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SBSI > SEC Filings for SBSI > Form 10-K on 14-Mar-2014All Recent SEC Filings




Annual Report


The following discussion and analysis provides a comparison of our results of operations for the years ended December 31, 2013, 2012, and 2011 and financial condition as of December 31, 2013 and 2012. This discussion should be read in conjunction with the financial statements and related notes included elsewhere in this report. All share data has been adjusted to give retroactive recognition to stock splits and stock dividends.


Certain statements of other than historical fact that are contained in this document and in written material, press releases and oral statements issued by or on behalf of Southside Bancshares, Inc., a bank holding company, may be considered to be "forward-looking statements" within the meaning of and subject to the protections of the Private Securities Litigation Reform Act of 1995. These forward-looking statements are not guarantees of future performance, nor should they be relied upon as representing management's views as of any subsequent date. These statements may include words such as "expect," "estimate," "project," "anticipate," "appear," "believe," "could," "should," "may," "intend," "probability," "risk," "target," "objective," "plans," "potential," and similar expressions. Forward-looking statements are statements with respect to our beliefs, plans, expectations, objectives, goals, anticipations, assumptions, estimates, intentions and future performance, and are subject to significant known and unknown risks and uncertainties, which could cause our actual results to differ materially from the results discussed in the forward-looking statements. For example, discussions of the effect of our expansion, trends in asset quality and earnings from growth, and certain market risk disclosures are based upon information presently available to management and are dependent on choices about key model characteristics and assumptions and are subject to various limitations. See "Item 1. Business" and this "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations." By their nature, certain of the market risk disclosures are only estimates and could be materially different from what actually occurs in the future. As a result, actual income gains and losses could materially differ from those that have been estimated. Other factors that could cause actual results to differ materially from forward-looking statements include, but are not limited to, the following:

general economic conditions, either globally, nationally, in the State of Texas, or in the specific markets in which we operate, including, without limitation, the deterioration of the commercial real estate, residential real estate, construction and development, credit and liquidity markets, which could cause an adverse change in our net interest margin, or a decline in the value of our assets, which could result in realized losses;

legislation, regulatory changes or changes in monetary or fiscal policy that adversely affect the businesses in which we are engaged, including the impact of the Dodd-Frank Act, the Federal Reserve's actions with respect to interest rates and other regulatory responses to current economic conditions;

adverse changes in the status or financial condition of the Government-Sponsored Enterprises (the "GSEs") impacting the GSEs' guarantees or ability to pay or issue debt;

adverse changes in the credit portfolio of other U.S. financial institutions relative to the performance of certain of our investment securities;

economic or other disruptions caused by acts of terrorism in the United States, Europe or other areas;

changes in the interest rate yield curve such as flat, inverted or steep yield curves, or changes in the interest rate environment that impact interest margins and may impact prepayments on the mortgage-backed securities ("MBS") portfolio;

increases in our nonperforming assets;

our ability to maintain adequate liquidity to fund operations and growth;

the failure of our assumptions underlying allowance for loan losses and other estimates;

unexpected outcomes of, and the costs associated with, existing or new litigation involving us;

changes impacting our balance sheet and leverage strategy;

risks related to actual U.S. agency MBS prepayments exceeding projected prepayment levels;

risks related to U.S. agency MBS prepayments increasing due to U.S. Government programs designed to assist homeowners to refinance their mortgage that might not otherwise have qualified;

our ability to monitor interest rate risk;

significant increases in competition in the banking and financial services industry;

changes in consumer spending, borrowing and saving habits;

technological changes;

our ability to increase market share and control expenses;

the effect of changes in federal or state tax laws;

the effect of compliance with legislation or regulatory changes;

the effect of changes in accounting policies and practices;

risks of mergers and acquisitions including the related time and cost of implementing transactions and the potential failure to achieve expected gains, revenue growth or expense savings;

credit risks of borrowers, including any increase in those risks due to changing economic conditions; and

risks related to loans secured by real estate, including the risk that the value and marketability of collateral could decline.

All written or oral forward-looking statements made by us or attributable to us are expressly qualified by this cautionary notice. We disclaim any obligation to update any factors or to announce publicly the result of revisions to any of the forward-looking statements included herein to reflect future events or developments.


On July 21, 2010, the Dodd-Frank Act was signed into law. The Dodd-Frank Act represents a significant overhaul of many aspects of the regulation of the financial services industry, although some of its provisions apply to companies that are significantly larger than us. The Dodd-Frank Act directs applicable regulatory authorities to promulgate regulations implementing its provisions, and its effect on us and the financial services industry as a whole will be clarified as those regulations are issued. Major elements of the Dodd-Frank Act include:

A permanent increase in deposit insurance coverage to $250,000 per account, unlimited deposit insurance on noninterest bearing transaction accounts beginning December 31, 2010 through December 31, 2012, and an increase in the minimum Deposit Insurance Fund reserve requirement from 1.15% to 1.35%, with assessments to be based on assets as opposed to deposits;

New disclosure and other requirements relating to executive compensation and corporate governance;

New prohibitions and restrictions on the ability of a banking entity and nonbank financial company to engage in proprietary trading and have certain interests in, or relationships with, a hedge fund or private equity fund;

Amendments to the Truth in Lending Act aimed at improving consumer protections with respect to mortgage originations, including originator compensation, minimum repayment standards, and prepayment considerations;

The establishment of the Financial Stability Oversight Council, which will be responsible for identifying and monitoring systemic risks posed by financial firms, activities, and practices;

The development of regulations to limit debit card interchange fees;

The future elimination of newly issued trust preferred securities as a permitted element of Tier 1 capital;

The creation of a special regime to allow for the orderly liquidation of systemically important financial companies, including the establishment of an orderly liquidation fund;

The development of regulations to address derivatives markets, including clearing and exchange trading requirements and a framework for regulating derivatives-market participants;

Enhanced supervision of credit rating agencies through the Office of Credit Ratings within the SEC;

Increased regulation of asset-backed securities, including a requirement that issuers of asset-backed securities retain at least 5% of the risk of the asset-backed securities; and

The establishment of a Bureau of Consumer Financial Protection with centralized authority, including examination and enforcement authority, for consumer protection in the banking industry.

Regulatory agencies are still in the process of issuing regulations, rules and reporting requirements as mandated by the Dodd-Frank Act. As a result, we are continuing to evaluate the potential impact of the Dodd-Frank Act on our business, financial condition and results of operations and expect that some provisions may have adverse effects on us, such as the cost of complying with the numerous new regulations and reporting requirements mandated by the Dodd-Frank Act.


Our accounting and reporting estimates conform with U.S. generally accepted accounting principles ("GAAP") and general practices within the financial services industry. The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates. We consider our critical accounting policies to include the following:

Allowance for Losses on Loans. The allowance for losses on loans represents our best estimate of probable losses inherent in the existing loan portfolio. The allowance for losses on loans is increased by the provision for losses on loans charged to expense and reduced by loans charged-off, net of recoveries. The provision for losses on loans is determined based on our assessment of several factors: reviews and evaluations of specific loans, changes in the nature and volume of the loan portfolio, current economic conditions and the related impact on specific borrowers and industry groups, historical loan loss experience, the level of classified and nonperforming loans and the results of regulatory examinations.

The loan loss allowance is based on the most current review of the loan portfolio and is validated by multiple processes. The servicing officer has the primary responsibility for updating significant changes in a customer's financial position. Each officer prepares status updates on any credit deemed to be experiencing repayment difficulties which, in the officer's opinion, would place the collection of principal or interest in doubt. Our internal loan review department is responsible for an ongoing review of our loan portfolio with specific goals set for the loans to be reviewed on an annual basis.

At each review, a subjective analysis methodology is used to grade the respective loan. Categories of grading vary in severity from loans that do not appear to have a significant probability of loss at the time of review to loans that indicate a probability that the entire balance of the loan will be uncollectible. If full collection of the loan balance appears unlikely at the time of review, estimates of future expected cash flows or appraisals of the collateral securing the debt are used to allocate the necessary allowances. The internal loan review department maintains a list of all loans or loan relationships that are graded as having more than the normal degree of risk associated with them. In addition, a list of specifically reserved loans or loan relationships of $50,000 or more is updated on a quarterly basis in order to properly allocate the necessary allowance and keep management informed on the status of attempts to correct the deficiencies noted with respect to the loan.

Loans are considered impaired if, based on current information and events, it is probable that we will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. The measurement of impaired loans is generally based on the present value of expected future cash flows discounted at the historical effective interest rate stipulated in the loan agreement, except that all collateral-dependent loans are measured for impairment based on fair value of the collateral. In measuring the fair value of the collateral, in addition to relying on third party appraisals, we use assumptions such as discount rates, and methodologies, such as comparison to the recent selling price of similar assets, consistent with those that would be utilized by unrelated third parties performing a valuation.

Changes in the financial condition of individual borrowers, economic conditions, historical loss experience and the conditions of the various markets in which collateral may be sold all may affect the required level of the allowance for losses on loans and the associated provision for loan losses.

As of December 31, 2013, our review of the loan portfolio indicated that a loan loss allowance of $18.9 million was appropriate to cover probable losses in the portfolio.

Refer to "Loan Loss Experience and Allowance for Loan Losses" and "Note 5 - Loans and Allowance for Probable Loan Losses" to our consolidated financial statements included in this report for a detailed description of our estimation process and methodology related to the allowance for loan losses.

Estimation of Fair Value. The estimation of fair value is significant to a number of our assets and liabilities. In addition, GAAP requires disclosure of the fair value of financial instruments as a part of the notes to the consolidated financial statements. Fair values for securities are volatile and may be influenced by a number of factors, including market interest rates, prepayment speeds, discount rates and the shape of yield curves. Fair values for most investment and MBS are based on quoted market prices, where available. If quoted market prices are not available, fair values are based on the quoted prices of similar instruments or estimates from independent pricing services. Where there are price variances outside certain ranges from different pricing services for specific securities, those pricing variances are reviewed with other market data to determine which of the price estimates is appropriate for that period. For securities carried at fair value through income, the change in fair value from the prior period is recorded on our income statement as fair value gain (loss) - securities.

At September 30, 2008 and continuing until the date of sale, the valuation inputs for our available for sale ("AFS") trust preferred securities ("TRUPs") became unobservable as a result of the significant market dislocation and illiquidity in the marketplace. We continued to rely on nonbinding prices compiled by third party vendors, which we verified to be an appropriate measure of fair value. However, the significant illiquidity in this market results in a fair value not clearly based on observable market data but rather a range of fair value data points from the market place. Accordingly, we had determined that the TRUPs security valuation was based on Level 3 inputs.

Impairment of Investment Securities and Mortgage-backed Securities. Investment securities and MBS classified as AFS are carried at fair value and the impact of changes in fair value are recorded on our consolidated balance sheet as an unrealized gain or loss in "Accumulated other comprehensive income (loss)," a separate component of shareholders' equity. Securities classified as AFS or held to maturity ("HTM") are subject to our review to identify when a decline in value is other-than-temporary. Factors considered in determining whether a decline in value is other-than-temporary include: whether the decline is substantial; the duration of the decline; the reasons for the decline in value; whether the decline is related to a credit event, a change in interest rate or a change in the market discount rate; and the financial condition and near-term prospects of the issuer. Additionally, we do not currently intend to sell the security and it is not more likely than not that we will be required to sell the security before the anticipated recovery of its amortized cost basis. When it is determined that a decline in value is other-than-temporary, the carrying value of the security is reduced to its estimated fair value, with a corresponding charge to earnings for the credit portion and to other comprehensive income for the noncredit portion. For certain assets we consider expected cash flows of the investment in determining if impairment exists.

Defined Benefit Pension Plan. The plan obligations and related assets of our defined benefit pension plan (the "Plan") are presented in "Note 11 - Employee Benefits" to our consolidated financial statements included in this report. Entry into the Plan by new employees was frozen effective December 31, 2005. Plan assets, which consist primarily of marketable equity and debt instruments, are valued using observable market quotations. Plan obligations and the annual pension expense are determined by independent actuaries and through the use of a number of assumptions that are reviewed by management. Key assumptions in measuring the plan obligations include the discount rate, the rate of salary increases and the estimated future return on plan assets. In determining the discount rate, we utilized a cash flow matching analysis to determine a range of appropriate discount rates for our defined benefit pension and restoration plans. In developing the cash flow matching analysis, we constructed a portfolio of high quality noncallable bonds (rated AA or better) to match as close as possible the timing of future benefit payments of the plans at December 31, 2013. Based on this cash flow matching analysis, we were able to determine an appropriate discount rate.

Salary increase assumptions are based upon historical experience and our anticipated future actions. The expected long-term rate of return assumption reflects the average return expected based on the investment strategies and asset allocation on the assets invested to provide for the Plan's liabilities. We considered broad equity and bond indices, long-term return projections, and actual long-term historical Plan performance when evaluating the expected long-term rate of return assumption. At December 31, 2013, the weighted-average actuarial assumptions of the Plan were: a discount rate of 5.06%; a long-term rate of return on Plan assets of 7.25%; and assumed salary increases of 4.50%. Material changes in pension benefit costs may occur in the future due to changes in these assumptions. Future annual amounts could be impacted by changes in the number of Plan participants, changes in the level of benefits provided, changes in the discount rates, changes in the expected long-term rate of return, changes in the level of contributions to the Plan and other factors.

Long-term Advance Commitments. During 2011 and 2010, we entered into the option to fund between one and a half years and two years forward from the advance commitment date, $200 million par in long-term advance commitments from the FHLB at the FHLB rates on the date the option was purchased. During the first quarter of 2013, the remaining $50 million par of long-term commitments expired unexercised.



During the year ended December 31, 2013, net income attributable to Southside Bancshares, Inc. increased $6.5 million, or 18.7%, to $41.2 million, from $34.7 million for the same period in 2012. The increase in net income was primarily attributable to the increase in net interest income, a decrease in the provision for loan losses, a reduction in income taxes, and no FHLB advance option impairment charges during 2013. These items were partially offset by a decrease in the gain on sale of securities available for sale and an increase in noninterest expense. Noninterest expense increased primarily due to an increase in salaries and employee benefits. Earnings per diluted share increased $0.39, or 20.4%, to $2.30 for the year ended December 31, 2013, from $1.91 for the same period in 2012.

During the year ended December 31, 2012, net income attributable to Southside Bancshares, Inc. decreased $4.4 million, or 11.3%, to $34.7 million, from $39.1 million for the same period in 2011. The decrease in net income was primarily attributable to the decrease in net interest income, the increase in the provision for loan losses and the decrease in fair value gain-securities. These items were partially offset by an increase in the gain on sale of securities available for sale and a reduction in the FHLB advance option impairment charge. Noninterest expense increased primarily due to an increase in salaries and employee benefits due to our overall growth and expansion while offset by a decrease in FDIC insurance. Earnings per diluted share decreased to $1.91 for the year ended December 31, 2012, from $2.16 for the same period in 2011.


Our total assets increased $208.3 million, or 6.4%, to $3.45 billion at December 31, 2013 from $3.24 billion at December 31, 2012. This increase was attributable to increases in our loans and in our investment and MBS. Our securities portfolio increased by $174.2 million, or 10.4%, to $1.84 billion compared to $1.67 billion at December 31, 2012. At December 31, 2013, loans were $1.35 billion compared to $1.26 billion at December 31, 2012. The increase in our securities was comprised of approximately $111 million of investment securities, all municipal securities, and approximately $64 million of MBS. The increase in loans was funded by cashflow from the increase in FHLB advances.

Our nonperforming assets at December 31, 2013 decreased to $13.6 million, and represented 0.39% of total assets, compared to $14.7 million, or 0.45% of total assets at December 31, 2012. Nonaccruing loans decreased $2.2 million to $8.1 million and the ratio of nonaccruing loans to total loans decreased to 0.60% at December 31, 2013 compared to 0.82% at December 31, 2012. Other Real Estate Owned ("OREO") increased to $726,000 at December 31, 2013 from $686,000 at December 31, 2012. Accruing loans past due more than 90 days at December 31, 2013 decreased to $3,000 compared to $15,000 at December 31, 2012. Repossessed assets increased to $901,000 at December 31, 2013 from $704,000 at December 31, 2012. Restructured performing loans at December 31, 2013 increased to $3.9 million compared to $3.0 million at December 31, 2012.

Our deposits increased $175.9 million to $2.53 billion at December 31, 2013 from $2.35 billion at December 31, 2012. Our deposits, net of brokered deposits, increased $141.0 million. The increase in our deposits during 2013 was due primarily to an increase in public fund deposits. During 2013, our public fund deposits increased $149.4 million while our brokered deposits increased $34.9 million. Total FHLB advances increased $52.7 million to $572.8 million at December 31, 2013, from $520.1 million at December 31, 2012. Short-term FHLB advances decreased $77.5 million to $73.4 million at December 31, 2013 from $151.0 million at December 31, 2012. Long-term FHLB advances increased $130.3 million to $499.3 million at December 31, 2013 from $369.1 million at December 31, 2012. During 2010 and 2011, we entered into the option to purchase, between one and a half years and two years forward from the advance commitment date $200 million par in long-term advance commitments from FHLB at the FHLB rates on the date the option was purchased. During the year ended December 31, 2012, $150 million par of long-term commitments expired unexercised. During the first quarter of 2013, the remaining $50 million par of long-term commitments expired unexercised. At December 31, 2013, we had no FHLB long-term advance commitments. Other borrowings at December 31, 2013 and 2012 totaled $61.2 million and $61.5 million, respectively, and at December 31, 2013 consisted of $859,000 of short-term borrowings and $60.3 million of long-term debt compared to $1.2 million of short-term borrowings and $60.3 million of long-term debt at December 31, 2012.

Assets under management in our trust department increased during 2013 and were approximately $880.5 million at December 31, 2013 compared to $758.3 million at December 31, 2012.

Shareholders' equity at December 31, 2013 totaled $259.5 million compared to $257.8 million at December 31, 2012. The increase primarily reflects net income of $41.2 million recorded for the year ended December 31, 2013 and the common stock issued of $1.4 million as a result of our dividend reinvestment plan. This was partially offset by cash dividends paid of $16.1 million, a decrease in accumulated other comprehensive income of $24.0 million and the purchase of treasury stock of $1.9 million. The decrease in accumulated other comprehensive income is comprised primarily of a decrease of $38.0 million, net of tax, in the unrealized gain on securities, net of reclassification adjustment and an increase of $14.0 million, net of tax, related to the change in the funded status of our defined benefit plan. See "Note 3 - Accumulated Other Comprehensive (Loss) Income" to our consolidated financial statements included in this report.

During 2013 the economy appeared to improve as unemployment rates dropped and gross domestic product increased. The housing market appeared to improve as well as housing prices across the nation continued to rise. The stock market ended the year with a healthy double digit increase. In December, the Federal Reserve announced that it would begin tapering in January 2014 as a result of the generally positive economic data.

Economic conditions in our market areas have continued to perform generally better than many other parts of the country. There continues to be some economic headwinds, however despite these headwinds, many economists predict the economy will continue to grow and improve at a slow to modest pace, in 2014.

Key financial indicators management follows include, but are not limited to, numerous interest rate sensitivity and interest rate risk indicators, credit risk, operations risk, liquidity risk, capital risk, regulatory risk, competition risk, yield curve risk, U.S. Agency MBS prepayment risk, and economic risk indicators.


We utilize wholesale funding and securities to enhance our profitability and balance sheet composition by determining acceptable levels of credit, interest rate and liquidity risk consistent with prudent capital management. This balance sheet strategy consists of borrowing a combination of long and short-term funds from the FHLB and, when determined appropriate, issuing brokered CDs. These funds are invested primarily in U.S. Agency MBS and long-term municipal securities. Although U.S. Agency MBS often carry lower yields than traditional mortgage loans and other types of loans we make, these securities generally (i) increase the overall quality of our assets because of either the implicit or explicit guarantees of the U.S. Government, (ii) are more liquid than individual loans and (iii) may be used to collateralize our borrowings or other obligations. While the strategy of investing a substantial portion of our assets in U.S. Agency MBS and municipal securities has historically resulted in lower interest rate spreads and margins, we believe that the lower operating expenses . . .

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