ITEM 1. BUSINESS
SPECIAL CAUTIONARY NOTICE REGARDING FORWARD-LOOKING STATEMENTS
Certain of the matters discussed in this document and in documents incorporated by reference herein, including matters discussed under the caption "Management's Discussion and Analysis of Financial Condition and Results of Operations," may constitute forward-looking statements for purposes of the Securities Act of 1933, as amended, and the Securities Exchange Act of 1934, as amended, and as such may involve known and unknown risks, uncertainties and other factors which may cause the actual results, performance or achievements of Southwest Bancorporation of Texas, Inc. (the "Company") to be materially different from future results, performance or achievements expressed or implied by such forward-looking statements. The words "expect," "anticipate," "intend," "plan," "believe," "seek," "estimate," and similar expressions are intended to identify such forward-looking statements. The Company's actual results may differ materially from the results anticipated in these forward-looking statements due to a variety of factors, including, without limitation: (a) the effects of future economic conditions on the Company and its customers; (b) governmental monetary and fiscal policies, as well as legislative and regulatory changes; (c) the risks of changes in interest rates on the level and composition of deposits, loan demand, and the values of loan collateral, securities and interest rate protection agreements, as well as interest rate risks; (d) the effects of competition from other commercial banks, thrifts, mortgage banking firms, consumer finance companies, credit unions, securities brokerage firms, insurance companies, money market and other mutual funds and other financial institutions operating in the Company's market area and elsewhere, including institutions operating locally, regionally, nationally and internationally, together with such competitors offering banking products and services by mail, telephone, computer and the Internet; and (e) the failure of assumptions underlying the establishment of reserves for loan losses and estimations of values of collateral and various financial assets and liabilities and technological changes are more difficult or expensive than anticipated. All written or oral forward-looking statements attributable to the Company are expressly qualified in their entirety by these cautionary statements.
THE COMPANY
GENERAL. The Company was incorporated as a business corporation under the laws of the State of Texas on March 28, 1996, for the purpose of serving as a bank holding company for Southwest Bank of Texas National Association (the "Bank"). The holding company formation was consummated and the Company acquired all of the outstanding shares of capital stock of the Bank as of the close of business on June 30, 1996. Based upon total assets as of December 31, 2000, the Company ranks as the largest independent bank holding company headquartered in the Houston metropolitan area. The Company's headquarters are located at 4400 Post Oak Parkway, Houston, Texas 77027, and its telephone number is (713) 235-8800.
MERGERS AND ACQUISITIONS. On August 1, 1997, Pinemont Bank was merged with and into the Bank in exchange for approximately 3.3 million shares of Company Common Stock in a transaction accounted for as a pooling-of-interests. The acquisition of Pinemont Bank added $235 million in total assets and $219 million in total deposits to the Company's balance sheet and nine banking locations to the Company's operations.
On April 1, 1999, Fort Bend Holding Corp. was merged with and into the Company and Fort Bend's subsidiary savings and loan association was merged with and into the Bank in exchange for approximately 4.1 million shares of Company Common Stock in a transaction accounted for as a pooling-of-interests. The acquisition of Fort Bend Holding Corp. added $316 million in total assets and $269 million in total deposits to the Company's balance sheet and seven banking locations to the Company's operations.
Through the merger with Fort Bend, the Company acquired Fort Bend's 51% ownership interest in Mitchell Mortgage Company L.L.C. ("Mitchell"), a full service mortgage banking affiliate of The Woodlands Operating Company
L.P. ("Woodlands"). On June 17, 1999, the Company issued 307,323 shares of Company Common Stock to Woodlands in exchange for Woodlands' 49% ownership interest in Mitchell and Mitchell became a wholly-owned subsidiary of the Bank effective as of June 30, 1999. As a result, 100% of the accounts and operations of Mitchell after that date are included in the financial statements of the Company.
On December 29, 2000, Citizens Bankers, Inc. was merged with and into the Company and the three wholly-owned subsidiary banks of Citizens Bankers, Inc. were merged with and into the Bank (and the assets and liabilities of a related partnership were acquired by the Bank) in exchange for approximately 4.0 million shares of Company Common Stock in a transaction accounted for as a pooling-of-interests. The acquisition of Citizens Bankers, Inc. added $436 million in total assets and $381 million in total deposits to the Company's balance sheet and seven banking locations to the Company's operations. See "Item 5.-- Recent Sales of Unregistered Securities" for additional information on the Company's merger with Citizens Bankers, Inc.
BUSINESS STRATEGY. The Company provides an array of sophisticated products typically found only in major regional banks. These services are provided to middle market businesses in the Houston metropolitan area through 33 full service banking facilities. Each banking office has seasoned management with significant lending experience who exercises substantial autonomy over credit and pricing decisions, subject to loan committee approval for larger credits. This decentralized management approach, coupled with the continuity of service by the same staff members, enables the Company to develop long-term customer relationships, maintain high quality service and provide quick responses to customer needs. The Company believes that its emphasis on local relationship banking, together with its conservative approach to lending and resultant strong asset quality, are important factors in the success and the growth of the Company.
The Company seeks credit risks of good quality within its target market that exhibit positive historical trends, stable cash flows and secondary sources of repayment from tangible collateral. The Company extends credit for the purpose of obtaining and continuing long term relationships. Lenders are provided with detailed underwriting policies for all types of credit risks accepted by the Company and must obtain appropriate approvals for credit extensions in excess of conservatively assigned individuals' lending limits. The Company also maintains strict documentation requirements and extensive credit quality assurance practices in order to identify credit portfolio weaknesses as early as possible so any exposures that are discovered might be reduced.
The Company has a three-part strategy for growth. First, the Company will continue to actively target the "middle market" and private banking customers in Houston for loan and deposit opportunities as it has successfully done for the past ten years. The "middle market" is generally characterized by privately owned companies having annual revenues ranging from $1 million to $500 million and borrowings ranging from $50,000 to $10 million, but primarily in the $150,000 to $5 million range. Typical middle market customers seek a relationship with a local independent bank that is sensitive to their needs and understands their business philosophy. These customers desire a long-term relationship with a decision-making loan officer who is responsive and experienced and has ready access to a bank's senior management. In implementing this part of its strategy, the Company continues to explore opportunities (i) to solidify its existing customer relationships and build new customer relationships by providing new services required by its middle market customers and (ii) to expand its base of services in the professional and executive market to meet the demands of that sector.
Second, the Company intends to establish branches in areas that demographically complement its existing or targeted customer base. As other local banks are acquired by out-of-state organizations, the Company believes that the establishment of branches will better meet the needs of customers in many Houston area neighborhoods who feel disenfranchised by larger regional or national organizations.
Third, the Company may pursue selected acquisitions of other financial institutions. The Company intends to conduct thorough studies and reviews of any possible acquisition candidates to assure that they are consistent with the Company's existing goals, both from an economic and strategic perspective. The Company believes market and regulatory factors may present opportunities for the Company to acquire other financial institutions.
THE BANK
The Bank provides a complete range of retail and commercial banking services that compete directly with major regional banks. Loans consist of commercial loans to middle market businesses, loans to individuals, commercial real estate loans, residential mortgages and construction loans. The Bank also originates and purchases residential and commercial mortgage loans to sell to investors with servicing rights retained. The Bank also promotes residential and commercial construction financing to builders and developers and acts as a broker in the origination of multi-family and commercial real estate loans. In addition, the Bank offers a broad array of fee income products including merchant card services, letters of credit, accounts receivable financing, customized cash management services, brokerage and mutual funds, trust and private banking activities.
The Bank maintains a staff of professional treasury management marketing officers who consult with middle market companies to design custom cost-effective cash management systems. The Bank offers a full product line of cash concentration, disbursement and automated information reporting services and a full suite of Internet products comparable to those offered by any major regional bank. Through the Bank's continued investment in new technology and people, the Bank has been able to attract some of Houston's largest middle market companies to utilize the Bank's treasury management products. The Bank has also been able to attract new loan customers through use of the Bank's treasury management products, such as an image-based lock box service and controlled disbursement and sweep products, which allow borrowers to minimize interest expense and convert excess operating funds into interest income. Through the use of an interactive terminal or personal computer, the Bank's NetStar system provides customers with instant access to all bank account information with multiple intraday updates. The Bank makes business communication more efficient through Electronic Data Interchange ("EDI"), which is an inter-organizational computer-to-computer exchange of business documentation in a standard computer-processable format. Through the use of EDI and electronic payments, the Bank can provide the customer with a paperless funds management system. Positive Pay, a service under which the Bank only pays checks listed on a legitimate "company issue" file, is another product which helps prevent check fraud. The Bank's average commercial customer uses five treasury management services. Because these services help customers improve their treasury operations and achieve new efficiencies in cash management, they are extremely useful in building and maintaining long-term relationships.
The Bank has a retail presence in 33 locations throughout the Houston metropolitan area. Such locations are emerging as an important source of bank funding and fee income. Retail products consist of both traditional deposit accounts such as checking, savings, money market accounts and certificates of deposit, and a wide array of consumer loan and electronic banking alternatives. The Bank is putting a strong emphasis on the cultivation of retail market opportunities and on its retail staff to help expand and deepen customer relationships.
The Bank maintains a strong community orientation by, among other things, supporting active participation of all employees in local charitable, civic, school and church activities. Several banking offices also appoint selected customers to a business development board that assists in introducing prospective customers to the Bank and in developing or modifying products and services to better meet customer needs.
COMPETITION
The banking business is highly competitive, and the profitability of the Company will depend principally upon the Company's ability to compete in its market area. The Company competes with other commercial and savings banks, savings and loan associations, credit unions, finance companies, mutual funds, insurance companies, brokerage and investment banking firms, asset-based non-bank lenders and certain other non-financial institutions, including certain governmental organizations which may offer subsidized financing at lower rates than those offered by the Company. The Company has been able to compete effectively with other financial institutions by emphasizing technology and customer service, including local office decision-making on loans, establishing long-term customer relationships and building customer loyalty, and by providing products and services designed to address the specific needs of its customers.
The success of the Company is also highly dependent on the economic strength of the Company's general market area. Significant deterioration in the local economy or economic problems in the greater Houston area could substantially impact the Company's performance. In addition, the enactment of the Gramm-Leach-Bliley Act (see discussion below) which breaks down many barriers between the banking, securities and insurance industries, may significantly affect the competitive environment in which the Company operates.
EMPLOYEES
As of December 31, 2000, the Company had 1,313 full-time employees, 415 of whom were officers of the Bank. The Company provides medical and hospitalization insurance to its full-time employees. The Company has also provided most of its employees with the benefit of Common Stock ownership through the Company's contributions to a 401(k) plan, in which 879 of its employees are currently participating. The Company considers its relations with its employees to be excellent.
SUPERVISION AND REGULATION
The federal banking laws contain numerous provisions affecting various aspects of the business and operations of the Company and the Bank. The following description or references herein to applicable statutes and regulations, which are not intended to be complete descriptions of these provisions or their effects on the Company or the Bank, are brief summaries and are qualified in their entirety by reference to such statutes and regulations.
THE BANK
As a national banking association, the Bank is principally supervised, examined and regulated by the Office of the Comptroller of the Currency (the "OCC"). The OCC regularly examines such areas as capital adequacy, reserves, loan portfolio, investments and management practices. The Bank must also furnish quarterly and annual reports to the OCC, and the OCC may exercise cease and desist and other enforcement powers over the Bank if its actions represent unsafe or unsound practices or violations of law. Since the deposits of the Bank are insured by the Bank Insurance Fund ("BIF") of the Federal Deposit Insurance Corporation (the "FDIC"), the Bank is also subject to regulation and supervision by the FDIC. Because the Board of Governors of the Federal Reserve System (the "Federal Reserve Board") regulates the Company, the Federal Reserve Board also has supervisory authority which affects the Bank.
RESTRICTIONS ON TRANSACTIONS WITH AFFILIATES AND INSIDERS. The Bank is subject to certain federal statutes limiting transactions with the Company and its nonbanking affiliates. Section 23A of the Federal Reserve Act affects loans or other credit extensions to, asset purchases from and investments in affiliates of the Bank. Such transactions with the Company or any of its nonbanking subsidiaries are limited in amount to ten percent of the Bank's capital and surplus and, with respect to the Company and all of its nonbanking subsidiaries together, to an aggregate of twenty percent of the Bank's capital and surplus. Furthermore, such loans and extensions of credit, as well as certain other transactions, are required to be secured in specified amounts.
In addition, Section 23B of the Federal Reserve Act requires that certain transactions between the Bank, including its subsidiaries, and its affiliates must be on terms substantially the same, or at least as favorable to the Bank or its subsidiaries, as those prevailing at the time for comparable transactions with or involving other nonaffiliated persons. In the absence of such comparable transactions, any transaction between the Bank and its affiliates must be on terms and under circumstances, including credit standards, that in good faith would be offered to or would apply to nonaffiliated persons. The Bank is also subject to certain prohibitions against any advertising that indicates the Bank is responsible for the obligations of its affiliates.
The restrictions on loans to directors, executive officers, principal shareholders and their related interests (collectively referred to herein as "insiders") contained in the Federal Reserve Act and Regulation O apply to all insured institutions and their subsidiaries and holding companies. These restrictions include limits on loans to one borrower and conditions that must be met before such loans can be made. There is also an aggregate limitation on all loans to insiders and their related interests. These loans cannot exceed the institution's total unimpaired capital and surplus,
and the OCC may determine that a lesser amount is appropriate. Insiders are subject to enforcement actions for knowingly accepting loans in violation of applicable restrictions.
INTEREST RATE LIMITS. Interest rate limitations for the Bank are primarily governed by the National Bank Act which generally defers to the laws of the state where the bank is located. Under the laws of the State of Texas, the maximum annual interest rate that may be charged on most loans made by the Bank is based on doubling the average auction rate, to the nearest 0.25%, for 26 week United States Treasury Bills, as computed by the Office of the Consumer Credit Commissioner of the State of Texas. However, the maximum rate does not decline below 18% or rise above 24% (except for loans in excess of $250,000 that are made for business, commercial, investment or other similar purposes in which case the maximum annual rate may not rise above 28%, rather than 24%). On fixed rate closed-end loans, the maximum non-usurious rate is to be determined at the time the rate is contracted, while on floating rate and open-end loans (such as credit cards), the rate varies over the term of the indebtedness. State usury laws (but not late charge limitations) have been preempted by federal law for loans secured by a first lien on residential real property.
EXAMINATIONS. The OCC periodically examines and evaluates national banks. Based upon such an evaluation, the OCC may revalue the assets of a national bank and require that it establish specific reserves to compensate for the difference between the OCC-determined value and the book value of such assets. Onsite examinations are to be conducted every 12 months, except that certain well capitalized banks may be examined every 18 months. The Federal Deposit Insurance Corporation Improvement Act of 1991 ("FDICIA") authorizes the OCC to assess the institution for its costs of conducting the examinations.
PROMPT CORRECTIVE ACTION. In addition to the capital adequacy guidelines, FDICIA requires the OCC to take "prompt corrective action" with respect to any national bank which does not meet specified minimum capital requirements. The applicable regulations establish five capital levels, ranging from "well capitalized" to "critically undercapitalized," which authorize, and in certain cases require, the OCC to take certain specified supervisory action. Under regulations implemented under FDICIA, a national bank is considered well capitalized if it has a total risk-based capital ratio of 10.0% or greater, a Tier 1 risk-based capital ratio of 8.0% or greater, and a leverage ratio of 5.0% or greater, and it is not subject to an order, written agreement, capital directive, or prompt corrective action directive to meet and maintain a specific capital level for any capital measure. A national bank is considered adequately capitalized if it has a total risk-based capital ratio of 8.0% or greater, a Tier 1 risk-based capital ratio of at least 4.0% and a leverage capital ratio of 4.0% or greater (or a leverage ratio of 3.0% or greater if the institution is rated composite 1 in its most recent report of examination, subject to appropriate federal banking agency guidelines), and the institution does not meet the definition of an undercapitalized institution. A national bank is considered undercapitalized if it has a total risk-based capital ratio that is less than 8.0%, a Tier 1 risk-based capital ratio that is less than 4.0%, or a leverage ratio that is less than 4.0% (or a leverage ratio that is less than 3.0% if the institution is rated composite 1 in its most recent report of examination, subject to appropriate federal banking agency guidelines). A significantly undercapitalized institution is one which has a total risk-based capital ratio that is less than 6.0%, a Tier 1 risk-based capital ratio that is less than 3.0%, or a leverage ratio that is less than 3.0%. A critically undercapitalized institution is one which has a ratio of tangible equity to total assets that is equal to or less than 2.0%. Under certain circumstances, a well capitalized, adequately capitalized or undercapitalized institution may be treated as if the institution were in the next lower capital category.
With certain exceptions, national banks will be prohibited from making capital distributions or paying management fees to a holding company if the payment of such distributions or fees will cause them to become undercapitalized. Furthermore, undercapitalized national banks will be required to file capital restoration plans with the OCC. Such a plan will not be accepted unless, among other things, the banking institution's holding company guarantees the plan up to a certain specified amount. Any such guarantee from a depository institution's holding company is entitled to a priority of payment in bankruptcy. Undercapitalized national banks also will be subject to restrictions on growth, acquisitions, branching and engaging in new lines of business unless they have an approved capital plan that permits otherwise. The OCC also may, among other things, require an undercapitalized national bank to issue shares or obligations, which could be voting stock, to recapitalize the institution or, under certain circumstances, to divest itself of any subsidiary.
The OCC is authorized by FDICIA to take various enforcement actions against any significantly undercapitalized national bank and any national bank that fails to submit an acceptable capital restoration plan or fails to implement a plan accepted by the OCC. These powers include, among other things, requiring the institution to be recapitalized, prohibiting asset growth, restricting interest rates paid, requiring primary approval of capital distributions by any bank holding company which controls the institution, requiring divestiture by the institution of its subsidiaries or by the holding company of the institution itself, requiring new election of directors, and requiring the dismissal of directors and officers.
Significantly and critically undercapitalized national banks may be subject to more extensive control and supervision. The OCC may prohibit any such institution from, among other things, entering into any material transaction not in the ordinary course of business, amending its charter or bylaws, or engaging in certain transactions with affiliates. In addition, critically undercapitalized institutions generally will be prohibited from making payments of principal or interest on outstanding subordinated debt. Within 90 days of a national bank becoming critically undercapitalized, the OCC must appoint a receiver or conservator unless certain findings are made with respect to the prospect for the institution's continued viability.
As of December 31, 2000, the Bank met the capital requirements of a "well capitalized" institution.
DIVIDENDS. There are certain statutory limitations on the payment of dividends by national banks. Without approval of the OCC, dividends may not be paid by the Bank in an amount in any calendar year which exceeds the Bank's total net profits for that year, plus its retained profits for the preceding two years, less any required transfers to capital surplus. In addition, a national bank may not pay dividends in excess of total retained profits, including current year's earnings after deducting bad debts in excess of reserves for losses. In some cases, the OCC may find a dividend payment that meets these statutory requirements to be an unsafe or unsound practice. Under FDICIA, the Bank cannot pay a dividend if it will cause the Bank to be undercapitalized.
FDIC INSURANCE ASSESSMENTS
Pursuant to FDICIA, the FDIC adopted a risk-based assessment system for insured depositary institutions that takes into account the risks attributable to different categories and concentrations of assets and liabilities. The risk-based system assigns an institution to one of three capital categories: (i) well-capitalized, (ii) adequately capitalized, or (iii) undercapitalized. These three categories are substantially similar to the prompt corrective action categories, with the "undercapitalized" category including institutions that are undercapitalized, significantly undercapitalized, and critically undercapitalized for prompt corrective action purposes. An institution is also assigned by the FDIC to one of three supervisory subgroups within each capital group. The supervisory subgroup to which an institution is assigned is based on an evaluation provided to the FDIC by the institution's primary federal regulator and information which the FDIC determines to be relevant to the institution's financial condition and the risk posed to the deposit insurance funds (which may include, if applicable, information provided by the institution's state supervisor). An institution's insurance assessment rate is then determined based on the capital category and supervisory category to which it is assigned.
Under the final risk-based assessment system there are nine assessment risk classifications (i.e., combinations of capital groups and supervisory subgroups) to which different assessment rates are applied. Assessment rates for deposit insurance currently range from zero basis points to 27 basis points. The supervisory subgroup to which an institution is assigned by the FDIC is confidential and may not be disclosed. A bank's rate of deposit insurance assessments will depend on the category and subcategory to which the bank is assigned by the FDIC. Any increase in insurance assessments could have an adverse effect on the earnings of insured institutions, including the Bank.
Under FDICIA, insurance of deposits may be terminated by the FDIC upon a finding that the institution has engaged in unsafe and unsound practices, is in an unsafe or unsound condition to continue operations, or has violated any applicable law, regulation, rule, order, or condition imposed by the FDIC. Management does not know of any practice, condition or violation that might lead to termination of deposit insurance.
CONSERVATOR AND RECEIVERSHIP POWERS. FDICIA significantly expanded the authority of the federal banking regulators to place depository institutions into conservatorship or receivership to include, among other things, appointment of
the FDIC as conservator or receiver of an undercapitalized institution under certain circumstances. In the event the Bank is placed into conservatorship or receivership, the FDIC is required, subject to certain exceptions, to choose the method for resolving the institution that is least costly to the BIF, such as liquidation.
BROKERED DEPOSIT RESTRICTIONS. The Financial Institutions Reform, Recovery and Enforcement Act of 1989 ("FIRREA") and FDICIA generally limit institutions which are not well capitalized from accepting brokered deposits. In general, undercapitalized institutions may not solicit, accept or renew brokered deposits. Adequately capitalized institutions may not solicit, accept or renew brokered deposits unless they obtain a waiver from the FDIC. Even in that event, they may not pay an effective yield of more than 75 basis points over the effective yield paid on deposits of comparable size and maturity in the institution's normal market area for deposits accepted from within that area, or the national rate paid on deposits of comparable size and maturity for deposits accepted from outside the institution's normal market area.
CONSUMER LAWS AND REGULATIONS. In addition to the laws and regulations discussed herein, the Bank is also subject to certain consumer laws and regulations that are designed to protect consumers in transactions with banks. While the list set forth herein is not exhaustive, these laws and regulations include the Truth in Lending Act, the Truth in Savings Act, the Electronic Funds Transfer Act, the Expedited Funds Availability Act, the Community Reinvestment Act, the Equal Credit Opportunity Act, and the Fair Housing Act, among others. These laws and regulations mandate certain disclosure requirements and regulate the manner in which financial institutions must deal with customers when taking deposits or making loans to such customers. The Bank must comply with the applicable provisions of these consumer protection laws and regulations as part of their ongoing customer relations.
Under Section 501 of the Gramm-Leach-Bliley Act (see discussion below), the federal banking agencies are required to establish appropriate standards for financial institutions regarding the implementation of safeguards to ensure the security and confidentiality of customer records and information, protection against any anticipated threats or hazards to the security or integrity of such records and protection against unauthorized access to or use of such records or information in a way that could result in substantial harm or inconvenience to a customer. The agencies have published a joint final rule which is effective July 1, 2001. Among other matters, the rule requires each bank to implement a comprehensive written information security program that includes administrative, technical and physical safeguards relating to customer information.
Under the Gramm-Leach-Bliley Act, a financial institution must provide its customers with a notice of privacy policies and practices. Section 502 prohibits a financial institution from disclosing nonpublic personal information about a consumer to nonaffiliated third parties unless the institution satisfies various notice and opt-out requirements and the customer has not elected to opt out of the disclosure. Under Section 504, the agencies are authorized to issue regulations as necessary to implement notice requirements and restrictions on a financial institution's ability to disclose nonpublic personal information about consumers to nonaffiliated third parties. In June 2000, the federal banking agencies issued a final rule, effective November 13, 2000, but compliance with which is optional until July 1, 2001. Under the rule, all banks must develop initial and annual privacy notices which describe in general terms the bank's information sharing practices. Banks that share nonpublic personal information about customers with nonaffiliated third parties must also provide customers with an opt-out notice and a reasonable period of time for the customer to opt out of any such disclosure (with certain exceptions). Limitations are placed on the extent to which a bank can disclose an account number or access code for credit card, deposit, or transaction accounts to any nonaffiliated third party for use in marketing.
THE COMPANY
The Company is a bank holding company registered under the Bank Holding Company Act of 1956 (the "BHCA"), and is subject to supervision and regulation by the Federal Reserve Board. The BHCA and other Federal laws subject bank holding companies to particular restrictions on the types of activities in which they may engage, and to a range of supervisory requirements and activities, including regulatory enforcement actions for violations of laws and regulations. As a bank holding company, the Company's activities and those of its banking and nonbanking subsidiaries have in the
past been limited to the business of banking and activities closely related or incidental to banking. Under new banking legislation (see discussion of Gramm-Leach-Bliley Act below), however, national banks will have broadened authority, subject to limitations on investment, to engage in activities that are financial in nature (other than insurance underwriting, merchant or insurance portfolio investment, real estate development and real estate investment) through subsidiaries if the bank is well capitalized, well managed and has at least a satisfactory rating under the Community Reinvestment Act.
Because the Company is a legal entity separate and distinct from its subsidiaries, its right to participate in the distribution of assets of any subsidiary upon the subsidiary's liquidation or reorganization will be subject to the prior claims of the subsidiary's creditors. In the event of a liquidation or other resolution of the Bank, the claims of depositors and other general or subordinated creditors of the Bank are entitled to a priority of payment over the claims of holders of any obligation of the institution to its shareholders, including any depository institution holding company (such as the Company) or any shareholder or creditor thereof.
SAFE AND SOUND BANKING PRACTICES. Bank holding companies are not permitted to engage in unsafe and unsound banking practices. For example, the Federal Reserve Board's Regulation Y requires a holding company to give the Federal Reserve Board prior notice of any redemption or repurchase of its own equity securities, if the consideration to be paid, together with the consideration paid for any repurchases or redemptions in the preceding year, is equal to 10% or more of the company's consolidated net worth. The Federal Reserve Board may oppose the transaction if it believes that the transaction would constitute an unsafe or unsound practice or would violate any law or regulation. As another example, a holding company could not impair its subsidiary bank's soundness by causing it to make funds available to nonbanking subsidiaries or their customers if the Federal Reserve Board believed it not prudent to do so.
FIRREA expanded the Federal Reserve Board's authority to prohibit activities of bank holding companies and their nonbanking subsidiaries which represent unsafe and unsound banking practices or which constitute violations of laws or regulations. Notably, FIRREA increased the amount of civil money penalties which the Federal Reserve Board can assess for certain activities conducted on a knowing and reckless basis, if those activities caused a substantial loss to a depository institution. The penalties can be as high as $1,000,000 for each day the activity continues. FIRREA also expanded the scope of individuals and entities against which such penalties may be assessed.
ANTI-TYING RESTRICTIONS. Bank holding companies and their affiliates are prohibited from tying the provision of certain services, such as extensions of credit, to other services offered by a holding company or its affiliates.
ANNUAL REPORTING; EXAMINATIONS. The Company is required to file an annual report with the Federal Reserve Board, and such additional information as the Federal Reserve Board may require pursuant to the BHCA. The Federal Reserve Board may examine a bank holding company or any of its subsidiaries, and charge the Company for the cost of such an examination.
CAPITAL ADEQUACY REQUIREMENTS. The Federal Reserve Board has adopted a system using risk-based capital guidelines to evaluate the capital adequacy of bank holding companies. Under the guidelines, specific categories of assets and certain off-balance sheet assets such as letters of credit are assigned different risk weights, based generally on the perceived credit risk of the asset. These risk weights are multiplied by corresponding asset balances to determine a "risk-weighted" asset base. The guidelines require a minimum total risk-based capital ratio of 8.0% (of which at least 4.0% is required to consist of Tier 1 capital elements).
In addition to the risk-based capital guidelines, the Federal Reserve Board uses a leverage ratio as an additional tool to evaluate the capital adequacy of bank holding companies. The leverage ratio is a company's Tier 1 capital divided by its total consolidated average assets. Bank holding companies must maintain a minimum leverage ratio of at least 3.0%, although most organizations are expected to maintain leverage ratios that are 100 to 200 basis points above this minimum ratio.
The federal banking agencies' risk-based and leverage ratios are minimum supervisory ratios generally applicable to banking organizations that meet certain specified criteria, assuming that they have the highest regulatory rating.
Banking organizations not meeting these criteria are expected to operate with capital positions well above the minimum ratios. The federal bank regulatory agencies may set capital requirements for a particular banking organization that are higher than the minimum ratios when circumstances warrant. Federal Reserve Board guidelines also provide that banking organizations experiencing internal growth or making acquisitions will be expected to maintain strong capital positions substantially above the minimum supervisory levels, without significant reliance on intangible assets. In addition, the regulations of the Federal Reserve Board provide that concentration of credit risk and certain risks arising from nontraditional activities, as well as an institution's ability to manage these risks, are important factors to be taken into account by regulatory agencies in assessing an organization's overall capital adequacy.
The Federal Reserve Board recently adopted amendments to its risk-based capital regulations to provide for the consideration of interest rate risk in the agencies' determination of a banking institution's capital adequacy.
GRAMM-LEACH-BLILEY ACT
Traditionally, the activities of bank holding companies have been limited to the business of banking and activities closely related or incidental to banking. On November 12, 1999, however, the Gramm-Leach-Bliley Act was signed into law which permits bank holding companies to engage in a broader range of financial activities. Specifically, bank holding companies may elect to become "financial holding companies" which may affiliate with securities firms and insurance companies and engage in other activities that are financial in nature or incidental to a financial activity. A bank holding company may become a financial holding company under the new statute only if each of its subsidiary banks is well capitalized, is well managed and has at least a satisfactory rating under the Community Reinvestment Act. A bank holding company that falls out of compliance with such requirement may be required to cease engaging in certain activities. Any bank holding company which does not elect to become a financial holding company remains subject to the current restrictions of the Bank Holding Company Act.
Under the new legislation, the Federal Reserve Board serves as the primary "umbrella" regulator of financial holding companies with supervisory authority over each parent company and limited authority over its subsidiaries. The primary regulator of each subsidiary of a financial holding company will depend on the type of activity conducted by the subsidiary. For example, broker-dealer subsidiaries will be regulated largely by securities regulators and insurance subsidiaries will be regulated largely by insurance authorities.
Under the Gramm-Leach-Bliley Act, among the activities that will be deemed "financial in nature" for "financial holding companies" are, in addition to traditional lending activities, securities underwriting, dealing in or making a market in securities, sponsoring mutual funds and investment companies, insurance underwriting and agency activities, activities which the Federal Reserve Board determines to be closely related to banking, and certain merchant banking activities.
In January 2001, the Federal Reserve Board and the Secretary of the Treasury promulgated final regulations governing the scope of permissible merchant banking investments which are those made under Section 4(k)(4)(H) of the Bank Holding Company Act, as amended by the Gramm-Leach-Bliley Act, which authorizes a financial holding company, directly or indirectly as principal or on behalf of one or more persons, to acquire or control any amount of shares, assets or ownership interests of a company or other entity that is engaged in any activity not otherwise authorized for the financial holding company under Section 4 of the Bank Holding Company Act. Under the regulation, the types of ownership that may be acquired include shares, assets or ownership interests of a company or other entity including debt or equity securities, warrants, options, partnership interests, trust certificates or other instruments representing an ownership interest in a company or entity whether voting or nonvoting. The merchant banking investments may be made by the financial holding company or any of its subsidiaries, other than a depository institution or subsidiary of a depository institution. Before acquiring or controlling a merchant banking investment, a financial holding company must either be or have a securities affiliate registered under the Securities Exchange Act of 1934 or a qualified insurance affiliate. The regulation places restrictions on the ability of a financial holding company to become involved in the routine management or operation of any of its portfolio companies. The regulation also provides that a financial holding company may own or control shares, assets and ownership interests pursuant to the merchant banking provisions only
for such period of time as to enable the sale or disposition on a reasonable basis consistent with the financial viability of the financial holding company's merchant banking investment activities. Generally, the ownership period is limited to ten years. Special provisions are included in the regulation governing the investment by a financial holding company in private equity funds. Under the merchant banking regulation, a financial holding company may not, without Federal Reserve Board approval, have aggregate merchant banking investments exceeding 30 percent of the Tier 1 capital of the financial holding company; or after excluding interests in private equity funds, 20 percent of the Tier 1 capital of the financial holding company.
The Federal Reserve Board and Secretary of Treasury have also requested public comment on the issue of whether to add the activities of real estate brokerage and real estate management to the list of permissible activities for financial holding companies and financial subsidiaries of national banks. The Company cannot predict whether the proposal will be adopted or the form any final rule might take.
The Federal Reserve Board, the OCC, and the FDIC have proposed for comment a rule which would establish special minimum regulatory capital requirements for equity investments in non-financial companies. The proposed capital treatment would apply symmetrically to equity investments of banks and bank holding companies and would apply a series of marginal capital charges on covered equity investments that increase with the level of a banking organization's overall exposure to equity investments relative to the organization's Tier 1 Capital. This is the second proposal the agencies have made of this nature and the Company cannot predict what final form the regulation may take.
ENFORCEMENT POWERS OF THE FEDERAL BANKING AGENCIES
The Federal Reserve Board and the OCC have broad enforcement powers, including the power to terminate deposit insurance, impose substantial fines and other civil and criminal penalties and appoint a conservator or receiver. Failure to comply with applicable laws, regulations and supervisory agreements could subject the Company or the Bank, as well as officers, directors and other institution-affiliated parties of these organizations, to administrative sanctions and potentially substantial civil money penalties. In addition to the grounds discussed above under " -- The Bank -- Prompt Corrective Action," the appropriate federal banking agency may appoint the FDIC as conservator or receiver for a banking institution (or the FDIC may appoint itself, under certain circumstances) if any one or more of a number of circumstances exist, including, without limitation, the fact that the banking institution is undercapitalized and has no reasonable prospect of becoming adequately capitalized; fails to become adequately capitalized when required to do so; fails to submit a timely and acceptable capital restoration plan; or materially fails to implement an accepted capital restoration plan.
IMPOSITION OF LIABILITY FOR UNDERCAPITALIZED SUBSIDIARIES. FDICIA requires bank regulators to take "prompt corrective action" to resolve problems associated with insured depository institutions whose capital declines below certain levels. In the event an institution becomes "undercapitalized," it must submit a capital restoration plan. The capital restoration plan will not be accepted by the regulators unless each company having control of the undercapitalized institution guarantees the subsidiary's compliance with the capital restoration plan. Under FDICIA, the aggregate liability of all companies controlling an undercapitalized bank is limited to the lesser of 5% of the institution's assets at the time it became undercapitalized or the amount necessary to cause the institution to be "adequately capitalized." The guarantee and limit on liability expire after the regulators notify the institution that it has remained adequately capitalized for each of four consecutive calendar quarters. FDICIA grants greater powers to the bank regulators in situations where an institution becomes "significantly" or "critically" undercapitalized or fails to submit a capital restoration plan. For example, a bank holding company controlling such an institution can be required to obtain prior Federal Reserve Board approval of proposed dividends, or might be required to consent to a consolidation or to divest the troubled institution or other affiliates. At December 31, 2000, the Bank met the requirements of a "well capitalized" institution and, therefore, these requirements presently do not apply to the Company.
ACQUISITIONS BY BANK HOLDING COMPANIES. The BHCA requires every bank holding company to obtain the prior approval of the Federal Reserve Board before it may acquire all or substantially all of the assets of any bank, or direct or indirect ownership or control of more than 5% of any class of voting shares of any bank.
The Federal Reserve Board will allow the acquisition by a bank holding company of an interest in any bank located in another state only if the laws of the state in which the target bank is located expressly authorize such acquisition. Texas law permits, in certain circumstances, out-of-state bank holding companies to acquire banks and bank holding companies in Texas.
EXPANDING ENFORCEMENT AUTHORITY
One of the major effects of FDICIA was the increased ability of banking regulators to monitor the activities of banks and their holding companies. In addition, the Federal Reserve Board and FDIC have extensive authority to police unsafe or unsound practices and violations of applicable laws and regulations by depository institutions and their holding companies. For example, the FDIC may terminate the deposit insurance of any institution which it determines has engaged in an unsafe or unsound practice. The agencies can also assess civil money penalties, issue cease and desist or removal orders, seek injunctions, and publicly disclose such actions.
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.
ITEM 2.
ITEM 2. PROPERTIES
FACILITIES
The Company currently maintains 33 locations in the greater Houston area, fifteen of which are leased. The following table sets forth specific information on each branch, each of which offers full service banking. The Company's headquarters are located at 4400 Post Oak Parkway, in a 28-story office tower in the Galleria area in Houston, Texas.
(1) Leased location.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
The Company is involved in various legal proceedings that arise in the normal course of business. In the opinion of management of the Company, after consultation with its legal counsel, such legal proceedings are not expected to have a material adverse effect on the Company's consolidated financial position, results of operations or cash flows.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matter was submitted during the fourth quarter of the fiscal year covered by this Annual Report to a vote of the Company's security holders.
PART II
ITEM 5.
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The Company's Common Stock began trading on the NASDAQ Stock Market on January 28, 1997, and is quoted in such Market under the symbol "SWBT". The Company's Common Stock was not publicly traded, nor was there an established market therefor, prior to January 28, 1997. On February 16, 2001, there were approximately 1,059 holders of record of the Company's Common Stock.
No cash dividends have ever been paid by the Company on its Common Stock, and the Company does not anticipate paying any cash dividends on its Common Stock in the foreseeable future. The Company's principal source of funds to pay cash dividends on its Common Stock would be cash dividends from the Bank. There are certain statutory limitations on the payment of dividends by national banks. Without approval of the OCC, dividends in any calendar year may not exceed the Bank's total net profits for that year, plus its retained profits for the preceding two years, less any required transfers to capital surplus or to a fund for the retirement of any preferred stock. In addition, a dividend may not be paid in excess of a bank's cumulative net profits after deducting bad debts in excess of the allowance for loan losses. As of December 31, 2000, approximately $104.4 million was available for payment of dividends by the Bank to the Company under these restrictions without regulatory approval. See "Item 1. Business -- Supervision and Regulation."
The following table presents the range of high and low sale prices reported on the NASDAQ during the years ended December 31, 2000 and December 31, 1999.
RECENT SALES OF UNREGISTERED SECURITIES
On December 29, 2000, (i) Citizens Bankers, Inc., a Texas corporation ("Citizens") was merged with and into the Company pursuant to an Agreement and Plan of Merger dated October 16, 2000 (the "Merger Agreement"), between the Company and Citizens, and (ii) the Bank acquired all of the assets and liabilities of Citizens Bankers Limited Partnership, a Texas limited partnership ("CBLP") pursuant to a Purchase Agreement dated as of November 9, 2000 (the "Purchase Agreement") among the Company, the Bank, CBLP and Baytown Land I, Ltd. (The office building that houses Citizens and its principal subsidiary bank and certain unrelated tenants was the only significant asset of CBLP.) In addition, on that date (i) the three wholly-owned subsidiary banks of Citizens (Citizens Bank and Trust Company of Baytown, Texas, Baytown State Bank and Pasadena State Bank) were merged into the Bank and their seven banking locations became branches of the Bank, and (ii) the 57.834% owned subsidiary bank of Citizens, First National Bank of Bay City, became a 57.834% owned subsidiary bank of the Company as a result of the merger.
No underwriters were involved in the transaction; however, Keefe, Bruyette & Woods, Inc. acted as a financial advisor to Citizens and Legg Mason Wood Walker, Incorporated acted as a financial advisor to the Company.
A total of approximately 4.0 million shares of Company Common Stock were issued to the shareholders of Citizens and the partners of CBLP in the combined transaction, which has been accounted for as a pooling-of-interests. As of December 31, 2000, Citizens had total assets of $436 million, net loans of $133 million, total deposits of $381 million and total shareholders' equity of $47 million.
The shares of Company Common Stock issued pursuant to the Merger Agreement and the Purchase Agreement were issued in a transaction exempt from registration under the Securities Act of 1933 pursuant to Regulation D thereunder. Citizens and CBLP were closely held entities with over 77% of the equity interests being owned beneficially by members of two families. In accordance with Regulation D, the shares of Company Common Stock issued in the transaction were issued to 38 accredited investors and 23 non-accredited investors. Keefe, Bruyette & Woods, Inc. acted as the purchaser representative for the non-accredited investors.
ITEM 6.
ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA
The following selected consolidated financial data should be read in conjunction with the Consolidated Financial Statements of the Company and the Notes thereto, appearing elsewhere in this Annual Report, and the information contained in "Item 7.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Management's Discussion and Analysis of Financial Condition and Results of Operations analyzes the major elements of the Company's consolidated financial statements and should be read in conjunction with the Consolidated Financial Statements of the Company and Notes thereto and other detailed information appearing elsewhere in this Annual Report.
FOR THE YEARS ENDED DECEMBER 31, 2000, 1999 AND 1998
OVERVIEW
On December 29, 2000, Southwest Bancorporation of Texas, Inc. (the "Company") and Citizens Bankers, Inc. ("Citizens") completed their merger, which was accounted for as a pooling of interests. The merger agreement provided for the exchange of 249.443 shares of the Company's Common Stock for each share of Citizens Stock, resulting in the issuance of approximately 3.9 million shares of Company Common Stock on a fully diluted basis. In connection with this merger, the Company incurred approximately $4.1 million in pretax merger-related expenses and other charges including investment banking fees, other professional fees and severance expenses (the "special charge").
In a related transaction, the Company, Citizens Bankers Limited Partnership ("CBLP") and Baytown Land I, Ltd., the general partner of CBLP, entered into an agreement pursuant to which the Company acquired the assets and assumed the liabilities of CBLP. CBLP's primary assets and liabilities were the bank building located at 1300 Rollingbrook and the related debt to third parties. In connection with this agreement, the Company issued approximately 106,000 shares of the Company's Common Stock on a fully diluted basis. The historical financial data has been restated to include the accounts and operations of Citizens and CBLP for all periods presented.
Total assets at December 31, 2000, 1999 and 1998 were $3.94 billion, $3.27 billion, and $2.94 billion, respectively. This growth was a result of a strong local economy, the addition of new loan officers, aggressive marketing, and the Company's overall growth strategy. Loans were $2.51 billion at December 31, 2000, an increase of $476.1 million or 23% from $2.04 billion at the end of 1999, marking the third consecutive year that total loan growth exceeded $350 million. Loans were $1.63 billion at year end 1998. Deposits increased to $3.09 billion at year end 2000 from $2.53 billion at year end 1999 and $2.37 billion at year end 1998.
Net income available for common shareholders was $43.5 million, $32.0 million, and $29.0 million and diluted earnings per common share was $1.29, $0.97, and $0.91 for the years ended 2000, 1999 and 1998, respectively. This increase in net income was primarily the result of strong loan growth, maintaining strong asset quality and expense control and resulted in returns on average assets ("ROA") of 1.23%, 1.06%, and 1.12% and returns on average common equity ("ROE") of 17.00%, 14.70%, and 15.10% for the years ended 2000, 1999 and 1998, respectively.
Results for 2000 include the impact of the special charge taken in the fourth quarter. On an operating basis, excluding this special charge, the Company's net income was $46.9 million, resulting in an ROA of 1.33%, ROE of 18.34%, and an efficiency ratio of 60.00%. Results for 1999 include $4.5 million of merger-related expenses and other charges. On an operating basis, excluding these charges, the Company's net income was $35.7 million, resulting in an ROA of 1.19%, ROE of 16.41%, and an efficiency ratio of 62.29%.
RESULTS OF OPERATIONS
NET INTEREST INCOME
Net interest income represents the amount by which interest income on interest-earning assets, including securities and loans, exceeds interest expense incurred on interest-bearing liabilities, including deposits and other borrowed funds. Net interest income is the principal source of the Company's earnings. In 2000, net interest income provided 77.8 % of the Company's net revenues, compared with 76.7% in 1999 and 77.0% in 1998. Interest rate fluctuations, as well as changes in the amount and type of earning assets and liabilities, combine to affect net interest income.
2000 VERSUS 1999. Net interest margin increased 20 basis points in 2000 to 4.64%. The principal factor contributing to the increase was higher yielding earning assets partially offset by higher cost of funds resulting in slightly higher interest rate spreads.
Net interest income was $150.5 million in 2000 compared to $123.0 million in 1999, an increase of $27.5 million or 22%. Growth in average earning assets was $472.7 million or 17% while yields increased 77 basis points to 8.39%. Yields increased throughout 2000 as the Bank's prime lending rate increased. The yield on earning assets during the fourth quarter was the highest for the year, resulting in increased yields on a weighted average basis.
Net interest margin risk is typically related to a narrowing of the prime rate and cost of funds. The Company reduced this risk with a modestly asset sensitive balance sheet during 2000. On February 4, 2000 the Federal Reserve increased the federal funds rate and discount rate by 25 basis points. This was followed by two additional increases on March 23, 2000 and May 17, 2000 of 25 and 50 basis points, respectively. Due to the Bank's asset sensitivity, the net interest margin gradually increased during the second half of the year. This resulted in net interest margins of 4.64% and 4.44% and net interest spreads of 3.45% and 3.44% for 2000 and 1999, respectively.
The increase in net interest income was due primarily to a $472.7 million or 17% increase in average earning assets. Average loans grew $518.5 million or 29% during 2000 while average securities decreased $45.1 million or 5% during the same period. The yield earned on average loans outstanding increased 71 basis points to 9.25% in 2000. Overall, the yield earned on average earning assets increased 77 basis points to 8.39% in 2000 compared to a 76 basis point increase in the rate paid on average interest-bearing liabilities.
1999 VERSUS 1998. Net interest income totaled $123.0 million in 1999 compared to $105.6 million in 1998, an increase of $17.4 million or 16%. This resulted in net interest margins of 4.44% and 4.38% and net interest spreads of 3.44% and 3.28% for 1999 and 1998, respectively.
The increase in net interest income was due primarily to a $360.7 million or 15% increase in average interest-earning assets. Average loans grew $352.8 million or 25% during 1999 while average securities grew $110.1 million or 13% during the same period. The increase in net interest income caused by this increase in average interest-earning assets was partially offset by an increase in average interest-bearing liabilities of $297.9 million or 16%. The yield earned on average interest-earning assets decreased eight basis points to 7.62% in 1999 compared to an overall decrease in the yield earned on average interest-bearing liabilities of 24 basis points to 4.18% for the period.
The following table presents, for the periods indicated, the total dollar amount of interest income from average interest-earning assets and the resultant yields, as well as the interest expense on average interest-bearing liabilities, expressed both in dollars and rates. No tax equivalent adjustments were made and all average balances are daily average balances. Nonaccruing loans have been included in the table as loans carrying a zero yield. The yield on the securities portfolio is based on average historical cost balances and does not give effect to changes in fair value that are reflected as a component of consolidated shareholders' equity.
YEAR ENDED DECEMBER 31, - ----------------------------------------------------------------------- - ----------------------------------------------------------------------- AVERAGE INTEREST AVERAGE OUTSTANDING EARNED/ YIELD/ BALANCE PAID RATE - ----------------------------------------------------------------------- (DOLLARS IN THOUSANDS) ASSETS Interest-earning assets: Loans $1,410,061 $125,847 8.92% Securities 844,494 51,503 6.10 Federal funds sold and other 156,024 8,313 5.33 - ----------------------------------------------------------------------- Total interest-earning assets 2,410,579 185,663 7.70% - ----------------------------------------------------------------------- Less allowance for loan losses (15,825) - ----------------------------------------------------------------------- 2,39,754 Noninterest-earning assets 205,109 - ----------------------------------------------------------------------- TOTAL ASSETS $2,599,863 - ----------------------------------------------------------------------- LIABILITIES AND SHAREHOLDERS' EQUITY Interest-bearing liabilities: Money market and savings deposits $ 934,398 35,032 3.75% Certificates of deposit 644,480 33,412 5.18 Repurchase agreements and borrowed funds 231,287 11,636 5.03 - ----------------------------------------------------------------------- Total interest-bearing liabilities 1,810,165 80,080 4.42% - ----------------------------------------------------------------------- Noninterest-bearing liabilities: Noninterest-bearing demand deposits 573,708 Other liabilities 23,842 - ----------------------------------------------------------------------- TOTAL LIABILITIES 2,407,715 - ----------------------------------------------------------------------- SHAREHOLDERS' EQUITY 192,148 - ----------------------------------------------------------------------- Total liabilities and shareholders' equity $2,599,863 - ----------------------------------------------------------------------- NET INTEREST INCOME $105,583 - ----------------------------------------------------------------------- NET INTEREST SPREAD 3.28% - ----------------------------------------------------------------------- NET INTEREST MARGIN 4.38% - -----------------------------------------------------------------------
The following table presents the dollar amount of changes in interest income and interest expense for the major components of interest-earning assets and interest-bearing liabilities and distinguishes between the increase (decrease) related to higher outstanding balances and the volatility of interest rates. For purposes of this table, changes attributable to both rate and volume which cannot be segregated have been allocated.
PROVISION FOR LOAN LOSSES
The 2000 provision for loan losses was $7.1 million, an increase of $579,000 from 1999. The provision for the year ended 1999 was $6.5 million, an increase of $2.2 million from the year ended December 31, 1998. Net charge-offs during 2000 equaled $1.3 million, which when subtracted from the provision for loan losses of $7.1 million resulted in a net increase in the allowance for loan losses of $5.8 million. Although no assurance can be given, management believes that the present allowance for loan losses is adequate considering loss experience, delinquency trends and current economic conditions. Management regularly reviews the Company' loan loss allowance as its loan portfolio grows and diversifies. (See "-- Financial Condition -- Review and Allowance for Loan Losses."
NONINTEREST INCOME
Noninterest income grew to $42.9 million for the year ended December 31, 2000, an increase of $5.4 million or 14% from 1999. Noninterest income totaled $37.5 million in 1999, an increase of $5.9 million or 19% from 1998.
YEAR ENDED DECEMBER 31, - -------------------------------------------------------------------------- 2000 1999 1998 - -------------------------------------------------------------------------- (DOLLARS IN THOUSANDS) Service charges on deposit accounts $20,765 $17,017 $13,020 Investment services 6,017 4,868 4,173 Factoring fee income 4,063 3,169 1,775 Loan fee income 3,910 4,192 4,144 Bank-owned life insurance income 1,665 1,379 390 Letters of credit fee income 947 829 627 Gain (loss) on sale of securities, net (467) (134) 933 Other income 5,993 6,144 6,475 - -------------------------------------------------------------------------- $42,893 $37,464 $31,537 ==========================================================================
The largest component of noninterest income is service charges, which were $20.8 million for the year ended December 31, 2000, compared to $17.0 million for 1999 and $13.0 for 1998. These were increases of 22% and 31%, respectively for 2000 and 1999. Several factors contributed to this growth. First, during this three-year period the Company introduced several new products to their existing retail product line. Secondly, in August 1999, the Company initiated a deposit campaign encompassing all of their existing market areas and redesigned the consumer banking area which has experienced strong growth since its inception. Additionally, the number of deposit accounts grew from 116,197 at December 31, 1998 to 124,424 at December 31, 1999 and to 155,610 at December 31, 2000.
Additional areas of increased growth included investment services and factoring fee income. Factoring fee income is derived from the purchase of accounts receivable. Gross accounts receivable purchased was $27.7 million at December 31, 2000, an increase of $9.2 million from $18.5 million at December 31, 1999. Investment services income grew to $6.0 million, or 24% from the 1999 period. During the past several years, the international department and the foreign exchange division have experienced strong growth, including the addition of several experienced calling officers and an increase in referrals from the Company's growing customer base. This addition adds to the high quality of personal service and responsiveness to customer needs. Secondly the Company introduced new services such as confirmation of letters of credit for a variety of countries and banks. The international department also has a registered broker for non-U.S. citizens which allows the Company to offer investment products in that market as well.
NONINTEREST EXPENSES
For the year ended December 31, 2000, noninterest expenses totaled $120.2 million, an increase of $15.7 million, or 15%, from $104.5 million during 1999, which had increased from $87.9 million during 1998. The increase in noninterest expenses during these periods was due primarily to salaries and employee benefits and occupancy expenses. The efficiency ratio was 61.98%, 65.07% and 64.52% for the years ended December 31, 2000, 1999 and 1998 respectively.
Salaries and employee benefits expense was $67.1 million for the year ended December 31, 2000, an increase of $9.6 million or 17% from $57.5 million for the year ended December 31, 1999. Salaries and employee benefits expense for the year ended December 31, 1999 increased $6.6 million or 13% from the same period in 1998. This increase was due primarily to hiring of additional personnel required to accommodate the Company' growth. Total full-time equivalent employees for the years ended December 31, 2000, 1999 and 1998 were 1,313, 1,168, and 1,080, respectively.
Occupancy expense rose $1.9 million to $18.0 million in 2000. Major categories included within occupancy expense are building lease expense, depreciation expense, and maintenance contract expense. Building lease expense increased to $4.7 million in 2000 from $3.9 million in 1999, an increase of $735,000 or 19%. The Company continues to increase the rentable square feet of the Galleria corporate location to accommodate the increases in personnel. In addition, the Company leased 91,689 square feet for an operations center in downtown Houston. Depreciation expense increased $249,000 to $8.0 million for the year ended December 31, 2000. This increase was due primarily to depreciation on equipment provided to new employees and expense related to technology upgrades throughout the Company. Maintenance contract expense for the year ended December 31, 2000 was $2.5 million, an increase of $678,000 or 38% compared to $1.8 million in 1999 and $1.5 million in 1998 . The Company has purchased maintenance contracts for major operating systems throughout the organization.
During 2000 and 1999, the Company recorded, on a pre-tax basis, approximately $4.1 million and $4.5 million, respectively in merger-related expenses and other charges including investment banking fees, other professional fees and severance expenses associated with the merger of Citizens in 2000 and Fort Bend in 1999.
INCOME TAXES
Income tax expense includes the regular federal income tax at the statutory rate, plus the income tax component of the Texas franchise tax. The amount of federal income tax expense is influenced by the amount of taxable income, the amount of tax-exempt income, the amount of nondeductible interest expense, and the amount of other nondeductible
expenses. Taxable income for the income tax component of the Texas franchise tax is the federal pre-tax income, plus certain officers salaries, less interest income from federal securities. In 2000 income tax expense was $22.6 million, an increase of $5.1 million or 29% from the $17.5 million of income tax expense in 1999 and an increase of $1.7 million or 11% from the $15.8 million of income tax expense in 1998.
IMPACT OF INFLATION
The effects of inflation on the local economy and on the Company' operating results have been relatively modest for the past several years. Since substantially all of the Company' assets and liabilities are monetary in nature, such as cash, securities, loans and deposits, their values are less sensitive to the effects of inflation than to changing interest rates, which do not necessarily change in accordance with inflation rates. The Company attempts to control the impact of interest rate fluctuations by managing the relationship between its interest rate sensitive assets and liabilities. See " Condition -- Rate Sensitivity and Liquidity" below.
FINANCIAL CONDITION
LOANS HELD FOR INVESTMENT
Loans held for investment were $2.43 billion at December 31, 2000, an increase of $467.2 million, or 24% from December 31, 1999. Loans were $1.96 billion at December 31, 1999, an increase of $340.7 million, or 21%, from $1.62 billion at December 31, 1998.
During the past 5 years loans have grown at an annualized rate of 20%. This growth is consistent with the Company' strategy of targeting corporate "middle market" and private banking customers and providing innovative products with superior customer service. This plan also includes establishing new branches in areas that demographically complement existing or targeted customer base, pursuing selected mergers/acquisitions which will add new markets, delivery systems and talent to the Company and leveraging new or existing technology to improve the profitability of the Company and its customers.
The following table summarizes the loan portfolio of the Company by major category as of the dates indicated:
The primary lending focus of the Company is on small-and medium-sized commercial, construction and land development, residential mortgage and consumer loans. The Company offers a variety of commercial lending products including term loans, lines of credit and equipment financing. A broad range of short-to medium-term commercial loans, both collateralized and uncollateralized, are made available to businesses for working capital (including inventory and receivables), business expansion (including acquisitions of real estate and improvements) and the purchase of equipment and machinery. The purpose of a particular loan generally determines its structure.
Generally, the Company' commercial loans are underwritten in the Company' primary market area on the basis of the borrower' ability to service such debt from cash flow. As a general practice, the Company takes as collateral a lien on any available real estate, equipment or other assets. Working capital loans are primarily collateralized by short-term assets whereas term loans are primarily collateralized by long-term assets.
A substantial portion of the Company' real estate loans consists of loans collateralized by real estate and other assets of commercial customers. Additionally, a portion of the Company' lending activity consists of the origination of single-family residential mortgage loans collateralized by owner-occupied properties located in the Company' primary market area. The Company offers a variety of mortgage loan products which generally are amortized over five to 30 years.
Loans collateralized by single-family residential real estate generally have been originated in amounts of no more than 90% of appraised value. The Company requires mortgage title insurance and hazard insurance in the amount of the loan. Although the contractual loan payment periods for single-family residential real estate loans are generally for a 15 to 30 year period, such loans often remain outstanding for significantly shorter periods than their contractual terms.
The Company originates and purchases residential and commercial mortgage loans to sell to investors with servicing rights retained. The Company also provides residential and commercial construction financing to builders and developers and acts as a broker in the origination of multi-family and commercial real estate loans.
Residential construction financing to builders generally has been originated in amounts of no more than 80% of appraised value. The Company requires a mortgage title binder and builder' risk insurance in the amount of the loan. The contractual loan payment periods for residential constructions loans are generally for a six to twelve month period.
Consumer loans made by the Company include automobile loans, recreational vehicle loans, boat loans, home improvement loans, personal loans (collateralized and uncollateralized) and deposit account collateralized loans. The terms of these loans typically range from 12 to 84 months and vary based upon the nature of collateral and size of loan.
The contractual maturity ranges of the commercial and industrial and real estate construction loan portfolio and the amount of such loans with fixed interest rates and floating rates in each maturity range as of December 31, 2000 are summarized in the following table:
LOANS HELD FOR SALE
Loans held for sale of $85.9 million at December 31, 2000 increased from $77.0 million at December 31, 1999. These loans are typically sold to investors within one year of origination.
LOAN REVIEW AND ALLOWANCE FOR LOAN LOSSES
The Company's loan review procedures include a Credit Quality Assurance Process that begins with approval of lending policies and underwriting guidelines by the Board of Directors, an independent loan review department staffed with OCC experienced personnel, low individual lending limits for officers, Senior Loan Committee approval for large credit relationships and quality loan documentation procedures. The Company also maintains a well developed
monitoring process for credit extensions in excess of $100,000. The Company performs monthly and quarterly concentration analyses based on various factors such as industries, collateral types, business lines, large credit sizes, international investments and officer portfolio loads. The Company has established underwriting guidelines to be followed by its officers. The Company also monitors its delinquency levels for any negative or adverse trends. There can be no assurance, however, that the Company's loan portfolio will not become subject to increasing pressures from deteriorating borrower credit due to general economic conditions.
Historically, the Houston metropolitan area has been affected by the state of the energy business, but since the mid 1980's the economic impact has been reduced by a combination of increased industry diversification and less reliance on debt to finance expansion. When energy prices fluctuate, it is the Company's practice to review and adjust underwriting standards with respect to companies affected by oil and gas price volatility, and to continuously monitor existing credit exposure to companies which are impacted by this price volatility.
The allowance for loan losses is established through charges to earnings in the form of a provision for loan losses. Based on an evaluation of the loan portfolio, management presents a quarterly analysis of the allowance for loan losses to the Board of Directors, indicating any changes in the allowance since the last review and any recommendations as to adjustments in the allowance. In making its evaluation, management considers, among other things, growth in the loan portfolio, the diversification by industry of the Company's commercial loan portfolio, the effect of changes in the local real estate market on collateral values, the results of recent regulatory examinations, the effects on the loan portfolio of current economic indicators and their probable impact on borrowers, the amount of charge-offs for the period, the amount of nonperforming loans and related collateral security and the evaluation of its loan portfolio by the loan review function. Charge-offs occur when loans are deemed to be uncollectible.
In order to determine the adequacy of the allowance for loan losses, management considers the risk classification or delinquency status of loans and other factors, such as collateral value, portfolio composition, trends in economic conditions and the financial strength of borrowers. Management establishes specific allowances for loans which management believes require reserves greater than those allocated according to their classification or delinquent status. The Company then charges a provision for loan losses to operations determined on an annualized basis to maintain the allowance for loan losses at an adequate level determined according to the foregoing methodology.
Management believes that the allowance for loan losses at December 31, 2000 is adequate to cover losses inherent in the portfolio as of such date. There can be no assurance, however, that the Company will not sustain losses in future periods, which could be greater than the size of the allowance at December 31, 2000.
The following table presents, for the periods indicated, an analysis of the allowance for loan losses and other related data:
The following table describes the allocation of the allowance for loan losses among various categories of loans and certain other information for the dates indicated. Portions of the allowance for loan losses are allocated to cover the estimated losses inherent in particular risk categories of loans. The allocation of the allowance for loan losses is based upon the Company's loss experience over a period of years and is adjusted for subjective factors such as economic trends, performance trends, portfolio age and concentrations of credit. Prior year allocations have been restated to conform to this methodology. 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 segment of loans.
NONPERFORMING ASSETS AND IMPAIRED LOANS
The Company generally places a loan on nonaccrual status and ceases accruing interest when loan payment performance is deemed unsatisfactory. All loans past due 90 days are placed on nonaccrual status, unless the loan is both well collateralized and in the process of collection. Cash payments received while a loan is classified as nonaccrual are recorded as a reduction of principal as long as doubt exists as to collection. The Company is sometimes required to revise a loan's interest rate or repayment terms in a troubled debt restructuring.
Nonperforming assets were $9.9 million at December 31, 2000, compared with $6.2 million at December 31, 1999 and $5.1 million at December 31, 1998. This resulted in a ratio of nonperforming assets to loans plus other real estate of 0.41%, 0.31%, and 0.31% for the years ended 2000, 1999, and 1998, respectively. Nonaccrual loans, the largest component of nonperforming assets, were $8.3 million at December 31, 2000, an increase of $5.8 million from $2.5 million at December 31, 1999. This increase is primarily due to the addition of two loans -- a $5.1 million secured relationship which is expected to be a long term workout and a $1.1 million loan secured by three houses which are expected to be sold in the near term.
The following table presents information regarding nonperforming assets as of the dates indicated:
The Company regularly updates appraisals on loans collateralized by real estate, particularly those categorized as nonperforming loans and potential problem loans. In instances where updated appraisals reflect reduced collateral values, an evaluation of the borrower's overall financial condition is made to determine the need, if any, for possible writedowns or appropriate additions to the allowance for loan losses.
A loan is considered impaired when, based upon current information and events, it is probable that the Company will be unable to collect the scheduled payments of principal and interest when due according to the contractual terms of the loan agreement. The Company's impaired loans were approximately $10.8 million and $13.7 million at December 31, 2000 and 1999, respectively. At December 31, 1999, the largest component of impaired loans was a commercial energy related loan of approximately $10.8 million. This loan was not considered impaired at December 31, 2000 as a result of payments in accordance with terms for a period of at least twelve months. The decrease in the impaired loan balance associated with this loan was partially offset by the addition of two loans with a principal balance of $6.2 million included in nonaccrual loans and discussed above. The average recorded investment in impaired loans during 2000, 1999 and 1998 was $9.3 million, $13.9 million and $6.3 million, respectively. The total required allowance for loan losses related to these loans was $1.0 million for 2000 and $0 for 1999. Interest income on impaired loans of $1.1 million, $1.5 million and $415,000 was recognized for cash payments received in 2000, 1999 and 1998, respectively.
The Bank is not committed to lend additional funds to debtors whose loans have been modified.
SECURITIES
At the date of purchase, the Company classifies debt and equity securities into one of three categories: held to maturity, trading or available for sale. At each reporting date, the appropriateness of the classification is reassessed. Investments in debt securities classified as held to maturity are stated at cost, increased by accretion of discounts and reduced by amortization of premiums, both computed by the interest method. Management has the positive intent and ability to hold those securities to maturity. Securities that are bought and held principally for the purpose of selling them in the near term are classified as trading and measured at fair value in the financial statements with unrealized gains and losses included in earnings. Securities not classified as either held to maturity or trading are classified as available for sale and measured at fair value in the financial statements with unrealized gains and losses reported, net of tax, as a component of accumulated other comprehensive income (loss) until realized. Gains and losses on sales of securities are determined using the specific-identification method. The Company has classified all securities as available for sale at December 31, 2000. This allows the Company to manage its investment portfolio more effectively and to enhance the average yield on the portfolio.
The amortized cost of securities classified as available for sale and held to maturity is as follows:
The following table presents the amortized cost of securities classified as held to maturity and available for sale and their approximate fair values as of the dates shown:
DECEMBER 31, 1998 - ------------------------------------------------------------------------------- GROSS UNREALIZED AMORTIZED ------------------- FAIR COST GAIN LOSS VALUE - ------------------------------------------------------------------------------- (DOLLARS IN THOUSANDS) Available for sale: U.S. Government securities $183,602 $1,878 $ (25) $185,455 Mortgage-backed securities 623,964 5,294 (2,811) 626,447 Federal Reserve Bank stock 2,442 -- -- 2,442 Federal Home Loan Bank stock 8,775 -- -- 8,775 Other securities 10,141 219 (23) 10,337 - ------------------------------------------------------------------------------- Total securities available for sale $828,924 $7,391 $(2,859) $833,456 =============================================================================== Held to maturity: U.S. Government securities $ 23,837 $ 102 $ (230) $ 23,709 Mortgage-backed securities 80,528 718 (298) 80,948 Other securities 13,964 258 -- 14,222 - ------------------------------------------------------------------------------- Total securities held to maturity $118,329 $1,078 $ (528) $118,879 ===============================================================================
In connection with the Citizens merger, the Company transferred all of Citizens' held to maturity debt securities to the available for sale category in 2000. The amortized cost of these securities at the time of transfer was $55.8 million and the unrealized gain was $267,000 ($174,000 net of income taxes). In connection with the Fort Bend merger, the Company transferred all of Fort Bend's held to maturity debt securities to the available for sale category in 1999. The amortized cost of these securities at the time of transfer was $57.8 million and the unrealized gain was $80,000 ($52,000 net of income taxes). The Company does not intend to sell these securities in the near term.
Securities totaled $848.2 million at December 31, 2000, a decrease of $42.2 million from $890.4 million at December 31, 1999. During 1999, securities decreased $61.4 million from $951.8 million at December 31, 1998. The yield on the securities portfolio for 2000 was 6.35% while the yield was 6.08% in 1999.
The Company has no mortgage-backed securities that have been issued by non-agency entities. Included in the Company' mortgage-backed securities at December 31, 2000 were agency issued collateral mortgage obligations with a book value of $300.7 million and a fair market value of $296.6 million.
At December 31, 2000, $427.2 million of the mortgage-backed securities held by the Company had final maturities of more than 10 years. At December 31, 2000, approximately $104.4 million of the Company' mortgage-backed securities earned interest at floating rates and repriced within one year, and accordingly, were less susceptible to declines in value should interest rates increase.
The following table summarizes the contractual maturity of investments and their weighted average yields at December 31, 2000. The yield on the securities portfolio is based on average historical cost balances and does not give effect to changes in fair value that are reflected as a separate component of other comprehensive income.
OTHER ASSETS
Other assets were $117.8 million at December 31, 2000, an increase of $24.1 million from $93.7 million at December 31, 1999. This increase is primarily attributable to increases in factored receivables, increases in mortgage servicing rights and on the increase in the cash value of Bank-owned life insurance policies. Cash value of bank-owned life insurance policies was approximately $28.7 million at December 31, 2000 compared with a balance of $27.2 million at December 31, 1999. This increase resulted from interest earned on these policies.
Factored receivables result from providing operating funds to businesses by converting their accounts receivable to cash. During 2000 factored receivables increased $9.0 million to $27.5 million. This increase was due to several factors including new officers hired and aggressive marketing, both internally and externally.
Capitalized mortgage servicing rights were $12.3 million at December 31, 2000, an increase of $5.6 million from $6.7 million at December 31, 1999. This increase was due to Mitchell's purchase of $5.5 million of mortgage servicing rights during the year.
DEPOSITS
The Company offers a variety of deposit accounts having a wide range of interest rates and terms. The Company' deposits consist of demand, savings, NOW accounts, money market and time accounts. The Company relies primarily on customer service, advertising, and competitive pricing policies to attract and retain these deposits. As of December 31, 2000, the Company had less than two percent of its deposits classified as brokered funds and does not anticipate any significant increase. Deposits provide the majority of the funding for the Company' lending and investment activities, and the interest paid for deposits must be managed carefully to control the level of interest expense.
The Company's ratio of average demand deposits to average total deposits for the years ended December 31, 2000, 1999, and 1998 was 29.50%, 30.47%, and 30.67%, respectively.
Average total deposits during 2000 increased to $2.82 billion from $2.38 billion in 1999, an increase of $437.6 million or 18%. Average noninterest-bearing deposits increased to $774.1 million in 2000 from $656.4 million in 1999 due to an increase in the number of deposit accounts. Average deposits in 1999 rose to $2.38 billion from $2.15 billion in 1998, an increase of $230.9 million or 11%.
The average daily balances and weighted average rates paid on deposits for each of the years ended December 31, 2000, 1999, and 1998 are presented below:
The following table sets forth the maturity of the Company's time deposits that are $100,000 or greater as of the dates indicated:
DECEMBER 31, - ------------------------------------------------------------------------- 2000 1999 1998 - ------------------------------------------------------------------------- (DOLLARS IN THOUSANDS) 3 months or less $265,232 $186,970 $226,353 Between 3 months and 6 months 124,144 75,389 60,652 Between 6 months and 1 year 61,774 77,604 53,506 Over 1 year 55,479 27,088 28,325 - ------------------------------------------------------------------------- Total time deposits $100,000 and over $506,629 $367,051 $368,836 =========================================================================
BORROWINGS
Securities sold under repurchase agreements and other borrowings, consisting of federal funds purchased and treasury, tax, and loan deposits, generally represent borrowings with maturities ranging from one to thirty days. Information relating to these borrowings is summarized as follows:
DECEMBER 31, - ------------------------------------------------------------------------ 2000 1999 - ------------------------------------------------------------------------ (DOLLARS IN THOUSANDS) Securities sold under repurchase agreements: Average $209,816 $184,358 Period-end 211,800 216,838 Maximum month-end balance during period 241,834 216,838 Interest Rate: Average 4.69% 4.06% Period-end 4.89% 4.03% Other borrowings: Average $205,213 $196,694 Period-end 305,961 267,140 Maximum month-end balance during period 380,121 284,455 Interest rate: Average 6.39% 5.39% Period-end 6.83% 5.27%
Securities sold under repurchase agreements are maintained in safekeeping by correspondent banks.
INTEREST RATE SENSITIVITY AND LIQUIDITY
Asset and liability management is concerned with the timing and magnitude of repricing assets compared to liabilities. It is the objective of the Company to generate stable growth in net interest income and to attempt to control risks associated with interest rate movements. In general, management's strategy is to reduce the impact of changes in interest rates on its net interest income by maintaining a favorable match between the maturities or repricing dates of its interest-earning assets and interest-bearing liabilities. The Company adjusts its interest sensitivity during the year through changes in the mix of assets and liabilities and may use interest rate products such as interest rate swap and cap agreements. The Company did not utilize derivative financial instruments to manage interest rate risk during the years ended December 31, 2000 and 1999. The Company's asset and liability management strategy is formulated and monitored by the Asset Liability Committee, which is composed of senior officers of the Bank and three outside directors, in accordance with policies approved by the Bank's Board of Directors. This Committee meets regularly to review, among other things, the sensitivity of the Bank's assets and liabilities to interest rate changes, the book and market values of assets and liabilities, unrealized gains and losses, purchase and sale activity, and maturities of investments and borrowings. The Asset Liability Committee also approves and establishes pricing and funding decisions with respect to the Bank's overall asset and liability composition. The Committee reviews the Bank's liquidity, cash flow flexibility, maturities of investments, deposits and borrowings, retail and institutional deposit activity, current market conditions, and interest rates on both a local and national level.
To effectively measure and manage interest rate risk, the Company uses simulation analysis to determine the impact on net interest income of changes in interest rates under various interest rate scenarios, balance sheet trends, and strategies. From these simulations, interest rate risk is quantified and appropriate strategies are developed and implemented.
The following table presents an analysis of the sensitivity inherent in the Company's net interest income and market value of portfolio equity. The interest rate scenarios presented in the table include interest rates at December 31, 2000 and 1999 and as adjusted by instantaneous rate changes upward and downward of up to 200 basis points. Each rate scenario reflects unique prepayment and repricing assumptions. Since there are limitations inherent in any methodology used to estimate the exposure to changes in market interest rates, this analysis is not intended to be a forecast of the actual effect of a change in market interest rates on the Company. The market value sensitivity analysis presented includes assumptions that (i) the composition of the Company's interest sensitive assets and liabilities existing at year end will remain constant over the twelve month measurement period; and (ii) that changes in market rates are parallel and instantaneous across the yield curve regardless of duration or repricing characteristics of specific assets or liabilities. Further, the analysis does not contemplate any actions that the Company might undertake in response to changes in market interest rates. Accordingly, this analysis is not intended and does not provide a precise forecast of the effect actual changes in market rates will have on the Company.
The interest rate sensitivity ("GAP") is defined as the difference between interest-earning assets and interest-bearing liabilities maturing or repricing within a given time period. A GAP is considered positive when the amount of interest rate sensitive assets exceeds the amount of interest rate sensitive liabilities. A GAP is considered negative when the amount of interest rate sensitive liabilities exceeds interest rate sensitive assets. During a period of rising interest rates, a negative GAP would tend to adversely affect net interest income, while a positive GAP would tend to result in an increase in net interest income. During a period of falling interest rates, a negative GAP would tend to result in an increase in net interest income, while a positive GAP would tend to affect net interest income adversely. While the GAP is a useful measurement and contributes toward effective asset and liability management, it is difficult to predict the effect of changing interest rates solely on that measure. Because different types of assets and liabilities with the same or similar maturities may react differently to changes in overall market rates or conditions, changes in interest rates may affect net interest income positively or negatively even if an institution were perfectly matched in each maturity category.
The Company's one-year cumulative GAP position at December 31, 2000 was positive $109.9 million or 2.77% of assets. This is a one-day position that is continually changing and is not indicative of the Company's position at any other time. While the GAP position is a useful tool in measuring interest rate risk and contributes toward effective asset and liability management, shortcomings are inherent in GAP analysis since certain assets and liabilities may not move proportionally as interest rates change.
The following table sets forth an interest rate sensitivity analysis for the Company as of December 31, 2000:
Since December 31, 2000, market interest rates have declined as a result of the Federal Reserve's 100 basis point reduction in the prime rate. This decline in interest rates has adversely impacted the Company's net interest margin in 2001 as a result of its short term position GAP. While additional reductions in interest rates may be expected, the Company believes that its ability to manage its interest rate sensitivity will minimize the potential adverse impact on net interest income for the year 2001. For information on the Company's results of operations for the month of January 2001, see "Item 8 -- Financial Statements and Supplementary Data" on pages 33-34.
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. For the year ended December 31, 2000, the Company's liquidity needs have primarily been met by growth in core deposits, and increases in short-term borrowings, primarily from the Federal Home Loan Bank. The cash and federal funds sold position, supplemented by amortizing securities and loan portfolios, have generally created an adequate liquidity position and are expected to do so in 2001.
Subject to certain limitations, the Bank may borrow funds from the Federal Home Loan Bank ("FHLB") in the form of advances. Credit availability from the FHLB to the Bank is based on the Bank's financial and operating condition. Borrowings from the FHLB to the Bank were approximately $193.4 million at December 31, 2000. In addition to creditworthiness, the Bank must own a minimum amount of FHLB capital stock. This minimum is 5.00% of outstanding FHLB advances. Unused borrowing capacity at December 31, 2000 was approximately $293.2 million. The Bank uses FHLB advances for both long-term and short-term liquidity needs. Other than normal banking operations, the Bank has no long-term liquidity needs. The Bank has never been involved with highly leveraged transactions that may cause unusual potential long-term liquidity needs.
CAPITAL RESOURCES
Shareholders' equity increased to $298.1 million at December 31, 2000 from $233.1 million at December 31, 1999, an increase of $65.0 million, or 28%.
Capital management consists of providing equity to support both current and future operations. The Company is subject to capital adequacy requirements imposed by the Federal Reserve Board and the Bank is subject to capital adequacy requirements imposed by the OCC. Both the Federal Reserve Board and the OCC have adopted risk-based capital requirements for assessing bank holding company and bank capital adequacy. These standards define capital and establish minimum capital requirements in relation to assets and off-balance sheet exposure, adjusted for credit risk. The risk-based capital standards currently in effect are designed to make regulatory capital requirements more sensitive to differences in risk profiles among bank holding companies and banks, to account for off-balance sheet exposure and to minimize disincentives for holding liquid assets. Assets and off-balance sheet items are assigned to broad risk categories, each with appropriate relative risk weights. The resulting capital ratios represent capital as a percentage of total risk-weighted assets and off-balance sheet items.
Bank regulatory authorities in the United States have issued risk-based capital standards by which all bank holding companies and banks are evaluated in terms of capital adequacy. The risk-based capital standards issued by the Federal Reserve Board apply to the Company, and the OCC guidelines apply to the Bank. These guidelines relate a financial institution's capital to the risk profile of its assets. The risk-based capital standards require all financial organizations to have "Tier 1 capital" of at least 4.0% of risk-adjusted assets and "total risk-based" capital (Tier 1 and Tier 2) of at least 8.0% of risk-adjusted assets. "Tier 1 capital" includes, generally, common shareholders' equity and qualifying perpetual preferred stock together with related surpluses and retained earnings, qualifying perpetual preferred stock and minority interest in equity accounts of consolidated subsidiaries less deductions for goodwill and various other intangibles. "Tier 2 capital"may consist of a limited amount of subordinated debt, certain hybrid capital instruments and other debt securities, preferred stock not qualifying as Tier 1 capital, and a limited amount of the general valuation allowance for loan losses. The sum of Tier 1 capital and Tier 2 capital is "total risk-based capital."
The agencies have also adopted guidelines which supplement the risk-based capital guidelines with a minimum leverage ratio of Tier 1 capital to average total consolidated assets ("leverage ratio") of 3.0% for institutions with well diversified risk, including no undue interest rate exposure; excellent asset quality; high liquidity; good earnings; and that are generally considered to be strong banking organizations, rated composite 1 under applicable federal guidelines, and that are not experiencing or anticipating significant growth. Other banking organizations are required to maintain a leverage ratio of at least 4.0% to 5.0%. These rules further provide that banking organizations experiencing internal growth or making acquisitions will be expected to maintain capital positions substantially above the minimum supervisory levels and comparable to peer group averages, without significant reliance on intangible assets.
The following table compares the Company's and the Bank's leverage and risk-weighted capital ratios as of December 31, 2000 and 1999 to the minimum regulatory standards:
Pursuant to Federal Deposit Insurance Corporation Improvement Act of 1991 ("FDICIA"), each federal banking agency revised its risk-based capital standards to ensure that those standards take adequate account of interest rate risk, concentration of credit risk and the risks of nontraditional activities, as well as reflect the actual performance and expected risk of loss on multifamily mortgages. Also pursuant to FDICIA, each federal banking agency has promulgated regulations setting the levels at which an insured institution would be considered "well capitalized," "adequately capitalized," "undercapitalized," "significantly undercapitalized" and "critically undercapitalized." Under the Federal Reserve Board's regulations, the Bank is classified as "well capitalized" for purposes of prompt corrective action. See "Supervision and Regulation."
OTHER MATTERS
In June 1998, Statement of Financial Accounting Standards (SFAS) No. 133, ACCOUNTING FOR DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES, as amended, was issued by the Financial Accounting Standards Board to establish accounting and reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts, and for hedging activities. SFAS No. 133 requires that an entity recognize those instruments at fair value. If certain conditions are met, a derivative may be specifically designated as (a) a hedge of the exposure to changes in the fair value of a recognized asset or liability or an unrecognized firm commitment, (b) a hedge of the exposure to variable cash flows of a forecasted transaction, or (c) a hedge of the foreign currency exposure of a net investment in a foreign operation, an unrecognized firm commitment, an available-for-sale security, or a foreign-currency-denominated forecasted transaction. The accounting for the changes in the fair value of a derivative depends on the intended use of the
derivative and the resulting designation. The Company adopted SFAS No. 133 on January 1, 2001. The impact of adoption was not material to the Company's consolidated financial position, results of operations or cash flows.
In December 1999, the Securities and Exchange Commission issued Staff Accounting Bulletin No. 101, "Revenue Recognition in Financial Statements" (SAB No. 101). SAB No. 101, as amended, was implemented in the fourth quarter of 2000 and did not have a material effect on the Company's consolidated financial position, results of operations or cash flows.
ITEM 7A.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Management may use derivative contracts to manage its exposure to commitments to originate mortgage loans. All of the derivatives utilized by the Company are for purposes other than trading. The derivatives utilized consist of purchased options on FNMA or FHLMC guaranteed mortgage-backed securities. These financial instruments are used to reduce the Company's exposure to the effects of fluctuations in interest rates on the Company's lending and secondary marketing activities. The notional amount and fair value of such derivatives was immaterial at December 31, 2000 and 1999.
In addition, reference is made to "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations -- Financial Condition -- Interest Rate Sensitivity and Liquidity" which is incorporated herein by reference.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Reference is made to the financial statements, the reports thereon, the notes thereto and supplementary data commencing at page of this Form 10-K, which financial statements, reports, notes and data are incorporated herein by reference.
Set forth below are certain unaudited financial results reflecting the combined operating results of the Company and Citizens for the thirty-one days ended January 31, 2001. These financial results are presented to satisfy the requirements for publication of combined results of operations with respect to affiliate trading restrictions as specified in pooling-of-interests accounting treatment. This information is presented only to satisfy such requirements and is not necessarily indicative of future operating results or financial condition.
SOUTHWEST BANCORPORATION OF TEXAS, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED BALANCE SHEET (IN THOUSANDS) (UNAUDITED)
JANUARY 31, 2001 - --------------------------------------------------------- Total Assets $4,090,100 Investment securities 842,112 Loans 2,547,362 Allowance for loan losses 28,602 Deposits 3,135,712 Shareholders' Equity 308,303
SOUTHWEST BANCORPORATION OF TEXAS, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENT OF INCOME (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) (UNAUDITED)
MONTH ENDED JANUARY 31, - --------------------------------------------------------- Interest income: Loans $19,806 Securities 4,776 Federal funds sold and other 668 - --------------------------------------------------------- Total interest income 25,250 Interest expense on deposits and other borrowings 11,568 - --------------------------------------------------------- Net interest income 13,682 Provision for loan losses 588 - --------------------------------------------------------- Net interest income after provision for loan losses 13,094 - --------------------------------------------------------- Noninterest income: Service charges on deposit accounts 1,968 Investment services 762 Other fee income 886 Other operating income 946 - --------------------------------------------------------- Total noninterest income 4,562 - --------------------------------------------------------- Noninterest expenses: Salaries and employee benefits 6,456 Occupancy expense 1,708 Other operating expenses 3,323 - --------------------------------------------------------- Total noninterest expenses 11,487 - --------------------------------------------------------- Income before income taxes and minority interest 6,169 Provision for income taxes 1,981 - --------------------------------------------------------- Income before minority interest 4,188 Minority interest 13 - --------------------------------------------------------- Net income $ 4,175 ========================================================= Earnings per common share Basic $ 0.13 ========================================================= Diluted $ 0.12 =========================================================
During the first quarter of 2001, market interest rates declined due to the Federal Reserve's rapid interest rate reduction of 50 basis points on January 4 and another 50 basis points on February 4. This decline in interest rates will unfavorably impact the Company's net interest margin in 2001 due to its short term GAP position. As illustrated on page 29, a 100 basis point drop in interest rates, as we have experienced in the first quarter of 2001, may reduce the Company's net interest income by 4.11% for the year, assuming no additional change in interest rates. However as more fully described in "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations -- Interest Rate Sensitivity and Liquidity", there are inherent limitations in any methodology used to estimate the exposure to changes in market interest rates. The market value sensitivity analysis presented includes assumptions that (i) the composition of the Company's interest sensitive assets and liabilities existing at year end will remain constant over the twelve month measurement period; and (ii) that changes in market rates are parallel and instantaneous across the yield curve regardless of duration or repricing characteristics of specific assets or liabilities. Further, the analysis does not contemplate any actions that the Company might undertake in response to changes in market interest rates. Although it is difficult to predict the long term impact of this decline in interest rates, management expects the net interest margin for the first quarter of 2001 to be in the range of 4.40% to 4.55%, compared to 4.67% for the fourth quarter of 2000. Consistent with the Company's objective to generate stable growth in net interest income and to attempt to control risks associated with interest rate movements, management routinely implements activities which adjust to changes in the interest rate environment. These activities are expected to have a favorable impact on net interest income over time.
QUARTERLY FINANCIAL DATA (UNAUDITED)
The following table represents summarized data for each of the quarters in fiscal 2000 and 1999 (in thousands, except earnings per share). Such information has been restated from amounts previously reported in the Company's Form 10-Q's to reflect the operations of Citizens Bankers, Inc. and Citizens Bankers Limited Partnership prior to December 29, 2000, the date on which they were merged into the Company in a transaction accounted for as a pooling-of-interests.
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
There have been no disagreements with accountants on any matter of accounting principles or practices or financial statement disclosures during the two year period ended December 31, 2000.
PART III
ITEM 10.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
For information regarding the directors and persons nominated to become directors of the Company, reference is made to the information presented in the Company's definitive Proxy Statement for its 2001 Annual Meeting of Shareholders to be filed with the Commission pursuant to Regulation 14A under the Securities and Exchange Act of 1934 (the "2001 Proxy Statement"). All of such information is incorporated herein by reference.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
For information concerning the compensation paid by the Company during the year ended December 31, 2000 to its executive officers, reference is made to the information presented in the Company's 2001 Proxy Statement. Such information is incorporated herein by reference.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
For information concerning the beneficial ownership of the common stock of the Company by its directors and officers and by certain other beneficial owners, reference is made to the information presented in the Company's 2001 Proxy Statement. Such information is incorporated herein by reference.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
For information regarding certain business relationships and related transactions involving the Company's officers and directors, reference is made to the information presented in the Company's 2001 Proxy Statement. Such information is incorporated herein by reference.
PART IV
ITEM 14.
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(A) AND (D) FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULES
The financial statements and financial statement schedule listed on the accompanying Index to Financial Statements and Schedule (see page) are filed as part of this Form 10-K.
(B) REPORTS ON FORM 8-K
One report on Form 8-K was filed by the Company during the three months ended December 31, 2000. The report was filed on October 17, 2000, and Item 5, was reported, including two exhibits.
(c) *Exhibits:
- ------------
* All Exhibits except for those filed herewith and as otherwise indicated are incorporated herein by reference to the Exhibits bearing the same Exhibit numbers in the Company's Form S-1 Registration Statement No. 333-16509.
** This Exhibit is not filed herewith because it meets the exclusion set forth in Section 601(b)(4)(iii)(A) of Regulation S-K and the Company hereby agrees to furnish a copy thereof to the Commission upon request.
*** Filed herewith.
+ Management contract or compensatory plan or arrangement.
SIGNATURES
PURSUANT TO THE REQUIREMENTS OF SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934, THE REGISTRANT HAS DULY CAUSED THIS REPORT TO BE SIGNED ON ITS BEHALF BY THE UNDERSIGNED, THEREUNTO DULY AUTHORIZED.
SOUTHWEST BANCORPORATION OF TEXAS, INC.
By: /s/ PAUL B. MURPHY, JR. PAUL B. MURPHY, JR. PRESIDENT AND CHIEF EXECUTIVE OFFICER
Date: March 1, 2001
PURSUANT TO THE REQUIREMENTS OF THE SECURITIES EXCHANGE ACT OF 1934, AS AMENDED, THIS REPORT HAS BEEN SIGNED BELOW BY THE FOLLOWING PERSONS ON BEHALF OF THE REGISTRANT AND IN THE CAPACITIES AND ON THE DATES INDICATED.
SOUTHWEST BANCORPORATION OF TEXAS, INC. AND SUBSIDIARIES INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
PAGE ---- Consolidated Financial Statements
Report of Independent Accountants
Consolidated Balance Sheet as of December 31, 2000 and 1999
Consolidated Statement of Income for the Years Ended December 31, 2000, 1999 and 1998
Consolidated Statement of Changes in Shareholders' Equity for the Years Ended December 31, 2000, 1999 and 1998
Consolidated Statement of Cash Flows for the Years Ended December 31, 2000, 1999 and 1998
Notes to Consolidated Financial Statements
Financial Statement Schedule
Report of Independent Accountants on Financial Statement Schedule
Schedule I -- Parent Company Condensed Financial Statements
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Shareholders Southwest Bancorporation of Texas, Inc.:
In our opinion, the accompanying consolidated balance sheet and the related consolidated statements of income, of changes in shareholders' equity, and of cash flows present fairly, in all material respects, the consolidated financial position of Southwest Bancorporation of Texas, Inc. and Subsidiaries (the "Company") at December 31, 2000 and 1999, and the consolidated 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. These financial statements are the responsibility of the Company's management; our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these statements in accordance with auditing standards generally accepted in the United States of America which require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
PricewaterhouseCoopers LLP
Houston, Texas February 23, 2001
SOUTHWEST BANCORPORATION OF TEXAS, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEET (DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
The accompanying notes are an integral part of the consolidated financial statements.
SOUTHWEST BANCORPORATION OF TEXAS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENT OF INCOME (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
The accompanying notes are an integral part of the consolidated financial statements.
SOUTHWEST BANCORPORATION OF TEXAS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS' EQUITY (DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
The accompanying notes are an integral part of the consolidated financial statements.
SOUTHWEST BANCORPORATION OF TEXAS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENT OF CASH FLOWS (DOLLARS IN THOUSANDS)
The accompanying notes are an integral part of the consolidated financial statements.
SOUTHWEST BANCORPORATION OF TEXAS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
1. NATURE OF OPERATIONS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
BASIS OF PRESENTATION AND NATURE OF OPERATIONS
The consolidated financial statements include the accounts of Southwest Bancorporation of Texas, Inc. (the "Company") and its direct and indirect wholly-owned subsidiaries, Southwest Holding Delaware Inc. (the "Delaware Company"), Southwest Bank of Texas National Association (the "Bank"), and Mitchell Mortgage Company, LLC ("Mitchell"). The consolidated financial statements also include the accounts of First National Bank of Bay City, a 58% owned subsidiary of the Delaware Company. All material intercompany accounts and transactions have been eliminated.
Substantially all of the Company's revenue and income is derived from the operations of the Bank. The Bank provides a full range of commercial and private banking services to small and middle market businesses and individuals in the Houston metropolitan area.
In connection with the Company's merger with Citizens Bankers, Inc. ("Citizens") and acquisition of all of the assets and liabilities of Citizens Bankers Limited Partnership ("CBLP") (as more fully discussed in note 2), the historical financial data has been restated to include the accounts and operations of Citizens and CBLP for all periods presented.
MANAGEMENT'S ESTIMATES
The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the dates of the financial statements and the reported amounts of income and expenses during the reporting periods. Actual results could differ from those estimates.
CASH AND CASH EQUIVALENTS
The Company considers federal funds sold, due from bank demand accounts and other highly liquid investments purchased with a maturity of three months or less to be cash equivalents. The Company classifies investments in money market funds as securities and not cash equivalents.
The Company is required to maintain noninterest-bearing cash reserve balances with the Federal Reserve Bank. The average of such cash balances was approximately $5,325 and $7,734 for the years ended December 31, 2000 and 1999, respectively.
SECURITIES
Securities which management intends and has the ability to hold to maturity are classified as held to maturity. Securities held to maturity are stated at cost, increased by accretion of discounts and reduced by amortization of premiums, both computed by the interest method.
Securities to be held for indefinite periods of time, including securities that management intends to use as part of its asset/liability strategy, or that may be sold in response to changes in interest rates, changes in prepayment risk, the need to increase regulatory capital or other similar factors, are classified as available for sale and are carried at fair value. Fair values of securities are estimated based on available market quotations. Unrealized holding gains and losses, net of taxes, on available for sale securities are reported as a separate component of other comprehensive income until realized. The amortized cost of securities available for sale is increased by accretion of discounts and reduced by amortization of premiums, both computed by the interest method. Gains and losses on the sale of available for sale securities are determined using the specific identification method.
SOUTHWEST BANCORPORATION OF TEXAS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Trading securities are carried at market value. Realized and unrealized gains and losses on trading securities are recognized in the consolidated statement of income as they occur. The Company held no trading securities at December 31, 2000 and 1999.
The Company reviews its financial position, liquidity and future plans in evaluating the criteria for classifying investment securities. Securities are classified among categories at the time the securities are purchased. Declines in the fair value of individual held to maturity and available for sale securities below their cost that are other than temporary would result in write-downs of the individual securities to their fair value. The Company believes that none of the unrealized losses should be considered other than temporary.
LOANS
Loans held for investment are reported at the principal amount outstanding, net of unearned discounts, deferred loan fees and the allowance for loan losses.
Loans on which the accrual of interest has been discontinued are designated as nonaccrual loans. Loans are designated as nonaccrual when reasonable doubt exists as to the full, timely collection of interest or principal. When a loan is placed on nonaccrual status, all interest previously accrued but not collected is reversed against current period interest income. Income on such loans is then recognized only to the extent that cash is received and where the future collection of interest and principal is probable. Interest accruals are resumed on such loans only when they are brought fully current with respect to interest and principal and when, in the judgment of management, the loans are estimated to be fully collectible as to both principal and interest.
A loan is considered impaired, based on current information and events, if it is probable that the Company will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. A loan is not considered impaired during a period of delay in payment if the Company expects to collect all amounts due, including interest past due. The Company generally considers a period of delay in payment to include delinquency up to 90 days. The measurement of impaired loans is based on the present value of expected future cash flows discounted at the loan's effective interest rate or the loan's observable market price or based on the fair value of the collateral if the loan is collateral-dependent. If the measure of the impaired loan is less than the recorded investment in the loan, an impairment is recognized through the provision for loan losses.
The accrual of interest on impaired loans is discontinued when, in management's opinion, the borrower may be unable to meet payments as they become due. When interest accrual is discontinued, all unpaid accrued interest is reversed. Interest income is subsequently recognized only to the extent cash payments are received.
Loans held for sale are carried at the lower of cost or market, which is computed by the aggregate method (unrealized losses are offset by unrealized gains). The carrying amount of loans held for sale in the near-term is adjusted by gains and losses generated from corresponding hedging transactions entered into to protect loss of value from increases in interest rates. Hedge positions are also used to protect the pipeline of loan applications in process from increases in interest rates. Gains and losses resulting from changes in the market value of the inventory and open hedge positions are netted.
ALLOWANCE FOR LOAN LOSSES
The allowance for loan losses is established through a provision for such losses charged against operations. Loans are charged against the allowance for loan losses when management believes that the collectibility of the principal is unlikely. The allowance is an amount that management believes will be adequate to reflect the risks inherent in the existing loan portfolio and is based on evaluations of the collectibility and prior loss experience of loans. In making its evaluation, management considers growth in the loan portfolio, the diversification by industry of the Company's commercial loan portfolio, the effect of changes in the local real estate market on collateral values, the results of recent
SOUTHWEST BANCORPORATION OF TEXAS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
regulatory examinations, the effects on the loan portfolio of current economic indicators and their probable impact on borrowers, the amount of charge-offs for the period, the amount of nonperforming loans and related collateral security and the evaluation of its loan portfolio by the loan review function.
The evaluation of the adequacy of loan collateral is often based upon estimates and appraisals. Because of changing economic conditions, the valuations determined from such estimates and appraisals may also change. Accordingly, the Company may ultimately incur losses which vary from management's current estimates. Adjustments to the allowance for loan losses will be reported in the period such adjustments become known or are reasonably estimable.
LOAN FEES AND COSTS
Nonrefundable loan origination and commitment fees net of certain direct costs associated with originating loans are deferred and recognized as an adjustment to the related loan yield.
PREMISES AND EQUIPMENT
Premises and equipment are stated at cost less accumulated depreciation and amortization. Depreciation expense is computed using the straight-line method and is charged to operating expense over the estimated useful lives of the assets. Depreciation expense has been computed principally using estimated lives of thirty years for premises, three to five years for hardware and software, and five to ten years for furniture and equipment. Leasehold improvements are amortized using the straight-line method over the shorter of the initial term of the respective lease or the estimated useful life of the improvement. Costs of major additions and improvements are capitalized. Expenditures for maintenance and repairs are charged to operations as incurred. When assets are retired or otherwise disposed of, the cost and related accumulated depreciation are removed from the accounts and any resulting gain or loss is reflected in income for the period.
OTHER REAL ESTATE OWNED
Real estate acquired through foreclosure is carried at the lower of the recorded investment in the property or its fair value less estimated selling costs. Prior to foreclosure, the value of the underlying collateral of the loan is written down to its estimated fair value less estimated selling costs by a charge to the allowance for loan losses, if necessary. Any subsequent write-downs are charged against operations. Operating expenses of such properties are included in other operating expenses in the accompanying consolidated statement of income.
MORTGAGE SERVICING
Mortgage servicing rights represent the right to receive future mortgage servicing fees. The Company recognizes as separate assets the right to service mortgage loans for others, whether the servicing rights are acquired through a separate purchase or through loan origination by allocating total costs incurred between the loan and the servicing rights retained based on their relative fair values. Mortgage servicing rights are amortized in proportion to, and over the period of, estimated net servicing income. The Company periodically evaluates the carrying value of the mortgage servicing rights in relation to the present value of the estimated future net servicing revenue based on management's best estimate of remaining loan lives.
Mortgage servicing rights are reported as a component of other assets in the accompanying consolidated balance sheet. Fair values are based on quoted market prices in active markets for loans and loan servicing rights. For purchased mortgage servicing rights, the cost of acquiring loan servicing contracts is capitalized to the extent such costs do not exceed the amount by which the present value of estimated future servicing revenue exceeds the present value of expected future servicing costs.
SOUTHWEST BANCORPORATION OF TEXAS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Mortgage loans serviced for others are not included in the consolidated balance sheet. The unpaid principal balance of mortgage loans serviced for others was approximately $1,317,000 and $908,000 at December 31, 2000 and 1999, respectively.
Custodial escrow balances maintained in connection with the foregoing loan servicing, and included in demand deposits, were approximately $41,018 and $21,306 at December 31, 2000 and 1999, respectively.
EARNINGS PER COMMON SHARE
Basic earnings per common share is computed by dividing income available for common shareholders by the weighted average number of common shares outstanding for the period. Diluted earnings per common share is computed by dividing income available for common shareholders, adjusted for any changes in income that would result from the assumed conversion of all potential dilutive common shares, by the sum of the weighted average number of common shares outstanding and the effect of all potential dilutive common shares outstanding for the period.
INCOME TAXES
Deferred income taxes are provided utilizing the liability method whereby deferred income tax assets or liabilities are recognized for the tax consequences in future years of differences in the tax bases of assets and liabilities and their financial reporting amounts based on enacted tax laws and statutory tax rates applicable to the periods in which the differences are expected to affect taxable income. Valuation allowances are established when necessary to reduce deferred tax assets to the amount expected to be realized.
OFF-BALANCE SHEET FINANCIAL INSTRUMENTS
In the ordinary course of business the Company has entered into off-balance sheet financial instruments consisting of commitments to extend credit, commitments to sell mortgage loans, commercial letters of credit and standby letters of credit. Such financial instruments are recorded in the financial statements when they are funded or related fees are incurred or received.
NEW ACCOUNTING PRONOUNCEMENTS
In June 1998, Statement of Financial Accounting Standards (SFAS) No. 133, ACCOUNTING FOR DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES, as amended, was issued by the Financial Accounting Standards Board to establish accounting and reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts, and for hedging activities. SFAS No. 133 requires that an entity recognize those instruments at fair value. If certain conditions are met, a derivative may be specifically designated as (a) a hedge of the exposure to changes in the fair value of a recognized asset or liability or an unrecognized firm commitment, (b) a hedge of the exposure to variable cash flows of a forecasted transaction, or (c) a hedge of the foreign currency exposure of a net investment in a foreign operation, an unrecognized firm commitment, an available-for-sale security, or a foreign-currency-denominated forecasted transaction. The accounting for the changes in the fair value of a derivative depends on the intended use of the derivative and the resulting designation. The Company adopted SFAS No. 133 on January 1, 2001. The impact of the adoption was not material to the Company's consolidated financial position, results of operations or cash flows.
In December 1999, the Securities and Exchange Commission issued Staff Accounting Bulletin No. 101, "Revenue Recognition in Financial Statements " (SAB No. 101). SAB No. 101, as amended, was implemented in the fourth quarter of 2000 and did not have a material effect on the Company's consolidated financial position, results of operations or cash flows.
2. MERGERS:
On December 29, 2000, the Company consummated its merger with Citizens. Citizens was a multi-bank holding company and the parent company of Citizens Bank and Trust Co., Baytown State Bank and Pasadena State Bank (which
SOUTHWEST BANCORPORATION OF TEXAS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
also were merged into the Bank on December 29, 2000) and the majority owner of First National Bank of Bay City. In accordance with the Agreement and Plan of Merger, the Company exchanged 249.443 shares of the Company's common shares for each share of Citizens common stock, resulting in the issuance of approximately 3.9 million shares of Company Common Stock on a fully diluted basis. At December 29, 2000, Citizens had total assets of approximately $436,000 and total deposits of approximately $381,000. In a related transaction, the Company, CBLP and Baytown Land I, Ltd., the general partner of CBLP, entered into an agreement pursuant to which the Company acquired the assets and assumed the liabilities of CBLP. CBLP's primary assets and liabilities were the building in which Citizens main branch was located and the related debt to third parties. In connection with this agreement, the Company issued approximately 106,000 shares of the Company's Common Stock on a fully diluted basis. These transactions have been accounted for as a pooling of interests.
On April 1, 1999, the Company consummated its merger with Fort Bend Holding Corp. ("Fort Bend"). Fort Bend was the parent company of Fort Bend Federal Savings and Loan Association of Rosenberg (which also was merged into the Bank on April 1, 1999) and the majority owner of Mitchell. In accordance with the Agreement and Plan of Merger, the Company exchanged 1.45 shares of the Company's common shares for each share of Fort Bend common stock, resulting in the issuance of approximately 4.1 million shares of Company Common Stock. At March 31, 1999 Fort Bend had total assets of approximately $316,000 and total deposits of approximately $269,000. The transaction has been accounted for as a pooling of interests.
Through the merger with Fort Bend, the Company acquired Fort Bend's 51% ownership interest in Mitchell Mortgage Company L.L.C. ("Mitchell"), a full service mortgage banking affiliate of The Woodlands Operating Company L.P. ("Woodlands"). On June 17, 1999, the Company issued 307,323 shares of Company Common Stock to Woodlands in exchange for Woodlands' 49% ownership in Mitchell and Mitchell became a wholly-owned subsidiary of the Bank effective as of June 30, 1999. As a result, 100% of the accounts and operations of Mitchell after that date are included in the financial statements of the Company.
The Company's consolidated financial statements have been restated to include the accounts and operations of Citizens, CBLP and Fort Bend for all periods presented. Separate interest income and net income amounts of the merged entities are presented in the following table:
2000 1999 1998 - ------------------------------------------------------------------------------- Interest income: Periods prior to consummation: Company $243,830 $ 37,612 $139,144 Citizens 28,336 25,009 23,916 Fort Bend -- 5,454 22,603 Periods subsequent to consummation -- 143,157 -- - ------------------------------------------------------------------------------- Total interest income $272,166 $211,232 $185,663 =============================================================================== Net income: Periods prior to consummation: Company $ 37,825 $ 6,305 $ 22,470 Citizens 5,636 5,113 4,557 Fort Bend -- 410 1,991 Periods subsequent to consummation -- 20,135 -- - ------------------------------------------------------------------------------- Total net income $ 43,461 $ 31,963 $ 29,018 ===============================================================================
SOUTHWEST BANCORPORATION OF TEXAS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
3. SECURITIES:
The amortized cost and fair value of securities classified as available for sale and held to maturity is as follows:
The scheduled maturities of securities classified as available for sale is as follows:
DECEMBER 31, 2000 - ------------------------------------------------------------------ AMORTIZED FAIR COST VALUE - ------------------------------------------------------------------ Available for sale: Due in one year or less $ 21,359 $ 21,395 Due from one year to five years 140,227 140,527 Due after five years 7,483 7,408 - ------------------------------------------------------------------ U.S. Government securities 169,069 169,330 Mortgage-backed securities 618,523 613,216 Federal Reserve Bank stock 3,949 3,949 Federal Home Loan Bank stock 17,972 17,972 Other securities 43,411 43,697 - ------------------------------------------------------------------ Total securities available for sale $852,924 $848,164 ==================================================================
Securities with a carrying value of $593,672 and $575,617 at December 31, 2000 and 1999, respectively, have been pledged to collateralize repurchase agreements, public deposits, Federal Home Loan Bank borrowings and other items.
SOUTHWEST BANCORPORATION OF TEXAS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
In connection with the Citizens merger, the Company transferred all of Citizens' held to maturity debt securities to the available for sale category. The amortized cost of these securities at the time of transfer was $55,800 and the unrealized gain was $267 ($174 net of income taxes). In connection with the Fort Bend merger, the Company transferred all of Fort Bend's held to maturity debt securities to the available for sale category in 1999. The amortized cost of these securities at the time of transfer was $57,800 and the unrealized gain was $80 ($52 net of income taxes). The Company does not intend to sell these securities in the near term.
Gross gains of $307, $286 and $996 and gross losses of $774, $420 and $63 were recognized on sales of investment securities for the years ended December 31, 2000, 1999 and 1998, respectively.
4. LOANS:
A summary of loans outstanding follows:
DECEMBER 31, - -------------------------------------------------------------------- 2000 1999 - -------------------------------------------------------------------- Commercial and industrial $ 958,146 $ 750,585 Real estate: Construction and land development 643,164 502,231 1-4 family residential 336,024 290,117 Other 303,568 246,442 Consumer 192,271 171,772 Less: Unearned income and fees, net of related costs (7,675) (2,852) Allowance for loan losses (28,150) (22,436) - -------------------------------------------------------------------- Loans held for investment, net 2,397,348 1,935,859 Loans held for sale 85,939 77,047 - -------------------------------------------------------------------- Total loans, net $2,483,287 $2,012,906 - --------------------------------------------------------------------
An analysis of the allowance for loan losses is as follows:
YEARS ENDED DECEMBER 31, - ---------------------------------------------------------------------------- 2000 1999 1998 - ---------------------------------------------------------------------------- Balance, beginning of year $22,436 $17,532 $14,385 Provision charged against operations 7,053 6,474 4,261 Charge-offs (2,093) (2,211) (1,506) Recoveries 754 641 374 Adjustment to conform reporting periods -- -- 18 - ---------------------------------------------------------------------------- Balance, end of year $28,150 $22,436 $17,532 - ----------------------------------------------------------------------------
The Company's impaired loans were approximately $10,800 and $13,700 at December 31, 2000 and 1999 respectively. The average recorded investment in impaired loans during 2000, 1999 and 1998 was $9,300, $13,900 and $6,300, respectively. The total required allowance for loan losses related to these loans was $1,000 and $0 at December 31, 2000 and 1999, respectively. Interest income on impaired loans of $1,100, $1,500 and $415 was recognized for cash payments received in 2000, 1999 and 1998, respectively.
The Bank is not committed to lend additional funds to debtors whose loans have been modified.
SOUTHWEST BANCORPORATION OF TEXAS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The Company has loans, deposits, and other transactions with its principal shareholders, officers, directors and organizations with which such persons are associated which were made in the ordinary course of business. At December 31, 2000, the aggregate amount of loans and unfunded lines of credit to such related parties was $65,302. Following is an analysis of activity with respect to these amounts:
DECEMBER 31, - ----------------------------------------------------- Balance, beginning of year $ 56,346 New loans and unfunded lines of credit 48,320 Repayments (39,364) ===================================================== Balance, end of year $ 65,302
5. PREMISES AND EQUIPMENT: Premises and equipment consist of the following:
DECEMBER 31, - ---------------------------------------------------------------- 2000 1999 - ---------------------------------------------------------------- Land $ 11,181 $ 9,129 Premises and leasehold improvements 37,363 30,246 Furniture and equipment 50,878 40,370 - ---------------------------------------------------------------- 99,422 79,745 Less accumulated depreciation and amortization (46,960) (40,113) - ---------------------------------------------------------------- $ 52,462 $ 39,632 ================================================================
6. OTHER ASSETS: Other assets consist of the following:
DECEMBER 31, - ---------------------------------------------------------------- 2000 1999 - --------------------------------------------------------------- Foreclosed real estate $ 454 $ 1,840 Deferred income taxes 13,053 15,766 Goodwill 2,847 3,103 Banker's acceptances 5,750 4,152 Investment in unconsolidated investees 6,557 5,474 Cash value of bank-owned life insurance 28,664 27,197 Factored receivables 27,503 18,542 Mortgage servicing rights 12,334 6,681 Other 20,627 10,960 - --------------------------------------------------------------- $117,789 $93,715 ===============================================================
SOUTHWEST BANCORPORATION OF TEXAS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
7. DEPOSITS
At December 31, 2000, scheduled maturities of time deposits are summarized as follows:
DECEMBER 31, - ------------------------------------------------------ 2001 $ 719,458 2002 121,289 2003 21,807 2004 16,397 2005 26,625 THEREAFTER 1,702 - ------------------------------------------------------ $ 907,278 ======================================================
At December 31, 2000 and 1999, the aggregate amount of deposits from related parties was $140,082 and $47,021, respectively.
Brokered deposits were $53,406 and $30,056 at December 31, 2000 and 1999, respectively.
8. SECURITIES SOLD UNDER REPURCHASE AGREEMENTS AND OTHER BORROWINGS:
Securities sold under repurchase agreements and other borrowings, consisting of federal funds purchased and treasury, tax, and loan deposits, generally represent borrowings with maturities ranging from one to thirty days. Information relating to these borrowings is summarized as follows:
DECEMBER 31, December 31, 2000 1999 - ------------------------------------------------------------------------------- Securities sold under repurchase agreements: Average 209,816 184,358 Year-end 211,800 216,838 Maximum month-end balance during year 241,834 216,838 Interest rate: Average 4.69% 4.06% Year-end 4.89% 4.03% Other borrowings: Average $205,213 $196,694 Year-end 305,961 267,140 Maximum month-end balance during year 380,121 284,455 Interest rate: Average 6.39% 5.39% Year-end 6.83% 5.27%
Securities sold under repurchase agreements generally include U.S. Government securities and are maintained in safekeeping by correspondent banks. The Company enters into these repurchase agreements as a service to its customers.
Subject to certain limitations, the Bank may borrow funds from the Federal Home Loan Bank ("FHLB") in the form of advances. Credit availability from the FHLB to the Bank is based on the Bank's financial and operating condition. Borrowings from the FHLB to the Bank were approximately $193,400 and $237,200 at December 31, 2000 and 1999, respectively. In addition to creditworthiness, the Bank must own a minimum amount of FHLB capital stock. This minimum is 5.00% of outstanding FHLB advances. Unused borrowing capacity at December 31, 2000 was approximately $293,200.
SOUTHWEST BANCORPORATION OF TEXAS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
9. INCOME TAXES:
The income tax provision (benefit) for the years ended December 31, 2000, 1999 and 1998 is composed of the following:
2000 1999 1998 - ---------------------------------------------------------------------------- Current $24,287 $18,647 $18,172 Deferred (1,680) (1,147) (2,406) - ---------------------------------------------------------------------------- TOTAL $22,607 $17,500 $15,766 ============================================================================
The types of temporary differences between the tax bases of assets and liabilities and their financial reporting amounts that give rise to deferred income tax assets and liabilities and their approximate tax effects are as follows:
In connection with the Company' merger with Citizens and CBLP, the Company recorded deferred tax assets of $2,669 with an offsetting credit to additional paid in capital related to differences in the tax bases of assets and liabilities and their financial reporting amounts. Such deferred taxes were not previously recorded by CBLP as it was organized as a limited partnership.
The reconciliation between the Company' effective income tax rate and the statutory federal income tax rate is as follows:
YEAR ENDED DECEMBER 31, - -------------------------------------------------------------------------- 2000 1999 1998 - -------------------------------------------------------------------------- Statutory federal income tax rate 35.0 % 35.0 % 35.0 % Permanent differences (0.91) 0.36 (0.09) Effective income tax rate 34.09% 35.36% 34.91% ==========================================================================
10. EMPLOYEE BENEFITS:
STOCK-BASED COMPENSATION PLAN
The Company sponsors, and currently grants awards under, the Southwest Bancorporation of Texas, Inc. 1996 Stock Option Plan (the "Stock Option Plan", which is a stock-based compensation plan as described below. The Company has also sponsored similar stock-based compensation plans in prior years.
SOUTHWEST BANCORPORATION OF TEXAS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The Company applies the intrinsic value method in accounting for the Stock Option Plan and the Company' other prior stock-based compensation plans in accordance with Accounting Principles Board Opinion No. 25 ("APB 25". In 1995, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 123, ACCOUNTING FOR STOCK-BASED COMPENSATION, ("SFAS 123" which, if fully adopted by the Company, would change the method the Company applies in recognizing the expense of its stock-based compensation plans for awards subsequent to 1994. Adoption of the expense recognition provisions of SFAS 123 is optional and the Company decided not to elect these provisions of SFAS 123. However, pro forma disclosures as if the Company adopted the expense recognition provisions of SFAS 123 are required by SFAS 123 and are presented below.
THE STOCK OPTION PLAN
Under the 1996 Stock Option Plan, the Company is authorized to issue up to 3,000,000 shares of common stock pursuant to "Awards" granted in the form of incentive stock options which qualify under Section 422 of the Internal Revenue Code of 1986, as amended (the "Code", nonqualified stock options which do not qualify under Section 422 of the Code, and stock appreciation rights. Awards may be granted to selected employees and directors of the Company or any subsidiary. The Stock Option Plan provides that the exercise price of any incentive stock option may not be less than the fair market value of the common stock on the date of grant, and that the exercise price of any nonqualified stock option may be equal to, greater than or less than the fair market value of the common stock on the date of grant.
The Company granted 636,605, 353,893 and 640,552 stock options in 2000, 1999 and 1998, respectively. These stock options were granted with an exercise price, as determined in each individual grant agreement. The majority of the options granted vest over a five year period commencing on the date of grant (i.e., 60% vest on the third anniversary of the date of grant and 20% vest on each of the next two anniversaries of the date of grant) with the remaining options vesting over a period not to exceed five years.
In accordance with APB 25, compensation expense is recognized for discounted stock options granted and for performance-based stock options granted (but not for the nondiscounted stock options granted). The Company has recognized $3, $108 and $172 of compensation expense in connection with these grants in 2000, 1999 and 1998, respectively.
A summary of the status of the Company' stock options as of December 31, 2000, 1999, and 1998 and the change during the years is as follows:
SOUTHWEST BANCORPORATION OF TEXAS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The fair value of each stock option granted is estimated on the date of grant using the Black-Scholes stock option valuation model with the following weighted-average assumptions for grants in 2000, 1999 and 1998: dividend yield of 0.00%: risk-free interest rates are different for each grant and range from 5.18% to 6.47%; the expected lives of options range from 5 to 6 years; and a volatility of 29.30%, 28.59% and 26.77% respectively. The weighted average fair value of options granted during the year is as follows:
The following table summarizes information about stock options outstanding and exercisable at December 31, 2000:
* All options, with an exercise price between $.20 to $5.20, are exercisable while the employee remains an employee at the Company and cease to be exercisable three months after termination of employment.
If the fair value based method of accounting under SFAS 123 had been applied, the Company' net income available for common shareholders and earnings per common share would have been reduced to the pro forma amounts indicated below (assuming that the fair value of options granted during the year are amortized over the vesting period):
YEAR ENDED DECEMBER 31, --------------------------------------- 2000 1999 1998 - -------------------------------------------------------------------------------- Net income As reported $43,461 $31,963 $29,018 Pro forma $41,812 $30,695 $27,967 Basic earnings per common share As reported $ 1.34 $ 1.01 $ 0.97 Pro forma $ 1.29 $ 0.97 $ 0.94 Diluted earnings per common share As reported $ 1.29 $ 0.97 $ 0.91 Pro forma $ 1.24 $ 0.93 $ 0.88
The effects of applying SFAS 123 in the above pro forma disclosure are not indicative of future amounts. The Company anticipates making awards in the future under its stock-based compensation plans.
BENEFIT PLANS
The Company has adopted a contributory profit sharing plan pursuant to Internal Revenue Code Section 401(k) covering substantially all employees (the "401-K Plan"). Each year the Company determines, at its discretion, the amount of matching contributions. The Company presently matches 100% of the employee contributions not to exceed
SOUTHWEST BANCORPORATION OF TEXAS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
5.0% of the employee's annual compensation. Total plan expense charged to the Company's operations for the years ended December 31, 2000, 1999 and 1998 was $1,744, $1,374 and $972, respectively.
The 401-K Plan allows for the Company to contribute up to 500,000 shares of common stock of the Company (valued at the approximate fair market value on the date of contribution) instead of cash. A total of 4,431 shares at $16.58 were issued to the 401-K Plan during the year ended December 31, 1999. No shares were issued to the 401-K Plan in 2000 and 1998.
Prior to December 31, 2000, Citizens had a defined benefit pension plan covering substantially all of their employees. The benefits under the plan were based on years of service and the employee's final average monthly compensation. Effective December 31, 2000, the Company curtailed the defined benefit pension plan. Pursuant to the curtailment, no further benefits will be accrued under the plan from and after December 31, 2000 and no individual who is not currently a participant in the plan shall be eligible to become a participant in the plan. Each participant who is an employee at December 31, 2000 became 100% vested in their accrued benefit on December 31, 2000.
The three wholly-owned subsidiary banks of Citizens had a profit sharing plan covering substantially all of their employees. The profit sharing plan was funded on an annual basis as determined by the Banks' Boards of Directors. Contributions to the profit sharing plan were $573, $681 and $655 for the years ended December 31, 2000, 1999 and 1998, respectively. Effective October 1, 2000, the profit sharing plan was converted to a 401(k) plan.
11. EARNINGS PER COMMON SHARE:
Earnings per common share is computed as follows:
SOUTHWEST BANCORPORATION OF TEXAS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
12. COMMITMENTS AND CONTINGENCIES:
LITIGATION
The Company is involved in various litigation that arise in the normal course of business. In the opinion of management of the Company, after consultation with its legal counsel, such litigation will not have a material adverse effect on the Company' consolidated financial position, results of operations or cash flows.
LEASES
At December 31, 2000, the Company has certain noncancelable operating leases which cover the Company' premises with approximate future minimum annual rental payments as follows:
2001 $ 5,196 2002 4,910 2003 4,664 2004 4,564 2005 4,494 Thereafter 9,934 ------------------------------------------------ $33,762 ================================================
Rent expense was $4,672, $3,937 and $3,057 for the years ended December 31, 2000, 1999 and 1998, respectively.
13. REGULATORY CAPITAL COMPLIANCE:
The Company and the Bank are subject to regulatory risk-based capital requirements that assign risk factors to all assets, including off-balance sheet items such as loan commitments and standby letters of credit. Failure to meet minimum capital requirements can initiate certain mandatory, and possibly additional discretionary, actions by regulators that, if undertaken, could have a direct material effect on the Company's consolidated financial statements. Capital is separated into two categories, Tier 1 and Tier 2, which combine for total capital. At December 31, 2000, the Company's and Bank's Tier 1 capital consists of their respective shareholders' equity adjusted for minority interest in equity accounts of consolidated subsidiaries, goodwill, and various other intangibles and Tier 2 consists of the allowance for loan losses subject to certain limitations. The guidelines require total capital of 8% of risk-weighted assets.
In conjunction with risk-based capital guidelines, the regulators have issued capital leverage guidelines. The leverage ratio consists of Tier 1 capital as a percent of average assets. The minimum leverage ratio for all banks is 3%, with a higher minimum ratio dependent upon the condition of the individual bank. The 3% minimum was established to make certain that all banks have a minimum capital level to support their assets, regardless of risk profile.
As of December 31, 2000, the most recent notification from the regulators categorized the Bank and the Company as "well capitalized" under the regulatory framework for prompt corrective action. There are no conditions or events since that notification that management believes have changed the category.
SOUTHWEST BANCORPORATION OF TEXAS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The following table compares the Company's and the Bank's leverage and risk-weighted capital ratios as of December 31, 2000 and 1999 to the minimum regulatory standards:
The Company and the Bank are also subject to certain restrictions on the amount of dividends that they may declare without prior regulatory approval.
14. FINANCIAL INSTRUMENTS WITH OFF-BALANCE SHEET RISK AND CONCENTRATIONS OF CREDIT RISK:
The Company is party to financial instruments with off-balance sheet risk in the normal course of business in order to meet the financing needs of its customers. These financial instruments, which are for purposes other than trading, include loan commitments, letters of credit, commitments to sell mortgage loans to permanent investors, purchased option contracts and financial guarantees on GNMA mortgage-backed securities administered. These financial instruments involve, to varying degrees, elements of credit risk in excess of the amounts recognized in the financial statements.
The Company's exposure to credit loss in the event of nonperformance by the other party to the loan commitments and letters of credit is limited to the contractual amount of those instruments. The Company uses the same credit policies in evaluating loan commitments and letters of credit as it does for on-balance sheet instruments. In order to control the credit risk associated with entering into commitments, the Company subjects such activity to the same credit quality and monitoring controls as its lending activities. For commitments to sell mortgage loans to permanent investors, the contract amounts do not represent exposure to credit loss. For purchased put options, the Company's exposure is limited to the option premium paid, not the notional amount of the option. For GNMA mortgage-backed securities administered, the contract amount administered exceeds the Company's exposure to credit loss.
SOUTHWEST BANCORPORATION OF TEXAS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The approximate amounts of financial instruments with off-balance sheet risk are as follows:
Loan commitments 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 loan commitments and letters of credit may expire without being drawn upon, the total commitment amount does not necessarily represent future cash requirements. Standby letters of credit are conditional commitments by the Company to guarantee the performance of a customer to a third party.
The Company evaluates each customer's credit worthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by the Company upon extension of credit, is based on management's credit evaluation of the counterparty. Collateral held varies but may include certificates of deposit, accounts receivable, inventory, property, plant and equipment, and real property.
Commitments to sell mortgage loans to permanent investors are contracts in which the Company agrees to deliver mortgage loans at specific future dates at specified prices or yields. Risks arise from the possible inability of counterparties to meet the terms of their contracts and from movements in interest rates.
The Company purchases option contracts on FNMA or FHLMC guaranteed mortgage backed securities to reduce the Company's exposure to the effects of fluctuations in interest rates on the Company's lending and secondary marketing activities. The time value portion of option premiums paid is recorded in other assets and is amortized to expense over the term of the option. Changes in the intrinsic value of options are deferred and recognized as the related mortgage loans are sold.
The Company administers GNMA mortgage-backed securities on which it guarantees payment of monthly principal and interest to the security holders. The underlying loans are supported by FHA and VA mortgage insurance and are collateralized by real estate. In the event of mortgagor default, losses may arise from principal, interest or other costs which may exceed reimbursement limitations established by FHA or VA.
The Company originates real estate, commercial, construction and consumer loans primarily to customers in the greater Houston, Texas area. Although the Company has a diversified loan portfolio, a substantial portion of its customers' ability to honor their contracts is dependent upon the local Houston economy and the real estate market.
The Company maintains funds on deposit at correspondent banks which at times exceed the federally insured limits. Management of the Company monitors the balance in these accounts and periodically assesses the financial condition of correspondent banks.
15. FAIR VALUES OF FINANCIAL INSTRUMENTS:
The fair value of financial instruments provided below represents estimates of fair values at a point in time. Significant estimates regarding economic conditions, loss experience, risk characteristics associated with particular financial instruments and other factors were used for the purposes of this disclosure. These estimates are subjective in
SOUTHWEST BANCORPORATION OF TEXAS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
nature and involve matters of judgment. Therefore, they cannot be determined with precision. Changes in the assumptions could have a material impact on the amounts estimated.
While the estimated fair value amounts are designed to represent estimates of the amounts at which these instruments could be exchanged in a current transaction between willing parties, many of the Company's financial instruments lack an available trading market as characterized by willing parties engaging in an exchange transaction. In addition, it is the Company's intent to hold most of its financial instruments to maturity and, therefore, it is not probable that the fair values shown will be realized in a current transaction.
The estimated fair values disclosed do not reflect the value of assets and liabilities that are not considered financial instruments. In addition, the value of long-term relationships with depositors (core deposit intangibles) and other customers is not reflected. The value of these items is significant.
Because of the wide range of valuation techniques and the numerous estimates which must be made, it may be difficult to make reasonable comparisons of the Company's fair value information to that of other financial institutions. It is important that the many uncertainties discussed above be considered when using the estimated fair value disclosures and to realize that because of these uncertainties, the aggregate fair value amount should in no way be construed as representative of the underlying value of the Company.
The following methods and assumptions were used by the Company in estimating its fair value disclosures for financial instruments:
CASH AND CASH EQUIVALENTS: The carrying amounts for cash and cash equivalents approximate their fair values.
SECURITIES: Fair values for investment securities are based on quoted market prices. The fair value of stock in the Federal Home Loan Bank of Dallas and the Federal Reserve Bank Stock is estimated to be equal to its carrying amount given it is not a publicly traded equity security, it has an adjustable dividend rate, and transactions in the stock are executed at the stated par value.
LOANS HELD FOR SALE: Fair values of loans held for sale are estimated based on outstanding commitments from investors or current market prices for similar loans.
LOANS AND ACCRUED INTEREST RECEIVABLE: For variable-rate loans that reprice frequently and with no significant change in credit risk, fair values are based on carrying values. The fair value of all other loans are estimated using discounted cash flow analyses, using interest rates currently being offered for loans with similar terms to borrowers of similar credit quality. Fair values for impaired loans are estimated using discounted cash flow analyses or underlying collateral values, where applicable. The carrying amount of accrued interest approximates its fair value.
OFF-BALANCE-SHEET INSTRUMENTS: The fair values of the Company's lending commitments, letters of credit, commitments to sell loans and guarantees are based on fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the counterparties' credit standing. The fair value of the Company's option contracts are based on the estimated amounts the Company would receive from terminating the contracts at the reporting date.
DEPOSIT LIABILITIES AND ACCRUED INTEREST PAYABLE: The fair values disclosed for demand deposits (e.g., interest and noninterest checking and money market accounts) are, by definition, equal to the amount payable on demand at the reporting date. Fair values for fixed-rate time deposits are estimated using a discounted cash flow analysis, using interest rates currently being offered on certificates to a schedule of aggregated expected monthly maturities on time deposits. The carrying amount of accrued interest approximates its fair value.
BORROWINGS: The carrying amounts of federal funds purchased, securities sold under repurchase agreements, and other borrowings approximate their fair values.
SOUTHWEST BANCORPORATION OF TEXAS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The following table summarizes the carrying values and estimated fair values of financial instruments (all of which are held for purposes other than trading):
The fair value of the Company's off-balance sheet instruments was immaterial at December 31, 2000 and 1999.
16. SUPPLEMENTAL CASH FLOW INFORMATION:
The supplemental cash flow information for the years ended December 31, 2000, 1999, and 1998 is as follows:
REPORT OF INDEPENDENT ACCOUNTANTS ON FINANCIAL STATEMENT SCHEDULE
To the Board of Directors and Shareholders Southwest Bancorporation of Texas, Inc.:
Our audits of the consolidated financial statements referred to in our report dated February 23, 2001 of Southwest Bancorporation of Texas, Inc. and Subsidiaries included on page of this Form 10-K also included an audit of the financial statement schedule listed in the index on page of this Form 10-K. In our opinion, this financial statement schedule presents fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements.
PricewaterhouseCoopers LLP
Houston, Texas February 23, 2001
SOUTHWEST BANCORPORATION OF TEXAS, INC. AND SUBSIDIARIES SCHEDULE I -- PARENT COMPANY CONDENSED FINANCIAL STATEMENTS CONDENSED BALANCE SHEET (IN THOUSANDS, EXCEPT SHARE AMOUNTS)
These condensed financial statements should be read in conjunction with the Consolidated Financial Statements and Notes thereto of Southwest Bancorporation of Texas, Inc. and Subsidiaries included herein.
SOUTHWEST BANCORPORATION OF TEXAS, INC. AND SUBSIDIARIES SCHEDULE I -- PARENT COMPANY CONDENSED FINANCIAL STATEMENTS (CONTINUED) CONDENSED STATEMENT OF INCOME AND COMPREHENSIVE INCOME (IN THOUSANDS)
These condensed financial statements should be read in conjunction with the Consolidated Financial Statements and Notes thereto of Southwest Bancorporation of Texas, Inc. and Subsidiaries included herein.
SOUTHWEST BANCORPORATION OF TEXAS, INC. AND SUBSIDIARIES SCHEDULE I -- PARENT COMPANY CONDENSED FINANCIAL STATEMENTS (CONTINUED) CONDENSED STATEMENT OF CASH FLOWS (IN THOUSANDS)
These condensed financial statements should be read in conjunction with the Consolidated Financial Statements and Notes thereto of Southwest Bancorporation of Texas, Inc. and Subsidiaries included herein.