ANNUAL REPORT 98
SHAPING OUR COMPANY THROUGH GROWTH AND ACQUISITION
[Photograph: two individuals standing by pillars of a building,
enclosed in square]
[Photograph: eyeglasses placed on a sheet of graph paper,
enclosed in a circle]
[Photograph: man holding up a boy, enclosed in a triangle]
[Independent Bankshares Logo]
INDEPENDENT BANKSHARES, INC. 1998 ANNUAL REPORT
<PAGE>
[Illustration of Texas with an inset showing different Texas
cities in the West and North Central Regions]
[Independent Bankshares, Inc. Logo]
First State Bank, N.A.
Banking Locations in West Texas
=================================================================
<TABLE>
<S> <C> <C>
ABILENE - MAIN BANK AZLE - MAIN BRANCH ODESSA - WINWOOD BRANCH
547 Chestnut Street 150 Industrial Avenue 3898 E. 42nd Street
Abilene, Texas 79602 Azle, Texas 76020 Odessa, Texas 79762
(915)672-2902 (817) 444-2525 (915) 366-5903
SAN ANGELO BRANCH ABILENE - WYLIE BRANCH AZLE - NORTH BRANCH
4112 College 6301 Buffalo Gap Road 11588 FM 730 North
Hills Boulevard Abilene, Texas 79606 Azle, Texas 76020
San Angelo, Texas 76904 (915) 691-0000 (817) 270-1112
(915) 942-8757
ODESSA - 42nd STREET STAMFORD BRANCH ABILENE - BUFFALO
BRANCH 210 S. Swenson Street GAP ROAD BRANCH
4950 E. 42nd Street Stamford, Texas 79553 4450 Buffalo Gap Road
Odessa, Texas 79762 (915) 773-5755 Abilene, Texas 79606
(915) 362-2106 (915) 793-2477
LUBBOCK BRANCH ODESSA - COUNTY ROAD WINTERS BRANCH
82nd Street and WEST BRANCH 500 S. Main Street
Nashville Avenue 2751 County Road West Winters, Texas 79567
Lubbock, Texas 79423 Odessa, Texas 79763 (915) 754-5511
(806) 794-8300 (915) 335-8200
ODESSA - MAIN BRANCH
1330 E. 8th Street
Odessa, Texas 79761
(915) 332-0141
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[Graphic: large square and a small circle]
FINANCIAL HIGHLIGHTS 98
<PAGE>
</TABLE>
<TABLE>
<CAPTION>
INCOME STATEMENT DATA
<PAGE>
FOR THE YEAR 1998 1997 1996
==================================================================
<S> <C> <C> <C>
Net Income $2,188,000 $2,110,000 $1,422,000
Basic Earnings
Per Common Share 1.07 1.12 1.00
Diluted Earnings
Per Common Share 1.02 1.03 0.84
BALANCE SHEET DATA
AT YEAR END 1998 1997 1996
==============================================================================
Assets $370,178,000 $264,574,000 $205,968,000
Loans 184,560,000 140,853,000 92,017,000
Deposits 330,804,000 242,801,000 189,575,000
Stockholders' Equity 24,505,000 20,527,000 14,937,000
BALANCE SHEET DATA
DAILY AVERAGES 1998 1997 1996
==============================================================================
Assets $293,579,000 $258,874,000 $196,155,000
Loans 153,188,000 132,891,000 85,880,000
Deposits 265,959,000 237,379,000 180,005,000
Stockholders' Equity 22,114,000 19,275,000 14,375,000
STOCK TRANSFER AGENT STOCK EXCHANGE LISTING
===============================================================
First State Bank, N.A. American Stock Exchange
547 Chestnut Street (AMEX)
P.O. Box 3296
Abilene, Texas 79604
COMPANY SECURITIES AMEX TRADING SYMBOL AMEX LISTING
===============================================================
Common Stock IBK Indep Bksh
Trust Preferred Securities IBK.Pr Indep Cap
INDEPENDENT BANKSHARES, INC.
1
<PAGE>
[Graphic: large triangle with small circle] PRESIDENT'S LETTER
BRYAN STEPHENSON [PHOTOGRAPH OF BRYAN STEPHENSON AND RANDAL
CROSSWHITE]
President and Chief Executive Officer
RANDAL CROSSWHITE
Senior Vice President and Chief Financial Officer
TO OUR SHAREHOLDERS: Independent Bankshares, Inc. is a bank
holding company headquartered in Abilene, Texas. Through its
subsidiary, First State Bank, N.A., the Company offers a full
range of financial products to businesses and individuals located
in and around five of the more populated communities in West
Texas. With thirteen branches and a loan limit in excess of
$4,000,000, the Company has the management, the visibility and
the size to compete effectively in its market.
During 1998, the Company continued its philosophy of growth
through acquisition with the purchase of Azle Bancorp and its
subsidiary, Azle State Bank, Azle, Texas. The Company obtained
the funds necessary to complete this transaction through a
successful secondary Common Stock offering and an offering of
Trust Preferred Securities. The purchase of Azle follows
acquisitions of Western National Bank, Lubbock, Texas in 1997,
and Peoples National Bank, Winters, Texas and a savings bank
branch in San Angelo, Texas, both in 1996. The acquisitions
contributed significantly to the Company's market diversification
and provided important economies of scale.
While located in West Texas, a review of the accompanying map
indicates the geographic diversification the Company currently
enjoys. Each market is driven by a different set of economic
forces. Lubbock, for example, enjoys the benefits of higher
education, a large medical complex and agriculture, primarily
cotton. Odessa, on the other hand, continues to be largely
dependent on the petroleum industry. Abilene relies on a strong
military base, healthcare, education and retail distribution for
its economic base, while the San Angelo economy is centered
around ranching, retail businesses and a large retirement
community.
The Company's purchase of Azle State Bank provides a new and
exciting opportunity for market diversification. Azle, located
on the doorstep of the Fort Worth/Dallas metroplex, is a growing
bedroom community. As small businesses spring up to support this
population growth, the Company's marketing efforts will be
directed toward the solicitation of these small businesses and
the attendant consumer relationships.
As noted above, our acquisitions have brought important economies
of scale. There has been significant discussion in analytical
circles about the "urge to merge" and whether or not merging
companies actually realize expected economies of scale. Our
Company has benefited from its acquisition savings in many areas,
the most notable being
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2
<PAGE>
greater employee efficiencies and utilization of excess computing
capacity. The results of these economies of scale can be seen in
our five-year trend of improving efficiency ratios.
The movement to change the mix of our loan portfolio began in
earnest in January 1997. Due in part to the acquisition of
Western National Bank, the Company had achieved a concentration
in consumer loans that was significantly higher than desired.
Because of our perception that the consumer was becoming
overextended and due to competitive market forces that prevented
the Company from charging interest rates that would compensate
for the increased risk associated with such loans, we determined
to scale back our solicitation of this type of business and to
redirect our efforts toward increasing our commercial business
and commercial real estate lending. The interest rates on
commercial loans were higher and we believed the market was
underserved.
As a result of this change in direction, the Company (excluding
the Azle acquisition) experienced a 30.7% reduction in loans to
individuals and a 32% increase in commercial business and
commercial real estate loans during 1998. This shift, along with
the acquisition of Azle State Bank, allowed the Company to
increase its net interest margin in a generally decreasing net
interest margin environment.
Year 2000, or Y2K, computer issues have been high on our list of
operational priorities during 1998, and will undoubtedly consume
considerable time and effort during 1999. Because the Company
had planned to upgrade all computer hardware during 1998 and
1999, and because the cost of hardware has continued to decline
over the last few years, the economic impact of the hardware
replacement has not been material to the Company. All
replacement hardware is certified to be Y2K compliant. The
Company is concluding the installation of software upgrades and
in-house tests as this letter is being written. The goal is, of
course, to assure that our operating systems will not be
negatively affected by the Y2K bug. Because external Y2K
disruptions cannot be controlled by the Company, we have devised
a contingency plan and business resumption plan aimed at assuring
that the customers' faith in our Company will not be diminished.
Lastly, we are a large community bank. A community bank, by our
definition, is one in which qualified banking professionals take
care of the financial needs of the businesses and individuals
within its community. This definition
[Photograph: man holding up a boy in front of a house]
[Independent Bankshares, Inc. Logo]
[Photograph caption: The West Texas market area experienced a
stable economy. Our Company was able to capitalize on this
environment by increasing loans to small businesses]
Independent Bankshares, Inc.
3
<PAGE>
requires that we concentrate our efforts on hiring, training and
retraining highly qualified personnel. We are fortunate to have
added several high-caliber lending officers and support staff and
two highly motivated individuals to our Company's Board of
Directors.
As pleased as we are with our staff, I am particularly pleased
with the two newest members of our Board: Nancy Jones, Executive
Director of The Community Foundation of Abilene, and John Beckham
of the Beckham, Eargle & Rector Law Firm. They are young,
energetic individuals who bring new ideas and renewed vigor to
our Board.
Officers, employees and directors of this caliber enable the
Company to prepare for the future. The future, as always, if
filled with challenges and opportunities.
Thank you for your continued support.
/s/ Bryan Stephenson
Bryan Stephenson
[Graphic: large circle and small triangle] PERFORMANCE HIGHLIGHTS
[Bar Chart illustrating the Company's total assets at year end
for each of the five years in the period ended December 31, 1998]
TOTAL ASSETS
The Company recorded consistent growth over the last four years.
Acquisitions of other financial institutions, including a bank in
Winters and a saving bank branch in San Angelo in 1996. Western
National Bank in Lubbock in 1997 and Azle State Bank in 1998,
contributed to this trend.
[Bar Chart illustrating the Company's total loans at year end for
each of the five years in the period ended December 31, 1998]
TOTAL LOANS
While acquisitions have fueled loan growth, the Company has
focused lending efforts to replace consumer loan roll-off with
commercial and commercial real estate loans.
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4
<PAGE>
[Bar Chart illustrating the Company's net income for each of the
five years in the period ended December 31, 1998]
NET INCOME
Increases in net income have been achieved through economies of
scale and an improved net interest margin.
[Bar Chart illustrating the Company's diluted earnings per share
for each of the five years in the period ended December 31, 1998]
DILUTED EARNINGS PER SHARE
Diluted earnings per share declined $0.01 in 1998 because of an
increase in the common shares outstanding.
[Bar Chart illustrating the Company's efficiency ratio for each
of the five years in the period ended December 31, 1998]
EFFICIENCY RATIO
The Company's efficiency ratio, calculated as noninterest
expenses, less goodwill amortization and expenses associated with
other real estate and other repossessed assets, divided by net
interest income and total noninterest income, excluding
securities gains (losses), has continued to improve with the
growth of the Company.
[Bar Chart illustrating the Company's return on average
stockholders' equity for each of the five years in the period
ended December 31, 1998]
RETURN ON AVERAGE STOCKHOLDERS' EQUITY
The decline in the return on average stockholders' equity for
1998 is a result of increases in stockholders' equity.
Independent Bankshares, Inc.
5
<PAGE>
[Text enclosed in a square with Independent Bankshares, Inc. Logo]
BOARD OF DIRECTORS
Bryan W. Stephenson
President & Chief Executive Officer
Independent Bankshares, Inc.
John L. Beckham
Attorney
Beckham, Rector & Eargle, L.L.P.
Scott L. Taliaferro
Chairman of the Board
Independent Bankshares, Inc.
President
Scott Oils, Inc.
Lee Caldwell
Attorney
Mrs. William R. (Amber) Cree
Entrepreneuse
Randal N. Crosswhite
Senior Vice President &
Chief Financial Officer
Independent Bankshares, Inc.
James D. Webster, M.D.
Physician
Nephrology Associates
Louis S. Gee
Chairman of the Board &
Chief Executive Officer
Tippett & Gee, Inc.,
Consulting Engineers
C.G. Whitten
Attorney, Whitten & Young, P.C.
Nancy E. Jones
Executive Director
Community Foundation of Abilene
Marshal M. Keller
Chairman of the Board
West Texas Wholesale Supply Co.
Tommy McAlister
President
McAlister, Inc.
[Text enclosed in a circle]
ADVISORY DIRECTORS
L.H. Mosley
President
Mosley Investments, Inc.
J.E. Smith
Investments
John A. Wright*
Banking Consultant
*Emeritus
[Text enclosed in a triangle]
Bryan W. Stephenson
President & Chief
Executive Officer
Randal N. Crosswhite
Senior Vice President &
Chief Financial Officer
CORPORATE OFFICERS
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6
<PAGE>
[Text enclosed in a square] REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and
Shareholders of Independent Bankshares, Inc.
In our opinion, the accompanying consolidated balance sheets and
the related consolidated statements of income and comprehensive
income, changes in stockholders' equity and cash flows present
fairly, in all material respects, the financial position of
Independent Bankshares, Inc. at December 31, 1998 and 1997, and
the results of its operations and its cash flows for each of the
three years in the period ended December 31, 1998, in conformity
with generally accepted accounting principles. 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 generally accepted auditing
standards 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, accessing 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 the
opinion expressed above.
/s/ PricewaterhouseCoopers LLP
PricewaterhouseCoopers LLP
January 29, 1998
Independent Bankshares, Inc.
7
<PAGE>
[Independent Bankshares, Inc. Logo]
<PAGE>
INDEPENDENT BANKSHARES, INC.
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 1998 AND 1997
</TABLE>
<TABLE>
<CAPTION>
ASSETS
1998 1997
------------- -------------
<S> <C> <C>
Assets:
Cash and Cash Equivalents:
Cash and Due from Banks $ 22,562,000 $ 14,518,000
Federal Funds Sold 42,175,000 24,900,000
------------- -------------
Total Cash and Cash Equivalents 64,737,000 39,418,000
------------- -------------
Securities (Note 3):
Available-for-sale 30,370,000 22,501,000
Held-to-maturity 64,838,000 47,293,000
------------- -------------
Total Securities 95,208,000 69,794,000
------------- -------------
Loans (Note 4):
Total Loans 186,326,000 142,315,000
Less:
Unearned Income on Installment Loans 1,766,000 1,462,000
Allowance for Possible Loan Losses 1,842,000 1,173,000
------------- -------------
Net Loans 182,718,000 139,680,000
------------- -------------
Intangible Assets (Note 5) 10,831,000 3,159,000
Premises and Equipment (Note 6) 10,294,000 7,518,000
Accrued Interest Receivable 3,254,000 2,208,000
Other Real Estate and Other Repossessed Assets 630,000 739,000
Other Assets 2,506,000 2,058,000
------------- -------------
Total Assets $ 370,178,000 $ 264,574,000
============= =============
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities:
Deposits (Note 7):
Noninterest-bearing Demand Deposits $ 60,086,000 $ 43,868,000
Interest-bearing Demand Deposits 110,485,000 77,495,000
Interest-bearing Time Deposits 160,233,000 121,438,000
------------- -------------
Total Deposits 330,804,000 242,801,000
Accrued Interest Payable 1,163,000 947,000
Notes Payable (Note 8) 1,000 57,000
Other Liabilities 705,000 242,000
------------- -------------
Total Liabilities 332,673,000 244,047,000
------------- -------------
Guaranteed Preferred Beneficial Interests in the Company's
Subordinated Debentures (Note 10) 13,000,000 0
------------- -------------
Commitments and Contingent Liabilities (Notes 15 and 17)
Stockholders' Equity (Notes 11 and 18):
Preferred Stock - Par Value $10.00; 5,000,000 Shares Authorized:
Series C Preferred Stock - Stated Value $42.00; 50,000 Shares
Designated; 5,066 and 5,590 Shares Issued and Outstanding at
December 31, 1998 and 1997, Respectively 51,000 56,000
Common Stock - Par Value $0.25; 30,000,000 Shares Authorized;
2,217,296 and 1,975,263 Shares Issued and Outstanding
at December 31, 1998 and 1997, Respectively 554,000 494,000
Additional Paid-in Capital 15,933,000 13,921,000
Retained Earnings 7,975,000 6,218,000
Net Unrealized Gain on Available-for-sale Securities (Note 3) 161,000 31,000
Unearned Employee Stock Ownership Plan Stock (Note 11) (169,000) (193,000)
------------- -------------
Total Stockholders' Equity 24,505,000 20,527,000
------------- -------------
Total Liabilities and Stockholders' Equity $ 370,178,000 $ 264,574,000
============= =============
</TABLE>
See accompanying notes.
-8-
<PAGE>
INDEPENDENT BANKSHARES, INC.
CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME
YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
<TABLE>
<CAPTION>
1998 1997 1996
------------- ------------- -------------
<S> <C> <C> <C>
Interest Income:
Interest and Fees on Loans (Note 4) $ 14,150,000 $ 12,236,000 $ 8,005,000
Interest on Securities 4,425,000 5,176,000 4,504,000
Interest on Federal Funds Sold 1,859,000 912,000 1,047,000
------------- ------------- -------------
Total Interest Income 20,434,000 18,324,000 13,556,000
------------- ------------- -------------
Interest Expense:
Interest on Deposits 9,268,000 8,600,000 6,382,000
Interest on Notes Payable (Note 8) 8,000 59,000 59,000
------------- ------------- -------------
Total Interest Expense 9,276,000 8,659,000 6,441,000
------------- ------------- -------------
Net Interest Income 11,158,000 9,665,000 7,115,000
Provision for Loan Losses (Note 4) 570,000 250,000 201,000
------------- ------------- -------------
Net Interest Income After Provision for Loan Losses 10,588,000 9,415,000 6,914,000
------------- ------------- -------------
Noninterest Income:
Service Charges 2,227,000 1,605,000 1,259,000
Trust Fees 199,000 195,000 189,000
Other Income 365,000 109,000 103,000
------------- ------------- -------------
Total Noninterest Income 2,791,000 1,909,000 1,551,000
------------- ------------- -------------
Noninterest Expenses:
Salaries and Employee Benefits 4,752,000 3,970,000 3,082,000
Net Occupancy Expense 1,099,000 857,000 716,000
Equipment Expense 887,000 834,000 663,000
Stationery, Printing and Supplies Expense 442,000 419,000 288,000
Amortization of Intangible Assets 339,000 218,000 46,000
Professional Fees 305,000 333,000 304,000
Distributions on Guaranteed Preferred Beneficial Interests
in the Company's Subordinated Debentures (Note 10) 304,000 0 0
Net Costs (Revenues) Applicable to Other Real Estate
and Other Repossessed Assets 106,000 23,000 (24,000)
Other Expenses 1,764,000 1,583,000 1,215,000
------------- ------------- -------------
Total Noninterest Expenses 9,998,000 8,237,000 6,290,000
------------- ------------- -------------
Income Before Federal Income Taxes 3,381,000 3,087,000 2,175,000
Federal Income Taxes (Note 9) 1,193,000 977,000 753,000
------------- ------------- -------------
Net Income 2,188,000 2,110,000 1,422,000
Other Comprehensive Income, Net of Tax:
Unrealized Holding Gains (Losses) on Available-for-sale
Securities Arising During the Period 130,000 6,000 (43,000)
------------- ------------- -------------
Comprehensive Income $ 2,318,000 $ 2,116,000 $ 1,379,000
============= ============= =============
Preferred Stock Dividends (Note 11) $ 22,000 $ 41,000 $ 63,000
============= ============= =============
Net Income Available to Common Stockholders $ 2,166,000 $ 2,069,000 $ 1,359,000
============= ============= =============
Basic Earnings Per Common Share
Available to Common Stockholders (Note 12) $ 1.07 $ 1.12 $ 1.00
============= ============= =============
Diluted Earnings Per Common Share
Available to Common Stockholders (Note 12) $ 1.02 $ 1.03 $ 0.84
============= ============= =============
</TABLE>
See accompanying notes.
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<PAGE>
INDEPENDENT BANKSHARES, INC.
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
<TABLE>
<CAPTION>
SERIES C
PREFERRED STOCK COMMON STOCK ADDITIONAL
-------------------- -------------------- PAID-IN RETAINED
SHARES AMOUNT SHARES AMOUNT CAPITAL EARNINGS
--------- ---------- --------- ---------- ---------- ----------
<S> <C> <C> <C> <C> <C> <C>
Balances-January 1, 1996 16,436 $ 164,000 1,050,292 $ 263,000 $ 9,875,000 $ 3,448,000
Net Income 1,422,000
Adjustment to Unrealized Gain
on Available-for-sale Securities,
Net of Tax of $22,000 (Note 3)
Cash Dividends (260,000)
Conversion of Series C
Preferred Stock (Note 11) (2,958) (29,000) 54,352 13,000 16,000
--------- ---------- --------- ---------- ---------- ----------
Balances-December 31, 1996 13,478 135,000 1,104,644 276,000 9,891,000 4,610,000
Net Income 2,110,000
Adjustment to Unrealized Gain
on Available-for-sale Securities,
Net of Tax of $3,000 (Note 3)
Cash Dividends (405,000)
Sale of Stock in Secondary Offering (Note 11) 316,250 79,000 3,899,000
Purchase of Stock in Secondary Offering by
ESOP, Financed by a Loan from the
Company - Unearned Stock (Note 11)
Principal Payments on Loan to ESOP for
Stock Purchase - Earned Stock (Note 11)
5-for-4 Stock Split (Note 11) 388,911 97,000 (5,000) (97,000)
Exercise of Stock Options (Note 11) 17,499 5,000 94,000
Conversion of Series C Preferred
Stock (Note 11) (7,888) (79,000) 147,959 37,000 42,000
--------- ---------- --------- ---------- ----------- -----------
Balances--December 31, 1997 5,590 56,000 1,975,263 494,000 13,921,000 6,218,000
Net Income 2,188,000
Adjustment to Unrealized Gain
on Available-for-sale Securities, Net
of Tax of $67,000 (Note 3)
Cash Dividends (431,000)
Sale of Stock in Secondary Offering (Note 11) 230,000 57,000 2,010,000
Principal Payments on Loan to ESOP for
Stock Purchase - Earned Stock (Note 11)
Conversion of Series C Preferred
Stock (Note 11) (524) (5,000) 12,033 3,000 2,000
--------- --------- --------- ---------- ----------- ----------
Balances--December 31, 1998 5,066 $ 51,000 2,217,296 $ 554,000 $15,933,000 $7,975,000
========= ========= ========= ========== =========== ==========
UNREALIZED UNEARNED EMPLOYEE
GAIN ON STOCK OWNERSHIP
AVAILABLE- PLAN STOCK
FOR-SALE ---------------------
SECURITIES SHARES AMOUNT
---------- -------- -----------
<S> <C> <C> <C>
Balances-January 1, 1996 $ 68,000 0 $ 0
Net Income
Adjustment to Unrealized Gain
on Available-for-sale Securities,
Net of Tax of $22,000 (Note 3) (43,000)
Cash Dividends
Conversion of Series C
Preferred Stock (Note 11)
----------- -------- -----------
Balances-December 31, 1996 25,000 0 0
Net Income
Adjustment to Unrealized Gain
on Available-for-sale Securities,
Net of Tax of $3,000 (Note 3) 6,000
Cash Dividends
Sale of Stock in Secondary Offering (Note 11)
Purchase of Stock in Secondary Offering by
ESOP, Financed by a Loan from the
Company - Unearned Stock (Note 11) (15,000) (214,000)
Principal Payments on Loan to ESOP for
Stock Purchase - Earned Stock (Note 11) 1,789 21,000
5-for-4 Stock Split (Note 11) (3,750)
Exercise of Stock Options (Note 11)
Conversion of Series C Preferred
Stock (Note 11) ----------- -------- -----------
Balances--December 31, 1997 31,000 (16,961) (193,000)
Net Income
Adjustment to Unrealized Gain
on Available-for-sale Securities, Net
of Tax of $67,000 (Note 3) 130,000
Cash Dividends
Sale of Stock in Secondary Offering (Note 11)
Principal Payments on Loan to ESOP for
Stock Purchase - Earned Stock (Note 11) 2,122 24,000
Conversion of Series C Preferred
Stock (Note 11)
----------- -------- -----------
Balances--December 31, 1998 $ 161,000 (14,839) $ (169,000)
=========== ======== ===========
See accompanying notes.
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<PAGE>
INDEPENDENT BANKSHARES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
</TABLE>
<TABLE>
<CAPTION>
1998 1997 1996
------------ ------------ ------------
<S> <C> <C> <C>
Cash Flows from Operating Activities:
Net Income $ 2,188,000 $ 2,110,000 $ 1,422,000
Adjustments to Reconcile Net Income to Net Cash
Provided by Operating Activities:
Deferred Federal Income Tax Expense 488,000 772,000 677,000
Depreciation and Amortization 962,000 733,000 404,000
Provision for Loan Losses 570,000 250,000 201,000
Losses on Sales of Investment Securities 0 0 10,000
Gains on Sales of Other Real Estate and Other Repossessed Assets (12,000) (58,000) (50,000)
Writedown of Other Real Estate and Other Repossessed Assets 3,000 2,000 21,000
Increase in Accrued Interest Receivable (190,000) (192,000) (17,000)
Decrease (Increase) in Other Assets (698,000) 452,000 (382,000)
Decrease in Accrued Interest Payable (92,000) (182,000) (14,000)
Increase (Decrease) in Other Liabilities 84,000 (1,106,000) 166,000
------------ ------------ ------------
Net Cash Provided by Operating Activities 3,303,000 2,781,000 2,438,000
------------ ------------ ------------
Cash Flows from Investing Activities:
Proceeds from Maturities of Available-for-sale Securities 15,766,000 17,809,000 9,437,000
Proceeds from Maturities of Held-to-maturity Securities 36,745,000 20,195,000 26,461,000
Proceeds from Sales of Available-for-sale Securities 0 193,000 30,000
Proceeds from Sales of Held-to-maturity Securities 0 0 2,000,000
Purchases of Available-for-sale Securities (19,489,000) (8,060,000) (19,382,000)
Purchases of Held-to-maturity Securities (22,627,000) (15,080,000) (36,680,000)
Net Increase in Loans (254,000) (8,692,000) (8,160,000)
Proceeds from Sales of Premises and Equipment 0 0 94,000
Additions to Premises and Equipment (651,000) (819,000) (138,000)
Proceeds from Sales of Other Real Estate and Other Repossessed Assets 1,551,000 1,352,000 754,000
Net Cash and Cash Equivalents Acquired (Paid) in Acquisitions (10,133,000) (1,236,000) 14,203,000
------------ ------------ ------------
Net Cash Provided by (Used in) Investing Activities 908,000 5,662,000 (11,381,000)
------------ ------------ ------------
Cash Flows from Financing Activities:
Net Increase (Decrease) in Deposits 7,048,000 (378,000) 5,018,000
Proceeds from Notes Payable 4,300,000 1,300,000 0
Repayment of Notes Payable (4,356,000) (3,572,000) (616,000)
Net Proceeds from Issuance of Equity Securities 2,067,000 4,077,000 0
Net Proceeds from Issuance of Guaranteed Preferred Beneficial
Interests in the Company's Subordinated Debentures 12,480,000 0 0
Payment of Cash Dividends (431,000) (405,000) (260,000)
Cash Paid for Fractional Shares in Stock Dividend 0 (5,000) 0
------------ ------------ ------------
Net Cash Provided by Financing Activities 21,108,000 1,017,000 4,142,000
------------ ------------ ------------
Net Increase (Decrease) in Cash and Cash Equivalents 25,319,000 9,460,000 (4,801,000)
Cash and Cash Equivalents at Beginning of Year 39,418,000 29,958,000 34,759,000
------------ ------------ ------------
Cash and Cash Equivalents at End of Year $ 64,737,000 $ 39,418,000 $ 29,958,000
============ ============ ============
</TABLE>
See accompanying notes.
-11-
<PAGE>
INDEPENDENT BANKSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998, 1997 AND 1996
NOTE 1: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
- ---------------------------------------------------
Business
Independent Bankshares, Inc., a Texas corporation (the "Company"), is a
bank holding company headquartered in Abilene, Texas. The Company owns all of
the common securities of Independent Capital Trust ("Independent Capital")
and indirectly owns through a Delaware subsidiary, Independent Financial
Corp. ("Independent Financial"), 100% of the stock of First State Bank,
National Association, Abilene, Texas ("First State"), and Azle State Bank,
Azle, Texas ("Azle State") (collectively, the "Banks"). The Banks currently
operate full-service banking locations in the Texas cities of Abilene (3
locations), Azle (2 locations), Lubbock, Odessa (4 locations), San Angelo,
Stamford and Winters.
The Company's primary activities are to assist the Banks in the
management and coordination of their financial resources and to provide
capital, business development, long range planning and public relations for
the Banks. The Banks operate under the day-to-day management of their own
officers and boards of directors and formulate their own policies with
respect to banking matters.
The principal services provided by the Banks are as follows:
Commercial Services. The Banks provide a full range of banking services
for their commercial customers. Commercial lending activities include
short-term and medium-term loans, revolving credit arrangements, inventory
and accounts receivable financing, equipment financing and interim and
permanent real estate lending. Other services include cash management
programs and federal tax depository and night depository services.
Consumer Services. The Banks also provide a wide range of consumer
banking services, including checking, savings and money market accounts,
savings programs and installment and personal loans. The Banks make
automobile and other installment loans directly to customers, as well as
indirectly through automobile dealers. The Banks make home improvement, home
equity and real estate loans and provide safe deposit services. As a result
of sharing arrangements with the Pulse automated teller machine system
network, the Banks provide 24-hour routine banking services through automated
teller machines ("ATMs"). The Pulse network provides ATM accessibility
throughout the United States. The Banks also offer investment services and
banking by phone or personal computer.
Trust Services. First State provides trust and agency services to
individuals, partnerships and corporations from its offices in Abilene,
Lubbock and Odessa. The trust division also provides investment management,
administration and advisory services for agency and trust accounts, and acts
as trustee for pension and profit sharing plans.
PRINCIPLES OF CONSOLIDATION
The Consolidated Financial Statements include the accounts of the
Company, Independent Capital, Independent Financial and the Banks. All
significant intercompany accounts and transactions have been eliminated upon
consolidation.
STATEMENTS OF CASH FLOWS
For purposes of reporting cash flows, cash and cash equivalents include
cash on hand, amounts due from banks and federal funds sold. Generally,
federal funds are purchased and sold for one-day periods.
SECURITIES
Management determines the appropriate classification of securities at
the time of purchase. If the securities are purchased with the positive
intent and the ability to hold the securities until maturity, they are
classified as held-to-maturity and carried at historical cost, adjusted for
amortization of premiums and accretion of fees and discounts using
-12-
<PAGE>
a method that approximates the interest method. Securities to be held for
indefinite periods of time are classified as available-for-sale and carried
at fair value. Unrealized gains and losses, net of taxes, related to
securities available-for-sale are recorded as a separate component of
stockholders' equity. The Company has no securities classified as trading as
of December 31, 1998 and 1997. The cost of securities sold is based on the
specific identification method.
LOANS
Loans are stated at the principal amount outstanding. Interest on the
various types of commercial loans is accrued daily based on the principal
balances outstanding. Income on installment loans is recognized using this
method or other methods under which income approximates the effective
interest method.
The recognition of income on a loan is discontinued, and previously
accrued interest is reversed, when interest or principal payments become
ninety (90) days past due unless, in the opinion of management, the
outstanding interest remains collectible. Interest is subsequently recognized
only as received until the loan is returned to accrual status.
ALLOWANCE FOR POSSIBLE LOAN LOSSES
The allowance for possible loan losses is maintained at a level that, in
management's opinion, is adequate to absorb possible losses in the loan
portfolio and unfunded loan commitments. The allowance is based on a number
of factors, including risk ratings of individual credits, current business
and economic conditions, the size and diversity of the portfolio, collateral
values and past loan loss experience.
Impaired loans, should they occur, are normally placed on nonaccrual
status and, as a result, interest income is recorded only as cash is
received. There was no interest income recognized on such loans during the
years ended December 31, 1998, 1997 or 1996.
PREMISES AND EQUIPMENT
Premises and equipment are stated at cost less accumulated depreciation.
Depreciation for financial reporting purposes is computed primarily on the
straight-line method over the estimated useful lives of five (5) to forty
(40) years. 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 included in the results of operations for the
period.
INTANGIBLE ASSETS
A core deposit intangible resulting from the acquisition of Azle State
is being amortized over a twelve (12) year period. Goodwill resulting from
the acquisition of Azle State and other acquisitions accounted for using the
purchase method is being amortized on the straight-line method over a period
of fifteen (15) to twenty-five (25) years. Management assesses the
recoverability of goodwill by comparing the goodwill to the undiscounted cash
flows expected to be generated by the acquired banks during the anticipated
period of benefit. As of December 31, 1998, management believes that no
impairment has occurred.
FEDERAL INCOME TAXES
The Company uses the liability method of accounting for income taxes as
required by the Financial Accounting Standards Board (the "FASB") Statement
of Financial Accounting Standards No. 109, "Accounting for Income Taxes ("FAS
109"). Deferred income taxes reflect the net effects of temporary differences
between the carrying amount of assets and liabilities for financial reporting
purposes and the amounts used for income tax purposes.
OTHER REAL ESTATE AND OTHER REPOSSESSED ASSETS
Other real estate and other repossessed assets consist principally of
real estate properties and automobiles acquired by the Company through
foreclosure. Such assets are carried at the lower of cost (generally the
outstanding loan balance) or estimated fair value, net of estimated costs of
disposal, if any. If the estimated fair value of the collateral securing the
loan is less than the amount outstanding on the loan at the time the assets
are acquired, the difference is charged against the allowance for possible
loan losses. Subsequent declines in estimated fair value, if any, are charged
to noninterest expense.
-13-
<PAGE>
EARNINGS PER SHARE
In March 1997, the FASB issued Statement of Financial Accounting
Standards No. 128, "Earnings Per Share" ("FAS 128"), which establishes
standards for computing and presenting earnings per share for entities with
publicly held common stock or potential common stock. It replaces the
presentation of primary earnings per share with a presentation of basic
earnings per share, which excludes dilution. It also requires dual
presentation of basic and diluted earnings per share on the face of the
income statement for all entities with complex capital structures. The
Company adopted FAS 128 on December 31, 1997.
COMPREHENSIVE INCOME
In June 1997, the FASB issued Statement of Financial Accounting
Standards No. 130, "Reporting Comprehensive Income" ("FAS 130"). FAS 130
establishes standards for reporting and display of comprehensive income and
its components (revenues, expenses, gains and losses) in a full set of
general purpose financial statements. FAS 130 requires that all items that
are required to be recognized under accounting standards as components of
comprehensive income be reported in a financial statement that is displayed
with the same prominence as other financial statements. The Company adopted
FAS 130 on January 1, 1998.
USE OF ESTIMATES
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make certain estimates
and assumptions that affect the reported amounts of assets and liabilities
and disclosure of contingent assets and liabilities at the date of the
financial statements and the reported amounts of revenues and expenses during
the reporting period. Actual results could differ from those estimates.
NOTE 2: BANK ACQUISITIONS
- --------------------------
The Company completed the acquisition of Azle Bancorp and its subsidiary
bank, Azle State, effective September 22, 1998, for an aggregate cash
consideration of $19,025,000. To obtain funding for the acquisition, the
Company sold an aggregate of 230,000 shares of Common Stock at a price of
$11.50 per share, and Independent Capital, a Delaware business trust formed
by the Company, sold 1,300,000 of its 8.5% Cumulative Trust Preferred
Securities (the "Trust Preferred Securities") at $10.00 per preferred
security (having a liquidation value of $13,000,000) in an underwritten
offering (the "1998 Offering"). The proceeds from the sale of the Trust
Preferred Securities were used by Independent Capital to purchase an
equivalent amount of Subordinated Debentures ("Subordinated Debentures") of
the Company. The Company also borrowed $4,300,000 from a financial
institution in Fort Worth, Texas (the "Fort Worth Bank") to finance a portion
of the cost of acquiring Azle Bancorp. The borrowings from the Fort Worth
Bank were paid off on September 30, 1998, from the proceeds of a cash
dividend paid to the Company by Azle State. At the date of acquisition, Azle
Bancorp had total assets of $93,158,000, total loans, net of unearned income,
of $45,163,000, total deposits of $80,955,000 and stockholders' equity of
$9,872,000. This acquisition was accounted for using the purchase method of
accounting. A total of $8,014,000 of intangible assets, including $2,895,000
of core deposit intangible and $5,119,000 of goodwill, was recorded as a
result of this acquisition. The core deposit intangible is being amortized
over a period of 12 years and the goodwill is being amortized over a period
of 25 years.
The Company completed the acquisition of Crown Park Bancshares, Inc.
("Crown Park") and its wholly owned subsidiary bank, Western National Bank,
Lubbock, Texas ("Western National"), effective January 28, 1997, for an
aggregate cash consideration of $7,510,000. On the acquisition date, Crown
Park was merged with and into a wholly owned subsidiary of the Company and
Western National was merged with and into the First State. To obtain funding
for the acquisition, the Company sold an aggregate of 395,312 shares of its
common stock ("Common Stock") in an underwritten offering at a price of
$11.40 per share (the "1997 Offering"). The 1997 Offering included the sale
of 51,562 shares covered by the underwriter's over-allotment option. The
above number of shares and price per share have been adjusted for the 5-for-4
stock split, effected in the form of a 25% stock dividend, paid to the
Company's shareholders in May 1997. The Company borrowed $800,000 from a
financial institution in Amarillo, Texas (the "Amarillo Bank") to finance a
portion of the cost of acquiring Crown Park. The $800,000 of borrowings was
reduced to $400,000 with the proceeds of the sale of the over-allotment
shares. The borrowing was paid off on December 31, 1997. At the date of
acquisition, Crown Park had total assets of $60,420,000, total loans, net of
unearned income, of $41,688,000, total deposits of $53,604,000 and
stockholders' equity of $4,238,000. This
-14-
<PAGE>
acquisition was accounted for using the purchase method of accounting. A
total of $2,486,000 of goodwill was recorded as a result of this acquisition.
Such goodwill is being amortized over a period of 15 years.
A total of $339,000, $218,000 and $46,000 in amortization expense of
intangible assets was recorded during the years ended December 31, 1998, 1997
and 1996, respectively.
The following pro forma financial information combines the historical
results of the Company as if the Azle Bancorp acquisition had occurred as of
the beginning of each period presented. The pro forma amounts do not purport
to be indicative of the results that would have actually been obtained if the
acquisition had occurred at the beginning of each period presented or that
may be obtained in the future:
Year Ended December 31,
------------------------
1998 1997
--------- ---------
(In thousands,
except per share amounts)
Net interest income $ 14,195 $ 13,667
Net income 1,889 2,333
Basic earnings per share 0.85 1.11
Diluted earnings per share 0.82 1.02
Certain amounts, specifically the pro forma amounts for net income and
basic and diluted earnings per share for the year ended December 31, 1998,
are less than the amounts reported herein.
NOTE 3: SECURITIES
- -------------------
The amortized cost and estimated fair value of available-for-sale
securities at December 31, 1998 and 1997, were as follows:
<TABLE>
<CAPTION>
1998
---------------------------------------------------------
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
Obligations of U.S. Government agencies
and corporations $ 18,085,000 $ 158,000 $ 13,000 $ 18,230,000
Mortgage-backed securities 2,426,000 1,000 16,000 2,411,000
U.S. Treasury securities 9,031,000 115,000 0 9,146,000
Other securities 583,000 0 0 583,000
------------ ------------ ------------ ------------
Total available-for-sale securities $ 30,125,000 $ 274,000 $ 29,000 $ 30,370,000
============ ============ ============ ============
1997
---------------------------------------------------------
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
Obligations of U.S. Government agencies
and corporations $ 4,520,000 $ 20,000 $ 2,000 $ 4,538,000
U.S. Treasury securities 16,280,000 40,000 13,000 16,307,000
Mortgage-backed securities 1,066,000 7,000 0 1,073,000
Other securities 583,000 0 0 583,000
------------ ------------ ------------ ------------
Total available-for-sale securities $ 22,449,000 $ 67,000 $ 15,000 $ 22,501,000
============ ============ ============ ============
</TABLE>
-15-
<PAGE>
The amortized cost and estimated fair value of held-to-maturity
securities at December 31, 1998 and 1997, were as follows:
<TABLE>
<CAPTION>
1998
---------------------------------------------------------
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
Obligations of U.S. Government agencies
and corporations $ 43,452,000 $ 49,000 $ 116,000 $ 43,385,000
Mortgage-backed securities 9,697,000 42,000 10,000 9,729,000
U.S. Treasury securities 2,427,000 27,000 0 2,454,000
Obligations of states and political
subdivisions 9,262,000 76,000 0 9,338,000
------------ ------------ ------------ ------------
Total held-to-maturity securities $ 64,838,000 $ 194,000 $ 126,000 $ 64,906,000
============ ============ ============ ============
1997
---------------------------------------------------------
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
Obligations of U.S. Government agencies
and corporations $ 31,584,000 $ 119,000 $ 113,000 $ 31,590,000
U.S. Treasury securities 4,985,000 7,000 0 4,992,000
Mortgage-backed securities 10,549,000 82,000 21,000 10,610,000
Obligations of states and political
subdivisions 175,000 9,000 0 184,000
------------ ------------ ------------ ------------
Total held-to-maturity securities $ 47,293,000 $ 217,000 $ 134,000 $ 47,376,000
============ ============ ============ ============
</TABLE>
The amortized cost and estimated fair value of securities at December
31, 1998, by contractual maturity, are shown below. Expected maturities may
differ from contractual maturities because borrowers may have the right to
call or prepay obligations with or without call or prepayment penalties.
<TABLE>
<CAPTION>
Amortized Estimated
Available-for-sale Securities Cost Fair Value
----------------------------- ------------ ------------
<S> <C> <C>
Due in one year or less $ 5,014,000 $ 5,063,000
Due after one year through five years 22,102,000 22,313,000
Due after five years through ten years 0 0
Due after ten years 583,000 583,000
------------ ------------
27,699,000 27,959,000
Mortgage-backed securities 2,426,000 2,411,000
------------ ------------
Total available-for-sale securities $ 30,125,000 $ 30,370,000
============ ============
Amortized Estimated
Held-to-maturity Securities Cost Fair Value
--------------------------- ------------ -------------
<S> <C> <C>
Due in one year or less $ 7,453,000 $ 7,468,000
Due after one year through five years 38,607,000 38,567,000
Due after five years through ten years 8,079,000 8,124,000
Due after ten years 1,002,000 1,018,000
------------ ------------
55,141,000 55,177,000
Mortgage-backed securities 9,697,000 9,729,000
------------ ------------
Total held-to-maturity securities $ 64,838,000 $ 64,906,000
============ ============
</TABLE>
At December 31, 1998, securities with an amortized cost and estimated
fair value of $17,094,000 and $17,355,000, respectively, were pledged as
collateral for public and trust fund deposits and for other purposes required
or permitted by law. At December 31, 1997, the amortized cost and estimated
fair value of pledged securities were $9,666,000 and $9,650,000,
respectively.
-16-
<PAGE>
During 1998, the Company did not sell any securities prior to marturity.
During 1997, the Company sold available-for-sale securities with a book value
of $193,000 and recorded no gain or loss on such sale. During 1996, the
Company sold available-for-sale securities with a book value of $42,000 and
recorded a $12,000 loss on such sale. In addition, the Company sold held-to-
maturity securities with a book value of $1,198,000 approximately thirty (30)
days prior to their scheduled maturity and recorded a $2,000 gain on such
sale.
NOTE 4: LOANS
- --------------
The composition of loans at December 31, 1998 and 1997, was as follows:
<TABLE>
<CAPTION>
1998 1997
------------ ------------
<S> <C> <C>
Real estate loans $ 71,901,000 $ 44,569,000
Loans to individuals 57,564,000 67,453,000
Commercial and industrial loans 47,551,000 24,184,000
Other loans 9,310,000 6,109,000
------------ ------------
Total loans 186,326,000 142,315,000
Less unearned income 1,766,000 1,462,000
------------ ------------
Total loans, net of unearned income $184,560,000 $140,853,000
============ ============
</TABLE>
Nonperforming assets at December 31, 1998 and 1997, were as follows:
<TABLE>
<CAPTION>
1998 1997
---------- ----------
<S> <C> <C>
Nonaccrual loans $ 238,000 $ 70,000
Accruing loans past due over ninety days 198,000 121,000
Restructured loans 110,000 104,000
Other real estate and other repossessed assets 630,000 739,000
---------- ----------
Total nonperforming assets $1,176,000 $1,034,000
========== ==========
</TABLE>
The amount of interest income that would have been recorded on
nonaccrual loans for the years ended December 31, 1998, 1997 and 1996, based
on the loans' original terms was $12,000, $16,000 and $17,000, respectively.
A total of $1,000 and $2,000 in interest on nonaccrual loans was actually
collected and recorded as income during the year ended December 31, 1998 and
1997, respectively. No interest was collected on such loans and recorded as
income during 1996.
A summary of the activity in the allowance for possible loan losses for
the years ended December 31, 1998, 1997 and 1996, is as follows:
<TABLE>
<CAPTION>
1998 1997 1996
---------- ---------- ----------
<S> <C> <C> <C>
Balance at beginning of year $1,173,000 $ 793,000 $ 759,000
Provision for loan losses 570,000 250,000 201,000
Loans charged off (729,000) (581,000) (389,000)
Recoveries of loans charged off 102,000 316,000 73,000
Bank acquisitions 726,000 395,000 149,000
---------- ---------- ----------
Balance at end of year $1,842,000 $1,173,000 $ 793,000
========== ========== ==========
</TABLE>
NOTE 5: INTANGIBLE ASSETS
- --------------------------
The following is a summary of intangible assets at December 31, 1998 and
1997:
<TABLE>
<CAPTION>
1998 1997
----------- -----------
<S> <C> <C>
Goodwill $ 8,539,000 $ 3,423,000
Core deposit intangible 2,895,000 0
----------- -----------
11,434,000 3,423,000
Less accumulated amortization 603,000 264,000
----------- -----------
Net intangible assets $10,831,000 $ 3,159,000
=========== ===========
</TABLE>
-17-
<PAGE>
NOTE 6: PREMISES AND EQUIPMENT
- -------------------------------
The following is a summary of premises and equipment at December 31,
1998 and 1997:
1998 1997
----------- -----------
Land $ 1,684,000 $ 1,486,000
Buildings and improvements 9,207,000 6,821,000
Furniture and equipment 2,573,000 2,028,000
----------- -----------
13,464,000 10,335,000
Less accumulated depreciation 3,170,000 2,817,000
----------- -----------
Net premises and equipment $10,294,000 $ 7,518,000
=========== ===========
NOTE 7: DEPOSITS
- -----------------
At December 31, 1998 and 1997, interest-bearing time deposits of
$100,000 or more were $49,674,000, and $38,371,000, respectively.
At December 31, 1998, the scheduled maturities of interest-bearing time
deposits was as follows:
Interest-bearing
Time Deposits
-----------------
1999 $ 140,926,000
2000 12,504,000
2001 2,987,000
2002 2,214,000
2003 1,602,000
----------------
Total interest-bearing
time deposits $ 160,233,000
=================
NOTE 8: NOTES PAYABLE
- ----------------------
The Company has a revolving line of credit with the Fort Worth Bank.
Proceeds of $4,300,000 under the $6,500,000 line of credit were used to fund
the purchase of Azle Bancorp on September 22, 1998. These borrowings were
paid off on September 30, 1998, from the proceeds of a $4,500,000 dividend
that was paid to the Company by Azle State. The amount available under the
line of credit was reduced to $1,500,000 on January 5, 1999, and reduces
further to $1,000,000 on October 5, 1999. The line of credit matures on
October 1, 2000, bears interest at the floating prime interest rate of the
Fort Worth Bank (7.75% at December 31, 1998) and is collateralized by 100% of
the stock of Independent Financial and First State. There was no balance
outstanding under the line of credit at December 31, 1998.
At December 31, 1998, First State had a $1,000 note payable to an
individual which matures in March 1999. Principal, plus interest at 7.5%, is
payable monthly. The note is collateralized by a two-story commercial
building in Abilene, Texas.
The Company had a note payable to the Amarillo Bank. The note, proceeds
of which were used to help fund the purchase of Crown Park, originated on
January 23, 1997, in the amount of $800,000. The balance was reduced to
$200,000 by July 23, 1997. The note bore interest at the Amarillo Bank's
floating base rate plus 1% and was collateralized by 100% of the stock of
First State. On December 31, 1997, the Company paid off the remaining
principal balance of the note.
At December 31, 1997, the Company had a note payable to one current
director of the Company with a balance of $50,000. The note had an original
face amount of $152,000, but was discounted upon issuance because it bore
interest at a below-market interest rate (6%). The note was payable in three
equal annual installments, plus accrued interest beginning March 1, 1996. The
note was paid off on January 2, 1998. The note represented a portion of the
final settlement of certain litigation.
NOTE 9: FEDERAL INCOME TAXES
- -----------------------------
Due to the fact that the Company effected a quasi-reorganization as of
December 31, 1989, utilization of any of the Company's net operating loss
carryforwards subsequent to that date will not be credited to future income.
For periods subsequent to December 31, 1994, the effect of such utilization
has been credited against the Company's gross
-18-
<PAGE>
deferred tax asset. The Company's deferred tax provision for 1998, 1997 and
1996 totaled $488,000, $772,000 and $677,000, respectively.
Significant components of the Company's deferred tax assets and
liabilities at December 31, 1998 and 1997, were as follows:
<TABLE>
<CAPTION>
1998 1997
------------ ------------
<S> <C> <C>
Deferred tax assets:
Tax credit carryforwards $ 527,000 $ 998,000
Net operating loss carryforwards 211,000 238,000
Retirement plan 228,000 0
Allowance for possible loan losses 67,000 265,000
Other real estate and other repossessed assets 55,000 115,000
Director indemnification 0 17,000
------------ ------------
Total gross deferred tax assets 1,088,000 1,633,000
Less valuation allowance for deferred tax assets (132,000) (167,000)
------------ ------------
Net deferred tax assets 956,000 1,466,000
------------ ------------
Deferred tax liabilities:
Depreciation and amortization (257,000) (93,000)
Net unrealized gain on available-for-sale securities (83,000) (17,000)
Other, net (108,000) (74,000)
------------ ------------
Total gross deferred tax liabilities (448,000) (184,000)
------------ ------------
Net deferred tax asset $ 508,000 $ 1,282,000
============ ============
</TABLE>
Deferred income taxes reflect the net effects of temporary differences
between the carrying amount of assets and liabilities for financial reporting
purposes and the amounts used for income tax purposes. As a result of the
acquisition of Peoples National Bank in Winters, Texas ("Peoples National")
in 1996, the Company increased its gross deferred tax asset and the related
valuation allowance by $162,000. The Company decreased the valuation
allowance relating to Peoples National and Winters State Bank, Winters, Texas
("Winters State"), which was acquired in 1993, by $35,000 and $112,000 during
1998 and 1997, respectively, based on the Company's trend of positive
operating results. The Company may reduce or increase its valuation allowance
depending on changes in the expectation of future earnings and other
circumstances. Management believes that it is more likely than not that the
Company will generate sufficient future taxable income to realize the
deferred tax asset less the related valuation allowance.
At December 31, 1998, the Company had available net operating loss
carryforwards of approximately $335,000 acquired as part of the Winters State
acquisition and approximately $325,000 acquired as part of the Peoples
National acquisition. For federal income tax purposes, due to certain change
of ownership requirements of the Internal Revenue Code, utilization of the
Winters State and Peoples National net operating loss carryforwards are
limited to approximately $37,000 per year and $42,000 per year, respectively.
If the full amount of these limitations is not used in any year, the amount
not used increases the allowable limit in the subsequent year. These net
operating loss carryforwards, if not used, expire between 2003 and 2010.
At December 31, 1998, the Company had available general business credit
and alternative minimum tax credit carryforwards of approximately $17,000 and
$510,000, respectively. If not utilized, the general business credit
carryforwards will expire as follows: 1999-$6,000 and 2000-$11,000. The
alternative minimum tax credit will carryforward until utilized to reduce
future federal income taxes.
The comprehensive provisions for federal income taxes for the years
ended December 31, 1998, 1997 and 1996, consist of the following:
<TABLE>
<CAPTION>
1998 1997 1996
----------- ----------- -----------
<S> <C> <C> <C>
Current tax provision $ 705,000 $ 205,000 $ 76,000
Deferred tax provision 488,000 772,000 677,000
----------- ----------- -----------
Provision for tax expense charged to
results of operations 1,193,000 977,000 753,000
Tax (benefit) on adjustment to unrealized
gain/loss on available-for-sale securities 67,000 3,000 (23,000)
----------- ----------- -----------
Comprehensive provision for
federal income taxes $ 1,260,000 $ 980,000 $ 730,000
=========== =========== ===========
</TABLE>
-19-
<PAGE>
NOTE 10: GUARANTEED PREFERRED BENEFICIAL INTERESTS IN THE COMPANY'S
SUBORDINATED DEBENTURES
- -------------------------------------------------------------------
Independent Capital sold 1,300,000 of Trust Preferred Securities at
$10.00 per preferred security in the 1998 Offering. The proceeds from the
sale of the Trust Preferred Securities were used by Independent Capital to
purchase an equivalent amount of Subordinated Debentures of the Company. The
Trust Preferred Securities carry a distribution rate of 8.5%, have a stated
maturity of September 22, 2028, and are guaranteed by the Company. The
securities are redeemable at par after September 22, 2003, and can be
redeemed during the first five years after issuance for a premium to par.
Distributions on the Trust Preferred Securities are payable quarterly on
March 31, June 30, September 30 and December 31. Distributions paid during
the year ended December 31, 1998, totaled $304,000.
NOTE 11: STOCKHOLDERS' EQUITY
- ------------------------------
The Company's Series C Cumulative Convertible Preferred Stock (the
"Series C Preferred Stock") pays quarterly dividends at the annual rate of
$4.20 per share, is senior to the Common Stock with respect to dividends and
liquidation rights, is convertible into Common Stock at a price of $1.83 per
share, adjusted for stock dividends, and has certain voting rights if
dividends are in arrears for three quarters. The Series C Preferred Stock is
redeemable in cash and/or Common Stock at the Company's option at $42.00 per
share.
An additional 388,911 shares of Common Stock were issued as a result of
the 5-for-4 stock split, effected in the form of a 25% stock dividend, paid
to stockholders in May 1997. The stock dividend was accounted for by a
transfer from retained earnings to common stock of $97,000, representing the
above respective number of shares at a par value of $0.25 per share. Cash
paid in lieu of fractional shares was transferred from additional paid-in
capital.
All references throughout these consolidated financial statements to the
number of shares of Common Stock, per share amounts, stock option data and
market prices of the Common Stock have been restated for stock dividends.
The following are summaries of the number of shares of Series C
Preferred Stock, the number of shares of Common Stock reserved for issuance
upon conversion of Series C Preferred Stock and the related conversion price
per share, adjusted for stock dividends, for the three years ended December
31, 1998:
<TABLE>
<CAPTION>
Shares Conversion
Reserved for Price
Series C Preferred Stock Issuance Per Share
------------------------ ------------ -------------
<S> <C> <C>
Balance January 1, 1996 302,010 $ 2.29
Shares Converted (54,352) 0
-------- -------
Balance December 31, 1996 247,658 2.29
5-for-4 Stock Split 28,697 (0.46)
Shares Converted (147,959) 0
-------- -------
Balance December 31, 1997 128,396 1.83
Shares Converted (12,033) 0
-------- -------
Balance December 31, 1998 116,363 $ 1.83
======== =======
</TABLE>
The Company's Employee Stock Ownership/401(k) Plan (the "ESOP/401(k)
Plan") purchased 18,750 shares of the Company's Common Stock in the 1997
Offering for $214,000. The funds used for the purchase were borrowed from the
Company. The note evidencing such borrowing is due in eighty-four equal
monthly installments of $4,000, including interest, and matures on February
27, 2004. The note bears interest at the Company's floating base rate plus 1%
(8.75% at December 31, 1998). The note is collateralized by the stock
purchased in the stock offering.
As a result of the lending arrangement between the Company and the
ESOP/401(k) Plan, the shares are considered "unearned." The shares are
"earned" on a pro rata basis as principal payments are made on the note used
to purchase the shares. The shares are included in the Company's earnings per
share calculations only as they are earned. At December 31, 1998, a total
14,839 shares with an original cost of $169,000 are considered to be
unearned.
-20-
<PAGE>
NOTE 12: EARNINGS PER SHARE
- ----------------------------
Basic earnings per common share is computed by dividing net income
available to common stockholders by the weighted average number of common
shares outstanding during the period. Because the Company's outstanding
Series C Preferred Stock is cumulative, the dividends allocable to such
preferred stock reduces income available to common stockholders in the basic
earnings per share calculations. In computing diluted earnings per common
share for the years ended December 31, 1998, 1997 and 1996, the conversion of
the Series C Preferred Stock and the exercise of any outstanding stock
options were assumed, as the effects are dilutive. The following table
presents information necessary to calculate earnings per share for the years
ended December 31, 1998, 1997 and 1996 (adjusted for the 5-for-4 stock split,
effected in the form of a 25% stock dividend, paid to stockholders in May
1997):
<TABLE>
<CAPTION>
Year Ended December 31,
----------------------------------------
1998 1997 1996
---------- ---------- ----------
Basic Earnings Per Common Share (In thousands)
- -------------------------------
<S> <C> <C> <C>
Net income $ 2,188 $ 2,110 $ 1,422
Preferred stock dividends (22) (41) (63)
---------- ---------- ----------
Net income available to common stockholders $ 2,166 $ 2,069 $ 1,359
========== ========== ==========
Weighted average shares outstanding 2,031 1,842 1,355
========== ========== ==========
Year Ended December 31,
----------------------------------------
1998 1997 1996
---------- ---------- ----------
Diluted Earnings Per Common Share (In thousands)
- ---------------------------------
<S> <C> <C> <C>
Net income $ 2,188 $ 2,110 $ 1,422
========== ========== ==========
Weighted average shares outstanding 2,031 1,842 1,355
Exercise of stock options 0 9 8
Conversion of Series C Preferred Stock 120 197 335
---------- ----------- ----------
Adjusted weighted average shares outstanding 2,151 2,048 1,698
========== =========== ==========
</TABLE>
NOTE 13: BENEFIT PLANS
- -----------------------
The Company's ESOP/401(k) Plan covers most of its officers and
employees. The ESOP/401(k) Plan stipulates, among other things, that vesting
in employer contributions begins after one year of service, each participant
will become fully vested in employer contributions after seven years of
service and the determination of the level of vesting began with the original
date of current employment of each participant with the Company or the Banks.
Contributions made to the employee stock ownership portion of the ESOP/401(k)
Plan by the Company were $106,000, $100,000 and $77,000 for the years ended
December 31, 1998, 1997 and 1996, respectively. These contributions were used
to make distributions to employees who left the Company's employment in the
respective years and to purchase Common Stock of the Company. No
contributions have been made by the Company to match contributions made by
plan participants in the 401(k) portion of the ESOP/401(k) Plan. The amount
of all such contributions is at the discretion of the Company's board of
directors. Employee contributions are invested in various equity, debt and
money market investments, including Common Stock of the Company. At December
31, 1998, 157,059 shares of Common Stock of the Company were held by the
ESOP/401(k) Plan.
NOTE 14: RELATED PARTY TRANSACTIONS
- ------------------------------------
In the ordinary course of business, the Company and the Banks have
loans, deposits and other transactions with their respective directors and
businesses with which such persons are associated. It is the Company's policy
that all such transactions are entered into on substantially the same terms
as those prevailing at the time for comparable transactions with unrelated
third parties. The balances of loans to all such persons were $3,880,000,
$2,511,000 and $3,025,000 at December 31, 1998, 1997 and 1996, respectively.
Additions and reductions on such loans were $4,338,000 and $2,969,000,
respectively, for the year ended December 31, 1998.
The Company and its subsidiaries paid $39,000, $42,000 and $28,000 in
fees to a director-related company for services rendered on various legal
matters during 1998, 1997 and 1996, respectively.
-21-
<PAGE>
NOTE 15: COMMITMENTS AND CONTINGENT LIABILITIES
- ------------------------------------------------
The Company is involved in various litigation proceedings incidental to
the ordinary course of business. In the opinion of management, the ultimate
liability, if any, resulting from such other litigation would not be material
in relation to the Company's financial condition, results of operations and
liquidity.
The Banks lease certain of their premises and equipment under
noncancellable operating leases. Rental expense under such operating leases
was approximately $322,000, $289,000 and $336,000 in 1998, 1997 and 1996,
respectively.
The minimum payments due under these leases at December 31, 1998, are as
follows:
1999 $ 404,000
2000 403,000
2001 364,000
2002 327,000
2003 121,000
-----------
Total $ 1,619,000
===========
NOTE 16: FAIR VALUE OF FINANCIAL INSTRUMENTS
- ---------------------------------------------
The carrying amounts and fair values of financial assets and financial
liabilities at December 31, 1998 and 1997, were as follows:
<TABLE>
<CAPTION>
1998 1997
--------------------------- ---------------------------
Carrying Carrying
Amount Fair Value Amount Fair Value
Financial Assets ------------ ------------ ------------ ------------
----------------
<S> <C> <C> <C> <C>
Cash and due from banks $ 22,562,000 $ 22,562,000 $ 14,518,000 $ 14,518,000
Federal funds sold 42,175,000 42,175,000 24,900,000 24,900,000
Available-for-sale securities 30,370,000 30,370,000 22,501,000 22,501,000
Held-to-maturity securities 64,838,000 64,906,000 47,293,000 47,376,000
Loans, net of unearned income 184,560,000 186,194,000 140,853,000 143,744,000
Accrued interest receivable 3,254,000 3,254,000 2,208,000 2,208,000
Financial Liabilities
---------------------
Noninterest-bearing demand deposits $ 60,086,000 $ 60,086,000 $ 43,868,000 $ 43,868,000
Interest-bearing demand deposits 110,485,000 110,485,000 77,495,000 77,495,000
Interest-bearing time deposits 160,233,000 161,035,000 121,438,000 121,724,000
Accrued interest payable 1,163,000 1,163,000 947,000 947,000
Notes payable 1,000 1,000 57,000 57,000
Guaranteed preferred beneficial
interests in the Company's
subordinated debentures 13,000,000 13,000,000 - -
</TABLE>
Fair values for investment securities are based on quoted market prices,
where available. If quoted market prices are not available, fair values are
based on quoted market prices of comparable instruments.
For variable-rate loans that reprice frequently with no significant
change in credit risk, fair values are based on carrying values. The fair
values of other loans are estimated using discounted cash flow analyses,
which utilize interest rates currently being offered for loans with similar
terms to borrowers of similar credit quality.
The fair values of noninterest and interest-bearing demand deposits are,
by definition, equal to the amount payable on demand, i.e., their carrying
amount. The fair values of interest-bearing time deposits are estimated using
a discounted cash flow calculation that applies interest rates currently
being offered on certificates of similar maturities.
Fair value for the guaranteed preferred beneficial interests in the
Company's subordinated debentures is based on the closing price for the Trust
Preferred Securities as quoted on the American Stock Exchange at December 31,
1998.
-22-
<PAGE>
The carrying amounts for cash and due from banks, federal funds sold,
accrued interest receivable, accrued interest payable, notes payable and
approximate the fair values of such assets and liabilities.
Fair values for the Company's off-balance-sheet instruments, which
consist of lending commitments and standby and commercial letters of credit,
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. Management believes that the fair value of these off-
balance-sheet instruments is not materially different from the commitment
amount.
NOTE 17: FINANCIAL INSTRUMENTS WITH OFF-BALANCE-SHEET RISK
- -----------------------------------------------------------
The Company is a party to financial instruments with off-balance-sheet
risk entered into in the normal course of business to meet the financing
needs of its customers. These financial instruments include commitments to
extend credit and standby and commercial letters of credit. Those instruments
involve, to varying degrees, elements of credit risk in excess of the amount
recognized in the accompanying financial statements. The contractual amounts
of those instruments reflect the extent of involvement the Company has in
particular classes of financial instruments.
The Company's exposure to credit loss in the event of nonperformance by
the other party to the financial instrument for commitments to extend credit
or standby or commercial letters of credit is represented by the contractual
amount of those instruments. The Company uses the same credit policies in
making commitments and conditional obligations as it does for on-balance-
sheet instruments. Unless noted otherwise, the Company does not require
collateral or other security to support financial instruments with credit
risk. The Company had outstanding loan commitments of approximately
$19,606,000 and outstanding standby and commercial letters of credit of
approximately $206,000 at December 31, 1998.
Commitments to extend credit are agreements to lend to a customer as
long as there is no violation of any condition established in the contract.
Commitments generally have fixed expiration dates or other termination
clauses and may require payment of a fee. Because many of the commitments are
expected to expire without being drawn upon, the total commitment amounts do
not necessarily represent future cash requirements. The Company evaluates
each customer's creditworthiness 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 customer.
Collateral held varies but may include real estate, accounts receivable,
inventory, property, plant and equipment and income-producing commercial
properties.
Standby and commercial letters of credit are conditional commitments
issued by the Company to guarantee the performance of a customer to a third
party. These guarantees are primarily issued to support public and private
borrowing arrangements. The credit risk involved in issuing standby or
commercial letters of credit is essentially the same as that involved in
making loans to customers.
The Company does not expect any material losses as a result of loan
commitments or standby or commercial letters of credit that were outstanding
at December 31, 1998.
In the normal course of business, the Company maintains deposits with
other financial institutions in amounts which exceed FDIC insurance coverage
limits.
NOTE 18: REGULATORY MATTERS
- ----------------------------
The Company and the Banks are subject to various regulatory capital
requirements administered by the federal banking agencies. Failure to meet
minimum capital requirements could cause the initiation of certain mandatory,
and possibly additional discretionary, actions by the regulatory authorities
that, if undertaken, could have a direct material effect on the Company's and
each of the Banks' respective financial statements. Under capital adequacy
guidelines and the regulatory framework for prompt corrective action, the
Company and each of the Banks must meet specific capital guidelines that
involve quantitative measures of the Company's and each Banks' respective
assets, liabilities, and certain off-balance-sheet items as calculated under
regulatory accounting practices. The Company's and each Banks' respective
capital amounts and classification are also subject to qualitative judgments
by the regulators about components, risk weightings and other factors.
Quantitative measures established by regulation to ensure capital
adequacy require the Company and each of the Banks to maintain minimum
amounts and ratios (set forth in the table below) of Tier 1 capital and total
capital (Tier 1 and Tier 2) to risk-weighted assets and of Tier 1 capital to
adjusted quarterly average assets. At December 31, 1998, the Company and the
Banks met all capital adequacy requirements to which they were subject.
At December 31, 1998, the most recent notifications from the FDIC
categorized the Banks as well capitalized under the regulatory framework for
prompt corrective action. To be categorized as well capitalized, the Company
and
-23-
<PAGE>
the Banks must maintain minimum Tier 1 capital to risk-weighted assets, total
capital to risk-weighted assets and Tier 1 capital to adjusted quarterly
average assets ratios as set forth in the tables. There are no other
conditions or events since the most recent notification that management
believes have changed either the Company's or any of the Banks' category.
The minimum regulatory capital ratios, minimum capital ratios for well
capitalized bank holding companies and the Company's actual capital amounts
and ratios at December 31, 1998 and 1997, were as follows:
<TABLE>
<CAPTION>
December 31, Minimum Well
------------------------ Capital Capitalized
1998 1997 Ratios Ratios
--------- --------- ------- -----------
(Dollars in thousands)
<S> <C> <C> <C> <C>
Tier 1 capital $ 21,344 $ 17,737
Total capital 28,356 18,510
Risk-weighted assets 205,971 154,036
Adjusted quarterly average assets 357,815 258,496
Capital ratios:
Tier 1 capital to risk-weighted assets 10.36% 11.26% 4.00% 6.00%
Total capital to risk-weighted assets 13.77 12.02 8.00 10.00
Tier 1 capital to adjusted quarterly average
assets 5.97 6.71 4.00 5.00
</TABLE>
The minimum capital ratios for well capitalized banks and the Banks'
actual capital ratios at December 31, 1998, were as follows:
<TABLE>
<CAPTION>
Minimum
Ratios for Well Actual Ratios at
Capitalized Banks December 31, 1998
----------------- -----------------
<S> <C> <C>
Tier 1 capital to risk-weighted assets 6.00% 11.46-12.04%
Total capital to risk-weighted assets 10.00 12.21-13.22
Tier 1 capital to adjusted quarterly average assets 5.00 6.77-7.53
</TABLE>
At December 31, 1998, retained earnings of the Banks included
approximately $4,254,000 that was available for payment of dividends to the
Company without prior approval of regulatory authorities.
-24-
<PAGE>
NOTE 19: PARENT COMPANY FINANCIAL INFORMATION
- ----------------------------------------------
Condensed financial statements of the Company, parent only, are
presented below:
INDEPENDENT BANKSHARES, INC.
CONDENSED BALANCE SHEETS
DECEMBER 31, 1998 AND 1997
<TABLE>
<CAPTION>
1998 1997
------------ ------------
<S> <C> <C>
Assets:
Cash $ 550,000 $ 326,000
Loans 65,000 0
Investment in subsidiaries 36,314,000 19,125,000
Premises and equipment 0 2,000
Other assets 1,033,000 1,214,000
------------ ------------
Total assets $ 37,962,000 $ 20,667,000
============ ============
Liabilities:
Note payable $ 0 $ 50,000
Accrued interest payable and other liabilities 55,000 90,000
------------ ------------
Total liabilities 55,000 140,000
Subordinated debentures 13,402,000 0
Stockholders' equity 24,505,000 20,527,000
------------ ------------
Total liabilities and stockholders' equity $ 37,962,000 $ 20,667,000
============ ============
</TABLE>
INDEPENDENT BANKSHARES, INC.
CONDENSED INCOME STATEMENTS
YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
<TABLE>
<CAPTION>
1998 1997 1996
------------ ------------ ------------
<S> <C> <C> <C>
Income:
Dividends from subsidiaries (see Note 18) $ 5,259,000 $ 900,000 $ 1,000,000
Management fees from subsidiaries 145,000 150,000 161,000
Interest on loan to the ESOP/401(k) Plan 23,000 18,000 0
Interest from subsidiaries 6,000 1,000 3,000
Other income 11,000 0 0
------------ ------------ ------------
Total income 5,444,000 1,069,000 1,164,000
------------ ------------ ------------
Expenses:
Interest 321,000 33,000 58,000
Other expenses 680,000 570,000 557,000
------------ ------------ ------------
Total expenses 1,001,000 603,000 615,000
------------ ------------ ------------
Income before federal income taxes and equity in
undistributed earnings of subsidiaries 4,443,000 466,000 549,000
Federal income tax benefit (93,000) (276,000) (162,000)
------------ ------------ ------------
Income before equity in undistributed
earnings of subsidiaries 4,536,000 742,000 711,000
Equity in undistributed earnings of subsidiaries (2,348,000) 1,368,000 711,000
------------ ------------ ------------
Net income $ 2,188,000 $ 2,110,000 $ 1,422,000
============ ============ ============
</TABLE>
-25-
<PAGE>
INDEPENDENT BANKSHARES, INC.
CONDENSED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
<TABLE>
<CAPTION>
1998 1997 1996
------------ ------------ ------------
<S> <C> <C> <C>
Cash flows from operating activities:
Net income $ 2,188,000 $ 2,110,000 $ 1,422,000
Adjustments to reconcile net income to net cash
provided by operating activities:
Deferred federal income tax expense 488,000 772,000 677,000
Depreciation and amortization 2,000 1,000 1,000
Equity in undistributed earnings of subsidiaries 2,348,000 (1,368,000) (711,000)
Increase in other assets (398,000) (197,000) (540,000)
Increase (decrease) in accrued interest payable
and other liabilities 76,000 (231,000) (16,000)
------------ ------------ ------------
Net cash provided by operating activities 4,704,000 1,087,000 833,000
------------ ------------ ------------
Cash flows from investing activities:
Loans made to employee stock ownership plan (95,000) (239,000) 0
Proceeds from repayments of loans made to
employee stock ownership plan 54,000 46,000 0
Purchase of subsidiary bank (19,025,000) 0 0
Capital contributions made to subsidiaries (402,000) (4,200,000) 0
------------ ------------ ------------
Net cash used in investing activities (19,468,000) (4,393,000) 0
------------ ------------ ------------
Cash flows from financing activities:
Proceeds from notes payable 4,300,000 800,000 0
Repayment of notes payable (4,350,000) (983,000) (616,000)
Proceeds from issuance of subordinated debentures 13,402,000 0 0
Net proceeds from issuance of equity securities 2,067,000 4,077,000 0
Cash paid for fractional shares in stock dividend 0 (5,000) 0
Payment of cash dividends (431,000) (405,000) (260,000)
------------ ------------ ------------
Net cash provided by (used in) financing activities 14,988,000 3,484,000 (876,000)
------------ ------------ ------------
Net increase (decrease) in cash and cash equivalents 224,000 178,000 (43,000)
Cash and cash equivalents at beginning of year 326,000 148,000 191,000
------------ ------------ ------------
Cash and cash equivalents at end of year $ 550,000 $ 326,000 $ 148,000
============ ============ ============
</TABLE>
NOTE 20: SUPPLEMENTAL CASH FLOW INFORMATION
- --------------------------------------------
Supplemental cash flow information for the years ended December 31,
1998, 1997 and 1996, is as follows:
<TABLE>
<CAPTION>
1998 1997 1996
------------ ------------ ------------
<S> <C> <C> <C>
Cash paid during the year for:
Interest $ 9,368,000 $ 8,663,000 $ 6,372,000
Federal income taxes 630,000 670,000 438,000
Noncash investing activities:
Additions to other real estate and other repossessed assets
during the year through foreclosures $ 1,433,000 $ 1,283,000 $ 1,015,000
Sales of other real estate and other repossessed assets
financed with loans 167,000 93,000 240,000
Increase (decrease) in unrealized gain on
available-for-sale securities, net of tax $ 130,000 $ 6,000 $ (43,000)
Details of acquisitions:
Cash paid in acquisitions $ 19,025,000 $ 7,510,000 $ 1,505,000
Cash and cash equivalents held by companies acquired
at dates of acquisition (8,892,000) (6,274,000) (15,708,000)
------------ ------------ ------------
Net cash paid (acquired) in acquisitions $ 10,133,000 $ 1,236,000 $(14,203,000)
============ ============ ============
-26-
<PAGE>
QUARTERLY DATA (UNAUDITED)
- -------------------------
The following table presents the unaudited results of operations for the
past two years by quarter. See "Note 12: Earnings Per Share" in the Company's
Consolidated Financial Statements.
</TABLE>
<TABLE>
<CAPTION>
1998
------------------------------------------------
First Second Third Fourth
Quarter Quarter Quarter Quarter Total
-------- -------- -------- -------- --------
(In thousands, except per share amounts)
<S> <C> <C> <C> <C> <C>
Interest income $ 4,575 $ 4,649 $ 4,872 $ 6,338 $ 20,434
Interest expense 2,153 2,134 2,196 2,793 9,276
Net interest income 2,422 2,515 2,676 3,545 11,158
Provision for loan losses 175 125 135 135 570
Income before federal income taxes 723 814 890 954 3,381
Net income 455 519 568 646 2,188
Basic earnings per common share
available to common stockholders $ 0.23 $ 0.26 $ 0.28 $ 0.30 $ 1.07
Diluted earnings per common share
available to common stockholders 0.22 0.25 0.27 0.28 1.02
1997
-------------------------------------------------
First Second Third Fourth
Quarter Quarter Quarter Quarter Total
-------- -------- -------- -------- ---------
(In thousands, except per share amounts)
<S> <C> <C> <C> <C> <C>
Interest income $ 4,296 $ 4,678 $ 4,678 $ 4,672 $ 18,324
Interest expense 2,056 2,193 2,204 2,206 8,659
Net interest income 2,240 2,485 2,474 2,466 9,665
Provision for loan losses 0 60 150 40 250
Income before federal income taxes 772 821 698 796 3,087
Net income 493 562 550 505 2,110
Basic earnings per common share
available to common stockholders $ 0.29 $ 0.30 $ 0.27 $ 0.26 $ 1.12
Diluted earnings per common share
available to common stockholders 0.26 0.27 0.26 0.24 1.03
</TABLE>
The above unaudited financial information reflects all adjustments that
are, in the opinion of management, necessary to present a fair statement of
the results of operations for the interim periods presented.
-27-
<PAGE>
SELECTED CONSOLIDATED FINANCIAL INFORMATION
The following table presents selected consolidated financial information
for the last five years. Such financial information has been restated to
reflect the 4-for-3 stock split, effected in the form of a 33-1/3% stock
dividend, paid to stockholders in May 1995 and the 5-for-4 stock split,
effected in the form of a 25% stock dividend, paid to stockholders in May
1997. See "Note 1: Summary of Significant Accounting Policies-Principles of
Consolidation," "Note 2: Bank Acquisitions," Note 12: Earnings Per Share" and
the Other Notes in the Company's Consolidated Financial Statements for an
explanation of changes in financial statement items.
<TABLE>
<CAPTION>
1998 1997 1996 1995 1994
----------- ----------- ----------- ----------- -----------
(In thousands, except per share amounts)
<S> <C> <C> <C> <C> <C>
Balance sheet information:
Assets $ 370,178 $ 264,574 $ 205,698 $ 180,344 $ 159,860
Loans, net of unearned income 184,560 140,853 92,017 81,927 81,306
Deposits 330,804 242,801 189,575 164,704 146,184
Notes payable 1 57 240 849 930
Stockholders' equity 24,505 20,527 14,937 13,818 11,073
Income statement information:
Total interest income $ 20,434 $ 18,324 $ 13,556 $ 11,962 $ 10,131
Net interest income 11,158 9,665 7,115 6,653 6,679
Net income 2,188 2,110 1,422 1,132 450
Basic earnings per common share
available to common stockholders $ 1.07 $ 1.12 $ 1.00 $ 0.82 $ 0.29
Diluted earnings per common share
available to common stockholders 1.02 1.03 0.84 0.67 0.27
Cash dividends per common share 0.20 0.19 0.14 0.09 0.06
Weighted average common shares
outstanding:
Basic 2,031 1,842 1,355 1,299 1,302
Diluted 2,151 2,048 1,698 1,689 1,685
</TABLE>
-28-
<PAGE>
MARKET INFORMATION
The Company's Common Stock trades on the American Stock Exchange (the
"AMEX") under the symbol "IBK." Independent Capital's Trust Preferred
Securities trade on the AMEX under the symbol "IBK.Pr." The following table
sets forth, for the periods indicated, the high and low sales prices for the
Common Stock and Trust Preferred Securities as quoted on the AMEX and the
amount of cash dividends and distributions paid per share, adjusted for the
5-for-4 stock split of the Common Stock, effected in the form of a 25% stock
dividend, paid to stockholders in May 1997.
<TABLE>
<CAPTION>
Common Stock Trust Preferred Securities
----------------------------- ---------------------------------
Cash Distributions
Dividends Per
High Low Per Share High Low Security
------- ------- --------- ------ ------ --------------
Year Ended December 31, 1997
----------------------------
<S> <C> <C> <C> <C> <C> <C>
First Quarter $13-5/8 $11-1/2 $0.04 $ - $ - $ -
Second Quarter 13-1/4 11-13/16 0.05 - - -
Third Quarter 18-1/4 13-1/8 0.05 - - -
Fourth Quarter 19-3/4 16-1/8 0.05 - - -
Year Ended December 31, 1998
----------------------------
First Quarter $19-5/8 $15-3/4 $0.05 $ - $ - $ -
Second Quarter 19 14-3/8 0.05 - - -
Third Quarter 15-9/16 11 0.05 10-1/16 10-1/16 -
Fourth Quarter 11-7/8 10-1/4 0.05 10-3/4 9-1/2 0.23
Year Ending December 31, 1999
-----------------------------
First Quarter (through March 18) $12-1/8 $10-1/2 $0.05(1) 10-7/8 9-1/2 0.21(2)
_____________
(1) This cash dividend was paid February 26, 1999, to shareholders of record
on February 12, 1999.
(2) This distribution is scheduled to be paid on March 31, 1999, to security
holders of record on such date.
At March 18, 1999, there were approximately 1,777 stockholders who were
individual participants in security position listings.
</TABLE>
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<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Forward-looking Statements - Cautionary Statements
- --------------------------------------------------
THIS REPORT CONTAINS CERTAIN FORWARD-LOOKING STATEMENTS AND INFORMATION
RELATING TO INDEPENDENT BANKSHARES, INC. (THE "COMPANY") AND ITS SUBSIDIARIES
THAT ARE BASED ON THE BELIEFS OF THE COMPANY'S MANAGEMENT AS WELL AS
ASSUMPTIONS MADE BY AND INFORMATION CURRENTLY AVAILABLE TO THE COMPANY'S
MANAGEMENT. WHEN USED IN THIS REPORT, THE WORDS "ANTICIPATE," "BELIEVE,"
"ESTIMATE," "EXPECT" AND "INTEND" AND WORDS OR PHRASES OF SIMILAR IMPORT, AS
THEY RELATE TO THE COMPANY OR ITS SUBSIDIARIES OR COMPANY MANAGEMENT, ARE
INTENDED TO IDENTIFY FORWARD-LOOKING STATEMENTS. SUCH STATEMENTS REFLECT THE
CURRENT VIEW OF THE COMPANY WITH RESPECT TO FUTURE EVENTS AND ARE SUBJECT TO
CERTAIN RISKS, UNCERTAINTIES AND ASSUMPTIONS RELATED TO CERTAIN FACTORS
INCLUDING, WITHOUT LIMITATION, COMPETITIVE FACTORS, GENERAL ECONOMIC
CONDITIONS, CUSTOMER RELATIONS, THE INTEREST RATE ENVIRONMENT, GOVERNMENTAL
REGULATION AND SUPERVISION, NONPERFORMING ASSET LEVELS, LOAN CONCENTRATIONS,
CHANGES IN INDUSTRY PRACTICES, ONE TIME EVENTS AND OTHER FACTORS DESCRIBED
HEREIN. BASED UPON CHANGING CONDITIONS, SHOULD ANY ONE OR MORE OF THESE RISKS
OR UNCERTAINTIES MATERIALIZE, OR SHOULD ANY UNDERLYING ASSUMPTIONS PROVE
INCORRECT, ACTUAL RESULTS MAY VARY MATERIALLY FROM THOSE DESCRIBED HEREIN AS
ANTICIPATED, BELIEVED, ESTIMATED, EXPECTED OR INTENDED. THE COMPANY DOES NOT
INTEND TO UPDATE THESE FORWARD-LOOKING STATEMENTS.
The Company
- -----------
The Company is a bank holding company headquartered in Abilene, Texas.
The Company owns all of the common securities of Independent Capital Trust
("Independent Capital") and indirectly owns through a Delaware subsidiary,
Independent Financial Corp. ("Independent Financial"), 100% of the stock of
First State Bank, N.A., Abilene, Texas ("First State") and Azle State Bank,
Azle, Texas ("Azle State") (collectively, the "Banks"). The Banks currently
operate full-service banking locations in the Texas cities of Abilene (3
locations), Azle (2 locations), Lubbock, Odessa (4 locations), San Angelo,
Stamford and Winters. On March 12, 1999, Azle State was merged with and into
First State and Azle State's two locations became branches of First State.
General
- -------
The following discussion and analysis presents the more significant
factors affecting the Company's financial condition at December 31, 1998 and
1997, and results of operations for each of the three years in the period
ended December 31, 1998, after accounting for the acquisition of the
subsidiary banks noted below. This discussion and analysis should be read in
conjunction with the Company's Consolidated Financial Statements, notes
thereto and other financial information appearing elsewhere in this annual
report. All references herein to the number of shares of Common Stock, per
share amounts and market prices of the Common Stock have been restated for
the stock split, effected in the form of a stock dividend, described in Note
11 to the Company's Consolidated Financial Statements.
Bank Acquisitions
- -----------------
AZLE BANCORP AND AZLE STATE. The Company completed the acquisition of
Azle Bancorp and its subsidiary bank, Azle State, effective September 22,
1998, for an aggregate cash consideration of $19,025,000. To obtain funding
for the acquisition, the Company sold an aggregate of 230,000 shares of
Common Stock at a price of $11.50 per share, and Independent Capital, a
Delaware business trust formed by the Company, sold 1,300,000 of its 8.5%
Cumulative Trust Preferred Securities (the "Trust Preferred Securities") at
$10.00 per preferred security (having a liquidation value of $13,000,000) in
an underwritten offering (collectively, the "1998 Offering"). The proceeds
from the sale of the Trust Preferred Securities were used by Independent
Capital to purchase an equivalent amount of Subordinated Debentures of the
Company. The Company also borrowed $4,300,000 from a financial institution in
Fort Worth, Texas (the "Fort Worth Bank") to finance a portion of the cost of
acquiring Azle Bancorp. The borrowings from the Fort Worth Bank were paid off
on September 30, 1998, from the proceeds of a cash dividend paid to the
Company by Azle State. At the date of acquisition, Azle Bancorp had total
assets of $93,158,000, total loans, net of unearned income, of $45,163,000,
total deposits of $80,955,000 and stockholders' equity of $9,872,000. This
acquisition was accounted for using the purchase method of accounting. A
total of $8,014,000 of intangible assets, including $2,895,000 of core
deposit intangible and $5,119,000 of goodwill, was
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<PAGE>
recorded as a result of this acquisition. The core deposit intangible is
being amortized over a period of 12 years and the goodwill is being amortized
over a period of 25 years.
CROWN PARK AND WESTERN NATIONAL. The Company completed the acquisition
of Crown Park Bancshares, Inc. ("Crown Park") and its wholly owned subsidiary
bank, Western National Bank, Lubbock, Texas ("Western National"), effective
January 28, 1997, for an aggregate cash consideration of $7,510,000. On the
acquisition date, Crown Park was merged with and into a wholly owned
subsidiary of the Company and Western National was merged with and into First
State. To obtain funding for the acquisition, the Company sold an aggregate
of 395,312 shares of its common stock ("Common Stock") in an underwritten
offering at a price of $11.40 per share (the "1997 Offering"). The 1997
Offering included the sale of 51,562 shares covered by the underwriter's
over-allotment option. The above number of shares and price per share have
been adjusted for the 5-for-4 stock split, effected in the form of a 25%
stock dividend, paid to the Company's shareholders in May 1997. The Company
borrowed $800,000 from a financial institution in Amarillo, Texas (the
"Amarillo Bank") to finance a portion of the cost of acquiring Crown Park.
The $800,000 of borrowings was reduced to $400,000 with the proceeds of the
sale of the over-allotment shares. The borrowing was paid off on December 31,
1997. At the date of acquisition, Crown Park had total assets of $60,420,000,
total loans, net of unearned income, of $41,688,000, total deposits of
$53,604,000 and stockholders' equity of $4,238,000. This acquisition was
accounted for using the purchase method of accounting. A total of $2,486,000
of goodwill was recorded as a result of this acquisition. Such goodwill is
being amortized over a period of 15 years.
SAN ANGELO BRANCH. On May 27, 1996, First State assumed the deposits and
certain other liabilities and purchased the loans and certain other assets of
the San Angelo, Texas branch of Coastal Banc ssb ("Coastal Banc - San
Angelo") in a cash transaction, and Coastal Banc - San Angelo became a branch
of First State. On the date of the acquisition, Coastal Banc - San Angelo had
approximately $14,895,000 in total deposits and $155,000 in total loans. A
total of $743,000 of goodwill was recorded as a result of this acquisition
and is being amortized over a period of 15 years.
Peoples National. First State completed the acquisition of Peoples
National Bank, Winters, Texas ("Peoples National") effective January 1, 1996,
and Peoples National became part of the Winters branch of First State. At
December 31, 1995, Peoples National had total assets of $5,505,000, total
loans, net of unearned income, of $2,767,000, total deposits of $4,958,000
and stockholders' equity of $525,000. A total of $260,000 of goodwill was
recorded as a result of this acquisition and is being amortized over a period
of 15 years.
These acquisitions were accounted for under the purchase method of
accounting, and the results of operations of Azle State, Western National,
Coastal Banc - San Angelo and Peoples National are included in the Company's
results of operations from their respective dates of purchase. The assets and
liabilities of Azle State, Western National, Coastal Banc - San Angelo and
Peoples National were recorded at their estimated fair value.
Results of Operations
- ---------------------
GENERAL
Net income for the year ended December 31, 1998, amounted to $2,188,000
($1.02 diluted earnings per common share) compared to net income of
$2,110,000 ($1.03 diluted earnings per common share) for the year ended
December 31, 1997, and compared to net income of $1,422,000 ($0.84 diluted
earnings per common share) for the year ended December 31, 1996. The results
of operations for 1998 were negatively impacted by $125,000 ($83,000, net of
tax), or $0.04 diluted earnings per common share, as a result of the
settlement of certain potential litigation.
Two industry measures of the performance by a banking institution are
its return on average assets and return on average stockholders' equity.
Return on average assets ("ROA") measures net income in relation to average
total assets and indicates a company's ability to employ its resources
profitably. During 1998, the Company's ROA was 0.75%, compared to 0.82% for
1997 and compared to 0.72% for 1996. Excluding the nonrecurring item noted
above, the Company's ROA for 1998 would have been 0.77%.
Return on average stockholders' equity ("ROE") is determined by dividing
net income by average stockholders' equity and indicates how effectively a
company can generate net income on the capital invested by its
-31-
<PAGE>
stockholders. During 1998, the Company's ROE was 9.89%, compared to 10.95%
for 1997 and 9.89% for 1996. Excluding the nonrecurring item noted above, the
Company's ROE for 1998 would have been 10.27%.
NET INTEREST INCOME
Net interest income represents the amount by which interest income on
interest-earning assets, including loans and securities, exceeds interest
paid on interest-bearing liabilities, including deposits and other borrowed
funds. Net interest income is the principal source of the Company's earnings.
Interest rate fluctuations, as well as changes in the amount and type of
interest-earning assets and interest-bearing liabilities, combine to affect
net interest income.
Net interest income amounted to $11,158,000 for 1998, an increase of
$1,493,000, or 15.4%, from 1997. Net interest income for 1997 was $9,665,000,
an increase of $2,550,000, or 35.8%, from 1996. The increase in 1998 was
primarily due to the acquisition of Azle State in September 1998. The
increase in 1997 was primarily due to the acquisition of Western National in
January 1997. The net interest margin on a fully taxable-equivalent basis was
4.30% for 1998, compared to 4.13% for 1997 and 3.95% for 1996. The primary
reasons for the increase in net interest margin during 1998 were a small
increase in the Company's average loan-to-deposit ratio, a decrease in the
Company's overall costs of funds and a shift within the loan portfolio to
more commercial and real estate loans and away from lower-yielding indirect
installment loans. The primary reason for the increase in 1997 was the
acquisition of Western National, which had a higher loan-to-deposit ratio
than First State.
At December 31, 1998, approximately $48,093,000, or 26.1%, of the
Company's total loans, net of unearned income, were loans with floating
interest rates. This amount represented 37.4% of loans, excluding loans to
individuals, which are exclusively fixed rate in nature. The overall average
rate paid for total deposits decreased slightly in 1998. The average rate
paid by the Company for certificates of deposit and other time deposits of
$100,000 or more decreased to 5.35% during 1998 from 5.54% in 1997. The
average rate paid for certificates of deposit less than $100,000 decreased
from 5.36% in 1997 to 5.31% in 1998. Rates on other types of deposits, such
as savings accounts, money market accounts and NOW accounts, decreased from
an average of 2.69% in 1997 to an average of 2.55% in 1998. Given the fact
that the Company's interest-bearing liabilities are subject to repricing
faster than its interest-earning assets in the very short term, an overall
falling interest rate environment would normally produce a higher net
interest margin than a rising interest rate environment. As noted under
"Analysis of Financial Condition - Interest Rate Sensitivity" below, because
the Company's interest-bearing demand, savings and money market deposits are
somewhat less rate-sensitive, the Company's net interest margin does not
necessarily increase significantly in an overall falling interest rate
environment.
The following table presents the average balance sheets of the Company
for each of the last three fiscal years and indicates the interest earned or
paid on each major category of interest-earning assets and interest-bearing
liabilities on a fully taxable-equivalent basis, and the average rates earned
or paid on each major category. This analysis details the contribution of
interest-earning assets and the overall impact of the cost of funds on net
interest income.
-32-
<PAGE>
<TABLE>
<CAPTION>
Year Ended December 31,
-------------------------------------------------------------------------------------
1998 1997 1996
-------------------------- -------------------------- -------------------------
Interest Interest Interest
Average Income/ Yield/ Average Income/ Yield/ Average Income/ Yield/
Balance Expense Rate Balance Expense Rate Balance Expense Rate
------- ------- ------ ------- ------- ------ ------- ------- ------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
ASSETS (1) (Dollars in thousands)
Interest-earning assets:
Loans, net of unearned income (2) $153,188 $ 14,150 9.24% $132,891 $ 12,236 9.21% $ 85,880 $ 8,005 9.32%
Securities (3) 73,363 4,498 6.13 84,566 5,181 6.13 74,920 4,507 6.02
Federal funds sold 34,472 1,859 5.39 16,469 912 5.54 19,406 1,047 5.40
-------- -------- ------ -------- -------- ------ -------- -------- ------
Total interest-earning assets 261,023 20,507 7.86 233,926 18,329 7.84 180,206 13,559 7.52
-------- -------- ------ -------- -------- ------ -------- -------- ------
Noninterest-earning assets:
Cash and due from banks 15,149 11,051 7,151
Premises and equipment, net 8,233 6,951 4,427
Intangible assets 5,242 3,116 689
Accrued interest receivable
and other assets 5,220 5,030 4,507
Allowance for possible loan losses (1,288) (1,200) (825)
-------- -------- --------
Total noninterest-earning assets 32,556 24,948 15,949
-------- -------- --------
Total assets $293,579 $258,874 $196,155
======== ======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY (1)
Interest-bearing liabilities:
Demand, savings and money
market deposits $ 86,428 $ 2,207 2.55% $ 75,833 $ 2,037 2.69% $ 57,847 $ 1,397 2.41%
Time deposits 132,654 7,061 5.32 121,218 6,563 5.41 92,065 4,985 5.41
-------- -------- ------- -------- -------- ------ -------- -------- ------
Total interest-bearing deposits 219,082 9,268 4.23 197,051 8,600 4.36 149,912 6,382 4.26
Notes payable 100 8 8.00 714 59 8.26 568 59 10.39
-------- -------- ------- -------- -------- ------ -------- -------- ------
Total interest-bearing liabilities 219,182 9,276 4.23 197,765 8,659 4.38 150,480 6,441 4.28
-------- -------- ------- -------- -------- ------ -------- -------- ------
Noninterest-bearing liabilities:
Demand deposits 46,877 40,328 30,093
Accrued interest payable and
other liabilities 1,809 1,506 1,207
-------- -------- --------
Total noninterest-bearing liabilities 48,686 41,834 31,300
-------- -------- --------
Total liabilities 267,868 239,599 181,780
Guaranteed preferred beneficial
interests in the Company's
subordinated debentures 3,597 0 0
Stockholders' equity 22,114 19,275 14,375
-------- -------- --------
Total liabilities and
stockholders' equity $293,579 $258,874 $196,155
======== ======== ========
Net interest income $ 11,231 $ 9,670 $ 7,118
======== ======== ========
Interest rate spread (4) 3.63% 3.46% 3.24%
====== ====== ======
Net interest margin (5) 4.30% 4.13% 3.95%
====== ====== ======
______________________________
(1) The Average Balance and Interest Income/Expense columns include the
balance sheet and income statement accounts of Peoples National, Coastal
Banc-San Angelo, Western National and Azle State from January 1, 1996,
May 27, 1996, January 28, 1997 and September 22, 1998 (the respective
dates of acquisition of such banks), through December 31, 1998.
(2) Nonaccrual loans are included in the Average Balance columns and income
recognized on these loans, if any, is included in the Interest
Income/Expense columns. Interest income on loans includes fees on loans,
which are not material in amount.
(3) Nontaxable interest income on securities was adjusted to a taxable yield
assuming a tax rate of 34%.
(4) The interest rate spread is the difference between the average yield on
interest-earning assets and the average cost of interest-bearing
liabilities.
(5) The net interest margin is equal to net interest income, on a fully
taxable-equivalent basis, divided by average interest-earning assets.
</TABLE>
-33-
<PAGE>
The following table presents the changes in the components
of net interest income and identifies the part of each change due
to differences in the average volume of interest-earning assets
and interest-bearing liabilities and the part of each change due
to the average rate on those assets and liabilities. The changes
in interest due to both volume and rate in the table have been
allocated to volume or rate change in proportion to the absolute
amounts of the change in each.
<TABLE>
<CAPTION>
1998(1) vs 1997 1997(1) vs 1996
--------------------------- ---------------------------
Increase (Decrease) Due To Increase (Decrease) Due To
Changes In: Changes In:
--------------------------- ---------------------------
Volume Rate Total Volume Rate Total
------- ------- ------- ------- ------- -------
(In thousands)
<S> <C> <C> <C> <C> <C> <C>
Interest-earning assets:
Loans, net of unearned income $ 1,875 $ 39 $ 1,914 $ 4,377 $ (146) $ 4,231
Securities (2) (683) 0 (683) 581 93 674
Federal funds sold 971 (24) 947 (158) 23 (135)
------- ------- ------- ------- ------- -------
Total interest income 2,163 15 2,178 4,800 (30) 4,770
------- ------- ------- ------- ------- -------
Interest-bearing liabilities:
Deposits:
Demand, savings and money
market deposits 270 (100) 170 430 210 640
Time deposits 608 (110) 498 1,578 0 1,578
------- ------- ------- ------- ------- -------
Total deposits 878 (210) 668 2,008 210 2,218
Notes payable (49) (2) (51) 15 (15) 0
------- ------- ------- ------- ------- -------
Total interest expense 829 (212) 617 2,023 195 2,218
------- ------- ------- ------- ------- -------
Increase (decrease) in net
interest income $ 1,334 $ 227 $ 1,561 $ 2,777 $ (225) $ 2,552
======= ======= ======= ======= ======= =======
______________________________
(1) Income statement items include the income statement accounts
of Peoples National, Coastal Banc - San Angelo Western
National and Azle State beginning January 1, 1996, May 27,
1996, January 28, 1997 and September 22, 1998 (the
respective dates of acquisition of such banks), through
December 31, 1998.
(2) Information with respect to interest income on tax-exempt
securities is provided on a fully taxable-equivalent basis
assuming a tax rate of 34%.
</TABLE>
Provision for Loan Losses
- -------------------------
The amount of the provision for loan losses is based on
periodic (not less than quarterly) evaluations of the loan
portfolio, especially nonperforming and other potential problem
loans. During these evaluations, consideration is given to such
factors as: management's evaluation of specific loans; the level
and composition of nonperforming loans; historical loss
experience; results of examinations by regulatory agencies; an
internal asset review process conducted by the Company that is
independent of the management of the Banks; expectations of
future economic conditions and their impact on particular
industries and individual borrowers; the market value of
collateral; the strength of available guarantees; concentrations
of credit; and other judgmental factors. The provision for loan
losses for the year ended December 31, 1998, was $570,000,
compared to $250,000 for the previous year. The provision in 1998
represented an increase of $320,000, or 128%, from the 1997
provision. The higher provision in 1998 is due to increased
charge-offs during 1998, primarily in the indirect installment
loan portfolio. This situation was mitigated somewhat by the fact
that the Company's classified loans have continued to decline,
notwithstanding the acquisitions made during 1996, 1997 and 1998.
The provision in 1997 represented an increase of $49,000, or
24.4%, from the 1996 provision due to increased charge-offs in
the indirect installment loan portfolio noted above.
Noninterest Income
- ------------------
Noninterest income increased $882,000, or 46.2%, from
$1,909,000 in 1997 to $2,791,000 in 1998. The amount for 1997
increased $358,000, or 23.1%, from $1,551,000 in 1996.
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<PAGE>
Service charges on deposit accounts and charges for other
types of services are the major source of noninterest income to
the Company. This source of income increased $622,000, or 38.8%,
from $1,605,000 for 1997 to $2,227,000 for 1998. Approximately
33% of the increase was attributable to the acquisition of Azle
State in September 1998. The remainder of the increase was due to
service charges on the accounts of seven (7) large grocery
stores, which began in October 1997, and an increase in rates on
selected charges during the first quarter of 1998. Service charge
income increased $346,000, or 27.5%, from $1,259,000 for 1996 to
$1,605,000 for 1997, primarily due to the acquisition of Western
National in January 1997.
Trust fees from trust operations increased $4,000, or 2.1%,
from $195,000 in 1997 to $199,000 in 1998. Trust fees increased
$6,000, or 3.2%, from $189,000 during 1996 to $195,000 during
1997. The increases in 1998 and 1997 are due to an overall
increase in the value of assets under management of the trust
department.
There were no sales of securities during 1998. Securities
with a carrying value of $193,000 were sold during 1997. There
was no gain or loss recorded on such sale. Securities with a
carrying value of $2,028,000 were sold during 1996. Net losses of
$10,000 were recorded on the securities sold during 1996. The
securities portfolio had an average life of approximately 2.36
years at December 31, 1998, compared to approximately 1.32 years
at December 31, 1997. The increase in average life is due to the
acquisition of Azle State, whose securities, particularly
obligations of states and political subdivisions, have a longer
average maturity than First State's securities portfolio.
Other income is the sum of several components of noninterest
income including insurance premiums earned on automobiles
financed through the Company's indirect installment loan program,
check printing income, commissions earned on the sale of mutual
funds and annuities, bankcard royalty income and other sources of
miscellaneous income. Other income increased $256,000, or 234.9%,
from $109,000 in 1997 to $365,000 in 1998 due to the acquisition
of Azle State in September 1998, a significant increase in
insurance premiums received during the first half of 1998 on
automobiles financed through the Company's indirect installment
lending program and an increase in check printing income. The
Company also had a significant increase in commissions earned
from investment services, which the Company began promoting
during the second quarter of 1997. Other income increased $6,000,
or 5.8%, from $103,000 in 1996 to $109,000 for 1997, due to the
acquisition of Western National in January 1997.
Noninterest Expenses
- --------------------
Noninterest expenses increased $1,761,000, or 21.4%, from
$8,237,000 in 1997 to $9,998,000 in 1998. Over two-thirds of the
increase was attributable to the acquisition of Azle State and
the payment of distributions on the Company's Trust Preferred
Securities that were sold in the 1998 Offering. Noninterest
expenses increased $1,947,000, or 31.0%, from $6,290,000 in 1996
to $8,237,000 in 1997. Approximately 80% of the increase was due
to the acquisition of Western National.
Salaries and benefits rose $782,000, or 19.7%, from
$3,970,000 in 1997 to $4,752,000 in 1998. Approximately 61% of
the increase was a result of the acquisition of Azle State in
September 1998. An additional 23% of the increase was due to the
opening of three supermarket branch locations, two in October
1997 and one in May 1998. Salaries and employee benefits
increased $888,000, or 28.8%, from $3,082,000 in 1996 to
$3,970,000 in 1997. Approximately 79% of the increase was a
result of the acquisition of Western National.
Net occupancy expense increased $242,000, or 28.2%, from
$857,000 in 1997 to $1,099,000 in 1998. Approximately 37% of the
increase was due to the acquisition of Azle State. An additional
42% of the increase was due to the opening of the three
supermarket branch locations. Net occupancy expense increased
$141,000, or 19.7%, from $716,000 in 1996 to $857,000 in 1997.
The increase was due entirely to the acquisition of Western
National.
Equipment expense increased $53,000, or 6.4%, from $834,000
in 1997, to $887,000 in 1998. The relatively small increase was
due to the expiration of operating leases on certain data
processing equipment during the first half of 1998. The
equipment was purchased at the end of the leases. The
depreciation expense on this equipment and other replacement
equipment purchased later in 1998 was less than the lease expense
previously recorded. The reduction in these expenses helped
offset additional equipment expense incurred as a result of the
acquisition of Azle State and the opening of the three
supermarket branches. Equipment expense increased $171,000, or
25.8%, from $663,000 in 1996 to $834,000 for 1997. Approximately
three-fourths of this increase was the result of the Western
National acquisition.
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<PAGE>
Stationery, printing and supplies expense increased $23,000,
or 5.5%, from $419,000 for 1997 to $442,000 for 1998.
Approximately three-fourths of the increase was due to the Azle
State acquisition and the opening of the three supermarket bank
branches. Stationery, printing and supplies expense increased
$131,000, or 45.5%, from $288,000 for 1996 to $419,000 for 1997,
primarily due to the acquisition of Western National and the
opening of two of the supermarket branches during the fourth
quarter of 1997.
Amortization of intangible assets increased $121,000 or
55.5%, from $218,000 for 1997 to $339,000 for 1998 as a result of
the amortization of the core deposit intangible and goodwill
incurred in conjunction with the acquisition of Azle State.
These expenses increased $172,000, or 373.9%, from $46,000 for
1996 to $218,000 for 1997 as a result of amortization of goodwill
recorded upon the acquisition of Western National.
Professional fees, which include legal and accounting fees,
decreased $28,000, or 8.4%, from $333,000 during 1997 to $305,000
during 1998. The decrease was a result of increased legal fees
incurred immediately after the 1997 acquisition related to
Western National and legal fees incurred during the first quarter
of 1997 to settle litigation, which resulted in a recovery of
approximately $108,000 of a previously charged off loan.
Professional fees increased $29,000, or 9.5%, from $304,000
during 1996 to $333,000 for 1997. The increase during 1997 was
due to the additional legal fees incurred on collection of loans
made by Western National noted above.
Distributions on guaranteed preferred beneficial interests
in the Company's Subordinated Debentures totaled $304,000 for
1998. Independent Capital issued $13,000,000 of Trust Preferred
Securities in the 1998 Offering, on which distributions are
payable quarterly at the rate of 8.5%.
Net costs (revenues) applicable to other real estate and
other repossessed assets consist of expenses associated with
holding and maintaining various repossessed assets, the net gain
or loss on the sales of such assets, the write-down of the
carrying value of the assets and any rental income on such assets
that is credited as a reduction in such expenses. The Company
recorded net costs of $106,000 in 1998 compared to net costs of
$23,000 in 1997, an increase of $83,000, or 360.9%. The increase
in net costs during 1998 was partially due to an increase in the
number of repossessed automobiles during 1998 and the acquisition
of Azle State. In addition, net gains on sales and rental income
received on such assets totaled $27,000 for 1998, compared to
$81,000 for 1997. Net costs of the Company were $23,000 in 1997
compared to net revenues of $24,000 in 1996 as a result of
$52,000 of such expenses recorded by the Lubbock branch of First
State during 1997.
Other noninterest expense includes, among many other items,
postage, due from bank account charges, data processing, armored
car and courier fees, travel and entertainment, advertising,
insurance, regulatory examinations, directors' fees, dues and
subscriptions, franchise taxes and Federal Deposit Insurance
Corporation ("FDIC") insurance. These expenses increased
$181,000, or 11.4%, from $1,583,000 during 1997 to $1,764,000
during 1998. Approximately 71% of the increase was due to the
acquisition of Azle State in September 1998. These expenses
increased $368,000, or 30.3%, from $1,215,000 for 1996 to
$1,583,000 for 1997. The entire increase in 1997 was due to the
acquisition of Western National.
Federal Income Taxes
- --------------------
Due to the fact that the Company effected a quasi-
reorganization as of December 31, 1989, utilization of any of the
Company's net operating loss carryforwards subsequent to that
date will not be credited to future income. For periods
subsequent to December 31, 1994, the tax effect of such
utilization has been credited against the Company's gross
deferred tax asset. The Company provided for $1,193,000, $977,000
and $753,000 in federal income taxes in 1998, 1997 and 1996,
respectively. The 1998 and 1997 amounts were lowered by $35,000
and $112,000, respectfully, as a result of a reduction made in
the Company's deferred tax asset valuation allowance relating to
Peoples National and Winters State based on the Company's trend
of positive operating results.
Impact of Inflation
- -------------------
The effects of inflation on the local economy and on the
Company's operating results have been relatively modest for the
past several years. Because substantially all of the Company's
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
-36-
<PAGE>
control the impact of interest rate fluctuations by managing the
relationship between its interest rate sensitive assets and
liabilities. See "Analysis of Financial Condition - Interest Rate
Sensitivity" below.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The business of the Company and the composition of its
consolidated balance sheet consists of investments in interest-
earning assets (primarily loans and investment securities) which
are primarily funded by interest-bearing liabilities (deposits).
Such financial instruments have varying levels of sensitivity to
changes in market interest rates resulting in the market risk.
Interest Rate Risk Measurement
- ------------------------------
Interest rate risk arises when an interest-earning asset
matures or when its rate of interest changes in a time frame
different from that of the supporting interest-bearing liability.
The Company seeks to minimize the difference between the amount
of interest-earning assets and the amount of interest-bearing
liabilities that could change interest rates in the same time
frame in an attempt to reduce the risk of significant adverse
effects on the Company's net interest income caused by interest
rate changes. The Company does not attempt to match each
interest-earning asset with a specific interest-bearing
liability. Instead, as shown in the table below, it aggregates
all of its interest-earning assets and interest-bearing
liabilities to determine the difference between the two in
specific time frames. This difference is known as the rate-
sensitivity gap. A positive gap indicates that more interest-
earning assets than interest-bearing liabilities mature in a time
frame, and a negative gap indicates the opposite. Maintaining a
balanced position will reduce risk associated with interest rate
changes, but it will not guarantee a stable interest rate spread
because the various rates within a time frame may change by
differing amounts and occasionally change in different
directions. Management regularly monitors the interest
sensitivity position and considers this position in its decisions
in regard to interest rates and maturities for interest-earning
assets acquired and interest-bearing liabilities accepted.
In adjusting the Company's asset/liability position,
management attempts to manage the Company's interest rate risk
while enhancing net interest margins. The rates, terms and
interest rate indices of the Company's interest-earning assets
result primarily from the Company's strategy of investing in
loans and securities, which permit the Company to limit its
exposure to interest rate risk, together with credit risk, while
at the same time achieving a positive interest rate spread from
the difference between the income earned on interest-earning
assets and the cost of interest-bearing liabilities.
The Company's objective is to maintain a ratio of interest-
sensitive assets to interest-sensitive liabilities that is as
balanced as possible. The following tables show that ratio to be
70.2% at the 90-day interval, 64.7% at the 180-day interval and
63.0% at the 365-day interval at December 31, 1998. Currently,
the Company is in a liability-sensitive position at the three
intervals. During an overall falling interest rate environment,
this position would normally produce a higher net interest margin
than in a rising interest rate environment; however, because the
Company had $110,485,000 of interest-bearing demand, savings and
money market deposits at December 31, 1998, that are somewhat
less rate-sensitive, the Company's net interest margin does not
necessarily increase significantly in an overall declining
interest rate environment. Excluding these types of deposits, the
Company's interest-sensitive assets to interest sensitive
liabilities ratio at the 365-day interval would have been 112.3%
at December 31, 1998. The interest sensitivity position is
presented as of a point in time and can be modified to some
extent by management as changing conditions dictate.
-37-
<PAGE>
The following table shows the interest rate sensitivity
position of the Company at December 31, 1998:
<TABLE>
<CAPTION>
Volumes
Subject to
Cumulative Volumes Repricing
Subject to Repricing Within After
90 Days 180 Days 365 Days 1 Year Total
-------- -------- -------- ---------- --------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C>
Interest-earning assets:
Federal funds sold $ 42,175 $ 42,175 $ 42,175 $ 0 $ 42,175
Securities 4,404 7,411 13,450 81,758 95,208
Loans, net of unearned income 68,205 81,634 102,707 81,853 184,560
-------- -------- -------- -------- --------
Total interest-earning assets 114,784 131,220 158,332 163,611 321,943
-------- -------- -------- -------- --------
Interest-bearing liabilities:
Demand, savings and money market
deposits 110,485 110,485 110,485 0 110,485
Time deposits 52,939 92,215 140,926 19,307 160,233
Notes payable 1 1 1 0 1
-------- -------- -------- -------- --------
Total interest-bearing liabilities 163,425 202,701 251,412 19,307 270,719
-------- -------- -------- -------- --------
Rate-sensitivity gap(1) $(48,641) $(71,481) $(93,080) $144,304 $ 51,224
======== ======== ======== ======== ========
Rate-sensitivity ratio (2) 70.2% 64.7% 63.0%
==== ==== ====
______________________________
(1) Rate-sensitive interest-earning assets less rate-sensitive
interest-bearing liabilities.
(2) Rate-sensitive interest-earning assets divided by rate-
sensitive interest-bearing liabilities.
</TABLE>
Net Economic Value
- ------------------
The interest rate risk ("IRR") component is a dollar amount
that is deducted from total capital for the purpose of
calculating an institution's risk-based capital requirement and
is measured in terms of the sensitivity of its net economic value
("NEV") to changes in interest rates. An institution's NEV is
calculated as the net discounted cash flows from assets,
liabilities and off-balance sheet contracts. As an institution's
IRR component is measured as the change in the ratio of NEV to
the net present value of total assets as a result of a
hypothetical 200 basis point change in market interest rates. A
resulting decline in this ratio of more than 2% of the estimated
present value of an institution's total assets prior to the
hypothetical 200 basis point change will require the institution
to deduct from its regulatory capital 50% of that excess decline.
Based on quarterly calculations, the Banks experienced no such
decline.
Although certain assets and liabilities may have similar
maturities or periods to repricing, they may react in different
degrees to changes in market interest rates. Also, the interest
rates on certain types of assets and liabilities may fluctuate in
advance of changes in market interest rates, while interest rates
on other types may lag behind changes in market rates.
Additionally, certain assets, such as adjustable-rate mortgage
loans, have features that restrict changes in interest rates on a
short-term basis and over the life of the loan. Further, in the
event of a change in interest rates, prepayment and early
withdrawal levels could deviate significantly from those assumed
in calculating the table. Finally, the ability of many borrowers
to service their debt may decrease in the event of a significant
interest rate increase. The Company considers all of these
factors in monitoring its exposure to interest rate risk.
The repricing of certain categories of assets and
liabilities are subject to competitive and other pressures beyond
the Company's control. As a result, certain assets and
liabilities indicated as maturing or otherwise repricing within a
stated period may in fact mature or reprice at different times
and at different volumes.
The following table provides information about the Company's
financial instruments that are sensitive to changes in interest
rates. Except for the effects of prepayments and scheduled
principal amortization on mortgage
-38-
<PAGE>
related assets, the table presents principal cash flows and
related weighted average interest rates by the contractual terms
to maturity. Nonaccrual loans are included in the loan totals.
All investments are classified as other than trading.
<TABLE>
<CAPTION>
Year Ending December 31
------------------------------------------------- Fair
1999 2000 2001 2002 2003 Thereafter Total Value
--------- --------- --------- --------- --------- --------- --------- ---------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
(Dollars in thousands)
Fixed Rate Loans:
Maturities $ 54,679 $ 27,137 $ 18,876 $ 17,952 $ 15,387 $ 2,436 $ 136,467 $ 138,101
Average interest rate 9.51% 9.90% 9.79% 9.73% 8.87% 9.11% 9.58%
Adjustable Rate Loans:
Maturities 22,747 6,570 4,720 3,750 3,055 7,251 48,093 48,093
Average interest rate 9.49% 9.23% 9.44% 9.39% 9.17% 8.94% 9.34%
Investments and Other
Interest-earning Assets:
Maturities 55,625 28,253 15,841 9,249 17,680 10,735 137,383 137,450
Average interest rate 5.21% 5.56% 6.08% 6.36% 6.43% 8.11% 5.84%
Total Interest-earning
Assets:
Maturities $ 133,051 $ 61,960 $ 39,437 $ 30,951 $ 36,122 $ 20,422 $ 321,943 $ 323,644
Average interest rate 7.71% 7.85% 8.26% 8.68% 7.70% 8.52% 7.95%
Savings Deposits:
Maturities $ 0 $ 0 $ 0 $ 0 $ 0 $ 22,864 $ 22,864 $ 22,864
Average interest rate --% --% --% --% --% 2.63% 2.63%
NOW Deposits:
Maturities 0 0 0 0 0 52,006 52,006 52,006
Average interest rate --% --% --% --% --% 1.67% 1.67%
Money Market Deposits:
Maturities 0 0 0 0 0 35,615 35,615 35,615
Average interest rate --% --% --% --% --% 3.15% 3.15%
Certificates of Deposit:
Maturities 140,926 12,504 2,987 2,214 1,602 0 160,233 161,035
Average interest rate 5.08% 5.59% 5.64% 5.78% 3.95% --% 5.13%
Notes Payable:
Maturities 1 0 0 0 0 0 1 1
Average interest rate 7.50% --% --% --% --% --% 7.50%
Total Interest-bearing
Liabilities:
Maturities $ 140,927 $ 12,504 $ 2,987 $ 2,214 $ 1,602 $ 110,485 $ 270,719 $ 271,521
Average interest rate 5.08% 5.59% 5.64% 5.78% 3.95% 2.35% 3.99%
</TABLE>
The Company assumes that 100% of savings, NOW and money
market deposits at December 31, 1998, are core deposits and are,
therefore, expected to roll off after five years. No roll-off is
applied to certificates of deposit. Fixed maturity deposits
reprice at maturity.
ANALYSIS OF FINANCIAL CONDITION
Assets
- ------
Total assets increased $105,604,000, or 39.9%, from
$264,574,000 at December 31, 1997, to $370,178,000 at December
31, 1998, due to the acquisition of Azle Bancorp, which had total
assets of $93,158,000 at September 22, 1998, the date of
acquisition. Total assets increased $58,606,000, or 28.5%, from
$205,968,000 at year-end 1996 to
-39-
<PAGE>
$264,574,000 at December 31, 1997, due to the acquisition of
Crown Park, which had total assets of $60,420,000 at January 28,
1997, the date of acquisition.
Cash and Cash Equivalents
- -------------------------
At December 31, 1998, the Company had $64,737,000 in cash
and cash equivalents, up $25,319,000, or 64.2%, from $39,418,000
at December 31, 1997, due to the acquisition of Azle State, which
had $8,892,000 at the date of acquisition, and due to an
increased amount of funds being invested temporarily in federal
funds sold. During 1997, cash and cash equivalents increased
$9,460,000, or 31.6%, from the December 31, 1996, balance of
$29,958,000 as a result of the then-existing interest rate
environment. Cash and cash equivalents averaged $49,621,000,
$27,520,000 and $26,557,000 for the years ended December 31,
1998, 1997 and 1996, respectively.
Securities
- ----------
Securities increased $25,414,000, or 36.4%, from $69,794,000
at December 31, 1997, to $95,208,000 at December 31, 1998. The
increase in 1998 was due to the acquisition of Azle State, which
had $35,808,000 in securities at the date of acquisition. This
increase was offset somewhat by a decrease in securities due to
lower interest rates that were being paid on securities during
the fourth quarter of 1998. As a result, more of the Company's
available funds were being invested temporarily in federal funds
sold as noted above.
The boards of directors of the Banks review all securities
transactions monthly and the securities portfolio periodically.
The Company's current investment policy provides for the purchase
of U.S. Treasury securities and federal agency securities having
maturities of five years or less and for the purchase of state,
county and municipal agencies' securities with maximum maturities
of 10 years. The Company's policy is to maintain a securities
portfolio with a mixture of securities classified as held-to-
maturity and available-for-sale with staggered maturities to meet
its overall liquidity needs. Municipal securities must be rated A
or better. Certain school district issues, however, are
acceptable with a Baa rating. Securities totaling $30,370,000 are
classified as available-for-sale and are carried at fair value at
December 31, 1998. Securities totaling $64,838,000 are classified
as held-to-maturity and are carried at amortized cost. The
securities portfolio had an average life of approximately 2.36
years at December 31, 1998, compared to approximately 1.32 years
at December 31, 1996. The decision to sell securities classified
as available-for-sale is based upon management's assessment of
changes in economic or financial market conditions.
Certain of the Company's securities are pledged to secure
public and trust fund deposits and for other purposes required or
permitted by law. At December 31, 1998, the book value of U.S.
Government and other securities so pledged amounted to
$17,094,000, or 18.0% of the total securities portfolio.
The following table summarizes the amounts and the
distribution of the Company's investment securities held at the
dates indicated:
<TABLE>
<CAPTION>
December 31,
--------------------------------------------------------
1998 1997 1996
---------------- ---------------- ----------------
Amount % Amount % Amount %
-------- ------ -------- ------ -------- ------
<S> <C> <C> <C> <C> <C> <C>
(Dollars in thousands)
Carrying value:
Obligations of U.S. Government
agencies and corporations $ 61,669 64.8% $ 36,122 51.8% $ 29,928 39.8%
Mortgage-backed securities 12,121 12.7 11,622 16.7 9,438 12.6
U.S. Treasury securities 11,573 12.2 21,292 30.5 35,143 46.8
Obligations of states and
political subdivisions 9,262 9.7 175 0.2 200 0.2
Other securities 583 0.6 583 0.8 443 0.6
-------- ------ -------- ------ -------- ------
Total securities $ 95,208 100.0% $ 69,794 100.0% $ 75,152 100.0%
======== ====== ======== ====== ======== ======
Total fair value $ 95,276 $ 69,877 $ 75,062
======== ======== ========
</TABLE>
-40-
<PAGE>
The fair value of held-to-maturity securities is usually
different from the reported carrying value of such securities due
to interest rate fluctuations that cause market valuations to
change.
The following table provides the maturity distribution and
weighted average interest rates of the Company's total securities
portfolio at December 31, 1998. The yield has been computed by
relating the forward income stream on the securities, plus or
minus the anticipated amortization of premium or accretion of
discount, to the book value of the securities. The book value of
available-for-sale securities is their fair value. The book value
of held-to-maturity securities is their cost, adjusted for
previous amortization or accretion. The restatement of the yields
on tax-exempt securities to a fully taxable-equivalent basis has
been computed assuming a tax rate of 34%.
<TABLE>
<CAPTION>
Estimated Weighted
Principal Carrying Fair Average
Type and Maturity Grouping at December 31, 1998 Amount Value Value Yield
- ----------------------------------------------- --------- -------- --------- --------
<S> <C> <C> <C> <C>
(Dollars in thousands)
Obligations of U.S. Government
agencies and corporations:
Within one year $ 7,000 $ 7,000 $ 7,016 6.19%
After one but within five years 52,800 53,182 53,097 5.80
After five but within ten years 1,500 1,500 1,500 6.08
--------- --------- --------- --------
Total obligations of U.S. government
agencies and corporations 61,300 61,682 61,613 5.86
--------- --------- --------- --------
Mortgage-backed securities 11,999 12,108 12,140 6.03
--------- --------- --------- --------
U.S. Treasury securities:
Within one year 5,400 5,465 5,465 6.15
After one but within five years 6,000 6,108 6,135 5.62
--------- --------- --------- --------
Total U.S. Treasury securities 11,400 11,573 11,600 5.87
--------- --------- --------- --------
Obligations of states and political subdivisions:
Within one year 50 50 50 6.36
After one but within five years 1,545 1,631 1,648 8.87
After five but within ten years 6,185 6,579 6,624 9.24
After ten years 945 1,002 1,018 8.36
--------- --------- --------- --------
Total obligations of states and
political subdivisions 8,725 9,262 9,340 9.05
--------- --------- --------- --------
Other securities:
Within one year 0 0 0 --
After one but within five years 0 0 0 --
After five but within ten years 0 0 0 --
After ten years 583 583 583 3.96
--------- --------- --------- --------
Total other securities 583 583 583 3.96
--------- --------- --------- --------
Total securities $ 94,007 $ 95,208 $ 95,276 6.15%
========= ========= ========= ========
</TABLE>
Loan Portfolio
- --------------
Total loans, net of unearned income, increased $43,707,000,
or 31.0%, from $140,853,000 at December 31, 1997, to $184,560,000
at December 31, 1998. The increase during 1998 was due to the
acquisition of Azle State, which had $45,163,000 in loans, net of
unearned income, at the date of acquisition.
The Banks primarily make installment loans to individuals
and commercial loans to small to medium-sized businesses and
professionals. The Banks offer a variety of commercial lending
products including revolving lines of credit, letters of credit,
working capital loans and loans to finance accounts receivable,
inventory and equipment. Typically, the Banks' commercial loans
have floating rates of interest, are for varying terms (generally
not exceeding
-41-
<PAGE>
five years), are personally guaranteed by the borrower and are
collateralized by real estate, accounts receivable, inventory or
other business assets.
Due to the diminished loan demand during the early 1990's,
First State instituted an installment loan program whereby it
began to purchase automobile loans from automobile dealerships in
its market areas. Under this program, an automobile dealership
will agree to make a loan to a prospective customer to finance
the purchase of a new or used automobile. The different financial
institutions that have a pre-established relationship with the
particular dealership review the transaction, including the
credit history of the prospective borrower, and decide if they
would agree to purchase the loan from the dealership and, if so,
at what rate of interest. The dealership selects the financial
institution to which it decides to sell the loan. The financial
institution purchasing the loan has a direct loan to the borrower
collateralized by the automobile, and the dealership realizes a
profit based on the difference between the interest rate quoted
to the buyer by the dealership and the interest rate at which the
loan is purchased by the financial institution. At December 31,
1998 and 1997, the Company had approximately $29,890,000 and
$50,052,000 net of unearned income, respectively, of this type of
loan outstanding. The decrease is due to management's decision to
shift the loan portfolio toward more commercial and real estate
loans and less toward indirect installment loans.
The following table presents the Company's loan balances at
the dates indicated separated by loan type:
<TABLE>
<CAPTION>
December 31,
---------------------------------------------------------------------
1998 1997 1996 1995 1994
--------- --------- --------- --------- ---------
(In thousands)
<S> <C> <C> <C> <C> <C>
Real estate loans $ 71,901 $ 44,569 $ 26,233 $ 23,265 $ 22,760
Loans to individuals 57,564 67,453 46,975 42,142 43,113
Commercial and industrial loans 47,551 24,184 18,430 17,236 16,702
Other loans 9,310 6,109 2,626 2,638 2,943
--------- --------- --------- --------- ---------
Total loans 186,326 142,315 94,264 85,281 85,518
Less unearned income 1,766 1,462 2,247 3,354 4,212
--------- --------- --------- --------- ---------
Loans, net of unearned income $ 184,560 $ 140,853 $ 92,017 $ 81,927 $ 81,306
========= ========= ========= ========= =========
</TABLE>
Loan concentrations are considered to exist when there are
amounts loaned to a multiple number of borrowers engaged in
similar activities that would cause them to be similarly impacted
by economic or other conditions. The Company had no
concentrations of loans at December 31, 1998, except for those
described above. The Banks had no loans outstanding to foreign
countries or borrowers headquartered in foreign countries at
December 31, 1998.
Management of the Banks may renew loans at maturity when
requested by a customer whose financial strength appears to
support such renewal or when such renewal appears to be in the
Company's best interest. The Company requires payment of accrued
interest in such instances and may adjust the rate of interest,
require a principal reduction or modify other terms of the loan
at the time of renewal.
-42-
<PAGE>
The following table presents the distribution of the
maturity of the Company's loans and the interest rate sensitivity
of those loans, excluding loans to individuals, at December 31,
1998. The table also presents the portion of loans that have
fixed interest rates or interest rates that fluctuate over the
life of the loans in accordance with changes in the interest rate
environment as represented by the prime rate.
<TABLE>
<CAPTION>
One to Over Total
One Year Five Five Carrying
and Less Years Years Value
--------- --------- --------- ---------
(In thousands)
<S> <C> <C> <C> <C>
Real estate loans $ 24,323 $ 43,388 $ 4,190 $ 71,901
Commercial and industrial loans 25,438 18,163 3,950 47,551
Other loans 5,847 3,125 338 9,310
--------- --------- --------- ---------
Total loans $ 55,608 $ 64,676 $ 8,478 $ 128,762
========= ========= ========= =========
With fixed interest rates $ 32,861 $ 46,581 $ 1,227 $ 80,669
With variable interest rates 22,747 18,095 7,251 48,093
--------- --------- --------- ---------
Total loans $ 55,608 $ 64,676 $ 8,478 $ 128,762
========= ========= ========= =========
</TABLE>
Nonperforming Assets
- --------------------
Nonperforming loans consist of nonaccrual, past due and
restructured loans. A past due loan is an accruing loan that is
contractually past due 90 days or more as to principal or
interest payments. Loans on which management does not expect to
collect interest in the normal course of business are placed on
nonaccrual or are restructured. When a loan is placed on
nonaccrual, any interest previously accrued but not yet collected
is reversed against current income unless, in the opinion of
management, the outstanding interest remains collectible.
Thereafter, interest is included in income only to the extent of
cash received. A loan is restored to accrual status when all
interest and principal payments are current and the borrower has
demonstrated to management the ability to make payments of
principal and interest as scheduled.
A "troubled debt restructuring" is a restructured loan upon
which interest accrues at a below market rate or upon which
certain principal has been forgiven so as to aid the borrower in
the final repayment of the loan, with any interest previously
accrued, but not yet collected, being reversed against current
income. Interest is accrued based upon the new loan terms.
Nonperforming loans are fully or substantially
collateralized by assets, with any excess of loan balances over
collateral values allocated in the allowance. Assets acquired
through foreclosure are carried at the lower of cost or estimated
fair value, net of estimated costs of disposal, if any. See
"Other Real Estate and Other Repossessed Assets" below.
The following table lists nonaccrual, past due and
restructured loans and other real estate and other repossessed
assets at year-end for each of the past five years.
<TABLE>
<CAPTION>
December 31,
----------------------------------------------
1998 1997 1996 1995 1994
------ ------ ------ ------ ------
(In thousands)
<S> <C> <C> <C> <C> <C>
Nonaccrual loans $ 238 $ 70 $ 82 $ 204 $ 48
Accruing loans contractually past
due over 90 days 198 121 41 23 26
Restructured loans 110 104 73 65 80
Other real estate and other
repossessed assets 630 739 389 337 631
------ ------ ------ ------ ------
Total nonperforming assets $1,176 $1,034 $ 585 $ 629 $ 785
====== ====== ====== ====== ======
</TABLE>
-43-
<PAGE>
The gross interest income that would have been recorded in
1998 on the Company's nonaccrual loans if such loans had been
current, in accordance with the original terms thereof and had
been outstanding throughout the period or, if shorter, since
origination, was approximately $12,000. A total of $1,000 in
interest on nonaccrual loans was actually recorded (received)
during 1998.
A potential problem loan is defined as a loan where
information about possible credit problems of the borrower is
known, causing management to have serious doubts as to the
ability of the borrower to comply with the present loan repayment
terms and which may result in the inclusion of such loan in one
of the nonperforming asset categories. The Company does not
believe it has any potential problem loans other than these
reported in the above table.
The Company follows a loan review program to evaluate the
credit risk in its loan portfolio. Through the loan review
process, the Banks maintain an internally classified loan list
that, along with the list of nonperforming loans discussed below,
helps management assess the overall quality of the loan portfolio
and the adequacy of the allowance. Loans classified as
"substandard" are those loans with clear and defined weaknesses
such as highly leveraged positions, unfavorable financial ratios,
uncertain repayment sources or poor financial condition, which
may jeopardize recoverability of the loan. Loans classified as
"doubtful" are those loans that have characteristics similar to
substandard loans, but also have an increased risk that a loss
may occur or at least a portion of the loan may require a charge-
off if liquidated at present. Although loans classified as
substandard do not duplicate loans classified as doubtful, both
substandard and doubtful loans may include some loans that are
past due at least 90 days, are on nonaccrual status or have been
restructured. Loans classified as "loss" are those loans that are
in the process of being charged off. At December 31, 1998,
substandard loans totaled $880,000, of which $188,000 were loans
designated as nonaccrual, 90 days past due or restructured, there
was one $5,000 doubtful loan and one $10,000 loss loan. Both the
doubtful and loss loans were on nonaccrual.
In addition to the internally classified loans, the Banks
also have a "watch list" of loans that further assists the Banks
in monitoring their respective loan portfolios. A loan is
included on the watch list if it demonstrates one or more
deficiencies requiring attention in the near term or if the
loan's ratios have weakened to a point where more frequent
monitoring is warranted. These loans do not have all the
characteristics of a classified loan (substandard, doubtful or
loss), but do have weakened elements as compared with those of a
satisfactory credit. Management of the Banks review these loans
to assist in assessing the adequacy of the allowance.
Substantially all of the loans on the watch list at December 31,
1998, were current and paying in accordance with loan terms. At
December 31, 1998, watch list loans totaled $2,198,000 (including
$197,000 of loans guaranteed by U.S. governmental agencies). At
such date, $214,000 (including $60,000 of loans guaranteed by
U.S. Governmental agencies) of loans on the watch list were
designated as nonaccural, 90 days past due or restructured loans.
In addition, at December 31, 1998, $129,000 of loans not
classified and not on the watch list were designated as 90 days
past due or restructured loans.
Other Real Estate and Other Repossessed Assets
- ----------------------------------------------
Other real estate and other repossessed assets consist of
real property and other assets unrelated to banking premises or
facilities. Income derived from other real estate and other
repossessed assets, if any, is generally less than that which
would have been earned as interest at the original contract rates
on the related loans. At December 31, 1998 and 1997, other real
estate and other repossessed assets had an aggregate book value
of $630,000 and $739,000, respectively. Other real estate and
other repossessed assets decreased $109,000, or 14.7%, during
1998 even after the acquisition of Azle State. At the date of
acquisition, Azle State had a total of $162,000 in other real
estate and other repossessed assets. The reduction in 1998 was
primarily due to the sale of a parcel of real estate for
$357,000. This decrease was partially offset by an increase in
the number of repossessed automobiles held by the Company at
December 31, 1998. The December 31, 1998, balance of $630,000
included fifty repossessed automobiles ($416,000), three
commercial properties ($169,000) and two residential properties
($45,000). Of the December 31, 1997, balance, $391,000
represented three commercial properties, $302,000 represented
thirty-eight repossessed automobiles and $46,000 represented five
residential properties.
Allowance for Possible Loan Losses
- ----------------------------------
Implicit in the Company's lending activities is the fact
that loan losses will be experienced and that the risk of loss
will vary with the type of loan being made and the
creditworthiness of the borrower over the term of the loan. To
-44-
<PAGE>
reflect the currently perceived risk of loss associated with the
Company's loan portfolio, additions are made to the Company's
allowance for possible loan losses (the "allowance"). The
allowance is created by direct charges against income (the
"provision" for loan losses), and the allowance is available to
absorb possible loan losses. See "Results of Operations -
Provision for Loan Losses" above.
The amount of the allowance equals the cumulative total of
the provisions made from time to time, reduced by loan charge-
offs and increased by recoveries of loans previously charged off.
The Company's allowance was $1,842,000, or 1.00% of loans, net of
unearned income, at December 31, 1998, compared to $1,173,000, or
0.83% of loans, net of unearned income, at December 31, 1997, and
$793,000, or 0.86% of loans, net of unearned income, at December
31, 1996. The increase in the balance of the allowance from
December 31, 1997, to December 31, 1998, was a result of the
acquisition of Azle State, which had an allowance of $726,000 at
the date of acquisition. The reduction in the ratio of the
allowance to total loans, net of unearned income during the past
several years, is primarily due to the improvement in the overall
credit quality of the Company's loan portfolio.
Credit and loan decisions are made by management and the
boards of directors of the Banks in conformity with loan policies
established by the board of directors of the Company. The
Company's practice is to charge off any loan or portion of a loan
when the loan is determined by management to be uncollectible due
to the borrower's failure to meet repayment terms, the borrower's
deteriorating or deteriorated financial condition, the
depreciation of the underlying collateral, the loan's
classification as a loss by regulatory examiners or for other
reasons. The Company charged off $729,000 in loans during 1998.
Charge-offs for 1998 were concentrated in the following
categories: loans to individuals-$671,000, or 92.0%, real
estate-$40,000, or 5.5%, and commercial and industrial-$18,000,
or 2.5%. A charge-off on one real estate loan was $37,000, or
5.1%, of total charge-offs. All but $21,000 of the remaining
$692,000 in charge-offs were installment loans, of which $573,000
represented indirect loans secured by automobiles. Recoveries
during 1998 were $102,000 and were concentrated in the following
categories: loans to individuals-$45,000, or 44.1%, commercial
and industrial-$41,000, or 40.2%, and real estate-$16,000, or
15.7%. Recoveries of $27,000 on one commercial and industrial
loan, and $15,000 on one real estate loan accounted for 41.2% of
total recoveries during 1998.
-45-
<PAGE>
The following table presents the provisions, loans charged
off and recoveries of loans previously charged off, the amount of
the allowance, average loans outstanding and certain pertinent
ratios for the last five years.
<TABLE>
<CAPTION>
1998(1) 1997(2) 1996(3) 1995 1994
-------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C>
Analysis of allowance for possible loan losses: (Dollars in thousands)
Balance at January 1 $ 1,173 $ 793 $ 759 $ 817 $ 896
Provision for loan losses 570 250 201 206 147
Acquisition of subsidiary 726 395 149 0 0
-------- -------- -------- -------- --------
2,469 1,438 1,109 1,023 1,043
-------- -------- -------- -------- --------
Loans charged off:
Loans to individuals 671 457 231 297 150
Real estate loans 40 6 100 72 119
Commercial and industrial loans 18 107 58 7 32
Other loans 0 11 0 0 77
-------- -------- -------- -------- --------
Total charge-offs 729 581 389 376 378
-------- -------- -------- -------- --------
Recoveries of loans previously charged off:
Loans to individuals 45 60 28 43 45
Real estate loans 16 35 20 2 0
Commercial and industrial loans 41 220 25 52 48
Other loans 0 1 0 15 59
-------- -------- -------- --------- --------
Total recoveries 102 316 73 112 152
-------- -------- -------- --------- --------
Net loans charged off 627 265 316 264 226
-------- -------- -------- --------- --------
Balance at December 31 $ 1,842 $ 1,173 $ 793 $ 759 $ 817
======== ======== ======== ======== ========
Average loans outstanding,
net of unearned income $153,188 $132,891 $ 85,880 $ 82,302 $ 74,727
======== ======== ======== ======== ========
Ratio of net loan charge-offs to average loans,
net of unearned income 0.41% 0.20% 0.37% 0.32% 0.30%
==== ==== ==== ==== ====
Ratio of allowance for possible loan losses
to total loans, net of unearned income, at
December 31 1.00% 0.83% 0.86% 0.93% 1.00%
==== ==== ==== ==== ====
______________________________
(1) Average loans, net of unearned income, for 1998 include the
average loans, net of unearned income, of Azle State from
September 22 through December 31, 1998.
(2) Average loans, net of unearned income, for 1997 include the
average loans, net of unearned income, of Western National
from January 28 through December 31, 1997.
(3) Average loans, net of unearned income, for 1996 include the
average loans, net of unearned income, of Peoples National
from January 1 through December 31, 1996, and of Coastal
Banc - San Angelo from May 27 through December 31, 1996.
</TABLE>
Foreclosures on defaulted loans result in the Company
acquiring other real estate and other repossessed assets.
Accordingly, the Company incurs other expenses, specifically net
costs applicable to other real estate and other repossessed
assets, in maintaining, insuring and selling such assets. The
Banks attempt to convert nonperforming loans into interest-
earning assets, although usually at a lower dollar amount than
the face value of such loans, either through liquidation of the
collateral securing the loan or through intensified collection
efforts.
As the economies of the Company's market areas recovered and
stabilized during the early 1990's, there was a steady reduction
in the amount of the provision, as a percentage of average loans
outstanding, necessary to maintain an adequate balance in the
allowance. The amount of the provision was fairly stable during
the mid-1990's. This reflected management's assessment of the
continued reduction of credit risks associated with the loan
portfolio. The Company increased the provision in 1998, however,
due to the higher amount of net charge-offs in the Company's
indirect installment loan portfolio, which declined significantly
during 1998.
-46-
<PAGE>
The amount of the allowance is established by management
based upon estimated risks inherent in the existing loan
portfolio. Management reviews the loan portfolio on a continuing
basis to evaluate potential problems. This review encompasses
management's estimate of current economic conditions and the
potential impact on various industries, prior loan loss
experience and financial conditions of individual borrowers.
Loans that have been specifically identified as problem or
nonperforming loans are reviewed on at least a quarterly basis,
and management critically evaluates the prospect of the ultimate
losses arising from such loans, based on the borrower's financial
condition and the value of available collateral. When a risk can
be specifically quantified for a loan, that amount is
specifically allocated in the allowance. In addition, the Company
allocates the allowance based upon the historical loan loss
experience of the different types of loans. Despite such
allocation, both the allocated and unallocated portions of the
allowance are available for charge-offs of all loans.
The following table shows the allocations in the allowance
and the respective percentages of each loan category to total
loans at year-end for each of the past five years.
<TABLE>
<CAPTION>
December 31,
--------------------------------------------------------------------------------------
1998 1997 1996
-------------------------- --------------------------- --------------------------
Percent of Percent of Percent of
Amount of Loans by Amount of Loans by Amount of Loans by
Allowance Category to Allowance Category to Allowance Category to
Allocated Loans, Net Allocated Loans, Net Allocated Loans, Net
to of Unearned to of Unearned to of Unearned
Category Income Category Income Category Income
---------- ----------- --------- ------------ ---------- -----------
(Dollars in thousands)
Real estate loans $ 106 39.0% $ 52 31.6% $ 128 28.5%
Loans to individuals 577 30.2 570 46.8 323 48.6
Commercial and industrial loans 164 25.8 193 17.2 97 20.0
Other loans 9 5.0 28 4.4 43 2.9
---------- ------------ ---------- ------------ ---------- -----------
Total allocated 856 100.0% 843 100.0% 591 100.0%
============ ============ ===========
Unallocated 986 330 202
========== ========== ==========
Total allowance for possible
loan losses $1,842 $1,173 $ 793
========== ========== ==========
December 31,
---------------------------------------------------------
1995 1997
-------------------------- ---------------------------
Percent of Percent of
Amount of Loans by Amount of Loans by
Allowance Category to Allowance Category to
Allocated Loans, Net Allocated Loans, Net
to of Unearned to of Unearned
Category Income Category Income
---------- ----------- ---------- ------------
(Dollars in thousands)
<S> <C> <C> <C> <C>
Real estate loans $ 197 28.4% $ 165 28.0%
Loans to individuals 136 47.4 207 47.8
Commercial and industrial loans 96 21.0 122 20.5
Other loans 59 3.2 68 3.7
---------- ------------ ---------- -------------
Total allocated 488 100.0% 562 100.0%
========== ============ ========== =============
Unallocated 271 255
---------- ----------
Total allowance for possible
loan losses $ 759 $ 817
========== ==========
</TABLE>
Intangible Assets
- -----------------
Intangible assets increased $7,672,000, or 242.9%, from
$3,159,000 at December 31, 1997, to $10,831,000 at December 31,
1998, due to the acquisition of Azle State. A total of $8,014,000
of intangible assets were recorded as a result of this
acquisition, which was partially offset by $339,000 in
amortization expense during 1998.
Premises and Equipment
- ----------------------
Premises and equipment increased $2,776,000, or 36.9%, from
$7,518,000 at December 31, 1997, to $10,294,000 at December 31,
1998. The increase was due to the purchase of Azle State, which
had $2,748,000 in net
-47-
<PAGE>
premises and equipment at the date of acquisition, and the
opening of one additional supermarket branch banking facility
during 1998. These increases were partially offset by
depreciation expense of $623,000 recorded for 1998.
Accrued Interest Receivable
- ---------------------------
Accrued interest receivable consists of interest that has
accrued on securities and loans, but is not yet payable under the
terms of the related agreements. The balance of accrued interest
receivable increased $1,046,000, or 47.4%, from $2,208,000 at
December 31, 1997, to $3,254,000 at December 31, 1998. The
increase during 1998 was primarily a result of the purchase of
Azle State, which had $856,000 in accrued interest receivable at
the date of acquisition. Of the total balance at December 31,
1998, $1,819,000, or 55.9%, was interest accrued on loans and
$1,435,000, or 44.1%, was interest accrued on securities.
Other Assets
- ------------
The most significant component of other assets at December
31, 1998 and 1997, is a net deferred tax asset of $508,000 and
$1,282,000, respectively. The balance of other assets increased
$448,000, or 21.8%, to $2,506,000 at December 31, 1998, from
$2,058,000 at December 31, 1997 due to the acquisition of Azle
State, which has $255,000 in other assets at the date of
acquisition and an increase in other assets at the Company due to
the payment of a $520,000 underwriting fee related to the sale of
Independent Capital's Trust Preferred Securities in the 1998
Offering. These increases were partially offset by a decrease in
the Company's net deferred tax asset due principally to the
utilization of a portion of the Company's tax credit
carryforwards.
Deposits
- --------
The Banks' lending and investing activities are funded
almost entirely by core deposits, 51.5% of which are demand,
savings and money market deposits at December 31, 1998. Total
deposits increased $88,003,000, or 36.2%, from $242,801,000 at
December 31, 1997, to $330,804,000 at December 31, 1998. The
increase is due primarily to the purchase of Azle State, which
had $80,955,000 in total deposits at the date of acquisition. The
Banks do not have any brokered deposits.
The following table presents the average amounts of and the
average rate paid on deposits of the Company for each of the last
three years:
<TABLE>
<CAPTION>
Year Ended December 31,
---------------------------------------------------------
1998(1) 1997(2) 1996(3)
----------------- ----------------- -----------------
Average Average Average Average Average Average
Amount Rate Amount Rate Amount Rate
-------- ------- -------- ------- -------- -------
<S> <C> <C> <C> <C> <C> <C>
(Dollars in thousands)
Noninterest-bearing
demand deposits $ 46,887 --% $ 40,328 --% $ 30,093 --%
Interest-bearing demand, savings
and money market deposits 86,428 2.55 75,833 2.69 57,847 2.41
Time deposits of less
than $100,000 91,087 5.31 84,267 5.36 64,112 5.42
Time deposits of $100,000
or more 41,567 5.35 36,951 5.54 27,953 5.39
-------- ------- -------- ------- -------- -------
Total deposits $265,959 3.48% $237,379 3.62% $180,005 3.55%
======== ======= ======== ======= ======== =======
______________________
(1) The average amounts and average rates paid on deposits for
the year ended December 31, 1998, include the averages of
Azle State from September 22 through December 31, 1998.
(2) The average amounts and average rates paid on deposits for
the year ended December 31, 1997, include the averages of
Western National from January 28 through December 31, 1997.
(3) The average amounts and average rates paid on deposits for
the year ended December 31, 1996, include the averages of
Peoples National and Coastal Banc - San Angelo from January
1 and May 27 (the respective dates of acquisition of such
banks) through December 31, 1996.
</TABLE>
-48-
<PAGE>
The maturity distribution of time deposits of $100,000 or
more at December 31, 1998, is presented below:
December 31, 1998
-----------------
(In thousands)
3 months or less $ 17,515
Over 3 through 6 months 11,737
Over 6 through 12 months 16,173
Over 12 months 4,249
---------
Total time deposits of $100,000 or more $ 49,674
=========
The Banks experience relatively limited reliance on time
deposits of $100,000 or more. Time deposits of $100,000 or more
are a more volatile and costly source of funds than other
deposits and are most likely to affect the Company's future
earnings because of interest rate sensitivity. At December 31,
1998, time deposits of $100,000 or more represented 13.4% of the
Company's total assets, compared to 14.5% of the Company's total
assets at December 31, 1997.
Accrued Interest Payable
- ------------------------
Accrued interest payable consists of interest that has
accrued on deposits and notes payable, but is not yet payable
under the terms of the related agreements. The balance of accrued
interest payable increased $216,000, or 22.8%, from $947,000 at
December 31, 1997, to $1,163,000 at December 31, 1998. The
increase was due to the acquisition of Azle State, which had
$308,000 in accrued interest payable at the date of acquisition.
This increase was offset somewhat by a decrease in accrued
interest payable at First State due to overall lower interest
rates on deposits at December 31, 1998, when compared to December
31, 1997.
Notes Payable
- -------------
The Company's notes payable decreased $56,000, or 98.2%,
from $57,000 at December 31, 1997, to $1,000 at December 31,
1998. The decrease was a result of the payoff of the one
remaining note payable to the current and former directors during
1998.
Other Liabilities
- -----------------
The most significant components of other liabilities are
amounts accrued for various types of expenses. The balance of
other liabilities increased $463,000, or 191.3%, from $242,000 at
December 31, 1997, to $705,000 at December 31, 1998, due to the
acquisition of Azle State, which had $884,000 in other
liabilities at the date of acquisition and $342,000 at December
31, 1998, and an increase in other liabilities, primarily federal
income taxes payable at the Company at December 31, 1998.
-49-
<PAGE>
Selected Financial Ratios
The following table presents selected financial ratios for
each of the last three fiscal years:
<TABLE>
<CAPTION>
Year Ended December 31,
---------------------------
1998(1) 1997(2) 1996(3)
------- ------- -------
<S> <C> <C> <C>
Net income to:
Average assets 0.75% 0.82% 0.72%
Average interest-earning assets 0.84 0.90 0.79
Average stockholders' equity 9.89 10.95 9.89
Dividend payout (4) to:
Net income 18.69 17.30 13.85
Average stockholders' equity 1.84 1.89 1.37
Average stockholders' equity to:
Average total assets 7.53 7.45 7.33
Average loans (5) 14.44 14.50 16.74
Average total deposits 8.31 8.12 7.99
Average interest-earning assets to:
Average total assets 88.91 90.36 91.87
Average total deposits 98.14 98.55 100.11
Average total liabilities 97.44 97.63 99.13
Ratio to total average deposits of:
Average loans (5) 57.60 55.98 47.71
Average noninterest-bearing deposits 17.63 16.99 16.72
Average interest-bearing deposits 82.37 83.01 83.28
Total interest expense to total interest income 45.39 47.25 47.51
Efficiency ratio (6) 68.49 69.09 72.78
_________________________
(1) Average balance sheet and income statement items for 1998
include the averages for Azle State from September 22
through December 31, 1998.
(2) Average balance sheet and income statement items for 1997
include the averages for Western National from January 28
through December 31, 1997.
(3) Average balance sheet and income statement items for 1996
include the averages for Peoples National and Coastal Banc -
San Angelo from January 1 and May 27 (the respective dates
of acquisition of such banks) through December 31, 1996.
(4) Dividends for Common Stock only.
(5) Before allowance for possible loan losses.
(6) Calculated as noninterest expense less amortization of
intangibles and expenses related to other real estate and
other repossessed assets divided by the sum of net interest
income before provision for loan losses and total
noninterest income, excluding securities gains and losses.
</TABLE>
LIQUIDITY
The Bank
- --------
Liquidity with respect to a financial institution is the
ability to meet its short-term needs for cash without suffering
an unfavorable impact on its on-going operations. The need for
the Banks to maintain funds on hand arises principally from
maturities of short-term borrowings, deposit withdrawals,
customers' borrowing needs and the maintenance of reserve
requirements. Liquidity with respect to a financial institution
can be met from either assets or liabilities. On the asset side,
the primary sources of liquidity are cash and due from banks,
federal funds sold, maturities of securities and scheduled
repayments and maturities of loans. The Banks maintain adequate
levels of cash and near-cash investments to meet their day-to-day
needs. Cash and due from banks averaged $15,149,000 and
$11,051,000 during the years ended December 31, 1998 and 1997,
respectively. These amounts comprised 5.2% and 4.3% of average
total assets during the years ended December 31, 1998 and 1997,
respectively. The average level of securities and federal funds
sold was $107,835,000 and $101,035,000 during the years ended
December 31, 1998 and 1997, respectively. The increases from 1997
to 1998 were primarily due to the acquisition of Azle State on
September 22, 1998.
-50-
<PAGE>
The Banks sold no securities during the year ended December
31, 1998. First State sold securities classified as available-
for-sale with a book value of $193,000 during the year ended
December 31, 1997. At December 31, 1998, $12,515,000, or 15.1%,
of the Company's securities portfolio, excluding mortgage-backed
securities, matured within one year and $60,921,000, or 73.3%,
excluding mortgage-backed securities, matured after one but
within five years. The Banks' commercial lending activities are
concentrated in loans with maturities of less than five years and
with both fixed and adjustable interest rates, while its
installment lending activities are concentrated in loans with
maturities of three to five years and with fixed interest rates.
The Banks' experience, however, has been that these installment
loans are paid off in an average of approximately thirty months.
At December 31, 1998, approximately $102,707,000, or 55.6%, of
the Company's loans, net of unearned income, matured within one
year and/or had adjustable interest rates. Approximately
$80,954,000, or 62.9%, of the Company's loans (excluding loans to
individuals) matured within one year and/or had adjustable
interest rates. See "Analysis of Financial Condition - Loan
Portfolio" above.
On the liability side, the principal sources of liquidity
are deposits, borrowed funds and the accessibility to money and
capital markets. Customer deposits are by far the largest source
of funds. During the years ended December 31, 1998 and 1997, the
Company's average deposits were $265,959,000, or 90.6% of average
total assets, and $237,379,000, or 91.7% of average total assets,
respectively. The Company attracts its deposits primarily from
individuals and businesses located within the market areas served
by the Banks. See "Analysis of Financial Condition - Deposits"
above.
The level of nonperforming assets has squeezed interest
margins and has resulted in noninterest expenses from net
operating costs and write-downs associated with nonperforming
assets, although the ratio of such nonperforming assets to total
assets has generally been decreasing over the past several years.
To improve liquidity, the Banks have implemented various cost-
cutting and revenue-generating measures and extended efforts to
reduce nonperforming assets.
The Company
- -----------
The Company depends on the Banks for liquidity in the form
of cash flow, primarily to meet debt service and dividend
requirements and to cover other operating expenses. This cash
flow comes from three sources: (1) dividends resulting from
earnings of the Banks, (2) current tax liabilities generated by
the Banks and (3) management and service fees for services
performed for the Banks.
The payment of dividends from the Banks is subject to
applicable law and the scrutiny of regulatory authorities.
Dividends paid by the Banks to Independent Financial in 1998
aggregated $5,250,000; in turn, Independent Financial paid
dividends to the Company totaling $5,250,000 during 1998.
Independent Capital, organized during the third quarter of 1998,
paid dividends totaling $9,000 to the Company during 1998.
Dividends paid by the Banks during 1998 include a $4,500,000
dividend paid by Azle State after the acquisition of such bank.
Proceeds from this dividend were used to pay off the borrowings
from the Fort Worth Bank. Dividends paid by First State to
Independent Financial and by Independent Financial to the Company
totaled $900,000 and $900,000, respectively, during 1997. At
December 31, 1998, there were approximately $4,254,000 in
dividends available for payment to Independent Financial by the
Banks without prior regulatory approval.
The payment of current tax liabilities generated by the
Banks and management and service fees constituted approximately
21.5% and 2.1%, respectively, of the Company's cash flow from the
Banks during 1998. Pursuant to a tax-sharing agreement, the Banks
pay to the Company an amount equal to its individual tax
liability on the accrual method of federal income tax reporting.
The accrual method generates more timely payments of current tax
liabilities by the Banks to the Company, increasing the
regularity of cash flow and shifting the time value of such funds
to the Company. In the event that the Banks incur losses, the
Company may be required to refund tax liabilities previously
collected. Current tax liabilities totaling $1,480,000 were paid
by the Banks to the Company during 1998, compared to a total of
$1,266,000 in 1997.
From January 1, 1989, through December 31, 1995, the Company
collected federal income taxes from its subsidiaries based on an
effective tax rate of approximately 34% and paid taxes to the
federal government at the rate of approximately 2% as a result of
the utilization of the Company's net operating loss carryforwards
for both regular tax
-51-
<PAGE>
and alternative minimum tax purposes. At December 31, 1995, the
Company's net operating loss carryforwards for alternative tax
purposes had been fully utilized. As a result, the Company began
paying federal income taxes at the effective tax rate of
approximately 20% during the first quarter of 1996. The net
operating carryforwards available for regular federal income tax
purposes were fully utilized by the fourth quarter of 1997.
The Banks pay management fees to the Company for services
performed. These services include, but are not limited to,
financial and accounting consultation, attendance at the Banks'
board meetings, audit and loan review services and related
expenses. The Banks paid a total of $147,000 in management fees
to the Company in 1998, compared to $150,000 in 1997. The
Company's fees must be reasonable in relation to the management
services rendered, and the Banks are prohibited from paying
management fees to the Company if the Banks would be
undercapitalized after any such distribution or payment.
The Company has a revolving line of credit with the Fort
Worth Bank. Proceeds of $4,300,000 under the $6,500,000 line of
credit were used to fund the purchase of Azle Bancorp on
September 22, 1998. These borrowings were paid off on September
30, 1998, from the proceeds of a $4,500,000 dividend that was
paid to the Company by Azle State. The amount available under
the line of credit was reduced to $1,500,000 on January 5, 1999,
and reduces further to $1,000,000 on October 5, 1999. The line
of credit matures on October 1, 2000, bears interest at the
floating prime interest rate of the Fort Worth Bank and is
collateralized by 100% of the stock of Independent Financial and
First State. There was no balance outstanding under the line of
credit at December 31, 1998.
The Company had a note payable to the Amarillo Bank. The
note, proceeds of which were used to help fund the purchase of
Crown Park, originated on January 23, 1997, in the amount of
$800,000. The balance was reduced to $200,000 by July 23, 1997.
The note bore interest at the Amarillo Bank's floating base rate
plus 1% and was collateralized by 100% of the stock of First
State. On December 31, 1997, the Company paid off the remaining
principal balance of the note.
In addition, at December 31, 1997, the Company had a note
payable to one current director of the Company with a balance of
$50,000. The note had an original face amount of $152,000, but
was discounted upon issuance because it bore interest at a below-
market interest rate (6%). The note was payable in three equal
annual installments, plus accrued interest beginning March 1,
1996. The note was paid off on January 2, 1998. The note
represented a portion of the final settlement of certain
litigation.
At December 31, 1998, First State had a $1,000 note payable
to an individual which matures in March 1999. Principal, plus
interest at 7.5%, is payable monthly. The note is collateralized
by a two-story commercial building in Abilene, Texas.
CAPITAL RESOURCES
At December 31, 1998, stockholders' equity totaled
$24,505,000, or 6.6% of total assets, compared to $20,527,000, or
7.8% of total assets, at December 31, 1997.
Bank regulatory authorities in the United States have risk-
based capital standards by which all bank holding companies and
banks are evaluated in terms of capital adequacy. These
guidelines relate a banking company's capital to the risk profile
of its assets. The risk-based capital standards require all banks
to have Tier 1 capital of at least 4%, and total capital (Tier 1
and Tier 2 capital) of at least 8%, of risk-weighted assets, and
to be designated as well-capitalized, the banking company must
have Tier 1 and total capital ratios of 6% and 10%, respectively.
For the Company, Tier 1 capital includes common stockholders'
equity and qualifying Series C Cumulative Convertible Preferred
Stock (the "Series C Preferred Stock") and guaranteed preferred
beneficial interests in the Company's subordinated debentures,
reduced by intangible assets. Tier 2 capital for the Company is
comprised of the remainder of guaranteed preferred beneficial
interests in the Company's subordinated debentures not qualifying
as Tier 1 capital and all of the allowance for possible loan
losses.
Banking regulators also have leverage ratio requirements.
The leverage ratio requirement is measured as the ratio of Tier 1
capital to adjusted quarterly average assets. The leverage ratio
standards require all banking companies to have a minimum
leverage ratio of 4%, and to be designated as well-capitalized,
the banking company must have a leverage ratio of at least 5%.
The following table provides a calculation of the Company's risk-
based capital and leverage ratios and a comparison of the
Company's and the Banks' risk-based capital ratios and leverage
ratios to the minimum regulatory and well-capitalized minimum
requirements at December 31, 1998:
-52-
<PAGE>
<TABLE>
<CAPTION>
The Company December 31, 1998
----------- -----------------
(In thousands)
<S> <C>
Tier 1 capital:
Common stockholders' equity, excluding unrealized
gain on available-for-sale securities $ 24,132
Qualifying Series C Preferred Stock and guaranteed preferred beneficial interests
in the Company's Subordinated Debentures (1) 8,043
Intangible assets (10,831)
----------
Total Tier 1 capital 21,344
----------
Tier 2 capital:
Guaranteed preferred beneficial interests in the Company's Subordinated Debentures (1) 5,170
Allowance for possible loan losses (2) 1,842
----------
Total Tier 2 capital 7,012
----------
Total capital $ 28,356
==========
Risk-weighted assets $ 205,971
==========
Adjusted quarterly average assets $ 357,815
==========
_______________________________
(1) Limited to 25% of total Tier 1 capital, with any remainder
qualifying as Tier 2 capital.
(2) Limited to 1.25% of risk-weighted assets.
</TABLE>
The minimum regulatory capital ratios, minimum capital
ratios for well capitalized holding companies and the Company's
actual capital amounts and ratios at December 31, 1998 and 1997,
were as follows:
<TABLE>
<CAPTION>
December 31, Minimum Well
------------------------ Capital Capitalized
1998 1997 Ratios Ratios
--------- --------- ------- -----------
<S> <C> <C> <C> <C>
(Dollars in thousands)
Tier 1 capital $ 21,344 $ 17,737
Total capital 28,356 18,510
Risk-weighted assets 205,971 154,036
Adjusted quarterly average assets 357,815 258,496
Capital ratios:
Tier 1 capital to risk-weighted assets 10.36% 11.26% 4.00% 6.00%
Total capital to risk-weighted assets 13.77 12.02 8.00 10.00
Tier 1 capital to adjusted quarterly average
assets 5.97 6.71 4.00 5.00
</TABLE>
-53-
<PAGE>
The minimum regulatory capital ratios, minimum capital
ratios for well capitalized banks and the Banks' actual capital
ratios at December 31, 1998, were as follows:
<TABLE>
<CAPTION>
Regulatory Minimum Minimum Ratio for Actual Ratios at
Ratio for Banks Well Capitalized Banks December 31, 1998
------------------- ---------------------- -----------------
<S> <C> <C> <C>
Tier 1 capital to risk-weighted assets 4.00% 6.00% 11.46-12.04%
Total capital to risk-weighted assets 8.00 10.00 12.21-13.22
Tier 1 capital to adjusted quarterly
average assets 4.00 5.00 6.77-7.53
</TABLE>
The Federal Deposit Insurance Corporation Improvement Act of
1991 ("FDICIA") requires each federal banking agency to revise
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 non-traditional activities, as well
as reflect the actual performance and expected risk of loss on
multi-family mortgages. The law also requires each federal
banking agency to specify the levels at which an insured
institution would be considered "well capitalized," "adequately
capitalized," "undercapitalized," "significantly
undercapitalized" and "critically undercapitalized." Under the
FDIC's regulations, the Company and the Banks were all "well
capitalized" at December 31, 1998.
The Company's ability to generate capital internally through
retention of earnings and access to capital markets is essential
for satisfying the capital guidelines for bank holding companies
as prescribed by the Federal Reserve Board.
The payment of dividends on the Common Stock and the Series
C Preferred Stock is determined by the Company's board of
directors in light of circumstances and conditions then existing,
including the earnings of the Company and the Banks, funding
requirements and financial condition, applicable loan covenants
and applicable laws and regulations. The Company's ability to pay
cash dividends is restricted by the requirement that it maintain
a certain level of capital as discussed above in accordance with
regulatory guidelines. Holders of the Series C Preferred Stock
are entitled to receive, if, as and when declared by the
Company's board of directors, out of funds legally available
therefor, quarterly cumulative cash dividends at the annual rate
of 10%. The Federal Reserve Board has promulgated a policy
prohibiting bank holding companies from paying dividends on
common stock unless such bank holding company can pay such
dividends from current earnings. The Federal Reserve Board has
asserted that this policy is also applicable to payment of
dividends on preferred stock. Such an interpretation may limit
the ability of the Company to pay dividends on the Series C
Preferred Stock.
At December 31, 1998, retained earnings of the Banks
included approximately $4,254,000 that was available for payment
of dividends to the Company without prior approval of regulatory
authorities.
The Company began paying quarterly cash dividends of $0.03
per share on its Common Stock during the second quarter of 1994.
The Company also paid 4-for-3 stock split, effected in the form
of a 33-1/3% stock dividend, on May 31, 1995. The Company's Board
of Directors increased the Company's quarterly Common Stock cash
dividend to $0.05 per share during the second quarter of 1996. In
addition, the Company paid a 5-for-4 stock split, effected in the
form of a 25% stock dividend, on May 30, 1997.
In connection with the Company's acquisition of Crown Park,
the Company sold an aggregate of 395,312 shares of Common Stock
in the 1997 Offering at a price of $11.40 per share. This amount
included 51,562 shares covered by the underwriters' over-
allotment option. The Company received net proceeds of
approximately $3,978,000 from the 1997 Offering.
In connection with the Company's acquisition of Azle
Bancorp, the Company sold an aggregate of 230,000 shares of
Common Stock and 1,300,000 Trust Preferred Securities in the 1998
Offering at a price of $11.50 and $10.00 per share or security,
respectively. The Company received net proceeds of approximately
$14,547,000 from the 1998 Offering.
-54-
<PAGE>
YEAR 2000 READINESS DISCLOSURE
The inability of computers, software and other equipment
utilizing microprocessors to recognize and properly process data
fields containing a four digit year is commonly referred to as
the Year 2000 Compliance issue. As the year 2000 approaches, such
systems may be unable to accurately process certain date-based
information. The Year 2000 will have a broad impact on the
business environment in which the Company operates due to the
possibility that many computerized systems across all industries
will be unable to process information containing the dates
beginning in the Year 2000.
The Company believes it has identified all significant
applications that will require modification to ensure Year 2000
Compliance. Internal and external resources are being used to
make the required modifications and test Year 2000 Compliance.
The Company leased virtually all of its computer hardware under
leases that expired during 1998. The Company replaced this
hardware, as well as the software used for its main operating
system and major banking applications, during this same time
period. The modification process of all significant mission-
critical applications by outside hardware and software suppliers
is complete. The testing process of all significant mission-
critical applications has been substantially completed and all
such hardware and software tested to date was found to be Year
2000 compliant. It is anticipated that the testing on the
remaining mission-critical applications will be completed by
March 31, 1999. Management currently anticipates that testing of
all nonmission-critical applications will take place by mid-1999.
In addition, the Company has had formal communications with
other vendors with which it does significant business and with
significant loan and deposit customers to determine their Year
2000 readiness and the extent to which the Company appears
vulnerable to any third party Year 2000 issues. The Company will
continue to seek information from nonresponsive vendors and
customers. There can be no assurance, however, that the systems
of other companies will be timely converted, or that a failure to
convert by another company, or a conversion that is incompatible
with the Company's systems, would not have a material adverse
effect on the Company.
As a result of the timing of the replacement and upgrade of
the Company's hardware and software, the total cost to the
Company of Year 2000 Compliance activities has not been, and is
not anticipated to be, material to the Company's financial
position or results of operations in any given year. Year 2000
compliance costs and the date on which the Company plans to
complete the Year 2000 modifications and testing processes are
based on management's best estimates, which were derived
utilizing numerous assumptions of future events, including the
continued availability of certain resources, third party
modification plans and other factors. There can be no assurance,
however, that these estimates will be achieved and actual results
could differ from those plans.
The Company has developed a contingency plan and a business
resumption plan to address issues that may not be corrected in a
timely manner by implementation of the Company's own Year 2000
Compliance plan and to address the possibilities that third party
vendor or supplier systems may not be Year 2000 compliant. The
Company has prepared alternate strategies where necessary if
significant exposures are identified.
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<PAGE>
[Independent Bankshares, Inc. Logo]
P.O. Box 3296, Abilene, Texas 79604 (915) 677-5550
