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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934 FOR THE FISCAL YEAR ENDED DECEMBER 31, 1998
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
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COMMISSION FILE NUMBER: 000-22007
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SOUTHWEST BANCORPORATION OF TEXAS, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
TEXAS 76-0519693
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)
4400 POST OAK PARKWAY
HOUSTON, TEXAS 77027
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES, INCLUDING ZIP CODE)
(713) 235-8800
(REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE)
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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)
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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 [ ]
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Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of 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. [ ]
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There were 23,411,791 shares of the Registrant's Common Stock outstanding
as of the close of business on February 19, 1999. The aggregate market value of
the Registrant's Common Stock held by non-affiliates was approximately $275
million (based upon the closing price of $14 1/4 on February 19, 1999, as
reported on the NASDAQ National Market System).
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Registrant's Proxy Statement relating to the 1999 Annual
Meeting of Shareholders, which will be filed within 120 days after December 31,
1998, are incorporated by reference into Part III of this Report.
PART I
ITEM 1. BUSINESS
SPECIAL CAUTIONARY NOTICE REGARDING FORWARD-LOOKING STATEMENTS
Certain of the matters discussed in this document and in documents
incorporated by reference herein, including matters discussed under the caption
"Management's Discussion and Analysis of Financial Condition and Results of
Operations," may constitute forward-looking statements for purposes of the
Securities Act of 1933, as amended, and the Securities Exchange Act of 1934, as
amended, and as such may involve known and unknown risks, uncertainties and
other factors which may cause the actual results, performance or achievements of
Southwest Bancorporation of Texas, Inc. (the "Company") to be materially
different from future results, performance or achievements expressed or implied
by such forward-looking statements. The words "expect," "anticipate,"
"intend," "plan," "believe," "seek," "estimate," and similar
expressions are intended to identify such forward-looking statements. The
Company's actual results may differ materially from the results anticipated in
these forward-looking statements due to a variety of factors, including, without
limitation: (a) the effects of future economic conditions on the Company and its
customers; (b) governmental monetary and fiscal policies, as well as legislative
and regulatory changes; (c) the risks of changes in interest rates on the level
and composition of deposits, loan demand, and the values of loan collateral,
securities and interest rate protection agreements, as well as interest rate
risks; (d) the effects of competition from other commercial banks, thrifts,
mortgage banking firms, consumer finance companies, credit unions, securities
brokerage firms, insurance companies, money market and other mutual funds and
other financial institutions operating in the Company's market area and
elsewhere, including institutions operating locally, regionally, nationally and
internationally, together with such competitors offering banking products and
services by mail, telephone, computer and the Internet; and (e) the failure of
assumptions underlying the establishment of reserves for loan losses and
estimations of values of collateral and various financial assets and liabilities
and technological changes, including "Year 2000" data systems compliance
issues, are more difficult or expensive than anticipated. All written or oral
forward-looking statements attributable to the Company are expressly qualified
in their entirety by these cautionary statements.
THE COMPANY
The Company was incorporated as a business corporation under the laws of
the State of Texas on March 28, 1996, for the purpose of serving as a bank
holding company for Southwest Bank of Texas National Association (the "Bank").
The holding company formation was consummated and the Company acquired all of
the outstanding shares of capital stock of the Bank as of the close of business
on June 30, 1996. Based upon total assets as of December 31, 1998, the Company
ranks as the largest independent bank holding company headquartered in the
metropolitan Houston area. The Company's headquarters are located at 4400 Post
Oak Parkway, Houston, Texas 77027, and its telephone number is (713) 235-8800.
The Company provides an array of sophisticated products typically found
only in major regional banks. These services are provided to middle market
businesses in the metropolitan Houston area through seventeen full service
banking facilities. Each banking office has seasoned management with significant
lending experience who exercises substantial autonomy over credit and pricing
decisions, subject to loan committee approval for larger credits. This
decentralized management approach, coupled with the continuity of service by the
same staff members, enables the Company to develop long-term customer
relationships, maintain high quality service and provide quick responses to
customer needs. The Company believes that its emphasis on local relationship
banking, together with its conservative approach to lending and resultant strong
asset quality, are important factors in the success and the growth of the
Company.
The Company seeks credit risks of good quality within its target market
that exhibit good historical trends, stable cash flows and secondary sources of
repayment from tangible collateral. The Company extends credit for the purpose
of obtaining and continuing long term relationships. Lenders are provided with
detailed underwriting policies for all types of credit risks accepted by the
Company and must obtain
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appropriate approvals for credit extensions in excess of conservatively assigned
individuals' lending limits. The Company also maintains strict documentation
requirements and extensive credit quality assurance practices in order to
identify credit portfolio weaknesses as early as possible so any exposures that
are discovered might be reduced.
The Company has a three-part strategy for growth. First, the Company will
continue to actively target the "middle market" and private banking customers
in Houston for loan and deposit opportunities as it has successfully done for
the past nine years. The "middle market" is generally characterized by
privately owned companies having annual revenues ranging from $1 million to $250
million and borrowings ranging from $50,000 to $10 million, but primarily in the
$150,000 to $5 million range. Typical middle market customers seek a
relationship with a local independent bank that is sensitive to their needs and
understands their business philosophy. These customers desire a long-term
relationship with a decision-making loan officer who is responsive and
experienced and has ready access to a bank's senior management. In implementing
this part of its strategy, the Company continues to explore opportunities (i) to
solidify its existing customer relationships and build new customer
relationships by providing new services required by its middle market customers
and (ii) to expand its base of services in the professional and executive market
to meet the demands of that sector.
Second, the Company intends to establish branches in areas that
demographically complement its existing or targeted customer base. As other
local banks are acquired by out-of-state organizations, the Company believes
that the establishment of branches will better meet the needs of customers in
many Houston area neighborhoods who feel disenfranchised by larger regional or
national organizations.
Third, the Company may pursue selected acquisitions of other financial
institutions. The Company intends to conduct thorough studies and reviews of any
possible acquisition candidates to assure that they are consistent with the
Company's existing goals, both from an economic and strategic perspective. The
Company believes market and regulatory factors may present opportunities for the
Company to acquire other financial institutions.
THE BANK
The Bank, a national banking association, was chartered in January 1982 and
commenced business operations in October 1982. In July 1989, the Bank hired as
its President and Chief Executive Officer, Walter E. Johnson who had worked in
the banking industry for over 30 years. From 1972 to 1988 Mr. Johnson had been
president of Allied Bank of Texas, a premier Houston middle market lender whose
total assets approached $4 billion at the time it was acquired by First
Interstate Bancorp in 1988. Mr. Johnson improved the Bank's credit review
practices and lending policies and assembled an experienced team of loan
officers, consisting primarily of individuals with whom he had worked at Allied
Bank of Texas and First Interstate Bank. The Bank's 74 senior loan officers
average more than 15 years of lending experience in the metropolitan Houston
area.
The Bank provides a complete range of retail and commercial banking
services that compete directly with major regional banks. Loans consist of
commercial loans to middle market businesses, loans to individuals, commercial
real estate loans, residential mortgages and construction loans. In addition,
the Bank offers a broad array of fee income products including merchant card
services, letters of credit, customized cash management services, brokerage and
mutual funds and drive-in banking services.
The Bank maintains a staff of professional treasury management marketing
officers who consult with middle market companies to design custom
cost-effective cash management systems. The Bank offers a full product line of
cash concentration, disbursement and automated information reporting services
comparable to those offered by any major regional bank. Through the Bank's
continued investment in new technology and people, the Bank has been able to
attract some of Houston's largest middle market companies to utilize the Bank's
treasury management products. The Bank has also been able to attract new loan
customers through use of the Bank's treasury management products, such as an
image-based lock box service and controlled disbursement and sweep products,
which allow borrowers to minimize interest expense and convert excess operating
funds into interest income. Through the use of an interactive terminal or
personal
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computer, the Bank's STAR system provides customers with instant access to all
bank account information with multiple intraday updates. The Bank makes business
communication more efficient through Electronic Data Interchange ("EDI"),
which is an inter-organizational computer-to-computer exchange of business
documentation in a standard computer-processable format. Through the use of EDI
and electronic payments, the Bank can provide the customer with a paperless
funds management system. Positive Pay, a service under which the Bank only pays
checks listed on a legitimate "company issue" file, is another product which
helps prevent check fraud. The Bank's average commercial customer uses five
treasury management services. Because these services help customers improve
their treasury operations and achieve new efficiencies in cash management, they
are extremely useful in building and maintaining long-term relationships.
The Bank maintains a strong community orientation by, among other things,
supporting active participation of all employees in local charitable, civic,
school and church activities. Each banking office also appoints selected
customers to a business development board that assists in introducing
prospective customers to the Bank and in developing or modifying products and
services to better meet customer needs.
COMPETITION
The banking business is highly competitive, and the profitability of the
Company will depend principally upon the Company's ability to compete in its
market area. The Company competes with other commercial and savings banks,
savings and loan associations, credit unions, finance companies, mutual funds,
insurance companies, brokerage and investment banking firms, asset-based
non-bank lenders and certain other non-financial institutions, including certain
governmental organizations which may offer subsidized financing at lower rates
than those offered by the Company. The Company has been able to compete
effectively with other financial institutions by emphasizing technology and
customer service, including local office decision-making on loans, establishing
long-term customer relationships and building customer loyalty, and by providing
products and services designed to address the specific needs of its customers.
The success of the Company is also highly dependent on the economic
strength of the Company's general market area. Significant deterioration in the
local economy or economic problems in the greater Houston area could
substantially impact the Company's performance.
EMPLOYEES
As of December 31, 1998, the Company had 702 full-time employees, 241 of
whom were officers of the Bank. The Company provides medical and hospitalization
insurance to its full-time employees. The Company has also provided most of its
employees with the benefit of Common Stock ownership through the Company's
contributions to a 401(k) plan, in which 548 of its employees are currently
participating. The Company considers its relations with its employees to be
excellent.
SUPERVISION AND REGULATION
The federal banking laws contain numerous provisions affecting various
aspects of the business and operations of the Company and the Bank. The
following description of references herein to applicable statutes and
regulations, which are not intended to be complete descriptions of these
provisions or their effects on the Company or the Bank, are brief summaries and
are qualified in their entirety by reference to such statutes and regulations.
THE BANK
As a national banking association, the Bank is principally supervised,
examined and regulated by the Office of the Comptroller of the Currency (the
"OCC"). The OCC regularly examines such areas as capital adequacy, reserves,
loan portfolio, investments and management practices. The Bank must also furnish
quarterly and annual reports to the OCC, and the OCC may exercise cease and
desist and other enforcement powers over the Bank if its actions represent
unsafe or unsound practices or violations of law. Since the deposits of the Bank
are insured by the Bank Insurance Fund ("BIF") of the Federal Deposit
Insurance
3
Corporation (the "FDIC"), the Bank is also subject to regulation and
supervision by the FDIC. Because the Board of Governors of the Federal Reserve
System (the "Federal Reserve Board") regulates the Company, the Federal
Reserve Board has supervisory authority which affects the Bank.
RESTRICTIONS ON TRANSACTIONS WITH AFFILIATES AND INSIDERS. The Bank is
subject to certain federal statutes limiting transactions with the Company and
its nonbanking affiliates. Section 23A of the Federal Reserve Act affects loans
or other credit extensions to asset purchases with and investments in affiliates
of the Bank. Such transactions with the Company or any of its nonbanking
subsidiaries are limited in amount to ten percent of the Bank's capital and
surplus and, with respect to the Company and all of its nonbanking subsidiaries
together, to an aggregate of twenty percent of the Bank's capital and surplus.
Furthermore, such loans and extensions of credit, as well as certain other
transactions, are required to be secured in specified amounts.
In addition, Section 23B of the Federal Reserve Act requires that certain
transactions between the Bank, including its subsidiaries, and its affiliates
must be on terms substantially the same, or at least as favorable to the Bank or
its subsidiaries, as those prevailing at the time for comparable transactions
with or involving other nonaffiliated persons. In the absence of such comparable
transactions, any transaction between the Bank and its affiliates must be on
terms and under circumstances, including credit standards, that in good faith
would be offered to or would apply to nonaffiliated persons. The Bank is also
subject to certain prohibitions against any advertising that indicates the Bank
is responsible for the obligations of its affiliates. The Bank does not have any
nonbanking affiliates as of the date of this Annual Report.
The restrictions on loans to directors, executive officers, principal
shareholders and their related interests (collectively referred to herein as
"insiders") contained in the Federal Reserve Act and Regulation O now 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 loans can be made. There is also an aggregate limitation on all
loans to insiders and their related interests. These loans cannot exceed the
institution's total unimpaired capital and surplus, and the OCC may determine
that a lesser amount is appropriate. Insiders are subject to enforcement actions
for knowingly accepting loans in violation of applicable restrictions.
INTEREST RATE LIMITS. Interest rate limitations for the Bank are primarily
governed by the National Bank Act which generally defers to the laws of the
state where the bank is located. Under the laws of the State of Texas, the
maximum annual interest rate that may be charged on most loans made by the Bank
is based on doubling the average auction rate, to the nearest 0.25%, for United
States Treasury Bills, as computed by the Office of the Consumer Credit
Commissioner of the State of Texas. However, the maximum rate does not decline
below 18% or rise above 24% (except for loans in excess of $250,000 that are
made for business, commercial, investment or other similar purposes (excluding
agricultural loans), in which case the maximum annual rate may not rise above
28%, rather than 24%). On fixed rate closed-end loans, the maximum non-usurious
rate is to be determined at the time the rate is contracted, while on floating
rate and open-end loans (such as credit cards), the rate varies over the term of
the indebtedness. State usury laws (but not late charge limitations) have been
preempted by federal law for loans secured by a first lien on residential real
property.
EXAMINATIONS. The OCC periodically examines and evaluates national banks.
Based upon such an evaluation, the OCC may revalue the assets of a national bank
and require that it establish specific reserves to compensate for the difference
between the OCC-determined value and the book value of such assets. Onsite
examinations are to be conducted every 12 months, except that certain well
capitalized banks may be examined every 18 months. The Federal Deposit Insurance
Corporation Improvement Act of 1991 ("FDICIA") authorizes the OCC to assess
the institution for its costs of conducting the examinations.
PROMPT CORRECTIVE ACTION. In addition to the capital adequacy guidelines,
FDICIA requires the OCC to take "prompt corrective action" with respect to any
national bank which does not meet specified minimum capital requirements. The
applicable regulations establish five capital levels, ranging from "well
capitalized" to "critically undercapitalized," which authorize, and in
certain cases require, the OCC to take certain specified supervisory action.
Under regulations implemented under FDICIA, a national bank is
4
considered well capitalized if it has a total risk-based capital ratio of 10.0%
or greater, a Tier 1 risk-based capital ratio of 8.0% or greater, and a leverage
ratio of 5.0% or greater, and it is not subject to an order, written agreement,
capital directive, or prompt corrective action directive to meet and maintain a
specific capital level for any capital measure. A national bank is considered
adequately capitalized if it has a total risk-based capital ratio of 8.0% or
greater, a Tier 1 risk-based capital ratio of at least 4.0% and a leverage
capital ratio of 4.0% or greater (or a leverage ratio of 3.0% or greater if the
institution is rated composite 1 in its most recent report of examination,
subject to appropriate federal banking agency guidelines), and the institution
does not meet the definition of an undercapitalized institution. A national bank
is considered undercapitalized if it has a total risk-based capital ratio that
is less than 8.0%, a Tier 1 risk-based capital ratio that is less than 4.0%, or
a leverage ratio that is less than 4.0% (or a leverage ratio that is less than
3.0% if the institution is rated composite 1 in its most recent report of
examination, subject to appropriate federal banking agency guidelines). A
significantly undercapitalized institution is one which has a total risk-based
capital ratio that is less than 6.0%, a Tier 1 risk-based capital ratio that is
less than 3.0%, or a leverage ratio that is less than 3.0%. A critically
undercapitalized institution is one which has a ratio of tangible equity to
total assets that is equal to or less than 2.0%. Under certain circumstances, a
well capitalized, adequately capitalized or undercapitalized institution may be
treated as if the institution were in the next lower capital category.
With certain exceptions, national banks will be prohibited from making
capital distributions or paying management fees to a holding company if the
payment of such distributions or fees will cause them to become
undercapitalized. Furthermore, undercapitalized national banks will be required
to file capital restoration plans with the OCC. Such a plan will not be accepted
unless, among other things, the banking institutions's holding company
guarantees the plan up to a certain specified amount. Any such guarantee from a
depository institution's holding company is entitled to a priority of payment in
bankruptcy. Undercapitalized national banks also will be subject to restrictions
on growth, acquisitions, branching and engaging in new lines of business unless
they have an approved capital plan that permits otherwise. The OCC also may,
among other things, require an undercapitalized national bank to issue shares or
obligations, which could be voting stock, to recapitalize the institution or,
under certain circumstances, to divest itself of any subsidiary.
The OCC is authorized by FDICIA to take various enforcement actions against
any significantly undercapitalized national bank and any national bank that
fails to submit an acceptable capital restoration plan or fails to implement a
plan accepted by the OCC. These powers include, among other things, requiring
the institution to be recapitalized, prohibiting asset growth, restricting
interest rates paid, requiring primary approval of capital distributions by any
bank holding company which controls the institution, requiring divestiture by
the institution of its subsidiaries or by the holding company of the institution
itself, requiring new election of directors, and requiring the dismissal of
directors and officers.
Significantly and critically undercapitalized national banks may be subject
to more extensive control and supervision. The OCC may prohibit any such
institution from, among other things, entering into any material transaction not
in the ordinary course of business, amending its charter or bylaws, or engaging
in certain transactions with affiliates. In addition, critically
undercapitalized institutions generally will be prohibited from making payments
of principal or interest on outstanding subordinated debt. Within 90 days of a
national bank becoming critically undercapitalized, the OCC must appoint a
receiver or conservator unless certain findings are made with respect to the
prospect for the institution's continued viability.
As of December 31, 1998, the Bank met the capital requirements of an
"adequately-capitalized" institution.
DIVIDENDS. There are certain statutory limitations on the payment of
dividends by national banks. Without approval of the OCC, dividends may not be
paid by the Bank in an amount in any calendar year which exceeds the Bank's
total net profits for that year, plus its retained profits for the preceding two
years, less any required transfers to capital surplus. In addition, a national
bank may not pay dividends in excess of total retained profits, including
current year's earnings after deducting bad debts in excess of reserves for
losses. In some cases, the OCC may find a dividend payment that meets these
statutory requirements to be
5
an unsafe or unsound practice. Under FDICIA, the Bank cannot pay a dividend if
it will cause the Bank to be "undercapitalized."
DEPOSIT INSURANCE. The deposits of the Bank are insured by the FDIC
through the BIF to the extent provided by law. Under the FDIC's risk-based
insurance system, BIF-insured institutions are currently assessed premiums of
between zero and twenty seven cents per $100 of eligible deposits, depending
upon the institution's capital position and other supervisory factors. Congress
recently enacted legislation that, among other things, provides for assessments
against BIF-insured institutions that will be used to pay certain Financing
Corporation ("FICO") OBLIGATIONS. In addition to any BIF insurance
assessments, BIF-insured banks are expected to make payments for the FICO
obligations equal to $0.01296 per $100 of eligible deposits each year during
1997 through 1999, and an estimated $0.024 per $100 of eligible deposits
thereafter.
CONSERVATOR AND RECEIVERSHIP POWERS. FDICIA significantly expanded the
authority of the federal banking regulators to place depository institutions
into conservatorship or receivership to include, among other things, appointment
of the FDIC as conservator or receiver of an undercapitalized institution under
certain circumstances. In the event the Bank is placed into conservatorship or
receivership, the FDIC is required, subject to certain exceptions, to choose the
method for resolving the institution that is least costly to the BIF, such as
liquidation.
BROKERED DEPOSIT RESTRICTIONS. The Financial Institutions Reform, Recovery
and Enforcement Act of 1989 ("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,
they may not pay an effective yield of more than 75 basis points over the
effective yield paid on deposits of comparable size and maturity in the
institution's normal market area for deposits accepted from within that area, or
the national rate paid on deposits of comparable size and maturity for deposits
accepted from outside the institution's normal market area.
CONSUMER LAWS AND REGULATIONS. In addition to the laws and regulations
discussed herein, the Bank is also subject to certain consumer laws and
regulations that are designed to protect consumers in transactions with banks.
While the list set forth herein is not exhaustive, these laws and regulations
include the Truth in Lending Act, the Truth in Savings Act, the Electronic Funds
Transfer Act, the Expedited Funds Availability Act, the Community Reinvestment
Act, the Equal Credit Opportunity Act, and the Fair Housing Act, among others.
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.
THE COMPANY
The Company is a bank holding company registered under the Bank Holding
Company Act of 1956 (the "BHCA"), and is subject to supervision and regulation
by the Federal Reserve Board. The BHCA and other 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 regulations.
As a bank holding company, the Company's activities and those of its banking and
nonbanking subsidiaries are limited to the business of banking and activities
closely related or incidental to banking, and the Company may not directly or
indirectly acquire the ownership or control of more than five percent of any
class of voting shares or substantially all of the assets of any company,
including a bank, without the prior approval of the Federal Reserve Board.
Because the Company is a legal entity separate and distinct from its
subsidiary, its right to participate in the distribution of assets of any
subsidiary upon the subsidiary's liquidation or reorganization will be subject
to the prior claims of the subsidiary's creditors. In the event of a liquidation
or other resolution of the Bank, the claims of depositors and other general or
subordinated creditors of the Bank are entitled to a priority of payment over
the claims of holders of any obligation of the institution to its shareholders,
6
including any depository institution holding company (such as the Company) or
any shareholder or creditor thereof.
SAFE AND SOUND BANKING PRACTICES. Bank holding companies are not permitted
to engage in unsafe and unsound banking practices. For example, the Federal
Reserve Board's Regulation Y requires a holding company to give the Federal
Reserve Board prior notice of any redemption or repurchase of its own equity
securities, if the consideration to be paid, together with the consideration
paid for any repurchases or redemptions in the preceding year, is equal to 10%
or more of the company's consolidated net worth. The Federal Reserve Board may
oppose the transaction if it believes that the transaction would constitute an
unsafe or unsound practice or would violate any law or regulation. As another
example, a holding company could not impair its subsidiary bank's soundness by
causing it to make funds available to nonbanking subsidiaries or their customers
if the Federal Reserve Board believed it not prudent to do so.
FIRREA expanded the Federal Reserve Board's authority to prohibit
activities of bank holding companies and their nonbanking 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 which the Federal Reserve Board can assess for certain activities
conducted on a knowing and reckless basis, if those activities caused a
substantial loss to a depository institution. The penalties can be as high as
$1,000,000 for each day the activity continues. FIRREA also expanded the scope
of individuals and entities against which such penalties may be assessed.
ANTI-TYING RESTRICTIONS. Bank holding companies and their affiliates are
prohibited from tying the provision of certain services, such as extensions of
credit, to other services offered by a holding company or its affiliates.
ANNUAL REPORTING; EXAMINATIONS. The Company is required to file an annual
report with the Federal Reserve Board, and such additional information as the
Federal Reserve Board may require pursuant to the BHCA. The Federal Reserve
Board may examine a bank holding company or any of its subsidiaries, and charge
the company for the cost of such an examination.
CAPITAL ADEQUACY REQUIREMENTS. The Federal Reserve Board has adopted a
system using risk-based capital guidelines to evaluate the capital adequacy of
bank holding companies. Under the guidelines, specific categories of assets and
certain off-balance sheet assets such as letters of credit 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-weighted" asset base. The guidelines require a minimum total
risk-based capital ratio of 8.0% (of which at least 4.0% is required to consist
of Tier 1 capital elements).
In addition to the risk-based capital guidelines, the Federal Reserve Board
uses a leverage ratio as an additional tool to evaluate the capital adequacy of
bank holding companies. The leverage ratio is a company's Tier 1 capital divided
by its total consolidated average assets. Bank holding companies must maintain a
minimum leverage ratio of at least 3.0%, although most organizations are
expected to maintain leverage ratios that are 100 to 200 basis points above this
minimum ratio.
The federal banking agencies' risk-based and leverage ratios are minimum
supervisory ratios generally applicable to banking organizations that meet
certain specified criteria, assuming that they have the highest regulatory
rating. Banking organizations not meeting these criteria are expected to operate
with capital positions well above the minimum ratios. The federal bank
regulatory agencies may set capital requirements for a particular banking
organization that are higher than the minimum ratios when circumstances warrant.
Federal Reserve Board guidelines also provide that banking organizations
experiencing internal growth or making acquisitions will be expected to maintain
strong capital positions substantially above the minimum supervisory levels,
without significant reliance on intangible assets. In addition, the regulations
of the Federal Reserve Board provide that concentration of credit risk and
certain risks arising from nontraditional activities, as well as an
institution's ability to manage these risks, are important factors to be taken
into account by regulatory agencies in assessing an organization's overall
capital adequacy.
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The Federal Reserve Board recently adopted amendments to its risk-based
capital regulations to provide for the consideration of interest rate risk in
the agencies' determination of a banking institution's capital adequacy.
The Bank is subject to capital adequacy guidelines of the OCC that are
substantially similar to the Federal Reserve Board's guidelines.
ENFORCEMENT POWERS OF THE FEDERAL BANKING AGENCIES
The Federal Reserve Board and the OCC have broad enforcement powers,
including the power to terminate deposit insurance, impose substantial fines and
other civil and criminal penalties and appoint a conservator or receiver.
Failure to comply with applicable laws, regulations and supervisory agreements
could subject the Company or the Bank, as well as officers, directors and other
institution-affiliated parties of these organizations, to administrative
sanctions and potentially substantial civil money penalties. In addition to the
grounds discussed above under " -- The Bank -- Prompt Corrective Action," the
appropriate federal banking agency may appoint the FDIC as conservator or
receiver for a banking institution (or the FDIC may appoint itself, under
certain circumstances) if any one or more of a number of circumstances exist,
including, without limitation, the fact that the banking institution is
undercapitalized and has no reasonable prospect of becoming adequately
capitalized; fails to become adequately capitalized when required to do so;
fails to submit a timely and acceptable capital restoration plan; or materially
fails to implement an accepted capital restoration plan.
IMPOSITION OF LIABILITY FOR UNDERCAPITALIZED SUBSIDIARIES. FDICIA requires
bank regulators to take "prompt corrective action" to resolve problems
associated with insured depository institutions whose capital declines below
certain levels. In the event an institution becomes "undercapitalized," it
must submit a capital restoration plan. The capital restoration plan will not be
accepted by the regulators unless each company having control of the
undercapitalized institution guarantees the subsidiary's compliance with the
capital restoration plan. Under FDICIA, the aggregate liability of all companies
controlling an undercapitalized bank is limited to the lesser of 5% of the
institution's assets at the time it became undercapitalized or the amount
necessary to cause the institution to be "adequately capitalized." The
guarantee and limit on liability expire after the regulators notify the
institution that it has remained adequately capitalized for each of four
consecutive calendar quarters. FDICIA grants greater powers to the bank
regulators in situations where an institution becomes "significantly" or
"critically" undercapitalized or fails to submit a capital restoration plan.
For example, a bank holding company controlling such an institution can be
required to obtain prior Federal Reserve Board approval of proposed dividends,
or might be required to consent to a consolidation or to divest the troubled
institution or other affiliates. At December 31, 1998, the Bank met the
requirements of an "adequately capitalized" institution and, therefore, these
requirements presently do not apply to the Company.
ACQUISITIONS BY BANK HOLDING COMPANIES. The BHCA requires every bank
holding company to obtain the prior approval of the Federal Reserve Board before
it may acquire all or substantially all of the assets of any bank, or direct or
indirect ownership or control of more than 5% of any class of voting shares of
any bank.
The Federal Reserve Board will allow the acquisition by a bank holding
company of an interest in any bank located in another state only if the laws of
the state in which the target bank is located expressly authorize such
acquisition. Texas law permits, in certain circumstances, out-of-state bank
holding companies to acquire banks and bank holding companies in Texas.
Congress has been considering legislation in various forms that would
require federal thrifts to convert their charters to national or state bank
charters. The Regulatory Reduction Act required the Treasury Department to
prepare for Congress by March 31, 1997 a comprehensive study on development of a
common charter for federal savings associations and commercial banks; and, in
the event that the thrift charter was eliminated by January 1, 1999, would
require the merger of the BIF and the SAIF into a single Deposit Insurance Fund
on that date. The Company cannot determine whether, or in what form, such
legislation may eventually be enacted.
8
EXPANDING ENFORCEMENT AUTHORITY
One of the major effects of FDICIA was 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.
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.
ITEM 2. PROPERTIES
FACILITIES
The Company currently maintains seventeen locations, ten of which are
leased. The following table sets forth specific information on each branch, each
of which offers full service banking. The Company's headquarters are located at
4400 Post Oak Parkway, in a 35-story office tower located in the Galleria area.
BRANCH DEPOSITS
AT
BRANCH SQ. FT. LOCATION DECEMBER 31, 1998
- ---------------------------------------- --------- -------------------------- -----------------
(IN THOUSANDS)
Galleria/Corporate...................... 109,000 4400 Post Oak Parkway $ 851,712
Downtown -- 1100 Louisiana.............. 10,000 1100 Louisiana 142,351
Northwest Crossing...................... 8,134 Hwy 290 at Tidwell 154,635
Memorial City........................... 3,554 899 Frostwood 107,704
Greenway Plaza.......................... 2,669 12 Greenway Plaza 84,993
Medical Center.......................... 2,437 6602 Fannin 10,385
Downtown -- Two Houston Center.......... 2,219 909 Fannin 55,226
Hempstead............................... 17,000 12130 Hempstead Hwy. 109,553
Tanglewood.............................. 5,625 5791 Woodway 66,203
Pasadena................................ 4,900 4207 Fairmont Parkway 17,335
Memorial West........................... 1,700 14803 Memorial 3,288
Spring.................................. 6,300 2000 Spring Cypress Road 31,934
Bell Tower.............................. 4,500 1330 Wirt Road 18,301
Kingwood................................ 5,500 29805 Loop 494 33,046
Porter.................................. 2,450 23741 Highway 59, #2 10,104
North Port.............................. 5,000 9191 North Loop East 16,872
Sugar Land.............................. 4,000 14965 Southwest Freeway 15,744
-----------------
$ 1,729,386
=================
9
ITEM 3. LEGAL PROCEEDINGS
Neither the Company nor the Bank is currently involved in any material
legal proceeding.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matter was submitted during the fourth quarter of the fiscal year
covered by this Annual Report to a vote of the Company's security holders.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The Company's Common Stock began trading on the NASDAQ Stock Market on
January 28, 1997, and is quoted in such Market under the symbol "SWBT". The
Company's Common Stock was not publicly traded, nor was there an established
market therefor, prior to January 28, 1997. On February 19, 1999, there were
approximately 727 holders of record of the Company's Common Stock.
No cash dividends have ever been paid by the Company on its Common Stock,
and the Company does not anticipate paying any cash dividends on its Common
Stock in the foreseeable future. The Company's principal source of funds to pay
cash dividends on its Common Stock would be cash dividends from the Bank. There
are certain statutory limitations on the payment of dividends by national banks.
Without approval of the OCC, dividends in any calendar year may not exceed the
Bank's total net profits for that year, plus its retained profits for the
preceding two years, less any required transfers to capital surplus or to a fund
for the retirement of any preferred stock. In addition, a dividend may not be
paid in excess of a bank's cumulative net profits after deducting bad debts in
excess of the allowance for loan losses. As of December 31, 1998, approximately
$50.8 million was available for payment of dividends by the Bank to the Company
under these restrictions without regulatory approval. See "Item 1.
Business -- Supervision and Regulation."
The following table presents the range of high and low sale prices reported
on the NASDAQ during the year ended December 31, 1998.
1998 1997
---------------------------------- ------------------------------------------
FOURTH THIRD SECOND FIRST FOURTH THIRD SECOND FIRST
QTR. QTR. QTR. QTR. QTR. QTR. QTR. QTR.
------ ----- ------ ----- --------- --------- ------ ---------
Common stock sale price:
High............................... $ 18 1/2 $19 1/4 $21 3/8 $19 7/8 $16 5/16 $15 1/4 $ 14 $10 1/4
Low................................ 10 12 3/4 16 1/2 15 13 1/2 12 3/4 9 8 15/16
RECENT SALES OF UNREGISTERED SECURITIES
No securities were sold by the Company during the fiscal year ended
December 31, 1998 that were not registered under the Securities Act of 1933,
except for those reported under Item 2 of the Company's Form 10-Q Quarterly
Report for the three month period ended March 31, 1998.
10
ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA
The following selected consolidated financial data should be read in
conjunction with the Consolidated Financial Statements of the Company and the
Notes thereto, appearing elsewhere in this Annual Report, and the information
contained in "Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations." The selected historical consolidated
financial data as of the end of and for each of the five years in the period
ended December 31, 1998 are derived from the Company's Consolidated Financial
Statements which have been audited by independent public accountants.
YEARS ENDED DECEMBER 31,
-----------------------------------------------------
1998 1997 1996 1995 1994
--------- --------- --------- --------- ---------
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
INCOME STATEMENT DATA:
Interest income.................. $ 139,144 $ 108,932 $ 78,257 $ 61,695 $ 42,063
Interest expense................. 58,850 45,729 32,275 25,509 13,848
--------- --------- --------- --------- ---------
Net interest income.......... 80,294 63,203 45,982 36,186 28,215
Provision for loan losses........ 3,900 3,886 2,090 1,121 1,349
--------- --------- --------- --------- ---------
Net interest income after
provision for loan
losses..................... 76,394 59,317 43,892 35,065 26,866
Noninterest income............... 15,801 10,573 6,847 4,867 3,986
Noninterest expenses............. 57,347 44,013 32,210 25,684 20,903
--------- --------- --------- --------- ---------
Income before income taxes... 34,848 25,877 18,529 14,248 9,949
Provision for income taxes....... 12,378 9,072 6,468 4,919 3,462
--------- --------- --------- --------- ---------
Net income before preferred stock
dividend....................... 22,470 16,805 12,061 9,329 6,487
Preferred stock dividend......... -- 36 457 50 --
--------- --------- --------- --------- ---------
Net income available to common
shareholders................... $ 22,470 $ 16,769 $ 11,604 $ 9,279 $ 6,487
========= ========= ========= ========= =========
PER SHARE DATA:
Basic earnings per common
share(1)....................... $ 0.97 $ 0.77 $ 0.62 $ 0.52 $ 0.38
Diluted earnings per common
share(1)....................... $ 0.93 $ 0.72 $ 0.57 $ 0.47 $ 0.35
Cash dividends per common
share.......................... -- -- -- -- --
Book value per share............. $ 6.15 $ 5.13 $ 3.90 $ 3.23 $ 2.61
Average common shares............ 23,111 21,918 18,790 18,064 17,226
Average common share
equivalents.................... 1,119 1,324 1,604 1,374 1,252
PERFORMANCE RATIOS:
Return on average assets......... 1.19% 1.15% 1.09% 1.15% 1.04%
Return on average common
equity......................... 17.46% 16.46% 17.58% 17.50% 15.43%
Net interest margin.............. 4.57% 4.67% 4.69% 4.81% 4.86%
Efficiency ratio(3).............. 59.97% 60.06% 60.97% 62.56% 64.91%
BALANCE SHEET DATA(2):
Total assets..................... $2,205,521 $1,807,604 $1,272,141 $1,007,616 $ 703,497
Securities....................... 647,462 555,398 345,398 347,908 196,333
Loans............................ 1,339,158 986,150 724,255 531,770 417,601
Allowance for loan losses........ 13,281 10,335 7,400 6,024 4,991
Total deposits................... 1,729,386 1,512,341 1,041,447 840,174 603,481
Total shareholders' equity....... 143,734 114,835 73,415 58,304 46,969
CAPITAL RATIO:
Equity to average assets......... 6.81% 6.99% 6.89% 6.64% 6.72%
ASSET QUALITY RATIOS(2):
Nonperforming assets to loans and
other real estate.............. 0.21% 0.37% 0.26% 0.19% 0.18%
Net charge-offs to average
loans.......................... 0.08% 0.11% 0.13% 0.09% 0.04%
Allowance for loan losses to
total loans.................... 0.99% 1.05% 1.02% 1.13% 1.20%
Allowance for loan losses to
nonperforming loans(4)......... 578.19% 332.64% 452.05% 675.34% 1250.88%
- ------------
(1) Basic earnings per common share is computed by dividing income available for
common shareholders by the weighted average number of common shares
outstanding for the period. Diluted earnings per common share is computed by
dividing income available for common shareholders by the sum of the weighted
average number of common shares outstanding and the effect of all dilutive
potential common shares outstanding for the period.
(2) At period end, except net charge-offs (recoveries) to average loans.
(3) Calculated by dividing total noninterest expenses, by net interest income
plus noninterest income, excluding net security gains/losses.
(4) Nonperforming loans consist of nonaccrual loans and loans contractually past
due 90 days or more.
11
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 analyzes the major elements of the Company's consolidated financial
statements and should be read in conjunction with the Company's consolidated
financial statements and accompanying notes and other detailed information
appearing elsewhere in this Annual Report.
FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
OVERVIEW
Total assets at December 31, 1998, 1997 and 1996 were $2.2 billion, $1.8
billion, and $1.3 billion, respectively. This growth was a result of a strong
local economy, the addition of new loan officers, and the Company's style of
relationship banking. Loans were $1.3 billion at December 31, 1998, an increase
of $353 million or 36% from $986.2 million at the end of 1997. Loans were $724.2
million at year end 1996. Deposits experienced similar growth, increasing to
$1.7 billion at year end 1998 from $1.5 billion at year end 1997 and $1.0
billion at year end 1996. Shareholders' equity was $143.7 million, $114.8
million and $73.4 million at December 31, 1998, 1997 and 1996, respectively.
Net income available for common shareholders was $22.5 million, $16.8
million, and $11.6 million and diluted earnings per common share was $0.93,
$0.72, and $0.57 for the years ended 1998, 1997 and 1996, respectively. This
increase in net income was primarily the result of strong loan growth,
maintaining strong asset quality and expense control and resulted in returns on
average assets of 1.19%, 1.15%, and 1.09% and returns on average common equity
of 17.46%, 16.46%, and 17.58% for the years ended 1998, 1997 and 1996,
respectively.
RESULTS OF OPERATIONS
NET INTEREST INCOME
Net interest income represents the amount by which interest income on
interest-earning assets, including securities and loans, exceeds interest
expense incurred 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.
1998 VERSUS 1997. Net interest income totaled $80.3 million in 1998
compared to $63.2 million in 1997, an increase of $17.1 million or 27%. This
resulted in net interest margins of 4.57% and 4.67% and net interest spreads of
3.41% and 3.43% for 1998 and 1997, respectively.
The increase in net interest income was due primarily to a $404.9 million
or 30% increase in average earning assets. Average loans grew $280.8 million or
33% during 1998 while average securities grew $129.4 million or 32% during the
same period. The yield earned on average loans outstanding decreased 27 basis
points to 8.92% in 1998. Overall, the yield earned on average earning assets
decreased 14 basis points to 7.91% in 1998 compared to a 12 basis point decrease
in the rate paid on average interest-bearing liabilities.
1997 VERSUS 1996. Net interest income totaled $63.2 million in 1997
compared to $46.0 million in 1996, an increase of $17.2 million or 37%. This
resulted in net interest margins of 4.67% and 4.69% and net interest spreads of
3.43% and 3.52% for 1997 and 1996, respectively.
The increase in net interest income was due primarily to a $372.7 million
or 38% increase in average earning assets. Average loans grew $251.3 million or
42% during 1997 while average securities grew $51.5 million or 15% during the
same period. The yield earned on average loans outstanding decreased 7 basis
points to 9.19% in 1997 and was partially offset by a 24 basis point increase in
the yield earned on average securities. Overall, the yield earned on average
earning assets increased 7 basis points to 8.05% in 1997 compared to a 16 basis
point increase in the rate paid on average interest-bearing liabilities.
12
The following table presents, for the periods indicated, the total dollar
amount of interest income from average interest-earning assets and the resultant
yields, as well as the interest expense on average interest-bearing liabilities,
expressed both in dollars and rates. No tax equivalent adjustments were made and
all average balances are daily average balances. Nonaccruing loans have been
included in the table as loans carrying a zero yield. The yield on the
securities portfolio is based on average historical cost balances and does not
give effect to changes in fair value that are reflected as a component of
consolidated shareholders' equity.
YEAR ENDED DECEMBER 31,
-------------------------------------------------------------------------------------------
1998 1997 1996
-------------------------------- -------------------------------- ---------------------
AVERAGE INTEREST AVERAGE AVERAGE INTEREST AVERAGE AVERAGE INTEREST AVERAGE
OUTSTANDING EARNED/ YIELD/ OUTSTANDING EARNED/ YIELD/ OUTSTANDING EARNED/ YIELD/
BALANCE PAID RATE BALANCE PAID RATE BALANCE PAID RATE
----------- -------- ------- ----------- -------- ------- ----------- -------- -------
(DOLLARS IN THOUSANDS)
ASSETS
Interest-earning assets:
Loans.......................... $1,134,656 $101,200 8.92% $ 853,829 $ 78,509 9.19% $ 602,484 $55,771 9.26%
Securities..................... 530,131 32,804 6.19 400,748 24,908 6.22 349,214 20,892 5.98
Federal funds sold and other... 94,047 5,140 5.47 99,278 5,515 5.56 29,471 1,594 5.41
----------- -------- ------- ----------- -------- ------- ----------- -------- -------
Total interest-earning
assets................... 1,758,834 139,144 7.91% 1,353,855 108,932 8.05% 981,169 78,257 7.98%
-------- ------- -------- ------- -------- -------
Less allowance for loan losses... (11,704) (8,654) (6,593)
----------- ----------- -----------
1,747,130 1,345,201 974,576
Nonearning assets................ 142,945 111,283 89,343
----------- ----------- -----------
Total assets............... $1,890,075 $1,456,484 $1,063,919
=========== =========== ===========
LIABILITIES AND
SHAREHOLDERS' EQUITY
Interest-bearing liabilities:
Money market and savings
deposits..................... $ 735,258 29,953 4.07% $ 548,666 22,688 4.14% $ 405,711 15,955 3.93%
Certificates of deposit........ 365,021 18,722 5.13 296,416 15,733 5.31 201,072 10,557 5.25
Repurchase agreements and
borrowed funds............... 208,288 10,175 4.89 144,881 7,308 5.04 117,073 5,763 4.92
----------- -------- ------- ----------- -------- ------- ----------- -------- -------
Total interest-bearing
liabilities.............. 1,308,567 58,850 4.50% 989,963 45,729 4.62% 723,856 32,275 4.46%
----------- -------- ------- ----------- -------- ------- ----------- -------- -------
Noninterest-bearing liabilities:
Noninterest-bearing demand
deposits..................... 444,961 357,697 260,782
Other liabilities.............. 7,852 6,964 5,941
----------- ----------- -----------
Total liabilities.......... 1,761,380 1,354,624 990,579
Bank preferred stock............. -- -- 7,323
Shareholders' equity............. 128,695 101,860 66,017
----------- ----------- -----------
Total liabilities and
shareholders' equity..... $1,890,075 $1,456,484 $1,063,919
=========== =========== ===========
Net interest income.............. $ 80,294 $ 63,203 $45,982
======== ======== ========
Net interest spread.............. 3.41% 3.43% 3.52%
======= ======= =======
Net interest margin.............. 4.57% 4.67% 4.69%
======= ======= =======
13
The following table presents the dollar amount of changes in interest
income and interest expense for the major components of interest-earning assets
and interest-bearing liabilities and distinguishes between the increase
(decrease) related to higher outstanding balances and the volatility of interest
rates. For purposes of this table, changes attributable to both rate and volume
which cannot be segregated have been allocated.
YEAR ENDED DECEMBER 31,
--------------------------------------------------------------------------
1998 VS. 1997 1997 VS. 1996
------------------------------ ----------------------------------------
INCREASE (DECREASE) INCREASE (DECREASE)
DUE TO DUE TO
------------------- ----------------------------
VOLUME RATE TOTAL VOLUME RATE DAYS TOTAL
------- --------- --------- ------- --------- ----- ---------
(DOLLARS IN THOUSANDS)
INTEREST-EARNING ASSETS:
Loans................................... $25,822 $ (3,131) $ 22,691 $23,419 $ (529) $(152) $ 22,738
Securities.............................. 8,042 (146) 7,896 3,140 933 (57) 4,016
Federal funds sold and other............ (291) (84) (375) 3,792 134 (5) 3,921
------- --------- --------- ------- --------- ----- ---------
Total increase (decrease) in
interest income................... 33,573 (3,361) 30,212 30,351 538 (214) 30,675
------- --------- --------- ------- --------- ----- ---------
INTEREST-BEARING LIABILITIES:
Money market and savings deposits....... 7,716 (451) 7,265 5,666 1,111 (44) 6,733
Certificates of deposits................ 3,642 (653) 2,989 5,035 170 (29) 5,176
Repurchase agreements and borrowed
funds................................. 3,198 (331) 2,867 1,385 176 (16) 1,545
------- --------- --------- ------- --------- ----- ---------
Total increase (decrease) in
interest expense.................. 14,556 (1,435) 13,121 12,086 1,457 (89) 13,454
------- --------- --------- ------- --------- ----- ---------
Increase (decrease) in net interest
income................................ $19,017 $ (1,926) $ 17,091 $18,265 $ (919) $(125) $ 17,221
======= ========= ========= ======= ========= ===== =========
PROVISION FOR LOAN LOSSES
The 1998 provision for loan losses was $3.9 million, unchanged from 1997.
The provision for the year ended 1997 increased by $1.8 million or 86% from $2.1
million for the year ended December 31, 1996. The increased provision in 1997
resulted from strong loan growth rather than higher nonperforming assets.
Although no assurance can be given, management believes that the present
allowance for loan losses is adequate considering loss experience, delinquency
trends and current economic conditions. Management constantly reviews the
Company's loan loss allowance policy as its loan portfolio grows and
diversifies. (See "-- Financial Condition -- Loan Review and Allowance for Loan
Losses.")
NONINTEREST INCOME
Noninterest income for the year ended December 31, 1998 was $15.8 million,
an increase of $5.2 million or 49% over the same period in 1997. Noninterest
income of $10.6 million earned in the year ended December 31, 1997 represented
an increase of $3.7 million or 54% over the same period in 1996. The following
table presents for the periods indicated the major components of noninterest
income.
YEAR ENDED DECEMBER 31,
-------------------------------
1998 1997 1996
--------- --------- ---------
(DOLLARS IN THOUSANDS)
Service charges on deposit accounts..... $ 7,708 $ 6,025 $ 4,473
Loan operations......................... 1,297 833 599
Investment services..................... 3,303 2,339 1,215
Gain on sale of securities, net......... 463 498 --
Factoring fee income.................... 1,775 -- --
Other noninterest income................ 1,255 878 560
--------- --------- ---------
Total noninterest income...... $ 15,801 $ 10,573 $ 6,847
========= ========= =========
14
Service charges were $7.7 million for the year ended December 31, 1998,
compared to $6.0 million for the year ended December 31, 1997, an increase of
$1.7 million or 28%, and increased $1.6 million or 35% from 1996 to 1997. During
this three year period the Company changed their policy regarding deposit
accounts and introduced several new products which contributed to the increase
in service charge income. In addition, the number of deposit accounts grew from
35,258 at December 31, 1996 to 39,311 at December 31, 1997 to 44,370 at December
31, 1998.
Other changes in noninterest income were recognized in the categories of
investment services and factoring fee income. For the year ended December 31,
1998, investment services income grew to $3.3 million, an increase of 41% over
the 1997 level. These increases are attributable to the expanding international
and foreign exchange departments, as well as the continued strategic focus by
the Company to increase its competitive position in providing investment
services. Factoring fee income results from the acquisition of First Republic
Capital Corp. and City Financial Services, Inc. in February of 1998. This
acquisition was accounted for as a pooling of interests, and due to
immateriality, prior years financial statements were not restated.
NONINTEREST EXPENSES
For the year ended December 31, 1998, noninterest expenses totaled $57.3
million, an increase of $13.3 million, or 30%, from $44.0 million during 1997,
which had increased from $32.2 million during 1996. The increase in noninterest
expenses during these periods was due primarily to salaries and employee
benefits, and occupancy expenses. The efficiency ratio was 59.97%, 60.06% and
60.97% for the years ended December 31, 1998, 1997 and 1996 respectively. The
improvement was due primarily to a large increase in earning assets and the
Company's continued efforts to control overhead expenses.
Salary and benefit expense for the year ended December 31, 1998 was $34.9
million, an increase of $10 million or 40% from $25.0 million for the year ended
December 31, 1997. Salary and benefit expense for the year ended December 31,
1997 increased $6.0 million or 31% from the same period in 1996. This increase
was due primarily to hiring of additional personnel required to accommodate the
Company's growth. Total full-time equivalent employees for the years ended
December 31, 1998, 1997 and 1996 were 702, 559, and 434, respectively.
Occupancy expense rose $2.1 million and $1.9 million or 32% and 40% in 1998
and 1997, respectively. Major categories included within occupancy expense are
building lease expense, depreciation expense, and maintenance contract expense.
Building lease expense increased to $2.3 million in 1998 from $1.8 million in
1997, an increase of $500,000 or 28%. The Company increased the rentable square
feet of the Galleria location by moving to a larger facility in November 1997
and subsequently adding additional space in 1988. Depreciation expense increased
$669,000 to $3.6 million for the year ended December 31, 1998. This increase was
due primarily to depreciation on equipment provided to new employees and expense
related to technology upgrades throughout the Company, which include new wire
transfer and telephone systems. Maintenance contract expense for the year ended
December 31, 1998 was $980,000, an increase of $273,000 or 39% compared to
$707,000 in 1997 and $412,000 in 1996. The Company has purchased maintenance
contracts for major operating systems throughout the organization.
INCOME TAXES
Income tax expense includes the regular federal income tax at the statutory
rate, plus the income tax component of the Texas franchise tax. The amount of
federal income tax expense is influenced by the amount of taxable income, the
amount of tax-exempt income, the amount of nondeductible interest expense, and
the amount of other nondeductible expenses. Taxable income for the income tax
component of the Texas franchise tax is the federal pre-tax income, plus certain
officers salaries, less interest income from federal securities. In 1998 income
tax expense was $12.4 million, an increase of $3.3 million or 36% from the $9.1
million of income tax expense in 1997. In 1997 income tax expense was $9.1
million, an increase of $2.6 million or 40% from the $6.5 million of income tax
expense in 1996.
15
IMPACT OF INFLATION
The effects of inflation on the local economy and on the Company's
operating results have been relatively modest for the past several years. Since
substantially all of the Company's assets and liabilities are monetary in
nature, such as cash, securities, loans and deposits, their values are less
sensitive to the effects of inflation than to changing interest rates, which do
not necessarily change in accordance with inflation rates. The Company tries to
control the impact of interest rate fluctuations by managing the relationship
between its interest rate sensitive assets and liabilities. See " -- Financial
Condition -- Interest Rate Sensitivity and Liquidity" below.
FINANCIAL CONDITION
LOAN PORTFOLIO
Loans before the allowance for loan losses were $1.34 billion at December
31, 1998, an increase of $353.0 million, or 36% from December 31, 1997. Loans
before the allowance for loan losses were $986.2 million at December 31, 1997,
an increase of $254.5 million, or 35%, from $731.7 million at December 31, 1996.
The following table summarizes the loan portfolio of the Company by major
category as of the dates indicated:
YEAR ENDED DECEMBER 31,
--------------------------------------------------------------------------------------------
1998 1997 1996 1995
-------------------- ------------------- ------------------- -------------------
AMOUNT PERCENT AMOUNT PERCENT AMOUNT PERCENT AMOUNT PERCENT
--------- ------- -------- ------- -------- ------- -------- -------
Commercial and industrial............ $ 634,558 47.38 % $448,348 45.46 % $330,566 45.18 % $218,074 41.01%
Real estate
Construction & land development.... 231,353 17.28 128,985 13.08 89,803 12.27 62,560 11.76
1-4 family residential............. 189,439 14.15 171,551 17.40 130,407 17.83 99,340 18.68
Commercial owner occupied.......... 157,356 11.75 132,052 13.39 97,116 13.27 63,649 11.97
Farmland........................... 8,314 0.62 8,384 0.85 8,879 1.21 5,327 1.00
Consumer............................. 103,440 7.72 88,631 8.99 71,640 9.79 59,480 11.19
Other................................ 14,698 1.10 8,199 0.83 3,244 0.45 23,340 4.39
--------- ------- -------- ------- -------- ------- -------- -------
Total Loans...................... $1,339,158 100.00 % $986,150 100.00 % $731,655 100.00 % $531,770 100.00%
========= ======= ======== ======= ======== ======= ======== =======
YEAR ENDED
DECEMBER 31,
1994
-------------------
AMOUNT PERCENT
-------- -------
Commercial and industrial............ $166,798 39.94 %
Real estate
Construction & land development.... 53,116 12.72
1-4 family residential............. 81,149 19.43
Commercial owner occupied.......... 41,753 10.00
Farmland........................... 3,097 0.74
Consumer............................. 46,643 11.17
Other................................ 25,046 6.00
-------- -------
Total Loans...................... $417,602 100.00 %
======== =======
The primary lending focus of the Company is on small- and medium-sized
commercial, residential mortgage and consumer loans. The Company offers a
variety of commercial lending products including term loans, lines of credit and
equipment financing. A broad range of short- to medium-term commercial loans,
both collateralized and uncollateralized, are made available to businesses for
working capital (including inventory and receivables), business expansion
(including acquisitions of real estate and improvements) and the purchase of
equipment and machinery. The purpose of a particular loan generally determines
its structure.
Generally, the Company's commercial loans are underwritten in the Company's
primary market area on the basis of the borrower's ability to service such debt
from income. As a general practice, the Company takes as collateral a lien on
any available real estate, equipment or other assets. Working capital loans are
primarily collateralized by short-term assets whereas term loans are primarily
collateralized by long-term assets.
A substantial portion of the Company's real estate loans consists of loans
collateralized by real estate and other assets of commercial customers.
Additionally, a portion of the Company's lending activity consists of the
origination of single-family residential mortgage loans collateralized by
owner-occupied properties located in the Company's primary market area. The
Company offers a variety of mortgage loan products which generally are amortized
over five to 30 years.
Loans collateralized by single-family residential real estate generally
have been originated in amounts of no more than 90% of appraised value. The
Company requires mortgage title insurance and hazard insurance in the amount of
the loan. Although the contractual loan payment periods for single-family
residential real estate loans are generally for a three to seven year period,
such loans often remain outstanding for significantly shorter periods than their
contractual terms.
16
Consumer loans made by the Company include automobile loans, recreational
vehicle loans, boat loans, home improvement loans, personal loans
(collateralized and uncollateralized) and deposit account collateralized loans.
The terms of these loans typically range from 12 to 84 months and vary based
upon the nature of collateral and size of loan.
The contractual maturity ranges of the commercial and industrial and real
estate construction loan portfolio and the amount of such loans with fixed
interest rates and floating rates in each maturity range as of December 31, 1998
are summarized in the following table:
DECEMBER 31, 1998
---------------------------------------------
AFTER ONE AFTER
ONE YEAR THROUGH FIVE
OR LESS FIVE YEARS YEARS TOTAL
---------- ---------- --------- ----------
Commercial and industrial............ $ 384,381 $ 235,263 $ 14,914 $ 634,558
Real estate construction............. 131,143 92,416 7,794 231,353
---------- ---------- --------- ----------
Total......................... $ 515,524 $ 327,679 $ 22,708 $ 865,911
========== ========== ========= ==========
Loans with a fixed interest rate..... $ 144,179 $ 89,941 $ 5,667 $ 239,787
Loans with a floating interest
rate............................... 371,345 237,738 17,041 626,124
---------- ---------- --------- ----------
Total......................... $ 515,524 $ 327,679 $ 22,708 $ 865,911
========== ========== ========= ==========
LOAN REVIEW AND ALLOWANCE FOR LOAN LOSSES
The Company's loan review procedures include a Credit Quality Assurance
Process that begins with approval of lending policies and underwriting
guidelines by the Board of Directors, an independent loan review department
staffed with OCC experienced personnel, low individual lending limits for
officers, Senior Loan Committee approval for large credit relationships and
quality loan documentation procedures. The Company also maintains a well
developed monitoring process for credit extensions in excess of $100,000. The
Company performs monthly and quarterly concentration analyses based on various
factors such as industries, collateral types, business lines, large credit
sizes, international investments and officer portfolio loads. The Company has
established underwriting guidelines to be followed by its officers. The Company
also monitors its delinquency levels for any negative or adverse trends. There
can be no assurance, however, that the Company's loan portfolio will not become
subject to increasing pressures from deteriorating borrower credit due to
general economic conditions.
Historically, Houston has been affected by the state of the energy
business, but since the mid 1980's the economic impact has been reduced by a
combination of increased industry diversification and less reliance on debt to
finance expansion. Nevertheless, slowdowns in the energy industry caused by
declining oil prices continue to affect the Houston economy. When energy prices
drop, as they have in the last 12 months, it is the Company's practice to review
and adjust underwriting standards with respect to companies affected by oil and
gas price volatility, and to continuously monitor existing credit exposure to
companies which are impacted by this price volatility. To date, the Company has
not deemed it necessary to increase its allowance for loan losses due to
conditions in this industry but no assurance can be given that such an increase
in the allowance will not be necessary in the future.
The allowance for loan losses is established through charges to earnings in
the form of a provision for loan losses. Based on an evaluation of the loan
portfolio, management presents a quarterly review of the allowance for loan
losses to the 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 growth in the loan portfolio, the
diversification by industry of the Company's commercial loan portfolio, the
effect of changes in the local real estate market on collateral values, the
results of recent regulatory examinations, the effects on the loan portfolio of
current economic indicators and their probable impact on borrowers, the amount
of charge-offs for the period, the amount of nonperforming loans and related
collateral security and the evaluation of its loan portfolio by the loan review
function. Charge-offs occur when loans are deemed to be uncollectible.
17
In order to determine the adequacy of the allowance for loan losses,
management considers the risk classification or delinquency status of loans and
other factors, such as collateral value, portfolio composition, trends in
economic conditions and the financial strength of borrowers. Management
establishes specific allowances for loans which management believes require
reserves greater than those allocated according to their classification or
delinquent status. An unallocated allowance is also established based on the
Company's historical charge-off experience. The Company then charges to
operations a provision for loan losses determined on an annualized basis to
maintain the allowance for loan losses at an adequate level determined according
to the foregoing methodology.
Management believes that the allowance for loan losses at December 31, 1998
is adequate to cover losses inherent in the portfolio as of such date. There can
be no assurance, however, that the Company will not sustain losses in future
periods, which could be greater than the size of the allowance at December 31,
1998.
The following table presents, for the periods indicated, an analysis of the
allowance for loan losses and other related data:
YEARS ENDED DECEMBER 31,
-------------------------------------------------------
1998 1997 1996 1995 1994
--------- --------- --------- ---------- ----------
(DOLLARS IN THOUSANDS)
Allowance for loan losses, beginning
balance............................ $ 10,335 $ 7,400 $ 6,024 $ 4,991 $ 3,802
Provision charged against
operations......................... 3,900 3,886 2,090 1,121 1,349
Charge-offs.......................... (1,087) (1,078) (807) (440) (243)
Recoveries........................... 133 127 93 24 83
Increase from acquisition............ -- -- -- 328 --
--------- --------- --------- ---------- ----------
Allowance for loan losses, ending
balance............................ $ 13,281 $ 10,335 $ 7,400 $ 6,024 $ 4,991
========= ========= ========= ========== ==========
Allowance to period-end loans........ 0.99% 1.05% 1.01% 1.13% 1.20%
Net charge-offs to average loans..... 0.08% 0.11% 0.13% 0.09% 0.04%
Allowance to period-end nonperforming
loans.............................. 578.19% 332.64% 452.05% 675.34% 1250.88%
The following table describes the allocation of the allowance for loan
losses among various categories of loans and certain other information for 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 segment of loans.
DECEMBER 31,
---------------------------------------------------------------------------
1998 1997 1996
----------------------- ----------------------- -----------------------
PERCENT OF PERCENT OF PERCENT OF
LOANS TO LOANS TO LOANS TO
AMOUNT TOTAL LOANS AMOUNT TOTAL LOANS AMOUNT TOTAL LOANS
--------- ----------- --------- ----------- --------- -----------
(DOLLARS IN THOUSANDS)
Balance of allowance for loan losses
applicable to:
Commercial and industrial........ $ 1,732 47.4% $ 922 45.4% $ 468 45.1%
Real estate:
Construction and land
development............... -- 17.3 25 13.1 53 12.3
1-4 family residential...... -- 14.1 -- 17.4 7 17.8
Commercial owner occupied... -- 11.8 -- 13.4 29 13.3
Farmland.................... -- 0.6 -- 0.9 -- 1.2
Other....................... -- 7.7 -- 0.8 1 0.5
Consumer......................... -- 1.1 38 9.0 54 9.8
Unallocated...................... 11,549 -- 9,350 -- 6,788 --
--------- ----------- --------- ----------- --------- -----------
Total allowance for loan losses...... $ 13,281 100.0% $ 10,335 100.0% $ 7,400 100.0%
========= =========== ========= =========== ========= ===========
(TABLE CONTINUED ON FOLLOWING PAGE)
18
DECEMBER 31,
-------------------------------------------------
1995 1994
----------------------- -----------------------
PERCENT OF PERCENT OF
LOANS TO LOANS TO
AMOUNT TOTAL LOANS AMOUNT TOTAL LOANS
--------- ----------- --------- -----------
(DOLLARS IN THOUSANDS)
Balance of allowance for loan losses
applicable to:
Commercial and industrial........ $ 109 41.0% $ 140 40.0%
Real estate:
Construction and land
development............... 1 11.8 24 12.7
1-4 family residential...... 6 18.7 10 19.4
Commercial owner
occupied.................. 75 12.0 63 10.0
Farmland.................... -- 0.9 -- 0.7
Other....................... 5 4.4 4 6.0
Consumer......................... 31 11.2 53 11.2
Unallocated...................... 5,797 -- 4,697 --
--------- ----------- --------- -----------
Total allowance for loan losses...... $ 6,024 100.0% $ 4,991 100.0%
========= =========== ========= ===========
NONPERFORMING ASSETS AND IMPAIRED LOANS
The Company generally places a loan on nonaccrual status and ceases
accruing interest when loan payment performance is deemed unsatisfactory. All
loans past due 90 days, however, are placed on nonaccrual status, unless the
loan is both well collateralized and in the process of collection. Cash payments
received while a loan is classified as nonaccrual are recorded as a reduction of
principal as long as doubt exists as to collection. The Company is sometimes
required to revise a loan's interest rate or repayment terms in a troubled debt
restructuring.
Nonperforming assets were $2.8 million at December 31, 1998, compared with
$3.7 million at December 31, 1997 and $1.9 million at December 31, 1996. This
resulted in a ratio of nonperforming assets to loans plus other real estate of
0.21%, 0.37%, and 0.26% for the years ended 1998, 1997, and 1996, respectively.
Nonaccrual loans at December 31, 1998 included a loan totalling $100,000 that
has been restructured from its original terms. Prior years had no restructured
loans.
The following table presents information regarding nonperforming assets as
of the dates indicated:
DECEMBER 31,
-----------------------------------------------------
1998 1997 1996 1995 1994
--------- --------- --------- --------- ---------
(DOLLARS IN THOUSANDS)
Nonaccrual loans..................... $ 1,616 $ 2,724 $ 1,615 $ 869 $ 397
Accruing loans 90 or more days past
due................................ 681 383 22 23 2
Other real estate and foreclosed
property........................... 464 546 297 102 371
--------- --------- --------- --------- ---------
Total nonperforming assets.... $ 2,761 $ 3,653 $ 1,934 $ 994 $ 770
========= ========= ========= ========= =========
Nonperforming assets to total loans
and other real estate.............. 0.21% 0.37% 0.26% 0.19% 0.18%
The Company regularly updates appraisals on loans collateralized by real
estate, particularly those categorized as nonperforming loans and potential
problem loans. In 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 writedowns or appropriate additions to
the allowance for loan losses.
A loan is considered impaired when, based upon current information and
events, it is probable that the Company will be unable to collect the scheduled
payments of principal and interest when due according to the contractual terms
of the loan agreement. The Company's impaired loans were approximately $14.0
million and $2.7 million at December 31, 1998 and 1997, respectively. The
largest component of impaired loans at December 31, 1998 is a commercial energy
related loan of approximately $10.6 million. The average recorded investment in
impaired loans during 1998 and 1997 was $6.0 million and $2.2 million,
respectively. The total required allowance for loan losses related to these
loans was $0 at December 31,
19
1998 and 1997. Interest income on impaired loans of $415,000 and $0 was
recognized for cash payments received in 1998 and 1997, respectively.
The Bank is not committed to lend additional funds to debtors whose loans
have been modified.
SECURITIES
At the date of purchase, the Company classifies debt and equity securities
into one of three categories: held to maturity, trading or available for sale.
At each reporting date, the appropriateness of the classification is reassessed.
Investments in debt securities are classified as held to maturity and measured
at amortized cost in the financial statements only if management has the
positive intent and ability to hold those securities to maturity. Securities
that are bought and held principally for the purpose of selling them in the near
term are classified as trading and measured at fair value in the financial
statements with unrealized gains and losses included in earnings. Securities not
classified as either held to maturity or trading are classified as available for
sale and measured at fair value in the financial statements with unrealized
gains and losses reported, net of tax, in a separate component of other
comprehensive income until realized. Gains and losses on sales of securities are
determined using the specific-identification method. Since December 31, 1995,
the Company has classified all securities as available for sale. This allows the
Company to manage its investment portfolio more effectively and to enhance the
average yield on the portfolio.
The following table summarizes the amortized cost of securities held by the
Company as of the dates shown:
DECEMBER 31,
----------------------------------------------------------
1998 1997 1996 1995 1994
---------- ---------- ---------- ---------- ----------
(DOLLARS IN THOUSANDS)
U.S. Government securities........... $ 143,570 $ 163,230 $ 126,966 $ 136,294 $ 123,426
Mortgage-backed securities........... 488,641 323,434 169,399 165,853 70,430
Federal Reserve Bank stock........... 1,869 1,791 950 946 718
Federal Home Loan Bank stock......... 6,271 37,942 39,386 38,348 2,037
Other securities..................... 1,346 26,281 8,827 6,494 2,465
---------- ---------- ---------- ---------- ----------
Total securities available for
sale.......................... $ 641,697 $ 552,678 $ 345,528 $ 347,935 $ 199,076
========== ========== ========== ========== ==========
The following table presents the amortized cost of securities classified as
available for sale and their approximate fair values as of the dates shown:
DECEMBER 31, 1998 DECEMBER 31, 1997
---------------------------------------------- ---------------------------------
GROSS GROSS GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED FAIR AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAIN LOSS VALUE COST GAIN LOSS VALUE
--------- ---------- ---------- -------- --------- ---------- ---------- --------
(DOLLARS IN THOUSANDS)
U.S. Government securities........... $143,570 $1,575 $-- $145,145 $163,230 $ 536 $ (4) $163,762
Mortgage-backed securities........... 488,641 4,549 (452) 492,738 323,434 2,275 (151) 325,558
Federal Reserve Bank stock........... 1,869 -- -- 1,869 1,791 -- -- 1,791
Federal Home Loan Bank stock......... 6,271 -- -- 6,271 37,942 -- -- 37,942
Other securities..................... 1,346 94 (1) 1,439 26,281 64 -- 26,345
--------- ---------- ---------- -------- --------- ---------- ---------- --------
Total securities available for
sale............................ $641,697 $6,218 $ (453) $647,462 $552,678 $2,875 $ (155) $555,398
========= ========== ========== ======== ========= ========== ========== ========
DECEMBER 31, 1996
----------------------------------------------
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAIN LOSS VALUE
--------- ---------- ---------- --------
U.S. Government securities........... $126,966 $ 372 $ (484) $126,854
Mortgage-backed securities........... 169,399 571 (617) 169,353
Federal Reserve Bank stock........... 950 -- -- 950
Federal Home Loan Bank stock......... 39,386 -- -- 39,386
Other securities..................... 8,827 31 (3) 8,855
--------- ---------- ---------- --------
Total securities available for
sale............................ $345,528 $ 974 $ (1,104) $345,398
========= ========== ========== ========
Securities totaled $647.5 million at December 31, 1998, an increase of
$92.1 million from $555.4 million at December 31, 1997. During 1997, securities
increased $210.0 million from $345.4 million at December 31, 1996. The yield on
the securities portfolio for 1998 was 6.19% while the yield was 6.22% in 1997.
20
The Company has no mortgage-backed securities that have been issued by
non-agency entities. Included in the Company's mortgage-backed securities at
December 31, 1998 were agency issued collateral mortgage obligations with a book
value of $277.0 million and a fair market value of $281.6 million.
At December 31, 1998, 347.6 million of the mortgage-backed securities held
by the Company had final maturities of more than 10 years. At December 31, 1998,
approximately $62.1 million of the Company's mortgage-backed securities earned
interest at floating rates and repriced within one year, and accordingly, were
less susceptible to declines in value should interest rates increase.
The following table summarizes the contractual maturity of investments
(including securities, federal funds sold and interest-bearing deposits) and
their weighted average yields at December 31, 1998. The yield on the securities
portfolio is based on average historical cost balances and does not give effect
to changes in fair value that are reflected as a separate component of other
comprehensive income.
DECEMBER 31, 1998
------------------------------------------------------------------------------
AFTER ONE AFTER FIVE
YEAR BUT WITHIN YEARS BUT WITHIN
WITHIN
ONE YEAR FIVE YEARS TEN YEARS AFTER TEN YEARS
----------------- ---------------- ---------------- -----------------
AMOUNT YIELD AMOUNT YIELD AMOUNT YIELD AMOUNT YIELD
-------- ----- ------- ----- ------- ----- -------- -----
(DOLLARS IN THOUSANDS)
U.S. Government securities.............. $ 49,061 5.90 % $64,509 5.80 % $30,000 6.44 % $ -- -- %
Mortgage-backed securities.............. 58,426 6.09 27,122 6.71 55,450 6.55 347,643 6.43
Federal Reserve Bank stock.............. 1,869 6.00 -- -- -- -- -- --
Federal Home Loan Bank stock............ 6,271 6.00 -- -- -- -- -- --
Other securities........................ 280 4.65 203 7.58 557 7.14 306 7.59
Federal funds sold...................... 27,122 4.72 -- -- -- -- -- --
Interest-bearing deposits............... 413 5.04 -- -- -- -- -- --
-------- ----- ------- ----- ------- ----- -------- -----
Total investments................... $143,442 5.76 % $91,834 6.07 % $86,007 6.52 % $347,949 6.43%
======== ===== ======= ===== ======= ===== ======== =====
TOTAL YIELD
-------- -----
U.S. Government securities.............. $143,570 5.97 %
Mortgage-backed securities.............. 488,641 6.42
Federal Reserve Bank stock.............. 1,869 6.00
Federal Home Loan Bank stock............ 6,271 6.00
Other securities........................ 1,346 6.79
Federal funds sold...................... 27,122 4.72
Interest-bearing deposits............... 413 5.04
-------- -----
Total investments................... $669,232 6.25 %
======== =====
PREPAID EXPENSES AND OTHER ASSETS
Total prepaid expenses and other assets were $44.8 million at December 31,
1998, an increase of $37.9 million from $6.9 million at December 31, 1997. This
increase is primarily attributable to the purchase of Bank-owned life insurance
policies with a cash value of approximately $20.4 million at December 31, 1998
and the acquisition of two factoring companies during the first quarter of 1998.
On February 5, 1998, the Bank acquired First Republic Capital Corp. and City
Financial Services, Inc., two related commercial finance companies. These
companies specialize in providing operating funds to businesses by converting
their accounts receivable to cash. The transaction, which resulted in the
exchange of 280,000 shares of the Company's common shares for all of the
outstanding stock of First Republic Capital Corp. and City Financial Services,
Inc., has been accounted for as a pooling of interests, although historical
financial statements have not been restated due to immateriality. Factored
receivables outstanding at December 31, 1998 were approximately $8.9 million.
DEPOSITS
The Company offers a variety of deposit accounts having a wide range of
interest rates and terms. The Company's deposits consist of demand, savings, NOW
accounts, money market and time accounts. The Company relies primarily on
customer service, advertising, and competitive pricing policies to attract and
retain these deposits. As of December 31, 1998, the Company had less than five
percent of its deposits classified as brokered funds and does not anticipate any
significant increase. Deposits provide generally all the funding for the
Company's lending and investment activities, and the interest paid for deposits
must be managed carefully to control the level of interest expense.
The Company's ratio of average demand deposits to average total deposits
for years ended December 31, 1998, 1997, and 1996 was 28.80%, 29.88%, and
30.06%, respectively.
Average total deposits during 1998 increased to $1.55 billion from $1.20
billion in 1997, an increase of $350.0 million or 29%. Average
noninterest-bearing deposits increased to $445.0 million in 1998 from
21
$357.7 million in 1997 due to the increase in the number of deposit accounts.
Average deposits in 1997 rose to $1.20 billion from $867.6 million in 1996, an
increase of $332.4 million or 38%.
The average daily balances and weighted average rates paid on deposits for
each of the years ended December 31, 1998, 1997 and 1996 are presented below:
YEAR ENDED DECEMBER 31,
---------------------------------------------------------------------------
1998 1997 1996
----------------------- ----------------------- ------------------------
AVERAGE AVERAGE AVERAGE
OUTSTANDING OUTSTANDING OUTSTANDING
BALANCE RATE BALANCE RATE BALANCE RATE
------------ --------- ------------ --------- ------------ ---------
(DOLLARS IN THOUSANDS)
NOW accounts......................... $ 20,621 1.48% $ 36,944 1.73% $ 51,854 1.51%
Regular savings...................... 11,715 2.05 11,373 2.29 9,952 2.35
Premium Yield........................ 426,034 4.69 278,448 4.91 172,597 4.84
Money market......................... 276,888 3.41 221,901 3.66 171,308 3.84
CD's less than $100,000.............. 75,874 5.03 80,835 5.14 69,532 5.09
CD's $100,000 and over............... 270,550 5.15 198,202 5.38 115,510 5.34
IRA's, QRP's & Other................. 18,597 5.25 17,379 5.26 16,030 5.28
------------ --------- ------------ --------- ------------ ---------
Total interest-bearing
deposits........................ 1,100,279 4.42% 845,082 4.55% 606,783 4.37%
========= ========= =========
Noninterest-bearing deposits......... 444,961 357,697 260,782
------------ ------------ ------------
Total deposits.................. $ 1,545,240 $ 1,202,779 $867,565
============ ============ ============
The following table sets forth the maturity of the Company's time deposits
that are $100,000 or greater as of the dates indicated:
DECEMBER 31,
----------------------------------
1998 1997 1996
---------- ---------- ----------
(DOLLARS IN THOUSANDS)
3 months or less..................... $ 209,776 $ 179,422 $ 92,229
Between 3 months and 6 months........ 51,729 38,902 19,997
Between 6 months and 1 year.......... 34,451 40,722 20,933
Over 1 year.......................... 14,995 8,487 6,520
---------- ---------- ----------
Total time deposits $100,000 and
over.......................... $ 310,951 $ 267,533 $ 139,679
========== ========== ==========
22
BORROWINGS
Securities sold under repurchase agreements and other short-term
borrowings, consisting of federal funds purchased and treasury, tax, and loan
deposits, generally represent borrowings with maturities ranging from one to
thirty days. Information relating to these borrowings is summarized as follows:
DECEMBER 31,
----------------------
1998 1997
---------- ----------
(DOLLARS IN THOUSANDS)
Securities sold under repurchase
agreements:
Average......................... $ 182,254 $ 129,460
Period-end...................... 181,696 155,832
Maximum month-end balance during
period........................ 240,670 155,832
Interest Rate:
Average......................... 4.77% 4.97%
Period-end...................... 5.16% 5.02%
Other short-term borrowings:
Average......................... $ 26,034 $ 14,843
Period-end...................... 138,388 17,243
Maximum month-end balance during
period........................ 138,388 50,645
Interest rate:
Average......................... 5.65% 5.60%
Period-end...................... 5.53% 6.54%
Securities sold under repurchase agreements are maintained in safekeeping
by correspondent banks.
INTEREST RATE SENSITIVITY AND LIQUIDITY
Asset and liability management is concerned with the timing and magnitude
of repricing assets compared to liabilities. It is the objective of the Company
to generate stable growth in net interest income and to attempt to control risks
associated with interest rate movements. In general, management's strategy is to
reduce the impact of changes in interest rates on its net interest income by
maintaining a favorable match between the maturities or repricing dates of its
interest-earning assets and interest-bearing liabilities. The Company adjusts
its interest sensitivity during the year through changes in the mix of assets
and liabilities and may use interest rate products such as interest rate swap
and cap agreements. The Company did not utilize derivative financial instruments
to manage interest rate risk during the years ended December 31, 1998 and 1997.
The Company's asset and liability management strategy is formulated and
monitored by the Asset Liability Committee, which is composed of senior officers
of the Bank, in accordance with policies approved by the Bank's Board of
Directors. This Committee meets regularly to review, among other things, the
sensitivity of the Bank's assets and liabilities to interest rate changes, the
book and market values of assets and liabilities, unrealized gains and losses,
purchase and sale activity, and maturities of investments and borrowings. The
Asset Liability Committee also approves and establishes pricing and funding
decisions with respect to the Bank's overall asset and liability composition.
The Committee reviews the Bank's liquidity, cash flow flexibility, maturities of
investments, deposits and borrowings, retail and institutional deposit activity,
current market conditions, and interest rates on both a local and national
level.
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.
23
The following table presents an analysis of the sensitivity inherent in the
Company's net interest income and market value of portfolio equity. The interest
rate scenarios presented in the table include interest rates at December 31,
1998 and 1997 and as adjusted by instantaneous rate changes upward and downward
of up to 200 basis points. 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 market value sensitivity analysis presented
includes assumptions that (i) the composition of the Company's interest
sensitive assets and liabilities existing at year end will remain constant over
the twelve month 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 and does not provide a precise forecast of the effect actual changes in
market rates will have on the Company.
CHANGES IN INTEREST RATES
-----------------------------------------------------
-200 -100 0 +100 +200
--------- --------- --------- --------- ---------
Impact on net interest income:
December 31, 1998............... -6.99% -4.93% 0.00% 0.77% 0.97%
December 31, 1997............... -4.22% -2.10% 0.00% 1.52% 2.48%
Impact on market value of portfolio
equity:
December 31, 1998............... -13.89% -7.04% 0.00% 3.09% 3.62%
December 31, 1997............... -15.28% -7.21% 0.00% 5.96% 10.93%
The interest rate sensitivity ("GAP") is defined as the difference
between interest-earning assets and interest-bearing liabilities maturing or
repricing within a given time period. A GAP is considered positive when the
amount of interest rate sensitive assets exceeds the amount of interest rate
sensitive liabilities. A GAP is considered negative when the amount of interest
rate sensitive liabilities exceeds interest rate sensitive assets. 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. While the GAP is a useful
measurement and contributes toward effective asset and liability management, it
is difficult to predict the effect of changing interest rates solely on that
measure. Because different types of assets and liabilities with the same or
similar maturities may react differently to changes in overall market rates or
conditions, changes in interest rates may affect net interest income positively
or negatively even if an institution were perfectly matched in each maturity
category.
Shortcomings are inherent in any GAP analysis since certain assets and
liabilities may not move proportionally as interest rates change. The Bank's
management continuously monitors its net interest rate sensitivity position and
the effect of various interest rate fluctuations on future earnings.
24
The following table sets forth an interest rate sensitivity analysis for
the Company as of December 31, 1998:
AFTER
0-30 DAYS 31-180 DAYS 181-360 DAYS ONE YEAR TOTAL
---------- ----------- ------------ ---------- ------------
(DOLLARS IN THOUSANDS)
Interest-earning assets:
Money market funds.............. $ 228 $ -- $ -- $ -- $ 228
Securities...................... 101,467 72,971 66,683 396,802 637,923
Loans........................... 849,513 95,281 41,798 346,193 1,332,785
Overdrafts...................... 6,372 -- -- -- 6,372
Federal funds sold.............. 32,023 -- -- -- 32,023
---------- ----------- ------------ ---------- ------------
Total interest-earning assets... 989,603 168,252 108,481 742,995 2,009,331
---------- ----------- ------------ ---------- ------------
Interest-bearing liabilities:
Demand, money market and savings
deposits...................... 789,254 -- -- -- 789,254
Certificates of deposit and
other time deposits........... 176,197 135,525 51,433 37,055 400,210
Short-term borrowings........... 320,084 -- -- -- 320,084
---------- ----------- ------------ ---------- ------------
Total interest-bearing
liabilities................... 1,285,535 135,525 51,433 37,055 1,509,548
---------- ----------- ------------ ---------- ------------
Period GAP........................... $ (295,932) $ 32,727 $ 57,048 $ 705,940 $ 499,783
========== =========== ============ ========== ============
Cumulative GAP....................... $ (295,932) $ (263,205) $ (206,157) $ 499,783
========== =========== ============ ==========
Period GAP to total assets........... -13.42% 1.48% 2.59% 32.01%
Cumulative GAP to total assets....... -13.42% -11.93% -9.35% 22.66%
Liquidity involves the Company's ability to raise funds to support asset
growth or reduce assets to meet deposit withdrawals and other payment
obligations, to maintain reserve requirements and otherwise to operate the
Company on an ongoing basis. For the year ended December 31, 1998, the Company's
liquidity needs have primarily been met by growth in core deposits, as
previously discussed. Although access to purchased funds from correspondent
banks is available and has been utilized on occasion to take advantage of
investment opportunities, the Company does not generally rely on these external
funding sources. The cash and federal funds sold position, supplemented by
amortizing securities and loan portfolios, have generally created an adequate
liquidity position. In January 1997, the Company completed an initial public
offering of its common stock. Substantially all of the net proceeds
(approximately $20.3 million) from the sale of 1,322,500 shares of common stock
were contributed to the Bank. Approximately $7.5 million was used to redeem the
750,000 outstanding shares of the Bank's preferred stock, and the balance was
used for general corporate purposes.
Subject to certain limitations, the Bank may borrow funds from the Federal
Home Loan Bank ("FHLB") in the form of advances. Credit availability from the
FHLB to the Bank is based on the Bank's financial and operating condition.
Borrowings from the FHLB to the Bank was approximately $30.0 million at December
31, 1998. In addition to creditworthiness, the Bank must own a minimum amount of
FHLB capital stock. This minimum is 5.00% of outstanding FHLB advances. Unused
borrowing capacity at December 31, 1998 was $118.4 million. The Bank uses FHLB
advances for both long-term and short-term liquidity needs. Other than normal
banking operations, the Bank has no long-term liquidity needs. The Bank has
never been involved with highly leveraged transactions that may cause unusual
potential long-term liquidity needs.
CAPITAL RESOURCES
Capital management consists of providing equity to support both current and
future operations. The Company is subject to capital adequacy requirements
imposed by the Federal Reserve Board and the Bank is subject to capital adequacy
requirements imposed by the OCC. Both the Federal Reserve Board and the
25
OCC have adopted risk-based capital requirements for assessing bank holding
company and bank capital adequacy. These standards define capital and establish
minimum capital requirements in relation to assets and off-balance sheet
exposure, adjusted for credit risk. The risk-based capital standards currently
in effect are designed to make regulatory capital requirements more sensitive to
differences in risk profiles among bank holding companies and banks, to account
for off-balance sheet exposure and to minimize disincentives for holding liquid
assets. Assets and off-balance sheet items are assigned to broad risk
categories, each with appropriate relative risk weights. The resulting capital
ratios represent capital as a percentage of total risk-weighted assets and
off-balance sheet items.
Bank regulatory authorities in the United States have issued risk-based
capital standards by which all bank holding companies and banks are evaluated in
terms of capital adequacy. The risk-based capital standards issued by the
Federal Reserve Board apply to the Company, and the OCC guidelines apply to the
Bank. These guidelines relate a financial institution's capital to the risk
profile of its assets. The risk-based capital standards require all financial
organizations to have "Tier 1 capital" of at least 4.0% of risk-adjusted
assets and "total risk-based" capital (Tier 1 and Tier 2) of at least 8.0% of
risk-adjusted assets. "Tier 1 capital" includes, generally, common
shareholders' equity and qualifying perpetual preferred stock together with
related surpluses and retained earnings, qualifying perpetual preferred stock
and minority interest in equity accounts of consolidated subsidiaries less
deductions for goodwill and various other intangibles. "Tier 2 capital" may
consist of a limited amount of subordinated debt, certain hybrid capital
instruments and other debt securities, preferred stock not qualifying as Tier 1
capital, and a limited amount of the general valuation allowance for loan
losses. The sum of Tier 1 capital and Tier 2 capital is "total risk-based
capital."
The agencies have also adopted guidelines which supplement the risk-based
capital guidelines with a minimum leverage ratio of Tier 1 capital to average
total consolidated assets ("leverage ratio") of 3.0% for institutions with
well diversified risk, including no undue interest rate exposure; excellent
asset quality; high liquidity; good earnings; and that are generally considered
to be strong banking organizations, rated composite 1 under applicable federal
guidelines, and that are not experiencing or anticipating significant growth.
Other banking organizations are required to maintain a leverage ratio of at
least 4.0% to 5.0%. These rules further provide that banking organizations
experiencing internal growth or making acquisitions will be expected to maintain
capital positions substantially above the minimum supervisory levels and
comparable to peer group averages, without significant reliance on intangible
assets.
Shareholders' equity increased to $143.7 million at December 31, 1998 from
$114.8 million at December 31, 1997, an increase of $28.9 million, or 25%.
26
The following table compares the Company's and the Bank's leverage and
risk-weighted capital ratios as of December 31, 1998 and 1997 to the minimum
regulatory standards:
TO BE WELL
CAPITALIZED UNDER
FOR CAPITAL PROMPT CORRECTIVE
ACTUAL ADEQUACY PURPOSES ACTION PROVISIONS
--------------------- ------------------ ---------------------
AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO
---------- --------- ---------- ----- ---------- ---------
(DOLLARS IN THOUSANDS)
As of December 31, 1998
Total Capital (to Risk
Weighted Assets):
The Company..................... $ 151,642 9.13% $ 132,852 8.00 % $ 166,065 10.00%
The Bank........................ 146,915 8.86% 132,625 8.00 % 165,781 10.00%
Tier I Capital (to Risk
Weighted Assets):
The Company..................... 138,361 8.33% 66,426 4.00 % 132,852 8.00%
The Bank........................ 133,634 8.06% 66,312 4.00 % 132,625 8.00%
Tier I Capital
(to Average Assets):
The Company..................... 138,361 6.74% 61,544 3.00 % 102,573 5.00%
The Bank........................ 133,634 6.52% 61,450 3.00 % 102,416 5.00%
As of December 31, 1997
Total Capital (to Risk
Weighted Assets):
The Company..................... 121,761 10.32% 94,405 8.00 % 118,006 10.00%
The Bank........................ 119,151 10.10% 94,401 8.00 % 118,002 10.00%
Tier I Capital (to Risk
Weighted Assets:
The Company..................... 111,426 9.44% 47,203 4.00 % 94,405 8.00%
The Bank........................ 108,816 9.22% 47,201 4.00 % 94,401 8.00%
Tier I Capital
(to Average Assets):
The Company..................... 111,426 6.70% 49,873 3.00 % 83,121 5.00%
The Bank........................ 108,816 6.54% 49,888 3.00 % 83,147 5.00%
Pursuant to Federal Deposit Insurance Corporation Improvement Act of 1991
("FDICIA"), each federal banking agency revised its risk-based capital
standards to ensure that those standards take adequate account of interest rate
risk, concentration of credit risk and the risks of nontraditional activities,
as well as reflect the actual performance and expected risk of loss on
multifamily mortgages. Also pursuant to FDICIA, each federal banking agency has
promulgated regulations setting the levels at which an insured institution would
be considered "well capitalized," "adequately capitalized,"
"undercapitalized," "significantly undercapitalized" and "critically
undercapitalized." Under the Federal Reserve Board's regulations, the Bank is
classified as "adequately capitalized" for purposes of prompt corrective
action. See "Supervision and Regulation."
YEAR 2000 INFORMATION AND READINESS DISCLOSURE
The Company has undertaken a company-wide initiative to address the Year
2000 issue and has developed a comprehensive plan to prepare, as appropriate,
its computer systems and facilities. The Company has completed a thorough
education and awareness initiative and an inventory and assessment of its
technology and application portfolio to understand the scope of the Year 2000
impact. The Company is presently renovating, in the way of upgrades, and testing
these technologies and applications in partnership with software development
organizations.
27
The Company has focused on developing appropriate policies or risk
mitigation actions to address Year 2000 related failures prior to the millennium
due to reliance on internal or external dependencies. The Company is working
with key external parties, including customers, counterparties, vendors,
exchanges, depositories, utilities, suppliers, agents, and regulatory agencies,
to eliminate the potential risks posed by the Year 2000 problem. Year 2000
compliance by the Company's borrowers is now an integral part of its
underwriting procedures. The Company is prepared to curtail credit availability
to customers identified as having material exposure to the Year 2000 issue.
However, its ability to exercise curtailment may be limited by various factors,
including existing legal agreements and potential concerns regarding lender
liability.
The Company has also completed an extensive review of its non-information
technology systems, such as elevators, escalators, bank vaults and security
systems. Most of these systems do not have date sensitive systems or imbedded
computer chips, and the Company has received written confirmation from
substantially all vendors of these systems that they are Year 2000 compliant.
The failure of external parties to resolve their own Year 2000 issues in a
timely manner could result in a material financial risk to the Company. For
potential failure scenarios where the risk to the Company is deemed significant
and where the risk is considered to have higher probability of occurrence, the
Company has developed business recovery/contingency plans. These plans define
the infrastructure that should be put in place for managing a failure after
January 1, 2000.
Costs to prepare the Company's systems for the Year 2000 are estimated at
approximately $4.0 million, for internal systems renovation and testing, testing
equipment and both internal and external resources working on the project.
Through December 31, 1998, the Company had incurred approximately $2.4 million
of these costs. Capital expenditures total approximately $584,000 and
non-capital expenditures total approximately $1.8 million.
OTHER MATTERS
On October 20, 1998, the Company and the Bank entered into an Agreement and
Plan of Merger (the "Merger Agreement") with Fort Bend Holding Corp. ("Fort
Bend"), whereby Fort Bend will merge into the Company. Fort Bend is the parent
company of Fort Bend Federal Savings and Loan Association of Rosenberg and the
majority owner of Mitchell Mortgage Co., L.L.C. of The Woodlands, Texas. The
Merger Agreement, which is subject to approval of the shareholders of Fort Bend
and various regulatory authorities, provides for the exchange of 1.45 shares of
the Company's common shares for each share of Fort Bend common stock,
approximately 4.3 million shares. At December 31, 1998, Fort Bend had total
assets of approximately $317 million and total deposits of $270 million. The
transaction is expected to be accounted for as a pooling of interests.
In June 1998, SFAS No. 133, ACCOUNTING FOR DERIVATIVE INSTRUMENTS AND
HEDGING ACTIVITIES, was issued by the Financial Accounting Standards Board to
establish accounting and reporting standards for derivative instruments,
including certain derivative instruments embedded in other contracts, and for
hedging activities. SFAS No. 133 requires that an entity recognize those
instruments at fair value. If certain conditions are met, a derivative may be
specifically designated as (a) a hedge of the exposure to changes in the fair
value of a recognized asset or liability or an unrecognized firm commitment, (b)
a hedge of the exposure to variable cash flows of a forecasted transaction, or
(c) a hedge of the foreign currency exposure of a net investment in a foreign
operation, an unrecognized firm commitment, an available-for-sale security, or a
foreign-currency-denominated forecasted transaction. The accounting for the
changes in the fair value of a derivative depends on the intended use of the
derivative and the resulting designation. The standard is effective for all
fiscal years beginning after June 15, 1999. This pronouncement is not
anticipated to have a material effect on the Company's financial position,
results of operations or cash flows.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Reference is made to "Item 7. Management's Discussion and Analysis of
Financial Condition and Results of Operations -- Financial Condition -- Interest
Rate Sensitivity and Liquidity" which is incorporated herein by reference.
28
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Reference is made to the financial statements, the reports thereon, the
notes thereto and supplementary data commencing at page F-1 of this Form 10-K,
which financial statements, reports, notes and data are incorporated herein by
reference.
QUARTERLY FINANCIAL DATA (UNAUDITED)
The following table represents summarized data for each of the quarters in
fiscal 1998 and 1997 (in thousands, except earnings per share).
1998 1997
------------------------------------- -------------------------------------
FOURTH THIRD SECOND FIRST FOURTH THIRD SECOND FIRST
QUARTER QUARTER QUARTER QUARTER QUARTER QUARTER QUARTER QUARTER
------- ------- ------- ------- ------- ------- ------- -------
Interest income...................... $36,942 $36,354 $33,902 $31,947 $31,189 $29,285 $25,870 $22,587
Interest expense..................... 15,288 15,235 14,170 14,157 13,354 12,585 10,458 9,331
------- ------- ------- ------- ------- ------- ------- -------
Net interest income.............. 21,654 21,119 19,732 17,790 17,835 16,700 15,412 13,256
Provision for loan losses............ 1,200 1,200 900 600 1,150 1,158 1,036 542
------- ------- ------- ------- ------- ------- ------- -------
Net interest income after
provision for loan losses...... 20,454 19,919 18,832 17,190 16,685 15,542 14,376 12,714
Noninterest income................... 4,532 4,000 3,672 3,598 2,923 2,556 2,793 2,327
Noninterest expenses................. 15,724 14,804 13,998 12,823 11,832 12,805 10,074 9,328
------- ------- ------- ------- ------- ------- ------- -------
Income before income taxes....... 9,262 9,115 8,506 7,965 7,776 5,293 7,095 5,713
Provision for income taxes........... 3,297 3,236 3,019 2,826 2,721 1,855 2,490 2,006
------- ------- ------- ------- ------- ------- ------- -------
Net income before bank preferred
stock dividends.................... 5,965 5,879 5,487 5,139 5,055 3,438 4,605 3,707
Bank preferred stock dividends....... -- -- -- -- -- -- -- 36
------- ------- ------- ------- ------- ------- ------- -------
Net income available to common
shareholders....................... $ 5,965 $ 5,879 $ 5,487 $ 5,139 $ 5,055 $ 3,438 $ 4,605 $ 3,671
======= ======= ======= ======= ======= ======= ======= =======
Basic earnings per common share...... $ 0.26 $ 0.25 $ 0.24 $ 0.23 $ 0.23 $ 0.15 $ 0.21 $ 0.18
Diluted earnings per common share.... $ 0.25 $ 0.24 $ 0.23 $ 0.22 $ 0.21 $ 0.15 $ 0.20 $ 0.16
Weighted average common shares and
common share equivalents
outstanding (in 000's)............. 24,273 24,234 24,342 24,003 23,688 23,698 23,540 22,657
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
There have been no disagreements with accountants on any matter of
accounting principles or practices or financial statement disclosures during the
two year period ended December 31, 1998.
29
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
For information regarding the directors and persons nominated to become
directors of the Company, reference is made to the information presented in the
Company's definitive Proxy Statement for its 1999 Annual Meeting of Shareholders
to be filed with the Commission pursuant to Regulation 14A under the Securities
and Exchange Act of 1934 (the "1999 Proxy Statement"). All of such information
is incorporated herein by reference.
ITEM 11. EXECUTIVE COMPENSATION
For information concerning the compensation paid by the Company during the
year ended December 31, 1998 to its executive officers, reference is made to the
information presented in the Company's 1999 Proxy Statement. Such information is
incorporated herein by reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
For information concerning the beneficial ownership of the common stock of
the Company by its directors and officers and by certain other beneficial
owners, reference is made to the information presented in the Company's 1999
Proxy Statement. Such information is incorporated herein by reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
For information regarding certain business relationships and related
transactions involving the Company's officers and directors, reference is made
to the information presented in the Company's 1999 Proxy Statement. Such
information is incorporated herein by reference.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) AND (d) FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULES
The financial statements and financial statement schedule listed on the
accompanying Index to Financial Statements and Schedule (see page F-1) are filed
as part of this Form 10-K.
(b) REPORTS ON FORM 8-K
The following report on Form 8-K was filed by the Company during the three
months ended December 31, 1998:
Current Report on Form 8-K dated October 20, 1998, covering "Item 5. Other
Events."
The purpose of this Form 8-K Current Report was to file as exhibits, a copy
of the joint news release dated October 21, 1998 of the Company and Fort Bend
Holding Corp. ("Fort Bend") announcing the execution of an Agreement and Plan
of Merger and a copy of the Agreement and Plan of Merger providing for the
merger of Fort Bend with and into the Company.
30
(c) *Exhibits:
2.1 -- Agreement and Plan of Merger dated October 20, 1998, between the Company and
Fort Bend Holding Corp. (incorporated by reference to Appendix A to the Proxy
Statement/Prospectus contained in the Company's Form S-4 Registration Statement
No. 333-70525)
3.1 -- Articles of Incorporation of the Company
3.2 -- Bylaws of the Company (Restated as of December 31, 1996)
3.3 -- Amendment dated December 18, 1996 to Articles of Incorporation of the Company
4.1 -- Specimen Common Stock certificate
10.1 -- 1989 Stock Option Plan
10.2 -- 1993 Stock Option Plan
10.3 -- Form of Stock Option Agreement under 1989 Stock Option Plan and 1993 Stock
Option Plan
10.4 -- 1996 Stock Option Plan, as amended February 23, 1998
10.5 -- Form of Incentive Stock Option Agreement under 1996 Stock Option Plan
10.6 -- Form of Non-qualified Stock Option Agreement under 1996 Stock Option Plan
10.7 -- Directors Stock Option Plan, adopted October, 1993
10.8 -- Form of Stock Option Agreement under Directors Stock Option Plan
10.9 -- Form of Change in Control Agreement between the Company and each of Walter E.
Johnson, Paul B. Murphy, Jr., Joseph H. Argue, David C. Farries, Sharon K.
Sokol, Yale Smith, Steve D. Stephens and Anthony Torentinos
10.10 -- Form of Employment Contract between the Company and J. Nolan Bedford
(incorporated by reference to Exhibit B-1 to Exhibit 2.1 to the Registrant's
Form S-4 Registration Statement No. 333-27897).
21.1 -- List of subsidiaries of the Company
**23.1 -- Consent of PricewaterhouseCoopers LLP
**27.1 -- Financial Data Schedule
- ------------
* All Exhibits except for those filed herewith and as otherwise indicated are
incorporated herein by reference to the Exhibits bearing the same Exhibit
numbers in the Registrant's Form S-1 Registration Statement No. 333-16509.
** Filed herewith.
31
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.
SOUTHWEST BANCORPORATION
OF TEXAS, INC.
By: /s/ WALTER E. JOHNSON
CHAIRMAN OF THE BOARD AND CHIEF
EXECUTIVE OFFICER
Date: March 2, 1999
PURSUANT TO THE REQUIREMENTS OF THE SECURITIES EXCHANGE ACT OF 1934, AS
AMENDED, THIS REPORT HAS BEEN SIGNED BELOW BY THE FOLLOWING PERSONS ON BEHALF OF
THE REGISTRANT AND IN THE CAPACITIES AND ON THE DATES INDICATED.
SIGNATURE TITLE DATE
- --------------------------------------------------- ------------------------------------------ --------------
/s/WALTER E. JOHNSON Chairman of the Board and Chief Executive March 2, 1999
WALTER E. JOHNSON Officer (Principal Executive Officer)
/s/DAVID C. FARRIES Executive Vice President, Treasurer and March 2, 1999
DAVID C. FARRIES Secretary (Principal Financial Officer)
/s/R. JOHN McWHORTER Senior Vice President and Controller March 2, 1999
R. JOHN MCWHORTER (Principal Accounting Officer)
/s/JOHN W. JOHNSON Director and Chairman of the Executive March 2, 1999
JOHN W. JOHNSON Committee of the Board
/s/PAUL B. MURPHY, JR. Director, President and Chief Operating March 2, 1999
PAUL B. MURPHY, JR. Officer
/s/JOHN B. BROCK III Director March 2, 1999
JOHN B. BROCK III
/s/ERNEST H. COCKRELL Director March 2, 1999
ERNEST H. COCKRELL
/s/J. DAVID HEANEY Director March 2, 1999
J. DAVID HEANEY
/s/WILHELMINA R. MORIAN Director March 2, 1999
WILHELMINA R. MORIAN
/s/ANDRES PALANDJOGLOU Director March 2, 1999
ANDRES PALANDJOGLOU
/s/ADOLPH A. PFEFFER, JR. Director March 2, 1999
ADOLPH A. PFEFFER, JR.
/s/STANLEY D. STEARNS, JR. Director March 2, 1999
STANLEY D. STEARNS, JR.
/s/MICHAEL T. WILLIS Director March 2, 1999
MICHAEL T. WILLIS
32
SOUTHWEST BANCORPORATION OF TEXAS, INC. AND SUBSIDIARY
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
PAGE
----
Consolidated Financial Statements
Report of Independent
Accountants.................... F-2
Consolidated Balance Sheet as of
December 31, 1998 and 1997..... F-3
Consolidated Statement of Income
for the Years Ended December
31, 1998, 1997 and 1996........ F-4
Consolidated Statement of
Changes in Shareholders' Equity
for the Years Ended
December 31, 1998, 1997 and
1996........................... F-5
Consolidated Statement of Cash
Flows for the Years Ended
December 31, 1998, 1997 and
1996........................... F-6
Notes to Consolidated Financial
Statements..................... F-7
Financial Statement Schedule
Report of Independent
Accountants.................... F-24
Schedule I -- Parent Company
Condensed Financial
Statements..................... F-25
F-1
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Shareholders
Southwest Bancorporation of Texas, Inc.:
In our opinion, the accompanying consolidated balance sheet and the related
consolidated statements of income, changes in shareholders' equity, and cash
flows present fairly, in all material respects, the consolidated financial
position of Southwest Bancorporation of Texas, Inc. and Subsidiary (the
"Company") at December 31, 1998 and 1997, and the consolidated results of
their operations and their cash flows for each of the three years in the period
ended December 31, 1998, in conformity with generally accepted accounting
principles. These financial statements are the responsibility of the Company's
management; our responsibility is to express an opinion on these financial
statements based on our audits. We conducted our audits of these statements in
accordance with generally accepted auditing standards which require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements, assessing the accounting principles used and significant estimates
made by management, and evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for the opinion expressed
above.
PricewaterhouseCoopers LLP
Houston, Texas
February 12, 1999
F-2
SOUTHWEST BANCORPORATION OF TEXAS, INC. AND SUBSIDIARY
CONSOLIDATED BALANCE SHEET
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
DECEMBER 31,
--------------------------
1998 1997
------------ ------------
ASSETS
Cash and due from banks.............. $ 119,916 $ 104,363
Federal funds sold and other cash
equivalents........................ 27,535 132,616
------------ ------------
Total cash and cash
equivalents............. 147,451 236,979
Securities -- available for sale..... 647,462 555,398
Loans receivable, net................ 1,325,877 975,815
Premises and equipment, net.......... 26,329 21,348
Accrued interest receivable.......... 13,558 11,159
Prepaid expenses and other assets.... 44,844 6,905
------------ ------------
Total assets............... $ 2,205,521 $ 1,807,604
============ ============
LIABILITIES AND SHAREHOLDERS' EQUITY
Deposits:
Demand -- noninterest-bearing... $ 539,922 $ 492,843
Demand -- interest-bearing...... 65,933 58,915
Money market accounts........... 710,852 580,605
Savings......................... 12,469 14,850
Time, $100 and over............. 310,951 267,533
Other time...................... 89,259 97,595
------------ ------------
Total deposits............. 1,729,386 1,512,341
Securities sold under repurchase
agreements......................... 181,696 155,832
Other short-term borrowings.......... 138,388 17,243
Accrued interest payable............. 1,292 1,259
Other liabilities.................... 11,025 6,094
------------ ------------
Total liabilities.......... 2,061,787 1,692,769
------------ ------------
Commitments and contingencies
Shareholders' equity:
Common stock -- $1 par value,
50,000,000 shares authorized;
23,353,414 and 22,370,526
shares issued and outstanding
at December 31, 1998 and 1997,
respectively................... 23,353 22,370
Additional paid-in capital...... 41,830 38,364
Retained earnings............... 74,803 52,333
Accumulated other comprehensive
income......................... 3,748 1,768
------------ ------------
Total shareholders'
equity.................. 143,734 114,835
------------ ------------
Total liabilities and
shareholders' equity.... $ 2,205,521 $ 1,807,604
============ ============
The accompanying notes are an integral part of the consolidated financial
statements.
F-3
SOUTHWEST BANCORPORATION OF TEXAS, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENT OF INCOME
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
YEAR ENDED DECEMBER 31,
--------------------------------
1998 1997 1996
---------- --------- ---------
Interest income:
Loans........................... $ 101,200 $ 78,509 $ 55,771
Securities...................... 32,804 24,908 20,892
Federal funds sold and other.... 5,140 5,515 1,594
---------- --------- ---------
Total interest income...... 139,144 108,932 78,257
Interest expense on deposits and
other borrowings................... 58,850 45,729 32,275
---------- --------- ---------
Net interest income........ 80,294 63,203 45,982
Provision for loan losses............ 3,900 3,886 2,090
---------- --------- ---------
Net interest income after
provision for loan
losses.................. 76,394 59,317 43,892
---------- --------- ---------
Other income:
Service charges................. 7,708 6,025 4,473
Investment services............. 3,303 2,339 1,215
Other operating income.......... 4,327 1,711 1,159
Gain on sale of securities...... 463 498 --
---------- --------- ---------
Total other income......... 15,801 10,573 6,847
---------- --------- ---------
Other expenses:
Salaries and employee
benefits...................... 34,900 24,950 18,984
Occupancy expense............... 8,963 6,814 4,881
Loss on sale of securities...... -- -- 112
Merger-related expenses and
other charges................. 67 2,011 --
Other operating expenses........ 13,417 10,238 8,233
---------- --------- ---------
Total other expenses....... 57,347 44,013 32,210
---------- --------- ---------
Income before income
taxes................... 34,848 25,877 18,529
Provision for income taxes........... 12,378 9,072 6,468
---------- --------- ---------
Net income before bank
preferred stock
dividend................ 22,470 16,805 12,061
Bank preferred stock dividend........ -- 36 457
---------- --------- ---------
Net income available for
common shareholders..... $ 22,470 $ 16,769 $ 11,604
========== ========= =========
Earnings per common share:
Basic...................... $ 0.97 $ 0.77 $ 0.62
========== ========= =========
Diluted.................... $ 0.93 $ 0.72 $ 0.57
========== ========= =========
The accompanying notes are an integral part of the consolidated financial
statements.
F-4
SOUTHWEST BANCORPORATION OF TEXAS, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS' EQUITY
(DOLLARS IN THOUSANDS, EXCEPT SHARE AMOUNTS)
ACCUMULATED
COMMON STOCK ADDITIONAL OTHER TOTAL
------------------- PAID-IN RETAINED COMPREHENSIVE SHAREHOLDERS'
SHARES DOLLARS CAPITAL EARNINGS INCOME/(LOSS) EQUITY
--------- ------- ---------- -------- -------------- -------------
BALANCE, DECEMBER 31, 1995........... 18,085,160 $18,085 $ 16,278 $23,960 $ (18) $ 58,305
Issuance of common stock to
benefit plan................... 34,870 35 133 168
Liquidation of partial shares.... (108) (1) (1)
Proceeds from sale of common
stock.......................... 687,242 687 2,587 3,274
Deferred compensation
amortization................... 135 135
Cash dividends on preferred stock
($.61 per share)............... (457) (457)
Comprehensive income:
Net income for the year ended
December 31, 1996.............. 12,061 12,061
Net change in unrealized
depreciation on securities
available for sale, net of
deferred taxes of $38.......... (70) (70)
-------------
Total comprehensive income....... 11,991
--------- ------- ---------- -------- -------------- -------------
BALANCE, DECEMBER 31, 1996........... 18,807,164 18,807 19,132 35,564 (88) 73,415
Issuance of common stock to
benefit plan................... 5,040 5 30 35
Exercise of stock options........ 913,322 913 2,058 2,971
Proceeds of public offering...... 2,645,000 2,645 17,165 19,810
Redemption of Bank preferred
stock.......................... (177) (177)
Deferred compensation
amortization................... 156 156
Cash dividends on preferred stock
($.05 per share)............... (36) (36)
Comprehensive income:
Net income for the year ended
December 31, 1997.............. 16,805 16,805
Net change in unrealized
appreciation on securities
available for sale, net of
deferred taxes of ($999)....... 1,856 1,856
-------------
Total comprehensive income....... 18,661
--------- ------- ---------- -------- -------------- -------------
BALANCE, DECEMBER 31, 1997........... 22,370,526 22,370 38,364 52,333 1,768 114,835
Common stock issued in
acquisition.................... 280,000 280 304 584
Exercise of stock options........ 702,888 703 3,018 3,721
Deferred compensation
amortization................... 144 144
Comprehensive income:
Net income for the year ended
December 31, 1998........... 22,470 22,470
Net change in unrealized
appreciation on securities
available for sale, net of
deferred taxes of
($1,066).................... 1,980 1,980
-------------
Total comprehensive income..... 24,450
--------- ------- ---------- -------- -------------- -------------
BALANCE, DECEMBER 31, 1998........... 23,353,414 $23,353 $ 41,830 $74,803 $ 3,748 $ 143,734
========= ======= ========== ======== ============== =============
The accompanying notes are an integral part of the consolidated financial
statements.
F-5
SOUTHWEST BANCORPORATION OF TEXAS, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENT OF CASH FLOWS
(DOLLARS IN THOUSANDS)
YEAR ENDED DECEMBER 31,
----------------------------------------
1998 1997 1996
------------ ------------ ------------
Cash flows from operating activities:
Net income......................... $ 22,470 $ 16,805 $ 12,061
Adjustments to reconcile net income
to net cash provided by
operating activities:
Provision for loan losses....... 3,900 3,886 2,090
Depreciation.................... 4,731 3,715 2,832
Compensation expense............ -- 36 168
Deferred compensation
amortization.................... 144 165 135
Deferred tax (benefit)
expense......................... (2,679) (67) 340
Loss on sale of other assets.... 132 559 4
Realized (gain) loss on
securities available for sale,
net............................. (463) (142) 112
Net amortization of premiums and
discounts....................... 1,407 1,424 1,994
Dividends on Federal Home Loan
Bank stock...................... (853) (2,861) (1,694)
(Increase) decrease in accrued
interest receivable, prepaid
expenses and other assets..... (14,241) (5,350) 659
Increase (decrease) in accrued
interest payable and other
liabilities................... 2,877 5,651 (1,144)
------------ ------------ ------------
Net cash provided by
operating activities.... 17,425 23,821 17,557
------------ ------------ ------------
Cash flows from investing activities:
Proceeds from maturity of
securities available for sale... 284,496 42,080 53,657
Principal paydowns of
mortgage-backed securities
available for sale.............. 111,817 47,139 50,138
Proceeds from sale of securities
available for sale.............. 123,185 93,109 43,011
Purchase of securities available
for sale........................ (608,608) (387,894) (144,811)
Proceeds from sale of other real
estate and other loan related
assets.......................... 492 56 24
Net increase in loans receivable... (354,359) (255,748) (201,215)
Purchase of Bank-owned life
insurance policies.............. (20,000) -- --
Purchase of premises and
equipment....................... (9,711) (9,157) (7,205)
------------ ------------ ------------
Net cash used in investing
activities.............. (472,688) (470,415) (206,401)
------------ ------------ ------------
Cash flows from financing activities:
Net increase in noninterest-bearing
demand deposits................. 47,079 119,818 117,381
Net increase in time deposits...... 35,082 138,464 60,357
Net increase in other
interest-bearing deposits....... 134,884 212,612 23,536
Net increase in securities sold
under repurchase agreements..... 25,864 19,713 40,480
Net increase in other short-term
borrowings...................... 121,145 7,216 8,739
Net proceeds from public offering
of common stock................. -- 19,810 3,275
Proceeds from exercise of stock
options......................... 1,681 729 --
Payment of dividends on Bank
preferred stock................. -- (152) (391)
Retirement of Bank preferred
stock........................... -- (7,500) --
------------ ------------ ------------
Net cash provided by
financing activities.... 365,735 510,710 253,377
------------ ------------ ------------
Net increase (decrease) in cash and
cash equivalents................... (89,528) 64,116 64,533
Cash and cash equivalents at
beginning of year.................. 236,979 172,863 108,330
------------ ------------ ------------
Cash and cash equivalents at end of
year............................... $ 147,451 $ 236,979 $ 172,863
============ ============ ============
The accompanying notes are an integral part of the consolidated financial
statements.
F-6
SOUTHWEST BANCORPORATION OF TEXAS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
1. NATURE OF OPERATIONS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
BASIS OF PRESENTATION AND NATURE OF OPERATIONS
The consolidated financial statements include the accounts of Southwest
Bancorporation of Texas, Inc. (the "Company") and its wholly-owned subsidiary
Southwest Bank of Texas National Association (the "Bank"). All material
intercompany accounts and transactions have been eliminated.
Substantially all of the Company's revenue and income is derived from the
operations of the Bank. The Bank provides a full range of commercial and private
banking services to small and middle market businesses and individuals in the
Houston metropolitan area.
Effective August 1, 1997, the Company and the Bank consummated their merger
with Pinemont Bank, whereby Pinemont Bank, another Houston area metropolitan
bank, was merged into the Bank. In accordance with the Agreement and Plan of
Merger, the Company exchanged 0.625 of a share of the Company's common shares
for each share of Pinemont Bank stock, resulting in the issuance of 1,668,621
shares of the Company's common shares. The transaction was accounted for as a
pooling of interests; therefore the Company's consolidated financial statements
have been restated to include the accounts and operations of Pinemont Bank for
all periods presented.
On February 5, 1998, the Bank acquired all the common stock of First
Republic Capital Corp. and City Financial Services, Inc., two related commercial
finance companies. These companies specialize in providing operating funds to
businesses by converting their accounts receivable to cash. The transaction
which resulted in the exchange of 280,000 shares of the Company's common shares
for all of the outstanding stock of First Republic Capital Corp. and City
Financial Services, Inc., has been accounted for as a pooling of interests,
although historical financial statements have not been restated due to
immateriality.
On April 28, 1998 the Board of Directors declared a two-for-one split of
its common stock to be effected in the form of a 100% stock dividend. The common
stock distributed as a result of the stock split was distributed on May 29, 1998
to shareholders of record at the close of business on May 15, 1998. All common
shares and per common share amounts in the accompanying financial statements
have been adjusted to give retroactive effect to the stock split.
MANAGEMENT'S ESTIMATES
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the dates of the financial
statements and the reported amounts of income and expenses during the reporting
periods. Actual results could differ from those estimates.
CASH AND CASH EQUIVALENTS
The Company considers federal funds sold, due from bank demand accounts and
other highly liquid investments purchased with a maturity of three months or
less to be cash equivalents. The Company classifies investments in money market
funds as securities and not cash equivalents.
The Company is required to maintain noninterest-bearing cash reserve
balances with the Federal Reserve Bank. The average balance was approximately
$3,000 and $10,800 for the years ended December 31, 1998 and 1997, respectively.
F-7
SOUTHWEST BANCORPORATION OF TEXAS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
SECURITIES
Securities which management intends and has the ability to hold to maturity
are classified as held to maturity. Securities held to maturity are stated at
cost, increased by accretion of discounts and reduced by amortization of
premiums, both computed by the interest method. The Company held no securities
classified as held to maturity at December 31, 1998 or 1997.
Securities to be held for indefinite periods of time, including securities
that management intends to use as part of its asset/liability strategy, or that
may be sold in response to changes in interest rates, changes in prepayment
risk, the need to increase regulatory capital or other similar factors, are
classified as available for sale and are carried at fair value. Fair values of
securities are estimated based on available market quotations. Unrealized
holding gains and losses, net of taxes, on available for sale securities are
reported as a separate component of other comprehensive income until realized.
The amortized cost of securities available for sale is increased by accretion of
discounts and reduced by amortization of premiums, both computed by the interest
method. Gains and losses on the sale of available for sale securities are
determined using the specific identification method.
Trading securities are carried at market value. Realized and unrealized
gains and losses on trading securities are recognized in the statement of income
as they occur. The Company held no trading securities at December 31, 1998 and
1997.
The Company reviews its financial position, liquidity and future plans in
evaluating the criteria for classifying investment securities. Securities are
classified among categories at the time the securities are purchased. Declines
in the fair value of individual held to maturity and available for sale
securities below their cost that are other than temporary would result in
write-downs of the individual securities to their fair value. The Company
believes that none of the unrealized losses should be considered other than
temporary.
LOANS
Loans are reported at the principal amount outstanding, net of unearned
discount, deferred loan fees and the allowance for loan losses.
Loans on which the accrual of interest has been discontinued are designated
as nonaccrual loans. Loans are designated as nonaccrual when reasonable doubt
exists as to the full, timely collection of interest or principal. When a loan
is placed on nonaccrual status, all interest previously accrued but not
collected is reversed against current period interest income. Income on such
loans is then recognized only to the extent that cash is received and where the
future collection of interest and principal is probable. Interest accruals are
resumed on such loans only when they are brought fully current with respect to
interest and principal and when, in the judgment of management, the loans are
estimated to be fully collectible as to both principal and interest.
A loan is considered impaired, based on current information and events, if
it is probable that the Company will be unable to collect the scheduled payments
of principal or interest when due according to the contractual terms of the loan
agreement. A loan is not considered impaired during a period of delay in payment
if the Company expects to collect all amounts due, including interest past due.
The Company generally considers a period of delay in payment to include
delinquency up to 90 days. The measurement of impaired loans is based on the
present value of expected future cash flows discounted at the loan's effective
interest rate or the loan's observable market price or based on the fair value
of the collateral if the loan is collateral-dependent. If the measure of the
impaired loan is less than the recorded investment in the loan, an impairment is
recognized through the provision for loan losses.
The accrual of interest on impaired loans is discontinued when, in
management's opinion, the borrower may be unable to meet payments as they become
due. When interest accrual is discontinued, all unpaid
F-8
SOUTHWEST BANCORPORATION OF TEXAS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
accrued interest is reversed. Interest income is subsequently recognized only to
the extent cash payments are received.
ALLOWANCE FOR LOAN LOSSES
The allowance for loan losses is established through a provision for such
losses charged against operations. Loans are charged against the allowance for
loan losses when management believes that the collectibility of the principal is
unlikely. The allowance is an amount that management believes will be adequate
to reflect the risks inherent in the existing loan portfolio and commitments to
extend credit and is based on evaluations of the collectibility and prior loss
experience of loans. The evaluations are based on a number of subjective factors
including current and anticipated economic conditions, changes in the loan
portfolio, adequacy of loan collateral and other relevant factors.
The evaluation of the adequacy of loan collateral is often based upon
estimates and appraisals. Because of changing economic conditions, the
valuations determined from such estimates and appraisals may also change.
Accordingly, the Company may ultimately incur losses which vary from
management's current estimates. Adjustments to the allowance for loan losses
will be reported in the period such adjustments become known or are reasonably
estimable.
LOAN FEES AND COSTS
Nonrefundable loan origination and commitment fees and direct costs
associated with originating loans are deferred and recognized over the lives of
the related loans as an adjustment to the loans' yield.
PREMISES AND EQUIPMENT
Premises and equipment are stated at cost less accumulated depreciation and
amortization. Depreciation expense is computed using the straight-line method
and is charged to operating expense over the estimated useful lives of the
assets. Depreciation expense has been computed principally using estimated lives
of ten to twenty years for premises, three to five years for hardware and
software, and three to ten years for furniture and equipment. Leasehold
improvements are amortized using the straight-line method over the shorter of
the initial term of the respective lease or the estimated useful life of the
improvement. Costs of major additions and improvements are capitalized.
Expenditures for maintenance and repairs are charged to operations as incurred.
When assets are retired or otherwise disposed of, the cost and related
accumulated depreciation are removed from the accounts and any resulting gain or
loss is reflected in income for the period.
OTHER REAL ESTATE OWNED
Real estate acquired through foreclosure is carried at the lower of the
recorded investment in the property or its fair value less estimated selling
costs. Prior to foreclosure, the value of the underlying collateral of the loan
is written down to its estimated fair value less estimated selling costs by a
charge to the allowance for loan losses, if necessary. Any subsequent
write-downs are charged against operations. Operating expenses of such
properties, net of related income is included in other operating expenses.
EARNINGS PER COMMON SHARE
Basic earnings per common share is computed by dividing income available
for common shareholders by the weighted average number of common shares
outstanding for the period. Diluted earnings per common share is computed by
dividing income available for common shareholders by the sum of the weighted
average number of common shares outstanding and the effect of all potential
dilutive common shares outstanding for the period.
F-9
SOUTHWEST BANCORPORATION OF TEXAS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
INCOME TAX
Deferred income taxes are provided utilizing the liability method whereby
deferred income tax assets or liabilities are recognized for the tax
consequences in future years of differences in the tax bases of assets and
liabilities and their financial reporting amounts based on enacted tax laws and
statutory tax rates applicable to the periods in which the differences are
expected to affect taxable income. Valuation allowances are established when
necessary to reduce deferred tax assets to the amount expected to be realized.
OFF-BALANCE SHEET FINANCIAL INSTRUMENTS
In the ordinary course of business the Company has entered into
off-balance-sheet financial instruments consisting of commitments to extend
credit, commercial letters of credit, and standby letters of credit. Such
financial instruments are recorded in the financial statements when they are
funded or related fees are incurred or received.
NEW ACCOUNTING PRONOUNCEMENTS
In June 1998, Statement of Financial Accounting Standards ("SFAS") No.
133, ACCOUNTING FOR DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES, was issued by
the Financial Accounting Standards Board to establish accounting and reporting
standards for derivative instruments, including certain derivative instruments
embedded in other contracts, and for hedging activities. SFAS 133 requires that
an entity recognize those instruments at fair value. If certain conditions are
met, a derivative may be specifically designated as (a) a hedge of the exposure
to changes in the fair value of a recognized asset or liability or an
unrecognized firm commitment, (b) a hedge of the exposure to variable cash flows
of a forecasted transaction, or (c) a hedge of the foreign currency exposure of
a net investment in a foreign operation, an unrecognized firm commitment, an
available-for-sale security, or a foreign-currency-denominated forecasted
transaction. The accounting for the changes in the fair value of a derivative
depends on the intended use of the derivative and the resulting designation. The
standard is effective for all fiscal years beginning after June 15, 1999. This
pronouncement is not anticipated to have a material effect on the Company's
financial position, results of operations or cash flows.
2. SECURITIES:
The amortized cost and fair value of securities classified as available for
sale is as follows:
DECEMBER 31, 1998
----------------------------------------------
GROSS UNREALIZED
AMORTIZED ------------------ FAIR
COST GAINS LOSSES VALUE
--------- ------ ------ ----------
U.S. Government securities........... $ 143,570 $1,575 $ -- $ 145,145
Mortgage-backed securities........... 488,641 4,549 (452) 492,738
Federal Reserve Bank stock........... 1,869 -- -- 1,869
Federal Home Loan Bank stock......... 6,271 -- -- 6,271
Other securities..................... 1,346 94 (1) 1,439
--------- ------ ------ ----------
Total securities available for
sale.......................... $ 641,697 $6,218 $ (453) $ 647,462
========= ====== ====== ==========
F-10
SOUTHWEST BANCORPORATION OF TEXAS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
DECEMBER 31, 1997
----------------------------------------------
GROSS UNREALIZED
AMORTIZED ------------------ FAIR
COST GAINS LOSSES VALUE
--------- ------ ------ ----------
U.S. Government securities........... $ 163,230 $ 536 $ (4) $ 163,762
Mortgage-backed securities........... 323,434 2,275 (151) 325,558
Federal Reserve Bank stock........... 1,791 -- -- 1,791
Federal Home Loan Bank stock......... 37,942 -- -- 37,942
Other securities..................... 26,281 64 -- 26,345
--------- ------ ------ ----------
Total securities available for
sale.......................... $ 552,678 $2,875 $ (155) $ 555,398
========= ====== ====== ==========
The scheduled maturities of securities classified as available for sale is
as follows:
DECEMBER 31, 1998 DECEMBER 31, 1997
----------------------- -----------------------
AMORTIZED FAIR AMORTIZED FAIR
COST VALUE COST VALUE
---------- ---------- ---------- ----------
Due in one year or less.............. $ 49,061 $ 49,335 $ 100,767 $ 100,853
Due from one year to five years...... 64,509 65,650 62,463 62,909
Due after 5 years.................... 30,000 30,160 -- --
---------- ---------- ---------- ----------
143,570 145,145 163,230 163,762
Mortgage-backed securities........... 488,641 492,738 323,434 325,558
Federal Reserve Bank stock........... 1,869 1,869 1,791 1,791
Federal Home Loan Bank stock......... 6,271 6,271 37,942 37,942
Other securities..................... 1,346 1,439 26,281 26,345
---------- ---------- ---------- ----------
Total securities available for
sale.......................... $ 641,697 $ 647,462 $ 552,678 $ 555,398
========== ========== ========== ==========
Securities with a market value of $507,178 and $354,896 at December 31,
1998 and 1997, respectively, have been pledged to collateralize repurchase
agreements, public deposits and other items.
3. LOANS:
DECEMBER 31,
------------------------
1998 1997
------------ ----------
Commercial........................... $ 635,161 $ 448,575
Real estate:
Construction.................... 232,951 129,932
1-4 family residential.......... 189,613 171,739
Other........................... 180,773 149,028
Consumer............................. 103,548 88,862
------------ ----------
1,342,046 988,136
Less:
Unearned fees and discounts..... (2,888) (1,986)
Allowance for loan losses....... (13,281) (10,335)
------------ ----------
$ 1,325,877 $ 975,815
============ ==========
F-11
SOUTHWEST BANCORPORATION OF TEXAS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
An analysis of the allowance for loan losses is as follows:
1998 1997 1996
--------- --------- ---------
Balance, beginning of year........... $ 10,335 $ 7,400 $ 6,024
Provision charged against
operations......................... 3,900 3,886 2,090
Charge-offs.......................... (1,087) (1,078) (807)
Recoveries........................... 133 127 93
--------- --------- ---------
Balance, end of year................. $ 13,281 $ 10,335 $ 7,400
========= ========= =========
A loan is considered impaired when, based upon current information and
events, it is probable that the Company will be unable to collect the scheduled
payments of principal and interest when due according to the contractual terms
of the loan agreement. The Company's impaired loans were approximately $14.000
and $2.700 at December 31, 1998 and 1997, respectively. The largest component of
impaired loans at December 31, 1998 is a commercial energy related loan of
approximately $10.600. The average recorded investment in impaired loans during
1998 and 1997 was $6.300 and $2.200, respectively. The total required allowance
for loan losses related to these loans was $0 at December 31, of 1998 and 1997.
Interest income on impaired loans of $415 and $0 was recognized for cash
payments received in 1998 and 1997, respectively.
The Bank is not committed to lend additional funds to debtors whose loans
have been modified.
The Company has loans, deposits, and other transactions with its principal
shareholders, officers, directors and organizations with which such persons are
associated which were made in the ordinary course of business. At December 31,
1998 and 1997, the aggregate amount of loans and unfunded lines of credit to
such related parties was $44,724 and $13,493, respectively.
Following is an analysis of activity with respect to these amounts:
DECEMBER 31,
--------------------
1998 1997
--------- ---------
Balance, beginning of year........... $ 13,493 $ 9,227
New loans and unfunded lines of
credit............................... 32,661 5,866
Repayments........................... (930) (1,600)
--------- ---------
Balance, end of year................. $ 44,724 $ 13,493
========= =========
4. PREMISES AND EQUIPMENT:
Premises and equipment consists of the following:
DECEMBER 31,
--------------------
1998 1997
--------- ---------
Land.................................... $ 6,079 $ 3,998
Premises and leasehold improvements..... 10,722 9,522
Furniture and equipment................. 24,406 18,393
--------- ---------
41,207 31,913
Less accumulated depreciation and
amortization............................ (14,878) (10,565)
--------- ---------
$ 26,329 $ 21,348
========= =========
F-12
SOUTHWEST BANCORPORATION OF TEXAS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
5. PREPAID EXPENSES AND OTHER ASSETS:
Prepaid expenses and other assets consists of the following:
DECEMBER 31,
--------------------
1998 1997
--------- ---------
Foreclosed real estate.................. $ 464 $ 546
Deferred income taxes................... 2,254 641
Goodwill................................ 1,510 1,641
Prepaid expenses........................ 696 629
Banker's acceptances.................... 1,936 70
Investment in unconsolidated investee... 3,500 1,925
Cash value of bank-owned life
insurance............................. 20,390 --
Factored receivables.................... 8,948 --
Other................................... 5,346 1,453
--------- ---------
$ 44,844 $ 6,905
========= =========
6. DEPOSITS:
At December 31, 1998, scheduled maturities of time deposits are summarized
as follows:
1999.................................... $ 368,725
2000.................................... 18,837
2001.................................... 7,315
2002.................................... 2,553
2003.................................... 1,514
Thereafter.............................. 1,266
----------
$ 400,210
==========
At December 31, 1998 and 1997, the aggregate amount of deposits from
related parties was $46,712 and $43,673, respectively.
F-13
SOUTHWEST BANCORPORATION OF TEXAS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
7. SECURITIES SOLD UNDER REPURCHASE AGREEMENTS AND OTHER SHORT-TERM BORROWINGS:
Securities sold under repurchase agreements and other short-term
borrowings, consisting of federal funds purchased and treasury, tax, and loan
deposits, generally represent borrowings with maturities ranging from one to
thirty days. Information relating to these borrowings is summarized as follows:
DECEMBER 31, DECEMBER 31,
1998 1997
------------ ------------
Securities sold under repurchase
agreements:
Average......................... $182,254 $129,460
Year-end........................ 181,696 155,832
Maximum month-end balance during
year.......................... 240,670 155,832
Interest rate:
Average......................... 4.77% 4.97%
Year-end........................ 5.16% 5.02%
Other short-term borrowings:
Average......................... $ 26,034 $ 14,843
Year-end........................ 138,388 17,243
Maximum month-end balance during
year.......................... 138,388 50,645
Interest rate:
Average......................... 5.65% 5.60%
Year-end........................ 5.60% 6.54%
Securities sold under repurchase agreements generally include U.S.
Government securities and are maintained in safekeeping by correspondent banks.
The Company enters into these repurchase agreements as a service to its
customers.
Subject to certain limitations, the Bank may borrow funds from the Federal
Home Loan Bank ("FHLB") in the form of advances. Credit availability from the
FHLB to the Bank is based on the Bank's financial and operating condition.
Borrowings from the FHLB to the Bank were approximately $30,000 and $17,200 at
December 31, 1998 and 1997, respectively. In addition to creditworthiness, the
Bank must own a minimum amount of FHLB capital stock. This minimum is 5.00% of
outstanding FHLB advances. Unused borrowing capacity at December 31, 1998 was
$118,400.
8. INCOME TAXES:
The income tax provision (benefit) for the years ended December 31, 1998,
1997 and 1996 is composed of the following:
1998 1997 1996
--------- --------- ---------
Current.............................. $ 15,057 $ 9,139 $ 6,128
Deferred............................. (2,679) (67) 340
--------- --------- ---------
$ 12,378 $ 9,072 $ 6,468
========= ========= =========
F-14
SOUTHWEST BANCORPORATION OF TEXAS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The types of temporary differences between the tax bases of assets and
liabilities and their financial reporting amounts that give rise to deferred
income tax assets and liabilities and their approximate tax effects are as
follows:
DECEMBER 31, 1998 DECEMBER 31, 1997
----------------------- -----------------------
TEMPORARY TAX TEMPORARY TAX
DIFFERENCES EFFECT DIFFERENCES EFFECT
------------ ------- ------------ -------
Premises and equipment............... $ 307 $ 107 $ 623 $ 218
Allowance for loan losses............ 12,708 4,448 9,609 3,364
Unearned fees........................ 20 7 43 15
Deferred compensation................ 344 120 692 242
Accruals............................. 111 39 163 57
Other................................ 256 90 -- --
------------ ------- ------------ -------
Deferred income tax asset....... $ 13,746 4,811 $ 11,130 3,896
============ ------- ============ -------
Unrealized gain on securities
available for sale................. $ 5,765 2,018 $ 2,720 952
Market discounts on securities....... 360 126 369 129
Federal Home Loan Bank stock
dividend........................... 1,180 413 6,211 2,174
------------ ------- ------------ -------
Deferred income tax liability... $ 7,305 2,557 $ 9,300 3,255
============ ------- ============ -------
Net deferred income tax asset........ $ 2,254 $ 641
======= =======
The reconciliation between the Company's effective income tax rate and the
statutory federal income tax rate is as follows:
YEAR ENDED DECEMBER 31,
------------------------
1998 1997 1996
---- ---- ----
Statutory federal income tax rate....... 35.0% 35.0% 35.0%
Permanent differences................... 0.5 1.5 0.6
Effect of utilization of graduated tax
rates................................. -- -- (0.7)
Other................................... -- (1.5) 0.1
---- ---- ----
Effective income tax rate............... 35.5% 35.0% 35.0%
==== ==== ====
9. EMPLOYEE BENEFITS:
STOCK-BASED COMPENSATION PLAN
The Company sponsors, and currently grants awards under, the Southwest
Bancorporation of Texas, Inc. 1996 Stock Option Plan (the "Stock Option
Plan"), which is a stock-based compensation plan as described below. The
Company has also sponsored similar stock-based compensation plans in prior
years.
The Company applies the intrinsic value method in accounting for the Stock
Option Plan and the Company's other prior stock-based compensation plans. In
1995, the Financial Accounting Standards Board issued Statement of Financial
Accounting Standards No. 123, ACCOUNTING FOR STOCK-BASED COMPENSATION, ("SFAS
123") which, if fully adopted by the Company, would change the method the
Company applies in recognizing the expense of its stock-based compensation plans
for awards subsequent to 1994. Adoption of the expense recognition provisions of
SFAS 123 is optional and the Company decided not to elect these provisions of
SFAS 123. However, pro forma disclosures as if the Company adopted the expense
recognition provisions of SFAS 123 are required by SFAS 123 and are presented
below.
F-15
SOUTHWEST BANCORPORATION OF TEXAS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
THE STOCK OPTION PLAN
Under the Stock Option Plan, the Company is authorized to issue up to
2,000,000 shares of common stock pursuant to "Awards" granted in the form of
incentive stock options which qualify under Section 422 of the Internal Revenue
Code of 1986, as amended (the "Code"), nonqualified stock options which do not
qualify under Section 422 of the Code, and stock appreciation rights. Awards may
be granted to selected employees and directors of the Company or any subsidiary.
The Stock Option Plan provides that the exercise price of any incentive stock
option may not be less than the fair market value of the common stock on the
date of grant, and that the exercise price of any nonqualified stock option may
be equal to, greater than or less than the fair market value of the common stock
on the date of grant.
The Company granted 637,652, 220,074 and 848,500 stock options in 1998,
1997 and 1996, respectively. These stock options were granted with an exercise
price, as determined in each individual grant agreement. The majority of the
options granted vest over a five year period commencing on the date of grant
(i.e., 60% vest on the third anniversary of the date of grant and 20% vest on
each of the next two anniversaries of the date of grant) with the remaining
options vesting over a period not to exceed five years.
Included in the 1996 grants were 5,000 nonqualified stock options that will
vest only if a specified performance measure is attained. These
performance-based stock options were fully vested at December 31, 1997, as the
performance measure was attained.
In accordance with APB 25, compensation expense is recognized for
discounted stock options granted and for performance-based stock options granted
(but not for the nondiscounted stock options granted). The Company has
recognized $144, $165 and $135 of compensation expense in connection with these
grants in 1998, 1997 and 1996, respectively.
A summary of the status of the Company's stock options as of December 31,
1998, 1997, and 1996 and the change during the years is as follows:
1998 1997 1996
---------------------- ---------------------- ----------------------
WEIGHTED WEIGHTED WEIGHTED
# SHARES AVERAGE # SHARES AVERAGE # SHARES AVERAGE
UNDERLYING EXERCISE UNDERLYING EXERCISE UNDERLYING EXERCISE
OPTIONS PRICES OPTIONS PRICES OPTIONS PRICES
---------- -------- ---------- -------- ---------- --------
Outstanding at beginning of the
year............................... 2,681,964 $ 4.63 3,416,660 $ 3.35 2,616,910 $ 1.54
Granted at a discount........... 19,715 $ 5.05 30,000 $ 5.94 42,500 $ 4.73
Granted at-the-money............ 617,937 $ 8.14 190,074 $ 9.04 801,000 $ 8.07
Granted at a premium............ 0 n/a 0 n/a 5,000 $ 5.00
Total granted........................ 637,652 $ 8.04 220,074 $ 8.67 848,500 $ 7.88
Exercised............................ 702,888 $ 1.20 913,322 $ 1.04 0 n/a
Forfeited............................ 33,725 $ 5.98 41,448 $ 2.43 48,750 $ 4.17
Expired.............................. 0 n/a 0 n/a 0 n/a
Outstanding at end of year........... 2,583,003 $ 7.08 2,681,964 $ 4.63 3,416,660 $ 3.35
Exercisable at end of year........... 781,434 $ 6.56 877,606 $ 2.70 1,272,198 $ 1.27
F-16
SOUTHWEST BANCORPORATION OF TEXAS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The fair value of each stock option granted is estimated on the date of
grant using the Black-Scholes stock option valuation model with the following
weighted-average assumptions for grants in 1998, 1997 and 1996: dividend yield
of 0.00%: risk-free interest rates are different for each grant and range from
5.21% to 6.48%; the expected lives of options range from 5 to 6 years; and a
volatility of 26.77%, 25.36% and 0% respectively. The weighted average grant
date fair value of options granted during the year is as follows:
1998 1997 1996
--------- --------- ---------
Weighted-average fair value of
options granted at a discount...... $ 4.71 $ 7.06 $ 1.59
Weighted-average fair value of
options granted at-the-money....... $ 2.96 $ 3.68 $ 2.37
Weighted-average fair value of
options granted at a premium....... n/a n/a $ 1.20
Weighted-average fair value of all
options granted during the year.... $ 3.43 $ 4.14 $ 2.32
The following table summarizes information about stock options outstanding
and exercisable at December 31, 1998:
OPTIONS OUTSTANDING
-------------------------------------- OPTIONS EXERCISABLE
WEIGHTED -----------------------
AVERAGE WEIGHTED WEIGHTED
REMAINING AVERAGE AVERAGE
NUMBER CONTRACTUAL EXERCISE NUMBER EXERCISE
RANGE OF EXERCISE PRICES OUTSTANDING LIFE PRICE EXERCISABLE PRICE
- ------------------------------------- ----------- ----------- -------- ----------- --------
$.20 to $5.20........................ 1,070,316 * $2.83 671,718 $2.81
$7.50 to $11.16...................... 886,410 7.65 $8.38 69,566 $8.25
$12.54 to $15.35..................... 43,740 8.77 $13.81 0 n/a
15.38 to 20.19....................... 582,537 9.50 $16.33 40,150 $15.38
----------- =========== -------- ----------- --------
$.20 to $20.19....................... 2,583,003 * $7.97 781,434 $3.94
=========== ===========
- ------------
* All options, with an exercise price between $.20 to $5.20, are exercisable
while the employee remains an employee at the Company and cease to be
exercisable three months after termination of employment.
If the fair value based method of accounting under SFAS 123 had been
applied, the Company's net income available for common shareholders and earnings
per common share would have been reduced to the pro forma amounts indicated
below (assuming that the fair value of options granted during the year are
amortized over the vesting period):
YEAR ENDED DECEMBER 31,
-------------------------------
1998 1997 1996
--------- --------- ---------
Net income available for common
shareholders
As reported..................... $ 22,470 $ 16,769 $ 11,604
Pro forma....................... 21,419 15,962 11,382
Basic earnings per common share......
As reported..................... $ 0.97 $ 0.77 $ 0.62
Pro forma....................... 0.92 0.73 0.61
Diluted earnings per common share
As reported..................... $ 0.93 $ 0.72 $ 0.57
Pro forma....................... 0.89 0.69 0.56
The effects of applying SFAS 123 in the above pro forma disclosure are not
indicative of future amounts. The Company anticipates making awards in the
future under its stock-based compensation plans.
F-17
SOUTHWEST BANCORPORATION OF TEXAS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
BENEFIT PLAN
The Company has adopted a contributory profit sharing plan pursuant to
Internal Revenue Code Section 401(k) covering substantially all employees (the
"401-K Plan"). Each year the Company determines, at its discretion, the amount
of matching contributions. The Company presently matches 50% of the employee
contributions not to exceed 3% of the employee's annual compensation. Total plan
expense charged to the Company's operations for the years ended December 31,
1998, 1997 and 1996 was $972, $385 and $336, respectively.
The 401-K Plan allows for the Company to contribute up to 500,000 shares of
common stock of the Company (valued at the approximate fair market value on the
date of contribution) instead of cash. A total of 0, 5,040, and 34,870 shares at
prices ranging from $0, $7.00, and $4.60 to $5.10 were issued to the 401-K Plan
during the years ended December 31, 1998, 1997 and 1996, respectively.
10. PREFERRED STOCK:
The Bank authorized 1,500,000 shares of Series 1 Adjustable Rate First
Preferred Stock, $5 par value, ("Bank Preferred Stock") in October 1995 and
issued 750,000 shares in November 1995. The Bank Preferred Stock holders have no
voting rights except in certain circumstances. Each share of preferred stock is
entitled to a liquidation preference of $10.
Dividends on the Bank Preferred Stock are noncumulative. The Bank is
prohibited from paying any cash dividends on the common stock unless all
dividends on the Bank Preferred Stock have been paid in full for all completed
quarterly periods. Bank Preferred Stock dividends are payable quarterly in
arrears and are calculated on the $10 subscription price at a rate of 1% above
the United States Treasury bill rate.
The Bank Preferred Stock may be redeemed at the option of the Bank at the
redemption price if a change of control occurs prior to December 31, 1997. In
January 1997, upon written approval of the holders of the Bank Preferred Stock,
the Bank redeemed all of the outstanding shares for $7,500.
11. EARNINGS PER COMMON SHARE:
Earnings per common share is computed as follows:
YEAR ENDED DECEMBER 31,
-------------------------------
1998 1997 1996
--------- --------- ---------
Net income available for common
shareholders....................... $ 22,470 $ 16,769 $ 11,604
========= ========= =========
Divided by weighted average common
shares and common share
equivalents:
Weighted average common
shares........................ 23,111 21,918 18,790
Weighted average common share
equivalents................... 1,119 1,324 1,603
--------- --------- ---------
Total weighted average common shares
and common share equivalents....... 24,230 23,242 20,393
========= ========= =========
Basic earnings per common share...... $ 0.97 $ 0.77 $ 0.62
========= ========= =========
Diluted earnings per common share.... $ 0.93 $ 0.72 $ 0.57
========= ========= =========
F-18
SOUTHWEST BANCORPORATION OF TEXAS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
12. COMMITMENTS AND CONTINGENCIES:
LITIGATION
The Company is involved in various litigation that arise in the normal
course of business. In the opinion of management of the Company, after
consultation with its legal counsel, such litigation will not have a material
adverse effect on the Company's consolidated financial position, results of
operations or cash flows.
LEASES
At December 31, 1998, the Company has certain noncancelable operating
leases which cover the Company's premises with approximate future minimum annual
rental payments as follows:
1999................................. $ 2,771
2000................................. 3,150
2001................................. 2,938
2002................................. 2,802
2003................................. 2,604
Thereafter........................... 7,575
---------
$ 21,840
=========
Rent expense was $2,287, $1,840 and $1,145 for the years ended December 31,
1998, 1997 and 1996, respectively.
13. REGULATORY CAPITAL COMPLIANCE:
The Company and the Bank are subject to regulatory risk-based capital
requirements that assign risk factors to all assets, including off-balance sheet
items such as loan commitments and standby letters of credit. Failure to meet
minimum capital requirements can initiate certain mandatory, and possibly
additional discretionary, actions by regulators that, if undertaken, could have
a direct material effect on the Company's consolidated financial statements.
Capital is separated into two categories, Tier 1 and Tier 2, which combine for
total capital. At December 31, 1998, the Company's and Bank's Tier 1 capital
consists of their respective shareholders' equity and Tier 2 consists of the
allowance for loans losses subject to certain limitations. The guidelines
require total capital of 8% of risk-weighted assets.
In conjunction with risk-based capital guidelines, the regulators have
issued capital leverage guidelines. The leverage ratio consists of Tier 1
capital as a percent of average assets. The minimum leverage ratio for all banks
is 3%, with a higher minimum ratio dependent upon the condition of the
individual bank. The 3% minimum was established to make certain that all banks
have a minimum capital level to support their assets, regardless of risk
profile.
F-19
SOUTHWEST BANCORPORATION OF TEXAS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
As of December 31, 1998, the most recent notification from the regulators
categorized the Bank as "adequately capitalized" under the regulatory
framework for prompt corrective action. There are no conditions or events since
that notification that management believes have changed the category.
The following table compares the Company's and the Bank's leverage and
risk-weighted capital ratios as of December 31, 1998 and 1997 to the minimum
regulatory standards:
TO BE WELL
CAPITALIZED UNDER
FOR CAPITAL PROMPT CORRECTIVE
ACTUAL ADEQUACY PURPOSES ACTION PROVISIONS
--------------------- ------------------ ---------------------
AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO
---------- --------- ---------- ----- ---------- ---------
As of December 31, 1998
Total Capital (to Risk
Weighted Assets):
The Company..................... $ 151,642 9.13% $ 132,852 8.00 % $ 166,065 10.00%
The Bank ....................... 146,915 8.86% 132,625 8.00 % 165,781 10.00%
Tier I Capital (to Risk
Weighted Assets):
The Company..................... 138,361 8.33% 66,426 4.00 % 132,852 8.00%
The Bank ....................... 133,634 8.06% 66,312 4.00 % 132,625 8.00%
Tier I Capital
(to Average Assets):
The Company..................... 138,361 6.74% 61,544 3.00 % 102,573 5.00%
The Bank ....................... 133,634 6.52% 61,450 3.00 % 102,416 5.00%
As of December 31, 1997
Total Capital (to Risk
Weighted Assets):
The Company..................... 121,761 10.32% 94,405 8.00 % 118,006 10.00%
The Bank ....................... 119,151 10.10% 94,401 8.00 % 118,002 10.00%
Tier I Capital (to Risk
Weighted Assets:
The Company..................... 111,426 9.44% 47,203 4.00 % 94,405 8.00%
The Bank ....................... 108,817 9.22% 47,201 4.00 % 94,401 8.00%
Tier I Capital
(to Average Assets):
The Company..................... 111,426 6.70% 49,873 3.00 % 83,121 5.00%
The Bank ....................... 108,816 6.54% 49,888 3.00 % 83,147 5.00%
The Company and the Bank are also subject to certain restrictions on the
amount of dividends that they may declare without prior regulatory approval.
14. FINANCIAL INSTRUMENTS WITH OFF-BALANCE SHEET RISK AND CONCENTRATIONS OF
CREDIT RISK:
The Company is party to financial instruments with off-balance sheet risk
in the normal course of business in order to meet the financing needs of its
customers. These financial instruments, which are for purposes other than
trading, include loan commitments and letters of credit that involve, to varying
degrees, elements of credit risk in excess of the amounts recognized in the
financial statements.
The Company's exposure to credit loss in the event of nonperformance by the
other party to the loan commitments and letters of credit is limited to the
contractual amount of those instruments. The Company uses the same credit
policies in evaluating loan commitments and letters of credit as it does for
on-balance sheet instruments.
F-20
SOUTHWEST BANCORPORATION OF TEXAS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The approximate amounts of financial instruments with off-balance sheet
risk are as follows:
DECEMBER 31, DECEMBER 31,
1998 1997
CONTRACT CONTRACT
AMOUNT AMOUNT
------------ ------------
Financial instruments whereby whole
contract amounts represent credit
risk:
Loan commitments including
unfunded lines of credit...... $698,000 $543,000
Standby letters of credit....... 63,000 35,000
Commercial letters of credit.... 5,000 1,000
------------ ------------
$766,000 $579,000
============ ============
Loan commitments 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 loan commitments and letters of credit may expire without
being drawn upon, the total commitment amount does not necessarily represent
future cash requirements. Standby letters of credit are conditional commitments
by the Company to guarantee the performance of a customer to a third party.
The Company evaluates each customer's credit worthiness on a case-by-case
basis. The amount of collateral obtained, if deemed necessary by the Company
upon extension of credit, is based on management's credit evaluation of the
counterparty. Collateral held varies but may include certificates of deposit,
accounts receivable, inventory, property, plant and equipment, and real
property.
The Company originates real estate, commercial and consumer loans primarily
to customers in the greater Houston, Texas area. Although the Company has a
diversified loan portfolio, a substantial portion of its customers' ability to
honor their contracts is dependent upon the local Houston economy and the real
estate market.
The Company maintains funds on deposit at correspondent banks which at
times exceed the federally insured limits. Management of the Company monitors
the balance in these accounts and periodically assesses the financial condition
of correspondent banks.
15. FAIR VALUES OF FINANCIAL INSTRUMENTS:
The fair value of financial instruments provided below represent estimates
of fair values at a point in time. Significant estimates regarding economic
conditions, loss experience, risk characteristics associated with particular
financial instruments and other factors were used for the purposes of this
disclosure. These estimates are subjective in nature and involve matters of
judgment. Therefore, they cannot be determined with precision. Changes in the
assumptions could have a material impact on the amounts estimated.
While the estimated fair value amounts are designed to represent estimates
of the amounts at which these instruments could be exchanged in a current
transaction between willing parties, many of the Company's financial instruments
lack an available trading market as characterized by willing parties engaging in
an exchange transaction. In addition, it is the Company's intent to hold most of
its financial instruments to maturity and, therefore, it is not probable that
the fair values shown will be realized in a current transaction.
The estimated fair values disclosed do not reflect the value of assets and
liabilities that are not considered financial instruments. In addition, the
value of long-term relationships with depositors (core deposit intangibles) and
other customers is not reflected. The value of these items is significant.
F-21
SOUTHWEST BANCORPORATION OF TEXAS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Because of the wide range of valuation techniques and the numerous
estimates which must be made, it may be difficult to make reasonable comparisons
of the Company's fair value information to that of other financial institutions.
It is important that the many uncertainties discussed above be considered when
using the estimated fair value disclosures and to realize that because of these
uncertainties, the aggregate fair value amount should in no way be construed as
representative of the underlying value of the Company.
The following methods and assumptions were used by the Company in
estimating its fair value disclosures for financial instruments:
CASH AND CASH EQUIVALENTS: The carrying amounts for cash and cash
equivalents approximate their fair values.
SECURITIES: Fair values for investment securities are based on quoted
market prices.
FEDERAL HOME LOAN BANK STOCK: The fair value of stock in the Federal Home
Loan Bank of Dallas is estimated to be equal to its carrying amount given it is
not a publicly traded equity security, it has an adjustable dividend rate, and
transactions in the stock are executed at the stated par value.
LOAN RECEIVABLES AND ACCRUED INTEREST RECEIVABLE: For variable-rate loans
that reprice frequently and with no significant change in credit risk, fair
values are based on carrying values. The fair value of all other loans are
estimated using discounted cash flow analyses, using interest rates currently
being offered for loans with similar terms to borrowers of similar credit
quality. Fair values for impaired loans are estimated using discounted cash flow
analyses or underlying collateral values, where applicable. The carrying amount
of accrued interest approximates its fair value.
OFF-BALANCE-SHEET INSTRUMENTS: The fair values of the Company's
off-balance-sheet instruments (lending commitments and letters of credit) are
based on fees currently charged to enter into similar agreements, taking into
account the remaining terms of the agreements and the counterparties' credit
standing.
DEPOSIT LIABILITIES AND ACCRUED INTEREST PAYABLE: The fair values
disclosed for demand deposits (e.g., interest and noninterest checking and money
market accounts) are, by definition, equal to the amount payable on demand at
the reporting date. Fair values for fixed-rate time deposits are estimated using
a discounted cash flow analysis, using interest rates currently being offered on
certificates to a schedule of aggregated expected monthly maturities on time
deposits. The carrying amount of accrued interest approximates its fair value.
SHORT-TERM BORROWINGS: The carrying amounts of federal funds purchased,
securities sold under repurchase agreements, and other short-term borrowings
approximate their fair values.
F-22
SOUTHWEST BANCORPORATION OF TEXAS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The following table summarizes the carrying values and estimated fair
values of financial instruments (all of which are held for purposes other than
trading):
DECEMBER 31, 1998 DECEMBER 31, 1997
------------------------ ------------------------
CARRYING ESTIMATED CARRYING ESTIMATED
AMOUNT FAIR VALUE AMOUNT FAIR VALUE
---------- ---------- ---------- ----------
Assets
Cash and due from banks......... $ 119,916 $ 119,916 $ 104,363 $ 104,363
Fed funds sold.................. 27,535 27,535 132,616 132,616
Securities available for sale... 647,462 647,462 555,398 555,398
Loans, net of allowance......... 1,325,877 1,333,670 975,815 988,217
Accrued interest receivable..... 13,558 13,558 11,159 11,159
Liabilities
Deposits........................ 1,729,386 1,735,265 1,512,341 1,512,385
Securities sold under repurchase
agreements.................... 181,696 181,696 155,832 155,832
Other short-term borrowings..... 138,388 138,388 17,243 17,243
Accrued interest payable........ 1,292 1,292 1,259 1,259
The total fair value of the Company's loan commitments and letters of
credit was immaterial at December 31, 1998 and 1997.
16. SUPPLEMENTAL CASH FLOW INFORMATION:
The supplemental cash flow information for the years ended December 31,
1998, 1997, and 1996 is as follows:
DECEMBER 31,
-------------------------------
1998 1997 1996
--------- --------- ---------
Cash paid for interest............... $ 58,817 $ 45,593 $ 32,168
Cash paid for income taxes........... 11,350 7,875 6,037
Noncash financing activities during 1998 and 1997 included an increase in
additional paid-in capital and a corresponding decrease in income taxes payable
totaling approximately $1,800 and $1,400, respectively, related to the exercise
of stock options.
17. MERGER-RELATED ACTIVITY:
On October 20, 1998, the Company and the Bank entered into an Agreement and
Plan of Merger (the "Merger Agreement") with Fort Bend Holding Corp. ("Fort
Bend"), whereby Fort Bend will merge into the Company. Fort Bend is the parent
company of Fort Bend Federal Savings and Loan Association of Rosenberg and the
majority owner of Mitchell Mortgage Co., L.L.C. of The Woodlands, Texas. The
Merger Agreement, which is subject to approval of the shareholders of Fort Bend
and various regulatory authorities, provides for the exchange of 1.45 shares of
the Company's common shares for each share of Fort Bend common stock, or
approximately 4,300,000 shares. At December 31, 1998, Fort Bend had total assets
of approximately $317,000 and total deposits of $270,000. The transaction is
expected to be accounted for as a pooling of interests.
F-23
REPORT OF INDEPENDENT ACCOUNTANTS ON FINANCIAL STATEMENT SCHEDULE
To the Board of Directors and Shareholders
Southwest Bancorporation of Texas, Inc.:
Our audits of the consolidated financial statements referred to in our
report dated February 12, 1999 of Southwest Bancorporation of Texas, Inc. and
Subsidiary included on page F-2 of this Form 10-K also included an audit of the
financial statement schedule listed in the index on page F-1 of this Form 10-K.
In our opinion, this financial statement schedule presents fairly, in all
material respects, the information set forth therein when read in conjunction
with the related consolidated financial statements.
PricewaterhouseCoopers LLP
Houston, Texas
February 12, 1999
F-24
SOUTHWEST BANCORPORATION OF TEXAS, INC. AND SUBSIDIARY
SCHEDULE I -- PARENT COMPANY CONDENSED FINANCIAL STATEMENTS
CONDENSED BALANCE SHEET
(IN THOUSANDS)
DECEMBER 31,
----------------------
1998 1997
---------- ----------
ASSETS
Cash and cash equivalents............ $ 4,722 $ 2,541
Investment in subsidiary............. 138,892 112,223
Other assets......................... 120 71
---------- ----------
Total assets............... $ 143,734 $ 114,835
========== ==========
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities:
Total liabilities.......... $ -- $ --
---------- ----------
Shareholders' equity:
Common stock.................... 23,353 22,370
Additional paid-in capital...... 41,830 38,364
Retained earnings............... 74,803 52,333
Accumulated other comprehensive
income......................... 3,748 1,768
---------- ----------
Total shareholders'
equity....................... 143,734 114,835
---------- ----------
Total liabilities and
shareholders' equity......... $ 143,734 $ 114,835
========== ==========
These condensed financial statements should be read in conjunction with the
Consolidated Financial Statements and Notes thereto of
Southwest Bancorporation of Texas, Inc. and Subsidiary included herein.
F-25
SOUTHWEST BANCORPORATION OF TEXAS, INC. AND SUBSIDIARY
SCHEDULE I -- PARENT COMPANY CONDENSED FINANCIAL STATEMENTS (CONTINUED)
CONDENSED STATEMENT OF INCOME AND COMPREHENSIVE INCOME
(IN THOUSANDS)
YEAR ENDED DECEMBER
31,
--------------------
1998 1997
--------- ---------
Equity in undistributed income of
subsidiary......................... $ 22,556 $ 14,907
Dividends received from subsidiary... -- 2,000
Operating expenses................... 135 209
--------- ---------
Income before income taxes...... 22,421 16,698
Income tax benefit.............. (49) (71)
--------- ---------
Net income........................... 22,470 16,769
Other comprehensive income, net of
tax:
Net unrealized appreciation on
securities available for
sale........................... 3,748 1,768
--------- ---------
Comprehensive income............ $ 26,218 $ 18,537
========= =========
These condensed financial statements should be read in conjunction with the
Consolidated Financial Statements and Notes thereto of
Southwest Bancorporation of Texas, Inc. and Subsidiary included herein.
F-26
SOUTHWEST BANCORPORATION OF TEXAS, INC. AND SUBSIDIARY
SCHEDULE I -- PARENT COMPANY CONDENSED FINANCIAL STATEMENTS (CONTINUED)
CONDENSED STATEMENT OF CASH FLOWS
(IN THOUSANDS)
YEAR ENDED
DECEMBER 31,
----------------------
1998 1997
---------- ----------
Cash flows from operating activities:
Net income...................... $ 22,470 $ 16,769
Adjustments to reconcile net
income to net cash provided by
(used in) operating activities:
Equity in undistributed income
of subsidiary.................. (22,557) (14,907)
(Increase) decrease in other
assets......................... (49) 55
Decrease in other liabilities... -- (72)
---------- ----------
Net cash provided by (used
in) operating activities..... (136) 1,845
---------- ----------
Cash flows from investing activities:
Investment in subsidiary........ -- (20,000)
---------- ----------
Net cash used in investing
activities................... -- (20,000)
---------- ----------
Cash flows from financing activities:
Net proceeds from issuance of
common stock................... 2,317 20,641
---------- ----------
Net cash provided by
financing activities.... 2,317 20,641
---------- ----------
Net increase in cash and cash
equivalents.......................... 2,181 2,486
Cash and cash equivalents at
beginning of year.................. 2,541 55
---------- ----------
Cash and cash equivalents at end of
year............................... $ 4,722 $ 2,541
========== ==========
Supplemental noncash financing and
investing activities:
Increase in investment in
subsidiary related to stock
options exercised.............. $ 2,702 $ 2,154
========== ==========
These condensed financial statements should be read in conjunction with the
Consolidated Financial Statements and Notes thereto of
Southwest Bancorporation of Texas, Inc. and Subsidiary included herein.
F-27