10-K405 1 a2074759z10-k405.txt FORM 10-K405 ================================================================================ UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 ---------- FORM 10-K /X/ ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the Fiscal Year Ended: December 31, 2001 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 (IRS Employer Incorporation or Organization) Identification No.) 1617 BROADWAY LUBBOCK, TEXAS 79408 (Address of Principal Executive Offices) (Zip Code) Registrant's Telephone Number, Including Area Code: (806) 749-1850 Securities Registered Pursuant to Section 12(b) of the Act:
Name of each exchange Title of each class on which registered ----------------------------------------------------------- ----------------------------- 8.5% CUMULATIVE TRUST PREFERRED SECURITIES, GUARANTEED BY AMERICAN STOCK EXCHANGE INDEPENDENT BANKSHARES, INC., STATED VALUE $10.00
Securities Registered Pursuant to Section 12(g) of the Act: COMMON STOCK, $0.25 PAR VALUE (TITLE OF CLASS) ---------- Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 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/ On March 5, 2002, all of the shares of the Registrant's voting stock was held indirectly by State National Bancshares, Inc. and thus no shares were held by non-affiliates of the Registrant. At March 5, 2002, 2,273,674 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: NONE ================================================================================ TABLE OF CONTENTS
PAGE ---- PART I............................................................................................................2 ITEM 1. BUSINESS.........................................................................................2 ITEM 2. PROPERTIES......................................................................................13 ITEM 3. LEGAL PROCEEDINGS...............................................................................14 ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.............................................14 PART II..........................................................................................................15 ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.......................15 ITEM 6. SELECTED FINANCIAL DATA.........................................................................16 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS...........17 ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISKS.....................................40 ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.....................................................41 ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE............66 PART III.........................................................................................................68 ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.............................................68 ITEM 11. EXECUTIVE COMPENSATION.........................................................................70 ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.................................71 ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.................................................72 PART IV..........................................................................................................73 ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K................................73 SIGNATURES.......................................................................................................75
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 Lubbock, Texas. The Company is an indirect wholly owned subsidiary of State National Bancshares, Inc., Lubbock, Texas ("State National"). At December 31, 2001, the Company owned all of the common securities of Independent Capital Trust ("Independent Capital") and indirectly owned through a Delaware subsidiary, Independent Financial Corp. ("Independent Financial"), 100% of the stock of State National Bank of West Texas, Lubbock, Texas (the "Bank" or the "Lubbock Bank"). At December 31, 2001, the Bank operated full-service banking locations in the Texas cities of Abilene (five locations), Azle (two locations), Bangs, Big Spring, Lubbock, (3 locations), Odessa (two locations), Plainview, San Angelo, Stamford, Trent and Winters. The Company's primary activities are to assist the Bank in the management and coordination of its financial resources. The Bank operates under the day-to-day management of its own officers and board of directors and formulates its own policies with respect to banking matters. At December 31, 2001, the Company had, on a consolidated basis, total assets of $637,383,000, total deposits of $544,030,000, total loans, net of unearned income, of $304,246,000 and total stockholder's equity of $75,381,000. The Company's complete mailing address is 1617 Broadway, Lubbock, Texas 79408, and the telephone number is (806) 749-1850. ACQUISITION OF THE COMPANY On August 11, 2000, State National acquired 100% of the issued and outstanding common stock of the Company, pursuant to the terms of an Agreement and Plan of Reorganization, dated as of March 1, 2000 ( "the Acquisition"), between the Company and State National. Pursuant to the Merger Agreement, New FSB, Inc., a wholly owned subsidiary of State National, merged with and into the Company, with the Company surviving the Acquisition as a wholly owned subsidiary of State National. As a result of the Acquisition, each share of the Company's Common Stock was exchanged into the right to receive $20.0165 in cash, representing total aggregate merger consideration of approximately $45,510,000. State National obtained the funds for the purchase of the Company's Common Stock from (i) the sale of shares of State National's common stock to certain qualified investors and (ii) from a $10,000,000 advance on State National's line of credit ("Loan") with the Amarillo National Bank, Amarillo, Texas. The Loan bears interest at the rate equal to the prime rate as established by J.P. Morgan/Chase. A principal payment of $500,000, plus interest, was made on February 28, 2002, and a principal payment of $1,000,000, plus interest, is due on February 28, 2003. The remaining balance, plus interest, is due on May 31, 2003. The Loan is secured by all of the common stock of the indirect bank subsidiaries of State National, including the Bank. REORGANIZATIONS UNITED BANK & TRUST. On October 24, 2000, State National, the owner of all the common stock of the Company, contributed to the Company, and the Company, in turn, contributed to Independent Financial, all of the capital stock of United 2 Bank & Trust, of Abilene, Texas, a Texas banking association ("UB&T"). UB&T was a community bank that offered interest and noninterest bearing depository accounts, and made consumer and commercial loans. On November 9, 2000, UB&T was then merged with and into First State Bank, National Association, Abilene, Texas, the Company's subsidiary bank ("First State"). In addition, immediately after the merger, the name of the combined bank was changed to State National Bank of West Texas, Abilene, Texas ("the Abilene Bank"). There was no merger consideration paid because, prior to the transactions, the Company and UB&T were both direct or indirect subsidiaries of State National. The merger was accounted for similar to a pooling of interests. As a result of the merger, the balance sheet and results of operations of UB&T have been included in the Company's consolidated financial statements since August 11, 2000, the date of the Acquisition. At August 11, 2000, UB&T had total assets of $112,806,000, and total deposits of $93,946,000, total loans of $70,230,000 and total stockholder's equity of $16,729,000. STATE NATIONAL BANK OF WEST TEXAS. On February 28, 2001, State National contributed its ownership interest in State National Bank of West Texas, Lubbock, Texas, a national banking association ("the Lubbock Bank"), and wholly owned subsidiary of State National, to the Company. The Company in turn, contributed to Independent Financial, all of the capital stock of the Lubbock Bank. The Lubbock Bank is a community bank that offers interest and noninterest-bearing depository accounts, and makes consumer and commercial loans. On March 9, 2001, the Abilene Bank was merged with and into the Lubbock Bank. The Lubbock Bank continued as the surviving entity in the merger and is an indirect wholly owned subsidiary of the Company. There was no merger consideration paid as, prior to the transactions, the Abilene Bank and the Lubbock Bank were both direct or indirect subsidiaries of State National. The merger was accounted for similar to a pooling of interests. As a result of the merger, the balance sheet and results of operations of the Lubbock Bank have been included in the Company's consolidated financial statements since August 11, 2000, the date of the Acquisition. At August 11, 2000, the Lubbock Bank had total assets of $210,409,000, total deposits of $190,828,000, total loans of $121,130,000 and stockholder" equity of $18,405,000. THE BANK GENERAL. The Company conducts substantially all of its business through the Bank and its various branches in Texas. Each of the Bank's branches is an established franchise in its respective service area. The combined branches in Abilene and Trent had the third largest total deposits of ten FDIC-insured financial institutions operating in Taylor County, at June 30, 2001, the latest date for which information is available. The combined branches in Azle had the twenty-sixth largest total deposits of fifty-four financial institutions operating in Tarrant County at June 30, 2001. The branch in Bangs had the seventh largest total deposits of eight financial institutions operating in Brown County at June 30, 2001. The branch in Big Spring had the third largest total deposits of the six financial institutions operating in Howard County at June 30, 2001. The branch in Lubbock had the eighth largest total deposits of seventeen financial institutions operating in Lubbock County at June 30, 2001. The combined branches in Odessa had the seventh largest total deposits of eleven financial institutions operating in Ector County at June 30, 2001. The branch in Plainview had the third largest total deposits of the seven financial institutions operating in Hale County at June 30, 2001. The branch in San Angelo had the ninth largest total deposits of fifteen financial institutions operating in Tom Green County at June 30, 2001. The branch in Stamford had the third largest total deposits of five financial institutions operating in Jones County at June 30, 2001. The branch in Winters had the fifth largest total deposits of seven financial institutions operating in Runnels County at June 30, 2001. The Bank, through its branches, operates as a community bank focusing on long-term relationships with customers and providing individualized quality service. Reflecting its community-banking heritage, the Bank has a stable deposit base from customers located within its Texas market area. The deposits of the Bank are insured by the Federal Deposit Insurance Corporation (the "FDIC") to the maximum extent provided by law. AT DECEMBER 31, 2001, the Bank had total assets of $636,725,000, total deposits of $544,111,000, total loans, net of unearned income, of $304,246,000; and total stockholder's equity of $87,514,000. SERVICES. The principal services provided by the Bank are as follows: COMMERCIAL SERVICES. The Bank provides a full range of banking services for its commercial customers. Commercial lending activities include short-term and medium-term loans, revolving credit arrangements, inventory and account 3 receivable financing, equipment financing and interim and permanent real estate lending. Other services include cash management programs and federal tax depository and night depository services. CONSUMER SERVICES. The Bank also provides a wide range of consumer banking services, including checking, savings and money market accounts, savings programs and installment and personal loans. The Bank makes automobile and other installment loans directly to customers, as well as indirectly through automobile dealers. The Bank makes home improvement, home equity and real estate loans and provides safe deposit services. As a result of sharing arrangements with the Pulse automated teller machine system network, the Bank provides 24-hour routine banking services through automated teller machines ("ATMs"). The Pulse network provides ATM accessibility throughout the United States. The Bank also offers investment services and banking by phone, personal computer or the Internet. TRUST SERVICES. The Bank provides trust and agency services to individuals, partnerships and corporations from its offices in Abilene, Lubbock and Odessa. The trust division also provides investment management, administration and advisory services for agency and trust accounts, and acts as trustee for pension and profit sharing plans. SUPERMARKET BRANCHES. On July 15, 2001, the Bank closed three branch banking facilities located in large supermarkets: one in Abilene and two in Odessa. OTHER SUBSIDIARIES At the present time, the Company does not have any subsidiaries other than Independent Capital, Independent Financial and the Bank. 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 also 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. 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 introduction of computer and telephone home banking and Internet banking. The Company also maintains twelve ATMs throughout its market area. ACQUISITION ACTIVITY. The Company's strategy of opportunistically acquiring banks in its West Texas market resulted in its acquisition of four banks and one branch in the six-year period ended December 31, 1999. Since the acquisition of the Company by State National on August 11, 2000, the Company has grown by the reorganizations in which it acquired UB&T and the Lubbock Bank. Subsequent to the Acquisition, the Company's acquisition strategy remains the same. See "Reorganizations" above. The Company currently has locations in or near five of the major markets in West and North Central Texas. 4 SUPERVISION AND REGULATION GENERAL The Company and the Bank are extensively regulated under federal and state law. These laws and regulations are intended to protect consumers and depositors, not shareholders. To the extent that the following information describes or summarizes 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 System (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. The BHCA imposes certain limitations on extensions of credit and other transactions by and between banks that are members of the Federal Reserve and other banks and non-bank companies in the same holding company. Under the BHCA and the Federal Reserve's regulations, 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. The Bank, 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 "Comptroller"). Because the FDIC provides deposit insurance to the Bank, the Bank is also subject to supervision and regulation by the FDIC (even though the FDIC is not the primary federal regulator of the Bank). The Company, as an affiliate of the Bank, is subject to certain restrictions regarding transactions between a bank and companies with which it is affiliated. These provisions limit extensions of credit (including guarantees of loans) by the Bank to affiliates, investments in the stock or other securities of the Company by the Bank, and the nature and amount of collateral that the Bank may accept from any affiliate to secure loans extended to the affiliate. SIGNIFICANT 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 Bank 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 5 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 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, 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: - reform the deposit insurance system, including the implementation of risk-based deposit insurance premiums; - 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; - 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; - require 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; - 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; and - revise risk-based capital standards to ensure that they take adequate account of interest-rate changes, concentration of credit risk and the risks of nontraditional activities, and reflect the actual performance and expected risk of loss of multi-family mortgages. 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 6 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: - "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; - "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, or a leverage ratio of 4% or greater; - "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%; - "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 - "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 and forced or mandated actions. 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 Bank were "well capitalized" at December 31, 2001. 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 rules have had no material adverse impact on the Company and the Bank. 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 consumers can make a meaningful comparison between the competing claims of financial institutions with regard to deposit accounts and products. 7 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 previously 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 that 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. 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. Although Texas originally adopted legislation to "opt out" of the interstate branching provisions, Texas' decision to opt out of these provisions was rendered ineffective with the 1998 decision of the United States District Court for the Northern District of Texas affirming the Comptroller's decision to permit an interstate merger involving a Texas national bank. The Texas Legislature responded in 1999 by passing The Interstate Banking and Branching Bill, which became effective September 1, 1999. This legislation provides a framework for interstate branching in Texas, providing for DE NOVO branching by banks headquartered in states offering reciprocity to Texas institutions or institutions authorized to branch in Texas. However, banks in other, nonreciprocal states, are prohibited from acquiring a Texas bank in an interstate merger transaction if the Texas bank has not been in existence and in continuous operation for at least five years. The legislation also clarifies other provisions of Texas law relating to interstate banks operating in Texas, and included a "super parity" provision that provides a framework for a bank chartered in Texas, upon application, to conduct any of the activities allowed to any other state or federal financial institution in the nation. GRAMM-LEACH-BLILEY ACT OF 1999 Historically, the Company has been prohibited from acquiring a direct or indirect interest in or control of more than 5% of the voting shares of any company that is not a bank or bank holding company and from engaging directly or indirectly in activities other than those of banking, managing or controlling banks or furnishing services to the Bank, except that the Federal Reserve has permitted bank holding companies to engage in and own shares of companies engaged in certain activities found by the Federal Reserve to be so closely related to banking or managing and controlling banks as to be a proper incident thereto. These activities include, among others, operating a mortgage, finance, credit card, or factoring company; performing certain data processing operations; providing investment and financial advice; acting as an insurance agent for certain types of credit-related insurance; leasing personal property on a full pay out, non-operating basis; and providing certain stock brokerage and investment advisory services. In approving acquisitions or the addition of activities, the Federal Reserve has considered whether the acquisition or the additional activities can reasonably be expected to produce benefits to the public, such as greater convenience, increased competition, or gains in efficiency, that outweigh such possible adverse effects as undue concentration of resources, decreased or unfair competition, and conflicts of interest or unsound banking practices. In considering any application for approval of an acquisition or merger, the Federal Reserve is also required to consider the financial and managerial resources of the companies and the banks concerned, as well as the applicant's record of compliance with the Community Reinvestment Act, which generally requires a financial institution to take affirmative action to ascertain and meet the credit needs of its entire community, including low and moderate income neighborhoods. The Gramm-Leach-Bliley Act ("Gramm-Leach"), enacted by Congress in November 1999, now permits bank holding companies with subsidiary banks meeting certain capital and management requirements to elect to become "financial holding companies." Beginning in March 2000, financial holding companies may engage in a full range of financial activities, including not only banking, insurance and securities activities, but also merchant banking and additional activities determined to be "financial in nature." Gramm-Leach also provides that the list of permissible activities will be expanded as necessary for a financial holding company to keep abreast of competitive and technological change. 8 Although it preserves the Federal Reserve as the umbrella supervisor of financial holding companies, Gramm-Leach adopts an administrative approach to regulation that defers to the approval and supervisory requirements of the functional regulators of insurers and insurance agents, broker-dealers, investment companies and banks, as applicable. Thus, the various state and federal regulators of a financial holding company's operating subsidiaries would retain their jurisdiction and authority over the operating entities. As the umbrella supervisor, however, the Federal Reserve has the potential to affect the operations and activities of financial holding companies' subsidiaries through its power over the financial holding company parent. In addition, Gramm-Leach contains numerous trigger points related to legal noncompliance and other serious problems affecting bank affiliates that could lead to direct Federal Reserve involvement and to the possible exercise of remedial authority affecting both financial holding companies and their affiliated operating companies. The Company has not, as of the date hereof, elected to become a financial holding company. PENDING LEGISLATION Proposals to change the laws and regulations governing the banking and financial services industry are frequently introduced in Congress, in the state legislatures and before the various bank regulatory agencies. The likelihood and timing of any such changes and the impact such changes might have on the Company and the Bank cannot be determined at this time. INSURANCE OF ACCOUNTS The FDIC provides insurance, through the BIF, to deposit accounts at the Bank to a maximum of $100,000 for each insured depositor. Effective January 1, 1996, the FDIC implemented an amendment to the BIF risk-based assessment schedule that effectively eliminated deposit insurance assessments for most commercial banks and other depository institutions with deposits insured by the BIF only. At this time, the deposit insurance assessment rate for institutions in the lowest risk-based premium category is zero and slightly higher for other risk categories. 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 non-bank businesses or to open facilities. The Federal Reserve and the Comptroller have 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. 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 Bank. 9 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 Bank. 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. CHANGE IN BANK CONTROL ACT The Change in Bank Control Act prohibits a person or group of persons from acquiring "control" of a bank holding company, unless the Federal Reserve has been notified and has not objected to the transaction. Under a rebuttal presumption established by the Federal Reserve, the acquisition of 10% or more of a class of voting stock of a bank holding company with a class of securities registered under Section 12 of the Exchange Act, such as the Company, would, under the circumstance set forth in the presumption, constitute acquisition of control of the bank holding company. In addition, a company is required to obtain the approval of the Federal Reserve under the Bank Holding Company Act before acquiring 25% (5% in the case of an acquirer that is a bank holding company) or more of any class of outstanding voting stock of a bank holding company, or otherwise obtaining control or a "controlling influence" over that bank holding company. 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 Bank is subject to certain restrictions imposed by the Federal Reserve Act on extensions of credit to the Company or the Bank 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 Bank 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 Bank may not generally require a customer to obtain other services from the Bank 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 Bank is 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 Bank is 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 $42.8 million or less (subject to adjustment by the Federal Reserve) and an initial reserve of $1,284,000 plus 10% of the amount over $42.8 million (subject to adjustment by the Federal Reserve) 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. 10 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 before borrowing from the Federal Reserve Bank. DIVIDENDS The Company's primary sources of funds have been the dividends, current tax liabilities and management fees paid by the Bank. The ability of the Bank to pay dividends and management fees is limited by various state and federal laws, by the regulations promulgated by its primary regulators and by the principles of prudent bank management. Since the Acquisition, the Bank has not paid management fees to the Company. TECHNOLOGY RISK MANAGEMENT Federal banking regulators have issued various policy statements emphasizing the importance of technology risk management and supervision in evaluating the safety and soundness of depository institutions. Banks are contracting increasingly with outside vendors to provide data processing and core banking functions. The use of technology-related products, services, delivery channels, and processes expose a bank to various risks, particularly operational, privacy, security, strategic, reputation and compliance risk. Banks are generally expected to successfully manage technology-related risks with all other risks to ensure that the bank's risk management is integrated and comprehensive, primarily through identifying, measuring, monitoring and controlling risks associated with the use of technology. 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 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 Bank cannot be predicted. COMPETITION The activities in which the Company and the Bank engage are highly competitive. Each activity engaged in and the geographic market served involves competition with other banks and savings and loan associations as well as with nonbanking financial institutions and nonfinancial enterprises. In Texas, savings and loan associations and banks are allowed to establish statewide branch offices. The Bank actively competes with other banks in its effort to obtain deposits and make loans, in the scope and type of services offered, in interest rates paid on time deposits and charged on loans and in other aspects of banking. In addition to competing with other commercial banks within and without its primary service areas, the Bank competes with other financial institutions engaged in the business of making loans or accepting deposits, such as savings and loan associations, credit unions, insurance companies, small loan companies, finance companies, mortgage companies, real estate investment trusts, factors, certain governmental agencies, credit card organizations and other enterprises. Additional competition for deposits comes from government and private issues of debt obligations and other investment alternatives for depositors such as money market funds. The Bank also competes with suppliers of equipment in providing equipment financing. 11 EMPLOYEES At March 5, 2002, the Company and the Bank had 243 full-time equivalent employees. Employees are provided with employee benefits, such as a 401(k) profit sharing plan and life, health and long-term disability insurance plans. The Company considers the relationship of the Bank with its employees to be good. 12 ITEM 2. PROPERTIES At March 5, 2002, the Company occupied approximately 2,600 square feet of space for its corporate offices at 1617 Broadway, Lubbock, Texas. The Broadway Branch of the Bank occupies approximately 9,800 square feet at this same facility. The following table sets forth, at March 5, 2002, certain information with respect to the banking premises owned or leased by the Company and the Bank. The Company considers such premises adequate for its needs and the needs of the Bank.
APPROXIMATE LOCATION SQUARE FOOTAGE OWNERSHIP AND OCCUPANCY ----------------------- ---------------- --------------------------------------------------------------------- Abilene, Texas 8,600 Owned by the Bank; occupied by the Chestnut Branch Abilene, Texas 3,500 Owned by the Bank; occupied by the Wylie Branch Abilene, Texas 58,900(1) Owned by the Bank; occupied and leased by the North 3rd Street Branch Abilene, Texas 1,200 Leased by the Bank; occupied by the South 14th Street Branch Azle, Texas 20,400(2) Owned by the Bank and three other condominium owners; occupied and leased by the Azle Main Branch Azle, Texas 3,900 Owned by the Bank; occupied by the Azle North Branch Bangs, Texas 5,800(3) Owned by the Bank; occupied by the Bangs Branch Big Spring, Texas 3,200 Owned by the Bank; occupied by the Big Spring Branch Lubbock, Texas 12,400 Owned by the Bank; occupied by the Broadway Branch and the Company Lubbock, Texas 15,300 Leased by the Bank; occupied by Operations Lubbock, Texas 23,200(4) Owned by the Bank; occupied and leased by the 82nd Street Branch Lubbock, Texas 1,800 Owned by the Bank; occupied by the Indiana Branch Odessa, Texas 62,400(5) Owned by the Bank; occupied and leased by the Odessa Main Branch Odessa, Texas 2,400 Leased by the Bank; occupied by the Winwood Branch Plainview, Texas 6,300 Owned by the Bank; occupied by the Plainview Branch San Angelo, Texas 6,800(6) Owned by the Bank; occupied and leased by the San Angelo Branch Stamford, Texas 14,000 Owned by the Bank; occupied by the Stamford Branch Trent, Texas 4,900 Leased by the Bank; occupied by the Trent Branch Winters, Texas 9,500 Owned by the Bank; occupied by the Winters Branch
---------- (1) The North 3rd Street Branch occupies approximately 14,400 square feet and leases approximately 44,500 square feet to third parties. (2) The Bank owns condominium interests totaling approximately 16,800 square feet. Three other condominium owners own units totaling approximately 3,600 square feet. (3) The Bangs Branch occupies approximately 3,600 square feet and donates the usage of approximately 2,200 square feet to a nonprofit agency. (4) The 82nd Street Branch occupies approximately 13,300 square feet, leases approximately 6,300 square feet to third parties and is attempting to lease the remaining approximately 3,600 square feet. (5) The Odessa Main Branch occupies approximately 18,500 square feet, leases approximately 26,100 square feet to third parties and is attempting to lease the remaining approximately 17,800 square feet. (6) The San Angelo Branch occupies approximately 3,400 square feet, leases approximately 3,400 square feet to third parties. 13 The Bank owns or leases certain additional tracts of land for parking, drive-in facilities and for future expansion or construction of new premises. Aggregate annual rentals of the Company and the Bank for all leased premises during the year ended December 31, 2001, were $242,000. This amount represents rentals paid for the lease of land by the Wylie Branches and of banking premises by the Operations Center, and the South 14th Street, Winwood and Trent Branches of the Bank. ITEM 3. LEGAL PROCEEDINGS. The Estate of Harry V. Howard, Deceased, filed a lawsuit against the Bank (as successor to First State Bank of Odessa, N.A.), (JOHN AND BILLY NEAL STORIE V. FIRST STATE BANK OF ODESSA, N.A., ODESSA, TEXAS, Cause No. 22080-B) in the 104th District Court for Taylor County, Texas. The plaintiffs' lawsuit related to the Bank's management of the Harry V. Howard Trust, wherein plaintiff's alleged that the Bank, in its capacity as trustee of this testamentary trust, failed to adequately oversee the trust assets and allowed waste to occur to the trust principal. Additionally, the plaintiff's alleged that the Bank made inappropriate distributions to the current beneficiary of the trust, that there were other acts of mismanagement and breach of fiduciary duty. The trial on this matter began on October 7, 2001. On October 10, 2001, the parties reached a mutual settlement of the matter. The terms of the settlement call for the Company's insurer to pay a nominal sum to the plaintiffs in return for a full release of the Bank and a dismissal with prejudice by the plaintiffs of this matter. From time to time, the Company is involved in litigation proceedings incidental to the normal course of its business. In the opinion of management, the ultimate liability, if any, resulting from known, current litigation, either singularly or in aggregate, would not reasonable be expected to have a material adverse effect on the Company's financial position or results of operations. 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. 14 PART II ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS MARKET INFORMATION Until August 11, 2000, the Company's Common Stock was traded on the American Stock Exchange (the "AMEX") under the symbol "IBK." Upon completion of the Acquisition, listing of the Company's Common Stock on the AMEX ceased. Independent Capital's Trust Preferred Securities currently 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.
Common Stock Trust Preferred Securities ----------------------------------- --------------------------------------- Cash Distributions Dividends Per High Low Per Share High Low Security ---------- ----------- --------- ----------- ----------- ------------- YEAR ENDED DECEMBER 31, 2000 First Quarter $ 21.125 $ 11.75 $ 0.06 $ 8.75 $ 6.4375 $ 0.21 Second Quarter 19.5 17.25 0.06 8.75 7.625 0.21 Third Quarter (through August 11 For Common Stock) 20 18 -- 8.5625 8.75 0.21 Fourth Quarter N/A N/A N/A 8.25 6.625 0.22 YEAR ENDED DECEMBER 31, 2001 First Quarter N/A N/A N/A $ 9.44 $ 8.00 $ 0.22 Second Quarter N/A N/A N/A 10.10 9.00 0.21 Third Quarter N/A N/A N/A 10.15 8.75 0.22 Fourth Quarter N/A N/A N/A 10.25 9.20 0.22 YEAR ENDED DECEMBER 31, 2002 First Quarter (through March 5) N/A N/A N/A $ 10.00 $ 9.60 $ 0.21
SHAREHOLDERS At March 5, 2002, all of the Company's Common Stock was owned indirectly by State National. DIVIDEND POLICY As the holder of all of the Common Stock, State National is entitled to receive any cash dividends that may be declared by the Company's Board of Directors. The declaration and payment of future dividends to State National 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 for the payment of dividends, 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. In addition, the Company is prohibited from paying dividends on the Common Stock in the event that it is in default under the terms of its junior subordinated debentures issued to Independent Capital in connection with the issuance of the Trust Preferred Securities or the Company extends the regular interest payment date with respect to its debentures to Independent Capital. 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 15 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. ITEM 6. SELECTED FINANCIAL DATA The following table presents selected consolidated financial information for the last five years. This financial information has been restated to reflect 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: Acquisition of the Company," "Note 3: Bank Merger," "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.
August 12, January 1, 2000, 2000, through through December August 11, 2001 31, 2000 2000 1999 1998 1997 --------- ---------- ---------- ----------- ----------- ----------- (Dollars in thousands, except per share amounts) Balance sheet information: Assets $ 637,383 $ 695,270 $ -- $ 358,262 $ 370,178 $ 264,574 Loans, net of unearned income 304,246 366,933 -- 186,626 184,560 140,853 Deposits 544,030 593,605 -- 318,299 330,804 242,801 Note payable 0 0 -- 0 1 57 Stockholder's equity 75,381 81,984 -- 25,356 24,505 20,527 Income statement information: Total interest income $ 41,183 19,724 $ 15,273 $ 24,206 $ 20,434 $ 18,324 Net interest income 22,012 10,472 8,918 14,308 11,158 9,665 Net income (loss) (7,197) 235 (1,908) 2,452 2,188 2,110 Basic earnings (loss) per common share available to common stockholders N/A N/A $ (.84) $ 1.12 $ 1.07 $ 1.12 Diluted earnings (loss) per share available to common stockholders N/A N/A $ (.84) $ 1.08 $ 1.02 $ 1.03 Cash dividends per common share N/A N/A $ 0.12 $ 0.20 $ 0.20 $ 0.19 Weighted average common shares outstanding: Basic N/A N/A 2,262 2,178 2,031 1,842 Diluted N/A N/A 2,262 2,275 2,151 2,048
16 ITEM 7. 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 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, ACTS OF TERRORISM AND WAR, 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. GENERAL The following discussion and analysis presents the more significant factors affecting the Company's financial condition at December 31, 2001 and 2000, and results of operations for each of the three years in the period ended December 31, 2001, after accounting for the Acquisition and the Mergers (defined below) as described in Note 2 and 3 in the Company's consolidated financial statements. 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. The results of operations for the Company for the year ended December 31, 2000, include the results of operations for UB&T and the Lubbock Bank beginning August 11, 2000, the date of the Acquisition. UB&T and the Lubbock Bank were previously owned subsidiaries of State National, which were merged with and into the Bank ("the Mergers"). The Mergers were accounted for similar to a pooling of interests. The name of the resulting bank was changed to State National Bank of West Texas, Lubbock, Texas (previously defined as the "Bank" or the "Lubbock Bank"). On March 1, 2000, the Company entered into an Agreement and Plan of Reorganization (the "Agreement") with State National for the Acquisition. The Company and State National consummated the Acquisition at the close of business August 11, 2000. Pursuant to the terms of the Agreement, each share of common stock of the Company was exchanged for $20.0165 in cash. Upon consummation of the Acquisition, State National became the sole shareholder of the Company, owning all 2,273,647 outstanding shares of the Company's common stock. In connection with the Acquisition, State National agreed to assume and guarantee the outstanding Trust Preferred Securities issued by Independent Capital, a Delaware business trust controlled by the Company. State National accounted for its acquisition of the Company as a purchase business combination, and purchase accounting adjustments, including goodwill, have been pushed down and reflected in the consolidated financial statements of the Company subsequent to August 11, 2000. The consolidated financial statements of the Company for the periods ended before August 12, 2000 (predecessor), were prepared using the Company's historical basis of accounting. The comparability of operating results for these periods and the periods encompassing push down accounting are affected by the purchase accounting adjustments, including the amortization of goodwill (straight-line method) and core deposit intangibles (accelerated method) over a period of 20 and 10 years, respectively. 17 RESULTS OF OPERATIONS GENERAL The net loss for the year ended December 31, 2001 was $7,197,000. The net loss for the period from January 1, 2000, through August 11, 2000, the date of the Acquisition, was $1,908,000 ($0.84 diluted loss per common share). The net income for the period from August 12, 2000, through December 31, 2000, was $235,000. Net income for the year ended December 31, 1999, amounted to $2,452,000 ($1.08 diluted earnings per common share). The net losses recorded during 2001 were due primarily to loan loss provisions recorded during the year related to the further deterioration of the Bank's collateral position on two particular large borrowing relationships from the original IBK loan portfolio, as well as further evaluation of the credit quality of the original IBK loan portfolio, all of which existed at the date of Acquisition. Net losses recorded in 2000 were due primarily to expenses incurred in connection with the Acquisition and increases in the provisions for loan losses. 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 $22,012,000 for 2001, an increase of $2,622,000, or 13.5%, from 2000. Net interest income for 2000 was $19,390,000, an increase of $5,082,000, or 35.5%, from 1999. The increase in 2001 and 2000 were primarily due to the Mergers. The net interest margin on a fully taxable-equivalent basis was 3.88% for 2001, compared to 4.64% for 2000 and 4.57% for 1999. The primary reason for the decrease in the net interest margin during 2001 was the lag in repricing for time deposits as compared to the repricing of assets. As the drop in interest rates occurred, the assets repriced much faster than did some of the longer-term time deposits. The decrease was partially offset by a stabilization of the yield related to securities. This stabilization is primarily due to the Company reinvesting security funds into higher yielding, longer maturity investments subsequent to the Acquisition and the Mergers. The primary reasons for the increase in the net interest margin during 2000 was the Mergers. UB&T had a historically higher loan to deposit ratio than the Company and the Lubbock Bank prior to the Mergers. At December 31, 2001, approximately $143,689,000, or 47.2%, of the Company's total loans, net of unearned income, were loans with floating interest rates. Approximately 53.9% of loans, excluding loans to individuals, were loans with floating interest rates. Average overall rates paid for various types of certificates of deposit decreased during 2001 when compared to 2000. For example, the average rate paid for certificates of deposit less than $100,000 decreased from 5.66% in 2000 to 5.29% in 2001, while the average rate paid by the Company for certificates of deposit of $100,000 or more also decreased from 5.90% during 2000 to 5.65% in 2001. Rates on other types of deposits, such as interest-bearing demand, savings and money market deposits, decreased from an average of 2.56% in 2000 to an average of 1.82% in 2001. As noted under "Analysis of Financial Condition-Interest Rate Sensitivity" below, by excluding interest-bearing demand, savings and money market deposits, the company would be in an asset sensitive position or positive gap. These deposits are excluded, as it has been the Company's experience that interest rates change more slowly for these types of deposits. Given the fact that the Company's interest-bearing assets are subject to repricing faster than its interest-earning liabilities in the short term, when excluding the slower changing deposits, an overall declining interest rate environment, as was experienced during 2001, would normally produce a lower net interest margin than in a rising 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. 18
Year Ended December 31, ---------------------------------------------------------------- 2001 2000(1)(2) ------------------------------- ------------------------------- Interest Interest Average Income/ Yield/ Average Income/ Yield/ Balance Expense Rate Balance Expense Rate --------- --------- -------- --------- --------- ------- (Dollars in thousands) ASSETS Interest-earning assets: Loans, net of unearned income (3) $ 326,920 $ 27,292 8.35% $ 258,327 $ 24,851 9.62% Securities (4) 185,333 11,632 6.28 135,765 8,507 6.27 Time Deposits in Other banks 709 28 3.95 194 12 6.19 Federal funds sold 59,010 2,428 4.11 28,025 1,846 6.59 --------- --------- -------- --------- --------- ------- Total interest-earning assets 571,972 41,380 7.23 422,311 35,216 8.34 --------- --------- -------- --------- --------- ------- Noninterest-earning assets: Cash and due from banks 32,767 24,653 Intangible assets 46,908 25,979 Premises and equipment, net 15,929 11,826 Accrued interest receivable and other assets 16,084 7,789 Allowance for possible loan losses (6,763) (4,512) --------- --------- Total noninterest-earning assets 104,925 65,735 --------- --------- Total assets $ 676,897 $ 488,046 ========= LIABILITIES AND STOCKHOLDER'S EQUITY Interest-bearing liabilities: Demand, savings and money market deposits $ 186,941 $ 3,407 1.82% $ 136,829 $ 3,505 2.56% Time deposits 290,547 15,760 5.42 210,502 12,095 5.75 Fed funds purchased and securities sold Under agreement to repurchase 150 4 2.67 373 7 1.88 --------- --------- -------- --------- --------- -------- Total interest-bearing liabilities 477,638 19,171 4.01 347,704 15,607 4.49 Noninterest-bearing liabilities: Demand deposits 100,197 75,425 Accrued interest payable and other liabilities 8,056 4,975 --------- --------- Total noninterest-bearing liabilities 108,253 80,400 --------- --------- Total liabilities 585,891 428,104 Guaranteed preferred beneficial interests in the Company's subordinated debentures 10,918 12,126 Stockholder's equity 80,088 47,816 --------- --------- Total liabilities and stockholder's equity $ 676,897 $ 488,046 ========= ========== Net interest income $ 22,209 $ 19,609 ========= ========= Interest rate spread (5) 3.22% 3.85% ======== ======= Net interest margin (6) 3.88% 4.64% ======== ======= Year Ended December 31, ------------------------------- 1999 ------------------------------- Interest Average Income/ Yield/ Balance Expense Rate --------- --------- -------- (Dollars in thousands) ASSETS Interest-earning assets: Loans, net of unearned income (3) $ 184,471 $ 17,027 9.23% Securities (4) 106,782 6,074 5.69 Time Deposits in Other banks 0 0 0.00 Federal funds sold 26,826 1,332 4.97 --------- --------- -------- Total interest-earning assets 318,079 24,433 7.68 --------- --------- -------- Noninterest-earning assets: Cash and due from banks 19,539 Intangible assets 10,480 Premises and equipment, net 10,034 Accrued interest receivable and other assets 6,099 Allowance for possible loan losses (1,787) --------- Total noninterest-earning assets 44,365 --------- Total assets $ 362,444 ========= LIABILITIES AND STOCKHOLDER'S EQUITY Interest-bearing liabilities: Demand, savings and money market deposits $ 106,485 $ 2,231 2.10% Time deposits 157,994 7,667 4.85 Fed funds purchased and securities sold Under agreement to repurchase 0 0 0.00 --------- --------- -------- Total interest-bearing liabilities 264,479 9,898 3.74 Noninterest-bearing liabilities: Demand deposits 58,041 Accrued interest payable and other liabilities 2,070 Total noninterest-bearing --------- liabilities 60,111 --------- Total liabilities 324,590 Guaranteed preferred beneficial interests in the Company's subordinated debentures 13,000 Stockholder's equity 24,854 --------- Total liabilities and stockholder's equity $ 362,444 ========= Net interest income $ 14,535 ========= Interest rate spread (5) 3.94% ======== Net interest margin (6) 4.57% ========
---------- (1) The Average Balance and Interest Income/Expense columns include the balance sheet and income statement accounts of Abilene Bank and Lubbock Bank from August 12, 2000, through December 31, 2000. (2) The Average Balance and Interest Income/Expense columns for the year ended December 31, 2000, included information for the predecessor Company pre-Acquisition (January 1, 2000, through August 11, 2000) and post-Acquisition (August 12, 2000, through December 31, 2000). (3) 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. (4) Nontaxable interest income on securities was adjusted to a taxable yield assuming a tax rate of 34%. (5) The interest rate spread is the difference between the average yield on interest-earning assets and the average cost of interest-bearing liabilities. (6) The net interest margin is equal to net interest income, on a fully taxable-equivalent basis, divided by average interest-earning assets. 19 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.
2001 vs. 2000(1) 2000(1) vs. 1999 ------------------------------------ ------------------------------------ Increase (Decrease) Due To Increase (Decrease) Due To ------------------------------------ ------------------------------------ Changes In: Changes In: ------------------------------------ ------------------------------------ Volume Rate Total Volume Rate Total -------- -------- ------- --------- ---------- --------- (Dollars in thousands) Interest-earning assets: Loans, net of unearned income $ 6,599 $ (4,158) $ 2,441 $ 6,817 $ 1,007 $ 7,824 Securities (2) 3,106 19 3,125 1,649 784 2,433 Time deposits in other banks 32 (16) 16 12 0 12 Federal funds sold 2,041 (1,459) 582 60 454 514 -------- -------- ------- --------- ---------- --------- Total interest income 11,778 (5,614) 6,164 8,538 2,245 10,783 -------- -------- ------- --------- ---------- --------- Interest-bearing liabilities: Deposits: Demand, savings and money market deposits 1,284 (1,382) (98) 636 638 1,274 Time deposits 4,599 (934) 3,665 2,548 1,880 4,428 Fed Funds Purchased and Securities sold under Agreement to repurchase (4) 1 (3) 7 0 7 -------- -------- ------- --------- ---------- --------- Total interest expense 5,879 (2,315) 3,564 3,191 2,518 5,709 -------- -------- ------- --------- ---------- --------- Increase (Decrease) in net interest income $ 5,899 $ (3,299) $ 2,600 $ 5,347 $ (273) $ 5,074 ======== ======== ======= ========= ========== =========
---------- (1) Income statement items include the income statement accounts of the Abilene Bank and the Lubbock Bank beginning August 12, 2000, through December 31, 2000. (2) Information with respect to interest income on tax-exempt securities is provided on a fully taxable-equivalent basis assuming a tax rate of 34%. PROVISION FOR LOAN LOSSES The amount of the provision for loan losses is based on periodic (not less than quarterly) evaluations of the loan portfolio, especially nonperforming and other potential problem loans. During these evaluations, consideration is given to such factors as: management's evaluation of specific loans; the level and composition of nonperforming loans; historical loss experience; results of examinations by regulatory agencies; an internal asset review process conducted by the Company that is independent of the management of the Bank; expectations of future economic conditions and their impact on particular industries and individual borrowers; the market value of collateral; the strength of available guarantees; concentrations of credit; and other judgmental factors. The provision for loan losses for the year ended December 31, 2001, was $10,765,000, compared to $2,278,000 for the previous year. The provision in 2001 represented an increase of $8,487,000, or 372.6%, from the 2000 provision. The provision recorded in 2001 was primarily related to the further deterioration of the Bank's collateral position on two particular large borrowing relationships from the original IBK loan portfolio, as well as further evaluation of the credit quality of the original IBK loan portfolio, all of which existed at the date of Acquisition. The provision in 2000 represented an increase of $1,833,000, or 411.9%, from the 1999 provision primarily due to increased classified, nonperforming and charged off loans during the second half of 2000. 20 NONINTEREST INCOME Noninterest income increased $1,614,000, or 42.6%, from $3,792,000 in 2000 to $5,406,000 in 2001. Noninterest income for 2000 increased $525,000, or 16.1%, from $3,267,000 in 1999. 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 $279,000, or 8.6%, from $3,227,000 for 2000 to $3,506,000 for 2001. The increase was attributable to the Mergers. Service charge income increased $385,000, or 13.5%, from $2,842,000 for 1999 to $3,227,000 for 2000 primarily due to the Mergers. Trust fees from trust operations increased $234,000, or 90.7%, from $258,000 in 2000 to $492,000 in 2001. Trust fees also increased $50,000, or 24.0%, from $208,000 during 1999 to $258,000 during 2000. The increases in 2001 and 2000 are due to an overall increase in the value of assets under management of the trust department. In particular, during the fourth quarter of 2000, the Bank purchased approximately $33,000,000 in trust assets from another trust company. Other income is the sum of several components of noninterest income including other customer service fees, brokerage service fees, credit and debit card income, safe deposit box rental income and other sources of miscellaneous income. Other income increased $1,101,000, or 358.6%, from $307,000 in 2000 to $1,408,000 in 2001 primarily due to the Mergers as well as income generated from the Bank Owned Life Insurance ("BOLI") purchased in 2001. Other income increased $90,000, or 41.5%, from $217,000 in 1999 to $307,000 for 2000, primarily due to the Mergers. NONINTEREST EXPENSES Noninterest expenses increased $5,074,000, or 23.1%, from $21,981,000 in 2000 to $27,055,000 in 2001, primarily as a result of the Mergers. Noninterest expenses increased $8,477,000, or 62.8%, from $13,504,000 in 1999 to $21,981,000 in 2000. The increase in 2000 was primarily a result of costs incurred in association with the Acquisition and due to the Mergers. Salaries and benefits rose $2,390,000, or 28.8%, from $8,291,000 in 2000 to $10,681,000 in 2001, primarily due to the Mergers. Salaries and employee benefits increased $2,245,000, or 37.1%, from $6,046,000 in 1999 to $8,291,000 in 2000, primarily due to the Mergers. Merger-related expenses totaled $51,000 for the year ended December 31, 2001,and $1,970,000 for the year ended December 31, 2000, a decrease of $1,919,000 or 97.4%. The expenses in 2000 include approximately $887,000 in accrued retention agreement payments payable to certain officers of the Company and the Bank, approximately $605,000 in payments made to the Company's investment advisor in connection with the Acquisition, approximately $319,000 paid for legal services rendered to the Company in connection with the Acquisition, approximately $65,000 for the purchase of tail insurance covering the Company's former officers and directors subsequent to the Acquisition and other miscellaneous expenses related to the Acquisition. Amortization of intangible assets increased $2,269,000, or 108.2%, from $2,098,000 for 2000 to $4,367,000 for 2001, and increased $1,425,000, or 211.7%, from $673,000 for 1999 to $2,098,000 for 2000. The increase in 2001 and 2000 is due to the amortization of the additional core deposit intangible and goodwill recorded as a result of the Acquisition. Net occupancy expense increased $611,000, or 49.4%, from $1,237,000 in 2000 to $1,848,000 in 2001. The increase was due to the Mergers. Net occupancy expense increased $293,000, or 31.0%, from $944,000 in 1999 to $1,237,000 in 2000. This increase was due to the Mergers and increases in property taxes and utilities in 2000. Distributions on guaranteed preferred beneficial interests in the Company's Subordinated Debentures increased $7,000, or 0.6%, from $1,112,000 for 2000 to $1,119,000 for 2001 and increased $7,000, or 0.6% from $1,105,000 for 1999 to $1,112,000 for 2000. The increase in 2001 and 2000 are due to the accretion into expense of the purchase accounting discount recorded on the Trust Preferred Securities in connection with the Acquisition. 21 Equipment expense increased $438,000, or 30.4%, from $1,440,000 in 2000 to $1,878,000 in 2001. The increase was primarily due to increased depreciation expense caused by the Mergers. Equipment expense increased $337,000, or 30.6%, from $1,103,000 in 1999 to $1,440,000 for 2000. The increase was due to the Mergers and the write-off of equipment and capitalized data processing conversion costs which would not be utilized or have any future value subsequent to the Acquisition. Professional fees, which include legal, accounting and other professional fees, decreased $293,000, or 24.8%, from $1,181,000 during 2000 to $888,000 during 2001, primarily due to the Acquisition completed in 2000. Professional fees increased $745,000, or 170.9%, from $436,000 during 1999 to $1,181,000 for 2000. The increase in 2000 is primarily a result of increased professional fees due to the Acquisition and the Mergers, as well as consulting and other professional fees paid for services subsequent to and related to the Acquisition. Stationery, printing and supplies expense increased $15,000, or 2.5%, from $612,000 for 2000 to $627,000 for 2001 due to the Mergers. Stationery, printing and supplies expense increased $38,000, or 6.6%, from $574,000 for 1999 to $612,000 for 2000, primarily caused by the Acquisition and the Mergers. Communication expense increased $261,000, or 39.3%, from $664,000 in 2000 to $925,000 in 2001, and increased $175,000, or 35.8%, from $489,000 in 1999 to $664,000 in 2000. The increase was due to enhanced voice and data communication capacity necessary to support a larger number of Bank branch locations as a result of the Mergers. Data processing expense increased $149,000, or 29.5%, from $505,000 in 2000 to $654,000 in 2001, and increased $170,000, or 50.7%, from $335,000 in 1999 to $505,000 in 2000. The increase was due to several data processing conversions that were performed as a result of the Acquisition and the Mergers and the fact that State National out-sources the Company's data processing function, which had previously been performed by the Company in-house prior to the Acquisition. Advertising and business development expense decreased $35,000 or 6.1% from $575,000 in 2000 to $540,000 in 2001 primarily due to the large increase in advertising which occurred in the fourth quarter of 2000 needed to promote the newly merged banks. Advertising and business development expense increased $438,000 or 319.7% from $137,000 in 1999 to $575,000 for 2000 due primarily to the Mergers and the more aggressive advertising and public relations campaign employed by State National as compared to the Company prior to the Acquisition. Net costs 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 $95,000 in 2001 compared to net costs of $6,000 in 2000, an increase of $89,000, or 1,483.3%. The increase in net costs during 2001 was primarily due to an increase in foreclosures on loans, most of which existed at the time of the Acquisition. Net costs for the Company were $6,000 in 2000 compared to $91,000 in 1999. The decrease for 2000 is primarily due to a decrease in the number of repossessed automobiles during 2000 as a result of a reduction in the number of outstanding indirect installment loans secured by automobiles. Other noninterest expense includes, among many other items, postage, loan and collection expenses, armored car and courier fees, travel, insurance, ATM transaction expenses, regulatory examinations, franchise taxes, dues and subscriptions, Federal Deposit Insurance Corporation ("FDIC") insurance expense and director's fees. These expenses increased $1,092,000, or 47.7%, from $2,290,000 during 2000 to $3,382,000 during 2001. The majority of the increase is due to the Mergers. These expenses increased $719,000, or 45.8%, from $1,571,000 for 1999 to $2,290,000 for 2000. The increase was primarily due to the Mergers. 22 FEDERAL INCOME TAXES The Company recorded a federal income tax benefit of $3,205,000 for 2001 and provided for $596,000 and $1,174,000 in federal income taxes in 2000 and 1999, respectively. The benefit was recorded due to the pretax loss incurred in 2001. The provision was made in 2000 despite the fact that the Company had a pretax loss due to a substantial amount of nondeductible Acquisition related expenses that were incurred during the year ended December 31, 2000. The effective tax rate for the Company was 32.4% for the year ended December 31, 1999. IMPACT OF INFLATION The effects of inflation on the local economy and on the Company's operating results have been relatively modest for the past several years. Because substantially all of the Company's assets and liabilities are monetary in nature, such as cash, securities, loans and deposits, their values are less sensitive to the effects of inflation than to changing interest rates, which do not necessarily change in accordance with inflation rates. The Company attempts to control the impact of interest rate fluctuations by managing the relationship between its interest rate sensitive assets and liabilities. See "Analysis of Financial Condition--Interest Rate Sensitivity" below. 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 following table, 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 company is considered to be asset sensitive, or having a positive gap, when the amount of its interest-earning assets maturing or repricing within a given period exceeds the amount of its interest bearing liabilities also maturing or repricing within that time period. Conversely, a company is considered to be liability sensitive, or having a negative gap, when the amount of its interest-bearing liabilities maturing or repricing within a given time period exceeds the amount of its interest-earning assets also maturing or repricing within that time period. During a period of rising interest rates, a negative gap would tend to affect net interest income adversely, while a positive gap would tend to result in an increase in net interest income. During a period of falling interest rates, as experienced in 2001, a negative gap would tend to result in an increase in net interest income, while a positive gap would tend to affect net interest income adversely. 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 and relatively stable interest rate spread from the difference between the income earned on interest-earning assets and the cost of interest-bearing liabilities. The Company's ratios of interest-sensitive assets to interest-sensitive liabilities, as shown in the following tables, are 63.4% at the 90-day interval, 63.3% at the 180-day interval and 63.5% at the 365-day interval at December 23 31, 2001. Currently, the Company is in a liability-sensitive position at the three intervals. However, the Company had $180,021,000 of interest-bearing demand, savings and money market deposits at December 31, 2001, which from the Company's experience, change more slowly in a declining interest rate environment than do the other types of deposits. Therefore, excluding these types of deposits, the Company's interest-sensitive assets to interest-sensitive liabilities ratio at the 365-day interval would have been 114.3% at December 31, 2001, a positive gap position. The interest sensitivity position is presented as of a point in time and can be modified to some extent by management as changing conditions dictate. The following table shows the interest rate sensitivity position of the Company at December 31, 2001:
Volumes Cumulative Volumes Subject to Subject to Repricing Within Repricing -------------------------------------- After 90 Days 180 Days 365 Days 1 Year Total ---------- ----------- ---------- ---------- ---------- (Dollars in thousands) Interest-earning assets: Federal funds sold $ 10,528 $ 10,528 $ 10,528 $ 0 $ 10,528 Securities 17,961 42,114 58,803 157,309 216,112 Loans, net of unearned income 153,286 162,614 187,619 116,651 304,270 ---------- ----------- ---------- ---------- ---------- Total interest-earning assets 181,775 215,256 256,950 273,960 530,910 ---------- ----------- ---------- ---------- ---------- Interest-bearing liabilities: Demand, savings and money market Deposits 180,021 180,021 180,021 0 180,021 Securities sold under agreement to Repurchase 151 151 151 0 151 Time deposits 106,585 159,854 224,626 27,339 251,965 ---------- ----------- ---------- ---------- ---------- Total interest-bearing liabilities 286,757 340,026 404,798 27,339 432,137 ---------- ----------- ---------- ---------- ---------- Rate-sensitivity gap (1) $ (104,982) $ (124,770) $(147,848) $ 246,621 $ 98,773 ========== =========== ========== ========== ========== Rate-sensitivity ratio (2) 63.4% 63.3% 63.5% ========== =========== ==========
---------- (1) Rate-sensitive interest-earning assets less rate-sensitive interest-bearing liabilities. (2) Rate-sensitive interest-earning assets divided by rate-sensitive interest-bearing liabilities. 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 Bank experienced no such decline. Although certain assets and liabilities may have similar maturities or periods of 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 24 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. 25 The following table provides information about the Company's financial instruments that are sensitive to changes in interest rates. Except for the effects of prepayments and scheduled principal amortization on mortgage related assets, the table presents principal cash flows and related weighted average interest rates by the contractual terms to maturity. Nonaccrual loans are included in the loan totals. All investments are classified as available-for-sale.
Year Ending December 31, ------------------------------------------------------ 2002 2003 2004 2005 2006 Thereafter Total Fair Value --------- -------- ------- ------- ------- ---------- -------- ---------- (Dollars in thousands) Fixed Rate Loans: Maturities $ 50,465 $ 27,823 $27,823 $18,854 $18,854 $ 16,762 $160,581 $ 163,298 Average interest rate 8.11% 9.04% 9.04% 8.72% 8.72% 8.38% 8.60% Adjustable Rate Loans: Maturities 80,335 10,482 10,482 11,953 11,953 18,484 143,689 143,689 Average interest rate 5.30% 5.73% 5.73% 5.47% 5.47% 6.84% 5.59% Securities and Other Interest-earning Assets: Maturities 84,271 47,043 48,308 18,696 18,696 9,626 226,640 226,640 Average interest rate 5.21% 5.13% 4.96% 6.43% 6.43% 6.74% 5.41% Total interest-earning Assets: Maturities $ 215,071 $ 85,348 $86,613 $49,503 $49,503 $ 44,872 $530,910 $ 533,627 Average interest rate 5.92% 6.48% 6.36% 7.07% 7.07% 7.39% 6.42% Savings Deposits: Maturities $ 0 $ 0 $ 0 $ 0 $ 0 $ 22,721 $ 22,721 $ 22,721 Average interest rate --% --% --% --% --% 0.36% 0.36% NOW Deposits: Maturities 0 0 0 0 0 81,646 81,646 81,646 Average interest rate --% --% --% --% --% 0.34% 0.34% Money Market Deposits: Maturities 0 0 0 0 0 75,654 75,654 75,654 Average interest rate --% --% --% --% --% 1.53% 1.53% Certificates of Deposit: Maturities 224,626 18,133 4,702 3,321 1,164 19 251,965 255,257 Average interest rate 3.91% 5.59% 5.79% 6.57% 5.02% 3.70% 4.11% Total Interest-bearing Liabilities: Maturities $224,626 $ 18,133 $ 4,702 $ 3,321 $ 1,164 $ 180,040 $431,986 $ 435,278 Average interest rate 3.91% 5.59% 5.79% 6.574% 5.02% .84% 2.75%
The Company assumes that 100% of savings, NOW and money market deposits at December 31, 2001, 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 decreased $57,887,000, or 8.3%, from $695,270,000 at December 31, 2000, to $637,383,000 at December 31, 2001, due primarily to decreases in net loans and cash, which are related to decreases in total deposits. The decreases in net loans and cash were partially offset by an increase in securities. CASH AND CASH EQUIVALENTS At December 31, 2001, the Company had $46,590,000 in cash and cash equivalents, down $36,995,000, or 44.3%, from $83,585,000 at December 31, 2000, due primarily to the use of cash to fund an increase in the securities balance. 26 SECURITIES Securities increased $38,918,000, or 22.0%, from $177,194,000 at December 31, 2000, to $216,112,000 at December 31, 2001. The increase in 2001 was due primarily to the inflow of cash from loans, which were paid off, and the investment of those proceeds into securities. The board of directors of the Bank reviews all securities transactions monthly and the securities portfolio periodically. The Company's current investment policy provides for the purchase of U.S. Treasury securities, U.S. Government agency securities, mortgage-backed securities having maturities of twelve 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 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. All securities are classified as available-for-sale and are carried at fair value at December 31, 2001. 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, 2001, the carrying value of U.S. Government and other securities so pledged amounted to $47,785,000, or 22.1% 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, ------------------------------------------------------------------------ 2001 2000 1999 --------------------- -------------------- ------------------ Amount % Amount % Amount % -------- ------ -------- -------- -------- ------ (Dollars in thousands) Carrying value: U.S. Treasury securities and obligations of U.S. Government agencies and corporations $136,025 62.9% $129,038 72.8% $ 90,998 83.6% Mortgage-backed securities and collateralized mortgage obligations 69,735 32.3 36,694 20.7 7,783 7.1 Obligations of states and political subdivisions 7,109 3.3 8,334 4.7 9,103 8.4 Other securities 3,243 1.5 3,128 1.8 1,019 0.9 -------- ------ -------- -------- -------- ------ Total securities $216,112 100.0% $177,194 100.0% $108,903 100.0% ======== ====== ======== ======== ======== ====== Total fair value $216,112 $177,161 $107,608 ======== ======== ========
27 The following table provides the maturity distribution and weighted average interest rates of the Company's total securities portfolio at December 31, 2001. 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 carrying value of securities. The book value of securities classified as held-to-maturity was their historical cost, adjusted for premium amortization and discount accretion. The adjustment of the yields on tax-exempt securities to a fully taxable-equivalent basis has been computed assuming a tax rate of 34%.
Weighted Principal Carrying Estimated Average Type and Maturity Grouping at December 31, 2001 Amount Value Fair Value Yield ----------------------------------------------------------- --------- -------- ---------- -------- (Dollars in thousands) U.S. Treasury securities and obligations of U.S. Government agencies and corporations: Within one year $ 22,172 $ 22,567 $ 22,567 6.76% After one but within five years 97,845 100,441 100,441 5.11% After five but within ten years 12,346 13,017 13,017 6.57% --------- -------- -------- -------- Total U.S. Treasury securities and obligations of U.S. Government agencies and corporations 132,363 136,025 136,025 5.52% --------- -------- -------- -------- Mortgage-backed securities and collateralized mortgage obligations 68,943 69,735 69,735 5.74% Obligations of states and political subdivisions: Within one year 325 326 326 6.88% After one but within five years 5,032 5,113 5,113 7.55% After five but within ten years 1,508 1,542 1,542 6.82% After ten years 120 128 128 8.02% --------- -------- -------- -------- Total obligations of states and political subdivisions 6,985 7,109 7,109 7.37% --------- -------- -------- -------- Other securities: Within one year 0 0 0 0.00% After one but within five years 0 0 0 0.00% After five but within ten years 0 0 0 0.00% After ten years 3,243 3,243 3,243 1.75% --------- -------- -------- -------- Total other securities 3,243 3,243 3,243 1.75% --------- -------- -------- -------- Total securities $ 211,534 $216,112 $216,112 5.60% ========= ======== ======== ========
LOAN PORTFOLIO Total loans, net of unearned income, decreased $62,687,000, or 17.1%, from $366,933,000 at December 31, 2000, to $304,246,000 at December 31, 2001. The decrease in loans in 2001 was primarily a result of a decrease in commercial loans associated with a restructuring of the general loan portfolio due to the Acquisition and a decrease in loans to individuals. The Bank primarily makes installment loans to individuals and commercial loans to small to medium-sized businesses and professionals. The Bank offers a variety of commercial lending products including revolving lines of credit, letters of credit, working capital loans, loans to finance accounts receivable, inventory and equipment and various types of agriculture loans. Typically, the Bank's commercial loans have floating rates of interest, are for varying terms (generally not exceeding five years), are personally guaranteed by the borrower and are collateralized by real estate, accounts receivable, inventory or other business assets. Due to the diminished loan demand during the early 1990's, the Bank instituted an installment loan program whereby it began to purchase automobile loans from automobile dealerships in its market areas. At December 31, 2001 and 2000, the Company had approximately $5,016,000 and $13,133,000, net of unearned income, respectively, of this type of loan outstanding. The decrease during 2000 is due to management's decision to shift the loan portfolio toward more commercial and real estate loans and less toward indirect installment loans. 28 The following table presents the Company's loan balances at the dates indicated separated by loan type:
December 31, -------------------------------------------------------- 2001 2000 1999 1998 1997 -------- ---------- --------- --------- -------- (Dollars in thousands) Real estate loans $ 135,544 $ 127,510 $ 72,268 $ 71,901 $ 44,569 Commercial loans 98,129 127,205 55,270 47,551 24,184 Loans to individuals 37,873 53,308 46,748 57,564 67,453 Agriculture and other loans 32,724 59,036 12,857 9,310 6,109 -------- ---------- --------- --------- -------- Total loans 304,270 367,059 187,143 186,326 142,315 Less unearned income 24 126 517 1,766 1,462 -------- ---------- --------- --------- -------- Loans, net of unearned income $ 304,246 $ 366,933 $ 186,626 $ 184,560 $140,853 ======== ========== ========= ========= ========
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, 2001, except for those described above and a geographic concentration of loans in West and North Texas. The Bank had no loans outstanding to foreign countries or borrowers headquartered in foreign countries at December 31, 2001. Management of the Bank may renew loans at maturity when requested by a customer whose financial strength appears to support such renewal or when such renewal appears to be in the Company's best interest. The Company requires payment of accrued interest in such instances and may adjust the rate of interest, require a principal reduction or modify other terms of the loan at the time of renewal. The following table presents the distribution of the maturity of the Company's loans and the interest rate sensitivity of those loans, excluding loans to individuals, at December 31, 2001. 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 Total One Year Five Over Five Carrying and Less Years Years Value -------- -------- --------- --------- (Dollars in thousands) Real estate loans $ 63,864 $ 58,914 $ 12,766 $ 135,544 Commercial loans 80,096 14,386 3,647 98,129 Agriculture and other loans 30,447 2,049 227 32,723 -------- -------- --------- --------- Total loans $174,407 $ 75,349 $ 16,640 $ 266,396 ======== ======== ========= ========= With fixed interest rates $ 37,253 $ 69,078 $ 16,376 $ 122,707 With variable interest rates 137,154 6,271 264 143,689 -------- -------- --------- --------- Total loans $174,407 $ 75,349 $ 16,640 $ 266,396 ======== ======== ========= =========
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 status, 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. 29 Nonperforming loans are fully or substantially collateralized by assets, with any excess of loan balances over collateral values allocated in the allowance for loan loss. 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, --------------------------------------------------- 2001 2000 1999 1998 1997 --------- -------- ------- -------- ------- (Dollars in thousands) Nonaccrual loans $ 5,581 $ 3,337 $ 236 $ 238 $ 70 Accruing loans contractually past due over 90 days 223 2,572 203 198 121 Restructured loans 29 119 186 110 104 Other real estate and other repossessed assets 691 576 272 630 739 --------- -------- ------- -------- ------- Total nonperforming assets $ 6,524 $ 6,604 $ 897 $ 1,176 $ 1,034 ========= ======== ======= ======== ======= Total Allowance for Loan Loss Reserve to Total nonperforming assets 100.0% 126.9% 204.3% 156.6% 113.4% ========= ======== ======= ======== =======
The gross interest income that would have been recorded in 2001 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 $582,000. A total of $1,000 in interest on nonaccrual loans was actually recorded (received) during 2001. 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 those reported in the above table or those included on the watch list as discussed below. The Company follows a loan review program to evaluate the credit risk in its loan portfolio. Through the loan review process, the Bank maintains an internally classified loan list that, along with the list of nonperforming loans discussed below, helps management assess the overall quality of the loan portfolio and the adequacy of the allowance. Loans classified as "substandard" are those loans with clear and defined weaknesses such as highly leveraged positions, unfavorable financial ratios, uncertain repayment sources, involvement in bankruptcy proceedings 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, 2001, substandard loans totaled $12,460,000, of which $4,366,000 were loans designated as nonaccrual, 90 days past due or restructured, and doubtful loans totaled $976,000, of which $945,000 were loans designated as nonaccrual or 90 days past due. There were no loans designated as loss as of December 31, 2001. Substandard and doubtful loans at December 31, 2000 were $15,082,000 and $1,742,000, respectively. In addition to the internally classified loans, the Bank also has a "watch list" of loans that further assists the Bank in monitoring its loan portfolio. A loan is included on the watch list if it demonstrates one or more deficiencies requiring attention in the near term or if the loan's ratios have weakened to a point where more frequent monitoring is warranted. These loans do not have all the characteristics of a classified loan (substandard, doubtful or loss), but do have weakened elements as compared with those of a satisfactory credit. Management of the Bank reviews these loans to assist in assessing the adequacy of the allowance. Substantially all of the loans on the watch list at December 31, 2001, were current and paying in 30 accordance with loan terms. At December 31, 2001, watch list loans totaled $12,011,000. At such date, $53,000 of loans on the watch list were designated as nonaccrual or 90 days past due. In addition, at December 31, 2001, $441,000 of unclassified loans were designated as nonaccrual, 90 days past due or restructured. OTHER REAL ESTATE AND OTHER REPOSSESSED ASSETS Foreclosures on defaulted loans result in the Company acquiring other real estate and other repossessed assets. Accordingly, the Company incurs other expenses, specifically net costs applicable to other real estate and other repossessed assets, in maintaining, insuring and selling such assets. The Bank attempts to convert nonperforming loans into interest-earning assets, although usually at a lower dollar amount than the face value of such loans, either through liquidation of the collateral securing the loan or through intensified collection efforts. 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, 2001 and 2000, other real estate and other repossessed assets had an aggregate book value of $691,000 and $576,000, respectively. Other real estate and other repossessed assets increased $115,000, or 20.0%, during 2001. The increase was primarily due to an increase in foreclosures on loans that existed at the time of acquisition. The December 31, 2001, balance of $691,000 included four commercial properties ($565,000), three residential properties ($70,000) and eight repossessed automobiles ($56,000). Of the December 31, 2000, balance of $576,000, $434,000 represented six commercial properties, $62,000 represented two residential properties and $80,000 represented sixteen repossessed automobiles. ALLOWANCE FOR LOAN LOSSES Implicit in the Company's lending activities is the fact that loan losses will be experienced and that the risk of loss will vary with the type of loan being made and the creditworthiness of the borrower over the term of the loan. To reflect the currently perceived risk of loss associated with the Company's loan portfolio, additions are made to the Company's allowance for 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 allowance is reduced by loan charge-offs and increased by recoveries of loans previously charged off and the loan provision necessary to bring the allowance to an amount determined by management to be adequate. The Company's allowance was $6,525,000, or 2.14% of loans, net of unearned income, at December 31, 2001, compared to $8,379,000, or 2.28% of loans, net of unearned income, at December 31, 2000, and compared to $1,833,000, or 0.98% of loans, net of unearned income, at December 31, 1999. The decrease in the balance of the allowance from December 31, 2000, to December 31, 2001, and the decrease in the ratio of the allowance to total loans, net of unearned income, during the past year, are primarily due to the net charge off of loans, most of which existed at the time of Acquisition, of $12,619,000. Provisions to loan loss of $10,765,000 offset net charge offs. Credit and loan decisions are made by management and the board of directors of the Bank in conformity with loan policies established by the board of directors of the Company. The Company's practice is to charge off any loan or portion of a loan when the loan is determined by management to be uncollectible due to the borrower's failure to meet repayment terms, the borrower's deteriorating or deteriorated financial condition, the depreciation of the underlying collateral, the loan's classification as a loss by regulatory examiners or for other reasons. The Company charged off $13,694,000 in loans during 2001. Charge-offs for 2001 were concentrated in the following categories: commercial loans--$9,565,000, or 69.9%; agriculture and other loans--$2,892,000, or 21.1%; and loans to individuals--$1,237,000, or 9.0%. These charge-offs were primarily due to the further deterioration of the Bank's collateral position on two large borrowing relationships, which existed at the date of the Acquisition. The outstanding loan balances associated with these relationships have continued to be reduced through charge offs as noted above, to estimated net realizable balances of the underlying collateral. Recoveries during 2001 were $1,075,000 and were concentrated in commercial loans, which accounted for $909,000, or 84.6%, of total recoveries during 2001. 31 The following table presents the activity in the allowance for the year ended 2001, the period from January 1, 2000, to August 11, 2000, the period from August 12, 2000, to December 31, 2000, and the years ended December 31, 1999, 1998 and 1997. Also presented are average loans outstanding and certain pertinent ratios for the last five years.
August 12, January 1, Year Ended 2000, to 2000, to Years Ended December 31, December 31, December 31, August 11, --------------------------------- 2001 2000(1) 2000 1999 1998(2) 1997(3) ------------ ------------ ----------- -------- -------- -------- (Dollars in thousands) Analysis of allowance for possible loan losses: Balance, beginning of period $ 8,379 $ 6,371 $ 1,833 $ 1,842 $ 1,173 $ 793 Provision for loan losses 10,765 618 1,660 445 570 250 Purchase accounting adjustment 0 0 3,028 0 0 0 Bank acquisition/merger 0 3,147 0 0 726 395 ------------ ------------ ----------- -------- -------- -------- 19,144 10,136 6,521 2,287 2,469 1,438 ------------ ------------ ----------- -------- -------- -------- Loans charged off: Real estate loans 0 19 0 5 40 6 Commercial loans 9,565 1,459 50 106 18 107 Loans to individuals 1,237 308 174 586 671 457 Agriculture and other loans 2,892 10 6 0 0 11 ------------ ------------ ----------- -------- -------- -------- Total charge-offs 13,694 1,796 230 697 729 581 ------------ ------------ ----------- -------- -------- -------- Recoveries of loans previously charged off: Real estate loans 2 0 1 104 16 35 Commercial loans 909 6 6 20 41 220 Loans to individuals 158 33 72 118 45 60 Agriculture and other loans 6 0 1 1 0 1 ------------ ------------ ----------- -------- -------- -------- Total recoveries 1,075 39 80 243 102 316 ------------ ------------ ----------- -------- -------- -------- Net loans charged off 12,619 1,757 150 454 627 265 ------------ ------------ ----------- -------- -------- -------- Balance, end of period $ 6,525 $ 8,379 $ 6,371 $ 1,833 $ 1,842 $ 1,173 ============ ============ =========== ======== ======== ======== Average loans outstanding, net of unearned income, for the year ended December 31 $ 326,920 $374,347 $184,471 $153,188 $132,891 ============ ============ ======== ======== ======== Ratio of net loan charge-offs to average loans, net of unearned income, for the year ended December 31 3.86% 0.47% 0.25% 0.41% 0.20% ============ ============ ======== ======== ======== Ratio of allowance for possible loan losses to total loans, net of unearned income, at December 31 2.14% 2.28% 0.98% 1.00% 0.83% ============ ============ ======== ======== ========
---------- (1) Average loans, net of unearned income, for 2000 include the average loans, net of unearned income, of UB&T and the Lubbock Bank from August 12, to December 31, 2000. (2) 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. (3) Average loans, net of unearned income, for 1997 include the average loans, net of unearned income, of Western National Bank, Lubbock, Texas, from January 28 through December 31, 1997. 32 The increase in the allowance of $3,028,000 related to purchase accounting adjustments is due primarily to five borrowing relationships with whom predecessor management had intended to continue to work and extend or renew the loans as necessary. Predecessor management believed that the net carrying amount, after considering specific reserves, was adequate to reflect the estimated carrying amount of the loans. Successor management has determined that the Company will no longer maintain a relationship with these borrowers, has informed the borrowers that the borrowers will have to pay off their respective loans with the Company and, if necessary, liquidate the collateral supporting the loans within no later than one year of the Acquisition date. As of December 31, 2001, substantially all of these relationships have been exited. The Company also offered a reduction in principal to one borrower to provide an incentive for the borrower to move its loan relationship. As these loans are collateral dependent, the estimated losses on these loans are primarily due to estimated collateral liquidation value shortfalls. Overall, successor management has determined that the intended method of ultimate recovery on loans from these five borrowing relationships is demonstrably different from the plans that had served as the basis for predecessor management's estimation of recovery on such loans. The provision for loan losses for the period of August 12, 2000, to December 31, 2000, includes the impact of successor management conforming certain predecessor loan loss methodology to its loan loss calculation methodology. Specifically, successor management has conformed certain charge-off factors on pools of loans to its own historical loan loss factors. The amount of the allowance is established by management based upon estimated risks inherent in the existing loan portfolio. The allowance is comprised of three components: specific reserves on specific problem loans, historical loss percentages applied to pools of loans with similar characteristics, and an unallocated portion. Management reviews the loan portfolio on a continuing basis to evaluate potential problem loans. This review encompasses management's estimate of current economic conditions and the potential impact on various industries, prior loan loss experience and the financial conditions of individual borrowers. Loans that have been specifically identified as problem or nonperforming loans are reviewed on at least a quarterly basis, and management critically evaluates the prospect of ultimate losses arising from such loans, based on the borrower's financial condition and the value of available collateral. When a risk can be specifically quantified for a loan, that amount is specifically allocated in the allowance. In addition, the Company allocates the allowance based upon the historical loan loss experience of the different types of loans. Despite such allocation, both the allocated and unallocated portions of the allowance are available for charge-offs for 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, -------------------------------------------------------------------------------- 2001 2000 1999 ------------------------- -------------------------- ------------------------- Percent of Percent of Percent of Loans by Loans by Loans by Category Amount of Category to Amount of Category to Amount of to Loans, Allowance Loans, Net Allowance Loans, Net Allowance Net of, Allocated of Unearned Allocated of Unearned Allocated Unearned to Category Income to Category Income to Category Income ----------- ----------- ------------ ------------ ------------- ----------- (Dollars in thousands) Real estate loans $ 1,092 44.5% $ 685 34.7% $ 198 38.7% Commercial loans 1,714 32.3 3,434 34.7 254 29.6 Loans to individuals 868 12.4 1,248 14.5 672 24.8 Agriculture and other loans 19 10.8 1,819 16.1 37 6.9 ----------- ------------ ------------ ------------ ------------- ------------ Total allocated 3,693 100.0% 7,186 100.0% 1,161 100.0% ============ ============ ============ Unallocated 2,832 1,193 672 ----------- ------------ ------------- Total allowance for possible loan losses $ 6,525 $ 8,379 $ 1,833 =========== ============= =============
33
December 31, ---------------------------------------------------- 1998 1997 ------------------------ -------------------------- Percent of Percent of Loans by Loans by Amount of Category to Amount of Category to Allowance Loans, Net Allowance Loans, Net Allocated of Unearned Allocated of Unearned to Category Income to Category Income ----------- ----------- ------------- ----------- (Dollars in thousands) Real estate loans $ 106 39.0% $ 52 31.6% Commercial loans 164 25.8 193 17.2 Loans to individuals 577 30.2 570 46.8 Agriculture and other loans 9 5.0 28 4.4 ----------- ----------- ----------- ----------- Total allocated 856 100.0% 843 100.0% =========== =========== Unallocated 986 330 ----------- ----------- Total allowance for possible loan losses $ 1,842 $ 1,173 =========== ===========
The increase of $1,639,000 in the unallocated portion of the reserve from December 31, 2000 to December 31, 2001 is primarily caused by the decline in current economic conditions and the recent loan loss experience. INTANGIBLE ASSETS Intangible assets decreased $5,457,000, or 11.1%, from $49,176,000 at December 31, 2000, to $43,719,000 at December 31, 2001, primarily due to amortization of the intangible balance during the 2001. PREMISES AND EQUIPMENT Premises and equipment decreased $475,000, or 3.0%, from $15,855,000 at December 31, 2000, to $15,380,000 at December 31, 2001. The decrease was primarily due to the depreciation of premises and equipment occurring in 2001. This decrease was partially offset by additions to premises and equipment during the year. 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 decreased $2,694,000, or 33.6%, from $8,015,000 at December 31, 2000, to $5,321,000 at December 31, 2001. The decrease during 2001 was a result of decreases in the loan balance during the year as well as decreases in the interest rates charged on loans. This decrease was partially offset by increases in accrued interest due to higher security balances and higher yields on securities. Of the total balance at December 31, 2001, $2,953,000, or 55.5%, was interest accrued on loans and $2,368,000, or 44.5%, was interest accrued on securities. OTHER ASSETS The balance of other assets increased $9,534,000, or 411.8%, to $11,849,000 at December 31, 2001, from $2,315,000 at December 31, 2000, due principally to the purchase of bank owned life insurance on various officers of the Bank. DEPOSITS The Bank's lending and investing activities are funded almost entirely by core deposits, 53.7% of which were noninterest-bearing and interest-bearing demand deposits at December 31, 2001. Total deposits decreased $49,575,000, or 8.4%, from $593,605,000 at December 31, 2000, to $544,030,000 at December 31, 2001. The decrease in deposits was primarily due to prime rates falling during the year, which allowed the bank to lower rates paid on deposits. These lower 34 rates caused customers to remove their deposits in favor of other types of investment opportunities. The Bank does 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, ---------------------------------------------------------------------- 2001 2000(1) 1999 --------------------- --------------------- ------------------- Average Average Average Average Average Average Amount Rate Amount Rate Amount Rate -------- ------- ---------- ------- --------- ------- (Dollars in thousands) Noninterest-bearing demand deposits $ 100,197 --% $ 75,425 --% $ 58,041 --% Interest-bearing demand, savings and money market deposits 186,941 1.82 136,829 2.56 106,485 2.10 Time deposits of less than $100,000 182,860 5.29 138,167 5.66 109,140 4.81 Time deposits of $100,000 or more 107,687 5.65 72,335 5.90 48,854 4.95 --------- ------- ---------- ------- --------- ------- Total deposits $ 577,685 3.32% $ 422,756 3.69% $ 322,520 3.07% ========= ======= ========== ======= ========= =======
---------- (1) The average amounts and average rates paid on deposits for the year ended December 31, 2000, include the averages of UB&T and the Lubbock Bank from August 12 through December 31, 2000. The maturity distribution of time deposits of $100,000 or more at December 31, 2001, is presented below:
December 31, 2001 ----------------- (In thousands) 3 months or less $ 40,563 Over 3 through 6 months 16,332 Over 6 through 12 months 22,604 Over 12 months 9,149 ------- Total time deposits of $100,000 or more $88,648 =======
The Bank experiences 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, 2001, time deposits of $100,000 or more represented 16.3% of the Company's total deposits compared to 18.3% of the Company's total deposits at December 31, 2000. FED FUNDS PURCHASED AND SECURITIES SOLD UNDER AGREEMENT TO REPURCHASE The balance of fed funds purchased and securities sold under agreement to repurchase increased $151,000 or 100.0%, from $0 at December 31, 2000 to $151,000 at December 31, 2001. The market of securities sold under agreement to repurchase was entered into during 2001 due to the advantageous conditions that exist of obtaining funds at favorable interest rates. ACCRUED INTEREST PAYABLE Accrued interest payable consists of interest that has accrued on deposits, but is not yet payable under the terms of the related agreements. The balance of accrued interest payable decreased $1,026,000, or 41.2%, from $2,488,000 at December 31, 2000, to $1,462,000 at December 31, 2001, due to a decrease in interest rates being paid on interest-bearing time deposits. 35 OTHER LIABILITIES The balance of other liabilities decreased $848,000, or 13.5%, from $6,289,000 at December 31, 2000, to $5,441,000 at December 31, 2001, due primarily to a reduction in deferred taxes payable associated with the amortization of the core deposit intangible. SELECTED FINANCIAL RATIOS The following table presents selected financial ratios for each of the last three fiscal years:
Year Ended December 31, ---------------------------------- 2001 2000(1) 1999 ------- -------------- --------- Net income (loss) to: Average assets (1.06)% (0.34)% 0.68% Average interest-earning assets (1.26) (0.40) 0.77 Average stockholder's equity (8.99) (3.50) 9.87 Dividend payout (2) to: Net income (loss) N/A N/A 17.82 Average stockholder's equity N/A N/A 1.76 Average stockholder's equity to: Average total assets 11.83 9.80 6.86 Average loans (3) 24.50 18.51 13.47 Average total deposits 13.86 11.31 7.71 Average interest-earning assets to: Average total assets 84.50 86.53 87.76 Average total deposits 99.01 99.89 98.62 Average total liabilities 97.62 98.65 97.99 Ratio to total average deposits of: Average loans (3) 56.59 61.11 57.20 Average noninterest bearing deposits 17.34 17.84 18.00 Average interest-bearing deposits 82.66 82.16 82.00 Total interest expense to total interest income 46.55 44.60 40.89 Efficiency Ratio (4) 78.13 72.45 66.20
---------- (1) Average balance sheet and income statement items for 2000 include the averages for UB&T and the Lubbock Bank from August 12 through December 31, 2000. (2) Dividends for Common Stock only. (3) Before allowance for loan losses. (4) Calculated as noninterest expense less distributions on guaranteed preferred beneficial interests in the Company's subordinated debentures, amortization of intangibles, merger-related expense and net costs (revenues) 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 Bank to maintain funds on hand arises principally from maturities of short-term borrowings, deposit withdrawals, customers' borrowing needs and the maintenance of reserve requirements. Liquidity with respect to a financial institution can be met from either assets or liabilities. On the asset side, the primary sources of liquidity are cash and due from banks, federal funds sold, maturities of securities and scheduled repayments and maturities of loans. The Bank maintains adequate levels of cash and near-cash investments to meet their day-to-day needs. Cash and due from banks averaged $32,767,000 and $24,653,000 during the years ended December 31, 2001 and 2000, respectively. These amounts comprised 4.8% and 5.05% of average 36 total assets during the years ended December 31, 2001 and 2000, respectively. The average level of securities, time deposits in other banks and federal funds sold was $245,052,000 and $163,984,000 during the years ended December 31, 2001 and 2000, respectively. The increases from 2000 to 2001 were primarily due to the Mergers. A total of $59,919,000 and $42,692,000 of securities classified as available-for-sale were sold during the years ended December 31, 2001 and 2000. At December 31, 2001, $22,893,000, or 15.6%, of the Company's securities portfolio, excluding mortgage-backed securities, matured within one year and $105,554,000, or 72.1%, excluding mortgage-backed securities, matured after one but within five years. The Bank's commercial and real estate lending activities are concentrated in loans with maturities of less than five years with both fixed and adjustable interest rates, while its installment lending activities are concentrated in loans with maturities of three to five years with primarily fixed interest rates. At December 31, 2001, approximately $187,619,000, or 61.7%, of the Company's loans, net of unearned income, matured within one year and/or had adjustable interest rates. Approximately $174,408,000, or 65.5%, 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, 2001 and 2000, the Company's average deposits were $577,685,000, or 85.3% of average total assets, and $422,756,000, or 86.6% of average total assets, respectively. The Company attracts its deposits primarily from individuals and businesses located within the market areas served by the Bank. See "Analysis of Financial Condition--Deposits" above. THE COMPANY The Company depends on the Bank for liquidity in the form of cash flow, primarily to meet distribution requirements on Independent Capital's Trust Preferred Securities and to cover other operating expenses. Prior to the Acquisition, this cash flow came from three sources: (1) dividends resulting from earnings of the Bank, (2) current tax liabilities generated by the Bank and (3) management and service fees for services performed for the Bank. Subsequent to the Acquisition, the Company ceased charging management fees to the Bank. The Company's immediate liquidity needs have been and can continue to be satisfied by advances from the Company's parent company. The payment of dividends from the Bank is subject to applicable law and the scrutiny of regulatory authorities. Dividends paid by the Bank to Independent Financial in 2001 aggregated $700,000; in turn, Independent Financial and Independent Capital paid dividends to the Company totaling $734,000 during 2001. Dividends paid by the Bank to Independent Financial during 2000 aggregated $2,900,000; in turn, Independent Financial and Independent Capital paid dividends to the Company totaling $2,935,000. At December 31, 2001, there were no dividends available for payment to Independent Financial by the Bank without prior regulatory approval. Pursuant to a tax-sharing agreement, the Bank pays to the Company an amount equal to its individual tax liability on the accrual method of federal income tax reporting. The accrual method generates more timely payments of current tax liabilities by the Bank to the Company, increasing the regularity of cash flow and shifting the time value of such funds to the Company. In the event that the Bank incurs losses, the Company may be required to refund tax liabilities previously collected. There were no current tax liabilities generated by the Bank during 2001 due to the pre-tax loss incurred by the Bank and current tax liabilities totaling $1,096,000 were paid by the Bank to the Company during 2000. Prior to the Acquisition, the Bank paid management fees to the Company for services performed. These services included, but were not limited to, financial and accounting consultation, attendance at the Bank's board meetings, audit and loan review services and related expenses. The Bank paid a total of $102,000 in management fees to the Company during 2000. The Company's fees must be reasonable in relation to the management services rendered, and the Bank was prohibited from paying management fees to the Company if the Bank would have been undercapitalized after any such distribution or payment. 37 CAPITAL RESOURCES At December 31, 2001, stockholders' equity totaled $75,381,000, or 11.8% of total assets, compared to $81,984,000, or 11.8% of total assets, at December 31, 2000. The reason for the decrease is the net loss recorded in 2001. 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 banking companies to have Tier 1 capital of at least 4%, and total capital (Tier 1 and Tier 2 capital) of at least 8%, of net risk-weighted assets, and to be designated as "well-capitalized", the banking company must have Tier 1 and total risk based capital ratios of 6% and 10%, respectively. For the Company, Tier 1 capital includes common stockholder's equity (net of available for sale fair value adjustment) and qualifying guaranteed preferred beneficial interests in the Company's subordinated debentures, reduced by intangible assets, net of the deferred tax liability associated with the core deposit intangible, and any deferred tax asset disallowed for regulatory capital purposes. For the Company, Tier 2 capital is comprised of the remainder of guaranteed preferred beneficial interests in the Company's subordinated debentures not qualifying as Tier 1 capital and the qualifying amount 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 at least 4% and to be designated as well-capitalized, the banking company must have a leverage ratio of at least 5%. The following tables provide a calculation of the Company's risk-based capital ratios and leverage ratio and a comparison of the Company's and the Bank's risk-based capital ratios and leverage ratio to the minimum regulatory and well-capitalized minimum requirements at December 31, 2001:
December 31, Minimum "Well -------------------- Capital Capitalized" 2001 2000 Ratios Ratios -------- -------- ------- ------------ (Dollars in thousands) Tier 1 capital $ 42,640 $ 45,667 Total capital 47,048 49,680 Net risk-weighted assets 350,516 316,641 Adjusted quarterly average assets 608,689 514,958 Capital ratios: Tier 1 capital to net risk-weighted assets 12.16% 14.42% 4.00% 6.00% Total capital to net risk-weighted assets 13.42 15.69 8.00 10.00 Tier 1 capital to adjusted quarterly average assets 7.01 8.87 4.00 5.00
38 The minimum regulatory capital ratios, minimum capital ratios for "well capitalized" banks and the Bank's actual capital ratios at December 31, 2001, were as follows:
Regulatory Minimum Minimum Ratio for Actual Ratios at Ratio for Banks "Well Capitalized" Banks December 31, 2001 ------------------ ------------------------ ----------------- Tier 1 capital to net risk-weighted assets 4.00% 6.00% 12.41% Total capital to net risk-weighted assets 8.00 10.00 13.67 Tier 1 capital to adjusted quarterly average assets 4.00 5.00 7.15
The Federal Deposit Insurance Corporation Improvement Act of 1991 ("FDICIA") requires each federal banking agency to revise its risk-based capital standards to ensure that those standards take adequate account of interest rate risk, concentration of credit risk and the risks of non-traditional activities, as well as reflect the actual performance and expected risk of loss on multi-family mortgages. The law also requires each federal banking agency to specify the levels at which an insured institution would be considered "well capitalized," "adequately capitalized," "undercapitalized," "significantly undercapitalized" and "critically undercapitalized." Under the FDIC's regulations, the Company and the Bank were both "well capitalized" at December 31, 2001. 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 is determined by the Company's board of directors in light of circumstances and conditions then existing, including the earnings of the Company and the Bank, funding requirements and financial condition 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. 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. At December 31, 2001, retained earnings of the Bank included $0 that was available for payment of dividends to the Company without prior approval of regulatory authorities. The Company's immediate liquidity needs have been and can continue to be satisfied by advances from the Company's parent company. PENDING ADOPTION OF ACCOUNTING STANDARDS In June 2001, the Financial Accounting Standards board issued Statement of Financial Accounting Standards No. 141, BUSINESS COMBINATIONS, and No. 142, GOODWILL AND OTHER INTANGIBLE ASSETS. Statement 141 requires that the purchase method of accounting be used for all business combinations initiated after June 30, 2001. Statement 141 also included guidance on the initial recognition and measurement of goodwill and other intangible assets arising from business combinations completed after June 30, 2001. Statement 142 prohibits the amortization of goodwill and intangible assets with indefinite useful lives. Statement 142 requires that these assets be reviewed for impairment at least annually. Intangible assets with finite lives will continue to be amortized over their estimated useful lives. Additionally, Statement 142 requires that goodwill included in the carrying value of equity method investments no longer be amortized. The Company will apply Statement 142 beginning in the first quarter 2002. Application of the nonamortization provisions of Statement 142 is expected to result in an increase in net income before cumulative effect of a change in accounting principle of $1,730,000 pre tax in 2002. The company will test goodwill for impairment using the two-step process prescribed in Statement 142. The first step is a screen for potential impairment, while the second step measures the amount of the impairment, if any. The Company expects to perform the first of the required impairment tests of goodwill and indefinite lived intangible assets as of January 1, 2002 in the first quarter of 2002. Based on steps the Company has taken to prepare for the adoption of Statement 142, it is likely between $10,000,000 and $15,000,000 of the goodwill related to Independent Bankshares, Inc. will be impaired using the impairment test required by Statement 142. The Company currently evaluates goodwill for impairment by the standards set forth in Statement of Financial Accounting Standards No. 121, ACCOUNTING FOR THE IMPAIRMENT OF LONG-LIVED ASSETS AND FOR LONG-LIVED ASSETS TO BE DISPOSED OF, which does not result in an indicated impairment. An impairment that is required to be recognized when adopting Statement 142 will be reflected as the cumulative effect of a change in accounting principle in the first 39 quarter of 2002. The Company has not yet determined the exact amount of the potential impairment loss. ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISKS For quantitative and qualitative disclosures about market risk affecting the Company, see "Management's Discussion and Analysis of Financial Condition and Results of Operations--Quantitative and Qualitative Disclosures about Market Risk" in Item 7 above, which is incorporated herein by reference. 40 ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA TABLE OF CONTENTS
PAGE ---- Report of Independent Auditors...................................................................................42 Report of Independent Accountants................................................................................43 Consolidated Balance Sheets as of December 31, 2001 and 2000.....................................................44 Consolidated Statements of Operations and Comprehensive Income (Loss) for the Year ended December 31, 2001, the Period from August 12, 2000, through December 31, 2000, the Period from January 1, 2000, through August 11, 2000, and the Year ended December 31, 1999...........................................................................45 Consolidated Statements of Changes in Stockholder's Equity for the Year ended December 31, 2001, the Period from August 12, 2000, through December 31, 2000, the Period from January 1, 2000, through August 11, 2000, and the Year ended December 31, 1999........................................................................................46 Consolidated Statements of Cash Flows for the Year ended December 31, 2001, the Period from August 12, 2000, through December 31, 2000, the Period from January 1, 2000, through August 11, 2000, and the Year ended December 31, 1999 ................................47 Notes to Consolidated Financial Statements.......................................................................48 Quarterly Data (Unaudited).......................................................................................66
41 DRAFT REPORT OF INDEPENDENT AUDITORS The Stockholder and Board of Directors Independent Bankshares, Inc. We have audited the accompanying consolidated balance sheets of Independent Bankshares, Inc., a wholly owned subsidiary of State National Bancshares, Inc., as of December 31, 2001 and 2000, and the related consolidated statements of operations and comprehensive income (loss), changes in stockholder's equity, and cash flows for the year ended December 31, 2001 and each of the periods from August 12, 2000 through December 31, 2000 and from January 1, 2000 through August 11, 2000. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Independent Bankshares, Inc. at December 31, 2001 and 2000, and the consolidated results of its operations and its cash flows for the year ended December 31, 2001 and the periods from August 12, 2000 through December 31, 2000 and from January 1, 2000 through August 11, 2000, in conformity with accounting principles generally accepted in the United States. /s/ Ernst & Young LLP Dallas, Texas March 5, 2002 42 REPORT OF INDEPENDENT ACCOUNTANTS To the Shareholder and Board of Directors Independent Bankshares, Inc.: In our opinion, the consolidated statements of income and comprehensive income, of shareholder's equity and of cash flows of Independent Bankshares, Inc. present fairly, in all material respects, the results of its operations and cash flows for the year in the period ended December 31, 1999, in conformity with accounting principles generally accepted in the United States of America. 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 auditing standards generally accepted in the United States of America, 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, assessing 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 our opinion. /s/ PricewaterhouseCoopers LLP PricewaterhouseCoopers LLP Fort Worth, Texas January 28, 2000 43 INDEPENDENT BANKSHARES, INC. A WHOLLY OWNED SUBSIDIARY OF STATE NATIONAL BANCSHARES, INC. CONSOLIDATED BALANCE SHEETS DECEMBER 31, 2001 AND 2000
ASSETS 2001 2000 ------------- ------------- ASSETS: Cash and Cash Equivalents: Cash and Due from Banks $ 33,212,000 $ 43,813,000 Interest-earning Time Deposits 2,850,000 502,000 Federal Funds Sold 10,528,000 39,270,000 ------------- ------------- Total Cash and Cash Equivalents 46,590,000 83,585,000 ------------- ------------- Securities (Note 4): Available-for-sale 216,112,000 163,677,000 Held-to-maturity 0 13,517,000 ------------- ------------- Total Securities 216,112,000 177,194,000 ------------- ------------- Loans (Note 5): Total Loans 304,270,000 367,059,000 Less: Unearned Income on Installment Loans 24,000 126,000 Allowance for Possible Loan Losses 6,525,000 8,379,000 ------------- ------------- Net Loans 297,721,000 358,554,000 ------------- ------------- Intangible Assets (Note 6) 43,719,000 49,176,000 Premises and Equipment (Note 7) 15,380,000 15,855,000 Accrued Interest Receivable 5,321,000 8,015,000 Other Real Estate and Other Repossessed Assets 691,000 576,000 Other Assets 11,849,000 2,315,000 ------------- ------------- Total Assets $ 637,383,000 $ 695,270,000 ============= ============= LIABILITIES AND STOCKHOLDER'S EQUITY LIABILITIES: Deposits (Note 8): Noninterest-bearing Demand Deposits $ 112,044,000 $ 100,795,000 Interest-bearing Demand Deposits 180,021,000 188,952,000 Interest-bearing Time Deposits 251,965,000 303,858,000 ------------- ------------- Total Deposits 544,030,000 593,605,000 Fed Funds Purchased and Securities Sold Under Agreement To Repurchase 151,000 0 Accrued Interest Payable 1,462,000 2,488,000 Other Liabilities 5,441,000 6,289,000 ------------- ------------- Total Liabilities 551,084,000 602,382,000 ------------- ------------- Guaranteed Preferred Beneficial Interests in the Company's Subordinated Debentures (Note 10) 10,918,000 10,904,000 Commitments and Contingent Liabilities (Notes 15 and 17) STOCKHOLDER'S EQUITY (Notes 11 and 18): Common Stock--Par Value $0.25; 30,000,000 Shares Authorized; 2,273,647 Shares Issued at December 31, 2001 and 2000 568,000 568,000 Additional Paid-in Capital 80,071,000 80,181,000 Retained Earnings (Deficit) (8,280,000) (383,000) Unrealized Gain (Loss) on Available-for-sale Securities, net (Note 4) 3,022,000 1,618,000 ------------- ------------- Total Stockholder's Equity 75,381,000 81,984,000 ------------- ------------- Total Liabilities and Stockholder's Equity $ 637,383,000 $ 695,270,000 ============= =============
See accompanying notes. 44 INDEPENDENT BANKSHARES, INC. A WHOLLY OWNED SUBSIDIARY OF STATE NATIONAL BANCSHARES, INC. CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (LOSS) FOR THE YEAR ENDED DECEMBER 31, 2001, THE PERIOD FROM AUGUST 12, 2000, THROUGH DECEMBER 31, 2000, THE PERIOD FROM JANUARY 1, 2000, THROUGH AUGUST 11, 2000, AND THE YEAR ENDED DECEMBER 31, 1999
PREDECESSOR ----------------------------- YEAR ENDED AUGUST 12, 2000, JANUARY 1, 2000 YEAR ENDED DECEMBER 31, THROUGH THROUGH DECEMBER 31, 2001 DECEMBER 31, 2000 AUGUST 11, 2000 1999 ------------ ----------------- --------------- ----------- Interest Income: Interest and Fees on Loans (Note 5) $ 27,292,000 $ 14,105,000 $ 10,746,000 $ 17,027,000 Interest on Securities 11,435,000 4,583,000 3,705,000 5,847,000 Interest on Deposits in Other Banks 28,000 12,000 0 0 Interest on Federal Funds Sold 2,428,000 1,024,000 822,000 1,332,000 ------------ ------------ -------------- ------------ Total Interest Income 41,183,000 19,724,000 15,273,000 24,206,000 ------------ ------------ -------------- ------------ Interest Expense: Interest on Deposits 19,167,000 9,245,000 6,355,000 9,898,000 Interest on Federal funds Purchased and Securities Sold Under Agreement to Repurchase 4,000 7,000 0 0 ------------ ------------ -------------- ------------ Total Interest Expense 19,171,000 9,252,000 6,355,000 9,898,000 ------------ ------------ -------------- ------------ Net Interest Income 22,012,000 10,472,000 8,918,000 14,308,000 Provision for Loan Losses (Note 5) 10,765,000 618,000 1,660,000 445,000 ------------ ------------ -------------- ------------ Net Interest Income After Provision for Loan Losses 11,247,000 9,854,000 7,258,000 13,863,000 ------------ ------------ -------------- ------------ Noninterest Income: Service Charges 3,506,000 1,606,000 1,621,000 2,842,000 Trust Fees 492,000 118,000 140,000 208,000 Net realized gain (loss) on sale of securities 1,000 36,000 0 0 Other Income 1,407,000 129,000 142,000 217,000 ------------ ------------ -------------- ------------ Total Noninterest Income 5,406,000 1,889,000 1,903,000 3,267,000 ------------ ------------ -------------- ------------ Noninterest Expenses: Salaries and Employee Benefits 10,681,000 4,422,000 3,869,000 6,046,000 Amortization of Intangible Assets 4,367,000 1,685,000 413,000 673,000 Merger-related Expense 51,000 0 1,970,000 0 Net Occupancy Expense 1,848,000 520,000 717,000 944,000 Equipment Expense 1,878,000 631,000 809,000 1,103,000 Professional Fees 888,000 765,000 416,000 436,000 Distributions on Guaranteed Preferred Beneficial Interests in the Company's Subordinated Debentures (Note 10) 1,119,000 434,000 678,000 1,105,000 Stationery, Printing and Supplies Expense 627,000 252,000 360,000 574,000 Communication 925,000 467,000 197,000 489,000 Data Processing Expense 654,000 411,000 94,000 335,000 Advertising and Business Development Expense 540,000 451,000 124,000 137,000 Net Costs (Revenues) Applicable to Other Real Estate and Other Repossessed Assets 95,000 (23,000) 29,000 91,000 Other Expenses 3,382,000 996,000 1,294,000 1,571,000 ------------ ------------ -------------- ------------ Total Noninterest Expenses 27,055,000 11,011,000 10,970,000 13,504,000 ------------ ------------ -------------- ------------ Income (Loss) Before Federal Income Taxes (10,402,000) 732,000 (1,809,000) 3,626,000 Federal Income Tax Expense (Benefit) (Note 9) (3,205,000) 497,000 99,000 1,174,000 ------------ ------------ -------------- ------------ Net Income (Loss) (7,197,000) 235,000 (1,908,000) 2,452,000 Other Comprehensive Income, Net of Tax: Unrealized Holding Gains (Losses) on Available-for-sale Securities Arising During the Period 1,405,000 1,654,000 150,000 (504,000) Reclassification adjustment for gains included in net income (1,000) (36,000) 0 0 ------------ ------------ -------------- ------------ Comprehensive Income (Loss) $ (5,793,000) $ 1,853,000 $ (1,758,000) $ 1,948,000 ============ ============ ============== ============ Preferred Stock Dividends $ 0 $ 20,000 ============== ============ Net Income (Loss) Available to Common Stockholders $ (1,908,000) $ 2,432,000 ============== ============ Basic Earnings (Loss) Per Common Share Available to Common Stockholders (Note 12) $ (0.84) $ 1.12 ============== ============ Diluted Earnings (Loss) Per Common Share Available to Common Stockholders (Note 12) $ (0.84) $ 1.08 ============== ============
See accompanying notes. 45 INDEPENDENT BANKSHARES, INC. A WHOLLY OWNED SUBSIDIARY OF STATE NATIONAL BANCSHARES, INC. CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDER'S EQUITY FOR THE YEAR ENDED DECEMBER 31, 2001, THE PERIOD FROM AUGUST 12, 2000, THROUGH DECEMBER 31, 2000, THE PERIOD FROM JANUARY 1, 2000, THROUGH AUGUST 11, 2000, AND THE YEAR ENDED DECEMBER 31, 1999
SERIES C PREFERRED STOCK COMMON STOCK ADDITIONAL -------------------------- --------------------- PAID-IN SHARES AMOUNT SHARES AMOUNT CAPITAL ----------- ----------- --------- -------- ----------- Balances--January 1, 1999 5,006 $ 51,000 2,217,296 $ 554,000 $ 15,933,000 Net Income Adjustment to Unrealized Loss on Available-for-sale Securities, Net of Tax of $260,000 (Note 4) Cash Dividends ($0.20 Per Share) Principal Payments on Loan to ESOP for Stock Purchase - Earned Stock Conversion of Series C Preferred Stock (5,066) (51,000) 116,351 29,000 22,000 Purchase of Treasury Stock ----------- ----------- --------- -------- ----------- Balances--December 31, 1999 0 0 2,333,647 583,000 15,955,000 Net Loss, January 1 to August 11 Adjustment to Unrealized Loss on Available-for-sale Securities, Net of Tax of $77,000 (Note 4) Cash Dividends ($0.12 Per Share) Principal Payments on Loan to ESOP for Stock Purchase - Earned Stock ----------- ----------- --------- -------- ----------- Balances--August 11, 2000 (Predecessor) 0 0 2,333,647 583,000 15,955,000 Purchase Accounting Adjustments (Note 2) 30,258,000 Retirement of Treasury Stock (60,000) (15,000) (654,000) Merger of UB&T effective August 11, 2000 16,622,000 Merger of Lubbock effective August 11, 2000 18,000,000 Purchase Price Adjustment Net Loss, August 12 to December 31 Adjustment to Unrealized Gain on Available-for-sale Securities, Net of Tax of $1,347,000 (Note 4) Cash Dividends ----------- ----------- --------- -------- ----------- Balances--December 31, 2000 0 0 2,273,647 568,000 80,181,000 Net Loss UB&T Purchase Price Adjustment (110,000) Adjustment to Unrealized Gain on Available-for-sale Securities, Net of Tax of $723,000 (Note 4) Cash Dividends ----------- ----------- --------- -------- ----------- Balances--December 31, 2001 0 $ 0 2,273,647 $568,000 $80,071,000 =========== =========== ========= ======== =========== UNREALIZED GAIN (LOSS) UNEARNED EMPLOYEE STOCK RETAINED ON AVAILABLE TREASURY STOCK OWNERSHIP PLAN STOCK EARNINGS FOR-SALE ---------------------- ----------------------- (DEFICIT) SECURITIES SHARES AMOUNT SHARES AMOUNT ----------- ----------- --------- ----------- ---------- ----------- Balances--January 1, 1999 $ 7,975,000 $ 161,000 0 $ 0 (14,839 $ (169,000) Net Income 2,452,000 Adjustment to Unrealized Loss on Available-for-sale Securities, Net of Tax of $260,000 (Note 4) (504,000) Cash Dividends ($0.20 Per Share) (455,000) Principal Payments on Loan to ESOP for Stock Purchase - Earned Stock 2,369 27,000 Conversion of Series C Preferred Stock Purchase of Treasury Stock (60,000) (669,000) ----------- ----------- --------- ----------- ---------- ----------- Balances--December 31, 1999 9,972,000 (343,000) (60,000) (669,000) (12,470) (142,000) Net Loss, January 1 to August 11 (1,908,000) Adjustment to Unrealized Loss on Available-for-sale Securities, Net of Tax of $77,000 (Note 4) 150,000 Cash Dividends ($0.12 Per Share) (273,000) Principal Payments on Loan to ESOP for Stock Purchase - Earned Stock 12,470 142,000 ----------- ----------- --------- ----------- ---------- ----------- Balances--August 11, 2000 (Predecessor) 7,791,000 (193,000) (60,000) (669,000) 0 0 Purchase Accounting Adjustments (Note 2) (7,791,000) 193,000 Retirement of Treasury Stock 60,000 669,000 Merger of UB&T effective August 11, 2000 483,000 (376,000) Merger of Lubbock effective August 11, 2000 1,026,000 (621,000) Purchase Price Adjustment (76,000) Net Loss, August 12 to December 31 235,000 Adjustment to Unrealized Gain on Available-for-sale Securities, Net of Tax of $1,347,000 (Note 4) 2,615,000 Cash Dividends (2,051,000) ----------- ----------- --------- ----------- ---------- ----------- Balances--December 31, 2000 (383,000) 1,618,000 0 0 0 0 Net Loss UB&T Purchase Price Adjustment (7,197,000) Adjustment to Unrealized Gain on Available-for-sale Securities, Net of Tax of $723,000 (Note 4) 1,404,000 Cash Dividends (700,000) ----------- ----------- --------- ----------- ---------- ----------- Balances--December 31, 2001 $(8,280,000) $ 3,022,000 0 $ 0 0 0 =========== =========== ========= =========== ========== ===========
See accompanying notes. 46 INDEPENDENT BANKSHARES, INC. A WHOLLY OWNED SUBSIDIARY OF STATE NATIONAL BANCSHARES, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE YEAR ENDED DECEMBER 31, 2001, THE PERIOD FROM AUGUST 12, 2000, THROUGH DECEMBER 31, 2000, THE PERIOD FROM JANUARY 1, 2000, THROUGH AUGUST 11, 2000, AND THE YEAR ENDED DECEMBER 31, 1999
PREDECESSOR ---------------------------- YEAR ENDED AUGUST 12, 2000, JANUARY 1, 2000 YEAR ENDED DECEMBER 31, THROUGH THROUGH DECEMBER 31, 1999 DECEMBER 31, 2000 AUGUST 11, 2000 1999 ------------- ---------------- --------------- ------------ Cash Flows from Operating Activities: Net Income (Loss) $ (7,197,000) $ 235,000 $ (1,908,000) $ 2,452,000 Adjustments to Reconcile Net Income (Loss) to Net Cash Provided by Operating Activities: Deferred Federal Income Tax Expense (Benefit) 88,000 103,000 (817,000) 260,000 Depreciation and Amortization 5,668,000 2,286,000 864,000 1,424,000 Provision for Loan Losses 10,765,000 618,000 1,660,000 445,000 Gain on Sales of Securities (1,000) (36,000) 0 0 Gain on Sales of Premises and Equipment (24,000) (40,000) 0 (1,000) Writedown of Premises and Equipment 129,000 0 0 0 Gains on Sales of Other Real Estate and Other Repossessed Assets (29,000) 0 0 (1,000) Writedown of Other Real Estate and Other Repossessed Assets 124,000 2,000 4,000 6,000 Decrease (Increase) in Accrued Interest Receivable 2,694,000 (1,013,000) 6,000 (284,000) Decrease in Other Assets 466,000 1,050,000 1,180,000 224,000 Increase (Decrease) in Accrued Interest Payable (1,026,000) 187,000 99,000 (89,000) Increase (Decrease) in Other Liabilities (1,451,000) (1,396,000) 1,227,000 88,000 ------------- ------------ ------------ ------------ Net Cash Provided by Operating Activities 10,206,000 1,996,000 2,315,000 4,524,000 ------------- ------------ ------------ ------------ Cash Flows from Investing Activities: Proceeds from Maturities of Available-for-sale Securities 70,034,000 8,599,000 12,200,000 6,768,000 Proceeds from Maturities of Held-to-maturity Securities 0 3,977,000 4,724,000 34,031,000 Proceeds from Sales of Available-for-sale Securities 59,919,000 39,692,000 3,000,000 0 Purchases of Available-for-sale Securities (166,507,000) (41,145,000) (4,891,000) (25,663,000) Purchases of Held-to-maturity Securities 0 0 (5,836,000) (29,918,000) Purchase of Bank Owned Life Insurance (10,000,000) 0 0 0 Net Decrease (Increase) in Loans 48,719,000 3,184,000 3,167,000 (3,027,000) Proceeds from Sales of Premises and Equipment 310,000 99,000 0 1,000 Additions to Premises and Equipment (1,656,000) (1,387,000) (82,000) (273,000) Proceeds from Sales of Other Real Estate and Other Repossessed Assets 1,104,000 104,000 356,000 1,210,000 Net Cash and Cash Equivalents Received in Merger/Acquisition 0 9,344,000 0 0 ------------- ------------ ------------ ------------ Net Cash Provided by (Used in) Investing Activities 1,923,000 22,467,000 12,638,000 (16,871,000) ------------- ------------ ------------ ------------ Cash Flows from Financing Activities: Net Decrease in Deposits (49,575,000) (2,504,000) (6,962,000) (12,505,000) Increase in Federal Funds Purchased and Securities Sold Under Agreement to Repurchase 151,000 0 0 0 Repayment of Notes Payable 0 0 0 (1,000) Advances from State National 1,000,000 0 0 0 Payment of Cash Dividends (700,000) (2,051,000) (273,000) (455,000) Purchase of Treasury Stock 0 0 0 (669,000) ------------- ------------ ------------ ------------ Net Cash Used in Financing Activities (49,124,000) (4,555,000) (7,235,000) (13,630,000) ------------- ------------ ------------ ------------ Net Increase (Decrease) in Cash and Cash Equivalents (36,995,000) 19,908,000 7,718,000 (25,977,000) Cash and Cash Equivalents at Beginning of Period 83,585,000 63,677,000 38,760,000 64,737,000 ------------- ------------ ------------ ------------ Cash and Cash Equivalents at End of Period $ 46,590,000 $ 83,585,000 $ 46,478,000 $ 38,760,000 ============= ============ ============ ============
See accompanying notes. 47 INDEPENDENT BANKSHARES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2001, 2000 AND 1999 NOTE 1: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES BUSINESS Independent Bankshares, Inc., a Texas corporation (the "Company") is a bank holding company headquartered in Lubbock, Texas. The Company is an indirect wholly owned subsidiary of State National Bancshares, Inc., Lubbock, Texas ("State National"). At December 31, 2001, the Company owned all of the common securities of Independent Capital Trust ("Independent Capital") and indirectly owned through a Delaware subsidiary, Independent Financial Corp. ("Independent Financial"), 100% of the stock of State National Bank of West Texas, Lubbock, Texas (the "Bank"). At December 31, 2001, the Bank operated full-service banking locations in the Texas cities of Abilene (five locations), Azle (two locations), Bangs, Big Spring, Lubbock (three locations), Odessa (two locations), Plainview, San Angelo, Stamford, Trent and Winters. The Company's primary activities are to assist the Bank in the management and coordination of its financial resources. The Bank operates under the day-to-day management of its own officers and board of directors and formulates its own policies with respect to banking matters. The principal services provided by the Bank are as follows: Commercial Services. The Bank provides a full range of banking services for its commercial customers. Commercial lending activities include short-term and medium-term loans, revolving credit arrangements, inventory and accounts receivable financing, equipment financing and interim and permanent real estate lending. Other services include cash management programs and federal tax depository and night depository services. Consumer Services. The Bank also provides a wide range of consumer banking services, including checking, savings and money market accounts, savings programs and installment and personal loans. The Bank makes automobile and other installment loans directly to customers, as well as indirectly through automobile dealers. The Bank makes home improvement, home equity and real estate loans and provides safe deposit services. As a result of sharing arrangements with the Pulse automated teller machine system network, the Bank provides 24-hour routine banking services through automated teller machines ("ATMs"). The Pulse network provides ATM accessibility throughout the United States. The Bank also offers investment services and banking by phone or personal computer. Trust Services. The Bank provides trust and agency services to individuals, partnerships and corporations from its offices in Abilene, Lubbock and Odessa. The trust division also provides investment management, administration and advisory services for agency and trust accounts, and acts as trustee for pension and profit sharing plans. Investment Services. The Bank provides investment services, including purchases and sales of various investments, and management of such investments, for its customers. PRINCIPLES OF CONSOLIDATION The Consolidated Financial Statements include the accounts of the Company, Independent Capital, Independent Financial and the Bank. 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, interest earning time deposits and federal funds sold. Generally, federal funds are purchased and sold for one-day periods. 48 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 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 stockholder's equity. The Company had no securities classified as held-to-maturity or trading as of December 31, 2001. The cost of securities sold is based on the specific identification method. The Company currently owns no derivative financial instruments subject to FAS 133 Accounting for Derivative Instruments and Hedging Activities and does not engage in hedging activities. LOANS Loans are stated at the principal amount outstanding. Interest on the various types of commercial, real estate and other 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. A loan is considered impaired when, based on current information and events, it is probable that the Bank will be unable to collect all amounts due (both principal and interest) according to the terms of the loan agreement. Reserves on impaired loans are measured based on the present value of expected future cash flows discounted at the loan's effective interest rate or the fair value of the underlying collateral. ALLOWANCE FOR LOAN LOSSES The allowance for loan losses (the "allowance") is reduced by charge-offs and increased by recoveries of loans previously charged off and the loan loss provision necessary to bring the allowance to an amount determined by management to be adequate. Management's periodic evaluation of the adequacy of the allowance is based on past loan loss experience, known inherent risks in the portfolio, adverse situations that may affect the borrowers' ability to repay, the estimated value of any underlying collateral and current economic conditions. The allowance is comprised of three elements which include: (1) allowances established on specific loans, (2) allowances based on loss experience and trends in pools of loans with similar characteristics, and (3) unallocated allowances based on general economic conditions and other internal and external risk factors in the Company's individual markets. The total allowance includes activity related to allowances calculated in accordance with Statement of Financial Accounting Standards No. 114 "Accounting by Creditors for Impairment of a Loan" (FAS 114") and activity related to other allowances determined in accordance with Statement of Financial Accounting Standards "Accounting for Contingencies" ("FAS 5"). 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 the Company is being amortized on an accelerated method over a ten (10) year period. Goodwill resulting from the acquisition of the Company is being amortized on the straight-line method over a twenty (20) year period. All intangible assets are evaluated periodically to determine recoverability of their carrying value when economic conditions indicate impairment may exist. These conditions would include an ongoing negative performance history and a forecast of anticipated performance that is significantly below management's initial expectation for the acquired entity. Impairment would be determined based upon the estimated discounted cash flows of the entity acquired over the remaining amortization period, compared to the 49 remaining intangible balance. As of December 31, 2001, management believes that no impairment of intangible assets had occurred as determined by Financial Accounting Standards Board ("the FASB") Statement of Financial Accounting Standards No. 121 , "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of" ("FAS 121"). FEDERAL INCOME TAXES The Company uses the liability method of accounting for deferred 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. ADVERTISING COSTS Advertising costs are expensed as incurred. The total amounts charged to advertising expense for the years ended December 31, 2001, 2000 and 1999 were approximately $540,000, $575,000 and $137,000, respectively. PENDING ADOPTION OF ACCOUNTING STANDARDS In June 2001, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 141, BUSINESS COMBINATIONS, and No. 142, GOODWILL AND OTHER INTANGIBLE ASSETS. Statement 141 requires that the purchase method of accounting be used for all business combinations initiated after June 30, 2001. Statement 141 also included guidance on the initial recognition and measurement of goodwill and other intangible assets arising from business combinations completed after June 30, 2001. Statement 142 prohibits the amortization of goodwill and intangible assets with indefinite useful lives. Statement 142 requires that these assets be reviewed for impairment at least annually. Intangible assets with finite lives will continue to be amortized over their estimated useful lives. Additionally, Statement 142 requires that goodwill included in the carrying value of equity method investments no longer be amortized. The Company will apply Statement 142 beginning in the first quarter of 2002. Application of the nonamortization provisions of Statement 142 is expected to result in an increase in net income before cumulative effect of a change in accounting principle of $1,730,000 pretax in 2002. The company will test goodwill for impairment using the two-step process prescribed in Statement 142. The first step is a screen for potential impairment, while the second step measures the amount of the impairment, if any. The Company expects to perform the first of the required impairment tests of goodwill and indefinite lived intangible assets as of January 1, 2002 in the first quarter of 2002. Based on steps the Company has taken to prepare for the adoption of Statement 142, it is likely between $10,000,000 and $15,000,000 of the goodwill related to Independent Bankshares, Inc. will be impaired using the impairment test required by Statement 142. The Company currently evaluates goodwill for impairment by the standards set forth in Statement of Financial Accounting Standards No. 121, ACCOUNTING FOR THE IMPAIRMENT OF LONG-LIVED ASSETS AND FOR LONG-LIVED ASSETS TO BE DISPOSED OF, which does not result in an indicated impairment. An impairment that is required to be recognized when adopting Statement 142 will be reflected as the cumulative effect of a change in accounting principle in the first quarter of 2002. The Company has not yet determined the exact amount of the potential impairment loss. 50 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: ACQUISITION OF THE COMPANY On March 1, 2000, the Company entered into an Agreement and Plan of Reorganization (the "Merger Agreement") with State National for a cash acquisition of the Company by State National (the "Acquisition"). The Company and State National consummated the Merger at the close of business August 11, 2000. Pursuant to the terms of the Merger Agreement, each share of common stock of the Company was exchanged for $20.0165 in cash. Upon conclusion of the Acquisition, State National became the sole shareholder of the Company, owning all 2,273,647 outstanding shares of the Company's common stock. In connection with the Acquisition, State National agreed to assume and guarantee the outstanding Trust Preferred Securities issued by Independent Capital, a Delaware business trust controlled by the Company. State National accounted for its acquisition of the Company as a purchase business combination and purchase accounting adjustments, including goodwill, have been pushed down and reflected in the consolidated financial statements of the Company subsequent to August 11, 2000. The consolidated financial statements of the Company for the periods ended before August 12, 2000 (predecessor), were prepared using the Company's historical basis of accounting. The comparability of operating results for these periods and the periods encompassing push down accounting is affected by the purchase accounting adjustments, including the amortization of goodwill (straight-line method) and core deposit intangibles (accelerated method) over a period of 20 and 10 years, respectively. The purchase price, including costs incurred by State National directly associated with the Acquisition, were preliminarily allocated to net assets acquired. Final allocation has been obtained and the purchase allocations finalized at December 31, 2000. The following table summarizes the changes made to the accounts of the Company as of August 11, 2000, as a result of applying push down accounting:
Balance at Push Down Date of Accounting Adjusted Acquisition Adjustments Balance ----------- ----------- --------- (In thousands) Investment securities $ 99,906 $ (1,494) $ 98,412 Loans, net of unearned income 183,082 (1,169) 181,913 Allowance for possible loan losses (3,343) (3,028) (6,371) Goodwill and core deposit intangibles 9,746 30,099 39,845 Premises and equipment 9,446 (492) 8,954 Other assets 1,659 (126) 1,533 --------- -------- --------- Total assets $ 350,735 $ 23,790 $ 374,525 ========= ======== ========= Other liabilities $ 1,760 $ 3,233 $ 4,993 Trust Preferred Securities 13,000 (2,103) 10,897 Stockholder's equity 23,465 22,660 46,125 --------- -------- --------- Total liabilities and stockholder's equity $ 350,735 $ 23,790 $ 374,525 ========= ======== =========
NOTE 3: BANK MERGERS On October 24, 2000, State National contributed to the Company its ownership of United Bank & Trust, Abilene, Texas ("UB&T"). UB&T was merged with and into First State Bank, National Association, Abilene, Texas ("First State"), a subsidiary of the Company at that time. At the time of the merger, the name of the resulting bank was changed to State National Bank of West Texas, Abilene, Texas (the "Abilene Bank"). The merger was accounted for similar to a pooling of interests. As a result of the merger, the balance sheet and results of operations of UB&T have been included in the Company's consolidated financial statements since August 12, 2000, the date of the acquisition of the Company by State National (the "Acquisition"). At August 12, 2000, UB&T had total assets of $112,806,000, 51 loans, net of allowance for possible loan losses, of $70,230,000, total deposits of $93,946,000 and total stockholder's equity of $16,729,000. On February 28, 2001, State National contributed to the Company, its ownership interest in State National Bank of West Texas, Lubbock, Texas (the "Lubbock Bank"). The Abilene Bank was merged with and into the Lubbock Bank. The Lubbock Bank continued as the surviving entity in the merger (the "Bank"). The merger was accounted for similar to a pooling of interests. As a result of the merger, the balance sheet and results of operations of the Lubbock Bank have been included in the Company's consolidated financial statements since August 11, 2000, the date of the acquisition of the Company by State National (the "Acquisition"). At August 11, 2000, the Lubbock Bank had total assets of $210,409,000, loans, net of allowance for possible loan losses, of $121,130,000, total deposits of $190,828,000 and total stockholder's equity of $18,405,000. Collectively, the UB&T Merger and the Lubbock Bank Merger are referred to as the Bank Mergers. NOTE 4: SECURITIES The amortized cost and estimated fair value of available-for-sale securities at December 31, 2001 and 2000, were as follows:
2001 -------------------------------------------------------- Gross Gross Unrealized Unrealized Estimated Fair Amortized Cost Gains Losses Value -------------- ---------- ---------- -------------- U.S. Treasury securities and obligations of U.S. Government agencies and corporations $132,363,000 $3,900,000 $(238,000) $136,025,000 Mortgage-backed securities and collateralized mortgage obligations 68,943,000 954,000 (162,000) 69,735,000 Obligations of states and political subdivisions 6,985,000 124,000 0 7,109,000 Other securities 3,243,000 0 0 3,243,000 ------------ ---------- --------- ------------ Total available-for-sale securities $211,534,000 $4,978,000 $(400,000) $216,112,000 ============ ========== ========= ============ 2001 -------------------------------------------------------- Gross Gross Unrealized Unrealized Estimated Fair Amortized Cost Gains Losses Value -------------- ---------- ---------- -------------- U.S. Treasury securities and obligations of U.S. Government agencies and corporations $121,769,000 $2,226,000 $(141,000) $123,854,000 Mortgage-backed securities and collateralized mortgage obligations 28,040,000 435,000 (114,000) 28,361,000 Obligations of states and political subdivisions 8,291,000 55,000 (12,000) 8,334,000 Other securities 3,128,000 0 0 3,128,000 ------------ ---------- --------- ------------ Total available-for-sale securities $161,228,000 $2,716,000 $(267,000) $163,677,000 ============ ========== ========= ============
52 There were no held-to maturity securities at December 31, 2001, as they were reclassified to available for sale in 2001 in conjunction with the adoption of Statement of Financial Accounting Standards No. 133, "Accounting for Derivative Instruments and Hedging Activities" ("FAS 133"). The amortized cost and estimated fair value of held-to maturity securities at December 31, 2000, were as follows:
2001 -------------------------------------------------------- Gross Gross Unrealized Unrealized Estimated Fair Amortized Cost Gains Losses Value -------------- ---------- ---------- -------------- U.S. Treasury securities and obligations of U.S. Government agencies and corporations $ 5,184,000 $ 1,000 $ 0 $ 5,185,000 Mortgage-backed securities and collateralized mortgage obligations 8,333,000 8,000 (31,000) 8,310,000 ----------- ---------- --------- ----------- Total held-to-maturity securities $13,517,000 $ 9,000 $ (31,000) $13,495,000 =========== ========== ========= ===========
The amortized cost and estimated fair value of securities at December 31, 2001, 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 Fair Available-for-sale Securities Cost Value ----------------------------- ------------ -------------- Due in one year or less $ 22,497,000 $ 22,893,000 Due after one year through five years 102,877,000 105,554,000 Due after five years through ten years 13,854,000 14,559,000 Due after ten years 3,363,000 3,371,000 ------------ -------------- 142,591,000 146,377,000 Mortgage-backed securities and collateralized mortgage obligations 68,943,000 69,735,000 ------------ -------------- Total available-for-sale securities $211,534,000 $216,112,000 ============ ============
At December 31, 2001, securities with an amortized cost and estimated fair value of $45,996,000 and $47,785,000, respectively, were pledged as collateral for public and trust fund deposits and for other purposes required or permitted by law. At December 31, 2000, the amortized cost and estimated fair value of pledged securities were $76,154,000 and $77,130,000, respectively. During 2001, the Company sold available-for-sale securities with an aggregate book value of $59,919,000 and a gross realized gain of approximately $1,000. Available-for-sale securities aggregating $3,000,000 were sold immediately prior to maturity during the first six months of 2000. Available-for-sale securities aggregating $39,692,000 were sold immediately after the Acquisition and a similar amount of available-for-sale securities were then purchased to reposition the Company's securities portfolio. 53 NOTE 5: LOANS The composition of loans at December 31, 2001 and 2000, was as follows:
2001 2000 ------------ ------------- Real estate loans $135,544,000 $ 127,510,000 Commercial loans 98,129,000 127,205,000 Loans to individuals 37,873,000 53,308,000 Agriculture and other loans 32,724,000 59,036,000 ------------ ------------- Total loans 304,270,000 367,059,000 Less unearned income 24,000 126,000 ------------ ------------- Total loans, net of unearned income $304,246,000 $366,933,000 ============ ============
Included in the Loan balance at December 31, 2001 is a purchase discount with a remaining balance of $753,000 related to the acquisition of the Company by State National. The original balance of the discount was $1,169,000 and was calculated at a effective purchase yield of 10.00%. The discount is being accreted into income over the life of the related loans. The estimated remaining life of the loans on which the discount was calculated is five years. Nonperforming assets at December 31, 2001 and 2000, were as follows:
2001 2000 ---------- ---------- Nonaccrual loans $5,581,000 $3,337,000 Accruing loans past due over ninety days 223,000 2,572,000 Restructured loans 29,000 119,000 Other real estate and other repossessed assets 691,000 576,000 ---------- ---------- Total nonperforming assets $6,524,000 $6,604,000 ========== ==========
At December 31, 2001, loans identified as being impaired consisted of loans placed on nonaccrual status. At December 31, 2000, loans identified as being impaired consisted of loans placed on nonaccrual status as well as additional loans related to five borrowing relationships which were still on accrual status but were considered by successor management to be impaired under FAS 114. See below for discussion of the five borrowing relationships. The entire balance in the allowance for loan loss is available to absorb loan losses on the entire portfolio. At December 31, 2001, and 2000, the recorded investment in loans that are considered to be impaired under FAS 114 was approximately $5,581,000 and $10,941,000, respectively. Included in these amounts at December 31, 2001 and 2000, was approximately $4,710,000 and $7,491,000, respectively, of impaired loans for which the related specific reserve for loan losses was approximately $1,190,000 and $4,516,000, respectively. Impaired loans of $871,000 and $3,450,000 at December 31, 2001 and 2000, respectively, did not have a specific reserve for loan losses. The amount of interest income that would have been recorded on nonaccrual loans for the year ended December 31, 2001, the period from August 12, 2000, to December 31, 2000, the period from January 1, 2000, to August 11, 2000, and for the year ended December 31, 1999, based on the loans' original terms was $582,000, $100,000, $12,000 and $23,000, respectively. A total of $1,000, $0, $16,000 and $2,000 in interest on nonaccrual loans was actually collected and recorded as income during the year ended December 31, 2001, the period from August 12, 2000, to December 31, 2000, the period from January 1, 2000, to August 11, 2000, and for the year ended December 31, 1999, respectively. A summary of the activity in the allowance for loan losses for the year ended December 31, 2001, the period from August 12, 2000, to December 31, 2000, the period from January 1, 2000, to August 11, 2000, and for the year ended December 31, 1999, is as follows:
Year ended August 12, 2000, January 1, 2000 Year ended December 31, to December 31, to August 11, December 31, 2001 2000 2000 1999 ----------- ---------- ---------- ---------- Balance at beginning of period $ 8,379,000 $6,371,000 $1,833,000 $1,842,000 Provision for loan losses 10,765,000 618,000 1,660,000 445,000 Loans charged off (13,694,000) (1,796,000) (230,000) (697,000) Recoveries of loans charged off 1,075,000 39,000 80,000 243,000 Purchase accounting adjustment 0 0 3,028,000 0 Mergers 0 3,147,000 0 0 ----------- ---------- ---------- ---------- Balance at end of period $ 6,525,000 $8,379,000 $6,371,000 $1,833,000 =========== ========== ========== ==========
The increase in the allowance of $3,028,000 related to the purchase accounting adjustment is due primarily to five borrowing relationships with whom predecessor management had intended to continue to work and extend or renew the loan as necessary. Predecessor management believed that the net carrying amount, after considering specific reserves, was adequate to reflect the estimated carrying amount of the loans. Successor management has determined that they will no longer maintain a relationship with these borrowers, has informed the borrowers that the borrowers will have to pay off their respective loans with the Company and, if necessary, liquidate the collateral supporting the loans within no later than one year of the Acquisition date. The Company offered a reduction in principal to one borrower to provide an incentive for the borrower 54 to move its loan relationship. As these loans are collateral dependant, the estimated losses on these loans are primarily due to estimated collateral liquidation value shortfalls. Overall, successor management has determined that the intended method of ultimate recovery on loans from these five borrowing relationships is demonstrably different from the plans that served as the basis for predecessor management estimation of recovery on such loans. This portion of the allowance will only be used for these specific relationships. As these loans are collected, any excess allowance would have been adjusted against goodwill. As of December 31, 2001, the bank has exited substantially all of these relationships. For those loans exited, there was no excess allowance remaining at the date of exit. NOTE 6: INTANGIBLE ASSETS The following is a summary of intangible assets at December 31, 2001 and 2000:
2001 2000 ----------- ----------- Goodwill $34,591,000 $35,879,000 Core deposit intangible 17,163,000 16,961,000 ----------- ----------- 51,754,000 52,840,000 Less accumulated amortization 8,035,000 3,664,000 ----------- ----------- Net intangible assets $43,719,000 $49,176,000 =========== ===========
NOTE 7: PREMISES AND EQUIPMENT The following is a summary of premises and equipment at December 31, 2001 and 2000:
2001 2000 ------------ ------------ Land $ 3,444,000 $ 3,262,000 Buildings and improvements 14,163,000 14,185,000 Furniture and equipment 4,098,000 4,136,000 ------------ ------------ 21,705,000 21,583,000 Less accumulated depreciation 6,325,000 5,728,000 ------------ ------------ Net premises and equipment $15,380,000 $ 15,855,000 =========== =============
Depreciation expense for the year ended December 31, 2001, 2000 and 1999 was $1,534,000, $991,000 and $751,000, respectively. 55 NOTE 8: DEPOSITS At December 31, 2001, the scheduled maturities of interest-bearing time deposits was as follows:
Interest-bearing Time Deposits ---------------- 2002 $224,626,000 2003 18,133,000 2004 4,702,000 2005 3,321,000 2006 1,164,000 Thereafter 19,000 ------------ Total interest-bearing time deposits $251,965,000 ============
At December 31, 2001 and 2000, interest-bearing time deposits of $100,000 or more were $88,648,000 and $108,240,000, respectively. NOTE 9: FEDERAL INCOME TAXES Significant components of the Company's deferred tax assets and liabilities at December 31, 2001 and 2000, were as follows:
2001 2000 ----------- ---------- Deferred tax assets: Allowance for possible loan losses $ 2,141,000 $2,714,000 Investment securities 210,000 350,000 Retirement plan 0 279,000 Net operating loss carryforwards 152,000 160,000 Employee retention agreements 41,000 72,000 Other real estate and other repossessed assets 17,000 17,000 Other 626,000 711,000 ----------- ---------- Total gross deferred tax assets 3,187,000 4,303,000 Less valuation allowance for deferred tax assets 0 (40,000) ----------- ---------- Net deferred tax assets 3,187,000 4,263,000 ----------- ---------- Deferred tax liabilities: Core deposit intangible (3,327,000) (5,131,000) Net unrealized gain on available-for-sale securities (1,557,000) (833,000) Discount on Trust Preferred Securities (708,000) (713,000) Depreciation and amortization (117,000) (249,000) Other, net (63,000) (125,000) ----------- ---------- Total gross deferred tax liabilities (5,772,000) (7,051,000) ----------- ---------- Net deferred tax liability $(2,585,000) $(2,788,000) =========== ===========
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. The Company records a valuation allowance on deferred tax assets if it is more likely than not that some portion or all of a deferred tax asset will not be realized. The valuation allowance was $0 and $40,000 at December 31, 2001 and 2000, respectively. Management believes that it is more likely than not that the Company will generate sufficient future taxable income to realize the net deferred tax asset. 56 At December 31, 2001, the Company had available net operating loss carryforwards of approximately $447,000 acquired as part of prior acquisitions. These net operating loss carryforwards, if not used, expire between 2003 and 2010. The comprehensive provisions for federal income taxes for the year ended December 31, 2001, the periods from August 12, 2000, through December 31, 2000, from January 1, 2000, through August 11, 2000, and for the year ended December 31, 1999, were as follows:
Year Ended August 12, 2000 January 1, 2000 Year Ended December 31, 2001 through through December 31, 2001 December 31, 2000 August 11, 2000 1999 ---------------- ----------------- --------------- ------------- Current tax provision (benefit) $ (3,293,000) $ 394,000 $ 916,000 $ 914,000 Deferred tax provision (benefit) 88,000 103,000 (817,000) 260,000 -------------- ---------- ----------- ----------- Provision (benefit) for tax expense charged to results of operations (3,205,000) 497,000 99,000 1,174,000 Tax provision (benefit) on adjustment to unrealized gain/loss on available-for-sale securities 723,000 833,000 77,000 (260,000) -------------- -------- ----------- ----------- Comprehensive provision for federal income taxes $ (2,482,000) $1,330,000 $ 176,000 $ 914,000 ============== ========== =========== ===========
The following is a reconciliation of the difference between income tax expense as reported and the amount of expense (benefit) computed by applying the statutory income tax rate to income (loss) before income taxes:
Year Ended August 12, 2000 January 1, 2000 Year Ended December 31, 2001 through through December 31, 2001 December 31, 2000 August 11, 2000 1999 ---------------- ----------------- --------------- ------------- Income (loss) before income taxes $ (10,402,000) $ 732,000 $ (1,809,000) $ 3,626,000 Statutory rate 34% 34% 34% 34% --------------- -------- -------------- ------------- Income tax expense (benefit) at statutory rate (3,537,000) 249,000 (615,000) 1,233,000 Amortization of goodwill 616,000 224,000 130,000 212,000 Tax-exempt income (276,000) (40,000) (113,000) (187,000) Nondeductible acquisition expenses 0 0 717,000 24,000 Other (8,000) 64,000 (20,000) (108,000) --------------- --------- -------------- ------------- Income tax expense (benefit) as reported $ (3,205,000) $ 497,000 $ 99,000 $ 1,174,000 =============== ========= ============= =============
NOTE 10: GUARANTEED PREFERRED BENEFICIAL INTERESTS IN THE COMPANY'S SUBORDINATED DEBENTURES Independent Capital sold 1,300,000 shares of Trust Preferred Securities at $10.00 per preferred security in an underwritten offering in 1998. 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 State National. The securities are redeemable at par after September 22, 2003. Distributions on the Trust Preferred Securities are payable quarterly on March 31, June 30, September 30 and December 31. Distributions paid to holders of the Trust Preferred Securities during both the years ended December 31, 2001 and 2000, totaled $1,105,000. Included in the balance of Trust Preferred Securities at December 31, 2001 is a discount with a remaining balance of $2,082,000 related to the acquisition of the Company by State National. The original balance of the discount was $2,103,000 and was calculated at an effective purchase yield of 10.26%. The discount is being amortized into expense over the life of the instrument. The estimated remaining life of the instrument on which the discount was calculated is twenty-seven years. 57 NOTE 11: STOCKHOLDERS' EQUITY At December 31, 2001, 100% of the shares of the Bank are pledged in a debt agreement between State National and a third party which has an outstanding balance of $7,000,000 at December 31, 2001. 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 and share equivalents outstanding during the period. The remainder of the Series C Preferred Stock was converted to Common Stock during the fourth quarter of 1999. Because the Company's outstanding Series C Preferred Stock was cumulative, the dividends allocable to such preferred stock reduced income available to common stockholders in the basic earnings per share calculations. In computing diluted earnings per common share for the year ended December 31, 1999, the conversion of the Series C Preferred Stock was assumed, as the effect was dilutive. The following table presents information necessary to calculate earnings per share for the period from January 1, 2000, to August 11, 2000, and for the year ended December 31, 1999:
Period from January Year Ended 1, 2000 to December 31, August 11, 2000 1999 ------------------- ----------- BASIC EARNINGS (LOSS) PER COMMON SHARE (In Thousands) Net income (loss) $(1,908) $2,452 Preferred stock dividends 0 (20) ------- ------ Net income (loss) available to common stockholders $(1,908) $2,432 ======= ====== Weighted average shares outstanding 2,262 2,178 ======= ====== Period from January Year Ended 1, 2000 to December 31, August 11, 2000 1999 ------------------- ----------- DILUTED EARNING (LOSS) PER COMMON SHARE (In Thousands) Net income (loss) $(1,908) $2,452 ======= ====== Weighted average shares outstanding 2,262 2,178 Conversion of Series C Preferred Stock 0 97 ------- ------ Adjusted weighted average shares outstanding 2,262 2,275 ======= ======
NOTE 13: BENEFIT PLANS The Company's ESOP/401(k) Plan covered most of its officers and employees. Contributions made to the ESOP/401(k) Plan by the Company were $214,000 and $141,000 for the period from January 1 to August 11, 2000, and for the year ended December 31, 1999, 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 were made by the Company to match contributions made by plan participants in the 401(k) portion of the ESOP/401(k) Plan during the year ended December 31, 1999; however, the Company's board of directors voted to match 25% of up to a maximum of the first 4% of each employees' salary which was deferred and contributed to the 401(k) portion of the ESOP/401(k) Plan beginning January 1, 2000. The amount of all such contributions was at the discretion of the Company's board of directors. Contributions were invested in various equity, debt and money market investments, including Common Stock of the Company. The ESOP/401(k) Plan was terminated at the date of the Acquisition and was liquidated subsequent to the Acquisition. Subsequent to the Acquisition, most of the Company's officers and employees became eligible to participate in State National's 401(k) profit sharing plan. Beginning August 12, 2000, the Company matched 100% of the first 3%, and 58 50% of the next 2%, of each employee's salary which was deferred and contributed to such plan. The Company contributed $217,000 and $80,000 to the plan for the year ended December 31, 2001and for the period from August 12 to December 31, 2000, respectively. NOTE 14: RELATED PARTY TRANSACTIONS In the ordinary course of business, the Company and the Bank have loans, deposits and other transactions with their respective directors and businesses with which such persons are associated. It is the Company's policy that all such transactions are entered into on substantially the same terms as those prevailing at the time for comparable transactions with unrelated third parties. The balances of loans to all such persons were $298,000, $40,000 and $4,113,000 at December 31, 2001, 2000 and 1999, respectively. Additions and reductions on such loans were $294,000 and $36,000, respectively, for the year ended December 31, 2001. 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 Bank leases certain of its premises and equipment under noncancellable operating leases. Rental expense under such operating leases was approximately $1,050,000, $723,000 and $436,000 in 2001, 2000 and 1999, respectively. The minimum payments due under these leases at December 31, 2001 are as follows: 2002 $ 1,024,000 2003 634,000 2004 245,000 2005 202,000 Thereafter 63,000 ------------- Total $2,168,000 ==========
59 NOTE 16: FAIR VALUE OF FINANCIAL INSTRUMENTS The carrying amounts and fair values of financial assets and financial liabilities at December 31, 2001 and 2000, were as follows:
2001 2000 --------------------------- --------------------------- Carrying Carrying Amount Fair Value Amount Fair Value ------------ ---------- ------------ ------------ FINANCIAL ASSETS Cash and due from banks $ 33,212,000 33,212,000 $ 45,415,000 $ 45,415,000 Interest-earning Time Deposits 2,850,000 2,850,000 500,000 500,000 Federal funds sold 10,528,000 10,528,000 39,270,000 39,270,000 Available-for-sale securities 216,112,000 216,112,000 163,666,000 163,666,000 Held-to-maturity securities 0 0 13,517,000 13,495228 Loans, net of unearned income 304,246,000 306,987,000 366,933,000 376,051,000 Accrued interest receivable 5,321,000 5,321,000 8,014,000 8,014,000 FINANCIAL LIABILITIES Noninterest-bearing demand deposits $112,044,000 $112,044,000 $100,795,000 $100,795,000 Interest-bearing demand deposits 180,021,000 180,021,000 188,952,000 188,952,000 Interest-bearing time deposits 251,965,000 255,257,000 303,224,000 302,932,000 Fed Funds Purchased and Securities Sold Under Agreement to Repurchase 151,000 151,000 0 0 Accrued interest payable 1,462,000 1,462,000 2,491,000 2,491,000 Guaranteed preferred beneficial interests in the Company's subordinated debentures 10,918,000 12,350,000 10,904,000 10,569,000
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, 2001 and 2000. The carrying amounts for cash and due from banks, interest earning time deposits, federal funds sold, accrued interest receivable, fed funds purchased and securities sold under agreement to repurchase and accrued interest payable approximate the fair values of such assets and liabilities. Fair values for the Company's off-balance-sheet instruments, which consist of lending commitments and standby 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 significant. 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 and 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 60 instruments. The Company does require collateral or other security to support financial instruments with credit risk. The Company had outstanding loan commitments of approximately $49,302,000 and outstanding financial and performance standby letters of credit of approximately $1,780,000 at December 31, 2001. 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. Financial and performance standby 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 letters of credit is essentially the same as that involved in making loans to customers. In the normal course of business, the Company maintains deposits with other financial institutions in amounts that exceed FDIC insurance coverage limits. NOTE 18: REGULATORY MATTERS The Company and the Bank are subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements could cause the initiation of certain mandatory, and possibly additional discretionary, actions by the regulatory authorities that, if undertaken, could have a direct material effect on the Company's and the Bank's respective financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Company and the Bank must meet specific capital guidelines that involve quantitative measures of the Company's and the Bank's respective assets, liabilities, and certain off-balance-sheet items as calculated under regulatory accounting practices. The Company's and the Bank's respective capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings and other factors. Quantitative measures established by regulation to ensure capital adequacy require the Company and the Bank to maintain minimum amounts and ratios (set forth in the table below) of Tier 1 capital and total capital (Tier 1 and Tier 2) to net risk-weighted assets and of Tier 1 capital to adjusted quarterly average assets. At December 31, 2001, the Company and the Bank met all capital adequacy requirements to which they were subject. At December 31, 2001, the most recent notifications from the Federal Deposit Insurance Corporation (the "FDIC") categorized the Bank as well capitalized under the regulatory framework for prompt corrective action. To be categorized as well capitalized, the Company and the Bank must maintain minimum Tier 1 capital to net risk-weighted assets, total capital to net risk-weighted assets and Tier 1 capital to adjusted quarterly average assets ratios as set forth in the tables. No other conditions or events have occurred since the most recent notification that management believes have changed either the Company's or the Bank's category. 61 The minimum regulatory capital ratios for "well capitalized" bank holding companies and the Company's actual capital amounts and ratios at December 31, 2001 and 2000, were as follows:
December 31 Minimum "Well -------------------- Capital Capitalized" 2001 2000 Ratios Ratios -------- -------- -------- ------------ (Dollars in thousands) Tier 1 capital $ 42,640 $ 45,667 Total capital 47,048 49,680 Net risk-weighted assets 350,516 316,641 Adjusted quarterly average assets 608,689 514,958 Capital ratios: Tier 1 capital to net risk-weighted assets 12.16% 14.42% 4.00% 6.00% Total capital to net risk-weighted assets 13.42 15.69 8.00 10.00 Tier 1 capital to adjusted quarterly average assets 7.01 8.87 4.00 5.00
The minimum capital ratios for "well capitalized" banks and the Bank's actual capital ratios at December 31, 2001, were as follows:
Minimum Ratios for "Well Actual Ratios at Capitalized" Banks December 31, 2001 ------------------------ ----------------- Tier 1 capital to net risk-weighted assets 6.00% 12.41% Total capital to net risk-weighted assets 10.00 13.67 Tier 1 capital to adjusted quarterly average assets 5.00 7.15
At December 31, 2001, retained earnings of the Bank included $0 that was available for payment of dividends to the Company without prior approval of regulatory authorities. The Bank is required to maintain a certain average balance with the Federal Reserve Bank. At December 31, 2001, the average balance required to be maintained was $12,168,000. 62 NOTE 19: PARENT COMPANY FINANCIAL INFORMATION Condensed financial statements of the Company, parent only, are presented below: INDEPENDENT BANKSHARES, INC. A WHOLLY OWNED SUBSIDIARY OF STATE NATIONAL BANCSHARES, INC. CONDENSED BALANCE SHEETS DECEMBER 31, 2001 AND 2000
2001 2000 ----------- ----------- Assets: Cash $ 78,000 $ 39,000 Investment in subsidiaries 87,919,000 93,609,000 Other assets 658,000 1,089,000 ----------- ----------- Total assets $88,655,000 $94,737,000 =========== =========== Liabilities: Accrued interest payable and other liabilities $ 1,954,000 $ 1,447,000 ----------- ----------- Total liabilities 1,954,000 1,447,000 Subordinated debentures 11,320,000 11,306,000 Stockholder's equity 75,381,000 81,984,000 ----------- ----------- Total liabilities and stockholder's equity $88,655,000 $94,737,000 =========== ===========
INDEPENDENT BANKSHARES, INC. A WHOLLY OWNED SUBSIDIARY OF STATE NATIONAL BANCSHARES, INC. CONDENSED INCOME STATEMENTS FOR THE YEAR ENDED DECEMBER 31, 2001, THE PERIOD FROM AUGUST 12, 2000, THROUGH DECEMBER 31, 2000, THE PERIOD FROM JANUARY 1, 2000, THROUGH AUGUST 11, 2000, AND THE YEAR ENDED DECEMBER 31, 1999
Year ended August 12, 2000 January 1, 2000, Year ended December 31, through, through December 31, 2001 December 31, 2000 August 11, 2000 1999 ----------------- ----------------- ---------------- ------------- Income: Dividends from subsidiaries (see Note 18) $ 734,000 $ 17,000 $ 2,917,000 $1,709,000 Management fees from subsidiaries 0 0 90,000 144,000 Interest on loan to the ESOP/401(k) Plan 0 0 8,000 20,000 Interest from subsidiaries 0 0 3,000 8,000 Other income 3,000 0 2,000 0,000 ------------ -------- ----------- ---------- Total income 737,000 17,000 3,020,000 1,881,000 ------------ -------- ----------- ---------- Expenses: Interest 1,153,000 447,000 699,000 1,139,000 Other expenses 266,000 160,000 2,433,000 629,000 ------------ -------- ----------- ---------- Total expenses 1,419,000 607,000 3,132,000 1,768,000 ------------ -------- ----------- ---------- Income (loss) before federal income taxes and equity in undistributed earnings of subsidiaries (682,000) (590,000) (112,000) 113,000 Federal income tax benefit (469,000) (205,000) (347,000) (762,000) ------------ -------- ----------- ---------- Income (loss) before equity in undistributed earnings of subsidiaries (213,000) (385,000) 235,000 875,000 Equity in undistributed earnings (loss) of subsidiaries (6,984,000) 620,000 (2,143,000) 1,577,000 ------------ -------- ----------- ---------- Net income (loss) $ (7,197,000) $235,000 $(1,908,000) $2,452,000 ============ ======== =========== ==========
63 INDEPENDENT BANKSHARES, INC. A WHOLLY OWNED SUBSIDIARY OF STATE NATIONAL BANCSHARES, INC. CONDENSED STATEMENTS OF CASH FLOWS FOR THE YEAR ENDED DECEMBER 31, 2001, THE PERIOD FROM AUGUST 12, 2000, THROUGH DECEMBER 31, 2000, THE PERIOD FROM JANUARY 1, 2000, THROUGH AUGUST 11, 2000, AND THE YEAR ENDED DECEMBER 31, 1999
Year ended August 12, 2000, January 1, 2000, Year ended December 31, through through August December 31, 2001 December 31, 2000 11, 2000 1999 ---------------- ------------------ ----------------- ---------------- Cash flows from operating activities: Net income (loss) $ (7,197,000) $ 235,000 $ (1,908,000) $ 2,452,000 Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities: Deferred federal income tax expense 536,000 0 0 260,000 Equity in undistributed earnings of subsidiaries 6,984,000 (620,000) 2,143,000 (1,577,000) Decrease (increase) in other assets 40,000 (188,000) 175,000 (303,000) Increase (decrease) in accrued interest payable and other liabilities (664,000) (306,000) 1,109,000 49,000 ---------------- ---------------- ---------------- ---------------- Net cash provided by (used in) operating activities (301,000) (879,000) 1,519,000 881,000 ---------------- ---------------- ---------------- ---------------- Cash flows from investing activity: Proceeds from repayments of loans made to employee stock ownership plan 0 0 0 65,000 ---------------- ---------------- ---------------- ---------------- Net cash provided by investing activity 0 0 0 65,000 ---------------- ---------------- ---------------- ---------------- Cash flows from financing activities: Advances from State National 1,000,000 0 0 0 Payment of cash dividends (700,000) (700,000) (273,000) (455,000) Other, Net 40,000 0 0 (669,000) ---------------- ---------------- ---------------- ---------------- Net cash provided by (used in) financing activities 340,000 (700,000) (273,000) (1,124,000) ---------------- ---------------- ---------------- ---------------- Net increase (decrease) in cash and cash equivalents 39,000 (1,579,000) 1,246,000 (178,000) Cash and cash equivalents at beginning of period 39,000 1,618,000 372,000 550,000 ---------------- ---------------- ---------------- ---------------- Cash and cash equivalents at end of period $ 78,000 $ 39,000 $ 1,618,000 $ 372,000 ================ ================ ================ ================
64 NOTE 20: SUPPLEMENTAL CASH FLOW INFORMATION Supplemental cash flow information for the year ended December 31, 2001, the period from August 12, 2000, through December 31, 2000, the period from January 1, 2000, through August 11, 2000, and the year ended December 31, 1999, is as follows:
Year ended August 12, 2000, January 1, 2000, Year ended December 31, through December through December December 31, 2001 31, 2000 31, 2000 1999 --------------- ---------------- ---------------- --------------- Cash paid during the period for: Interest $ 20,197,000 $ 10,091,000 $ 6,256,000 $ 9,987,000 Federal income taxes 0 325,000 800,000 1,000,000 Noncash investing activities: Additions to other real estate and other repossessed assets during the period through foreclosures $ 1,314,000 $ 385,000 $ 317,000 $ 857,000
65 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.
2001 ------------------------------------------------------------------- First Second Third Fourth Quarter Quarter Quarter Quarter Total ------- ------- ------- ------- ----- (In thousands, except per share amounts) Interest income $ 11,839 $ 10,345 $ 9,926 $ 9,073 $41,183 Interest expense 5,988 5,297 4,446 3,440 19,171 Net interest income 5,851 5,048 5,480 5,633 22,012 Provision for loan losses 1,635 2,930 1,000 5,200 10,765 Income (loss) before federal income taxes (1,459) (3,165) (734) (5,044) (10,402) Net income (loss) (1,077) (2,172) (556) (3,392) (7,197)
2001 -------------------------------------------------------------------- July 1 August 12 First Second Through Through Fourth Quarter Quarter August 11 September 30 Quarter Total ------- ------- --------- ------------ ------ ----- (In thousands, except per share amounts) Interest income $6,150 $6,241 $2,882 $6,994 $12,730 $34,997 Interest expense 2,527 2,608 1,220 3,178 6,074 15,607 Net interest income 3,623 3,633 1,662 3,816 6,656 19,390 Provision for loan losses 110 400 1,150 483 135 2,278 Income (loss) before federal income taxes 746 479 (3,034) 314 418 (1,079) Net income (loss) 493 310 (2,711) 201 34 (1,673) Basic earnings (loss) per common share available to common stockholders $ 0.22 $ 0.14 $(1.20) N/A N/A $(0.84)(1) Diluted earnings (loss) per common share available to common stockholders 0.22 0.14 (1.20) N/A N/A (0.84)(1)
---------- (1) Earnings per share and dividends per share were calculated for the period from January 1 through August 11, 2000, the date of the Acquisition. 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. ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE Effective September 27, 2000, the Company dismissed PricewaterhouseCoopers LLP ("PWC") as its independent accountant and engaged the firm of Ernst & Young LLP ("EY") as the Company's independent accountant to audit the Company's financial statements for the years ending December 31, 2001 and 2000. The Company's Board of Directors recommended and approved the change in the Company's certifying accountants. PWC audited the Company's financial statements for the fiscal year ended December 31, 1999. The change in certifying accountants was made by the Company following the acquisition of control of the Company by State National, effective August 11, 2000. 66 PWC's reports with respect to the Company's financial statements for the year ended December 31, 1999, did not contain an adverse opinion or a disclaimer of opinion, and were not qualified or modified as to uncertainty, audit scope or accounting principles. During the year ended December 31, 1999, and from January 1, 2000, through September 27, 2000, there were no disagreements with PWC on any matters of accounting principles or practices, financial statement disclosure, or auditing scope or procedure which, if not resolved to the satisfaction of PWC, would have caused it to make reference to the subject matter of the disagreement in any of its reports on the Company's financial statements, except as described in the following paragraph. As previously reported on the Company's Current Report on Form 8-K dated October 4, 2000, in connection with the preparation and original filing of the Company's Form 10-Q for the quarter ended March 31, 2000 ("First Quarter Form 10-Q"), the Company capitalized costs related to its then pending merger with State National. PWC maintained that such costs should be expensed and discussed this disagreement with the audit committee of the Company's board of directors prior to the filing of the First Quarter Form 10-Q. In August 2000, the Company prepared and filed an amendment to the First Quarter Form 10-Q to restate its financial statements for the first quarter. In the restatement, costs related to the pending merger of the Company with State National that had been capitalized through March 31, 2000 ($209,000), were expensed. In preparing and filing its Form 10-Q for the quarter ended June 30, 2000, the Company appropriately expensed the merger costs incurred in the second quarter. The Company has authorized PWC to respond fully to the inquiries of EY concerning the subject matter of the disagreement. 67 PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT DIRECTORS The Bylaws of the Company provide that the Board of Directors consists of not fewer than seven nor more than 30 members (exclusive of advisory directors) and that the number of directors, within such limits, is to be determined by resolution of the Board of Directors at any meeting. The Board of Directors has set the Board at nine members (exclusive of advisory directors). Directors serve for one-year terms. The tables below set forth for each director: - the name, - age and the principal occupation of each director; - the directorships of public companies, if any, held by each director; and - the year he first became a director of the Company.
YEAR FIRST BECAME A DIRECTOR OF THE NAME AND AGE COMPANY PRINCIPAL OCCUPATION DURING THE LAST FIVE YEARS -------------------------- --------------- ----------------------------------------------------- Tom C. Nichols (54) 2000 President, Chief Executive Officer and Director of the Company since 2001; Chief Executive Officer and Chairman of the Board of State National and the Lubbock Bank since 1996. Don E. Cosby (47) 2000 Executive Vice President, Chief Financial Officer and Director of the Company since 2001; Executive Vice President, Chief Financial Officer and Director of State National and the Lubbock Bank since 1996 Rick J. Calhoon (48) 2000 Partner, Pruet Companies (oil and gas) James A. Cardwell (70) 2000 Chairman and Chief Executive Officer, Petro Stopping Centers, L.P. (truck stops) Gary J. Fletcher (55) 2000 Rancher, Salt Fork Ranch Ronald Simpson (55) 2000 President and Director of the Bank Ben Stribling (59) 2001 Real Estate Development and Investments
RESIGNATION AND APPOINTMENT OF DIRECTORS AND OFFICERS Effective May 15, 2001, Mr. Bryan W. Stephenson, President and Chief Executive Officer, Mr. Randal N. Crosswhite, Chief Financial Officer, and Mr. David D. Kirk each resigned from the Company's Board of Directors as well as from their respective positions as officers of the Company. Effective May 15, 2001, the Company appointed Mr. Tom C. Nichols, Chairman of the Board, to the position of President and Chief Executive Officer, and 68 effective May 31, 2001 Mr. Don E. Cosby, Executive Vice President, was appointed to the position of Chief Financial Officer and Secretary. MEETINGS AND COMMITTEES OF THE BOARD OF DIRECTORS The Board of Directors conducts its business through meetings of the Board of Directors and through its committees. In accordance with the Bylaws of the Company, the Board of Directors has established an Audit Committee. During 2001, the Board of Directors held four regular meetings and the Audit Committee held four meetings. Each director attended at least 75% of the total number of meetings of the Board of Directors and the committees on which he served. AUDIT COMMITTEE. The Audit Committee recommends to the Board of Directors the appointment and discharge of the Company's independent auditors; reviews the completed audit with the independent auditors regarding the conduct of the audit, accounting adjustments, recommendations for improving internal controls and any other significant findings during the audit; meets periodically with management; monitors accounting and financial controls; and initiates and supervises special investigations. Members of the Audit Committee during 2001 consist of Rick J. Calhoon, James A. Cardwell, Gary J. Fletcher and Ben Stribling. EXECUTIVE OFFICERS The table below sets forth at the date of this report the name, age, current positions with the Company, principal occupation during the last five years of each principal executive officer of the Company and the year he first became an executive officer of the Company:
EXECUTIVE OFFICER CURRENT POSITION WITH THE OF THE COMPANY PRINCIPAL OCCUPATION DURING LAST NAME AND AGE COMPANY OR THE BANK COMPANY SINCE FIVE YEARS ------------------------------ --------------------------- ----------------- ------------------------------- Tom C. Nichols (54) President, Chief Executive 2000 Chairman of the Board and Chief Officer, and Chairman of the Executive Officer of State Board of the Company and National and the Lubbock Bank Chief Executive Officer and Chairman of the Board of the Bank Don E. Cosby (47) Executive Vice President, 2000 Executive Vice President, Chief Chief Financial Officer and Financial Officer, and Director Director of the Company and of State National and the of the Bank Lubbock Bank
TERM OF OFFICE Executive officers of the Company are elected by the Board of Directors at its annual meeting and hold office until the next annual meeting of the Board of Directors or until their respective successors are duly elected and have qualified. The officers of the Bank are elected by the board of directors of the Bank at its annual meeting and hold office until the next annual meeting of such board of directors or until their respective successors are duly elected and have qualified. COMPLIANCE WITH SECTION 16(a) OF THE SECURITIES EXCHANGE ACT OF 1934 Officers, directors and beneficial owners of more than ten percent of the Common Stock must file initial reports of ownership and reports of changes in ownership with the Securities and Exchange Commission and AMEX pursuant to Section 16(a). In August 2000, State National acquired 100% of the common stock of the Company in a cash merger. Because the Company is wholly owned by State National, none of these individuals beneficially has owned any securities of the Company at any time since their respective appointments. 69 ITEM 11. EXECUTIVE COMPENSATION SUMMARY COMPENSATION TABLE As the compensation of the Company's executive officers (including those who are employed by the Company's direct and indirect subsidiaries) are allocated between the Company and State National, cash compensation paid by the Company to the executive officers did not exceed $100,000 during the fiscal year ended December 31, 2001.
LONG-TERM COMPENSATION AWARDS OTHER ANNUAL ------------- ANNUAL COMPENSATION COMPENSATION SECURITIES -------------------- ------------ UNDERLYING NAME AND PRINCIPAL POSITION FISCAL YEAR SALARY BONUS ($) ($)(1) OPTIONS -------------------------------------- ----------- ------------ ------------ ------------ ------------ Tom C. Nichols 2001 $ 66,000 $ 0 $ 3,000 $ 0 PRESIDENT, CHIEF EXECUTIVE OFFICER, 2000 28,000 0 0 0 CHAIRMAN OF THE BOARD AND DIRECTOR OF THE COMPANY
---------- (1) Constitutes automobile allowance and other benefits. STOCK OPTION GRANTS/EXERCISES IN FISCAL 2001 No stock options to acquire shares of the Company's Common Stock were granted to, or exercised by, the Chief Executive Officer or any other executive officers of the Company during fiscal 2001. The Company has never granted stock appreciation rights. EMPLOYEE RETENTION AGREEMENTS In September 1999, the Company entered into employee retention agreements with its key employees and selected executive officers (individually, the "Key Employee," or collectively, the "Key Employees") to provide additional incentives to such Key Employees to continue their employment with the Company in the event that the Company experienced a change of control, i.e., merger, consolidation, or sale of the assets or stock of the Company. Each employee retention agreement provides that the Key Employee would receive a cash lump sum payment equal to one or two times the Key Employee's annual compensation, including bonus compensation. This amount is payable after one year from the change in control unless such Key Employee is terminated sooner for cause or resigns or severs his employment with the Company for any reason other than constructive termination. In the event the Key Employee is terminated without cause or the Key Employee is constructively terminated because the Key Employee's compensation is diminished, his job title is changed to a position of lesser importance, or his responsibilities are materially reduced, the retention benefit must be paid by the Company within thirty (30) days of such termination. In the event of the Key Employee's death or disability, the pro rated portion of the retention benefit must be paid by the Company within thirty (30) days of such death or disability. 70 The Acquisition of the Company by State National constituted a change in control of the Company and triggered the provisions of certain of these retention agreements. Pursuant to the terms of the Key Employee retention agreements, the following named executive officers received payment of the specific retention benefit detailed below:
Aggregate Received to Payment Date --------- ---------- Bryan W. Stephenson $352,000 $352,000 Randal N. Crosswhite 210,000 210,000 Michael D. Jarrett 113,000 113,000 James G. Fitzhugh 92,000 92,000
To date, all payments have been made to the above-mentioned Key Employees and the retention agreements described above have terminated. The Company has no further obligation to any key employee pursuant to any employee retention agreement. DIRECTOR COMPENSATION During the period from January 1, 2000, through August 16, 2000, each non-employee director and advisory director was paid $250 for each regular directors' meeting of the Company attended and $100 for each meeting of the Executive Committee and Audit Committee attended. No fees have been paid by the Company to any director of the Company subsequent to the Acquisition. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT SECURITY OWNERSHIP OF MANAGEMENT All of the common stock of the Company is owned indirectly by State National. Accordingly, none of the directors or executive officers of the Company has owned any shares of Common Stock since the Company's acquisition of State National was completed on August 11, 2000. In addition, none of the directors or executive officers of the Company own any derivative securities with respect to the Company's common stock. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS The following entity is known by the Company to own beneficially more than five percent of the Company's Common Stock on March 5, 2002.
NUMBER OF PERCENT OF NAME AND ADDRESS SHARES(1) CLASS (2) ---------------------------------------------- --------- ---------- State National Bancshares of Delaware, Inc., a 2,273,647 100% wholly owned subsidiary of State National Bancshares, Inc. 1617 Broadway Lubbock, Texas 79401
---------- (1) Beneficial ownership as reported in the above table has been determined in accordance with Rule 13d-3 under the Securities Exchange Act of 1934, as amended. (2) The percentage of Common Stock indicated is based on 2,273,647 shares of Common Stock outstanding on March 5, 2002. 71 ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS TRANSACTIONS WITH MANAGEMENT LOAN TRANSACTIONS. The Bank had, during the period from January 1, 2001, to March 5, 2002, and expects to have in the future, loan transactions with directors of the Company and the Bank and their respective associates, which includes any immediate family member or any corporation or firm of which such person is an executive officer or partner or is, directly or indirectly, the beneficial owner of 10% or more of any class of equity securities or any trusts of which such person serves as trustee or in which he or she has a substantial beneficial interest. These loan transactions have been made in the ordinary course of the Bank's business and have been and will continue to be on substantially the same terms, including interest rates, collateral and repayment, as those prevailing at the time for comparable transactions with unaffiliated persons and did not involve more than the normal risk of collectibility or present other unfavorable features. All loans made to directors and nominees for director of the Company and their respective associates are believed to be in compliance with the Financial Institutions Regulatory and Interest Rate Control Act of 1978. LUBBOCK BANK. On February 28, 2001, State National-- Delaware, the owner of all of the common stock of the Company, contributed to the Company, and the Company in turn contributed to Independent Financial, all of the capital stock of the Lubbock Bank. On March 9, 2001, the Abilene Bank was merged with and into the Lubbock Bank. The Lubbock Bank continued as the surviving entity in the merger. The result of the transaction was that the Bank was merged into the Lubbock Bank, which became an indirect wholly owned subsidiary of the Company. There was no merger consideration paid as, prior to the transactions, the Bank and the Lubbock Bank were both direct or indirect subsidiaries of State National. The merger was accounted for similar to a pooling of interests. See "Item 1. Business--Reorganizations." At the time of this merger, there were parent-subsidiary relationships among State National, State National - Delaware, the Company, Independent Financial, the Bank and the Lubbock Bank. Further, there were common directors and officers among the above-named entities. The common directors and officers were Rick Calhoon (Director of State National and the Company), Jack Cardwell (Director of State National and the Company), Don Cosby (Director of State National, State National - Delaware, the Company, Independent Financial, the Bank and the Lubbock Bank; Executive Vice President and Chief Financial Officer of State National; President of State National - Delaware; Executive Vice President of the Company; and President of Independent Financial), Randal Crosswhite (Director of the Company and the Bank, Chief Financial Officer and Secretary of the Company; and Executive Vice President and Chief Financial Officer of the Bank), Gary Fletcher (Director of State National, the Company and the Lubbock Bank), David Kirk (Director of State National, the Company, the Bank and the Lubbock Bank), Tom Nichols (Chairman of the Board and Chief Executive Officer of State National, the Bank and the Lubbock Bank and Chairman of the Board of the Company), Ronald Simpson (Director of the Company and Director and President of the Bank) and Bryan Stephenson (Director and President and Chief Executive Officer of the Company and Director and Vice Chairman the Bank). 72 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 are included in PART II of this report:
PAGE REFERENCE TO ANNUAL REPORT ON ITEM FORM 10-K ---------------------------------------------------------------------------- ----------------- Report of Ernst & Young, LLP, Independent Auditors 42 Report of PricewaterhouseCoopers LLP, Independent Accountants 43 Consolidated Balance Sheets as of December 31, 2001 and 2000 44 Consolidated Statements of Income (Loss) and Comprehensive Income (Loss) for the year ended December 31, 2001, the period from August 12, 2000, through December 31, 2000, the period from January 1, 2000, through August 11, 2000, and the year ended December 31, 1999 45 Consolidated Statements of Changes in Stockholder's Equity for the year ended December 31, 2001, the period from August 12, 2000, through December 31, 2000, the period from January 1, 2000, through August 11, 2000, and the year ended December 31, 1999 46 Consolidated Statements of Cash Flows for the year ended December 31, 2001, the period from August 12, 2000, through December 31, 2000, the period from January 1, 2000, through August 11, 2000, and the year ended December 31, 1999 47 Notes to Consolidated Financial Statements 48 Quarterly Data (unaudited) 66
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. 73
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, 2000). 3.2 Articles of Amendment to the Articles of Incorporation of Independent Bankshares, Inc. (Exhibit 3.2 to the Company's Annual Report on Form 10-K for the year ended December 31, 2000). 3.3 Restated Bylaws of Independent Bankshares, Inc., as amended (Exhibit 3.3 to the Company's Annual Report on Form 10-K for the year ended December 31, 2000). 4.1 Specimen Stock Certificate for Common Stock of the Company (Exhibit 4.1 to the Company's Registration Statement on Form S-1, SEC File No. 333-16419). 10.1 Form of Employee Retention Agreement. (Exhibit 10.1 to the Company's Quarterly Report on Form 10-Q dated September 30, 1999). 10.2 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 10.4 to the Company's Annual Report on Form 10-K for the year ended December 31, 1999). 10.4 Agreement and Plan of Reorganization, dated as of March 1, 2000, by and among State National Bancshares, Inc. and Independent Bankshares, Inc. (Exhibit 2.1 to the Company's Current Report on Form 8-K dated March 8, 2000). 10.5 Agreement and Plan of Merger by and among United Bank & Trust, Abilene, Texas and First State Bank, N.A., Abilene, Texas, dated October 24, 2000 (Exhibit 2.1 to the Company's Current Report on Form 8-K dated November 28, 2000). 10.6 Agreement and Plan of Merger by and between State National Bank of West Texas and State National Bank of West Texas, Abilene, Texas, dated February 21, 2001; but effective as of March 9, 2001 (Exhibit 2.1 to the Company's Current Report on Form 8-K dated March 23, 2001). 21.1 Subsidiaries of Independent Bankshares, Inc. (filed herewith). (b) Current Reports on form 8-K. None.
74 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/ Tom C. Nichols ------------------------------------- Tom C. Nichols, PRESIDENT, CHIEF EXECUTIVE OFFICER, CHAIRMAN OF THE BOARD AND DIRECTOR (PRINCIPAL EXECUTIVE OFFICER) By: /s/ Don E. Cosby ------------------------------------- Don E. Cosby, EXECUTIVE VICE PRESIDENT, CHIEF FINANCIAL OFFICER AND DIRECTOR (PRINCIPAL FINANCIAL OFFICER) Date: March 5, 2002 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/ Tom C. Nichols President, Chief Executive March 5, 2002 -------------------------------- Officer, Chairman of the Tom C. Nichols Board and Director /s/ Don E. Cosby Executive Vice President, March 5, 2002 -------------------------------- Chief Financial Officer, Don E. Cosby and Director /s/ Rick J. Calhoon Director March 5, 2002 -------------------------------- Rick J. Calhoon /s/ James A. Cardwell Director March 5, 2002 -------------------------------- James A. Cardwell /s/ Gary J. Fletcher Director March 5, 2002 -------------------------------- Gary J. Fletcher /s/ Ronald Simpson Director March 5, 2002 -------------------------------- Ronald Simpson /s/ Ben Stribling Director March 5, 2002 -------------------------------- Ben Stribling
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