separable intangible assets that are not deemed to have indefinite lives will continue to be amortized over their useful lives (but with no maximum life). The amortization provisions of FAS 142 apply to goodwill and intangible assets acquired after June 30, 2001. With respect to goodwill and intangible assets acquired prior to July 1, 2001, the Company was required to adopt FAS 142 effective January 1, 2002. The adoption of this new accounting pronouncement did not have a material impact on the Company's consolidated financial position or results of operations. In June 2001, the Financial Accounting Standards Board issued Financial Accounting Standard No. 143, "Accounting for Asset Retirement Obligations" (FAS 143). FAS 143 requires liability recognition for retirement obligations associated with tangible long-lived assets. The obligations included within the scope of FAS 143 are those for which a company faces a legal obligation for settlement. The initial measurement of the asset retirement obligation is to be at fair value. The asset retirement cost equal to the fair value of the retirement obligation is to be capitalized as part of the cost of the related long-lived asset and amortized to expense over the useful life of the asset. FAS 143 is effective for all fiscal years beginning after June 15, 2002. The Company does not believe that FAS 143 will have a material impact on its consolidated financial statements. In August 2001, the Financial Accounting Standards Board issued Statement of Financial Accounting Standard No. 144, "Accounting for the Impairment and Disposal of Long-lived Assets" (FAS 144). This statement addresses financial accounting and reporting for the impairment or disposal of long-lived assets. FAS 144 supercedes FAS 121, "Accounting for the Impairment of Long-lived Assets and for Long-lived Assets to be Disposed of" and the accounting and reporting provisions of Accounting Principles Board ("APB") Opinion No. 30, "Reporting the Results of Operations - Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions," for the disposal of a segment of the business previously defined in that opinion. FAS 144 also amends Accounting Research Bulletin No. 51, "Consolidated Financial Statements" to eliminate the exception to consolidation for a subsidiary for which control is likely to be temporary. The Company does not believe that FAS 144 will have a material impact on its financial statements. In April 2002, the Financial Accounting Standards Board issued Statement of Financial Accounting Standard No. 145, "Rescission of FAS 4, 44, and 64, Amendment of FAS 13, and Technical Corrections" (FAS 145). This statement updates, clarifies and simplifies existing accounting pronouncements with respect to the accounting for gains and losses from the extinguishments of debt. FAS 4 required all gains and losses from extinguishments of debt to be aggregated and, if material, classified as an extraordinary item, net of related tax effect. As a result of the rescission of FAS 4, the criteria in APB Opinion No. 30 will now be used to classify those gains and losses. The provisions of this statement are applicable to transactions occurring after May 15, 2002. The Company does not believe that FAS 145 will have a material impact on its consolidated financial statements. 15
In June 2002, the Financial Accounting Standards Board issued Statement of Financial Accounting Standard No. 146, "Accounting for Costs Associated with Exit or Disposal Activities" (FAS 146). This Statement addresses financial accounting and reporting for costs associated with exit or disposal activities and nullifies Emerging Issues Task Force (EITF) Issue No. 94-3, "Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring)." The principal difference between this Statement and Issue 94-3 relates to its requirements for recognition of a liability for a cost associated with an exit or disposal activity. This Statement requires that a liability for a cost associated with an exit or disposal activity be recognized when the liability is incurred. Under Issue 94-3, a liability for an exit cost as defined in Issue 94-3 was recognized at the date of an entity's commitment to an exit plan. A fundamental conclusion reached by the Board in this Statement is that an entity's commitment to a plan, by itself, does not create a present obligation to others that meets the definition of a liability. Therefore, this Statement eliminates the definition and requirements for recognition of exit costs in Issue 94-3. This Statement also establishes that fair value is the objective for initial measurement of the liability. The provisions of this Statement are effective for exit or disposal activities that are initiated after December 31, 2002, with early application encouraged. The Company does not believe that FAS 146 will have a material impact on its consolidated financial statements. 16
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 the Company's interest rate sensitivity, or risk, is to provide management the tools necessary to manage the balance sheet to minimize adverse changes in net interest income as a result of changes in the direction and level of interest rates. Federal Reserve Board monetary control efforts, the effects of deregulation and legislative changes have been significant factors affecting the task of managing interest rate sensitivity positions in recent years. In an attempt to manage its exposure to changes in interest rates, management closely monitors the Company's exposure to interest rate risk. Management maintains an asset/liability committee which meets regularly and reviews the Company's interest rate risk position and makes recommendations for adjusting this position. In addition, the Board reviews on a monthly basis the Company's asset/liability position. The Company primarily uses two methods for measuring and analyzing interest rate risk: Net income simulation analysis and market value of portfolio equity modeling. Through these simulations the Company attempts to estimate the impact on net interest income of a 200 basis point parallel shift in the yield curve. Policy guidelines limit the estimated change in net interest income to 10 percent of forecasted net income over the succeeding 12 months and 200 basis point parallel rate shock. 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, 2002, were within policy guidelines. This type of stimulation analysis requires numerous assumptions including but not limited to changes in balance sheet mix, prepayment assumptions and changes in spreads. Assumptions are based on management's best estimates but may not accurately reflect actual results under certain changes in interest rates. 17
The following table provides information about the Company's financial instruments that are sensitive to changes in interest rates. Except for the effects of prepayments and scheduled principal amortization, the table presents principal cash flows and related weighted average interest rates by the contractual term to maturity. Nonaccrual loans are not included in the loan totals. All instruments are classified as other than trading. EXPECTED MATURITY DATE (dollars in thousands) <Table> <Caption> Twelve Months Ending June 30, ------------------------------------------------------------------------ Fair 2002 2003 2004 2005 2006 Thereafter Total Value --------- --------- --------- -------- -------- ---------- ----------- ---------- <S> <C> <C> <C> <C> <C> <C> <C> <C> Fixed Rate Loans ...... $211,116 $ 91,716 $ 54,002 $29,667 $16,494 $ 49,173 $ 452,168 $ 468,027 7.68% 7.67% 7.44% 7.23% 6.92% 5.88% 7.40% Adjustable Rate Loans . 31,143 4,200 6,781 9,029 17,408 30,094 98,655 98,655 5.44% 5.12% 5.39% 5.28% 5.29% 5.16% 5.30% Mortgage-backed Securities ............ 204,430 117,779 68,781 40,032 23,202 30,584 484,808 484,808 5.70% 5.72% 5.68% 5.65% 5.62% 5.54% 5.68% Investments and Other Interest Earning Assets .............. 35,423 6,447 265 4,456 1,046 122,763 170,400 170,400 3.37% 3.51% 7.66% 5.66% 7.15% 7.30% 6.30% Total Interest Earning Assets ........ $482,112 $220,142 $129,829 $83,184 $58,150 $232,614 $1,206,031 $1,221,890 6.38% 6.46% 6.40% 6.17% 5.92% 6.49% 6.38% Savings Deposits ...... $ 3,575 $ 1,787 $ 1,787 $ 1,787 $ 1,787 $ 25,020 $ 35,743 $ 33,956 1.50% 1.50% 1.50% 1.50% 1.50% 1.50% 1.50% NOW Deposits .......... 27,893 4,088 4,088 4,088 4,088 57,227 101,472 95,389 1.59% 1.00% 1.00% 1.00% 1.00% 1.00% 1.16% Money Market Deposits . 20,783 6,928 6,928 6,928 6,928 20,784 69,279 68,557 1.63% 1.62% 1.62% 1.62% 1.62% 1.62% 1.62% Platinum Money Market . 24,309 2,605 2,605 2,605 2,605 -- 34,729 35,143 1.88% 1.88% 1.88% 1.88% 1.88% -- 1.88% Certificates of Deposit ............ 257,076 44,872 25,351 7,359 21,087 406 356,151 363,142 3.17% 4.00% 5.31% 5.68% 5.09% 5.92% 3.60% FHLB Dallas Advances .. 136,675 98,798 49,251 31,352 15,476 38,162 369,714 376,131 3.91% 4.42% 4.59% 5.48% 5.33% 6.14% 4.56% Other Borrowings ...... 17,600 -- -- -- -- 35,070 52,670 52,670 2.36% -- -- -- -- 8.61% 6.52% Total Interest Bearing Liabilities ... $487,911 $159,078 $ 90,010 $54,119 $51,971 $176,669 $1,019,758 $1,024,988 3.12% 4.02% 4.26% 4.37% 4.09% 3.78% 3.59% </Table> 18
Residential fixed rate loans are assumed to have annual prepayment rates between 7% and 35% of the portfolio. Commercial and multi-family real estate loans are assumed to prepay at an annualized rate between 10% and 39%. Consumer loans are assumed to prepay at an annualized rate between 10% and 45%. Fixed and adjustable rate mortgage-backed securities, including Collateralized Mortgage Obligations ("CMOs") and Real Estate Mortgage Investment Conduits ("REMICs"), have annual payment assumptions ranging from 6% to 50%. At June 30, 2002, the contractual maturity of substantially all of the Company's mortgage-backed or related securities was in excess of ten years. The actual maturity of a mortgage-backed or related security is less than its stated maturity due to regular principal payments and prepayments of the underlying mortgages. Prepayments that are faster than anticipated may shorten the life of the security and affect its yield to maturity. The yield to maturity is based upon the interest income and the amortization of any premium or discount related to the security. In accordance with generally accepted accounting principles, premiums and discounts are amortized over the estimated lives of the loans, which decrease and increase interest income, respectively. The prepayment assumptions used to determine the amortization period for premiums and discounts can significantly affect the yield of the mortgage-backed or related security, and these assumptions are reviewed periodically to reflect actual prepayments. Although prepayments of underlying mortgages depend on many factors, including the type of mortgages, the coupon rate, the age of mortgages, the geographical location of the underlying real estate collateralizing the mortgages and general levels of market interest rates, the difference between the interest rates on the underlying mortgages and the prevailing mortgage interest rates generally is the most significant determinant of the rate of prepayments. During periods of falling mortgage interest rates, if the coupon rate of the underlying mortgages exceeds the prevailing market interest rates offered for mortgage loans, refinancing may increase and accelerate the prepayment of the underlying mortgages and the related security. At June 30, 2002, of the $484.8 million of mortgage-backed and related securities held by the Company, an aggregate of $481.5 million were collateralized by fixed-rate mortgage loans and an aggregate of $3.3 million were collateralized by adjustable-rate mortgage loans. The Company assumes 70% of savings accounts and transaction accounts at June 30, 2002, are core deposits and are, therefore, expected to roll-off after five years. The Company assumes 30% of Money Market accounts at June 30, 2002 are core deposits and are, therefore, expected to roll-off after five years. The Company does not consider any of its Platinum Money Markets accounts as core deposits. No roll-off rate is applied to certificates of deposit. Fixed maturity deposits reprice at maturity. In evaluating the Company's exposure to interest rate risk, certain limitations inherent in the method of analysis presented in the foregoing table must be considered. For example, although certain assets and liabilities may have similar maturities or periods to repricing, they may react in different degrees to changes in market interest rates. Also, the interest rates on certain types of assets and liabilities may fluctuate in advance of changes in market interest rates, while interest rates on other types may lag behind changes in market rates. Additionally, certain assets, such as adjustable rate mortgages, have features which restrict changes in interest rates, prepayment and early withdrawal levels may deviate significantly from those assumed in calculating the table. Finally, the ability of many borrowers to service their debt may decrease in the event of an interest rate increase. The Company considers all of these factors in monitoring its exposure to interest rate risk. 19
PART II.OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS The Company is a party to certain litigation that it considers routine and incidental to its business. Management does not expect the results of any of these actions to have a material effect on the Company's business, results of operations or financial condition. 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. ------- * 99.1 - Certification Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 -------------- * Filed herewith. (b) Reports on Form 8-K - None 20
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: August 12, 2002 ------------------------- /s/ LEE R. GIBSON ----------------------------------- Lee R. Gibson, Executive Vice President (Principal Financial and Accounting Officer) DATE: August 12, 2002 ------------------------- 21
Exhibit Index <Table> <Caption> EXHIBIT NUMBER DESCRIPTION ------- ----------- <S> <C> 99.1 Certification Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 </Table> 22