ITEM 1 -- BUSINESS
GENERAL
Sterling Bancshares, Inc. (the "Company"), headquartered in Houston, Texas, is a bank holding company that provides commercial and retail banking services primarily in the Houston metropolitan area through the banking offices of Sterling Bank, a banking association chartered under the laws of the State of Texas (the "Bank"). The Company also provides mortgage banking services through its 80 percent owned subsidiary, Sterling Capital Mortgage Company ("SCMC").
The Company's principal executive offices are located at 15000 Northwest Freeway, Houston, Texas, 77040 and its telephone number is (713) 466-8300. The Company was incorporated under the laws of the State of Texas in 1980 and became the parent bank holding company of Sterling Bank in 1981. Sterling Bank was chartered in 1974. The Company completed its initial public offering on October 22, 1992.
The Company had approximately 743 and 351 full time equivalent employees, including 189 and 36 officers, in its commercial banking and mortgage banking segments, respectively, as of December 31, 2000. At December 31, 2000, the Company had total assets of $1.9 billion, deposits of $1.6 billion, and shareholders' equity of $159.1 million.
The Company has two operating segments: commercial banking and mortgage banking. The segments are managed separately as they require different marketing strategies and offer different products and services. See Note T to the Consolidated Financial Statements for summarized financial information by operating segment.
COMMERCIAL BANKING
The Bank provides a wide range of retail and commercial banking services, including demand, savings and time deposits; commercial, real estate and consumer loans; merchant credit card services; letters of credit; and cash and asset management services. In addition, the Bank facilitates sales of brokerage, mutual fund, and insurance products. The deposits of the Bank are insured by the Bank Insurance Fund ("BIF") of the Federal Deposit Insurance Corporation ("FDIC").
The primary lending focus of the Bank is on commercial loans and owner-occupied real estate loans to local businesses with annual sales ranging from $300,000 to $30 million. Typically, the Bank's customers have financing requirements between $50,000 and $500,000. The Bank does not seek loans of more than $2 million but will consider larger lending relationships which involve exceptional levels of credit quality. The Bank's credit range, while well below its legal lending limit of $20 million, allows for greater diversity in the loan portfolio, less competition from large banks, and better pricing opportunities.
BUSINESS BANKING STRATEGY. Under its business banking strategy, the Bank focuses on a broad line of financial products and services to small and medium-sized businesses through full service banking offices. Each banking office has senior management with extensive lending experience. These managers exercise substantial authority over credit and pricing decisions, subject to loan committee approval for larger credits. This decentralized management approach, coupled with continuity of service by the same staff members, enables the Bank to develop long-term customer relationships, maintain high quality service and respond quickly to customer needs. The Company believes that its emphasis on local relationship banking, together with a conservative approach to lending, are important factors in the success and growth of the Bank.
The Company and the Bank have maintained a strong community orientation by, among other things, supporting the active participation of staff members in local charitable, civic, school, religious and community development activities. Each banking office may also appoint selected customers to a business development board that assists in introducing prospective customers to the Bank and in developing or improving products and services to meet customer needs. As a result of the development of broad banking relationships with customers and the
convenience and service of the Company's twenty-four banking offices, lending and investing activities are funded primarily by core deposits, over one-third of which are noninterest bearing demand deposits.
The Bank centralizes operational and support functions that are transparent to customers in order to achieve consistency and cost efficiencies in the delivery of products and services by each banking office. The central office provides services such as data processing, bookkeeping, accounting, treasury management, loan administration, loan review, compliance, risk management, and internal auditing to enhance their delivery of quality service. The Company also provides overall direction in the areas of credit policy and administration, strategic planning, marketing, investment portfolio management, and other financial and administrative services. The banking offices work closely with the Company to develop new products and services needed by their customers and to introduce enhancements to existing products and services.
MORTGAGE BANKING
The Company originates, sells and services single family residential mortgages through its 80 percent ownership of SCMC. SCMC has production offices in Texas and nine other states, with corporate offices in Houston, Texas and Seattle, Washington. The typical mortgage originated by SCMC is approximately $110,000. A substantial portion of SCMC's loan production is generated through joint ventures known as affiliated business arrangements with established home builders and realtor-based organizations. SCMC is an approved Government National Mortgage Association ("GNMA") issuer of mortgage-backed securities. SCMC is also an approved Federal National Mortgage Association ("FNMA") and Federal Home Loan Mortgage Corporation ("FHLMC") seller/servicer and a HUD- Approved Title II nonsupervised mortgagee. During 2000, SCMC funded approximately $1.4 billion in residential mortgage loans.
EXPANSION
The Company's growth strategy has been concentrated on increasing its banking presence in the greater Houston area and on entering both the Dallas and San Antonio markets. The Company has grown through a combination of internal growth, mergers and acquisitions, and the opening of new banking offices.
DE NOVO OFFICES. In December 2000, the Company opened a new banking office in Dallas. This is the Company's first office outside of the Houston market.
In April 2000, the Company opened a new banking office in Bellaire. In conjunction with the opening of this office, the Company's Board designated 50,000 shares of Series H convertible preferred stock and authorized the offering and sale of such shares to investors who may assist in the business development efforts of the office. A total of 39,000 of the preferred shares were actually sold. These preferred shares will be convertible into a maximum of 48,750 shares of the Company's common stock. The conversion ratio is dependent upon the Bellaire office meeting certain performance goals.
On May 13, 1998, the Company opened its seventeenth banking office in Fort Bend County. In conjunction with the opening of this office, in April 1998, the Company's Board designated two additional series of convertible preferred stock consisting of 30,000 shares of Series F convertible preferred stock and 50,000 shares of Series G convertible preferred stock. Shares of Series F and Series G convertible preferred stock were offered and a total of 61,500 shares were sold to prospective investors whom the Company believes will be helpful in the development of the office. In September 2000, the Series G convertible preferred stock was converted into 45,000 shares of the Company's common stock. The currently outstanding 1,000 shares of Series F convertible preferred stock will automatically convert into 1,000 shares of common stock on May 18, 2001.
In January 1998, the Company opened a new banking office on Spencer Highway in Pasadena. In conjunction with the opening of this office, the Company's Board designated 50,000 shares of Series E convertible preferred stock and authorized the offering and sale of such shares to investors who may assist in the business
development efforts of the office. A total of 27,000 of the preferred shares were actually sold. In February 2000, these preferred shares were converted into 33,750 shares of the Company's common stock as a result of the Spencer Highway office achieving meeting certain performance goals.
MERGERS AND ACQUISITIONS. On March 22, 2001, the Company acquired CaminoReal Bancshares of Texas, Inc. ("CaminoReal") and its subsidiary bank, CaminoReal Bank, National Association, for an aggregate cash purchase price of $51.8 million. CaminoReal Bank has four banking offices in San Antonio, Texas and four banking offices in the south Texas cities of Eagle Pass, Carrizo Springs, Crystal City and Pearsall. The Company anticipates completing operational integration of CaminoReal Bank and Sterling Bank in the second quarter of 2001.
On March 1, 2001, the Company entered a definitive agreement to acquire Lone Star Bancorporation, Inc. and its subsidiary bank, Lone Star Bank, headquartered in Houston, Texas. The Company will issue approximately 1.76 million shares of its common stock to the shareholders of Lone Star Bancorporation and assume up to $2 million in indebtedness. The merger is subject to customary closing conditions including (i) the qualification of the transaction for pooling of accounting treatment and the Company's receipt of an opinion of Lone Star Bancorporation's accountants satisfactory to the Company confirming the availability of pooling of accounting, (ii) receipt of necessary regulatory approvals and consents from applicable regulatory agencies, which approvals may not impose conditions or restrictions that would, in the Company's good faith judgment, adversely impact the transaction, and (iii) approval of the shareholders of Lone Star Bancorporation. Lone Star Bancorporation is privately held and is the bank holding company of Lone Star Bank, which operates four banking offices in the Houston metropolitan area. As of December 31, 2000, Lone Star Bank had total assets of $152 million, loans of $117 million and deposits of $141 million.
On June 1, 1999, the Company acquired B.O.A. Bancshares, Inc. ("B.O.A.") and its subsidiary Houston Commerce Bank in exchange for 1,854,600 shares of the Company's common stock. The acquisition of B.O.A. added $115 million in total assets and $103 million in total deposits to the Company's balance sheet. Houston Commerce Bank operated three locations in Houston. During October 1999, the Company merged Houston Commerce Bank into Sterling Bank.
On November 20, 1998, the Company acquired Hometown Bancshares, Inc. ("Hometown"), which was the bank holding company for Clear Lake National Bank, in a stock-for-stock merger. The acquisition of Hometown added $92 million in total assets and $84 million in total deposits to the Company's balance sheet. Clear Lake National Bank operated two locations in the Clear Lake area of southeast Houston. During April 1999, the Company merged Clear Lake National Bank into Sterling Bank.
On June 30, 1998, Humble National Bank ("Humble") was acquired by the Company in a stock-for-stock merger. The acquisition of Humble added $54 million in total assets and $49 million in total deposits to the Company's balance sheet. Humble operated a full service banking office in the Humble area of northeast Houston. During August 1998, the Company merged Humble into Sterling Bank.
The Company will continue to seek acquisition and new office opportunities when available and consistent with its business banking philosophy. To accommodate further growth, the Company will continue to upgrade its central office data processing and telecommunication systems and facilities to provide the Company with the technological capacity necessary to meet the needs and expectations of its customers.
COMPETITION
The Company engages in highly competitive activities. Each activity and market served involves competition with other banks and mortgage companies, as well as with non-banking and non-financial enterprises that offer financial products and services that compete directly with the Company's product and service offerings. The Company actively competes with other banks, mortgage companies and other financial service companies in its efforts to obtain deposits and make loans, in the scope and types of services offered, in interest rates paid on time deposits and charged on loans, and in other aspects of banking.
In addition to competing with other banks and mortgage companies, the Company competes with other financial institutions engaged in the business of making loans or accepting deposits, such as savings and loan associations, credit unions, industrial loan associations, insurance companies, small loan companies, finance companies, real estate investment trusts, certain governmental agencies, credit card organizations and other enterprises. In recent years, competition for money market accounts from securities brokers has also intensified. Additional competition for deposits comes from government and private issues of debt obligations and other investment alternatives for depositors such as money market funds. The Bank also competes with a variety of other institutions in providing brokerage services.
SUPERVISION AND REGULATION
References herein to applicable statutes and regulations are brief summaries, do not purport to be complete and are qualified in their entirety by reference to such statutes and regulations.
THE BANK HOLDING COMPANY
The Company and its second tier holding company, Sterling Bancorporation, Inc., are bank holding companies registered under the Bank Holding Company Act of 1956, as amended ("BHCA"), and are subject to supervision and regulation by the Federal Reserve Board. Federal laws subject bank holding companies to particular restrictions on the types of activities in which they engage, and to a range of supervisory requirements and activities, including regulatory enforcement actions for violations of laws and policies. In addition, Texas law authorizes the Texas Department of Banking to supervise and regulate a holding company controlling a state bank.
PERMISSIBLE ACTIVITIES
As a bank holding company, the activities of the Company, as well as the activities of entities which are controlled by the Company or of which the Company owns 5% or more of the voting securities, are limited by the BHCA to banking, management and control of banks, furnishing or performing services for its subsidiaries, or any other activity which the Federal Reserve Board determines to be incidental or closely related to banking or managing or controlling banks. The recently enacted Gramm-Leach-Bliley Act, however, amended the BHCA and granted certain expanded powers to bank holding companies. See discussion below under "Recently Enacted Legislative and Regulatory Changes." In approving acquisitions by the Company of entities engaged in banking-related activities, the Federal Reserve Board considers a number of factors, including the expected benefits to the public, such as greater convenience and increased competition or gains in efficiency, which are weighted against the risks of possible adverse effects, such as an attempt to monopolize the business of banking, undue concentration of resources, decreased or unfair competition, conflicts of interest, or unsound banking practices.
MORTGAGE COMPANY
SCMC is an approved GNMA issuer of mortgage-backed securities. SCMC is also an approved FNMA and FHLMC seller/servicer and a HUD-Approved Title II nonsupervised mortgagee. As such, SCMC must operate under certain guidelines set forth by GNMA, FNMA, FHLMC and HUD. As a majority owned subsidiary of a bank holding company, SCMC is also subject to the regulatory authority of the FDIC, the Texas Department of Banking and the Federal Reserve Board.
NON-BANKING ACTIVITIES
The BHCA sets forth exceptions to its general prohibition against bank holding company ownership of voting shares in any company engaged in non-banking activities. The exceptions include certain activities exempt based upon the type of activity and those determined by the Federal Reserve Board to be closely related to banking or managing or controlling banks. The Economic Growth and Regulatory Paperwork Reduction Act of 1996 ("EGRPRA"), streamlined the non- banking activities application process for bank holding companies which qualify as well-capitalized and well-managed. Also, see discussion of the Gramm-Leach- Bliley Act, which amends certain portions of the BHCA, under the "Recently Enacted Legislative and Regulatory Changes" caption below.
RECENTLY ENACTED LEGISLATIVE AND REGULATORY CHANGES
The Gramm-Leach-Bliley ("G-L-B") Act, which became effective in 2000, authorizes affiliations between banking, securities and insurance firms and authorizes bank holding companies and state banks, if permitted by state law, to engage in a variety of new financial activities. Bank holding companies may also elect to become financial holding companies if they meet certain requirements relating to capitalization and management and
have filed a declaration with the Federal Reserve Board electing to be a financial holding company. Among the new activities that will be permitted by bank holding companies are securities and insurance brokerage, securities underwriting, insurance underwriting and merchant banking. The Federal Reserve Board, in consultation with the Department of Treasury, may approve additional financial activities.
The G-L-B Act also imposes new requirements on financial institutions with respect to customer privacy. The G-L-B Act generally prohibits disclosure of customer information to non-affiliated third parties unless the customer has been given the opportunity to object and has not objected to such disclosure. Financial institutions are further required to disclose their privacy policies to customers annually. Financial institutions, however, will be required to comply with state law if it is more protective of customer privacy than the G-L- B Act. The privacy provisions will become effective on July 1, 2001.
The G-L-B Act contains a variety of other provisions including a prohibition against ATM surcharges unless the customer has first been provided notice of the imposition and amount of the fee.
The Company has not filed on election to be a financial holding company. At this time, the Company is unable to predict the impact of the authorized affiliations and new financial activities permitted by the G-L-B Act on its operations. The Company is actively addressing the customer privacy requirements of the G-L-B Act and fully expects to be in compliance on the effective date.
SAFETY AND SOUNDNESS STANDARDS
The Financial Institutions Reform, Recovery and Enforcement Act of 1989 ("FIRREA") expanded the Federal Reserve Board's authority to prohibit activities of bank holding companies and their non-banking subsidiaries which represent unsafe and unsound banking practices or which constitute violations of laws or regulations. Notably, FIRREA increased the amount of civil money penalties that the Federal Reserve Board can assess for certain activities conducted on a knowing and reckless basis, if those activities cause a substantial loss to a depository institution. The penalties can be as high as $1 million per day. FIRREA also expanded the scope of individuals and entities against which such penalties may be assessed.
On July 10, 1995, the four federal agencies that regulate banks and savings associations (FDIC, Federal Reserve Board, the Office of the Comptroller of the Currency and the Office of Thrift Supervision) jointly issued guidelines for safe and sound banking operations (Interagency Guidelines Establishing Standards for Safety and Soundness) as required by Section 132 of the Federal Deposit Insurance Corporation Improvement Act ("FDICIA"). The guidelines identify the fundamental standards that the four agencies follow when evaluating the operational and managerial controls at insured institutions. An institution's performance will be evaluated against these standards during the regulators' periodic on-site examinations.
DIVIDEND RESTRICTIONS
It is the policy of the Federal Reserve Board that bank holding companies should pay cash dividends on common stock only out of income available over the past year and only if prospective earnings retention is consistent with the organization's expected future needs and financial condition. The policy provides that bank holding companies should not maintain a level of cash dividends that undermines the bank holding company's ability to serve as a source of strength to its banking subsidiaries.
Under Federal Reserve Board policy, a bank holding company is expected to act as a source of financial strength to each of its banking subsidiaries and commit resources to their support. Such support may be required at times when, absent this Federal Reserve Board policy, a bank holding company may not be inclined to provide it.
CAPITAL ADEQUACY REQUIREMENTS
The Bank is subject to the capital adequacy requirements promulgated by the FDIC and the Texas Department of Banking. In addition, the Federal Reserve Board monitors the capital adequacy of bank holding companies.
The Federal Reserve Board has adopted a system using risk-based capital adequacy guidelines to evaluate the capital adequacy of bank holding companies. Under the risk-based capital guidelines, different categories of assets are assigned different risk weights, based generally on the perceived credit risk of the asset. These risk weights are multiplied by corresponding asset balances to determine a "risk-related" asset base. Certain off balance sheet items are added to the risk-weighted asset base by converting them to a balance sheet equivalent and assigning to them the appropriate risk weight. In addition, the guidelines define each of the capital components. Total capital is defined as the sum of "core capital elements" ("Tier 1") and "supplemental capital elements" ("Tier 2"), with "Tier 2" being limited to 100% of "Tier 1." For bank holding companies, "Tier 1" capital includes, with certain restrictions, common shareholders' equity, perpetual preferred stock, and minority interest in consolidated subsidiaries. "Tier 2" capital includes, with certain limitations, certain forms of perpetual preferred stock, as well as maturing capital instruments and the reserve for credit losses. The guidelines require achievement of a minimum ratio of total capital-to-risk-weighted assets of 8.0% (of which at least 4.0% is required to be comprised of "Tier 1" capital elements). At December 31, 2000, the Company's ratios of "Tier 1" and "Total" capital-to-risk-weighted assets were 10.78%, and 11.51%, respectively.
In addition to the risk-based capital guidelines, the Federal Reserve Board and the FDIC have adopted the use of a minimum "Tier 1" leverage ratio as an additional tool to evaluate the capital adequacy of banks and bank holding companies. The banking organization's "Tier 1" leverage ratio is defined to be a company's "Tier 1" capital divided by its average total consolidated assets. The leverage ratio adopted by the federal banking agencies requires a minimum 3.0% "Tier 1" capital to total assets ratio for institutions with the highest regulatory rating. All other institutions will be expected to maintain a leverage ratio of 4.0% to 5.0%. The Company's leverage ratio at December 31, 2000 of 9.39% significantly exceeded the regulatory minimum.
IMPOSITION OF LIABILITY FOR UNDERCAPITALIZED SUBSIDIARIES
A bank holding company that fails to meet the applicable risk-based capital standards will be at a disadvantage. For example, Federal Reserve Board policy discourages the payment of dividends by a bank holding company from borrowed funds as well as payments that would adversely affect capital adequacy. Failure to meet the capital guidelines may result in the institution of supervisory or enforcement actions by the Federal Reserve Board. FDICIA requires bank regulators to take "prompt corrective action" to resolve problems associated with insured depository institutions whose capital declines below certain levels.
AUDIT REPORTS
The regulations promulgated by the FDIC to implement FDICIA subjects depository institutions with assets of $500 million or more to certain audit and reporting requirements. FDICIA requires insured institutions to submit annual audit reports prepared by independent auditors to federal and state regulators. The audit report of the institution's holding company can be used to satisfy this requirement. Auditors must apply procedures agreed to by the FDIC to determine compliance by the institution or holding company with legal requirements designated by FDICIA. The annual audit report must include financial statements prepared in accordance with generally accepted accounting principles, statements concerning management's responsibility for the financial statements and internal controls designated by the FDIC, and an attestation by the auditor regarding the statements of management. For certain large institutions, independent auditors may be required to review quarterly financial statements. FDICIA requires that independent audit committees be formed, consisting solely of outside directors. The Company has an audit committee comprised of outside directors with at least one certified public accountant and, therefore, is in compliance with the requirements for large institutions.
ACQUISITIONS BY BANK HOLDING COMPANIES
The BHCA requires a bank holding company to obtain the prior approval of the Federal Reserve Board before it acquires all or substantially all of the assets of any bank, or ownership or control of any voting shares of any bank, if after such acquisition it would own or control, directly or indirectly, more that 5% of the voting shares of such bank. In approving bank acquisitions, the Federal Reserve Board considers the financial and managerial resources and future prospects of the bank holding company and the banks concerned, the convenience and needs of the communities to be served, and various competitive factors. The Attorney General of the United
States may, within 30 days after approval of an acquisition by the Federal Reserve Board, bring an action challenging such acquisition under the federal antitrust laws, in which case the effectiveness of such approval is stayed pending a final ruling by the courts.
COMMUNITY REINVESTMENT ACT
The Community Reinvestment Act of 1977 ("CRA") and the regulations promulgated by the FDIC to implement CRA are intended to ensure that banks meet the credit needs of their service area, including low and moderate income communities and individuals, consistent with safe and sound banking practices. In 1995, the bank regulatory agencies adopted final regulations for implementing CRA. The CRA regulations also require the banking regulatory authorities to evaluate a bank's record in meeting the needs of its service area when considering applications to establish new offices or consummate any merger or acquisition transaction. Under FIRREA, the federal banking agencies are required to rate each insured institution's performance under CRA and to make such information publicly available. In the case of an acquisition by a bank holding company, the CRA performance records of the banks involved in the transaction are reviewed as part of the processing of the acquisition application. A CRA rating other than `outstanding' or `satisfactory' can substantially delay or block a transaction. Based upon its most recent examination, Sterling Bank has a satisfactory CRA rating.
INTERSTATE BANKING
The Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 (the "Interstate Branching Act") increased the ease and likelihood of interstate branching throughout much of the United States. The Interstate Branching Act removes state law barriers to acquisitions in all states and allows multi-state banking operations to merge into a single bank with interstate branches. Interstate banking and branching authority will be subject to certain conditions and restrictions, such as capital adequacy, management and CRA compliance. The Interstate Branching Act preempts existing barriers that restrict entry into all states, such as regional compacts and reciprocity agreements, thus creating opportunities for expansion into markets that were previously closed. Under the Interstate Branching Act, bank holding companies are now able to acquire banks in any state, subject to certain conditions. Banks acquired pursuant to this authority may subsequently be converted to branches. Interstate branching is permitted by allowing banks to merge across state lines to form a single institution. Interstate merger transactions can be used to consolidate existing multi-state operations or to acquire new branches. A bank may establish a new branch as its initial entry into a state only if the state has authorized de novo branching. In addition, out-of-state banks may merge with a single branch of a bank if the state has authorized such a transaction. The Federal Reserve Board, however, will only allow the acquisition by a bank holding company of an interest in any bank located in another state if the statutory laws of the state in which the target bank is located expressly authorize such acquisitions. The interstate branching provisions became effective on June 1, 1997, unless a state took action before that time. Texas elected to "opt out" of the Interstate Branching Act. Despite Texas' having opted out of the Interstate Branching Act, the Texas Banking Act permits, in certain circumstances, out-of-state bank holding companies to acquire certain existing banks and bank holding companies in Texas.
STERLING BANK
Sterling Bank is a Texas-chartered banking association. The Bank's deposits are insured by the FDIC. Therefore, the Bank is subject to supervision and regulation by both the Texas Department of Banking and the FDIC. Pursuant to such regulation, the Bank is subject to special restrictions, supervisory requirements and potential enforcement actions. Sterling Bank is not a member of the Federal Reserve System; however, the Federal Reserve Board also has supervisory authority that directly affects the Bank. Sterling Bank is a member of the Federal Home Loan Bank and, therefore, is also subject to compliance with its requirements.
PERMISSIBLE ACTIVITIES FOR STATE-CHARTERED INSTITUTIONS
The Texas Constitution provides that a Texas-chartered bank has the same rights and privileges that are or may be granted to national banks domiciled in Texas. FDICIA provides that no state bank or subsidiary thereof may engage as principal in any activity not permitted for national banks, unless the institution complies with
applicable capital requirements and the FDIC determines that the activity poses no significant risk to the Bank Insurance Fund ("BIF").
Branching
Texas law provides that a Texas-chartered bank can establish a branch anywhere in Texas provided that the branch is approved in advance by the Commissioner of the Texas Department of Banking (the "Commissioner"). The branch must also be approved by the FDIC, which considers a number of factors, including financial history, capital adequacy, earnings prospects, character of management, needs of the community, and consistency with corporate powers. There are no federal limitations on the ability of insured non-member state banks to branch across state lines; however, such branching would be subject to applicable state law restrictions.
Restrictions on Subsidiary Banks
Dividends paid by the Bank are the primary source of the Company's cash flow. Although the Bank elected in August 1997 to temporarily suspend the payment of dividends to the Company and to use the proceeds from the issuance of $28.75 million of trust preferred securities by Sterling Bancshares Capital Trust I to meet the Company's current cash flow needs, the Bank is expected to provide substantially all of the Company's cash flow in the foreseeable future. Under federal law, the Bank may not pay a dividend that results in an "undercapitalized" situation. At December 31, 2000, there was an aggregate of approximately $72.5 million available for the payment of dividends by the Bank to the Company without prior regulatory approval.
Other requirements in Texas law affecting the operation of subsidiary banks include requirements relating to maintenance of reserves against deposits, restrictions on the nature and amount of loans that may be made and the interest that may be charged thereon and limitations relating to investments and other activities.
Examinations
The FDIC periodically examines and evaluates insured banks. FDIC examinations are conducted every 12 months. The FDIC may, however, accept the result of a Texas Department of Banking examination in lieu of conducting an independent examination. FDICIA authorizes the FDIC to assess the institution for its costs of conducting the examinations.
The Commissioner also conducts examinations annually, unless additional examinations are deemed necessary to safeguard the interests of shareholders, depositors and creditors. The Commissioner may accept the results of a federal examination in lieu of conducting an independent examination. However, since the total assets of the Bank exceed $1 billion, the FDIC and the Texas Department of Banking jointly examine the Bank on an annual basis.
Deposit Insurance Assessments
The FDIC assesses deposit insurance premiums on all banks in order to adequately fund the BIF so as to resolve any insured institution that is declared insolvent by its primary regulator. The FDIC has established a risk-based deposit insurance premium system to calculate a depository institution's semi-annual deposit insurance assessment. The FDIC's semi-annual assessment is based upon the designated reserve ratio for the deposit insurance fund and the probability and extent to which the deposit insurance fund will incur a loss with respect to the institution. In addition, the FDIC can impose special assessments to cover the cost of borrowings from the U.S. Treasury, the Federal Financing Bank, and BIF member banks.
The FDIC established a process for raising or lowering all rates for insured institutions semi-annually if conditions warrant a change. Under this new system, the FDIC has the flexibility to adjust the assessment rate schedule twice a year without seeking prior public comment, but only within a range of five cents per $100 above or below the premium schedule adopted. The FDIC can make changes in the rate schedule outside the five-cent range above or below the current schedule only after a full rulemaking with opportunity for public comment.
On September 30, 1996, then President Clinton signed into law an act that contained a comprehensive approach to recapitalizing the Savings Association Insurance Fund ("SAIF") and to assure the payment of the Financing Corporation's ("FICO") bond obligations. Under this act, banks insured under the BIF are required to pay a portion of the interest due on bonds that were issued by FICO to help shore up the ailing Federal Savings and Loan Insurance Corporation in 1987. With regard to the assessment for the FICO obligation, the current BIF and SAIF rate is .0196% of deposits.
Expanding Enforcement Authority
One of the major additional impacts imposed on the banking industry by FDICIA is the increased ability of banking regulators to monitor the activities of banks and their holding companies. In addition, the Federal Reserve Board and FDIC have extensive authority to police unsafe or unsound practices and violations of applicable laws and regulations by depository institutions and their holding companies. For example, the FDIC may terminate the deposit insurance of any institution which it determines has engaged in an unsafe or unsound practice. The agencies can also assess civil money penalties, issue cease and desist or removal orders, seek injunctions, and publicly disclose such actions. FDICIA, FIRREA and other laws have expanded the agencies' authority in recent years, and the agencies have not yet fully tested the limits of their powers.
Effect on Economic Environment
The policies of regulatory authorities, including the monetary policy of the Federal Reserve Board, have a significant effect on the operating results of bank holding companies and their subsidiaries. Among the means available to the Federal Reserve Board to affect the money supply are open market operations in U.S. government securities, changes in the discount rate on member bank borrowings, and changes in reserve requirements against member bank deposits. These means are used in varying combinations to influence overall growth and distribution of bank loans, investments and deposits, and their use may affect interest rates charged on loans or paid for deposits.
Federal Reserve Board monetary policies have materially affected the operating results of commercial banks in the past and are expected to continue to do so in the future. The nature of future monetary policies and the effect of such policies on the business and earnings of the Company and its subsidiaries cannot be predicted.
Consumer Laws and Regulations
In addition to the banking laws and regulations discussed above, banks are also subject to certain consumer laws and regulations that are designed to protect consumers in transactions with banks. Among the more prominent of such laws and regulations are the Truth in Lending Act, the Truth in Savings Act, the Electronic Funds Transfer Act, the Expedited Funds Availability Act, the Equal Credit Opportunity Act, the Fair Credit Reporting Act, and the Fair Housing Act. These laws and regulations mandate certain disclosure requirements and regulate the manner in which financial institutions must deal with customers when taking deposits or making loans to such customers. The Bank must comply with the applicable provisions of these consumer protection laws and regulations as part of their ongoing customer relations. Also, see discussion of the consumer privacy protection provision of the Gramm-Leach-Bliley Act under the "Recently Enacted Legislative and Regulatory Changes" caption above.
ITEM 2
ITEM 2 -- PROPERTIES
The principal executive offices of the Company and the Bank, as well as the Company's management information systems, are located at 15000 Northwest Freeway, Houston, Texas, 77040, in a building owned by the Bank. In addition to its principal office, the Company operates the following locations:
ITEM 3
ITEM 3 -- LEGAL PROCEEDINGS
Neither the Company nor any of its subsidiaries is presently involved in any material legal proceedings.
ITEM 4
ITEM 4 -- SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
PART -- II
ITEM 5
ITEM 5 -- MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED SHAREHOLDER MATTERS
The Company's stock trades through the NASDAQ Stock Market under the symbol SBIB. The following table sets forth the high and low closing stock prices of the Company's common stock, as quoted on the NASDAQ Stock Market, and the dividends paid thereon for each quarter of the last two fiscal years. This information has been restated to reflect all stock splits occurring prior to the issuance of this report.
On January 22, 2001, the Company's Board of Directors declared a quarterly cash dividend of $0.055 per share payable on February 17, 2001, to shareholders of record on February 2, 2001. The Company intends to continue to pay a dividend at the rate of $0.055 per share quarterly throughout 2001.
On January 24, 2000, the Company's Board of Directors declared a quarterly cash dividend of $0.050 per share payable on February 24, 2000, to shareholders of record on February 10, 2000.
On January 25, 1999, the Company's Board of Directors declared a quarterly cash dividend of $0.045 per share payable on February 22, 1999, to shareholders of record on February 5, 1999.
On January 26, 1998, the Company's Board of Directors declared a three-for-two stock split (effected as a 50% stock dividend) of the Company's common stock distributed on February 20, 1998, to shareholders of record on February 6, 1998. Concurrently with the 1998 stock split, the Company declared a quarterly $0.04 cash dividend per share (computed on an "after-split" basis) payable on February 20, 1998, to shareholders of record on February 6, 1998.
As of February 2, 2001, there were 853 shareholders of record of common stock. The number of beneficial shareholders is unknown to the Company at this time.
In April 2000, the Company issued 39,000 shares of its Series H convertible preferred stock in a private offering exempt from registration pursuant to Section 4(2) of the Securities Act of 1933. The shares of Series H convertible preferred stock were sold at $9.875 per share for an aggregate offering of $385,125. The shares of the Series H convertible preferred stock are convertible into common stock dependent upon the Company's Bellaire banking office meeting certain performance goals. The conversion ratio ranges from 1.25 shares of common stock if the performance goals are met prior to April 3, 2002 to 1.1 shares of common stock if the performance goals are met prior to April 3, 2003. After April 3, 2003, each share of Series H convertible preferred stock will automatically convert into one share of common stock.
DESCRIPTION OF CAPITAL STOCK
AUTHORIZED CAPITAL STOCK
The authorized capital stock of the Company consists of (i) 50,000,000 shares of Common Stock, $1.00 per share par value, of which 26,230,607 shares were issued and outstanding as of December 31, 2000 and (ii) 1,000,000 shares of Preferred Stock, $1.00 per share par value ("Preferred Stock"), issuable in series, of which 11,500 shares of Series F and 39,000 shares of Series H Convertible Preferred Stock were issued and outstanding as of December 31, 2000. All prior series of Preferred Stock have been converted into shares of common stock in accordance with the relative rights and preferences of each such series. As of December 31,
2000, an additional 588,496 shares of Common Stock were issuable upon exercise of the Company's vested outstanding employee stock options and pursuant to outstanding subscriptions under the Company's Employee Stock Purchase Plan.
The following discussion of the terms and provisions of the Company's capital stock is qualified in its entirety by reference to the Company's Articles of Incorporation and Bylaws, which were previously filed as exhibits.
COMMON STOCK
All outstanding shares of Common Stock are fully paid and nonassessable. There are no preemptive, conversion, subscription, redemption or repurchase rights associated with shares of Common Stock, except as exist under the 1994 Incentive Stock Option Plan and the 1994 Employee Stock Purchase Plan. Each holder of shares of Common Stock is entitled to one vote for each share held of record as to all matters requiring a shareholder vote. Holders of shares of Common Stock are not entitled to cumulative voting rights in the election of directors. Upon the dissolution of the Company, the holders of Common Stock would be entitled to participate ratably in the assets available for distribution after satisfaction of the claims of creditors of the Company and of holders of any series of Preferred Stock having a liquidation preference, to the extent of such preference.
The holders of shares of the Common Stock are entitled to such dividends as the Board of Directors, in its discretion, may declare out of funds legally available therefor. Under the Texas Business Corporation Act, as amended (the "TBCA"), dividends may not be paid if, after the payment, the Company's total assets would be less than the sum of its total debts and stated capital, or if the Company would be unable to pay its debts as they become due in the usual course of its business. There can be no assurances such dividends will continue to be paid in the future. Payment of future dividends will be dependent upon, among other things, the Company's and the Bank's earnings and financial condition, and the general economic and regulatory climate.
Funds for the payment of dividends by the Company are obtained primarily from dividends received from the Bank. Certain restrictions exist regarding the ability of the Bank to pay dividends to the Company. Under federal law, the Bank cannot pay a dividend if it will cause the Bank to be "undercapitalized." The regulators of the Bank and the Company may administratively impose stricter limits on the ability of the Bank to pay dividends to the Company.
The Bank is also subject to risk based capital rules that restrict its ability to pay dividends. The risk based capital rules set an explicit schedule for achieving minimum capital levels in relation to risk weighted assets. The Bank has been required to meet a minimum ratio of total capital to risk weighted assets of 8.0%. As of December 31, 2000, the Bank was in compliance with all capital requirements.
American Stock Transfer & Trust Company presently serves as the transfer agent and registrar for the Common Stock.
PREFERRED STOCK
The Board, without any further action by the shareholders but subject to limits contained in the Articles of Incorporation, is authorized to issue up to 1,000,000 shares of Preferred Stock, in one or more series. The Board may fix by resolution the terms of a series of Preferred Stock, such as: dividend rates and preference of dividends, if any; conversion rights; voting rights; terms of redemption and liquidation preferences; and, the number of shares constituting each such series.
Holders of Preferred Stock have no right or power to vote on any matter except as otherwise as required by law in which case they are entitled to one vote for each share of Preferred Stock held. Upon the Company's dissolution, liquidation or winding up, the holders of shares of Preferred Stock are entitled to receive out of the Company's assets an amount per share equal to the respective liquidation preference before any payment or distribution is made on the Common Stock or any other class of capital stock that ranks junior to the particular series of Preferred Stock. All outstanding series of Preferred Stock rank equal. If the Company's assets available for distribution upon dissolution, liquidation or winding up are insufficient to pay in full the liquidation preference payable to the holders of shares of all series of Preferred Stock, distributions are to be made proportionately on all outstanding shares of Preferred Stock.
ITEM 6
ITEM 6 -- SELECTED FINANCIAL DATA
The following table sets forth summary historical data for the Company for the periods indicated. The stock-for-stock bank mergers that have been consummated by the Company during the reported periods were all accounted for using the "pooling of interests" method. As such, all data prior to the respective mergers have been restated to include the merged entities' balance sheet data and historical results of operations. In addition, data has been restated to reflect the effect of stock splits where applicable.
ITEM 7
ITEM 7 -- MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
"Management's Discussion and Analysis of Financial Condition and Results of Operations" of the Company analyzes the major elements of the Company's consolidated balance sheets and statements of income. This section should be read in conjunction with the Company's consolidated financial statements and accompanying notes and other detailed information incorporated by reference. The stock-for-stock bank mergers that have been consummated by the Company during the reported periods were all accounted for using the "pooling of interests" method. As such, all data prior to the respective mergers have been restated to include the merged entities' balance sheet data and historical results of operations.
RESULTS OF OPERATIONS
PERFORMANCE SUMMARY
Net income for 2000 was $26.6 million, an increase of $5.2 million, or 24.1% over the $21.4 million recorded for 1999. Net income of $21.4 million in 1999 increased $3.1 million, or 17.0% over the $18.3 million recorded for 1998.
Diluted earnings per share for 2000 was $1.00 as compared to $0.81 for 1999 and $0.70 for 1998. All per share amounts have been restated to reflect the stock splits effected as stock dividends through February 20, 1998.
Two industry measures of the performance by a banking institution are its return on average assets and return on average equity. Return on average assets ("ROA") measures net earnings in relation to average total assets and indicates a company's ability to employ its resources profitably. During 2000, the Company's ROA was 1.36%, as compared to 1.31% and 1.27% for 1999 and 1998, respectively. During 2000, the Company's return on equity was 18.08% compared to 16.89% and 17.22% for 1999 and 1998, respectively.
Net Interest Income and Net Interest Margin
Net interest income represents the amount by which interest income on interest earning assets, including securities and loans, exceeds interest paid on interest bearing liabilities, including deposits and other borrowed funds. Net interest income is the principal source of the Company's earnings. Interest rate fluctuations, as well as changes in the amount and type of earning assets and liabilities, combine to affect net interest income.
Net interest income for 2000 was $98.3 million, up $9.8 million or 11.1% from $88.5 million for 1999 primarily due to a 20% increase in average earning assets. During 2000, the yield on interest earning assets increased 45 basis points from 8.38% in 1999 to 8.83% in 2000. Throughout the second half of 1999 and the first half of 2000, the Board of Governors of the Federal Reserve System ("Federal Reserve") increased the discount rate six times. The cost of interest bearing liabilities increased 107 basis points from 3.52% in 1999 to 4.59% in 2000. This increase was due to the Federal Reserve rate increases as well as new FHLB advances resulting from the leveraging program initiated in 1999. For 2000, the tax equivalent net interest margin (net interest income divided by average total interest earning assets) decreased 46 basis points to 5.63% from 6.09% for 1999.
Net interest income for 1999 was $88.5 million, compared to $78.2 million for 1998, an increase of $10.3 million or 13.1%. The improvement in net interest income for 1999 was mainly due to an increase in total interest earning assets, specifically in the loan portfolio. During 1999, the yield on interest earning assets decreased slightly from 8.48% in 1998 to 8.38% in 1999. The total yield on interest bearing liabilities decreased by 18 basis points from 3.70% in 1998 to 3.52% in 1999. These declines were consistent with the overall trend in interest rates during 1999. For 1999, the tax equivalent net interest margin increased 4 basis points to 6.09% from 6.05% for 1998.
Also of note, during the third quarter of 1999, the Bank initiated a temporary leveraging strategy in order to enhance earnings by better utilizing current levels of capital. Prior to the commencement of this leverage program, the Bank's balance sheet was asset sensitive. The leverage program, taken alone, creates an interest rate mismatch. However, taken together with the core assets and liabilities of the Bank, the leverage program serves to mitigate the interest rate risk of the Bank. This leveraging was achieved by borrowing funds (primarily short-term FHLB advances) and investing these funds in fixed and variable rate mortgage-backed securities and variable rate collateralized mortgage obligations. The spread on these assets over the cost of borrowed funds averaged 163 basis points. Excluding the leverage program, the tax equivalent net interest margin would have been 6.31% for 1999. This program accounted for $554 thousand in net income after tax or $0.02 per diluted share for 1999.
To provide a more in-depth analysis of net interest income, the following average balance sheets and net interest income analysis detail the contribution of interest earning assets to overall net interest income and the impact of the cost of funds:
- ----------- (1) Loan origination fees are considered adjustments to interest income. These fees aggregated $1,919,000, $1,878,000 and $1,662,000 for the years ended December 31, 2000, 1999 and 1998, respectively. Related loan origination costs are not separately allocated to loans, but are charged to non-interest expense. For the purpose of calculating loan yields, average loan balances include nonaccrual loans with no related interest income. (2) The net interest margin is equal to net interest income divided by average total interest earning assets. (3) In order to make pretax income and resultant yields on tax-exempt investments and loans comparable to those on taxable investments and loans, a tax-equivalent adjustment is made equally to interest income and income tax expense with no effect on after tax income. The tax equivalent adjustment has been computed using a federal income tax rate of 35%.
The following rate/volume analysis shows the portions of the net change in interest income due to changes in volume or rate. The changes in interest income due to both rate and volume in the analysis have been allocated to the volume or rate change in proportion to the absolute amounts of the change in each (in thousands):
NONINTEREST INCOME
Total noninterest income for 2000 totaled $39.6 million, an increase of $10.3 million or 35.2% over $29.3 million in 1999. For 1999, noninterest income totaled $29.3 million, an increase of $7.5 million or 34.3% over $21.8 million in 1998. On July 2, 1998, the Bank purchased an additional 40 percent interest in SCMC, resulting in total ownership of 80 percent. The Bank's portion of SCMC's earnings prior to July 2, 1998 is shown as "equity in earnings from Sterling Capital Mortgage Company" and included in noninterest income. Earnings from July 2, 1998 forward are consolidated into the earnings of the Company in their natural classifications.
The following table shows the breakout of noninterest income between commercial banking and mortgage banking for 2000, 1999 and 1998 (in thousands):
COMMERCIAL BANKING SEGMENT. For 2000, noninterest income from commercial banking was $17.8 million, as compared to $15.7 million for 1999, and increase of $2.1 million or 13.3%. During the latter half of 1999, the Bank purchased bank-owned life insurance ("BOLI") policies. Interest credits for these BOLI policies totaled $1.9 million for 2000 as compared to $606 for 1999, an increase of $1.3 million. Customer service fees increased $451 thousand or 4.7% primarily as a result of an overall increase in average demand and savings accounts of 7.9%. In December 2000, the Bank sold land for a gain of $244 thousand. Finally, during the first quarter of 2000, the Bank sold its credit card portfolio to a correspondent bank for a net gain of $237 thousand. For 1999, noninterest income from commercial banking totaled $15.7 million, an increase of $1.6 million or 11.1% compared to $14.1 million in 1998. The increase is primarily attributed to volume growth in deposit accounts. Also, during 1999, the Bank sold its University of Houston office which had approximately $10 million in student loans. A gain of $450 thousand was recognized on the sale. During 1998, the Bank received a condemnation award of $478 thousand for damages to real property seized by the Texas Department of Transportation.
MORTGAGE BANKING SEGMENT. For 2000, noninterest income from the mortgage banking segment increased $8.2 million or 60.4% from $13.6 million for 1999. Income from the mortgage banking segment primarily consists of fees and gains on sale of mortgage loans. The average length of time a mortgage loan is held in the portfolio of SCMC is approximately twenty-five to thirty days. The increase in noninterest income and noninterest expense is primarily due to an increase in loan funding volume as well as SCMC's acquisition of Alliance Capital Mortgage located in Portland, Oregon in April 2000 and Select Mortgage Company located in Seattle, Washington in November 1999.
NONINTEREST EXPENSE
For 2000, noninterest expenses totaled $89.9 million, an increase of $11.9 million or 15.3% over $78.0 million in 1999. Noninterest expenses are shown as follows (in thousands):
COMMERCIAL BANKING SEGMENT. For 2000, noninterest expenses related to commercial banking were $73.2 million, as compared to $66.8 million for 1999, an increase of $6.4 million or 9.6%. During the second quarter of 1999, the Bank recorded noninterest expenses of $1 million related to the acquisition of B.O.A. Bancshares. Excluding the special charges related to the acquisition, noninterest expenses increased $7.4 million or 11.2%.
Salaries and employee benefits in the commercial banking segment for 2000 totaled $41.4 million, an increase of $5.3 million or 14.8% over $36.1 million for 1999 due primarily to an increase in the number of full time equivalent employees and routine salary increases. The Bank increased its number of full- time equivalent personnel by 35 or 4.9% during the year, from 708 at year-end 1999 to 743 at year-end 2000. The largest part of this increase is attributable to the hiring of new employees to expand the Bank's lending force and its credit analyst pool, personnel for the two de novo offices (Bellaire and Dallas), and two new senior credit officers. Salaries and employee benefits in the commercial banking segment for 1999 totaled $36.1 million, an increase of $4.7 million or 15.0% over $31.4 million for 1998 due primarily to an increase in the number of full time equivalent employees and routine salary increases. The Bank increased its number of full-time equivalent
personnel by 38 or 5.7% during 1999, from 670 at year-end 1998 to 708 at year- end 1999. Average full-time equivalent personnel increased 8.61% in 1999 compared to 1998. The increases in full-time equivalents are due to staffing requirements to propel and sustain growth in loans and deposits as well as increases in central support functions.
Occupancy expense in the commercial banking segment totaled $9.6 million in 2000 as compared to $8.5 million in 1999, an increase of $1.1 million, or 12.5%. This increase primarily resulted from the opening of the two de novo offices during 2000. Occupancy expense in the commercial banking segment totaled $8.5 million in 1999, an increase of $916 thousand or 12.1% over $7.6 million in 1998. This increase was due to the new lease space for the Memorial and Fort Bend offices. Also, there were asset write-downs and lease-buy-outs for equipment which were related to the Houston Commerce Bank acquisition and conversion.
Technology expense in 2000 totaled $3.6 million, a decrease of $227 thousand or 5.9% from $3.9 million in 1999. Technology expense in 1999 totaled $3.9 million, a decrease of $373 thousand or 8.8% from $4.2 million in 1998. In 1998, technology expense included non-recurring expenses associated with the acquisition of Humble and Hometown as well as Year 2000 readiness initiatives and 1999 included non-recurring expenses associated with the acquisition of Houston Commerce Bank.
Other expenses in the commercial banking segment totaled $11.0 million in 2000, an increase of $119 thousand or 1.1%, from $10.8 million in 1999. Other expenses in the commercial banking segment totaled $10.8 million in 1999, an increase of $663 thousand or 6.5%, from $10.2 million in 1998. This increase is due to an expanding infrastructure to support growth.
MORTGAGE BANKING SEGMENT. Noninterest expense for the mortgage banking segment for 2000 was $16.7 million, as compared to $11.2 million for 1999, an increase $5.5 million or 49.1%. This increase in noninterest expense is primarily due to the increase in loan funding volume as well as SCMC's acquisition of Alliance Capital Mortgage and Select Mortgage Company. Noninterest expense for the mortgage banking segment for 1999 increased 111% over 1998. This increase resulted from the fact that, prior to July 2, 1998, the Bank owned only 40 percent of SCMC and recorded income on the equity basis. Subsequent to July 2, 1998, the Bank owned 80 percent of SCMC and earnings were consolidated with the Bank. Accordingly, the expenses for 1999 were approximately double those of 1998.
INCOME TAXES
The Company provided $12.3 million for federal income taxes for 2000, $9.7 million for 1999, and $8.9 million for 1998. The effective tax rates for 2000, 1999, and 1998 were 31.6%, 31.1%, and 32.7%, respectively.
FINANCIAL CONDITION
LOANS HELD FOR INVESTMENT
At December 31, 2000, loans held for investment totaled $1.229 billion, an increase of $104.4 million or 9.3% over loans at December 31, 1999 of $1.125 billion.
At December 31, 2000, total loans were 86.7% of deposits and 71.1% of total assets. At December 31, 1999, total loans were 84.4% of deposits and 61.0% of total assets.
The following table summarizes the loan portfolio of the Bank by type of loan as of December 31 of the year indicated, excluding loans held for sale (in thousands):
The primary lending focus of the Bank is on commercial loans and owner-occupied real estate loans to local businesses with annual sales ranging from $300,000 to $30 million. Typically, the Bank's customers have financing requirements between $50,000 and $500,000. Although the Bank's legal lending limit was $20 million at December 31, 2000, the Bank has not maintained an exposure greater than $9.6 million on any single relationship.
The Bank makes commercial loans primarily to small and medium-sized businesses and to professionals. The Bank offers a variety of commercial loan products including revolving lines of credit, letters of credit, working capital loans, and loans to finance accounts receivable, inventory and equipment. Typically, the Bank's commercial loans have floating rates of interest, are for varying terms (generally not exceeding three years), are personally guaranteed by the business owner and are secured by accounts receivable, inventory and/or other business assets. In addition to the commercial loans secured solely by non-real estate business assets, the Bank makes commercial loans that are secured by owner-occupied real estate, as well as other business assets.
The Bank's commercial mortgage loans are secured by first liens on real estate, typically have floating interest rates, and are amortized over a 15-year period with balloon payments due at the end of three years. In underwriting commercial mortgage loans, consideration is given to the property's operating history, future operating projections, current and projected occupancy, location and physical condition. The underwriting analysis also includes credit checks, appraisals, and a review of the financial condition of the borrower.
The Bank makes loans to finance the construction of residential and, to a lesser extent, nonresidential properties, such as churches. Generally, construction loans are secured by first liens on real estate and have floating interest rates. The Bank conducts periodic inspections, either directly or through an architect or other agent, prior to approval of periodic draws on these loans. Underwriting guidelines similar to those described above are also used in the Bank's construction lending activities.
The Bank makes automobile, boat, home improvement and other loans to consumers. These loans are primarily made to customers who have other relationships with the Bank. During the first quarter of 2000, the Bank sold its credit card portfolio to a correspondent bank. As of December 31, 1999, the Bank had an outstanding credit card balance of $6.1 million.
The Bank seeks to compete effectively in its chosen markets by consistent application of its business strategy. See further discussion of "BUSINESS - Business Banking Strategy" and "BUSINESS - Competition".
As of December 31, 2000, there was no concentration of loans to any one type of industry exceeding 10% of total loans nor were there any loans classified as highly leveraged transactions.
LOANS HELD FOR SALE
Loans held for sale totaled $139.1 million at December 31, 2000, an increase from $70.4 million at December 31, 1999. The $68.7 million increase is due to the increase in loans funded by the Bank through an
intercompany mortgage warehouse with SCMC. Mortgage loans originated by SCMC are held for sale and are typically sold to investors within one month of origination. Due to the timing of the sales of loans to investors, the balance of these loans at any given time is somewhat volatile.
RISK ELEMENTS
Nonperforming, past due, and restructured loans are fully or substantially secured by assets, with any excess of loan balances over collateral values specifically allocated in the allowance for credit losses. The Bank receives, on an ongoing basis, updated appraisals on loans secured by real estate, particularly those categorized as nonperforming loans and potential problem loans. In those instances where updated appraisals reflect reduced collateral values, an evaluation of the borrower's overall financial condition is made to determine the need, if any, for possible write-downs or appropriate additions to the allowance for credit losses.
The Bank defines potential problem loans as those loans not classified as nonperforming, but where information known by management indicates serious doubt that the borrower will be able to comply with the present payment terms. Management identifies these loans through its continuous loan review process and classifies potential problem loans as those loans graded as substandard, doubtful, or loss, excluding all nonperforming loans. The Bank's increase in potential problem loans can be directly attributed to loan growth and an ascending loan review function.
The Bank had no material foreign loans outstanding or loan concentrations for the years ended December 31, 1996 through 2000. The Bank, however, continues to monitor the potential risk of foreign borrowers and concentrations of credit.
The following table presents information regarding non-performing loans and assets as of December 31, 1996 through 2000 (in thousands):
ALLOWANCE FOR CREDIT LOSSES
The Bank has several systems in place to assist in maintaining the overall quality of its loan portfolios. The Bank has established underwriting guidelines to be followed by its bank offices. The Bank also monitors its delinquency levels for any negative or adverse trends and particularly monitors credits which have a total exposure of $50,000 or more. However, there can be no assurance that the Bank's loan portfolios will not become subject to increasing pressures from deteriorating borrower creditworthiness due to general economic conditions.
The allowance for credit losses is a reserve established through charges to earnings in the form of a provision for credit losses. Based on an evaluation of the loan portfolio, management presents a quarterly review of the allowance for credit losses to the Bank's Board of Directors, indicating any changes in the allowance since the last review and any recommendations as to adjustments in the allowance. In making its evaluation, management considers the industry diversification of the Bank's commercial loan portfolio and the effect of changes in the local real estate market on collateral values. The Bank also considers the results of recent regulatory examinations. The Bank continues to monitor the effects of current economic indicators and their probable impact on borrowers, the amount of charge-offs for the period, the amount of non- performing loans and related collateral security. The Bank monitors the loan portfolio through its internal loan review department and obtains an annual loan review by independent consultants. Charge-offs occur when loans are deemed to be uncollectible.
The Bank follows a loan review program to evaluate the credit risk in the commercial loan portfolio for substantially all commercial loans and real estate loans. Through the loan review process, the Bank maintains an internally classified loan list, which, along with the delinquency list of loans, helps management assess the overall quality of the loan portfolios and the adequacy of the allowance for credit losses. Loans classified as "substandard" are those loans with clear and defined weaknesses such as highly leveraged positions, unfavorable financial ratios, uncertain repayment sources or poor financial condition, which may jeopardize recoverability of the debt.
Loans classified as "doubtful" are those loans which have characteristics similar to substandard accounts but with an increased risk that a loss may occur, or at least a portion of the loan may require a charge-off if liquidated at present. Although loans classified as substandard do not duplicate loans classified as doubtful, both substandard and doubtful loans include some loans that are delinquent at least 30 days or on nonaccrual status. Loans classified as "loss" are those loans that are in the process of being charged off.
At December 31, 2000, substandard loans totaled $44.6 million, of which $8.4 million were loans designated as delinquent or nonaccrual; and doubtful loans totaled $2.2 million of which $2.0 million were designated as delinquent or nonaccrual.
In addition to the internally classified loan list and delinquency list of loans, the Bank maintains a separate "watch list" which further aids the Bank in monitoring loan portfolios. Watch list loans show warning elements where the present status portrays one or more deficiencies that require attention in the short run or where pertinent ratios of the loan account have weakened to a point where more frequent monitoring is warranted. These loans do not have all the characteristics of a classified loan (substandard or doubtful) but do show weakened elements as compared with those of a satisfactory credit. The Bank reviews these loans to assist in assessing the adequacy of the allowance for credit losses. As of December 31, 2000, watch list loans totaled $67.0 million.
Management assigns loan grades by loan and allocations are made within each loan grade so that double allocations are avoided. Loans are assigned a grade according to payment history, collateral values, and financial condition of the borrower.
The Bank maintains an adequate allowance for credit losses through its watchlist classifications, allocating an increasing reserve amount as the severity of a problem loan increases. The Bank maintains an unallocated reserve for satisfactory non-classified credits based on the average of the last three year's actual net charge-offs.
The Company's Board of Directors formed a sub-committee for Asset Quality in 1999 which meets eight times each year. That committee is composed of three outside Board of Directors and five senior management members. This committee reviews all large loans, past-dues, and overdrafts, as well as ratio and trend analysis and approves all charge-offs over $25 thousand. This committee also mandates action items for future meetings to evaluate potential problems and assess the potential need for additional reserve requirements by any particular sector.
The following table presents, for the periods indicated, an analysis of the allowance for credit losses and other related data (in thousands):
ALLOCATION OF THE ALLOWANCE FOR CREDIT LOSSES
The following table describes the allocation of the allowance for credit losses among various categories of loans and certain other information as of the dates indicated. The allocation is made for analytical purposes and is not necessarily indicative of the categories in which future loan losses may occur. The total allowance is available to absorb losses from any category of loans.
SECURITIES
The following table summarizes the book value of securities held by the Bank as of the dates shown. See Note D to the Company's consolidated financial statements for information relating to fair values and details of held-to- maturity and available-for-sale securities portfolios.
At December 31, 2000, securities of $291.2 million had decreased $234.0 million from $525.2 million at December 31, 1999. During the third quarter of 1999, the Bank initiated a temporary leveraging strategy in order to enhance earnings by better utilizing current levels of capital. With this strategy, the Bank had invested $254 million in variable and fixed rate mortgage-backed securities and variable rate collateralized mortgage obligations. Through paydowns, maturities and sales, the leverage strategy was unwound by the end of 2000. At December 31, 2000 and 1999, securities represented 18.5% and 37.1% of total deposits and 15.1% and 26.8% of total assets, respectively.
The yield on the Bank's securities portfolio at December 31, 2000, was 6.5%. The weighted-average life of the portfolio was approximately 6.2 years and the duration was approximately 4.2 years. The yield on the Bank's securities portfolio at December 31, 1999, was 5.9%. The weighted-average life of the portfolio was approximately 10.0 years and the duration was approximately 2.8 years.
The maturity distribution and weighted average yield of the Bank's debt security portfolio as of December 31, 2000, are summarized in the following table (in thousands).
DEPOSITS
The Bank's lending and investing activities are funded almost entirely by core deposits, approximately 74.5% of which are demand and savings deposits. Noninterest bearing deposits at December 31, 2000 were $561.9 million as compared to $481.8 million at December 31, 1999, an increase of $80.2 million or 16.6% over 1999. Approximately 35.6% of deposits at December 31, 2000 were noninterest bearing as compared to 34.0% at December 31, 1999. The Bank does not accept brokered deposits.
The Bank's average total deposits for 2000 were $1.5 billion, or $106.6 million and 7.8% over average total deposits during 1999 that were $1.4 billion. The Bank's total deposits at December 31, 2000 were $1.6 billion, up $162.2 million or 11.5% over total deposits of $1.4 billion at year-end 1999. Deposit growth continues to be concentrated primarily in core deposits, consisting of all deposits other than retail and public fund certificates of deposit in excess of $100,000.
The average balances and weighted average rates paid on deposits for each of the years ended December 31, 2000, 1999, and 1998 are presented below (in thousands):
The Bank's time deposits of $100,000 or more have consistently shown a pattern of renewal similar to that for deposits of less than $100,000. See Note I of the consolidated financial statements for maturities of certificates of deposits of $100,000 or more.
OTHER BORROWED FUNDS
Deposits are the primary source of funds for the Bank's lending and investment activities and for its general business purposes. Additionally, the Bank has available borrowing facilities through the Federal Home Loan Bank and numerous correspondent banking relationships.
During the third quarter of 1999, the Company initiated a leveraging strategy whereby the Bank borrowed funds on a short-term basis from the Federal Home Loan Bank ("FHLB") and invested $254 million in mortgage backed securities and collateralized mortgage obligations. Through paydowns, maturities, and sales of securities, the borrowings at FHLB decreased. As a result, FHLB borrowings totaled $128.0 million at December 31, 2000 and had a rate of 6.74% and a maturity of four days.
COMPANY-OBLIGATED MANDATORILY REDEEMABLE TRUST PREFERRED SECURITIES
In June 1997, the Company formed Sterling Bancshares Capital Trust I, a trust formed under the laws of the State of Delaware ("Trust I"). Trust I issued $28,750,000 of 9.28% Trust Preferred Securities and invested the proceeds thereof in the 9.28% Junior Subordinated Deferrable Interest Debentures (the "9.28% Junior Subordinated Debentures") issued by the Company. The 9.28% Junior Subordinated Debentures will mature on June 6, 2027, which date may be shortened to a date not earlier than June 6, 2002 if certain conditions are met (including the Company having received prior approval of the Federal Reserve and any other required regulatory approvals). The 9.28% Trust Preferred Securities will be subject to mandatory redemption in a like amount contemporaneously with the optional prepayment of the 9.28% Junior Subordinated Debentures by the Company. The 9.28% Junior Subordinated Debentures may be prepaid upon the occurrence and continuation of certain events including a change in the tax status or regulatory capital treatment of the 9.28% Trust Preferred Securities. In each case, redemption will be made at a price equal to 100% of the face amount of the 9.28% Trust Preferred Securities, plus the accrued and unpaid distributions thereon through the redemption date.
In February 2001, the Company formed Sterling Bancshares Capital Trust II ("Trust II") and Sterling Bancshares Capital Trust III, each a trust formed under the laws of the State of Delaware. On March 21, 2001, Trust II issued $28,750,000 of 9.20% Trust Preferred Securities and invested the proceeds thereof in the 9.20% Junior Subordinated Deferrable Interest Debentures (the "9.20% Junior Subordinated Debentures") issued by the Company. The 9.20% Junior Subordinated Debentures will mature on March 21, 2031, which date may be shortened to a date not earlier than March 21, 2006 if certain conditions are met (including the Company having received prior approval of the Federal Reserve and any other required regulatory approvals). The 9.20% Trust Preferred Securities will be subject to mandatory redemption in a like amount contemporaneously with the optional prepayment of the 9.20% Junior Subordinated Debentures by the Company. The 9.20% Junior Subordinated Debentures may be prepaid upon the occurrence and continuation of certain events including a change in the tax statutes or regulatory capital treatment of the 9.20% Trust Preferred Securities. In each case, redemption will be made at a price equal to 100% of the face amount of the 9.20% Trust Preferred Securities, plus the accrued and unpaid distributions thereon through the redemption date.
INTEREST RATE SENSITIVITY AND LIQUIDITY
The Company manages its interest rate risk through structuring the balance sheet to maximize net interest income while maintaining an acceptable level of risk to changes in market interest rates. This process requires a balance between profitability, liquidity, and interest rate risk.
To effectively measure and manage interest rate risk, the Company uses simulation analysis to determine the impact on net interest income of changes in interest rates under various interest rate scenarios, balance sheet trends, and strategies. From these simulations, interest rate risk is quantified and appropriate strategies are developed and implemented. The overall interest rate risk position and strategies are reviewed by senior management, the Asset/Liability Management Committee and the Company's Board of Directors on an ongoing basis.
Based on simulation analysis of the interest rate sensitivity inherent in the Company's net interest income and market value of portfolio equity, as of December 31, 2000 and as adjusted by instantaneous rate changes upward and downward of up to 100 basis points, the Company is slightly asset sensitive. The Company's analysis indicates that an instantaneous 100 basis point move downward in interest rates would decrease net interest income by 1.86% and increase the present value of equity by 0.26%; likewise, an instantaneous 100 basis point move upward in interest rates would increase net interest income by 1.87% and decrease the present value of equity by 1.78%. These sensitivities are all within the threshold set by the Company's Asset/Liability Committee. Each rate scenario reflects unique prepayment and repricing assumptions. Since there are limitations inherent in any methodology used to estimate the exposure to changes in market interest rates, this analysis is not intended to be a forecast of the actual effect of a change in market interest rates on the Company. The Company's interest rate sensitivity analysis includes assumptions that (i) the composition of the Company's interest sensitive assets and liabilities existing at fiscal year end will remain constant over the measurement period; and (ii) that changes in market rates are parallel and instantaneous across the yield curve regardless of duration or repricing characteristics of specific assets or liabilities. Further, the analysis does not contemplate any actions that the Company might undertake in response to changes in market interest rates. Accordingly, this analysis is not intended to and does not provide a precise forecast of the effect actual changes in market rates will have on the Company.
An interest rate sensitive asset or liability is one that, within a defined time period, either matures or experiences an interest rate change in line with general market interest rates. The management of interest rate risk is performed by analyzing the maturity and repricing relationships between interest earning assets and interest bearing liabilities at specific points in time ("GAP") and by analyzing the effects of interest rate changes on net interest income over specific periods of time by projecting the performance of the mix of assets and liabilities in varied interest rate environments. Interest rate sensitivity reflects the potential effect on net interest income of a movement in interest rates. A company is considered to be asset sensitive, or having a positive GAP, when the amount of its interest earning assets maturing or repricing within a given period exceeds the amount of its interest bearing liabilities also maturing or repricing within that time period. Conversely, a company is considered to be liability sensitive, or having a negative GAP, when the amount of its interest bearing liabilities maturing or repricing within a given period exceeds the amount of its interest earning assets also maturing or repricing within that time period. During a period of rising interest rates, a negative GAP would tend to affect adversely net interest income, while a positive GAP would tend to result in an increase in net interest income. During a period of falling interest rates, a negative GAP would tend to result in an increase in net interest income, while a positive GAP would tend to affect net interest income adversely. When analyzing its GAP position, the Company emphasizes the next twelve-month period.
The following table sets forth the expected maturity and repricing characteristics of the Company's interest earning assets and interest bearing liabilities as of December 31, 2000:
Shortcomings are inherent in any GAP analysis since certain assets and liabilities may not reprice proportionally as interest rates change. Consequently, the Company's management has begun to utilize an interest rate risk simulation model to increase its ability to monitor and forecast the effect of various interest rate environments on earnings and its net capital position.
Liquidity involves the Company's ability to raise funds to support asset growth or reduce assets to meet deposit withdrawals and other payment obligations, to maintain reserve requirements and otherwise to operate the Company on an ongoing basis. In recent years, the Company's liquidity needs have primarily been met by growth in core deposits. Additionally, the Bank has access to purchased funds from correspondent banks and borrowings from the Federal Home Loan Bank, supplemented by amortizing investment and loan portfolios, which has created an adequate liquidity position. Also, the Company maintains a $20 million revolving line of credit with Wells Fargo Bank Minnesota, National Association. The initial line of credit was renewed on February 2, 2001 for an additional one year period ending on February 2, 2002. If the Company draws on the line of credit, it will pay interest equal to 1.95% in excess of the Federal Funds Rate in effect from time to time. In addition, the Company pays a quarterly fee equal to one-eighth of one percent (0.125%) of the average daily unused portion of the line of credit.
CAPITAL RESOURCES
At December 31, 2000, shareholders' equity totaled $159.1 million or 8.3% of total assets, as compared to $134.5 million and 6.9% of total assets at December 31, 1999.
Regulatory authorities in the United States have issued risk-based capital standards by which all bank holding companies and banks will be evaluated in terms of capital adequacy. These guidelines relate a banking company's capital compared to the risk profile of its assets. Tier 1 capital includes common shareholders' equity, minority interest in consolidated subsidiaries, and qualifying perpetual preferred stock together with related surpluses and retained earnings. Tier 2 capital may be comprised of limited life preferred stock, qualifying debt instruments, and the reserves for credit losses.
Banking regulators have also issued leverage ratio requirements. The leverage ratio requirement is measured as the ratio of Tier 1 capital to adjusted assets. See Note S to the Company's consolidated financial statements for further discussion of the Company's and the Bank's regulatory capital requirements.
The Bank's capital levels at December 31, 2000 and 1999 qualify it as "well- capitalized," the highest of five tiers under applicable regulatory definitions.
RISK FACTORS AND CAUTIONARY STATEMENT FOR PURPOSES OF THE PROVISIONS OF THE "SAFE HARBOR" PROVISIONS OF THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995
Some of the statements and information contained in this Annual Report may contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements discuss future expectations, activities or events and by their nature, they are subject to risks and uncertainties. Forward-looking statements can be identified by the fact that they do not relate strictly to historical or current facts. They often include words such as "believe," "expect," "anticipate," "intend," "plan," "estimate," or words of similar meaning, or future or conditional verbs such as "will," "would," "should," "could," or "may." Forward-looking statements speak only as of the date they are made. We will not update these forward-looking statements to reflect circumstances or events that occur after the date the forward-looking statements are made.
Many possible factors could affect our future financial performance. Our actual results may differ materially from what is expressed in any forward-looking statement. Important factors that could cause actual results to differ materially from estimates or projections contained in forward-looking statements include:
. general business and economic conditions in the markets we serve may be less favorable than anticipated which could decrease the demand for loan, deposit and other financial services and increase loan delinquencies and defaults;
. changes in market rates and prices may adversely impact the value of securities, loans, deposits and other financial instruments;
. our liquidity requirements could be adversely affected by changes in our assets and liabilities;
. legislative or regulatory developments including changes in laws concerning taxes, banking, securities, insurance and other aspects of the financial securities industry;
. competitive factors, including product and pricing pressures among financial services organizations, may increase; and
. fiscal and governmental policies of the United States federal government.
With this in mind, you should consider the following important factors that could cause actual results to differ materially from those expressed in any forward-looking statement made by us or on our behalf:
OUR PROFITABILITY DEPENDS SIGNIFICANTLY ON LOCAL ECONOMIC CONDITIONS.
Our success depends primarily on the general economic conditions of the Houston metropolitan area. Unlike larger banks that are more geographically diversified, we provide banking and financial services to customers primarily in the Houston metropolitan area. Houston's local economic conditions have a significant impact on our commercial, real estate and construction loans, the ability of the borrowers to repay these loans and the value of the collateral securing these loans. A significant decline in general economic conditions, such as inflation, recession, unemployment and other factors beyond our control will impact these local economic conditions and will negatively affect the financial results of our banking operations. In addition, since Houston remains largely dependent on the energy industry, a downturn in the energy industry and energy-related businesses could adversely affect our results of operations and financial condition.
WE RELY ON AN OWNER-OPERATED BUSINESS MARKET.
We target our business development and marketing strategy primarily to serve the banking and financial needs of owner-operated businesses with credit needs of up to $2 million. These owner-operated businesses represent a major sector of the Houston and national economies. If general economic conditions negatively impact this economic sector in the Houston metropolitan area or the other Texas markets in which we operate, our results of operations and financial condition will be significantly affected.
IF OUR ALLOWANCE FOR LOAN LOSSES IS NOT SUFFICIENT TO COVER ACTUAL LOAN LOSSES, OUR EARNINGS COULD DECREASE.
Our loan customers may not repay their loans according to the terms of these loans and the collateral securing the payment of these loans may be insufficient to assure repayment. We may experience significant credit losses which could have a material adverse effect on our operating results. We make various assumptions and judgments about the collectibility of our loan portfolio, including the creditworthiness of our borrowers and the value of the real estate and other assets serving as collateral for the repayment of many of our loans. In determining the size of the allowance, we rely on our experience and our evaluation of economic conditions. If our assumptions prove to be incorrect, our current allowance may not be sufficient to cover future loan losses and adjustments may be necessary to allow for different economic conditions or adverse developments in our loan portfolio. Material additions to our allowance would materially decrease our net income.
In addition, federal and state regulators periodically review our allowance for loan losses and may require us to increase our provision for loan losses or recognize further loan charge-offs, based on judgments different than those or our management. Any increase in our loan allowance or loan charge-offs as required by these regulatory agencies could have a negative effect on us.
FLUCTUATIONS IN INTEREST RATES COULD REDUCE OUR PROFITABILITY.
We realize income primarily from the difference between interest earned on loans and investments and the interest paid on deposits and borrowings. We expect that we will periodically experience "gaps" in the interest rate sensitivities of our assets and liabilities, meaning that either our interest-bearing liabilities will be more sensitive to changes in market interest rates than our interest-earning assets, or vice versa. In either event, if market interest rates should move contrary to our position, this "gap" will work against us, and our earnings may be negatively affected.
We are unable to predict fluctuations of market interest rates, which are affected by the following factors:
. inflation;
. recession;
. a rise in unemployment;
. tightening money supply; and
. international disorder and instability in domestic and foreign financial markets.
Our asset liability management strategy, which is designed to control our risk from changes in market interest rates, may not be able to prevent changes in interest rates from having a material adverse effect on our results of operation and financial condition.
COMPETITION WITH OTHER FINANCIAL INSTITUTIONS COULD ADVERSELY AFFECT OUR PROFITABILITY.
We face vigorous competition from banks and other financial institutions, including savings and loan associations, savings banks, finance companies and credit unions. A number of these banks and other financial institutions have substantially greater resources and lending limits, larger branch systems and a wider array of banking services. To a limited extent, we also compete with other providers of financial services, such as money market mutual funds, brokerage firms, consumer finance companies and insurance companies. This competition may reduce or limit our margins on banking services, reduce our market share and adversely affect our results of operations and financial condition.
WE MAY NOT BE ABLE TO MAINTAIN OUR HISTORICAL GROWTH FATE WHICH MAY ADVERSELY IMPACT OUR RESULTS OF OPERATIONS AND FINANCIAL CONDITION.
To achieve our growth, we have initiated internal growth programs, completed various acquisitions and opened additional branches in the past few years. We may not be able to sustain our historical rate of growth or may not even be able to grow at all. We may not be able to obtain the financing necessary to fund additional growth and may not be able to find suitable candidates for acquisition. Various factors, such as economic conditions and competition, may impede or prohibit the opening of new branch offices. Further, our inability to attract and retain experienced bankers may adversely affect our internal growth. A significant decrease in our historical rate of growth may adversely impact our results of operation and financial condition.
WE MAY BE UNABLE TO COMPLETE ACQUISITIONS, AND ONCE COMPLETE, MAY NOT BE ABLE TO INTEGRATE OUR ACQUISITIONS SUCCESSFULLY.
Our growth strategy is dependent on our ability to acquire other financial institutions. On March 1, 2001, we entered into a definitive agreement to acquire Lone Star Bancorporation, Inc., headquartered in Houston, Texas, and its subsidiary bank, Lone Star Bank. We will complete the acquisition of Lone Star Bancorporation only if all closing conditions are met, including qualification of the transaction for pooling of interests accounting treatment, receipt of regulatory approvals and approval of Lone Star Bancorporation's shareholders.
We may not be able to complete the Lone Star Bancorporation acquisition and any future acquisitions and, if completed, we may not be able to successfully integrate the operations, management, products and services of the entities we acquire. Following each acquisition, we must expend substantial managerial, operating, financial and other resources to integrate these entities. In particular, we may be required to install and standardize adequate operational and control systems, deploy or modify equipment, implement marketing efforts in new as well as existing locations and employ and maintain qualified personnel. Our failure to successfully integrate the entities we acquire into our existing operations may adversely affect our financial condition and results of operations.
WE OPERATE IN A HIGHLY REGULATED ENVIRONMENT AND MAY BE ADVERSELY AFFECTED BY CHANGES IN FEDERAL AND LOCAL LAWS AND REGULATIONS.
We are subject to extensive regulation, supervision and examination by federal and state banking authorities. Any change in applicable regulations or federal or state legislation could have a substantial impact on us and our subsidiary, Sterling Bank, and its operations. Additional legislation and regulations may be enacted or adopted in the future that could significantly affect our powers, authority and operations, which could have a material adverse effect on our financial condition and results of operations. Further, regulators have significant discretion and power to prevent or remedy unsafe or unsound practices or violations of laws by banks and bank holding companies in the performance of their supervisory and enforcement duties. The exercise of this regulatory discretion and power may have a negative impact on us.
ITEM 7A
ITEM 7A - QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
For information regarding the market risk of the Company's financial instruments, see "MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - INTEREST RATE SENSITIVITY AND LIQUIDITY." The Company's principal market risk exposure is to interest rates.
ITEM 8
ITEM 8 -- FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
See the index included on page 34 and the Consolidated Financial Statements which begin on page 36 of this Form 10-K.
ITEM 9
ITEM 9 -- CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.
PART - III
ITEM 10
ITEM 10 -- DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information set forth under the caption "ELECTION OF DIRECTORS" of the Company's Proxy Statement dated March 23, 2001, relating to the 2001 Annual Meeting of Shareholders of the Company, is incorporated herein by reference.
ITEM 11
ITEM 11 -- EXECUTIVE COMPENSATION
The information set forth under the caption "EXECUTIVE COMPENSATION" of the Company's Proxy Statement dated March 23, 2001, relating to the 2001 Annual Meeting of Shareholders of the Company, is incorporated herein by reference.
ITEM 12
ITEM 12 -- SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information relating to the beneficial ownership of the outstanding shares of Common Stock of the Company by its directors and executive officers set forth under the caption "SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT" of the Company's Proxy Statement dated March 23, 2001, relating to the 2001 Annual Meeting of Shareholders of the Corporation, is incorporated herein by reference.
ITEM 13
ITEM 13 -- CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information set forth under the caption "CERTAIN TRANSACTIONS" of the Company's Proxy Statement dated March 23, 2001, relating to the 2001 Annual Meeting of Shareholders of the Company, is incorporated herein by reference.
PART -- IV
ITEM 14
ITEM 14 -- EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a)(1) List of documents filed as part of this report
INDEPENDENT AUDITORS' REPORT CONSOLIDATED FINANCIAL STATEMENTS: Balance Sheets Statements of Income Statements of Shareholders' Equity Statements of Cash Flows Notes to Consolidated Financial Statements
(a)(2) No financial statement schedules are required to be filed as a part of this report.
(b) Current Report on Form 8-K filed on October 30, 2000, announcing the execution of an agreement and plan of merger on October 23, 2000, by CaminoReal Bancshares of Texas, Inc. and Sterling Bancshares, Inc. providing for the merger of CaminoReal Bancshares with Sterling Bancshares.
(c) Exhibits
2.1 Agreement and Plan of Merger dated as of March 18, 1997, by and among the Company, Sterling Bancorporation, Inc. and First Houston Bancshares, Inc. [Incorporated by reference to the Company's Registration Statement on Form S-4 (File No. 333-28153)]
2.2 Agreement and Plan of Consolidation dated as of February 17, 1998, by and between the Company and Humble National Bank [Incorporated by reference to the Company's Report on Form 8-K filed on February 27, 1998 (File No. 000-20750)]
2.3 Agreement and Plan of Merger dated as of June 12, 1998 among the Company, Sterling Bancorporation, and Hometown Bancshares, Inc., as amended. [Incorporated by reference to Exhibit 2.6 of the Company's Annual Report on Form 10-K (File No. 000-20750)]
2.4 Agreement and Plan of Merger dated as of February 24, 1999 among the Company, Sterling Bancorporation, and B. O. A. Bancshares, Inc., as amended. [Incorporated by reference to the Company's Report on Form 8-K filed on June 2, 1999 (File No. 000-20750)]
2.5* Agreement and Plan of Merger dated as of October 23, 2000 among the Company, Sterling Bancorporation, and CaminoReal Bancshares of Texas, Inc., as amended.
3.1 Restated and Amended Articles of Incorporation of the Company, as amended. [Incorporated by reference to the Company's Annual Report on Form 10-K (File No. 000-20750)]
3.2 Restated By-Laws of the Company [Incorporated by reference to Exhibit 4.2 of the Company's Registration Statement on Form S-8, effective November 25, 1996 (File No. 333-16719)]
4.1 Form of Indenture to be dated as of June 6, 1997 [Incorporated by reference to Exhibit 4.1 to the Company's Registration Statement on Form S-3 (File No. 333-27185)]
4.2 Form of Junior Subordinated Debenture [Included as an exhibit to the Form of Indenture that is incorporated by reference to Exhibit 4.1 to the Company's Registration Statement on Form S-3 (File No. 333-27185)]
4.3 Form of Trust Preferred Securities Guarantee Agreement of the Company [Incorporated by reference to Exhibit 4.7 to the Company's Registration Statement on Form S-3 (File No. 333-27185)]
4.4 Preferred Securities Guarantee Agreement dated March 21, 2001 [Incorporated by reference to Exhibit 4.2 of the Company's Report on Form 8-K filed on March 21, 2001 (File No. 000-20750)].
4.5 Indenture dated March 21, 2001 [Incorporated by reference to Exhibit 4.4 of the Company's Report on Form 8-K filed on March 21, 2001 (File No. 000-20750)].
4.6 First Supplemental Indenture dated March 21, 2001 [Incorporated by reference to Exhibit 4.5 of the Company's Report on Form 8-K filed on March 21, 2001 (File No. 000-20750)].
4.7 9.20% Subordinated Deferrable Interest Debenture due March 21, 2031 [Incorporated by reference to Exhibit 4.7 of the Company's Report on Form 8-K filed on March 21, 2001 (File No. 000-20750)].
10.1** 1994 Incentive Stock Option Plan of the Company [Incorporated by reference to Exhibit 10.1 of the Company's Annual Report on Form 10-K for the year ended December 31, 1994]
10.2 1994 Employee Stock Purchase Plan of the Company [Incorporated by reference to Exhibit 10.2 of the Company's Annual Report on Form 10-K for the year ended December 31, 1994]
10.3** 1984 Incentive Stock Option Plan of the Company [Incorporated by reference to Exhibit 10.1 of the Company's Registration Statement on Form S-1, effective October 22, 1992 (Registration No. 33-51476)]
10.4** 1995 Non-Employee Director Stock Compensation Plan [Incorporated by reference to Exhibit 4.3 of the Company's Registration Statement on Form S-8 (File No. 333-16719)]
10.5* Letter Agreement dated February 2, 2000 made by and between the Company and Wells Fargo Bank Minnesota, National Association regarding a line of credit in the amount of $20,000,000
10.6* First Amendment to Letter Agreement dated February 2, 2001 made by and between the Company and Wells Fargo Bank Minnesota, National Association regarding a line of credit in the amount of $20,000,000
21* Subsidiaries of the Company
23.1* Consent of Deloitte & Touche LLP, Independent Auditors
- -------------- * As filed herewith.
** Management Compensation Agreement
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
STERLING BANCSHARES, INC.
by /s/ George Martinez ------------------------------ DATE: March 23, 2001 George Martinez, Chairman
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant in the capacity indicated on this the 23th day of March, 2001.
STERLING BANCSHARES, INC.
- -------------------------------------------------------------------------------- PAGE INDEPENDENT AUDITORS' REPORT 38
CONSOLIDATED FINANCIAL STATEMENTS:
Balance Sheets 39
Statements of Income 40
Statements of Shareholders' Equity 41
Statements of Cash Flows 43
Notes to Consolidated Financial Statements 44
INDEPENDENT AUDITORS' REPORT
To the Board of Directors and Shareholders of Sterling Bancshares, Inc.
Houston, Texas
We have audited the accompanying consolidated balance sheets of Sterling Bancshares, Inc. and subsidiaries (the "Company") as of December 31, 2000 and 1999, and the related consolidated statements of income, shareholders' equity and cash flows for each of the three years in the period ended December 31, 2000. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in all material respects, the consolidated financial position of Sterling Bancshares, Inc. and subsidiaries as of December 31, 2000 and 1999, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2000, in conformity with accounting principles generally accepted in the United States of America.
/s/ DELOITTE & TOUCHE LLP - ------------------------- DELOITTE & TOUCHE LLP Houston, Texas March 23, 2001
STERLING BANCSHARES, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS DECEMBER 31, 2000 AND 1999 (In thousands, except share amounts) - --------------------------------------------------------------------------------
SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
STERLING BANCSHARES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME FOR THE YEARS ENDED DECEMBER 31, 2000, 1999, AND 1998 (In thousands except per share amounts) - --------------------------------------------------------------------------------
SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
STERLING BANCSHARES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY FOR THE YEARS ENDED DECEMBER 31, 2000, 1999, AND 1998 (In thousands except share amounts) - --------------------------------------------------------------------------------
SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
STERLING BANCSHARES,INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE YEARS ENDED DECEMBER 31, 2000, 1999, AND 1998 (IN THOUSANDS) - --------------------------------------------------------------------------------
SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
STERLING BANCSHARES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEARS ENDED DECEMBER 31, 2000, 1999 AND 1998 - --------------------------------------------------------------------------------
A. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING AND REPORTING POLICIES
ORGANIZATION - Sterling Bancshares, Inc. (hereinafter, collectively with its subsidiaries, the "Company" or "Bancshares"), headquartered in Houston, Texas, is a bank holding company that provides commercial and retail banking services in the Houston metropolitan area through the community banking offices of Sterling Bank, a banking association chartered under the laws of the State of Texas ("Bank"). In December 2000, the Bank began operations in Dallas, Texas. Also, the Company provides mortgage banking services through its 80 percent ownership of Sterling Capital Mortgage Company ("SCMC").
SUMMARY OF SIGNIFICANT ACCOUNTING AND REPORTING POLICIES - The accounting and reporting policies of the Company conform to accounting principles generally accepted in the United States of America and the prevailing practices within the banking industry. A summary of significant accounting policies follows:
BASIS OF PRESENTATION - The consolidated financial statements include the accounts of Bancshares and its subsidiaries. Intercompany transactions have been eliminated in consolidation. The consolidated financial statements have been restated to present the combined financial information of acquisitions accounted for using the pooling of interests method (see Note B).
USE OF ESTIMATES - The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts in the financial statements. Actual results could differ from those estimates. Material estimates that are particularly susceptible to significant change in the near term relate to the determination of the allowance for credit losses, and the valuation of foreclosed real estate, deferred tax assets and trading activities.
SECURITIES - Securities classified as held-to-maturity are carried at cost, adjusted for the amortization of premiums and the accretion of discounts. Management has the positive intent and the Company has the ability to hold these assets until their maturities. Under certain circumstances (including the deterioration of the issuer's creditworthiness or a change in tax law or statutory or regulatory requirements), these securities may be sold or transferred to another portfolio.
Securities classified as available-for-sale are carried at fair value. Unrealized gains and losses are excluded from earnings and reported, net of tax, as accumulated comprehensive income until realized. Securities within the available-for-sale portfolio may be used as part of the Company's asset and liability management strategy and may be sold in response to changes in interest rate risk, prepayment risk or other factors.
Premiums and discounts are amortized and accreted to operations using the level-yield method of accounting, adjusted for prepayments as applicable. The specific identification method of accounting is used to compute gains or losses on the sales of these assets.
INVESTMENT IN STERLING CAPITAL MORTGAGE COMPANY - In September 1996, the Company acquired a 40 percent equity and 44 percent voting interest in SCMC. On July 2, 1998, the Company acquired
an additional 40 percent interest, increasing its total ownership to 80 percent. The consolidated income statements include the Company's 40 percent share of SCMC's equity earnings from the initial acquisition through July 1, 1998 using the equity method of accounting. Beginning July 2, 1998, SCMC's financial statements are fully consolidated with the Company's and the remaining 20 percent ownership is shown as minority interest.
LOANS HELD FOR SALE - Loans originated and intended for sale in the secondary market are carried at the lower of cost or market value in the aggregate. Premiums, discounts and loan fees (net of certain direct loan origination costs) on loans held for sale are deferred until the related loans are sold or repaid. Gains or losses on loan sales are recognized at the time of sale and determined using the specific identification method.
LOANS HELD FOR INVESTMENT - Loans held for investment are stated at the principal amount outstanding, net of unearned discount. Unearned discount relates principally to consumer installment loans. The related interest income for installment loans is recognized principally by the "sum of the months' digits" method, which records interest in proportion to the declining outstanding balances of the loans. This method approximates the interest method. For other loans, such income is recognized using the simple interest method.
Impaired loans, with the exception of groups of smaller-balance homogeneous loans that are collectively evaluated for impairment, are defined as loans for which, based on current information and events, it is probable that a creditor will be unable to collect all amounts due, both interest and principal, according to the contractual terms of the loan agreement. The allowance for credit losses related to impaired loans is determined based on the present value of expected cash flows discounted at the loan's effective interest rate or, as a practical expedient, the loan's observable market price or the fair value of the collateral if the loan is collateral dependent.
NONACCRUAL, PAST-DUE AND RESTRUCTURED LOANS - Included in this loan category are loans which have been categorized by management as nonaccrual because collection of interest is doubtful and loans which have been restructured to provide a reduction in the interest rate below the current market rate or a deferral of interest or principal payments.
When the payment of principal or interest on a loan is delinquent for 90 days, or earlier in some cases, the loan is placed on nonaccrual status and classified as impaired unless the loan is in the process of collection and the underlying collateral fully supports the carrying value of the loan. If the decision is made to continue accruing interest on the loan, periodic reviews are made to evaluate the appropriateness of the accruing status of the loan. When a loan is placed on nonaccrual status, interest accrued and uncollected during the current year prior to the judgment of noncollectibility is charged to operations. Interest accrued and uncollected during prior periods is charged to the allowance for credit losses. Generally, any payments received on nonaccrual loans are applied first to outstanding loan amounts and next to the recovery of charged-off loan amounts. Any excess is treated as a recovery of lost interest.
Restructured loans are those loans for which concessions in terms have been granted because of a borrower's financial difficulty. Interest is generally accrued on such loans in accordance with the new terms.
ALLOWANCE FOR CREDIT LOSSES - The allowance for credit losses is a valuation allowance for probable losses incurred on loans. All losses are charged to the allowance when the loss actually occurs or
when a determination is made that a probable loss has occurred. Recoveries are credited to the allowance at the time of recovery.
Throughout the year, management estimates the probable level of losses to determine whether the allowance for credit losses is adequate to absorb losses in the existing portfolio. Based on these estimates, an amount is charged to the provision for credit losses and credited to the allowance for credit losses in order to adjust the allowance to a level determined to be adequate to absorb losses.
Management's judgment as to the level of probable losses on existing loans involves the consideration of current economic conditions and their estimated effects on specific borrowers; an evaluation of the existing relationships among loans, potential credit losses and the present level of the allowance; results of examinations of the loan portfolio by regulatory agencies; and management's internal review of the loan portfolio. In determining the collectibility of certain loans, management also considers the fair value of any underlying collateral. The amount ultimately realized may differ from the carrying value of these assets because of economic, operating or other conditions beyond the Company's control.
It should be understood that estimates of credit losses involve an exercise of judgment. While it is reasonably possible that in the near term the Company may sustain losses which are substantial relative to the allowance for credit losses, it is the judgment of management that the allowance for credit losses reflected in the consolidated balance sheets is adequate to absorb estimated losses that exist in the current loan portfolio.
PREMISES AND EQUIPMENT - Land is carried at cost. Premises and equipment are carried at cost, less accumulated depreciation and amortization. Depreciation expense is computed primarily using the straight-line method over the estimated useful lives of the assets. Leasehold improvements are amortized using the straight-line method over the periods of the leases or the estimated useful lives, whichever is shorter.
GOODWILL - Goodwill is amortized using the straight-line method over a period of 10 to 25 years. Management periodically performs an evaluation to determine whether any impairment of goodwill has occurred. If any such impairment is identified, a write-down of the goodwill is recorded.
REAL ESTATE ACQUIRED BY FORECLOSURE - The Bank records real estate acquired by foreclosure at fair value less estimated costs to sell. Adjustments are made to reflect declines in value subsequent to acquisition, if any, below the recorded amounts. Required developmental costs associated with foreclosed property under construction are capitalized and considered in determining the fair value of the property. Operating expenses of such properties, net of related income, and gains and losses on their disposition are included in noninterest expense.
INCOME TAXES - Bancshares files a consolidated federal income tax return with its subsidiaries. Each computes income taxes as if it filed a separate return and remits to, or is reimbursed by Bancshares based on the portion of taxes currently due or refundable.
Deferred income taxes are accounted for by applying statutory tax rates in effect at the balance sheet date to differences between the book basis and the tax basis of assets and liabilities. The resulting deferred tax assets and liabilities are adjusted to reflect changes in enacted tax laws or rates.
Realization of net deferred tax assets is dependent on generating sufficient future taxable income. Although realization is not assured, management believes it is more likely than not that all of the
net deferred tax assets will be realized. The amount of the net deferred tax asset considered realizable, however, could be reduced in the near term if estimates of future taxable income are reduced.
STOCK-BASED COMPENSATION - The Company accounts for stock-based employee compensation plans using the intrinsic value-based method of accounting as permitted and discloses pro forma information assuming the fair value-based method as prescribed by SFAS No. 123.
PROFIT SHARING PLAN - The Company has a profit sharing plan that covers substantially all employees. Contributions are accrued and funded currently.
STATEMENTS OF CASH FLOWS - For purposes of the statements of cash flows, cash and cash equivalents are defined as cash, due from banks and federal funds sold. Generally, federal funds are sold for one-day periods.
EARNINGS PER SHARE - Basic earnings per share is computed using the weighted average number of shares outstanding. Diluted earnings per share is computed using the weighted average number of shares outstanding adjusted for the incremental shares issuable upon conversion of preferred stock and issuable upon exercise of outstanding stock options.
COMPREHENSIVE INCOME - Comprehensive income includes all changes in equity during the period presented that result from transactions and other econmic events other than transactions with shareholders. The Company reports comprehensive income in the consolidated statements of shareholders' equity.
SEGMENT INFORMATION - The Company considers its business as two operating segments: commercial banking and mortgage banking. The company has disclosed separately results of operations relating to the two segments in Note S to the consolidated financial statements.
RECLASSIFICATIONS - Certain reclassifications have been made to prior year amounts to conform to current year presentation. All reclassifications have been applied consistently for the periods presented.
RECENT ACCOUNTING STANDARDS - Effective October 1, 2000, the Company adopted SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities" which establishes accounting and reporting standards for derivative instruments and requires that an entity recognize all derivatives as either assets or liabilities in the balance sheet and measure those instruments at fair value. Upon implementation of SFAS No. 133, $56.1 million of securities classified as held-to-maturity were redesignated as available-for-sale or trading. The securities had a fair value of $56.1 million. The company has no derivative instruments. Management believes the implementation of this pronouncement did not have any other material effect on the Company's financial statements.
Effective January 1, 2000, the Company adopted SFAS No. 140, "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities". This Statement provides accounting and reporting standards for transfers and servicing of financial assets and extinguishments of liabilities. Those standards are based on consistent application of a financial-components approach that focuses on control. Under that approach, after a transfer of financial assets, an entity recognizes the financial and servicing assets it controls and the liabilities it has incurred, derecognizes financial assets when control has been surrendered, and derecognizes liabilities when extinguished. This Statement provides consistent standards for distinguishing transfers of financial assets that are sales from transfers that are secured borrowings. Management
believes the implementation of this pronouncement did not have a material effect on the Company's financial statements.
B. ACQUISITIONS
The following table shows transactions that have been accounted for using the pooling of interests method. The consolidated financial statements have been restated to present the combined financial information of the Company and the acquired entities. There were no material adjustments to the net assets of the acquired entities as a result of adopting the same accounting practices as the Company.
(1) Hometown Bancshares, Inc. was the bank holding company for Clear Lake National Bank. (2) B.O.A. Banchares, Inc. was the bank holding company for Houston Commerce Bank.
On July 2, 1998, the Company acquired an additional 40 percent of Sterling Capital Mortgage Company ("SCMC") in exchange for 296,287 shares of the Company's common stock valued at approximately $4.6 million. As a result of the transaction, the Company owned 80 percent of SCMC. The transaction has been accounted for as a purchase. This transaction resulted in $4.7 million in goodwill, which is being amortized over 20 years. The results of operations from SCMC are included in the consolidated statements of the Company beginning July 2, 1998. If the results of operations of SCMC had been included in consolidated income as though the acquisition of the additional 40 percent had occurred January 1, 1998, there would have been no material change in reported net income and earnings per share for 1998.
On March 22, 2001, the Company acquired CaminoReal Bancshares of Texas, Inc. ("CaminoReal") and its subsidiary bank, CaminoReal Bank, National Association, for an aggregate cash purchase price of $51.8 million. CaminoReal Bank has four banking offices in San Antonio, Texas and four banking offices in the south Texas cities of Eagle Pass, Carrizo Springs, Crystal City and Pearsall. The Company anticipates completing operational integration of CaminoReal Bank and Sterling Bank in the second quarter of 2001.
C. CASH AND CASH EQUIVALENTS
The Bank is required by the Board of Governors of the Federal Reserve System (the "FRB") to maintain average reserve balances. "Cash and cash equivalents" in the consolidated balance sheets includes amounts so restricted of approximately $500 thousand at December 31, 2000 and December 31, 1999.
D. SECURITIES
The amortized cost and fair value of securities are as follows (in thousands):
The amortized cost and fair value of securities at December 31, 2000, by contractual maturity, are shown below. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties. All amounts are shown in thousands.
The Company does not own any securities of any one issuer (other than the U.S. government and its agencies) of which aggregate adjusted cost exceeds 10% of the consolidated shareholders' equity at December 31, 2000 or 1999.
Securities with carrying values totaling $235.7 million and fair values totaling $237.0 million at December 31, 2000 were pledged to secure public deposits, securities sold under repurchase agreements and Federal Home Loan Bank advances.
E. LOANS
The loan portfolio consists of various types of loans made principally to borrowers located in the Houston metropolitan area, and is classified by major type as follows (in thousands):
DECEMBER 31, --------------------------- 2000 1999 ---------- ---------- Commercial, financial and industrial $ 435,676 $ 411,324 Real estate - commercial 402,765 339,593 Real estate - mortgage 145,784 137,848 Real estate - construction 122,800 110,850 Consumer 116,828 119,463 Foreign commercial and industrial 4,807 5,917 Unearned premium (discount) 321 (418) ---------- ---------- Total loans held for investment 1,228,981 1,124,577 Loans held for sale 139,148 70,404 ---------- ---------- Total loans $1,368,129 $1,194,981 ========== ==========
The recorded investment in impaired loans under SFAS No. 114 is approximately $46.8 million and $30.8 million, at December 31, 2000 and 1999, respectively. Under SFAS No. 114, such impaired loans required an allowance for credit losses of approximately $8.7 million and $6.7 million, respectively.
The average recorded investment in impaired loans for the years ended December 31, 2000, 1999 and 1998 was $39.7 million, $28.1 million and $20.1 million, respectively.
Loan maturities and rate sensitivity of the loan portfolio, excluding real estate - mortgage, consumer and foreign loans and unearned discount, at December 31, 2000 are as follows (in thousands):
As of December 31, 2000 and 1999, loans outstanding to directors, officers and their affiliates were approximately $11.0 million and $10.6 million, respectively. In the opinion of management, all transactions entered into between the Bank and such related parties have been and are, in the ordinary course of business, made on the same terms and conditions as similar transactions with unaffiliated persons.
An analysis of activity with respect to these related-party loans is as follows (in thousands):
YEAR ENDED DECEMBER 31, ------------------- 2000 1999 -------- ------- Beginning balance $10,632 $ 7,764 New loans and reclassified related loans 8,810 8,621 Repayments (8,422) (5,753) ------- ------- Ending balance $11,020 $10,632 ======= =======
F. NONACCRUAL, PAST-DUE AND RESTRUCTURED LOANS
The following table presents information relating to nonaccrual, past-due and restructured loans (in thousands):
YEAR ENDED DECEMBER 31, ------------------ 2000 1999 ------ ------ Nonaccrual loans $8,081 $5,501 Loans 90 days or more past due, not on nonaccrual status 604 351 Restructured loans, performing 1,298 218 ------ ------ $9,983 $6,070 ====== ======
As of December 31, 2000 and 1999, interest foregone on nonaccrual loans was $463 thousand and $356 thousand, respectively.
G. ALLOWANCE FOR CREDIT LOSSES
An analysis of activity in the allowance for credit losses is as follows (in thousands):
YEAR ENDED DECEMBER 31, ---------------------------------- 2000 1999 1998 ------- ------- ------- Balance at beginning of year $13,187 $10,829 $ 8,278 Provisions 9,100 8,643 6,232 Loans charged off 7,453 7,120 4,288 Loan recoveries (859) (835) (607) ------- ------- ------- Net loans charged off 6,594 6,285 3,681 ------- ------- ------- Balance at end of year $15,693 $13,187 $10,829 ======= ======= =======
H. PREMISES AND EQUIPMENT
Premises and equipment are summarized as follows (in thousands):
DECEMBER 31, -------------------- 2000 1999 -------- ------- Land $ 9,679 $ 9,646 Buildings and improvements 30,981 27,896 Furniture, fixtures and equipment 35,412 29,243 ------- ------- 76,072 66,785
Less accumulated depreciation and amortization 31,238 25,782 ------- ------- Total $44,834 $41,003 ======= =======
I. DEPOSITS
Included in certificates of deposit and other time deposits are certificates of deposit in amounts of $100,000 or more. The remaining maturities of these certificates are summarized as of December 31, 2000 as follows (in thousands):
Three months or less $145,014 Four through six months 50,502 Seven through twelve months 37,163 Thereafter 15,476 -------- $248,155 ========
Interest expense for certificates of deposit in excess of $100,000 was approximately $12.0 million, $8.4 million, and $8.1 million for the years ended December 31, 2000, 1999 and 1998, respectively.
The Bank has no brokered deposits and there are no major concentrations of deposits.
J. OTHER BORROWED FUNDS
Other borrowed funds are summarized as follows (in thousands):
The Bank has an available line of credit with the Federal Home Loan Bank of Dallas, which allows the Bank to borrow on a collateralized basis. At December 31, 2000, the Bank had $128 million, bearing an interest rate of 6.74%, borrowed under this line of credit, with a maturity of four days. This amount was repaid in January 2001.
Securities sold under agreements to repurchase generally mature within one to four days from the transaction date. Information concerning securities sold under agreements to repurchase is summarized as follows (dollars in thousands):
2000 1999 -------- -------- Average balance during the year $ 10,124 $ 11,038 Average interest rate during the year 5.52% 4.16% Maximum month-end balance during the year $ 8,745 $ 11,553 Average interest rate at the end of the year 5.94% 4.82%
At December 31, 2000, the Bank has two promissory notes outstanding bearing an interest rate of 5.81%. These notes matured and were repaid in February 2001.
Finally, the Bank has available lines for federal funds purchased at correspondent banks. These funds are generally outstanding for periods of less than one week. As of December 31, 2000, there were no outstanding balances related to these lines.
K. TRUST PREFERRED SECURITIES
In June 1997, the Company formed Sterling Bancshares Capital Trust I, a trust formed under the laws of the State of Delaware (the "Trust"). The Trust issued $28,750,000 of 9.28% Trust Preferred Securities and invested the proceeds thereof in the 9.28% Junior Subordinated Deferrable Interest Debentures (the "Junior Subordinated Debentures") issued by the Company. The Junior Subordinated Debentures will mature on June 6, 2027, which date may be shortened to a date not earlier than June 6, 2002 if certain conditions are met (including the Company having received prior approval of the Federal Reserve and any other required regulatory approvals). The Trust Preferred Securities will be subject to mandatory redemption if the Junior Subordinated Debentures are repaid by the Company. The Junior Subordinated Debentures may be prepaid if certain events occur, including a change in the tax status or regulatory capital treatment of the Trust Preferred Securities. In each case, redemption will be made at par, plus the accrued and unpaid distributions thereon through the redemption date.
L. INCOME TAXES
The components of the provision for income taxes follow (in thousands):
YEAR ENDED DECEMBER 31, ----------------------------------- 2000 1999 1998 ------ --------- ------ Current expense $12,474 $11,363 $ 9,961 Deferred benefit (193) (1,698) (1,051) ------- ------- ------- Total $12,281 $ 9,665 $ 8,910 ======= ======= =======
The provision for income taxes differs from the amount computed by applying the federal income tax statutory rate on operations as follows (in thousands):
Significant deferred tax assets and liabilities at December 31, 2000 and 1999, were as follows (in thousands):
M. EMPLOYEE BENEFITS
PROFIT SHARING PLAN - The Company's profit sharing plan includes substantially all employees. Contributions to the plan are made at the discretion of the Board of Directors but generally equal up to 10% of the Company's pretax income, subject to IRS limitations. Employee contributions to 401(K) plan accounts are optional. Beginning in 1997, the Company matched 50 percent of the employee's contribution, up to 6 percent of the employee's base pay. Profit sharing contributions are accrued and funded currently. Total profit sharing expense for 2000, 1999 and 1998 was approximately $2.9 million, $2.5 million, and $2.3 million, respectively.
STOCK-BASED COMPENSATION - During April 1994, the Company adopted the "1994 Stock Incentive Plan" (the "Stock Plan"). The Stock Plan provides for a maximum of 2,000,000 shares of the Company's common stock to be issued. No options or performance shares may be granted under the Stock Plan after April 2004. Options are granted to officers and employees at exercise prices determined by the Compensation Committee of the Board of Directors. These options generally have exercise prices equal to the fair market value of the common stock at the date of grant and vest ratably over a four-year period. Options granted under the plan must be exercised not later than ten years from the date of grant. Stock grant awards may also be made under the Stock Plan with compensation expense recognized for any stock grant awards. A total of 4,250, 200, and 1,400 stock grants were awarded under the Stock Plan during 2000, 1999 and 1998, respectively.
A summary of changes in outstanding options, as restated for stock splits, is as follows (shares in thousands):
If compensation cost for the Company's stock-based compensation plan had been determined based on the fair value at the grant dates for awards, there would have been no material impact on the Company's reported net income or earnings per share.
The fair value of options at date of grant was estimated using the Black- Scholes option-pricing model with the following weighted-average assumptions:
2000 1999 1998 ---- ---- ----- Expected life (years) 5.17 5.51 7.57 Risk free interest rate 5.03% 6.63% 4.64% Volatility 28.97% 26.88% 26.23% Dividend yield 1.11% 1.79% 1.19%
STOCK PURCHASE PLAN - The Company offers the 1994 Employee Stock Purchase Plan (the "Purchase Plan"), which is a compensatory benefit plan, to all employees who are employed for more than 20 hours per week and meet minimum length-of-service requirements of three months. The Purchase Plan provides for an aggregate of 675,000 shares of the Company's common stock to be issued under the Plan with no more than 67,500 shares available during any annual offering. The purchase price for shares available under the Purchase Plan is equal to the fair market value on the date of the offering. During 2000 and 1999, 4,311 and 5,091 shares, respectively, were purchased and 7,426 and 21,298 shares, respectively, were subscribed for through payroll deduction for a maximum of two years. Shares are issued upon full payment.
N. SHAREHOLDERS' EQUITY
STOCK SPLITS - The Board of Directors declared stock splits effected in the form of stock dividends as follows:
DECLARATION DATE SPLIT RATIO DISTRIBUTION DATE ------------------- ----------------- ----------------------- January 26, 1998 3-for-2 February 20, 1998
PREFERRED STOCK - The Board of Directors has approved the sale of convertible preferred stock in series pursuant to confidential private placement memoranda upon the opening of various banking offices. The shares are sold to investors who may assist in the business development efforts of the opening office and are convertible to common shares dependent on that banking office meeting certain performance and deposit growth goals. During 2000, 77,000 shares of preferred stock under Series E, Series F and Series G issued in 1998 were converted into 92,750 common shares. At December 31, 2000, there are 50,500 convertible preferred shares outstanding. These shares are convertible into a maximum of 63,125 shares of common stock if the performance and deposit growth goals of the banking offices are achieved.
O. EARNINGS PER COMMON SHARE
Earnings per common share was computed based on the following (in thousands, except per share data):
The incremental shares for the assumed exercise of the outstanding options was determined by application of the treasury stock method. The incremental shares for the conversion of the preferred stock was determined assuming applicable performance goals had been met.
P. COMMITMENTS AND CONTINGENCIES
LEASES - A summary as of December 31, 2000, of noncancelable future operating lease commitments follows (in thousands):
2001 $ 2,526 2002 2,508 2003 2,658 2004 2,448 2005 1,838 Thereafter 7,632 ------- Total $19,610 =======
Rent expense under all noncancelable operating lease obligations, net of income from noncancelable subleases aggregated, was approximately $3.6 million, $2.2 million, and $1.5 million for the years ended December 31, 2000, 1999 and 1998, respectively.
LITIGATION - The Company has been named as a defendant in various legal actions arising in the normal course of business. In the opinion of management, after reviewing such claims with outside counsel, resolution of such matters will not have a materially adverse impact on the consolidated financial statements.
Q. FINANCIAL INSTRUMENTS WITH OFF-BALANCE SHEET RISK
The Bank is a party to various financial instruments with off-balance sheet risk in the normal course of business to meet the financial needs of its customers. These financial instruments include commitments to extend credit and standby letters of credit. These instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amounts recognized in the consolidated balance sheets. The Bank's exposure to credit loss in the event of nonperformance by
the other party to the financial instrument for commitments to extend credit is represented by the contractual notional amount of these instruments. The Bank uses the same credit policies in making these commitments and conditional obligations as it does for on-balance sheet instruments.
The following is a summary of the various financial instruments entered into by the Bank (in thousands):
DECEMBER 31, ------------------- 2000 1999 ---- ---- Financial instruments whose contract amount represents credit risk: Commitments to extend credit $206,810 $171,362 Standby letters of credit 19,191 12,530 Mortgages sold with recourse 383,301 186,881
Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments are expected to expire without being fully drawn upon, the total commitment amounts disclosed above do not necessarily represent future cash requirements.
The Bank evaluates each customer's creditworthiness on a case-by-case basis. The amount of collateral obtained, if considered necessary by the Bank upon extension of credit, is based on management's credit evaluation of the customer.
Standby letters of credit are conditional commitments issued by the Bank to guarantee the performance of a customer to a third party. The credit risk to the Bank in issuing letters of credit is essentially the same as that involved in extending loan facilities to its customers.
The Bank's mortgage subsidiary, SCMC, sells mortgages in the secondary market. A portion of these loans are sold with recourse for a period which generally does not exceed one year.
R. REGULATORY MATTERS
CAPITAL REQUIREMENTS - The Company is subject to various regulatory capital requirements administered by the federal banking agencies. Any institution that fails to meet its minimum capital requirements is subject to actions by regulators that could have a direct material effect on its financial statements. Under the capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank must meet specific capital guidelines based on the Bank's assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices. The Company's capital amount and the Bank's classification under the regulatory framework for prompt corrective action are also subject to qualitative judgments by the regulators.
To meet the capital adequacy requirements, the Company must maintain minimum capital amounts and ratios as defined in the regulations. Management believes, as of December 31, 2000 and 1999, that the Company and the Bank met all capital adequacy requirements to which they are subject.
As of December 31, 2000, the most recent notification categorized the Bank as "well capitalized" under the regulatory capital framework for prompt corrective action and there have been no events since that notification that management believes have changed the Bank's category. To be
categorized as well capitalized, the Bank must maintain minimum total risk- based, Tier I risk-based, and Tier I leverage ratios as set forth in the table:
DIVIDEND RESTRICTIONS - Dividends paid by the Bank and the Company are subject to certain restrictions imposed by regulatory agencies. Under these restrictions there was an aggregate of approximately $72.5 million and $51.4 million available for payment of dividends at December 31, 2000, by the Bank and the Company, respectively.
S. SEGMENTS
The Company has two operating segments: commercial banking and mortgage banking. Each segment is managed separately because each business requires different marketing strategies and each offers different products and services.
The accounting policies of the segments are the same as those described in Note A. The Company evaluates each segment's performance based on the profit or loss from its operations before income taxes, excluding non-recurring items. Intersegment financing arrangements are accounted for at current market rates as if they were with third parties.
Summarized financial information by operating segment for the years ended December 31, 2000 and 1999 follows:
Intersegment interest was paid to Sterling Bank by SCMC in the amount of $7.4 million and $4.1 million for the years ended December 31, 2000 and 1999, respectively. Total loans in the mortgage warehouse of $136.0 million and $70.4 million were eliminated in consolidation at December 31, 2000 and 1999, respectively.
T. DISCLOSURES ABOUT FAIR VALUE OF FINANCIAL STATEMENTS
Fair values were estimated by management as of December 31, 2000 and 1999, and required considerable judgment. Accordingly, the estimates presented herein are not necessarily indicative of the amounts the Company 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 values presented.
The following methods and assumptions were used to estimate the fair value of cash and of financial instruments for which it is practicable to estimate that value:
SHORT-TERM INVESTMENTS - For short-term investments, the carrying amount is a reasonable estimate of fair value.
SECURITIES - For securities held as investment, fair value equals quoted market prices, if available. If a quoted market price is not available, fair value is estimated using quoted market prices for similar securities.
LOANS HELD FOR SALE - For loans held for sale, fair value equals quoted market prices, if available. If a quoted market price is not available, the fair value is estimated by discounting the future cash flows using the current rates at which similar loans would be made to borrowers with similar credit ratings and for the same remaining maturities.
LOANS HELD FOR INVESTMENT - The fair value of loans is estimated by discounting the future cash flows using the current rates at which similar loans would be made to borrowers with similar credit ratings and for the same remaining maturities.
DEPOSIT LIABILITIES - The fair value of demand deposits, savings accounts and certain money market deposits is the amount payable on demand at the reporting date. The fair value of certificates of deposit is estimated using the rates currently offered for deposits of similar remaining maturities.
OTHER BORROWED FUNDS - The carrying amounts approximate fair value because these borrowings reprice at market rates generally within four days.
COMMITMENTS TO EXTEND CREDIT, STANDBY LETTERS OF CREDIT AND FINANCIAL GUARANTEES WRITTEN - The fair value of commitments is estimated using the fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the present creditworthiness of the counterparties. For fixed-rate loan commitments, fair value also considers the difference between current levels of interest rates and the committed rates. The fair value of guarantees and letters of credit is based on fees currently charged for similar agreements or on the estimated cost to terminate them or otherwise settle the obligations with the counterparties at the reporting date.
The estimated fair values of the Company's financial instruments are as follows (in thousands):
U. SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED)
The table below sets forth unaudited financial information for each quarter of the last two years (in thousands, except per share amounts):
Earnings per common share are computed independently for each of the quarters presented and therefore may not sum to the totals for the year.
All quarters have been restated to present the combined financial information of acquisitions accounted for using the pooling of interests method.
V. SUBSEQUENT EVENTS
On March 1, 2001, Sterling Bancshares, Inc. announced that it has entered into a definitive merger agreement to acquire Houston based Lone Star Bancorporation, Inc., and its subsidiary bank, Loan Star Bank in a stock-for- stock merger. The merger agreement provides that the shareholders of Lone Star Bancorporation, Inc. will receive an aggregate of 1,760,000 shares of common stock of Sterling for all of the outstanding common stock, assuming that all outstanding Lone Star stock options are exercised. As of December 31, 2000, Lone Star Bancorporation, Inc. had total assets of $152 million, loans of $117 million, and deposits of $141 million. The proposed merger is subject to customary closing conditions, including receipt of all requisite regulatory approval and the approval of Lone Star's shareholders and a determination that the transaction will qualify for pooling accounting treatment.
In February 2001, the Company formed Sterling Bancshares Capital Trust II ("Trust II") and Sterling Bancshares Capital Trust III, each trust formed under the laws of the State of Delaware. Trust II issued $28,750,000 of 9.20% Trust Preferred Securities and invested the proceeds thereof in the 9.20% Junior Subordinated Deferrable Interest Debentures (the "Junior Subordinated Debentures") issued by the Company. The Junior Subordinated Debentures will mature on March 21, 2031, which date may be shortened to a date not earlier than March 21, 2006 if certain conditions are met (including the Company having
received prior approval of the Federal Reserve and any other required regulatory approvals). The Trust Preferred Securities will be subject to mandatory redemption if the Junior Subordinated Debentures are repaid by the Company. The Junior Subordinated Debentures may be prepaid if certain events occur, including a change in the tax status or regulatory capital treatment of the Trust Preferred Securities. In each case, redemption will be made at par, plus the accrued and unpaid distributions thereon through the redemption date.
On March 22, 2001, Sterling Bank, Inc. acquired CaminoReal Bancshares of Texas, Inc., based in San Antonio, Texas and its subsidiary bank, CaminoReal Bank, National Association. CaminoReal Bancshares is privately held and is the bank holding company of CaminoReal, National Association, which operates four banking offices in San Antonio and four banking offices in the south Texas cities of Eagle Pass, Carrizo Springs, Crystal City and Pearsall. This acquisition will be accounted for using the purchase method of accounting.
STERLING BANCSHARES, INC. (PARENT COMPANY ONLY)
STATEMENTS OF CASH FLOWS FOR THE YEARS ENDED DECEMBER 31, 2000, 1999 AND 1998 (IN THOUSANDS)