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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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FORM 10-K
(Mark One)
[X]ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For fiscal year ended December 31, 2001
OR
[_]TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from to
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Commission File Number 0-20750
STERLING BANCSHARES, INC.
(Exact name of registrant as specified in its charter)
Texas 74-2175590
(State or other jurisdiction of (I.R.S. employer
Incorporation or organization) Identification number)
2550 North Loop West, Suite 600 77092
Houston, Texas (Zip Code)
(Address of principal executive
offices)
Registrant's telephone number, including area code: (713) 466-8300
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Securities registered pursuant to Section 12(b) of the Act: NONE
Securities registered pursuant to Section 12(g) of the Act:
Title of Each Class Shares Outstanding at December 31, 2001
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Common Stock, $1.00 Par Value... 43,769,664
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days: Yes [X] No [_]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K (17 CFR 229.405) is not contained herein, and will not
be contained, to the best of the registrant's knowledge, in definitive proxy
or information statements incorporated by reference in Part III of this Form
10-K or any amendment to this Form 10-K. [_]
The aggregate market value of the registrant's Common Stock held by non-
affiliates as of March 1, 2002, was $520,041,486 based on the closing sales
price of $13.66 on such date. For purposes of this calculation, non-affiliates
are defined as all directors and executive officers.
As of March 1, 2002, registrant had outstanding 43,782,080 shares of Common
Stock, $1.00 par value.
Documents incorporated by reference: Portions of Sterling Bancshares,
Inc.'s definitive proxy statement relating to the registrant's 2002 Annual
Meeting of Shareholders, which proxy statement will be filed under the
Securities Exchange Act of 1934 within 120 days of the end of the registrant's
fiscal year ended December 31, 2001, are incorporated by reference into Part
III of this Form 10-K.
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PART I
Item 1--Business
GENERAL
Sterling Bancshares, Inc. (the "Company"), headquartered in Houston, Texas,
is a bank holding company that provides commercial and retail banking services
primarily in the Houston, Dallas and San Antonio metropolitan areas through
the banking offices of Sterling Bank, Lone Star Bank and Community Bank, which
are banking associations chartered under the laws of the State of Texas.
(Sterling Bank, Lone Star Bank and Community Bank are collectively referred to
as the "Bank" or the "Banks".) The Company also provides mortgage banking
services through its 80 percent owned subsidiary, Sterling Capital Mortgage
Company ("SCMC").
The Company's principal executive offices are located at 2550 North Loop
West, Suite 600, Houston, Texas, 77092 and its telephone number is (713) 466-
8300. The Company was incorporated under the laws of the State of Texas in
1980 and became the parent bank holding company of Sterling Bank in 1981.
During 2001, the Company completed the acquisitions of CaminoReal Bancshares
of Texas, Inc., Lone Star Bancorporation, Inc. and Community Bancshares, Inc.
and as a result, became the parent bank holding company of CaminoReal Bank,
National Association, Lone Star Bank and Community Bank. CaminoReal Bank was
merged into Sterling Bank during 2001. Sterling Bank was chartered in 1974.
Lone Star Bank was chartered as a national bank in 1985 under the name First
National Bank of Highlands. Lone Star Bank changed its name to Lone Star Bank,
N.A. in July 1988, and on July 20, 1999, converted to a Texas banking
association under the name Lone Star Bank. The Company completed its initial
public offering on October 22, 1992.
The Company had approximately 1,014 and 622 full time equivalent employees,
including 274 and 61 officers, in its commercial banking and mortgage banking
segments, respectively, as of December 31, 2001. At December 31, 2001, the
Company had total assets of $2.8 billion, deposits of $2.3 billion, and
shareholders' equity of $217.4 million.
The Company has two operating segments: commercial banking and mortgage
banking. The segments are managed separately as they require different
marketing strategies and offer different products and services. See Note U to
the Consolidated Financial Statements for summarized financial information by
operating segment.
Commercial Banking
The Bank provides a wide range of retail and commercial banking services,
including demand, savings and time deposits; commercial, real estate and
consumer loans; merchant credit card services; letters of credit; and cash and
asset management services. In addition, the Bank facilitates sales of
brokerage, mutual fund, alternative financing and insurance products through
third party vendors. The deposits of the Bank are insured by the Bank
Insurance Fund ("BIF") of the Federal Deposit Insurance Corporation ("FDIC").
The primary lending focus of the Bank is providing commercial loans and
owner-occupied real estate loans to local businesses with annual sales ranging
from $300,000 to $30 million. Typically, the Bank's customers have financing
requirements between $50,000 and $500,000. The Bank does not seek loans of
more than $2 million but will consider larger lending relationships which
involve exceptional levels of credit quality. The Bank's credit range, while
well below its legal lending limit of $20 million, allows for greater
diversity in the loan portfolio, less competition from large banks, and better
pricing opportunities.
Business Banking Strategy. Under its business banking strategy, the Bank
focuses on a broad line of financial products and services to small and
medium-sized businesses through full service banking offices. Each banking
office has senior management with extensive lending experience. These managers
exercise substantial authority over credit and pricing decisions, subject to
loan committee approval for larger credits. This decentralized
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management approach, coupled with continuity of service by the same staff
members, enables the Bank to develop long-term customer relationships,
maintain high quality service and respond quickly to customer needs. The
Company believes that its emphasis on local relationship banking, together
with a conservative approach to lending, are important factors in the success
and growth of the Bank.
The Company and the Bank have maintained a strong community orientation by,
among other things, supporting the active participation of staff members in
local charitable, civic, school, religious and community development
activities. Each banking office may also appoint selected customers to a
business development board that assists in introducing prospective customers
to the Bank and in developing or improving products and services to meet
customer needs. As a result of the development of broad banking relationships
with customers and the convenience and service of the Company's thirty-eight
banking offices, lending and investing activities are funded primarily by core
deposits, over one-third of which are noninterest bearing demand deposits.
The Bank centralizes operational and support functions that are transparent
to customers in order to achieve consistency and cost efficiencies in the
delivery of products and services by each banking office. The central office
provides services such as data processing, bookkeeping, accounting, treasury
management, loan administration, loan review, compliance, risk management and
internal auditing to enhance their delivery of quality service. The Company
also provides overall direction in the areas of credit policy and
administration, strategic planning, marketing, investment portfolio management
and other financial and administrative services. The banking offices work
closely with the Company to develop new products and services needed by their
customers and to introduce enhancements to existing products and services.
Mortgage Banking
The Company originates, sells and services single family residential
mortgages through its 80 percent ownership of SCMC. SCMC has production
offices in Texas and eleven other states, with corporate offices in Houston,
Texas and Seattle, Washington. The typical mortgage originated by SCMC is
approximately $135,000. A substantial portion of SCMC's loan production is
generated through joint ventures known as affiliated business arrangements
with established home builders and realtor-based organizations. SCMC is an
approved Government National Mortgage Association ("GNMA") issuer of mortgage-
backed securities. SCMC is also an approved Federal National Mortgage
Association ("FNMA"), Federal Home Loan Mortgage Corporation ("FHLMC")
seller/servicer and a HUD-Approved Title II nonsupervised mortgagee. During
2001, SCMC funded approximately $2.6 billion in residential mortgage loans.
Expansion
The Company's growth strategy has been concentrated on increasing its
banking presence in the greater Houston area and on entering both the Dallas
and San Antonio markets. The Company has grown through a combination of
internal growth, mergers and acquisitions and the opening of new banking
offices.
De Novo Offices. In March 2001, the Company opened a new banking office in
Deer Park.
In December 2000, the Company opened a new banking office in Dallas. This
is the Company's first office outside of the Houston market. In connection
with the opening of this office, the Company's Board designated 50,000 shares
of Series I convertible preferred stock and authorized the offering and sale
of such shares to investors who may assist in the business development efforts
of the office. Subscriptions for a total of 20,000 of the preferred shares
have been received by the Company. The offering of the Series I convertible
preferred stock has terminated and it is anticipated that the shares will be
issued prior to March 31, 2002. The Series I convertible preferred shares will
be convertible into a maximum of 25,000 shares of the Company's common stock.
The conversion ratio is dependent upon the Dallas office meeting certain
performance goals.
In April 2000, the Company opened a new banking office in Bellaire. In
conjunction with the opening of this office, the Company's Board designated
50,000 shares of Series H convertible preferred stock and authorized the
offering and sale of such shares to investors who may assist in the business
development efforts of the office. A total of 39,000 of the preferred shares
were actually sold. The Series H preferred shares will be convertible into a
maximum of 73,125 shares of the Company's common stock. The conversion ratio
is dependent upon the Bellaire office meeting certain performance goals.
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Mergers and Acquisitions. On December 17, 2001, the Company acquired
Community Bancshares, Inc. and its subsidiary bank, Community Bank in a stock
and cash merger. The shareholders of Community Bancshares, Inc. received $14.6
million in cash and 1,443,753 shares of the Company's common stock for all of
the outstanding shares of common stock of Community Bancshares, Inc. The stock
issuance occurred after the three-for-two stock split effected by the Company
in September 2001. Community Bank operates two banking offices in west
Houston. As of December 31, 2001, Community Bank had total assets of $155
million, loans of $80 million and deposits of $114 million. The Company plans
to merge Community Bank into Sterling Bank in the second quarter of 2002. This
acquisition was accounted for using the purchase method of accounting.
Goodwill of $28.7 was recorded in connection with this acquisition.
On August 23, 2001, the Company acquired Lone Star Bancorporation, Inc. and
its subsidiary bank, Lone Star Bank in a stock-for-stock merger. The
shareholders of Lone Star Bancorporation, Inc. received an aggregate of 1.76
million shares of the Company's common stock for all of the outstanding shares
of common stock of Lone Star Bancorporation, Inc. The stock issuance occurred
prior to the three-for-two stock split effected by the Company in September
2001. All previously reported amounts have been restated to reflect this
transaction which was accounted for using the "pooling of interests" method.
Lone Star Bank operated four banking offices in the Houston metropolitan area.
As of December 31, 2001, Lone Star Bank had total assets of $170 million,
loans of $123 million and deposits of $154 million. The Company merged Lone
Star Bank into Sterling Bank in February 2002.
On March 22, 2001, the Company acquired CaminoReal Bancshares of Texas,
Inc. and its subsidiary bank, CaminoReal Bank, National Association, for an
aggregate cash purchase price of $51.8 million. CaminoReal Bank has four
banking offices in San Antonio, Texas and four banking offices in the south
Texas cities of Eagle Pass, Carrizo Springs, Crystal City and Pearsall. During
June 2001, the Company completed the operational integration of CaminoReal
Bank and Sterling Bank. This acquisition was accounted for using the purchase
method of accounting. Goodwill of $21.2 million was recorded in connection
with this acquisition.
On June 1, 1999, the Company acquired B.O.A. Bancshares, Inc. and its
subsidiary Houston Commerce Bank in exchange for 1,854,600 shares of the
Company's common stock. All previously reported amounts have been restated to
reflect this transaction which was accounted for using the "pooling of
interests" method. The acquisition of B.O.A. Bancshares added $115 million in
total assets and $103 million in total deposits to the Company's balance
sheet. Houston Commerce Bank operated three locations in Houston. During
October 1999, the Company merged Houston Commerce Bank into Sterling Bank.
On November 20, 1998, the Company acquired Hometown Bancshares, Inc., which
was the bank holding company for Clear Lake National Bank, in a stock-for-
stock merger. The acquisition of Hometown added $92 million in total assets
and $84 million in total deposits to the Company's balance sheet. Clear Lake
National Bank operated two locations in the Clear Lake area of southeast
Houston. All previously reported amounts have been restated to reflect this
transaction which was accounted for using the "pooling of interests" method.
During April 1999, the Company merged Clear Lake National Bank into Sterling
Bank.
On June 30, 1998, Humble National Bank was acquired by the Company in a
stock-for-stock merger. The acquisition of Humble added $54 million in total
assets and $49 million in total deposits to the Company's balance sheet.
Humble operated a full service banking office in the Humble area of northeast
Houston. All previously reported amounts have been restated to reflect this
transaction which was accounted for using the "pooling of interests" method.
During August 1998, the Company merged Humble into Sterling Bank.
On September 30, 1997, the Company completed the acquisition of First
Houston Bancshares, Inc. and its wholly owned subsidiary bank, Houston
National Bank, in a stock-for-stock merger. The acquisition of First Houston
added $135 million in total assets and $125 million in total deposits to the
Company's balance sheet. All previously reported amounts have been restated to
reflect this transaction which was accounted for using the "pooling of
interests" method. In October 1997, Houston National was merged into the Bank
adding the Bayou Bend Office to the Bank's expanding office network.
The Company will continue to seek acquisition and new office opportunities
when available and consistent with its business banking philosophy. To
accommodate further growth, the Company will continue to upgrade its
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central office data processing and telecommunication systems and facilities to
provide the Company with the technological capacity necessary to meet the
needs and expectations of its customers.
Competition
The Company engages in highly competitive activities. Each activity and
market served involves competition with other banks and mortgage companies, as
well as with non-banking and non-financial enterprises that offer financial
products and services that compete directly with the Company's product and
service offerings. The Company actively competes with other banks, mortgage
companies and other financial service companies in its efforts to obtain
deposits and make loans, in the scope and types of services offered, in
interest rates paid on time deposits and charged on loans, and in other
aspects of banking.
In addition to competing with other banks and mortgage companies, the
Company competes with other financial institutions engaged in the business of
making loans or accepting deposits, such as savings and loan associations,
credit unions, industrial loan associations, insurance companies, small loan
companies, finance companies, real estate investment trusts, certain
governmental agencies, credit card organizations and other enterprises. In
recent years, competition for money market accounts from securities brokers
has also intensified. Additional competition for deposits comes from
government and private issues of debt obligations and other investment
alternatives for depositors such as money market funds. The Bank also competes
with a variety of other institutions in providing brokerage services.
SUPERVISION AND REGULATION
References herein to applicable statutes and regulations are brief
summaries, do not purport to be complete and are qualified in their entirety
by reference to such statutes and regulations.
The Bank Holding Company
The Company and its second tier holding company, Sterling Bancorporation,
Inc., are bank holding companies registered under the Bank Holding Company Act
of 1956, as amended ("BHCA"), and are subject to supervision and regulation by
the Federal Reserve Board. Federal laws subject bank holding companies to
particular restrictions on the types of activities in which they engage, and
to a range of supervisory requirements and activities, including regulatory
enforcement actions for violations of laws and policies. In addition, Texas
law authorizes the Texas Department of Banking to supervise and regulate a
holding company controlling a state bank.
Permissible Activities
As a bank holding company, the activities of the Company, as well as the
activities of entities which are controlled by the Company or of which the
Company owns 5% or more of the voting securities, are limited by the BHCA to
banking, management and control of banks, furnishing or performing services
for its subsidiaries, or any other activity which the Federal Reserve Board
determines to be incidental or closely related to banking or managing or
controlling banks. However, the Gramm-Leach-Bliley Act enacted in 2000 amended
the BHCA and granted certain expanded powers to bank holding companies. See
discussion below under "Recently Enacted Legislative and Regulatory Changes."
In approving acquisitions by the Company of entities engaged in banking-
related activities, the Federal Reserve Board considers a number of factors,
including the expected benefits to the public, such as greater convenience and
increased competition or gains in efficiency, which are weighted against the
risks of possible adverse effects, such as an attempt to monopolize the
business of banking, undue concentration of resources, decreased or unfair
competition, conflicts of interest, or unsound banking practices.
Mortgage Company
SCMC is an approved GNMA issuer of mortgage-backed securities. SCMC is also
an approved FNMA and FHLMC seller/servicer and a HUD-Approved Title II
nonsupervised mortgagee. As such, SCMC must operate
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under certain guidelines set forth by GNMA, FNMA, FHLMC and HUD. As a majority
owned subsidiary of a bank holding company, SCMC is also subject to the
regulatory authority of the FDIC, the Texas Department of Banking and the
Federal Reserve Board.
Non-Banking Activities
The BHCA sets forth exceptions to its general prohibition against bank
holding company ownership of voting shares in any company engaged in non-
banking activities. The exceptions include certain activities exempt based
upon the type of activity and those determined by the Federal Reserve Board to
be closely related to banking or managing or controlling banks. The Economic
Growth and Regulatory Paperwork Reduction Act of 1996 ("EGRPRA"), streamlined
the non-banking activities application process for bank holding companies
which qualify as well-capitalized and well-managed. Also, see discussion of
the Gramm-Leach-Bliley Act, which amends certain portions of the BHCA, under
the "Recently Enacted Legislative and Regulatory Changes" caption below.
Recently Enacted Legislative and Regulatory Changes
The Gramm-Leach-Bliley ("G-L-B") Act, which became effective in 2000,
authorizes affiliations between banking, securities and insurance firms and
authorizes bank holding companies and state banks, if permitted by state law,
to engage in a variety of new financial activities. Bank holding companies may
also elect to become financial holding companies if they meet certain
requirements relating to capitalization and management and have filed a
declaration with the Federal Reserve Board electing to be a financial holding
company. Among the new activities that will be permitted by bank holding
companies are securities and insurance brokerage, securities underwriting,
insurance underwriting and merchant banking. The Federal Reserve Board, in
consultation with the Department of Treasury, may approve additional financial
activities.
The G-L-B Act also imposes new requirements on financial institutions with
respect to customer privacy. The G-L-B Act generally prohibits disclosure of
customer information to non-affiliated third parties unless the customer has
been given the opportunity to object and has not objected to such disclosure.
Financial institutions are further required to disclose their privacy policies
to customers annually. Financial institutions, however, will be required to
comply with state law if it is more protective of customer privacy than the G-
L-B Act. The privacy provisions became effective on July 1, 2001.
The G-L-B Act contains a variety of other provisions including a
prohibition against ATM surcharges unless the customer has first been provided
notice of the imposition and amount of the fee.
The Company has not filed an election to be a financial holding company. At
this time, the Company is unable to predict the impact of the authorized
affiliations and new financial activities permitted by the G-L-B Act on its
operations. However, the Company is currently in compliance with the customer
privacy requirements of the G-L-B Act.
On October 26, 2001, President Bush signed the USA Patriot Act of 2001.
Enacted in response to the terrorist attacks in New York, Pennsylvania and
Washington, D.C. on September 11, 2001, the Patriot Act is intended to
strengthen U.S. law enforcement's and the intelligence communities' ability to
work cohesively to combat terrorism on a variety of fronts. The potential
impact of the Patriot Act on financial institutions of all kinds is
significant and wide ranging. The Patriot Act contains sweeping anti-money
laundering and financial transparency laws and requires various regulations,
including:
. due diligence requirements for financial institutions that administer,
maintain, or manage private bank accounts or correspondent accounts for
non-U.S. persons;
. standards for verifying customer identification at account opening;
. rules to promote cooperation among financial institutions, regulators,
and law enforcement entities in identifying parties that may be involved
in terrorism or money laundering;
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. reports by nonfinancial trades and business filed with the Treasury
Department's Financial Crimes Enforcement Network for transactions
exceeding $10,000; and
. filing of suspicious activities reports involving securities by brokers
and dealers if they believe a customer may be violating U.S. laws and
regulations.
The Company is not able to predict the impact of such law on its financial
condition or results of operations at this time.
Safety and Soundness Standards
The Financial Institutions Reform, Recovery and Enforcement Act of 1989
("FIRREA") expanded the Federal Reserve Board's authority to prohibit
activities of bank holding companies and their non-banking subsidiaries which
represent unsafe and unsound banking practices or which constitute violations
of laws or regulations. Notably, FIRREA increased the amount of civil money
penalties that the Federal Reserve Board can assess for certain activities
conducted on a knowing and reckless basis, if those activities cause a
substantial loss to a depository institution. The penalties can be as high as
$1 million per day. FIRREA also expanded the scope of individuals and entities
against which such penalties may be assessed.
On July 10, 1995, the four federal agencies that regulate banks and savings
associations (FDIC, Federal Reserve Board, the Office of the Comptroller of
the Currency and the Office of Thrift Supervision) jointly issued guidelines
for safe and sound banking operations (Interagency Guidelines Establishing
Standards for Safety and Soundness) as required by Section 132 of the Federal
Deposit Insurance Corporation Improvement Act ("FDICIA"). The guidelines
identify the fundamental standards that the four agencies follow when
evaluating the operational and managerial controls at insured institutions. An
institution's performance will be evaluated against these standards during the
regulators' periodic on-site examinations.
Dividend Restrictions
It is the policy of the Federal Reserve Board that bank holding companies
should pay cash dividends on common stock only out of income available over
the past year and only if prospective earnings retention is consistent with
the organization's expected future needs and financial condition. The policy
provides that bank holding companies should not maintain a level of cash
dividends that undermines the bank holding company's ability to serve as a
source of strength to its banking subsidiaries.
Under Federal Reserve Board policy, a bank holding company is expected to
act as a source of financial strength to each of its banking subsidiaries and
commit resources to their support. Such support may be required at times when,
absent this Federal Reserve Board policy, a bank holding company may not be
inclined to provide it.
Capital Adequacy Requirements
The Bank is subject to the capital adequacy requirements promulgated by the
FDIC and the Texas Department of Banking. In addition, the Federal Reserve
Board monitors the capital adequacy of bank holding companies.
The Federal Reserve Board has adopted a system using risk-based capital
adequacy guidelines to evaluate the capital adequacy of bank holding
companies. Under the risk-based capital guidelines, different categories of
assets are assigned different risk weights, based generally on the perceived
credit risk of the asset. These risk weights are multiplied by corresponding
asset balances to determine a "risk-related" asset base. Certain off balance
sheet items are added to the risk-weighted asset base by converting them to a
balance sheet equivalent and assigning to them the appropriate risk weight. In
addition, the guidelines define each of the capital components. Total capital
is defined as the sum of "core capital elements" ("Tier 1") and "supplemental
capital elements" ("Tier 2"), with "Tier 2" being limited to 100% of "Tier 1."
For bank holding companies, "Tier 1"
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capital includes, with certain restrictions, common shareholders' equity,
perpetual preferred stock, and minority interest in consolidated subsidiaries.
"Tier 2" capital includes, with certain limitations, certain forms of
perpetual preferred stock, as well as maturing capital instruments and the
reserve for credit losses. The guidelines require achievement of a minimum
ratio of total capital-to-risk-weighted assets of 8.0% (of which at least 4.0%
is required to be comprised of "Tier 1" capital elements). At December 31,
2001, the Company's ratios of "Tier 1" and "Total" capital-to-risk-weighted
assets were 9.64%, and 10.66%, respectively.
In addition to the risk-based capital guidelines, the Federal Reserve Board
and the FDIC have adopted the use of a minimum "Tier 1" leverage ratio as an
additional tool to evaluate the capital adequacy of banks and bank holding
companies. The banking organization's "Tier 1" leverage ratio is defined to be
a company's "Tier 1" capital divided by its average total consolidated assets.
The leverage ratio adopted by the federal banking agencies requires a minimum
3.0% "Tier 1" capital to total assets ratio for institutions with the highest
regulatory rating. All other institutions will be expected to maintain a
leverage ratio of 4.0% to 5.0%. The Company's leverage ratio at December 31,
2001 of 8.40% significantly exceeded the regulatory minimum.
Imposition of Liability for Undercapitalized Subsidiaries
A bank holding company that fails to meet the applicable risk-based capital
standards will be at a disadvantage. For example, Federal Reserve Board policy
discourages the payment of dividends by a bank holding company from borrowed
funds as well as payments that would adversely affect capital adequacy.
Failure to meet the capital guidelines may result in the institution of
supervisory or enforcement actions by the Federal Reserve Board. FDICIA
requires bank regulators to take "prompt corrective action" to resolve
problems associated with insured depository institutions whose capital
declines below certain levels.
Audit Reports
The regulations promulgated by the FDIC to implement FDICIA subjects
depository institutions with assets of $500 million or more to certain audit
and reporting requirements. FDICIA requires insured institutions to submit
annual audit reports prepared by independent auditors to federal and state
regulators. The audit report of the institution's holding company can be used
to satisfy this requirement. Auditors must apply procedures agreed to by the
FDIC to determine compliance by the institution or holding company with legal
requirements designated by FDICIA. The annual audit report must include
financial statements prepared in accordance with generally accepted accounting
principles, statements concerning management's responsibility for the
financial statements and internal controls designated by the FDIC, and an
attestation by the auditor regarding the statements of management. For certain
large institutions, independent auditors may be required to review quarterly
financial statements. FDICIA requires that independent audit committees be
formed, consisting solely of outside directors. The Company has an audit
committee comprised soley of outside directors with at least one certified
public accountant and, therefore, is in compliance with the requirements for
large institutions.
Acquisitions by Bank Holding Companies
The BHCA requires a bank holding company to obtain the prior approval of
the Federal Reserve Board before it acquires all or substantially all of the
assets of any bank, or ownership or control of any voting shares of any bank,
if after such acquisition it would own or control, directly or indirectly,
more that 5% of the voting shares of such bank. In approving bank
acquisitions, the Federal Reserve Board considers the financial and managerial
resources and future prospects of the bank holding company and the banks
concerned, the convenience and needs of the communities to be served, and
various competitive factors. The Attorney General of the United States may,
within 30 days after approval of an acquisition by the Federal Reserve Board,
bring an action challenging such acquisition under the federal antitrust laws,
in which case the effectiveness of such approval is stayed pending a final
ruling by the courts.
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Community Reinvestment Act
The Community Reinvestment Act of 1977 ("CRA") and the regulations
promulgated by the FDIC to implement CRA are intended to ensure that banks
meet the credit needs of their service area, including low and moderate income
communities and individuals, consistent with safe and sound banking practices.
The CRA regulations also require the banking regulatory authorities to
evaluate a bank's record in meeting the needs of its service area when
considering applications to establish new offices or consummate any merger or
acquisition transaction. Under FIRREA, the federal banking agencies are
required to rate each insured institution's performance under CRA and to make
such information publicly available. In the case of an acquisition by a bank
holding company, the CRA performance records of the banks involved in the
transaction are reviewed as part of the processing of the acquisition
application. A CRA rating other than "outstanding" or "satisfactory" can
substantially delay or block a transaction. Based upon its most recent
examination, Sterling Bank has a satisfactory CRA rating.
Interstate Banking
The Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994
(the "Interstate Branching Act") increased the ease and likelihood of
interstate branching throughout much of the United States. The Interstate
Branching Act removes state law barriers to acquisitions in all states and
allows multi-state banking operations to merge into a single bank with
interstate branches. Interstate banking and branching authority will be
subject to certain conditions and restrictions, such as capital adequacy,
management and CRA compliance. The Interstate Branching Act preempts existing
barriers that restrict entry into all states, such as regional compacts and
reciprocal agreements, thus creating opportunities for expansion into markets
that were previously closed. Under the Interstate Branching Act, bank holding
companies are now able to acquire banks in any state, subject to certain
conditions. Banks acquired pursuant to this authority may subsequently be
converted to branches. Interstate branching is permitted by allowing banks to
merge across state lines to form a single institution. Interstate merger
transactions can be used to consolidate existing multi-state operations or to
acquire new branches. A bank may establish a new branch as its initial entry
into a state only if the state has authorized de novo branching. In addition,
out-of-state banks may merge with a single branch of a bank if the state has
authorized such a transaction. The Federal Reserve Board, however, will only
allow the acquisition by a bank holding company of an interest in any bank
located in another state if the statutory laws of the state in which the
target bank is located expressly authorize such acquisitions. The interstate
branching provisions became effective on June 1, 1997, unless a state took
action before that time. Texas elected to "opt out" of the Interstate
Branching Act. Despite Texas' having opted out of the Interstate Branching
Act, the Texas Banking Act permits, in certain circumstances, out-of-state
bank holding companies to acquire certain existing banks and bank holding
companies in Texas.
Sterling Bank, Lone Star Bank and Community Bank
Sterling Bank, Lone Star Bank and Community Bank are Texas-chartered
banking associations. The Banks' deposits are insured by the FDIC. Therefore,
the Banks are subject to supervision and regulation by both the Texas
Department of Banking and the FDIC. Pursuant to such regulation, the Banks are
subject to special restrictions, supervisory requirements and potential
enforcement actions. Sterling Bank is not a member of the Federal Reserve
System; however, the Federal Reserve Board also has supervisory authority that
directly affects the Bank. Lone Star and Community Bank are members of the
Federal Reserve System and are therefore subject to the supervision and
regulation of the Federal Reserve Board. Sterling Bank and Community Bank are
members of the Federal Home Loan Bank and, therefore, are also subject to
compliance with its requirements.
Permissible Activities for State-Chartered Institutions
The Texas Constitution provides that a Texas-chartered bank has the same
rights and privileges that are or may be granted to national banks domiciled
in Texas. To the extent that the Texas laws and regulations may have allowed
state-chartered banks to engage in a broader range of activities than national
banks, FDICIA has
9
operated to limit this authority. FDICIA provides that no state bank or
subsidiary thereof may engage as principal in any activity not permitted for
national banks, unless the institution complies with applicable capital
requirements and the FDIC determines that the activity poses no significant
risk to the Bank Insurance Fund ("BIF").
Branching
Texas law provides that a Texas-chartered bank can establish a branch
anywhere in Texas provided that the branch is approved in advance by the
Commissioner of the Texas Department of Banking (the "Commissioner"). The
branch must also be approved by the FDIC, which considers a number of factors,
including financial history, capital adequacy, earnings prospects, character
of management, needs of the community, and consistency with corporate powers.
There are no federal limitations on the ability of insured non-member state
banks to branch across state lines; however, such branching would be subject
to applicable state law restrictions.
Restrictions on Subsidiary Banks
Dividends paid by the Bank provided substantially all of the Company's cash
flow during 2001 and will continue to do so in the foreseeable future. Under
federal law, the Bank may not pay a dividend that results in an
"undercapitalized" situation. At December 31, 2001, there was an aggregate of
approximately $60.6 million available for the payment of dividends by the Bank
to the Company without prior regulatory approval.
Other requirements in Texas law affecting the operation of subsidiary banks
include requirements relating to maintenance of reserves against deposits,
restrictions on the nature and amount of loans that may be made and the
interest that may be charged thereon and limitations relating to investments
and other activities.
Examinations
The FDIC periodically examines and evaluates insured banks. FDIC
examinations are conducted every 12 months. The FDIC may, however, accept the
result of a Texas Department of Banking examination in lieu of conducting an
independent examination. FDICIA authorizes the FDIC to assess the institution
for its costs of conducting the examinations.
The Commissioner also conducts examinations annually, unless additional
examinations are deemed necessary to safeguard the interests of shareholders,
depositors and creditors. The Commissioner may accept the results of a federal
examination in lieu of conducting an independent examination. However, since
the total assets of the Bank exceed $1 billion, the FDIC and the Texas
Department of Banking jointly examine the Bank on an annual basis.
Deposit Insurance Assessments
The FDIC assesses deposit insurance premiums on all banks in order to
adequately fund the BIF so as to resolve any insured institution that is
declared insolvent by its primary regulator. The FDIC has established a risk-
based deposit insurance premium system to calculate a depository institution's
semi-annual deposit insurance assessment. The FDIC's semi-annual assessment is
based upon the designated reserve ratio for the deposit insurance fund and the
probability and extent to which the deposit insurance fund will incur a loss
with respect to the institution. In addition, the FDIC can impose special
assessments to cover the cost of borrowings from the U.S. Treasury, the
Federal Financing Bank, and BIF member banks.
The FDIC established a process for raising or lowering all rates for
insured institutions semi-annually if conditions warrant a change. Under this
new system, the FDIC has the flexibility to adjust the assessment rate
schedule twice a year without seeking prior public comment, but only within a
range of five cents per $100 above or below the premium schedule adopted. The
FDIC can make changes in the rate schedule outside the five-cent range above
or below the current schedule only after a full rulemaking with opportunity
for public comment.
10
In 1996, a law was passed that contained a comprehensive approach to
recapitalizing the Savings Association Insurance Fund ("SAIF") and to assure
the payment of the Financing Corporation's ("FICO") bond obligations. Under
this act, banks insured under the BIF are required to pay a portion of the
interest due on bonds that were issued by FICO to help shore up the ailing
Federal Savings and Loan Insurance Corporation in 1987. With regard to the
assessment for the FICO obligation, the current BIF and SAIF rate is .0182% of
deposits.
Expanding Enforcement Authority
One of the major additional impacts imposed on the banking industry by
FDICIA is the increased ability of banking regulators to monitor the
activities of banks and their holding companies. In addition, the Federal
Reserve Board and FDIC have extensive authority to police unsafe or unsound
practices and violations of applicable laws and regulations by depository
institutions and their holding companies. For example, the FDIC may terminate
the deposit insurance of any institution which it determines has engaged in an
unsafe or unsound practice. The agencies can also assess civil money
penalties, issue cease and desist or removal orders, seek injunctions, and
publicly disclose such actions. FDICIA, FIRREA and other laws have expanded
the agencies' authority in recent years, and the agencies have not yet fully
tested the limits of their powers.
Effect on Economic Environment
The policies of regulatory authorities, including the monetary policy of
the Federal Reserve Board, have a significant effect on the operating results
of bank holding companies and their subsidiaries. Among the means available to
the Federal Reserve Board to affect the money supply are open market
operations in U.S. government securities, changes in the discount rate on
member bank borrowings and changes in reserve requirements against member bank
deposits. These means are used in varying combinations to influence overall
growth and distribution of bank loans, investments and deposits, and their use
may affect interest rates charged on loans or paid for deposits.
Federal Reserve Board monetary policies have materially affected the
operating results of commercial banks in the past and are expected to continue
to do so in the future. The nature of future monetary policies and the effect
of such policies on the business and earnings of the Company and its
subsidiaries cannot be predicted.
Consumer Laws and Regulations
In addition to the banking laws and regulations discussed above, banks are
also subject to certain consumer laws and regulations that are designed to
protect consumers in transactions with banks. Among the more prominent of such
laws and regulations are the Truth in Lending Act, the Truth in Savings Act,
the Electronic Funds Transfer Act, the Expedited Funds Availability Act, the
Equal Credit Opportunity Act, the Fair Credit Reporting Act, and the Fair
Housing Act. These laws and regulations mandate certain disclosure
requirements and regulate the manner in which financial institutions must deal
with customers when taking deposits or making loans to such customers. The
Bank must comply with the applicable provisions of these consumer protection
laws and regulations as part of their ongoing customer relations. Also, see
discussion of the consumer privacy protection provision of the Gramm-Leach-
Bliley Act under the "Recently Enacted Legislative and Regulatory Changes"
caption above.
11
Item 2--Properties
The principal executive offices of the Company and the Bank are located at
2550 North Loop West, Houston, Texas, 77092, in spaced leased by the Company.
In addition to its principal office, the Company operates the following
locations:
Owned Leased Total
----- ------ -----
Banking offices in the
Houston metropolitan area.. 17 12 29
Banking offices in the San
Antonio metropolitan area.. 2 2 4
Banking offices in the South
Texas...................... 4 -- 4
Banking offices in the
Dallas metropolitan area... -- 1 1
Central department offices.. 1 2 3
Mortgage production offices
Arizona.................... -- 6 6
Colorado................... -- 1 1
California................. -- 1 1
Illinois................... -- 1 1
Kentucky................... -- 1 1
Louisiana.................. -- 1 1
Nevada..................... -- 1 1
Oregon..................... -- 2 2
Texas...................... -- 17 17
Virginia................... -- 1 1
Washington................. -- 5 5
--- --- ---
Total................... 24 54 78
=== === ===
Item 3--Legal Proceedings
From time to time, the Bank is a party to various legal proceeding incident
to its business. Currently, neither the Company nor any of its subsidiaries is
involved in any material legal proceedings.
Item 4--Submission of Matters to a Vote of Security Holders
None.
12
PART II
Item 5--Market for Registrant's Common Stock and Related Shareholder Matters
The Company's stock trades through the Nasdaq Stock Market under the symbol
SBIB. The following table sets forth the high and low closing stock prices of
the Company's common stock, as quoted on the Nasdaq Stock Market, and the
dividends paid thereon for each quarter of the last two fiscal years. This
information has been restated to reflect all stock splits occurring prior to
the issuance of this report.
High Low Dividend
------ ------ --------
2001
First quarter.................................... $14.00 $10.83 $0.03667
Second quarter................................... 12.79 11.08 $0.03667
Third quarter.................................... 15.65 12.34 $0.03667
Fourth quarter................................... 13.47 11.56 $0.03667
2000
First quarter.................................... $ 7.29 $ 5.81 $0.03333
Second quarter................................... 7.92 6.33 $0.03333
Third quarter.................................... 10.63 6.79 $0.03333
Fourth quarter................................... 13.42 9.67 $0.03333
On January 28, 2002, the Company's Board of Directors declared a quarterly
cash dividend of $0.04 per share payable on February 22, 2002, to shareholders
of record on February 8, 2002. The Company intends to continue to pay a
dividend at the rate of $0.040 per share quarterly throughout 2002.
On July 24, 2001, the Company's Board of Directors declared a three-for-two
stock split to be effected in the form of a stock dividend on its common stock
to shareholders of record on September 4, 2001. Cash paid in lieu of
fractional shares was based on the average of the high and low bids on the
record date, as adjusted for the split. The payment date for the stock
dividend was September 18, 2001.
As of February 8, 2001, there were 1,122 shareholders of record of common
stock. The number of beneficial shareholders is unknown to the Company at this
time.
DESCRIPTION OF CAPITAL STOCK
Authorized Capital Stock
The authorized capital stock of the Company consists of (i) 50,000,000
shares of Common Stock, $1.00 per share par value, of which 43,769,664 shares
were issued and outstanding as of December 31, 2001 and (ii) 1,000,000 shares
of Preferred Stock, $1.00 per share par value ("Preferred Stock"), issuable in
series, of which 39,000 shares of Series H Convertible Preferred Stock were
issued and outstanding as of December 31, 2001. The number of outstanding
shares of the Series H Convertible Preferred Stock was not increased as a
result of the stock split effected by the Company in September 2001; however,
the conversion ratio for the Series H Convertible Preferred Stock has been
adjusted so that upon conversion of the preferred stock, the number of shares
of Common Stock issuable upon the conversion will be increased to give effect
to the stock split. The Company's Board has also designated 50,000 shares of
Series I convertible preferred. It is anticipated that the 20,000 shares of
the Series I convertible preferred stock will be issued prior to March 31,
2002. All series of Preferred Stock prior to the Series H Convertible
Preferred Stock have been converted into shares of common stock in accordance
with the relative rights and preferences of each such series. As of December
31, 2001, an additional 943,239 shares of Common Stock were issuable upon
exercise of the Company's vested outstanding employee stock options and
pursuant to outstanding subscriptions under the Company's Employee Stock
Purchase Plan.
The following discussion of the terms and provisions of the Company's
capital stock is qualified in its entirety by reference to the Company's
Articles of Incorporation and Bylaws, which were previously filed as exhibits.
13
Common Stock
All outstanding shares of Common Stock are fully paid and nonassessable.
There are no preemptive, conversion, subscription, redemption or repurchase
rights associated with shares of Common Stock, except as exist under the 1994
Incentive Stock Option Plan and the 1994 Employee Stock Purchase Plan. Each
holder of shares of Common Stock is entitled to one vote for each share held
of record as to all matters requiring a shareholder vote. Holders of shares of
Common Stock are not entitled to cumulative voting rights in the election of
directors. Upon the dissolution of the Company, the holders of Common Stock
would be entitled to participate ratably in the assets available for
distribution after satisfaction of the claims of creditors of the Company and
of holders of any series of Preferred Stock having a liquidation preference,
to the extent of such preference.
The holders of shares of the Common Stock are entitled to such dividends as
the Board of Directors, in its discretion, may declare out of funds legally
available therefore. Under the Texas Business Corporation Act, as amended (the
"TBCA"), dividends may not be paid if, after the payment, the Company's total
assets would be less than the sum of its total debts and stated capital, or if
the Company would be unable to pay its debts as they become due in the usual
course of its business. There can be no assurances such dividends will
continue to be paid in the future. Payment of future dividends will be
dependent upon, among other things, the Company's and the Bank's earnings and
financial condition, and the general economic and regulatory climate.
Funds for the payment of dividends by the Company are obtained primarily
from dividends received from the Bank. Certain restrictions exist regarding
the ability of the Bank to pay dividends to the Company. Under federal law,
the Bank cannot pay a dividend if it will cause the Bank to be
"undercapitalized." The regulators of the Bank and the Company may
administratively impose stricter limits on the ability of the Bank to pay
dividends to the Company.
The Bank is also subject to risk based capital rules that restrict its
ability to pay dividends. The risk based capital rules set an explicit
schedule for achieving minimum capital levels in relation to risk weighted
assets. The Banks have been required to meet a minimum ratio of total capital
to risk weighted assets of 8.0%. As of December 31, 2001, the Banks were in
compliance with all capital requirements.
American Stock Transfer & Trust Company presently serves as the transfer
agent and registrar for the Common Stock.
Preferred Stock
The Board, without any further action by the shareholders but subject to
limits contained in the Articles of Incorporation, is authorized to issue up
to 1,000,000 shares of Preferred Stock, in one or more series. The Board may
fix by resolution the terms of a series of Preferred Stock, such as: dividend
rates and preference of dividends, if any; conversion rights; voting rights;
terms of redemption and liquidation preferences; and, the number of shares
constituting each such series.
Holders of Preferred Stock have no right or power to vote on any matter
except as otherwise as required by law in which case they are entitled to one
vote for each share of Preferred Stock held. Upon the Company's dissolution,
liquidation or winding up, the holders of shares of Preferred Stock are
entitled to receive out of the Company's assets an amount per share equal to
the respective liquidation preference before any payment or distribution is
made on the Common Stock or any other class of capital stock that ranks junior
to the particular series of Preferred Stock. All outstanding series of
Preferred Stock rank equal. If the Company's assets available for distribution
upon dissolution, liquidation or winding up are insufficient to pay in full
the liquidation preference payable to the holders of shares of all series of
Preferred Stock, distributions are to be made proportionately on all
outstanding shares of Preferred Stock.
14
Item 6--Selected Financial Data
The following table sets forth summary historical data for the Company for
the periods indicated. During the periods indicated, the Company completed
seven acquisitions of bank holding companies and/or banks in merger
transactions that were accounted for using either the purchase method of
accounting or the "pooling of interests" method of accounting. With respect to
the five mergers completed during the reported periods which were accounted
for using the "pooling of interests" method, all financial data relating to
such entities prior to the respective mergers have been restated to include
the merged entities' balance sheet data and historical results of operations.
In addition, data has been restated to reflect the effect of stock splits
where applicable.
Year Ended December 31,
----------------------------------------------------------
2001 2000 1999 1998 1997
---------- ---------- ---------- ---------- ----------
(In thousands, except for per share amounts)
SUMMARY OF INCOME:
Interest income......... $ 173,053 $ 167,517 $ 129,658 $ 115,839 $ 99,814
Interest expense........ 50,052 62,824 37,470 34,600 31,841
---------- ---------- ---------- ---------- ----------
Net interest income..... 123,001 104,693 92,188 81,239 67,973
Provision for credit
losses................. 11,684 9,668 9,236 6,275 3,321
Noninterest income...... 66,171 40,648 30,265 22,761 13,895
Noninterest expense..... 130,677 95,492 81,778 69,699 55,321
---------- ---------- ---------- ---------- ----------
Income before income
taxes.................. 46,811 40,181 31,439 28,026 23,226
Provision for income
taxes.................. 16,410 12,641 9,803 9,116 7,777
---------- ---------- ---------- ---------- ----------
Net income.............. $ 30,401 $ 27,540 $ 21,636 $ 18,910 $ 15,449
========== ========== ========== ========== ==========
COMMON SHARE DATA:
Basic earnings per
share.................. $ 0.72 $ 0.66 $ 0.52 $ 0.47 $ 0.40
Diluted earnings per
share.................. $ 0.71 $ 0.65 $ 0.51 $ 0.46 $ 0.38
Book value per share at
period-end............. $ 4.96 $ 3.98 $ 3.40 $ 2.98 $ 2.47
Tangible book value per
share at period-end.... $ 3.70 $ 3.84 $ 3.25 $ 2.83 $ 2.43
Weighted average common
shares................. 42,180 41,596 41,422 39,830 38,973
Weighted average common
and common equivalent
shares................. 43,044 42,212 42,218 41,276 40,522
BALANCE SHEET DATA (at
period-end):
Total assets............ $2,778,090 $2,077,214 $2,060,112 $1,591,284 $1,466,798
Loans, net of unearned
discount............... 1,928,293 1,484,990 1,261,273 1,079,657 907,201
Allowance for credit
losses................. 22,927 16,862 13,998 11,352 8,820
Total securities........ 342,899 308,202 545,148 267,819 327,550
Deposits................ 2,268,980 1,718,822 1,508,789 1,410,076 1,279,381
Other borrowed funds.... 180,298 140,364 362,332 15,333 46,669
Notes payable........... 20,879 1,600 -- 2,069 2,621
Company-obligated
mandatorily redeemable
trust preferred
securities of
subsidiary trust....... 57,500 28,750 28,750 28,750 28,750
Shareholders' equity.... 217,369 166,825 141,070 122,040 98,261
SELECTED PERFORMANCE
RATIOS:
Return on average
assets................. 1.24% 1.32% 1.26% 1.25% 1.20%
Return on average
shareholders' equity... 16.58% 17.82% 16.37% 17.02% 16.92%
Dividend payout ratio... 19.45% 19.04% 20.85% 21.71% 20.01%
Net interest margin (tax
equivalent)............ 5.75% 5.61% 6.05% 6.02% 5.93%
ASSET QUALITY RATIOS:
Period-end nonperforming
loans to total loans... 0.74% 0.65% 0.48% 0.51% 0.55%
Period-end nonperforming
assets to total
assets................. 0.58% 0.55% 0.37% 0.49% 0.45%
Period-end allowance for
credit losses to
nonperforming loans.... 161.51% 175.74% 229.89% 207.53% 176.47%
Period-end allowance for
credit losses to total
loans.................. 1.19% 1.14% 1.11% 1.05% 0.97%
Net charge-offs to
average loans.......... 0.49% 0.51% 0.59% 0.38% 0.36%
LIQUIDITY AND CAPITAL
RATIOS:
Average loans to average
deposits............... 84.28% 83.34% 77.70% 74.37% 68.68%
Period-end shareholders'
equity to total
assets................. 7.82% 8.03% 6.85% 7.67% 6.70%
Average shareholders'
equity to average
assets................. 7.50% 7.41% 7.70% 7.36% 7.06%
Period-end Tier 1
capital to risk
weighted assets........ 9.64% 10.51% 10.82% 11.56% 12.23%
Period-end total capital
to risk weighted
assets................. 10.66% 11.26% 11.74% 12.45% 13.27%
Period-end Tier 1
leverage ratio (Tier 1
capital to total
average assets)........ 8.40% 9.10% 8.21% 9.39% 9.72%
15
Item 7--Management's Discussion and Analysis of Financial Condition and
Results of Operations
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" of the Company analyzes the major elements of the Company's
consolidated balance sheets and statements of income. This section should be
read in conjunction with the Company's consolidated financial statements and
accompanying notes and other detailed information incorporated by reference.
Management believes that the most critical accounting policies relate to the
determination of the allowance for credit losses. During the periods
indicated, the Company completed seven acquisitions of bank holding companies
and/or banks in merger transactions that were accounted for using either the
purchase method of accounting or the "pooling of interests" method of
accounting. With respect to the five mergers completed during the reported
periods which were accounted for using the "pooling of interests" method, all
financial data relating to such entities to the respective mergers have been
restated to include the merged entities' balance sheet data and historical
results of operations.
RESULTS OF OPERATIONS
Performance Summary
Net income for 2001 was $30.4 million or $.71 per diluted share. Included
in this amount is $2.1 million in after-tax charges relating to the
acquisitions of CaminoReal Bancshares, Inc., Lone Star Bancorporation, Inc.
and Community Bancshares, Inc. Excluding the acquisition charges, operating
income for 2001 was $32.5 million or $.75 per diluted share, an increase of
$4.9 million, up 15% over the $.65 per diluted share earned in 2000. Net
income of $27.5 million in 2000 increased $5.9 million, or 27.3% over the
$21.6 million recorded for 1999. Diluted earnings per share for 2000 was $.65
as compared to $.51 for 1999. All per share amounts have been restated to
reflect the stock splits effected as stock dividends through September 18,
2001.
Two industry measures of the performance by a banking institution are its
return on average assets and return on average equity. Return on average
assets ("ROA") measures net earnings in relation to average total assets and
indicates a company's ability to employ its resources profitably. During 2001,
the Company's ROA was 1.24%, as compared to 1.32% and 1.26% for 2000 and 1999,
respectively. During 2001, the Company's return on equity was 16.58% compared
to 17.82% and 16.37% for 2000 and 1999, respectively.
Net Interest Income and Net Interest Margin
Net interest income represents the amount by which interest income on
interest earning assets, including securities and loans, exceeds interest paid
on interest bearing liabilities, including deposits and other borrowed funds.
Net interest income is the principal source of the Company's earnings.
Interest rate fluctuations, as well as changes in the amount and type of
earning assets and liabilities, combine to affect net interest income.
Net interest income for 2001 was $123.0 million, up $18.3 million or 17.5%
from $104.7 million for 2000. The growth in net interest income is primarily
attributable to the 27.2% increase in average loans. The loan growth related
to the CaminoReal Bancshares and Community Bancshares acquisitions was 8.9%.
Since the Lone Star Bancorporation acquisition was accounted for using the
"pooling of interests" accounting method, the financial data was restated to
include Lone Star Bancorporation's balance sheet data and historical results
of operations and there is no loan growth separately attributable to the
acquisition of Lone Star Bancorporation. Average earning assets increased
14.7% from 2000 to 2001. During the latter part of 2000, the Bank deleveraged
its balance sheet resulting in a decrease in average securities of 29.9% from
2000 to 2001. The yield on interest earning assets decreased 88 basis points
from 8.86% in 2000 to 7.98% in 2001. Additionally during 2000, the Board of
Governors of the Federal Reserve System ("Federal Reserve") increased the
discount rate a total of 100 basis points whereas in 2001, the Federal Reserve
decreased the discount rate 11 times for a total of 475 basis points. The cost
of interest bearing liabilities decreased 133 basis points from 4.64% in 2000
to 3.31% in 2001. This decrease in rates was due to a combination of the
Federal Reserve rate decreases as well as the deleverageing of the balance
sheet. For 2001, the tax equivalent net interest margin (net interest income
divided by average total interest earning assets) increased 14 basis points to
5.75% from 5.61% for 2000.
16
Net interest income for 2000 was $104.7 million, compared to $92.2 million
for 1999, an increase of $12.5 million or 13.6%, primarily due to a 22%
increase in average earning assets. During 2001, the yield on interest earning
assets increased 48 basis points from 8.38% in 1999 to 8.86% in 2000.
Throughout the second half of 1999 and the first half of 2000, the Federal
Reserve System increased the discount rate six times. The cost of interest
bearing liabilities increased 107 basis points from 3.57% in 1999 to 4.64% in
2000. This increase was due to the Federal Reserve rate increases as well as
new FHLB advances resulting from the leveraging program initiated in 1999 by
the Bank. For 2000, the tax equivalent net interest margin (net interest
income divided by average total interest earning assets) decreased 44 basis
points to 5.61% from 6.05% for 1999.
Also of note, during the third quarter of 1999, the Bank initiated a
temporary leveraging strategy in order to enhance earnings by better utilizing
current levels of capital. Prior to the commencement of this leverage program,
the Bank's balance sheet was asset sensitive. This leveraging was achieved by
borrowing funds (primarily short-term FHLB advances) and investing these funds
in fixed and variable rate mortgage-backed securities and variable rate
collateralized mortgage obligations. The spread on these assets over the cost
of borrowed funds averaged 163 basis points. The leverage program, taken
alone, creates an interest rate mismatch. However, taken together with the
core assets and liabilities of the Bank, the leverage program serves to
mitigate the interest rate risk of the Bank.
17
To provide a more in-depth analysis of net interest income, the following
average balance sheets and net interest income analysis detail the
contribution of interest earning assets to overall net interest income and the
impact of the cost of funds:
Year Ended December 31,
--------------------------------------------------------------------------------------
2001 2000 1999
---------------------------- ---------------------------- ----------------------------
Average Average Average Average Average Average
Balance Interest Yield Balance Interest Yield Balance Interest Yield
---------- -------- ------- ---------- -------- ------- ---------- -------- -------
(in thousands)
Interest earning assets:
Deposits in financial
institutions........... $ 1,235 $ 79 6.40% $ 1,225 $ 74 6.04% $ 3,492 $ 180 5.15%
Federal funds sold and
securities purchased
under agreements to
resell................. 74,229 3,578 4.82% 60,401 4,471 7.40% 69,359 3,972 5.73%
Trading assets.......... 49,352 2,787 5.65% -- -- -- -- -- --
Securities (taxable).... 277,842 17,121 6.16% 417,062 28,208 6.76% 276,704 17,338 6.27%
Securities (non-
taxable)............... 70,814 3,304 4.67% 80,282 3,503 4.36% 75,568 3,341 4.42%
Loans, net of unearned
discount (taxable)
(1).................... 1,689,627 145,899 8.63% 1,330,357 131,203 9.86% 1,122,250 104,784 9.34%
Loans, net of unearned
discount
(non-taxable).......... 4,240 285 6.72% 925 58 6.27% 584 43 7.36%
---------- -------- ---- ---------- -------- ---- ---------- ------- ----
Total interest
earning assets...... 2,167,339 173,053 7.98% 1,890,252 167,517 8.86% 1,547,957 129,658 8.38%
Noninterest earning
assets:
Cash and due from
banks.................. 88,773 68,710 74,501
Premises and equipment,
net.................... 53,525 45,892 41,915
Other assets............ 156,427 98,134 65,529
Allowance for credit
losses................. (20,296) (15,454) (13,125)
---------- ---------- ----------
Total noninterest
earning assets...... 278,429 197,282 168,820
---------- ---------- ----------
Total assets......... $2,445,768 $2,087,534 $1,716,777
========== ========== ==========
Interest bearing
liabilities:
Demand and savings
deposits............... $ 784,054 $ 16,915 2.16% $ 621,038 $ 19,879 3.20% $ 564,747 $13,671 2.42%
Certificates and other
time deposits.......... 547,600 26,141 4.77% 440,062 24,256 5.51% 388,953 18,421 4.74%
Other borrowed funds.... 175,106 6,861 3.92% 293,556 18,653 6.35% 96,038 5,310 5.53%
Notes payable........... 3,369 135 4.01% 416 36 8.65% 955 68 7.12%
---------- -------- ---- ---------- -------- ---- ---------- ------- ----
Total interest
bearing
liabilities......... 1,510,129 50,052 3.31% 1,355,072 62,824 4.64% 1,050,693 37,470 3.57%
Noninterest bearing
liabilities:
Demand deposits......... 678,134 536,351 491,415
Other liabilities....... 21,330 12,772 13,721
---------- ---------- ----------
Total noninterest
bearing
liabilities......... 699,464 549,123 505,136
Trust preferred
securities............. 52,853 28,750 28,750
Shareholders' equity.... 183,322 154,589 132,198
---------- ---------- ----------
Total liabilities and
shareholders'
equity.............. $2,445,768 $2,087,534 $1,716,777
========== ========== ==========
Net interest income and
margin (2)............. $123,001 5.68% $104,693 5.54% $92,188 5.96%
======== ==== ======== ==== ======= ====
Net interest income and
margin
(tax-equivalent basis)
(3).................... $124,644 5.75% $106,127 5.61% $93,680 6.05%
======== ==== ======== ==== ======= ====
- --------
(1) Loan origination fees are considered adjustments to interest income. These
fees aggregated $2,776,000, $2,232,000 and $2,041,000 for the years ended
December 31, 2001, 2000 and 1999, respectively. Related loan origination
costs are not separately allocated to loans, but are charged to non-
interest expense. For the purpose of calculating loan yields, average loan
balances include nonaccrual loans with no related interest income.
(2) The net interest margin is equal to net interest income divided by average
total interest earning assets.
(3) In order to make pretax income and resultant yields on tax-exempt
investments and loans comparable to those on taxable investments and
loans, a tax-equivalent adjustment is made equally to interest income and
income tax expense with no effect on after tax income. The tax equivalent
adjustment has been computed using a federal income tax rate of 35%.
18
The following rate/volume analysis shows the portions of the net change in
interest income due to changes in volume or rate. The changes in interest
income due to both rate and volume in the analysis have been allocated to the
volume or rate change in proportion to the absolute amounts of the change in
each (in thousands):
2001 vs. 2000 2000 vs. 1999
Increase (Decrease) Increase (Decrease)
Due to Changes in: Due to Changes in:
--------------------------- ------------------------
Volume Rate Total Volume Rate Total
------- -------- -------- ------- ------ -------
Interest earning assets:
Deposits in financial
institutions........... $ 1 $ 4 $ 5 $ (137) $ 31 $ (106)
Federal funds sold and
securities purchased
under agreements to
resell................. 667 (1,560) (893) (663) 1,162 499
Trading assets.......... 2,787 -- 2,787 -- -- --
Securities (taxable).... (8,579) (2,508) (11,087) 9,493 1,377 10,870
Securities (non-
taxable)............... (442) 243 (199) 206 (44) 162
Loans, net of unearned
discount (taxable)..... 31,023 (16,327) 14,696 20,524 5,895 26,419
Loans, net of unearned
discount (non-
taxable)............... 223 4 227 21 (6) 15
------- -------- -------- ------- ------ -------
Total interest income... 25,680 (20,144) 5,536 29,444 8,415 37,859
------- -------- -------- ------- ------ -------
Interest bearing
liabilities:
Demand and savings
deposits............... 3,517 (6,481) (2,964) 1,802 4,406 6,208
Certificates and other
time deposits.......... 5,134 (3,249) 1,885 2,817 3,018 5,835
Other borrowed funds.... (4,641) (7,151) (11,792) 12,551 792 13,343
Notes payable........... 99 -- 99 (47) 15 (32)
------- -------- -------- ------- ------ -------
Total interest expense.. 4,109 (16,881) (12,772) 17,123 8,231 25,354
------- -------- -------- ------- ------ -------
Net interest income..... $21,571 $ (3,263) $ 18,308 $12,321 $ 184 $12,505
======= ======== ======== ======= ====== =======
Noninterest Income
The Company's non-interest income consists primarily of customer service
fees, gains arising from the sale of mortgage loans and origination fees
relating to mortgage loans. Total noninterest income for 2001 totaled $66.2
million, an increase of $25.5 million or 62.8% over $40.6 million in 2000. For
2000, noninterest income totaled $40.6 million, an increase of $10.4 million
or 34.3% over $30.3 million in 1999.
The following table shows the breakout of noninterest income between
commercial banking and mortgage banking for 2001, 2000 and 1999 (in
thousands):
2001 2000 1999
---------------------------- ---------------------------- ----------------------------
Commercial Mortgage Commercial Mortgage Commercial Mortgage
Banking Banking Combined Banking Banking Combined Banking Banking Combined
---------- -------- -------- ---------- -------- -------- ---------- -------- --------
Customer service fees... $ 14,834 $ -- $14,834 $10,832 $ -- $10,832 $10,361 $ -- $10,361
Bank-owned life
insurance income....... 2,049 -- 2,049 1,888 -- 1,888 606 -- 606
Gain on the sale of
University of Houston
office................. -- -- -- -- -- -- 450 -- 450
Gain on the sale of
credit card loan
portfolio.............. -- -- -- 237 -- 237 -- -- --
Gain on the sale of
land................... -- -- -- 244 -- 244 -- -- --
Gains on sale of
mortgage loans......... -- 24,206 24,206 -- 11,959 11,959 -- 10,898 10,898
Debit card fees......... 877 -- 877 223 -- 223 -- -- --
Origination fees........ -- 10,392 10,392 -- 5,892 5,892 -- 451 451
Servicing fees.......... -- 1,051 1,051 -- 426 426 -- 611 611
Other................... 6,436 6,326 12,762 5,428 3,519 8,947 5,263 1,625 6,888
-------- ------- ------- ------- ------- ------- ------- ------- -------
$ 24,196 $41,975 $66,171 $18,852 $21,796 $40,648 $16,680 $13,585 $30,265
======== ======= ======= ======= ======= ======= ======= ======= =======
19
Commercial Banking Segment. For 2001, noninterest income from commercial
banking was $24.2 million, as compared to $18.9 million for 2000, an increase
of $5.3 million or 28.3%. During 2001, customer service fees increased $4.0
million or 36.9%, primarily as a result of an overall increase in average
demand and savings accounts of 26.2% from volume growth in deposit accounts
and the acquisition of CaminoReal Bank. Also during the latter half of 2000,
the bank introduced its debit card. Fees related to the debit cards totaled
$877 thousand in 2001 as compared to $223 thousand in 2000. In December 2000,
the Bank sold land for a gain of $244 thousand. Finally, during the first
quarter of 2000, the Bank sold its credit card portfolio to a correspondent
bank for a net gain of $237 thousand. For 2000, noninterest income from
commercial banking totaled $18.9 million, an increase of $2.2 million or 13.0%
compared to $16.7 million in 1999. The increase is primarily attributed to
volume growth in deposit accounts. During the latter half of 1999 the Bank
purchased bank-owned life insurance ("BOLI") policies. Interest credits for
these BOLI policies totaled $1.9 million for 2000 as compared to $606 thousand
for 1999, an increase of $1.3 million. Also, during 1999, the Bank sold its
University of Houston office which had approximately $10 million in student
loans. A gain of $450 thousand was recognized on the sale.
Mortgage Banking Segment. For 2001, noninterest income from the mortgage
banking segment increased $20.2 million or 92.6% from $21.8 million for 2000.
Income from the mortgage banking segment primarily consists of origination
fees and gains on the sale of mortgage loans. The average length of time a
mortgage loan is held in the portfolio of SCMC is approximately twenty-five to
thirty days. During 2001, SCMC had $2.6 billion in loan fundings as compared
to $1.4 billion in 2000. The increase in noninterest income and noninterest
expense is primarily due to the favorable interest rate environment which led
to increased loan refinancing and new loan activity. In addition, new retail
locations were opened in 2001.
Noninterest Expense
For 2001, noninterest expenses totaled $130.7 million, an increase of $35.2
million or 36.8% over $95.5 million in 2000. For 2000, noninterest expense
totaled $95.5 which was a $13.7 million increase over $81.8 million in 1999.
Noninterest expenses are shown as follows (in thousands):
2001 2000 1999
---------------------------- ---------------------------- ----------------------------
Commercial Mortgage Commercial Mortgage Commercial Mortgage
Banking Banking Combined Banking Banking Combined Banking Banking Combined
---------- -------- -------- ---------- -------- -------- ---------- -------- --------
Salaries and employee
benefits............... $ 55,115 $13,916 $ 69,031 $44,660 $ 8,803 $53,463 $38,049 $ 6,781 $44,830
Occupancy expenses...... 13,964 4,320 18,284 10,229 3,533 13,762 9,006 2,190 11,196
Net losses and carrying
costs of real estate
acquired by
forclosure............. 176 -- 176 284 -- 284 29 -- 29
FDIC assessment......... 470 -- 470 316 -- 316 374 -- 374
Technology.............. 5,053 288 5,341 3,851 122 3,973 3,695 97 3,792
Postage and delivery
charges................ 2,049 528 2,577 1,476 325 1,801 1,540 167 1,707
Supplies................ 1,512 514 2,026 1,391 428 1,819 1,542 359 1,901
Professional fees....... 2,966 237 3,203 2,117 246 2,363 1,919 131 2,050
Minority interest
expense................ 4,716 2,273 6,989 2,668 752 3,420 2,668 352 3,020
Conversion costs related
to acquisitions........ 3,181 -- 3,181 -- -- -- 774 -- 774
Other................... 14,873 4,526 19,399 11,791 2,500 14,291 10,974 1,131 12,105
-------- ------- -------- ------- ------- ------- ------- ------- -------
$104,075 $26,602 $130,677 $78,783 $16,709 $95,492 $70,570 $11,208 $81,778
======== ======= ======== ======= ======= ======= ======= ======= =======
Commercial Banking Segment. For 2001, noninterest expenses related to
commercial banking were $104.1 million, as compared to $78.8 million for 2000,
an increase of $25.3 million or 32.1%.
Salaries and employee benefits in the commercial banking segment for 2001
totaled $55.1 million, an increase of $10.5 million or 23.4% over $44.7
million for 2000. Salaries and employee benefit expense related to the
CaminoReal Bank offices since acquisition was $4.0 million. The increase is
also attributable to the hiring of personnel for two de novo offices (Dallas
and Deer Park) as well as new central departments such as internet banking,
document imaging and community affairs. Additionally, medical insurance
expense increased $1.2
20
million during 2001. Salaries and employee benefits in the commercial banking
segment for 2000 totaled $44.7 million, an increase of $6.6 million or 17.4%
over $38.0 million for 1999. The largest part of the increase is due to the
hiring of new employees to expand the Bank's lending force and its credit
analyst pool, personnel for two de novo offices (Bellaire and Dallas) and two
new senior credit officers. The Bank increased its number of full-time
equivalent personnel by 38 or 5.7% during 2000, from 670 at year-end 1999 to
708 at year-end 2000. The increases in full-time equivalents are due to
staffing requirements to propel and sustain growth in loans and deposits as
well as increases in central support functions.
Occupancy expense in the commercial banking segment totaled $14.0 million
in 2001 as compared to $10.2 million in 2000, an increase of $3.7 million, or
36.5%. The increase is primarily due to leasing additional space for central
departments and the new Dallas office as well as the acquisition of CaminoReal
Bank. The 2001 occupancy expenses related to the CaminoReal Bank offices was
$1.2 million. Occupancy expense in the commercial banking segment totaled
$10.2 million in 2000, an increase of $1.2 million or 13.6% over $9.0 million
in 1999. This increase primarily resulted from the opening of the two de novo
offices during 2000.
Technology expense in 2001 totaled $5.1 million, an increase of $1.2
million or 31.2% from $3.9 million in 2000. This increase is the result of the
purchase of a new intranet wire transfer system and technology charges related
to the new departments such as internet banking and document imaging.
Technology expense in 2000 totaled $3.9 million, an increase of $156 thousand
or 4.2% from $3.7 million in 1999.
Minority interest expense increased $2.0 million or 76.8% from 2000 as
compared to 2001. The increase is related to the interest on the additional
$28.75 million in trust preferred securities issued in March 2001. Please
refer to the subsequent discussion of Company-Obligated Mandatorily Redeemable
Trust Preferred Securities for additional details of the issuance.
Conversion costs related to the acquisition of Community Bancshares, Inc.
in December 2001, Lone Star Bancshares, Inc. in August 2001 and CaminoReal
Bancshares in March 2001 totaled $957 thousand, $1.2 million and $1.0 million,
respectively. The costs include retention and severance expenses as well as
data processing costs related to the conversion of Community Banchares', Lone
Star Bancshares' and CaminoReal Bancshares' systems.
Other expenses in the commercial banking segment totaled $14.9 million in
2001, an increase of $3.1 million or 26.1%, from $12.0 million in 2000. The
increase in goodwill amortization related to the CaminoReal Bancshares
acquisition was $787.5 thousand. Also, charges related to the new debit card
program increased $251.3 thousand from 2000. Other expenses in the commercial
banking segment totaled $12.0 million in 2000, an increase of $817 thousand or
7.4%, from $11.0 million in 1999. This increase is due to an expanding
infrastructure to support growth.
Mortgage Banking Segment. Noninterest expense for the mortgage banking
segment for 2001 was $26.6 million, as compared to $16.7 million for 2000, an
increase $9.9 million or 59.2%. This increase in noninterest expense is
primarily due to the favorable interest rate environment which led to
increased loan refinancing and new loan activity. In addition, new retail
locations were opened in 2001. At December 31, 2001 loan fundings were $2.6
billion, a 90.7% increase over the $1.4 billion at December 31, 2000.
Noninterest expense for the mortgage banking segment for 2000 was $16.7
million, as compared to $11.2 million for 1999, an increase $5.5 million or
49.1%.
Income Taxes
The Company provided $16.4 million for federal income taxes for 2001, $12.6
million for 2000, and $9.8 million for 1999. The effective tax rates for 2001,
2000, and 1999 were 35.1%, 31.5%, and 31.2%, respectively.
21
FINANCIAL CONDITION
Loans Held for Investment
At December 31, 2001, loans held for investment totaled $1.7 billion, an
increase of $320.9 million or 23.8% over loans at December 31, 2000 of $1.3
billion. Loans acquired as a result of the acquisitions of CaminoReal
Bancshares and Community Bancshares totaled $149.6 million and $82.3 million,
respectively. Excluding the loans acquired in the acquisitions of CaminoReal
Bancshares and Community Bancshares, loans held for investment at December 31,
2001 totaled $1.4 billion, an increase of $89.4 million or 6.6% of loans at
December 31, 2000 of $1.3 billion.
At December 31, 2001, total loans were 85.0% of deposits and 69.4% of total
assets. At December 31, 2000, total loans were 86.4% of deposits and 71.5% of
total assets.
The following table summarizes the loan portfolio of the Bank by type of
loan as of December 31 of the year indicated, excluding loans held for sale
(in thousands):
2001 2000 1999 1998 1997
---------------- ---------------- ---------------- -------------- --------------
Amount % Amount % Amount % Amount % Amount %
---------- ----- ---------- ----- ---------- ----- -------- ----- -------- -----
Commercial, financial
and industrial:
US addressees.......... $ 506,272 30.4% $ 472,392 35.1% $ 436,518 36.7% $357,872 36.0% $315,709 37.6%
Non-US addressees...... 7,594 0.5% 4,807 0.4% 5,917 0.5% 4,047 0.4% 771 0.1%
Real estate mortgage:
Commercial............. 530,076 31.8% 449,007 33.4% 360,092 30.2% 273,067 27.4% 226,543 27.0%
Residential............ 186,527 11.2% 155,796 11.5% 141,661 11.9% 122,252 12.3% 105,132 12.5%
Real estate
construction........... 282,304 16.9% 134,482 10.0% 115,761 9.7% 114,502 11.5% 74,639 8.9%
Installment............. 154,015 9.2% 129,358 9.6% 130,920 11.0% 123,057 12.4% 116,259 13.9%
---------- ----- ---------- ----- ---------- ----- -------- ----- -------- -----
$1,666,788 100.0% $1,345,842 100.0% $1,190,869 100.0% $994,797 100.0% $839,053 100.0%
========== ===== ========== ===== ========== ===== ======== ===== ======== =====
The primary lending focus of the Bank is on commercial loans and owner-
occupied real estate loans to local businesses with annual sales ranging from
$300,000 to $30 million. Typically, the Bank's customers have financing
requirements between $50,000 and $500,000. Although the Bank's legal lending
limit was $20 million at December 31, 2001, the Bank has not maintained an
exposure greater than $15 million on any single relationship.
The Bank makes commercial loans primarily to small and medium-sized
businesses and to professionals. The Bank offers a variety of commercial loan
products including revolving lines of credit, letters of credit, working
capital loans, and loans to finance accounts receivable, inventory and
equipment. Typically, the Bank's commercial loans have floating rates of
interest, are for varying terms (generally not exceeding three years), are
personally guaranteed by the business owner and are secured by accounts
receivable, inventory and/or other business assets. In addition to the
commercial loans secured solely by non-real estate business assets, the Bank
makes commercial loans that are secured by owner-occupied real estate, as well
as other business assets.
The Bank's commercial mortgage loans are secured by first liens on real
estate, typically have floating interest rates, and are amortized over a 15-
year period with balloon payments due at the end of three years. In
underwriting commercial mortgage loans, consideration is given to the
property's operating history, future operating projections, current and
projected occupancy, location and physical condition. The underwriting
analysis also includes credit checks, appraisals, and a review of the
financial condition of the borrower.
The Bank makes loans to finance the construction of residential and, to a
lesser extent, nonresidential properties, such as churches. Generally,
construction loans are secured by first liens on real estate and have floating
interest rates. The Bank conducts periodic inspections, either directly or
through an architect or other agent, prior to approval of periodic draws on
these loans. Underwriting guidelines similar to those described above are also
used in the Bank's construction lending activities.
22
The Bank makes automobile, boat, home improvement and other loans to
consumers. These loans are primarily made to customers who have other
relationships with the Bank. During the first quarter of 2000, the Bank sold
its credit card portfolio to a correspondent bank.
The Bank seeks to compete effectively in its chosen markets by consistent
application of its business strategy. See further discussion of "BUSINESS--
Business Banking Strategy" and "BUSINESS--Competition".
As of December 31, 2001, there was no concentration of loans to any one
type of industry exceeding 10% of total loans nor were there any loans
classified as highly leveraged transactions.
Loans Held for Sale
Loans held for sale totaled $261.5 million at December 31, 2001, an
increase from $139.1 million at December 31, 2000. The $122.4 million increase
is due to the increase in loans funded by the Bank through an intercompany
mortgage warehouse with SCMC. Mortgage loans originated by SCMC are held for
sale and are typically sold to investors within one month of origination. Due
to the timing of the sales of loans to investors, the balance of these loans
at any given time is somewhat volatile. See Note E to the Consolidated
Financial Statements for loan maturities and rate sensitivity of the loan
portfolio, excluding real estate--mortgage, consumer and foreign loans and
unearned discount at December 31, 2001.
Risk Elements
Nonperforming, past due, and restructured loans are fully or substantially
secured by assets, with any excess of loan balances over collateral values
specifically allocated in the allowance for credit losses. The Bank receives,
on an ongoing basis, updated appraisals on loans secured by real estate,
particularly those categorized as nonperforming loans and potential problem
loans. In those instances where updated appraisals reflect reduced collateral
values, an evaluation of the borrower's overall financial condition is made to
determine the need, if any, for possible write-downs or appropriate additions
to the allowance for credit losses.
The Bank defines potential problem loans as those loans not classified as
nonperforming, but where information known by management indicates serious
doubt that the borrower will be able to comply with the present payment terms.
Management identifies these loans through its continuous loan review process
and classifies potential problem loans as those loans graded as substandard,
doubtful, or loss, excluding all nonperforming loans. The Bank's increase in
potential problem loans can be directly attributed to acquisitions, loan
growth and economic conditions.
The Bank had no material foreign loans outstanding or loan concentrations
for the years ended December 31, 1997 through 2001. The Bank, however,
continues to monitor the potential risk of foreign borrowers and
concentrations of credit.
23
The following table presents information regarding non-performing loans and
assets as of December 31, 1997 through 2001 (in thousands):
2001 2000 1999 1998 1997
---------- ---------- ---------- ---------- ----------
Nonaccrual loans........ $ 14,179 $ 8,297 $ 5,871 $ 5,158 $ 4,779
Restructured loans...... 16 1,298 218 312 217
---------- ---------- ---------- ---------- ----------
Total nonperforming
loans.................. 14,195 9,595 6,089 5,470 4,996
Real estate acquired by
foreclosure............ 1,837 1,702 1,323 1,969 1,086
Other repossessed
assets................. 127 192 264 356 537
---------- ---------- ---------- ---------- ----------
Total nonperforming
assets................. $ 16,159 $ 11,489 $ 7,676 $ 7,795 $ 6,619
========== ========== ========== ========== ==========
Nonperforming loans to
total loans............ 0.74% 0.65% 0.48% 0.51% 0.55%
Nonperforming assets to
total assets........... 0.58% 0.55% 0.37% 0.49% 0.45%
Potential problem
loans.................. $ 51,456 $ 38,753 $ 25,565 $ 21,983 $ 14,401
========== ========== ========== ========== ==========
Accruing loans past due
90 days or more........ $ 1,360 626 351 824 527
========== ========== ========== ========== ==========
Total loans............. $1,928,293 $1,484,990 $1,261,273 $1,079,657 $ 907,201
========== ========== ========== ========== ==========
Total assets............ $2,778,090 $2,077,214 $2,060,112 $1,591,284 $1,466,798
========== ========== ========== ========== ==========
Allowance for Credit Losses
The Bank has several systems in place to assist in maintaining the overall
quality of its loan portfolios. The Bank has established underwriting
guidelines to be followed by its bank offices. The Bank also monitors its
delinquency levels for any negative or adverse trends and particularly
monitors credits which have a total exposure of $50,000 or more. However,
there can be no assurance that the Bank's loan portfolios will not become
subject to increasing pressures from deteriorating borrower creditworthiness
due to general economic conditions.
The allowance for credit losses is a reserve established through charges to
earnings in the form of a provision for credit losses. Based on an evaluation
of the loan portfolio, management presents a quarterly review of the allowance
for credit losses to the Bank's Board of Directors, indicating any changes in
the allowance since the last review and any recommendations as to adjustments
in the allowance. In making its evaluation, management considers the industry
diversification of the Bank's commercial loan portfolio and the effect of
changes in the local real estate market on collateral values. The Bank also
considers the results of recent regulatory examinations. The Bank continues to
monitor the effects of current economic indicators and their probable impact
on borrowers, the amount of charge-offs for the period, the amount of non-
performing loans and related collateral security. The Bank monitors the loan
portfolio through its internal loan review department and obtains an annual
loan review by independent consultants. Charge-offs occur when loans are
deemed to be uncollectible.
The Bank follows a loan review program to evaluate the credit risk in the
commercial loan portfolio for substantially all commercial loans and real
estate loans. Through the loan review process, the Bank maintains an
internally classified loan list, which, along with the delinquency list of
loans, helps management assess the overall quality of the loan portfolios and
the adequacy of the allowance for credit losses. Loans classified as
"substandard" are those loans with clear and defined weaknesses such as highly
leveraged positions, unfavorable financial ratios, uncertain repayment sources
or poor financial condition, which may jeopardize recoverability of the debt.
Loans classified as "doubtful" are those loans which have characteristics
similar to substandard accounts but with an increased risk that a loss may
occur, or at least a portion of the loan may require a charge-off if
liquidated at present. Although loans classified as substandard do not
duplicate loans classified as doubtful, both substandard and doubtful loans
include some loans that are delinquent at least 30 days or on nonaccrual
status. Loans classified as "loss" are those loans that are in the process of
being charged off.
24
At December 31, 2001, substandard loans totaled $61.2 million, of which
$14.4 million were loans designated as delinquent or nonaccrual; and doubtful
loans totaled $4.5 million of which $4.3 million were designated as delinquent
or nonaccrual.
In addition to the internally classified loan list and delinquency list of
loans, the Bank maintains a separate "watch list" which further aids the Bank
in monitoring loan portfolios. Watch list loans show warning elements where
the present status portrays one or more deficiencies that require attention in
the short run or where pertinent ratios of the loan account have weakened to a
point where more frequent monitoring is warranted. These loans do not have all
the characteristics of a classified loan (substandard or doubtful) but do show
weakened elements as compared with those of a satisfactory credit. The Bank
reviews these loans to assist in assessing the adequacy of the allowance for
credit losses. As of December 31, 2001, watch list loans totaled $90.4
million.
Management assigns loan grades by loan and allocations are made within each
loan grade so that double allocations are avoided. Loans are assigned a grade
according to payment history, collateral values, and financial condition of
the borrower.
The Bank maintains an adequate allowance for credit losses through its
watchlist classifications, allocating an increasing reserve amount as the
severity of a problem loan increases. The Bank maintains an unallocated
reserve for satisfactory non-classified credits based on the average of the
last three year's actual net charge-offs.
The Company's Board of Directors formed a sub-committee for Asset Quality
in 1999 which meets eight times each year. That committee is composed of three
outside Board of Directors and five senior management members. This committee
reviews all large loans, past-dues, and overdrafts, as well as ratio and trend
analysis and approves all charge-offs over $25 thousand. This committee also
mandates action items for future meetings to evaluate potential problems and
assess the potential need for additional reserve requirements by any
particular sector.
25
The following table presents, for the periods indicated, an analysis of the
allowance for credit losses and other related data (in thousands):
Year Ended December 31,
--------------------------------------------------------
2001 2000 1999 1998 1997
---------- ---------- ---------- ---------- --------
Average loans
outstanding............ $1,693,867 $1,331,282 $1,122,834 $ 991,769 $790,208
========== ========== ========== ========== ========
Loans outstanding at
period end............. $1,928,293 $1,484,990 $1,261,273 $1,079,657 $907,201
========== ========== ========== ========== ========
Allowance for credit
losses at January 1.... $ 16,862 $ 13,998 $ 11,352 $ 8,820 $ 8,323
Charge-offs:
Commercial, financial,
and industrial....... 6,969 7,061 5,485 2,723 1,845
Real estate, mortgage
and construction..... 1,057 643 162 510 140
Installment........... 1,797 63 1,925 1,134 1,381
---------- ---------- ---------- ---------- --------
Total charge-offs... 9,823 7,767 7,572 4,367 3,366
Recoveries:
Commercial, financial,
and industrial....... 871 861 750 229 301
Real estate, mortgage
and construction..... 111 33 42 120 47
Installment........... 464 69 190 275 194
---------- ---------- ---------- ---------- --------
Total recoveries.... 1,446 963 982 624 542
---------- ---------- ---------- ---------- --------
Net charge-offs......... 8,377 6,804 6,590 3,743 2,824
Acquisition of
CaminoReal and
Community.............. 2,758 -- -- -- --
Provision for credit
losses................. 11,684 9,668 9,236 6,275 3,321
---------- ---------- ---------- ---------- --------
Allowance for credit
losses at December 31.. $ 22,927 $ 16,862 $ 13,998 $ 11,352 $ 8,820
========== ========== ========== ========== ========
Ratios:
Allowance to average
loans.................. 1.35% 1.27% 1.25% 1.14% 1.12%
Allowance to period end
loans.................. 1.19% 1.14% 1.11% 1.05% 0.97%
Net charge-offs to
average loans.......... 0.49% 0.51% 0.59% 0.38% 0.36%
Allowance to period-end
nonperforming loans.... 161.51% 175.74% 229.89% 207.53% 176.47%
Allocation of the Allowance for Credit Losses
The following table describes the allocation of the allowance for credit
losses among various categories of loans and certain other information as of
the dates indicated. The allocation is made for analytical purposes and is not
necessarily indicative of the categories in which future loan losses may
occur. The total allowance is available to absorb losses from any category of
loans.
Year ended December 31,
(In thousands)
----------------------------------------------------------------------------------------------
2001 2000 1999 1998 1997
------------------- ------------------ ------------------ ------------------ -----------------
% of % of % of % of % of
Category Category Category Category Category
Balance of allowance to Loans to Loans to Loans to Loans to Loans
for credit losses at Held for Held for Held for Held for Held for
end of period Amount Investment Amount Investment Amount Investment Amount Investment Amount Investment
applicable to: -------- ---------- ------- ---------- ------- ---------- ------- ---------- ------ ----------
Commercial, financial
and industrial........ $ 8,361 31% $ 7,521 35% $ 5,461 37% $ 3,548 37% $1,926 38%
Real estate, mortgage
and construction...... 5,538 60% 3,348 55% 3,014 52% 1,712 51% 751 48%
Installment............ 868 9% 1,073 10% 909 11% 770 12% 690 14%
Unallocated............ 8,160 N/A 4,920 N/A 4,614 N/A 5,322 N/A 5,453 N/A
-------- --- ------- --- ------- --- ------- --- ------ ---
$ 22,927 100% $16,862 100% $13,998 100% $11,352 100% $8,820 100%
======== === ======= === ======= === ======= === ====== ===
26
Securities
The following table summarizes the book value of securities held by the
Bank as of the dates shown. See Note D to the Company's consolidated financial
statements for information relating to fair values and details of held-to-
maturity and available-for-sale securities portfolios.
Year ended December 31,
----------------------------------------------
2001 % 2000 % 1999 %
-------- ----- -------- ----- -------- -----
(In thousands)
U.S. Treasury securities and
obligations of U.S.
government agencies.......... $ 28,937 8.4% $ 36,120 11.7% $118,005 21.6%
Obligations of states and
political subdivisions....... 74,985 21.9% 79,065 25.6% 82,300 15.1%
Mortgage-backed securities and
collateralized mortgage
obligations.................. 220,355 64.3% 180,207 58.5% 328,313 60.2%
Other securities.............. 18,622 5.4% 12,810 4.2% 16,530 3.1%
-------- ----- -------- ----- -------- -----
$342,899 100.0% $308,202 100.0% $545,148 100.0%
======== ===== ======== ===== ======== =====
At December 31, 2001, securities of $342.9 million increased $34.7 million
from $308.2 million at December 31, 2000. Securities acquired with CaminoReal
Bancshares and Community Bancshares totaled $95.7 million and $17.7 million,
respectively. At December 31, 2001 and 2000, securities represented 15.1% and
17.9% of total deposits and 12.3% and 14.8% of total assets, respectively.
The yield on the Bank's securities portfolio at December 31, 2001, was
5.8%. At December 31, 2001, the weighted-average life of the portfolio was
approximately 2.8 years and the duration was approximately 2.0 years. The
yield on the Bank's securities portfolio at December 31, 2000, was 6.5%. At
December 31, 2000, the weighted-average life of the portfolio was
approximately 6.2 years and the duration was approximately 4.2 years.
The maturity distribution and weighted average yield of the Bank's debt
security portfolio as of December 31, 2001, are summarized in the following
table (in thousands).
Due 5-10 Due >10
Due <1 Year Due 1-5 Years Years Years Total
-------------- -------------- ------------- ------------ --------
Amount Yield Amount Yield Amount Yield Amount Yield
-------- ----- -------- ----- ------- ----- ------ -----
Obligations of U.S.
government agencies.... $ 12,285 6.03% $ 13,126 6.08% $ 3,526 7.22% $ -- -- $ 28,937
Obligations of states
and political
subdivisions........... 12,529 5.80% 38,028 6.20% 22,174 6.62% 2,254 8.18% 74,985
Mortgage-backed
securities and
collateralized mortgage
obligations............ 2,494 5.58% 183,044 6.47% 32,990 5.87% 1,827 4.65% 220,355
-------- ---- -------- ---- ------- ---- ------ ---- --------
$ 27,308 5.90% $234,198 6.41% $58,690 6.24% $4,081 6.60% $324,277
======== ==== ======== ==== ======= ==== ====== ==== ========
Deposits
The Bank's lending and investing activities are funded almost entirely by
core deposits, approximately 85.9%, of which are total deposits excluding time
deposits over $100 thousand. Noninterest bearing deposits at December 31, 2001
were $797.9 million as compared to $598.3 million at December 31, 2000, an
increase of $199.6 million or 33.4% of which $57.0 million and $36.4 million
related to the acquisitions of CaminoReal Bancshares and Community Bancshares,
respectively. Approximately 35.2% of deposits at December 31, 2001 were
noninterest bearing as compared to 34.8% at December 31, 2000.
The Bank's average total deposits for 2001 were $2.0 billion, or $412.3
million and 25.8% over average total deposits during 2000 that were $1.6
billion. The increase in the Bank's average total deposits is primarily
attributable to the acquisition of CaminoReal Bancshares. Deposits acquired
with CaminoReal Bancshares and Community Bankcshares totaled $248.8 million
and $114.2 million, respectively. Deposit growth continues to be concentrated
primarily in core deposits, consisting of all deposits other than retail and
public fund certificates of deposit in excess of $100,000. The Bank's average
total deposits at December 31, 2000 were $1.6 billion, up $152.3 million or
10.5% over total deposits of $1.4 billion at year-end 1999.
27
The average balances and weighted average rates paid on deposits for each of
the years ended December 31, 2001, 2000, and 1999 are presented below (in
thousands):
2001 2000 1999
------------------- ------------------ ------------------
Average Average Average Average Average Average
Balance Rate Balance Rate Balance Rate
----------- ------- ---------- ------- ---------- -------
Noninterest bearing
demand deposits........ $ 678,134 $ 536,351 $ 491,415
Interest bearing demand
and savings deposits... 784,054 2.16% 621,038 3.20% 564,747 2.42%
Time deposits........... 547,600 4.77% 440,062 5.51% 388,953 4.74%
----------- ---- ---------- ---- ---------- ----
$ 2,009,788 3.23% $1,597,451 4.16% $1,445,115 3.36%
=========== ==== ========== ==== ========== ====
The Bank's time deposits of $100,000 or more have consistently shown a
pattern of renewal similar to that for deposits of less than $100,000. See Note
J of the consolidated financial statements for maturities of certificates of
deposits of $100,000 or more.
Other Borrowed Funds
Deposits are the primary source of funds for the Bank's lending and
investment activities and for its general business purposes. Additionally, the
Bank has available borrowing facilities through the Federal Home Loan Bank and
numerous correspondent banking relationships.
Notes Payable
Effective February 2, 2002, the Company entered into a Credit Agreement with
Wells Fargo Bank Minnesota, National Association which provides for a $20
million revolving credit facility. The Company currently has $20 million
outstanding under the terms of the credit facility. The term of the credit
facility is for a one year period ending on February 2, 2003. The interest rate
payable by the Company on all funds drawn under the credit facility is 1.95% in
excess of the Federal Funds Rate in effect from time to time. In addition, the
Company pays an annual fee equal to one-eighth of one percent (0.125%) of the
average daily unused portion of the credit facility. The indebtedness under the
credit facility is guaranteed by Sterling Bancorporation, Inc. The Credit
Agreement contains various covenants and restrictions including, among other
things, (i) limitations on dividends, redemptions and repurchases of capital
stock, (ii) limitations on the incurrence of indebtedness, (iii) limitations on
mergers, acquisitions and the sale of all or substantially all of the Company's
assets, and (iv) maintenance of certain financial covenants by the Company and
the Bank. Although such restrictions could restrict the Company's corporate
activities, the Company does not anticipate that the credit facility or the
covenants and conditions contained therein will have any material impact upon
the Company or its operations.
Company-Obligated Mandatorily Redeemable Trust Preferred Securities