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FORM 10-K
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the Year Ended December 31, 2004
Commission File Number 0-23064
SOUTHWEST BANCORP, INC.
(Exact name of registrant as specified in its charter)
OKLAHOMA 73-1136584
-------- -----------
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
608 SOUTH MAIN STREET, STILLWATER, OKLAHOMA 74074
- ------------------------------------------- -----
(Address of principal executive office) (Zip Code)
Registrant's telephone number, including area code: (405) 372-2230
Securities registered pursuant to Section 12(b) of the Act: NONE
Securities registered pursuant to Section 12(g) of the Act:
COMMON STOCK, PAR VALUE $1.00 PER SHARE
---------------------------------------
(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 is not contained herein, and will not be contained, to the
best of 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 a check mark if the registrant is an accelerated filer.
YES X NO
--- --
The registrant's Common Stock is traded on the NASDAQ National Market under the
symbol OKSB. The aggregate market value of approximately 10,421,628 shares of
Common Stock of the registrant issued and outstanding held by nonaffiliates on
June 30, 2004, the last day of the registrant's most recently completed second
fiscal quarter, was approximately $190.2 million based on the closing sales
price of $18.25 per share of the registrant's Common Stock on that date. Solely
for purposes of this calculation, it is assumed that directors, officers, and 5%
stockholders of the registrant (other than institutional investors) are
affiliates.
As of the close of business on March 4, 2005, 12,189,527 shares of the
registrant's Common Stock were outstanding.
Documents Incorporated by Reference
Part III: Portions of the definitive proxy statement for the Annual
Meeting of Shareholders to be held on April 28, 2005 (the
"Proxy Statement").
SOUTHWEST BANCORP, INC.
INDEX
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Forward-Looking Statements................................................................................................1
Form 10-K Cross Reference Sheet...........................................................................................1
Southwest Bancorp, Inc. ..................................................................................................3
About This Report.........................................................................................................4
Five Year Summary of Selected Financial Data..............................................................................5
Securities Listing, Prices, and Dividends.................................................................................6
Management's Discussion and Analysis of Financial Condition and Results of Operations.....................................8
Controls and Procedures..................................................................................................29
Reports of Independent Registered Public Accounting Firm.................................................................30
Consolidated Financial Statements........................................................................................32
Notes to the Consolidated Financial Statements...........................................................................37
Other Material Required by Form 10-K.....................................................................................63
Description of Business..............................................................................................63
Board of Directors...................................................................................................75
Executive Officers...................................................................................................76
Other Material.......................................................................................................80
Availability of Filings..............................................................................................81
Properties...........................................................................................................82
Exhibits, Financial Statement Schedules..............................................................................84
Signatures...........................................................................................................86
i
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FORWARD-LOOKING STATEMENTS
Southwest Bancorp, Inc. ("Southwest") makes forward-looking statements in this
Annual Report on Form 10-K that are subject to risks and uncertainties. These
forward-looking statements include: statements of Southwest's goals, intentions,
and expectations; estimates of risks and of future costs and benefits;
expectations regarding future financial performance of Southwest and its
operating segments; assessments of loan quality, probable loan losses, and the
amount and timing of loan payoffs; liquidity, contractual obligations,
off-balance sheet risk, and market, or interest rate risk; and statements of
Southwest's ability to achieve financial and other goals. These forward-looking
statements are subject to significant uncertainties because they are based upon:
the amount and timing of future changes in interest rates, market behavior, and
other economic conditions; future laws, regulations and accounting principles;
and a variety of other matters. Because of these uncertainties, the actual
future results may be materially different from the results indicated by these
forward-looking statements. In addition, Southwest's past growth and performance
do not necessarily indicate its future results.
- --------------------------------------------------------------------------------
SOUTHWEST BANCORP, INC.
FORM 10-K CROSS REFERENCE SHEET OF MATERIAL INCORPORATED BY REFERENCE
The following table shows the location in this Annual Report on Form 10-K or the
accompanying Proxy Statement of the information required to be disclosed by the
United States Securities and Exchange Commission ("SEC") Form 10-K. Where
indicated below, information has been incorporated by reference in this Report
from the Proxy Statement that accompanies it. Other portions of the Proxy
Statement are not included in this Report. This Report is not part of the Proxy
Statement. References are to pages in this report unless otherwise indicated.
ITEM OF FORM 10-K LOCATION
PART I
Item 1. Business "Forward-Looking Statements" on page 1,
"Southwest Bancorp, Inc." on page 3, "About this
Report" on page 4, and "Business" on pages 63
through 79.
Item 2. Properties "Properties" on page 82.
Item 3. Legal Proceedings Note 14 "Commitments and Contingencies" on
page 56.
Item 4. Submission of Matters to a Vote of Not applicable. No matter was submitted to a Security
Holders vote of security holders during the fourth quarter of
2004.
PART II
Item 5. Market for Registrant's Common Equity, "Securities Listing, Prices, and Dividends" on pages
Related Stockholder Matters, and 6 and 7.
Issuer Purchases of Equity Securities
Item 6. Selected Financial Data "Five Year Summary of Selected Financial Data"
on pages 5 and 6.
1
ITEM OF FORM 10-K LOCATION
Item 7. Management's Discussion and Analysis "Management's Discussion and Analysis of
Of Financial Condition and Results of Financial Condition and Results of Operations" on
Condition pages 8 through 28.
Item 7A. Quantitative and Qualitative Disclosures The section titled "Asset/Liability Management
About Market Risk Quantitative and Qualitative Disclosures about
Market Risk" on pages 24 through 26.
Item 8. Financial Statements and Supplementary Pages 30 through 62.
Data
Item 9. Changes in and Disagreements with Not applicable. During the past two years or any
Auditors on Accounting and Financial subsequent period there has been no change in or
Disclosure reportable disagreement with the independent registered
public accounting firm for Southwest or any of its
subsidiaries.
Item 9A. Controls and Procedures "Controls and Procedures" on page 29.
Item 9B. Other Information "Certain Changes in Executive Compensation
Plans" on page 80.
PART III.
Item 10. Directors and Executive Officers The material labeled "Election of Directors" on
pages 2 through 8 of the Proxy Statement, "Section 16(a)
Beneficial Ownership Reporting Compliance" on page 17 of
the Proxy Statement, and "Code of Ethics" on page 19 of
the Proxy Statement is incorporated by reference in this
Report. Information regarding executive officers is
included under the caption "Executive Officers" on
pages 81 through 85 of this Report.
Item 11. Executive Compensation The material labeled "Director Compensation" on
page 8 and the material labeled "Executive Compensation
and Other Benefits," and "Stock Performance Comparisons"
on pages 11 through 16 of the Proxy Statement is
incorporated by reference in this Report.
Item 12. Security Ownership of Certain The material labeled "Common Stock Owned by
Beneficial Owners and Management Directors and Executive Officers" and "Ownership
of More than 5% of Southwest's Common Stock"
on pages 9 and 10 of the Proxy Statement is
incorporated by reference in this Report.
Item 13. Certain Relationships and Related The material labeled "Certain Transactions" on
Transactions page 17 of the Proxy Statement is incorporated
by reference in this Report.
Item 14. Principal Accountant Fees and Services The material labeled "Fees" on pages 17 and 18 of the
Proxy Statement incorporated by reference in this
Report.
2
ITEM OF FORM 10-K LOCATION
PART IV.
Item 15. Exhibits, Financial Statement Schedules "Exhibits, Financial Statement Schedules" on pages
84 and 85.
SIGNATURES "Signatures" on page 94.
SOUTHWEST BANCORP, INC.
Southwest Bancorp, Inc. ("Southwest") is the financial holding company for
Stillwater National Bank and Trust Company ("Stillwater National") and SNB Bank
of Wichita ("SNB Wichita"), and Southwest's management consulting subsidiaries,
Business Consulting Group, Inc. ("BCG") and Healthcare Strategic Support, Inc.
("HSSI"). Southwest is an independent company, not controlled by other
organizations or individuals. Southwest pursues an established strategy of
independent operation for the benefit of all of its shareholders.
A substantial portion of Southwest's current business and focus for the future
are services for local businesses, their primary employees, healthcare
facilities and professionals, and other managers and professionals. Southwest
seeks to be the premier financial services company for its selected markets.
Information regarding Southwest can be retrieved via the Internet at
www.oksb.com. Southwest, Stillwater National, and SNB Wichita offer commercial
and consumer lending, deposit, and investment services, and specialized cash
management, consulting, and other financial services from offices in Stillwater,
Tulsa, Oklahoma City, and Chickasha, Oklahoma, Wichita, Kansas, and metropolitan
Dallas, Austin, and San Antonio, Texas; loan production offices in Kansas City,
Kansas, and on the campuses of Oklahoma State University-Tulsa and the
University of Oklahoma Health Sciences Center-Oklahoma City; a marketing
presence in the Student Union at Oklahoma State University-Stillwater; and on
the Internet. Information regarding products and services of Stillwater National
and SNB Wichita, including SNB DirectBanker(R), Southwest's online banking
product, can be retrieved via the Internet, at www.banksnb.com and
www.snbwichita.com. The Stillwater National and SNB Wichita websites and online
banking technology are frequently updated in response to the changing needs of
the large base of Internet banking customers.
Southwest was organized in 1981 as the holding company for Stillwater National,
which was chartered in 1894. Southwest became a public company in late 1993 with
assets of approximately $434.0 million. At December 31, 2004, Southwest had
total assets of $1.9 billion, deposits of $1.5 billion, and shareholders' equity
of $126.0 million.
3
ABOUT THIS REPORT
This report comprises the entire 2004 Form 10-K, other than exhibits, as filed
with the SEC. The 2004 annual report to shareholders, including this report, and
the annual proxy materials for the 2005 annual meeting are being distributed
together to shareholders. Copies of exhibits and additional copies of the Form
10-K can be obtained free of charge by writing to Kerby E. Crowell, Chief
Financial Officer, Southwest Bancorp, Inc., P.O. Box 1988, Stillwater, OK 74076.
This report is provided along with the annual proxy statement for convenience of
use and to decrease costs, but is not part of the proxy materials.
THE SEC HAS NOT APPROVED OR DISAPPROVED THIS REPORT OR PASSED UPON ITS ACCURACY
OR ADEQUACY.
4
FIVE YEAR SUMMARY OF SELECTED FINANCIAL DATA
The following table presents Southwest's selected consolidated financial
information for each of the five years in the period ended December 31, 2004.
The selected consolidated financial data should be read in conjunction with the
Consolidated Financial Statements of Southwest, including the accompanying
Notes, presented elsewhere in this report.
For the Year Ended December 31,
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(Dollars in thousands, except per share data) 2004 2003 2002 2001 2000
- ------------------------------------------------------------------------------------------------------------------------------------
OPERATIONS DATA
Interest income $ 104,723 $ 84,079 $ 76,495 $ 90,400 $ 97,274
Interest expense 32,246 28,611 30,678 48,939 57,227
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Net interest income 72,477 55,468 45,817 41,461 40,047
Provision for loan losses 12,982 8,522 5,443 4,000 3,550
Gain on sales of loans and securities 3,185 4,139 3,498 3,346 1,753
Other income 10,900 10,361 9,220 7,467 6,808
Other expenses 44,412 38,448 33,319 31,165 29,615
- ------------------------------------------------------------------------------------------------------------------------------------
Income before taxes 29,168 22,998 19,773 17,109 15,443
Taxes on income 10,539 8,106 6,354 5,357 5,238
- ------------------------------------------------------------------------------------------------------------------------------------
Net income $ 18,629 $ 14,892 $ 13,419 $ 11,752 $ 10,205
====================================================================================================================================
DIVIDENDS DECLARED
Common stock $ 3,380 $ 2,959 $ 2,533 $ 1,826 $ 1,678
Ratio of total dividends declared to net income 18.14% 19.87% 18.87% 15.52% 16.44%
PER SHARE DATA (1)
Basic earnings per common share $ 1.54 $ 1.26 $ 1.17 $ 1.03 $ 0.89
Diluted earnings per common share 1.48 1.22 1.11 1.00 0.88
Common stock cash dividends 0.28 0.25 0.22 0.16 0.15
Book value per common share (2) 10.41 9.20 8.35 7.47 6.44
Weighted average common shares outstanding:
Basic 12,060,842 11,798,810 11,490,166 11,386,258 11,467,248
Diluted 12,548,059 12,159,620 12,052,118 11,728,844 11,585,704
FINANCIAL CONDITION DATA (2)
Investment securities $ 220,051 $ 204,266 $ 188,689 $ 227,346 $ 229,792
Total loans (3) 1,623,875 1,308,836 1,101,112 931,046 912,550
Interest-earning assets 1,845,401 1,514,314 1,292,232 1,160,478 1,142,945
Total assets 1,912,834 1,580,725 1,350,554 1,217,281 1,204,352
Interest-bearing deposits 1,316,320 1,036,793 885,812 777,600 825,370
Total deposits 1,500,058 1,204,125 1,021,757 904,796 945,102
Other borrowings 200,065 183,850 199,282 195,367 150,498
Subordinated debentures 72,180 72,180 25,787 25,787 25,787
Total shareholders' equity (4) 125,984 109,935 96,372 85,125 73,239
Mortgage servicing portfolio 125,353 124,366 107,733 91,120 94,545
SELECTED RATIOS
Return on average assets 1.03% 0.99% 1.05% 0.96% 0.87%
Return on average equity 15.80 14.59 14.94 14.87 14.89
Net interest margin 4.16 3.80 3.75 3.53 3.57
Efficiency ratio (5) 51.31 54.95 56.92 59.62 60.93
Average assets per employee (6) $ 5,098 $ 4,382 $ 3,938 $ 3,919 $ 3,783
5
SELECTED CONSOLIDATED FINANCIAL DATA (CONTINUED)
At December 31,
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(Dollars in thousands, except per share data) 2004 2003 2002 2001 2000
- ------------------------------------------------------------------------------------------------------------------------------------
ASSET QUALITY RATIOS
Allowance for loan losses to total loans (2) 1.23% 1.21% 1.08% 1.23% 1.33%
Nonperforming loans to total loans (2)(7) 1.43 1.22 1.17 0.99 1.32
Allowance for loan losses to nonperforming loans
loans (2)(7) 86.12 99.59 92.11 124.56 100.71
Nonperforming assets to total loans and other real
estate owned (2)(8) 1.72 1.34 1.24 1.06 1.45
Net loan charge-offs to average total loans 0.58 0.36 0.50 0.49 0.29
CAPITAL RATIOS
Average total shareholders' equity to average assets 6.51 6.75 7.04 6.44 5.81
Tier I capital to risk-weighted assets (2) 10.88 11.13 10.38 11.15 10.36
Total capital to risk-weighted assets (2) 13.92 14.90 11.42 12.34 11.68
Leverage ratio (2) 8.61 9.32 8.99 8.84 8.08
(1) All share and per share information has been restated to reflect the
three-for-two stock split effected in the form of a stock dividend paid
August 29, 2001, and the two-for-one stock split effected in the form of a
stock dividend paid August 29, 2003.
(2) At period end.
(3) Net of unearned discounts but before deduction of allowance for loan
losses.
(4) Reflects the repurchases of common shares in 2000, 2001, and 2002. Please
see note 8 to the consolidated financial statements.
(5) The efficiency ratio = other expenses/(net interest income + total other
income) as shown on the consolidated statements of operations. This ratio
has not been adjusted to remove any income or expense recorded under
accounting principles generally accepted in the United States.
(6) Ratio = year-to-date average assets divided by the number of FTE employees
at year-end.
(7) Nonperforming loans consist of nonaccrual loans, loans contractually past
due 90 days or more and loans with restructured terms.
(8) Nonperforming assets consist of nonperforming loans and foreclosed assets.
SECURITIES LISTING, PRICES, AND DIVIDENDS
STOCK LISTING
Common shares of Southwest Bancorp, Inc. are traded on the National Association
of Security Dealers (NASDAQ) National Market under the symbol OKSB. Trust
Preferred securities of SBI Capital Trust are traded on the NASDAQ National
Market under the symbol OKSBO.
TRANSFER AGENT AND REGISTRAR
For Southwest Bancorp, Inc.:
Computershare Investor Services, LLC
2 North LaSalle St.
Chicago, IL 60602
For SBI Capital Trust:
U.S. Bank, Corporate Trust Services
P.O. Box 778 Boston, MA 02102-0778
6
RECENT STOCK PRICES AND DIVIDENDS
Shareholders received quarterly cash dividends totaling $3.3 million in 2004 and
$2.8 million in 2003. Regular dividends have been declared and paid every year
since Southwest was organized in 1981. Southwest has increased its dividends per
share each year since going public in 1993.
The dividend amount is established by the Board of Directors each quarter. In
making its decision on dividends, the Board considers operating results,
financial condition, capital adequacy, regulatory requirements, shareholder
returns, and other factors. The ability of Southwest to pay dividends depends
upon dividend payments from its subsidiaries. For information regarding the
ability of Stillwater National and SNB Wichita to pay dividends to Southwest and
the restrictions on bank dividends under federal banking laws, see "Note 9.
Capital Requirements" to the Consolidated Financial Statements on page 57 of
this report.
Shares issued under the employee stock purchase plan, which commenced on January
1, 1996, totaled 3,642 in 2004 and 4,257 in 2003, while issuances pursuant to
the stock option plans were 140,726 and 398,713 in the respective years.
Southwest has a stock repurchase program that permits the repurchase of up to 5%
(approximately 600,000 shares) of Southwest's outstanding common stock, par
value $1.00 per share, in connection with shares expected to be issued under
Southwest's dividend reinvestment, stock option, and employee benefit plans, and
for other corporate purposes. The share repurchases are expected to be made
primarily on the open market from time to time until April 1, 2005, or earlier
termination of the repurchase program by the Board. Repurchases under the
program will be made at the discretion of management based upon market,
business, legal, and other factors. This program, which has been publicly
announced, replaced a publicly announced program that expired on March 31, 2004.
No shares were repurchased during 2004.
As of March 4, 2005, there were approximately 2,494 holders of record of
Southwest's common stock. The following table sets forth the common stock
dividends declared for each quarter during 2004 and 2003, and the range of high
and low closing trade prices for the common stock for those periods.
2004 2003
----------------------------- -----------------------------
DIVIDEND Dividend
HIGH LOW DECLARED High Low Declared
------- ------- -------- ------- ------- --------
For the Quarter Ending:
March 31 $ 18.94 $ 16.11 $ 0.07 $ 13.36 $ 11.07 $0.0625
June 30 18.75 15.75 $ 0.07 13.71 11.18 $0.0625
September 30 22.21 17.70 $ 0.07 17.83 13.63 $0.0625
December 31 27.10 21.50 $ 0.07 18.91 14.37 $0.0625
7
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
OVERVIEW
Southwest Bancorp, Inc.'s ("Southwest") net income, diluted earnings per share,
loans, deposits, and assets reached their highest levels in our history. The
earnings growth was driven by a substantial (24%) increase in total loans, which
contributed to an improved margin, offset in part by a 52% higher provision for
loan losses, a 3% decrease in noninterest income, due to reduced gains on sales
of loans as the demand for mortgage refinancings declined, and greater operating
expenses (up 16%), and income taxes (up 30%).
o Net income for 2004 was $18.6 million, up from $14.9 million
in 2003 and $13.4 million in 2002.
o Diluted earnings per common share increased to $1.48 in 2004,
compared to $1.22 in 2003 and $1.11 in 2002.
o Total assets at year-end 2004 increased 21%, ending the year
at $1.91 billion compared to $1.58 billion at year-end 2003
and $1.35 billion at year-end 2002.
o Total loans grew to $1.62 billion at December 31, 2004,
compared to $1.31 billion at December 31, 2003, and $1.10
billion for 2002.
o Total shareholders' equity at year-end increased 15% to $126.0
million for 2004 compared to $109.9 million for 2003 and $96.4
million for 2002.
On August 29, 2003, Southwest effected a 2:1 stock split of its common stock in
the form of a dividend of 6,121,521 shares. All share and per share amounts in
this annual report have been retroactively restated to reflect this stock split.
RESULTS OF OPERATIONS
For the year ended December 31, 2004, Southwest reported net income of $18.6
million, a $3.7 million, or 25%, increase over the $14.9 million earned in 2003.
Basic earnings per common share increased by 22% to $1.54 per share for 2004,
from $1.26 per share for 2003. Diluted earnings per common share increased by
21% to $1.48 per share for 2004 from $1.22 per share for 2003.
Significant growth in loans, which was funded by growth in deposits and other
borrowings, was the primary factor contributing to Southwest's performance in
2004. In an increasing interest rate environment, Southwest was able to price
its loans and deposits and negotiate other borrowings to result in an increase
in net interest margin from 3.80% in 2003 to 4.16% in 2004.
For the year ended December 31, 2003, Southwest reported net income of $14.9
million, a $1.5 million, or 11%, increase over the $13.4 million earned in 2002.
Basic earnings per common share increased by 8% to $1.26 per share for 2003 from
$1.17 per share for 2002. Diluted earnings per common share increased by 10% to
$1.22 per share for 2003 from $1.11 per share for 2002.
These factors are discussed in more detail in the sections that follow.
8
CRITICAL ACCOUNTING POLICIES
Southwest's consolidated financial statements are prepared in accordance with
accounting principles generally accepted in the United States of America
("GAAP") and follow general practices within the industry in which it operates.
Application of these principles requires management to make estimates,
assumptions, and judgments that affect the amounts reported in the financial
statements and accompanying notes. These estimates, assumptions, and judgments
are based on information available as of the date of the financial statements;
accordingly, as this information changes, the financial statements may reflect
different estimates, assumptions, and judgments. Certain policies inherently
rely more on the use of estimates, assumptions, and judgments, and as such have
a greater possibility of producing results that could be materially different
than originally reported. Estimates, assumptions, and judgments are necessary
when assets and liabilities are required to be recorded at fair value, when a
decline in the value of an asset not carried on the financial statements at fair
value warrants an impairment write-down or valuation allowance to be
established, or when an asset or liability must be recorded contingent upon a
future event. Carrying assets and liabilities at fair value inherently results
in more financial statement volatility. The fair values and the information used
to record valuation adjustments for certain assets and liabilities are based
either on quoted market prices or are provided by other third-party sources,
when available.
The following table presents a five-year history for the allocation of the
allowance for loan losses along with the percentage of total loans in each
category (dollars in thousands).
At December 31,
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(Dollars in thousands) 2004 2003 2002 2001 2000
- ------------------------------------------------------------------------------------------------------------------------------------
Real estate mortgage -
Commercial $ 4,687 32% $ 4,980 31% $ 4,076 34% $ 2,277 32% $ 916 30%
One to four family
residential 313 5 291 6 509 9 557 11 546 12
Real estate construction
construction 1,434 15 1,538 18 1,405 12 750 10 3,003 11
Commercial 9,644 24 7,318 27 4,271 32 6,680 34 4,286 34
Installment and consumer -
Guaranteed student loans 175 22 105 16 59 11 46 10 -- 9
Other 583 2 319 2 225 2 298 3 347 4
General 3,108 1,297 1,343 884 3,027
------- --- ------- --- ------- --- ------- --- ------- ---
Total $19,944 100% $15,848 100% $11,888 100% $11,492 100% $12,125 100%
======= === ======= === ======= === ======= === ======= ===
The allowance for loan losses is an estimate of the losses that may be sustained
in the loan portfolio. The allowance is based on two basic principles of
accounting: (1) Statement of Financial Accounting Standards ("SFAS") No. 5,
"Accounting for Contingencies", which requires that losses be accrued when they
are probable of occurring and estimable, and (2) SFAS No. 114, "Accounting by
Creditors for Impairment of a Loan", which requires that losses be accrued when
it is probable that Southwest will not collect all principal and interest
payments according to the loan's contractual terms.
9
Management believes that the allowance is adequate. However, its determination
requires significant judgment, and estimates of probable losses inherent in the
loan portfolio can vary significantly from the amounts actually observed. While
management uses available information to recognize probable losses, future
additions to the allowance may be necessary based on changes in the loans
comprising the portfolio and changes in the financial condition of borrowers,
such as may result from changes in economic conditions. In addition, various
regulatory agencies, as an integral part of their examination process, and
independent consultants engaged by Southwest, periodically review the loan
portfolio and the allowance. Such review may result in additional provisions
based on their judgments of information available at the time of each
examination. Because the loan portfolio contains a significant number of
commercial and commercial real estate loans with relatively large balances, the
unexpected deterioration of one or a few of such loans may cause a significant
increase in nonperforming assets, and may lead to a material increase in
charge-offs and the provision for loan losses in future periods.
Southwest's systematic methodology for assessing the appropriateness of the
allowance includes determination of a formula allowance, specific allowances,
and an unallocated allowance, as described in "Provision for Loan Losses" on
page 18 and in Note 1 to the Consolidated Financial Statements on page 42. The
formula and specific allowances comprised 84.41% of the total allowance at
December 31, 2004. At that date, a 10% decrease or increase in all categories of
risk rated assets for which specific allowances had not been recorded would have
resulted in a corresponding decrease or increase of approximately $588,000 in
the recommended allowance, assuming no change in other elements considered in
the methodology.
10
COMPARISON SUMMARY 2004 CHANGE 2003 Change
(Dollars in thousands, except per share data) 2004 FROM 2003 2003 From 2002 2002
- --------------------------------------------------------------------------------------------------------------------
OPERATIONS DATA
Interest income $ 104,723 $ 20,644 $ 84,079 $ 7,584 $ 76,495
Interest expense 32,246 3,635 28,611 (2,067) 30,678
- --------------------------------------------------------------------------------------------------------------------
Net interest income 72,477 17,009 55,468 9,651 45,817
Provision for loan losses 12,982 4,460 8,522 3,079 5,443
Gain on sales of loans and securities 3,185 (954) 4,139 641 3,498
Other income 10,900 539 10,361 1,141 9,220
Other expenses 44,412 5,964 38,448 5,129 33,319
- --------------------------------------------------------------------------------------------------------------------
Income before taxes 29,168 6,170 22,998 3,225 19,773
Taxes on income 10,539 2,433 8,106 1,752 6,354
- --------------------------------------------------------------------------------------------------------------------
Net income $ 18,629 $ 3,737 $ 14,892 $ 1,473 $ 13,419
====================================================================================================================
PER SHARE DATA
Basic earnings per common share $ 1.54 $ 0.28 $ 1.26 $ 0.09 $ 1.17
Diluted earnings per common share 1.48 0.26 1.22 0.11 1.11
FINANCIAL CONDITION DATA - AVERAGES
Investment securities $ 214,988 $ 23,712 $ 191,276 $ (16,739) $ 208,015
Total loans 1,527,935 258,719 1,269,216 256,729 1,012,487
Interest-earning assets 1,743,986 282,402 1,461,584 238,418 1,223,166
Total assets 1,809,924 298,185 1,511,739 235,795 1,275,944
Interest-bearing deposits 1,180,970 159,655 1,021,315 159,156 862,159
Total deposits 1,355,336 194,960 1,160,376 179,816 980,560
Other borrowings 252,131 51,658 200,473 34,728 165,745
Subordinated debentures 72,180 30,138 42,042 16,255 25,787
Total shareholders' equity 117,912 15,866 102,046 12,201 89,845
SELECTED RATIOS
Return on average assets 1.03% 0.04% 0.99% (0.06)% 1.05%
Return on average equity 15.80 1.21 14.59 (0.35) 14.94
Net interest margin 4.16 0.36 3.80 0.05 3.75
ASSET QUALITY RATIOS
Allowance for loan losses to total loans 1.23% 0.02% 1.21% 0.13% 1.08%
Nonperforming loans to total loans 1.43 0.21 1.22 0.05 1.17
Allowance for loan losses to nonperforming loans 86.12 (13.47) 99.59 7.48 92.11
Nonperforming assets to total loans and
other real estate 1.72 0.38 1.34 0.10 1.24
Net loan charge-offs to average total loans 0.58 0.22 0.36 (0.14) 0.50
The table on the next page provides certain information relating to Southwest's
average consolidated statements of financial condition and reflects the interest
income on interest-earning assets, interest expense of interest-bearing
liabilities, and the average yields earned and rates paid for the periods
indicated. Yields and rates are derived by dividing income or expense reflected
in the Consolidated Statements of Operations by the average daily balance of the
related assets or liabilities, respectively, for the periods presented.
Nonaccrual loans have been included in the average balances of total loans.
This table shows a shift in the composition of Southwest's interest-earning
assets over the periods toward a higher level of loans and a lower level of
investment securities, while the composition of interest-bearing liabilities
changed as Southwest increased noninterest-bearing and money market deposits.
The changes in the composition of interest-earning assets and their funding
sources reflect market demand and management's efforts to maximize net interest
margin while controlling interest rate, credit and other risks.
11
AVERAGE BALANCES, YIELDS & RATES
For the Year Ended December 31,
(Dollars in thousands) 2004 2003 2002
- ------------------------------------------------------------------------------------------------------------------------------------
AVERAGE YIELD/ Average Yield/ Average Yield/
BALANCE INTEREST RATE(1) Balance Interest Rate(1) Balance Interest Rate(1)
------------------------------ ------------------------------ ----------------------------
ASSETS
Total loans and leases $1,527,935 $ 96,832 6.34% $1,269,216 $76,115 6.00% $1,012,487 $65,503 6.47%
Investment securities 214,988 7,881 3.67 191,276 7,954 4.16 208,015 10,948 5.26
Other interest-earning assets 1,063 10 0.94 1,092 10 0.92 2,664 44 1.65
- ------------------------------------------------------------------------------------------------------------------------------------
Total interest-earning assets 1,743,986 104,723 6.00 1,461,584 84,079 5.75 1,223,166 76,495 6.25
Other assets 65,938 50,155 52,778
- ------------------------------------------------------------------------------------------------------------------------------------
Total assets $1,809,924 $1,511,739 $1,275,944
====================================================================================================================================
LIABILITIES AND
SHAREHOLDERS' EQUITY
Interest-bearing demand deposits $ 58,375 $ 291 0.50% $ 56,011 $ 355 0.63% $ 52,096 $ 372 0.71%
Money market accounts 405,116 6,118 1.51 336,274 5,237 1.56 211,883 4,305 2.03
Savings accounts 7,819 19 0.24 6,608 17 0.26 5,702 25 0.44
Time deposits 709,660 15,350 2.16 622,422 15,036 2.42 592,478 18,749 3.16
- ------------------------------------------------------------------------------------------------------------------------------------
Total interest-bearing deposits 1,180,970 21,778 1.84 1,021,315 20,645 2.02 862,159 23,451 2.72
Other borrowings (2) 252,131 5,979 2.37 200,473 4,887 2.44 165,745 4,829 2.91
Subordinated debentures 72,180 4,489 6.22 42,042 3,079 7.22 25,787 2,398 9.30
- ------------------------------------------------------------------------------------------------------------------------------------
Total interest-bearing liabilities 1,505,281 32,246 2.14 1,263,830 28,611 2.26 1,053,691 30,678 2.91
---------------- --------------- --------------
Noninterest-bearing demand deposits 174,366 139,061 118,401
Other liabilities 12,365 6,802 14,007
Shareholders' equity 117,912 102,046 89,845
- ------------------------------------------------------------------------------------------------------------------------------------
Total liabilities and
shareholders' equity $1,809,924 $1,511,739 $1,275,944
====================================================================================================================================
Net interest income $ 72,477 $55,468 $45,817
====================================================================================================================================
Interest rate spread 3.86% 3.49% 3.34%
====================================================================================================================================
Net interest margin (3) 4.16% 3.80% 3.75%
====================================================================================================================================
Ratio of average interest-
earning assets to average
interest-bearing liabilities 115.86% 115.65% 116.08%
====================================================================================================================================
(1) Yields, net interest spreads, and net interest margins are calculated
using income recorded in accordance with accounting principals
generally accepted in the United States ("GAAP"), and are not shown on
the higher, non-GAAP tax-equivalent basis.
(2) The fluctuation in other borrowings resulted mainly from changes in
Federal Home Loan Bank borrowings.
(3) Net interest margin = net interest income / total interest-earning
assets.
12
The following table analyzes changes in interest income and interest expense of
Southwest for the periods indicated. For each category of interest-earning asset
and interest-bearing liability, information is provided on changes attributable
to: (i) changes in volume (changes in volume multiplied by the prior period's
rate); and (ii) changes in rates (changes in rate multiplied by the prior
period's volume). Changes in rate-volume (changes in rate multiplied by the
changes in volume) are allocated between changes in rate and changes in volume
in proportion to the relative contribution of each.
2004 VS. 2003 2003 vs. 2002
- --------------------------------------------------------------------------------------------------------
INCREASE DUE TO CHANGE Increase Due to Change
OR IN AVERAGE: Or In Average:*
(Dollars in thousands) (DECREASE) VOLUME RATE (Decrease) Volume Rate
- --------------------------------------------------------------------------------------------------------
Interest earned on:
Loans receivable (1) $ 20,717 $ 16,206 $ 4,511 $ 10,612 $ 15,722 $ (5,110)
Investment securities (73) 827 (900) (2,994) (775) (2,219)
Other interest-earning assets -- -- -- (34) (20) (14)
--------------------------------------------------------------------
Total interest income 20,644 17,033 3,611 7,584 14,927 (7,343)
Interest paid on:
Interest-bearing demand (64) 12 (76) (17) 27 (44)
Money market accounts 881 1,054 (173) 932 2,094 (1,162)
Savings accounts 2 3 (1) (8) 3 (11)
Time deposits 314 1,850 (1,536) (3,713) 693 (4,406)
Other borrowings 1,092 1,236 (144) 58 908 (850)
Subordinated debentures 1,410 1,880 (470) 681 1,273 (592)
--------------------------------------------------------------------
Total interest expense 3,635 6,035 (2,400) (2,067) 4,998 (7,065)
--------------------------------------------------------------------
Net interest income $ 17,009 $ 10,998 $ 6,011 $ 9,651 $ 9,929 $ (278)
====================================================================
(1) Average balances include nonaccrual loans. Fees included in interest
income on loans receivable are not considered material. Interest on
tax-exempt loans and securities is not shown on a tax-equivalent basis
because it is not considered material.
NET INTEREST INCOME
Net interest income is the difference between interest income on earning assets,
such as loans and investment securities, and interest expense on liabilities,
such as deposits and borrowings, which are used to fund those assets. Net
interest income is Southwest's largest source of revenue, representing 84% of
total revenue in 2004. Net interest margin is net interest income as a
percentage of average earning assets for the period. Net interest income and net
interest margin increase or decrease as a result of changes in the levels of
interest rates, the volume and the mix of earning assets and interest-bearing
liabilities, and the percentage of interest-earning assets funded by
noninterest-bearing funding sources.
Net interest income for 2004 was $72.5 million, an increase of $17.0 million, or
31%, from the $55.5 million earned in 2003. The net interest margin was 4.16%
for the year ended December 31, 2004, an increase of thirty-six basis points
from 2003.
The 2004 increase in net interest income and net interest margin from 2003 is
the result of the significant increase in interest-earning assets, the increase
in net interest margin due to the slightly increasing interest rate environment
experienced during 2004, and an increased use of noninterest-bearing funding.
13
Net interest income for 2003 was $55.5 million, an increase of $9.7 million, or
21%, from the $45.8 million earned in 2002. The net interest margin was 3.80%
for the year ended December 31, 2003, an increase of five basis points from
2002.
Interest rate spread, which represents the difference between the rate earned on
interest-earning assets and the rates paid out on interest-bearing liabilities,
was 3.86% for 2004 compared to 3.49% for 2003 and 3.34% for 2002.
Southwest has also seen significant growth in money market deposit accounts
which are a low rate funding source compared to time deposits and other
borrowings. The average balance of money market deposit accounts increased to
$405.1 million in 2004 from $336.3 million in 2003 and $211.9 million in 2002.
PROVISION FOR LOAN LOSSES
Southwest makes provisions for loan losses in amounts necessary to maintain the
allowance for loan losses at the level Southwest determines is appropriate based
on a systematic methodology. The allowance is based on careful, continuous
review and evaluation of the loan portfolio and ongoing, quarterly assessments
of the probable losses inherent in the loan and lease portfolio and unused
commitments to provide financing. Southwest's systematic methodology for
assessing the appropriateness of the allowance includes determination of a
formula allowance, specific allowances and an unallocated allowance. The formula
allowance is calculated by applying loss factors to corresponding categories of
outstanding loans and leases. Loss factors generally are based on Southwest's
historical loss experience in the various portfolio categories over the prior
eighteen months or twelve months, but may be adjusted for categories where
eighteen and twelve month loss experience is historically unusual. The use of
these loss factors is intended to reduce the differences between estimated
losses inherent in the portfolio and observed losses. Formula allowances also
are established for loans that do not have specific allowances according to the
application of credit risk factors. These factors are set by management to
reflect its assessment of the relative level of risk inherent in each credit
grade. Specific allowances are established in cases where management has
identified significant conditions or circumstances related to individual loans
that management believes indicate the probability that losses may be incurred in
an amount different from the amounts determined by application of the formula
allowance. Specific allowances include amounts related to loans that are
identified for evaluation of impairment, which is based on discounted cash flows
using each loan's initial effective interest rate or the fair value of the
collateral for certain collateral dependent loans. All of Southwest's nonaccrual
loans are considered to be impaired loans. The unallocated allowance is based
upon management's evaluation of various factors that are not directly measured
in the determination of the formula and specific allowances. These factors may
include general economic and business conditions affecting lending areas, credit
quality trends (including trends in delinquencies and nonperforming loans
expected to result from existing conditions), loan volumes and concentrations,
specific industry conditions within portfolio categories, recent loss experience
in particular loan categories, duration of the current business cycle, bank
regulatory examination results, findings of internal credit examiners, and
management's judgment with respect to various other conditions including credit
administration and management and the quality of risk identification systems.
Management reviews these conditions quarterly. Based upon this review,
management established an allowance of $19.9 million, or 1.23% of total loans,
at December 31, 2004 compared to an allowance of $15.8 million, or 1.21% of
total loans, at December 31, 2003. This represents an annual increase in the
allowance of $4.1 million, or 26%, from year-end 2003. At December 31, 2004,
total nonperforming loans were $23.2 million, or 1.43% of total loans, compared
to $15.9 million, or 1.22% of total loans, at December 31, 2003. The
government-guaranteed portions of year-end nonperforming loans were $1.5 million
for 2004 and $2.7 million for 2003. The allowance for loan losses equaled 86.12%
of nonperforming loans at December 31, 2004 compared to 99.59% at December 31,
2003. During 2004, 2003, and 2002, the provisions for loan losses were $13.0
million, $8.5 million, and $5.4 million, respectively, while net charge-offs
were $8.9 million, $4.6 million, and $5.0 million, respectively.
14
Both the dollar amount and the percentage of the allowance to loans increased
during 2004. The increase was primarily the result of increases in nonperforming
loans, increased allocations on impaired loans, and increases in portfolio
loans. At December 31, 2004, the unallocated allowance totaled $3.1 million, a
$1.8 million increase from year-end 2003, and accounted for 16% of the total
allowance, up from 8% the prior year. The increase in the unallocated allowance
related primarily to changes in general economic conditions, including
increasing interest rates, and on the level of growth in the Other states
banking segment portfolio loans and the resulting increase in relatively
unseasoned loans.
Management strives to carefully monitor credit quality and to identify loans
that may become nonperforming. At any time, however, there are loans included in
the portfolio that will result in losses to Southwest, but that have not been
identified as nonperforming or potential problem loans. Because the loan
portfolio contains a significant number of commercial and commercial real estate
loans with relatively large balances, the unexpected deterioration of one or a
few of such loans may cause a significant increase in nonperforming assets, and
may lead to a material increase in charge-offs and the provision for loan losses
in future periods.
Those performing loans considered potential nonperforming loans, loans which are
not included in the past due, nonaccrual, or restructured categories, but for
which known information about possible credit problems cause management to be
uncertain as to the ability of the borrowers to comply with the present loan
repayment terms over the next six months, amounted to approximately $25.6
million at December 31, 2004, compared to $37.8 million at December 31, 2003 and
$28.9 million at December 31, 2002. Loans may be monitored by management and
reported as potential nonperforming loans for an extended period of time during
which management continues to be uncertain as to the ability of certain
borrowers to comply with the present loan repayment terms. These loans are
subject to continuing management attention and are considered by management in
determining the level of the allowance for loan losses.
The following table shows the amounts of nonperforming assets at the end of the
periods indicated.
At December 31,
- -----------------------------------------------------------------------------------------
(Dollars in thousands) 2004 2003 2002 2001 2000
- -----------------------------------------------------------------------------------------
Total nonaccrual $22,230 $14,530 $11,455 $ 7,291 $ 3,138
Total past due 90 days or more 929 1,384 1,452 1,935 208
Total restructured -- -- -- -- 8,694
- -----------------------------------------------------------------------------------------
Total nonperforming loans 23,159 15,914 12,907 9,226 12,040
Other real estate owned 4,937 1,699 747 640 1,225
- -----------------------------------------------------------------------------------------
Total nonperforming assets $28,096 $17,613 $13,654 $ 9,866 $13,265
=========================================================================================
Nonperforming loans to total loans 1.43% 1.22% 1.17% 0.99% 1.32%
Allowance for loan losses to
nonperforming loans 86.12% 99.59% 92.11% 124.56% 100.71%
Government-guaranteed portion of
nonperforming loans $ 1,458 $ 2,694 $ 1,017 $ 905 $ 200
15
At December 31, 2004, three credit relationships accounted for approximately
$16.3 million, or 71%, of total nonperforming loans. All of these credits were
identified as problem or potential problem credits in previous quarters or
years. Management continues to actively manage these relationships, and
anticipates they will be significantly reduced within the next six months.
The following table analyzes Southwest's allowance for loan losses for the
periods indicated.
For the Year Ended December 31,
- --------------------------------------------------------------------------------------------------------
(Dollars in thousands) 2004 2003 2002 2001 2000
- --------------------------------------------------------------------------------------------------------
Balance at beginning of period $15,848 $11,888 $11,492 $12,125 $11,190
LOANS CHARGED-OFF:
Real estate mortgage 812 717 777 445 563
Real estate construction 275 3 -- 99 1,083
Commercial 8,382 3,915 4,248 4,364 1,170
Installment and consumer 565 442 371 621 474
- --------------------------------------------------------------------------------------------------------
Total charge-offs 10,034 5,077 5,396 5,529 3,290
- --------------------------------------------------------------------------------------------------------
RECOVERIES:
Real estate mortgage 151 173 93 54 155
Real estate construction -- -- -- 22 --
Commercial 907 230 107 574 360
Installment and consumer 90 112 149 246 160
- --------------------------------------------------------------------------------------------------------
Total recoveries 1,148 515 349 896 675
- --------------------------------------------------------------------------------------------------------
Net loans charged-off 8,886 4,562 5,047 4,633 2,615
Provision for loan losses 12,982 8,522 5,443 4,000 3,550
- --------------------------------------------------------------------------------------------------------
Balance at end of period $19,944 $15,848 $11,888 $11,492 $12,125
========================================================================================================
Ratio of allowance for loan losses to total loans:
Average 1.31% 1.25% 1.17% 1.22% 1.35%
End of period 1.23 1.21 1.08 1.23 1.33
Ratio of net charge-offs to average total loans
during the period 0.58 0.36 0.50 0.49 0.29
OTHER INCOME
Other income was $14.1 million for 2004, down 3% when compared with 2003. Other
income increased by 14% in 2003. Fluctuations in other income for the periods
presented in the table below occurred primarily in two areas: service charges
and fees on deposit accounts and gain on sales of loans.
COMPARISON SUMMARY-OTHER INCOME 2004 Change 2003 Change
(Dollars in thousands) 2004 From 2003 2003 From 2002 2002
- --------------------------------------------------------------------------------------------------
Service charges and fees $ 9,898 $ 605 $ 9,293 $ 1,077 $ 8,216
Gain on sales of loans 3,247 (864) 4,111 941 3,170
Other noninterest income 1,002 (66) 1,068 64 1,004
Gain (loss) on sales of
investment securities (62) (90) 28 (300) 328
- --------------------------------------------------------------------------------------------------
Total other income $ 14,085 $ (415) $ 14,500 $ 1,782 $ 12,718
==================================================================================================
16
Service charges and fees increased $605,000, or 7%, due to increased fees
received on overdrawn deposit accounts and increased servicing fees received on
participated loans. Service charges and fees on deposit accounts increased $1.1
million, or 13%, in 2003 as compared to the prior year due to increased volumes
in consumer deposit accounts and higher revenues on commercial deposit accounts.
The higher revenue from commercial deposit accounts resulted primarily from a
lower earnings credit rate. The earnings credit rate is the value given to
deposits maintained by commercial customers. In a lower rate environment,
deposit balances are not as valuable because of a lower earnings credit rate.
This results in customers paying for most of their services through fees rather
than through the use of deposit balances.
Gain on sales of loans, the major factor in the reduction of other income,
declined in 2004 due primarily to a $1.1 million reduction in gain on sales of
mortgage loans, which occurred due to the lower refinancing demand created by
higher mortgage interest rates during 2004 as compared to those prevalent during
2003. Gains on sales of student loans increased $174,000, or 11%, during 2004.
Proceeds from sales of guaranteed student loans increased to $537.2 million in
2004 from $278.1 million in 2003.
Gain on sale of loans increased $941,000, or 30%, in 2003. Proceeds from sales
of guaranteed student loans increased to $278.1 million in 2003 from $117.7
million in 2002. This dramatic increase in student loan volumes was attributed
to the escalation of loans produced through agreements with the Student Loan
Marketing Association ("SLMA"). These loans have typically been sold at the time
the student withdraws from school, however, an increasing number of student
loans are now being sold at the time the loan becomes fully disbursed, which
could be within 90 to 180 days of origination.
Proceeds from sales of residential mortgage loans declined to $87.5 million in
2004 after an increase to $177.4 million in 2003 from $133.2 million in 2002.
Sales of residential mortgages increased in 2002 and 2003 as a result of reduced
interest rates, which increased refinancings and overall originations. Southwest
typically sells residential mortgages within thirty days of origination.
OTHER EXPENSE
Other expense was $44.4 million for 2004, an increase of $6.0 million, or 16%,
from 2003. Other expense increased $5.1 million, or 15%, from 2002.
COMPARISON SUMMARY-OTHER EXPENSE 2004 Change 2003 Change
(Dollars in thousands) 2004 From 2003 2003 From 2002 2002
- ------------------------------------------------------------------------------------------
Salaries and employee benefits $22,599 $ 2,807 $19,792 $ 2,624 $17,168
Occupancy 9,223 1,116 8,107 988 7,119
FDIC and other insurance 420 80 340 54 286
Other real estate 242 27 215 213 2
General and administrative 11,928 1,934 9,994 1,250 8,744
- ------------------------------------------------------------------------------------------
Total other expense $44,412 $ 5,964 $38,448 $ 5,129 $33,319
==========================================================================================
Salaries and employee benefits increased $2.8 million, or 14%, in 2004 and $2.6
million, or 15% in 2003 primarily as a result of the cost of employees hired to
staff the offices opened in the Texas and Kansas offices, the hiring of
employees for HSSI, as well as normal increases in salaries and benefits of
existing staff.
17
Occupancy expense increased $1.1 million, or 14%, in 2004 and $988,000, or 14%,
in 2003 due to the expenses related to opening the new offices in Texas and
Kansas, and the furniture and equipment costs related to those offices. Data
processing costs related to guaranteed student loans increased $678,000, in 2004
and $456,000 in 2003, which also contributed to the increase in occupancy
expense. General and administrative expense increased $1.9 million, or 19%, in
2004 and $1.3 million, or 14%, in 2003. Postage and freight expense increased
only $15,000 in 2004 after increasing $228,000 in 2003 due to additional courier
costs required to transport documents between offices and items to be processed
to their respective processing centers. Loan costs incurred in the origination
of loans that are not paid by the customer declined $11,000 in 2004 after
increasing $142,000 in 2003. Fees paid to SLMA for the origination of
government-guaranteed student loans increased $361,000 in 2004 and $268,000 in
2003.
OPERATING SEGMENTS
CONTRIBUTION OF OPERATING SEGMENTS FOR THE YEARS ENDED DECEMBER 31,
(Dollars in thousands) 2004 2003 2002
- -------------------------------------------------------------------------------------------
Oklahoma banking $ 8,114 $ 10,691 $ 10,608
Other states banking 2,610 1,816 (157)
Secondary market 10,420 5,560 2,984
Other operations (2,515) (3,175) (16)
- -------------------------------------------------------------------------------------------
Consolidated net income $ 18,629 $ 14,892 $ 13,419
===========================================================================================
Oklahoma banking $ 881,682 $ 865,688 $ 878,959
Other states banking 388,002 228,620 91,399
Secondary market 353,812 214,377 130,661
Other operations 379 151 93
- -------------------------------------------------------------------------------------------
Consolidated total loans $ 1,623,875 $ 1,308,836 $ 1,101,112
===========================================================================================
Oklahoma banking $ 889,165 $ 878,627 $ 889,965
Other states banking 386,029 230,977 92,498
Secondary market 368,557 220,346 134,556
Other operations 269,083 250,775 233,535
- -------------------------------------------------------------------------------------------
Consolidated total assets $ 1,912,834 $ 1,580,725 $ 1,350,554
===========================================================================================
Southwest has three reportable operating segments: Oklahoma banking operations;
other states banking operations; and loans originated for sale in the secondary
market ("secondary market"). These business units were identified through the
products and services that are offered within each unit and the geographic area
they serve.
The contribution of the Oklahoma banking segment decreased $2.6 million, or 24%,
in 2004, primarily as a result of greater loan loss provision and increased
operating expenses. This segment's 2003 earnings were approximately the same as
in 2002.
The contribution of the other states banking segment increased by $794,000, or
44%, as a result of increased net interest margin due to earning asset growth,
offset in part by increased provision for loan losses related to loan growth and
increased other expenses due in part to expansion. Other states banking
contributed $1.8 million in 2003, an increase of $2.0 million from the 2002 net
loss incurred in 2002. The 2002 segment loss was primarily a consequence of
initial expansion into new markets.
18
The secondary market segment contributed $10.4 million in 2004, up $4.9 million,
or 87%, from 2003, primarily as a result of growth in guaranteed student
lending, offset in part of lower mortgage banking revenues. This segment's 2003
contribution of $5.6 million increased by $2.6 million, or 86%, primarily as a
result of increased mortgage banking activity and student lending volume. Please
see "Recent Developments" on page 31 of this report for information regarding
reduced yields on certain future student lending activities.
The segment disclosures above and in Note 16 to the Consolidated Financial
Statements show that, although the Oklahoma banking and secondary market
segments provide the significant majority of consolidated interest income and
net income, the new, other states banking segment, consisting of the Texas and
Kansas operations, began to contribute a significant percentage of consolidated
interest income and net income in 2003, and by year-end 2004 accounted for
approximately $386.0 million, or 20%, of total assets.
The segment disclosures are based upon a number of assumptions and allocations
of expense. Southwest allocates resources and evaluates performance of its
segments after allocation of funds, indirect expenses, taxes and capital costs.
The funds management unit is included in the other operations segment. The cost
of funds borrowed from the funds management unit by the operating segments is
transfer priced at Southwest's incremental borrowing rates.
The value of funds provided by the operating segments to the funds management
unit is based on blended borrowing rates which include core deposits and
borrowings from the Federal Home Loan Bank and other wholesale sources. Deposit
accounts with indeterminate maturities, such as demand deposit accounts and
interest-bearing transaction accounts, are transfer priced based on the expected
duration of the accounts. The expected duration ranges from two to three years.
Please also see "Note 16. Operating Segments" to the Consolidated Financial
Statements on page 62 of this report, and "Business-Organization" on page 69 of
this report.
TAXES ON INCOME
Southwest's income tax expense for fiscal years 2004, 2003, and 2002 was $10.5
million, $8.1 million, and $6.4 million, respectively. Southwest's effective tax
rates have been lower than statutory federal and state statutory rates primarily
because of tax-exempt income on municipal obligations and loans and the
organization in July 2001 of a real estate investment trust, as well as tax
credits generated by certain lending and investment activities.
FINANCIAL CONDITION
Southwest's total assets increased by $332.1 million, or 21%, from $1.58 billion
at December 31, 2003 to $1.91 billion at December 31, 2004 after increasing by
$230.2 million, or 17%, between December 31, 2002 and 2003. The growth in assets
in 2004 was primarily attributable to the $315.0 million, or 24%, increase in
total loans.
19
Southwest's investment securities increased by $15.8 million, or 8%, to $220.1
million at December 31, 2004 from $204.3 million at December 31, 2003 after
increasing by $15.6 million, or 8%, in 2002. The increases in both 2004 and 2003
came primarily from U.S. government and federal agency securities, which
increased $24.6 million, or 16%, in 2004 and $48.9 million, or 47%, in 2003.
Southwest's investments in Federal Reserve Bank and Federal Home Loan Bank stock
also increased during both years. Decreases occurred during the same periods in
Southwest's investment in mortgage-backed securities, which decreased $2.1
million, or 11%, in 2004 and $22.1 million, or 53%, in 2003, and tax-exempt
municipal securities, which decreased $9.5 million, or 63%, in 2004 and $12.7
million, or 46%, in 2003.
At December 31,
- ---------------------------------------------------------------------------------
(Dollars in thousands) 2004 2003 2002
- ---------------------------------------------------------------------------------
U.S. Government and agency obligations $177,953 $153,344 $104,409
Obligations of states and political subdivisions 5,477 14,997 27,679
Mortgage-backed securities 17,565 19,681 41,751
Other securities 19,056 16,244 14,850
-------- -------- --------
Total investment securities $220,051 $204,266 $188,689
======== ======== ========
Available for sale (fair value) $204,092 $177,074 $148,476
Held to maturity (amortized cost) 2,495 15,916 31,154
Federal Reserve Bank and Federal Home
Loan Bank Stock 13,464 11,276 9,059
-------- -------- --------
Total investment securities $220,051 $204,266 $188,689
======== ======== ========
Southwest does not have any material amounts of investment securities or other
interest-earning assets, other than loans, that would have been classified as
nonperforming if such assets were loans, or which were recognized by management
as potential problem assets based upon known information about possible credit
problems of the borrower or issuer.
The following table shows the maturities, carrying value (amortized cost for
investment securities being held to maturity or estimated fair value for
investment securities available for sale), estimated fair market values, and
average yields for Southwest's investment portfolio at December 31, 2004. Yields
are not presented on a tax-equivalent basis. Maturities of mortgage-backed
securities are based on expected maturities. Expected maturities differ from
contractual maturities due to scheduled repayments and because borrowers on the
underlying mortgages may have the right to call or prepay obligations with or
without prepayment penalties. The securities of no single issuer (other than the
United States or its agencies), or in the case of securities issued by state and
political subdivisions, no source or group of sources of repayment, accounted
for more than 10% of shareholders' equity of Southwest at December 31, 2004.
20
One Year Two through Five through More than Total Investment
or Less Five Years Ten Years Ten Years Securities
- ------------------------------------------------------------------------------------------------------------------------------------
(Dollars in thousands) Cost Yield Cost Yield Cost Yield Cost Yield Cost Market Yield
- ------------------------------------------------------------------------------------------------------------------------------------
Held to Maturity:
U.S. government and
agency obligations $ -- -- % $ 1,028 2.51% $ -- -- % $ -- -- % $ 1,028 $ 1,024 2.51%
Obligations of states and
political subdivisions 1,467 4.98 -- -- -- -- -- -- 1,467 1,485 4.98
------- -------- ------- ------ -------- --------
Total 1,467 4.98 1,028 2.51 -- -- -- -- 2,495 2,509 3.96
------- -------- ------- ------ -------- --------
Available for Sale:
U.S. government and
agency obligations 24,975 3.85 153,355 3.53 -- -- -- -- 178,330 176,925 3.58
Obligations of states and
political subdivisions 2,230 3.35 1,700 4.50 -- -- -- -- 3,930 4,010 3.85
Mortgage-backed securities 1,357 3.79 15,856 3.07 -- -- 399 5.59 17,612 17,565 3.18
Other securities -- -- 16,699 3.23 -- -- 2,286 6.66 18,985 19,056 3.65
------- -------- ------- ------ -------- --------
Total 28,562 3.80 187,610 3.48 -- -- 2,685 6.50 218,857 217,556 3.56
------- -------- ------- ------ -------- --------
Total $30,029 $188,638 $ -- $2,685 $221,352 $220,065
======= ======== ======= ====== ======== ========
Total loans were $1.62 billion at December 31, 2004, an increase of $315.0
million, or 24%, compared to December 31, 2003. All categories of loans
increased, except other consumer loans. The allowance for loan losses increased
by $4.1 million, or 26%, from December 31, 2003 to December 31, 2004. At
December 31, 2004, the allowance for loan losses was $19.9 million, or 1.23% of
total loans, compared to 15.8 million, or 1.21% of total loans, at December 31,
2003.
Total loans were $1.31 billion at December 31, 2003, an increase of $207.7
million, or 19%, compared to December 31, 2002. All categories of loans
increased, except one-to-four family residential mortgages and consumer loans.
The allowance for loan losses increased by $4.0 million, or 33%, from December
31, 2002 to December 31, 2003. At December 31, 2003, the allowance for loan
losses was $15.8 million, or 1.21% of total loans, compared to $11.9 million, or
1.08% of total loans, at December 31, 2002. (See "Provision for Loan Losses" on
page 18.)
21
This table presents the trends in the composition of the loan portfolio over the
previous five years.
At December 31,
- ----------------------------------------------------------------------------------------------------------------------
(Dollars in thousands) 2004 2003 2002 2001 2000
- ----------------------------------------------------------------------------------------------------------------------
Real estate mortgage -
Commercial $ 523,358 $ 402,596 $ 374,999 $ 301,578 $ 276,525
One to four family residential 87,858 83,250 102,423 106,206 107,360
Real estate construction 248,278 230,292 130,001 91,897 103,951
Commercial 390,272 355,965 348,879 312,577 311,953
Installment and consumer -
Guaranteed student loans 348,970 211,546 119,064 91,841 77,846
Other 25,139 25,187 25,746 26,947 34,915
----------- ----------- ----------- ----------- -----------
1,623,875 1,308,836 1,101,112 931,046 912,550
Less: Allowance for loan loss (19,944) (15,848) (11,888) (11,492) (12,125)
----------- ----------- ----------- ----------- -----------
Total $ 1,603,931 $ 1,292,988 $ 1,089,224 $ 919,554 $ 900,425
=========== =========== =========== =========== ===========
CAPITAL RESOURCES
At December 31, 2004, total shareholders' equity was $126.0 million compared to
$109.9 million at December 31, 2003. Earnings, net of common dividends,
contributed $15.2 million to shareholders' equity. Sales of common stock through
the dividend reinvestment plan, the employee stock purchase plan, and the
employee stock option plan contributed an additional $2.0 million to
shareholders' equity in 2004, including tax benefits realized by Southwest
relating to option exercises. Under accounting principles generally accepted in
the United States, these tax benefits increase shareholders' equity, but do not
affect net income. Net unrealized holding gains (losses) on investment
securities available for sale (net of tax) decreased to a loss of $797,000 at
December 31, 2004 compared to a gain of $360,000 at December 31, 2003. Although
Southwest had share repurchase plans in place during 2004, no shares were
repurchased during the year. Repurchases of an additional 603,675 shares may be
made under the repurchase plan adopted in April 2004. Repurchases may be made
from time to time based on market conditions, projected capital needs, and other
factors. During 2004 and 2003, repurchased shares were used to satisfy the
requirements of the employee stock option plan, the employee stock purchase
plan, and the dividend reinvestment plan.
At December 31, 2003, total shareholders' equity was $109.9 million compared to
$96.4 million at December 31, 2002. Earnings, net of common dividends,
contributed $11.9 million to shareholders' equity. Sales of common stock through
the dividend reinvestment plan, the employee stock purchase plan, and the
employee stock option plan contributed an additional $3.5 million to
shareholders' equity in 2003, including tax benefits realized by Southwest
relating to option exercises. Net unrealized holding gains (losses) on
investment securities available for sale (net of tax) decreased to a gain of
$360,000 at December 31, 2003 compared to $2.2 million at December 31, 2002.
Although Southwest had share repurchase plans in place during 2003, no shares
were repurchased during the year.
Bank holding companies are required to maintain capital ratios in accordance
with guidelines adopted by the Federal Reserve Board. The guidelines are
commonly known as Risk-Based Capital Guidelines. On December 31, 2004, Southwest
exceeded all applicable capital requirements, having a total risk-based capital
ratio of 13.92%, a Tier 1 risk-based capital ratio of 10.88%, and a leverage
ratio of 8.61%. As of December 31, 2004, Stillwater National and SNB Wichita
also met the criteria for classification as a "well-capitalized" institution
under the prompt corrective action rules promulgated under the Federal Deposit
Insurance Act. Designation as a well-capitalized institution under these
regulations does not constitute a recommendation or endorsement of Southwest,
Stillwater National, or SNB Wichita by Federal bank or thrift regulators.
22
LIQUIDITY
Liquidity is measured by a financial institution's ability to raise funds
through deposits, borrowed funds, capital, or the sale of highly marketable
assets such as residential mortgage loans and available for sale investments in
order to meet current and future cash flow needs as they become due. Southwest's
portfolio of guaranteed student loans and Small Business Administration ("SBA")
loans are also readily salable. Additional sources of liquidity, including cash
flow from the repayment of loans and maturities of investment securities, are
also considered in determining whether liquidity is satisfactory. Liquidity is
also achieved through growth of deposits and liquid assets, and accessibility to
the capital and money markets. These funds are used to meet deposit withdrawals,
maintain reserve requirements, fund loans, purchase securities, and operate the
organization.
Deposits remain the primary source of funding for Southwest. Interest-bearing
demand accounts in particular have shown a positive growth trend over the three
year period, which has been a key factor in Southwest's ability to maintain a
low cost of funds. For 2004, average interest-bearing demand deposits and money
market accounts were 34.2% of total average deposits, up from 33.8% in 2003 and
26.9% in 2002.
The following table indicates the amount of Southwest's certificates of deposit
of $100,000 or more by time remaining until maturity as of December 31, 2004:
- --------------------------------------------------------------------------------
(Dollars in thousands) Amount
- --------------------------------------------------------------------------------
Three months or less(1) $190,194
Over three through six months(1) 128,069
Over six through 12 months(1) 246,145
Over 12 months 45,262
--------
Total $609,670
========
(1) The amount of certificates of deposit that mature within 12 months is
$564.4 million. The Company does not have any liquidity concerns as a
result of the volume of these maturities.
Loans continue to be the largest component of the earning assets mix and have
shown a positive trend over the three year period.
23
Percentage of Total Average Assets
-----------------------------------------
Sources and uses of funds 2004 2003 2002
- --------------------------------------------------------------------------------------------------------
Sources of Funds:
Deposits:
Noninterest-bearing demand 9.63% 9.20% 9.28%
Interest-bearing demand and money market accounts 25.61 25.95 20.69
Time and savings deposits 39.65 41.61 46.88
Other borrowings 13.93 13.26 12.99
Subordinated debentures 3.99 2.78 2.02
Other liabilities 0.68 0.45 1.10
Equity capital 6.51 6.75 7.04
- --------------------------------------------------------------------------------------------------------
Total 100.00% 100.00% 100.00%
========================================================================================================
Uses of Funds:
Loans 84.42% 83.96% 79.35%
Investment securities 11.88 12.65 16.30
Other interest-earning assets 0.06 0.07 0.21
Noninterest-earning assets 3.64 3.32 4.14
- --------------------------------------------------------------------------------------------------------
Total 100.00% 100.00% 100.00%
========================================================================================================
Sources and uses of cash are presented in the Consolidated Statements of Cash
Flows. Total cash decreased by $9.9 million, or 29%, to $24.1 million in 2004
from $34.0 million at year-end 2003, as a result of a $15.9 million increase in
cash used in operating activities (primarily from the increase in originations
of guaranteed student loans, net of sales proceeds); a $90.6 million increase in
cash used in investing activities (primarily from an increase in loans
originated); and a $97.5 million increase in cash provided by financing
activities (primarily from a $113.6 million increase in deposits).
Total cash decreased by $866,000, or less than 3%, to $34.0 million in 2003 from
$34.8 million at year-end 2002, as a result of the net effects of a $76.1
million increase in cash used in operating activities (primarily from the
increase in originations of guaranteed student loans, net of sales proceeds); a
$21.2 million increase in cash used in investing activities (primarily from the
increase in purchases of available for sale securities net of the reduction in
loan originations); and a $94.0 million increase in cash provided by financing
activities (primarily from a $65.4 million increase in deposits and the $46.4
million net proceeds from issuance of subordinated debentures).
ASSET/LIABILITY MANAGEMENT AND QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT
MARKET RISK
Southwest's net income is largely dependent on its net interest income.
Southwest seeks to maximize its net interest margin within an acceptable level
of interest rate risk. Interest rate risk can be defined as the amount of
forecasted net interest income that may be gained or lost due to favorable or
unfavorable movements in interest rates. Interest rate risk, or sensitivity,
arises when the maturity or repricing characteristics of assets differ
significantly from the maturity or repricing characteristics of liabilities. Net
interest income is also affected by changes in the portion of interest-earning
assets that are funded by interest-bearing liabilities rather than by other
sources of funds, such as noninterest-bearing deposits and shareholders' equity.
24
Southwest attempts to manage interest rate risk while enhancing net interest
margin by adjusting its asset/liability position. At times, depending on the
level of general interest rates, the relationship between long-term and other
interest rates, market conditions and competitive factors, Southwest may
determine to increase its interest rate risk position in order to increase its
net interest margin. Southwest monitors interest rate risk and adjusts the
composition of its rate-sensitive assets and liabilities in order to limit its
exposure to changes in interest rates on net interest income over time.
Southwest's asset/liability committee reviews its interest rate risk position
and profitability, and recommends adjustments. The asset/liability committee
also reviews the securities portfolio, formulates investment strategies, and
oversees the timing and implementation of transactions. Notwithstanding
Southwest's interest rate risk management activities, the actual magnitude,
direction, and relationship of future interest rates are uncertain, and can have
adverse effects on net income and liquidity.
Interest rate sensitivity analysis measures the cumulative differences between
the amounts of assets and liabilities maturing or repricing within various time
periods.
The following table shows Southwest's interest rate sensitivity gaps for
selected maturity periods at December 31, 2004:
0 to 3 4 to 12 Over 1 to Over
(Dollars in thousands) Months Months 5 Years 5 Years Total
- -------------------------------------------------------------------------------------------------------------------
RATE-SENSITIVE ASSETS:
Total loans $1,093,719 $ 260,832 $ 150,231 $ 119,093 $1,623,875
Investment securities 20,238 26,454 170,640 2,719 220,051
Due from banks 1,475 -- -- -- 1,475
- -------------------------------------------------------------------------------------------------------------------
Total 1,115,432 287,286 320,871 121,812 1,845,401
RATE-SENSITIVE LIABILITIES:
Money market deposit accounts 379,818 -- -- -- 379,818
Time deposits 265,604 471,653 129,152 4,626 871,035
Savings accounts 8,108 -- -- -- 8,108
Interest-bearing demand 57,359 -- -- -- 57,359
Other borrowings 78,565 60,000 30,000 31,500 200,065
Subordinated debentures -- -- -- 72,180 72,180
- -------------------------------------------------------------------------------------------------------------------
Total 789,454 531,653 159,152 108,306 1,588,565
- -------------------------------------------------------------------------------------------------------------------
Interest sensitivity gap $ 325,978 $ (244,367) $ 161,719 $ 13,506 $ 256,836
===================================================================================================================
Cumulative interest sensitivity gap $ 325,978 $ 81,611 $ 243,330 $ 256,836 $ 256,836
===================================================================================================================
Percentage of rate-sensitive assets
to rate-sensitive liabilities 141.29% 54.04% 201.61% 112.47% 116.17%
===================================================================================================================
Percentage of cumulative gap to
total assets 17.04% 4.27% 12.72% 13.43% 13.43%
===================================================================================================================
The percentage of rate-sensitive assets to rate-sensitive liabilities presents a
static position as of a single day and is not necessarily indicative of
Southwest's position at any other point in time and does not take into account
the sensitivity of yields and costs of specific assets and liabilities to
changes in market rates. The foregoing analysis assumes that Southwest's
mortgage-backed securities mature during the period in which they are estimated
to prepay. No other prepayment or repricing assumptions have been applied to
Southwest's interest-earning assets for this analysis.
A principal objective of Southwest's asset/liability management effort is to
balance the various factors that generate interest rate risk, thereby
maintaining the interest rate sensitivity of Southwest within acceptable risk
levels. To measure its interest rate sensitivity position, Southwest utilizes a
simulation model that facilitates the forecasting of net interest income over
the next twelve month period under a variety of interest rate and growth
scenarios.
25
At December 31, 2004, the model projected net income would decrease by 2.28% if
interest rates immediately fell by 100 basis points. It projected an increase in
net income of 9.39% if interest rates immediately rose by 100 basis points. The
model projected net income would decrease by 3.36% if interest rates gradually
fell by 100 basis points over a one-year time horizon. It projected an increase
in net income of 5.99% if interest rates gradually rose by 100 basis points over
a one-year time horizon.
At December 31, 2003, the model projected net income would decrease by 8.11% if
interest rates immediately fell by 100 basis points. It projected an increase in
net income of 0.125% if interest rates immediately rose by 100 basis points. The
model projected net income would decrease by 4.44% if interest rates gradually
fell by 100 basis points over a one-year time horizon. It projected an increase
in net income of 0.599% if interest rates gradually rose by 100 basis points
over a one-year time horizon.
The earnings simulation model uses numerous assumptions regarding the effect of
changes in interest rates on the timing and extent of repricing characteristics,
future cash flows, and customer behavior. These assumptions are inherently
uncertain and, as a result, the model cannot precisely estimate net income.
Actual results differ from simulated results due to timing, cash flows,
magnitude, and frequency of interest rate changes and changes in market
conditions and management strategies, among other factors.
OFF-BALANCE SHEET ARRANGEMENTS
In the normal course of business, Southwest makes use of a number of different
financial instruments to help meet the financial needs of its customers. In
accordance with accounting principles generally accepted in the United States,
the full notional amounts of these transactions are not recorded in the
accompanying consolidated financial statements and are referred to as
off-balance sheet instruments. These transactions and activities include
commitments to extend lines of commercial and real estate mortgage credit, and
standby and commercial letters of credit and are discussed further in footnote
13 on page 60 of this report.
Off-balance sheet arrangements also include the Trust Preferred Securities,
which have been de-consolidated in this report as required by Financial
Accounting Standards Board Interpretation 46R, "Consolidation of Variable
Interest Entities." Further information regarding the Trust Preferred Securities
can be found in footnote 6 on page 53 of this report.
EFFECTS OF INFLATION
The consolidated financial statements and related consolidated financial data in
this report have been prepared in accordance with accounting principles
generally accepted in the United States and practices within the banking
industry that require the measurement of financial position and operating
results in terms of historical dollars without considering fluctuations in the
relative purchasing power of money over time due to inflation. Unlike most
industrial companies, virtually all the assets and liabilities of a financial
institution are monetary in nature. As a result, interest rates have a more
significant impact on a financial institution's performance than the effects of
general levels of inflation.
26
RECENT DEVELOPMENTS
STUDENT LENDING. Southwest, through its subsidiary, Stillwater National,
maintains a significant portfolio of guaranteed student loans. Stillwater
National has been actively involved in student lending for many years.
SLM Corporation ("Sallie Mae") has informed Stillwater National that it will
significantly increase the servicing fees on new loans made under the Signature
Education Loan Program to students who attend schools owned by Career Education
Corporation. Loans made under this program are insured by HEMAR Insurance
Corporation of America, a subsidiary of Sallie Mae. At year-end 2004, loans in
this program were approximately $190.0 million, or approximately 55% of the
total $349.0 million in student loans outstanding. This increase in servicing
fees will be paid to Sallie Mae through a decrease in interest rates receivable
by Stillwater National on new loans made under the program. This change will
have a negative effect on future interest revenues, net interest margin, and net
income of Southwest and its Secondary Market operating segment. If current
amounts of loan balances were maintained under this program throughout 2005,
interest revenues, less servicing costs, on these loans would be approximately
$5 million less (pre-tax) than Stillwater National earned on loans in this
program during 2004. However, Southwest currently expects an increase in volume
in this program which will offset, in part, the negative effects of the
increased servicing costs. Sallie Mae has agreed to provide an additional $200
million line of credit to support future loans made under this program. This
yield reduction is expected to reduce the future profitability of student
lending and Southwest's secondary market segment, but had no effect on 2004
earnings and will not affect the profitability of Southwest's other operating
segments.
NEW BRANCH OFFICES. In the first quarter of 2005, Stillwater National received
regulatory approval for two additional Texas branches: the second Austin branch
and the new San Antonio branch. The San Antonio branch replaces an existing loan
production office. With the addition of these branches, Southwest's Other States
banking segment has five bank branches in Texas (two each in the Dallas and
Austin metropolitan areas and one in San Antonio), and two Kansas offices (SNB
Bank of Wichita and a Kansas City loan production office).
RECENTLY ADOPTED ACCOUNTING STANDARDS
In January 2003, the FASB issued FIN 46, "Consolidation of Variable Interest
Entities." The objective of this interpretation was to provide guidance on how
to identify a variable interest entity ("VIE") and determine when the assets,
liabilities, noncontrolling interests, and results of operations of a VIE need
to be included in a company's consolidated financial statements. A company that
holds variable interests in an entity will need to consolidate the entity if the
company's interest in the VIE is such that the company will absorb a majority of
the VIE's expected losses and/or receive a majority of the entity's expected
residual returns, if they occur. FIN 46 also requires additional disclosures by
primary beneficiaries and other significant variable interest holders. The
provisions of this interpretation became effective upon issuance for all
subsequent transactions involving variable interest entities and were required
to be adopted no later than the first interim or annual reporting period
beginning after December 15, 2003 for all VIE transactions that existed as of
the issuance date. On December 24, 2003, the FASB issued a revision of the
Interpretation (the "Revised Interpretation 46"). Revised Interpretation 46
codifies both the proposed modifications and other decisions previously issued
through certain FASB Staff Positions ("FSPs") and supersedes the original FIN 46
to include: (1) deferring the effective date of the Interpretation's provisions
for certain variable interests, (2) providing additional scope exceptions for
certain other variable interests, (3) clarifying the impact of troubled debt
restructurings on the requirement to reconsider (a) whether an entity is a VIE
or (b) which party is the primary beneficiary of a VIE, and (4) revising
Appendix B of the Interpretation to provide additional guidance on what
constitutes a variable interest. FIN 46 and Revised Interpretation 46 required
Southwest to de-consolidate its investments in SBI Capital Trust, OKSB Statutory
Trust I, and SBI Capital Trust II (the "Trusts") in this Annual Report and all
future reports. This de-consolidation has resulted in the replacement of the
Trust Preferred Securities, which were reported as long-term debt in the
consolidated statements of financial condition, with the subordinated debentures
issued by the Trusts to Southwest. In spite of this change in reporting, the
adoption of FIN 46 did not have a material impact on Southwest's results of
operations or financial position.
27
CONTRACTUAL OBLIGATIONS
Southwest has various contractual obligations that require future cash payment.
The following table presents, as of December 31, 2004, significant fixed and
determinable contractual obligations to third parties by payment date.
Payments due by period
- ----------------------------------------------------------------------------------------------------------------
Less than 1-3 3-5 Over
(Dollars in thousands) 1 Year Years Years 5 Years Total
- ----------------------------------------------------------------------------------------------------------------
Deposits without stated maturity:(1)
Noninterest bearing $ 183,738 $ -- $ -- $ -- $ 183,738
Interest bearing 445,285 -- -- -- 445,285
Time deposits(2) 745,247 77,052 65,106 5,611 893,016
Other borrowings(2) 142,372 19,622 18,719 33,829 214,542
Subordinated debentures 4,759 9,518 9,518 177,661 201,456
Operating leases 1,494 2,466 1,756 1,146 6,862
- ----------------------------------------------------------------------------------------------------------------
Total $1,522,895 $ 108,658 $ 95,099 $ 218,247 $1,944,899
================================================================================================================
(1) Excludes interest.
(2) Includes interest. Interest on variable rate obligations is shown at
rates in effect at December 31, 2004. The contractual amounts to be
paid on variable rate obligations are affected by changes in market
interest rates. Future changes in market interest rates could
materially affect the contractual amounts to be paid.
At December 31, 2004, Southwest's purchase obligations not reflected on the
Consolidated Statements of Condition, and its other long-term liabilities
(consisting primarily of benefits under deferred compensation arrangements) are
not considered material.
For additional information regarding contractual obligations, please also see
"Asset/Liability Management and Quantitative and Qualitative Disclosures about
Market Risk" on page 24, "Off-Balance Sheet Arrangements" on page 26, and "Note
5. Other Borrowed Funds" on page 46, "Note 6. Subordinated Debentures" on page
48, "Note 11. Operating Leases" on page 54, "Note 13. Financial Instruments with
Off-Balance Sheet Risk" on page 55, and "Note 14. Commitments and Contingencies"
on page 56, to the Consolidated Financial Statements.
NON-GAAP FINANCIAL MEASURES
None of the financial measures used in this report are defined as non-GAAP
financial measures under federal securities regulations. Other banking
organizations, however, may present such non-GAAP financial measures, which
differ from measures based upon accounting principles generally accepted in the
United States. For example, such non-GAAP measures may exclude certain income or
expense items in calculating operating income or efficiency ratios, or may
increase yields and margins to reflect the benefits of tax-exempt earning
assets. Readers of this report should be aware that non-GAAP ratios and other
measures presented by some banking organizations or financial analysts may not
be directly comparable to similarly named ratios or other measures used by
Southwest or other banking organizations.
28
CONTROLS AND PROCEDURES
DISCLOSURE CONTROLS AND PROCEDURES
As required by SEC rules, Southwest's management evaluated the effectiveness of
Southwest's disclosure controls and procedures as of December 31, 2004.
Southwest's Chief Executive Officer and Chief Financial Officer participated in
the evaluation. Based on this evaluation, Southwest's Chief Executive Officer
and Chief Financial Officer concluded that Southwest's disclosure controls and
procedures were effective as of December 31, 2004.
INTERNAL CONTROL OVER FINANCIAL REPORTING
Southwest's management is responsible for establishing and maintaining adequate
internal control over financial reporting. As required by SEC rules, Southwest's
management evaluated the effectiveness of Southwest's internal control over
financial reporting as defined in SEC Rule 13a-15 as of December 31, 2004.
Southwest's Chief Executive Officer and Chief Financial Officer participated in
the evaluation, which was based upon the criteria for effective internal control
over financial reporting included in the "Internal Control-Integrated Framework"
issued by the Committee of Sponsoring Organizations of the Treadway Commission.
Based on this evaluation, Southwest's Chief Executive Officer and Chief
Financial Officer concluded that Southwest's internal control over financial
reporting was effective as of December 31, 2004.
The audit report by Southwest's independent registered public accounting firm,
Ernst & Young, LLP, on management's assessment of internal control over
financial reporting is included on page 31.
FOURTH QUARTER 2004 CHANGES IN INTERNAL CONTROL OVER FINANCIAL REPORTING
No change occurred during the fourth quarter of 2004 that has materially