<PAGE>
===============================================================================
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D. C. 20549
___________
FORM 10 - Q
____________
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 FOR THE QUARTER ENDED SEPTEMBER 30, 1999
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
Commission File Number: 0-20750
STERLING BANCSHARES, INC.
(Exact name of registrant as specified in its charter)
TEXAS 74-2175590
(State of Incorporation) (IRS Employer ID Number)
15000 NORTHWEST FREEWAY, SUITE 200
HOUSTON, TEXAS 77040
(Address of principal executive office)
713-466-8300
(Registrant's telephone number)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities and Exchange Act of 1934
("Act") during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days
Yes X No _____________
-----------
The number of shares outstanding of each class of the registrant's capital stock
as of September 30, 1999:
CLASS OF STOCK SHARES OUTSTANDING
---------------- --------------------
Common Stock, Par Value $1.00 25,990,934
================================================================================
<PAGE>
PART I. FINANCIAL INFORMATION
ITEM I. CONDENSED FINANCIAL STATEMENTS
STERLING BANCSHARES, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(In thousands)
<TABLE>
<CAPTION>
<S> <C> <C>
September 30, December 31,
1999 1998
------------- -------------
(Unaudited)
ASSETS
Cash and cash equivalents $ 93,279 $ 139,690
Interest bearing deposits in financial institutions 355 600
Securities purchased with an agreement to resell 37,435 32,992
Available-for-sale securities, at fair value 284,460 92,338
Held-to-maturity securities, at amonized cost 167,847 157,990
Loans held for sale 45,192 84,855
Loans held for investment 1,087,491 952,518
Allowance for credit losses (13,329) (10,829)
---------- ----------
Loans, net 1,074,162 941,689
Accrued interest receivable 9,838 8,952
Real estate acquired by foreclosure 1,464 1,965
Premises and equipment, net 40,960 39,574
Goodwill, net 5,733 6,064
Other assets 40,516 13,871
---------- ----------
TOTAL ASSETS $1,801,241 $1,520,580
========== ==========
LIABILITIES AND SHAREHOLDERS' EQUITY
Demand deposits:
Noninterest bearing $ 492,436 $ 469,183
Interest bearing 559,270 534,887
Certificates of deposit and other time deposits 358,472 341,241
---------- -----------
Total deposits 1,410,178 1,345,311
Securities sold under agreements to repurchase and
other borrowed funds 217,060 15,333
Accrued interest payable and other liabilities 13,079 11,236
ESOP indebtedness - 186
Notes payable - 1,883
---------- -----------
Total liabilities 1,640,317 1,373,949
COMPANY-OBLIGATED MANDITORILY REDEEMABLE
TRUST PREFERRED SECURITIES OF SUBSIDIARY TRUST 28,750 28,750
MINORITY INTEREST IN STERLING CAPITAL MORTGAGE COMPANY 1,210 948
Shareholders' equity:
Convertible preferred stock, $1 par value,
1 million shares authorized 88 137
Common stock, $1 par value, 50 million
shares authorized 25,991 25,526
Capital surplus 28,492 27,038
Retained earnings 75,908 64,015
ESOP indebtedness - (186)
Accumulated other comprehensive income--net unrealized
loss on available-for-sale securities, net of tax 485 403
---------- ----------
Total shareholders' equity 130,964 116,933
---------- ----------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $1,801,241 $1,520,580
========== ==========
</TABLE>
SEE NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS.
2
<PAGE>
STERLING BANCSHARES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(In thousands)
<TABLE>
<CAPTION>
THREE MONTHS NINE MONTHS
ENDED SEPTEMBER 30, ENDED SEPTEMBER 30,
1999 1998 1999 1998
------------------- -------------------
<S> <C> <C> <C> <C>
Interest income:
Loans, including fees $ 25,370 $22,929 $ 72,204 $ 66,441
Securities:
Taxable 4,047 3,414 9,819 11,459
Tax-exempt 845 533 2,259 1,124
Federal funds sold and securities purchased under agreements
to resell 847 1,291 2,986 2,994
Deposits in financial institutions 3 65 75 322
-------- -------- -------- --------
Total interest income 31,112 28,232 87,343 82,340
Interest expense:
Demand and savings deposits 3,437 3,824 9,390 11,711
Certificates and other time deposits 4,065 4,202 12,121 12,106
Other borrowed funds 1,227 274 1,539 807
ESOP indebtedness - 12 - 28
-------- -------- -------- --------
Total interest expense 8,729 8,312 23,050 24,652
-------- -------- -------- --------
NET INTEREST INCOME 22,383 19,920 64,293 57,688
-------- -------- -------- --------
Provision for credit losses 1,928 1,456 5,714 4,312
-------- -------- -------- --------
NET INTEREST INCOME AFTER
PROVISION FOR CREDIT LOSSES 20,455 18,464 58,579 53,376
Noninterest income:
Customer service fees 2,527 2,254 7,050 6,642
Equity in earnings of Sterling Capital Mortgage Company - - - 495
Gain on sale of mortgage loans 2,703 2,906 7,866 2,906
Other 1,954 2,209 6,154 4,893
-------- -------- -------- --------
Total noninterest income 7,184 7,369 21,070 14,936
Noninterest expense:
Salaries and employee benefits 10,942 9,183 31,238 24,114
Occupancy expense 2,819 2,542 8,527 6,381
Net losses (gains) and carrying costs of real estate acquired
by foreclosure 6 153 (67) 191
FDIC assessment 67 134 331 263
Technology 796 809 2,677 3,080
Postage and delivery charges 383 418 1,215 1,012
Supplies 366 459 1,188 1,062
Professional fees 350 477 1,448 1,465
Minority interest expense
Company-obligated mandatorily redeemable trust preferred
securities of subsidiary trust 667 667 2,001 2,001
Sterling Capital Mortgage Company 95 190 261 190
Other 2,760 3,071 8,725 7,806
-------- -------- -------- --------
Total noninterest expense 19,251 18,103 57,544 47,565
NET INCOME BEFORE INCOME TAXES 8,388 7,730 22,105 20,747
Provision for income taxes 2,657 2,627 6,876 6,767
-------- -------- -------- --------
NET INCOME $ 5,731 $ 5,103 $ 15,229 $ 13,980
======== ======== ======== ========
EARNINGS PER SHARE:
Basic $ 0.22 $ 0.20 $ 0.59 $ 0.56
======== ======== ======== ========
Diluted $ 0.22 $ 0.19 $ 0.58 $ 0.53
======== ======== ======== ========
</TABLE>
SEE NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS.
3
<PAGE>
STERLING BANCSHARES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
<TABLE>
<CAPTION>
Nine months ended September 30,
1999 1998
-------------- --------------
(Unaudited)
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 15,229 $ 13,980
Adjustments to reconcile net income to net cash provided by (used in)
operating activities:
Amorization and accretion of premiums and discounts
on securities, net 356 325
Equity in undistributed earnings of Sterling Capital Mortgage
Company - (437)
Provision for credit losses 5,714 4,312
Write-downs, less gains on sale of real estate acquired by
foreclosure and repossessed assets (219) (101)
Depreciation an amorization 4,726 3,991
Net change in loans held for sale, excluding loans sold with
University of Houston office location 28,746 (11,767)
Gain on the sale of University of Houston office location (450) -
Increase in accrued interest receivable and other assets (27,960) (469)
Increase (decrease) in accrued interest payable and other liabilities 2,205 (1,046)
---------- ---------
Net cash provided by operating activities 28,347 8,788
CASH FLOWS FROM INVESTING ACTIVITIES:
Increase in securities purchased under agreements to resell (4,443) (20,749)
Proceeds from maturity and paydowns of held-to-maturity securities 21,939 61,853
Purchases of held-to-maturity securities (32,046) (30,660)
Proceeds from maturity and paydowns of available-for-sale securities 27,458 61,608
Purchases of available-for-sale securities (219,549) (42,180)
Net increase in loans held for investment (138,743) (115,542)
Proceeds from sale of real estate acquired by foreclosure 1,276 1,869
Net decrease in interest-bearing deposits in financial institutions 245 309
Cash and cash equivalents acquired with Sterling Capital Mortgage Company
Proceeds from sale of University of Houston office location 5,269 -
Proceeds from sale of premises and equipment 3,098 782
Purchase of premises and equipment (8,706) (5,291)
---------- ---------
Net cash used in investing activities (344,202) (88,001)
CASH FLOWS FROM FINANCING ACTIVITIES:
Net increase in deposit accounts 71,066 96,475
Net increase(decrease) in repurchase agreements/funds purchased 201,727 (19,215)
Proceeds from issuance of common stock and preferred stock 1,870 2,735
Repayment of notes payable (1,883) (417)
Redemption of preferred stock - (21)
Dividends paid (3,336) (2,881)
---------- ---------
Net cash provided by financing activities 269,444 76,676
NET DECREASE IN CASH AND CASH EQUIVALENTS (46,411) (2,537)
CASH AND CASH EQUIVALENTS:
Beginning of period 139,690 151,744
---------- ---------
End of period $ 93,279 $ 149,207
========== =========
Supplemental information:
Income taxes paid $ 7,700 $ 5,523
========== =========
Interest paid $ 23,001 $ 24,374
=========== =========
Noncash investing and financing activities:
Acquisitions of real estate through foreclosure of collateral $ 550 $ 2,552
=========== ==========
</TABLE>
SEE NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS.
4
<PAGE>
STERLING BANCSHARES, INC., AND SUBSIDIARIES
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 1999
1. Basis of Presentation:
The accompanying unaudited consolidated financial statements have been prepared
in accordance with generally accepted accounting principles for interim
financial information and with the rules and regulations of the Securities and
Exchange Commission. Accordingly, they do not include all of the information
and footnotes required by generally accepted accounting principles for complete
financial statements. In the opinion of management, all adjustments (consisting
of normal recurring items) considered necessary for a fair presentation have
been included. Operating results for the nine month period ended September 30,
1999, are not necessarily indicative of the results that may be expected for the
entire year or any interim period. For further information, refer to the
consolidated financial statements and notes thereto included in the annual
report on Form 10-K of Sterling Bancshares, Inc. (the "Company") for the year
ended December 31, 1998.
2. Acquisition:
On June 1, 1999, the Company acquired B.O.A. Bancshares and its subsidiary
Houston Commerce Bank (hereinafter collectively referred to as "Houston
Commerce") in exchange for 1,854,600 shares of the Company's common stock. This
transaction was accounted for as a pooling of interests and previously issued
financial statements have been restated accordingly.
The following table reflects the results of operations of the Company and
Houston Commerce as separate entities and the combined amounts after the pooling
of interests (in thousands):
<TABLE>
<CAPTION>
Nine Months Ended September 30,
-------------------------------------------------------------------------------
1999 1998
-------------------------------------- --------------------------------------
Sterling Sterling
(without (without
Houston Houston Houston Houston
Commerce) Commerce Combined Commerce) Commerce Combined
---------- --------- ---------- ----------- ---------- -----------
<S> <C> <C> <C> <C> <C> <C>
Interest income $ 80,440 $ 6,903 $ 87,343 $ 76,822 $ 5,518 $ 82,340
Interest expense 20,774 2,276 23,050 22,647 2,005 24,652
--------- --------- ---------- ---------- --------- ---------
Net interest income 59,666 4,627 64,293 54,175 3,513 57,688
Provision for credit losses 5,198 516 5,714 4,073 239 4,312
--------- --------- ---------- ---------- --------- ---------
Net interest income after
provision for loan losses 54,468 4,111 58,579 50,102 3,274 53,376
Noninterest income 20,210 860 21,070 14,016 920 14,936
Noninterest expense 53,262 4,282 57,544 44,479 3,086 47,565
--------- --------- ---------- ---------- --------- ---------
Net income before income
taxes 21,416 689 22,105 19,639 1,108 20,747
Provision for income taxes 6,654 222 6,876 6,390 377 6,767
--------- --------- ---------- ---------- --------- ---------
Net income $ 14,762 $ 467 $ 15,229 $ 13,249 $ 731 $ 13,980
========= ========= ========== ========== ========= =========
</TABLE>
5
<PAGE>
3. Earnings Per Common Share
Earnings per common share ("EPS") was computed based on the following (in
thousands, except per share amounts):
<TABLE>
<CAPTION>
Three Months Ended September 30, Nine Months Ended September 30,
1999 1998 1999 1998
------------------ -------------------- ------------------- -----------------
Per Per
Amount Share Amount Share Amount Per Share Amount Per Share
-------- ------- -------- -------- -------- ----------- -------- ----------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Net income $ 5,731 $ 5,103 $ 15,229 $ 13,980
========== ========= ========== ==========
Basic:
Weighted average shares
outstanding 25,920 $ 0.22 25,413 $ 0.20 25,737 $ 0.59 $ 25,093 $ 0.56
========= ======== ======== ========
Diluted:
Add incremental shares for:
Assumed exercise of
outstanding options 349 368 341 428
Assumed conversion of
preferred stock 173 477 184 689
--------- -------- -------- --------
Total 26,442 $ 0.22 26,258 $ 0.19 26,262 $ 0.58 26,210 $ 0.53
========= ========= ======== ========= ======== ======== ======= ========
</TABLE>
All previously reported amounts have been restated to reflect the acquisition of
Houston Commerce on June 1, 1999 and the acquisition of Hometown Bancshares,
Inc. on November 20, 1998, both of which were accounted for using the pooling of
interests method.
4. Shareholders' Equity
The following table displays the changes in shareholders' equity for the three
and nine-month periods ended September 30, 1999 and 1998 (in thousands):
<TABLE>
<CAPTION>
Three Months Ended September 30, Nine Months Ended September 30,
1999 1998 1999 1998
------------------ -------------------- ------------------- -----------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Equity, beginning of period $ 125,008 $ 102,793 $ 116,933 $ 93,813
Comprehensive income:
Net income $ 5,731 $ 5,103 $ 15,229 $ 13,980
Net change in net unrealized
losses on AFS securities 1,116 545 82 537
-------- -------- -------- --------
Total comprehensive
income 6,847 5,648 15,311 14,517
Issuance of common stock, 278 278 1,839 2,341
Common stock issued in exchange
for an additional 40%
interest in SCMC - 4,630 - 4,630
Redemption of common stock - - - (21)
Issuance of preferred stock - 394 31 394
Cash dividends paid (1,169) (883) (3,336) (2,880)
ESOP indebtedness repayments - 34 186 100
--------- --------- --------- ---------
Equity, end of period $ 130,964 $ 112,894 $ 130,964 $ 112,894
========= ========= ========= =========
</TABLE>
5. Segments
On July 2, 1998, Sterling Bank (the "Bank") acquired an additional 40 percent
interest in Sterling Capital Mortgage Company ("SCMC"), resulting in 80 percent
ownership in SCMC. Accordingly, the financial position and results of
operations of SCMC are reported on a consolidated basis with the Company.
Whereas previously earnings from SCMC were shown on the income statement as
"Equity in earnings from Sterling Capital Mortgage Company", earnings subsequent
to July 2, 1998 are shown as components of their natural classifications. The
commercial banking and mortgage banking segments are managed separately as each
business requires different marketing strategies and each offers different
products and services.
6
<PAGE>
The Company evaluates each segment's performance based on the profit or loss
from its operations before income taxes, excluding non-recurring items.
Intersegment financing arrangements are accounted for at current market rates as
if they were with third parties.
Summarized financial information by operating segment as of and for the nine-
month periods ended September 30, follows (in thousands):
<TABLE>
<CAPTION>
1999 1998
---------------------------------------------- ----------------------------------------------
Commercial Mortgage Commercial Mortgage
Banking Banking Total Banking Banking Total
----------- --------- -------- ----------- ---------- --------
<S> <C> <C> <C> <C> <C> <C>
Net interest income $ 64,293 $ - $ 64,293 $ 57,688 $ - $ 57,688
Noninterest income 11,317 9,753 21,070 10,687 3,754 14,441
Equity in earnings of SCMC - - - - 495 495
---------- ------ ---------- ---------- ------ ----------
Total revenue 75,610 9,753 85,363 68,375 4,249 72,624
Provision for credit losses 5,714 - 5,714 4,312 - 4,312
Noninterest expense 49,713 7,831 57,544 45,072 2,493 47,565
---------- ------ ---------- ---------- ------ ----------
Income before income taxes 20,183 1,922 22,105 18,991 1,756 20,747
Provision for income taxes 6,020 856 6,876 6,266 501 6,767
---------- ------ ---------- ---------- ------ ----------
Net income $ 14,163 $1,066 $ 15,229 $ 12,725 $1,255 $ 13,980
========== ====== ========== ========== ====== ==========
Total assets $1,796,784 $4,457 $1,801,241 $1,495,120 $3,334 $1,498,454
========== ====== ========== ========== ====== ==========
</TABLE>
Intersegment interest was paid to the Company by SCMC in the amount of $2.8
million for the nine-month period ended September 30, 1999. Total loans in a
mortgage warehouse of $45 million were eliminated in consolidation as of
September 30, 1999.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
FORWARD-LOOKING STATEMENTS
This report on Form 10-Q and other documents filed by the Company with
Securities and Exchange Commission contain forward-looking statements. By their
nature, forward-looking statements are subject to risks and uncertainties.
Forward-looking statements include information about possible or assumed future
financial results of the Company and are not guarantees of future performance.
Forward-looking statements can be identified by the fact that they do not relate
strictly to historical or current facts. They often include words such as
"believe," "expect," "anticipate," "intend," "plan," "estimate," or words of
similar meaning, or future or conditional verbs such as "will," "would,"
"should," "could," or "may." Forward looking-statement speak only as of the
date they are made. The Company does not undertake to update forward-looking
statements to reflect circumstances or events that occur after the date the
forward-looking statements are made.
Many possible events, circumstances or other factors could affect the future
financial performance of the Company. Accordingly, actual results may differ
materially from what is expressed or forecasted in, or implied by any
forward-looking statement. There are a broad range of factors, events, and
developments that could affect the Company's future financial results. The
Company's earnings and overall financial performance are sensitive to business
and economic conditions. For example, deteriorating national or local economic
conditions could decrease the demand for loan, deposit and other financial
services and/or increase loan delinquencies and defaults. Changes in market
rates and prices may adversely impact the value of securities, loans, deposits
and other financial instruments. Liquidity requirements could also be negatively
influenced by fluctuations in assets and liabilities or off-balance sheet
exposures. Fiscal and governmental policies of the United States federal
government also affect the Company's business and earnings prospects. Changes in
these policies are beyond the Company's control and are difficult to predict.
Competitive factors may also have a significant impact on the Company's business
and financial results. Legislative and regulatory developments may also have a
significant impact on the Company's future operations. The foregoing discussion
is merely a brief overview of the key factors that may affect the Company's
future business prospects and financial results and is not a complete list or
discussion of the full range of events, developments, facts and circumstances
that may influence the Company's operations, earnings or financial condition.
7
<PAGE>
SIGNIFICANT DEVELOPMENTS
Expansion - On June 1, 1999, the Company acquired B.O.A. Bancshares, Inc. and
its subsidiary Houston Commerce Bank. Houston Commerce Bank had assets and
deposits totaling $107 million and $92 million, respectively, at September 30,
1999. All previously reported amounts have been restated to reflect this
transaction which is accounted for using the pooling of interests method.
RESULTS OF OPERATIONS
NINE MONTHS ENDED SEPTEMBER 30, 1999 COMPARED TO SAME PERIOD IN 1998
NET INCOME - Net income for the nine-month period ended September 30, 1999, was
$15.2 million as compared to $14.0 million for the same period in 1998, an
increase of approximately $1.2 million or 8.9%. This increase is attributable to
continued solid loan and deposit growth and maintenance of a strong tax
equivalent net interest margin of 6.20% for the period.
NET INTEREST INCOME - Net interest income for the nine-month period ended
September 30, 1999, was $64.3 million, as compared to $57.7 million for the same
period in 1998, an increase of $6.6 million or 11.4%. The growth in net
interest income is attributable primarily to an increase in average earning
assets, enhanced by the maintenance of a strong net interest margin. Average
earning assets for the nine months ended September 30, 1999, were $1.4 billion,
up $118 million, or 9.2% from $1.3 billion for the same period in 1998. The
yield on average earning assets for the nine-month period ended September 30,
1999, was 8.30%, as compared to 8.54% for the same period in 1998. This
decrease is due primarily to an overall decline in interest rates. For the
first nine months of 1999, average total loans represented 74.8% of average
total interest earning assets, compared to 72.8% for the same period in 1998.
The cost of interest bearing liabilities declined 47 basis points
from 3.78% in 1998 to 3.31% in 1999. The Company's 6.20% tax equivalent net
interest margin for the first nine months of 1999 increased from the 6.04%
during the same period in 1998.
8
<PAGE>
The following schedule gives a comparative analysis of the Company's daily
average interest earning assets and interest bearing liabilities for the nine-
month periods ended September 30, 1999 and 1998, respectively:
CONSOLIDATED YIELD ANALYSIS
NINE MONTHS ENDED SEPTEMBER 30,
(Dollars in thousands)
<TABLE>
<CAPTION>
1999 1998
----------------------------------- ---------------------------------
Average Average
Balance Interest Yield Balance Interest Yield
---------- -------- ----- ---------- -------- -----
<S> <C> <C> <C> <C> <C> <C>
Interest Earning Assets:
Interest bearing deposits in financial institutions $ 2,054 $ 75 4.88% $ 7,347 $ 322 5.86%
Federal funds sold 33,281 1,288 5.17% 35,939 1,477 5.49%
Securities purchased under agreements to resell 35,538 1,698 6.39% 28,573 1,517 7.10%
Securities (taxable) 217,298 9,819 6.04% 248,168 11,459 6.17%
Securities (tax-exempt) 67,254 2,259 4.49% 31,239 1,124 4.81%
Loans (taxable) 1,051,682 72,172 9.18% 937,429 66,396 9.47%
Loans (tax-exempt) 595 32 7.19% 761 45 7.91%
---------- ------- ----- ---------- -------- -----
Total Interest Earning Assets 1,407,702 87,343 8.30% 1,289,456 82,340 8.54%
Noninterest Earning Assets:
Cash and due from banks 69,054 78,372
Premises and equipment, net 40,174 38,069
Other assets 55,878 26,940
Allowance for credit losses (12,120) (9,138)
---------- ----------
Total Noninterest Earning Assets 152,986 134,243
---------- ----------
Total Assets $1,560,688 $1,423,699
========== ==========
Interest Bearing Liabilities:
Demand and savings deposits $ 545,415 $ 9,390 2.30% $ 539,245 $ 11,711 2.90%
Certificates and other time deposits 345,938 12,121 4.68% 310,961 12,106 5.21%
Other borrowings 39,286 1,539 5.24% 22,182 835 5.03%
---------- ------- ----- ---------- -------- -----
Total Interest Bearing Liabilities 930,639 23,050 3.31% 872,388 24,652 3.78%
Noninterest Bearing Liabilities:
Demand deposits 465,137 407,795
Other liabilities 11,843 12,033
Trust preferred securities 28,750 28,750
Shareholders' equity 124,319 102,733
---------- ----------
630,049 551,311
---------- ----------
Total Liabilities and Shareholders' Equity $1,560,688 $1,423,699
========== ==========
Net Interest Income & Margin $64,293 6.11% $ 57,688 5.98%
======= ===== ======== =====
Net Interest Income & Margin (tax equivalent) $65,328 6.20% $ 58,209 6.04%
======= ===== ======== =====
</TABLE>
PROVISION FOR CREDIT LOSSES - The provision for credit losses for the first nine
months of 1999 was $5.7 million, as compared to $4.3 million for the same period
in 1998, an increase of $1.4 million or 32.5%. The majority of this increase in
the provision for credit losses is to provide for loan growth. Also, $335
thousand of this increase was due to an additional provision in 1999 for Houston
Commerce to align their methodology for establishing the allowance with that of
the Company. After net charge-offs of $3.2 million and provisions for the first
nine months of 1999, the Company's allowance for credit losses increased by $2.5
million from $10.8 million on December 31, 1998, to $13.3 million on September
30, 1999. Please refer to the subsequent discussion of FINANCIAL CONDITION --
ALLOWANCES FOR CREDIT LOSSES for additional insight to management's approach and
methodology in estimating the allowance for credit losses.
9
<PAGE>
NONINTEREST INCOME - Total noninterest income for the nine-month period ended
September 30, 1999 was $21.1 million, as compared to $14.9 million for the same
period in 1998, an increase of $6.1 million or 41.1%. As a result of the change
in reporting presentation described in Note 5 to the unaudited interim
consolidated financial statements included in Part I of this document,
noninterest income from SCMC of $9.8 million is now consolidated into the Bank's
income. For the first six months of 1998, the Company recorded equity earnings
of $495 thousand from SCMC. Additionally, in June 1998, the Humble office
obtained a condemnation award, net of legal fees, of $478 thousand for damages
to real property seized by the Texas Department of Transportation. In the first
quarter of 1999, the Company sold its banking office at the University of
Houston for a gain of $450 thousand. Customer service fees increased 6.1% and
other noninterest income increased 7.0% for the nine months ended September 30,
1999 compared with the same period in 1998. This compares to an increase in
average demand and savings accounts for the comparable periods of 5.5%.
Noninterest income for the nine months ended September 30, is summarized as
follows (in thousands):
<TABLE>
<CAPTION>
Nine Months Ended September 30, 1999 Nine Months Ended September 30, 1998
----------------------------------------- --------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Commercial Mortgage Commercial Mortgage
Banking Banking Combined Banking Banking Combined
----------------------------------------- --------------------------------------
NONINTEREST INCOME
Customer service fees $ 7,050 $ - $ 7,050 $ 6,642 $ - $ 6,642
Equity in earnings of
Sterling Capital Mortgage Company - - - - 495 495
Gain on the sale of
University of Houston office 450 - 450 - - -
Condemnation award - - - 478 - 478
Gain on sale of mortgage loans - 7,866 7,866 - 2,906 2,906
Other 3,817 1,887 5,704 3,567 848 4,415
----------------------------------------- --------------------------------------
Total $ 11,317 $ 9,753 $ 21,070 $ 10,687 $ 4,249 $ 14,936
========================================= =======================================
</TABLE>
The income from SCMC consists primarily of fees and gains on sale of mortgage
loans. These gains are from recurring loan production, as the average length of
time a mortgage loan is held in portfolio at SCMC is approximately twenty-five
to thirty days. During the first nine months of 1999, SCMC had $763 million in
loan fundings, or $254 million average per quarter compared to $260 million
for the third quarter of 1998. The gains on sale of mortgage loans of $2.9
million for the nine months ended September 30, 1998, represent third quarter
gains only as SCMC's earnings were not consolidated with the Bank's for the
first two quarters of 1998.
NONINTEREST EXPENSE - Noninterest expense increased $10.0 million, or 21.0%, to
$57.5 million for the first nine months of 1999 as compared to $47.6 million for
the same period in 1998. As discussed in the previous section, results of
operations from SCMC were included in their natural classifications subsequent
to July 2, 1998. This accounts for $5.3 million of the increase in noninterest
expense, as shown in the table below.
10
<PAGE>
Noninterest expense for the nine months ended September 30, is summarized as
follows (in thousands):
<TABLE>
<CAPTION>
NINE MONTHS ENDED SEPTEMBER 30, 1999 NINE MONTHS ENDED SEPTEMBER 30, 1998
------------------------------------ ------------------------------------
COMMERCIAL MORTGAGE COMMERCIAL MORTGAGE
BANKING BANKING COMBINED BANKING BANKING COMBINED
------------------------------------ ------------------------------------
<S> <C> <C> <C> <C> <C> <C>
NONINTEREST EXPENSE
Salaries and employee benefits $26,463 $4,775 $31,238 $22,953 $1,161 $24,114
Occupancy expense 6,936 1,591 8,527 5,866 515 6,381
Technology 2,634 43 2,677 3,080 - 3,080
Supplies 947 241 1,188 966 96 1,062
Professional fees 1,338 110 1,448 1,425 40 1,465
Minority interest expense 2,001 261 2,262 2,001 190 2,191
Other 9,394 810 10,204 8,781 491 9,272
-----------------------------------------------------------------------------
Total $49,713 $7,831 $57,544 $45,072 $2,493 $47,565
=============================================================================
</TABLE>
Salaries and employee benefits from commercial banking for the nine-month period
ended September 30, 1999, were $26.5 million, as compared to $23.0 million for
the same period in 1998, an increase of $3.5 million or 15.3%. The increase is
due to an increase in headcount as result of supporting a larger customer base
and a concentrated effort to increase loan growth. During 1998, the Bank opened
a new office location in Fort Bend County. Also, the Bank hired fifteen new
lenders during 1998 and six during 1999. The remaining increase in personnel
costs is attributable to normal market adjustments and cost-of-living pay
increases.
Occupancy expense relating to commercial banking for the nine-month period ended
September 30, 1999, was $6.9 million, as compared to $5.9 million for the same
period in 1998, an increase of 18.2%. This increase is the result of opening
the new office in Fort Bend County in May 1998, and leasing additional space for
the new cash management, brokerage services, trust administration and call
center areas, as well as for portions of the central departments which have now
outgrown the original central operations office.
Other noninterest expense from commercial banking for the nine-month period
ended September 30, 1999, was $9.4 million, as compared to $8.8 million for the
same period in 1998, an increase of $613 thousand or 7.0%. In 1999, the Company
expanded its marketing efforts by utilizing television advertising resulting in
increased marketing expenses of $496 thousand.
PROVISION FOR INCOME TAXES - The provision for income taxes as a percent of net
income before taxes decreased from 32.6% for the first nine months of 1998 to
31.1% for the first nine months of 1999. This decrease is related to the $1.1
million increase in interest income from tax-exempt securities. Additionally,
the Bank invested $25 million in bank-owned life insurance policies in August
1999. The $214 thousand of other income from these policies is tax-exempt.
THREE MONTHS ENDED SEPTEMBER 30, 1999 COMPARED TO SAME PERIOD IN 1998
NET INCOME - Net income for the three-month period ended September 30, 1999, was
$5.7 million as compared to $5.1 million for the same period in 1998, an
increase of approximately of $628 thousand or 12.3%. This increase is
attributable to continued solid loan and deposit growth and maintenance of a
strong tax equivalent net interest margin of 6.09% for the period.
NET INTEREST INCOME - Net interest income for the three-month period ended
September 30, 1999, was $22.4 million, as compared to $19.9 million for the same
period in 1998, an increase of $2.5 million or 12.4%. The growth in net
interest income is attributable primarily to an increase in average earning
assets, enhanced by the maintenance of a strong net interest margin. Average
earning assets for the three months ended September 30, 1999, were $1.5 billion,
up $152.2 million, or 11.4% from
11
<PAGE>
1.3 billion for the same period in 1998. The yield on average earning assets for
the three-month period ended September 30, 1999, was 8.33%, as compared to 8.42%
for the same period in 1998. This decrease is due primarily to an overall
decline in interest rates. The cost of interest bearing liabilities declined 21
basis points from 3.68% in 1998 to 3.47% in 1999. The Company's 6.09% tax
equivalent net interest margin for the third quarter of 1999 increased from
6.02% during the same period in 1998. This is the result of growth in average
noninterest bearing demand deposits of $47.8 million, or 11.2%, reinvestment of
earnings and issuance of stock resulting in an increase of average equity of
$18.0 million, or 16.2 %. However, the tax equivalent net interest margin for
the third quarter of 1999 declined from the 6.34% in the second quarter of 1999.
The decrease is a result of a leverage program initiated by the Bank in August
1999. Excluding the leverage program, the net interest margin would have been
6.29% for the third quarter of 1999. Please refer to the subsequent discussion
of FINANCIAL CONDITION - - SECURITIES for discussion of the leverage program.
The following schedule gives a comparative analysis of the Company's daily
average interest earning assets and interest bearing liabilities for the three-
month periods ended September 30, 1999 and 1998, respectively:
CONSOLIDATED YIELD ANALYSIS
THREE MONTHS ENDED SEPTEMBER 30,
(Dollars in thousands)
<TABLE>
<CAPTION>
1999 1998
------------------------------ ------------------------------
Average Average
Balance Interest Yield Balance Interest Yield
---------- -------- ----- ---------- -------- -----
<S> <C> <C> <C> <C> <C> <C>
Interest Earning Assets:
Interest bearing deposits in financial institutions $ 291 $ 3 4.09% $ 4,237 $ 65 6.09%
Federal funds sold 16,088 194 4.78% 46,783 645 5.47%
Securities purchased under agreements to resell 38,782 653 6.68% 36,090 646 7.10%
Securities (taxable) 257,614 4,047 6.23% 226,314 3,414 5.98%
Securities (tax-exempt) 76,113 845 4.40% 40,665 533 5.20%
Loans (taxable) 1,092,252 25,360 9.21% 974,721 22,914 9.33%
Loans (tax-exempt) 544 10 7.29% 716 15 8.31%
---------- ------- ----- ---------- ------- -----
Total Interest Earning Assets 1,481,684 31,112 8.33% 1,329,526 28,232 8.42%
Noninterest Earning Assets:
Cash and due from banks 62,335 76,133
Premises and equipment, net 40,607 38,864
Other assets 69,913 35,917
Allowance for credit losses (13,178) (9,807)
---------- ----------
Total Noninterest Earning Assets 159,677 141,107
---------- ----------
Total Assets $1,641,361 $1,470,633
========== ==========
Interest Bearing Liabilities:
Demand and savings deposits $ 555,986 $ 3,437 2.45% $ 548,559 $ 3,824 2.77%
Certificates and other time deposits 352,336 4,065 4.58% 325,150 4,202 5.13%
Other borrowings 88,306 1,227 5.51% 21,439 286 5.29%
---------- ------- ----- ---------- ------- -----
Total Interest Bearing Liabilities 996,628 8,729 3.47% 895,148 8,312 3.68%
Noninterest Bearing Liabilities:
Demand deposits 473,756 425,950
Other liabilities 13,281 9,814
Trust preferred securities 28,750 28,750
Shareholders' equity 128,946 110,971
---------- ----------
644,733 575,485
---------- ----------
Total Liabilities and Shareholders' Equity $1,641,361 $1,470,633
========== ==========
Net Interest Income & Margin $22,383 5.99% $19,920 5.94%
======= ===== ======= =====
Net Interest Income & Margin (tax equivalent) $22,762 6.09% $20,169 6.02%
======= ===== ======= =====
</TABLE>
12
<PAGE>
PROVISION FOR CREDIT LOSSES - The provision for credit losses for the third
quarter of 1999 was $1.9 million, as compared to $1.5 million for the same
period in 1998, an increase of $472 thousand or 32.4%. The increase in the
provision for credit losses is to provide for loan growth and a build up of the
reserve from $12.8 million at June 30, 1999 to $13.3 million at September 30,
1999.
NONINTEREST INCOME - Total noninterest income for the three-month period ended
September 30, 1999, was $7.1 million, as compared to $7.4 million for the same
period in 1998, a decrease of $185 thousand or 2.5%.
Noninterest income for the three months ended September 30, is summarized as
follows (in thousands):
<TABLE>
<CAPTION>
QUARTER ENDED SEPTEMBER 30, 1999 QUARTER ENDED SEPTEMBER 30, 1998
------------------------------------ ------------------------------------
COMMERCIAL MORTGAGE COMMERCIAL MORTGAGE
BANKING BANKING COMBINED BANKING BANKING COMBINED
------------------------------------ ------------------------------------
<S> <C> <C> <C> <C> <C> <C>
NONINTEREST INCOME
Customer service fees $2,527 $ - $2,527 $2,254 $ - $2,254
Gain on sale of mortgage loans - 2,703 2,703 - 2,906 2,906
Other 1,345 609 1,954 1,361 848 2,209
----------------------------------------------------------------------------
Total $3,872 $3,312 $7,184 $3,615 $3,754 $7,369
============================================================================
</TABLE>
Noninterest income from commercial banking increased 7.1% in the third quarter
of 1999 compared to 1998. This increase is comparable to the 5.7% increase in
average demand and savings accounts for the third quarter of 1999 compared to
1998.
Noninterest income from mortgage banking decreased $442 thousand, or 11.8%, in
the third quarter of 1999 compared to the same period in 1998. The decrease in
income was despite the fact that the mortgage company funded loans totaling $272
million for the third quarter of 1999, compared to $260 million in the third
quarter of 1998. The compression in income resulted from lower spreads derived
from the sale of mortgages.
NONINTEREST EXPENSE - Noninterest expense increased $1.1 million, or 6.3%, to
$19.3 million for the third quarter of 1999 as compared to $18.1 million for the
same period in 1998.
Noninterest expense for the three months ended September 30, is summarized as
follow (in thousands):
<TABLE>
<CAPTION>
QUARTER ENDED SEPTEMBER 30, 1999 QUARTER ENDED SEPTEMBER 30, 1998
------------------------------------ ------------------------------------
COMMERCIAL MORTGAGE COMMERCIAL MORTGAGE
BANKING BANKING COMBINED BANKING BANKING COMBINED
------------------------------------ ------------------------------------
<S> <C> <C> <C> <C> <C> <C>
NONINTEREST EXPENSE
Salaries and employee benefits $ 9,312 $1,630 $10,942 $ 8,022 $1,161 $ 9,183
Occupancy expense 2,295 524 2,819 2,027 515 2,542
Technology 762 34 796 809 - 809
Supplies 296 70 366 363 96 459
Professional fees 384 (34) 350 437 40 477
Minority interest expense 667 95 762 667 190 857
Other 2,890 326 3,216 3,285 491 3,776
----------------------------------------------------------------------------
Total $16,606 $2,645 $19,251 $15,610 $2,493 $18,103
============================================================================
</TABLE>
Salaries and employee benefits from commercial banking for the three-month
period ended September 30, 1999 were $9.3 million, as compared to $8.0 million
for the same period in 1998, an increase of $1.3 million or 16.1%. The increase
is primarily due to an increase in headcount resulting
13
<PAGE>
from the need to support a larger customer base and a concentrated effort to
increase loan growth. During 1998 the Bank opened a new office location in Fort
Bend County. Also, the Bank hired four new lenders during the third quarter of
1998 and six new lenders during the first nine months of 1999. The remaining
increase in personnel costs is attributable to normal market adjustments and
cost-of-living pay increases.
Occupancy expense relating to commercial banking for the three-month period
ended September 30, 1999, was $2.3 million, as compared to $2.0 million for the
same period in 1998, an increase of 13.2%. This increase is the result of
leasing space for the new Fort Bend office in November 1998, and leasing
additional space for the new cash management, brokerage services, trust
administration and call center areas, as well as for portions of the central
departments which have now outgrown the original central operations office.
Other noninterest expense from commercial banking for the three-month period
ended September 30, 1999, was $2.9 million, as compared to $3.3 million for the
same period in 1998, a decrease of $395 thousand or 12.0%. In the third quarter
of 1998, outdated computer equipment and software was written off at a loss of
$118 thousand. Additionally, the net losses (gains) and carrying costs of real
estate acquired by foreclosure decreased by $147 thousand from $153 thousand for
the three-month period ended September 30, 1998, to $6 thousand for the same
period in 1999. The Bank recorded gains on several foreclosed properties sold
in 1999 which offset the carrying costs of the properties.
PROVISION FOR INCOME TAXES - The provision for income taxes as a percent of net
income before taxes decreased from 34.0% for the third quarter of 1998 to 31.7%
for the third quarter of 1999. This decrease is related to the $312 thousand
increase in interest income from tax-exempt securities. Additionally, the Bank
invested $25 million in bank-owned life insurance policies in August 1999. The
$214 thousand of other income from these policies is tax-exempt.
FINANCIAL CONDITION
TOTAL ASSETS - The total consolidated assets of the Company increased $280.7
million or 18.5% from $1.5 billion on December 31, 1998, to $1.8 billion on
September 30, 1999.
CASH AND CASH EQUIVALENTS - The Company had cash and cash equivalents of $93.3
million at September 30, 1999. Comparatively, the Company had $139.7 million in
cash and cash equivalents on December 31, 1998, a decrease of $46.4 million or
33.2%. The decrease was due to the reinvestment of funds in loans, investment
securities and repurchase agreements.
SECURITIES PURCHASED UNDER AGREEMENTS TO RESELL - As of September 30, 1999,
securities purchased under agreements to resell totaled $37.4 million as
compared to $33.0 million as of December 31, 1998. The securities purchased are
SBA or USDA guaranteed loan certificates. These repurchase agreements generally
have a term of nine months or less.
SECURITIES - The Company's securities portfolio as of September 30, 1999,
totaled $452.3 million, as compared to $250.3 million on December 31, 1998, an
increase of $202.0 million or 80.7%. During the third quarter of 1999, the
Company initiated a leveraging strategy in order to enhance earnings by better
utilizing current levels of capital. Prior to the commencement of this leverage
program, the Company's balance sheet was asset sensitive. The leverage program,
taken alone, creates interest rate mismatch. However, taken together with the
core assets and liabilities of the Bank, the leverage program serves to mitigate
the interest rate risk of the Bank. This leveraging was achieved by borrowing
funds (primarily short-term FHLB advances) and investing these funds in fixed
and variable rate mortgage-backed securities and variable rate collateralized
mortgage obligations. This
14
<PAGE>
program accounted for an increase in assets at September 30, 1999 of
approximately $182 million and average assets of $62 million during the quarter.
LOANS HELD FOR SALE - Total loans held for sale decreased from $84.9 million at
December 31, 1998, to $45.2 million at September 30, 1999, a decrease of $39.7
million, or 46.7%. The decrease is partially due to the sale of the University
of Houston office on March 25, 1999, which held student loans of $9.7 million as
of December 31, 1998. Also, loans funded by the Bank through an intercompany
mortgage warehouse to SCMC decreased by $30.0 million as compared to December
31, 1998.
LOANS HELD FOR INVESTMENT - As of September 30, 1999, loans held for investment
were $1.09 billion. When compared to loans held for investment of $952.5
million on December 31, 1998, the loan balance at September 30, 1999, represents
a year-to-date increase of $135 million in internal loan production, net of loan
reductions, or an increase of 14.2%. At September 30, 1999, loans held for
investment as a percentage of assets and deposits were 60.4% and 77.1%, as
compared to 62.6% and 70.8% at December 31, 1998, respectively.
The following table summarizes the Company's held for investment loan portfolio
by type of loan as of September 30, 1999 (in thousands):
PERCENT OF
TOTAL
----------
Commercial, financial and industrial $ 393,792 34.77%
Real estate - commercial 301,239 26.60%
Real estate - residential mortgage 158,556 14.00%
Real estate - construction 113,583 10.03%
Foreign commercial and industrial 6,259 0.55%
Consumer and other 114,542 10.10%
Less unearned discount (480) -0.04%
---------- ------
Total loans held for investment 1,087,491 96.01%
Loans held for sale 45,192 3.99%
---------- ------
Total loans $1,132,683 100.00%
========== ======
ALLOWANCE FOR CREDIT LOSSES - The following is a summary of the changes in the
allowance for credit losses for the nine months ended September 30, 1999, and
the relationship of the allowance to total loans at September 30, 1999, and
December 31, 1998 (in thousands):
<TABLE>
<CAPTION>
<S> <C> <C>
Allowance for credit losses, December 31, 1998 $ 10,829
Charge-offs (3,739)
Recoveries 525
Provision for credit losses 5,714
---------
Allowance for credit losses, September 30, 1999 $ 13,329
==========
SEPTEMBER 30, DECEMBER 31,
1999 1998
------------- ------------
Loans held for investment at period-end $1,087,491 $952,518
Allowance for credit losses $ 13,329 $ 10,829
Allowance as a percent of period-end loans held
for investment 1.23% 1.14%
</TABLE>
In order to determine the adequacy of the allowance for credit losses,
management considers the risk classification and delinquency status of loans and
other factors. Management also establishes specific
15
<PAGE>
allowances for credits which management believes require allowances greater than
those allocated according to their risk classification. An unallocated allowance
is also established based on the Company's historical charge-off experience over
the last ten years. The Company will continue to monitor the adequacy of the
allowance for credit losses to determine the appropriate accrual for the
Company's provision for credit losses. See CONTINGENCIES AND UNCERTAINTIES--YEAR
2000 for a discussion of the analysis of the adequacy of the allowance for
credit losses with respect to Year 2000 credit risks.
RISK ELEMENTS - Nonperforming, past-due, and restructured loans are fully or
substantially secured by assets, with any excess of loan balances over
collateral values specifically allocated in the allowance for credit losses.
Twenty-one properties make up the $1.5 million of other real estate owned
("ORE") at September 30, 1999. All properties are carried at the current fair
market value, less estimated selling and holding costs.
The Company defines potential problem loans as those loans for which information
known by management creates serious doubt regarding a borrower's ability to
comply with the present payment terms. Management identifies these loans
through monitoring efforts by loan officers as well as its continuous loan
review process and defines potential problem loans as those loans classified as
"substandard", "doubtful", or "loss". As of September 30, 1999, the Company has
no material foreign loans outstanding or loan concentrations.
The following table summarizes total nonperforming assets and potential problem
loans at December 31, 1998 and at September 30, 1999:
SEPTEMBER 30, DECEMBER 31,
1999 1998
------------- ------------
(IN THOUSANDS)
Nonaccrual loans $ 7,547 $ 4,828
Restructured loans 219 312
Accruing loans past due 90 days
or more 564 824
------- -------
Total nonperforming loans 8,330 5,964
ORE and other foreclosed assets 1,819 2,321
------- -------
Total nonperforming assets $10,149 $ 8,285
======= =======
Total nonperforming loans as a
percent of gross loans held for
investment 0.77% 0.63%
Total nonperforming assets as a
percent of total assets 0.56% 0.54%
Potential problem loans, other than
those shown above as nonperforming $22,401 $20,870
PREMISES AND EQUIPMENT - The Company's premises and equipment, net of
depreciation, as of September 30, 1999, were $41.0 million as compared to $39.6
million as of December 31, 1998, an increase of $1.4 million or 3.5%. The
increase is primarily due to the build-out of the new office space leased for
the Bank's Memorial office.
DEPOSITS - Total deposits as of September 30, 1999, were $1.4 billion, as
compared to $1.3 billion on December 31, 1998, an increase of $64.9 million, or
4.8%. Noninterest bearing demand deposits at September 30, 1999, were $492.4
million, as compared to $469.2 million at December 31, 1998, an
16
<PAGE>
increase of $23.3 million or 5.0%. The percentage of noninterest bearing
deposits to total deposits as of September 30, 1999, continued to be strong at
34.9%.
CAPITAL RESOURCES AND LIQUIDITY
SHAREHOLDERS' EQUITY - The Company's risk-based capital ratios remain above the
levels designated by regulatory agencies as "well capitalized" on September 30,
1999, with Tier-1 Capital, Total Risk-Based Capital, and Leverage Capital Ratios
of 11.44%, 12.43%, and 8.91%, respectively.
LIQUIDITY - Effective management of balance sheet liquidity is necessary to fund
growth in earning assets and to pay liability maturities, depository withdrawals
and shareholders' dividends. The Company has instituted asset/liability
management policies, including a computer simulation model, to improve liquidity
controls and to enhance its management of interest rate risk and financial
condition. The Company has numerous sources of liquidity including a
significant portfolio of short-term assets, marketable investment securities
(excluding those presently classified as "held-to-maturity"), increases in
customers' deposits, and access to borrowing arrangements. Available borrowing
arrangements maintained by the Company include federal funds lines with other
commercial banks and an advancement arrangement with the Federal Home Loan Bank
("FHLB").
CONTINGENCIES AND UNCERTAINTIES--YEAR 2000
We include this discussion of the Year 2000 century date change to update the
discussion contained in our Annual Report on Form 10-K for the year ended
December 31, 1998.
GENERAL - This section contains forward-looking statements prepared based on our
best judgments and currently available information. These forward-looking
statements are subject to significant business, third-party, and regulatory
uncertainties and other contingencies, many of which are beyond our control.
These forward-looking statements are also based on our current internal
assessments and remediation plans, incorporating some representations of third-
party servicers, and are subject to change. We cannot assure you that our
results of operations will not be adversely affected by difficulties or delays
in our third parties' Year 2000 readiness efforts. See RISKS OF OUR YEAR 2000
ISSUES below for a discussion of factors that may cause such forward-looking
statements to differ from actual results.
The Year 2000 century date change involves the risk that computer programs and
systems may not perform without interruption into the Year 2000. If computer
systems do not correctly recognize the date change from December 31, 1999 to
January 1, 2000, computer applications that rely on the date field could fail or
create erroneous results. These erroneous results could affect interest
payments or due dates and could cause the temporary inability to process
transactions and to engage in ordinary business activities. Our failure or that
of our suppliers and borrowers to address the Year 2000 century date change
could have a material adverse effect on our financial condition, results of
operations, or liquidity.
THE COMPANY'S STATE OF READINESS - Management developed and commenced
implementation of a comprehensive plan in April 1997 to ensure that the
Company's operational and financial systems will not be adversely affected by
the Year 2000 century date change. In October 1995, the boards of directors of
the Company and the Bank approved a three-year technology plan, prior to formal
adoption of the Year 2000 Plan. The technology plan represented a comprehensive
program to reengineer and redesign our entire information systems,
telecommunications and technology infrastructure and resolved many of the
potential concerns that could be raised by the Year 2000 century date change.
17
<PAGE>
Implementation of the Company's Year 2000 Plan has been actively managed by the
Bank and regularly supervised by bank regulatory authorities. Our Year 2000
project management team, with representation from all functional and operational
areas of the Bank, has been working to ensure Year 2000 readiness. Four full-
time employees have been dedicated to the project team with the requisite level
of experience and knowledge to ensure that all mission critical applications are
Year 2000 compliant. In addition, we have retained experienced consultants to
assist in the assessment of Year 2000 risks to the Bank's loan portfolio and
overall asset quality. The board of directors of the Company and the Bank are
cognizant of the Year 2000 business risk, have formally reviewed and approved
the Year 2000 plan, and have committed the necessary resources for successful
completion of the project. Senior management is thoroughly involved in the Year
2000 compliance effort and has closely monitored this effort. Regular status
reports have been furnished to the Company's board of directors. All employees
have been required to attend training programs regarding the Year 2000 issue and
our plan.
Our Year 2000 project team has conducted a complete inventory of all systems,
applications and lines of business to assess and prioritize the potential risks
of any Year 2000 errors related to the integrity of our systems and
applications, the accuracy of data and critical information, and the operational
stability of all management information systems and bank office environments.
Based upon the risk priorities identified through the inventory and assessment
phase, we have tested all applications. As part of the testing process, we
constructed a stand alone network to safely test all networked systems and
applications. All mission critical applications and systems were deemed through
the testing and validation phases to be Year 2000 compliant but will be retested
throughout the remainder of 1999. Concerning non-information technology
systems, such as embedded microcontrollers, we have tested such things as vault
doors and alarm systems and we are not aware of any problems with such systems.
We have material relationships with several third party vendors whose failure to
address Year 2000 issues could have an adverse effect upon the operations or
financial condition of the Company. We have contacted each of these third party
vendors and requested Year 2000 plan and testing information. Rather than
relying upon the information furnished by our third party suppliers, we have
included the testing of all third party mission critical applications and
systems in our testing plans. In addition, we have contacted our major
borrowers and assessed their exposure to potential Year 2000 difficulties that
might adversely affect their ability to repay their indebtedness to the Bank.
Based upon our evaluation of the Bank's significant borrowers, we do not believe
that the Year 2000 century date change poses a material risk to the Company's
overall asset quality.
COSTS TO ADDRESS YEAR 2000 ISSUES - At this time, management cannot predict the
total cost associated with Year 2000 issues with absolute certainty. We spent a
combined total of $3.3 million during fiscal years 1996 through 1998 to upgrade
our core data processing, network communications, and teller systems. As part
of the selection process for any new systems or software applications, each
system and application upgrade was evaluated for Year 2000 compliance. We
estimate 1999 costs related to Year 2000 readiness will be $750 thousand. As of
September 30, 1999, the Bank had spent a total of $1.9 million specifically
related to Year 2000 readiness.
THE RISKS OF OUR YEAR 2000 ISSUES - Our significant possible Year 2000 risks
that could adversely impact our business operations and financial condition
include: the inability to process checks through the normal payment system; the
inability to post customer accounts or calculate interest accruals properly;
liquidity risks arising from customers' possible fears about the Year 2000
century date change; loan losses arising from the business impact of our
customers not being adequately prepared; and business interruption from vendors
who are not adequately prepared.
We do not expect any of these potential risks to have an adverse impact on our
operations.
18
<PAGE>
Nevertheless, we have developed contingency plans to address these
possibilities.
OUR CONTINGENCY PLANS - For the computer systems and facilities that we have
determined to be most critical, we completed the development, testing, and
adoption of business contingency and resumption plans as of June 30, 1999.
These plans conform to recently issued guidance from the Federal Financial
Institutions Examinations Council on Business Contingency Planning for Year 2000
readiness. Contingency plans include manual workarounds, identification of
resource requirements and alternative solutions for resuming critical business
processes in the event of a Year 2000 related failure. Testing and training of
the personnel necessary to deploy any of the business contingency and resumption
plans has been ongoing throughout 1999. We have also developed a liquidity plan
to address a potential increase in cash withdrawals by our depository customers
in anticipation of the Year 2000 century date change.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
There have been no material changes since December 31, 1998. See Form 10K, Item
7 "MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS -- INTEREST RATE SENSITIVITY AND LIQUIDITY".
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
Neither the Company nor any of its subsidiaries is presently involved in any
material legal proceedings.
ITEM 2. CHANGES IN SECURITIES
There were no changes in securities during the nine months ended September 30,
1999.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
STOCKHOLDER PROPOSALS FOR 2000 ANNUAL MEETING OF STOCKHOLDERS
Any proposal of stockholders to be included in the Company's proxy statement
relating to the Company's 2000 Annual Meeting of Stockholders pursuant to Rule
14a-8 under the Exchange Act must be received by the Company at its principal
executive offices no later than December 24, 1999; such proposal must also
comply with the Company's Bylaws and Rule 14a-8 if the proposal is to be
considered for inclusion in the Company's proxy statement for such meeting. The
Company must receive notice of any stockholder proposal to be brought before the
meeting outside the process of Rule 14a-8 at the Company's principal executive
offices not less than 45 days nor more than 180 days prior to the meeting;
provided, if the Company gives notice or prior public disclosure of the date of
the annual meeting less than 50 days before the meeting, such stockholders
notice must be received not later than the close of business on the seventh day
following the date on which the Company's notice of the date of the annual
meeting was mailed or public disclosure made. The form of such stockholder
notice must also comply with the Company's Bylaws.
19
<PAGE>
ITEM 5. OTHER INFORMATION
Not applicable.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
Exhibits:
EXHIBIT 11. COMPUTATION OF EARNINGS PER SHARE
Included as Note 3 to the Interim Consolidated Financial Statements on page 6 of
this Form 10-Q.
EXHIBIT 27. FINANCIAL DATA SCHEDULE
The required Financial Data Schedules have been included as Exhibit 27 of the
Form 10-Q filed electronically with the Securities and Exchange Commission.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused the report to be signed on its behalf by the
undersigned thereunto duly authorized.
STERLING BANCSHARES, INC.
(Registrant)
BY: /s/ George Martinez
---------------------------------------
GEORGE MARTINEZ
Chairman and Chief Financial Officer
20
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