ITEM 1. BUSINESS
GENERAL
Texas Regional Bancshares, Inc. ("Texas Regional" or the "Company"), a Texas business corporation incorporated in 1983 and headquartered in McAllen, Texas, is a bank holding company within the meaning of the Bank Holding Company Act of 1956 ("the BHCA") and as such is registered with the Board of Governors of the Federal Reserve System ("Federal Reserve Board"). Texas Regional Delaware, Inc., incorporated under the laws of Delaware as a wholly owned second tier bank holding company subsidiary, owns Texas State Bank (the "Bank"), the Company's primary operating subsidiary. The Bank has two wholly owned subsidiaries: (i) TSB Securities, Inc., incorporated in 1997 to provide full service broker-dealer services and (ii) TSB Properties, Inc., incorporated in 1998 to receive and liquidate foreclosed assets.
Texas State Bank acquired the Rio Grande City and Roma branches of First National Bank of South Texas during 1995. The Company completed a secondary public offering of 2.5 million shares of the Company's Class A Voting Common Stock on May 14, 1996. Concurrently, Texas Regional also completed the acquisition of First State Bank & Trust Co., Mission, Texas and The Border Bank, Hidalgo, Texas, through merger with the Bank. On February 19, 1998, the Company acquired Brownsville National Bank, Brownsville, Texas, Texas Bank and Trust, Brownsville, Texas and Bank of Texas, Raymondville, Texas through merger with the Bank.
Texas State Bank operates twenty banking locations in the Rio Grande Valley including four banking locations in McAllen (including its main office), four banking locations in Brownsville, three banking locations in Mission, two banking locations in Weslaco, and one banking location each in Edinburg, Harlingen, Hidalgo, Penitas, Raymondville, Rio Grande City and Roma. At December 31, 1998, Texas Regional had consolidated total assets of $1.8 billion, loans outstanding (net of unearned discount) of $1.1 billion, total deposits of $1.6 billion, and shareholders' equity of $177.5 million.
The business strategy of Texas Regional is for the Bank to provide its customers with the financial sophistication and breadth of products of a regional bank, while retaining the local appeal and level of service of a community bank. The Board of Directors and management of the Company have maintained the Company's community orientation by tailoring products and services to meet community and customer needs. Management believes that the Company is well positioned in its market due to its responsive customer service, the strong community involvement of management and employees, the recent trends in the Texas banking environment and the vitality of the Rio Grande Valley economy. Management's strategy is to provide a business culture in which individual customers and small and medium sized businesses are accorded the highest priority in all aspects of the Company's operations. Management believes that individualized customer service will allow the Company to increase its market share in loan and deposit volumes. As part of its operating and growth strategies, the Company is working to continue to attract business from, and provide service to, small and medium sized businesses, and expand operations in the Rio Grande Valley.
For its business customers, Texas State Bank offers checking facilities, certificates of deposit, short-term loans for working capital purposes, construction financing, mortgage loans, term loans for fixed asset and expansion needs, and other commercial loans. The services provided for individuals by the Bank include checking accounts, savings accounts, certificates of deposit, individual retirement accounts and consumer loan programs, including installment loans for home repair and for purchases of consumer goods, including automobiles, trucks and boats, and mortgage loans. The Bank also provides travelers checks, money orders and safe deposit facilities, and offers trust services.
The Bank has also expanded the services that it provides to third party correspondent banks. The Bank's data processing center, for example, presently serves five banks in addition to providing data processing services for all of the Bank's banking locations.
Management believes there may be opportunities to expand by acquiring financial institutions or by acquiring assets and deposits that will allow the Company to enter adjacent markets or further increase market share in existing markets. Management intends to pursue acquisition opportunities in strategic markets in circumstances in which management believes that its managerial, operational and capital resources will enhance the performance of acquired institutions. There are currently no agreements or understandings related to any acquisition.
COMPETITION
The Company's operations are located in the Rio Grande Valley, which consists of Cameron, Hidalgo, Willacy and Starr Counties. Cameron, Hidalgo and Starr Counties are each directly adjacent to the Rio Grande River, which forms part of the border between the United States and Mexico. The Company's twenty banking locations are currently located in Cameron County (Brownsville and Harlingen), Hidalgo County (Edinburg, Hidalgo, McAllen, Mission, Penitas and Weslaco), Starr County (Rio Grande City and Roma) and Willacy County (Raymondville).
The Bank encounters intense competition in its commercial banking business, primarily from other banks located in its market area. The Bank also competes with insurance, finance and mortgage companies, savings and loan institutions, credit unions, money market funds and other financial institutions. Competition is based upon interest rates offered on deposit accounts, interest rates charged on loans and other credit and service charges, the quality and scope of the services rendered, the convenience of banking facilities, and, in the case of loans to commercial borrowers, relative lending limits. A substantial number of the commercial banks in the Rio Grande Valley are branches of much larger organizations affiliated with national, regional or state-wide banking companies which are larger than the Bank in terms of capital, resources and personnel. However, as a major independent community bank headquartered in its primary market area, management believes that the Company's community commitment and involvement in its primary market area, as well as its commitment to quality and personalized banking services, are factors that contribute to the Company's competitiveness.
REGULATION AND SUPERVISION
In addition to the generally applicable state and federal laws governing businesses and employers, special federal and state laws applicable only to financial institutions and their parent companies further extensively regulate the Company and the Bank. Virtually all aspects of the Company's operations are subject to specific requirements or restrictions and general regulatory oversight, from laws regulating consumer finance transactions, such as the Truth In Lending Act, the Home Mortgage Disclosure Act and the Equal Credit Opportunity Act, to laws regulating collections and confidentiality, such as the Fair Debt Collections Practices Act, the Fair Credit Reporting Act and the Right to Financial Privacy Act. With few exceptions, state and federal banking laws have as their principal objective either the maintenance of the safety and soundness of the federal deposit insurance system or the protection of consumers or classes of consumers, rather than the specific protection of shareholders of the Company. To the extent the following material describes statutory or regulatory provisions, it is qualified in its entirety by reference to the particular statute or regulation.
REGULATION OF THE COMPANY
Texas Regional is a bank holding company within the meaning of the Bank Holding Company Act of 1956 (the "BHCA"), as amended, and therefore is subject to regulation and supervision by the Federal Reserve Board (the "FRB"). In addition, the Company is required to file reports with and to furnish such other information as the FRB may require pursuant to the BHCA, and to subject itself to examination by the FRB. The FRB has the authority to issue bank holding companies orders to cease and desist from unsound practices and violations of conditions imposed by, or violation of agreements with, the FRB. The FRB is also empowered to assess civil penalties against companies or individuals who violate the BHCA or orders or regulations thereunder in amounts up to $1.0 million per day, to order termination of non-banking activities of non-banking subsidiaries of bank holding companies, and to order termination of ownership and control of a non-banking subsidiary by a bank holding company. Certain violations may also result in criminal penalties. The FRB and the Federal Deposit Insurance Corporation (the "FDIC"), as appropriate, are authorized to exercise comparable authority, under the Federal Deposit Insurance Act (the "FDI Act") and other statutes, with respect to subsidiary banks.
The FRB takes the position that a bank holding company is required to serve as a source of financial and managerial strength to its subsidiary banks and may not conduct its operations in an unsafe or unsound manner. In addition, it is the FRB's position that, in serving as a source of strength to its subsidiary banks, a bank holding company should stand ready to use available resources to provide adequate capital funds to its subsidiary banks during periods of financial stress or adversity and should maintain the financial flexibility and capital-raising capacity to obtain additional resources for assisting its subsidiary banks. A bank holding company's failure to meet its obligations to serve as a source of strength to its subsidiary banks will generally be considered by the FRB to be an unsafe and unsound banking practice or a violation of the FRB regulations or both. Changes in the FDI Act made by the Federal Deposit Insurance Corporation Improvement Act of 1991 (the "FDICIA") now require an undercapitalized institution to submit to the FRB a capital restoration plan with a guaranty, by each company having control of the bank, of the bank's compliance with the plan.
The BHCA and the Change in Bank Control Act, together with regulations promulgated by the FRB, require that, depending on the particular circumstances, either FRB approval must be obtained or notice must be furnished to the FRB and not disapproved prior to any person or company acquiring "control" of a bank holding company, such as the Company, subject to certain exemptions for certain transactions. Control is conclusively presumed to exist if an individual or company acquires 25% or more of any class of voting securities of the bank holding company. Control is rebuttably presumed to exist if a person acquires 10% or more but less than 25% of any class of voting securities and either the company has registered securities under Section 12 of the Exchange Act or no other person will own a greater percentage of that class of voting securities immediately after the transaction. The regulations provide a procedure for challenge of the rebuttable control presumption.
As a bank holding company, the Company is required to obtain approval prior to merging or consolidating with any other bank holding company, acquiring all or substantially all of the assets of any bank or acquiring ownership or control of shares of a bank or bank holding company if, after the acquisition, the Company would directly or indirectly own or control 5% or more of the voting shares of such bank or bank holding company.
The Company is also prohibited from acquiring a direct or indirect interest in or control of more than 5% of the voting shares of any company which is not a bank or bank holding company and from engaging directly or indirectly in activities other than those of banking, managing or controlling banks or furnishing services to its subsidiary bank, except that it may engage in and may own shares of companies engaged in certain activities found by the FRB to be so closely related to banking or managing and controlling banks as to be a proper incident thereto. These activities include, among others, operating a mortgage, finance, credit card, or factoring company; performing certain data processing operations; providing investment and financial advice; acting as an insurance agent for certain types of credit-related insurance; leasing personal property on a full payout, non-operating basis; and providing certain stock brokerage and investment advisory services. In approving acquisitions or the addition of activities, the FRB considers whether the acquisition or the additional activities can reasonably be expected to produce benefits to the public, such as greater convenience, increased competition, or gains in efficiency, that
outweigh such possible adverse effects as undue concentration of resources, decreased or unfair competition, conflicts of interest or unsound banking practices. In considering any application for approval of an acquisition or merger, the FRB is also required to consider the financial and managerial resources of the companies and the banks concerned, as well as the applicant's record of compliance with the Community Reinvestment Act (the "CRA"). The CRA generally requires a financial institution to take affirmative action to ascertain and meet the credit needs of its entire community, including low and moderate income neighborhoods.
The BHCA generally imposes certain limitations on extensions of credit and other transactions by and between banks that are a member of the Federal Reserve System and other banks and non-bank companies in the same holding company. Under the BHCA and the FRB's regulations, a bank holding company and its subsidiaries are prohibited from engaging in certain tie-in arrangements in connection with any extension of credit, lease or sale of property or furnishing of services.
The Company, as an affiliate of the Bank, is subject to certain restrictions regarding transactions between a bank and companies with which it is affiliated. These provisions limit extensions of credit (including guarantees of loans) by the Bank to affiliates, investments in the stock or other securities of the Company by the Bank, and the nature and amount of collateral that the Bank may accept from any affiliate to secure loans extended to the affiliate.
REGULATION OF THE BANK
Texas State Bank is a state-chartered bank subject to regulation by the Texas Department of Banking. The Bank, whose deposits are insured by the Bank Insurance Fund (the "BIF") of the FDIC, is also a member of the Federal Reserve System, and therefore the FRB is the primary federal regulator for the Bank.
The requirements and restrictions applicable to the Bank under laws of the United States and the State of Texas include (i) the requirement that reserves be maintained, (ii) restrictions on the nature and amount of loans which can be made, (iii) restrictions on the business activities in which the Bank may engage, (iv) restrictions on the payment of dividends to shareholders, and (v) the maintenance of minimum capital requirements.
The Company is dependent upon dividends received from the Bank for discharge of the Company's obligations and for payment of dividends to the Company's shareholders. However, the application of minimum capital requirements and other rules and regulations applicable to the Bank restrict the amount of dividends that it may declare without prior regulatory approval. The Texas Banking Department and the FRB can each further limit payment of dividends if the regulatory authority finds that the payment of dividends would constitute an unsafe or unsound practice. Except to absorb losses in excess of undivided profits and uncertified surplus, such certified surplus may not be reduced without the prior written consent of the Banking Commissioner.
The laws of the State of Texas primarily govern interest rate limitations for the Bank. The maximum annual interest rate that may be charged on most loans made by the Bank is based on doubling the average auction rate, to the nearest 0.25%, for United States Treasury Bills, as computed by the Office of Consumer Credit Commissioner of the State of Texas. However, the maximum rate does not decline below 18% or rise above 24% (except for loans in excess of $250,000 that are made for business, commercial, investment or other similar purposes (excluding agricultural loans), in which case the maximum annual rate may not rise above 28%, rather than 24%). On fixed rate closed-end loans, the maximum non-usurious rate is to be determined at the time the rate is contracted; while on floating rate and open-end loans (such as credit cards), the rate varies over the term of the indebtedness. Federal law has preempted state usury laws (but not late charge limitations) for loans secured by a first lien on residential real property.
Banks are affected by the credit policies of other monetary authorities, including the FRB, which regulate the national supply of bank credit. Such regulation influences overall growth of bank loans, investments, and deposits and may also affect interest rates charged on loans and paid on deposits. The monetary policies of the FRB have had a significant effect on the operating results of commercial banks in the past and are expected to continue to do so in the future.
FDICIA
FDICIA requires that federal bank regulatory authorities take "prompt corrective action" with respect to any depository institution that does not meet specified minimum capital requirements. The applicable regulations establish five capital levels which require or permit the FRB and other regulatory authorities to take supervisory action. The relevant classifications range from "well capitalized" to "critically undercapitalized". Under these regulations, an institution is considered well capitalized if it has a total risk-based capital ratio of 10.0% or greater, a Tier I risk-based capital ratio of 6.0% or greater, and a leverage ratio of 5.0% or greater, and it is not subject to an order, written agreement, capital directive, or prompt corrective action directive to meet and maintain a specific capital level for any capital measure. An institution is considered adequately capitalized if it has a total risk-based capital ratio of 8.0% or greater, a Tier I risk-based capital ratio of 4.0% or greater and a leverage capital ratio of 3.0% or greater (if the institution is rated composite 1 in its most recent report of examination, subject to appropriate federal banking agency guidelines), and the institution does not meet the definition of a well capitalized institution. An institution is considered undercapitalized if it has a total risk-based capital ratio that is less than 8.0%, a Tier I risk-based capital ratio that is less than 4.0%, or a leverage ratio that is less than 4.0% (or a leverage ratio that is less than 3.0% if the institution is rated composite 1 in its most recent report of examination, subject to appropriate federal banking agency guidelines). A significantly undercapitalized institution is one which has a total risk-based capital ratio that is less than 6.0%, a Tier I risk-based capital ratio that is less than 3.0%, or a leverage ratio that is less than 3.0%. A critically undercapitalized institution is one that has a ratio of tangible equity to total assets that is equal to or less than 2.0%.
The FRB is authorized by the legislation to take various enforcement actions against any significantly undercapitalized institution and any undercapitalized institution that fails to submit an acceptable capital restoration plan or fails to implement a plan accepted by the appropriate agency. These powers include, among other things, requiring the institution to be recapitalized, prohibiting asset growth, restricting interest rates paid, requiring prior approval of capital distributions by any bank holding company which controls the institution, requiring divestiture by the institution of its subsidiaries or by the holding company of the institution itself, requiring a new election of directors, and requiring the dismissal of directors and officers. If imposed these restrictions, either individually or in aggregate, could have a significantly adverse impact on the operations of the Bank.
With certain exceptions, an institution will be prohibited from making capital distributions or paying management fees if the payment of such distributions or fees will cause the institution to become undercapitalized. Furthermore, undercapitalized institutions will be required to file capital restoration plans with the appropriate federal regulator. Pursuant to FDICIA, undercapitalized institutions also will be subject to restrictions on growth, acquisitions, branching and engaging in new lines of business unless they have an approved capital plan that permits otherwise. The FRB also may, among other things, require an undercapitalized institution to issue shares or obligations, which could be voting stock, to recapitalize the institution or, under certain circumstances to divest itself of any subsidiary.
Critically undercapitalized institutions may be subject to more extensive control and supervision and the FRB may prohibit any critically undercapitalized institution from, among other things, entering into any material transaction not in the ordinary course of business, amending its charter or bylaws, or engaging in certain transactions with affiliates. In addition, critically undercapitalized institutions generally will be prohibited from making payments of principal or interest on outstanding subordinated debt. Within 90 days of an institution becoming critically undercapitalized, the FRB must appoint a receiver or
conservator unless certain findings are made with respect to the prospect for the institution's continued operation.
Management believes that the Company meets all capital adequacy requirements to which it is subject at December 31, 1998. The Bank's capital ratios exceeded the minimum requirements for "well capitalized" institutions under the regulatory framework for prompt corrective action at December 31, 1998. As a result, the Company does not believe that FDICIA's prompt corrective action regulations will have any material effect on the activities or operations of the Bank.
FDICIA also requires the FDIC to establish a schedule to increase (over a period of not more than 15 years) the reserve ratio of the BIF, which insures deposits of Texas State Bank, to 1.25% of insured deposits, and impose higher deposit insurance premiums on BIF members, if necessary, to achieve that ratio. FDICIA also requires a risk-based assessment system for deposit insurance premiums commencing January 1, 1994. Since BIF reached its designated reserve ratio in mid-1995, the FDIC adjusted the BIF assessments, so that the assessment rate now in effect ranges from a minimum of zero to a maximum of $0.27 per $100 of deposits.
FDICIA contains numerous other provisions, including accounting, auditing and reporting requirements, the termination of the "too big to fail" doctrine except in special cases, regulatory standards in areas such as asset quality, earnings and compensation, and revised regulatory standards for the powers of state chartered banks, real estate lending, bank closures and capital adequacy.
The Deposit Insurance Funds Act of 1996 (the "Funds Act") was enacted on September 30, 1996. Among its provisions, the Funds Act authorizes the Financing Corporation (the "FICO") to impose periodic assessments on depository institutions that are members of BIF in addition to institutions that are members of the Savings Association Insurance Fund (the "SAIF") in order to spread the cost of the interest payments on the outstanding FICO bonds over a larger number of institutions. Until this change in the law, only SAIF-member institutions bore the cost of funding these interest payments. Thus, BIF-member institutions will share in the cost of financing outstanding FICO bonds. An institution's FICO assessments will fluctuate based on a defined rate applied to deposits held in periods after the date the legislation was enacted. Currently, the FICO BIF annual rate is 1.2 cents for each $100 of qualified deposits.
ACQUISITIONS
The BHC Act generally limits acquisitions by the Company to commercial banks and companies engaged in activities that the Federal Reserve Board has determined to be so closely related to banking as to be a proper incident thereto. The Company's direct activities are generally limited to furnishing to its subsidiaries services that qualify under the prescribed regulatory tests. Prior Federal Reserve Board approval is required under the BHC Act for new activities and acquisitions of most nonbanking companies.
The BHC Act, the Federal Bank Merger Act, and the Texas Banking Code regulate the acquisition of commercial banks. The BHC Act requires the prior approval of the Federal Reserve Board for the direct or indirect acquisition of more than five percent of the voting shares of a commercial bank or bank holding company. With respect to the Company's subsidiary bank, the approval of the Texas Department of Banking is required for branching, purchasing the assets of other banks and for bank mergers.
In reviewing bank acquisition and merger applications, the bank regulatory authorities will consider, among other things, the competitive effect and public benefits of the transactions, the capital position of the combined organization, and the applicant's record under the Community Reinvestment Act and fair housing laws.
The Corporation regularly evaluates acquisition opportunities and regularly conducts due diligence activities in connection with possible acquisitions. As a result, acquisition discussions and, in some cases negotiations, regularly take place and future acquisitions could occur.
INTERSTATE BANKING AND BRANCHING LEGISLATION
The Riegle-Neal Interstate Branching Efficiency Act of 1994 ("IBBEA"), authorizes interstate acquisitions of banks and bank holding companies without geographic limitation beginning one year after enactment. In addition, beginning June 1, 1997 IBBEA authorizes a bank to merge with a bank in another state as long as neither of the states has opted out of interstate branching between the date of enactment of IBBEA and May 31, 1997. IBBEA further provides that states may enact laws permitting interstate bank merger transactions prior to June 1, 1997. A bank may establish a de novo branch in a state in which the bank does not maintain a branch if the state expressly permits de novo branching. Once a bank has established branches in a state through an interstate merger transaction, the bank may establish and acquire additional branches at any location in the state where any bank involved in the merger transaction could have established or acquired branches under applicable federal or state law. A bank that has established a branch in a state through de novo branching may establish and acquire additional branches in such state in the same manner and to the same extent as a bank having a branch in such state as a result of an interstate merger. If a state opts out of interstate branching within the specified time period, no bank in any other state may establish a branch in the opting out state, whether through an acquisition or de novo. On August 28, 1995, Texas enacted legislation opting out of interstate branching.
ECONOMIC ENVIRONMENT
The earnings of the Bank are affected not only by general economic conditions but also by the policies of various governmental regulatory authorities. The FRB regulates the supply of credit in order to influence general economic conditions, primarily through open market operations in United States government obligations, varying the discount rate of financial institution borrowings, varying reserve requirements against financial institutions and their subsidiaries. The deregulation of interest rates has had and is expected to continue to have an impact on the competitive environment in which the Bank operates.
Governmental policies have had a significant effect on the operating results of commercial banks in the past and are expected to continue to do so in the future. However, the Company cannot accurately predict the nature or extent of any effect that such policies may have on its future business and earnings.
PERSONNEL
The Company employed 727 full-time equivalent employees at December 31, 1998. Employees enjoy a variety of employee benefit programs, including an employee stock ownership plan with 401(k) provisions, medical, accident, group life and long-term disability plans, and paid vacations. The Company's employees are not unionized, and management believes employee relations to be favorable.
ITEM 2.
ITEM 2. PROPERTIES
The executive offices of the Company, as well as the principal banking quarters of Texas State Bank, are housed in an eleven-story office tower located in McAllen, Texas. This new building, completed during 1998, also includes space for lease to third party tenants and for future growth. The Company also owns the Kerria Plaza building, adjacent to the new headquarters building, and leases space to third party tenants.
All of the Company's banking locations are owned, except for the Roma, Texas banking location. The Brownsville, Edinburg, Harlingen, Hidalgo, McAllen, Mission, Penitas and Weslaco, Texas banking locations include extensive drive-through facilities.
Management believes that it will be desirable in the future to consider the establishment of additional banking locations.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
The Company is involved in routine litigation in the normal course of its business, which in the opinion of management, will not have a material adverse effect on the financial condition or results of operations of the Company.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
None
PART II
ITEM 5.
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.
Since March 1994, the Corporation's Class A Voting Common Stock has traded on The Nasdaq Stock Market(R) under the symbol TRBS. The following table shows (i) high and low prices of the Common Stock as provided to the Company by The Nasdaq Stock Market(R) for transactions occurring on The Nasdaq Stock Market during the past two years, and (ii) the total number of shares involved in such transactions.
The following information has been restated to retroactively give effect to the three-for-two stock split declared and distributed by the Corporation during the third quarter of 1997.
Price Per Share Cash --------------------- Dividends Volume Quarter Ended High Low Declared Traded - ------------------------------------------------------------------------------ March 31, 1997 ...... $ 24.50 $ 21.17 $ 0.07 926,227 June 30, 1997 ....... 30.25 19.00 0.07 1,371,797 September 30, 1997... 31.50 24.50 0.11 1,691,818 December 31, 1997.... 31.50 26.00 0.11 1,049,074 March 31, 1998 ...... 35.63 27.00 0.11 1,897,668 June 30, 1998 ....... 35.13 29.25 0.11 1,421,623 September 30, 1998... 34.00 21.00 0.13 1,824,207 December 31, 1998.... 27.38 17.00 0.13 2,416,388 - ------------------------------------------------------------------------------
On December 31, 1998, there were 961 holders of record of the Corporation's Class A Common Stock.
During the two years ended December 31, 1998, an aggregate of 57,500 shares purchased by the Texas Regional Bancshares, Inc. Employee Stock Ownership Plan (with 401(k) provisions) are included in the foregoing table.
The final determination of the timing, amount and payment of dividends on the Common Stock is at the discretion of the Company's Board of Directors. There can be no assurance as to future dividends because they are dependent on future earnings, capital requirements and financial conditions. The Company's principal source of the funds to pay dividends on the Common Stock is dividends from Texas
State Bank. The payment of dividends by the Bank is subject to certain restrictions imposed by federal and state banking laws, regulations and authorities. At December 31, 1998, an aggregate of $48.8 million was available for payment of dividends by the Bank to the Company under the applicable limitations and without regulatory approval.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA
The following table sets for selected consolidated financial data for the Company and its subsidiaries for, and as of, each of the years in the five-year period ended December 31, 1998. This selected financial data has been derived from the consolidated financial statements and accounting records of the Company. The data presented below should be read in conjunction with the consolidated financial statements, related notes and other financial information included herein:
ITEM 7.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
ITEM 7A.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
The following analysis of the financial condition and results of operations of the Company should be read in conjunction with the Company's Consolidated Financial Statements and Notes thereto and the other financial data included herein. The ratios and percentages set forth below are calculated using the detailed financial information contained in the Consolidated Financial Statements and the Notes thereto, and the financial data included elsewhere in this Form 10-K.
SELECTED CONSOLIDATED FINANCIAL INFORMATION
Net income for the year ended December 31, 1998 was $22.5 million, reflecting a net decrease of $648,000 or a 2.8% decrease compared to net income of $23.1 million for the year ended December 31, 1997. The earnings per diluted common share of $1.54 for the year ended December 31, 1998 decreased $0.04 or 2.5% compared to the earnings per diluted common share of $1.58 for the year ended December 31, 1997. Earnings performance for the year ended December 31, 1998 reflected gains in net interest income and an increase in noninterest income. However, an increase in provision for loan losses and noninterest expenses offset these positive factors. A more detailed description of the results of operations is included in the material that follows.
On February 19, 1998, Texas Regional Bancshares, Inc., (the "Company") completed the acquisition of three bank holding companies and their three subsidiary banks (the "Mergers"). The acquisition of Brownsville Bancshares, Inc. and its subsidiary, Brownsville National Bank, included two banking locations in Brownsville, Cameron County, Texas, with assets of approximately $100.1 million, equity of $12.1 million, loans of $42.6 million, and deposits of $87.2 million. The Company achieved this acquisition by the exchange of 984,806 shares of Company stock for all of the outstanding shares of Brownsville Bancshares, Inc. and cancellation of outstanding stock options. Brownsville National Bank merged with and into Texas State Bank (the "Bank").
The second acquisition was TB&T Bancshares, Inc. and its subsidiary, Texas Bank and Trust of Brownsville, Cameron County, Texas. Texas Bank and Trust of Brownsville had assets of approximately $44.9 million, equity of $4.1 million, loans of $21.9 million, and deposits of $40.3 million. This acquisition was achieved by exchange of 308,039 shares of Company stock for all of the outstanding shares of TB&T Bancshares, Inc., a portion of which are retained in a holdback escrow account pending resolution of certain claims. Texas Bank and Trust of Brownsville merged with and into Texas State Bank.
The third acquisition was Raymondville Bancorp, Inc. and its subsidiary, Bank of Texas. Bank of Texas was headquartered in Raymondville, Willacy County, Texas, with one additional banking facility in Brownsville, Texas. The shareholder of Raymondville Bancorp, Inc. received cash consideration of $9.6 million in this acquisition, and the Company paid $100,000 in consideration for a covenant not to compete. The Company discharged approximately $330,000 of existing Raymondville Bancorp, Inc. indebtedness. Bank of Texas had assets of approximately $63.7 million, equity of $5.1 million, loans of $25.5 million, and deposits of $56.5 million. Bank of Texas was merged with and into Texas State Bank.
The Company accounted for its acquisition of Brownsville Bancshares, Inc. and TB&T Bancshares, Inc. under the pooling-of-interests method of accounting, and as such, the enclosed financial information has been restated for all periods presented to include the results of operations and financial position of these acquired entities. A One Time Charge-Acquisitions of $728,000 or $0.03 per diluted common share, net of federal income tax, reduced net income for the year ended December 31, 1998. These expenses, primarily professional fees and computer conversion costs, related to business combinations accounted for by the pooling-of-interests method. The Company accounted for its acquisition of Raymondville Bancorp, Inc. under the purchase method of accounting; therefore, the results of operations are included in the consolidated financial statements from the date of acquisition, February 19, 1998.
ANALYSIS OF RESULTS OF OPERATIONS NET INTEREST INCOME
Net interest income is the difference between interest income earned on assets and interest expense incurred for the funds supporting those assets. The largest category of earning assets consists of loans. The second largest category of earning assets is securities, followed by federal funds sold. For analytical purposes, income from tax-exempt assets, primarily securities issued by state and local governments or authorities, is adjusted by an increment which equates tax-exempt income to interest from taxable assets.
Earning assets are financed by consumer and commercial deposits and short-term borrowings. In addition to these interest-bearing funds, assets also are supported by interest-free funds, primarily demand deposits and shareholders' equity. Variations in the volume and mix of assets and liabilities, and their relative sensitivity to interest rate movements, determine changes in net interest income.
Taxable-equivalent net interest income was $68.7 million for the year ended December 31, 1998, an increase of $5.1 million or 7.9% compared to the year ended December 31, 1997, and taxable-equivalent net interest income of $63.7 million for the year ended December 31, 1997, increased $11.4 million or 21.9% compared to the year ended December 31, 1996. Both net interest income and the yield on earning assets were reduced by interest foregone on nonaccrual and renegotiated loans. If interest on those loans had been accrued at the original contractual rates, additional interest income would have approximated $2.2 million, $1.6 million and $807,000 for the years ended December 31, 1998, 1997 and 1996, respectively.
The net yield on total interest-earning assets, also referred to as net interest margin, represents net interest income divided by average interest-earning assets. Since a significant portion of the Company's funding is derived from interest-free sources, primarily demand deposits and shareholders' equity, the effective rate paid for all funds is lower than the rate paid on interest-bearing liabilities alone. The net interest margin of 4.61% for the year ended December 31, 1998 decreased 28 basis points compared to 4.89% for the year ended December 31, 1997 while the net interest margin of 4.89% for the year ended December 31, 1997 decreased 17 basis points compared to 5.06% for the year ended December 31, 1996.
The decrease in the interest margin for the year ended December 31, 1998 reflected decreases in the rates earned on interest-earnings assets. The yield on interest-earning assets of 8.52% for the year ended December 31, 1998 decreased 26 basis points compared to 8.78% for the year ended December 31, 1997 and yield on interest-earning assets of 8.78% for the year ended December 31, 1997 increased 8 basis points compared to 8.70% for the year ended December 31, 1996. The mix of average interest-earning assets for the year ended December 31, 1998 compared to the year ended December 31, 1997 was changed by total average loans of $1.0 billion increasing $147.7 million or 16.9%, total average securities of $432.8 million increasing $46.5 million or 12.1% and average federal funds sold of $33.6 million decreasing $6.0 million or 15.2%. The decrease in loan yield for 1998 reflects lower market rates in response to recent Federal Reserve Bank actions and continued strong competition from local financial institutions and, to a lesser extent, the charge-off of $900,000 in interest income on agricultural loans during the three months ended September 30, 1998. The decrease in loan yield for 1997 reflects the general decrease in average interest rates in 1997 compared to 1996. The decrease in securities yield for the year ended December 31, 1998 resulted from sales and maturities of higher yielding securities and reinvestment at lower rates. The increase in securities yield in 1997 compared to 1996 resulted from lower yielding securities maturing and the reinvesting of the proceeds into higher yields.
The rate paid on interest-bearing liabilities of 4.67% for the year ended December 31, 1998 did not change from the year ended December 31, 1997 and the rate on interest-bearing liabilities of 4.67% for the year ended December 31, 1997 increased 24 basis points compared to 4.43% for the year ended December 31, 1996. The rate paid on interest-bearing liabilities during 1998 did not change due to competition from local financial institutions and time deposit maturities, which prevent the Company from rapidly lowering deposit rates. The increase in the rate paid on interest-bearing liabilities during 1997 resulted from the general increase in average short-term interest rates and increased competition from local financial institutions.
The following table presents for the last three calendar years the total dollar amount of interest income from average interest-earning assets and the resultant yields, reported on a tax-equivalent basis, and average interest-bearing liabilities, expressed both in dollars and rates. Average balances are derived from average daily balances and the yields and costs are established by dividing income or expense by the average balance of the asset or liability. Income and yield on interest-earning assets include amounts to convert tax-exempt income to a taxable-equivalent basis, assuming a 35% effective tax rate for 1998, 1997, and 1996.
1 For analytical purposes, income from tax-exempt assets, primarily securities issued by state and local governments or authorities, is adjusted by an increment which equates tax-exempt income to interest from taxable assets (assuming a 35% effective federal income tax rate for 1998, 1997, and 1996).
The following table presents the effects of changes in volume, rate and rate/volume on interest income and interest expense for major categories of interest-earning assets and interest-bearing liabilities. Nonaccrual loans are included in assets, thereby reducing yields (see "Nonperforming Assets"). The allocation of the rate/volume variance has been made pro-rata on the percentage that volume and rate variances produce in each category.
(1) For analytical purposes, income from tax-exempt assets, primarily securities issued by state and local governments or authorities, is adjusted by an increment which equates tax-exempt income to interest from taxable assets (assuming a 35% effective federal income tax rate for 1998, 1997 and 1996).
NET YIELD ON EARNING ASSETS
The following table presents net interest income, average earning assets and the net yield by quarter for the past three years. Income and yield on earning assets include amounts to convert tax-exempt income to a taxable-equivalent basis, assuming a 35% effective federal income tax rate for 1998, 1997 and 1996.
(1) For analytical purposes, income from tax-exempt assets, primarily securities issued by state and local governments or authorities, is adjusted by an increment which equates tax-exempt income to interest from taxable assets (assuming a 35% effective federal income tax rate for 1998, 1997 and 1996).
PROVISION FOR LOAN LOSSES
The Company recorded a provision for loan losses of $9.7 million for the year ended December 31, 1998, compared to $2.9 million in the year ended December 31, 1997 and $2.2 million for the year ended December 31, 1996. Net charge-offs for the year ended December 31, 1998 totaled $8.1 million compared to $2.5 million for 1997 and $1.4 million for 1996. Charge offs of $5.5 million on agriculture loans and loan growth of $138.2 million, to a lesser extent, factored heavily in the increase of $6.8 million, or 230.1%, in the provision for loan losses for the year ended December 31, 1998. The provision for loan losses reflected an increase of $774,000 or 35.6% for the year ended December 31, 1997 due to loan growth of $132.7 million during the year. Management charges provisions for loan losses to earnings to bring the total allowance for loan losses to a level deemed appropriate. Management bases its decision on many factors which include historical experience, the volume and type of lending conducted by the Company, the amount of nonperforming assets, regulatory policies, generally accepted accounting principles, and general economic conditions, particularly as they relate to the Company's lending area. See "Allowance for Loan Losses."
NONINTEREST INCOME
Noninterest income totaled $17.7 million for the year ended December 31, 1998 compared to $13.0 million for 1997 and $10.7 million for 1996. Excluding net realized gains on sales of securities available for sale, total noninterest income increased $2.5 million or 20.6% from 1997 and $2.0 million or 19.3% from 1996. The noninterest income growth in 1998 and 1997 resulted primarily from the increased volume of business conducted by the Company and, in part, because of the Raymondville merger.
Total Service Charges of $10.1 million for the year ended December 31, 1998, increased $1.5 million or 17.8% compared to $8.6 million for the year ended December 31, 1997. Total Service Charges of $8.6 million for the year ended December 31, 1997 increased $1.5 million or 20.8% compared to $7.1 million for the year ended December 31, 1996. The increase in Total Service Charges for the years ended December 31, 1998 and 1997 is attributable to increased account transaction fees generated by deposit growth experienced by the Company and due to the Raymondville merger.
Trust Service Fees of $1.8 million for the year ended December 31, 1998 increased $79,000 or 4.7% compared to $1.7 million for the year ended December 31, 1997. Trust Service Fees of $1.7 million for the year ended December 31,
increased $186,000 or 12.4% compared to $1.5 million for the year ended December 31, 1996. The increase in Trust Service Fees in each of the years 1998 and 1997 is attributable to an increase in the number of trust accounts managed. The fair market value of assets managed at December 31, 1998 of $328.7 million increased $78.0 million or 31.1% compared to $250.8 million at December 31, 1997. Assets held by the trust department of the Bank in fiduciary or agency capacities are not assets of the Company and are not included in the consolidated balance sheets.
Net Realized Gains on Sales of Securities Available for Sale of $2.9 million for the year ended December 31, 1998 increased $2.2 million or 296.5% compared to $734,000 for 1997. Long-term interest rates reached or neared 30 year lows during the latter half of 1998. This coupled with management's belief in the fundamental underlying strength of the U.S., Texas and Rio Grande Valley economies, presented an opportunity to realize some of the gains in the securities available for sale portfolio. Net Realized Gains on Sales of Securities Available for Sale totaled $734,000 for 1997 compared to $401,000 for 1996 as a result of sales designed to reduce asset sensitivity of callable bonds and improve bond quality during 1997.
Data Processing Fees of $1.5 million for the year ended December 31, 1998 increased $435,000 or 40.3% compared to $1.1 million for the year ended December 31, 1997. This increase arose from the acquisition of additional banking clients and increased utilization of services offered to existing clients during 1998. Data Processing Fees of $1.1 million for the year ended December 31, 1997 increased $170,000 from $910,000 in 1996. The Company obtained two additional banking clients during 1998 and none during 1997.
Other Operating Income of $1.3 million for the year ended December 31, 1998 increased $469,000 or 55.0% compared to $852,000 for the year ended December 31, 1997. Other Operating Income of $852,000 for the year ended December 31, 1997 increased $146,000 or 20.7% compared to $706,000 for 1996. The increase in Other Operating Income for 1998 was primarily attributable to the increased volume of deposit accounts and other business conducted by the Company.
A detailed summary of noninterest income during the last three years follows below:
NONINTEREST EXPENSE
Noninterest expense of $41.1 million for the year ended December 31, 1998 increased $3.9 million or 10.6% compared to $37.2 million for 1997. Noninterest expense of $37.2 million for the year ended December 31, 1997 increased $5.1 million or 15.8% compared with $32.1 million for the year ended December 31, 1996. The increases for the years ended December 31, 1998 and 1997 were primarily attributable to an increased volume of business conducted by the Company and the Raymondville merger. Noninterest expense averaged 2.48% of total assets for the year ended December 31, 1998 compared to 2.58% for the year ended December 31, 1997 and 2.81% for the year ended December 31, 1996.
Salaries and Employee Benefits, the largest category of noninterest expense, of $18.5 million for the year ended December 31, 1998 increased $834,000 or 4.7% compared to the year ended December 31, 1997 levels of $17.7 million. Salaries and Employee Benefits of $17.7 million for the year ended December 31, 1997 increased $1.5 million or 9.3% compared to the year ended December 31, 1996 levels of $16.2 million. Salaries and Employee Benefits increased for the year ended December 31, 1998 primarily due to staffing increases, including the staff acquired as a result of the Raymondville merger. Salaries and Employee Benefits averaged 1.12% of total assets for the year ended December 31, 1998 compared to 1.23% for the year ended December 31, 1997 and 1.41% for the year ended December 31, 1996.
Net Occupancy Expense of $3.6 million for the year ended December 31, 1998 increased $944,000 or 35.1% compared to $2.7 million for 1997. Expenses associated with the new corporate headquarters building in McAllen, Texas, opened during 1998, contributed to the increase in Net Occupancy Expense during the year ended December 31, 1998. Net Occupancy Expense of $2.7 million for the year ended December 31, 1997 increased $355,000 or 15.2% when compared to Net Occupancy Expense of $2.3 million for the year ended December 31, 1996. The increase for the year ended December 31, 1997 is primarily attributable to the occupancy expenses associated with mergers completed during 1996.
Equipment Expense of $4.6 million for the year ended December 31, 1998 increased $821,000 or 21.7% compared to $3.8 million for 1997. Expenses associated with the new corporate headquarters building contributed to the increase in Equipment Expense during the year ended December 31, 1998. Equipment Expense of $3.8 million for the year ended December 31, 1997 increased $380,000 or 11.2% when compared with $3.4 million for the year ended December 31, 1996. The Equipment Expense increase incurred during the year ended December 31, 1997 is primarily attributable to equipment obtained in mergers completed during 1996 and equipment acquired to service the Company's increasing customer base.
Other Real Estate (Income) Expense, Net includes rent income from foreclosed properties, gain or loss on sale of other real estate properties and direct expenses of foreclosed real estate including property taxes, maintenance costs and write-downs. Write-downs of Other Real Estate are required if the fair value of an asset acquired in a loan foreclosure subsequently declines below its carrying value. The category Other Real Estate (Income) Expense, Net reflects net expense of $307,000 for the year ended December 31, 1998, which compares unfavorably to net expense of $105,000 for the year ended December 31, 1997. Other Real Estate (Income) Expense, Net of $105,000 for the year ended December 31, 1997 increased $198,000 or 212.9% compared to net income of $93,000 for the year ended December 31, 1996. The net increase for the year ended December 31, 1998 is primarily attributable to higher volumes in Other Real Estate owned offsetting increased operating income and gain on sale of foreclosed properties. Management is actively seeking buyers for all Other Real Estate.
Amortization of Goodwill and Identifiable Intangibles of $2.7 million for the year ended December 31, 1998 increased $408,000 or 18.1% compared to $2.3 million for 1997. Amortization of Goodwill and Identifiable Intangibles of $2.3 million for the year ended December 31, 1997 increased $659,000 or 41.4% compared to $1.6 million for the year ended December 31, 1996. The increase in Amortization of Goodwill and Identifiable Intangibles was due to the amortization of goodwill and core deposit premiums associated with the 1998 and 1996 acquisitions.
An impairment loss of $630,000 was recorded during the three months ended June 30, 1997 to reflect the impairment of an existing bank building. The building was razed to provide additional parking upon completion of a new building in McAllen, Texas. The new bank building completed in 1998 serves as the headquarters for Texas State Bank and Texas Regional Bancshares, Inc. The amount of the impairment loss represented the book value of the building at June 30, 1997.
One Time Charge - Acquisitions of $728,000, related primarily to professional fees and computer conversion cost resulting from the Company's 1998 acquisitions.
Other Noninterest Expense $10.7 million for the year ended December 31, 1998 increased $625,000 or 6.2% compared to $10.0 for 1997. Other Noninterest Expense of $10.0 million for the year ended December 31, 1997 increased $1.3 million or 15.5% compared to $8.7 million for the year ended December 31, 1996. The increase in Other Noninterest Expense for 1998 and 1997 was primarily attributable to an increased volume of business, primarily due to the 1998 and 1996 acquisitions.
All Other Noninterest Expense categories, not previously discussed, reflect a net increase for the year ended December 31, 1998 compared to the year ended December 31, 1997 and was attributable to an increased volume of business.
The Efficiency Ratio of expense to total revenue averaged 48.86% for the year ended December 31, 1998 compared to 48.82% for the year ended December 31, 1997 and 51.49% for the year ended December 31, 1996.
A detailed summary of noninterest expense during the last three years follows below:
POSTRETIREMENT BENEFITS OTHER THAN PENSIONS
The Company provides the following postretirement benefits: (1) benefits provided under the Texas Regional Bancshares, Inc. Employee Stock Ownership Plan (with 401(k) provisions), (2) a nonqualified deferred compensation plan for the benefit of Glen E. Roney, Chairman of the Board, President and Chief Executive Officer, (3) four existing separate nonqualified deferred compensation plans for the benefit of certain employees acquired through past mergers, (4) a 401 (k) plan for the benefit of certain employees (limited to past contributions) acquired through the Bank of Texas acquisition and (5) medical insurance on a selected basis.
INCOME TAX
The Company recorded income tax expense of $11.6 million for the year ended December 31, 1998 compared to $11.9 million for the year ended December 31, 1997. The decrease in income tax expense for the year ended December 31, 1998 is due primarily to a decreased level of pretax income during the year ended December 31, 1998.
NET INCOME
Net income was $22.5 million, $23.1 million and $18.2 million for the years ended December 31, 1998, 1997 and 1996, respectively.
ANALYSIS OF FINANCIAL CONDITION
BALANCE SHEET COMPOSITION
The Company continues to experience growth in total assets, deposits and loans attributable, in the opinion of management, to the vitality of the Rio Grande Valley economy and due to the Raymondville merger. The continued devaluation of the Mexican peso relative to the U.S. dollar has reduced retail sales to Mexican nationals. However, the effects of NAFTA and the continued devaluation have also increased cross-border trade and industrial development including activity at twin manufacturing plants located on each side of the border (referred to as maquiladoras) which benefit the Rio Grande Valley economy. Management does not believe that the on-going Mexican financial problems will materially affect the Company's growth and earnings prospects.
Average interest-earning assets of $1.5 billion increased $189.3 million or 14.5% for the year ended December 31, 1998 compared to $1.3 billion for the year ended December 31, 1997 and increased $269.9 million or 26.1% compared to $1.0 billion for the year ended December 31, 1996. Average loans increased $147.7 million or 16.9% to $1.0 billion for the year ended December 31, 1998 compared to December 31, 1997 levels of $875.8 million, while average securities of $432.8 million increased $46.5 million or 12.1% for the year ended December 31, 1998 compared to December 31, 1997 levels of $386.2 million. Total average assets increased $214.2 million or 14.9% to $1.7 billion for the year ended December 31, 1998 compared to December 31, 1997 levels and $295.8 million or 25.9% to $1.4 billion for the year ended December 31, 1997 compared to December 31, 1996 levels of $1.1 billion.
Average interest-bearing deposits increased $161.2 million or 14.9% to $1.2 billion for the year ended December 31, 1998 compared to the year ended December 31, 1997 levels of $1.1 billion. Demand deposits also increased $26.6 million or 13.8% for the year ended December 31, 1998 to $218.7 million compared to the year ended December 31, 1997 levels of $192.1 million.
The following table presents the Company's average balance sheets during the last three years:
CASH AND DUE FROM BANKS
Texas State Bank, through its main office and branches, offers a broad range of commercial banking services to individuals and businesses in its service area. Texas State Bank also acts as a correspondent to a number of banks in its service area, providing check clearing, wire transfer, federal funds transactions, loan participations and other correspondent services. The amount of cash and due from banks held on any one day is significantly influenced by temporary changes in cash items in process of collection. At December 31, 1998, cash and due from banks was $58.3 million.
SECURITIES
Securities consist of U.S. Treasury, federal agency, mortgage-backed and state, county and municipal securities. The Bank classifies debt and equity securities into one of three categories: Held to Maturity, Trading or Available for Sale. At each reporting date, management reassesses the appropriateness of the classification. Investments in debt securities are classified as Held to Maturity and measured at amortized cost in the consolidated balance sheet only if management has the positive intent and ability to hold those securities to maturity. Securities that are bought and held principally for the purpose of selling them in the near term are classified as Trading and measured at fair value in the consolidated balance sheet with unrealized holding gains and losses included in earnings. Securities not classified as either Held to Maturity or Trading are classified as Available for Sale and measured at fair value in the consolidated balance sheet with unrealized holding gains and losses reported in a separate component of shareholders' equity net of applicable income taxes until realized.
At December 31, 1998, 1997 and 1996, no securities were classified as Trading. The Company does not currently engage in trading activities or use derivative instruments to control interest rate risk. Even though such activities may be permitted with the approval of the Board of Directors, the Company does not intend to engage in such activities in the immediate future.
The following table presents estimated market value of Securities Available for Sale at December 31, 1998, 1997 and 1996:
*Not meaningful.
The following table presents the maturities, amortized cost, estimated market value and weighted average yields of the Securities Available for Sale at December 31, 1998:
1 Amortized cost for Securities Available for Sale is stated at par plus any remaining unamortized premium paid or less any remaining unamortized discounts received.
The following table presents amortized cost of Securities Held to Maturity at December 31, 1998, 1997 and 1996:
All investments in states and political subdivisions are investments in entities within the State of Texas. No single issuer accounted for as much as 10.0% of total shareholders' equity at December 31, 1998. Of the obligations of states and political subdivisions held by the Company at December 31, 1998, 70.4% were rated A or better by Moody's Investor Services, Inc. and 56.7% of the non-rated issues or $6.3 million are local issues purchased in private placement transactions.
The following table presents the maturities, amortized cost, estimated market value and weighted average yields of Securities Held to Maturity at December 31, 1998:
(1) Amortized cost for Securities Held to Maturity is stated at par plus any remaining unamortized premium paid or less any remaining unamortized discount received.
LOANS
The Company manages its credit risk by establishing and implementing strategies and guidelines appropriate to the characteristics of borrowers, industries, geographic locations and risk products. Diversification of risk within each of these areas is a primary objective. Policies and procedures are developed to ensure that loan commitments conform to current strategies and guidelines. Management continually refines the Company's credit policies and procedures to address the risks in the current and prospective environment and to reflect management's current strategic focus. The credit process is controlled with continuous credit review and analysis, and by review by internal and external auditors and regulatory authorities. The Company's loans are widely diversified by borrower and industry group.
The Company has collateral management policies in place so that collateral lending of all types is approached on a basis consistent with safe and sound standards. Valuation analysis is utilized to take into consideration the potentially adverse economic conditions under which liquidation could occur. Collateral accepted against the commercial loan portfolio includes accounts receivable and inventory, marketable securities, equipment and agricultural products. Autos, deeds of trust, life insurance and marketable securities are accepted as collateral for the installment loan portfolio.
Management of the Company believes that the Company has benefited from increased loan demand due to passage of the North American Free Trade Agreement ("NAFTA") and the strong population growth in the Rio Grande Valley. More recently, the continued devaluation of the Mexican peso relative to the U.S. dollar has reduced retail sales to residents of Mexico. However, the effects of NAFTA and the devaluations have also increased cross-border trade and industrial development including activity at twin manufacturing plants located on each side of the border (referred to as maquiladoras) which benefit the Rio Grande Valley economy. Management believes the on-going Mexican financial problems will not have a material adverse effect on the Company's growth and earnings prospects, in part because the Company presently has a low percentage of loans secured by Mexican assets or that otherwise rely on collateral located in Mexico.
The extension of credits denominated in a currency other than that of the country in which a borrower is located are called "cross-border" credits. With the completion of the Mergers, the Company has acquired some dollar-denominated cross-border credits to individuals or companies that are residents of, or domiciled in Mexico. The Company's total cross-border credits at December 31, 1998 of $7.6 million were less than .7% of total loans. See "Nonperforming Assets" for additional information on cross-border credits.
Total loans of $1.1 billion for the year ended December 31, 1998 increased $138.2 million or 14.5% compared to the year ended December 31, 1997 levels of $951.3 million and increased $132.7 million or 16.2% for the year ended December 31, 1997 compared to levels of $818.6 million at December 31, 1996. The increase in total loans for the year ended December 31, 1998 is primarily attributable to an increased volume of business conducted by the Company. The increase in total loans for the year ended December 31, 1997 reflects growth in all loan categories except Commercial Tax-Exempt loans and is representative in part to the vitality of the Rio Grande Valley economy. A substantial portion of the increase in loans classified as Real Estate-Commercial Mortgage loans consists of loans secured by real estate and other assets to commercial customers. The following table presents the composition of the loan portfolio at the end of each of the last five years:
The contractual maturity schedule of the loan portfolio at December 31, 1998 follows:
The Company's policy on maturity extensions and rollovers is based on management's assessment of individual loans. Approvals for the extension or renewal of loans without reduction of principal for more than one twelve-month period are generally avoided, unless the loans are fully secured and properly margined by cash or marketable securities, or are revolving lines subject to annual analysis and renewal.
NONPERFORMING ASSETS
The Bank has several procedures in place to assist in maintaining the overall quality of its loan portfolio. The Bank has established underwriting guidelines to be followed by its officers and monitors its delinquency levels for any negative or adverse trends.
Nonperforming assets consist of nonaccrual loans, loans for which the interest rate has been renegotiated below originally contracted rates and real estate or other assets that have been acquired in partial or full satisfaction of loan obligations. The Company's policy generally is to place a loan on nonaccrual status when payment of principal or interest is contractually past due 90 days, or earlier when concern exists as to the ultimate collection of principal and interest. At the time a loan is placed on nonaccrual status, interest previously accrued but uncollected is reversed and charged against current income.
Nonaccrual loans of $10.4 million at December 31, 1998 increased $2.1 million or 24.6% compared to $8.4 million at December 31, 1997 and nonaccrual loans at December 31, 1997 of $8.4 million increased $1.6 million or 22.8% compared to $6.8 million at December 31, 1996. The increases in nonaccrual loans during 1998 and 1997 are due to several diverse credits secured primarily by real estate. Cross-border nonaccrual loans at December 31, 1998 of $7.6 million reflect a decrease of $100,000 when compared to the $7.7 million at December 31, 1997.
Loans which are contractually past due 90 days or more, which are both well secured or guaranteed by financially responsible third parties and in the process of collection, generally are not placed on nonaccrual status. The amount of such loans past due 90 days or more for the years ended December 31, 1998, 1997 and 1996 that are not classified as nonaccrual totaled $3.1 million, $3.3 million and $5.3 million, respectively. The decrease in accruing loans past due 90 days or more at December 31, 1998 as compared to the year ended December 31, 1997 is partly attributable to loan collections.
Nonperforming Assets of $15.8 million at December 31, 1998 increased $4.1 million, 35.1% compared to December 31, 1997 levels of $11.7 million, and increased $3.8 million or 47.5% compared to December 31, 1996 levels of $7.9 million. The increase in Foreclosed Assets during 1998 was primarily attributable to a higher rate of foreclosure loans with real estate collateral, net of write-downs and liquidations. Management actively seeks buyers for all Other Real Estate. See "Noninterest Expense" above. The ratio of Nonperforming Assets Plus Accruing Loans 90 Days or More Past Due as a percent of Total Loans and Foreclosed Assets at December 31, 1998 increased to 1.72% from 1.57% at December 31, 1997 due primarily to the increase in foreclosed assets.
The Company's classification of nonperforming loans includes those loans for which management believes collection is doubtful. Management is not aware of any specific borrower relationships that are not reported as nonperforming where management has serious doubts as to the ability of such borrowers to comply with the present loan repayment terms which would cause nonperforming assets to increase materially.
The Company identifies loans to be reported as impaired when such loans are on nonaccrual status or are considered troubled debt restructurings due to the granting of a below-market rate of interest or a partial forgiveness of indebtedness on an existing loan. The balance of impaired loans was $10.4 million at December 31, 1998 and $8.4 million at December 31, 1997. The average recorded investment in impaired loans during 1998 and 1997 was $11.2 million and $10.8 million, respectively. The total allowance for loan losses related to these loans was $1.4 million and $1.0 million on December 31, 1998 and 1997, respectively. Interest income on impaired loans of $232,000, $238,000 and $561,000 was recognized for cash payments received in 1998, 1997 and 1996, respectively. If interest on these impaired loans had been accrued at the original contractual rates, interest income would have been increased by approximately $2.2 million, $1.6 million and $807,000 for the years ended December 31, 1998, 1997 and 1996, respectively.
An analysis of the components of nonperforming assets for the last five years follows:
Management regularly reviews and monitors the loan portfolio to identify borrowers experiencing financial difficulties. Management believes that, at December 31, 1998, all such loans had been identified and included in the nonaccrual, renegotiated or 90 days past due loan totals reflected in the table above. Management continues to emphasize maintaining a low level of nonperforming assets and returning nonperforming assets to an earning status.
ALLOWANCE FOR LOAN LOSSES
Management analyzes the loan portfolio to determine the adequacy of the allowance for loan losses and the appropriate provision required to maintain an adequate allowance. In assessing the adequacy of the allowance, management reviews the size, quality and risks of loans in the portfolio and considers factors such as specific known risks, past experience, the status and amount of nonperforming assets and economic conditions. A specific percentage is allocated to total loans in good standing and additional amounts are added for individual loans considered to have specific loss potential. Loans identified as losses are charged-off. In addition, the loan review committee of the Bank reviews the assessments of management in determining the adequacy of the Bank's allowance for loan losses. Based on total allocations, the provision is recorded to maintain the allowance at a level deemed appropriate by management. While management uses available information to recognize losses on loans, there can be no assurance that future additions to the allowance will not be necessary.
The allowance for loan losses at year ended December 31, 1998 totaled $13.2 million, representing a net increase of $1.9 million or 17.2% compared to $11.3 million at December 31, 1997. Management believes that the allowance for loan losses at December 31, 1998 adequately reflects the risks in the loan portfolio. Various regulatory agencies, as an integral part of their examination process, periodically review the Company's allowance for loan losses. Such agencies may require the Company to recognize additions to the allowance based on their judgments of information available to them at the time of their examination.
The following table summarizes the activity in the allowance for loan losses for the last five years:
The allocation of the allowance for loan losses by loan category and the percentage of loans in each category to total loans at the end of each of the last five years follows:
PREMISES AND EQUIPMENT
Premises and equipment of $69.8 million at December 31, 1998 increased $17.4 million or 33.1% compared to $52.4 million at December 31, 1997 and increased $12.2 million or 30.2% for December 31, 1997 compared to $40.3 million at December 31, 1996. The increase for the year ended December 31, 1998 resulted primarily from completion costs of the Company's new headquarters in McAllen of $10.2 million, net of construction in progress of $9.4 million as of December 31, 1997. The net increase for the year ended December 31, 1997 was primarily attributable to the construction in progress of the Company's new headquarters in McAllen.
GOODWILL AND IDENTIFIABLE INTANGIBLES
Intangibles of $26.9 million at December 31, 1998 increased $2.8 million or 11.8% compared to $24.1 million at December 31, 1997 and decreased $2.3 million or 8.6% for December 31, 1997 compared to $26.3 million at December 31, 1996. The net increase in 1998 was due to amortization of existing intangibles and the acquisition of Raymondville Bancorp, Inc. The net decrease for the year ended December 31, 1997 is attributable to amortization of existing intangibles.
DEPOSITS
Total deposits of $1.6 billion at December 31, 1998 increased $200.2 million or 14.7% compared to December 31, 1997 levels of $1.4 billion, and total deposits of $1.4 billion for the year ended December 31, 1997 increased $147.1 million or 12.1% compared to December 31, 1996 levels of $1.2 billion. The increase in total deposits for the year ended December 31, 1998 is attributable in part to the vitality of the Rio Grande Valley economy. The increase in total deposits at December 31, 1997 compared to December 31, 1996 is primarily attributable to growth in the volume of business conducted by the Company. Total noninterest-bearing deposits of $234.7 million for the year ended December 31, 1998 represented an increase of $26.2 million or 12.6% compared to the year ended December 31, 1997 and increased $17.3 million or 9.0% for the year ended December 31, 1997 compared to the year ended December 31, 1996. Total public funds deposits (consisting of Public Funds Demand Deposits, Savings, Money Market Checking and Savings and Time Deposits) of $265.9 million for the year ended December 31, 1998 increased $58.6 million or 28.3% compared to December 31, 1997 levels of $207.3 million. The Bank actively seeks consumer and commercial deposits, including deposits from correspondent banks and public funds deposits. The following table presents the composition of total deposits at the end of the last three years:
Time deposits of $100,000 or more are solicited from markets served by the Bank and are not sought through brokered sources. Time deposits continue to be a significant source of funds. The following table presents the maturities of time deposits of $100,000 or more as of December 31, 1998 and 1997:
Maturities of Time Deposits of $100,000 or More December 31, (Dollars in Thousands) 1998 1997 - ------------------------------------------------------------------------- Three Months or Less ............................. $254,936 $228,072 After Three through Six Months ................... 88,718 98,902 After Six through Twelve Months .................. 123,231 70,615 After Twelve Months .............................. 78,811 60,478 - ------------------------------------------------------------------------- Total .................................... $545,696 $458,067 ========================================================================= Weighted Average Rate on Time Deposits of $100,000 or More ............................ 5.32% 5.50% =========================================================================
Mexico is a part of the trade territory of the Company and foreign deposits from Mexican sources have traditionally been a source of funding. In December 1995, the Mexican government announced a 20% devaluation of the Mexican peso relative to the United States dollar, and the Mexican peso has since continued to decline relative to the dollar. The Company does not anticipate any negative impact on foreign deposits due to these recent devaluations of the peso. The increase in foreign deposits is primarily attributable to Mexican deposits obtained from acquisitions. The following table presents foreign deposits, primarily from Mexican sources, as of December 31, 1998 and 1997:
Foreign Deposits December 31, (Dollars in Thousands) 1998 1997 - ----------------------------------------------------------------------- Demand Deposits ............................... $ 10,667 $ 8,066 - ----------------------------------------------------------------------- Interest-Bearing Deposits Savings ............................... 21,638 20,373 Money Market Checking and Savings ..... 32,324 26,400 Time Deposits Under $100,000 .......... 66,104 57,645 Time Deposits of $100,000 or more ..... 133,641 99,486 - ----------------------------------------------------------------------- Total Interest-Bearing Deposits 253,707 203,904 - ----------------------------------------------------------------------- Total Foreign Deposits ........ $264,374 $211,970 ======================================================================= Percentage of Total Deposits .................. 16.92% 15.60% ======================================================================= Weighted Average Rate on Foreign Deposits ..... 4.60% 4.75% =======================================================================
LIQUIDITY
Liquidity management assures that adequate funds are available to meet deposit withdrawals, loan demand and maturing liabilities. Insufficient liquidity can result in higher costs of obtaining funds, while excessive liquidity can lead to a decline in earnings due to the cost of foregoing alternative investments. The ability to renew and acquire additional deposit liabilities is a major source of liquidity. The Company's principal sources of funds are primarily within the local markets of the Bank and consist of deposits, interest and principal payments on loans and securities, sales of loans and securities and borrowings. See previous discussion regarding the maturity dates for "Loans," "Securities" and "Deposits."
Asset liquidity is provided by cash and assets which are readily marketable, or which can be pledged, or which will mature in the near future. These include cash, federal funds sold and U.S. Government Agency and mortgage-backed securities. At December 31, 1998, the Company's liquidity ratio, defined as cash, U.S. Government Agency and mortgage-backed securities and federal funds sold as a percentage of deposits, was 33.0% compared to 34.3% at December 31, 1997 and compared to 35.0% at December 31, 1996.
Liability liquidity is provided by access to core funding sources, principally various customers' interest-bearing and noninterest-bearing deposit accounts in the Company's trade area. The Company does not have nor does it solicit brokered deposits. Federal funds purchased and short-term borrowings are additional sources of liquidity. These sources of liquidity are short-term in nature, and are used, as necessary, to fund asset growth and meet short-term liquidity needs.
During 1998, funds for $720.0 million of securities purchases and $131.7 million of net loan growth came from various sources, including a net increase in deposits of $143.7 million, $378.4 million in proceeds from sale of securities, $311.9 million in proceeds from maturing securities and $22.5 million of net income.
The Federal Deposit Insurance Corporation Improvement Act of 1991 ("FDICIA") requires that federal bank regulatory authorities take "prompt corrective action" with respect to any depository institution which does not meet specified minimum capital requirements. The applicable regulations establish five capital levels which require or permit the Federal Reserve Board and other regulatory authorities to take supervisory action. The relevant classifications range from "well capitalized" to "critically undercapitalized." The classifications are generally determined by applicable ratios of the institution, including Tier I capital to risk-weighted assets, total capital to risk-weighted assets and leverage ratios. Capital ratios for Texas State Bank as of December 31, 1998 exceeded the "well capitalized" requirements under the applicable regulations. As a result, the Company does not believe that the prompt corrective action regulations have any material effect on the activities or operations of the Company or Texas State Bank.
The Corporation is dependent on dividends from its subsidiaries and the sale of stock for its liquidity. Applicable Federal Reserve Board regulations provide that bank holding companies are permitted by regulatory authorities to pay cash dividends on their common or preferred stock if consolidated earnings and consolidated capital are within regulatory guidelines and the Bank is classified as "well capitalized" for purposes of FDICIA.
The principal source of liquidity for the Corporation during 1998 was dividends received from subsidiaries of $10.4 million. Uses of the funds received included investments in subsidiaries of $8.0 million and common stock dividends paid of $6.4 million.
The funds management policy of the Company is to maintain a reasonably balanced position of rate sensitive assets and liabilities to avoid adverse changes in net interest income. Changes in net interest income occur when interest rates on loans and securities change in a different time period from that of changes in interest rates on liabilities, or when the mix and volume of interest-earning assets and interest-bearing liabilities change. The interest rate sensitivity gap represents the dollar amount of difference between rate sensitive assets and rate sensitive liabilities within a given time period ("GAP"). A GAP ratio is determined by dividing rate sensitive assets by rate sensitive liabilities. A ratio of 1.0 indicates a perfectly matched position, in which case the effect on net interest income due to interest rate movements would be zero.
Rate sensitive liabilities maturing within one year exceeded rate sensitive assets with comparable maturities at December 31, 1998 by $449.1 million. Management monitors the rate sensitivity GAP on a regular basis and takes steps when appropriate to improve the sensitivity. The cumulative rate sensitive GAP to Total Assets at a period of twelve months or less was (25.5)% at December 31, 1998.
The following table summarizes interest rate sensitive assets and liabilities by their repricing dates at December 31, 1998:
(1) Rate sensitive interest-earning assets less rate sensitive interest-bearing liabilities.
Gap analysis is the simplest representation of the Company's interest rate sensitivity. However, it cannot reveal the impact of factors such as administered rates (e.g., the prime lending rate), pricing strategies on consumer and business deposits, changes in balance sheet mix, or the effect of various options embedded in balance sheet instruments. Accordingly, the Funds Management Committee conducts simulations of net interest income under a variety of market interest rate scenarios. These simulations, which consider forecasted balances sheet changes and forecasted changes in interest rate spreads, provide the Committee with an estimate of earnings at risk for given changes in interest rates. Assuming an immediate 100 basis point decline in interest rates based upon the asset and liability mix at December 31, 1998, projected net interest income for the following twelve months would decline by 6.6%. An immediate 100 basis point decline in interest rates is a hypothetical rate scenario, used to calibrate risk, and does not necessarily represent management's current view of future market developments.
All the measurements of risk described above are made based upon the Company's business mix and interest rate exposures at the particular point in time. The exposures change continuously as a result of the Corporation's ongoing business and its risk management initiatives. While management believes these measures provide a meaningful representation of the Company's interest rate sensitivity, they do not necessarily take in account all business developments that have an effect on net income, such as changes in credit quality or the size and composition of the balance sheet.
The Company does not currently engage in trading activities or use derivative instruments to control interest rate risk. Even though such activities may be permitted with the approval of the Board of Directors, the Company does not intend to engage in such activities in the immediate future.
Interest rate risk is the most significant market risk affecting the Company. Other types of market risk, such as foreign currency exchange rate risk and commodity price risk, do not arise in the normal course of the Company's business activities.
EFFECTS OF INFLATION
Financial institutions are impacted differently by inflation than are industrial companies. While industrial and manufacturing companies generally have significant investments in inventories and fixed assets, financial institutions ordinarily do not have such investments. As a result, financial institutions are generally in a better position than industrial companies to respond to inflationary trends by monitoring the spread between interest costs and interest income yields through adjustments of maturities and interest rates of assets and liabilities. In addition, inflation tends to increase demand for loans from financial institutions as industrial companies attempt to maintain a constant level of goods in inventory and assets. As consumers of goods and services, financial institutions are affected by inflation as prices increase, causing an increase in costs of salaries, employee benefits, occupancy expense and similar items.
CAPITAL RESOURCES
Shareholders' equity of $177.5 million for the year ended December 31, 1998 reflects a net increase of approximately $15.9 million or 9.8% compared to shareholders' equity of $161.6 million for the year ended December 31, 1997. This net increase was primarily attributable to earnings in 1998.
The risk-based capital standards as established by the Federal Reserve Board of Governors apply to Texas Regional and Texas State Bank. The numerator of the risk-based capital ratio for bank holding companies includes Tier I capital, consisting of common shareholders' equity and qualifying cumulative and noncumulative perpetual preferred stock; and Tier II capital, consisting of other preferred stock, reserve for possible loan losses and certain subordinated and term-debt securities. Goodwill is deducted from Tier I capital. At no time is Tier II capital allowed to exceed Tier I capital in the calculation of total capital. The denominator or asset portion of the risk-based ratio aggregates generic classes of balance sheet and off-balance sheet exposures, each weighted by one of four factors, ranging from 0% to 100%, based on the relative risk of the exposure class.
Ratio targets are set for both Tier I and total capital (Tier I plus Tier II capital). The minimum level of Tier I capital to total assets is 4.0% and the minimum total capital ratio is 8.0%. The Federal Reserve Board has guidelines for a leverage ratio that is designed as an additional evaluation of capital adequacy of banks and bank holding companies. The leverage ratio is defined to be the company's Tier I capital divided by its quarterly average total assets less goodwill and other intangible assets. An insured depository institution is "well capitalized" for purposes of FDICIA if its Total Capital Ratio is equal to or greater than 10.0%, and Tier I Capital Ratio is equal to or greater than 6.0%, and Leverage Capital Ratio is equal to or greater than 5.0%. The Company's Tier I Capital Ratio was approximately 12.92% and 13.60% as of December 31, 1998 and 1997, respectively. The Company's Total Capital Ratio was approximately 14.06% and 14.73% as of December 31, 1998 and 1997, respectively. The Company's Leverage Capital Ratio was 8.85% and 9.21% at December 31, 1998 and 1997, respectively. Based on capital ratios, the Company is within the definition of "well capitalized" for Federal Reserve purposes as of December 31, 1998.
The following table presents the Company's risk-based capital calculation:
Risk-Based Capital December 31, (Dollars in Thousands) 1998 1997 - ------------------------------------------------------------------------------- Total Shareholders' Equity before unrealized gains or losses on Securities Available for Sale ..................... $ 176,859 $ 160,648 Less Goodwill and Other Deductions ............. (26,894) (24,001) - ------------------------------------------------------------------------------- Total Tier I Capital ........................... 149,965 136,647 Total Tier II Capital .......................... 13,236 11,291 - ------------------------------------------------------------------------------- Total Qualifying Capital ....................... $ 163,201 $ 147,938 =============================================================================== Risk Adjusted Assets (Including Off-Balance Sheet Exposure) ..................... $ 1,161,053 $ 1,004,511 =============================================================================== Tier I Capital Ratio ........................... 12.92% 13.60% Total Capital Ratio ............................ 14.06 14.73 Leverage Capital Ratio ......................... 8.85 9.21 ===============================================================================
YEAR 2000 PROJECT
GENERAL
The Year 2000 problem affects all companies. This problem is rooted in storage constraints of systems developed in the 1960's and 1970's. Many computer codes used only two-digit year codes, e.g., 98 instead of four digits, 1998. Thus, many computer applications interpret the year "00" as 1900 and accordingly need to be modified to process in the next century.
In the early 1990's, management of Texas State Bank (the "Bank") decided to process all data in-house and offer data processing services to third party banks. As part of this initiative, management decided to purchase all critical software and support services from third party software vendors. All of the critical software purchased had already been coded to recognize a four-digit date. The Bank has no in-house supported computer applications.
STATE OF READINESS
In early 1997, the Bank established an ongoing corporate-wide effort to address the issues associated with the Year 2000. The Bank adopted the phased approach to Year 2000 project management as outlined by the Federal Financial Institutions Examination Council ("FFIEC"). The Bank's project goals are to meet if not exceed all Year 2000 regulatory guidelines. This approach requires the active involvement of management and the Board of Directors. This active management involvement provides the sponsorship and commitment to ensure the business issues and risks are adequately addressed and resolved. The FFIEC phases used are Awareness Phase, Assessment Phase, Renovation Phase, Validation Phase and Implementation Phase.
AWARENESS PHASE: DEFINE THE PROBLEM AND GAIN MANAGEMENT SUPPORT.
The Bank established a Year 2000 Committee comprised of all levels of management to address the Year 2000 project. An action plan was developed that includes strategies for dealing with in-house and third party computer systems, vendors, customers and business partners. An ongoing process to continually evaluate customers, business partners and management practices and policies will be phased in as the Year 2000 project evolves.
ASSESSMENT PHASE: ASSESS THE SIZE AND COMPLEXITY OF THE PROBLEM. EVALUATE RISK IMPACT AND ESTABLISH CONTINGENCY PLANS.
The Bank has essentially completed the assessment phase. Information Technology "(IT)" and Non IT systems have been identified. Systems have generally been identified as Core Mission critical, Non Mission critical and Business critical. Risk impact of material customers and other business partners are identified and due diligence procedures developed. The impact of strategic business initiatives, resources, needs and time lines have been addressed. A contingency plan for the Bank was completed on June 22, 1998 and addresses Core Mission critical and Business critical systems. Continually assessing risk is a major goal in the Year 2000 process.
RENOVATION PHASE: UPGRADE OR REPLACE NON-COMPLIANT SYSTEMS.
Core Mission critical software and hardware vendors of the Bank have represented their products as being Year 2000 compliant. The Bank is currently testing these products to corroborate the vendor representations. Certain Non Mission critical systems have been identified as not Year 2000 compliant. These systems will require the purchase of compliant systems from third party vendors. Renovation timelines have been established and all upgrades will be completed by June 30, 1999.
VALIDATION PHASE: TESTING CURRENT AND UPGRADED SYSTEMS.
The Bank has created a Year 2000 Test Lab located in the Data Center to test many of the internal and external Core Mission critical systems. The Bank completed all internal Core Mission critical testing by September 30, 1998. In addition, the Bank has requested and received vendor representations that all Core Mission critical applications are Year 2000 compliant. Interface testing with FEDLINE had been completed by the Data Center and Trust Department at December 31, 1998. The Wire Transfer Department and Customer Service Department will be completed by March 31, 1999.
IMPLEMENTATION PHASE: SYSTEMS MUST BE YEAR 2000 READY BEFORE YEAR 2000.
In this phase, all systems should be fully renovated, tested and certified as Year 2000. If systems fail to meet Year 2000 requirements, contingency plans will be implemented. The Bank anticipates that all systems will be fully renovated and tested by June 30, 1999.
ESTIMATED COSTS
The Bank has estimated the total cost of the Year 2000 project at $500,000. The approximate cost expensed was $31,000 in 1997, $253,000 in 1998 and is estimated to be $216,000 in 1999.
RISK
Testing and planning do not ensure that any organization will be able to conduct business around and after the Year 2000. Testing does not ensure that the Bank's customers and other business partners will be able to conduct business. The Bank is performing due diligence on its customers and other business partners. Where our customers and business partners are regulated, we take comfort from knowing that this is a regulated entity and its regulator is doing its own due diligence. Where our customers and business partners are not regulated, the Bank implemented processes for evaluating readiness of customers and business partners for the Year 2000. These processes are continuously monitored.
CONTINGENCY PLAN
The Bank has implemented procedures and continues to refine its processes for evaluating its business readiness. Still, the possibility exists that something can go wrong. The Bank has prepared contingency plans to ensure a smooth flow of funds in the event of unforeseen problems. The effect of many business disruptions at the same time may impact the Bank. These contingency plans are reviewed continually to reasonably address these incidents.
CURRENT ACCOUNTING ISSUES
In June 1997, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 130, ("Statement 130") "Reporting Comprehensive Income." Statement 130 establishes standards for reporting and display of comprehensive income and its components (revenues, expenses, gains, and losses) in a full set of general-purpose financial statements. Statement 130 requires that an enterprise (a) classify items of other comprehensive income by their nature in a financial statement and (b) display the accumulated balance of other comprehensive income separately from retained earnings and additional paid-in capital in the equity section of a statement of financial position. Statement 130 is effective for fiscal years beginning after December 15, 1997. The adoption of Statement 130 did not have a material impact on the Company's financial position, results of operations, or liquidity.
In June 1997, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 131, ("Statement 131") "Disclosures about Segments of an Enterprise and Related Information." Statement 131 establishes standards for the way that public business enterprises report information about operation segments in annual financial statements and requires that those enterprises report selected information about operation segments in interim financial reports issued to shareholders. Statement 131 also establishes standards for related disclosures about products and services, geographic areas, and major customers. Statement 131 is effective for financial statements for periods beginning after December 15, 1997. The Company did not identify any reportable operating segments based on the requirements of Statement 131.
The Financial Accounting Standards Board's Statement No. 133 ("Statement 133"), "Accounting for Derivative Instruments and for Hedging Activities," was issued in June 1998. Statement 133 requires companies to recognize all derivatives as either assets or liabilities in the statement of financial condition and measure those instruments at fair value. Statement 133 requires that changes in fair value of a derivative be recognized currently in earnings unless specific hedge accounting criteria are met. Statement 133 is effective for fiscal years beginning after June 15, 1999. The Company does not currently have derivative instruments as defined by Statement 133.
FOURTH QUARTER RESULTS
The fourth quarter net income for 1998 of $7.1 million or $0.48 per diluted common share reflected an increase of $1.3 million or 21.6% compared to $5.8 million or $.40 per share for the fourth quarter of 1997. Results for the fourth quarter of 1998 reflected increases in net interest income, noninterest income and noninterest expense compared to the fourth quarter of 1997.
Net interest income of $17.8 million for the fourth quarter of 1998 increased $1.6 million or 9.9% compared to $16.2 million for the fourth quarter of 1997, reflecting an increased volume of earning assets in part to the vitality of the Rio Grande Valley economy. Average earning assets of $1.6 billion for the fourth quarter of 1998 increased $194.4 million or 14.2% compared to $1.4 billion for the fourth quarter of 1997. Net interest margin for the fourth quarter of 1998 was 4.52% compared to 4.70 % for the fourth quarter of 1997.
The provision for loan losses charged against earnings in the fourth quarter of 1998 totaled $650,000 compared to $1.2 million for the fourth quarter of 1997, reflecting a decrease of $516,000 or 44.3%. Net charge-offs (recoveries) of $(31,000) for the fourth quarter of 1998 decreased $505,000 or 106.5% compared to net charge-offs of $474,000 for the fourth quarter of 1997.
Noninterest income of $4.2 million for the fourth quarter of 1998 increased $821,000 or 24.1% compared to $3.4 million for the fourth quarter of 1997, primarily due to an increased volume of business. All components of noninterest income reflected increases for fourth quarter of 1998 compared to fourth quarter of 1997.
Noninterest expense of $10.4 million for the fourth quarter of 1998 increased $1.1 million or 12.2% compared to $9.2 million for the fourth quarter of 1997, primarily due to an increased volume of business. The Efficiency Ratio of expense to total revenue averaged 46.66% for the fourth quarter of 1998 compared to 47.75% for the fourth quarter of 1997.
The fourth quarter net income for 1998 of $7.1 million or $0.48 per diluted common share reflected an increase of $4.3 million or 152.9% compared to $2.8 million or $0.19 per diluted common share for the third quarter of 1998. Operating results for the fourth quarter of 1998 reflected an increase in net interest income while provision for loan losses, noninterest income and noninterest expense decreased from the third quarter of 1998.
Net interest income of $17.8 million for the fourth quarter of 1998 increased $1.5 million or 9.3% compared to $16.3 million for the third quarter of 1998, reflecting a continued increasing volume of earning assets. Average earning assets of $1.6 billion for the fourth quarter of 1998 increased $41.2 million or 2.7% compared to $1.5 billion for the third quarter of 1998. The fourth quarter of 1998 net interest margin was 4.52% compared to 4.25% in the third quarter of 1998.
The provision for loan losses charged against earnings in the fourth quarter of 1998 of $650,000 compared to $7.2 million for the third quarter of 1998, reflecting a decrease of $6.5 million or 90.9%. Net charge-offs (recoveries) of $(31,000) for the fourth quarter of 1998 decreased $6.7 million or 100.5% compared to net charge-offs of $6.6 for the third quarter of 1998.
Noninterest income of $4.2 million for the fourth quarter of 1998 decreased $1.6 million or 27.8% compared to $5.9 million for the third quarter of 1998, primarily due to realized gains on sales of securities in the third quarter. Net Realized Gains on Sales of Available for Sale Securities of $353,000 for the fourth quarter of 1998 reflect a net decrease of $1.8 million compared to $2.1 million for the third quarter of 1998.
Noninterest expense of $10.4 million for the fourth quarter of 1998 decreased $227,000 or 2.1% compared to $10.6 million for the third quarter of 1998. The Efficiency Ratio of expense to total revenue averaged 46.66% for the fourth quarter of 1998 compared to 52.69% for the third quarter of 1998.
The nonaccrual and renegotiated loans at December 31, 1998 of $10.4 million decreased $4.7 million or 31.3% compared to $15.2 million at September 30, 1998 primarily due to lower nonaccrual loan volumes.
The following table presents a summary of operations for the last five quarters:
*Taxable-equivalent basis assuming a 35% tax rate.
FORWARD-LOOKING STATEMENTS
Certain of these statements contained herein that are not historical facts are forward-looking statements as that term is defined for purposes of the Private Securities Litigation Reform Act. The Company's actual results may differ materially from those included in the forward-looking statements. Forward-looking statements involve risks and uncertainties including, but not limited to, the following: changes in general economic conditions, including the performance of financial markets and interest rates; customer responsiveness to new products; competitive, regulatory, or tax changes that affect the cost of or demand for the Company's products and services; and other risks detailed from time to time in the Company's filings with the Securities and Exchange Commission. The Company disclaims any obligation to update statements herein.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
MANAGEMENTS REPORT ON RESPONSIBILITY FOR FINANCIAL REPORTING
To Our Shareholders
The management of Texas Regional Bancshares, Inc. and its subsidiaries has the responsibility for preparing the accompanying consolidated financial statements and for their integrity and objectivity. The statements were prepared in accordance with generally accepted accounting principles. The consolidated financial statements include amounts that are based on management's best estimates and judgments. Management also prepared the other information in the annual report and is responsible for its accuracy and consistency with the consolidated financial statements.
Management maintains a comprehensive system of internal control to assure the proper authorization of transactions, the safeguarding of assets, and the reliability of the financial records. The system of internal control provides for appropriate division of responsibility and is documented by written policies and procedures that are communicated to employees. The Company maintains a strong internal auditing program that independently assesses the effectiveness of the internal controls and recommends possible improvements thereto. Management believes that as of December 31, 1998, the Company maintains an effective system of internal control.
The Audit Committee of the Board of Directors reviews the systems of internal control and financial reporting. The Committee meets and consults regularly with management, the internal auditors and the independent accountants to review the scope and results of their work.
The accounting firm of KPMG LLP has performed an independent audit of the Company's consolidated financial statements. Management has made available to KPMG LLP all of the Company's financial records and related data, as well as the minutes of shareholders' and directors' meetings. Furthermore, management believes that all representations made to KPMG LLP during its audit were valid and appropriate. The firm's report appears below.
Glen E. Roney R. T. Pigott, Jr. Chairman of the Board, President Executive Vice President & Chief Executive Officer & Chief Financial Officer
January 29, 1999
INDEPENDENT AUDITORS' REPORT
Board of Directors Texas Regional Bancshares, Inc.
We have audited the accompanying consolidated balance sheets of Texas Regional Bancshares, Inc. and subsidiaries as of December 31, 1998 and 1997, the related consolidated statements of income and comprehensive income, changes in shareholders' equity and cash flows for each of the years in the three-year period ended December 31, 1998. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Texas Regional Bancshares, Inc. and subsidiaries at December 31, 1998 and 1997, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 1998 in conformity with generally accepted accounting principles.
KPMG LLP
Houston, Texas January 29, 1999
CONSOLIDATED FINANCIAL STATEMENTS
The accompanying notes are an integral part of the consolidated financial statements.
CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
The accompanying notes are an integral part of the consolidated financial statements.
CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Texas Regional Bancshares, Inc. and Subsidiaries CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY Years Ended December 31, 1998, 1997 and 1996
Consolidated Financial Statements (Continued)
CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Texas Regional Bancshares, Inc. and Subsidiaries NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 1998, 1997 and 1996
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Texas Regional Bancshares, Inc. (the "Parent" or "Corporation") and subsidiaries (collectively, the "Company") is headquartered in McAllen, Texas. The Company provides a broad array of customary banking services and operates twenty banking offices throughout the Rio Grande Valley at December 31, 1998. The accounting and reporting policies followed by the Company conform to generally accepted accounting principles and to general practices within the banking industry.
PRINCIPLES OF CONSOLIDATION -
The consolidated financial statements include the accounts of Texas Regional Bancshares, Inc. and its wholly owned subsidiaries, Texas Regional Delaware, Inc. and Texas State Bank (the "Bank"). The Company eliminates all significant intercompany transactions and balances in consolidation. The Corporation accounts for investments in the subsidiaries on the equity method in the Parent's financial statements.
USE OF ESTIMATES -
The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
TRUST ASSETS -
Assets held by the trust department of the Bank in fiduciary or agency capacities are not assets of the Company and are not included in the consolidated balance sheets.
CASH AND CASH EQUIVALENTS -
For purposes of the consolidated statements of cash flows, cash and cash equivalents include cash on hand, amounts due from banks and investments with original maturities of three months or less.
SECURITIES -
Securities that management has both the positive intent and ability to hold to maturity are classified as securities held to maturity and are carried at cost, adjusted for amortization of premium or accretion of discount using the interest method. Securities that may be sold prior to maturity for asset/liability management purposes, or that may be sold in response to changes in interest rates, to changes in prepayment risk, to increase regulatory capital or other similar factors, are classified as securities available for sale and carried at fair value with any adjustments to fair value, after tax, reported as a separate component of shareholders' equity and as other comprehensive income. Declines in the fair value of individual held to maturity and available for sale securities below their cost that are other than temporary result in write-downs of the individual securities to their fair value. The related write-downs are included in earnings as realized losses.
The Company reports interest and dividends on securities, including the amortization of premiums and the accretion of discounts, in interest on securities using the interest method. It records gains and losses on the sale of securities on the trade date using the specific-identification method.
LOANS -
Loans that management has the intent and ability to hold for the foreseeable future or until maturity or pay-off generally are reported at their outstanding unpaid principal balances adjusted for charge-offs, the allowance for loan losses, and any deferred fees or costs on originated loans or unamortized premiums or discounts on purchased loans. The Company recognizes interest income on discounted loans on the sum-of-the-months-digits method, which approximates the interest method. Interest income accrues on the unpaid principal balance of other loans. Interest income includes discounts and premiums amortized using the interest method. Loan origination fees, net of certain direct origination costs, are deferred and recognized as an adjustment of the yield (interest method).
NONACCRUAL LOANS -
The Company discontinues the accrual of interest on loans at the time the loan is 90 days delinquent unless the credit is well secured and in process of collections. In all cases, loans must be placed on nonaccrual or charged-off at an earlier date if collection of principal or interest is considered doubtful.
All interest accrued but not collected for loans that are placed on nonaccrual or charged off is reversed against interest income. The interest on these loans is accounted for on the cash basis or cost-recovery method, until qualifying for a return to accrual status. Loans are returned to accrual status when all the principal and interest amounts contractually due are reasonably assured of repayment within a reasonable period and when the borrower has demonstrated payment performance history.
ALLOWANCE FOR LOAN LOSSES -
The Company has established the allowance for loan losses through provisions for loan losses charged against income. It charges off portions of loans deemed uncollectible against the allowance for loan losses, and credits subsequent recoveries, if any, to the allowance.
The allowance for loan losses related to impaired loans that are identified for evaluation is based on discounted cash flows using the loan's initial effective interest rate, or for collateral-dependent loans, the fair value, less selling costs, of the collateral. By the time a loan becomes probable of foreclosure, the Company charges it down to fair value, less estimated cost to sell.
Management's periodic evaluation of the adequacy of the allowance is based on the Company's past loan loss experience, known and inherent risks in the portfolio, adverse situations that may affect the borrower's ability to repay (including the timing of future payments), the estimated value of any underlying collateral, composition of the loan portfolio, and current economic conditions. This evaluation is inherently subjective, as it requires material estimates that are susceptible to significant change including the amounts and timing of future cash flows expected to be received on impaired loans.
Management believes that the allowance for loan losses at December 31, 1998 adequately reflects the risks in the loan portifolio. Various regulatory agenies, as an integral part of their examination process, periodically review the Company's allowance for loan losses. Such agenies may require the Company to recognize additions to the allowance based on their judgements of information available to them at the time of their examination.
FORECLOSED ASSETS -
Foreclosed assets, which includes other foreclosed assets included in Other Assets, include properties acquired through foreclosure in full or partial satisfaction of the related loan.
The Company records foreclosed assets initially at the lower of fair value, net of estimated selling costs, or cost, at the date of foreclosure. After foreclosure, it carries the assets at the lower of (1) cost or (2) fair value, less estimated costs to sell based on valuations periodically performed by management. Revenue and expenses from operations and changes in the valuation allowance are included in noninterest expense.
INCOME TAXES -
Deferred income tax assets and liabilities are determined using the liability (or balance sheet) method. Under this method, the net deferred tax asset or liability is determined based on the tax effects of the differences between the book and tax basis of the various balance sheet assets and liabilities and gives current recognition to changes in tax rates and laws. The Company files a consolidated federal income tax return.
PREMISES AND EQUIPMENT -
Premises and equipment are stated at cost, net of accumulated depreciation and amortization. Depreciable assets are depreciated over their estimated useful lives. For financial reporting, depreciation is computed using the straight-line method; in computing federal income tax, both the straight-line and accelerated methods are used. Maintenance and repairs which do not extend the life of premises and equipment are charged to noninterest expense.
GOODWILL AND IDENTIFIABLE INTANGIBLES -
Goodwill represents the excess of the purchase price over the estimated fair value of identifiable net assets associated with acquisition transactions. The Company amortizes goodwill on a straight-line basis over 15 years and identifiable intangibles on a straight-line basis over their estimated periods of benefit.
YEAR 2000 -
The Company has developed and implemented a plan to deal with the Year 2000 problem. The plan provides for addressing Core Mission critical, Non Mission critical and Business critical issues, complete with the assignment of responsibility and target dates for completion. Core applications, such as mainframe software and hardware, and some platform software have been certified as Year 2000 compliant. Testing of these applications are scheduled to be completed by March 31, 1999. The Year 2000 problem is the result of computer programs being written using two digits rather that four to define the applicable year. The Company is expensing all costs incurred as a result of addressing the Year 2000 issue.
STOCK OPTION PLAN -
Prior to January 1, 1996, the Company accounted for its stock compensation programs in accordance with the provisions of Accounting Principles Board ("APB") Opinion No. 25, "Accounting for Stock Issued to Employees," and related: interpretations. As such, compensation expense would be recorded on the date of grant only if the current market price of the underlying stock exceeded the exercise price. On January 1, 1996, the Company adopted the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 123, ("Statement 123") "Accounting for Stock-Based Compensation," which permits entities to recognize as expense over the vesting period the fair value of all stock-based awards on the date of grant. Alternatively, Statement 123 also allows entities to continue to apply the provisions of APB Opinion No. 25 and provide pro forma net income and pro forma earnings per share disclosures for employee stock option grants made in 1995 and future years as if the fair-value-based method defined in Statement 123 had been applied. The Company has elected to continue to apply the provisions of APB Opinion No. 25 and provide the pro forma disclosure provisions of Statement 123.
EARNINGS PER COMMON SHARE COMPUTATIONS -
In February 1997, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 128, ("Statement 128") "Earnings per Share." Statement 128 specifies the computation, presentation, and disclosure requirements for earnings per share (EPS) for entities with publicly held common stock or potential common stock. Statement 128 replaces primary EPS and fully diluted EPS on the face of the income statement for all entities with complex capital structures and requires a reconciliation of the basic EPS computation to the diluted EPS. Basic EPS is calculated by dividing net income available to common shareholders, by the weighted average number of common shares outstanding. The computation of diluted EPS assumes the issuance of common shares for all dilutive potential common shares outstanding during the reporting period. The dilutive effect of stock options are considered in earnings per share calculations if dilutive, using the treasury stock method. Statement 128 is effective for financial statements issued for periods ending after December 15, 1997, including interim periods. The Company adopted Statement 128 in 1997, accordingly, all prior-period earnings per share data presented in the accompanying consolidated financial statements has been restated to conform to the requirements of Statement 128. Adoption of Statement 128 did not have a material effect on the Company's consolidated financial statements.
IMPAIRMENT OF LONG-LIVED ASSETS AND LONG-LIVED ASSETS TO BE DISPOSED OF -
The Company adopted the provisions of Statement of Financial Accounting Standards No. 121, ("Statement 121") "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of," on January 1, 1996. Statement 121 requires that Long-lived assets and certain identifiable intangibles will be reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to future net cash flows expected to be generated by the asset. If such assets are considered impaired, the impairment to be recognized will be measured by the amount by which the carrying amounts of the assets exceed the fair value of the assets. Assets to be disposed of will reported at the lower of the carrying amount or fair value less costs to sell.
TRANSFERS AND SERVICING OF FINANCIAL ASSETS AND EXTINGUISHMENTS OF LIABILITIES -
In June 1996, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 125, ("Statement 125") "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities." In December 1996, the Financial Accounting Standards No. 127, ("Statement 127") "Deferral of the Effective Date of Certain Provisions of FASB No. 125." Statement 125 is effective for transfers and servicing of financial assets and extinguishment of liabilities occurring after December 31, 1996 and is to be applied prospectively. Statement 127 defers for a year the effective date for all transfers of financial assets. Statement 125 provides accounting and reporting standards for transfers and servicing of financial assets and extinguishment of liabilities based on consistent application of a financial-components approach that focuses on control. It distinguishes transfers of financial assets that are sales from transfers that are secured borrowings. Adoption of Statement 125 and 127 did not have a material impact on the Company's financial position, results of operations, or liquidity.
DISCLOSURE OF INFORMATION ABOUT CAPITAL STRUCTURE -
In February 1997, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 129, ("Statement 129") "Disclosure of Information about Capital Structure." Statement 129 lists required disclosures about capital structure that had been included in a number of previously existing separate statements and opinions. It applies to all entities, public and nonpublic. Statement 129 is effective for financial statements issued for periods ending after December 15, 1997. Adoption of Statement 129 did not have a material effect or significantly alter the Company's consolidated financial statements.
REPORTING COMPREHENSIVE INCOME -
In June 1997, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 130, ("Statement 130") "Reporting Comprehensive Income." Statement 130 establishes standards for reporting and display of comprehensive income and its components (revenues, expenses, gains and losses) in a full set of general-purpose financial statements. Statement 130 requires that an enterprise (a) classify items of other comprehensive income by their nature in a financial statement and (b) display the accumulated balance of other comprehensive income separately from retained earnings and additional paid-in capital in the equity section of a statement of financial position. Statement 130 is effective for fiscal years beginning after December 15, 1997. Adoption of Statement 130 did not have a material impact on the Company's consolidated financial statements.
DISCLOSURES ABOUT SEGMENTS OF AN ENTERPRISE AND RELATED INFORMATION -
In June 1997, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 131, ("Statement 131") "Disclosures about Segments of an Enterprise and Related Information." Statement 131 establishes standards for the way that public business enterprises report information about operation segments in annual financial statements and requires that those enterprises report selected information about operation segments in interim financial reports issued to shareholders. Statement 131 also establishes standards for related disclosures about products and services, geographic areas, and major customers. Statement 131 is effective for financial statements for periods beginning after December 15, 1997. The Company did not identify any reportable operating segments based on the requirements of Statement 131.
ACCOUNTING FOR DERIVATIVE INSTRUMENTS AND FOR HEDGING ACTIVITIES -
The Financial Accounting Standards Board's Statement No. 133 ("Statement 133"), "Accounting for Derivative Instruments and for Hedging Activities," was issued in June 1998. Statement 133 requires companies to recognize all derivatives as either assets or liabilities in the statement of financial condition and measure those instruments at fair value. Statement 133 requires that changes in fair value of a derivative be recognized currently in earnings unless specific hedge accounting criteria are met. Statement 133 is effective for fiscal years beginning after June 15, 1999. The Company does not currently have derivative instruments as defined by Statement 133.
(2) CASH AND DUE FROM BANKS
The Bank is required to maintain reserves with the Federal Reserve Bank. No reserves were required at December 31, 1998 and the reserves required at December 31, 1997 were $1.4 million.
(3) SECURITIES
The amortized cost of securities and their estimated market values at December 31, 1998 and 1997 follow (dollars in thousands):
Net unrealized holding gains, net of related tax effect, of $609,000 and $907,000 at December 31, 1998 and 1997, respectively, on securities available for sale are reported as a separate component of shareholders' equity and as other comprehensive income.
Gross realized gains and gross realized losses on sales of securities available for sale were $3.0 million and $93,000, respectively, in 1998, $781,000 and $47,000 respectively, in 1997 and $705,000 and $304,000, respectively, in 1996. There were no sales of securities held to maturity in 1998, 1997 or 1996.
The scheduled maturities of securities available for sale and securities held to maturity at December 31, 1998 were as follows. Actual maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
SECURITIES -------------------------------------------- AVAILABLE FOR SALE HELD TO MATURITY ------------------------ ------------------- ESTIMATED ESTIMATED AMORTIZED MARKET AMORTIZED MARKET (Dollars in Thousands) COST VALUE COST VALUE - -------------------------------------------------------------------------------- Due in One Year or Less ........ $ 12,845 $ 12,865 $ 5,802 $ 5,846 Due From One to Five Years ..... 119,442 119,722 7,123 7,401 Due From Five To Ten Years ..... 203,389 203,839 1,406 1,403 Due After Ten Years ............ 119,315 119,510 -- -- - -------------------------------------------------------------------------------- Total .......... $454,991 $455,936 $ 14,331 $ 14,650 - --------------------------------------------------------------------------------
Securities with carrying values of $351.7 million at December 31, 1998 and $291.2 million at December 31, 1997 were pledged to secure public funds, trust assets on deposit and for other purposes required or permitted by law.
(4) Loans and Allowance for Loan Losses
The components of loans at December 31, 1998 and 1997 follows:
(Dollars in Thousands) 1998 1997 - -------------------------------------------------------------------------------- Commercial ............................... $ 311,966 $ 249,819 Commercial Tax-Exempt .................... 22,155 29,024 Agricultural ............................. 52,302 51,346 Real Estate Construction ........................... 66,018 69,477 Commercial Mortgage .................... 354,134 304,215 Agricultural Mortgage .................. 34,440 31,949 1-4 Family Mortgage .................... 128,945 122,043 Consumer ................................. 119,545 93,443 - -------------------------------------------------------------------------------- Total .................... $1,089,505 $ 951,316 - --------------------------------------------------------------------------------
In the ordinary course of business, the Company's subsidiary bank makes loans to its officers and directors, including entities related to those individuals. These loans are made on substantially the same terms and conditions as those prevailing at the time for comparable transactions with other persons and do not involve more than the normal risk of collectibility or present other unfavorable features. An analysis of these loans for the years ended December 31, 1998 and December 31, 1997 follows:
(Dollars in Thousands) 1998 1997 - -------------------------------------------------------------------------------- Balance at Beginning of Year ................. $ 5,507 $ 4,371 Additions .................................... 2,286 4,339 Reductions Collections .......................... (1,954) (3,203) Charge-Offs .......................... -- -- - -------------------------------------------------------------------------------- Balance at End of Year ....................... $ 5,839 $ 5,507 - --------------------------------------------------------------------------------
A summary of the transactions in the allowance for loan losses for the years ended December 31, 1998, 1997 and 1996 follows:
(Dollars in Thousands) 1998 1997 1996 - -------------------------------------------------------------------------------- Balance at Beginning of Year ............... $ 11,291 $ 10,806 $ 5,376 Balance from Acquisitions .................. 308 -- 4,647 Provision Charged to Expense ............... 9,729 2,947 2,173 Recovery of Amounts Previously Charged to Allowance ....................... 1,066 759 550 Losses Charged to Allowance ................ (9,158) (3,221) (1,940) - -------------------------------------------------------------------------------- Balance at End of Year ..................... $ 13,236 $ 11,291 $ 10,806 - --------------------------------------------------------------------------------
The Company identifies loans to be reported as impaired when such loans are on nonaccrual status or are considered troubled debt restructurings due to the granting of a below-market rate of interest or a partial forgiveness of indebtedness on an existing loan. The balance of impaired loans was $10.4 million at December 31, 1998 and $8.4 million at December 31, 1997. The average recorded investment in impaired loans during 1998 and 1997 was $11.2 million and $10.8 million, respectively. The total allowance for loan losses related to these loans was $1.4 million and $1.0 million on December 31, 1998 and 1997, respectively. Interest income on impaired loans of $232,000, $238,000 and $561,000 was recognized for cash payments received during 1998, 1997 and 1996, respectively. If interest on these impaired loans had been accrued at the original contractual rates, interest income would have been increased by approximately $2.2 million, $1.6 million and $807,000 for the years ended December 31, 1998, 1997 and 1996, respectively.
(5) Premises and Equipment
A summary of premises and equipment and related accumulated depreciation and amortization as of December 31, 1998 and December 31, 1997 follows:
Estimated (Dollars in Thousands) Useful Lives 1998 1997 - -------------------------------------------------------------------------------- Land ......................................... $ 10,373 $ 8,066 Buildings and Leasehold Improvements ......... 2-40 years 56,569 31,842 Construction in Progress ..................... 168 9,407 Furniture and Equipment ..................... 3-10 years 22,896 18,376 - -------------------------------------------------------------------------------- Subtotal ..................................... 90,006 67,691 Less Accumulated Depreciation and Amortization (20,179) (15,248) - -------------------------------------------------------------------------------- Total ........................ $ 69,827 $ 52,443 - --------------------------------------------------------------------------------
Depreciation and amortization expense for the years ended December 31, 1998, 1997 and 1996 was approximately $4.4 million, $3.4 million and $2.9 million, respectively.
The Company recorded an impairment loss of $630,000 during the three months ended June 30, 1997 to reflect the impairment of an existing bank building. During 1998, construction of a new corporate headquarters building in McAllen, Texas was completed adjacent to this site and the existing building was razed to provide additional parking. The amount of the impairment loss was the book value of the building at June 30, 1997.
(6) Time Deposits
Time deposits of $100,000 or more totaled $545.7 million and $458.1 million at December 31, 1998 and 1997, respectively. Interest expense for the years ended December 31, 1998, 1997 and 1996 on time deposits of $100,000 or more was approximately $28.7 million, $23.3 million and $14.9 million, respectively.
(7) Federal Funds Purchased and Securities Sold Under Repurchase Agreements
The following table summarizes selected information regarding federal funds purchased and securities sold under repurchase agreements as of and for the years ended December 31, 1998, 1997 and 1996:
(Dollars in Thousands) 1998 1997 1996 - -------------------------------------------------------------------------------- Balance at End of Year ............... $ 7,407 $ 1,801 $ 632 Rate on Balance at End of Year ....... 4.52% 5.98% 3.92% Average Daily Balance ................ $ 5,772 $ 980 $ 507 Average Interest Rate ................ 4.97% 5.27% 3.74% Maximum Month-End Balance ............ $14,835 $11,100 $ 700 - --------------------------------------------------------------------------------
Securities sold under agreements to repurchase are comprised of customer deposit agreements with maturities ranging from overnight to six months. These obligations are not federally insured but are collateralized by a security interest in various securities. These pledged securities are segregated and maintained by a third party bank.
(8) Income Tax
The components of income tax expense for the years ended December 31, 1998, 1997 and 1996 consisted of the following:
Following is a reconciliation between the amount of reported income tax expense for the years ended December 31, 1998, 1997 and 1996 and the amount computed by multiplying the income before tax by the federal statutory tax rate:
The net deferred tax liability included with accounts payable and accrued expenses in the accompanying consolidated balance sheets is comprised of the following deferred tax assets and liabilities as of December 31, 1998 and December 31, 1997.
(Dollars in Thousands) 1998 1997 - -------------------------------------------------------------------------------- Deferred Tax Liability Premises and Equipment ........................... $ 5,039 $ 4,394 Intangibles ...................................... 3,170 2,764 Unrealized Gain on Securities Available for Sale . 335 499 Other ............................................ 779 424 - -------------------------------------------------------------------------------- Total Deferred Tax Liability ..... 9,323 8,081 - -------------------------------------------------------------------------------- Deferred Tax Asset Allowance for Loan Losses ........................ 3,868 2,798 Unrealized Losses on Loans ....................... 61 834 Other Real Estate ................................ 28 55 Other ............................................ 579 542 - -------------------------------------------------------------------------------- Total Deferred Tax Assets Before Valuation Allowance ..... 4,536 4,229 Valuation Allowance ...................................... (35) (36) - -------------------------------------------------------------------------------- Total Deferred Tax Assets less Valuation Allowance ....... 4,501 4,193 - -------------------------------------------------------------------------------- Net Deferred Tax Liability ....... $ 4,822 $ 3,888 - --------------------------------------------------------------------------------
For the years ended December 31, 1998 and December 31, 1997, the deferred tax liability results primarily from the use of accelerated methods of depreciation of equipment for tax purposes and the write-off of core deposits for financial statement purposes. The deferred tax asset results from differences in the bad debts written-off for financial statement purposes and the amount allowed under tax law, and a difference in other real estate basis due to write-downs for financial statement purposes for both years ended December 31, 1998 and 1997, respectively.
Based upon the level of historical taxable income and projections for future taxable income over the periods which the deferred tax assets are deductible, management believes it is more likely than not the Company will realize the benefits of these deductible differences, net of the existing valuation allowances at December 31, 1998. The amount of the deferred tax asset considered realizable, however, could be reduced in the near term if estimates of future taxable income during the carryforward period are reduced.
(9) PREFERRED STOCK
The Corporation has 10.0 million authorized shares of $1 par value Preferred Stock. The Articles of Incorporation of the Corporation grant discretion to the Board of Directors to establish series of Preferred Stock with such rights, preferences and limitations as may be determined by resolution of the Board. No shares of preferred stock are currently outstanding.
(10) COMMON STOCK
The Corporation has 50.0 million authorized shares of $1 par value Common Stock. At December 31, 1998, 1997 and 1996, the number of common shares outstanding, retroactively adjusted for the three-for-two stock split effected as a stock dividend during 1997, are 14,411,583, 14,403,484 and 14,356,193, respectively.
On May 14, 1996, Texas Regional Bancshares, Inc. completed its secondary public offering of 2.5 million shares of the Corporation's Class A Voting Common Stock. On May 14, 1996 Texas Regional Bancshares, Inc. also completed the acquisition of First State Bank & Trust Co., Mission, Texas, and the Border Bank, Hidalgo, Texas, (the "Mergers"), through merger with Texas State Bank, the principal operating subsidiary of Texas Regional Bancshares, Inc. The purchase price of the Mergers was financed with a combination of proceeds from the 2.5 million share common equity offering and cash on the balance sheet of the Company.
(11) EMPLOYEE BENEFITS
The Company has an Employee Stock Ownership Plan (with section 401(k) provisions) (the "KSOP") covering substantially all of their employees. Employer contributions to the KSOP are discretionary, and as such, determined at the sole discretion of the Board of Directors. The KSOP covers employees who have completed twelve consecutive months of credited service, as defined in the plan, and attained age 21. A participant's account balance will be fully vested after six years of credited service. Pension expense, which includes employer matching as discussed below, for the years ended December 31, 1998, 1997 and 1996 was $469,000, $652,000 and $814,000, respectively.
The Company acquired an existing 401(k) plan in connection with its acquisition of the Bank of Texas. The plan is restricted to pre-acquisition participation by qualified employees.
The Company has granted stock options providing for the purchase of Class A Voting Common shares by certain key employees under five separate option plans approved by the shareholders. The following discussion concerning stock option plans has been restated to retroactively give effect for the three-for-two stock split declared and distributed by the Corporation during the third quarter of 1997.
The 1985 Nonstatutory Stock Option Plan ("the 1985 NSO Plan") authorized the award of stock options for 190,076 shares to the chief executive officer at a price determined by a committee of directors on the grant date. Options to acquire 190,076 shares at a weighted average exercise price of $8.00 per share were outstanding and exercisable under 1985 NSO Plan expiring on May 10, 2000 at December 31, 1998.
The 1985 Incentive Stock Option Plan ("the 1985 ISO Plan") provided for the grant of options for 190,076 shares at an exercise price of fair market value on the grant date to certain key employees of the Company. Options to acquire 21,065 shares at a weighted average exercise price of $8.00 per share were outstanding and exercisable under 1985 ISO Plan expiring on May 10, 2000 at December 31, 1998.
The 1995 Nonstatutory Stock Option Plan ("the 1995 NSO Plan") authorized the award of options up to an aggregate maximum of 135,000 shares at an exercise price of fair market value on the grant date. The Company granted options in 1996 with contractual terms of seven years and a vesting period of four years. Options to acquire 123,375 shares at a weighted average exercise price of $11.50 per share were outstanding, with 90,938 exercisable, under 1995 NSO Plan expiring on July 1, 2002 at December 31, 1998.
The 1997 Nonstatutory Stock Option Plan ("the 1997 NSO Plan") authorized the award of options up to an aggregate maximum of 125,000 shares at an exercise price of fair market value on the grant date. The Company granted options in 1998 with contractual terms of approximately five years and a vesting period of approximately three years. Options to acquire 125,000 shares at a weighted average exercise price of $33.56 per share were outstanding, with 29,738 exercisable, under the 1997 NSO Plan expiring on July 1, 2003 at December 31, 1998.
The 1997 Incentive Stock Option Plan ("the 1997 ISO Plan") authorized the award of options up to an aggregate maximum of 100,000 shares at an exercise price of fair market value on the grant date. The Company granted options in 1998 with contractual terms of approximately five years and a vesting period of approximately three years. Options to acquire 100,000 shares at a weighted average exercise price of $33.68 per share were outstanding, with 24,262 exercisable, under the 1997 ISO Plan expiring on July 1, 2003 at December 31, 1998.
The Company applies APB Opinion 25 and related interpretations in accounting for its plans. Accordingly, no compensation cost has been recognized for its fixed stock option plans. Had compensation cost for the Company's stock-based compensation plans been determined based on the fair value at the grant dates for awards under those plans consistent with the method of FASB Statement 123 adopted in 1995, the Company's net income and earnings per share would have been reduced to the pro forma amounts indicated below:
The fair value of options at date of grant was estimated using the Black-Scholes option pricing model with the following weighted-average assumptions:
1998 1997 1996 - -------------------------------------------------------------------------------- Expected life (years) .......... 3.46 -- -- Interest rate .................. 5.52% -- -- Volatility ..................... 30.00 -- -- Dividend yield ................. 1.49 -- -- - --------------------------------------------------------------------------------
No options were granted during the years ended December 31, 1997 and 1996. Pro forma net income reflects options granted in 1998 and 1995.
A summary of the status of the Company's five fixed option plans as of December 31, 1998, 1997 and 1996, and changes during the years ending on those dates is presented below:
The following table summarizes information about fixed stock options outstanding at December 31, 1998.
Options Outstanding Options Exercisable ------------------- ------------------------ Weighted Average Weighted Weighted Shares Remaining Average Shares Average Range of Outstanding Contractual Exercise Exercisable Exercise Exercise Prices (000) Life (Years) Price (000) Price - -------------------------------------------------------------------------------- $ 8.00 211 1.4 $ 8.00 211 $ 8.00 $ 11.50 124 3.5 11.50 91 11.50 $ 27.38 9 4.5 27.38 -- 27.38 $ 33.88 216 4.5 33.88 54 33.88 - -------------------------------------------------------------------------------- $8.00 to $33.88 560 356 - --------------------------------------------------------------------------------
Effective as of December 14, 1993, the Company adopted a Deferred Compensation Plan for the benefit of Glen E. Roney, Chief Executive Officer of the Company. The Deferred Compensation Plan provides for a retirement benefit payable to Mr. Roney (or his designated beneficiary or his estate if Mr. Roney dies prior to payment of the full amount of deferred compensation) of $100,000 per year commencing October 29, 2002, and continuing annually thereafter for fourteen years. In the event payments are to commence after October 30, 2002, the Company shall pay to Employee on the Late Retirement Date a lump sum equal to the amount of money that would have been paid to Employee had payments commenced on October 30, 2002 (the "Catch-Up Amount"), and in addition, the Company shall pay to Employee $100,000 per year commencing on October 30 of the year next following the Late Retirement Date and continuing regularly on the same calendar day of each year thereafter, (including the Catch-Up Amount and all other payments) the aggregate sum of $1,500,000; and on the Late Retirement Date, the Company shall pay Employee an amount intended to compensate for Employee's lost earnings potential on the Catch-Up Amount. If Mr. Roney dies prior to commencement of the retirement benefit, payments would commence immediately and be paid to his designated beneficiary or his estate. The Company also adopted the Trust Under Glen E. Roney Deferred Compensation Plan, in the form prescribed by applicable regulations adopted by the Internal Revenue Service for nonqualified deferred compensation plans. Among other things, the Plan and Trust provide for an initial deposit into the Trust by the Company and subsequent deposits at the discretion of the Board of Directors, and further provide for full funding of the amount necessary to discharge the retirement benefit in the event of a change of control, as that term is defined in the Trust.
With the consummation of the Mergers the Company acquired four existing separate deferred compensation plans for the benefit of certain Texas State Bank employees. The plans provide for retirement benefits to be paid to the specific employee (or a designated beneficiary or estate if death occurs prior to payment of the full amount of deferred compensation) on reaching age 65. One plan entered into on December 10, 1963, commenced payments of approximately $13,000 each year on January 4, 1988, continuing annually thereafter through June 2003. A second plan, entered into on September 1, 1979, provides for payments of approximately $13,000 each year which was scheduled to commence on April 1, 1990, continuing annually thereafter through June 2005; however, the employee elected to receive an amount less than that provided for in the plan over a longer period of time. The third plan provides for a retirement benefit payable of $50,000 per year commencing in March 1999 and continuing annually thereafter for 20 years. The fourth plan provides for a retirement benefit payable of $13,350 each year beginning March 15, 1995 and continuing annually thereafter for fourteen years.
The Company has incurred deferred compensation expense of $152,000, $130,000 and $87,000 for the years ended December 31, 1998, 1997 and 1996, respectively, related to the five deferred compensation plans previously discussed.
The Bank owns and is the beneficiary of five life insurance policies on the former employees covered by the deferred compensation plans. The life insurance policies' face values are amounts equal to the total benefits paid under the plan.
(12) COMMITMENTS AND CONTINGENCIES
In the normal course of business, the Company enters into various transactions which, in accordance with generally accepted accounting principles, are not included on the consolidated balance sheets. These transactions are referred to as "off-balance sheet commitments." The Company enters into these transactions to meet the financing needs of its customers. These transactions include commitments to extend credit and letters of credit which involve elements of credit risk in excess of the amounts recognized in the consolidated balance sheets. The Company attempts to minimize its exposure to loss under these commitments by subjecting them to the same credit approval and monitoring procedures as its other credit facilities.
The Company enters into contractual commitments to extend credit, normally with fixed expiration dates or termination clauses, at specified rates and for specific purposes. Customers use credit commitments to ensure that funds will be available for working capital purposes, for capital expenditures and to ensure access to funds at specified terms and conditions. Substantially all of the Company's commitments to extend credit are contingent on customers maintaining specific credit standards at the time of loan funding. Management assesses the credit risk associated with certain commitments to extend credit in determining the level of the allowance for possible loan losses.
Letters of credit are written for conditional commitments issued by the Company to guarantee the performance of a customer to a third party. The Company's policies generally require that letters of credit arrangements contain security and debt covenants similar to those contained in loan agreements.
At December 31, 1998, the Company had outstanding commitments to extend credit of approximately $167.7 million, which included standby letters of credit of approximately $11.7 million.
Future minimum lease payments on operating leases as of December 31, 1998 are as follows:
Office Office (Dollars in Thousands) Space Equipment Total - -------------------------------------------------------------------------------- 1999 $ 36 $127 $163 2000 36 127 163 2001 36 127 163 2002 36 127 163 2003 38 127 165 - -------------------------------------------------------------------------------- Total $182 $635 $817 - --------------------------------------------------------------------------------
The Company is a defendant in various legal proceedings arising in connection with its ordinary course of business. In the opinion of management, the financial position of the Company will not be materially affected by the final outcome of these legal proceedings.
(13) OTHER NONINTEREST EXPENSE
Other noninterest expense for the years ended December 31, 1998, 1997 and 1996 consisted of the following:
(Dollars in Thousands) 1998 1997 1996 - -------------------------------------------------------------------------------- Advertising and Public Relations ........ $ 1,536 $ 1,372 $ 1,292 Data Processing and Check Clearing ...... 1,183 1,120 1,193 Director Fees ........................... 333 515 521 Franchise Tax ........................... 600 533 281 Insurance ............................... 430 327 242 FDIC Insurance .......................... 166 150 92 Legal ................................... 1,255 1,050 714 Professional ............................ 638 775 703 Postage, Delivery and Freight ........... 816 689 558 Stationery and Supplies ................. 1,325 1,056 1,015 Telephone ............................... 534 433 393 Other Losses ............................ 68 837 664 Miscellaneous Expense ................... 1,767 1,169 1,015 - -------------------------------------------------------------------------------- Total ........................... $10,651 $10,026 $ 8,683 - --------------------------------------------------------------------------------
(14) EARNINGS PER COMMON SHARE COMPUTATIONS
Basic earnings per share was computed by dividing net income available to common shareholders by the weighted average number of common stock outstanding during the year, retroactively adjusted for stock splits effected as a stock dividend.
Diluted earnings per share was computed by dividing net income by the weighted average number of common stock and common stock equivalents outstanding during the year, retroactively adjusted for stock splits effected as a stock dividend. The Diluted earnings per share computations include the effects of common stock equivalents applicable to stock option contracts.
The number of shares outstanding and related earnings per share amounts have been restated to retroactively give effect for the three-for-two stock split declared and distributed by the Corporation during the third quarter of 1997.
The table below presents a reconciliation of basic and diluted earnings per share computations for the years ended December 31, 1998, 1997 and 1996 (Dollars in thousands, except per share data.)
(15) TEXAS REGIONAL BANCSHARES, INC. (PARENT ONLY) CONDENSED FINANCIAL STATEMENTS
CONDENSED BALANCE SHEETS December 31, 1998 and 1997 (Dollars in Thousands) 1998 1997 - -------------------------------------------------------------------------------- Assets Cash in Subsidiary Bank ........................ $ 5,473 $ 9,694 - -------------------------------------------------------------------------------- Total Cash and Cash Equivalents .............. 5,473 9,694 Investments in Consolidated Subsidiaries ....... 173,766 153,217 Furniture and Equipment ........................ 45 56 Other Assets ................................... 30 95 - -------------------------------------------------------------------------------- Total Assets ................................. $179,314 $163,062 - -------------------------------------------------------------------------------- Liabilities Accounts Payable and Accrued Liabilities ....... $ 45 $ 65 Dividends Payable .............................. 1,801 1,442 - -------------------------------------------------------------------------------- Total Liabilities ............................ 1,846 1,507 Shareholders' Equity ................................... 177,468 161,555 - -------------------------------------------------------------------------------- Total Liabilities and Shareholders' Equity ... $179,314 $163,062 - --------------------------------------------------------------------------------
(16) RESTRICTIONS ON RETAINED EARNINGS
The Bank is subject to certain restrictions on the amount of dividends that it may declare without prior regulatory approval.
The amount of retained earnings in the Bank at December 31, 1998 was $67.5 million. On December 31, 1998, the aggregate amount of dividends, which legally could be paid to the Corporation without prior approval of various regulatory agencies, totaled $48.8 million.
(17) REGULATORY MATTERS
The Company is subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory, and possibly additional discretionary, actions by regulators that, if undertaken, could have a direct material effect on the Company's financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Company must meet specific capital guidelines that involve quantitative measures of the Company's assets, liabilities, and certain off-balance-sheet items as calculated under regulatory accounting practices. The Company's capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors.
Quantitative measures established by regulation to ensure capital adequacy require the Company to maintain minimum amounts and ratios (set forth in the table below) of Total and Tier I capital (as defined in the regulations) to risk-weighted assets (as defined), and of Tier I capital (as defined) to average assets (as defined). Management believes that the Company meets all capital adequacy requirements to which it is subject at December 31, 1997.
At December 31, 1998, the most recent notification from the Federal Deposit Insurance Corporation categorized the Company as adequately capitalized under the regulatory framework for prompt corrective action. To be categorized as adequately capitalized the Company must maintain minimum total risk-based, Tier I risk-based, and Tier I leverage ratios as set forth in the table. There are no conditions or events since that notification that management believes have changed the institution's category. The Company's actual capital amounts and ratios are also presented in the table.
(18) FAIR VALUE OF FINANCIAL INSTRUMENTS
DISCLOSURES ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS-
Statement of Financial Accounting Standards No. 107 ("Statement 107"), "Disclosures about Fair Value of Financial Instruments", requires that the Company disclose estimated fair values for its financial instruments. Fair value estimates, methods and assumptions are set forth below for the Company's financial instruments.
DEBT SECURITIES-
For securities held, estimated fair value equals quoted market price, if available. If a quoted market price is not available, fair value is estimated using quoted market prices for a similar security.
Securities not classified as Held to Maturity or Trading are classified as Available for Sale and measured at fair value in the consolidated balance sheets with unrealized holding gains and losses reported as a separate component of shareholders' equity until realized.
The following table presents the amortized cost and estimated fair value of securities classified as Available for Sale at December 31, 1998 and December 31, 1997:
1998 1997 -------------------- -------------------- Amortized Estimated Amortized Estimated (Dollars in Thousands) Cost Fair Value Cost Fair Value - -------------------------------------------------------------------------------- U.S. Treasury ...................... $ -- $ -- $ 6,976 $ 7,002 U.S. Government Agency ............. 313,647 313,970 277,385 277,764 Mortgage-Backed .................... 101,670 101,365 15,549 15,561 States and Political Subdivisions .. 36,112 36,988 19,927 20,898 Other .............................. 3,562 3,613 2,842 2,952 - -------------------------------------------------------------------------------- Total .............. $454,991 $455,936 $322,679 $324,177 - --------------------------------------------------------------------------------
The following table presents the carrying value and estimated fair value of securities classified as Held to Maturity at December 31, 1998 and December 31, 1997:
1998 1997 ------------------- ------------------- Carrying Estimated Carrying Estimated (Dollars in Thousands) Amount Fair Value Amount Fair Value - -------------------------------------------------------------------------------- U.S. Treasury ......................... $10,013 $10,186 $20,249 $20,480 U.S. Government Agency ................ -- -- 64,171 64,302 Mortgage-Backed ....................... -- -- 750 743 States and Political Subdivisions ..... 4,318 4,464 7,474 7,656 Other ................................. -- -- 100 100 - -------------------------------------------------------------------------------- Total ................. $14,331 $14,650 $92,744 $93,281 - --------------------------------------------------------------------------------
LOANS-
The Company does not consider its loan portfolio to have the homogeneous categories of loans for which the fair value could be estimated by using quoted market prices for securities backed by similar loans. Therefore, the fair value of all loans is estimated by discounting future cash flows using the current rates at which similar loans would be made to borrowers with similar credit ratings for the same remaining maturities. Assumptions regarding credit risk, cash flows and discount rates are judgmentally determined using available market information and specific borrower information.
The following table presents information for loans at or for the year ended December 31, 1998 and December 31, 1997:
DEPOSIT LIABILITIES-
The fair value of demand deposits, savings accounts and certain money market deposits is the amount payable on demand at the reporting date. The fair value of certificates of deposit is based on the discounted value of contractual cash flows. The discount rate is estimated using the rates currently offered for deposits of similar remaining maturities. The following table presents the carrying value and estimated fair value of deposit liabilities at December 31, 1998 and December 31, 1997:
The fair value estimates above do not include the benefit that results from the low-cost funding provided by the deposit liabilities compared to the cost of borrowing funds in the market. The Company has not attempted to determine the amount of increase in net assets that would result from the benefit of considering the low-cost funding provided by deposit liabilities.
COMMITMENTS TO EXTEND CREDIT, STANDBY LETTERS OF CREDIT AND FINANCIAL GUARANTEES WRITTEN-
These financial instruments are not sold or traded, and estimated fair values are not readily available. The carrying amount of commitments to extend credit and standby letters of credit is the net unamortized deferred cost or income arising from these unrecognized financial instruments. The estimated fair value of these commitments is considered to be the carrying value. Financial guarantees written consist of obligations for credit cards issued to certain customers. Substantially all of the liability for financial guarantees written is collateralized by deposits pledged to the Company.
The following table presents the contract amount, carrying amount and estimated fair value for commitments to extend credit, standby letters of credit and financial guarantees written at December 31, 1998 and 1997:
LIMITATIONS-
Fair value estimates are made at a specific point in time, based on relevant market information and information about the financial instrument. These estimates do not reflect any premium or discount that could result from offering for sale at one time the Company's entire holdings of a particular financial instrument. Because no market exists for a significant portion of the Company's financial instruments, fair value estimates are based on judgments regarding future expected loss experience, current economic conditions, risk characteristics of various financial instruments and other factors. These estimates are subjective in nature and involve uncertainties and matters of significant judgment and therefore cannot be determined with precision. Changes in assumptions could significantly affect the estimates.
Fair value estimates are based on existing on-and off-balance sheet financial instruments without attempting to estimate the value of anticipated future business and the value of assets and liabilities that are not considered financial instruments. For example, the Company has a substantial trust department that contributes net fee income annually. The trust department is not considered a financial instrument, and its value has not been incorporated into the fair value estimates. Other significant assets and liabilities that are not considered financial assets or liabilities include the deferred tax liabilities, property, plant, equipment and goodwill. In addition, the tax ramifications related to the realization of the unrealized gains and losses can have a significant effect on fair value estimates and have not been considered in many of the estimates.
(19) ACQUISITION ACTIVITY
On February 19,1998, the Company completed the acquisition of three bank holding companies and their three subsidiary banks. The acquisition of Brownsville Bancshares, Inc. and its subsidiary, Brownsville National Bank, includes two banking locations in Brownsville, Cameron County, Texas, with assets of approximately $100.1 million, equity of $12.1 million, loans of $42.6 million, and deposits of $87.2 million. This acquisition was achieved by the exchange of 984,806 shares of Company stock for all of the outstanding shares of Brownsville Bancshares, Inc. and cancellation of outstanding stock options. Brownsville National Bank merged with and into Texas State Bank.
The second acquisition was TB&T Bancshares, Inc. and its subsidiary, Texas Bank and Trust of Brownsville, Cameron County, Texas. Texas Bank and Trust of Brownsville had assets of approximately $44.9 million, equity of $4.1 million, loans of $21.9 million, and deposits of $40.3 million. This acquisition was achieved by exchange of 308,039 shares of Company stock for all of the outstanding shares of TB&T Bancshares, Inc., a portion of which are retained in a holdback escrow account pending resolution of certain claims. Texas Bank and Trust of Brownsville merged with and into Texas State Bank.
The third acquisition was Raymondville Bancorp, Inc. and its subsidiary, Bank of Texas. Bank of Texas is headquartered in Raymondville, Willacy County, Texas, with one additional banking facility in Brownsville, Texas. The shareholder of Raymondville Bancorp, Inc. received cash consideration of $9.6 million in this acquisition, and the Company paid $100,000 in consideration for a covenant not to compete. Texas Regional discharged approximately $330,000 of existing Raymondville Bancorp, Inc. indebtedness. Bank of Texas had assets of approximately $63.7 million, equity of $5.1 million, loans of $25.5 million, and deposits of $56.5 million. Bank of Texas merged with and into Texas State Bank.
The acquisition of Brownsville Bancshares, Inc. and TB&T Bancshares, Inc. are accounted for under the pooling-of-interests method of accounting, and as such, the enclosed financial information has been restated for all periods presented to include the results of operations and financial position of these acquired entities. The acquisition of Raymondville Bancorp, Inc. was accounted for under the purchase method of accounting; therefore, the results of operations are included in the consolidated financial statements from the date of acquisition, February 19, 1998. The One Time Charge - Acquisitions of $728,000 primarily included professional fees and computer conversion costs related to effecting business combinations accounted for by the pooling-of-interests method.
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.
None.
PART III
ITEM 10.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information regarding directors and executive officers called for by Item 10 is incorporated herein by reference to the sections entitled "Election of Directors" and "Executive Officers" in the Company's Proxy Statement for its Annual Meeting of Shareholders to be held April 26, 1999.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
The information regarding executive compensation called for by Item 11 is incorporated herein by reference to the sections entitled "Executive Officers" in the Company's Proxy Statement for its Annual Meeting of Shareholders to be held April 26, 1999.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information regarding ownership of the Company's common stock by certain beneficial owners and by management called for by Item 12 is incorporated herein by reference to the sections entitled "Stock Ownership of Management and Others" in the Company's Proxy Statement for its Annual Meeting of Shareholders to be held April 26, 1999.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information regarding transactions between management and others and the Company called for by Item 13 is incorporated herein by reference to the sections entitled "Transactions with Management and Others" in the Company's Proxy Statement for its Annual Meeting of Shareholders to be held April 26, 1999.
PART IV
ITEM 14.
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) The following documents are filed as part of this Annual Report on Form 10-K:
(1) The following consolidated financial statements of the registrant and its subsidiaries, are included herein:
(i) Independent Auditors' Report
(ii) Consolidated Balance Sheets - December 31, 1998 and 1997
(iii) Consolidated Statements of Income and Comprehensive Income - Years Ended December 31, 1998, 1997, and 1996
(iv) Consolidated Statements of Changes in Shareholders' Equity - Years Ended December 31, 1998, 1997, and 1996
(v) Consolidated Statements of Cash Flows - Years Ended December 31, 1998, 1997, and 1996
(vi) Notes to Consolidated Financial Statements - December 31, 1998, 1997 and 1996
(2) Financial Statement Schedules are omitted because the required information is not applicable.
(3) Exhibits -- The following exhibits are filed as a part of this Annual Report on Form 10-K:
2.1 Agreement and Plan of Reorganization dated as of October 15, 1997, by and between Texas Regional Bancshares, Inc. and Raymondville Bancorp, Inc. (incorporated by reference from 1998 Form 10-K, Commission File No. 000-14517).
2.2 Agreement and Plan of Reorganization dated as of October 20, 1997, by and between Texas Regional Bancshares, Inc. and Brownsville Bancshares, Inc. (incorporated by reference from Form S-4, Commission File No. 333-41959).
2.3 Agreement and Plan of Reorganization dated as of October 15, 1997, by and between Texas Regional Bancshares, Inc. and TB&T Bancshares, Inc. (incorporated by reference from Form S-4, Commission File No. 333-41945).
2.4 Agreement and Plan of Reorganization by and between Texas State Bank, McAllen, Texas, First State Bank & Trust Co., Mission, Texas ("First State Bank"), Texas Regional Bancshares, Inc., and certain shareholders of First State Bank, dated as of January 9, 1996 (incorporated by reference from Form 8-K, Commission File No. 000-14517).
2.5 Agreement and Plan of Reorganization by and between Texas State Bank, McAllen, Texas, The Border Bank, Hidalgo, Texas ("Border Bank"), Texas Regional Bancshares, Inc., and certain shareholders of Border Bank, dated as of January 9, 1996 (incorporated by reference from Form 8-K, Commission File No. 000-14517).
3.1 Articles of Incorporation of Texas Regional Bancshares, Inc. (incorporated by reference from Form 10, Commission File No. 000-14517).
3.2 Amendment to Articles of Incorporation of Texas Regional Bancshares, Inc., filed December 28, 1983 (incorporated by reference from Form 10, Commission File No. 000-14517).
3.3 Amendment to Articles of Incorporation of Texas Regional Bancshares, Inc., filed June 25, 1986 (incorporated by reference from Form S-1, Commission File No. 33-28340).
3.4 Amendment to Articles of Incorporation of Texas Regional Bancshares, Inc., filed April 4, 1988 (incorporated by reference from Form S-1, Commission File No. 33-28340).
3.5 Amendment to Articles of Incorporation of Texas Regional Bancshares, Inc., filed April 12, 1991 (incorporated by reference from Form 10-K, Commission File No. 000-14517).
3.6 Amendment to Articles of Incorporation of Texas Regional Bancshares, Inc., filed March 2, 1992 (incorporated by reference from Form 10-K, Commission File No. 000-14517).
3.7 Resolution Eliminating from the Articles of Incorporation certain preferred series of shares of Texas Regional Bancshares, Inc., filed February 21, 1995 (incorporated by reference from 1994 Form 10-K, Commission File No. 000-14517).
3.8 Bylaws of Texas Regional Bancshares, Inc., as amended (incorporated by reference from Form S-1, Commission File No. 33-74992).
4 Relevant portions of Texas Regional Bancshares, Inc. Articles of Incorporation and Bylaws (incorporated by reference from Form S-1, Commission File No. 333-1467).
10.1 Incentive Stock Option Plan (incorporated by reference from Form 10, Commission File No. 000-14517).
10.2 1985 Non-Statutory Stock Option Plan (incorporated by reference from Form 10, Commission File No. 000-14517).
10.3 1995 Non-Statutory Stock Option Plan (incorporated by reference from Form S-1, Commission File No. 333-1467).
10.4 Texas Regional Bancshares, Inc., 1997 Incentive Stock Option Plan (incorporated by reference from Form S-4, Commission File No. 000-14517).
10.5 Texas Regional Bancshares, Inc., 1997 Nonstatutory Stock Option Plan (incorporated by reference from Form S-4, Commission File No. 000-14517).
10.6 Texas Regional Bancshares, Inc. Employees Stock Ownership Plan (with 401(k) provisions) (incorporated by reference from Form S-8, Commission File No. 33-39386).
10.7 Amendment No. 1 to Texas Regional Bancshares, Inc. Employees Stock Ownership Plan, adopted July 9, 1991 (incorporated by reference from 1991 Form 10-K, Commission File No. 000-14517).
10.8 Amendment No. 2 to Texas Regional Bancshares, Inc. Employees Stock Ownership Plan, adopted May 12, 1992 (incorporated by reference from 1992 Form 10-K, Commission File No. 000-14517).
10.9 Amendment No. 3 to Texas Regional Bancshares, Inc. Employees Stock Ownership Plan, adopted September 8, 1992, effective January 1, 1992 (incorporated by reference from Form S-1, Commission File No. 33-74992).
10.10 Amendment No. 4 to Texas Regional Bancshares, Inc. Employees Stock Ownership Plan (with 401(k) provisions), adopted August 10, 1993 (incorporated by reference from Form S-1, Commission File No. 33-74992).
10.11 Amendment No. 5 to Texas Regional Bancshares, Inc. Employees Stock Ownership Plan (with 401(k) provisions), adopted August 10, 1993 (incorporated by reference from 1994 Form 10-K, Commission File No. 000-14517).
10.12 Amendment No. 6 to Texas Regional Bancshares, Inc. Employee Stock Ownership Plan (with 401(k) provisions), adopted as of August 8, 1995 (incorporated by reference from Form S-1, Commission File No. 333-1467).
10.13 Amendment No. 7 to Texas Regional Bancshares, Inc. Employees Stock Ownership Plan (with 401(k) provisions), adopted May 21, 1996 (incorporated by reference from 1996 Form 10-K, Commission File No. 000-14517).
10.14 Amendment No. 8 to Texas Regional Bancshares, Inc. Employee Stock Ownership Plan (with 401(k) provisions), adopted March 10, 1998 (incorporated by reference from 1998 Form 10-K, Commission File No. 000-14517).
10.15 Glen E. Roney Amended and Restated Deferred Compensation Plan dated as of March 11, 1997 (incorporated by reference from Form S-4, Commission File No. 333-41959).
10.16 Amendment No. 9 to Texas Regional Bancshares, Inc. Employee Stock Ownership Plan (with 401(k) provisions), adopted June 9, 1998 (incorporated by reference from Form 10-Q for quarter ended June 30, 1998, Commission File No. 000-14517).
21 Subsidiaries of the Registrant.
27 Financial Data Schedule
(b) Reports on Form 8-K
No report on Form 8-K was filed by Texas Regional Bancshares, Inc. during the three months ended December 31, 1998
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
TEXAS REGIONAL BANCSHARES, INC. (Registrant)
By: /s/ G. E. RONEY ------------------------------------ Glen E. Roney Chairman of the Board, President and Chief Executive Officer
Date: March 22, 1999
Pursuant to the requirement of the Securities Exchange Act of 1934, this report has signed below by the following persons on behalf of the Registrant and in the capacities and on the date indicated.
SIGNATURE TITLE DATE ----------- ------- ------
/s/ Morris Atlas Director March 22, 1999 ---------------------- Morris Atlas
/s/ Frank N. Boggus Director March 22, 1999 ---------------------- Frank N. Boggus
/s/ Robert G. Farris Director March 22, 1999 ------------------------ Robert G. Farris
/s/ C. Kenneth Landrum, M.D. Director March 22, 1999 - ---------------------------- C. Kenneth Landrum, M.D.
/s/ R. T. Pigott, Jr. Executive Vice President March 22, 1999 ----------------------- & Chief Financial Officer R. T. Pigott, Jr.
/s/ G. E. Roney Chairman of the Board, March 22, 1999 ---------------------- President, Chief Executive Glen E. Roney Officer & Director
/s/ Nancy Schultz Senior Vice President & March 22, 1999 ---------------------- Secretary/Treasurer Nancy F. Schultz
/s/ Ann Sefcik Controller & Assistant March 22, 1999 ---------------------- Secretary Ann Sefcik
/s/ Julie G. Uhlhorn Director March 22, 1999 ----------------------- Julie G. Uhlhorn
/s/ Jack Whetsel Director March 22, 1999 ----------------------- Jack Whetsel
INDEX TO EXHIBITS FILED HEREWITH
NO. SEQUENTIALLY NUMBERED EXHIBIT ----- ------------------------------ 21 Subsidiaries of the Registrant.
27 Financial Data Schedule