-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, TwTF/OMMfT0+3UbNoabPFc3O+BEJn3g4lPj4m0K1FOKU6mYvj0uECS0vwodB08pp jPgXxnaOnC4ZsfW5dnXw3Q== 0000950129-03-001383.txt : 20030314 0000950129-03-001383.hdr.sgml : 20030314 20030314171052 ACCESSION NUMBER: 0000950129-03-001383 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 7 CONFORMED PERIOD OF REPORT: 20021231 FILED AS OF DATE: 20030314 FILER: COMPANY DATA: COMPANY CONFORMED NAME: STERLING BANCSHARES INC CENTRAL INDEX KEY: 0000891098 STANDARD INDUSTRIAL CLASSIFICATION: STATE COMMERCIAL BANKS [6022] IRS NUMBER: 742175590 STATE OF INCORPORATION: TX FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K SEC ACT: 1934 Act SEC FILE NUMBER: 000-20750 FILM NUMBER: 03604651 BUSINESS ADDRESS: STREET 1: 15000 NORTHWEST FRWY STE 308 CITY: HOUSTON STATE: TX ZIP: 77040 BUSINESS PHONE: 7134668300 10-K 1 h03904e10vk.txt STERLING BANCSHARES, INC.- DECEMBER 31, 2002 - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 --------------------- FORM 10-K (Mark One) [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR FISCAL YEAR ENDED DECEMBER 31, 2002 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM ________ TO________
--------------------- COMMISSION FILE NUMBER 0-20750 STERLING BANCSHARES, INC. (Exact name of registrant as specified in its charter) TEXAS 74-2175590 (State or other jurisdiction of (I.R.S. employer incorporation or organization) identification number) 2550 NORTH LOOP WEST, SUITE 600 HOUSTON, TEXAS 77092 (Address of principal executive offices) (Zip Code)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (713) 466-8300 --------------------- SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT: NONE SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT: Common Stock, $1.00 par value (Title of Class) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days: Yes [X] No [ ] Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (17 CFR 229.405) 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. [ ] Indicate by check mark whether the registrant is an accelerated filer (as defined by Rule 12b-2 of the Act). Yes [X] No [ ] The aggregate market value of the registrant's Common Stock held by non-affiliates as of June 28, 2002, the last business day of the most recently completed second fiscal quarter, was $587,252,851 based on the closing sales price of $14.77 on such date. For purposes of this calculation, affiliates are defined as all directors and executive officers. As of February 28, 2003, registrant had outstanding 43,990,054 shares of Common Stock, $1.00 par value. DOCUMENTS INCORPORATED BY REFERENCE: Portions of Sterling Bancshares, Inc.'s definitive proxy statement relating to the registrant's 2003 Annual Meeting of Shareholders, which proxy statement will be filed under the Securities Exchange Act of 1934 within 120 days of the end of the registrant's fiscal year ended December 31, 2002, are incorporated by reference into Part III of this Form 10-K. - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- PART -- I ITEM 1 -- BUSINESS GENERAL Sterling Bancshares, Inc. (the "Company"), headquartered in Houston, Texas, is a bank holding company that provides commercial and retail banking services primarily in the Houston, Dallas and San Antonio metropolitan areas through the banking offices of Sterling Bank, a banking association chartered under the laws of the State of Texas (the "Bank"). The Company also provides mortgage banking services through its 80 percent owned subsidiary, Sterling Capital Mortgage Company ("SCMC"). The Company's principal executive offices are located at 2550 North Loop West, Suite 600, Houston, Texas, 77092 and its telephone number is (713) 466-8300. The Company was incorporated under the laws of the State of Texas in 1980 and became the parent bank holding company of Sterling Bank in 1981. Sterling Bank was chartered in 1974. The Company completed its initial public offering on October 22, 1992. The Company had approximately 1,065 and 1,100 full time equivalent employees, including 276 and 88 officers, in its commercial banking and mortgage banking segments, respectively, as of December 31, 2002. At December 31, 2002, the Company had total assets of $3.6 billion, deposits of $2.5 billion, and shareholders' equity of $249.3 million. The Company's website address is www.banksterling.com. The Company makes available on its website its annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to those reports as soon as reasonably practicable after it electronically files such reports with the Securities and Exchange Commission (the "SEC"). Copies of such reports are available at no charge. The information found on the Company's website does not constitute a part of this or any other report. The Company has two operating segments: commercial banking and mortgage banking. The segments are managed separately as they require different marketing strategies and offer different products and services. See Note V to the Consolidated Financial Statements for summarized financial information by operating segment. COMMERCIAL BANKING The Bank provides a wide range of retail and commercial banking services, including demand, savings and time deposits; commercial, real estate and consumer loans; merchant credit card services; letters of credit; and cash and asset management services. In addition, the Bank facilitates sales of brokerage, mutual fund, alternative financing and insurance products through third party vendors. The deposits of the Bank are insured up to applicable limits by the Bank Insurance Fund ("BIF") of the Federal Deposit Insurance Corporation ("FDIC"). The primary lending focus of the Bank is providing commercial loans and owner-occupied real estate loans to local businesses with annual sales ranging from $300,000 to $30 million. Typically, the Bank's customers have financing requirements between $50,000 and $500,000. The Bank's credit range, while well below its legal lending limit of $20 million, allows for greater diversity in the loan portfolio, less competition from large banks, and better pricing opportunities. Business Banking Strategy. Under its business banking strategy, the Bank focuses on a broad line of financial products and services to small and medium-sized businesses through full service banking offices. Each banking office has senior management with extensive lending experience. These managers exercise substantial authority over credit and pricing decisions, subject to loan committee approval for larger credits. This decentralized management approach, coupled with continuity of service by the same staff members, enables the Bank to develop long-term customer relationships, maintain high quality service and respond quickly to customer needs. The Company believes that its emphasis on local relationship banking, together with a conservative approach to lending, are important factors in the success and growth of the Bank. 1 The Company and the Bank have maintained a strong community orientation by, among other things, supporting the active participation of staff members in local charitable, civic, school, religious and community development activities. Each banking office may also appoint selected customers to a business development board that assists in introducing prospective customers to the Bank and in developing or improving products and services to meet customer needs. As a result of the development of broad banking relationships with customers and the convenience and service of the Company's forty banking offices, lending and investing activities are funded primarily by core deposits, over one-third of which are noninterest bearing demand deposits. The Bank centralizes operational and support functions that are transparent to customers in order to achieve consistency and cost efficiencies in the delivery of products and services by each banking office. The central office provides services such as data processing, bookkeeping, accounting, treasury management, loan administration, loan review, compliance, risk management and internal auditing to enhance their delivery of quality service. The Company also provides overall direction in the areas of credit policy and administration, strategic planning, marketing, investment portfolio management and other financial and administrative services. The banking offices work closely with the Company to develop new products and services needed by their customers and to introduce enhancements to existing products and services. MORTGAGE BANKING The Company originates, sells and services single family residential mortgages through its 80 percent owned subsidiary SCMC. SCMC has production offices in Texas and fourteen other states, with corporate offices in Houston, Texas and Seattle, Washington. The typical mortgage originated by SCMC is approximately $140,000. A substantial portion of SCMC's loan production is generated through joint ventures known as affiliated business arrangements with established home builders and realtor-based organizations. SCMC is an approved Government National Mortgage Association ("GNMA") issuer of mortgage-backed securities. SCMC is also an approved Federal National Mortgage Association ("FNMA"), Federal Home Loan Mortgage Corporation ("FHLMC") seller/servicer and a HUD-Approved Title II nonsupervised mortgagee. During 2002, SCMC funded approximately $4.5 billion in residential mortgage loans. COMPANY GROWTH STRATEGY The Company's growth strategy has been concentrated on increasing its banking presence in the greater Houston area and on entering both the Dallas and San Antonio markets. The Company has grown through a combination of internal growth, mergers and acquisitions and the opening of new banking offices. Consistent with its operating philosophy and growth strategy, the Company regularly evaluates opportunities to acquire banks and other financial services companies that complement its existing business, expand its market coverage and share, and enhance its client product offerings. De Novo Offices. Two new banking offices were opened in 2002. A new banking office was opened in Houston in December 2002 and in June 2002, the Company opened a new banking office in San Antonio. Additionally, in March 2001, the Company opened a new banking office in Deer Park. In December 2000, the Company opened a new banking office in Dallas. This was the Company's first banking office outside of the Houston market. In connection with the opening of this office, the Company's Board designated 50,000 shares of Series I convertible preferred stock and authorized the offering and sale of such shares to investors who may assist in the business development efforts of the office. A total of 20,000 of the Series I convertible preferred shares were actually sold and issued in March 2002. The Series I convertible preferred shares will be convertible into a maximum of 25,000 shares of the Company's common stock. The conversion ratio is dependent upon the Dallas office meeting certain performance goals. In April 2000, the Company opened a new banking office in Bellaire. In conjunction with the opening of this office, the Company's Board designated 50,000 shares of Series H convertible preferred stock and authorized the offering and sale of such shares to investors who may assist in the business development efforts of the office. A total of 39,000 of the Series H convertible preferred shares were actually sold. The Series H preferred shares will be convertible into a maximum of 73,125 shares of the Company's common stock. The conversion ratio is dependent upon the Bellaire office meeting certain performance goals. 2 Mergers and Acquisitions. On September 13, 2002, the Company acquired ENB Bankshares, Inc. of Dallas, for an aggregate cash purchase price of $10.4 million. ENB Bankshares, Inc. is the privately held bank holding company of Eagle National Bank ("Eagle National"), which operates one banking office in North Dallas. Additionally during September 2002, the Company completed the operational integration of Eagle National Bank and Sterling Bank. This acquisition was accounted for using the purchase method of accounting. Goodwill of $5.7 million was recorded in connection with this acquisition. On December 17, 2001, the Company acquired Community Bancshares, Inc. and its subsidiary bank, Community Bank in a stock and cash merger. The shareholders of Community Bancshares, Inc. received $14.6 million in cash and 1,443,753 shares of the Company's common stock for all of the outstanding shares of common stock of Community Bancshares, Inc. The stock issuance occurred after the three-for-two stock split effected by the Company in September 2001. Community Bank operated two banking offices in west Houston. During May 2002, the Company completed the operational integration of Community Bank and Sterling Bank. This acquisition was accounted for using the purchase method of accounting. Goodwill of $28.7 million was recorded in connection with this acquisition. In June 2002, the Company sold Community Bank's charter to Sabine State Bank & Trust Company. On August 23, 2001, the Company acquired Lone Star Bancorporation, Inc. and its subsidiary bank, Lone Star Bank in a stock-for-stock merger. The shareholders of Lone Star Bancorporation, Inc. received an aggregate of 1.76 million shares of the Company's common stock for all of the outstanding shares of common stock of Lone Star Bancorporation, Inc. The stock issuance occurred prior to the three-for-two stock split effected by the Company in September 2001. All previously reported amounts have been restated to reflect this transaction which was accounted for using the "pooling of interests" method. Lone Star Bank operated four banking offices in the Houston metropolitan area. The Company merged Lone Star Bank into Sterling Bank in February 2002. On March 22, 2001, the Company acquired CaminoReal Bancshares of Texas, Inc. and its subsidiary bank, CaminoReal Bank, National Association, for an aggregate cash purchase price of $51.8 million. CaminoReal Bank operated four banking offices in San Antonio, Texas and four banking offices in the south Texas cities of Eagle Pass, Carrizo Springs, Crystal City and Pearsall. During June 2001, the Company completed the operational integration of CaminoReal Bank and Sterling Bank. This acquisition was accounted for using the purchase method of accounting. Goodwill of $21.2 million was recorded in connection with this acquisition. On June 1, 1999, the Company acquired B.O.A. Bancshares, Inc. and its subsidiary Houston Commerce Bank in exchange for 1,854,600 shares of the Company's common stock. All previously reported amounts have been restated to reflect this transaction which was accounted for using the "pooling of interests" method. The acquisition of B.O.A. Bancshares added $115 million in total assets and $103 million in total deposits to the Company's balance sheet. Houston Commerce Bank operated three banking offices in Houston. During October 1999, the Company merged Houston Commerce Bank into Sterling Bank. On November 20, 1998, the Company acquired Hometown Bancshares, Inc., which was the bank holding company for Clear Lake National Bank, in a stock-for-stock merger. The acquisition of Hometown added $92 million in total assets and $84 million in total deposits to the Company's balance sheet. Clear Lake National Bank operated two banking offices in the Clear Lake area of southeast Houston. All previously reported amounts have been restated to reflect this transaction which was accounted for using the "pooling of interests" method. During April 1999, the Company merged Clear Lake National Bank into Sterling Bank. On June 30, 1998, Humble National Bank was acquired by the Company in a stock-for-stock merger. The acquisition of Humble added $54 million in total assets and $49 million in total deposits to the Company's balance sheet. Humble operated a full service banking office in the Humble area of northeast Houston. All previously reported amounts have been restated to reflect this transaction which was accounted for using the "pooling of interests" method. During August 1998, the Company merged Humble into Sterling Bank. The Company will continue to seek acquisition and new office opportunities when available and consistent with its business banking philosophy. To accommodate further growth, the Company will continue 3 to upgrade its central office data processing and telecommunication systems and facilities to provide the Company with the technological capacity necessary to meet the needs and expectations of its customers. Divestitures. On October 29, 2002, the Bank entered into an agreement to sell its banking office located in Eagle Pass, Texas to South Texas National Bank of Laredo. At December 31, 2002, the Eagle Pass banking office had assets of $23.6 million, loans of $16.7 million and deposits of $98.2 million. The proposed sale is subject to customary closing conditions, including receipt of necessary approvals. If the necessary regulatory approvals are received, it is anticipated that the closing of the sale will occur during the first quarter of 2003. On July 16, 2002, the Bank entered into an agreement to sell its banking offices located in Carrizo Springs, Crystal City and Pearsall to an investor group headed by the current executive officers of these three locations. As of December 31, 2002, the three banking offices had combined assets of $19.2 million, loans of $16.3 million and deposits of $41.9 million. The proposed sale is subject to customary closing conditions, including receipt of necessary regulatory approvals. If the necessary regulatory approvals are received, it is anticipated that the closing this sale will occur during the second quarter of 2003. COMPETITION The Company engages in highly competitive activities. Each activity and market served involves competition with other banks and mortgage companies, as well as with non-banking and non-financial enterprises that offer financial products and services that compete directly with the Company's product and service offerings. The Company actively competes with other banks, mortgage companies and other financial service companies in its efforts to obtain deposits and make loans, in the scope and types 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 banks and mortgage companies, the Company competes with other financial institutions engaged in the business of making loans or accepting deposits, such as savings and loan associations, credit unions, industrial loan associations, insurance companies, small loan companies, finance companies, real estate investment trusts, certain governmental agencies, credit card organizations and other enterprises. In recent years, competition for money market accounts from securities brokers has also intensified. 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 a variety of other institutions in providing brokerage services. SUPERVISION AND REGULATION Bank holding companies and banks are extensively regulated by both federal and state law. This regulation is intended primarily for the protection of depositors and the deposit insurance fund and not for the benefit of shareholders of the Company. Set forth below is a summary description of the material laws and regulations which relate to the operation of the Company and the Bank. The following descriptions do not purport to be complete and are qualified in their entirety by reference to such statutes and regulations. THE BANK HOLDING COMPANY The Company and its second tier holding company, Sterling Bancorporation, Inc., are bank holding companies registered under the Bank Holding Company Act of 1956, as amended ("BHCA"), and are subject to supervision and regulation by the Federal Reserve Board. Federal laws subject bank holding companies to particular restrictions on the types of activities in which they may engage, and to a range of supervisory requirements and activities, including regulatory enforcement actions for violations of laws and policies. In addition, Texas law authorizes the Texas Department of Banking to supervise and regulate a holding company controlling a state bank. Further, the Company's securities are registered with the SEC under the Securities Exchange Act of 1934, as amended (the "Exchange Act"). As such, the Company is subject to the information, proxy solicitation, insider trading and other requirements and restrictions of the Exchange Act. 4 Permissible Activities. As a bank holding company, the activities of the Company, as well as the activities of entities which are controlled by the Company or of which the Company owns 5% or more of the voting securities, are limited by the BHCA to banking, management and control of banks, furnishing or performing services for its subsidiaries, or any other activity which the Federal Reserve Board determines to be incidental or closely related to banking or managing or controlling banks. However, the Gramm-Leach-Bliley Act enacted in 2000 amended the BHCA and granted certain expanded powers to bank holding companies. See discussion below under "Recently Enacted Legislative and Regulatory Changes." In approving acquisitions by the Company of entities engaged in banking-related activities, the Federal Reserve Board considers a number of factors, including the expected benefits to the public, such as greater convenience and increased competition or gains in efficiency, which are weighted against the risks of possible adverse effects, such as an attempt to monopolize the business of banking, undue concentration of resources, decreased or unfair competition, conflicts of interest, or unsound banking practices. Non-Banking Activities. The BHCA sets forth exceptions to its general prohibition against bank holding company ownership of voting shares in any company engaged in non-banking activities. The exceptions include certain activities exempt based upon the type of activity and those determined by the Federal Reserve Board to be closely related to banking or managing or controlling banks. The Economic Growth and Regulatory Paperwork Reduction Act of 1996 ("EGRPRA"), streamlined the non-banking activities application process for bank holding companies which qualify as well-capitalized and well-managed. Also, see discussion of the Gramm-Leach-Bliley Act, which amends certain portions of the BHCA, under the "Recently Enacted Legislative and Regulatory Changes" caption below. Recently Enacted Legislative and Regulatory Changes. Gramm-Leach-Bliley. The Gramm-Leach-Bliley ("G-L-B") Act, which became effective in 2000, authorizes affiliations between banking, securities and insurance firms and authorizes bank holding companies and state banks, if permitted by state law, to engage in a variety of new financial activities. Bank holding companies may also elect to become financial holding companies if they meet certain requirements relating to capitalization and management and have filed a declaration with the Federal Reserve Board electing to be a financial holding company. Among the new activities that will be permitted by bank holding companies are securities and insurance brokerage, securities underwriting, insurance underwriting and merchant banking. The Federal Reserve Board, in consultation with the Department of Treasury, may approve additional financial activities. The Company has not filed an election to be a financial holding company. The Company does not believe that the G-L-B Act will have a material adverse effect on operations in the near-term. However, to the extent that it permits banks, securities firms and insurance companies to affiliate, the financial services industry may experience further consolidation. The G-L-B Act is intended to grant to community banks certain powers as a matter of right that larger institutions have accumulated on an ad hoc basis. Nevertheless, this act may have the result of increasing the amount of competition that the Company and the Bank face from larger institutions and other types of companies offering financial products, many of which may have substantially more financial resources than the Company and the Bank. USA Patriot Act. On October 26, 2001, President Bush signed the USA Patriot Act of 2001. Enacted in response to the terrorist attacks in New York, Pennsylvania and Washington, D.C. on September 11, 2001, the Patriot Act is intended to strengthen U.S. law enforcement's and the intelligence communities' ability to work cohesively to combat terrorism on a variety of fronts. The potential impact of the Patriot Act on financial institutions of all kinds is significant and wide ranging. The Patriot Act contains sweeping anti-money laundering and financial transparency laws and requires various regulations, including: - due diligence requirements for financial institutions that administer, maintain, or manage private bank accounts or correspondent accounts for non-U.S. persons; - standards for verifying customer identification at account opening; 5 - rules to promote cooperation among financial institutions, regulators, and law enforcement entities in identifying parties that may be involved in terrorism or money laundering; - reports by nonfinancial trades and business filed with the Treasury Department's Financial Crimes Enforcement Network for transactions exceeding $10,000; and - filing of suspicious activities reports involving securities by brokers and dealers if they believe a customer may be violating U.S. laws and regulations. It is anticipated that the U.S. Department of the Treasury and the FDIC will issue final regulations regarding additional requirements for customer information and identification programs. At this time, the Company is not able to predict the impact of such law on its financial condition or results of operations. Sarbanes-Oxley Act of 2002. On July 30, 2002, President Bush signed into law the Sarbanes-Oxley Act of 2002 (the "Sarbanes-Oxley Act"). The stated goals of the Sarbanes-Oxley Act are to increase corporate responsibility, to provide for enhanced penalties for accounting and auditing improprieties at publicly traded companies and to protect investors by improving the accuracy and reliability of corporate disclosures pursuant to the securities laws. The Sarbanes-Oxley Act is the most far-reaching U.S. securities legislation enacted in some time. The Sarbanes-Oxley Act generally applies to all companies, both U.S. and non-U.S., that file or are required to file periodic reports with the SEC under the Securities Exchange Act of 1934 (the "Exchange Act"). Given the extensive SEC role in implementing rules relating to many of the Sarbanes-Oxley Act's new requirements, the final scope of these requirements remains to be determined. The Sarbanes-Oxley Act includes very specific additional disclosure requirements and new corporate governance rules, requires the SEC and securities exchanges to adopt extensive additional disclosure, corporate governance and other related rules and mandates further studies of certain issues by the SEC. The Sarbanes-Oxley Act represents significant federal involvement in matters traditionally left to state regulatory systems, such as the regulation of the accounting profession, and to state corporate law, such as the relationship between a board of directors and management and between a board of directors and its committees. The Sarbanes-Oxley Act addresses, among other matters: - audit committees for all reporting companies; - certification of financial statements by the chief executive officer and the chief financial officer; - the forfeiture of bonuses or other incentive-based compensation and profits from the sale of an issuer's securities by directors and senior officers in the twelve month period following initial publication of any financial statements that later require restatement; - a prohibition on insider trading during pension plan black-out periods; - disclosure of off-balance sheet transactions; - a prohibition on personal loans to directors and officers; - expedited filing requirements for Form 4's; - disclosure of a code of ethics, if applicable, and filing a Form 8-K for a change or waiver of such code; - "real time" filing of periodic reports; - the formation of a public accounting oversight board; - auditor independence; and - various increased criminal penalties for violations of securities laws. The Sarbanes-Oxley Act contains provisions which became effective upon enactment on July 30, 2002, and provisions which will become effective from within 30 days to one year from enactment. The SEC has 6 been delegated the task of enacting rules to implement various provisions with respect to, among other matters, disclosure in periodic filings pursuant to the Exchange Act. Regulation W. Transactions between a bank and its "affiliates" are quantitatively and qualitatively restricted under the Federal Reserve Act. The Federal Deposit Insurance Act applies Sections 23A and 23B to insured nonmember banks in the same manner and to the same extent as if they were members of the Federal Reserve System. The Federal Reserve Board has also recently issued Regulation W, which codifies prior regulations under Sections 23A and 23B of the Federal Reserve Act and interpretative guidance with respect to affiliate transactions. Affiliates of a bank include, among other entities, the bank's holding company and companies that are under common control with the bank. The Company is considered to be an affiliate of the Bank. In general, subject to certain specified exemptions, a bank or its subsidiaries are limited in their ability to engage in "covered transactions" with affiliates: - to an amount equal to 10% of the bank's capital and surplus, in the case of covered transactions with any one affiliate; and - to an amount equal to 20% of the bank's capital and surplus, in the case of covered transactions with all affiliates. In addition, a bank and its subsidiaries may engage in certain transactions only on terms and under circumstances that are substantially the same, or at least as favorable to the bank or its subsidiary, as those prevailing at the time for comparable transactions with nonaffiliated companies. Safety and Soundness Standards. The Financial Institutions Reform, Recovery and Enforcement Act of 1989 ("FIRREA") expanded the Federal Reserve Board's authority to prohibit activities of bank holding companies and their non-banking subsidiaries which represent unsafe and unsound banking practices or which constitute violations of laws or regulations. Notably, FIRREA increased the amount of civil money penalties that the Federal Reserve Board can assess for certain activities conducted on a knowing and reckless basis, if those activities cause a substantial loss to a depository institution. The penalties can be as high as $1 million per day. FIRREA also expanded the scope of individuals and entities against which such penalties may be assessed. On July 10, 1995, the four federal agencies that regulate banks and savings associations (FDIC, Federal Reserve Board, the Office of the Comptroller of the Currency and the Office of Thrift Supervision) jointly issued guidelines for safe and sound banking operations (Interagency Guidelines Establishing Standards for Safety and Soundness) as required by Section 132 of the Federal Deposit Insurance Corporation Improvement Act ("FDICIA"). The guidelines identify the fundamental standards that the four agencies follow when evaluating the operational and managerial controls at insured institutions. An institution's performance will be evaluated against these standards during the regulators' periodic on-site examinations. Dividend Restrictions. It is the policy of the Federal Reserve Board that bank holding companies should pay cash dividends on common stock only out of income available over the past year and only if prospective earnings retention is consistent with the organization's expected future needs and financial condition. The policy provides that bank holding companies should not maintain a level of cash dividends that undermines the bank holding company's ability to serve as a source of strength to its banking subsidiaries. Under Federal Reserve Board policy, a bank holding company is expected to act as a source of financial strength to each of its banking subsidiaries and commit resources to their support. Such support may be required at times when, absent this Federal Reserve Board policy, a bank holding company may not be inclined to provide it. Capital Adequacy Requirements. The Federal Reserve Board monitors the capital adequacy of bank holding companies. The Federal Reserve Board has adopted a system using risk-based capital adequacy guidelines to evaluate the capital adequacy of bank holding companies. Under the risk-based capital guidelines, different categories of assets are assigned different risk weights, based generally on the perceived credit risk of the asset. These risk weights are multiplied by corresponding asset balances to determine a "risk-related" asset base. Certain off balance sheet items are added to the risk-weighted asset base by converting 7 them to a balance sheet equivalent and assigning to them the appropriate risk weight. In addition, the guidelines define each of the capital components. Total capital is defined as the sum of "core capital elements" ("Tier 1") and "supplemental capital elements" ("Tier 2"), with "Tier 2" being limited to 100% of "Tier 1." For bank holding companies, "Tier 1" capital includes, with certain restrictions, common shareholders' equity, perpetual preferred stock, and minority interest in consolidated subsidiaries. "Tier 2" capital includes, with certain limitations, certain forms of perpetual preferred stock, as well as maturing capital instruments and the reserve for credit losses. The guidelines require achievement of a minimum ratio of total capital-to-risk-weighted assets of 8.0% (of which at least 4.0% is required to be comprised of "Tier 1" capital elements). At December 31, 2002, the Company's ratios of "Tier 1" and "Total" capital-to-risk-weighted assets were 8.41%, and 9.29%, respectively. In addition to the risk-based capital guidelines, the Federal Reserve Board and the FDIC have adopted the use of a minimum "Tier 1" leverage ratio as an additional tool to evaluate the capital adequacy of banks and bank holding companies. The banking organization's "Tier 1" leverage ratio is defined to be a company's "Tier 1" capital divided by its average total consolidated assets. Certain highly rated bank holding companies may maintain a minimum leverage ratio of 3.0% "Tier 1" capital to total assets but other bank holding companies are required to maintain a leverage ratio of 4.0% to 5.0%. The Company's leverage ratio at December 31, 2002 of 7.81% significantly exceeded the regulatory minimum. Imposition of Liability for Undercapitalized Subsidiaries. A bank holding company that fails to meet the applicable risk-based capital standards will be at a disadvantage. For example, Federal Reserve Board policy discourages the payment of dividends by a bank holding company from borrowed funds as well as payments that would adversely affect capital adequacy. Failure to meet the capital guidelines may result in the institution of supervisory or enforcement actions by the Federal Reserve Board. FDICIA requires bank regulators to take "prompt corrective action" to resolve problems associated with insured depository institutions whose capital declines below certain levels. Acquisitions by Bank Holding Companies. The BHCA requires a bank holding company to obtain the prior approval of the Federal Reserve Board before it acquires all or substantially all of the assets of any bank, or ownership or control of any voting shares of any bank, if after such acquisition it would own or control, directly or indirectly, more than 5% of the voting shares of such bank. In approving bank acquisitions, the Federal Reserve Board considers the financial and managerial resources and future prospects of the bank holding company and the banks concerned, the convenience and needs of the communities to be served, and various competitive factors. The Attorney General of the United States may, within 30 days after approval of an acquisition by the Federal Reserve Board, bring an action challenging such acquisition under the federal antitrust laws, in which case the effectiveness of such approval is stayed pending a final ruling by the courts. Community Reinvestment Act. The Community Reinvestment Act of 1977 ("CRA") and the regulations promulgated by the FDIC to implement CRA are intended to ensure that banks meet the credit needs of their service area, including low and moderate income communities and individuals, consistent with safe and sound banking practices. The CRA regulations also require the banking regulatory authorities to evaluate a bank's record in meeting the needs of its service area when considering applications to establish new offices or consummate any merger or acquisition transaction. Under FIRREA, the federal banking agencies are required to rate each insured institution's performance under CRA and to make such information publicly available. In the case of an acquisition by a bank holding company, the CRA performance records of the banks involved in the transaction are reviewed as part of the processing of the acquisition application. A CRA rating other than "outstanding" or "satisfactory" can substantially delay or block a transaction. Based upon its most recent examination, Sterling Bank has a satisfactory CRA rating. Interstate Banking. The Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 (the "Interstate Branching Act") increased the ease and likelihood of interstate branching throughout much of the United States. The Interstate Branching Act removes state law barriers to acquisitions in all states and allows multi-state banking operations to merge into a single bank with interstate branches. Interstate banking and branching authority will be subject to certain conditions and restrictions, such as capital adequacy, management and CRA compliance. The Interstate Branching Act preempts existing barriers that restrict 8 entry into all states, such as regional compacts and reciprocal agreements, thus creating opportunities for expansion into markets that were previously closed. Under the Interstate Branching Act, bank holding companies are now able to acquire banks in any state, subject to certain conditions. Banks acquired pursuant to this authority may subsequently be converted to branches. Interstate branching is permitted by allowing banks to merge across state lines to form a single institution. Interstate merger transactions can be used to consolidate existing multi-state operations or to acquire new branches. A bank may establish a new branch as its initial entry into a state only if the state has authorized de novo branching. In addition, out-of-state banks may merge with a single branch of a bank if the state has authorized such a transaction. The Federal Reserve Board, however, will only allow the acquisition by a bank holding company of an interest in any bank located in another state if the statutory laws of the state in which the target bank is located expressly authorize such acquisitions. The interstate branching provisions became effective on June 1, 1997, unless a state took action before that time. Texas elected to "opt out" of the Interstate Branching Act. Despite Texas' having opted out of the Interstate Branching Act, the Texas Banking Act permits, in certain circumstances, out-of-state bank holding companies to acquire certain existing banks and bank holding companies in Texas. STERLING BANK Sterling Bank is a Texas-chartered banking association. The Bank's deposits are insured, up to applicable limits, by the Bank Insurance Fund of the FDIC. Therefore, the Banks are subject to supervision and regulation by both the Texas Department of Banking and the FDIC. Pursuant to such regulation, the Bank may be subject to special restrictions, supervisory requirements and potential enforcement actions. Sterling Bank is not a member of the Federal Reserve System; however, the Federal Reserve Board also has supervisory authority that directly affects the Bank. Sterling Bank is a member of the Federal Home Loan Bank and, therefore, is also subject to compliance with its requirements. Permissible Activities for State-Chartered Institutions. The Texas Constitution provides that a Texas-chartered bank has the same rights and privileges that are or may be granted to national banks domiciled in Texas. To the extent that the Texas laws and regulations may have allowed state-chartered banks to engage in a broader range of activities than national banks, FDICIA has operated to limit this authority. FDICIA provides that no state bank or subsidiary thereof may engage as principal in any activity not permitted for national banks, unless the institution complies with applicable capital requirements and the FDIC determines that the activity poses no significant risk to the Bank Insurance Fund ("BIF"). Branching. Texas law provides that a Texas-chartered bank can establish a branch anywhere in Texas provided that the branch is approved in advance by the Commissioner of the Texas Department of Banking (the "Commissioner"). The branch must also be approved by the FDIC, which considers a number of factors, including financial history, capital adequacy, earnings prospects, character of management, needs of the community, and consistency with corporate powers. There are no federal limitations on the ability of insured non-member state banks to branch across state lines; however, such branching would be subject to applicable state law restrictions. Restrictions on Transactions with Affiliates and Insiders. Transactions between the Bank and its nonbanking subsidiaries, including the Company, are subject to Section 23A of the Federal Reserve Act. In general, Section 23A imposes limits on the amount of such transactions, and also requires certain levels of collateral for loans to affiliated parties. It also limits the amount of advances to third parties which are collateralized by the securities or obligations of the Company or its subsidiaries. Affiliate transactions are also subject to Section 23B of the Federal Reserve Act which generally requires that certain transactions between the Bank and its affiliates be on terms substantially the same, or at least as favorable to the Bank, as those prevailing its time for comparable transactions with or involving other non-affiliated persons. The restrictions on loans to directors, executive officers, principal shareholders and their related interests (collectively, the "insiders") contained in the Federal Reserve Act and Regulation O apply to all insured institutions and their subsidiaries and holding companies. These restrictions include limits on loans to one borrower and conditions that must be met before such a loan can be made. There is also an aggregate 9 limitation on all loans to insiders and their related interests. These loans cannot exceed the institution's total unimpaired capital and surplus, and the FDIC may determine that a lesser amount is appropriate. Insiders are subject to enforcement actions for knowingly accepting loans in violation of applicable restrictions. Capital Adequacy Requirements. The Bank is subject to the capital adequacy requirements promulgated by the FDIC and the Texas Department of Banking. The FDIC has adopted regulations establishing minimum requirements for the capital adequacy of insured institutions. The FDIC may establish higher minimum requirements if, for example, a bank has previously received special attention or has a high susceptibility to interest rate risk. The FDIC's risk-based capital guidelines generally require state banks to have a minimum ratio of Tier 1 capital to total risk-weighted assets of 4.0% and a ratio of total capital to total risk-weighted assets of 8.0%. As of December 31, 2002, the Bank's ratio of Tier 1 capital to total risk-weighted assets was 8.94% and its ratio of total capital to total risk-weighted assets was 9.82%. See "Management's Discussion and Analysis of Financial Condition and Result of Operation -- Financial Condition -- Capital Resources." The FDIC's leverage guidelines require state banks to maintain Tier 1 capital of no less than 4.0% of average total assets, except in the case of certain highly rated banks for which the requirement is 3.0% of average total assets. The Texas Banking Department has issued a policy which generally requires state chartered banks to maintain a leverage ratio (defined in accordance with federal capital guidelines) of 6.0%. As of December 31, 2002, the Bank's ratio of Tier 1 capital to average total assets (leverage ratio) was 8.31%. Corrective Measures for Capital Deficiencies. The federal banking regulators are required to take "prompt corrective action" with respect to capital-deficient institutions. Agency regulations define, for each capital category, the levels at which institutions are "well capitalized," "adequately capitalized," "under capitalized," "significantly under capitalized" and "critically under capitalized." A "well capitalized" bank has a total risk-based capital ratio of 10.0% or higher; a Tier 1 risk-based capital ratio of 6.0% or higher, a leverage ratio of 5.0% or higher; and is not subject to any written agreement, order or directive requiring it to maintain a specific capital ratio for any capital measure. An "adequately capitalized" bank has a total risk- based capital ratio of 8.0% or higher; a Tier 1 risk-based capital ratio of 4.0% or higher; a leverage ratio of 4.0% or higher (3.0% or higher if the bank was rated a composite 1 in its most recent examination report and is not experiencing significant growth); and does not meet the criteria for a well capitalized bank. A bank is "under capitalized" if it fails to meet any one of the ratios required to be adequately capitalized. As of December 31, 2002, the Bank was classified as "adequately capitalized" for purposes of the FDIC's prompt corrective action regulations. In addition to requiring undercapitalized institutions to submit a capital restoration plan, agency regulations contain broad restrictions on certain activities of undercapitalized institutions including asset growth, acquisition, branch establishment and expansion into new lines of business. With certain exceptions, an insured depository institution is prohibited from making capital distributions, including dividends, and is prohibited from paying management fees to control persons if the institution would be undercapitalized after any such distribution or payment. As an institution's capital decreases, the FDIC's enforcement powers become more severe. A significantly undercapitalized institution is subject to mandated capital raising activities, restrictions on interest rates paid and transactions with affiliates, removal of management and other restrictions. The FDIC has only very limited discretion in dealing with a critically undercapitalized institution and is virtually required to appoint a receiver or conservator. Banks with risk-based capital and leverage ratios below the required minimums may also be subject to certain administrative actions, including the termination of deposit insurance upon notice and hearing, or a temporary suspension of insurance without a hearing in the event the institution has no tangible capital. Brokered Deposit Restrictions. FIRREA and FDICIA generally limit institutions which are not well capitalized from accepting brokered deposits. In general, undercapitalized institutions may not solicit, accept or renew brokered deposits. Adequately capitalized institutions may not solicit, accept or renew brokered deposits unless they obtain a waiver from the FDIC. Even in that event, the institution must comply with rate 10 limitations imposed by the FDI Act. At December 31, 2002, the most recent report filed by the Bank categorized it as "adequately capitalized." The Bank has received a waiver from the FDIC permitting it to solicit, accept or renew brokered deposits through June 30, 2003; however, the waiver may be revoked by the FDIC at any time. Restrictions on Subsidiary Banks. Dividends paid by the Bank provided substantially all of the Company's cash flow during 2002 and will continue to do so in the foreseeable future. Under federal law, the Bank may not pay a dividend that results in an "undercapitalized" situation. At December 31, 2002, there was an aggregate of approximately $67.2 million available for the payment of dividends by the Bank to the Company without prior regulatory approval. Other requirements in Texas law affecting the operation of subsidiary banks include requirements relating to maintenance of reserves against deposits, restrictions on the nature and amount of loans that may be made and the interest that may be charged thereon and limitations relating to investments and other activities. Examinations. The FDIC periodically examines and evaluates insured banks. FDIC examinations are conducted every 12 months. The FDIC may, however, accept the result of a Texas Department of Banking examination in lieu of conducting an independent examination. FDICIA authorizes the FDIC to assess the institution for its costs of conducting the examinations. The Commissioner also conducts examinations annually, unless additional examinations are deemed necessary to safeguard the interests of shareholders, depositors and creditors. The Commissioner may accept the results of a federal examination in lieu of conducting an independent examination. However, since the total assets of the Bank exceed $1 billion, the FDIC and the Texas Department of Banking jointly examine the Bank on an annual basis. Audit Reports. Insured institutions with total assets of $500 million must submit annual audit reports prepared by independent auditors to federal and state regulators. In some instances, the audit report of the institution's holding company can be used to satisfy this requirement. Auditors must receive examination reports, supervisory agreements and reports of enforcement actions. In addition, financial statements prepared in accordance with generally accepted accounting principles, management's certifications concerning responsibility for the financial statements, internal controls and compliance with legal requirements designated by the FDIC, and an attestation by the auditor regarding the statements of management relating to the internal controls must be submitted. For certain institutions with total assets of more than $3 billion, independent auditors may be required to review quarterly financial statements. FDICIA requires that independent audit committees be formed, consisting solely of outside directors. The committees of such institutions must include members with experience in banking or financial management, must have access to outside counsel, and must not include representatives of large customers. The Company has an audit committee comprised solely of outside directors with at least one certified public accountant and, therefore, is in compliance with the requirements for large institutions. Deposit Insurance Assessments. The FDIC assesses deposit insurance premiums on all banks in order to adequately fund the BIF so as to resolve any insured institution that is declared insolvent by its primary regulator. The FDIC has established a risk-based deposit insurance premium system to calculate a depository institution's semi-annual deposit insurance assessment. The FDIC's semi-annual assessment is based upon the designated reserve ratio for the deposit insurance fund and the probability and extent to which the deposit insurance fund will incur a loss with respect to the institution. In addition, the FDIC can impose special assessments to cover the cost of borrowings from the U.S. Treasury, the Federal Financing Bank, and BIF member banks. The FDIC established a process for raising or lowering all rates for insured institutions semi-annually if conditions warrant a change. Under this new system, the FDIC has the flexibility to adjust the assessment rate schedule twice a year without seeking prior public comment, but only within a range of five cents per $100 above or below the premium schedule adopted. The FDIC can make changes in the rate schedule outside the five-cent range above or below the current schedule only after a full rulemaking with opportunity for public comment. 11 In 1996, a law was passed that contained a comprehensive approach to recapitalizing the Savings Association Insurance Fund ("SAIF") and to assure the payment of the Financing Corporation's ("FICO") bond obligations. Under this act, banks insured under the BIF are required to pay a portion of the interest due on bonds that were issued by FICO to help shore up the ailing Federal Savings and Loan Insurance Corporation in 1987. With regard to the assessment for the FICO obligation, the current BIF and SAIF rate is .0168% of deposits. Expanding Enforcement Authority. One of the major additional impacts imposed on the banking industry by FDICIA is the increased ability of banking regulators to monitor the activities of banks and their holding companies. In addition, the Federal Reserve Board and FDIC have extensive authority to police unsafe or unsound practices and violations of applicable laws and regulations by depository institutions and their holding companies. For example, the FDIC may terminate the deposit insurance of any institution which it determines has engaged in an unsafe or unsound practice. The agencies can also assess civil money penalties, issue cease and desist or removal orders, seek injunctions, and publicly disclose such actions. FDICIA, FIRREA and other laws have expanded the agencies' authority in recent years, and the agencies have not yet fully tested the limits of their powers. Effect on Economic Environment. The policies of regulatory authorities, including the monetary policy of the Federal Reserve Board, have a significant effect on the operating results of bank holding companies and their subsidiaries. Among the means available to the Federal Reserve Board to affect the money supply are open market operations in U.S. government securities, changes in the discount rate on member bank borrowings and changes in reserve requirements against member bank deposits. These means are used in varying combinations to influence overall growth and distribution of bank loans, investments and deposits, and their use may affect interest rates charged on loans or paid for deposits. Federal Reserve Board monetary policies have materially affected the operating results of commercial banks in the past and are expected to continue to do so in the future. The nature of future monetary policies and the effect of such policies on the business and earnings of the Company and its subsidiaries cannot be predicted. Consumer Laws and Regulations. In addition to the banking laws and regulations discussed above, banks are also subject to certain consumer laws and regulations that are designed to protect consumers in transactions with banks. Among the more prominent of such laws and regulations are the Truth in Lending Act, the Truth in Savings Act, the Electronic Funds Transfer Act, the Expedited Funds Availability Act, the Equal Credit Opportunity Act, the Fair Credit Reporting Act, and the Fair Housing Act. These laws and regulations mandate certain disclosure requirements and regulate the manner in which financial institutions must deal with customers when taking deposits or making loans to such customers. The Bank must comply with the applicable provisions of these consumer protection laws and regulations as part of their ongoing customer relations. Also, see discussion of the consumer privacy protection provision of the Gramm-Leach-Bliley Act under the "Recently Enacted Legislative and Regulatory Changes" caption above. MORTGAGE COMPANY SCMC is an approved GNMA issuer of mortgage-backed securities. SCMC is also an approved FNMA and FHLMC seller/servicer and a HUD-Approved Title II nonsupervised mortgagee. As such, SCMC must operate under certain guidelines set forth by GNMA, FNMA, FHLMC and HUD. As a majority owned subsidiary of a bank holding company, SCMC is also subject to the regulatory authority of the FDIC, the Texas Department of Banking and the Federal Reserve Board. 12 ITEM 2 -- PROPERTIES The principal executive offices of the Company and the Bank are located at 2550 North Loop West, Suite 600, Houston, Texas, 77092, in spaced leased by the Company. In addition to its principal office, the Company operates the following locations:
OWNED LEASED TOTAL ----- ------ ----- Banking offices in the Houston metropolitan area............ 17 12 29 Banking offices in the San Antonio metropolitan area........ 2 3 5 Banking offices in the South Texas.......................... 4 -- 4 Banking offices in the Dallas metropolitan area............. 1 1 2 Central department offices.................................. 1 3 4 Mortgage production offices Arizona................................................... -- 10 10 Colorado.................................................. -- 2 2 California................................................ -- 19 19 Florida................................................... -- 1 1 Hawaii.................................................... -- 1 1 Illinois.................................................. -- 1 1 Kansas.................................................... -- 1 1 Kentucky.................................................. -- 1 1 Louisiana................................................. -- 1 1 Missouri.................................................. -- 1 1 Nevada.................................................... -- 3 3 Oregon.................................................... -- 4 4 Texas..................................................... -- 21 21 Virginia.................................................. -- 1 1 Washington................................................ -- 6 6 -- -- --- Total.................................................. 25 92 117 == == ===
ITEM 3 -- LEGAL PROCEEDINGS From time to time, the Bank is a party to various legal proceedings incident to its business. Currently, neither the Company nor any of its subsidiaries is involved in any material legal proceedings. ITEM 4 -- SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS None. 13 PART -- II ITEM 5 -- MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED SHAREHOLDER MATTERS The Company's stock trades through The Nasdaq National Market under the symbol "SBIB." The following table sets forth the high and low closing stock prices of the Company's common stock, as quoted on The Nasdaq National Market, and the dividends paid thereon for each quarter of the last two fiscal years. This information has been restated to reflect all stock splits occurring prior to the issuance of this report.
HIGH LOW DIVIDEND ------ ------ -------- 2002 First quarter.......................................... $14.41 $12.36 $0.04000 Second quarter......................................... 15.09 12.69 $0.04000 Third quarter.......................................... 15.30 12.65 $0.04000 Fourth quarter......................................... 13.50 10.60 $0.04000 2001 First quarter.......................................... $14.00 $10.83 $0.03667 Second quarter......................................... 12.79 11.08 $0.03667 Third quarter.......................................... 15.65 12.34 $0.03667 Fourth quarter......................................... 13.47 11.56 $0.03667
On January 27, 2003, the Company's Board of Directors declared a quarterly cash dividend of $0.045 per share payable on February 21, 2003, to shareholders of record on February 7, 2003. The Company intends to continue to pay a dividend at the rate of $0.045 per share quarterly throughout 2003. On July 24, 2001, the Company's Board of Directors declared a three-for-two stock split to be effected in the form of a stock dividend on its common stock to shareholders of record on September 4, 2001. Cash paid in lieu of fractional shares was based on the average of the high and low bids on the record date, as adjusted for the split. The payment date for the stock dividend was September 18, 2001. As of February 7, 2003, the Company estimates that there were 1,053 shareholders of record of common stock. The number of beneficial shareholders is unknown to the Company at this time. For information on the ability of the Bank to pay dividends and make loans to the Company, see "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Financial Condition -- Interest Rate Sensitivity and Liquidity" and Note U of the consolidated financial statements. ITEM 6 -- SELECTED FINANCIAL DATA The following table sets forth summary historical data for the Company for the periods indicated. During the periods indicated, the Company completed seven acquisitions of bank holding companies and/or banks in merger transactions that were accounted for using either the purchase method of accounting or the "pooling of interests" method of accounting. With respect to the four mergers completed during the reported periods which were accounted for using the "pooling of interests" method, all financial data relating to such entities prior to the respective mergers have been restated to include the merged entities' balance sheet data and 14 historical results of operations. In addition, data has been restated to reflect the effect of stock splits where applicable.
YEAR ENDED DECEMBER 31, -------------------------------------------------------------- 2002 2001 2000 1999 1998 ---------- ---------- ---------- ---------- ---------- (IN THOUSANDS, EXCEPT FOR PER SHARE AMOUNTS) SUMMARY OF INCOME: Interest income.................. $ 176,391 $ 170,418 $ 166,523 $ 129,291 $ 115,586 Interest expense................. 29,719 47,257 62,824 37,470 34,600 ---------- ---------- ---------- ---------- ---------- Net interest income.............. 146,672 123,161 103,699 91,821 80,986 Provision for credit losses...... 14,018 11,684 9,668 9,236 6,275 Noninterest income............... 94,510 64,762 41,642 30,632 23,014 Noninterest expense.............. 172,352 128,523 95,492 81,778 69,699 ---------- ---------- ---------- ---------- ---------- Income from continuing operations before income taxes............ 54,812 47,716 40,181 31,439 28,026 Provision for income taxes from continuing operations.......... 18,139 16,731 12,641 9,803 9,116 ---------- ---------- ---------- ---------- ---------- Income from continuing operations..................... 36,673 30,985 27,540 21,636 18,910 ---------- ---------- ---------- ---------- ---------- Loss from discontinued operations before income taxes............ (183) (905) -- -- -- Provision for income taxes from discontinued operations........ (61) (321) -- -- -- ---------- ---------- ---------- ---------- ---------- Loss from discontinued operations..................... (122) (584) -- -- -- ---------- ---------- ---------- ---------- ---------- Net income....................... $ 36,551 $ 30,401 $ 27,540 $ 21,636 $ 18,910 ========== ========== ========== ========== ========== COMMON SHARE DATA: Basic earnings per share......... $ 0.83 $ 0.72 $ 0.66 $ 0.52 $ 0.47 Diluted earnings per share....... $ 0.82 $ 0.71 $ 0.65 $ 0.51 $ 0.46 Cash dividends declared.......... $ 0.160 $ 0.147 $ 0.133 $ 0.120 $ 0.107 Book value per share at period-end..................... $ 5.65 $ 4.96 $ 3.98 $ 3.40 $ 2.98 Tangible book value per share at period-end..................... $ 4.26 $ 3.70 $ 3.84 $ 3.25 $ 2.83 Weighted average common shares... 43,872 42,180 41,596 41,422 39,830 Weighted average common and common equivalent shares....... 44,756 43,044 42,212 42,218 41,276 BALANCE SHEET DATA (at period-end): Total assets..................... $3,582,745 $2,778,090 $2,077,214 $2,060,112 $1,591,284 Loans, net of unearned discount....................... 2,611,866 1,897,645 1,484,990 1,261,273 1,079,657 Allowance for credit losses...... 27,621 22,927 16,862 13,998 11,352 Total securities................. 313,054 329,416 295,392 528,743 263,682 Deposits......................... 2,532,902 2,138,601 1,718,822 1,508,789 1,410,076 Other borrowed funds............. 509,590 180,298 140,364 362,332 15,333 Notes payable.................... 21,430 20,879 1,600 -- 2,069 Company-obligated mandatorily redeemable trust preferred securities of subsidiary trust.......................... 80,000 57,500 28,750 28,750 28,750 Shareholders' equity............. 249,327 217,369 166,825 141,070 122,040
15
YEAR ENDED DECEMBER 31, -------------------------------------------------------------- 2002 2001 2000 1999 1998 ---------- ---------- ---------- ---------- ---------- (IN THOUSANDS, EXCEPT FOR PER SHARE AMOUNTS) SELECTED PERFORMANCE RATIOS: Return on average assets......... 1.21% 1.24% 1.32% 1.26% 1.25% Return on average shareholders' equity......................... 15.44% 16.58% 17.82% 16.37% 17.02% Dividend payout ratio............ 19.24% 19.45% 19.04% 20.85% 21.71% Net interest margin (tax equivalent).................... 5.66% 5.88% 5.61% 6.05% 6.02% ASSET QUALITY RATIOS: Period-end nonperforming loans to total loans.................... 0.75% 0.75% 0.65% 0.48% 0.51% Period-end nonperforming assets to total assets................ 0.64% 0.58% 0.55% 0.37% 0.49% Period-end allowance for credit losses to nonperforming loans.......................... 140.54% 161.51% 175.74% 229.89% 207.53% Period-end allowance for credit losses to total loans.......... 1.06% 1.21% 1.14% 1.11% 1.05% Net charge-offs to average loans.......................... 0.46% 0.50% 0.51% 0.59% 0.38% LIQUIDITY AND CAPITAL RATIOS: Average loans to average deposits....................... 96.89% 88.39% 83.34% 77.70% 74.37% Period-end shareholders' equity to total assets................ 6.96% 7.82% 8.03% 6.85% 7.67% Average shareholders' equity to average assets................. 7.83% 7.50% 7.41% 7.70% 7.36% Period-end Tier 1 capital to risk weighted assets................ 8.41% 9.64% 10.51% 10.82% 11.56% Period-end total capital to risk weighted assets................ 9.29% 10.66% 11.26% 11.74% 12.45% Period-end Tier 1 leverage ratio (Tier 1 capital to total average assets)................ 7.81% 8.40% 9.10% 8.21% 9.39%
ITEM 7 -- MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS "Management's Discussion and Analysis of Financial Condition and Results of Operations" of the Company analyzes the major elements of the Company's consolidated balance sheets and statements of income. This section should be read in conjunction with the Company's consolidated financial statements and accompanying notes and other detailed information incorporated by reference. During the periods indicated, the Company completed seven acquisitions of bank holding companies and/or banks in merger transactions that were accounted for using either the purchase method of accounting or the "pooling of interests" method of accounting. With respect to the four mergers completed during the reported periods which were accounted for using the "pooling of interests" method, all financial data relating to such entities to the respective mergers have been restated to include the merged entities' balance sheet data and historical results of operations. In 2002, the Company entered into two separate agreements for the sale of four banking offices in South Texas. Revenues, operating costs and expenses, and other non-operating results from the discontinued operations of the four banking offices are excluded from the Company's results from continuing operations for 2002. Alternatively, the financial results are presented in the Company's Consolidated Balance Sheets in line 16 items entitled "Assets related to discontinued operations" and "Liabilities related to discontinued operations;" the Consolidated Statements of Income under line items "Loss from discontinued operations before income taxes" and "Loss from discontinued operations;" and, Consolidated Statements of Cash Flows as "Net cash provided by (used in) discontinued operations." See further discussion of discontinued operations in Note J to the consolidated financial statements in this annual report. Certain statements under this caption constitute "forward-looking statements" within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, which involve risks and uncertainties. Our actual results may differ significantly from the results discussed in such forward-looking statements. Factors that might cause such a difference include, but are not limited to, those factors discussed in "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Risk Factors and Cautionary Statement for Purposes of the Provisions of the 'Safe Harbor' Provisions of the Private Securities Litigation Reform Act of 1995" below. CRITICAL ACCOUNTING ESTIMATES The Company's accounting policies are integral to understanding the results reported. Accounting policies are described in detail in Note A to the consolidated financial statements in this annual report. The Company believes that of its significant accounting policies, the allowance for credit losses may involve a higher degree of judgment and complexity Allowance for Credit Losses -- The allowance for credit losses is a valuation allowance for probable losses incurred on loans. Loans are charged to the allowance when the loss actually occurs or when a determination is made that a probable loss has occurred. Recoveries are credited to the allowance at the time of recovery. Throughout the year, management estimates the probable level of losses to determine whether the allowance for credit losses is adequate to absorb losses in the existing portfolio. Based on these estimates, an amount is charged to the provision for credit losses and credited to the allowance for credit losses in order to adjust the allowance to a level determined to be adequate to absorb losses. Management's judgment as to the level of probable losses on existing loans involves the consideration of current economic conditions and their estimated effects on specific borrowers; an evaluation of the existing relationships among loans, potential credit losses and the present level of the allowance; results of examinations of the loan portfolio by regulatory agencies; and management's internal review of the loan portfolio. In determining the collectibility of certain loans, management also considers the fair value of any underlying collateral. The amount ultimately realized may differ from the carrying value of these assets because of economic, operating or other conditions beyond the Company's control. Please refer to the subsequent discussion of "Allowance for Credit Losses" below as well as Note A to the consolidated financial statements in this annual report for additional insight into management's approach and methodology in estimating the allowance for credit losses. RESULTS OF OPERATIONS PERFORMANCE SUMMARY Net income for 2002 was $36.6 million compared with $30.4 million in 2001, an increase of 20.2%. Diluted earnings per share were $.82 in 2002 and $.71 in 2001, an increase of 15.5%. Included in net income is the after-tax merger related charges of $631,000 in 2002 and $2.1 million in 2001. In addition to the merger costs, the Company incurred noncash expenses of $1.4 million in 2002 in relation to the prepayment of its 9.28% Trust Preferred Securities. Please refer to "Company-Obligated Mandatorily Redeemable Trust Preferred Securities" below. Net income for 2001 was $30.4 million or $.71 per diluted share. After-tax acquisition charges of $2.1 million, are included in net income. All per share amounts have been restated to reflect the stock splits effected as stock dividends through September 18, 2001. Two industry measures of the performance by a banking institution are its return on average assets and return on average equity. Return on average assets ("ROA") measures net earnings in relation to average total assets and indicates a company's ability to employ its resources profitably. During 2002, the Company's 17 ROA was 1.21%, as compared to 1.24% and 1.32% for 2001 and 2000, respectively. During 2002, the Company's return on equity was 15.44% compared to 16.58% and 17.82% for 2001 and 2000, respectively. NET INTEREST INCOME AND NET INTEREST MARGIN Net interest income represents the amount by which interest income on interest earning assets, including securities and loans, 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 earning assets and liabilities, combine to affect net interest income. Net interest income for 2002 was $146.7 million, up $23.5 million or 19.1% from $123.2 million for 2001. The growth in net interest income is primarily attributable to decreasing interest rates in 2001 and the 30.4% increase in average loans. The loan growth related to the acquisitions of ENB Bankshares, CaminoReal Bancshares and Community Bancshares was 5.2%. Since the Lone Star Bancorporation acquisition was accounted for using the "pooling of interests" accounting method, the financial data was restated to include Lone Star Bancorporation's balance sheet data and historical results of operations, and there is no loan growth separately attributable to the acquisition of Lone Star Bancorporation. The Federal Reserve Bank decreased the discount rate in the aggregate by 475 basis points in 2001 and 50 basis points in November of 2002. Consequently, the Bank's yields decreased in 2001 and 2002 as a result of the Bank lowering its prime rate in relation to the Federal Reserve decreases. While average earning assets increased 23.3%, the yield decreased 129 basis points from 8.03% in 2001 to 6.74% in 2002. As of December 31, 2002, average interest bearing liabilities were $1.7 billion, an increase of $317.6 million or 22.6% from December 31, 2001. Average interest bearing deposits increased 15.5%. The increase in average interest bearing deposits related to the acquisitions of ENB Bankshares, CaminoReal Bancshares and Community Bancshares was 6.6%. The cost of interest bearing liabilities decreased 164 basis points from 3.37% in 2001 to 1.73% in 2002. The Company's 5.66% tax equivalent net interest margin for 2002 decreased from the 5.88% recorded in 2001. Net interest income for 2001 was $123.2 million, up $19.5 million or 18.9% from $103.7 million for 2000. The growth in net interest income is primarily attributable to the 27.2% increase in average loans. Average earning assets increased 13.2% from 2000 to 2001. During the latter part of 2000, the Bank deleveraged its balance sheet resulting in a decrease in average securities of 30.2% from 2000 to 2001. The yield on interest earning assets decreased 86 basis points from 8.89% in 2000 to 8.03% in 2001. Additionally during 2000, the Board of Governors of the Federal Reserve System ("Federal Reserve") increased the discount rate a total of 100 basis points whereas in 2001, the Federal Reserve decreased the discount rate 11 times for a total of 475 basis points. The cost of interest bearing liabilities decreased 127 basis points from 4.64% in 2000 to 3.37% in 2001. This decrease in rates was due to a combination of the Federal Reserve rate decreases as well as the deleveraging of the balance sheet. For 2001, the tax equivalent net interest margin increased 27 basis points to 5.88% from 5.61% for 2000. 18 To provide a more in-depth analysis of net interest income, the following average balance sheets and net interest income analysis detail the contribution of interest earning assets to overall net interest income and the impact of the cost of funds:
YEAR ENDED DECEMBER 31, --------------------------------------------------------------------------------------------------- 2002 2001 2000 ------------------------------- ------------------------------- ------------------------------- AVERAGE AVERAGE AVERAGE AVERAGE AVERAGE AVERAGE BALANCE INTEREST YIELD BALANCE INTEREST YIELD BALANCE INTEREST YIELD ---------- -------- ------- ---------- -------- ------- ---------- -------- ------- (IN THOUSANDS) INTEREST EARNING ASSETS: Deposits in financial institutions............... $ 1,960 $ 106 5.41% $ 1,235 $ 79 6.40% $ 1,225 $ 74 6.04% Federal funds sold and securities purchased under agreements to resell....... 25,326 463 1.83% 74,229 3,578 4.82% 60,401 4,471 7.40% Trading assets.............. 114,752 4,540 3.96% 49,352 2,787 5.65% -- -- -- Securities (taxable)........ 242,004 13,957 5.77% 265,064 16,667 6.29% 400,815 27,214 6.79% Securities (non-taxable).... 66,509 2,890 4.35% 70,814 3,304 4.67% 80,282 3,503 4.36% Loans held for sale (taxable) (1).............. 407,055 27,660 6.80% 179,627 13,459 7.49% 84,736 7,301 8.62% Loans held for investment (taxable) (1).............. 1,754,650 126,505 7.21% 1,478,556 130,296 8.81% 1,245,621 123,902 9.95% Loans held for investment (non-taxable).............. 4,746 270 5.69% 3,435 248 7.22% 925 58 6.27% ---------- -------- ---- ---------- -------- ---- ---------- -------- ---- Total interest earning assets................... 2,617,002 176,391 6.74% 2,122,312 170,418 8.03% 1,874,005 166,523 8.89% NONINTEREST EARNING ASSETS: Cash and due from banks..... 90,851 84,106 68,710 Premises and equipment, net........................ 53,783 51,516 45,892 Other assets................ 245,661 168,966 114,381 Allowance for credit losses..................... (25,192) (20,296) (15,454) Assets related to discontinued operations.... 40,056 39,164 -- ---------- ---------- ---------- Total noninterest earning assets................... 405,159 323,456 213,529 ---------- ---------- ---------- Total assets............... $3,022,161 $2,445,768 $2,087,534 ========== ========== ========== INTEREST BEARING LIABILITIES: Demand and savings deposits................... $ 835,842 $ 7,940 0.95% $ 731,442 $ 16,010 2.19% $ 621,038 $ 19,879 3.20% Certificates and other time deposits................... 579,005 16,036 2.77% 493,244 24,251 4.92% 440,062 24,256 5.51% Other borrowed funds........ 284,965 4,946 1.74% 175,106 6,861 3.92% 293,556 18,653 6.35% Notes payable............... 20,985 797 3.80% 3,369 135 4.01% 416 36 8.65% ---------- -------- ---- ---------- -------- ---- ---------- -------- ---- Total interest bearing liabilities.............. 1,720,797 29,719 1.73% 1,403,161 47,257 3.37% 1,355,072 62,824 4.64% NONINTEREST BEARING LIABILITIES: Demand deposits............. 821,097 655,074 536,351 Other liabilities........... 39,627 20,795 12,772 Liabilities related to discontinued operations.... 134,351 130,563 -- ---------- ---------- ---------- Total noninterest bearing liabilities.............. 995,075 806,432 549,123 Trust preferred securities................. 69,620 52,853 28,750 Shareholders' equity........ 236,669 183,322 154,589 ---------- ---------- ---------- Total liabilities and shareholders' equity..... $3,022,161 $2,445,768 $2,087,534 ========== ========== ========== Net interest income and margin (2)................. $146,672 5.60% $123,161 5.80% $103,699 5.53% ======== ==== ======== ==== ======== ==== Net interest income and margin (tax-equivalent basis) (3)................. $148,243 5.66% $124,800 5.88% $105,133 5.61% ======== ==== ======== ==== ======== ====
- --------------- (1) Loan origination fees are considered adjustments to interest income. These fees aggregated $5,144,000, $2,776,000 and $2,232,000 for the years ended December 31, 2002, 2001 and 2000, respectively. Related loan origination costs are not separately allocated to loans, but are charged to non-interest expense. For the purpose of calculating loan yields, average loan balances include nonaccrual loans with no related interest income. (2) The net interest margin is equal to net interest income divided by average total interest earning assets. (3) In order to make pretax income and resultant yields on tax-exempt investments and loans comparable to those on taxable investments and loans, a tax-equivalent adjustment is made equally to interest income and income tax expense with no effect on after tax income. The tax equivalent adjustment has been computed using a federal income tax rate of 35%. 19 The following rate/volume analysis shows the portions of the net change in interest income due to changes in volume or rate. The changes in interest income due to both rate and volume in the analysis have been allocated to the volume or rate change in proportion to the absolute amounts of the change in each (in thousands):
2002 VS. 2001 INCREASE (DECREASE) 2001 VS. 2000 INCREASE (DECREASE) DUE TO CHANGES IN: DUE TO CHANGES IN: ----------------------------------- ----------------------------------- VOLUME RATE TOTAL VOLUME RATE TOTAL --------- ---------- ---------- --------- ---------- ---------- INTEREST EARNING ASSETS: Deposits in financial institutions.................... $ 39 $ (12) $ 27 $ 1 $ 4 $ 5 Federal funds sold and securities purchased under agreements to resell.......................... (894) (2,221) (3,115) 667 (1,560) (893) Trading assets.................... 2,587 (834) 1,753 2,787 -- 2,787 Securities (taxable).............. (1,330) (1,380) (2,710) (8,536) (2,011) (10,547) Securities (non-taxable).......... (187) (227) (414) (442) 243 (199) Loans held for sale (taxable)..... 15,454 (1,253) 14,201 7,110 (952) 6,158 Loans held for investment (taxable)....................... 19,906 (23,697) (3,791) 20,527 (14,133) 6,394 Loans held for investment (non- taxable)........................ 75 (53) 22 181 9 190 ------- -------- -------- ------- -------- -------- Total interest income............. 35,650 (29,677) 5,973 22,295 (18,400) 3,895 ------- -------- -------- ------- -------- -------- INTEREST BEARING LIABILITIES: Demand and savings deposits....... 992 (9,062) (8,070) 2,417 (6,286) (3,869) Certificates and other time deposits........................ 2,375 (10,590) (8,215) 2,615 (2,620) (5) Other borrowed funds.............. 1,907 (3,822) (1,915) (4,641) (7,151) (11,792) Notes payable..................... 669 (7) 662 118 (19) 99 ------- -------- -------- ------- -------- -------- Total interest expense............ 5,943 (23,481) (17,538) 509 (16,076) (15,567) ------- -------- -------- ------- -------- -------- Net interest income............... $29,707 $ (6,196) $ 23,511 $21,786 $ (2,324) $ 19,462 ======= ======== ======== ======= ======== ========
NONINTEREST INCOME The Company's noninterest income consists primarily of customer service fees, gains arising from the sale of mortgage loans and origination fees relating to mortgage loans. Noninterest income for 2002 totaled $94.5 million, an increase of $29.7 million or 45.9% over the $64.8 million in 2001. Noninterest income for 2001 totaled $64.8 million, an increase of $23.1 million or 55.5% over the $41.6 million in 2000. The following 20 table shows the breakout of noninterest income between commercial banking and mortgage banking for 2002, 2001 and 2000 (in thousands):
2002 2001 2000 -------------------------------- -------------------------------- -------------------------------- COMMERCIAL MORTGAGE COMMERCIAL MORTGAGE COMMERCIAL MORTGAGE BANKING BANKING COMBINED BANKING BANKING COMBINED BANKING BANKING COMBINED ---------- -------- -------- ---------- -------- -------- ---------- -------- -------- Customer service fees..... $15,209 $ -- $15,209 $13,245 $ -- $13,245 $10,832 $ -- $10,832 Gains on sale of mortgage loans................... -- 32,385 32,385 -- 24,206 24,206 -- 11,959 11,959 Origination fees.......... -- 23,641 23,641 -- 10,392 10,392 -- 5,892 5,892 Servicing fees............ -- 3,207 3,207 -- 1,051 1,051 -- 426 426 Bank-owned life insurance income.................. 2,084 -- 2,084 2,049 -- 2,049 1,888 -- 1,888 Debit card fees........... 1,327 -- 1,327 877 -- 877 223 -- 223 Gain on the sale of trading assets.......... 1,018 -- 1,018 298 -- 298 -- -- -- Gain on the sale of credit card loan portfolio..... -- -- -- -- -- -- 237 -- 237 Gain on the sale of land.................... -- -- -- -- -- -- 244 -- 244 Other..................... 7,859 7,780 15,639 6,318 6,326 12,644 6,422 3,519 9,941 ------- ------- ------- ------- ------- ------- ------- ------- ------- $27,497 $67,013 $94,510 $22,787 $41,975 $64,762 $19,846 $21,796 $41,642 ======= ======= ======= ======= ======= ======= ======= ======= =======
Commercial Banking Segment. For 2002, noninterest income from commercial banking was $27.5 million, as compared to $22.8 million for 2001, an increase of $4.7 million or 20.7%. During 2002, customer service fees increased $2.0 million or 14.8%, as a result of the acquisitions of Eagle National, Community and CaminoReal and the growth in deposit transaction accounts. The increase of $720,000 from the gain on trading assets is due to the trading department being established in the second quarter of 2001. Increased debit card usage caused the debit card fees to increase $450,000. In 2002, the Bank began selling the guaranteed portion of SBA loans resulting in a premium of $312,000 being recognized in 2002. Also in 2002, the Bank began selling fixed and variable annuity products and recorded income totaling $300,000 in 2002. Additionally, the Company sold the charter for Community Bank in June 2002 for $150,000. During 2001, customer service fees increased $2.4 million or 22.2%, primarily as a result of an overall increase in average demand and savings accounts of 26.2% from volume growth in deposit accounts and the acquisition of CaminoReal Bank. Also during the latter half of 2000, the Bank introduced its debit card. Fees related to the debit cards totaled $877,000 in 2001 as compared to $223,000 in 2000. In December 2000, the Bank sold land for a gain of $244,000. Finally, during the first quarter of 2000, the Bank sold its credit card portfolio to a correspondent bank for a net gain of $237,000. Mortgage Banking Segment. For 2002, noninterest income from the mortgage banking segment increased $25.0 million or 59.6% from $42.0 million for 2001 to $67.0 million in 2002. Income from the mortgage banking segment primarily consists of origination fees and gains on the sale of mortgage loans. The average length of time a mortgage loan is held in the portfolio of SCMC is approximately thirty days. During 2002, SCMC had $4.5 billion in loan fundings as compared to $2.6 billion in 2001. The increase in noninterest income and noninterest expense is mainly due to the favorable interest rate environment which led to increased loan refinancing and new loan activity and the opening of thirty-six new retail locations in 2002. For 2001, noninterest income from the mortgage banking segment increased $20.2 million or 92.6% from $21.8 million for 2000 to $42.0 in 2001. During 2001, SCMC had $2.6 billion in loan fundings as compared to $1.4 billion in 2000. The increase in noninterest income and noninterest expense is primarily due to the favorable interest rate environment which led to increased loan refinancing and new loan activity. In addition, new retail locations were opened in 2001. 21 NONINTEREST EXPENSE Noninterest expense for 2002 totaled $172.4 million, an increase of $43.8 million or 34.1% over the $128.5 million in 2001. Noninterest expense increased $33.0 million or 34.6% from $95.5 million in 2000 to $128.5 million in 2001. The following table shows the breakout of noninterest expense between commercial banking and mortgage banking for 2002, 2001 and 2000 (in thousands):
2002 2001 2000 -------------------------------- -------------------------------- -------------------------------- COMMERCIAL MORTGAGE COMMERCIAL MORTGAGE COMMERCIAL MORTGAGE BANKING BANKING COMBINED BANKING BANKING COMBINED BANKING BANKING COMBINED ---------- -------- -------- ---------- -------- -------- ---------- -------- -------- Salaries and employee benefits................ $ 61,705 $26,814 $88,519 $ 53,971 $13,916 $67,887 $44,660 $ 8,803 $53,463 Occupancy expenses........ 14,792 8,663 23,455 13,656 4,320 17,976 10,229 3,533 13,762 Mortgage servicing rights amortization and impairment.............. -- 13,150 13,150 -- 1,154 1,154 -- 252 252 Technology................ 5,001 676 5,677 5,030 288 5,318 3,851 122 3,973 Professional fees......... 4,165 536 4,701 2,960 237 3,197 2,117 246 2,363 Postage and delivery charges................. 2,162 1,119 3,281 1,965 528 2,493 1,476 325 1,801 Supplies.................. 1,342 1,388 2,730 1,442 514 1,956 1,391 428 1,819 Net losses and carrying costs of real estate acquired by foreclosure............. 481 -- 481 176 -- 176 284 -- 284 FDIC assessment........... 390 -- 390 470 -- 470 316 -- 316 Minority interest expense................. 5,916 842 6,758 4,716 2,273 6,989 2,668 752 3,420 Conversion costs related to acquisitions......... 822 -- 822 3,181 -- 3,181 -- -- -- Other..................... 16,610 5,778 22,388 14,354 3,372 17,726 11,791 2,248 14,039 -------- ------- -------- -------- ------- -------- ------- ------- ------- $113,386 $58,966 $172,352 $101,921 $26,602 $128,523 $78,783 $16,709 $95,492 ======== ======= ======== ======== ======= ======== ======= ======= =======
Commercial Banking Segment. For 2002, noninterest expenses related to commercial banking were $113.4 million, as compared to $101.9 million for 2001, an increase of $11.5 million or 11.2%. Salaries and employee benefits in the commercial banking segment for 2002 totaled $61.7 million, an increase of $7.7 million or 14.3% over $54.0 million for 2001. Increased salaries and employee benefits expenses related to the acquisitions of Eagle National, Community and CaminoReal offices since acquisition were $1.7 million. Also salaries increased due to the new banking office opened in San Antonio in June 2002, the new energy lending division established during the first quarter of 2002 and the trading department established in the second quarter of 2001. Salaries and employee benefits expenses including discontinued operations in the commercial banking segment for 2001 totaled $54.0 million, an increase of $9.3 million or 20.1% over $44.7 million for 2000. Increased salaries and employee benefits expenses related to the acquisition of the CaminoReal Bank offices since acquisition were $2.8 million. The increase is also attributable to the hiring of personnel for two de novo offices (Dallas and Deer Park) as well as new central departments such as internet banking, document imaging and community affairs. Additionally, medical insurance expense increased $1.2 million during 2001. Professional fees relating to commercial banking in 2002 totaled $4.2 million, an increase of $1.2 million or 40.7% from $3.0 million in 2001. This increase is the primarily due to $906,000 of computer software consulting fees related to the trustee deposits held by the Bank. Additionally the Company incurred expenses of $109,000 in the second quarter of 2002 related to its 401(k) plan conversion. Minority interest expense increased $1.2 million or 25.4% from 2001 as compared to 2002 and $2.0 million or 76.8% from 2000 as compared to 2001. The increases are related to the interest on the additional trust preferred securities issued in September 2002, August 2002 and March 2001. Please refer to the subsequent discussion of "Company-Obligated Mandatorily Redeemable Trust Preferred Securities" for additional details of the issuances. 22 In 2002, the Company recorded $822,000 in conversion costs related to the acquisition of Eagle National. Conversion costs in 2001 related to the acquisition of Community Bancshares, Inc. in December 2001, Lone Star Bancshares, Inc. in August 2001 and CaminoReal Bancshares in March 2001 totaled $957,000, $1.2 million and $1.0 million, respectively. The costs include retention and severance expenses as well as data processing costs related to the conversions of the acquired banks' systems. Other expenses in the commercial banking segment totaled $16.6 million in 2002, an increase of $2.3 million or 15.7%, from $14.4 million in 2001. Due to the adoption of SFAS 142, amortization of the goodwill presently on the Company's books was terminated January 1, 2002. Amortization of goodwill expensed in 2001 was $767,000. The Company incurred $1.4 million in noncash charges related to the early redemption of its trust preferred securities in November 2002. Amortization in 2002 of the core deposit intangible related to the acquisition of Community Bank and Eagle National Bank was $426,000. Other expenses in the commercial banking segment totaled $14.4 million in 2001, an increase of $2.6 million or 21.7%, from $11.8 million in 2000. The increase in goodwill amortization recorded in 2001 related to the CaminoReal Bancshares acquisition was $583,000. Also, charges related to the new debit card program increased $252,000 from 2000. Mortgage Banking Segment. Noninterest expense for the mortgage banking segment for 2002 was $59.0 million, as compared to $26.6 million for 2001, an increase of $32.4 million or 121.7%. The increase in expenses is due to variable expenses related to the increase in loan fundings and the opening of thirty-six new locations in 2002. Employees increased from 622 in 2001 to 1,100 in 2002. Also based upon an outside valuation of the mortgage servicing rights, an impairment of $9.5 million was recorded in 2002. The impairment of mortgage servicing rights is a result of the decline in mortgage interest rates and an increase in prepayments of mortgages which are serviced by SCMC due to a favorable interest rate environment which led to increased loan refinancing and new loan activity. Noninterest expense for the mortgage banking segment for 2001 was $26.6 million, as compared to $16.7 million for 2000, an increase of $9.9 million or 59.2%. This increase in noninterest expense is primarily due to the favorable interest rate environment which led to increased loan refinancing and new loan activity. In addition, new retail locations were opened in 2001. INCOME TAXES The Company provided $18.1 million for federal income taxes for 2002, $16.4 million for 2001, and $12.6 million for 2000. The effective tax rates for 2002, 2001, and 2000 were 33.1%, 35.1%, and 31.5%, respectively. FINANCIAL CONDITION LOANS HELD FOR INVESTMENT At December 31, 2002, loans held for investment totaled $1.9 billion, an increase of $274.4 million or 16.8% over loans at December 31, 2001 of $1.6 billion. Loans acquired as a result of the acquisition of Eagle National in September 2002 totaled $64.4 million. At December 31, 2002, loans held for investment were 75.4% of deposits and 53.3% of total assets. At December 31, 2001, loans held for investment were 76.5% of deposits and 58.9% of total assets. 23 The following table summarizes the loan portfolio of the Bank by type of loan as of December 31 of the year indicated, excluding loans held for sale (in thousands):
2002 2001 2000 1999 1998 ------------------ ------------------ ------------------ ------------------ ---------------- AMOUNT % AMOUNT % AMOUNT % AMOUNT % AMOUNT % ---------- ----- ---------- ----- ---------- ----- ---------- ----- -------- ----- Commercial, financial and industrial: US addressees......... $ 576,994 30.2% $ 498,850 30.5% $ 472,392 35.1% $ 436,518 36.7% $357,872 36.0% Non-US addressees..... 7,207 0.4% 7,594 0.5% 4,807 0.4% 5,917 0.5% 4,047 0.4% Real estate mortgage: Commercial............ 618,047 32.3% 521,780 31.9% 449,007 33.4% 360,092 30.2% 273,067 27.4% Residential........... 194,585 10.2% 180,088 11.0% 155,796 11.5% 141,661 11.9% 122,252 12.3% Real estate construction.......... 368,468 19.3% 280,696 17.1% 134,482 10.0% 115,761 9.7% 114,502 11.5% Consumer................ 145,264 7.6% 147,132 9.0% 129,358 9.6% 130,920 11.0% 123,057 12.4% ---------- ----- ---------- ----- ---------- ----- ---------- ----- -------- ----- $1,910,565 100.0% $1,636,140 100.0% $1,345,842 100.0% $1,190,869 100.0% $994,797 100.0% ========== ===== ========== ===== ========== ===== ========== ===== ======== =====
The primary lending focus of the Bank is on commercial loans and owner-occupied real estate loans to local businesses with annual sales ranging from $300,000 to $30 million. Typically, the Bank's customers have financing requirements between $50,000 and $500,000. The Bank's legal lending limit was $20 million at December 31, 2002 and was not exceeded by any single relationship. The Bank makes commercial loans primarily to small and medium-sized businesses and to professionals. The Bank offers a variety of commercial loan products including revolving lines of credit, letters of credit, working capital loans, and loans to finance accounts receivable, inventory and equipment. Typically, the Bank's commercial loans have floating rates of interest, are for varying terms (generally not exceeding three years), are personally guaranteed by the business owner and are secured by accounts receivable, inventory and/or other business assets. In addition to the commercial loans secured solely by non-real estate business assets, the Bank makes commercial loans that are secured by owner-occupied real estate, as well as other business assets. The Bank's commercial mortgage loans are secured by first liens on real estate, typically have floating interest rates, and are amortized over a 15-year period with balloon payments due at the end of three years. In underwriting commercial mortgage loans, consideration is given to the property's operating history, future operating projections, current and projected occupancy, location and physical condition. The underwriting analysis also includes credit checks, appraisals, and a review of the financial condition of the borrower. The Bank makes loans to finance the construction of residential and, to a lesser extent, nonresidential properties, such as churches. Generally, construction loans are secured by first liens on real estate and have floating interest rates. The Bank conducts periodic inspections, either directly or through an architect or other agent, prior to approval of periodic draws on these loans. Underwriting guidelines similar to those described above are also used in the Bank's construction lending activities. The Bank makes automobile, boat, home improvement and other loans to consumers. These loans are primarily made to customers who have other relationships with the Bank. During the first quarter of 2000, the Bank sold its credit card portfolio to a correspondent bank. The Bank seeks to compete effectively in its chosen markets by consistent application of its business strategy. See further discussion of "Business -- Business Banking Strategy" and "Business -- Competition". 24 Loan maturities and rate sensitivity of the loan portfolio, excluding real estate -- mortgage, consumer and foreign loans and unearned discount at December 31, 2002 are as follows (in thousands):
DUE AFTER ONE YEAR DUE IN ONE THROUGH DUE AFTER YEAR OR LESS FIVE YEARS FIVE YEARS TOTAL ------------ ---------- ---------- ---------- Commercial, financial and industrial.... $ 455,206 $120,980 $ 3,432 $ 579,618 Real estate -- commercial............... 369,087 228,059 22,367 619,513 Real estate -- construction............. 294,963 68,069 4,589 367,621 Foreign loans........................... 6,835 1,094 1,721 9,650 ---------- -------- ------- ---------- Total loans............................. $1,126,091 $418,202 $32,109 $1,576,402 ========== ======== ======= ========== Loans with a fixed interest rate........ $ 127,673 $413,570 $32,109 $ 573,352 Loans with a floating interest rate..... 998,418 4,632 -- 1,003,050 ---------- -------- ------- ---------- Total loans............................. $1,126,091 $418,202 $32,109 $1,576,402 ========== ======== ======= ==========
As of December 31, 2002, there was no concentration of loans to any one type of industry exceeding 10% of total loans nor were there any loans classified as highly leveraged transactions. LOANS HELD FOR SALE Loans held for sale totaled $701.3 million at December 31, 2002, an increase from $261.5 million at December 31, 2001. The $439.8 million, or 168.2%, increase is due to the increase in loans funded by the Bank through an intercompany mortgage warehouse line of credit with SCMC. Mortgage loans originated by SCMC are held for sale and are typically sold to investors within one month of origination. Due to the timing of the sales of loans to investors, the balance of these loans at any given time is somewhat volatile. Loan fundings by SCMC increased $1.8 billion from $2.6 billion funded in 2001 to $4.5 billion funded in 2002. RISK ELEMENTS Nonperforming, past due, and restructured loans are fully or substantially secured by assets, with any excess of loan balances over collateral values specifically allocated in the allowance for credit losses. The Bank receives, on an ongoing basis, updated appraisals on loans secured by real estate, particularly those categorized as nonperforming loans and potential problem loans. In those instances where updated appraisals reflect reduced collateral values, an evaluation of the borrower's overall financial condition is made to determine the need, if any, for possible write-downs or appropriate additions to the allowance for credit losses. The Bank defines potential problem loans as those loans not classified as nonperforming, but where information known by management indicates serious doubt that the borrower will be able to comply with the present payment terms. Management identifies these loans through its continuous loan review process and classifies potential problem loans as those loans graded as substandard, doubtful, or loss, excluding all nonperforming loans. The Bank's increase in potential problem loans can be directly attributed to acquisitions, loan growth and economic conditions. The Bank had no material foreign loans outstanding or loan concentrations for the years ended December 31, 1998 through 2002. The Bank, however, continues to monitor the potential risk of foreign borrowers and concentrations of credit. 25 The following table presents information regarding non-performing loans and assets as of December 31, 2002, 2001, 2000, 1999, and 1998 (in thousands):
2002 2001 2000 1999 1998 ---------- ---------- ---------- ---------- ---------- Nonaccrual loans......... $ 19,654 $ 14,179 $ 8,297 $ 5,871 $ 5,158 Restructured loans....... -- 16 1,298 218 312 ---------- ---------- ---------- ---------- ---------- Total nonperforming loans.................. 19,654 14,195 9,595 6,089 5,470 Real estate acquired by foreclosure............ 3,358 1,837 1,702 1,323 1,969 Other repossessed assets................. 66 127 192 264 356 ---------- ---------- ---------- ---------- ---------- Total nonperforming assets................. $ 23,078 $ 16,159 $ 11,489 $ 7,676 $ 7,795 ========== ========== ========== ========== ========== Nonperforming loans to total loans............ 0.75% 0.75% 0.65% 0.48% 0.51% Nonperforming assets to total assets........... 0.64% 0.58% 0.55% 0.37% 0.49% Potential problem loans.................. $ 62,189 $ 51,456 $ 38,753 $ 25,565 $ 21,983 ========== ========== ========== ========== ========== Accruing loans past due 90 days or more........ $ 984 $ 1,360 626 351 824 ========== ========== ========== ========== ========== Total loans.............. $2,611,866 $1,897,645 $1,484,990 $1,261,273 $1,079,657 ========== ========== ========== ========== ========== Total assets............. $3,582,745 $2,778,090 $2,077,214 $2,060,112 $1,591,284 ========== ========== ========== ========== ==========
ALLOWANCE FOR CREDIT LOSSES The Bank has several systems in place to assist in maintaining the overall quality of its loan portfolios. The Bank has established underwriting guidelines to be followed by its bank officers. The Bank also monitors its delinquency levels for any negative or adverse trends and particularly monitors credits which have a total exposure of $50,000 or more. However, there can be no assurance that the Bank's loan portfolios will not become subject to increasing pressures from deteriorating borrower creditworthiness due to general economic conditions. The allowance for credit losses is a reserve established through charges to earnings in the form of a provision for credit losses. Based on an evaluation of the loan portfolio, management presents a quarterly review of the allowance for credit losses to the Bank's Board of Directors, indicating any changes in the allowance since the last review and any recommendations as to adjustments in the allowance. In making its evaluation, management considers the industry diversification of the Bank's commercial loan portfolio and the effect of changes in the local real estate market on collateral values. The Bank also considers the results of recent regulatory examinations. The Bank continues to monitor the effects of current economic indicators and their probable impact on borrowers, the amount of charge-offs for the period, the amount of non-performing loans and related collateral security. The Bank monitors the loan portfolio through its internal loan review department. Charge-offs occur when loans are deemed to be uncollectible. The Bank follows a loan review program to evaluate the credit risk in the commercial loan portfolio for substantially all commercial loans and real estate loans. Through the loan review process, the Bank maintains an internally classified loan list, which, along with the delinquency list of loans, helps management assess the overall quality of the loan portfolios and the adequacy of the allowance for credit losses. Loans classified as "substandard" are those loans with clear and defined weaknesses such as highly leveraged positions, unfavorable financial ratios, uncertain repayment sources or poor financial condition, which may jeopardize recoverability of the debt. Loans classified as "doubtful" are those loans which have characteristics similar to substandard accounts but with an increased risk that a loss may occur, or at least a portion of the loan may require a charge-off if 26 liquidated at present. Although loans classified as substandard do not duplicate loans classified as doubtful, both substandard and doubtful loans include some loans that are delinquent at least 30 days or on nonaccrual status. Loans classified as "loss" are those loans that are in the process of being charged off. At December 31, 2002, substandard loans totaled $79.9 million, of which $17.9 million were loans designated as delinquent or nonaccrual; and doubtful loans totaled $2.0 million of which $1.5 million were designated as delinquent or nonaccrual. In addition to the internally classified loan list and delinquency list of loans, the Bank maintains a separate "watch list" which further aids the Bank in monitoring loan portfolios. Watch list loans show warning elements where the present status portrays one or more deficiencies that require attention in the short run or where pertinent ratios of the loan account have weakened to a point where more frequent monitoring is warranted. These loans do not have all the characteristics of a classified loan (substandard or doubtful) but do show weakened elements as compared with those of a satisfactory credit. The Bank reviews these loans to assist in assessing the adequacy of the allowance for credit losses. As of December 31, 2002, watch list loans totaled $123.7 million. Management assigns loan grades by loan and allocations are made within each loan grade so that double allocations are avoided. Loans are assigned a grade according to payment history, collateral values, and financial condition of the borrower. The Bank maintains an adequate allowance for credit losses through its watchlist classifications, allocating an increasing reserve amount as the severity of a problem loan increases. The Bank maintains an unallocated reserve for satisfactory non-classified credits based on the average of the last three year's actual net charge-offs. The Company has formed a sub-committee for Asset Quality in 1999 which meets eight times each year. That committee is composed of three outside members of the Company's Board of Directors and five senior members of the Bank's management. This committee reviews all large loans, past-dues, and overdrafts, as well as ratio and trend analysis and approves all charge-offs over $25,000. This committee also mandates action items for future meetings to evaluate potential problems and assess the potential need for additional reserve requirements by any particular sector. 27 The following table presents, for the periods indicated, an analysis of the allowance for credit losses and other related data (in thousands):
YEAR ENDED DECEMBER 31, -------------------------------------------------------------- 2002 2001 2000 1999 1998 ---------- ---------- ---------- ---------- ---------- Average loans outstanding..... $2,166,451 $1,661,618 $1,331,282 $1,122,834 $ 991,769 ========== ========== ========== ========== ========== Loans outstanding at period-end.................. $2,611,866 $1,897,645 $1,484,990 $1,261,273 $1,079,657 ========== ========== ========== ========== ========== Allowance for credit losses at January 1................... $ 22,927 $ 16,862 $ 13,998 $ 11,352 $ 8,820 Charge-offs: Commercial, financial, and industrial............... 7,384 6,969 7,061 5,485 2,723 Real estate, mortgage and construction............. 3,198 1,057 643 162 510 Consumer.................... 1,122 1,797 63 1,925 1,134 ---------- ---------- ---------- ---------- ---------- Total charge-offs........ 11,704 9,823 7,767 7,572 4,367 Recoveries: Commercial, financial, and industrial............... 1,400 871 861 750 229 Real estate, mortgage and construction............. 79 111 33 42 120 Consumer.................... 245 464 69 190 275 ---------- ---------- ---------- ---------- ---------- Total recoveries......... 1,724 1,446 963 982 624 ---------- ---------- ---------- ---------- ---------- Net charge-offs............... 9,980 8,377 6,804 6,590 3,743 Acquired allowance for credit losses...................... 656 2,758 -- -- -- Provision for credit losses... 14,018 11,684 9,668 9,236 6,275 ---------- ---------- ---------- ---------- ---------- Allowance for credit losses at December 31................. $ 27,621 $ 22,927 $ 16,862 $ 13,998 $ 11,352 ========== ========== ========== ========== ========== Ratios: Allowance to average loans.................... 1.27% 1.38% 1.27% 1.25% 1.14% Allowance to period end loans.................... 1.06% 1.21% 1.14% 1.11% 1.05% Net charge-offs to average loans.................... 0.46% 0.50% 0.51% 0.59% 0.38% Allowance to period-end nonperforming loans...... 140.54% 161.51% 175.74% 229.89% 207.53%
28 ALLOCATION OF THE ALLOWANCE FOR CREDIT LOSSES The following table describes the allocation of the allowance for credit losses among various categories of loans and certain other information as of the dates indicated. The allocation is made for analytical purposes and is not necessarily indicative of the categories in which future loan losses may occur. The total allowance is available to absorb losses from any category of loans.
YEAR ENDED DECEMBER 31, ---------------------------------------------------------------------------- 2002 2001 2000 1999 -------------------- -------------------- -------------------- ------- % OF % OF % OF CATEGORY CATEGORY CATEGORY TO LOANS TO LOANS TO LOANS HELD FOR HELD FOR HELD FOR AMOUNT INVESTMENT AMOUNT INVESTMENT AMOUNT INVESTMENT AMOUNT ------- ---------- ------- ---------- ------- ---------- ------- (IN THOUSANDS) Balance of allowance for credit losses at end of period applicable to: Commercial, financial and industrial....... $ 9,188 30% $ 8,361 31% $ 7,521 35% $ 5,461 Real estate, mortgage and construction..... 8,111 62% 5,538 60% 3,348 55% 3,014 Consumer............... 1,323 8% 868 9% 1,073 10% 909 Unallocated............ 8,999 N/A 8,160 N/A 4,920 N/A 4,614 ------- --- ------- --- ------- --- ------- $27,621 100% $22,927 100% $16,862 100% $13,998 ======= === ======= === ======= === ======= YEAR ENDED DECEMBER 31, --------------------------------- 1999 1998 ---------- -------------------- % OF % OF CATEGORY CATEGORY TO LOANS TO LOANS HELD FOR HELD FOR INVESTMENT AMOUNT INVESTMENT ---------- ------- ---------- (IN THOUSANDS) Balance of allowance for credit losses at end of period applicable to: Commercial, financial and industrial....... 37% $ 3,548 37% Real estate, mortgage and construction..... 52% 1,712 51% Consumer............... 11% 770 12% Unallocated............ N/A 5,322 N/A --- ------- --- 100% $11,352 100% === ======= ===
SECURITIES The following table summarizes the book value of securities held by the Bank as of the dates shown. See Note D to the Company's consolidated financial statements for information relating to fair values and details of held-to-maturity and available-for-sale securities portfolios.
YEAR ENDED DECEMBER 31, ------------------------------------------------------ 2002 % 2001 % 2000 % -------- ----- -------- ----- -------- ----- (IN THOUSANDS) U.S. Treasury securities and obligations of U.S. government agencies.......... $ 39,388 12.6% $ 28,937 8.8% $ 36,120 12.2% Obligations of states and political subdivisions....... 60,823 19.4% 74,985 22.8% 79,065 26.8% Mortgage-backed securities and collateralized mortgage obligations.................. 189,560 60.6% 220,355 66.9% 180,207 61.0% Other securities............... 23,283 7.4% 5,139 1.5% -- -- -------- ----- -------- ----- -------- ----- $313,054 100.0% $329,416 100.0% $295,392 100.0% ======== ===== ======== ===== ======== =====
At December 31, 2002, securities of $313.1 million decreased $16.4 million from $329.4 million at December 31, 2001. At December 31, 2002 and 2001, securities represented 12.4% and 15.4% of total deposits and 8.7% and 11.9% of total assets, respectively. The yield on the Bank's securities portfolio at December 31, 2002, was 4.7%. At December 31, 2002, the weighted-average life of the portfolio was approximately 2.3 years and the duration was approximately 1.7 years. The yield on the Bank's securities portfolio at December 31, 2001, was 5.8%. At December 31, 2001, the weighted-average life of the portfolio was approximately 2.8 years and the duration was approximately 2.0 years. 29 The contractual maturity distribution and weighted average yield of the Bank's security portfolio as of December 31, 2002 are summarized in the following table (in thousands). No tax equivalent adjustments were made.
DUE < 1 YEAR DUE 1-5 YEARS DUE 5-10 YEARS DUE > 10 YEARS --------------- --------------- --------------- ---------------- AMOUNT YIELD AMOUNT YIELD AMOUNT YIELD AMOUNT YIELD TOTAL ------- ----- ------- ----- ------- ----- -------- ----- -------- Obligations of U.S. government agencies........... $16,329 4.31% $23,059 3.81% $ -- -- $ -- -- $ 39,388 Obligations of states and political subdivisions....... 19,577 6.05% 24,747 6.69% 16,440 6.72% 59 8.50% 60,823 Mortgage-backed securities and collateralized mortgage obligations........ 892 5.16% 6,020 4.67% 9,383 7.28% 173,265 4.87% 189,560 Other securities..... 23,283 4.71% -- -- -- -- -- -- 23,283 ------- ---- ------- ---- ------- ----- -------- ---- -------- $60,081 5.04% $53,826 5.23% $25,823 6.92% $173,324 4.87% $313,054 ======= ==== ======= ==== ======= ===== ======== ==== ========
DEPOSITS The Bank's investing activities and loans held for investment are funded primarily by core deposits, approximately 82.6% of which are total deposits excluding time deposits over $100,000. Noninterest bearing deposits at December 31, 2002 were $991.3 million as compared to $776.7 million at December 31, 2001, an increase of $214.5 million or 27.6% of which $11.8 million related to the acquisition of Eagle National Bank. Approximately 39.1% of deposits from at December 31, 2002 were noninterest bearing. The Bank's average total deposits for 2002 were $2.2 billion, which is $356.2 million or 18.9% over average total deposits during 2001 of $1.9 billion. The increase in the Bank's average total deposits is primarily attributable to the acquisition of Community Bancshares in December 2001 and ENB Bankshares in September 2002. Deposits acquired with Community Bankshares and ENB Bankshares totaled $114.6 million and $58.0 million, respectively. Deposit growth continues to be concentrated primarily in core deposits, consisting of all deposits other than retail and public fund certificates of deposit in excess of $100,000. The Bank's average total deposits for 2001 were $1.9 billion, which is $282.3 million or 17.7% over average total deposits during 2000 of $1.6 billion. A portion of the increase in the Bank's average total deposits is attributable to acquisitions. Deposits acquired in 2001 with CaminoReal Bancshares and Community Bancshares totaled $115.0 million and $114.2 million, respectively. The Bank began accepting brokered certificates of deposit in 2002. Average brokered certificates of deposit totaled $34.9 million in 2002. The average balances and weighted average rates paid on deposits for each of the years ended December 31, 2002, 2001, and 2000 are presented below (in thousands):
2002 2001 2000 -------------------- -------------------- -------------------- AVERAGE AVERAGE AVERAGE AVERAGE AVERAGE AVERAGE BALANCE RATE BALANCE RATE BALANCE RATE ---------- ------- ---------- ------- ---------- ------- Noninterest bearing demand deposits....... $ 821,097 $ 655,074 $ 536,351 Interest bearing demand and savings deposits.............. 835,842 0.95% 731,442 2.19% 621,038 3.20% Time deposits........... 579,005 2.77% 493,244 4.92% 440,062 5.51% ---------- ---- ---------- ---- ---------- ---- $2,235,944 1.69% $1,879,760 3.29% $1,597,451 4.16% ========== ==== ========== ==== ========== ====
30 The Bank's time deposits of $100,000 or more have consistently shown a pattern of renewal similar to that for deposits of less than $100,000. The remaining maturities of certificates of deposits of $100,000 or more as of December 31, 2002 are summarized as follows (in thousands):
2002 -------- Three months or less........................................ $232,406 Over three through six months............................... 88,860 Over six through twelve months.............................. 69,694 Thereafter.................................................. 49,840 -------- $440,800 ========
OTHER BORROWED FUNDS Deposits are the primary source of funds for the Bank's lending and investment activities and for its general business purposes. Additionally, the Bank has available borrowing facilities through the Federal Home Loan Bank and numerous correspondent banking relationships. NOTES PAYABLE The Company has entered into a Credit Agreement with Wells Fargo Bank Minnesota, National Association dated February 2, 2002, as amended by the First Amendment to Credit Agreement dated February 2, 2003 between the Company and Wells Fargo Bank, National Association ("Wells Fargo"), successor by assignment to Wells Fargo Bank Minnesota, National Association (as amended, the "Credit Agreement"). Pursuant to the Credit Agreement, the Company has borrowed $20 million which is evidenced by the Term Note dated February 2, 2003. The Term Note bears interest at a rate per annum of 1.95% above the federal funds rate in effect from time to time. The federal funds rate is a fluctuating interest rate per annum set daily by Wells Fargo as the rate at which funds are offered to Wells Fargo by federal funds brokers. The indebtedness evidenced by the Term Note is repayable in quarterly installments with a final maturity date of February 1, 2006. The Credit Agreement requires the Company and the Bank to maintain certain financial ratios and includes other restrictive covenants. Included within these financial covenants is a covenant requiring the Bank to maintain its categorization as "well capitalized." At December 31, 2002, the most recent report filed by the Bank categorized it as "adequately capitalized" under applicable regulatory requirements. Wells Fargo has provided to the Company a written waiver with respect this financial covenant which is effective through March 31, 2003. COMPANY-OBLIGATED MANDATORILY REDEEMABLE TRUST PREFERRED SECURITIES With the proceeds received by the Company from the sale of its 8.30% Junior Subordinated Debentures to Trust III on September 26, 2002, the Company, on November 1, 2002, prepaid all $29,639,200 of the 9.28% Junior Subordinated Deferrable Interest Debentures previously issued by the Company to Sterling Bancshares Capital Trust I ("Trust I"). Upon the prepayment, the 9.28% Trust Preferred Securities and the 9.28% Trust Common Securities issued by Trust I were mandatorily redeemed. In each case, the redemption was made at par, plus the accrued and unpaid distributions through November 1, 2002. On September 26, 2002, Sterling Bancshares Capital Trust III ("Trust III"), a trust formed under the laws of the State of Delaware in February 2001, issued $31,250,000 of 8.30% Trust Preferred Securities and invested the proceeds thereof in the 8.30% Junior Subordinated Deferrable Interest Debentures (the "8.30% Junior Subordinated Debentures") issued by the Company. The 8.30% Junior Subordinated Debentures will mature on September 26, 2032, which date may be shortened to a date not earlier than September 26, 2007 if certain conditions are met (including the Company having received prior approval of the Federal Reserve and any other required regulatory approvals). The 8.30% Trust Preferred Securities will be subject to mandatory redemption in a like amount contemporaneously with the optional prepayment of the 8.30% Junior Subordinated Debentures by the Company. The 8.30% Junior Subordinated Debentures may be prepaid upon the occurrence and continuation of certain events including a change in the tax status or regulatory capital 31 treatment of the 8.30% Trust Preferred Securities. In each case, redemption will be made at a price equal to 100% of the face amount of the 8.30% Trust Preferred Securities, plus the accrued and unpaid distributions thereon through the redemption date. In August 2002, the Company formed Sterling Bancshares Statutory Trust One, a trust formed under the laws of the State of Connecticut ("Statutory Trust One"). On August 30, 2002, Statutory Trust One completed a private placement of $20,000,000 of Floating Rate Trust Preferred Securities to an institutional buyer. The proceeds from the sale were invested in the Floating Rate Junior Subordinated Deferrable Interest Debentures issued by the Company. The Floating Rate Trust Preferred Securities and the Floating Rate Junior Subordinated Deferrable Interest Debentures have a floating rate equal to the three-month LIBOR plus 3.45%, which resets quarterly. For the first five years, there is a ceiling on the three-month LIBOR of 8.50% resulting in a ceiling on the floating rate of 11.95% during this period. As of December 31, 2002, the rate was 4.85%. The Floating Rate Junior Subordinated Debentures will mature on August 30, 2032, which date may be shortened to a date not earlier than August 30, 2007 if certain conditions are met (including the Company having received prior approval of the Federal Reserve and any other required regulatory approvals). The Floating Rate Trust Preferred Securities will be subject to mandatory redemption in a like amount contemporaneously with the optional prepayment of the Floating Rate Junior Subordinated Deferrable Interest Debentures by the Company. The Floating Rate Junior Subordinated Deferrable Interest Debentures may be prepaid upon the occurrence and continuation of certain events including a change in the tax status or regulatory capital treatment of the Floating Rate Trust Preferred Securities. In each case, redemption will be made at a price equal to 100% of the face amount of the Floating Rate Trust Preferred Securities, plus the accrued and unpaid distributions thereon through the redemption date. In February 2001, the Company formed Sterling Bancshares Capital Trust II ("Trust II") and Trust III, each a trust formed under the laws of the State of Delaware. On March 21, 2001, Trust II issued $28,750,000 of 9.20% Trust Preferred Securities and invested the proceeds thereof in the 9.20% Junior Subordinated Deferrable Interest Debentures (the "9.20% Junior Subordinated Debentures") issued by the Company. The 9.20% Junior Subordinated Debentures will mature on March 21, 2031, which date may be shortened to a date not earlier than March 21, 2006 if certain conditions are met (including the Company having received prior approval of the Federal Reserve and any other required regulatory approvals). The 9.20% Trust Preferred Securities will be subject to mandatory redemption in a like amount contemporaneously with the optional prepayment of the 9.20% Junior Subordinated Debentures by the Company. The 9.20% Junior Subordinated Debentures may be prepaid upon the occurrence and continuation of certain events including a change in the tax status or regulatory capital treatment of the 9.20% Trust Preferred Securities. In each case, redemption will be made at a price equal to 100% of the face amount of the 9.20% Trust Preferred Securities, plus the accrued and unpaid distributions thereon through the redemption date. INTEREST RATE SENSITIVITY AND LIQUIDITY The Company manages its interest rate risk through structuring the balance sheet to maximize net interest income while maintaining an acceptable level of risk to changes in market interest rates. This process requires a balance between profitability, liquidity, and interest rate risk. To effectively measure and manage interest rate risk, the Company uses simulation analysis to determine the impact on net interest income of changes in interest rates under various interest rate scenarios, balance sheet trends, and strategies. From these simulations, interest rate risk is quantified and appropriate strategies are developed and implemented. The overall interest rate risk position and strategies are reviewed by senior management, the Asset/Liability Management Committee and the Company's Board of Directors on an ongoing basis. An interest rate sensitive asset or liability is one that, within a defined time period, either matures or experiences an interest rate change in line with general market interest rates. The management of interest rate risk is performed by analyzing the maturity and repricing relationships between interest earning assets and interest bearing liabilities at specific points in time ("GAP") and by analyzing the effects of interest rate changes on net interest income over specific periods of time by projecting the performance of the mix of assets 32 and liabilities in varied interest rate environments. Interest rate sensitivity reflects the potential effect on net interest income of a movement in interest rates. 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 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 adversely affect net interest income, while a positive GAP would tend to result in an increase in net interest income. During a period of falling interest rates, 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. When analyzing its GAP position, the Company emphasizes the next twelve-month period. The Company's net interest income is positioned to benefit from rising short-term rates due to an asset sensitive position. The Company would likely benefit from an increase in short-term interest rates as this might signify that economic conditions are improving. In addition, an increase in short-term interest rates would likely affect the Company's fixed-rate/variable-rate product origination mix and origination volumes and would likely slow prepayments. However, even in the current interest rate environment, the Company's loan demand remains strong. Also, management continues to evaluate the Company's lending rates and those rates may not be adjusted downward on a basis that is entirely consistent with short term interest rate trends should such trends reflect a further decrease in rates. While this asset sensitivity may compress net interest income in the short-term or if the current interest rate environment continues for an extended period of time, the Company believes this asset sensitive position is justified because current rates are well below historical averages and, consequently, there is a greater possibility over time of higher interest rates versus lower interest rates. However, if interest rates remain stable or decrease, the Company could continue to experience an increase in prepayments of commercial loans, mortgage-backed securities and, with respect to SCMC, mortgage servicing rights and may experience further compression of net interest margin or net interest income. As mentioned, the Company utilizes simulation models to estimate the impact on net interest income of changes in interest rates under various scenarios. Based on simulation analysis of the interest rate sensitivity inherent in the Company's net interest income and market value of portfolio equity, as of December 31, 2002 and as adjusted by instantaneous rate changes upward and downward of up to 100 basis points, the Company is slightly asset sensitive. The Company's analysis indicates that an instantaneous 100 basis point move downward in interest rates would decrease net interest income by 5.11% and decrease the present value of equity by 4.90%; likewise, an instantaneous 100 basis point move upward in interest rates would increase net interest income by 5.05% and increase the present value of equity by 4.12%. These sensitivities are all within the threshold set by the Company's Asset/Liability Committee. Each rate scenario reflects unique prepayment and repricing assumptions. Since there are limitations inherent in any methodology used to estimate the exposure to changes in market interest rates, this analysis is not intended to be a forecast of the actual effect of a change in market interest rates on the Company. The Company's interest rate sensitivity analysis includes assumptions that (i) the composition of the Company's interest sensitive assets and liabilities existing at fiscal year end will remain constant over the measurement period; and (ii) that changes in market rates are parallel and instantaneous across the yield curve regardless of duration or repricing characteristics of specific assets or liabilities. Further, the analysis does not contemplate any actions that the Company might undertake in response to changes in market interest rates. Accordingly, this analysis is not intended to and does not provide a precise forecast of the effect actual changes in market rates will have on the Company. 33 The following table sets forth the expected maturity and repricing characteristics of the Company's interest earning assets and interest bearing liabilities as of December 31, 2002:
0-90 90-365 1-3 3-5 OVER DAYS DAYS YEARS YEARS 5 YEARS TOTAL ---------- -------- -------- -------- ---------- ---------- (IN THOUSANDS, EXCEPT FOR DATA EXPRESSED IN PERCENTAGES) INTEREST EARNING ASSETS: Cash and cash equivalents............ $ 6,037 $ -- $ -- $ -- $ -- $ 6,037 Deposits in other financial institutions........... 217 99 697 99 190 1,302 Trading assets........... 142,803 -- -- -- -- 142,803 Securities............... 54,687 74,054 68,872 45,180 70,261 313,054 Loans.................... 1,821,439 140,175 290,599 298,802 60,851 2,611,866 ---------- -------- -------- -------- ---------- ---------- Total interest earning assets.............. 2,025,183 214,328 360,168 344,081 131,302 3,075,062 INTEREST BEARING LIABILITIES: Demand and savings deposits............... 867,942 -- -- -- -- 867,942 Certificates of deposit and other time deposits............... 318,094 257,197 72,661 25,737 -- 673,689 Other borrowed funds..... 509,590 -- -- -- -- 509,590 Notes payable............ 21,070 -- 360 -- -- 21,430 ---------- -------- -------- -------- ---------- ---------- Total interest bearing liabilities......... 1,716,696 257,197 73,021 25,737 -- 2,072,651 ---------- -------- -------- -------- ---------- ---------- Period GAP............... $ 308,487 $(42,869) $287,147 $318,344 $ 131,302 $1,002,411 ========== ======== ======== ======== ========== ========== Cumulative GAP........... $ 308,487 $265,618 $552,765 $871,109 $1,002,411 ========== ======== ======== ======== ========== Period GAP to total assets................. 8.61% (1.20)% 8.01% 8.89% 3.66% ========== ======== ======== ======== ========== Cumulative GAP to total assets................. 8.61% 7.41% 15.43% 24.31% 27.98% ========== ======== ======== ======== ==========
Shortcomings are inherent in any GAP analysis since certain assets and liabilities may not reprice proportionally as interest rates change. The Company's management has begun to utilize an interest rate risk simulation model to increase its ability to monitor and forecast the effect of various interest rate environments on earnings and its net capital position. The objectives of the Company's liquidity management is to maintain the Bank's ability to meet day-to-day deposit withdrawals and other payment obligations, to raise funds to support asset growth, to maintain reserve requirements and otherwise operate the Company on an ongoing basis. The Company strives to manage its liquidity position to allow the Bank to meet its requirements while maintaining an appropriate balance between assets and liabilities to meet the return on investment expectations of the Company's shareholders. In recent years, the Company's liquidity needs have primarily been met by growth in core deposits. The acquisitions of CaminoReal Bancshares and Community Bancshares during 2001 and ENB Bankshares in 2002 resulted in the receipt of an additional $344.2 million in core deposits. In addition to core deposits, the Bank has access to purchased funds from correspondent banks and from the Federal Home Loan Bank, supplemented by amortizing investment and loan portfolios. Also in 2002, the Bank began accepting brokered certificates of deposit. The Company is a separate and distinct entity from the Bank and must provide for its own liquidity and fund its obligations. The primary source of the Company's revenues are from dividends declared by the Bank. There are statutory and regulatory provisions that could limit the ability of the Bank to pay dividends to the Company. At December 31, 2002, the Bank had approximately $67.2 million in the aggregate available to be 34 paid as dividends to the Company. It is not anticipated that such restrictions will have an impact on the ability of the Company to meet its ongoing cash obligations. As of December 31, 2002, the Company did not have any material commitments for capital expenditures. CONTRACTUAL OBLIGATIONS AND OTHER COMMITMENTS The Company's future cash payments associated with its contractual obligations pursuant to its notes payable, trust preferred securities and operating leases are as follows (in thousands):
LESS THAN 1-3 3-5 OVER ONE YEAR YEARS YEARS 5 YEARS TOTAL --------- ------ ------ ------- -------- Operating leases...................... $ 3,702 $5,827 $2,938 $ 5,708 $ 18,175 Notes payable......................... 21,070 360 -- -- 21,430 Trust preferred securities............ -- -- -- 80,000 80,000 ------- ------ ------ ------- -------- Total............................... $24,772 $6,187 $2,938 $85,708 $119,605 ======= ====== ====== ======= ========
The Company's commitments associated with commitments to extend credit, outstanding letters of credit and mortgages sold with recourse as of December 31, 2002 are summarized below (in thousands). Since commitments associated with letters of credit and lending and financing arrangements may expire unused, the amounts shown do not necessarily reflect the actual future cash funding requirements. See Note T to the consolidated financial statements for additional discussion of financial instruments with off-balance sheet risk.
LESS THAN 1-3 3-5 OVER ONE YEAR YEARS YEARS 5 YEARS TOTAL ---------- ------- ------- ------- ---------- Commitments to extend credit............ $ 310,975 $55,439 $69,383 $29,605 $ 465,402 Standby letters of credit............... 15,876 1,912 375 133 18,296 Mortgages sold with recourse............ 851,061 -- -- -- 851,061 ---------- ------- ------- ------- ---------- Total................................. $1,177,912 $57,351 $69,758 $29,738 $1,334,759 ========== ======= ======= ======= ==========
CAPITAL RESOURCES At December 31, 2002, shareholders' equity totaled $249.3 million or 7.0% of total assets, as compared to $217.4 million and 7.8% of total assets at December 31, 2001. Regulatory authorities in the United States have issued risk-based capital standards by which all bank holding companies and banks will be evaluated in terms of capital adequacy. These guidelines relate a banking company's capital compared to the risk profile of its assets. Tier 1 capital includes common shareholders' equity, minority interest in consolidated subsidiaries, and qualifying perpetual preferred stock together with related surpluses and retained earnings. Tier 2 capital may be comprised of limited life preferred stock, qualifying debt instruments, and the reserves for credit losses. On September 26, 2002, Trust III issued $31,250,000 of 8.30% Trust Preferred Securities and invested the proceeds thereof in the 8.30% Junior Subordinated Debentures issued by the Company. The net proceeds received by the Company from the sale of the 8.30% Junior Subordinated Debentures were used to prepay all $29,639,200 of the 9.28% Junior Subordinated Deferrable Interest Debentures previously issued by the Company to Trust I. In connection with such prepayment, the trust redeemed the 9.28% Trust Preferred Securities and the 9.28% Trust Common Securities previously issued by Trust I. On August 30, 2002, Statutory Trust One issued $20,000,000 of Floating Rate Trust Preferred Securities and invested the proceeds thereof in the Floating Rate Junior Subordinated Deferrable Interest Debentures issued by the Company. The net proceeds received by the Company from the sale of its Floating Rate Junior Subordinated Deferrable Interest Debentures were used, in part, to fund the acquisition of ENB Bankshares Inc. 35 In March 2001, the Sterling Bancshares Capital Trust II completed the issuance of $28,750,000 of 9.20% Trust Preferred Securities and invested the proceeds in the 9.20% Junior Subordinated Debentures issued by the Company. The proceeds received by the Company were used, in part, to fund the acquisition of CaminoReal Bancshares. Under applicable regulatory guidelines, the 8.30% Trust Preferred Securities, the Floating Rate Trust Preferred Securities and the 9.20% Trust Preferred Securities qualify as Tier 1 capital up to a maximum of 25% of Tier 1 capital. Any additional portion of the Trust Preferred Securities would qualify as Tier 2 capital. The Company may consider other sources of funds, including additional equity or debt offerings. Banking regulators have also issued leverage ratio requirements. The leverage ratio requirement is measured as the ratio of Tier 1 capital to adjusted assets. The total risk-based capital, Tier 1 risk-based capital and Tier 1 leverage ratios as well as the minimum capital amounts and ratios for the Company as of December 31, 2002 are as follows (in thousands):
FOR CAPITAL ACTUAL ADEQUACY PURPOSES ---------------- ------------------ AMOUNT RATIO AMOUNT RATIO -------- ----- --------- ------ Total Capital (to Risk Weighted Assets).......... $292,010 9.29% $251,521 8.0% Tier 1 Capital (to Risk Weighted Assets)......... 264,387 8.41% 125,761 4.0% Tier 1 Capital (to Average Assets)............... 264,387 7.81% 135,358 4.0%
See Note U to the Company's consolidated financial statements for further discussion of the Company's regulatory capital requirements. RISK FACTORS AND CAUTIONARY STATEMENT FOR PURPOSES OF THE PROVISIONS OF THE "SAFE HARBOR" PROVISIONS OF THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995 Some of the statements and information contained in this Annual Report may contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements discuss future expectations, activities or events and by their nature, they are subject to risks and uncertainties. Forward-looking statements can be identified by the fact that they do not relate strictly to historical or current facts. They often include words such as "believe," "expect," "anticipate," "intend," "plan," "estimate," or words of similar meaning, or future or conditional verbs such as "will," "would," "should," "could," or "may." Forward-looking statements speak only as of the date they are made. We will not update these forward-looking statements to reflect circumstances or events that occur after the date the forward-looking statements are made. Many possible factors could affect our future financial performance. Our actual results may differ materially from what is expressed in any forward-looking statement. Important factors that could cause actual results to differ materially from estimates or projections contained in forward-looking statements include: - general business and economic conditions in the markets we serve may be less favorable than anticipated which could decrease the demand for loan, deposit and other financial services and increase loan delinquencies and defaults; - changes in market rates and prices may adversely impact the value of securities, loans, deposits and other financial instruments; - our liquidity requirements could be adversely affected by changes in our assets and liabilities; - legislative or regulatory developments including changes in laws concerning taxes, banking, securities, insurance and other aspects of the financial securities industry; 36 - competitive factors, including product and pricing pressures among financial services organizations, may increase; and - fiscal and governmental policies of the United States federal government. With this in mind, you should consider the following important factors that could cause actual results to differ materially from those expressed in any forward-looking statement made by us or on our behalf: OUR PROFITABILITY DEPENDS SIGNIFICANTLY ON LOCAL ECONOMIC CONDITIONS. Our success depends primarily on the general economic conditions of the Houston metropolitan area. Unlike larger banks that are more geographically diversified, we provide banking and financial services to customers primarily in the Houston metropolitan area. We also provide, to a lesser extent, banking and financial services to customers in the San Antonio and Dallas metropolitan areas. The local economic conditions of Houston, and to a lesser extent, San Antonio and Dallas, have a significant impact on our commercial, real estate and construction loans, the ability of the borrowers to repay these loans and the value of the collateral securing these loans. A significant decline in general economic conditions, such as inflation, recession, acts of terrorism, an outbreak of hostilities, unemployment and other factors beyond our control will impact these local economic conditions and will negatively affect the financial results of our banking operations. In addition, since Houston remains largely dependent on the energy industry, the recent downturn in the energy industry and energy-related businesses has adversely affected the economic conditions of the Houston metropolitan area. This downturn in the energy industry and the energy-related business could adversely affect our results of operations and financial condition. WE RELY ON AN OWNER-OPERATED BUSINESS MARKET. We target our business development and marketing strategy primarily to serve the banking and financial needs of owner-operated businesses with credit needs of up to $2 million. These owner-operated businesses represent a major sector of the Houston and national economies. If general economic conditions negatively impact this economic sector in the Houston metropolitan area or the other Texas markets in which we operate, our results of operations and financial condition will be significantly affected. IF OUR ALLOWANCE FOR LOAN LOSSES IS NOT SUFFICIENT TO COVER ACTUAL LOAN LOSSES, OUR EARNINGS COULD DECREASE. Our loan customers may not repay their loans according to the terms of these loans and the collateral securing the payment of these loans may be insufficient to assure repayment. We may experience significant credit losses which could have a material adverse effect on our operating results. We make various assumptions and judgments about the collectibility of our loan portfolio, including the creditworthiness of our borrowers and the value of the real estate and other assets serving as collateral for the repayment of many of our loans. In determining the size of the allowance, we rely on our experience and our evaluation of economic conditions. If our assumptions prove to be incorrect, our current allowance may not be sufficient to cover future loan losses and adjustments may be necessary to allow for different economic conditions or adverse developments in our loan portfolio. Material additions to our allowance would materially decrease our net income. In addition, federal and state regulators periodically review our allowance for loan losses and may require us to increase our provision for loan losses or recognize further loan charge-offs, based on judgments different than those or our management. Any increase in our loan allowance or loan charge-offs as required by these regulatory agencies could have a negative effect on us. FLUCTUATIONS IN INTEREST RATES COULD REDUCE OUR PROFITABILITY. We realize income primarily from the difference between interest earned on loans and investments and the interest paid on deposits and borrowings. We expect that we will periodically experience "gaps" in the interest rate sensitivities of our assets and liabilities, meaning that either our interest-bearing liabilities will be more sensitive to changes in market interest rates than our interest-earning assets, or vice versa. In either 37 event, if market interest rates should move contrary to our position, this "gap" will work against us, and our earnings may be negatively affected. We are unable to predict fluctuations of market interest rates, which are affected by the following factors: - inflation; - recession; - a rise in unemployment; - tightening money supply; - international disorder and instability in domestic and foreign financial markets; and - instability in domestic and foreign financial markets. Our asset liability management strategy, which is designed to control our risk from changes in market interest rates, may not be able to prevent changes in interest rates from having a material adverse effect on our results of operation and financial condition. COMPETITION WITH OTHER FINANCIAL INSTITUTIONS COULD ADVERSELY AFFECT OUR PROFITABILITY. We face vigorous competition from banks and other financial institutions, including savings and loan associations, savings banks, finance companies and credit unions. A number of these banks and other financial institutions have substantially greater resources and lending limits, larger branch systems and a wider array of banking services. To a limited extent, we also compete with other providers of financial services, such as money market mutual funds, brokerage firms, consumer finance companies and insurance companies. This competition may reduce or limit our margins on banking services, reduce our market share and adversely affect our results of operations and financial condition. WE MAY NOT BE ABLE TO MAINTAIN OUR HISTORICAL GROWTH RATE WHICH MAY ADVERSELY IMPACT OUR RESULTS OF OPERATIONS AND FINANCIAL CONDITION. To achieve our growth, we have initiated internal growth programs, completed various acquisitions and opened additional branches in the past few years. We may not be able to sustain our historical rate of growth or may not even be able to grow at all. We may not be able to obtain the financing necessary to fund additional growth and may not be able to find suitable candidates for acquisition. Various factors, such as economic conditions and competition, may impede or prohibit the opening of new branch offices. Further, our inability to attract and retain experienced bankers may adversely affect our internal growth. A significant decrease in our historical rate of growth may adversely impact our results of operation and financial condition. WE MAY BE UNABLE TO COMPLETE ACQUISITIONS, AND ONCE COMPLETE, MAY NOT BE ABLE TO INTEGRATE OUR ACQUISITIONS SUCCESSFULLY. Our growth strategy is dependent on our ability to acquire other financial institutions. We may not be able to complete any future acquisitions and, if completed, we may not be able to successfully integrate the operations, management, products and services of the entities we acquire. Following each acquisition, we must expend substantial managerial, operating, financial and other resources to integrate these entities. In particular, we may be required to install and standardize adequate operational and control systems, deploy or modify equipment, implement marketing efforts in new as well as existing locations and employ and maintain qualified personnel. Our failure to successfully integrate the entities we acquire into our existing operations may adversely affect our financial condition and results of operations. WE OPERATE IN A HIGHLY REGULATED ENVIRONMENT AND MAY BE ADVERSELY AFFECTED BY CHANGES IN FEDERAL AND LOCAL LAWS AND REGULATIONS. We are subject to extensive regulation, supervision and examination by federal and state banking authorities. Any change in applicable regulations or federal or state legislation could have a substantial impact 38 on us and our subsidiary, Sterling Bank, and its operations. Additional legislation and regulations may be enacted or adopted in the future that could significantly affect our powers, authority and operations, which could have a material adverse effect on our financial condition and results of operations. Further, regulators have significant discretion and power to prevent or remedy unsafe or unsound practices or violations of laws by banks and bank holding companies in the performance of their supervisory and enforcement duties. The exercise of this regulatory discretion and power may have a negative impact on us. ITEM 7A -- QUALITATIVE DISCLOSURES ABOUT MARKET RISK For information regarding the market risk of the Company's financial instruments, see "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Interest Rate Sensitivity and Liquidity." The Company's principal market risk exposure is to interest rates. ITEM 8 -- FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA See the index included on page 46 and the consolidated financial statements which begin on page 48 of this Form 10-K. ITEM 9 -- CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None. PART -- III ITEM 10 -- DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT The information required by this Item as to the directors and executive officers of the Company is hereby incorporated by reference from the information appearing under the captions "Election of Directors" in the Company's definitive proxy statement which involves the election of directors and is to be filed with the SEC pursuant to the Securities Exchange Act of 1934 within 120 days of the end of the Company's fiscal year on December 31, 2002. ITEM 11 -- EXECUTIVE COMPENSATION The information required by this Item as to the management of the Company is hereby incorporated by reference from the information appearing under the captions "Executive Compensation" in the Company's definitive proxy statement which involves the election of directors and is to be filed with the SEC pursuant to the Securities Exchange Act of 1934 within 120 days of the end of the Company's fiscal year on December 31, 2002. Notwithstanding the foregoing, in accordance with the instructions to Item 402 of Regulation S-K, the information contained in the Company's proxy statement under the subheading "Human Resources Programs Committee Report" and "Performance Graph" shall not be deemed to be filed as part of or incorporated by reference into this Form 10-K. ITEM 12 -- SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The information required by this Item as to the ownership by management and others of securities of the Company is hereby incorporated by reference from the information appearing under the caption "Security Ownership of Certain Beneficial Owners and Management" to the Company's definitive proxy statement which involves the election of directors and is to be filed with the SEC pursuant to the Securities Exchange Act of 1934 within 120 days of the end of the Company's fiscal year on December 31, 2002. ITEM 13 -- CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS The information required by this Item as to certain business relationships and transactions with management and other related parties of the Company is hereby incorporated by reference to such information 39 appearing under the captions "Certain Transactions" in the Company's definitive proxy statement which involves the election of directors and is to be filed with the SEC pursuant to the Securities Exchange Act of 1934 within 120 days of the end of the Company's fiscal year on December 31, 2002. ITEM 14 -- CONTROLS AND PROCEDURES Evaluation of Disclosure Controls and Procedures. Within 90 days prior to the date of this report, the Company carried out an evaluation, under the supervision and with the participation of the Company's management, including its Chief Executive Officer and its Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures. Based on this evaluation, the Company's Chief Executive Officer and its Chief Financial Officer concluded that the Company's disclosure controls and procedures (as defined in rules 13a-14(c) and 15d-14(c) under the Securities Exchange Act of 1934) are effective to ensure that information required to disclosed by the Company in reports that it files or submits under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported to the Company's management within the time periods specified in the Securities and Exchange Commission's rules and forms. Changes in Internal Controls. Subsequent to the date of their evaluation, there were no significant changes in the Company's internal controls or in other factors that could significantly affect the Company's disclosure controls and procedures, and there were no corrective actions with regard to significant deficiencies and material weaknesses based on such evaluation. PART -- IV ITEM 15 -- EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K (a)(1) List of documents filed as part of this report INDEPENDENT AUDITORS' REPORT CONSOLIDATED FINANCIAL STATEMENTS: Balance Sheets Statements of Income Statements of Shareholders' Equity Statements of Cash Flows Notes to Consolidated Financial Statements (a)(2) No financial statement schedules are required to be filed as a part of this report. (a)(3) See Item 14(c) below. (b) During the fourth quarter of 2002, the Company filed the following current reports on Form 8-K: (1) October 3, 2002 (reporting under Items 5 and 7 the Company's intention to redeem all of its 9.28% Trust Preferred Securities); and (2) October 17, 2002 (reporting under Items 5 and 7 the release of the Company's third quarter 2002 financial results). (c) Exhibits
EXHIBIT NUMBER DESCRIPTION - ------- ----------- 2.1 Agreement and Plan of Consolidation dated as of February 17, 1998, by and between the Company and Humble National Bank. [Incorporated by reference to the Company's Report on Form 8-K filed on February 27, 1998 (File No. 000-20750).] 2.2 Agreement and Plan of Merger dated as of June 12, 1998 among the Company, Sterling Bancorporation, and Hometown Bancshares, Inc., as amended. [Incorporated by reference to Exhibit 2.6 of the Company's Annual Report on Form 10-K (File No. 000-20750).]
40
EXHIBIT NUMBER DESCRIPTION - ------- ----------- 2.3 Agreement and Plan of Merger dated as of February 24, 1999 among the Company, Sterling Bancorporation, and B. O. A. Bancshares, Inc., as amended. [Incorporated by reference to the Company's Report on Form 8-K filed on June 2, 1999 (File No. 000-20750).] 2.4 Agreement and Plan of Merger dated as of October 23, 2000 among the Company, Sterling Bancorporation, Inc. and CaminoReal Bancshares of Texas, Inc., as amended. [Incorporated by reference to Exhibit 2.5 of the Company's Annual Report on Form 10-K (File No. 000-20750).] 2.5 Agreement and Plan of Merger dated as of March 1, 2001, by and between Sterling Bancshares, Inc. and Lone Star Bancorporation, Inc., as amended. [Incorporated by referenced to Exhibit 2 of the Company's Quarterly Report on Form 10-Q filed on May 14, 2001 (File No. 000-20750).] 2.6 Agreement and Plan of Merger dated as of October 1, 2001 by and among Sterling Bancshares, Inc., Sterling Bancorporation, Inc. and Community Bancshares, Inc., as amended. [Incorporated by referenced to Exhibit 2.7 of the Company's Annual Report on Form 10-K (File No. 000-20750).] 2.7 Agreement and Plan of Merger Among Sterling Bancshares, Inc., Sterling Bancorporation, Inc. and ENB Bankshares Inc. dated as of May 22, 2002. [Incorporated by referenced to Exhibit 2.1 of the Company's Quarterly Report on Form 10-Q filed on August 14, 2002 (File No. 000-20750).] 2.8 Purchase and Assumption Agreement dated July 12, 2002 between Sterling Bank Inc. and James Wilson as amended by First Amendment to Purchase and Assumption Agreement dated as of August 2, 2002. [Incorporated by reference to Exhibit 2.2 of the Company's Quarterly Report on Form 10-Q filed on August 13, 2002 (File No. 000-20750).] 2.9* Purchase and Assumption Agreement dated as of October 29, 2002 between Sterling Bank Inc. and South Texas National Bank of Laredo. 3.1 Restated and Amended Articles of Incorporation of the Company, as amended. [Incorporated by reference to Exhibit 3.1 to the Registration Statement on Form S-3 (File Nos. 333-55724, 333-55724-01, and 333-55724-02).] 3.2 Articles of Amendment to the Restated and Amended Articles of Incorporation of Sterling Bancshares, Inc. [Incorporated by reference to Exhibit 3.2 of the Company's Quarterly Report on Form 10-Q filed on August 13, 2002 (File No. 000-20750).] 3.3 Amended and Restated Bylaws of Sterling Bancshares, Inc. [Incorporated by reference to Exhibit 3.3 of the Company's Quarterly Report on Form 10-Q filed on August 13, 2002 (File No. 000-20750).] 4.1 Preferred Securities Guarantee Agreement dated March 21, 2001. [Incorporated by reference to Exhibit 4.2 of the Company's Report on Form 8-K filed on March 21, 2001 (File No. 000-20750).] 4.2 Indenture dated March 21, 2001. [Incorporated by reference to Exhibit 4.4 of the Company's Report on Form 8-K filed on March 21, 2001 (File No. 000-20750).] 4.3 First Supplemental Indenture dated March 21, 2001. [Incorporated by reference to Exhibit 4.5 of the Company's Report on Form 8-K filed on March 21, 2001 (File No. 000-20750).] 4.4 9.20% Subordinated Deferrable Interest Debenture due March 21, 2031. [Incorporated by reference to Exhibit 4.7 of the Company's Report on Form 8-K filed on March 21, 2001 (File No. 000-20750).] 4.5 Indenture dated August 30, 2002. [Incorporated by reference to Exhibit 4.4 of the Company's Report on Form 8-K filed on September 12, 2002 (File No. 000-20750).] 4.6 Junior Subordinated Deferrable Interest Debenture due August 30, 2032. [Incorporated by reference to Exhibit 4.6 of the Company's Report on Form 8-K filed on September 12, 2002 (File No. 000-20750).] 4.7 Guarantee Agreement dated August 30, 2002. [Incorporated by reference to Exhibit 4.6 of the Company's Report on Form 8-K filed on September 12, 2002 (File No. 000-20750).] 4.8 Preferred Securities Guarantee Agreement dated September 26, 2002. [Incorporated by reference to Exhibit 4.2 of the Company's Report on Form 8-K dated September 26, 2002 (File No. 000-20750).] 4.9 Second Supplemental Indenture dated September 26, 2002. [Incorporated by reference to Exhibit 4.9 of the Company's Report on Form 8-K dated September 26, 2002 (File No. 000-20750).]
41
EXHIBIT NUMBER DESCRIPTION - ------- ----------- 4.10 8.30% Junior Subordinated Deferrable Interest Debenture due September 26, 2032. [Incorporated by reference to Exhibit 4.8 of the Company's Report on Form 8-K dated September 26, 2002 (File No. 000-20750).] 10.1** 1994 Incentive Stock Option Plan of the Company. [Incorporated by reference to Exhibit 10.1 of the Company's Annual Report on Form 10-K for the year ended December 31, 1994.] 10.2 1994 Employee Stock Purchase Plan of the Company. [Incorporated by reference to Exhibit 10.2 of the Company's Annual Report on Form 10-K for the year ended December 31, 1994.] 10.3** 1984 Incentive Stock Option Plan of the Company. [Incorporated by reference to Exhibit 10.1 of the Company's Registration Statement on Form S-1, effective October 22, 1992 (Registration No. 33-51476).] 10.4** 1995 Non-Employee Director Stock Compensation Plan. [Incorporated by reference to Exhibit 4.3 of the Company's Registration Statement on Form S-8 (File No. 333-16719).] 10.5 Credit Agreement dated February 2, 2002 made by and between the Company and Wells Fargo Bank Minnesota, National Association regarding a line of credit in the amount of $20,000,000. [Incorporated by reference to the Company's Annual Report on Form 10-K for the year ended December 31, 2001 (File No. 000-207501).] 10.6* First Amendment to Credit Agreement dated February 2, 2003 made by and between the Company and Wells Fargo Bank, National Association regarding a line of credit in the amount of $20,000,000. 10.7** Employment Agreement between Sterling Bancshares, Inc. and George Martinez executed on October 31, 2001 and effective as of January 1, 2002. [Incorporated by reference to Exhibit 99.2 of the Company's Report on Form 8-K filed on October 14, 2001 (File No. 000-207500).] 10.8** Employment Agreement between Sterling Bancshares, Inc. and J. Downey Bridgwater executed on October 31, 2001 and effective as of January 1, 2002. [Incorporated by reference to Exhibit 99.3 of the Company's Report on Form 8-K filed on October 14, 2001 (File No. 000-207500).] 10.9** Incentive Compensation Agreement between Sterling Bancshares, Inc. and Eugene S. Putnam effective as of January 1, 2002. [Incorporated by reference to Exhibit 10 of the Company's Quarterly Report on Form 10-Q filed on May 13, 2002 (File No. 000-207500).] 21* Subsidiaries of the Company 23.1* Consent of Deloitte & Touche LLP, Independent Auditors 99.1* Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. 99.2* Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
- --------------- * As filed herewith. ** Management Compensation Agreement 42 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. STERLING BANCSHARES, INC. By /s/ J. DOWNEY BRIDGWATER -------------------------------------- J. Downey Bridgwater President and Chief Executive Officer Date: March 14, 2003 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 in the capacity indicated on this the 14th day of March, 2002.
SIGNATURE TITLE --------- ----- /s/ J. DOWNEY BRIDGWATER President, Chief - ---------------------------------- Executive Officer and J. Downey Bridgwater Director /s/ STEPHEN C. RAFFAELE Executive Vice President - ---------------------------------- and Chief Financial Stephen C. Raffaele Officer /s/ GEORGE MARTINEZ Chairman and Director - ---------------------------------- George Martinez /s/ GEORGE BEATTY, JR. Director - ---------------------------------- George Beatty, Jr. /s/ ANAT BIRD Director - ---------------------------------- Anat Bird /s/ JOHN H. BUCK Director - ---------------------------------- John H. Buck /s/ JAMES D. CALAWAY Director - ---------------------------------- James D. Calaway /s/ HAROLD L. CAMPBELL Director - ---------------------------------- Harold L. Campbell /s/ JAMES M. CLEPPER Director - ---------------------------------- James M. Clepper /s/ BRUCE J. HARPER Director - ---------------------------------- Bruce J. Harper /s/ DAVID HATCHER Director - ---------------------------------- David Hatcher
SIGNATURE TITLE --------- ----- /s/ GLENN H. JOHNSON Director - ---------------------------------- Glenn H. Johnson /s/ JAMES J. KEARNEY Director - ---------------------------------- James J. Kearney /s/ PAUL MICHAEL MANN, M.D. Director - ---------------------------------- Paul Michael Mann, M.D. /s/ DAVID B. MOULTON Director - ---------------------------------- David B. Moulton /s/ G. EDWARD POWELL Director - ---------------------------------- G. Edward Powell Director - ---------------------------------- Christian A. Rasch /s/ THOMAS A. REISER Director - ---------------------------------- Thomas A. Reiser /s/ STEVEN F. RETZLOFF Director - ---------------------------------- Steven F. Retzloff /s/ RAIMUNDO RIOJAS E. Director - ---------------------------------- Raimundo Riojas E. /s/ GREGORY A. STIRMAN Director - ---------------------------------- Gregory A. Stirman /s/ HOWARD T. TELLEPSEN, JR. Director - ---------------------------------- Howard T. Tellepsen, Jr.
43 CERTIFICATION I, J. Downey Bridgwater, certify that: 1. I have reviewed this annual report on Form 10-K of Sterling Bancshares, Inc.; 2. Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report; 3. Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report; 4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and have: (a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this annual report is being prepared; (b) evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this annual report (the "Evaluation Date"); and (c) presented in this annual report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; 5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent functions): (a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and (b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and 6. The registrant's other certifying officers and I have indicated in this annual report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. /s/ J. DOWNEY BRIDGWATER -------------------------------------- J. Downey Bridgwater President and Chief Executive Officer Date: March 14, 2003 44 CERTIFICATION I, Stephen C. Raffaele, certify that: 1. I have reviewed this annual report on Form 10-K of Sterling Bancshares, Inc.; 2. Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report; 3. Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report; 4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and have: (a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this annual report is being prepared; (b) evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this annual report (the "Evaluation Date"); and (c) presented in this annual report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; 5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent functions): (a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and (b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and 6. The registrant's other certifying officers and I have indicated in this annual report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. /s/ STEPHEN C. RAFFAELE -------------------------------------- Stephen C. Raffaele Executive Vice President and Chief Financial Officer Date: March 14, 2003 45 STERLING BANCSHARES, INC. TABLE OF CONTENTS
PAGE ---- INDEPENDENT AUDITORS' REPORT................................ 47 CONSOLIDATED FINANCIAL STATEMENTS: Balance Sheets............................................ 48 Statements of Income...................................... 49 Statements of Shareholders' Equity........................ 50 Statements of Cash Flows.................................. 51 Notes to Consolidated Financial Statements................ 52
46 INDEPENDENT AUDITORS' REPORT To the Board of Directors and Shareholders of Sterling Bancshares, Inc. Houston, Texas We have audited the accompanying consolidated balance sheets of Sterling Bancshares, Inc. and subsidiaries (the "Company") as of December 31, 2002 and 2001, and the related consolidated statements of income, shareholders' equity and cash flows for each of the three years in the period ended December 31, 2002. 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 of America. 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, such consolidated financial statements present fairly, in all material respects, the consolidated financial position of Sterling Bancshares, Inc. and subsidiaries as of December 31, 2002 and 2001, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2002, in conformity with accounting principles generally accepted in the United States of America. As discussed in Note A to the consolidated financial statements, in 2002 the Company adopted the provisions of Statement of Accounting Standards No. 142 "Goodwill and Other Intangible Assets." /s/ DELOITTE & TOUCHE LLP Houston, Texas March 10, 2003 47 STERLING BANCSHARES, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS DECEMBER 31, 2002 AND 2001
2002 2001 ---------- ---------- (IN THOUSANDS, EXCEPT SHARE AMOUNTS) ASSETS Cash and cash equivalents (Note C).......................... $ 139,209 $ 141,399 Interest-bearing deposits in financial institutions......... 1,302 2,114 Securities purchased with an agreement to resell............ -- 12,313 Trading assets.............................................. 142,803 118,511 Available-for-sale securities, at fair value (Note D)....... 251,165 251,008 Held-to-maturity securities, at amortized cost (Note D)..... 61,889 78,408 Loans held for sale (Note E)................................ 701,301 261,505 Loans held for investment (Notes E and F)................... 1,910,565 1,636,140 Allowance for credit losses (Note G)........................ (27,621) (22,927) ---------- ---------- Loans, net................................................ 1,882,944 1,613,213 Accrued interest receivable................................. 15,637 11,421 Real estate acquired by foreclosure......................... 3,358 1,837 Premises and equipment, net (Note H)........................ 54,919 52,591 Goodwill, net (Note I)...................................... 61,284 54,812 Mortgage servicing rights (Note I).......................... 26,467 19,592 Other assets................................................ 197,695 120,056 Assets related to discontinued operations (Note J).......... 42,772 39,310 ---------- ---------- TOTAL ASSETS................................................ $3,582,745 $2,778,090 ========== ========== LIABILITIES AND SHAREHOLDERS' EQUITY LIABILITIES: Demand deposits: Noninterest-bearing..................................... $ 991,271 $ 776,725 Interest-bearing........................................ 867,942 823,225 Certificates of deposit and other time deposits (Note K)...................................................... 673,689 538,651 ---------- ---------- Total deposits.......................................... 2,532,902 2,138,601 Other borrowed funds (Note L)............................. 509,590 180,298 Notes payable (Note M).................................... 21,430 20,879 Accrued interest payable and other liabilities............ 44,082 28,532 Liabilities related to discontinued operations (Note J)... 140,340 130,679 ---------- ---------- Total liabilities....................................... 3,248,344 2,498,989 COMMITMENTS AND CONTINGENCIES (Notes S and T) COMPANY-OBLIGATED MANDATORILY REDEEMABLE TRUST PREFERRED SECURITIES (Note N)....................................... 80,000 57,500 MINORITY INTEREST IN STERLING CAPITAL MORTGAGE COMPANY...... 5,074 4,232 SHAREHOLDERS' EQUITY (Notes P, Q and U): Convertible Preferred stock, $1 par value; 1,000,000 shares authorized, 59,000 and 39,000 issued and outstanding at December 31, 2002 and 2001, respectively............................................ 59 39 Common stock, $1 par value; 100,000,000 shares authorized, 43,982,677 and 43,769,664 issued and outstanding at December 31, 2002 and 2001, respectively................ 43,983 43,770 Capital surplus........................................... 44,633 42,526 Retained earnings......................................... 156,664 127,144 Accumulated other comprehensive income -- net unrealized gain on available-for-sale securities, net of tax....... 3,988 3,890 ---------- ---------- Total shareholders' equity.............................. 249,327 217,369 ---------- ---------- TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY.................. $3,582,745 $2,778,090 ========== ==========
See notes to consolidated financial statements. 48 STERLING BANCSHARES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME FOR THE YEARS ENDED DECEMBER 31, 2002, 2001, AND 2000
2002 2001 2000 -------- -------- -------- (IN THOUSANDS EXCEPT PER SHARE AMOUNTS) Interest income: Loans, including fees..................................... $154,435 $144,003 $131,261 Securities: Taxable................................................. 13,957 16,667 27,214 Non-taxable............................................. 2,890 3,304 3,503 Trading assets............................................ 4,540 2,787 -- Federal funds sold and securities purchased under agreements to resell.................................... 463 3,578 4,471 Deposits in financial institutions........................ 106 79 74 -------- -------- -------- Total interest income................................... 176,391 170,418 166,523 -------- -------- -------- Interest expense: Demand and savings deposits............................... 7,940 16,010 19,879 Certificates and other time deposits...................... 16,036 24,251 24,256 Other borrowed funds...................................... 4,946 6,861 18,653 Notes payable............................................. 797 135 36 -------- -------- -------- Total interest expense.................................. 29,719 47,257 62,824 -------- -------- -------- Net interest income......................................... 146,672 123,161 103,699 Provision for credit losses (Note G)........................ 14,018 11,684 9,668 -------- -------- -------- Net interest income after provision for credit losses....... 132,654 111,477 94,031 -------- -------- -------- Noninterest income: Customer service fees..................................... 15,209 13,245 10,832 Gain on sale of mortgage loans............................ 32,385 24,206 11,959 Other..................................................... 46,916 27,311 18,851 -------- -------- -------- Total noninterest income................................ 94,510 64,762 41,642 -------- -------- -------- Noninterest expense: Salaries and employee benefits (Note P)................... 88,519 67,887 53,463 Occupancy expense......................................... 23,455 17,976 13,762 Technology................................................ 5,677 5,318 3,973 Minority interest expense: Company-obligated mandatorily redeemable trust preferred securities of subsidiary trust (Note N)............... 5,916 4,716 2,668 Sterling Capital Mortgage Company....................... 842 2,273 752 Conversion costs related to acquisitions.................. 822 3,181 -- Other..................................................... 47,121 27,172 20,874 -------- -------- -------- Total noninterest expense............................... 172,352 128,523 95,492 -------- -------- -------- Income from continuing operations before income taxes..... 54,812 47,716 40,181 Provision for income taxes (Note O)....................... 18,139 16,731 12,641 -------- -------- -------- Income from continuing operations......................... $ 36,673 $ 30,985 $ 27,540 -------- -------- -------- Loss from discontinued operations before income taxes..... (183) (905) -- Provision for income taxes................................ (61) (321) -- -------- -------- -------- Loss from discontinued operations......................... (122) (584) -- -------- -------- -------- Net Income............................................ $ 36,551 $ 30,401 $ 27,540 ======== ======== ======== Earnings per share (Note R): Basic..................................................... $ 0.83 $ 0.72 $ 0.66 ======== ======== ======== Diluted................................................... $ 0.82 $ 0.71 $ 0.65 ======== ======== ======== Earnings per share from continuing operations: Basic..................................................... $ 0.84 $ 0.73 $ 0.66 ======== ======== ======== Diluted................................................... $ 0.82 $ 0.72 $ 0.65 ======== ======== ========
See notes to consolidated financial statements. 49 STERLING BANCSHARES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY FOR THE YEARS ENDED DECEMBER 31, 2002, 2001, AND 2000
ACCUMULATED OTHER COMPREHENSIVE INCOME- CONVERTIBLE NET UNREALIZED PREFERRED STOCK COMMON STOCK GAIN (LOSS) ON TOTAL --------------- ------------------ CAPITAL RETAINED AVAILABLE-FOR-SALE SHAREHOLDERS' SHARES AMOUNT SHARES AMOUNT SURPLUS EARNINGS SECURITIES, NET OF TAX EQUITY ------ ------ ------- -------- ------- -------- ---------------------- ------------- (IN THOUSANDS) BALANCE AT JANUARY 1, 2000... 353 $ 353 41,025 $41,025 $19,699 $ 81,355 $(1,362) $141,070 Net income................. 27,540 27,540 Net change in unrealized gain (loss) on available-for-sale securities, net of tax... 2,399 2,399 -------- Total comprehensive income............. 29,939 -------- Issuance of common stock (Note Q)................. 235 235 1,051 1,286 Sale of preferred stock.... 39 39 346 385 Conversion of preferred stock to common stock.... (341) (341) 536 536 (195) -- Cash dividends paid........ (5,243) (5,243) Purchase of treasury stock.................... (68) (68) (544) (612) Transfer to capital surplus.................. 1,000 (1,000) -- ---- ----- ------ ------- ------- -------- ------- -------- BALANCE AT DECEMBER 31, 2000....................... 51 51 41,728 41,728 21,357 102,652 1,037 166,825 Net income................. 30,401 30,401 Net change in unrealized gain (loss) on available-for-sale securities, net of tax... 2,853 2,853 -------- Total comprehensive income............. 33,254 -------- Issuance of common stock (Note Q)................. 581 581 3,170 3,751 Issuance of common stock for Community Bank....... 1,444 1,444 18,004 19,448 Conversion of preferred stock to common stock.... (12) (12) 17 17 (5) -- Cash dividends paid........ (5,909) (5,909) ---- ----- ------ ------- ------- -------- ------- -------- BALANCE AT DECEMBER 31, 2001....................... 39 39 43,770 43,770 42,526 127,144 3,890 217,369 Net income................. 36,551 36,551 Net change in unrealized gain on available-for-sale securities, net of tax... 98 98 -------- Total comprehensive income............. 36,649 -------- Issuance of common stock (Note Q)................. 213 213 1,885 2,098 Issuance of preferred stock.................... 20 20 222 242 Cash dividends paid........ (7,031) (7,031) ---- ----- ------ ------- ------- -------- ------- -------- BALANCE AT DECEMBER 31, 2002....................... 59 $ 59 43,983 $43,983 $44,633 $156,664 $ 3,988 $249,327 ==== ===== ====== ======= ======= ======== ======= ========
See notes to consolidated financial statements. 50 STERLING BANCSHARES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE YEARS ENDED DECEMBER 31, 2002, 2001, AND 2000
2002 2001 2000 --------- --------- --------- (IN THOUSANDS) CASH FLOWS FROM OPERATING ACTIVITIES: Net income from continuing operations..................... $ 36,673 $ 30,985 $ 27,540 Adjustments to reconcile net income to net cash provided by (used in) operating activities: Amortization and accretion of premiums and discounts on securities, net........................................ 2,529 479 333 Provision for credit losses............................. 14,018 11,684 9,668 Deferred income tax expense............................. (144) 9,128 (370) Gain on sale of assets.................................. (33,615) (24,540) (12,020) Depreciation and amortization........................... 10,330 9,806 7,713 Write-down of real estate acquired by foreclosure....... 594 94 254 Net loans originated or purchased for sale or resale.... (407,411) (98,151) (56,785) Purchases of trading assets............................. (529,176) (336,019) -- Proceeds from sale of trading assets.................... 498,366 216,705 -- Capitalized mortgage servicing rights................... (20,025) (19,839) (678) Amortization of mortgage servicing rights............... 13,150 1,154 252 Increase in accrued interest receivable and other assets................................................. (80,004) (36,836) (6,148) Increase in accrued interest payable and other liabilities............................................ 16,159 8,686 1,682 --------- --------- --------- Net cash used in operating activities from continuing operations........................................... (478,556) (226,664) (28,559) CASH FLOWS FROM INVESTING ACTIVITIES: Decrease in securities purchased under agreements to resell.................................................. 12,313 25,550 2,971 Proceeds from maturities and principal paydowns of held-to-maturity securities............................. 16,306 12,275 18,831 Proceeds from sale of available-for-sale securities....... 6,477 87,144 158,374 Proceeds from maturities and principal paydowns of available-for-sale securities........................... 131,761 88,125 77,287 Purchases of available-for-sale securities................ (140,361) (105,249) (14,195) Proceeds from maturities and principal paydowns of trading securities.............................................. 7,537 1,101 -- Net increase in loans..................................... (223,374) (99,121) (162,970) Purchase of Bank Owned Life Insurance..................... (2,084) (2,049) (5,988) Proceeds from sale of real estate acquired by foreclosure............................................. 2,969 1,881 605 Net decrease in interest-bearing deposits in financial institutions............................................ 812 396 1,189 Purchase of CaminoReal Bancshares, Inc. .................. -- (51,813) -- Cash and cash equivalents acquired with CaminoReal Bancshares, Inc. ....................................... -- 33,390 -- Purchase of Community Bancshares, Inc. ................... -- (14,552) -- Cash and cash equivalents acquired with Community Bancshares, Inc. ....................................... -- 18,531 -- Purchase of ENB Bankshares, Inc. ......................... (10,386) -- -- Cash and cash equivalents acquired with ENB Bankshares, Inc. ................................................... 2,438 -- -- Proceeds from sale of premises and equipment.............. 5,059 8,370 391 Purchase of premises and equipment........................ (14,956) (17,525) (11,682) --------- --------- --------- Net cash (used in) provided by investing activities from continuing operations........................... (205,489) (13,546) 64,813 CASH FLOWS FROM FINANCING ACTIVITIES: Net increase in deposit accounts.......................... 336,279 186,265 210,021 Net increase (decrease) in repurchase agreements and federal funds purchased................................. 322,292 35,720 (221,968) Proceeds from notes payable............................... -- 20,000 1,600 Repayments of notes payable............................... (602) (1,600) -- Issuance of company-obligated mandatorily redeemable trust preferred securities.................................... 51,250 28,750 -- Redemption of trust preferred securities.................. (28,750) -- -- Proceeds from issuance of common and preferred stock...... 2,340 3,751 1,671 Purchase of treasury stock................................ -- -- (612) Payments of cash dividends................................ (7,031) (5,909) (5,243) --------- --------- --------- Net cash provided by (used in) financing activities from continuing operations........................... 675,778 266,977 (14,531) --------- --------- --------- Net cash provided by (used in) discontinued operations.... 6,077 (7,480) -- Net increase (decrease) in cash and cash equivalents........ (2,190) 19,287 21,723 Cash and cash equivalents at beginning of year.............. 141,399 122,112 100,389 --------- --------- --------- Cash and cash equivalents at end of year.................... $ 139,209 $ 141,399 $ 122,112 ========= ========= ========= Supplemental information: Income taxes paid......................................... $ 14,173 $ 18,700 $ 18,959 ========= ========= ========= Interest paid............................................. $ 30,373 $ 50,896 $ 62,956 ========= ========= ========= Noncash investing and financing activities: Acquisition of real estate through foreclosure of collateral............................................. $ 3,981 $ 1,932 $ 1,192 ========= ========= =========
See notes to consolidated financial statements. 51 STERLING BANCSHARES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEARS ENDED DECEMBER 31, 2002, 2001 AND 2000 A. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING AND REPORTING POLICIES Organization -- Sterling Bancshares, Inc. (hereinafter, collectively with its subsidiaries, the "Company" or "Bancshares"), headquartered in Houston, Texas, is a bank holding company that provides commercial and retail banking services in the greater metro areas of Dallas, Houston, San Antonio, and South Texas through the community banking offices of Sterling Bank, a banking association chartered under the laws of the State of Texas (the "Bank"). Also, the Company provides mortgage banking services through its 80 percent ownership of Sterling Capital Mortgage Company ("SCMC"). Summary of Significant Accounting and Reporting Policies -- The accounting and reporting policies of the Company conform to accounting principles generally accepted in the United States of America and the prevailing practices within the banking industry. A summary of significant accounting policies follows: Basis of Presentation -- The consolidated financial statements include the accounts of Bancshares and its subsidiaries. Intercompany transactions have been eliminated in consolidation. The consolidated financial statements have been restated to present the combined financial information of acquisitions accounted for using the pooling of interests method (see Note B). Use of Estimates -- The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts in the financial statements. Actual results could differ from those estimates. Material estimates that are particularly susceptible to significant change in the near term relate to the determination of the allowance for credit losses, and the valuation of foreclosed real estate, deferred tax assets, goodwill, servicing rights and trading activities. Trading Assets -- Securities classified as trading assets are bought with the anticipation of sale in the near term and are carried at fair market value. These assets are held up to 120 days. These securities consist primarily of the government-guaranteed portion of SBA loans. Securities -- Securities classified as held-to-maturity are carried at cost, adjusted for the amortization of premiums and the accretion of discounts. Management has the positive intent and the Company has the ability to hold these assets until their maturities. Under certain circumstances (including the deterioration of the issuer's creditworthiness or a change in tax law or statutory or regulatory requirements), these securities may be sold or transferred to another portfolio. Securities classified as available-for-sale are carried at fair value. Unrealized gains and losses are excluded from earnings and reported, net of tax, as accumulated comprehensive income until realized. Securities within the available-for-sale portfolio may be used as part of the Company's asset and liability management strategy and may be sold in response to changes in interest rate risk, prepayment risk or other factors. Premiums and discounts are amortized and accreted to operations using the level-yield method of accounting, adjusted for prepayments as applicable. The specific identification method of accounting is used to compute gains or losses on the sales of these assets. Loans Held for Sale -- Loans originated and intended for sale in the secondary market are carried at the lower of cost or market value in the aggregate. Premiums, discounts and loan fees (net of certain direct loan origination costs) on loans held for sale are deferred until the related loans are sold or repaid. Gains or losses on loan sales are recognized at the time of sale and determined using the specific identification method. Loans Held for Investment -- Loans held for investment are stated at the principal amount outstanding, net of unearned discount. Unearned discount relates principally to consumer installment loans. The related interest income for installment loans is recognized principally by the simple interest method, which records 52 STERLING BANCSHARES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) interest in proportion to the declining outstanding balances of the loans. This method approximates the interest method. For other loans, such income is recognized using the simple interest method. Impaired loans, with the exception of groups of smaller-balance homogeneous loans that are collectively evaluated for impairment, are defined as loans for which, based on current information and events, it is probable that a creditor will be unable to collect all amounts due, both interest and principal, according to the contractual terms of the loan agreement. The allowance for credit losses related to impaired loans is determined based on the present value of expected cash flows discounted at the loan's effective interest rate or, as a practical expedient, the loan's observable market price or the fair value of the collateral if the loan is collateral dependent. Nonaccrual, Past-Due and Restructured Loans -- Included in this loan category are loans which have been categorized by management as nonaccrual because collection of interest is doubtful and loans which have been restructured to provide a reduction in the interest rate below the current market rate or a deferral of interest or principal payments. When the payment of principal or interest on a loan is delinquent for 90 days, or earlier in some cases, the loan is placed on nonaccrual status and classified as impaired unless the loan is in the process of collection and the underlying collateral fully supports the carrying value of the loan. If the decision is made to continue accruing interest on the loan, periodic reviews are made to evaluate the appropriateness of the accruing status of the loan. When a loan is placed on nonaccrual status, interest accrued and uncollected during the current year prior to the judgment of noncollectibility is charged to operations. Interest accrued and uncollected during prior periods is charged to the allowance for credit losses. Generally, any payments received on nonaccrual loans are applied first to outstanding loan amounts and next to the recovery of charged-off loan amounts. Any excess is treated as a recovery of lost interest. Restructured loans are those loans for which concessions in terms have been granted because of a borrower's financial difficulty. Interest is generally accrued on such loans in accordance with the new terms. Allowance for Credit Losses -- The allowance for credit losses is a valuation allowance for probable losses incurred on loans. All losses are charged to the allowance when the loss actually occurs or when a determination is made that a probable loss has occurred. Recoveries are credited to the allowance at the time of recovery. Throughout the year, management estimates the probable level of losses to determine whether the allowance for credit losses is adequate to absorb losses in the existing portfolio. Based on these estimates, an amount is charged to the provision for credit losses and credited to the allowance for credit losses in order to adjust the allowance to a level determined to be adequate to absorb losses. Management's judgment as to the level of probable losses on existing loans involves the consideration of current economic conditions and their estimated effects on specific borrowers; an evaluation of the existing relationships among loans, potential credit losses and the present level of the allowance; results of examinations of the loan portfolio by regulatory agencies; and management's internal review of the loan portfolio. In determining the collectibility of certain loans, management also considers the fair value of any underlying collateral. The amount ultimately realized may differ from the carrying value of these assets because of economic, operating or other conditions beyond the Company's control. It should be understood that estimates of credit losses involve an exercise of judgment. While it is reasonably possible that in the near term the Company may sustain losses which are substantial relative to the allowance for credit losses, it is the judgment of management that the allowance for credit losses reflected in the consolidated balance sheets is adequate to absorb estimated losses that exist in the current loan portfolio. Premises and Equipment -- Land is carried at cost. Premises and equipment are carried at cost, less accumulated depreciation and amortization. Depreciation expense is computed primarily using the straight- 53 STERLING BANCSHARES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) line method over the estimated useful lives of the assets. Leasehold improvements are amortized using the straight-line method over the periods of the leases or the estimated useful lives, whichever is shorter. Goodwill -- Through December 31, 2001, goodwill was amortized using the straight-line method over a period of 10 to 25 years. Due to the adoption of SFAS 142 on January 1, 2002, amortization of goodwill has been terminated. See subsequent discussion in "Recent Accounting Standards". Mortgage Servicing Rights -- SCMC determines the fair value of capitalized mortgage servicing rights ("MSRs") using assumptions regarding economic factors as they relate to the servicing portfolio. These assumptions are obtained from an independent servicing consultant and agreed to by management. SCMC evaluates impairment of the servicing rights by stratifying the portfolio based on predominant risk characteristics of the underlying loans including loan type and interest rate. Real Estate Acquired by Foreclosure -- The Bank records real estate acquired by foreclosure at fair value less estimated costs to sell. Adjustments are made to reflect declines in value subsequent to acquisition, if any, below the recorded amounts. Required developmental costs associated with foreclosed property under construction are capitalized and considered in determining the fair value of the property. Operating expenses of such properties, net of related income, and gains and losses on their disposition are included in noninterest expense. Income Taxes -- Bancshares files a consolidated federal income tax return with its subsidiaries. Each computes income taxes as if it filed a separate return and remits to, or is reimbursed by Bancshares based on the portion of taxes currently due or refundable. Deferred income taxes are accounted for by applying statutory tax rates in effect at the balance sheet date to differences between the book basis and the tax basis of assets and liabilities. The resulting deferred tax assets and liabilities are adjusted to reflect changes in enacted tax laws or rates. Realization of net deferred tax assets is dependent on generating sufficient future taxable income. Although realization is not assured, management believes it is more likely than not that all of the net deferred tax assets will be realized. The amount of the net deferred tax asset considered realizable, however, could be reduced in the near term if estimates of future taxable income are reduced. Stock-based Compensation -- The Company accounts for stock-based employee compensation plans using the intrinsic value-based method of accounting as permitted and discloses pro forma information assuming the fair value-based method as prescribed by SFAS No. 123. Profit Sharing Plan -- The Company has a profit sharing plan that covers substantially all employees. Contributions are accrued and funded currently. Statements of Cash Flows -- For purposes of the statements of cash flows, cash and cash equivalents are defined as cash, due from banks and federal funds sold. Generally, federal funds are sold for one-day periods. Earnings Per Share -- Basic earnings per share is computed using the weighted average number of shares outstanding. Diluted earnings per share is computed using the weighted average number of shares outstanding adjusted for the incremental shares issuable upon conversion of preferred stock and issuable upon exercise of outstanding stock options. All outstanding and weighted average share amounts presented in this report have been restated to reflect the effect of stock splits where applicable. Comprehensive Income -- Comprehensive income includes all changes in equity during the period presented that result from transactions and other economic events other than transactions with shareholders. The Company reports comprehensive income in the consolidated statements of shareholders' equity. 54 STERLING BANCSHARES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) Segment Information -- The Company considers its business as two operating segments: commercial banking and mortgage banking. The Company has disclosed separately results of operations relating to the two segments in Note V to the consolidated financial statements. Reclassifications -- Certain reclassifications have been made to prior year amounts to conform to current year presentation. All reclassifications have been applied consistently for the periods presented. Recent Accounting Standards -- In December 2002, the FASB issued Statement No. 148, "Accounting for Stock-Based Compensation -- Transition and Disclosure", ("SFAS 148"). SFAS 148 provides guidance on the accounting for stock based compensation. In addition, this Statement amends the disclosure requirements of Statement 123 to require prominent disclosures in both annual and interim financial statements about the method of accounting for stock-based employee compensation and the effect of the method used on reported results. The Company adopted SFAS 148 as of December 31, 2002 and has elected to continue to account for its employee stock options using the intrinsic value-based method. In October 2002, the FASB issued Statement No. 147, "Acquisitions of Certain Financial Institutions" ("SFAS 147"). SFAS 147 provides guidance on the accounting for the acquisition of a financial institution, except transactions between two or more mutual enterprises. The implementation of this standard did not have a material impact on the financial position or results of operation. In June 2002, the FASB issued Statement of Financial Accounting Standards No. 146 ("SFAS 146"), "Accounting for Costs Associated with Exit or Disposal Activities." SFAS 146 addresses accounting and reporting costs associated with exit or disposal activities and nullifies Emerging Issues Task Force (EITF) Issue 94-3, "Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity". This statement requires that a liability for a cost associated with an exit or disposal activity shall be recognized and measured initially at its fair value in the period in which the liability is incurred. This statement is effective for exit or disposal activities that are initiated after December 31, 2002. The Company does not believe that the adoption of SFAS 146 will have a significant impact on its financial statements. In April 2002, the FASB issued Statement of Financial Accounting Standards No. 145 ("SFAS 145"), "Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections". The provisions of this Statement related to the rescission of Statement 4 shall be applied in fiscal years beginning after May 15, 2002. The provisions in paragraphs 8 and 9(c) of this Statement related to Statement 13 shall be effective for transactions occurring after May 15, 2002. All other provisions of this Statement shall be effective for financial statements issued on or after May 15, 2002. SFAS 145 amends other existing authoritative pronouncements to make various technical corrections, clarify meanings, or describe their applicability under changed conditions. The Company does not believe that the adoption of SFAS 145 will have a significant impact on its financial statements. In August 2001, the FASB issued Statement No. 143, Accounting for Asset Retirement Obligations ("SFAS 143"), and Statement No. 144, Accounting for Impairment or Disposal of Long Lived Assets ("SFAS 144"). SFAS 143 requires the recording of the fair value of a liability for an asset retirement obligation in the period in which it is incurred, and is effective January 1, 2003. SFAS 144 was effective January 1, 2002, and supersedes existing accounting literature dealing with impairment and disposal of long lived assets, including discontinued operations. It addresses financial accounting and reporting for the impairment of long lived assets and for long lived assets to be disposed of, and expands current reporting for discontinued operations to include disposals of a "component" of an entity that has been disposed of or is classified as held for sale. The Company's management does not believe that the implementation of SFAS 143 will have a material impact on the Company's consolidated financial statements. In June 2001, the Financial Accounting Standards Board ("FASB") issued Statement No. 141, "Business Combinations" ("SFAS 141") and Statement No. 142, "Goodwill and Other Intangible Assets" ("SFAS 142"). These statements establish new standards for accounting and reporting for business 55 STERLING BANCSHARES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) combinations and for goodwill and intangible assets resulting from business combinations. SFAS 141 applies to all business combinations initiated after June 30, 2001, and requires the application of the purchase method of accounting to all business combinations. The Company implemented SFAS 141 on July 1, 2001. SFAS 142 terminates the amortization of the goodwill presently on the Company's books. Such amortization, after-tax, was $1.2 million for year ended December 31, 2001. Under SFAS 142, the Company is required to periodically assess its goodwill and other intangible assets for potential impairment, based on the fair value of the reporting unit at which the goodwill is recorded. The Company implemented SFAS 142 on January 1, 2002. Goodwill currently carried on the balance sheet was subject to an initial assessment for impairment. The Company has completed its initial assessment and determined that there was no impairment of goodwill as of January 1, 2002. The adoption of this statement did not have a material impact on the Company's financial position or results of operations with the exception of no longer amortizing goodwill. Effective October 1, 2000, the Company adopted SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities" which establishes accounting and reporting standards for derivative instruments and requires that an entity recognize all derivatives as either assets or liabilities in the balance sheet and measure those instruments at fair value. Upon implementation of SFAS No. 133, $56.1 million of securities classified as held-to-maturity were redesignated as available-for-sale or trading. The securities had a fair value of $56.1 million. The Company has no derivative instruments. Management believes the implementation of this pronouncement did not have any other material effect on the Company's financial statements. B. ACQUISITIONS On September 13, 2002, the Company acquired ENB Bankshares, Inc. of Dallas, for an aggregate cash purchase price of $10.4 million. ENB Bankshares, Inc. is the privately held bank holding company of Eagle National Bank ("Eagle National"), which operates one banking office in North Dallas. Additionally during September 2002, the Company completed the operational integration of Eagle National Bank and Sterling Bank. This acquisition was accounted for using the purchase method of accounting. Goodwill of $5.7 million was recorded in connection with this acquisition. On December 17, 2001, the Company acquired Community Bancshares, Inc. and its subsidiary bank, Community Bank in a stock and cash merger. The shareholders of Community Bancshares, Inc. received $14.6 million in cash and 1,443,753 shares of the Company's common stock for all the outstanding common stock of Community Bancshares, Inc. Community Bank operated two banking offices in west Houston. As of December 31, 2001, Community Bank had total assets of $155 million, loans of $80 million and deposits of $114 million. The Company merged Community Bank into Sterling Bank in May of 2002. This acquisition was accounted for using the purchase method of accounting. Goodwill of $28.7 million was recorded. On August 23, 2001, the Company acquired Lone Star Bancorporation, Inc. and its subsidiary bank, Lone Star Bank in a stock-for-stock merger. The shareholders of Lone Star Bancorporation, Inc. received an aggregate of 1.76 million shares of the Company's common stock for all the outstanding common stock of Lone Star Bancorporation, Inc. The stock issuance occurred prior to the stock split in September 2001. All previously reported amounts have been restated to reflect this transaction which was accounted for using the "pooling of interests" method. Lone Star Bank operated four banking offices in the Houston metropolitan area. As of December 31, 2001, Lone Star Bank had total assets of $170 million, loans of $123 million and deposits of $154 million. The Company merged Lone Star Bank into Sterling Bank in the February of 2002. On March 22, 2001, the Company acquired CaminoReal Bancshares of Texas, Inc. and its subsidiary bank, CaminoReal Bank, National Association, for an aggregate cash purchase price of $51.8 million. CaminoReal Bank has four banking offices in San Antonio, Texas and four banking offices in the south Texas cities of Eagle Pass, Carrizo Springs, Crystal City and Pearsall. During June 2001, the Company completed the operational integration of CaminoReal Bank and Sterling Bank. This acquisition was accounted for using the purchase method of accounting. Goodwill of $21.2 million was recorded. 56 STERLING BANCSHARES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) C. CASH AND CASH EQUIVALENTS The Bank is required by the Board of Governors of the Federal Reserve System (the "FRB") to maintain average reserve balances. "Cash and cash equivalents" in the consolidated balance sheets includes amounts so restricted of approximately $4.4 million at December 31, 2002 and $5.6 million at December 31, 2001. D. SECURITIES The amortized cost and fair value of securities are as follows (in thousands):
DECEMBER 31, 2002 ------------------------------------------------ GROSS GROSS AMORTIZED UNREALIZED UNREALIZED COST GAINS LOSSES FAIR VALUE --------- ---------- ---------- ---------- AVAILABLE-FOR-SALE Obligations of U.S. government agencies.... $ 38,608 $ 800 $ 20 $ 39,388 Obligations of states and political subdivisions............................. 4,506 189 -- 4,695 Mortgage-backed securities and collateralized mortgage obligations...... 178,638 5,272 111 183,799 Other equity securities.................... 23,277 6 23,283 -------- ------ ---- -------- Total...................................... $245,029 $6,267 $131 $251,165 ======== ====== ==== ======== HELD-TO-MATURITY Obligations of states and political subdivisions............................. $ 56,128 $2,844 $ 1 $ 58,971 Mortgage-backed securities and collateralized mortgage obligations...... 5,761 96 43 5,814 -------- ------ ---- -------- Total...................................... $ 61,889 $2,940 $ 44 $ 64,785 ======== ====== ==== ========
DECEMBER 31, 2001 ------------------------------------------------ GROSS GROSS AMORTIZED UNREALIZED UNREALIZED COST GAINS LOSSES FAIR VALUE --------- ---------- ---------- ---------- AVAILABLE-FOR-SALE U.S. Treasury securities and obligations of U.S. government agencies................. $ 25,217 $ 767 $ 44 $ 25,940 Obligations of states and political subdivisions............................. 7,432 174 -- 7,606 Mortgage-backed securities collateralized mortgage obligations..................... 207,235 5,141 53 212,323 Other equity securities.................... 5,235 -- 96 5,139 -------- ------ ---- -------- Total...................................... $245,119 $6,082 $193 $251,008 ======== ====== ==== ======== HELD-TO-MATURITY U.S. Treasury securities and obligations of U.S. government agencies................. $ 2,997 $ 25 $ -- $ 3,022 Obligations of states and political subdivisions............................. 67,379 1,569 5 68,943 Mortgage-backed securities and collateralized mortgage obligations...... 8,032 77 146 7,963 -------- ------ ---- -------- Total...................................... $ 78,408 $1,671 $151 $ 79,928 ======== ====== ==== ========
57 STERLING BANCSHARES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) The amortized cost and fair value of securities at December 31, 2002, by contractual maturity, are shown below. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties. All amounts are shown in thousands.
HELD-TO-MATURITY AVAILABLE-FOR-SALE ---------------------- ---------------------- AMORTIZED AMORTIZED COST FAIR VALUE COST FAIR VALUE --------- ---------- --------- ---------- Due in one year or less.................... $17,917 $18,161 $ 17,769 $ 17,989 Due after one year through five years...... 22,178 23,548 24,914 25,628 Due after five years through ten years..... 16,033 17,262 379 407 Due after ten years........................ -- -- 52 59 Mortgage-backed securities and collateralized mortgage obligations...... 5,761 5,814 178,638 183,799 Other equity securities.................... -- -- 23,277 23,283 ------- ------- -------- -------- $61,889 $64,785 $245,029 $251,165 ======= ======= ======== ========
The Company does not own any securities of any one issuer (other than the U.S. government and its agencies) of which aggregate adjusted cost exceeds 10% of the consolidated shareholders' equity at December 31, 2002 or 2001. Securities with carrying values totaling $260.4 million and fair values totaling $269.2 million at December 31, 2002 were pledged to secure public deposits and Federal Home Loan Bank advances. E. LOANS The loan portfolio from continuing operations consists of various types of loans made principally to borrowers located in the Houston, Dallas and San Antonio metropolitan areas, and is classified by major type as follows (in thousands):
DECEMBER 31, ----------------------- 2002 2001 ---------- ---------- Domestic Commercial, financial and industrial...................... $ 576,994 $ 498,850 Real estate -- commercial................................. 616,451 520,748 Real estate -- mortgage................................... 194,102 179,477 Real estate -- construction............................... 367,621 279,780 Consumer.................................................. 142,969 144,991 Foreign Commercial and industrial................................. 7,207 7,594 Other loans............................................... 5,226 4,760 Unearned premium (discount)................................. (5) (60) ---------- ---------- Total loans held for investment........................ 1,910,565 1,636,140 Loans held for sale Commercial, financial and industrial...................... 2,624 -- Real estate -- commercial................................. 3,062 -- Real estate -- mortgage................................... 695,615 261,505 ---------- ---------- Total loans............................................ $2,611,866 $1,897,645 ========== ==========
58 STERLING BANCSHARES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) The recorded investment in impaired loans under SFAS No. 114 is approximately $81.8 million and $65.6 million, at December 31, 2002 and 2001, respectively. Under SFAS No. 114, such impaired loans required an allowance for credit losses of approximately $14.0 million and $16.4 million, respectively. The average recorded investment in impaired loans for the years ended December 31, 2002, 2001 and 2000 was $72.2 million, $56.4 million and $40.6 million, respectively. Loan maturities and rate sensitivity of the loan portfolio, excluding real estate -- mortgage and consumer and unearned discount, at December 31, 2002 are as follows (in thousands):
DUE AFTER ONE YEAR DUE IN ONE THROUGH FIVE DUE AFTER YEAR OR LESS YEARS FIVE YEARS TOTAL ------------ ------------ ---------- ---------- Commercial, financial and industrial.......................... $ 455,206 $120,980 $ 3,432 $ 579,618 Real estate -- commercial............. 369,087 228,059 22,367 619,513 Real estate -- construction........... 294,963 68,069 4,589 367,621 Foreign Loans......................... 6,835 1,094 1,721 9,650 ---------- -------- ------- ---------- Total loans........................... $1,126,091 $418,202 $32,109 $1,576,402 ========== ======== ======= ========== Loans with a fixed interest rate...... $ 127,673 $413,570 $32,109 $ 573,352 Loans with a floating interest rate... 998,418 4,632 -- 1,003,050 ---------- -------- ------- ---------- Total loans........................... $1,126,091 $418,202 $32,109 $1,576,402 ========== ======== ======= ==========
As of December 31, 2002 and 2001, loans outstanding to directors, officers and their affiliates were approximately $11.5 million and $13.1 million, respectively. In the opinion of management, all transactions entered into between the Bank and such related parties have been and are, in the ordinary course of business, made on the same terms and conditions as similar transactions with unaffiliated persons. An analysis of activity with respect to these related-party loans is as follows (in thousands):
YEAR ENDED DECEMBER 31, ------------------ 2002 2001 ------- -------- Beginning balance........................................... $13,148 $ 14,971 New loans and reclassified related loans.................... 869 18,573 Loans to insiders/directors who resigned.................... (428) (3,653) Repayments.................................................. (2,075) (16,743) ------- -------- Ending balance.............................................. $11,514 $ 13,148 ======= ========
59 STERLING BANCSHARES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) F. NONACCRUAL, PAST-DUE AND RESTRUCTURED LOANS The following table presents information relating to nonaccrual, past-due and restructured loans (in thousands):
DECEMBER 31, ----------------- 2002 2001 ------- ------- Nonaccrual loans............................................ $19,654 $14,179 Loans 90 days or more past due, not on nonaccrual status.... 984 1,360 Restructured loans, performing.............................. -- 16 ------- ------- $20,638 $15,555 ======= =======
For the years ended December 31, 2002 and 2001, interest foregone on nonaccrual loans was approximately $1.1 million and $766 thousand, respectively. G. ALLOWANCE FOR CREDIT LOSSES An analysis of activity in the allowance for credit losses is as follows (in thousands):
YEAR ENDED DECEMBER 31, --------------------------- 2002 2001 2000 ------- ------- ------- Balance at beginning of year............................ $22,927 $16,862 $13,998 Provisions............................................ 14,018 11,684 9,668 Loans charged off..................................... 11,704 9,823 7,767 Loan recoveries....................................... (1,724) (1,446) (963) ------- ------- ------- Net loans charged off.............................. 9,980 8,377 6,804 Allowance from acquisitions........................... 656 2,758 -- ------- ------- ------- Balance at end of year.................................. $27,621 $22,927 $16,862 ======= ======= =======
H. PREMISES AND EQUIPMENT Premises and equipment are summarized as follows (in thousands):
DECEMBER 31, ------------------- 2002 2001 -------- -------- Land........................................................ $ 12,116 $ 10,682 Buildings and improvements.................................. 39,092 40,328 Furniture, fixtures and equipment........................... 48,973 42,519 -------- -------- 100,181 93,529 Less accumulated depreciation and amortization.............. (45,262) (40,938) -------- -------- Total....................................................... $ 54,919 $ 52,591 ======== ========
60 STERLING BANCSHARES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) I. INTANGIBLE ASSETS Under the provisions of SFAS No. 142, goodwill was subjected to an initial assessment for impairment. The Company completed its initial assessment and determined that there was no impairment of goodwill as of January 1, 2002. The Company will review goodwill on an annual basis for impairment or as events occur or circumstances change that would more likely than not reduce fair value of a reporting unit below its carrying amount. The changes in the carrying amount of goodwill by reportable segment for the year ended December 31, 2001 and 2002 are as follows (in thousands):
COMMERCIAL BANKING --------------------------------------------- DISCONTINUED MORTGAGE HOUSTON SAN ANTONIO DALLAS OPERATIONS BANKING TOTAL ------- ----------- ------ ------------ -------- ------- Balance, January 1, 2001.................. $ 1,110 $ -- $ -- $ -- $4,842 $ 5,952 Amortization.......... (185) (583) -- (205) (279) (1,252) Purchase price adjustment......... -- -- -- -- 217 217 CaminoReal acquisition........ -- 15,662 -- 5,517 -- 21,179 Community acquisition........ 28,716 -- -- -- -- 28,716 ------- ------- ------ ------ ------ ------- Balance, December 31, 2001.................. 29,641 15,079 -- 5,312 4,780 54,812 Purchase price adjustment......... (28) -- -- -- 838 810 Eagle National acquisition........ -- -- 5,662 -- -- 5,662 ------- ------- ------ ------ ------ ------- Balance, December 31, 2002.................. $29,613 $15,079 $5,662 $5,312 $5,618 $61,284 ======= ======= ====== ====== ====== =======
The Company adopted SFAS No. 142, in its entirety, effective January 1, 2002. The following presents the net income for 2002 and 2001 that would have been reported, exclusive of goodwill amortization (in thousands).
DECEMBER 31, ----------------- 2002 2001 ------- ------- Reported net income......................................... $36,551 $30,401 Add: Goodwill amortization, net of taxes.................... -- 814 ------- ------- Adjusted net income......................................... $36,551 $31,215 ======= ======= Reported diluted earnings per share......................... $ 0.82 $ 0.71 Add: Goodwill amortization, net of taxes.................... -- 0.02 ------- ------- Adjusted diluted earnings per share......................... $ 0.82 $ 0.73 ======= =======
61 STERLING BANCSHARES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) The changes in the carrying amounts of intangible assets other than goodwill for the year ended December 31, 2002 and 2001 are as follows (in thousands):
CORE MORTGAGE DEPOSIT SERVICING INTANGIBLE RIGHTS TOTAL ---------- --------- -------- Balance, January 1, 2001.............................. $ -- $ 907 $ 907 Amortization........................................ -- (1,154) (1,154) Servicing rights originated......................... -- 19,839 19,839 Community acquisition............................... 2,036 -- 2,036 ------ -------- -------- Balance, December 31, 2001............................ 2,036 19,592 21,628 Amortization and impairment......................... (426) (13,150) (13,576) Servicing rights originated......................... -- 20,025 20,025 Eagle National acquisition.......................... 486 -- 486 ------ -------- -------- Balance, December 31, 2002............................ $2,096 $ 26,467 $ 28,563 ====== ======== ========
As of December 31, 2002 and 2001, SCMC serviced loans with unpaid principal balances of approximately $2.7 billion and $1.3 billion, respectively. These amounts include loans that are held in the warehouse until shipped to the investor, typically 30 days. Escrow funds totaling approximately $9.7 million and $6.1 million at December 31, 2002 and 2001, respectively, are held in trust for mortgagors at various financial institutions. The loans and escrow funds are not included in the accompanying balance sheet. The projected amortization for the intangible assets other than goodwill as of December 31, 2002 is as follows (in thousands):
CORE MORTGAGE DEPOSIT SERVICING INTANGIBLE RIGHTS TOTAL ---------- --------- ------- 2003.................................................... $ 443 $ 7,340 $ 7,783 2004.................................................... 358 7,370 7,728 2005.................................................... 292 7,336 7,628 2006.................................................... 241 4,421 4,662 2007.................................................... 201 -- 201 Amount thereafter....................................... 561 -- 561 ------ ------- ------- $2,096 $26,467 $28,563 ====== ======= =======
J. DISCONTINUED OPERATIONS The Bank entered into an agreement dated October 29, 2002 to sell its banking office located in Eagle Pass, Texas. On July 12, 2002 the Bank entered into an agreement to sell three banking offices in Carrizo Springs, Crystal City and Pearsall, Texas. The four banking offices have combined loans of $33.0 million and combined deposits of $140.2 million as of December 31, 2002. The proposed sales are subject to customary closing conditions, including receipt of all requisite regulatory approvals. Subject to the receipt of all requisite regulatory approvals, the Company anticipates closing the sale of the Eagle Pass banking office in the first quarter of 2003 and the sale of the three banking offices in Carrizo Springs, Crystal City and Pearsall in the second quarter of 2003. The business related to these four offices is accounted for as discontinued operations and therefore, the results of operations and cash flows have been removed from the Company's results of continuing operations for all periods presented in this document. The results of these four offices are presented 62 STERLING BANCSHARES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) as discontinued operations in a separate category on the income statement following results from continuing operations. The assets and liabilities of the discontinued operations are stated separately as of December 31, 2002 and December 31, 2001 on the consolidated balance sheet. The major asset and liability categories are as follows (in thousands):
DECEMBER 31, ------------------- 2002 2001 -------- -------- Cash equivalents............................................ $ 7,791 $ 6,896 Loans held for investment................................... 32,996 30,648 Other assets................................................ 1,985 1,766 -------- -------- Assets related to discontinued operations................... $ 42,772 $ 39,310 ======== ======== Demand deposits: Noninterest-bearing....................................... $ 25,547 $ 21,125 Interest-bearing.......................................... 51,535 56,317 Certificates of deposit and other time deposits............. 63,088 52,937 -------- -------- Total deposits............................................ 140,170 130,379 Other liabilities........................................... 170 300 -------- -------- Liabilities related to discontinued operations.............. $140,340 $130,679 ======== ========
K. DEPOSITS Included in certificates of deposit and other time deposits are certificates of deposit in amounts of $100,000 or more. The remaining maturities of these certificates are summarized as of December 31, 2002 as follows (in thousands): Three months or less........................................ $232,406 Four through six months..................................... 88,860 Seven through twelve months................................. 69,694 Thereafter.................................................. 49,840 -------- $440,800 ========
Interest expense for certificates of deposit in excess of $100,000 was approximately $11.0 million, $15.0 million, and $14.1 million for the years ended December 31, 2002, 2001 and 2000, respectively. At December 31, 2002, the Bank has $99.5 million in brokered deposits. These deposits will mature within year 2003. Deposits of $90.4 million will mature in the next six months and the remaining balance of $9.1 million in the second half of year 2003. There are no major concentrations of deposits. 63 STERLING BANCSHARES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) L. OTHER BORROWED FUNDS Other borrowed funds are summarized as follows (in thousands):
2002 2001 -------- -------- Federal Home Loan Bank advances............................. $490,790 $146,000 Federal funds purchased with correspondent banks............ 18,800 10,950 Securities sold under agreements to repurchase.............. -- 18,248 Promissory notes payable to unaffiliated third party........ -- 5,100 -------- -------- $509,590 $180,298 ======== ========
The Bank has an available line of credit with the Federal Home Loan Bank of Dallas, which allows the Bank to borrow on a collateralized basis. At December 31, 2002, the Bank had $490.8 million, of which $475 million bearing an interest rate of 1.30% and $15.8 million bearing an interest rate of 1.35%, borrowed under this line of credit, with a maturity of two days. These borrowings are collateralized by single family residential mortgage loans. The amounts were repaid in January 2003. Securities sold under agreements to repurchase generally mature within one to four days from the transaction date. However, the Bank eliminated the Repurchase Agreement Sweep product as of December 31, 2002 because of the smaller number of customers utilizing the service and it was uncompetitive with other Bank products. Information concerning securities sold under agreements to repurchase during the year 2002 is summarized as follows (dollars in thousands):
2002 2001 ------- ------- Average balance during the year............................. $13,559 $15,074 Average interest rate during the year....................... 0.96% 2.67% Maximum month-end balance during the year................... $19,796 $18,248 Average interest rate at the end of the year................ -- 1.16%
The Bank has available lines for federal funds purchased at correspondent banks. As of December 31, 2002, federal funds outstanding with correspondent banks was $18.8 million, of which $18.5 million will mature in the next three months. The amounts will be repaid when they mature. M. NOTES PAYABLE Effective February 2, 2002, the Company entered into a Credit Agreement with Wells Fargo Bank Minnesota, National Association which provides for a $20 million revolving credit facility. The Company currently has $20 million outstanding under the terms of the credit facility. The original term of the credit facility is for a one year period ending on February 2, 2003. This line of credit was renewed on February 2, 2003 by the Company with the Wells Fargo Bank, National Association, successor by assignment to Wells Fargo Bank Minnesota, National Association. The note matures on February 1, 2006. The interest rate payable by the Company on all funds drawn under the credit facility is 1.95% in excess of the Federal Funds Rate in effect from time to time. The indebtedness under the credit facility is guaranteed by Sterling Bancorporation, Inc. The Credit Agreement contains various covenants and restrictions including, among other things, (i) limitations on dividends, redemptions and repurchases of capital stock, (ii) limitations on the incurrence of indebtedness, (iii) limitations on mergers, acquisitions and the sale of all or substantially all of the Company's assets, and (iv) maintenance of certain financial covenants by the Company and the Bank. Included within these financial covenants is a financial covenant requiring the Bank to maintain its categorization as "well capitalized." At December 31, 2002, the most recent report filed by the Bank categorized it as "adequately capitalized" under applicable regulatory requirements. Wells Fargo has provided to the Company a written waiver with respect to this financial covenant which is effective through March 31, 64 STERLING BANCSHARES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) 2003. Although the covenants and restrictions could restrict the Company's corporate activities, the Company does not anticipate that the credit facility or the covenants and conditions contained therein will have any material impact upon the Company or its operations. Upon the acquisition of ENB Bancshares, Inc. in September 2002, the Company assumed a note payable to Wells Fargo Bank Minnesota, National Association. The balance of $1.1 million was repaid January 2, 2003. In addition the Company assumed notes payable totaling $879 thousand to two executives with the acquisition of Community Bancshares, Inc. in December 2001. Notes payable of $519 thousand were repaid in August 2002. The remaining notes payable of $360 thousand as of December 31, 2002 will mature January 11, 2004. N. TRUST PREFERRED SECURITIES On September 26, 2002, Sterling Bancshares Capital Trust III ("Trust III"), a trust formed under the laws of the State of Delaware in February, 2001, issued 1,250,000 8.30% Trust Preferred Securities with an aggregate liquidation value of $31,250,000. Concurrent with the issuance of the 8.30% Trust Preferred Securities, Trust III issued trust common securities to the Company in the aggregate liquidation value of $966,500. The proceeds of the issuance of the 8.30% Trust Preferred Securities and trust common securities were invested the Company's 8.30% Junior Subordinated Deferrable Interest Debentures (the "8.30% Junior Subordinated Debentures") issued by the Company. The 8.30% Junior Subordinated Debentures will mature on September 26, 2032, which date may be shortened to a date not earlier than September 26, 2007 if certain conditions are met (including the Company having received prior approval of the Federal Reserve and any other required regulatory approvals). The 8.30% Trust Preferred Securities will be subject to mandatory redemption in a like amount contemporaneously with the optional prepayment of the 8.30% Junior Subordinated Debentures by the Company. The 8.30% Junior Subordinated Debentures may be prepaid upon the occurrence and continuation of certain events including a change in the tax status or regulatory capital treatment of the 8.30% Trust Preferred Securities. In each case, redemption will be made at a price equal to 100% of the face amount of the 8.30% Trust Preferred Securities, plus the accrued and unpaid distributions thereon through the redemption date. In August 2002, the Company formed Sterling Bancshares Statutory Trust One, a trust formed under the laws of the State of Connecticut ("Statutory Trust One"). On August 30, 2002, Statutory Trust One completed a private placement of $20,000,000 of Floating Rate Trust Preferred Securities to an institutional buyer. The proceeds from the sale were invested in the Floating Rate Junior Subordinated Deferrable Interest Debentures issued by the Company. The Floating Rate Trust Preferred Securities and the Floating Rate Junior Subordinated Deferrable Interest Debentures have a floating rate equal to the three-month LIBOR plus 3.45%, which resets quarterly. For the first five years, there is a ceiling on the three-month LIBOR of 8.50% resulting in a ceiling on the floating rate of 11.95% during this period. As of December 31, 2002, the rate was 4.85%. The Floating Rate Junior Subordinated Debentures will mature on August 30, 2032, which date may be shortened to a date not earlier than August 30, 2007 if certain conditions are met (including the Company having received prior approval of the Federal Reserve and any other required regulatory approvals). The Floating Rate Trust Preferred Securities will be subject to mandatory redemption in a like amount contemporaneously with the optional prepayment of the Floating Rate Junior Subordinated Deferrable Interest Debentures by the Company. The Floating Rate Junior Subordinated Deferrable Interest Debentures may be prepaid upon the occurrence and continuation of certain events including a change in the tax status or regulatory capital treatment of the Floating Rate Trust Preferred Securities. In each case, redemption will be made at a price equal to 100% of the face amount of the Floating Rate Trust Preferred Securities, plus the accrued and unpaid distributions thereon through the redemption date. As a result during the fourth quarter of 2002, The Company recorded a cost relating to the early redemption. 65 STERLING BANCSHARES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) In February 2001, the Company formed Sterling Bancshares Capital Trust II ("Trust II") and Trust III. On March 21, 2001, Trust II issued 1,150,000 9.20% Trust Preferred Securities with an aggregate liquidation value of $28,750,000. Concurrent with the issuance of the 9.20% Trust Preferred Securities, Trust II issued trust common securities to the Company in the aggregate liquidation value of $889,175. The proceeds of the issuance of the 9.20% Trust Preferred Securities and trust common securities were invested in the Company's 9.20% Junior Subordinated Deferrable Interest Debentures (the "9.20% Junior Subordinated Debentures"). The proceeds of the issuance of the 9.20% Junior Subordinated Debentures were invested in the 9.20% Junior Subordinated Deferrable Interest Debentures (the "9.20% Junior Subordinated Debentures") issued by the Company. The 9.20% Junior Subordinated Debentures will mature on March 21, 2031, which date may be shortened to a date not earlier than March 21, 2006 if certain conditions are met (including the Company having received prior approval of the Federal Reserve and any other required regulatory approvals). The 9.20% Trust Preferred Securities will be subject to mandatory redemption if the 9.20% Junior Subordinated Debentures are repaid by the Company. The 9.20% Junior Subordinated Debentures may be prepaid if certain events occur, including a change in the tax status or regulatory capital treatment of the 9.20% Trust Preferred Securities. In each case, redemption will be made at par, plus the accrued and unpaid distributions thereon through the redemption date. In June 1997, the Company formed Sterling Bancshares Capital Trust I, a trust formed under the laws of the State of Delaware (the "Trust I"). The Trust I issued 1,150,000 9.28% Trust Preferred Securities with an aggregate liquidation value of $28,750,000. Concurrent with the issuance of the 9.28% Trust Preferred Securities, Trust I issued trust common securities to the Company in the aggregate liquidation value of $889,200. The proceeds of the issuance of the 9.28% Trust Preferred Securities and trust common securities were invested in the Company's 9.28% Junior Subordinated Deferrable Interest Debentures (the "9.28% Junior Subordinated Debentures"). The proceeds of the issuance of the 9.28% Junior Subordinated Debentures were invested in the 9.28% Junior Subordinated Deferrable Interest Debentures (the "9.28% Junior Subordinated Debentures") issued by the Company. With the proceeds received by the Company from the sale of its 8.30% Junior Subordinated Debentures to Trust III on September 26, 2002, the Company, on November 1, 2002, prepaid all $29,639,200 of the 9.28% Junior Subordinated Deferrable Interest Debentures previously issued by the Company to Trust I. Upon the prepayment, the 9.28% Trust Preferred Securities and the 9.28% Trust Common Securities issued by Trust I were mandatorily redeemed. In each case, the redemption was made at par, plus the accrued and unpaid distributions through November 1, 2002. O. INCOME TAXES The components of the provision for income taxes follow (in thousands):
YEAR ENDED DECEMBER 31, --------------------------- 2002 2001 2000 ------- ------- ------- Current expense......................................... $18,638 $ 7,282 $13,011 Deferred benefit........................................ (560) 9,128 (370) ------- ------- ------- Total................................................. $18,078 $16,410 $12,641 ======= ======= =======
66 STERLING BANCSHARES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) The provision for income taxes differs from the amount computed by applying the federal income tax statutory rate on operations as follows (in thousands):
YEAR ENDED DECEMBER 31, --------------------------- 2002 2001 2000 ------- ------- ------- Taxes calculated at statutory rate...................... $19,120 $16,384 $14,063 Increase (decrease) resulting from: Tax-exempt interest income............................ (1,011) (1,104) (1,255) Tax-exempt income from bank-owned life insurance...... (729) (717) (661) Goodwill amortization................................. -- 342 157 Adjustments to valuation allowance.................... -- -- -- Other, net............................................ 698 1,505 337 ------- ------- ------- Income tax expense...................................... $18,078 $16,410 $12,641 ======= ======= =======
Significant deferred tax assets and liabilities at December 31, 2002 and 2001, were as follows (in thousands):
DECEMBER 31, ----------------- 2002 2001 ------- ------- Deferred tax assets: Real estate acquired by foreclosure....................... $ 82 $ 31 Allowance for credit losses............................... 9,667 7,455 Net operating loss carryforward........................... 133 174 Deferred compensation..................................... 2,310 1,314 Other..................................................... 589 128 ------- ------- Total deferred tax assets.............................. 12,781 9,102 Deferred tax liabilities: Net unrealized gains on available-for-sale securities..... 2,147 1,939 Depreciable assets........................................ 1,345 1,159 Earnings from Sterling Capital Mortgage Company........... 396 396 Federal Home Loan Bank stock dividends.................... 1,028 867 Originated mortgage servicing rights...................... 9,264 7,385 Insurance................................................. 1,554 -- Other..................................................... 170 831 ------- ------- Total deferred tax liabilities......................... 15,904 12,577 ------- ------- Net deferred tax liabilities before valuation allowance..... (3,123) (3,475) Valuation allowance......................................... 262 262 ------- ------- Net deferred tax liabilities................................ $(3,385) $(3,737) ======= =======
P. EMPLOYEE BENEFITS Profit Sharing Plan -- The Company's profit sharing plan includes substantially all employees. Contributions to the plan are made at the discretion of the Board of Directors but generally equal up to 10% of the Company's pretax income, subject to IRS limitations. Employee contributions to 401(K) plan accounts are optional. Beginning in 1997, the Company matched 50 percent of the employee's contribution, up to 6 percent 67 STERLING BANCSHARES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) of the employee's base pay. Profit sharing contributions are accrued and funded currently. Total profit sharing expense for 2002, 2001 and 2000 was approximately $5.1 million, $3.9 million, and $2.9 million, respectively. Stock-based Compensation -- During April 1994, the Company adopted the "1994 Stock Incentive Plan (the "Stock Plan"). The Stock Plan, as amended, provides for a maximum of 3,900,000 shares (after adjustment for stock splits) of the Company's common stock to be issued. No options or performance shares may be granted under the Stock Plan after April 2004. Options are granted to officers and employees at exercise prices determined by the Human Resources Programs Committee of the Board of Directors. These options generally have exercise prices equal to the fair market value of the common stock at the date of grant and vest ratably over a four-year period. Options granted under the plan must be exercised not later than ten years from the date of grant. Stock grant awards may also be made under the Stock Plan with compensation expense recognized for any stock grant awards. A total of 19,685, 20,264, and 4,250 stock grants were awarded under the Stock Plan during 2002, 2001 and 2000, respectively. A summary of changes in outstanding options, as restated for stock splits, is as follows (shares in thousands):
YEAR ENDED DECEMBER 31, --------------------------------------------------------- 2002 2001 2000 ----------------- ----------------- ----------------- WEIGHTED WEIGHTED WEIGHTED AVERAGE AVERAGE AVERAGE EXERCISE EXERCISE EXERCISE SHARES PRICE SHARES PRICE SHARES PRICE ------ -------- ------ -------- ------ -------- Shares under option, beginning of year........................... 2,301 $8.63 1,800 $6.45 1,574 $6.12 Shares granted................. 221 12.23 880 12.28 455 7.88 Shares canceled/expired........ (88) 11.85 (122) 9.48 (80) 7.61 Shares exercised............... (164) 5.75 (257) 5.40 (149) 3.31 ----- ----- ----- ----- ----- ----- Shares under option, end of year........................... 2,270 $9.07 2,301 $8.63 1,800 $6.45 ===== ===== ===== ===== ===== ===== Shares exercisable, end of year........................... 1,222 $7.07 935 $5.54 870 $4.82 ===== ===== ===== ===== ===== ===== Shares reserved for future granting of options, end of year........................... 408 635 615 ===== ===== ===== Weighted average fair value of options granted during the year........................... $3.35 $3.64 $2.81 ===== ===== =====
The fair value of options at date of grant was estimated using the Black-Scholes option-pricing model with the following weighted-average assumptions:
2002 2001 2000 ----- ----- ----- Expected life (years)....................................... 4.52 4.82 5.17 Risk free interest rate..................................... 2.55% 4.22% 5.03% Volatility.................................................. 29.29% 29.35% 28.97% Dividend yield.............................................. 1.47% 1.28% 1.11%
68 STERLING BANCSHARES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) The following table presents information relating to the Company's stock options outstanding at December 31, 2002 (share data in thousands):
OPTIONS OUTSTANDING OPTIONS EXERCISABLE ------------------------------------------------- ------------------------------ WEIGHTED-AVERAGE NUMBER WEIGHTED-AVERAGE REMAINING LIFE NUMBER WEIGHTED-AVERAGE RANGE OF EXERCISE PRICES OUTSTANDING EXERCISE PRICE (YEARS) EXERCISABLE EXERCISE PRICE - ------------------------ ----------- ---------------- ---------------- ----------- ---------------- $ 0.00 - $ 1.56.............. 6 $ -- 8.6 -- $ -- $ 1.57 - $ 3.13.............. 285 2.36 1.8 285 2.36 $ 3.14 - $ 4.69.............. 82 3.84 3.1 82 3.84 $ 4.70 - $ 6.26.............. 71 5.88 4.9 59 5.85 $ 6.27 - $ 7.82.............. 465 7.12 5.8 307 7.16 $ 7.83 - $ 9.39.............. 291 8.72 5.9 228 8.75 $ 9.40 - $10.95.............. 125 10.11 6.8 77 10.06 $10.96 - $12.51.............. 502 11.70 8.0 107 11.75 $12.52 - $14.08.............. 273 13.14 8.3 43 12.97 $14.09 - $15.64.............. 170 15.30 8.4 34 15.50 ----- ------ --- ----- ------ 2,270 $ 9.07 6.2 1,222 $ 7.07 ===== ====== === ===== ======
Annual Reconciliation of Reported and Pro Forma Net Income and EPS -- If compensation cost for the Company's stock-based compensation plan had been determined based on the fair value at the grant dates for awards, there would have been no material impact on the Company's reported net income or earnings per share. Pro forma information regarding net income and earnings per share is required under Statement of Financial Accounting Standard No. 123 ("SFAS 123"), "Accounting for Stock-Based Compensation" and has been determined as if the Company accounted for its employee stock option plans under the fair value method of SFAS 123. The fair value of options was estimated using a Black-Scholes option pricing model. Option valuation models require use of highly subjective assumptions. Also, employee stock options have characteristics that are significantly different from those of traded options, including vesting provisions and trading limitations that impact their liquidity. Because employee stock options have differing characteristics and changes in the subjective input assumptions can materially affect the fair value estimate, the Black-Scholes valuation model does not necessarily provide a reliable measure of the fair value of employee stock options. The following table shows information related to stock-based compensation in both the reported and pro forma earnings per share amounts (dollars in thousands except for per share amounts):
2002 2001 2000 ------- ------- ------- Net Income, as reported................................. $36,551 $30,401 $27,540 Total stock-based employee compensation expense determined under fair value based method for all awards granted since January 1, 1995, net of related tax effects........................................... 1,050 1,116 686 ------- ------- ------- Pro Forma net income.................................... $35,501 $29,285 $26,854 ======= ======= ======= Earnings per share: Basic -- as reported.................................. $ 0.83 $ 0.72 $ 0.66 ======= ======= ======= Basic -- pro forma.................................... $ 0.81 $ 0.69 $ 0.65 ======= ======= ======= Diluted -- as reported................................ $ 0.82 $ 0.71 $ 0.65 ======= ======= ======= Diluted -- pro forma.................................. $ 0.79 $ 0.68 $ 0.64 ======= ======= =======
69 STERLING BANCSHARES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) Stock Purchase Plan -- The Company offers the 1994 Employee Stock Purchase Plan (the "Purchase Plan"), which is a compensatory benefit plan, to all employees who are employed for more than 20 hours per week and meet minimum length-of-service requirements of three months. The Purchase Plan provides for an aggregate of 675,000 shares of the Company's common stock to be issued under the Plan with no more than 67,500 shares available during any annual offering. The purchase price for shares available under the Purchase Plan is equal to the fair market value on the date of the offering. During 2002 and 2001, 13,016 and 5,448 shares, respectively, were subscribed for through payroll deduction for a maximum of two years. In 2001, 450 shares were purchased upon the offering. Shares are issued upon full payment. Q. SHAREHOLDERS' EQUITY Stock Splits -- On July 24, 2001, the Board of Directors declared a three-for-two stock split that was effected in the form of a stock dividend on its common stock. Stockholders of record on September 4, 2001 received one additional share of common stock for every two shares of the Company's common stock held on that date. Cash paid in lieu of fractional shares was based on the average of the high and low bids on the record date, as adjusted for the split. The payment date for the stock dividend was September 18, 2001. Preferred Stock -- The Board of Directors has approved the sale of convertible preferred stock in series pursuant to confidential private placement memoranda upon the opening of various banking offices. The shares are sold to investors who may assist in the business development efforts of the opening office and are convertible to common shares dependent on that banking office meeting certain performance and deposit growth goals. On March 7, 2002, the Company completed a private placement of 20,000 shares of the Company's Series I Convertible Preferred Stock. Shares of the Series I Preferred Stock will convert into shares of the Company's common stock based upon performance goals for the Dallas banking office for which such shares were issued. The conversion ratio ranges from 1.25 shares of common stock if the performance goals are met prior to November 7, 2003, to 1.1 shares of common stock if the performance goals are met prior to November 7, 2004. After November 7, 2004, each share of Series I Preferred Stock will automatically convert into one share of common stock. During 2001, 11,500 shares of preferred stock under Series F issued in 1998 were converted into 11,500 common shares prior to the stock split in September 2001. At December 31, 2002, there are 59,000 convertible preferred shares outstanding. These shares are convertible into a maximum of 98,125 shares of common stock if the performance and deposit growth goals of the banking offices are achieved. 70 STERLING BANCSHARES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) R. EARNINGS PER COMMON SHARE Earnings per common share was computed based on the following (in thousands, except per share data):
2002 2001 2000 AMOUNT AMOUNT AMOUNT ------- ------- ------- Net income from continuing operations................... $36,673 $30,985 $27,540 Loss from discontinued operations..................... (122) (584) -- ------- ------- ------- Net income.............................................. $36,551 $30,401 $27,540 ======= ======= ======= Basic: Weighted average shares outstanding................... 43,872 42,180 41,596 Diluted: Add incremental shares for: Assumed exercise of outstanding options............ 790 803 509 Assumed conversion of preferred stock.............. 94 61 107 ------- ------- ------- Total................................................... 44,756 43,044 42,212 ======= ======= ======= Earnings per share from continuing operations Basic................................................. $ 0.84 $ 0.73 $ 0.66 ======= ======= ======= Diluted............................................... $ 0.82 $ 0.72 $ 0.65 ======= ======= ======= Earnings per share Basic................................................. $ 0.83 $ 0.72 $ 0.66 ======= ======= ======= Diluted............................................... $ 0.82 $ 0.71 $ 0.65 ======= ======= =======
The incremental shares for the assumed exercise of the outstanding options was determined by application of the treasury stock method. The incremental shares for the conversion of the preferred stock was determined assuming applicable performance goals had been met. The Company did not have any antidilutive shares in 2002, 2001 and 2000. S. COMMITMENTS AND CONTINGENCIES Leases -- A summary as of December 31, 2002, of noncancelable future operating lease commitments follows (in thousands): 2003........................................................ $ 3,702 2004........................................................ 3,305 2005........................................................ 2,522 2006........................................................ 1,540 2007........................................................ 1,398 Thereafter.................................................. 5,708 ------- Total....................................................... $18,175 =======
Rent expense under all noncancelable operating lease obligations, net of income from noncancelable subleases aggregated, was approximately $8.1 million, $5.6 million, and $3.7 million for the years ended December 31, 2002, 2001 and 2000, respectively. 71 STERLING BANCSHARES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) Litigation -- The Company has been named as a defendant in various legal actions arising in the normal course of business. In the opinion of management, after reviewing such claims with outside counsel, resolution of such matters will not have a materially adverse impact on the consolidated financial statements. T. FINANCIAL INSTRUMENTS WITH OFF-BALANCE SHEET RISK The Bank is a party to various financial instruments with off-balance sheet risk in the normal course of business to meet the financial needs of its customers. These financial instruments include commitments to extend credit and standby letters of credit. These instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amounts recognized in the consolidated balance sheets. The Bank's exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit is represented by the contractual notional amount of these instruments. The Bank uses the same credit policies in making these commitments and conditional obligations as it does for on-balance sheet instruments. The following is a summary of the various financial instruments entered into by the Bank (in thousands):
DECEMBER 31, ------------------- 2002 2001 -------- -------- Commitments to extend credit................................ $465,402 $344,507 Standby letters of credit................................... 18,296 19,470 Mortgages sold with recourse................................ 851,061 272,894
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. Since many of the commitments are expected to expire without being fully drawn upon, the total commitment amounts disclosed above do not necessarily represent future cash requirements. The Bank evaluates each customer's creditworthiness on a case-by-case basis. The amount of collateral obtained, if considered necessary by the Bank upon extension of credit, is based on management's credit evaluation of the customer. Standby letters of credit are conditional commitments issued by the Bank to guarantee the performance of a customer to a third party. The credit risk to the Bank in issuing letters of credit is essentially the same as that involved in extending loan facilities to its customers. The Bank's mortgage subsidiary, SCMC, sells mortgages in the secondary market either to dealers or investors. A portion of these loans are sold with recourse for a period which generally does not exceed one year. SCMC sells its non-conforming conventional loan production on a non-recourse basis. Other loans are sold with limited recourse. Regardless of the form of sale of loan production, and while SCMC generally does not retain primary credit risk, it does have potential liability under the representations and warranties it makes to purchasers and insurers of the loans. In the event of a breach of these representations and warranties, SCMC may be required to repurchase a mortgage loan. If SCMC is required to repurchase the mortgage loan or make additional payments to the purchaser, subsequent losses on the mortgage loan will be borne by SCMC. For the years ended December 2002 and 2001, these losses totaled $4.5 million and $0 respectively. As of December 31, 2002 and 2001, loans sold with recourse totaled $851 million and $273 million, respectively. 72 STERLING BANCSHARES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) U. REGULATORY MATTERS Capital Requirements -- The Company is subject to various regulatory capital requirements administered by the federal banking agencies. Any institution that fails to meet its minimum capital requirements is subject to actions by regulators that could have a direct material effect on its financial statements. Under the capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank must meet specific capital guidelines based on the Bank's assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices. The Company's capital amount and the Bank's classification under the regulatory framework for prompt corrective action are also subject to qualitative judgments by the regulators. To meet the capital adequacy requirements, the Company must maintain minimum capital amounts and ratios as defined in the regulations. Management believes, as of December 31, 2002 and 2001, that the Company and the Bank met all capital adequacy requirements to which they are subject. As of December 31, 2002, the most recent notification categorized the Bank as "adequate" under the regulatory capital framework for prompt corrective action and there have been no events since that notification that management believes have changed the Bank's category. To be categorized as well capitalized, the Bank must maintain minimum total risk-based, Tier I risk-based, and Tier I leverage ratios as set forth in the table:
TO BE WELL CAPITALIZED UNDER FOR CAPITAL PROMPT CORRECTIVE ACTUAL ADEQUACY PURPOSES ACTION PROVISIONS ---------------- ------------------ ------------------ AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO -------- ----- --------- ------ --------- ------ (IN THOUSANDS, EXCEPT PERCENTAGE AMOUNTS) CONSOLIDATED: As of December 31, 2002: Total Capital (to Risk Weighted Assets)............................... $292,010 9.29% $251,521 8.0% N/A N/A Tier I Capital (to Risk Weighted Assets)............................... 264,387 8.41% 125,761 4.0% N/A N/A Tier I Capital (to Average Assets)...... 264,387 7.81% 135,358 4.0% N/A N/A As of December 31, 2001: Total Capital (to Risk Weighted Assets)............................... $239,234 10.66% $179,538 8.0% N/A N/A Tier I Capital (to Risk Weighted Assets)............................... 216,307 9.64% 89,754 4.0% N/A N/A Tier I Capital (to Average Assets)...... 216,307 8.40% 103,003 4.0% N/A N/A STERLING BANK: As of December 31, 2002: Total Capital (to Risk Weighted Assets)............................... $308,426 9.82% $251,221 8.0% $314,027 10.0% Tier I Capital (to Risk Weighted Assets)............................... 280,803 8.94% 125,611 4.0% 188,416 6.0% Tier I Capital (to Average Assets)...... 280,803 8.31% 135,244 4.0% 169,055 5.0% As of December 31, 2001: Total Capital (to Risk Weighted Assets)............................... $231,694 11.37% $163,021 8.0% $203,777 10.0% Tier I Capital (to Risk Weighted Assets)............................... 211,356 10.38% 81,447 4.0% 122,171 6.0% Tier I Capital (to Average Assets)...... 211,356 8.73% 96,841 4.0% 121,052 5.0% LONE STAR BANK: As of December 31, 2001: Total Capital (to Risk Weighted Assets)............................... $ 15,623 11.94% $ 10,468 8.0% $ 13,085 10.0% Tier I Capital (to Risk Weighted Assets)............................... 14,025 10.72% 5,233 4.0% 7,850 6.0% Tier I Capital (to Average Assets)...... 14,025 8.23% 6,817 4.0% 8,521 5.0%
73 STERLING BANCSHARES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
TO BE WELL CAPITALIZED UNDER FOR CAPITAL PROMPT CORRECTIVE ACTUAL ADEQUACY PURPOSES ACTION PROVISIONS ---------------- ------------------ ------------------ AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO -------- ----- --------- ------ --------- ------ COMMUNITY BANK: As of December 31, 2001: Total Capital (to Risk Weighted Assets)............................... $ 9,421 12.10% $ 6,229 8.0% $ 7,786 10.0% Tier I Capital (to Risk Weighted Assets)............................... 8,449 10.86% 3,112 4.0% 4,668 6.0% Tier I Capital (to Average Assets)...... 8,449 5.46% 6,190 4.0% 7,737 5.0%
Dividend Restrictions -- Dividends paid by the Bank and the Company are subject to certain restrictions imposed by regulatory agencies. Under these restrictions there was an aggregate of approximately $67.2 million and $75.3 million available for payment of dividends at December 31, 2002, by the Bank and the Company, respectively. V. SEGMENTS The Company has two operating segments: commercial banking and mortgage banking. Each segment is managed separately because each business requires different marketing strategies and each offers different products and services. The accounting policies of the segments are the same as those described in Note A. The Company evaluates each segment's performance based on the profit or loss from its operations before income taxes. Intersegment financing arrangements are accounted for at current market rates as if they were with third parties. 74 STERLING BANCSHARES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) Summarized financial information by operating segment for the years ended December 31, 2002 and 2002 follows:
2002 2001 ---------------------------------- ---------------------------------- COMMERCIAL MORTGAGE COMMERCIAL MORTGAGE BANKING BANKING COMBINED BANKING BANKING COMBINED ---------- -------- ---------- ---------- -------- ---------- Net interest income...... $ 146,672 $ -- $ 146,672 $ 123,161 $ -- $ 123,161 Noninterest income....... 27,497 67,013 94,510 22,787 41,975 64,762 ---------- ------- ---------- ---------- ------- ---------- Total revenue.......... 174,169 67,013 241,182 145,948 41,975 187,923 Provision for credit losses................. 11,700 2,318 14,018 11,684 -- 11,684 Noninterest expense...... 113,386 58,966 172,352 101,921 26,602 128,523 ---------- ------- ---------- ---------- ------- ---------- Income from continuing operations before income taxes........... 49,083 5,729 54,812 32,343 15,373 47,716 Provision for income taxes.................. 15,778 2,361 18,139 10,451 6,280 16,731 ---------- ------- ---------- ---------- ------- ---------- Income from continuing operations.......... 33,305 3,368 36,673 21,892 9,093 30,985 Loss from discontinued operations before income taxes........... (183) -- (183) (905) -- (905) Provision for income taxes.................. (61) -- (61) (321) -- (321) ---------- ------- ---------- ---------- ------- ---------- Loss from discontinued operations............. (122) -- (122) (584) -- (584) ---------- ------- ---------- ---------- ------- ---------- Net Income............. $ 33,183 $ 3,368 $ 36,551 $ 21,892 $ 9,093 $ 30,401 ========== ======= ========== ========== ======= ========== Total assets............. $3,558,529 $24,216 $3,582,745 $2,762,463 $15,627 $2,778,090 ========== ======= ========== ========== ======= ==========
Intersegment interest was paid to Sterling Bank by SCMC in the amount of $27.7 million and $13.5 million for the years ended December 31, 2002 and 2001, respectively. Total loans in the mortgage warehouse line of credit of $640.3 million and $253.7 million were eliminated in consolidation at December 31, 2002 and 2001, respectively. W. DISCLOSURES ABOUT FAIR VALUE OF FINANCIAL STATEMENTS Fair values were estimated by management as of December 31, 2002 and 2001, and required considerable judgment. Accordingly, the estimates presented herein are not necessarily indicative of the amounts the Company could realize in a current market exchange. The use of different market assumptions and/or estimation methodologies may have a material effect on the estimated fair values presented. The following methods and assumptions were used to estimate the fair value of cash and of financial instruments for which it is practicable to estimate that value: Cash and Short-term Investments -- For cash and short-term investments, the carrying amount is a reasonable estimate of fair value. Securities -- For securities held as investment, fair value equals quoted market prices, if available. If a quoted market price is not available, fair value is estimated using quoted market prices for similar securities. Trading Assets -- Securities are bought with the anticipation of sale in the near term are carried at fair market value which equals quoted market prices. 75 STERLING BANCSHARES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) Loans Held for Sale -- For loans held for sale, fair value equals quoted market prices, if available. If a quoted market price is not available, the fair value is estimated by discounting the future cash flows using the current rates at which similar loans would be made to borrowers with similar credit ratings and for the same remaining maturities. Loans Held for Investment -- The fair value of loans is estimated by discounting the future cash flows using the current rates at which similar loans would be made to borrowers with similar credit ratings and for the same remaining maturities. Deposit Liabilities -- The fair value of demand deposits, savings accounts and certain money market deposits is the amount payable on demand at the reporting date. The fair value of certificates of deposit is estimated using the rates currently offered for deposits of similar remaining maturities. Other Borrowed Funds -- The carrying amounts approximate fair value because these borrowings reprice at market rates generally within four days. Commitments to Extend Credit, Standby Letters of Credit and Financial Guarantees Written -- The fair value of commitments is estimated using the fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the present creditworthiness of the counterparties. For fixed-rate loan commitments, fair value also considers the difference between current levels of interest rates and the committed rates. The fair value of guarantees and letters of credit is based on fees currently charged for similar agreements or on the estimated cost to terminate them or otherwise settle the obligations with the counterparties at the reporting date. The estimated fair values of the Company's financial instruments are as follows (in thousands):
DECEMBER 31, ------------------------------------------------- 2002 2001 ----------------------- ----------------------- CARRYING ESTIMATED CARRYING ESTIMATED AMOUNT FAIR VALUE AMOUNT FAIR VALUE ---------- ---------- ---------- ---------- Financial assets: Cash and short-term investments.... $ 140,511 $ 140,511 $ 155,826 $ 155,826 Available-for-sale securities...... 251,165 251,165 251,008 251,008 Held-to-maturity securities........ 61,889 64,785 78,408 79,928 Trading assets..................... 142,803 142,803 118,511 118,511 Loans held for sale................ 701,301 701,301 261,505 261,505 Loans held for investment.......... 1,910,565 1,935,489 1,636,140 1,651,195 Less allowance for credit losses... (27,621) (27,621) (22,927) (22,927) ---------- ---------- ---------- ---------- Total................................ $3,180,613 $3,208,433 $2,478,471 $2,495,046 ========== ========== ========== ========== Financial liabilities: Deposits........................... $2,532,902 $2,542,052 $2,138,601 $2,145,608 Other borrowed funds............... 509,590 509,590 180,298 180,298 ---------- ---------- ---------- ---------- Total................................ $3,042,492 $3,051,642 $2,318,899 $2,325,906 ========== ========== ========== ========== Off-balance-sheet instruments: Commitments to extend credit....... ( --) ( --) Standby letters of credit.......... ( --) ( --)
76 STERLING BANCSHARES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) X. SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED) The table below sets forth unaudited financial information for each quarter of the last two years (in thousands, except per share amounts):
2002 2001 ------------------------------------- ------------------------------------- FOURTH THIRD SECOND FIRST FOURTH THIRD SECOND FIRST QUARTER QUARTER QUARTER QUARTER QUARTER QUARTER QUARTER QUARTER ------- ------- ------- ------- ------- ------- ------- ------- Interest income............ $48,463 $45,681 $42,092 $40,155 $40,600 $44,065 $44,767 $40,986 Interest expense........... 7,912 7,505 7,045 7,257 8,638 11,647 13,114 13,858 ------- ------- ------- ------- ------- ------- ------- ------- Net interest income...... 40,551 38,176 35,047 32,898 31,962 32,418 31,653 27,128 Provision for credit losses................... 4,868 3,439 3,088 2,623 3,092 3,120 3,112 2,360 ------- ------- ------- ------- ------- ------- ------- ------- Net interest income after provision for credit losses................... 35,683 34,737 31,959 30,275 28,870 29,298 28,541 24,768 Noninterest income......... 28,931 27,268 22,566 15,745 19,297 13,659 18,910 12,896 Noninterest expense........ 49,280 48,190 40,382 33,678 34,441 29,104 34,828 26,969 Conversion costs related to acquisitions............. (151) 973 -- -- 957 1,194 -- 1,030 ------- ------- ------- ------- ------- ------- ------- ------- INCOME FROM CONTINUING OPERATIONS BEFORE INCOME TAXES........... 15,485 12,842 14,143 12,342 12,769 12,659 12,623 9,665 Provision for income taxes.................. 5,117 4,314 4,723 3,985 4,643 4,544 4,553 2,991 ------- ------- ------- ------- ------- ------- ------- ------- INCOME FROM CONTINUING OPERATIONS............. 10,368 8,528 9,420 8,357 8,126 8,115 8,070 6,674 INCOME FROM DISCONTINUED OPERATIONS BEFORE INCOME TAXES........... (23) (17) (55) (88) (201) (370) (287) (47) Provision for income taxes.................. (7) (7) (18) (29) (74) (128) (104) (15) ------- ------- ------- ------- ------- ------- ------- ------- INCOME FROM DISCONTINUED OPERATIONS............. (16) (10) (37) (59) (127) (242) (183) (32) ------- ------- ------- ------- ------- ------- ------- ------- NET INCOME............... $10,352 $ 8,518 $ 9,383 $ 8,298 $ 7,999 $ 7,873 $ 7,887 $ 6,642 ======= ======= ======= ======= ======= ======= ======= ======= Earnings per share: Basic.................... $ 0.24 $ 0.19 $ 0.21 $ 0.19 $ 0.19 $ 0.19 $ 0.19 $ 0.16 ======= ======= ======= ======= ======= ======= ======= ======= Diluted.................. $ 0.23 $ 0.19 $ 0.21 $ 0.19 $ 0.18 $ 0.19 $ 0.19 $ 0.16 ======= ======= ======= ======= ======= ======= ======= ======= Earnings per share from continuing operations: Basic.................... $ 0.24 $ 0.19 $ 0.21 $ 0.19 $ 0.19 $ 0.19 $ 0.19 $ 0.16 ======= ======= ======= ======= ======= ======= ======= ======= Diluted.................. $ 0.23 $ 0.19 $ 0.21 $ 0.19 $ 0.19 $ 0.19 $ 0.19 $ 0.16 ======= ======= ======= ======= ======= ======= ======= ======= Weighted average shares Basic.................... 43,940 43,917 43,849 43,779 42,558 42,263 42,080 41,809 ======= ======= ======= ======= ======= ======= ======= ======= Diluted.................. 44,687 44,872 44,797 44,658 43,346 43,224 42,886 42,711 ======= ======= ======= ======= ======= ======= ======= =======
Earnings per common share are computed independently for each of the quarters presented and therefore may not sum to the totals for the year. All quarters have been restated to present the combined financial information of acquisitions accounted for using the pooling of interests method. 77 STERLING BANCSHARES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) Y. PARENT-ONLY FINANCIAL STATEMENTS STERLING BANCSHARES, INC. (PARENT COMPANY ONLY) BALANCE SHEETS DECEMBER 31, 2002 AND 2001
DECEMBER 31, ------------------- 2002 2001 -------- -------- (IN THOUSANDS) ASSETS Cash and cash equivalents................................... $ 79 $ 546 Accrued interest receivable and other assets................ 5,188 3,527 Goodwill, net............................................... 527 527 Investment in bank subsidiaries............................. 345,216 291,496 Investment in Sterling Bancshares Capital Trusts............ 2,475 1,778 -------- -------- TOTAL....................................................... $353,485 $297,874 ======== ======== LIABILITIES AND SHAREHOLDERS' EQUITY LIABILITIES: Accrued interest payable and other liabilities............ $ 253 $ 348 Notes payable............................................. 21,430 20,879 Junior subordinated debentures............................ 82,475 59,278 -------- -------- Total liabilities................................. 104,158 80,505 COMMITMENTS AND CONTINGENCIES SHAREHOLDERS' EQUITY: Preferred stock........................................... 59 39 Common stock.............................................. 43,983 43,770 Capital surplus........................................... 44,633 42,526 Retained earnings......................................... 156,664 127,144 Accumulated other comprehensive income -- net unrealized loss on available-for-sale securities, net of tax...... 3,988 3,890 -------- -------- 249,327 217,369 -------- -------- TOTAL....................................................... $353,485 $297,874 ======== ========
78 STERLING BANCSHARES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) STERLING BANCSHARES, INC. (PARENT COMPANY ONLY) STATEMENTS OF INCOME FOR THE YEARS ENDED DECEMBER 31, 2002, 2001 AND 2000
2002 2001 2000 ------- ------- ------- (IN THOUSANDS) REVENUES: Dividends received from bank subsidiaries................. $12,650 $26,200 $ -- Interest income........................................... -- -- -- Other income.............................................. 150 -- -- ------- ------- ------- Total revenues......................................... 12,800 26,200 -- EXPENSES: Interest expense: Notes payable.......................................... 797 135 36 Junior subordinated debentures......................... 5,916 4,716 2,668 Goodwill amortization..................................... -- 28 28 General and administrative................................ 2,809 1,171 990 ------- ------- ------- Total expenses......................................... 9,522 6,050 3,722 Income (deficit) before equity in undistributed earnings of subsidiaries and income taxes............................. 3,278 20,150 (3,722) Equity in undistributed earnings of subsidiaries............ 30,021 8,162 29,982 ------- ------- ------- Income before income tax benefit............................ 33,299 28,312 26,260 Income tax benefit.......................................... 3,252 2,089 1,280 ------- ------- ------- Net income.................................................. $36,551 $30,401 $27,540 ======= ======= =======
79 STERLING BANCSHARES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) STERLING BANCSHARES, INC. (PARENT COMPANY ONLY) STATEMENTS OF CASH FLOWS FOR THE YEARS ENDED DECEMBER 31, 2002, 2001 AND 2000
YEAR ENDED DECEMBER 31, ----------------------------- 2002 2001 2000 -------- -------- ------- (IN THOUSANDS) CASH FLOWS FROM OPERATING ACTIVITIES: Net income................................................ $ 36,551 $ 30,401 $27,540 Adjustments to reconcile net income to net cash provided by operating activities: Amortization of goodwill............................... -- 28 28 Equity in undistributed earnings of subsidiary......... (30,021) (8,162) (29,982) Change in operating assets and liabilities: Accrued interest receivable and other assets......... (1,565) (1,471) 2,392 Accrued interest payable and other liabilities....... (263) 59 128 -------- -------- ------- Net cash provided by (used in) operating activities...................................... 4,702 20,855 106 CASH FLOWS FROM INVESTING ACTIVITIES: Purchase of CaminoReal Bancshares, Inc. .................. -- (51,813) -- Cash and cash equivalents acquired with CaminoReal Bancshares, Inc. ...................................... -- 115 -- Purchase of Community Bancshares, Inc. ................... -- (14,552) -- Cash and cash equivalents acquired with Community Bancshares, Inc. ...................................... -- 90 -- Purchase of ENB Bankshares, Inc. ......................... (10,386) -- -- Cash and cash equivalents acquired with ENB Bankshares, Inc. .................................................. 10 -- -- Capital contribution to Sterling Bancshares Capital Trust II..................................................... -- (889) -- Capital contribution to Sterling Bancshares Capital Trust III.................................................... (967) -- -- Capital contribution to Sterling Bancshares Statutory Trust One.............................................. (619) -- -- Redemption of investment in Sterling Bancshares Capital Trust I................................................ 889 -- -- Capital investment in subsidiary banks.................... (12,000) (10,750) -- -------- -------- ------- Net cash used in investing activities............. (23,073) (77,799) -- CASH FLOWS FROM FINANCING ACTIVITIES: Repayments of notes payable............................... (602) (1,600) -- Additions to long term debt............................... -- 20,000 -- Proceeds from issuance of common stock.................... 2,098 3,751 1,275 Proceeds from issuance of preferred stock................. 242 -- 385 Redemption of common stock................................ -- -- -- Purchase of treasury stock................................ -- -- (612) Payments of cash dividends................................ (7,031) (5,909) (5,243)
80 STERLING BANCSHARES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
YEAR ENDED DECEMBER 31, ----------------------------- 2002 2001 2000 -------- -------- ------- (IN THOUSANDS) Proceeds from issuance of junior subordinated debentures............................................. 52,836 29,639 -- Redemption of junior subordinated debentures.............. (29,639) -- -- -------- -------- ------- Net cash provided by (used in) financing activities...................................... 17,904 45,881 (4,195) -------- -------- ------- NET DECREASE IN CASH........................................ (467) (11,063) (4,089) CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR.............. 546 11,609 15,698 -------- -------- ------- CASH AND CASH EQUIVALENTS AT END OF YEAR.................... $ 79 $ 546 $11,609 ======== ======== =======
Z. SUBSEQUENT EVENT On February 28, 2003, Sterling Capital Mortgage Company (SCMC) completed the sale of loan servicing rights related to $728 million in loans to HSBC Mortgage Corporation. The sale generated a premium of $8.6 million. Mortgage servicing rights associated with this sale totaled $12.3 million, while the valuation allowance totaled $3.7 million resulting in no gain or loss being recorded. 81 EXHIBIT INDEX
EXHIBIT NUMBER DESCRIPTION - ------- ----------- 2.1 Agreement and Plan of Consolidation dated as of February 17, 1998, by and between the Company and Humble National Bank. [Incorporated by reference to the Company's Report on Form 8-K filed on February 27, 1998 (File No. 000-20750).] 2.2 Agreement and Plan of Merger dated as of June 12, 1998 among the Company, Sterling Bancorporation, and Hometown Bancshares, Inc., as amended. [Incorporated by reference to Exhibit 2.6 of the Company's Annual Report on Form 10-K (File No. 000-20750).] 2.3 Agreement and Plan of Merger dated as of February 24, 1999 among the Company, Sterling Bancorporation, and B. O. A. Bancshares, Inc., as amended. [Incorporated by reference to the Company's Report on Form 8-K filed on June 2, 1999 (File No. 000-20750).] 2.4 Agreement and Plan of Merger dated as of October 23, 2000 among the Company, Sterling Bancorporation, Inc. and CaminoReal Bancshares of Texas, Inc., as amended. [Incorporated by reference to Exhibit 2.5 of the Company's Annual Report on Form 10-K (File No. 000-20750).] 2.5 Agreement and Plan of Merger dated as of March 1, 2001, by and between Sterling Bancshares, Inc. and Lone Star Bancorporation, Inc., as amended. [Incorporated by referenced to Exhibit 2 of the Company's Quarterly Report on Form 10-Q filed on May 14, 2001 (File No. 000-20750).] 2.6 Agreement and Plan of Merger dated as of October 1, 2001 by and among Sterling Bancshares, Inc., Sterling Bancorporation, Inc. and Community Bancshares, Inc., as amended. [Incorporated by referenced to Exhibit 2.7 of the Company's Annual Report on Form 10-K (File No. 000-20750).] 2.7 Agreement and Plan of Merger Among Sterling Bancshares, Inc., Sterling Bancorporation, Inc. and ENB Bankshares Inc. dated as of May 22, 2002. [Incorporated by referenced to Exhibit 2.1 of the Company's Quarterly Report on Form 10-Q filed on August 14, 2002 (File No. 000-20750).] 2.8 Purchase and Assumption Agreement dated July 12, 2002 between Sterling Bank Inc. and James Wilson as amended by First Amendment to Purchase and Assumption Agreement dated as of August 2, 2002. [Incorporated by reference to Exhibit 2.2 of the Company's Quarterly Report on Form 10-Q filed on August 13, 2002 (File No. 000-20750).] 2.9* Purchase and Assumption Agreement dated as of October 29, 2002 between Sterling Bank Inc. and South Texas National Bank of Laredo. 3.1 Restated and Amended Articles of Incorporation of the Company, as amended. [Incorporated by reference to Exhibit 3.1 to the Registration Statement on Form S-3 (File Nos. 333-55724, 333-55724-01, and 333-55724-02).] 3.2 Articles of Amendment to the Restated and Amended Articles of Incorporation of Sterling Bancshares, Inc. [Incorporated by reference to Exhibit 3.2 of the Company's Quarterly Report on Form 10-Q filed on August 13, 2002 (File No. 000-20750).] 3.3 Amended and Restated Bylaws of Sterling Bancshares, Inc. [Incorporated by reference to Exhibit 3.3 of the Company's Quarterly Report on Form 10-Q filed on August 13, 2002 (File No. 000-20750).] 4.1 Preferred Securities Guarantee Agreement dated March 21, 2001. [Incorporated by reference to Exhibit 4.2 of the Company's Report on Form 8-K filed on March 21, 2001 (File No. 000-20750).] 4.2 Indenture dated March 21, 2001. [Incorporated by reference to Exhibit 4.4 of the Company's Report on Form 8-K filed on March 21, 2001 (File No. 000-20750).] 4.3 First Supplemental Indenture dated March 21, 2001. [Incorporated by reference to Exhibit 4.5 of the Company's Report on Form 8-K filed on March 21, 2001 (File No. 000-20750).] 4.4 9.20% Subordinated Deferrable Interest Debenture due March 21, 2031. [Incorporated by reference to Exhibit 4.7 of the Company's Report on Form 8-K filed on March 21, 2001 (File No. 000-20750).] 4.5 Indenture dated August 30, 2002. [Incorporated by reference to Exhibit 4.4 of the Company's Report on Form 8-K filed on September 12, 2002 (File No. 000-20750).] 4.6 Junior Subordinated Deferrable Interest Debenture due August 30, 2032. [Incorporated by reference to Exhibit 4.6 of the Company's Report on Form 8-K filed on September 12, 2002 (File No. 000-20750).]
EXHIBIT NUMBER DESCRIPTION - ------- ----------- 4.7 Guarantee Agreement dated August 30, 2002. [Incorporated by reference to Exhibit 4.6 of the Company's Report on Form 8-K filed on September 12, 2002 (File No. 000-20750).] 4.8 Preferred Securities Guarantee Agreement dated September 26, 2002. [Incorporated by reference to Exhibit 4.2 of the Company's Report on Form 8-K dated September 26, 2002 (File No. 000-20750).] 4.9 Second Supplemental Indenture dated September 26, 2002. [Incorporated by reference to Exhibit 4.9 of the Company's Report on Form 8-K dated September 26, 2002 (File No. 000-20750).] 4.10 8.30% Junior Subordinated Deferrable Interest Debenture due September 26, 2032. [Incorporated by reference to Exhibit 4.8 of the Company's Report on Form 8-K dated September 26, 2002 (File No. 000-20750).] 10.1** 1994 Incentive Stock Option Plan of the Company. [Incorporated by reference to Exhibit 10.1 of the Company's Annual Report on Form 10-K for the year ended December 31, 1994.] 10.2 1994 Employee Stock Purchase Plan of the Company. [Incorporated by reference to Exhibit 10.2 of the Company's Annual Report on Form 10-K for the year ended December 31, 1994.] 10.3** 1984 Incentive Stock Option Plan of the Company. [Incorporated by reference to Exhibit 10.1 of the Company's Registration Statement on Form S-1, effective October 22, 1992 (Registration No. 33-51476).] 10.4** 1995 Non-Employee Director Stock Compensation Plan. [Incorporated by reference to Exhibit 4.3 of the Company's Registration Statement on Form S-8 (File No. 333-16719).] 10.5 Credit Agreement dated February 2, 2002 made by and between the Company and Wells Fargo Bank Minnesota, National Association regarding a line of credit in the amount of $20,000,000. [Incorporated by reference to the Company's Annual Report on Form 10-K for the year ended December 31, 2001 (File No. 000-207501).] 10.6* First Amendment to Credit Agreement dated February 2, 2003 made by and between the Company and Wells Fargo Bank, National Association regarding a line of credit in the amount of $20,000,000. 10.7** Employment Agreement between Sterling Bancshares, Inc. and George Martinez executed on October 31, 2001 and effective as of January 1, 2002. [Incorporated by reference to Exhibit 99.2 of the Company's Report on Form 8-K filed on October 14, 2001 (File No. 000-207500).] 10.8** Employment Agreement between Sterling Bancshares, Inc. and J. Downey Bridgwater executed on October 31, 2001 and effective as of January 1, 2002. [Incorporated by reference to Exhibit 99.3 of the Company's Report on Form 8-K filed on October 14, 2001 (File No. 000-207500).] 10.9** Incentive Compensation Agreement between Sterling Bancshares, Inc. and Eugene S. Putnam effective as of January 1, 2002. [Incorporated by reference to Exhibit 10 of the Company's Quarterly Report on Form 10-Q filed on May 13, 2002 (File No. 000-207500).] 21* Subsidiaries of the Company 23.1* Consent of Deloitte & Touche LLP, Independent Auditors 99.1* Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. 99.2* Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
- --------------- * As filed herewith. ** Management Compensation Agreement EX-2.9 3 h03904exv2w9.txt PURCHASE & ASSUMPTION AGREEMENT EXHIBIT 2.9 ================================================================================ PURCHASE AND ASSUMPTION AGREEMENT BETWEEN STERLING BANK AND SOUTH TEXAS NATIONAL BANK OF LAREDO DATED AS OF OCTOBER 29, 2002 ================================================================================ Table of Contents
Page ---- ARTICLE I DEFINITIONS............................................................... 1 ARTICLE II ASSUMPTION OF LIABILITIES AND OBLIGATIONS................................. 6 2.1 Liabilities Assumed by the Assuming Bank.................................. 6 2.2 Interest on Deposits...................................................... 7 2.3 Assumption of Contracts................................................... 8 2.4 Informational Tax Reporting............................................... 8 ARTICLE III PURCHASE OF ASSETS........................................................ 8 3.1 Assets Purchased by the Assuming Bank..................................... 8 3.2 Manner of Conveyance; Limited Warranty; Nonrecourse; Etc.................. 8 3.3 Assets Not Purchased by the Assuming Bank................................. 9 ARTICLE IV BANK PREMISES; SAFE DEPOSIT BOXES; LETTERS OF CREDIT...................... 10 4.1 Bank Premises............................................................. 10 4.2 Agreement with Respect to Safe Deposit Business........................... 11 4.3 Letters of Credit......................................................... 11 ARTICLE V DUTIES WITH RESPECT TO DEPOSITORS OF THE PURCHASED BRANCH................. 11 5.1 Payment of Checks, Drafts and Orders...................................... 11 5.2 Certain Agreements Related to Deposits.................................... 11 5.3 Correspondent Banking Relationship........................................ 12 5.4 Settlement and Return Items............................................... 12 ARTICLE VI RECORDS................................................................... 12 6.1 Transfer of Records....................................................... 12 6.2 Delivery of Assigned Records.............................................. 13 6.3 Preservation of Records................................................... 13 6.4 Access to Records; Copies................................................. 13 ARTICLE VII PURCHASE PRICE; CLOSING................................................... 14 7.1 Purchase Price............................................................ 14
Table of Contents (continued)
Page ---- 7.2 Form of Payment........................................................... 14 7.3 Interest.................................................................. 14 7.4 Subsequent Adjustments.................................................... 14 7.5 Closing................................................................... 15 ARTICLE VIII CONTINUING COOPERATION.................................................... 15 8.1 General Matters........................................................... 15 8.2 Additional Title Documents................................................ 15 8.3 Payment of Deposits....................................................... 15 ARTICLE IX CONDITIONS PRECEDENT...................................................... 16 9.1 Conditions to Obligations of Each Party................................... 16 9.2 Additional Conditions to the Obligations of the Assuming Bank............. 16 9.3 Additional Conditions to the Obligations of Seller........................ 17 ARTICLE X REPRESENTATIONS AND WARRANTIES............................................ 18 10.1 Representations and Warranties of Seller.................................. 18 10.2 Representations and Warranties of the Assuming Bank....................... 21 ARTICLE XI CERTAIN COVENANTS OF SELLER AND THE ASSUMING BANK......................... 23 11.1 Covenants of Seller....................................................... 23 11.2 Covenants of the Assuming Bank............................................ 29 11.3 Solicitation of Employees................................................. 29 11.4 Best Efforts; Taking of Necessary Action.................................. 30 11.5 Use of Names, Trademarks and Service Marks................................ 31 11.6 Allocation of Purchase Price.............................................. 31 ARTICLE XII EMPLOYEE PLANS............................................................ 32 12.1 Employees; Participation in Assuming Bank Plans........................... 32 12.2 Claims Incurred Prior to and After Closing................................ 32 12.3 Severance Pay............................................................. 32 ARTICLE XIII INDEMNIFICATION........................................................... 33 13.1 Indemnification........................................................... 33 13.2 Limitations on Indemnification............................................ 34 13.3 Exclusivity of Remedies................................................... 34
ii Table of Contents (continued)
Page ---- ARTICLE XIV MISCELLANEOUS............................................................. 35 14.1 Entire Agreement.......................................................... 35 14.2 Headings.................................................................. 35 14.3 Governing Law............................................................. 35 14.4 Successors................................................................ 35 14.5 Modification; Assignment.................................................. 36 14.6 Notice.................................................................... 36 14.7 Manner of Payment......................................................... 37 14.8 Costs, Fees and Expenses.................................................. 37 14.9 Waiver.................................................................... 37 14.10 Severability.............................................................. 37 14.11 Termination of Agreement.................................................. 38 14.12 Survival of Representations and Warranties................................ 39 14.13 Public Notice............................................................. 39 14.14 Counterparts.............................................................. 39
Exhibits: Exhibit A - Form of Special Warranty Deed Exhibit B - Form of General Assignment and Bill of Sale Exhibit C - Form of Instrument of Assumption Schedules: Schedule 2.1 Liabilities Assumed Schedule 2.3 Contracts Schedule 3.1 Acquired Assets Schedule 10.1(b) Seller Consents Schedule 10.1(g) Litigation Schedule 10.1(h) Environmental Compliance Schedule 10.1(i) Loans Schedule 11.1(b) Public Funds Deposits Schedule 12.1 Employees Schedule 13.3 Environmental Laws iii PURCHASE AND ASSUMPTION AGREEMENT THIS AGREEMENT, made and entered into as of the 29th day of October, 2002 is by and between STERLING BANK, organized under the laws of the State of Texas and having its principal place of business in Houston, Texas ("Seller"), and SOUTH TEXAS NATIONAL BANK OF LAREDO, a national banking association having its principal place of business in Laredo, Texas (the "Assuming Bank"). WITNESSETH: WHEREAS, Seller desires to sell certain of the assets and liabilities of its branch located at 700 Quarry Street, Eagle Pass, Texas (the "Purchased Branch"); WHEREAS, Seller desires to sell and the Assuming Bank desires to purchase the banking business of Seller at the Purchased Branch on the terms and conditions set forth in this Agreement; and NOW THEREFORE, in consideration of the mutual promises herein set forth and other valuable consideration, the parties hereto agree as follows: ARTICLE I DEFINITIONS As used herein, words imparting the singular include the plural and vice versa. "ACH" means automated clearing house. "ACQUIRED ASSETS" means, without duplication, the operating assets of the Purchased Branch as of the Closing Date (other than the Excluded Assets) including (i) all Loans of the Purchased Branch other than Loans which are Excluded Assets, (ii) Bank Premises, Furniture and Equipment, and Fixtures including, but not limited to, all Furniture (including works of art, paintings, etc.) and Equipment and Fixtures identified on Schedule 3.1 hereto, and (iii) petty cash tickets and cash float related to the Purchased Branch on the Closing Date. "AFFILIATES" of a person means any director, officer or employee of such Person and any other Person (i) who is directly or indirectly controlling, or controlled by, or under common control with, such Person, or (ii) who is an affiliate of such Person as the term "affiliate" is defined in Section 2 of the Bank Holding Company Act of 1956, as amended. "AGREEMENT" means this Purchase and Assumption Agreement by and between Seller and the Assuming Bank, as amended or otherwise modified from time to time. "ASSUMED COMMITMENTS" means all commitments and all amendments, modifications, renewals, and extensions thereof, as reflected on the books and records of the Purchased Branch, that were legally binding on the Seller as of the Closing Date. "ASSUMED CONTRACTS" shall have the meaning provided in Section 2.3 of this Agreement. "ASSUMING BANK" shall have the meaning provided in the recitals on page one of this Agreement. "ASSUMING BANK INDEMNIFIED PERSONS" shall have the meaning provided in Section 13.1(a) of this Agreement. "BANK PREMISES" means (i) the banking and teller facilities (staffed or automated) together with appurtenant storage and service facilities, that are owned or leased by Seller which relate to the Purchased Branch and (ii) the raw land in Eagle Pass, Texas owned by Seller and which was acquired for expansion. "BOOK VALUE" means, with respect to any Acquired Asset and any Liability Assumed, the dollar amount thereof stated on the accounting records of Seller. The Book Value of any item shall be determined as of the Closing Date after adjustments made by Seller for differences in accounts, suspense items, unposted debits and credits, and other similar adjustments or corrections. Without limiting the generality of the foregoing, the Book Value of (i) a Liability Assumed shall include all accrued and unpaid interest thereon as of the Closing Date, (ii) a Loan shall reflect adjustments for earned or unearned interest (as it relates to the "rule of 78s" or add-on-interest loans, as applicable), if any, as of the Closing Date, and adjustments for the portion of earned or unearned loan-related credit life and/or disability insurance premiums and FAS 91 costs, if any, attributable to Seller as of the Closing Date, in each case as determined for financial reporting purposes, (iii) an Assumed Commitment shall be deemed to be zero, and (iv) the Bank Premises and Furniture and Equipment shall not exceed 105% of their fair market value (such fair market value to be mutually agreed by Seller and Assuming Bank). The Book Value of an Acquired Asset shall not include any adjustment for any general or specific reserves on the accounting records of Seller, except that Loans set forth on Seller's monitored loan list as of the Closing Date shall be net of Seller's allocated reserve with respect to such Loans as shall be mutually agreed to by Seller and the Assuming Bank. "BUSINESS DAY" means a day other than (i) a Saturday, Sunday, Federal legal holiday, or legal holiday under the laws of the State of Texas, or (ii) a day on which the principal office of Seller is closed. "CLOSING" shall have the meaning provided in Section 7.5 of this Agreement. "CLOSING DATE" shall have the meaning provided in Section 7.5 of this Agreement. "CLOSING BALANCE SHEET" shall have the meaning provided in Section 7.1(a) of this Agreement. "COBRA" shall mean the Consolidated Omnibus Budget Reconciliation Act of 1985, as amended. "COMMITMENT" shall have the meaning provided in Section 4.1 of this Agreement. "DEPOSIT" means a deposit, as defined in 12 U.S.C. Section 1813(l), including, without limitation, all uncollected items included in the depositors' balances and credited on the books of the Purchased Branch; provided, however, that for purposes of this Agreement, Deposit shall not include brokered deposits nor public fund deposits except those described on Schedule 11.1(b) hereof and renewals thereof. "EDP CONVERSION" shall have the meaning provided in Section 11.1(g) of this Agreement. "EXCLUDED ASSETS" shall have the meaning provided in Section 3.3 of this Agreement. "EXCLUDED LIABILITIES" shall have the meaning provided in Section 2.1(b) of this Agreement. "FIXTURES" means those improvements, additions, alterations and installations constituting all or a part of Bank Premises and which were acquired, added, built, installed, or purchased at the expense of Seller, regardless of the holder of legal title thereto as of the Closing Date. "FURNITURE AND EQUIPMENT" means the furniture and equipment, leased or owned by Seller and used by the Purchased Branch and reflected on the accounting records of Seller as of the Closing Date, including, without limitation, the furniture and equipment (other than personal computers) listed on Schedule 3.1 and all other carpeting, furniture, office machinery (excluding personal computers), shelving, office supplies, telephone, surveillance, and security systems, and artwork. "GOVERNMENTAL AUTHORITY" means any foreign governmental authority, the United States of America, any State of the United States, any local authority and any political subdivision of any of the foregoing, any multi-national organization or body, any agency, department, commission, board, bureau, court or other authority thereof, or any quasi-governmental or private body exercising, or purporting to exercise, any executive, legislative, judicial, administrative, police, regulatory or taxing authority or power of any nature. "INQUIRIES" shall have the meaning provided in Section 6.3 of this Agreement. "INTERIM BALANCE SHEET" shall have the meaning provided in Section 7.1(b) of this Agreement. "KNOWLEDGE" or "KNOWN" means an individual shall be deemed to have "knowledge" of or to have "known" a particular fact or other matter if such individual is actually aware of such fact or other matter. Seller shall be deemed to have "knowledge" of or to have "known" a particular fact or other matter if Patrick Oaks, Josh Yost, or any individual who is serving as a senior vice president, chief financial officer, or more senior officer of Seller has, or at any time had, actual awareness of such fact or other matter. "LIABILITIES ASSUMED" shall have the meaning provided in Section 2.1 of this Agreement. "LIENS" means any mortgage, lien, pledge, charge, assignment for security purposes, security interest, or encumbrance of any kind with respect to an Acquired Asset, including any conditional sale agreement or capital lease or other title retention agreement relating to such Acquired Asset. "LOANS" means all of the following owed to or held by the Purchased Branch as of the Closing Date and reflected on the Closing Balance Sheet: (i) loans, interests in loan participations, funded portions of lines of credit or credit plans (whether revolving or not, and whether commercial or consumer), consumer loans, residential mortgage loans, overdrafts of customers (including but not limited to overdrafts made pursuant to overdraft protection plans, cash reserve accounts, or similar extensions of credit in connection with demand deposit accounts) ("overdrafts"), letters of credit (as contemplated by Section 4.3) and United States and/or state-guaranteed student loans; (ii) all Liens, rights (including rights of set-off), remedies, powers, privileges, demands, claims, priorities, equities and benefits owned or held by, or accruing or to accrue to or for the benefit of, the holder of the obligations or instruments referred to in clause (i) above, including, but not limited to, those arising under or based upon the credit documents, casualty insurance policies and binders, standby letters of credit, mortgagee title insurance policies and binders, payment bonds and performance bonds at any time and from time to time existing with respect to any of the obligations or instruments referred to in clause (i) above; and (iii) all written amendments, modifications, renewals, extensions, refinancings, and refundings of or for any of the foregoing. "MATERIAL ADVERSE EFFECT" shall mean any material adverse change in the financial condition, assets, liabilities (absolute, accrued, contingent or otherwise), reserves, business or results of operations. "PERMITTED ENCUMBRANCES" shall mean with respect to any Acquired Assets, (i) statutory liens for taxes and special assessments not yet delinquent, (ii) covenants and restrictions, right-of-way, easements and other matters of public records (other than liens voluntarily created by Seller), (iii) any and all provisions of any ordinance, municipal regulation or public law, and (iv) other matters to which like properties commonly are subject which does not, individually or in the aggregate, materially interfere with the current use of such Acquired Asset. "PERSON" means any individual, corporation, partnership, joint venture, association, joint-stock company, trust, unincorporated organization or other entity, or government or any agency or political subdivision thereof. "POST-CLOSING SETTLEMENT PAYMENT" shall have the meaning provided in Section 7.1(b) of this Agreement. "PROVIDING PARTY" shall have the meaning provided in Section 11.1(f) of this Agreement. "PURCHASE PRICE" shall have the meaning provided in Section 7.1 of this Agreement. "PURCHASED BRANCH" shall have the meaning provided in the recitals on page one of this Agreement. "QUALIFIED BENEFICIARIES" shall have the meaning provided in COBRA. "RECEIVING PARTY" shall have the meaning provided in Section 11.1(f) of this Agreement. "RECORD" means any document, microfiche, microfilm and computer record (including but not limited to magnetic tape, disc storage, card forms and printed copy) or, where reasonable and appropriate, copies thereof, of the Purchased Branch relating to any of the Acquired Assets or Liabilities Assumed. "SAFE DEPOSIT BOXES" shall mean the safe deposit boxes of the Purchased Branch, if any, including the removable safe deposit boxes and safe deposit stacks in the Purchased Branch vault(s), all rights and benefits under rental agreements with respect to such safe deposit boxes, and all keys and combinations thereto. "SELLER" shall have the meaning provided in the recitals on page one of this Agreement. "SELLER'S RELATED PARTIES" shall have the meaning provided in Section 13.3 of this Agreement. "SETTLEMENT DATE" shall have the meaning provided in Section 7.1(b) of this Agreement. "SETTLEMENT PAYMENT" shall have the meaning provided in Section 7.1(b) of this Agreement. "SUBSIDIARY" shall have the meaning provided in 12 U.S.C. Section 1813(w)(4). "WELFARE BENEFIT PLANS" shall have the meaning provided in Section 3(1) of the Employee Retirement Income Security Act of 1974, as amended. ARTICLE II ASSUMPTION OF LIABILITIES AND OBLIGATIONS 2.1 LIABILITIES ASSUMED BY THE ASSUMING BANK. (a) Effective as of the Closing Date, except as otherwise provided in this Agreement, the Assuming Bank hereby expressly assumes at Book Value and agrees to pay, perform, and discharge (i) all liabilities of Seller in respect to Deposits of the Purchased Branch as of the Closing Date, (ii) ad valorem and personal property taxes applicable to any Acquired Asset, if any, and pro-rated as of the Closing Date, (iii) liabilities with respect to Assumed Commitments, (iv) liabilities with respect to the Assumed Contracts, and (v) other liabilities, if any, with respect to the Purchased Branch, the Deposits and the Safe Deposit Box businesses, and the Acquired Assets which are directly attributable to and used in the business of the Purchased Branch as reflected on the accounting records of Seller as of the Closing Date (collectively, the "Liabilities Assumed"). Prepaid expenses, other than expenses related to Federal Deposit Insurance Corporation premiums ("FDIC Premium"), of the Purchased Branch shall be prorated as of the Closing Date. The Assuming Bank shall pay to Seller, the pro rata portion of the FDIC Premium payment which is attributable to the Deposits being assumed as of the Closing Date by the Assuming Bank hereunder. Attached hereto as Schedule 2.1 is a list of all projected Liabilities Assumed as of the date of this Agreement (and Seller shall separately provide as of the date hereof a confidential detailed list of all Deposits). (b) Except for those liabilities and obligations specifically assumed by Assuming Bank under Subsection (a) above, Assuming Bank is not assuming any other duties, responsibilities, liabilities or obligations. Liabilities not assumed ("Excluded Liabilities") include, but are not limited to, the following: (i) Seller's cashier checks, letters of credit, money orders, interest checks and expense checks issued prior to Closing, consignments of U.S. Government "E" and "EE" bonds and any and all traveler's checks; (ii) Deposit accounts associated with qualified retirement plans where Seller is the trustee of such plan or the sponsor of a prototype plan used by such plan; (iii) All transactions related to or arising from credit card relationships with Seller, including, without limitation, merchant accounts; (iv) Any trust account, or liability or obligation of Seller used in, or made by or with respect to, the operations of Seller in its trust business; (v) All liabilities of Seller for individual retirement account or Keogh account deposits in which the custodial duties of Seller cannot be transferred to and assumed by Assuming Bank; (vi) All liabilities or claims, actual or contingent, made or unmade, from any person with regard to any aspect of the business, assets, liabilities or operation of the Purchased Branch prior to the Closing Date; (vii) (A) Any income, profits, franchise or similar tax relating to the business, assets, liabilities or operation of the Purchased Branch prior to the Closing Date; (B) any liability or claims for personal injury, property damage or consequential damages relating to the condition or operation of the Purchased Branch (including the Bank Premises and Furniture and Equipment), or otherwise, prior to the Closing Date; (C) any liability or losses due to or arising from forgery or from any fraud, defalcation or any other improper act or omission on the part of Seller or any of its officers, directors, employees, representatives or agents; (D) any liability or obligation of Seller arising out of any threatened or pending litigation relating to the Purchased Branch prior to the Closing Date or relating to Seller's other banking locations; or (E) any liability arising out of Seller's acts or omissions under any statute, rule or regulation, including, but not limited to, antitrust, banking, bank secrecy, Patriot Act, civil rights, health, safety, labor, discrimination and environmental laws, rules and regulations; and (viii) Except as specifically set out in Article XII of this Agreement, with respect to any employee or former employee of Seller, (A) any pension or other liabilities, (B) any liabilities arising from the employment by Seller of employees, or of the termination by Seller of employees (or any liabilities arising from any decision by the Assuming Bank not to hire Seller's employees), and (C) any liabilities arising by virtue of any collective bargaining relationship or agreement or pursuant to the National Labor Relations Act or any other labor relations law. 2.2 INTEREST ON DEPOSITS. The Assuming Bank agrees that, from and after the Closing Date, it will accrue and pay interest on Deposits assumed under this Agreement at the rate(s) at which Seller was legally obligated to accrue and pay interest on such Deposits as of the Closing Date. 2.3 ASSUMPTION OF CONTRACTS. Attached hereto as Schedule 2.3 is a list of all contracts, agreements, and other obligations that shall be assigned to, and assumed by, the Assuming Bank (the "Assumed Contracts") which Assumed Contracts relate specifically to the operation of the Purchased Branch, and include, as applicable, service contracts, maintenance contracts, consulting contracts, agency agreements and licensing agreements (but excluding contracts that relate to Seller's bank operations generally and that are not being assumed by the Assuming Bank); provided, however, that Schedule 2.3 need not list Assumed Contracts relating to the Deposits or the Safe Deposit Box contracts with customers at the Purchased Branch; and provided, further, that if Seller notifies the Assuming Bank not later than thirty (30) days prior to the Closing Date that one or more of such contracts or agreements may not be legally assigned, Seller shall not be required to assign such contracts or agreements at Closing and shall have no liability to the Assuming Bank as a result of its inability to accomplish such assignments. Assuming Bank shall assume no liabilities, obligations, duties or responsibilities relating to contracts, agreements, and other obligations which are not listed on Schedule 2.3. 2.4 INFORMATIONAL TAX REPORTING. Effective as of the Closing Date, the Assuming Bank agrees to perform all obligations of Seller with respect to federal and state income tax informational reporting with respect to the Purchased Branch including, but not limited to filing obligations with respect to Forms 940, 941, 1099, 1098, W-2 and back up withholding related to (i) the Acquired Assets and the Liabilities Assumed; and (ii) for periods after the Closing Date, compensation paid to employees and contractors of the Purchased Branch who have been hired by the Assuming Bank; provided, however, that Seller shall report savings bond interest for the full tax year in which the Closing occurs. Seller and the Assuming Bank agree to cooperate with each other in order to fulfill these and all other reporting obligations set forth or contemplated herein. ARTICLE III PURCHASE OF ASSETS 3.1 ASSETS PURCHASED BY THE ASSUMING BANK. Effective as of the Closing Date and subject to Section 3.3, the Assuming Bank shall purchase from Seller, and Seller shall sell, assign, transfer, convey, and deliver to the Assuming Bank, all right, title, and interest of Seller in and to the Acquired Assets. Attached as Schedule 3.1 is a list of all projected Acquired Assets as of the date of this Agreement. 3.2 MANNER OF CONVEYANCE; LIMITED WARRANTY; NONRECOURSE; ETC. THE CONVEYANCE OF ALL ACQUIRED ASSETS, INCLUDING REAL AND PERSONAL PROPERTY INTERESTS, PURCHASED BY THE ASSUMING BANK UNDER THIS AGREEMENT SHALL BE MADE, AS NECESSARY, BY DEED OR BILL OF SALE, "AS IS", "WHERE IS", WITHOUT RECOURSE AND, EXCEPT AS OTHERWISE SPECIFICALLY PROVIDED IN THIS AGREEMENT, WITHOUT ANY WARRANTIES WHATSOEVER WITH RESPECT TO SUCH ACQUIRED ASSETS, EXPRESS OR IMPLIED, WITH RESPECT TO TITLE, ENFORCEABILITY, COLLECTIBILITY, DOCUMENTATION, CONDITION, QUALITY, PERFORMANCE, MERCHANTABILITY OR FITNESS FOR A PARTICULAR PURPOSE OR FREEDOM FROM LIENS OR ENCUMBRANCES (IN WHOLE OR IN PART), OR ANY OTHER MATTERS. 3.3 ASSETS NOT PURCHASED BY THE ASSUMING BANK. The Assuming Bank does not purchase, or obtain an option to purchase under this Agreement, any of the following (the "Excluded Assets"): (a) any financial institution bonds, banker's blanket bonds, or any other similar insurance policy of Seller, or any proceeds payable with respect to any of the foregoing; (b) any interest, right, action, claim, or judgment of Seller or any of its Affiliates against (i) any officer, director, employee, accountant, attorney, or any other Person employed or retained by Seller or any of its Affiliates or any Subsidiary of Seller on or prior to the Closing Date arising out of any act or omission of such Person in such capacity, (ii) any underwriter of financial institution bonds, banker's blanket bonds or any other insurance policy of Seller, (iii) any shareholder or holding company of Seller, or (iv) any other Person whose action or inaction may be related to any loss (exclusive of any loss resulting from such Person's failure to pay on a Loan on the books of the Purchased Branch) incurred by Seller; provided, that for the purposes hereof, the acts, omissions, or other events giving rise to any such claim shall have occurred on or before the Closing Date, regardless of when any such claim is discovered and regardless of whether any such claim is made with respect to a financial institution bond, banker's blanket bond, or any other insurance policy of Seller in force as of the Closing Date; (c) legal or equitable interests in tax receivables of Seller, if any, including any claims arising as a result of Seller, as the case may be, having entered into any agreement or otherwise being joined with another Person with respect to the filing of tax returns or the payment of taxes; (d) insurance policies and agreements and the rights and benefits thereunder (including any prepaid assessments or prepaid insurance premiums, premium refunds derived from cancellation, proceeds payable with respect to any of the foregoing, and collateral pledged under such agreements and any rights to such collateral) of Seller with respect to insurance coverage for public liability, casualty, fire, extended coverage, and similar coverage provided with respect to assets of Seller; (e) any rights in or to any trademarks, service marks, copyrights, and trade, corporate, or fictitious names registered in the name of or owned by Seller or any of its Affiliates; (f) recoveries from legal actions or claims filed in any legal proceedings, including without limitation, bankruptcy and administrative proceedings, before the Closing Date; (g) any Loans, or portions thereof, charged-off or designated for charge-off prior to the Closing Date, and any recoveries on Loans charged-off or designated for charge-off prior to the Closing Date; (h) credit card relationships; (i) annuity, mutual fund or other brokerage accounts; (j) software; (k) goodwill and other intangibles; (l) repossessed assets or other real estate owned; (m) sign faces and sign surrounds; and (n) any tangible or intangible asset of Seller used in, or related to, the operations of Seller in its trust business. ARTICLE IV BANK PREMISES; SAFE DEPOSIT BOXES; LETTERS OF CREDIT 4.1 BANK PREMISES. (a) At Closing, Seller agrees to execute and deliver to the Assuming Bank a special warranty deed for the Bank Premises which are owned by Seller in substantially the form of Exhibit A attached hereto. (b) By the Closing Date, the Assuming Bank must receive, at its expense, a Commitment for Title Insurance (the "Commitment") and copies of all recorded instruments affecting title to the Bank Premises and recited as exceptions in such Commitment from a title insurance company reasonably acceptable to Seller for the issuance of an Owner Policy of Title Insurance, insuring good and indefeasible title in the Bank Premises as of the date of Closing, subject to: (i) the standard printed exceptions contained in the usual form of title policy; (ii) rights of parties in possession; (iii) standby fees, taxes and assessments for the current year and subsequent years, and subsequent assessments for prior years due to a change in land usage or ownership; (iv) any discrepancies, conflicts or shortages in area or boundary lines, or any encroachments or protrusions, or any overlapping of improvements; (v) covenants, restrictions, conditions, reservations, exceptions and easements shown of record; (vi) oil, gas, mineral and royalty conveyances, and leases of record, if any, in effect and shown of record; (vii) other conditions and encumbrances validly subsisting and affecting title to the Bank Premises as of the date of Closing; and (viii) all other matters to which like properties similarly situated are commonly subject, which do not, individually or in the aggregate, materially interfere with the current use of the Bank Premises. 4.2 AGREEMENT WITH RESPECT TO SAFE DEPOSIT BUSINESS. The Assuming Bank hereby assumes and agrees to discharge, from and after the Closing Date, in the usual course of conducting a banking business, the duties and obligations of Seller with respect to all Safe Deposit Boxes, if any, of the Purchased Branch and to maintain all of the necessary facilities for the use of such boxes by the renters thereof during the period for which such boxes have been rented and the rent therefor paid to Seller, subject to the provisions of the rental agreements between Seller, as the case may be, and the respective renters of such boxes. 4.3 LETTERS OF CREDIT. The Assuming Bank will use its reasonable efforts to replace all letters of credit of the Purchased Branch where Seller or CaminoReal Bank, or any predecessor thereto, is named as issuer, endorser or guarantor with letters of credit of the Assuming Bank. ARTICLE V DUTIES WITH RESPECT TO DEPOSITORS OF THE PURCHASED BRANCH 5.1 PAYMENT OF CHECKS, DRAFTS AND ORDERS. Effective as of the Closing Date and subject to Section 8.3, the Assuming Bank agrees to pay all properly drawn checks, drafts and withdrawal orders including, without limitation, electronic debit transactions, presented for payment by depositors of the Purchased Branch, whether drawn on the check or draft forms provided by Seller or the Assuming Bank, to the extent that the Deposit balances to the credit of the respective makers or drawers assumed by the Assuming Bank under this Agreement are sufficient to permit the payment thereof, and in all other respects to discharge, in the usual course of conducting a banking business, the duties and obligations of Seller with respect to the Deposit balances due and owing to the depositors of the Purchased Branch assumed by the Assuming Bank under this Agreement. 5.2 CERTAIN AGREEMENTS RELATED TO DEPOSITS. Effective as of the Closing Date and subject to Section 2.2, the Assuming Bank agrees to honor the terms and conditions of any written escrow or mortgage servicing agreement or other similar agreement relating to a Deposit assumed by the Assuming Bank pursuant to this Agreement. After the Closing Date, the Assuming Bank, at its sole expense, will issue to Deposit account customers checks with appropriate routing and transit numbers for use by such customers after the Closing Date. With respect to Deposit accounts, Seller will (i) pay interest payable, if any, on non-certificate deposit accounts and credit such interest to such accounts as of the Closing Date, and (ii) transfer to Assuming Bank, certificate of deposit accounts with both principal and accrued, but unpaid, interest. 5.3 CORRESPONDENT BANKING RELATIONSHIP. For a period not to exceed ninety (90) days after Closing Date, Seller agrees to receive all items (including, but not limited to ACH items) which contain Seller's transit routing number that are drawn on and presented for payment against a Deposit account of the Purchased Branch. Such items which Seller receives with respect to the Deposit accounts of the Purchased Branch shall be promptly transmitted or presented on their respective settlement dates to the Assuming Bank. Items received after the 90th day after the Closing Date will be returned by Seller to the originator. Likewise, the Assuming Bank agrees to promptly send to the appropriate Federal Reserve Bank any return items. The Assuming Bank further agrees to issue and furnish to Seller notifications of change with respect to each ACH item received containing Seller's transit routing number drawn against a Deposit account of the Purchased Branch and Assuming Bank agrees to submit a notification of change to the appropriate Federal Reserve Bank. Seller and the Assuming Bank both agree to comply with applicable clearinghouse association rules, Regulation CC of the Board of Governors of the Federal Reserve System and any other applicable law. During such ninety (90) day period ACH items will be delivered by Seller to Assuming Bank in NACHA format each business morning. Seller shall not be required to break-out or otherwise isolate ACH items pertaining to the Purchased Branch received on the last processing day prior to the Closing. 5.4 SETTLEMENT AND RETURN ITEMS. Subject to Section 5.3, settlement, return items, servicing fees, loan payments received and other transaction matters shall be processed in accordance with a service agreement mutually agreeable to the parties to be executed by Seller and Assuming Bank prior to the Closing Date. ARTICLE VI RECORDS 6.1 TRANSFER OF RECORDS. Effective as of the Closing Date, Seller shall assign, transfer, convey and deliver to the Assuming Bank the following Records (in original) pertaining to Deposits of the Purchased Branch: signature cards, orders, contracts between the Seller and the depositors of the Purchased Branch, and Records of similar character pertaining to the Deposit account relationships of the Purchased Branch assumed by the Assuming Bank under this Agreement, except as provided in Section 6.4. Effective as of the Closing Date, Seller shall assign, transfer, convey and deliver to the Assuming Bank the following Records (in original) pertaining to the Acquired Assets and Liabilities Assumed: (i) Loan and collateral records and credit documents and other documents; (ii) deeds, mortgages, abstracts, surveys, and other instruments or records of title pertaining to real estate or real estate mortgages, if any; and (iii) Safe Deposit Box agreements, if any; (iv) any other Records, whether held at the Purchased Branch or Seller's other branches/business locations, that relate to the Acquired Assets or Liabilities Assumed, (including Records relating to the Assuming Bank's obligations under Section 2.4, taxpayer information on all depositors of the Purchased Branch, documents of title relating to the Bank Premises, Furniture and Equipment, and Fixtures, and ATM cardholders/users) to the extent such Records are not commingled with Records of Seller relating to its other branches/business locations; and, upon request, all other Records which are required for the Assuming Bank to perform its obligations and exercise its rights under this Agreement. 6.2 DELIVERY OF ASSIGNED RECORDS. Seller shall deliver to the Assuming Bank all Records described in Section 6.1 as soon as practicable on or after the Closing Date, and shall not use any retained records for any purpose except as contemplated by Section 6.4 or as may be required by applicable law. 6.3 PRESERVATION OF RECORDS. The Assuming Bank agrees that it will preserve and maintain for the joint benefit of, Seller and the Assuming Bank, all Records of which it has custody for such period as may be required by law or regulation. The Assuming Bank shall have the primary responsibility to respond to subpoenas, discovery requests, and other similar official inquiries ("Inquiries") with respect to the Records of which it has custody. Seller shall have primary responsibility to respond to Inquiries with respect to the Records of which it has custody. Seller and Assuming Bank agree to provide to each other copies of all Inquiries delivered to Seller or the Assuming Bank promptly upon determination that such Inquiry relates to the Purchased Branch. 6.4 ACCESS TO RECORDS; COPIES. Subject to applicable law, the Assuming Bank and Seller agree to permit the other party access to all Records of which the Assuming Bank or Seller has custody, and to use, inspect, make extracts from or request copies of any such Records in the manner and to the extent requested, and to duplicate, any Record in the form of microfilm or microfiche pertaining to Deposit account relationships of the Purchased Branch for the sole purpose of responding to Inquiries, requests of customers of the Purchased Branch for their account history information, or in furtherance of the rights and duties described herein. On or before the 30th day after the Closing Date, copies of Records will be provided without charge to the party requesting such copies. Beginning on the 31st day after the Closing Date, the party requesting a copy of any Record shall bear the cost (based on standard accepted industry charges to the extent applicable) for providing such duplicate Records. A copy of each Record requested and documentation evidencing the relevant Inquiry or customer request shall be provided as soon as practicable by the party having custody thereof. ARTICLE VII PURCHASE PRICE; CLOSING 7.1 PURCHASE PRICE. (a) Subject to subsection (c) below, the purchase price ("Purchase Price") of the Acquired Assets shall equal the sum of (a) an amount (which may be negative) determined by Seller and the Assuming Bank pursuant to Articles II and III equal to the aggregate Book Value of the Acquired Assets, minus the aggregate Book Value of the Liabilities Assumed which shall be reflected on a balance sheet dated as of the Closing Date and based on Seller's accounting records as of the close of business on the Closing Date ("Closing Balance Sheet"), plus (b) a premium in an amount equal to 7.5% of Deposits as of the close of business on the Closing Date. (b) For the purpose of the Closing, the amount due Seller or the Assuming Bank, respectively, pursuant to subsection (a) hereof shall be estimated as of the month end prior to Closing Date ("Interim Balance Sheet") and a settlement payment ("Settlement Payment") shall be made at Closing based upon the Interim Balance Sheet. Within 10 days prior to the Closing Date, or at such time as the parties mutually agree, Seller and the Assuming Bank shall jointly determine the Settlement Payment required at Closing. Within 30 days after the Closing Date, or at such time as the parties may mutually agree, Seller and the Assuming Bank shall jointly determine the actual settlement payment required by subsection (a) above and the Closing Balance Sheet, as applicable, and make appropriate adjustments ("Post-Closing Settlement Payment"). (c) In the event any bookkeeping omissions or errors are discovered in preparing any balance sheet for the Purchased Branch or in completing the transfer and assumptions contemplated hereby, the parties agree to correct such errors and omissions, it being understood that no adjustments will be made that are inconsistent with the judgments, methods, policies, or accounting principles utilized by Seller in preparing and maintaining the accounting records of the Purchased Branch. Adjustments made pursuant to this Section 7.1(c) are not intended to bring the accounting records of the Purchased Branch into accordance with generally accepted accounting principles. 7.2 FORM OF PAYMENT. The Settlement Payment shall be made in immediately available funds on the Closing Date by the Assuming Bank if the Settlement Payment is a positive number and by Seller if the Settlement Payment is a negative number. 7.3 INTEREST. The Post-Closing Settlement Payment shall bear no interest. 7.4 SUBSEQUENT ADJUSTMENTS. In the event that the Assuming Bank or Seller discovers any errors or omissions as contemplated by Section 7.1(c) or any error with respect to the payments made under Section 7.1(b) after the Settlement Date, the Assuming Bank and Seller agree to promptly correct any such error or omission, make any payments and effect any transfers or assumptions as may be necessary to reflect any such correction; provided, that interest shall not be paid with respect to any such payments. 7.5 CLOSING. Unless this Agreement shall have been terminated and the transactions herein contemplated shall have been abandoned pursuant to the provisions of Section 14.11, and subject to the conditions of Article IX hereof, the closing (the "Closing") of the purchase and assumption of the Acquired Assets and Liabilities Assumed as provided by Sections 2.1 and 3.1 shall take place at 10:00 a.m., Houston, Texas time, at the offices of Locke Liddell & Sapp LLP, Houston, Texas, on a mutually agreeable date within ten (10) business days or as promptly as practicable after receipt of all regulatory approvals, the expiration of all waiting periods and the satisfaction of all conditions to Closing under this Agreement, or at such other place, time and date as the parties may agree. The date and time of the Closing are herein referred to as the "Closing Date." For purposes of this Agreement, the Closing shall be deemed to be effective immediately following the close of business on the date on which the Closing shall occur. ARTICLE VIII CONTINUING COOPERATION 8.1 GENERAL MATTERS. The parties hereto agree that they will, in good faith and with their best efforts, cooperate with each other to carry out the transactions contemplated by this Agreement and to effect the purposes hereof. 8.2 ADDITIONAL TITLE DOCUMENTS. Seller and the Assuming Bank each agree, at any time, and from time to time, upon the request of any party hereto, to execute and deliver such additional instruments and documents of conveyance as shall be reasonably necessary to vest in the appropriate party its full legal or equitable title in and to the property transferred pursuant to this Agreement or to be transferred in accordance herewith. The Assuming Bank shall prepare such instruments and documents of conveyance (in form and substance satisfactory to Seller) as shall be necessary to vest title in the Assuming Bank to the Acquired Assets. The Assuming Bank shall be responsible for recording such instruments and documents of conveyance at its own expense. 8.3 PAYMENT OF DEPOSITS. (a) In the event any depositor does not accept the obligation of the Assuming Bank to pay any Deposit of the Purchased Branch assumed by the Assuming Bank pursuant to this Agreement and asserts a claim against Seller for all or any portion of any such Deposit, the Assuming Bank agrees on demand to provide to Seller, as the case may be, funds sufficient to pay such claim in an amount not in excess of the Deposit reflected on the books of the Assuming Bank at the time such claim is made. Upon payment of such amount by the Assuming Bank to Seller, as the case may be, the Assuming Bank shall be discharged from any further obligation under this Agreement to pay to any such depositor the amount of such Deposit paid to Seller. (b) For a period of one hundred and eighty (180) days after the Closing Date, Seller shall promptly reimburse the Assuming Bank for any (i) amount the Assuming Bank refunds to depositors of the Purchased Branch in interest adjustments after the Closing Date arising out of errors occurring prior to the Closing Date, and (ii) any prepaid fees which the Assuming Bank is required to refund to depositors of the Purchased Branch after the Closing Date as a result of the cancellation of services formerly provided by Seller, in accordance with the applicable schedules of service charges for which such depositors had prepaid Seller prior to the Closing Date. ARTICLE IX CONDITIONS PRECEDENT 9.1 CONDITIONS TO OBLIGATIONS OF EACH PARTY. The respective obligations of each party under this Agreement are subject to the fulfillment at or prior to the Closing Date of the condition precedent that no preliminary or permanent injunction or other order, decree or ruling issued by a court of competent jurisdiction or by a Governmental Authority nor any statute, rule, regulation or executive order promulgated or enacted by any Governmental Authority shall be in effect enjoining or otherwise materially impairing the consummation of the transactions contemplated by this Agreement. 9.2 ADDITIONAL CONDITIONS TO THE OBLIGATIONS OF THE ASSUMING BANK. The obligations of the Assuming Bank are also subject to fulfillment (or waiver by the Assuming Bank) at or prior to the Closing Date of each of the following conditions precedent: (a) Representations and Warranties True. The representations and warranties of Seller contained in Section 10.1 of this Agreement shall be true and correct as of the date hereof and as of the Closing Date (other than any inaccuracies which individually or in the aggregate would not materially and adversely affect the ability of Seller to perform, satisfy or observe any obligation or condition under this Agreement) as though made at and as of the Closing Date, except to the extent that they expressly refer to an earlier time. (b) Performance of Covenants. Seller shall have duly performed and complied in all material respects with each covenant, agreement and condition required by this Agreement to be performed or complied with by it prior to or on the Closing Date. (c) Regulatory Approvals. All regulatory approvals necessary for the consummation by the Assuming Bank of the sale and assumption contemplated by this Agreement shall have been obtained and be in full force and effect, and all required waiting periods shall have expired or been terminated. (d) Officer's Certificate. The Assuming Bank shall have received from a duly authorized senior officer of Seller a certificate as to the matters described in Sections 9.2(a), 9.2(b) and 9.2(f). (e) Deed; Bill of Sale and Assignment. The Assuming Bank shall have received from Seller a special warranty deed in substantially the form of Exhibit A attached hereto, and a bill of sale and assignment in substantially the form of Exhibit B attached hereto. (f) No Material Adverse Effect. Nothing shall have occurred which has a Material Adverse Effect with respect to the Purchased Branch since the date hereof. (g) Title Insurance. The Assuming Bank shall have obtained a Commitment in accordance with Section 4.1(b), in a form and with such exceptions that are consistent with Section 4.1(b) and endorsements that are acceptable to the Assuming Bank. 9.3 ADDITIONAL CONDITIONS TO THE OBLIGATIONS OF SELLER. The obligations of Seller are also subject to fulfillment (or waiver by Seller) at or prior to the Closing Date of each of the following conditions precedent: (a) Representations and Warranties True. The representations and warranties of the Assuming Bank contained in Section 10.2 of this Agreement shall be true and correct as of the date hereof and as of the Closing Date (other than any inaccuracies which would not materially and adversely affect the ability of the Assuming Bank to perform, satisfy or observe any obligation or condition under this Agreement) as though made at and as of the Closing Date, except to the extent they expressly refer to an earlier time. (b) Performance of Covenants. The Assuming Bank shall have duly performed and complied in all material respects with each covenant, agreement and condition required by this Agreement to be performed or complied with by it prior to or on the Closing Date. (c) Regulatory Approvals. All regulatory approvals necessary for the consummation by the Assuming Bank of the sale and assumption contemplated by this Agreement shall have been obtained and be in full force and effect, and all required waiting periods shall have expired or been terminated. (d) Officer's Certificate. Seller shall have received from a duly authorized senior officer of the Assuming Bank a certificate as to the matters described in Sections 9.3(a), 9.3(b) and 9.3(c). (e) Instrument of Assumption. Seller shall have received from the Assuming Bank an instrument of assumption in substantially the form of Exhibit C attached hereto. ARTICLE X REPRESENTATIONS AND WARRANTIES 10.1 REPRESENTATIONS AND WARRANTIES OF SELLER. Seller represents and warrants to the Assuming Bank as follows: (a) Corporate Existence and Authority. Seller (i) is duly organized, validly existing and in good standing under the laws of the State of Texas and has full power and authority to own and operate its properties and to conduct its business as now conducted by it, and (ii) subject to regulatory approval, has full power and authority to execute and deliver this Agreement and to perform its obligations under this Agreement in accordance with its terms. Seller has taken all necessary corporate action to authorize the execution, delivery and performance of this Agreement and the performance of the transactions contemplated hereby. (b) Third Party Consents. Except as set forth on Schedule 10.1(b), no Governmental Authority or other third party consents (including but not limited to approvals, licenses, registrations, or declarations) are required in connection with execution, delivery, or performance by Seller of this Agreement. (c) Execution and Enforceability. This Agreement has been duly executed and delivered by Seller. Upon the due authorization, execution and delivery of this Agreement by the Assuming Bank, this Agreement will constitute the legal, valid and binding obligation of Seller, enforceable, (subject to regulatory approval) in accordance with its terms, except as such enforceability may be limited by bankruptcy, insolvency, reorganization, moratorium or other similar laws relating to or affecting creditors rights generally and by general equity principles. (d) Title and Right to Convey. Seller has good title to, and is the sole owner of, all of the Acquired Assets, free and clear of any lien, pledge, claim, security interest, encumbrance, charge or restriction of any kind; except for the Permitted Encumbrances. (e) Compliance with Law. (i) The Acquired Assets and Liabilities Assumed are not in violation of any statute, regulation, order, decision, judgment, or decree of, or any restriction imposed by any Governmental Authority having jurisdiction over Seller or any assets or liabilities of Seller, or any foreign government or agency thereof having such jurisdiction, with respect to the conduct of the business of Seller, the nature of the Deposits of the Purchased Branch held by Seller or the ownership of the assets of Seller, which, either individually or in the aggregate with all other such violations, would materially and adversely affect the Acquired Assets or the Liabilities Assumed, or the ability of Seller to perform, satisfy, or observe any obligation or condition under this Agreement or which would otherwise have a Material Adverse Effect on the Purchased Branch. (ii) Neither the execution and delivery nor the performance by Seller of this Agreement will result in any violation by Seller of, or be in conflict with, any provision of any applicable law or regulation, or any order, writ, or decree of any Governmental Authority. (iii) The Deposits are insured by the FDIC to the fullest extent permitted by law, and all premiums and assessments due and payable in connection therewith have been paid by Seller. (iv) All Records and accountings of Seller (including, when prepared, the Interim Closing Balance Sheet and Closing Balance Sheet) are maintained in all material respects in accordance with applicable legal and accounting requirements, reflect only actual transactions, and reflect in all material respects assets, liabilities, accruals and items of income and expense in accordance with generally accepted accounting principles consistently applied. All Records and accountings of the Purchased Branch are true, complete and correct in all material respects. (f) Compliance with Law and Other Obligations. (i) Seller is not in violation or breach of or in default under (A) any obligation, agreement, covenant, or condition contained in its charter or organizational documents, articles of association, or by-laws or (B) any contract, lease, or other instrument to which Seller is a party (or which is binding on Seller or any assets of Seller), which violation, breach, or default, either individually or in the aggregate with all such other violations, breaches and defaults, would materially and adversely affect the Acquired Assets or the Liabilities Assumed or Seller's ability to perform, satisfy, or observe any obligation or condition under this Agreement or which would otherwise have a Material Adverse Effect on the Purchased Branch. (ii) Neither the execution and delivery nor the performance by Seller of this Agreement will result in a violation, breach of, or default under or be in conflict with: (A) its organizational documents or charter, articles of association, or by-laws, or (B) any other agreement or instrument to which Seller is a party, or which is binding on Seller or the assets of Seller, or (C) any order, decree, award, or judgment issued by any Governmental Authority which is binding on Seller or any assets of Seller, and will not result in the creation of any Lien on the assets of Seller. (g) Litigation. Except as set forth on Schedule 10.1(g) hereto, there is no legal action, suit, investigation or proceeding (whether or not Seller is a party thereto), claim, controversy or contingent liability pending or, to Seller's knowledge, threatened against Seller, any assets of Seller or the Purchased Branch, which questions the validity of this Agreement, any Assumed Contract or any of the transactions contemplated hereby or which would, if adversely determined, either individually or in the aggregate with all such other actions, suits, investigations or proceedings if adversely determined, materially and adversely affect the Acquired Assets or the Liabilities Assumed or Seller's ability to perform, satisfy, or observe any obligation or condition under this Agreement or which would otherwise have a Material Adverse Effect on the Purchased Branch. There is no injunction, order, judgment, decree, or regulatory restriction imposed upon Seller or the Purchased Branch that, either individually or in the aggregate (i) has had since March 22, 2001, or could reasonably be expected to have, a Material Adverse Effect on the Purchased Branch, or (ii) which has affected, or could reasonably be expected to affect, in a materially adverse manner, the Acquired Assets, the Liabilities Assumed or Seller's ability to perform, satisfy or observe any obligation or condition under this Agreement. To the knowledge of Seller, there are no facts, circumstances or conditions affecting the Purchased Branch which would indicate or suggest the possibility of any unrecognized future loss caused (A) by defalcation, embezzlement or other employee malfeasance, or by (B) payments made, cash transactions effected or Deposits accepted in violation of any law, rule or regulation. (h) Environmental Compliance. To Seller's knowledge and except as set forth on Schedule 10.1(h), the Seller is in compliance in all material respects with all material federal, state, and local laws, regulations, and ordinances relating to the environment and to the release, emission or discharge of materials, wastes, substances, pollutants or contaminants into the air, ground, or water applicable to the Bank Premises. There are no material actions, suits, or proceedings pending or, to Seller's knowledge, threatened against Seller by or before any Governmental Authority, concerning any noncompliance or alleged noncompliance with any such laws, regulations, and ordinances. (i) Loans. (i) Except as set forth on Schedule 10.1(i), to the knowledge of Seller, (A) each of the Loans was validly and legally made and constitutes a valid and binding agreement of the borrower enforceable in accordance with its terms subject to bankruptcy, insolvency, reorganization, moratorium and similar laws affecting the rights and remedies of creditors generally and subject to general principles of equity; (B) any mortgage or security agreement relating to each Loan is properly secured and recorded or perfected and represents a valid mortgage or security interest on properties described therein; and (C) no amount owed under any Loan is subject to any meritorious defenses. Seller has not entered into any agreement which, to Seller's knowledge, will result in a future waiver or negation of any material rights or remedies currently available against the borrower (or guarantor, if any) on any such Loan. To Seller's knowledge, no claim, counterclaim, set-off right or other similar right has been asserted, and no grounds for any meritorious claim, counterclaim, set-off right or other similar right exists, with respect to any Loan which could impair the collectability thereof. (ii) Except as set forth on Schedule 10.1(i), each mortgage securing a Loan has been, since March 22, 2001, and is evidenced by documentation of the types customarily employed by Seller, which are consistent in all material respects with federal and state banking laws, rules and regulations, and prudent banking practices and standards, and complete copies thereof have been maintained by Seller in accordance with such standards and practices. Seller has duly performed in all material respects all of its obligations under such documentation to the extent that such obligations to perform have accrued. (iii) Except as set forth on Schedule 10.1(i), to Seller's knowledge, since March 22, 2001, all of the Loans currently held by the Purchased Branch were solicited, originated and currently exist in material compliance with all applicable loan policies and procedures of Seller (as previously described to the Assuming Bank) and comply in all material respects with all applicable federal and state laws, rules and regulations (including applicable usury statutes, the Truth in Lending Act, the Equal Credit Opportunity Act, the Real Estate Settlement Procedures Act, the Flood Disaster Protection Act, and other applicable consumer protection statutes and the regulations thereunder). (iv) If, under generally accepted accounting principles, any reserve should be established in respect of any Loan (or in respect of all Loans in the aggregate as an unallocated reserve), such reserve has been established with respect to such Loan or Loans in the amount set out in Schedule 10.1(i). (v) Each reserve (if any) identified in Schedule 10.1(i) is adequate, in the reasonable and good faith judgment of Seller, to absorb any loss which may occur in respect of the Loan or Loans to which such reserve relates. 10.2 REPRESENTATIONS AND WARRANTIES OF THE ASSUMING BANK. The Assuming Bank represents and warrants to Seller as follows: (a) Corporate Existence and Authority. The Assuming Bank (i) is duly organized, validly existing and in good standing under the laws of the United States and has full power and authority to own and operate its properties and to conduct its business as now conducted by it, and (ii) subject to regulatory approval, has full power and authority to execute and deliver this Agreement and to perform its obligations under this Agreement in accordance with its terms. The Assuming Bank has taken all necessary corporate action to authorize the execution, delivery and performance of this Agreement and the performance of the transactions contemplated hereby. (b) Third Party Consents. Except for the consent of the Office of the Comptroller of the Currency under 12 U.S.C. Section 1828(c), no Governmental Authority or other third party consents (including but not limited to approvals, licenses, registrations, or declarations) are required in connection with execution, delivery, or performance by the Assuming Bank of this Agreement. (c) Execution and Enforceability. This Agreement has been duly executed and delivered by the Assuming Bank. Upon the due authorization, execution and delivery of this Agreement by Seller, this Agreement will constitute the legal, valid and binding obligation of the Assuming Bank, enforceable (subject to regulatory approval) in accordance with its terms except as such enforceability may be limited by bankruptcy, insolvency, reorganization, moratorium or other similar laws relating to or affecting creditors rights generally and by general equity principles. (d) Compliance with Law. (i) The Assuming Bank is not in violation of any statute, regulation, order, decision, judgment, or decree of, or any restriction imposed by any Governmental Authority having jurisdiction over the Assuming Bank or any of its assets, or any foreign government or agency thereof having such jurisdiction, with respect to the conduct of the business of the Assuming Bank, or the ownership of the properties of the Assuming Bank, which, either individually or in the aggregate with all other such violations, would materially and adversely affect the ability of the Assuming Bank to perform, satisfy, or observe any obligation or condition under this Agreement. (ii) Neither the execution and delivery nor the performance by the Assuming Bank of this Agreement will result in any violation by the Assuming Bank of, or be in conflict with, any provision of any applicable law or regulation, or any order, writ, or decree of any Governmental Authority. (e) Compliance with Obligations. (i) The Assuming Bank is not in violation or breach of or in default under (A) any obligation, agreement, covenant, or condition contained in its charter or organizational documents, articles of association, or by-laws or (B) any contract, lease, or other instrument to which the Assuming Bank is a party (or which is binding on the Assuming Bank or any assets of the Assuming Bank), which violation, breach, or default, either individually or in the aggregate with all such other violations, breaches and defaults, would materially and adversely affect the Assuming Bank's ability to perform, satisfy, or observe any obligation or condition under this Agreement. (ii) Neither the execution and delivery nor the performance by the Assuming Bank of this Agreement will result in a violation, breach of, or default under or be in conflict with: (A) its organizational documents or charter, articles of association, or by-laws, or (B) any other agreement or instrument to which the Assuming Bank is a party, or which is binding on the Assuming Bank or the assets of Assuming Bank, or (C) any order, decree, award, or judgment issued by any Governmental Authority which is binding on the Assuming Bank or any assets of Assuming Bank, and will not result in the creation of any Lien on the assets of the Assuming Bank. (f) Litigation. There is no legal action, suit, investigation or proceeding (whether or not the Assuming Bank is a party thereto) pending or, to Assuming Bank's knowledge, threatened against the Assuming Bank or of its any assets which questions the validity of this Agreement or any of the transactions contemplated hereby or which would, if adversely determined, either individually or in the aggregate with all such other actions, suits, investigations or proceedings if adversely determined, materially and adversely affect the Assuming Bank's ability to perform, satisfy, or observe any obligation or condition under this Agreement. (g) Capital. To he best of the Assuming Bank's knowledge, the Assuming Bank has such capital that regulatory approval of this transaction should not be denied on the basis of inadequacy of capital. ARTICLE XI CERTAIN COVENANTS OF SELLER AND THE ASSUMING BANK 11.1 COVENANTS OF SELLER. (a) General Covenants. Except as otherwise provided herein, Seller hereby covenants and agrees that it shall do or cause to be done at all times all things necessary to maintain and preserve and keep in full force and effect its corporate existence, and all rights and franchises material to the business of Seller. (b) Operation of the Purchased Branch. (i) During the period commencing on the date of this Agreement through the Closing, unless otherwise consented to by Assuming Bank, which consent shall not be unreasonably withheld, Seller shall use its best efforts, except as specifically otherwise contemplated by this Agreement: (A) to preserve intact the Purchased Branch's management, assets (including, but not limited to, Furniture and Equipment and Fixtures) licenses, permits, authorizations, and relationships; (B) to comply with all material contractual obligations applicable to the Purchased Branch's operations, except those as to which Seller may in good faith reasonably contest; (C) to maintain all the Purchased Branch's properties in the repair, order and condition, of such properties, reasonable wear and tear excepted, and maintain the insurance coverages from reputable insurers which, in respect to amounts, types and risks insured, are adequate for the Purchased Branch; and (D) to conduct its business of banking at the Purchased Branch in the usual, regular and ordinary course consistent with past practice, use reasonable efforts to maintain and preserve intact the Purchased Branch's business relationships (including relationships with customers), and take no action which would adversely affect or delay the ability of any party hereto to obtain any regulatory approval or to perform its covenants and agreements under this Agreement. Without limiting the foregoing, during the period commencing on the date of this Agreement through the Closing, without the prior approval of the Assuming Bank (whose consent shall not be unreasonably withheld), Seller shall use its best efforts to not cause nor permit the Purchased Branch (except as specifically contemplated by this Agreement), to: (1) engage or participate in any material transaction or incur or sustain any material obligation except in the ordinary course of business consistent with all material requirements of law and with past practice; (2) transfer from the Purchased Branch to Seller's other operations or branches any assets, or liabilities or records which are expected to constitute Acquired Assets, Liabilities Assumed or Records related to the Purchased Branch as set forth herein, except upon the unsolicited request of a depositor or customer in the ordinary course of business; or transfer to the Purchased Branch from Seller's other operations or branches assets or liabilities of a type which are expected to constitute Acquired Assets or Liabilities Assumed, except upon the unsolicited request of a depositor or customer in the ordinary course of business; (3) make or purchase any new, or increase any, Loan held by the Purchased Branch (i) not in accordance with the Purchased Branch's established lending policies and procedures as previously described to the Assuming Bank and as in effect on the date hereof, or (ii) in an amount exceeding $100,000; (4) enter into any commitment, agreement, understanding or other arrangement to dispose of the Purchased Branch other than pursuant to the terms of this Agreement, or furnish to any other Person (other than a Governmental Authority, as required by law) any information with respect to the Purchased Branch; (5) undertake any extraordinary marketing or advertising efforts not in the ordinary course of business; (6) increase or agree to increase the salary, remuneration or compensation of any Purchased Branch employee, in the aggregate in excess of 5% of such employee's base pay; (7) hire, or terminate in a manner inconsistent with Seller's current branch staffing policies (as previously described to the Assuming Bank), any Purchased Branch employee; (8) invest in any fixed assets or leasehold improvements related to the Purchased Branch, except for replacements of furnishings, Furniture and Equipment, Fixtures and normal maintenance and refurbishing in the ordinary course of business of the Purchased Branch consistent with past practice; (9) enter into any new line of business in the Purchased Branch not previously engaged in at such Branch; (10) offer rates on Deposits or loans in a manner which is inconsistent with prior practice or which are more than 25 basis points in variance from prevailing market rates for the areas served by the Purchased Branch; (11) change the Purchased Branch's accounting methods, policies or procedures, except as required by changes in generally accepted accounting procedures; (12) undertake, enter into or renew, amend or terminate, or give notice of a proposed renewal, amendment or termination of any commitment with respect to any lease, contract or agreement involving the Purchased Branch other than in the ordinary course of business consistent with past practice; (13) waive any material right, whether in equity or at law, that it has with respect to any Loan; (14) make less stringent than as in effect on the date of this Agreement (and as previously disclosed to the Assuming Bank) the Purchased Branch's operational policies, activities or practices (including practices with respect to customer service charges, credit underwriting policies or standards and policies or practices with respect to lending, charge-off or classification of loans, reserves and provisions for loan losses, the placement of loans in non-accrual status, the acceptance of deposits, the implementation of know-your-customer and related standards, and liability management); or (15) bid for public fund deposits except for renewals of those public fund deposits set forth on Schedule 11.1(b) hereof. (c) Untrue Representations. Seller shall promptly notify the Assuming Bank in writing if Seller has knowledge of any fact or condition that makes untrue, or shows to have been untrue, in any material respect, any schedule or any other information furnished pursuant to this Agreement by Seller to the Assuming Bank or any representation or warranty made in or pursuant to this Agreement or that results in Seller's failure to comply with any covenant, condition or agreement contained in this Agreement. (d) Litigation and Claims. Seller shall promptly notify the Assuming Bank in writing if Seller has knowledge of any litigation, or of any claim, controversy or contingent liability that might be expected to become the subject of litigation affecting the Acquired Assets or the Liabilities Assumed (other than garnishment proceedings), and Seller shall promptly notify the Assuming Bank of any legal action, suit or proceeding or judicial, administrative or governmental investigation, pending or, to the knowledge of Seller, threatened against Seller that questions or might question the validity of this Agreement or the agreements contemplated hereby, or any actions taken or to be taken by Seller pursuant hereto or thereto or seeks to enjoin or otherwise restrain the transactions contemplated hereby or thereby. (e) Adverse Changes. Seller shall promptly notify in writing the Assuming Bank if, to Seller's knowledge, any change or development shall have occurred or been threatened with regard to Seller, the Acquired Assets or the Liabilities Assumed that has or may reasonably be expected to have or lead to a Material Adverse Effect on Seller, the Acquired Assets or the Liabilities Assumed. Notwithstanding the disclosure to the Assuming Bank of any such change, Seller shall not be relieved of any liability to the Assuming Bank pursuant to this Agreement for, nor shall the providing of such information by Seller to the Assuming Bank be deemed a waiver by the Assuming Bank of, the breach of any representation or warranty of Seller contained in this Agreement. (f) Investigation. Between the date of this Agreement and the Closing Date, Seller shall afford to the Assuming Bank and its authorized agents and representatives reasonable access at mutually convenient times to the Purchased Branch and to Records and other information within Seller's possession relating to the Purchased Branch and the Acquired Assets and Liabilities Assumed. Seller shall cause its personnel to cooperate with the Assuming Bank and provide to the Assuming Bank reasonable assistance in the Assuming Bank's investigation of matters relating to the Purchased Branch and to the Acquired Assets and Liabilities Assumed and the Assuming Bank's preparation for an orderly transition (including, at Assuming Bank's request, arranging employment interviews with Purchased Branch employees). Notwithstanding the foregoing, the parties agree that the Assuming Bank's investigations and preparations for the transition shall be conducted in a manner which does not unreasonably interfere with the Purchased Branch's normal operations, customers and employee relations. All information provided by a party hereto (the "Providing Party") to the other Party hereto (the "Receiving Party") will be kept confidential by the Receiving Party and shall not, except as required by law or with the prior written consent of Providing Party, be disclosed by the Receiving Party in any manner whatsoever except as contemplated herein, in whole or in part, and shall not be used by the Receiving Party, other than in connection with the transactions contemplated by this Agreement. In the event that the transactions contemplated by this Agreement shall not be consummated, all copies of the information, including that portion of the information which consists of analyses, compilations, forecasts, studies or other documents prepared by the Receiving Party which reflect such information, will be, at the Receiving Party's sole option, either returned to Providing Party or destroyed upon the written request of Providing Party. A written certification of such destruction shall be delivered by the Receiving Party promptly following such destruction. The foregoing shall not apply to any information which (i) is or becomes generally available to the public other than as a result of a disclosure by the Receiving Party, or (ii) becomes available to the Receiving Party on a nonconfidential basis from a source which is not prohibited from disclosing such information to the Receiving Party by a legal, contractual or fiduciary obligation to Providing Party. In the event that the Receiving Party becomes legally compelled to disclose any of the information furnished to it by Providing Party, the Receiving Party will provide Providing Party with prompt notice so that Providing Party may seek a protective order or other appropriate remedy or waive compliance with the provisions of this Agreement. In the event that such protective order or other remedy is not obtained, or that Providing Party waives compliance with the provisions of this Agreement, the Receiving Party shall furnish only that portion of the information that is legally required and shall exercise reasonable efforts to obtain reliable assurance that confidential treatment will be afforded the information. The Receiving Party shall not be liable for the disclosure of the information hereunder to a tribunal compelling such disclosure unless such disclosure to such tribunal was caused by or resulted from a previous disclosure by the Receiving Party or any of its agents, affiliates or advisors not permitted by this Agreement. In any filings that may be required to obtain the regulatory approvals, the Assuming Bank will request confidential treatment of this Agreement, including the exhibits and schedules hereto, and the amount of the Purchase Price and will consult with the other party hereto prior to the disclosure of this Agreement, the exhibits or the schedules or the amount of the Purchase Price in the event such request is denied. Notwithstanding any other provision of this Agreement, the Assuming Bank and its agents or representatives shall not perform any investigation or study of Seller, or any asset or property of Seller which may involve the intrusive or destructive sampling or analysis or chemical testing of any portion of such asset or property or any improvements thereon, including without limitation, of any soil, water or groundwater on, under or about such asset or property ("Phase II Investigation"), without first (a) submitting to Seller a detailed description of (i) the work to be performed as part of the Phase II Investigation, (ii) the persons to undertake such Phase II Investigation, and (iii) the types and amounts of insurance coverage maintained by such persons, and (b) obtaining the prior written consent of Seller as to such matters. Seller may grant or withhold such consent in its sole discretion and may grant such consent subject to such terms, conditions or restrictions as Seller may in its sole discretion require. In all events, Seller or its representatives shall have the right, but not the obligation, to observe any and all activities associated with performance of any agreed Phase II Investigation, and may obtain half of any samples which the Assuming Bank or its representatives may collect during the Phase II Investigation. In the event the Assuming Bank or its representatives conduct a Phase II Investigation, the Assuming Bank shall cause (x) any investigation-derived waste generated or created in connection with performance of the Phase II Investigation (including without limitation, drill cuttings, purged or developed water, or sample remnants) to be removed from any investigated property, (y) any wells installed during the Phase II Investigation to be plugged and abandoned, and (z) the restoration of any investigated property to substantially the same physical condition which existed before commencement of the Phase II Investigation, all within seven (7) days after completion of the field activities related to the Phase II Investigation, and in compliance with applicable laws and regulations. The Assuming Bank shall be responsible for executing on its own behalf, and in compliance with applicable laws and regulations any and all manifests, shipping documents, plugging and abandoning reports and similar documents in connection with its obligations under this paragraph. The Assuming Bank agrees to indemnify and hold Seller harmless from and against any and all claims, liabilities, damages, expenses, and causes of action arising out of the Assuming Bank's inspections of the real or personal property of Seller, including without limitation, any Phase II Investigation. (g) EDP Conversion. Between the date hereof and the Closing Date, Seller shall use its best efforts to cooperate in the conversion of the Purchased Branch from Seller's existing electronic data processing systems to the systems of the Assuming Bank ("EDP Conversion") so that Assuming Bank is able to and shall convert the Purchased Branch's existing electronic data processing systems to the systems of the Assuming Bank on the Closing Date. Seller will provide conversions files in Seller's standard format. Seller will provide to Assuming Bank a maximum of three test tapes. Service for debit and ATM cards on Deposit accounts shall be discontinued at the end of Seller's business day on the Closing Date. (h) Condemnation. If prior to Closing all or any portion of the Bank Premises is taken or is made subject to eminent domain or other governmental acquisition proceedings, then Seller shall promptly notify Assuming Bank thereof, and on the Closing Date pay to the Assuming Bank all payments received or to be received in respect thereto; provided, however, that the Assuming Bank shall have the right to terminate this Agreement in the event that the Book Value of the portion of the Bank Premises so taken or made subject to eminent domain is in excess of $50,000, unless Seller agrees to pay the Assuming Bank the difference between the fair market value of such portion as of the date immediately preceding such condemnation and the condemnation award. (i) Insurance Proceeds and Casualty Payments. In the event of any damage, or destruction affecting the Acquired Assets between the date hereof and the time of the Closing, Seller shall deliver to the Assuming Bank notice of such damage or destruction and, at the Assuming Bank's election, shall either fix or repair such damage or destruction or pay to the Assuming Bank the insurance proceeds, to the extent of the applicable amount set forth in Section 7.1(a) hereof with respect to Bank Premises, Fixtures and the replacement cost with respect to the Furniture and Equipment, as the case may be, received (or with respect to insurance proceeds, which would be received assuming Seller's insurance policy had no deductible) by Seller as a result thereof; provided, however, that the Assuming Bank shall have the right to terminate this agreement in the event of that the Book Value of such Acquired Assets so damaged or destroyed is in excess of $50,000, unless Seller agrees to pay the Assuming Bank the difference between the fair market value of such Acquired Assets as of the date immediately preceding such damage or destruction and the insurance proceeds. (j) Notices to Customers. The Assuming Bank may, following receipt of all required regulatory approvals for the transactions contemplated herein, but no earlier than 35 days prior to the Closing Date, communicate with, and deliver information, brochures, bulletins, press releases and other communications to, depositors and borrowers of the Purchased Branch concerning the transactions contemplated by this Agreement and concerning the business and operations of the Purchased Branch, and Seller shall take all reasonable steps to cooperate with the Assuming Bank in effecting such communications. 11.2 COVENANTS OF THE ASSUMING BANK. Except as otherwise provided herein, the Assuming Bank hereby covenants and agrees that it shall do or cause to be done at all times all things necessary to maintain and preserve and keep in full force and effect its corporate existence, and all rights and franchises material to the business of the Assuming Bank, up through the Closing Date. 11.3 SOLICITATION OF EMPLOYEES. In the event this Agreement is terminated in accordance with its terms, for a period of 18 months after the date of such termination, neither party will, without the prior approval of the other party, directly or indirectly (excluding contacts initiated by the employee and any contact that results from advertisements in public journals or mass media or contact by search firms engaged by the other party in the ordinary course of business and directed only as to the position to be filled and not directed as to a specific employee or group of employees) hire or solicit for employment, or otherwise disrupt the employment relationship of any person who is employed by the other party, and whose employment relates to the Purchased Branch or with whom the other party has had significant contact. 11.4 BEST EFFORTS; TAKING OF NECESSARY ACTION. Each of the parties hereto agrees to use its best efforts promptly to take or cause to be taken all action and promptly to do or cause to be done all things necessary, proper or advisable under applicable laws and regulations to consummate and make effective the transactions contemplated by this Agreement. In case at any time after the Closing Date any further action is necessary, proper or advisable to carry out the purposes of this Agreement, as soon as reasonably practicable each party to this Agreement shall cause its proper officers and/or directors to take all such necessary action. Without limiting the foregoing, the Assuming Bank agrees to promptly prepare and file all applications and other notices required in connection with on or before the 15th business day after the date hereof, and to use its best efforts to obtain promptly and comply with all conditions contained in, the regulatory approvals described in Section 10.2(b) and any other consent, approval or other action by, or notice to or registration or filing with, any governmental or administrative agency or authority required or necessary to be made, obtained or complied with, as the case may be, by the Assuming Bank in connection with the performance of this Agreement by the Assuming Bank or the consummation of the transactions contemplated hereby; provided, that any delay by Seller in furnishing information for the application or reviewing the application shall extend the period in which the Assuming Bank is required to file the application under this Section 11.4 The Assuming Bank shall provide an information request to Seller for Seller's information to be included in the application on or before the tenth business day after the date hereof. To the extent that any application filed in connection with obtaining any such approval contains any significant information relating to Seller, prior to submitting such application to any regulatory agency, the Assuming Bank will permit Seller to review such information and will consider in good faith the suggestions of Seller with respect thereto. Seller shall have the right to approve any such information that relates to Seller, provided that such approval shall not be unreasonably withheld. The Assuming Bank shall use its best efforts to insure that any information provided by Seller, its Affiliates or representatives to be submitted in connection with submissions to governmental or administrative agencies or authorities receives confidential treatment if so requested by Seller. The Assuming Bank shall provide to Seller copies of all applications and other notices required in connection with the regulatory approvals described in Section 10.2(b) (excluding personal financial information relating to directors or regulatory examinations of the Assuming Bank and its Affiliates) and any other consent, approval or other action by, or notice to, or registration or filing in connection with the transaction contemplated by this Agreement within five days of such submissions. The Assuming Bank shall provide copies of any comments, requests or actions by governmental or administrative agencies or authorities to Seller within five days of the Assuming Bank's receipt thereof. The Assuming Bank shall not be required to provide copies of any such comments or requests which relate to personal information of directors or regulatory examinations of the Assuming Bank and its Affiliates, unless such comments or requests indicate that the applications related thereto may not be approved. Information provided under this paragraph shall be subject to the provisions of Section 11.1(f). 11.5 USE OF NAMES, TRADEMARKS AND SERVICE MARKS. Anything herein to the contrary notwithstanding, no interest in or right to use any logo, name, trademark or service mark presently or previously used by Seller is being conveyed pursuant to this Agreement. The Assuming Bank agrees that on and after the Closing Date neither it nor any of its Affiliates (including the Purchased Branch) will use names containing the words "Sterling" or "CaminoReal" in connection with any business or activity engaged in by the Assuming Bank and its Affiliates; provided, however, that Assuming Bank may identify the Acquired Assets and the Liabilities Assumed as being formerly owned by Seller in connection with any customer or regulatory inquiry. Promptly after the Closing Date, the Assuming Bank shall commence the removal of the trade names, names, service marks, logos, insignia, slogans, emblems, symbols, designs, and other identifying characteristics ("names") from all premises, equipment, interior decor items, fixtures and furnishings. Such removal shall be at the sole expense of the Assuming Bank and shall be completed not later than five days after the Closing Date. Within three business days after the Closing Date, Seller shall, and the Assuming Bank will permit Seller to, remove all exterior signs containing Seller's name. On the Closing Date, Seller will remove all printed materials and related business literature associated with the Purchased Branch. 11.6 ALLOCATION OF PURCHASE PRICE. The parties to this Agreement agree to allocate the Purchase Price in accordance with the rules under Section 1060 of the Code, and the Treasury Regulations promulgated thereunder. Such allocation shall be based on the fair market value of the Acquired Assets. The Assuming Bank agrees to provide Seller with a schedule allocating the Purchase Price among the Acquired Assets and with a properly completed Internal Revenue Service Form 8594 within 60 days after the Closing Date but in no event later than 90 days before the due date, including extensions, for the consolidated federal income tax return that includes Seller for the taxable year including the Closing Date. If Seller objects to any items reflected on such schedule, Seller shall notify the Assuming Bank of such objection and its reasons for objecting, in which case the Assuming Bank and Seller shall attempt to resolve the disagreement. If the Assuming Bank and Seller cannot resolve the disagreement, the allocation shall be determined by a nationally recognized independent appraiser selected by Seller and reasonably acceptable to the Assuming Bank. The fees and expenses of such appraiser shall be borne equally by the Assuming Bank and Seller. Seller and the Assuming Bank agree to act in accordance with the computations and allocations contained in the schedule as finally agreed or determined by such independent appraiser (including any modifications thereto reflecting any post-closing adjustments) in any relevant Tax Returns or similar filings (including any forms or reports required to be filed pursuant to Section 1060 of the Code or the Treasury Regulations promulgated thereunder ("1060 Forms")) and to file such 1060 Forms in the manner required by applicable law. Seller and the Assuming Bank will promptly notify each other in accordance with Section 14.6 of any challenge by any tax authority to such computations or allocations. ARTICLE XII EMPLOYEE PLANS 12.1 EMPLOYEES; PARTICIPATION IN ASSUMING BANK PLANS. Attached hereto as Schedule 12.1 is a list which Seller represents sets out all Purchased Branch employees, including inactive employees, as of the date hereof. Except as set forth in this Agreement, the Assuming Bank shall have no obligation in respect of any Purchased Branch employee employed by Seller unless such employee is hired by the Assuming Bank. The Assuming Bank's decision to offer employment is subject to the Assuming Bank's sole discretion and nothing contained herein is to be construed as an employment contract, as an offer of employment, or as an agreement to offer employment, with respect to any such employee. Unless employment has been offered by the Assuming Bank and accepted by the employee by the Closing Date, all Purchased Branch employees employed by Seller shall be terminated by Seller as of the Closing Date. Effective as of the Closing Date, employees of the Purchased Branch who are hired by the Assuming Bank shall cease participation in all plans, programs, policies and arrangements maintained for their benefit by Seller or any of its Affiliates. Commencing on the Closing Date, the Assuming Bank shall provide to employees of the Purchased Branch who are hired by the Assuming Bank such plans, programs, policies and arrangements being maintained by the Assuming Bank and which contain terms that are, in the aggregate, no less favorable than those provided to similarly situated employees of the Assuming Bank or any of its Affiliates. Each employee of Seller who is hired by the Assuming Bank shall be given credit for all purposes under such plans, programs, policies and arrangements, including fringe benefits, maintained by the Assuming Bank (except for benefit accrual under a defined benefit plan) for all service prior to the Closing Date with Seller and its Affiliates. 12.2 CLAIMS INCURRED PRIOR TO AND AFTER CLOSING. Seller will retain responsibility for and continue to pay all medical, life insurance, disability and other welfare plan expenses and benefits for each employee of the Purchased Branch or their covered dependents which are covered and payable under Seller's Welfare Benefit Plans with respect to claims incurred by such employees and former employees or their covered dependents prior to the Closing Date. Expenses and benefits with respect to claims incurred by employees of the Purchased Branch who are hired by the Assuming Bank or their covered dependents on or after the Closing Date shall be the responsibility of the Assuming Bank. For purposes of this Section, a claim is deemed incurred when the services that are the subject of the claim are performed: in the case of life insurance, when the death occurs; in the case of long-term disability benefits, when the disability occurs; and, in the case of a hospital stay, when such stay commences. Seller will retain responsibility for all welfare plan expenses and benefits, if any, including responsibility for compliance with COBRA, for all former employees of the Purchased Branch who are not employed by Seller on the Closing Date or such former employees' Qualified Beneficiaries and for all Qualified Beneficiaries with respect to Seller's plans who are eligible for COBRA coverage prior to the Closing Date. 12.3 SEVERANCE PAY. The Assuming Bank agrees to reimburse Seller within 5 days after Seller invoices Assuming Bank that severance benefits have been paid in accordance with Seller's severance plan (as previously disclosed to the Assuming Bank as of the date hereof), and all unused accrued vacation benefits paid in accordance with Seller's vacation benefits plan (as previously disclosed to the Assuming Bank as of the date hereof) to all employees of the Purchased Branch who are not hired by the Assuming Bank. The Assuming Bank will, as soon as practicable and in any event within 45 days of the date hereof, inform Seller of its intentions with respect to each employee of the Purchased Branch. ARTICLE XIII INDEMNIFICATION 13.1 INDEMNIFICATION. (a) From the Closing Date and for a period of two years thereafter, Seller shall indemnify, hold harmless, and defend the Assuming Bank, its Affiliates and their respective directors, officers, agents and employees (collectively, "Assuming Bank Indemnified Persons") from and against any and all costs, losses, liabilities (including, without limitation, STRICT LIABILITIES), expenses (including, without limitation, reasonable attorneys' fees and expenses), judgments, fines and settlements actually and reasonably incurred by any such indemnitee in connection with any and all actions, suits, claims, investigations or other proceedings based upon: (i) any liability of Seller or any of its Affiliates not expressly assumed by the Assuming Bank pursuant hereto; (ii) any breach by Seller of any of its representations, warranties, covenants or agreements herein or in any instrument, certificate, or agreement delivered by Seller to the Assuming Bank pursuant hereto; or (iii) any check or other instrument drawn on or deposited into a Purchased Branch Deposit account prior to the Closing Date upon which a forgery (signature or endorsement) or alteration claim is asserted against the Assuming Bank. (b) From the Closing Date and for a period of two years thereafter, the Assuming Bank shall indemnify, hold harmless and defend Seller, its Affiliates and their respective directors, officers, agents and employees from and against any and all costs, losses, liabilities (including, without limitation, STRICT LIABILITIES), expenses (including, without limitation, reasonable attorneys' fees and expenses), judgments, fines and settlements actually and reasonably incurred by any such indemnitee in connection with any and all actions, suits, claims, investigations or other proceedings based upon: (i) performance or nonperformance by the Assuming Bank of any and all liabilities of Seller assumed by the Assuming Bank pursuant to this Agreement; or (ii) any breach by the Assuming Bank of any of its representations, warranties, covenants or agreements herein or in any instrument, certificate, or agreement delivered by the Assuming Bank to Seller pursuant thereto. (c) With respect to any claim made or threatened against any indemnitee hereunder for which such indemnitee is or may be entitled to indemnification hereunder, it shall be a condition to such indemnification that such indemnitee shall: (i) promptly upon discovering any facts or circumstances that might reasonably be expected to give rise to such a claim, give written notice of such facts or circumstances to the indemnitor; (ii) as soon as practicable after such a claim is made or threatened, give written notice thereof to the indemnitor, which notice shall specify in reasonable detail the nature of the claim and the amount (or an estimate of the amount) of the claim; (iii) provide to the indemnitor such information and cooperation with respect to such claim as the indemnitor may reasonably require including, without limitation, (a) making records and appropriate personnel available to the indemnitor at such times as the indemnitor shall request (provided that such personnel are under the employ of the indemnitee as such time), (b) providing copies of invoices or other evidence of expense incurred, and (c) providing the indemnitor copies of any process, pleadings, correspondence or other writings relating to the claim; (iv) cooperate and take all such steps as the indemnitor may reasonably request to preserve and protect any defense to such claim; and (v) upon reasonable prior notice, afford to the indemnitor the right, which the indemnitor may exercise at its (or their) sole discretion and at its (or their) own expense, to participate in (and/or assume full responsibility for the direction of) the investigation, defense and/or settlement of such claims. 13.2 LIMITATIONS ON INDEMNIFICATION. Notwithstanding anything to the contrary contained in this Article XIII, no indemnification shall be required to be made by either party until the aggregate amount of all such claims by a party exceeds $50,000. Once such aggregate amount exceeds $50,000, such party shall thereupon be entitled to indemnification for all amounts in excess of such $50,000 which result in direct damage to such party by way of any cost, loss, liability, expense, judgment, fine, or settlement actually incurred by such party in accordance with Section 13.1; provided, however, subject to the foregoing, no party shall have any liability under this Article XIII for consequential damages. 13.3 EXCLUSIVITY OF REMEDIES. The remedies of the Assuming Bank Indemnified Persons under Section 13.1(a) shall be considered the Assuming Bank Indemnified Persons' sole and exclusive remedies. Without limiting the generality of the foregoing, except with respect to such remedies specifically set forth herein, the Assuming Bank hereby releases, waives and agrees not to sue Seller or any of its shareholders officers, directors, affiliates, employees, agents, representatives, successors or assigns ("Seller's Related Parties") for any and all claims, causes of action, rights of contribution, cost recovery, losses, liabilities, suits, costs, fees, judgments or expenses which may now exist or which may hereafter arise, REGARDLESS OF WHETHER CAUSED IN WHOLE OR IN PART BY THE SOLE, CONTRIBUTORY, PASSIVE OR PARTIAL NEGLIGENCE OR STRICT LIABILITY OF SELLER OR ANY OF THE SELLER'S RELATED PARTIES, in connection with: (i) any material, waste, substance, substance, pollutant or contaminant, the use, collection, handling, recycling, generation, treatment, storage, disposal, release or transportation of which by the Seller or any of its predecessors, or is or may become regulated or controlled by any Governmental Authority, or the improper handling, management or disposal of which may affect human health or safety, property (or the use thereof) or the environment, or (ii) the compliance by Seller or any of its predecessors, or any of its current or former real or personal property, with applicable laws, regulations, standards to, pollutant or contaminant limitations, orders or directives pertaining directly or indirectly to human health or safety or the environment, including without limitation the laws listed on Schedule 13.3 as amended from time to time, and any state or local analogue of the same. ARTICLE XIV MISCELLANEOUS 14.1 ENTIRE AGREEMENT. This Agreement embodies the entire agreement of the parties hereto in relation to the subject matter herein and supersedes all prior understandings or agreements, oral or written, between the parties. 14.2 HEADINGS. The headings and subheadings of the Table of Contents, Articles and Sections contained in this Agreement, except the terms identified for definition in Article I and elsewhere in this Agreement, are inserted for convenience only and shall not affect the meaning or interpretation of this Agreement or any provision hereof. 14.3 GOVERNING LAW. This Agreement and the rights and obligations hereunder shall be governed by and construed in accordance with the laws of the State of Texas. 14.4 SUCCESSORS. All terms and conditions of this Agreement shall be binding on the successors and assigns of Seller and the Assuming Bank. Except as otherwise expressly provided in this Agreement, nothing expressed or referred to in this Agreement is intended or shall be construed to give any Person other than Seller and the Assuming Bank any legal or equitable right, remedy, or claim under or with respect to this Agreement or any provisions contained herein, it being the intention of the parties hereto that this Agreement, the obligations and statements of responsibilities hereunder, and all other conditions and provisions hereof are for the sole and exclusive benefit of Seller and the Assuming Bank and for the benefit of no other Person. 14.5 MODIFICATION; ASSIGNMENT. No amendment or other modification, rescission, release, or assignment of any part of this Agreement shall be effective except pursuant to a written agreement subscribed by the duly authorized representatives of the parties hereto. 14.6 NOTICE. Any notice, request, demand, consent, approval or other communication to any party hereto shall be effective when received and shall be given in writing, and delivered in person against receipt therefor, or sent by certified mail, postage prepaid, courier service, telex, or facsimile transmission to such party (with copies as indicated below) at its address set forth below or at such other address as it shall hereafter furnish in writing to the other parties. All such notices and other communications shall be deemed given on the date received by the addressee. STERLING BANK: J. Downey Bridgwater Sterling Bank 2550 North Loop West, Suite 600 Houston, Texas 77092 Facsimile: (713) 466-3117 and James W. Goolsby, Jr. Sterling Bancshares, Inc. 2550 North Loop West, Suite 600 Houston, Texas 77092 Facsimile: (713) 849-5498 with a copy to: Annette L. Tripp Locke Liddell & Sapp LLP 3400 JPMorgan Chase Tower 600 Travis Houston, Texas 77002 Facsimile: (713) 223-3717 ASSUMING BANK Douglas G. Macdonald South Texas National Bank of Laredo 2211 Guadalupe Laredo, Texas 78042 with a copy to: Robert L. Tortoriello Cleary, Gottlieb, Steen & Hamilton One Liberty Plaza New York, New York 10006 Facsimile (212) 225-3999 14.7 MANNER OF PAYMENT. All payments due under this Agreement shall be in lawful money of the United States of America in immediately available funds as each party hereto may specify to the other parties. 14.8 COSTS, FEES AND EXPENSES. Except as otherwise specifically provided herein, each party hereto agrees to pay all costs, fees and expenses which it has incurred in connection with or incidental to the matters contained in this Agreement, including without limitation any fees and disbursements to its accountants and counsel. 14.9 WAIVER. Seller and the Assuming Bank may waive their respective rights, powers, or privileges under this Agreement; provided, that such waiver shall be in writing; and further provided, that no failure or delay on the part of Seller or the Assuming Bank to exercise any right, power, or privilege under this Agreement shall operate as a waiver thereof, nor will any single or partial exercise of any right, power, or privilege under this Agreement preclude any other or further exercise thereof or the exercise of any other right, power, or privilege by Seller or the Assuming Bank under this Agreement, nor will any such waiver operate or be construed as a future waiver of such right, power, or privilege under this Agreement. 14.10 SEVERABILITY. If any provision of this Agreement is declared invalid or unenforceable, then, to the extent possible, all of the remaining provisions of this Agreement shall remain in full force and effect and shall be binding upon the parties hereto so long as there is no material adverse effect on the economic or legal substance of the transactions contemplated by this Agreement or any Material Adverse Effect on any party hereto. Upon such determination that any term or other provision is invalid or unenforceable, the parties hereto shall negotiate in good faith to modify this Agreement so as to effect the original intent of the parties with respect to the relative benefits, rights and obligations thereof as closely as possible in a mutually acceptable manner so that the transactions contemplated hereto may be fulfilled to the greatest extent possible. 14.11 TERMINATION OF AGREEMENT. (a) This Agreement may be terminated at any time prior to the Closing: (i) By mutual agreement of Seller and the Assuming Bank; (ii) By Seller or the Assuming Bank upon notice given to the other in the event that the other shall, contrary to the terms of this Agreement, fail or refuse to consummate the Closing contemplated hereby or to take any other action referred to herein necessary to consummate the Closing contemplated hereby or if there shall have been a material failure of condition, or a material breach of any representation or warranty, covenant or agreement, after affording such defaulting party a 30 day period after notice in which to cure; (iii) By Seller or the Assuming Bank upon notice given to the other if the Closing shall not have taken place on or before the 180th calendar day after the date hereof; (iv) By Seller if the Assuming Bank's regulatory agencies have failed to issue a formal approval of the Assuming Bank's applications by the 165th calendar day after the date hereof; (v) By Seller if the Assuming Bank's applications are disapproved by the Assuming Bank's regulatory agencies; (vi) By Seller or the Assuming Bank upon written notice to the other party if any court or governmental authority of competent jurisdiction shall have issued a final permanent order, enjoining, prohibiting or otherwise materially limiting or conditioning the Assuming Bank's business or the transactions contemplated by this Agreement, or shall have issued an order denying approval of the purchase and assumption and the other transactions contemplated hereby, and the time for appeal or petition for reconsideration of such order shall have expired; or (b) In the event of the termination of this Agreement as provided in this Section, this Agreement shall forthwith become wholly void and of no further force and effect other than Section 11.1(f) with respect to information provided to the Assuming Bank, Section 11.2(b) and, other than as set forth in Section 14.11(c), there shall be no liability on the part of Seller, the Assuming Bank or their respective officers or directors (except as set forth in this Section). The obligations of the parties to this Agreement under this Section shall survive any such termination. (c) In the event Seller or the Assuming Bank terminates this Agreement pursuant to Sections 14.11(a)(iii), (iv), (v) or (vi) and such termination is a result of alleged anti-competitive effects of the transactions contemplated by this Agreement, then the Assuming Bank agrees to pay to Seller the sum of $ -0- in immediately available funds on or before the third business day after such termination. 14.12 SURVIVAL OF REPRESENTATIONS AND WARRANTIES. The representations and warranties of the parties in this Agreement shall survive the Closing for a period of two years. 14.13 PUBLIC NOTICE. All written notices to third parties (including customers of the Branches) and all public announcements and press releases concerning the transactions contemplated by this Agreement made prior to the Closing Date shall be jointly planned, coordinated and reviewed by Seller and Assuming Bank. 14.14 COUNTERPARTS. This Agreement may be executed in any number of counterparts and by the duly authorized representative of a different party hereto on separate counterparts, each of which when so executed shall be deemed to be an original and all of which when taken together shall constitute one and the same Agreement. [SIGNATURE PAGES FOLLOW] IN WITNESS WHEREOF, the parties hereto have caused this Agreement to be executed by their duly authorized representatives as of the date first above written. STERLING BANK By: /s/ Eugene Putnam, Jr. --------------------------------------- Its: EVP & CFO SOUTH TEXAS NATIONAL BANK OF LAREDO By: /s/ Douglas G. MacDonald --------------------------------------- Its: President EX-10.6 4 h03904exv10w6.txt FIRST AMENDMENT TO CREDIT AGREEMENT EXHIBIT 10.6 FIRST AMENDMENT TO CREDIT AGREEMENT THIS FIRST AMENDMENT TO CREDIT AGREEMENT (this "Amendment") is entered into as of February 2, 2003, by and between STERLING BANCSHARES, INC., a Texas corporation ("Borrower"), and WELLS FARGO BANK, NATIONAL ASSOCIATION, successor by assignment to Wells Fargo Bank Minnesota, National Association ("Bank"). RECITALS WHEREAS, Borrower is currently indebted to Bank pursuant to the terms and conditions of that certain Credit Agreement between Borrower and Bank dated as of February 2, 2002, as amended from time to time ("Credit Agreement"). WHEREAS, Bank and Borrower have agreed to certain changes in the terms and conditions set forth in the Credit Agreement and have agreed to amend the Credit Agreement to reflect said changes. NOW, THEREFORE, for valuable consideration, the receipt and sufficiency of which are hereby acknowledged, the parties hereto agree that the Credit Agreement shall be amended as follows: 1. Sections 1.1(a) and (b) are hereby deleted in their entirety, and the following substituted therefor: "SECTION 1.1. TERM LOAN. (a) Term Loan. Subject to the terms and conditions of this Agreement, Bank hereby agrees to convert the total outstanding amount of the Line of Credit to a term loan to Borrower in a principal amount not to exceed Twenty Million Dollars ($20,000,000.00) ("Term Loan"). Borrower's obligation to repay the Term Loan shall be evidenced by a promissory note substantially in the form of Exhibit A attached hereto ("Term Note"), all terms of which are incorporated herein by this reference. Such conversion shall be effective on the date of this Amendment and, as of such date, the Line of Credit is terminated and no further advances will be made. (b) Repayment. The principal amount of the Term Loan shall be repaid in accordance with the provisions of the Term Note." 2. The following is hereby added to the Credit Agreement as Section 1.1(c): "(c) Prepayment. Borrower may prepay principal on the Term Loan solely in accordance with the provisions of the Term Note." 3. Section 1.2(c) is hereby deleted in its entirety, without substitution. 4. Section 4.9(e) is hereby deleted in its entirety, without substitution. 5. Section 4.10(a) is hereby deleted in its entirety, and the following substituted therefor: "(a) ROA not less than 1.0% on a rolling four quarter basis, determined as of each fiscal quarter end, with "ROA" defined as the percentage arrived at by dividing net income by Total Assets, as reported in the most recent Call Report." 6. A new Section 5.7 is hereby added to the Credit Agreement, to read as follows.: "5.7 NEGATIVE PLEDGE. Incur, create, assume or suffer to exist any security interest, pledge, lien, charge or other encumbrance of any nature whatsoever on the stock of Sterling Bank." 7. Except as specifically provided herein, all terms and conditions of the Credit Agreement remain in full force and effect, without waiver or modification. All terms defined in the Credit Agreement shall have the same meaning when used in this Amendment. This Amendment and the Credit Agreement shall be read together, as one document. 8. Borrower hereby remakes all representations and warranties contained in the Credit Agreement and reaffirms all covenants set forth therein. Borrower further certifies that as of the date of this Amendment there exists no Event of Default as defined in the Credit Agreement, nor any condition, act or event which with the giving of notice or the passage of time or both would constitute any such Event of Default. IN WITNESS WHEREOF, the parties hereto have caused this Amendment to be executed as of the day and year first written above. WELLS FARGO BANK, NATIONAL ASSOCIATION, successor by assignment to Wells Fargo Bank Minnesota, STERLING BANCSHARES, INC. National Association By: /s/ Eugene S. Putnam, Jr. By: /s/ Michael W. Moses -------------------------------- ----------------------------- Eugene S. Putnam, Jr. Michael W. Moses Executive Vice President/CFO Vice President -2- EX-21 5 h03904exv21.txt SUBSIDIARIES OF THE COMPANY . . . EXHIBIT 21 SUBSIDIARIES OF STERLING BANCSHARES, INC. The following is a list of the subsidiaries of Sterling Bancshares, Inc.: Sterling Bancorporation, Inc. Sterling Bank A Delaware corporation A Texas state banking association PO Box 631 2550 North Loop West, Suite 600 Wilmington, Delaware 19899 Houston, Texas 77092 Sterling Bancshares Capital Trust I Sterling Bancshares Capital Trust II A Delaware statutory business trust A Delaware statutory business trust 15000 Northwest Freeway 15000 Northwest Freeway Houston, Texas 77040 Houston, Texas 77040 Sterling Bancshares Statutory Trust One Sterling Bancshares Capital Trust III A Connecticut statutory business trust A Delaware statutory business trust 2550 North Loop West, Suite 600 15000 Northwest Freeway Houston, Texas 77092 Houston, Texas 77040 CMCR Holding Company A Delaware corporation 13100 Northwest Freeway Houston, Texas 77040
CMCR Holding Company is the parent company of Sterling Capital Mortgage Company, an originator and servicer of one-to-four single family residential mortgage loans. Sterling Capital Mortgage Company originates a significant portion of its mortgage business through twenty-five subsidiary entities. EX-23.1 6 h03904exv23w1.txt CONSENT OF DELOITTE & TOUCHE LLP EXHIBIT 23.1 INDEPENDENT AUDITORS' CONSENT We consent to the incorporation by reference in Registration Statement No. 333-46345 and 333-86487 of Sterling Bancshares, Inc. on Form S-4 and in Registration Statements Nos. 33-75444, 33-75442, 33-84398, 33-85624, 333-16719, 333-57171 and 333-102544 of Sterling Bancshares, Inc. on Forms S-8 of our report dated March 10, 2003, appearing in this Annual Report on Form 10-K of Sterling Bancshares, Inc. for the year ended December 31, 2002. DELOITTE & TOUCHE LLP Houston, Texas March 14, 2003 EX-99.1 7 h03904exv99w1.txt CERTIFICATION OF CEO PURSUANT TO SECTION 906 EXHIBIT 99.1 CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 In connection with the Annual Report of Sterling Bancshares, Inc. (the "Company") on Form 10-K for the year ended December 31, 2002 as filed with the Securities and Exchange Commission on the date hereof (the "Report"), I, J. Downey Bridgwater, President and Chief Executive Officer of the Company, certify, pursuant to 18 U.S.C. (Section )1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that: (1) The Report fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934; and (2) The information contained in the Report fairly presents, in all material respects, the financial condition and result of operations of the Company. Dated: March 14, 2003 /s/ J. Downey Bridgwater ------------------------------------- J. Downey Bridgwater President and Chief Executive Officer Sterling Bancshares, Inc. EX-99.2 8 h03904exv99w2.txt CERTIFICATION OF CFO PURSUANT TO SECTION 906 EXHIBIT 99.2 CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 In connection with the Annual Report of Sterling Bancshares, Inc. (the "Company") on Form 10-K for the year ended December 31, 2002 as filed with the Securities and Exchange Commission on the date hereof (the "Report"), I, Stephen C. Raffaele, Executive Vice President and Chief Financial Officer of the Company, certify, pursuant to 18 U.S.C. (Section )1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that: (1) The Report fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934; and (2) The information contained in the Report fairly presents, in all material respects, the financial condition and result of operations of the Company. Dated: March 14, 2003 /s/ Stephen C. Raffaele ------------------------------------ Stephen C. Raffaele Executive Vice President and Chief Financial Officer Sterling Bancshares, Inc. -----END PRIVACY-ENHANCED MESSAGE-----