**UNITED STATES**

**SECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C.  20549**

** **

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** **

**FORM 10-K**

 

| **ý** | **ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE  SECURITIES EXCHANGE ACT OF 1934**     |
|------------|-----------------------------------------------------------------------------------------------|
|       |                                                                                          |   |
|       |                                                                                          | **For the Fiscal Year Ended: December 31, 2002** |
|       |                                                                                          |   |
|       |                                                                                          | **or** |
|       |                                                                                          |   |
| **o**      | **TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE  SECURITIES EXCHANGE ACT OF 1934** |
|       |                                                                                          |   |
|       |                                                                                          | **For the Transition Period  from          to          ** |

** **

**CommissionFile Number: 0-10196**

** **

**INDEPENDENT BANKSHARES, INC.**

(Exact Name of Registrant as Specified in itsCharter)

 

| **Texas**                                                       |   | **75-1717279**                     |
|-----------------------------------------------------------------|--------|------------------------------------|
| (State or Other Jurisdiction of  Incorporation or Organization) |   | (IRS Employer  Identification No.) |
|                                                            |   |                               |
| **1617 Broadway  Lubbock, Texas**                               |   | **79408**                          |
| (Address of Principal Executive Offices)                        |   | (Zip Code)                         |

 

Registrant’s Telephone Number, Including AreaCode:  **(806) 749-1850**

 

Securities Registered Pursuant to Section12(b) of the Act:

 

| **Title of each class**                                                                                       |   | **Name of each exchange   on which registered** |
|---------------------------------------------------------------------------------------------------------------|--------|-------------------------------------------------|
| 8.5% Cumulative Trust Preferred  Securities, Guaranteed by  Independent Bankshares, Inc., Stated Value $10.00 |   | American Stock Exchange                         |

 

Securities Registered Pursuant to Section12(g) of the Act:

**CommonStock, $0.25 Par Value**

(Title of Class)

 

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Indicate bycheck mark whether the Registrant (1) has filed all reports required to befiled by Section 13 of the Securities Exchange Act of 1934 during the preceding12 months (or for such shorter period that the Registrant was required to filesuch reports) and (2) has been subject to such filing requirements for the past90 days.                     Yes  ý  No  o

 

Indicate bycheck mark if disclosure of delinquent filers pursuant to Item 405 ofRegulation S-K is not contained herein, and will not be contained, to the bestof the Registrant’s knowledge, in definitive proxy or information statementsincorporated by reference in Part III of this Form 10-K or any amendment tothis Form10-K.                  ý

 

Indicate bycheck mark whether the registrant is an accelerated filer (as defined in Rule12-b of the Act).     Yes   o  No  ý

 

On March 7, 2003, all of the shares of the Registrant’s voting stockwas held indirectly by State National Bancshares, Inc. and thus no shares wereheld by non-affiliates of the Registrant. At March 7, 2003, 2,273,674 shares ofthe Registrant’s common stock, $0.25 par value per share, were outstanding.

 

**DOCUMENTSINCORPORATED BY REFERENCE**

Portions of the following documents are incorporated by reference intothe indicated part or parts of this report: **None**

 

 

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**TABLE OF CONTENTS**

 
| PART I         |
|----------------|
| ITEM 1.        | BUSINESS |
|           |   |
| ITEM 2.        | PROPERTIES |
|           |   |
| ITEM 3.        | LEGAL PROCEEDINGS |
|           |   |
| ITEM 4.        | SUBMISSION OF MATTERS TO A VOTE OF SECURITY  HOLDERS |
|           |   |
| PART II        |
| ITEM 5.        | MARKET FOR THE REGISTRANT’S COMMON EQUITY  AND RELATED STOCKHOLDER MATTERS |
|           |   |
| ITEM 6.        | SELECTED FINANCIAL DATA |
|           |   |
| ITEM 7.        | MANAGEMENT’S DISCUSSION AND ANALYSIS OF  FINANCIAL CONDITION AND RESULTS OF OPERATIONS |
|           |   |
| ITEM 7A.       | QUANTITATIVE AND QUALITATIVE DISCLOSURE  ABOUT MARKET RISKS |
|           |   |
| ITEM 8.        | FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA |
|           |   |
| ITEM 9.        | CHANGES IN AND DISAGREEMENTS WITH  ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE |
|           |   |
| PART III       |
| ITEM  10.      | DIRECTORS AND EXECUTIVE OFFICERS OF THE  REGISTRANT |
|           |   |
| ITEM  11.      | EXECUTIVE COMPENSATION |
|           |   |
| ITEM  12.      | SECURITY OWNERSHIP OF CERTAIN BENEFICIAL  OWNERS AND MANAGEMENT |
|           |   |
| ITEM  13.      | CERTAIN RELATIONSHIPS AND RELATED  TRANSACTIONS |
|           |   |
| ITEM  14.      | CONTROLS AND PROCEDURES |
|           |   |
| PART IV        |
| ITEM  15.      | EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND  REPORTS ON FORM 8-K |
|           |
| SIGNATURES     |   |
|           |   |
| CERTIFICATIONS |   |
|                |  |  |

 

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# **PART I**

 

*Other than historical and factual statements,the matters and items discussed in this Annual Report on Form 10-K areforward-looking statements that involve risks and uncertainties.  Actual results of Independent Bankshares,Inc. and its subsidiaries may differ materially from the results discussed inthe forward-looking statements.  Certainfactors that could contribute to such differences are discussed with theforward-looking statements throughout this report and are summarized in“Management’s Discussion and Analysis of Financial Condition and Results of Operations- Forward-Looking Statements - Cautionary Language.”*

 

**ITEM 1**.     BUSINESS

 

**General**

 

Independent Bankshares, Inc., a Texas corporation (the “Company”), is abank holding company headquartered in Lubbock, Texas. The Company is anindirect wholly owned subsidiary of State National Bancshares, Inc., Lubbock,Texas (“State National”). At December 31, 2002, the Company owned all of thecommon securities of Independent Capital Trust (“Independent Capital”) andindirectly owned, through a Delaware subsidiary, Independent Financial Corp.(“Independent Financial”), 100% of the stock of State National Bank, Lubbock,Texas (the “Bank” or the “Lubbock Bank”) and 100% of the stock of Twoenc, Inc.(“Twoenc”) a subsidiary of the bank used for holding certain foreclosed assetsof the Bank. At December 31, 2002, the Bank operated full-service bankinglocations in the Texas cities of Abilene (four locations), Azle (twolocations), Big Spring, Lubbock (three locations), Odessa (two locations),Plainview, San Angelo, Stamford and Winters.

 

The Company’s primary activities are to assist the Bank in themanagement and coordination of its financial resources.

 

At December31, 2002, the Company had, on a consolidated basis, total assets of$558,287,000, total deposits of $482,643,000, total loans, net of unearnedincome, of $287,302,000 and total stockholder’s equity of $58,593,000.

 

The Company’scomplete mailing address is 1617 Broadway, Lubbock, Texas 79408, and thetelephone number is (806) 749-1850.

 

**Acquisition of theCompany**

 

On August 11,2000, State National acquired 100% of the issued and outstanding common stockof the Company, pursuant to the terms of an Agreement and Plan ofReorganization, dated as of March 1, 2000 (“the Acquisition”), between theCompany and State National. Pursuant to the Merger Agreement, New FSB, Inc., awholly owned subsidiary of State National merged with and into the Company,with the Company surviving the Acquisition as a wholly owned subsidiary ofState National. As a result of the Acquisition, each share of the Company’scommon stock was exchanged into the right to receive $20.0165 in cash,representing total aggregate merger consideration of approximately$45,510,000.  State National obtainedthe funds for the purchase of the Company’s common stock from (i) the sale ofshares of State National’s common stock to certain qualified investors and (ii)from a $10,000,000 advance on State National’s line of credit (“Loan”) with theAmarillo National Bank, Amarillo, Texas. The Loan bore interest at the rate equal to the prime rate asestablished by J.P. Morgan/Chase. The Loan was secured by all of the commonstock of the indirect bank subsidiaries of State National, including theBank.  During 2002, the remainingprincipal balance plus interest was paid in full.

 

**Reorganizations**

 

**United Bank &Trust**. On October 24, 2000, State National, the ownerof all the common stock of the Company, contributed to the Company, and theCompany, in turn, contributed to Independent Financial, all of the capital stockof United Bank & Trust, of Abilene, Texas, a Texas banking association(“UB&T”).  UB&T was a communitybank that offered interest and noninterest bearing depository accounts and madeconsumer and

 

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commercial loans.  On November 9, 2000, UB&T was thenmerged (the “UB&T Merger”) with and into First State Bank, NationalAssociation, Abilene, Texas, the Company’s subsidiary bank (“First State”).  In addition, immediately after the merger,the name of the combined bank was changed to State National Bank of West Texas,Abilene, Texas (the “Abilene Bank”). There was no merger consideration paid because, prior to thetransactions, the Company and UB&T were both direct and or indirectsubsidiaries of State National.  Themerger was accounted for similar to a pooling of interests.  As a result of the merger, the balance sheetand results of operations of UB&T have been included in the Company’sconsolidated financial statements since August 11, 2000, the date of theAcquisition.  At August 11, 2000,UB&T had total assets of $112,806,000, and total deposits of $93,946,000,total loans of $70,230,000 and total stockholder’s equity of $16,729,000.

 

**State National Bank***.*On February 28, 2001, State National contributed its ownership interest in theLubbock Bank to the Company. The Company in turn, contributed to IndependentFinancial, all of the capital stock of the Lubbock Bank. The Lubbock Bank is acommunity bank that offers interest and noninterest-bearing depository accountsand makes consumer and commercial loans. On March 9, 2001, the Abilene Bank was merged with and into the LubbockBank (the “Lubbock Merger”).  TheLubbock Bank continued as the surviving entity in the merger and is an indirectwholly owned subsidiary of the Company. There was no merger consideration paidas, prior to the transactions, the Abilene Bank and the Lubbock Bank were bothdirect or indirect subsidiaries of State National.  The merger was accounted for similar to a pooling of interests.  As a result of the merger, the balance sheetand results of operations of the Lubbock Bank have been included in theCompany’s consolidated financial statements since August 11, 2000, the date ofthe Acquisition.  At August 11, 2000,the Lubbock Bank had total assets of $210,409,000, total deposits of$190,828,000, total loans of $121,130,000 and stockholder equity of$18,405,000.

 

**The Bank**

 

**General***.*TheCompany conducts substantially all of its business through the Bank and itsvarious branches in Texas.  Each of theBank’s branches is an established franchise in its respective service area. Thecombined branches in Abilene had the fifth largest total deposits of 11financial institutions operating in Taylor County, at June 30, 2002, the latestdate for which information is available. The combined branches in Azle had the 27th largest totaldeposits of 52 financial institutions operating in Tarrant County at June 30,2002. The branch in Big Spring had the third largest total deposits of the sixfinancial institutions operating in Howard County at June 30, 2002.  The combined branches in Lubbock had theninth largest total deposits of 17 financial institutions operating in LubbockCounty at June 30, 2002. The combined branches in Odessa had the****seventhlargest total deposits of 11 financial institutions operating in Ector Countyat June 30, 2002. The branch in Plainview had the fourth largest total depositsof the six financial institutions operating in Hale County at June 30, 2002.  The branch in San Angelo had the tenthlargest total deposits of 13 financial institutions operating in Tom GreenCounty at June 30, 2002.  The branch inStamford had the third largest total deposits of five financial institutionsoperating in Jones County at June 30, 2002. The branch in Winters had the sixth largest total deposits of sevenfinancial institutions operating in Runnels County at June 30, 2002.  The Bank, through its branches, operates asa community bank focusing on long-term relationships with customers and providingindividualized quality service. Reflecting its community-banking heritage, the Bank has a stable depositbase from customers located within its Texas market area. The deposits of theBank are insured by the Federal Deposit Insurance Corporation (the “FDIC”) tothe maximum extent provided by law.

 

At December31, 2002, the Bank had total assets of $557,883,000, total deposits of$482,701,000, total loans, net of unearned income, of $287,302,000, and totalstockholder’s equity of $70,009,000.

 

**Services***.*Theprincipal services provided by the Bank are as follows:

 

***Commercial Services***.  The Bank provides a full range of bankingservices for its commercial customers. Commercial lending activities includeshort-term and medium-term loans, revolving credit arrangements,inventory and account receivable financing, equipment financing and interim andpermanent real estate lending.  Otherservices include cash management programs and federal tax depository and nightdepository services.

 

***Consumer Services***.  The Bank also provides a wide range ofconsumer banking services, including checking, savings and money marketaccounts, savings programs and installment and personal loans.  The Bank makes automobile and other installmentloans directly to customers, as well as indirectly through automobile dealers.

 

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The Bank makes homeimprovement, home equity and real estate loans and provides safe depositservices.  As a result of sharingarrangements with the Pulse automated teller machine system network, the Bankprovides 24-hour routine banking services through automated tellermachines (“ATMs”).  The Pulse networkprovides ATM accessibility throughout the United States.  The Bank also offers investment services andbanking by phone, personal computer or the Internet.

 

***Trust Services***.  The Bank provides trust and agency servicesto individuals, partnerships and corporations from its offices in Abilene,Lubbock and Odessa.  The trust divisionalso provides investment management, administration and advisory services foragency and trust accounts, and acts as trustee for pension and profit sharingplans.

 

**Supermarket Branches**.On July 15, 2001, the Bank closed three branch banking facilities located inlarge supermarkets: one in Abilene and two in Odessa.

 

**BranchSales**. On July 1, 2002 the Bank sold its branch inBangs, Texas to an unrelated financial institution.  At July 1, 2002 the branch had total assets of $1,609,000, totalloans, net of allowance for loan loss of $1,263,000 and total deposits of$5,194,000.  A loss of $21,000 wasrecorded related to this transaction. Net income for this branch for the period ended June 30, 2002 was$44,000.

 

On October 11,2002 the Bank sold it branch in Trent, Texas to an unrelated financialinstitution.  At October 11, 2002, thebranch had total assets of $1,582,000, total loans, net of allowance for loanloss of $1,446,000 and total deposits of $9,164,000.  A loss of $13,000 was recorded related to this transaction.  Net income for this branch for the periodended June 30, 2002 was $43,000.

 

The Companyhas sold some of its smaller branches in an effort to streamline its servicesand concentrate on the larger market areas.

 

**Other Subsidiaries**

 

At the presenttime, the Company does not have any subsidiaries other than IndependentCapital, Independent Financial, the Bank and Twoenc.

 

**Business Objectives and Strategy**

 

The Company’sprincipal business objectives are to increase its profitability and shareholdervalue by building a valuable Texas banking franchise using core deposits as afunding base to support local commercial and consumer lending programs.  The Company employs several strategies,including the following, to accomplish its objectives:

 

**Sophistication andBreadth of Products; Personal Services**.  The Company’s goal is to provide customerswith the business sophistication and breadth of products of a regionalfinancial services company, while retaining the special attention to personalservice and the local appeal of a community bank. The Company believes that, asa result of consolidation in the financial industry within the Company’smarketplace, there are few financial institutions in its market area that havelarger lending limits than the Company that are also willing to provide thepersonal customer service that the Company is committed to providing to itscustomers.

 

**DecentralizedDecision Making**. The Company’s decentralized decision making authority, vested in thepresident and senior officers of the Abilene, Azle, Lubbock and Odessa branchesallows for rapid response time and flexibility in dealing with customerrequests and credit needs.

 

**Efficient andConvenient Delivery Systems**.  The Company’s efforts to maintain and expand efficient andconvenient delivery systems for its products and services have included theintroduction of computer and telephone home banking and Internet banking.  The Company also maintains 11 ATMsthroughout its market area.

 

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**Acquisition Activity**.  The Company’s strategy of acquiring banks inits West Texas market resulted in its acquisition of four banks and one branchin the six-year period ended December 31, 1999. Since the acquisition of theCompany by State National on August 11, 2000, the Company has grown by thereorganizations in which it acquired UB&T and the Lubbock Bank.  The Company will continue to evaluateacquisition opportunities as they arise. The Company currently has locations in or near five of the major marketsin West and North Central Texas.

 

**Supervision andRegulation**

 

**General**

 

The Companyand the Bank are extensively regulated under federal and state laws.  These laws and regulations are intended toprotect consumers and depositors, not shareholders, to the extent that thefollowing information describes or summarizes statutory or regulatoryprovisions, it is qualified in its entirety by reference to the particularstatutory or regulatory provisions. Any change in applicable laws orregulations may have a material effect on the business and prospects of theCompany. The operations of the Company may be affected by legislative changesand by the policies of various regulatory authorities. The Company is unable topredict the nature or the extent of the effects on its business and earningsthat fiscal or monetary policies, economic controls or new federal or statelegislation may have in the future.

 

The Company isa registered bank holding company under the Bank Holding Company Act of 1956(as amended, the “BHCA”) and, as such, is subject to regulation, supervisionand examination by the Board of Governors of the Federal Reserve System (the“Federal Reserve”). The Company is required to file annual reports with theFederal Reserve and to provide the Federal Reserve such additional informationas it may require.

 

The BHCAimposes certain limitations on extensions of credit and other transactions byand between banks that are members of the Federal Reserve and other banks andnonbank companies in the same holding company. Under the BHCA and the FederalReserve’s regulations, a bank holding company and its subsidiaries areprohibited from engaging in certain tying arrangements in connection with anyextension of credit, lease or sale of property or furnishing of services.

 

The Bank, anational banking association organized under the National Bank Act, is subjectto the supervision and regulation of the Office of the Comptroller of theCurrency (the “Comptroller”). Because the FDIC provides deposit insurance tothe Bank, the Bank is also subject to supervision and regulation by the FDIC(even though the FDIC is not the primary federal regulator of the Bank).

 

The Company,as an affiliate of the Bank, is subject to certain restrictions regardingtransactions between a bank and companies with which it is affiliated. Theseprovisions limit extensions of credit (including guarantees of loans) by theBank to affiliates, investments in the stock or other securities of the Companyby the Bank, and the nature and amount of collateral that the Bank may acceptfrom any affiliate to secure loans extended to the affiliate.

 

**Significant Legislation**

 

The enactmentof the legislation described below has significantly affected the bankingindustry generally and will have an ongoing effect on the Company and the Bankin the future.

 

*Financial Institutions Reform, Recovery andEnforcement Act of 1989*

 

The FinancialInstitutions Reform, Recovery, and Enforcement Act of 1989 (“FIRREA”)reorganized and reformed the regulatory structure applicable to financialinstitutions generally. FIRREA, among other things, enhanced the supervisoryand enforcement powers of the federal bank regulatory agencies, requiredinsured financial institutions to guarantee repayment of losses incurred by theFDIC in connection with the failure of an affiliated financial institution,required financial institutions to provide their primary federal regulator withnotice (under certain circumstances) of changes in senior management andbroadened authority for bank holding companies to acquire savings institutions.

 

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Under FIRREA,federal bank regulators were granted expanded enforcement authority over“institution-affiliated parties” (i.e*.*, officers, directors, controllingshareholders, as well as attorneys, appraisers or accountants who knowingly orrecklessly participate in wrongful action likely to have an adverse effect onan insured institution). Federal banking regulators have greater flexibility tobring enforcement actions against insured institutions andinstitution-affiliated parties, including cease and desist orders, prohibitionorders, civil money penalties, termination of insurance and the imposition ofoperating restrictions and capital plan requirements. These enforcementactions, in general, may be initiated for violations of laws and regulationsand unsafe or unsound practices. Since the enactment of FIRREA, the federalbank regulators have significantly increased the use of written agreements tocorrect compliance deficiencies with respect to applicable laws and regulationsand to ensure safe and sound practices. Violations of such written agreementsare grounds for initiation of cease-and-desist proceedings. FIRREA granted theFDIC back-up enforcement authority to recommend enforcement action to anappropriate federal banking agency and to bring such enforcement action againsta financial institution or an institution-affiliated party if such federalbanking agency fails to follow the FDIC’s recommendation.

 

FIRREA alsoestablished a cross-guarantee provision pursuant to which the FDIC may recoverfrom a depository institution losses that the FDIC incurs in providingassistance to, or paying off the insured depositors of, any of such depositoryinstitution’s affiliated insured banks or thrifts. The cross-guarantee thusenables the FDIC to assess a holding company’s healthy Bank Insurance Fund(“BIF”) members and Savings Association Insurance Fund (“SAIF”) members for thelosses of any of such holding company’s failed BIF and SAIF members.Cross-guarantee liabilities are generally superior in priority to obligationsof the depository institution to its shareholders due solely to their status asshareholders and obligations to other affiliates. Cross-guarantee liabilities aregenerally subordinated, except with respect to affiliates, deposit liabilities,secured obligations or any other general or senior liabilities, and anyobligations subordinated to depositors or other general creditors.

 

*The Federal Deposit Insurance CorporationImprovement Act of 1991*

 

The FederalDeposit Insurance Corporation Improvement Act of 1991 (“FDICIA”) was adopted torecapitalize the BIF and impose certain supervisory and regulatory reforms oninsured depository institutions. FDICIA, in general, includes provisions, amongothers, to:

 

•                  reform thedeposit insurance system, including the implementation of risk-based depositinsurance premiums;

 

•                  establish aformat for closer monitoring of financial institutions to enable promptcorrective action by banking regulators when a financial institution begins toexperience financial difficulty;

 

•                  establish fivecapital levels for financial institutions (“well capitalized,” “adequatelycapitalized,” “undercapitalized,” “significantly undercapitalized” and“critically undercapitalized”) that impose more scrutiny and restrictions onless capitalized institutions;

 

•                  require bankingregulators to set operational and managerial standards for all insureddepository institutions and their holding companies, including limits onexcessive compensation to executive officers, directors, employees andprincipal shareholders, and establish standards for loans secured by realestate;

 

•                  adopt certainaccounting reforms and require annual on-site examinations of federally insuredinstitutions, including the ability to require independent audits of banks andthrifts; and

 

•                  reviserisk-based capital standards to ensure that they take adequate account ofinterest-rate changes, concentration of credit risk and the risks of nontraditionalactivities and reflect the actual performance and expected risk of loss ofmulti-family mortgages.

 

FDICIA alsoauthorized the FDIC to make special assessments on insured depositoryinstitutions, in amounts determined by the FDIC to be necessary to give itsufficient assessment income to repay amounts borrowed from the

 

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U.S. Treasuryand other sources or for any other purpose the FDIC deems necessary. FDICIAalso grants authority to the FDIC to establish semiannual assessment rates onBIF and SAIF member banks so as to maintain these funds at the designatedreserve ratios.

 

FDICIA, as noted above, authorizes and (under certain circumstances)requires the federal banking agencies to take certain actions againstinstitutions that fail to meet certain capital-based requirements. The federalbanking agencies are required, under FDICIA, to establish five levels ofinsured depository institutions based on leverage limit and risk-based capitalrequirements established for institutions subject to their jurisdiction plus,in their discretion, individual additional capital requirements for suchinstitutions. Under the final rules that have been adopted by each of thefederal banking agencies, an institution is designated:

 

•                  “well-capitalized”if the institution has a total risk-based capital ratio of 10% or greater, aTier 1 risk-based capital ratio of 6% or greater, and a leverage ratio of 5% orgreater, and the institution is not subject to an order, written agreement,capital directive, or prompt corrective action directive to meet and maintain aspecific capital level for any capital measure;

 

•                  “adequatelycapitalized” if the institution has a total risk-based capital ratio of 8% orgreater, a Tier 1 risk-based capital ratio of 4% or greater, or a leverageratio of 4% or greater;

 

•                  “undercapitalized”if the institution has a total risk-based capital ratio that is less than 8%, aTier 1 risk-based capital ratio that is less than 4%, or a leverage ratio thatis less than 4%;

 

•                  “significantlyundercapitalized” if the institution has a total risk-based capital ratio thatis less than 6%, a Tier 1 risk-based capital ratio that is less than 3%, or aleverage ratio that is less than 3%; and

 

•                  “critically undercapitalized”if the institution has a ratio of tangible equity to total assets that is equalto or less than 2%.

 

“Undercapitalized,”“significantly undercapitalized” and “critically undercapitalized” institutionsare required to submit capital restoration plans to the appropriate federalbanking agency and are subject to certain operational restrictions. Companiescontrolling an undercapitalized institution are also required to guarantee thesubsidiary institution’s compliance with the capital restoration plan subjectto an aggregate limitation of the lesser of 5% of the institution’s assets atthe time it received notice that it was undercapitalized or the amount of thecapital deficiency when the institution first failed to meet the plan.

 

Significantlyor critically undercapitalized institutions and undercapitalized institutionsthat do not submit or comply with acceptable capital restoration plans aresubject to restrictions on the compensation of senior executive officers and toadditional regulatory sanctions and forced or mandated actions. FDICIAgenerally requires the appointment of a conservator or receiver within 90 daysafter an institution becomes critically undercapitalized. The federal bankingagencies have adopted uniform procedures for the issuance of directives by theappropriate federal banking agency. Under these procedures, an institution willgenerally be provided advance notice when the appropriate federal bankingagency proposes to impose one or more of the sanctions set forth above. Theseprocedures provide an opportunity for the institution to respond to theproposed agency action or, where circumstances warrant immediate agency action,an opportunity for administrative review of the agency’s action.

 

As describedunder “Management’s Discussion and Analysis of Financial Condition and Resultsof Operations**—**Capital Resources,” both the Company and the Bank were “wellcapitalized” at December 31, 2002.

 

Pursuant toFDICIA, the Federal Reserve and the other federal banking agencies adopted realestate lending guidelines pursuant to which each insured depository institutionis required to adopt and maintain written real estate lending policies inconformity with the prescribed guidelines. Under these guidelines, eachinstitution is expected to set loan-to-value ratios not exceeding thesupervisory limits set forth in the guidelines. A loan-to-value ratio isgenerally defined as the total loan amount divided by the appraised value ofthe property at the time the loan is 

 

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originated. The guidelinesrequire that the institution’s real estate policy include proper loandocumentation and prudent underwriting standards. These rules have had nomaterial adverse impact on the Company and the Bank.

 

FDICIA alsocontained the Truth in Savings Act, which requires clear and uniform disclosureof the rates of interest payable on deposit accounts by depositoryinstitutions, and the fees assessable against deposit accounts, so thatconsumers can make a meaningful comparison between the competing claims offinancial institutions with regard to deposit accounts and products.

 

*Riegle-Neal Interstate Banking and BranchingEfficiency Act of 1994*

 

Congressenacted the Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994(the “Interstate Act”) in September 1994. Since September 1995, bank holdingcompanies have the right to expand, by acquiring existing banks, into allstates, even those, which had previously restricted entry. The legislation alsoprovided that, subject to future action by individual states, a holding companyhas the right, commencing in 1997, to convert the banks which it owns indifferent states to branches of a single bank. A state was permitted to “optout” of provisions of the Interstate Act that permitted conversion of separatebanks to branches, but was not permitted to “opt out” of the law allowing bankholding companies from other states to enter the state. The federal legislationalso establishes limits on acquisitions by large banking organizations,providing that no acquisition may be undertaken if it would result in theorganization having deposits exceeding either 10% of all bank deposits in theUnited States or 30% of the bank deposits in the state in which the acquisitionwould occur.

 

Although Texasoriginally adopted legislation to “opt out” of the interstate branchingprovisions, Texas’ decision to opt out of these provisions was renderedineffective with the 1998 decision of the United States District Court for theNorthern District of Texas affirming the Comptroller’s decision to permit aninterstate merger involving a Texas national bank. The Texas Legislatureresponded in 1999 by passing The Interstate Banking and Branching Bill, whichbecame effective September 1, 1999. This legislation provides a framework forinterstate branching in Texas, providing for *de novo*branching by banksheadquartered in states offering reciprocity to Texas institutions orinstitutions authorized to branch in Texas. However, banks in other,nonreciprocal states, are prohibited from acquiring a Texas bank in aninterstate merger transaction if the Texas bank has not been in existence andin continuous operation for at least five years. The legislation also clarifiesother provisions of Texas law relating to interstate banks operating in Texasand included a “super parity” provision that provides a framework for a bankchartered in Texas, upon application, to conduct any of the activities allowedto any other state or federal financial institution in the nation.

 

*Gramm-Leach-Bliley Act of 1999*

 

Historically,the Company has been prohibited from acquiring a direct or indirect interest inor control of more than 5% of the voting shares of any company that is not abank or bank holding company and from engaging directly or indirectly inactivities other than those of banking, managing or controlling banks orfurnishing services to the Bank, except that the Federal Reserve has permittedbank holding companies to engage in and own shares of companies engaged incertain activities found by the Federal Reserve to be so closely related tobanking or managing and controlling banks as to be a proper incident thereto.These activities include, among others, operating a mortgage, finance, creditcard, or factoring company; performing certain data processing operations;providing investment and financial advice; acting as an insurance agent forcertain types of credit-related insurance; leasing personal property on a fullpay out, nonoperating basis; and providing certain stock brokerage andinvestment advisory services. In approving acquisitions or the addition ofactivities, the Federal Reserve has considered whether the acquisition or theadditional activities can reasonably be expected to produce benefits to thepublic, such as greater convenience, increased competition, or gains inefficiency, that outweigh such possible adverse effects as undue concentrationof resources, decreased or unfair competition, and conflicts of interest orunsound banking practices. In considering any application for approval of anacquisition or merger, the Federal Reserve is also required to consider thefinancial and managerial resources of the companies and the banks concerned, aswell as the applicant’s record of compliance with the Community ReinvestmentAct, which generally requires a financial institution to take affirmativeaction to ascertain and meet the credit needs of its entire community,including low and moderate income neighborhoods.

 

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TheGramm-Leach-Bliley Act (“Gramm-Leach”), enacted by Congress in November 1999,now permits bank holding companies with subsidiary banks meeting certaincapital and management requirements to elect to become “financial holding companies.”Beginning in March 2000, financial holding companies may engage in a full rangeof financial activities, including not only banking, insurance and securitiesactivities, but also merchant banking and additional activities determined tobe “financial in nature.” Gramm-Leach also provides that the list ofpermissible activities will be expanded as necessary for a financial holdingcompany to keep abreast of competitive and technological change.

 

Although itpreserves the Federal Reserve as the umbrella supervisor of financial holdingcompanies, Gramm-Leach adopts an administrative approach to regulation thatdefers to the approval and supervisory requirements of the functionalregulators of insurers and insurance agents, broker-dealers, investment companiesand banks, as applicable. Thus, the various state and federal regulators of afinancial holding company’s operating subsidiaries would retain theirjurisdiction and authority over the operating entities. As the umbrellasupervisor, however, the Federal Reserve has the potential to affect theoperations and activities of financial holding companies’ subsidiaries throughits power over the financial holding company parent. In addition, Gramm-Leachcontains numerous trigger points related to legal noncompliance and otherserious problems affecting bank affiliates that could lead to direct FederalReserve involvement and to the possible exercise of remedial authorityaffecting both financial holding companies and their affiliated operatingcompanies.

 

The Companyhas not, as of the date hereof, elected to become a financial holding company.

 

**Pending Legislation**

 

Proposals tochange the laws and regulations governing the banking and financial servicesindustry are frequently introduced in congress, in the state legislatures andbefore the various bank regulatory agencies. The likelihood and timing of anysuch changes and the impact such changes might have on the Company and the Bankcannot be determined at this time.

 

**Insurance of Accounts**

 

The FDICprovides insurance, through the BIF, to deposit accounts at the Bank to amaximum of $100,000 for each insured depositor. Effective January 1, 1996, theFDIC implemented an amendment to the BIF risk-based assessment schedule thateffectively eliminated deposit insurance assessments for most commercial banksand other depository institutions with deposits insured by the BIF only. Atthis time, the deposit insurance assessment rate for institutions in the lowestrisk-based premium category is zero and slightly higher for other riskcategories.

 

**Regulations GoverningCapital Adequacy**

 

The federalbank regulatory agencies use capital adequacy guidelines in their examinationand regulation of bank holding companies and banks. If the capital falls belowthe minimum levels established by these guidelines, the bank holding company orbank may be denied approval to acquire or establish additional banks ornon-bank businesses or to open facilities.

 

The FederalReserve and the Comptroller have adopted risk-based capital guidelines forbanks and bank holding companies. The risk-based capital guidelines aredesigned to make regulatory capital requirements more sensitive to differencesin risk profile among banks and bank holding companies, to account foroff-balance sheet exposure and to minimize disincentives for holding liquidassets. Assets and off-balance sheet items are assigned to broad riskcategories, each with appropriate weights. The resulting capital ratiosrepresent capital as a percentage of total risk-weighted assets and off-balancesheet items. The Federal Reserve has noted that bank holding companiescontemplating significant expansion programs should not allow expansion todiminish their capital ratios and should maintain ratios well in excess of theminimums. Under these guidelines, all bank holding companies and federallyregulated banks must maintain a minimum risk-based total capital ratio equal to8%, of which at least one-half must be Tier 1 capital.

 

9

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The FederalReserve also has implemented a leverage ratio, which is Tier 1 capital to totalassets, to be used as a supplement to the risk-based guidelines. The principalobjective of the leverage ratio is to place a constraint on the maximum degreeto which a bank holding company may leverage its equity capital base. TheFederal Reserve requires a minimum leverage ratio of 3%. For all but the mosthighly rated bank holding companies and for bank holding companies seeking toexpand, however, the Federal Reserve expects that additional capital sufficientto increase the ratio by at least 100 to 200 basis points will be maintained.

 

See“Management’s Discussion and Analysis of Financial Condition and Results ofOperations—Capital Resources” for a discussion of the capital adequacy of theCompany and the Bank.

 

Management ofthe Company believes that the risk weighting of assets and the risk-basedcapital guidelines do not have a material adverse impact on the Company’soperations or on the operations of the Bank. The requirement of deductingcertain intangibles in computing capital ratios contained in the guidelines,however, could adversely affect the ability of the Company to make acquisitionsin the future in transactions that would be accounted for using the purchasemethod of accounting.

 

**Change in Bank Control Act**

 

The Change inBank Control Act prohibits a person or group of persons from acquiring“control” of a bank holding company, unless the Federal Reserve has beennotified and has not objected to the transaction. Under a rebuttal presumptionestablished by the Federal Reserve, the acquisition of 10% or more of a classof voting stock of a bank holding company with a class of securities registeredunder Section 12 of the Exchange Act, such as the Company, would, under thecircumstance set forth in the presumption, constitute acquisition of control ofthe bank holding company. In addition, a company is required to obtain theapproval of the Federal Reserve under the Bank Holding Company Act beforeacquiring 25% (5% in the case of an acquirer that is a bank holding company) ormore of any class of outstanding voting stock of a bank holding company, orotherwise obtaining control or a “controlling influence” over that bank holdingcompany.

 

**CommunityReinvestment Act**

 

The CommunityReinvestment Act of 1977 requires that, in connection with examinations offinancial institutions within their jurisdiction, the federal bankingregulators must evaluate the record of the financial institutions in meetingthe credit needs of their local communities, including low and moderate incomeneighborhoods, consistent with the safe and sound operation of those banks.These factors are also considered in evaluating mergers, acquisitions andapplications to open a branch or facility.

 

**Regulations Governing Extensions of Credit**

 

The Bank issubject to certain restrictions imposed by the Federal Reserve Act onextensions of credit to the Company or the Bank or investments in theirsecurities and on the use of their securities as collateral for loans to anyborrowers. These regulations and restrictions limit the ability of the Companyto borrow funds from the Bank for its cash needs, including funds foracquisitions and for payment of dividends, interest and operating expenses.Further, under the BHCA and certain regulations of the Federal Reserve, a bankholding company and its subsidiaries are prohibited from engaging in certaintying arrangements in connection with any extension of credit, lease or sale ofproperty or furnishing of services. For example, the Bank may not generallyrequire a customer to obtain other services from the Bank or the Company, andmay not require the customer to promise not to obtain other services from acompetitor as a condition to an extension of credit to the customer.

 

The Bank isalso subject to certain restrictions imposed by the Federal Reserve Act onextensions of credit to executive officers, directors, principal shareholdersor any related interest of such persons. Extensions of credit (i) must be madeon substantially the same terms, including interest rates and collateral as,and following credit underwriting procedures that are not less stringent thanthose prevailing at the time for comparable transactions with persons notcovered above and who are not employees and (ii) must not involve more than thenormal risk of 

 

10

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repayment or present otherunfavorable features. The Bank is also subject to certain lending limits andrestrictions on overdrafts to such persons.

 

**Reserve Requirements**

 

The FederalReserve requires all depository institutions to maintain reserves against theirtransaction accounts and nonpersonal time deposits. Reserves of 3% must bemaintained against net transaction accounts of $42.8 million or less (subjectto adjustment by the Federal Reserve) and an initial reserve of $1,284,000 plus10% of the amount over $42.8 million (subject to adjustment by the FederalReserve) must be maintained against that portion of net transaction accounts inexcess of such amount. The balances maintained to meet the reserve requirementsimposed by the Federal Reserve may be used to satisfy liquidity requirements.

 

Institutionsare authorized to borrow from the Federal Reserve Bank “discount window,” butFederal Reserve regulations require institutions to exhaust other reasonablealternative sources of funds before borrowing from the Federal Reserve Bank.

 

**Dividends**

 

The Company’sprimary sources of funds have been the dividends, current tax liabilities andmanagement fees paid by the Bank. The ability of the Bank to pay dividends andmanagement fees is limited by various state and federal laws, by theregulations promulgated by its primary regulators and by the principles ofprudent bank management. Since the Acquisition, the Bank has not paidmanagement fees to the Company.

 

**Technology Risk Management**

 

Federalbanking regulators have issued various policy statements emphasizing theimportance of technology risk management and supervision in evaluating thesafety and soundness of depository institutions. Banks are contractingincreasingly with outside vendors to provide data processing and core bankingfunctions. The use of technology-related products, services, delivery channels,and processes expose a bank to various risks, particularly operational,privacy, security, strategic, reputation and compliance risk. Banks aregenerally expected to successfully manage technology-related risks with allother risks to ensure that the bank’s risk management is integrated andcomprehensive, primarily through identifying, measuring, monitoring andcontrolling risks associated with the use of technology.

 

**Monetary Policy and Economic Control**

 

The commercialbanking business in which the Company engages is affected not only by generaleconomic conditions, but also by the monetary policies of the Federal Reserve.Changes in the discount rate on member bank borrowing, availability ofborrowing at the “discount window,” open market operations, the imposition ofchanges in reserve requirements against member banks deposits and assets offoreign branches, and the imposition of and changes in reserve requirementsagainst certain borrowings by banks and their affiliates are some of theinstruments of monetary policy available to the Federal Reserve. These monetarypolicies are used in varying combinations to influence overall growth anddistributions of bank loans, investments and deposits, and such use may affectinterest rates charged on loans or paid on deposits. The monetary policies ofthe Federal Reserve have had a significant effect on the operating results ofcommercial banks and are expected to do so in the future. The monetary policiesof the Federal Reserve are influenced by various factors, including inflation,unemployment, short-term and long-term changes in the international tradebalance and in the fiscal policies of the U.S. Government. Future monetarypolicies and the effect of such policies on the future business and earnings ofthe Company and the Bank cannot be predicted.

 

11

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**Sarbanes-Oxley Act**

 

On July 30,2002, the Sarbanes-Oxley Act of 2002 was signed into law.  The Act addresses many aspects of financialaccounting, corporate governance and public company disclosure.  Among other things, it establishes acomprehensive framework for the oversight of public company auditing and forstrengthening the independence of auditors and audit committees.  Under the Act, audit committees areresponsible for the appointment, compensation and oversight of the work of theauditors.  The non-audit services thatcan be provided to a company by its auditor are limited.  Audit committee members are subject to newrules addressing their independence. The Act also requires enhanced and accelerated financial disclosures,and it establishes various responsibility measures (including, for example,requiring the chief executive officer and chief financial officer to certify tothe quality of a company’s financial reporting).  The Act imposes new restriction on and accelerated reportingrequirements for certain insider trading activities.  It imposes a variety of new penalties for fraud and otherviolations and creates a new federal felony for securities fraud.  Various sections of the Act are applicableto the Company.  Portions of the Actwere effective immediately; others became effective or are in the process ofbecoming effective through rulings by the Securities and Exchange Commission,based on timelines set forth in the law.

 

**Available Information**

 

The Company’sannual reports on Form 10-K, quarterly reports on Form 10-Q, current reports onForm 8-K and all amendments to those reports filed or furnished pursuant toSection 13(a) or 15(d) of the Exchange Act are available free of charge throughthe Securities and Exchange website (http://www.sec.gov) as soon as reasonablepracticable after such material is electronically filed or furnished to theSecurities and Exchange Commission.

 

**Competition**

 

The activitiesin which the Company and the Bank engage are highly competitive.  Each activity engaged in and the geographicmarket served involves competition with other banks and savings and loanassociations; as well as with nonbanking financial institutions andnonfinancial enterprises.  In Texas,savings and loan associations and banks are allowed to establish statewidebranch offices.  The Bank activelycompetes with other banks in its effort to obtain deposits and make loans, inthe scope and type of services offered, in interest rates paid on time depositsand charged on loans and in other aspects of banking.  In addition to competing with other commercial banks within andwithout its primary service areas, the Bank competes with other financial institutionsengaged in the business of making loans or accepting deposits, such as savingsand loan associations, credit unions, insurance companies, small loancompanies, finance companies, mortgage companies, real estate investmenttrusts, factors, certain governmental agencies, credit card organizations andother enterprises.  Additionalcompetition for deposits comes from government and private issues of debtobligations and other investment alternatives for depositors such as moneymarket funds.  The Bank also competeswith suppliers of equipment in providing equipment financing.

 

**Employees**

 

At March 7,2003, the Company and the Bank had 478 full-time equivalentemployees.  Employees are provided withemployee benefits, such as a 401(k) profit sharing plan and life, health andlong-term disability insurance plans. The Company considers the relationship of the Bank with its employees tobe good.

 

12

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**ITEM 2**.     PROPERTIES

 

At March 7,2003, the Company occupied approximately 2,600 square feet of space for itscorporate offices at 1617 Broadway, Lubbock, Texas.  The Broadway Branch of the Bank occupies approximately 9,800square feet at this same facility. The following table sets forth, at March 7,2003, certain information with respect to the banking premises owned or leasedby the Company and the Bank.  TheCompany considers such premises adequate for its needs and the needs of theBank.

** **
| **Location**      |   | **Approximate  Square Footage** |   | **Ownership  and Occupancy**                                                                        |   |
|-------------------|--------|---------------------------------|--------|-----------------------------------------------------------------------------------------------------|--------|
| Abilene, Texas    |   | 8,600                           |   | Owned  by the Bank; occupied by the Chestnut Branch                                                 |   |
|              |   |                            |   |                                                                                                |   |
| Abilene, Texas    |   | 3,500                           |   | Owned  by the Bank; occupied by the Wylie Branch                                                    |   |
|              |   |                            |   |                                                                                                |   |
| Abilene, Texas    |   | 58,900                          | (1)    | Owned  by the Bank; occupied and leased by the North 3rd Street Branch                              |   |
|              |   |                            |   |                                                                                                |   |
| Abilene, Texas    |   | 1,200                           |   | Leased  by the Bank; occupied by the South 14th Street Branch                                       |   |
|              |   |                            |   |                                                                                                |   |
| Azle, Texas       |   | 20,400                          | (2)    | Owned  by the Bank and three other condominium owners; occupied and leased by the  Azle Main Branch |   |
|              |   |                            |   |                                                                                                |   |
| Azle, Texas       |   | 3,900                           |   | Owned  by the Bank; occupied by the Azle North Branch                                               |   |
|              |   |                            |   |                                                                                                |   |
| Big Spring, Texas |   | 3,200                           |   | Owned  by the Bank; occupied by the Big Spring Branch                                               |   |
|              |   |                            |   |                                                                                                |   |
| Lubbock, Texas    |   | 12,400                          |   | Owned  by the Bank; occupied by the Broadway Branch and the Company                                 |   |
|              |   |                            |   |                                                                                                |   |
| Lubbock, Texas    |   | 15,300                          |   | Leased  by the Bank; occupied by Operations                                                         |   |
|              |   |                            |   |                                                                                                |   |
| Lubbock, Texas    |   | 23,200                          | (3)    | Owned  by the Bank; occupied and leased by the 82nd Street Branch                                   |   |
|              |   |                            |   |                                                                                                |   |
| Lubbock, Texas    |   | 1,800                           |   | Owned  by the Bank; occupied by the Indiana Branch                                                  |   |
|              |   |                            |   |                                                                                                |   |
| Odessa, Texas     |   | 62,400                          | (4)    | Owned  by the Bank; occupied and leased by the Odessa Main Branch                                   |   |
|              |   |                            |   |                                                                                                |   |
| Odessa, Texas     |   | 2,400                           |   | Leased  by the Bank; occupied by the Winwood Branch                                                 |   |
|              |   |                            |   |                                                                                                |   |
| Plainview, Texas  |   | 6,300                           |   | Owned  by the Bank; occupied by the Plainview Branch                                                |   |
|              |   |                            |   |                                                                                                |   |
| San Angelo, Texas |   | 6,800                           | (5)    | Owned  by the Bank; occupied and leased by the San Angelo Branch                                    |   |
|              |   |                            |   |                                                                                                |   |
| Stamford, Texas   |   | 14,000                          |   | Owned  by the Bank; occupied by the Stamford Branch                                                 |   |
|              |   |                            |   |                                                                                                |   |
| Winters, Texas    |   | 9,500                           |   | Owned  by the Bank; occupied by the Winters Branch                                                  |   |

 

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(1)        The North3rd Street Branch occupies approximately 14,400 square feet and leasesapproximately 44,500 square feet to third parties.

(2)        The Bankowns condominium interests totaling approximately 16,800 square feet.   Three other condominium owners own unitstotaling approximately 3,600 square feet.

(3)        The 82ndStreet Branch occupies approximately 14,300 square feet, leases approximately8,000 square feet to third parties and is attempting to lease the remainingapproximate 900 square feet.

(4)        The OdessaMain Branch occupies approximately 24,500 square feet, leases approximately18,700 square feet to third parties and is attempting to lease the remainingapproximate 19,200 square feet.

(5)        The SanAngelo Branch occupies approximately 3,400 square feet, leases approximately3,400 square feet to third parties.

 

The Bank ownsor leases certain additional tracts of land for parking, drive-infacilities and for future expansion or construction of new premises.  Aggregate annual rentals of the Company and theBank for all leased premises during the year ended December 31, 2002, were$263,000.  This amount representsrentals paid for the lease of land by the North 3rd Branch and of bankingpremises by the Operations Center, and the South 14th Street andWinwood branches of the Bank.

 

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**ITEM 3**.     LEGAL PROCEEDINGS

 

Neither theCompany nor the Bank is currently a party to any material legalproceedings.  From time to time, theCompany is involved in litigation proceedings incidental to the normal courseof its business. In the opinion of management, the ultimate liability, if any,resulting from known, current litigation, either singularly or in aggregate,would not reasonably be expected to have a material adverse effect on theCompany’s financial position, results of operations or cash flows.

 

**ITEM 4**.     SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

 

During thefourth quarter of the fiscal year, no matter was submitted by the Company to avote of its shareholders through the solicitation of proxies or otherwise.

 

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# **PARTII**

 

**ITEM 5**.               MARKET FOR THE REGISTRANT’S COMMON EQUITY ANDRELATED STOCKHOLDER MATTERS

 

**Market Information**

 

Until August11, 2000, the Company’s common stock was traded on the American Stock Exchange(the “AMEX”) under the symbol “IBK.” Upon completion of the Acquisition,listing of the Company’s common stock on the AMEX ceased.  Independent Capital’s Trust PreferredSecurities currently trade on the AMEX under the symbol “IBK_Pr.” The followingtable sets forth, for the periods indicated, the high and low sales prices forthe Trust Preferred Securities as quoted on the AMEX and the amount of cashdividends and distributions paid per security.

 
|                            |   | **Trust  Preferred Securities** |   |
|---------------------------------|--------|---------------------------------|--------|
|                            |   | **High**                        |   | **Low** |   | **Distributions  Per Security** |   |
| Year Ended December 31, 2001    |   |                            |   |   |   |   |   |
| First Quarter                   |   | $                               | 9.44   |   | $ | 8.00 |   | $ | 0.22 |   |
| Second Quarter                  |   | 10.10                           |   | 9.00 |   | 0.21 |   |
| Third Quarter                   |   | 10.15                           |   | 8.75 |   | 0.22 |   |
| Fourth Quarter                  |   | 10.25                           |   | 9.20 |   | 0.22 |   |
|                            |   |                            |   |   |   |   |   |
| Year Ended December 31, 2002    |   |                            |   |   |   |   |   |
| First Quarter                   |   | $                               | 10.00  |   | $ | 9.60 |   | $ | 0.22 |   |
| Second Quarter                  |   | 10.15                           |   | 9.62 |   | 0.21 |   |
| Third Quarter                   |   | 10.15                           |   | 9.50 |   | 0.21 |   |
| Fourth Quarter                  |   | 10.50                           |   | 9.86 |   | 0.22 |   |
|                            |   |                            |   |   |   |   |   |
| Year Ended December 31, 2003    |   |                            |   |   |   |   |   |
| First Quarter (through March 7) |   | $                               | 10.20  |   | $ | 9.90 |   | $ | 0.21 |   |

 

**Shareholders**

 

At March 7,2003, all of the Company’s common stock was owned indirectly by State National.

 

**Dividend Policy**

 

As the holderof all of the common stock, State National is entitled to receive any cashdividends that may be declared by the Company’s Board of Directors.  The declaration and payment of futuredividends to State National will be at the discretion of the Company’s Board ofDirectors and will depend upon a number of factors, including the extent offunds legally available for the payment of dividends, the Company’s earningsand financial condition, capital requirements of its subsidiaries, regulatoryrequirements and considerations and such other factors as the Company’s Boardof Directors may deem relevant.  Inaddition, the Company is prohibited from paying dividends on the common stockin the event that it is in default under the terms of its junior subordinateddebentures issued to Independent Capital in connection with the issuance of theTrust Preferred Securities or the Company extends the regular interest paymentdate with respect to its debentures to Independent Capital.

 

As a holdingcompany, the Company is ultimately dependent upon its subsidiaries to providefunding for its operating expenses, debt service and dividends.  Various banking laws applicable to theCompany’s subsidiaries limit the payment of dividends, management fees andother distributions by such subsidiaries to the Company and may therefore limitthe ability of the Company to make dividend payments.

 

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**ITEM 6**.                                                   SELECTED FINANCIAL DATA

 

 

The following table presents selected consolidated financialinformation for the last five years. See “Note 1: Summary of SignificantAccounting Policies-Principles of Consolidation,” “Note 2: Acquisition of theCompany,” “Note 3: Bank Merger,” “Note 12: Earnings Per Share” and the OtherNotes in the Company’s Consolidated Financial Statements for an explanation ofchanges in financial statement items. As the Company is a wholly owned subsidiary of State National, percommon share data is not meaningful after the date of the Acquisition.

 
|                                                                     |   | **2002**                                              |    | **2001** |   | **August 12,   2000   through  December   31,2000** |   | **January   1, 2000  through  August  11, 2000** |    | **1999** |   | **1998** |   |
|--------------------------------------------------------------------------|--------|-------------------------------------------------------|---------|----------|--------|-----------------------------------------------------|--------|--------------------------------------------------|---------|----------|--------|----------|--------|
|                                                                     |   | **(Dollars in  thousands, except per share amounts)** |    |
| Balance sheet information:                                               |   |                                                  |    |     |   |                                                |   |                                             |    |     |   |     |   |
| Assets                                                                   |   | $                                                     | 558,287 |     | $      | 637,383                                             |   | $                                                | 695,270 |     | $      | —   |   | $ | 358,262 |   | $ | 370,178 |   |
| Loans, net of unearned income                                            |   | 287,302                                               |    | 304,246  |   | 366,933                                             |   | —                                           |    | 186,626  |   | 184,560  |   |
| Allowance for loan losses                                                |   | (6,261                                                | )       | (6,525   | )      | (8,379                                              | )      | —                                           |    | (1,833   | )      | (1,842   | )      |
| Deposits                                                                 |   | 482,643                                               |    | 544,030  |   | 593,605                                             |   | —                                           |    | 318,299  |   | 330,804  |   |
| Note payable                                                             |   | 143                                                   |    | 0        |   | 0                                                   |   | —                                           |    | 0        |   | 1        |   |
| Stockholder’s equity                                                |   | 58,593                                                |    | 75,381   |   | 81,984                                              |   | —                                           |    | 25,356   |   | 24,505   |   |
|                                                                     |   |                                                  |    |     |   |                                                |   |                                             |    |     |   |     |   |
| Income statement information:                                            |   |                                                  |    |     |   |                                                |   |                                             |    |     |   |     |   |
| Total interest income                                                    |   | $                                                     | 30,682  |     | $      | 41,183                                              |   | $                                                | 19,724  |     | $      | 15,273   |   | $ | 24,206 |   | $ | 20,434 |   |
| Net interest income                                                      |   | 22,646                                                |    | 22,012   |   | 10,472                                              |   | 8,918                                            |    | 14,308   |   | 11,158   |   |
| Net (loss) income                                                        |   | (11,868                                               | )       | (7,197   | )      | 235                                                 |   | (1,908                                           | )       | 2,452    |   | 2,188    |   |
|                                                                     |   |                                                  |    |     |   |                                                |   |                                             |    |     |   |     |   |
| Basic (loss) earnings per common share available to common  stockholders |   | N/A                                                   |    | N/A      |   | N/A                                                 |   | $                                                | (.84    | )        | $      | 1.12     |   | $ | 1.07 |   |
|                                                                     |   |                                                  |    |     |   |                                                |   |                                             |    |     |   |     |   |
| Diluted (loss) earnings per share available to common stockholders       |   | N/A                                                   |    | N/A      |   | N/A                                                 |   | $                                                | (.84    | )        | $      | 1.08     |   | $ | 1.02 |   |
|                                                                     |   |                                                  |    |     |   |                                                |   |                                             |    |     |   |     |   |
| Cash dividends per common share                                          |   | N/A                                                   |    | N/A      |   | N/A                                                 |   | $                                                | 0.12    |     | $      | 0.20     |   | $ | 0.20 |   |
|                                                                     |   |                                                  |    |     |   |                                                |   |                                             |    |     |   |     |   |
| Weighted average common shares outstanding:                              |   |                                                  |    |     |   |                                                |   |                                             |    |     |   |     |   |
| Basic                                                                    |   | N/A                                                   |    | N/A      |   | N/A                                                 |   | 2,262                                            |    | 2,178    |   | 2,031    |   |
| Diluted                                                                  |   | N/A                                                   |    | N/A      |   | N/A                                                 |   | 2,262                                            |    | 2,275    |   | 2,151    |   |
|                                                                          |        |                                                       |         |          |        |                                                     |        |                                                  |         |          |        |          |        |  |  |  |  |  |  |  |

 

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**ITEM 7**.                                                   MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIALCONDITION AND RESULTS OF OPERATIONS

 

**Forward-LookingStatements—Cautionary Statements**

 

*This report contains certain forward-lookingstatements and information relating to the Company and its subsidiaries thatare based on the beliefs of the Company’s management, as well as assumptionsmade by and information currently available to the Company’s management. Whenused in this report, the words “anticipate,” “believe,” “estimate,” “expect”and “intend” and words or phrases of similar import, as they relate to theCompany or its subsidiaries or Company management, are intended to identifyforward-looking statements. Such statements are intended to be covered by thesafe-harbor provisions for forward-looking statements contained in the PrivateSecurities Litigation Reform Act of 1995 and we are including this statementfor purposes of invoking those safe harbor provisions.  The forward-looking statements reflect thecurrent view of the Company with respect to future events and are subject tocertain risks, uncertainties and assumptions related to certain factorsincluding, without limitation, competitive factors, general economic conditionsnationally and within the State of Texas, customer relations, the interest rateenvironment, governmental regulation and supervision, nonperforming assetlevels, loan concentrations, changes in industry practices, acts of terrorismand war, one time events and other factors described herein. Based uponchanging conditions, should any one or more of these risks or uncertaintiesmaterialize, or should any underlying assumptions prove incorrect, actualresults may vary materially from those described herein as anticipated,believed, estimated, expected or intended. The Company does not intend toupdate these forward-looking statements.*

 

**CriticalAccounting Policies**

 

The Company’s accounting policies are integral to understanding theresults reported.  Accounting policiesare described in detail in Note 1 to the consolidated financialstatements.  The Company believes thatof its significant accounting policies, the following may involve a higherdegree of judgment and complexity:

 

Allowance for Loan Losses – The allowance forloan losses is a reserve established through charges to earnings in the form ofa provision for loan losses.  Managementhas established an allowance for loan losses which it believes is adequate forestimated losses in the Company’s portfolio. Based on an evaluation of the loan portfolio, management presents amonthly review of the allowance for loan losses to the Board of Directors,indicating any change in the allowance since the last review and anyrecommendations as to adjustments in the allowance.  In making its evaluation, management considers factors such ashistorical loan loss experience, industry diversification of the Company’scommercial loan portfolio, the amount of nonperforming assets and relatedcollateral, the volume, growth and composition of the Company’s loan portfolio,current economic changes that may affect the borrower’s ability to pay and thevalue of collateral, the evaluation of the Company’s loan portfolio through itsinternal loan review process and other relevant factor.  Charge-offs occur when loans are deemed tobe uncollectible.

 

**General**

 

The following discussion and analysis presents the more significantfactors affecting the Company’s financial condition at December 31, 2002 and2001, and results of operations for each of the three years in the period endedDecember 31, 2002, after accounting for the Acquisition and the Mergers(defined below) as described in Note 2 and 3 in the Company’s consolidatedfinancial statements. This discussion and analysis should be read inconjunction with the Company’s consolidated financial statements, notes theretoand other financial information appearing elsewhere in this annual report. Theresults of operations for the Company for the year ended December 31, 2000,include the results of operations for UB&T and the Lubbock Bank beginningAugust 12, 2000, the date of the Acquisition. UB&T and the Lubbock Bankwere previously owned subsidiaries of State National, which were merged withand into the Bank  (the “Mergers”). Thename of the resulting bank was changed to State National Bank of West Texas,Lubbock, Texas (previously defined as the “Bank” or the “Lubbock Bank”).

 

On March 1,2000, the Company entered into an Agreement and Plan of Reorganization (the“Agreement”) with State National providing for the acquisition of the Companyby State National (the “Acquisition”). The 

 

17

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Company and State Nationalconsummated the Acquisition at the close of business August 11, 2000.  Pursuant to the terms of the Agreement, eachshare of common stock of the Company was exchanged for $20.0165 in cash. Uponconsummation of the Acquisition, State National became the sole shareholder ofthe Company, owning all 2,273,647 outstanding shares of the Company’s commonstock. In connection with the Acquisition, State National agreed to assume andguarantee the outstanding Trust Preferred Securities issued by IndependentCapital, a Delaware business trust controlled by the Company.

 

State Nationalaccounted for its acquisition of the Company as a purchase business combinationand purchase accounting adjustments, including goodwill, have been pushed downand reflected in the consolidated financial statements of the Companysubsequent to August 11, 2000. The consolidated financial statements of theCompany for the periods ended before August 12, 2000 (predecessor) wereprepared using the Company’s historical basis of accounting. The comparabilityof operating results for these periods and the periods encompassing push downaccounting are affected by the purchase accounting adjustments, including theamortization of goodwill (straight-line method until amortization of goodwillceased beginning January 1, 2002) and core deposit intangibles (acceleratedmethod) over a period of 20 and 10 years, respectively.

 

**Results of Operations**

 

*General*

 

The net loss for the year ended December 31, 2002 was $11,868,000.   Net income before cumulative effect of achange in accounting principle for the year ended December 31, 2002 was$3,774,000.  The net loss for the yearended December 31, 2001 was $7,197,000. The net loss for the period from January 1, 2000, through August 11,2000, the date of the Acquisition, was $1,908,000 ($0.84 diluted loss percommon share). The net income for the period from August 12, 2000, throughDecember 31, 2000, was $235,000. Giving effect to the cumulative effect of achange in accounting principle, net loss recorded during 2002 was primarily dueto a $15,642,000 impairment recorded in the first quarter of 2002 as acumulative effect of a change in accounting principle, related to the adoptionof Statement of Accounting Standards (“SFAS”), No.  142 “Goodwill and Other Intangible Assets”.  The net losses recorded during 2001 were dueprimarily to loan loss provisions recorded during the year related to thefurther deterioration of the Bank’s collateral position on two large borrowingrelationships in the loan portfolio that pre-dated the Acquisition.

 

*NetInterest Income*

 

Net interest income represents the amount by which interest income oninterest-earning assets, including loans and securities, exceeds interest paidon interest-bearing liabilities, including deposits and other borrowed funds.Net interest income is the principal source of the Company’s earnings. Interestrate fluctuations, as well as changes in the amount and type ofinterest-earning assets and interest-bearing liabilities, combine to affect netinterest income.

 

Net interest income amounted to $22,646,000 for 2002, an increase of$634,000, or 2.9%, from 2001. Net interest income for 2001 was $22,012,000, anincrease of $2,622,000, or 13.5%, from net interest income in 2000 of$19,390,000.  The net interest margin ona fully taxable-equivalent basis was 4.51% for 2002, compared to 3.88% for 2001and 4.64% for 2000.  During the yearended December 31, 2001, in which the prime interest rate decreased from 9.50%to 4.75%, interest earning assets were repricing faster than interest bearingliabilities, thereby pulling the net interest margin down from December 31,2000 to December 31, 2001.  During theyear ended December 31, 2002, there has been one reduction in the primeinterest rate in November from 4.75% to 4.25%. This relatively flat prime rate during the year ended December 31, 2002allowed the repricing lag effect of interest bearing liabilities to be reducedand creates an upward trend in the net interest margin form December 31, 2001to December 31, 2002.

 

At December 31, 2002, approximately $148,020,000, or 51.5%, of theCompany’s total loans, net of unearned income, were loans with floatinginterest rates. Approximately 56.2% of loans, excluding loans to individuals,were loans with floating interest rates.

 

Average overall rates paid for various typesof certificates of deposit decreased during 2002 when compared to 2001.  For example, the average rate paid forcertificates of deposit less than $100,000 decreased from 5.29% in 2001 to2.93% in 2002, while the average rate paid by the Company for certificates ofdeposit of $100,000 or more also

 

18

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decreased from 5.65% during 2001 to 3.19% in2002.  Rates on other types of deposits,such as interest-bearing demand, savings and money market deposits, decreasedfrom an average of 1.82% in 2001 to an average of 0.79% in 2002. Though theinterest rate decreases mentioned above occurred during 2001, the repricing lageffect for interest bearing liabilities prevented large decreases in theinterest rate paid on these liabilities from occurring until 2002.

 

The following table presents the average balance sheets of the Companyfor each of the last three fiscal years and indicates the interest earned orpaid on each major category of interest-earning assets and interest-bearingliabilities on a fully taxable-equivalent basis, and the average rates earnedor paid on each major category. This analysis details the contribution ofinterest-earning assets and the overall impact of the cost of funds on netinterest income.

 

19

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|                                                                                     |   | **Year Ended  December 31,** |   |
|------------------------------------------------------------------------------------------|--------|------------------------------|--------|
|                                                                                     |   | **2002**                     |   | **2001** |   | **2000(1)(2)** |   |
|                                                                                     |   | **Average  Balance**         |   | **Interest  Income/  Expense** |   | **Yield/  Rate** |   | **Average  Balance** |   | **Interest  Income/  Expense** |   | **Yield/  Rate** |   | **Average  Balance** |   | **Interest  Income/  Expense** |   | **Yield/  Rate** |   |
|                                                                                     |   | **(Dollars in thousands)**   |   |
| ASSETS                                                                                   |   |                         |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Interest-earning assets:                                                                 |   |                         |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Loans, net of unearned income(3)                                                         |   | $283,381                     |   | $20,070 |   | 7.08 | % | $326,920 |   | $27,292 |   | 8.35 | % | $258,327 |   | $24,851 |   | 9.62 | % |
| Securities(4)                                                                            |   | 200,273                      |   | 10,416 |   | 5.20 | % | 185,333 |   | 11,632 |   | 6.28 | % | 135,765 |   | 8,507 |   | 6.27 | % |
| Time Deposits in Other banks                                                             |   | 5,946                        |   |  98 |   | 1.65 | % | 709 |   | 28 |   | 3.95 | % | 194 |   | 12 |   |  6.19 | % |
| Federal funds sold                                                                       |   | 15,652                       |   | 244 |   | 1.56 | % | 59,010 |   | 2,428 |   | 4.11 | % | 28,025 |   | 1,846 |   | 6.59 | % |
| Total interest-earning assets                                                            |   | 505,252                      |   | 30,828 |   | 6.10 | % | 571,972 |   | 41,380 |   | 7.23 | % | 422,311 |   | 35,216 |   | 8.34 | % |
|                                                                                     |   |                         |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Noninterest-earning assets:                                                              |   |                         |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Cash and due from banks                                                                  |   | 23,243                       |   |   |   |   |   | 32,767 |   |   |   |   |   | 24,653 |   |   |   |   |   |
| Intangible assets                                                                        |   | 31,299                       |   |   |   |   |   | 46,908 |   |   |   |   |   | 25,979 |   |   |   |   |   |
| Premises and equipment, net                                                              |   | 14,773                       |   |   |   |   |   | 15,929 |   |   |   |   |   | 11,826 |   |   |   |   |   |
| Accrued interest receivable and other assets                                             |   | 21,194                       |   |   |   |   |   | 16,084 |   |   |   |   |   | 7,789 |   |   |   |   |   |
| Allowance for possible loan losses                                                       |   | (7,073                       | )      |   |   |   |   | (6,763 | ) |   |   |   |   | (4,512 | ) |   |   |   |   |
| Total noninterest-earning assets                                                         |   | 83,436                       |   |   |   |   |   | 104,925 |   |   |   |   |   | 65,735 |   |   |   |   |   |
|                                                                                     |   |                         |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Total assets                                                                             |   | $588,688                     |   |   |   |   |   | $676,897 |   |   |   |   |   | $488,046 |   |   |   |   |   |
|                                                                                     |   |                         |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| LIABILITIES AND STOCKHOLDER’S EQUITY                                                |   |                         |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Interest-bearing liabilities:                                                            |   |                         |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Demand, savings and money market deposits                                                |   | $185,597                     |   | $1,474 |   | 0.79 | % | $186,941 |   | $3,407 |   | 1.82 | % | $136,829 |   | $3,505 |   | 2.56 | % |
| Time deposits                                                                            |   | 216,953                      |   | 6,560 |   | 3.02 | % | 290,547  |   | 15,760 |   | 5.42 | % | 210,502 |   | 12,095 |   | 5.75 | % |
| Fed funds purchased and securities sold under agreement to repurchase                    |   | 214                          |   | 2 |   | 0.93 | % | 150 |   | 4 |   | 2.67 | % | 373 |   | 7 |   | 1.88 | % |
| Total interest-bearing liabilities                                                       |   | 402,764                      |   | 8,036 |   | 2.00 | % | 477,638 |   | 19,171 |   | 4.01 | % | 347,704 |   | 15,607 |   | 4.49 | % |
| Noninterest-bearing liabilities:                                                         |   |                         |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Demand deposits                                                                          |   | 100,513                      |   |   |   |   |   | 100,197 |   |   |   |   |   | 75,425 |   |   |   |   |   |
| Accrued interest payable and other liabilities                                           |   | 5,446                        |   |   |   |   |   | 8,056 |   |   |   |   |   | 4,975 |   |   |   |   |   |
| Total noninterest-bearing liabilities                                                    |   | 105,959                      |   |   |   |   |   | 108,253 |   |   |   |   |   | 80,400 |   |   |   |   |   |
| Total liabilities                                                                        |   | 508,723                      |   |   |   |   |   | 585,891 |   |   |   |   |   | 428,104 |   |   |   |   |   |
| Guaranteed preferred beneficial interests in the Company’s  subordinated debentures |   | 10,934                       |   |   |   |   |   | 10,918 |   |   |   |   |   | 12,126 |   |   |   |   |   |
| Stockholder’s equity                                                                |   | 69,031                       |   |   |   |   |   | 80,088 |   |   |   |   |   | 47,816 |   |   |   |   |   |
| Total liabilities and stockholder’s equity                                          |   | $588,688                     |   |   |   |   |   | $676,897 |   |   |   |   |   | $488,046 |   |   |   |   |   |
|                                                                                     |   |                         |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Net interest income(4)                                                                   |   |                         |   | $22,792 |   |   |   |   |   | $22,209 |   |   |   |   |   | $19,609 |   |   |   |
|                                                                                     |   |                         |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Interest rate spread(5)                                                                  |   |                         |   |   |   | 4.10 | % |   |   |   |   | 3.22 | % |   |   |   |   | 3.85 | % |
|                                                                                     |   |                         |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Net interest margin(6)                                                                   |   |                         |   |   |   | 4.51 | % |   |   |   |   | 3.88 | % |   |   |   |   | 4.64 | % |

 

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(1)          TheAverage Balance and Interest Income/Expense columns include the balance sheetand income statement accounts of Abilene Bank and Lubbock Bank from August 12,2000, through December 31, 2000.

(2)          TheAverage Balance and Interest Income/Expense columns for the year ended December31, 2000, included information for the predecessor Company pre-Acquisition(January 1, 2000, through August 11, 2000) and post-Acquisition (August 12,2000, through December 31, 2000).

(3)          Nonaccrualloans are included in the Average Balance columns and income recognized onthese loans, if any, is included in the Interest Income/Expense columns.Interest income on loans includes fees on loans, which are not material inamount.

(4)          Nontaxableinterest income on securities was adjusted to a taxable yield assuming a taxrate of 34%.

(5)          Theinterest rate spread is the difference between the average yield oninterest-earning assets and the average cost of interest-bearing liabilities.

(6)          The net interest margin is equal to net interest income, on a fullytaxable-equivalent basis, divided by average interest-earning assets.

 

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The following table presents the changes in the components of netinterest income and identifies the part of each change due to differences inthe average volume of interest-earning assets and interest-bearing liabilitiesand the part of each change due to the average rate on those assets andliabilities. The changes in interest due to both volume and rate in the tablehave been allocated to volume or rate change in proportion to the absoluteamounts of the change in each.

 
|                                                                  |   | **2002 vs.  2001**                           |   | **2001 vs.  2000(1)**                        |   |
|-----------------------------------------------------------------------|--------|----------------------------------------------|--------|----------------------------------------------|--------|
|                                                                  |   | **Increase  (Decrease) Due To Changes  In:** |   | **Increase  (Decrease) Due To  Changes In:** |   |
|                                                                  |   | **Volume**                                   |   | **Rate**                                     |   | **Total** |   | **Volume** |   | **Rate** |   | **Total** |   |
|                                                                  |   | **(Dollars in  thousands)**                  |   |
| Interest-earning assets:                                              |   |                                         |   |                                         |   |   |   |   |   |   |   |   |   |
| Loans, net of unearned income                                         |   | $                                            | (3,635 | )                                            | $      | (3,587 | ) | $ | (7,222 | ) | $ | 6,599 |   | $ | (4,158 | ) | $ | 2,441 |   |
| Securities(2)                                                         |   | 938                                          |   | (2,154                                       | )      | (1,216 | ) | 3,106 |   | 19 |   | 3,125 |   |
| Time deposits in other banks                                          |   | 207                                          |   | (137                                         | )      | 70 |   | 32 |   | (16 | ) | 16 |   |
| Federal funds sold                                                    |   | (1,784                                       | )      | (400                                         | )      | (2,184 | ) | 2,041 |   | (1,459 | ) | 582 |   |
| Total interest income                                                 |   | (4,274                                       | )      | (6,278                                       | )      | (10,552 | ) | 11,778 |   | (5,614 | ) | 6,164 |   |
| Interest-bearing liabilities:                                         |   |                                         |   |                                         |   |   |   |   |   |   |   |   |   |
| Deposits:                                                             |   |                                         |   |                                         |   |   |   |   |   |   |   |   |   |
| Demand, savings and money market deposits                             |   | (24                                          | )      | (1,909                                       | )      | (1,933 | ) | 1,284 |   | (1,382 | ) | (98 | ) |
| Time deposits                                                         |   | (3,992                                       | )      | (5,208                                       | )      | (9,200 | ) | 4,599 |   | (934 | ) | 3,665 |   |
| Fed Funds Purchased and Securities sold under agreement to repurchase |   | 2                                            |   | (4                                           | )      | (2 | ) | (4 | ) | 1 |   | (3 | ) |
| Total interest expense                                                |   | (4,014                                       | )      | (7,121                                       | )      | (11,135 | ) | 5,879 |   | (2,315 | ) | 3,564 |   |
| (Decrease) Increase in net interest income                            |   | $                                            | (260   | )                                            | $      | 843 |   | $ | 583 |   | $ | 5,899 |   | $ | (3,299 | ) | $ | 2,600 |   |

 

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(1)          Income statement items include the income statementaccounts of the Abilene Bank and the Lubbock Bank beginning August 12, 2000,through December 31, 2000.

(2)          Information with respect to interest income ontax-exempt securities is provided on a fully taxable-equivalent basis assuminga tax rate of 34%.

 

*Provisionfor Loan Losses*

 

The amount of the provision for loan losses is based on periodic (notless than quarterly) evaluations of the loan portfolio, especiallynonperforming and other potential problem loans. During these evaluations,consideration is given to such factors as: management’s evaluation of specificloans; the level and composition of nonperforming loans; historical lossexperience; results of examinations by regulatory agencies; an internal assetreview process conducted by the Company that is independent of the managementof the Bank; expectations of future economic conditions and their impact onparticular industries and individual borrowers; the market value of collateral;the strength of available guarantees; concentrations of credit; and otherjudgmental factors. The provision for loan losses for the year ended December 31,2002, was a reversal of $77,000, compared to $10,765,000 for the previous year.The provision in 2002 represented a decrease of $10,842,000, or 100.7%, fromthe 2001 provision. The reversals in the provision for 2002 were primarily dueto recoveries received during 2002.  The provision in 2001 represented an increase of $8,487,000, or 372.6%,from the 2000 provision primarily related to further deterioration of theBank’s collateral position on two particular large borrowing relationships inthe loan portfolio that pre-dated the Acquisition.

 

*NoninterestIncome*

 

Noninterest income increased $606,000, or 11.2%, from $5,406,000 in2001 to $6,012,000 in 2002. Noninterest income for 2001 increased $1,614,000,or 42.6%, from $3,792,000 in 2000.

 

Service charges on deposit accounts and charges for other types ofservices are the major source of noninterest income to the Company. This sourceof income increased $181,000, or 5.2%, from $3,506,000 for 2001 to $3,687,000for 2002. The increase was attributable to management emphasis placed on fullcollection of returned check fees in

 

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2002.  Service charge income increased $279,000, or 8.6%, from$3,227,000 for 2000 to $3,506,000 for 2001 primarily due to the Mergers.

 

Trust fees from trust operations decreased $5,000, or 1.0%, from$492,000 in 2001 to $487,000 in 2002. Trust fees increased $234,000, or 90.7%,from $258,000 during 2000 to $492,000 during 2001. The decrease in 2002 isprimarily the result of nonrecurring income recorded in the first quarter of2001.  The increase in 2001 was due toan overall increase in the value of assets under management of the trustdepartment. In particular, during the fourth quarter of 2000, the Bankpurchased approximately $33,000,000 in trust assets from another trust company.

 

Other income is the sum of several components of noninterest incomeincluding other customer service fees, brokerage service fees, credit and debitcard income, safe deposit box rental income Bank Owned Life Insurance (“BOLI”)income, mortgage origination fees and other sources of miscellaneousincome.  Other income increased$418,000, or 29.7%, from $1,407,000 in 2001 to $1,825,000 in 2002 primarily dueto income generated from the BOLI, which was purchased in March 2001.  The year ended December 31, 2001 includes 10months of BOLI income and the period ended December 31, 2002 includes 12 monthsof BOLI income.  Also, additional BOLIwas purchased in 2002.  The increase in2002 is also due to an increase in mortgage origination fees.  The Company had limited involvement in themarket in early 2001 and, beginning in late 2001, began to increase the levelof participation in this market.  Otherincome increased $1,136,000, or 419.2%, from $271,000 in 2000 to $1,407,000 for2001, primarily due to the Mergers, as well as income generated from the BOLIpurchased in 2001.

 

*NoninterestExpenses*

 

Noninterest expenses decreased $3,221,000, or 11.9%, from $27,055,000in 2001 to $23,834,000 in 2002, primarily as a result of the discontinuation ofgoodwill amortization related to the adoption of SFAS No. 142 and efficienciescreated after the completion of the Acquisition and the Mergers.  Noninterest expenses increased $5,074,000,or 23.1%, from $21,981,000 in 2000 to $27,055,000 in 2001. The increase in 2001was primarily a result of the Mergers.

 

Salaries and benefits decreased $211,000, or 2.0%, from $10,681,000 in2001 to $10,470,000 in 2002.  After theAcquisition and the Mergers, some positions were eliminated creating some costsavings. These savings were partially offset by employee raises, which wentinto effect in July of 2002.  Salariesand employee benefits increased $2,390,000, or 28.8%, from $8,291,000 in 2000to $10,681,000 in 2001, primarily due to the Mergers.

 

Amortization of intangible assets decreased $2,530,000, or 57.9%, from$4,367,000 for 2001 to $1,837,000 for 2002. The decrease in amortization is primarily due to SFAS No. 142, whichprevents further amortization of goodwill. Amortization increased $2,269,000, or 108.2%, from $2,098,000 for 2000to $4,367,000 for 2001. The increase in 2001 is due to the amortization of theadditional core deposit intangible and goodwill recorded as a result of theAcquisition.

 

Net occupancy expense increased $128,000, or 3.4%, from $3,726,000 in2001 to $3,854,000 in 2002. The increase in net occupancy expense is primarilydue to the costs associated with the removal of old documents and data.  Document retention policies were reviewedand it was determined that older documents and data which were no longerrequired to be retained, were able to be destroyed and removed.  Several storage facilities, which held someof these very old records, were cleaned out and many of the old documents wereeliminated or moved to different storage facilities.  The increase in expense is also related to clean-up costsassociated with an event of flooding that occurred at one of the Abilenebranches  The increase was partiallyoffset by cost savings from the closure of the supermarket branches whichoccurred in July 2001.  Net occupancyexpense increased $1,049,000, or 39.2%, from $2,677,000 in 2000 to $3,726,000in 2001. This increase was due to the Mergers.

 

Distributions on guaranteed preferred beneficial interests in theCompany’s Subordinated Debentures increased $2,000, or 0.2%, from $1,119,000for 2001 to $1,121,000 for 2002 and increased $7,000, or 0.6% from $1,112,000for 2000 to $1,119,000 for 2001.  Theincrease in 2002 and 2001 are due to the accretion into expense of the purchaseaccounting discount recorded on the Trust Preferred Securities in connectionwith the Acquisition.

 

22

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Communication expense decreased $113,000, or 12.2%, from $925,000 in2001 to $812,000 in 2002, and increased $261,000, or 39.3%, from $664,000 in2000 to $925,000 in 2001.  The decreaseis primarily due to efficiencies created over time, after the completion of theMergers and the Acquisition.

 

Professional fees, which include legal, accounting and otherprofessional fees, decreased $209,000, or 23.5%, from $888,000 during 2001 to$679,000 during 2002.  The decrease isdue primarily to nonrecurring accounting fees in the first quarter of 2001associated with various regulatory filings that were required as a result ofthe Lubbock Merger.  Professional feesdecreased $293,000, or 24.8%, from $1,181,000 during 2000 to $888,000 during2001, primarily due to the Acquisition, which was completed in 2000.

 

Data processing expense decreased $124,000, or 19.0%, from $654,000 in2001 to $530,000 in 2002, and increased $149,000, or 29.5%, from $505,000 in2000 to $654,000 in 2001.  The decreasewas due to several data processing conversions that were performed as a resultof the Lubbock Merger.

 

Net costs applicable to other real estate and other repossessed assetsconsist of expenses associated with holding and maintaining various repossessedassets, the net gain or loss on the sales of such assets, the write-down of thecarrying value of the assets and any rental income on such assets that iscredited as a reduction in such expenses. The Company recorded net costs of$52,000 in 2002 compared to net costs of $95,000 in 2001, a decrease of$43,000, or 45.3%.  The increase in netcosts during 2001 was primarily due to an increase in foreclosures on loans,most of which existed at the time of the Acquisition.  Net costs for the Company were $95,000 in 2001 compared to $6,000in 2000.  The increase in net costsduring 2001 was primarily due to an increase in foreclosures on loans, most ofwhich existed at the time of the Acquisition.

 

Merger-relatedexpenses totaled $546,000 for the year ended December 31, 2002, and $51,000 forthe year ended December 31, 2001, an increase of $495,000 or 970.6%.  On February 14, 2003, State National Bank,El Paso, a wholly owned subsidiary of State National was contributed to theCompany (see Note 21:  SubsequentEvents).  In doing so, the back officeoperations which existed at State National Bank, El Paso were relocated andconsolidated with the back office operations of the Bank.  The process to complete this merger began inthe fourth quarter of 2002.  Of theabove mentioned costs, $283,000 was related to old imaging equipment whichneeded to be replaced to handle the additional volume of the mergedentity.  The imaging equipment wasleased and the costs related to the remaining contract were recorded at thedate the old imaging equipment ceased to be used.  In connection with the leased imaging equipment, the Bank ownedsoftware that was utilized with the imaging equipment.  These capitalized costs with a remainingbook value of $160,000 were expensed when the equipment ceased to be used.  In addition to the above mentioned costs,the Company incurred other miscellaneous expenses associated with therelocation of State National Bank, El Paso back office operations to Lubbockwhich were expenses as incurred.  Thetotal of these expenses was $103,000. These expenses were accounted for in accordance with Statement ofFinancial Accounting Standard No. 146 *Accounting for Costs Associated with Exit or DisposalActivities*.  Themerger-related expenses recorded in 2001 were related to the Lubbock Merger.

 

Other noninterest expense includes, among many other items, stationary,supplies, advertising and business development, postage, loan and collectionexpenses, armored car and courier fees, travel, insurance, ATM transactionexpenses, regulatory examinations, franchise taxes, dues and subscriptions,FDIC insurance expense and director’s fees. These expenses decreased $652,000,or 14.3%, from $4,549,000 during 2001 to $3,897,000 during 2002. The decrease is primarily due to efficienciescreated over time, after the completion of the Mergers and theAcquisition.  These expenses increased $1,072,000, or 30.8%,from $3,477,000 for 2000 to $4,549,000 for 2001. The increase was primarily dueto the Mergers.

 

*FederalIncome Taxes*

 

The Company provided for $1,223,000 in federal income taxes in 2002,recorded a federal income tax benefit of $3,205,000 for 2001 and provided for$596,000 in federal income taxes in 2000. The benefit was recorded due to thepretax loss incurred in 2001.  Theprovision was made in 2000 despite that the Company had a pretax loss due to asubstantial amount of nondeductible Acquisition-related expenses that wereincurred during the year ended December 31, 2000.

 

23

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*Impact of Inflation*

 

The effects ofinflation on the local economy and on the Company’s operating results have beenrelatively modest for the past several years. Because substantially all of theCompany’s assets and liabilities are monetary in nature, such as cash,securities, loans and deposits, their values are less sensitive to the effectsof inflation than to changing interest rates, which do not necessarily changein accordance with inflation rates. The Company attempts to control the impactof interest rate fluctuations by managing the relationship between its interestrate sensitive assets and liabilities. See “Analysis of FinancialCondition—Interest Rate Sensitivity” below.

 

**Quantitativeand Qualitative Disclosures About Market Risk**

 

The businessof the Company and the composition of its consolidated balance sheet consistsof investments in interest-earning assets (primarily loans and investmentsecurities), which are primarily funded by interest-bearing liabilities(deposits).  Such financial instrumentshave varying levels of sensitivity to changes in market interest ratesresulting in the market risk.

 

*Interest Rate Risk Measurement*

 

Interest raterisk arises when an interest-earning asset matures or when its rate of interestchanges in a time frame different from that of the supporting interest-bearingliability.  The Company seeks tominimize the difference between the amount of interest-earning assets and theamount of interest-bearing liabilities that could change interest rates in thesame time frame in an attempt to reduce the risk of significant adverse effectson the Company’s net interest income caused by interest rate changes.  The Company does not attempt to match eachinterest-earning asset with a specific interest-bearing liability.  Instead, as shown in the following table, itaggregates all of its interest-earning assets and interest-bearing liabilitiesto determine the difference between the two in specific time frames.  This difference is known as therate-sensitivity gap.  A company isconsidered to be asset sensitive, or having a positive gap, when the amount ofits interest-earning assets maturing or repricing within a given period exceedsthe amount of its interest bearing liabilities also maturing or repricingwithin that time period.  Conversely, acompany is considered to be liability sensitive, or having a negative gap, whenthe amount of its interest-bearing liabilities maturing or repricing within agiven time period exceeds the amount of its interest-earning assets alsomaturing or repricing within that time period. During a period of rising interest rates, a negative gap would tend to affectnet interest income adversely, while a positive gap would tend to result in anincrease in net interest income.  Duringa period of falling interest rates, as experienced in 2001, a negative gapwould tend to result in an increase in net interest income, while a positivegap would tend to affect net interest income adversely.  Maintaining a balanced position will reducerisk associated with interest rate changes, but it will not guarantee a stableinterest rate spread because the various rates within a time frame may changeby differing amounts and occasionally change in different directions.  Management regularly monitors the interestsensitivity position and considers this position in its decisions in regard tointerest rates and maturities for interest-earning assets acquired andinterest-bearing liabilities accepted.

 

In adjustingthe Company’s asset/liability position, management attempts to manage theCompany’s interest rate risk while enhancing net interest margins.  The rates, terms and interest rate indicesof the Company’s interest-earning assets result primarily from the Company’sstrategy of investing in loans and securities, which permit the Company tolimit its exposure to interest rate risk, together with credit risk, while atthe same time achieving a positive and relatively stable interest rate spreadfrom the difference between the income earned on interest-earning assets andthe cost of interest-bearing liabilities.

 

The Company’s ratios of interest-sensitive assets to interest-sensitiveliabilities, as shown in the following tables, are 68.3% at the 90-dayinterval, 66.0% at the 180-day interval, and 70.7% at the 365-day interval atDecember 31, 2002. Currently, the Company is in a liability-sensitive positionat the three intervals. However, the Company had $178,981,000 ofinterest-bearing demand, savings and money market deposits at December 31,2002, which from the Company’s experience, change more quickly in a declininginterest rate environment than do the other types of deposits.  Therefore, excluding these types ofdeposits, the Company’s interest-sensitive assets to interest-sensitiveliabilities ratio at the 365-day interval would have been 144.7% at December31, 2002, a positive gap position. The interest sensitivity

24

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position is presented as of apoint in time and can be modified to some extent by management as changingconditions dictate.

 

The following table shows the interest ratesensitivity position of the Company at December 31, 2002:

 
|                                         |   | **Cumulative Volumes********Subject to  Repricing Within** |    | **Volumes  Subject to   Repricing  After  1 Year** |   | **Total** |   |
|----------------------------------------------|--------|------------------------------------------------------------|---------|----------------------------------------------------|--------|-----------|--------|
| **90 Days**                                  |   | **180 Days**                                               |    | **365 Days**                                       |
|                                         |   | **(Dollars in  thousands)**                                |    |
| Interest-earning assets:                     |   |                                                       |    |                                               |   |      |   |   |   |   |   |
| Federal funds sold                           |   | $                                                          | 6,784   |                                               | $      | 6,784     |   | $ | 6,784 |   | $ | 0 |   | $ | 6,784 |   |
| Securities                                   |   | 12,201                                                     |    | 26,537                                             |   | 54,403    |   | 119,228 |   | 173,631 |   |
| Loans, net of unearned income                |   | 159,084                                                    |    | 167,756                                            |   | 186,012   |   | 101,290 |   | 287,302 |   |
| Total interest-earning assets                |   | 178,069                                                    |    | 201,077                                            |   | 247,199   |   | 220,518 |   | 467,717 |   |
|                                         |   |                                                       |    |                                               |   |      |   |   |   |   |   |
| Interest-bearing liabilities:                |   |                                                       |    |                                               |   |      |   |   |   |   |   |
| Demand, savings and money market Deposits    |   | 178,981                                                    |    | 178,981                                            |   | 178,981   |   | 0 |   | 178,981 |   |
| Securities sold under agreement toRepurchase |   | 106                                                        |    | 106                                                |   | 106       |   | 0 |   | 106 |   |
| Time deposits                                |   | 81,592                                                     |    | 125,473                                            |   | 170,746   |   | 25,966 |   | 196,712 |   |
| Total interest-bearing liabilities           |   | 260,679                                                    |    | 304,560                                            |   | 349,833   |   | 25,966 |   | 375,799 |   |
|                                         |   |                                                       |    |                                               |   |      |   |   |   |   |   |
| Rate-sensitivity gap(1)                      |   | $                                                          | (82,610 | )                                                  | $      | (103,483  | )      | $ | (102,634 | ) | $ | 194,552 |   | $ | 91,918 |   |
|                                         |   |                                                       |    |                                               |   |      |   |   |   |   |   |
| Rate-sensitivity ratio(2)                    |   | 68.3                                                       | %       | 66.0                                               | %      | 70.7      | %      |   |   |   |   |

 

----

(1)          Rate-sensitive interest-earning assets lessrate-sensitive interest-bearing liabilities.

(2)          Rate-sensitive interest-earning assets divided byrate-sensitive interest-bearing liabilities.

 

*Net Economic Value*

 

The interestrate risk (“IRR”) component is a dollar amount that is deducted from totalcapital for the purpose of calculating an institution’s risk-based capitalrequirement and is measured in terms of the sensitivity of its net economicvalue (“NEV”) to changes in interest rates. An institution’s NEV is calculated as the net discounted cash flows fromassets, liabilities and off-balance sheet contracts.  As an institution’s IRR component is measured as the change inthe ratio of NEV to the net present value of total assets as a result of ahypothetical 200-basis point change in market interest rates, a resultingdecline in this ratio of more than 2% of the estimated present value of aninstitution’s total assets prior to the hypothetical 200-basis point changewill require the institution to deduct from its regulatory capital 50% of thatexcess decline.  Based on quarterlycalculations, the Bank experienced no such decline.

 

Althoughcertain assets and liabilities may have similar maturities or periods ofrepricing, they may react in different degrees to changes in market interestrates.  Also, the interest rates oncertain types of assets and liabilities may fluctuate in advance of changes inmarket interest rates, while interest rates on other types may lag behindchanges in market rates.  Additionally,certain assets, such as adjustable-rate mortgage loans, have features thatrestrict changes in interest rates on a short-term basis and over the life ofthe loan.  Further, in the event of achange in interest rates, prepayment and early withdrawal levels could deviatesignificantly from those assumed in calculating the table.  Finally, the ability of many borrowers toservice their debt may decrease in the event of a significant interest rateincrease. The Company considers all of these factors in monitoring its exposureto interest rate risk.

 

25

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The repricingof certain categories of assets and liabilities are subject to competitive andother pressures beyond the Company’s control. As a result, certain assets and liabilities indicated as maturing orotherwise repricing within a stated period may in fact mature or reprice atdifferent times and at different volumes.

 

The following table provides informationabout the Company’s financial instruments that are sensitive to changes ininterest rates. Except for the effects of prepayments and scheduled principalamortization on mortgage related assets, the table presents principal cashflows and related weighted average interest rates by the contractual terms tomaturity. Nonaccrual loans are included in the loan totals. All investments areclassified as available-for-sale.

 
|                                          |   | **Years  Ending December 31,** |    |     |   |     |   |     |   |
|-----------------------------------------------|--------|--------------------------------|---------|----------|--------|----------|--------|----------|--------|
|                                          |   | **2003**                       |    | **2004** |   | **2005** |   | **2006** |   | **2007** |   | **Thereafter** |   | **Total** |   | **Fair Value** |   |
|                                          |   | **(Dollars in  thousands)**    |    |
| Fixed Rate Loans:                             |   |                           |    |     |   |     |   |     |   |   |   |   |   |   |   |   |   |
| Maturities                                    |   | $                              | 46,725  |     | $      | 20,361   |   | $        | 20,361 |   | $ | 21,914 |   | $ | 21,914 |   | $ | 10,622 |   | $ | 141,897 |   | $ | 143,544 |   |
| Average interest rate                         |   | 7.20                           | %       | 8.42     | %      | 8.42     | %      | 7.54     | %      | 7.54 | % | 8.23 | % | 7.73 | % |   |   |
|                                          |   |                           |    |     |   |     |   |     |   |   |   |   |   |   |   |   |   |
| Adjustable Rate Loans:                        |   |                           |    |     |   |     |   |     |   |   |   |   |   |   |   |   |   |
| Maturities                                    |   | 75,394                         |    | 9,927    |   | 9,927    |   | 10,888   |   | 10,888 |   | 28,381 |   | 145,405 |   | 145,406 |   |
| Average interest rate                         |   | 5.16                           | %       | 5.11     | %      | 5.11     | %      | 4.97     | %      | 4.97 | % | 5.61 | % | 5.22 | % |   |   |
|                                          |   |                           |    |     |   |     |   |     |   |   |   |   |   |   |   |   |   |
| Securities and Other Interest-earning Assets: |   |                           |    |     |   |     |   |     |   |   |   |   |   |   |   |   |   |
| Maturities                                    |   | 109,142                        |    | 46,362   |   | 20,550   |   | 7,332    |   | 7,332 |   | 410 |   | 191,128 |   | 191,127 |   |
| Average interest rate                         |   | 4.05                           | %       | 4.61     | %      | 5.95     | %      | 6.85     | %      | 6.85 | % | 7.32 | % | 4.63 | % |   |   |
|                                          |   |                           |    |     |   |     |   |     |   |   |   |   |   |   |   |   |   |
| Total interest-earning Assets:                |   |                           |    |     |   |     |   |     |   |   |   |   |   |   |   |   |   |
| Maturities                                    |   | $                              | 231,261 |     | $      | 76,650   |   | $        | 50,838 |   | $ | 40,134 |   | $ | 40,134 |   | $ | 39,413 |   | $ | 478,430 |   | $ | 480,077 |   |
| Average interest rate                         |   | 5.05                           | %       | 5.69     | %      | 6.77     | %      | 6.72     | %      | 6.72 | % | 6.33 | % | 5.73 | % |   |   |
|                                          |   |                           |    |     |   |     |   |     |   |   |   |   |   |   |   |   |   |
| Savings Deposits:                             |   |                           |    |     |   |     |   |     |   |   |   |   |   |   |   |   |   |
| Maturities                                    |   | $                              | 0       |     | $      | 0        |   | $        | 0      |   | $ | 0 |   | $ | 0 |   | $ | 20,913 |   | $ | 20,913 |   | $ | 20,913 |   |
| Average interest rate                         |   | —                         | %       | —   | %      | —   | %      | —   | %      | — | % | 0.25 | % | 0.25 | % |   |   |
|                                          |   |                           |    |     |   |     |   |     |   |   |   |   |   |   |   |   |   |
| NOW Deposits:                                 |   |                           |    |     |   |     |   |     |   |   |   |   |   |   |   |   |   |
| Maturities                                    |   | 0                              |    | 0        |   | 0        |   | 0        |   | 0 |   | 79,630 |   | 79,630 |   | 79,630 |   |
| Average interest rate                         |   | —                         | %       | —   | %      | —   | %      | —   | %      | — | % | 0.18 | % | 0.18 | % |   |   |
|                                          |   |                           |    |     |   |     |   |     |   |   |   |   |   |   |   |   |   |
| Money Market Deposits:                        |   |                           |    |     |   |     |   |     |   |   |   |   |   |   |   |   |   |
| Maturities                                    |   | 0                              |    | 0        |   | 0        |   | 0        |   | 0 |   | 78,438 |   | 78,438 |   | 78,438 |   |
| Average interest rate                         |   | —                         | %       | —   | %      | —   | %      | —   | %      | — | % | 1.04 | % | 1.04 | % |   |   |
|                                          |   |                           |    |     |   |     |   |     |   |   |   |   |   |   |   |   |   |
| Certificates of Deposit:                      |   |                           |    |     |   |     |   |     |   |   |   |   |   |   |   |   |   |
| Maturities                                    |   | 170,746                        |    | 13,673   |   | 5,413    |   | 1,572    |   | 4,163 |   | 1,145 |   | 196,712 |   | 199,239 |   |
| Average interest rate                         |   | 2.29                           | %       | 3.91     | %      | 5.35     | %      | 4.73     | %      | 4.02 | % | 4.02 | % | 2.54 | % |   |   |
|                                          |   |                           |    |     |   |     |   |     |   |   |   |   |   |   |   |   |   |
| Total Interest-bearing Liabilities:           |   |                           |    |     |   |     |   |     |   |   |   |   |   |   |   |   |   |
| Maturities                                    |   | $                              | 170,746 |     | $      | 13,673   |   | $        | 5,413  |   | $ | 1,572 |   | $ | 4,163 |   | $ | 180,126 |   | $ | 375,693 |   | $ | 378,220 |   |
| Average interest rate                         |   | 2.29                           | %       | 3.91     | %      | 5.35     | %      | 4.73     | %      | 4.02 | % | 0.59 | % | 1.60 | % |   |   |

 

The Company assumes that 100% of savings, NOW and money market depositsat December 31, 2002, are core deposits and are, therefore, expected to rolloff after five years. No roll-off is applied to certificates of deposit. Fixedmaturity deposits reprice at maturity.

 

26

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**Analysisof Financial Condition**

 

*Assets*

 

Total assetsdecreased $79,096,000, or 12.4%, from $637,383,000 at December 31, 2001, to$558,287,000 at December 31, 2002.  Thisdecrease is primarily due to a decrease in deposits resulting from conservativedeposit pricing and an overall decline in deposit rates, as well as thegoodwill impairment.

 

*Cash,Due From Banks and Interest – Earning Time Deposits*

 

At December 31, 2002, the Company had $33,583,000 in cash and cashequivalents, down $2,479,000, or 6.9%, from $36,062,000 at December 31,2001.   The decrease in 2002 was dueprimarily to a decrease in the balance required to be maintained with theFederal Reserve Bank.  After an in-depthanalysis performed by a third party, the Company restructured many of itstransaction accounts to reduce the overall required reserves, thereby decreasingthe balance required to be kept with the Federal Reserve Bank.  The decrease is also due to improvedmanagement of currency on hand.

 

*FedFunds Sold*

 

Federal funds sold decreased $3,744,000, or 35.6%, from $10,528,000 atDecember 31, 2001, to $6,784,000 at December 31, 2002.  The decrease is primarily due to shrinkageof the deposit balance.

 

*Securities*

 

Securities decreased $42,481,000, or 19.7%, from $216,112,000 atDecember 31, 2001, to $173,631,000 at December 31, 2002, due primarily toshrinkage of the deposit balance.

 

The Board of Directors of the Bank reviews all securities transactionsmonthly and the securities portfolio periodically. The Company’s currentinvestment policy provides for the purchase of U.S. Treasury securities, U.S.Government agency securities, mortgage-backed securities having maturities of12 years or less and for the purchase of state, county and municipal agencies’securities with maximum maturities of 10 years. The Company’s policy is tomaintain a securities portfolio with staggered maturities to meet its overallliquidity needs. Municipal securities must be rated A or better. Certain schooldistrict issues, however, are acceptable with a Baa rating. All securities areclassified as available-for-sale and are carried at fair value at December 31,2002.  The decision to sell securitiesclassified as available-for-sale is based upon management’s assessment ofchanges in economic or financial market conditions.

 

Certain of the Company’s securities are pledged to secure public andtrust fund deposits and for other purposes required or permitted by law. AtDecember 31, 2002, the carrying value of U.S. Government and other securitiesso pledged amounted to $35,632,000, or 20.5% of the total securities portfolio.

 

27

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The following table summarizes the amounts and the distribution of theCompany’s investment securities held at the dates indicated:

 
|                                                                                   |   | **December  31,**           |    |
|----------------------------------------------------------------------------------------|--------|-----------------------------|---------|
|                                                                                   |   | **2002**                    |    | **2001** |   | **1999** |   |
|                                                                                   |   | **Amount**                  |    | **%** |   | **Amount** |   | **%** |   | **Amount** |   | **%** |   |
|                                                                                   |   | **(Dollars in  thousands)** |    |
| Carrying value:                                                                        |   |                        |    |   |   |   |   |   |   |   |   |   |   |
| U.S. Treasury securities and obligations of U.S. Government agencies  and corporations |   | $                           | 121,412 |   | 69.9 | % | $ | 136,025 |   | 62.9 | % | $ | 129,038 |   | 72.8 | % |
| Mortgage-backed securities and collateralized mortgage obligations                     |   | 44,753                      |    | 25.8 |   | 69,735 |   | 32.3 |   | 36,694 |   | 20.7 |   |
| Obligations of states and political subdivisions                                       |   | 3,581                       |    | 2.1 |   | 7,109 |   | 3.3 |   | 8,334 |   | 4.7 |   |
| Other securities                                                                       |   | 3,885                       |    | 2.2 |   | 3,243 |   | 1.5 |   | 3,128 |   | 1.8 |   |
| Total securities                                                                       |   | $                           | 173,631 |   | 100.0 | % | $ | 216,112 |   | 100.0 | % | $ | 177,194 |   | 100.0 | % |
|                                                                                   |   |                        |    |   |   |   |   |   |   |   |   |   |   |
| Total fair value                                                                       |   | $                           | 173,631 |   |   |   | $ | 216,112 |   |   |   | $ | 177,161 |   |   |   |

 

The followingtable provides the maturity distribution and weighted average interest rates ofthe Company’s total securities portfolio at December 31, 2002. The yield hasbeen computed by relating the forward income stream on the securities, plus orminus the anticipated amortization of premium or accretion of discount, to thecarrying value of securities.  The bookvalue of securities classified as held-to-maturity was their historical cost,adjusted for premium amortization and discount accretion.  The adjustment of the yields on tax-exemptsecurities to a fully taxable-equivalent basis has been computed assuming a taxrate of 34%.

 
| **Type and Maturity Grouping at December 31, 2002**                                          |   | **Principal  Amount**       |    | **Carrying  Value** |   | **Estimated  Fair Value** |   | **Weighted  Average  Yield** |    |
|----------------------------------------------------------------------------------------------|--------|-----------------------------|---------|---------------------|--------|---------------------------|--------|------------------------------|---------|
|                                                                                         |   | **(Dollars in  thousands)** |    |
| U.S. Treasury securities and obligations of U.S. Government agencies  and corporations:      |   |                        |    |                |   |                      |   |                         |    |
| Within one year                                                                              |   | $                           | 27,667  |                | $      | 28,149                    |   | $                            | 28,149  |   | 4.70 | % |
| After one but within five years                                                              |   | 88,386                      |    | 93,263              |   | 93,263                    |   | 5.19                         | %       |
| After five but within ten years                                                              |   | 0                           |    | 0                   |   | 0                         |   | 0.00                         | %       |
| Total U.S. Treasury securities and obligations of U.S. Government  agencies and corporations |   | 116,053                     |    | 121,412             |   | 121,412                   |   | 5.08                         | %       |
|                                                                                         |   |                        |    |                |   |                      |   |                         |    |
| Mortgage-backed securities and collateralized mortgage obligations                           |   | 43,934                      |    | 44,753              |   | 44,753                    |   | 4.73                         | %       |
|                                                                                         |   |                        |    |                |   |                      |   |                         |    |
| Obligations of states and political subdivisions:                                            |   |                        |    |                |   |                      |   |                         |    |
| Within one year                                                                              |   | 954                         |    | 963                 |   | 963                       |   | 6.62                         | %       |
| After one but within five years                                                              |   | 1,765                       |    | 1,833               |   | 1,833                     |   | 7.93                         | %       |
| After five but within ten years                                                              |   | 609                         |    | 652                 |   | 652                       |   | 7.07                         | %       |
| After ten years                                                                              |   | 120                         |    | 133                 |   | 133                       |   | 8.02                         | %       |
| Total obligations of states and political subdivisions                                       |   | 3,448                       |    | 3,581               |   | 3,581                     |   | 7.42                         | %       |
|                                                                                         |   |                        |    |                |   |                      |   |                         |    |
| Other securities:                                                                            |   |                        |    |                |   |                      |   |                         |    |
| Within one year                                                                              |   | 0                           |    | 0                   |   | 0                         |   | 0.00                         | %       |
| After one but within five years                                                              |   | 0                           |    | 0                   |   | 0                         |   | 0.00                         | %       |
| After five but within ten years                                                              |   | 0                           |    | 0                   |   | 0                         |   | 0.00                         | %       |
| After ten years                                                                              |   | 3,882                       |    | 3,885               |   | 3,885                     |   | 1.25                         | %       |
| Total other securities                                                                       |   | 3,882                       |    | 3,885               |   | 3,885                     |   | 1.25                         | %       |
|                                                                                         |   |                        |    |                |   |                      |   |                         |    |
| Total securities                                                                             |   | $                           | 167,317 |                | $      | 173,631                   |   | $                            | 173,631 |   | 4.95 | % |

 

28

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*LoanPortfolio*

 

Total loans, net of unearned income, decreased $16,944,000, or 5.6%,from $304,246,000 at December 31, 2001, to $287,302,000 at December 31,2002.  The decrease in loans in 2002 wasprimarily a result of the pay down of loans with fewer renewals occurring dueto current economic conditions.

 

The Bank primarily makes commercial loans to small-to medium-sizedbusinesses and professionals.  The Bankoffers a variety of commercial and real estate lending products includingrevolving lines of credit, letters of credit, working capital loans, loans tofinance accounts receivable, inventory and equipment, commercial real estatepurchase loans, construction loans, refinance loans and various types ofagriculture loans. Typically, the Bank’s commercial loans have floating ratesof interest, are for varying terms (generally not exceeding five years), arepersonally guaranteed by the principal owners and are collateralized by realestate, accounts receivable, inventory or other business assets.  Due to customer demand, the Bank also makesinstallment loans to individuals.

 

Due to the diminished loan demand during the mid to late 1990’s, theBank instituted an installment loan program whereby it began to purchaseautomobile loans from automobile dealerships in its market areas. At December31, 2002 and 2001, the Company had approximately $1,308,000 and $5,016,000, netof unearned income, respectively, of this type of loan outstanding. Thedecrease during 2002 is due to management’s decision to shift the loanportfolio toward more commercial and real estate loans and less toward indirectinstallment loans.

 

The following table presents the Company’s loan balances at the datesindicated separated by loan type:

 

|                          |   | **December 31,**           |    |
|-------------------------------|--------|----------------------------|---------|
|                          |   | **2002**                   |    | **2001** |   | **2000** |   | **1999** |   | **1998** |   |
|                          |   | **(Dollars in thousands)** |    |
| Real estate loans             |   | $                          | 139,711 |   | $ | 135,544 |   | $ | 127,510 |   | $ | 72,268 |   | $ | 71,901 |   |
| Commercial loans              |   | 87,508                     |    | 98,129 |   | 127,205 |   | 55,270 |   | 47,551 |   |
| Loans to individuals          |   | 24,016                     |    | 37,873 |   | 53,308 |   | 46,748 |   | 57,564 |   |
| Agriculture and other loans   |   | 36,070                     |    | 32,724 |   | 59,036 |   | 12,857 |   | 9,310 |   |
| Total loans                   |   | 287,305                    |    | 304,270 |   | 367,059 |   | 187,143 |   | 186,326 |   |
| Less:  Unearned income   |   | 3                          |    | 24 |   | 126 |   | 517 |   | 1,766 |   |
|                          |   |                       |    |   |   |   |   |   |   |   |   |
| Loans, net of unearned income |   | $                          | 287,302 |   | $ | 304,246 |   | $ | 366,933 |   | $ | 186,626 |   | $ | 184,560 |   |

 

Loan concentrations are considered to exist when there are amounts loanedto a multiple number of borrowers engaged in similar activities that wouldcause them to be similarly impacted by economic or other conditions. TheCompany had no concentrations of loans at December 31, 2002, except for thosedescribed above and a geographic concentration of loans in West and NorthTexas. The Bank had no loans outstanding to foreign countries or borrowersheadquartered in foreign countries at December 31, 2002.

 

Management of the Bank may renew loans at maturity when requested by acustomer whose financial strength appears to support such renewal or when suchrenewal appears to be in the Company’s best interest. The Company requirespayment of accrued interest in such instances and may adjust the rate ofinterest, require a principal reduction or modify other terms of the loan atthe time of renewal.

 

29

----

 

The following table presents the distributionof the maturity of the Company’s loans and the interest rate sensitivity ofthose loans, excluding loans to individuals, at December 31, 2002. The tablealso presents the portion of loans that have fixed interest rates or interestrates that fluctuate over the life of the loans in accordance with changes inthe interest rate environment as represented by the prime rate.

 

|                         |   | **One Year  and Less**     |    | **One to  Five Years** |   | **Over Five  Years** |   | **Total  Carrying  Value** |   |
|------------------------------|--------|----------------------------|---------|------------------------|--------|----------------------|--------|----------------------------|--------|
|                         |   | **(Dollars in thousands)** |    |
| Real estate loans            |   | $                          | 69,503  |                   | $      | 60,882               |   | $                          | 9,326  |   | $ | 139,711 |   |
| Commercial loans             |   | 75,022                     |    | 11,586                 |   | 900                  |   | 87,508                     |   |
| Agriculture and other loans  |   | 33,753                     |    | 2,116                  |   | 201                  |   | 36,070                     |   |
|                         |   |                       |    |                   |   |                 |   |                       |   |
| Total loans                  |   | $                          | 178,278 |                   | $      | 74,584               |   | $                          | 10,427 |   | $ | 263,289 |   |
|                         |   |                       |    |                   |   |                 |   |                       |   |
| With fixed interest rates    |   | $                          | 40,756  |                   | $      | 66,869               |   | $                          | 7,644  |   | $ | 115,269 |   |
| With variable interest rates |   | 137,522                    |    | 7,715                  |   | 2,783                |   | 148,020                    |   |
|                         |   |                       |    |                   |   |                 |   |                       |   |
| Total loans                  |   | $                          | 178,278 |                   | $      | 74,584               |   | $                          | 10,427 |   | $ | 263,289 |   |

 

*NonperformingAssets*

 

Nonperforming loans consist of nonaccrual, past due and restructuredloans. A past due loan is an accruing loan that is contractually past due 90days or more as to principal or interest payments. Loans on which managementdoes not expect to collect interest in the normal course of business are placedon nonaccrual or are restructured. When a loan is placed on nonaccrual status,any interest previously accrued, but not yet collected, is reversed againstcurrent income unless, in the opinion of management, the outstanding interestremains collectible. Thereafter, interest is included in income only to theextent of cash received. A loan is restored to accrual status when all interestand principal payments are current and the borrower has demonstrated tomanagement the ability to make payments of principal and interest as scheduled.

 

A “troubled debt restructuring” is a restructured loan upon whichinterest accrues at a below market rate or upon which certain principal hasbeen forgiven so as to aid the borrower in the final repayment of the loan,with any interest previously accrued, but not yet collected, being reversedagainst current income. Interest is accrued based upon the new loan terms.

 

Nonperforming loans are fully or substantially collateralized byassets, with any excess of loan balances over collateral values allocated inthe allowance for loan loss. Assets acquired through foreclosure are carried atthe lower of cost or estimated fair value, net of estimated costs of disposal,if any. See “Other Real Estate and Other Repossessed Assets” below.

 

The following table lists nonaccrual, past due and restructured loansand other real estate and other repossessed assets at year end for each of thepast five years.

 
|                                                                 |   | **December 31,**           |   |
|----------------------------------------------------------------------|--------|----------------------------|--------|
|                                                                 |   | **2002**                   |   | **2001** |   | **2000** |   | **1999** |   | **1998** |   |
|                                                                 |   | **(Dollars in thousands)** |   |
| Nonaccrual loans                                                     |   | $                          | 4,016  |   | $ | 5,581 |   | $ | 3,337 |   | $ | 236 |   | $ 238 |   |
| Accruing loans contractually  past due over 90 days                  |   | 85                         |   | 223 |   | 2,572 |   | 203 |   | 198 |   |
| Restructured loans                                                   |   | 17                         |   | 29 |   | 119 |   | 186 |   | 110 |   |
| Other real estate and other  repossessed assets                      |   | 3,631                      |   | 691 |   | 576 |   | 272 |   | 630 |   |
|                                                                 |   |                       |   |   |   |   |   |   |   |   |   |
| Total nonperforming assets                                           |   | $                          | 7,749  |   | $ | 6,524 |   | $ | 6,604 |   | $ | 897 |   | $ 1,176 |   |
| Total Allowance for Loan Loss  Reserve to Total nonperforming assets |   | 80.8                       | %      | 100.0 | % | 126.9 | % | 204.3 | % | 156.6 | % |
|                                                                      |        |                            |        |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

30

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The gross interest income that would have been recorded in 2002 on theCompany’s nonaccrual loans if such loans had been current, in accordance withthe original terms thereof and had been outstanding throughout the period or,if shorter, since origination, was approximately $430,000. No interest incomewas recorded (received) on nonaccrual loans during 2002.

 

A potential problem loan is defined as a loan where information aboutpossible credit problems of the borrower is known, causing management to haveserious doubts as to the ability of the borrower to comply with the presentloan repayment terms and which may result in the inclusion of such loan in oneof the nonperforming asset categories. The Company does not believe it has anypotential problem loans other than those reported in the above table or thoseincluded on the watch list as discussed below.

 

The Company follows a loan review program to evaluate the credit riskin its loan portfolio.  Through the loanreview process, the Bank maintains an internally classified loan list that,along with the list of nonperforming loans discussed below, helps managementassess the overall quality of the loan portfolio and the adequacy of theallowance. Loans classified as “substandard” are those loans with clear anddefined weaknesses such as highly leveraged positions, unfavorable financialratios, uncertain repayment sources, involvement in bankruptcy proceedings orpoor financial condition, which may jeopardize recoverability of the loan.  Loans classified as “doubtful” are thoseloans that have characteristics similar to substandard loans, but also have anincreased risk that a loss may occur or at least a portion of the loan mayrequire a charge-off if liquidated at present. Although loans classified as substandard do not duplicate loansclassified as doubtful, both substandard and doubtful loans may include someloans that are past due at least 90 days, are on nonaccrual status or have beenrestructured. Loans classified as “loss” are those loans that are in theprocess of being charged off.  Therewere no loans designated as loss as of December 31, 2002.

 

In addition to the internally classified loans, the Bank also has a“watch list” of loans that further assists the Bank in monitoring its loanportfolio. A loan is included on the watch list if it demonstrates one or moredeficiencies requiring attention in the near term or if the loan’s ratios haveweakened to a point where more frequent monitoring is warranted. These loans donot have all the characteristics of a classified loan (substandard, doubtful orloss), but do have weakened elements as compared with those of a satisfactorycredit. Management of the Bank reviews these loans to assist in assessing theadequacy of the allowance. Substantially all of the loans on the watch list atDecember 31, 2002, were current and paying in accordance with loan terms.

 

*OtherReal Estate and Other Repossessed Assets*

 

Foreclosures on defaulted loans result in the Company acquiring otherreal estate and other repossessed assets. Accordingly, the Company incurs otherexpenses, specifically net costs applicable to other real estate and otherrepossessed assets, in maintaining, insuring and selling such assets. The Bankattempts to convert nonperforming loans into interest-earning assets, althoughusually at a lower dollar amount than the face value of such loans, eitherthrough liquidation of the collateral securing the loan or through intensifiedcollection efforts.

 

Other real estate and other repossessed assets consist of real propertyand other assets unrelated to banking premises or facilities. Income derivedfrom other real estate and other repossessed assets, if any, is generally lessthan that which would have been earned as interest at the original contractrates on the related loans. At December 31, 2002 and 2001, other real estate andother repossessed assets had an aggregate book value of $3,631,000 and$691,000, respectively. Other real estate and other repossessed assetsincreased $2,940,000, or 425.5%, during 2002. The increase was primarily due tothe foreclosure of five large commercial loans and the addition of thecollateral from these loans into other real estate and other repossessedassets.  The December 31, 2002 balanceof $3,631,000 included 11 commercial and or agriculture properties($2,930,000), 3 residential properties ($647,000) and 9 repossessed automobiles($54,000). Of the December 31, 2001 balance of $691,000, $565,000 representedfour commercial properties, $70,000 represented three residential propertiesand $56,000 represented eight repossessed automobiles.

 

*Allowancefor Loan Losses*

 

Implicit in the Company’s lending activities is the fact that loanlosses will be experienced and that the risk of loss will vary with the type ofloan being made and the creditworthiness of the borrower over the term of theloan. To reflect the currently perceived risk of loss associated with theCompany’s loan portfolio, additions are made to the

31

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Company’s allowance for loanlosses (the “allowance”). The allowance is created by direct charges againstincome (the “provision” for loan losses), and the allowance is available toabsorb possible loan losses. See “Results of Operations—Provision for LoanLosses” above.

 

The allowance is reduced by loan charge offs, increased by recoveriesof loans previously charged off and increased or decreased by the loan lossprovision to arrive at a balance determined by management to be appropriate.The Company’s allowance was $6,261,000, or 2.18% of loans, net of unearnedincome, at December 31, 2002, compared to $6,525,000, or 2.14% of loans, net ofunearned income, at December 31, 2001, and compared to $8,379,000, or 2.28% ofloans, net of unearned income, at December 31, 2000. The decrease in thebalance of the allowance from December 31, 2000 through December 31, 2001, andthe decrease in the ratio of the allowance to total loans, net of unearnedincome, during the past year, are primarily due to the net charge-off of loans,most of which existed at the time of Acquisition, of $12,619,000.  Provisions to loan loss of $10,765,000offset net charge-offs.

 

Credit and loan decisions are made by management and the Board ofDirectors of the Bank in conformity with loan policies established by the Boardof Directors of the Company. The Company’s practice is to charge-off any loanor portion of a loan when the loan is determined by management to beuncollectible due to the borrower’s failure to meet repayment terms, theborrower’s deteriorating or deteriorated financial condition, the depreciationof the underlying collateral, the loan’s classification as a loss by regulatoryexaminers or for other reasons. The Company charged-off $1,772,000 in loansduring 2002. Charge offs for 2002 were concentrated in the followingcategories: commercial loans—$968,000, or 54.6%; real estate loans—$352,000, or19.9%; and loans to individuals—$452,000, or 25.5%. Recoveries during 2002 were$1,585,000 and were concentrated in commercial loans, which accounted for$1,341,000, or 84.6%, of total recoveries during 2002.  The majority of the recovery recorded during2002 was related to a substantial loan charge off of a large relationship,which occurred in the second quarter of 2001. Settlement of negotiations with borrowers occurred in the first quarterof 2002 and a portion of the loan balance, which was previously charged-off,was recovered.

 

32

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The following table presents the activity inthe allowance for the year ended 2002, 2001, the period from January 1, 2000through August 11, 2000, the period from August 12, 2000 through December 31,2000, and the years ended December 31, 1999 and 1998. Also presented areaverage loans outstanding and certain pertinent ratios for the last five years.

 
|                                                                                                    |   | **Years Ended December 31,** |    | **Period Ended  From August  12, 2000 to  December 31** |   | **Period Ended  From January  1, 2000 to  August 11,** |   | **Years Ended December 31,** |    |
|---------------------------------------------------------------------------------------------------------|--------|------------------------------|---------|---------------------------------------------------------|--------|--------------------------------------------------------|--------|------------------------------|---------|
|                                                                                                    |   | **2002**                     |    | **2001**                                                |   | **2000(1)**                                            |   | **2000**                     |    | **1999** |   | **1998(2)** |   |
|                                                                                                    |   | (Dollars in thousands)       |    |
| Analysis of allowance for  possible loan losses:                                                        |   |                         |    |                                                    |   |                                                   |   |                         |    |   |   |   |   |
| Balance, beginning of period                                                                            |   | $                            | 6,525   |                                                    | $      | 8,379                                                  |   | $                            | 6,371   |   | $ | 1,833 |   | $ | 1,842 |   | $ | 1,173 |   |
| Provision for loan losses                                                                               |   | (77                          | )       | 10,765                                                  |   | 618                                                    |   | 1,660                        |    | 445 |   | 570 |   |
| Bank acquisition/merger                                                                                 |   | 0                            |    | 0                                                       |   | 3,147                                                  |   | 3,028                        |    | 0 |   | 726 |   |
|                                                                                                    |   | 6,448                        |    | 19,144                                                  |   | 10,136                                                 |   | 6,521                        |    | 2,287 |   | 2,469 |   |
| Loans charged off:                                                                                      |   |                         |    |                                                    |   |                                                   |   |                         |    |   |   |   |   |
| Real estate loans                                                                                       |   | 352                          |    | 0                                                       |   | 19                                                     |   | 0                            |    | 5 |   | 40 |   |
| Commercial loans                                                                                        |   | 968                          |    | 9,565                                                   |   | 1,459                                                  |   | 50                           |    | 106 |   | 18 |   |
| Loans to individuals                                                                                    |   | 452                          |    | 1,237                                                   |   | 308                                                    |   | 174                          |    | 586 |   | 671 |   |
| Agriculture and other loans                                                                             |   | 0                            |    | 2,892                                                   |   | 10                                                     |   | 6                            |    | 0 |   | 0 |   |
| Total charge offs                                                                                       |   | 1,772                        |    | 13,694                                                  |   | 1,796                                                  |   | 230                          |    | 697 |   | 729 |   |
|                                                                                                    |   |                         |    |                                                    |   |                                                   |   |                         |    |   |   |   |   |
| Recoveries of loans previously  charged off:                                                            |   |                         |    |                                                    |   |                                                   |   |                         |    |   |   |   |   |
| Real estate loans                                                                                       |   | 20                           |    | 2                                                       |   | 0                                                      |   | 1                            |    | 104 |   | 16 |   |
| Commercial loans                                                                                        |   | 1,341                        |    | 909                                                     |   | 6                                                      |   | 6                            |    | 20 |   | 41 |   |
| Loans to individuals                                                                                    |   | 106                          |    | 158                                                     |   | 33                                                     |   | 72                           |    | 118 |   | 45 |   |
| Agriculture and other loans                                                                             |   | 118                          |    | 6                                                       |   | 0                                                      |   | 1                            |    | 1 |   | 0 |   |
| Total recoveries                                                                                        |   | 1,585                        |    | 1,075                                                   |   | 39                                                     |   | 80                           |    | 243 |   | 102 |   |
| Net loans charged off                                                                                   |   | 187                          |    | 12,619                                                  |   | 1,757                                                  |   | 150                          |    | 454 |   | 627 |   |
|                                                                                                    |   |                         |    |                                                    |   |                                                   |   |                         |    |   |   |   |   |
| Balance, end of period                                                                                  |   | $                            | 6,261   |                                                    | $      | 6,525                                                  |   | $                            | 8,379   |   | $ | 6,371 |   | $ | 1,833 |   | $ | 1,842 |   |
|                                                                                                    |   |                         |    |                                                    |   |                                                   |   |                         |    |   |   |   |   |
| Average loans outstanding, net  of unearned income, for the year ended December 31                      |   | $                            | 283,381 |                                                    | $      | 326,920                                                |   | $                            | 374,347 |   |   |   | $ | 184,471 |   | $ | 153,188 |   |
| Ratio of net loan charge offs  to average loans, net of unearned income, for the year ended December 31 |   | 0.07                         | %       | 3.86                                                    | %      | 0.47                                                   | %      |                         |    | 0.25 | % | 0.41 | % |
| Ratio of allowance for  possible loan losses to total loans, net of unearned income, at December 31     |   | 2.18                         | %       | 2.14                                                    | %      | 2.28                                                   | %      |                         |    | 0.98 | % | 1.00 | % |

 

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(1)          Average loans, net of unearned income, for 2001include the average loans, net of unearned income, of UB&T and the LubbockBank from August 12, to December 31, 2001.

(2)          Average loans, net of unearned income, for 1998include the average loans, net of unearned income, of Azle State Bank fromSeptember 22 through December 31, 1998.

 

The increasein the allowance of $3,028,000 during 2001 is due primarily to five borrowingrelationships with whom predecessor management had intended to continue to workand extend or renew the loans as necessary. Predecessor management believedthat the net carrying amount, after considering specific reserves, was adequateto reflect the estimated carrying amount of the loans. Successor management hasdetermined that the Company will no longer maintain a relationship with theseborrowers, has informed the borrowers that the borrowers will have to pay offtheir respective loans with the Company and, if necessary, liquidate the collateralsupporting the loans within no later than one year of the acquisition date. Asof December 31, 2002, substantially all of these relationships have beenexited.  The Company also offered areduction in principal to one borrower to provide an incentive for the

33

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borrower to move its loanrelationship. As these loans are collateral dependent, the estimated losses onthese loans are primarily due to estimated collateral liquidation valueshortfalls. Overall, successor management has determined that the intendedmethod of ultimate recovery on loans from these five borrowing relationships isdemonstrably different from the plans that had served as the basis forpredecessor management’s estimation of recovery on such loans. The provisionfor loan losses for the period from August 12, 2000 through December 31, 2001,includes the impact of successor management conforming certain predecessor loanloss methodology to its loan loss calculation methodology. Specifically,successor management has conformed certain charge-off factors on pools of loansto its own historical loan loss factors.

 

The amount ofthe allowance is established by management based upon estimated risks inherentin the existing loan portfolio. The allowance is comprised of three components:specific reserves on specific problem loans, historical loss percentagesapplied to pools of loans with similar characteristics, and an unallocatedportion. Management reviews the loan portfolio on a continuing basis toevaluate potential problem loans. This review encompasses management’s estimateof current economic conditions and the potential impact on various industries,prior loan loss experience and the financial conditions of individualborrowers. Loans that have been specifically identified as problem ornonperforming loans are reviewed on at least a quarterly basis, and managementcritically evaluates the prospect of ultimate losses arising from such loans,based on the borrower’s financial condition and the value of availablecollateral.  When a risk can bespecifically quantified for a loan, that amount is specifically allocated inthe allowance. In addition, the Company allocates the allowance based upon the historicalloan loss experience of the different types of loans. Despite such allocation,both the allocated and unallocated portions of the allowance are available forcharge offs for all loans.

 

The following table shows the allocations in the allowance and therespective percentages of each loan category to total loans at year end foreach of the past five years.

 
|                                      |   | **December 31,**                              |   |
|-------------------------------------------|--------|-----------------------------------------------|--------|
|                                      |   | **2002**                                      |   | **2001** |   | **2000** |   |
|                                      |   | **Amount of Allowance Allocated to Category** |   | **Percentage of Loans by Category to Loans, Net of Unearned  Income** |   | **Amount of Allowance Allocated to Category** |   | **Percentage of Loans by Category to Loans, Net of Unearned  Income** |   | **Amount of Allowance Allocated to Category** |   | **Percentage of Loans by Category to Loans, Net of Unearned  Income** |   |
|                                      |   | **(Dollars in thousands)**                    |   |
| Real estate loans                         |   | $1,079                                        |   | 48.6 | % | $1,092 |   | 44.5 | % | $685 |   | 34.7 | % |
| Commercial loans                          |   | 984                                           |   | 30.4 |   | 1,714 |   | 32.3 |   | 3,434 |   | 34.7 |   |
| Loans to individuals                      |   | 541                                           |   | 8.4 |   | 868 |   | 12.4 |   | 1,248 |   | 14.5 |   |
| Agriculture and other loans               |   | 262                                           |   | 12.6 |   | 19 |   | 10.8 |   | 1,819 |   | 16.1 |   |
| Total allocated                           |   | 2,866                                         |   | 100.0 | % | 3,693 |   | 100.0 | % | 7,186 |   | 100.0 | % |
| Unallocated                               |   | 3,395                                         |   |   |   | 2,832 |   |   |   | 1,193 |   |   |   |
| Total allowance for possible  loan losses |   | $6,261                                        |   |   |   | $6,525 |   |   |   | $8,379 |   |   |   |

 

34

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|                                      |   | **December 31,**                              |   |
|-------------------------------------------|--------|-----------------------------------------------|--------|
|                                      |   | **1999**                                      |   | **1998** |   |
|                                      |   | **Amount of Allowance Allocated to Category** |   | **Percent of  Loans by  Category to  Loans, Net of Unearned  Income** |   | **Amount of Allowance Allocated to Category** |   | **Percent of  Loans by  Category to  Loans, Net of Unearned  Income** |   |
|                                      |   | **(Dollars in thousands)**                    |   |
| Real estate loans                         |   | $198                                          |   | 38.7 | % | $106 |   | 39.0 | % |
| Commercial loans                          |   | 254                                           |   | 29.6 |   | 164 |   | 25.8 |   |
| Loans to individuals                      |   | 672                                           |   | 24.8 |   | 577 |   | 30.2 |   |
| Agriculture and other loans               |   | 37                                            |   | 6.9 |   | 9 |   | 5.0 |   |
| Total allocated                           |   | 1,161                                         |   | 100.0 | % | 856 |   | 100.0 | % |
| Unallocated                               |   | 672                                           |   |   |   | 986 |   |   |   |
| Total allowance for possible  loan losses |   | $1,833                                        |   |   |   | $1,842 |   |   |   |

 

The increase of $563,000 in the unallocated portion of the reserve fromDecember 31, 2001 through December 31, 2002, is primarily caused by the effectsthat the decline in current economic conditions and loan losses experienced in2000 and 2001 have had on the allowance for loan loss calculation.

 

*IntangibleAssets*

 

Intangible assets decreased $17,639,000, or 40.4%, from $43,719,000 atDecember 31, 2001, to $26,080,000 at December 31, 2002, primarily due to theimpairment of goodwill of $15,642,000 recorded in the first quarter of2002.  The remaining decrease isprimarily due to amortization of the core deposit intangible balance during2002.

 

*Premisesand Equipment*

 

Premises andequipment decreased $926,000, or 6.0%, from $15,380,000 at December 31, 2001,to $14,454,000 at December 31, 2002. The decrease was primarily due to thedepreciation recorded during 2002 totaling $1,690,000.  This decrease was partially offset byadditions to premises and equipment during the year.

 

*Accrued Interest Receivable*

 

Accrued interest receivable consists of interest that has accrued onsecurities and loans, but is not yet payable under the terms of the relatedagreements. The balance of accrued interest receivable decreased $895,000, or16.8%, from $5,321,000 at December 31, 2001, to $4,426,000 at December 31,2002. The decrease during 2002 was primarily a result of decreases in the loanbalance during the year and reclassification during the year of certain loansto nonaccrual status where interest previously accrued is reversed.  Of the total balance at December 31, 2002,$2,310,000, or 52.2%, was interest accrued on loans and $2,116,000, or 47.8%,was interest accrued on securities.

 

*OtherAssets*

 

The balance of other assets increased $2,808,000, or 23.7%, to$14,657,000 at December 31, 2002, from $11,849,000 at December 31, 2001, dueprincipally to the additional purchase of bank-owned life insurance on variousofficers of the Bank.

 

*Deposits*

 

The Bank’s lending and investing activities are funded almost entirelyby core deposits, 59.2% of which were noninterest-bearing and interest-bearingdemand deposits at December 31, 2002. Total deposits decreased $61,387,000, or11.3%, from $544,030,000 at December 31, 2001, to $482,643,000 at December 31,2002. The decrease in deposits was primarily due to decreases in interest ratespaid on time deposit accounts causing a lower demand for these

35

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accounts.  The reduction was one which managementplanned, specifically in an effort to realign our deposit mix.  The Bank does not have any brokereddeposits.

 

The following table presents the average amounts of and the averagerate paid on deposits of the Company for each of the last three years:

 
|                                                        |   | **Years Ended December 31,** |   |
|-------------------------------------------------------------|--------|------------------------------|--------|
|                                                        |   | **2002**                     |   | **2001** |   | **2000(1)** |   |
|                                                        |   | **Average Amount**           |   | **Average  Rate** |   | **Average Amount** |   | **Average  Rate** |   | **Average Amount** |   | **Average  Rate** |   |
|                                                        |   | **(Dollars in thousands)**   |   |
| Noninterest-bearing demand  deposits                        |   | $100,513                     |   | — | % | $100,197 |   | — | % | $75,425 |   | — | % |
| Interest-bearing demand,  savings and money market deposits |   | 185,597                      |   | 0.79 | % | 186,941 |   | 1.82 | % | 136,829 |   | 2.56 | % |
| Time deposits of less than  $100,000                        |   | 141,099                      |   | 2.93 | % | 182,860 |   | 5.29 | % | 138,167 |   | 5.66 | % |
| Time deposits of $100,000 or  more                          |   | 75,854                       |   | 3.19 | % | 107,687 |   | 5.65 | % | 72,335 |   | 5.90 | % |
|                                                        |   |                         |   |   |   |   |   |   |   |   |   |   |   |
| Total deposits                                              |   | $503,063                     |   | 1.60 | % | $577,685 |   | 3.32 | % | $422,756 |   | 3.69 | % |

 

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(1)          The average amounts and average rates paid ondeposits for the year ended December 31, 2000, include the averages of UB&Tand the Lubbock Bank from August 12 through December 31, 2000.

 

The maturity distribution of time deposits of $100,000 or more atDecember 31, 2002, is presented below:

 

|                                     |   | **December 31, 2002** |   |
|------------------------------------------|--------|-----------------------|--------|
|                                     |   | **(In thousands)**    |   |
| 3 months or less                         |   | $                     | 31,608 |   |
| Over 3 through 6 months                  |   | 14,500                |   |
| Over 6 through 12 months                 |   | 14,769                |   |
| Over 12 months                           |   | 10,689                |   |
|                                     |   |                  |   |
| Total time deposits of  $100,000 or more |   | $                     | 71,566 |   |

 

The Bank experiences relatively limited reliance on time deposits of$100,000 or more. Time deposits of $100,000 or more are a more volatile andcostly source of funds than other deposits and are most likely to affect theCompany’s future earnings because of interest rate sensitivity. At December 31,2002, time deposits of $100,000 or more represented 14.8% of the Company’stotal deposits compared to 16.3% of the Company’s total deposits atDecember 31, 2001.

 

*Fed Funds Purchased andSecurities Sold Under Agreement to Repurchase*

 

The balance of fed funds purchased and securities sold under agreementto repurchase decreased $45,000 or 29.8%, from $151,000 at December 31, 2001 to$106,000 at December 31, 2002.

 

*AccruedInterest Payable*

 

Accrued interest payable consists of interest that has accrued ondeposits, but is not yet payable under the terms of the related agreements. Thebalance of accrued interest payable decreased $793,000, or 54.2%, from$1,462,000 at December 31, 2001, to $669,000 at December 31, 2002, due to adecrease in interest-bearing deposit balances as well as decreases in interestrates being paid on interest-bearing time deposits during 2002.

 

*Note Payable*

 

During 2002,the Company incurred two separate advances with the Federal Home Loan Bankrelated to the match funding of certain loan arrangements under a Federal HomeLoan Bank Community Development Program. The advances totaled $143,000 and have maturities of 60 and 180 months.

 

36

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*Other Liabilities*

 

The balance of other liabilities decreased $242,000, or 4.5%, from$5,441,000 at December 31, 2001, to $5,199,000 at December 31, 2002, dueprimarily to a reduction in deferred taxes payable associated with theamortization of the core deposit intangible.

 

*SelectedFinancial Ratios*

 

The following table presents selected financial ratios for each of thelast three fiscal years:

 
|                                             |   | **Years Ended December 31,** |   |
|--------------------------------------------------|--------|------------------------------|--------|
|                                             |   | **2002**                     |   | **2001** |   | **2000(1)** |   |
| Net income (loss) to:                            |   |                         |   |   |   |   |   |
| Average assets                                   |   | (2.02                        | )%     | (1.06 | )% | (0.34 | )% |
| Average interest-earning  assets                 |   | (2.35                        | )%     | (1.26 | )% | (0.40 | )% |
| Average stockholder’s equity                |   | (17.19                       | )%     | (8.99 | )% | (3.50 | )% |
| Dividend payout (2) to:                          |   |                         |   |   |   |   |   |
| Net income (loss)                                |   | N/A                          |   | N/A |   | N/A |   |
| Average stockholder’s equity                |   | N/A                          |   | N/A |   | N/A |   |
| Average stockholder’s equity  to:           |   |                         |   |   |   |   |   |
| Average total assets                             |   | 11.73                        | %      | 11.83 | % | 9.80 | % |
| Average loans (3)                                |   | 24.36                        | %      | 24.50 | % | 18.51 | % |
| Average total deposits                           |   | 13.72                        | %      | 13.86 | % | 11.31 | % |
| Average interest-earning  assets to:             |   |                         |   |   |   |   |   |
| Average total assets                             |   | 85.83                        | %      | 84.50 | % | 86.53 | % |
| Average total deposits                           |   | 100.44                       | %      | 99.01 | % | 99.89 | % |
| Average total liabilities                        |   | 99.32                        | %      | 97.62 | % | 98.65 | % |
| Ratio to total average  deposits of:             |   |                         |   |   |   |   |   |
| Average loans (3)                                |   | 56.33                        | %      | 56.59 | % | 61.11 | % |
| Average noninterest bearing  deposits            |   | 19.98                        | %      | 17.34 | % | 17.84 | % |
| Average interest-bearing  deposits               |   | 80.02                        | %      | 82.66 | % | 82.16 | % |
| Total interest expense to  total interest income |   | 26.19                        | %      | 46.55 | % | 44.60 | % |
| Efficiency Ratio (4)                             |   | 83.17                        | %      | 98.68 | % | 94.82 | % |
|                                                  |        |                              |        |  |  |  |  |  |  |  |

 

----

(1)          Average balance sheet and income statement itemsfor 2001 include the averages for UB&T and the Lubbock Bank from August 12through December 31, 2000.

(2)          Dividends for common stock only.

(3)          Before allowance for loan losses.

(4)          Calculated as total noninterest expense, excludingsecurities losses and loan loss provision, divided by net interest income plusnoninterest income.  Taxes are not partof this calculation.

 

**Liquidity**

 

*The Bank*

 

Liquidity withrespect to a financial institution is the ability to meet its short-term needsfor cash without suffering an unfavorable impact on its on-going operations.The need for the Bank to maintain funds on hand arises principally frommaturities of short-term borrowings, deposit withdrawals, customers’ borrowingneeds and the maintenance of reserve requirements. Liquidity with respect to afinancial institution can be met from either assets or liabilities. On theasset side, the primary sources of liquidity are cash and due from banks,federal funds sold, maturities of securities and scheduled repayments andmaturities of loans. The Bank maintains adequate levels of cash and near-cashinvestments to meet their day-to-day needs. Cash and due from banks averaged$23,243,000 and $32,767,000 during the years ended December 31, 2002 and 2001,respectively. These amounts comprised 4.0% and 4.8% of average total assetsduring the years ended December 31, 2002 and 2001, respectively.

 

The average level of securities, interest-earning time deposits inother banks and federal funds sold was $221,871,000 and $245,052,000 during theyears ended December 31, 2002 and 2001, respectively.

 

37

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A total of$1,414,000 and $59,919,000 of securities classified as available-for-sale weresold during the years ended December 31, 2002 and 2001.  At December 31, 2002, $29,112,000, or 22.6%,of the Company’s securities portfolio, excluding mortgage-backed securities,matured within one year and $95,096,000, or 73.8%, excluding mortgage-backedsecurities, matured after one but within five years. The Bank’s commercial andreal estate lending activities are concentrated in loans with maturities ofless than five years with both fixed and adjustable interest rates, while itsinstallment lending activities are concentrated in loans with maturities ofthree to five years with primarily fixed interest rates. At December 31, 2002,approximately $186,011,000, or 64.7%, of the Company’s loans, net of unearnedincome, matured within one year and/or had adjustable interest rates.Approximately $178,278,000, or 67.7%, of the Company’s loans (excluding loansto individuals) matured within one year and/or had adjustable interest rates.See “Analysis of Financial Condition—Loan Portfolio” above.

 

On theliability side, the principal sources of liquidity are deposits, borrowed fundsand the accessibility to money and capital markets. Customer deposits are byfar the largest source of funds. During the years ended December 31, 2002 and2001, the Company’s average deposits were $503,063,000, or 85.5% of averagetotal assets, and $577,685,000, or 85.3% of average total assets, respectively.The Company attracts its deposits primarily from individuals and businesseslocated within the market areas served by the Bank. See “Analysis of FinancialCondition—Deposits” above.

 

*The Company*

 

The Company depends on the Bank for liquidity in the form of cash flow,primarily to meet distribution requirements on the Company’s subordinateddebentures, which payments, in turn, are used to meet distribution requirementson Independent Capital’s Trust Preferred Securities and to cover otheroperating expenses.  Prior to theAcquisition, this cash flow came from three sources: (i) dividendsresulting from earnings of the Bank, (ii) current tax liabilitiesgenerated by the Bank and (iii) management and service fees for servicesperformed for the Bank.  The Company’simmediate liquidity needs have been and can continue to be satisfied byadvances from the Company’s parent company.

 

The payment of dividends from the Bank is subject to applicable law andthe scrutiny of regulatory authorities. Cash paid by the Bank to IndependentFinancial in 2002 aggregated $7,500,000 by means of a capital reduction at theBank; in turn, Independent Financial and Independent Capital paid dividends tothe Company totaling $7,534,000 during 2002. Dividends paid by the Bank toIndependent Financial during 2001 aggregated $700,000; in turn, IndependentFinancial and Independent Capital paid dividends to the Company totaling$734,000. At December 31, 2002, there were no dividends available forpayment to Independent Financial by the Bank without prior regulatory approval.

 

Pursuant to a tax-sharing agreement, the Bank pays to the Company anamount equal to its individual tax liability on the accrual method of federalincome tax reporting. The accrual method generates more timely payments ofcurrent tax liabilities by the Bank to the Company, increasing the regularityof cash flow and shifting the time value of such funds to the Company. In theevent that the Bank incurs losses, the Company may be required to refund taxliabilities previously collected. The current tax liabilities generated by thebank and paid to the Company during 2002 were $1,732,000.  There were no current tax liabilitiesgenerated by the Bank during 2001 due to the pre-tax loss incurred by the Bank.

 

Prior to the Acquisition, the Bank paid management fees to the Companyfor services performed. These services included, but were not limited to,financial and accounting consultation, attendance at the Bank’s board meetings,audit and loan review services and related expenses. The Bank paid a total of$102,000 in management fees to the Company during 2000.  Subsequent to the Acquisition, the Companyceased charging management fees to the Bank.

 

**CapitalResources**

 

At December 31, 2002, stockholder’s equity totaled $58,593,000, or10.5% of total assets, compared to $75,381,000, or 11.8% of total assets, atDecember 31, 2001. The decrease in equity was caused by the net loss recordedin 2002, as well as a dividend of $6,060,000 paid to State National in November2002.  The dividend was funded by acapital reduction at the Bank.  Asdiscussed below, there are dividend restrictions placed on the Bank byregulatory

38

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authorities.  However, due to the fact that the impairmentof goodwill is excluded from regulatory capital calculations, the Bank hadexcess regulatory capital.  Managementand the Board of Directors determined that it was in the best interest of theBank, the Company and State National to have a capital reduction at the Bankand contribute those funds to the Company which in turn contributed most of thefunds to State National in the form of a dividend to be used to pay down debt,fund future acquisitions and provide for general corporate liquidity needs.

 

Bank regulatory authorities in the United States have risk-basedcapital standards by which all bank holding companies and banks are evaluatedin terms of capital adequacy.  Theseguidelines relate a banking company’s capital to the risk profile of itsassets. The risk-based capital standards require all banking companies to haveTier 1 capital of at least 4%, and total capital (Tier 1 and Tier 2capital) of at least 8%, of net risk-weighted assets, and to be designated as“well-capitalized”, the banking company must have Tier 1 and total risk based capitalratios of 6% and 10%, respectively. For the Company, Tier 1 capital includescommon stockholder’s equity (net of available for sale fair value adjustment)and qualifying guaranteed preferred beneficial interests in the Company’ssubordinated debentures, reduced by intangible assets, net of the deferred taxliability associated with the core deposit intangible, and any deferred taxasset disallowed for regulatory capital purposes.  For the Company, Tier 2 capital is comprised of the remainder ofguaranteed preferred beneficial interests in the Company’s subordinateddebentures not qualifying as Tier 1 capital and the qualifying amount of theallowance for possible loan losses.

 

Bankingregulators also have a leverage ratio requirement.  The leverage ratio requirement is measured as the ratio of Tier 1capital to adjusted quarterly average assets. The leverage ratio standards require all banking companies to have aminimum leverage ratio of at least 4% and to be designated as well-capitalized,the banking company must have a leverage ratio of at least 5%.  The following tables provide a calculationof the Company’s risk-based capital ratios and leverage ratio and a comparisonof the Company’s and the Bank’s risk-based capital ratios and leverage ratio tothe minimum regulatory and well-capitalized minimum requirements at December31, 2002:

 
|                                                 |   | **December 31,**           |   | **Minimum  Capital  Ratios** |   | **Well  Capitalized  Ratios** |   |
|------------------------------------------------------|--------|----------------------------|--------|------------------------------|--------|-------------------------------|--------|
| **2002**                                             |   | **2001**                   |
|                                                 |   | **(Dollars in thousands)** |   |
| Tier 1 capital                                       |   | $                          | 42,230 |                         | $      | 42,640                        |   |   |   |   |   |
|                                                 |   |                       |   |                         |   |                          |   |   |   |
| Total capital                                        |   | 46,544                     |   | 47,048                       |   |                          |   |   |   |
|                                                 |   |                       |   |                         |   |                          |   |   |   |
| Net risk weighted assets                             |   | 343,228                    |   | 350,516                      |   |                          |   |   |   |
|                                                 |   |                       |   |                         |   |                          |   |   |   |
| Adjusted quarterly average  assets                   |   | 534,830                    |   | 608,689                      |   |                          |   |   |   |
|                                                 |   |                       |   |                         |   |                          |   |   |   |
| Capital ratios:                                      |   |                       |   |                         |   |                          |   |   |   |
|                                                 |   |                       |   |                         |   |                          |   |   |   |
| Tier 1 capital to net  risk-weighted assets          |   | 12.30                      | %      | 12.16                        | %      | 4.00                          | %      | 6.00 | % |
|                                                 |   |                       |   |                         |   |                          |   |   |   |
| Total capital to net  risk-weighted assets           |   | 13.56                      |   | 13.42                        |   | 8.00                          |   | 10.00 |   |
|                                                 |   |                       |   |                         |   |                          |   |   |   |
| Tier 1 capital to adjusted  quarterly average assets |   | 7.90                       |   | 7.01                         |   | 4.00                          |   | 5.00 |   |
|                                                      |        |                            |        |                              |        |                               |        |  |  |  |  |

 

The minimum regulatory capital ratios,minimum capital ratios for well capitalized banks and the Bank’s actual capitalratios at December 31, 2002 were as follows:

 
|                                                 |   | **Regulatory Minimum  Ratio for Banks** |   | **Minimum Ratio for Well  Capitalized Banks** |   | **Actual Ratios at  December 31, 2002** |   |
|------------------------------------------------------|--------|-----------------------------------------|--------|-----------------------------------------------|--------|-----------------------------------------|--------|
|                                                 |   |                                    |   |                                          |   |                                    |   |
| Tier 1 capital to net risk  weighted assets          |   | 4.00                                    | %      | 6.00                                          | %      | 12.24                                   | %      |
| Total capital to net risk  weighted assets           |   | 8.00                                    |   | 10.00                                         |   | 13.50                                   |   |
| Tier 1 capital to adjusted  quarterly average assets |   | 4.00                                    |   | 5.00                                          |   | 7.92                                    |   |

 

The FDICIA requires each federal banking agency to revise itsrisk-based capital standards to ensure that those standards take adequateaccount of interest rate risk, concentration of credit risk and the risks ofnontraditional activities,

39

----

 

as well as reflect the actualperformance and expected risk of loss on multi-family mortgages. The law alsorequires each federal banking agency to specify the levels at which an insuredinstitution would be considered “well capitalized,” “adequately capitalized,”“undercapitalized,” “significantly undercapitalized” and “criticallyundercapitalized.”  Under the FDIC’sregulations, the Company and the Bank were both well capitalized at December31, 2002.

 

The Company’sability to generate capital internally through retention of earnings and accessto capital markets is essential for satisfying the capital guidelines for bankholding companies as prescribed by the Federal Reserve Board.

 

The payment ofdividends is determined by the Company’s Board of Directors in light ofcircumstances and conditions then existing, including the earnings of theCompany and the Bank, funding requirements and financial condition andapplicable laws and regulations. The Company’s ability to pay cash dividends isrestricted by the requirement that it maintain a certain level of capital asdiscussed above in accordance with regulatory guidelines. The Federal ReserveBoard has promulgated a policy prohibiting bank holding companies from payingdividends on common stock unless such bank holding company can pay suchdividends from current earnings.

 

At December31, 2002, none of the capital of the Bank was available for payment ofdividends to the Company without prior approval of regulatory authorities. TheCompany’s immediate liquidity needs have been and can continue to be satisfiedby advances from the Company’s parent company.

 

**ITEM 7A****.               QUANTITATIVEAND QUALITATIVE DISCLOSURE ABOUT MARKET RISKS**

 

Forquantitative and qualitative disclosures about market risk affecting theCompany, see “Management’s Discussion and Analysis of Financial Condition andResults of Operations—Quantitative and Qualitative Disclosures about MarketRisk” in Item 7 above, which is incorporated herein by reference.

 

40

----

 

**ITEM 8****.  FINANCIALSTATEMENTS AND SUPPLEMENTARY DATA**

 

**TABLE OF CONTENTS**

 
| Independent Auditors’ Report                                                                                                                                                                                                               |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|                                                                                                                                                                                                                                            |
| Report of Independent Accountants                                                                                                                                                                                                               |
|                                                                                                                                                                                                                                            |
| Consolidated Balance Sheets As of December 31, 2002 and 2001                                                                                                                                                                                    |
|                                                                                                                                                                                                                                            |
| Consolidated Statements of Operations and Comprehensive Income (Loss)  for the Years Ended December 31, 2002 and 2001, the Period From August 12,  2000 Through December 31, 2000 and the Period From January 1, 2000 Through  August 11, 2000  |
|                                                                                                                                                                                                                                            |
| Consolidated Statements of Changes in Stockholder’s Equity for the  Years ended December 31, 2002 and   2001, the Period From August 12, 2000 through December 31, 2000, and  the Period From January 1, 2000 Through August 11, 2000 |
|                                                                                                                                                                                                                                            |
| Consolidated Statements of Cash Flows for the Years ended December  31, 2002 and 2001 the Period From August 12, 2000 Through December 31, 2000  and the Period from January 1, 2000 Through August 11, 2000                                    |
|                                                                                                                                                                                                                                            |
| Notes to Consolidated Financial Statements                                                                                                                                                                                                      |
|                                                                                                                                                                                                                                            |
| Quarterly Data (Unaudited)                                                                                                                                                                                                                      |

 

41

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**INDEPENDENT AUDITORS’ REPORT**

 

The Stockholder and Board ofDirectors

Independent Bankshares, Inc.

 

We have audited theaccompanying consolidated balance sheet of Independent Bankshares, Inc. andsubsidiaries (collectively, the “Company”) a wholly owned subsidiary of StateNational Bancshares, Inc., as of December 31, 2002, and the relatedconsolidated statement of operations, changes in stockholder’s equity and cashflows for the year then ended.  Thesefinancial statements are the responsibility of the Company’s management.  Our responsibility is to express an opinionon these financial statements based on our audit.

 

We conducted our audit inaccordance with auditing standards generally accepted in the United States ofAmerica. Those standards require that we plan and perform the audit to obtainreasonable assurance about whether the financial statements are free ofmaterial misstatement. An audit includes examining, on a test basis, evidencesupporting the amounts and disclosures in the financial statements. An auditalso includes assessing the accounting principles used and significantestimates made by management, as well as evaluating the overall financialstatement presentation. We believe that our audit provides a reasonable basisfor our opinion.

 

In our opinion, such consolidatedfinancial statements present fairly, in all material respects, the consolidatedfinancial position of Independent Bankshares, Inc. and subsidiaries at December31, 2002, and the consolidated results of its operations and its cash flows forthe year ended December 31, 2002, in conformity with accounting principlesgenerally accepted in the United States of America.

 

As discussed in Note 1 to theconsolidated financial statements, in 2002 the Company adopted the provisionsof Statement of Accounting Standards No. 142 “Goodwill and Other IntangibleAssets.”

 
|            | /s/ DELOITTE  & TOUCHE LLP |   |
|-----------------|--------------------------------|--------|
|            |                           |
|            |                           |
| Houston,  Texas |                           |
| March 7,  2003  |                           |

 

42

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**Report of Independent Auditors**

 

The Stockholder and Board ofDirectors

Independent Bankshares, Inc.

 

We have audited theaccompanying consolidated balance sheet of Independent Bankshares, Inc., awholly owned subsidiary of State National Bancshares, Inc., as of December 31,2001, and the related consolidated statements of operations, changes instockholder’s equity, and cash flows for the year ended December 31, 2001 andeach of the periods from August 12, 2000 through December 31, 2000 and fromJanuary 1, 2000 though August 11, 2000. These financial statements are theresponsibility of the Company’s management. Our responsibility is to express an opinion on these financialstatements based on our audits.

 

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

 

In our opinion, theconsolidated financial statements referred to above present fairly, in allmaterial respects, the consolidated financial position of IndependentBankshares, Inc. at December 31, 2001, and the consolidated results of itsoperations and its cash flows for the year ended December 31, 2001 and theperiods from August 12, 2000 through December 31, 2000 and from January 1, 2000through August 11, 2000, in conformity with accounting principles generallyaccepted in the United States.

 
|           | /s/ ERNST  & YOUNG LLP |   |
|----------------|----------------------------|--------|
|           |                       |
|           |                       |
| Dallas,  Texas |                       |
| March 5,  2002 |                       |

 

43

----

 

**INDEPENDENT BANKSHARES, INC.**

**A WHOLLY OWNED SUBSIDIARY OF STATENATIONAL BANCSHARES, INC.**

**CONSOLIDATED BALANCE SHEETS****AS OF**

**DECEMBER 31, 2002 AND 2001**

 

**ASSETS**

 
|                                                    |   | **2002**                   |    | **2001** |   |
|---------------------------------------------------------|--------|----------------------------|---------|----------|--------|
|                                                    |   | **(Dollars in thousands)** |    |
| **Assets**:                                             |   |                       |    |
| Cash and Cash Equivalents:                              |   |                       |    |     |   |
| Cash, Due from Banks and Interest-Earning Time Deposits |   | $                          | 33,583  |     | $      | 36,062 |   |
| Federal Funds Sold                                      |   | 6,784                      |    | 10,528   |   |
| Total Cash and Cash Equivalents                         |   | 40,367                     |    | 46,590   |   |
| Available-for-sale Securities, at fair value            |   | 173,631                    |    | 216,112  |   |
| Loans                                                   |   |                       |    |     |   |
| Total Loans                                             |   | 287,305                    |    | 304,270  |   |
| Less:                                                   |   |                       |    |     |   |
| Unearned Income on Installment Loans                    |   | 3                          |    | 24       |   |
| Allowance for Loan Losses                               |   | 6,261                      |    | 6,525    |   |
| Net Loans                                               |   | 281,041                    |    | 297,721  |   |
| Goodwill (Note 6)                                       |   | 16,098                     |    | 31,742   |   |
| Other Intangible Assets (Note 6)                        |   | 9,982                      |    | 11,977   |   |
| Premises and Equipment, net (Note 7)                    |   | 14,454                     |    | 15,380   |   |
| Accrued Interest Receivable                             |   | 4,426                      |    | 5,321    |   |
| Other Real Estate and Other Repossessed Assets          |   | 3,631                      |    | 691      |   |
| Other Assets                                            |   | 14,657                     |    | 11,849   |   |
| Total Assets                                            |   | $                          | 558,287 |     | $      | 637,383 |   |

 

**LIABILITIES AND STOCKHOLDER’S EQUITY**

 
| **Liabilities**:                                                                                                        |   |    |    |    |   |
|-------------------------------------------------------------------------------------------------------------------------|--------|---------|---------|---------|--------|
| Deposits                                                                                                                |   |    |    |    |   |
| Noninterest-bearing Demand Deposits                                                                                     |   | $       | 106,950 |    | $      | 112,044 |   |
| Interest-bearing Demand Deposits                                                                                        |   | 178,981 |    | 180,021 |   |
| Interest-bearing Time Deposits                                                                                          |   | 196,712 |    | 251,965 |   |
| Total Deposits                                                                                                          |   | 482,643 |    | 544,030 |   |
| Fed Funds Purchased and Securities Sold Under Agreement to Repurchase                                                   |   | 106     |    | 151     |   |
| Accrued Interest Payable                                                                                                |   | 669     |    | 1,462   |   |
| Note Payable                                                                                                            |   | 143     |    | 0       |   |
| Other Liabilities                                                                                                       |   | 5,199   |    | 5,441   |   |
| Total Liabilities                                                                                                       |   | 488,760 |    | 551,084 |   |
|                                                                                                                    |   |    |    |    |   |
| Guaranteed Preferred Beneficial Interests in the Company’s  Subordinated Debentures                                |   | 10,934  |    | 10,918  |   |
|                                                                                                                    |   |    |    |    |   |
| Commitments and Contingent Liabilities (Notes 15 and 17)                                                                |   |    |    |    |   |
|                                                                                                                    |   |    |    |    |   |
| **Stockholder’s  Equity**                                                                                          |   |    |    |    |   |
| Common Stock—Par Value $0.25; 30,000,000 Shares Authorized; 2,273,647  Shares Issued at December 31, 2002 and 2001 |   | 568     |    | 568     |   |
| Additional Paid-In Capital                                                                                              |   | 80,066  |    | 80,071  |   |
| Retained Deficit                                                                                                        |   | (26,208 | )       | (8,280  | )      |
| Unrealized Gain on Available-for-sale Securities, net                                                                   |   | 4,167   |    | 3,022   |   |
| Total Stockholder’s Equity                                                                                         |   | 58,593  |    | 75,381  |   |
| Total Liabilities and Stockholder’s Equity                                                                         |   | $       | 558,287 |    | $      | 637,383 |   |

 

**See accompanying notes.**

 

44

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**INDEPENDENTBANKSHARES, INC.**

**A WHOLLY OWNEDSUBSIDIARY OF STATE NATIONAL BANCSHARES, INC.**

**CONSOLIDATEDSTATEMENTS OF OPERATIONS FOR**

**THE YEARS ENDEDDECEMBER 31, 2002 AND 2001, THE PERIOD FROM AUGUST 12, 2000 THROUGH**

**DECEMBER 31, 2000,AND THE PERIOD FROM JANUARY 1, 2000 THROUGH AUGUST 11, 2000**

 

** **
|                                                                                                                             |   |                                               |    |                                |   |                                               |   | **Predecessor**                                 |   |
|----------------------------------------------------------------------------------------------------------------------------------|--------|----------------------------------------------------|---------|-------------------------------------|--------|----------------------------------------------------|--------|-------------------------------------------------|--------|
|                                                                                                                             |   | **Year  Ended  December  31, 2002**                |    | **Year  Ended  December  31, 2001** |   | **August  12, 2000,  Through  December  31, 2000** |   | **January 1,  2000  Through  August 11,  2000** |   |
| Interest Income:                                                                                                                 |   | **(Dollars in thousands, except per share data )** |    |
| Interest and Fees on Loans (Note 5)                                                                                              |   | $                                                  | 20,070  |                                | $      | 27,292                                             |   | $                                               | 14,105 |   | $ | 10,746 |   |
| Interest on Securities                                                                                                           |   | 10,270                                             |    | 11,435                              |   | 4,583                                              |   | 3,705                                           |   |
| Interest on Deposits in Other Banks                                                                                              |   | 98                                                 |    | 28                                  |   | 12                                                 |   | 0                                               |   |
| Interest on Federal Funds Sold                                                                                                   |   | 244                                                |    | 2,428                               |   | 1,024                                              |   | 822                                             |   |
| Total Interest Income                                                                                                            |   | 30,682                                             |    | 41,183                              |   | 19,724                                             |   | 15,273                                          |   |
| Interest Expense:                                                                                                                |   |                                               |    |                                |   |                                               |   |                                            |   |
| Interest on Deposits                                                                                                             |   | 8,034                                              |    | 19,167                              |   | 9,245                                              |   | 6,355                                           |   |
| Interest on Federal funds Purchased and  Securities Sold  Under Agreement to  Repurchase                                    |   | 2                                                  |    | 4                                   |   | 7                                                  |   | 0                                               |   |
| Total Interest Expense                                                                                                           |   | 8,036                                              |    | 19,171                              |   | 9,252                                              |   | 6,355                                           |   |
| Net Interest Income                                                                                                              |   | 22,646                                             |    | 22,012                              |   | 10,472                                             |   | 8,918                                           |   |
| (Credit) provision for Loan Losses (Note 5)                                                                                      |   | (77                                                | )       | 10,765                              |   | 618                                                |   | 1,660                                           |   |
| Net Interest Income After (Credit)  Provision for Loan Losses                                                                    |   | 22,723                                             |    | 11,247                              |   | 9,854                                              |   | 7,258                                           |   |
| Noninterest Income:                                                                                                              |   |                                               |    |                                |   |                                               |   |                                            |   |
| Service Charges                                                                                                                  |   | 3,687                                              |    | 3,506                               |   | 1,606                                              |   | 1,621                                           |   |
| Trust Fees                                                                                                                       |   | 487                                                |    | 492                                 |   | 118                                                |   | 140                                             |   |
| Net   Realized Gain on Sale of   Securities                                                                            |   | 13                                                 |    | 1                                   |   | 36                                                 |   | 0                                               |   |
| Other Income                                                                                                                     |   | 1,825                                              |    | 1,407                               |   | 129                                                |   | 142                                             |   |
| Total Noninterest Income                                                                                                         |   | 6,012                                              |    | 5,406                               |   | 1,889                                              |   | 1,903                                           |   |
| Noninterest Expenses:                                                                                                            |   |                                               |    |                                |   |                                               |   |                                            |   |
| Salaries and Employee Benefits                                                                                                   |   | 10,470                                             |    | 10,681                              |   | 4,422                                              |   | 3,869                                           |   |
| Net Occupancy Expense                                                                                                            |   | 3,854                                              |    | 3,726                               |   | 1,151                                              |   | 1,526                                           |   |
| Amortization of Intangible Assets                                                                                                |   | 1,873                                              |    | 4,367                               |   | 1,685                                              |   | 413                                             |   |
| Distributions on Guaranteed Preferred  Beneficial Interests in the Company’s Subordinated Debentures (Note 10)              |   | 1,121                                              |    | 1,119                               |   | 434                                                |   | 678                                             |   |
| Communication                                                                                                                    |   | 812                                                |    | 925                                 |   | 467                                                |   | 197                                             |   |
| Professional Fees                                                                                                                |   | 679                                                |    | 888                                 |   | 765                                                |   | 416                                             |   |
| Data Processing Expense                                                                                                          |   | 530                                                |    | 654                                 |   | 411                                                |   | 94                                              |   |
| Net Costs (Revenues) Applicable to Other  Real Estate and Other Repossessed Assets                                               |   | 52                                                 |    | 95                                  |   | (23                                                | )      | 29                                              |   |
| Merger Related Expense                                                                                                           |   | 546                                                |    | 51                                  |   | 0                                                  |   | 1,970                                           |   |
| Other Expenses                                                                                                                   |   | 3,897                                              |    | 4,549                               |   | 1,699                                              |   | 1,778                                           |   |
| Total Noninterest Expenses                                                                                                       |   | 23,834                                             |    | 27,055                              |   | 11,011                                             |   | 10,970                                          |   |
| Income (Loss) From Continuing Operations  Before Federal Income Taxes and Cumulative Effect of a Change in Accounting  Principle |   | 4,901                                              |    | (10,402                             | )      | 732                                                |   | (1,809                                          | )      |
| Federal Income Tax Expense (Benefit)  (Note 9)                                                                              |   | 1,190                                              |    | (3,205                              | )      | 497                                                |   | 99                                              |   |
| Income (Loss) From Continuing Operations  Before Cumulative Effect of a Change in Accounting Principle                           |   | 3,711                                              |    | (7,197                              | )      | 235                                                |   | (1,908                                          | )      |
| Discontinued Operations                                                                                                          |   |                                               |    |                                |   |                                               |   |                                            |   |
| Gain From Operations of Sold Branches  (including loss on disposal of $35,000)                                                   |   | 96                                                 |    | 0                                   |   | 0                                                  |   | 0                                               |   |
| Federal Income Taxes on Discontinued  Operations                                                                                 |   | 33                                                 |    | 0                                   |   | 0                                                  |   | 0                                               |   |
| Income Before Cumulative Effect of a Change  in Accounting Principle                                                             |   | 3,774                                              |    | (7,197                              | )      | 235                                                |   | (1,908                                          | )      |
| Cumulative Effect of a Change in Accounting  Principle                                                                           |   | 15,642                                             |    | 0                                   |   | 0                                                  |   | 0                                               |   |
| Net (Loss) Income                                                                                                                |   | $                                                  | (11,868 | )                                   | $      | (7,197                                             | )      | $                                               | 235    |   | $ | (1,908 | ) |
| Preferred Stock Dividends                                                                                                        |   |                                               |    |                                |   |                                               |   | $                                               | 0      |   |
| Net Loss Available to Common Stockholders                                                                                        |   |                                               |    |                                |   |                                               |   | $                                               | (1,908 | ) |
| Basic Loss Per Common Share Available to  Common Stockholders (Note 12)                                                          |   |                                               |    |                                |   |                                               |   | $                                               | (0.84  | ) |
| Diluted Loss Per Common Share Available to  Common Stockholders (Note 12)                                                        |   |                                               |    |                                |   |                                               |   | $                                               | (0.84  | ) |

 

**See accompanyingnotes.**

 

45

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** **

**INDEPENDENTBANKSHARES, INC.**

**A WHOLLY OWNEDSUBSIDIARY OF STATE NATIONAL BANCSHARES, INC.**

**CONSOLIDATEDSTATEMENTS OF CHANGES IN STOCKHOLDER’S EQUITY**

**FOR THE YEARS ENDEDDECEMBER 31, 2002 AND 2001, THE PERIOD FROM AUGUST 12, 2000 THROUGH**

**DECEMBER 31, 2000,AND THE PERIOD FROM JANUARY 1, 2000 THROUGH AUGUST 11, 2000**

** **
|                                                                                               |                |                                              |       | **Additional  Paid-in  Capital** |       | **Retained  Earnings  (Deficit)** |   | **Accumulated  Other  Comprehensive  Income (Loss)** |   |   |    |    |   |
|----------------------------------------------------------------------------------------------------|---------------------|---------------------------------------------------|------------|----------------------------------|------------|-----------------------------------|--------|------------------------------------------------------|--------|--------|---------|---------|--------|
|                                                                                               |                |                                              |       |                             |       |                              |
| **Common  Stock**                                                                                  | **Treasury  Stock** | **Unearned  Employee Stock   Ownership Plan**     |
| **Shares**                                                                                         |                | **Amount**                                        | **Shares** |                             | **Amount** | **Shares**                        |   | **Amount**                                           |
|                                                                                               |                | **(Dollars in thousands, except per share data)** |       |
| Balances-January 1, 2000 (Predecessor)                                                             |                | 2,333,647                                         |       | $                                | 583        |                              | $      | 15,955                                               |   | $      | 9,972   |    | $      | (343 | ) | (60,000 | ) | $ | (669 | ) | (12,470 | ) | $ | (142 | ) |
| Net Loss, January 1 to August 11                                                                   |                |                                              |       |                             |       |                              |   | (1,908                                               | )      |   |    |    |   |   |   |   |   |   |   |
| Adjustment to Unrealized Loss on Available-For-Sale Securities, Net of  Tax of $77,000 (Note 4)    |                |                                              |       |                             |       |                              |   |                                                 |   | 150    |    |    |   |   |   |   |   |   |   |
| Cash Dividends ($0.12 Per Share)                                                                   |                |                                              |       |                             |       |                              |   | (273                                                 | )      |   |    |    |   |   |   |   |   |   |   |
| Principal Payments on Loan to ESOP for Stock Purchase – Earned Stock  (Note 11)               |                |                                              |       |                             |       |                              |   |                                                 |   |   |    |    |   |   |   | 12,470 |   | 142 |   |
| Balances — August 11, 2000 (Predecessor)                                                      |                | 2,333,647                                         |       | 583                              |       | 15,955                            |   | 7,791                                                |   | (193   | )       | (60,000 | )      | (669 | ) | 0 |   | 0 |   |
| Purchase Accounting Adjustments (Note 2)                                                           |                |                                              |       |                             |       | 30,258                            |   | (7,791                                               | )      | 193    |    |    |   |   |   |   |   |   |   |
| Retirement of Treasury Stock                                                                       |                | (60,000                                           | )          | (15                              | )          | (654                              | )      |                                                 |   |   |    | 60,000  |   | 669 |   |   |   |   |   |
| Merger of UB&T effective August 11, 2000                                                       |                |                                              |       |                             |       | 16,622                            |   | 483                                                  |   | (376   | )       |    |   |   |   |   |   |   |   |
| Merger of Lubbock effective August 11, 2000                                                        |                |                                              |       |                             |       | 18,000                            |   | 1,026                                                |   | (621   | )       |    |   |   |   |   |   |   |   |
| Purchase Price Adjustment                                                                          |                |                                              |       |                             |       |                              |   | (76                                                  | )      |   |    |    |   |   |   |   |   |   |   |
| Net Income, August 12 through December 31                                                          |                |                                              |       |                             |       |                              |   | 235                                                  |   |   |    |    |   |   |   |   |   |   |   |
| Adjustment to Unrealized Loss on Available-For-Sale Securities, Net of  Tax of $1,347,000 (Note 4) |                |                                              |       |                             |       |                              |   |                                                 |   | 2,615  |    |    |   |   |   |   |   |   |   |
| Cash Dividends                                                                                     |                |                                              |       |                             |       |                              |   | (2,051                                               | )      |   |    |    |   |   |   |   |   |   |   |
| Balances—December 31, 2000 (Predecessor)                                                      |                | 2,273,647                                         |       | 568                              |       | 80,181                            |   | (383                                                 | )      | 1,618  |    | 0       |   | 0 |   | 0 |   | 0 |   |
| Net Loss                                                                                           |                |                                              |       |                             |       |                              |   | (7,197                                               | )      |   |    |    |   |   |   |   |   |   |   |
| UB&T Purchase Price Adjustment                                                                 |                |                                              |       |                             |       | (110                              | )      |                                                 |   |   |    |    |   |   |   |   |   |   |   |
| Adjustment to Unrealized Gain on Available-For-Sale Securities, Net of  Tax of $723,000 (Note 4)   |                |                                              |       |                             |       |                              |   |                                                 |   | 1,404  |    |    |   |   |   |   |   |   |   |
| Cash Dividends                                                                                     |                |                                              |       |                             |       |                              |   | (700                                                 | )      |   |    |    |   |   |   |   |   |   |   |
| Balances-December 31, 2001 (Predecessor)                                                           |                | 2,273,647                                         |       | 568                              |       | 80,071                            |   | (8,280                                               | )      | 3,022  |    | 0       |   | 0 |   | 0 |   | 0 |   |
| Net Loss                                                                                           |                |                                              |       |                             |       |                              |   | (11,868                                              | )      |   |    |    |   |   |   |   |   |   |   |
| UB&T Purchase Price Adjustment                                                                 |                |                                              |       |                             |       | (5                                | )      |                                                 |   |   |    |    |   |   |   |   |   |   |   |
| Adjustment to Unrealized Gain on Available-For-Sale Securities, Net of  Tax of $591,000 (Note 4)   |                |                                              |       |                             |       |                              |   |                                                 |   | 1,158  |    |    |   |   |   |   |   |   |   |
| Reclassification adjustment for gains included in net income                                       |                |                                              |       |                             |       |                              |   |                                                 |   | (13    | )       |    |   |   |   |   |   |   |   |
| Cash Dividends                                                                                     |                |                                              |       |                             |       |                              |   | (6,060                                               | )      |   |    |    |   |   |   |   |   |   |   |
| Balances—December 31, 2002                                                                    |                | 2,273,647                                         |       | $                                | 568        |                              | $      | 80,066                                               |   | $      | (26,208 | )       | $      | 4,167 |   | 0 |   | $ | 0 |   | 0 |   | $ | 0 |   |

** **

**See accompanying notes.**

 

46

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**INDEPENDENT BANKSHARES, INC.A WHOLLY OWNED SUBSIDIARY OF STATE NATIONAL BANCSHARES, INC.CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THEYEARS ENDED DECEMBER 31,2002 AND 2001, THE PERIOD FROM AUGUST 12, 2000 THROUGH DECEMBER 31, 2000 ANDTHE PERIOD FROMJANUARY 1, 2000 THROUGH AUGUST 11, 2000**

** **
|                                                                                              |   |                               |    |                               |   |                                               |   | **Predecessor**                                |   |
|---------------------------------------------------------------------------------------------------|--------|------------------------------------|---------|------------------------------------|--------|----------------------------------------------------|--------|------------------------------------------------|--------|
|                                                                                              |   | **Year Ended  December 31,  2002** |    | **Year Ended  December 31,  2001** |   | **August 12,  2000,  Through  December 31,  2000** |   | **January 1,  2000  Through  August 11, 2000** |   |
|                                                                                              |   | **(Dollars in thousands )**        |    |
| Cash Flows from Operating Activities:                                                             |   |                               |    |                               |   |                                               |   |                                           |   |   |   |   |   |
| Net (Loss) Income                                                                                 |   | $                                  | (11,868 | )                                  | $      | (7,197                                             | )      | $                                              | 235    |   | $ | (1,908 | ) |
| Adjustments to Reconcile Net Income (Loss) to Net Cash Provided by  Operating Activities:         |   |                               |    |                               |   |                                               |   |                                           |   |
| Cumulative Effect of a Change in Accounting Principle - Goodwill  Impairment                      |   | 15,642                             |    | 0                                  |   | 0                                                  |   | 0                                              |   |
| Deferred Federal Income Tax (Benefit) Expense                                                     |   | (262                               | )       | 88                                 |   | 103                                                |   | (817                                           | )      |
| Depreciation and Amortization                                                                     |   | 4,271                              |    | 5,668                              |   | 2,286                                              |   | 864                                            |   |
| Provision (credit) for Loan Losses                                                                |   | (77                                | )       | 10,765                             |   | 618                                                |   | 1,660                                          |   |
| Loss on Branch Sale                                                                               |   | 35                                 |    | 0                                  |   | 0                                                  |   | 0                                              |   |
| Gain on Sales of Securities                                                                       |   | (13                                | )       | (1                                 | )      | (36                                                | )      | 0                                              |   |
| Loss (Gain) on Sales of Premises and Equipment                                                    |   | 10                                 |    | (24                                | )      | (40                                                | )      | 0                                              |   |
| Writedown of Premises and Equipment                                                               |   | 146                                |    | 129                                |   | 0                                                  |   | 0                                              |   |
| Gains on Sales of Other Real Estate and Other Repossessed Assets                                  |   | (9                                 | )       | (29                                | )      | 0                                                  |   | 0                                              |   |
| Writedown of Other Real Estate and Other Repossessed Assets                                       |   | 0                                  |    | 124                                |   | 2                                                  |   | 4                                              |   |
| Decrease (Increase) in Accrued Interest Receivable                                                |   | 847                                |    | 2,694                              |   | (1,013                                             | )      | 6                                              |   |
| Decrease (Increase) in Other Assets                                                               |   | (928                               | )       | 466                                |   | 1,050                                              |   | 1,180                                          |   |
| Increase (Decrease) in Accrued Interest Payable                                                   |   | (767                               | )       | (1,026                             | )      | 187                                                |   | 99                                             |   |
| Increase (Decrease) in Other Liabilities                                                          |   | (567                               | )       | (1,451                             | )      | (1,396                                             | )      | 1,227                                          |   |
| Net Cash Provided by Operating Activities                                                         |   | 6,460                              |    | 10,206                             |   | 1,996                                              |   | 2,315                                          |   |
|                                                                                              |   |                               |    |                               |   |                                               |   |                                           |   |
| Cash Flows from Investing Activities:                                                             |   |                               |    |                               |   |                                               |   |                                           |   |
| Proceeds From Maturities of Available-For-Sale Securities                                         |   | 110,019                            |    | 70,034                             |   | 8,599                                              |   | 12,200                                         |   |
| Proceeds From Maturities of Held-To-Maturity Securities                                           |   | 0                                  |    | 0                                  |   | 3,977                                              |   | 4,724                                          |   |
| Proceeds From Sales of Available-For-Sale Securities                                              |   | 1,414                              |    | 59,919                             |   | 39,692                                             |   | 3,000                                          |   |
| Purchases of Available-For-Sale Securities                                                        |   | (67,895                            | )       | (166,507                           | )      | (41,145                                            | )      | (4,891                                         | )      |
| Purchases of Held-To-Maturity Securities                                                          |   | 0                                  |    | 0                                  |   | 0                                                  |   | (5,836                                         | )      |
| Purchase of Bank Owned Life Insurance                                                             |   | (1,994                             | )       | (10,000                            | )      | 0                                                  |   | 0                                              |   |
| Net Decrease in Loans                                                                             |   | 10,490                             |    | 48,719                             |   | 3,184                                              |   | 3,167                                          |   |
| Proceeds from Sales of Premises and Equipment                                                     |   | 68                                 |    | 310                                |   | 99                                                 |   | 0                                              |   |
| Additions to Premises and Equipment                                                               |   | (1,281                             | )       | (1,656                             | )      | (1,387                                             | )      | (82                                            | )      |
| Proceeds from Sales of Other Real Estate and Other Repossessed Assets                             |   | 640                                |    | 1,104                              |   | 104                                                |   | 356                                            |   |
| Net Cash and Cash Equivalents Paid in Branch Sale                                                 |   | (11,124                            | )       | 0                                  |   | 0                                                  |   | 0                                              |   |
| Net Cash and Cash Equivalents Received  in Merger/Acquisition                                |   | 0                                  |    | 0                                  |   | 9,344                                              |   | 0                                              |   |
| Net Cash Provided by Investing Activities                                                         |   | 40,337                             |    | 1,923                              |   | 22,467                                             |   | 12,638                                         |   |
|                                                                                              |   |                               |    |                               |   |                                               |   |                                           |   |
| Cash Flows from Financing Activities:                                                             |   |                               |    |                               |   |                                               |   |                                           |   |
| Net Decrease in Deposits                                                                          |   | (47,058                            | )       | (49,575                            | )      | (2,504                                             | )      | (6,962                                         | )      |
| (Decrease) Increase in Federal Funds Purchased and Securities Sold  Under Agreement to Repurchase |   | (45                                | )       | 151                                |   | 0                                                  |   | 0                                              |   |
| Repayment of Notes Payable                                                                        |   | 0                                  |    | 0                                  |   | 0                                                  |   | 0                                              |   |
| Advances from State National                                                                      |   | 0                                  |    | 1,000                              |   | 0                                                  |   | 0                                              |   |
| Payment of Cash Dividends                                                                         |   | (6,060                             | )       | (700                               | )      | (2,051                                             | )      | (273                                           | )      |
| Advances on Federal Home Loan Bank Note                                                           |   | 143                                |    | 0                                  |   | 0                                                  |   | 0                                              |   |
| Net Cash Used in Financing Activities                                                             |   | (53,020                            | )       | (49,124                            | )      | (4,555                                             | )      | (7,235                                         | )      |
| Net (Decrease) Increase in Cash and Cash Equivalents                                              |   | (6,223                             | )       | (36,995                            | )      | 19,908                                             |   | 7,718                                          |   |
| Cash and Cash Equivalents at Beginning of Period                                                  |   | 46,590                             |    | 83,585                             |   | 63,677                                             |   | 38,760                                         |   |
| Cash and Cash Equivalents at End of Period                                                        |   | $                                  | 40,367  |                               | $      | 46,590                                             |   | $                                              | 83,585 |   | $ | 46,478 |   |

 

**See accompanying notes.**

 

47

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**INDEPENDENTBANKSHARES, INC.**

**A WHOLLY OWNEDSUBSIDIARY OF STATE NATIONAL BANCSHARES, INC.**

**NOTES TO CONSOLIDATEDFINANCIAL STATEMENTS**

**DECEMBER 31, 2002,2001 AND 2000**

 

**NOTE 1: SUMMARY OF SIGNIFICANT ACCOUNTINGPOLICIES**

 

**Business**

 

IndependentBankshares, Inc., a Texas corporation (the “Company”), is a bank holdingcompany headquartered in Lubbock, Texas. The Company is an indirect, whollyowned subsidiary of State National Bancshares, Inc., Lubbock, Texas (“StateNational”). At December 31, 2002, the Company owned all of the commonsecurities of Independent Capital Trust (“Independent Capital”) and indirectly,owned through a Delaware subsidiary, Independent Financial Corp. (“IndependentFinancial”), 100% of the stock of State National Bank, Lubbock, Texas (the“Bank” or the “Lubbock Bank”) and 100% of the stock of Twoenc, Inc. (“Twoenc”)a subsidiary of the bank used for holding certain foreclosed assets of theBank. At December 31, 2002, the Bank operated full-service banking locations inthe Texas cities of Abilene (four locations), Azle (two locations), Big Spring,Lubbock, (3 locations), Odessa (two locations), Plainview, San Angelo,Stamford and Winters.

 

The Company’sprimary activities are to assist the Bank in the management and coordination ofits financial resources.

 

The principalservices provided by the Bank are as follows:

 

CommercialServices. The Bank provides a full range of banking services for its commercialcustomers. Commercial lending activities include short-term and medium-termloans, revolving credit arrangements, inventory and accounts receivablefinancing, equipment financing and interim and permanent real estate lending.Other services include cash management programs and federal tax depository andnight depository services.

 

ConsumerServices. The Bank also provides a wide range of consumer banking services,including checking, savings and money market accounts, savings programs andinstallment and personal loans. The Bank makes automobile and other installmentloans directly to customers, as well as indirectly through automobile dealers.The Bank makes home improvement, home equity and real estate loans and providessafe deposit services. As a result of sharing arrangements with the Pulse automatedteller machine system network, the Bank provides 24-hour routine bankingservices through automated teller machines (“ATMs”). The Pulse network providesATM accessibility throughout the United States. The Bank also offers investmentservices and banking by phone or personal computer.

 

TrustServices. The Bank provides trust and agency services to individuals,partnerships and corporations from its offices in Abilene, Lubbock and Odessa.The trust division also provides investment management, administration andadvisory services for agency and trust accounts, and acts as trustee forpension and profit sharing plans.

 

InvestmentServices. The Bank provides investment services, including purchases and salesof various investments, and management of such investments, for its customers.

 

**Principles of Consolidation**

 

Theconsolidated financial statements include the accounts of the Company,Independent Capital, Independent Financial, the Bank and Twoenc. Allsignificant intercompany accounts and transactions have been eliminated uponconsolidation.

 

48

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**Statements of Cash Flows**

 

For purposesof reporting cash flows, cash and cash equivalents include cash on hand,amounts due from banks, interest earning time deposits and federal funds sold.Generally, federal funds are purchased and sold for one-day periods.

 

**Securities**

 

Managementdetermines the appropriate classification of securities at the time ofpurchase. If the securities are purchased ith the positive intent and theability to hold the securities until maturity, they are classified asheld-to-maturity and carried at historical cost, adjusted for amortization ofpremiums and accretion of fees and discounts using a method that approximatesthe interest method. Securities to be held for indefinite periods of time areclassified as available-for-sale and carried at fair value. Unrealized gainsand losses, net of taxes, related to securities available-for-sale are recordedas a separate component of stockholder’s equity. The Company had no securitiesclassified as held-to-maturity or trading as of December 31, 2002.  The cost of securities sold is based on thespecific identification method. The Company currently owns no derivativefinancial instruments subject to Statement of Financial Accounting Standard(“SFAS”) No. 133, “Accounting forDerivative Instruments and Hedging Activities”, and does not engage inhedging activities.

 

**Loans**

 

Loans arestated at the principal amount outstanding. Interest on the various types ofcommercial, real estate and other loans is accrued daily based on the principalbalances outstanding. Income on installment loans is recognized using thismethod or other methods under which income approximates the effective interestmethod.

 

The recognitionof income on a loan is discontinued, and previously accrued interest isreversed, when interest or principal payments become ninety (90) days past dueunless, in the opinion of management, the outstanding interest remainscollectible. Interest is subsequently recognized only as received until theloan is returned to accrual status.

 

A loan isconsidered impaired when, based on current information and events, it isprobable that the Bank will be unable to collect all amounts due (bothprincipal and interest) according to the terms of the loan agreement. Reserveson impaired loans are measured based on the present value of expected futurecash flows discounted at the loan’s effective interest rate or the fair valueof the underlying collateral.

 

**Allowance for Loan Losses**

 

The allowancefor loan losses (the “allowance”) is reduced by charge-offs and increased byrecoveries of loans previously charged off and reduced or increased by the loanloss provision necessary to arrive at a balance determined by management to beappropriate.  Management’s periodicevaluation of the adequacy of the allowance is based on past loan lossexperience, known inherent risks in the portfolio, adverse situations that mayaffect the borrowers’ ability to repay, the estimated value of any underlyingcollateral and current economic conditions. The allowance is comprised of three elements which include: (i)allowances established on specific loans, (ii) allowances based on lossexperience and trends in pools of loans with similar characteristics, and (iii)unallocated allowances based on general economic conditions and other internaland external risk factors in the Company’s individual markets.  The total allowance includes activity relatedto allowances calculated in accordance with SFAS No. 114 “Accounting byCreditors for Impairment of a Loan” and activity related to other allowancesdetermined in accordance with SFAS No. 5 “Accounting for Contingencies” .

 

**Premises and Equipment**

 

Premises andequipment are stated at cost less accumulated depreciation. Depreciation forfinancial reporting purposes is computed primarily on the straight-line methodover the estimated useful lives of three (3) to forty (40) years. When assetsare retired or otherwise disposed of, the cost and related accumulateddepreciation are removed from the accounts and any resulting gain or loss isincluded in the results of operations for the period.

 

49

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**Intangible Assets**

 

A core depositintangible resulting from the acquisition of the Company is being amortized onan accelerated method over a ten (10) year period. Through December 31, 2001,goodwill resulting from the acquisition of the Company as well as previousacquisitions was being amortized on the straight-line method over a twenty (20)year period.  Beginning in 2002,amortization of goodwill has ceased as a result of the adoption of SFAS No. 142**“Goodwilland Other Intangible Assets”.

 

SFAS No. 142requires that goodwill and intangible assets with indefinite useful lives bereviewed for impairment at least annually. The implementation of SFAS No. 142 resulted in the Company recording anoncash, goodwill impairment charge of $15,642,000 during the first quarter of2002.  This charge reflects the cumulativeeffect of adopting the accounting change in the statement of operations, butdoes not affect the Company’s operations and has no impact on cash flows.  Goodwill was tested for impairment as ofOctober 1, 2002, and due to the results of that valuation, no furtherimpairment was deemed necessary.

 

All otherintangible assets are evaluated periodically to determine recoverability oftheir carrying value when economic conditions indicate impairment mayexist.  These conditions would includean ongoing negative performance history and a forecast of anticipatedperformance that is significantly below management’s initial expectation forthe acquired entity. Impairment would be determined based upon the estimateddiscounted cash flows of the entity acquired over the remaining amortizationperiod, compared to the remaining intangible balance. As of December 31, 2002,management believes that no impairment of other intangible assets had occurredas determined by SFAS No. 144, “Accounting for the Impairment or Disposal ofLong-Lived Assets.”

 

**Federal Income Taxes**

 

The Companyuses the liability method of accounting for deferred income taxes as requiredby the SFAS No. 109, “Accounting for Income Taxes.” Deferred income taxesreflect the net effects of temporary differences between the carrying amount ofassets and liabilities for financial reporting purposes and the amounts usedfor income tax purposes.

 

**Other Real Estate and Other RepossessedAssets**

 

Other realestate and other repossessed assets consist principally of real estateproperties and automobiles acquired by the Company through foreclosure. Suchassets, recorded, upon foreclosure, at estimated fair value, net of estimatedcosts of disposal, if any. If the estimated fair value of the collateralsecuring the loan is less than the amount outstanding on the loan at the timethe assets are acquired, the difference is charged against the allowance forpossible loan losses. Subsequent declines in estimated fair value, if any arecharged to noninterest expense.

 

**Advertising Costs**

 

Advertisingcosts are expensed as incurred. The total amounts charged to advertisingexpense for the years ended December 31, 2002, 2001 and 2000 were approximately$405,000, $540,000 and $575,000, respectively.

 

**Recently Issued Accounting Pronouncements**

 

In June 2001the Financial Accounting Standards Board (“FASB”) issued SFAS No. 141,“Business Combinations.”  SFAS No. 141establishes accounting and reporting standards for business combinations.  This Statement eliminates the use of the pooling-of-interestmethod of accounting for business combinations, requiring future businesscombinations to be accounted for using the purchase method of accounting.  Additionally, SFAS No.141 enhances thedisclosures related to business combinations and requires that all intangibleassets acquired in a business combination be reported separately fromgoodwill.  These intangible assets mustthen be assigned to a specifically identified reporting unit and assigned auseful life.  The provisions of this statementapply to all business combinations initiated after June 30, 2001.  The adoption of this statement did not havea material impact on the Company’s financial position or results of operations.

 

In July 2001the FASB issued SFAS No. 142, “Goodwill and Other Intangible Assets”*,*whichaddresses the accounting for goodwill and other intangible assets.  SFAS No. 142 prohibits the amortization ofgoodwill and

50

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intangible assets withindefinite useful lives.  SFAS No. 142requires that these assets be reviewed for impairment at least annually.  Intangible assets with finite lives willcontinue to be amortized over their estimated useful lives.  Additionally, SFAS No. 142 requires thatgoodwill included in the carrying value of equity method investments no longerbe amortized.

 

SFAS No. 142was effective for the Company’s fiscal year beginning January 1, 2002.  The implementation of SFAS No. 142 resultedin the Company recording a non-cash goodwill impairment charge of $15,642,000during the first quarter of 2002.  Thischarge reflects the cumulative effect of adopting the accounting change in thestatement of operations, but does not affect the Company’s operations and hasno impact on cash flows.  The applicationof the nonamortization provisions of SFAS No. 142 resulted in an increase innet income before federal income taxes and cumulative effect of a change inaccounting principle of $1,733,000 for the year ended December 31, 2002.

 

In July 2001FASB issued SFAS No. 143, “Accounting for Asset Retirement Obligations”.  The statement requires entities to recordthe fair value of a liability for an asset retirement obligation in the periodin which it is incurred.  When theliability is initially recorded, the entity capitalizes a cost by increasingthe carrying amount of the related long-lived asset.  Over time, the liability is accreted to its present value eachperiod, and the capitalized cost is depreciated over the useful life of therelated asset.  Upon settlement of theliability, an entity either settles the obligation for its recorded amount orincurs a gain or loss upon settlement. The standard is effective for fiscal years beginning after September 15,2002, with earlier application encouraged. The adoption of this statement did not have a material impact on theCompany’s financial position or results of operation.

 

In August 2001the FASB issued SFAS No. 144, “Accounting for the Impairment or Disposal ofLong-Lived Assets”.  SFAS No. 144addresses financial accounting and reporting for the impairment of long-livedassets and for long-lived assets to be disposed of.  More specifically, this statement broadens the presentation ofdiscontinued operations to include a component of an entity whose operationsand cash flows can be clearly distinguished, operationally and for financialreporting purposes, from the rest of the entity.  It supersedes, with exceptions, SFAS No. 121, “Accounting for theImpairment of Long-Lived Assets and Long-Lived Assets to be Disposed of”, andwas adopted January 1, 2002.

 

In 2002 theCompany sold two branches located in Bangs and Trent, Texas.  Accordingly, the operating results of thedeposed properties have been reclassified and reported as discontinuedoperations in the Consolidated Statements of operations and comprehensiveincome.

 

In May of 2002the FASB issued FAS No. 145, “Rescission of FASB Statements No. 4, 44, and 64,Amendment of FASB Statement No. 13, and Technical Corrections as of April2002”.  This statement rescinds SFAS No.4 and 64, “Reporting Gains and Losses from Extinguishment of Debt andExtinguishment of Debt Made to Satisfy Sinking-Fund Requirements”,respectively, and restricts the classification of early extinguishment of debtas an extraordinary item to the provisions of APB Opinion No. 30, “Reportingthe Results of Operations-Reporting the Effects of Disposal of a Segment of aBusiness, and Extraordinary, Unusual and Infrequently Occurring Events andTransactions”.  The statement alsorescinds SFAS No. 44, “Accounting for Intangible Assets of Motor Carriers”,which is no longer necessary because the transition to the provisions of theMotor Carrier Act of 1980 is complete. The statement also amends SFAS No. 13, “Accounting for Leases”, toeliminate an inconsistency between the required accounting for sale-leasebacktransactions and the required accounting for certain lease modifications thathave economic effects that are similar to sale-leaseback transactions.  Finally, the statement makes various technicalcorrections to existing pronouncements which are not consideredsubstantive.  The provisions of thestatement are effective for fiscal years beginning after May 15, 2002.  The adoption of this statement is notexpected to have a material impact on the Company’s financial position orresults of operations.

 

In June 2002the FASB issued SFAS No. 146, “Accounting for Costs Associated with Exit orDisposal Activities”.  SFAS No. 146provides guidance on the recognition and measurement of liabilities for costsassociated with exit or disposal activities. SFAS No. 146 is effective for exit or disposal activities that areinitiated after December 31, 2002, but early adoption is allowed andencouraged.  As such, the statement wasadopted at the date of issuance in October 2002.  The adoption of this statement did not have a material impact onthe Company’s financial position or results of operations.

 

51

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In October2002 the FASB issued SFAS No. 147, “Acquisitions of Certain FinancialInstitutions”.  SFAS No. 147 providesguidance on the accounting for the acquisition of a financial institution,except transactions between two or more mutual enterprises.  SFAS No. 147 shall be effective foracquisitions on or after October 1, 2002. The implementation of this standard is not expected to have a materialimpact on the Company’s financial position or results of operation.

 

**Use of Estimates**

 

Thepreparation of financial statements in conformity with accounting principlesgenerally accepted in the United States of America requires management to makecertain estimates and assumptions that affect the reported amounts of assetsand liabilities and disclosure of contingent assets and liabilities at the dateof the financial statements and the reported amounts of revenues and expensesduring the reporting period. Actual results could differ from these estimates.

 

**NOTE 2: ACQUISITION OF THE COMPANY**

 

On March 1,2000, the Company entered into an Agreement and Plan of Reorganization (the“Merger Agreement”) with State National for a cash acquisition of the Companyby State National (the “Acquisition”). The Company and State Nationalconsummated the merger at the close of business August 11, 2000.  Pursuant to the terms of the MergerAgreement, each share of common stock of the Company was exchanged for $20.0165in cash. Upon conclusion of the Acquisition, State National became the soleshareholder of the Company, owning all 2,273,647 outstanding shares of theCompany’s common stock. In connection with the Acquisition, State Nationalagreed to assume and guarantee the outstanding Trust Preferred Securitiesissued by Independent Capital, a Delaware business trust controlled by theCompany.

 

State Nationalaccounted for its acquisition of the Company as a purchase business combinationand purchase accounting adjustments, including goodwill, have been pushed downand reflected in the consolidated financial statements of the Companysubsequent to August 11, 2000. The consolidated financial statements of theCompany for the periods ended before August 12, 2000 (predecessor), wereprepared using the Company’s historical basis of accounting. The comparabilityof operating results for these periods and the periods encompassing push- downaccounting is affected by the purchase accounting adjustments, including theamortization of goodwill (straight-line method until amortization of goodwillceased beginning January 1, 2002) and core deposit intangibles (acceleratedmethod) over a period of 20 and 10 years, respectively.

 

52

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The purchaseprice, including costs incurred by State National directly associated with theAcquisition, was preliminarily allocated to net assets acquired. Finalallocation has been obtained and the purchase allocations finalized at December31, 2000.  The following tablesummarizes the changes made to the accounts of the Company as of August 11,2000, as a result of applying push down accounting:

 
|                                            |   | **Balance at  Date  of Acquisition** |    | **Push Down  Accounting  Adjustments** |   | **Adjusted  Balance** |   |
|-------------------------------------------------|--------|--------------------------------------|---------|----------------------------------------|--------|-----------------------|--------|
|                                            |   | **(In  thousands)**                  |    |
| Investment securities                           |   | $                                    | 99,906  |                                   | $      | (1,494                | )      | $ | 98,412 |   |
| Loans, net of unearned income                   |   | 183,082                              |    | (1,169                                 | )      | 181,913               |   |
| Allowance for possible loan losses              |   | (3,343                               | )       | (3,028                                 | )      | (6,371                | )      |
| Goodwill and core deposit intangibles           |   | 9,746                                |    | 30,099                                 |   | 39,845                |   |
| Premises and equipment                          |   | 9,446                                |    | (492                                   | )      | 8,954                 |   |
| Other assets                                    |   | 1,659                                |    | (126                                   | )      | 1,533                 |   |
| Total assets                                    |   | $                                    | 350,735 |                                   | $      | 23,790                |   | $ | 374,525 |   |
|                                            |   |                                 |    |                                   |   |                  |   |
| Other liabilities                               |   | $                                    | 1,760   |                                   | $      | 3,233                 |   | $ | 4,993 |   |
| Trust Preferred Securities                      |   | 13,000                               |    | (2,103                                 | )      | 10,897                |   |
| Stockholder’s equity                       |   | 23,465                               |    | 22,660                                 |   | 46,125                |   |
| Total liabilities and stockholder’s equity |   | $                                    | 350,735 |                                   | $      | 23,790                |   | $ | 374,525 |   |

 

**NOTE 3: BANK MERGERS**

 

On October 24,2000, State National contributed to the Company its ownership of United Bank& Trust, Abilene, Texas (“UB&T”). UB&T was merged with and intoFirst State Bank, National Association, Abilene, Texas (“First State”), asubsidiary of the Company at that time. At the time of the merger, the name ofthe resulting bank was changed to State National Bank of West Texas, Abilene,Texas (the “Abilene Bank”).

 

The merger wasaccounted for similar to a pooling of interests.  As a result of the merger, the balance sheet and results of operationsof UB&T have been included in the Company’s consolidated financialstatements since August 12, 2000, the date of the acquisition of the Company byState National (the “Acquisition”).  AtAugust 12, 2000, UB&T had total assets of $112,806,000, loans, net ofallowance for possible loan losses, of $70,230,000, total deposits of$93,946,000 and total stockholder’s equity of $16,729,000.

 

On February28, 2001, State National contributed to the Company, its ownership interest inState National Bank of West Texas, Lubbock, Texas (the “Lubbock Bank”).  The Abilene Bank was merged with and intothe Lubbock Bank.  The Lubbock Bankcontinued as the surviving entity in the merger (the “Bank”).

 

The merger wasaccounted for similar to a pooling of interests.  As a result of the merger, the balance sheet and results ofoperations of the Lubbock Bank have been included in the Company’s consolidatedfinancial statements since August 11, 2000, the date of the acquisition of theCompany by Acquisition.  At August 11,2000, the Lubbock Bank had total assets of $210,409,000, loans, net ofallowance for possible loan losses, of $121,130,000, total deposits of$190,828,000 and total stockholder’s equity of $18,405,000.

 

Collectively,the UB&T merger and the Lubbock Bank merger are referred to as the BankMergers.

 

53

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**NOTE 4: SECURITIES**

 

The amortizedcost and estimated fair value of available-for-sale securities at December 31,2002 and 2001 were as follows:

 
|                                                                                   |   | **2002**            |   |
|----------------------------------------------------------------------------------------|--------|---------------------|--------|
|                                                                                   |   | **Amortized  Cost** |   | **Gross  Unrealized  Gains** |   | **Gross  Unrealized  Losses** |   | **Estimated  Fair  Value** |   |
| U.S. Treasury securities and obligations of U.S. Government agencies  and corporations |   | $  116,053,000      |   | $  5,359,000 |   | $  0 |   | $  121,412,000 |   |
| Mortgage-backed securities and collateralized mortgage obligations                     |   | 43,934,000          |   | 871,000 |   | (52,000 | ) | 44,753,000 |   |
| Obligations of states and political subdivisions                                       |   | 3,448,000           |   | 133,000 |   | 0 |   | 3,581,000 |   |
| Other securities                                                                       |   | 3,882,000           |   | 3,000 |   | 0 |   | 3,885,000 |   |
|                                                                                   |   |                |   |   |   |   |   |   |   |
| Total available-for-sale securities                                                    |   | $  167,317,000      |   | $  6,366,000 |   | $  (52,000 | ) | $  173,631,000 |   |
|                                                                                   |   |                |   |
|                                                                                   |   | **2001**            |   |
|                                                                                   |   | **Amortized  Cost** |   | **Gross  Unrealized  Gains** |   | **Gross  Unrealized  Losses** |   | **Estimated  Fair  Value** |   |
| U.S. Treasury securities and obligations of U.S. Government agencies  and corporations |   | $  132,363,000      |   | $  3,900,000 |   | $  (238,000 | ) | $  136,025,000 |   |
| Mortgage-backed securities and collateralized mortgage obligations                     |   | 68,943,000          |   | 954,000 |   | (162,000 | ) | 69,735,000 |   |
| Obligations of states and political subdivisions                                       |   | 6,985,000           |   | 124,000 |   | 0 |   | 7,109,000 |   |
| Other securities                                                                       |   | 3,243,000           |   | 0 |   | 0 |   | 3,243,000 |   |
|                                                                                   |   |                |   |   |   |   |   |   |   |
| Total available-for-sale securities                                                    |   | $  211,534,000      |   | $  4,978,000 |   | $  (400,000 | ) | $  216,112,000 |   |
|                                                                                        |        |                     |        |  |  |  |  |  |  |  |  |  |

 

There were noheld-to maturity securities at December 31, 2002 or 2001, as they werereclassified to available for sale in conjunction with the adoption of SFAS No.133, “Accounting for Derivative Instruments and Hedging Activities.”

 

The amortizedcost and estimated fair value of securities at December 31, 2002, by contractualmaturity, are shown below. Expected maturities may differ from contractualmaturities because borrowers may have the right to call or prepay obligationswith or without call or prepayment penalties.

 

| **Available-For-Sale Securities**                                  |   | **Amortized  Cost** |        | **Estimated  Fair  Value** |   |
|--------------------------------------------------------------------|--------|---------------------|-------------|----------------------------|--------|
|                                                               |   |                |        |                       |   |
| Due in one year or less                                            |   | $                   | 28,621,000  |                       | $      | 29,112,000 |   |
| Due after one year through five years                              |   | 90,151,000          |        | 95,096,000                 |   |
| Due after five years through ten years                             |   | 609,000             |        | 652,000                    |   |
| Due after ten years                                                |   | 4,002,000           |        | 4,018,000                  |   |
|                                                               |   | 123,383,000         |        | 128,878,000                |   |
| Mortgage-backed securities and collateralized mortgage obligations |   | 43,934,000          |        | 44,753,000                 |   |
|                                                               |   |                |        |                       |   |
| Total available-for-sale securities                                |   | $                   | 167,317,000 |                       | $      | 173,631,000 |   |

 

At December31, 2002, securities with an amortized cost and estimated fair value of$33,566,000 and $35,632,000, respectively, were pledged as collateral forpublic and trust fund deposits and for other purposes required or permitted bylaw. At December 31, 2001, the amortized cost and estimated fair value ofpledged securities were $45,996,000 and $47,785,000, respectively.

 

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During 2002and 2001 the Company sold available-for-sale securities with an aggregate bookvalue of $1,414,000 and $59,919,000 respectively and a gross realized gain ofapproximately $13,000 and $1,000, respectively.

 

**NOTE 5: LOANS**

 

Thecomposition of loans at December 31, 2002 and 2001 was as follows:

 

|                                |   | **2002**    |        | **2001**    |   |
|-------------------------------------|--------|-------------|-------------|-------------|--------|
|                                |   |        |        |        |   |
| Real estate loans                   |   | $           | 139,711,000 |        | $      | 135,544,000 |   |
| Commercial loans                    |   | 87,508,000  |        | 98,129,000  |   |
| Loans to individuals                |   | 24,016,000  |        | 37,873,000  |   |
| Agriculture and other loans         |   | 36,070,000  |        | 32,724,000  |   |
| Total loans                         |   | 287,305,000 |        | 304,270,000 |   |
| Less unearned income                |   | 3,000       |        | 24,000      |   |
|                                |   |        |        |        |   |
| Total loans, net of unearned income |   | $           | 287,302,000 |        | $      | 304,246,000 |   |

 

Included inthe loan balance at December 31, 2002, is a purchase discount with a remainingbalance of $489,000 related to the acquisition of the Company by StateNational.  The original balance of thediscount was $1,169,000 and was calculated at an effective purchase yield of10.00%.  The discount is being accretedinto income over the life of the related loans.  The estimated remaining life of the loans on which the discountwas calculated is five years.

 

Nonperformingassets at December 31, 2002 and 2001 were as follows:

 

|                                           |   | **2002**  |      | **2001** |   |
|------------------------------------------------|--------|-----------|-----------|----------|--------|
|                                           |   |      |      |     |   |
| Nonaccrual loans                               |   | $         | 4,016,000 |     | $      | 5,581,000 |   |
| Accruing loans past due over ninety days       |   | 85,000    |      | 223,000  |   |
| Restructured loans                             |   | 17,000    |      | 29,000   |   |
| Other real estate and other repossessed assets |   | 3,631,000 |      | 691,000  |   |
|                                           |   |      |      |     |   |
| Total nonperforming assets                     |   | $         | 7,749,000 |     | $      | 6,524,000 |   |

 

At December31, 2002 and 2001, loans identified as being impaired consisted of loans placedon nonaccrual status.  The entire balancein the allowance for loan loss is available to absorb loan losses on the entireportfolio.

 

At December31, 2002, and 2001, the recorded investment in loans that are considered to beimpaired under SFAS No.114 was approximately $4,016,000 and $5,581,000,respectively.  Included in these amountsat December 31, 2002 and 2001, was approximately $3,985,000 and $4,710,000,respectively, of impaired loans for which the related specific reserve for loanlosses was approximately $1,114,000 and $1,190,000, respectively.  Impaired loans of $31,000 and $871,000 atDecember 31, 2002 and 2001, respectively, did not have a specific reserve forloan losses.

 

The amount ofinterest income that would have been recorded on nonaccrual loans for the yearsended December 31, 2002, 2001, the period from August 12, 2000 throughDecember 31, 2000 and the period from January 1, 2000 through August 11, 2000,based on the loans’ original terms was $430,000, $582,000, $100,000 and$12,000, respectively. A total of $0, $1,000 $0 and $16,000 in interest onnonaccrual loans was actually collected and recorded as income during the yearsended December 31, 2002, 2001, the period from August 12, 2001 throughDecember 31, 2001 and the period from January 1, 2000 through August 11, 2000.

 

55

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A summary ofthe activity in the allowance for loan losses for the years ended December 31,2002 and 2001, the period from August 12, 2000 through December 31, 2001and the period from January 1, 2000 through August 11, 2000, is as follows:

 
|                                      |   | **Year Ended  December 31, 2002** |      | **Year Ended  December 31, 2001** |   | **August 12,  2000 to December 31, 2000** |   | **January 1,  2000  to August 11,  2000** |      |
|-------------------------------------------|--------|-----------------------------------|-----------|-----------------------------------|--------|-------------------------------------------|--------|-------------------------------------------|-----------|
|                                      |   |                              |      |                              |   |                                      |   |                                      |      |
| Balance at beginning of period            |   | $                                 | 6,525,000 |                              | $      | 8,379,000                                 |   | $                                         | 6,371,000 |   | $ | 1,833,000 |   |
| (Credit) Provision  for loan  losses |   | (77,000                           | )         | 10,765,000                        |   | 618,000                                   |   | 1,660,000                                 |      |
| Loans charged off                         |   | (1,772,000                        | )         | (13,694,000                       | )      | (1,796,000                                | )      | (230,000                                  | )         |
| Recoveries of loans charged off           |   | 1,585,000                         |      | 1,075,000                         |   | 39,000                                    |   | 80,000                                    |      |
| Mergers                                   |   | 0                                 |      | 0                                 |   | 3,147,000                                 |   | 3,028,000                                 |      |
|                                      |   |                              |      |                              |   |                                      |   |                                      |      |
| Balance at end of period                  |   | $                                 | 6,261,000 |                              | $      | 6,525,000                                 |   | $                                         | 8,379,000 |   | $ | 6,371,000 |   |

 

The increasein the allowance of $3,028,000 in 2000 is due primarily to five borrowingrelationships with whom predecessor management had intended to continue to workand extend or renew the loan as necessary. Predecessor management believed that the net carrying amount, afterconsidering specific reserves, was adequate to reflect the estimated carryingamount of the loans.  Successormanagement has determined that they will no longer maintain a relationship withthese borrowers, has informed the borrowers that the borrowers will have to payoff their respective loans with the Company and, if necessary, liquidate thecollateral supporting the loans within no later than one year of theacquisition date.  The Company offered areduction in principal to one borrower to provide an incentive for the borrowerto move its loan relationship.  As theseloans are collateral dependant, the estimated losses on these loans areprimarily due to estimated collateral liquidation value shortfalls.  Overall, successor management has determinedthat the intended method of ultimate recovery on loans from these fiveborrowing relationships is demonstrably different from the plans that served asthe basis for predecessor management estimation of recovery on such loans.  As these loans are collected, any excessallowance would have been adjusted against goodwill.  As of December 31, 2002, the bank has exited substantially all ofthese relationships.  For those loansexited, there was no excess allowance remaining at the date of exit.

 

**NOTE 6: GOODWILL AND OTHER INTANGIBLE ASSETS**

 

Amortizableintangibles assets at December 31, 2002 and 2001:

 

|                                  |   | **2002**  |       | **2001**  |   |
|---------------------------------------|--------|-----------|------------|-----------|--------|
|                                  |   |      |       |      |   |
| Core deposit intangible               |   | $         | 16,878,000 |      | $      | 17,163,000 |   |
| Less:   Accumulated amortization |   | 6,896,000 |       | 5,186,000 |   |
|                                  |   |      |       |      |   |
| Amortizable intangible assets         |   | $         | 9,982,000  |      | $      | 11,977,000 |   |

 

Core deposit intangibleamortization expense was $1,873,000 for the year ended December 31, 2002.

 

Aggregate amortization expenseis anticipated to be as follows for the years ended December 31:

 

| 2003  |   | $         | 1,627,000 |   |
|-------|--------|-----------|-----------|--------|
| 2004  |   | 1,500,000 |      |
| 2005  |   | 1,467,000 |      |
| 2006  |   | 1,419,000 |      |
| 2007  |   | 1,180,000 |      |
| Total |   | $         | 7,193,000 |   |

 

56

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The change inthe carrying amount of goodwill for the year ended December 31, 2002 is asfollows:

 
| Balance as of January 1, 2002                     |   | $           | 31,742,000 |   |
|---------------------------------------------------|--------|-------------|------------|--------|
| United Bank & Trust Purchase Price Adjustment |   | (2,000      | )          |
| Impairment Loss                                   |   | (15,642,000 | )          |
| Balance as of December 31, 2002                   |   | $           | 16,098,000 |   |

* *

Substantialloan charge offs that occurred during the year in 2001 were attributable toloans that were carried by the Company at the date of the Acquisition.  As a result of charged-off loans, managementof the Company required that other related loans be paid off thereby generatinga further reduction in loans.  Theoverall reduction in fair value of the Company primarily resulting from thesefactors along with other factors caused an impairment of $15,642,000 to becalculated under the guidance established by SFAS No. 142 and recorded in thefirst quarter of 2002 to the goodwill associated with the Acquisition.  The fair value of the Company was calculatedthrough a combination of the market comparison, asset value, earnings value andacquisition analysis methods by a third party.

 

The followingtable adjusts earnings for the adoption of SFAS No. 142.

 
|                                     |   | **Years Ended  December 31,** |        |
|------------------------------------------|--------|-------------------------------|-------------|
|                                     |   | **2002**                      |        | **2001** |   | **2000** |   |
| Reported Net Loss                        |   | $                             | (11,868,000 | ) | $ | (7,197,000 | ) | $ | (1,673,000 | ) |
| Add Back After Tax Goodwill Amortization |   | 0                             |        | 1,195,000 |   | 839,000 |   |
| Adjusted Net Loss                        |   | $                             | (11,868,000 | ) | $ | (6,002,000 | ) | $ | (834,000 | ) |

 

**NOTE 7: PREMISES AND EQUIPMENT**

 

The followingis a summary of premises and equipment at December 31, 2002 and 2001:

 

|                                 |   | **2002**   |       | **2001**   |   |
|--------------------------------------|--------|------------|------------|------------|--------|
|                                 |   |       |       |       |   |
| Land                                 |   | $          | 3,327,000  |       | $      | 3,444,000 |   |
| Buildings and improvements           |   | 14,399,000 |       | 14,163,000 |   |
| Furniture and equipment              |   | 3,194,000  |       | 4,098,000  |   |
|                                 |   | 20,920,000 |       | 21,705,000 |   |
| Less:  Accumulated depreciation |   | 6,466,000  |       | 6,325,000  |   |
|                                 |   |       |       |       |   |
| Net premises and equipment           |   | $          | 14,454,000 |       | $      | 15,380,000 |   |

 

Depreciationexpense for the year ended December 31, 2002, 2001 and 2000 was $1,690,000,$1,534,000 and $991,000, respectively.

 

**NOTE8: DEPOSITS**

 

At December31, 2002, the scheduled maturities of interest-bearing time deposits were asfollows:

 

|                                 |   | **Interest-Bearing  Time Deposits** |        |
|--------------------------------------|--------|-------------------------------------|-------------|
|                                 |   |                                |        |
| 2003                                 |   | $                                   | 171,278,000 |   |
| 2004                                 |   | 13,672,000                          |        |
| 2005                                 |   | 5,413,000                           |        |
| 2006                                 |   | 1,572,000                           |        |
| 2007                                 |   | 4,143,000                           |        |
| Thereafter                           |   | 634,000                             |        |
|                                 |   |                                |        |
| Total interest-bearing time deposits |   | $                                   | 196,712,000 |   |

 

57

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At December31, 2002 and 2001, interest-bearing time deposits of $100,000 or more were$71,566,000 and $88,648,000, respectively.

 

**NOTE9: FEDERAL INCOME TAXES**

 

Significantcomponents of the Company’s deferred tax assets and liabilities at December 31,2002 and 2001, were as follows:

 
|                                                 |   | **2002**   |       | **2001**   |   |
|------------------------------------------------------|--------|------------|------------|------------|--------|
|                                                 |   |       |       |       |   |
| Deferred tax assets:                                 |   |       |       |       |   |
| Allowance for loan losses                            |   | $          | 2,129,000  |       | $      | 2,141,000 |   |
| Investment securities                                |   | 0          |       | 210,000    |   |
| Depreciation and amortization                        |   | 39,000     |       | 0          |   |
| Net operating loss carryforwards                     |   | 98,000     |       | 152,000    |   |
| Employee retention agreements                        |   | 41,000     |       | 41,000     |   |
| Other real estate and other repossessed assets       |   | 0          |       | 17,000     |   |
| Other                                                |   | 320,000    |       | 626,000    |   |
| Net deferred tax assets                              |   | 2,627,000  |       | 3,187,000  |   |
| Deferred tax liabilities:                            |   |       |       |       |   |
| Core deposit intangible                              |   | (2,691,000 | )          | (3,327,000 | )      |
| Net unrealized gain on available-for-sale securities |   | (2,147,000 | )          | (1,557,000 | )      |
| Discount on Trust Preferred Securities               |   | (702,000   | )          | (708,000   | )      |
| Depreciation and amortization                        |   | 0          |       | (117,000   | )      |
| Other, net                                           |   | 0          |       | (63,000    | )      |
| Total gross deferred tax liabilities                 |   | (5,540,000 | )          | (5,772,000 | )      |
|                                                 |   |       |       |       |   |
| Net deferred tax liability                           |   | $          | (2,913,000 | )          | $      | (2,585,000 | ) |

 

Deferredincome taxes reflect the net effects of temporary differences between thecarrying amount of assets and liabilities for financial reporting purposes andthe amounts used for income tax purposes. The Company records a valuationallowance on deferred tax assets if it is more likely than not that someportion or all of a deferred tax asset will not be realized.  The valuation allowance was $0 at December31, 2002 and 2001, respectively. Management believes that it is more likely than not that the Companywill generate sufficient future taxable income to realize the net deferred taxasset.

 

At December31, 2002, the Company had available net operating loss carryforwards ofapproximately $289,000 acquired as part of prior acquisitions.  These net operating loss carryforwards, ifnot used, expire between 2003 and 2010.

 

58

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Thecomprehensive provisions for federal income taxes for the years ended December31, 2002 and 2001, the periods from August 12, 2000  through December 31, 2000 and from January 1, 2000 through August11, 2000, were as follows:

 
|                                                                                  |   | **Year Ended  December 31,  2002** |      | **Year Ended  December 31,  2001** |   | **August 12,  2000  Through  December 31, 2000** |   | **January 1,  2000  Through  August 11, 2000** |      |
|---------------------------------------------------------------------------------------|--------|------------------------------------|-----------|------------------------------------|--------|--------------------------------------------------|--------|------------------------------------------------|-----------|
|                                                                                  |   |                               |      |                               |   |                                             |   |                                           |      |
| Current tax provision (benefit)                                                       |   | $                                  | 1,485,000 |                               | $      | (3,293,000                                       | )      | $                                              | 394,000   |   | $ | 916,000 |   |
| Deferred tax (benefit)provision                                                       |   | (262,000                           | )         | 88,000                             |   | 103,000                                          |   | (817,000                                       | )         |
| Provision (benefit) for tax expense charged to results of operations                  |   | 1,223,000                          |      | (3,205,000                         | )      | 497,000                                          |   | 99,000                                         |      |
| Tax provision on adjustment to unrealized gain/loss on  available-for-sale securities |   | 591,000                            |      | 723,000                            |   | 833,000                                          |   | 77,000                                         |      |
| Comprehensive provision for federal income taxes                                      |   | $                                  | 1,814,000 |                               | $      | (2,482,000                                       | )      | $                                              | 1,330,000 |   | $ | 176,000 |   |

 

The followingis a reconciliation of the difference between income tax expense as reportedand the amount of expense (benefit) computed by applying the statutory incometax rate to income (loss) before income taxes:

 
|                                           |   | **Year Ended  December 31,  2002** |        | **Year Ended  December 31,  2001** |   | **August 12,  2000  through  December 31, 2000** |   | **January 1,  2000  through  August 11, 2000** |    |
|------------------------------------------------|--------|------------------------------------|-------------|------------------------------------|--------|--------------------------------------------------|--------|------------------------------------------------|---------|
|                                           |   |                               |        |                               |   |                                             |   |                                           |    |
| (Loss) income before income taxes              |   | $                                  | (10,645,000 | )                                  | $      | (10,402,000                                      | )      | $                                              | 732,000 |   | $ | (1,809,000 | ) |
| Statutory rate                                 |   | 34                                 | %           | 34                                 | %      | 34                                               | %      | 34                                             | %       |
| Income tax (benefit) expense at statutory rate |   | (3,619,000                         | )           | (3,537,000                         | )      | 249,000                                          |   | (615,000                                       | )       |
| Goodwill impairment                            |   | 5,318,000                          |        | 0                                  |   | 0                                                |   | 0                                              |    |
| Amortization of goodwill                       |   | 0                                  |        | 616,000                            |   | 224,000                                          |   | 130,000                                        |    |
| Tax-exempt income                              |   | (307,000                           | )           | (276,000                           | )      | (40,000                                          | )      | (113,000                                       | )       |
| Nondeductible acquisition expenses             |   | 0                                  |        | 0                                  |   | 0                                                |   | 717,000                                        |    |
| Other                                          |   | (169,000                           | )           | (8,000                             | )      | 64,000                                           |   | (20,000                                        | )       |
|                                           |   |                               |        |                               |   |                                             |   |                                           |    |
| Income tax expense (benefit) as reported       |   | $                                  | 1,223,000   |                               | $      | (3,205,000                                       | )      | $                                              | 497,000 |   | $ | 99,000 |   |

 

**NOTE10:  GUARANTEED PREFERRED BENEFICIALINTERESTS IN THE COMPANY’S SUBORDINATED DEBENTURES**

 

IndependentCapital sold 1,300,000 shares of Trust Preferred Securities at $10.00 perpreferred security in an underwritten offering in 1998.  The proceeds from the sale of the TrustPreferred Securities were used by Independent Capital to purchase an equivalentamount of Subordinated Debentures of the Company.  The Trust Preferred Securities carry a distribution rate of 8.5%,have a stated maturity of September 22, 2028, and are guaranteed by State National.  The securities are redeemable at par afterSeptember 22, 2003.

 

Distributionson the Trust Preferred Securities are payable quarterly on March 31, June 30,September 30 and December 31. Distributions paid to holders of the Trust Preferred Securities duringboth the years ended December 31, 2002 and 2001, totaled $1,105,000.

 

Included inthe balance of Trust Preferred Securities at December 31, 2002 is a discountwith a remaining balance of $2,066,000 related to the acquisition of theCompany by State National.  The originalbalance of the discount was $2,103,000 and was calculated at an effectivepurchase yield of 10.26%.  The discountis being amortized into expense over the life of the instrument.  The estimated remaining life of theinstrument on which the discount was calculated is 27 years.

 

59

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**NOTE11: STOCKHOLDERS’ EQUITY**

 

At December31, 2001, 100% of the shares of the Bank were pledged in a debt agreementbetween State National and a third party which had an outstanding balance of$7,000,000 at December 31, 2001.  As ofDecember 31, 2002, the balance plus interest has been paid in full and theshares released from collateral.

 

**NOTE12: EARNINGS PER SHARE**

 

Basic earningsper common share is computed by dividing net income available to commonstockholders by the weighted average number of common shares and shareequivalents outstanding during the period. The following table presents information necessary to calculate earningsper share for the period from January 1, 2000, to August 11, 2000.  As the Company is a wholly owned subsidiaryof State National, per common share data is not meaningful after the date ofthe Acquisition:

 

|                                               |   | **Period from  January 1,  2000 to August 11, 2000** |   |
|----------------------------------------------------|--------|------------------------------------------------------|--------|
|                                               |   | **(In  Thousands)**                                  |   |
| Basic  (Loss) Earnings Per Common Share            |   |                                                 |   |
| Net(loss)income                                    |   | $                                                    | (1,908 | ) |
| Preferred stock dividends                          |   | 0                                                    |   |
|                                               |   |                                                 |   |
| Net (loss) income available to common stockholders |   | $                                                    | (1,908 | ) |
|                                               |   |                                                 |   |
| Weighted average shares outstanding                |   | 2,262                                                |   |
|                                               |   |                                                 |   |
| Diluted (Loss) Earning Per Common Share            |   |                                                 |   |
| Net income (loss)                                  |   | $                                                    | (1,908 | ) |
|                                               |   |                                                 |   |
| Weighted average shares outstanding                |   | 2,262                                                |   |
| Conversion of Series C preferred stock             |   | 0                                                    |   |
|                                               |   |                                                 |   |
| Adjusted weighted average shares outstanding       |   | 2,262                                                |   |

** **

**NOTE 13: BENEFIT PLANS**

 

The Company’sESOP/401(k) Plan covered most of its officers and employees. Contributions madeto the ESOP/401(k) Plan by the Company were $214,000 for the period fromJanuary 1 through August 11, 2000. These contributions were used to makedistributions to employees who left the Company’s employment in the respectiveyears and to purchase common stock of the Company.   The Company’s Board of Directors voted to match 25% of up to amaximum of the first 4% of each employees’ salary which was deferred andcontributed to the 401(k) portion of the ESOP/401(k) Plan beginning January 1,2000. The amount of all such contributions was at the discretion of theCompany’s board of directors. Contributions were invested in various equity,debt and money market investments, including common stock of the Company. TheESOP/401(k) Plan was terminated at the date of the Acquisition and wasliquidated subsequent to the Acquisition.

 

Subsequent tothe Acquisition, most of the Company’s officers and employees became eligibleto participate in State National’s 401(k) profit sharing plan. Beginning August12, 2000, the Company matched 100% of the first 3% and 50% of the next 2%, ofeach employee’s salary, which was deferred and contributed to such plan. TheCompany contributed $206,000 and $217,000 to the plan for the year endedDecember 31, 2002 and for the period from August 12 through December 31, 2000,respectively.

 

**NOTE 14: RELATED PARTY TRANSACTIONS**

 

In theordinary course of business, the Company and the Bank have loans, deposits andother transactions with their respective directors and businesses with whichsuch persons are associated. It is the Company’s policy that all such

60

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transactions are entered intoon substantially the same terms as those prevailing at the time for comparabletransactions with unrelated third parties. The balances of loans to all suchpersons were $36,000, $298,000 and $40,000 at December 31, 2002, 2001 and 2000,respectively. Additions and reductions on such loans were $52,000 and $314,000,respectively, for the year ended December 31, 2002.

 

**NOTE 15: COMMITMENTS AND CONTINGENTLIABILITIES**

 

From time totime, the Company is involved in litigation proceedings incidental to thenormal course of its business. In the opinion of management, the ultimateliability, if any, resulting from known, current litigation, either singularlyor in aggregate, would not reasonably be expected to have a material adverseeffect on the Company’s financial position, results of operations or cashflows.

 

The Bankleases certain of its premises and equipment under noncancellable operatingleases. Rental expense under such operating leases was approximately $985,000,$1,050,000 and $723,000 in 2002, 2001 and 2000, respectively.

 

The minimum paymentsdue under these leases at December 31, 2002 are as follows:

 

| 2003       |   | $       | 400,000   |   |
|------------|--------|---------|-----------|--------|
| 2004       |   | 359,000 |      |
| 2005       |   | 359,000 |      |
| 2006       |   | 337,000 |      |
| 2007       |   | 278,000 |      |
| Thereafter |   | 234,000 |      |
|       |   |    |      |
| Total      |   | $       | 1,967,000 |   |

 

**NOTE16: FAIR VALUE OF FINANCIAL INSTRUMENTS**

 

The carryingamounts and fair values of financial assets and financial liabilities atDecember 31, 2002 and 2001, were as follows:

 
|                                                                                     |   | **2002**             |        | **2001**       |   |
|------------------------------------------------------------------------------------------|--------|----------------------|-------------|----------------|--------|
|                                                                                     |   | **Carrying  Amount** |        | **Fair Value** |   | **Carrying  Amount** |   | **Fair Value** |   |
| Financial Assets                                                                         |   |                 |        |           |   |   |   |   |   |
| Cash and due from banks                                                                  |   | $                    | 22,873,000  |           | $      | 22,873,000 |   | $ | 33,212,000 |   | $ | 33,212,000 |   |
| Interest-earning time deposits                                                           |   | 10,710,000           |        | 10,710,000     |   | 2,850,000 |   | 2,850,000 |   |
| Federal funds sold                                                                       |   | 6,784,000            |        | 6,784,000      |   | 10,528,000 |   | 10,528,000 |   |
| Available-for-sale securities                                                            |   | 173,671,000          |        | 173,671,000    |   | 216,112,000 |   | 216,112,000 |   |
| Loans, net of unearned income                                                            |   | 287,302,000          |        | 288,950,000    |   | 304,246,000 |   | 306,987,000 |   |
| Accrued interest receivable                                                              |   | 4,426,000            |        | 4,426,000      |   | 5,321,000 |   | 5,321,000 |   |
|                                                                                     |   |                 |        |           |   |   |   |   |   |
| Financial Liabilities                                                                    |   |                 |        |           |   |   |   |   |   |
| Noninterest-bearing demand deposits                                                      |   | $                    | 106,950,000 |           | $      | 106,950,000 |   | $ | 112,044,000 |   | $ | 112,044,000 |   |
| Interest-bearing demand deposits                                                         |   | 178,981,000          |        | 178,981,000    |   | 180,021,000 |   | 180,021,000 |   |
| Interest-bearing time deposits                                                           |   | 196,712,000          |        | 199,239,000    |   | 251,965,000 |   | 255,257,000 |   |
| Fed funds purchased and securities sold under agreement to repurchase                    |   | 106,000              |        | 106,000        |   | 151,000 |   | 151,000 |   |
| Note Payable                                                                             |   | 143,000              |        | 143,000        |   | 0 |   | 0 |   |
| Accrued interest payable                                                                 |   | 669,000              |        | 669,000        |   | 1,462,000 |   | 1,462,000 |   |
| Guaranteed preferred beneficial interests in the Company’s  subordinated debentures |   | 10,934,000           |        | 13,065,000     |   | 10,918,000 |   | 12,350,000 |   |

 

Fair valuesfor investment securities are based on quoted market prices, where available.If quoted market prices are not available, fair values are based on quotedmarket prices of comparable instruments.

 

61

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Forvariable-rate loans that reprice frequently with no significant change incredit risk, fair values are based on carrying values. The fair values of otherloans are estimated using discounted cash flow analyses, which utilize interestrates currently being offered for loans with similar terms to borrowers ofsimilar credit quality.

 

The fairvalues of noninterest and interest-bearing demand deposits are, by definition,equal to the amount payable on demand, i.e., their carrying amount. The fairvalues of interest-bearing time deposits are estimated using a discounted cashflow calculation that applies interest rates currently being offered oncertificates of similar maturities.

 

Fair value forthe guaranteed preferred beneficial interests in the Company’s subordinateddebentures is based on the closing price for the Trust Preferred Securities asquoted on the American Stock Exchange at December 31, 2002 and 2001.

 

The carryingamounts for cash and due from banks, interest earning time deposits, federalfunds sold, accrued interest receivable, federal funds purchased and securitiessold under agreement to repurchase and accrued interest payable approximate thefair values of such assets and liabilities.

 

Fair valuesfor the Company’s off-balance-sheet instruments, which consist of lendingcommitments and standby and commercial letters of credit, are based on feescurrently charged to enter into similar agreements, taking into account theremaining terms of the agreements and the counterparties’ credit standing.Management believes that the fair value of these off-balance-sheet instrumentsis not significant.

 

**NOTE 17: FINANCIAL INSTRUMENTS WITHOFF-BALANCE-SHEET RISK**

 

The Company isa party to financial instruments with off-balance-sheet risk entered into inthe normal course of business to meet the financing needs of its customers.These financial instruments include commitments to extend credit and standbyand commercial letters of credit. Those instruments involve, to varyingdegrees, elements of credit risk in excess of the amount recognized in theaccompanying financial statements. The contractual amounts of those instrumentsreflect the extent of involvement the Company has in particular classes offinancial instruments.

 

The Company’sexposure to credit loss in the event of nonperformance by the other party tothe financial instrument for commitments to extend credit and standby orcommercial letters of credit is represented by the contractual amount of thoseinstruments. The Company uses the same credit policies in making commitmentsand conditional obligations as it does for on-balance-sheet instruments. TheCompany does require collateral or other security to support financialinstruments with credit risk. The Company had outstanding loan commitments ofapproximately $56,396,000 and outstanding financial and performance standbyletters of credit of approximately $2,175,000 at December 31, 2002.

 

Commitments toextend credit are agreements to lend to a customer as long as there is noviolation of any condition established in the contract. Commitments generallyhave fixed expiration dates or other termination clauses and may requirepayment of a fee. Because many of the commitments are expected to expirewithout being drawn upon, the total commitment amounts do not necessarilyrepresent future cash requirements. The Company evaluates each customer’screditworthiness on a case-by-case basis. The amount of collateral obtained, ifdeemed necessary by the Company upon extension of credit, is based onmanagement’s credit evaluation of the customer. Collateral held varies but mayinclude real estate, accounts receivable, inventory, property, plant andequipment and income-producing commercial properties.

 

Financial andperformance standby letters of credit are conditional commitments issued by theCompany to guarantee the performance of a customer to a third party. Theseguarantees are primarily issued to support public and private borrowingarrangements. The credit risk involved in issuing standby letters of credit isessentially the same as that involved in making loans to customers.

 

In the normalcourse of business, the Company maintains deposits with other financialinstitutions in amounts that exceed FDIC insurance coverage limits.

 

62

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**NOTE 18: REGULATORY MATTERS**

 

The Companyand the Bank are subject to various regulatory capital requirementsadministered by the federal banking agencies. Failure to meet minimum capitalrequirements could cause the initiation of certain mandatory, and possiblyadditional discretionary, actions by the regulatory authorities that, if undertaken,could have a direct material effect on the Company’s and the Bank’s respectivefinancial statements. Under capital adequacy guidelines and the regulatoryframework for prompt corrective action, the Company and the Bank must meetspecific capital guidelines that involve quantitative measures of the Company’sand the Bank’s respective assets, liabilities, and certain off-balance-sheetitems as calculated under regulatory accounting practices. The Company’s andthe Bank’s respective capital amounts and classification are also subject toqualitative judgments by the regulators about components, risk weightings andother factors.

 

Quantitativemeasures established by regulation to ensure capital adequacy require theCompany and the Bank to maintain minimum amounts and ratios (set forth in thetable below) of Tier 1 capital and total capital (Tier 1 and Tier 2)to net risk-weighted assets and of Tier 1 capital to adjusted quarterly averageassets. At December 31, 2002, the Company and the Bank met all capital adequacyrequirements to which they were subject.

 

At December31, 2002, the most recent notification from the FDIC categorized the Bank aswell-capitalized under the regulatory framework for prompt corrective action.To be categorized as well-capitalized, the Company and the Bank must maintainminimum Tier 1 capital to net risk-weighted assets, total capital to netrisk-weighted assets and Tier 1 capital to adjusted quarterly average assetsratios as set forth in the tables. No other conditions or events have occurredsince the most recent notification that management believes have changed eitherthe Company’s or the Bank’s category.

 

The minimumregulatory capital ratios for well-capitalized bank holding companies and theCompany’s actual capital amounts and ratios at December 31, 2002 and 2001, wereas follows:

 
|                                                |   | **December  31,**           |   | **Minimum  Capital  Ratios** |   | **Well  Capitalized  Ratios** |   |
|-----------------------------------------------------|--------|-----------------------------|--------|------------------------------|--------|-------------------------------|--------|
| **2002**                                            |   | **2001**                    |
|                                                |   | **(Dollars in  thousands)** |   |
| Tier 1 capital                                      |   | $                           | 42,230 |                         | $      | 42,640                        |   |   |   |   |   |
| Total capital                                       |   | 46,544                      |   | 47,048                       |   |                          |   |   |   |
| Net risk weighted assets                            |   | 343,228                     |   | 350,516                      |   |                          |   |   |   |
| Adjusted quarterly average assets                   |   | 534,830                     |   | 608,689                      |   |                          |   |   |   |
| Capital ratios:                                     |   |                        |   |                         |   |                          |   |   |   |
| Tier 1 capital to net risk weighted assets          |   | 12.30                       | %      | 12.16                        | %      | 4.00                          | %      | 6.00 | % |
| Total capital to net risk weighted assets           |   | 13.56                       |   | 13.42                        |   | 8.00                          |   | 10.00 |   |
| Tier 1 capital to adjusted quarterly average assets |   | 7.90                        |   | 7.01                         |   | 4.00                          |   | 5.00 |   |
|                                                     |        |                             |        |                              |        |                               |        |  |  |  |  |

 

The minimumcapital ratios for well-capitalized banks and the Bank’s actual capital ratiosat December 31, 2002, were as follows:

 
|                                                |   | **Minimum  Ratios for Well  Capitalized Banks** |   | **Actual  Ratios at  December 31, 2002** |   |
|-----------------------------------------------------|--------|-------------------------------------------------|--------|------------------------------------------|--------|
|                                                |   |                                            |   |                                     |   |
| Tier 1 capital to net risk-weighted assets          |   | 6.00                                            | %      | 12.24                                    | %      |
| Total capital to net risk-weighted assets           |   | 10.00                                           |   | 13.50                                    |   |
| Tier 1 capital to adjusted quarterly average assets |   | 5.00                                            |   | 7.90                                     |   |

 

At December31, 2002, none of the capital of the Bank was available for payment ofdividends to the Company without prior approval of regulatory authorities.  However, as approved by the regulatoryauthorities, the Bank

63

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performed a capital reductionin the amount of $7,500,000.  Thesefunds were contributed to Independent Financial which in turn contributed thefunds to the Company in the form of a dividend.

 

The Bank isrequired to maintain a certain average balance with the Federal ReserveBank.  At December 31, 2002, the averagebalance required to be maintained was $450,000.  This requirement is being satisfied by the Bank’s vault cashbalance.

 

**NOTE 19: PARENT COMPANY FINANCIAL INFORMATION**

 

Condensedfinancial statements of the Company, parent only, are presented below:

 

INDEPENDENTBANKSHARES, INC.

AWHOLLY OWNED SUBSIDIARY OF STATE NATIONAL BANCSHARES, INC.

CONDENSEDBALANCE SHEETS

DECEMBER31, 2002 AND 2001

 
|                                            |   | **2002**   |       | **2001**   |   |
|-------------------------------------------------|--------|------------|------------|------------|--------|
| Assets:                                         |   |       |       |       |   |
| Cash                                            |   | $          | 24,000     |       | $      | 78,000 |   |
| Investment in subsidiaries                      |   | 70,414,000 |       | 87,919,000 |   |
| Other assets                                    |   | 447,000    |       | 658,000    |   |
|                                            |   |       |       |       |   |
| Total assets                                    |   | $          | 70,885,000 |       | $      | 88,655,000 |   |
|                                            |   |       |       |       |   |
| Liabilities:                                    |   |       |       |       |   |
| Accrued interest payable and other liabilities  |   | $          | 956,000    |       | $      | 1,954,000 |   |
| Total liabilities                               |   | 956,000    |       | 1,954,000  |   |
|                                            |   |       |       |       |   |
| Subordinated debentures                         |   | 11,336,000 |       | 11,320,000 |   |
| Stockholder’s equity                       |   | 58,593,000 |       | 75,381,000 |   |
|                                            |   |       |       |       |   |
| Total liabilities and stockholder’s equity |   | $          | 70,885,000 |       | $      | 88,655,000 |   |

 

64

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INDEPENDENTBANKSHARES, INC.

AWHOLLY OWNED SUBSIDIARY OF STATE NATIONAL BANCSHARES, INC. CONDENSED INCOMESTATEMENTS

FORTHE YEARS ENDED DECEMBER 31, 2002 AND 2001, THE PERIOD FROM AUGUST 12, 2000THROUGH DECEMBER 31, 2000 AND THE PERIOD FROM JANUARY 1, 2000,THROUGH AUGUST11, 2000

 
|                                                                                            |   | **Year ended  December 31,  2002** |        | **Year ended  December 31,  2001** |   | **August 12,  2000  through,  December 31, 2000** |   | **January 1,  2000,  through  August 11, 2000** |    |
|-------------------------------------------------------------------------------------------------|--------|------------------------------------|-------------|------------------------------------|--------|---------------------------------------------------|--------|-------------------------------------------------|---------|
| Income:                                                                                         |   |                               |        |                               |   |                                              |   |                                            |    |
| Dividends from subsidiaries (see Note 18)                                                       |   | $                                  | 7,534,000   |                               | $      | 734,000                                           |   | $                                               | 17,000  |   | $ | 2,917,000 |   |
| Management fees from subsidiaries                                                               |   | 0                                  |        | 0                                  |   | 0                                                 |   | 90,000                                          |    |
| Interest on loan to the ESOP/401(k) Plan                                                        |   | 0                                  |        | 0                                  |   | 0                                                 |   | 8,000                                           |    |
| Interest from subsidiaries                                                                      |   | 0                                  |        | 0                                  |   | 0                                                 |   | 3,000                                           |    |
| Other income                                                                                    |   | 7,000                              |        | 3,000                              |   | 0                                                 |   | 2,000                                           |    |
| Total income                                                                                    |   | 7,541,000                          |        | 737,000                            |   | 17,000                                            |   | 3,020,000                                       |    |
| Expenses:                                                                                       |   |                               |        |                               |   |                                              |   |                                            |    |
| Interest                                                                                        |   | 1,155,000                          |        | 1,153,000                          |   | 447,000                                           |   | 699,000                                         |    |
| Other expenses                                                                                  |   | 118,000                            |        | 266,000                            |   | 160,000                                           |   | 2,433,000                                       |    |
| Total expenses                                                                                  |   | 1,273,000                          |        | 1,419,000                          |   | 607,000                                           |   | 3,132,000                                       |    |
| Income (loss) before federal income taxes and equity in undistributed  earnings of subsidiaries |   | 6,268,000                          |        | (682,000                           | )      | (590,000                                          | )      | (112,000                                        | )       |
| Federal income tax benefit                                                                      |   | (509,000                           | )           | (469,000                           | )      | (205,000                                          | )      | (347,000                                        | )       |
| Income (loss) before equity in undistributed earnings of subsidiaries                           |   | 6,777,000                          |        | (213,000                           | )      | (385,000                                          | )      | 235,000                                         |    |
| Equity in undistributed earnings (loss) of subsidiaries                                         |   | (18,645,000                        | )           | (6,984,000                         | )      | 620,000                                           |   | (2,143,000                                      | )       |
|                                                                                            |   |                               |        |                               |   |                                              |   |                                            |    |
| Net(loss) income                                                                                |   | $                                  | (11,868,000 | )                                  | $      | (7,197,000                                        | )      | $                                               | 235,000 |   | $ | (1,908,000 | ) |

 

INDEPENDENTBANKSHARES, INC.

AWHOLLY OWNED SUBSIDIARY OF STATE NATIONAL BANCSHARES, INC.

CONDENSEDSTATEMENTS OF CASH FLOWS

FORTHE YEARS ENDED DECEMBER 31, 2002 AND 2001, THE PERIOD FROM AUGUST 12, 2000THROUGH DECEMBER 31, 2000 AND THE PERIOD FROM JANUARY 1, 2000,THROUGH AUGUST11, 2000

 
|                                                                                                |   | **Year ended  December 31,  2002** |        | **Year ended  December 31,  2001** |   | **August 12,  2000,  through December  31, 2000** |   | **January 1,  2000,  through August  11, 2000** |    |
|-----------------------------------------------------------------------------------------------------|--------|------------------------------------|-------------|------------------------------------|--------|---------------------------------------------------|--------|-------------------------------------------------|---------|
| Cash flows from operating activities:                                                               |   |                               |        |                               |   |                                              |   |                                            |    |
| Net (loss) income                                                                                   |   | $                                  | (11,868,000 | )                                  | $      | (7,197,000                                        | )      | $                                               | 235,000 |   | $ | (1,908,000 | ) |
| Adjustments to reconcile net income (loss) to net cash provided by  (used in) operating activities: |   |                               |        |                               |   |                                              |   |                                            |    |
| Deferred federal income tax expense                                                                 |   | 0                                  |        | 536,000                            |   | 0                                                 |   | 0                                               |    |
| Equity in undistributed earnings of subsidiaries                                                    |   | 18,646,000                         |        | 6,984,000                          |   | (620,000                                          | )      | 2,143,000                                       |    |
| Decrease (increase) in other assets                                                                 |   | 211,000                            |        | 40,000                             |   | (188,000                                          | )      | 175,000                                         |    |
| Increase (decrease) in accrued interest payable and other liabilities                               |   | (999,000                           | )           | (664,000                           | )      | (306,000                                          | )      | 1,109,000                                       |    |
| Net cash provided by (used in) operating activities                                                 |   | 5,990,000                          |        | (301,000                           | )      | (879,000                                          | )      | 1,519,000                                       |    |
| Cash flows from investing activity:                                                                 |   |                               |        |                               |   |                                              |   |                                            |    |
| Net cash provided by  investing  activity                                                      |   | 0                                  |        | 0                                  |   | 0                                                 |   | 0                                               |    |
| Cash flows from financing activities:                                                               |   |                               |        |                               |   |                                              |   |                                            |    |
| Advances from State National                                                                        |   | 0                                  |        | 1,000,000                          |   | 0                                                 |   | 0                                               |    |
| Payment of cash dividends                                                                           |   | (6,060,000                         | )           | (700,000                           | )      | (700,000                                          | )      | (273,000                                        | )       |
| Other, Net                                                                                          |   | 16,000                             |        | 40,000                             |   | 0                                                 |   | 0                                               |    |
| Net cash provided by (used in) financing activities                                                 |   | (6,044,000                         | )           | 340,000                            |   | (700,000                                          | )      | (273,000                                        | )       |
| Net increase (decrease) in cash and cash equivalents                                                |   | (54,000                            | )           | 39,000                             |   | (1,579,000                                        | )      | 1,246,000                                       |    |
| Cash and cash equivalents at beginning of period                                                    |   | 78,000                             |        | 39,000                             |   | 1,618,000                                         |   | 372,000                                         |    |
|                                                                                                |   |                               |        |                               |   |                                              |   |                                            |    |
| Cash and cash equivalents at end of period                                                          |   | $                                  | 24,000      |                               | $      | 78,000                                            |   | $                                               | 39,000  |   | $ | 1,618,000 |   |

 

65

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**NOTE 20: SUPPLEMENTAL CASH FLOW INFORMATION**

 

Supplementalcash flow information for the years ended December 31, 2002 and 2001, theperiod from August 12, 2000 through December 31, 2001, and the period fromJanuary 1, 2000 through August 11, 2000, is as follows:

 
|                                                                                                |   | **Year ended  December 31,  2002** |      | **Year ended  December 31,  2001** |   | **August 12,  2000  through December  31, 2000** |   | **January 1,  2000  through December  31, 2000** |       |
|-----------------------------------------------------------------------------------------------------|--------|------------------------------------|-----------|------------------------------------|--------|--------------------------------------------------|--------|--------------------------------------------------|------------|
| Cash paid during the period for:                                                                    |   |                               |      |                               |   |                                             |   |                                             |       |
| Interest                                                                                            |   | $                                  | 8,829,000 |                               | $      | 20,197,000                                       |   | $                                                | 10,091,000 |   | $ | 6,256,000 |   |
| Federal income taxes                                                                                |   | 934,000                            |      | 0                                  |   | 325,000                                          |   | 800,000                                          |       |
| Noncash investing activities:                                                                       |   |                               |      |                               |   |                                             |   |                                             |       |
| Additions to other real estate and other repossessed assets during the  period through foreclosures |   | $                                  | 3,756,000 |                               | $      | 1,314,000                                        |   | $                                                | 385,000    |   | $ | 317,000 |   |

** **

**NOTE 21: SUBSEQUENT EVENTS**

 

On February14, 2003, State National contributed to the Company and the Company, in turn,contributed to Independent Financial, all of the capital stock of StateNational Bank, El Paso, Texas, a national banking association (“SNB El Paso”).  After the contribution, SNB El Paso was thenmerged with and into the Bank.  Therewas no merger consideration paid prior to the transactions, as the Company andSNB El Paso were both direct or indirect subsidiaries of State National.

 

SNB El Paso isa community bank that offers interest and noninterest bearing depositoryaccounts and makes consumer and commercial loans.  At February 13, 2003, SNB El Paso had total assets of$566,271,000, total deposits of $465,317,000, total loans, net of unearnedincome, of $383,705,000 and stockholder’s equity of $72,679,000.  At February 13, 2003, the Bank had totalassets of $544,793,000, total deposits of $469,798,000, total loans, net ofunearned income, of $286,093,000 and stockholder’s equity of $69,718,000.

 

66

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**QUARTERLYDATA (UNAUDITED)**

 

The followingtable presents the unaudited results of operations for the past two years byquarter. See “Note 12: Earnings Per Share” in the Company’s consolidatedfinancial statements.

 
|                                      |   | **2002**                                      |   |
|-------------------------------------------|--------|-----------------------------------------------|--------|
|                                      |   | **First  Quarter**                            |   | **Second  Quarter** |   | **Third  Quarter** |   | **Fourth  Quarter** |   | **Total** |   |
|                                      |   | **(In  thousands, except per share amounts)** |   |
|                                      |   |                                          |   |   |   |   |   |   |   |   |   |
| Interest income                           |   | $  8,290                                      |   | $  7,737 |   | $  7,652 |   | $  7,003 |   | $  30,682 |   |
| Interest expense                          |   | 2,527                                         |   | 2,101 |   | 1,890 |   | 1,518 |   | 8,036 |   |
| Net interest income                       |   | 5,763                                         |   | 5,636 |   | 5,762 |   | 5,485 |   | 22,646 |   |
| Benefit (provision) for loan losses       |   | 185                                           |   | (340 | ) | 78 |   | 0 |   | (77 | ) |
| Income (loss) before federal income taxes |   | 1,318                                         |   | 1,853 |   | 1,279 |   | 451 |   | 4,901 |   |
| Net income (loss)                         |   | (14,796                                       | )      | 1,287 |   | 1,015 |   | 626 |   | (11,868 | ) |
|                                           |        |                                               |        |  |  |  |  |  |  |  |  |  |

 
|                             |   | **2001**                                      |   |
|----------------------------------|--------|-----------------------------------------------|--------|
|                             |   | **First  Quarter**                            |   | **Second  Quarter** |   | **Third  Quarter** |   | **Fourth  Quarter** |   | **Total** |   |
|                             |   | **(In  thousands, except per share amounts)** |   |
|                             |   |                                          |   |   |   |   |   |   |   |   |   |
| Interest income                  |   | $  11,839                                     |   | $  10,345 |   | $  9,926 |   | $  9,073 |   | $  41,183 |   |
| Interest expense                 |   | 5,988                                         |   | 5,297 |   | 4,446 |   | 3,440 |   | 19,171 |   |
| Net interest income              |   | 5,851                                         |   | 5,048 |   | 5,480 |   | 5,633 |   | 22,012 |   |
| Provision for loan losses        |   | 1,635                                         |   | 2,930 |   | 1,000 |   | 5,200 |   | 10,765 |   |
| Loss before federal income taxes |   | (1,459                                        | )      | (3,165 | ) | (734 | ) | (5,044 | ) | (10,402 | ) |
| Net loss                         |   | (1,077                                        | )      | (2,172 | ) | (556 | ) | (3,392 | ) | (7,197 | ) |
|                                  |        |                                               |        |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

The aboveunaudited financial information reflects all adjustments that are, in theopinion of management, necessary to present a fair statement of the results ofoperations for the interim periods presented.

 

**ITEM9****.****                              CHANGESIN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE**

 

As reported oncurrent report Form 8-K dated May 10, 2002 and June 27, 2002, respectively,effective May 10, 2002, the Company dismissed Ernst & Young LLP (“EY”) asits independent accountant and engaged the firm of Deloitte & Touche LLP asthe Company’s independent accountant to audit the Company’s financialstatements for the year ending December 31, 2002.  The Audit Committee of the Company’s Board of Directorsrecommended the change in the Company’s certifying accountants, which changewas approved by the board of Directors. EY audited the Company’s financialstatements for the fiscal years ended December 31, 2001 and 2000.

 

EY’s reports,with respect to the Company’s financial statements for the years ended December31, 2001 and 2000, did not contain an adverse opinion or a disclaimer ofopinion and were not qualified or modified as to uncertainty, audit scope oraccounting principles.  During the yearsended December 31, 2001 and 2000, and from January 1, 2002 through May 10,2002, there were no disagreements with EY on any matters of accountingprinciples or practices, financial statement disclosure, or auditing scope orprocedure which, if not resolved to the satisfaction of EY, would have causedit to make reference to the subject matter of the disagreement in any of itsreports on the Company’s financial statements.

 

67

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**PART III**

** **

**ITEM 10****.               DIRECTORSAND EXECUTIVE OFFICERS OF THE REGISTRANT**

 

**Directors**

 

The bylaws ofthe Company provide that the Board of Directors consists of not fewer than 7nor more than 30 members (exclusive of advisory directors) and that the numberof directors, within such limits, is to be determined by resolution of theBoard of Directors at any meeting.  TheBoard of Directors has set the board at 7 members (exclusive of advisorydirectors). Directors serve for one-year terms.

 

The tablesbelow set forth for each director:

 

•              thename;

 

•              ageand the principal occupation of each director;

 

•              thedirectorships of public companies, if any, held by each director; and

 

•              theyear he first became a director of the Company.

 
| **Name and Age**        |   | **Year First  Became a  Director of the  Company** |   | **Principal  Occupation During the Last Five Years**                                                                                                                                |
|-------------------------|--------|----------------------------------------------------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|                    |   |                                               |   |                                                                                                                                                                                |
| Tom C.  Nichols (55)    |   | 2000                                               |   | President,  Chief Executive Officer and Director of the Company since 2002; Chief  Executive Officer and Chairman of the Board the Bank since 1996.                                 |
|                    |   |                                               |   |                                                                                                                                                                                |
| Don E. Cosby  (48)      |   | 2000                                               |   | Executive  Vice President, Chief Financial Officer and Director of the Company since  2001; Executive Vice President, Chief Financial Officer and Director of the  Bank since 1996. |
|                    |   |                                               |   |                                                                                                                                                                                |
| Rick J.  Calhoon (49)   |   | 2000                                               |   | Partner,  Pruet Companies (oil and gas)                                                                                                                                             |
|                    |   |                                               |   |                                                                                                                                                                                |
| James A.  Cardwell (71) |   | 2000                                               |   | Chairman and  Chief Executive Officer, Petro Stopping Centers, L.P. (truck stops)                                                                                                   |
|                    |   |                                               |   |                                                                                                                                                                                |
| Gary J.  Fletcher (56)  |   | 2000                                               |   | Rancher,  Salt Fork Ranch                                                                                                                                                           |
|                    |   |                                               |   |                                                                                                                                                                                |
| Ronald  Simpson (56)    |   | 2000                                               |   | President  and Director of the Bank                                                                                                                                                 |
|                    |   |                                               |   |                                                                                                                                                                                |
| Ben Stribling  (60)     |   | 2001                                               |   | Real Estate  Development and Investments                                                                                                                                            |

 

**Resignation and Appointment of Directors andOfficers**

 

Effective May15, 2001, Mr. Bryan W. Stephenson, President and Chief Executive Officer, Mr.Randal N. Crosswhite, Chief Financial Officer, and Mr. David D. Kirk, eachresigned from the Company’s Board of Directors as well as from their respectivepositions as officers of the Company. Effective May 15, 2001, the Company appointed Mr. Tom C. Nichols, Chairmanof the Board, to the position of President and Chief Executive Officer, and

68

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effective May 31, 2001, theCompany appointed Mr. Don E. Cosby, Executive Vice President, to the positionof Chief Financial Officer and Secretary.

 

**Meetings and Committees of the Board ofDirectors**

 

The Board ofDirectors conducts its business through meetings of the Board of Directors andthrough its committees.  In accordancewith the bylaws of the Company, the Board of Directors has established an AuditCommittee.  During 2002, the Board ofDirectors held four regular meetings and the Audit Committee held fourmeetings.  Each director attended atleast 75% of the total number of meetings of the Board of Directors and thecommittees on which he served.

 

**Audit Committee.**  The Audit Committee recommends to the Boardof Directors the appointment and discharge of the Company’s independentauditors; reviews the completed audit with the independent auditors regardingthe conduct of the audit, accounting adjustments, recommendations for improvinginternal controls and any other significant findings during the audit; meetsperiodically with management; monitors accounting and financial controls; andinitiates and supervises special investigations.  Members of the Audit Committee during 2002 consisted of Rick J.Calhoon, James A. Cardwell, Gary J. Fletcher and Ben Stribling.

 

**ExecutiveOfficers**

 

The tablebelow sets forth at the date of this report the name, age, current positionswith the Company, and principal occupation during the last five years of eachprincipal executive officer of the Company and the year he first became anexecutive officer of the Company:

 
| **Name and Age**     |   | **Current  Position with the  Company or the Bank**                                                                                                     |   | **Executive  Officer of the  Company Since** |   | **Principal  Occupation During  Last Five Years**                                                |
|----------------------|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------|--------|----------------------------------------------|--------|--------------------------------------------------------------------------------------------------|
|                 |   |                                                                                                                                                    |   |                                         |   |                                                                                             |
| Tom C.  Nichols (55) |   | President,  Chief Executive Officer, and Chairman of the Board of the Company and Chief  Executive Officer and Chairman of the Board   of the Bank |   | 2000                                         |   | Chairman of  the Board and Chief Executive Officer of State National and the Bank                |
|                 |   |                                                                                                                                                    |   |                                         |   |                                                                                             |
| Don E. Cosby  (48)   |   | Executive  Vice President, Chief Financial Officer, Secretary and Director of the  Company and of the Bank                                              |   | 2000                                         |   | Executive  Vice President, Chief Financial Officer, and Director of State National and  the Bank |

 

**Term of Office**

 

Executiveofficers of the Company are elected by the Board of Directors at its annualmeeting and hold office until the next annual meeting of the Board of Directorsor until their respective successors are duly elected and have qualified.  The officers of the Bank are elected by theboard of directors of the Bank at its annual meeting and hold office until thenext annual meeting of such board of directors or until their respective successorsare duly elected and have qualified.

 

**Compliance with Section 16(a) of theSecurities Exchange Act of 1934**

 

Officers,directors and beneficial owners of more than 10% of the common stock must fileinitial reports of ownership and reports of changes in ownership with theSecurities and Exchange Commission and AMEX pursuant to Section 16(a).  In August 2000 State National acquired 100%of the Common Stock of the Company in a cash

69

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merger. Because the Company iswholly owned by State National, none of these individuals beneficially hasowned any securities of the Company at any time since their respectiveappointments.

 

**ITEM 11****.               EXECUTIVECOMPENSATION**

 

**Summary Compensation Table**

 

As thecompensation of the Company’s executive officers (including those who areemployed by the Company’s direct and indirect subsidiaries) are allocatedbetween the Company and State National, cash compensation paid by the Companyto the executive officers did not exceed $100,000 during the fiscal year endedDecember 31, 2002.

 
|                                                 |   |            |       |                     |       |                            |   |                       |   | **Long-Term  Compensation  Awards** |       |
|------------------------------------------------------|--------|-----------------|------------|--------------------------|------------|---------------------------------|--------|----------------------------|--------|-------------------------------------|------------|
|                                                 |   |            |       | **Annual  Compensation** |       | **Other  Annual  Compensation** |   | **Securities  Underlying** |   |
| **Name and Principal Position**                      |   | **Fiscal Year** |       | **Salary**               |       | **Bonus ($)**                   |   | **($(1)**                  |   | **Options**                         |       |
|                                                 |   |            | ** ** |                     | ** ** |                            |   |                       |   |                                | ** ** |
| Tom C. Nichols                                       |   | 2002            |       | $  63,000           |       | $  0                            |   | $  3,000                   |   | $  0                                |       |
| *President,  Chief Executive Officer,*               |   | 2001            |       | 66,000                   |       | 0                               |   | 3,000                      |   | 0                                   |       |
| *Chairman  of the Board and Director of the Company* |   | 2000            |       | 28,000                   |       | 0                               |   | 0                          |   | 0                                   |       |
|                                                      |        |                 |            |                          |            |                                 |        |                            |        |                                     |            |  |

 

----

(1)           Constitutesautomobile allowance and other benefits.

 

**Stock Option Grants/Exercises in Fiscal 2002**

 

No stockoptions to acquire shares of the Company’s common stock were granted to, orexercised by, the chief executive officer or any other executive officers ofthe Company during fiscal 2002.  TheCompany has never granted stock appreciation rights.

 

**Director Compensation**

 

Directors ofthe Company do not receive fees for serving on the Company’s Board ofDirectors.

 

**ITEM 12****.               SECURITYOWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT**

 

**Security Ownership of Management**

 

All of thecommon stock of the Company is owned indirectly by State National. Accordingly,none of the directors or executive officers of the Company has owned any sharesof common stock since the Company’s acquisition by State National was completedon August 11, 2000. In addition, none of the directors or executive officers ofthe Company own any derivative securities with respect to the Company’s commonstock.

 

70

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**Security Ownership of Certain BeneficialOwners**

 

The followingentity is known by the Company to own beneficially more than 5% of theCompany’s common stock on March 7, 2003.

 

| **Name and Address**                                                                                       |   | **Number of  Shares(1)** |   | **Percent of  Class (2)** |   |
|------------------------------------------------------------------------------------------------------------|--------|--------------------------|--------|---------------------------|--------|
|                                                                                                       |   |                     |   |                      |   |
| State National Bancshares of Delaware, Inc., a wholly owned subsidiary  of State National Bancshares, Inc. |   | 2,273,647                |   | 100                       | %      |
| 1617 BroadwayLubbock,  Texas 79401                                                                         |   |                     |   |                      |   |

 

----

(1)                                  Beneficial ownership as reported in the abovetable has been determined in accordance with Rule 13d-3 under theSecurities Exchange Act of 1934, as amended.

(2)           Thepercentage of common stock indicated is based on 2,273,647 shares of commonstock outstanding on March 7, 2003.

 

**ITEM 13****.               CERTAINRELATIONSHIPS AND RELATED TRANSACTIONS**

 

**Transactions with Management**

 

**Loan Transactions**.The Bank had, during the period from January 1, 2002 through March 7,2003, and expects to have in the future, loan transactions with directors ofthe Company and the Bank and their respective associates, which includes anyimmediate family member or any corporation or firm of which such person is anexecutive officer or partner or is, directly or indirectly, the beneficialowner of 10% or more of any class of equity securities or any trusts of whichsuch person serves as trustee or in which he or she has a substantial beneficialinterest. These loan transactions have been made in the ordinary course of theBank’s business and have been and will continue to be on substantially the sameterms, including interest rates, collateral and repayment, as those prevailingat the time for comparable transactions with unaffiliated persons and did notinvolve more than the normal risk of collectibility or present otherunfavorable features. All loans made to directors and nominees for director ofthe Company and their respective associates are believed to be in compliancewith the Financial Institutions Regulatory and Interest Rate Control Act of1978.

 

**ITEM 14****.               CONTROLSAND PROCEDURES**

 

Based on theevaluation of the Company’s disclosure controls and procedures as of a datewithin 90 days prior to the filing date of this report, each of Tom C. Nichols,the Company’s Chairman, President and Chief Executive Officer, and Don E.Cosby, the Company’s Executive Vice President, Chief Financial Officer andSecretary, have concluded that, in their judgment, the Company’s disclosurecontrols and procedures are effective to ensure that material informationrelating to the registrant, including its consolidated subsidiaries, is madeknown to such officers by others within the Company or its subsidiaries.

 

There were nosignificant changes in the Company’s internal controls or in other factors thatcould significantly affect these controls subsequent to the date of theirevaluation, including any corrective actions with regard to significantdeficiencies and material weaknesses.

 

71

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**PART IV**

** **

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

 

(a)           Documents Filed as Part of Report.

 

1.              FinancialStatements

 

The following consolidated financial statements of the Company areincluded in PART II of this report:

 
| **Item**                                                                                                                                                                                                                                           |   |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|
| Report of Deloitte & Touche, LLP, Independent Auditors                                                                                                                                                                                         |   |
|                                                                                                                                                                                                                                               |   |
| Report of Ernst & Young, LLP, Independent Auditors                                                                                                                                                                                             |   |
|                                                                                                                                                                                                                                               |   |
| Consolidated Balance Sheets as of December 31, 2002 and 2001                                                                                                                                                                                       |   |
|                                                                                                                                                                                                                                               |   |
| Consolidated Statements of Income (Loss) and Comprehensive Income  (Loss) for the years ended December 31, 2002 and 2001, the period from August  12, 2000 through December 31, 2000, and the period from January 1, 2000  through August 11, 2000 |   |
|                                                                                                                                                                                                                                               |   |
| Consolidated Statements of Changes in Stockholder’s Equity for the  years ended December 31, 2002 and 2001, the period from August 12, 2000  through December 31, 2000 and the period from January 1, 2000 through August  11, 2000           |   |
|                                                                                                                                                                                                                                               |   |
| Consolidated Statements of Cash Flows for the years ended December  31, 2002 and 2001, the period from August 12, 2000 through December 31, 2000,  and the period from January 1, 2000 through August 11, 2000                                     |   |
|                                                                                                                                                                                                                                               |   |
| Notes to Consolidated Financial Statements                                                                                                                                                                                                         |   |
|                                                                                                                                                                                                                                               |   |
| Quarterly Data (unaudited)                                                                                                                                                                                                                         |   |

 

2.              FinancialStatement Schedules

 

All schedules for which provision is made in the applicable accountingregulations of the Securities and Exchange Commission have been omitted becausesuch schedules are not required under the related instructions or are inapplicableor because the information required is included in the Company’s consolidatedfinancial statements or notes thereto.

 

3.              Exhibits

 

The exhibits listed below are filed as part of or incorporated byreference in this report.  Where suchfiling is made by incorporation by reference to a previously filed document,such document is identified in parenthesis. See the Index of Exhibits included with the exhibits filed as part ofthis report.

 

72

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| **No.** |   | **Description**                                                                                                                                                                                                                                               |
|---------|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|    |   |                                                                                                                                                                                                                                                          |
| 3.1     |   | Restated  Articles of Incorporation of Independent Bankshares, Inc. (Exhibit 3.1 to the  Company’s Annual Report on Form 10-K for the year ended December 31, 1994).                                                                                     |
|    |   |                                                                                                                                                                                                                                                          |
| 3.2     |   | Articles of  Amendment to the Articles of Incorporation of Independent Bankshares, Inc.  (Exhibit 3.2 to the Company’s Annual Report on Form 10-K for the year ended  December 31, 1994).                                                                |
|    |   |                                                                                                                                                                                                                                                          |
| 3.3     |   | Restated  Bylaws of Independent Bankshares, Inc., as amended (Exhibit 3.3 to the  Company’s Annual Report on Form 10-K for the year ended December 31, 1998).                                                                                            |
|    |   |                                                                                                                                                                                                                                                          |
| 4.1     |   | Specimen  Stock Certificate for Common Stock of the Company (Exhibit 4.1 to the  Company’s Registration Statement on Form S-1, SEC File No. 333-16419).                                                                                                  |
|    |   |                                                                                                                                                                                                                                                          |
| 4.2     |   | Form of  Indenture of the Company relating to the Subordinated Debentures (Exhibit 4.2  to the Company’s Registration Statement on Form S-2, as amended (Reg. No.  333-60649), as filed with the Securities and Exchange Commission on August 4,  1998). |
|    |   |                                                                                                                                                                                                                                                          |
| 4.3     |   | Form of  Subordinated Debenture of the Company (Exhibit 4.3 to the Company’s  Registration Statement on Form S-2, as amended (Reg. No. 333-60649), as filed  with the Securities and exchange Commission on August 4, 1998).                             |
|    |   |                                                                                                                                                                                                                                                          |
| 4.4     |   | Certificate  of Trust of Independent Capital Trust (Exhibit 4.4 to the Company’s Registration  Statement on Form S-2, as amended (Reg. No. 333-60649), as filed with the  Securities and Exchange Commission on August 4, 1998).                         |
|    |   |                                                                                                                                                                                                                                                          |
| 4.5     |   | Declaration  of Trust of Independent Capital Trust (Exhibit 4.5 to the Company’s  Registration Statement on Form S-2, as amended (Reg. No. 333-60649), as filed  with the Securities and Exchange Commission on August 4, 1998).                         |
|    |   |                                                                                                                                                                                                                                                          |
| 4.6     |   | Form of  Amended and Restated Trust Agreement (Exhibit 4.6 to the Company’s  Registration Statement on Form S-2, as amended (Reg. No. 333-60649), as filed  with the Securities and Exchange Commission on August 4, 1998).                              |
|    |   |                                                                                                                                                                                                                                                          |
| 4.7     |   | Form of  Preferred Security Certificate (included as an exhibit to Exhibit 4.6).                                                                                                                                                                              |
|    |   |                                                                                                                                                                                                                                                          |
| 4.8     |   | Form of  Preferred Securities Guarantee Agreement (Exhibit 4.8 to the Company’s  Registration Statement on Form S-2, as amended (Reg. No. 333-60649), as filed  with the Securities and Exchange Commission on August 4, 1998).                          |
|    |   |                                                                                                                                                                                                                                                          |
| 4.9     |   | Form of  Agreement as to Expenses and Liabilities (included as an exhibit to Exhibit  4.6).                                                                                                                                                                   |
|    |   |                                                                                                                                                                                                                                                          |
| 10.1    |   | Form of  Employee Retention Agreement.   (Exhibit 10.1 to the Company’s Quarterly Report on Form 10-Q dated  September 30, 1999).                                                                                                                   |
|    |   |                                                                                                                                                                                                                                                          |
| 21.1    |   | Subsidiaries  of Independent Bankshares, Inc. (filed herewith).                                                                                                                                                                                               |
|    |   |                                                                                                                                                                                                                                                          |
| 23.1    |   | Report of  Independent Auditors (included in Item 8).                                                                                                                                                                                                         |
|    |   |                                                                                                                                                                                                                                                          |
| 99.1    |   | Chief  Executive Officer and Chief Financial Officer Certification (filed herewith).                                                                                                                                                                          |

 

(b)          Current Reports onform 8-K.

 

None.

 

73

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SIGNATURES

 

Pursuant tothe 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 theundersigned, thereunto duly authorized.

 
|   | **INDEPENDENT BANKSHARES, INC.** |
|--------|----------------------------------|
|   |                             |
|   |                             |
|   | By:                              | /s/ Tom C. Nichols |
|   |                             | Tom C.  Nichols, |
|   |                             | *President, Chief Executive Officer,  Chairman of the  Board and Director (principal executive officer)* |
|   |                             |   |
|   | By:                              | /s/ Don E. Cosby |
|   |                             | Don E.  Cosby, |
|   |                             | *Executive Vice President, Chief Financial  Officer,  Secretary and Director (principal financial officer)* |

 

Date:       March 7, 2003

 

Pursuant tothe requirements of the Securities Exchange Act of 1934, this report has beensigned below by the following persons on behalf of the Registrant and in thecapacities and on the dates indicated.

 
| **Signature**         |   | **Title**                                        |   | **Date**      |
|-----------------------|--------|--------------------------------------------------|--------|---------------|
|                  |   |                                             |   |          |
|                  |   |                                             |   |          |
| /s/ Tom C. Nichols    |   | President,  Chief Executive                      |   | March 7, 2003 |
| Tom C. Nichols        |   | Officer,  Chairman of the Board and Director     |   |          |
|                  |   |                                             |   |          |
| /s/ Don E. Cosby      |   | Executive  Vice President,                       |   | March 7, 2003 |
| Don E. Cosby          |   | Chief  Financial Officer, Secretary and Director |   |          |
|                  |   |                                             |   |          |
| /s/ Rick J. Calhoon   |   | Director                                         |   | March 7, 2003 |
| Rick J. Calhoon       |   |                                             |   |          |
|                  |   |                                             |   |          |
| /s/ James A. Cardwell |   | Director                                         |   | March 7, 2003 |
| James A. Cardwell     |   |                                             |   |          |
|                  |   |                                             |   |          |
| /s/ Gary J. Fletcher  |   | Director                                         |   | March 7, 2003 |
| Gary J. Fletcher      |   |                                             |   |          |
|                  |   |                                             |   |          |
| /s/ Ronald Simpson    |   | Director                                         |   | March 7, 2003 |
| Ronald Simpson        |   |                                             |   |          |
|                  |   |                                             |   |          |
| /s/ Ben Stribling     |   | Director                                         |   | March 7, 2003 |
| Ben Stribling         |   |                                             |   |          |

 

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I, Tom C. Nichols, certify that:

 

1.          I have reviewed this annual report onForm 10-K of Independent Bankshares, Inc.;

 

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

 

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

 

4.                               The registrant’s othercertifying officers and I are responsible for establishing and maintainingdisclosure controls and procedures (as defined in Exchange ActRules 13a-14 and 15d-14) for the registrant and have:

 

(a)      designedsuch disclosure controls and procedures to ensure that material informationrelating to the  registrant, includingits consolidated subsidiaries, is made known to us by others within thoseentities, particularly during the period in which this annual report is beingprepared;

 

(b)      evaluatedthe effectiveness of the registrant’s disclosure controls and procedures as ofa date within 90 days prior to the filing date of this annual report (the“Evaluation Date”); and

 

(c)      presentedin this annual report our conclusions about the effectiveness of the disclosurecontrols and procedures based on our evaluation as of the Evaluation Date;

 

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

 

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

 

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

 

6.                               The registrant’s othercertifying officers and I have indicated in this annual report whether therewere significant changes in internal controls or in other factors that couldsignificantly affect the internal controls subsequent to the date of our mostrecent evaluation, including any corrective actions with regard to significantdeficiencies and material weaknesses.

 
|   | Date: March  7, 2003                             |
|--------|--------------------------------------------------|
|   |                                             |
|   | /s/ Tom  C. Nichols                         |
|   | Tom C.  Nichols                                  |
|   | Chairman,  President and Chief Executive Officer |

 

75

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I, Don E. Cosby, certify that:

 

1.          I have reviewed this annual report onForm 10-K of Independent Bankshares, Inc.;

 

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

 

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

 

4.                               The registrant’s othercertifying officers and I are responsible for establishing and maintaining disclosurecontrols and procedures (as defined in Exchange Act Rules 13a-14 and15d-14) for the registrant and have:

 

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

 

(b)                  evaluated the effectiveness of theregistrant’s disclosure controls and procedures as of a date within90 days prior to the filing date of this annual report (the “EvaluationDate”); and

 

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

 

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

 

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

 

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

 

6.                               The registrant’s othercertifying officers and I have indicated in this annual report whether therewere significant changes in internal controls or in other factors that couldsignificantly affect the internal controls subsequent to the date of our mostrecent evaluation, including any corrective actions with regard to significantdeficiencies and material weaknesses.

 
|   | Date: March  7, 2003                                  |
|--------|-------------------------------------------------------|
|   |                                                  |
|   | /s/ Don. E.  Cosby                                    |
|   | Don E. Cosby                                          |
|   | Executive  Vice President and Chief Financial Officer |

 

76

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