-----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, JigewwmT9p9ISG1P0mSMTO3DdwOz5BdR9R+4xAr8pToNeW08+CtrMK+JwwnUB1jm 47gsaKW3TqhBX+/23/moZw== 0000909143-99-000060.txt : 19990402 0000909143-99-000060.hdr.sgml : 19990402 ACCESSION NUMBER: 0000909143-99-000060 CONFORMED SUBMISSION TYPE: 10-K405 PUBLIC DOCUMENT COUNT: 9 CONFORMED PERIOD OF REPORT: 19981231 FILED AS OF DATE: 19990331 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: 99582923 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, 1998 or TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the Transition Period from to Commission File Number: 0-10196 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: Name of each exchange Title of each class on which registered _____________________________________________ ______________________ Common Stock, $0.25 Par Value American Stock Exchange 8.5% Cumulative Trust Preferred Securities, American Stock Exchange Guaranteed by Independent Bankshares, Inc., Stated Value $10.00 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. [X] The aggregate market value of the voting stock held by nonaffiliates of the Registrant, based on the market value of such stock on March 18, 1999, was $18,130,000. 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 18, 1999, 2,228,780 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, 1998, 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 27, 1999 - 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 owns all of the common securities of Independent Capital Trust ("Independent Capital") and indirectly owns through a Delaware subsidiary, Independent Financial Corp. ("Independent Financial"), 100% of the stock of First State Bank, National Association, Abilene, Texas (the "First State") and Azle State Bank, Azle, Texas ("Azle State") (collectively, the "Banks"). At December 31, 1998, the Banks operated full-service banking locations in the Texas cities of Abilene (3 locations), Azle (2 locations), Lubbock, Odessa (4 locations), San Angelo, Stamford and Winters. The Company's primary activities are to assist the Banks in the management and coordination of their financial resources and to provide capital, business development, long range planning and public relations for the Banks. The Banks operate under the day-to-day management of their own officers and board of directors and formulates their own policies with respect to banking matters. At December 31, 1998, the Company had, on a consolidated basis, total assets of $370,178,000, total deposits of $330,804,000, total loans, net of unearned income, of $184,560,000 and total stockholders' equity of $24,505,000. The Company's net income has grown from $224,000 in 1991 to $2,188,000 in 1998. Additionally, since 1991, the Company's total loans have grown at a 19.7% 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 BANKS The Company conducts substantially all of its business through the Banks and its various branches in Texas. Each of the Banks' branches is an established franchise with a significant presence in its respective service area. The combined branches in Abilene had the seventh largest total deposits of eleven financial institutions that had branch(es) in Taylor County, at June 30, 1998, 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, 1998. The combined branches in Odessa had the seventh largest total deposits of nine banks that had branch(es) in Ector County at June 30, 1998. The branch in San Angelo had the eighth largest total deposits of twelve banks that had branch(es) in Tom Green County at June 30, 1998. The branch in Lubbock had the twelfth largest total deposits of sixteen banks that had branch(es) in Lubbock County at June 30, 1998. Azle State had the twenty-second largest total deposits of forty-nine banks that had branch(es) in Tarrant County at June 30, 1998. The Banks operate through their branches as the community banks that focus on long-term relationships with customers and provide individualized, quality service. Reflecting its community banking heritage, the Banks have a stable deposit base from customers located within its Texas market area. Their recent financial performance is characterized by consistent core earnings, an increasingly diversified loan portfolio and strong asset quality. The deposits of the Banks are insured by the Federal Deposit Insurance Corporation (the "FDIC") to the maximum extent provided by law. At December 31, 1998, First State had total assets of $268,438,000, total deposits of $246,181,000, total loans, net of unearned income, of $141,031,000, and total stockholder's equity of $21,011,000 and Azle State had total assets of $100,584,000, total deposits of $85,177,000, total loans, net of unearned income, of $43,464,000, and total stockholder's equity of $14,827,000. On March 12, 1999, Azle State was merged with and into First State. The principal services provided by the Banks are as follows: Commercial Services. The Banks provide a full range of banking services for their commercial customers. Commercial lending activities include short-term and medium-term loans, revolving credit arrangements, inventory and -1- 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 Banks also provide a wide range of consumer banking services, including checking, savings and money market accounts, savings programs and installment and personal loans. The Banks make automobile and other installment loans directly to customers, as well as indirectly through automobile dealers. The Banks make 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 Banks provide 24-hour routine banking services through automated teller machines ("ATMs"). The Pulse network provides ATM accessibility throughout the United States. The Banks also offer investment services and banking by phone or personal computer. Trust Services. First State 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. ACQUISITION AND BRANCH ACTIVITIES Azle Bancorp and Azle State Bank. The Company completed the acquisition of Azle Bancorp and its subsidiary bank, Azle State, effective September 22, 1998, for an aggregate cash consideration of $19,025,000. To obtain funding for the acquisition, the Company sold an aggregate of 230,000 shares of Common Stock at a price of $11.50 per share, and Independent Capital sold 1,300,000 of its 8.5% Cumulative Trust Preferred Securities (the "Trust Preferred Securities") at $10.00 per preferred security (having a liquidation value of $13,000,000) (together, the "1998 Offering"). The proceeds from the sale of the Trust Preferred Securities were used by Independent Capital to purchase an equivalent amount of Subordinated Debentures of the Company. The Company also borrowed $4,300,000 from a financial institution in Fort Worth, Texas (the "Fort Worth Bank") to finance a portion of the cost of acquiring Azle Bancorp. The borrowings from the Fort Worth Bank were paid off on September 30, 1998, from the proceeds of a cash dividend paid to the Company by Azle State. At the date of acquisition, Azle Bancorp had total assets of $93,158,000, total loans, net of unearned income, of $45,163,000, total deposits of $80,955,000 and stockholders' equity of $9,872,000. This acquisition was accounted for using the purchase method of accounting. A total of $8,014,000 of intangible assets was recorded as a result of this acquisition. The core deposit intangible is being amortized over a period of 12 years, and the goodwill is being amortized over a period of 25 years. 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 First State. 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 "1997 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 realized savings in the area of non-interest expenses through consolidation of the operations of Western National into First State. In addition to the immediate increase in asset size and the potential for improved future profitability, the Azle Bancorp and Crown Park acquisitions have allowed the Company to expand its market area into what the Company believes are additional desirable banking locations. This expansion has increased the geographic diversity of the Company's loan portfolio, and, thus, decreased the Company's overall lending risks. Supermarket Branches. During the second quarter of 1997, First State 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 large supermarkets. First State received approval to open the branches during the third quarter and in October 1997 opened two full- service branch locations in large supermarkets, one in Abilene and one in Odessa. One additional branch in another large supermarket in Odessa opened during the second quarter of 1998. The fourth supermarket branch, to be located in Abilene, should be operational in -2- 2000. Management of the Company believes that establishing bank branches in supermarkets is one of the most economical ways to increase market share of the Banks in their West and North Central Texas market areas. OTHER SUBSIDIARIES At the present time, the Company does not have any subsidiaries other than Independent Capital, Independent Financial and the Banks. BUSINESS OBJECTIVES AND STRATEGY The Company's principal business objectives are to increase its profitability and shareholder value by building a valuable Texas banking franchise using core deposits as a funding base to support local commercial and consumer lending programs. The Company employs several strategies, including the following, to accomplish its objectives: Sophistication and Breadth of Products; Personal Services. The Company's goal 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. The Company believes that, as a result of consolidation in the financial industry within the Company's marketplace, there are few financial institutions in its market area that have larger lending limits than the Company that are willing to provide the personal customer service that the Company is committed to providing to its customers. Decentralized Decision Making. The Company's decentralized decision making authority, vested in the president and senior officers of the Abilene, Azle, Lubbock and Odessa branches, allows for rapid response time and flexibility in dealing with customer requests and credit needs and has contributed to a 25.5% increase in the Company's commercial and real estate loan portfolio, excluding the acquisition of Azle State, during the twelve-month period ended December 31, 1998. Credit Quality Standards. The Company's attention to credit quality standards has allowed it to expand its commercial loan portfolio while maintaining superior asset quality. Nonperforming assets were 0.3% of total assets at December 31, 1998. Efficient and Convenient Delivery Systems. The Company's efforts to maintain and expand efficient and convenient delivery systems for its products and services have included the recent expansion of its branch network by locating banking centers in a leading supermarket chain in Abilene (one location) and Odessa (two locations) and the introduction of computer and telephone home banking. The Company also maintains 15 ATMs throughout its market area. Acquisition Activity. The Company's strategy of opportunistically acquiring banks in its West Texas market has resulted in its acquisition of three banks and one branch in the last five years. Following the acquisition of Azle Bancorp and its subsidiary Azle State in September 1998, the Company has locations in or near five of the major markets in West and North Central Texas. 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. General The Company and the Banks are extensively regulated under federal and state law. These laws and regulations are intended to protect depositors, not shareholders. To the extent that the following information describes statutory or regulatory provisions, it is qualified in its entirety by reference to the particular statutory or regulatory provisions. Any change in applicable laws or regulations may have a material effect on the business and prospects of the Company. The operations of the Company may be affected by legislative changes and by the policies of various regulatory authorities. The Company is unable to predict the nature or the extent of the effects on its business and earnings that fiscal or monetary policies, economic controls or new federal or state legislation may have in the future. The Company is a registered bank holding company under the Bank Holding Company Act of 1956 (as amended, the "BHCA") and, as such, is subject to regulation, supervision and examination by the Board of Governors of the Federal Reserve (the "Federal Reserve"). The Company is required to file annual reports with the Federal Reserve and to provide the Federal Reserve such additional information as it may require. -3- First State, a national banking association organized under the National Bank Act, is subject to the supervision and regulation of the Office of the Comptroller of the Currency (the "OCC"). Prior to its merger with and into First State on March 12, 1999, Azle State was a Texas state-chartered bank subject to regulation by the Texas Department of Banking (the "TDB"). Because the FDIC provides deposit insurance to the Banks, the Banks are also subject to supervision and regulation by the FDIC (even though the FDIC is not the primary federal regulator of the Banks). RECENT AND PENDING LEGISLATION The enactment of the legislation described below has significantly affected the banking industry generally and will have an ongoing effect on the Company and the Banks in the future. Financial Institutions Reform, Recovery and Enforcement Act of 1989 The Financial Institutions Reform, Recovery, and Enforcement Act of 1989 ("FIRREA") reorganized and reformed the regulatory structure applicable to financial institutions generally. FIRREA, among other things, enhanced the supervisory and enforcement powers of the federal bank regulatory agencies, required insured financial institutions to guarantee repayment of losses incurred by the FDIC in connection with the failure of an affiliated financial institution, required financial institutions to provide their primary federal regulator with notice (under certain circumstances) of changes in senior management and broadened authority for bank holding companies to acquire savings institutions. Under FIRREA, federal bank regulators were granted expanded enforcement authority over "institution-affiliated parties" (i.e., officers, directors, controlling shareholders, as well as attorneys, appraisers or accountants who knowingly or recklessly participate in wrongful action likely to have an adverse effect on an insured institution). Federal banking regulators have greater flexibility to bring enforcement actions against insured institutions and institution-affiliated parties, including cease and desist orders, prohibition orders, civil money penalties, termination of insurance and the imposition of operating restrictions and capital plan requirements. These enforcement actions, in general, may be initiated for violations of laws and regulations and unsafe or unsound practices. Since the enactment of FIRREA, the federal bank regulators have significantly increased the use of written agreements to correct compliance deficiencies with respect to applicable laws and regulations and to ensure safe and sound practices. Violations of such written agreements are grounds for initiation of cease-and-desist proceedings. FIRREA granted the FDIC back-up enforcement authority to recommend enforcement action to an appropriate federal banking agency and to bring such enforcement action against a financial institution or an institution-affiliated party if such federal banking agency fails to follow the FDIC's recommendation. FIRREA also requires, except under certain circumstances, public disclosure of final enforcement actions by the federal banking agencies. FIRREA also established a cross-guarantee provision pursuant to which the FDIC may recover from a depository institution losses that the FDIC incurs in providing assistance to, or paying off the insured depositors of, any of such depository institution's affiliated insured banks or thrifts. The cross- guarantee thus enables the FDIC to assess a holding company's healthy Bank Insurance Fund ("BIF") members and Savings Association Insurance Fund ("SAIF") members for the losses of any of such holding company's failed BIF and SAIF members. Cross- guarantee liabilities are generally superior in priority to obligations of the depository institution to its shareholders due solely to their status as shareholders and obligations to other affiliates. Cross-guarantee liabilities are generally subordinated, except with respect to affiliates, to deposit liabilities, secured obligations or any other general or senior liabilities, and any obligations subordinated to depositors or other general creditors. The Federal Deposit Insurance Corporation Improvement Act of 1991 The Federal Deposit Insurance Corporation Improvement Act of 1991 ("FDICIA") was adopted to recapitalize the BIF and impose certain supervisory and regulatory reforms on insured depository institutions. FDICIA, in general, includes provisions, among others, to (i) increase the FDIC's line of credit with the U.S. Treasury in order to provide the FDIC with additional funds to cover the losses of federally insured banks, (ii) reform the deposit insurance system, including the implementation of risk- based deposit insurance premiums, (iii) establish a format for closer monitoring of financial institutions to enable prompt corrective action by banking regulators when a financial institution begins to experience financial difficulty, (iv) establish five capital levels for financial institutions ("well capitalized," "adequately capitalized," "undercapitalized," "significantly undercapitalized" and "critically undercapitalized") that impose more scrutiny and restrictions on less capitalized institutions, (v) require the banking regulators to set operational and managerial standards for all insured depository institutions and their holding companies, including limits on excessive compensation to executive officers, directors, employees and principal shareholders, and establish standards for loans secured by real estate, (vi) adopt certain accounting reforms and require annual on-site examinations of federally insured institutions, including the ability to require independent audits of banks and thrifts, (vii) revise risk-based -4- capital standards to ensure that they (a) take adequate account of interest-rate changes, concentration of credit risk and the risks of nontraditional activities, and (b) reflect the actual performance and expected risk of loss of multi-family mortgages, and (viii) restrict state-chartered banks from engaging in activities not permitted for national banks unless they are adequately capitalized and have FDIC approval. FDICIA also authorized the FDIC to make special assessments on insured depository institutions, in amounts determined by the FDIC to be necessary to give it sufficient assessment income to repay amounts borrowed from the U.S. Treasury and other sources or for any other purpose the FDIC deems necessary. FDICIA also grants authority to the FDIC to establish semiannual assessment rates on BIF and SAIF member banks so as to maintain these funds at the designated reserve ratios. FDICIA, as noted above, authorizes and (under certain circumstances) requires the federal banking agencies to take certain actions against institutions that fail to meet certain capital-based requirements. The federal banking agencies are required, under FDICIA, to establish five levels of insured depository institutions based on leverage limit and risk-based capital requirements established for institutions subject to their jurisdiction plus, in their discretion, individual additional capital requirements for such institutions. Under the final rules that have been adopted by each of the federal banking agencies, an institution is designated (i) "well-capitalized" if the institution has a total risk-based capital ratio of 10% or greater, a Tier 1 risk-based capital ratio of 6% or greater, and a leverage ratio of 5% or greater, and the institution is not subject to an order, written agreement, capital directive, or prompt corrective action directive to meet and maintain a specific capital level for any capital measure, (ii) "adequately capitalized" if the institution has a total risk-based capital ratio of 8% or greater, a Tier 1 risk-based capital ratio of 4% or greater, and a leverage ratio of 4% or greater, (iii) "undercapitalized" if the institution has a total risk-based capital ratio that is less than 8%, a Tier 1 risk-based capital ratio that is less than 4%, or a leverage ratio that is less than 4%, (iv) "significantly undercapitalized" if the institution has a total risk-based capital ratio that is less than 6%, a Tier 1 risk-based capital ratio that is less than 3%, or a leverage ratio that is less than 3%, and (v) "critically undercapitalized" if the institution has a ratio of tangible equity to total assets that is equal to or less than 2%. "Undercapitalized," "significantly undercapitalized" and "critically undercapitalized" institutions are required to submit capital restoration plans to the appropriate federal banking agency and are subject to certain operational restrictions. Companies controlling an undercapitalized institution are also required to guarantee the subsidiary institution's compliance with the capital restoration plan subject to an aggregate limitation of the lesser of 5% of the institution's assets at the time it received notice that it was undercapitalized or the amount of the capital deficiency when the institution first failed to meet the plan. Significantly or critically undercapitalized institutions and undercapitalized institutions that do not submit or comply with acceptable capital restoration plans are subject to restrictions on the compensation of senior executive officers and to additional regulatory sanctions that may include a forced offering of shares or merger, restrictions on affiliate transactions, restrictions on rates paid on deposits, asset growth and new activities, the dismissal of directors or senior executive officers and mandatory divestitures by the institution or its parent company. The banking agency must require the offering of shares or merger and restrict affiliate transactions and the rates paid on deposits unless it is determined that they would not further capital improvement. FDICIA generally requires the appointment of a conservator or receiver within 90 days after an institution becomes critically undercapitalized. The federal banking agencies have adopted uniform procedures for the issuance of directives by the appropriate federal banking agency. Under these procedures, an institution will generally be provided advance notice when the appropriate federal banking agency proposes to impose one or more of the sanctions set forth above. These procedures provide an opportunity for the institution to respond to the proposed agency action or, where circumstances warrant immediate agency action, an opportunity for administrative review of the agency's action. As described under "Management's Discussion and Analysis of Financial Condition and Results of Operations-Capital Resources," both the Company and the Banks were "well capitalized" at December 31, 1998. Pursuant to FDICIA, the Federal Reserve and the other federal banking agencies adopted real estate lending guidelines pursuant to which each insured depository institution is required to adopt and maintain written real estate lending policies in conformity with the prescribed guidelines. Under these guidelines, each institution is expected to set loan-to-value ratios not exceeding the supervisory limits set forth in the guidelines. A loan-to-value ratio is generally defined as the total loan amount divided by the appraised value of the property at the time the loan is originated. The guidelines require that the institution's real estate policy include proper loan documentation and prudent underwriting standards. These guidelines became effective on March 19, 1993. These rules have had no material adverse impact on the Company and the Banks. FDICIA also contained the Truth in Savings Act, which requires clear and uniform disclosure of the rates of interest payable on deposit accounts by depository institutions, and the fees assessable against deposit accounts, so that -5- consumers can make a meaningful comparison between the competing claims of financial institutions with regard to deposit accounts and products. Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 Congress enacted the Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 (the "Interstate Act") in September 1994. Since September 1995, bank holding companies have the right to expand, by acquiring existing banks, into all states, even those which had theretofore restricted entry. The legislation also provided that, subject to future action by individual states, a holding company has the right, commencing in 1997, to convert the banks which it owns in different states to branches of a single bank. A state was permitted to "opt out" of provisions of the Interstate Act which permitted conversion of separate banks to branches, but was not permitted to "opt out" of the law allowing bank holding companies from other states to enter the state. Texas has adopted legislation to "opt out" of the interstate branching provisions (which Texas law currently expires on September 2, 1999). The federal legislation also establishes limits on acquisitions by large banking organizations, providing that no acquisition may be undertaken if it would result in the organization having deposits exceeding either 10% of all bank deposits in the United States or 30% of the bank deposits in the state in which the acquisition would occur. Economic Growth and Regulatory Paperwork Reduction Act of 1996 The Economic Growth and Regulatory Paperwork Reduction Act of 1996 ("EGRPRA") was signed into law on September 30, 1996. EGRPRA streamlined the non-banking activities application process for well-capitalized and well-managed bank holding companies. Under EGRPRA, qualified bank holding companies may commence a regulatorily approved non-banking activity without prior notice to the Federal Reserve; written notice is required within 10 days after commencing the activity. Under EGRPRA, the prior notice period is reduced to 12 days in the event of any non-banking acquisition or share purchase, assuming the size of the acquisition does not exceed 10% of risk-weighted assets of the acquiring bank holding company and the consideration does not exceed 15% of Tier 1 capital. The foregoing prior notice requirement also applies to commencing non-banking activity de novo which has been previously approved by order of the Federal Reserve, but not yet implemented by regulations. PENDING LEGISLATION Because of concerns relating to competitiveness and the safety and soundness of the banking industry, Congress is considering a number of wide-ranging proposals for altering the structure, regulation and competitive relationships of the nation's financial institutions. Among such bills are new proposals to merge the BIF and the SAIF insurance funds, to eliminate the federal thrift charter, to alter the statutory separation of commercial and investment banking and to further expand the powers of banks, bank holding companies and competitors of banks. It cannot be predicted whether or in what form any of these proposals will be adopted or the extent to which the business of the Company may be affected thereby. BANK AND BANK HOLDING COMPANY REGULATION Under the BHCA, the activities of a bank holding company are limited to businesses so closely related to banking, managing or controlling banks as to be a proper incident thereto. The Company is also subject to capital requirements applied on a consolidated basis in a form substantially similar to those required of the Banks. The BHCA also requires a bank holding company to obtain approval from the Federal Reserve before (i) acquiring, directly or indirectly, ownership or control of any voting shares of another bank or bank holding company if, after such acquisition, it would own or control more than 5% of such shares (unless it already owns or controls the majority of such shares), (ii) acquiring all or substantially all of the assets of another bank or bank holding company, or (iii) merging or consolidating with another bank holding company. The Federal Reserve will not approve any acquisition, merger or consolidation that would have a substantially anticompetitive result, unless the anticompetitive effects of the proposed transaction are clearly outweighed by a greater public interest in meeting the convenience and needs of the community to be served. The Federal Reserve also considers capital adequacy and other financial and managerial factors in reviewing acquisitions or mergers. The BHCA also prohibits a bank holding company, with certain limited exceptions, (i) from acquiring or retaining direct or indirect ownership or control of more than 5% of the voting shares of any company which is not a bank or bank holding company, or (ii) from engaging directly or indirectly in activities other than those of banking, managing or controlling banks, or providing services for its subsidiaries. The principal exceptions to these prohibitions involve certain non-bank activities which, by statute or by Federal Reserve regulation or order, have been identified as activities closely related to the business of banking or of managing or controlling banks. The Federal Reserve, in making such determination, considers whether the performance of such activities by a bank holding company can be -6- expected to produce benefits to the public such as greater convenience, increased competition or gains in efficiency in resources, which can be expected to outweigh the risks of possible adverse effects such as decreased or unfair competition, conflicts of interest or unsound banking practices. FIRREA (described in more detail herein) made a significant addition to the list of permitted non-bank activities for bank holding companies by providing that bank holding companies may acquire thrift institutions upon approval by the Federal Reserve. INSURANCE OF ACCOUNTS The FDIC provides insurance, through the BIF, to deposit accounts at the Banks to a maximum of $100,000 for each insured depositor. Through December 31, 1992, all FDIC-insured institutions, whether members of the BIF or the SAIF, paid the same premium (23 cents per $100 of assessable deposits) under a flat-rate system mandated by law. FDICIA required the FDIC to raise the reserves of the BIF and the SAIF, implement a risk-related premium system and adopt a long-term schedule for recapitalizing the BIF. Effective January 1, 1993, the FDIC amended its regulations regarding insurance premiums to provide that a bank or thrift would pay an insurance assessment within a range of 23 cents to 31 cents for each $100 of assessable deposits, depending on its risk classification. Effective January 1, 1996, the FDIC implemented an amendment to the BIF risk-based assessment schedule which effectively eliminated deposit insurance assessments for most commercial banks and other depository institutions with deposits insured by the BIF only, while maintaining the assessment rate for SAIF- insured institutions in even the lowest risk-based premium category at 23 cents for each $100 of assessable deposits. Following enactment of EGRPRA, the overall assessment rate beginning in 1997 for institutions in the lowest risk-based premium category was revised to equal 1.29 cents and 6.44 cents for each $100 of assessable deposits of BIF and SAIF, respectively, in comparison to the prior assessment rate for such institutions, applicable only to SAIF deposits, of 23 cents for each $100 of assessable deposits. At this time, the deposit insurance assessment rate for institutions in the lowest risk- based premium category is zero, and all of the assessments paid by institutions in this category are used to service debt issued by the Financing Corporation, a federal agency established to finance the recapitalization of the former Federal Savings and Loan Insurance Corporation. REGULATIONS GOVERNING CAPITAL ADEQUACY The federal bank regulatory agencies use capital adequacy guidelines in their examination and regulation of bank holding companies and banks. If the capital falls below the minimum levels established by these guidelines, the bank holding company or bank may be denied approval to acquire or establish additional banks or nonbank businesses or to open facilities. The Federal Reserve and the OCC adopted risk-based capital guidelines for banks and bank holding companies. The risk-based capital guidelines are designed to make regulatory capital requirements more sensitive to differences in risk profile among banks and bank holding companies, to account for off-balance sheet exposure and to minimize disincentives for holding liquid assets. Assets and off-balance sheet items are assigned to broad risk categories, each with appropriate weights. The resulting capital ratios represent capital as a percentage of total risk- weighted assets and off-balance sheet items. The Federal Reserve has noted that bank holding companies contemplating significant expansion programs should not allow expansion to diminish their capital ratios and should maintain ratios well in excess of the minimums. Under these guidelines, all bank holding companies and federally regulated banks must maintain a minimum risk-based total capital ratio equal to 8%, of which at least one-half must be Tier 1 capital. The Federal Reserve also has implemented a leverage ratio, which is Tier 1 capital to total assets, to be used as a supplement to the risk-based guidelines. The principal objective of the leverage ratio is to place a constraint on the maximum degree to which a bank holding company may leverage its equity capital base. The Federal Reserve requires a minimum leverage ratio of 3%. For all but the most highly-rated bank holding companies and for bank holding companies seeking to expand, however, the Federal Reserve expects that additional capital sufficient to increase the ratio by at least 100 to 200 basis points will be maintained. On October 21, 1996, the Federal Reserve issued a press release announcing that it had approved the use of certain cumulative preferred stock instruments in Tier 1 capital for bank holding companies. See "Management's Discussion and Analysis of Financial Condition and Results of Operations-Capital Resources" for a discussion of the capital adequacy of the Company and the Banks. -7- Management of the Company believes that the risk-weighting of assets and the risk-based capital guidelines do not have a material adverse impact on the Company's operations or on the operations of the Banks. The requirement of deducting certain intangibles in computing capital ratios contained in the guidelines, however, could adversely affect the ability of the Company to make acquisitions in the future in transactions that would be accounted for using the purchase method of accounting. Although these requirements would not reduce the ability of the Company to make acquisitions using the pooling of interests method of accounting, the Company has not historically made, and has no present plans to make, acquisitions on this basis. COMMUNITY REINVESTMENT ACT The Community Reinvestment Act of 1977 requires that, in connection with examinations of financial institutions within their jurisdiction, the federal banking regulators must evaluate the record of the financial institutions in meeting the credit needs of their local communities, including low and moderate income neighborhoods, consistent with the safe and sound operation of those banks. These factors are also considered in evaluating mergers, acquisitions and applications to open a branch or facility. REGULATIONS GOVERNING EXTENSIONS OF CREDIT The Banks are subject to certain restrictions imposed by the Federal Reserve Act on extensions of credit to the Company or the Banks or investments in their securities and on the use of their securities as collateral for loans to any borrowers. These regulations and restrictions limit the ability of the Company to borrow funds from the Banks for its cash needs, including funds for acquisitions and for payment of dividends, interest and operating expenses. Further, under the BHCA and certain regulations of the Federal Reserve, a bank holding company and its subsidiaries are prohibited from engaging in certain tying arrangements in connection with any extension of credit, lease or sale of property or furnishing of services. For example, the Banks may not generally require a customer to obtain other services from the Banks or the Company, and may not require the customer to promise not to obtain other services from a competitor as a condition to an extension of credit to the customer. The Banks are also subject to certain restrictions imposed by the Federal Reserve Act on extensions of credit to executive officers, directors, principal shareholders or any related interest of such persons. Extensions of credit (i) must be made on substantially the same terms, including interest rates and collateral as, and following credit underwriting procedures that are not less stringent than, those prevailing at the time for comparable transactions with persons not covered above and who are not employees, and (ii) must not involve more than the normal risk of repayment or present other unfavorable features. The Banks are also subject to certain lending limits and restrictions on overdrafts to such persons. RESERVE REQUIREMENTS The Federal Reserve requires all depository institutions to maintain reserves against their transaction accounts and non- personal time deposits. Reserves of 3% must be maintained against net transaction accounts of $47.8 million or less (subject to adjustment by the Federal Reserve) and an initial reserve of $1,434,000 plus 10% (subject to adjustment by the Federal Reserve to a level between 8% and 14%) must be maintained against that portion of net transaction accounts in excess of such amount. The balances maintained to meet the reserve requirements imposed by the Federal Reserve may be used to satisfy liquidity requirements. Institutions are authorized to borrow from the Federal Reserve Bank "discount window," but Federal Reserve regulations require institutions to exhaust other reasonable alternative sources of funds, including Federal Home Loan Bank advances, before borrowing from the Federal Reserve Bank. DIVIDENDS The Company's primary sources of funds are the dividends and management fees paid by the Banks. The ability of the Banks to pay dividends and management fees is limited by various state and federal laws, by the regulations promulgated by their respective primary regulators and by the principles of prudent bank management. MONETARY POLICY AND ECONOMIC CONTROL The commercial banking business in which the Company engages is affected not only by general economic conditions, but also by the monetary policies of the Federal Reserve. Changes in the discount rate on member bank borrowing, availability of borrowing at the "discount window," open market operations, the imposition of changes in reserve requirements against member banks deposits and assets of foreign branches, and the imposition of and changes -8- in reserve requirements against certain borrowings by banks and their affiliates are some of the instruments of monetary policy available to the Federal Reserve. These monetary policies are used in varying combinations to influence overall growth and distributions of bank loans, investments and deposits, and such use may affect interest rates charged on loans or paid on deposits. The monetary policies of the Federal Reserve have had a significant effect on the operating results of commercial banks and are expected to do so in the future. The monetary policies of the Federal Reserve are influenced by various factors, including inflation, unemployment, short-term and long-term changes in the international trade balance and in the fiscal policies of the U.S. Government. Future monetary policies and the effect of such policies on the future business and earnings of the Company and the Banks cannot be predicted. COMPETITION The activities in which the Company and the Banks 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 Banks actively compete 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 Banks compete 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 Banks also compete with suppliers of equipment in providing equipment financing. EMPLOYEES At March 18, 1999, the Company and the Banks had 177 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 Banks with their respective employees to be good. -9- ITEM 2. PROPERTIES At March 18, 1999, the Company occupied approximately 600 square feet of space for its corporate offices at 547 Chestnut Street, Abilene, Texas. The Main Bank of First State occupies approximately 8,000 square feet at this same facility. The following table sets forth, at March 18, 1999, certain information with respect to the banking premises owned or leased by the Company and First State. The Company considers such premises adequate for its needs and the needs of First State.
Approximate Location Square Footage Ownership and Occupancy -------------- ------------------ ------------------------------------------- Abilene, Texas 8,600 Owned by First State; occupied by the Main Bank and the Company Abilene, Texas 3,500 Owned by First State; occupied by the Wylie Branch Abilene, Texas 400 Leased by First State; occupied by the Buffalo Gap Road Branch Azle, Texas 20,400(1) Owned by First State and two other condominium owners; occupied and leased by the Azle Main Branch Azle, Texas 3,900 Owned by First State; occupied by the Azle North Branch Lubbock, Texas 23,200(2) Owned by First State; occupied and leased by the Lubbock Branch Odessa, Texas 62,400(3) Owned by First State; occupied and leased by the Odessa Main Branch Odessa, Texas 2,400 Leased by First State; occupied by the Winwood Branch Odessa, Texas 400 Leased by First State; occupied by the 42nd Street Branch Odessa, Texas 400 Leased by First State; occupied by the County Road West Branch San Angelo, Texas 6,800(4) Owned by First State; occupied and leased by the San Angelo Branch Stamford, Texas 14,000 Owned by First State; occupied by the Stamford Branch Winters, Texas 9,500 Owned by First State; occupied by the Winters Branch _________________ (1) First State owns condominium interests totaling approximately 17,100 square feet, of which it leases approximately 300 square feet. Two other condominium owners own units totaling approximately 3,300 square feet. (2) The Lubbock Branch occupies approximately 13,300 square feet and leases approximately 9,900 square feet. (3) The Odessa Main Branch occupies approximately 18,500 square feet, leases approximately 23,900 square feet and is attempting to lease the remaining approximately 20,000 square feet. (4) The San Angelo Branch occupies approximately 3,400 square feet and leases approximately 3,400 square feet.
The Banks own or lease 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 Banks for all leased premises during the year ended December 31, 1998, were $116,000. This amount represents rentals paid for the lease of land by the Wylie Branch and of banking premises by the Buffalo Gap Road, Winwood, 42nd Street and County Road West Branches of First State. ITEM 3. LEGAL PROCEEDINGS In November 1995, the Pension Benefit Guaranty Corporation (the "PBGC") sent a letter to the Company regarding the Retirement Plan for Employees of the Texas Bank and Trust Co., Sweetwater, Texas (the "Texas Bank -10- Plan"). In the letter, the PBGC alleged that the Company was responsible for the Texas Bank Plan and asked that the Company assume sponsorship of the Texas Bank Plan. The Company declined the PBGC's request to assume responsibility for, and sponsorship of, the Texas Bank Plan. If the Company had assumed responsibility for the Texas Bank Plan, the Company would have owed as of June 30, 1995, according to PBGC calculations, approximately $656,000 to the PBGC. In response, the PBGC, in June 1996, terminated the Texas Bank Plan and became the Texas Bank Plan's trustee, effective as of June 30, 1992. Texas Bank and Trust Co., Sweetwater, Texas ("Texas Bank"), became a repossessed asset of the First State, a former subsidiary of the Company, through a bank foreclosure that occurred in 1985. The First State was placed into receivership by the Federal Deposit Insurance Corporation (the "FDIC") on February 17, 1989. Texas Bank was placed into receivership by the FDIC on July 27, 1989. The Company did not intend to assume any responsibility for the Texas Bank Plan and had decided to vigorously contest any attempt by the PBGC to have the Company assume responsibility with respect to any aspect of the Texas Bank Plan. The statute of limitations for any action to be taken by the PBGC against the Company regarding this matter was set to expire on June 30, 1998. The PBGC indicated to the Company that as of June 30, 1998, the Company's potential responsibility to the Texas Bank Plan, according to PBGC calculations, was in excess of $1,000,000. The Company and the PBGC entered into settlement negotiations, and on June 30, 1998, the Company and the PBGC executed a tolling agreement to extend the expiration of the statute of limitations regarding this matter to July 20, 1998. A settlement agreement was negotiated and consummated on July 20, 1998, and the Company paid a total of $125,000 ($83,000, net of tax) to the PBGC to avoid costs of litigation regarding this matter. The Company is involved in certain legal proceedings arising in the ordinary course of business. Based upon information currently available to the Company, management believes that the ultimate liability resulting from such litigation will not have a material adverse effect on the Company's results of operation or 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. -11- PART II ITEM 5.MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS MARKET INFORMATION The Company's Common Stock trades on the American Stock Exchange (the "AMEX") under the symbol "IBK." Independent Capital's Trust Preferred Securities trade on the AMEX under the symbol "IBK.Pr." The following table sets forth, for the periods indicated, the high and low sales prices for the Common Stock and Trust Preferred Securities as quoted on the AMEX and the amount of cash dividends and distributions paid per share, adjusted for the 5-for-4 stock split of the Common Stock, effected in the form of a 25% stock dividend, paid to stockholders in May 1997.
Common Stock Trust Preferred Securities ------------------------------ --------------------------- Cash Dividends Distributions High Low Per Share High Low Per Security ------- ------- ----------- ---- ---- ------------- 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 Ended December 31, 1998 - ---------------------------- First Quarter $19 5/8 $15 3/4 $0.05 $ ___ $ ___ $ ___ Second Quarter 19 14 3/8 0.05 ___ ___ ___ Third Quarter 15 9/16 11 0.05 10 1/16 10 1/16 ___ Fourth Quarter 11 7/8 10 1/4 0.05 10 3/4 9 1/2 0.23 Year Ending December 31, 1999 - ----------------------------- First Quarter (through March 18) $12 1/8 $10 1/2 $0.05(1) $10 7/8 $ 9 1/2 $ 0.21(2) _____________ (1) This cash dividend was paid February 26, 1999, to stockholders of record on February 12, 1999. (2) This distribution is scheduled to be paid on March 31, 1999, to security holders of record on such date.
SHAREHOLDERS At March 18, 1999, there were 1,777 stockholders who were individual participants in security position listings. DIVIDEND POLICY The holders of the Common Stock will be entitled to receive any cash dividends as may be declared by the Company's Board of Directors. The declaration and payment of future dividends to holders of the Common Stock will be at the discretion of the Company's 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 ("Series C Preferred Stock"), the Company's earnings and financial condition, capital requirements of its subsidiaries, regulatory requirements and considerations and such other factors as the Company's Board of Directors may deem relevant. As a holding company, the Company is ultimately dependent upon its subsidiaries to provide funding for its operating expenses, debt service and dividends. Various banking laws applicable to the Company's subsidiaries limit the payment of dividends, management fees and other distributions by such subsidiaries to the Company and may therefore limit the ability of the Company to make dividend payments. 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 (i.e., an annual rate of 10%). The aggregate annual dividend payment on the 5,066 shares of the Series C Preferred Stock outstanding at December 31, 1998, was approximately $21,000. 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 -12- 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, on any anniversary of December 12, 1997, the mandatory conversion of the Series C Preferred Stock into cash and/or Common Stock. The Series C Preferred Stock is the Company's only outstanding preferred stock. 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 shareholders' 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 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 ($298,000 at December 31, 1998) 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 (none at December 31, 1998). Dividend payments on any other stock junior to the Series C Preferred Stock with respect to dividends or liquidation rights would be similarly limited. See "Item 1. Business-Regulation and Supervision." ITEM 6. SELECTED FINANCIAL DATA The information required by this item is incorporated herein by reference from page 28 of the Company's 1998 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 55, inclusive, of the Company's 1998 Annual Report to Shareholders under the caption "Management's Discussion and Analysis of Financial Condition and Results of Operations." ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISKS The information required by this item is incorporated herein by reference from page 37 through 39, inclusive, of the Company's 1998 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 All information required by this item is incorporated herein by reference from pages 7 through 27, inclusive, of the Company's 1998 Annual Report to Shareholders under the captions "Report of PricewaterhouseCoopers LLP, Independent Accountants," "Consolidated Balance Sheets," "Consolidated Statements of Income and Comprehensive Income," "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. -13- PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT The information required by this item is incorporated herein by reference from pages 4 through 6 and page 11, 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 27, 1999 (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 12 and 13 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 2 and 3, inclusive, of the Company's Definitive Proxy Statement under the caption "Voting Securities and Principal Shareholders." ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS The information required by this item is incorporated herein by reference from pages 12 and 13 of the Company's Definitive Proxy Statement under the caption "Executive Compensation - Transactions with Management." -14- 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, 1998, furnished to the Securities and Exchange Commission pursuant to Rule 14a-3(b): Page Reference to Item Annual Report ---------------------------------- ------------------ Report of PricewaterhouseCoopers LLP, Independent Accountants 7 Consolidated Balance Sheets as of December 31, 1998 and 1997 8 Consolidated Statements of Income and Comprehensive Income for the three years in the period ended December 31, 1998 9 Consolidated Statements of Changes in Stockholders' Equity for the three years in the period ended December 31, 1998 10 Consolidated Statements of Cash Flows for the three years in the period ended December 31, 1998 11 Notes to Consolidated Financial Statement 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 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). 3.3 Amendment to Restated Bylaws of Independent Bankshares, Inc. dated March 17, 1999 (filed herewith). 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). 4.2 1999 Stock Option Plan of Independent Bankshares, Inc. (filed herewith). 10.1 Form of Incentive Stock Option Agreement (filed herewith). -15- 10.2 Form of Nonqualified Stock Option Agreement (filed herewith). 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 Loan Agreement, dated September 21, 1998, by and between Bank One, Texas, National Association and the Company and Independent Financial Corp. and First State Bank, National Association and related Promissory Note of the Company, Pledge Agreement of the Company and Pledge Agreement of Independent Financial Corp. (Exhibit 10.1 to the Company's Current Report on Form 8-K dated September 22, 1998). 10.5 Agreement and Plan of Reorganization dated May 29, 1998, by and between the Company and Azle Bancorp (previously filed as Exhibit 1.1 to the Company's Current Report on Form 8-K dated June 19, 1998). 13.1 Annual Report to Shareholders for the year ended December 31, 1998 (filed herewith). 21.1 Subsidiaries of Independent Bankshares, Inc. (filed herewith). 23.1 Consent of PricewaterhouseCoopers LLP (filed herewith). 27.1 Financial Data Schedule (filed herewith). (b) Current Reports on Form 8-K. Current Report on Form 8-K dated September 22, 1998, reporting the consummation of the acquisition of Azle Bancorp and Azle State by the Company. -16- 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 31, 1999 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 31, 1999 - ---------------------------------- Officer and Director Bryan W. Stephenson /s/ Randal N. Crosswhite Senior Vice President, Chief March 31, 1999 - ---------------------------------- Financial Officer, Corporate Randal N. Crosswhite Secretary and Director /s/John L. Beckham Director March 31, 1999 - ---------------------------------- John L. Beckham /s/ Lee Caldwell Director March 31, 1999 - ---------------------------------- Lee Caldwell /s/ Mrs. Wm. R. (Amber) Cree Director March 31, 1999 - ----------------------------------- Mrs. Wm. R. (Amber) Cree - ----------------------------------- Director March __, 1999 Louis S. Gee - ---------------------------------- Director March __, 1999 Nancy E. Jones /s/Marshal M. Keller - ----------------------------------- Director March 3, 1999 Marshal M. Kellar -17- /s/ Tommy McAlister Director March 31, 1999 - ---------------------------------- Tommy McAlister /s/ Scott Taliaferro Director March 31, 1999 - ---------------------------------- Scott L. Taliaferro /s/ James D. Webster, M.D. Director March 31, 1999 - ----------------------------------- James D. Webster, M.D. /s/ C.G. Whitten Director March __, 1999 - ----------------------------------- C.G. Whitten
-18- 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). 3.3 Amendment to Restated Bylaws of Independent Bankshares, Inc. dated March 17, 1999 (filed herewith). 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). 4.2 1999 Stock Option Plan of Independent Bankshares, Inc. (filed herewith). 10.1 Form of Incentive Stock Option Agreement (filed herewith). 10.2 Form of Nonqualified Stock Option Agreement (filed herewith). 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 Loan Agreement, dated September 21, 1998, by and between Bank One, Texas, National Association and the Company and Independent Financial Corp. and First State Bank, National Association and related Promissory Note of the Company, Pledge Agreement of the Company and Pledge Agreement of Independent Financial Corp. (previously filed as Exhibit 10.1 to the Company's Current Report on Form 8-K dated September 22, 1998). Pledge Agreement of the Company and Pledge Agreement of Independent Financial Corp. (Exhibit 10.1 to the Company's Current Report on Form 8-K dated September 22, 1998). 10.5 Agreement and Plan of Reorganization dated May 29, 1998, by and between the Company and Azle Bancorp (previously filed as Exhibit 1.1 to the Company's Current Report on Form 8-K dated June 19, 1998). 13.1 Annual Report to Shareholders for the year ended December 31, 1998 (filed herewith). 21.1 Subsidiaries of Independent Bankshares, Inc. (filed herewith). 23.1 Consent of PricewaterhouseCoopers LLP (filed herewith). 27.1 Financial Data Schedule (filed herewith). -19- EX-3.3 2 EXHIBIT 3.3 AMENDMENT TO THE BYLAWS INDEPENDENT BANKSHARES, INC. MARCH 17, 1999 The Bylaws of the Corporation are amended by adding thereto new Sections 1(c) and 1(d) to Article III thereof, to read in their entirety, as follows: (c) No person shall be eligible to be newly elected or appointed, or to continue to serve, as a director of the corporation after reaching 75 years of age; provided, however, that any person who was a director on March 17, 1999, and was older than age 70 at such date shall be eligible to be elected and appointed, and to continue to serve, as a director of the corporation until such person reaches age 80. As soon as a person's eligibility to continue to serve as a director of the corporation terminates because of such person's age, such person shall immediately be deemed to have retired and resigned as a director without further action by such person or the corporation's board of directors or shareholders. (d) Any director, following mandatory retirement as a director because of the age limitations contained in Section 1(c) of this Article, may, at the discretion of the board of directors, be elected by the directors as an advisory director (including a director emeritus) of the corporation. An advisory director shall have the right to attend and participate in meetings of the board of directors, and to receive such compensation in connection therewith as the board may approve from time to time, but shall not have the right to vote and shall not be counted in determining a quorum. Advisory directors shall serve at the pleasure of the board of directors until their earlier death, resignation or removal (with or without cause) by the board of directors. EX-4.2 3 EXHIBIT 4.2 INDEPENDENT BANKSHARES, INC. 1999 STOCK OPTION PLAN Adopted Effective February 17, 1999 TABLE OF CONTENTS ------------------ ARTICLE I PURPOSE OF PLAN 1 ARTICLE II EFFECTIVE DATE AND TERM OF PLAN 1 2.1 Term of Plan 1 2.2 Effect on Stock Options 1 2.3 Shareholder Approval 1 ARTICLE III SHARES SUBJECT TO PLAN 1 3.1 Number of Shares 1 3.2 Source of Shares 1 3.3 Availability of Unused Shares 1 3.4 Adjustment Provisions 1 3.5 Reservation of Shares 2 ARTICLE IV ADMINISTRATION OF PLAN 2 4.1 Administering Body 2 4.2 Authority of Administering Body 3 4.3 No Liability 3 4.4 Amendments 4 4.5 Other Compensation Plans 4 4.6 Plan Binding on Successors 4 4.7 References to Successor Statutes, Regulations and Rules 4 4.8 Issuances for Compensation Purposes Only 4 4.9 Invalid Provisions 4 4.10 Governing Law 4 ARTICLE V GENERAL AWARD PROVISIONS 4 5.1 Participation in the Plan 4 5.2 Stock Option Documents 5 5.3 Exercise of Stock Options 5 5.4 Payment For Stock Options 5 5.5 No Employment Rights 5 5.6 Restrictions Under Applicable Laws and Regulations 6 5.7 Additional Conditions 6 5.8 No Privileges of Stock Ownership 7 5.9 Nonassignability 7 5.10 Information to Optionees 7 5.11 Withholding Taxes 8 5.12 Legends on Stock Options and Stock Certificates 8 5.13 Effect of Termination of Employment on Stock Options 8 5.14 Limits on Stock Options to Certain Eligible Persons 9 ARTICLE VI STOCK OPTIONS 9 6.1 Nature of Stock Options 9 6.2 Option Exercise Price 9 6.3 Option Period and Vesting 9 6.4 Special Provisions Regarding Incentive Stock Options 9 ARTICLE VII REORGANIZATIONS 9 7.1 Corporate Transactions Not Involving a Change in Control 9 7.2 Corporate Transactions Involving a Change in Control 10 ARTICLE VIII DEFINITIONS 10 i INDEPENDENT BANKSHARES, INC. 1999 STOCK OPTION PLAN _______________________________________________________ ARTICLE I ------------------ PURPOSE OF PLAN The Company has adopted this Plan to promote the interests of the Company and its shareholders by using investment interests in the Company to attract, retain and motivate its management and other persons, to encourage and reward their contributions to the performance of the Company and to align their interests with the interests of the Company's shareholders. Capitalized terms not otherwise defined herein shall have the meanings ascribed to them in Article VIII. ARTICLE II ------------ EFFECTIVE DATE AND TERM OF PLAN 2.1 TERM OF PLAN. This Plan became effective as of the Effective Date and shall continue in effect until the Expiration Date, at which time this Plan shall automatically terminate. 2.2 EFFECT ON STOCK OPTIONS. Stock Options may be granted during the Plan Term, but no Stock Options may be granted after the Plan Term. Notwithstanding the foregoing, each Stock Option properly granted under this Plan during the Plan Term shall remain in effect after termination of this Plan until such Stock Option has been exercised, terminated or expired in accordance with its terms and the terms of this Plan. 2.3 SHAREHOLDER APPROVAL. This Plan shall be approved by the Company's shareholders within 12 months after the Effective Date. The effectiveness of any Stock Options granted prior to such shareholder approval shall be subject to such shareholder approval. ARTICLE III ------------ SHARES SUBJECT TO PLAN 3.1 NUMBER OF SHARES. The maximum number of shares of Common Stock that may be issued pursuant to Stock Options granted under this Plan shall be 60,000, subject to adjustment as set forth in Section 3.4. 3.2 SOURCE OF SHARES. The Common Stock to be issued under this Plan will be made available, at the discretion of the Board, either from authorized but unissued shares of Common Stock or from previously issued shares of Common Stock reacquired by the Company, including without limitation shares purchased on the open market. 3.3 AVAILABILITY OF UNUSED SHARES. Shares of Common Stock subject to unexercised portions of any Stock Option granted under this Plan that expire, terminate or are canceled, and shares of Common Stock issued pursuant to Stock Options under this Plan that are reacquired by the Company pursuant to the terms of the Stock Options under which such shares were issued, will again become available for the grant of further Stock Options under this Plan. 3.4 ADJUSTMENT PROVISIONS. (a) If (i) the outstanding shares of Common Stock of the Company are increased, decreased or exchanged for a different number or kind of shares or other securities, or if additional shares or new or different shares or other securities are distributed in respect of such shares of Common Stock (or any stock or securities received with respect to such Common Stock), through merger, consolidation, sale or exchange of all or substantially all of the assets of the Company, reorganization, recapitalization, reclassification, stock dividend, stock split, reverse stock split, spin-off or other distribution with respect to such shares of Common Stock (or any stock or securities received with respect to such Common Stock), or (ii) the value of the outstanding shares of Common Stock of the Company is reduced by reason of an extraordinary cash dividend, an appropriate and proportionate adjustment may be made in (1) the maximum number and kind of shares subject to this Plan as provided in Section 3.1, (2) the number and kind of shares or other securities subject to then outstanding Stock Options and/or (3) the price for each share or other unit of any other securities subject to then outstanding Stock Options. (b) No fractional interests will be issued under this Plan resulting from any adjustments. (c) To the extent any adjustments relate to stock or securities of the Company, such adjustments shall be made by the Administering Body, whose determination in that respect shall be final, binding and conclusive. (d) The grant of Stock Options pursuant to this Plan shall not affect in any way the right or power of the Company to make adjustments, reclassifications, reorganizations or changes of its capital or business structure or to merge or to consolidate or to dissolve, liquidate or sell, or transfer all or any part of its business or assets. (e) No adjustment to the terms of an Incentive Stock Option shall be made unless such adjustment either (i) would not cause such Option to lose its status as an Incentive Stock Option or (ii) is agreed to in writing by the Administering Body and the Recipient. 3.5 RESERVATION OF SHARES. The Company will at all times reserve and keep available such number of shares of Common Stock as shall equal at least the number of shares of Common Stock subject to then outstanding Stock Options issuable in shares of Common Stock under this Plan. ARTICLE IV ADMINISTRATION OF PLAN 4.1 ADMINISTERING BODY. (a) Subject to the provisions of Section 4.1(b)(ii), this Plan shall be administered by the Board or by the Stock Option Plan Committee of the Board appointed pursuant to Section 4.1(b). (b) (i) The Board in its sole discretion may from time to time appoint a Stock Option Plan Committee of not less than two Board members to administer this Plan and, subject to applicable law, to exercise all of the powers, authority and discretion of the Board under this Plan. The Board may from time to time increase or decrease (but not below two) the number of members of the Stock Option Plan Committee, remove from membership on the Stock Option Plan Committee all or any portion of its members, and/or appoint such person or persons as it desires to fill any vacancy existing on the Stock Option Plan Committee, whether caused by removal, resignation or otherwise. The Board may disband the Stock Option Plan Committee at any time and revest in the Board the administration of this Plan. (ii) Notwithstanding the foregoing provisions of this Section 4.1(b) to the contrary, so long as the Company remains an Exchange Act Registered Company, (1) the Board shall appoint the Stock Option Plan Committee, (2) this Plan shall be administered by the Stock Option Plan Committee and (3) each member of the Stock Option Plan Committee shall be a Non-employee Director, and, in addition, if Stock Options are to be made to persons subject to Section 162(m) of the IRC and such Stock Options are intended to constitute Performance-Based Compensation, then each member of the Stock Option Plan Committee shall, in addition to being a Non-employee Director, be an Outside Director. (iii) The Stock Option Plan Committee shall report to the Board the names of Eligible Persons granted Stock Options, the number of shares of Common Stock covered by each Stock Option and the terms and conditions of each such Stock Option. A-2 4.2 AUTHORITY OF ADMINISTERING BODY. (a) Subject to the express provisions of this Plan, the Administering Body shall have the power to interpret and construe this Plan and any Stock Option Documents or other documents defining the rights and obligations of the Company and Optionees hereunder and thereunder, to determine all questions arising hereunder and thereunder, to adopt and amend such rules and regulations for the administration hereof and thereof as it may deem desirable, and otherwise to carry out the terms of this Plan and such Stock Option Documents and other documents. The interpretation and construction by the Administering Body of any provisions of this Plan or of any Stock Option shall be conclusive and binding. Any action taken by, or inaction of, the Administering Body relating to this Plan or any Stock Options shall be within the absolute discretion of the Administering Body and shall be conclusive and binding upon all persons. Subject only to compliance with the express provisions hereof, the Administering Body may act in its absolute discretion in matters related to this Plan and any and all Stock Options. (b) Subject to the express provisions of this Plan, the Administering Body may from time to time in its discretion select the Eligible Persons to whom, and the time or times at which, Stock Options shall be granted, the nature of each Stock Option, the number of shares of Common Stock that make up or underlie each Stock Option, the period for the exercise of each Stock Option, and such other terms and conditions applicable to each individual Stock Option as the Administering Body shall determine. The Administering Body may grant at any time new Stock Options to an Eligible Person who has previously received Stock Options whether such prior Stock Options are still outstanding, have previously been exercised as a whole or in part, or are canceled in connection with the issuance of new Stock Options. The Administering Body may grant Stock Options singly, in combination or in tandem with other Stock Options, as it determines in its discretion. Any and all terms and conditions of the Stock Options, including exercise price, may be established by the Administering Body without regard to existing Stock Options. (c) Any action of the Administering Body with respect to the administration of this Plan shall be taken pursuant to a majority vote of the authorized number of members of the Administering Body or by the unanimous written consent of its members; provided, however, that (i) if the Administering Body is the Stock Option Plan Committee and consists of two members, then actions of the Administering Body must be unanimous and (ii) if the Administering Body is the Board, actions taken at a meeting of the Board shall be valid if approved by directors constituting a majority of the required quorum for such meeting. 4.3 NO LIABILITY. No member of the Board or the Stock Option Plan Committee or any designee thereof will be liable for any action or inaction with respect to this Plan or any Stock Option or any transaction arising under this Plan or any Stock Option, except in circumstances constituting bad faith of such member. 4.4 AMENDMENTS. (a) The Administering Body may, insofar as permitted by applicable law, rule or regulation, from time to time suspend or discontinue this Plan or revise or amend it in any respect whatsoever, and this Plan as so revised or amended will govern all Stock Options hereunder, including those granted before such revision or amendment; provided, however, that no such revision or amendment shall alter, impair or diminish any rights or obligations under any Stock Option previously granted under this Plan, without the written consent of the Optionee. Without limiting the generality of the foregoing, the Administering Body is authorized to amend this Plan to comply with or take advantage of amendments to applicable laws, rules or regulations, including amendments to the Securities Act, Exchange Act or the IRC or any rules or regulations promulgated thereunder. No shareholder approval of any amendment or revision shall be required unless (i) such approval is required by applicable law, rule or regulation or (ii) an amendment or revision to this Plan would materially increase the number of shares subject to this Plan (as adjusted under Section 3.4), materially modify the requirements as to eligibility for participation in this Plan, extend the final date upon which Stock Options may be granted under this Plan, or otherwise materially increase the benefits accruing to Recipients in a manner not specifically contemplated herein, or affect this Plan's compliance with Rule 16b-3 or applicable provisions of or regulations under the IRC, and shareholder approval of the amendment or revision is required to comply with Rule 16b-3 or applicable provisions of or rules under the IRC. (b) The Administering Body may, with the written consent of an Optionee, make such modifications in the terms and conditions of a Stock Option as it deems advisable. Without limiting the generality of the A-3 foregoing, the Administering Body may, in its discretion with the written consent of Optionee, at any time and from time to time after the grant of any Stock Option accelerate or extend the vesting or exercise period of any Stock Option as a whole or in part, and adjust or reduce the exercise price of Stock Options held by such Optionee by cancellation of such Stock Options and granting of Stock Options at lower or exercise prices or by modification, extension or renewal of such Stock Options. In the case of Incentive Stock Options, Recipients acknowledge that extensions of the exercise period may result in the loss of the favorable tax treatment afforded incentive stock options under Section 422 of the IRC. (c) Except as otherwise provided in this Plan or in the applicable Stock Option Document, no amendment, revision, suspension or termination of this Plan will, without the written consent of the Optionee, alter, terminate, impair or adversely affect any right or obligation under any Stock Option previously granted under this Plan. 4.5 OTHER COMPENSATION PLANS. The adoption of this Plan shall not affect any other stock option, incentive or other compensation plans in effect for the Company, and this Plan shall not preclude the Company from establishing any other forms of incentive or other compensation for employees, directors, advisors or consultants of the Company, whether or not approved by shareholders. 4.6 PLAN BINDING ON SUCCESSORS. This Plan shall be binding upon the successors and assigns of the Company. 4.7 REFERENCES TO SUCCESSOR STATUTES, REGULATIONS AND RULES. Any reference in this Plan to a particular statute, regulation or rule shall also refer to any successor provision of such statute, regulation or rule. 4.8 ISSUANCES FOR COMPENSATION PURPOSES ONLY. This Plan constitutes an "employee benefit plan" as defined in Rule 405 promulgated under the Securities Act. Stock Options to eligible employees or directors shall be granted for any lawful consideration, including compensation for services rendered, promissory notes or otherwise. Stock Options to consultants and advisors shall be granted only in exchange for bona fide services rendered by such consultants or advisors and such services must not be in connection with the offer and sale of securities in a capital-raising transaction. 4.9 INVALID PROVISIONS. In the event that any provision of this Plan is found to be invalid or otherwise unenforceable under any applicable law, such invalidity or unenforceability shall not be construed as rendering any other provisions contained herein invalid or unenforceable, and all such other provisions shall be given full force and effect to the same extent as though the invalid and unenforceable provision were not contained herein. 4.10 GOVERNING LAW. This Agreement shall be governed by and interpreted in accordance with the internal laws of the State of Texas, without giving effect to the principles of the conflicts of laws thereof. ARTICLE V ---------- GENERAL AWARD PROVISIONS 5.1 PARTICIPATION IN THE PLAN. (a) A person shall be eligible to receive grants of Stock Options under this Plan if, at the time of the grant of the Stock Option, such person is an Eligible Person. (b) Incentive Stock Options may be granted only to Eligible Persons meeting the employment requirements of Section 422 of the IRC. (c) Notwithstanding anything to the contrary herein, the Administering Body may, in order to fulfill the purposes of this Plan, modify grants of Stock Options to Recipients who are foreign nationals or employed outside of the United States to recognize differences in applicable law, tax policy or local custom. A-4 5.2 STOCK OPTION DOCUMENTS. (a) Each Stock Option granted under this Plan shall be evidenced by an agreement duly executed on behalf of the Company and by the Recipient or, in the Stock Option Plan Committee's discretion, a confirming memorandum issued by the Company to the Recipient, setting forth such terms and conditions applicable to the Stock Option as the Stock Option Plan Committee may in its discretion determine. Stock Option Documents may but need not be identical and shall comply with and be subject to the terms and conditions of this Plan, a copy of which shall be provided to each Recipient and incorporated by reference into each Stock Option Document. Any Stock Option Document may contain such other terms, provisions and conditions not inconsistent with this Plan as may be determined by the Stock Option Plan Committee. (b) In case of any conflict between this Plan and any Stock Option Document, this Plan shall control. 5.3 EXERCISE OF STOCK OPTIONS. No Stock Option shall be exercisable except in respect of whole shares, and fractional share interests shall be disregarded. Not less than 100 shares of Common Stock (or such other amount as is set forth in the applicable Stock Option Documents) may be purchased at one time and Stock Options must be exercised in multiples of 100 unless the number purchased is the total number at the time available for purchase under the terms of the Stock Option. A Stock Option shall be deemed to be exercised when the Secretary or other designated official of the Company receives written notice of such exercise from the Optionee, together with payment of the exercise price made in accordance with Section 5.4 and any amounts required under Section 5.11. Notwithstanding any other provision of this Plan, the Administering Body may impose, by rule and/or in Stock Option Documents, such conditions upon the exercise of Stock Options (including without limitation conditions limiting the time of exercise to specified periods) as may be required to satisfy applicable regulatory requirements, including without limitation Rule 16b-3 and Rule 10b-5 under the Exchange Act, and any amounts required under Section 5.12 or other applicable section of or regulation under the IRC. 5.4 PAYMENT FOR STOCK OPTIONS. (a) The exercise price or other payment for a Stock Option shall be payable upon the exercise of a Stock Option pursuant to a Stock Option granted hereunder by delivery of legal tender of the United States or payment of such other consideration as the Administering Body may from time to time deem acceptable in any particular instance. (b) The Company may assist any person to whom Stock Options are granted hereunder (including without limitation any officer or director of the Company) in the payment of the exercise price or other amounts payable in connection with the receipt or exercise of that Stock Option, by lending such amounts to such person on such terms and at such rates of interest and upon such security (if any) as shall be approved by the Administering Body. (c) In the discretion of the Administering Body, Stock Options may be exercised by matured capital stock of the Company (i.e., owned longer than six months) delivered in transfer to the Company by or on behalf of the person exercising the Stock Option and duly endorsed in blank or accompanied by stock powers duly endorsed in blank, with signatures guaranteed in accordance with the Exchange Act if required by the Administering Body (valued at Fair Market Value as of the exercise date); or such other consideration as the Administering Body may from time to time in the exercise of its discretion deem acceptable in any particular instance; provided, however, that the Administering Body may, in the exercise of its discretion, (i) allow exercise of Stock Options in a broker-assisted or similar transaction in which the exercise price is not received by the Company until promptly after exercise, and/or (ii) allow the Company to loan the exercise price to the Optionee, if the exercise will be followed by a prompt sale of some or all of the underlying shares and a portion of the sale proceeds is dedicated to full payment of the exercise price and amounts required pursuant to Section 5.11. 5.5 NO EMPLOYMENT RIGHTS. Nothing contained in this Plan (or in Stock Option Documents or in any other documents related to this Plan or to Stock Options granted hereunder) shall confer upon any Eligible Person or Recipient any right to continue in the employ of the Company or any Affiliated Entity or constitute any contract or agreement of employment or engagement, or interfere in any way with the right of the Company or any Affiliated Entity to reduce such person's compensation or other benefits or to terminate the employment or engagement of A-5 such Eligible Person or Recipient, with or without cause. Except as expressly provided in this Plan or in any statement evidencing the grant of Stock Options pursuant to this Plan, the Company shall have the right to deal with each Recipient in the same manner as if this Plan and any such statement evidencing the grant of Stock Options pursuant to this Plan did not exist, including without limitation with respect to all matters related to the hiring, discharge, compensation and conditions of the employment or engagement of the Recipient. Any questions as to whether and when there has been a termination of a Recipient's employment or engagement, the reason (if any) for such termination, and/or the consequences thereof under the terms of this Plan or any statement evidencing the grant of Stock Options pursuant to this Plan shall be determined by the Administering Body and the Administering Body's determination thereof shall be final and binding. . 5.6 RESTRICTIONS UNDER APPLICABLE LAWS AND REGULATIONS. (a) All Stock Options granted under this Plan shall be subject to the requirement that, if at any time the Company shall determine, in its discretion, that the listing, registration or qualification of the shares subject to Stock Options granted under this Plan upon any securities exchange or under any federal, state or foreign law, or the consent or approval of any government regulatory body, is necessary or desirable as a condition of, or in connection with, the granting of such Stock Options or the issuance, if any, or purchase of shares in connection therewith, such Stock Options may not be exercised as a whole or in part unless and until such listing, registration, qualification, consent or approval shall have been effected or obtained free of any conditions not acceptable to the Company. During the term of this Plan, the Company will use its reasonable efforts to seek to obtain from the appropriate regulatory agencies any requisite qualifications, consents, approvals or authorizations in order to issue and sell such number of shares of its Common Stock as shall be sufficient to satisfy the requirements of this Plan. The inability of the Company to obtain from any such regulatory agency having jurisdiction thereof the qualifications, consents, approvals or authorizations deemed by the Company to be necessary for the lawful issuance and sale of any shares of its Common Stock hereunder shall relieve the Company of any liability in respect of the nonissuance or sale of such stock as to which such requisite authorization shall not have been obtained. (b) The Company shall be under no obligation to register or qualify the issuance of Stock Options or underlying shares under the Securities Act or applicable state securities laws. Unless the issuance of Stock Options and underlying shares have been registered under the Securities Act and qualified or registered under applicable state securities laws, the Company shall be under no obligation to issue any Stock Options or underlying shares of Common Stock covered by any Stock Options unless the Stock Options and underlying shares may be issued pursuant to applicable exemptions from such registration or qualification requirements. In connection with any such exempt issuance, the Administering Body may require the Optionee to provide a written representation and undertaking to the Company, satisfactory in form and scope to the Company and upon which the Company may reasonably rely, that such Optionee is acquiring such Stock Options and underlying shares for such Optionee's own account as an investment and not with a view to, or for sale in connection with, the distribution of any such shares of stock, and that such person will make no transfer of the same except in compliance with any rules and regulations in force at the time of such transfer under the Securities Act and other applicable law, and that if shares of stock are issued without such registration, a legend to this effect (together with any other legends deemed appropriate by the Administering Body) may be endorsed upon the securities so issued. The Company may also order its transfer agent to stop transfers of such shares. The Administering Body may also require the Optionee to provide the Company such information and other documents as the Administering Body may request in order to satisfy the Administering Body as to the investment sophistication and experience of the Optionee and as to any other conditions for compliance with any such exemptions from registration or qualification. 5.7 ADDITIONAL CONDITIONS. Any Stock Option may also be subject to such other provisions (whether or not applicable to any other Stock Option or Optionee) as the Administering Body determines appropriate including without limitation provisions to assist the Optionee in financing the purchase of Common Stock through the exercise of Stock Options, provisions for the forfeiture of or restrictions on resale or other disposition of shares of Common Stock acquired under any form of benefit, provisions giving the Company the right to repurchase shares of Common Stock acquired under any form of benefit in the event the Optionee elects to dispose of such shares, and provisions to comply with federal and state securities laws and federal and state income tax withholding requirements. A-6 5.8 NO PRIVILEGES OF STOCK OWNERSHIP. Except as otherwise set forth herein, an Optionee shall have no rights as a shareholder with respect to any shares issuable or issued in connection with the Stock Option until the date of the receipt by the Company of all amounts payable in connection with exercise of the Stock Option and performance by the Optionee of all obligations thereunder. Status as an Eligible Person shall not be construed as a commitment that any Stock Option will be granted under this Plan to an Eligible Person or to Eligible Persons generally. No person shall have any right, title or interest in any fund or in any specific asset (including shares of capital stock) of the Company by reason of any Stock Option granted hereunder. Neither this Plan (or any documents related hereto) nor any action taken pursuant hereto (or thereto) shall be construed to create a trust of any kind or a fiduciary relationship between the Company and any Person. To the extent that any Person acquires a right to receive Stock Options hereunder, such right shall be no greater than the right of any unsecured general creditor of the Company. 5.9 NONASSIGNABILITY. No Stock Option granted under this Plan shall be assignable or transferable except (a) by will or by the laws of descent and distribution, or (b) subject to the final sentence of this Section 5.9, upon dissolution of marriage pursuant to a qualified domestic relations order or, in the discretion of the Administering Body and under circumstances that would not adversely affect the interests of the Company, pursuant to a nominal transfer that does not result in a change in beneficial ownership; provided, however, that the Administering Body may in the applicable Stock Option Document evidencing Stock Options granted hereunder or at any time thereafter provide that Stock Options granted hereunder may be transferred without consideration by the Recipient, subject to such rules as the Administering Body may adopt to preserve the purposes of the Plan, to one or more Permitted Transferees; provided further, that the Recipient gives the Administering Body advance written notice describing the terms and conditions of the proposed transfer and the Administering Body notifies the Recipient in writing that such transfer would comply with the requirements of the Plan and any applicable Stock Option Document. The terms of any Stock Option transferred to Permitted Transferees in accordance with the immediately preceding sentence shall apply to the Permitted Transferee, except that (a) Permitted Transferees shall not be entitled to transfer any Stock Options, other than by will or the laws of descent and distribution; and (b) Permitted Transferees shall not be entitled to exercise any transferred Stock Options unless there shall be in effect a registration statement on an appropriate form covering the shares of Common Stock to be acquired pursuant to the exercise of such Stock Option if the Administering Body determines that such a registration statement is necessary or appropriate. During the lifetime of an Optionee, Stock Options shall be exercisable only by the Optionee or such person's guardian or legal representative. Notwithstanding the foregoing, (a) no Stock Option owned by an Optionee subject to Section 16 of the Exchange Act may be assigned or transferred in any manner inconsistent with Rule 16b- 3, and (b) Incentive Stock Options (or other Stock Options subject to transfer restrictions under the IRC) may not be assigned or transferred in violation of Section 422(b)(5) of the IRC (or any comparable or successor provision) or the regulations thereunder, and nothing herein is intended to allow such assignment or transfer. 5.10 INFORMATION TO OPTIONEES. (a) The Administering Body in its sole discretion shall determine what, if any, financial and other information shall be provided to Optionees and when such financial and other information shall be provided after giving consideration to applicable federal and state laws, rules and regulations, including without limitation applicable federal and state securities laws, rules and regulations. (b) The furnishing of financial and other information that is confidential to the Company shall be subject to the Optionee's agreement that the Optionee shall maintain the confidentiality of such financial and other information, shall not disclose such information to third parties, and shall not use the information for any purpose other than evaluating an investment in the Company's securities under this Plan. The Administering Body may impose other restrictions on the access to and use of such confidential information and may require an Optionee to acknowledge the Optionee's obligations under this Section 5.10(b) (which acknowledgment shall not be a condition to the Optionee's obligations under this Section 5.10(b)). 5.11 WITHHOLDING TAXES. Whenever the granting, vesting or exercise of any Stock Option granted under this Plan, or the transfer of any shares issued upon exercise of any Stock Option, gives rise to tax or tax withholding liabilities or obligations, the Administering Body shall have the right to require the Optionee to remit to A-7 the Company an amount sufficient to satisfy any federal, state and local withholding tax requirements prior to issuance of such shares. The Administering Body may, in the exercise of its discretion, allow satisfaction of tax withholding requirements by accepting delivery of stock of the Company or by withholding a portion of the stock otherwise issuable in connection with Stock Options. 5.12 LEGENDS ON STOCK OPTIONS AND STOCK CERTIFICATES. Each Stock Option Document and each certificate representing shares acquired upon exercise of Stock Options shall be endorsed with all legends, if any, required by applicable federal and state securities and other laws to be placed on the Stock Option Document and/or the certificate. The determination of which legends, if any, shall be placed upon Stock Option Documents or the certificates shall be made by the Administering Body in its sole discretion and such decision shall be final and binding. 5.13 EFFECT OF TERMINATION OF EMPLOYMENT ON STOCK OPTIONS. (a) Termination for Just Cause. Subject to Section 5.13(c), and except as otherwise provided in a written agreement between the Company and the Optionee which may be entered into at any time before or after termination of employment of the Recipient, in the event of a Just Cause Dismissal of a Recipient, all of the Optionee's unexercised Stock Options, whether or not vested, shall expire and become unexercisable as of the date of such Just Cause Dismissal. (b) Termination Other than for Just Cause Dismissal. Subject to Section 5.13(c) and except as otherwise provided in a written agreement between the Company and the Optionee, which may be entered into at any time before or after termination of employment, in the event of a Recipient's termination of employment for: (i) any reason other than for Just Cause Dismissal, death, Permanent Disability or normal retirement, the Optionee's Stock Options, whether or not vested, shall expire and become unexercisable as of the earlier of (A) the date such Stock Options would expire in accordance with their terms had the Recipient remained employed and (B) 30 days after the date of employment termination. (ii) death, Permanent Disability or normal retirement, the Optionee's unexercised Stock Options shall, whether or not vested, expire and become unexercisable as of the earlier of (A) the date such Stock Options would expire in accordance with their terms had the Recipient remained employed and (B) six months after the date of employment termination. (c) Alteration of Vesting and Exercise Periods. Notwithstanding anything to the contrary in Section 5.13(a) or Section 5.13(b), the Administering Body may in its discretion designate shorter or longer periods to exercise Stock Options following a Recipient's termination of employment; provided, however, that any shorter periods determined by the Administering Body shall be effective only if provided for in the instrument that evidences the grant to the Optionee of such Stock Options or if such shorter period is agreed to in writing by the Optionee. Notwithstanding anything to the contrary herein, Stock Options shall be exercisable by an Optionee following such Optionee's termination of employment only to the extent that installments thereof had become exercisable on or prior to the date of such termination; and provided, further, that the Administering Body may, in its discretion, elect to accelerate the vesting of all or any portion of any Stock Options that had not become exercisable on or prior to the date of such termination. (d) Leave of Absence. In the case of any employee on an approved leave of absence, the Administering Body may make such provision respecting continuance of Stock Options as the Administering Body in its discretion deems appropriate, except that in no event shall a Stock Option be exercisable after the date such Stock Option would expire in accordance with its terms had the Recipient remained continuously employed. 5.14 LIMITS ON STOCK OPTIONS TO CERTAIN ELIGIBLE PERSONS. Notwithstanding any other provision of this Plan, in order for the compensation attributable to Stock Options hereunder to qualify as Performance-Based Compensation, no one Eligible Person shall be granted any Stock Options with respect to more than 20,000 shares of Common Stock in any one calendar year. The limitation set forth in this Section 5.14 shall be subject to adjustment as provided in Section 3.4 or under Article VII, but only to the extent such adjustment would not affect the status of compensation attributable to Stock Options granted hereunder as Performance-Based Compensation. A-8 ARTICLE VI ---------- STOCK OPTIONS 6.1 NATURE OF STOCK OPTIONS. Stock Options may be Incentive Stock Options or Non-qualified Stock Options. 6.2 OPTION EXERCISE PRICE. The exercise price for each Stock Option shall be determined by the Administering Body as of the date such Stock Option is granted. The exercise price shall be no less than the Fair Market Value of the Common Stock subject to the Option. The Administering Body may, with the consent of the Optionee and subject to compliance with statutory or administrative requirements applicable to Incentive Stock Options, amend the terms of any Stock Option to provide that the exercise price of the shares remaining subject to the Stock Option shall be reestablished at a price not less than 100% of the Fair Market Value of the Common Stock on the effective date of the amendment. No modification of any other term or provision of any Stock Option that is amended in accordance with the foregoing shall be required, although the Administering Body may, in its discretion, make such further modifications of any such Stock Option as are not inconsistent with this Plan. 6.3 OPTION PERIOD AND VESTING. Stock Options granted hereunder shall vest and may be exercised as determined by the Administering Body, except that exercise of such Stock Options after termination of the Recipient's employment shall be subject to Section 5.13. Each Stock Option granted hereunder and all rights or obligations thereunder shall expire on such date as shall be determined by the Administering Body, but not later than 10 years after the date the Stock Option is granted and shall be subject to earlier termination as provided herein or in the Stock Option Document. The Administering Body may, in its discretion at any time and from time to time after the grant of a Stock Option, accelerate vesting of such Option as a whole or in part by increasing the number of shares then purchasable, provided that the total number of shares subject to such Stock Option may not be increased. Except as otherwise provided herein, a Stock Option shall become exercisable, as a whole or in part, on the date or dates specified by the Administering Body and thereafter shall remain exercisable until the expiration or earlier termination of the Stock Option. 6.4 SPECIAL PROVISIONS REGARDING INCENTIVE STOCK OPTIONS. (a) Notwithstanding anything in this Article VI to the contrary, the exercise price and vesting period of any Stock Option intended to qualify as an Incentive Stock Option shall comply with the provisions of Section 422 of the IRC and the regulations thereunder. As of the Effective Date, such provisions require, among other matters, that (i) the exercise price must not be less than the Fair Market Value of the underlying stock as of the date the Incentive Stock Option is granted, and not less than 110% of the Fair Market Value as of such date in the case of a grant to a Significant Shareholder; and (ii) that the Incentive Stock Option not be exercisable after the expiration of five years from the date of grant in the case of an Incentive Stock Option granted to a Significant Shareholder. (b) The aggregate Fair Market Value (determined as of the respective date or dates of grant) of the Common Stock for which one or more Options granted to any Recipient under this Plan (or any other option plan of the Company or any of its subsidiaries or affiliates) may for the first time become exercisable as Incentive Stock Options under the federal tax laws during any one calendar year shall not exceed $100,000. (c) Any Options granted as Incentive Stock Options pursuant to this Plan that for any reason fail or cease to qualify as such shall be treated as Non-qualified Stock Options. ARTICLE VII ----------- REORGANIZATIONS 7.1 CORPORATE TRANSACTIONS NOT INVOLVING A CHANGE IN CONTROL. If the Company shall consummate any Reorganization not involving a Change in Control in which holders of shares of Common Stock are entitled to receive in respect of such shares any securities, cash or other consideration (including without limitation a different number of shares of Common Stock), each Stock Option outstanding under this Plan shall thereafter be exercisable, in accordance with this Plan, only for the kind and amount of securities, cash and/or other consideration receivable upon such Reorganization by a holder of the same number of shares of Common Stock as A-9 are subject to that Stock Option immediately prior to such Reorganization, and any adjustments will be made to the terms of the Stock Option in the sole discretion of the Administering Body as it may deem appropriate to give effect to the Reorganization. 7.2 CORPORATE TRANSACTIONS INVOLVING A CHANGE IN CONTROL. As of the effective time and date of any Change in Control, this Plan and any then outstanding Stock Options (whether or not vested) shall automatically terminate unless (a) provision is made in writing in connection with such transaction for the continuance of this Plan and for the assumption of such Stock Options, or for the substitution for such Stock Options of new awards covering the securities of a successor entity or an affiliate thereof, with appropriate adjustments as to the number and kind of securities and exercise prices, in which event this Plan and such outstanding Stock Options shall continue or be replaced, as the case may be, in the manner and under the terms so provided; or (b) the Board otherwise has provided or shall provide in writing for such adjustments as it deems appropriate in the terms and conditions of the then-outstanding Stock Options (whether or not vested), including without limitation (i) accelerating the vesting of outstanding Stock Options and/or (ii) providing for the cancellation of Stock Options and their automatic conversion into the right to receive the securities, cash and/or other consideration that a holder of the shares underlying such Stock Options would have been entitled to receive upon consummation of such Change in Control had such shares been issued and outstanding immediately prior to the effective date and time of the Change in Control (net of the appropriate option exercise prices). If, pursuant to the foregoing provisions of this Section 7.2, this Plan and the Stock Options shall terminate by reason of the occurrence of a Change in Control without provision for any of the actions described in clause (a) or (b) hereof, then any Optionee holding outstanding Stock Options shall have the right, at such time immediately prior to the consummation of the Change in Control as the Board shall designate, to exercise the Optionee's Stock Options to the full extent not theretofore exercised, including any installments which have not yet become vested. ARTICLE VIII ------------ DEFINITIONS Capitalized terms used in this Plan and not otherwise defined shall have the meanings set forth below: "ADMINISTERING BODY" shall mean the Board as long as no Stock Option Plan Committee has been appointed and is in effect and shall mean the Stock Option Plan Committee as long as the Stock Option Plan Committee is appointed and in effect. "AFFILIATED ENTITY" means any Parent Corporation or Subsidiary Corporation. "BOARD" means the Board of Directors of the Company. "CHANGE IN CONTROL" means the following and shall be deemed to occur if any of the following events occur: (a) Any Person becomes after the Effective Date the beneficial owner (within the meaning of Rule 13d-3 promulgated under the Exchange Act) of 30% or more of either the then outstanding shares of Common Stock or the combined voting power of the Company's then outstanding securities entitled to vote generally in the election of directors; or (b) Individuals who, as of the effective date hereof, constitute the Board of Directors of the Company (the "Incumbent Board") cease for any reason to constitute at least a majority of the Board of Directors of the Company, provided that any individual who becomes a director after the effective date hereof whose election, or nomination for election by the Company's shareholders, is approved by a vote of at least a majority of the directors then comprising the Incumbent Board shall be considered to be a member of the Incumbent Board unless that individual was nominated or elected by any Person having the power to exercise, through beneficial ownership, voting agreement and/or proxy, 20% or more of either the outstanding shares of Common Stock or the combined voting power of the Company's then outstanding voting securities entitled to vote generally in the election of directors, in which case that individual shall not be considered to be a member of the Incumbent Board unless such individual's election or nomination for election by the Company's shareholders is approved by a vote of at least two-thirds of the directors then comprising the Incumbent Board; or A-10 (c) Consummation by the Company of the sale or other disposition by the Company of all or substantially all of the Company's assets or a reorganization or merger or consolidation of the Company with any other person, entity or corporation, other than (i) a reorganization or merger or consolidation that would result in the voting securities of the Company outstanding immediately prior thereto (or, in the case of a reorganization or merger or consolidation that is preceded or accomplished by an acquisition or series of related acquisitions by any Person, by tender or exchange offer or otherwise, of voting securities representing 5% or more of the combined voting power of all securities of the Company, immediately prior to such acquisition or the first acquisition in such series of acquisitions) continuing to represent, either by remaining outstanding or by being converted into voting securities of another entity, more than fifty percent (50%) of the combined voting power of the voting securities of the Company or such other entity outstanding immediately after such reorganization or merger or consolidation (or series of related transactions involving such a reorganization or merger or consolidation), or (ii) a reorganization or merger or consolidation effected to implement a recapitalization or reincorporation of the Company (or similar transaction) that does not result in a material change in beneficial ownership of the voting securities of the Company or its successor; or (d) Approval by the shareholders of the Company or any order by a court of competent jurisdiction of a plan of liquidation of the Company. Notwithstanding the foregoing, a Change in Control of the type described in paragraph (b), (c) or (d) shall be deemed to be completed on the date it occurs, and a Change in Control of the type described in paragraph (a) shall be deemed to be completed as of the date the entity or group attaining 30% or greater ownership has elected its representatives to the Company's Board of Directors and/or caused its nominees to become officers of the Company with the authority to terminate or alter the terms of employee's employment. "COMMISSION" means the Securities and Exchange Commission. "COMMON STOCK" means the common stock of the Company, par value $0.25 per share, as constituted on the Effective Date of this Plan, and as thereafter adjusted as a result of any one or more events requiring adjustment of outstanding Stock Options under Section 3.4 above. "COMPANY" means Independent Bankshares, Inc., a Texas corporation. "EFFECTIVE DATE" means February 17, 1999, which is the date this Plan was adopted by the Board. "ELIGIBLE PERSON" shall include directors (other than non- employee directors of the Company), officers, employees, consultants and advisors of the Company or of any Affiliated Entity. "ERISA" means the Employee Retirement Income Security Act of 1974, as amended. "EXCHANGE ACT" means the Securities Exchange Act of 1934, as amended. "EXCHANGE ACT REGISTERED COMPANY" means that the Company has any class of any equity security registered pursuant to Section 12 of the Exchange Act. "EXPIRATION DATE" means the tenth anniversary of the Effective Date. "FAIR MARKET VALUE" of a share of the Company's capital stock as of a particular date shall be: (a) if the stock is listed on an established stock exchange or exchanges (including for this purpose, the Nasdaq National Market), the average of the highest and lowest sale prices of the stock quoted for such date as reported in the Transactions Index of each such exchange, as published in The Wall Street Journal and determined by the Administering Body, or, if no sale price was quoted in any such Index for such date, then as of the next preceding date on which such a sale price was quoted; or (b) if the stock is not then listed on an exchange or the Nasdaq A-11 National Market, the average of the closing bid and asked prices per share for the stock in the over-the-counter market as quoted on The Nasdaq Small Cap Market on such date (in the case of (a) or (b), subject to adjustment as and if necessary and appropriate to set an exercise price not less than 100% of the Fair Market Value of the stock on the date an option is granted); or (c) if the stock is not then listed on an exchange or quoted in the over- the-counter market, an amount determined in good faith by the Administering Body; provided, however, that (i) when appropriate, the Administering Body, in determining Fair Market Value of capital stock of the Company, may take into account such other factors as it may deem appropriate under the circumstances and (ii) if the stock is traded on the Nasdaq Small Cap Market and both sales prices and bid and asked prices are quoted or available, the Administering Body may elect to determine Fair Market Value under either clause (i) or (ii) above. Notwithstanding the foregoing, the Fair Market Value of capital stock for purposes of grants of Incentive Stock Options shall be determined in compliance with applicable provisions of the IRC. "IMMEDIATE FAMILY" means the Recipient's spouse, children or grandchildren (including adopted and stepchildren and grandchildren). "INCENTIVE STOCK OPTION" means a Stock Option that qualifies as an incentive stock option under Section 422 of the IRC, or any successor statute thereto. "IRC" means the Internal Revenue Code of 1986, as amended. "JUST CAUSE DISMISSAL" shall mean a termination of a Recipient's employment for any of the following reasons: (a) the Recipient violates any reasonable rule or regulation of the Board, the Company's Chief Executive Officer or the Recipient's superiors that results in damage to the Company or which, after written notice to do so, the Recipient fails to correct within a reasonable time; (b) any willful misconduct or gross negligence by the Recipient in the responsibilities assigned to the Recipient; (c) any willful failure to perform the Recipient's job as required to meet Company objectives; (d) any wrongful conduct of a Recipient which has an adverse impact on the Company or which constitutes a misappropriation of Company assets; (e) the Recipient's performing services for any other person or entity that competes with the Company while the Recipient is employed by the Company, without the written approval of the Chief Executive Officer of the Company; or (f) any other conduct that the Administering Body determines constitutes Just Cause for Dismissal; provided, however, that if a Recipient is party to an employment agreement with the Company providing for just cause dismissal (or some comparable notion) of Recipient from Recipient's employment with the Company, "Just Cause Dismissal" for purposes of this Plan shall have the same meaning as ascribed thereto or to such comparable notion in such employment agreement. "NON-EMPLOYEE DIRECTOR" means any director of the Company who qualifies as a "non-employee director" within the meaning of Rule 16b-3. "NON-QUALIFIED STOCK OPTION" means a Stock Option that is not an Incentive Stock Option. "OPTIONEE" means a Recipient or the Recipient's successor in interest. "OUTSIDE DIRECTOR" means an "outside director" as defined in the regulations adopted under Section 162(m) of the IRC. "PARENT CORPORATION" means any Parent Corporation as defined in Section 424(e) of the IRC. "PERFORMANCE-BASED COMPENSATION" means performance-based compensation as described in Section 162(m) of the IRC. If the amount of compensation an Eligible Person will receive under any Stock Option is not based solely on an increase in the value of Common Stock after the date of grant or award, the Stock Option Plan Committee, in order to qualify Stock Options as performance- based compensation under Section 162(m) of the IRC, can condition the grant, award, vesting or exercisability of such Stock Options on the attainment of a preestablished, objective performance goal. For this purpose, a preestablished, objective performance goal may include one or more of the following performance criteria: (a) book value; (b) earnings per share; (c) return on equity; (d) total shareholder return; (e) return on capital; (f) return on assets or net assets; (g) income or net income; (h) net interest income; (i) net margin; (j) attainment of stated goals related to the Company's capitalization, costs, financial condition or results of operations; and (k) any other similar performance criteria. A-12 "PERSON" means any person, entity or group, within the meaning of Section 13(d) or 14(d) of the Exchange Act, but excluding (a) the Company and its subsidiaries, (b) any employee stock ownership or other employee benefit plan maintained by the Company that is qualified under ERISA and (c) any underwriter or underwriting syndicate that has acquired the Company's securities solely in connection with a public offering thereof. "PERMANENT DISABILITY" shall mean that the Recipient becomes physically or mentally incapacitated or disabled so that the Recipient is unable to perform substantially the same services as the Recipient performed prior to incurring such incapacity or disability (the Company, at its option and expense, being entitled to retain a physician to confirm the existence of such incapacity or disability, and the determination of such physician to be binding upon the Company and the Recipient), and such incapacity or disability continues for a period of three consecutive months or six months in any 12-month period or such other period(s) as may be determined by the Stock Option Plan Committee with respect to any Stock Option, provided that for purposes of determining the period during which an Incentive Stock Option may be exercised pursuant to Section 5.13(b)(ii) hereof, Permanent Disability shall mean "permanent and total disability" as defined in Section 22(e) of the IRC. "PERMITTED TRANSFEREE" means (a) the Recipient's Immediate Family; (b) a trust solely for the benefit of the Recipient and/or his or her Immediate Family; or (c) a partnership or limited liability company the partners or shareholders of which are limited to the Recipient and his or her Immediate Family. "PLAN" means this 1999 Stock Option Plan of the Company. "PLAN TERM" means the period during which this Plan remains in effect (commencing on the Effective Date and ending on the Expiration Date). "RECIPIENT" means a person who has received Stock Options under this Plan. "REORGANIZATION" means any merger, consolidation or other reorganization. "RULE 16B-3" means Rule 16b-3 under the Exchange Act. "SECURITIES ACT" means the Securities Act of 1933, as amended. "SIGNIFICANT SHAREHOLDER" is an individual who, at the time a Stock Option is granted to such individual under this Plan, owns more than 10% of the combined voting power of all classes of stock of the Company or of any Parent Corporation or Subsidiary Corporation (after application of the attribution rules set forth in Section 424(d) of the IRC). "STOCK OPTION" means a right to purchase stock of the Company granted under Article VI of this Plan to an Eligible Person. "STOCK OPTION DOCUMENT" means the agreement or confirming memorandum setting forth the terms and conditions of Stock Options. "STOCK OPTION PLAN COMMITTEE" means the committee appointed by the Board to administer this Plan pursuant to Section 4.1. "SUBSIDIARY CORPORATION" means any Subsidiary Corporation as defined in Section 424(f) of the IRC. A-13 EX-10.1 4 EXHIBIT 10.1 INCENTIVE STOCK OPTION AGREEMENT --------------------------------- pursuant to the INDEPENDENT BANKSHARES, INC. 1999 STOCK OPTION PLAN This INCENTIVE STOCK OPTION AGREEMENT (the "Agreement") is made and entered into by and between INDEPENDENT BANKSHARES, INC., a Texas Corporation (the "Company"), and ______________ (the "Optionee"), effective as of ________, 1999/2000 (the "Date of Grant"). 1. GRANT OF OPTION. The Company hereby grants to the Optionee and the Optionee hereby accepts, subject to the terms and conditions hereof, an incentive stock option (the "Option") to purchase up to _______ shares of Company's Common Stock at the Exercise Price per share set forth in Section 4 below. 2. GOVERNING PLAN. This Option is granted pursuant to the Company's 1999 Stock Option Plan (the "Plan"), a copy of which is attached hereto. Capitalized terms used but not otherwise defined herein have the meanings as set forth in the Plan. The Optionee agrees to be bound by the terms and conditions of the Plan, which are incorporated herein by reference and which control in case of any conflict with this Agreement. 3. EXPIRATION OF THE OPTION. The Option (to the extent not earlier exercised or terminated due to cessation of the Optionee's employment or otherwise in accordance with the Plan) will expire at the end of business on _______, ____, ___(__) years from the Date of Grant of the option. The Option may terminate sooner under certain circumstances, including, without limitation, termination of the Optionee's employment, as set forth in Section 5.13 (death, normal retirement, Permanent Disability and termination for other reasons) of the Plan. The Option may not be exercised after its expiration or termination. 4. EXERCISE PLAN. The "Option Price" of the Option is $_____ per share of Common Stock. The Exercise Price is subject to adjustment as set forth in Section 6.2 of the Plan. 5. VESTING. On each Measurement Date set forth in Column 1 below, the Option shall vest and become exercisable for the corresponding number of shares of Common Stock set forth in Column 2 below if the Optionee's employment has not terminated. The "Vested Portion" of the Option as of any particular date shall be the cumulative total of all shares for which the Option has become exercisable as of that date. Column 1 Column 2 Shares Vesting on Measurement Date Measurement Date Notwithstanding the foregoing, in the event the Optionee's employment with the Company and/or any Parent Corporation or Subsidiary Corporation is terminated within ________ (___) year(s) after a "Change in Control" (as defined below) then, immediately prior to the effective date of such termination, all Options or converted rights which have not expired, shall become fully vested and exercisable (if not already vested and exercisable) by Optionee for -1- a period of three (3) months thereafter. In addition, upon a Change in Control, pursuant to Section 7.2 of the Plan, this Option shall be cancelled and automatically converted into the right to receive, and thereafter shall be exercisable for, in accordance with the Plan and this Agreement, the securities, cash and/or other consideration that a holder of the shares underlying the Options would have been entitled to receive upon consummation of a Change in Control had such shares been issued and outstanding immediately prior to the effective date and time of the Change in Control (net of appropriate exercise prices 6. EXERCISE OF THE OPTION. The Vested Portion (as herein defined) of the Option may be exercised, to the extent not previously exercised, in whole or in part, at any time or from time to time prior to the expiration or termination of the Option, except that no Option shall be exercisable except in respect to whole shares, and not less than one hundred (100) shares may be purchased at one time unless the number purchased is the total number at the time available for purchase under the terms of the Option. Exercise shall be accomplished by providing the Company with written notice in the form of Exhibit I hereto, which notice shall be irrevocable when delivered and effective upon payment in full of the Option Price in accordance with Section 5.4 of the Plan and any amounts required in accordance with Section 5.11 of the Plan for withholding taxes, and the satisfaction of all other conditions to exercise imposed under the Plan. 7. PAYMENT OF OPTION PRICE. Upon any exercise of the Option, the exercise price for the number of shares for which the Option is then being exercised and the amount of any federal, state and local withholding shall be paid in full to the Company in cash or with shares of Common Stock that have been owned for at least six months, or a combination thereof. 8. NONTRANSFERABILITY OF OPTION. The Option shall not be transferable or assignable by the Optionee, other than in accordance with Section 5.9 of the Plan or by will or the laws of descent and distribution (or as otherwise permitted by the Compensation Committee in its sole discretion), and shall be exercisable during the Optionee's lifetime only by him or her or by his or her legal representative(s) or guardian(s). 9. ADMINISTRATION. The Plan and this Agreement shall be administered and may be definitively interpreted by the Compensation Committee, and the Optionee agrees to accept and abide by the decisions of such Compensation Committee concerning administration and interpretation of the Plan and this Agreement. IN WITNESS WHEREOF, this Agreement has been executed on behalf of the Company by its duly authorized officer, and by the Optionee in acceptance of the above-mentioned Option, subject to the terms and conditions of the Plan and of this Agreement, all as of the day and year first above written. INDEPENDENT BANKSHARES, INC. ___________________________________ By: OPTIONEE ___________________________________ -2- NOTICE OF EXERCISE under INCENTIVE STOCK OPTION AGREEMENT --------------------------------- pursuant to the INDEPENDENT BANKSHARES, INC. 1999 STOCK OPTION PLAN To: Independent Bankshares, Inc. (the "Company") From: ____________________ Date: ____________________ Pursuant to the Independent Bankshares, Inc. 1999 Stock Option Plan (the "Plan") and the Incentive Stock Option Agreement (the "Agreement") between the Company and myself effective ______________________, I hereby exercise my Option as follows: Number of shares of Common Stock I wish to purchase under the Option Exercise Price per share $ Total Exercise Price $ "Vested Portion" of Option (see definition in Section 5 of the Agreement) Number of shares I have previously purchased by exercising the Option Expiration Date of the Option I hereby represent, warrant, and covenant to the Company that: a. I am acquiring the Common Stock for my own account, for investment, and not for distribution or resale, and I will make no transfer of such Common Stock except in compliance with applicable federal and state securities laws and in accordance with the provisions of the Plan. b. I can bear the economic risk of the investment in the Common Stock resulting from this exercise of the Option, including a total loss of my investment. c. I am experienced in business and financial matters and am capable of (i) evaluating the merits and risks of an investment in the Company Stock; (ii) making an informed investment decision regarding exercise of the Option; and (iii) protecting my interests in connection therewith. I acknowledge that I must pay the exercise price in full and make appropriate arrangements for the payment of all federal, state and local tax withholdings due with respect to the Option exercised herein, before the stock certificate evidencing the shares of Common Stock resulting from this exercise of the Option will be issued to me. Attached in full payment of the exercise price for the Option exercised herein is ( ) a check made payable to the Company in the amount of $___________________ and/or ( ) a stock certificate for _______ shares of Common Stock that have been owned for at least six months with a duly completed stock power attached. ______________________________ EX-10.2 5 EXHIBIT 10.2 NONQUALIFIED STOCK OPTION AGREEMENT ------------------------------------ pursuant to the INDEPENDENT BANKSHARES, INC. 1999 STOCK OPTION PLAN This NONQUALIFIED STOCK OPTION AGREEMENT (the "Agreement") is made and entered into by and between INDEPENDENT BANKSHARES, INC., a Texas Corporation (the "Company"), and ______________ (the "Optionee"), effective as of _______, 1999/2000 (the "Date of Grant"). 1. GRANT OF OPTION. The Company hereby grants to the Optionee and the Optionee hereby accepts, subject to the terms and conditions hereof, a nonqualified stock option (the "Option") to purchase up to _______ shares of Company's Common Stock at the Exercise Price per share set forth in Section 4 below. 2. GOVERNING PLAN. This Option is granted pursuant to the Company's 1999 Stock Option Plan (the "Plan"), a copy of which is attached hereto. Capitalized terms used but not otherwise defined herein have the meanings as set forth in the Plan. The Optionee agrees to be bound by the terms and conditions of the Plan, which are incorporated herein by reference and which control in case of any conflict with this Agreement. 3. EXPIRATION OF THE OPTION. The Option (to the extent not earlier exercised or terminated due to cessation of the Optionee's employment or otherwise in accordance with the Plan) will expire at the end of business on _______, 20__, ___ (__) years from the Date of Grant of the option. The Option may terminate sooner under certain circumstances, including, without limitation, termination of the Optionee's employment, as set forth in Section 5.13 (death, normal retirement, Permanent Disability and termination for other reasons) of the Plan. The Option may not be exercised after its expiration or termination. 4. EXERCISE PLAN. The "Option Price" of the Option is $_____ per share of Common Stock. The Exercise Price is subject to adjustment as set forth in Section 6.2 of the Plan. 5. VESTING. On each Measurement Date set forth in Column 1 below, the Option shall vest and become exercisable for the corresponding number of shares of Common Stock set forth in Column 2 below if the Optionee's employment has not terminated. The "Vested Portion" of the Option as of any particular date shall be the cumulative total of all shares for which the Option has become exercisable as of that date. Column 1 Column 2 Shares Vesting on Measurement Date Measurement Date Notwithstanding the foregoing, in the event the Optionee's employment with the Company and/or any Parent Corporation or Subsidiary Corporation is terminated within _______ (___) year(s) after a "Change in Control" then, immediately prior to the effective date of such termination, all Options or converted rights which have not expired, shall become fully vested and exercisable (if not already vested and exercisable) by Optionee for a period of -1- three (3) months thereafter. In addition, upon a Change in Control, pursuant to Section 7.2 of the Plan, this Option shall be cancelled and automatically converted into the right to receive, and thereafter shall be exercisable for, in accordance with the Plan and this Agreement, the securities, cash and/or other consideration that a holder of the shares underlying the Options would have been entitled to receive upon consummation of a Change in Control had such shares been issued and outstanding immediately prior to the effective date and time of the Change in Control (net of appropriate exercise prices). 6. EXERCISE OF THE OPTION. The Vested Portion (as herein defined) of the Option may be exercised, to the extent not previously exercised, in whole or in part, at any time or from time to time prior to the expiration or termination of the Option, except that no Option shall be exercisable except in respect to whole shares, and not less than one hundred (100) shares may be purchased at one time unless the number purchased is the total number at the time available for purchase under the terms of the Option. Exercise shall be accomplished by providing the Company with written notice in the form of Exhibit I hereto, which notice shall be irrevocable when delivered and effective upon payment in full of the Option Price in accordance with Section 5.4 of the Plan and any amounts required in accordance with Section 5.11 of the Plan for withholding taxes, and the satisfaction of all other conditions to exercise imposed under the Plan. 7. PAYMENT OF OPTION PRICE. Upon any exercise of the Option, the exercise price for the number of shares for which the Option is then being exercised and the amount of any federal, state and local withholding shall be paid in full to the Company in cash or with shares of Common Stock that have been owned for at least six months, or a combination thereof, or in such other form as the Committee deems acceptable at the time of exercise. 8. NONTRANSFERABILITY OF OPTION. The Option shall not be transferable or assignable by the Optionee, other than in accordance with Section 5.9 of the Plan or by will or the laws of descent and distribution (or as otherwise permitted by the Compensation Committee in its sole discretion), and shall be exercisable during the Optionee's lifetime only by him or her or by his or her legal representative(s) or guardian(s). 9. ADMINISTRATION. The Plan and this Agreement shall be administered and may be definitively interpreted by the Compensation Committee, and the Optionee agrees to accept and abide by the decisions of such Compensation Committee concerning administration and interpretation of the Plan and this Agreement. IN WITNESS WHEREOF, this Agreement has been executed on behalf of the Company by its duly authorized officer, and by the Optionee in acceptance of the above-mentioned Option, subject to the terms and conditions of the Plan and of this Agreement, all as of the day and year first above written. INDEPENDENT BANKSHARES, INC. __________________________________ By: OPTIONEE __________________________________ -2- NOTICE OF EXERCISE under NONQUALIFIED STOCK OPTION AGREEMENT ------------------------------------ pursuant to the INDEPENDENT BANKSHARES, INC. 1999 STOCK OPTION PLAN To: Independent Bankshares, Inc. (the "Company") From: ____________________ Date: ____________________ Pursuant to the Independent Bankshares, Inc. 1999 Stock Option Plan (the "Plan") and the Nonqualified Stock Option Agreement (the "Agreement") between the Company and myself effective ______________________, I hereby exercise my Option as follows: Number of shares of Common Stock I wish to purchase under the Option Exercise Price per share $ Total Exercise Price $ "Vested Portion" of Option (see definition in Section 5 of the Agreement) Number of shares I have previously purchased by exercising the Option Expiration Date of the Option I hereby represent, warrant, and covenant to the Company that: a. I am acquiring the Common Stock for my own account, for investment, and not for distribution or resale, and I will make no transfer of such Common Stock except in compliance with applicable federal and state securities laws and in accordance with the provisions of the Plan. b. I can bear the economic risk of the investment in the Common Stock resulting from this exercise of the Option, including a total loss of my investment. c. I am experienced in business and financial matters and am capable of (i) evaluating the merits and risks of an investment in the Company Stock; (ii) making an informed investment decision regarding exercise of the Option; and (iii) protecting my interests in connection therewith. I acknowledge that I must pay the exercise price in full and make appropriate arrangements for the payment of all federal, state and local tax withholdings due with respect to the Option exercised herein, before the stock certificate evidencing the shares of Common Stock resulting from this exercise of the Option will be issued to me. Attached in full payment of the exercise price for the Option exercised herein is ( ) a check made payable to the Company in the amount of $___________________ and/or ( ) a stock certificate for _______ shares of Common Stock that have been owned for at least six months with a duly completed stock power attached. ___________________________ EX-13.1 6 ANNUAL REPORT 98 SHAPING OUR COMPANY THROUGH GROWTH AND ACQUISITION [Photograph: two individuals standing by pillars of a building, enclosed in square] [Photograph: eyeglasses placed on a sheet of graph paper, enclosed in a circle] [Photograph: man holding up a boy, enclosed in a triangle] [Independent Bankshares Logo] INDEPENDENT BANKSHARES, INC. 1998 ANNUAL REPORT [Illustration of Texas with an inset showing different Texas cities in the West and North Central Regions] [Independent Bankshares, Inc. Logo] First State Bank, N.A. Banking Locations in West Texas ================================================================= ABILENE - MAIN BANK AZLE - MAIN BRANCH ODESSA - WINWOOD BRANCH 547 Chestnut Street 150 Industrial Avenue 3898 E. 42nd Street Abilene, Texas 79602 Azle, Texas 76020 Odessa, Texas 79762 (915)672-2902 (817) 444-2525 (915) 366-5903 SAN ANGELO BRANCH ABILENE - WYLIE BRANCH AZLE - NORTH BRANCH 4112 College 6301 Buffalo Gap Road 11588 FM 730 North Hills Boulevard Abilene, Texas 79606 Azle, Texas 76020 San Angelo, Texas 76904 (915) 691-0000 (817) 270-1112 (915) 942-8757 ODESSA - 42nd STREET STAMFORD BRANCH ABILENE - BUFFALO BRANCH 210 S. Swenson Street GAP ROAD BRANCH 4950 E. 42nd Street Stamford, Texas 79553 4450 Buffalo Gap Road Odessa, Texas 79762 (915) 773-5755 Abilene, Texas 79606 (915) 362-2106 (915) 793-2477 LUBBOCK BRANCH ODESSA - COUNTY ROAD WINTERS BRANCH 82nd Street and WEST BRANCH 500 S. Main Street Nashville Avenue 2751 County Road West Winters, Texas 79567 Lubbock, Texas 79423 Odessa, Texas 79763 (915) 754-5511 (806) 794-8300 (915) 335-8200 ODESSA - MAIN BRANCH 1330 E. 8th Street Odessa, Texas 79761 (915) 332-0141 AR|98 [Graphic: large square and a small circle] FINANCIAL HIGHLIGHTS 98
INCOME STATEMENT DATA FOR THE YEAR 1998 1997 1996 ================================================================== Net Income $2,188,000 $2,110,000 $1,422,000 Basic Earnings Per Common Share 1.07 1.12 1.00 Diluted Earnings Per Common Share 1.02 1.03 0.84 BALANCE SHEET DATA AT YEAR END 1998 1997 1996 ============================================================================== Assets $370,178,000 $264,574,000 $205,968,000 Loans 184,560,000 140,853,000 92,017,000 Deposits 330,804,000 242,801,000 189,575,000 Stockholders' Equity 24,505,000 20,527,000 14,937,000 BALANCE SHEET DATA DAILY AVERAGES 1998 1997 1996 ============================================================================== Assets $293,579,000 $258,874,000 $196,155,000 Loans 153,188,000 132,891,000 85,880,000 Deposits 265,959,000 237,379,000 180,005,000 Stockholders' Equity 22,114,000 19,275,000 14,375,000 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 COMPANY SECURITIES AMEX TRADING SYMBOL AMEX LISTING =============================================================== Common Stock IBK Indep Bksh Trust Preferred Securities IBK.Pr Indep Cap INDEPENDENT BANKSHARES, INC. 1 [Graphic: large triangle with small circle] PRESIDENT'S LETTER BRYAN STEPHENSON [PHOTOGRAPH OF BRYAN STEPHENSON AND RANDAL CROSSWHITE] President and Chief Executive Officer RANDAL CROSSWHITE Senior Vice President and Chief Financial Officer TO OUR SHAREHOLDERS: Independent Bankshares, Inc. is a bank holding company headquartered in Abilene, Texas. Through its subsidiary, First State Bank, N.A., the Company offers a full range of financial products to businesses and individuals located in and around five of the more populated communities in West Texas. With thirteen branches and a loan limit in excess of $4,000,000, the Company has the management, the visibility and the size to compete effectively in its market. During 1998, the Company continued its philosophy of growth through acquisition with the purchase of Azle Bancorp and its subsidiary, Azle State Bank, Azle, Texas. The Company obtained the funds necessary to complete this transaction through a successful secondary Common Stock offering and an offering of Trust Preferred Securities. The purchase of Azle follows acquisitions of Western National Bank, Lubbock, Texas in 1997, and Peoples National Bank, Winters, Texas and a savings bank branch in San Angelo, Texas, both in 1996. The acquisitions contributed significantly to the Company's market diversification and provided important economies of scale. While located in West Texas, a review of the accompanying map indicates the geographic diversification the Company currently enjoys. Each market is driven by a different set of economic forces. Lubbock, for example, enjoys the benefits of higher education, a large medical complex and agriculture, primarily cotton. Odessa, on the other hand, continues to be largely dependent on the petroleum industry. Abilene relies on a strong military base, healthcare, education and retail distribution for its economic base, while the San Angelo economy is centered around ranching, retail businesses and a large retirement community. The Company's purchase of Azle State Bank provides a new and exciting opportunity for market diversification. Azle, located on the doorstep of the Fort Worth/Dallas metroplex, is a growing bedroom community. As small businesses spring up to support this population growth, the Company's marketing efforts will be directed toward the solicitation of these small businesses and the attendant consumer relationships. As noted above, our acquisitions have brought important economies of scale. There has been significant discussion in analytical circles about the "urge to merge" and whether or not merging companies actually realize expected economies of scale. Our Company has benefited from its acquisition savings in many areas, the most notable being AR|98 2 greater employee efficiencies and utilization of excess computing capacity. The results of these economies of scale can be seen in our five-year trend of improving efficiency ratios. The movement to change the mix of our loan portfolio began in earnest in January 1997. Due in part to the acquisition of Western National Bank, the Company had achieved a concentration in consumer loans that was significantly higher than desired. Because of our perception that the consumer was becoming overextended and due to competitive market forces that prevented the Company from charging interest rates that would compensate for the increased risk associated with such loans, we determined to scale back our solicitation of this type of business and to redirect our efforts toward increasing our commercial business and commercial real estate lending. The interest rates on commercial loans were higher and we believed the market was underserved. As a result of this change in direction, the Company (excluding the Azle acquisition) experienced a 30.7% reduction in loans to individuals and a 32% increase in commercial business and commercial real estate loans during 1998. This shift, along with the acquisition of Azle State Bank, allowed the Company to increase its net interest margin in a generally decreasing net interest margin environment. Year 2000, or Y2K, computer issues have been high on our list of operational priorities during 1998, and will undoubtedly consume considerable time and effort during 1999. Because the Company had planned to upgrade all computer hardware during 1998 and 1999, and because the cost of hardware has continued to decline over the last few years, the economic impact of the hardware replacement has not been material to the Company. All replacement hardware is certified to be Y2K compliant. The Company is concluding the installation of software upgrades and in-house tests as this letter is being written. The goal is, of course, to assure that our operating systems will not be negatively affected by the Y2K bug. Because external Y2K disruptions cannot be controlled by the Company, we have devised a contingency plan and business resumption plan aimed at assuring that the customers' faith in our Company will not be diminished. Lastly, we are a large community bank. A community bank, by our definition, is one in which qualified banking professionals take care of the financial needs of the businesses and individuals within its community. This definition [Photograph: man holding up a boy in front of a house] [Independent Bankshares, Inc. Logo] [Photograph caption: The West Texas market area experienced a stable economy. Our Company was able to capitalize on this environment by increasing loans to small businesses] Independent Bankshares, Inc. 3 requires that we concentrate our efforts on hiring, training and retraining highly qualified personnel. We are fortunate to have added several high-caliber lending officers and support staff and two highly motivated individuals to our Company's Board of Directors. As pleased as we are with our staff, I am particularly pleased with the two newest members of our Board: Nancy Jones, Executive Director of The Community Foundation of Abilene, and John Beckham of the Beckham, Eargle & Rector Law Firm. They are young, energetic individuals who bring new ideas and renewed vigor to our Board. Officers, employees and directors of this caliber enable the Company to prepare for the future. The future, as always, if filled with challenges and opportunities. Thank you for your continued support. /s/ Bryan Stephenson Bryan Stephenson [Graphic: large circle and small triangle] PERFORMANCE HIGHLIGHTS [Bar Chart illustrating the Company's total assets at year end for each of the five years in the period ended December 31, 1998] TOTAL ASSETS The Company recorded consistent growth over the last four years. Acquisitions of other financial institutions, including a bank in Winters and a saving bank branch in San Angelo in 1996. Western National Bank in Lubbock in 1997 and Azle State Bank in 1998, contributed to this trend. [Bar Chart illustrating the Company's total loans at year end for each of the five years in the period ended December 31, 1998] TOTAL LOANS While acquisitions have fueled loan growth, the Company has focused lending efforts to replace consumer loan roll-off with commercial and commercial real estate loans. AR|98 4 [Bar Chart illustrating the Company's net income for each of the five years in the period ended December 31, 1998] NET INCOME Increases in net income have been achieved through economies of scale and an improved net interest margin. [Bar Chart illustrating the Company's diluted earnings per share for each of the five years in the period ended December 31, 1998] DILUTED EARNINGS PER SHARE Diluted earnings per share declined $0.01 in 1998 because of an increase in the common shares outstanding. [Bar Chart illustrating the Company's efficiency ratio for each of the five years in the period ended December 31, 1998] EFFICIENCY RATIO The Company's efficiency ratio, calculated as noninterest expenses, less goodwill amortization and expenses associated with other real estate and other repossessed assets, divided by net interest income and total noninterest income, excluding securities gains (losses), has continued to improve with the growth of the Company. [Bar Chart illustrating the Company's return on average stockholders' equity for each of the five years in the period ended December 31, 1998] RETURN ON AVERAGE STOCKHOLDERS' EQUITY The decline in the return on average stockholders' equity for 1998 is a result of increases in stockholders' equity. Independent Bankshares, Inc. 5 [Text enclosed in a square with Independent Bankshares, Inc. Logo] BOARD OF DIRECTORS Bryan W. Stephenson President & Chief Executive Officer Independent Bankshares, Inc. John L. Beckham Attorney Beckham, Rector & Eargle, L.L.P. Scott L. Taliaferro Chairman of the Board Independent Bankshares, Inc. President Scott Oils, Inc. Lee Caldwell Attorney Mrs. William R. (Amber) Cree Entrepreneuse Randal N. Crosswhite Senior Vice President & Chief Financial Officer Independent Bankshares, Inc. James D. Webster, M.D. Physician Nephrology Associates Louis S. Gee Chairman of the Board & Chief Executive Officer Tippett & Gee, Inc., Consulting Engineers C.G. Whitten Attorney, Whitten & Young, P.C. Nancy E. Jones Executive Director Community Foundation of Abilene Marshal M. Keller Chairman of the Board West Texas Wholesale Supply Co. Tommy McAlister President McAlister, Inc. [Text enclosed in a circle] ADVISORY DIRECTORS L.H. Mosley President Mosley Investments, Inc. J.E. Smith Investments John A. Wright* Banking Consultant *Emeritus [Text enclosed in a triangle] Bryan W. Stephenson President & Chief Executive Officer Randal N. Crosswhite Senior Vice President & Chief Financial Officer CORPORATE OFFICERS AR|98 7 [Text enclosed in a square] REPORT OF INDEPENDENT ACCOUNTANTS To the Board of Directors and Shareholders of Independent Bankshares, Inc. In our opinion, the accompanying consolidated balance sheets and the related consolidated statements of income and comprehensive income, changes in stockholders' equity and cash flows present fairly, in all material respects, the financial position of Independent Bankshares, Inc. at December 31, 1998 and 1997, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 1998, in conformity with generally accepted accounting principles. 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 of these statements in accordance with generally accepted auditing standards which 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, accessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for the opinion expressed above. /s/ PricewaterhouseCoopers LLP PricewaterhouseCoopers LLP January 29, 1998 Independent Bankshares, Inc. 7 [Independent Bankshares, Inc. Logo] INDEPENDENT BANKSHARES, INC. CONSOLIDATED BALANCE SHEETS DECEMBER 31, 1998 AND 1997
ASSETS 1998 1997 ------------- ------------- Assets: Cash and Cash Equivalents: Cash and Due from Banks $ 22,562,000 $ 14,518,000 Federal Funds Sold 42,175,000 24,900,000 ------------- ------------- Total Cash and Cash Equivalents 64,737,000 39,418,000 ------------- ------------- Securities (Note 3): Available-for-sale 30,370,000 22,501,000 Held-to-maturity 64,838,000 47,293,000 ------------- ------------- Total Securities 95,208,000 69,794,000 ------------- ------------- Loans (Note 4): Total Loans 186,326,000 142,315,000 Less: Unearned Income on Installment Loans 1,766,000 1,462,000 Allowance for Possible Loan Losses 1,842,000 1,173,000 ------------- ------------- Net Loans 182,718,000 139,680,000 ------------- ------------- Intangible Assets (Note 5) 10,831,000 3,159,000 Premises and Equipment (Note 6) 10,294,000 7,518,000 Accrued Interest Receivable 3,254,000 2,208,000 Other Real Estate and Other Repossessed Assets 630,000 739,000 Other Assets 2,506,000 2,058,000 ------------- ------------- Total Assets $ 370,178,000 $ 264,574,000 ============= ============= LIABILITIES AND STOCKHOLDERS' EQUITY Liabilities: Deposits (Note 7): Noninterest-bearing Demand Deposits $ 60,086,000 $ 43,868,000 Interest-bearing Demand Deposits 110,485,000 77,495,000 Interest-bearing Time Deposits 160,233,000 121,438,000 ------------- ------------- Total Deposits 330,804,000 242,801,000 Accrued Interest Payable 1,163,000 947,000 Notes Payable (Note 8) 1,000 57,000 Other Liabilities 705,000 242,000 ------------- ------------- Total Liabilities 332,673,000 244,047,000 ------------- ------------- Guaranteed Preferred Beneficial Interests in the Company's Subordinated Debentures (Note 10) 13,000,000 0 ------------- ------------- Commitments and Contingent Liabilities (Notes 15 and 17) Stockholders' Equity (Notes 11 and 18): Preferred Stock - Par Value $10.00; 5,000,000 Shares Authorized: Series C Preferred Stock - Stated Value $42.00; 50,000 Shares Designated; 5,066 and 5,590 Shares Issued and Outstanding at December 31, 1998 and 1997, Respectively 51,000 56,000 Common Stock - Par Value $0.25; 30,000,000 Shares Authorized; 2,217,296 and 1,975,263 Shares Issued and Outstanding at December 31, 1998 and 1997, Respectively 554,000 494,000 Additional Paid-in Capital 15,933,000 13,921,000 Retained Earnings 7,975,000 6,218,000 Net Unrealized Gain on Available-for-sale Securities (Note 3) 161,000 31,000 Unearned Employee Stock Ownership Plan Stock (Note 11) (169,000) (193,000) ------------- ------------- Total Stockholders' Equity 24,505,000 20,527,000 ------------- ------------- Total Liabilities and Stockholders' Equity $ 370,178,000 $ 264,574,000 ============= =============
See accompanying notes. -8- INDEPENDENT BANKSHARES, INC. CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
1998 1997 1996 ------------- ------------- ------------- Interest Income: Interest and Fees on Loans (Note 4) $ 14,150,000 $ 12,236,000 $ 8,005,000 Interest on Securities 4,425,000 5,176,000 4,504,000 Interest on Federal Funds Sold 1,859,000 912,000 1,047,000 ------------- ------------- ------------- Total Interest Income 20,434,000 18,324,000 13,556,000 ------------- ------------- ------------- Interest Expense: Interest on Deposits 9,268,000 8,600,000 6,382,000 Interest on Notes Payable (Note 8) 8,000 59,000 59,000 ------------- ------------- ------------- Total Interest Expense 9,276,000 8,659,000 6,441,000 ------------- ------------- ------------- Net Interest Income 11,158,000 9,665,000 7,115,000 Provision for Loan Losses (Note 4) 570,000 250,000 201,000 ------------- ------------- ------------- Net Interest Income After Provision for Loan Losses 10,588,000 9,415,000 6,914,000 ------------- ------------- ------------- Noninterest Income: Service Charges 2,227,000 1,605,000 1,259,000 Trust Fees 199,000 195,000 189,000 Other Income 365,000 109,000 103,000 ------------- ------------- ------------- Total Noninterest Income 2,791,000 1,909,000 1,551,000 ------------- ------------- ------------- Noninterest Expenses: Salaries and Employee Benefits 4,752,000 3,970,000 3,082,000 Net Occupancy Expense 1,099,000 857,000 716,000 Equipment Expense 887,000 834,000 663,000 Stationery, Printing and Supplies Expense 442,000 419,000 288,000 Amortization of Intangible Assets 339,000 218,000 46,000 Professional Fees 305,000 333,000 304,000 Distributions on Guaranteed Preferred Beneficial Interests in the Company's Subordinated Debentures (Note 10) 304,000 0 0 Net Costs (Revenues) Applicable to Other Real Estate and Other Repossessed Assets 106,000 23,000 (24,000) Other Expenses 1,764,000 1,583,000 1,215,000 ------------- ------------- ------------- Total Noninterest Expenses 9,998,000 8,237,000 6,290,000 ------------- ------------- ------------- Income Before Federal Income Taxes 3,381,000 3,087,000 2,175,000 Federal Income Taxes (Note 9) 1,193,000 977,000 753,000 ------------- ------------- ------------- Net Income 2,188,000 2,110,000 1,422,000 Other Comprehensive Income, Net of Tax: Unrealized Holding Gains (Losses) on Available-for-sale Securities Arising During the Period 130,000 6,000 (43,000) ------------- ------------- ------------- Comprehensive Income $ 2,318,000 $ 2,116,000 $ 1,379,000 ============= ============= ============= Preferred Stock Dividends (Note 11) $ 22,000 $ 41,000 $ 63,000 ============= ============= ============= Net Income Available to Common Stockholders $ 2,166,000 $ 2,069,000 $ 1,359,000 ============= ============= ============= Basic Earnings Per Common Share Available to Common Stockholders (Note 12) $ 1.07 $ 1.12 $ 1.00 ============= ============= ============= Diluted Earnings Per Common Share Available to Common Stockholders (Note 12) $ 1.02 $ 1.03 $ 0.84 ============= ============= =============
See accompanying notes. -9- INDEPENDENT BANKSHARES, INC. CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
SERIES C PREFERRED STOCK COMMON STOCK ADDITIONAL -------------------- -------------------- PAID-IN RETAINED SHARES AMOUNT SHARES AMOUNT CAPITAL EARNINGS --------- ---------- --------- ---------- ----------- ----------- Balances-January 1, 1996 16,436 $ 164,000 1,050,292 $ 263,000 $ 9,875,000 $ 3,448,000 Net Income 1,422,000 Adjustment to Unrealized Gain on Available-for-sale Securities, Net of Tax of $22,000 (Note 3) Cash Dividends (260,000) Conversion of Series C Preferred Stock (Note 11) (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 Net Income 2,110,000 Adjustment to Unrealized Gain on Available-for-sale Securities, Net of Tax of $3,000 (Note 3) Cash Dividends (405,000) Sale of Stock in Secondary Offering (Note 11) 316,250 79,000 3,899,000 Purchase of Stock in Secondary Offering by ESOP, Financed by a Loan from the Company - Unearned Stock (Note 11) Principal Payments on Loan to ESOP for Stock Purchase - Earned Stock (Note 11) 5-for-4 Stock Split (Note 11) 388,911 97,000 (5,000) (97,000) Exercise of Stock Options (Note 11) 17,499 5,000 94,000 Conversion of Series C Preferred Stock (Note 11) (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 Net Income 2,188,000 Adjustment to Unrealized Gain on Available-for-sale Securities, Net of Tax of $67,000 (Note 3) Cash Dividends (431,000) Sale of Stock in Secondary Offering (Note 11) 230,000 57,000 2,010,000 Principal Payments on Loan to ESOP for Stock Purchase - Earned Stock (Note 11) Conversion of Series C Preferred Stock (Note 11) (524) (5,000) 12,033 3,000 2,000 --------- --------- --------- ---------- ----------- ----------- Balances--December 31, 1998 5,066 $ 51,000 2,217,296 $ 554,000 $15,933,000 $ 7,975,000 ========= ========= ========= ========== =========== =========== UNREALIZED UNEARNED EMPLOYEE GAIN ON STOCK OWNERSHIP AVAILABLE- PLAN STOCK FOR-SALE --------------------- SECURITIES SHARES AMOUNT ---------- -------- ----------- Balances-January 1, 1996 $ 68,000 0 $ 0 Net Income Adjustment to Unrealized Gain on Available-for-sale Securities, Net of Tax of $22,000 (Note 3) (43,000) Cash Dividends Conversion of Series C Preferred Stock (Note 11) ----------- -------- ----------- Balances-December 31, 1996 25,000 0 0 Net Income Adjustment to Unrealized Gain on Available-for-sale Securities, Net of Tax of $3,000 (Note 3) 6,000 Cash Dividends Sale of Stock in Secondary Offering (Note 11) Purchase of Stock in Secondary Offering by ESOP, Financed by a Loan from the Company - Unearned Stock (Note 11) (15,000) (214,000) Principal Payments on Loan to ESOP for Stock Purchase - Earned Stock (Note 11) 1,789 21,000 5-for-4 Stock Split (Note 11) (3,750) Exercise of Stock Options (Note 11) Conversion of Series C Preferred Stock (Note 11) ----------- -------- ----------- Balances--December 31, 1997 31,000 (16,961) (193,000) Net Income Adjustment to Unrealized Gain on Available-for-sale Securities, Net of Tax of $67,000 (Note 3) 130,000 Cash Dividends Sale of Stock in Secondary Offering (Note 11) Principal Payments on Loan to ESOP for Stock Purchase - Earned Stock (Note 11) 2,122 24,000 Conversion of Series C Preferred Stock (Note 11) ----------- -------- ----------- Balances--December 31, 1998 $ 161,000 (14,839) $ (169,000) =========== ======== =========== See accompanying notes. -10- INDEPENDENT BANKSHARES, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
1998 1997 1996 ------------ ------------ ------------ Cash Flows from Operating Activities: Net Income $ 2,188,000 $ 2,110,000 $ 1,422,000 Adjustments to Reconcile Net Income to Net Cash Provided by Operating Activities: Deferred Federal Income Tax Expense 488,000 772,000 677,000 Depreciation and Amortization 962,000 733,000 404,000 Provision for Loan Losses 570,000 250,000 201,000 Losses on Sales of Investment Securities 0 0 10,000 Gains on Sales of Other Real Estate and Other Repossessed Assets (12,000) (58,000) (50,000) Writedown of Other Real Estate and Other Repossessed Assets 3,000 2,000 21,000 Increase in Accrued Interest Receivable (190,000) (192,000) (17,000) Decrease (Increase) in Other Assets (698,000) 452,000 (382,000) Decrease in Accrued Interest Payable (92,000) (182,000) (14,000) Increase (Decrease) in Other Liabilities 84,000 (1,106,000) 166,000 ------------ ------------ ------------ Net Cash Provided by Operating Activities 3,303,000 2,781,000 2,438,000 ------------ ------------ ------------ Cash Flows from Investing Activities: Proceeds from Maturities of Available-for-sale Securities 15,766,000 17,809,000 9,437,000 Proceeds from Maturities of Held-to-maturity Securities 36,745,000 20,195,000 26,461,000 Proceeds from Sales of Available-for-sale Securities 0 193,000 30,000 Proceeds from Sales of Held-to-maturity Securities 0 0 2,000,000 Purchases of Available-for-sale Securities (19,489,000) (8,060,000) (19,382,000) Purchases of Held-to-maturity Securities (22,627,000) (15,080,000) (36,680,000) Net Increase in Loans (254,000) (8,692,000) (8,160,000) Proceeds from Sales of Premises and Equipment 0 0 94,000 Additions to Premises and Equipment (651,000) (819,000) (138,000) Proceeds from Sales of Other Real Estate and Other Repossessed Assets 1,551,000 1,352,000 754,000 Net Cash and Cash Equivalents Acquired (Paid) in Acquisitions (10,133,000) (1,236,000) 14,203,000 ------------ ------------ ------------ Net Cash Provided by (Used in) Investing Activities 908,000 5,662,000 (11,381,000) ------------ ------------ ------------ Cash Flows from Financing Activities: Net Increase (Decrease) in Deposits 7,048,000 (378,000) 5,018,000 Proceeds from Notes Payable 4,300,000 1,300,000 0 Repayment of Notes Payable (4,356,000) (3,572,000) (616,000) Net Proceeds from Issuance of Equity Securities 2,067,000 4,077,000 0 Net Proceeds from Issuance of Guaranteed Preferred Beneficial Interests in the Company's Subordinated Debentures 12,480,000 0 0 Payment of Cash Dividends (431,000) (405,000) (260,000) Cash Paid for Fractional Shares in Stock Dividend 0 (5,000) 0 ------------ ------------ ------------ Net Cash Provided by Financing Activities 21,108,000 1,017,000 4,142,000 ------------ ------------ ------------ Net Increase (Decrease) in Cash and Cash Equivalents 25,319,000 9,460,000 (4,801,000) Cash and Cash Equivalents at Beginning of Year 39,418,000 29,958,000 34,759,000 ------------ ------------ ------------ Cash and Cash Equivalents at End of Year $ 64,737,000 $ 39,418,000 $ 29,958,000 ============ ============ ============
See accompanying notes. -11- INDEPENDENT BANKSHARES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1998, 1997 AND 1996 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 owns all of the common securities of Independent Capital Trust ("Independent Capital") and indirectly owns through a Delaware subsidiary, Independent Financial Corp. ("Independent Financial"), 100% of the stock of First State Bank, National Association, Abilene, Texas ("First State"), and Azle State Bank, Azle, Texas ("Azle State") (collectively, the "Banks"). The Banks currently operate full-service banking locations in the Texas cities of Abilene (3 locations), Azle (2 locations), Lubbock, Odessa (4 locations), San Angelo, Stamford and Winters. The Company's primary activities are to assist the Banks in the management and coordination of their financial resources and to provide capital, business development, long range planning and public relations for the Banks. The Banks operate under the day-to-day management of their own officers and boards of directors and formulate their own policies with respect to banking matters. The principal services provided by the Banks are as follows: Commercial Services. The Banks provide a full range of banking services for their 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 Banks also provide a wide range of consumer banking services, including checking, savings and money market accounts, savings programs and installment and personal loans. The Banks make automobile and other installment loans directly to customers, as well as indirectly through automobile dealers. The Banks make 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 Banks provide 24-hour routine banking services through automated teller machines ("ATMs"). The Pulse network provides ATM accessibility throughout the United States. The Banks also offer investment services and banking by phone or personal computer. Trust Services. First State 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. PRINCIPLES OF CONSOLIDATION The Consolidated Financial Statements include the accounts of the Company, Independent Capital, Independent Financial and the Banks. All significant intercompany accounts and transactions have been eliminated upon consolidation. 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 historical cost, adjusted for amortization of premiums and accretion of fees and discounts using -12- a method that approximates the interest method. Securities to be held for indefinite periods of time are classified as available-for-sale and carried at fair value. Unrealized gains and losses, net of taxes, related to securities available-for-sale are recorded as a separate component of stockholders' equity. The Company has no securities classified as trading as of December 31, 1998 and 1997. The cost of securities sold is based on the specific identification method. 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 the effective interest 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. Impaired loans, should they occur, are normally placed on nonaccrual status and, as a result, interest income is recorded only as cash is received. There was no interest income recognized on such loans during the years ended December 31, 1998, 1997 or 1996. 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. INTANGIBLE ASSETS A core deposit intangible resulting from the acquisition of Azle State is being amortized over a twelve (12) year period. Goodwill resulting from the acquisition of Azle State and other acquisitions accounted for using the purchase method is being amortized on the straight-line method over a period of fifteen (15) to twenty-five (25) 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, 1998, management believes that no impairment has occurred. FEDERAL INCOME TAXES The Company uses the liability method of accounting for income taxes as required by the Financial Accounting Standards Board (the "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. 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. -13- 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. 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 adopted FAS 130 on January 1, 1998. USE OF ESTIMATES The preparation of financial statements in conformity with generally accepted accounting principles requires management to make certain 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 Company completed the acquisition of Azle Bancorp and its subsidiary bank, Azle State, effective September 22, 1998, for an aggregate cash consideration of $19,025,000. To obtain funding for the acquisition, the Company sold an aggregate of 230,000 shares of Common Stock at a price of $11.50 per share, and Independent Capital, a Delaware business trust formed by the Company, sold 1,300,000 of its 8.5% Cumulative Trust Preferred Securities (the "Trust Preferred Securities") at $10.00 per preferred security (having a liquidation value of $13,000,000) in an underwritten offering (the "1998 Offering"). The proceeds from the sale of the Trust Preferred Securities were used by Independent Capital to purchase an equivalent amount of Subordinated Debentures ("Subordinated Debentures") of the Company. The Company also borrowed $4,300,000 from a financial institution in Fort Worth, Texas (the "Fort Worth Bank") to finance a portion of the cost of acquiring Azle Bancorp. The borrowings from the Fort Worth Bank were paid off on September 30, 1998, from the proceeds of a cash dividend paid to the Company by Azle State. At the date of acquisition, Azle Bancorp had total assets of $93,158,000, total loans, net of unearned income, of $45,163,000, total deposits of $80,955,000 and stockholders' equity of $9,872,000. This acquisition was accounted for using the purchase method of accounting. A total of $8,014,000 of intangible assets, including $2,895,000 of core deposit intangible and $5,119,000 of goodwill, was recorded as a result of this acquisition. The core deposit intangible is being amortized over a period of 12 years and the goodwill is being amortized over a period of 25 years. 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 First State. To obtain funding for the acquisition, the Company sold an aggregate of 395,312 shares of its common stock ("Common Stock") in an underwritten offering at a price of $11.40 per share (the "1997 Offering"). The 1997 Offering included the sale of 51,562 shares covered by the underwriter's over-allotment option. The above number of shares and price per share have been adjusted for the 5-for-4 stock split, effected in the form of a 25% stock dividend, paid to the Company's shareholders in May 1997. 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 unearned income, of $41,688,000, total deposits of $53,604,000 and stockholders' equity of $4,238,000. This -14- 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. Such goodwill is being amortized over a period of 15 years. A total of $339,000, $218,000 and $46,000 in amortization expense of intangible assets was recorded during the years ended December 31, 1998, 1997 and 1996, respectively. The following pro forma financial information combines the historical results of the Company as if the Azle Bancorp 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, ----------------------- 1998 1997 --------- -------- (In thousands, except per share amounts) Net interest income $ 14,195 $ 13,667 Net income 1,889 2,333 Basic earnings per share 0.85 1.11 Diluted earnings per share 0.82 1.02 Certain amounts, specifically the pro forma amounts for net income and basic and diluted earnings per share for the year ended December 31, 1998, are less than the amounts reported herein. NOTE 3: SECURITIES - ------------------- The amortized cost and estimated fair value of available-for-sale securities at December 31, 1998 and 1997, were as follows:
1998 --------------------------------------------------------- Gross Gross Estimated Amortized Unrealized Unrealized Fair Cost Gains Losses Value ------------ ------------ ------------ ------------ Obligations of U.S. Government agencies and corporations $ 18,085,000 $ 158,000 $ 13,000 $ 18,230,000 Mortgage-backed securities 2,426,000 1,000 16,000 2,411,000 U.S. Treasury securities 9,031,000 115,000 0 9,146,000 Other securities 583,000 0 0 583,000 ------------ ------------ ------------ ------------ Total available-for-sale securities $ 30,125,000 $ 274,000 $ 29,000 $ 30,370,000 ============ ============ ============ ============ 1997 --------------------------------------------------------- Gross Gross Estimated Amortized Unrealized Unrealized Fair Cost Gains Losses Value ------------ ------------ ------------ ------------ Obligations of U.S. Government agencies and corporations $ 4,520,000 $ 20,000 $ 2,000 $ 4,538,000 U.S. Treasury securities 16,280,000 40,000 13,000 16,307,000 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 ============ ============ ============ ============
-15- The amortized cost and estimated fair value of held-to-maturity securities at December 31, 1998 and 1997, were as follows:
1998 --------------------------------------------------------- Gross Gross Estimated Amortized Unrealized Unrealized Fair Cost Gains Losses Value ------------ ------------ ------------ ------------ Obligations of U.S. Government agencies and corporations $ 43,452,000 $ 49,000 $ 116,000 $ 43,385,000 Mortgage-backed securities 9,697,000 42,000 10,000 9,729,000 U.S. Treasury securities 2,427,000 27,000 0 2,454,000 Obligations of states and political subdivisions 9,262,000 76,000 0 9,338,000 ------------ ------------ ------------ ------------ Total held-to-maturity securities $ 64,838,000 $ 194,000 $ 126,000 $ 64,906,000 ============ ============ ============ ============ 1997 --------------------------------------------------------- Gross Gross Estimated Amortized Unrealized Unrealized Fair Cost Gains Losses Value ------------ ------------ ------------ ------------ Obligations of U.S. Government agencies and corporations $ 31,584,000 $ 119,000 $ 113,000 $ 31,590,000 U.S. Treasury securities 4,985,000 7,000 0 4,992,000 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 ============ ============ ============ ============
The amortized cost and estimated fair value of securities at December 31, 1998, 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 $ 5,014,000 $ 5,063,000 Due after one year through five years 22,102,000 22,313,000 Due after five years through ten years 0 0 Due after ten years 583,000 583,000 ------------ ------------ 27,699,000 27,959,000 Mortgage-backed securities 2,426,000 2,411,000 ------------ ------------ Total available-for-sale securities $ 30,125,000 $ 30,370,000 ============ ============ Amortized Estimated Held-to-maturity Securities Cost Fair Value --------------------------- ------------ ------------- Due in one year or less $ 7,453,000 $ 7,468,000 Due after one year through five years 38,607,000 38,567,000 Due after five years through ten years 8,079,000 8,124,000 Due after ten years 1,002,000 1,018,000 ------------ ------------ 55,141,000 55,177,000 Mortgage-backed securities 9,697,000 9,729,000 ------------ ------------ Total held-to-maturity securities $ 64,838,000 $ 64,906,000 ============ ============
At December 31, 1998, securities with an amortized cost and estimated fair value of $17,094,000 and $17,355,000, respectively, were pledged as collateral for public and trust fund deposits and for other purposes required or permitted by law. At December 31, 1997, the amortized cost and estimated fair value of pledged securities were $9,666,000 and $9,650,000, respectively. -16- During 1998, the Company did not sell any securities prior to marturity. 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 and recorded a $12,000 loss on such sale. In addition, the Company sold held-to- maturity securities with a book value of $1,198,000 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, 1998 and 1997, was as follows:
1998 1997 ------------ ------------ Real estate loans $ 71,901,000 $ 44,569,000 Loans to individuals 57,564,000 67,453,000 Commercial and industrial loans 47,551,000 24,184,000 Other loans 9,310,000 6,109,000 ------------ ------------ Total loans 186,326,000 142,315,000 Less unearned income 1,766,000 1,462,000 ------------ ------------ Total loans, net of unearned income $184,560,000 $140,853,000 ============ ============
Nonperforming assets at December 31, 1998 and 1997, were as follows:
1998 1997 ---------- ---------- Nonaccrual loans $ 238,000 $ 70,000 Accruing loans past due over ninety days 198,000 121,000 Restructured loans 110,000 104,000 Other real estate and other repossessed assets 630,000 739,000 ---------- ---------- Total nonperforming assets $1,176,000 $1,034,000 ========== ==========
The amount of interest income that would have been recorded on nonaccrual loans for the years ended December 31, 1998, 1997 and 1996, based on the loans' original terms was $12,000, $16,000 and $17,000, respectively. A total of $1,000 and $2,000 in interest on nonaccrual loans was actually collected and recorded as income during the year ended December 31, 1998 and 1997, respectively. No interest was collected on such loans and recorded as income during 1996. A summary of the activity in the allowance for possible loan losses for the years ended December 31, 1998, 1997 and 1996, is as follows:
1998 1997 1996 ---------- ---------- ---------- Balance at beginning of year $1,173,000 $ 793,000 $ 759,000 Provision for loan losses 570,000 250,000 201,000 Loans charged off (729,000) (581,000) (389,000) Recoveries of loans charged off 102,000 316,000 73,000 Bank acquisitions 726,000 395,000 149,000 ---------- ---------- ---------- Balance at end of year $1,842,000 $1,173,000 $ 793,000 ========== ========== ==========
NOTE 5: INTANGIBLE ASSETS - -------------------------- The following is a summary of intangible assets at December 31, 1998 and 1997:
1998 1997 ----------- ----------- Goodwill $ 8,539,000 $ 3,423,000 Core deposit intangible 2,895,000 0 ----------- ----------- 11,434,000 3,423,000 Less accumulated amortization 603,000 264,000 ----------- ----------- Net intangible assets $10,831,000 $ 3,159,000 =========== ===========
-17- NOTE 6: PREMISES AND EQUIPMENT - ------------------------------- The following is a summary of premises and equipment at December 31, 1998 and 1997: 1998 1997 ----------- ----------- Land $ 1,684,000 $ 1,486,000 Buildings and improvements 9,207,000 6,821,000 Furniture and equipment 2,573,000 2,028,000 ----------- ----------- 13,464,000 10,335,000 Less accumulated depreciation 3,170,000 2,817,000 ----------- ----------- Net premises and equipment $10,294,000 $ 7,518,000 =========== =========== NOTE 7: DEPOSITS - ----------------- At December 31, 1998 and 1997, interest-bearing time deposits of $100,000 or more were $49,674,000, and $38,371,000, respectively. At December 31, 1998, the scheduled maturities of interest-bearing time deposits was as follows: Interest-bearing Time Deposits ----------------- 1999 $ 140,926,000 2000 12,504,000 2001 2,987,000 2002 2,214,000 2003 1,602,000 ---------------- Total interest-bearing time deposits $ 160,233,000 ================= NOTE 8: NOTES PAYABLE - ---------------------- The Company has a revolving line of credit with the Fort Worth Bank. Proceeds of $4,300,000 under the $6,500,000 line of credit were used to fund the purchase of Azle Bancorp on September 22, 1998. These borrowings were paid off on September 30, 1998, from the proceeds of a $4,500,000 dividend that was paid to the Company by Azle State. The amount available under the line of credit was reduced to $1,500,000 on January 5, 1999, and reduces further to $1,000,000 on October 5, 1999. The line of credit matures on October 1, 2000, bears interest at the floating prime interest rate of the Fort Worth Bank (7.75% at December 31, 1998) and is collateralized by 100% of the stock of Independent Financial and First State. There was no balance outstanding under the line of credit at December 31, 1998. At December 31, 1998, First State had a $1,000 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. The Company had a note payable to the Amarillo Bank. The note, proceeds of which were used to help fund the purchase of Crown Park, originated on January 23, 1997, in the amount of $800,000. The balance was reduced to $200,000 by July 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 First State. On December 31, 1997, the Company paid off the remaining principal balance of the note. 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 note represented a portion of the final settlement of certain litigation. NOTE 9: 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 subsequent to December 31, 1994, the effect of such utilization has been credited against the Company's gross -18- deferred tax asset. The Company's deferred tax provision for 1998, 1997 and 1996 totaled $488,000, $772,000 and $677,000, respectively. Significant components of the Company's deferred tax assets and liabilities at December 31, 1998 and 1997, were as follows:
1998 1997 ------------ ------------ Deferred tax assets: Tax credit carryforwards $ 527,000 $ 998,000 Net operating loss carryforwards 211,000 238,000 Retirement plan 228,000 0 Allowance for possible loan losses 67,000 265,000 Other real estate and other repossessed assets 55,000 115,000 Director indemnification 0 17,000 ------------ ------------ Total gross deferred tax assets 1,088,000 1,633,000 Less valuation allowance for deferred tax assets (132,000) (167,000) ------------ ------------ Net deferred tax assets 956,000 1,466,000 ------------ ------------ Deferred tax liabilities: Depreciation and amortization (257,000) (93,000) Net unrealized gain on available-for-sale securities (83,000) (17,000) Other, net (108,000) (74,000) ------------ ------------ Total gross deferred tax liabilities (448,000) (184,000) ------------ ------------ Net deferred tax asset $ 508,000 $ 1,282,000 ============ ============
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 Bank in Winters, Texas ("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 Bank, Winters, Texas ("Winters State"), which was acquired in 1993, by $35,000 and $112,000 during 1998 and 1997, respectively, 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, 1998, the Company had available net operating loss carryforwards of approximately $335,000 acquired as part of the Winters State acquisition and approximately $325,000 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, 1998, the Company had available general business credit and alternative minimum tax credit carryforwards of approximately $17,000 and $510,000, respectively. If not utilized, the general business credit carryforwards will expire as follows: 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, 1998, 1997 and 1996, consist of the following:
1998 1997 1996 ----------- ----------- ----------- Current tax provision $ 705,000 $ 205,000 $ 76,000 Deferred tax provision 488,000 772,000 677,000 ----------- ----------- ----------- Provision for tax expense charged to results of operations 1,193,000 977,000 753,000 Tax (benefit) on adjustment to unrealized gain/loss on available-for-sale securities 67,000 3,000 (23,000) ----------- ----------- ----------- Comprehensive provision for federal income taxes $ 1,260,000 $ 980,000 $ 730,000 =========== =========== ===========
-19- NOTE 10: GUARANTEED PREFERRED BENEFICIAL INTERESTS IN THE COMPANY'S SUBORDINATED DEBENTURES - ------------------------------------------------------------------- Independent Capital sold 1,300,000 of Trust Preferred Securities at $10.00 per preferred security in the 1998 Offering. The proceeds from the sale of the Trust Preferred Securities were used by Independent Capital to purchase an equivalent amount of Subordinated Debentures of the Company. The Trust Preferred Securities carry a distribution rate of 8.5%, have a stated maturity of September 22, 2028, and are guaranteed by the Company. The securities are redeemable at par after September 22, 2003, and can be redeemed during the first five years after issuance for a premium to par. Distributions on the Trust Preferred Securities are payable quarterly on March 31, June 30, September 30 and December 31. Distributions paid during the year ended December 31, 1998, totaled $304,000. NOTE 11: STOCKHOLDERS' EQUITY - ------------------------------ The Company's Series C Cumulative Convertible Preferred Stock (the "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 stock dividends, 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 at $42.00 per share. 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 stock dividend was accounted for by a transfer from retained earnings to common stock of $97,000, 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 stock dividends. The following are summaries of the number of shares of Series C Preferred Stock, the number of shares of Common Stock reserved for issuance upon conversion of Series C Preferred Stock and the related conversion price per share, adjusted for stock dividends, for the three years ended December 31, 1998:
Shares Conversion Reserved for Price Series C Preferred Stock Issuance Per Share ------------------------ ------------ ------------- Balance January 1, 1996 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 Shares Converted (12,033) 0 -------- ------- Balance December 31, 1998 116,363 $ 1.83 ======== =======
The Company's Employee Stock Ownership/401(k) Plan (the "ESOP/401(k) Plan") purchased 18,750 shares of the Company's Common Stock in the 1997 Offering 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% (8.75% at December 31, 1998). The note is collateralized by the stock purchased in the stock offering. As a result of the lending arrangement between the Company and the ESOP/401(k) Plan, the shares are considered "unearned." The shares are "earned" on a pro rata basis as principal payments are made on the note used to purchase the shares. The shares are included in the Company's earnings per share calculations only as they are earned. At December 31, 1998, a total 14,839 shares with an original cost of $169,000 are considered to be unearned. -20- NOTE 12: 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, 1998, 1997 and 1996, the conversion of the Series C Preferred Stock and the exercise of any 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, 1998, 1997 and 1996 (adjusted for the 5-for-4 stock split, effected in the form of a 25% stock dividend, paid to stockholders in May 1997):
Year Ended December 31, ---------------------------------------- 1998 1997 1996 ---------- ---------- ---------- Basic Earnings Per Common Share (In thousands) - ------------------------------- Net income $ 2,188 $ 2,110 $ 1,422 Preferred stock dividends (22) (41) (63) ---------- ---------- ---------- Net income available to common stockholders $ 2,166 $ 2,069 $ 1,359 ========== ========== ========== Weighted average shares outstanding 2,031 1,842 1,355 ========== ========== ========== Year Ended December 31, ---------------------------------------- 1998 1997 1996 ---------- ---------- ---------- Diluted Earnings Per Common Share (In thousands) - --------------------------------- Net income $ 2,188 $ 2,110 $ 1,422 ========== ========== ========== Weighted average shares outstanding 2,031 1,842 1,355 Exercise of stock options 0 9 8 Conversion of Series C Preferred Stock 120 197 335 ---------- ---------- ---------- Adjusted weighted average shares outstanding 2,151 2,048 1,698 ========== ========== ==========
NOTE 13: BENEFIT PLANS - ----------------------- The Company's ESOP/401(k) Plan covers most of its officers and employees. The ESOP/401(k) 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 Banks. Contributions made to the employee stock ownership portion of the ESOP/401(k) Plan by the Company were $106,000, $100,000 and $77,000 for the years ended December 31, 1998, 1997 and 1996, 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 ESOP/401(k) 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, 1998, 157,059 shares of Common Stock of the Company were held by the ESOP/401(k) Plan. NOTE 14: RELATED PARTY TRANSACTIONS - ------------------------------------ In the ordinary course of business, the Company and the Banks 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 $3,880,000, $2,511,000 and $3,025,000 at December 31, 1998, 1997 and 1996, respectively. Additions and reductions on such loans were $4,338,000 and $2,969,000, respectively, for the year ended December 31, 1998. The Company and its subsidiaries paid $39,000, $42,000 and $28,000 in fees to a director-related company for services rendered on various legal matters during 1998, 1997 and 1996, respectively. -21- NOTE 15: 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, results of operations and liquidity. The Banks lease certain of their premises and equipment under noncancellable operating leases. Rental expense under such operating leases was approximately $322,000, $289,000 and $336,000 in 1998, 1997 and 1996, respectively. The minimum payments due under these leases at December 31, 1998, are as follows: 1999 $ 404,000 2000 403,000 2001 364,000 2002 327,000 2003 121,000 ----------- Total $ 1,619,000 =========== NOTE 16: FAIR VALUE OF FINANCIAL INSTRUMENTS - --------------------------------------------- The carrying amounts and fair values of financial assets and financial liabilities at December 31, 1998 and 1997, were as follows:
1998 1997 --------------------------- --------------------------- Carrying Carrying Amount Fair Value Amount Fair Value Financial Assets ------------ ------------ ------------ ------------ ---------------- Cash and due from banks $ 22,562,000 $ 22,562,000 $ 14,518,000 $ 14,518,000 Federal funds sold 42,175,000 42,175,000 24,900,000 24,900,000 Available-for-sale securities 30,370,000 30,370,000 22,501,000 22,501,000 Held-to-maturity securities 64,838,000 64,906,000 47,293,000 47,376,000 Loans, net of unearned income 184,560,000 186,194,000 140,853,000 143,744,000 Accrued interest receivable 3,254,000 3,254,000 2,208,000 2,208,000 Financial Liabilities --------------------- Noninterest-bearing demand deposits $ 60,086,000 $ 60,086,000 $ 43,868,000 $ 43,868,000 Interest-bearing demand deposits 110,485,000 110,485,000 77,495,000 77,495,000 Interest-bearing time deposits 160,233,000 161,035,000 121,438,000 121,724,000 Accrued interest payable 1,163,000 1,163,000 947,000 947,000 Notes payable 1,000 1,000 57,000 57,000 Guaranteed preferred beneficial interests in the Company's subordinated debentures 13,000,000 13,000,000 - -
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. 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. Fair value for the guaranteed preferred beneficial interests in the Company's subordinated debentures is based on the closing price for the Trust Preferred Securities as quoted on the American Stock Exchange at December 31, 1998. -22- The carrying amounts for cash and due from banks, federal funds sold, accrued interest receivable, accrued interest payable, notes payable and 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 and commercial 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 17: 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 and standby and commercial letters of credit. 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 or standby or commercial letters of credit 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 $19,606,000 and outstanding standby and commercial letters of credit of approximately $206,000 at December 31, 1998. 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 and commercial letters of credit 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 or commercial 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 or standby or commercial letters of credit that were outstanding at December 31, 1998. In the normal course of business, the Company maintains deposits with other financial institutions in amounts which exceed FDIC insurance coverage limits. NOTE 18: REGULATORY MATTERS - ---------------------------- The Company and the Banks 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 each of the Banks' respective financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Company and each of the Banks must meet specific capital guidelines that involve quantitative measures of the Company's and each Banks' respective assets, liabilities, and certain off-balance-sheet items as calculated under regulatory accounting practices. The Company's and each Banks' respective capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings and other factors. Quantitative measures established by regulation to ensure capital adequacy require the Company and each of the Banks 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, 1998, the Company and the Banks met all capital adequacy requirements to which they were subject. At December 31, 1998, the most recent notifications from the FDIC categorized the Banks as well capitalized under the regulatory framework for prompt corrective action. To be categorized as well capitalized, the Company and -23- the Banks 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 any of the Banks' category. The minimum regulatory capital ratios, minimum capital ratios for well capitalized bank holding companies and the Company's actual capital amounts and ratios at December 31, 1998 and 1997, were as follows:
December 31, Minimum Well ------------------------ Capital Capitalized 1998 1997 Ratios Ratios --------- --------- ------- ----------- (Dollars in thousands) Tier 1 capital $ 21,344 $ 17,737 Total capital 28,356 18,510 Risk-weighted assets 205,971 154,036 Adjusted quarterly average assets 357,815 258,496 Capital ratios: Tier 1 capital to risk-weighted assets 10.36% 11.26% 4.00% 6.00% Total capital to risk-weighted assets 13.77 12.02 8.00 10.00 Tier 1 capital to adjusted quarterly average assets 5.97 6.71 4.00 5.00
The minimum capital ratios for well capitalized banks and the Banks' actual capital ratios at December 31, 1998, were as follows:
Minimum Ratios for Well Actual Ratios at Capitalized Banks December 31, 1998 ----------------- ----------------- Tier 1 capital to risk-weighted assets 6.00% 11.46-12.04% Total capital to risk-weighted assets 10.00 12.21-13.22 Tier 1 capital to adjusted quarterly average assets 5.00 6.77-7.53
At December 31, 1998, retained earnings of the Banks included approximately $4,254,000 that was available for payment of dividends to the Company without prior approval of regulatory authorities. -24- NOTE 19: PARENT COMPANY FINANCIAL INFORMATION - ---------------------------------------------- Condensed financial statements of the Company, parent only, are presented below: INDEPENDENT BANKSHARES, INC. CONDENSED BALANCE SHEETS DECEMBER 31, 1998 AND 1997
1998 1997 ------------ ------------ Assets: Cash $ 550,000 $ 326,000 Loans 65,000 0 Investment in subsidiaries 36,314,000 19,125,000 Premises and equipment 0 2,000 Other assets 1,033,000 1,214,000 ------------ ------------ Total assets $ 37,962,000 $ 20,667,000 ============ ============ Liabilities: Note payable $ 0 $ 50,000 Accrued interest payable and other liabilities 55,000 90,000 ------------ ------------ Total liabilities 55,000 140,000 Subordinated debentures 13,402,000 0 Stockholders' equity 24,505,000 20,527,000 ------------ ------------ Total liabilities and stockholders' equity $ 37,962,000 $ 20,667,000 ============ ============
INDEPENDENT BANKSHARES, INC. CONDENSED INCOME STATEMENTS YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
1998 1997 1996 ------------ ------------ ------------ Income: Dividends from subsidiaries (see Note 18) $ 5,259,000 $ 900,000 $ 1,000,000 Management fees from subsidiaries 145,000 150,000 161,000 Interest on loan to the ESOP/401(k) Plan 23,000 18,000 0 Interest from subsidiaries 6,000 1,000 3,000 Other income 11,000 0 0 ------------ ------------ ------------ Total income 5,444,000 1,069,000 1,164,000 ------------ ------------ ------------ Expenses: Interest 321,000 33,000 58,000 Other expenses 680,000 570,000 557,000 ------------ ------------ ------------ Total expenses 1,001,000 603,000 615,000 ------------ ------------ ------------ Income before federal income taxes and equity in undistributed earnings of subsidiaries 4,443,000 466,000 549,000 Federal income tax benefit (93,000) (276,000) (162,000) ------------ ------------ ------------ Income before equity in undistributed earnings of subsidiaries 4,536,000 742,000 711,000 Equity in undistributed earnings of subsidiaries (2,348,000) 1,368,000 711,000 ------------ ------------ ------------ Net income $ 2,188,000 $ 2,110,000 $ 1,422,000 ============ ============ ============
-25- INDEPENDENT BANKSHARES, INC. CONDENSED STATEMENTS OF CASH FLOWS YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
1998 1997 1996 ------------ ------------ ------------ Cash flows from operating activities: Net income $ 2,188,000 $ 2,110,000 $ 1,422,000 Adjustments to reconcile net income to net cash provided by operating activities: Deferred federal income tax expense 488,000 772,000 677,000 Depreciation and amortization 2,000 1,000 1,000 Equity in undistributed earnings of subsidiaries 2,348,000 (1,368,000) (711,000) Increase in other assets (398,000) (197,000) (540,000) Increase (decrease) in accrued interest payable and other liabilities 76,000 (231,000) (16,000) ------------ ------------ ------------ Net cash provided by operating activities 4,704,000 1,087,000 833,000 ------------ ------------ ------------ Cash flows from investing activities: Loans made to employee stock ownership plan (95,000) (239,000) 0 Proceeds from repayments of loans made to employee stock ownership plan 54,000 46,000 0 Purchase of subsidiary bank (19,025,000) 0 0 Capital contributions made to subsidiaries (402,000) (4,200,000) 0 ------------ ------------ ------------ Net cash used in investing activities (19,468,000) (4,393,000) 0 ------------ ------------ ------------ Cash flows from financing activities: Proceeds from notes payable 4,300,000 800,000 0 Repayment of notes payable (4,350,000) (983,000) (616,000) Proceeds from issuance of subordinated debentures 13,402,000 0 0 Net proceeds from issuance of equity securities 2,067,000 4,077,000 0 Cash paid for fractional shares in stock dividend 0 (5,000) 0 Payment of cash dividends (431,000) (405,000) (260,000) ------------ ------------ ------------ Net cash provided by (used in) financing activities 14,988,000 3,484,000 (876,000) ------------ ------------ ------------ Net increase (decrease) in cash and cash equivalents 224,000 178,000 (43,000) Cash and cash equivalents at beginning of year 326,000 148,000 191,000 ------------ ------------ ------------ Cash and cash equivalents at end of year $ 550,000 $ 326,000 $ 148,000 ============ ============ ============
NOTE 20: SUPPLEMENTAL CASH FLOW INFORMATION - -------------------------------------------- Supplemental cash flow information for the years ended December 31, 1998, 1997 and 1996, is as follows:
1998 1997 1996 ------------ ------------ ------------ Cash paid during the year for: Interest $ 9,368,000 $ 8,663,000 $ 6,372,000 Federal income taxes 630,000 670,000 438,000 Noncash investing activities: Additions to other real estate and other repossessed assets during the year through foreclosures $ 1,433,000 $ 1,283,000 $ 1,015,000 Sales of other real estate and other repossessed assets financed with loans 167,000 93,000 240,000 Increase (decrease) in unrealized gain on available-for-sale securities, net of tax $ 130,000 $ 6,000 $ (43,000) Details of acquisitions: Cash paid in acquisitions $ 19,025,000 $ 7,510,000 $ 1,505,000 Cash and cash equivalents held by companies acquired at dates of acquisition (8,892,000) (6,274,000) (15,708,000) ------------ ------------ ------------ Net cash paid (acquired) in acquisitions $ 10,133,000 $ 1,236,000 $(14,203,000) ============ ============ ============ -26- QUARTERLY DATA (UNAUDITED) - ------------------------- The following table presents the unaudited results of operations for the past two years by quarter. See "Note 12: Earnings Per Share" in the Company's Consolidated Financial Statements.
1998 ------------------------------------------------ First Second Third Fourth Quarter Quarter Quarter Quarter Total -------- -------- -------- -------- -------- (In thousands, except per share amounts) Interest income $ 4,575 $ 4,649 $ 4,872 $ 6,338 $ 20,434 Interest expense 2,153 2,134 2,196 2,793 9,276 Net interest income 2,422 2,515 2,676 3,545 11,158 Provision for loan losses 175 125 135 135 570 Income before federal income taxes 723 814 890 954 3,381 Net income 455 519 568 646 2,188 Basic earnings per common share available to common stockholders $ 0.23 $ 0.26 $ 0.28 $ 0.30 $ 1.07 Diluted earnings per common share available to common stockholders 0.22 0.25 0.27 0.28 1.02 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
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 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 12: Earnings Per Share" and the Other Notes in the Company's Consolidated Financial Statements for an explanation of changes in financial statement items.
1998 1997 1996 1995 1994 ----------- ----------- ----------- ----------- ----------- (In thousands, except per share amounts) Balance sheet information: Assets $ 370,178 $ 264,574 $ 205,698 $ 180,344 $ 159,860 Loans, net of unearned income 184,560 140,853 92,017 81,927 81,306 Deposits 330,804 242,801 189,575 164,704 146,184 Notes payable 1 57 240 849 930 Stockholders' equity 24,505 20,527 14,937 13,818 11,073 Income statement information: Total interest income $ 20,434 $ 18,324 $ 13,556 $ 11,962 $ 10,131 Net interest income 11,158 9,665 7,115 6,653 6,679 Net income 2,188 2,110 1,422 1,132 450 Basic earnings per common share available to common stockholders $ 1.07 $ 1.12 $ 1.00 $ 0.82 $ 0.29 Diluted earnings per common share available to common stockholders 1.02 1.03 0.84 0.67 0.27 Cash dividends per common share 0.20 0.19 0.14 0.09 0.06 Weighted average common shares outstanding: Basic 2,031 1,842 1,355 1,299 1,302 Diluted 2,151 2,048 1,698 1,689 1,685
-28- MARKET INFORMATION The Company's Common Stock trades on the American Stock Exchange (the "AMEX") under the symbol "IBK." Independent Capital's Trust Preferred Securities trade on the AMEX under the symbol "IBK.Pr." The following table sets forth, for the periods indicated, the high and low sales prices for the Common Stock and Trust Preferred Securities as quoted on the AMEX and the amount of cash dividends and distributions paid per share, adjusted for the 5-for-4 stock split of the Common Stock, effected in the form of a 25% stock dividend, paid to stockholders in May 1997.
Common Stock Trust Preferred Securities ----------------------------- --------------------------------- Cash Distributions Dividends Per High Low Per Share High Low Security ------- ------- --------- ------ ------ -------------- 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 Ended December 31, 1998 ---------------------------- First Quarter $19-5/8 $15-3/4 $0.05 $ - $ - $ - Second Quarter 19 14-3/8 0.05 - - - Third Quarter 15-9/16 11 0.05 10-1/16 10-1/16 - Fourth Quarter 11-7/8 10-1/4 0.05 10-3/4 9-1/2 0.23 Year Ending December 31, 1999 ----------------------------- First Quarter (through March 18) $12-1/8 $10-1/2 $0.05(1) 10-7/8 9-1/2 0.21(2) _____________ (1) This cash dividend was paid February 26, 1999, to shareholders of record on February 12, 1999. (2) This distribution is scheduled to be paid on March 31, 1999, to security holders of record on such date. At March 18, 1999, there were approximately 1,777 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 owns all of the common securities of Independent Capital Trust ("Independent Capital") and indirectly owns through a Delaware subsidiary, Independent Financial Corp. ("Independent Financial"), 100% of the stock of First State Bank, N.A., Abilene, Texas ("First State") and Azle State Bank, Azle, Texas ("Azle State") (collectively, the "Banks"). The Banks currently operate full-service banking locations in the Texas cities of Abilene (3 locations), Azle (2 locations), Lubbock, Odessa (4 locations), San Angelo, Stamford and Winters. On March 12, 1999, Azle State was merged with and into First State and Azle State's two locations became branches of First State. General - ------- The following discussion and analysis presents the more significant factors affecting the Company's financial condition at December 31, 1998 and 1997, and results of operations for each of the three years in the period ended December 31, 1998, 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 split, effected in the form of a stock dividend, described in Note 11 to the Company's Consolidated Financial Statements. Bank Acquisitions - ----------------- AZLE BANCORP AND AZLE STATE. The Company completed the acquisition of Azle Bancorp and its subsidiary bank, Azle State, effective September 22, 1998, for an aggregate cash consideration of $19,025,000. To obtain funding for the acquisition, the Company sold an aggregate of 230,000 shares of Common Stock at a price of $11.50 per share, and Independent Capital, a Delaware business trust formed by the Company, sold 1,300,000 of its 8.5% Cumulative Trust Preferred Securities (the "Trust Preferred Securities") at $10.00 per preferred security (having a liquidation value of $13,000,000) in an underwritten offering (collectively, the "1998 Offering"). The proceeds from the sale of the Trust Preferred Securities were used by Independent Capital to purchase an equivalent amount of Subordinated Debentures of the Company. The Company also borrowed $4,300,000 from a financial institution in Fort Worth, Texas (the "Fort Worth Bank") to finance a portion of the cost of acquiring Azle Bancorp. The borrowings from the Fort Worth Bank were paid off on September 30, 1998, from the proceeds of a cash dividend paid to the Company by Azle State. At the date of acquisition, Azle Bancorp had total assets of $93,158,000, total loans, net of unearned income, of $45,163,000, total deposits of $80,955,000 and stockholders' equity of $9,872,000. This acquisition was accounted for using the purchase method of accounting. A total of $8,014,000 of intangible assets, including $2,895,000 of core deposit intangible and $5,119,000 of goodwill, was -30- recorded as a result of this acquisition. The core deposit intangible is being amortized over a period of 12 years and the goodwill is being amortized over a period of 25 years. CROWN PARK AND WESTERN NATIONAL. 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 First State. To obtain funding for the acquisition, the Company sold an aggregate of 395,312 shares of its common stock ("Common Stock") in an underwritten offering at a price of $11.40 per share (the "1997 Offering"). The 1997 Offering included the sale of 51,562 shares covered by the underwriter's over-allotment option. The above number of shares and price per share have been adjusted for the 5-for-4 stock split, effected in the form of a 25% stock dividend, paid to the Company's shareholders in May 1997. 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 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. Such goodwill is being amortized over a period of 15 years. SAN ANGELO BRANCH. On May 27, 1996, First State 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") in a cash transaction, and Coastal Banc - San Angelo became a branch of First State. On the date of the acquisition, Coastal Banc - San Angelo had approximately $14,895,000 in total deposits and $155,000 in total loans. A total of $743,000 of goodwill was recorded as a result of this acquisition and is being amortized over a period of 15 years. Peoples National. First State 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 First State. 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. A total of $260,000 of goodwill was recorded as a result of this acquisition and is being amortized over a period of 15 years. These acquisitions were accounted for under the purchase method of accounting, and the results of operations of Azle State, Western National, 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 Azle State, Western National, Coastal Banc - San Angelo and Peoples National were recorded at their estimated fair value. Results of Operations - --------------------- GENERAL Net income for the year ended December 31, 1998, amounted to $2,188,000 ($1.02 diluted earnings per common share) compared to net income of $2,110,000 ($1.03 diluted earnings per common share) for the year ended December 31, 1997, and compared to net income of $1,422,000 ($0.84 diluted earnings per common share) for the year ended December 31, 1996. The results of operations for 1998 were negatively impacted by $125,000 ($83,000, net of tax), or $0.04 diluted earnings per common share, as a result of the settlement of certain potential 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 1998, the Company's ROA was 0.75%, compared to 0.82% for 1997 and compared to 0.72% for 1996. Excluding the nonrecurring item noted above, the Company's ROA for 1998 would have been 0.77%. 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 -31- stockholders. During 1998, the Company's ROE was 9.89%, compared to 10.95% for 1997 and 9.89% for 1996. Excluding the nonrecurring item noted above, the Company's ROE for 1998 would have been 10.27%. 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 $11,158,000 for 1998, an increase of $1,493,000, or 15.4%, from 1997. Net interest income for 1997 was $9,665,000, an increase of $2,550,000, or 35.8%, from 1996. The increase in 1998 was primarily due to the acquisition of Azle State in September 1998. The increase in 1997 was primarily due to the acquisition of Western National in January 1997. The net interest margin on a fully taxable-equivalent basis was 4.30% for 1998, compared to 4.13% for 1997 and 3.95% for 1996. The primary reasons for the increase in net interest margin during 1998 were a small increase in the Company's average loan-to-deposit ratio, a decrease in the Company's overall costs of funds and a shift within the loan portfolio to more commercial and real estate loans and away from lower-yielding indirect installment loans. The primary reason for the increase in 1997 was the acquisition of Western National, which had a higher loan-to-deposit ratio than First State. At December 31, 1998, approximately $48,093,000, or 26.1%, of the Company's total loans, net of unearned income, were loans with floating interest rates. This amount represented 37.4% of loans, excluding loans to individuals, which are exclusively fixed rate in nature. The overall average rate paid for total deposits decreased slightly in 1998. The average rate paid by the Company for certificates of deposit and other time deposits of $100,000 or more decreased to 5.35% during 1998 from 5.54% in 1997. The average rate paid for certificates of deposit less than $100,000 decreased from 5.36% in 1997 to 5.31% in 1998. Rates on other types of deposits, such as savings accounts, money market accounts and NOW accounts, decreased from an average of 2.69% in 1997 to an average of 2.55% in 1998. 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 falling interest rate environment would normally produce a higher net interest margin than a rising 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 increase significantly in an overall falling 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, ------------------------------------------------------------------------------------- 1998 1997 1996 -------------------------- -------------------------- ------------------------- Interest Interest Interest Average Income/ Yield/ Average Income/ Yield/ Average Income/ Yield/ Balance Expense Rate Balance Expense Rate Balance Expense Rate ------- ------- ------ ------- ------- ------ ------- ------- ------ ASSETS (1) (Dollars in thousands) Interest-earning assets: Loans, net of unearned income (2) $153,188 $ 14,150 9.24% $132,891 $ 12,236 9.21% $ 85,880 $ 8,005 9.32% Securities (3) 73,363 4,498 6.13 84,566 5,181 6.13 74,920 4,507 6.02 Federal funds sold 34,472 1,859 5.39 16,469 912 5.54 19,406 1,047 5.40 -------- -------- ------ -------- -------- ------ -------- -------- ------ Total interest-earning assets 261,023 20,507 7.86 233,926 18,329 7.84 180,206 13,559 7.52 -------- -------- ------ -------- -------- ------ -------- -------- ------ Noninterest-earning assets: Cash and due from banks 15,149 11,051 7,151 Premises and equipment, net 8,233 6,951 4,427 Intangible assets 5,242 3,116 689 Accrued interest receivable and other assets 5,220 5,030 4,507 Allowance for possible loan losses (1,288) (1,200) (825) -------- -------- -------- Total noninterest-earning assets 32,556 24,948 15,949 -------- -------- -------- Total assets $293,579 $258,874 $196,155 ======== ======== ======== LIABILITIES AND STOCKHOLDERS' EQUITY (1) Interest-bearing liabilities: Demand, savings and money market deposits $ 86,428 $ 2,207 2.55% $ 75,833 $ 2,037 2.69% $ 57,847 $ 1,397 2.41% Time deposits 132,654 7,061 5.32 121,218 6,563 5.41 92,065 4,985 5.41 -------- -------- ------- -------- -------- ------ -------- -------- ------ Total interest-bearing deposits 219,082 9,268 4.23 197,051 8,600 4.36 149,912 6,382 4.26 Notes payable 100 8 8.00 714 59 8.26 568 59 10.39 -------- -------- ------- -------- -------- ------ -------- -------- ------ Total interest-bearing liabilities 219,182 9,276 4.23 197,765 8,659 4.38 150,480 6,441 4.28 -------- -------- ------- -------- -------- ------ -------- -------- ------ Noninterest-bearing liabilities: Demand deposits 46,877 40,328 30,093 Accrued interest payable and other liabilities 1,809 1,506 1,207 -------- -------- -------- Total noninterest-bearing liabilities 48,686 41,834 31,300 -------- -------- -------- Total liabilities 267,868 239,599 181,780 Guaranteed preferred beneficial interests in the Company's subordinated debentures 3,597 0 0 Stockholders' equity 22,114 19,275 14,375 -------- -------- -------- Total liabilities and stockholders' equity $293,579 $258,874 $196,155 ======== ======== ======== Net interest income $ 11,231 $ 9,670 $ 7,118 ======== ======== ======== Interest rate spread (4) 3.63% 3.46% 3.24% ====== ====== ====== Net interest margin (5) 4.30% 4.13% 3.95% ====== ====== ====== ______________________________ (1) The Average Balance and Interest Income/Expense columns include the balance sheet and income statement accounts of Peoples National, Coastal Banc-San Angelo, Western National and Azle State from January 1, 1996, May 27, 1996, January 28, 1997 and September 22, 1998 (the respective dates of acquisition of such banks), through December 31, 1998. (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.
1998(1) vs 1997 1997(1) vs 1996 --------------------------- --------------------------- 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 $ 1,875 $ 39 $ 1,914 $ 4,377 $ (146) $ 4,231 Securities (2) (683) 0 (683) 581 93 674 Federal funds sold 971 (24) 947 (158) 23 (135) ------- ------- ------- ------- ------- ------- Total interest income 2,163 15 2,178 4,800 (30) 4,770 ------- ------- ------- ------- ------- ------- Interest-bearing liabilities: Deposits: Demand, savings and money market deposits 270 (100) 170 430 210 640 Time deposits 608 (110) 498 1,578 0 1,578 ------- ------- ------- ------- ------- ------- Total deposits 878 (210) 668 2,008 210 2,218 Notes payable (49) (2) (51) 15 (15) 0 ------- ------- ------- ------- ------- ------- Total interest expense 829 (212) 617 2,023 195 2,218 ------- ------- ------- ------- ------- ------- Increase (decrease) in net interest income $ 1,334 $ 227 $ 1,561 $ 2,777 $ (225) $ 2,552 ======= ======= ======= ======= ======= ======= ______________________________ (1) Income statement items include the income statement accounts of Peoples National, Coastal Banc - San Angelo Western National and Azle State beginning January 1, 1996, May 27, 1996, January 28, 1997 and September 22, 1998 (the respective dates of acquisition of such banks), through December 31, 1998. (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 Banks; 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, 1998, was $570,000, compared to $250,000 for the previous year. The provision in 1998 represented an increase of $320,000, or 128%, from the 1997 provision. The higher provision in 1998 is due to increased charge-offs during 1998, 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, 1997 and 1998. The provision in 1997 represented an increase of $49,000, or 24.4%, from the 1996 provision due to increased charge-offs in the indirect installment loan portfolio noted above. Noninterest Income - ------------------ Noninterest income increased $882,000, or 46.2%, from $1,909,000 in 1997 to $2,791,000 in 1998. The amount for 1997 increased $358,000, or 23.1%, from $1,551,000 in 1996. -34- 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 $622,000, or 38.8%, from $1,605,000 for 1997 to $2,227,000 for 1998. Approximately 33% of the increase was attributable to the acquisition of Azle State in September 1998. The remainder of the increase was due to service charges on the accounts of seven (7) large grocery stores, which began in October 1997, and an increase in rates on selected charges during the first quarter of 1998. Service charge income increased $346,000, or 27.5%, from $1,259,000 for 1996 to $1,605,000 for 1997, primarily due to the acquisition of Western National in January 1997. Trust fees from trust operations increased $4,000, or 2.1%, from $195,000 in 1997 to $199,000 in 1998. Trust fees increased $6,000, or 3.2%, from $189,000 during 1996 to $195,000 during 1997. The increases in 1998 and 1997 are due to an overall increase in the value of assets under management of the trust department. There were no sales of securities during 1998. 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. The securities portfolio had an average life of approximately 2.36 years at December 31, 1998, compared to approximately 1.32 years at December 31, 1997. The increase in average life is due to the acquisition of Azle State, whose securities, particularly obligations of states and political subdivisions, have a longer average maturity than First State's securities portfolio. Other income is the sum of several components of noninterest income including insurance premiums earned on automobiles financed through the Company's indirect installment loan program, check printing income, commissions earned on the sale of mutual funds and annuities, bankcard royalty income and other sources of miscellaneous income. Other income increased $256,000, or 234.9%, from $109,000 in 1997 to $365,000 in 1998 due to the acquisition of Azle State in September 1998, a significant increase in insurance premiums received during the first half of 1998 on automobiles financed through the Company's indirect installment lending program and an increase in check printing income. The Company also had a significant increase in commissions earned from investment services, which the Company began promoting during the second quarter of 1997. Other income increased $6,000, or 5.8%, from $103,000 in 1996 to $109,000 for 1997, due to the acquisition of Western National in January 1997. Noninterest Expenses - -------------------- Noninterest expenses increased $1,761,000, or 21.4%, from $8,237,000 in 1997 to $9,998,000 in 1998. Over two-thirds of the increase was attributable to the acquisition of Azle State and the payment of distributions on the Company's Trust Preferred Securities that were sold in the 1998 Offering. Noninterest expenses increased $1,947,000, or 31.0%, from $6,290,000 in 1996 to $8,237,000 in 1997. Approximately 80% of the increase was due to the acquisition of Western National. Salaries and benefits rose $782,000, or 19.7%, from $3,970,000 in 1997 to $4,752,000 in 1998. Approximately 61% of the increase was a result of the acquisition of Azle State in September 1998. An additional 23% of the increase was due to the opening of three supermarket branch locations, two in October 1997 and one in May 1998. Salaries and employee benefits increased $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 Western National. Net occupancy expense increased $242,000, or 28.2%, from $857,000 in 1997 to $1,099,000 in 1998. Approximately 37% of the increase was due to the acquisition of Azle State. An additional 42% of the increase was due to the opening of the three supermarket branch locations. Net occupancy expense increased $141,000, or 19.7%, from $716,000 in 1996 to $857,000 in 1997. The increase was due entirely to the acquisition of Western National. Equipment expense increased $53,000, or 6.4%, from $834,000 in 1997, to $887,000 in 1998. The relatively small increase was due to the expiration of operating leases on certain data processing equipment during the first half of 1998. The equipment was purchased at the end of the leases. The depreciation expense on this equipment and other replacement equipment purchased later in 1998 was less than the lease expense previously recorded. The reduction in these expenses helped offset additional equipment expense incurred as a result of the acquisition of Azle State and the opening of the three supermarket branches. Equipment expense increased $171,000, or 25.8%, from $663,000 in 1996 to $834,000 for 1997. Approximately three-fourths of this increase was the result of the Western National acquisition. -35- Stationery, printing and supplies expense increased $23,000, or 5.5%, from $419,000 for 1997 to $442,000 for 1998. Approximately three-fourths of the increase was due to the Azle State acquisition and the opening of the three supermarket bank branches. Stationery, printing and supplies expense increased $131,000, or 45.5%, from $288,000 for 1996 to $419,000 for 1997, primarily due to the acquisition of Western National and the opening of two of the supermarket branches during the fourth quarter of 1997. Amortization of intangible assets increased $121,000 or 55.5%, from $218,000 for 1997 to $339,000 for 1998 as a result of the amortization of the core deposit intangible and goodwill incurred in conjunction with the acquisition of Azle State. These expenses increased $172,000, or 373.9%, from $46,000 for 1996 to $218,000 for 1997 as a result of amortization of goodwill recorded upon the acquisition of Western National. Professional fees, which include legal and accounting fees, decreased $28,000, or 8.4%, from $333,000 during 1997 to $305,000 during 1998. The decrease was a result of increased legal fees incurred immediately after the 1997 acquisition related to Western National and legal fees incurred during the first quarter of 1997 to settle litigation, which resulted in a recovery of approximately $108,000 of a previously charged off loan. Professional fees increased $29,000, or 9.5%, from $304,000 during 1996 to $333,000 for 1997. The increase during 1997 was due to the additional legal fees incurred on collection of loans made by Western National noted above. Distributions on guaranteed preferred beneficial interests in the Company's Subordinated Debentures totaled $304,000 for 1998. Independent Capital issued $13,000,000 of Trust Preferred Securities in the 1998 Offering, on which distributions are payable quarterly at the rate of 8.5%. 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 $106,000 in 1998 compared to net costs of $23,000 in 1997, an increase of $83,000, or 360.9%. The increase in net costs during 1998 was partially due to an increase in the number of repossessed automobiles during 1998 and the acquisition of Azle State. In addition, net gains on sales and rental income received on such assets totaled $27,000 for 1998, compared to $81,000 for 1997. Net costs of the Company were $23,000 in 1997 compared to net revenues of $24,000 in 1996 as a result of $52,000 of such expenses recorded by the Lubbock branch of First State during 1997. Other noninterest expense includes, among many other items, postage, due from bank account charges, data processing, armored car and courier fees, travel and entertainment, advertising, insurance, regulatory examinations, directors' fees, dues and subscriptions, franchise taxes and Federal Deposit Insurance Corporation ("FDIC") insurance. These expenses increased $181,000, or 11.4%, from $1,583,000 during 1997 to $1,764,000 during 1998. Approximately 71% of the increase was due to the acquisition of Azle State in September 1998. These expenses increased $368,000, or 30.3%, from $1,215,000 for 1996 to $1,583,000 for 1997. The entire increase in 1997 was due to the acquisition of Western National. 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 subsequent to December 31, 1994, the tax effect of such utilization has been credited against the Company's gross deferred tax asset. The Company provided for $1,193,000, $977,000 and $753,000 in federal income taxes in 1998, 1997 and 1996, respectively. The 1998 and 1997 amounts were lowered by $35,000 and $112,000, respectfully, 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 -36- 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. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK The business of the Company and the composition of its consolidated balance sheet consists of investments in interest- earning assets (primarily loans and investment securities) which are primarily funded by interest-bearing liabilities (deposits). Such financial instruments have varying levels of sensitivity to changes in market interest rates resulting in the market risk. Interest Rate Risk Measurement - ------------------------------ Interest rate risk arises when an interest-earning asset matures or when its rate of interest changes in a time frame different from that of the supporting interest-bearing liability. The Company seeks to minimize the difference between the amount of interest-earning assets and the amount of interest-bearing liabilities that could change interest rates in the same time frame in an attempt to reduce the risk of significant adverse effects on the Company's net interest income caused by interest rate changes. The Company does not attempt to match each interest-earning asset with a specific interest-bearing liability. Instead, as shown in the table below, it aggregates all of its interest-earning assets and interest-bearing liabilities to determine the difference between the two in specific time frames. This difference is known as the rate- sensitivity gap. A positive gap indicates that more interest- earning assets than interest-bearing liabilities mature in a time frame, and a negative gap indicates the opposite. Maintaining a balanced position will reduce risk associated with interest rate changes, but it will not guarantee a stable interest rate spread because the various rates within a time frame may change by differing amounts and occasionally change in different directions. Management regularly monitors the interest sensitivity position and considers this position in its decisions in regard to interest rates and maturities for interest-earning assets acquired and interest-bearing liabilities accepted. In adjusting the Company's asset/liability position, management attempts to manage the Company's interest rate risk while enhancing net interest margins. The rates, terms and interest rate indices of the Company's interest-earning assets result primarily from the Company's strategy of investing in loans and securities, which permit the Company to limit its exposure to interest rate risk, together with credit risk, while at the same time achieving a positive interest rate spread from the difference between the income earned on interest-earning assets and the cost of interest-bearing liabilities. 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 70.2% at the 90-day interval, 64.7% at the 180-day interval and 63.0% at the 365-day interval at December 31, 1998. Currently, the Company is in a liability-sensitive position at the three intervals. During an overall falling interest rate environment, this position would normally produce a higher net interest margin than in a rising interest rate environment; however, because the Company had $110,485,000 of interest-bearing demand, savings and money market deposits at December 31, 1998, that are somewhat less rate-sensitive, the Company's net interest margin does not necessarily increase significantly in an overall declining interest rate environment. Excluding these types of deposits, the Company's interest-sensitive assets to interest sensitive liabilities ratio at the 365-day interval would have been 112.3% at December 31, 1998. 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. -37- The following table shows the interest rate sensitivity position of the Company at December 31, 1998:
Volumes Subject to Cumulative Volumes Repricing Subject to Repricing Within After 90 Days 180 Days 365 Days 1 Year Total -------- -------- -------- ---------- -------- (Dollars in thousands) Interest-earning assets: Federal funds sold $ 42,175 $ 42,175 $ 42,175 $ 0 $ 42,175 Securities 4,404 7,411 13,450 81,758 95,208 Loans, net of unearned income 68,205 81,634 102,707 81,853 184,560 -------- -------- -------- -------- -------- Total interest-earning assets 114,784 131,220 158,332 163,611 321,943 -------- -------- -------- -------- -------- Interest-bearing liabilities: Demand, savings and money market deposits 110,485 110,485 110,485 0 110,485 Time deposits 52,939 92,215 140,926 19,307 160,233 Notes payable 1 1 1 0 1 -------- -------- -------- -------- -------- Total interest-bearing liabilities 163,425 202,701 251,412 19,307 270,719 -------- -------- -------- -------- -------- Rate-sensitivity gap(1) $(48,641) $(71,481) $(93,080) $144,304 $ 51,224 ======== ======== ======== ======== ======== Rate-sensitivity ratio (2) 70.2% 64.7% 63.0% ==== ==== ==== ______________________________ (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.
Net Economic Value - ------------------ The interest rate risk ("IRR") component is a dollar amount that is deducted from total capital for the purpose of calculating an institution's risk-based capital requirement and is measured in terms of the sensitivity of its net economic value ("NEV") to changes in interest rates. An institution's NEV is calculated as the net discounted cash flows from assets, liabilities and off-balance sheet contracts. As an institution's IRR component is measured as the change in the ratio of NEV to the net present value of total assets as a result of a hypothetical 200 basis point change in market interest rates. A resulting decline in this ratio of more than 2% of the estimated present value of an institution's total assets prior to the hypothetical 200 basis point change will require the institution to deduct from its regulatory capital 50% of that excess decline. Based on quarterly calculations, the Banks experienced no such decline. Although certain assets and liabilities may have similar maturities or periods to repricing, they may react in different degrees to changes in market interest rates. Also, the interest rates on certain types of assets and liabilities may fluctuate in advance of changes in market interest rates, while interest rates on other types may lag behind changes in market rates. Additionally, certain assets, such as adjustable-rate mortgage loans, have features that restrict changes in interest rates on a short-term basis and over the life of the loan. Further, in the event of a change in interest rates, prepayment and early withdrawal levels could 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 a significant interest rate increase. The Company considers all of these factors in monitoring its exposure to interest rate risk. The repricing of certain categories of assets and liabilities are subject to competitive and other pressures beyond the Company's control. As a result, certain assets and liabilities indicated as maturing or otherwise repricing within a stated period may in fact mature or reprice at different times and at different volumes. 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 -38- 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 1999 2000 2001 2002 2003 Thereafter Total Value --------- --------- --------- --------- --------- --------- --------- --------- (Dollars in thousands) Fixed Rate Loans: Maturities $ 54,679 $ 27,137 $ 18,876 $ 17,952 $ 15,387 $ 2,436 $ 136,467 $ 138,101 Average interest rate 9.51% 9.90% 9.79% 9.73% 8.87% 9.11% 9.58% Adjustable Rate Loans: Maturities 22,747 6,570 4,720 3,750 3,055 7,251 48,093 48,093 Average interest rate 9.49% 9.23% 9.44% 9.39% 9.17% 8.94% 9.34% Investments and Other Interest-earning Assets: Maturities 55,625 28,253 15,841 9,249 17,680 10,735 137,383 137,450 Average interest rate 5.21% 5.56% 6.08% 6.36% 6.43% 8.11% 5.84% Total Interest-earning Assets: Maturities $ 133,051 $ 61,960 $ 39,437 $ 30,951 $ 36,122 $ 20,422 $ 321,943 $ 323,644 Average interest rate 7.71% 7.85% 8.26% 8.68% 7.70% 8.52% 7.95% Savings Deposits: Maturities $ 0 $ 0 $ 0 $ 0 $ 0 $ 22,864 $ 22,864 $ 22,864 Average interest rate --% --% --% --% --% 2.63% 2.63% NOW Deposits: Maturities 0 0 0 0 0 52,006 52,006 52,006 Average interest rate --% --% --% --% --% 1.67% 1.67% Money Market Deposits: Maturities 0 0 0 0 0 35,615 35,615 35,615 Average interest rate --% --% --% --% --% 3.15% 3.15% Certificates of Deposit: Maturities 140,926 12,504 2,987 2,214 1,602 0 160,233 161,035 Average interest rate 5.08% 5.59% 5.64% 5.78% 3.95% --% 5.13% Notes Payable: Maturities 1 0 0 0 0 0 1 1 Average interest rate 7.50% --% --% --% --% --% 7.50% Total Interest-bearing Liabilities: Maturities $ 140,927 $ 12,504 $ 2,987 $ 2,214 $ 1,602 $ 110,485 $ 270,719 $ 271,521 Average interest rate 5.08% 5.59% 5.64% 5.78% 3.95% 2.35% 3.99%
The Company assumes that 100% of savings, NOW and money market deposits at December 31, 1998, 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. ANALYSIS OF FINANCIAL CONDITION Assets - ------ Total assets increased $105,604,000, or 39.9%, from $264,574,000 at December 31, 1997, to $370,178,000 at December 31, 1998, due to the acquisition of Azle Bancorp, which had total assets of $93,158,000 at September 22, 1998, the date of acquisition. Total assets increased $58,606,000, or 28.5%, from $205,968,000 at year-end 1996 to -39- $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. Cash and Cash Equivalents - ------------------------- At December 31, 1998, the Company had $64,737,000 in cash and cash equivalents, up $25,319,000, or 64.2%, from $39,418,000 at December 31, 1997, due to the acquisition of Azle State, which had $8,892,000 at the date of acquisition, and due to an increased amount of funds being invested temporarily in federal funds sold. During 1997, cash and cash equivalents increased $9,460,000, or 31.6%, from the December 31, 1996, balance of $29,958,000 as a result of the then-existing interest rate environment. Cash and cash equivalents averaged $49,621,000, $27,520,000 and $26,557,000 for the years ended December 31, 1998, 1997 and 1996, respectively. Securities - ---------- Securities increased $25,414,000, or 36.4%, from $69,794,000 at December 31, 1997, to $95,208,000 at December 31, 1998. The increase in 1998 was due to the acquisition of Azle State, which had $35,808,000 in securities at the date of acquisition. This increase was offset somewhat by a decrease in securities due to lower interest rates that were being paid on securities during the fourth quarter of 1998. As a result, more of the Company's available funds were being invested temporarily in federal funds sold as noted above. The boards of directors of the Banks review 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 $30,370,000 are classified as available-for-sale and are carried at fair value at December 31, 1998. Securities totaling $64,838,000 are classified as held-to-maturity and are carried at amortized cost. The securities portfolio had an average life of approximately 2.36 years at December 31, 1998, compared to approximately 1.32 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, 1998, the book value of U.S. Government and other securities so pledged amounted to $17,094,000, or 18.0% of the total securities portfolio. The following table summarizes the amounts and the distribution of the Company's investment securities held at the dates indicated:
December 31, -------------------------------------------------------- 1998 1997 1996 ---------------- ---------------- ---------------- Amount % Amount % Amount % -------- ------ -------- ------ -------- ------ (Dollars in thousands) Carrying value: Obligations of U.S. Government agencies and corporations $ 61,669 64.8% $ 36,122 51.8% $ 29,928 39.8% Mortgage-backed securities 12,121 12.7 11,622 16.7 9,438 12.6 U.S. Treasury securities 11,573 12.2 21,292 30.5 35,143 46.8 Obligations of states and political subdivisions 9,262 9.7 175 0.2 200 0.2 Other securities 583 0.6 583 0.8 443 0.6 -------- ------ -------- ------ -------- ------ Total securities $ 95,208 100.0% $ 69,794 100.0% $ 75,152 100.0% ======== ====== ======== ====== ======== ====== Total fair value $ 95,276 $ 69,877 $ 75,062 ======== ======== ========
-40- 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, 1998. 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%.
Estimated Weighted Principal Carrying Fair Average Type and Maturity Grouping at December 31, 1998 Amount Value Value Yield - ----------------------------------------------- --------- -------- --------- -------- (Dollars in thousands) Obligations of U.S. Government agencies and corporations: Within one year $ 7,000 $ 7,000 $ 7,016 6.19% After one but within five years 52,800 53,182 53,097 5.80 After five but within ten years 1,500 1,500 1,500 6.08 --------- --------- --------- -------- Total obligations of U.S. government agencies and corporations 61,300 61,682 61,613 5.86 --------- --------- --------- -------- Mortgage-backed securities 11,999 12,108 12,140 6.03 --------- --------- --------- -------- U.S. Treasury securities: Within one year 5,400 5,465 5,465 6.15 After one but within five years 6,000 6,108 6,135 5.62 --------- --------- --------- -------- Total U.S. Treasury securities 11,400 11,573 11,600 5.87 --------- --------- --------- -------- Obligations of states and political subdivisions: Within one year 50 50 50 6.36 After one but within five years 1,545 1,631 1,648 8.87 After five but within ten years 6,185 6,579 6,624 9.24 After ten years 945 1,002 1,018 8.36 --------- --------- --------- -------- Total obligations of states and political subdivisions 8,725 9,262 9,340 9.05 --------- --------- --------- -------- 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 $ 94,007 $ 95,208 $ 95,276 6.15% ========= ========= ========= ========
Loan Portfolio - -------------- Total loans, net of unearned income, increased $43,707,000, or 31.0%, from $140,853,000 at December 31, 1997, to $184,560,000 at December 31, 1998. The increase during 1998 was due to the acquisition of Azle State, which had $45,163,000 in loans, net of unearned income, at the date of acquisition. The Banks primarily make installment loans to individuals and commercial loans to small to medium-sized businesses and professionals. The Banks offer 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 Banks' commercial loans have floating rates of interest, are for varying terms (generally not exceeding -41- five years), are personally guaranteed by the borrower and are collateralized by real estate, accounts receivable, inventory or other business assets. Due to the diminished loan demand during the early 1990's, First State instituted an installment loan program whereby it began to purchase automobile loans from automobile dealerships in its market areas. 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 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, 1998 and 1997, the Company had approximately $29,890,000 and $50,052,000 net of unearned income, respectively, of this type of loan outstanding. The decrease is due to management's decision to shift the loan portfolio toward more commercial and real estate loans and less toward indirect installment loans. The following table presents the Company's loan balances at the dates indicated separated by loan type:
December 31, --------------------------------------------------------------------- 1998 1997 1996 1995 1994 --------- --------- --------- --------- --------- (In thousands) Real estate loans $ 71,901 $ 44,569 $ 26,233 $ 23,265 $ 22,760 Loans to individuals 57,564 67,453 46,975 42,142 43,113 Commercial and industrial loans 47,551 24,184 18,430 17,236 16,702 Other loans 9,310 6,109 2,626 2,638 2,943 --------- --------- --------- --------- --------- Total loans 186,326 142,315 94,264 85,281 85,518 Less unearned income 1,766 1,462 2,247 3,354 4,212 --------- --------- --------- --------- --------- Loans, net of unearned income $ 184,560 $ 140,853 $ 92,017 $ 81,927 $ 81,306 ========= ========= ========= ========= =========
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, 1998, except for those described above. The Banks had no loans outstanding to foreign countries or borrowers headquartered in foreign countries at December 31, 1998. Management of the Banks 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. -42- 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, 1998. 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 $ 24,323 $ 43,388 $ 4,190 $ 71,901 Commercial and industrial loans 25,438 18,163 3,950 47,551 Other loans 5,847 3,125 338 9,310 --------- --------- --------- --------- Total loans $ 55,608 $ 64,676 $ 8,478 $ 128,762 ========= ========= ========= ========= With fixed interest rates $ 32,861 $ 46,581 $ 1,227 $ 80,669 With variable interest rates 22,747 18,095 7,251 48,093 --------- --------- --------- --------- Total loans $ 55,608 $ 64,676 $ 8,478 $ 128,762 ========= ========= ========= =========
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 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, ---------------------------------------------- 1998 1997 1996 1995 1994 ------ ------ ------ ------ ------ (In thousands) Nonaccrual loans $ 238 $ 70 $ 82 $ 204 $ 48 Accruing loans contractually past due over 90 days 198 121 41 23 26 Restructured loans 110 104 73 65 80 Other real estate and other repossessed assets 630 739 389 337 631 ------ ------ ------ ------ ------ Total nonperforming assets $1,176 $1,034 $ 585 $ 629 $ 785 ====== ====== ====== ====== ======
-43- The gross interest income that would have been recorded in 1998 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 $12,000. A total of $1,000 in interest on nonaccrual loans was actually recorded (received) during 1998. 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 Banks maintain 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, 1998, substandard loans totaled $880,000, of which $188,000 were loans designated as nonaccrual, 90 days past due or restructured, there was one $5,000 doubtful loan and one $10,000 loss loan. Both the doubtful and loss loans were on nonaccrual. In addition to the internally classified loans, the Banks also have a "watch list" of loans that further assists the Banks in monitoring their respective loan portfolios. 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 Banks review these loans to assist in assessing the adequacy of the allowance. Substantially all of the loans on the watch list at December 31, 1998, were current and paying in accordance with loan terms. At December 31, 1998, watch list loans totaled $2,198,000 (including $197,000 of loans guaranteed by U.S. governmental agencies). At such date, $214,000 (including $60,000 of loans guaranteed by U.S. Governmental agencies) of loans on the watch list were designated as nonaccural, 90 days past due or restructured loans. In addition, at December 31, 1998, $129,000 of loans not classified and not on the watch list were designated as 90 days past due or 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, 1998 and 1997, other real estate and other repossessed assets had an aggregate book value of $630,000 and $739,000, respectively. Other real estate and other repossessed assets decreased $109,000, or 14.7%, during 1998 even after the acquisition of Azle State. At the date of acquisition, Azle State had a total of $162,000 in other real estate and other repossessed assets. The reduction in 1998 was primarily due to the sale of a parcel of real estate for $357,000. This decrease was partially offset by an increase in the number of repossessed automobiles held by the Company at December 31, 1998. The December 31, 1998, balance of $630,000 included fifty repossessed automobiles ($416,000), three commercial properties ($169,000) and two residential properties ($45,000). Of the December 31, 1997, balance, $391,000 represented three commercial properties, $302,000 represented thirty-eight repossessed automobiles and $46,000 represented five 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 -44- 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 $1,842,000, or 1.00% of loans, net of unearned income, at December 31, 1998, compared to $1,173,000, or 0.83% of loans, net of unearned income, at December 31, 1997, and $793,000, or 0.86% of loans, net of unearned income, at December 31, 1996. The increase in the balance of the allowance from December 31, 1997, to December 31, 1998, was a result of the acquisition of Azle State, which had an allowance of $726,000 at the date of acquisition. The reduction in the ratio of the allowance to total loans, net of unearned income during the past several years, 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 boards of directors of the Banks 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 $729,000 in loans during 1998. Charge-offs for 1998 were concentrated in the following categories: loans to individuals-$671,000, or 92.0%, real estate-$40,000, or 5.5%, and commercial and industrial-$18,000, or 2.5%. A charge-off on one real estate loan was $37,000, or 5.1%, of total charge-offs. All but $21,000 of the remaining $692,000 in charge-offs were installment loans, of which $573,000 represented indirect loans secured by automobiles. Recoveries during 1998 were $102,000 and were concentrated in the following categories: loans to individuals-$45,000, or 44.1%, commercial and industrial-$41,000, or 40.2%, and real estate-$16,000, or 15.7%. Recoveries of $27,000 on one commercial and industrial loan, and $15,000 on one real estate loan accounted for 41.2% of total recoveries during 1998. -45- 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.
1998(1) 1997(2) 1996(3) 1995 1994 -------- -------- -------- -------- -------- Analysis of allowance for possible loan losses: (Dollars in thousands) Balance at January 1 $ 1,173 $ 793 $ 759 $ 817 $ 896 Provision for loan losses 570 250 201 206 147 Acquisition of subsidiary 726 395 149 0 0 -------- -------- -------- -------- -------- 2,469 1,438 1,109 1,023 1,043 -------- -------- -------- -------- -------- Loans charged off: Loans to individuals 671 457 231 297 150 Real estate loans 40 6 100 72 119 Commercial and industrial loans 18 107 58 7 32 Other loans 0 11 0 0 77 -------- -------- -------- -------- -------- Total charge-offs 729 581 389 376 378 -------- -------- -------- -------- -------- Recoveries of loans previously charged off: Loans to individuals 45 60 28 43 45 Real estate loans 16 35 20 2 0 Commercial and industrial loans 41 220 25 52 48 Other loans 0 1 0 15 59 -------- -------- -------- --------- -------- Total recoveries 102 316 73 112 152 -------- -------- -------- --------- -------- Net loans charged off 627 265 316 264 226 -------- -------- -------- --------- -------- Balance at December 31 $ 1,842 $ 1,173 $ 793 $ 759 $ 817 ======== ======== ======== ======== ======== Average loans outstanding, net of unearned income $153,188 $132,891 $ 85,880 $ 82,302 $ 74,727 ======== ======== ======== ======== ======== Ratio of net loan charge-offs to average loans, net of unearned income 0.41% 0.20% 0.37% 0.32% 0.30% ==== ==== ==== ==== ==== Ratio of allowance for possible loan losses to total loans, net of unearned income, at December 31 1.00% 0.83% 0.86% 0.93% 1.00% ==== ==== ==== ==== ==== ______________________________ (1) Average loans, net of unearned income, for 1998 include the average loans, net of unearned income, of Azle State from September 22 through December 31, 1998. (2) Average loans, net of unearned income, for 1997 include the average loans, net of unearned income, of Western National from January 28 through December 31, 1997. (3) 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.
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 Banks attempt 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 Company's market areas recovered and stabilized during the early 1990's, there was a steady reduction in the amount of the provision, as a percentage of average loans outstanding, necessary to maintain an adequate balance in the allowance. The amount of the provision was fairly stable during the mid-1990's. This reflected management's assessment of the continued reduction of credit risks associated with the loan portfolio. The Company increased the provision in 1998, however, due to the higher amount of net charge-offs in the Company's indirect installment loan portfolio, which declined significantly during 1998. -46- 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 the 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, -------------------------------------------------------------------------------------- 1998 1997 1996 -------------------------- --------------------------- -------------------------- 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) Real estate loans $ 106 39.0% $ 52 31.6% $ 128 28.5% Loans to individuals 577 30.2 570 46.8 323 48.6 Commercial and industrial loans 164 25.8 193 17.2 97 20.0 Other loans 9 5.0 28 4.4 43 2.9 ---------- ------------ ---------- ------------ ---------- ----------- Total allocated 856 100.0% 843 100.0% 591 100.0% ============ ============ =========== Unallocated 986 330 202 ========== ========== ========== Total allowance for possible loan losses $1,842 $1,173 $ 793 ========== ========== ========== December 31, --------------------------------------------------------- 1995 1997 -------------------------- --------------------------- 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) Real estate loans $ 197 28.4% $ 165 28.0% Loans to individuals 136 47.4 207 47.8 Commercial and industrial loans 96 21.0 122 20.5 Other loans 59 3.2 68 3.7 ---------- ------------ ---------- ------------- Total allocated 488 100.0% 562 100.0% ========== ============ ========== ============= Unallocated 271 255 ---------- ---------- Total allowance for possible loan losses $ 759 $ 817 ========== ==========
Intangible Assets - ----------------- Intangible assets increased $7,672,000, or 242.9%, from $3,159,000 at December 31, 1997, to $10,831,000 at December 31, 1998, due to the acquisition of Azle State. A total of $8,014,000 of intangible assets were recorded as a result of this acquisition, which was partially offset by $339,000 in amortization expense during 1998. Premises and Equipment - ---------------------- Premises and equipment increased $2,776,000, or 36.9%, from $7,518,000 at December 31, 1997, to $10,294,000 at December 31, 1998. The increase was due to the purchase of Azle State, which had $2,748,000 in net -47- premises and equipment at the date of acquisition, and the opening of one additional supermarket branch banking facility during 1998. These increases were partially offset by depreciation expense of $623,000 recorded for 1998. 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 $1,046,000, or 47.4%, from $2,208,000 at December 31, 1997, to $3,254,000 at December 31, 1998. The increase during 1998 was primarily a result of the purchase of Azle State, which had $856,000 in accrued interest receivable at the date of acquisition. Of the total balance at December 31, 1998, $1,819,000, or 55.9%, was interest accrued on loans and $1,435,000, or 44.1%, was interest accrued on securities. Other Assets - ------------ The most significant component of other assets at December 31, 1998 and 1997, is a net deferred tax asset of $508,000 and $1,282,000, respectively. The balance of other assets increased $448,000, or 21.8%, to $2,506,000 at December 31, 1998, from $2,058,000 at December 31, 1997 due to the acquisition of Azle State, which has $255,000 in other assets at the date of acquisition and an increase in other assets at the Company due to the payment of a $520,000 underwriting fee related to the sale of Independent Capital's Trust Preferred Securities in the 1998 Offering. These increases were partially offset by a decrease in the Company's net deferred tax asset due principally to the utilization of a portion of the Company's tax credit carryforwards. Deposits - -------- The Banks' lending and investing activities are funded almost entirely by core deposits, 51.5% of which are demand, savings and money market deposits at December 31, 1998. Total deposits increased $88,003,000, or 36.2%, from $242,801,000 at December 31, 1997, to $330,804,000 at December 31, 1998. The increase is due primarily to the purchase of Azle State, which had $80,955,000 in total deposits at the date of acquisition. The Banks do not have any brokered deposits. 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, --------------------------------------------------------- 1998(1) 1997(2) 1996(3) ----------------- ----------------- ----------------- Average Average Average Average Average Average Amount Rate Amount Rate Amount Rate -------- ------- -------- ------- -------- ------- (Dollars in thousands) Noninterest-bearing demand deposits $ 46,887 --% $ 40,328 --% $ 30,093 --% Interest-bearing demand, savings and money market deposits 86,428 2.55 75,833 2.69 57,847 2.41 Time deposits of less than $100,000 91,087 5.31 84,267 5.36 64,112 5.42 Time deposits of $100,000 or more 41,567 5.35 36,951 5.54 27,953 5.39 -------- ------- -------- ------- -------- ------- Total deposits $265,959 3.48% $237,379 3.62% $180,005 3.55% ======== ======= ======== ======= ======== ======= ______________________ (1) The average amounts and average rates paid on deposits for the year ended December 31, 1998, include the averages of Azle State from September 22 through December 31, 1998. (2) The average amounts and average rates paid on deposits for the year ended December 31, 1997, include the averages of Western National from January 28 through December 31, 1997. (3) 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.
-48- The maturity distribution of time deposits of $100,000 or more at December 31, 1998, is presented below: December 31, 1998 ----------------- (In thousands) 3 months or less $ 17,515 Over 3 through 6 months 11,737 Over 6 through 12 months 16,173 Over 12 months 4,249 --------- Total time deposits of $100,000 or more $ 49,674 ========= 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, 1998, time deposits of $100,000 or more represented 13.4% of the Company's total assets, compared to 14.5% of the Company's total assets at December 31, 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 increased $216,000, or 22.8%, from $947,000 at December 31, 1997, to $1,163,000 at December 31, 1998. The increase was due to the acquisition of Azle State, which had $308,000 in accrued interest payable at the date of acquisition. This increase was offset somewhat by a decrease in accrued interest payable at First State due to overall lower interest rates on deposits at December 31, 1998, when compared to December 31, 1997. Notes Payable - ------------- The Company's notes payable decreased $56,000, or 98.2%, from $57,000 at December 31, 1997, to $1,000 at December 31, 1998. The decrease was a result of the payoff of the one remaining note payable to the current and former directors during 1998. Other Liabilities - ----------------- The most significant components of other liabilities are amounts accrued for various types of expenses. The balance of other liabilities increased $463,000, or 191.3%, from $242,000 at December 31, 1997, to $705,000 at December 31, 1998, due to the acquisition of Azle State, which had $884,000 in other liabilities at the date of acquisition and $342,000 at December 31, 1998, and an increase in other liabilities, primarily federal income taxes payable at the Company at December 31, 1998. -49- Selected Financial Ratios The following table presents selected financial ratios for each of the last three fiscal years:
Year Ended December 31, --------------------------- 1998(1) 1997(2) 1996(3) ------- ------- ------- Net income to: Average assets 0.75% 0.82% 0.72% Average interest-earning assets 0.84 0.90 0.79 Average stockholders' equity 9.89 10.95 9.89 Dividend payout (4) to: Net income 18.69 17.30 13.85 Average stockholders' equity 1.84 1.89 1.37 Average stockholders' equity to: Average total assets 7.53 7.45 7.33 Average loans (5) 14.44 14.50 16.74 Average total deposits 8.31 8.12 7.99 Average interest-earning assets to: Average total assets 88.91 90.36 91.87 Average total deposits 98.14 98.55 100.11 Average total liabilities 97.44 97.63 99.13 Ratio to total average deposits of: Average loans (5) 57.60 55.98 47.71 Average noninterest-bearing deposits 17.63 16.99 16.72 Average interest-bearing deposits 82.37 83.01 83.28 Total interest expense to total interest income 45.39 47.25 47.51 Efficiency ratio (6) 68.49 69.09 72.78 _________________________ (1) Average balance sheet and income statement items for 1998 include the averages for Azle State from September 22 through December 31, 1998. (2) Average balance sheet and income statement items for 1997 include the averages for Western National from January 28 through December 31, 1997. (3) 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. (4) Dividends for Common Stock only. (5) Before allowance for possible loan losses. (6) 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.
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 Banks 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 Banks maintain adequate levels of cash and near-cash investments to meet their day-to-day needs. Cash and due from banks averaged $15,149,000 and $11,051,000 during the years ended December 31, 1998 and 1997, respectively. These amounts comprised 5.2% and 4.3% of average total assets during the years ended December 31, 1998 and 1997, respectively. The average level of securities and federal funds sold was $107,835,000 and $101,035,000 during the years ended December 31, 1998 and 1997, respectively. The increases from 1997 to 1998 were primarily due to the acquisition of Azle State on September 22, 1998. -50- The Banks sold no securities during the year ended December 31, 1998. First State sold securities classified as available- for-sale with a book value of $193,000 during the year ended December 31, 1997. At December 31, 1998, $12,515,000, or 15.1%, of the Company's securities portfolio, excluding mortgage-backed securities, matured within one year and $60,921,000, or 73.3%, excluding mortgage-backed securities, matured after one but within five years. The Banks' 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 Banks' experience, however, has been that these installment loans are paid off in an average of approximately thirty months. At December 31, 1998, approximately $102,707,000, or 55.6%, of the Company's loans, net of unearned income, matured within one year and/or had adjustable interest rates. Approximately $80,954,000, or 62.9%, 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, 1998 and 1997, the Company's average deposits were $265,959,000, or 90.6% of average total assets, and $237,379,000, or 91.7% of average total assets, respectively. The Company attracts its deposits primarily from individuals and businesses located within the market areas served by the Banks. 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. To improve liquidity, the Banks have implemented various cost- cutting and revenue-generating measures and extended efforts to reduce nonperforming assets. The Company - ----------- The Company depends on the Banks 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 Banks, (2) current tax liabilities generated by the Banks and (3) management and service fees for services performed for the Banks. The payment of dividends from the Banks is subject to applicable law and the scrutiny of regulatory authorities. Dividends paid by the Banks to Independent Financial in 1998 aggregated $5,250,000; in turn, Independent Financial paid dividends to the Company totaling $5,250,000 during 1998. Independent Capital, organized during the third quarter of 1998, paid dividends totaling $9,000 to the Company during 1998. Dividends paid by the Banks during 1998 include a $4,500,000 dividend paid by Azle State after the acquisition of such bank. Proceeds from this dividend were used to pay off the borrowings from the Fort Worth Bank. Dividends paid by First State to Independent Financial and by Independent Financial to the Company totaled $900,000 and $900,000, respectively, during 1997. At December 31, 1998, there were approximately $4,254,000 in dividends available for payment to Independent Financial by the Banks without prior regulatory approval. The payment of current tax liabilities generated by the Banks and management and service fees constituted approximately 21.5% and 2.1%, respectively, of the Company's cash flow from the Banks during 1998. Pursuant to a tax-sharing agreement, the Banks pay 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 Banks 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 Banks incur losses, the Company may be required to refund tax liabilities previously collected. Current tax liabilities totaling $1,480,000 were paid by the Banks to the Company during 1998, compared to a total of $1,266,000 in 1997. From January 1, 1989, through December 31, 1995, the Company collected federal income taxes from its subsidiaries 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 -51- 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. The Banks pay management fees to the Company for services performed. These services include, but are not limited to, financial and accounting consultation, attendance at the Banks' board meetings, audit and loan review services and related expenses. The Banks paid a total of $147,000 in management fees to the Company in 1998, compared to $150,000 in 1997. The Company's fees must be reasonable in relation to the management services rendered, and the Banks are prohibited from paying management fees to the Company if the Banks would be undercapitalized after any such distribution or payment. The Company has a revolving line of credit with the Fort Worth Bank. Proceeds of $4,300,000 under the $6,500,000 line of credit were used to fund the purchase of Azle Bancorp on September 22, 1998. These borrowings were paid off on September 30, 1998, from the proceeds of a $4,500,000 dividend that was paid to the Company by Azle State. The amount available under the line of credit was reduced to $1,500,000 on January 5, 1999, and reduces further to $1,000,000 on October 5, 1999. The line of credit matures on October 1, 2000, bears interest at the floating prime interest rate of the Fort Worth Bank and is collateralized by 100% of the stock of Independent Financial and First State. There was no balance outstanding under the line of credit at December 31, 1998. The Company had a note payable to the Amarillo Bank. The note, proceeds of which were used to help fund the purchase of Crown Park, originated on January 23, 1997, in the amount of $800,000. The balance was reduced to $200,000 by July 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 First State. 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 note represented a portion of the final settlement of certain litigation. At December 31, 1998, First State had a $1,000 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. CAPITAL RESOURCES At December 31, 1998, stockholders' equity totaled $24,505,000, or 6.6% of total assets, compared to $20,527,000, or 7.8% of total assets, at December 31, 1997. 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 6% and 10%, respectively. For the Company, Tier 1 capital includes common stockholders' equity and qualifying Series C Cumulative Convertible Preferred Stock (the "Series C Preferred Stock") and guaranteed preferred beneficial interests in the Company's subordinated debentures, reduced by intangible assets. Tier 2 capital for the Company is comprised of the remainder of guaranteed preferred beneficial interests in the Company's subordinated debentures not qualifying as Tier 1 capital and 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 4%, and to be designated as well-capitalized, the banking company must have a leverage ratio of at least 5%. 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 Banks' risk-based capital ratios and leverage ratios to the minimum regulatory and well-capitalized minimum requirements at December 31, 1998: -52-
The Company December 31, 1998 ----------- ----------------- (In thousands) Tier 1 capital: Common stockholders' equity, excluding unrealized gain on available-for-sale securities $ 24,132 Qualifying Series C Preferred Stock and guaranteed preferred beneficial interests in the Company's Subordinated Debentures (1) 8,043 Intangible assets (10,831) ---------- Total Tier 1 capital 21,344 ---------- Tier 2 capital: Guaranteed preferred beneficial interests in the Company's Subordinated Debentures (1) 5,170 Allowance for possible loan losses (2) 1,842 ---------- Total Tier 2 capital 7,012 ---------- Total capital $ 28,356 ========== Risk-weighted assets $ 205,971 ========== Adjusted quarterly average assets $ 357,815 ========== _______________________________ (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 minimum regulatory capital ratios, minimum capital ratios for well capitalized holding companies and the Company's actual capital amounts and ratios at December 31, 1998 and 1997, were as follows:
December 31, Minimum Well ------------------------ Capital Capitalized 1998 1997 Ratios Ratios --------- --------- ------- ----------- (Dollars in thousands) Tier 1 capital $ 21,344 $ 17,737 Total capital 28,356 18,510 Risk-weighted assets 205,971 154,036 Adjusted quarterly average assets 357,815 258,496 Capital ratios: Tier 1 capital to risk-weighted assets 10.36% 11.26% 4.00% 6.00% Total capital to risk-weighted assets 13.77 12.02 8.00 10.00 Tier 1 capital to adjusted quarterly average assets 5.97 6.71 4.00 5.00
-53- The minimum regulatory capital ratios, minimum capital ratios for well capitalized banks and the Banks' actual capital ratios at December 31, 1998, were as follows:
Regulatory Minimum Minimum Ratio for Actual Ratios at Ratio for Banks Well Capitalized Banks December 31, 1998 ------------------- ---------------------- ----------------- Tier 1 capital to risk-weighted assets 4.00% 6.00% 11.46-12.04% Total capital to risk-weighted assets 8.00 10.00 12.21-13.22 Tier 1 capital to adjusted quarterly average assets 4.00 5.00 6.77-7.53
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 Banks were all "well capitalized" at December 31, 1998. 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 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 Banks, 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, 1998, retained earnings of the Banks included approximately $4,254,000 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, the Company sold an aggregate of 395,312 shares of Common Stock in the 1997 Offering at a price of $11.40 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 the 1997 Offering. In connection with the Company's acquisition of Azle Bancorp, the Company sold an aggregate of 230,000 shares of Common Stock and 1,300,000 Trust Preferred Securities in the 1998 Offering at a price of $11.50 and $10.00 per share or security, respectively. The Company received net proceeds of approximately $14,547,000 from the 1998 Offering. -54- YEAR 2000 READINESS DISCLOSURE 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 Year 2000 will have a broad impact on the business environment in which the Company operates due to the possibility that many computerized systems across all industries will be unable to process information containing the dates beginning in the Year 2000. 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 Company leased virtually all of its computer hardware under leases that expired during 1998. The Company replaced this hardware, as well as the software used for its main operating system and major banking applications, during this same time period. The modification process of all significant mission- critical applications by outside hardware and software suppliers is complete. The testing process of all significant mission- critical applications has been substantially completed and all such hardware and software tested to date was found to be Year 2000 compliant. It is anticipated that the testing on the remaining mission-critical applications will be completed by March 31, 1999. Management currently anticipates that testing of all nonmission-critical applications will take place by mid-1999. In addition, the Company has had formal communications with other vendors with which it does significant business and with significant loan and deposit customers to determine their Year 2000 readiness and the extent to which the Company appears vulnerable to any third party Year 2000 issues. The Company will continue to seek information from nonresponsive vendors and customers. 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. The Company has developed a contingency plan and a business resumption plan to address issues that may not be corrected in a timely manner by implementation of the Company's own Year 2000 Compliance plan and to address the possibilities that third party vendor or supplier systems may not be Year 2000 compliant. The Company has prepared alternate strategies where necessary if significant exposures are identified. -55- [Independent Bankshares, Inc. Logo] P.O. Box 3296, Abilene, Texas 79604 (915) 677-5550 EX-21.1 7 EXHIBIT 21.1 INDEPENDENT BANKSHARES, INC. LIST OF SUBSIDIARIES DECEMBER 31, 1998 STATE OF NAME INCORPORATION ---------------------------- ------------- Parent: Independent Bankshares, Inc. Texas Non-banking Subsidiaries: Independent Financial Corp. Delaware Independent Capital Trust Delaware Banking Subsidiaries: First State Bank, National Association Texas Azle State Bank Texas EX-23.1 8 CONSENT OF INDEPENDENT ACCOUNTANTS We consent to the incorporation by reference in the registration statement of Independent Bankshares, Inc. on Form S-8 (File No. 33-83112 and 333-07567) of our report dated January 29, 1999, on our audits of the consolidated financial statements of Independent Bankshares, Inc. as of December 31, 1998 and 1997, and for each of the three years in the period ended December 31, 1998, which report is incorporated by reference in this Annual Report on Form 10-K. /s/ PricewaterhouseCoopers LLP Fort Worth, Texas March 30, 1999 EX-27.1 9
9 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL EXTRACTED FROM THE AUDITED FINANCIAL STATEMENTS FOR INDEPENDENT BANKSHARES, INC. AS OF AND FOR THE YEAR ENDED DECEMBER 31, 1998 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS. 0000318870 INDEPENDENT BANKSHARES, INC. YEAR DEC-31-1998 JAN-01-1998 DEC-31-1998 22,562,000 0 42,175,000 0 30,370,000 95,208,000 95,276,000 184,560,000 1,842,000 370,178,000 330,804,000 1,000 1,868,000 0 0 51,000 554,000 23,900,000 370,178,000 14,150,000 4,425,000 1,859,000 20,434,000 9,268,000 9,276,000 11,158,000 570,000 0 9,998,000 3,381,000 3,381,000 0 0 2,188,000 1.07 1.02 4.30 238,000 198,000 110,000 0 1,173,000 729,000 102,000 1,842,000 1,842,000 0 986,000 Includes investments held for sale. Net of unearned incomeon installment loans of $1,766,000. Includes unallocated portion of the allowance
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