FORM 10-Q

 

(Mark One)

 

 

For the transition period from               to              

 

Commission file number 000-14517

 

TEXAS REGIONAL BANCSHARES, INC.

(Exact name of registrant as specified in its charter)

 

 

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 ý No o

 

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

 

There were 29,624,100 shares of the registrant’s Class A Voting Common Stock, $1.00 par value, outstanding as of November 10, 2003.

 

 

PART I. FINANCIAL INFORMATION

 

ITEM 1. Financial Statements

 

Texas Regional Bancshares, Inc. and Subsidiaries

Condensed Consolidated Balance Sheets

(Dollars in Thousands, Except Share Data)		September 30, 2003			December 31, 2002
		(Unaudited)
Assets
Cash and Due From Banks		$	131,102		$	124,125
Interest-Bearing Deposits at Other Banks		55,531			614
Federal Funds Sold		79,000			13,800
Total Cash and Cash Equivalents		265,633			138,539
Time Deposits		200			299
Securities Available for Sale, at Fair Value		1,288,743			1,195,665
Securities Held to Maturity, at Amortized Cost (Fair Value of $441 in 2003 and $451 in 2002)		414			414
Loans Held for Sale		25,326			56,175
Loans Held for Investment, Net of Unearned Discount of $380 in 2003 and $1,109 in 2002		2,417,245			2,267,530
Less: Allowance for Loan Losses		(29,924		)	(28,116		)
Net Loans Held for Investment		2,387,321			2,239,414
Premises and Equipment, Net		106,639			89,500
Accrued Interest Receivable		26,723			27,781
Other Real Estate		8,763			9,159
Goodwill, Net		29,856			28,501
Identifiable Intangibles, Net		16,095			18,454
Other Assets		29,912			31,286
Total Assets		$	4,185,625		$	3,835,187
Liabilities
Deposits
Demand		$	534,887		$	445,978
Savings		145,955			139,531
Money Market Checking and Savings		914,440			838,642
Time Deposits		1,803,208			1,708,040
Total Deposits		3,398,490			3,132,191
Other Borrowed Money		353,650			293,518
Accounts Payable and Accrued Liabilities		23,744			32,023
Total Liabilities		3,775,884			3,457,732
Commitments and Contingencies
Shareholders’ Equity
Preferred Stock; $1.00 Par Value, 10,000,000 Shares Authorized; None Issued and Outstanding		—			—
Common Stock – Class A; $1.00 Par Value, 50,000,000 Shares Authorized; Issued and Outstanding 29,449,088 Shares in 2003 and 26,488,153 Shares in 2002		29,449			26,488
Paid-In Capital		277,549			186,169
Retained Earnings		91,386			142,670
Accumulated Other Comprehensive Income, Net of Tax		11,357			22,128
Total Shareholders’ Equity		409,741			377,455
Total Liabilities and Shareholders’ Equity		$	4,185,625		$	3,835,187

 

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

 

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Texas Regional Bancshares, Inc. and Subsidiaries
Condensed Consolidated Statements of Income and Comprehensive Income

		Three Months Ended September 30,						Nine Months Ended September 30,
(Dollars in Thousands, Except Per Share Data)		2003			2002			2003			2002
		(Unaudited)
Interest Income
Loans Held for Sale		$	703		$	609		$	1,996		$	1,465
Loans Held for Investment, Including Fees		40,354			39,714			120,502			114,556
Securities
Taxable		9,268			10,754			29,898			31,239
Tax-Exempt		869			767			2,539			2,093
Interest-Bearing and Time Deposits		18			13			156			40
Federal Funds Sold		24			36			149			92
Total Interest Income		51,236			51,893			155,240			149,485
Interest Expense
Deposits		12,393			16,673			41,408			48,935
Federal Funds Purchased and Securities Sold Under Repurchase Agreements		798			1,072			2,719			2,932
Federal Home Loan Bank Advances		583			593			1,601			1,182
Trust Preferred Securities		319			326			958			800
Subordinated Debentures		—			110			110			267
Total Interest Expense		14,093			18,774			46,796			54,116
Net Interest Income Before Provision for Loan Losses		37,143			33,119			108,444			95,369
Provision for Loan Losses		3,851			2,950			9,971			8,655
Net Interest Income After Provision for Loan Losses		33,292			30,169			98,473			86,714
Noninterest Income
Service Charges on Deposit Accounts		6,756			5,261			17,985			14,713
Other Service Charges		1,500			1,243			4,817			3,930
Trust Service Fees		710			743			2,129			2,040
Net Realized Gains on Sales of Securities Available for Sale		3,041			1,885			9,653			2,961
Data Processing Service Fees		1,950			1,676			5,412			4,784
Loan Servicing Income (Loss), Net		(1,276		)	84			(3,202		)	661
Other Noninterest Income		560			435			2,498			1,099
Total Noninterest Income		13,241			11,327			39,292			30,188
Noninterest Expense
Salaries and Employee Benefits		11,954			9,412			35,174			27,875
Net Occupancy Expense		1,967			1,481			5,221			4,157
Equipment Expense		2,790			2,362			7,842			6,326
Other Real Estate Expense, Net		124			152			435			314
Amortization of Identifiable Intangibles		849			961			2,532			2,526
Other Noninterest Expense		5,583			5,134			16,899			15,030
Total Noninterest Expense		23,267			19,502			68,103			56,228
Income Before Income Tax Expense		23,266			21,994			69,662			60,674
Income Tax Expense		7,697			7,732			23,297			20,745
Net Income		15,569			14,262			46,365			39,929
Other Comprehensive Income (Loss), Net of Tax Unrealized Gain (Loss) on Securities Available for Sale
Unrealized Holding Gain (Loss) Arising During Period		(12,326		)	11,656			(4,497		)	19,919
Less: Reclassification Adjustment for Gains Included in Net Income		1,977			1,225			6,274			1,925
Total Other Comprehensive Income (Loss)		(14,303		)	10,431			(10,771		)	17,994
Comprehensive Income		$	1,266		$	24,693		$	35,594		$	57,923
Net Income Per Common Share
Basic		$	0.53		$	0.49		$	1.58		$	1.40
Diluted		0.52			0.49			1.56			1.39

 

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

 

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Texas Regional Bancshares, Inc. and Subsidiaries

Condensed Consolidated Statements of Changes In Shareholders’ Equity

(Dollars in Thousands)		Common Stock - Class A			Paid-In Capital			Retained Earnings			Accumulated Other Comprehensive Income			Total Shareholders’ Equity
		(Unaudited)
Nine Months Ended September 30, 2003
Balance, Beginning of Period		$	26,488		$	186,169		$	142,670		$	22,128		$	377,455
Net Income		—			—			46,365			—			46,365
Net Change in Unrealized Losses on Securities Available for Sale, Net of Tax and Reclassification Adjustment		—			—			—			(10,771		)	(10,771		)
Total Comprehensive Income		—			—			46,365			(10,771		)	35,594
Exercise of Stock Options, 256,343 Shares of Class A Common Stock		256			5,052			—			—			5,308
Tax Effect of Nonqualified Stock Options Exercised and Disqualifying Dispositions On Qualified Stock Options		—			921			—			—			921
Ten Percent Stock Dividend		2,668			84,292			(87,004		)	—			(44		)
Purchase of Corpus Christi Bancshares, Inc.		37			1,115			—			—			1,152
Class A Common Stock Cash Dividends		—			—			(10,645		)	—			(10,645		)
Balance, End of Period		$	29,449		$	277,549		$	91,386		$	11,357		$	409,741
Nine Months Ended September 30, 2002 Balance, Beginning of Period		$	16,236		$	137,027		$	109,412		$	2,584		$	265,259
Net Income		—			—			39,929			—			39,929
Net Change in Unrealized Gains on Securities Available for Sale, Net of Tax and Reclassification Adjustment		—			—			—			17,994			17,994
Total Comprehensive Income		—			—			39,929			17,994			57,923
Exercise of Stock Options, 165,048 Shares of Class A Common Stock		165			3,932			—			—			4,097
Tax Effect of Nonqualified Stock Options Exercised and Disqualifying Dispositions On Qualified Stock Options		—			703			—			—			703
Three-For-Two Stock Split		8,749			—			(8,770		)	—			(21		)
Purchase of Riverway Holdings, Inc.		1,177			39,603			—			—			40,780
Class A Common Stock Cash Dividends		—			—			(8,623		)	—			(8,623		)
Balance, End of Period		$	26,327		$	181,265		$	131,948		$	20,578		$	360,118

 

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

 

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Texas Regional Bancshares, Inc. and Subsidiaries
Condensed Consolidated Statements of Cash Flows

		Nine Months Ended September 30,
(Dollars in Thousands)		2003			2002
		(Unaudited)
Cash Flows from Operating Activities
Net Income		$	46,365		$	39,929
Adjustments to Reconcile Net Income to Net Cash Provided by Operating Activities
Depreciation, Amortization and Accretion, Net		18,662			10,142
Provision for Loan Losses		9,971			8,655
Provision for Estimated Losses on Other Real Estate and Other Assets		9			49
Deferred Tax Expense (Benefit)		(3,190		)	364
Net Realized Gains on Sales of Securities Available for Sale		(9,653		)	(2,961		)
(Gain) Loss on Sale of Other Assets		99			(19		)
Gain on Sale of Other Real Estate		(60		)	(164		)
(Gain) Loss on Disposal of Premises and Equipment		(10		)	338
Gain on Sale of Loans Held for Sale		(1,565		)	(74		)
Net Decrease in Loans Held for Sale		32,414			8,255
(Increase) Decrease in Accrued Interest Receivable and Other Assets		2,281			(4,089		)
Increase in Accounts Payable and Accrued Liabilities		2,332			222
Net Cash Provided by Operating Activities		97,655			60,647
Cash Flows from Investing Activities
Net (Increase) Decrease in Time Deposits		99			(5		)
Proceeds from Sales of Securities Available for Sale		437,275			252,124
Proceeds from Maturing Securities Available for Sale		198,303			113,005
Purchases of Securities Available for Sale		(739,916		)	(522,138		)
Proceeds from Maturing Securities Held to Maturity		—			500
Loan Originations and Advances, Net		(143,892		)	(143,350		)
Recoveries of Charged-Off Loans		922			656
Proceeds from Sale of Premises and Equipment		24			32
Purchases of Premises and Equipment		(23,001		)	(12,907		)
Proceeds from Sale of Other Real Estate		1,127			350
Proceeds from Sale of Other Assets		880			811
Purchase of Data Processing Contracts		—			(849		)
Net Cash Provided by Merger		5,883			17,349
Net Cash Used in Investing Activities		(262,296		)	(294,422		)
Cash Flows from Financing Activities
Net Increase in Demand Deposits, Savings, Money Market Checking and Savings Accounts		151,879			80,344
Net Increase in Time Deposits		85,198			159,998
Net Increase in Other Borrowed Money		59,682			20,667
Cash Dividends Paid on Class A Common Stock		(10,288		)	(8,146		)
Cash Paid in lieu of Fractional Shares		(44		)	(21		)
Proceeds from the Sale of Common Stock		5,308			4,097
Net Cash Provided by Financing Activities		291,735			256,939
Increase in Cash and Cash Equivalents		127,094			23,164
Cash and Cash Equivalents at Beginning of Period		138,539			95,702
Cash and Cash Equivalents at End of Period		$	265,633		$	118,866
Supplemental Disclosures of Cash Flow Information:
Interest Paid		$	48,117		$	54,787
Income Taxes Paid		25,477			21,749
Supplemental Schedule of Noncash Investing and Financing Activities:
Foreclosure and Repossession in Partial Satisfaction of Loans Receivable		6,588			4,823
Financing Provided for Sales of Other Real Estate		2,186			1,346
Net Increase (Decrease) in Security Trades Not Settled		(479		)	139
Net Increase in Dividends Payable		359			477
The Company Acquired Corpus Christi Bancshares, Inc. and its Subsidiary, First State Bank, on February 14, 2003.  Assets Acquired and Liabilities Assumed are as Follows:
Fair Value of Assets Acquired Including Goodwill		31,067			—
Fair Value of Liabilities Assumed		29,915			—
Fair Value of Stock Issued		1,152			—
The Company Acquired Riverway Holdings, Inc. and its Subsidiary, Riverway Bank, on February 22, 2002.  Assets Acquired and Liabilities Assumed are as Follows:
Fair Value of Assets Acquired Including Goodwill		—			691,322
Fair Value of Liabilities Assumed		—			650,542
Fair Value of Stock Issued		—			40,780

 

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

 

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TEXAS REGIONAL BANCSHARES, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

NOTE 1: BASIS OF PRESENTATION

 

The accompanying unaudited condensed consolidated financial statements were prepared in accordance with instructions for Form 10-Q and, therefore, do not include all information and notes necessary for a complete presentation of financial position, results of operations, changes in shareholders’ equity, and cash flows in conformity with accounting principles generally accepted in the United States of America. However, the condensed consolidated financial statements include all adjustments that, in the opinion of management, are necessary for a fair presentation. All such adjustments were of a normal and recurring nature. The results of operations and cash flows for the nine months ended September 30, 2003 should not be considered indicative of the results to be expected for the full year. These condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in the Texas Regional Bancshares, Inc. and Subsidiaries (“Texas Regional” or the “Company”) Annual Report on Form 10-K for the year ended December 31, 2002.

 

The condensed consolidated financial statements include the accounts of Texas Regional Bancshares, Inc. (the “Parent”) and its wholly-owned subsidiaries, Texas Regional Delaware, Inc. and Texas State Bank (the “Bank”). The Company eliminates all significant intercompany transactions and balances in consolidation. The Company accounts for its investments in subsidiaries on the equity method in the Parent’s financial statements.

 

NEW ACCOUNTING PRONOUNCEMENTS

 

In October 2002, The Financial Accounting Standards Board issued Statement No. 147 (“Statement 147”), “Acquisitions of Certain Financial Institutions-an amendment of FASB Statements No. 72 and 144 and FASB Interpretation No. 9”. Except for transactions between two or more mutual enterprises, this Statement removes acquisitions of financial institutions from the scope of both Statement 72 and Interpretation 9 and requires that those transactions be accounted for in accordance with Statements No. 141 and 142. In addition, this Statement amends Financial Accounting Standards Board Statement 144, “Accounting for the Impairment or Disposal of Long-Lived Assets”, to include in its scope long-term customer relationship intangible assets of financial institutions such as depositor and borrower relationship intangible assets and credit cardholder intangible assets. Consequently, those intangible assets are subject to the same undiscounted cash flow recoverability test and impairment loss recognition and measurement provisions that Statement 144 requires for other long-lived assets that are held and used. The Company adopted Statement 147 on October 1, 2002 and the Statement did not have an impact on the Company’s consolidated financial statements.

 

In November 2002, the Financial Accounting Standards Board issued FASB Interpretation No. 45 (“FIN 45”), “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others, an interpretation of FASB Statements No. 5, 57 and 107 and rescission of FASB Interpretation No. 34”.  FIN 45 elaborates on the disclosures to be made by a guarantor in its interim and annual financial statements about its obligations under certain guarantees that it has issued.  The disclosures required by FIN 45 improve the transparency of the financial statement information about the guarantor’s obligations and liquidity risks related to guarantees issued. This interpretation also incorporates, without change, the guidance in Financial Accounting Standards Board Interpretation No. 34 (“FIN 34”), “Disclosure of Indirect Guarantees of Indebtedness of Others”, which is being superceded. FIN 45 also clarifies that a guarantor is required to recognize, at the inception of a guarantee, a liability for the obligations it has undertaken in issuing the guarantee, including its ongoing obligation to stand ready to perform over the term of the guarantee in the event that the specified triggering events or conditions occur. The initial recognition and initial measurement provisions of FIN 45 are applicable on a prospective basis to guarantees issued or modified after December 31, 2002, irrespective of the guarantor’s fiscal year-end. The disclosure requirements are effective for financial statements of interim or annual periods ending after December 15, 2002.  The adoption of FIN 45 did not have a material impact on the Company’s consolidated financial statements.

 

In December 2002, the Financial Accounting Standards Board issued Statement No. 148 (“Statement 148”), “Accounting for Stock-Based Compensation - Transition and Disclosure, an amendment of FASB Statement No. 123”. Statement 148 amends Financial Accounting Standards Board Statement No. 123 (“Statement 123”), “Accounting for Stock-Based Compensation”, to provide alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. In addition, Statement 148 amends the disclosure requirement of Statement 123 to require prominent disclosures in both annual and interim financial statements about the fair value based method of accounting for stock-based employee compensation for those companies that have

 

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elected to continue to apply Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees”. The adoption of Statement 148 did not have an impact on the Company’s consolidated financial statements, other than additional disclosures in the Company’s interim consolidated financial statements.

 

In January 2003, the Financial Accounting Standards Board issued FASB Interpretation No. 46 (“FIN 46”), “Consolidation of Variable Interest Entities, an interpretation of Accounting Research Bulletin No. 51”. This interpretation is intended to achieve more consistent application of consolidation policies to variable interest entities (“VIE”) and, thus, to improve comparability between enterprises engaged in similar activities even if some of those activities are conducted through VIE’s. Including the assets, liabilities and results of activities of VIE’s in the consolidated financial statements of their primary beneficiaries will provide more complete information about the resources, obligations, risk and opportunities of the consolidated enterprise. FIN 46 applies immediately to VIE’s created after January 31, 2003, and to VIE’s in which an enterprise obtains an interest after that date. It applies in the first fiscal or interim period beginning after June 15, 2003, to VIE’s in which an enterprise holds a variable interest that was acquired before February 1, 2003. However, in October 2003, the FASB deferred the implementation date of FIN 46 for VIE’s that existed before February 1, 2003 until the first fiscal year or interim period ending after December 15, 2003. FIN 46 applies to public enterprises as of the beginning of the applicable interim or annual period, and it applies to nonpublic enterprises as of the end of the applicable annual period. FIN 46 may be applied prospectively with a cumulative-effect adjustment as of the date on which it is first applied or by restating previously issued financial statement for one or more years with a cumulative-effect adjustment as of the date on which it is first applied or by restating previously issued financial statements for one or more years with a cumulative-effect adjustment as of the beginning of the first year restated.

 

The Company’s Trust Preferred Securities were issued through business trusts. We currently believe the continued consolidation of these trusts is appropriate under FIN 46. However, the application of FIN 46 to these types of trusts is an emerging issue and a possible unintended consequence of FIN 46 is the deconsolidation of these types of trusts. The Company is currently evaluating the impact that deconsolidation of these trusts would have on its consolidated financial statements.

 

In April 2003, the Financial Accounting Standards Board issued Statement No. 149 (“Statement 149”), “Amendment of Statement 133 on Derivative Instruments and Hedging Activities”.  Statement 149 amends Financial Accounting Standards Board Statement No. 133 (“Statement 133”), “Accounting for Derivative Instruments and Hedging Activities” and clarifies financial accounting and reporting for derivative instruments, including certain derivative instruments embedded in other contracts and for hedging activities.  Statement 149 improves financial reporting by requiring that contracts with comparable characteristics be accounted for similarly.  In particular, this Statement clarifies under what circumstances a contract with an initial net investment meets the characteristic of a derivative, clarifies when a derivative contains a financing component, amends the definition of underlying to conform to the language in FIN 45, and amends certain other existing pronouncements.  Statement 149 is effective for contracts entered into or modified after September 30, 2003 and for hedging relationships designated after September 30, 2003.  However, the provisions of Statement 149 that relate to Statement 133 Implementation Issues that have been effective for fiscal quarters that began prior to June 15, 2003, should continue to be applied in accordance with their respective effective dates. The adoption of Statement 149 is not expected to have a material impact on the Company’s consolidated financial statements.

 

In May 2003, the Financial Accounting Standards Board issued Statement No. 150 (“Statement 150”), “Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and Equity”.  Statement 150 requires certain financial instruments that have characteristics of both liabilities and equity to be classified as a liability on the balance sheet.  Prior to the issuance of Statement 150, the Company classified trust preferred securities as other borrowed money on the consolidated balance sheets and its related interest cost as interest expense on the consolidated statements of income and comprehensive income, which is consistent with the requirements of Statement 150. Statement 150 is effective for financial instruments entered into or modified after May 31, 2003, and otherwise is effective at the beginning of the first interim period beginning after June 15, 2003. Statement 150 will be effected by reporting the cumulative effect of a change in accounting principle for contracts created before the issuance date and still existing at the beginning of that interim period. The adoption of Statement 150 did not have an impact on the Company’s consolidated financial statements.

 

STOCK BASED EMPLOYEE COMPENSATION

 

The Company has accounted for its stock-based compensation plans in accordance with the intrinsic value provisions of Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees”. As such, compensation expense would be recorded on the date of grant only if the current market price of the underlying stock

 

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exceeded the exercise price. All outstanding options have been granted at fair market value at date of grant; therefore, the Company did not record any compensation expense in the condensed consolidated financial statements for its stock-based compensation plans. In accordance with Statement 148, the following table illustrates the effect on net income and net income per share had compensation expense been recognized consistent with the fair value provisions of Statement of Financial Accounting Standards No. 123 (“Statement 123”), “Accounting for Stock-Based Compensation” (dollars in thousands, except per share data):

 

		Three Months Ended September 30,						Nine Months Ended September 30,
		2003			2002			2003			2002
Net Income, As Reported		$	15,569		$	14,262		$	46,365		$	39,929
Deduct:  Total Stock-Based Employee Compensation Expense Determined Under Fair Value Based Method For All Awards, Net of Related Tax Effect		(352		)	(378		)	(1,301		)	(1,225		)
Pro Forma Net Income		$	15,217		$	13,884		$	45,064		$	38,704
Net Income Per Share:
Basic – As Reported		$	0.53		$	0.49		$	1.58		$	1.40
Basic – Pro Forma		0.52			0.48			1.54			1.36
Diluted – As Reported		0.52			0.49			1.56			1.39
Diluted – Pro Forma		0.51			0.47			1.52			1.34

 

RECLASSIFICATIONS

 

Certain amounts in the prior year’s presentation have been reclassified to conform to the current presentation. These reclassifications have no effect on previously reported net income.

 

NOTE 2: IMPAIRED LOANS

 

Loans that the Company does not expect to collect the full principal and interest based on the terms of the original loan agreement are identified as impaired loans. These include loans that are on nonaccrual status or are considered troubled debt restructurings due to the granting of a below-market rate of interest or a partial forgiveness of indebtedness on an existing loan. The balance of impaired loans was $10,561,000 at September 30, 2003 for which there was a related allowance for loan losses of $1,834,000. At September 30, 2003, the Company had $588,000 in impaired loans for which there was no related allowance for loan losses. The average recorded investment in impaired loans during the nine months ended September 30, 2003 was $13,318,000. Interest income on impaired loans of $210,000 for cash payments received on nonaccrual loans was recognized during the nine months ended September 30, 2003.

 

NOTE 3: COMMON STOCK

 

On September 9, 2003, the Board of Directors approved a cash dividend of $0.12 per share for shareholders of record on October 1, 2003 and payable on October 15, 2003.

 

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NOTE 4: NET INCOME PER COMMON SHARE COMPUTATIONS

 

The table below presents a reconciliation of basic and diluted net income per share computations ("EPS") (dollars in thousands, except share data). The number of shares outstanding and related net income per share amounts for 2003 and 2002 have been restated to retroactively give effect to the 10 percent stock dividend declared during March 2003 and distributed in April 2003.

 

		Three Months Ended September 30,						Nine Months Ended September 30,
		2003			2002			2003			2002
		(Unaudited)
Net Income		$	15,569		$	14,262		$	46,365		$	39,929
Weighted Average Number of Common Shares Outstanding
Used in Basic EPS Calculation		29,433,001			28,910,482			29,342,145			28,466,353
Add Assumed Exercise of Dilutive Securities
Outstanding Stock Options		138,380			218,519			162,746			196,226
Riverway Holdback shares		165,000			165,000			165,000			133,571
Weighted Average Number of Common Shares
Outstanding Used in Diluted EPS Calculations		29,736,381			29,294,001			29,669,891			28,796,150
Basic EPS		$	0.53		$	0.49		$	1.58		$	1.40
Diluted EPS		0.52			0.49			1.56			1.39

 

NOTE 5: RELATED PARTY TRANSACTIONS

 

On May 28, 2002, the Company purchased approximately 2.6 acres of land for $1.6 million from an affiliate of a Texas Regional Board member. The property was purchased for a future branch location.

 

On April 4, 2003, the Company purchased approximately 15.9 acres of land for $2.8 million from a partnership. The Chairman of the Board of the Company owns a 10 percent interest in the partnership. The property was purchased for development of an operation and branch facility for the Company.

 

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

Forward-Looking Statements. This Management’s Discussion and Analysis includes forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, and are subject to the “safe harbor” created by these sections. These forward-looking statements involve certain risks and uncertainties that could cause actual results to differ materially from those in the forward-looking statements. Such risks and uncertainties include, but are not limited to, the following factors: significant increases in competitive pressure in the banking industry; changes in the interest rate environment reducing margins; general economic conditions, either nationally or regionally, becoming less favorable than expected, resulting in, among other things, a deterioration in credit quality and an increase in the provision for possible loan losses; changes in the regulatory environment; changes in business conditions; volatility of rate sensitive deposits; operational risks including data processing system failures or fraud; asset/liability matching risks and liquidity risks; and changes in the securities markets. Because of these uncertainties, actual future results may be materially different from the results indicated by these forward-looking statements. The Company assumes no obligation and does not intend to update these forward-looking statements. In addition, the Company’s past results do not necessarily indicate its future results.

 

Management’s discussion and analysis of the Company’s consolidated financial condition and results of operations at the dates and for the periods indicated follows. This discussion should be read in conjunction with the Company’s condensed consolidated financial statements and the accompanying notes.

 

GENERAL

 

Texas Regional Bancshares, Inc. is a Texas business corporation incorporated in 1983 and headquartered in McAllen, Texas. The Company is a bank holding company within the meaning of the Bank Holding Company Act of 1956 and as such is registered with the Board of Governors of the Federal Reserve System (“Federal Reserve Board”).

 

9

 

Texas Regional Delaware, Inc., incorporated under the laws of Delaware as a wholly-owned second tier bank holding company subsidiary, owns Texas State Bank (the “Bank”), the Company’s primary operating subsidiary. The Bank has two active wholly-owned subsidiaries: (i) TSB Securities, Inc., incorporated in 1997 to provide full service broker-dealer services and (ii) TSB Properties, Inc., incorporated in 1998 primarily to receive and liquidate foreclosed assets.

 

By authority of the Board of Directors of the Company, Texas Regional in May 2000 filed a Declaration Electing to be a Financial Holding Company with the Federal Reserve Bank of Dallas. The Declaration became effective in June 2000.

 

Texas State Bank operates thirty-four banking locations.  Twenty-eight banking locations are located in the Rio Grande Valley including four banking locations in McAllen (including its main office), four banking locations in Brownsville, four banking locations in Harlingen, three banking locations in Mission, two banking locations in Weslaco, and one banking location each in Edinburg, Hidalgo, La Feria, Mercedes, Palm Valley, Penitas, Progresso, Raymondville, Rio Grande City, Roma and San Juan. In addition, Texas State Bank operates one banking location each in Bishop, Corpus Christi, Eagle Pass and Sugar Land and two banking locations in Houston. As of September 30, 2003, Texas Regional had consolidated total assets of $4,185,625,000, loans held for investment (net of unearned discount) of $2,417,245,000, deposits of $3,398,490,000 and shareholders’ equity of $409,741,000.

 

During 2002, the Bank expanded the services that it provides to third party correspondent banks. The Bank’s data processing center serves banks both in North Texas and the Rio Grande Valley, in addition to providing data processing services for all of the Bank’s banking locations.

 

FINANCIAL CONDITION

 

CASH AND CASH EQUIVALENTS

 

The Company offers a broad range of commercial banking services to individuals and businesses in its service area. It also acts as a correspondent to a number of banks in its service area, providing check clearing, wire transfer, federal funds transactions, loan participations and other correspondent services. The amount of cash and cash equivalents held on any day is significantly influenced by temporary changes in cash items in process of collection. The Company had cash and cash equivalents totaling $265,633,000 at September 30, 2003. By comparison, the Company had $138,539,000 in cash and cash equivalents at December 31, 2002, an increase of $127,094,000 or 91.7%. The increase resulted primarily from a $65,200,000 and $54,917,000 increase in federal funds sold and interest bearing time deposits at other banks, respectively. The increase is primarily due to excess funds resulting from an increase in deposits by $266,299,000 during 2003, while loans increased by only $149,715,000.

 

SECURITIES

 

Securities consist of U.S. Treasury, U.S. Government Agency, mortgage-backed and state, county and municipal securities. The Bank classifies debt and equity securities into one of three categories: held to maturity, trading or available for sale. At each reporting date, management reassesses the appropriateness of the classification. Investments in debt securities are classified as held to maturity and measured at amortized cost in the condensed consolidated balance sheets 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 condensed consolidated balance sheets with unrealized holding 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 condensed consolidated balance sheets with unrealized holding gains and losses reported in accumulated other comprehensive income, net of applicable income taxes, until realized.

 

At September 30, 2003 and December 31, 2002, no securities were classified as trading. The Company does not currently engage in trading activities or use derivative instruments to control interest rate risk. Even though such activities may be permitted with the approval of the Board of Directors, the Company does not intend to engage in such activities in the immediate future.

 

10

 

The following table presents the amortized cost and estimated fair value of securities at September 30, 2003 and December 31, 2002 (dollars in thousands):

 

		Amortized Cost			Gross Unrealized Gains			Gross Unrealized Losses			Estimated Fair Value
Securities Available for Sale
September 30, 2003 (Unaudited)
U.S. Treasury		$	707		$	8		$	—		$	715
U.S. Government Agency		809,548			18,299			(3,802		)	824,045
Mortgage-Backed		323,387			2,036			(2,353		)	323,070
States and Political Subdivisions		104,410			3,501			(144		)	107,767
Other		33,038			109			(1		)	33,146
Total		$	1,271,090		$	23,953		$	(6,300	)	$	1,288,743
December 31, 2002
U.S. Treasury		$	715		$	12		$	—		$	727
U.S. Government Agency		781,099			27,843			(17		)	808,925
Mortgage-Backed		279,859			3,479			(102		)	283,236
States and Political Subdivisions		77,699			3,294			(57		)	80,936
Other		21,792			49			—			21,841
Total		$	1,161,164		$	34,677		$	(176	)	$	1,195,665
Securities Held to Maturity
September 30, 2003 (Unaudited)
States and Political Subdivisions		$	414		$	27		$	—		$	441
Total		$	414		$	27		$	—		$	441
December 31, 2002
States and Political Subdivisions		$	414		$	37		$	—		$	451
Total		$	414		$	37		$	—		$	451

 

Net unrealized holding gains on securities available for sale, net of related tax effect, of $11,357,000 and $22,128,000 at September 30, 2003 and December 31, 2002, respectively, were reported in a separate component of shareholders’ equity as accumulated other comprehensive income.

 

Securities available for sale and securities held to maturity with carrying values of $1,197,103,000 and $414,000, respectively, at September 30, 2003 and $1,120,929,000 and $414,000, respectively, at December 31, 2002 were pledged to secure public funds, trust assets on deposit and for other purposes required or permitted by law.

 

LOANS HELD FOR SALE

 

Loans held for sale of $25,326,000 at September 30, 2003 decreased $30,849,000 or 54.9% compared to December 31, 2002 balance of $56,175,000. During the third quarter 2003, mortgage rates began to fluctuate resulting in a decline in mortgage loan volumes.

 

LOANS HELD FOR INVESTMENT

 

The Company manages its credit risk by establishing and implementing strategies and guidelines appropriate to the characteristics of borrowers, industries, geographic locations and risk products. Diversification of risk within each of these areas is a primary objective. Policies and procedures are developed to ensure that loan commitments conform to current strategies and guidelines. Management continually refines the Company’s credit policies and procedures to address the risks in the current and prospective environment and to reflect management’s current strategic

 

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focus. The credit process is controlled with continuous credit review and analysis, and review by internal and external auditors and regulatory authorities. The Company’s loans are widely diversified by borrower and industry group.

 

The Company has collateral management policies in place so that collateral lending of all types is approached on a basis consistent with safe and sound standards. Valuation analysis is utilized to take into consideration the potentially adverse economic conditions under which liquidation could occur. Collateral accepted against the commercial loan portfolio includes deeds of trust, accounts receivable, inventory, marketable securities, equipment and agricultural products. Autos, deeds of trust, life insurance and marketable securities are accepted as collateral for the consumer loan portfolio.

 

Management of the Company believes that the Company has benefited from increased loan demand due to passage of the North American Free Trade Agreement (“NAFTA”) and the strong population growth in the Rio Grande Valley. The effects of NAFTA have also increased cross-border trade and industrial development including activity at twin manufacturing plants located on each side of the border (referred to as maquiladoras) which benefit the Rio Grande Valley economy. Management believes that NAFTA will continue to have a positive impact on the Company’s growth and earnings prospects.

 

International loans are loans to borrowers that are domiciled in a country other than the United States of America. The Company’s total international loans at September 30, 2003 of $46,548,000 represented 1.9% of total loans held for investment. See “Nonperforming Assets” for additional information on international loans.

 

Total loans held for investment of $2,417,245,000 at September 30, 2003 increased $149,715,000 or 6.6% compared to December 31, 2002 levels of $2,267,530,000. The increase in loans held for investment for the nine months ended September 30, 2003 reflects growth in all loan categories except Agricultural, Agricultural Mortgage, 1-4 Family Mortgage and Consumer, in addition to loans acquired with the Corpus Christi Bancshares, Inc. (“Corpus Christi”) acquisition. The following table presents the composition of the loans held for investment portfolio (dollars in thousands):

 

		September 30, 2003			December 31, 2002
		(Unaudited)
Commercial		$	701,909		$	668,359
Commercial Tax-Exempt		63,152			29,474
Total Commercial		765,061			697,833
Agricultural		59,414			63,522
Real Estate
Construction		286,615			238,686
Commercial Mortgage		946,946			848,404
Agricultural Mortgage		52,874			57,995
1-4 Family Mortgage		181,099			221,962
Total Real Estate		1,467,534			1,367,047
Consumer		125,236			139,128
Total Loans Held for Investment		$	2,417,245		$	2,267,530

 

The Company’s policy on maturity extensions and rollovers is based on management’s assessment of individual loans. Approvals for the extension or renewal of loans without reduction of principal for more than one twelve-month period are generally avoided, unless the loans are fully secured and properly margined by cash or marketable securities, or are revolving lines subject to annual analysis and renewal.

 

NONPERFORMING ASSETS

 

The Company has several procedures in place to assist in maintaining the overall quality of its loan portfolio. The Bank has established underwriting guidelines to be followed by its officers and monitors its delinquency levels for any negative or adverse trends.

 

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Nonperforming assets consist of nonperforming (impaired) loans and other assets, primarily real estate, acquired in partial or full satisfaction of loan obligations. The Company’s policy generally is to place a loan on nonaccrual status when payment of principal or interest is contractually past due 90 days, or earlier when concern exists as to the ultimate collection of principal and interest. At the time a loan is placed on nonaccrual status, interest previously accrued but uncollected is reversed and charged against current income unless the collateral provides more than adequate margin to ensure collection of that interest. A restructured loan is generally a loan that is accruing interest, but on which concessions in terms have been made as a result of deterioration in the borrower’s financial condition. The Company’s classification of nonperforming loans includes those loans for which management believes collection is doubtful. Management is not aware of any specific borrower relationships that are not reported as nonperforming where management has serious doubts as to the ability of such borrowers to comply with the present loan repayment terms which would cause nonperforming assets to increase materially.

 

Nonperforming assets of $21,408,000 at September 30, 2003 decreased $4,002,000 or 15.7% compared to December 31, 2002 levels of $25,410,000. Nonaccrual loans of $10,561,000 at September 30, 2003 decreased $4,239,000 or 28.6% compared to $14,800,000 at December 31, 2002. The decrease resulted primarily from one loan relationship in which $4,079,000 was either charged off or recorded to either other real estate or other assets. Foreclosed and other assets increased by $237,000 or 2.2% to $10,847,000 at September 30, 2003 compared to $10,610,000 at December 31, 2002. The increase in foreclosed assets during 2003 was primarily attributable to $3,771,000 in additions relating to two loan relationships. The increase was partially offset by the sale of three properties totaling $1,165,000, combined with the sales recognition of two properties totaling $2,378,000 whose sales were not previously recognized for financial reporting purposes. Management actively seeks buyers for all Other Real Estate. See “Noninterest Expense” below.

 

Loans which are contractually past due 90 days or more, which are both well secured or guaranteed by financially responsible third parties and in the process of collection, generally are not placed on nonaccrual status. The amount of such loans past due 90 days or more and still accruing at September 30, 2003 of $4,440,000 remained comparable to $4,411,000 reported for December 31, 2002, increasing by $29,000 or 0.7%. The ratio of nonperforming assets plus accruing loans 90 days or more past due as a percent of total loans held for investment and foreclosed and other assets at September 30, 2003 decreased to 1.06% from 1.31% at December 31, 2002. An analysis of the components of nonperforming assets follows (dollars in thousands):

 

		September 30, 2003			December 31, 2002
		(Unaudited)
Nonaccrual Loans		$	10,561		$	14,800
Nonperforming Loans		10,561			14,800
Foreclosed and Other Assets		10,847			10,610
Total Nonperforming Assets		21,408			25,410
Accruing Loans 90 Days or More Past Due		4,440			4,411
Total Nonperforming Assets and Accruing Loans 90 Days or More Past Due		$	25,848		$	29,821
Nonperforming Loans as a % of Total Loans Held for Investment		0.44		%	0.65		%
Nonperforming Assets as a % of Total Loans Held for Investment and Foreclosed and Other Assets		0.88			1.12
Nonperforming Assets as a % of Total Assets		0.51			0.66
Nonperforming Assets Plus Accruing Loans 90 Days or More Past Due as a % of Total Loans Held for Investment and Foreclosed and Other Assets		1.06			1.31

 

Management regularly reviews and monitors the loan portfolio to identify borrowers experiencing financial difficulties. Management believes that, at September 30, 2003, all such loans had been identified and included in the nonaccrual, renegotiated or 90 days or more past due loan totals reflected in the table above. Management continues to emphasize maintaining a low level of nonperforming assets and returning nonperforming assets to an earning status.

 

ALLOWANCE FOR LOAN LOSSES - CRITICAL ACCOUNTING POLICY

 

Management analyzes the loan portfolio to determine the adequacy of the allowance for loan losses and the appropriate provision required to maintain an adequate allowance. Estimating the allowance is a critical accounting

 

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policy. It is subjective in nature and requires material estimates that may be subject to revision as facts and circumstances warrant. In assessing the adequacy of the allowance, management reviews the size, quality and risks of loans in the portfolio and considers factors such as specific known risks, past experience, the status and amount of nonperforming assets and economic conditions. A specific percentage is allocated to total loans in good standing and not specifically reserved while additional amounts are added for individual loans considered to have specific probable loss potential. Loans identified as losses are charged-off. In addition, the loan review committee of the Bank reviews the assessments of management in determining the adequacy of the Bank’s allowance for loan losses on a quarterly basis. Based on total allocations, the provision is recorded to maintain the allowance at a level deemed appropriate by management based on probable losses in the loan portfolio. There can be no assurance that future additions or reductions to the allowance will not be necessary.

 

The allowance for loan losses at September 30, 2003 totaled $29,924,000, representing a net increase of $1,808,000 or 6.4% compared to $28,116,000 at December 31, 2002. The increase in the allowance for loan losses is comparable to the growth in the loans held for investment portfolio of 6.6%. Management believes that the allowance for loan losses at September 30, 2003 adequately reflects the probable losses in the loan portfolio. Various regulatory agencies, as an integral part of their examination process, periodically review the Bank’s allowance for loan losses. Such agencies may require the Bank to recognize additions to the allowance based on their judgments of information available to them at the time of their examination.

 

The following table summarizes the activity in the allowance for loan losses (dollars in thousands):

 

		Three Months Ended September 30,						Nine Months Ended September 30,
		2003			2002			2003			2002
		(Unaudited)
Balance at Beginning of Period		$	29,366		$	26,494		$	28,116		$	21,050
Balance from Acquisition		—			—			228			4,333
Provision for Loan Losses		3,851			2,950			9,971			8,655
Charge-Offs
Commercial		1,875			469			5,506			4,566
Agricultural		296			36			1,296			49
Real Estate		681			1,774			793			1,836
Consumer		687			599			1,718			1,416
Total Charge-Offs		3,539			2,878			9,313			7,867
Recoveries
Commercial		50			65			304			163
Agricultural		56			36			56			39
Real Estate		7			38			50			58
Consumer		133			122			512			396
Total Recoveries		246			261			922			656
Net Charge-Offs		3,293			2,617			8,391			7,211
Balance at End of Period		$	29,924		$	26,827		$	29,924		$	26,827
Ratio of Allowance for Loan Losses to Loans Held for Investment Outstanding, Net of Unearned Discount		1.24		%	1.23		%	1.24		%	1.23		%
Ratio of Allowance for Loan Losses to Nonperforming Loans		283.34			156.39			283.34			156.39
Ratio of Net Charge-Offs to Average Total Loans Held for Investment Outstanding, Net of Unearned Discount		0.56			0.48			0.48			0.47

 

PREMISES AND EQUIPMENT, NET

 

Premises and equipment of $106,639,000 at September 30, 2003 increased by $17,139,000 or 19.1% compared to December 31, 2002 levels of $89,500,000. The increase resulted primarily from $4,204,000 of real estate purchased in Sugarland, Weslaco and Eagle Pass, Texas for future banking locations, as well as $2,805,000 in real estate purchased for the development of an operation and branch facility in McAllen. In addition, there was a $3,406,000 increase in construction in progress associated with the Edinburg banking location.

 

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GOODWILL AND IDENTIFIABLE INTANGIBLES

 

Goodwill of $29,856,000 at September 30, 2003 increased $1,355,000 or 4.8% compared to $28,501,000 at December 31, 2002. The increase is attributable to $1,355,000 in goodwill added with the Corpus Christi acquisition. Identifiable intangibles of $16,095,000 at September 30, 2003 decreased $2,359,000 or 12.8% compared to $18,454,000 at December 31, 2002. Identifiable intangibles decreased primarily due to amortization of $2,532,000 for the nine months ended September 30, 2003, as well as a $395,000 downward adjustment relating to the San Juan Bancshares, Inc. (“San Juan”) core deposit intangible. The decrease was partially offset by the addition of a $551,000 core deposit intangible relating to the Corpus Christi acquisition.

 

DEPOSITS

 

Total deposits of $3,398,490,000 at September 30, 2003 increased $266,299,000 or 8.5% compared to December 31, 2002 levels of $3,132,191,000. The increase in total deposits is primarily attributable to growth in the volume of business conducted by the Company as well as the Corpus Christi acquisition. The following table presents the composition of total deposits (dollars in thousands):

 

		September 30, 2003			December 31, 2002
		(Unaudited)
Demand Deposits
Commercial and Individual		$	530,929		$	441,775
Public Funds		3,958			4,203
Total Demand Deposits		534,887			445,978
Interest-Bearing Deposits
Savings
Commercial and Individual		145,585			139,157
Public Funds		370			374
Money Market Checking and Savings
Commercial and Individual		584,212			514,907
Public Funds		330,228			323,735
Time Deposits
Commercial and Individual		1,243,349			1,217,787
Public Funds		559,859			490,253
Total Interest-Bearing Deposits		2,863,603			2,686,213
Total Deposits		$	3,398,490		$	3,132,191

 

OTHER BORROWED MONEY

 

Other borrowed money of $353,650,000 at September 30, 2003 increased $60,132,000 or 20.5% compared to December 31, 2002 levels of $293,518,000. The increase in other borrowed money is primarily attributable to a $55,000,000 increase in borrowings with the Federal Home Loan Bank. In addition, $4,400,000 in subordinated debentures were paid off on March 28, 2003. The components of other borrowed money are as follows (dollars in thousands):

 

		September 30, 2003			December 31, 2002
		(Unaudited)
Federal Funds Purchased and Securities Sold Under Repurchase Agreements		$	98,650		$	89,118
Federal Home Loan Bank Advances		240,000			185,000
Trust Preferred Securities		15,000			15,000
Subordinated Debentures		—			4,400
Total Other Borrowed Money		$	353,650		$	293,518

 

At September 30, 2003, the Company had lines of credit totaling $60,000,000 with correspondent banks for short-term liquidity needs. In addition, the Company had available credit of approximately $377,345,000 from the Federal Home Loan Bank, of which $240,000,000 was advanced at September 30, 2003.

 

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SHAREHOLDERS’ EQUITY

 

Shareholders’ equity increased by $32,286,000 or 8.6% during the nine months ended September 30, 2003 primarily due to comprehensive income of $35,594,000 less cash dividends of $10,645,000. Comprehensive income for the period included net income of $46,365,000 and unrealized loss on securities available for sale, net of tax, of $10,771,000.

 

Bank holding companies are required to maintain capital ratios in accordance with guidelines adopted by the Federal Reserve Board. The guidelines are commonly known as Risk-Based Capital Guidelines. The table below reflects various measures of regulatory capital (dollars in thousands):

 

		Actual					For Capital Adequacy Purposes					To Be Well Capitalized Under Prompt Corrective Action Provision
		Amount			Ratio		Amount			Ratio		Amount			Ratio
Texas Regional Bancshares, Inc.
As of September 30, 2003 (Unaudited)
Total Capital (to Risk-Weighted Assets)		$	397,094		13.93	%	$	227,972		8.00	%	$	284,965		10.00	%
Tier I Capital (to Risk-Weighted Assets)		367,170			12.88		113,986			4.00		170,979			6.00
Tier I Capital (to Average Assets)		367,170			9.11		161,245			4.00		201,556			5.00
As of December 31, 2002
Total Capital (to Risk-Weighted Assets)		$	350,334		13.77	%	$	203,474		8.00	%	$	254,342		10.00	%
Tier I Capital (to Risk-Weighted Assets)		322,218			12.67		101,737			4.00		152,605			6.00
Tier I Capital (to Average Assets)		322,218			8.89		145,004			4.00		181,255			5.00
Texas State Bank
As of September 30, 2003 (Unaudited)
Total Capital (to Risk-Weighted Assets)		$	373,321		13.11	%	$	227,796		8.00	%	$	284,745		10.00	%
Tier I Capital (to Risk-Weighted Assets)		343,397			12.06		113,898			4.00		170,847			6.00
Tier I Capital (to Average Assets)		343,397			8.52		161,159			4.00		201,449			5.00
As of December 31, 2002
Total Capital (to Risk-Weighted Assets)		$	328,630		12.93	%	$	203,267		8.00	%	$	254,084		10.00	%
Tier I Capital (to Risk-Weighted Assets)		300,514			11.83		101,634			4.00		152,451			6.00
Tier I Capital (to Average Assets)		300,514			8.29		144,938			4.00		181,173			5.00

 

At September 30, 2003, the Company and the Bank met the criteria for classification as a “well-capitalized” institution under the prompt corrective action rules promulgated under the Federal Deposit Insurance Act. Designation as a well-capitalized institution under these regulations does not constitute a recommendation or endorsement of the Company or the Bank by Federal bank regulators.

 

RESULTS OF OPERATIONS

 

NET INCOME

 

Net income was $15,569,000 and $14,262,000 and net income per diluted common share was $0.52 and $0.49 for the three months ended September 30, 2003 and 2002, respectively. Return on assets averaged 1.51% and 1.58% while return on shareholders’ equity averaged 15.09% and 16.26% for the three months ended September 30, 2003 and 2002, respectively.

 

For the nine months ended September 30, 2003, net income was $46,365,000 compared to $39,929,000 for the same period in 2002, representing an increase of $6,436,000 or 16.1%. Net income per diluted common share was $1.56 and $1.39 for the nine months ended September 30, 2003 and 2002, respectively. Return on assets averaged 1.55% and return on shareholders’ equity averaged 15.50% for the nine months ended September 30, 2003 compared to 1.61% and 16.47%, respectively, for the same period in 2002.

 

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INTEREST INCOME

 

Total interest income for the three months ended September 30, 2003 was $51,236,000, representing a decrease of $657,000 or 1.3% from the three months ended September 30, 2002. For the nine months ended September 30, 2003, interest income was $155,240,000, reflecting a $5,755,000 or 3.8% increase from the same period in 2002. This increase in interest income during the nine months ended September 30, 2003 compared to the same period in 2002 resulted primarily from a $649,738,000 or 21.3% increase in average interest-earning assets during the nine months ended September 30, 2003 compared to the same period in 2002. Average interest-earning assets increased by $491,525,000 or 14.9% to $3,789,144,000 for the three months ended September 30, 2003 compared to the same period in 2002. The increase in average interest-earning assets resulted from continued emphasis on loan growth, as well as the San Juan and Corpus Christi acquisitions during fourth quarter 2002 and first quarter 2003, respectively. Although average interest-earning assets increased substantially, the growth in interest income was hampered by interest rate reductions driven by the Federal Reserve monetary policy.

 

Interest income on loans held for investment increased $640,000 or 1.6% to $40,354,000 for the three months ended September 30, 2003 compared to the same period in 2002. A $212,362,000 or 9.8% increase in average loans held for investment over the same period in 2002 propelled the increase. This was partially offset by a 54 basis point decrease in the yield on loans held for investment as a result of declining interest rates. The increase in average loans held for investment is primarily due to the San Juan and Corpus Christi acquisitions. Interest income on securities decreased to $10,137,000, reflecting a $1,384,000 or 12.0% decrease from the prior comparable period. This decrease was attributable to a 124 basis point decrease in the yield on securities during third quarter 2003 compared to the same period in 2002, which was partially offset by a $267,309,000 or 24.7% increase in average securities compared to the three months ended September 30, 2002.

 

For the nine months ended September 30, 2003, interest income on loans held for investment increased $5,946,000 or 5.2% to $120,502,000, up from $114,556,000 for the same period in 2002. Although average loans held for investment increased by $287,861,000 or 14.0% to $2,344,196,000 for the nine months ended September 30, 2003 compared to the same period in 2002, the increase in interest income was hindered by a 58 basis point decrease in the yield on loans held for investment over the comparable prior year period. Interest income on securities decreased to $32,437,000, a decrease of $895,000 or 2.7% from the comparable prior period. The decrease was principally related to a 128 basis point decrease in the yield on securities during the nine months ended September 30, 2003 compared to the same period in 2002. The decrease was partially offset by a $325,427,000 or 34.1% increase in average securities to $1,278,801,000 for the nine months ended September 30, 2003 from the same period last year.

 

INTEREST EXPENSE

 

Interest expense decreased to $14,093,000 for the three months ended September 30, 2003 compared to $18,774,000 for the same period in 2002, representing a decrease of $4,681,000 or 24.9%. The decrease was primarily due to an 88 basis point decrease in the cost of funds during third quarter 2003 compared to the same period in 2002 resulting from declining market rates. The decrease was partially offset by an increase in average interest-bearing liabilities of $332,088,000 or 11.9% to $3,124,065,000 compared to $2,791,977,000 for third quarter 2002. Interest expense on deposits decreased by $4,280,000 or 25.7% to $12,393,000 for third quarter 2003 compared to the comparable period in 2002. The decrease reflects the effects of interest rate reductions made by the Company since September 30, 2002, as well as the offsetting effect of an increase in average interest-bearing deposits by $300,570,000 or 11.8% to $2,854,405,000 for third quarter 2003 compared with third quarter 2002. The increase in average interest-bearing deposits was primarily attributable to the San Juan and Corpus Christi acquisitions. Interest expense on other borrowed money decreased $401,000 or 19.1% to $1,700,000 for the three months ended September 30, 2003 compared to the same period in 2002. The decrease was primarily attributable to a 100 basis point decrease in the cost of other borrowed money during the three months ended September 30, 2003 compared to the same period in 2002. The decrease was partially offset by a $31,518,000 or 13.2% increase in average other borrowed money to $269,660,000 during the three months ended September 30, 2003 compared to $238,142,000 during the three months ended September 30, 2002.

 

For the nine months ended September 30, 2003, interest expense was $46,796,000 compared to $54,116,000 for the same period in 2002. The decrease was primarily due to a 76 basis point decrease in the cost of funds during the nine months ended September 30, 2003 from the comparable period in 2002 resulting from declining rates. This was partially offset by an increase in average interest-bearing liabilities of $488,083,000 or 18.9% to $3,072,816,000 compared to $2,584,733,000 for the nine months ended September 30, 2002. Interest expense on deposits totaled $41,408,000 for the nine months ended September 30, 2003, reflecting a decrease of $7,527,000 or 15.4% compared to the same prior year period. Although average interest-bearing deposits increased by $437,063,000 or 18.2% during the

 

17

 

nine months ended September 30, 2003, a decrease of 78 basis points in the rate paid on deposits more than offset the effect of the increase in average deposits. Interest expense on other borrowed money increased to $5,388,000 for the nine months ended September 30, 2003 compared to $5,181,000 for the same prior year period. The increase is primarily attributable to a $51,020,000 or 27.1% increase in average other borrowed money to $239,496,000 during the nine months ended September 30, 2003 compared to $188,476,000 during the nine months ended September 30, 2002.

 

NET INTEREST INCOME

 

Net interest income was $37,143,000 for the three months ended September 30, 2003 compared with $33,119,000 for the same period in 2002, an increase of $4,024,000 or 12.2%. For the nine months ended September 30, 2003, net interest income increased $13,075,000 or 13.7% to $108,444,000 from $95,369,000 for the same period in 2002. See “Interest Income” and “Interest Expense” for a discussion on the increase in net interest income during the three and nine months ended September 30, 2003.

 

The net interest margin was 3.89% for the three months ended September 30, 2003 compared with 3.98% for the same period in 2002. The net interest margin was 3.92% for the nine months ended September 30, 2003, down from 4.18% for the same period in 2002.

 

The Company’s net interest income is affected by changes in the amount and mix of interest-earning assets and interest-bearing liabilities, referred to as a “volume change”. It is also affected by changes in yields earned on interest-earning assets and rates paid on interest-bearing deposits and other borrowed funds, referred to as a “rate change”. The following tables present for periods indicated the total dollar amount of interest income from average interest-earning assets and the resultant yields and the interest expense on average interest-bearing liabilities, expressed both in dollars and rates. Average balances are derived from average daily balances and the yields and costs are established by dividing income or expense by the average balance of the asset or liability (dollars in thousands):

 

18

 

		Three Months Ended
		September 30, 2003								September 30, 2002
		Average Balance			Interest			Yield/ Rate (1)		Average Balance			Interest			Yield/ Rate (1)
		(Unaudited)
Assets
Interest-Earning Assets
Loans Held for Sale		$	44,556		$	703		6.26	%	$	38,456		$	609		6.28	%
Loans Held for Investment
Commercial		807,015			11,934			5.87		676,252			10,992			6.45
Real Estate		1,444,189			25,683			7.06		1,346,107			25,452			7.50
Consumer		128,060			2,737			8.48		144,543			3,270			8.98
Total Loans Held for Investment		2,379,264			40,354			6.73		2,166,902			39,714			7.27
Securities
Taxable		1,258,063			9,268			2.92		1,010,745			10,754			4.22
Tax-Exempt		91,888			869			3.75		71,897			767			4.23
Total Securities		1,349,951			10,137			2.98		1,082,642			11,521			4.22
Interest-Bearing and Time Deposits		5,320			18			1.34		1,129			13			4.57
Federal Funds Sold		10,053			24			0.95		8,490			36			1.68
Total Interest-Earning Assets		3,789,144			$	51,236		5.36	%	3,297,619			$	51,893		6.24	%
Cash and Due from Banks		125,479								98,741
Premises and Equipment, Net		103,899								88,249
Other Assets		114,337								115,302
Allowance for Loan Losses		(30,435		)						(27,411		)
Total Assets		$	4,102,424							$	3,572,500
Liabilities
Interest-Bearing Liabilities
Savings		$	148,218		$	120		0.32	%	$	131,588		$	404		1.22	%
Money Market Checking and Savings		904,197			1,848			0.81		767,414			2,943			1.52
Time Deposits		1,801,990			10,425			2.30		1,654,833			13,326			3.19
Total Savings and Time Deposits		2,854,405			12,393			1.72		2,553,835			16,673			2.59
Other Borrowed Money		269,660			1,700			2.50		238,142			2,101			3.50
Total Interest-Bearing Liabilities		3,124,065			$	14,093		1.79	%	2,791,977			$	18,774		2.67	%
Demand Deposits		540,734								404,447
Other Liabilities		28,396								28,048
Total Liabilities		3,693,195								3,224,472
Shareholders’ Equity		409,229								348,028
Total Liabilities and Shareholders’ Equity		$	4,102,424							$	3,572,500
Net Interest Income					$	37,143							$	33,119
Net Yield on Total Interest-Earning Assets								3.89	%							3.98	%

 

(1) Annualized.

 

19

 

		Nine Months Ended
		September 30, 2003								September 30, 2002
		Average Balance			Interest			Yield/ Rate (1)		Average Balance			Interest			Yield/ Rate (1)
		(Unaudited)
Assets
Interest-Earning Assets
Loans Held for Sale		$	44,417		$	1,996		6.01	%	$	32,826		$	1,465		5.97	%
Loans Held for Investment
Commercial		787,474			35,600			6.04		665,702			32,259			6.48
Real Estate		1,424,251			76,281			7.16		1,248,886			72,323			7.74
Consumer		132,471			8,621			8.70		141,747			9,974			9.41
Total Loans Held for Investment		2,344,196			120,502			6.87		2,056,335			114,556			7.45
Securities
Taxable		1,190,891			29,898			3.36		888,949			31,239			4.70
Tax-Exempt		87,910			2,539			3.86		64,425			2,093			4.34
Total Securities		1,278,801			32,437			3.39		953,374			33,332			4.67
Interest-Bearing and Time Deposits		15,286			156			1.36		1,006			40			5.32
Federal Funds Sold		17,762			149			1.12		7,183			92			1.71
Total Interest-Earning Assets		3,700,462			$	155,240		5.61	%	3,050,724			$	149,485		6.55	%
Cash and Due from Banks		120,340								102,838
Premises and Equipment, Net		97,720								84,243
Other Assets		116,411								105,939
Allowance for Loan Losses		(30,265		)						(26,235		)
Total Assets		$	4,004,668							$	3,317,509
Liabilities
Interest-Bearing Liabilities
Savings		$	146,869		$	551		0.50	%	$	128,635		$	1,219		1.27	%
Money Market Checking and Savings		887,985			6,622			1.00		726,629			8,404			1.55
Time Deposits		1,798,466			34,235			2.55		1,540,993			39,312			3.41
Total Savings and Time Deposits		2,833,320			41,408			1.95		2,396,257			48,935			2.73
Other Borrowed Money		239,496			5,388			3.01		188,476			5,181			3.68
Total Interest-Bearing Liabilities		3,072,816			$	46,796		2.04	%	2,584,733			$	54,116		2.80	%
Demand Deposits		500,088								386,348
Other Liabilities		31,746								22,341
Total Liabilities		3,604,650								2,993,422
Shareholders’ Equity		400,018								324,087
Total Liabilities and Shareholders’ Equity		$	4,004,668							$	3,317,509
Net Interest Income					$	108,444							$	95,369
Net Yield on Total Interest-Earning Assets								3.92	%							4.18	%

 

(1) Annualized.

 

20

 

The following table presents the effects of changes in volume, rate and rate/volume on interest income and interest expense for major categories of interest-earning assets and interest-bearing liabilities. Nonaccrual loans are included in assets, thereby reducing yields (see “Nonperforming Assets”). The allocation of the rate/volume variance has been made pro-rata on the percentage that volume and rate variances produce in each category. An analysis of changes in net interest income follows (dollars in thousands):

 

		Three Months Ended September 30, 2003 Compared to 2002												Nine Months Ended September 30, 2003 Compared to 2002
		Net			Due to Change in						Rate/			Net			Due to Change in						Rate/
		Change			Volume			Rate			Volume			Change			Volume			Rate			Volume
		(Unaudited)
Interest Income
Loans Held for Sale		$	94		$	96		$	(2	)	$	—		$	531		$	517		$	10		$	4
Loans Held for Investment		640			3,892			(2,962		)	(290		)	5,946			16,036			(8,851		)	(1,239		)
Securities
Taxable		(1,486		)	2,631			(3,308		)	(809		)	(1,341		)	10,610			(8,921		)	(3,030		)
Tax-Exempt		102			213			(87		)	(24		)	446			763			(232		)	(85		)
Interest-Bearing and Time Deposits		5			48			(9		)	(34		)	116			568			(30		)	(422		)
Federal Funds Sold		(12		)	7			(16		)	(3		)	57			136			(32		)	(47		)
Total Interest Income		(657		)	6,887			(6,384		)	(1,160		)	5,755			28,630			(18,056		)	(4,819		)
Interest Expense
Deposits		(4,280		)	1,962			(5,585		)	(657		)	(7,527		)	8,926			(13,915		)	(2,538		)
Other Borrowed Money		(401		)	278			(600		)	(79		)	207			1,403			(941		)	(255		)
Total Interest Expense		(4,681		)	2,240			(6,185		)	(736		)	(7,320		)	10,329			(14,856		)	(2,793		)
Net Interest Income Before Allocation of Rate/Volume		4,024			4,647			(199		)	(424		)	13,075			18,301			(3,200		)	(2,026		)
Allocation of Rate/Volume		—			(406		)	(18		)	424			—			(1,810		)	(216		)	2,026
Changes in Net Interest Income		$	4,024		$	4,241		$	(217	)	$	—		$	13,075		$	16,491		$	(3,416	)	$	—

 

PROVISION FOR LOAN LOSSES

 

The Company recorded a provision for loan losses of $3,851,000 for the three months ended September 30, 2003 compared to $2,950,000 for the three months ended September 30, 2002. For the nine months ended September 30, 2003, the Company recorded a provision for loan losses of $9,971,000 compared to $8,655,000 for the same period in 2002. The increase in the provision for loan losses for the nine months ended September 30, 2003 compared to the same period in 2002 was a result of loan growth, management’s assessment of current regional economic conditions and probable losses in the portfolio. Net charge-offs totaled $3,293,000 and $8,391,000 for the three and nine months ended September 30, 2003, respectively, compared to $2,617,000 and $7,211,000 for the same comparable periods. Net charge-offs to average loans held for investment increased to 0.48% for the nine months ended September 30, 2003 compared to 0.47% for the same period in 2002.

 

Management charges provisions for loan losses to earnings to bring the total allowance for loan losses to a level deemed appropriate. Management bases its decision on many factors which include historical loan loss experience, the volume and type of lending conducted by the Company, the amount of nonperforming assets, specific provisions for individual nonperforming loans, regulatory policies, generally accepted accounting principles, and general economic conditions, particularly as they relate to the Company’s lending area. For additional information on charge-offs and recoveries and the aggregate provision for loan losses, see the “Allowance for Loan Losses – Critical Accounting Policy” section of this report.

 

NONINTEREST INCOME

 

The Company’s primary sources of noninterest income are service charges on deposit accounts, other banking service related fees and data processing service fees. Noninterest income totaled $13,241,000 for the three months ended September 30, 2003 compared to $11,327,000 for the same period in 2002. Excluding net realized gains on sales of securities available for sale, noninterest income for third quarter 2003 increased $758,000 or 8.0% compared to third quarter 2002. For the nine months ended September 30, 2003, noninterest income totaled $39,292,000, up from $30,188,000 for the same period in 2002. Noninterest income for the nine months ended September 30, 2003, excluding net realized gains on securities available for sale, increased $2,412,000 or 8.9% over the same period in 2002. The majority of the increase is attributable to an increase in total service charges.

 

21

 

Total service charges of $8,256,000 for the three months ended September 30, 2003 increased $1,752,000 or 26.9% compared to $6,504,000 for the same period in 2002. Total service charges were $22,802,000 for the nine months ended September 30, 2003 compared to $18,643,000 for the same period in 2002. The increase in total service charges was primarily attributable to a $1,308,000 or 32.0% and a $2,870,000 or 25.7% increase in non-sufficient and return item charges for the three and nine months ended September 30, 2003, respectively. The increase was generated from deposit growth combined with an increase in non-sufficient fund item charges implemented by the Company during July 2003 from $25 per item to $30 per item.

 

Trust service fees of $710,000 for the three months ended September 30, 2003 decreased $33,000 or 4.4% compared to $743,000 for comparable prior year period. Trust service fees were $2,129,000 for the nine months ended September 30, 2003 compared to $2,040,000 for the same period in 2002, increasing by $89,000 or 4.4%. The fair market value of assets managed at September 30, 2003 was $479,126,000 compared to $491,087,000 at December 31, 2002 and $470,802,000 a year ago. Assets held by the trust department of the Bank in fiduciary or agency capacities are not assets of the Company and are not included in the condensed consolidated balance sheets.

 

Net realized gains on sales of securities available for sale for the three months ended September 30, 2003 totaled $3,041,000 compared to $1,885,000 for the same period in 2002. For the nine months ended September 30, 2003, net realized gains on sales of securities available for sale totaled $9,653,000 compared to $2,961,000 for the comparable period in 2002. During 2003, the Company sold various securities that had unrealized gains and were likely to be called or mature during 2003 and 2004. Net unrealized holding gains on securities available for sale, net of tax, totaled $11,357,000 at September 30, 2003. See “Shareholders’ Equity”.

 

Data processing service fees of $1,950,000 for the three months ended September 30, 2003 increased $274,000 or 16.3% compared to $1,676,000 for the same period last year. During the nine months ended September 30, 2003, data processing service fees increased $628,000 or 13.1% to $5,412,000 compared to $4,784,000 during the same period in 2002. There were 25 data processing clients at September 30, 2003 compared to 23 at September 30, 2002.

 

Loan servicing income (loss), net of the amortization of the mortgage servicing rights (“MSR”) asset decreased $1,360,000 to a $1,276,000 loss for third quarter 2003 compared to third quarter 2002. The decrease resulted from a $1,195,000 increase in amortization of the MSR asset during third quarter 2003 to $1,850,000 compared to third quarter 2002 due to increased mortgage prepayments resulting from a rapid decline in mortgage rates during the last twelve months. During the nine months ended September 30, 2003, loan servicing income (loss), net decreased $3,863,000 to a $3,202,000 loss compared to the same period in 2002. MSR amortization increased $3,918,000 to $5,050,000 for the nine months ended September 30, 2003 compared to the comparable prior year period.

 

Other noninterest income of $560,000 for the three months ended September 30, 2003 increased $125,000 or 28.7% compared to $435,000 for the three months ended September 30, 2002. During the nine months ended September 30, 2003, other noninterest income increased $1,399,000 or 127.3% to $2,498,000 compared to $1,099,000 during the same period in 2002. The increase resulted primarily from a $277,000 and $1,491,000 increase in the gain on sale of loans held for sale during three and nine months ended September 30, 2003, respectively compared to the same periods in 2002. The increases were partially offset by an increase of $98,000 in losses recognized on the sale of securities held in the Rabbi Trust during third quarter 2003 compared to third quarter 2002. The Rabbi Trust was set up to provide funding for the Deferred Compensation Plan for the benefit of Glen E. Roney, Chief Executive Officer of the Company. In addition, during second quarter 2002 the Bank recognized a $340,000 loss on disposal of obsolete computer equipment. There were no large losses on premises and equipment recognized during the nine months ended September 30, 2003.

 

NONINTEREST EXPENSE

 

Noninterest expense of $23,267,000 for the three months ended September 30, 2003 increased $3,765,000 or 19.3% compared to $19,502,000 for the same period in 2002. For the nine months ended September 30, 2003, noninterest expense totaled $68,103,000 compared to $56,228,000 for the same period in 2002, representing an increase of $11,875,000 or 21.1%. The efficiency ratio was 46.18% for the three months ended September 30, 2003 compared to 43.88% for the same period in 2002. For the nine months ended September 30, 2003, the efficiency ratio was 46.10%, up from 44.78% for 2002. The efficiency ratio is defined as noninterest expense divided by the total of net interest income and noninterest income.

 

Salaries and employee benefits, the largest category of noninterest expense, of $11,954,000 for the three months ended September 30, 2003 increased $2,542,000 or 27.0% compared to the same period last year of

 

22

 

$9,412,000. Salaries and employee benefits for the nine months ended September 30, 2003 totaled $35,174,000, reflecting an increase of $7,299,000 or 26.2% from the comparable prior year period. The increase reflects increases in base salaries and higher levels of staff, including staff acquired as a result of recent acquisitions and branch openings. In addition, in May 2002 the Company began paying 100% of non-officer employee’s medical insurance, up from 50% paid in prior periods. This contributed to medical insurance premiums increasing by $1,684,000 or 54.6% during the nine months ended September 30, 2003 compared to the same prior year periods. The number of full-time equivalent employees of 1,269 at September 30, 2003 represents an increase of 15.5% from 1,099 at September 30, 2002. Salaries and employee benefits averaged 1.16% of average assets for the three months ended September 30, 2003 compared to 1.05% for the three months ended September 30, 2002. For the nine months ended September 30, 2003, salaries and employee benefits averaged 1.17% of average assets compared to 1.12% for the nine months ended September 30, 2002.

 

Net occupancy expense totaled $1,967,000 for the three months ended September 30, 2003 compared to $1,481,000 reported for third quarter 2002, increasing by $486,000 or 32.8%. For the nine months ended September 30, 2003, net occupancy expense increased $1,064,000 or 25.6% to $5,221,000 compared to the same period a year ago. The increase was primarily attributable to occupancy expenses resulting from recent acquisitions and new branch openings.

 

Equipment expense of $2,790,000 for the three months ended September 30, 2003 increased $428,000 or 18.1% from $2,362,000 reported for the same period in 2002. For the nine months ended September 30, 2003, equipment expense totaled $7,842,000, reflecting an increase of $1,516,000 or 24.0% compared to the same period in 2002. The increase is primarily the result of equipment expenses incurred in the acquired and new banking locations.

 

Other real estate expense, net includes income from foreclosed properties, gain or loss on sale of other real estate properties and direct expenses of foreclosed real estate including property taxes, maintenance costs and write-downs. Write-downs of other real estate are required if the fair value less estimated selling costs of an asset acquired in a loan foreclosure subsequently declines below its carrying value. Other real estate expense, net of $124,000 for the three months ended September 30, 2003 decreased $28,000 or 18.4% from $152,000 for the three months ended September 30, 2002. During the nine months ended September 30, 2003, other real estate expense, net totaled $435,000, resulting in an increase of $121,000 or 38.5% compared to $314,000 for the same period in 2002. The increases resulted from a $104,000 decrease in the gain on sale of other real estate during the nine months ended September 30, 2003 compared to the same period in 2002. Management is actively seeking buyers for all other real estate.

 

Amortization of identifiable intangibles of $849,000 for the three months ended September 30, 2003 decreased $112,000 or 11.7% compared to $961,000 reported for the same period in 2002. For the nine months ended September 30, 2003, amortization of identifiable intangibles of $2,532,000 remained comparable to the same prior year period, increasing by $6,000 or 0.2% compared to the same prior year period.

 

23

 

A detailed summary of Noninterest Expense follows (dollars in thousands):

 

		Three Months Ended September 30,						Nine Months Ended September 30,
		2003			2002			2003			2002
		(Unaudited)
Salaries and Wages		$	8,703		$	7,101		$	25,553		$	21,172
Employee Benefits		3,251			2,311			9,621			6,703
Total Salaries and Employee Benefits		11,954			9,412			35,174			27,875
Net Occupancy Expense		1,967			1,481			5,221			4,157
Equipment Expense		2,790			2,362			7,842			6,326
Other Real Estate Expense, Net
Income		(103		)	(208		)	(373		)	(530		)
Gain on Sale		(82		)	(8		)	(60		)	(164		)
Expenses		309			319			863			959
Write-Downs		—			49			5			49
Total Other Real Estate Expense, Net		124			152			435			314
Amortization of Identifiable Intangibles		849			961			2,532			2,526
Other Noninterest Expense
Advertising and Public Relations		892			642			2,640			1,984
Data Processing and Check Clearing		848			718			2,611			2,067
Director Fees		129			125			371			353
Franchise Tax		74			32			222			139
Insurance		157			153			409			409
FDIC Insurance		133			121			389			404
Legal		570			303			1,167			1,058
Professional Fees		813			980			2,512			2,448
Postage, Delivery and Freight		408			441			1,257			1,149
Printing, Stationery and Supplies		505			486			1,732			1,598
Telephone		244			211			694			636
Other Losses		51			250			478			682
Miscellaneous Expense		759			672			2,417			2,103
Total Other Noninterest Expense		5,583			5,134			16,899			15,030
Total Noninterest Expense		$	23,267		$	19,502		$	68,103		$	56,228

 

INCOME TAX EXPENSE

 

The Company recorded income tax expense of $7,697,000 for the three months ended September 30, 2003 compared to $7,732,000 for the three months ended September 30, 2002. For the nine months ended September 30, 2003, income tax expense totaled $23,297,000, representing an increase of $2,552,000 or 12.3% compared to the same prior year period. The increase in income tax is primarily due to an increased level of pretax income for the nine months ended September 30, 2003 compared to the same period in 2002. The Company’s effective tax rate was 33.4% for the nine months ended September 30, 2003 compared to 34.2% for nine months ended September 30, 2002.

 

CAPITAL AND LIQUIDITY

 

Bank holding companies are required to maintain capital ratios in accordance with guidelines adopted by the Federal Reserve Board. The guidelines are commonly known as Risk-Based Capital Guidelines. On September 30, 2003, the Company exceeded all applicable capital requirements, having a total risk-based capital ratio of 13.93%, a Tier I risk-based capital ratio of 12.88%, and a leverage ratio of 9.11%.

 

Liquidity management assures that adequate funds are available to meet deposit withdrawals, loan demand and maturing liabilities. Insufficient liquidity can result in higher costs of obtaining funds, while excessive liquidity can lead to a decline in earnings due to the cost of foregoing alternative investments. The ability to renew and acquire additional deposit liabilities is a major source of liquidity. The Company’s principal sources of funds are primarily within the local markets of the Bank and consist of deposits, interest and principal payments on loans and securities, sales of loans and securities and borrowings.

 

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Cash and assets which are readily marketable, or which can be pledged, or which will mature in the near future provide asset liquidity. These include cash, federal funds sold, time deposits, U.S. Treasury, U.S. Government Agency and mortgage-backed securities. At September 30, 2003, the Company’s liquidity ratio, defined as cash, U.S. Treasury, U.S. Government Agency, mortgage-backed securities, interest-bearing deposits, time deposits and federal funds sold as a percentage of deposits was 41.2% compared to 38.3% at December 31, 2002.

 

Liability liquidity is provided by access to core funding sources, principally various customers’ interest-bearing and noninterest-bearing deposit accounts in the Company’s trade area. The Company does not have nor does it solicit brokered deposits. Federal funds purchased and short-term borrowings are additional sources of liquidity. At September 30, 2003, the Company had lines of credit totaling $60,000,000 with correspondent banks for short-term liquidity needs. In addition, the Company had available credit of approximately $377,345,000 from the Federal Home Loan Bank, of which $240,000,000 was advanced at September 30, 2003. These sources of liquidity are short-term in nature, and are used, as necessary, to fund asset growth and meet short-term liquidity needs.

 

At September 30, 2003, the Company had outstanding commitments to extend credit of approximately $496,537,000, commercial letters of credit of $8,051,000, standby letters of credit of $81,831,000, and credit card guarantees of $1,365,000. In addition, the Company had construction and real estate purchase commitments of $2,037,000.

 

During the nine months ended September 30, 2003, funds for $739,916,000 of security purchases and $143,892,000 of net loan growth came from various sources, including $635,578,000 of proceeds from security sales and maturities, a net increase in deposits of $237,077,000 and $97,655,000 from operating activities.

 

The Company is dependent on dividend and interest income from the Bank and the sale of stock for its liquidity. Applicable Federal Reserve Board regulations provide that bank holding companies are permitted by regulatory authorities to pay cash dividends on their common or preferred stock if consolidated earnings and consolidated capital are within regulatory guidelines.

 

EFFECTS OF INFLATION

 

Financial institutions are impacted differently by inflation than are industrial companies. While industrial and manufacturing companies generally have significant investments in inventories and fixed assets, financial institutions ordinarily do not have such investments. As a result, financial institutions are generally in a better position than industrial companies to respond to inflationary trends by monitoring the spread between interest costs and interest income yields through adjustments of maturities and interest rates of assets and liabilities. In addition, inflation tends to increase demand for loans from financial institutions as industrial companies attempt to maintain a constant level of goods in inventory and assets. As consumers of goods and services, financial institutions are affected by inflation as prices increase, causing an increase in costs of salaries, employee benefits, occupancy expense and similar items.

 

CRITICAL ACCOUNTING POLICIES

 

The Company considers its Allowance for Loan Losses policy as a policy critical to the sound operations of the Company. The Company provides for loan losses each period by an amount resulting from both (a) an estimate by management of loan losses that are identified as probable during the period and (b) the ongoing adjustment of prior estimates of losses occurring in prior periods. The provision for loan losses increases the allowance for loan losses which is netted against loans on the condensed consolidated balance sheet. As losses are confirmed, the loan is written down, reducing the allowance for loan losses. See “Allowance for Loan Losses - Critical Accounting Policy” and “Provision for Loan Losses” for further information regarding the Company’s provision and allowance for loan losses policy.

 

POSSIBLE NEGATIVE IMPACT OF LITIGATION

 

From time to time, the Company is a party to legal proceedings including matters involving commercial banking issues and other proceedings arising in the ordinary course of business. Although not currently anticipated by management, the Company’s consolidated results could be materially impacted by legal and settlement expenses related to such lawsuits.

 

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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

 

Market risk is the exposure to loss resulting from changes in interest rates, foreign currency exchange rates, commodity prices and equity prices. The primary market risk to which the Company is exposed is interest rate risk. Interest rate risk occurs when assets and liabilities reprice at different times as interest rates change. For example, if fixed-rate loans are funded with floating-rate deposits, the spread between loan and deposit rates will decline or turn negative if rates increase. Other types of market risk, such as foreign currency exchange rate risk and commodity price risk, do not arise in the normal course of the Company’s business activities. The Company’s interest rate risk arises from transactions entered into for purposes other than trading. The Company does not currently engage in trading activities or use derivative instruments to control interest rate risk. Even though such activities may be permitted with the approval of the Board of Directors, the Company does not intend to engage in such activities in the immediate future.

 

Interest rate risk is managed within the funds management policy of the Company. The principal objectives of the funds management policy are to avoid fluctuating net interest margins and to maintain consistent growth of net interest income through periods of changing interest rates. The Board of Directors oversees implementation of strategies to control interest rate risk. The Company may take steps to alter its net sensitivity position by offering deposit and/or loan structures that tend to counter the natural rate risk profile of the Company. Funding positions are kept within predetermined limits designed to ensure that risk-taking is not excessive and that liquidity is properly managed. Because of the volatility of market rates and uncertainties, there can be no assurance of the effectiveness of management programs to achieve a targeted moderation of risk.

 

In order to measure earnings and fair value sensitivity to changing rates, the Company utilizes three different measurement tools including static gap analysis, simulation earnings, and market value sensitivity (fair value at risk). The primary analytical tool used by the Company to quantify interest rate risk is a simulation model to project changes in net interest income that result from forecast changes in interest rates. This analysis estimates a percentage of change in net interest income from the stable rate scenario under scenarios of rising and falling market interest rates over a twelve month time horizon. The prime rate serves as a “driver” and is made to rise (or fall) evenly in 100 basis point increments over the 12-month forecast interval. These simulations incorporate assumptions regarding balance sheet growth and mix, pricing and the repricing and maturity characteristics of the existing and projected balance sheet.

 

The following table summarizes the simulated change in net interest income over a 12-month period as of September 30, 2003 and December 31, 2002 (dollars in thousands):

 

Changes in Interest Rates (Basis Points)		Estimated Net Interest Income			Increase (Decrease) in Net Interest Income
					Amount			Percent
September 30, 2003 (Unaudited)
+100		$	163,034		$	6,413		4.1	%
-		156,621			—			—
-100		149,420			(7,201		)	(4.6	)
December 31, 2002
+100		154,527			1,856			1.2
-		152,671			—			—
-100		150,664			(2,007		)	(1.3	)

 

All the measurements of risk described above are made based upon the Company’s business mix and interest rate exposures at the particular point in time. An immediate 100 basis point decline in interest rates is a hypothetical rate scenario, used to calibrate risk, and does not necessarily represent management’s current view of future market developments. Because of uncertainties as to the extent of customer behavior, refinance activity, absolute and relative loan and deposit pricing levels, competitor pricing and market behavior, product volumes and mix, and other unexpected changes in economic events impacting movements and volatility in market rates, there can be no assurance that simulation results are reliable indicators of net interest income under such conditions.

 

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ITEM 4. CONTROLS AND PROCEDURES

 

An evaluation was performed under the supervision and with the participation of the Company’s management, including the Company’s Chief Executive Officer and Chief Financial Officer, of the effectiveness of the Company’s disclosure controls and procedures (as defined in Rule 13a-15(e) and Rule 15d-15(e) as promulgated pursuant to the Exchange Act) as of September 30, 2003. Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that the Company’s disclosure controls and procedures were effective, in all material respects. There has been no change in the Company’s internal control over financial reporting during the Company's last fiscal quarter that has materially affected, or is reasonably likely to materially affect, the Company's internal control over financial reporting.

 

PART II. OTHER INFORMATION

 

ITEM 1. LEGAL PROCEEDINGS

 

The Company faces routine litigation and other legal proceedings arising in the normal course of business. In the opinion of management, liabilities (if any) arising from such litigation and other legal proceedings will not have a material adverse effect upon the business, consolidated results of operations or financial position of the Company.

 

ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K

 

(a)          The following documents are filed as part of this Quarterly Report on Form 10-Q:

 

(1)          Exhibits — The following exhibits are filed as a part of this Quarterly Report on Form 10-Q:

 

Exhibit 31.1 – Certification required by Rule 13a-14(a) as adopted pursuant to section 302 of the Sarbanes-Oxley Act of 2002.

 

Exhibit 31.2 – Certification required by Rule 13a-14(a) as adopted pursuant to section 302 of the Sarbanes-Oxley Act of 2002.

 

Exhibit 32.1 – Certification required by Rule 13a-14(b) and 18 U.S.C. §1350 as adopted pursuant to section 906 of the Sarbanes-Oxley Act of 2002.

 

Exhibit 10.1 - Amendment Number 7 to Texas Regional Bancshares, Inc. Amended and Restated Employee Stock Ownership Plan (with 401(k) Provisions).

 

(b)         Reports of Form 8-K

 

On July 15, 2003, Texas Regional Bancshares, Inc. filed a Current Report on Form 8-K disclosing the Company’s press release announcing second quarter 2003 earnings.

 

On September 9, 2003, Texas Regional Bancshares, Inc. filed a Current Report on Form 8-K disclosing the Company’s press release announcing that its Board of Directors declared a regular quarterly cash dividend of $0.12 per share payable on October 15, 2003 to common shareholders of record on October 1, 2003.

 

On September 15, 2003, Texas Regional Bancshares, Inc. filed a Current Report on Form 8-K disclosing the Company’s press release announcing an agreement in principle under which Texas Regional will acquire through merger Southeast Texas Bancshares, Inc. and its banking subsidiary, Community Bank and Trust, SSB and its other subsidiaries including Port Arthur Abstract and Title Company, Southeast Texas Title Company, and Community Insurance.

 

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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.

 

		TEXAS REGIONAL BANCSHARES, INC.
		(Registrant)
November 14, 2003		/s/ G. E. Roney
		Glen E. Roney
		Chairman of the Board, President
		& Chief Executive Officer
November 14, 2003		/s/ R. T. Pigott, Jr.
		R. T. Pigott, Jr.
		Executive Vice President
		& Chief Financial Officer

 

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