-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, UE2AIaq+K4TG347hqpwtCOZJ5oatEiPWTWjPJAPof2a5J96UaSYMIl7Png3inLsg 4WWj54RXvRrQkZm4R5TS3w== 0000909143-98-000047.txt : 19980330 0000909143-98-000047.hdr.sgml : 19980330 ACCESSION NUMBER: 0000909143-98-000047 CONFORMED SUBMISSION TYPE: 10-K405 PUBLIC DOCUMENT COUNT: 4 CONFORMED PERIOD OF REPORT: 19971231 FILED AS OF DATE: 19980327 SROS: AMEX FILER: COMPANY DATA: COMPANY CONFORMED NAME: INDEPENDENT BANKSHARES INC CENTRAL INDEX KEY: 0000318870 STANDARD INDUSTRIAL CLASSIFICATION: NATIONAL COMMERCIAL BANKS [6021] IRS NUMBER: 751717279 STATE OF INCORPORATION: TX FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K405 SEC ACT: SEC FILE NUMBER: 001-11531 FILM NUMBER: 98576608 BUSINESS ADDRESS: STREET 1: 547 CHESTNUT ST STREET 2: PO BOX 3296 CITY: ABILENE STATE: TX ZIP: 79604 BUSINESS PHONE: 9156775550 10-K405 1 ANNUAL REPORT ON FORM 10-K ================================================================= UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 ______________________________ FORM 10-K [ ] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the Fiscal Year Ended: December 31, 1997 or [ X ] 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: 0-10196 INDEPENDENT BANKSHARES, INC. (Exact Name of Registrant as Specified in its Charter) Texas 75-1717279 (State or Other Jurisdiction of (I.R.S. Employer Incorporation or Organization) Identification No.) 547 Chestnut Street Abilene, Texas 79602 (Address of Principal Executive Offices) (Zip Code) Registrant's Telephone Number, Including Area Code: (915) 677-5550 Securities Registered Pursuant to Section 12(b) of the Act: Common Stock, par value $0.25 per share Securities Registered Pursuant to Section 12(g) of the Act: None ______________________________ 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 [ ] Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the Registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [ ] The aggregate market value of the voting stock held by nonaffiliates of the Registrant, based on the market value of such stock on March 16, 1998, was $25,081,000. For purposes of this computation, all executive officers, directors and 5% beneficial owners of the Registrant are deemed to be affiliates. Such determination should not be deemed an admission that such executive officers, directors and beneficial owners are, in fact, affiliates of the Registrant. At March 16, 1998, 1,977,099 shares of the Registrant's common stock, $0.25 par value per share, were outstanding. DOCUMENTS INCORPORATED BY REFERENCE Portions of the following documents are incorporated by reference into the indicated part or parts of this report: (1) Annual Report to Shareholders for the fiscal year ended December 31, 1997, furnished to the Commission pursuant to Rule 14a-3(b) - Part II and Part IV. (2) Definitive proxy statement to be filed with the Commission pursuant to Regulation 14A in connection with the Annual Meeting of Shareholders to be held April 28, 1998 - Part III. ================================================================== PART I OTHER THAN HISTORICAL AND FACTUAL STATEMENTS, THE MATTERS AND ITEMS DISCUSSED IN THIS ANNUAL REPORT ON FORM 10-K ARE FORWARD- LOOKING STATEMENTS THAT INVOLVE RISKS AND UNCERTAINTIES. ACTUAL RESULTS OF INDEPENDENT BANKSHARES, INC. AND ITS SUBSIDIARIES MAY DIFFER MATERIALLY FROM THE RESULTS DISCUSSED IN THE FORWARD-LOOKING STATEMENTS. CERTAIN FACTORS THAT COULD CONTRIBUTE TO SUCH DIFFERENCES ARE DISCUSSED WITH THE FORWARD-LOOKING STATEMENTS THROUGHOUT THIS REPORT AND ARE SUMMARIZED IN "MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - FORWARD-LOOKING STATEMENTS - CAUTIONARY LANGUAGE." ITEM 1. BUSINESS General - ------- Independent Bankshares, Inc., a Texas corporation (the "Company"), is a bank holding company headquartered in Abilene, Texas. The Company indirectly owns through a Delaware subsidiary, Independent Financial Corp. ("Independent Financial"), 100% of the stock of First State Bank, National Association, Abilene, Texas (the "Bank"). The Bank currently operates full-service banking locations in the West Texas cities of Abilene (3 locations), Lubbock, Odessa (3 locations), San Angelo, Stamford and Winters. The Company's primary activities are to assist the Bank in the management and coordination of its financial resources and to provide capital, business development, long range planning and public relations for the Bank. The Bank operates under the day-to-day management of its own officers and board of directors and formulates its own policies with respect to banking matters. At December 31, 1997, the Company had, on a consolidated basis, total assets of $264,574,000, total deposits of $242,801,000, total loans, net of unearned income, of $140,853,000 and total stockholders' equity of $20,527,000. The Company's net income has grown from $224,000 in 1991 to $2,110,000 in 1997. Additionally, since 1991, the Company's total loans have grown at an 18% average annual rate, resulting from a combination of internal growth and the Company's acquisition of community banks. The Company's complete mailing address and telephone number is 547 Chestnut Street, Abilene, Texas 79602, (915) 677-5550. The Bank - -------- The Company conducts substantially all of its business through the Bank and its various branches in West Texas. Each of the Bank's branches is an established franchise with a significant presence in its respective service area. The combined branches in Abilene had the sixth largest total deposits of ten commercial banks that had branch(es) in Taylor County, at June 30, 1997, the latest date for which information is available. The branches in Stamford and Winters were the largest bank branches in Jones and Runnels Counties, respectively, in terms of total deposits at June 30, 1997. The combined branches in Odessa had the sixth largest total deposits of eight banks that had branch(es) in Ector County at June 30, 1997. The branch in San Angelo had the eighth largest total deposits of ten banks that had branch(es) in Tom Green County at June 30, 1997. The branch in Lubbock had the tenth largest total deposits of twenty-one banks that had branch(es) in Lubbock County at June 30, 1997. The Bank operates through its branches as a community bank that focuses on long-term relationships with customers and provides individualized, quality service. Reflecting its community banking heritage, the Bank has a stable deposit base from customers located within its West Texas market area. Its recent financial performance is characterized by consistent core earnings, an increasingly diversified loan portfolio and strong asset quality. The deposits of the Bank are insured by the Federal Deposit Insurance Corporation (the "FDIC") to the maximum extent provided by law. At December 31, 1997, the Bank had total assets of $263,426,000, total deposits of $243,130,000, total loans, net of unearned income, of $140,853,000, and total stockholders' equity of $19,044,000. The principal services provided by the Bank are as follows: COMMERCIAL SERVICES. The Bank provides a full range of banking services for its commercial customers. Commercial lending activities include short-term and medium-term loans, revolving credit arrangements, inventory and accounts receivable financing, equipment financing and interim and permanent real estate lending. Other services include cash management programs and federal tax depository and night depository services. -2- CONSUMER SERVICES. The Bank also provides a wide range of consumer banking services, including checking, savings and money market accounts, savings programs and installment and personal loans. The Bank makes automobile and other installment loans directly to customers, as well as indirectly through automobile dealers. The Bank makes home improvement, home equity and real estate loans and provide safe deposit services. As a result of sharing arrangements with the Pulse automated teller machine system network, the Bank provides 24-hour routine banking services through automated teller machines ("ATMs"). The Pulse network provides ATM accessibility throughout the United States. The Bank also offers investment services and banking by phone or personal computer. TRUST SERVICES. The Bank provides trust and agency services to individuals, partnerships and corporations from its offices in Abilene, Lubbock and Odessa. The trust division also provides investment manage,ment, administration and advisory services for agency and trust accounts, and acts as trustee for pension and profit sharing plans. Acquisition and Branch Activities - --------------------------------- CROWN PARK AND WESTERN NATIONAL. On January 28, 1997, the Company consummated the acquisition of Crown Park Bancshares, Inc. ("Crown Park") and its wholly owned subsidiary bank, Western National Bank, Lubbock, Texas ("Western National"), for an aggregate cash purchase price of $7,510,000. On the closing date, Crown Park was merged with and into a wholly owned subsidiary of the Company and Western National was merged with and into the Bank. To obtain funding for the acquisition, simultaneously with the closing, the Company consummated an underwritten public offering of an aggregate of 395,312 shares of its common stock at a price of $11.40 per share (the "Offering"). This included 51,562 shares covered by the underwriter's over-allotment option. The Company borrowed $800,000 from a financial institution in Amarillo, Texas (the "Amarillo Bank") to finance the remaining cost of acquiring Crown Park. The $800,000 of borrowings was later reduced to $400,000 with the proceeds of the sale of the over-allotment shares and the remaining principal amount of this borrowing was paid in full by December 31, 1997. See "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital Resources." This acquisition was accounted for using the purchase method of accounting. A total of $2,486,000 of goodwill was recorded as a result of this transaction. At the date of acquisition, Crown Park had, on a consolidated basis, total assets of $60,420,000, total deposits of $53,604,000, total loans, net of unearned income, of $41,688,000, and stockholders' equity of $4,238,000. The Company has and will continue to realize savings in the area of noninterest expenses through consolidation of the operations of Western National into the Bank. In addition to the immediate increase in asset size and the potential for improved future profitability, the Crown Park acquisition has allowed the Company to expand its market area into what the Company believes is a desirable banking location. This expansion has increased the geographic diversity of the Company's loan portfolio, and, thus, decreased the Company's overall lending risks. ALBERTSON SUPERMARKET BRANCHES. During the second quarter of 1997, the Bank filed an application with the Office of the Comptroller of the Currency (the "Comptroller") to establish four additional branch banking facilities. These facilitates, two in Abilene and two in Odessa, are to be located in Albertson's supermarkets. The Bank received approval to open the branches during the third quarter and in October 1997 opened two full- service branch locations in Albertson's supermarkets, one in Abilene and one in Odessa. One additional branch in another Albertson's supermarket in Odessa is schedule to open during the second quarter of 1998. No definitive plans have been established for opening the fourth branch in Abilene at this time. Management of the Company believes that establishing bank branches in supermarkets is one of the most economical ways to increase the Bank's market share in its West Texas market area. Other Subsidiaries - ------------------ At the present time, the Company does not have any subsidiaries other than Independent Financial and the Bank. Business Strategy - ----------------- The Company's strategic plan contemplates an increase in profitability and shareholder value through the building of a valuable West Texas banking franchise consisting of low cost core deposits as a funding base to support local consumer and commercial lending programs. The Company's acquisition activities have been designed to augment this franchise by increasing market share and expanding into contiguous markets demographically similar to its current service areas. Following the acquisition of Crown Park and its subsidiary Western National, the Company has locations in four of the fastest growing consumer markets in West Texas. Management believes that it can increase the profitability of the Company through increased operating efficiencies, an increase in the loan to deposit ratio and cross-selling a more expansive product line to newly acquired customers. -3- The Company's operating strategy is to provide customers with the business sophistication and breadth of products of a regional financial services company, while retaining the special attention to personal service and the local appeal of a community bank. Decentralized decision making authority vested in the presidents and senior officers of the Abilene, Lubbock and Odessa branches allows for rapid response time and flexibility in dealing with customer requests and credit needs. The participation of the Company's directors, officers and employees in area civic and service organizations demonstrates the Company's continuing commitment to the communities it serves. Management believes that these qualities distinguish the Company from its competitors and will allow the Company to compete successfully in its market against larger regional and out-of-state institutions. Supervision and Regulation - -------------------------- References in this report to applicable statutes, regulations and policies are brief summaries thereof, do not purport to be complete, and are qualified in their entirety by reference to such statutes, regulations and policies. THE COMPANY General ------- The Company is a bank holding company registered with, and subject to regulation by the Board of Governors of the Federal Reserve System (the "Federal Reserve Board") under the Bank Holding Company Act of 1956, as amended (the "BHCA"). Federal law subjects bank holding companies to particular restrictions on the types of activities in which they may engage and to a range of supervisory requirements and activities, including regulatory enforcement actions for violations of laws and policies. Scope of Permissible Activities ------------------------------- The BHCA prohibits a bank holding company, with certain limited exceptions, from acquiring direct or indirect ownership or control of any voting shares of any company that is not a bank or from engaging in any activities other than those of banking. One principal exception to these prohibitions allows the acquisition of interests in companies whose activities are found by the Federal Reserve Board, by order or regulation, to be so closely related to banking as to be a proper incident thereto. Some of the activities that have been determined by regulation to be closely related to banking are making or servicing loans, performing certain data processing services, acting as an investment or financial advisor to certain investment trusts and investment companies and providing certain securities brokerage services. In approving acquisitions by the Company of entities engaged in banking-related activities, the Federal Reserve Board would consider a number of factors, including the expected benefits to the public, such as greater convenience and increased competition or gains in efficiency, which would be weighed against the risk of potential negative effects, such as undue concentration of resources, decreased or unfair competition, conflicts of interest or unsound banking practices. The Federal Reserve Board may also differentiate between activities commenced DE NOVO and activities commenced through the acquisition of a going concern. The Company has no current plans to form or acquire any non-banking subsidiaries. The Federal Reserve Board has approved applications by bank holding companies to engage, through nonbank subsidiaries, in certain securities-related activities (underwriting of municipal revenue bonds, commercial paper, consumer-receivable-related securities and certain mortgage-backed securities), provided that the subsidiaries would not be "principally engaged" in such activities for purposes of Section 20 of the Glass-Steagall Act. In very limited situations, holding companies may be able to use such subsidiaries to underwrite and deal in corporate debt and equity securities. Bills from time to time have been introduced in both the U.S. Senate and House of Representatives that would, if enacted, remove many of the restraints imposed by the Glass-Steagall Act, although no comprehensive bill has been enacted to date. On March 26, 1996, the U.S. Supreme Court ruled that Section 92 of the National Bank Act of 1864, as amended (the "National Bank Act"), preempts state insurance laws which prevent banks from exercising insurance powers granted under those laws. Section 92 grants national banks located and doing business in a place with a population not exceeding 5,000 inhabitants (the "Eligible Banks") the authority to act as insurance agent for any insurance company authorized to do business in a state where the bank is located. -4- In response to this decision, the 1997 Texas State Legislature amended Article 21.07 of the Texas Insurance Code (the "Code"), which governs the licensing of insurance agents, to include Eligible Banks. The Code contains licensing and consumer protection procedures that apply to all insurance agents in Texas, including banks and savings associations. In addition, the Comptroller has issued an advisory letter that provides guidance to national banks regarding insurance and annuity sales activities. The Comptroller has subsequently approved applications by banks to engage in such general insurance agency activities through operating subsidiaries. Bank holding companies are not permitted to engage in unsafe or unsound banking practices. For example, the Federal Reserve Board's Regulation Y requires a holding company to give the Federal Reserve Board prior notice of any redemption or repurchase of its own equity securities, if the consideration to be paid, together with the consideration paid for any repurchases or redemptions in the preceding twelve-month period, is equal to 10% or more of the company's consolidated net worth. The Federal Reserve Board may oppose the transaction if it would constitute an unsafe or unsound practice or would violate any law or regulation. Additionally, a holding company may not impair the financial soundness of a subsidiary bank by causing it to make funds available to nonbanking subsidiaries or their customers when such a transaction would not be prudent. The Federal Reserve Board may exercise several administrative remedies including cease-and-desist powers over parent holding companies and nonbanking subsidiaries when the actions of such companies would constitute a serious threat to the safety, soundness or stability of a subsidiary bank. The Financial Institutions Reform, Recovery and Enforcement Act of 1989 ("FIRREA") expanded the Federal Reserve Board's authority to prohibit activities of bank holding companies and their nonbanking subsidiaries that represent unsafe and unsound banking practices or that constitute violations of laws or regulations. FIRREA authorizes the appropriate banking agency to issue cease and desist orders that may, among other things, require affirmative action to correct any harm resulting from a violation or practice, including restitution, reimbursement, indemnification or guarantee against loss. A financial institution may also be ordered to restrict its growth, dispose of certain assets or take other appropriate action as determined by the ordering agency. FIRREA increased the amount of civil money penalties that the Federal Reserve Board may assess for certain activities conducted on a knowing and reckless basis, if those activities cause a substantial loss to a depository institution. The penalties may reach as much as $1,000,000 per day. FIRREA also expanded the scope of individuals and entities or "institution-affiliated parties" against which such penalties may be assessed. In addition, FIRREA contains a "cross-guarantee" provision that makes commonly controlled insured depository institutions liable to the FDIC for any losses incurred, or reasonably anticipated to be incurred, in connection with the failure of an affiliated insured depository institution. The FDIC must present its claim within two years of incurring such loss and may require either immediate or installment payments. Bank holding companies and their affiliates are prohibited from tying the provision of certain services, such as extensions of credit, to certain other services offered by a holding company or its affiliates. The Company is required to file quarterly and annual reports with the Federal Reserve Bank of Dallas (the "Federal Reserve Bank") and such additional information as the Federal Reserve Bank may require pursuant to the BHCA. The Federal Reserve Bank may examine a bank holding company or any of its subsidiaries and charge the examined institution for the cost of such an examination. The Company is also subject to reporting and disclosure requirements under state and federal securities laws. Capital Adequacy Requirements ----------------------------- The Federal Reserve Board monitors the capital adequacy of bank holding companies. The Federal Reserve Board has adopted a system using a combination of risk-based guidelines and leverage ratios to evaluate the capital adequacy of bank holding companies. Under the risk-based capital guidelines, each category of assets is assigned a different risk weight, based generally on the perceived credit risk of the asset. These risk weights are multiplied by corresponding asset balances to determine a "risk-weighted" asset base. Certain off-balance sheet items, which previously were not expressly considered in capital adequacy computations, are added to the risk-weighted asset base by converting them to a balance sheet equivalent and assigning to them the appropriate risk weight. In addition, the guidelines define the capital components. Total capital is defined as the sum of Tier 1 and Tier 2 capital elements, with Tier 2 being limited to 100% of Tier 1. For the Company, Tier 1 capital includes common stockholders' equity and qualifying perpetual preferred stock, reduced by goodwill. Tier 2 capital for the Company includes all of the allowance for possible loan losses. -5- The guidelines require a minimum ratio of qualifying total capital to total risk-weighted assets of 8.0% (of which at least 4.0% is required to be in the form of Tier 1 capital elements). To be designated as well capitalized, a banking company must have Tier 1 and total capital ratios of 8% and 10%, respectively. At December 31, 1997, the Company's ratios of Tier 1 and total capital to risk-weighted assets were 11.26% and 12.02%, respectively, and the Bank's ratios of Tier 1 and total capital to risk-weighted assets were 10.24% and 11.00%, respectively. At such date, all ratios exceeded both regulatory and well capitalized bank minimums. In addition to the risk-based capital guidelines, the Federal Reserve Board and the FDIC have adopted the use of a leverage ratio as an additional tool to evaluate the capital adequacy of bank holding companies and banks. The leverage ratio is defined to be a company's Tier 1 capital divided by its adjusted quarterly average total assets. The leverage ratio adopted by the federal banking agencies requires a regulatory minimum of 3% and a minimum of 6.0% Tier 1 capital to adjusted quarterly average total assets ratio for a banking organization to be considered well capitalized. The Company's and the Bank's leverage ratios at December 31, 1997, were 6.71% and 6.18%, respectively, and each was considered to be well capitalized under the risk-based capital guidelines. A bank holding company that fails to meet the applicable capital standards will be at a disadvantage. For example, Federal Reserve Board policy discourages the payment of dividends by a bank holding company from borrowed funds as well as payments that would adversely affect capital adequacy. Failure to meet the capital guidelines may result in institution by the Federal Reserve Board of appropriate supervisory or enforcement actions. Imposition of Liability for Undercapitalized Subsidiaries --------------------------------------------------------- The Federal Deposit Insurance Corporation Improvement Act of 1991 ("FDICIA") became effective at various times through January 1994. FDICIA requires bank regulators to take "prompt corrective action" to resolve problems associated with insured depository institutions. In the event an institution becomes "undercapitalized," it must submit a capital restoration plan. The capital restoration plan will not be accepted by applicable regulators unless each company "having control of" the undercapitalized institution "guarantees" the subsidiary's compliance with the capital restoration plan until it becomes "adequately capitalized." The Company has control of the Bank for purposes of this statute. Under FDICIA, the aggregate liability of all companies controlling a particular institution is generally limited to the lesser of 5% of the institution's assets at the time it became undercapitalized or the amount necessary to bring the institution into compliance with applicable capital standards. FDICIA grants greater powers to regulatory authorities in situations where an institution becomes "significantly" or "critically" undercapitalized or fails to submit a capital restoration plan. For example, a bank holding company controlling such an institution may be required to obtain prior Federal Reserve Board approval of proposed dividends or could be required to consent to a merger or to divest the troubled institution or other affiliates. Acquisitions by Bank Holding Companies -------------------------------------- Subject to certain exceptions, the BHCA requires every bank holding company to obtain the prior approval of the Federal Reserve Board before it may acquire all or substantially all of the assets of any bank, or ownership or control of any voting shares of any bank, if after such acquisition it would own or control, directly or indirectly, more than 5% of the voting shares of such bank. In approving bank acquisitions by bank holding companies, the Federal Reserve Board is required to consider the financial and managerial resources and future prospects of the bank holding company and the banks concerned, the convenience and needs of the communities to be served, and various competitive factors. The Attorney General of the United States may, within 30 days after approval of an acquisition by the Federal Reserve Board, bring an action challenging such acquisition under the federal antitrust laws, in which case the effectiveness of such approval is stayed pending a final ruling by the courts. Currently, the Federal Reserve Board will only allow the acquisition by a bank holding company of an interest in any bank located in another state if the statutory laws of the state in which the target bank is located expressly authorize such acquisition. The Texas Banking Act permits, in certain circumstances, out-of-state bank holding companies to acquire certain existing banks and bank holding companies in Texas. However, the Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 (the "Interstate Act"), permits bank holding companies to acquire banks located in any state without regard to whether the transaction is prohibited under any state law, except that states may establish the minimum age of their local banks subject to interstate acquisition by out-of-state bank holding companies. The minimum age of local banks subject to interstate acquisition is limited to a maximum of five years. -6- FDICIA eased restrictions on cross-industry mergers. Members of the Bank Insurance Fund (the "BIF") and the Savings Association Insurance Fund (the "SAIF") are generally allowed to merge, assume each other's deposits, and transfer assets in exchange for an assumption of deposit liabilities. A formula applies to treat insurance assessments relating to acquired deposits as if they were still insured through the acquired institution's insurance fund. The transaction must be approved by the appropriate federal banking regulator. In considering such approval, the regulators take into account applicable capital requirements, certain interstate banking restrictions and other factors. The Competitive Equality Banking Act of 1987 ("CEBA") amended the Federal Deposit Insurance Act and certain other statutes to provide federal regulatory agencies with expanded authority to deal with troubled institutions. Among other things, CEBA expanded the ability of out-of-state holding companies to acquire certain financial institutions that are in danger of closing and permits the FDIC, in certain circumstances, to establish a "bridge bank" to assume the deposits or liabilities of one or more closed banks or to perform certain other functions. THE BANK General ------- The Bank is a national banking association organized under the National Bank Act, and is subject to regulatory supervision and examination by the Comptroller. Pursuant to such regulation, the Bank is subject to special restrictions, supervisory requirements and potential enforcement actions. Permissible Activities for National Banks ----------------------------------------- The National Bank Act delineates the rights, privileges and powers of national banks and defines the activities in which national banks may engage. National banks are authorized to engage in the following: make, arrange, purchase or sell loans or extensions of credit secured by liens on interests in real estate; purchase, hold and convey real estate under certain conditions; offer certain trust services to the public; deal in investment securities in certain circumstances; and, more broadly, engage in the "business of banking" and activities that are "incidental" to banking. Specifically, the following are a few of the activities deemed incidental to the business of banking: the borrowing and lending of money; receiving deposits, including deposits of public funds; holding or selling stock or other property acquired in connection with security on a loan; discounting and negotiating evidences of debt; acting as guarantor, if the bank has a "substantial interest in the performance of the transaction"; issuing letters of credit to or on behalf of its customers; operating a safe deposit business; providing check guarantee plans; issuing credit cards; operating a loan production office; selling loans under repurchase agreements; selling money orders at offices other than bank branches; providing consulting services to banks; and verifying and collecting checks. In general, statutory restrictions on the activities of banks are aimed at protecting the safety and soundness of such depository institutions. Many of the statutory restrictions limit the participation of national banks in the securities and insurance product markets. These restrictions do not now affect the Bank, because the Bank is not presently involved in the types of transactions covered by the restrictions. Branching --------- National banks may establish a branch anywhere in Texas provided that the branch is approved in advance by the Comptroller, which considers a number of factors, including financial history, capital adequacy, earnings prospects, character of management, needs of the community and consistency with corporate powers. The Interstate Banking Act, which expands the authority of bank holding companies and banks to engage in interstate bank acquisitions and interstate banking, allows each state the option of "opting out" of the interstate branching (but not banking) provisions. The Texas Legislature opted out of the interstate branching provisions during its 1995 Session. Interstate banking was effective on September 29, 1995, and interstate branching would have become effective in Texas in June 1997, if Texas had not elected to "opt out." The Texas Legislature "opt-out" legislation prohibiting interstate branching is effective until September 1999. Restrictions on Transactions with Affiliates -------------------------------------------- Certain provisions of FDICIA applicable to the Bank enhance safeguards against insider abuse by recodifying current law restricting transactions among related parties. One set of restrictions is found in Section 23A of the Federal Reserve Act, which affects loans to and investments in "affiliates" of the Bank. The term "affiliates" include the Company and any of its subsidiaries. Section 23A imposes limits on the amount of such transactions and also requires certain levels of collateral for such loans. In addition, Section 23A limits the amount of advances to third parties that are collateralized by the securities or obligations of the Company or its subsidiaries. -7- Another set of restrictions is found in Section 23B of the Federal Reserve Act. Among other things, Section 23B requires that certain transactions between the Bank and its affiliates must be on terms substantially the same, or at least as favorable to the Bank, as those prevailing at the time for comparable transactions with or involving other nonaffiliated companies. In the absence of such comparable transactions, any transaction between the Bank and its affiliates must be on terms and under circumstances, including credit underwriting standards and procedures, that in good faith would be offered to or would apply to nonaffiliated companies. The Bank is also subject to certain prohibitions against advertising that suggests that the Bank is responsible for the obligations of its affiliates. The restrictions on loans to insiders contained in the Federal Reserve Act and Regulation O of the Federal Reserve Board now apply to all insured institutions and their subsidiaries and holding companies. The aggregate amount of an institution's loans to insiders is limited to the amount of its unimpaired capital and surplus, unless the FDIC determines that a lesser amount is appropriate. The Bank may pay, on behalf of any executive officer or director, an amount exceeding funds on deposit in that individual's personal account only if there is a written, preauthorized, interest-bearing extension of credit specifying a method of repayment and a written preauthorized transfer of funds from another account of the executive officer or director at the Bank. Insiders are subject to enforcement actions for knowingly accepting loans in violation of applicable restrictions. Interest Rate Limits and Lending Regulations -------------------------------------------- The Bank is subject to various state and federal statutes relating to the extension of credit and the making of loans. The maximum legal rate of interest that the Bank may charge on a loan depends on a variety of factors such as the type of borrower, purpose of the loan, amount of the loan and date the loan is made. Texas statutes establish maximum legal rates of interest for various lending situations. Loans made by banks located in Texas are subject to numerous other federal and state laws and regulations, including truth-in-lending statutes, the Texas Consumer Credit Code, the Equal Credit Opportunity Act, the Real Estate Settlement Procedures Act and the Home Mortgage Disclosure Act. These laws provide remedies to the borrower and penalties to the lender for failure of the lender to comply with such laws. The scope and requirements of these laws and regulations have expanded in recent years, and claims by borrowers under these laws and regulations may increase. Restrictions on Subsidiary Bank Dividends ----------------------------------------- Dividends payable by the Bank to Independent Financial are restricted under the National Bank Act. The Bank's ability to pay dividends is further restricted by the requirement that it maintain adequate capital in accordance with capital adequacy guidelines promulgated from time to time by the Comptroller. See "Dividend Policy." Moreover, the prompt corrective provisions of FDICIA and implementing regulations prohibit a bank from paying a dividend if, following the payment, the bank would be in any of the three capital categories for undercapitalized institutions. See "Capital Adequacy Requirements" below. Examinations ------------ The Comptroller periodically examines and evaluates national banks. Based upon such evaluations, the Comptroller may revalue certain assets of an institution and require that it establish specific reserves to compensate for the difference between the regulatory-determined value and the book value of such assets. The Comptroller is authorized to assess the institution an annual fee based upon deposits for, among other things, the costs of conducting the examinations. Capital Adequacy Requirements ----------------------------- FDICIA, among other things, substantially revised existing statutory capital standards, restricted certain powers of state banks, gave regulators the authority to limit officer and director compensation and required holding companies to guarantee the capital compliance of their banks in certain instances. Among other things, FDICIA requires the federal banking agencies to take "prompt corrective action" with respect to banks that do not meet minimum capital requirements. FDICIA established five capital tiers: "well capitalized," "adequately capitalized," "undercapitalized," "significantly undercapitalized" and "critically undercapitalized," as defined by regulations adopted by the Federal Reserve Board, the FDIC and the other federal depository institution regulatory agencies. A depository institution is well capitalized if it significantly exceeds the minimum level required by regulation for each relevant capital measure, adequately capitalized if it meets such measure, undercapitalized if it fails to meet any such measure, significantly undercapitalized if it is significantly below such measure and critically undercapitalized if it fails to meet any critical capital level set forth in the regulations. The critical capital level must be a level of tangible equity capital equal to the greater of 2% of total tangible assets or 65% of the minimum leverage ratio to be prescribed by regulation. -8- An institution may be deemed to be in a capitalization category that is lower than is indicated by its actual capital position if it receives an unsatisfactory examination rating. At December 31, 1997, the Bank was considered to be well capitalized. Banks with capital ratios below the required minimum are subject to certain administrative actions, including the termination of deposit insurance upon notice and hearing, or a temporary suspension of insurance without a hearing in the event the institution has no tangible capital. Corrective Measures for Capital Deficiencies -------------------------------------------- FDICIA requires the federal banking regulators to take "prompt corrective action" with respect to capital-deficient institutions with the overall goal to reduce losses to the depository insurance fund. In addition to requiring the submission of a capital restoration plan (as discussed above), FDICIA contains broad restrictions on certain activities of undercapitalized institutions involving asset growth, acquisitions, branch establishment and expansion into new lines of business. With certain exceptions, an insured depository institution is prohibited from making capital distributions, including dividends, and is prohibited from paying management fees to control persons if the institution would be undercapitalized after any such distribution or payment. As an institution's capital decreases, the FDIC's powers and scrutiny become greater. A significantly under-capitalized institution is subject to mandated capital raising activities, restrictions on interest rates paid and transactions with affiliates, removal of management, and other restrictions. Under proposed regulations, an institution will be considered critically undercapitalized if its tangible equity to assets ratio falls below 2%. The FDIC has only very limited discretion in dealing with a critically undercapitalized institution and is virtually required to appoint a receiver or conservator. Real Estate Lending Evaluations and Appraisal Requirements ---------------------------------------------------------- The FDIC is required by the Federal Deposit Insurance Act to assess all banks in order to adequately fund the BIF so as to resolve any insured institution that is declared insolvent by its primary regulator. FDICIA required the federal banking regulators to adopt uniform standards for evaluations by the regulators of loans collateralized by real estate or made to finance improvements to real estate. In formulating the standards, the banking agencies were required to take into consideration the risk posed to the insurance funds by real estate loans, the need for safe and sound operation of insured depository institutions and the availability of credit. FDICIA also prohibits the regulators from adversely evaluating a real estate loan or investment solely on the grounds that the investment involves commercial, residential or industrial property, unless the safety and soundness of an institution may be affected. The federal agencies adopted a number of regulatory standards with regard to real estate lending. These standards require banking institutions to establish and maintain written internal real estate lending policies. These policies must not only be consistent with safe and sound banking practices, but must also be appropriate to the size of the institution and the nature and scope of its operations. The policies must establish loan portfolio diversification standards, prudent underwriting standards, including clear and measurable loan-to-value limits (although such limits should not exceed specific supervisory limits), loan administration procedures and comprehensive documentation, approval and reporting requirements to ensure compliance with these policies. Additionally, the institution's policies must be reviewed and approved by that institution's Board of Directors on at least an annual basis and such policies must be continually monitored by the institutions to ensure compatibility with current market conditions. In addition, banks are required to secure appraisals for real estate-collateralized loans with a transaction value of $250,000 or more. Deposit Insurance Assessments ----------------------------- The FDIC is required by the Federal Deposit Insurance Act to assess all banks in order to adequately fund the BIF so as to resolve any insured institution that is declared insolvent by its primary regulator. FDICIA required the FDIC to establish a risk-based deposit insurance premium schedule. The risk-based assessment system is used to calculate a depository institution's semi-annual deposit insurance assessment based upon the designated reserve ratio for the deposit insurance fund and the probability and extent to which the deposit insurance fund will incur a loss with respect to this institution. In addition, the FDIC can impose special assessments to cover the cost of borrowings from the U.S. Treasury, the Federal Financing Bank and BIF member banks. -9- On September 15, 1992, the FDIC issued a rule revising its assessment regulations from the existing flat-rate system for deposit insurance assessments (or "premiums") to a new, risk-based assessment system. This system became effective for the assessment period beginning January 1, 1993. Under this system, each depository institution will be placed in one of nine assessment categories based on certain capital and supervisory measures. Institutions assigned to higher-risk categories - that is, institutions that pose a greater risk of loss to their respective deposit insurance funds - pay assessments at higher rates than would institutions that pose a lower risk. The Bank was assessed a weighted average premium of 0.016% of average deposits for the year ended December 31, 1997. On August 8, 1995, the FDIC amended its regulations to change the range of deposit insurance assessments charged to members of the BIF from the then-prevailing range of 0.23% to 0.31% of deposits, to a range of 0.04% to 0.31% of deposits. On November 14, 1995, the FDIC further reduced the deposit insurance assessments for BIF-member institutions, such that the range of BIF assessments is currently between 0% and 0.27% of deposits. BIF-member institutions which qualified for the 0% assessment category were, until September 30, 1996, required to pay the $1,000 minimum semi-annual assessment required by federal statute. In connection with the new rate schedule, the FDIC established a process for raising or lowering all rates for BIF-insured institutions semi-annually if conditions warrant a change. Under this new system, the FDIC will have the flexibility to adjust the entire BIF assessment rate schedule twice a year without seeking public comment first, but only within a range of five cents per $100 above or below the premium schedule adopted. Changes in the rate schedule outside the five cent range above or below the current schedule can be made by the FDIC only after a full rulemaking with opportunity for public comment. On September 30, 1996, President Clinton signed into law an act that contained a comprehensive approach to recapitalizing the SAIF and to assure the payment of the Financing Corporation's ("FICO") bond obligations. Under this new act, banks insured under the BIF are required to pay a portion of the interest due on bonds that were issued by FICO in 1987 to help shore up the ailing Federal Savings and Loan Insurance Corporation ("FSLIC"). The amount of FICO debt service to be paid by all BIF-insured institutions is currently estimated to be approximately $320,343,000 per year, or 0.013% of deposits from 1997 until the year 2000, when the obligation of BIF-insured institutions increases to approximately $598,500,000 or 0.024% of deposits per year through the year 2019. Community Reinvestment Act -------------------------- The Community Reinvestment Act of 1977 (the "CRA") and the regulations issued by the Comptroller to implement that law are intended to encourage banks to help meet the credit needs of their service area, including low and moderate income neighborhoods, consistent with the safe and sound operations of the banks. These regulations also provide for regulatory assessment of a bank's record in meeting the needs of its service area when considering applications to establish branches, merger applications and applications to acquire the assets and assume the liabilities of another bank. FIRREA requires federal banking agencies to make public a rating of a bank's performance under the CRA. In the case of a bank holding company, the CRA performance record of the banks involved in the transaction are reviewed in connection with the filing of an application to acquire ownership or control of shares or assets of a bank or to merge with any other bank holding company. An unsatisfactory record can substantially delay or block the transaction. The bank regulatory agencies in 1995 adopted final regulations implementing the CRA. These regulations affect extensive changes to the existing procedures for determining compliance with the CRA and the full effect of these new regulations cannot be determined at this time. Changing Regulatory Structure ----------------------------- Other legislative and regulatory proposals regarding changes in banking, and regulations of banks, thrifts and other financial institutions, are being considered by the executive branch of the federal government, Congress and various state governments, including Texas. Certain of these proposals, if adopted, could significantly change the regulation of banks and the financial services industry. The Company cannot predict accurately whether any of these proposals will be adopted or, if adopted, how these proposals will affect the Company or the Bank. Expanding Enforcement Authority ------------------------------- One of the major additional burdens imposed on the banking industry by FDICIA is the increased ability of banking regulators to monitor the activities of banks and their holding companies. In addition, the Federal Reserve Board and FDIC are possessed of extensive authority to police unsafe or unsound practices and violations of applicable laws and regulations by depository institutions and other holding companies. For example, the FDIC may terminate the deposit insurance of any institution that it determines has engaged in an unsafe or unsound practice. The regulatory agencies can also assess civil money penalties, issue cease and desist or removal orders, seek injunctions and publicly disclose such actions. FDICIA, FIRREA and other laws have expanded the agencies' authority in recent years, and the agencies have not yet fully tested the limits of their powers. -10- Effect on Economic Environment ------------------------------ The policies of regulatory authorities, including the monetary policy of the Federal Reserve Board, have a significant effect on the operating results of bank holding companies and their subsidiaries. Among the means available to the Federal Reserve Board to affect the money supply are open market operations in U.S. Government securities, control of borrowings at the "discount window," changes in the discount rate on member bank borrowings, changes in reserve requirements against member bank deposits and against certain borrowings by banks and their affiliates and the placing of limits on interest rates that member banks may pay on time and savings deposits. These means are used in varying combinations to influence overall growth and distribution of bank loans, investments and deposits, and their use may affect interest rates charged on loans or paid for deposits. Federal Reserve Board monetary policies have materially affected the operating results of commercial banks in the past and are expected to continue to do so in the future. The Company cannot predict the nature of future monetary policies and the effect of such policies on the business and earnings of the Company and the Bank. Competition - ----------- The activities in which the Company and the Bank engage are highly competitive. Each activity engaged in and the geographic market served involves competition with other banks and savings and loan associations as well as with nonbanking financial institutions and nonfinancial enterprises. In Texas, savings and loan associations and banks are allowed to establish statewide branch offices. The Bank actively competes with other banks in its effort to obtain deposits and make loans, in the scope and type of services offered, in interest rates paid on time deposits and charged on loans and in other aspects of banking. In addition to competing with other commercial banks within and without its primary service areas, the Bank competes with other financial institutions engaged in the business of making loans or accepting deposits, such as savings and loan associations, credit unions, insurance companies, small loan companies, finance companies, mortgage companies, real estate investment trusts, factors, certain governmental agencies, credit card organizations and other enterprises. Additional competition for deposits comes from government and private issues of debt obligations and other investment alternatives for depositors such as money market funds. The Bank also competes with suppliers of equipment in providing equipment financing. Employees - --------- At February 28, 1998, the Company and the Bank had 137 full-time equivalent employees. Employees are provided with employee benefits, such as an employee stock ownership/401(k) plan and life, health and long-term disability insurance plans. The Company considers the relationship of the Bank with its employees to be excellent. ITEM 2. PROPERTIES At February 28, 1998, the Company occupied approximately 600 square feet of space for its corporate offices at 547 Chestnut Street, Abilene, Texas. The Main Bank occupies approximately 8,000 square feet at this same facility. The following table sets forth, at February 28, 1998, certain information with respect to the banking premises owned or leased by the Company and the Bank. The Company considers such premises adequate for its needs and the needs of the Bank. -11- Approximate Location Square Footage Ownership and Occupancy - -------------- -------------- ------------------------- Abilene, Texas 8,600 Owned by the Bank; occupied by the Main Bank and the Company Abilene, Texas 3,500 Owned by the Bank; occupied by the Wylie Branch Abilene, Texas 400 Leased by the Bank; occupied by the Buffalo Gap Road Branch Lubbock, Texas 23,200(1) Owned by the Bank; occupied and leased by the Lubbock Branch Odessa, Texas 62,400(2) Owned by the Bank; occupied and leased by the Odessa Branch Odessa, Texas 2,400 Leased by the Bank; occupied by the Winwood Branch Odessa, Texas 400 Leased by the Bank; occupied by the 42nd Street Branch San Angelo, Texas 6,800(3) Owned by the Bank; occupied and leased by the San Angelo Branch Stamford, Texas 14,000 Owned by the Bank; occupied by the Stamford Branch Winters, Texas 9,500 Owned by the Bank; occupied by the Winters Branch _________________ (1) The Lubbock Branch occupies approximately 13,300 square feet, leases 7,800 square feet and is attempting to lease the remaining 2,100 square feet. (2) The Odessa Branch occupies approximately 18,500 square feet, leases 29,200 square feet and is attempting to lease the remaining 14,700 square feet. (3) The San Angelo Branch occupies approximately 3,400 square feet, leases 2,600 square feet and is attempting to lease the remaining 800 square feet. The Bank owns or leases certain additional tracts of land for parking, drive-in facilities and for future expansion or construction of new premises. Aggregate annual rentals of the Company and the Bank for all leased premises during the year ended December 31, 1997, were $51,000. This amount represents rentals paid for the lease of land by the Wylie Branch and of banking premises by the Winwood, Buffalo Gap Road and 42nd Street Branches of the Bank. ITEM 3. LEGAL PROCEEDINGS The Company is involved in various litigation proceedings incidental to the ordinary course of business. In the opinion of management, however, the ultimate liability, if any, resulting from such other litigation would not be material in relation to the Company's financial condition. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS During the fourth quarter of the fiscal year, no matter was submitted by the Company to a vote of its shareholders through the solicitation of proxies or otherwise. -12- PART II ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS Market Information - ------------------ Since September 12, 1995, the Company's Common Stock has traded on the American Stock Exchange (the "AMEX") under the symbol "IBK." The following table sets forth, for the periods indicated, the high and low sales prices for the Common Stock as reported by the AMEX and the amount of dividends per share, adjusted for the 5-for- 4 stock spit, effected in the form of a 25% stock dividend, paid to shareholders in May 1997. Cash Dividends High Low Per Share ---------- ---------- ---------- 1996 ---- First Quarter $ 8-3/8 $ 7-13/16 $ 0.02 Second Quarter 8-13/16 7-3/16 0.04 Third Quarter 9-11/16 8-11/16 0.04 Fourth Quarter 14 9-11/16 0.04 1997 ---- First Quarter $ 13-5/8 $ 11-1/2 $ 0.04 Second Quarter 13-1/4 11-13/16 0.05 Third Quarter 18-1/4 13-1/8 0.05 Fourth Quarter 19-3/4 16-1/8 0.05 1998 ---- First Quarter $ 19-5/8 $ 15-3/4 $ 0.05 (through March 16) Shareholders - ------------ At March 16, 1998, there were 1,656 stockholders who were individual participants in security position listings. Dividend Policy - --------------- THE COMPANY. Bank regulatory authorities in the United States have risk-based capital standards by which all bank holding companies and banks are evaluated in terms of capital adequacy. These guidelines relate a banking company's capital to the risk profile of its assets. The risk-based capital standards require all banks to have Tier 1 capital of at least 4%, and total capital (Tier 1 and Tier 2 capital) of at least 8% of risk-weighted assets, and to be designated as well capitalized, the banking company must have Tier 1 and total capital ratios of 8% and 10%, respectively. For the Company, Tier 1 capital includes common stockholders' equity and qualifying perpetual preferred stock reduced by goodwill. Tier 2 capital for the Company is comprised of all of the allowance for possible loan losses. The Board of Directors presently intends to continue the payment of a small cash dividend on the Common Stock. The continued payment of dividends and the amount and timing of any future dividend payments, however, will be determined by the Board of Directors and will depend upon a number of factors, including the extent of funds legally available therefor, dividend requirements of the Company's Series C Cumulative Convertible Preferred Stock (the "Series C Preferred Stock"), and the earnings, business prospects, acquisition opportunities, cash needs, financial condition, regulatory and capital requirements of the Company and the Bank and provisions of future loan or financing agreements. -13- The Company's ability to pay cash dividends is restricted by the requirement that it and the Bank maintain certain levels of capital in accordance with regulatory guidelines promulgated by, in the case of the Company, the Federal Reserve Board and, in the case of the Bank, the Comptroller. See "Item 1. Business - Regulation and Supervision - the Company - Capital Adequacy Requirements." Holders of the Series C Preferred Stock are entitled to receive, if, as and when declared by the Company's Board of Directors, out of funds legally available therefor, in preference to the holders of Common Stock and any other stock ranking junior to the Series C Preferred Stock in respect of dividends, quarterly cumulative cash dividends at the annual rate of $4.20 per share. The aggregate annual dividend payment on the 5,590 shares of the Series C Preferred Stock outstanding at December 31, 1997, was approximately $23,000. If earnings and cash flow from ordinary operations of the Company are not sufficient to enable it to pay the full amount of the dividend on the Series C Preferred Stock, the Company may cumulate all or a portion of the annual dividend. The Company currently has the right to cause the mandatory conversion of the Series C Preferred Stock into Common Stock. The Series C Preferred Stock is the Company's only outstanding preferred issue. The Company may not, among other things, declare or pay any cash dividend in respect of the Common Stock or any stock junior to the Series C Preferred Stock with respect to dividends or liquidation rights unless, on the date of payment, all accumulated dividends in respect of the Series C Preferred Stock are paid or set aside. Furthermore, the Company may not declare or pay any dividends in respect of the Common Stock or purchase, redeem or otherwise acquire shares of Common Stock if, on the record date for such payment, or on the date of such purchase, redemption or acquisition, such action would cause stockholders' equity (including mandatorily redeemable preferred stock) of the Company, as reported in the most recent quarterly or annual financial statements filed by the Company with the Securities and Exchange Commission, to be less than an amount equal to the sum of (i) 140% of the number of then outstanding shares of Series C Preferred Stock multiplied by its liquidation value and (ii) 140% of the number of then outstanding shares of any stock ranking senior as to dividends to the Series C Preferred Stock multiplied by the liquidation value of such senior stock. Dividend payments on any other stock junior to the Series C Preferred Stock with respect to dividends or liquidation rights would be similarly limited. The Federal Reserve Board has a policy prohibiting bank holding companies from paying dividends on common stock except out of current earnings. The Federal Reserve Board has asserted that this policy, originally only applicable to common stock, also limits dividends on preferred stocks. As expanded, the Federal Reserve Board policy would limit dividends on the Series C Preferred Stock to an amount equal to current earnings. To date, the Company's earnings have been sufficient to cover dividends on the Common Stock and the Series C Preferred Stock. THE BANK. The funds used by the Company to meet its operational expenses and debt service obligations, to maintain the necessary level of capital for itself and the Bank, and to pay cash dividends on the Common Stock and the Series C Preferred Stock will be derived primarily from dividends, management fees and tax liabilities paid to the Company by Independent Financial and to Independent Financial by the Bank. See "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations - Liquidity." The ability of the Bank to pay dividends is restricted by the requirement that the Bank maintain an adequate level of capital in accordance with regulatory guidelines and by statute. The FDIC requires insured banks, such as the Bank, to maintain certain minimum capital ratios. The FDIC is permitted to require higher ratios if it believes that the financial condition and operations of a particular bank mandates such a higher ratio. The Comptroller has substantially similar requirements. See "Item 1. Business - Regulation and Supervision - The Bank - Capital Adequacy Requirements" and "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations of the Company - Capital Resources." The National Bank Act provides that, prior to declaring a dividend, a bank must transfer to its surplus account an amount equal to or greater than 10% of the net profits earned by the bank since its last dividend was declared, unless such transfer would increase the surplus of the bank to an amount greater than the bank's stated capital. Moreover, the approval of the Comptroller is required for any dividend to a bank holding company by a national bank if the total of all dividends, including the proposed dividend, declared by the bank in any calendar year exceeds the total of its net profits for such year combined with its retained net profits for the preceding two years, less any required transfers to surplus. In addition, the prompt corrective provisions of FDICIA and implementing regulations prohibit a bank from paying a dividend if, following the payment, the bank would be in any of the three capital categories for undercapitalized institutions. See "Item 1. Business - Regulation and Supervision - The Bank - Capital Adequacy Requirements." -14- Dividends paid by the Bank to Independent Financial and by Independent Financial to the Company each totaled $900,000 during 1997. At December 31, 1997, there were approximately $2,780,000 in dividends available for payment to Independent Financial by the Bank without regulatory approval. ITEM 6. SELECTED FINANCIAL DATA The information required by this item is incorporated herein by reference from page 28 of the Company's 1997 Annual Report to Shareholders under the caption "Selected Consolidated Financial Information." ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The information required by this item is incorporated herein by reference from pages 30 through 54, inclusive, of the Company's 1997 Annual Report to Shareholders under the caption "Management's Discussion and Analysis of Financial Condition and Results of Operations." ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA The information required by this item is incorporated herein by reference from pages 7 through 27, inclusive, of the Company's 1997 Annual Report to Shareholders under the captions "Report of Coopers & Lybrand L.L.P., Independent Accountants," "Consolidated Balance Sheets," "Consolidated Income Statements," "Consolidated Statements of Changes in Stockholders' Equity," "Consolidated Statements of Cash Flows," "Notes to Consolidated Financial Statements" and "Quarterly Data (Unaudited)." ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None. PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT The information required by this item is incorporated herein by reference from pages 6 through 9, inclusive, of the Company's definitive proxy statement to be filed pursuant to Regulation 14A with the Securities and Exchange Commission relating to its Annual Meeting of Shareholders to be held April 28, 1998 (the "Definitive Proxy Statement"), under the respective captions "Item 1. Election of Directors" and "Executive Officers." ITEM 11. EXECUTIVE COMPENSATION The information required by this item is incorporated herein by reference from pages 10 and 11 of the Company's Definitive Proxy Statement under the caption "Executive Compensation." ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The information required by this item is incorporated herein by reference from pages 3 through 5, inclusive, of the Company's Definitive Proxy Statement under the caption "Voting Securities and Principal Shareholders." -15- ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS The information required by this item is incorporated herein by reference from page 11 of the Company's Definitive Proxy Statement under the caption "Executive Compensation - Transactions with Management." -16- PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K (a) Documents Filed as Part of Report. 1. Financial Statements The following Consolidated Financial Statements of the Company included in PART II of this report are incorporated by reference from the Company's Annual Report to Shareholders for the year ended December 31, 1997, furnished to the Securities and Exchange Commission pursuant to Rule 14a-3(b): Page Reference to Item Annual Report --------------------------------------- ------------- Report of Coopers & Lybrand L.L.P., Independent Accountants 7 Consolidated Balance Sheets as of December 31, 1997 and 1996 8 Consolidated Income Statements for the three years in the period ended December 31, 1997 9 Consolidated Statements of Changes in Stockholders' Equity for the three years in the period ended December 31, 1997 10 Consolidated Statements of Cash Flows for the three years in the period ended December 31, 1997 11 Notes to Consolidated Financial Statements 12-26 2. Financial Statement Schedules All schedules for which provision is made in the applicable accounting regulations of the Securities and Exchange Commission have been omitted because such schedules are not required under the related instructions or are inapplicable or because the information required is included in the Company's Consolidated Financial Statements or notes thereto. 3. Exhibits (a) The exhibits listed below are filed as part of or incorporated by reference in this report. Where such filing is made by incorporation by reference to a previously filed document, such document is identified in parenthesis. See the Index of Exhibits included with the exhibits filed as part of this report. No. Description --- ----------- 3.1 Restated Articles of Incorporation of Independent Bankshares, Inc. (Exhibit 3.1 to the Company's Annual Report on Form 10-K for the year ended December 31, 1994) 3.2 Restated Bylaws of Independent Bankshares, Inc. (Exhibit 3.2 to the Company's Annual Report on Form 10-K for the year ended December 31, 1994) 4.1 Specimen Stock Certificate for Common Stock of the Company (Exhibit 4.1 to the Company's Registration Statement on Form S-1, SEC File No. 333-16419) 10.1 Form of Nonqualified Option Agreement (Exhibit 10.2 to the Company's Annual Report on Form 10-K for the year ended December 31, 1992) -17- 10.2 Loan Agreement dated January 23, 1997, by and among Independent Bankshares, Inc. and Boatmen's First National Bank of Amarillo and related Variable Rate Promissory Note dated January 23, 1997, Security Agreement dated January 23, 1997 and Third Party Pledge Agreement dated January 23, 1997, executed by Independent Financial Corp. (Exhibit 10.2 to the Company's Annual Report on Form 10-K for the year ended December 31, 1996) 10.3 Master Equipment Lease Agreement, dated December 24, 1992, between Independent Bankshares, Inc. and NCR Credit Corporation, Amendment to Master Equipment Lease Agreement dated concurrently therewith, and related form of Schedule and Commencement Certificate (Exhibit 10.7 to the Company's Annual Report on Form 10-K for the year ended December 31, 1993) 10.4 Agreement and Plan of Reorganization dated July 11, 1996, between the Company and Crown Park Bancshares, Inc. and Agreement and Plan of Merger dated July 11, 1996 between Western National Bank and First State, N.A. Abilene (Exhibit 1.1 to the Company's Current Report on Form 8-K dated July 11, 1996) 13.1 Annual Report to Shareholders for the year ended December 31, 1997 (filed herewith) 21.1 Subsidiaries of Independent Bankshares, Inc. (Exhibit 21.1 to the Company's Registration Statement on Form S-1, SEC File No. 333-16419) 23.1 Consent of Coopers & Lybrand L.L.P. (filed herewith) 27.1 Financial Data Schedule (filed herewith) (b) Current Reports on Form 8-K. None -18- SIGNATURES Pursuant to the requirements of Section 13 or 15(d) 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. INDEPENDENT BANKSHARES, INC. By: /s/ BRYAN W. STEPHENSON --------------------------------------- Bryan W. Stephenson, President and Chief Executive Officer Date: March 25, 1998 Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated. Signature Title Date --------- ----- ---- /s/ Bryan W. Stephenson President, Chief Executive March 25, 1998 - ----------------------------- Officer and Director Bryan W. Stephenson /s/ Randal N. Crosswhite Senior Vice President, March 25, 1998 - ----------------------------- Chief Financial Officer, Rnadal N. Crosswhite Corporate Secretary and Director /s/ John L. Beckham Director March 25, 1998 - ----------------------------- John L. Beckham /s/ Lee Caldwell Director March 25, 1998 - ----------------------------- Lee Caldwell /s/ Mrs. Wm. R. (Amber) Cree Director March 25, 1998 - ----------------------------- Mrs. Wm. R. (Amber) Cree /s/ Louis S. Gee Director March 25, 1998 - ----------------------------- Louis S. Gee - ----------------------------- Director March __, 1998 Nancy E. Jones - ----------------------------- Director March __, 1998 Marshal M. Kellar -19- /s/ Tommy McAlister Director March 25, 1998 - ----------------------------- Tommy McAlister /s/ Scott L. Taliaferro Director March 25, 1998 - ----------------------------- Scott L. Taliaferro /s/ James D. Webster, M.D. Director March 25, 1998 - ----------------------------- James D. Webster, M.D. /s/ C. G. Whitten Director March 25, 1998 - ----------------------------- C.G. Whitten - ----------------------------- Director March __, 1998 John A. Wright -20- INDEX TO EXHIBITS Exhibit Number Description - -------------- ----------- 3.1 Restated Articles of Incorporation of Independent Bankshares, Inc. (Exhibit 3.1 to the Company's Annual Report on Form 10-K for the year ended December 31, 1994) 3.2 Restated Bylaws of Independent Bankshares, Inc. (Exhibit 3.2 to the Company's Annual Report on Form 10-K for the year ended December 31, 1994) 4.1 Specimen Stock Certificate for Common Stock of the Company (Exhibit 4.1 to the Company's Registration Statement on Form S-1, SEC File No. 333-16419) 10.1 Form of Nonqualified Option Agreement (Exhibit 10.2 to the Company's Annual Report on Form 10-K for the year ended December 31, 1992) 10.2 Loan Agreement dated January 23, 1997, by and among Independent Bankshares, Inc. and Boatmen's First National Bank of Amarillo and related Variable Rate Promissory Note dated January 23, 1997, Security Agreement dated January 23, 1997 and Third Party Pledge Agreement dated January 23, 1997 executed by Independent Financial Corp. (Exhibit 10.2 to the Company's Annual Report on Form 10-K for the year ended December 31, 1996) 10.3 Master Equipment Lease Agreement, dated December 24, 1992, between Independent Bankshares, Inc. and NCR Credit Corporation, Amendment to Master Equipment Lease Agreement dated concurrently therewith, and related form of Schedule and Commencement Certificate (Exhibit 10.7 to the Company's Annual Report on Form 10-K for the year ended December 31, 1993) 10.4 Agreement and Plan of Reorganization dated July 11, 1996, between the Company and Crown Park Bancshares, Inc. and Agreement and Plan of Merger dated July 11, 1996 between Western National Bank and First State, N.A. Abilene (Exhibit 1.1 to the Company's Current Report on Form 8-K dated July 11, 1996) 13.1 Annual Report to Shareholders for the year ended December 31, 1997 (filed herewith) 21.1 Subsidiaries of Independent Bankshares, Inc. (Exhibit 21.1 to the Company's Registration Statement on Form S-1, SEC File No. 333-16419) 23.1 Consent of Coopers & Lybrand L.L.P. (filed herewith) 27.1 Financial Data Schedule (filed herewith) EX-13.1 2 ANNUAL REPORT TO SHAREHOLDERS ANNUAL REPORT 1997 [PHOTOGRAPH OF TEXAS BLUEBONNETS] [LOGO OF INDEPENDENT BANKSHARES, INC.] [LOGO] FIRST STATE BANK, N.A. [MAP OF TEXAS/BANL LOCATIONS] Photographer Martin Pothier captures the beauty of our Texas State Flower, the Bluebonnet BANKING LOCATIONS IN WEST TEXAS Abilene/Main Bank 547 Chestnut Street Abilene, Texas 79602 (915) 672-2902 Abilene/Buffalo Gap Road Branch 4450 Buffalo Gap Road Abilene, Texas 79606 (915) 793-2477 Abilene/Wylie Branch 6301 Buffalo Gap Road Abilene, Texas 79606 (915) 691-0000 Lubbock Branch 82nd Street and Nashville Avenue Lubbock, Texas 79423 (806) 794-8300 Odessa/Main Branch 1330 East 8th Street Odessa, Texas 79761 (915) 332-0141 Odessa/42nd Street Branch 4950 East 42nd Street Odessa, Texas 79762 (915) 362-2106 Odessa/Winwood Branch 3898 East 42nd Street Odessa, Texas 76762 (915) 366-5903 San Angelo Branch 4112 College Hills Boulevard San Angelo, Texas 76904 (915) 942-8757 Stamford Branch 210 South Swenson Street Stamford, Texas 79553 (915) 773-5755 Winters Branch 500 South Main Street Winters, Texas 79567 (915) 754-5511 [INDEPENDENT BANKSHARES LOGO] FINANCIAL HIGHLIGHTS FOR THE YEAR 1997 1996 1995 ================================================================= Net Income $2,110,000 $1,422,000 $1,132,000 Basic Earnings Per Common Share 1.12 1.00 0.82 Diluted Earnings Per Common Share 1.03 0.84 0.67 AT YEAR END 1997 1996 1995 ================================================================= Assets $264,574,000 $205,968,000 $180,344,000 Loans 140,853,000 92,017,000 81,927,000 Deposits 242,801,000 189,575,000 164,704,000 Notes Payable 57,000 240,000 849,000 Stockholders' Equity 20,527,000 14,937,000 13,818,000 DAILY AVERAGES 1997 1996 1995 ================================================================= Assets $258,874,000 $196,155,000 $169,532,000 Loans 132,891,000 85,880,000 82,302,000 Deposits 237,379,000 180,005,000 154,547,000 Notes Payable 714,000 568,000 1,069,000 Stockholders' Equity 19,275,000 14,375,000 12,594,000 STOCK TRANSFER AGENT STOCK EXCHANGE LISTING First State Bank, N.A. American Stock Exchange 547 Chestnut Street (AMEX) P.O. Box 3296 Abilene, Texas 79604 AMEX TRADING SYMBOL AMEX LISTING IBK Indep Bksh [INDEPENDENT BANKSHARES LOGO] PRESIDENT'S LETTER To Our Shareholders: The end of 1997 concluded a year of growth for our Company and positive results for our shareholders. With the purchase of a community bank in Lubbock, Texas and the continued economic strength in our market area, the Company's assets increased $58,606,000, or 28.5 percent. Net income for the year increased $688,000, or 48.4 percent. Diluted earnings per share for 1997 were $1.03, up $0.19 or 22.6 percent, over 1996. Throughout 1997, our West Texas market area experienced a stable economy with solid earnings growth and mild inflation. The Company was able to capitalize on this environment by increasing loans to creditworthy individuals and small businesses. At year-end 1997, the Company's loan to deposit ratio was 58.0 percent, compared to 48.5 percent at year-end 1996. As a result of the increase in loans, the Company's net interest margin rose to 4.13 percent, up from 3.95 percent during 1996. The increased net interest margin translated into additional net income, improving the Company's return on equity to 10.95 percent in 1997 compared to 9.89 percent in 1996. We are pleased with these results and encourage you to review Management's Discussion and Analysis in the financial section of this report for greater detail of the Company's performance in 1997. While last year's results are an important measure of the acceptability of your investment, we know your primary interest is the Company's plans for 1998 and beyond. The Company is currently pursuing a strategy of building market share. To accomplish this goal, we have expanded the number of banking locations in Abilene and Odessa through supermarket [PHOTOGRAPH OF BRYAN STEPHENSON, President and Chief Executive Officer] [INDEPENDENT BANKSHARES LOGO] bank branches and have added telephone and personal computer banking to our service offerings. We believe this approach to consumer banking, when supported by our competitively-priced services, will expand our customer deposit base. To provide profitable investment opportunities for the expanding deposit base, the Company has intensified its officer calling program system wide. This calling program, strengthened by the addition of key personnel in our primary markets, is designed specifically to generate additional commercial and real estate loans. In addition to the solicitation of new customers, the introduction of new services and locations and the maintenance of existing relationships, the Company is in the midst of upgrading its technology to meet the challenge of Year 2000 compliance. The financial services industry has become increasely reliant on computers and technology to provide new products and services to its customers. As has been widely publicized, certain hardware and software applications may not function properly as we approach the turn of the century. Our Company has been concerned with this issue and is on track to be fully Year 2000 compliant by the end of 1998. This compliance will be achieved through upgrades to our primary operating software and through the replacement of our mainframe computer and personal computer platform systems. These systems were leased during 1993 and 1994 and were already scheduled to be upgraded or replaced during 1998. Our plan requires that all replacement hardware and software be Year 2000 compliant. [PHOTOGRAPH OF RANDAL CROSSWHITE, Senior Vice President and Chief Financial Officer] [INDEPENDENT BANKSHARES LOGO] This letter discusses a company in transition - a company that is moving from the position of being a reactive community bank to a proactive provider of financial services in West Texas. As we look to the future, we see the ever-present challenges and the accompanying opportunities. We are optimistic that the support of our employees, directors and shareholders, the future will be bright. Sincerely, /s/ Bryan Stephenson Bryan Stephenson [GRAPHICAL PRESENTATION OF TOTAL ASSETS] The Company has a record of consistent growth over the last four years. Acquisitions, including a bank in Winters and a savings bank in San Angelo in 1996, and Western National Bank in Lubbock in 1997, contributed to this trend. [GRAPHICAL PRESENTATION OF TOTAL LOANS] Loan growth has been fueled by a strong West Texas economy, resulting in increased loan demand, and the acquisition of Western National Bank in 1997. -4- [INDEPENDENT BANKSHARES LOGO] [GRAPHICAL PRESENTATION OF NET INCOME] Improved net income has been achieved through economies of scale and an improved net interest margin. [GRAPHICAL PRESENTATION OF DILUTED EARNINGS PER SHARE] Diluted earnings per share has increased from $0.27 in 1994 to $1.03 in 1997. The 1997 increase of $0.19, or 22.6 percent, was generated after a common stock offering that increased the outstanding common shares of the Company by 395,312, or 28.6 percent. [GRAPHICAL PRESENTATION OF RETURN ON AVERAGE STOCKHOLDERS' EQUITY] The Company's return on equity of 10.95 percent in 1997, reflected a continuation of improved shareholders' returns over the four years depicted. [GRAPHICAL PRESENTATION OF EFFICIENCY RATIO] The Company's efficiency ratio, calculated as noninterest expenses, less goodwill amortization and ORE/ORA expenses, divided by net interest income and total noninterest income, excluding securities gains or losses, has continued to improve with the growth of the Company. -5- [INDEPENDENT BANKSHARES LOGO] INDEPENDENT BANKSHARES, INC. BOARD OF DIRECTORS John L. Beckham Attorney, Beckham, Rector & Eargle, L.L.P. Lee Caldwell Attorney Mrs. William R. (Amber) Cree Entrepreneuse Randal N. Crosswhite Senior Vice President & Chief Financial Officer Independent Bankshares, Inc. Louis S. Gee Chairman of the Board & Chief Executive Officer, Tippett & Gee, Inc., Consulting Engineers Nancy E. Jones Executive Director, Community Foundation of Abilene Marshal M. Kellar Chairman of the Board, West Texas Wholesale Supply Co. Tommy McAlister President, McAlister, Inc. Bryan W. Stephenson President & Chief Executive Officer, Independent Bankshares, Inc. Scott L. Taliaferro Chairman of the Board, Independent Bankshares, Inc., President, Scott Oils, Inc. James D. Webster, M.D. Physician C.G. Whitten Attorney, Whitten & Young, P.C. John A. Wright Banking Consultant ADVISORY DIRECTORS Arlas Cavett Farming and Investments L.H. Mosley President, Mosley Investments, Inc. J.E. Smith Investments FIRST STATE BANK, N.A. BOARD OF DIRECTORS Jack D. Bargainer, M.D. Physician Randal N. Crosswhite Senior Vice President & Chief Financial Officer, Independent Bankshares, Inc. Thomas C. Darden Lubbock Branch President, First State Bank, N.A. James G. Fitzhugh Abilene Branch President, First State Bank, N.A. Timothy J. Gorman Manager SBR Business Integration, Ameripol Synpol Corporation Michael D. Jarrett Odessa Branch President, First State Bank, N.A. Bryan W. Stephenson, Chairman of the Board, First State Bank, N.A., President & Chief Executive Officer, Independent Bankshares, Inc. Scott L. Taliaferro, Jr. President, TDC Engineering, Inc. Mike Trout President, Rototech, Inc. Virgil W. Trower President, Trower Realtors, Inc. Stanley J. Whisenhunt Farming and Ranching -6- [INDEPENDENT BANKSHARES LOGO] REPORT OF INDEPENDENT ACCOUNTANTS Board of Directors and Shareholders Independent Bankshares, Inc. Abilene, Texas We have audited the accompanying consolidated balance sheets of Independent Bankshares, Inc. as of December 31, 1997 and 1996, and the related consolidated income statements, statements of changes in stockholders' equity and cash flows for each of the three years in the period ended December 31, 1997. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Independent Bankshares, Inc. as of December 31, 1997 and 1996, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 1997, in conformity with generally accepted accounting principles. /s/ Coopers & Lybrand L.L.P. Fort Worth, Texas February 2, 1998 -7- INDEPENDENT BANKSHARES, INC. CONSOLIDATED BALANCE SHEETS DECEMBER 31, 1997 AND 1996 ASSETS
1997 1996 ------------- ------------- ASSETS: Cash and Cash Equivalents: Cash and Due from Banks $ 14,518,000 $ 11,458,000 Federal Funds Sold 24,900,000 18,500,000 ------------- ------------- Total Cash and Cash Equivalents 39,418,000 29,958,000 ------------- ------------- Securities (Note 3): Available-for-sale 22,501,000 27,771,000 Held-to-maturity 47,293,000 47,381,000 ------------- ------------- Total Securities 69,794,000 75,152,000 ------------- ------------- Loans (Note 4): Total Loans 142,315,000 94,264,000 Less: Unearned Income on Installment Loans 1,462,000 2,247,000 Allowance for Possible Loan Losses 1,173,000 793,000 ------------- ------------- Net Loans 139,680,000 91,224,000 ------------- ------------- Premises and Equipment (Note 5) 7,518,000 4,437,000 Goodwill (Note 2) 3,159,000 957,000 Accrued Interest Receivable 2,208,000 1,599,000 Other Real Estate and Other Repossessed Assets 739,000 389,000 Other Assets 2,058,000 2,252,000 ------------- ------------- Total Assets $ 264,574,000 $ 205,968,000 ============= ============= LIABILITIES AND STOCKHOLDERS' EQUITY LIABILITIES: Deposits (Note 6): Noninterest-bearing Demand Deposits $ 43,868,000 $ 32,240,000 Interest-bearing Demand Deposits 77,495,000 58,676,000 Interest-bearing Time Deposits 121,438,000 98,659,000 ------------- ------------- Total Deposits 242,801,000 189,575,000 Accrued Interest Payable 947,000 951,000 Notes Payable (Note 7) 57,000 240,000 Other Liabilities 242,000 265,000 ------------- ------------- Total Liabilities 244,047,000 191,031,000 ------------- ------------- Commitments and Contingent Liabilities (Notes 13 and 15) STOCKHOLDERS' EQUITY (NOTES 9 AND 16): Preferred Stock - Par Value $10.00; 5,000,000 Shares Authorized: Series C Preferred Stock - Stated Value $42.00; 50,000 Shares Designated; 5,590 and 13,478 Shares Issued and Outstanding at December 31, 1997 and 1996, Respectively 56,000 135,000 Common Stock - Par Value $0.25; 30,000,000 Shares Authorized; 1,975,263 and 1,104,644 Shares Issued and Outstanding at December 31, 1997 and 1996, Respectively 494,000 276,000 Additional Paid-in Capital 13,921,000 9,891,000 Retained Earnings 6,218,000 4,610,000 Unrealized Gain on Available-for-sale Securities (Note 3) 31,000 25,000 Unearned Employee Stock Ownership Plan Stock (Note 9) (193,000) 0 ------------- ------------- Total Stockholders' Equity 20,527,000 14,937,000 ------------- ------------- Total Liabilities and Stockholders' Equity $ 264,574,000 $ 205,968,000 ============= =============
See accompanying notes. -8- INDEPENDENT BANKSHARES, INC. CONSOLIDATED INCOME STATEMENTS YEARS ENDED DECEMBER 31, 1997, 1996 and 1995
1997 1996 1995 ------------- ------------- ------------- Interest Income: Interest and Fees on Loans (Note 4) $ 12,236,000 $ 8,005,000 $ 7,726,000 Interest on Securities 5,176,000 4,504,000 2,389,000 Interest on Federal Funds Sold 912,000 1,047,000 1,847,000 ------------- ------------- ------------- Total Interest Income 18,324,000 13,556,000 11,962,000 ------------- ------------- ------------- Interest Expense: Interest on Deposits 8,600,000 6,382,000 5,201,000 Interest on Notes Payable (Note 7) 59,000 59,000 108,000 ------------- ------------- ------------- Total Interest Expense 8,659,000 6,441,000 5,309,000 ------------- ------------- ------------- Net Interest Income 9,665,000 7,115,000 6,653,000 Provision for Loan Losses (Note 4) 250,000 201,000 206,000 ------------- ------------- ------------- Net Interest Income After Provision for Loan Losses 9,415,000 6,914,000 6,447,000 ------------- ------------- ------------- Noninterest Income: Service Charges 1,605,000 1,259,000 1,167,000 Trust Fees 195,000 189,000 201,000 Other Income 109,000 103,000 141,000 ------------- ------------- ------------- Total Noninterest Income 1,909,000 1,551,000 1,509,000 ------------- ------------- ------------- Noninterest Expenses: Salaries and Employee Benefits 3,970,000 3,082,000 2,849,000 Net Occupancy Expense 857,000 716,000 643,000 Equipment Expense 834,000 663,000 723,000 Stationery, Printing and Supplies Expense 419,000 288,000 271,000 Professional Fees 333,000 304,000 454,000 Net Costs (Revenues) Applicable to Other Real Estate and Other Repossessed Assets 23,000 (24,000) (7,000) Other Expenses 1,801,000 1,261,000 1,309,000 ------------- ------------- ------------- Total Noninterest Expenses 8,237,000 6,290,000 6,242,000 ------------- ------------- ------------- Income Before Federal Income Taxes 3,087,000 2,175,000 1,714,000 Federal Income Taxes (Note 8) 977,000 753,000 582,000 ------------- ------------- ------------- Net Income $ 2,110,000 $ 1,422,000 $ 1,132,000 ============= ============= ============= Preferred Stock Dividends (Note 9) $ 41,000 $ 63,000 $ 70,000 ============= ============= ============= Net Income Available to Common Stockholders (Note 10) $ 2,069,000 $ 1,359,000 $ 1,062,000 ============= ============= ============= Basic Earnings Per Common Share Available to Common Stockholders (Note 10) $ 1.12 $ 1.00 $ 0.82 ============= ============= ============= Diluted Earnings Per Common Share Available to Common Stockholders (Note 10) $ 1.03 $ 0.84 $ 0.67 ============= ============= =============
See accompanying notes. -9- INDEPENDENT BANKSHARES, INC. CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
UNREALIZED GAIN (LOSS) SERIES C ON PREFERRED STOCK COMMON STOCK ADDITIONAL AVAILABLE ------------------- ----------------------- PAID-IN RETAINED FOR-SALE SHARES AMOUNT SHARES AMOUNT CAPITAL EARNINGS SECURITIES --------- --------- ---------- -------- ----------- ------------ ---------- Balances--January 1, 1995 16,668 $ 167,000 778,081 $195,000 $ 8,241,000 $2,570,000 $ (100,000) Net Income 1,132,000 Adjustment to Unrealized Gain on Available-for-sale Securities, Net of Tax of $86,000 (Note 3) 168,000 Reduction of Deferred Tax Asset Valuation Allowance 1,600,000 Cash Dividends (187,000) 4-for-3 Stock Split (Note 9) 259,371 65,000 (2,000) (67,000) Exercise of Stock Options (Note 9) 9,037 2,000 34,000 Conversion of Series C Preferred Stock (Note 9) (232) (3,000) 3,803 1,000 2,000 ------- --------- --------- -------- ----------- ---------- ---------- Balances--December 31, 1995 16,436 164,000 1,050,292 263,000 9,875,000 3,448,000 68,000 Net Income 1,422,000 Adjustment to Unrealized Loss on Available-for-sale Securities, Net of Tax of $23,000 (Note 3) (43,000) Cash Dividends (260,000) Conversion of Series C Preferred Stock (Note 9) (2,958) (29,000) 54,352 13,000 16,000 ------- --------- --------- -------- ----------- ---------- ---------- Balances--December 31, 1996 13,478 135,000 1,104,644 276,000 9,891,000 4,610,000 25,000 Net Income 2,110,000 Adjustment to Unrealized Gain on Available-for-sale Securities, Net of Tax of $3,000 (Note 3) 6,000 Cash Dividends (405,000) Sale of Stock in Public Offering (Note 9) 316,250 79,000 3,899,000 Purchase of Stock in Public Offering by ESOP, Financed by a Loan from the Company - Unearned Stock (Note 9) Principal Payments on Loan to ESOP for Stock Purchase - Earned Stock (Note 9) 5-for-4 Stock Split (Note 9) 388,911 97,000 (5,000) (97,000) Exercise of Stock Options (Note 9) 17,499 5,000 94,000 Conversion of Series C Preferred Stock (Note 9) (7,888) (79,000) 147,959 37,000 42,000 ------- --------- --------- -------- ----------- ---------- ---------- Balances--December 31, 1997 5,590 $ 56,000 1,975,263 $494,000 $13,921,000 $6,218,000 $ 31,000 ======= ========= ========= ======== =========== ========== ========== UNEARNED EMPLOYEE STOCK OWNERSHIP PLAN STOCK ------------------ SHARES AMOUNT -------- -------- Balances--January 1, 1995 0 $ 0 Net Income Adjustment to Unrealized Gain on Available-for-sale Securities, Net of Tax of $86,000 (Note 3) Reduction of Deferred Tax Asset Valuation Allowance Cash Dividends 4-for-3 Stock Split (Note 9) Exercise of Stock Options (Note 9) Conversion of Series C Preferred Stock (Note 9) -------- -------- Balances--December 31, 1995 0 0 Net Income Adjustment to Unrealized Loss on Available-for-sale Securities, Net of Tax of $23,000 (Note 3) Cash Dividends Conversion of Series C Preferred Stock (Note 9) -------- -------- Balances--December 31, 1996 0 0 Net Income Adjustment to Unrealized Gain on Available-for-sale Securities, Net of Tax of $3,000 (Note 3) Cash Dividends Sale of Stock in Public Offering (Note 9) Purchase of Stock in Public Offering by ESOP, Financed by a Loan from the Company - Unearned Stock (Note 9) (15,000) (214,000) Principal Payments on Loan to ESOP for Stock Purchase - Earned Stock (Note 9) 1,789 21,000 5-for-4 Stock Split (Note 9) (3,750) Exercise of Stock Options (Note 9) Conversion of Series C Preferred Stock (Note 9) ------- --------- Balances--December 31, 1997 (16,961) $(193,000) ======= =========
See accompanying notes. -10- INDEPENDENT BANKSHARES, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
1997 1996 1995 ------------ ------------ ------------ Cash Flows from Operating Activities: Net Income $ 2,110,000 $ 1,422,000 $ 1,132,000 Adjustments to Reconcile Net Income to Net Cash Provided by Operating Activities: Deferred Federal Income Tax Expense 772,000 677,000 547,000 Depreciation and Amortization 733,000 404,000 367,000 Provision for Loan Losses 250,000 201,000 206,000 Losses on Sales of Investment Securities 0 10,000 0 Gains on Sales of Premises and Equipment 0 0 (4,000) Gains on Sales of Other Real Estate and Other Repossessed Assets (58,000) (50,000) (45,000) Writedown of Other Real Estate and Other Repossessed Assets 2,000 21,000 32,000 Increase in Accrued Interest Receivable (192,000) (17,000) (549,000) Decrease (Increase) in Other Assets 452,000 (382,000) (176,000) Increase (Decrease) in Accrued Interest Payable (182,000) (14,000) 474,000 Increase (Decrease) in Other Liabilities (1,106,000) 166,000 (840,000) ------------ ------------ ------------ Net Cash Provided by Operating Activities 2,781,000 2,438,000 1,144,000 ------------ ------------ ------------ Cash Flows from Investing Activities: Proceeds from Maturities of Available-for-sale Securities 17,809,000 9,437,000 21,828,000 Proceeds from Maturities of Held-to-maturity Securities 20,195,000 26,461,000 12,930,000 Proceeds from Sale of Available-for-sale Securities 193,000 30,000 0 Proceeds from Sale of Held-to-maturity Securities 0 2,000,000 0 Purchases of Available-for-sale Securities (8,060,000) (19,382,000) (21,242,000) Purchases of Held-to-maturity Securities (15,080,000) (36,680,000) (35,864,000) Net Increase in Loans (8,692,000) (8,160,000) (1,603,000) Proceeds from Sales of Premises and Equipment 0 94,000 4,000 Additions to Premises and Equipment (819,000) (138,000) (177,000) Proceeds from Sales of Other Real Estate and Other Repossessed Assets 1,352,000 754,000 1,025,000 Net Cash and Cash Equivalents Acquired (Paid) in Acquisitions (1,236,000) 14,203,000 0 ------------ ------------ ------------ Net Cash Provided by (Used in) Investing Activities 5,662,000 (11,381,000) (23,099,000) ------------ ------------ ------------ Cash Flows from Financing Activities: Net Increase (Decrease) in Deposits (378,000) 5,018,000 18,520,000 Proceeds from Notes Payable 1,300,000 0 275,000 Repayment of Notes Payable (3,572,000) (616,000) (690,000) Net Proceeds from Issuance of Equity Securities 4,077,000 0 34,000 Payment of Cash Dividends (405,000) (260,000) (187,000) Cash Paid for Fractional Shares in Stock Dividend (5,000) 0 (2,000) ------------ ------------ ------------ Net Cash Provided by Financing Activities 1,017,000 4,142,000 17,950,000 ------------ ------------ ------------ Net Increase (Decrease) in Cash and Cash Equivalents 9,460,000 (4,801,000) (4,005,000) Cash and Cash Equivalents at Beginning of Year 29,958,000 34,759,000 38,764,000 ------------ ------------ ------------ Cash and Cash Equivalents at End of Year $ 39,418,000 $ 29,958,000 $ 34,759,000 ============ ============ ============
See accompanying notes. -11- INDEPENDENT BANKSHARES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1997, 1996 AND 1995 NOTE 1: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Business - -------- Independent Bankshares, Inc., a Texas corporation (the "Company"), is a bank holding company headquartered in Abilene, Texas. The Company indirectly owns through a Delaware subsidiary, Independent Financial Corp. ("Independent Financial"), 100% of the stock of First State Bank, National Association, Abilene, Texas (the "Bank"). The Bank currently operates full-service banking locations in the West Texas cities of Abilene (3 locations), Lubbock, Odessa (3 locations), San Angelo, Stamford and Winters. The Company's primary activities are to assist the Bank in the management and coordination of its financial resources and to provide capital, business development, long range planning and public relations for the Bank. The Bank operates under the day-to-day management of its own officers and board of directors and formulates its own policies with respect to banking matters. The principal services provided by the Bank are as follows: Commercial Services. The Bank provides a full range of banking services for its commercial customers. Commercial lending activities include short-term and medium-term loans, revolving credit arrangements, inventory and accounts receivable financing, equipment financing and interim and permanent real estate lending. Other services include cash management programs and federal tax depository and night depository services. Consumer Services. The Bank also provides a wide range of consumer banking services, including checking, savings and money market accounts, savings programs and installment and personal loans. The Bank makes automobile and other installment loans directly to customers, as well as indirectly through automobile dealers. The Bank makes home improvement, home equity and real estate loans and provides safe deposit services. As a result of sharing arrangements with the Pulse automated teller machine system network, the Bank provides 24-hour routine banking services through automated teller machines ("ATMs"). The Pulse network provides ATM accessibility throughout the United States. The Bank also offers investment services and banking by phone or personal computer. Trust Services. The Bank provides trust and agency services to individuals, partnerships and corporations from its offices in Abilene, Lubbock and Odessa. The trust division also provides investment management, administration and advisory services for agency and trust accounts, and acts as trustee for pension and profit sharing plans. Basis of Financial Statements - ----------------------------- The accounting and reporting policies of the Company conform with generally accepted accounting principles followed by the banking industry. Principles of Consolidation - --------------------------- The Consolidated Financial Statements include the accounts of the Company, Independent Financial and the Bank. All significant intercompany accounts and transactions have been eliminated upon consolidation. Effective December 30, 1996, an existing subsidiary bank of the Company, First State Bank, National Association, Odessa, Texas ("First State, N.A., Odessa"), was merged with and into the Bank. As a result of the merger, the offices of First State, N.A., Odessa became branches of the Bank. -12- Statements of Cash Flows - ------------------------ For purposes of reporting cash flows, cash and cash equivalents include cash on hand, amounts due from banks and federal funds sold. Generally, federal funds are purchased and sold for one-day periods. Securities - ---------- Management determines the appropriate classification of securities at the time of purchase. If the securities are purchased with the positive intent and the ability to hold the securities until maturity, they are classified as held-to-maturity and carried at amortized historical cost. Securities to be held for indefinite periods of time are classified as available-for-sale and carried at fair value. Loans - ----- Loans are stated at the principal amount outstanding. Interest on the various types of commercial loans is accrued daily based on the principal balances outstanding. Income on installment loans is recognized using this method or other methods under which income approximates this method. The recognition of income on a loan is discontinued, and previously accrued interest is reversed, when interest or principal payments become ninety (90) days past due unless, in the opinion of management, the outstanding interest remains collectible. Interest is subsequently recognized only as received until the loan is returned to accrual status. Allowance for Possible Loan Losses - ---------------------------------- The allowance for possible loan losses is maintained at a level that, in management's opinion, is adequate to absorb possible losses in the loan portfolio and unfunded loan commitments. The allowance is based on a number of factors, including risk ratings of individual credits, current business and economic conditions, the size and diversity of the portfolio, collateral values and past loan loss experience. At December 31, 1997 and 1996, the Company had no impaired loans. Impaired loans are normally placed on nonaccrual status and, as a result, interest income is recorded only as cash is received. The average balance of impaired loans during the years ended December 31, 1997 and 1996, was $0 and $50,000, respectively. There was no interest income recognized on such loans during the years ended December 31, 1997, 1996 or 1995. Premises and Equipment - ---------------------- Premises and equipment are stated at cost less accumulated depreciation. Depreciation for financial reporting purposes is computed primarily on the straight-line method over the estimated useful lives of five (5) to forty (40) years. When assets are retired or otherwise disposed of, the cost and related accumulated depreciation are removed from the accounts and any resulting gain or loss is included in the results of operations for the period. Goodwill - -------- Goodwill resulting from acquisitions accounted for using the purchase method is being amortized on the straight-line method over a period of fifteen (15) years. Management assesses the recoverability of goodwill by comparing the goodwill to the undiscounted cash flows expected to be generated by the acquired banks during the anticipated period of benefit. As of December 31, 1997, management believes that no impairment has occurred. Federal Income Taxes - -------------------- The Company uses the liability method of accounting for income taxes as required by FASB Statement of Financial Accounting Standards No. 109, "Accounting for Income Taxes ("FAS 109"). Deferred income taxes reflect the net effects of temporary differences between the carrying amount of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. -13- Other Real Estate and Other Repossessed Assets - ---------------------------------------------- Other real estate and other repossessed assets consist principally of real estate properties and automobiles acquired by the Company through foreclosure. Such assets are carried at the lower of cost (generally the outstanding loan balance) or estimated fair value, net of estimated costs of disposal, if any. If the estimated fair value of the collateral securing the loan is less than the amount outstanding on the loan at the time the assets are acquired, the difference is charged against the allowance for possible loan losses. Subsequent declines in estimated fair value, if any, are charged to noninterest expense. Earnings Per Share - ------------------ In March 1997, the FASB issued Statement of Financial Accounting Standards No. 128, "Earnings Per Share" ("FAS 128"), which establishes standards for computing and presenting earnings per share for entities with publicly held common stock or potential common stock. FAS 128 simplifies the standards for computing earnings per share previously found in Accounting Principles Board Opinion No. 15, "Earnings per Share," and makes them comparable to international earnings per share accounting standards. It replaces the presentation of primary earnings per share with a presentation of basic earnings per share, which excludes dilution. It also requires dual presentation of basic and diluted earnings per share on the face of the income statement for all entities with complex capital structures. The Company adopted FAS 128 on December 31, 1997. Comprehensive Income - -------------------- In June 1997, the FASB issued Statement of Financial Accounting Standards No. 130, "Reporting Comprehensive Income" ("FAS 130"). FAS 130 establishes standards for reporting and display of comprehensive income and its components (revenues, expenses, gains and losses) in a full set of general purpose financial statements. FAS 130 requires that all items that are required to be recognized under accounting standards as components of comprehensive income be reported in a financial statement that is displayed with the same prominence as other financial statements. The Company will adopt FAS 130 beginning January 1, 1998. Use of Estimates - ---------------- The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. NOTE 2: BANK ACQUISITIONS The Bank completed the acquisition of Peoples National Bank in Winters, Texas ("Peoples National") effective January 1, 1996. At December 31, 1995, Peoples National had total assets of $5,505,000, total loans, net of unearned income, of $2,767,000, total deposits of $4,958,000 and stockholders' equity of $525,000. The Bank paid $745,000 for the acquisition of Peoples National and, as a result of such acquisition, recorded $260,000 of goodwill. The Bank completed the acquisition of the San Angelo branch of Coastal Banc ssb ("Coastal Banc - San Angelo") effective May 27, 1996. On that date, Coastal Banc - San Angelo had total deposits of $14,895,000 and total loans, net of unearned income, of $155,000. The Bank paid $760,000 as a premium on the deposits of Coastal Banc - San Angelo and, as a result of such payment, recorded $743,000 of goodwill. The Company completed the acquisition of Crown Park Bancshares, Inc. ("Crown Park") and its wholly owned subsidiary bank, Western National Bank, Lubbock, Texas ("Western National"), effective January 28, 1997, for an aggregate cash consideration of $7,510,000. On the acquisition date, Crown Park was merged with and into a wholly owned subsidiary of the Company and Western National was merged with and into the Bank. To obtain funding for the acquisition, the Company sold an aggregate of 395,312 shares of its common stock in an underwritten offering at a price of $11.40 per share (the "Offering"). This included 51,562 shares covered by the underwriter's over-allotment option. The Company borrowed $800,000 from a financial institution in Amarillo, Texas (the "Amarillo Bank") to finance a portion of the cost of acquiring Crown Park. The $800,000 of borrowings was reduced to $400,000 with the proceeds of the sale of the over-allotment shares. The borrowing was paid off on December 31, 1997. At the date of acquisition, Crown Park had total assets of $60,420,000, total loans, net of -14- unearned income, of $41,688,000, total deposits of $53,604,000 and stockholders' equity of $4,238,000. This acquisition was accounted for using the purchase method of accounting. A total of $2,486,000 of goodwill was recorded as a result of this acquisition. A total of $218,000 and $46,000 in goodwill amortization expense was recorded during the years ended December 31, 1997 and 1996, respectively. No goodwill amortization expense was recorded during the year ended December 31, 1995. The following pro forma financial information combines the historical results of the Company as if the Crown Park acquisition had occurred as of the beginning of each period presented. The pro forma amounts do not purport to be indicative of the results that would have actually been obtained if the acquisition had occurred at the beginning of each period presented or that may be obtained in the future: Year Ended December 31, ------------------------- 1997 1996 -------- ---------- (In thousands, except per share amounts) Net interest income $ 9,833 $ 9,504 Net income 1,933 1,799 Basic earnings per share 1.03 0.99 Diluted earnings per share 0.94 0.86 Some amounts, specifically the pro forma amounts for net income and basic and diluted earnings per share for the year ended December 31, 1997, and basic earnings per share for the year ended December 31, 1996, are less than the amounts reported herein as a result of certain adjustments recorded by Crown Park prior to the acquisition. NOTE 3: SECURITIES The amortized cost and estimated fair value of available-for- sale securities at December 31, 1997 and 1996, were as follows:
1997 --------------------------------------------------------- Gross Gross Estimated Amortized Unrealized Unrealized Fair Cost Gains Losses Value ------------ ---------- ---------- ------------ U.S. Treasury securities $ 16,280,000 $ 40,000 $ 13,000 $ 16,307,000 Obligations of U.S. Government agencies and corporations 4,520,000 20,000 2,000 4,538,000 Mortgage-backed securities 1,066,000 7,000 0 1,073,000 Other securities 583,000 0 0 583,000 ------------ ---------- ---------- ------------ Total available-for-sale securities $ 22,449,000 $ 67,000 $ 15,000 $ 22,501,000 ============ ========== ========== ============ 1996 --------------------------------------------------------- Gross Gross Estimated Amortized Unrealized Unrealized Fair Cost Gains Losses Value ------------ ---------- ---------- ------------ U.S. Treasury securities $ 27,166,000 $ 76,000 $ 41,000 $ 27,201,000 Mortgage-backed securities 126,000 1,000 0 127,000 Other securities 443,000 0 0 443,000 ------------ ---------- ---------- ------------ Total available-for-sale securities $ 27,735,000 $ 77,000 $ 41,000 $ 27,771,000 ============ ========== ========== ============
-15- The amortized cost and estimated fair value of held-to- maturity securities at December 31, 1997 and 1996, were as follows:
1997 --------------------------------------------------------- Gross Gross Estimated Amortized Unrealized Unrealized Fair Cost Gains Losses Value ------------ ---------- ---------- ------------ U.S. Treasury securities $ 4,985,000 $ 7,000 $ 0 $ 4,992,000 Obligations of U.S. Government agencies and corporations 31,584,000 119,000 113,000 31,590,000 Mortgage-backed securities 10,549,000 82,000 21,000 10,610,000 Obligations of states and political subdivisions 175,000 9,000 0 184,000 ------------ ---------- ---------- ------------ Total held-to-maturity securities $ 47,293,000 $ 217,000 $ 134,000 $ 47,376,000 ============ ========== ========== ============ 1996 --------------------------------------------------------- Gross Gross Estimated Amortized Unrealized Unrealized Fair Cost Gains Losses Value ------------ ---------- ---------- ------------ U.S. Treasury securities $ 7,942,000 $ 25,000 $ 0 $ 7,967,000 Obligations of U.S. Government agencies and corporations 29,928,000 129,000 140,000 29,917,000 Mortgage-backed securities 9,311,000 1,000 111,000 9,201,000 Obligations of states and political subdivisions 200,000 6,000 0 206,000 ------------ ---------- ---------- ------------ Total held-to-maturity securities $ 47,381,000 $ 161,000 $ 251,000 $ 47,291,000 ============ ========== ========== ============
The amortized cost and estimated fair value of securities at December 31, 1997, by contractual maturity, are shown below. Expected maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties. Amortized Estimated Available-for-sale Securities Cost Fair Value ------------------------------------- ------------ ------------ Due in one year or less $ 11,744,000 $ 11,737,000 Due after one year through five years 9,056,000 9,108,000 Due after ten years 583,000 583,000 ------------ ------------ 21,383,000 21,428,000 Mortgage-backed securities 1,066,000 1,073,000 ------------ ------------ Total available-for-sale securities $ 22,449,000 $ 22,501,000 ============ ============ Amortized Estimated Held-to-maturity Securities Cost Fair Value --------------------------- ------------ ------------ Due in one year or less $ 4,985,000 $ 4,992,000 Due after one year through five years 31,584,000 31,590,000 Due after five years through ten years 175,000 184,000 ------------ ------------ 36,744,000 36,766,000 Mortgage-backed securities 10,549,000 10,610,000 ------------ ------------ Total held-to-maturity securities $ 47,293,000 $ 47,376,000 ============ ============ At December 31, 1997, securities with an amortized cost and estimated fair value of $9,666,000 and $9,650,000, respectively, were pledged as collateral for public and trust fund deposits and for other purposes required or permitted by law. At December 31, 1996, the amortized cost and estimated fair value of pledged securities were $10,847,000 and $10,820,000, respectively. During 1997, the Company sold available-for-sale securities with a book value of $193,000 and recorded no gain or loss on such sale. During 1996, the Company sold available-for-sale securities with a book value of $42,000 -16- and recorded a $12,000 loss on such sale. In addition, the Company sold held-to-maturity securities with a book value of $1,998,000 approximately thirty (30) days prior to their scheduled maturity and recorded a $2,000 gain on such sale. NOTE 4: LOANS The composition of loans at December 31, 1997 and 1996, was as follows: 1997 1996 ------------ ------------ Loans to individuals $ 67,453,000 $ 46,975,000 Real estate loans 44,569,000 26,233,000 Commercial and industrial loans 24,184,000 18,430,000 Other loans 6,109,000 2,626,000 ------------ ------------ Total loans 142,315,000 94,264,000 Less unearned income 1,462,000 2,247,000 ------------ ------------ Total loans, net of unearned income $140,853,000 $ 92,017,000 ============ ============ Nonperforming assets at December 31, 1997 and 1996, were as follows: 1997 1996 ---------- ---------- Nonaccrual loans $ 70,000 $ 82,000 Accruing loans past due over ninety days 121,000 41,000 Restructured loans 104,000 73,000 Other real estate and other repossessed assets 739,000 389,000 ---------- ---------- Total nonperforming assets $1,034,000 $ 585,000 ========== ========== The amount of interest income that would have been recorded on nonaccrual loans for the years ended December 31, 1997, 1996 and 1995, based on the loans' original terms was $16,000, $17,000 and $14,000, respectively. A total of $2,000 in interest on nonaccrual loans was actually collected and recorded as income during the year ended December 31, 1997. No interest was collected on such loans and recorded as income during 1996 or 1995. A summary of the transactions in the allowance for possible loan losses for the years ended December 31, 1997, 1996 and 1995, is as follows:
1997 1996 1995 ----------- ----------- ----------- Balance at beginning of year $ 793,000 $ 759,000 $ 817,000 Provision for loan losses 250,000 201,000 206,000 Loans charged off (581,000) (389,000) (376,000) Recoveries of loans charged off 316,000 73,000 112,000 Bank acquisitions 395,000 149,000 0 ----------- ----------- ----------- Balance at end of year $ 1,173,000 $ 793,000 $ 759,000 =========== =========== ===========
NOTE 5: PREMISES AND EQUIPMENT The following is a summary of premises and equipment at December 31, 1997 and 1996: 1997 1996 ----------- ----------- Land $ 1,486,000 $ 928,000 Buildings and improvements 6,821,000 4,312,000 Furniture and equipment 2,028,000 1,499,000 ----------- ----------- 10,335,000 6,739,000 Less accumulated depreciation 2,817,000 2,302,000 ----------- ----------- Net premises and equipment $ 7,518,000 $ 4,437,000 =========== =========== NOTE 6: DEPOSITS At December 31, 1997 and 1996, interest-bearing time deposits of $100,000 or more were $38,371,000, and $29,627,000, respectively. -17- At December 31, 1997, the scheduled maturities of interest- bearing time deposits was as follows: Interest-bearing Time Deposits ---------------- 1998 $ 108,810,000 1999 8,482,000 2000 1,785,000 2001 1,139,000 2002 1,222,000 ------------- Total interest-bearing time deposits $ 121,438,000 ============= NOTE 7: NOTES PAYABLE The Company had a note payable to a financial institution in Amarillo, Texas (the "Amarillo Bank"). The note, proceeds of which were used to help fund the purchase of Crown Park, originated on January 23, 1997, at $800,000. The balance was reduced to $200,000 by July 23, 1997. This $200,000 was renewed with a note that had a one-year maturity with payments of $50,000 principal plus interest to be made quarterly beginning October 23, 1997. The note bore interest at the Amarillo Bank's floating base rate plus 1% and was collateralized by 100% of the stock of the Bank. On December 31, 1997, the Company paid off the remaining principal balance of the note. In addition, at December 31, 1997, the Company had a note payable to one current director of the Company with a balance of $50,000. The note had an original face amount of $152,000, but was discounted upon issuance because it bore interest at a below-market interest rate (6%). The note was payable in three equal annual installments, plus accrued interest beginning March 1, 1996. The note was paid off on January 2, 1998. The balance of two additional notes to two former directors of the Company, with similar terms, aggregating $67,000 were paid off on December 19, 1997. The two additional notes had an aggregate original face amount of $198,000. The three notes represented a portion of the final settlement of certain litigation. At December 31, 1997, the Bank had a $7,000 note payable to an individual which matures in March 1999. Principal, plus interest at 7.5%, is payable monthly. The note is collateralized by a two- story commercial building in Abilene, Texas. NOTE 8: FEDERAL INCOME TAXES Due to the fact that the Company effected a quasi- reorganization as of December 31, 1989, utilization of any of the Company's net operating loss carryforwards subsequent to that date will not be credited to future income. For periods prior to January 1, 1995, the tax effect of the utilization of the Company's net operating loss carryforwards was credited directly to additional paid-in capital. For periods subsequent to December 31, 1994, the effect of such utilization has been and will be credited against the Company's gross deferred tax asset. The Company's deferred tax provision for 1997, 1996 and 1995 totaled $772,000, $677,000 and $547,000, respectively. -18- Significant components of the Company's deferred tax assets and liabilities at December 31, 1997 and 1996, were as follows:
1997 1996 ----------- ----------- Deferred tax assets: Net operating loss carryforwards $ 238,000 $ 1,112,000 Allowance for possible loan losses 265,000 278,000 Tax credit carryforwards 998,000 549,000 Director indemnification 17,000 79,000 Real estate and other repossessed assets 115,000 69,000 Other, net 0 3,000 ----------- ----------- Total gross deferred tax assets 1,633,000 2,090,000 Less valuation allowance for deferred tax assets (167,000) (389,000) ----------- ----------- Net deferred tax assets 1,466,000 1,701,000 ----------- ----------- Deferred tax liabilities: Unrealized gain on available-for-sale securities (17,000) (14,000) Depreciation and amortization (93,000) (23,000) Other, net (74,000) 0 ----------- ----------- Total gross deferred tax liabilities (184,000) (37,000) ----------- ----------- Net deferred tax asset $ 1,282,000 $ 1,664,000 =========== ===========
Deferred income taxes reflect the net effects of temporary differences between the carrying amount of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. As a result of the acquisition of Peoples National in 1996, the Company increased its gross deferred tax asset and the related valuation allowance by $162,000. The Company decreased the valuation allowance relating to Peoples National and Winters State by $112,000 during the third quarter of 1997 based on the Company's trend of positive operating results. The Company may reduce or increase its valuation allowance depending on changes in the expectation of future earnings and other circumstances. Management believes that it is more likely than not that the Company will generate sufficient future taxable income to realize the deferred tax asset less the related valuation allowance. At December 31, 1997, the Company had available net operating loss carryforwards of approximately $372,000 acquired as part of the Winters State acquisition and approximately $367,000 acquired as part of the Peoples National acquisition. For federal income tax purposes, due to certain change of ownership requirements of the Internal Revenue Code, utilization of the Winters State and Peoples National net operating loss carryforwards are limited to approximately $37,000 per year and $42,000 per year, respectively. If the full amount of these limitations is not used in any year, the amount not used increases the allowable limit in the subsequent year. These net operating loss carryforwards, if not used, expire between 2003 and 2010. At December 31, 1997, the Company had available general business credit and alternative minimum tax credit carryforwards of approximately $30,000 and $968,000, respectively. If not utilized, the general business credit carryforwards will expire as follows: 1998 - $13,000, 1999 - $6,000 and 2000 - $11,000. The alternative minimum tax credit will carryforward until utilized to reduce future federal income taxes. The comprehensive provisions for federal income taxes for the years ended December 31, 1997, 1996 and 1995, consist of the following:
1997 1996 1995 ----------- ----------- ----------- Current tax provision $ 205,000 $ 76,000 $ 35,000 Deferred tax provision 772,000 677,000 547,000 ----------- ----------- ----------- Provision for tax expense charged to results of operations 977,000 753,000 582,000 Tax (benefit) on adjustment to unrealized gain/loss on available-for-sale securities 3,000 (23,000) 86,000 ----------- ----------- ----------- Comprehensive provision for federal income taxes $ 980,000 $ 730,000 $ 668,000 =========== =========== ===========
-19- NOTE 9: STOCKHOLDERS' EQUITY In December 1993, the Company's board of directors approved the granting of nonqualified stock options for certain executive officers of the Company under which an original aggregate of 18,333 shares of Common Stock, adjusted for the 4-for-3 stock split, effected in the form of a 33-1/3% stock dividend, paid to stockholders in May 1995, and the 5-for-4 stock split, effected in the form of a 25% stock dividend, paid to stockholders in May 1997, may be issued. Options were exercisable at any time during the period January 1, 1994, to December 31, 1997, at a price of $5.40 per share, adjusted for the stock dividends noted above. The Company's Series C Cumulative Convertible Preferred Stock ("Series C Preferred Stock") pays quarterly dividends at the annual rate of $4.20 per share, is senior to the Common Stock with respect to dividends and liquidation rights, is convertible into Common Stock at a price of $1.83 per share, adjusted for the three stock dividends noted above, and has certain voting rights if dividends are in arrears for three quarters. The Series C Preferred Stock is redeemable in cash and/or Common Stock at the Company's option beginning December 12, 1997, at $42.00 per share. An additional 259,371 shares of Common Stock were issued as a result of the 4-for-3 stock split, effected in the form of a 33- 1/3% stock dividend, paid to stockholders in May 1995. An additional 388,911 shares of Common Stock were issued as a result of the 5-for-4 stock split, effected in the form of a 25% stock dividend, paid to stockholders in May 1997. The 1995 and 1997 stock dividends were accounted for by a transfer from retained earnings to common stock of $65,000 and $97,000, respectively, representing the above respective number of shares at a par value of $0.25 per share. Cash paid in lieu of fractional shares was transferred from additional paid-in capital. All references throughout these consolidated financial statements to the number of shares of Common Stock, per share amounts, stock option data and market prices of the Common Stock have been restated for the above-referenced stock splits, effected in the form of stock dividends. The following are summaries of the number of options or shares of Series C Preferred Stock, the number of shares of Common Stock reserved for issuance upon exercise of options or conversion of Series C Preferred Stock and the related exercise or conversion price per share, adjusted for the three stock dividends noted above, for the three years ended December 31, 1997: Exercise or Shares Conversion Reserved for Price Issuance Per Share ------------ ----------- 1993 Stock Options ------------------ Balance January 1, 1995 11,000 $ 9.00 4-for-3 Stock Split 3,666 (2.25) ------------ ------- Balance December 31, 1995 and 1996 14,666 6.75 5-for-4 Stock Split 2,833 (1.35) Options Exercised (17,499) (5.40) ------------ ------- Balance December 31, 1997 0 $ 0 ============ ======= Series C Preferred Stock ------------------------ Balance January 1, 1995 229,685 $ 3.05 4-for-3 Stock Split 76,128 (0.76) Shares Converted (3,803) 0 ------------ ------- Balance December 31, 1995 302,010 2.29 Shares Converted (54,352) 0 ------------ ------- Balance December 31, 1996 247,658 2.29 5-for-4 Stock Split 28,697 (0.46) Shares Converted (147,959) 0 ------------ ------- Balance December 31, 1997 128,396 $ 1.83 ============ ======= The Company's Employee Stock Ownership/401(k) Plan (the "Plan") purchased 18,750 shares, adjusted for the 5-for-4 stock split, effected in the form of a 25% stock dividend, paid to stockholders on May 30, 1997, of the Company's Common Stock in the Company's public stock offering in January 1997 for $214,000. The funds used for the purchase were borrowed from the Company. The note evidencing such borrowing is due in eighty-four equal monthly installments of $4,000, including interest, and matures on February 27, 2004. The note bears interest at the Company's floating base rate plus 1% (9.50% at December 31, 1997). The note is collateralized by the stock purchased in the stock offering. -20- As a result of the lending arrangement between the Company and the Plan, the shares are considered "unearned." The shares are "earned" on a pro rata basis as principal payments are made on the note. The shares are included in the Company's earnings per share calculations only as they are earned. At December 31, 1997, a total 16,961 shares with an original cost of $193,000 are considered to be unearned. NOTE 10: EARNINGS PER SHARE Basic earnings per common share is computed by dividing net income available to common stockholders by the weighted average number of common shares outstanding during the period. Because the Company's outstanding Series C Preferred Stock is cumulative, the dividends allocable to such preferred stock reduces income available to common stockholders in the basic earnings per share calculations. In computing diluted earnings per common share for the years ended December 31, 1997, 1996 and 1995, the conversion of the Series C Preferred Stock and the exercise of outstanding stock options were assumed, as the effects are dilutive. The following table presents information necessary to calculate earnings per share for the years ended December 31, 1997, 1996 and 1995 (adjusted for the 4-for-3 stock split, effected in the form of a 33-1/3% stock dividend, paid to stockholders in May 1995, and for the 5-for-4 stock split, effected in the form of a 25% stock dividend, paid to stockholders in May 1997):
Net income $ 2,110 $ 1,422 $ 1,132 ========= ========= ========= Weighted average shares outstanding 1,842 1,355 1,299 Exercise of stock options 9 8 11 Conversion of Series C Preferred Stock 197 335 379 --------- --------- --------- Adjusted weighted average shares outstanding 2,048 1,698 1,689 ========= ========= =========
NOTE 11: BENEFIT PLANS The Company's Plan covers most of its officers and employees. The Plan stipulates, among other things, that vesting in employer contributions begins after one year of service, each participant will become fully vested in employer contributions after seven years of service and the determination of the level of vesting began with the original date of current employment of each participant with the Company or the Bank. Contributions made to the employee stock ownership portion of the Plan by the Company were $100,000, $77,000 and $72,000 for the years ended December 31, 1997, 1996 and 1995, respectively. These contributions were used to make distributions to employees who left the Company's employment in the respective years and to purchase Common Stock of the Company. No contributions have been made by the Company to match contributions made by plan participants in the 401(k) portion of the Plan. The amount of all such contributions is at the discretion of the Company's board of directors. Employee contributions are invested in various equity, debt and money market investments, including Common Stock of the Company. At December 31, 1997, 154,199 shares of Common Stock of the Company were held by the Plan. NOTE 12: RELATED PARTY TRANSACTIONS In the ordinary course of business, the Company and the Bank have loans, deposits and other transactions with their respective directors and businesses with which such persons are associated. It is the Company's policy that all such transactions are entered into on substantially the same terms as those prevailing at the time for comparable transactions with unrelated third parties. The balances of loans to all such persons were $2,511,000, $3,025,000 and -21- $1,053,000 at December 31, 1997, 1996 and 1995, respectively. Additions and reductions on such loans were $2,903,000 and $3,417,000, respectively, for the year ended December 31, 1997. The Company and its subsidiaries paid $42,000, $28,000 and $19,000 in fees to a director-related company for services rendered on various legal matters during 1997, 1996 and 1995, respectively. During the year ended December 31, 1995, the Company reimbursed $800,000 ($450,000 in cash and $350,000 in notes payable) to three former directors (one of whom is also a current director of the Company) of a bank which was a repossessed asset of a former subsidiary bank for payment of reasonable legal fees and expenses in connection with their defense of an action brought by the Federal Deposit Insurance Corporation (the "FDIC"). NOTE 13: COMMITMENTS AND CONTINGENT LIABILITIES The Company is involved in various litigation proceedings incidental to the ordinary course of business. In the opinion of management, the ultimate liability, if any, resulting from such other litigation would not be material in relation to the Company's financial condition. The Bank leases certain of its premises and equipment under noncancellable operating leases. Rental expense under such operating leases was approximately $289,000, $336,000 and $290,000 in 1997, 1996 and 1995, respectively. The minimum payments due under these leases at December 31, 1997, are as follows: 1998 $ 160,000 1999 115,000 2000 118,000 2001 89,000 2002 64,000 2003 2,000 ---------- Total $ 548,000 ========== NOTE 14: FAIR VALUE OF FINANCIAL INSTRUMENTS The carrying amounts and fair values of financial assets and financial liabilities at December 31, 1997 and 1996, were as follows:
1997 1996 --------------------------- --------------------------- Carrying Carrying Amount Fair Value Amount Fair Value ------------ ------------ ------------ ------------ Financial Assets ---------------- Cash and due from banks $ 14,518,000 $ 14,518,000 $ 11,458,000 $ 11,458,000 Federal funds sold 24,900,000 24,900,000 18,500,000 18,500,000 Available-for-sale securities 22,501,000 22,501,000 27,771,000 27,771,000 Held-to-maturity securities 47,293,000 47,376,000 47,381,000 47,291,000 Loans, net of unearned income 140,853,000 143,744,000 92,017,000 93,814,000 Accrued interest receivable 2,208,000 2,208,000 1,599,000 1,599,000 Financial Liabilities --------------------- Noninterest-bearing demand deposits $ 43,868,000 $ 43,868,000 $ 32,240,000 $ 32,240,000 Interest-bearing demand deposits 77,495,000 77,495,000 58,676,000 58,676,000 Interest-bearing time deposits 121,438,000 121,724,000 98,659,000 98,923,000 Accrued interest payable 947,000 947,000 951,000 951,000 Notes payable 57,000 57,000 240,000 240,000
Fair values for investment securities are based on quoted market prices, where available. If quoted market prices are not available, fair values are based on quoted market prices of comparable instruments. For variable-rate loans that reprice frequently with no significant change in credit risk, fair values are based on carrying values. The fair values of other loans are estimated using discounted cash flow analyses, which utilize interest rates currently being offered for loans with similar terms to borrowers of similar credit quality. -22- The fair values of noninterest and interest-bearing demand deposits are, by definition, equal to the amount payable on demand, i.e., their carrying amount. The fair values of interest-bearing time deposits are estimated using a discounted cash flow calculation that applies interest rates currently being offered on certificates of similar maturities. The carrying amounts for cash and due from banks, federal funds sold, accrued interest receivable, notes payable and accrued interest payable approximate the fair values of such assets and liabilities. Fair values for the Company's off-balance-sheet instruments, which consist of lending commitments and standby letters of credit, are based on fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the counterparties' credit standing. Management believes that the fair value of these off-balance-sheet instruments is not materially different from the commitment amount. NOTE 15: FINANCIAL INSTRUMENTS WITH OFF-BALANCE-SHEET RISK The Company is a party to financial instruments with off- balance-sheet risk entered into in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit, standby letters of credit and financial guarantees. Those instruments involve, to varying degrees, elements of credit risk in excess of the amount recognized in the accompanying financial statements. The contractual amounts of those instruments reflect the extent of involvement the Company has in particular classes of financial instruments. The Company's exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit, standby letters of credit and financial guarantees is represented by the contractual amount of those instruments. The Company uses the same credit policies in making commitments and conditional obligations as it does for on- balance-sheet instruments. Unless noted otherwise, the Company does not require collateral or other security to support financial instruments with credit risk. The Company had outstanding loan commitments of approximately $6,930,000 and outstanding standby letters of credit and financial guarantees of approximately $187,000 at December 31, 1997. Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Because many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The Company evaluates each customer's creditworthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by the Company upon extension of credit, is based on management's credit evaluation of the customer. Collateral held varies but may include real estate, accounts receivable, inventory, property, plant and equipment and income-producing commercial properties. Standby letters of credit and financial guarantees are conditional commitments issued by the Company to guarantee the performance of a customer to a third party. These guarantees are primarily issued to support public and private borrowing arrangements. The credit risk involved in issuing standby letters of credit is essentially the same as that involved in making loans to customers. The Company does not expect any material losses as a result of loan commitments, standby letters of credit and financial guarantees that were outstanding at December 31, 1997. In the normal course of business, the Company maintains deposits with other financial institutions in amounts which exceed FDIC insurance coverage limits. NOTE 16: REGULATORY MATTERS The Company and the Bank are subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements could cause the initiation of certain mandatory, and possibly additional discretionary, actions by the regulatory authorities that, if undertaken, could have a direct material effect on the Company's and the Bank's respective financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Company and the Bank must meet specific capital guidelines that involve quantitative measures of the Company's and the Bank's respective assets, liabilities, and certain off-balance-sheet items as calculated under regulatory accounting practices. The Company's and the Bank's respective capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings and other factors. -23- Quantitative measures established by regulation to ensure capital adequacy require the Company and the Bank to maintain minimum amounts and ratios (set forth in the table below) of Tier 1 capital and total capital (Tier 1 and Tier 2) to risk-weighted assets and of Tier 1 capital to adjusted quarterly average assets. At December 31, 1997, the Company and the Bank met all capital adequacy requirements to which they were subject. At December 31, 1997, the most recent notifications from the FDIC categorized the Bank as well capitalized under the regulatory framework for prompt corrective action. To be categorized as well capitalized, the Company and the Bank must maintain minimum Tier 1 capital to risk-weighted assets, total capital to risk-weighted assets and Tier 1 capital to adjusted quarterly average assets ratios as set forth in the tables. There are no other conditions or events since the most recent notification that management believes have changed either the Company's or the Bank's category. The minimum capital amounts and ratios for well capitalized bank holding companies and the Company's actual capital amounts and ratios at December 31, 1997, were as follows:
Minimums for Well Capitalized Holding Companies Actual -------------------------- --------------------- Amount Ratio Amount Ratio ------------------ ------ ---------- ------ (Dollars in thousands) Tier 1 capital to risk-weighted assets $ 12,323 8.00% $ 17,337 11.26% Total capital to risk-weighted assets 15,404 10.00 18,510 12.02 Tier 1 capital to adjusted quarterly average assets 15,510 6.00 17,337 6.71
Minimums for Well Capitalized Banks Actual -------------------- --------------------- Amount Ratio Amount Ratio --------- ----- --------- ------ (Dollars in thousands) Tier 1 capital to risk-weighted assets $ 12,385 8.00% $ 15,855 10.24% Total capital to risk-weighted assets 15,482 10.00 17,028 11.00 Tier 1 capital to adjusted quarterly average assets 15,431 6.00 15,855 6.18
At December 31, 1997, retained earnings of the Bank included approximately $2,780,000 that was available for payment of dividends to the Company without prior approval of regulatory authorities. -24- NOTE 17: PARENT COMPANY FINANCIAL INFORMATION Condensed financial statements of the Company, parent only, are presented below: INDEPENDENT BANKSHARES, INC. CONDENSED BALANCE SHEETS DECEMBER 31, 1997 AND 1996
1997 1996 ----------- ----------- Assets: Cash $ 326,000 $ 148,000 Investment in subsidiaries 19,125,000 13,576,000 Premises and equipment 2,000 3,000 Other assets 1,214,000 1,452,000 ----------- ----------- Total assets $20,667,000 $15,179,000 =========== =========== Liabilities: Notes payable $ 50,000 $ 228,000 Accrued interest payable and other liabilities 90,000 14,000 ----------- ----------- Total liabilities 140,000 242,000 Stockholders' equity 20,527,000 14,937,000 ----------- ----------- Total liabilities and stockholders' equity $20,667,000 $15,179,000 =========== ===========
INDEPENDENT BANKSHARES, INC. CONDENSED INCOME STATEMENTS YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
1997 1996 1995 ----------- ----------- ----------- Income: Dividends from subsidiaries (see Note 16) $ 900,000 $ 1,000,000 $ 905,000 Management fees from subsidiaries 150,000 161,000 177,000 Interest on loan to the Plan 18,000 0 0 Interest from subsidiaries 1,000 3,000 2,000 ----------- ----------- ----------- Total income 1,069,000 1,164,000 1,084,000 ----------- ----------- ----------- Expenses: Interest 33,000 58,000 107,000 Other expenses 570,000 557,000 756,000 ----------- ----------- ----------- Total expenses 603,000 615,000 863,000 ----------- ----------- ----------- Income before federal income taxes and equity in undistributed earnings of subsidiaries 466,000 549,000 221,000 Federal income tax benefit (276,000) (162,000) (236,000) ----------- ----------- ----------- Income before equity in undistributed earnings of subsidiaries 742,000 711,000 457,000 Equity in undistributed earnings of subsidiaries 1,368,000 711,000 675,000 ----------- ----------- ----------- Net income $ 2,110,000 $ 1,422,000 $ 1,132,000 =========== =========== ===========
-25- INDEPENDENT BANKSHARES, INC. CONDENSED STATEMENTS OF CASH FLOWS YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
1997 1996 1995 ----------- ----------- ----------- Cash flows from operating activities: Net income $ 2,110,000 $ 1,422,000 $ 1,132,000 Adjustments to reconcile net income to net cash provided by operating activities: Deferred federal income tax expense 772,000 677,000 547,000 Depreciation and amortization 1,000 1,000 2,000 Equity in undistributed earnings of subsidiaries (1,368,000) (711,000) (675,000) Increase in other assets (197,000) (540,000) (97,000) Decrease in accrued interest payable and other liabilities (231,000) (16,000) (390,000) ----------- ----------- ----------- Net cash provided by operating activities 1,087,000 833,000 519,000 ----------- ----------- ----------- Cash flows from investing activities: Loans made to employee stock ownership plan (239,000) 0 11,000 Proceeds from repayments of loans made to employee stock ownership plan 46,000 0 (11,000) Capital contribution made to subsidiary (4,200,000) 0 0 ----------- ----------- ----------- Net cash used in investing activities (4,393,000) 0 0 ----------- ----------- ----------- Cash flows from financing activities: Proceeds from notes payable 800,000 0 275,000 Repayment of notes payable (983,000) (616,000) (687,000) Net proceeds from issuance of equity securities 4,077,000 0 34,000 Cash paid for fractional shares in stock dividend (5,000) 0 (4,000) Payment of cash dividends (405,000) (260,000) (187,000) ----------- ----------- ----------- Net cash used in financing activities 3,484,000 (876,000) (569,000) ----------- ----------- ----------- Net increase (decrease) in cash and cash equivalents 178,000 (43,000) (50,000) Cash and cash equivalents at beginning of year 148,000 191,000 241,000 ----------- ----------- ----------- Cash and cash equivalents at end of year $ 326,000 $ 148,000 $ 191,000 =========== =========== ===========
NOTE 18: SUPPLEMENTAL CASH FLOW INFORMATION Supplemental cash flow information for the years ended December 31, 1997, 1996 and 1995, is as follows:
1997 1996 1995 ----------- ------------ ----------- Cash paid during the year for: Interest $ 8,663,000 $ 6,372,000 $ 4,835,000 Federal income taxes 670,000 438,000 15,000 Noncash investing activities: Additions to other real estate and other repossessed assets during the year through foreclosures $ 1,283,000 $ 1,015,000 $ 1,039,000 Sales of other real estate and other repossessed assets financed with loans 93,000 240,000 196,000 Transfer of other real estate and other repossessed assets to loans 0 0 125,000 Increase (decrease) in unrealized gain/loss on available-for-sale securities, net of tax 6,000 (43,000) 168,000 Other liabilities replaced with notes payable 0 0 334,000 Details of acquisitions: Cash paid in acquisitions $ 7,510,000 $ 1,505,000 $ 0 Cash and cash equivalents held by companies acquired at dates of acquisition (6,274,000) (15,708,000) 0 ----------- ------------ ----------- Net cash paid (acquired) in acquisitions $ 1,236,000 $(14,203,000) $ 0 =========== ============ ===========
-26 QUARTERLY DATA (UNAUDITED) The following table presents the unaudited results of operations for the past two years by quarter. See "Note 10: Earnings Per Share" in the Company's Consolidated Financial Statements.
1997 ----------------------------------------------------- First Second Third Fourth Quarter Quarter Quarter Quarter Total -------- -------- -------- -------- -------- (In thousands, except per share amounts) Interest income $ 4,296 $ 4,678 $ 4,678 $ 4,672 $ 18,324 Interest expense 2,056 2,193 2,204 2,206 8,659 Net interest income 2,240 2,485 2,474 2,466 9,665 Provision for loan losses 0 60 150 40 250 Income before federal income taxes 772 821 698 796 3,087 Net income 493 562 550 505 2,110 Basic earnings per common share available to common stockholders $ 0.29 $ 0.30 $ 0.27 $ 0.26 $ 1.12 Diluted earnings per common share available to common stockholders 0.26 0.27 0.26 0.24 1.03 1996 ----------------------------------------------------- First Second Third Fourth Quarter Quarter Quarter Quarter Total -------- -------- -------- -------- -------- (In thousands, except per share amounts) Interest income $ 3,223 $ 3,284 $ 3,502 $ 3,547 $ 13,556 Interest expense 1,485 1,544 1,693 1,719 6,441 Net interest income 1,738 1,740 1,809 1,828 7,115 Provision for loan losses 50 71 40 40 201 Income before federal income taxes 547 479 558 591 2,175 Net income 361 299 355 407 1,422 Basic earnings per common share available to common stockholders $ 0.26 $ 0.22 $ 0.26 $ 0.26 $ 1.00 Diluted earnings per common share available to common stockholders 0.21 0.19 0.22 0.22 0.84
The above unaudited financial information reflects all adjustments that are, in the opinion of management, necessary to present a fair statement of the results of operations for the interim periods presented. -27- SELECTED CONSOLIDATED FINANCIAL INFORMATION The following table presents selected consolidated financial information for the last five years. Such financial information has been restated to reflect the 5% stock dividend paid to stockholders in May 1993, the 4-for-3 stock split, effected in the form of a 33-1/3% stock dividend, paid to stockholders in May 1995 and the 5-for-4 stock split, effected in the form of a 25% stock dividend, paid to stockholders in May 1997. See "Note 1: Summary of Significant Accounting Policies-Principles of Consolidation," "Note 2: Bank Acquisitions," "Note 7: Notes Payable" and "Note 10: Earnings Per Share" in the Company's Consolidated Financial Statements for other significant changes in financial statement items.
1997 1996 1995 1994 1993 ----------- ----------- ----------- ----------- ------------ (In thousands, except per share amounts) Balance sheet information: Assets $ 264,574 $ 205,698 $ 180,344 $ 159,860 $ 160,712 Loans, net of unearned income 140,853 92,017 81,927 81,306 69,647 Deposits 242,801 189,575 164,704 146,184 147,785 Notes payable 57 240 849 930 1,194 Stockholders' equity 20,527 14,937 13,818 11,073 10,845 Income statement information: Total interest income $ 18,324 $ 13,556 $ 11,962 $ 10,131 $ 9,221 Net interest income 9,665 7,115 6,653 6,679 6,045 Income before cumulative effect of accounting change 2,110 1,422 1,132 450 1,029 Cumulative effect of accounting change 0 0 0 0 200(1) Net income 2,110 1,422 1,132 450 1,229 Basic earnings per common share available to common stockholders: Income before cumulative effective of accounting change $ 1.12 $ 1.00 $ 0.82 $ 0.29 $ 0.74 Cumulative effect of accounting change 0.00 0.00 0.00 0.00 0.15(1) ----------- ----------- ----------- ----------- ------------ Net income $ 1.12 $ 1.00 $ 0.82 $ 0.29 $ 0.89 =========== =========== =========== =========== ============ Diluted earnings per common share available to common stockholders: Income before cumulative effect of accounting change $ 1.03 $ 0.84 $ 0.67 $ 0.27 $ 0.61 Cumulative effect of accounting change 0.00 0.00 0.00 0.00 0.12(1) ----------- ----------- ----------- ----------- ------------ Net income $ 1.03 $ 0.84 $ 0.67 $ 0.27 $ 0.73 =========== =========== =========== =========== ============ Cash dividends per common share $ 0.19 $ 0.14 $ 0.09 $ 0.06 $ 0.00 =========== =========== ========== =========== =========== ______________________ (1) Cumulative effect of a change in accounting for income taxes.
-28- MARKET INFORMATION The Company's Common Stock trades on the American Stock Exchange (the "AMEX") under the symbol "IBK." The following table sets forth, for the periods indicated, the high and low sales prices for the Common Stock as quoted on the AMEX and the amount of cash dividends paid per share, adjusted for the 5-for-4 stock split, effected in the form of a 25% stock dividend, paid to stockholders in May 1997. Cash Dividends High Low Per Share ------- --------- --------- Year Ended December 31, 1996 ---------------------------- First Quarter $ 8-3/8 $ 7-13/16 $ 0.02 Second Quarter 8-13/16 7-3/16 0.04 Third Quarter 9-11/16 8-11/16 0.04 Fourth Quarter 14 9-11/16 0.04 Year Ended December 31, 1997 ---------------------------- First Quarter $13-5/8 $11-1/2 $ 0.04 Second Quarter 13-1/4 11-13/16 0.05 Third Quarter 18-1/4 13-1/8 0.05 Fourth Quarter 19-3/4 16-1/8 0.05 Year Ending December 31, 1998 ----------------------------- First Quarter (through March 16) $19-5/8 $15-3/4 $ 0.05(1) _____________ (1) This cash dividend was paid February 27, 1998, to shareholders of record on February 13, 1998. At March 16, 1998, there were 1,656 stockholders who were individual participants in security position listings. -29- MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Forward-looking Statements - Cautionary Statements - -------------------------------------------------- THIS REPORT CONTAINS CERTAIN FORWARD-LOOKING STATEMENTS AND INFORMATION RELATING TO INDEPENDENT BANKSHARES, INC. (THE "COMPANY") AND ITS SUBSIDIARIES THAT ARE BASED ON THE BELIEFS OF THE COMPANY'S MANAGEMENT AS WELL AS ASSUMPTIONS MADE BY AND INFORMATION CURRENTLY AVAILABLE TO THE COMPANY'S MANAGEMENT. WHEN USED IN THIS REPORT, THE WORDS "ANTICIPATE," "BELIEVE," "ESTIMATE," "EXPECT" AND "INTEND" AND WORDS OR PHRASES OF SIMILAR IMPORT, AS THEY RELATE TO THE COMPANY OR ITS SUBSIDIARIES OR COMPANY MANAGEMENT, ARE INTENDED TO IDENTIFY FORWARD-LOOKING STATEMENTS. SUCH STATEMENTS REFLECT THE CURRENT VIEW OF THE COMPANY WITH RESPECT TO FUTURE EVENTS AND ARE SUBJECT TO CERTAIN RISKS, UNCERTAINTIES AND ASSUMPTIONS RELATED TO CERTAIN FACTORS INCLUDING, WITHOUT LIMITATION, COMPETITIVE FACTORS, GENERAL ECONOMIC CONDITIONS, CUSTOMER RELATIONS, THE INTEREST RATE ENVIRONMENT, GOVERNMENTAL REGULATION AND SUPERVISION, NONPERFORMING ASSET LEVELS, LOAN CONCENTRATIONS, CHANGES IN INDUSTRY PRACTICES, ONE TIME EVENTS AND OTHER FACTORS DESCRIBED HEREIN. BASED UPON CHANGING CONDITIONS, SHOULD ANY ONE OR MORE OF THESE RISKS OR UNCERTAINTIES MATERIALIZE, OR SHOULD ANY UNDERLYING ASSUMPTIONS PROVE INCORRECT, ACTUAL RESULTS MAY VARY MATERIALLY FROM THOSE DESCRIBED HEREIN AS ANTICIPATED, BELIEVED, ESTIMATED, EXPECTED OR INTENDED. THE COMPANY DOES NOT INTEND TO UPDATE THESE FORWARD-LOOKING STATEMENTS. The Company - ----------- The Company is a bank holding company headquartered in Abilene, Texas. The Company indirectly owns through a Delaware subsidiary, Independent Financial Corp. ("Independent Financial"), 100% of First State Bank, National Association, Abilene, Texas (the "Bank"). The Bank currently operates full-service banking locations in the West Texas cities of Abilene (3 locations), Lubbock, Odessa (3 locations), San Angelo, Stamford and Winters. General - ------- The following discussion and analysis presents the more significant factors affecting the Company's financial condition at December 31, 1997 and 1996, and results of operations for each of the three years in the period ended December 31, 1997, after accounting for the acquisition of the subsidiary banks noted below. This discussion and analysis should be read in conjunction with the Company's Consolidated Financial Statements, notes thereto and other financial information appearing elsewhere in this annual report. All references herein to the number of shares of Common Stock, per share amounts and market prices of the Common Stock have been restated for the stock splits, effected in the form of stock dividends, described in Note 9 to the Company's consolidated financial statements. Bank Acquisitions - ----------------- CROWN PARK AND WESTERN NATIONAL. On January 28, 1997, the Company consummated the acquisition of Crown Park Bancshares, Inc. ("Crown Park") and its wholly owned subsidiary bank, Western National Bank, Lubbock, Texas ("Western National"), for an aggregate cash consideration of $7,510,000. On the closing date, Crown Park was merged with and into a wholly owned subsidiary of the Company and Western National was merged with and into the Bank. To obtain funding for the acquisition, the Company sold an aggregate of 395,312 shares of its common stock in an underwritten offering at a price of $11.40 per share (the "Offering"). This included 51,562 shares covered by the underwriter's over-allotment option. The Company borrowed $800,000 from a financial institution in Amarillo, Texas (the "Amarillo Bank") to finance the remaining cost of acquiring Crown Park. The $800,000 of borrowings was paid down during 1997 and completely paid off on December 31, 1997. See "- Liquidity" and "- Capital Resources" below. At the date of acquisition, on a consolidated basis, Crown Park had total assets of $60,420,000, total loans, net of unearned income, of $41,688,000, total deposits of $53,604,000 and stockholders' equity of $4,238,000. SAN ANGELO BRANCH. On May 27, 1996, the Bank assumed the deposits and certain other liabilities and purchased the loans and certain other assets of the San Angelo, Texas branch of Coastal Banc ssb ("Coastal Banc - - San Angelo") -30- in a cash transaction, and Coastal Banc - San Angelo became a branch of the Bank. On the date of the acquisition, Coastal Banc - San Angelo had approximately $14,895,000 in total deposits and $155,000 in total loans. PEOPLES NATIONAL. The Bank completed the acquisition of Peoples National Bank, Winters, Texas ("Peoples National") effective January 1, 1996, and Peoples National became part of the Winters branch of the Bank. At December 31, 1995, Peoples National had total assets of $5,505,000, total loans, net of unearned income, of $2,767,000, total deposits of $4,958,000 and stockholders' equity of $525,000. These acquisitions were accounted for under the purchase method of accounting, and the results of operations of Crown Park, Coastal Banc - San Angelo and Peoples National are included in the Company's results of operations from their respective dates of purchase. The assets and liabilities of Crown Park, Coastal Banc - San Angelo and Peoples National were recorded at their estimated fair value. A total of $2,468,000, $743,000 and $260,000 of goodwill, respectively, was recorded as a result of these acquisitions. Results of Operations - --------------------- GENERAL Net income for the year ended December 31, 1997, amounted to $2,110,000 ($1.12 basic earnings per common share) compared to net income of $1,422,000 ($1.00 basic earnings per common share) for the year ended December 31, 1996, and compared to net income of $1,132,000 ($0.82 basic earnings per common share) for the year ended December 31, 1995. The results of operations for 1995 included legal and settlement expenses of $205,000 ($135,000, net of tax), or $0.10 basic earnings per common share, incurred as a result of the final settlement of certain litigation. Two industry measures of the performance by a banking institution are its return on average assets and return on average stockholders' equity. Return on average assets ("ROA") measures net income in relation to average total assets and indicates a company's ability to employ its resources profitably. During 1997, the Company's ROA was 0.82%, compared to 0.72% for 1996 and compared to 0.67% for 1995. Excluding the unusual item noted above, the Company's ROA for 1995 would have been 0.75%. Return on average stockholders' equity ("ROE") is determined by dividing net income by average stockholders' equity and indicates how effectively a company can generate net income on the capital invested by its stockholders. During 1997, the Company's ROE was 10.95%, compared to 9.89% for 1996 and 8.99% for 1995. Excluding the unusual item noted above, the Company's ROE for 1995 would have been 10.06%. NET INTEREST INCOME Net interest income represents the amount by which interest income on interest-earning assets, including loans and securities, exceeds interest paid on interest-bearing liabilities, including deposits and other borrowed funds. Net interest income is the principal source of the Company's earnings. Interest rate fluctuations, as well as changes in the amount and type of interest-earning assets and interest-bearing liabilities, combine to affect net interest income. Net interest income amounted to $9,665,000 for 1997, an increase of $2,550,000, or 35.8%, from 1996. Net interest income for 1996 was $7,115,000, an increase of $462,000, or 6.9%, from 1995. The increase in 1997 was primarily due to the acquisition of Crown Park in January 1997, which had a higher loan-to-deposit ratio than the Bank. The increase in 1996 was also due to the Company's overall growth. The net interest margin on a fully taxable-equivalent basis was 4.13% for 1997, compared to 3.95% for 1996 and 4.29% for 1995. The primary reason for the increase in 1997 was the acquisition of Crown Park noted above. The decrease in 1996 was due primarily to the fact that in the acquisitions of Peoples National and Coastal Banc - San Angelo, the Company acquired $19,853,000 in deposits and only $2,922,000 in loans. As a result, a significant amount of the increased funds was invested in investment securities and federal funds sold, which yielded a lower rate of interest than loans and, therefore, had a negative impact on the Company's net interest margin. -31- At December 31, 1997, approximately $28,475,000, or 20.2%, of the Company's total loans, net of unearned income, were loans with floating interest rates. This amount represented 38.0% of loans, excluding loans to individuals, which are exclusively fixed rate in nature. The overall average rate paid for total deposits increased slightly in 1997. The average rate paid by the Company for certificates of deposit and other time deposits of $100,000 or more increased to 5.54% during 1997 from 5.39% in 1996. The average rate paid for certificates of deposit less than $100,000 decreased from 5.42% in 1996 to 5.36% in 1997. Rates on other types of deposits, such as savings accounts, money market accounts and NOW accounts, increased from an average of 2.41% in 1996 to an average of 2.69% in 1997. Given the fact that the Company's interest-bearing liabilities are subject to repricing faster than its interest-earning assets in the very short term, an overall rising interest rate environment would normally produce a lower net interest margin than a falling interest rate environment. As noted under "Analysis of Financial Condition - Interest Rate Sensitivity" below, because the Company's interest-bearing demand, savings and money market deposits are somewhat less rate-sensitive, the Company's net interest margin does not necessarily decrease in a rising interest rate environment. The following table presents the average balance sheets of the Company for each of the last three fiscal years and indicates the interest earned or paid on each major category of interest-earning assets and interest-bearing liabilities on a fully taxable-equivalent basis, and the average rates earned or paid on each major category. This analysis details the contribution of interest-earning assets and the overall impact of the cost of funds on net interest income. -32-
Year Ended December 31, ---------------------------------------------------------------------------- 1997 1996 ------------------------------------ ------------------------------------ Interest Interest Average Income/ Yield/ Average Income/ Yield/ Balance Expense Rate Balance Expense Rate ---------- ---------- ------ ---------- ---------- ------ ASSETS (1) (Dollars in thousands) Interest-earning assets: Loans, net of unearned income (2) $ 132,891 $ 12,236 9.21% $ 85,880 $ 8,005 9.32% Securities (3) 84,566 5,181 6.13 74,920 4,507 6.02 Federal funds sold 16,469 912 5.54 19,406 1,047 5.40 ---------- ---------- ------ ---------- ---------- ------ Total interest-earning assets 233,926 18,329 7.84 180,206 13,559 7.52 ---------- ---------- ------ ---------- ---------- ------ Noninterest-earning assets: Cash and due from banks 11,051 7,151 Premises and equipment, net 6,951 4,427 Goodwill 3,116 689 Accrued interest receivable and other assets 5,030 4,507 Allowance for possible loan losses (1,200) (825) ---------- ---------- Total noninterest-earning assets 24,948 15,949 ---------- ---------- Total assets $ 258,874 $ 196,155 ========== ========== LIABILITIES AND STOCKHOLDERS' EQUITY (1) Interest-bearing liabilities: Demand, savings and money market deposits $ 75,833 $ 2,037 2.69% $ 57,847 $ 1,397 2.41% Time deposits 121,218 6,563 5.41 92,065 4,985 5.41 ---------- ---------- ------ ---------- ---------- ------ Total interest-bearing deposits 197,051 8,600 4.36 149,912 6,382 4.26 Notes payable 714 59 8.26 568 59 10.39 ---------- ---------- ------ ---------- ---------- ------ Total interest-bearing liabilities 197,765 8,659 4.38 150,480 6,441 4.28 ---------- ---------- ------ ---------- ---------- ------ Noninterest-bearing liabilities: Demand deposits 40,328 30,093 Accrued interest payable and other liabilities 1,506 1,207 ---------- ---------- Total noninterest-bearing liabilities 41,834 31,300 ---------- ---------- Total liabilities 239,599 181,780 ---------- ---------- Stockholders' equity 19,275 14,375 ---------- ---------- Total liabilities and stockholders' equity $ 258,874 $ 196,155 ========== ========== Net interest income $ 9,670 $ 7,118 ========== ========== Interest rate spread (4) 3.46% 3.24% ====== ====== Net interest margin (5) 4.13% 3.95% ====== ====== Year Ended December 31, ------------------------------------ 1995 ------------------------------------ Interest Average Income/ Yield/ Balance Expense Rate ---------- --------- ------ ASSETS (1) (Dollars in thousands) Interest-earning assets: Loans, net of unearned income (2) $ 82,302 $ 7,726 9.39% Securities (3) 41,846 2,391 5.71 Federal funds sold 31,076 1,847 5.94 ---------- --------- ------ Total interest-earning assets 155,224 11,964 7.71 ---------- --------- ------ Noninterest-earning assets: Cash and due from banks 7,066 Premises and equipment, net 4,211 Goodwill 0 Accrued interest receivable and other assets 3,817 Allowance for possible loan losses (786) ---------- Total noninterest-earning assets 14,308 ---------- Total assets $ 169,532 ========== LIABILITIES AND STOCKHOLDERS' EQUITY (1) Interest-bearing liabilities: Demand, savings and money market deposits $ 53,391 $ 1,257 2.35% Time deposits 72,137 3,944 5.47 ---------- ----------- ------ Total interest-bearing deposits 125,528 5,201 4.14 Notes payable 1,069 108 10.10 ---------- ----------- ------ Total interest-bearing liabilities 126,597 5,309 4.19 ---------- ----------- ------ Noninterest-bearing liabilities: Demand deposits 29,019 Accrued interest payable and other liabilities 1,322 ---------- Total noninterest-bearing liabilities 30,341 ---------- Total liabilities 156,938 ---------- Stockholders' equity 12,594 ---------- Total liabilities and stockholders' equity $ 169,532 ========== Net interest income $ 6,655 ========= Interest rate spread (4) 3.52% ====== Net interest margin (5) 4.29% ====== ______________________________ (1) The Average Balance and Interest Income/Expense columns include the balance sheet and income statement accounts of Peoples National, Coastal Banc - San Angelo and Crown Park from January 1, 1996, May 27, 1996 and January 28, 1997 (the respective dates of acquisition of such banks), through December 31, 1997. (2) Nonaccrual loans are included in the Average Balance columns and income recognized on these loans, if any, is included in the Interest Income/Expense columns. Interest income on loans includes fees on loans, which are not material in amount. (3) Nontaxable interest income on securities was adjusted to a taxable yield assuming a tax rate of 34%. (4) The interest rate spread is the difference between the average yield on interest-earning assets and the average cost of interest-bearing liabilities. (5) The net interest margin is equal to net interest income, on a fully taxable-equivalent basis, divided by average interest-earning assets.
-33- The following table presents the changes in the components of net interest income and identifies the part of each change due to differences in the average volume of interest-earning assets and interest-bearing liabilities and the part of each change due to the average rate on those assets and liabilities. The changes in interest due to both volume and rate in the table have been allocated to volume or rate change in proportion to the absolute amounts of the change in each.
1997(1) vs 1996 1996(1) vs 1995 --------------------------- --------------------------- Increase (Decrease) Due To Increase (Decrease) Due To Changes In: Changes In: --------------------------- --------------------------- Volume Rate Total Volume Rate Total ------- ------- ------- ------- ------- ------- (In thousands) Interest-earning assets: Loans, net of unearned income $ 4,377 $ (146) $ 4,231 $ 336 $ (57) $ 279 Securities (2) 581 93 674 1,980 136 2,116 Federal funds sold (158) 23 (135) (644) (156) (800) ------- ------- ------- ------- ------- ------- Total interest income 4,800 (30) 4,770 1,672 (77) 1,595 ------- ------- ------- ------- ------- ------- Interest-bearing liabilities: Deposits: Demand, savings and money market deposits 430 210 640 107 33 140 Time deposits 1,578 0 1,578 1,084 (43) 1,041 ------- ------- ------- ------- ------- ------- Total deposits 2,008 210 2,218 1,191 (10) 1,181 Notes payable 15 (15) 0 (52) 3 (49) ------- ------- ------- ------- ------- ------- Total interest expense 2,023 195 2,218 1,139 (7) 1,132 ------- ------- ------- ------- ------- ------- Increase (decrease) in net interest income $ 2,777 $ (225) $ 2,552 $ 533 $ (70) $ 463 ======= ======= ======= ======= ======= ======= ______________________________ (1) Income statement items include the income statement accounts of Peoples National, Coastal Banc - San Angelo and Crown Park beginning January 1, 1996, May 27, 1996 and January 28, 1997 (the respective dates of acquisition of such banks), through December 31, 1997. (2) Information with respect to interest income on tax-exempt securities is provided on a fully taxable-equivalent basis assuming a tax rate of 34%.
Provision for Loan Losses - ------------------------- The amount of the provision for loan losses is based on periodic (not less than quarterly) evaluations of the loan portfolio, especially nonperforming and other potential problem loans. During these evaluations, consideration is given to such factors as: management's evaluation of specific loans; the level and composition of nonperforming loans; historical loss experience; results of examinations by regulatory agencies; an internal asset review process conducted by the Company that is independent of the management of the Bank; expectations of future economic conditions and their impact on particular industries and individual borrowers; the market value of collateral; the strength of available guarantees; concentrations of credit; and other judgmental factors. The provision for loan losses for the year ended December 31, 1997, was $250,000, compared to $201,000 for the previous year. The provision in 1997 represented an increase of $49,000, or 24.4%, from the 1996 provision. The higher provision in 1997 is due to increased charge- offs during 1997, primarily in the indirect installment loan portfolio. This situation was mitigated somewhat by the fact that the Company's classified loans have continued to decline, notwithstanding the acquisitions made during 1996 and 1997. The provision in 1996 represented a decrease of $5,000, or 2.4%, from the 1995 provision. The relatively lower provisions over the past several years reflect the general stabilization of the economic conditions in the Company's primary service area. In addition, the overall quality of the Company's loan portfolio has improved during that same period of time, necessitating generally lower provisions. -34- Noninterest Income - ------------------ Noninterest income increased $358,000, or 23.1%, from $1,551,000 in 1996 to $1,909,000 in 1997. The amount for 1996 increased $42,000, or 2.8%, from $1,509,000 in 1995. Service charges on deposit accounts and charges for other types of services are the major source of noninterest income to the Company. This source of income increased $346,000, or 27.5%, from $1,259,000 for 1996 to $1,605,000 for 1997. Approximately 75% of the increase was attributable to the acquisition of Crown Park in January 1997. Service charge income increased $92,000, or 7.9%, from $1,167,000 for 1995 to $1,259,000 for 1996, primarily due to acquisitions and an increase in charges for checks drawn on insufficient funds. Trust fees from trust operations increased $6,000, or 3.2%, from $189,000 in 1996 to $195,000 in 1997. Trust fees decreased $12,000, or 6.0%, from $201,000 during 1995 to $189,000 during 1996. The decrease in 1996 is due to a one-time $24,000 fee received for services performed as executor of an estate during 1995, which was partially offset by a one- time $5,000 fee received in 1996. The 1996 one-time fee caused the increase in 1997 to be less than it normally would have been because of an increase in the market value of assets under management. Securities with a carrying value of $193,000 were sold during 1997. There was no gain or loss recorded on such sale. Securities with a carrying value of $2,028,000 were sold during 1996. Net losses of $10,000 were recorded on the securities sold during 1996. There were no sales of securities during 1995. The securities portfolio had an average life of approximately 1.32 years at December 31, 1997, compared to approximately 1.48 years at December 31, 1996. Other income is the sum of several small components of other operating income including insurance premiums earned on automobiles financed through the Company's indirect installment loan program, bankcard royalty income, check printing income and other sources of miscellaneous income. Other income increased $6,000, or 5.8%, from $103,000 in 1996 to $109,000 in 1997 due to the acquisition of Crown Park in January 1997. Other income decreased $38,000, or 27.0%, from $141,000 in 1995 to $103,000 for 1996, due to $25,000 in sales tax refunds that were received in 1995 and a net loss of $10,000 on sales of securities in 1996. Noninterest Expenses - -------------------- Noninterest expenses increased $1,947,000, or 31.0%, from $6,290,000 in 1996 to $8,237,000 in 1997, primarily due to the acquisition of Crown Park. This acquisition accounted for approximately 80% of the increase. Noninterest expenses increased $48,000, or 0.8%, from $6,242,000 in 1995 to $6,290,000 in 1996, primarily due to increases in salaries and benefits and net occupancy expense, which were partially offset by decreases in various other categories of noninterest expense. Salaries and benefits rose $888,000, or 28.8%, from $3,082,000 in 1996 to $3,970,000 in 1997. Approximately 79% of the increase was a result of the acquisition of Crown Park in January 1997. Salaries and employee benefits increased $233,000, or 8.2%, from $2,849,000 in 1995 to $3,082,000 in 1996. The increase was primarily a result of the acquisitions of Peoples National effective January 1, 1996, and Coastal Banc - San Angelo effective May 27, 1996, and overall salary increases effective January 1, 1996. Net occupancy expense increased $141,000, or 19.7%, from $716,000 in 1996 to $857,000 in 1997. The increase is due entirely to the acquisition of Crown Park. Net occupancy expense increased $73,000, or 11.4%, from $643,000 in 1995 to $716,000 in 1996. The increase is due primarily to a reduction in rental income received in 1996 as a result of the loss of two tenants in a Bank-owned building and the additional occupancy expense of the San Angelo branch acquired in May 1996. Equipment expense increased $171,000, or 25.8%, from $663,000 in 1996, to $834,000 in 1997. Approximately three-fourths of this increase is the result of the Crown Park acquisition. Equipment expense decreased $60,000, or 8.3%, from $723,000 in 1995 to $663,000 for 1996. This decrease is the result of a significant amount of furniture, fixtures and equipment that became fully depreciated during the latter part of 1995 and the first quarter of 1996, thereby decreasing depreciation expense associated with such assets. -35- Professional fees, which include legal and accounting fees, increased $29,000, or 9.5%, from $304,000 during 1996 to $333,000 during 1997. The entire increase was due to additional legal fees incurred by the Lubbock branch of the Bank, relating to collections of loans which had been made by management of Crown Park; otherwise professional fees would have decreased $40,000, or 13.2%. Professional fees decreased $150,000, or 33.0%, from $454,000 during 1995 to $304,000 for 1996. The decrease during 1996 was due to the payment of $205,000 in 1995 for legal fees and settlement expenses on the final settlement of certain litigation. Stationery, printing and supplies expense increased $131,000, or 45.5%, from $288,000 for 1996 to $419,000 for 1997, due primarily to the Crown Park acquisition and the opening of two supermarket bank branches in Abilene and Odessa. Stationery, printing and supplies expense increased $17,000, or 6.3%, from $271,000 for 1995 to $288,000 for 1996, primarily due to the acquisitions of Peoples National and Coastal Banc - San Angelo effective January 1, 1996, and May 27, 1996, respectively. Net costs (revenues) applicable to other real estate and other repossessed assets consist of expenses associated with holding and maintaining various repossessed assets, the net gain or loss on the sales of such assets, the write-down of the carrying value of the assets and any rental income on such assets that is credited as a reduction in such expenses. The Company recorded net costs of $23,000 in 1997 compared to net revenues of $24,000 in 1996 as a result of $52,000 of such expenses incurred by the Lubbock branch of the Bank during 1997. Net gains on sales of such assets totaled $58,000 for 1997, compared to $50,000 for 1996. Net revenues of the Company were $24,000 in 1996 compared to net revenues of $7,000 in 1995 as a result of additional gains on sales of, and rental income received on, such assets. Other noninterest expense includes, among many other items, postage, advertising, insurance, directors' fees, dues and subscriptions, regulatory examinations, franchise taxes, travel and entertainment, due from bank account charges and Federal Deposit Insurance Corporation ("FDIC") insurance. These expenses increased $540,000, or 42.8%, from $1,261,000 during 1996 to $1,801,000 during 1997. Approximately 71% of the increase was due to the acquisition of Crown Park in January 1997. These expenses decreased $48,000, or 3.7%, from $1,309,000 for 1995 to $1,261,000 for 1996. FDIC insurance premiums decreased $154,000 during 1996 as a result of a reduction by the FDIC of deposit insurance rates for banks. This decrease was partially offset by an increase in other expenses as a result of the acquisitions of Peoples National and Coastal Banc - San Angelo. Federal Income Taxes - -------------------- Due to the fact that the Company effected a quasi-reorganization as of December 31, 1989, utilization of any of the Company's net operating loss carryforwards subsequent to that date will not be credited to future income. For periods prior to January 1, 1995, the tax effect of the utilization of the Company's net operating loss carryforwards was credited directly to additional paid-in capital. For periods subsequent to December 31, 1994, the tax effect of such utilization has been and will be credited against the Company's gross deferred tax asset. The Company accrued $977,000, $753,000 and $582,000 in federal income taxes in 1997, 1996 and 1995, respectively. The 1997 amount was lowered by $112,000 as a result of a reduction made in the Company's deferred tax asset valuation allowance relating to Peoples National and Winters State based on the Company's trend of positive operating results. Impact of Inflation - ------------------- The effects of inflation on the local economy and on the Company's operating results have been relatively modest for the past several years. Because substantially all of the Company's assets and liabilities are monetary in nature, such as cash, securities, loans and deposits, their values are less sensitive to the effects of inflation than to changing interest rates, which do not necessarily change in accordance with inflation rates. The Company attempts to control the impact of interest rate fluctuations by managing the relationship between its interest rate sensitive assets and liabilities. See "Analysis of Financial Condition - Interest Rate Sensitivity" below. The Company's objective is to maintain a ratio of interest-sensitive assets to interest-sensitive liabilities that is as balanced as possible. The following tables show that ratio to be 55.5% at the 90-day interval, 49.5% at the 180-day interval and 47.5% at the 365-day interval at December 31, 1997. Currently, the Company is in a liability-sensitive -36- position at the three intervals. During an overall rising interest rate environment, this position would normally produce a lower net interest margin than in a falling interest rate environment; however, because the Company had $77,495,000 of interest-bearing demand, savings and money market deposits at December 31, 1997, that are somewhat less rate- sensitive, the Company's net interest margin does not necessarily decrease in a rising interest rate environment. The interest sensitivity position is presented as of a point in time and can be modified to some extent by management as changing conditions dictate. The following table shows the interest rate sensitivity position of the Company at December 31, 1997:
Volumes Cumulative Volumes Subject to Subject to Repricing Within Repricing --------------------------------------- After 90 Days 180 Days 365 Days 1 Year Total --------- --------- --------- ------------ --------- (Dollars in thousands) Interest-earning assets: Federal funds sold $ 24,900 $ 24,900 $ 24,900 $ 0 $ 24,900 Securities 8,016 11,244 17,798 51,996 69,794 Loans, net of unearned income 34,562 38,463 46,383 94,470 140,853 --------- --------- --------- --------- --------- Total interest-earning assets 67,478 74,607 89,081 146,466 235,547 --------- --------- --------- --------- ---------- Interest-bearing liabilities: Demand, savings and money market deposits 77,495 77,495 77,495 0 77,495 Time deposits 44,054 73,211 110,052 11,386 121,438 Notes payable 51 52 55 2 57 --------- --------- --------- --------- --------- Total interest-bearing liabilities 121,600 150,758 187,602 11,388 198,990 --------- --------- --------- --------- --------- Rate-sensitivity gap(1) $ (54,122) $ (76,151) $ (98,521) $ 135,078 $ 36,557 ========= ========= ========= ========= ========= Rate-sensitivity ratio (2) 55.5% 49.5% 47.5% ====== ====== ====== ______________________________ (1) Rate-sensitive interest-earning assets less rate-sensitive interest- bearing liabilities. (2) Rate-sensitive interest-earning assets divided by rate-sensitive interest-bearing liabilities.
-37- 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 on mortgage related assets, the table presents principal cash flows and related weighted average interest rates by the contractual terms to maturity. Nonaccrual loans are included in the loan totals. All investments are classified as other than trading.
Year Ending December 31 ------------------------------------------------- Fair 1998 1999 2000 2001 2002 Thereafter Total Value --------- --------- --------- --------- --------- ------------ --------- --------- (Dollars in thousands) Fixed Rate Loans: Maturities $ 44,640 $ 28,399 $ 20,292 $ 12,359 $ 3,725 $ 2,835 $ 112,250 $ 115,141 Average interest rate 8.88% 8.90% 8.99% 9.07% 9.03% 8.92% 8.93% Adjustable Rate Loans: Maturities 12,850 $ 6,370 4,701 2,915 910 857 28,603 28,603 Average interest rate 9.52% 9.95% 9.97% 9.97% 9.99% 9.87% 9.76% Investments and Other Interest-earning Assets: Maturities 41,623 10,478 12,010 14,443 15,382 758 94,694 94,777 Average interest rate 5.63% 6.30% 6.23% 6.53% 6.70% 4.35% 6.08% Total Interest-earning Assets: Maturities $ 99,113 $ 45,247 $ 37,003 $ 29,717 $ 20,017 $ 4,450 $ 235,547 $ 238,521 Average interest rate 7.60% 8.45% 8.22% 7.92% 7.28% 8.32% 7.89% Savings Deposits: Maturities $ 0 $ 0 $ 0 $ 0 $ 0 $ 13,201 $ 13,201 $ 13,201 Average interest rate --% --% --% --% --% 3.21% 3.21% NOW Deposits: Maturities 0 0 0 0 0 33,204 33,204 33,204 Average interest rate --% --% --% --% --% 2.05% 2.05% Money Market Deposits: Maturities 0 0 0 0 0 31,090 31,090 31,090 Average interest rate --% --% --% --% --% 3.25% 3.25% Certificates of Deposit: Maturities 108,810 8,482 1,785 1,139 1,222 0 121,438 121,724 Average interest rate 5.38% 5.69% 6.31% 5.79% 6.07% --% 5.43% Notes Payable: Maturities 57 0 0 0 0 0 57 57 Average interest rate 9.74% --% --% --% --% --% 9.74% Total Interest-bearing Liabilities: Maturities $ 108,867 $ 8,482 $ 1,785 $ 1,139 $ 1,222 $ 77,495 $ 198,990 $ 199,276 Average interest rate 5.38% 5.69% 6.31% 5.79% 6.07% 2.73% 4.38%
The Company assumes that 100% of savings, NOW and money market deposits at December 31, 1997, are core deposits and are, therefore, expected to roll off after five years. No roll-off 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 -38- rates, while interest rates on other types may lag behind changes in market rates. Additionally, certain other assets have features that restrict changes in interest rates, and 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. ANALYSIS OF FINANCIAL CONDITION Assets - ------ Total assets increased $58,606,000, or 28.5%, from $205,968,000 at December 31, 1996, to $264,574,000 at December 31, 1997, due to the acquisition of Crown Park, which had total assets of $60,420,000 at January 28, 1997, the date of acquisition. Total assets increased $20,484,000, or 12.8%, from $180,344,000 at year-end 1995 to $205,968,000 at December 31, 1996, primarily due to the overall growth in deposits at the Bank and the bank acquisitions made in 1996. Cash and Cash Equivalents - ------------------------- At December 31, 1997, the Company had $39,418,000 in cash and cash equivalents, up from $29,958,000 at December 31, 1996, due to a decreased amount of funds being invested in investment securities as a result of the current interest rate environment. During 1996, cash and cash equivalents decreased $4,801,000, or 13.8%, from the December 31, 1995, balance of $34,759,000. Cash and cash equivalents averaged $27,520,000, $26,557,000 and $38,142,000 for the years ended December 31, 1997, 1996 and 1995, respectively. Securities - ---------- Securities decreased $5,358,000, or 7.1%, from $75,152,000 at December 31, 1996, to $69,794,000 at December 31, 1997. The decrease in 1997 was due primarily to lower interest rates that were being paid on securities during the fourth quarter of 1997. As a result, more of the Company's available funds were being invested temporarily in federal funds sold. The board of directors of the Bank reviews all securities transactions monthly and the securities portfolio periodically. The Company's current investment policy provides for the purchase of U.S. Treasury securities and federal agency securities having maturities of five years or less and for the purchase of state, county and municipal agencies' securities with maximum maturities of 10 years. The Company's policy is to maintain a securities portfolio with a mixture of securities classified as held-to-maturity and available-for-sale with staggered maturities to meet its overall liquidity needs. Municipal securities must be rated A or better. Certain school district issues, however, are acceptable with a Baa rating. Securities totaling $22,501,000 are classified as available-for-sale and are carried at fair value at December 31, 1997. Securities totaling $47,293,000 are classified as held-to- maturity and are carried at amortized cost. The securities portfolio had an average life of approximately 1.32 years at December 31, 1997, compared to approximately 1.48 years at December 31, 1996. The decision to sell securities classified as available-for-sale is based upon management's assessment of changes in economic or financial market conditions. Certain of the Company's securities are pledged to secure public and trust fund deposits and for other purposes required or permitted by law. At December 31, 1997, the book value of U.S. Government and other securities so pledged amounted to $9,659,000, or 13.8% of the total securities portfolio. -39- The following table summarizes the amounts and the distribution of the Company's investment securities held at the dates indicated:
December 31, ------------------------------------------------------- 1997 1996 1995 ---------------- ---------------- --------------- Amount % Amount % Amount % -------- ------ -------- ------ ------- ----- (In thousands) Carrying value: U.S. Treasury securities $ 21,292 30.5% $ 35,143 46.8% $ 32,295 57.8% Obligations of other U.S. Government agencies and corporations 36,122 51.8 29,928 39.8 23,009 41.2 Mortgage-backed securities 11,622 16.7 9,438 12.6 160 0.2 Obligations of states and political subdivisions 175 0.2 200 0.2 0 -- Other securities 583 0.8 443 0.6 443 0.8 -------- ----- -------- ----- -------- ----- Total securities $ 69,794 100.0% $ 75,152 100.0% $ 55,907 100.0% ======== ===== ======== ===== ======== ===== Total fair value $ 69,877 $ 75,062 $ 56,130 ======== ======== ========
The fair value of held-to-maturity securities is usually different from the reported carrying value of such securities due to interest rate fluctuations that cause market valuations to change. The following table provides the maturity distribution and weighted average interest rates of the Company's total securities portfolio at December 31, 1997. The yield has been computed by relating the forward income stream on the securities, plus or minus the anticipated amortization of premium or accretion of discount, to the book value of the securities. The book value of available-for-sale securities is their fair value. The book value of held-to-maturity securities is their cost, adjusted for previous amortization or accretion. The restatement of the yields on tax-exempt securities to a fully taxable-equivalent basis has been computed assuming a tax rate of 34%. -40-
Estimated Weighted Principal Carrying Fair Average Type and Maturity Grouping at December 31, 1997 Amount Value Value Yield - ----------------------------------------------- --------- -------- --------- --------- (Dollars in thousands) U.S. Treasury securities: Within one year $ 16,250 $ 16,225 $ 16,231 5.75% After one but within five years 5,000 5,067 5,068 6.13 --------- --------- --------- ----- Total U.S. Treasury securities 21,250 21,292 21,299 5.84 --------- --------- --------- ----- Obligations of other U.S. Government agencies and corporations: Within one year 500 498 498 6.50 After one but within five years 35,600 35,624 35,630 6.38 --------- --------- --------- ----- Total obligations of other U.S. government agencies and corporations 36,100 36,122 36,128 6.38 --------- --------- --------- ----- Mortgage-backed securities 11,441 11,622 11,683 6.34 --------- --------- --------- ----- Obligations of states and political subdivisions: Within one year 0 0 0 -- After one but within five years 0 0 0 -- After five but within ten years 175 175 184 8.49 --------- --------- --------- ----- Total obligations of states and political subdivisions 175 175 184 8.49 --------- --------- --------- ----- Other securities: Within one year 0 0 0 -- After one but within five years 0 0 0 -- After five but within ten years 0 0 0 -- After ten years 583 583 583 3.96 --------- --------- --------- ----- Total other securities 583 583 583 3.96 --------- --------- --------- ----- Total securities $ 69,549 $ 69,794 $ 69,877 6.19% ========= ========= ========= =====
Loan Portfolio - -------------- Total loans, net of unearned income, increased $48,836,000, or 53.1%, from $92,017,000 at December 31, 1996, to $140,853,000 at December 31, 1997. The increase during 1997 was due to the acquisition of Crown Park which had $41,688,000 in loans, net of unearned income, at the date of acquisition and overall internal loan growth at the Bank, primarily at the Lubbock and San Angelo branches. The Bank primarily makes installment loans to individuals and commercial loans to small to medium-sized businesses and professionals. The Bank offers a variety of commercial lending products including revolving lines of credit, letters of credit, working capital loans and loans to finance accounts receivable, inventory and equipment. Typically, the Bank's commercial loans have floating rates of interest, are for varying terms (generally not exceeding five years), are personally guaranteed by the borrower and are collateralized by accounts receivable, inventory or other business assets. The Bank has an installment loan program whereby it purchases automobile loans from automobile dealerships in its west Texas market area. Under this program, an automobile dealership will agree to make a loan to a prospective customer to finance the purchase of a new or used automobile. The different financial institutions that have a pre- established relationship with the particular dealership review the transaction, including the credit history of the prospective borrower, and decide if they would agree to purchase the loan from the dealership and, if so, at what rate of interest. The dealership selects the financial institution to which it decides to sell the loan. The financial institution purchasing the loan has a direct loan to the borrower collateralized by the automobile, and the dealership realizes a -41- profit based on the difference between the interest rate quoted to the buyer by the dealership and the interest rate at which the loan is purchased by the financial institution. At December 31, 1997 and 1996, the Company had approximately $50,052,000 and $33,188,000 net of unearned income, respectively, of this type of loan outstanding. The increase is due to the acquisition of Crown Park, which had instituted its own indirect installment lending program prior to being acquired by the Company. The following table presents the Company's loan balances at the dates indicated separated by loan type:
December 31, ------------------------------------------------- 1997 1996 1995 1994 1993 --------- --------- --------- --------- --------- (In thousands) Loans to individuals $ 67,453 $ 46,975 $ 42,142 $ 43,113 $ 28,538 Real estate loans 44,569 26,233 23,265 22,760 22,658 Commercial and industrial loans 24,184 18,430 17,236 16,702 16,723 Other loans 6,109 2,626 2,638 2,943 4,322 --------- --------- --------- --------- --------- Total loans 142,315 94,264 85,281 85,518 72,241 Less unearned income 1,462 2,247 3,354 4,212 2,594 --------- --------- --------- --------- --------- Loans, net of unearned income $ 140,853 $ 92,017 $ 81,927 $ 81,306 $ 69,647 ========= ========= ========= ========= =========
Loan concentrations are considered to exist when there are amounts loaned to a multiple number of borrowers engaged in similar activities that would cause them to be similarly impacted by economic or other conditions. The Company had no concentrations of loans at December 31, 1997, except for those described above. The Bank had no loans outstanding to foreign countries or borrowers headquartered in foreign countries at December 31, 1997. Management of the Bank may renew loans at maturity when requested by a customer whose financial strength appears to support such renewal or when such renewal appears to be in the Company's best interest. The Company requires payment of accrued interest in such instances and may adjust the rate of interest, require a principal reduction or modify other terms of the loan at the time of renewal. The following table presents the distribution of the maturity of the Company's loans and the interest rate sensitivity of those loans, excluding loans to individuals, at December 31, 1997. The table also presents the portion of loans that have fixed interest rates or interest rates that fluctuate over the life of the loans in accordance with changes in the interest rate environment as represented by the prime rate.
One to Over Total One Year Five Five Carrying and Less Years Years Value --------- --------- --------- --------- (In thousands) Real estate loans $ 6,605 $ 30,368 $ 7,596 $ 44,569 Commercial and industrial loans 11,878 8,079 4,227 24,184 Other loans 3,872 1,764 473 6,109 --------- --------- --------- --------- Total loans $ 22,355 $ 40,211 $ 12,296 $ 74,862 ========= ========= ========= ========= With fixed interest rates $ 11,670 $ 30,036 $ 4,681 $ 46,387 With variable interest rates 10,685 10,175 7,615 28,475 --------- --------- --------- --------- Total loans $ 22,355 $ 40,211 $ 12,296 $ 74,862 ========= ========= ========= =========
Nonperforming Assets - -------------------- Nonperforming loans consist of nonaccrual, past due and restructured loans. A past due loan is an accruing loan that is contractually past due 90 days or more as to principal or interest payments. Loans on which management does not expect to collect interest in the normal course of business are placed on nonaccrual or are restructured. When -42- a loan is placed on nonaccrual, any interest previously accrued but not yet collected is reversed against current income unless, in the opinion of management, the outstanding interest remains collectible. Thereafter, interest is included in income only to the extent of cash received. A loan is restored to accrual status when all interest and principal payments are current and the borrower has demonstrated to management the ability to make payments of principal and interest as scheduled. A "troubled debt restructuring" is a restructured loan upon which interest accrues at a below market rate or upon which certain principal has been forgiven so as to aid the borrower in the final repayment of the loan, with any interest previously accrued, but not yet collected, being reversed against current income. Interest is accrued based upon the new loan terms. Nonperforming loans are fully or substantially collateralized by assets, with any excess of loan balances over collateral values allocated in the allowance. Assets acquired through foreclosure are carried at the lower of cost or estimated fair value, net of estimated costs of disposal, if any. See "Other Real Estate and Other Repossessed Assets" below. The following table lists nonaccrual, past due and restructured loans and other real estate and other repossessed assets at year-end for each of the past five years.
December 31, ----------------------------------------------- 1997 1996 1995 1994 1993 ------- ------- ------- ------- ------- (In thousands) Nonaccrual loans $ 70 $ 82 $ 204 $ 48 $ 1,646 Accruing loans contractually past due over 90 days 121 41 23 26 293 Restructured loans 104 73 65 80 195 Other real estate and other repossessed assets 739 389 337 631 803 ------- ------- ------- ------- ------- Total nonperforming assets $ 1,034 $ 585 $ 629 $ 785 $ 2,937 ======= ======= ======= ======= =======
The gross interest income that would have been recorded in 1997 on the Company's nonaccrual loans if such loans had been current, in accordance with the original terms thereof and had been outstanding throughout the period or, if shorter, since origination, was approximately $16,000. A total of $2,000 in interest on nonaccrual loans was actually recorded (received) during 1997. A potential problem loan is defined as a loan where information about possible credit problems of the borrower is known, causing management to have serious doubts as to the ability of the borrower to comply with the present loan repayment terms and which may result in the inclusion of such loan in one of the nonperforming asset categories. The Company does not believe it has any potential problem loans other than these reported in the above table. The Company follows a loan review program to evaluate the credit risk in its loan portfolio. Through the loan review process, the Bank maintains an internally classified loan list that, along with the list of nonperforming loans discussed below, helps management assess the overall quality of the loan portfolio and the adequacy of the allowance. Loans classified as "substandard" are those loans with clear and defined weaknesses such as highly leveraged positions, unfavorable financial ratios, uncertain repayment sources or poor financial condition, which may jeopardize recoverability of the loan. Loans classified as "doubtful" are those loans that have characteristics similar to substandard loans, but also have an increased risk that a loss may occur or at least a portion of the loan may require a charge-off if liquidated at present. Although loans classified as substandard do not duplicate loans classified as doubtful, both substandard and doubtful loans may include some loans that are past due at least 90 days, are on nonaccrual status or have been restructured. Loans classified as "loss" are those loans that are in the process of being charged off. At December 31, 1997, substandard loans totaled $941,000, of which $122,000 were loans designated as nonaccrual, 90 days past due or restructured, and there was one $16,000 doubtful loan, which was currently performing. There were no loss loans. -43- In addition to the internally classified loans, the Bank also has a "watch list" of loans that further assists the Bank in monitoring its loan portfolio. A loan is included on the watch list if it demonstrates one or more deficiencies requiring attention in the near term or if the loan's ratios have weakened to a point where more frequent monitoring is warranted. These loans do not have all the characteristics of a classified loan (substandard, doubtful or loss), but do have weakened elements as compared with those of a satisfactory credit. Management of the Bank reviews these loans to assist in assessing the adequacy of the allowance. Substantially all of the loans on the watch list at December 31, 1997, were current and paying in accordance with loan terms. At December 31, 1997, watch list loans totaled $1,271,000 (including $489,000 of loans guaranteed by U.S. governmental agencies). At such date, $75,000 of loans on the watch list were designated as 90 days past due. All of these loans involved borrowers who had filed Chapter 13 bankruptcy and the Bank was awaiting finalization of the individual borrowers' bankruptcy plans. In addition, at December 31, 1997, $88,000 of loans not classified and not on the watch list were designated as restructured loans. Other Real Estate and Other Repossessed Assets - ---------------------------------------------- Other real estate and other repossessed assets consist of real property and other assets unrelated to banking premises or facilities. Income derived from other real estate and other repossessed assets, if any, is generally less than that which would have been earned as interest at the original contract rates on the related loans. At December 31, 1997, 1996 and 1995, other real estate and other repossessed assets had an aggregate book value of $739,000, $389,000 and $337,000, respectively. Other real estate and other repossessed assets increased $350,000, or 90.0%, during 1997 due to the acquisition of Crown Park. At the date of acquisition, Crown Park had a total of $456,000 in other real estate and other repossessed assets. The December 31, 1997, balance of $739,000 included three commercial properties ($391,000), thirty-eight repossessed automobiles ($302,000) and five residential properties ($46,000). Of the December 31, 1996, balance, $204,000 represented nineteen repossessed automobiles, $103,000 represented four commercial properties and $82,000 represented three residential properties. Allowance for Possible Loan Losses - ---------------------------------- Implicit in the Company's lending activities is the fact that loan losses will be experienced and that the risk of loss will vary with the type of loan being made and the creditworthiness of the borrower over the term of the loan. To reflect the currently perceived risk of loss associated with the Company's loan portfolio, additions are made to the Company's allowance for possible loan losses (the "allowance"). The allowance is created by direct charges against income (the "provision" for loan losses), and the allowance is available to absorb possible loan losses. See "Results of Operations - Provision for Loan Losses" above. The amount of the allowance equals the cumulative total of the provisions made from time to time, reduced by loan charge-offs and increased by recoveries of loans previously charged off. The Company's allowance was $1,173,000, or 0.83% of loans, net of unearned income, at December 31, 1997, compared to $793,000, or 0.86% of loans, net of unearned income, at December 31, 1996, and $759,000, or 0.93% of loans, net of unearned income, at December 31, 1995. The increase in the balance of the allowance from December 31, 1996, to December 31, 1997, was a result of the acquisition of Crown Park, which had an allowance of $395,000 at the date of acquisition. The reduction in the ratio of the allowance to total loans, net of unearned income, is primarily due to the improvement in the overall credit quality of the Company's loan portfolio. Credit and loan decisions are made by management and the board of directors of the Bank in conformity with loan policies established by the board of directors of the Company. The Company's practice is to charge off any loan or portion of a loan when the loan is determined by management to be uncollectible due to the borrower's failure to meet repayment terms, the borrower's deteriorating or deteriorated financial condition, the depreciation of the underlying collateral, the loan's classification as a loss by regulatory examiners or for other reasons. The Company charged off $581,000 in loans during 1997. Charge-offs for 1997 were concentrated in the following categories: loans to individuals - - $457,000, or 78.7%, and commercial and industrial - $107,000, or 18.4%. Charge-offs on two commercial and industrial loans totaled $80,000, or 13.8%, of total charge-offs. All but $44,000 of the remaining $501,000 in charge-offs were installment loans, of which $424,000 represented indirect loans secured by automobiles. Recoveries during 1997 were $316,000 and were concentrated in the following categories: commercial and industrial - $220,000, or 69.6%, loans to individuals - $60,000, or 19.0%, and real estate - $35,000, or 11.1%. Recoveries of -44- $218,000 on four commercial and industrial loans, and $32,000 on one real estate loan accounted for 79.1% of total recoveries during 1997. The following table presents the provisions, loans charged off and recoveries of loans previously charged off, the amount of the allowance, average loans outstanding and certain pertinent ratios for the last five years.
1997(1) 1996(2) 1995 1994 1993(3) -------- -------- -------- -------- -------- Analysis of allowance for possible loan losses: (Dollars in thousands) Balance at January 1 $ 793 $ 759 $ 817 $ 896 $ 617 Provision for loan losses 250 201 206 147 154 Acquisition of subsidiary 395 149 0 0 233 -------- -------- -------- -------- -------- 1,438 1,109 1,023 1,043 1,004 -------- -------- -------- -------- -------- Loans charged off: Loans to individuals 457 231 297 150 88 Real estate loans 6 100 72 119 68 Commercial and industrial loans 107 58 7 32 69 Other loans 11 0 0 77 16 -------- -------- -------- -------- -------- Total charge-offs 581 389 376 378 241 -------- -------- -------- -------- -------- Recoveries of loans previously charged off: Loans to individuals 60 28 43 45 28 Real estate loans 35 20 2 0 4 Commercial and industrial loans 220 25 52 48 84 Other loans 1 0 15 59 17 -------- -------- -------- -------- -------- Total recoveries 316 73 112 152 133 -------- -------- -------- -------- -------- Net loans charged off 265 316 264 226 108 -------- -------- -------- -------- -------- Balance at December 31 $ 1,173 $ 793 $ 759 $ 817 $ 896 ======== ======== ======== ======== ======== Average loans outstanding, net of unearned income $132,891 $ 85,880 $ 82,302 $ 74,727 $ 59,767 ======== ======== ======== ======== ======== Ratio of net loan charge-offs to average loans, net of unearned income 0.20% 0.37% 0.32% 0.30% 0.18% ==== ==== ==== ==== ==== Ratio of allowance for possible loan losses to total loans, net of unearned income, at December 31 0.83% 0.86% 0.93% 1.00% 1.29% ==== ==== ==== ==== ==== ______________________________ (1) Average loans, net of unearned income, for 1997 include the average loans, net of unearned income, of Crown Park from January 28 through December 31, 1997. (2) Average loans, net of unearned income, for 1996 include the average loans, net of unearned income, of Peoples National from January 1 through December 31, 1996, and of Coastal Banc - San Angelo from May 27 through December 31, 1996. (3) Average loans, net of unearned income, for 1993 include the average loans, net of unearned income, of Winters State from August 31 through December 31, 1993.
Foreclosures on defaulted loans result in the Company acquiring other real estate and other repossessed assets. Accordingly, the Company incurs other expenses, specifically net costs applicable to other real estate and other repossessed assets, in maintaining, insuring and selling such assets. The Bank attempts to convert nonperforming loans into interest- earning assets, although usually at a lower dollar amount than the face value of such loans, either through liquidation of the collateral securing the loan or through intensified collection efforts. As the economies of the Bank's market areas over the past several years has recovered and stabilized, there has been a steady reduction in the amount of the provision, as a percentage of average loans outstanding, necessary to -45- maintain an adequate balance in the allowance. This reflects management's assessment of the continued reduction of credit risks associated with the loan portfolio. The amount of the allowance is established by management based upon estimated risks inherent in the existing loan portfolio. Management reviews the loan portfolio on a continuing basis to evaluate potential problems. This review encompasses management's estimate of current economic conditions and the potential impact on various industries, prior loan loss experience and financial conditions of individual borrowers. Loans that have been specifically identified as problem or nonperforming loans are reviewed on at least a quarterly basis, and management critically evaluates the prospect of ultimate losses arising from such loans, based on the borrower's financial condition and the value of available collateral. When a risk can be specifically quantified for a loan, that amount is specifically allocated in the allowance. In addition, the Company allocates the allowance based upon the historical loan loss experience of the different types of loans. Despite such allocation, both the allocated and unallocated portions of the allowance are available for charge-offs of all loans. The following table shows the allocations in the allowance and the respective percentages of each loan category to total loans at year-end for each of the past five years.
December 31, ------------------------------------------------------------------------ 1997 1996 1995 ----------------------- ---------------------- ---------------------- Percent of Percent of Percent of Amount of Loans by Amount of Loans by Amount of Loans by Allowance Category to Allowance Category to Allowance Category to Allocated Loans, Net Allocated Loans, Net Allocated Loans, Net to of Unearned to of Unearned to of Unearned Category Income Category Income Category Income --------- ------------ --------- ------------ --------- ------------ (Dollars in thousands) Loans to individuals $ 570 46.8% $ 323 48.6% $ 136 47.4% Real estate loans 52 31.6 128 28.5 197 28.4 Commercial and industrial loans 193 17.2 97 20.0 96 21.0 Other loans 28 4.4 43 2.9 59 3.2 ------ ------- ------ ------- ------ -------- Total allocated 843 100.0% 591 100.0% 488 100.0% ======= ======= ======== Unallocated 330 202 271 ------ ------ ------ Total allowance for possible loan losses $1,173 $ 793 $ 759 ====== ====== ====== December 31, ---------------------------------------------- 1994 1993 ----------------------- --------------------- Percent of Percent of Amount of Loans by Amount of Loans by Allowance Category to Allowance Category to Allocated Loans, Net Allocated Loans, Net to of Unearned to of Unearned Category Income Category Income --------- ------------ --------- ------------ (Dollars in thousands) Loans to individuals $ 207 47.8% $ 178 37.3% Real estate loans 165 28.0 272 32.5 Commercial and industrial loans 122 20.5 212 24.0 Other loans 68 3.7 108 6.2 ------ ------- ------ ------- Total allocated 562 100.0% 770 100.0% ======= ======= Unallocated 255 126 ------ ------ Total allowance for possible loan losses $ 817 $ 896 ====== ======
Premises and Equipment - ---------------------- Premises and equipment increased $3,081,000, or 69.4%, from $4,437,000 at December 31, 1996, to $7,518,000 at December 31, 1997. The increase was primarily due to the purchase of Crown Park, which had $2,777,000 in net book value of premises and equipment at the date of acquisition, and the opening of two supermarket -46- branch banking facilities during 1997. These increases were partially offset by depreciation expense of $515,000 recorded for 1997. Accrued Interest Receivable - --------------------------- Accrued interest receivable consists of interest that has accrued on securities and loans, but is not yet payable under the terms of the related agreements. The balance of accrued interest receivable increased $609,000, or 38.1%, from $1,599,000 at December 31, 1996, to $2,208,000 at December 31, 1997. The increase during 1997 was a result of the purchase of Crown Park, which had $418,000 in accrued interest receivable at the date of acquisition, and an increase in the amount of loans outstanding during 1997. Of the total balance at December 31, 1997, $1,220,000, or 55.3%, was interest accrued on loans and $988,000, or 44.7%, was interest accrued on securities. Goodwill - -------- Goodwill increased $2,202,000, or 230.1%, from $957,000 at December 31, 1996, to $3,159,000 at December 31, 1997, due to the acquisition of Crown Park. A total of $2,486,000 of goodwill was recorded as a result of this acquisition, which was partially offset by $218,000 in goodwill amortization expense during 1997. Other Assets - ------------ The most significant component of other assets at December 31, 1997 and 1996, is a net deferred tax asset of $1,282,000 and $1,664,000, respectively. The balance of other assets decreased $194,000, or 8.6%, to $2,058,000 at December 31, 1997, from $2,252,000 at December 31, 1996, primarily as a result of a decrease in the Company's net deferred tax asset due principally to the utilization of a portion of the Company's net operating loss carryforwards. Deposits - -------- The Bank's lending and investing activities are funded almost entirely by core deposits, one-half of which are demand, savings and money market deposits at December 31, 1997. Total deposits increased $53,226,000, or 28.1%, from $189,575,000 at December 31, 1996, to $242,801,000 at December 31, 1997. The increase is due to the purchase of Crown Park, which had $53,604,000 in total deposits at the date of acquisition. Decreases in deposits at the Lubbock branch subsequent to the date of acquisition were offset by an aggregate increase in deposits at the Bank's remaining branches. The Bank does not have any brokered deposits. -47- The following table presents the average amounts of and the average rate paid on deposits of the Company for each of the last three years:
Year Ended December 31, ------------------------------------------------------------------- 1997(1) 1996(2) 1995 ------------------ ----------------- ----------------- Average Average Average Average Average Average Amount Rate Amount Rate Amount Rate -------- ------- -------- ------- -------- ------- (Dollars in thousands) Noninterest-bearing demand deposits $ 40,328 -- % $ 30,093 -- % $ 29,019 -- % Interest-bearing demand, savings and money market deposits 75,833 2.69 57,847 2.41 53,391 2.35 Time deposits of less than $100,000 84,267 5.36 64,112 5.42 52,452 5.41 Time deposits of $100,000 or more 36,951 5.54 27,953 5.39 19,685 5.61 -------- ------ -------- ------ -------- ------ Total deposits $237,379 3.62% $180,005 3.55% $154,547 3.36% ======== ====== ======== ====== ======== ====== ______________________ (1) The average amounts and average rates paid on deposits for the year ended December 31, 1997, include the averages of Crown Park from January 28 through December 31, 1997. (2) The average amounts and average rates paid on deposits for the year ended December 31, 1996, include the averages of Peoples National and Coastal Banc - San Angelo from January 1 and May 27 (the respective dates of acquisition of such banks) through December 31, 1996.
The maturity distribution of time deposits of $100,000 or more at December 31, 1997, is presented below: December 31, 1997 ----------------- (In thousands) 3 months or less $ 13,669 Over 3 through 6 months 8,945 Over 6 through 12 months 12,852 Over 12 months 2,905 --------- Total time deposits of $100,000 or more $ 38,371 ========= The Banks experience relatively limited reliance on time deposits of $100,000 or more. Time deposits of $100,000 or more are a more volatile and costly source of funds than other deposits and are most likely to affect the Company's future earnings because of interest rate sensitivity. At December 31, 1997, deposits of $100,000 or more represented 14.5% of the Company's total assets, compared to 14.4% of the Company's total assets at December 31, 1996. Notes Payable - ------------- The Company's notes payable decreased $183,000, or 76.3%, from $240,000 at December 31, 1996, to $57,000 at December 31, 1997. The decrease was a result of the payoff of the note payable to the Amarillo Bank and all but one of the notes payable to the current and former directors during 1997. Accrued Interest Payable - ------------------------ Accrued interest payable consists of interest that has accrued on deposits and notes payable, but is not yet payable under the terms of the related agreements. The balance of accrued interest payable decreased $4,000, or 0.4%, from $951,000 at December 31, 1996, to $947,000 at December 31, 1997. The decrease was due primarily to a campaign by the Bank during 1995 to attract customers to purchase certificates of deposit with longer maturities. Certificates of deposit with original maturities of greater than two years totaled over $17,000,000 at an average rate of -48- 6.26%, at December 31, 1996, compared to approximately $15,000,000 at an average rate of 5.76% at December 31, 1997, causing accrued interest payable to be higher than normal at December 31, 1996, when compared to December 31, 1997. Other Liabilities The most significant components of other liabilities are amounts accrued for various types of expenses. The balance of other liabilities decreased $23,000, or 8.7%, from $265,000 at December 31, 1996, to $242,000 at December 31, 1997, due primarily to a reduction in the amount of insurance premiums on indirect automobile loans that had been collected from loan customers and were payable to the insurance company at December 31, 1997, when compared to December 31, 1996. Such reduction more than offset the increase in other liabilities as a result of the acquisition of Crown Park. Selected Financial Ratios The following table presents selected financial ratios for each of the last three fiscal years:
Year Ended December 31, --------------------------- 1997(1) 1996(2) 1995 ------- ------- ------- Net income to: Average assets 0.82% 0.72% 0.67% Average interest-earning assets 0.90 0.79 0.73 Average stockholders' equity 10.95 9.89 8.99 Dividend payout (3) to: Net income 17.30 13.85 10.34 Average stockholders' equity 1.89 1.37 0.93 Average stockholders' equity to: Average total assets 7.45 7.33 7.43 Average loans (4) 14.50 16.74 15.30 Average total deposits 8.12 7.99 8.15 Average interest-earning assets to: Average total assets 90.36 91.87 91.56 Average total deposits 98.55 100.11 100.44 Average total liabilities 97.63 99.13 98.91 Ratio to total average deposits of: Average loans (4) 55.98 47.71 53.25 Average noninterest-bearing deposits 16.99 16.72 18.78 Average interest-bearing deposits 83.01 83.28 81.22 Total interest expense to total interest income 47.25 47.51 44.38 Efficiency ratio (5) 69.09 72.78 76.56 _________________________ (1) Average balance sheet and income statement items for 1997 include the averages for Crown Park from January 28 through December 31, 1997. (2) Average balance sheet and income statement items for 1996 include the averages for Peoples National and Coastal Banc - San Angelo from January 1 and May 27 (the respective dates of acquisition of such banks) through December 31, 1996. (3) Dividends for Common Stock only. (4) Before allowance for possible loan losses. (5) Calculated as noninterest expense less amortization of intangibles and expenses related to other real estate and other repossessed assets divided by the sum of net interest income before provision for loan losses and total noninterest income excluding securities gains and losses.
-49- LIQUIDITY The Bank - -------- Liquidity with respect to a financial institution is the ability to meet its short-term needs for cash without suffering an unfavorable impact on its on-going operations. The need for the Bank to maintain funds on hand arises principally from maturities of short-term borrowings, deposit withdrawals, customers' borrowing needs and the maintenance of reserve requirements. Liquidity with respect to a financial institution can be met from either assets or liabilities. On the asset side, the primary sources of liquidity are cash and due from banks, federal funds sold, maturities of securities and scheduled repayments and maturities of loans. The Bank maintains adequate levels of cash and near-cash investments to meet its day-to-day needs. Cash and due from banks averaged $11,051,000 and $7,151,000 during the years ended December 31, 1997 and 1996, respectively. These amounts comprised 4.3% and 3.6% of average total assets during the years ended December 31, 1997 and 1996, respectively. The average level of securities and federal funds sold was $101,035,000 and $94,326,000 during the years ended December 31, 1997 and 1996, respectively. The increases from 1996 to 1997 were primarily due to the acquisition of Crown Park on January 28, 1997. The Bank sold securities classified as available-for-sale with a book value of $193,000 during the year ended December 31, 1997. The Bank sold securities with a book value of $2,028,000 during the year ended December 31, 1996. At December 31, 1997, $16,723,000, or 28.7%, of the Company's securities portfolio, excluding mortgage-backed securities, matured within one year and $40,691,000, or 69.9%, excluding mortgage-backed securities, matured after one but within five years. The Bank's commercial lending activities are concentrated in loans with maturities of less than five years and with both fixed and adjustable interest rates, while its installment lending activities are concentrated in loans with maturities of three to five years and with fixed interest rates. The Bank's experience, however, has been that these installment loans are paid off in an average of approximately thirty months. At December 31, 1997, approximately $46,383,000, or 32.9%, of the Company's loans, net of unearned income, matured within one year and/or had adjustable interest rates. Approximately $40,145,000, or 53.6%, of the Company's loans (excluding loans to individuals) matured within one year and/or had adjustable interest rates. See "Analysis of Financial Condition - Loan Portfolio" above. On the liability side, the principal sources of liquidity are deposits, borrowed funds and the accessibility to money and capital markets. Customer deposits are by far the largest source of funds. During the years ended December 31, 1997 and 1996, the Company's average deposits were $237,379,000, or 91.7% of average total assets, and $180,005,000, or 91.8% of average total assets, respectively. The Company attracts its deposits primarily from individuals and businesses located within the market areas served by the Bank. See "Analysis of Financial Condition - Deposits" above. The level of nonperforming assets has squeezed interest margins and has resulted in noninterest expenses from net operating costs and write- downs associated with nonperforming assets, although the ratio of such nonperforming assets to total assets has generally been decreasing over the past several years. In order to improve liquidity, the Bank has implemented various cost-cutting and revenue-generating measures and extended efforts to reduce nonperforming assets. The Company - ----------- The Company depends on the Bank for liquidity in the form of cash flow, primarily to meet debt service and dividend requirements and to cover other operating expenses. This cash flow comes from three sources: (1) dividends resulting from earnings of the Bank, (2) current tax liabilities generated by the Bank and (3) management and service fees for services performed for the Bank. The payment of dividends from the Bank is subject to applicable law and the scrutiny of regulatory authorities. Dividends paid by the Bank to Independent Financial in 1997 aggregated $900,000; in turn, Independent Financial paid dividends to the Company totaling $900,000 during 1997. Dividends paid by the Bank to Independent Financial and by Independent Financial to the Company totaled $1,000,000 and $1,000,000, respectively, during 1996. At -50- December 31, 1997, there were approximately $2,780,000 in dividends available for payment to Independent Financial by the Bank without prior regulatory approval. The payment of current tax liabilities generated by the Bank and management and service fees constituted approximately 54.6% and 6.5%, respectively, of the Company's cash flow from the Bank during 1997. Pursuant to a tax-sharing agreement, the Bank pays to the Company an amount equal to its individual tax liability on the accrual method of federal income tax reporting. The accrual method generates more timely payments of current tax liabilities by the Bank to the Company, increasing the regularity of cash flow and shifting the time value of such funds to the Company. In the event that the Bank incurs losses, the Company may be required to refund tax liabilities previously collected. Current tax liabilities totaling $1,266,000 were paid by the Bank to the Company during 1997, compared to a total of $885,000 in 1996. From January 1, 1989, through December 31, 1995, the Company collected federal income taxes from the Bank based on an effective tax rate of approximately 34% and paid taxes to the federal government at the rate of approximately 2% as a result of the utilization of the Company's net operating loss carryforwards for both regular tax and alternative minimum tax purposes. At December 31, 1995, the Company's net operating loss carryforwards for alternative tax purposes had been fully utilized. As a result, the Company began paying federal income taxes at the effective tax rate of approximately 20% during the first quarter of 1996. The net operating carryforwards available for regular federal income tax purposes were fully utilized by the fourth quarter of 1997, resulting in the Company having to pay taxes to the federal government at the statutory rate for the fourth quarter of 1997 and in future years. The Bank pays management fees to the Company for services performed. These services include, but are not limited to, financial and accounting consultation, attendance at the Bank's board meetings, audit and loan review services and related expenses. The Bank paid a total of $150,000 in management fees to the Company in 1997, compared to $162,000 in 1996. The Company's fees must be reasonable in relation to the management services rendered, and the Bank is prohibited from paying management fees to the Company if the Bank would be undercapitalized after any such distribution or payment. On January 28, 1997, the Company borrowed $800,000 from the Amarillo Bank to finance a portion of the cost of acquiring Crown Park. The terms of the loan provided that this loan accrued interest at a floating per annum rate equal to the Amarillo Bank's base rate plus one-half percent, principal and interest was payable on demand, but if no demand is made, at maturity and the loan matured on April 23, 1997. The loan was secured by a pledge of all of the stock of Independent Financial and the Bank and had certain other loan provisions, including limitations on additional debt, purchases and sales of assets, acquisitions and mergers, dividend restrictions if total debt to the Amarillo Bank exceeded $1,200,000 and certain other financial covenants. On February 14, 1997, the Company used $400,000 of the net proceeds from the sale of shares of Common Stock to the underwriter of the Company's Common Stock offering pursuant to the underwriters' over-allotment option to reduce the principal amount of the Amarillo Bank loan from $800,000 to $400,000. The balance was further reduced to $200,000 by the end of the first quarter of 1997. The loan maturity was extended to July 23, 1997, and on that day, the $200,000 balance was renewed into a note that had a one-year maturity with payments of $50,000 principal plus interest to be made quarterly beginning October 23, 1997. The first required principal payment was made and the Company paid off the remaining principal balance on the note on December 31, 1997. CAPITAL RESOURCES At December 31, 1997, stockholders' equity totaled $20,527,000, or 7.8% of total assets, compared to $14,937,000, or 7.3% of total assets, at December 31, 1996. Bank regulatory authorities in the United States have risk-based capital standards by which all bank holding companies and banks are evaluated in terms of capital adequacy. These guidelines relate a banking company's capital to the risk profile of its assets. The risk-based capital standards require all banks to have Tier 1 capital of at least 4%, and total capital (Tier 1 and Tier 2 capital) of at least 8%, of risk- weighted assets, and to be designated as well-capitalized, the banking company must have Tier 1 and total capital ratios of 8% and 10%, respectively. For the -51- Company, Tier 1 capital includes common stockholders' equity and qualifying perpetual preferred stock reduced by goodwill. Tier 2 capital for the Company is comprised of all of the allowance for possible loan losses. Banking regulators also have leverage ratio requirements. The leverage ratio requirement is measured as the ratio of Tier 1 capital to adjusted quarterly average assets. The leverage ratio standards require all banking companies to have a minimum leverage ratio of 3%, and to be designated as well-capitalized, the banking company must have a leverage ratio of 6%. The following table provides a calculation of the Company's risk-based capital and leverage ratios and a comparison of the Company's and the Bank's risk-based capital ratios and leverage ratios to the minimum regulatory and well-capitalized minimum requirements at December 31, 1997:
The Company December 31, 1997 ----------- ----------------- (In thousands) Tier 1 capital: Common stockholders' equity, excluding unrealized gain on available-for-sale securities $ 20,261 Preferred stockholders' equity (1) 235 Goodwill ( 3,159) ---------- Total Tier 1 capital 17,337 ---------- Tier 2 capital: Allowance for possible loan losses (2) 1,173 ---------- Total Tier 2 capital 1,173 ---------- Total capital $ 18,510 ========== Risk-weighted assets $ 154,036 ========== Adjusted quarterly average assets $ 258,496 ==========
The minimum regulatory capital amounts and ratios and minimum capital amounts and ratios for well capitalized holding companies and the Company's actual capital amounts and ratios at December 31, 1997, were as follows:
Regulatory Minimums for Minimums for Well Capitalized Holding Companies Holding Companies Actual ----------------- ----------------- ---------------- Amount Ratio Amount Ratio Amount Ratio --------- ------ --------- ------ --------- ------ (Dollars in thousands) Tier 1 capital to risk-weighted assets $ 6,161 4.00% $ 12,323 8.00% $ 17,337 11.26% Total capital to risk-weighted assets 12,323 8.00 15,404 10.00 18,510 12.02 Tier 1 capital to adjusted quarterly average assets 7,755 3.00 15,510 6.00 17,337 6.71
-52- The minimum regulatory capital amounts and ratios and minimum capital amounts and ratios for well capitalized banks and the Bank's actual capital amounts and ratios at December 31, 1997, were as follows:
Regulatory Minimums for Minimums for Well Capitalized Holding Companies Holding Companies Actual ----------------- ----------------- ---------------- Amount Ratio Amount Ratio Amount Ratio --------- ------- --------- ------- --------- ------ (Dollars in thousands) Tier 1 capital to risk-weighted assets $ 6,193 4.00% $ 12,385 8.00% $ 15,855 10.24% Total capital to risk-weighted assets 12,386 8.00 15,482 10.00 17,028 11.00 Tier 1 capital to adjusted quarterly average assets 7,710 3.00 15,431 6.00 15,855 6.18 _______________________________ (1) Limited to 25% of total Tier 1 capital, with any remainder qualifying as Tier 2 capital. (2) Limited to 1.25% of risk-weighted assets.
The Federal Deposit Insurance Corporation Improvement Act of 1991 ("FDICIA") requires each federal banking agency to revise its risk-based capital standards to ensure that those standards take adequate account of interest rate risk, concentration of credit risk and the risks of non- traditional activities, as well as reflect the actual performance and expected risk of loss on multi-family mortgages. The law also requires each federal banking agency to specify the levels at which an insured institution would be considered "well capitalized," "adequately capitalized," "undercapitalized," "significantly undercapitalized" and "critically undercapitalized." Under the FDIC's regulations, the Company and the Bank were both "well capitalized" at December 31, 1997. The Company's ability to generate capital internally through retention of earnings and access to capital markets is essential for satisfying the capital guidelines for bank holding companies as prescribed by the Federal Reserve Board. The payment of dividends on the Common Stock and the Series C Cumulative Convertible Preferred Stock (the "Series C Preferred Stock") is determined by the Company's board of directors in light of circumstances and conditions then existing, including the earnings of the Company and the Bank, funding requirements and financial condition, applicable loan covenants and applicable laws and regulations. The Company's ability to pay cash dividends is restricted by the requirement that it maintain a certain level of capital as discussed above in accordance with regulatory guidelines. Holders of the Series C Preferred Stock are entitled to receive, if, as and when declared by the Company's board of directors, out of funds legally available therefor, quarterly cumulative cash dividends at the annual rate of 10%. The Federal Reserve Board has promulgated a policy prohibiting bank holding companies from paying dividends on common stock unless such bank holding company can pay such dividends from current earnings. The Federal Reserve Board has asserted that this policy is also applicable to payment of dividends on preferred stock. Such an interpretation may limit the ability of the Company to pay dividends on the Series C Preferred Stock. At December 31, 1997, retained earnings of the Bank included approximately $2,780,000 that was available for payment of dividends to the Company without prior approval of regulatory authorities. The Company began paying quarterly cash dividends of $0.03 per share on its Common Stock during the second quarter of 1994. The Company also paid 4-for-3 stock split, effected in the form of a 33-1/3% stock dividend, on May 31, 1995. The Company's Board of Directors increased the Company's quarterly Common Stock cash dividend to $0.05 per share during the second quarter of 1996. In addition, the Company paid a 5-for-4 stock split, effected in the form of a 25% stock dividend, on May 30, 1997. In connection with the Company's acquisition of Crown Park and its subsidiary, Western National, the Company sold an aggregate of 395,312 shares of the Common Stock in an underwritten offering at a price of $11.40 -53- per share. This amount included 51,562 shares covered by the underwriters' over-allotment option. The Company received net proceeds of approximately $3,978,000 from its offering. YEAR 2000 COMPLIANCE The inability of computers, software and other equipment utilizing microprocessors to recognize and properly process data fields containing a four digit year is commonly referred to as the Year 2000 Compliance issue. As the year 2000 approaches, such systems may be unable to accurately process certain date-based information. The Company believes it has identified all significant applications that will require modification to ensure Year 2000 Compliance. Internal and external resources are being used to make the required modifications and test Year 2000 Compliance. The modification process of all significant applications by outside hardware and software suppliers is substantially complete. The Company plans on completing the testing process of all significant applications by December 31, 1998. The Company leases virtually all of its computer hardware under leases that expire during the first six months of 1998. The Company has scheduled the replacement of this hardware, as well as the software used for its main operating system and major banking applications, during this same time period. All such hardware and software will be Year 2000 compliant. In addition, the Company has had formal communications with other vendors with which it does significant business to determine their Year 2000 readiness and the extent to which the Company appears vulnerable to any third party Year 2000 issues. There can be no assurance, however, that the systems of other companies will be timely converted, or that a failure to convert by another company, or a conversion that is incompatible with the Company's systems, would not have a material adverse effect on the Company. As a result of the timing of the replacement and upgrade of the Company's hardware and software, the total cost to the Company of Year 2000 Compliance activities has not been and is not anticipated to be material to the Company's financial position or results of operations in any given year. Year 2000 Compliance costs and the date on which the Company plans to complete the Year 2000 modifications and testing processes are based on management's best estimates, which were derived utilizing numerous assumptions of future events, including the continued availability of certain resources, third party modification plans and other factors. There can be no assurance, however, that these estimates will be achieved and actual results could differ from those plans. RECENT ACCOUNTING PRONOUNCEMENTS In June 1997, the FASB issued Statement of Financial Accounting Standards No. 130, "Reporting Comprehensive Income" ("FAS 130"). FAS 130 establishes standards for reporting and display of comprehensive income and its components (revenues, expenses, gains and losses) in a full set of general purpose financial statements. FAS 130 requires that all items that are required to be recognized under accounting standards as components of comprehensive income be reported in a financial statement that is displayed with the same prominence as other financial statements. The Company will adopt FAS 130 beginning January 1, 1998. Management does not believe that the adoption of this pronouncement will have a material impact on the financial statements of the Company. -54- [LOGO] INDEPENDENT BANKSHARES, INC. [PHOTOGRAPH OF TEXAS BLUEBONNETS] [LOGO] INDEPENDENT BANKSHARES, INC. --------------------------------------------------------- P.O. Box 3296 * Abilene, Texas 79604 * (915) 677-5550 EX-23.1 3 CONSENT OF COOPERS & LYBRAND L.L.P. Exhibit 23.1 CONSENT OF INDEPENDENT ACCOUNTANTS We hereby consent to the incorporation by reference in the two separate registration statements of Independent Bankshares, Inc. on Form S-8 (File Nos. 33-83112 and 333-07567) of our report dated February 2, 1998, on our audits of the consolidated financial statements of Independent Bankshares, Inc. as of December 31, 1997 and 1996, and for each of the three years ended December 31, 1997, which report is incorporated by reference in this Annual Report on Form 10-K /s/ Coopers & Lybrand L.L.P Forst Worth, Texas March 26, 1998 EX-27.1 4 FINANCIAL DATA SCHEDULE
9 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE AUDITED FINANCIAL STATEMENTS FOR INDEPENDENT BANKSHARES, INC. AS OF AND FOR THE YEAR ENDED DECEMBER 31, 1997 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS. 0000318870 INDEPENDENT BANKSHARES, INC, YEAR DEC-31-1997 JAN-01-1997 DEC-31-1997 14,518,000 0 24,900,000 0 22,501,000 69,794,000 69,877,000 140,853,000 1,173,000 264,574,000 242,801,000 55,000 1,189,000 2,000 0 56,000 494,000 19,977,000 264,574,000 12,236,000 5,176,000 912,000 18,324,000 8,600,000 8,659,000 9,665,000 250,000 0 8,237,000 3,087,000 3,087,000 0 0 2,110,000 1.12 1.03 4.13 70,000 121,000 104,000 0 793,000 581,000 316,000 1,173,000 1,173,000 0 330,000 Includes investments held for sale. Net of unearned income on installment loans of $1,462,000. Includes unallocated portion of the allowance.
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