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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549


FORM 10-Q

(Mark One)

     
x   QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934
    FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2003
     
o   TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934

Commission file number 000-49928


TEXAS UNITED BANCSHARES, INC.

(Exact name of registrant as specified in its charter)
     
Texas   75-2768656
(State or other jurisdiction of   (I.R.S. Employer Identification No.)
Incorporation or organization)    

202 W. COLORADO
LA GRANGE, TEXAS 78945

(Address of principal executive offices including zip code)

(979) 968-8451
(Registrant’s telephone number, including area code)


          Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities 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 o.

          Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes o No x.

          As of October 31, 2003, the number of outstanding shares of Common Stock, par value $1.00 per share was 4,002,097.




 

TABLE OF CONTENTS

PART I FINANCIAL INFORMATION
Item 1. Condensed Consolidated Financial Statements
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
PART II OTHER INFORMATION
Item 1. Legal Proceedings
Item 2. Changes in Securities and Use of Proceeds
Item 3. Defaults Upon Senior Securities
Item 4. Submission of Matters to a Vote of Security Holders
Item 5. Other Information
Item 6A. Exhibits
Item 6B. Reports on Form 8-K
SIGNATURES
Exhibit Index
Certification of CEO pursuant to Rule 13a-14(a)
Certification of CFO pursuant to Rule 13a-14(a)
Certification of CEO pursuant to Section 906
Certification of CFO pursuant to Section 906

PART I

FINANCIAL INFORMATION

Item 1. Condensed Consolidated Financial Statements.

TEXAS UNITED BANCSHARES, INC. AND SUBSIDIARIES

Consolidated Balance Sheets

(In thousands, except share data)

                       
          September, 30,   December 31,
          2003   2002
         
 
          (Unaudited)        
ASSETS
               
Cash and cash equivalents:
               
 
Cash and due from banks
  $ 15,037     $ 20,574  
 
Federal funds sold and other temporary investments
           
 
   
     
 
   
Total cash and cash equivalents
    15,037       20,574  
Investment securities available-for-sale, at fair value
    190,616       132,140  
Loans, net
    367,323       349,345  
Loans held for sale
    2,219       33,674  
Premises and equipment, net
    24,081       23,363  
Accrued interest receivable
    2,945       3,006  
Goodwill
    9,432       9,432  
Deposit premiums
    423       512  
Mortgage servicing rights
    4,404       2,877  
Other assets
    13,662       12,139  
 
   
     
 
   
Total assets
  $ 630,142     $ 587,062  
 
   
     
 
LIABILITIES AND SHAREHOLDERS’ EQUITY
               
Deposits:
               
 
Noninterest-bearing
  $ 97,615     $ 82,294  
 
Interest-bearing
    406,091       370,625  
 
   
     
 
   
Total deposits
    503,706       452,919  
Federal funds purchased
    48       19,732  
Other liabilities
    5,223       5,807  
Borrowings
    77,769       62,945  
Company obligated mandatorily redeemable capital securities of subsidiary trust
    7,000       7,000  
Subordinated notes and debentures
          3,241  
 
   
     
 
   
Total liabilities
    593,746       551,644  
Commitments and contingencies
           
Shareholders’ equity:
               
 
Preferred stock, $1.00 par value, 500,000 shares authorized, none of which are issued and outstanding
           
 
Common stock, $1.00 par value, 20,000,000 shares authorized; 2,669,639 shares issued and 2,663,544 outstanding as of September 30, 2003 and 2,646,139 shares issued and 2,640,044 outstanding as of December 31, 2002
    2,670       2,646  
 
Additional paid-in capital
    16,881       16,683  
 
Retained earnings
    17,848       14,594  
 
Accumulated other comprehensive income
    (886 )     1,612  
 
Less treasury stock, at cost
    (117 )     (117 )
 
   
     
 
     
Total shareholders’ equity
    36,396       35,418  
 
   
     
 
     
Total liabilities and shareholders’ equity
  $ 630,142     $ 587,062  
 
   
     
 

See accompanying notes to condensed consolidated financial statements

1


 

TEXAS UNITED BANCSHARES, INC. AND SUBSIDIARIES
Consolidated Statements of Income

(In thousands, except per share data)
(Unaudited)

                                       
          For the three months   For the nine months
          ended September 30,   ended September 30,
         
 
          2003   2002   2003   2002
         
 
 
 
Interest income:
                               
 
Loans
  $ 7,966     $ 7,004     $ 23,730     $ 18,718  
 
Investment securities:
                               
   
Taxable
    1,513       1,248       4,143       3,752  
   
Tax-exempt
    126       161       424       698  
 
Federal funds sold and other temporary investments
    17       39       70       92  
 
   
     
     
     
 
     
Total interest income
    9,622       8,452       28,367       23,260  
 
   
     
     
     
 
Interest expense:
                               
 
Deposits
    1,854       1,988       5,743       6,042  
 
Federal funds purchased
    30       118       115       287  
 
Borrowings
    518       216       1,542       582  
 
Subordinated notes and debentures
          77       87       77  
 
Company obligated mandatorily redeemable capital securities of subsidiary trust
    185       194       554       577  
 
   
     
     
     
 
     
Total interest expense
    2,587       2,593       8,041       7,565  
 
   
     
     
     
 
Net interest income
    7,035       5,859       20,326       15,695  
Provision for loan losses
    800       500       2,100       1,350  
 
   
     
     
     
 
Net interest income after provision for loan losses
    6,235       5,359       18,226       14,345  
 
   
     
     
     
 
Non-interest income:
                               
 
Service charges on deposit accounts
    1,718       1,518       5,016       3,927  
 
Net servicing fees
    1,401       (263 )     1,551       1,139  
 
Gain on sale of investment securities, net
    376       397       1,291       949  
 
Other non-interest income
    654       546       2,259       1,789  
 
   
     
     
     
 
     
Total non-interest income
    4,149       2,198       10,117       7,804  
 
   
     
     
     
 
Non-interest expense:
                               
 
Employee compensation and benefits
    4,509       3,206       12,314       9,140  
 
Occupancy
    1,214       1,336       3,479       2,879  
 
Other non-interest expense
    2,465       2,235       6,770       5,436  
 
   
     
     
     
 
     
Total non-interest expense
    8,188       6,777       22,563       17,455  
 
   
     
     
     
 
Income before provision for income taxes
    2,196       780       5,780       4,694  
Provision for income taxes
    667       189       1,728       1,278  
 
   
     
     
     
 
Net income
  $ 1,529     $ 591     $ 4,052     $ 3,416  
 
   
     
     
     
 
Earnings per common share:
                               
 
Basic
  $ 0.57     $ 0.23     $ 1.53     $ 1.35  
 
Diluted
  $ 0.55     $ 0.22     $ 1.47     $ 1.30  
Weighted average shares outstanding:
                               
 
Basic
    2,663       2,589       2,653       2,523  
 
Diluted
    2,775       2,703       2,760       2,637  

See accompanying notes to condensed consolidated financial statements

2


 

TEXAS UNITED BANCSHARES, INC. AND SUBSIDIARIES

Consolidated Statements of Comprehensive Income

(In thousands)
(Unaudited)

                                   
      For the three months   For the nine months
      ended September 30,   ended September 30,
     
 
      2003   2002   2003   2002
     
 
 
 
Net income
  $ 1,529     $ 591     $ 4,052     $ 3,416  
 
   
     
     
     
 
Other comprehensive income (loss), net of tax:
                               
 
Unrealized holding gains (losses) on investment securities arising during the period
    (3,277 )     1,196       (1,646 )     2,291  
Less: reclassification adjustment for gains included in net income
    248       262       852       626  
 
   
     
     
     
 
 
Other comprehensive income (loss)
    (3,525 )     934       (2,498 )     1,665  
 
   
     
     
     
 
 
Total comprehensive income (loss)
  $ (1,996 )   $ 1,525     $ 1,554     $ 5,081  
 
   
     
     
     
 

See accompanying notes to condensed consolidated financial statements

3


 

TEXAS UNITED BANCSHARES, INC. AND SUBSIDIARIES

Consolidated Statements of Changes in Shareholders’ Equity

Year Ended December 31, 2002 and
Nine Months Ended September 30, 2003
(In thousands, except share amounts)

                                                         
                                    Accumulated                
                    Additional           Other   Treasury        
    Common Stock   Paid-in   Retained   Comprehensive   Stock        
    Shares   Amount   Capital   Earnings   Income (loss)   at Cost   Total
   
 
 
 
 
 
 
Balance at January 1, 2002
    2,502,145     $ 2,502     $ 14,136     $ 11,342     $ (275 )   $ (333 )   $ 27,372  
Net income
                      4,278                   4,278  
Other comprehensive income
                            1,887             1,887  
Issuance of common stock upon exercise of employee stock options
    6,291       6       47                         53  
Issuance of common stock related to the acquisition of The Bryan-College Station Financial Holding Company
    137,703       138       2,477                         2,615  
Compensation related to grant of treasury stock to employees
                5                   45       50  
Sale of treasury stock
                18                   171       189  
Dividends
                      (1,026 )                 (1,026 )
 
   
     
     
     
     
     
     
 
Balance at December 31, 2002
    2,646,139     $ 2,646     $ 16,683     $ 14,594     $ 1,612     $ (117 )   $ 35,418  
 
   
     
     
     
     
     
     
 
                                                         
                                    Accumulated                
                    Additional           Other   Treasury        
    Common Stock   Paid-in   Retained   Comprehensive   Stock        
Unaudited   Shares   Amount   Capital   Earnings   Income (loss)   at Cost   Total
   
 
 
 
 
 
 
Balance at January 1, 2003
    2,646,139     $ 2,646     $ 16,683     $ 14,594     $ 1,612     $ (117 )   $ 35,418  
Net income
                      4,052                   4,052  
Other comprehensive income (loss)
                            (2,498 )           (2,498 )
Issuance of common stock upon exercise of employee stock options
    23,500       24       198                         222  
Dividends
                      (798 )                 (798 )
 
   
     
     
     
     
     
     
 
Balance at September 30, 2003
    2,669,639     $ 2,670     $ 16,881     $ 17,848     $ (886 )   $ (117 )   $ 36,396  
 
   
     
     
     
     
     
     
 

See accompanying notes to condensed consolidated financial statements

4


 

TEXAS UNITED BANCSHARES, INC. AND SUBSIDIARIES

Consolidated Statements of Cash Flows

(In thousands)
(Unaudited)

                         
            For the nine months
            ended September 30,
           
            2003   2002
           
 
Cash flows from operating activities:
               
 
Net income
  $ 4,052     $ 3,416  
 
Adjustments to reconcile net income to net cash provided by operating activities:
               
   
Depreciation and amortization
    2,269       1,474  
   
Impairment of mortgage servicing rights
    (144 )     306  
   
Provision for loan losses
    2,100       1,350  
   
Gain on sales of securities, net
    (1,291 )     (949 )
   
(Gain) loss on sale of other real estate, loans, premises and equipment
    (406 )     1  
   
Amortization of premium, net of discounts on securities
    1,186       210  
   
Changes in:
               
     
Loans held for sale
    31,833       (12,350 )
     
Other assets
    (3,485 )     (5,211 )
     
Other liabilities
    721       2,868  
 
   
     
 
       
Net cash provided (used) by operating activities
    36,835       (8,885 )
 
   
     
 
Cash flows from investing activities:
               
   
Purchases of securities available-for-sale
    (175,657 )     (108,474 )
   
Proceeds from sales, maturities, and principal paydowns of securities available-for-sale
    113,447       94,078  
   
Net change in loans
    (20,011 )     (22,685 )
   
Proceeds from sale of other real estate, loans, premises and equipment
    710       4,204  
   
Net increase in cash resulting from acquisitions
          19,087  
   
Purchases of premises and equipment
    (2,975 )     (5,675 )
 
   
     
 
     
Net cash used by investing activities
    (84,486 )     (19,465 )
 
   
     
 
Cash flows from financing activities:
               
 
Net change in:
               
   
Deposits
    50,787       (7,573 )
   
Other borrowings
    14,824       9,514  
   
Federal funds purchased
    (19,684 )     15,135  
   
Subordinated notes and debentures
    (3,241 )      
 
Net proceeds from issuance of common stock upon exercise of employee stock options
    225       36  
 
Treasury stock sold
          190  
 
Dividends paid
    (797 )     (741 )
 
   
     
 
     
Net cash provided by financing activities
    42,114       16,561  
 
   
     
 
Net decrease in cash and cash equivalents
    (5,537 )     (11,789 )
Cash and cash equivalents at beginning of period
    20,574       32,666  
 
   
     
 
Cash and cash equivalents at end of period
  $ 15,037     $ 20,877  
 
   
     
 

See accompanying notes to condensed consolidated financial statements

5


 

TEXAS UNITED BANCSHARES, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

1.   BASIS OF PRESENTATION

          The unaudited condensed consolidated financial statements include the accounts of Texas United Bancshares, Inc. (the “Company”) and its wholly-owned subsidiaries Texas United Nevada, Inc. (“TUNI”), State Bank (the “Bank”), Third Coast Wealth Advisors, Inc. (“Third Coast”), and TXUI Statutory Trust I (the “Trust”). All material intercompany accounts and transactions have been eliminated in the consolidated report of the Company.

          The accompanying unaudited condensed consolidated financial statements were prepared in accordance with generally accepted accounting principles for interim financial information and with the instructions for Form 10-Q. In the opinion of management, the unaudited condensed consolidated financial statements reflect all adjustments, consisting only of normal and recurring adjustments, necessary to present fairly the Company’s consolidated financial position at September 30, 2003, the Company’s consolidated results of operations for the three and nine months ended September 30, 2003 and 2002, respectively, consolidated cash flows for the nine months ended September 30, 2003 and 2002, and consolidated changes in shareholders’ equity for the nine months ended September 30, 2003. Interim period results are not necessarily indicative of results of operations or cash flows for a full-year period. The 2002 year-end consolidated balance sheet and statement of changes in shareholders’ equity data were derived from audited financial statements, but do not include all disclosures required by generally accepted accounting principles.

          Certain amounts applicable to the prior periods have been reclassified to conform to the classifications currently followed. Such reclassifications do not affect earnings.

          These financial statements and the notes thereto should be read in conjunction with the Company’s audited consolidated financial statements for the year ended December 31, 2002 appearing in the Company’s Annual Report on Form 10-K for 2002.

2.   EARNINGS PER COMMON SHARE

          Basic earnings per share (“EPS”) is computed by dividing net income available to common shareholders by the weighted-average number of common shares outstanding during the period. Diluted EPS is computed by dividing net income available to common shareholders by the weighted-average number of common shares and potentially dilutive common shares outstanding during the period. Potentially dilutive common shares are computed using the treasury stock method. Potentially dilutive shares include stock options granted.

                                 
    For the three months   For the nine months
    ended September 30,   ended September 30,
   
 
    2003   2002   2003   2002
   
 
 
 
    (In thousands, except per share data)
Net income available to common shareholders
  $ 1,529     $ 591     $ 4,052     $ 3,416  
 
   
     
     
     
 
Weighted-average common shares outstanding
    2,663       2,589       2,653       2,523  
Weighted-average common shares and potentially dilutive common shares
    2,775       2,703       2,760       2,637  
 
   
     
     
     
 
Basic EPS
  $ 0.57     $ 0.23     $ 1.53     $ 1.35  
Diluted EPS
  $ 0.55     $ 0.22     $ 1.47     $ 1.30  

          Basic and diluted earnings per share have not been adjusted for the three for two stock split in the form of a 50% stock dividend issued to shareholders of record on October 1, 2003.

6


 

3.   INTANGIBLE ASSETS

          The gross carrying amount of intangible assets and associated amortization at September 30, 2003 is presented in the following table:

                   
      Gross   Accumulated
      Carrying   Amortization
      Amount   and Impairment
     
 
Amortized intangible assets:
               
 
Mortgage servicing rights
  $ 6,069     $ 1,665  
 
Core deposit intangibles
  $ 564     $ 141  

          The projections of amortization expense shown below for mortgage servicing rights are based on existing asset balances and the existing interest rate environment as of September 30, 2003. Future amortization expense may be significantly different depending upon changes in the mortgage servicing portfolio, mortgage interest rates and market conditions.

     The following table shows the current period and estimated future amortization for intangible assets:

                           
      Mortgage                
      Servicing   Core Deposit        
      Rights   Intangibles   Total
     
 
 
Nine months ended September 30, 2003 (actual)
  $ 633     $ 89     $ 722  
Three months ended December 31, 2003 (estimate)
    253       30       283  
Estimate for the year ended December 31,
                       
 
2004
    1,003       103       1,106  
 
2005
    950       88       1,038  
 
2006
    897       72       969  
 
2007
    819       56       875  
 
2008
    482       40       522  

4.   STOCK BASED COMPENSATION

          The Company accounts for its stock based employee compensation plans on the “intrinsic value method” provided in Accounting Principles Board Opinion (APB) No. 25, “Accounting for Stock Issued to Employees,” and related Interpretations. Because the exercise price of the Company’s employee stock options equals or exceeds the market price of the underlying stock on the date of grant, no compensation expense is recognized on option plans.

          Statement of Financial Accounting Standards (SFAS) No. 123, (SFAS 123) “Accounting for Stock-Based Compensation,” as amended by SFAS No. 148, “Accounting for Stock-Based Compensation – Transition and Disclosure,” requires pro forma disclosures of net income and earnings per share for companies not adopting its fair value accounting method for stock-based employee compensation. The pro forma disclosures below use the fair value method of SFAS 123 to measure compensation expense for stock-based compensation plans.

                                 
    Three Months Ended   Nine Months Ended
    September 30,   September 30,
   
 
    2003   2002   2003   2002
   
 
 
 
Net income, as reported
  $ 1,529     $ 591     $ 4,052     $ 3,416  
Less: Total stock-based compensation expense determined under the fair value method for all awards, net of tax
    8       5       24       15  
 
   
     
     
     
 
Pro forma net income
  $ 1,521     $ 586     $ 4,028     $ 3,401  
 
   
     
     
     
 

7


 

                                   
      Three Months Ended   Nine Months Ended
      September 30,   September 30,
     
 
      2003   2002   2003   2002
     
 
 
 
Earnings per share:
                               
 
Basic – as reported
  $ 0.57     $ 0.23     $ 1.53     $ 1.35  
 
Basic – pro forma
    0.57       0.23       1.52       1.35  
 
Diluted – as reported
    0.55       0.22       1.47       1.30  
 
Diluted – pro forma
    0.55       0.21       1.46       1.29  

5.   ACCOUNTING CHANGES

          Financial Accounting Standards Board (FASB) Interpretation No. 46 (FIN 46), “Consolidation of Variable Interest Entities, an interpretation of Accounting Research Bulletin No. 51” establishes accounting guidance for consolidation of variable interest entities (VIE) that function to support the activities of the primary beneficiary. The primary beneficiary of a VIE is the entity that absorbs a majority of the VIE’s expected losses, receives a majority of the VIE’s expected residual returns, or both, as a result of ownership, controlling interest, contractual relationship or other business relationship with the VIE. Prior to the implementation of FIN 46, VIE were generally consolidated by an enterprise when the enterprise had a controlling financial interest through ownership of a majority of voting interest in the entity. The provisions of FIN 46 were effective immediately for all arrangements entered after January 31, 2003, and are otherwise effective at the beginning of the first interim or annual period ending after December 15, 2003.

          In its current form, FIN 46 may require the Company to de-consolidate its investment in TXUI Statutory Trust I in future financial statements. The potential de-consolidation of subsidiary trusts of bank holding companies formed in connection with the issuance of trust preferred securities, like TXUI Statutory Trust I, appears to be a unintended consequence of FIN 46. It is currently unknown if, or when, the Financial Accounting Standards Board will address this issue. In July 2003, the Board of Governors of the Federal Reserve System issued a supervisory letter instructing bank holding companies to continue to include the trust preferred securities in their Tier 1 capital for regulatory capital purposes until notice is given to the contrary. The Federal Reserve intends to review the regulatory implications of any accounting treatment changes and, if warranted, provide appropriate guidance. If the trust preferred securities were no longer allowed to be included in Tier 1 capital, the Company would be permitted to redeem the capital securities without penalty. The Company does not have any additional VIEs.

          SFAS No. 149 (SFAS 149), “Amendment of Statement 133 on Derivative Instruments and Hedging Activities” was issued in April 2003. SFAS 149 amends and clarifies financial accounting and reporting for derivative instruments, including certain derivative instruments embedded in other contracts and for hedging activities under SFAS 133, “Accounting for Derivative Instruments and Hedging Activities.” The amendments (i) reflect decisions of the Derivatives Implementation Group (DIG), (ii) reflect decisions made by the FASB in conjunction with other projects dealing with financial instruments and (iii) address implementation issues related to the application of the definition of a derivative. SFAS 149 also modifies various other existing pronouncements to conform with the changes made to SFAS 133. SFAS 149 is effective for contracts entered into or modified after June 30, 2003, and for hedging relationships designated after June 30, 2003, with all provisions applied prospectively. Adoption of SFAS 149 on July 1, 2003 did not have a significant impact on the Company’s financial statements.

          SFAS No. 150 (SFAS 150), “Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity” was issued in May 2003. SFAS 150 establishes standards for how an issuer classifies, measures and discloses in its financial statements certain financial instruments with characteristics of both liabilities and equity. SFAS 150 requires that an issuer classify financial instruments that are within its scope as liabilities, in most circumstances. Such financial instruments include (i) financial instruments that are issued in the form of shares

8


 

that are mandatorily redeemable; (ii) financial instruments that embody an obligation to repurchase the issuer’s equity shares, or are indexed to such an obligation, and that require the issuer to settle the obligation by transferring assets; (iii) financial instruments that embody an obligation that the issuer may settle by issuing a variable number of its equity shares if, at inception, the monetary value of the obligation is predominantly based on a fixed amount, variations in something other than the fair value of the issuer’s equity shares or variations inversely related to changes in the fair value of the issuer’s equity shares; and (iv) certain freestanding financial instruments. SFAS 150 is effective for contracts entered into or modified after May 31, 2003, and is otherwise generally effective at the beginning of the first interim period beginning after June 15, 2003. Adoption of SFAS 150 on July 1, 2003 did not have a significant impact on the Company’s financial statements. For financial reporting purposes, the company obligated mandatorily redeemable capital securities of subsidiary trust has been reclassified as a liability.

6.   OFF BALANCE SHEET CREDIT COMMITMENTS

          In the normal course of business, the Company enters into various transactions, which, in accordance with generally accepted accounting principles, are not included in its consolidated balance sheet. These transactions are referred to as “off balance-sheet commitments.” The Company enters into these transactions to meet the financing needs of its customers. These transactions include commitments to extend credit and standby letters of credit, which involve elements of credit risk in excess of the amounts recognized in the consolidated balance sheet. The Company minimizes its exposure to loss under these commitments by subjecting them to credit approval and monitoring procedures.

          The Company enters into contractual commitments to extend credit, normally with fixed expiration dates or termination clauses, at specified rates and for specific purposes. Customers use credit commitments to ensure that funds will be available for working capital purposes, for capital expenditures and to ensure access to funds at specified terms and conditions. Substantially all of the Company’s commitments to extend credit are contingent upon customers maintaining specific credit standards at the time of loan funding. Management assesses the credit risk associated with certain commitments to extend credit in determining the level of the allowance for loan losses. Commitments to extend credit totaled $52.5 million at September 30, 2003 and $38.9 million at December 31, 2002.

          Standby letters of credit are written conditional commitments issued by the Company to guarantee the performance of a customer to a third party. The Company’s policies generally require that standby letters of credit arrangements contain collateral and debt covenants similar to those contained in loan agreements. In the event the customer does not perform in accordance with the terms of the agreement with the third party, the Company would be required to fund the commitment. The approximate terms of these letters of credit are 18 months. The maximum potential amount of future payments the Company could be required to make is represented by the contractual amount of the commitment. If the commitment is funded, the Company would be entitled to seek recovery from the customer. The Company expects that the estimated proceeds obtained on liquidation of collateral would cover approximately 93% of the maximum potential amount of future payments under such guarantees. The maximum undiscounted amount of future payments of these standby letters of credit totaled $629,000 at September 30, 2003 and $787,000 at December 31, 2002. As of September 30, 2003 and December 31, 2002, no liability for the fair value of the Company’s potential obligations under these guarantees has been recorded since the amount is deemed immaterial.

7.   CRITICAL ACCOUNTING POLICIES

          The Company’s accounting policies are integral to understanding the results reported. The Company believes that of its significant accounting policies, the policies with respect to the allowance for loan losses and mortgage servicing rights assets may involve a higher degree of judgment and complexity.

          The allowance for loan losses is a valuation allowance for probable losses incurred on loans. Loans are charged to the allowance when the loss actually occurs or when a determination is made that a probable loss has occurred. Recoveries are credited to the allowance at the time of recovery. Throughout the year, management estimates the probable level of losses to determine whether the allowance for credit losses is adequate to absorb losses in the existing portfolio. Based on these estimates, an amount is charged to the provision for loan losses and credited to the allowance for loan losses in order to adjust the allowance to a level determined to be adequate to absorb losses. Management’s judgment as to the level of probable losses on existing loans involves the consideration of current economic conditions and their estimated effects on specific borrowers; an evaluation of the existing relationships among loans, potential loan losses and the present level of the allowance; results of examinations of

9


 

the loan portfolio by regulatory agencies; and management’s internal review of the loan portfolio. In determining the collectability of certain loans, management also considers the fair value of any underlying collateral. The amount ultimately realized may differ from the carrying value of these assets because of economic, operating or other conditions beyond the Company’s control. Refer to the subsequent discussion of “Allowance for Loan Losses” included in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” for additional insight into management’s approach and methodology in estimating 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, loan 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. Refer to Note 3 to the Condensed Consolidated Financial Statements above and discussion of “Noninterest Income” included in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” for additional insight into management’s approach in estimating transfers and servicing of financial assets.

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

          Special Cautionary Notice Regarding Forward-looking Statements

          Statements and financial discussion and analysis contained in the Form 10-Q that are not historical facts are forward-looking statements made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. These forward-looking statements include information about possible or assumed future results of the Company’s operations or performance. When we use any of the words “believe,” “expect”, “anticipate”, “estimate”, “continue”, “intend”, “may”, “will”, “should”, or similar expressions, identifies these forward-looking statements. Many possible factors or events could affect the future financial results and performance of the Company and could cause those financial results or performance to differ materially from those expressed in the forward-looking statement. These possible events or factors include, without limitation:

    deposit attrition, operating costs, customer loss and business disruption are greater than we expected;
 
    competitive factors including product and pricing pressures among financial services organizations may increase;
 
    changes in the interest rate environment reduce our interest margins;
 
    changes in market rates and prices may adversely impact securities, loans, deposits, mortgage servicing rights, and other financial instruments;
 
    general business and economic conditions in the markets the Company serves change or are less favorable than it expected;
 
    legislative or regulatory changes adversely affect the Company’s business;
 
    personal or commercial bankruptcies increase;
 
    changes in accounting principles, policies or guidelines;
 
    changes occur in the securities markets; and
 
    technology-related changes are harder to make or more expensive than the Company anticipated.

          A forward-looking statement may include a statement of the assumptions or bases underlying the forward-looking statement. The Company believes it has chosen the assumptions or bases in good faith and that they are reasonable. However, the Company cautions you that assumptions or bases almost always vary from actual results, and the differences between assumptions or bases and actual results can be material. The Company will not update these statements unless the securities laws require it to do so.

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          General. The Company is a bank holding company formed in June 1998 as a result of the merger of South Central Texas Bancshares, Inc. with and into Premier Bancshares, Inc. At the effective date of the merger, the resulting company changed its name to Texas United Bancshares, Inc. The Company derives substantially all of its net income from its wholly-owned subsidiary State Bank. At September 30, 2003, State Bank had eighteen full service banking centers serving eleven counties in central and south central Texas.

          Net income for the three months ended September 30, 2003 was $1.5 million, an increase of 153.8% compared with $591,000 for the same period in 2002. The increase in net income was a combined result of higher net interest income and a $1.0 million reversal on the impairment allowance for mortgage servicing rights which increased non-interest income, partially offset by higher non-interest expense and provisions for loan loss. Net income for the nine months ended September 30, 2003 was $4.1 million, representing an increase of 20.6% compared with the $3.4 million for the same period in 2002. Basic and diluted earnings per share (EPS) for the three months ended September 30, 2003 were $0.57 and $0.55, respectively, compared with $0.23 and $0.22, respectively, for the same period in 2002. For the nine months ended September 30, 2003, basic and diluted EPS were $1.53 and $1.47, respectively, compared with $1.35 and $1.30, respectively, for the same period in 2002.

          At September 30, 2003, total assets were $630.1 million compared with $587.1 million at December 31, 2002. The $43.0 million or 7.3% increase in total assets over December 31, 2002 was primarily attributable to increases in investment securities and partially offset by a decrease of $31.5 million in loans held for sale. At September 30, 2003, net loans, excluding loans held for sale, were $367.3 million compared with $349.3 million at December 31, 2002. Loans held for sale were $2.2 million compared to $33.7 million at December 31, 2002. Total deposits at September 30, 2003 were $503.7 million compared with $452.9 million at December 31, 2002. The $50.8 million or 11.2% increase in deposits compared with December 31, 2002 is attributed to internal growth. Shareholders’ equity at September 30, 2003 was $36.4 million compared to $35.4 million at December 31, 2002. The $1.0 million or 2.8% increase is attributed to earnings retention partially offset by the deterioration on the fair market value of available-for-sale securities included in accumulated other comprehensive income. The Company’s return on average assets was 0.93% for the nine months ended September 30, 2003, compared with 0.97% for the same period in 2002. The return on average shareholders’ equity was 15.1% for the nine months ended September 30, 2003, down from 15.4% for the same period in 2002.

          Recent Developments. Effective November 6, 2003, State Bank sold its credit card portfolio to Elan Financial Service of Minneapolis, Minnesota. At the date of sale, the portfolio comprised 6,300 accounts with receivables totaling $6.8 million. The sale generated an after tax gain of approximately $242,000. On November 7, 2003, the Company sold its wholly owned subsidiary Third Coast Wealth Advisors to two employees of Third Coast. The sale generated an after tax loss of $250,000.

          Effective October 15, 2003, the Company effected a three for two stock split in the form of a 50% stock dividend payable to shareholders of record as of October 1, 2003. The share and per share information as of September 30, 2003 or any prior date has not been adjusted to give effect to the stock split.

          Net Interest Income. For the three months ended September 30, 2003, net interest income, before the provision for loan losses, increased by 18.6% to $7.0 million from $5.9 million in the same period in 2002. The increase was primarily due to the increased volumes in loans, not including loans held for sale, and investment securities and the strategic lowering of the cost of funds in relation to the decrease in rates on earning assets. This has resulted in slightly lower yields on earning assets partially offset by lower rates paid for interest-bearing liabilities. For the three months ended September 30, 2003 and 2002, the net interest margin decreased by 2 basis points to 4.91% from 4.93% and the net interest spread decreased by 8 basis points to 4.64% from 4.72%, respectively.

          For the nine months ended September 30, 2003, net interest income, before the provision for loan losses, increased by 29.3% to $20.3 million compared with $15.7 million over the same period in 2002. For the nine months ended September 30, 2003 and 2002, the net interest margin widened by 3 basis points to 5.05% from 5.02% and the net interest spread widened by 1 basis point to 4.75% from 4.74%, respectively. The widening of the net interest margin was a combined result of increased volumes in investments and loan balances, and a decrease in the cost of funds.

          Interest income for the three months ended September 30, 2003 was $9.6 million compared with $8.5 million for the same period in 2002. As compared to the three months ended September 30, 2002, the average total loan volumes for the three months ended September 30, 2003 increased by $30.5 million or 8.6%, and the average

11


 

yields on average total loan volumes increased 37 basis points to 8.21%. Average total investment volumes for the three months ended September 30, 2003 increased by $65.5 million or 57.9% compared with the same period in 2002, while the average yields on average investments decreased by 141 basis points. For the three months ended September 30, 2003, compared to the same period in 2002, the yield on total average earning assets decreased by 39 basis points to 6.72%.

          Interest income for the nine months ended September 30, 2003 was $28.4 million compared with $23.3 million for the same period in 2002. This increase was primarily maintained through growth in average earning assets. As compared to the nine months ended September 30, 2002, the average total loan volumes for the nine month period ended September 30, 2003 increased by $78.2 million or 26.0%, and the average yields on average total loans increased by 5 basis points to 8.36%. As compared with the nine months ended September 30, 2002, average total investment volumes for the nine months ended September 30, 2003 increased by $41.7 million or 36.7%, while the average yields on average investments decreased by 150 basis points. For the nine months ended September 30, 2003 compared to the same period in 2002, the yield on total average earning assets decreased by 40 basis points to 7.05%.

          Interest expense for the three months ended September 30, 2003 and 2002 was $2.6 million. Interest expense was maintained as the result of higher average interest bearing deposit volumes coupled with lower interest rates paid on those deposits. As compared to the three month period ended September 30, 2002, average interest bearing deposit volumes increased by $25.2 million or 6.7% while the average rates paid on interest bearing deposits decreased by 27 basis points to 1.82%.

          For the nine months ended September 30, 2003, interest expense increased by $400,000 or 5.3% to $8.0 million compared with $7.6 million for the same period in 2002. The increased interest expense was mainly the result of higher interest bearing deposit volumes coupled with lower interest rates paid on those deposits. As compared to the nine months ended September 30, 2002, average interest bearing deposit volumes increased by $54.3 million or 16.5% while the average rates paid on deposits decreased by 41 basis points or 2.0%.

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          The following tables set forth for the periods indicated an analysis of net interest income by each major category of interest-earning assets and interest-bearing liabilities, the average amounts outstanding and the interest earned or paid on such amounts. The tables also set forth the average rate earned on total interest-earning assets, the average rate paid on total interest-bearing liabilities and the net interest margin on average total interest-earning assets for the same periods. Nonaccruing loans have been included in the table as loans carrying a zero yield.

                                                         
            For the three months ended September 30,
           
            2003   2002
           
 
            Average   Interest   Average   Average   Interest   Average
            Outstanding   Earned/   Yield/   Outstanding   Earned/   Yield/
            Balance   Paid   Rate (1)   Balance   Paid   Rate (1)
           
 
 
 
 
 
            (Dollars in thousands)
Assets
                                               
Interest-earning assets:
                                               
   
Total loans
  $ 384,748     $ 7,966       8.21 %   $ 354,191     $ 7,004       7.84 %
   
Taxable securities
    168,502       1,513       3.56       99,653       1,248       4.97  
   
Tax-exempt securities
    11,237       126       4.45       14,540       161       4.39  
   
Federal funds sold and other temporary investments
    3,581       17       1.88       3,467       39       4.46  
 
   
     
             
     
         
   
Total interest earning assets
    568,068       9,622       6.72       471,851       8,452       7.11  
   
Less allowance for loan losses
    3,663                       3,041                  
 
   
                     
                 
Total interest-earning assets, net of allowance for loan losses
    564,405                       468,810                  
Noninterest-earning assets
    66,993                       70,949                  
 
   
                     
                 
       
Total assets
  $ 631,398                     $ 539,759                  
 
   
                     
                 
Liabilities and shareholders’ equity
                                               
Interest-bearing liabilities:
                                               
     
Interest-bearing demand deposits
  $ 126,239     $ 297       0.93 %   $ 113,109     $ 361       1.27 %
     
Savings and money market accounts
    83,262       219       1.04       69,733       217       1.23  
     
Time deposits
    193,781       1,338       2.74       195,280       1,410       2.86  
     
Federal funds purchased
    7,574       30       1.57       9,368       118       5.00  
Company obligated mandatorily redeemable capital securities of subsidiary trust
    7,000       185       10.49       7,000       194       10.99  
Subordinated notes and debentures
                      2,442       77       12.51  
Other borrowings
    74,598       518       2.75       33,140       216       2.59  
 
   
     
             
     
         
Total interest-bearing liabilities
    492,454       2,587       2.08       430,072       2,593       2.39  
 
           
                     
         
Noninterest-bearing liabilities:
                                               
   
Noninterest-bearing demand deposits
    97,926                       70,660                  
   
Other liabilities
    4,397                       5,389                  
 
   
                     
                 
       
Total liabilities
    594,777                       506,121                  
Shareholders’ equity
    36,621                       33,638                  
 
   
                     
                 
Total liabilities and shareholders’ equity
  $ 631,398                     $ 539,759                  
 
   
                     
                 
Net interest income
          $ 7,035                     $ 5,859          
 
           
                     
         
Net interest spread
                    4.64 %                     4.72 %
Net interest margin
                    4.91 %                     4.93 %


(1)   Annualized

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            For the nine months ended September 30,
           
            2003   2002
           
 
            Average   Interest   Average   Average   Interest   Average
            Outstanding   Earned/   Yield/   Outstanding   Earned/   Yield/
            Balance   Paid   Rate (1)   Balance   Paid   Rate (1)
           
 
 
 
 
 
            (Dollars in thousands)
Assets
                                               
Interest-earning assets:
                                               
   
Total loans
  $ 379,303     $ 23,730       8.36 %   $ 301,121     $ 18,718       8.31 %
   
Taxable securities
    142,561       4,143       3.89       92,994       3,752       5.39  
   
Tax-exempt securities
    12,655       424       4.48       20,572       698       4.54  
   
Federal funds sold and other temporary investments
    3,427       70       2.73       2,964       92       4.15  
 
   
     
             
     
         
   
Total interest earning assets
    537,946       28,367       7.05       417,651       23,260       7.45  
   
Less allowance for loan losses
    3,515                       2,580                  
 
   
                     
                 
Total interest-earning assets, net of allowance for loan losses
    534,431                       415,071                  
Noninterest-earning assets
    68,502                       59,280                  
 
   
                     
                 
       
Total assets
  $ 602,933                     $ 474,351                  
 
   
                     
                 
Liabilities and shareholders’ equity
                                               
Interest-bearing liabilities:
                                               
   
Interest-bearing demand deposits
  $ 122,656     $ 957       1.04 %   $ 103,786     $ 1,231       1.58 %
   
Savings and money market accounts
    74,350       619       1.11       60,842       691       1.52  
   
Time deposits
    186,925       4,167       2.98       164,985       4,120       3.34  
   
Federal funds purchased
    9,675       115       1.59       10,639       287       3.61  
Company obligated mandatorily redeemable capital securities of subsidiary trust
    7,000       554       10.58       7,000       577       11.02  
Subordinated notes and debentures
    1,011       87       11.51       814       77       12.65  
Other borrowings
    64,806       1,542       3.18       25,238       582       3.08  
 
   
     
             
     
         
Total interest-bearing liabilities
    466,423       8,041       2.30       373,304       7,565       2.71  
 
           
                     
         
Noninterest-bearing liabilities:
                                               
   
Noninterest-bearing demand deposits
    94,948                       64,763                  
   
Other liabilities
    4,403                       5,760                  
 
   
                     
                 
       
Total liabilities
    565,774                       443,827                  
Shareholders’ equity
    37,159                       30,524                  
 
   
                     
                 
Total liabilities and shareholders’ equity
  $ 602,933                     $ 474,351                  
 
   
                     
                 
Net interest income
          $ 20,326                     $ 15,695          
 
           
                     
         
Net interest spread
                    4.75 %                     4.74 %
Net interest margin
                    5.05 %                     5.02 %


(1)   Annualized

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       The following tables present 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 outstanding balances and changes in interest rates for the three and nine month periods ended September 30, 2003 compared with the same periods in 2002. For purposes of these tables, changes attributable to both volume and rate have been allocated proportionately to the change due to volume and rate.

                             
        Three months ended September 30,
       
        2003 vs. 2002
       
        Increase (Decrease)        
        Due to        
       
       
        Volume   Rate   Total
       
 
 
        (Dollars in thousands)
Interest-earning assets:
                       
 
Total loans
  $ 627     $ 330     $ 957  
 
Securities
    583       (353 )     230  
 
Federal funds sold and other temporary investments
    1       (18 )     (17 )
 
 
   
     
     
 
   
Total increase (decrease) in interest income
    1,211       (41 )     1,170  
Interest-bearing liabilities:
                       
 
Interest-bearing demand deposits
    31       (95 )     (64 )
 
Savings and money market accounts
    35       (33 )     2  
 
Time deposits
    10       (82 )     (72 )
 
Federal funds purchased
    (7 )     (81 )     (88 )
 
Company obligated mandatorily redeemable capital securities of subsidiary trust
          (9 )     (9 )
 
Subordinated notes and debentures
    (77 )           (77 )
 
Other borrowings
    285       17       302  
 
   
     
     
 
   
Total increase (decrease) in interest expense
    277       (283 )     (6 )
 
   
     
     
 
Increase in net interest income
  $ 934     $ 242     $ 1,176  
 
   
     
     
 
                             
        Nine months ended September 30,
       
        2003 vs. 2002
       
        Increase (Decrease)        
        Due to        
       
       
        Volume   Rate   Total
       
 
 
        (Dollars in thousands)
Interest-earning assets:
                       
 
Total loans
  $ 4,902     $ 110     $ 5,012  
 
Securities
    1,215       (1,098 )     117  
 
Federal funds sold and other temporary investments
    9       (31 )     (22 )
 
   
     
     
 
   
Total increase (decrease) in interest income
    6,126       (1,019 )     5,107  
Interest-bearing liabilities:
                       
 
Interest-bearing demand deposits
    147       (421 )     (274 )
 
Savings and money market accounts
    112       (184 )     (72 )
 
Time deposits
    490       (443 )     47  
 
Federal funds purchased
    (11 )     (161 )     (172 )
 
Company obligated mandatorily redeemable capital securities of subsidiary trust
          (23 )     (23 )
 
Subordinated notes and debentures
    10             10  
 
Other borrowings
    943       17       960  
 
   
     
     
 
   
Total increase (decrease) in interest expense
    1,691       (1,215 )     476  
 
   
     
     
 
Increase in net interest income
  $ 4,435     $ 196     $ 4,631  
 
   
     
     
 

          Provision for Loan Losses. Provisions for loan losses are charged to income to bring the Company’s allowance for loan losses to a level deemed appropriate by management. For the three and nine month periods ended September 30, 2003 compared to the same periods in 2002, the provision increased by $300,000 or 60.0% to $800,000, and increased by $750,000 or 55.6% to $2.1 million, respectively. The allowance for loan losses at September 30, 2003 was $3.9 million, compared with $3.3 million at December 31, 2002. During the latter part of

15


 

2002 and the first nine months of 2003, management increased its provisions primarily due to growth in the loan portfolio and changes in the Central Texas economy. At September 30, 2003, the ratio of the loan loss allowance to total loans was 1.04% compared with 0.85% at December 31, 2002.

          Noninterest Income. Noninterest income for the three months ended September 30, 2003 and 2002 was $4.1 million and $2.2 million, respectively, an increase of $1.9 million or 86.4%. For the nine months ended September 30, 2003 and 2002, noninterest income was $10.1 million and $7.8 million, respectively, an increase of $2.3 million or 29.5%. The increase in noninterest income for both periods is primarily attributed to an increase in service charges on deposit accounts and a $1.0 million reversal on the impairment allowance for mortgage servicing rights.

          Mortgage servicing fees, net of amortization and impairment reversal, were $1.4 million for the three months ended September 30, 2003. Mortgage servicing fees, net of amortization and impairment charge, were $(263,000) for the same period in 2002. For the nine months ended September 30, 2003, net mortgage servicing fees were $1.6 million compared with $1.1 million for the same period in 2002. The Company recorded a $1.0 million reversal on its mortgage servicing rights impairment allowance during the third quarter of 2003 to reflect an increase in the fair value of the mortgage servicing rights asset. The increase in fair value of capitalized mortgage servicing rights is a result of the rise in the 10-year Treasury rate, which produced higher mortgage rates and caused a decrease in prepayments of mortgages serviced by the Company.

          The following table presents, for the periods indicated, the major categories of noninterest income:

                                   
      For the three months ended   For the nine months ended
      September 30,   September 30,
     
 
      2003   2002   2003   2002
     
 
 
 
      (Dollars in thousands)
Service charges on deposit accounts
  $ 1,718     $ 1,518     $ 5,016     $ 3,927  
Net servicing fees
    1,401       (263 )     1,551       1,139  
Gain on sale of securities, net
    376       397       1,291       949  
Other noninterest income
    654       546       2,259       1,789  
 
   
     
     
     
 
 
Total noninterest income
  $ 4,149     $ 2,198     $ 10,117     $ 7,804  
 
   
     
     
     
 

          Noninterest Expense. For the three months ended September 30, 2003, noninterest expense increased by $1.4 million or 20.6% to $8.2 million, compared to $6.8 million for the same period in 2002. For the nine months ended September 30, 2003, noninterest expense increased by $5.1 million or 29.1% to $22.6 million, compared to $17.5 million for the same period in 2002. The increase in noninterest expense for both periods was mainly due to additional employee compensation and benefits, and increased professional fees, telecommunications and technology costs, and printing and supplies.

          The following table presents, for the periods indicated, the major categories of noninterest expense:

                                     
        For the three months   For the nine months
        ended September 30,   ended September 30,
       
 
        2003   2002   2003   2002
       
 
 
 
        (Dollars in thousands)
Employee compensation and benefits
  $ 4,509     $ 3,206     $ 12,314     $ 9,140  
Non-staff expenses:
                               
 
Occupancy
    1,214       1,336       3,479       2,879  
 
Depreciation and amortization
    757       902       2,269       1,605  
 
Data processing
    291       301       791       746  
 
Professional fees, consultants, and contract labor
    242       227       777       572  
 
Advertising
    313       352       600       753  
 
Printing and supplies
    163       127       449       384  
 
Telecommunications
    212       183       469       377  
 
Other noninterest expense
    487       143       1,415       999  
 
   
     
     
     
 
   
Total non-staff expenses
    3,679       3,571       10,249       8,315  
 
   
     
     
     
 
   
Total noninterest expense
  $ 8,188     $ 6,777     $ 22,563     $ 17,455  
 
   
     
     
     
 

16


 

          Employee compensation and benefits expense represents 55.1% and 54.6% of total noninterest expense for the three and nine month periods ended September 30, 2003, respectively. Employee compensation and benefits expense for the three months ended September 30, 2003 was $4.5 million, an increase of $1.3 million or 40.6% from $3.2 million for the same period in 2002. For the nine months ended September 30, 2003, employee compensation and benefits expense was $12.3 million, reflecting an increase of $3.2 million or 35.2% from $9.1 million for the same period in 2002. The increases for both periods resulted primarily from the costs associated with the additional staff to meet loan growth, the addition of one de novo banking center in December 2002, the addition of three banking centers as a result of The Bryan-College Station Financial Holding Company acquisition, and the addition of two loan production offices. Total full-time equivalent (FTE) employees at September 30, 2003 and 2002 were 322 and 282, respectively.

          For the three months ended September 30, 2003, non-staff expenses increased by $100,000 or 2.8% compared with the same period in 2002. For the nine months ended September 30, 2003, non-staff expenses increased by $1.9 million or 22.9% compared with the same period in 2002. The increased non-staff expenses for both periods was primarily due to the addition of one de novo banking center and two loan production offices, the upgrade of technology systems, increased printing costs, as well as other operating systems improvements.

Financial Condition

          Loan Portfolio. Total loans, including loans held for sale, decreased by $12.9 million or 33.4%, from $386.3 million at December 31, 2002 to $373.4 million at September 30, 2003. The decrease is primarily due to the sale of $31.5 million in loans held for sale and the $2.0 million decrease in other real estate loans, partially offset by a $13.6 million increase in commercial mortgages and a $5.7 million increase in consumer loans. At September 30, 2003 and December 31, 2002, the ratio of total loans to total deposits was 74.1% and 85.3%, respectively. For the same periods, total loans represented 59.3% and 65.8% of total assets, respectively.

          The following table summarizes the loan portfolio of the Company by type of loan at the dates indicated:

                                     
        September 30, 2003   December 31, 2002
       
 
        Amount   Percent   Amount   Percent
       
 
 
 
        (Dollars in thousands)
Commercial and industrial
  $ 63,029       16.9 %   $ 62,391       16.2 %
Real estate mortgage
                               
 
1-4 residential
    150,011       40.2       149,471       38.7  
 
Commercial
    75,587       20.2       62,014       16.0  
 
Held for sale
    2,219       0.6       33,674       8.7  
 
Other
    16,347       4.4       18,269       4.7  
Consumer and other, net
    66,245       17.7       60,496       15.7  
 
   
     
     
     
 
Total loans
  $ 373,438       100.0 %   $ 386,315       100.0 %
 
           
             
 
Allowance for loan losses
    3,896               3,296          
 
   
             
         
   
Net loans
  $ 369,542             $ 383,019          
 
   
             
         

          Nonperforming Assets. Nonperforming assets at September 30, 2003 and December 31, 2002 were $1.8 million and $2.0 million, respectively.

          The Company generally places a loan on nonaccrual status and ceases to accrue interest when loan payment performance is deemed unsatisfactory. Loans where the interest payments jeopardize the collection of principal are placed on nonaccrual status, unless the loan is both well-secured and in the process of collection. Cash payments received while a loan is classified as nonaccrual are recorded as a reduction of principal as long as doubt exists as to collection.

17


 

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

                   
      September 30, 2003   December 31, 2002
     
 
      (Dollars in thousands)
Nonaccrual loans
  $ 95     $ 709  
Accruing loans 90 days or more past due
    1,278       960  
Other real estate
    449       356  
 
   
     
 
 
Total nonperforming assets
  $ 1,822     $ 2,025  
 
   
     
 
Nonperforming assets to total assets
    0.29 %     0.34 %
Nonperforming assets to total loans and other real estate
    0.49 %     0.52 %

          Allowance for Loan Losses. The Company has several systems in place to assist in maintaining the overall quality of its loan portfolio. The Company has established underwriting guidelines to be followed at each of its banking centers. The Company also monitors its delinquency levels for any negative or adverse trends and particularly monitors credits that have a total exposure of $75,000 or more.

          The allowance for loan losses is a reserve established through charges to earnings in the form of a provision for loan losses. The Company utilizes a model to determine the specific and general portions of the allowance for loan losses. Through the loan review process, management assigns one of four loan grades to each loan, according to payment history, collateral values and financial condition of the borrower. Specific reserves are allocated for loans assigned to a grade of “watch” or below, meaning that management has determined that deterioration in a loan has occurred. The percentage of the specific allocation for each loan is based on the risk elements attributable to that particular loan. In addition, a general allocation is made for all loans in an amount determined based on general economic condition, historical loan loss experience, loan growth within a category, amount of past due loans and peer averages. Management maintains the allowance based on the amounts determined using the procedures set forth above.

          For the nine months ended September 30, 2003, net loan charge-offs were $1.5 million or 0.40% of average loans outstanding compared with $1.1 million or 0.34% for the year ended December 31, 2002. At September 30, 2003 and December 31, 2002, the allowance for loan losses aggregated $3.9 million and $3.3 million, or 1.04% and 0.85% of total loans, respectively. At September 30, 2003, the allowance for loan losses as a percentage of nonperforming loans was 283.8% compared with 197.5% at December 31, 2002.

18


 

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

                     
        Nine Months Ended   Year Ended
        September 30, 2003   December 31, 2002
       
 
        (Dollars in thousands)
Average total loans outstanding
  $ 379,303     $ 319,151  
 
   
     
 
Total loans outstanding at end of period
  $ 373,438     $ 386,315  
 
   
     
 
Allowance for loan losses at beginning of period
    3,296       1,754  
Provision for loan losses
    2,100       1,900  
Balance acquired in the Bryan-College Station acquisition
          740  
Charge-offs:
               
 
Commercial and industrial
    (465 )     (401 )
 
Real estate
    (268 )     (117 )
 
Consumer
    (1,498 )     (1,528 )
 
Other
          (6 )
 
   
     
 
   
Total charge-offs
    (2,231 )     (2,052 )
 
   
     
 
Recoveries:
               
 
Commercial and industrial
    80       261  
 
Real estate
    71       36  
 
Consumer
    569       603  
 
Other
    11       54  
 
   
     
 
   
Total recoveries
    731       954  
 
   
     
 
Net loan charge-offs
    (1,500 )     (1,098 )
 
   
     
 
Allowance for loan losses at end of period
  $ 3,896     $ 3,296  
 
   
     
 
Ratio of allowance to end of period total loans
    1.04 %     0.85 %
Ratio of net loan charge-offs to average total loans
    0.40 %     0.34 %
Ratio of allowance to end of period nonperforming loans
    283.76 %     197.48 %

19


 

          Securities. At September 30, 2003, the securities portfolio totaled $190.6 million, reflecting an increase of $58.5 million or 44.3% from $132.1 million at December 31, 2002. During the nine months ended September 30, 2003, the Company purchased $175.7 million in investment securities. Included in this amount were $99.4 million in mortgage loans originated by the Company that were sold to Fannie Mae in various mortgage pools and reacquired by the Company as investment securities. Additionally, the Company sold $83.4 million of securities in an effort to reposition the portfolio for current economic conditions and to provide funding for loan growth. The Company also received $30.0 million in maturities and paydowns on investment securities.

          Deposits. At September 30, 2003, total deposits were $503.7 million, an increase of $50.8 million or 11.2% from $452.9 million at December 31, 2002. Noninterest-bearing deposits at September 30, 2003 increased by $15.3 million or 18.6% to $97.6 million from $82.3 million at December 31, 2002. Interest-bearing deposits at September 30, 2003 increased by $35.5 million or 9.6% to $406.1 million from $370.6 million at December 31, 2002. The Company’s ratios of noninterest-bearing demand deposits to total deposits for September 30, 2003 and December 31, 2002 were 19.4% and 18.2%, respectively.

          Borrowings. Borrowings consist of short-term and long-term advances from the Federal Home Loan Bank (FHLB) and advances on the revolving operating credit line with a bank. Borrowings increased $14.9 million to $77.8 million at September 30, 2003 from $62.9 million at December 31, 2002. The maturity dates for the FHLB borrowings range from the years 2003 to 2013 and have interest rates from 1.17% to 5.91%.

          Federal funds purchased decreased $19.6 million to $48,000 at September 30, 2003 from $19.7 million at December 31, 2002. Additionally, the Company had three unused, unsecured federal funds lines of credit with correspondent banks totaling $29.9 million at September 30, 2003 and $10.3 million at December 31, 2002.

          As of September 30, 2003, the Company’s subsidiary trust had $7.0 million outstanding in trust preferred securities.

          In connection with the acquisition of Bryan-College Station, the Company assumed $3.6 million in subordinated debentures. The debentures carried an interest rate of 11.5% and were redeemed on March 31, 2003.

          At September 30, 2003, the Company had $6.3 million borrowed on its $10.0 million revolving operating credit line with a bank. The funds were used to redeem the outstanding shares of Series A preferred stock issued by Bryan-College Station, costs associated with becoming a reporting company listed on the Nasdaq Stock Market, a capital injection into State Bank, and the redemption of the subordinated debentures.

          Liquidity. Liquidity involves the Company’s ability to raise funds to support asset growth or reduce assets to meet deposit withdrawals and other payment obligations, to maintain reserve requirements and otherwise to operate the Company on an ongoing basis. The Company’s liquidity needs are primarily met by growth in core deposits. Although access to purchased funds from correspondent banks is available and has been utilized on occasion to take advantage of investment opportunities, the Company does not rely on these external funding sources. The Company maintains investments in liquid assets based upon management’s assessment of cash needs, expected deposit flows, objectives of its asset/liability management program, availability of federal funds or FHLB advances, and other available yield on liquid assets. Several options are available to increase liquidity, including loan originations, increasing deposit marketing activities, and borrowing from the FHLB or correspondent banks. The cash and federal funds sold position, supplemented by amortizing investments along with payments and maturities within the loan portfolio, have historically created an adequate liquidity position.

20


 

          Asset liquidity is provided by cash and assets which are readily marketable or which will mature in the near future. At September 30, 2003, the Company had cash and cash equivalents of $15.0 million, down from $20.6 million at December 31, 2002. The decrease is mainly attributed to the decrease in federal funds purchased, partially offset by the increase in borrowings.

          The Company views time deposits as a stable means of supporting loan growth. The Company believes, based on its historical experience, that its large time deposits have core-type characteristics. The Company anticipates that this source of funding will continue to sustain a portion of the Company’s asset growth in the future.

          Capital Resources. Shareholders’ equity increased from $35.4 million at December 31, 2002 to $36.4 million at September 30, 2003, an increase of $1.0 million or 2.8%. The increase was primarily due to a net addition to undivided profits of $4.1 million as a result of net income for the period, partially offset by the $2.5 million deterioration in unrealized security gains and losses and cash dividends paid of $800,000.

          The following table provides a comparison of the Company’s and the State Bank’s leverage and risk-weighted capital ratios as of September 30, 2003 to the minimum and well-capitalized regulatory standards.

                           
              To be Well        
      Minimum   Capitalized Under        
      Required for   Prompt Corrective   Actual Ratio at
      Capital Purposes   Action Provisions   September 30, 2003
     
 
 
The Company
                       
 
Leverage ratio
    4.00 %(1)     N/A       5.47 %
 
Tier 1 risk-based capital ratio
    4.00 %     N/A       8.09 %
 
Risk-based capital ratio
    8.00 %     N/A       9.01 %
The Bank
                       
 
Leverage ratio
    4.00 %(2)     5.00 %     6.16 %
 
Tier 1 risk-based capital ratio
    4.00 %     6.00 %     9.15 %
 
Risk-based capital ratio
    8.00 %     10.00 %     10.08 %


(1)   The Federal Reserve Board may require the Company to maintain a leverage ratio above the required minimum.
 
(2)   The FDIC may require the Bank to maintain a leverage ratio above the required minimum.

Item 3. Quantitative and Qualitative Disclosures About Market Risk.

          There have been no material changes in the market risk information disclosed in the Company’s Annual Report on Form 10-K as of and for the year ended December 31, 2002, and in particular, Item 7 “Management’s Discussion and Analysis of Financial Condition and Results of Operations - Interest Rate Sensitivity and Market Risk.”

Item 4. Controls and Procedures.

          Evaluation of disclosure controls and procedures. The Company carried out an evaluation, under the supervision and with the participation of its management, including the Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of the Company’s disclosure controls and procedures as of the end of the period covered by this report. Based on this evaluation, the Company’s Chief Executive Officer and Chief Financial Officer concluded that the Company’s disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934 (the “Exchange Act”)) are effective to ensure that information required to be disclosed by the Company in reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported to the Company’s management within the time periods specified in the Securities and Exchange Commission’s rules and forms.

          Changes in internal controls over financial reporting. There were no changes in the Company’s internal

21


 

control over financial reporting that occurred during the Company’s most recent fiscal quarter that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

PART II

OTHER INFORMATION

Item 1. Legal Proceedings

               Not applicable

Item 2. Changes in Securities and Use of Proceeds

               Not applicable

Item 3. Defaults Upon Senior Securities

               Not applicable

Item 4. Submission of Matters to a Vote of Security Holders

               Not applicable

Item 5. Other Information

               Not applicable

Item 6A. Exhibits

     
Exhibit   Identification
Number   of Exhibit
31.1
 
Certification of the Chief Executive Officer pursuant to Rule 13a-14(a) of the Securities Exchange Act of 1934, as amended.
 
 
31.2
 
Certification of the Chief Financial Officer pursuant to Rule 13a-14(a) of the Securities Exchange Act of 1934, as amended.
 
 
32.1
 
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.
 
 
32.2
 
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.

Item 6B. Reports on Form 8-K

          The Company filed a Current Report on Form 8-K under Item 7 and Item 9 on July 30, 2003 to announce the release of its earnings for the second quarter of 2003.

22


 

SIGNATURES

          Pursuant to the requirements 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.

         
    By:   /s/ L. Don Stricklin
       
Date: November 12, 2003       L. Don Stricklin
        President and Chief Executive Officer
        (principal executive officer)
         
Date: November 12, 2003   By:   /s/ Thomas N. Adams
       
        Thomas N. Adams
        Executive Vice President and
        Chief Financial Officer
        (principal financial officer/
        principal accounting officer)

23


 

Exhibit Index

     
Exhibit   Identification
Number   of Exhibit
31.1
 
Certification of the Chief Executive Officer pursuant to Rule 13a-14(a) of the Securities Exchange Act of 1934, as amended.
 
 
31.2
 
Certification of the Chief Financial Officer pursuant to Rule 13a-14(a) of the Securities Exchange Act of 1934, as amended.
 
 
32.1
 
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.
 
 
32.2
 
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.