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EX-32.A - EX-32.A - SOUTHWEST BANCORP INCy91218exv32wa.htm
 
 
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
FORM 10-Q
     
þ   QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2011
OR
     
o   TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from __________ to __________
Commission File Number: 0-23064
SOUTHWEST BANCORP, INC.
(Exact name of registrant as specified in its charter)
     
Oklahoma   73-1136584 
(State or other jurisdiction of   (I.R.S. Employer
incorporation or organization)   Identification Number)
     
608 South Main Street    
Stillwater, Oklahoma
(Address of principal executive office)
  74074
(Zip Code)
Registrant’s telephone number, including area code: (405) 742-1800
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.
þ YES o NO
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
o YES o NO
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definition of “accelerated filer”, “large accelerated filer”, and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
             
Large Accelerated Filer o   Accelerated Filer þ   Non-Accelerated Filer o   Smaller reporting company o
        (Do not check if a smaller reporting company)    
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
o YES þ NO
APPLICABLE ONLY TO CORPORATE ISSUERS: Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.
19,438,861 (5/10/11)
 
 

 


 

SOUTHWEST BANCORP, INC.
INDEX TO FORM 10-Q
         
PART I. FINANCIAL INFORMATION
       
 
ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS
       
 
Unaudited Consolidated Statements of Financial Condition
    3  
 
Unaudited Consolidated Statements of Operations
    4  
 
Unaudited Consolidated Statements of Cash Flows
    5  
 
Unaudited Consolidated Statement of Shareholders’ Equity
    6  
 
Unaudited Consolidated Statements of Comprehensive Income
    7  
 
Notes to Unaudited Consolidated Financial Statements
    8  
 
ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITIONS AND RESULTS OF OPERATIONS
    26  
 
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
    37  
 
ITEM 4. CONTROLS AND PROCEDURES
    38  
 
PART II: OTHER INFORMATION
    39  
 
SIGNATURES
    42  

2


 

SOUTHWEST BANCORP, INC.
Unaudited Consolidated Statements of Financial Condition
                 
    March 31,   December 31,
(Dollars in thousands)   2011   2010
 
Assets:
               
Cash and due from banks
  $ 28,034     $ 26,478  
Interest-bearing deposits
    89,529       41,018  
 
Cash and cash equivalents
    117,563       67,496  
Securities held to maturity (fair values of $12,903 and $14,029, respectively)
    13,042       14,304  
Securities available for sale (amortized cost $243,556 and $246,649, respectively)
    245,394       248,221  
Loans held for sale
    37,348       35,194  
Noncovered loans receivable
    2,241,080       2,331,293  
Less: Allowance for loan losses
    (61,285 )     (65,229 )
 
Net noncovered loans
    2,179,795       2,266,064  
Covered loans receivable (includes loss share of $12,617 and $14,370, respectively)
    49,117       53,628  
 
Net loans receivable
    2,228,912       2,319,692  
Accrued interest receivable
    8,789       8,590  
Premises and equipment, net
    23,555       23,772  
Noncovered other real estate
    41,067       37,722  
Covered other real estate
    4,016       4,187  
Goodwill
    6,811       6,811  
Other intangible assets, net
    5,141       5,371  
Other assets
    47,390       49,181  
 
Total assets
  $ 2,779,028     $ 2,820,541  
 
 
               
Liabilities:
               
Deposits:
               
Noninterest-bearing demand
  $ 369,013     $ 377,182  
Interest-bearing demand
    112,731       92,584  
Money market accounts
    486,770       495,253  
Savings accounts
    28,440       26,665  
Time deposits of $100,000 or more
    669,817       694,565  
Other time deposits
    551,800       566,479  
 
Total deposits
    2,218,571       2,252,728  
Accrued interest payable
    1,805       1,577  
Income tax payable
    3,510       2,878  
Other liabilities
    8,497       8,981  
Other borrowings
    85,332       94,602  
Subordinated debentures
    81,963       81,963  
 
Total liabilities
    2,399,678       2,442,729  
Shareholders’ equity:
               
Serial preferred stock — $1,000 par value; 2,000,000 shares authorized; 70,000 shares issued and outstanding
    67,902       67,724  
Common stock — $1 par value; 40,000,000 shares authorized; 19,438,290 and 19,421,900 shares issued and outstanding, respectively
    19,438       19,422  
Paid in capital
    98,994       98,894  
Retained earnings
    192,200       190,793  
Accumulated other comprehensive income
    816       979  
 
Total shareholders’ equity
    379,350       377,812  
 
Total liabilities & shareholders’ equity
  $ 2,779,028     $ 2,820,541  
 
The accompanying notes are an integral part of this statement.

3


 

SOUTHWEST BANCORP, INC.
Unaudited Consolidated Statements of Operations
                 
    For the three months
    ended March 31,
(Dollars in thousands, except earnings per share data)   2011   2010
 
Interest income:
               
Interest and fees on loans
  $ 30,539     $ 34,372  
Investment securities:
               
U.S. Government and agency obligations
    376       596  
Mortgage-backed securities
    1,245       1,446  
State and political subdivisions
    80       65  
Other securities
    45       63  
Other interest-earning assets
    140       217  
 
Total interest income
    32,425       36,759  
 
               
Interest expense:
               
Interest-bearing demand
    124       132  
Money market accounts
    677       1,013  
Savings accounts
    16       16  
Time deposits of $100,000 or more
    2,349       4,024  
Other time deposits
    1,967       2,989  
Other borrowings
    497       517  
Subordinated debentures
    1,374       1,267  
 
Total interest expense
    7,004       9,958  
 
 
               
Net interest income
    25,421       26,801  
 
               
Provision for loan losses
    9,050       8,531  
 
Net interest income after provision for loan losses
    16,371       18,270  
 
 
               
Noninterest income:
               
Service charges and fees
    2,878       3,096  
Other noninterest income
    177       90  
Gain on sales of loans, net
    194       985  
Gain on sale/call of investment securities, net
          7  
 
Total noninterest income
    3,249       4,178  
 
               
Noninterest expense:
               
Salaries and employee benefits
    7,515       7,580  
Occupancy
    2,804       2,783  
FDIC and other insurance
    1,243       1,587  
Other real estate, net
    436       106  
General and administrative
    3,627       3,202  
 
Total noninterest expense
    15,625       15,258  
 
Income before taxes
    3,995       7,190  
Taxes on income
    1,534       2,818  
 
Net income
  $ 2,461     $ 4,372  
 
Net income available to common shareholders
  $ 1,408     $ 3,329  
 
 
               
Basic earnings per common share
  $ 0.07     $ 0.23  
Diluted earnings per common share
    0.07       0.23  
Cash dividends declared per share
           
 
The accompanying notes are an integral part of this statement.

4


 

SOUTHWEST BANCORP, INC.
Unaudited Consolidated Statements of Cash Flows
                 
    For the three months
    ended March 31,
(Dollars in thousands)   2011   2010
 
Operating activities:
               
Net income
  $ 2,461     $ 4,372  
Adjustments to reconcile net income to net cash provided by operating activities:
               
Provision for loan losses
    9,050       8,531  
Deferred tax expense (benefit)
    1,155       (927 )
Asset depreciation
    689       711  
Securities premium amortization, net of discount accretion
    632       468  
Amortization of intangibles
    360       359  
Stock based compensation expense
    103       88  
Net gain on sales/calls of investment securities
          (7 )
Net gain on sales of available for sale loans
    (194 )     (985 )
Net loss on sales of premises/equipment
    16       112  
Net loss (gain) on sales of other real estate
    146       (76 )
Proceeds from sales of held for sale loans
    12,457       60,344  
Held for sale loans originated for resale
    (12,173 )     (31,694 )
Net changes in assets and liabilities:
               
Accrued interest receivable
    (199 )     535  
Other assets
    711       5,095  
Income taxes payable
    509       2,275  
Excess tax expense from share-based payment arrangements
    123        
Accrued interest payable
    228       (198 )
Other liabilities
    (942 )     (2,226 )
 
Net cash provided by operating activities
    15,132       46,777  
 
Investing activities:
               
Proceeds from principal repayments, calls and maturities:
               
Held to maturity securities
    1,250        
Available for sale securities
    18,945       14,953  
Purchases of other investments
    (14 )     (78 )
Purchases of available for sale securities
    (16,472 )     (9,737 )
Principal repayments, net of loans originated
    74,562       13,296  
Purchases of premises and equipment
    (507 )     (301 )
Proceeds from sales of premises and equipment
    31       30  
Proceeds from sales of other real estate
    1,537       1,685  
 
Net cash provided from investing activities
    79,332       19,848  
 
Financing activities:
               
Net decrease in deposits
    (34,157 )     (38,565 )
Net (decrease) increase in other borrowings
    (9,270 )     598  
Net proceeds from issuance of common stock
    29       46  
Excess tax expense from share-based payment arrangements
    (123 )      
Preferred stock dividends paid
    (876 )     (876 )
Common stock dividends paid
          (350 )
 
Net cash used in financing activities
    (44,397 )     (39,147 )
 
Net increase in cash and cash equivalents
    50,067       27,478  
Cash and cash equivalents:
               
Beginning of period
    67,496       118,847  
 
End of period
  $ 117,563     $ 146,325  
 
The accompanying notes are an integral part of this statement.

5


 

SOUTHWEST BANCORP, INC.
Unaudited Consolidated Statement of Shareholders’ Equity
                                                         
                                            Accumulated    
                            Additional           Other   Total
    Preferred   Common Stock   Paid in   Retained   Comprehensive   Shareholders’
(Dollars in thousands)   Stock   Shares   Amount   Capital   Earnings   Income   Equity
 
Balance, December 31, 2010
  $ 67,724       19,421,900     $ 19,422     $ 98,894     $ 190,793     $ 979     $ 377,812  
 
                                                       
Cash dividends:
                                                       
Preferred
                            (876 )           (876 )
Warrant amortization
    178                         (178 )            
Common stock issued
          15,400       15       210                   225  
Net common stock issued under employee plans and related tax expense
          990       1       (110 )                 (109 )
Other comprehensive loss, net of tax
                                  (163 )     (163 )
Net income
                            2,461             2,461  
 
 
                                                       
Balance, March 31, 2011
  $ 67,902       19,438,290     $ 19,438     $ 98,994     $ 192,200     $ 816     $ 379,350  
 
The accompanying notes are an integral part of this statement.

6


 

SOUTHWEST BANCORP, INC.
Unaudited Consolidated Statements of Comprehensive Income
                 
    For the three months
    ended March 31,
(Dollars in thousands)   2011   2010
 
Net income
  $ 2,461     $ 4,372  
 
               
Other comprehensive income:
               
Unrealized holding gain on available for sale securities
    266       3,004  
Reclassification adjustment for losses arising during the period
          (7 )
Change in fair value of derivative used for cash flow hedge
    (513 )      
 
Other comprehensive (loss) income, before tax
    (247 )     2,997  
Tax benefit (expense) related to items of other comprehensive income
    84       (1,159 )
 
Other comprehensive (loss) income, net of tax
    (163 )     1,838  
 
Comprehensive income
  $ 2,298     $ 6,210  
 
The accompanying notes are an integral part of this statement.

7


 

SOUTHWEST BANCORP, INC.
Notes to Unaudited Consolidated Financial Statements
NOTE 1: SIGNIFICANT ACCOUNTING AND REPORTING POLICIES
The accompanying unaudited 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, shareholders’ equity, cash flows, and comprehensive income in conformity with accounting principles generally accepted in the United States. However, the unaudited consolidated financial statements include all adjustments which, in the opinion of management, are necessary for a fair presentation. Those adjustments consist of normal recurring adjustments. The results of operations for the three months ended March 31, 2011, and the cash flows for the three months ended March 31, 2011, should not be considered indicative of the results to be expected for the full year. These unaudited consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in the Southwest Bancorp, Inc. Annual Report on Form 10-K for the year ended December 31, 2010.
The accompanying unaudited consolidated financial statements include the accounts of Southwest Bancorp, Inc. (“Southwest”), its wholly owned financial institution subsidiaries, Stillwater National Bank and Trust Company (“Stillwater National”) and Bank of Kansas, and SNB Capital Corporation, a lending and loan workout subsidiary. All significant intercompany transactions and balances have been eliminated in consolidation.
Certain reclassifications have been made to prior year amounts on the statement of financial condition to conform to current year presentation.
In accordance with Accounting Standards Codification (“ASC”) 855, Subsequent Events, Southwest has evaluated subsequent events for potential recognition and disclosure through the date the consolidated financial statements included in this Quarterly Report on Form 10-Q were issued.
NOTE 2: INVESTMENT SECURITIES
A summary of the amortized cost and fair values of investment securities at March 31, 2011 and December 31, 2010 follows:
                                 
    Amortized   Gross Unrealized   Fair
(Dollars in thousands)   Cost   Gains   Losses   Value
 
At March 31, 2011:
                               
Held to Maturity:
                               
Obligations of state and political subdivisions
  $ 13,042     $ 59     $ (198 )   $ 12,903  
 
Total
  $ 13,042     $ 59     $ (198 )   $ 12,903  
 
 
                               
Available for Sale:
                               
U.S. Government obligations
  $ 1,099     $ 7     $     $ 1,107  
Federal agency securities
    65,139       370       (922 )     64,587  
Obligations of state and political subdivisions
    220       3             223  
Residential mortgage-backed securities
    176,004       3,559       (1,697 )     177,866  
Equity securities
    1,094       517             1,611  
 
Total
  $ 243,556     $ 4,456     $ (2,619 )   $ 245,394  
 
 
                               
At December 31, 2010:
                               
Held to Maturity:
                               
Obligations of state and political subdivisions
  $ 14,304     $ 43     $ (318 )   $ 14,029  
 
Total
  $ 14,304     $ 43     $ (318 )   $ 14,029  
 
 
                               
Available for Sale:
                               
U.S. Government obligations
  $ 1,099     $ 9     $     $ 1,108  
Federal agency securities
    65,522       545       (693 )     65,374  
Obligations of state and political subdivisions
    231       2             233  
Residential mortgage-backed securities
    178,695       3,535       (2,213 )     180,017  
Equity securities
    1,102       387             1,489  
 
Total
  $ 246,649     $ 4,478     $ (2,906 )   $ 248,221  
 

8


 

Residential mortgage-backed securities consist of agency securities underwritten and guaranteed by Government National Mortgage Association (“Ginnie Mae”), Federal Home Loan Mortgage Corporation (“Freddie Mac”), and Federal National Mortgage Association (“Fannie Mae”).
Securities with limited marketability, such as Federal Reserve Bank stock, Federal Home Loan Bank stock, and certain other investments, are carried at cost and included in other assets on the statement of condition. Total investments carried at cost were $10.4 million at both March 31, 2011 and December 31, 2010. There are no identified events or changes in circumstances that may have a significant adverse effect on these investments carried at cost.
A comparison of the amortized cost and approximate fair value of Southwest’s investment securities by maturity date at March 31, 2011 follows:
                                 
    Available for Sale   Held to Maturity
    Amortized   Fair   Amortized   Fair
(Dollars in thousands)   Cost   Value   Cost   Value
 
One year or less
  $ 18,154     $ 18,363     $ 3,476     $ 3,495  
More than one year through five years
    144,377       147,767       3,085       3,125  
More than five years through ten years
    69,239       67,355       6,481       6,283  
More than ten years
    11,786       11,909              
 
Total
  $ 243,556     $ 245,394     $ 13,042     $ 12,903  
 
The foregoing analysis assumes that Southwest’s residential mortgage-backed securities mature during the period in which they are estimated to prepay. No other prepayment or repricing assumptions have been applied to Southwest’s investment securities for this analysis.
Gain or loss on sale of investments is based upon the specific identification method. There were no sales of investment securities as of either March 31, 2011 or March 31, 2010.
The following table presents securities with gross unrealized losses and fair value by length of time that the individual securities had been in a continuous unrealized loss position at March 31, 2011 and December 31, 2010. Securities whose market values exceed cost are excluded from this table.
                                         
                    Continuous Unrealized    
            Amortized cost of   Loss Existing for:   Fair value of
    Number of   securities with   Less Than   More Than   securities with
(Dollars in thousands)   Securities   unrealized losses   12 Months   12 Months   unrealized losses
 
At March 31, 2011:
                                       
Held to Maturity:
                                       
Obligations of state and political subdivisions
    6     $ 6,481     $ (198 )   $     $ 6,283  
 
 
    6     $ 6,481     $ (198 )   $     $ 6,283  
 
 
                                       
Available for Sale:
                                       
Federal agency securities
    15     $ 35,900     $ (922 )   $     $ 34,978  
Residential mortgage-backed securities
    34       68,878       (1,697 )           67,181  
 
Total
    49     $ 104,778     $ (2,619 )   $     $ 102,159  
 
 
                                       
At December 31, 2010:
                                       
Held to Maturity:
                                       
Obligations of state and political subdivisions
    6     $ 6,490     $ (318 )   $     $ 6,172  
 
 
    6     $ 6,490     $ (318 )   $     $ 6,172  
 
 
                                       
Available for Sale:
                                       
Federal agency securities
    11     $ 26,645     $ (693 )   $     $ 25,952  
Obligations of state and political subdivisions
    1       55                   55  
Residential mortgage-backed securities
    27       62,197       (2,213 )           59,984  
 
Total
    39     $ 88,897     $ (2,906 )   $     $ 85,991  
 
Southwest evaluates all securities on an individual basis for other-than-temporary impairment on at least a quarterly basis.

9


 

Consideration is given to the length of time and the extent to which the fair value has been less than cost, the financial condition and near-term prospects of the issuer, and the intent and ability of Southwest to retain its investment in the issuer for a period of time sufficient to allow for an anticipated recovery in fair value.
Management has the ability and intent to hold the securities classified as held to maturity in the table above until they mature, at which time Southwest expects to receive full value for the securities. Furthermore, as of March 31, 2011, management does not have the intent to sell any of the securities classified as available for sale in the table above and believes that it is not more likely than not that Southwest will have to sell any such securities before a recovery of cost. The declines in fair value were attributable to increases in market interest rates over the yields available at the time the underlying securities were purchased or increases in spreads over market interest rates. Management does not believe any of the securities are impaired due to credit quality. Accordingly, as of March 31, 2011, management believes the impairment of these investments is not deemed to be other-than-temporary.
As required by law, available for sale investment securities are pledged to secure public and trust deposits, sweep agreements, and borrowings from the FHLB. Securities with an amortized cost of $202.7 million and $216.4 million were pledged to meet such requirements at March 31, 2011 and December 31, 2010, respectively. Any amount over-pledged can be released at any time.
NOTE 3: LOANS AND ALLOWANCE FOR LOAN LOSSES
Southwest extends commercial and consumer credit primarily to customers in the states of Oklahoma, Texas, and Kansas. Its commercial lending operations are concentrated in Oklahoma City, Dallas, Tulsa, and other metropolitan markets in Texas, Kansas, and Oklahoma. As a result, the collectibility of Southwest’s loan portfolio can be affected by changes in the economic conditions in those states and markets. At March 31, 2011 and December 31, 2010, substantially all of Southwest’s loans were collateralized with real estate, inventory, accounts receivable, and/or other assets or were guaranteed by agencies of the United States government.
Southwest’s loan classifications were as follows:
                                 
    March 31, 2011   December 31, 2010
(Dollars in thousands)   Noncovered   Covered   Noncovered   Covered
 
Real estate mortgage:
                               
Commercial
  $ 1,302,164     $ 28,929     $ 1,310,464     $ 30,997  
One-to-four family residential
    87,286       8,192       89,800       9,122  
Real estate construction:
                               
Commercial
    403,635       6,144       441,265       6,840  
One-to-four family residential
    26,758       281       27,429       439  
Commercial
    416,392       5,021       452,626       5,554  
Installment and consumer:
                               
Guaranteed student loans
    5,700             5,843        
Other
    36,493       550       39,060       676  
 
 
    2,278,428       49,117       2,366,487       53,628  
Less: Allowance for loan losses
    (61,285 )           (65,229 )      
 
Total loans, net
  $ 2,217,143     $ 49,117     $ 2,301,258     $ 53,628  
 
Concentrations of Credit. As of March 31, 2011, approximately $684.0 million, or 30%, of Southwest’s noncovered loans consisted of loans to individuals and businesses in the healthcare industry. Southwest does not have any other concentrations of loans to individuals or businesses involved in a single industry totaling 10% or more of total loans.
Loan Servicing. Southwest earns fees for servicing real estate mortgages and other loans owned by others. The fees are generally calculated on the outstanding principal balance of the loans serviced and are recorded as noninterest income when earned. The unpaid principal balance of real estate mortgage loans serviced for others totaled $281.3 million and $241.2 million at March 31, 2011 and March 31, 2010, respectively. Loan servicing rights are capitalized based on estimated fair value at the point of origination. The servicing rights are amortized on an individual loan by loan basis over the period of estimated net servicing income.
Acquired Loans. On June 19, 2009, Bank of Kansas entered into a purchase and assumption agreement with the Federal Deposit Insurance Corporation (“FDIC”) to acquire substantially all loans as well as certain other related assets of First National Bank of Anthony, Anthony, Kansas (“FNBA”) in an FDIC-assisted transaction. Bank of Kansas and the FDIC

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entered into loss sharing agreements that provide Bank of Kansas with significant protection against credit losses from loans and related assets acquired in the transaction. Under these agreements, the FDIC will reimburse Bank of Kansas 80% of net losses up to $35.0 million on covered assets, primarily acquired loans and other real estate, and 95% of any net losses above $35.0 million. Bank of Kansas services the covered assets.
Loans covered under the loss sharing agreements with the FDIC, including the amounts of expected reimbursements from the FDIC under these agreements, are reported in loans and are referred to as “covered” loans. Covered loans were initially recorded at fair value (as determined by the present value of expected future cash flows) with no allowance for loan losses. Subsequent decreases in expected cash flows are recognized as impairments. The allowance for loan losses on these impaired loans reflects only losses incurred after the acquisition.
The expected payments from the FDIC under the loss sharing agreements are recorded as part of the covered loans in the Unaudited Consolidated Statement of Financial Condition. As of March 31, 2011, Bank of Kansas has identified $16.0 million in cumulative net losses to submit to the FDIC under such loss sharing agreements.
Changes in the carrying and net accretable amounts for ASC 310.30 loans were as follows for the three months ended March 31, 2011 and March 31, 2010.
                                 
    For the three months ended March 31,
    2011   2010
    Net   Carrying   Net   Carrying
    accretable   amount   accretable   amount
(Dollars in thousands)   amount   of loans   amount   of loans
 
Fair value of acquired loans at beginning of period
  $ 2,688     $ 53,628     $ 3,074     $ 85,405  
Payments received
          (3,196 )           (7,333 )
Transfers to other real estate / repossessed assets
    4       (1,008 )     (18 )     (1,318 )
Charge-offs
    7       (362 )     (3 )      
Amortization
    (55 )     55       (155 )     155  
 
Balance at end of period
  $ 2,644     $ 49,117     $ 2,898     $ 76,909  
 
Nonperforming / Past Due Loans. Southwest identifies past due loans based on contractual terms on a loan by loan basis and generally places loans, except for consumer loans, on nonaccrual when any portion of the principal or interest is ninety days past due and collateral is insufficient to discharge the debt in full. Interest accrual may also be discontinued earlier if, in management’s opinion, collection is unlikely. Generally, consumer installment loans are not placed on nonaccrual but are charged-off when they are four months past due. Accrued interest is written off when a loan is placed on nonaccrual status. Subsequent interest income is recorded when cash receipts are received from the borrower and collectibility of the principal amount is reasonably assured.
Under generally accepted accounting principles and instructions to reports of condition and income of federal banking regulators, a nonaccrual loan may be returned to accrual status: when none of its principal and interest is due and unpaid, repayment is expected, and there has been a sustained period (at least six months) of repayment performance; when the loan is not brought current, but there is a sustained period of performance and repayment within a reasonable period is reasonably assured; or when the loan otherwise becomes well-secured and in the process of collection. Purchased impaired loans also may be returned to accrual status without becoming fully current. Loans that have been restructured because of weakened financial positions of the borrowers also may be returned to accrual status if repayment is reasonably assured under the revised terms and there has been a sustained period of repayment performance.
Management strives to carefully monitor credit quality and to identify loans that may become nonperforming. At any time, however, there are loans included in the portfolio that will result in losses to Southwest but that have not been identified as nonperforming or potential problem loans. Because the loan portfolio contains a significant number of commercial and commercial real estate loans with relatively large balances, the unexpected deterioration of one or a few such loans may cause a significant increase in nonperforming assets and may lead to a material increase in charge-offs and the provision for loan losses in future periods.

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The following table presents the recorded investment in loans on nonaccrual status.
                                 
    At March 31, 2011   At December 31, 2010
(Dollars in thousands)   Noncovered   Covered   Noncovered   Covered
 
Real estate mortgage:
                               
Commercial
  $ 47,986     $ 4,407     $ 29,996     $ 4,391  
One-to-four family residential
    2,634       548       1,984       932  
Real estate construction:
                               
Commercial
    53,881       4,179       53,269       4,744  
One-to-four family residential
    14,302             14,302       153  
Commercial
    16,104       667       6,977       581  
Other consumer
    27       8       38       5  
 
Total nonaccrual loans
  $ 134,934     $ 9,809     $ 106,566     $ 10,806  
 
During the first three months of 2011, less than $0.1 million of interest income was received on nonaccruing loans. If interest on all nonaccrual loans had been accrued for the three months ended March 31, 2011, additional interest income of $1.7 million would have been recorded.
Included in noncovered nonaccrual loans as of March 31, 2011 and December 31, 2010, respectively, are thirteen and nine collateral dependent lending relationships with aggregate principal balances of approximately $104.2 million and $75.4 million and related impairment reserves of $8.7 million and $5.9 million, which were established either based on recent appraisal values obtained for the respective properties or the discounted present value of expected cash flows using the loan’s initial effective interest rate. At March 31, 2011, eleven of these lending relationships are in the commercial real estate industry and include a residential condominium construction project with two loans outstanding, two residential apartment complex relationships, one with two loans outstanding and the other with one loan outstanding, a retail building project with one loan outstanding, a hospital with one loan outstanding, a hotel construction relationship with two loans outstanding, a lending relationship consisting of four loans for residential care buildings, a residential land development lending relationship with two loans outstanding, and three commercial land development relationships each with one loan outstanding. The remaining two lending relationships are commercial lending relationships, with one relationship consisting of two loans and the other of five loans.

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The following table presents an age analysis of past due loans at March 31, 2011 and December 31, 2010.
                                                 
            90 days and                           Recorded loans
    30-89 days   greater   Total past           Total   > 90 days and
(Dollars in thousands)   past due   past due   due   Current   loans   accruing
 
At March 31, 2011
                                               
Noncovered:
                                               
Real estate mortgage:
                                               
Commercial
  $ 687     $ 47,986     $ 48,673     $ 1,253,491     $ 1,302,164     $  
One-to-four family residential
    741       2,634       3,375       83,911       87,286        
Real estate construction
                                               
Commercial
          53,881       53,881       349,754       403,635        
One-to-four family residential
          14,302       14,302       12,456       26,758        
Commercial
    860       16,633       17,493       398,899       416,392       529  
Other
    541       27       568       41,625       42,193        
 
Total — noncovered
    2,829       135,463       138,292       2,140,136       2,278,428       529  
 
                                               
Covered:
                                               
Real estate mortgage:
                                               
Commercial
  $ 75     $ 4,407     $ 4,482     $ 24,447     $ 28,929     $  
One-to-four family residential
    60       548       608       7,584       8,192        
Real estate construction
                                               
Commercial
          4,179       4,179       1,965       6,144        
One-to-four family residential
                      281       281        
Commercial
    11       667       678       4,343       5,021        
Other
    3       8       11       539       550        
 
Total — covered
    149       9,809       9,958       39,159       49,117        
 
Total
  $ 2,978     $ 145,272     $ 148,250     $ 2,179,295     $ 2,327,545     $ 529  
 
 
                                               
At December 31, 2010
                                               
Noncovered:
                                               
Real estate mortgage:
                                               
Commercial
  $ 3,793     $ 30,510     $ 34,303     $ 1,276,161     $ 1,310,464     $ 514  
One-to-four family residential
    1,438       1,984       3,422       86,378       89,800        
Real estate construction
                                               
Commercial
    7,569       53,269       60,838       380,427       441,265        
One-to-four family residential
          14,302       14,302       13,127       27,429        
Commercial
    10,707       6,977       17,684       434,942       452,626        
Other
    1,236       41       1,277       43,626       44,903       3  
 
Total — noncovered
    24,743       107,083       131,826       2,234,661       2,366,487       517  
 
                                               
Covered:
                                               
Real estate mortgage:
                                               
Commercial real estate
  $ 227     $ 4,391     $ 4,618     $ 26,379     $ 30,997     $  
One-to-four family residential
    142       932       1,074       8,048       9,122        
Real estate construction
                                               
Commercial real estate
          4,744       4,744       2,096       6,840        
One-to-four family residential
    108       153       261       178       439        
Commercial
          581       581       4,973       5,554        
Other
    14       5       19       657       676        
 
Total — covered
    491       10,806       11,297       42,331       53,628        
 
Total
  $ 25,234     $ 117,889     $ 143,123     $ 2,276,992     $ 2,420,115     $ 517  
 
Impaired Loans. A loan is considered to be impaired when, based on current information and events, it is probable that Southwest will be unable to collect all amounts due according to the contractual terms of the loan agreement. Each loan

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deemed to be impaired (all loans on nonaccrual or restructured) is evaluated on an individual basis using the discounted present value of expected cash flows using the loan’s initial effective interest rate, the fair value of collateral, or the market value of the loan, and a specific allowance is recorded. Smaller balance, homogeneous loans, including mortgage, student, and consumer, are collectively evaluated for impairment. Loans for which the terms have been modified resulting in a concession, and for which the borrower is experiencing financial difficulties, are considered troubled debt restructurings and classified as impaired or performing restructured as applicable.
Interest payments on impaired loans are typically applied to principal unless collectibility of the principal amount is reasonably assured, in which case interest is recognized on a cash basis. Impaired loans, or portions thereof, are charged-off when deemed uncollectible.
Impaired loans are presented in the following tables.
                                         
            Unpaid           Average   Interest
    Recorded   Principal   Related   Recorded   Income
(Dollars in thousands)   Investment   Balance   Allowance   Investment   Recognized
 
At March 31, 2011
                                       
Noncovered:
                                       
With no specific allowance recorded:
                                       
Commercial real estate
  $ 22,341     $ 23,900     $     $ 16,597     $  
One-to-four family residential
    506       555             399       1  
Real estate construction
    38,115       42,376             38,037        
Commercial
    3,531       4,710             2,758       44  
With a specific allowance recorded:
                                       
Commercial real estate
    72,062       79,793       8,971       68,337        
One-to-four family residential
    2,128       2,410       197       1,899        
Real estate construction
    45,068       48,025       5,297       44,658        
Commercial
    21,133       21,613       5,977       14,785        
Other
    27       34       7       18        
 
Total noncovered
  $ 204,911     $ 223,416     $ 20,449     $ 187,488     $ 45  
 
Covered:
                                       
With no specific allowance recorded:
                                       
Commercial real estate
  $ 4,407     $ 5,994     $     $ 29,884     $  
One-to-four family residential
    548       760             8,647        
Real estate construction
    4,179       5,162             7,034        
Commercial
    667       1,317             5,210        
Other
    8       21             605        
 
Total covered
  $ 9,809     $ 13,254     $     $ 51,380     $  
 

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            Unpaid           Average   Interest
    Recorded   Principal   Related   Recorded   Income
(Dollars in thousands)   Investment   Balance   Allowance   Investment   Recognized
 
At December 31, 2010
                                       
Noncovered:
                                       
With no related allowance recorded:
                                       
Commercial real estate
  $ 30,064     $ 30,534     $     $ 23,473     $ 16  
One-to-four family residential
    323       368             343       19  
Real estate construction
    46,978       51,644             36,141       741  
Commercial
    3,790       5,039             2,075       (49 )
With an allowance recorded:
                                       
Commercial real estate
  $ 42,732     $ 46,192     $ 10,813     $ 37,191     $  
One-to-four family residential
    1,660       1,909       197       1,382        
Real estate construction
    35,579       37,667       5,313       26,217        
Commercial
    8,464       8,728       3,643       2,971       2  
Other
    38       48       28       34        
 
Total noncovered
  $ 169,628     $ 182,129     $ 19,994     $ 129,827     $ 729  
 
Covered:
                                       
With no related allowance recorded:
                                       
Commercial real estate
  $ 4,391     $ 6,120     $     $ 35,783     $ 15  
One-to-four family residential
    932       1,104             10,848       43  
Real estate construction
    4,897       6,179             12,079        
Commercial
    581       1,092             8,852       8  
Other
    5       14             1,144        
 
Total covered
  $ 10,806     $ 14,509     $     $ 68,706     $ 66  
 
Included in the tables above are $89.0 million and $69.1 million in loans whose terms have been modified in troubled debt restructurings of which $70.0 million and $63.1 million are performing as of March 31, 2011 and December 31, 2010, respectively. Southwest has allocated $7.4 million and $7.0 million of specific reserves to these troubled debt restructured loans, respectively, and has no significant commitments to lend additional amounts.
The average recorded investment in impaired loans was $94.9 million and interest income recognized on the impaired loans was $0.3 million for the three month period ended March 31, 2010.
Credit Quality Indicators. To assess the credit quality of loans, Southwest categorizes loans into risk categories based on relevant information about the ability of the borrowers to service their debts such as: current financial information, historical payment experience, credit documentation, public information, and current economic trends, among other factors. This analysis is performed on a quarterly basis. Southwest uses the following definitions for risk ratings:
Special mention — Loans classified as special mention have potential weaknesses that deserve management’s close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for these loans or of the institution’s credit position at some future date.
Substandard — Loans classified as substandard are inadequately protected by the current net worth and paying capacity of the obligors or of the collateral pledged, if any. Loans so classified have one or more well-defined weaknesses that jeopardize the liquidation of the debt. They are characterized by the distinct possibility that Southwest will sustain some loss if the deficiencies are not corrected. These loans are considered potential nonperforming or nonperforming loans depending on the accrual status of the loans.
Doubtful — Loans classified as doubtful have all the weaknesses inherent in those classified as substandard, with the added characteristics that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions, and values, highly questionable and improbable. These loans are considered nonperforming.
Loans not meeting the criteria above that are analyzed as part of the above described process are considered to be pass rated loans. As of March 31, 2011 and December 31, 2010, and based on the most recent analysis performed as of those dates, the risk category of loans by class of loans is as follows:

15


 

                                                 
    Commercial   1-4 Family   Real Estate            
(Dollars in thousands)   Real Estate   Residential   Construction   Commercial   Other   Total
 
At March 31, 2011
                                               
Grade:
                                               
Pass
  $ 1,157,845     $ 91,450     $ 237,075     $ 370,041     $ 41,594     $ 1,898,005  
Special Mention
    34,154       798       15,607       13,136       1,100       64,795  
Substandard
    135,688       3,230       177,338       31,878       49       348,183  
Doubtful
    3,406             6,798       6,358             16,562  
 
Total
  $ 1,331,093     $ 95,478     $ 436,818     $ 421,413     $ 42,743     $ 2,327,545  
 
 
                                               
At December 31, 2010
                                               
Grade:
                                               
Pass
  $ 1,190,587     $ 93,961     $ 276,613     $ 399,344     $ 44,161     $ 2,004,666  
Special Mention
    13,854       1,840       24,023       13,436       1,340       54,493  
Substandard
    132,148       2,644       168,220       41,906       54       344,972  
Doubtful
    4,872       477       7,117       3,494       24       15,984  
 
Total
  $ 1,341,461     $ 98,922     $ 475,973     $ 458,180     $ 45,579     $ 2,420,115  
 
Allowance for Loan Losses. The allowance for loan losses is a reserve established through a provision for loan losses charged to operations. Loan amounts which are determined to be uncollectible are charged against this allowance, and recoveries, if any, are added to the allowance. The appropriate amount of the allowance is based on continuous review and evaluation of the loan portfolio and ongoing, quarterly assessments of the probable losses inherent in the loan and lease portfolio. The amount of the loan loss provision for a period is based solely upon the amount needed to cause the allowance to reach the level deemed appropriate after the effects of net charge-offs for the period.
Management believes the level of the allowance is appropriate to absorb probable losses inherent in the loan portfolio. The allowance for loan losses is determined in accordance with regulatory guidelines and generally accepted accounting principles and is comprised of two primary components. There is no one factor, or group of factors, that produces the amount of an appropriate allowance for loan losses, as the methodology for assessing the allowance for loan losses makes use of evaluations of individual impaired loans along with other factors and analysis of loan categories. This assessment is highly qualitative and relies upon judgments and estimates by management.
A specific allowance is recorded based on the result consistent with ASC 310.10.35, Receivables: Subsequent Measurement, for each impaired loan. Collateral dependent loans are evaluated for impairment based upon the fair value of the collateral. The amount and level of the impairment allowance is ultimately determined by management’s estimate of the amount of expected future cash flows or, if the loan is collateral dependent, on the value of collateral, which may vary from period to period depending on changes in the financial condition of the borrower or changes in the estimated value of the collateral. Charge-offs against the allowance for impaired loans are made when and to the extent loans are deemed uncollectible. Any portion of a collateral dependent impaired loan in excess of the fair value of the collateral that is determined to be uncollectible is charged off.
The remaining portion of the allowance is calculated based on ASC 450, Contingencies. Loans not evaluated for specific allowance are segmented into loan pools by type of loan. Estimated allowances are based on historical loss trends with adjustments factored in based on qualitative risk factors both internal and external to Southwest. The historical loss trend is determined by loan pool and is based on the actual loss history experienced by Southwest over the most recent three years. The qualitative risk factors include, but are not limited to, economic and business conditions, changes in lending staff, lending policies and procedures, quality of loan review, changes in the nature and volume of the portfolios, loss and recovery trends, asset quality trends, and legal and regulatory considerations.
Independent appraisals on real estate collateral securing loans are obtained at origination. New appraisals are obtained periodically and upon discovery of factors that may significantly affect the value of the collateral. Appraisals usually are received within 30 days of request. Results of appraisals on nonperforming and potential problem loans are reviewed promptly upon receipt and considered in the determination of the allowance for loan losses. Southwest is not aware of any significant time lapses in the process that have resulted, or would result in, a significant delay in determination of a credit weakness, the identification of a loan as nonperforming, or the measurement of an impairment.
The following table presents the balance in the allowance for loan losses and the recorded investment in loans by portfolio segment and based on impairment evaluation method.

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    Commercial   1-4 Family   Real Estate            
(Dollars in thousands)   Real Estate   Residential   Construction   Commercial   Other   Total
 
At March 31, 2011
                                               
Balance at beginning of period
  $ 32,508     $ 1,597     $ 19,605     $ 10,605     $ 914     $ 65,229  
Loans charged-off
    (7,325 )     (83 )     (1,134 )     (4,526 )     (324 )     (13,392 )
Recoveries
    35       25       122       189       27       398  
Provision for loan losses
    4,850       (122 )     (1,174 )     5,234       262       9,050  
 
Balance at end of period
  $ 30,068     $ 1,417     $ 17,419     $ 11,502     $ 879     $ 61,285  
 
 
                                               
Period-end amount allocated to:
                                               
Individually evaluated for impairment
  $ 8,971     $ 197     $ 5,297     $ 5,977     $ 7     $ 20,449  
Collectively evaluated for impairment
    21,097       1,220       12,122       5,525       872       40,836  
Acquired with deteriorated credit quality
                                   
 
Total ending allowance balance
  $ 30,068     $ 1,417     $ 17,419     $ 11,502     $ 879     $ 61,285  
 
 
                                               
Loans receivable ending balance:
                                               
Individually evaluated for impairment
  $ 94,403     $ 2,634     $ 83,183     $ 24,664     $ 27     $ 204,911  
Collectively evaluated for impairment
    1,207,761       84,652       347,210       391,728       42,166       2,073,517  
Acquired with deteriorated credit quality
    28,929       8,192       6,425       5,021       550       49,117  
 
Total ending loans balance
  $ 1,331,093     $ 95,478     $ 436,818     $ 421,413     $ 42,743     $ 2,327,545  
 
At March 31, 2010
                                               
Allowance for loan losses ending balances:
                                               
Balance at beginning of period
  $ 26,670     $ 2,454     $ 22,241     $ 10,052     $ 996     $ 62,413  
Loans charged-off
    (928 )     (573 )     (3,516 )     (1,279 )     (249 )     (6,545 )
Recoveries
    9       15       596       131       18       769  
Provision for loan losses
    2,895       561       4,315       566       194       8,531  
 
Balance at end of period
  $ 28,646     $ 2,457     $ 23,636     $ 9,470     $ 959     $ 65,168  
 
 
                                               
Period-end amount allocated to:
                                               
Individually evaluated for impairment
  $ 5,905     $ 1,079     $ 2,682     $ 2,437     $ 33     $ 12,136  
Collectively evaluated for impairment
    22,741       1,378       20,954       7,033       926       53,032  
Acquired with deteriorated credit quality
                                   
 
Total ending allowance balance
  $ 28,646     $ 2,457     $ 23,636     $ 9,470     $ 959     $ 65,168  
 
 
                                               
Loans receivable ending balance:
                                               
Individually evaluated for impairment
  $ 28,520     $ 10,553     $ 54,648     $ 9,753     $ 38       103,512  
Collectively evaluated for impairment
    1,201,489       100,632       610,820       477,321       48,209       2,438,471  
Acquired with deteriorated credit quality
    37,487       10,843       16,446       10,807       1,326       76,909  
 
Total ending loans balance
  $ 1,267,496     $ 122,028     $ 681,914     $ 497,881     $ 49,573     $ 2,618,892  
 
NOTE 4: FAIR VALUE MEASUREMENTS
Fair value is defined as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. In estimating fair value, Southwest utilizes valuation techniques that are consistent with the market approach, the income approach, and/or the cost approach. Such valuation techniques are consistently applied. Inputs to valuation techniques include the assumptions that market participants would use in pricing an asset or liability.
ASC 820, Fair Value Measurements and Disclosure, establishes a fair value hierarchy for valuation inputs that gives the highest priority to quoted prices in active markets for identical assets or liabilities and the lowest priority to unobservable inputs. The fair value hierarchy is as follows:
Level 1   Quoted prices in active markets for identical assets or liabilities: Level 1 assets and liabilities include debt and equity securities that are traded in an active exchange market, as well as certain U.S. Treasury securities that are highly liquid and are actively traded in over-the-counter markets.

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Level 2   Observable inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities. Level 2 assets and liabilities include debt securities with quoted prices that are traded less frequently than exchange-traded instruments. This category includes U.S. Government and agency securities, residential mortgage-backed debt securities, municipal obligation securities, loans held for sale, certain private equity investments, and other real estate.
Level 3   Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities. Level 3 assets and liabilities include financial instruments whose values are determined using pricing models, discounted cash flow methodologies, or similar techniques, as well as instruments for which the determination of fair value requires significant management judgment or estimation. This category includes certain impaired loans, certain other real estate, goodwill, and other intangible assets.
The estimated fair value amounts have been determined by Southwest using available market information and appropriate valuation methodologies. However, considerable judgment is required to interpret market data to develop the estimates of fair value. Accordingly, the estimates presented herein are not necessarily indicative of the amount Southwest could realize in a current market exchange. The use of different market assumptions and/or estimation methodologies may have a material effect on the estimated fair value amounts.
A description of the valuation methodologies used for assets measured at fair value on a recurring basis is as follows:
     Loans held for sale — Real estate mortgage loans held for sale are carried at the lower of cost or market, which is determined on an individual loan basis. Guaranteed student loans held for sale are carried at the lower of cost or market, which is determined on an aggregate basis.
     Available for sale securities — The fair value of U.S. Government and federal agency securities, equity securities, and residential mortgage-backed securities is estimated based on quoted market prices or dealer quotes. The fair value of other investments such as obligations of state and political subdivisions is estimated based on quoted market prices. The fair value of a certain private equity investment is estimated based on Southwest’s proportionate share of the net asset value, $1.5 million and $1.3 million as of March 31, 2011 and December 31, 2010, respectively. The investee invests in small and mid-sized U.S. financial institutions and other financial-related companies. This investment has a quarterly redemption with sixty-five days notice.
     Derivative instrument — Southwest utilizes an interest rate swap agreement to convert one of its variable-rate subordinated debentures to a fixed rate (cash flow hedge). The fair value of the interest rate swap agreement is obtained from dealer quotes.

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The following table summarizes financial assets measured at fair value on a recurring basis.
                                         
            Fair Value Measurement at Reporting Date Using        
            Quoted Prices in           Significant        
            Active Markets for   Significant Other   Unobservable        
            Identical Assets   Observable Inputs   Inputs        
(Dollars in thousands)   Total   (Level 1)   (Level 2)   (Level 3)        
 
At March 31, 2011
                                       
Loans held for sale:
                                       
Student loans
  $ 5,700     $     $ 5,700     $          
One-to-four family residential
    2,515             2,515                
Government guaranteed commercial real estate
    28,508             28,508                
Other loans held for sale
    625             625                
 
Available for sale securities:
                                       
U.S. Government obligations
    1,107       1,107                      
Federal agency securities
    64,587             64,587                
Obligations of state and political subdivisions
    223             223                
Residential mortgage-backed securities
    177,866             177,866                
Equity securities
    1,611       143       1,468                
 
Derivative instrument
    (513 )           (513 )              
 
Total
  $ 282,229     $ 1,250     $ 280,979     $          
 
At December 31, 2010
                                       
Loans held for sale:
                                       
Student loans
  $ 5,843     $     $ 5,843     $          
One-to-four family residential
    2,300             2,300                
Government guaranteed commercial real estate
    26,242             26,242                
Other loans held for sale
    809             809                
 
Available for sale securities:
                                       
U.S. Government obligations
    1,108       1,108                      
Federal agency securities
    65,374             65,374                
Obligations of state and political subdivisions
    233             233                
Residential mortgage-backed securities
    180,017             180,017                
Equity securities
    1,489       222       1,267                
 
Total
  $ 283,415     $ 1,330     $ 282,085     $          
 
Certain financial assets are measured at fair value on a nonrecurring basis; that is, the instruments are not measured at fair value on an ongoing basis but are subject to fair value adjustments in certain circumstances (for example, when there is evidence of impairment). These assets are recorded at the lower of cost or fair value. Valuation methodologies for assets measured on a nonrecurring basis are as follows:
     Impaired loans — Certain impaired loans are reported at the fair value of the underlying collateral if repayment is expected solely from collateral. Collateral values are estimated using Level 2 inputs based on third-party appraisals or Level 3 inputs based on customized discounting criteria. Certain other impaired loans are remeasured and reported through a specific valuation allowance allocation of the allowance for loan losses based upon the net present value of cash flows.
     Other real estate — Other real estate fair value is based on third-party appraisals for significant properties less the estimated costs to sell the asset.
     Goodwill — Fair value of goodwill is based on the fair value of each of Southwest’s reporting units to which goodwill is allocated compared with their respective carrying value. There has been no impairment during 2011 or 2010; therefore, no fair value adjustment was recorded through earnings.
     Core deposit premiums — The fair value of core deposit premiums are based on third-party appraisals. There has been no impairment during 2011 or 2010; therefore, no fair value adjustment was recorded through earnings.
     Mortgage loan servicing rights — There is no active trading market for loan servicing rights. The fair value of loan servicing rights is estimated by calculating the present value of net servicing revenue over the anticipated life of each loan. A cash flow model is used to determine fair value. Key assumptions and estimates, including projected prepayment speeds and assumed servicing costs, earnings on escrow deposits, ancillary income, and discount rates, used by this model are based

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on current market sources. A separate third party model is used to estimate prepayment speeds based on interest rates, housing turnover rates, estimated loan curtailment, anticipated defaults, and other relevant factors. The prepayment model is updated for changes in market conditions. There has been no impairment during 2011 or 2010; therefore, no fair value adjustment was recorded through earnings.
Assets measured at fair value on a nonrecurring basis are summarized below.
                                         
            Fair Value Measurements Using    
            Quoted Prices in           Significant    
            Active Markets for   Significant Other   Unobservable    
    Fair Value   Identical Assets   Observable Inputs   Inputs   Total Gains
(Dollars in thousands)   Total   (Level 1)   (Level 2)   (Level 3)   (Losses)
 
At March 31, 2011                                        
Noncovered impaired loans at fair value :
                                       
Commercial real estate
  $ 72,478     $     $ 69,045     $ 3,433     $ (1,248 )
One-to-four family residential
    2,154             2,154             211  
Real estate construction
    45,147             31,642       13,505       3,637  
Commercial
    21,197             21,197             (4,777 )
Other consumer
    27             27             3  
 
Total
  $ 141,003     $     $ 124,065     $ 16,938     $ (2,174 )
 
 
At December 31, 2010                                        
Noncovered impaired loans at fair value :
                                       
Commercial real estate
  $ 43,349     $     $ 43,349     $     $ (5,003 )
One-to-four family residential
    1,660             1,660             1,819  
Real estate construction
    42,577             29,072       13,505       (4,144 )
Commercial
    9,727             9,727             (1,214 )
Other consumer
    38             38             86  
 
Noncovered other real estate
    37,722             37,722             (360 )
 
Total
  $ 135,073     $     $ 121,568     $ 13,505     $ (8,816 )
 
Noncovered impaired loans measured at fair value with a carrying amount of $166.8 million were written down to a fair value of $141.0 million, resulting in a life-to-date impairment of $25.8 million, of which $2.2 million was included in the provision for loan losses for the three months ended March 31, 2011. As of December 31, 2010, noncovered impaired loans measured at fair value with a carrying amount of $125.2 million were written down to the fair value of $97.4 million at December 31, 2010, resulting in a life-to-date impairment charge of $27.9 million, of which $8.5 million was included in the provision for loan losses for the year ended December 31, 2010.
As of December 31, 2010, noncovered other real estate assets were written down to their respective fair values, resulting in impairment charges of $0.4 million, which was included in noninterest expense for the year ended December 31, 2010.
ASC 825, Financial Instruments, requires an entity to provide disclosures about fair value of financial instruments, including those that are not measured and reported at fair value on a recurring or nonrecurring basis. The methodologies used in estimating the fair value of financial instruments that are measured on a recurring or nonrecurring basis are discussed above. The methodologies for the other financial instruments are discussed below:
     Cash and cash equivalents — For cash and cash equivalents, the carrying amount is a reasonable estimate of fair value.
     Investment securities — The investment securities held to maturity are carried at cost. The fair value of the held to maturity securities is estimated based on quoted market prices or dealer quotes.
     Loans — Fair values are estimated for certain homogenous categories of loans adjusted for differences in loan characteristics. Southwest’s loans have been aggregated by categories consisting of commercial, real estate, student, and other consumer. The fair value of loans is estimated by discounting the cash flows using risks inherent in the loan category and interest rates currently offered for loans with similar terms and credit risks.
     Accrued interest receivable — The carrying amount is a reasonable estimate of fair value for accrued interest receivable.

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     Other assets — The estimated fair value of other assets, which primarily consists of investments carried at cost, prepaids, and deferred taxes, approximates their carrying values.
     Deposits — The fair value of demand deposits, savings accounts, and certain money market deposits is the amount payable on demand at the statement of financial condition date. The fair value of fixed maturity certificates of deposit is estimated using the rates currently offered for deposits of similar remaining maturities.
     Other liabilities and accrued interest payable — The estimated fair value of other liabilities, which primarily includes trade accounts payable, and accrued interest payable approximates their carrying values.
     Other borrowings — The fair value for fixed rate FHLB advances is based upon discounted cash flow analysis using interest rates currently being offered for similar instruments. The fair values of other borrowings are the amounts payable at the statement of financial condition date, as the carrying amount is a reasonable estimate of fair value due to the short-term maturity rates. Included in other borrowings are federal funds purchased, FHLB advances, securities sold under agreements to repurchase, and treasury tax and loan demand notes.
     Subordinated debentures — Two subordinated debentures have floating rates that reset quarterly and the third subordinated debenture has a fixed rate. The fair value of the floating rate subordinated debentures approximates current book value. The fair value of the fixed rate subordinated debenture is based on market price.
The carrying values and estimated fair values of Southwest’s financial instruments follow:
                                 
    At March 31, 2011   At December 31, 2010
    Carrying   Fair   Carrying   Fair
(Dollars in thousands)   Values   Values   Values   Values
 
Cash and cash equivalents
  $ 117,563     $ 117,563     $ 67,496     $ 67,496  
Securities held to maturity
    13,042       12,903       14,304       14,029  
Securities available for sale
    245,394       245,394       248,221       248,221  
Total loans, net of allowance
    2,266,260       2,160,413       2,354,886       2,279,605  
Accrued interest receivable
    8,789       8,789       8,590       8,590  
Other assets
    47,390       47,390       49,181       49,181  
Deposits
    2,218,571       2,098,045       2,252,728       2,119,840  
Accrued interest payable
    1,805       1,805       1,577       1,577  
Other liabilities
    9,010       9,010       8,981       8,981  
Derivative instrument
    (513 )     (513 )            
Other borrowings
    85,332       91,036       94,602       100,550  
Subordinated debentures
    81,963       84,061       81,963       84,654  
NOTE 5: DERIVATIVE INSTRUMENTS
On February 11, 2011, Southwest entered into an interest rate swap agreement with a total notional amount of $25.0 million. The interest rate swap contract was designated as a hedging instrument in cash flow hedges with the objective of protecting the overall cash flow from Southwest’s quarterly interest payments on the SBI Capital Trust II preferred securities throughout the seven year period beginning February 11, 2011 and ending April 7, 2018 from the risk of variability of those payments resulting from changes in the three-month London Interbank Offered Rate (“LIBOR”). Under the swap, Southwest will pay a fixed interest rate of 6.15% and receive a variable interest rate of three-month LIBOR plus a margin of 2.85% on a total notional amount of $25.0 million, with quarterly settlements. The rate received by Southwest as of March 31, 2011 was 3.15%.
The estimated fair value of the interest rate derivative contract outstanding as of March 31, 2011 resulted in a loss of $0.5 million and was included in other liabilities in the statement of condition. Southwest obtained the counterparty valuation to validate its interest rate derivative contract as of March 31, 2011.
The effective portion of the gain or loss due to changes in the fair value of the derivative hedging instrument, $0.3 million as of March 31, 2011, is included in other comprehensive income, net of tax, while the ineffective portion (indicated by the excess of the cumulative change in the fair value of the derivative over that which is necessary to offset the cumulative change in expected future cash flows on the hedge transaction) is included in other noninterest income or other noninterest expense. No ineffectiveness related to the interest rate derivative was recognized during the reporting period.
Net cash flows as a result of the interest rate swap agreement were $0.1 million for the quarter ended March 31, 2011 and were included in interest expense on subordinated debentures.

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Derivative contracts involve the risk of dealing with institutional derivative counterparties and their ability to meet contractual terms. Institutional counterparties must have an investment grade credit rating and be approved by Southwest’s asset/liability management committee. Southwest’s credit exposure on interest rate swaps is limited to the net favorable value and interest payments of all swaps by each counterparty. Credit exposure may be reduced by the amount of collateral pledged by the counterparty. There are no credit-risk-related contingent features associated with Southwest’s derivative contract.
The fair value of cash and securities posted as collateral by Southwest related to the derivative contract was $1.6 million at March 31, 2011.
NOTE 6: TAXES ON INCOME
In accordance with ASC 740, Income Taxes, the total gross balance of unrecognized tax benefits at March 31, 2011 was $5.5 million. Of this total, $1.9 million (net of federal benefit on state issues) represents the amount of unrecognized tax benefits that if recognized would favorably affect the effective tax rate in future periods.
Southwest recognizes interest accrued related to unrecognized tax benefits and penalties in operating expenses. For the three months ended March 31, 2011, an additional $0.3 million has been accrued in interest and penalties. Southwest had approximately $3.0 million accrued for interest and penalties at March 31, 2011.
Southwest and its subsidiaries file income tax returns in the U.S. federal jurisdiction and various state jurisdictions. With few exceptions, Southwest is no longer subject to U.S. federal or state tax examinations for years before 2005.
Southwest is currently under audit by the State of Oklahoma for the 2002 through 2007 tax years. During 2008, Southwest received a Notice of Assessment from the Oklahoma Tax Commission and filed a formal Notice of Protest. It is possible that a reduction in the unrecognized tax benefits may occur; however, quantification of an estimated range cannot be made at this time.
NOTE 7: EARNINGS PER SHARE
Earnings per common share is computed using the two-class method prescribed by ASC 260, Earnings Per Share. Using the two-class method, basic earnings per common share is computed based upon net income available to common shareholders divided by the weighted average number of common shares outstanding during each period, which excludes outstanding unvested restricted stock. Diluted earnings per share is computed using the weighted average number of common shares determined for the basic earnings per common share computation plus the dilutive effect of stock options using the treasury stock method. Stock options and warrants with exercise prices greater than the average market price of common shares were not included in the computation of earnings per diluted share as they would have been antidilutive. On March 31, 2011 and 2010, there were 135,166 and 380,390 antidilutive stock options to purchase common shares, respectively. An antidilutive warrant to purchase 703,753 shares of common stock was also outstanding on March 31, 2011.

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The following table sets forth the computation of basic and diluted earnings per common share:
                 
    For the three months
    ended March 31,
(Dollars in thousands, except earnings per share data)   2011   2010
 
Numerator:
               
Net income
  $ 2,461     $ 4,372  
Preferred dividend
    (875 )     (875 )
Warrant amortization
    (178 )     (168 )
 
Net income available to common shareholders
  $ 1,408     $ 3,329  
Earnings allocated to participating securities
    (2 )     (11 )
 
Numerator for basic earnings per common share
  $ 1,406     $ 3,318  
Effect of reallocating undistributed earnings of participating securities
           
 
Numerator for diluted earnings per common share
  $ 1,406     $ 3,318  
 
               
Denominator:
               
Denominator for basic earnings per common share -
               
Weighted average common shares outstanding
    19,409,317       14,712,594  
Effect of dilutive securities:
               
Stock options
    3,967       11,981  
Warrant
           
 
Denominator for diluted earnings per common share
    19,413,284       14,724,575  
 
               
Earnings per common share:
               
Basic
  $ 0.07     $ 0.23  
 
Diluted
  $ 0.07     $ 0.23  
 
NOTE 8: OPERATING SEGMENTS
Southwest operates six principal segments: Oklahoma Banking, Texas Banking, Kansas Banking, Other States Banking, Secondary Market, and Other Operations. The Oklahoma Banking segment, the Texas Banking segment, and the Kansas Banking segment provide deposit and lending services to customers in the states of Oklahoma, Texas, and Kansas. The Other States Banking segment provides lending services to customers outside Oklahoma, Texas, and Kansas. The Secondary Market segment consists of three operating units: one that provides student lending services to post-secondary students in Oklahoma and several other states, one that provides residential mortgage lending services to customers in Oklahoma, Texas, and Kansas, and one that provides United States Department of Agriculture (“USDA”) government guaranteed commercial real estate lending services to rural healthcare providers. Other Operations includes Southwest’s funds management unit.
The primary purpose of the funds management unit is to manage Southwest’s overall internal liquidity needs and interest rate risk. Each segment borrows funds from or provides funds to the funds management unit as needed to support its operations. The value of funds provided to and the cost of funds borrowed from the funds management unit by each segment are internally priced at rates that approximate market rates for funds with similar duration. The yield used in the funds transfer pricing curve is a blend of rates based on the volume usage of retail and brokered certificates of deposit and Federal Home Loan Bank advances.
The Other Operations segment also includes SNB Wealth Management and corporate investments.
Southwest identifies reportable segments by type of service provided and geographic location. Operating results are adjusted for borrowings, allocated service costs, and management fees. Portfolio loans are allocated based upon the state of the borrower or the location of the real estate in the case of real estate loans. Loans included in the Other States Banking segment are portfolio loans attributable to thirty-three states other than Oklahoma, Texas, or Kansas and primarily consist of healthcare and commercial real estate credits. These out of state loans are administered by offices in Oklahoma, Texas, or Kansas.
The accounting policies of each reportable segment are the same as those of Southwest. Expenses for consolidated back-office operations are allocated to operating segments based on estimated uses of those services. General overhead expenses such as executive administration, accounting, and audit are allocated based on the direct expense and/or deposit and loan volumes of the operating segment. Income tax expense for the operating segments is calculated at statutory rates. The Other Operations segment records the tax expense or benefit necessary to reconcile to the consolidated financial statements.

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Capital is assigned to each of the segments using a risk-based capital pricing methodology that assigns capital ratios by asset, deposit, or revenue category based on credit risk, interest rate risk, market risk, operational risk, and liquidity risk.
Beginning January 1, 2011, all segments of Southwest’s subsidiaries reported results using organizational profitability. Prior to January 1, 2011, only the segments of Stillwater National reported results using organizational profitability, while the segments of Bank of Kansas reported results using a direct profitability approach. The change in method did not materially affect segment reporting and had no impact on the consolidated results of Southwest. The amounts for the three months ending March 31, 2010 have been restated using consolidated organizational profitability.
The following table summarizes financial results by operating segment:
                                                         
    For the Three Months Ended March 31, 2011                
    Oklahoma   Texas   Kansas   Other States   Secondary   Other   Total
(Dollars in thousands)   Banking   Banking   Banking   Banking   Market   Operations   Company
 
Net interest income
  $ 10,997     $ 10,091     $ 3,369     $ 1,882     $ 311     $ (1,229 )   $ 25,421  
Provision for loan losses
    225       5,008       815       3,002                   9,050  
Noninterest income
    1,873       424       529       53       145       225       3,249  
Noninterest expenses
    6,998       3,727       2,870       455       478       1,097       15,625  
 
Income (loss) before taxes
    5,647       1,780       213       (1,522 )     (22 )     (2,101 )     3,995  
Taxes on income
    2,212       701       82       (598 )     (9 )     (854 )     1,534  
 
Net income (loss)
  $ 3,435     $ 1,079     $ 131     $ (924 )   $ (13 )   $ (1,247 )   $ 2,461  
 
 
                                                       
Fixed asset expenditures
  $ 19     $     $ 28     $     $ 3     $ 457     $ 507  
Total loans at period end
    838,006       953,123       272,685       226,383       37,348             2,327,545  
Total assets at period end
    862,907       946,457       296,567       221,007       39,139       412,951       2,779,028  
Total deposits at period end
    1,527,731       166,734       275,381             2,394       246,331       2,218,571  
 
    For the Three Months Ended March 31, 2010                
    Oklahoma   Texas   Kansas   Other States   Secondary   Other   Total
(Dollars in thousands)   Banking   Banking   Banking   Banking   Market   Operations   Company
 
Net interest income
  $ 10,944     $ 11,063     $ 4,032     $ 2,258     $ 353     $ (1,849 )   $ 26,801  
Provision for loan losses
    2,033       5,412       2,277       (1,191 )                 8,531  
Noninterest income
    2,057       409       669       133       745       165       4,178  
Noninterest expenses
    6,230       3,254       3,002       664       558       1,550       15,258  
 
Income (loss) before taxes
    4,738       2,806       (578 )     2,918       540       (3,234 )     7,190  
Taxes on income
    1,881       1,121       (256 )     1,168       230       (1,326 )     2,818  
 
Net income (loss)
  $ 2,857     $ 1,685     $ (322 )   $ 1,750     $ 310     $ (1,908 )   $ 4,372  
 
 
                                                       
Fixed asset expenditures
  $ 19     $ 40     $ 27     $     $ 43     $ 172     $ 301  
Total loans at period end
    926,870       1,063,511       342,596       260,329       25,586             2,618,892  
Total assets at period end
    942,869       1,051,089       359,815       254,438       28,436       438,276       3,074,923  
Total deposits at period end
    1,675,308       162,455       280,705             5,340       430,357       2,554,165  
NOTE 9: NEW AUTHORITATIVE ACCOUNTING GUIDANCE
On January 21, 2010, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update No. 2010-06, Improving Disclosures about Fair Value Measurements (“ASU 2010-06”), which amends ASC 820, Fair Value Measurements and Disclosures, to require a number of additional disclosures regarding fair value measurements. Specifically, entities are required to disclose: the amount of significant transfers between Level 1 and Level 2 of the fair value hierarchy and the reasons for these transfers; the reasons for any transfers in or out of Level 3; and information in the reconciliation of recurring Level 3 measurements about purchases, sales, issuances, and settlements on a gross basis. In addition to these new disclosure requirements, ASU 2010-06 also amends ASC 820 to clarify certain existing disclosure requirements. Except for the requirement to disclose information about purchases, sales, issuances, and settlements in the reconciliation of recurring Level 3 measurements on a gross basis, all the amendments to ASC 820 made by ASU 2010-06 were effective for Southwest on January 1, 2010, and the required disclosures are reported in Note 5. The requirement to

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separately disclose purchases, sales, issuances, and settlements of recurring Level 3 measurements became effective for Southwest on January 1, 2011, and did not have a significant impact on Southwest’s financial statements.
On July 21, 2010, FASB issued Accounting Standards Update No. 2010-20, Disclosures about the Credit Quality of Financing Receivables and the Allowance for Credit Losses (“ASU 2010-20”), which amends ASC 830, Receivables, to enhance disclosures about the credit quality of financing receivables and the allowance for credit losses. ASU 2010-20 requires entities to provide disclosures designed to facilitate financial statement users’ evaluation of (i) the nature of credit risk inherent in the entity’s portfolio of financing receivables, (ii) how that risk is analyzed and assessed in arriving at the allowance for credit losses, and (iii) the changes and reasons for those changes in the allowance for credit losses. Disclosures must be disaggregated by portfolio segment, the level at which an entity develops and documents a systematic method for determining its allowance for credit losses, and class of financing receivable, which is generally a disaggregation of portfolio segment. The required disclosures include, among other things, the activity in the allowance for credit losses as well as information about modified, impaired, nonaccrual, and past due loans and credit quality indicators. ASU 2010-20, as it relates to disclosures required as of the end of a reporting period was effective for Southwest’s financial statements as of December 31, 2010. Disclosures that relate to activity during a reporting period are required for Southwest’s financial statements issued after January 1, 2011. Southwest has incorporated the required disclosures, see Note 3.
On April 5, 2011, FASB issued Accounting Standards Update No. 2011-02, A Creditor’s Determination of Whether a Restructuring Is a Troubled Debt Restructuring (“ASU 2011-02”). ASU 2011-02 clarifies whether loan modifications constitute troubled debt restructuring. In evaluating whether a restructuring constitutes a troubled debt restructuring, a creditor must separately conclude that both of the following exist: (a) the restructuring constitutes a concession; and (b) the debtor is experiencing financial difficulties. ASU 2011-02 is effective for Southwest’s financial statements ending September 30, 2011, and applies retrospectively to restructurings occurring on or after January 1, 2011. Southwest is currently assessing the impact of the new guidance on its consolidated financial statements and disclosures.

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SOUTHWEST BANCORP, INC.
ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITIONS AND RESULTS OF OPERATIONS
Caution About Forward-Looking Statements.
We make forward-looking statements in this Form 10-Q and documents incorporated by reference into it that are subject to risks and uncertainties. We intend these statements to be covered by the safe harbor provision for forward-looking statements contained in the Private Securities Litigation Reform Act of 1995.
These forward-looking statements include:
    Statements of our goals, intentions, and expectations:
 
    Estimates of risks and of future costs and benefits;
 
    Expectations regarding our future financial performance and the financial performance of our operating segments;
 
    Assessments of loan quality, probable loan losses, and the amount and timing of loan payoffs;
 
    Assessments of liquidity, off-balance sheet risk, and interest rate risk; and
 
    Statements of our ability to achieve financial and other goals.
These forward-looking statements are subject to significant uncertainties because they are based upon: the amount and timing of future changes in interest rates, market behavior, and other economic conditions; future laws, regulations and accounting principles; changes in regulatory standards and examination policies, and a variety of other matters. These other matters include, among other things, the direct and indirect effects of economic conditions on interest rates, credit quality, loan demand, liquidity, and monetary and supervisory policies of banking regulators. Because of these uncertainties, the actual future results may be materially different from the results indicated by these forward-looking statements. In addition, Southwest’s past growth and performance do not necessarily indicate its future results. For other factors, risks, and uncertainties that could cause actual results to differ materially from estimates and projections contained in forward-looking statements, please read the “Risk Factors” contained in Southwest’s reports to the Securities and Exchange Commission.
The cautionary statements in this Form 10-Q and any documents incorporated by reference herein also identify important factors and possible events that involve risk and uncertainties that could cause our actual results to differ materially from those contained in the forward-looking statements. These forward-looking statements speak only as of the date on which the statements were made. We do not intend, and undertake no obligation, to update or revise any forward-looking statements contained in this Form 10-Q, whether as a result of differences in actual results, changes in assumptions or changes in other factors affecting such statements, except as required by law.
Management’s discussion and analysis of Southwest’s consolidated financial condition and results of operations should be read in conjunction with Southwest’s unaudited consolidated financial statements and the accompanying notes.
CRITICAL ACCOUNTING POLICIES, JUDGMENTS AND ESTIMATES
The accounting and reporting policies followed by Southwest Bancorp, Inc. (“Southwest”) conform, in all material respects, to U.S. generally accepted accounting principles (“GAAP”) and to general practices within the financial services industry. The preparation of the financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. While Southwest bases estimates on historical experience, current information, and other factors deemed to be relevant, actual results could differ from those estimates.
Southwest considers accounting estimates to be critical to reported financial results if (i) the accounting estimate requires management to make assumptions about matters that are highly uncertain and (ii) different estimates that management reasonably could have used for the accounting estimate in the current period, or changes in the accounting estimate that are reasonably likely to occur from period to period, could have a material impact on Southwest’s financial statements. Accounting policies related to the allowance for loan losses and goodwill and other intangible assets are considered to be critical, as these policies involve considerable subjective judgment and estimation by management.
For additional information regarding critical accounting policies, refer to “Note 1: Summary of Significant Accounting and Reporting Policies” in the Notes to the Consolidated Financial Statements and the sections captioned “Critical Accounting Policies” and “Allowance for Loan Losses” in Management’s Discussion and Analysis of Financial Condition and Results of

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Operations included in Southwest’s 2010 Annual Report on Form 10-K. There have been no significant changes in Southwest’s application of critical accounting policies since December 31, 2010.
GENERAL
Southwest is the bank holding company for Stillwater National Bank and Trust Company (“Stillwater National”) and Bank of Kansas. Through its subsidiaries, Southwest offers commercial and consumer lending, deposit and investment services, and specialized cash management, and other financial services from offices in Oklahoma, Texas, and Kansas; and on the Internet, through SNB DirectBanker®.
Southwest was organized in 1981 as the holding company for Stillwater National, which was chartered in 1894. Southwest has established and pursued a strategy of independent operation for the benefit of all of its shareholders. Southwest became a public company in late 1993. At March 31, 2011, Southwest had total assets of $2.8 billion, deposits of $2.2 billion, and shareholders’ equity of $379.4 million.
Southwest’s banking philosophy has led to the development of a line of deposit, lending, and other financial products that respond to professional and commercial customers needs for speed, efficiency, and information and complement more traditional banking products. Southwest has developed a highly automated lockbox, imaging, and information service for commercial customers called “SNB Digital Lockbox” and deposit products that automatically sweep excess funds from commercial demand deposit accounts and invest them in interest bearing funds. Other specialized financial services include integrated document imaging and cash management services designed to help our customers in the healthcare industry and other record-intensive enterprises operate more efficiently. Information regarding Southwest is available online at www.oksb.com. Information regarding the products and services of Southwest’s subsidiaries is available online at www.banksnb.com and www.bankofkansas.com. The information on these websites is not a part of this report on Form 10-Q.
Southwest focuses on converting its strategic vision into long-term shareholder value. Our vision includes a commercial banking model and a community banking model focused on more traditional banking operations in our three-state market.
At March 31, 2011, the Texas Banking segment accounted for $953.1 million in loans, the Oklahoma Banking segment accounted for $838.0 million in loans, the Kansas Banking segment accounted for $272.7 million in loans, and the Other States Banking segment accounted for $226.4 million in loans. Southwest offers products to the student, residential mortgage, and rural healthcare lending markets. These operations comprise the Secondary Market business segment. At March 31, 2011, Secondary Market loans accounted for $37.3 million in loans. Southwest engages in residential mortgage lending, but residential mortgages have not been a significant element of Southwest’s strategy. Please see “Financial Condition: Loans” below for additional information.
For additional information on Southwest’s operating segments, please see “Note 8: Operating Segments” in the Notes to Unaudited Consolidated Financial Statements.
FINANCIAL CONDITION
Investment Securities
Southwest’s investment security portfolio decreased $4.1 million, or 2%, from $262.5 million at December 31, 2010, to $258.4 million at March 31, 2011. The decrease is primarily the result of a $2.1 million, or 1%, decrease in residential mortgage-backed securities, a $1.3 million, or 9%, decrease in tax-exempt securities, and a $0.8 million, or 1%, decrease in U.S. government and agency securities, offset in part by a $0.1 million, or 8%, increase in other equity securities during the first three months of 2011.
Loans
Total loans, including loans held for sale, were $2.3 billion at March 31, 2011, a 4% decrease from December 31, 2010. All loan classifications decreased.

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The following table presents the trends in the composition of the loan portfolio at the dates indicated:
                                                 
    March 31,   December 31,        
    2011   2010   Total   Total
(Dollars in thousands)   Noncovered   Covered   Noncovered   Covered   $ Change   % Change
 
Real estate mortgage
                                               
Commercial
  $ 1,302,164     $ 28,929     $ 1,310,464     $ 30,997     $ (10,368 )     (0.77 )%
One-to-four family residential
    87,286       8,192       89,800       9,122       (3,444 )     (3.48 )
Real estate construction
                                               
Commercial
    403,635       6,144       441,265       6,840       (38,326 )     (8.55 )
One-to-four family residential
    26,758       281       27,429       439       (829 )     (2.97 )
Commercial
    416,392       5,021       452,626       5,554       (36,767 )     (8.02 )
Installment and consumer
                                               
Guaranteed student loans
    5,700             5,843             (143 )     (2.45 )
Other
    36,493       550       39,060       676       (2,693 )     (6.78 )
         
Total loans
  $ 2,278,428     $ 49,117     $ 2,366,487     $ 53,628     $ (92,570 )     (3.83 )%
         
The composition of loans held for sale and reconciliation to total loans is shown in the following table:
                                 
    March 31,   December 31,        
(Dollars in thousands)   2011   2010   $ Change   % Change
 
Loans held for sale:
                               
Student loans
  $ 5,700     $ 5,843     $ (143 )     (2.45 )%
One-to-four family residential
    2,515       2,300       215       9.35  
Government guaranteed commercial real estate
    28,508       26,242       2,266       8.64  
Other loans held for sale
    625       809       (184 )     (22.74 )
         
Total loans held for sale
    37,348       35,194       2,338       6.64  
Noncovered portfolio loans
    2,241,080       2,331,293       (90,213 )     (3.87 )
Covered portfolio loans
    49,117       53,628       (4,511 )     (8.41 )
         
Total loans
  $ 2,327,545     $ 2,420,115     $ (92,386 )     (3.82 )%
         
Management determines the appropriate level of the allowance for loan losses using an established methodology. (See “Note 3: Loans and Allowance for Loan Losses” in the Notes to Unaudited Consolidated Financial Statements.) The allowance for loan losses is comprised of two primary components. Loans deemed to be impaired (all loans on nonaccrual or restructured) are evaluated on an individual basis using the discounted present value of expected cash flows, the fair value of collateral, or the market value of the loan, and a specific allowance is recorded based upon the result. Collateral dependent loans are evaluated for impairment based upon the fair value of the collateral. Any portion of a collateral dependent impaired loan in excess of the fair value of the collateral that is determined to be uncollectible is charged off. Loans other than impaired loans are segmented into loan pools by type of loan. The allowance on these other loans is determined by use of historical loss ratios adjusted for qualitative internal and external risk factors.
At March 31, 2011, the allowance for loan losses was $61.3 million, a decrease of $3.9 million, or 6%, from the allowance for loan losses at December 31, 2010. Changes in the amount of the allowance resulted from the application of the methodology, which is designed to estimate inherent losses on total portfolio loans, including nonperforming loans. At March 31, 2011, the allowance on the $134.9 million in noncovered nonaccrual loans was $13.1 million (9.7%), compared with an allowance on $106.6 million in noncovered nonaccrual loans at December 31, 2010 of $12.9 million (12.1%), an increase in the allowance of $0.2 million, or 2%. At March 31, 2011, the allowance for noncovered troubled debt restructured loans was $7.4 million (10.6%), compared to $7.0 million (11%) at December 31, 2010, an increase in the allowance of $0.4 million, or 6%. At March 31, 2011, the allowance for other noncovered loans was $40.8 million (1.9%), compared to $45.3 million (2.1%) at December 31, 2010, a decrease in the allowance of $4.5 million, or 10%. The decrease in the allowance related to these other noncovered loans mainly resulted from consideration of certain trends and qualitative factors. These included management’s assessment of economic risk (particularly with respect to commercial and commercial real estate loans), and asset quality trends, including levels of potential problem loans and loan concentrations in commercial real estate mortgage and construction loans, which together comprised approximately 75% of our noncovered loans at March 31, 2011, and portfolio loss trends. Based on its analysis, management believes the amount of the allowance is appropriate. Covered loans were $49.1 million and $53.6 million as of March 31, 2011 and December 31, 2010, respectively. These

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loans are subject to protection under the loss sharing agreements with the FDIC and currently do not have an allowance for loan losses.
The amount of the loan loss provision for a period is based solely upon the amount needed to cause the allowance to reach the level deemed appropriate, after the effects of net charge-offs for the period. Net charge-offs for the first three months of 2011 were $13.0 million, an increase of $7.2 million, or 124%, over the $5.8 million recorded for the first three months of 2010. The provision for loan losses for the first three months of 2011 was $9.1 million, representing an increase of $0.5 million, or 6%, from the $8.5 million recorded for the first three months of 2010.
At March 31, 2011, the allowance for loan losses was 45.24% of noncovered nonperforming loans, compared to 60.91% of noncovered nonperforming loans, at December 31, 2010 (see “Provision for Loan Losses” on page 34). Noncovered nonaccrual loans, which comprise the majority of noncovered nonperforming loans, were $134.9 million as of March 31, 2011, an increase of $28.4 million, or 27%, from December 31, 2010. Noncovered nonaccrual loans at March 31, 2011 were comprised of 59 relationships and were primarily concentrated in real estate construction (51%) and commercial real estate (36%) loans. All noncovered nonaccrual loans are considered impaired and are carried at their estimated collectible amounts. Noncovered loans 90 days or more past due, another component of noncovered nonperforming loans, remained relatively flat at $0.5 million compared to December 31, 2010. These noncovered loans are believed to have sufficient collateral and are in the process of being collected. Covered nonperforming loans of $9.8 million are subject to protection under the loss share agreements with the FDIC.
                                 
    March 31,   December 31,
    2011   2010
(Dollars in thousands)   Noncovered   Covered   Noncovered   Covered
 
Nonaccrual loans:
                               
Commercial real estate
  $ 47,986     $ 4,407     $ 29,996     $ 4,391  
One-to-four family residential
    2,634       548       1,984       932  
Real estate construction
    68,183       4,179       67,571       4,897  
Commercial
    16,104       667       6,977       581  
Other consumer
    27       8       38       5  
           
Total nonaccrual loans
    134,934       9,809       106,566       10,806  
 
                               
Past due 90 days or more:
                               
Commercial real estate
                514        
One-to-four family residential
                       
Real estate construction
                       
Commercial
    529                    
Other consumer
                3        
           
Total past due 90 days or more
    529             517        
           
Total nonperforming loans
    135,463       9,809       107,083       10,806  
Other real estate
    41,067       4,016       37,722       4,187  
           
Total nonperforming assets
  $ 176,530     $ 13,825     $ 144,805     $ 14,993  
           
Performing restructured
  $ 2,166     $     $ 2,177     $  
           
Nonperforming assets to portfolio loans receivable and other real estate
    7.74 %     26.02 %     6.11 %     25.93 %
Nonperforming loans to portfolio loans receivable
    6.04 %     19.97 %     4.59 %     20.15 %
Allowance for loan losses to nonperforming loans
    45.24 %           60.91 %      
At March 31, 2011 and December 31, 2010, thirteen and nine credit relationships represented 77% and 70% of noncovered nonperforming loans and 59% and 52% of noncovered nonperforming assets, respectively. As of March 31, 2011, these credit relationships were all collateral dependent and included eleven commercial real estate lending relationships and two commercial lending relationships with aggregate principal balances of $104.2 million and related impairment reserves of $8.6 million.
Performing loans considered potential problem loans, loans which are not included in the past due, nonaccrual, or restructured categories but for which known information about possible credit problems causes management to be uncertain as to the ability of the borrowers to comply with the present loan repayment terms, amounted to approximately $220.9 million at March 31, 2011, compared to $236.6 million at December 31, 2010. Included are $3.4 million and $3.5 million, respectively, of covered potential problem loans, which are subject to protection under the loss share agreements with the

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FDIC. Loans may be monitored by management and reported as potential problem loans for an extended period of time during which management continues to be uncertain as to the ability of certain borrowers to comply with the present loan repayment terms. These loans are subject to continuing management attention and are considered by management in determining the level of the allowance for loan losses.
At March 31, 2011, the reserve for unfunded loan commitments was $1.8 million, a $0.1 million, or 3%, decrease from the amount at December 31, 2010. Management believes the amount of the reserve is appropriate and the decreased amount is the result of application of our methodology.
Deposits and Other Borrowings
Southwest’s deposits were $2.2 billion and $2.3 billion at March 31, 2011 and December 31, 2010, respectively. The following table presents the trends in the composition of deposits at the dates indicated:
                                 
    March 31,   December 31,        
(Dollars in thousands)   2011   2010   $ Change   % Change
 
Noninterest-bearing demand
  $ 369,013     $ 377,182     $ (8,169 )     (2.17 )%
Interest-bearing demand
    112,731       92,584       20,147       21.76  
Money market accounts
    486,770       495,253       (8,483 )     (1.71 )
Savings accounts
    28,440       26,665       1,775       6.66  
Time deposits of $100,000 or more
    669,817       694,565       (24,748 )     (3.56 )
Other time deposits
    551,800       566,479       (14,679 )     (2.59 )
         
Total deposits
  $ 2,218,571     $ 2,252,728     $ (34,157 )     (1.52 )%
               
Stillwater National has substantial unused borrowing availability in the form of unsecured brokered certificate of deposits from Bank of America Merrill Lynch, Citigroup Global Markets, Inc., Wells Fargo Bank, NA, UBS Securities, LLC, RBC Capital Markets Corp., and Morgan Stanley & Co., Inc. in connection with its retail certificate of deposit program. At March 31, 2011, $96.9 million in these retail certificates of deposit were included in time deposits of $100,000 or more, a decrease of $13.1 million, or 12%, from December 31, 2010.
Stillwater National has other brokered certificates of deposit totaling $0.7 million and $1.0 million as of March 31, 2011 and December 31, 2010, respectively, included in time deposits of $100,000 or more in the above table.
Other borrowings, which includes short-term federal funds purchased, FHLB borrowings, and repurchase agreements, decreased $9.3 million, or 10%, to $85.3 million during the first three months of 2011. The decrease reflects the changes in the need for other funding based on lending activities for the period.
Shareholders’ Equity
Shareholders’ equity increased $1.5 million, or less than 1%, due to earnings of $2.5 million, offset in part by preferred dividends declared totaling $0.9 million for the first three months of 2011. Net unrealized holding gains on available for sale investment securities and derivative instruments (net of tax) decreased to $0.8 million at March 31, 2011, compared to $1.0 million at December 31, 2010.
At March 31, 2011, Southwest, Stillwater National, and Bank of Kansas continued to exceed all applicable regulatory capital requirements. See “Capital Requirements” on page 35.
RESULTS OF OPERATIONS
FOR THE THREE MONTH PERIODS ENDED MARCH 31, 2011 and 2010
Net income available to common shareholders for the first quarter of 2011 of $1.4 million represented a decrease of $1.9 million, or 58%, from the $3.3 million earned in the first quarter of 2010. Diluted earnings per share were $0.07, compared to $0.23, a 70% decrease, which reflects the additional shares that were issued in the common stock offering in April 2010. The decrease in quarterly net income available to common shareholders was the result of a $1.4 million, or 5%, decrease in net interest income, a $0.9 million, or 22%, decrease in noninterest income, a $0.5 million, or 6%, increase in the provision for loan losses, and a $0.4 million, or 2% increase in noninterest expense, offset in part by a $1.3 million, or 46%, decrease in income tax expense.

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Provisions for loan losses are booked in the amounts necessary to increase the allowance for loan losses to an appropriate level at period end after net charge-offs for the period. The necessary provision for first quarter of 2011 was $0.5 million more than the provision required for first quarter of 2010. (See “Note 3: Loans and Allowance for Loan Losses” in the Notes to Unaudited Consolidated Financial Statements and “Provision for Loan Losses” on page 34.)
On an operating segment basis, the decrease in net income was the net result of a $2.7 million decrease in net income from the Other States Banking segment, a $0.6 million decrease in net income from the Texas Banking segment, and a $0.3 million decrease in net income from the Secondary Market segment, offset in part by a $0.7 million decrease in net loss from the Other Operations segment, a $0.6 million increase in net income from the Oklahoma Banking segment, and a $0.5 million increase in net income from the Kansas Banking segment.
Net Interest Income
                                 
    For the three months        
    ended March 31,        
(Dollars in thousands)   2011   2010   $ Change   % Change
 
Interest income:
                               
Loans
  $ 30,539     $ 34,372     $ (3,833 )     (11.15 )%
Investment securities:
                               
U.S. government and agency obligations
    376       596       (220 )     (36.91 )
Mortgage-backed securities
    1,245       1,446       (201 )     (13.90 )
State and political subdivisions
    80       65       15       23.08  
Other securities
    45       63       (18 )     (28.57 )
Other interest-earning assets
    140       217       (77 )     (35.48 )
               
Total interest income
    32,425       36,759       (4,334 )     (11.79 )
 
                               
Interest expense:
                               
Interest-bearing demand deposits
    124       132       (8 )     (6.06 )
Money market accounts
    677       1,013       (336 )     (33.17 )
Savings accounts
    16       16             0.00  
Time deposits of $100,000 or more
    2,349       4,024       (1,675 )     (41.63 )
Other time deposits
    1,967       2,989       (1,022 )     (34.19 )
Other borrowings
    497       517       (20 )     (3.87 )
Subordinated debentures
    1,374       1,267       107       8.45  
         
Total interest expense
    7,004       9,958       (2,954 )     (29.66 )
               
 
                               
Net interest income
  $ 25,421     $ 26,801     $ (1,380 )     (5.15 )%
               
Net interest income is the difference between the interest income Southwest earns on its loans, investments, and other interest-earning assets and the interest paid on interest-bearing liabilities, such as deposits and borrowings. Net interest income is affected by changes in market interest rates because different types of assets and liabilities may react differently and at different times to changes in market interest rates. When interest-earning assets mature or reprice more quickly than interest-bearing liabilities, falling interest rates could reduce net interest income. Similarly, when interest-bearing liabilities mature or reprice more quickly than interest-earning assets in a period, an increase of market rates of interest could reduce net interest income.
Yields on Southwest’s interest-earning assets decreased 11 basis points, while the rates paid on Southwest’s interest-bearing liabilities decreased 26 basis points, resulting in an increase in the interest rate spread to 3.44% for the first quarter of 2011 from 3.29% for the first quarter of 2010. During the same periods, annualized net interest margin was 3.78% and 3.59%, respectively, and the ratio of average interest-earning assets to average interest-bearing liabilities increased to 132.93% from 122.68%. Included in first quarter of 2011 net interest margin is a net interest margin recovery of $0.1 million from the quarterly adjustment of the discount accretion on loans and loss share receivable offset in part by interest reversals on nonaccrual loans. Included in first quarter 2010 net interest margin was a net recovery of $0.4 million from the resolution of a nonperforming loans and the quarterly adjustment of the discount accretion on loans and the loss share receivable, offset by interest reversals on nonaccrual loans. The net effects of these adjustments on net interest margin were a 1 basis point increase in the first quarter of 2011 and a 5 basis point increase in the first quarter of 2010.

31


 

The decrease in total interest income was the result of a decrease in the yield earned on interest-earning assets and a $298.8 million, or 10%, decrease in average interest-earning assets. Southwest’s average loans decreased $291.3 million, or 11%, and the related yield decreased to 5.21% for the first quarter of 2011 from 5.22% for the first quarter of 2010. During the same period, average investment securities increased $15.1 million, or 6%; however, the related yield decreased to 2.76% from 3.65% in 2010. Average other interest earning assets decreased $22.7 million, or 20% and the related yield decreased to 0.61% for the first quarter of 2011 from 0.76% for the first quarter of 2010.
The decrease in total interest expense can be attributed to the decrease in rates paid on interest-bearing liabilities and the effects of a $415.0 million, or 17%, decrease in average interest-bearing liabilities. Southwest’s average total interest-bearing deposits decreased $407.9 million, or 18%, and the related rates paid for interest expense decreased to 1.10% for the first quarter of 2011 from 1.45% for the first quarter of 2010. Average other borrowings decreased $7.1 million, or 7%; however, the related rates paid for interest expense increased to 2.23% for the first quarter of 2011 from 2.15% for the first quarter of 2010.
UNAUDITED RATE VOLUME TABLE
The following table analyzes changes in interest income and interest expense of Southwest for the periods indicated. For each category of interest-earning asset and interest-bearing liability, information is provided on changes attributable to: (i) changes in volume (changes in volume multiplied by the prior period’s rate); and (ii) changes in rates (changes in rate multiplied by the prior period’s volume). Changes in rate-volume (changes in rate multiplied by the changes in volume) are allocated between changes in rate and changes in volume in proportion to the relative contribution of each.
                         
    For the three months ended March 31,
    2011 vs. 2010
    Increase   Due to Change
    Or   In Average:
(Dollars in thousands)   (Decrease)   Volume   Rate
 
Interest earned on:
                       
Noncovered loans receivable (1)
  $ (3,326 )   $ (3,322 )   $ (4 )
Covered loans receivable
    (507 )     (525 )     18  
Investment securities (1)
    (483 )     56       (539 )
Other interest-earning assets
    (18 )     (9 )     (9 )
                 
Total interest income
    (4,334 )     (3,566 )     (768 )
 
                       
Interest paid on:
                       
Interest-bearing demand
    (8 )     6       (14 )
Money market accounts
    (336 )     (26 )     (310 )
Savings accounts
          1       (1 )
Time deposits
    (2,697 )     (1,535 )     (1,162 )
Other borrowings
    (20 )     (39 )     19  
Subordinated debentures
    107             107  
                 
Total interest expense
    (2,954 )     (1,540 )     (1,414 )
 
 
                       
Net interest income
  $ (1,380 )   $ (2,026 )   $ 646  
 
 
(1)   Interest on tax-exempt loans and securities is not shown on a tax-equivalent basis because it is not considered material.

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UNAUDITED AVERAGE BALANCES, YIELDS AND RATES
The following table sets forth average interest-earning assets and interest-bearing liabilities and the average yields and rates thereon for the periods indicated.
                                                 
    For the three months ended March 31,
    2011   2010
    Average           Average   Average           Average
(Dollars in thousands)   Balance   Interest   Yield/Rate   Balance   Interest   Yield/Rate
 
Assets
                                               
Noncovered loans (1) (2)
  $ 2,326,882     $ 29,655       5.17 %   $ 2,587,603     $ 32,981       5.17 %
Covered loans (1)
    51,494       884       6.96       82,043       1,391       6.88  
Investment securities (2)
    256,384       1,746       2.76       241,276       2,170       3.65  
Other interest-earning assets
    92,692       140       0.61       115,374       217       0.76  
                     
Total interest-earning assets
    2,727,452       32,425       4.82       3,026,296       36,759       4.93  
Other assets
    91,807                       79,238                  
 
Total assets
  $ 2,819,259                     $ 3,105,534                  
 
 
                                               
Liabilities and shareholders’ equity
                                               
Interest-bearing demand deposits
  $ 112,441     $ 124       0.45 %   $ 107,510     $ 132       0.50 %
Money market accounts
    491,306       677       0.56       504,486       1,013       0.81  
Savings accounts
    27,741       16       0.23       25,628       16       0.25  
Time deposits
    1,248,152       4,316       1.40       1,649,888       7,013       1.72  
                     
Total interest-bearing deposits
    1,879,640       5,133       1.10       2,287,512       8,174       1.45  
Other borrowings
    90,198       497       2.23       97,297       517       2.15  
Subordinated debentures
    81,969       1,374       6.70       81,963       1,267       6.18  
                     
Total interest-bearing liabilities
    2,051,807       7,004       1.38       2,466,772       9,958       1.64  
 
                                               
Noninterest-bearing demand deposits
    365,161                       303,684                  
Other liabilities
    19,789                       19,032                  
Shareholders’ equity
    382,502                       316,046                  
 
Total liabilities and shareholders’ equity
  $ 2,819,259                     $ 3,105,534                  
 
 
                                               
Net interest income and interest rate spread
          $ 25,421       3.44 %           $ 26,801       3.29 %
         
Net interest margin (3)
                    3.78 %                     3.59 %
     
Ratio of average interest-earning assets to average interest-bearing liabilities
    132.93 %                     122.68 %                
 
 
(1)   Average balances include nonaccrual loans. Fees included in interest income on loans receivable are not considered material.
 
(2)   Interest on tax-exempt loans and securities is not shown on a tax-equivalent basis because it is not considered material.
 
(3)   Net interest margin = annualized net interest income / average interest-earning assets

33


 

Noninterest Income
                                 
    For the three months        
    ended March 31,        
(Dollars in thousands)   2011   2010   $ Change   % Change
         
Noninterest income:
                               
Other service charges
  $ 2,478     $ 2,698     $ (220 )     (8.15 )%
Other fees
    400       398       2       0.50  
Other noninterest income
    177       90       87       96.67  
Gain on sales of loans:
                               
Student loan sales
          624       (624 )     (100.00 )
One-to-four family residential
    193       267       (74 )     (27.72 )
All other loan sales
    1       94       (93 )      
Gain on sale/call of investment securities
          7       (7 )     (100.00 )
         
Total noninterest income
  $ 3,249     $ 4,178     $ (929 )     (22.24 )%
               
The decrease in other service charges is the result of decreased overdraft service charges and deposit account service charges.
Gain on sales of loans is a reflection of the activity in the student, mortgage, and commercial lending areas discussed elsewhere in this report.
Noninterest Expense
                                 
    For the three months        
    ended March 31,        
(Dollars in thousands)   2011   2010   $ Change   % Change
         
Noninterest expense:
                               
Salaries and employee benefits
  $ 7,515     $ 7,580     $ (65 )     (0.86 )%
Occupancy
    2,804       2,783       21       0.75  
FDIC and other insurance
    1,243       1,587       (344 )     (21.68 )
Other real estate (net)
    436       106       330       311.32  
Unfunded loan commitment reserve
    (55 )     (465 )     410       (88.17 )
Other general and administrative
    3,682       3,667       15       0.41  
         
Total noninterest expense
  $ 15,625     $ 15,258     $ 367       2.41 %
               
The number of full-time equivalent employees decreased from 432 at the beginning of the quarter to 424 as of March 31, 2011. For the first quarter of 2010, the number of full-time equivalent employees decreased from 466 at the beginning of the quarter to 455 as of March 31, 2010.
Southwest’s financial institution subsidiaries pay deposit insurance premiums to the FDIC based on assessment rates. The decrease from prior year is the result of the decrease in average deposits.
The unfunded loan commitment reserve expense increased as a result of the stabilization in the level of commitments in the first quarter of 2011 when compared to a decline in the level of commitments the same period of the prior year.
Provisions for Loan Losses
Southwest records provisions for loan losses in amounts necessary to maintain the allowance for loan losses at the levels Southwest determines are appropriate. (See “Note 3: Loans and Allowance for Loan Losses” in the Notes to Unaudited Consolidated Financial Statements.)
The allowance for loan losses of $61.3 million at March 31, 2011 decreased $3.9 million, or 6%, from year-end 2010. A provision for loan losses of $9.1 million was recorded in the first three months of 2011, an increase of $0.5 million, or 6%, from the first three months of 2010. The increase in the provision for loan losses was the result of the calculations of the appropriate allowance at each period end. (See “Note 3: Loans and Allowance for Loan Losses” in the Notes to Unaudited Consolidated Financial Statements and “Loans” on page 27.)

34


 

Taxes on Income
Southwest’s income tax expense was $1.5 million and $2.8 million for the first three months of 2011 and 2010, respectively, a decrease of $1.3 million, or 46%. The effective tax rate for the first three months of 2011 was 38.40% while the effective tax rate for the first three months of 2010 was 39.19%. The decrease in the effective tax rate is the result of decreased income.
LIQUIDITY
Liquidity is measured by a financial institution’s ability to raise funds through deposits, borrowed funds, capital, or the sale of highly marketable assets such as available for sale investments. Additional sources of liquidity, including cash flow from the repayment of loans and the sale of participations in outstanding loans, are also considered in determining whether liquidity is satisfactory. Liquidity is also achieved through growth of deposits, reductions in liquid assets, and accessibility to capital and money markets. These funds are used to meet deposit withdrawals, maintain reserve requirements, fund loans, and operate the organization.
Southwest, Stillwater National, and Bank of Kansas have available various forms of short-term borrowings for cash management and liquidity purposes. These forms of borrowings include federal funds purchased, securities sold under agreements to repurchase, and borrowings from the Federal Reserve Bank (“FRB”) and the Federal Home Loan Bank of Topeka (“FHLB”).
Stillwater National also carries interest-bearing demand notes issued by the U.S. Treasury in connection with the Treasury Tax and Loan note program. The outstanding balance of those notes was $1.6 million at March 31, 2011. Stillwater National has approved federal funds purchase lines totaling $232.0 million with seven banks; $60,000 was outstanding on these lines at March 31, 2011. Stillwater National is qualified to borrow funds from the FRB through their Borrower-In-Custody (“BIC”) program. Collateral under this program consists of pledged selected commercial and industrial loans. Currently the collateral will allow Stillwater National to borrow up to $110.1 million. As of March 31, 2011, no borrowings were made through the BIC program. In addition, Stillwater National has available a $414.1 million line of credit and Bank of Kansas has a $70.0 million line of credit from the FHLB. Borrowings under the FHLB lines are secured by investment securities and loans. At March 31, 2011, the Stillwater National FHLB line of credit had an outstanding balance of $51.5 million, and the Bank of Kansas line of credit had an outstanding balance of $5.0 million.
(See also “Deposits and Other Borrowings” on page 30 for funds available on brokered certificate of deposit lines of credit and “Note 8: Operating Segments” in the Notes to Unaudited Consolidated Financial Statements for a discussion on Southwest’s funds management unit.)
Stillwater National sells securities under agreements to repurchase with Stillwater National retaining custody of the collateral. Collateral consists of U.S. government agency obligations, which are designated as pledged with Stillwater National’s safekeeping agent. These transactions are for one to four day periods. Outstanding balances under this program were $27.2 million and $33.2 million as of March 31, 2011 and March 31, 2010, respectively.
At March 31, 2011, $202.7 million of the total carrying value of investment securities of $254.8 million were pledged as collateral to secure public and trust deposits, sweep agreements, and borrowings from the FHLB. Any amount over pledged can be released at any time
During the first three months of 2011, no category of short-term borrowings had an average balance that exceeded 30% of ending shareholders’ equity.
During the first three months of 2011, cash and cash equivalents increased by $50.1 million, or 74%, to $117.6 million. This increase was the net result of cash provided from investing activities of $79.3 million (primarily from net repayments of loans and proceeds from repayments, call and maturities of securities) and cash provided by operating activities of $15.1 million, offset in part by cash used in financing activities of $44.4 million (primarily from decreases in deposits).
During the first three months of 2010, cash and cash equivalents increased by $27.5 million, or 23%, to $146.3 million. This increase was the net result of cash provided by operating activities of $46.8 million and cash provided from investing activities of $19.8 million (primarily net repayments of loans and proceeds from repayments, calls and maturities of available for sale securities), offset in part by cash used in financing activities of $39.2 million (primarily from decreases in deposits).

35


 

CAPITAL REQUIREMENTS
Bank holding companies are required to maintain capital ratios in accordance with regulations adopted by the Federal Reserve Bank. The guidelines are commonly known as Risk-Based Capital Guidelines. At March 31, 2011, Southwest exceeded all applicable capital requirements, having a total risk-based capital ratio of 19.77%, a Tier I risk-based capital ratio of 18.49%, and a leverage ratio of 15.95%. As of March 31, 2011, Stillwater National and Bank of Kansas met the criteria for classification as “well-capitalized” institutions under the prompt corrective action rules of the Federal Deposit Insurance Act. Designation as a well-capitalized institution under these regulations does not constitute a recommendation or endorsement of Southwest, Stillwater National, or Bank of Kansas by bank regulators.
On January 27, 2010, Stillwater National informally agreed with the Office of the Comptroller of the Currency, its primary federal regulator, to maintain a ratio of capital to risk weighted assets of at least 12.5% and a Tier 1 leverage ratio of at least 8.5%. As of March 31, 2011, Stillwater National had a capital to risk weighted assets ratio of 17.94% and a Tier 1 leverage ratio of 14.28%.
EFFECTS OF INFLATION
The unaudited consolidated financial statements and related unaudited consolidated financial data presented herein have been prepared in accordance with accounting principles generally accepted in the United States of America and practices within the banking industry which require the measurement of financial position and operating results in terms of historical dollars without considering fluctuations in the relative purchasing power of money over time due to inflation. Unlike most industrial companies, virtually all the assets and liabilities of a financial institution are monetary in nature. As a result, interest rates have a more significant impact on a financial institution’s performance than do the effects of general levels of inflation.
* * * * * * *

36


 

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Southwest’s net income is largely dependent on its net interest income. Southwest seeks to maximize its net interest margin within an acceptable level of interest rate risk. Interest rate risk can be defined as the amount of forecasted net interest income that may be gained or lost due to favorable or unfavorable movements in interest rates. Interest rate risk, or sensitivity, arises when the maturity or repricing characteristics of assets differ significantly from the maturity or repricing characteristics of liabilities. Net interest income is also affected by changes in the portion of interest-earning assets that are funded by interest-bearing liabilities rather than by other sources of funds, such as noninterest-bearing deposits and shareholders’ equity.
Southwest attempts to manage interest rate risk while enhancing net interest margin by adjusting its asset/liability position. At times, depending on the level of general interest rates, the relationship between long-term and other interest rates, market conditions, and competitive factors, Southwest may determine to increase its interest rate risk position in order to increase its net interest margin. Southwest monitors interest rate risk and adjusts the composition of its rate-sensitive assets and liabilities in order to limit its exposure to changes in interest rates on net interest income over time. Southwest’s asset/liability committee reviews its interest rate risk position and profitability, and recommends adjustments. The asset/liability committee also reviews the securities portfolio, formulates investment strategies, and oversees the timing and implementation of transactions. Notwithstanding Southwest’s interest rate risk management activities, the actual magnitude, direction, and relationship of future interest rates are uncertain and can have adverse effects on net income and liquidity.
A principal objective of Southwest’s asset/liability management effort is to balance the various factors that generate interest rate risk, thereby maintaining the interest rate sensitivity of Southwest within acceptable risk levels. To measure its interest rate sensitivity position, Southwest utilizes a simulation model that facilitates the forecasting of net interest income over the next twelve month period under a variety of interest rate and growth scenarios.
The earnings simulation model uses numerous assumptions regarding the effect of changes in interest rates on the timing and extent of repricing characteristics, future cash flows, and customer behavior. These assumptions are inherently uncertain and, as a result, the model cannot precisely estimate net income. Actual results differ from simulated results due to timing, cash flows, magnitude, and frequency of interest rate changes, and changes in market conditions and management strategies, among other factors.
The balance sheet is subject to quarterly testing for six alternative interest rate shock possibilities to indicate the inherent interest rate risk. Average interest rates are shocked by +/- 100, 200, and 300 basis points (“bp”), although Southwest may elect not to use particular scenarios that it determines are impractical in a current rate environment. It is management’s goal to structure the balance sheet so that net interest earnings at risk over a twelve-month period and the economic value of equity at risk do not exceed policy guidelines at the various interest rate shock levels.
Measures of net interest income at risk produced by simulation analysis are indicators of an institution’s short-term performance in alternative rate environments. These measures are typically based upon a relatively brief period, usually one year. They do not necessarily indicate the long-term prospects or economic value of the institution.
                         
Changes in Interest Rates:   + 300 bp   +200 bp   +100 bp
 
Policy Limit
    (18.00 )%     (10.00 )%     (5.00 )%
March 31, 2011
    (1.77 )%     (4.98 )%     (4.35 )%
December 31, 2010
    1.58 %     (2.77 )%     (3.30 )%
The current overnight rate as established by the Federal Open Market Committee is in the 0% to 0.25% range. Southwest believes that all down rate scenarios are impractical since they would result in an overnight rate of less than 0%. As a result, the down 100 bp, down 200 bp, and down 300 bp scenarios have been excluded. Net interest income at risk increased in each of the rising interest rate scenarios when compared to the December 31, 2010 risk position. Southwest’s greatest exposure to changes in interest rate is in the +200 bp scenario with a decline in net interest income of (4.98%) at March 31, 2011, a 2.21 percentage point decline from the December 31, 2010 level of (2.77%). All of the above measures of net interest income at risk remain well within prescribed policy limits.
The measures of equity value at risk indicate the ongoing economic value of Southwest by considering the effects of changes in interest rates on all of Southwest’s cash flows and discounting the cash flows to estimate the present value of assets and liabilities. The difference between these discounted values of the assets and liabilities is the economic value of equity, which, in theory, approximates the fair value of Southwest’s net assets.

37


 

                         
Changes in Interest Rates:   +300 bp   +200 bp   +100 bp
 
Policy Limit
    (35.00 )%     (20.00 )%     (10.00 )%
March 31, 2011
    (5.65 )%     (4.27 )%     (1.92 )%
December 31, 2010
    (2.15 )%     (1.35 )%     (0.47 )%
As of March 31, 2011, the economic value of equity measure declined in each of the three rising interest rate scenarios when compared to the December 31, 2010 percentages. Southwest’s largest economic value of equity exposure is the +300 bp scenario which declined 3.50 percentage points to (5.65%) at March 31, 2011 from the December 31, 2010 value of (2.15%). The economic value of equity ratio in all scenarios remains well within Southwest’s asset/liability management policy limits.
* * * * * * *
ITEM 4. CONTROLS AND PROCEDURES
Disclosure Controls and Procedures
As required by SEC rules, Southwest’s management evaluated the effectiveness of Southwest’s disclosure controls and procedures as of March 31, 2011. Southwest’s Chief Executive Officer and Chief Financial Officer participated in the evaluation. Based on this evaluation, Southwest’s Chief Executive Officer and Chief Financial Officer concluded that Southwest’s disclosure controls and procedures were effective as of March 31, 2011.
First Three Months of 2011 Changes in Internal Control over Financial Reporting
No change occurred during the first three months of 2011 that has materially affected, or is reasonably likely to materially affect, Southwest’s internal control over financial reporting.

38


 

PART II: OTHER INFORMATION
     
Item 1:  
Legal proceedings
   
 
   
None
   
 
Item 1A:  
Risk Factors
   
 
   
There were no material changes in risk factors during the first three months of 2011 from those disclosed in Southwest’s Form 10-K for the year ended December 31, 2010.
   
 
Item 2:  
Unregistered sales of equity securities and use of proceeds
   
 
   
There were no unregistered sales of equity securities by Southwest during the quarter ended March 31, 2011.
   
 
   
There were no purchases of Southwest’s common stock by or on behalf of Southwest or any affiliated purchasers of Southwest (as defined in Securities and Exchange Commission Rule 10b-18) during the three months ended March 31, 2011.
   
 
Item 3:  
Defaults upon senior securities
   
 
   
None
   
 
Item 4:  
(removed and reserved)
   
 
Item 5:  
Other information
   
 
   
Credit Management Restructure
   
 
   
Southwest has established a disciplined program to identify and resolve problem credits, as described elsewhere in this report. Still, Southwest is far from satisfied with the levels of problem and classified assets. After serious study, the Board of Directors and Management have decided to realign the executive management resources to provide maximum focus on the identification and resolution of problem and classified assets. Therefore, Southwest is pleased to announce that Jerry Lanier (age 62), Executive Vice President, will devote all of his attention to those tasks as the new Chief Resolution Officer. Jerry, who is a former National Bank Examiner with years of bank executive experience, will manage an expanded workout force and is ceding his other responsibilities as Chief Lending Officer to focus solely on resolutions. He joined Southwest in 1998.
   
 
   
To make this realignment immediately possible while ensuring continuity, Southwest has appointed experienced senior management to the positions of interim Chief Banking Officer (“CBO”) and interim Chief Credit Officer (“CCO”). Southwest has also retained an experienced executive search firm to help fill these positions on a permanent basis. Southwest is considering internal and external applications for the positions. The Board of Directors and Rick Green, President and CEO, are confident that each of the interim officers will do an excellent job.
   
 
   
The CBO is responsible for management of our commercial lending operations and commercial deposits, including responsibility for our commercial offices in Oklahoma and Texas. Our regional presidents in Oklahoma and Texas now report to the CBO. John Osborne (age 60), President of Oklahoma City Division, is interim CBO. He is a widely known and well respected, experienced commercial bank president, chief executive officer, and commercial lender with over 35 years of experience in the Oklahoma City market. He joined Southwest in 2007.
   
 
   
The CCO has responsibility for credit functions, including lending policy, credit analysis, credit approvals, risk rating accuracy, training, and workouts. Priscilla Barnes (age 54), Executive Vice President, Regulatory Risk Management, and Secretary, is interim CCO. Priscilla is an experienced banker with over

39


 

     
   
31 years of banking industry experience and is a former Federal Reserve Bank examiner. She has been with Southwest since 2005. The CBO and CCO both report directly to President and CEO, Rick Green.
   
 
   
Corrections of Certain Statement of Condition and Problem and Potential Problem Loan Data
   
 
   
This Quarterly Report on Form 10-Q includes corrected data regarding the derivative instrument, charge-offs, problem assets, troubled debt restructurings, nonaccrual loans, and potential problem loans as of and for the quarter ended March 31, 2011, which differ from and supersede data included in the Earnings Release dated April 19, 2011. These corrections had no effect on the statement of operations or earnings per common share for the first quarter of 2011.
   
 
   
The following tables present the corrected items.
                         
    As Previously           As
(Dollars in thousands)   Reported   Adjustment   Adjusted
 
Selected Balance Sheet Data
                       
Noncovered loans receivable
  $ 2,243,105     $ (2,025 )   $ 2,241,080  
Allowance for loan losses
    (63,310 )     2,025       (61,285 )
Other assets
    47,195       195       47,390  
Total assets
    2,778,833       195       2,779,028  
 
                       
Other liabilities
    7,471       1,026       8,497  
Subordinated debentures
    82,476       (513 )     81,963  
Total liabilities
    2,399,165       513       2,399,678  
 
                       
Accumulated other comprehensive income
    1,134       (318 )     816  
Total shareholder’s equity
    379,668       (318 )     379,350  
 
                       
Selected Unaudited Quarterly Summary Financial Data
                       
Per Share Data
                       
Book value per common share
    16.04       (0.02 )     16.62  
Tangible book value per share
    15.69       (0.02 )     15.67  
Loan Composition — Noncovered
                       
Real estate mortgage:
                       
Commercial
    1,302,254       (90 )     1,302,164  
One-to-four family residential
    87,324       (38 )     87,286  
Real estate construction: commercial
    403,954       (319 )     403,635  
Commercial
    417,970       (1,578 )     416,392  
Total noncovered loans, including held for sale
    2,280,453       (2,025 )     2,278,428  
Less allowance for loan losses
    (63,310 )     2,025       (61,285 )
 
                       
Loans by Segment
                       
Oklahoma banking
    838,464       (458 )     838,006  
Texas banking
    954,584       (1,461 )     953,123  
Other states banking
    226,489       (106 )     226,383  
Subtotal
    2,292,222       (2,025 )     2,290,197  
Total loans
    2,329,570       (2,025 )     2,327,545  

40


 

                         
    As Previously           As
(Dollars in thousands)   Reported   Adjustment   Adjusted
 
Selected Unaudited Quarterly Supplemental Analytical Data
                       
Nonperforming Assets — Noncovered
                       
Nonaccrual loans
    107,303       27,631       134,934  
Total nonperforming loans
    107,832       27,631       135,463  
Total nonperforming assets
    148,899       27,631       176,530  
 
Potential problem loans
    204,834       12,572       217,406  
 
                       
Allowance Activity
                       
Charege-offs
    11,367       2,025       13,392  
Net charge-offs
    10,969       2,025       12,994  
Balance, end of period
    63,310       (2,025 )     61,285  
 
                       
Asset Quality Ratios
                       
Net loan charge-offs to average portfolio loans (annualized)
    1.90 %     0.35 %     2.25 %
 
                       
Noncovered
                       
Nonperforming assets to portfolio loans and other real estate
    6.52       1.22       7.74  
Nonperforming loans to portfolio loans
    4.81       1.23       6.04  
Allowance for loan losses to portfolio loans
    2.82       (0.09 )     2.73  
Allowance for loan losses to nonperforming loans
    58.71       (13.47 )     45.24  
 
                       
Key and Capital Ratios
                       
Shareholders’ equity to total assets
    13.66       (0.01 )     13.65  
Tangible common equity to tangible assets
    11.00       (0.01 )     10.99  
 
                       
Regulatory Capital Data
                       
Total capital
  $ 478,736     $ (23 )   $ 478,713  
Total risk adjusted assets
    2,421,580       172       2,421,752  
         
Item 6:   Exhibits    
 
       
 
  Exhibit 31(a), (b)   Rule 13a-14(a)/15d-14(a) Certifications
 
  Exhibit 32(a), (b)   18 U.S.C. Section 1350 Certifications

41


 

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.
SOUTHWEST BANCORP, INC.
(Registrant)
                 
By:
    /s/ Rick Green
 
Rick Green
      May 10, 2011
 
Date
   
 
  President and Chief Executive Officer            
 
  (Principal Executive Officer)            
 
               
By:
    /s/ Laura Robertson
 
Laura Robertson
      May 10, 2011
 
Date
   
 
  Executive Vice President, Chief Financial Officer            
 
  (Principal Financial Officer)            

42