10-Q 1 h10600e10vq.txt STERLING BANCSHARES, INC. - 9/30/2003 =============================================================================== UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D. C. 20549 ----------- FORM 10 - Q ------------ [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended September 30, 2003 [ ] 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 office) (Zip Code) 713-466-8300 (Registrant's telephone number, including area code) 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 and Exchange Act of 1934 ("Act") 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 whether the registrant is an accelerated filer (as defined by Rule 12b-2 of the Act). Yes [X] No [ ] As of November 7, 2003, there were outstanding 44,401,944 shares of common stock, par value $1.00 per share, of the registrant. =============================================================================== STERLING BANCSHARES, INC. AND SUBSIDIARIES INDEX TO FORM 10-Q PART I. FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS Condensed Consolidated Balance Sheets as of September 30, 2003 and December 31, 2002 (unaudited) 2 Condensed Consolidated Statements of Income for the Three Months Ended and Nine Months Ended September 30, 2003 and 2002 (unaudited) 3 Condensed Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2003 and 2002 (unaudited) 4 Notes to Interim Condensed Consolidated Financial Statements (unaudited) 5 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 12 Item 3. Quantitative and Qualitative Disclosures about Market Risk 24 Item 4. Controls and Procedures 24 PART II. OTHER INFORMATION Item 1. Legal Proceedings 25 Item 2. Changes in Securities and Use of Proceeds 25 Item 3. Defaults Upon Senior Securities 25 Item 4. Submission of Matters a Vote of Security Holders 25 Item 5. Other Information 25 Item 6. Exhibits and Reports on Form 8-K 25 Signatures 27
1 PART I. FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS STERLING BANCSHARES, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED BALANCE SHEETS (In thousands)
SEPTEMBER 30, DECEMBER 31, 2003 2002 ------------- ------------ (UNAUDITED) ASSETS Cash and cash equivalents $ 134,133 $ 147,000 Interest-bearing deposits in financial institutions 1,338 1,302 Trading assets 131,597 142,803 Available-for-sale securities, at fair value 312,005 251,165 Held-to-maturity securities, at amortized cost 45,973 61,889 Loans held for sale 311,729 701,301 Loans held for investment 2,010,253 1,943,561 Allowance for credit losses (31,350) (27,248) ----------- ----------- Loans held for investment, net 1,978,903 1,916,313 Accrued interest receivable 11,549 15,800 Real estate acquired by foreclosure 2,669 3,358 Premises and equipment, net 44,845 51,645 Goodwill, net 50,354 55,666 Other assets 98,359 178,444 Assets related to discontinued operations -- 56,059 ----------- ----------- TOTAL ASSETS $ 3,123,454 $ 3,582,745 =========== =========== LIABILITIES AND SHAREHOLDERS' EQUITY Demand deposits: Noninterest-bearing $ 961,877 $ 1,016,818 Interest-bearing 862,271 919,477 Certificates of deposit and other time deposits 592,114 736,777 ----------- ----------- Total deposits 2,416,262 2,673,072 Other borrowed funds 231,956 509,590 Notes payable 17,028 21,430 Subordinated debt 47,453 -- Accrued interest payable and other liabilities 43,625 16,920 Liabilities related to discontinued operations -- 32,406 ----------- ----------- Total liabilities 2,756,324 3,253,418 Company-obligated mandatorily redeemable trust preferred securities of subsidiary 80,000 80,000 trusts Shareholders' equity: Convertible preferred stock, $1 par value, 1 million shares authorized 20 59 Common stock, $1 par value, 100 million shares authorized 44,232 43,983 Capital surplus 46,329 44,633 Retained earnings 193,928 156,664 Accumulated other comprehensive income--net unrealized gain on available-for-sale securities, net of tax 2,621 3,988 ----------- ----------- Total shareholders' equity 287,130 249,327 ----------- ----------- TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 3,123,454 $ 3,582,745 =========== ===========
See Notes to Interim Consolidated Financial Statements which are an integral part of these Interim Consolidated Financial Statements 2 STERLING BANCSHARES, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF INCOME (In thousands, except per share data)
THREE MONTHS NINE MONTHS ENDED SEPTEMBER 30, ENDED SEPTEMBER 30, 2003 2002 2003 2002 -------------------------- -------------------------- (UNAUDITED) (UNAUDITED, (UNAUDITED) (UNAUDITED, AS RESTATED AS RESTATED NOTE 11) NOTE 11) Interest income: Loans, including fees $ 40,396 $ 40,912 $121,592 $112,863 Securities: Taxable 2,162 3,303 7,087 10,953 Tax-exempt 529 697 1,773 2,217 Federal funds sold 27 76 113 415 Trading assets 857 1,282 2,590 3,249 Deposits in financial institutions 17 27 53 86 -------- -------- -------- -------- Total interest income 43,988 46,297 133,208 129,783 Interest expense: Demand and savings deposits 987 2,054 3,736 6,766 Certificates and other time deposits 3,461 4,088 11,514 12,632 Other borrowed funds 1,491 1,651 4,417 3,372 Notes payable 137 202 457 602 Subordinated debt 589 -- 1,305 -- -------- -------- -------- -------- Total interest expense 6,665 7,995 21,429 23,372 -------- -------- -------- -------- NET INTEREST INCOME 37,323 38,302 111,779 106,411 Provision for credit losses 4,150 3,439 14,698 9,150 -------- -------- -------- -------- NET INTEREST INCOME AFTER PROVISION FOR CREDIT LOSSES 33,173 34,863 97,081 97,261 Noninterest income: Customer service fees 4,061 4,126 12,361 12,378 Other 3,369 3,185 13,336 9,244 -------- -------- -------- -------- Total noninterest income 7,430 7,311 25,697 21,622 Noninterest expense: Salaries and employee benefits 16,583 16,143 49,916 46,681 Occupancy expense 3,996 3,800 11,708 11,312 Technology 1,289 1,309 3,718 3,741 Postage and delivery charges 527 583 1,646 1,702 Supplies 304 352 990 1,000 Professional fees 1,317 1,243 3,300 3,107 Minority interest expense: Company-obligated mandatorily redeemable trust preferred securities of subsidiary trusts 1,542 1,462 4,643 4,117 Conversion costs related to acquisitions -- 973 -- 973 Other 3,913 4,081 12,246 11,601 -------- -------- -------- -------- Total noninterest expense 29,471 29,946 88,167 84,234 INCOME FROM CONTINUING OPERATIONS BEFORE INCOME TAXES 11,132 12,228 34,611 34,649 Provision for income taxes 3,707 4,034 11,454 11,098 -------- -------- -------- -------- INCOME FROM CONTINUING OPERATIONS 7,425 8,194 23,157 23,551 INCOME FROM DISCONTINUED OPERATIONS BEFORE INCOME TAXES 44,426 597 44,719 4,518 Provision for income taxes 24,510 273 24,657 1,870 -------- -------- -------- -------- INCOME FROM DISCONTINUED OPERATIONS 19,916 324 20,062 2,648 -------- -------- -------- -------- NET INCOME $ 27,341 $ 8,518 $ 43,219 $ 26,199 ======== ======== ======== ======== EARNINGS PER SHARE: Basic $ 0.62 $ 0.19 $ 0.98 $ 0.60 ======== ======== ======== ======== Diluted $ 0.61 $ 0.19 $ 0.97 $ 0.59 ======== ======== ======== ======== EARNINGS PER SHARE FROM CONTINUING OPERATIONS: Basic $ 0.17 $ 0.18 $ 0.53 $ 0.54 ======== ======== ======== ======== Diluted $ 0.17 $ 0.18 $ 0.52 $ 0.53 ======== ======== ======== ========
See Notes to Interim Consolidated Financial Statements which are an integral part of these Interim Consolidated Financial Statements. 3 STERLING BANCSHARES, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (In thousands)
NINE MONTHS ENDED SEPTEMBER 30, 2003 2002 ------------------------------- (UNAUDITED) (UNAUDITED, AS RESTATED NOTE 11) CASH FLOWS FROM OPERATING ACTIVITIES: Income from continuing operations $ 23,157 $ 23,551 Adjustments to reconcile income from continuing operations to net cash provided by (used in) operating activities: Amortization and accretion of premiums and discounts on securities, net 6,481 167 Net gain on the sale of assets (386) (100) Net gain on the sale of trading assets (1,032) (618) Gain on the sale of the Eagle Pass banking office (3,382) -- Loss on the sale of the South Texas banking offices 142 -- Provision for credit losses 14,698 9,150 Write-downs, less gains on sale, of real estate acquired by foreclosure (416) 278 Depreciation and amortization 6,565 6,739 Net decrease (increase) in loans held for sale 389,572 (465,722) Net decrease (increase) in accrued interest receivable and other assets 84,507 (14,721) Net increase in accrued interest payable and other liabilities 24,427 2,899 --------- --------- NET CASH PROVIDED BY (USED IN) OPERATING ACTIVITIES FROM CONTINUING OPERATIONS 544,333 (438,377) CASH FLOWS FROM INVESTING ACTIVITIES: Net decrease in securities purchased under agreements to resell -- 10,423 Proceeds from maturity and paydowns of held-to-maturity securities 15,799 13,846 Proceeds from the sale of available-for-sale securities 16,870 6,810 Proceeds from maturity and paydowns of available-for-sale securities 160,553 81,932 Purchases of available-for-sale securities (246,344) (68,924) Proceeds from the sale of trading assets 359,092 363,379 Purchases of trading assets (350,285) (370,736) Proceeds from principal paydowns of trading securities 3,431 6,420 Net increase in loans held for investment (113,397) (174,921) Proceeds from sale of real estate acquired by foreclosure 5,544 1,083 Net decrease in interest-bearing deposits in financial institutions (36) 445 Purchase of ENB Bankshares, Inc. -- (10,386) Cash and cash equivalents acquired with ENB Bankshares, Inc. -- 2,212 Proceeds from sale of Eagle Pass banking office 6,952 -- Cash and cash equivalents sold with the Eagle Pass banking office (78,138) -- Proceeds from sale of South Texas banking offices 1,600 -- Cash and cash equivalents sold with the South Texas banking offices (26,323) -- Proceeds from sale of premises and equipment 1,665 3,036 Purchase of premises and equipment (2,779) (7,229) --------- --------- NET CASH USED IN INVESTING ACTIVITIES FROM CONTINUING OPERATIONS (245,796) (142,610) CASH FLOWS FROM FINANCING ACTIVITIES: Net (decrease) increase in deposit accounts (118,974) 303,833 Repayment of notes payable (4,402) (561) Issuance of subordinated debt 49,940 -- Net decrease (increase) in repurchase agreements/funds purchased (277,634) 220,800 Proceeds from issuance of common stock and preferred stock 1,907 2,070 Issuance of company-obligated mandatorily redeemable trust preferred securities -- 51,250 Dividends paid (5,956) (5,271) --------- --------- NET CASH (USED IN) PROVIDED BY FINANCING ACTIVITIES FROM CONTINUING OPERATIONS (355,119) 572,121 NET CASH PROVIDED BY DISCONTINUED OPERATIONS 43,715 1,377 NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS (12,867) (7,489) CASH AND CASH EQUIVALENTS: Beginning of period 147,000 148,295 --------- --------- End of period $ 134,133 $ 140,806 ========= ========= SUPPLEMENTAL INFORMATION: Income taxes paid $ 21,199 $ 9,300 ========= ========= Interest paid $ 21,343 $ 24,097 ========= ========= Noncash investing and financing activities: Acquisitions of real estate through foreclosure of collateral $ 4,439 $ 3,945 --------- ---------
See Notes to Interim Consolidated Financial Statements which are an integral part of these Interim Consolidated Financial Statements. 4 STERLING BANCSHARES, INC., AND SUBSIDIARIES NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS SEPTEMBER 30, 2003 (UNAUDITED) 1. BASIS OF PRESENTATION The accompanying unaudited interim condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information and in accordance with the instructions to Form 10-Q as prescribed by the Securities and Exchange Commission. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring items) considered necessary for a fair presentation have been included. Operating results for the nine-month period ended September 30, 2003, are not necessarily indicative of the results that may be expected for the entire year or any interim period. For further information, refer to the consolidated financial statements and notes thereto included in Amendment No. 1 to the Annual Report on Form 10-K/A of Sterling Bancshares, Inc. (the "Company") for the year ended December 31, 2002. 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 and had no effect on net income or stockholders' equity. 2. EARNINGS PER COMMON SHARE Earnings per common share ("EPS") were computed based on the following (in thousands, except per share amounts):
THREE MONTHS ENDED SEPTEMBER 30, NINE MONTHS ENDED SEPTEMBER 30, 2003 2002 2003 2002 -------------------------------- ------------------------------- AMOUNT AMOUNT AMOUNT AMOUNT Income from continuing operations $ 7,425 $ 8,194 $23,157 $23,551 Income from discontinued operations 19,916 324 20,062 2,648 ------- ------- ------- ------- Net income $27,341 $ 8,518 $43,219 $26,199 ======= ======= ======= ======= Basic: Weighted average shares outstanding 44,202 43,917 44,097 43,849 Diluted: Add incremental shares for: Assumed exercise of outstanding options 630 857 635 838 Assumed conversion of preferred stock 20 98 33 92 ------- ------- ------- ------- Total 44,852 44,872 44,765 44,779 ======= ======= ======= ======= Earnings per share from continuing operations: Basic $ 0.17 $ 0.18 $ 0.53 $ 0.54 ======= ======= ======= ======= Diluted $ 0.17 $ 0.18 $ 0.52 $ 0.53 ======= ======= ======= ======= Earnings per share: Basic $ 0.62 $ 0.19 $ 0.98 $ 0.60 ======= ======= ======= ======= Diluted $ 0.61 $ 0.19 $ 0.97 $ 0.59 ======= ======= ======= =======
5 3. SHAREHOLDERS' EQUITY The following table displays the changes in shareholders' equity for the three-month and nine-month periods ended September 30, 2003 and 2002 (in thousands):
THREE MONTHS ENDED SEPTEMBER 30, NINE MONTHS ENDED SEPTEMBER 30, 2003 2002 2003 2002 ----------------------------------------------- ----------------------------------------- Equity, beginning of period $ 261,514 $233,772 $249,327 $217,369 Comprehensive income: Net income $27,341 $8,518 $43,219 $26,199 Net change in net unrealized gains on available-for-sale securities (527) (54) (1,367) 663 ------- ------ ------- ------- Total comprehensive income 26,814 8,464 41,852 26,862 Issuance of common stock 791 554 1,907 1,828 Issuance of preferred stock -- -- -- 242 Cash dividends paid (1,989) (1,760) (5,956) (5,271) -------- -------- -------- -------- Equity, end of period $287,130 $241,030 $287,130 $241,030 ======== ======== ======== ========
4. SEGMENTS Prior to September 30, 2003, the Company had two reportable operating segments: commercial banking and mortgage banking. Sterling Bank (the "Bank") had an 80 percent ownership interest in Sterling Capital Mortgage Company ("SCMC") and reported its financial position and results of operations on a consolidated basis. The commercial banking and mortgage banking segments were managed separately because each business required different marketing strategies and each offered different products and services. On September 30, 2003, the Company completed the sale of its indirect interest in SCMC to RBC Mortgage Company. The business related to SCMC 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. In addition, the assets and liabilities of SCMC are stated separately as discontinued operations at December 31, 2002. However, the assets and liabilities of SCMC are not included as discontinued operations at September 30, 2003 since the sale of SCMC was completed on September 30, 2003. Details of SCMC's results of operations are disclosed in Note 5. 5. DISCONTINUED OPERATIONS On September 30, 2003, the Company and the Bank completed the sale of the Bank's 80% indirect interest in SCMC to RBC Mortgage Company, an indirect subsidiary of the Royal Bank of Canada. The purchase price for SCMC was $100 million, subject to post-closing adjustments. The gross proceeds available to the Company for its indirect interest were $74.2 million. In addition, effective July 16, 2003, the Bank purchased from SCMC its mortgage servicing portfolio of $15.5 million. The mortgage servicing rights were sold to a third party in a separate transaction during September 2003 for $13.5 million. A loss of $873 thousand was recorded on the sale of the mortgage servicing rights which is subject to post-closing adjustments. 6 The business related to SCMC 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 SCMC are presented as discontinued operations in a separate category on the income statement following results from continuing operations. The income from discontinued operations for the nine months and three months ended September 30, 2003 and 2002, respectively, is as follows (in thousands):
THREE MONTHS NINE MONTHS ENDED SEPTEMBER 30, ENDED SEPTEMBER 30, 2003 2002 2003 2002 ------------------------ ------------------------ (UNAUDITED) (UNAUDITED) Net interest income after provision for credit losses $ (699) $ -- $ (4,407) $ -- Noninterest income: Gain on sale of mortgage loans 9,237 9,320 34,621 20,990 Mortgage origination income 6,228 8,802 23,823 17,808 Gain on the sale of SCMC 45,983 -- 45,983 -- Other 2,889 2,359 8,064 6,743 ------- ------- -------- ------- Total noninterest income 64,337 20,481 112,491 45,541 Noninterest expense: Salaries and employee benefits 8,105 8,448 24,246 20,223 Occupancy expense 3,356 2,447 9,420 5,907 Mortgage servicing rights amortization and impairment 1,155 6,141 16,615 7,983 Technology 299 277 878 398 Postage and delivery charges 398 325 1,231 732 Supplies 426 398 1,351 977 Professional fees 341 159 773 341 Minority interest expense for SCMC 3 81 40 662 Other 5,129 1,608 8,811 3,800 ------- ------- -------- ------- Total noninterest expense 19,212 19,884 63,365 41,023 Income from discontinued operations before income taxes 44,426 597 44,719 4,518 Provision for income taxes 24,510 273 24,657 1,870 ------- ------- -------- ------- Income from discontinued operations $19,916 $ 324 $ 20,062 $ 2,648 ======= ======= ======== =======
All assets and liabilities of SCMC were sold as of September 30, 2003. Thus these assets and liabilities were not included in the September 30, 2003 interim condensed consolidated balance sheet. The major asset and liability categories of discontinued operations are as follows (in thousands):
DECEMBER 31, 2002 ------------ (UNAUDITED) Premises and equipment, net $ 5,059 Mortgage servicing rights 26,467 Goodwill, net 5,618 Other assets 18,915 ------- Assets related to discontinued operations $56,059 ======= Other liabilities $27,332 Minority interest in Sterling Capital Mortgage Company 5,074 ------- Liabilities related to discontinued operations $32,406 =======
7 6. DISPOSITIONS OF BANKING OFFICES On March 20, 2003, the Bank completed the sale of its banking office located in Eagle Pass, Texas to South Texas National Bank of Laredo. Assets of $18.7 million, loans of $16.8 million and deposits of $95.7 million were sold in the transaction. A before-tax gain of $3.4 million related to the sale of the Eagle Pass banking office was recorded in the first quarter of 2003. On May 8, 2003, the Bank sold three banking offices in south Texas to an investor group headed by current executive officers of the three locations. Assets of $16.6 million, loans of $15.2 million and deposits of $42.1 million were sold in the transaction. A before-tax loss of $142 thousand was recorded on the sale. 7. STOCK OPTIONS The Company accounts for its employee stock options using the intrinsic value-based method. If the 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. 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):
THREE MONTHS ENDED SEPTEMBER 30, NINE MONTHS ENDED SEPTEMBER 30, 2003 2002 2003 2002 -------------------------------- ------------------------------- Net income, as reported $27,341 $8,518 $43,219 $26,199 Total stock-based employee compensation expense determined under fair value based method for all awards, net of related tax effects 268 265 751 786 ------- ------ ------- ------- Pro Forma net income $27,073 $8,253 $42,468 $25,413 ======= ====== ======= ======= Earnings per share: Basic- as reported $ 0.62 $ 0.19 $ 0.98 $ 0.60 ======= ====== ======= ======= Basic- pro forma $ 0.61 $ 0.19 $ 0.96 $ 0.58 ======= ====== ======= ======= Diluted - as reported $ 0.61 $ 0.19 $ 0.97 $ 0.59 ======= ====== ======= ======= Diluted - pro forma $ 0.60 $ 0.18 $ 0.95 $ 0.57 ======= ====== ======= =======
8 8. INTANGIBLE ASSETS AND GOODWILL The changes in the carrying amount of goodwill for the year ended December 31, 2002 and the nine months ended September 30, 2003 are as follows (in thousands):
(Unaudited) SOUTH HOUSTON SAN ANTONIO DALLAS TEXAS TOTAL ---------- ----------- -------- --------- --------- Balance, January 1, 2002 $29,641 $15,079 $ -- $ 5,312 $50,032 Purchase price adjustment (28) -- -- -- (28) Eagle National acquisition -- -- 5,662 -- 5,662 ------- ------- ------ ------- ------- Balance, December 31, 2002 29,613 15,079 5,662 5,312 55,666 Sale of Eagle Pass office -- -- -- (3,570) (3,570) Sale of South Texas offices -- -- -- (1,742) (1,742) ------- ------- ------ ------- ------- Balance, September 30, 2003 $29,613 $15,079 $5,662 $ -- $50,354 ======= ======= ====== ======= =======
The changes in the carrying amounts of intangible assets other than goodwill for the year ended December 31, 2002 and nine months ended September 30, 2003 are as follows (in thousands):
CORE (Unaudited) DEPOSIT INTANGIBLE ---------- Balance, January 1, 2002 $2,036 Amortization (426) Eagle National acquisition 486 ------ Balance, December 31, 2002 2,096 Amortization (339) ------ Balance, September 30, 2003 $1,757 ======
9. RECENT ACCOUNTING PRONOUNCEMENTS On January 17, 2003, the Financial Accounting Standards Board ("FASB") issued FASB Interpretation No. 46 ("FIN 46") "Consolidation of Variable Interest Entities", which addresses consolidation by business enterprises of variable interest entities. FIN No. 46 clarifies the application of Accounting Research Bulletin No. 51, "Consolidated Financial Statements", to certain entities in which equity investors do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties. FIN No. 46 applies immediately to variable interest entities created after January 31, 2003, and to variable interest entities in which an enterprise obtains an interest after that date. Adoption of FIN No. 46 has been deferred until the end of the first interim or annual period ending after December 15, 2003. In its current form, Fin 46 may require the Corporation to de-consolidate its investment in Sterling Bancshares Capital Trust II ("Capital Trust II"), Sterling Bancshares Capital Trust III ("Capital Trust III") and Sterling Bancshares Statutory Trust One ("Statutory Trust One"). The potential de-consolidation of subsidiary trusts of bank holding companies formed in connection with the issuance of trust preferred securities, such as Capital Trust I, Capital Trust II and Statutory Trust One, appears to be an unintended consequence of FIN 46. It is currently unknown if, or when, the FASB will address this issue. In July 2003, the Board of Governors of the Federal Reserve System issued a supervisory letter instructing bank holding companies to continue to include the trust preferred securities in their Tier 1 capital for regulatory capital purposes until notice is given to the contrary. The Federal Reserve intends to review the regulatory implications of any accounting treatment changes and, if necessary or warranted, provide further appropriate guidance. There can be no assurance that the Federal Reserve will continue to allow institutions to include trust preferred securities in Tier 1 capital for regulatory capital purposes. If the trust preferred securities were no longer allowed to be included in Tier 1 capital, the Company would, subject to the conditions applicable thereto, also be permitted to redeem the trust preferred securities. 9 In April 2003, FASB issued Statement No. 149, "Amendment of Statement 133 on Derivative Instruments and Hedging Activities" ("SFAS 149"). SFAS 149 amends and clarifies financial accounting and reporting for derivative instruments, including certain derivative instruments embedded in other contracts and for hedging activities under FASB Statement No. 133, Accounting for Derivative Instruments and Hedging Activities. The amendments (i) reflect decisions of the Derivatives Implementation Group process that effectively required amendments to SFAS 133, (ii) reflect decisions made by the Financial Accounting Standards Board in connection with other board projects dealing with financial instruments, and (iii) address implementation issues related to the application of the definition of a derivative. SFAS 149 is effective for contracts entered into or modified after June 30, 2003, and for hedging relationships designated after June 30, 2003, with all provisions applied prospectively. The Company does not believe the adoptions of SFAS 149 will have a significant impact on its financial statements. In May 2003, FASB issued FASB Statement No. 150, "Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity" ("SFAS 150"). SFAS 150 establishes standards for how an issuer classifies, measures and discloses in its financial statements certain financial instruments with characteristics of both liabilities and equity. SFAS 150 requires that an issuer classify financial instruments that are within its scope as liabilities, in some circumstances. Such financial instruments include (i) financial instruments that are issued in the form of shares that are mandatorily redeemable; (ii) financial instruments that embody an obligation to repurchase the issuer's equity shares, or are indexed to such an obligation, and that require the issuer to settle the obligation by transferring assets; (iii) financial instruments that embody an obligation to repurchase the issuer's equity shares if, at inception, the monetary value of the obligation is predominantly based on a fixed amount, variations in something other than the fair value of the issuer's equity shares or variations inversely related to changes in the fair value of the issuer's equity shares; and (iv) certain free standing financial instruments. SFAS 150 is effective for contracts entered into or modified after May 31 2003, and is otherwise effective at the beginning of the first interim period beginning after June 15, 2003. However, on October 29, 2003, FASB announced that the adoption of SFAS 150 in regards to mandatorily redeemable noncontrolling interests has been indefinitely deferred. Early adoption of the provisions of SFAS 150 for instruments within the scope of indefinite deferrals is precluded during the deferral period. The Company previously released its earnings announcement for the third quarter ended September 30, 2003 on October 21, 2003. The Company's earnings announcement was released before FASB's announcement on October 29, 2003 that it had indefinitely deferred the adoption of certain provisions of SFAS 150. Consequently, the Company's earnings release for the third quarter ended September 30, 2003 reflected the effects of SFAS 150. Due to the indefinite deferral of the adoption of SFAS 150 relating to mandatorily redeemable noncontrolling interests, the unaudited interim condensed consolidated financial statements and other financial information herein do not reflect the effect of those provisions of SFAS 150. While the ultimate adoption of SFAS 150 as it relates to mandatorily redeemable noncontrolling interests will reduce the net interest margin, it will have no impact on net income or results of operation. 10. SUBSEQUENT EVENT On October 31, 2003, the Company completed the acquisition of the South Texas Capital Group, Inc., and its subsidiary bank, Plaza Bank, in a stock and cash merger. The shareholders of South Texas Capital Group, Inc. received $16.0 million in cash and 124,987 shares of the Company's common stock for all of the outstanding shares of common stock of South Texas Capital Group, Inc. Plaza Bank has three banking offices in San Antonio. As of September 30, 2003, Plaza Bank had assets of approximately $88.6 million, loans of $66.0 million, and deposits of $74.5 million. Full integration of Plaza Bank's operations with the Bank's operations is expected to occur during the first quarter of 2004. This acquisition was accounted using the purchase method of accounting and goodwill of $11.3 million was recorded in connection with this acquisition. 10 11. RESTATEMENT Subsequent to the filing of Form 10-Q for the quarter ended June 30, 2003, the Company determined that the sales of its banking offices in Eagle Pass, Carrizo Springs, Crystal City and Pearsall and the financial results and condition pertaining to these offices should not have been separately reported as discontinued operations. The Company initially determined that the sales of the banking offices met the requirements of SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets," for presentation as discontinued operations. However, after further consideration we have determined that the sales of these banking offices do not meet such requirements. Net income, basic and diluted earnings per share and shareholders' equity were not affected by such presentation. The Company determined that it was necessary to amend the Quarterly Reports on Form 10-Q for the quarterly periods ending March 31, 2003 and June 30, 2003 and the Annual Report on Form 10-K for the year ended December 31, 2002 so that the financial results and condition pertaining to these banking offices are not separately reported as discontinued operations. As a consequence, the interim condensed financial statements as of and for the three months and nine months ended September 30, 2002 have been restated to conform with the restatements described above. The first three columns in the following tables provide a summary of the effects of this restatement as well as certain reclassifications to conform the previously reported amounts to current classifications. As discussed in Note 5, the financial results of SCMC have been reported as discontinued operations. The fourth column in the following tables provides a summary of the effects of the reclassification of SCMC as discontinued operations in the current period report.
FOR THE THREE MONTHS ENDED SEPTEMBER 30, 2002 --------------------------------------------------------------------- DISCONTINUED OPERATIONS AS PREVIOUSLY RESTATEMENT AS SCMC AS CURRENTLY REPORTED ADJUSTMENT RESTATED ADJUSTMENT REPORTED ------------- ----------- -------- ------------ ------------ Interest income: Loans, including fees $ 40,606 $ 306 $ 40,912 $ -- $ 40,912 Securities: Taxable 3,230 73 3,303 -- 3,303 Tax-exempt 697 -- 697 -- 697 Federal funds sold 76 -- 76 -- 76 Trading assets 1,229 53 1,282 -- 1,282 Deposits in financial institutions 27 -- 27 -- 27 -------- -------- -------- ------- -------- Total interest income 45,865 432 46,297 -- 46,297 Interest expense: Demand and savings deposits 1,999 55 2,054 -- 2,054 Certificates and other time deposits 4,035 53 4,088 -- 4,088 Other borrowed funds 1,651 -- 1,651 -- 1,651 Notes payable 202 -- 202 -- 202 -------- -------- -------- ------- -------- Total interest expense 7,887 108 7,995 -- 7,995 -------- -------- -------- ------- -------- NET INTEREST INCOME 37,978 324 38,302 -- 38,302 Provision for credit losses 3,439 -- 3,439 -- 3,439 -------- -------- -------- ------- -------- NET INTEREST INCOME AFTER PROVISION FOR CREDIT LOSSES 34,539 324 34,863 -- 34,863 Noninterest income: Customer service fees 3,893 233 4,126 -- 4,126 Gain on the sale of mortgage servicing rights 9,320 -- 9,320 (9,320) -- Other 14,167 179 14,346 (11,161) 3,185 -------- -------- -------- ------- -------- Total noninterest income 27,380 412 27,792 (20,481) 7,311 Noninterest expense: Salaries and employee benefits 24,393 198 24,591 (8,448) 16,143 Occupancy expense 6,207 40 6,247 (2,447) 3,800 Technology 1,580 6 1,586 (277) 1,309 Minority interest expense: Company-obligated mandatorily redeemable trust preferred securities of subsidiary trusts 1,462 -- 1,462 -- 1,462 Sterling Capital Mortgage Company 81 -- 81 (81) -- Conversion costs related to acquisitions 973 -- 973 -- 973 Other 14,831 59 14,890 (8,631) 6,259 -------- -------- -------- ------- -------- Total noninterest expense 49,527 303 49,830 (19,884) 29,946 INCOME FROM CONTINUING OPERATIONS BEFORE INCOME TAXES 12,392 433 12,825 (597) 12,228 Provision for income taxes 4,163 144 4,307 (273) 4,034 -------- -------- -------- ------- -------- INCOME FROM CONTINUING OPERATIONS $ 8,229 $ 289 $ 8,518 $ (324) $ 8,194 ======== ======== ======== ======= ========
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2002 --------------------------------------------------------------------- DISCONTINUED OPERATIONS AS PREVIOUSLY RESTATEMENT AS SCMC AS CURRENTLY REPORTED ADJUSTMENT RESTATED ADJUSTMENT REPORTED ------------- ----------- -------- ------------ ------------ Interest income: Loans, including fees $111,825 $ 1,038 $112,863 $ -- $112,863 Securities: Taxable 10,594 359 10,953 -- 10,953 Tax-exempt 2,217 -- 2,217 -- 2,217 Federal funds sold 415 -- 415 -- 415 Trading assets 3,222 27 3,249 -- 3,249 Deposits in financial institutions 86 -- 86 -- 86 -------- -------- -------- ------- -------- Total interest income 128,359 1,424 129,783 -- 129,783 Interest expense: Demand and savings deposits 6,601 165 6,766 -- 6,766 Certificates and other time deposits 12,457 175 12,632 -- 12,632 Other borrowed funds 3,372 -- 3,372 -- 3,372 Notes payable 602 -- 602 -- 602 -------- -------- -------- ------- -------- Total interest expense 23,032 340 23,372 -- 23,372 -------- -------- -------- ------- -------- NET INTEREST INCOME 105,327 1,084 106,411 -- 106,411 Provision for credit losses 9,150 -- 9,150 -- 9,150 -------- -------- -------- ------- -------- NET INTEREST INCOME AFTER PROVISION FOR CREDIT LOSSES 96,177 1,084 97,261 -- 97,261 Noninterest income: Customer service fees 11,662 716 12,378 -- 12,378 Gain on the sale of mortgage servicing rights 20,990 -- 20,990 (20,990) -- Other 33,333 462 33,795 (24,551) 9,244 -------- -------- -------- ------- -------- Total noninterest income 65,985 1,178 67,163 (45,541) 21,622 Noninterest expense: Salaries and employee benefits 66,319 585 66,904 (20,223) 46,681 Occupancy expense 17,094 125 17,219 (5,907) 11,312 Technology 4,119 20 4,139 (398) 3,741 Minority interest expense: Company-obligated mandatorily redeemable trust preferred securities of subsidiary trusts 4,117 -- 4,117 -- 4,117 Sterling Capital Mortgage Company 662 -- 662 (662) -- Conversion costs related to acquisitions 973 -- 973 -- 973 Other 31,056 187 31,243 (13,833) 17,410 -------- -------- -------- ------- -------- Total noninterest expense 124,340 917 125,257 (41,023) 84,234 INCOME FROM CONTINUING OPERATIONS BEFORE INCOME TAXES 37,822 1,345 39,167 (4,518) 34,649 Provision for income taxes 12,520 448 12,968 (1,870) 11,098 -------- -------- -------- ------- -------- INCOME FROM CONTINUING OPERATIONS $ 25,302 $ 897 $ 26,199 $(2,648) $ 23,551 ======== ======== ======== ======= ========
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS FORWARD-LOOKING STATEMENTS This Quarterly Report on Form 10-Q, including Management's Discussion and Analysis of Financial Condition and Results of Operations, contains "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. The Company 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 the Company's future financial performance and 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, but are not limited to, the following: general business and economic conditions in the markets the Company serves 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; the Company's liquidity requirements could be adversely affected by changes in its assets and liabilities; legislative or regulatory developments including changes in laws concerning taxes, banking, securities, insurance and other aspects of the financial securities industry; competitive factors, including product and pricing pressures among financial services organizations, may increase; and changes in fiscal and governmental policies of the United States federal government could have an adverse effect on the Company's business. For additional discussion of such risks, uncertainties and assumptions, see the Company's Amendment No. 1 to the Annual Report on Form 10-K/A for the year ended December 31, 2002, filed with the Securities and Exchange Commission under the Securities Exchange Act of 1934. 11 RESTATEMENT As discussed in note 11 to the interim condensed consolidated financial statements, we have restated our consolidated financial statements as of and for the three months and six months ended March 31, 2003 and 2002, and June 30, 2003 and 2002, respectively and for the year ended December 31, 2002. Additionally, the interim condensed consolidated financial statements for the three months and nine months ended September 30, 2002 have been restated to conform with the restatements described in note 11. The accompanying management's discussion and analysis gives effect to restatement. CRITICAL ACCOUNTING POLICIES 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 the 2002 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 the annual report for additional insight into management's approach and methodology in estimating the allowance for credit losses. SIGNIFICANT DEVELOPMENTS On September 30, 2003, the Company and the Bank completed the sale of the Bank's 80% indirect interest in SCMC to RBC Mortgage Company, an indirect subsidiary of the Royal Bank of Canada. The purchase price for SCMC was $100 million, subject to post-closing adjustments. The gross proceeds available to the Company for its indirect interest were $74.2 million. In addition, effective July 16, 2003, the Bank purchased from SCMC its mortgage servicing portfolio of $15.5 million. The mortgage servicing rights were sold to a third party in a separate transaction during September 2003 for $13.5 million. A loss of $873 thousand was recorded on the sale of the mortgage servicing rights which is subject to post-closing adjustments. On May 8, 2003, the Bank sold three banking offices in south Texas to an investor group headed by the current executive officers of the three locations. Assets of $16.6 million, loans of $15.2 million and deposits of $42.1 million were sold in the transaction. A before-tax loss of $142 thousand was recorded on the sale in the second quarter of 2003. On March 20, 2003, the Bank sold its banking office located in Eagle Pass, Texas to South Texas National Bank of Laredo. Assets of $18.7 million, loans of $16.8 million and deposits of $95.7 million were sold 12 in the transaction. A before-tax gain of $3.4 million related to the sale of the Eagle Pass banking office was recorded in the first quarter of 2003. During April, 2003, the Bank raised approximately $50 million through a private offering of subordinated unsecured notes. The subordinated notes issued by the Bank bear interest at a fixed rate of 7.375% and mature over a ten year period ending April 15, 2013, with semi-annual interest payment. These subordinated notes are not convertible or redeemable. In June 2003, the Bank entered into an interest rate swap agreement in which the Bank swapped $50 million fixed rate subordinated debt to floating rate debt. Under the terms of the agreement, the Bank will receive the fixed coupon rate of 7.375% associated with the subordinated debt and will pay its swap counterparty a variable interest rate equal to the three-month London Inter-Bank Rate ("LIBOR"), that is reset on a quarterly basis, plus 3.62%. This swap is designated as a fair-value hedge and qualifies for "short-cut" hedge accounting treatment under SFAS 133, such that changes in the fair value of the swap will not be reflected in the income statement. The effective rate for the swap was 4.73% at September 30, 2003. NON-GAAP PRESENTATIONS The following Management's Discussion and Analysis of Financial Condition and Results of Operations contains financial information determined by methods other than in accordance with Generally Accepted Accounting Principles ("GAAP"). Management uses these non-GAAP measures in their analysis of the business and its performance. In particular, net interest income and net interest margin as reflected in the Consolidated Yield Analysis table are calculated on both a GAAP based measurement and on a fully tax-equivalent basis ("FTE"). Management believes that these measures calculated on a FTE basis provide a useful picture of net interest income and net interest margin for comparative purposes. The GAAP based measures do not take into consideration the tax-exempt status of certain income. Net interest income and net interest margin calculated on a FTE basis are determined by adjusting net interest income to reflect tax-exempt interest income on an equivalent before-tax basis. Non-GAAP information presented by other companies may not be comparable to that presented herein, since each company may define non-GAAP measures differently. RESULTS OF OPERATIONS A discussion of the Company's results of operations is presented below. Certain reclassifications have been made to make prior periods comparable. On September 30, 2003, the Company and the Bank sold the Bank's indirect interest in SCMC. As a result, the revenues, operating costs and expenses, and other non-operating results from the discontinued operations of SCMC are excluded from the Company's results from continuing operations at and for the periods ending September 30, 2003 and September 30, 2002. The financial results of SCMC are presented in the Company's Consolidated Statements of Income under the line items "Income from discontinued operations before income taxes" and "Income from discontinued operations" and in the Company's Consolidated Statements of Cash Flows as "Net cash used in discontinued operations" for each of the periods ending September 30, 2003 and September 30, 2002. Additionally, the assets and liabilities of SCMC are presented in the Company's Consolidated Balance Sheets in the line items "Assets related to discontinued operations" and "Liabilities related to discontinued operations" at December 31, 2002. However, the assets and liabilities of SCMC are not included as discontinued operations at September 30, 2003 since the sale of SCMC was completed on September 30, 2003. NINE MONTHS ENDED SEPTEMBER 30, 2003 COMPARED TO SAME PERIOD IN 2002 NET INCOME - Net income for the nine-month period ended September 30, 2003 was $43.2 million as compared to $26.2 million for the same period in 2002, an increase of approximately $17.0 million or 65.0%. Included in net income is a $21.0 million gain related to the sale of SCMC. The gain is included 13 in income from discontinued operations. Income from continuing operations for the nine-month period ended September 30, 2003 was $23.2 million as compared to $23.6 million for the same period in 2002, a decrease of approximately $394 thousand or 1.7%. The decrease was due, in part, to a higher loan loss provision during the quarter ended September 30, 2003. NET INTEREST INCOME - Net interest income for the nine-month period ended September 30, 2003, was $111.8 million, as compared to $106.4 million for the same period in 2002, an increase of $5.4 million or 5.0%. While average earning assets for the period ended September 30, 2003 increased $508 million over a year ago, the average yield decreased 100 basis points from 6.88% for the nine-month period ended September 30, 2002, to 5.88% for the same period in 2003. As of September 30, 2003, average interest bearing liabilities were $2.1 billion, an increase of $355.7 million or 20.4% from September 30, 2002. Average interest bearing deposits at September 30, 2003 were $1.58 billion, an increase of 7.06% from September 30, 2002. The cost of interest bearing liabilities decreased 43 basis points from 1.80% for the nine months ended September 30, 2002 to 1.37% during the same period in 2003. The Company's 4.93% net interest margin for the nine months ended September 30, 2003 decreased from the 5.64% net interest margin recorded during the same period in 2002. Additionally, the Company's 4.98% tax equivalent net interest margin for the nine months ended September 30, 2003 decreased from the 5.70% tax equivalent net interest margin recorded during the same period in 2002. In November 2002 and June 2003, the Federal Reserve Bank decreased the discount rate 50 basis points and 25 basis points, respectively. Since the Company's balance sheet is asset sensitive, the interest earning assets generally reprice more quickly than the interest bearing liabilities. Thus, the Company's net interest margin tends to increase in periods of rising interest rates in the market and decrease in periods of declining interest rates. 14 The following schedule gives a comparative analysis of the Company's daily average interest-earning assets and interest-bearing liabilities for the nine-month periods ended September 30, 2003 and 2002, respectively: CONSOLIDATED YIELD ANALYSIS NINE MONTHS ENDED SEPTEMBER 30, (DOLLARS IN THOUSANDS)
2003 2002 -------------------------------- -------------------------------- AVERAGE AVERAGE AVERAGE AVERAGE BALANCE INTEREST YIELD BALANCE INTEREST YIELD --------- -------- ------- ------- -------- ------- INTEREST EARNING ASSETS: Interest bearing deposits in financial institutions $ 1,262 $ 53 5.61% $ 2,082 $ 86 5.52% Federal funds sold and securities purchased under agreements to resell 14,311 113 1.06% 29,113 415 1.91% Trading assets 118,323 2,590 2.93% 103,619 3,249 4.19% Investment securities (taxable) 252,001 7,087 3.76% 241,286 10,953 6.07% Investment securities (tax-exempt) 53,940 1,773 4.39% 68,156 2,217 4.35% Loans held for sale (taxable) 585,303 23,844 5.45% 327,141 17,669 7.22% Loans held for investment (taxable) 2,000,584 97,525 6.52% 1,745,878 94,963 7.27% Loans (tax-exempt) 4,673 223 6.38% 5,048 231 6.12% ----------- --------- ---- ---------- -------- ---- Total Interest Earning Assets 3,030,397 133,208 5.88% 2,522,323 129,783 6.88% NONINTEREST EARNING ASSETS: Cash and due from banks 98,781 95,391 Premises and equipment, net 48,329 51,694 Other assets 215,527 191,119 Allowance for credit losses (29,961) (24,386) Assets related to discontinued operations 47,600 41,855 ----------- ---------- Total Noninterest Earning Assets 380,276 355,673 ----------- ---------- TOTAL ASSETS $ 3,410,673 $2,877,996 =========== ========== INTEREST BEARING LIABILITIES: Demand and savings deposits $ 894,814 $ 3,736 0.56% $ 881,276 $ 6,766 1.03% Certificates and other time deposits 684,051 11,514 2.25% 593,455 12,632 2.85% Other borrowed funds 466,660 4,417 1.27% 244,191 3,372 1.85% Notes payable 19,343 457 3.16% 20,824 602 3.87% Subordinated debt 30,620 1,305 5.70% -- -- -- ----------- --------- ---- ---------- -------- ---- Total Interest Bearing Liabilities 2,095,488 21,429 1.37% 1,739,746 23,372 1.80% NONINTEREST BEARING LIABILITIES: Demand deposits 925,580 808,196 Other liabilities 12,444 14,680 Liabilities related to discontinued operations 34,825 22,519 ----------- ---------- Total Noninterest Bearing Liabilities 972,849 845,395 Trust preferred securities 80,000 60,343 Shareholders' equity 262,336 232,512 ----------- ---------- TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 3,410,673 $2,877,996 =========== ========== NET INTEREST INCOME & MARGIN $ 111,779 4.93% $106,411 5.64% ========= ===== ======== ==== NET INTEREST INCOME & MARGIN (TAX EQUIVALENT) (1) $ 112,786 4.98% $107,618 5.70% ========= ===== ======== ====
----------- (1) In order to present pretax income and resultant yields on tax-exempt investments and loans on a comparable basis to those on taxable investments and loans, a tax-equivalent adjustment has been 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%. 15 PROVISION FOR CREDIT LOSSES - The provision for credit losses for the nine months ended September 30, 2003 was $14.7 million, as compared to $9.2 million for the same period in 2002, an increase of $5.5 million. A provision for credit losses of $1.0 million was recorded in the first quarter of 2003 for loans acquired pursuant to the acquisition of Eagle National. The Company's allowance for credit losses increased by $4.1 million from $27.2 million at December 31, 2002, to $31.4 million on September 30, 2003. Net charge-offs of $10.2 million were recorded in the nine months ended September 30, 2003. Please refer to the subsequent discussion of ALLOWANCE FOR CREDIT LOSSES and RISK ELEMENTS for additional insight to management's approach and methodology in estimating the allowance for credit losses. NONINTEREST INCOME - Total noninterest income for the nine months ended September 30, 2003 was $25.7 million, as compared to $21.6 million for the same period in 2002, an increase of $4.1 million or 18.8%. The increase in noninterest income is primarily due to the $3.4 million gain on the sale of the Eagle Pass banking office. Noninterest income for the nine months ended September 30, 2003 and 2002, respectively, is summarized as follows (in thousands):
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2003 2002 --------------------------------------- Customer service fees $ 12,361 $ 12,378 Bank owned life insurance 1,515 1,557 Debit card income 1,123 951 Gain on the sale of trading assets 1,032 618 Gain on the sale of securities 374 97 Gain on the sale of the Eagle Pass banking office 3,382 -- Sale of Community Bank charter -- 150 Other 5,910 5,871 ---------- --------- $ 25,697 $ 21,622 ========== =========
NONINTEREST EXPENSE - Noninterest expense increased $3.9 million or 4.7%, to $88.2 million for the nine-month period ending September 30, 2003 as compared to $84.2 million for the same period in 2002. Noninterest expense for the nine months ended September 30, 2003 and 2002, respectively, is summarized as follows (in thousands):
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2003 2002 --------------------------------------- Salaries and employee benefits $ 49,916 $ 46,681 Occupancy expense 11,708 11,312 Net (gain) loss and carrying costs of real estate acquired by foreclosure (436) 300 FDIC assessment 262 291 Technology 3,718 3,741 Postage and delivery charges 1,646 1,702 Supplies 990 1,000 Professional fees 3,300 3,107 Minority interest expense: Company-obligated mandatorily redeemable trust preferred securities of subsidiary trusts 4,643 4,117 Marketing 1,592 701 Conversion costs related to acquisitions 973 Other 10,828 10,309 ---------- --------- $ 88,167 $ 84,234 ========== =========
16 Salaries and employee benefits for the nine-month period ended September 30, 2003 were $49.9 million, as compared to $46.7 million for the same period in 2002, an increase of $3.2 million or 6.9%. The increase is primarily related to merit increases, increased payroll taxes and increased hospital and medical insurance expenses. Minority interest expense increased $526 thousand from the nine months ended September 30, 2002 as compared to the same period in 2003. The increase is related to the interest due on the additional trust preferred securities issued in August 2002 and September 2002 offset by the redemption of trust preferred securities in November 2002. The Company has increased its marketing and branding efforts through increased television and radio programming. As a result of these efforts, marketing expenses for the nine-month period ended September 30, 2003 were $1.6 million, an increase of $891 thousand or 127.1% from $701 thousand for the same period in 2002. PROVISION FOR INCOME TAXES - The aggregate provision for income taxes as a percent of total income before taxes increased from 33.1% for the nine months of 2002 to 45.5% for the same period in 2003. The increase in taxes is due to the tax election pursuant to Section 338(h)(10) of the Internal Revenue Code which the Company agreed upon with RBC Mortgage Company related to the sale of SCMC. The provision of income taxes relating to continuing operations as a percent of income from continuing operations before taxes was 33.1% for the nine months ended September 30, 2003 as compared to 32.0% for the same period in 2002. THREE MONTHS ENDED SEPTEMBER 30, 2003 COMPARED TO SAME PERIOD IN 2002 NET INCOME - Net income for the three-month period ended September 30, 2003 was $27.3 million as compared to $8.5 million for the same period in 2002, an increase of approximately $18.8 million or 221.0%. Included in net income is an after-tax gain of $21.0 million related to the sale of SCMC. The gain is included in income from discontinued operations. Income from continuing operations for the three-month period ended September 30, 2003 was $7.4 million as compared to $8.2 million for the same period in 2002, a decrease of approximately $769 thousand or 9.4%. NET INTEREST INCOME - Net interest income for the three-month period ended September 30, 2003, was $37.3 million, as compared to $38.3 million for the same period in 2002, a decrease of $979 thousand or 2.6%. While average earning assets for the period ended September 30, 2003 increased over a year ago, the average yield decreased 113 basis points from 6.76% for the three-month period ended September 30, 2002, to 5.63% for the same period in 2003. As of September 30, 2003, average interest bearing liabilities were $2.1 billion, an increase of $242.9 million or 12.9% from September 30, 2002. Average interest bearing deposits at September 30, 2003 were $1.5 billion, an increase of 2.0% from September 30, 2002. The cost of interest bearing liabilities decreased 44 basis points from 1.68% for the three months end September 30, 2002 to 1.24% during the same period in 2003. The Company's 4.78% net interest margin for the three months ended September 30, 2003 decreased from the 5.60% net interest margin recorded during the same period in 2002. Additionally, the Company's 4.82% tax equivalent net interest margin for the three months ended September 30, 2003 decreased from the 5.65% tax equivalent net interest margin recorded during the same period in 2002. In November 2002 and June 2003, the Federal Reserve Bank decreased the discount rate 50 basis points and 25 basis points, respectively. Since the Company's balance sheet is asset sensitive, the interest earning assets generally reprice more quickly than the interest bearing liabilities. Thus, the Company's net interest margin tends to increase in periods of rising interest rates in the market and decrease in periods of declining interest rates. 17 The following schedule gives a comparative analysis of the Company's daily average interest-earning assets and interest-bearing liabilities for the three-month periods ended September 30, 2003 and 2002, respectively: CONSOLIDATED YIELD ANALYSIS THREE MONTHS ENDED SEPTEMBER 30, (DOLLARS IN THOUSANDS)
2003 2002 ------------------------------------- ---------------------------------- AVERAGE AVERAGE AVERAGE AVERAGE BALANCE INTEREST YIELD BALANCE INTEREST YIELD ----------- ---------- --------- ----------- ---------- -------- INTEREST EARNING ASSETS: Interest bearing deposits in financial institutions $ 1,344 $ 17 5.02% $ 1,722 $ 27 6.22% Federal funds sold and securities purchased under agreements to resell 12,722 27 0.84% 16,315 76 1.85% Trading assets 126,349 857 2.69% 105,418 1,282 4.82% Investment securities (taxable) 254,234 2,162 3.37% 238,653 3,303 5.49% Investment securities (tax-exempt) 48,706 529 4.31% 64,105 697 4.31% Loans held for sale (taxable) 621,113 8,240 5.26% 439,636 7,871 7.10% Loans held for investment (taxable) 2,029,679 32,086 6.27% 1,845,231 32,967 7.09% Loans (tax-exempt) 4,400 70 6.31% 4,793 74 6.13% ---------- -------- ---- ---------- -------- ---- Total Interest Earning Assets 3,098,547 43,988 5.63% 2,715,873 46,297 6.76% NONINTEREST EARNING ASSETS: Cash and due from banks 98,693 92,181 Premises and equipment, net 46,174 51,323 Other assets 186,583 216,007 Allowance for credit losses (32,333) (25,117) Assets related to discontinued operations 36,683 46,461 ------------ ---------- Total Noninterest Earning Assets 335,800 380,855 ------------ ---------- TOTAL ASSETS $ 3,434,347 $3,096,728 ============ ========== INTEREST BEARING LIABILITIES: Demand and savings deposits $ 877,274 $ 987 0.45% $ 886,260 $ 2,054 0.92% Certificates and other time deposits 658,217 3,461 2.09% 619,151 4,088 2.62% Other borrowed funds 527,771 1,491 1.12% 358,135 1,651 1.83% Notes payable 17,553 137 3.10% 20,716 202 3.87% Subordinated debt 46,356 589 5.04% -- -- -- ---------- -------- ---- ---------- -------- ---- Total Interest Bearing Liabilities 2,127,171 6,665 1.24% 1,884,262 7,995 1.68% NONINTEREST BEARING LIABILITIES: Demand deposits 913,403 862,041 Other liabilities 10,390 14,666 Liabilities related to discontinued operations 35,995 26,857 ------------ ---------- Total Noninterest Bearing Liabilities 959,788 903,564 Trust preferred securities 80,000 65,938 Shareholders' equity 267,388 242,964 ------------ ---------- TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 3,434,347 $3,096,728 ============ ========== NET INTEREST INCOME & MARGIN $ 37,323 4.78% $ 38,302 5.60% ======== ==== ======== ==== NET INTEREST INCOME & MARGIN (TAX EQUIVALENT) (1) $ 37,627 4.82% $ 38,684 5.65% ======== ==== ======== ====
---------- (1) In order to present pretax income and resultant yields on tax-exempt investments and loans on a comparable basis to those on taxable investments and loans, a tax-equivalent adjustment has been 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%. 18 PROVISION FOR CREDIT LOSSES - The provision for credit losses for the third quarter of 2003 was $4.2 million, as compared to $3.4 million for the same period in 2002, an increase of $711 thousand. The Company's allowance for credit losses decreased $224 thousand from $31.6 million at June 30, 2003, to $31.4 million on September 30, 2003. Net charge-offs of $4.4 million were recorded in the three months ended September 30, 2003. Please refer to the subsequent discussion of ALLOWANCE FOR CREDIT LOSSES and RISK ELEMENTS for additional insight to management's approach and methodology in estimating the allowance for credit losses. NONINTEREST INCOME - Total noninterest income for the quarter ended September 30, 2003 was $7.4 million, as compared to $7.3 million for the same period in 2002, an increase of $119 thousand or 1.6%. Noninterest income for the three months ended September 30, 2003 and 2002, respectively, is summarized as follows (in thousands):
FOR THE THREE MONTHS ENDED ------------------------------------------ SEPTEMBER 30, 2003 SEPTEMBER 30, 2002 ------------------ ------------------ Customer service fees $4,061 $4,126 Bank owned life insurance 503 528 Debit card income 338 352 Gain on the sale of trading assets 405 309 Other 2,123 1,996 ------ ------ $7,430 $7,311 ====== ======
NONINTEREST EXPENSE - Noninterest expense decreased $475 thousand or 1.6%, to $29.5 million for the three-month period ending September 30, 2003 as compared to $29.9 million for the same period in 2002. The decrease in noninterest expenses is mainly due to the conversion costs related to the acquisition of ENB Bankshares in September 2002. Noninterest expense for the three months ended September 30, 2003 and 2002, respectively, is summarized as follows (in thousands):
FOR THE THREE MONTHS ENDED -------------------------------------------- SEPTEMBER 30, 2003 SEPTEMBER 30, 2002 ------------------ ------------------ Salaries and employee benefits $ 16,583 $ 16,143 Occupancy expense 3,996 3,800 Net (gain) loss and carrying costs of real estate acquired by foreclosure (225) 229 FDIC assessment 49 102 Technology 1,289 1,309 Postage and delivery charges 527 583 Supplies 304 352 Professional fees 1,317 1,243 Minority interest expense: Company-obligated mandatorily redeemable trust preferred securities of subsidiary trusts 1,542 1,462 Marketing 414 170 Conversion costs related to acquisitions -- 973 Other 3,675 3,580 -------- -------- $ 29,471 $ 29,946 ======== ========
Salaries and employee benefits for the three-month period ended September 30, 2003 were $16.6 million, as compared to $16.1 million for the same period in 2002, an increase of $440 thousand or 2.7%. The increase is primarily related to merit increases, increased payroll taxes and increased hospital and medical insurance expenses. 19 The Company has increased its marketing and branding efforts through increased television and radio programming. As a result of these efforts, marketing expenses for the three-month period ended September 30, 2003 were $414 thousand, an increase of $2434 thousand or 143.5% from $170 thousand for the same period in 2002. PROVISION FOR INCOME TAXES - The aggregate provision for income taxes as a percent of total income before taxes increased from 33.6% for the third quarter of 2002 to 50.8% for the same period in 2003. The increase in taxes is due to the tax election pursuant to Section 338(h)(10) of the Internal Revenue Code which the Company agreed upon with RBC Mortgage Company related to the sale of SCMC. The provision for income taxes relating to continuing operations as a percent of income from continuing operations before taxes increased from 33.0% to 33.3% for the same period in 2003. FINANCIAL CONDITION TOTAL ASSETS - The total consolidated assets of the Company decreased $459.2 million from $3.6 billion at December 31, 2002 to $3.1 billion at September 30, 2003. Assets sold with the Eagle Pass office in March 2003 totaled $18.7 million. Assets sold with the banking offices located in Carrizo Springs, Crystal City and Pearsall in May 2003 totaled $16.6 million. CASH AND CASH EQUIVALENTS - The Company had cash and cash equivalents of $134.1 million at September 30, 2003. Comparatively, the Company had $147.0 million in cash and cash equivalents on December 31, 2002, a decrease of $12.9 million. TRADING ASSETS - The Company trades SBA 7(a) government guaranteed loans and pools. Trading assets as of September 30, 2003 were $131.6 million, a decrease of $11.2 million from December 31, 2002. These assets are generally held up to 120 days. The trading assets are carried at fair market value. The realized and unrealized gains and losses on these assets are included in income. SECURITIES - The Company's securities portfolio as of September 30, 2003, totaled $358.0 million, as compared to $313.1 million on December 31, 2002, an increase of $44.9 million or 14.4%. At September 30, 2003, the unrealized gain on the available for sale securities was $4.0 million. LOANS HELD FOR SALE - Total loans held for sale decreased from $701.3 million at December 31, 2002 to $311.7 million at September 30, 2003, a decrease of $389.6 million, or 55.6%. The majority of these loans represent loans funded by the Bank through a mortgage warehouse line to SCMC. Subsequent to the sale of SCMC on September 30, 2003, the mortgage warehouse line was repaid in October 2003 by RBC Mortgage Company. LOANS HELD FOR INVESTMENT - As of September 30, 2003, loans held for investment were $2.01 billion which was a $66.7 million increase from the balance of $1.94 billion at December 31, 2002. Loans sold with the Eagle Pass banking office and the South Texas offices totaled $16.5 million and $15.2 million, respectively. At September 30, 2003, loans held for investment as a percentage of total assets and total deposits were 64.4% and 83.2%, respectively. 20 The following table summarizes the Company's loan portfolio by type of loan as of September 30, 2003 (in thousands):
PERCENT OF AMOUNT TOTAL ---------- ------ Commercial, financial and industrial $ 619,597 26.68% Real estate - commercial 703,548 30.30% Real estate - residential mortgage 187,549 8.08% Real estate - construction 382,062 16.45% Foreign commercial and industrial 7,781 0.33% Consumer and other 109,716 4.73% ---------- ------ Total loans held for investment 2,010,253 86.57% Loans held for sale 311,729 13.43% ---------- ------ Total loans $2,321,982 100.00% ========== ======
ALLOWANCE FOR CREDIT LOSSES - The following is a summary of the changes in the allowance for credit losses for the nine months ended September 30, 2003 and September 30, 2002, respectively, (in thousands):
NINE MONTHS ENDED SEPTEMBER 30, --------------------------- 2003 2002 -------- -------- Allowance for credit losses, January 1, $ 27,248 $ 22,927 Charge-offs (11,721) (7,890) Recoveries 1,478 1,285 Provision for credit losses 14,698 9,150 Acquisition of Eagle National Bankshares, Inc. -- 656 Allowance related to Eagle Pass divestiture (353) -- -------- -------- Allowance for credit losses, September 30, $ 31,350 $ 26,128 ======== ======== Net charge-offs as a percentage of average loans (annualized) 0.53% 0.42% ======== ======== Provision for credit losses as a percentage of average loans (annualized) 0.76% 0.59% ======== ========
The following is a summary of the relationship of the allowance for credit losses to total loans at September 30, 2003, and December 31, 2002 (in thousands):
SEPTEMBER 30, DECEMBER 31, 2003 2002 ---------- ---------- Loans at period-end $2,321,982 $2,644,862 Allowance for credit losses $ 31,350 $ 27,248 Allowance as a percent of period-end loans 1.35% 1.03%
In order to determine the adequacy of the allowance for credit losses, management considers the risk classification and delinquency status of loans and other factors. Management also establishes specific allowances for credits which management believes require allowances greater than those allocated according to their risk classification. An unallocated allowance is also established based on the Company's historical charge-off experience. The Company will continue to monitor the adequacy of the allowance for credit losses to determine the appropriate accrual for the Company's provision for credit losses. 21 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. Twenty-three properties make up the $2.7 million of other real estate owned ("ORE") at September 30, 2003. All properties are carried at the lower of cost or fair market value. The Company defines potential problem loans as those loans for which 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 defines potential problem loans as those loans classified as "substandard", "doubtful", or "loss". As of September 30, 2003, the Company has no material foreign loans outstanding or loan concentrations. The following table summarizes total nonperforming assets and potential problem loans at September 30, 2003 and at December 31, 2002:
SEPTEMBER 30, DECEMBER 31, 2003 2002 ------- ------- (IN THOUSANDS) Nonaccrual loans $19,788 $19,654 Other real estate ("ORE") and other foreclosed assets 2,906 3,424 ------- ------- Total nonperforming assets $22,694 $23,078 ======= ======= Total nonperforming assets as a percentage of loans, ORE and other foreclosed assets 0.98% 0.87% Allowance for credit losses as a percentage of nonperforming assets 138.14% 118.07% Accruing loans past due 90 days or more $ 5,118 $ 984 Potential problem loans, other than those shown above as nonperforming $72,984 $62,189
PREMISES AND EQUIPMENT - The Company's premises and equipment, net of depreciation, as of September 30, 2003, was $44.8 million, as compared to $51.6 million as of December 31, 2002, a decrease of $6.8 million. Premises and equipment sold with the Eagle Pass banking office and the South Texas offices were $1.2 million and $504 thousand, respectively. DEPOSITS - Total deposits as of September 30, 2003, were $2.42 billion, as compared to $2.67 billion on December 31, 2002, a decrease of $256.9 million. Deposits sold with the Eagle Pass banking office and the South Texas offices were $95.7 million and $42.1 million, respectively. Additionally brokered certificate of deposits decreased $47.1 million. The percentage of noninterest bearing deposits to total deposits as of September 30, 2003 was 39.8%. CAPITAL RESOURCES AND LIQUIDITY SHAREHOLDERS' EQUITY - At September 30, 2003, shareholders' equity totaled $287.1 million, as compared to $249.3 million at December 31, 2002. The Company's risk-based capital ratios remain above the levels designated by regulatory agencies for the Company to be considered as "well capitalized" on September 30, 2003, with Tier 1 capital, total risk-based capital, and leverage capital ratios of 11.91%, 14.92%, and 9.23%, respectively. 22 LIQUIDITY - Effective management of balance sheet liquidity is necessary to fund growth in earning assets and to pay liability maturities, depository withdrawals and shareholders' dividends. The Company has instituted asset/liability management policies, including but not limited to a computer simulation model, to improve liquidity controls and to enhance its management of interest rate risk and financial condition. The Company has numerous sources of liquidity including a significant portfolio of short-term assets, marketable investment securities (excluding those presently classified as "held-to-maturity"), loans available-for-sale, core deposits and access to borrowing arrangements. Available borrowing arrangements maintained by the Company include federal funds lines with other commercial banks and Federal Home Loan Bank ("FHLB") advances. Also in 2002, the Bank began accepting brokered certificates of deposits to assist in funding the growth of the held for sale loan portfolio. During April, 2003, the Bank raised approximately $50 million through a private offering of subordinated unsecured notes. The subordinated notes issued by the Bank bear interest at a fixed rate of 7.375% and mature over a ten year period ending April 15, 2013, with semi-annual interest payment. These subordinated notes are not convertible or redeemable. In June 2003, the Bank entered into an interest rate swap agreement in which the Bank swapped $50 million fixed rate subordinated debt to floating rate debt. Under the terms of the agreement, the Bank will receive the fixed coupon rate of 7.375% associated with the subordinated debt and will pay its swap counterparty a variable interest rate equal to the three-month LIBOR that is reset on a quarterly basis, plus 3.62%. This swap is designated as a fair-value hedge and qualifies for "short-cut" hedge accounting treatment under SFAS 133, such that changes in the fair value of the swap will not be reflected in the income statement. The effective rate for the swap on September 30, 2003 was 4.73%. As of September 30, 2003, the Company had $16.7 million outstanding under a term loan with Wells Fargo Bank, National Association ("Wells Fargo"). The term note bears interest at a rate per annum of 1.95% above the federal funds rate 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 payable 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. At September 30, 2003, the Company and Bank were in compliance with all related financial covenants for this credit facility. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK. The Company's profitability, as with most financial institutions, is greatly dependent upon net interest income. The Company actively manages its overall exposure to changes in interest rates. While the Company has entered into the interest rate swap agreement described below, the Company believes that there have been no material changes in market risk faced by the Company since December 31, 2002. For more information regarding quantitative and qualitative disclosures about market risk, please refer to the Company's Annual Report on Form 10-K as of and for the year ended December 31, 2002. In June 2003, the Bank entered into an interest rate swap agreement in which the Bank swapped $50 million fixed rate subordinated debt to floating rate debt. Under the terms of the agreement, the Bank will receive the fixed coupon rate of 7.375% associated with the subordinated debt and will pay its swap counterparty a variable interest rate equal to the three-month LIBOR that is reset on a quarterly basis, plus 3.62%. This swap is designated as a fair-value hedge and qualifies for "short-cut" hedge accounting treatment under SFAS 133, such that changes in the fair value of the swap will not be reflected in the income statement. ITEM 4. CONTROLS AND PROCEDURES. Evaluation of disclosure controls and procedures - Based on their evaluation of the Company's disclosure controls and procedures as of the end of the period covered by this report, the Chief Executive Officer and 23 Chief Financial Officer of the Company have concluded that the disclosure controls and procedures are effective in ensuring that the information required to be disclosed by the Company in the reports that it files or submits under the Securities Exchange Act is recorded, processed, summarized and report within the time periods specified in the Securities and Exchange Commission's rules and forms. Changes in internal control over financial reporting - There were no changes in the Company's internal control over financial reporting that occurred during the Company's most recent fiscal quarter that have materially affected, or are reasonably likely to materially affect, the Company's internal control over financial reporting. PART II. OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS. Not applicable. ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS. Not applicable. ITEM 3. DEFAULTS UPON SENIOR SECURITIES. Not applicable. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS. Not applicable. ITEM 5. OTHER INFORMATION. Not applicable. ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits: 10.1 -- Stock Purchase Agreement dated as of July 16, 2003, by and among Sterling Bancshares, Inc., Sterling Bank, CMCR Holding Company and RBC Mortgage Company. [Incorporated by reference to Exhibit 2.1 of the Company's Current Report on Form 8-K filed on October 15, 2003 (File No. 000-20750).] 10.2 -- Amendment No. 1 to Stock Purchase Agreement dated as of September 30, 2003, by and among Sterling Bancshares, Inc., Sterling Bank, CMCR Holding Company and RBC Mortgage Company. [Incorporated by reference to Exhibit 2.2 of the Company's Current Report on Form 8-K filed on October 15, 2003 (File No. 000-20750).] *10.3 -- Agreement and Plan of Merger dated August 18, 2003 by and among Sterling Bancshares, Inc., SB 2003, Inc. and South Texas Capital Group, Inc. 11 -- Statement Regarding Computation of Earnings Per Share (included as Note (2) to Interim Consolidated Financial Statements on page 5 of this Quarterly Report on Form 10-Q). 24 *31.1-- Certification of J. Downey Bridgwater, President and Chief Executive Officer, as required pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. *31.2-- Certification of Stephen C. Raffaele, Executive Vice President and Chief Financial Officer, as required pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. *32.1-- Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. *32.2-- 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. (b) Reports on Form 8-K: (1) Current Report on Form 8-K filed July 17, 2003 announcing the release of Sterling Bancshares' preliminary earnings report for the second quarter and six months ended June 30 (2) Current Report on Form 8-K filed July 18, 2003 announcing the execution of a definitive stock purchase agreement in which Sterling Bancshares will sell its indirect 80% interest in Sterling Capital Mortgage Company to RBC Mortgage Company. (3) Current Report on Form 8-K/A filed July 18, 2003 announcing the execution of a definitive stock purchase agreement in which Sterling Bancshares will sell its indirect 80% interest in Sterling Capital Mortgage Company to RBC Mortgage Company. (4) Current Report on Form 8-K filed on August 20, 2003 announcing the execution of an Agreement and Plan of Merger by South Texas Capital Group, Inc. and Sterling Bancshares Inc. providing for the merger of South Texas Capital Group, Inc. with Sterling Bancshares. 25 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused the report to be signed on its behalf by the undersigned thereunto duly authorized. STERLING BANCSHARES, INC. ------------------------- (Registrant) DATE: November 14, 2003 BY: /s/ J. Downey Bridgwater ------------------------------------- --------------------------- J. DOWNEY BRIDGWATER PRESIDENT AND CHIEF EXECUTIVE OFFICER DATE: November 14, 2003 BY: /s/ Stephen C. Raffaele ------------------------------------- --------------------------- STEPHEN C. RAFFAELE EXECUTIVE VICE PRESIDENT AND CHIEF FINANCIAL OFFICER 26 EXHIBIT INDEX EXHIBIT DESCRIPTION ------- ----------- 10.1 -- Stock Purchase Agreement dated as of July 16, 2003, by and among Sterling Bancshares, Inc., Sterling Bank, CMCR Holding Company and RBC Mortgage Company. [Incorporated by reference to Exhibit 2.1 of the Company's Current Report on Form 8-K filed on October 15, 2003 (File No. 000-20750).] 10.2.1 -- Amendment No. 1 to Stock Purchase Agreement dated as of September 30, 2003, by and among Sterling Bancshares, Inc., Sterling Bank, CMCR Holding Company and RBC Mortgage Company. [Incorporated by reference to Exhibit 2.2 of the Company's Current Report on Form 8-K filed on October 15, 2003 (File No. 000-20750).] *10.3 -- Agreement and Plan of Merger dated August 18, 2003 by and among Sterling Bancshares, Inc., SB 2003, Inc. and South Texas Capital Group, Inc. 11 -- Statement Regarding Computation of Earnings Per Share (included as Note (2) to Interim Consolidated Financial Statements on page 5 of this Quarterly Report on Form 10-Q). *31.1 -- Certification of J. Downey Bridgwater, President and Chief Executive Officer, as required pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. *31.2 -- Certification of Stephen C. Raffaele, Executive Vice President and Chief Financial Officer, as required pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. *32.1 -- Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. *32.2 -- 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. 27