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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D. C. 20549

FORM 10 - Q

For the quarterly period ended March 31, 2004

For the transition period from                  to                 

Commission File Number: 0-20750

STERLING BANCSHARES, INC.

(Exact name of registrant as specified in its charter)

713-466-8300

(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities and Exchange Act of 1934 (“Act”) during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨

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

As of March 31, 2004, there were outstanding 44,757,214 shares of common stock, par value $1.00 per share, of the registrant.

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STERLING BANCSHARES, INC.

FORM 10-Q

FOR THE QUARTER ENDED MARCH 31, 2004

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PART I. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

STERLING BANCSHARES, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(UNAUDITED)

(In thousands, except share amounts)

See Notes to Consolidated Financial Statements.

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STERLING BANCSHARES, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF INCOME

(UNAUDITED)

(In thousands, except per share amounts)

See Notes to Consolidated Financial Statements.

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STERLING BANCSHARES, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY

(UNAUDITED)

(In thousands)

See Notes to Consolidated Financial Statements.

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STERLING BANCSHARES, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(UNAUDITED)

(In thousands)

See Notes to Consolidated Financial Statements.

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STERLING BANCSHARES, INC., AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

Basis of Presentation

The accompanying Consolidated Financial Statements are unaudited and include the accounts of Sterling Bancshares, Inc. (together with its subsidiaries the “Company”). The Company’s accounting and financial reporting policies are in accordance with accounting principles generally accepted in the United States of America for interim financial information and in accordance with the instructions to Form 10-Q. The information furnished in these interim statements reflects all adjustments that are, in the opinion of management, necessary for a fair statement of the results for such periods. Such adjustments are of a normal recurring nature unless otherwise disclosed in this Form 10-Q. The results of operations in the interim statements are not necessarily indicative of the results that may be expected for the full year. The interim financial information should be read in conjunction with the Company’s 2003 Annual Report on Form 10-K. Certain prior period amounts have been reclassified to conform to current period classifications. These reclassifications had no affect on net income or shareholders’ equity.

Recently Adopted Accounting Standards

On January 1, 2004, the Company adopted FIN 46R, Consolidation of Variable Interest Entities. Upon adoption, the trusts that previously issued the outstanding company-obligated mandatorily redeemable trust preferred securities were deconsolidated from the Company’s Consolidated Financial Statements. Instead, the junior subordinated debentures issued by the Company to these subsidiary trusts are shown as liabilities in the consolidated balance sheets and interest expense associated with the junior subordinated debentures are shown in the consolidated statements of income. The Consolidated Financial Statements have been restated to reflect the adoption of FIN 46R. Adoption of FIN 46R did not affect previously reported amounts for net income or shareholders’ equity.

Stock-Based Compensation

The Company accounts for stock-based employee compensation plans using the intrinsic value-based method of accounting, as permitted, and discloses pro forma information as if accounted for using the fair value-based method as prescribed by accounting principles. Because the exercise price of the Company’s employee stock options equals the market price of the underlying stock on the date of grant, no compensation expense is recognized on options granted. Compensation expense for restricted stock awards is based on the market price of the stock on the date of grant and is recognized ratably over the vesting period of the award.

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If compensation cost for the Company’s stock-based compensation plans had been determined based on the fair value method at the grant dates for awards, there would have been no material impact on the Company’s reported net income or earnings per share. Pro forma information regarding net income and earnings per share is required under accounting principles and has been determined as if the Company accounted for its employee stock option plans under the fair value method. The fair value of options was estimated using a Black-Scholes option pricing model. Because employee stock options have differing characteristics and changes in the subjective input assumptions can materially affect the fair value estimate, the Black-Scholes valuation model does not necessarily provide a reliable measure of the fair value of employee stock options. The following table shows information related to stock-based compensation in both the reported and pro forma earnings per share amounts (dollars in thousands except for per share amounts):

The Financial Accounting Standards Board (“FASB”) has issued a proposed Statement, Share-Based Payment, that addresses the accounting for share-based payment transactions in which an enterprise receives employee services in exchange for (a) equity instruments of the enterprise or (b) liabilities that are based on the fair value of the enterprise’s equity instruments or that may be settled by the issuance of such equity instruments. The proposed Statement would eliminate the ability to account for share-based compensation transactions using the intrinsic value-based method of accounting, and generally would require instead that such transactions be accounted for using a fair-value-based method. The proposed statement would permit use of option pricing models other than the Black-Scholes option pricing model. Management has not determined the impact of the proposed Statement on the Company’s Consolidated Financial Statements.

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Earnings per common share (“EPS”) were computed based on the following (in thousands, except per share amounts):

The incremental shares for the assumed exercise of the outstanding options were determined by application of the treasury stock method. The incremental shares for the conversion of the preferred stock were determined assuming applicable performance goals had been met. The calculation of the diluted EPS excludes 262,860 and 591,327 options outstanding during the three months ended March 31, 2004 and 2003, respectively that were antidilutive.

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The Company sold its mortgage-banking operations on September 30, 2003 to RBC Mortgage Company, an indirect subsidiary of the Royal Bank of Canada. The mortgage-banking operations were reported previously as the Company’s mortgage-banking segment and are now reported as discontinued operations. The results of income from discontinued operations for the three months ended March 31, 2003, are as follows (in thousands):

On March 20, 2003, the Company sold one of its banking offices located in a rural area for a pre-tax gain of $3.4 million. At the sale date, this banking office had approximately $18.7 million in assets, $16.8 million in loans and $95.7 million of deposits that were included in the sale transaction. The net gain was determined based on the Company’s recorded investment in this office including allocated goodwill and intangibles.

This banking office, located in a rural area, was sold because its location and growth potential did not align with the Company’s business banking strategy. This office was acquired originally as part of a previous acquisition.

The changes in the carrying amount of goodwill by reporting unit for the year ended December 31, 2003 and the three months ended March 31, 2004 are as follows (in thousands):

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The changes in the carrying amounts of core deposit intangibles for the year ended December 31, 2003 and three months ended March 31, 2004 are as follows (in thousands):

6. SUBSEQUENT EVENT

On April 29, 2004, the Company securitized and sold certain interest-only securities held in its available for sale portfolio. The Company received net proceeds of $67.5 million and recognized an estimated after-tax net securitization gain of $3.5 million for this transaction. The Company did not retain any interests in the securities and neither the investors in the securitization trust nor the trust have any recourse other than for a breach of customary representations as to ownership and origination, but not for credit loss or default.

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

FORWARD-LOOKING STATEMENTS

This report may contain certain statements relating to the future results of the Company based upon information currently available. These “forward-looking statements” (as defined in Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Exchange Act) are typically identified by words such as “expects,” “anticipates,” “intends,” “plans,” “believes,” “seeks,” “estimates,” or words of similar meaning, or future or conditional verbs such as “will,” “would,” “should,” “could,” or “may.”

Forward-looking statements provide our expectation or predictions of future conditions, events or results. Forward-looking statements involve risks and uncertainties that may cause actual results to differ materially from those in such statements. These risks and uncertainties include, but are not limited to, the following:

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For additional discussion of such risks, uncertainties and assumptions, see the Company’s Annual Report on Form 10-K for the year ended December 31, 2003, filed with the Securities and Exchange Commission.

OVERVIEW

We are a bank holding company headquartered in Houston, Texas that provides a range of commercial and consumer banking services through our subsidiary, Sterling Bank. We operate 37 banking offices in the greater metropolitan areas of Houston, Dallas and San Antonio. At March 31, 2004, the Company had consolidated total assets of $3.2 billion, deposits of $2.5 billion and shareholders’ equity of $299.9 million.

The first quarter of 2004 continued a period of transition. This was the first complete quarter of operations following the pay-off of the mortgage warehouse credit facility previously extended to our mortgage banking segment, thus effectively terminating all remaining business relationships with this segment which was sold on September 30, 2003.

Our net income for the first quarter of 2004 was $5.2 million, compared to $11.2 million for the first quarter of 2003, reflecting, in part, the effect of our divestiture of our mortgage banking segment while focusing our efforts on our core banking operations. Net income for the first quarter of 2003 included income from discontinued operations after taxes of $1.7 million. In addition, net income for the first quarter included an after-tax gain on the sale of a rural banking office of $2.2 million.

An area of focus during the first quarter of 2004 was asset quality and improvements were made. Nonperforming loans were $16.4 million at March 31, 2004 as compared to $33.9 million at December 31, 2003. Included in this reduction was a sale of $10.7 million of nonperforming loans which resulted in an increase in charge-offs of $4.6 million, for which the Company had previously made provisions.

SUBSEQUENT EVENT

On April 29, 2004, we securitized and sold certain interest-only securities held in our available for sale portfolio. We received net proceeds of $67.5 million and recognized an estimated after-tax net securitization gain of $3.5 million for this transaction. We did not retain any interests in the securities and neither the investors in the securitization trust nor the trust have any recourse other than for a breach of customary representations as to ownership and origination, but not for credit loss or default.

CRITICAL ACCOUNTING POLICIES

The preparation of financial statements in accordance with accounting principles generally accepted in the United States of America requires management to make a number of judgments, estimates and assumptions that affect the reported amount of assets, liabilities, income and expenses in our Consolidated Financial Statements and accompanying notes. We believe that the judgments, estimates and assumptions used in the preparation of our Consolidated Financial Statements are appropriate given the factual circumstances as of March 31, 2004.

Various elements of our accounting policies, by their nature, are inherently subject to estimation techniques, valuation assumptions and other subjective assessments. We have identified two accounting policies that, due to the judgments, estimates and assumptions inherent in those policies, and the sensitivity of our Consolidated Financial Statements to those judgments, estimates and assumptions, are critical to an understanding of our Consolidated Financial Statements. These policies relate to the methodology that determines our allowance for credit losses and the assumptions used in determining stock-based compensation.

These policies and the judgments, estimates and assumptions are described in greater detail in the Company’s 2003 Annual Report on Form 10-K in the “Critical Accounting Estimates” section of Management’s Discussion and Analysis and in Note 1 to the Consolidated Financial Statements – “Organization and Summary of Significant Accounting and Reporting Policies.” There have been no material changes in these policies since December 31, 2003.

RECENTLY ADOPTED ACCOUNTING STANDARDS

On January 1, 2004, we adopted FIN 46R, Consolidation of Variable Interest Entities. Upon adoption, the trusts that previously issued the outstanding company-obligated mandatorily redeemable trust preferred securities were deconsolidated from our Consolidated Financial Statements. Instead, the junior subordinated debentures issued by the Company to these subsidiary trusts are shown as liabilities in the consolidated balance sheets and interest expense associated with the junior subordinated debentures are shown in the consolidated statements of income. The Consolidated Financial Statements have been restated to reflect the adoption of FIN 46R. Adoption of FIN 46R did not affect previously reported amounts for net income or shareholders’ equity.

RESULTS OF OPERATIONS

Net Income - Net income for the three-month period ended March 31, 2004 was $5.2 million as compared to $11.2 million for the same period in 2003, a decrease of approximately $6.0 million or 53.4%. Net income for the first quarter of 2003 included income from discontinued operations after taxes of $1.7 million or $0.04 per diluted share and an after-tax gain on the sale of a rural banking office of $2.2 million or $0.05 per diluted share. The remaining decrease in net income is principally the result of lower net interest income and a lower provision for credit losses partially offset by higher noninterest expenses.

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Net Interest Income - Net interest income was $33.0 million for the three-months ended March 31, 2004, as compared to $35.5 million for the same period in 2003, a decrease of $2.5 million or 7.1%. The decrease in net interest income was caused by a decline in both average earning assets and the net interest margin.

Certain average balances, together with the total dollar amounts of interest income and expense and the average interest rates, were as follows (dollars in thousands):