STERLING BANCSHARES INC - 10-K Annual Report

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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, 2002

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
HOUSTON, TEXAS 77092
(Address of principal executive offices) (Zip Code)

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:
Common Stock, $1.00 par value
(Title of Class)

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. [ ]

Indicate by check mark whether the registrant is an accelerated filer (as
defined by Rule 12b-2 of the Act). Yes [X] No [ ]

The aggregate market value of the registrant's Common Stock held by
non-affiliates as of June 28, 2002, the last business day of the most recently
completed second fiscal quarter, was $587,252,851 based on the closing sales
price of $14.77 on such date. For purposes of this calculation, affiliates are
defined as all directors and executive officers.

As of February 28, 2003, registrant had outstanding 43,990,054 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 2003 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, 2002, 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, a banking association chartered under the laws
of the State of Texas (the "Bank"). 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.
Sterling Bank was chartered in 1974. The Company completed its initial public
offering on October 22, 1992.

The Company had approximately 1,065 and 1,100 full time equivalent
employees, including 276 and 88 officers, in its commercial banking and mortgage
banking segments, respectively, as of December 31, 2002. At December 31, 2002,
the Company had total assets of $3.6 billion, deposits of $2.5 billion, and
shareholders' equity of $249.3 million.

The Company's website address is www.banksterling.com. The Company makes
available on its website its annual report on Form 10-K, quarterly reports on
Form 10-Q, current reports on Form 8-K and amendments to those reports as soon
as reasonably practicable after it electronically files such reports with the
Securities and Exchange Commission (the "SEC"). Copies of such reports are
available at no charge. The information found on the Company's website does not
constitute a part of this or any other report.

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 V 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 up to applicable limits 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'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 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.

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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 forty 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 owned subsidiary SCMC. SCMC has production
offices in Texas and fourteen other states, with corporate offices in Houston,
Texas and Seattle, Washington. The typical mortgage originated by SCMC is
approximately $140,000. 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 2002, SCMC funded
approximately $4.5 billion in residential mortgage loans.

COMPANY GROWTH STRATEGY

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.
Consistent with its operating philosophy and growth strategy, the Company
regularly evaluates opportunities to acquire banks and other financial services
companies that complement its existing business, expand its market coverage and
share, and enhance its client product offerings.

De Novo Offices. Two new banking offices were opened in 2002. A new
banking office was opened in Houston in December 2002 and in June 2002, the
Company opened a new banking office in San Antonio. Additionally, 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
was the Company's first banking 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. A total of 20,000 of the Series I convertible
preferred shares were actually sold and issued in March 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 Series H convertible
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 September 13, 2002, the Company acquired ENB
Bankshares, Inc. of Dallas, for an aggregate cash purchase price of $10.4
million. ENB Bankshares, Inc. is the privately held bank holding company of
Eagle National Bank ("Eagle National"), which operates one banking office in
North Dallas. Additionally during September 2002, the Company completed the
operational integration of Eagle National Bank and Sterling Bank. This
acquisition was accounted for using the purchase method of accounting. Goodwill
of $5.7 million was recorded in connection with this acquisition.

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 operated two banking offices in west Houston. During May 2002, the Company
completed the operational integration of Community Bank and Sterling Bank. This
acquisition was accounted for using the purchase method of accounting. Goodwill
of $28.7 million was recorded in connection with this acquisition. In June 2002,
the Company sold Community Bank's charter to Sabine State Bank & Trust Company.

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.
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 operated 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 banking offices 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 banking offices 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.

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

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to upgrade its 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.

Divestitures. On October 29, 2002, the Bank entered into an agreement to
sell its banking office located in Eagle Pass, Texas to South Texas National
Bank of Laredo. At December 31, 2002, the Eagle Pass banking office had assets
of $23.6 million, loans of $16.7 million and deposits of $98.2 million. The
proposed sale is subject to customary closing conditions, including receipt of
necessary approvals. If the necessary regulatory approvals are received, it is
anticipated that the closing of the sale will occur during the first quarter of
2003.

On July 16, 2002, the Bank entered into an agreement to sell its banking
offices located in Carrizo Springs, Crystal City and Pearsall to an investor
group headed by the current executive officers of these three locations. As of
December 31, 2002, the three banking offices had combined assets of $19.2
million, loans of $16.3 million and deposits of $41.9 million. The proposed sale
is subject to customary closing conditions, including receipt of necessary
regulatory approvals. If the necessary regulatory approvals are received, it is
anticipated that the closing this sale will occur during the second quarter of
2003.

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

Bank holding companies and banks are extensively regulated by both federal
and state law. This regulation is intended primarily for the protection of
depositors and the deposit insurance fund and not for the benefit of
shareholders of the Company. Set forth below is a summary description of the
material laws and regulations which relate to the operation of the Company and
the Bank. The following descriptions 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 may 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. Further, the Company's securities are
registered with the SEC under the Securities Exchange Act of 1934, as amended
(the "Exchange Act"). As such, the Company is subject to the information, proxy
solicitation, insider trading and other requirements and restrictions of the
Exchange Act.

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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.

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.

Gramm-Leach-Bliley. 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 Company has not filed an election to be a financial holding company.
The Company does not believe that the G-L-B Act will have a material adverse
effect on operations in the near-term. However, to the extent that it permits
banks, securities firms and insurance companies to affiliate, the financial
services industry may experience further consolidation. The G-L-B Act is
intended to grant to community banks certain powers as a matter of right that
larger institutions have accumulated on an ad hoc basis. Nevertheless, this act
may have the result of increasing the amount of competition that the Company and
the Bank face from larger institutions and other types of companies offering
financial products, many of which may have substantially more financial
resources than the Company and the Bank.

USA Patriot 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;

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- rules to promote cooperation among financial institutions, regulators,
and law enforcement entities in identifying parties that may be involved
in terrorism or money laundering;

- 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.

It is anticipated that the U.S. Department of the Treasury and the FDIC
will issue final regulations regarding additional requirements for customer
information and identification programs. At this time, the Company is not able
to predict the impact of such law on its financial condition or results of
operations.

Sarbanes-Oxley Act of 2002. On July 30, 2002, President Bush signed into
law the Sarbanes-Oxley Act of 2002 (the "Sarbanes-Oxley Act"). The stated goals
of the Sarbanes-Oxley Act are to increase corporate responsibility, to provide
for enhanced penalties for accounting and auditing improprieties at publicly
traded companies and to protect investors by improving the accuracy and
reliability of corporate disclosures pursuant to the securities laws.

The Sarbanes-Oxley Act is the most far-reaching U.S. securities legislation
enacted in some time. The Sarbanes-Oxley Act generally applies to all companies,
both U.S. and non-U.S., that file or are required to file periodic reports with
the SEC under the Securities Exchange Act of 1934 (the "Exchange Act"). Given
the extensive SEC role in implementing rules relating to many of the
Sarbanes-Oxley Act's new requirements, the final scope of these requirements
remains to be determined.

The Sarbanes-Oxley Act includes very specific additional disclosure
requirements and new corporate governance rules, requires the SEC and securities
exchanges to adopt extensive additional disclosure, corporate governance and
other related rules and mandates further studies of certain issues by the SEC.
The Sarbanes-Oxley Act represents significant federal involvement in matters
traditionally left to state regulatory systems, such as the regulation of the
accounting profession, and to state corporate law, such as the relationship
between a board of directors and management and between a board of directors and
its committees.

The Sarbanes-Oxley Act addresses, among other matters:

- audit committees for all reporting companies;

- certification of financial statements by the chief executive officer and
the chief financial officer;

- the forfeiture of bonuses or other incentive-based compensation and
profits from the sale of an issuer's securities by directors and senior
officers in the twelve month period following initial publication of any
financial statements that later require restatement;

- a prohibition on insider trading during pension plan black-out periods;

- disclosure of off-balance sheet transactions;

- a prohibition on personal loans to directors and officers;

- expedited filing requirements for Form 4's;

- disclosure of a code of ethics, if applicable, and filing a Form 8-K for
a change or waiver of such code;

- "real time" filing of periodic reports;

- the formation of a public accounting oversight board;

- auditor independence; and

- various increased criminal penalties for violations of securities laws.

The Sarbanes-Oxley Act contains provisions which became effective upon
enactment on July 30, 2002, and provisions which will become effective from
within 30 days to one year from enactment. The SEC has
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been delegated the task of enacting rules to implement various provisions with
respect to, among other matters, disclosure in periodic filings pursuant to the
Exchange Act.

Regulation W. Transactions between a bank and its "affiliates" are
quantitatively and qualitatively restricted under the Federal Reserve Act. The
Federal Deposit Insurance Act applies Sections 23A and 23B to insured nonmember
banks in the same manner and to the same extent as if they were members of the
Federal Reserve System. The Federal Reserve Board has also recently issued
Regulation W, which codifies prior regulations under Sections 23A and 23B of the
Federal Reserve Act and interpretative guidance with respect to affiliate
transactions. Affiliates of a bank include, among other entities, the bank's
holding company and companies that are under common control with the bank. The
Company is considered to be an affiliate of the Bank. In general, subject to
certain specified exemptions, a bank or its subsidiaries are limited in their
ability to engage in "covered transactions" with affiliates:

- to an amount equal to 10% of the bank's capital and surplus, in the case
of covered transactions with any one affiliate; and

- to an amount equal to 20% of the bank's capital and surplus, in the case
of covered transactions with all affiliates.

In addition, a bank and its subsidiaries may engage in certain transactions
only on terms and under circumstances that are substantially the same, or at
least as favorable to the bank or its subsidiary, as those prevailing at the
time for comparable transactions with nonaffiliated companies.

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 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

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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" 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, 2002, the Company's ratios of "Tier 1" and "Total"
capital-to-risk-weighted assets were 8.41%, and 9.29%, 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.
Certain highly rated bank holding companies may maintain a minimum leverage
ratio of 3.0% "Tier 1" capital to total assets but other bank holding companies
are required to maintain a leverage ratio of 4.0% to 5.0%. The Company's
leverage ratio at December 31, 2002 of 7.81% 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.

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 than 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.

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

8

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

Sterling Bank is a Texas-chartered banking association. The Bank's deposits
are insured, up to applicable limits, by the Bank Insurance Fund of 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 Bank may be
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. Sterling Bank is a member of the Federal Home Loan
Bank and, therefore, is 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
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 Transactions with Affiliates and Insiders. Transactions
between the Bank and its nonbanking subsidiaries, including the Company, are
subject to Section 23A of the Federal Reserve Act. In general, Section 23A
imposes limits on the amount of such transactions, and also requires certain
levels of collateral for loans to affiliated parties. It also limits the amount
of advances to third parties which are collateralized by the securities or
obligations of the Company or its subsidiaries.

Affiliate transactions are also subject to Section 23B of the Federal
Reserve Act which generally requires that certain transactions between the Bank
and its affiliates be on terms substantially the same, or at least as favorable
to the Bank, as those prevailing its time for comparable transactions with or
involving other non-affiliated persons.

The restrictions on loans to directors, executive officers, principal
shareholders and their related interests (collectively, the "insiders")
contained in the Federal Reserve Act and Regulation O apply to all insured
institutions and their subsidiaries and holding companies. These restrictions
include limits on loans to one borrower and conditions that must be met before
such a loan can be made. There is also an aggregate
9

limitation on all loans to insiders and their related interests. These loans
cannot exceed the institution's total unimpaired capital and surplus, and the
FDIC may determine that a lesser amount is appropriate. Insiders are subject to
enforcement actions for knowingly accepting loans in violation of applicable
restrictions.

Capital Adequacy Requirements. The Bank is subject to the capital adequacy
requirements promulgated by the FDIC and the Texas Department of Banking. The
FDIC has adopted regulations establishing minimum requirements for the capital
adequacy of insured institutions. The FDIC may establish higher minimum
requirements if, for example, a bank has previously received special attention
or has a high susceptibility to interest rate risk.

The FDIC's risk-based capital guidelines generally require state banks to
have a minimum ratio of Tier 1 capital to total risk-weighted assets of 4.0% and
a ratio of total capital to total risk-weighted assets of 8.0%. As of December
31, 2002, the Bank's ratio of Tier 1 capital to total risk-weighted assets was
8.94% and its ratio of total capital to total risk-weighted assets was 9.82%.
See "Management's Discussion and Analysis of Financial Condition and Result of
Operation -- Financial Condition -- Capital Resources."

The FDIC's leverage guidelines require state banks to maintain Tier 1
capital of no less than 4.0% of average total assets, except in the case of
certain highly rated banks for which the requirement is 3.0% of average total
assets. The Texas Banking Department has issued a policy which generally
requires state chartered banks to maintain a leverage ratio (defined in
accordance with federal capital guidelines) of 6.0%. As of December 31, 2002,
the Bank's ratio of Tier 1 capital to average total assets (leverage ratio) was
8.31%.

Corrective Measures for Capital Deficiencies. The federal banking
regulators are required to take "prompt corrective action" with respect to
capital-deficient institutions. Agency regulations define, for each capital
category, the levels at which institutions are "well capitalized," "adequately
capitalized," "under capitalized," "significantly under capitalized" and
"critically under capitalized." A "well capitalized" bank has a total risk-based
capital ratio of 10.0% or higher; a Tier 1 risk-based capital ratio of 6.0% or
higher, a leverage ratio of 5.0% or higher; and is not subject to any written
agreement, order or directive requiring it to maintain a specific capital ratio
for any capital measure. An "adequately capitalized" bank has a total risk-
based capital ratio of 8.0% or higher; a Tier 1 risk-based capital ratio of 4.0%
or higher; a leverage ratio of 4.0% or higher (3.0% or higher if the bank was
rated a composite 1 in its most recent examination report and is not
experiencing significant growth); and does not meet the criteria for a well
capitalized bank. A bank is "under capitalized" if it fails to meet any one of
the ratios required to be adequately capitalized. As of December 31, 2002, the
Bank was classified as "adequately capitalized" for purposes of the FDIC's
prompt corrective action regulations.

In addition to requiring undercapitalized institutions to submit a capital
restoration plan, agency regulations contain broad restrictions on certain
activities of undercapitalized institutions including asset growth, acquisition,
branch establishment and expansion into new lines of business. With certain
exceptions, an insured depository institution is prohibited from making capital
distributions, including dividends, and is prohibited from paying management
fees to control persons if the institution would be undercapitalized after any
such distribution or payment.

As an institution's capital decreases, the FDIC's enforcement powers become
more severe. A significantly undercapitalized institution is subject to mandated
capital raising activities, restrictions on interest rates paid and transactions
with affiliates, removal of management and other restrictions. The FDIC has only
very limited discretion in dealing with a critically undercapitalized
institution and is virtually required to appoint a receiver or conservator.

Banks with risk-based capital and leverage ratios below the required
minimums may also be subject to certain administrative actions, including the
termination of deposit insurance upon notice and hearing, or a temporary
suspension of insurance without a hearing in the event the institution has no
tangible capital.

Brokered Deposit Restrictions. FIRREA and FDICIA generally limit
institutions which are not well capitalized from accepting brokered deposits. In
general, undercapitalized institutions may not solicit, accept or renew brokered
deposits. Adequately capitalized institutions may not solicit, accept or renew
brokered deposits unless they obtain a waiver from the FDIC. Even in that event,
the institution must comply with rate
10

limitations imposed by the FDI Act. At December 31, 2002, the most recent report
filed by the Bank categorized it as "adequately capitalized." The Bank has
received a waiver from the FDIC permitting it to solicit, accept or renew
brokered deposits through June 30, 2003; however, the waiver may be revoked by
the FDIC at any time.

Restrictions on Subsidiary Banks. Dividends paid by the Bank provided
substantially all of the Company's cash flow during 2002 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, 2002, there was
an aggregate of approximately $67.2 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.

Audit Reports. Insured institutions with total assets of $500 million must
submit annual audit reports prepared by independent auditors to federal and
state regulators. In some instances, the audit report of the institution's
holding company can be used to satisfy this requirement. Auditors must receive
examination reports, supervisory agreements and reports of enforcement actions.
In addition, financial statements prepared in accordance with generally accepted
accounting principles, management's certifications concerning responsibility for
the financial statements, internal controls and compliance with legal
requirements designated by the FDIC, and an attestation by the auditor regarding
the statements of management relating to the internal controls must be
submitted. For certain institutions with total assets of more than $3 billion,
independent auditors may be required to review quarterly financial statements.
FDICIA requires that independent audit committees be formed, consisting solely
of outside directors. The committees of such institutions must include members
with experience in banking or financial management, must have access to outside
counsel, and must not include representatives of large customers. The Company
has an audit committee comprised solely of outside directors with at least one
certified public accountant and, therefore, is in compliance with the
requirements for large institutions.

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.

11

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 .0168% 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.

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 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.

12

ITEM 2 -- PROPERTIES

The principal executive offices of the Company and the Bank are located at
2550 North Loop West, Suite 600, Houston, Texas, 77092, in spaced leased by the
Company. In addition to its principal office, the Company operates the following
locations:

ITEM 3 -- LEGAL PROCEEDINGS

From time to time, the Bank is a party to various legal proceedings
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.

13

PART -- II

ITEM 5 -- MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED SHAREHOLDER MATTERS

The Company's stock trades through The Nasdaq National 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 National 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.

On January 27, 2003, the Company's Board of Directors declared a quarterly
cash dividend of $0.045 per share payable on February 21, 2003, to shareholders
of record on February 7, 2003. The Company intends to continue to pay a dividend
at the rate of $0.045 per share quarterly throughout 2003.

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 7, 2003, the Company estimates that there were 1,053
shareholders of record of common stock. The number of beneficial shareholders is
unknown to the Company at this time.

For information on the ability of the Bank to pay dividends and make loans
to the Company, see "Management's Discussion and Analysis of Financial Condition
and Results of Operations -- Financial Condition -- Interest Rate Sensitivity
and Liquidity" and Note U of the consolidated financial statements.

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 four 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

14

historical results of operations. In addition, data has been restated to reflect
the effect of stock splits where applicable.

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.

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 four 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.

In 2002, the Company entered into two separate agreements for the sale of
four banking offices in South Texas. Revenues, operating costs and expenses, and
other non-operating results from the discontinued operations of the four banking
offices are excluded from the Company's results from continuing operations for
2002. Alternatively, the financial results are presented in the Company's
Consolidated Balance Sheets in line

16

items entitled "Assets related to discontinued operations" and "Liabilities
related to discontinued operations;" the Consolidated Statements of Income under
line items "Loss from discontinued operations before income taxes" and "Loss
from discontinued operations;" and, Consolidated Statements of Cash Flows as
"Net cash provided by (used in) discontinued operations." See further discussion
of discontinued operations in Note J to the consolidated financial statements in
this annual report.

Certain statements under this caption constitute "forward-looking
statements" within the meaning of Section 27A of the Securities Act of 1933, as
amended, and Section 21E of the Securities Exchange Act of 1934, as amended,
which involve risks and uncertainties. Our actual results may differ
significantly from the results discussed in such forward-looking statements.
Factors that might cause such a difference include, but are not limited to,
those factors discussed in "Management's Discussion and Analysis of Financial
Condition and Results of Operations -- Risk Factors and Cautionary Statement for
Purposes of the Provisions of the 'Safe Harbor' Provisions of the Private
Securities Litigation Reform Act of 1995" below.

CRITICAL ACCOUNTING ESTIMATES

The Company's accounting policies are integral to understanding the results
reported. Accounting policies are described in detail in Note A to the
consolidated financial statements in this annual report. The Company believes
that of its significant accounting policies, the allowance for credit losses may
involve a higher degree of judgment and complexity

Allowance for Credit Losses -- The allowance for credit losses is a
valuation allowance for probable losses incurred on loans. Loans are charged to
the allowance when the loss actually occurs or when a determination is made that
a probable loss has occurred. Recoveries are credited to the allowance at the
time of recovery. Throughout the year, management estimates the probable level
of losses to determine whether the allowance for credit losses is adequate to
absorb losses in the existing portfolio. Based on these estimates, an amount is
charged to the provision for credit losses and credited to the allowance for
credit losses in order to adjust the allowance to a level determined to be
adequate to absorb losses. Management's judgment as to the level of probable
losses on existing loans involves the consideration of current economic
conditions and their estimated effects on specific borrowers; an evaluation of
the existing relationships among loans, potential credit losses and the present
level of the allowance; results of examinations of the loan portfolio by
regulatory agencies; and management's internal review of the loan portfolio. In
determining the collectibility of certain loans, management also considers the
fair value of any underlying collateral. The amount ultimately realized may
differ from the carrying value of these assets because of economic, operating or
other conditions beyond the Company's control. Please refer to the subsequent
discussion of "Allowance for Credit Losses" below as well as Note A to the
consolidated financial statements in this annual report for additional insight
into management's approach and methodology in estimating the allowance for
credit losses.

RESULTS OF OPERATIONS

PERFORMANCE SUMMARY

Net income for 2002 was $36.6 million compared with $30.4 million in 2001,
an increase of 20.2%. Diluted earnings per share were $.82 in 2002 and $.71 in
2001, an increase of 15.5%. Included in net income is the after-tax merger
related charges of $631,000 in 2002 and $2.1 million in 2001. In addition to the
merger costs, the Company incurred noncash expenses of $1.4 million in 2002 in
relation to the prepayment of its 9.28% Trust Preferred Securities. Please refer
to "Company-Obligated Mandatorily Redeemable Trust Preferred Securities" below.
Net income for 2001 was $30.4 million or $.71 per diluted share. After-tax
acquisition charges of $2.1 million, are included in net income. 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 2002, the
Company's

17

ROA was 1.21%, as compared to 1.24% and 1.32% for 2001 and 2000, respectively.
During 2002, the Company's return on equity was 15.44% compared to 16.58% and
17.82% for 2001 and 2000, 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 2002 was $146.7 million, up $23.5 million or 19.1%
from $123.2 million for 2001. The growth in net interest income is primarily
attributable to decreasing interest rates in 2001 and the 30.4% increase in
average loans. The loan growth related to the acquisitions of ENB Bankshares,
CaminoReal Bancshares and Community Bancshares was 5.2%. 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. The Federal Reserve Bank decreased the discount rate in the
aggregate by 475 basis points in 2001 and 50 basis points in November of 2002.
Consequently, the Bank's yields decreased in 2001 and 2002 as a result of the
Bank lowering its prime rate in relation to the Federal Reserve decreases. While
average earning assets increased 23.3%, the yield decreased 129 basis points
from 8.03% in 2001 to 6.74% in 2002. As of December 31, 2002, average interest
bearing liabilities were $1.7 billion, an increase of $317.6 million or 22.6%
from December 31, 2001. Average interest bearing deposits increased 15.5%. The
increase in average interest bearing deposits related to the acquisitions of ENB
Bankshares, CaminoReal Bancshares and Community Bancshares was 6.6%. The cost of
interest bearing liabilities decreased 164 basis points from 3.37% in 2001 to
1.73% in 2002. The Company's 5.66% tax equivalent net interest margin for 2002
decreased from the 5.88% recorded in 2001.

Net interest income for 2001 was $123.2 million, up $19.5 million or 18.9%
from $103.7 million for 2000. The growth in net interest income is primarily
attributable to the 27.2% increase in average loans. Average earning assets
increased 13.2% from 2000 to 2001. During the latter part of 2000, the Bank
deleveraged its balance sheet resulting in a decrease in average securities of
30.2% from 2000 to 2001. The yield on interest earning assets decreased 86 basis
points from 8.89% in 2000 to 8.03% 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 127 basis points from 4.64% in 2000 to
3.37% in 2001. This decrease in rates was due to a combination of the Federal
Reserve rate decreases as well as the deleveraging of the balance sheet. For
2001, the tax equivalent net interest margin increased 27 basis points to 5.88%
from 5.61% for 2000.

18

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:

- ---------------

(1) Loan origination fees are considered adjustments to interest income. These
fees aggregated $5,144,000, $2,776,000 and $2,232,000 for the years ended
December 31, 2002, 2001 and 2000, 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%.

19

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):

NONINTEREST INCOME

The Company's noninterest income consists primarily of customer service
fees, gains arising from the sale of mortgage loans and origination fees
relating to mortgage loans. Noninterest income for 2002 totaled $94.5 million,
an increase of $29.7 million or 45.9% over the $64.8 million in 2001.
Noninterest income for 2001 totaled $64.8 million, an increase of $23.1 million
or 55.5% over the $41.6 million in 2000. The following

20

table shows the breakout of noninterest income between commercial banking and
mortgage banking for 2002, 2001 and 2000 (in thousands):

Commercial Banking Segment. For 2002, noninterest income from commercial
banking was $27.5 million, as compared to $22.8 million for 2001, an increase of
$4.7 million or 20.7%. During 2002, customer service fees increased $2.0 million
or 14.8%, as a result of the acquisitions of Eagle National, Community and
CaminoReal and the growth in deposit transaction accounts. The increase of
$720,000 from the gain on trading assets is due to the trading department being
established in the second quarter of 2001. Increased debit card usage caused the
debit card fees to increase $450,000. In 2002, the Bank began selling the
guaranteed portion of SBA loans resulting in a premium of $312,000 being
recognized in 2002. Also in 2002, the Bank began selling fixed and variable
annuity products and recorded income totaling $300,000 in 2002. Additionally,
the Company sold the charter for Community Bank in June 2002 for $150,000.
During 2001, customer service fees increased $2.4 million or 22.2%, 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 $877,000 in 2001 as compared to $223,000 in
2000. In December 2000, the Bank sold land for a gain of $244,000. Finally,
during the first quarter of 2000, the Bank sold its credit card portfolio to a
correspondent bank for a net gain of $237,000.

Mortgage Banking Segment. For 2002, noninterest income from the mortgage
banking segment increased $25.0 million or 59.6% from $42.0 million for 2001 to
$67.0 million in 2002. 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 thirty days. During 2002, SCMC had $4.5 billion in loan fundings
as compared to $2.6 billion in 2001. The increase in noninterest income and
noninterest expense is mainly due to the favorable interest rate environment
which led to increased loan refinancing and new loan activity and the opening of
thirty-six new retail locations in 2002. For 2001, noninterest income from the
mortgage banking segment increased $20.2 million or 92.6% from $21.8 million for
2000 to $42.0 in 2001. 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.

21

NONINTEREST EXPENSE

Noninterest expense for 2002 totaled $172.4 million, an increase of $43.8
million or 34.1% over the $128.5 million in 2001. Noninterest expense increased
$33.0 million or 34.6% from $95.5 million in 2000 to $128.5 million in 2001.

The following table shows the breakout of noninterest expense between
commercial banking and mortgage banking for 2002, 2001 and 2000 (in thousands):

Commercial Banking Segment. For 2002, noninterest expenses related to
commercial banking were $113.4 million, as compared to $101.9 million for 2001,
an increase of $11.5 million or 11.2%. Salaries and employee benefits in the
commercial banking segment for 2002 totaled $61.7 million, an increase of $7.7
million or 14.3% over $54.0 million for 2001. Increased salaries and employee
benefits expenses related to the acquisitions of Eagle National, Community and
CaminoReal offices since acquisition were $1.7 million. Also salaries increased
due to the new banking office opened in San Antonio in June 2002, the new energy
lending division established during the first quarter of 2002 and the trading
department established in the second quarter of 2001. Salaries and employee
benefits expenses including discontinued operations in the commercial banking
segment for 2001 totaled $54.0 million, an increase of $9.3 million or 20.1%
over $44.7 million for 2000. Increased salaries and employee benefits expenses
related to the acquisition of the CaminoReal Bank offices since acquisition were
$2.8 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 million during 2001.

Professional fees relating to commercial banking in 2002 totaled $4.2
million, an increase of $1.2 million or 40.7% from $3.0 million in 2001. This
increase is the primarily due to $906,000 of computer software consulting fees
related to the trustee deposits held by the Bank. Additionally the Company
incurred expenses of $109,000 in the second quarter of 2002 related to its
401(k) plan conversion.

Minority interest expense increased $1.2 million or 25.4% from 2001 as
compared to 2002 and $2.0 million or 76.8% from 2000 as compared to 2001. The
increases are related to the interest on the additional trust preferred
securities issued in September 2002, August 2002 and March 2001. Please refer to
the subsequent discussion of "Company-Obligated Mandatorily Redeemable Trust
Preferred Securities" for additional details of the issuances.

22

In 2002, the Company recorded $822,000 in conversion costs related to the
acquisition of Eagle National. Conversion costs in 2001 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
$957,000, $1.2 million and $1.0 million, respectively. The costs include
retention and severance expenses as well as data processing costs related to the
conversions of the acquired banks' systems.

Other expenses in the commercial banking segment totaled $16.6 million in
2002, an increase of $2.3 million or 15.7%, from $14.4 million in 2001. Due to
the adoption of SFAS 142, amortization of the goodwill presently on the
Company's books was terminated January 1, 2002. Amortization of goodwill
expensed in 2001 was $767,000. The Company incurred $1.4 million in noncash
charges related to the early redemption of its trust preferred securities in
November 2002. Amortization in 2002 of the core deposit intangible related to
the acquisition of Community Bank and Eagle National Bank was $426,000. Other
expenses in the commercial banking segment totaled $14.4 million in 2001, an
increase of $2.6 million or 21.7%, from $11.8 million in 2000. The increase in
goodwill amortization recorded in 2001 related to the CaminoReal Bancshares
acquisition was $583,000. Also, charges related to the new debit card program
increased $252,000 from 2000.

Mortgage Banking Segment. Noninterest expense for the mortgage banking
segment for 2002 was $59.0 million, as compared to $26.6 million for 2001, an
increase of $32.4 million or 121.7%. The increase in expenses is due to variable
expenses related to the increase in loan fundings and the opening of thirty-six
new locations in 2002. Employees increased from 622 in 2001 to 1,100 in 2002.
Also based upon an outside valuation of the mortgage servicing rights, an
impairment of $9.5 million was recorded in 2002. The impairment of mortgage
servicing rights is a result of the decline in mortgage interest rates and an
increase in prepayments of mortgages which are serviced by SCMC due to a
favorable interest rate environment which led to increased loan refinancing and
new loan activity. Noninterest expense for the mortgage banking segment for 2001
was $26.6 million, as compared to $16.7 million for 2000, an increase of $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.

INCOME TAXES

The Company provided $18.1 million for federal income taxes for 2002, $16.4
million for 2001, and $12.6 million for 2000. The effective tax rates for 2002,
2001, and 2000 were 33.1%, 35.1%, and 31.5%, respectively.

FINANCIAL CONDITION

LOANS HELD FOR INVESTMENT

At December 31, 2002, loans held for investment totaled $1.9 billion, an
increase of $274.4 million or 16.8% over loans at December 31, 2001 of $1.6
billion. Loans acquired as a result of the acquisition of Eagle National in
September 2002 totaled $64.4 million.

At December 31, 2002, loans held for investment were 75.4% of deposits and
53.3% of total assets. At December 31, 2001, loans held for investment were
76.5% of deposits and 58.9% of total assets.

23

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):

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. The Bank's legal lending limit was
$20 million at December 31, 2002 and was not exceeded by 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.

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".

24

Loan maturities and rate sensitivity of the loan portfolio, excluding real
estate -- mortgage, consumer and foreign loans and unearned discount at
December 31, 2002 are as follows (in thousands):

As of December 31, 2002, 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 $701.3 million at December 31, 2002, an
increase from $261.5 million at December 31, 2001. The $439.8 million, or
168.2%, increase is due to the increase in loans funded by the Bank through an
intercompany mortgage warehouse line of credit 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. Loan fundings
by SCMC increased $1.8 billion from $2.6 billion funded in 2001 to $4.5 billion
funded in 2002.

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, 1998 through 2002. The Bank, however, continues
to monitor the potential risk of foreign borrowers and concentrations of credit.

25

The following table presents information regarding non-performing loans and
assets as of December 31, 2002, 2001, 2000, 1999, and 1998 (in thousands):

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 officers. 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. 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

26

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.

At December 31, 2002, substandard loans totaled $79.9 million, of which
$17.9 million were loans designated as delinquent or nonaccrual; and doubtful
loans totaled $2.0 million of which $1.5 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, 2002, watch list loans totaled $123.7 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 has formed a sub-committee for Asset Quality in 1999 which
meets eight times each year. That committee is composed of three outside members
of the Company's Board of Directors and five senior members of the Bank's
management. This committee reviews all large loans, past-dues, and overdrafts,
as well as ratio and trend analysis and approves all charge-offs over $25,000.
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.

27

The following table presents, for the periods indicated, an analysis of the
allowance for credit losses and other related data (in thousands):

28

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.

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.

At December 31, 2002, securities of $313.1 million decreased $16.4 million
from $329.4 million at December 31, 2001. At December 31, 2002 and 2001,
securities represented 12.4% and 15.4% of total deposits and 8.7% and 11.9% of
total assets, respectively.

The yield on the Bank's securities portfolio at December 31, 2002, was
4.7%. At December 31, 2002, the weighted-average life of the portfolio was
approximately 2.3 years and the duration was approximately 1.7 years. 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.

29

The contractual maturity distribution and weighted average yield of the
Bank's security portfolio as of December 31, 2002 are summarized in the
following table (in thousands). No tax equivalent adjustments were made.

DEPOSITS

The Bank's investing activities and loans held for investment are funded
primarily by core deposits, approximately 82.6% of which are total deposits
excluding time deposits over $100,000. Noninterest bearing deposits at December
31, 2002 were $991.3 million as compared to $776.7 million at December 31, 2001,
an increase of $214.5 million or 27.6% of which $11.8 million related to the
acquisition of Eagle National Bank. Approximately 39.1% of deposits from at
December 31, 2002 were noninterest bearing.

The Bank's average total deposits for 2002 were $2.2 billion, which is
$356.2 million or 18.9% over average total deposits during 2001 of $1.9 billion.
The increase in the Bank's average total deposits is primarily attributable to
the acquisition of Community Bancshares in December 2001 and ENB Bankshares in
September 2002. Deposits acquired with Community Bankshares and ENB Bankshares
totaled $114.6 million and $58.0 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 for 2001 were $1.9 billion, which is $282.3
million or 17.7% over average total deposits during 2000 of $1.6 billion. A
portion of the increase in the Bank's average total deposits is attributable to
acquisitions. Deposits acquired in 2001 with CaminoReal Bancshares and Community
Bancshares totaled $115.0 million and $114.2 million, respectively. The Bank
began accepting brokered certificates of deposit in 2002. Average brokered
certificates of deposit totaled $34.9 million in 2002.

The average balances and weighted average rates paid on deposits for each
of the years ended December 31, 2002, 2001, and 2000 are presented below (in
thousands):

30

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. The
remaining maturities of certificates of deposits of $100,000 or more as of
December 31, 2002 are summarized as follows (in thousands):

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

The Company has entered into a Credit Agreement with Wells Fargo Bank
Minnesota, National Association dated February 2, 2002, as amended by the First
Amendment to Credit Agreement dated February 2, 2003 between the Company and
Wells Fargo Bank, National Association ("Wells Fargo"), successor by assignment
to Wells Fargo Bank Minnesota, National Association (as amended, the "Credit
Agreement"). Pursuant to the Credit Agreement, the Company has borrowed $20
million which is evidenced by the Term Note dated February 2, 2003. The Term
Note bears interest at a rate per annum of 1.95% above the federal funds rate in
effect from time to time. The federal funds rate is a fluctuating interest rate
per annum set daily by Wells Fargo as the rate at which funds are offered to
Wells Fargo by federal funds brokers. The indebtedness evidenced by the Term
Note is repayable in quarterly installments with a final maturity date of
February 1, 2006. The Credit Agreement requires the Company and the Bank to
maintain certain financial ratios and includes other restrictive covenants.
Included within these financial covenants is a covenant requiring the Bank to
maintain its categorization as "well capitalized." At December 31, 2002, the
most recent report filed by the Bank categorized it as "adequately capitalized"
under applicable regulatory requirements. Wells Fargo has provided to the
Company a written waiver with respect this financial covenant which is effective
through March 31, 2003.

COMPANY-OBLIGATED MANDATORILY REDEEMABLE TRUST PREFERRED SECURITIES

With the proceeds received by the Company from the sale of its 8.30% Junior
Subordinated Debentures to Trust III on September 26, 2002, the Company, on
November 1, 2002, prepaid all $29,639,200 of the 9.28% Junior Subordinated
Deferrable Interest Debentures previously issued by the Company to Sterling
Bancshares Capital Trust I ("Trust I"). Upon the prepayment, the 9.28% Trust
Preferred Securities and the 9.28% Trust Common Securities issued by Trust I
were mandatorily redeemed. In each case, the redemption was made at par, plus
the accrued and unpaid distributions through November 1, 2002.

On September 26, 2002, Sterling Bancshares Capital Trust III ("Trust III"),
a trust formed under the laws of the State of Delaware in February 2001, issued
$31,250,000 of 8.30% Trust Preferred Securities and invested the proceeds
thereof in the 8.30% Junior Subordinated Deferrable Interest Debentures (the
"8.30% Junior Subordinated Debentures") issued by the Company. The 8.30% Junior
Subordinated Debentures will mature on September 26, 2032, which date may be
shortened to a date not earlier than September 26, 2007 if certain conditions
are met (including the Company having received prior approval of the Federal
Reserve and any other required regulatory approvals). The 8.30% Trust Preferred
Securities will be subject to mandatory redemption in a like amount
contemporaneously with the optional prepayment of the 8.30% Junior Subordinated
Debentures by the Company. The 8.30% Junior Subordinated Debentures may be
prepaid upon the occurrence and continuation of certain events including a
change in the tax status or regulatory capital

31

treatment of the 8.30% Trust Preferred Securities. In each case, redemption will
be made at a price equal to 100% of the face amount of the 8.30% Trust Preferred
Securities, plus the accrued and unpaid distributions thereon through the
redemption date.

In August 2002, the Company formed Sterling Bancshares Statutory Trust One,
a trust formed under the laws of the State of Connecticut ("Statutory Trust
One"). On August 30, 2002, Statutory Trust One completed a private placement of
$20,000,000 of Floating Rate Trust Preferred Securities to an institutional
buyer. The proceeds from the sale were invested in the Floating Rate Junior
Subordinated Deferrable Interest Debentures issued by the Company. The Floating
Rate Trust Preferred Securities and the Floating Rate Junior Subordinated
Deferrable Interest Debentures have a floating rate equal to the three-month
LIBOR plus 3.45%, which resets quarterly. For the first five years, there is a
ceiling on the three-month LIBOR of 8.50% resulting in a ceiling on the floating
rate of 11.95% during this period. As of December 31, 2002, the rate was 4.85%.
The Floating Rate Junior Subordinated Debentures will mature on August 30, 2032,
which date may be shortened to a date not earlier than August 30, 2007 if
certain conditions are met (including the Company having received prior approval
of the Federal Reserve and any other required regulatory approvals). The
Floating Rate Trust Preferred Securities will be subject to mandatory redemption
in a like amount contemporaneously with the optional prepayment of the Floating
Rate Junior Subordinated Deferrable Interest Debentures by the Company. The
Floating Rate Junior Subordinated Deferrable Interest Debentures may be prepaid
upon the occurrence and continuation of certain events including a change in the
tax status or regulatory capital treatment of the Floating Rate Trust Preferred
Securities. In each case, redemption will be made at a price equal to 100% of
the face amount of the Floating Rate Trust Preferred Securities, plus the
accrued and unpaid distributions thereon through the redemption date.

In February 2001, the Company formed Sterling Bancshares Capital Trust II
("Trust II") and Trust III, each a trust formed under the laws of the State of
Delaware. On March 21, 2001, Trust II issued $28,750,000 of 9.20% Trust
Preferred Securities and invested the proceeds thereof in the 9.20% Junior
Subordinated Deferrable Interest Debentures (the "9.20% Junior Subordinated
Debentures") issued by the Company. The 9.20% Junior Subordinated Debentures
will mature on March 21, 2031, which date may be shortened to a date not earlier
than March 21, 2006 if certain conditions are met (including the Company having
received prior approval of the Federal Reserve and any other required regulatory
approvals). The 9.20% Trust Preferred Securities will be subject to mandatory
redemption in a like amount contemporaneously with the optional prepayment of
the 9.20% Junior Subordinated Debentures by the Company. The 9.20% Junior
Subordinated Debentures may be prepaid upon the occurrence and continuation of
certain events including a change in the tax status or regulatory capital
treatment of the 9.20% Trust Preferred Securities. In each case, redemption will
be made at a price equal to 100% of the face amount of the 9.20% Trust Preferred
Securities, plus the accrued and unpaid distributions thereon through the
redemption date.

INTEREST RATE SENSITIVITY AND LIQUIDITY

The Company manages its interest rate risk through structuring the balance
sheet to maximize net interest income while maintaining an acceptable level of
risk to changes in market interest rates. This process requires a balance
between profitability, liquidity, and interest rate risk.

To effectively measure and manage interest rate risk, the Company uses
simulation analysis to determine the impact on net interest income of changes in
interest rates under various interest rate scenarios, balance sheet trends, and
strategies. From these simulations, interest rate risk is quantified and
appropriate strategies are developed and implemented. The overall interest rate
risk position and strategies are reviewed by senior management, the
Asset/Liability Management Committee and the Company's Board of Directors on an
ongoing basis.

An interest rate sensitive asset or liability is one that, within a defined
time period, either matures or experiences an interest rate change in line with
general market interest rates. The management of interest rate risk is performed
by analyzing the maturity and repricing relationships between interest earning
assets and interest bearing liabilities at specific points in time ("GAP") and
by analyzing the effects of interest rate changes on net interest income over
specific periods of time by projecting the performance of the mix of assets

32

and liabilities in varied interest rate environments. Interest rate sensitivity
reflects the potential effect on net interest income of a movement in interest
rates. A company is considered to be asset sensitive, or having a positive GAP,
when the amount of its interest earning assets maturing or repricing within a
given period exceeds the amount of its interest bearing liabilities also
maturing or repricing within that time period. Conversely, a company is
considered to be liability sensitive, or having a negative GAP, when the amount
of its interest bearing liabilities maturing or repricing within a given period
exceeds the amount of its interest earning assets also maturing or repricing
within that time period. During a period of rising interest rates, a negative
GAP would tend to adversely affect net interest income, while a positive GAP
would tend to result in an increase in net interest income. During a period of
falling interest rates, a negative GAP would tend to result in an increase in
net interest income, while a positive GAP would tend to affect net interest
income adversely. When analyzing its GAP position, the Company emphasizes the
next twelve-month period.

The Company's net interest income is positioned to benefit from rising
short-term rates due to an asset sensitive position. The Company would likely
benefit from an increase in short-term interest rates as this might signify that
economic conditions are improving. In addition, an increase in short-term
interest rates would likely affect the Company's fixed-rate/variable-rate
product origination mix and origination volumes and would likely slow
prepayments. However, even in the current interest rate environment, the
Company's loan demand remains strong. Also, management continues to evaluate the
Company's lending rates and those rates may not be adjusted downward on a basis
that is entirely consistent with short term interest rate trends should such
trends reflect a further decrease in rates.

While this asset sensitivity may compress net interest income in the
short-term or if the current interest rate environment continues for an extended
period of time, the Company believes this asset sensitive position is justified
because current rates are well below historical averages and, consequently,
there is a greater possibility over time of higher interest rates versus lower
interest rates. However, if interest rates remain stable or decrease, the
Company could continue to experience an increase in prepayments of commercial
loans, mortgage-backed securities and, with respect to SCMC, mortgage servicing
rights and may experience further compression of net interest margin or net
interest income.

As mentioned, the Company utilizes simulation models to estimate the impact
on net interest income of changes in interest rates under various scenarios.
Based on simulation analysis of the interest rate sensitivity inherent in the
Company's net interest income and market value of portfolio equity, as of
December 31, 2002 and as adjusted by instantaneous rate changes upward and
downward of up to 100 basis points, the Company is slightly asset sensitive. The
Company's analysis indicates that an instantaneous 100 basis point move downward
in interest rates would decrease net interest income by 5.11% and decrease the
present value of equity by 4.90%; likewise, an instantaneous 100 basis point
move upward in interest rates would increase net interest income by 5.05% and
increase the present value of equity by 4.12%. These sensitivities are all
within the threshold set by the Company's Asset/Liability Committee. Each rate
scenario reflects unique prepayment and repricing assumptions. Since there are
limitations inherent in any methodology used to estimate the exposure to changes
in market interest rates, this analysis is not intended to be a forecast of the
actual effect of a change in market interest rates on the Company. The Company's
interest rate sensitivity analysis includes assumptions that (i) the composition
of the Company's interest sensitive assets and liabilities existing at fiscal
year end will remain constant over the measurement period; and (ii) that changes
in market rates are parallel and instantaneous across the yield curve regardless
of duration or repricing characteristics of specific assets or liabilities.
Further, the analysis does not contemplate any actions that the Company might
undertake in response to changes in market interest rates. Accordingly, this
analysis is not intended to and does not provide a precise forecast of the
effect actual changes in market rates will have on the Company.

33

The following table sets forth the expected maturity and repricing
characteristics of the Company's interest earning assets and interest bearing
liabilities as of December 31, 2002:

Shortcomings are inherent in any GAP analysis since certain assets and
liabilities may not reprice proportionally as interest rates change. The
Company's management has begun to utilize an interest rate risk simulation model
to increase its ability to monitor and forecast the effect of various interest
rate environments on earnings and its net capital position.

The objectives of the Company's liquidity management is to maintain the
Bank's ability to meet day-to-day deposit withdrawals and other payment
obligations, to raise funds to support asset growth, to maintain reserve
requirements and otherwise operate the Company on an ongoing basis. The Company
strives to manage its liquidity position to allow the Bank to meet its
requirements while maintaining an appropriate balance between assets and
liabilities to meet the return on investment expectations of the Company's
shareholders. In recent years, the Company's liquidity needs have primarily been
met by growth in core deposits. The acquisitions of CaminoReal Bancshares and
Community Bancshares during 2001 and ENB Bankshares in 2002 resulted in the
receipt of an additional $344.2 million in core deposits. In addition to core
deposits, the Bank has access to purchased funds from correspondent banks and
from the Federal Home Loan Bank, supplemented by amortizing investment and loan
portfolios. Also in 2002, the Bank began accepting brokered certificates of
deposit.

The Company is a separate and distinct entity from the Bank and must
provide for its own liquidity and fund its obligations. The primary source of
the Company's revenues are from dividends declared by the Bank. There are
statutory and regulatory provisions that could limit the ability of the Bank to
pay dividends to the Company. At December 31, 2002, the Bank had approximately
$67.2 million in the aggregate available to be
34

paid as dividends to the Company. It is not anticipated that such restrictions
will have an impact on the ability of the Company to meet its ongoing cash
obligations. As of December 31, 2002, the Company did not have any material
commitments for capital expenditures.

CONTRACTUAL OBLIGATIONS AND OTHER COMMITMENTS

The Company's future cash payments associated with its contractual
obligations pursuant to its notes payable, trust preferred securities and
operating leases are as follows (in thousands):

The Company's commitments associated with commitments to extend credit,
outstanding letters of credit and mortgages sold with recourse as of December
31, 2002 are summarized below (in thousands). Since commitments associated with
letters of credit and lending and financing arrangements may expire unused, the
amounts shown do not necessarily reflect the actual future cash funding
requirements. See Note T to the consolidated financial statements for additional
discussion of financial instruments with off-balance sheet risk.

CAPITAL RESOURCES

At December 31, 2002, shareholders' equity totaled $249.3 million or 7.0%
of total assets, as compared to $217.4 million and 7.8% of total assets at
December 31, 2001.

Regulatory authorities in the United States have issued risk-based capital
standards by which all bank holding companies and banks will be evaluated in
terms of capital adequacy. These guidelines relate a banking company's capital
compared to the risk profile of its assets. Tier 1 capital includes common
shareholders' equity, minority interest in consolidated subsidiaries, and
qualifying perpetual preferred stock together with related surpluses and
retained earnings. Tier 2 capital may be comprised of limited life preferred
stock, qualifying debt instruments, and the reserves for credit losses.

On September 26, 2002, Trust III issued $31,250,000 of 8.30% Trust
Preferred Securities and invested the proceeds thereof in the 8.30% Junior
Subordinated Debentures issued by the Company. The net proceeds received by the
Company from the sale of the 8.30% Junior Subordinated Debentures were used to
prepay all $29,639,200 of the 9.28% Junior Subordinated Deferrable Interest
Debentures previously issued by the Company to Trust I. In connection with such
prepayment, the trust redeemed the 9.28% Trust Preferred Securities and the
9.28% Trust Common Securities previously issued by Trust I.

On August 30, 2002, Statutory Trust One issued $20,000,000 of Floating Rate
Trust Preferred Securities and invested the proceeds thereof in the Floating
Rate Junior Subordinated Deferrable Interest Debentures issued by the Company.
The net proceeds received by the Company from the sale of its Floating Rate
Junior Subordinated Deferrable Interest Debentures were used, in part, to fund
the acquisition of ENB Bankshares Inc.

35

In March 2001, the Sterling Bancshares Capital Trust II completed the
issuance of $28,750,000 of 9.20% Trust Preferred Securities and invested the
proceeds in the 9.20% Junior Subordinated Debentures issued by the Company. The
proceeds received by the Company were used, in part, to fund the acquisition of
CaminoReal Bancshares.

Under applicable regulatory guidelines, the 8.30% Trust Preferred
Securities, the Floating Rate Trust Preferred Securities and the 9.20% Trust
Preferred Securities qualify as Tier 1 capital up to a maximum of 25% of Tier 1
capital. Any additional portion of the Trust Preferred Securities would qualify
as Tier 2 capital.

The Company may consider other sources of funds, including additional
equity or debt offerings.

Banking regulators have also issued leverage ratio requirements. The
leverage ratio requirement is measured as the ratio of Tier 1 capital to
adjusted assets. The total risk-based capital, Tier 1 risk-based capital and
Tier 1 leverage ratios as well as the minimum capital amounts and ratios for the
Company as of December 31, 2002 are as follows (in thousands):

See Note U to the Company's consolidated financial statements for further
discussion of the Company's regulatory capital requirements.

RISK FACTORS AND CAUTIONARY STATEMENT FOR PURPOSES OF THE PROVISIONS OF
THE "SAFE HARBOR" PROVISIONS OF THE PRIVATE SECURITIES LITIGATION
REFORM ACT OF 1995

Some of the statements and information contained in this Annual Report may
contain forward-looking statements within the meaning of the Private Securities
Litigation Reform Act of 1995. Forward-looking statements discuss future
expectations, activities or events and by their nature, they are subject to
risks and uncertainties. Forward-looking statements can be identified by the
fact that they do not relate strictly to historical or current facts. They often
include words such as "believe," "expect," "anticipate," "intend," "plan,"
"estimate," or words of similar meaning, or future or conditional verbs such as
"will," "would," "should," "could," or "may." Forward-looking statements speak
only as of the date they are made. We will not update these forward-looking
statements to reflect circumstances or events that occur after the date the
forward-looking statements are made.

Many possible factors could affect our future financial performance. Our
actual results may differ materially from what is expressed in any
forward-looking statement. Important factors that could cause actual results to
differ materially from estimates or projections contained in forward-looking
statements include:

- general business and economic conditions in the markets we serve may be
less favorable than anticipated which could decrease the demand for loan,
deposit and other financial services and increase loan delinquencies and
defaults;

- changes in market rates and prices may adversely impact the value of
securities, loans, deposits and other financial instruments;

- our liquidity requirements could be adversely affected by changes in our
assets and liabilities;

- legislative or regulatory developments including changes in laws
concerning taxes, banking, securities, insurance and other aspects of the
financial securities industry;

36

- competitive factors, including product and pricing pressures among
financial services organizations, may increase; and

- fiscal and governmental policies of the United States federal government.

With this in mind, you should consider the following important factors that
could cause actual results to differ materially from those expressed in any
forward-looking statement made by us or on our behalf:

OUR PROFITABILITY DEPENDS SIGNIFICANTLY ON LOCAL ECONOMIC CONDITIONS.

Our success depends primarily on the general economic conditions of the
Houston metropolitan area. Unlike larger banks that are more geographically
diversified, we provide banking and financial services to customers primarily in
the Houston metropolitan area. We also provide, to a lesser extent, banking and
financial services to customers in the San Antonio and Dallas metropolitan
areas. The local economic conditions of Houston, and to a lesser extent, San
Antonio and Dallas, have a significant impact on our commercial, real estate and
construction loans, the ability of the borrowers to repay these loans and the
value of the collateral securing these loans. A significant decline in general
economic conditions, such as inflation, recession, acts of terrorism, an
outbreak of hostilities, unemployment and other factors beyond our control will
impact these local economic conditions and will negatively affect the financial
results of our banking operations. In addition, since Houston remains largely
dependent on the energy industry, the recent downturn in the energy industry and
energy-related businesses has adversely affected the economic conditions of the
Houston metropolitan area. This downturn in the energy industry and the
energy-related business could adversely affect our results of operations and
financial condition.

WE RELY ON AN OWNER-OPERATED BUSINESS MARKET.

We target our business development and marketing strategy primarily to
serve the banking and financial needs of owner-operated businesses with credit
needs of up to $2 million. These owner-operated businesses represent a major
sector of the Houston and national economies. If general economic conditions
negatively impact this economic sector in the Houston metropolitan area or the
other Texas markets in which we operate, our results of operations and financial
condition will be significantly affected.

IF OUR ALLOWANCE FOR LOAN LOSSES IS NOT SUFFICIENT TO COVER ACTUAL LOAN LOSSES,
OUR EARNINGS COULD DECREASE.

Our loan customers may not repay their loans according to the terms of
these loans and the collateral securing the payment of these loans may be
insufficient to assure repayment. We may experience significant credit losses
which could have a material adverse effect on our operating results. We make
various assumptions and judgments about the collectibility of our loan
portfolio, including the creditworthiness of our borrowers and the value of the
real estate and other assets serving as collateral for the repayment of many of
our loans. In determining the size of the allowance, we rely on our experience
and our evaluation of economic conditions. If our assumptions prove to be
incorrect, our current allowance may not be sufficient to cover future loan
losses and adjustments may be necessary to allow for different economic
conditions or adverse developments in our loan portfolio. Material additions to
our allowance would materially decrease our net income.

In addition, federal and state regulators periodically review our allowance
for loan losses and may require us to increase our provision for loan losses or
recognize further loan charge-offs, based on judgments different than those or
our management. Any increase in our loan allowance or loan charge-offs as
required by these regulatory agencies could have a negative effect on us.

FLUCTUATIONS IN INTEREST RATES COULD REDUCE OUR PROFITABILITY.

We realize income primarily from the difference between interest earned on
loans and investments and the interest paid on deposits and borrowings. We
expect that we will periodically experience "gaps" in the interest rate
sensitivities of our assets and liabilities, meaning that either our
interest-bearing liabilities will be more sensitive to changes in market
interest rates than our interest-earning assets, or vice versa. In either

37

event, if market interest rates should move contrary to our position, this "gap"
will work against us, and our earnings may be negatively affected.

We are unable to predict fluctuations of market interest rates, which are
affected by the following factors:

- inflation;

- recession;

- a rise in unemployment;

- tightening money supply;

- international disorder and instability in domestic and foreign financial
markets; and

- instability in domestic and foreign financial markets.

Our asset liability management strategy, which is designed to control our
risk from changes in market interest rates, may not be able to prevent changes
in interest rates from having a material adverse effect on our results of
operation and financial condition.

COMPETITION WITH OTHER FINANCIAL INSTITUTIONS COULD ADVERSELY AFFECT OUR
PROFITABILITY.

We face vigorous competition from banks and other financial institutions,
including savings and loan associations, savings banks, finance companies and
credit unions. A number of these banks and other financial institutions have
substantially greater resources and lending limits, larger branch systems and a
wider array of banking services. To a limited extent, we also compete with other
providers of financial services, such as money market mutual funds, brokerage
firms, consumer finance companies and insurance companies. This competition may
reduce or limit our margins on banking services, reduce our market share and
adversely affect our results of operations and financial condition.

WE MAY NOT BE ABLE TO MAINTAIN OUR HISTORICAL GROWTH RATE WHICH MAY ADVERSELY
IMPACT OUR RESULTS OF OPERATIONS AND FINANCIAL CONDITION.

To achieve our growth, we have initiated internal growth programs,
completed various acquisitions and opened additional branches in the past few
years. We may not be able to sustain our historical rate of growth or may not
even be able to grow at all. We may not be able to obtain the financing
necessary to fund additional growth and may not be able to find suitable
candidates for acquisition. Various factors, such as economic conditions and
competition, may impede or prohibit the opening of new branch offices. Further,
our inability to attract and retain experienced bankers may adversely affect our
internal growth. A significant decrease in our historical rate of growth may
adversely impact our results of operation and financial condition.

WE MAY BE UNABLE TO COMPLETE ACQUISITIONS, AND ONCE COMPLETE, MAY NOT BE ABLE TO
INTEGRATE OUR ACQUISITIONS SUCCESSFULLY.

Our growth strategy is dependent on our ability to acquire other financial
institutions. We may not be able to complete any future acquisitions and, if
completed, we may not be able to successfully integrate the operations,
management, products and services of the entities we acquire. Following each
acquisition, we must expend substantial managerial, operating, financial and
other resources to integrate these entities. In particular, we may be required
to install and standardize adequate operational and control systems, deploy or
modify equipment, implement marketing efforts in new as well as existing
locations and employ and maintain qualified personnel. Our failure to
successfully integrate the entities we acquire into our existing operations may
adversely affect our financial condition and results of operations.

WE OPERATE IN A HIGHLY REGULATED ENVIRONMENT AND MAY BE ADVERSELY AFFECTED BY
CHANGES IN FEDERAL AND LOCAL LAWS AND REGULATIONS.

We are subject to extensive regulation, supervision and examination by
federal and state banking authorities. Any change in applicable regulations or
federal or state legislation could have a substantial impact
38

on us and our subsidiary, Sterling Bank, and its operations. Additional
legislation and regulations may be enacted or adopted in the future that could
significantly affect our powers, authority and operations, which could have a
material adverse effect on our financial condition and results of operations.
Further, regulators have significant discretion and power to prevent or remedy
unsafe or unsound practices or violations of laws by banks and bank holding
companies in the performance of their supervisory and enforcement duties. The
exercise of this regulatory discretion and power may have a negative impact on
us.

ITEM 7A -- QUALITATIVE DISCLOSURES ABOUT MARKET RISK

For information regarding the market risk of the Company's financial
instruments, see "Management's Discussion and Analysis of Financial Condition
and Results of Operations -- Interest Rate Sensitivity and Liquidity." The
Company's principal market risk exposure is to interest rates.

ITEM 8 -- FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

See the index included on page 46 and the consolidated financial statements
which begin on page 48 of this Form 10-K.

ITEM 9 -- CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE

None.

PART -- III

ITEM 10 -- DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

The information required by this Item as to the directors and executive
officers of the Company is hereby incorporated by reference from the information
appearing under the captions "Election of Directors" in the Company's definitive
proxy statement which involves the election of directors and is to be filed with
the SEC pursuant to the Securities Exchange Act of 1934 within 120 days of the
end of the Company's fiscal year on December 31, 2002.

ITEM 11 -- EXECUTIVE COMPENSATION

The information required by this Item as to the management of the Company
is hereby incorporated by reference from the information appearing under the
captions "Executive Compensation" in the Company's definitive proxy statement
which involves the election of directors and is to be filed with the SEC
pursuant to the Securities Exchange Act of 1934 within 120 days of the end of
the Company's fiscal year on December 31, 2002. Notwithstanding the foregoing,
in accordance with the instructions to Item 402 of Regulation S-K, the
information contained in the Company's proxy statement under the subheading
"Human Resources Programs Committee Report" and "Performance Graph" shall not be
deemed to be filed as part of or incorporated by reference into this Form 10-K.

ITEM 12 -- SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

The information required by this Item as to the ownership by management and
others of securities of the Company is hereby incorporated by reference from the
information appearing under the caption "Security Ownership of Certain
Beneficial Owners and Management" to the Company's definitive proxy statement
which involves the election of directors and is to be filed with the SEC
pursuant to the Securities Exchange Act of 1934 within 120 days of the end of
the Company's fiscal year on December 31, 2002.

ITEM 13 -- CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

The information required by this Item as to certain business relationships
and transactions with management and other related parties of the Company is
hereby incorporated by reference to such information

39

appearing under the captions "Certain Transactions" in the Company's definitive
proxy statement which involves the election of directors and is to be filed with
the SEC pursuant to the Securities Exchange Act of 1934 within 120 days of the
end of the Company's fiscal year on December 31, 2002.

ITEM 14 -- CONTROLS AND PROCEDURES

Evaluation of Disclosure Controls and Procedures. Within 90 days prior to
the date of this report, the Company carried out an evaluation, under the
supervision and with the participation of the Company's management, including
its Chief Executive Officer and its Chief Financial Officer, of the
effectiveness of the design and operation of our disclosure controls and
procedures. Based on this evaluation, the Company's Chief Executive Officer and
its Chief Financial Officer concluded that the Company's disclosure controls and
procedures (as defined in rules 13a-14(c) and 15d-14(c) under the Securities
Exchange Act of 1934) are effective to ensure that information required to
disclosed by the Company in reports that it files or submits under the
Securities Exchange Act of 1934 is recorded, processed, summarized and reported
to the Company's management within the time periods specified in the Securities
and Exchange Commission's rules and forms.

Changes in Internal Controls. Subsequent to the date of their evaluation,
there were no significant changes in the Company's internal controls or in other
factors that could significantly affect the Company's disclosure controls and
procedures, and there were no corrective actions with regard to significant
deficiencies and material weaknesses based on such evaluation.

PART -- IV

ITEM 15 -- EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K

(a)(1) List of documents filed as part of this report

INDEPENDENT AUDITORS' REPORT
CONSOLIDATED FINANCIAL STATEMENTS:
Balance Sheets
Statements of Income
Statements of Shareholders' Equity
Statements of Cash Flows
Notes to Consolidated Financial Statements

(a)(2) No financial statement schedules are required to be filed as a part
of this report.

(a)(3) See Item 14(c) below.

(b) During the fourth quarter of 2002, the Company filed the following
current reports on Form 8-K: (1) October 3, 2002 (reporting under Items 5 and 7
the Company's intention to redeem all of its 9.28% Trust Preferred Securities);
and (2) October 17, 2002 (reporting under Items 5 and 7 the release of the
Company's third quarter 2002 financial results).

(c) Exhibits

- ---------------

* As filed herewith.

** Management Compensation Agreement

42

SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.

STERLING BANCSHARES, INC.

By /s/ J. DOWNEY BRIDGWATER
--------------------------------------
J. Downey Bridgwater
President and Chief Executive Officer

Date: March 14, 2003

Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant in the capacity indicated on this the 14th day of March, 2002.

43

CERTIFICATION

I, J. Downey Bridgwater, certify that:

1. I have reviewed this annual report on Form 10-K of Sterling Bancshares,
Inc.;

2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this annual
report;

3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this annual report;

4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and have:

(a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities,
particularly during the period in which this annual report is being
prepared;

(b) evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to the filing
date of this annual report (the "Evaluation Date"); and

(c) presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;

5. The registrant's other certifying officers and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent functions):

(a) all significant deficiencies in the design or operation of
internal controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have identified
for the registrant's auditors any material weaknesses in internal controls;
and

(b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's internal
controls; and

6. The registrant's other certifying officers and I have indicated in this
annual report whether or not there were significant changes in internal controls
or in other factors that could significantly affect internal controls subsequent
to the date of our most recent evaluation, including any corrective actions with
regard to significant deficiencies and material weaknesses.

/s/ J. DOWNEY BRIDGWATER
--------------------------------------
J. Downey Bridgwater
President and Chief Executive Officer

Date: March 14, 2003

44

CERTIFICATION

I, Stephen C. Raffaele, certify that:

1. I have reviewed this annual report on Form 10-K of Sterling Bancshares,
Inc.;

2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this annual
report;

3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this annual report;

4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and have:

(a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities,
particularly during the period in which this annual report is being
prepared;

(b) evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to the filing
date of this annual report (the "Evaluation Date"); and

(c) presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;

5. The registrant's other certifying officers and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent functions):

(a) all significant deficiencies in the design or operation of
internal controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have identified
for the registrant's auditors any material weaknesses in internal controls;
and

(b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's internal
controls; and

6. The registrant's other certifying officers and I have indicated in this
annual report whether or not there were significant changes in internal controls
or in other factors that could significantly affect internal controls subsequent
to the date of our most recent evaluation, including any corrective actions with
regard to significant deficiencies and material weaknesses.

/s/ STEPHEN C. RAFFAELE
--------------------------------------
Stephen C. Raffaele
Executive Vice President and Chief
Financial Officer

Date: March 14, 2003

45

STERLING BANCSHARES, INC.

TABLE OF CONTENTS

46

INDEPENDENT AUDITORS' REPORT

To the Board of Directors and Shareholders of
Sterling Bancshares, Inc.
Houston, Texas

We have audited the accompanying consolidated balance sheets of Sterling
Bancshares, Inc. and subsidiaries (the "Company") as of December 31, 2002 and
2001, and the related consolidated statements of income, shareholders' equity
and cash flows for each of the three years in the period ended December 31,
2002. These financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements based on our audits.

We conducted our audits in accordance with auditing standards generally
accepted in the United States of America. Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.

In our opinion, such consolidated financial statements present fairly, in
all material respects, the consolidated financial position of Sterling
Bancshares, Inc. and subsidiaries as of December 31, 2002 and 2001, and the
results of their operations and their cash flows for each of the three years in
the period ended December 31, 2002, in conformity with accounting principles
generally accepted in the United States of America.

As discussed in Note A to the consolidated financial statements, in 2002
the Company adopted the provisions of Statement of Accounting Standards No. 142
"Goodwill and Other Intangible Assets."

/s/ DELOITTE & TOUCHE LLP

Houston, Texas
March 10, 2003

47

STERLING BANCSHARES, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 2002 AND 2001

See notes to consolidated financial statements.
48

STERLING BANCSHARES, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF INCOME
FOR THE YEARS ENDED DECEMBER 31, 2002, 2001, AND 2000

See notes to consolidated financial statements.
49

STERLING BANCSHARES, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
FOR THE YEARS ENDED DECEMBER 31, 2002, 2001, AND 2000

See notes to consolidated financial statements.
50

STERLING BANCSHARES, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, 2002, 2001, AND 2000

See notes to consolidated financial statements.

51

STERLING BANCSHARES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2002, 2001 AND 2000

A. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING AND REPORTING POLICIES

Organization -- Sterling Bancshares, Inc. (hereinafter, collectively with
its subsidiaries, the "Company" or "Bancshares"), headquartered in Houston,
Texas, is a bank holding company that provides commercial and retail banking
services in the greater metro areas of Dallas, Houston, San Antonio, and South
Texas through the community banking offices of Sterling Bank, a banking
association chartered under the laws of the State of Texas (the "Bank"). Also,
the Company provides mortgage banking services through its 80 percent ownership
of Sterling Capital Mortgage Company ("SCMC").

Summary of Significant Accounting and Reporting Policies -- The accounting
and reporting policies of the Company conform to accounting principles generally
accepted in the United States of America and the prevailing practices within the
banking industry. A summary of significant accounting policies follows:

Basis of Presentation -- The consolidated financial statements include the
accounts of Bancshares and its subsidiaries. Intercompany transactions have been
eliminated in consolidation. The consolidated financial statements have been
restated to present the combined financial information of acquisitions accounted
for using the pooling of interests method (see Note B).

Use of Estimates -- The preparation of financial statements in conformity
with accounting principles generally accepted in the United States of America
requires management to make estimates and assumptions that affect the reported
amounts in the financial statements. Actual results could differ from those
estimates. Material estimates that are particularly susceptible to significant
change in the near term relate to the determination of the allowance for credit
losses, and the valuation of foreclosed real estate, deferred tax assets,
goodwill, servicing rights and trading activities.

Trading Assets -- Securities classified as trading assets are bought with
the anticipation of sale in the near term and are carried at fair market value.
These assets are held up to 120 days. These securities consist primarily of the
government-guaranteed portion of SBA loans.

Securities -- Securities classified as held-to-maturity are carried at
cost, adjusted for the amortization of premiums and the accretion of discounts.
Management has the positive intent and the Company has the ability to hold these
assets until their maturities. Under certain circumstances (including the
deterioration of the issuer's creditworthiness or a change in tax law or
statutory or regulatory requirements), these securities may be sold or
transferred to another portfolio.

Securities classified as available-for-sale are carried at fair value.
Unrealized gains and losses are excluded from earnings and reported, net of tax,
as accumulated comprehensive income until realized. Securities within the
available-for-sale portfolio may be used as part of the Company's asset and
liability management strategy and may be sold in response to changes in interest
rate risk, prepayment risk or other factors.

Premiums and discounts are amortized and accreted to operations using the
level-yield method of accounting, adjusted for prepayments as applicable. The
specific identification method of accounting is used to compute gains or losses
on the sales of these assets.

Loans Held for Sale -- Loans originated and intended for sale in the
secondary market are carried at the lower of cost or market value in the
aggregate. Premiums, discounts and loan fees (net of certain direct loan
origination costs) on loans held for sale are deferred until the related loans
are sold or repaid. Gains or losses on loan sales are recognized at the time of
sale and determined using the specific identification method.

Loans Held for Investment -- Loans held for investment are stated at the
principal amount outstanding, net of unearned discount. Unearned discount
relates principally to consumer installment loans. The related interest income
for installment loans is recognized principally by the simple interest method,
which records

52

STERLING BANCSHARES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

interest in proportion to the declining outstanding balances of the loans. This
method approximates the interest method. For other loans, such income is
recognized using the simple interest method.

Impaired loans, with the exception of groups of smaller-balance homogeneous
loans that are collectively evaluated for impairment, are defined as loans for
which, based on current information and events, it is probable that a creditor
will be unable to collect all amounts due, both interest and principal,
according to the contractual terms of the loan agreement. The allowance for
credit losses related to impaired loans is determined based on the present value
of expected cash flows discounted at the loan's effective interest rate or, as a
practical expedient, the loan's observable market price or the fair value of the
collateral if the loan is collateral dependent.

Nonaccrual, Past-Due and Restructured Loans -- Included in this loan
category are loans which have been categorized by management as nonaccrual
because collection of interest is doubtful and loans which have been
restructured to provide a reduction in the interest rate below the current
market rate or a deferral of interest or principal payments.

When the payment of principal or interest on a loan is delinquent for 90
days, or earlier in some cases, the loan is placed on nonaccrual status and
classified as impaired unless the loan is in the process of collection and the
underlying collateral fully supports the carrying value of the loan. If the
decision is made to continue accruing interest on the loan, periodic reviews are
made to evaluate the appropriateness of the accruing status of the loan. When a
loan is placed on nonaccrual status, interest accrued and uncollected during the
current year prior to the judgment of noncollectibility is charged to
operations. Interest accrued and uncollected during prior periods is charged to
the allowance for credit losses. Generally, any payments received on nonaccrual
loans are applied first to outstanding loan amounts and next to the recovery of
charged-off loan amounts. Any excess is treated as a recovery of lost interest.

Restructured loans are those loans for which concessions in terms have been
granted because of a borrower's financial difficulty. Interest is generally
accrued on such loans in accordance with the new terms.

Allowance for Credit Losses -- The allowance for credit losses is a
valuation allowance for probable losses incurred on loans. All losses are
charged to the allowance when the loss actually occurs or when a determination
is made that a probable loss has occurred. Recoveries are credited to the
allowance at the time of recovery.

Throughout the year, management estimates the probable level of losses to
determine whether the allowance for credit losses is adequate to absorb losses
in the existing portfolio. Based on these estimates, an amount is charged to the
provision for credit losses and credited to the allowance for credit losses in
order to adjust the allowance to a level determined to be adequate to absorb
losses.

Management's judgment as to the level of probable losses on existing loans
involves the consideration of current economic conditions and their estimated
effects on specific borrowers; an evaluation of the existing relationships among
loans, potential credit losses and the present level of the allowance; results
of examinations of the loan portfolio by regulatory agencies; and management's
internal review of the loan portfolio. In determining the collectibility of
certain loans, management also considers the fair value of any underlying
collateral. The amount ultimately realized may differ from the carrying value of
these assets because of economic, operating or other conditions beyond the
Company's control.

It should be understood that estimates of credit losses involve an exercise
of judgment. While it is reasonably possible that in the near term the Company
may sustain losses which are substantial relative to the allowance for credit
losses, it is the judgment of management that the allowance for credit losses
reflected in the consolidated balance sheets is adequate to absorb estimated
losses that exist in the current loan portfolio.

Premises and Equipment -- Land is carried at cost. Premises and equipment
are carried at cost, less accumulated depreciation and amortization.
Depreciation expense is computed primarily using the straight-
53

STERLING BANCSHARES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

line method over the estimated useful lives of the assets. Leasehold
improvements are amortized using the straight-line method over the periods of
the leases or the estimated useful lives, whichever is shorter.

Goodwill -- Through December 31, 2001, goodwill was amortized using the
straight-line method over a period of 10 to 25 years. Due to the adoption of
SFAS 142 on January 1, 2002, amortization of goodwill has been terminated. See
subsequent discussion in "Recent Accounting Standards".

Mortgage Servicing Rights -- SCMC determines the fair value of capitalized
mortgage servicing rights ("MSRs") using assumptions regarding economic factors
as they relate to the servicing portfolio. These assumptions are obtained from
an independent servicing consultant and agreed to by management. SCMC evaluates
impairment of the servicing rights by stratifying the portfolio based on
predominant risk characteristics of the underlying loans including loan type and
interest rate.

Real Estate Acquired by Foreclosure -- The Bank records real estate
acquired by foreclosure at fair value less estimated costs to sell. Adjustments
are made to reflect declines in value subsequent to acquisition, if any, below
the recorded amounts. Required developmental costs associated with foreclosed
property under construction are capitalized and considered in determining the
fair value of the property. Operating expenses of such properties, net of
related income, and gains and losses on their disposition are included in
noninterest expense.

Income Taxes -- Bancshares files a consolidated federal income tax return
with its subsidiaries. Each computes income taxes as if it filed a separate
return and remits to, or is reimbursed by Bancshares based on the portion of
taxes currently due or refundable.

Deferred income taxes are accounted for by applying statutory tax rates in
effect at the balance sheet date to differences between the book basis and the
tax basis of assets and liabilities. The resulting deferred tax assets and
liabilities are adjusted to reflect changes in enacted tax laws or rates.

Realization of net deferred tax assets is dependent on generating
sufficient future taxable income. Although realization is not assured,
management believes it is more likely than not that all of the net deferred tax
assets will be realized. The amount of the net deferred tax asset considered
realizable, however, could be reduced in the near term if estimates of future
taxable income are reduced.

Stock-based Compensation -- The Company accounts for stock-based employee
compensation plans using the intrinsic value-based method of accounting as
permitted and discloses pro forma information assuming the fair value-based
method as prescribed by SFAS No. 123.

Profit Sharing Plan -- The Company has a profit sharing plan that covers
substantially all employees. Contributions are accrued and funded currently.

Statements of Cash Flows -- For purposes of the statements of cash flows,
cash and cash equivalents are defined as cash, due from banks and federal funds
sold. Generally, federal funds are sold for one-day periods.

Earnings Per Share -- Basic earnings per share is computed using the
weighted average number of shares outstanding. Diluted earnings per share is
computed using the weighted average number of shares outstanding adjusted for
the incremental shares issuable upon conversion of preferred stock and issuable
upon exercise of outstanding stock options. All outstanding and weighted average
share amounts presented in this report have been restated to reflect the effect
of stock splits where applicable.

Comprehensive Income -- Comprehensive income includes all changes in equity
during the period presented that result from transactions and other economic
events other than transactions with shareholders. The Company reports
comprehensive income in the consolidated statements of shareholders' equity.

54

STERLING BANCSHARES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

Segment Information -- The Company considers its business as two operating
segments: commercial banking and mortgage banking. The Company has disclosed
separately results of operations relating to the two segments in Note V to the
consolidated financial statements.

Reclassifications -- Certain reclassifications have been made to prior year
amounts to conform to current year presentation. All reclassifications have been
applied consistently for the periods presented.

Recent Accounting Standards -- In December 2002, the FASB issued Statement
No. 148, "Accounting for Stock-Based Compensation -- Transition and Disclosure",
("SFAS 148"). SFAS 148 provides guidance on the accounting for stock based
compensation. In addition, this Statement amends the disclosure requirements of
Statement 123 to require prominent disclosures in both annual and interim
financial statements about the method of accounting for stock-based employee
compensation and the effect of the method used on reported results. The Company
adopted SFAS 148 as of December 31, 2002 and has elected to continue to account
for its employee stock options using the intrinsic value-based method.

In October 2002, the FASB issued Statement No. 147, "Acquisitions of
Certain Financial Institutions" ("SFAS 147"). SFAS 147 provides guidance on the
accounting for the acquisition of a financial institution, except transactions
between two or more mutual enterprises. The implementation of this standard did
not have a material impact on the financial position or results of operation.

In June 2002, the FASB issued Statement of Financial Accounting Standards
No. 146 ("SFAS 146"), "Accounting for Costs Associated with Exit or Disposal
Activities." SFAS 146 addresses accounting and reporting costs associated with
exit or disposal activities and nullifies Emerging Issues Task Force (EITF)
Issue 94-3, "Liability Recognition for Certain Employee Termination Benefits and
Other Costs to Exit an Activity". This statement requires that a liability for a
cost associated with an exit or disposal activity shall be recognized and
measured initially at its fair value in the period in which the liability is
incurred. This statement is effective for exit or disposal activities that are
initiated after December 31, 2002. The Company does not believe that the
adoption of SFAS 146 will have a significant impact on its financial statements.

In April 2002, the FASB issued Statement of Financial Accounting Standards
No. 145 ("SFAS 145"), "Rescission of FASB Statements No. 4, 44, and 64,
Amendment of FASB Statement No. 13, and Technical Corrections". The provisions
of this Statement related to the rescission of Statement 4 shall be applied in
fiscal years beginning after May 15, 2002. The provisions in paragraphs 8 and
9(c) of this Statement related to Statement 13 shall be effective for
transactions occurring after May 15, 2002. All other provisions of this
Statement shall be effective for financial statements issued on or after May 15,
2002. SFAS 145 amends other existing authoritative pronouncements to make
various technical corrections, clarify meanings, or describe their applicability
under changed conditions. The Company does not believe that the adoption of SFAS
145 will have a significant impact on its financial statements.

In August 2001, the FASB issued Statement No. 143, Accounting for Asset
Retirement Obligations ("SFAS 143"), and Statement No. 144, Accounting for
Impairment or Disposal of Long Lived Assets ("SFAS 144"). SFAS 143 requires the
recording of the fair value of a liability for an asset retirement obligation in
the period in which it is incurred, and is effective January 1, 2003. SFAS 144
was effective January 1, 2002, and supersedes existing accounting literature
dealing with impairment and disposal of long lived assets, including
discontinued operations. It addresses financial accounting and reporting for the
impairment of long lived assets and for long lived assets to be disposed of, and
expands current reporting for discontinued operations to include disposals of a
"component" of an entity that has been disposed of or is classified as held for
sale. The Company's management does not believe that the implementation of SFAS
143 will have a material impact on the Company's consolidated financial
statements.

In June 2001, the Financial Accounting Standards Board ("FASB") issued
Statement No. 141, "Business Combinations" ("SFAS 141") and Statement No. 142,
"Goodwill and Other Intangible Assets" ("SFAS 142"). These statements establish
new standards for accounting and reporting for business
55

STERLING BANCSHARES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

combinations and for goodwill and intangible assets resulting from business
combinations. SFAS 141 applies to all business combinations initiated after June
30, 2001, and requires the application of the purchase method of accounting to
all business combinations. The Company implemented SFAS 141 on July 1, 2001.
SFAS 142 terminates the amortization of the goodwill presently on the Company's
books. Such amortization, after-tax, was $1.2 million for year ended December
31, 2001. Under SFAS 142, the Company is required to periodically assess its
goodwill and other intangible assets for potential impairment, based on the fair
value of the reporting unit at which the goodwill is recorded. The Company
implemented SFAS 142 on January 1, 2002. Goodwill currently carried on the
balance sheet was subject to an initial assessment for impairment. The Company
has completed its initial assessment and determined that there was no impairment
of goodwill as of January 1, 2002. The adoption of this statement did not have a
material impact on the Company's financial position or results of operations
with the exception of no longer amortizing goodwill.

Effective October 1, 2000, the Company adopted SFAS No. 133, "Accounting
for Derivative Instruments and Hedging Activities" which establishes accounting
and reporting standards for derivative instruments and requires that an entity
recognize all derivatives as either assets or liabilities in the balance sheet
and measure those instruments at fair value. Upon implementation of SFAS No.
133, $56.1 million of securities classified as held-to-maturity were
redesignated as available-for-sale or trading. The securities had a fair value
of $56.1 million. The Company has no derivative instruments. Management believes
the implementation of this pronouncement did not have any other material effect
on the Company's financial statements.

B. ACQUISITIONS

On September 13, 2002, the Company acquired ENB Bankshares, Inc. of Dallas,
for an aggregate cash purchase price of $10.4 million. ENB Bankshares, Inc. is
the privately held bank holding company of Eagle National Bank ("Eagle
National"), which operates one banking office in North Dallas. Additionally
during September 2002, the Company completed the operational integration of
Eagle National Bank and Sterling Bank. This acquisition was accounted for using
the purchase method of accounting. Goodwill of $5.7 million was recorded in
connection with this acquisition.

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 the outstanding common stock of
Community Bancshares, Inc. Community Bank operated 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 merged
Community Bank into Sterling Bank in May of 2002. This acquisition was accounted
for using the purchase method of accounting. Goodwill of $28.7 million was
recorded.

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 the outstanding common
stock of Lone Star Bancorporation, Inc. The stock issuance occurred prior to the
stock split 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 the February of 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.
56

STERLING BANCSHARES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

C. CASH AND CASH EQUIVALENTS

The Bank is required by the Board of Governors of the Federal Reserve
System (the "FRB") to maintain average reserve balances. "Cash and cash
equivalents" in the consolidated balance sheets includes amounts so restricted
of approximately $4.4 million at December 31, 2002 and $5.6 million at December
31, 2001.

D. SECURITIES

The amortized cost and fair value of securities are as follows (in
thousands):

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STERLING BANCSHARES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

The amortized cost and fair value of securities at December 31, 2002, by
contractual maturity, are shown below. Expected maturities will differ from
contractual maturities because borrowers may have the right to call or prepay
obligations with or without call or prepayment penalties. All amounts are shown
in thousands.

The Company does not own any securities of any one issuer (other than the
U.S. government and its agencies) of which aggregate adjusted cost exceeds 10%
of the consolidated shareholders' equity at December 31, 2002 or 2001.

Securities with carrying values totaling $260.4 million and fair values
totaling $269.2 million at December 31, 2002 were pledged to secure public
deposits and Federal Home Loan Bank advances.

E. LOANS

The loan portfolio from continuing operations consists of various types of
loans made principally to borrowers located in the Houston, Dallas and San
Antonio metropolitan areas, and is classified by major type as follows (in
thousands):

58

STERLING BANCSHARES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

The recorded investment in impaired loans under SFAS No. 114 is
approximately $81.8 million and $65.6 million, at December 31, 2002 and 2001,
respectively. Under SFAS No. 114, such impaired loans required an allowance for
credit losses of approximately $14.0 million and $16.4 million, respectively.

The average recorded investment in impaired loans for the years ended
December 31, 2002, 2001 and 2000 was $72.2 million, $56.4 million and $40.6
million, respectively.

Loan maturities and rate sensitivity of the loan portfolio, excluding real
estate -- mortgage and consumer and unearned discount, at December 31, 2002 are
as follows (in thousands):

As of December 31, 2002 and 2001, loans outstanding to directors, officers
and their affiliates were approximately $11.5 million and $13.1 million,
respectively. In the opinion of management, all transactions entered into
between the Bank and such related parties have been and are, in the ordinary
course of business, made on the same terms and conditions as similar
transactions with unaffiliated persons.

An analysis of activity with respect to these related-party loans is as
follows (in thousands):

59

STERLING BANCSHARES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

F. NONACCRUAL, PAST-DUE AND RESTRUCTURED LOANS

The following table presents information relating to nonaccrual, past-due
and restructured loans (in thousands):

For the years ended December 31, 2002 and 2001, interest foregone on
nonaccrual loans was approximately $1.1 million and $766 thousand, respectively.

G. ALLOWANCE FOR CREDIT LOSSES

An analysis of activity in the allowance for credit losses is as follows
(in thousands):

H. PREMISES AND EQUIPMENT

Premises and equipment are summarized as follows (in thousands):

60

STERLING BANCSHARES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

I. INTANGIBLE ASSETS

Under the provisions of SFAS No. 142, goodwill was subjected to an initial
assessment for impairment. The Company completed its initial assessment and
determined that there was no impairment of goodwill as of January 1, 2002. The
Company will review goodwill on an annual basis for impairment or as events
occur or circumstances change that would more likely than not reduce fair value
of a reporting unit below its carrying amount. The changes in the carrying
amount of goodwill by reportable segment for the year ended December 31, 2001
and 2002 are as follows (in thousands):

The Company adopted SFAS No. 142, in its entirety, effective January 1,
2002. The following presents the net income for 2002 and 2001 that would have
been reported, exclusive of goodwill amortization (in thousands).

61

STERLING BANCSHARES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

The changes in the carrying amounts of intangible assets other than
goodwill for the year ended December 31, 2002 and 2001 are as follows (in
thousands):

As of December 31, 2002 and 2001, SCMC serviced loans with unpaid principal
balances of approximately $2.7 billion and $1.3 billion, respectively. These
amounts include loans that are held in the warehouse until shipped to the
investor, typically 30 days. Escrow funds totaling approximately $9.7 million
and $6.1 million at December 31, 2002 and 2001, respectively, are held in trust
for mortgagors at various financial institutions. The loans and escrow funds are
not included in the accompanying balance sheet.

The projected amortization for the intangible assets other than goodwill as
of December 31, 2002 is as follows (in thousands):

J. DISCONTINUED OPERATIONS

The Bank entered into an agreement dated October 29, 2002 to sell its
banking office located in Eagle Pass, Texas. On July 12, 2002 the Bank entered
into an agreement to sell three banking offices in Carrizo Springs, Crystal City
and Pearsall, Texas. The four banking offices have combined loans of $33.0
million and combined deposits of $140.2 million as of December 31, 2002. The
proposed sales are subject to customary closing conditions, including receipt of
all requisite regulatory approvals. Subject to the receipt of all requisite
regulatory approvals, the Company anticipates closing the sale of the Eagle Pass
banking office in the first quarter of 2003 and the sale of the three banking
offices in Carrizo Springs, Crystal City and Pearsall in the second quarter of
2003. The business related to these four offices is accounted for as
discontinued operations and therefore, the results of operations and cash flows
have been removed from the Company's results of continuing operations for all
periods presented in this document. The results of these four offices are
presented

62

STERLING BANCSHARES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

as discontinued operations in a separate category on the income statement
following results from continuing operations.

The assets and liabilities of the discontinued operations are stated
separately as of December 31, 2002 and December 31, 2001 on the consolidated
balance sheet. The major asset and liability categories are as follows (in
thousands):

K. DEPOSITS

Included in certificates of deposit and other time deposits are
certificates of deposit in amounts of $100,000 or more. The remaining maturities
of these certificates are summarized as of December 31, 2002 as follows (in
thousands):

Three months or less........................................ $232,406
Four through six months..................................... 88,860
Seven through twelve months................................. 69,694
Thereafter.................................................. 49,840
--------
$440,800
========

Interest expense for certificates of deposit in excess of $100,000 was
approximately $11.0 million, $15.0 million, and $14.1 million for the years
ended December 31, 2002, 2001 and 2000, respectively.

At December 31, 2002, the Bank has $99.5 million in brokered deposits.
These deposits will mature within year 2003. Deposits of $90.4 million will
mature in the next six months and the remaining balance of $9.1 million in the
second half of year 2003. There are no major concentrations of deposits.

63

STERLING BANCSHARES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

L. OTHER BORROWED FUNDS

Other borrowed funds are summarized as follows (in thousands):

The Bank has an available line of credit with the Federal Home Loan Bank of
Dallas, which allows the Bank to borrow on a collateralized basis. At December
31, 2002, the Bank had $490.8 million, of which $475 million bearing an interest
rate of 1.30% and $15.8 million bearing an interest rate of 1.35%, borrowed
under this line of credit, with a maturity of two days. These borrowings are
collateralized by single family residential mortgage loans. The amounts were
repaid in January 2003.

Securities sold under agreements to repurchase generally mature within one
to four days from the transaction date. However, the Bank eliminated the
Repurchase Agreement Sweep product as of December 31, 2002 because of the
smaller number of customers utilizing the service and it was uncompetitive with
other Bank products. Information concerning securities sold under agreements to
repurchase during the year 2002 is summarized as follows (dollars in thousands):

The Bank has available lines for federal funds purchased at correspondent
banks. As of December 31, 2002, federal funds outstanding with correspondent
banks was $18.8 million, of which $18.5 million will mature in the next three
months. The amounts will be repaid when they mature.

M. 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 original term of the
credit facility is for a one year period ending on February 2, 2003. This line
of credit was renewed on February 2, 2003 by the Company with the Wells Fargo
Bank, National Association, successor by assignment to Wells Fargo Bank
Minnesota, National Association. The note matures on February 1, 2006. 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. 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. Included within these financial
covenants is a financial covenant requiring the Bank to maintain its
categorization as "well capitalized." At December 31, 2002, the most recent
report filed by the Bank categorized it as "adequately capitalized" under
applicable regulatory requirements. Wells Fargo has provided to the Company a
written waiver with respect to this financial covenant which is effective
through March 31,
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STERLING BANCSHARES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

2003. Although the covenants and 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.

Upon the acquisition of ENB Bancshares, Inc. in September 2002, the Company
assumed a note payable to Wells Fargo Bank Minnesota, National Association. The
balance of $1.1 million was repaid January 2, 2003. In addition the Company
assumed notes payable totaling $879 thousand to two executives with the
acquisition of Community Bancshares, Inc. in December 2001. Notes payable of
$519 thousand were repaid in August 2002. The remaining notes payable of $360
thousand as of December 31, 2002 will mature January 11, 2004.

N. TRUST PREFERRED SECURITIES

On September 26, 2002, Sterling Bancshares Capital Trust III ("Trust III"),
a trust formed under the laws of the State of Delaware in February, 2001, issued
1,250,000 8.30% Trust Preferred Securities with an aggregate liquidation value
of $31,250,000. Concurrent with the issuance of the 8.30% Trust Preferred
Securities, Trust III issued trust common securities to the Company in the
aggregate liquidation value of $966,500. The proceeds of the issuance of the
8.30% Trust Preferred Securities and trust common securities were invested the
Company's 8.30% Junior Subordinated Deferrable Interest Debentures (the "8.30%
Junior Subordinated Debentures") issued by the Company. The 8.30% Junior
Subordinated Debentures will mature on September 26, 2032, which date may be
shortened to a date not earlier than September 26, 2007 if certain conditions
are met (including the Company having received prior approval of the Federal
Reserve and any other required regulatory approvals). The 8.30% Trust Preferred
Securities will be subject to mandatory redemption in a like amount
contemporaneously with the optional prepayment of the 8.30% Junior Subordinated
Debentures by the Company. The 8.30% Junior Subordinated Debentures may be
prepaid upon the occurrence and continuation of certain events including a
change in the tax status or regulatory capital treatment of the 8.30% Trust
Preferred Securities. In each case, redemption will be made at a price equal to
100% of the face amount of the 8.30% Trust Preferred Securities, plus the
accrued and unpaid distributions thereon through the redemption date.

In August 2002, the Company formed Sterling Bancshares Statutory Trust One,
a trust formed under the laws of the State of Connecticut ("Statutory Trust
One"). On August 30, 2002, Statutory Trust One completed a private placement of
$20,000,000 of Floating Rate Trust Preferred Securities to an institutional
buyer. The proceeds from the sale were invested in the Floating Rate Junior
Subordinated Deferrable Interest Debentures issued by the Company. The Floating
Rate Trust Preferred Securities and the Floating Rate Junior Subordinated
Deferrable Interest Debentures have a floating rate equal to the three-month
LIBOR plus 3.45%, which resets quarterly. For the first five years, there is a
ceiling on the three-month LIBOR of 8.50% resulting in a ceiling on the floating
rate of 11.95% during this period. As of December 31, 2002, the rate was 4.85%.
The Floating Rate Junior Subordinated Debentures will mature on August 30, 2032,
which date may be shortened to a date not earlier than August 30, 2007 if
certain conditions are met (including the Company having received prior approval
of the Federal Reserve and any other required regulatory approvals). The
Floating Rate Trust Preferred Securities will be subject to mandatory redemption
in a like amount contemporaneously with the optional prepayment of the Floating
Rate Junior Subordinated Deferrable Interest Debentures by the Company. The
Floating Rate Junior Subordinated Deferrable Interest Debentures may be prepaid
upon the occurrence and continuation of certain events including a change in the
tax status or regulatory capital treatment of the Floating Rate Trust Preferred
Securities. In each case, redemption will be made at a price equal to 100% of
the face amount of the Floating Rate Trust Preferred Securities, plus the
accrued and unpaid distributions thereon through the redemption date. As a
result during the fourth quarter of 2002, The Company recorded a cost relating
to the early redemption.

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STERLING BANCSHARES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

In February 2001, the Company formed Sterling Bancshares Capital Trust II
("Trust II") and Trust III. On March 21, 2001, Trust II issued 1,150,000 9.20%
Trust Preferred Securities with an aggregate liquidation value of $28,750,000.
Concurrent with the issuance of the 9.20% Trust Preferred Securities, Trust II
issued trust common securities to the Company in the aggregate liquidation value
of $889,175. The proceeds of the issuance of the 9.20% Trust Preferred
Securities and trust common securities were invested in the Company's 9.20%
Junior Subordinated Deferrable Interest Debentures (the "9.20% Junior
Subordinated Debentures"). The proceeds of the issuance of the 9.20% Junior
Subordinated Debentures were invested in the 9.20% Junior Subordinated
Deferrable Interest Debentures (the "9.20% Junior Subordinated Debentures")
issued by the Company. The 9.20% Junior Subordinated Debentures will mature on
March 21, 2031, which date may be shortened to a date not earlier than March 21,
2006 if certain conditions are met (including the Company having received prior
approval of the Federal Reserve and any other required regulatory approvals).
The 9.20% Trust Preferred Securities will be subject to mandatory redemption if
the 9.20% Junior Subordinated Debentures are repaid by the Company. The 9.20%
Junior Subordinated Debentures may be prepaid if certain events occur, including
a change in the tax status or regulatory capital treatment of the 9.20% Trust
Preferred Securities. In each case, redemption will be made at par, plus the
accrued and unpaid distributions thereon through the redemption date.

In June 1997, the Company formed Sterling Bancshares Capital Trust I, a
trust formed under the laws of the State of Delaware (the "Trust I"). The Trust
I issued 1,150,000 9.28% Trust Preferred Securities with an aggregate
liquidation value of $28,750,000. Concurrent with the issuance of the 9.28%
Trust Preferred Securities, Trust I issued trust common securities to the
Company in the aggregate liquidation value of $889,200. The proceeds of the
issuance of the 9.28% Trust Preferred Securities and trust common securities
were invested in the Company's 9.28% Junior Subordinated Deferrable Interest
Debentures (the "9.28% Junior Subordinated Debentures"). The proceeds of the
issuance of the 9.28% Junior Subordinated Debentures were invested in the 9.28%
Junior Subordinated Deferrable Interest Debentures (the "9.28% Junior
Subordinated Debentures") issued by the Company. With the proceeds received by
the Company from the sale of its 8.30% Junior Subordinated Debentures to Trust
III on September 26, 2002, the Company, on November 1, 2002, prepaid all
$29,639,200 of the 9.28% Junior Subordinated Deferrable Interest Debentures
previously issued by the Company to Trust I. Upon the prepayment, the 9.28%
Trust Preferred Securities and the 9.28% Trust Common Securities issued by Trust
I were mandatorily redeemed. In each case, the redemption was made at par, plus
the accrued and unpaid distributions through November 1, 2002.

O. INCOME TAXES

The components of the provision for income taxes follow (in thousands):

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STERLING BANCSHARES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

The provision for income taxes differs from the amount computed by applying
the federal income tax statutory rate on operations as follows (in thousands):

Significant deferred tax assets and liabilities at December 31, 2002 and
2001, were as follows (in thousands):

P. EMPLOYEE BENEFITS

Profit Sharing Plan -- The Company's profit sharing plan includes
substantially all employees. Contributions to the plan are made at the
discretion of the Board of Directors but generally equal up to 10% of the
Company's pretax income, subject to IRS limitations. Employee contributions to
401(K) plan accounts are optional. Beginning in 1997, the Company matched 50
percent of the employee's contribution, up to 6 percent

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

of the employee's base pay. Profit sharing contributions are accrued and funded
currently. Total profit sharing expense for 2002, 2001 and 2000 was
approximately $5.1 million, $3.9 million, and $2.9 million, respectively.

Stock-based Compensation -- During April 1994, the Company adopted the
"1994 Stock Incentive Plan (the "Stock Plan"). The Stock Plan, as amended,
provides for a maximum of 3,900,000 shares (after adjustment for stock splits)
of the Company's common stock to be issued. No options or performance shares may
be granted under the Stock Plan after April 2004. Options are granted to
officers and employees at exercise prices determined by the Human Resources
Programs Committee of the Board of Directors. These options generally have
exercise prices equal to the fair market value of the common stock at the date
of grant and vest ratably over a four-year period. Options granted under the
plan must be exercised not later than ten years from the date of grant. Stock
grant awards may also be made under the Stock Plan with compensation expense
recognized for any stock grant awards. A total of 19,685, 20,264, and 4,250
stock grants were awarded under the Stock Plan during 2002, 2001 and 2000,
respectively.

A summary of changes in outstanding options, as restated for stock splits,
is as follows (shares in thousands):

The fair value of options at date of grant was estimated using the
Black-Scholes option-pricing model with the following weighted-average
assumptions:

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STERLING BANCSHARES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

The following table presents information relating to the Company's stock
options outstanding at December 31, 2002 (share data in thousands):

Annual Reconciliation of Reported and Pro Forma Net Income and EPS -- If
compensation cost for the Company's stock-based compensation plan had been
determined based on the fair value at the grant dates for awards, there would
have been no material impact on the Company's reported net income or earnings
per share. Pro forma information regarding net income and earnings per share is
required under Statement of Financial Accounting Standard No. 123 ("SFAS 123"),
"Accounting for Stock-Based Compensation" and has been determined as if the
Company accounted for its employee stock option plans under the fair value
method of SFAS 123. The fair value of options was estimated using a
Black-Scholes option pricing model. Option valuation models require use of
highly subjective assumptions. Also, employee stock options have characteristics
that are significantly different from those of traded options, including vesting
provisions and trading limitations that impact their liquidity. Because employee
stock options have differing characteristics and changes in the subjective input
assumptions can materially affect the fair value estimate, the Black-Scholes
valuation model does not necessarily provide a reliable measure of the fair
value of employee stock options. The following table shows information related
to stock-based compensation in both the reported and pro forma earnings per
share amounts (dollars in thousands except for per share amounts):

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STERLING BANCSHARES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

Stock Purchase Plan -- The Company offers the 1994 Employee Stock Purchase
Plan (the "Purchase Plan"), which is a compensatory benefit plan, to all
employees who are employed for more than 20 hours per week and meet minimum
length-of-service requirements of three months. The Purchase Plan provides for
an aggregate of 675,000 shares of the Company's common stock to be issued under
the Plan with no more than 67,500 shares available during any annual offering.
The purchase price for shares available under the Purchase Plan is equal to the
fair market value on the date of the offering. During 2002 and 2001, 13,016 and
5,448 shares, respectively, were subscribed for through payroll deduction for a
maximum of two years. In 2001, 450 shares were purchased upon the offering.
Shares are issued upon full payment.

Q. SHAREHOLDERS' EQUITY

Stock Splits -- On July 24, 2001, the Board of Directors declared a
three-for-two stock split that was effected in the form of a stock dividend on
its common stock. Stockholders of record on September 4, 2001 received one
additional share of common stock for every two shares of the Company's common
stock held on that date. 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.

Preferred Stock -- The Board of Directors has approved the sale of
convertible preferred stock in series pursuant to confidential private placement
memoranda upon the opening of various banking offices. The shares are sold to
investors who may assist in the business development efforts of the opening
office and are convertible to common shares dependent on that banking office
meeting certain performance and deposit growth goals. On March 7, 2002, the
Company completed a private placement of 20,000 shares of the Company's Series I
Convertible Preferred Stock. Shares of the Series I Preferred Stock will convert
into shares of the Company's common stock based upon performance goals for the
Dallas banking office for which such shares were issued. The conversion ratio
ranges from 1.25 shares of common stock if the performance goals are met prior
to November 7, 2003, to 1.1 shares of common stock if the performance goals are
met prior to November 7, 2004. After November 7, 2004, each share of Series I
Preferred Stock will automatically convert into one share of common stock.
During 2001, 11,500 shares of preferred stock under Series F issued in 1998 were
converted into 11,500 common shares prior to the stock split in September 2001.
At December 31, 2002, there are 59,000 convertible preferred shares outstanding.
These shares are convertible into a maximum of 98,125 shares of common stock if
the performance and deposit growth goals of the banking offices are achieved.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

R. EARNINGS PER COMMON SHARE

Earnings per common share was computed based on the following (in
thousands, except per share data):

The incremental shares for the assumed exercise of the outstanding options
was determined by application of the treasury stock method. The incremental
shares for the conversion of the preferred stock was determined assuming
applicable performance goals had been met.

The Company did not have any antidilutive shares in 2002, 2001 and 2000.

S. COMMITMENTS AND CONTINGENCIES

Leases -- A summary as of December 31, 2002, of noncancelable future
operating lease commitments follows (in thousands):

2003........................................................ $ 3,702
2004........................................................ 3,305
2005........................................................ 2,522
2006........................................................ 1,540
2007........................................................ 1,398
Thereafter.................................................. 5,708
-------
Total....................................................... $18,175
=======

Rent expense under all noncancelable operating lease obligations, net of
income from noncancelable subleases aggregated, was approximately $8.1 million,
$5.6 million, and $3.7 million for the years ended December 31, 2002, 2001 and
2000, respectively.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

Litigation -- The Company has been named as a defendant in various legal
actions arising in the normal course of business. In the opinion of management,
after reviewing such claims with outside counsel, resolution of such matters
will not have a materially adverse impact on the consolidated financial
statements.

T. FINANCIAL INSTRUMENTS WITH OFF-BALANCE SHEET RISK

The Bank is a party to various financial instruments with off-balance sheet
risk in the normal course of business to meet the financial needs of its
customers. These financial instruments include commitments to extend credit and
standby letters of credit. These instruments involve, to varying degrees,
elements of credit and interest rate risk in excess of the amounts recognized in
the consolidated balance sheets. The Bank's exposure to credit loss in the event
of nonperformance by the other party to the financial instrument for commitments
to extend credit is represented by the contractual notional amount of these
instruments. The Bank uses the same credit policies in making these commitments
and conditional obligations as it does for on-balance sheet instruments.

The following is a summary of the various financial instruments entered
into by the Bank (in thousands):

Commitments to extend credit are agreements to lend to a customer as long
as there is no violation of any condition established in the contract.
Commitments generally have fixed expiration dates or other termination clauses
and may require payment of a fee. Since many of the commitments are expected to
expire without being fully drawn upon, the total commitment amounts disclosed
above do not necessarily represent future cash requirements.

The Bank evaluates each customer's creditworthiness on a case-by-case
basis. The amount of collateral obtained, if considered necessary by the Bank
upon extension of credit, is based on management's credit evaluation of the
customer.

Standby letters of credit are conditional commitments issued by the Bank to
guarantee the performance of a customer to a third party. The credit risk to the
Bank in issuing letters of credit is essentially the same as that involved in
extending loan facilities to its customers.

The Bank's mortgage subsidiary, SCMC, sells mortgages in the secondary
market either to dealers or investors. A portion of these loans are sold with
recourse for a period which generally does not exceed one year. SCMC sells its
non-conforming conventional loan production on a non-recourse basis. Other loans
are sold with limited recourse.

Regardless of the form of sale of loan production, and while SCMC generally
does not retain primary credit risk, it does have potential liability under the
representations and warranties it makes to purchasers and insurers of the loans.
In the event of a breach of these representations and warranties, SCMC may be
required to repurchase a mortgage loan. If SCMC is required to repurchase the
mortgage loan or make additional payments to the purchaser, subsequent losses on
the mortgage loan will be borne by SCMC. For the years ended December 2002 and
2001, these losses totaled $4.5 million and $0 respectively. As of December 31,
2002 and 2001, loans sold with recourse totaled $851 million and $273 million,
respectively.

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STERLING BANCSHARES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

U. REGULATORY MATTERS

Capital Requirements -- The Company is subject to various regulatory
capital requirements administered by the federal banking agencies. Any
institution that fails to meet its minimum capital requirements is subject to
actions by regulators that could have a direct material effect on its financial
statements. Under the capital adequacy guidelines and the regulatory framework
for prompt corrective action, the Bank must meet specific capital guidelines
based on the Bank's assets, liabilities, and certain off-balance sheet items as
calculated under regulatory accounting practices. The Company's capital amount
and the Bank's classification under the regulatory framework for prompt
corrective action are also subject to qualitative judgments by the regulators.

To meet the capital adequacy requirements, the Company must maintain
minimum capital amounts and ratios as defined in the regulations. Management
believes, as of December 31, 2002 and 2001, that the Company and the Bank met
all capital adequacy requirements to which they are subject.

As of December 31, 2002, the most recent notification categorized the Bank
as "adequate" under the regulatory capital framework for prompt corrective
action and there have been no events since that notification that management
believes have changed the Bank's category. To be categorized as well
capitalized, the Bank must maintain minimum total risk-based, Tier I risk-based,
and Tier I leverage ratios as set forth in the table:

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STERLING BANCSHARES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

Dividend Restrictions -- Dividends paid by the Bank and the Company are
subject to certain restrictions imposed by regulatory agencies. Under these
restrictions there was an aggregate of approximately $67.2 million and $75.3
million available for payment of dividends at December 31, 2002, by the Bank and
the Company, respectively.

V. SEGMENTS

The Company has two operating segments: commercial banking and mortgage
banking. Each segment is managed separately because each business requires
different marketing strategies and each offers different products and services.

The accounting policies of the segments are the same as those described in
Note A. The Company evaluates each segment's performance based on the profit or
loss from its operations before income taxes. Intersegment financing
arrangements are accounted for at current market rates as if they were with
third parties.

74

STERLING BANCSHARES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

Summarized financial information by operating segment for the years ended
December 31, 2002 and 2002 follows:

Intersegment interest was paid to Sterling Bank by SCMC in the amount of
$27.7 million and $13.5 million for the years ended December 31, 2002 and 2001,
respectively. Total loans in the mortgage warehouse line of credit of $640.3
million and $253.7 million were eliminated in consolidation at December 31, 2002
and 2001, respectively.

W. DISCLOSURES ABOUT FAIR VALUE OF FINANCIAL STATEMENTS

Fair values were estimated by management as of December 31, 2002 and 2001,
and required considerable judgment. Accordingly, the estimates presented herein
are not necessarily indicative of the amounts the Company could realize in a
current market exchange. The use of different market assumptions and/or
estimation methodologies may have a material effect on the estimated fair values
presented.

The following methods and assumptions were used to estimate the fair value
of cash and of financial instruments for which it is practicable to estimate
that value:

Cash and Short-term Investments -- For cash and short-term investments, the
carrying amount is a reasonable estimate of fair value.

Securities -- For securities held as investment, fair value equals quoted
market prices, if available. If a quoted market price is not available, fair
value is estimated using quoted market prices for similar securities.

Trading Assets -- Securities are bought with the anticipation of sale in
the near term are carried at fair market value which equals quoted market
prices.

75

STERLING BANCSHARES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

Loans Held for Sale -- For loans held for sale, fair value equals quoted
market prices, if available. If a quoted market price is not available, the fair
value is estimated by discounting the future cash flows using the current rates
at which similar loans would be made to borrowers with similar credit ratings
and for the same remaining maturities.

Loans Held for Investment -- The fair value of loans is estimated by
discounting the future cash flows using the current rates at which similar loans
would be made to borrowers with similar credit ratings and for the same
remaining maturities.

Deposit Liabilities -- The fair value of demand deposits, savings accounts
and certain money market deposits is the amount payable on demand at the
reporting date. The fair value of certificates of deposit is estimated using the
rates currently offered for deposits of similar remaining maturities.

Other Borrowed Funds -- The carrying amounts approximate fair value because
these borrowings reprice at market rates generally within four days.

Commitments to Extend Credit, Standby Letters of Credit and Financial
Guarantees Written -- The fair value of commitments is estimated using the fees
currently charged to enter into similar agreements, taking into account the
remaining terms of the agreements and the present creditworthiness of the
counterparties. For fixed-rate loan commitments, fair value also considers the
difference between current levels of interest rates and the committed rates. The
fair value of guarantees and letters of credit is based on fees currently
charged for similar agreements or on the estimated cost to terminate them or
otherwise settle the obligations with the counterparties at the reporting date.

The estimated fair values of the Company's financial instruments are as
follows (in thousands):

76

STERLING BANCSHARES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

X. SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED)

The table below sets forth unaudited financial information for each quarter
of the last two years (in thousands, except per share amounts):

Earnings per common share are computed independently for each of the
quarters presented and therefore may not sum to the totals for the year.

All quarters have been restated to present the combined financial
information of acquisitions accounted for using the pooling of interests method.

77

STERLING BANCSHARES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

Y. PARENT-ONLY FINANCIAL STATEMENTS

STERLING BANCSHARES, INC.
(PARENT COMPANY ONLY)

BALANCE SHEETS
DECEMBER 31, 2002 AND 2001

78

STERLING BANCSHARES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

STERLING BANCSHARES, INC.
(PARENT COMPANY ONLY)

STATEMENTS OF INCOME
FOR THE YEARS ENDED DECEMBER 31, 2002, 2001 AND 2000

79

STERLING BANCSHARES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

STERLING BANCSHARES, INC.
(PARENT COMPANY ONLY)

STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, 2002, 2001 AND 2000

80

STERLING BANCSHARES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

Z. SUBSEQUENT EVENT

On February 28, 2003, Sterling Capital Mortgage Company (SCMC) completed
the sale of loan servicing rights related to $728 million in loans to HSBC
Mortgage Corporation. The sale generated a premium of $8.6 million. Mortgage
servicing rights associated with this sale totaled $12.3 million, while the
valuation allowance totaled $3.7 million resulting in no gain or loss being
recorded.

81

EXHIBIT INDEX

- ---------------

* As filed herewith.

** Management Compensation Agreement