UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
------------------------
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE
ACT OF 1934 FOR THE QUARTER ENDED SEPTEMBER 30, 1998
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934
------------------------
COMMISSION FILE NUMBER: 000-22007
------------------------
SOUTHWEST BANCORPORATION OF TEXAS, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
TEXAS 76-0519693
(STATE OR OTHER JURISDICTION (I.R.S. EMPLOYER
OF INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)
4400 POST OAK PARKWAY
HOUSTON, TEXAS 77027
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES, INCLUDING ZIP CODE)
(713) 235-8800
(REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE)
------------------------
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]
------------------------
There were 23,215,048 shares of the Registrant's Common Stock outstanding
as of the close of business on November 2, 1998.
<PAGE>
SOUTHWEST BANCORPORATION OF TEXAS, INC. AND SUBSIDIARY
INDEX TO FORM 10-Q
PAGE
----
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Report of Independent Accountants ............................... 2
Condensed Consolidated Balance Sheet as of September 30, 1998
and December 31, 1997 (unaudited) .............................. 3
Condensed Consolidated Statement of Income for the Three and
Nine Months Ended September 30, 1998 and 1997 (unaudited) ...... 4
Condensed Consolidated Statement of Changes in Shareholders'
Equity for the Year Ended December 31, 1997, and for the
Nine Months Ended September 30, 1998 (unaudited) ............... 5
Condensed Consolidated Statement of Cash Flows for the Nine
Months Ended September 30, 1998 and 1997 (unaudited) ........... 6
Notes to Condensed Consolidated Financial Statements (unaudited) 7
Item 2. Management's Discussion and of Financial Condition and
Results of Operations ...................................... 9
PART II. OTHER INFORMATION
Item 1. Legal Proceedings ........................................... 23
Item 2. Changes in Securities ....................................... 23
Item 3. Defaults upon Senior Securities ............................. 23
Item 4. Submission of Matters to a Vote of Security Holders ......... 23
Item 5. Other Information ........................................... 24
Item 6. Exhibits and Reports on Form 8-K ............................ 24
Signatures ........................................................... 25
1
<PAGE>
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
REPORT OF INDEPENDENT ACCOUNTANTS
Board of Directors
Southwest Bancorporation of Texas, Inc.:
We have reviewed the accompanying condensed consolidated balance sheet of
Southwest Bancorporation of Texas, Inc. and Subsidiary (the "Company") as of
September 30, 1998, the related condensed consolidated statement of income for
the three- and nine-month periods ended September 30, 1998 and 1997, the
condensed consolidated statement of changes in shareholders' equity for the
nine-month period ended September 30, 1998 and the condensed consolidated
statement of cash flows for the nine-month periods ended September 30, 1998 and
1997. These financial statements are the responsibility of the Company's
management.
We conducted our review in accordance with standards established by the
American Institute of Certified Public Accountants. A review of interim
financial information consists principally of applying analytical procedures to
financial data and making inquiries of persons responsible for financial and
accounting matters. It is substantially less in scope than an audit conducted in
accordance with generally accepted auditing standards, the objective of which is
the expression of an opinion regarding the financial statements taken as a
whole. Accordingly, we do not express such an opinion.
Based on our review, we are not aware of any material modifications that
should be made to the aforementioned financial statements for them to be in
conformity with generally accepted accounting principles. Accordingly, we do not
express such an opinion.
We have previously audited, in accordance with generally accepted auditing
standards, the consolidated balance sheet as of December 31, 1997, and the
related consolidated statements of income, changes in shareholders' equity, and
cash flows for the year then ended (not presented herein); and, in our report
dated February 10, 1998, we expressed an unqualified opinion on those
consolidated financial statements. In our opinion, the information set forth in
the accompanying condensed consolidated balance sheet as of December 31, 1997
and the condensed consolidated statement of changes in shareholders' equity for
the year ended December 31, 1997, is fairly stated, in all material respects, in
relation to the consolidated financial statements from which it has been
derived.
PricewaterhouseCoopers LLP
Houston, Texas
October 29, 1998
2
<PAGE>
SOUTHWEST BANCORPORATION OF TEXAS, INC. AND SUBSIDIARY
CONDENSED CONSOLIDATED BALANCE SHEET
(IN THOUSANDS, EXCEPT SHARE AMOUNTS)
(UNAUDITED)
SEPTEMBER 30, DECEMBER 31,
1998 1997
------------- ------------
ASSETS
Cash and due from banks.............. $ 84,363 $ 104,363
Federal funds sold and other cash
equivalents.......................... 113,062 132,616
------------- ------------
Total cash and cash
equivalents............ 197,425 236,979
Securities -- available for sale..... 515,290 555,398
Loans receivable, net................ 1,193,961 975,815
Premises and equipment, net.......... 24,752 21,348
Accrued interest receivable.......... 12,027 11,159
Prepaid expenses and other assets.... 39,875 6,905
------------- ------------
Total assets............... $ 1,983,330 $1,807,604
============= ============
LIABILITIES AND SHAREHOLDERS' EQUITY
Deposits:
Demand -- noninterest-bearing... $ 483,686 $ 492,843
Demand -- interest-bearing...... 39,926 58,915
Money market accounts........... 704,332 580,605
Savings......................... 11,328 14,850
Time, $100 and over............. 309,072 271,730
Other time...................... 88,700 93,398
------------- ------------
Total deposits............. 1,637,044 1,512,341
Securities sold under repurchase
agreements......................... 197,175 155,832
Other short-term borrowings.......... 3,967 17,243
Accrued interest payable............. 1,155 1,259
Other liabilities.................... 6,473 6,094
------------- ------------
Total liabilities.......... 1,845,814 1,692,769
------------- ------------
Commitments and contingencies
Shareholders' equity:
Common stock -- $1 par value,
50,000,000 shares authorized;
23,215,048 and 22,370,526
shares issued and outstanding
at September 30, 1998 and
December 31, 1997,
respectively................... 23,215 22,370
Additional paid-in capital...... 41,682 38,364
Retained earnings............... 68,839 52,333
Accumulated other comprehensive
income......................... 3,780 1,768
------------- ------------
Total shareholders'
equity................. 137,516 114,835
------------- ------------
Total liabilities and
shareholders' equity... $ 1,983,330 $1,807,604
============= ============
The accompanying notes are an integral part of the condensed consolidated
financial statements.
3
<PAGE>
SOUTHWEST BANCORPORATION OF TEXAS, INC. AND SUBSIDIARY
CONDENSED CONSOLIDATED STATEMENT OF INCOME
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
-------------------- ---------------------
1998 1997 1998 1997
--------- --------- ---------- ---------
<S> <C> <C> <C> <C>
Interest income:
Loans........................... $ 26,883 $ 20,764 $ 74,144 $ 56,606
Securities...................... 8,015 6,379 23,576 17,737
Federal funds sold and other.... 1,456 2,142 4,483 3,399
--------- --------- ---------- ---------
Total interest income...... 36,354 29,285 102,203 77,742
Interest expense on deposits and
other borrowings................... 15,235 12,585 43,562 32,374
--------- --------- ---------- ---------
Net interest income........ 21,119 16,700 58,641 45,368
Provision for loan losses............ 1,200 1,158 2,700 2,736
--------- --------- ---------- ---------
Net interest income after
provision for loan
losses.................. 19,919 15,542 55,941 42,632
--------- --------- ---------- ---------
Other income:
Service charges................. 1,910 1,537 5,670 4,363
Other operating income.......... 2,059 1,004 5,383 2,801
Gain on sale of securities,
net........................... 31 15 216 569
--------- --------- ---------- ---------
Total other income......... 4,000 2,556 11,269 7,733
--------- --------- ---------- ---------
Other expenses:
Salaries and employee
benefits...................... 9,017 6,489 25,361 17,835
Occupancy expense............... 2,238 1,651 6,598 4,957
Merger-related expenses......... -- 2,011 67 2,011
Other operating expenses........ 3,549 2,654 9,597 7,460
--------- --------- ---------- ---------
Total other expenses....... 14,804 12,805 41,623 32,263
--------- --------- ---------- ---------
Income before income
taxes................... 9,115 5,293 25,587 18,102
Provision for income taxes........... 3,236 1,855 9,081 6,351
--------- --------- ---------- ---------
Net income before bank
preferred stock
dividend................ 5,879 3,438 16,506 11,751
Bank preferred stock dividend........ -- -- -- 36
--------- --------- ---------- ---------
Net income available for
common shareholders..... $ 5,879 $ 3,438 $ 16,506 $ 11,715
========= ========= ========== =========
Earnings per common share
Basic................. $ 0.25 $ 0.15 $ 0.72 $ 0.54
========= ========= ========== =========
Diluted............... $ 0.24 $ 0.15 $ 0.68 $ 0.50
========= ========= ========== =========
</TABLE>
The accompanying notes are an integral part of the condensed consolidated
financial statements.
4
<PAGE>
SOUTHWEST BANCORPORATION OF TEXAS, INC. AND SUBSIDIARY
CONDENSED CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS' EQUITY
(IN THOUSANDS, EXCEPT SHARE AMOUNTS)
(UNAUDITED)
<TABLE>
<CAPTION>
ACCUMULATED
COMMON STOCK ADDITIONAL OTHER TOTAL
------------------- PAID-IN RETAINED COMPREHENSIVE SHAREHOLDERS'
SHARES DOLLARS CAPITAL EARNINGS INCOME EQUITY
--------- ------- ---------- -------- -------------- -------------
<S> <C> <C> <C> <C> <C> <C>
BALANCE, DECEMBER 31, 1996........... 18,807,164 $18,807 $ 19,132 $ 35,564 $ (88) $ 73,415
Issuance of common stock to
benefit plan.................. 5,040 5 31 36
Exercise of stock options....... 913,322 913 2,057 2,970
Proceeds of public offering..... 2,645,000 2,645 17,165 19,810
Redemption of Bank preferred
stock......................... (177) (177)
Deferred compensation
amortization.................. 156 156
Cash dividends on preferred
stock ($.05 per share)........ (36) (36)
Comprehensive income:
Net income for the year ended
December 31, 1997.......... 16,805 16,805
Net change in unrealized
appreciation on securities
available for sale, net
of deferred taxes of
($999)..................... 1,856 1,856
-------------
Total comprehensive income.... 18,661
--------- ------- ---------- -------- -------------- -------------
BALANCE, DECEMBER 31, 1997........... 22,370,526 22,370 38,364 52,333 1,768 114,835
Common stock issued in
acquisition................... 280,000 280 304 584
Exercise of stock options....... 564,522 565 2,910 3,475
Deferred compensation
amortization.................. 104 104
Comprehensive income:
Net income for the nine months
ended September 30, 1998... 16,506 16,506
Net change in unrealized
appreciation on securities
available for sale, net
of deferred taxes of
($1,083)................... 2,012 2,012
-------------
Total comprehensive income.... 18,518
--------- ------- ---------- -------- -------------- -------------
BALANCE, SEPTEMBER 30, 1998.......... 23,215,048 $23,215 $ 41,682 $ 68,839 $3,780 $ 137,516
========= ======= ========== ======== ============== =============
</TABLE>
The accompanying notes are an integral part of the condensed consolidated
financial statements.
5
<PAGE>
SOUTHWEST BANCORPORATION OF TEXAS, INC. AND SUBSIDIARY
CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS
(IN THOUSANDS)
(UNAUDITED)
NINE MONTHS
ENDED SEPTEMBER 30,
--------------------------
1998 1997
------------ ------------
Cash flows from operating activities:
Net income...................... $ 16,506 $ 11,751
Adjustments to reconcile net
income to net cash provided by
operating activities:
Provision for loan
losses................... 2,700 2,736
Depreciation............... 3,460 2,732
Compensation expense....... -- 36
Deferred compensation
amortization............. 104 77
Realized gains on
securities available for
sale, net................ (216) (142)
Net amortization of
premiums and discounts... 1,103 986
Dividends on Federal Home
Loan Bank stock.......... (764) (1,752)
Increase in accrued
interest receivable,
prepaid expenses and
other assets............. (14,594) (2,391)
Increase in accrued
interest payable and
other liabilities........ 1,852 3,793
------------ ------------
Net cash provided by
operating
activities.......... 10,151 17,826
------------ ------------
Cash flows from investing activities:
Proceeds from maturity of
securities available for
sale........................... 193,974 30,080
Principal paydowns of
mortgage-backed securities
available for sale............. 83,425 29,820
Proceeds from sale of securities
available for sale............. 122,934 93,109
Purchase of securities available
for sale....................... (357,253) (238,175)
Proceeds from sale of other real
estate and other loan related
assets......................... 347 27
Net increase in loans
receivable..................... (220,846) (198,239)
Purchase of Bank-owned life
insurance policies............. (20,000) --
Purchase of premises and
equipment...................... (6,864) (5,157)
------------ ------------
Net cash used in
investing
activities.......... (204,283) (288,535)
------------ ------------
Cash flows from financing activities:
Net (decrease) increase in
noninterest-bearing deposits... (9,157) 34,323
Net increase in time deposits... 32,644 132,626
Net increase in other
interest-bearing deposits...... 101,216 183,807
Net increase (decrease) in
securities sold under
repurchase agreements.......... 41,343 (11,345)
Net decrease in other short-term
borrowings..................... (13,276) (4,984)
Net proceeds from public
offering of common stock....... -- 19,810
Net proceeds from exercise of
stock options.................. 1,808 390
Retirement of Bank preferred
stock.......................... -- (7,500)
Payment of dividends on Bank
preferred stock................ -- (152)
------------ ------------
Net cash provided by
financing
activities.......... 154,578 346,975
------------ ------------
Net (decrease) increase in cash and
cash equivalents................... (39,554) 76,266
Cash and cash equivalents at
beginning of period................ 236,979 172,863
------------ ------------
Cash and cash equivalents at end of
period............................. $ 197,425 $ 249,129
============ ============
The accompanying notes are an integral part of the condensed consolidated
financial statements.
6
<PAGE>
SOUTHWEST BANCORPORATION OF TEXAS, INC. AND SUBSIDIARY
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
1. BASIS OF PRESENTATION
The condensed consolidated financial statements include the accounts of
Southwest Bancorporation of Texas, Inc. (the "Company") and its wholly-owned
subsidiary Southwest Bank of Texas National Association (the "Bank"). All
material intercompany accounts and transactions have been eliminated. In the
opinion of management, the unaudited condensed consolidated financial statements
reflect all adjustments, consisting only of normal and recurring adjustments,
necessary to present fairly the Company's consolidated financial position at
September 30, 1998, the Company's consolidated results of operations for the
three and nine months ended September 30, 1998 and 1997, consolidated cash flows
for the nine months ended September 30, 1998 and 1997 and consolidated changes
in shareholders' equity for the nine months ended September 30, 1998. Interim
period results are not necessarily indicative of results of operations or cash
flows for a full-year period. The 1997 year-end condensed consolidated balance
sheet and statement of changes in shareholders' equity data were derived from
audited financial statements, but do not include all disclosures required by
generally accepted accounting principles.
On April 28, 1998 the Board of Directors declared a two-for-one split of
its common stock to be effected in the form of a 100% stock dividend. The common
stock distributed as a result of the stock split was distributed on May 29, 1998
to shareholders of record at the close of business on May 15, 1998. All common
shares and per common share amounts in the accompanying financial statements
have been adjusted to give retroactive effect to the stock split.
These financial statements and the notes thereto should be read in
conjunction with the Company's annual report on Form 10-K for the year ended
December 31, 1997.
NEW ACCOUNTING PRONOUNCEMENTS
In June 1998, Statement of Financial Accounting Standards (SFAS) No. 133,
ACCOUNTING FOR DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES, 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
standard is effective for all fiscal quarters beginning after June 15, 1999.
This pronouncement is not anticipated to have a material effect on the Company's
financial position, results of operations or cash flows.
7
<PAGE>
SOUTHWEST BANCORPORATION OF TEXAS, INC. AND SUBSIDIARY
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(UNAUDITED)
2. EARNINGS PER COMMON SHARE:
Earnings per common share is computed as follows:
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
-------------------- --------------------
1998 1997 1998 1997
--------- --------- --------- ---------
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
Net income available for common
shareholders....................... $ 5,879 $ 3,438 $ 16,506 $ 11,715
========= ========= ========= =========
Divided by average common shares and
common share equivalents:
Average common shares........... 23,205 22,202 23,058 21,781
Average common share
equivalents................... 1,029 1,496 1,141 1,521
--------- --------- --------- ---------
Total average common shares and
common
share equivalents.................. 24,234 23,698 24,199 23,302
========= ========= ========= =========
Earnings per common share:
Basic........................... $ 0.25 $ 0.15 $ 0.72 $ 0.54
========= ========= ========= =========
Diluted......................... $ 0.24 $ 0.15 $ 0.68 $ 0.50
========= ========= ========= =========
3. SUPPLEMENTAL NONCASH FINANCING ACTIVITIES:
During the nine months ended September 30, 1998, the Company reduced its
federal income tax liability by approximately $2.3 million and recorded a
corresponding increase to additional paid-in capital representing the tax
benefit related to the exercise of certain stock options.
4. SUBSEQUENT EVENT:
On October 20, 1998, the Company and the Bank entered into an Agreement and
Plan of Merger (the "Merger Agreement") with Fort Bend Holding Corp. ("Fort
Bend"), whereby Fort Bend will merge into the Company. Ft. Bend is the parent
company of Ft. Bend Federal Savings and Loan Association of Rosenberg and the
majority owner of Mitchell Mortgage Co., L.L.C. of the Woodlands, Texas. The
Merger Agreement, which is subject to approval of the shareholders of Fort Bend
and various regulatory authorities, provides for the exchange of 1.45 shares of
the Company's common shares for each share of Fort Bend common stock. At
September 30, 1998, Fort Bend had total assets of approximately $327 million and
total deposits of $276 million. The transaction is expected to be accounted for
as a pooling of interests.
8
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
OVERVIEW
Total assets at September 30, 1998, and December 31, 1997 were $1.98
billion, and $1.81 billion, respectively. Gross loans were $1.21 billion at
September 30, 1998, an increase of $220.0 million or 22% from $986.2 million at
December 31, 1997. This growth was a result of a strong local economy, and the
Company's style of relationship banking. Deposits experienced similar growth,
increasing to $1.64 billion at September 30, 1998 from $1.51 billion at December
31, 1997. Shareholders' equity was $137.5 million and $114.8 million at
September 30, 1998 and December 31, 1997, respectively.
Net income available for common shareholders was $5.9 million and $3.4
million and earnings per diluted common share was $0.24 and $0.15 for the three
months ended September 30, 1998 and 1997, respectively. For the nine months
ended September 30, 1998, net income was $16.5 million, or $0.68 per diluted
common share, an increase of 41% and 36%, respectively over the $11.7 million or
$0.50 per diluted common share for the first nine months of 1997. During the
three months ended September 30, 1997, the Company incurred approximately $2.0
million, pre-tax, in merger-related expenses and other charges in its
acquisition of Pinemont Bank, which was accounted for as a pooling of interests.
Increases in net income were primarily the result of strong loan growth,
maintaining strong asset quality and expense control and resulted in returns on
average assets of 1.21% and 0.88% and returns on average common equity of 17.81%
and 12.83% for the three months ended September 30, 1998 and 1997, respectively.
Return on average assets was 1.20% and return on average common equity was
17.63% for the first nine months of 1998 compared to 1.13% and 15.88%,
respectively for the same period in 1997.
RESULTS OF OPERATIONS
INTEREST INCOME
Interest income for the three months ended September 30, 1998 was $36.4
million, an increase of $7.1 million, or 24% from the three months ended
September 30, 1997. For the nine months ended September 30, 1998, interest
income was $102.2 million, a $24.5 million or 31% increase from the same period
in 1997. This increase in interest income is due to a $346.4 million increase in
average earning assets to $1.79 billion for the three months ended September 30,
1998, a 24% increase from the same period last year.
Interest income on loans increased $6.1 million to $26.9 million for the
three months ended September 30, 1998. This was due to a $291.9 million increase
in average loans outstanding over the same period in 1997. Interest income on
securities increased to $8.0 million, a $1.7 million increase from the prior
comparable period. This increase was attributable to a $101.6 million increase
in average securities, up 25% when compared to the three months ended September
30, 1997.
For the nine months ended September 30, 1998, interest income on loans
increased 31% to $74.1 million, up from $56.6 million for the same period last
year. Interest income on securities increased to $23.6 million, an increase of
$5.8 million or 33% from the prior period. These gains were principally related
to an increase of average earning assets to $1.71 billion for the nine months
ended September 30, 1998, an increase of 33% from the same period last year.
INTEREST EXPENSE.
Interest expense on deposits and other borrowings was $15.2 million for the
three months ended September 30, 1998, compared to $12.6 million for the same
period in 1997. For the nine months ended September 30, 1998, interest expense
on deposits and other borrowings was $43.6 million compared to $32.4 million for
the same period in 1997. The increase in interest expense was attributable to a
$270.9 million and $329.8 million increase in average interest-bearing
liabilities for the three- and nine-month comparable periods.
9
<PAGE>
NET INTEREST INCOME
Net interest income was $21.1 million for the three months ended September
30, 1998, compared with $16.7 million for the same period in 1997, an increase
of 26%. For the nine months ended September 30, 1998, net interest income
increased 29% from the same period in 1997 to $58.6 million. The increase in net
interest income during the three- and nine-months ended September 30, 1998 was
largely due to growth in average interest-earning assets, primarily loans.
The net interest margin was 4.67% for the three months ended September 30,
1998, compared with 4.58% in the third quarter of 1997. This increase in the net
interest margin was primarily due to a decrease in the cost of interest-bearing
liabilities which decreased 17 basis points to 4.53% for the three months ended
September 30, 1998. The net interest margin was 4.58% for the nine months ended
September 30, 1998, down from 4.71% for the first nine months of 1997. This
decrease was attributable to a ten basis point decrease in the yield on average
interest earning assets to 7.98%, down from 8.08% for the same period last year.
10
<PAGE>
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.
<TABLE>
<CAPTION>
THREE MONTHS ENDED THREE MONTHS ENDED
SEPTEMBER 30, 1998 SEPTEMBER 30, 1997
--------------------------------- ---------------------------------
AVERAGE INTEREST AVERAGE AVERAGE INTEREST AVERAGE
OUTSTANDING EARNED/ YIELD/ OUTSTANDING EARNED/ YIELD/
BALANCE PAID RATE BALANCE PAID RATE
----------- ------- ------- ----------- ------- -------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
ASSETS
Interest-earning assets:
Loans.............................. $ 1,183,667 $26,883 9.01% $ 891,750 $20,764 9.24%
Securities......................... 506,144 8,015 6.28 404,521 6,379 6.26
Federal funds sold and other....... 103,827 1,456 5.56 150,929 2,142 5.63
----------- ------- ------- ----------- ------- -------
Total interest-earning
assets..................... 1,793,638 36,354 8.04% 1,447,200 29,285 8.03%
------- ------- ------- -------
Less allowance for loan losses.......... (12,012) (8,841)
----------- -----------
Total earning assets, net of
allowance............................. 1,781,626 1,438,359
Nonearning assets....................... 141,004 106,386
----------- -----------
Total assets.................. $ 1,922,630 $ 1,544,745
=========== ===========
LIABILITIES AND SHAREHOLDERS' EQUITY
Interest-bearing liabilities:
Money market and savings
deposits......................... $ 766,501 8,035 4.16% $ 575,072 6,099 4.21%
Time deposits...................... 366,850 4,730 5.12 348,770 4,702 5.35
Repurchase agreements and borrowed
funds............................ 200,211 2,470 4.89 138,772 1,784 5.10
----------- ------- ------- ----------- ------- -------
Total interest-bearing
liabilities................ 1,333,562 15,235 4.53% 1,062,614 12,585 4.70%
------- ------- ------- -------
Noninterest-bearing liabilities:
Noninterest-bearing demand
deposits......................... 450,427 368,505
Other liabilities.................. 7,662 7,311
----------- -----------
Total liabilities............. 1,791,651 1,438,430
Shareholders' equity.................... 130,979 106,315
----------- -----------
Total liabilities and
shareholders' equity....... $ 1,922,630 $ 1,544,745
=========== ===========
Net interest income..................... $21,119 $16,700
======= =======
Net interest spread..................... 3.51% 3.33%
======= =======
Net interest margin..................... 4.67% 4.58%
======= =======
</TABLE>
11
<PAGE>
<TABLE>
<CAPTION>
NINE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, 1998 SEPTEMBER 30, 1997
---------------------------------- ---------------------------------
AVERAGE INTEREST AVERAGE AVERAGE INTEREST AVERAGE
OUTSTANDING EARNED/ YIELD/ OUTSTANDING EARNED/ YIELD/
BALANCE PAID RATE BALANCE PAID RATE
----------- -------- ------- ----------- ------- -------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
ASSETS
Interest-earning assets:
Loans.............................. $ 1,096,682 $ 74,144 9.04% $ 823,923 $56,606 9.19%
Securities......................... 506,610 23,576 6.22 381,163 17,737 6.22
Federal funds sold and other....... 108,084 4,483 5.55 81,756 3,399 5.56
----------- -------- ------- ----------- ------- -------
Total interest-earning
assets..................... 1,711,376 102,203 7.98% 1,286,842 77,742 8.08%
-------- ------- ------- -------
Less allowance for loan losses.......... (11,371) (8,213)
----------- -----------
Total earning assets, net of
allowance............................. 1,700,005 1,278,629
Nonearning assets....................... 135,176 107,300
----------- -----------
Total assets.................. $ 1,835,181 $ 1,385,929
=========== ===========
LIABILITIES AND SHAREHOLDERS' EQUITY
Interest-bearing liabilities:
Money market and savings
deposits......................... $ 721,382 22,492 4.17% $ 527,297 16,228 4.11%
Time deposits...................... 352,774 13,706 5.19 272,706 10,834 5.31
Repurchase agreements and borrowed
funds............................ 197,095 7,364 5.00 141,416 5,312 5.02
----------- -------- ------- ----------- ------- -------
Total interest-bearing
liabilities................ 1,271,251 43,562 4.58% 941,419 32,374 4.60%
-------- ------- ------- -------
Noninterest-bearing liabilities:
Noninterest-bearing demand
deposits......................... 432,479 338,971
Other liabilities.................. 6,254 6,115
----------- -----------
Total liabilities............. 1,709,984 1,286,505
Bank preferred stock.................... -- 805
Shareholders' equity.................... 125,197 98,619
----------- -----------
Total liabilities and
shareholders' equity....... $ 1,835,181 $ 1,385,929
=========== ===========
Net interest income..................... $ 58,641 $45,368
======== =======
Net interest spread..................... 3.40% 3.48%
======= =======
Net interest margin..................... 4.58% 4.71%
======= =======
</TABLE>
12
<PAGE>
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 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.
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------------------- -------------------------------
1998 VS. 1997 1998 VS. 1997
------------------------------- -------------------------------
INCREASE (DECREASE) INCREASE (DECREASE)
DUE TO DUE TO
------------------------------- -------------------------------
VOLUME RATE TOTAL VOLUME RATE TOTAL
--------- --------- --------- --------- --------- ---------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
INTEREST-EARNING ASSETS:
Loans................................... $ 6,797 $ (678) $ 6,119 $ 18,739 $ (1,201) $ 17,538
Securities.............................. 1,603 33 1,636 5,838 1 5,839
Federal funds sold and other............ (669) (17) (686) 1,095 (11) 1,084
--------- --------- --------- --------- --------- ---------
Total increase (decrease) in
interest income.................. 7,731 (662) 7,069 25,672 (1,211) 24,461
--------- --------- --------- --------- --------- ---------
INTEREST-BEARING LIABILITIES:
Money market and savings deposits....... 2,031 (95) 1,936 5,973 291 6,264
Time deposits........................... 244 (216) 28 3,181 (309) 2,872
Repurchase agreements and borrowed
funds................................. 790 (104) 686 2,091 (39) 2,052
--------- --------- --------- --------- --------- ---------
Total increase (decrease) in
interest expense................. 3,065 (415) 2,650 11,245 (57) 11,188
--------- --------- --------- --------- --------- ---------
Increase (decrease) in net interest
income................................ $ 4,666 $ (247) $ 4,419 $ 14,427 $ (1,154) $ 13,273
========= ========= ========= ========= ========= =========
</TABLE>
PROVISION FOR LOAN LOSSES
The provision for loan losses was $1.20 million for the three months ended
September 30, 1998 as compared to $1.16 million for the three months ended
September 30, 1997. The provision for loan losses was $2.70 million for the nine
months ended September 30, 1998 as compared to $2.74 million for the nine months
ended September 30, 1997. 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
constantly reviews the Company's loan loss allowance policy as its loan
portfolio grows and diversifies. (See Loan Review and Allowance for Loan
Losses.)
NONINTEREST INCOME
Noninterest income for the three months ended September 30, 1998 was $4.0
million, an increase of $1.4 million or 56% over the same period in 1997.
Noninterest income for the nine months ended September 30, 1998 was $11.3
million, an increase of 46%, from $7.7 million during the comparable period in
1997. The following table presents for the periods indicated the major changes
in noninterest income.
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
-------------------- --------------------
1998 1997 1998 1997
--------- --------- --------- ---------
(DOLLARS IN THOUSANDS)
Service charges on deposit
accounts.......................... $ 1,910 $ 1,537 $ 5,670 $ 4,363
Loan operations..................... 339 197 919 584
Investment services................. 934 631 2,509 1,663
Gain on sale of securities, net..... 31 15 216 569
Factoring fee income................ 508 -- 1,224 --
Other noninterest income............ 278 176 731 554
--------- --------- --------- ---------
Total noninterest income....... $ 4,000 $ 2,556 $ 11,269 $ 7,733
========= ========= ========= =========
13
<PAGE>
Except for gain on sale of securities, all categories of noninterest income
for the three- and nine-months ended September 30, 1998 reflect increased income
compared to the three- and nine-months ended September 30, 1997. The increase in
noninterest income is primarily due to the increase in deposit accounts, the
growth of the investment services department and the acquired factoring company.
Service charges were $1.9 million for the three months ended September 30,
1998, compared to $1.5 million for the three months ended September 30, 1997, an
increase of $400,000 or 27%. Service charges were $5.7 million for the nine
months ended September 30, 1998 compared to $4.4 million for the same period in
1997. This was an increase of $1.3 million, or 30%. The number of deposit
accounts serviced increased to 42,831 at September 30, 1998 from 38,651 at
September 30, 1997.
Other changes in noninterest income were recognized in the categories of
investment services and factoring fee income. For the three months ended
September 30, 1998 investment services income grew to $934,000, an increase of
48% over the 1997 level. For the nine months ended September 30, 1998 investment
services income grew to $2.5 million or 51% over the $1.7 million level during
the 1997 period. These increases are attributable to the expanding international
and foreign exchange departments, as well as the continued strategic focus by
the Company to increase its competitive position in providing investment
services. Factoring fee income results from the recent acquisitions of First
Republic Capital Corp. and City Financial Services, Inc. Due to the
acquisitions' immateriality, prior period financial information was not
restated.
NONINTEREST EXPENSES
For the three months ended September 30, 1998, noninterest expenses totaled
$14.8 million, an increase of $2.0 million, or 16%, from $12.8 million including
merger-related expenses and other charges of approximately $2.0 million (the
"special charge") during 1997. For the nine months ended September 30, 1998
noninterest expenses totaled $41.6 million, an increase of $9.4 million, or 29%,
from the same period in 1997. The increase in noninterest expenses during these
periods was primarily due to salaries and employee benefits. The efficiency
ratio decreased to 58.9% for the three months ended September 30, 1998 from
66.5% for the comparable period in 1997. For the nine months ended September 30,
the efficiency ratio decreased to 59.5% for 1998 from 60.8% for 1997.
Salary and benefit expense for the three months ended September 30, 1998
was $9.0 million, an increase of $2.5 million or 39% from the three months ended
September 30, 1997. Salary and benefit expense for the nine months ended
September 30, 1998 was $25.4 million, an increase of $7.5 million or 42% from
the same period in 1997. This increase was due primarily to hiring of additional
personnel required to accommodate the Company's growth. Total full-time
employees at September 30, 1998 and September 30, 1997 were 661 and 528,
respectively.
Occupancy expense increased $587,000, or 36% to $2.2 million for the three
months ended September 30, 1998. For the nine months ended September 30, 1998,
occupancy expense increased $1.6 million, or 33% from the same period a year ago
to $6.6 million. Major categories within occupancy expense are building lease
expense, depreciation expense and maintenance contract expense. Building lease
expense increased to $573,000 for the three months ended September 30, 1998 from
$465,000 for the same period in 1997. For the nine months ended September 30,
1998, building lease expense was $1.7 million, an increase of 31%, or $400,000
from $1.3 million for the first nine months of 1997. This increase resulted from
opening a new branch in Sugar Land, Ft. Bend County, Texas, and from increasing
the rentable square feet at the corporate office by approximately 21,000 square
feet to accommodate the Company's growth. Depreciation expense was $940,000 for
the three months ended September 30, 1998, an increase of 30% or $215,000 from
the $725,000 level from the prior comparable period. For the nine months ended
September 30, 1998 depreciation expense increased $500,000, or 23%, to $2.7
million from $2.2 million in the first nine months of 1997. This increase was
primarily due to depreciation on equipment provided to new employees and expense
related to technology upgrades throughout the Company. Maintenance contract
expense for the three months ended September 30, 1998 was $237,000, a 6% or
$13,000 increase from $224,000 for the same period last year. For the nine
months ended September 30, 1998, maintenance
14
<PAGE>
contract expense was $736,000. This was a $234,000, or 47% increase from the
prior amount of $502,000. The Company has purchased maintenance contracts for
major operating systems throughout the organization.
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. For the three
months ended September 30, 1998, the provision for income taxes was $3.2
million, an increase of $1.4 million or 74% from the $1.9 million provided for
the same period in 1997. For the nine months ended September 30, 1998, income
tax expense was $9.1 million compared to $6.4 million during the same period in
1997.
FINANCIAL CONDITION
LOAN PORTFOLIO
Total gross loans were $1.21 billion at September 30, 1998, an increase of
$220.0 million or 22% from $986.2 million at December 31, 1997. Consistent with
the Company's historically high rate of growth, this increase is believed to be
the result of the Company's style of relationship banking featuring
professional, attentive and responsive service to customers' needs, and focusing
on commercial lending to middle market companies and private banking for
individuals.
The following table summarizes the loan portfolio of the Company by type of
loan as of September 30, 1998 and December 31, 1997:
<TABLE>
<CAPTION>
SEPTEMBER 30, 1998 DECEMBER 31, 1997
---------------------- --------------------
AMOUNT PERCENT AMOUNT PERCENT
------------ ------- ---------- -------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C>
Commercial and industrial............... $ 557,804 46.2% $ 448,348 45.5%
Real estate.............................
Construction and land
development........................ 195,688 16.2 128,985 13.1
1-4 Family......................... 184,575 15.3 171,551 17.3
Commercial owner occupied.......... 150,869 12.5 132,052 13.4
Ranchland.......................... 8,042 0.7 8,384 0.9
Other................................... 14,048 1.2 8,199 0.8
Consumer................................ 95,077 7.9 88,631 9.0
------------ ------- ---------- -------
Total gross loans....................... $ 1,206,103 100.0% $ 986,150 100.0%
============ ======= ========== =======
</TABLE>
The primary lending focus of the Company is on small- and medium-sized
commercial, 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's commercial loans are underwritten in the Company's
primary market area on the basis of the borrower's ability to service such debt
from income. 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.
15
<PAGE>
A substantial portion of the Company's real estate loans consists of loans
collateralized by real estate and other assets of commercial customers.
Additionally, a portion of the Company's lending activity consists of the
origination of single-family residential mortgage loans collateralized by
owner-occupied properties located in the Company's primary market area. The
Company offers a variety of mortgage loan products which generally are amortized
over five to 30 years.
Loans are 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 three to seven year period,
such loans often remain outstanding for significantly shorter periods than their
contractual terms.
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 September 30,
1998 are summarized in the following table:
<TABLE>
<CAPTION>
AFTER ONE AFTER
ONE YEAR THROUGH FIVE
OR LESS FIVE YEARS YEARS TOTAL
---------- ----------- --------- ----------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C>
Commercial and industrial............... $ 346,999 $ 179,875 $ 30,930 $ 557,804
Real estate construction................ 108,708 79,345 7,635 195,688
---------- ----------- ---------
Total................................... $ 455,707 $ 259,220 $ 38,565 $ 753,492
========== =========== ========= ==========
Loans with a fixed interest rate........ $ 127,974 $ 73,749 $ 10,600 $ 212,323
Loans with a floating interest rate..... 327,733 185,471 27,965 541,169
---------- ----------- --------- ----------
Total................................... $ 455,707 $ 259,220 $ 38,565 $ 753,492
========== =========== ========= ==========
</TABLE>
LOAN REVIEW AND ALLOWANCE FOR LOAN LOSSES
The Company has well developed procedures in place to maintain a high
quality loan portfolio. These 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, Houston 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. Nevertheless, slowdowns in the industry caused by declining
oil prices continue to affect the Houston economy. When energy prices drop, as
they have in the last 12 months, 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. To date, the Company has
not deemed it necessary to increase
16
<PAGE>
its allowance for loan losses due to conditions in this industry but no
assurance can be given that such an increase in the allowance will not be
necessary in the future.
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 review 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 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. An unallocated allowance is also established based on the
Company's historical charge-off experience. The Company then charges to
operations a provision for loan losses 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 September 30,
1998 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
September 30, 1998.
The following table presents, for the periods indicated, an analysis of the
allowance for loan losses and other related data:
NINE MONTHS
ENDED YEAR ENDED
SEPTEMBER 30, DECEMBER 31,
1998 1997
--------------- -------------
(DOLLARS IN THOUSANDS)
Allowance for loan losses beginning
of period............................ $10,335 $ 7,400
Provision for loan losses............ 2,700 3,886
Charge-offs.......................... (990) (1,078)
Recoveries........................... 97 127
--------------- -------------
Allowance for loan losses end of
period............................... $12,142 $10,335
=============== =============
Allowance to period-end loans........ 1.01% 1.05%
Net charge-offs to average loans..... 0.11% 0.11%
Allowance to period-end nonperforming
loans.............................. 697.42% 332.64%
17
<PAGE>
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. The majority of the unallocated portion below represents
management's estimates of the amounts needed to cover economic and portfolio
trends, commitments, etc. 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.
<TABLE>
<CAPTION>
SEPTEMBER 30, 1998 DECEMBER 31, 1997
---------------------- ----------------------
PERCENT OF PERCENT OF
LOANS TO LOANS TO
AMOUNT TOTAL LOANS AMOUNT TOTAL LOANS
------- ----------- ------- -----------
<S> <C> <C> <C> <C>
Balance of allowance for loan losses
applicable to:
Commercial and industrial....... $ 217 46.20% $ 922 45.5%
Real estate:
Construction and loan
development................... -- 16.2 25 13.1
1-4 family residential.......... 15 15.3 -- 17.3
Commercial owner occupied....... -- 12.5 -- 13.4
Farmland........................ -- 0.7 -- 0.9
Other........................... -- 1.2 -- 0.8
Consumer............................. 73 7.9 38 9.0
Unallocated.......................... 11,837 -- 9,350 --
------- ----------- ------- -----------
Total allowance for loan
losses..................... $12,142 100.0% $10,335 100.0%
======= =========== ======= ===========
</TABLE>
NONPERFORMING ASSETS
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, however, 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 $2.3 million at September 30, 1998 compared with
$3.7 million at December 31, 1997. This resulted in a ratio of nonperforming
assets to loans plus other real estate of 0.19% and 0.37% at September 30, 1998
and December 31, 1997, respectively.
The following table presents information regarding nonperforming assets as
of the dates indicated:
SEPTEMBER 30, DECEMBER 31,
1998 1997
-------------- ------------
(DOLLARS IN THOUSANDS)
Nonaccrual loans..................... $1,549 $2,724
Accruing loans 90 or more days past
due.................................. 192 383
ORE and OLRA......................... 575 546
-------------- ------------
Total nonperforming assets...... $2,316 $3,653
============== ============
Nonperforming assets to total loans
and other real estate.............. 0.19% 0.37%
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 are classified as held to maturity and measured
at amortized cost in the financial statements only if management has the
positive intent and ability to hold those securities to maturity. Securities
that are bought and held principally for the purpose of selling them in the near
term are classified as trading and measured at fair value in the financial
statements with unrealized
18
<PAGE>
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 until realized.
Gains and losses on sales of securities are determined using the
specific-identification method. Since December 31, 1995, the Company has
classified all securities as available for sale. This allows the Company to
manage its investment portfolio more effectively and to enhance the average
yield on the portfolio.
The amortized cost and approximate fair value of securities classified as
available for sale is as follows:
<TABLE>
<CAPTION>
SEPTEMBER 30, 1998
----------------------------------------------
GROSS UNREALIZED
AMORTIZED ------------------ FAIR
COST GAIN LOSS VALUE
--------- ------ ------ ----------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C>
U. S. Government securities.......... $ 130,263 $ 894 $ (36) $ 131,121
Mortgage-backed securities........... 370,039 5,134 (275) 374,898
Federal Reserve Bank stock........... 1,869 -- -- 1,869
Federal Home Loan Bank stock......... 6,181 -- -- 6,181
Other securities..................... 1,124 97 -- 1,221
--------- ------ ------ ----------
Total securities available for
sale.......................... $ 509,476 $6,125 $ (311) $ 515,290
========= ====== ====== ==========
<CAPTION>
DECEMBER 31, 1997
----------------------------------------------
GROSS UNREALIZED
AMORTIZED ------------------ FAIR
COST GAIN LOSS VALUE
--------- ------ ------ ----------
(DOLLARS IN THOUSANDS)
U. S. Government securities.......... $ 163,230 $ 536 $ (4) $ 163,762
Mortgage-backed securities........... 323,434 2,275 (151) 325,558
Federal Reserve Bank stock........... 1,791 -- -- 1,791
Federal Home Loan Bank stock......... 37,942 -- -- 37,942
Other securities..................... 26,281 64 -- 26,345
--------- ------ ------ ----------
Total securities available for
sale.......................... $ 552,678 $2,875 $ (155) $ 555,398
========= ====== ====== ==========
</TABLE>
Securities totaled $515.3 million at September 30, 1998, a decrease of
$40.1 million from $555.4 million at December 31, 1997. The yield on the
securities portfolio for the nine months ended September 30, 1998 was 6.23%
while the yield was 5.97% in 1997.
The Company has no mortgage-backed securities that have been issued by
non-agency entities. Included in the Company's mortgage-backed securities at
September 30, 1998 were $233.4 million in agency issued collateral mortgage
obligations.
At September 30, 1998, 75.0% of the mortgage-backed securities held by the
Company had final maturities of more than 10 years. At September 30, 1998,
approximately $70.0 million of the Company's 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.
19
<PAGE>
The following table summarizes the contractual maturity of investments
(including securities, federal funds sold and interest-bearing deposits) and
their weighted average yields at September 30, 1998. 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.
<TABLE>
<CAPTION>
SEPTEMBER 30, 1998
-----------------------------------------------------------------------------------------
AFTER ONE AFTER FIVE
YEAR BUT YEARS BUT
WITHIN WITHIN WITHIN
ONE YEAR FIVE YEARS TEN YEARS AFTER TEN YEARS
----------------- ----------------- ----------------- -----------------
AMOUNT YIELD AMOUNT YIELD AMOUNT YIELD AMOUNT YIELD TOTAL
--------- ----- --------- ----- --------- ----- --------- ----- ---------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
(DOLLARS IN THOUSANDS)
U.S. Government
securities......................... $ 40,738 6.19 % $ 59,525 6.01 % $ 30,000 6.44 % $ -- -- $ 130,263
Mortgage-backed
securities......................... 320 6.29 32,314 6.74 60,057 6.44 277,348 6.41 370,039
Federal Reserve Bank
stock.............................. 1,869 6.00 -- -- -- -- -- -- 1,869
Federal Home Loan Bank stock......... 6,181 6.00 -- -- -- -- -- -- 6,181
Other securities..................... 52 5.01 206 7.90 558 7.24 308 8.08 1,124
Federal funds sold................... 112,883 5.61 -- -- -- -- -- -- 112,883
Interest-bearing deposits............ 179 5.58 -- -- -- -- -- -- 179
--------- ----- --------- ----- --------- ----- --------- ----- ---------
Total investments................ $ 162,222 5.78 % $ 92,045 6.27 % $ 90,615 6.44 % $ 277,656 6.41 % $ 622,538
========= ===== ========= ===== ========= ===== ========= ===== =========
</TABLE>
YIELD
-----
U.S. Government
securities......................... 6.17 %
Mortgage-backed
securities......................... 6.45
Federal Reserve Bank
stock.............................. 6.00
Federal Home Loan Bank stock......... 6.00
Other securities..................... 7.49
Federal funds sold................... 5.61
Interest-bearing deposits............ 5.58
-----
Total investments................ 6.23 %
=====
PREPAID EXPENSES AND OTHER ASSETS
Total prepaid expenses and other assets were $39.9 million at September 30,
1998, an increase of $33.0 from $6.9 million at December 31, 1997. This increase
is primarily attributable to the purchase of Bank-owned life insurance policies
with a cash value of approximately $20 million at September 30, 1998 and the
acquisition of two factoring companies during the first quarter of 1998. On
February 5, 1998, the Bank acquired First Republic Capital Corp. and City
Financial Services, Inc., two related commercial finance companies. These
companies specialize in providing operating funds to businesses by converting
their accounts receivable to cash. The transaction, which resulted in the
exchange of 280,000 shares of the Company's common shares for all of the
outstanding stock of First Republic Capital Corp. and City Financial Services,
Inc., has been accounted for as a pooling of interests, although historical
financial statements have not been restated due to immateriality. Factored
receivables outstanding at September 30, 1998 were approximately $7.8 million.
DEPOSITS
The Company offers a variety of deposit accounts having a wide range of
interest rates and terms. The Company's deposits consist of demand, savings, NOW
accounts, money market and time accounts. The Company relies primarily on
advertising, competitive pricing policies and customer service to attract and
retain these deposits. As of September 30, 1998, the Company had less than four
percent of its deposits classified as brokered funds and does not anticipate any
significant increase. Deposits provide the primary source of funding for the
Company's 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 periods ended September 30, 1998 and December 31, 1997, was 29% and 30%,
respectively.
20
<PAGE>
The average daily balances and weighted average rates paid on deposits for
the nine months ended September 30, 1998 and the year ended December 31, 1997,
are presented below:
<TABLE>
<CAPTION>
SEPTEMBER 30, 1998 DECEMBER 31, 1997
----------------------- -----------------------
AVERAGE AVERAGE
OUTSTANDING OUTSTANDING
BALANCE RATE BALANCE RATE
----------- --------- ----------- ---------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C>
NOW accounts......................... $ 22,452 1.10% $ 36,944 1.73%
Regular savings...................... 11,575 2.07 11,373 2.29
Premium Yield........................ 419,018 4.84 278,448 4.91
Money market......................... 268,338 3.46 221,901 3.66
CD's less than $100,000.............. 75,763 5.07 80,835 5.14
CD's $100,000 and over............... 258,395 5.22 198,202 5.38
IRA's & QRP's........................ 18,615 5.35 17,379 5.26
----------- --------- ----------- ---------
Total interest-bearing
deposits...................... 1,074,156 4.51% 845,082 4.55%
========= =========
Noninterest-bearing deposits......... 432,479 357,697
----------- -----------
Total deposits.................. $ 1,506,635 $ 1,202,779
=========== ===========
</TABLE>
The following table sets forth the maturity of the Company's time deposits
that are $100,000 or greater as of the dates indicated:
SEPTEMBER 30, 1998 DECEMBER 31, 1997
------------------ -----------------
(DOLLARS IN THOUSANDS)
3 months or less..................... $197,155 $ 179,422
Between 3 months and 6 months........ 51,619 38,902
Between 6 months and 1 year.......... 45,444 40,722
Over 1 year.......................... 14,854 12,684
------------------ -----------------
Total time deposits $100,000 and
over.......................... $309,072 $ 271,730
================== =================
21
<PAGE>
BORROWINGS
Securities sold under repurchase agreements and other short-term
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:
SEPTEMBER 30, DECEMBER 31,
1998 1997
------------- ------------
(DOLLARS IN THOUSANDS)
Securities sold under repurchase
agreements:
Average......................... $ 179,184 $129,460
Period-end...................... 197,175 155,832
Maximum month-end balance during
period........................ 240,670 155,832
Interest rate:
Average......................... 4.91% 4.97%
Period-end...................... 4.99% 5.02%
Other short-term borrowings:
Average......................... $ 17,424 $ 14,843
Period-end...................... 3,967 17,243
Maximum month-end balance during
period........................ 55,043 50,645
Interest rate:
Average......................... 5.51% 5.60%
Period-end...................... 5.31% 6.54%
Securities sold under repurchase agreements are maintained in safekeeping
by correspondent banks.
LIQUIDITY AND CAPITAL RESOURCES
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 three months ended September 30, 1998, the
Company's liquidity needs have primarily been met by growth in core deposits.
Although access to purchased funds from correspondent banks is available and has
been utilized on occasion to take advantage of investment opportunities, the
Company does not generally rely on these external funding sources. The cash and
federal funds sold position, supplemented by amortizing securities and loan
portfolios, have generally created an adequate liquidity position.
The Company's risk-based capital ratios including Leverage Capital, Tier 1
Risk-Based Capital and the Total Risk-Based Capital Ratio were 6.88%, 8.95% and
9.77%, respectively, at September 30, 1998.
YEAR 2000
With the new millennium approaching, organizations are examining their
computer systems to ensure they are year 2000 compliant. The issue, in simple
terms, is that many existing computer systems use only two numbers to identify a
year in the date field with the assumption that the first two digits are always
19. As the century is implied in the date, on January 1, 2000, computers that
are not year 2000 compliant will assume the year is 1900. Systems that
calculate, compare, or sort using the incorrect date will cause erroneous
results, ranging from system malfunctions to incorrect or incomplete transaction
processing. If not remedied, potential risks include business interruption or
shutdown, financial loss, reputation loss, and/or legal liability.
The Company has undertaken a firm wide initiative to address the year 2000
issue and has developed a comprehensive plan to prepare, as appropriate, our
computer systems and facilities.
We have completed a thorough education and awareness initiative and an
inventory and assessment of our technology and application portfolio to
understand the scope of the year 2000 impact at the Company. We presently are
renovating and testing these technologies and applications in partnership with
external
22
<PAGE>
consulting and software development organizations, as well as with year 2000
tool providers. We are on target with our plan to substantially complete
renovation, testing, and validation of our key systems by year-end 1998.
Our efforts also focus on developing appropriate policies or risk
mitigation actions to address year 2000 related failures prior to the millennium
due to reliance on internal or external dependencies. We are working with key
external parties, including customers, counterparties, vendors, exchanges,
depositories, utilities, suppliers, agents, and regulatory agencies, to stem the
potential risks the year 2000 problem poses to us and to the global financial
community. The failure of external parties to resolve their own year 2000 issues
in a timely manner could result in material financial risks to the Company. For
potential failure scenarios where the risk to the Company is deemed significant
and where such risk is considered to have a higher probability of occurrence, we
have developed business recovery/contingency plans. These plans define the
infrastructure that should be put in place for managing a failure during the
millennium event itself.
Costs to prepare our systems for the year 2000 are estimated at
approximately $4.0 million, for internal systems renovation and testing, testing
equipment, and both internal and external resources working on the project.
Through September 30, 1998, costs incurred are approximated at $1.7 million.
OTHER MATTERS
In June 1998, SFAS No. 133, ACCOUNTING FOR DERIVATIVE INSTRUMENTS AND
HEDGING ACTIVITIES, 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 than 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 standard is effective for all
fiscal quarters beginning after June 15, 1999. This pronouncement is not
anticipated to have a material affect on the Company's financial position,
results of operations or cash flows.
On October 20, 1998, the Company and the Bank entered into an Agreement and
Plan of Merger (the "Merger Agreement") with Fort Bend Holding Corp. ("Fort
Bend"), whereby Fort Bend will merge into the Company. Ft. Bend is the parent
company of Ft. Bend Federal Savings and Loan Association of Rosenberg and the
majority owner of Mitchell Mortgage Co., L.L.C. of the Woodlands, Texas. The
Merger Agreement, which is subject to approval of the shareholders of Fort Bend
and various regulatory authorities, provides for the exchange of 1.45 shares of
the Company's common shares for each share of Fort Bend common stock. At
September 30, 1998, Fort Bend had total assets of approximately $327 million and
total deposits of $276 million. The transaction is expected to be accounted for
as a pooling of interests.
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
None
ITEM 2. CHANGES IN SECURITIES
None
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None
23
<PAGE>
ITEM 5. OTHER INFORMATION
None
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
a) Exhibits:
Exhibit 15.1 Awareness Letter of PricewaterhouseCoopers LLP
Exhibit 27. Financial Data Schedule
The required Financial Data Schedule has been included as Exhibit 27 of
the Form 10-Q filed electronically with the Securities and Exchange
Commission.
b) Reports on Form 8-K
None
24
<PAGE>
SIGNATURES
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.
SIGNATURE TITLE DATE
- ------------------ ------------------------------------- -----------------
WALTER E. JOHNSON Chairman of the Board and Chief November 9, 1998
WALTER E. JOHNSON Executive Officer (Principal
Executive Officer)
DAVID C. FARRIES Executive Vice President, November 9, 1998
DAVID C. FARRIES Treasurer and Secretary (Principal
Financial Officer)
R. JOHN McWHORTER Senior Vice President and Controller November 9, 1998
R. JOHN MCWHORTER (Principal Accounting Officer)
25
AWARENESS LETTER OF INDEPENDENT ACCOUNTANTS
Securities and Exchange Commission
450 Fifth Street, N.W.
Washington, D.C. 205449
Re: Southwest Bancorporation of Texas, Inc.
Registration on Form S-8 and Form S-3
We are aware that our report dated October 29, 1998, on our review of interim
financial information of Southwest Bancorporation of Texas, Inc. and Subsidiary
as of and for the three- and nine-months periods ended September 30, 1998 and
1997, and included in the Company's quarterly report on Form 10-Q for the
quarter ended September 30, 1998 is incorporated by reference in the Company's
registration statements on Form S-8 (File Nos. 333-21619, 333-27891 and
333-33533) and Form S-3 (File No. 333-47995). Pursuant to Rule 436(c) under the
Securities Act of 1933, this report should not be considered a part of the
registration statement prepared or certified by us within the meaning of
Sections 7 and 11 of that Act.
/s/ PRICEWATERHOUSECOOPERS LLP
PricewaterhouseCoopers LLP
Houston, Texas
November 5, 1998
<TABLE> <S> <C>
<ARTICLE> 9
<MULTIPLIER> 1000
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-END> SEP-30-1998
<CASH> 84,363
<INT-BEARING-DEPOSITS> 179
<FED-FUNDS-SOLD> 112,883
<TRADING-ASSETS> 0
<INVESTMENTS-HELD-FOR-SALE> 515,290
<INVESTMENTS-CARRYING> 0
<INVESTMENTS-MARKET> 0
<LOANS> 1,206,103
<ALLOWANCE> 12,142
<TOTAL-ASSETS> 1,983,330
<DEPOSITS> 1,637,044
<SHORT-TERM> 201,142
<LIABILITIES-OTHER> 7,628
<LONG-TERM> 0
0
0
<COMMON> 23,215
<OTHER-SE> 114,301
<TOTAL-LIABILITIES-AND-EQUITY> 1,983,330
<INTEREST-LOAN> 74,144
<INTEREST-INVEST> 23,576
<INTEREST-OTHER> 4,483
<INTEREST-TOTAL> 102,203
<INTEREST-DEPOSIT> 36,198
<INTEREST-EXPENSE> 43,562
<INTEREST-INCOME-NET> 58,641
<LOAN-LOSSES> 2,700
<SECURITIES-GAINS> 216
<EXPENSE-OTHER> 39,651
<INCOME-PRETAX> 16,506
<INCOME-PRE-EXTRAORDINARY> 16,506
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 16,506
<EPS-PRIMARY> 0.72
<EPS-DILUTED> 0.68
<YIELD-ACTUAL> 4.58
<LOANS-NON> 1,549
<LOANS-PAST> 192
<LOANS-TROUBLED> 0
<LOANS-PROBLEM> 0
<ALLOWANCE-OPEN> 10,335
<CHARGE-OFFS> 990
<RECOVERIES> 97
<ALLOWANCE-CLOSE> 12,142
<ALLOWANCE-DOMESTIC> 12,142
<ALLOWANCE-FOREIGN> 0
<ALLOWANCE-UNALLOCATED> 0
</TABLE>
