SOUTHWEST BANCORP OF TEXAS INC - 10-K Annual Report

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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, 2002
[ ] 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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Indicate by check mark whether the Registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act.) Yes [X] No [ ]

The aggregate market value of the Registrant's Common Stock held by
non-affiliates was approximately $1.02 billion (based upon the closing price of
$36.22 on June 30, 2002, as reported on the NASDAQ National Market System).

There were 33,882,725 shares of the Registrant's Common Stock outstanding
as of the close of business on February 24, 2003.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the Registrant's Proxy Statement relating to the 2003 Annual
Meeting of Shareholders, which will be filed within 120 days after December 31,
2002, are incorporated by reference into Part III of this Report.
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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. All written
or oral forward-looking statements attributable to the Company are expressly
qualified in their entirety by these cautionary statements.

THE COMPANY

General. 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, 2002, the
Company ranks as the largest independent bank holding company headquartered in
the Houston metropolitan 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's internet address is www.swbanktx.com. The Company makes
available through its website, free of charge, its annual report on Form 10-K,
quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to
those reports as soon as reasonably practicable after filing with the Securities
and Exchange Commission.

Mergers and Acquisitions. On August 1, 1997, Pinemont Bank was merged with
and into the Bank in exchange for approximately 3.3 million shares of Company
Common Stock in a transaction accounted for as a pooling-of-interests. The
acquisition of Pinemont Bank added $235 million in total assets and $219 million
in total deposits to the Company's balance sheet and nine banking locations to
the Company's operations.

On April 1, 1999, Fort Bend Holding Corp. was merged with and into the
Company and Fort Bend's subsidiary savings and loan association was merged with
and into the Bank in exchange for approximately 4.1 million shares of Company
Common Stock in a transaction accounted for as a pooling-of-interests. The
acquisition of Fort Bend Holding Corp. added $316 million in total assets and
$269 million in total deposits to the Company's balance sheet and seven banking
locations to the Company's operations.

Through the merger with Fort Bend, the Company acquired Fort Bend's 51%
ownership interest in Mitchell Mortgage Company L.L.C. ("Mitchell"), a full
service mortgage banking affiliate of The Woodlands Operating Company L.P.
("Woodlands"). On June 17, 1999, the Company issued 307,323 shares of

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Company Common Stock to Woodlands in exchange for Woodlands' 49% ownership
interest in Mitchell and Mitchell became a wholly-owned subsidiary of the Bank
effective as of June 30, 1999. As a result, 100% of the accounts and operations
of Mitchell after that date are included in the financial statements of the
Company.

On December 29, 2000, Citizens Bankers, Inc. ("Citizens") was merged with
and into the Company and the three wholly-owned subsidiary banks of Citizens
were merged with and into the Bank (and the assets and liabilities of a related
partnership were acquired by the Bank) in exchange for approximately 4.0 million
shares of Company Common Stock in a transaction accounted for as a
pooling-of-interests. The acquisition of Citizens added $436 million in total
assets and $381 million in total deposits to the Company's balance sheet and six
banking locations to the Company's operations.

Business Strategy. The Company provides an array of sophisticated products
typically found only in major regional banks. These services are provided to
middle market businesses, private banking, and retail consumers in the Houston
metropolitan area through 33 full service banking facilities. Several banking
offices have seasoned management with significant lending experience who are
responsible for 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 opportunities of good quality within its target
market that exhibit positive 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 appropriate approvals for credit
extensions in excess of conservatively assigned individual 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 four-part strategy for growth. First, the Company will
continue to actively target the "middle market," private banking, and retail
customers in Houston for loan and deposit opportunities as it has successfully
done for the past thirteen years. The "middle market" is generally characterized
by companies having annual revenues ranging from $1 million to $500 million and
borrowings ranging from $50,000 to $15 million. 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, executive, and
retail markets to meet the demands of those sectors.

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 conducts 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.

Fourth, the Company is currently embarking upon a strategy of geographic
diversification into other parts of Texas, including the Dallas/Fort Worth
Metroplex, and contiguous states.

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The Company has two operating segments: the Bank and the mortgage company.
Each segment is managed separately because each business requires different
marketing strategies and each offers different products and services.

THE BANK

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 customized cash
management services, brokerage and mutual funds, trust and private banking
services, accounts receivable financing, letters of credit, and merchant card
services.

The Bank maintains a staff of professional treasury management marketing
officers who consult with middle market and large corporate companies to design
custom cost-effective cash management solutions. The Bank offers a full product
line of cash concentration, disbursement, and information reporting services and
a full suite of Internet products superior to those offered by most regional
banks. Through the Bank's continued investment in new technology and people, the
Bank has attracted some of Houston's largest middle market companies to utilize
the Bank's treasury management products. The Bank has also attracted new loan
customers through use of the Bank's treasury management services as a lead-in
with products such as an image-based lockbox service and controlled disbursement
and sweep products, which allow borrowers to minimize interest expense and earn
interest income on excess operating funds. Through the use of an interactive
terminal or personal computer, the Bank's NetStar 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 information 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 in the prevention of check fraud. The Bank's average
commercial customer uses six 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 has a retail presence in 33 locations throughout the Houston
metropolitan area. Such locations are emerging as an important source of bank
funding and fee income. Retail products consist of both traditional deposit
accounts such as checking, savings, money market and certificates of deposit,
and a wide array of consumer loan and electronic banking alternatives. The Bank
continues to emphasize the cultivation of retail market opportunities and
investment in retail staff to help expand and deepen customer 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. Several banking offices also appoint 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.

THE MORTGAGE COMPANY

The Company originates and purchases residential and commercial mortgage
loans both for its own portfolio and to sell to investors with servicing rights
retained through its ownership of Mitchell. Mitchell also promotes residential
and commercial construction financing to builders and developers and acts as a
broker in the origination of multi-family and commercial real estate loans.
Mitchell has production offices in Fort Bend and Montgomery Counties, Texas,
with corporate offices in The Woodlands, Texas. Mitchell is an approved
seller/servicer for Federal National Mortgage Association ("FNMA") and Federal
Home Loan Mortgage Corporation ("FHLMC") and an approved issuer of Government
National Mortgage Association ("GNMA") mortgage-backed securities. Mitchell is
also a HUD-Approved Title II nonsupervised mortga-

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gee. During 2002, Mitchell funded approximately $210 million in residential
mortgage loans, $136 million in commercial real estate loans and $177 million in
residential and commercial construction loans.

COMPETITION

The banking business is highly competitive, and the profitability of the
Company depends 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 providing products and services
designed to address the specific needs of its customers. Deposits in the Houston
area total approximately $68 billion.

The enactment of the Gramm-Leach-Bliley Act (see discussion below), which
breaks down many barriers between the banking, securities and insurance
industries, may significantly affect the competitive environment in which the
Company operates.

EMPLOYEES

As of December 31, 2002, the Company had 1,481 full-time equivalent
employees, 610 of whom were officers. Employees of the Company enjoy a variety
of employee benefit programs, including a stock option plan, a restricted stock
plan, a 401(k) stock purchase plan, various comprehensive medical, accident and
group life insurance plans, and paid vacations. The Company considers its
relations with its employees to be excellent.

ECONOMIC CONDITIONS

The Company's success is dependent to a significant degree on economic
conditions in the eight county region comprising the Houston metropolitan area
which the Company defines as its primary market. The banking industry in Texas
and in Houston is affected by general economic conditions including the effects
of inflation, recession, unemployment, real estate values, energy prices, trends
in the national and global economies, and other factors beyond the Company's
control. During the mid-1980's, severely depressed oil and gas prices and levels
of activity in the energy industries materially and adversely affected the Texas
and Houston economies, causing recession and unemployment in the region and
resulting in excess vacancies in the Houston real estate market and elsewhere in
the State. Since 1987, however, the Houston metropolitan economy has gained
nearly 790,000 jobs, averaging an annual growth rate of 3.2%. The population of
the eight county region has grown to approximately 4.7 million with a job count
of 2.1 million estimated at year-end 2002. This level of employment is greater
than the states of Alabama, Louisiana, South Carolina, Kentucky, and 25 other
states. The Texas Workforce Commission estimates that job growth for 2002 was a
positive 4,500 jobs, placing the Houston region as one of the best performing
large metropolitan areas in the United States. The Federal Reserve Branch in
Houston is forecasting new job growth for 2003 at 40,000. Since 1987, the
Houston area economy has diversified from being primarily energy dependent to
one that is now influenced by national and global economic trends as well as
activity in the energy industries. The energy independent sectors of the Houston
area economy have grown at an annual compounded rate of 7.4% since 1982. As a
result, it is estimated that the upstream sector of the energy industry now
accounts for approximately 32% of economic activity, down from 69% in 1981.
Nonetheless, an economic recession over a prolonged period of time in the
Houston area could cause an increase in the level of the Company's
non-performing assets and loan losses, thereby causing operating losses,
impairing liquidity and eroding capital. There can be no assurance that future
adverse changes in the local economy would not have a material adverse effect on
the Company's consolidated financial condition, results of operations, and cash
flows.

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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 descriptions of and 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 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
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, and because the Bank is a member
of the Federal Reserve System, the Federal Reserve Board also has supervisory
authority which affects the Bank.

Restrictions on Transactions with Affiliates and Insiders. The Bank is
subject to certain federal statutes limiting transactions between the Company
and its nonbanking affiliates. Section 23A of the Federal Reserve Act affects
loans or other credit extensions to, asset purchases from and investments in
affiliates of the Bank. Such transactions between 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 collateralized 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.

In May 2001, the Federal Reserve Board adopted an interim rule addressing
the applications of Section 23A and Section 23B of the Federal Reserve Act to
credit exposure arising out of derivative transactions between an insured
institution and its affiliates and intra-day extensions of credit by an insured
depository institution to its affiliates. The rule requires institutions to
adopt policies and procedures reasonably designed to monitor, manage, and
control credit exposures arising out of transactions and to clarify that the
transactions are subject to Section 23B of the Federal Reserve Act. In May 2001,
the Federal Reserve Board also proposed a new rule to implement comprehensively
Section 23A and 23B of the Federal Reserve Act. On October 31, 2002 the Federal
Reserve Board approved the final rule on Regulation W which becomes effective
April 1, 2003 and supersedes and unifies the Federal Reserve Board's
interpretation of Sections 23A and 23B. The Bank believes that Regulation W as
adopted will have no material impact on the operation of the Bank.

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 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

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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 26 week
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 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 have been preempted by federal law for loans collateralized 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 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 institution'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.

6

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, 2002, the Bank met the capital requirements of a "well
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 an unsafe or unsound practice. Under FDICIA, the
Bank cannot pay a dividend if it will cause the Bank to be undercapitalized.

FDIC INSURANCE ASSESSMENTS

Pursuant to FDICIA, the FDIC adopted a risk-based assessment system for
insured depository institutions that takes into account the risks attributable
to different categories and concentrations of assets and liabilities. The
risk-based system assigns an institution to one of three capital categories: (i)
well-capitalized, (ii) adequately capitalized, or (iii) undercapitalized. These
three categories are substantially similar to the prompt corrective action
categories, with the "undercapitalized" category including institutions that are
undercapitalized, significantly undercapitalized, and critically
undercapitalized for prompt corrective action purposes. An institution is also
assigned by the FDIC to one of three supervisory subgroups within each capital
group. The supervisory subgroup to which an institution is assigned is based on
an evaluation provided to the FDIC by the institution's primary federal
regulator and information which the FDIC determines to be relevant to the
institution's financial condition and the risk posed to the deposit insurance
funds (which may include, if applicable, information provided by the
institution's state supervisor). An institution's insurance assessment rate is
then determined based on the capital category and supervisory category to which
it is assigned.

Under the final risk-based assessment system there are nine assessment risk
classifications (i.e., combinations of capital groups and supervisory subgroups)
to which different assessment rates are applied. Assessment rates for deposit
insurance currently range from zero basis points to 27 basis points. The
supervisory subgroup to which an institution is assigned by the FDIC is
confidential and may not be disclosed. A bank's rate of deposit insurance
assessments will depend on the category and subcategory to which the bank is
assigned by the FDIC. Any increase in insurance assessments could have an
adverse effect on the earnings of insured institutions, including the Bank.

Under FDICIA, insurance of deposits may be terminated by the FDIC upon a
finding that the institution has engaged in unsafe and unsound practices, is in
an unsafe or unsound condition to continue operations, or has violated any
applicable law, regulation, rule, order, or condition imposed by the FDIC.
Management does not know of any practice, condition or violation that might lead
to termination of deposit insurance.

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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 following list 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 its ongoing customer relations.

Under Section 501 of the Gramm-Leach-Bliley Act (see discussion below), the
federal banking agencies are required to establish appropriate standards for
financial institutions regarding the implementation of safeguards to ensure the
security and confidentiality of customer records and information, protection
against any anticipated threats or hazards to the security or integrity of such
records and protection against unauthorized access to or use of such records or
information in a way that could result in substantial harm or inconvenience to a
customer. The agencies published a joint final rule, which was effective July 1,
2001. Among other matters, the rule requires each bank to implement a
comprehensive written information security program that includes administrative,
technical and physical safeguards relating to customer information.

Under the Gramm-Leach-Bliley Act, a financial institution must provide its
customers with a notice of privacy policies and practices. Section 502 prohibits
a financial institution from disclosing nonpublic personal information about a
consumer to nonaffiliated third parties unless the institution satisfies various
notice and opt-out requirements and the customer has not elected to opt out of
the disclosure. Under Section 504, the agencies are authorized to issue
regulations as necessary to implement notice requirements and restrictions on a
financial institution's ability to disclose nonpublic personal information about
consumers to nonaffiliated third parties. In June 2000, the federal banking
agencies issued a final rule, effective November 13, 2000, but compliance with
which was optional until July 1, 2001. Under the rule, all banks must develop
initial and annual privacy notices which describe in general terms the bank's
information sharing practices. Banks that share nonpublic personal information
about customers with nonaffiliated third parties must also provide customers
with an opt-out notice and a reasonable period of time for the customer to opt
out of any such disclosure (with certain exceptions). Limitations are placed on
the extent to which a bank can disclose an account number or access code for
credit card, deposit, or transaction accounts to any nonaffiliated third party
for use in marketing.

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

8

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 have in the past been limited to the business of banking
and activities closely related or incidental to banking. Under new banking
legislation (see discussion of Gramm-Leach-Bliley Act below), however, national
banks have broadened authority, subject to limitations on investment, to engage
in activities that are financial in nature (other than insurance underwriting,
merchant or insurance portfolio investment, real estate development and real
estate investment) through subsidiaries, if the bank is well capitalized and
well managed and has at least a satisfactory rating under the Community
Reinvestment Act.

Because the Company is a legal entity separate and distinct from its
subsidiaries, 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,
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.

9

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.

The Federal Reserve Board 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.

GRAMM-LEACH-BLILEY ACT

Traditionally, the activities of bank holding companies have been limited
to the business of banking and activities closely related or incidental to
banking. On November 12, 1999, however, the Gramm-Leach-Bliley Act was signed
into a statute that permits bank holding companies to engage in a broader range
of financial activities. Specifically, bank holding companies may elect to
become "financial holding companies," which may affiliate with securities firms
and insurance companies and engage in other activities that are financial in
nature or incidental to a financial activity. A bank holding company may become
a financial holding company under the new statute only if each of its subsidiary
banks is well capitalized, is well managed and has at least a satisfactory
rating under the Community Reinvestment Act. A bank holding company that falls
out of compliance with such requirement may be required to cease engaging in
certain activities. Any bank holding company that does not elect to become a
financial holding company remains subject to the current restrictions of the
Bank Holding Company Act.

Under the statute, the Federal Reserve Board serves as the primary
"umbrella" regulator of financial holding companies with supervisory authority
over each parent company and limited authority over its subsidiaries. The
primary regulator of each subsidiary of a financial holding company will depend
on the type of activity conducted by the subsidiary. For example, broker-dealer
subsidiaries will be regulated largely by securities regulators and insurance
subsidiaries will be regulated largely by insurance authorities.

Under the Gramm-Leach-Bliley Act, among the activities that will be deemed
"financial in nature" for "financial holding companies" are, in addition to
traditional lending activities, securities underwriting, dealing in or making a
market in securities, sponsoring mutual funds and investment companies,
insurance underwriting and agency activities, activities which the Federal
Reserve Board determines to be closely related to banking, and certain merchant
banking activities.

In January 2001, the Federal Reserve Board and the Secretary of the
Treasury promulgated final regulations governing the scope of permissible
merchant banking investments, which are those made under Section 4(k)(4)(H) of
the Bank Holding Company Act, as amended by the Gramm-Leach-Bliley Act, which
authorizes a financial holding company, directly or indirectly as principal or
on behalf of one or more persons, to acquire or control any amount of shares,
assets or ownership interests of a company or other entity that is engaged in
any activity not otherwise authorized for the financial holding company under
Section 4 of the Bank Holding Company Act. Under the regulations, the types of
ownership that may be acquired include shares, assets or ownership interests of
a company or other entity including debt or equity securities, warrants,
options, partnership interests, trust certificates or other instruments
representing an ownership interest in a company or entity, whether voting or
nonvoting. The merchant banking investments may be made by the financial holding
company or any of its subsidiaries, other than a depository institution or
subsidiary of a depository institution. Before acquiring or controlling a
merchant banking investment, a financial holding company must either be or have
a securities affiliate registered under the Securities Exchange Act of 1934 or a
qualified insurance affiliate. The regulation places restrictions on the ability
of a financial holding company to

10

become involved in the routine management or operation of any of its portfolio
companies. The regulation also provides that a financial holding company may own
or control shares, assets and ownership interests pursuant to the merchant
banking provisions only for such period of time as to enable the sale or
disposition on a reasonable basis consistent with the financial viability of the
financial holding company's merchant banking investment activities. Generally,
the ownership period is limited to ten years. Special provisions are included in
the regulation governing the investment by a financial holding company in
private equity funds. Under the merchant banking regulation, a financial holding
company may not, without Federal Reserve Board approval, have aggregate merchant
banking investments exceeding 30 percent of the Tier 1 capital of the financial
holding company; or after excluding interests in private equity funds, 20
percent of the Tier 1 capital of the financial holding company.

The Federal Reserve Board and Secretary of Treasury have also requested
public comment on the issue of whether to add the activities of real estate
brokerage and real estate management to the list of permissible activities for
financial holding companies and financial subsidiaries of national banks. The
Company cannot predict whether the proposal will be adopted or the form any
final rule might take.

The Federal Reserve Board, the OCC, and the FDIC adopted a rule, effective
April 1, 2002, which establishes special minimum regulatory capital requirements
for equity investments in non-financial companies. The capital requirements
apply symmetrically to equity investments of banks and bank holding companies
and impose a series of marginal capital charges on covered equity investments
that increase with the level of a banking organization's overall exposure to
equity investments relative to the organization's Tier 1 capital.

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, 2002, the Bank met the requirements of a "well capitalized"
institution and, therefore, these requirements presently do not apply to the
Company.

11

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.

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.

USA PATRIOT ACT OF 2001

On October 6, 2001, the "Uniting and Strengthening America by Providing
Appropriate Tools Required to Intercept and Obstruct Terrorism (USA Patriot) Act
of 2001" was enacted. The statute increased the power of the United States
Government to obtain access to information and to investigate a full array of
criminal activities. In the area of money laundering activities, the statute
added terrorism, terrorism support and foreign corruption to the definition of
money laundering offenses and increased the civil and criminal penalties for
money laundering; applied certain anti-money laundering measures to United
States bank accounts used by foreign persons; prohibited financial institutions
from establishing, maintaining, administering or managing a correspondent
account with a foreign shell bank; provided for certain forfeitures of funds
deposited in United States interbank accounts by foreign banks; provided the
Secretary of the Treasury with regulatory authority to ensure that certain types
of bank accounts are not used to hide the identity of customers transferring
funds and to impose additional reporting requirements with respect to money
laundering activities; and included other measures. In November 2001, the
Department of Treasury issued interim guidance concerning compliance by covered
United States financial institutions with the new statutory anti-money
laundering requirement regarding correspondent accounts established or
maintained for foreign banking institutions, including the requirement that
financial institutions take reasonable steps to ensure that correspondent
accounts provided to foreign banks are not being used to indirectly provide
banking services to foreign shell banks. On December 28, 2001 the Department of
the Treasury published for comment a notice of proposed rule making to codify
the interim guidance. The final rule became effective October 28, 2002. The
Company believes that compliance with the new requirements will not have a
material adverse impact on its operations or financial condition.

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
United States 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.

12

ITEM 2. PROPERTIES

FACILITIES

The Company currently maintains 34 locations in the greater Houston area
and a loan production office in the greater Dallas area, fourteen of which are
leased. The following table sets forth specific information on each location.
With the exception of the Operations Center, each Houston area location offers
full service banking. The Company's headquarters are located at 4400 Post Oak
Parkway in a 28-story office tower in the Galleria area in Houston, Texas.

- ---------------

(1) Leased location.

(2) Mitchell's headquarters.

13

ITEM 3. LEGAL PROCEEDINGS

The Company is involved in various legal proceedings that arise in the
normal course of business. In the opinion of management of the Company, after
consultation with its legal counsel, such legal proceedings are not expected to
have a material adverse effect on the Company's consolidated financial position,
results of operations or cash flows.

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 24, 2003 there were
approximately 940 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, 2002, approximately
$155.4 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 years ended December 31, 2002 and 2001.

RECENT SALES OF UNREGISTERED SECURITIES

None.

14

EQUITY COMPENSATION PLAN INFORMATION

The following table sets forth information as of December 31, 2002, with
respect to the Company's compensation plans under which equity securities are
authorized for issuance:

- ---------------
(1) The Southwest Bancorporation of Texas, Inc. Non-Employee Directors Deferred
Fee Plan allows non-employee directors to elect to defer all, one-half or
none of their director's fees earned each year. The Company will establish
an account for each non-employee director that elects to defer all or part
of their director's fees, and such account will be credited in phantom stock
units as of the last business day of the fiscal quarter in which such
portion of the director's fees would otherwise have been payable. The number
of phantom stock units to be credited to a director's account is determined
by dividing the amount of the director's fees deferred during the quarter by
the fair market value of a share of the Company's stock as of the date of
crediting, multiplying such result by 1.25, and rounding up to the nearest
whole phantom stock unit. Payment from the director's account will commence
as soon as reasonably practicable after the earlier of the director's
termination as a member of the Company's or Bank's Board of Directors or the
date specified by the director when he elects to make the deferral. The
payment from each account will be either lump sum or up to five installments
of the Company's common stock.

15

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, 2002 are derived from the Company's Consolidated Financial
Statements which have been audited by independent accountants.

- ---------------

(1) Basic earnings per common share is computed by dividing net income by the
weighted average number of common shares outstanding for the period. Diluted
earnings per common share is computed by dividing net income, adjusted for
any changes in income that would result from the assumed conversion of all
potential dilutive common shares, 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 to average loans.

(3) Calculated by dividing total noninterest expenses by net interest income
plus noninterest income, excluding net security gains (losses).

(4) Nonperforming assets consist of nonperforming loans and other real estate
owned.

(5) Nonperforming loans consist of nonaccrual loans, troubled debt
restructurings and loans contractually past due 90 days or more.

16

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 Consolidated Financial
Statements of the Company and Notes thereto and other detailed information
appearing elsewhere in this Annual Report.

FOR THE YEARS ENDED DECEMBER 31, 2002, 2001 AND 2000

OVERVIEW

Total assets at December 31, 2002, 2001 and 2000 were $5.17 billion, $4.40
billion, and $3.94 billion, respectively. This growth was a result of a
favorable local economy, the addition of new loan officers, aggressive
marketing, and the Company's overall growth strategy. Loans were $3.22 billion
at December 31, 2002, an increase of $459.9 million or 17% from $2.76 billion at
the end of 2001. Loans were $2.51 billion at year end 2000. Deposits increased
to $3.91 billion at year end 2002 from $3.43 billion at year end 2001 and $3.09
billion at year end 2000.

Net income was $59.2 million, $52.7 million, and $43.5 million and diluted
earnings per common share was $1.72, $1.55, and $1.29 for the years ended
December 31, 2002, 2001 and 2000, 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 1.30%, 1.32%, and
1.23% and returns on average common shareholders' equity of 14.55%, 15.82%, and
17.00% for the years ended 2002, 2001 and 2000, respectively. Return on average
assets is calculated by dividing annualized net income by the daily average of
total assets. Return on average common shareholders' equity is calculated by
dividing annualized net income by the daily average of common shareholders'
equity.

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, the principal source of the Company's
earnings, has declined as a percent of net revenues, defined as the sum of net
interest income and noninterest income, due to growth in the Company's fee
income. In 2002, net interest income provided 71.7% of the Company's net
revenues, compared with 73.3% in 2001 and 77.8% in 2000. Interest rate
fluctuations, as well as changes in the amount and type of earning assets and
liabilities, combine to affect net interest income.

2002 versus 2001. Net interest income was $178.6 million in 2002 compared
to $160.0 million in 2001, an increase of $18.6 million or 12%. Growth in
average earning assets, primarily loans, was $505.9 million or 14%, while yields
decreased 144 basis points to 5.81%. The impact of the growth in average
interest-earning assets was partially offset by a $324.0 million, or 12%,
increase in average interest-bearing liabilities, offset by a decrease in the
rate paid on interest-bearing liabilities of 170 basis points to 1.92% in 2002.

For the year ended December 31, 2002, the net interest margin, defined as
annualized net interest income divided by average interest-earning assets,
decreased to 4.35% compared to 4.44% for the prior year. This decrease resulted
from a decrease in the yield on interest-earning assets of 144 basis points,
from 7.25% for the year ended December 31, 2001 to 5.81% for the current year.
This decrease in the yield on interest-earning assets was partially offset by a
decrease in the cost of funds of 3.62% for the year ended December 31, 2001 to
1.92% for the year ended December 31, 2002.

Net interest margin risk is typically related to a narrowing of the yield
on interest-earning assets and cost of funds. The Company managed this risk with
asset and liability pricing to minimize the impact of declining rates, lowering
the average costs of deposits and adding interest rate floors to some of its
loan agreements. On November 6, 2002 the Federal Reserve decreased the federal
funds rate and discount rate by 50 basis points.

17

Due to the Bank's asset sensitivity, the net interest margin decreased after
this rate cut. This resulted in net interest margins of 4.35% and 4.44% and net
interest spreads of 3.89% and 3.63% for the years ended December 31, 2002 and
2001, respectively.

2001 versus 2000. Net interest income was $160.0 million in 2001 compared
to $150.5 million in 2000, an increase of $9.5 million or 6%. Growth in average
earning assets, primarily loans, was $356.4 million or 11% while yields
decreased 114 basis points to 7.25%. Yields decreased throughout 2001 as the
Bank's prime lending rate decreased. The yield on earning assets during the
fourth quarter was the lowest for the year, resulting in decreased yields on a
weighted average basis.

The impact of the growth in average earning assets was partially offset by
a $333.4 million or 14% increase in average interest-bearing liabilities, offset
by a decrease in the rate paid on interest-bearing liabilities of 132 basis
points to 3.62% in 2001.

Net interest margin decreased 20 basis points in 2001 to 4.44%. This
decrease in the net interest margin is the direct result of the Federal Reserve
lowering the federal funds rate 475 basis points since the beginning of 2001.

18

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. Interest on nonaccruing
loans is included to the extent it is received. 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.

19

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
have been allocated proportionately to the change due to volume and the change
due to rate.

PROVISION FOR LOAN LOSSES

The 2002 provision for loan losses was $11.8 million, an increase of $4.3
million from 2001. The provision for the year ended December 31, 2001 was $7.5
million, an increase of $447,000 from the year ended December 31, 2000. Changes
in the provision for loan losses were attributable to the changes in net charge-
offs and the recognition of changes in current risk factors. 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 regularly reviews the Company's loan loss
allowance in accordance with its standard procedures. (See "-- Financial
Condition -- Loan Review and Allowance for Loan Losses.")

NONINTEREST INCOME

Noninterest income grew to $70.4 million for the year ended December 31,
2002, an increase of $12.2 million, or 21%, from 2001. Noninterest income was
$58.2 million in 2001, an increase of $15.3 million, or 36%, from 2000.

The following table presents the breakout of noninterest income between the
bank and the mortgage company for 2002, 2001 and 2000:

Banking Segment. The largest component of noninterest income is service
charges on deposit accounts, which were $37.1 million for the year ended
December 31, 2002, compared to $27.7 million for 2001 and $20.8 million for
2000. These were increases of 34% and 33%, respectively, for 2002 and 2001.
Several factors contributed to this growth. First, the Bank's treasury
management group continues to grow, with service charges from commercial
analysis up $4.0 million, or 28%, in 2002. This success at winning new business
results from the Company's ability to design custom cost-effective cash
management solutions for middle market and large corporate customers. Second,
net NSF charges on deposit accounts were $15.3 million for the year ended
December 31, 2002, an increase of $3.5 million, or 29%, from $11.8 million for
the same period last year. This increase in NSF charges is primarily due to net
fee income on a deposit product introduced in 2001. Additionally, the total
number of deposit accounts grew from 141,036 at December 31, 2000 to 151,376 at
December 31, 2001 and to 159,860 at December 31, 2002.

Investment services income was $9.3 million for the year ended December 31,
2002 compared to $7.2 million for 2001 and $6.0 million for 2000. The increase
in investment services income is attributable to increased investment sales to
commercial and retail customers and to the expanding foreign exchange
department, as well as the addition of several experienced calling officers and
an increase in referrals from the Company's growing customer base.

Gain on sale of loans, net, was $472,000 for the year ended December 31,
2002. This gain primarily represents the premium for the sale of the Bank's
credit card portfolio. There were no such transactions in 2001 or 2000.

Gain (loss) on sale of securities, net, was $1.7 million for the year ended
December 31, 2002 compared to $14,000 in 2001 and ($467,000) in 2000. The 2002
gain was recorded on the sale of warrants and other investment securities with a
book value of $131.7 million.

Other income was $4.7 million for the year ended December 31, 2002,
compared to $4.3 million in 2001 and $4.0 million in 2000. The increase in 2002
is partially due to a gain recorded on the sale of the Company's interest in
First National Bank of Bay City and additional rental income recorded partially
offset by a decrease in income recorded from equity investees.

21

Income on Bank-owned life insurance was $4.9 million for the year ended
December 31, 2002, compared to $4.5 million for 2001 and $1.7 million for 2000.
These were increases of 8% and 171%, respectively, for 2002 and 2001. The
increase in 2001 was attributable to the purchase of $50.0 million of additional
Bank-owned life insurance early in the first quarter of 2001.

Mortgage Segment. Gain on sale of loans, net, was $3.4 million for the
year ended December 31, 2002, compared to $3.2 million for 2001 and $1.0 million
for 2000. These were increases of 8% and 211%, respectively, for 2002 and 2001.
Lower interest rates in 2001 and 2002 resulted in an increase in mortgage
refinancings and originations. This increase in loan volume resulted in a larger
portfolio of loans available for sale during the year. The principal balances of
mortgage loans sold were $180.5 million, $141.5 million, and $45.2 million
during the years ended December 31, 2002, 2001 and 2000, respectively.

Mortgage servicing fees, net of amortization and impairment were ($2.9)
million for the year ended December 31, 2002, as compared to $748,000 for the
same period last year. This decrease is primarily due to a provision established
for capitalized mortgage servicing rights in excess of fair value, net of
recovery, in the amount of $2.4 million during 2002. The decrease in the fair
value of capitalized mortgage servicing rights is a result of historically low
mortgage rates resulting in an increase in prepayments of mortgages serviced by
the Company. In addition, the Company recorded $3.0 million of payoff
amortization in 2002 compared to $2.0 million of payoff amortization in 2001.

NONINTEREST EXPENSES

For the year ended December 31, 2002, noninterest expenses totaled $151.1
million, an increase of $17.9 million, or 13%, from $133.2 million during 2001,
which had increased from $120.3 million during 2000. The increase in noninterest
expenses during these periods was due primarily to salaries and employee
benefits and occupancy expenses. The efficiency ratio is calculated by dividing
total noninterest expenses by net interest income plus noninterest income,
excluding net security gains (losses). An increase in the efficiency ratio
indicates that more resources are being utilized to generate the same volume of
income while a decrease would indicate a more efficient allocation of resources.
The Company's efficiency ratios were 61.09%, 61.06% and 62.04% for the years
ended December 31, 2002, 2001 and 2000, respectively. The increase in the
efficiency ratio in 2002 is primarily a result of the decline in the net
interest margin discussed in "-- Results of Operations -- Net Interest Income"
above. The efficiency ratio is a supplemental financial measure utilized in
management's evaluation of the Company and is not defined under generally
accepted accounting principles. It may not be a comparable measurement among
different financial institutions.

Salaries and employee benefits expense was $87.6 million for the year ended
December 31, 2002, an increase of $9.5 million, or 12%, from $78.0 million for
the year ended December 31, 2001. Salaries and employee benefits expense for the
year ended December 31, 2001 increased $11.0 million, or 16%, from the same
period in 2000. These increases were due primarily to hiring additional
personnel required to accommodate the Company's growth. Total full-time
equivalent employees for the years ended December 31, 2002, 2001 and 2000 were
1,481, 1,376, and 1,313, respectively.

Occupancy expense rose $2.5 million to $24.1 million in 2002. Major
categories included within occupancy expense are depreciation expense and
maintenance contract expense. Depreciation expense increased $1.5 million to
$9.2 million for the year ended December 31, 2002. This increase was due
primarily to additional depreciation resulting from the purchase of the downtown
operations center and capitalized leasehold improvements associated with
renovations at the Company's headquarters. Maintenance contract expense for the
year ended December 31, 2002 was $4.0 million, an increase of $827,000, or 26%,
compared to $3.2 million in 2001 and $2.5 million in 2000. The Company has
purchased maintenance contracts for major operating systems throughout the
organization.

Losses on deposit accounts increased to $3.9 million for the year ended
December 31, 2002 from $1.7 million for the same period last year, an increase
of $2.2 million, or 127%. This increase is primarily due to charge-offs of
deposit accounts related to a deposit product introduced in 2001. In addition,
the Company charged off $500,000 in 2002 related to check kiting.

22

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 2002 income
tax expense was $27.0 million, an increase of $2.2 million, or 9%, from the
$24.7 million of income tax expense in 2001 which increased $2.1 million, or 9%,
from the $22.6 million of income tax expense in 2000. The Company's effective
tax rates were 31%, 32%, and 34% for the years ended December 31, 2002, 2001 and
2000, respectively. The reduced tax rate is primarily due to an increase in tax
exempt income earned on the Company's bank-owned life insurance and other tax
exempt securities.

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 attempts
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

LOANS HELD FOR INVESTMENT

Loans held for investment were $3.12 billion at December 31, 2002, an
increase of $445.5 million, or 17% from December 31, 2001. Loans held for
investment were $2.67 billion at December 31, 2001, an increase of $247.0
million, or 10%, from $2.43 billion at December 31, 2000.

During the past five years loans have grown at an annualized rate of 21%.
This growth is consistent with the Company's strategy of targeting corporate
"middle market" and private banking customers and providing innovative products
with superior customer service. This plan also includes establishing new
branches in areas that demographically complement existing or targeted customer
base, pursuing selected mergers/acquisitions that will add new markets, delivery
systems and talent to the Company, and leveraging new or existing technology to
improve the profitability of the Company and its customers.

Loans increased during 2002 as the Company continued to expand its market
presence in its defined primary market. The Company continues to take a
conservative approach to credit underwriting, which it believes is a prudent
course of action, especially in uncertain economic conditions. While the
short-term outlook for economic conditions is unclear, the Company is optimistic
about the future and has continued to invest in new products, services, and
personnel that it believes will bring excellent opportunities for growth and
expansion.

The loan portfolio is concentrated in loans to commercial, real estate
construction and land development enterprises, with the balance in residential
and consumer loans. While no specific industry concentration is considered
significant, lending operations are located primarily in an eight county area in
and around Houston. An economic recession over a prolonged period of time in the
Houston area could cause increases in nonperforming assets, thereby causing
operating losses, impairing liquidity and eroding capital. There can be no
assurance that future adverse changes in the local economy would not have a
material adverse effect on the Company's consolidated financial condition,
results of operations or cash flows.

23

The following table summarizes the loan portfolio of the Company by major
category as of the dates indicated:

The primary lending focus of the Company is on small- and medium-sized
commercial, construction and land development, 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.

The Company's commercial loans are generally underwritten on the basis of
the borrower's ability to service such debt from cash flow. As a general
practice, the Company takes as collateral a lien on any available real estate,
equipment, or other assets and personal guarantees of company owners or project
sponsors. 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, other assets and personal guarantees of company
owners or project sponsors. 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 are typically
originated in amounts of no more than 90% of appraised value. The Company
typically 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 10 to 30 year period, such
loans often remain outstanding for significantly shorter periods than their
contractual terms.

The Company originates and purchases residential and commercial mortgage
loans to sell to investors with servicing rights retained. The Company also
provides residential and commercial construction financing to builders and
developers and acts as a broker in the origination of multi-family and
commercial real estate loans.

Residential construction financing to builders generally has been
originated in amounts of no more than 80% of appraised value. The Company
requires a mortgage title binder and builder's risk insurance in the amount of
the loan. The contractual loan payment periods for residential constructions
loans are generally for a six to twelve month period.

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 collateral-

24

ized 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 funded
real estate construction and land development loan portfolio and the amount of
such loans with fixed interest rates and floating interest rates in each
maturity range as of December 31, 2002 are summarized in the following table:

LOANS HELD FOR SALE

Loans held for sale of $101.4 million at December 31, 2002 increased from
$87.0 million at December 31, 2001. These loans are carried at the lower of cost
or market and are typically sold to investors within one year of origination.
The market value of these loans is impacted by changes in current interest
rates. An increase in interest rates would result in a decrease in the market
value of these loans while a decrease in interest rates would result in an
increase in the market value of these loans. The business of originating and
selling loans is conducted by the Company's mortgage segment.

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, a loan review department staffed, in part,
with Office of the Comptroller of the Currency experienced personnel, low
individual lending limits for officers, Senior Loan Committee approval for large
credit relationships and a quality control process for loan documentation. The
Company also maintains a monitoring process for credit extensions in excess of
$100,000. The Company performs quarterly concentration analyses based on various
factors such as industries, collateral types, business lines, large credit
sizes, international credit exposure 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.
The Company continues to invest in its loan portfolio monitoring system to
enhance its risk management capabilities.

The Company's loan portfolio is well diversified by industry type but is
generally concentrated in the eight county region defined as its primary market
area. Historically, the Houston metropolitan area has been affected both
positively and negatively by conditions in the energy industry. It is estimated
that approximately 32% of economic activity currently is related to the upstream
energy industry, down from 69% in 1981. Since the mid 1980's, the economic
impact of changes in the energy industry has been lessened due to the
diversification of the Houston economy driven by growth in such economic
entities as the Texas Medical Center, the Port of Houston, the Johnson Space
Center, among others, and government infrastructure spending to support the
population and job growth in the Houston area. As a result, the economy of the
Company's primary market area has become increasingly affected by changes in the
national and international economies.

25

The Company monitors changes in the level of energy prices, real estate
values, borrower collateral, and the level of local, regional, national, and
international economic activity. Recently, several major employers in the
Houston market have either experienced financial difficulties or reductions in
employment due to changes in the energy trading markets, corporate
consolidations, or political events affecting the global economy. While these
factors are significant, the Company's primary market area has managed to show a
12 month gain of approximately 4,500 jobs on an employment base estimated to be
2.1 million as of December 31, 2002. As of December 31, 2002, other than $4.3
million in charge-offs related to four commercial credits, these events have had
no material effect on the Company's loan portfolio. For the year ended December
31, 2002, net charge-offs to average loans was 0.22%. The average for all FDIC
insured banks was 1.12% for the nine months ended September 30, 2002. There can
be no assurance, however, the Company's loan portfolio will not become subject
to increasing pressures from deteriorating borrower credit due to changes in
general economic conditions.

The allowance for loan losses is established through a provision for loan
losses based on management's evaluation of risk inherent in the loan portfolio.
The allowance is increased by provisions charged against current earnings and
reduced by net charge-offs. Loans are charged off when they are deemed to be
uncollectible; recoveries are generally recorded only when cash payments are
received. Based on an evaluation of the loan portfolio, management presents a
quarterly analysis of the allowance for loan losses to a committee of 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
evaluations, management considers both quantitative and qualitative risk factors
in establishing an allowance for loan losses that it considers to be appropriate
at each reporting period. Quantitative factors include historical charge-off
experience, delinquency and past due trends, changes in collateral values,
changes in energy prices, changes in the level of borrower covenant violations,
the level of nonperforming loans, changes in the risk classification of credits,
growth and concentrations of credit in the loan portfolio, the results of
regulatory and internal loan review examinations, and changes in the loan
portfolio's composition by both industry and by borrower.

Qualitative factors include an evaluation of the economic factors affecting
the Company's primary market area, changes in the type and complexity of credit
extensions, the experience levels of its lending and loan review staff, new
lending products, the age of the loan portfolio, and other factors.

In order to determine the adequacy of the allowance for loan losses,
management performs periodic reviews of the loan portfolio, either individually
or in pools. Generally, commercial and real estate loans are reviewed
individually and consumer and single family residential loans are evaluated in
pools.

A general allowance for loan losses is established based upon (i) the
historical loss experience by loan type; (ii) management's internal grading of
the loans resulting in an allowance based upon the historical loss experience by
grade applied to the outstanding principal balance of the adversely graded
loans; and (iii) certain subjective factors such as economic trends, performance
trends, portfolio age and concentrations of credit. In addition, specific
allowances may be established for loans which management believes require
greater reserves than those allocated based on the above methodology. Future
changes in economic conditions, circumstances, or other factors could cause
management to increase or decrease the allowance for loan losses as necessary.

Management believes that the allowance for loan losses at December 31, 2002
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,
2002.

26

The following table presents, for the periods indicated, an analysis of the
allowance for loan losses and other related data:

27

The following table reflects the distribution of the allowance for loan
losses among various categories of loans for the dates indicated. The Company
has allocated portions of its general allowance for loan losses to cover the
estimated losses inherent in particular risk categories of loans. This
allocation is made for analytical purposes and is not necessarily indicative of
the categories in which loan losses may occur. The total allowance is available
to absorb losses from any category of loans.

NONPERFORMING ASSETS AND IMPAIRED LOANS

Nonperforming assets, which include nonaccrual loans, accruing loans 90 or
more days past due, restructured loans, and other real estate and foreclosed
property, were $15.7 million at December 31, 2002, compared with $14.2 million
at December 31, 2001 and $9.9 million at December 31, 2000. This resulted in a
ratio of nonperforming assets to loans and other real estate of 0.50%, 0.53%,
and 0.41% at December 31, 2002, 2001, and 2000, respectively. Nonaccrual loans,
the largest component of nonperforming assets, were $13.1 million at December
31, 2002, an increase of $2.1 million from $11.0 million at December 31, 2001.

The following table presents information regarding nonperforming assets as
of the dates indicated:

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 collection of interest and 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. Gross interest income
on nonaccrual loans that would have been recorded had these loans been
performing as

28

agreed was $814,000, $626,000 and $203,000 for the years ended December 31,
2002, 2001, and 2000, respectively.

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, based on current information and events, if
management believes 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. An insignificant delay (up to 90 days) or insignificant shortfall in
the amount of payment does not constitute an impairment. 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. All nonaccrual loans and
accruing loans 90 or more days past due are considered impaired at December 31,
2002.

The following is a summary of loans considered to be impaired:

The average recorded investment in impaired loans during 2002, 2001, and
2000 was $22.1 million, $15.5 million, and $9.3 million, respectively. Interest
income on impaired loans of $456,000, $425,000, and $1.1 million was recognized
for cash payments received in 2002, 2001 and 2000, respectively. The decrease in
the valuation allowance related to impaired loans is the result of a change in
the composition of these loans and charge-offs recorded in 2002.

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 classified as held to maturity are stated at
cost, increased by accretion of discounts and reduced by amortization of
premiums, both computed by the interest method, 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, as a component of accumulated other
comprehensive income (loss) until realized. Gains and losses on sales of
securities are determined using the specific-identification method. The Company
has classified all securities as available for sale at December 31, 2002.

29

The amortized cost of securities classified as available for sale and held
to maturity is as follows:

The amortized cost and approximate fair value of securities classified as
available for sale is as follows:

In connection with the Citizens merger, the Company transferred all of
Citizens' held to maturity debt securities to the available for sale category in
2000. The amortized cost of these securities at the time of transfer was $55.8
million and the unrealized gain was $267,000 ($174,000 net of income taxes).

Securities totaled $1.20 billion at December 31, 2002, an increase of
$132.9 million from $1.07 billion at December 31, 2001. During 2001, securities
increased $220.2 million from $848.2 million at December 31, 2000. The yield on
the securities portfolio for 2002 was 5.00% while the yield was 5.95% in 2001.

Included in the Company's mortgage-backed securities at December 31, 2002
were agency issued collateral mortgage obligations with a book value of $357.8
million and a fair market value of $360.9 million and non-agency issued
collateral mortgage obligations with a book value and fair market value of
$112,000.

At December 31, 2002, $683.0 million of the mortgage-backed securities held
by the Company had final maturities of more than 10 years. At December 31, 2002,
approximately $17.6 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.

30

The following table summarizes the contractual maturity of investments and
their weighted average yields at December 31, 2002. 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.

OTHER ASSETS

Other assets were $140.4 million at December 31, 2002, a decrease of $38.3
million from $178.7 million at December 31, 2001. This decrease is primarily
attributable to decreases in factored receivables. Factored receivables result
from providing operating funds to businesses by converting their accounts
receivable to cash. During 2002, factored receivables decreased $32.1 million to
$23.0 million. This decrease was due to unusual customer cash needs at December
31, 2001 that were not experienced in 2002.

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,
interest-bearing demand, money market and time accounts. The Company relies
primarily on its product and service offerings, high quality customer service,
advertising, and competitive pricing policies to attract and retain these
deposits. Deposits provide the primary source of 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 had $149.4 million and $300,000 of its deposits classified as
brokered funds at December 31, 2002 and 2001, respectively. The growth in
brokered deposits is attributable to a major new treasury management
relationship whereby the Bank provides banking and treasury management services
to mortgage companies throughout the United States. Under this relationship, a
referring source, whose business is to lend money to mortgage companies,
introduces its customers to the Bank. Deposits garnered as a result of those
introductions are classified as brokered deposits for financial and regulatory
reporting purposes. In spite of this classification, management believes that
the deposits in question are core and relationship in nature and that they do
not have the characteristics or risks normally associated with brokered
deposits.

The Company's ratio of average demand deposits to average total deposits
for the years ended December 31, 2002, 2001, and 2000 was 30%, 28%, and 30%,
respectively.

Average total deposits during 2002 increased to $3.47 billion from $3.20
billion in 2001, an increase of $277.4 million or 9%. Average
noninterest-bearing deposits increased to $994.1 million in 2002 from $836.4
million in 2001. Average total deposits in 2001 rose to $3.20 billion from $2.82
billion in 2000, an increase of $374.9 million, or 13%.

31

The average daily balances and weighted average rates paid on deposits for
each of the years ended December 31, 2002, 2001, and 2000 are presented below:

The following table sets forth the maturity of the Company's time deposits
that are $100,000 or greater as of the dates indicated:

32

BORROWINGS

Securities sold under repurchase agreements and other borrowings generally
represent borrowings with maturities ranging from one to thirty days. Short-term
borrowings consist of federal funds purchased and other bank borrowings. The
Company's long-term borrowings generally consist of borrowings with the Federal
Home Loan Bank maturing within one year. Information relating to these
borrowings for the years ended December 31, 2002 and 2001 is summarized as
follows:

INTEREST RATE SENSITIVITY

Asset and liability management is concerned with the timing and magnitude
of the repricing of assets as 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's asset and liability
management strategy is formulated and monitored by the Asset Liability
Management Committee (the "ALCO"), which is composed of senior officers of the
Bank and two outside directors, 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.

33

To effectively measure and manage interest rate risk, the Company uses
simulation analysis to determine the impact on net interest income of changes in
interest rates under various interest rate scenarios, balance sheet trends, and
strategies. From these simulations, interest rate risk is quantified and
appropriate strategies are developed and implemented.

The following table presents an analysis of the sensitivity inherent in the
Company's net interest income and market value of portfolio equity. The data
used to prepare the table is as of December 31, 2002, which may not be
representative of average balances found at year end or any other time period.
The analysis is a tool used by management that changes every month based on
changes in the composition of the balance sheet. Management believes that, based
on available information, the Bank has been and will continue to be slightly
asset sensitive. The interest rate scenarios presented in the table include
interest rates at December 31, 2002 and 2001 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.

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.

The Company's one-year cumulative GAP position at December 31, 2002 was a
positive $656.5 million or 12.70% of assets. This is a one-day position that is
continually changing and is not indicative of the Company's position at any
other time. While the GAP position is a useful tool in measuring interest rate
risk and contributes toward effective asset and liability management,
shortcomings are inherent in GAP analysis since certain assets and liabilities
may not move proportionally as interest rates change.

34

The following table sets forth an interest rate sensitivity analysis for
the Company as of December 31, 2002:

LIQUIDITY

Liquidity management involves maintaining sufficient cash levels to fund
operations and to meet the requirements of borrowers, depositors, and creditors.
Higher levels of liquidity bear higher corresponding costs, measured in terms of
lower yields on short-term, more liquid earning assets, and higher interest
expense involved in extending liability maturities. Liquid assets include cash
and cash equivalents, loans and securities maturing within one year, and money
market instruments. In addition, the Company holds securities maturing after one
year, which can be sold to meet liquidity needs.

The Company relies primarily on customer deposits, securities sold under
repurchase agreements and shareholders' equity to fund interest-earning assets.
The Federal Home Loan Bank ("FHLB") is also a major source of liquidity for the
Bank. The FHLB allows member banks to borrow against their eligible collateral
to satisfy liquidity requirements.

Maintaining a relatively stable funding base, which is achieved by
diversifying funding sources, competitively pricing deposit products, and
extending the contractual maturity of liabilities, reduces the Company's
exposure to roll over risk on deposits and limits reliance on volatile
short-term purchased funds. Short-term funding needs arise from declines in
deposits or other funding sources, funding of loan commitments and requests for
new loans. The Company's strategy is to fund assets to the maximum extent
possible with core deposits that provide a sizable source of relatively stable
and low-cost funds. Core deposits include all deposits, except certificates of
deposit and other time deposits of $100,000 and over. Average core deposits
funded approximately 71% of total interest-earning assets for the year ended
December 31, 2002 and 74% for the same period in 2001.

35

Management believes the Company has sufficient liquidity to meet all
reasonable borrower, depositor, and creditor needs in the present economic
environment. In addition, the Bank has access to the FHLB for borrowing
purposes. The Company has not received any recommendations from regulatory
authorities that would materially affect liquidity, capital resources or
operations.

Subject to certain limitations, the Bank may borrow funds from the 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 $353.3 million at December 31, 2002. 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, 2002 was approximately $286.0 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.

Payments due by period for the Company's contractual obligations (other
than deposit liabilities) at December 31, 2002 are presented below:

OFF-BALANCE SHEET ARRANGEMENTS

The contractual amount of the Company's financial instruments with
off-balance sheet risk expiring by period at December 31, 2002 is presented
below:

Due to the nature of the Company's unfunded loan commitments, including
unfunded lines of credit, the amounts presented above do not necessarily
represent amounts the Company anticipates funding in the periods presented
above. During the last three years, the Company has experienced stable usage at
66% of unfunded loan commitments, including unfunded lines of credit.

CRITICAL ACCOUNTING POLICIES

The Company has established various accounting policies which govern the
application of accounting principles generally accepted in the United States in
the preparation of the Company's financial statements. The significant
accounting policies of the Company are described in the footnotes to the
consolidated financial

36

statements. Certain accounting policies involve significant judgments and
assumptions by management which have a material impact on the carrying value of
certain assets and liabilities; management considers such accounting policies to
be critical accounting policies. The judgments and assumptions used by
management are based on historical experience and other factors, which are
believed to be reasonable under the circumstances. Because of the nature of the
judgments and assumptions made by management, actual results could differ from
these judgments and estimates which could have a material impact on the carrying
values of assets and liabilities and the results of operations of the Company.

The Company believes the allowance for loan losses is a critical accounting
policy that requires the most significant judgments and estimates used in the
preparation of its consolidated financial statements. In estimating the
allowance for loan losses, management utilizes historical experience as well as
other factors including the effect of changes in the local real estate market on
collateral values, the effect on the loan portfolio of current economic
indicators and their probable impact on borrowers and increases or decreases in
nonperforming and impaired loans. Changes in these factors may cause
management's estimate of the allowance to increase or decrease and result in
adjustments to the Company's provision for loan losses. See "-- Financial
Condition -- Loan Review and Allowance for Loan Losses" and "Note 1 -- Nature of
Operations and Summary of Significant Accounting Policies" for a detailed
description of the Company's estimation process and methodology related to the
allowance for loan losses.

Mortgage servicing rights assets are established and accounted for based on
discounted cash flow modeling techniques which require management to make
estimates regarding the amount and timing of expected future cash flows,
including assumptions about loan repayment rates, credit loss experience, and
costs to service, as well as discount rates that consider the risk involved.
Because the values of these assets are sensitive to changes in assumptions, the
valuation of mortgage servicing rights is considered a critical accounting
estimate. See "Note 1 -- Nature of Operations and Summary of Significant
Accounting Policies" and "Note 7 -- Mortgage Servicing Rights" for further
discussion on the accounting for these assets.

CAPITAL RESOURCES

Shareholders' equity increased to $445.5 million at December 31, 2002 from
$361.7 million at December 31, 2001, an increase of $83.8 million, or 23%,
primarily from comprehensive income of $68.6 million and the exercise of stock
options.

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 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

37

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.

The following table compares the Company's and the Bank's leverage and
risk-weighted capital ratios as of December 31, 2002 and 2001 to the minimum
regulatory standards:

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,
38

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 "well capitalized" for purposes of prompt corrective
action. See "Item 1. Business -- Supervision and Regulation."

OTHER MATTERS

On June 29, 2001, the Financial Accounting Standards Board ("FASB")
approved Statement of Financial Accounting Standards ("SFAS") No. 141, Business
Combinations and SFAS No. 142, Goodwill and Other Intangible Assets. SFAS No.
141 amends APB Opinion No. 16, Business Combinations, to prohibit use of the
pooling-of-interests (pooling) method of accounting for business combinations
initiated after June 30, 2001 and require the use of purchase accounting.

Goodwill generated from purchase business combinations consummated prior to
the issuance of SFAS No. 142 was amortized on a straight-line basis over 20
years. SFAS No. 142 addresses the initial recognition and measurement of
intangible assets acquired outside a business combination and the recognition
and measurement of goodwill and other intangible assets subsequent to
acquisition. Under the new standard, goodwill and intangible assets deemed to
have indefinite lives will no longer be amortized, but instead will be tested at
least annually for impairment. The standard is applicable for fiscal years
commencing after December 15, 2001. The standard was adopted by the Company on
January 1, 2002 and the impact of adoption was immaterial.

On October 24, 2002, the FASB approved SFAS No. 147, Acquisitions of
Certain Financial Institutions. SFAS No. 147 amends previously issued guidance
regarding the accounting and reporting for the acquisition of all or part of a
financial institution, effective for acquisitions after October 1, 2002. The
statement also provides guidance on the accounting for the impairment or
disposal of core deposits. This standard will impact any acquisitions the
Company makes beginning in 2003.

On December 31, 2002, the FASB approved SFAS No. 148, Accounting for
Stock-Based Compensation-Transition and Disclosure, an amendment of FASB
Statement No. 123. SFAS No. 148 amends SFAS No. 123, Accounting for Stock-Based
Compensation, to provide alternative methods of transition for an entity that
voluntarily changes to the fair value based method of accounting for stock-based
employee compensation. It also amends the disclosure provisions of SFAS No. 123
to require prominent disclosure about the effects on reported net income of an
entity's accounting policy decisions with respect to stock-based employee
compensation. Finally, it amends APB Opinion No. 28, Interim Financial
Reporting, to require disclosure about those effects in interim financial
information. The Company does not expect the adoption of this standard to have a
material effect on its financial condition or results of operations.

On November 25, 2002, the FASB issued FASB Interpretation No. 45 ("FIN No.
45"), Guarantor's Accounting and Disclosure Requirements for Guarantees,
Including Indirect Guarantees of Indebtedness of Others. FIN No. 45 considers
standby letters of credit, excluding commercial letters of credit and other
lines of credit, a guarantee of the Bank. The Bank enters into a standby letter
of credit to guarantee performance of a customer to a third party. These
guarantees are primarily issued to support public and private borrowing
arrangements. The credit risk involved is represented by the contractual amounts
of those instruments. Under the standby letters of credit, the Bank is required
to make payments to the beneficiary of the letters of credit upon request by the
beneficiary so long as all performance criteria have been met. Most guarantees
extend up to one year. At December 31, 2002 the maximum potential amount of
future payments is $166.8 million. See "Note 16 -- Financial Instruments with
Off-Balance Sheet Risk and Concentration of Credit Risk" for a discussion of
significant guarantees that have been entered into by the Company. The Company
does not expect the requirements of FIN No. 45 to have a material impact on its
financial condition or results of operations.

On January 17, 2003, the FASB issued Interpretation No. 46, ("FIN No. 46")
Consolidation of Variable Interest Entities, which addresses consolidation by
business enterprises of variable interest entities. FIN No. 46 clarifies the
application of Accounting Research Bulletin No. 51 ("ARB No. 51"), Consolidated
39

Financial Statements, to certain entities in which equity investors do not have
the characteristics of a controlling financial interest or do not have
sufficient equity at risk for the entity to finance its activities without
additional subordinated financial support from other parties. FIN No. 46 applies
immediately to variable interest entities created after January 31, 2003, and to
variable interest entities in which an enterprise obtains an interest after that
date. It applies in the first fiscal year or interim period beginning after June
15, 2003, to variable interest entities in which an enterprise holds a variable
interest that it acquired before February 1, 2003. The Company does not expect
the requirements of FIN No. 46 to have a material impact on its financial
condition or results of operations.

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

The Company's financial performance is impacted by, among other factors,
interest rate risk and credit risk. The Company relies on an extensive loan
review process to mitigate its credit risk. See "Item 7. Management's Discussion
and Analysis of Financial Condition and Results of Operations -- Financial
Condition -- Loan Review and Allowance for Loan Losses" herein.

Management may use derivative contracts to manage its exposure to
commitments to originate mortgage loans. All of the derivatives utilized by the
Company are for purposes other than trading. The derivatives utilized consist of
purchased options on FNMA or FHLMC guaranteed mortgage-backed securities and
forward delivery commitments with FNMA and other secondary market investors.
These financial instruments are used to reduce the Company's exposure to the
effects of fluctuations in interest rates on the Company's lending and secondary
marketing activities. The notional amount and fair value of such derivatives was
immaterial at December 31, 2002 and 2001.

Interest rate risk is the change in value due to changes in interest rates.
This risk is addressed by the Company's ALCO, which includes senior management
and Board of Director representatives. The ALCO monitors interest rate risk by
analyzing the potential impact to the net portfolio of equity value and net
interest income from potential changes to interest rates and considers the
impact of alternative strategies or changes in balance sheet structure. The ALCO
manages the Company's balance sheet in part to minimize the potential impact on
net portfolio value and net interest income despite changes in interest rates.
The Company's exposure to interest rate risk is reviewed on a monthly basis by
the ALCO. Interest rate risk exposure is measured using interest rate
sensitivity analysis to determine the change in net portfolio value in the event
of hypothetical changes in interest rates. If potential changes to net portfolio
value and net interest income resulting from hypothetical interest rate changes
are not within the limits established by the Board, the Board may direct
management to adjust its asset and liability mix to bring interest rate risk
within Board-approved limits. In order to reduce the exposure to interest rate
fluctuations, the Company has implemented strategies to more closely match its
balance sheet composition. Interest rate sensitivity is computed by estimating
the changes in net portfolio of equity value, or market value over a range of
potential changes in interest rates. The market value of equity is the market
value of the Company's assets minus the market value of its liabilities plus the
market value of any off-balance sheet items. The market value of each asset,
liability, and off-balance sheet item is its net present value of expected cash
flows discounted at market rates after adjustment for rate changes. The Company
measures the impact on market value for an immediate and sustained 200 basis
point increase and decrease (shock) in interest rates.

In addition, 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.

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

Reference is made to the financial statements, the reports thereon and the
notes thereto commencing at page 49 of this Form 10-K, which financial
statements, reports, notes and data are incorporated herein by reference.

40

QUARTERLY FINANCIAL DATA (UNAUDITED)

The following table represents summarized data for each of the quarters in
fiscal 2002 and 2001 (in thousands, except earnings per share).

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, 2002.

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 2003 Annual Meeting of Shareholders
to be filed with the Commission pursuant to Regulation 14A under the Securities
and Exchange Act of 1934 (the "2003 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, 2002 to its executive officers, reference is made to the
information presented in the 2003 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 2003 Proxy
Statement. Such information is incorporated herein by reference.

41

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 2003 Proxy Statement. Such information is
incorporated herein by reference.

ITEM 14. CONTROLS AND PROCEDURES

During 2002, management dedicated extensive time, resources, and capital
into the development and implementation of a comprehensive enterprise-wide risk
management system ("ERM"). The process placed all activities of the Company into
14 processes with 12 process owners. In the initial assessment, a catalogue of
the key risks in the Company were identified for ongoing monitoring. Detailed
risk assessments were then conducted to determine the risk profile.
Infrastructure supporting the ERM includes a Board Risk Committee, an internal
Risk Management Committee, and centralized Risk Management supervision. An
automated application, Enterprise Risk Management System ("ERMS"), has also been
developed to facilitate execution of this methodology. The basic ERMS system has
been implemented and is updated on a regular basis. Management is in the process
of developing measurement criteria and risk performance indicators for the
various risk processes.

The Company's chief executive officer and chief financial officer have
evaluated the Company's disclosure controls and procedures (as defined in Rule
13a-14(c) and Rule 15d-14(c) under the Exchange Act) as of December 31, 2002 and
concluded that those disclosure controls and procedures are effective.

There have been no changes in the Company's internal controls or in other
factors known to the Company that could significantly affect these controls
subsequent to their evaluation, nor any corrective actions with regard to
significant deficiencies and material weaknesses.

While the Company believes that its existing disclosure controls and
procedures have been effective to accomplish these objectives, the Company
intends to continue to examine, refine and formalize its disclosure controls and
procedures and to monitor ongoing developments in this area.

PART IV

ITEM 15. 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 47) are filed
as part of this Form 10-K.

(b) Reports On Form 8-K

Three reports on Form 8-K were filed by the Company during the three months
ended December 31, 2002:

(i) A Current Report on Form 8-K dated October 4, 2002 was filed on
October 4, 2002; Item 9 and Item 7.

(ii) A Current Report on Form 8-K dated October 10, 2002 was filed on
October 11, 2002; Item 5 and Item 7.

(iii) A Current Report on Form 8-K dated November 5, 2002 was filed on
November 5, 2002; Item 5 and Item 7.

(c) *Exhibits

3.1 -- Articles of Incorporation of the Company, restated as of May
1, 2001 (incorporated by reference to Exhibit 4.1 to the
Company's Form S-8 Registration Statement No. 333-60190)
3.2 -- Bylaws of the Company (Restated as of December 31, 1996)

42

4.1 -- Specimen Common Stock certificate
**4.2 -- Loan Agreement (and form of $10,000,000 Promissory Note)
dated March 30, 2000, between the Company and Bank of
Oklahoma, N.A.
**4.3 -- Loan Agreement (and form of $5,000,000 Promissory Note)
dated June 30, 2000, between the Company and Bank of
Oklahoma, N.A.
**4.4 -- Assumption and Modification Agreement dated December 29,
2000 and First Amendment thereto dated January 10, 2001,
between Southwest Bank of Texas National Association and
American General Life and Accident Insurance Company,
relating to Third Modification of Promissory Note (in the
original principal amount of $6,250,000), Deed of Trust and
Security Agreement and of Assignment of Leases and Rents
+10.1 -- 1989 Stock Option Plan, amended and restated as of May 29,
1998 (incorporated by reference to Exhibit 10.1 to the
Company's Quarterly Report on Form 10-Q for the quarterly
period ended March 31, 2000)
+10.2 -- 1993 Stock Option Plan, amended and restated as of May 29,
1998 (incorporated by reference to Exhibit 10.2 to the
Company's Quarterly Report on Form 10-Q for the quarterly
period ended March 31, 2000)
+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 January 24, 2000
(incorporated by reference to Exhibit 10.4 to the Company's
Annual Report on Form 10-K for the year ended December 31,
1999)
+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 -- Form of Stock Option Agreement for Directors under 1996
Stock Option Plan (incorporated by reference to Exhibit 10.8
to the Company's Form S-1 Registration Statement No.
333-16509)
+10.8 -- Form of Change in Control Agreement, dated as of January 1,
2000, between the Company and each of Joseph H. Argue, J.
Nolan Bedford, David C. Farries, James R. Massey, Randall E.
Meyer and Steve D. Stephens (incorporated by reference to
Exhibit 10.2 to the Company's Quarterly Report on Form 10-Q
for the quarterly period ended June 30, 2000)
***+10.9 -- Form of Change in Control Agreement, dated as of January 1,
2000, between the Company and each of John Drew, Debra
Innes, Marylyn Manis, George Marshall and John McWhorter.
***+10.10 -- Form of Change in Control Agreement, dated as of January 1,
2001, between the Company and each of Dale Andreas, Kenneth
Olan, Barbara Vilutis and Lane Ward.
+10.11 -- Employment Agreement, amended and restated as of February
17, 2001, between the Company and Walter E. Johnson
(incorporated by reference to Exhibit 10.11 to the Company's
Annual Report on Form 10-K for the year ended December 31,
2000)
+ 10.12 -- Employment Agreement between the Company and John H. Echols,
dated as of December 31, 2000 (incorporated by reference to
Exhibit 10.1 to the Company's Current Report on Form 8-K
filed January 2, 2001)
+ 10.13 -- Restricted Stock Plan (incorporated by reference to Appendix
B to the Company's Proxy Statement dated March 16, 2001 for
its 2001 Annual Meeting of Shareholders)
+10.14 -- Form of Restricted Stock Agreement under the Restricted
Stock Plan (incorporated by reference to Exhibit 4.6 to the
Company's Form S-8 Registration Statement No. 333-60190)
+10.15 -- Non-Employee Directors Deferred Fee Plan (incorporated by
reference to Exhibit 4.3 to the Company's Form S-8
Registration Statement No. 333-74452)
+10.16 -- Form of Deferral Election Form under Non-Employee Directors
Deferred Fee Plan (incorporated by reference to Exhibit 4.4
to the Company's Form S-8 Registration Statement No.
333-74452)
10.17 -- Purchase and Sale Agreement between TCP Renaissance
Partners, L.P. and Southwest Bank of Texas, N.A., dated May
24, 2002 (incorporated by reference to Exhibit 10.1 to the
Company's Quarterly Report on Form 10-Q for the quarterly
period ended September 30, 2002).
+10.18 -- 1996 Stock Option Plan, Amended and Restated as of June 4,
2002 (incorporated by reference to Exhibit 10.1 to the
Company's Quarterly Report on Form 10-Q for the quarterly
period ended June 30, 2002).

43

+10.19 -- Change in Control Agreement between the Company and Paul B.
Murphy, Jr., Amended and Restated as of June 4, 2002
(incorporated by reference to Exhibit 10.2 to the Company's
Quarterly Report on Form 10-Q for the quarterly period ended
June 30, 2002).
***+10.20 -- First Amendment to Change In Control Agreement [Two Year],
dated as of June 4, 2002 between the Company and Kenneth W.
Olan.
***+10.21 -- Form of Change in Control Agreement [Three Year], dated as
of July 15, 2002, between the Company and Scott J. McLean.
***+10.22 -- Form of Change in Control Agreement [Two Year], dated as of
September 16, 2002, between the Company and Paul A. Port.
***21.1 -- List of subsidiaries of the Company
***23.1 -- Consent of PricewaterhouseCoopers LLP
***99.1 -- Certification of the Chief Executive Officer Pursuant to 18
U.S.C. Section 1350, Adopted Pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
***99.2 -- Certification of the Chief Financial Officer Pursuant to 18
U.S.C. Section 1350, Adopted Pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.

- ---------------

* 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 Company's Form S-1 Registration Statement No. 333-16509.

** This Exhibit is not filed herewith because it meets the exclusion set forth
in Section 601(b)(4)(iii)(A) of Regulation S-K and the Company hereby agrees
to furnish a copy thereof to the Commission upon request.

*** Filed herewith.

+ Management contract or compensatory plan or arrangement.

44

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/ PAUL B. MURPHY, JR.
------------------------------------
Paul B. Murphy, Jr.
President and Chief Executive
Officer

Date: March 6, 2003

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.

46

I, Paul B. Murphy, Jr., certify that:

1. I have reviewed this annual report on Form 10-K of Southwest
Bancorporation of Texas, Inc.;

2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this annual
report;

3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this annual report;

4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:

a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities,
particularly during the period in which this annual report is being
prepared;

b) evaluated the effectiveness of the registrant's disclosure
controls and procedures as of December 31, 2002 (the "Evaluation Date");
and

c) presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;

5. The registrant's other certifying officers and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors:

a) all significant deficiencies in the design or operation of
internal controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have identified
for the registrant's auditors any material weaknesses in internal controls;
and

b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's internal
controls; and

6. The registrant's other certifying officers and I have indicated in this
annual report whether or not there were significant changes in internal controls
or in other factors that could significantly affect internal controls subsequent
to the date of our most recent evaluation, including any corrective actions with
regard to significant deficiencies and material weaknesses.

Dated February 25, 2003

/s/ PAUL B. MURPHY, JR.
--------------------------------------
Paul B. Murphy, Jr.
Director, President and Chief
Executive Officer

47

I, Randall E. Meyer, certify that:

1. I have reviewed this annual report on Form 10-K of Southwest
Bancorporation of Texas, Inc.;

2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this annual
report;

3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this annual report;

4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:

a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities,
particularly during the period in which this annual report is being
prepared;

b) evaluated the effectiveness of the registrant's disclosure
controls and procedures as of December 31, 2002 (the "Evaluation Date");
and

c) presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;

5. The registrant's other certifying officers and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors:

a) all significant deficiencies in the design or operation of
internal controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have identified
for the registrant's auditors any material weaknesses in internal controls;
and

b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's internal
controls; and

6. The registrant's other certifying officers and I have indicated in this
annual report whether or not there were significant changes in internal controls
or in other factors that could significantly affect internal controls subsequent
to the date of our most recent evaluation, including any corrective actions with
regard to significant deficiencies and material weaknesses.

Dated February 25, 2003

/s/ RANDALL E. MEYER
--------------------------------------
Randall E. Meyer
Executive Vice President and Chief
Financial Officer

48

SOUTHWEST BANCORPORATION OF TEXAS, INC. AND SUBSIDIARIES

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

49

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, of changes in shareholders' equity, and of
cash flows present fairly, in all material respects, the consolidated financial
position of Southwest Bancorporation of Texas, Inc. and Subsidiaries (the
"Company") at December 31, 2002 and 2001, and the consolidated results of their
operations and their cash flows for each of the three years in the period ended
December 31, 2002 in conformity with accounting principles generally accepted in
the United States of America. These financial statements are the responsibility
of the Company's management; our responsibility is to express an opinion on
these financial statements based on our audits. We conducted our audits of these
statements in accordance with auditing standards generally accepted in the
United States of America, which require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements, assessing
the accounting principles used and significant estimates made by management, and
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion.

PRICEWATERHOUSECOOPERS LLP

Houston, Texas
February 28, 2003

50

SOUTHWEST BANCORPORATION OF TEXAS, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEET

The accompanying notes are an integral part of the consolidated financial
statements.
51

SOUTHWEST BANCORPORATION OF TEXAS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENT OF INCOME

The accompanying notes are an integral part of the consolidated financial
statements.
52

SOUTHWEST BANCORPORATION OF TEXAS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS' EQUITY

The accompanying notes are an integral part of the consolidated financial
statements.
53

SOUTHWEST BANCORPORATION OF TEXAS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENT OF CASH FLOWS

The accompanying notes are an integral part of the consolidated financial
statements.
54

SOUTHWEST BANCORPORATION OF TEXAS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT 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 direct and indirect
wholly-owned subsidiaries. The consolidated financial statements also include
the accounts of First National Bank of Bay City, a 58% owned indirect subsidiary
of the Company, through November 1, 2002. On this date, the Company sold its
interest in this subsidiary and recognized a gain of approximately $1,068, which
has been recorded as a component of other operating income in the 2002
consolidated statement of income. The results of operations of First National
Bank of Bay City were insignificant to the consolidated Company. All material
intercompany accounts and transactions have been eliminated.

Substantially all of the Company's revenue and income is derived from the
operations of Southwest Bank of Texas National Association (the "Bank") and
Mitchell Mortgage Company, LLC ("Mitchell"). 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. Mitchell originates, sells and
services single family residential mortgages, residential and commercial
construction loans and commercial mortgages.

MANAGEMENT'S ESTIMATES

The preparation of financial statements in conformity with accounting
principles generally accepted in the United States of America requires
management to make estimates and assumptions that affect the reported amounts 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 an original 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 maintains noninterest-bearing cash reserve balances with the
Federal Reserve Bank. The average of such cash balances was approximately
$13,028 and $9,924 for the years ended December 31, 2002 and 2001, respectively.

SECURITIES

Debt 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 had no held to
maturity debt securities at December 31, 2002 and 2001.

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 temporary 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

55

SOUTHWEST BANCORPORATION OF TEXAS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

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 fair value. Realized and unrealized gains
and losses on trading securities are recognized in the consolidated statement of
income as they occur. The Company held no trading securities at December 31,
2002 and 2001.

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, as a realized loss, 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 held for investment are reported at the principal amount outstanding,
net of unearned discounts, deferred loan fees and the allowance for loan losses.
Interest income is accrued on the unpaid principal balance.

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 collection of interest and 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
management believes 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. An insignificant delay (up to 90 days) or insignificant shortfall in
the amount of payment does not constitute an impairment. 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. All nonaccrual loans and accruing loans 90 or more
days past due are considered impaired at December 31, 2002.

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 accrued interest is
reversed. Interest income is subsequently recognized only to the extent cash
payments are received.

Loans held for sale are carried at the lower of cost or market, which is
computed by the aggregate method (unrealized losses are offset by unrealized
gains). The carrying amount of loans held for sale in the near-term is adjusted
by gains and losses generated from corresponding hedging transactions entered
into to protect loss of value from increases in interest rates. Hedge positions
are also used to protect the pipeline of loan applications in process from
increases in interest rates. Gains and losses resulting from changes in the
market value of the inventory and open hedge positions are netted.

56

SOUTHWEST BANCORPORATION OF TEXAS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

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 is based on
evaluations of the collectibility and prior loss experience of loans. 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 and the evaluation of its loan portfolio by the loan review function.

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 are
reported in the period such adjustments become known or are reasonably
estimable.

LOAN FEES AND COSTS

Nonrefundable loan origination and commitment fees net of certain direct
costs associated with originating loans are deferred and recognized as an
adjustment to the related loan 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 thirty to forty years for premises, three to five years for hardware and
software, and five 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 are included in other operating expenses in the accompanying
consolidated statement of income.

INVESTMENTS IN UNCONSOLIDATED INVESTEES

Investments in unconsolidated investees are accounted for using the equity
method of accounting when the Company has the ability to exercise significant
influence, but not control, over the investees.

57

SOUTHWEST BANCORPORATION OF TEXAS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

MORTGAGE SERVICING

Mortgage servicing rights represent the right to receive future mortgage
servicing fees. The Company recognizes as separate assets the right to service
mortgage loans for others, whether the servicing rights are acquired through a
separate purchase or through loan origination by allocating total costs incurred
between the loan and the servicing rights retained based on their relative fair
values. Mortgage servicing rights are amortized in proportion to, and over the
period of, estimated net servicing income. The Company periodically evaluates
the carrying value of the mortgage servicing rights in relation to the present
value of the estimated future net servicing revenue based on management's best
estimate of the amount and timing of expected future cash flows, including
assumptions about loan repayment rates, credit loss experience, and costs to
service, as well as discount rates that consider the risk involved.

Mortgage servicing rights are reported as a component of other assets in
the accompanying consolidated balance sheet. Fair values are based on quoted
market prices in active markets for loans and loan servicing rights. For
purchased mortgage servicing rights, the cost of acquiring loan servicing
contracts is capitalized to the extent such costs do not exceed the amount by
which the present value of estimated future servicing revenue exceeds the
present value of expected future servicing costs.

Mortgage loans serviced for others are not included in the consolidated
balance sheet. The unpaid principal balance of mortgage loans serviced for
others was approximately $1,068,000, $1,281,000 and $1,317,000 at December 31,
2002, 2001 and 2000, respectively.

Custodial escrow balances maintained in connection with the foregoing loan
servicing, and included in demand deposits, were approximately $30,177 and
$44,991 at December 31, 2002 and 2001, respectively.

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, adjusted for any changes in
income that would result from the assumed conversion of all potential dilutive
common shares, 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.

INCOME TAXES

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.

STOCK-BASED COMPENSATION

The Company applies the intrinsic value method in accounting for its
stock-based compensation plans in accordance with Accounting Principles Board
Opinion No. 25 ("APB 25"). In 1995, the Financial Accounting Standards Board
issued Statement of Financial Accounting Standards No. 123, Accounting for
Stock-Based Compensation, ("SFAS No. 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 No. 123 is optional and the Company
decided not to elect these provisions of SFAS No. 123. However, pro forma
disclosures as if the Company adopted the expense recognition provisions of SFAS
No. 123 are required by SFAS No. 123 and are presented below.
58

SOUTHWEST BANCORPORATION OF TEXAS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

If the fair value based method of accounting under SFAS No. 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):

The effects of applying SFAS No. 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.

DERIVATIVE FINANCIAL INSTRUMENTS

The Company recognizes all derivative financial instruments, such as
forward option contracts and commitments to sell mortgage loans, in the
consolidated financial statements at fair value regardless of the purpose or
intent for holding the instrument. Changes in the fair value of derivative
financial instruments are either recognized periodically in income or in
shareholders' equity as a component of other comprehensive income depending on
whether the derivative financial instrument qualifies for hedge accounting, and
if so, whether it qualifies as a fair value hedge or a cash flow hedge.
Generally, changes in fair values of derivatives accounted for as fair value
hedges are recorded in income along with the portions of the changes in the fair
value of the hedged items that relate to the hedged risk(s). Changes in fair
values of derivatives accounted for as cash flow hedges, to the extent they are
effective as hedges, are recorded in other comprehensive income net of deferred
taxes. Changes in fair values of derivatives not qualifying as hedges are
reported in the statement of income.

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,
commitments to sell mortgage loans, 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

On June 29, 2001, the Financial Accounting Standards Board ("FASB")
approved Statement of Financial Accounting Standards ("SFAS") No. 141, Business
Combinations and SFAS No. 142, Goodwill and Other Intangible Assets. SFAS No.
141 amends APB Opinion No. 16, Business Combinations, to prohibit

59

SOUTHWEST BANCORPORATION OF TEXAS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

use of the pooling-of-interests (pooling) method of accounting for business
combinations initiated after June 30, 2001 and require the use of purchase
accounting.

Goodwill generated from purchase business combinations consummated prior to
the issuance of SFAS No. 142 was amortized on a straight-line basis over 20
years. SFAS No. 142 addresses the initial recognition and measurement of
intangible assets acquired outside a business combination and the recognition
and measurement of goodwill and other intangible assets subsequent to
acquisition. Under the new standard, goodwill and intangible assets deemed to
have indefinite lives will no longer be amortized, but instead will be tested at
least annually for impairment. The Company adopted this standard on January 1,
2002 and the impact of adoption was immaterial.

On October 24, 2002, the FASB approved SFAS No. 147, Acquisitions of
Certain Financial Institutions. SFAS No. 147 amends previously issued guidance
regarding the accounting and reporting for the acquisition of all or part of a
financial institution. The statement also provides guidance on the accounting
for impairment of core deposits. It is effective for acquisitions after October
1, 2002. This standard will impact any acquisitions the Company makes beginning
in 2003.

On December 31, 2002, the FASB approved SFAS No. 148, Accounting for
Stock-Based Compensation-Transition and Disclosure, an amendment of FASB
Statement No. 123. SFAS No. 148 amends SFAS No. 123, Accounting for Stock-Based
Compensation, to provide alternative methods of transition for an entity that
voluntarily changes to the fair value based method of accounting for stock-based
employee compensation. It also amends the disclosure provisions of SFAS No. 123
to require prominent disclosure about the effects on reported net income of an
entity's accounting policy decisions with respect to stock-based employee
compensation. Finally, it amends APB Opinion No. 28, Interim Financial
Reporting, to require disclosure about those effects in interim financial
information. The Company does not expect the adoption of this standard to have a
material effect on its financial condition or results of operations.

On November 25, 2002, the FASB issued FASB Interpretation No. 45, ("FIN No.
45") Guarantor's Accounting and Disclosure Requirements for Guarantees,
Including Indirect Guarantees of Indebtedness of Others. FIN No. 45 considers
standby letters of credit, excluding commercial letters of credit and other
lines of credit, a guarantee of the Bank. The Bank enters into a standby letter
of credit to guarantee performance of a customer to a third party. These
guarantees are primarily issued to support public and private borrowing
arrangements. The credit risk involved is represented by the contractual amounts
of those instruments. Under the standby letters of credit, the Bank is required
to make payments to the beneficiary of the letters of credit upon request by the
beneficiary so long as all performance criteria have been met. Most guarantees
extend up to one year. At December 31, 2002 the maximum potential amount of
future payments is $166,822. See "Note 16 -- Financial Instruments with
Off-Balance Sheet Risk and Concentration of Credit Risk" for a discussion of
significant guarantees that have been entered into by the Company. The Company
does not expect the requirements of FIN No. 45 to have a material impact on its
financial condition or results of operations.

On January 17, 2003, the FASB issued Interpretation No. 46, ("FIN No. 46")
Consolidation of Variable Interest Entities, which addresses consolidation by
business enterprises of variable interest entities. FIN No. 46 clarifies the
application of Accounting Research Bulletin No. 51 ("ARB No. 51"), Consolidated
Financial Statements, to certain entities in which equity investors do not have
the characteristics of a controlling financial interest or do not have
sufficient equity at risk for the entity to finance its activities without
additional subordinated financial support from other parties. FIN No. 46 applies
immediately to variable interest entities created after January 31, 2003, and to
variable interest entities in which an enterprise obtains an interest after that
date. It applies in the first fiscal year or interim period beginning after June
15, 2003, to variable interest entities in which an enterprise holds a variable
interest that it acquired before February 1, 2003. The Company does not expect
the requirements of FIN No. 46 to have a material impact on its financial
condition or results of operations.
60

SOUTHWEST BANCORPORATION OF TEXAS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

SEGMENT INFORMATION

In accordance with SFAS No. 131, Disclosure about Segments of an Enterprise
and Related Information, the Company uses the "management approach" for
reporting business segment information. The management approach designates the
internal organization that is used by management for making operating decisions
and assessing performance as the source of the Company's reportable segments.

The Company considers its business as two operating segments: the bank and
the mortgage company. The Company has disclosed results of operations relating
to the two segments in Note 15 to the consolidated financial statements.

RECLASSIFICATIONS

Certain previously reported amounts have been reclassified to conform to
the 2002 financial statement presentation. These reclassifications had no effect
on net income or stockholders' equity.

2. MERGERS

On December 29, 2000, the Company consummated its merger with Citizens.
Citizens was a multi-bank holding company and the parent company of Citizens
Bank and Trust Co., Baytown State Bank and Pasadena State Bank (which also were
merged into the Bank on December 29, 2000) and the majority owner of First
National Bank of Bay City. In accordance with the Agreement and Plan of Merger,
the Company exchanged 249.443 shares of the Company's common shares for each
share of Citizens common stock, resulting in the issuance of approximately 3.9
million shares of Company Common Stock on a fully diluted basis. At December 29,
2000, Citizens had total assets of approximately $436,000 and total deposits of
approximately $381,000. In a related transaction, the Company, CBLP and Baytown
Land I, Ltd., the general partner of CBLP, entered into an agreement pursuant to
which the Company acquired the assets and assumed the liabilities of CBLP.
CBLP's primary assets and liabilities were the building in which Citizens main
branch was located and the related debt to third parties. In connection with
this agreement, the Company issued approximately 106,000 shares of the Company's
Common Stock on a fully diluted basis. These transactions have been accounted
for as a pooling of interests.

61

SOUTHWEST BANCORPORATION OF TEXAS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

The Company's consolidated financial statements have been restated to
include the accounts and operations of Citizens and CBLP for all periods
presented. Separate interest income and net income amounts of the merged
entities are presented in the following table:

3. SECURITIES

The amortized cost and fair value of securities classified as available for
sale is as follows:

62

SOUTHWEST BANCORPORATION OF TEXAS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

The scheduled maturities of securities classified as available for sale is
as follows:

Securities with a carrying value of $700,715 and $675,658 at December 31,
2002 and 2001, respectively, have been pledged to collateralize repurchase
agreements, public deposits, Federal Home Loan Bank borrowings and other items.

In connection with the Citizens merger on December 29, 2000, the Company
transferred all of Citizens' held to maturity debt securities to the available
for sale category. The amortized cost of these securities at the time of
transfer was $55,800 and the unrealized gain was $267 ($174 net of income
taxes).

Gross gains of $2,299, $602 and $307 and gross losses of $562, $588 and
$774 were recognized on sales of investment securities for the years ended
December 31, 2002, 2001 and 2000, respectively. The tax benefit (expense)
applicable to these net realized gains and losses was ($608), ($5) and $163,
respectively.

4. LOANS

A summary of loans outstanding follows:

63

SOUTHWEST BANCORPORATION OF TEXAS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

An analysis of the allowance for loan losses, which includes activity
related to allowances on impaired loans calculated in accordance with SFAS No.
114 and activity related to other loan loss allowances determined in accordance
with SFAS No. 5, is as follows:

The following is a summary of loans considered to be impaired:

The average recorded investment in impaired loans during 2002, 2001, and
2000 was $22,085, $15,528, and $9,347, respectively. Interest income on impaired
loans of $456, $425, and $1,056 was recognized for cash payments received in
2002, 2001 and 2000, respectively. The decrease in the valuation allowance
related to impaired loans is the result of a change in the composition of these
loans and charge-offs recorded in 2002.

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. The aggregate
amount of term loans to such related parties was $46,562 and $11,838 at December
31, 2002 and 2001, respectively. Following is an analysis of activity with
respect to these amounts:

64

SOUTHWEST BANCORPORATION OF TEXAS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

5. PREMISES AND EQUIPMENT

Premises and equipment consist of the following:

6. OTHER ASSETS

Other assets consist of the following:

Investments in unconsolidated investees represent equity investments in
enterprises that primarily make investments in middle market businesses in the
form of debt and equity capital. Unfunded commitments to unconsolidated
investees were approximately $5,726 at December 31, 2002. The Company has no
other guarantees of investee activity.

7. MORTGAGE SERVICING RIGHTS

The Company originates, sells and services single family residential
mortgages and commercial mortgages through its ownership of Mitchell. Through
Mitchell, the Company also originates and services residential and commercial
construction loans. The Company periodically evaluates the carrying value of the
mortgage servicing rights in relation to the present value of the estimated
future net servicing revenue based on management's best estimate of the amount
and timing of expected future cash flows. Any excess carrying value is recorded
as a valuation allowance with the provision recorded as a component of other fee
income in the accompanying statement of income.

65

SOUTHWEST BANCORPORATION OF TEXAS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

The following table summarizes the changes in capitalized mortgage
servicing rights for the periods indicated:

The fair value of these servicing rights was approximately $9,793 and
$13,574 at December 31, 2002 and 2001, respectively. The fair value of servicing
rights was determined using discount rates ranging from 10.0% to 20.5% and
prepayment speeds ranging from 363.7% to 1,047.7% of standard Public Securities
Association prepayment speeds, depending upon the stratification of the specific
mortgage servicing right.

The managed servicing portfolio totaled $1,068,000 at December 31, 2002 and
$1,281,000 at December 31, 2001. Capitalized mortgage servicing rights represent
77 basis points and 94 basis points of the portfolio serviced at December 31,
2002 and 2001, respectively.

To the extent that capitalized mortgage servicing rights exceed fair value,
a valuation allowance is recorded. During the third quarter of 2002, due to the
significant decline in interest rates, the fair value of the Company's
capitalized mortgage servicing rights declined. As a result, the Company
recorded a $2,700 valuation allowance. Management believes the decline in the
fair value of capitalized mortgage servicing rights should be considered
temporary. The following table summarizes the changes in the valuation allowance
for capitalized mortgage servicing rights for the period indicated:

The provision for capitalized mortgage servicing rights in excess of fair
value and subsequent recovery are included in the other fee income in the
consolidated statement of income for the year ended December 31, 2002. No such
provision was recognized in prior years.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

8. DEPOSITS

At December 31, 2002, scheduled maturities of time deposits are summarized
as follows:

At December 31, 2002 and 2001, the aggregate amount of deposits from
related parties was $111,875 and $91,464, respectively.

Brokered deposits were $149,351 and $300 at December 31, 2002 and 2001,
respectively. The growth in brokered deposits is attributable to a major new
treasury management relationship whereby the Bank provides banking and treasury
management services to mortgage companies throughout the United States. Under
this relationship, a referring source, whose business is to lend money to
mortgage companies, introduces its customers to the Bank. Deposits garnered as a
result of those introductions are classified as brokered deposits for financial
and regulatory reporting purposes.

67

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

9. SECURITIES SOLD UNDER REPURCHASE AGREEMENTS AND OTHER BORROWINGS

Securities sold under repurchase agreements and other borrowings generally
represent borrowings with maturities ranging from one to thirty days. Short-term
borrowings consist of federal funds purchased and other bank borrowings. The
Company's long-term borrowings generally consist of borrowings with the Federal
Home Loan Bank maturing within one year. Information relating to these
borrowings is summarized as follows:

Securities sold under repurchase agreements generally include U.S.
Government and agency 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 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 by the
Bank were approximately $353,300 and $132,700 at December 31, 2002 and 2001,
respectively, and are included as a component of other borrowings in the
accompanying consolidated balance sheet. 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, 2002 was
approximately $286,000.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

At December 31, 2002, the contractual maturities of long-term borrowings
are as follows:

10. INCOME TAXES

The income tax provision (benefit) for the years ended December 31, 2002,
2001 and 2000 is composed of the following:

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:

In connection with the Company's merger with Citizens and CBLP in 2000, the
Company recorded deferred tax assets of $2,669 with an offsetting credit to
additional paid in capital related to differences in the

69

SOUTHWEST BANCORPORATION OF TEXAS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

tax bases of assets and liabilities and their financial reporting amounts. Such
deferred taxes were not previously recorded by CBLP as it was organized as a
limited partnership.

The reconciliation between the Company's effective income tax rate and the
statutory federal income tax rate is as follows:

11. 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 STOCK OPTION PLAN

Under the 1996 Stock Option Plan, the Company is authorized to issue up to
4,500,000 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 638,000, 386,725 and 636,605 stock options in 2002,
2001 and 2000, 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.

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 stock options having exercise prices equal to the fair market
value on the date of grant). The Company has recognized $19, $33 and $4 of
compensation expense in connection with these grants in 2002, 2001 and 2000,
respectively.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

A summary of the status of the Company's stock options as of December 31,
2002, 2001, and 2000 and the change during the years is as follows:

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 2002, 2001 and 2000: dividend yield
of 0.00%: risk-free interest rates of 4.33%, 5.92% and 6.47%, respectively; the
expected lives of options of 5 years; and a volatility of 29.76%, 29.26% and
29.30%, respectively. The weighted average fair value of options granted during
the year is as follows:

The following table summarizes information about stock options outstanding
and exercisable at December 31, 2002:

- ---------------

* All options, with an exercise price between $0.20 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.

THE RESTRICTED STOCK PLAN

Under the Restricted Stock Plan implemented in 2001, the Company is
authorized to issue up to 300,000 shares of common stock pursuant to "Awards"
granted thereunder. The shares of common stock are issued to the participant at
the time the Award is made or at some later date, and the shares are subject to
certain

71

SOUTHWEST BANCORPORATION OF TEXAS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

restrictions against disposition and certain obligations to forfeit such shares
to the Company under certain circumstances.

The Company granted Awards covering 118,000 and 47,335 shares of common
stock at a weighted-average fair value of $32.29 and $31.75 in 2002 and 2001,
respectively. The shares covered by these Awards generally vest over a five year
period commencing on the date of grant; provided, however, that 100% of the
shares may vest earlier if certain performance standards have been met by the
Company. None of these shares are exercisable at December 31, 2002.

In accordance with APB 25, compensation expense is recognized for the
performance-based Awards granted under the Restricted Stock Plan. The Company
has recognized $834 and $200 of compensation expense in connection with the
above Awards in 2002 and 2001, respectively.

NON-EMPLOYEE DIRECTORS DEFERRED FEE PLAN

On November 28, 2001, the Directors of the Company approved and adopted a
Non-Employee Directors Deferred Fee Plan, pursuant to which each Director of the
Company and each Director of the Bank may elect to defer receipt of all or
one-half of his compensation for serving as a director, committee member or
committee chairman for a period of time selected by the Director that terminates
no later than the date he ceases to be a Board member. The deferred amounts
credited to his account during each calendar quarter are deemed to be invested
in a number of shares of the Company's common stock determined by dividing the
amount of the Director's compensation deferred for that quarter by the closing
sale price of the common stock reported by NASDAQ on the last trading day of the
quarter and multiplying that result by 1.25 (rounding up to the nearest whole
share). Payment from the Director's account will commence as soon as reasonably
practicable after the earlier of the director's termination as a member of the
Company's or Bank's Board of Directors or the date specified by the director
when he elects to make the deferral. The payment from each account will be
either lump sum or up to five installments of the Company's common stock. A
total of 25,000 shares of Company common stock have been reserved for issuance
under the Non-Employee Directors Deferred Fee Plan. The Company has credited
7,015 phantom stock units to Director accounts under this plan.

BENEFIT PLANS

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 100% of the employee
contributions not to exceed 5% of the employee's annual compensation. Total plan
expense charged to the Company's operations for the years ended December 31,
2002, 2001 and 2000 was $2,510, $2,246 and $1,744, respectively.

The 401(k) Plan provides that the Company may contribute shares of common
stock of the Company (valued at the approximate fair market value on the date of
contribution) instead of cash. No shares were issued to the 401(k) Plan in 2002,
2001, and 2000.

Prior to December 31, 2000, Citizens had a defined benefit pension plan
covering substantially all of their employees. The benefits under the plan were
based on years of service and the employee's final average monthly compensation.
Effective December 31, 2000, the Company curtailed the defined benefit pension
plan. Pursuant to the curtailment, no further benefits will be accrued under the
plan from and after December 31, 2000 and no individual who is not currently a
participant in the plan shall be eligible to become a participant in the plan.
Each participant who was an employee at December 31, 2000 became 100% vested in
his or her

72

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

accrued benefit on December 31, 2000. The total pension benefit obligation under
the plan is immaterial to the consolidated financial statements.

The three wholly-owned subsidiary banks of Citizens had a profit sharing
plan covering substantially all of their employees. The profit sharing plan was
funded on an annual basis as determined by the Banks' Boards of Directors.
Contributions to the profit sharing plan were $573 for the year ended December
31, 2000. Effective October 1, 2000, the profit sharing plan was converted to
Citizens' 401(k) plan.

12. EARNINGS PER COMMON SHARE

Earnings per common share is computed as follows:

Stock options outstanding of 148,734, 94,759, and 8,644 for the years ended
December 2002, 2001, and 2000, respectively, have not been included in diluted
earnings per share because to do so would have been antidilutive for the periods
presented. Stock options are antidilutive when the exercise price is higher than
the current market price of the Company's common stock.

13. COMMITMENTS AND CONTINGENCIES

LITIGATION

The Company is involved in various litigation that arises in the normal
course of business. In the opinion of management, 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, 2002 the Company has certain noncancelable operating leases
which cover the company's premises with approximate future minimum annual rental
payments as follows:

2003........................................................ $ 4,605
2004........................................................ 4,539
2005........................................................ 4,396
2006........................................................ 3,625
2007........................................................ 461
Thereafter.................................................. 5,558
-------
$23,184
=======

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SOUTHWEST BANCORPORATION OF TEXAS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

The Company leases a portion of the available space in owned buildings that
is not utilized. Lease rental income for years ended December 31, 2002, 2001 and
2000 was $1,474, $737, and $1,273, respectively. Rent expense for the years
ended December 31, 2002, 2001 and 2000 was $5,438, $6,487, and $4,672,
respectively.

At December 31, 2002, future minimum lease payments to be received from
long-term leases are as follows:

2003........................................................ $ 1,911
2004........................................................ 1,744
2005........................................................ 1,642
2006........................................................ 1,512
2007........................................................ 1,050
Thereafter.................................................. 1,308
-------
$ 9,167
=======

14. 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, 2002, the Company's and Bank's Tier 1 capital
consists of their respective shareholders' equity adjusted for minority interest
in equity accounts of consolidated subsidiaries, goodwill, and various other
intangibles and Tier 2 consists of the allowance for loan 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.

As of December 31, 2002, the most recent notification from the regulators
categorized the Bank and the Company as "well 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.

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SOUTHWEST BANCORPORATION OF TEXAS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

The following table compares the Company's and the Bank's leverage and
risk-weighted capital ratios as of December 31, 2002 and 2001 to the minimum
regulatory standards:

The Company and the Bank are also subject to certain restrictions on the
amount of dividends that they may declare without prior regulatory approval.

15. SEGMENT INFORMATION

The Company has two operating segments: the bank and the mortgage company.
Each segment is managed separately because each business requires different
marketing strategies and each offers different products and services.

The Company evaluates each segment's performance based on the revenue and
expense from its operations. Intersegment financing arrangements are accounted
for at current market rates as if they were with third parties.

75

SOUTHWEST BANCORPORATION OF TEXAS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

Summarized financial information by operating segment for the years ended
December 31, 2002, 2001 and 2000 follows:

Intersegment interest was paid to the Bank by the mortgage company in the
amount of $6,201, $9,899, and $13,742 for the years ended December 31, 2002,
2001 and 2000, respectively. Advances from the Bank to the mortgage company of
$263,954 , $243,029, and $280,779 were eliminated in consolidation at December
31, 2002, 2001 and 2000, respectively.

76

SOUTHWEST BANCORPORATION OF TEXAS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

16. FINANCIAL INSTRUMENTS WITH OFF-BALANCE SHEET RISK AND CONCENTRATIONS OF
CREDIT RISK

In the normal course of business, the Company becomes a party to various
financial transactions that generally do not involve funding. These transactions
involve various risks, including market and credit risk. Since these
transactions generally are not funded, they do not necessarily represent future
liquidity requirements. They are referred to as financial instruments with
off-balance sheet risk and are not reflected on the balance sheet. The Company
offers these financial instruments to enable its customers to meet their
financing objectives and to manage their interest rate risk. Supplying these
instruments provides the Company with an ongoing source of fee income. These
financial instruments include loan commitments, letters of credit, commitments
to sell mortgage loans to permanent investors and financial guarantees on GNMA
mortgage-backed securities administered. These financial instruments involve, to
varying degrees, elements of credit risk in excess of the amounts recognized in
the financial statements.

The approximate contractual amounts of financial instruments with
off-balance sheet risk are as follows:

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. Commitments to extend credit are agreements to
lend to a customer as long as there is no violation of any condition established
in the contract. Commitments generally have fixed expiration dates or other
termination clauses and may require payment of a fee. Since many of the
commitments are expected to expire without being fully drawn upon, the total
commitment amounts do 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 contract amounts for commitments to sell mortgage loans to permanent
investors represent an agreement to sell mortgages currently in the process of
funding and commitment terms are generally less than 90 days. The balance at any
given date represents recent activity at the mortgage company. The contract
amount does not represent exposure to credit loss.

The Company administers GNMA mortgage-backed securities on which it
guarantees payment of monthly principal and interest to the security holders.
The underlying loans are guaranteed by FHA and VA mortgage insurance and are
collateralized by real estate. In the event of mortgagor default, the Company
may only incur losses of costs that may exceed reimbursement limitations
established by FHA or VA. The Company believes its exposure is immaterial, and
the contract amount does not represent the Company's exposure to credit loss.

The Company originates real estate, commercial, construction and consumer
loans primarily to customers in the eight county area in and around Houston.
Although the Company has a diversified loan portfolio, a

77

SOUTHWEST BANCORPORATION OF TEXAS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

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.

17. FAIR VALUES OF FINANCIAL INSTRUMENTS

The fair value of financial instruments provided below represents 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.

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 believed to be
significant.

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. The fair value of stock in the Federal Home Loan Bank of Dallas
and the Federal Reserve Bank 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.

Loans Held for Sale: Fair values of loans held for sale are estimated
based on outstanding commitments from investors or current market prices for
similar loans.

Loans 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.

Derivatives. Fair value is defined as the amount that the Company would
receive or pay to terminate the contracts at the reporting date. Market or
dealer quotes were used to value the instruments.

78

SOUTHWEST BANCORPORATION OF TEXAS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

Off-Balance-Sheet Instruments: The fair values of the Company's lending
commitments, letters of credit, commitments to sell loans and guarantees 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. The fair value of the Company's option contracts are based on the
estimated amounts the Company would receive from terminating the contracts at
the reporting date.

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 with similar remaining maturities. The carrying amount of accrued
interest approximates its fair value.

Borrowings: The carrying amounts of federal funds purchased, securities
sold under repurchase agreements, and other borrowings approximate their fair
values.

The following table summarizes the carrying values and estimated fair
values of financial instruments (all of which are held for purposes other than
trading):

The fair value of the Company's derivatives and off-balance sheet
instruments was immaterial at December 31, 2002 and 2001.

79

SOUTHWEST BANCORPORATION OF TEXAS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

18. SUPPLEMENTAL CASH FLOW INFORMATION

Supplemental cash flow information for the years ended December 31, 2002,
2001, and 2000 is as follows:

19. PARENT COMPANY ONLY CONDENSED FINANCIAL STATEMENTS

The balance sheet, statement of income and statement of cash flows for the
parent company are as follows:

BALANCE SHEET

80

SOUTHWEST BANCORPORATION OF TEXAS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

STATEMENT OF INCOME

81

SOUTHWEST BANCORPORATION OF TEXAS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

STATEMENT OF CASH FLOWS

82

EXHIBIT INDEX

(c) *Exhibits

3.1 -- Articles of Incorporation of the Company, restated as of May
1, 2001 (incorporated by reference to Exhibit 4.1 to the
Company's Form S-8 Registration Statement No. 333-60190)
3.2 -- Bylaws of the Company (Restated as of December 31, 1996)
4.1 -- Specimen Common Stock certificate
**4.2 -- Loan Agreement (and form of $10,000,000 Promissory Note)
dated March 30, 2000, between the Company and Bank of
Oklahoma, N.A.
**4.3 -- Loan Agreement (and form of $5,000,000 Promissory Note)
dated June 30, 2000, between the Company and Bank of
Oklahoma, N.A.
**4.4 -- Assumption and Modification Agreement dated December 29,
2000 and First Amendment thereto dated January 10, 2001,
between Southwest Bank of Texas National Association and
American General Life and Accident Insurance Company,
relating to Third Modification of Promissory Note (in the
original principal amount of $6,250,000), Deed of Trust and
Security Agreement and of Assignment of Leases and Rents
+10.1 -- 1989 Stock Option Plan, amended and restated as of May 29,
1998 (incorporated by reference to Exhibit 10.1 to the
Company's Quarterly Report on Form 10-Q for the quarterly
period ended March 31, 2000)
+10.2 -- 1993 Stock Option Plan, amended and restated as of May 29,
1998 (incorporated by reference to Exhibit 10.2 to the
Company's Quarterly Report on Form 10-Q for the quarterly
period ended March 31, 2000)
+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 January 24, 2000
(incorporated by reference to Exhibit 10.4 to the Company's
Annual Report on Form 10-K for the year ended December 31,
1999)
+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 -- Form of Stock Option Agreement for Directors under 1996
Stock Option Plan (incorporated by reference to Exhibit 10.8
to the Company's Form S-1 Registration Statement No.
333-16509)
+10.8 -- Form of Change in Control Agreement, dated as of January 1,
2000, between the Company and each of Joseph H. Argue, J.
Nolan Bedford, David C. Farries, James R. Massey, Randall E.
Meyer and Steve D. Stephens (incorporated by reference to
Exhibit 10.2 to the Company's Quarterly Report on Form 10-Q
for the quarterly period ended June 30, 2000)
***+10.9 -- Form of Change in Control Agreement, dated as of January 1,
2000, between the Company and each of John Drew, Debra
Innes, Marylyn Manis, George Marshall and John McWhorter.
***+10.10 -- Form of Change in Control Agreement, dated as of January 1,
2001, between the Company and each of Dale Andreas, Kenneth
Olan, Barbara Vilutis and Lane Ward.
+10.11 -- Employment Agreement, amended and restated as of February
17, 2001, between the Company and Walter E. Johnson
(incorporated by reference to Exhibit 10.11 to the Company's
Annual Report on Form 10-K for the year ended December 31,
2000)
+ 10.12 -- Employment Agreement between the Company and John H. Echols,
dated as of December 31, 2000 (incorporated by reference to
Exhibit 10.1 to the Company's Current Report on Form 8-K
filed January 2, 2001)
+ 10.13 -- Restricted Stock Plan (incorporated by reference to Appendix
B to the Company's Proxy Statement dated March 16, 2001 for
its 2001 Annual Meeting of Shareholders)
+10.14 -- Form of Restricted Stock Agreement under the Restricted
Stock Plan (incorporated by reference to Exhibit 4.6 to the
Company's Form S-8 Registration Statement No. 333-60190)
+10.15 -- Non-Employee Directors Deferred Fee Plan (incorporated by
reference to Exhibit 4.3 to the Company's Form S-8
Registration Statement No. 333-74452)

+10.16 -- Form of Deferral Election Form under Non-Employee Directors Deferred Fee Plan (incorporated by
reference to Exhibit 4.4 to the Company's Form S-8 Registration Statement No. 333-74452)
10.17 -- Purchase and Sale Agreement between TCP Renaissance Partners, L.P. and Southwest Bank of Texas,
N.A., dated May 24, 2002 (incorporated by reference to Exhibit 10.1 to the Company's Quarterly
Report on Form 10-Q for the quarterly period ended September 30, 2002).
+10.18 -- 1996 Stock Option Plan, Amended and Restated as of June 4, 2002 (incorporated by reference to
Exhibit 10.1 to the Company's Quarterly Report on Form 10-Q for the quarterly period ended June 30,
2002).
+10.19 -- Change in Control Agreement between the Company and Paul B. Murphy, Jr., Amended and Restated as of
June 4, 2002 (incorporated by reference to Exhibit 10.2 to the Company's Quarterly Report on Form
10-Q for the quarterly period ended June 30, 2002).
***+10.20 -- First Amendment to Change in Control Agreement [Two Year], dated as of June 4, 2002 between the
Company and Kenneth W. Olan.
***+10.21 -- Form of Change in Control Agreement [Three Year], dated as of July 15, 2002, between the Company and
Scott J. McLean.
***+10.22 -- Form of Change in Control Agreement [Two Year], dated as of September 16, 2002, between the Company
and Paul A. Port.
***21.1 -- List of subsidiaries of the Company
***23.1 -- Consent of PricewaterhouseCoopers LLP
***99.1 -- Certification of the Chief Executive Officer Pursuant to 18 U.S.C. Section 1350, Adopted Pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002.
***99.2 -- Certification of the Chief Financial Officer Pursuant to 18 U.S.C. Section 1350, Adopted Pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002.