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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q



|x | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
|- | ---------------------------------------------------------------------------------------

For the quarterly period ended September 30, 2006

OR



| ̈ | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
|- | ----------------------------------------------------------------------------------------

For the transition period from                  to

Commission file number: 0-20750

STERLING BANCSHARES, INC.

(Exact name of registrant as specified in its charter)



|                                                               |  |                                     
|-------------------------------------------------------------- |  | ------------------------------------
|Texas                                                          |  | 74-2175590                          
|(State or other jurisdiction of incorporation or organization) |  | (I.R.S. Employer Identification No.)
|                                                               | 
|2550 North Loop West, Suite 600 Houston, Texas                 |  | 77092                               
|(Address of principal executive offices)                       |  | (Zip Code)                          

713-466-8300

(Registrants telephone number, including area code)

[None]

(Former name, former address and former fiscal year, if changed since last report)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange
Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes  x    No ̈

Indicate by check mark whether the registrant is a large accelerated
filer, an accelerated filer, or a non-accelerated filer. See definition of accelerated filer and large accelerated filer in Rule 12b-2 of the Exchange Act

Large accelerated filer  x                    Accelerated
filer ̈Non-accelerated filer ̈

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the
Exchange Act).

Yes ̈No  x

Indicate the number of shares outstanding of each of
the issuers classes of common stock, as of the latest practicable date.



|                                          |  |                                
|----------------------------------------- |  | -------------------------------
|Class                                     |  | Outstanding at November 1, 2006
|[Common Stock, $1.00 par value per share] |  | 47,324,143 shares              



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##### Table of Contents

STERLING BANCSHARES, INC.

FORM 10-Q

FOR THE QUARTER ENDED SEPTEMBER 30, 2006

TABLE OF CONTENTS



|           |  |                                                                                       |  |   
|---------- |  | ------------------------------------------------------------------------------------- |  | --
|PART I.    |  | FINANCIAL INFORMATION                                                                 |  |   
|Item 1.    |  | Financial Statements (Unaudited)                                                      |  | 2 
|           |  | Consolidated Balance Sheets                                                           |  | 2 
|           |  | Consolidated Statements of Income                                                     |  | 3 
|           |  | Consolidated Statements of Shareholders Equity                                       |  | 4 
|           |  | Consolidated Statements of Cash Flows                                                 |  | 5 
|           |  | Notes to Consolidated Financial Statements                                            |  | 6 
|Item 2.    |  | Managements Discussion and Analysis of Financial Condition and Results of Operations |  | 20
|Item 3.    |  | Quantitative and Qualitative Disclosures about Market Risk                            |  | 36
|Item 4.    |  | Controls and Procedures                                                               |  | 36
|           |  |                                                                                      
|PART II.   |  | OTHER INFORMATION                                                                     |  |   
|Item 1.    |  | Legal Proceedings                                                                     |  | 37
|Item 1A.   |  | Risk Factors                                                                          |  | 37
|Item 2.    |  | Unregistered Sales of Equity Securities and Use of Proceeds                           |  | 37
|Item 3.    |  | Defaults Upon Senior Securities                                                       |  | 37
|Item 4.    |  | Submission of Matters to a Vote of Security Holders                                   |  | 37
|Item 5.    |  | Other Information                                                                     |  | 37
|Item 6.    |  | Exhibits                                                                              |  | 38
|           | 
|SIGNATURES |  | 39                                                                                   



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##### Table of Contents

PART I.    FINANCIAL INFORMATION

ITEM 1.    FINANCIAL STATEMENTS

STERLING BANCSHARES, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(UNAUDITED)

(In thousands, except
per share amounts)



|                                                                                                                                                                                                |  |                    |           |   |                   |   |           |  
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ------------------ | --------- | - | ----------------- | - | --------- | -
|                                                                                                                                                                                                |  | September 30, 2006 |           |   | December 31, 2005 |  
|ASSETS                                                                                                                                                                                          |  |                    |           |   |                   |   |           |  
|Cash and cash equivalents                                                                                                                                                                       |  | $                  | 146,442   |   |                   | $ | 147,154   |  
|Interest-bearing deposits in financial institutions                                                                                                                                             |  |                    | 21,666    |   |                   |   | 99        |  
|Trading assets                                                                                                                                                                                  |  |                    |          |   |                   |   | 28,515    |  
|Available-for-sale securities, at fair value                                                                                                                                                    |  |                    | 527,806   |   |                   |   | 495,945   |  
|Held-to-maturity securities, at amortized cost                                                                                                                                                  |  |                    | 167,243   |   |                   |   | 123,053   |  
|Loans held for sale                                                                                                                                                                             |  |                    | 72,789    |   |                   |   | 8,354     |  
|Loans held for investment                                                                                                                                                                       |  |                    | 3,030,344 |   |                   |   | 2,691,008 |  
|                                                                                                                                                                                                |  |                    |           |   |                   |   |           |  
|Total loans                                                                                                                                                                                     |  |                    | 3,103,133 |   |                   |   | 2,699,362 |  
|Allowance for loan losses                                                                                                                                                                       |  |                    | (34,146   | ) |                   |   | (31,230   | )
|                                                                                                                                                                                                |  |                    |           |   |                   |   |           |  
|Loans, net                                                                                                                                                                                      |  |                    | 3,068,987 |   |                   |   | 2,668,132 |  
|Premises and equipment, net                                                                                                                                                                     |  |                    | 42,115    |   |                   |   | 41,407    |  
|Real estate acquired by foreclosure                                                                                                                                                             |  |                    | 1,764     |   |                   |   | 460       |  
|Goodwill                                                                                                                                                                                        |  |                    | 129,131   |   |                   |   | 85,026    |  
|Core deposit intangibles, net                                                                                                                                                                   |  |                    | 10,728    |   |                   |   | 3,551     |  
|Accrued interest receivable                                                                                                                                                                     |  |                    | 18,576    |   |                   |   | 15,358    |  
|Other assets                                                                                                                                                                                    |  |                    | 129,666   |   |                   |   | 118,159   |  
|                                                                                                                                                                                                |  |                    |           |   |                   |   |           |  
|TOTAL ASSETS                                                                                                                                                                                    |  | $                  | 4,264,124 |   |                   | $ | 3,726,859 |  
|                                                                                                                                                                                                |  |                    |           |   |                   |   |           |  
|LIABILITIES AND SHAREHOLDERS EQUITY                                                                                                                                                            |  |                    |           |   |                   |   |           |  
|LIABILITIES:                                                                                                                                                                                    |  |                    |           |   |                   |   |           |  
|Deposits:                                                                                                                                                                                       |  |                    |           |   |                   |   |           |  
|Noninterest-bearing demand                                                                                                                                                                      |  | $                  | 1,045,416 |   |                   | $ | 1,045,937 |  
|Interest-bearing demand                                                                                                                                                                         |  |                    | 1,207,722 |   |                   |   | 1,017,832 |  
|Certificates and other time deposits                                                                                                                                                            |  |                    | 1,065,372 |   |                   |   | 774,374   |  
|                                                                                                                                                                                                |  |                    |           |   |                   |   |           |  
|Total deposits                                                                                                                                                                                  |  |                    | 3,318,510 |   |                   |   | 2,838,143 |  
|Short-term borrowings                                                                                                                                                                           |  |                    | 372,250   |   |                   |   | 392,850   |  
|Subordinated debt                                                                                                                                                                               |  |                    | 46,018    |   |                   |   | 46,238    |  
|Junior subordinated debt                                                                                                                                                                        |  |                    | 56,959    |   |                   |   | 82,475    |  
|Accrued interest payable and other liabilities                                                                                                                                                  |  |                    | 70,611    |   |                   |   | 32,681    |  
|                                                                                                                                                                                                |  |                    |           |   |                   |   |           |  
|Total liabilities                                                                                                                                                                               |  |                    | 3,864,348 |   |                   |   | 3,392,387 |  
|COMMITMENTS AND CONTINGENCIES                                                                                                                                                                   |  |                    |          |   |                   |   |          |  
|SHAREHOLDERS EQUITY:                                                                                                                                                                           |  |                    |           |   |                   |   |           |  
|Preferred stock, $1 par value, 1,000,000 shares authorized, no shares issued and outstanding at September 30, 2006 and December 31,
2005                                                        |  |                    |          |   |                   |   |          |  
|Common stock, $1 par value, 100,000,000 shares authorized, 47,892,543 and 45,458,500 issued and 47,392,543 and 45,333,500 outstanding at
September 30, 2006 and December 31, 2005, respectively |  |                    | 47,893    |   |                   |   | 45,458    |  
|Capital surplus                                                                                                                                                                                 |  |                    | 103,768   |   |                   |   | 58,757    |  
|Retained earnings                                                                                                                                                                               |  |                    | 262,678   |   |                   |   | 239,171   |  
|Treasury stock                                                                                                                                                                                  |  |                    | (8,540    | ) |                   |   | (1,984    | )
|Accumulated other comprehensive loss, net of tax                                                                                                                                                |  |                    | (6,023    | ) |                   |   | (6,930    | )
|                                                                                                                                                                                                |  |                    |           |   |                   |   |           |  
|Total shareholders equity                                                                                                                                                                      |  |                    | 399,776   |   |                   |   | 334,472   |  
|                                                                                                                                                                                                |  |                    |           |   |                   |   |           |  
|TOTAL LIABILITIES AND SHAREHOLDERS EQUITY                                                                                                                                                      |  | $                  | 4,264,124 |   |                   | $ | 3,726,859 |  
|                                                                                                                                                                                                |  |                    |           |   |                   |   |           |  

See Notes to Consolidated Financial Statements.



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STERLING BANCSHARES, INC., AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF INCOME

(UNAUDITED)

(In thousands, except
per share amounts)



|                                                      |  |                                  |        |                                 |   |        |  |   |         |   |  |   |        
|----------------------------------------------------- |  | -------------------------------- | ------ | ------------------------------- | - | ------ |  | - | ------- | - |  | - | -------
|                                                      |  | Three Months Ended September 30, |        | Nine Months Ended September 30,
|                                                      |  | 2006                             |        | 2005                            |   | 2006   |  |   | 2005   
|Interest income:                                      |  |                                  |        |                                 |   |        |  |   |         |   |  |   |        
|Loans, including fees                                 |  | $                                | 58,158 |                                 | $ | 45,545 |  | $ | 164,199 |   |  | $ | 125,469
|Securities:                                           |  |                                  |        |                                 |   |        |  |   |         |   |  |   |        
|Taxable                                               |  |                                  | 5,902  |                                 |   | 6,404  |  |   | 18,062  |   |  |   | 18,904 
|Non-taxable                                           |  |                                  | 549    |                                 |   | 604    |  |   | 1,700   |   |  |   | 1,844  
|Trading assets                                        |  |                                  | 73     |                                 |   | 259    |  |   | 643     |   |  |   | 893    
|Federal funds sold                                    |  |                                  | 55     |                                 |   | 59     |  |   | 140     |   |  |   | 218    
|Deposits in financial institutions                    |  |                                  | 34     |                                 |   | 24     |  |   | 124     |   |  |   | 39     
|                                                      |  |                                  |        |                                 |   |        |  |   |         |   |  |   |        
|Total interest income                                 |  |                                  | 64,771 |                                 |   | 52,895 |  |   | 184,868 |   |  |   | 147,367
|                                                      |  |                                  |        |                                 |   |        |  |   |         |   |  |   |        
|Interest expense:                                     |  |                                  |        |                                 |   |        |  |   |         |   |  |   |        
|Demand and savings deposits                           |  |                                  | 4,971  |                                 |   | 2,145  |  |   | 11,931  |   |  |   | 5,772  
|Certificates and other time deposits                  |  |                                  | 9,898  |                                 |   | 5,572  |  |   | 25,574  |   |  |   | 13,613 
|Short-term borrowings                                 |  |                                  | 4,690  |                                 |   | 4,498  |  |   | 13,265  |   |  |   | 10,857 
|Subordinated debt                                     |  |                                  | 1,155  |                                 |   | 950    |  |   | 3,335   |   |  |   | 2,645  
|Junior subordinated debt                              |  |                                  | 1,152  |                                 |   | 1,746  |  |   | 4,353   |   |  |   | 5,158  
|                                                      |  |                                  |        |                                 |   |        |  |   |         |   |  |   |        
|Total interest expense                                |  |                                  | 21,866 |                                 |   | 14,911 |  |   | 58,458  |   |  |   | 38,045 
|                                                      |  |                                  |        |                                 |   |        |  |   |         |   |  |   |        
|Net interest income                                   |  |                                  | 42,905 |                                 |   | 37,984 |  |   | 126,410 |   |  |   | 109,322
|Provision for credit losses                           |  |                                  | 895    |                                 |   | 4,565  |  |   | 4,058   |   |  |   | 11,126 
|                                                      |  |                                  |        |                                 |   |        |  |   |         |   |  |   |        
|Net interest income after provision for credit losses |  |                                  | 42,010 |                                 |   | 33,419 |  |   | 122,352 |   |  |   | 98,196 
|                                                      |  |                                  |        |                                 |   |        |  |   |         |   |  |   |        
|Noninterest income:                                   |  |                                  |        |                                 |   |        |  |   |         |   |  |   |        
|Customer service fees                                 |  |                                  | 3,313  |                                 |   | 2,840  |  |   | 8,951   |   |  |   | 8,720  
|Net gain (loss) on trading assets                     |  |                                  |       |                                 |   | 34     |  |   | (302    | ) |  |   | 132    
|Net gain on the sale of securities                    |  |                                  |       |                                 |   | 6      |  |   |        |   |  |   | 60     
|Net gain on the sale of loans                         |  |                                  | 292    |                                 |   | 626    |  |   | 802     |   |  |   | 1,300  
|Other                                                 |  |                                  | 3,899  |                                 |   | 3,588  |  |   | 13,562  |   |  |   | 10,188 
|                                                      |  |                                  |        |                                 |   |        |  |   |         |   |  |   |        
|Total noninterest income                              |  |                                  | 7,504  |                                 |   | 7,094  |  |   | 23,013  |   |  |   | 20,400 
|                                                      |  |                                  |        |                                 |   |        |  |   |         |   |  |   |        
|Noninterest expense:                                  |  |                                  |        |                                 |   |        |  |   |         |   |  |   |        
|Salaries and employee benefits                        |  |                                  | 18,843 |                                 |   | 14,794 |  |   | 56,340  |   |  |   | 45,466 
|Occupancy expense                                     |  |                                  | 4,018  |                                 |   | 3,841  |  |   | 11,922  |   |  |   | 11,392 
|Technology                                            |  |                                  | 1,695  |                                 |   | 1,409  |  |   | 4,784   |   |  |   | 4,004  
|Professional fees                                     |  |                                  | 1,408  |                                 |   | 1,870  |  |   | 4,306   |   |  |   | 4,796  
|Postage, delivery and supplies                        |  |                                  | 801    |                                 |   | 809    |  |   | 2,494   |   |  |   | 2,337  
|Marketing                                             |  |                                  | 675    |                                 |   | 542    |  |   | 1,768   |   |  |   | 1,804  
|Core deposit intangibles amortization                 |  |                                  | 195    |                                 |   | 102    |  |   | 584     |   |  |   | 316    
|Acquisition costs                                     |  |                                  | 638    |                                 |   | 831    |  |   | 638     |   |  |   | 831    
|Other                                                 |  |                                  | 4,294  |                                 |   | 3,514  |  |   | 13,882  |   |  |   | 11,156 
|                                                      |  |                                  |        |                                 |   |        |  |   |         |   |  |   |        
|Total noninterest expense                             |  |                                  | 32,567 |                                 |   | 27,712 |  |   | 96,718  |   |  |   | 82,102 
|                                                      |  |                                  |        |                                 |   |        |  |   |         |   |  |   |        
|Income before income taxes                            |  |                                  | 16,947 |                                 |   | 12,801 |  |   | 48,647  |   |  |   | 36,494 
|Provision for income taxes                            |  |                                  | 5,218  |                                 |   | 4,115  |  |   | 15,617  |   |  |   | 11,534 
|                                                      |  |                                  |        |                                 |   |        |  |   |         |   |  |   |        
|Net Income                                            |  | $                                | 11,729 |                                 | $ | 8,686  |  | $ | 33,030  |   |  | $ | 24,960 
|                                                      |  |                                  |        |                                 |   |        |  |   |         |   |  |   |        
|Earnings per share:                                   |  |                                  |        |                                 |   |        |  |   |         |   |  |   |        
|Basic                                                 |  | $                                | 0.26   |                                 | $ | 0.19   |  | $ | 0.73    |   |  | $ | 0.55   
|                                                      |  |                                  |        |                                 |   |        |  |   |         |   |  |   |        
|Diluted                                               |  | $                                | 0.26   |                                 | $ | 0.19   |  | $ | 0.72    |   |  | $ | 0.55   
|                                                      |  |                                  |        |                                 |   |        |  |   |         |   |  |   |        

See Notes to Consolidated Financial Statements.



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##### Table of Contents

STERLING BANCSHARES, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF SHAREHOLDERS EQUITY

(UNAUDITED)

(In
thousands)



|                                                                                                             |  |                 |  |              |   |                 |        |                   |   |        |                |        |         |                                   |   |         |       |  |     |  |   |        |   |  |   |        |   |  |   |         |  
|------------------------------------------------------------------------------------------------------------ |  | --------------- |  | ------------ | - | --------------- | ------ | ----------------- | - | ------ | -------------- | ------ | ------- | --------------------------------- | - | ------- | ----- |  | --- |  | - | ------ | - |  | - | ------ | - |  | - | ------- | -
|                                                                                                             |  | Preferred Stock |  | Common Stock |   | Capital Surplus |        | Retained Earnings |   |        | Treasury Stock |        |         | AccumulatedOtherComprehensiveLoss |   |         | Total | 
|                                                                                                             |  | Shares          |  | Amount       |   | Shares          |        | Amount            |   |        |                | Shares |         | Amount                            |   |         |      
|BALANCE AT JANUARY 1, 2005                                                                                   |  |                |  | $            |  |                 | 45,068 |                   | $ | 45,068 |                | $      | 54,522  |                                   | $ | 213,814 |       |  |    |  | $ |       |   |  | $ | (232   | ) |  | $ | 313,172 |  
|Comprehensive income:                                                                                        |  |                 |  |              |   |                 |        |                   |   |        |                |        |         |                                   |   |         |       |  |     |  |   |        |   |  |   |        |   |  |   |         |  
|Net income                                                                                                   |  |                 |  |              |   |                 |        |                   |   |        |                |        |         |                                   |   | 24,960  |       |  |     |  |   |        |   |  |   |        |   |  |   | 24,960  |  
|Net change in unrealized gains and losses on available-for-sale securities, net of taxes of ($2,452)         |  |                 |  |              |   |                 |        |                   |   |        |                |        |         |                                   |   |         |       |  |     |  |   |        |   |  |   | (4,477 | ) |  |   | (4,477  | )
|Less: Reclassification adjustment for gains included in net income, net of taxes of ($21)                    |  |                 |  |              |   |                 |        |                   |   |        |                |        |         |                                   |   |         |       |  |     |  |   |        |   |  |   | (39    | ) |  |   | (39     | )
|                                                                                                             |  |                 |  |              |   |                 |        |                   |   |        |                |        |         |                                   |   |         |       |  |     |  |   |        |   |  |   |        |   |  |   |         |  
|Total comprehensive income                                                                                   |  |                 |  |              |   |                 |        |                   |   |        |                |        |         |                                   |   |         |       |  |     |  |   |        |   |  |   |        |   |  |   | 20,444  |  
|                                                                                                             |  |                 |  |              |   |                 |        |                   |   |        |                |        |         |                                   |   |         |       |  |     |  |   |        |   |  |   |        |   |  |   |         |  
|Issuance of common stock                                                                                     |  |                 |  |              |   |                 | 324    |                   |   | 324    |                |        | 3,383   |                                   |   |         |       |  |     |  |   |        |   |  |   |        |   |  |   | 3,707   |  
|Cash dividends paid                                                                                          |  |                 |  |              |   |                 |        |                   |   |        |                |        |         |                                   |   | (8,143  | )     |  |     |  |   |        |   |  |   |        |   |  |   | (8,143  | )
|                                                                                                             |  |                 |  |              |   |                 |        |                   |   |        |                |        |         |                                   |   |         |       |  |     |  |   |        |   |  |   |        |   |  |   |         |  
|BALANCE AT SEPTEMBER 30, 2005                                                                                |  |                |  | $            |  |                 | 45,392 |                   | $ | 45,392 |                | $      | 57,905  |                                   | $ | 230,631 |       |  |    |  | $ |       |   |  | $ | (4,748 | ) |  | $ | 329,180 |  
|                                                                                                             |  |                 |  |              |   |                 |        |                   |   |        |                |        |         |                                   |   |         |       |  |     |  |   |        |   |  |   |        |   |  |   |         |  
|BALANCE AT JANUARY 1, 2006                                                                                   |  |                |  | $            |  |                 | 45,458 |                   | $ | 45,458 |                | $      | 58,757  |                                   | $ | 239,171 |       |  | 125 |  | $ | (1,984 | ) |  | $ | (6,930 | ) |  | $ | 334,472 |  
|Comprehensive income:                                                                                        |  |                 |  |              |   |                 |        |                   |   |        |                |        |         |                                   |   |         |       |  |     |  |   |        |   |  |   |        |   |  |   |         |  
|Net income                                                                                                   |  |                 |  |              |   |                 |        |                   |   |        |                |        |         |                                   |   | 33,030  |       |  |     |  |   |        |   |  |   |        |   |  |   | 33,030  |  
|Net change in unrealized gains and losses on available-for-sale securities, net of taxes of ($755)           |  |                 |  |              |   |                 |        |                   |   |        |                |        |         |                                   |   |         |       |  |     |  |   |        |   |  |   | (1,403 | ) |  |   | (1,403  | )
|Net change in unrealized gains and losses on effective cash flow hedging derivatives, net of taxes of $1,244 |  |                 |  |              |   |                 |        |                   |   |        |                |        |         |                                   |   |         |       |  |     |  |   |        |   |  |   | 2,310  |   |  |   | 2,310   |  
|                                                                                                             |  |                 |  |              |   |                 |        |                   |   |        |                |        |         |                                   |   |         |       |  |     |  |   |        |   |  |   |        |   |  |   |         |  
|Total comprehensive income                                                                                   |  |                 |  |              |   |                 |        |                   |   |        |                |        |         |                                   |   |         |       |  |     |  |   |        |   |  |   |        |   |  |   | 33,937  |  
|                                                                                                             |  |                 |  |              |   |                 |        |                   |   |        |                |        |         |                                   |   |         |       |  |     |  |   |        |   |  |   |        |   |  |   |         |  
|Issuance of common stock                                                                                     |  |                 |  |              |   |                 | 2,435  |                   |   | 2,435  |                |        | 45,011  |                                   |   |         |       |  |     |  |   |        |   |  |   |        |   |  |   | 47,446  |  
|Repurchase of common stock                                                                                   |  |                 |  |              |   |                 |       |                   |   |       |                |        |         |                                   |   |         |       |  | 375 |  |   | (6,556 | ) |  |   |        |   |  |   | (6,556  | )
|Cash dividends paid                                                                                          |  |                 |  |              |   |                 |        |                   |   |        |                |        |         |                                   |   | (9,523  | )     |  |     |  |   |        |   |  |   |        |   |  |   | (9,523  | )
|                                                                                                             |  |                 |  |              |   |                 |        |                   |   |        |                |        |         |                                   |   |         |       |  |     |  |   |        |   |  |   |        |   |  |   |         |  
|BALANCE AT SEPTEMBER 30, 2006                                                                                |  |                |  | $            |  |                 | 47,893 |                   | $ | 47,893 |                | $      | 103,768 |                                   | $ | 262,678 |       |  | 500 |  | $ | (8,540 | ) |  | $ | (6,023 | ) |  | $ | 399,776 |  
|                                                                                                             |  |                 |  |              |   |                 |        |                   |   |        |                |        |         |                                   |   |         |       |  |     |  |   |        |   |  |   |        |   |  |   |         |  

See Notes to Consolidated Financial Statements.



4



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##### Table of Contents

STERLING BANCSHARES, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(UNAUDITED)

(In thousands)



|                                                                                  |  |                                 |          |   |      |   |          |  
|--------------------------------------------------------------------------------- |  | ------------------------------- | -------- | - | ---- | - | -------- | -
|                                                                                  |  | Nine Months Ended September 30, |         
|                                                                                  |  | 2006                            |          |   | 2005 |  
|CASH FLOWS FROM OPERATING ACTIVITIES:                                             |  |                                 |          |   |      |   |          |  
|Net income                                                                        |  | $                               | 33,030   |   |      | $ | 24,960   |  
|Adjustments to reconcile net income to net cash provided by operating activities: |  |                                 |          |   |      |   |          |  
|Amortization and accretion of premiums and discounts on securities, net           |  |                                 | 1,842    |   |      |   | 2,386    |  
|Net gain on the sale of securities                                                |  |                                 |         |   |      |   | (60      | )
|Net gain on the sale of premises and equipment                                    |  |                                 | (1,177   | ) |      |   | (244     | )
|Net loss (gain) on trading assets                                                 |  |                                 | 302      |   |      |   | (132     | )
|Net gain on sale of loans                                                         |  |                                 | (802     | ) |      |   | (1,300   | )
|Provision for credit losses                                                       |  |                                 | 4,058    |   |      |   | 11,126   |  
|Writedowns, less gains on sale, of real estate acquired by foreclosure            |  |                                 | (301     | ) |      |   | (11      | )
|Depreciation and amortization                                                     |  |                                 | 6,219    |   |      |   | 5,680    |  
|Proceeds from sales of trading assets                                             |  |                                 | 31,113   |   |      |   | 134,837  |  
|Purchases of trading assets                                                       |  |                                 | (3,336   | ) |      |   | (150,484 | )
|Proceeds from principal paydowns of trading securities                            |  |                                 | 203      |   |      |   | 27,301   |  
|Stock-based compensation expense (net of tax benefit recognized)                  |  |                                 | 1,189    |   |      |   |         |  
|Excess tax benefits from share-based payment arrangements                         |  |                                 | (562     | ) |      |   |         |  
|Net decrease (increase) in loans held for sale                                    |  |                                 | 1,577    |   |      |   | (2,901   | )
|Net increase in accrued interest receivable and other assets                      |  |                                 | (2,026   | ) |      |   | (6,259   | )
|Net increase (decrease) in accrued interest payable and other liabilities         |  |                                 | 5,604    |   |      |   | (1,162   | )
|                                                                                  |  |                                 |          |   |      |   |          |  
|Net cash provided by operating activities                                         |  |                                 | 76,933   |   |      |   | 43,737   |  
|CASH FLOWS FROM INVESTING ACTIVITIES:                                             |  |                                 |          |   |      |   |          |  
|Proceeds from the maturities or calls and paydowns of held-to-maturity securities |  |                                 | 12,964   |   |      |   | 17,371   |  
|Proceeds from the sale of available-for-sale securities                           |  |                                 |         |   |      |   | 60,049   |  
|Proceeds from maturities or calls and paydowns of available-for-sale securities   |  |                                 | 81,585   |   |      |   | 110,322  |  
|Purchases of available-for-sale securities                                        |  |                                 | (45,041  | ) |      |   | (151,972 | )
|Purchases of held-to-maturity securities                                          |  |                                 | (18,006  | ) |      |   | (14,916  | )
|Net increase in loans held for investment                                         |  |                                 | (313,788 | ) |      |   | (338,783 | )
|Proceeds from sale of real estate acquired by foreclosure                         |  |                                 | 2,563    |   |      |   | 1,953    |  
|Proceeds from sale of land held for sale                                          |  |                                 | 1,570    |   |      |   | 615      |  
|Purchase of Prestonwood Bancshares, Inc. (including transaction costs)            |  |                                 |         |   |      |   | (34,638  | )
|Purchase of Bank of the Hills, Inc. (including transaction costs)                 |  |                                 | (536     | ) |      |   |         |  
|Cash and cash equivalents acquired with Bank of the Hills, Inc.                   |  |                                 | 27,860   |   |      |   |         |  
|Cash and cash equivalents acquired with Prestonwood Bancshares, Inc.              |  |                                 |         |   |      |   | 49,035   |  
|Net increase in interest-bearing deposits in financial institutions               |  |                                 |         |   |      |   | 396      |  
|Proceeds from sale of loans                                                       |  |                                 | 52,011   |   |      |   | 52,368   |  
|Proceeds from sale of premises and equipment                                      |  |                                 | 4,100    |   |      |   | 353      |  
|Purchase of premises and equipment                                                |  |                                 | (3,551   | ) |      |   | (3,314   | )
|                                                                                  |  |                                 |          |   |      |   |          |  
|Net cash used in investing activities                                             |  |                                 | (198,269 | ) |      |   | (251,161 | )
|CASH FLOWS FROM FINANCING ACTIVITIES:                                             |  |                                 |          |   |      |   |          |  
|Net increase in deposits                                                          |  |                                 | 182,143  |   |      |   | 207,337  |  
|Net (decrease) increase in short-term borrowings                                  |  |                                 | (20,600  | ) |      |   | 52,475   |  
|Redemption of junior subordinated debt                                            |  |                                 | (29,639  | ) |      |   |         |  
|Proceeds from issuance of common stock                                            |  |                                 | 4,237    |   |      |   | 3,707    |  
|Repurchase of common stock                                                        |  |                                 | (6,556   | ) |      |   |         |  
|Excess tax benefits from share-based payment arrangements                         |  |                                 | 562      |   |      |   |         |  
|Dividends paid                                                                    |  |                                 | (9,523   | ) |      |   | (8,143   | )
|                                                                                  |  |                                 |          |   |      |   |          |  
|Net cash provided by financing activities                                         |  |                                 | 120,624  |   |      |   | 255,376  |  
|NET (DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS                              |  |                                 | (712     | ) |      |   | 47,952   |  
|CASH AND CASH EQUIVALENTS:                                                        |  |                                 |          |   |      |   |          |  
|Beginning of period                                                               |  |                                 | 147,154  |   |      |   | 88,439   |  
|                                                                                  |  |                                 |          |   |      |   |          |  
|End of period                                                                     |  | $                               | 146,442  |   |      | $ | 136,391  |  
|                                                                                  |  |                                 |          |   |      |   |          |  
|Supplemental information:                                                         |  |                                 |          |   |      |   |          |  
|Income taxes paid                                                                 |  | $                               | 18,598   |   |      | $ | 15,143   |  
|Interest paid                                                                     |  |                                 | 53,325   |   |      |   | 36,223   |  
|Noncash investing and financing activities                                       |  |                                 |          |   |      |   |          |  
|Acquisitions of real estate through foreclosure of collateral                     |  |                                 | 3,566    |   |      |   | 1,041    |  
|Transfer of loans from held for investment to loans held for sale                 |  |                                 | 117,221  |   |      |   |         |  
|Acquisition of BOTH, Inc.                                                         |  |                                 |          |   |      |   |          |  
|Common stock issued                                                               |  |                                 | 40,971   |   |      |   |         |  
|Payable to BOTH, Inc. shareholders                                                |  |                                 | 31,530   |   |      |   |         |  

See Notes to Consolidated Financial Statements



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##### Table of Contents

STERLING BANCSHARES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

1.    ACCOUNTING
POLICIES

Basis of Presentation

The
consolidated Financial Statements are unaudited and include the accounts of Sterling Bancshares, Inc. and its subsidiaries (the Company) except for those subsidiaries where it has been determined that the Company is not the primary
beneficiary. The Companys accounting and financial reporting policies are in accordance with accounting principles generally accepted in the United States of America for interim financial information and in accordance with the instructions to
Form 10-Q. The information furnished in these interim statements reflects all adjustments that are, in the opinion of management, necessary for a fair statement of the results for such periods. Such adjustments are of a normal recurring nature
unless otherwise disclosed in this Form 10-Q. The results of operations in the interim statements are not necessarily indicative of the results that may be expected for the full year. The interim financial information should be read with the
Companys 2005 Annual Report on Form 10-K. Certain prior period amounts have been reclassified to conform to current period classifications. These reclassifications had no affect on net income or shareholders equity.

Recent Accounting Standards

Statement of Accounting
StandardsNo. 123R, Share-Based Payment (Revised 2004) (SFAS 123R) established standards for accounting for transactions in which an enterprise receives employee services in exchange for (a) equity instruments of the
enterprise or (b) liabilities that are based on the fair value of the enterprises equity instruments or that may be settled by the issuance of such equity instruments. SFAS 123R applies to new awards and to awards modified,
repurchased, or cancelled after January 1, 2006. The Company used the modified prospective application in implementing SFAS 123R. Beginning in 2006, the Companys results of operations reflect compensation expense for all employee
stock-based compensation, including the unvested portion of stock options granted prior to 2006. Prior to 2006, the Company accounted for stock-based employee compensation using the intrinsic value-based method of accounting, as permitted. Under the
intrinsic value-based method of accounting, no compensation expense was recognized for the Companys incentive stock options or for the Companys employee stock purchase plan. The adoption of this accounting standard resulted in additional
stock-based compensation expense of $80 thousand and $284 thousand for the three and nine-month periods ended September 30, 2006, respectively, attributable to stock options and the Companys employee stock purchase plan. There was no
income tax benefit recorded in the Companys income statement for the three and nine months ended September 30, 2006 for this additional stock-based compensation expense. The adoption of this accounting standard did not have a meaningful
impact on earnings per share for the same time periods.



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##### Table of Contents

The pro-forma net income and earnings per share information for the three and nine-month periods ended September 30,
2005 presented below was determined as if we had accounted for our employee stock-based compensation under the fair-value method (dollars in thousands except for per share amounts).



|                                                                                                                         |  |                                       |       |   |                                      |   |        |  
|------------------------------------------------------------------------------------------------------------------------ |  | ------------------------------------- | ----- | - | ------------------------------------ | - | ------ | -
|                                                                                                                         |  | Three months ended September 30, 2005 |       |   | Nine months ended September 30, 2005 |  
|Net income, as reported                                                                                                  |  | $                                     | 8,686 |   |                                      | $ | 24,960 |  
|Add: Stock-based employee compensation expense included in reported net income, net of related tax effect                |  |                                       | 105   |   |                                      |   | 347    |  
|Less: Total stock-based employee compensation expense determined under the fair-value based method, net of related taxes |  |                                       | (226  | ) |                                      |   | (739   | )
|                                                                                                                         |  |                                       |       |   |                                      |   |        |  
|Pro-forma net income                                                                                                     |  | $                                     | 8,565 |   |                                      | $ | 24,568 |  
|                                                                                                                         |  |                                       |       |   |                                      |   |        |  
|Earnings per share:                                                                                                      |  |                                       |       |   |                                      |   |        |  
|Basicas reported                                                                                                        |  | $                                     | 0.19  |   |                                      | $ | 0.55   |  
|                                                                                                                         |  |                                       |       |   |                                      |   |        |  
|Basicpro-forma                                                                                                          |  | $                                     | 0.19  |   |                                      | $ | 0.54   |  
|                                                                                                                         |  |                                       |       |   |                                      |   |        |  
|Dilutedas reported                                                                                                      |  | $                                     | 0.19  |   |                                      | $ | 0.55   |  
|                                                                                                                         |  |                                       |       |   |                                      |   |        |  
|Dilutedpro-forma                                                                                                        |  | $                                     | 0.19  |   |                                      | $ | 0.54   |  
|                                                                                                                         |  |                                       |       |   |                                      |   |        |  

In February 2006, the Financial Accounting Standard Board (FASB) issued Statement of Accounting
Standards No. 155 (SFAS 155) Accounting for Certain Hybrid Financial Instruments, an amendment of FASB Statements No. 133 and 140. It establishes, among other things, the accounting for certain derivatives embedded in
other financial instruments. The primary objective of this Statement with respect to FASB Statement No. 133, Accounting for Derivative Instruments and Hedging Activities, is to simplify accounting for any hybrid financial instrument that
contains an embedded derivative that would otherwise require bifurcation. The primary objective of this Statement with respect to FASB Statement No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of
Liabilities, is to eliminate a restriction on the passive derivative instruments that a qualifying special-purpose entity (QSPE) may hold. This Statement is effective for all financial instruments acquired or issued after the beginning of an
entitys first fiscal year that begins after September 15, 2006. The adoption of this accounting standard is not expected to have a material impact on the Companys financial statements.

In March 2006, the FASB issued Statement of Accounting Standards No. 156 (SFAS 156) Accounting for Servicing of Financial Assets, an amendment of
FASB Statement No. 140. It establishes, among other things, the accounting for all separately recognized servicing assets and servicing liabilities. This Statement amends Statement 140 to require that all separately recognized servicing assets
and servicing liabilities be initially measured at fair value, if practicable. This Statement is effective for fiscal years beginning after September 15, 2006. The adoption of this accounting standard is not expected to have a material impact
on the Companys financial statements.

In June 2006, the FASB issued FASB Interpretation No. 48 (FIN 48) Accounting for
Uncertainty in Income Taxes, an interpretation of FASB Statement No. 109. FIN 48 clarifies the accounting for uncertainty in income taxes recognized in an enterprises financial statements in accordance with FASB Statement No. 109
(FAS 109), Accounting for Income Taxes. FIN 48 clarifies the application of FAS 109 by defining a criterion that an individual tax position must meet for any part of the benefit of that position to be recognized in an
enterprises financial statements. Additionally, FIN 48 provides guidance on measurement, derecognition, classification, interest and penalties, accounting in interim periods, disclosure, and transition. FIN 48 is effective for fiscal years
beginning after December 15, 2006. The adoption of this accounting standard is not expected to have a material impact on the Companys financial statements.



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In September 2006, the FASB issued Statement of Accounting Standards No. 157 (SFAS 157) Fair Value
Measurements. This Statement defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles, and expands disclosures about fair value measurements. This Statement is effective for financial
statements issued for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years. The adoption of this accounting standard is not expected to have a material impact on the Companys financial statements.

2.    ACQUISITIONS

On
September 29, 2006, the Company acquired Kerrville, Texas-based BOTH, Inc., and its subsidiary bank, Bank of the Hills (BOTH). BOTH operates five banking offices in the San Antonio/Kerrville area. The purchase price of $72.5 million
consisted of $41.0 million of the Companys common stock (2.0 million shares), $31.5 million in cash and $536 thousand in acquisition-related costs. The shares of the Companys common stock issued in the transaction were valued at the
average of the closing price of the Companys common stock for the ten business days ending on August 23, 2006. This acquisition was accounted for using the purchase method of accounting in which the excess of the purchase price over the
estimated fair value of the net assets was recorded as goodwill, none of which is expected to be deductible for tax purposes. As of September 30, 2006, the Company had a liability totaling $31.5 million representing the cash portion of the
consideration that had not yet been tendered for cash payment to the BOTH shareholders.

The following table summarizes the estimated fair value of the
assets acquired and liabilities assumed at the date of acquisition. The purchase price allocation is preliminary and is subject to final determination and valuation of the fair value of assets acquired and liabilities assumed.



|                                               |  |                    |          |  
|---------------------------------------------- |  | ------------------ | -------- | -
|                                               |  | September 30, 2006 |         
|Cash and cash equivalents                      |  | $                  | 27,860   |  
|Interest-bearing deposits in other banks       |  |                    | 21,568   |  
|Available-for-sale securities                  |  |                    | 72,076   |  
|Held-to-maturity securities                    |  |                    | 39,245   |  
|Loans held for investment                      |  |                    | 149,875  |  
|Allowance for loan losses                      |  |                    | (2,152   | )
|Premises and equipment                         |  |                    | 5,740    |  
|Accrued interest receivable                    |  |                    | 1,797    |  
|Core deposit intangibles                       |  |                    | 7,761    |  
|Goodwill                                       |  |                    | 44,105   |  
|Other assets                                   |  |                    | 9,376    |  
|                                               |  |                    |          |  
|Total assets acquired                          |  |                    | 377,251  |  
|                                               | 
|Deposits                                       |  |                    | (298,224 | )
|Accrued interest payable and other liabilities |  |                    | (5,990   | )
|                                               |  |                    |          |  
|Total liabilities assumed                      |  |                    | (304,214 | )
|                                               | 
|Net assets acquired                            |  | $                  | 73,037   |  
|                                               |  |                    |          |  

Core deposit intangibles (CDI) are amortized using an economic life method based on deposit attrition
projections derived from nationally-observed patterns within the banking industry. As a result, CDI amortization will decline over time with most of the amortization occurring during the initial years. The core deposit intangible assets acquired in
this transaction are expected to be amortized over a period of 9.5 years. Additional information related to intangible assets and goodwill is included in Note 6  Goodwill and Other Intangibles.



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3.    SECURITIES

The amortized cost and fair value of securities were as follows (in thousands):



|                                                                    |  |                    |         |                        |   |                         |  |   |            |   |  |   |        
|------------------------------------------------------------------- |  | ------------------ | ------- | ---------------------- | - | ----------------------- |  | - | ---------- | - |  | - | -------
|                                                                    |  | September 30, 2006
|                                                                    |  | Amortized Cost     |         | Gross Unrealized Gains |   | Gross Unrealized Losses |  |   | Fair Value
|Available-for-Sale                                                  |  |                    |         |                        |   |                         |  |   |            |   |  |   |        
|Obligations of the U.S. Treasury and other U.S. government agencies |  | $                  | 43,671  |                        | $ |                        |  | $ | (89        | ) |  | $ | 43,582 
|Obligations of states of the U.S. and political subdivisions        |  |                    | 29,742  |                        |   | 19                      |  |   | (2         | ) |  |   | 29,759 
|Mortgage-backed securities and collateralized mortgage obligations  |  |                    | 451,149 |                        |   | 230                     |  |   | (11,006    | ) |  |   | 440,373
|Other securities                                                    |  |                    | 16,064  |                        |   |                        |  |   | (1,972     | ) |  |   | 14,092 
|                                                                    |  |                    |         |                        |   |                         |  |   |            |   |  |   |        
|Total                                                               |  | $                  | 540,626 |                        | $ | 249                     |  | $ | (13,069    | ) |  | $ | 527,806
|                                                                    |  |                    |         |                        |   |                         |  |   |            |   |  |   |        
|Held-to-Maturity                                                    |  |                    |         |                        |   |                         |  |   |            |   |  |   |        
|Obligations of states of the U.S. and political subdivisions        |  | $                  | 92,754  |                        | $ | 459                     |  | $ | (429       | ) |  | $ | 92,784 
|Mortgage-backed securities and collateralized mortgage obligations  |  |                    | 74,489  |                        |   | 60                      |  |   | (1,287     | ) |  |   | 73,262 
|                                                                    |  |                    |         |                        |   |                         |  |   |            |   |  |   |        
|Total                                                               |  | $                  | 167,243 |                        | $ | 519                     |  | $ | (1,716     | ) |  | $ | 166,046
|                                                                    |  |                    |         |                        |   |                         |  |   |            |   |  |   |        
|                                                                    | 
|                                                                    |  | December 31, 2005 
|                                                                    |  | Amortized Cost     |         | Gross Unrealized Gains |   | Gross Unrealized Losses |  |   | Fair Value
|Available-for-Sale                                                  |  |                    |         |                        |   |                         |  |   |            |   |  |   |        
|Obligations of the U.S. Treasury and other U.S. government agencies |  | $                  | 10,031  |                        | $ |                        |  | $ | (107       | ) |  | $ | 9,924  
|Obligations of states of the U.S. and political subdivisions        |  |                    | 3,303   |                        |   | 27                      |  |   | (4         | ) |  |   | 3,326  
|Mortgage-backed securities and collateralized mortgage obligations  |  |                    | 476,541 |                        |   | 286                     |  |   | (10,099    | ) |  |   | 466,728
|Other securities                                                    |  |                    | 16,732  |                        |   |                        |  |   | (765       | ) |  |   | 15,967 
|                                                                    |  |                    |         |                        |   |                         |  |   |            |   |  |   |        
|Total                                                               |  | $                  | 506,607 |                        | $ | 313                     |  | $ | (10,975    | ) |  | $ | 495,945
|                                                                    |  |                    |         |                        |   |                         |  |   |            |   |  |   |        
|Held-to-Maturity                                                    |  |                    |         |                        |   |                         |  |   |            |   |  |   |        
|Obligations of states of the U.S. and political subdivisions        |  | $                  | 58,288  |                        | $ | 649                     |  | $ | (562       | ) |  | $ | 58,375 
|Mortgage-backed securities and collateralized mortgage obligations  |  |                    | 64,765  |                        |   | 9                       |  |   | (1,134     | ) |  |   | 63,640 
|                                                                    |  |                    |         |                        |   |                         |  |   |            |   |  |   |        
|Total                                                               |  | $                  | 123,053 |                        | $ | 658                     |  | $ | (1,696     | ) |  | $ | 122,015
|                                                                    |  |                    |         |                        |   |                         |  |   |            |   |  |   |        



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The contractual maturities of securities at September 30, 2006 are shown below. Expected maturities will differ from
contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties. Dollar amounts are shown in thousands.



|                                                                   |  |                    |         |                  |   |               |  |            |         |  |   |        
|------------------------------------------------------------------ |  | ------------------ | ------- | ---------------- | - | ------------- |  | ---------- | ------- |  | - | -------
|                                                                   |  | Available-for-Sale |         | Held-to-Maturity
|                                                                   |  | AmortizedCost      |         | Fair Value       |   | AmortizedCost |  | Fair Value
|Due in one year or less                                            |  | $                  | 7,777   |                  | $ | 7,756         |  | $          | 6,546   |  | $ | 6,576  
|Due after one year through five years                              |  |                    | 21,589  |                  |   | 21,532        |  |            | 35,689  |  |   | 35,803 
|Due after five years through ten years                             |  |                    | 34,464  |                  |   | 34,470        |  |            | 50,519  |  |   | 50,405 
|Due after ten years                                                |  |                    | 9,583   |                  |   | 9,583         |  |            |        |  |   |       
|Mortgage-backed securities and collateralized mortgage obligations |  |                    | 451,149 |                  |   | 440,373       |  |            | 74,489  |  |   | 73,262 
|Other securities                                                   |  |                    | 16,064  |                  |   | 14,092        |  |            |        |  |   |       
|                                                                   |  |                    |         |                  |   |               |  |            |         |  |   |        
|Total                                                              |  | $                  | 540,626 |                  | $ | 527,806       |  | $          | 167,243 |  | $ | 166,046
|                                                                   |  |                    |         |                  |   |               |  |            |         |  |   |        

The following table summarizes the proceeds received and gross realized gains and losses on the sales of the
available-for-sale securities (in thousands):



|                              |  |                                  |   |      |                                 |        |      |  |      |   |  |   |        |  
|----------------------------- |  | -------------------------------- | - | ---- | ------------------------------- | ------ | ---- |  | ---- | - |  | - | ------ | -
|                              |  | Three months ended September 30, |   |      | Nine months ended September 30, |       
|                              |  | 2006                             |   | 2005 |                                 |        | 2006 |  | 2005 |  
|Proceeds from sales and calls |  | $                                |  |      | $                               | 15,792 |      |  | $    |  |  | $ | 60,049 |  
|Gross realized gains          |  |                                  |  |      |                                 | 63     |      |  |      |  |  |   | 206    |  
|Gross realized losses         |  |                                  |  |      |                                 | (57    | )    |  |      |  |  |   | (146   | )

Securities with unrealized losses segregated by length of impairment as of September 30, 2006 were as follows (in
thousands):



|                                                                    |  |                     |         |                         |   |        |            |  |                |         |                         |   |         |            |   |         |   |  |   |        
|------------------------------------------------------------------- |  | ------------------- | ------- | ----------------------- | - | ------ | ---------- |  | -------------- | ------- | ----------------------- | - | ------- | ---------- | - | ------- | - |  | - | -------
|                                                                    |  | Less than 12 Months |         | More than 12 Months    
|                                                                    |  | Amortized Cost      |         | Gross Unrealized Losses |   |        | Fair Value |  | Amortized Cost |         | Gross Unrealized Losses |   |         | Fair Value
|Available-for-Sale                                                  |  |                     |         |                         |   |        |            |  |                |         |                         |   |         |            |   |         |   |  |   |        
|Obligations of the U.S. Treasury and other U.S. government agencies |  | $                   | 36,667  |                         | $ |       |            |  | $              | 36,667  |                         | $ | 7,004   |            | $ | (89     | ) |  | $ | 6,915  
|Obligations of states of the U.S. and political subdivisions        |  |                     | 363     |                         |   | (1     | )          |  |                | 362     |                         |   | 196     |            |   | (1      | ) |  |   | 195    
|Mortgage-backed securities and collateralized mortgage obligations  |  |                     | 64,904  |                         |   | (709   | )          |  |                | 64,195  |                         |   | 346,688 |            |   | (10,297 | ) |  |   | 336,391
|Other securities                                                    |  |                     | 7,531   |                         |   | (1,572 | )          |  |                | 5,959   |                         |   | 8,709   |            |   | (400    | ) |  |   | 8,309  
|                                                                    |  |                     |         |                         |   |        |            |  |                |         |                         |   |         |            |   |         |   |  |   |        
|Total                                                               |  | $                   | 109,465 |                         | $ | (2,282 | )          |  | $              | 107,183 |                         | $ | 362,597 |            | $ | (10,787 | ) |  | $ | 351,810
|                                                                    |  |                     |         |                         |   |        |            |  |                |         |                         |   |         |            |   |         |   |  |   |        
|Held-to-Maturity                                                    |  |                     |         |                         |   |        |            |  |                |         |                         |   |         |            |   |         |   |  |   |        
|Obligations of states of the U.S. and political subdivisions        |  | $                   | 2,694   |                         | $ | (7     | )          |  | $              | 2,687   |                         | $ | 20,957  |            | $ | (422    | ) |  | $ | 20,535 
|Mortgage-backed securities and collateralized mortgage obligations  |  |                     | 16,910  |                         |   | (159   | )          |  |                | 16,751  |                         |   | 45,323  |            |   | (1,128  | ) |  |   | 44,195 
|                                                                    |  |                     |         |                         |   |        |            |  |                |         |                         |   |         |            |   |         |   |  |   |        
|Total                                                               |  | $                   | 19,604  |                         | $ | (166   | )          |  | $              | 19,438  |                         | $ | 66,280  |            | $ | (1,550  | ) |  | $ | 64,730 
|                                                                    |  |                     |         |                         |   |        |            |  |                |         |                         |   |         |            |   |         |   |  |   |        

Declines in the fair value of individual securities below their cost that are other-than-temporary would result in
writedowns, as a realized loss, of the individual securities to their fair value. In evaluating other-than-temporary



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impairment losses, management considers several factors including the severity and the duration that the fair value has been less than cost, the credit
quality of the issuer, and the intent and ability of the Company to hold the security until recovery of the fair value. The average loss on securities in an unrealized loss position was 2.6% of the amortized cost basis at September 30, 2006.
Other securities in an unrealized loss position of less than 12 months were in a loss position of approximately 21% of the Companys amortized cost basis. These investments have declined in value over the last nine months due to increases in
interest rates. There are no remaining securities in the Companys securities portfolio in a loss position greater than 10% of the Companys amortized cost basis at September 30, 2006. Management believes that the unrealized losses on
the Companys securities portfolio were caused primarily by interest rate increases. Because the decline in market value is attributable to changes in interest rates and not credit quality, and because the Company has the ability and
intent to hold those investments until a recovery of fair value, which may be at maturity, the Company does not consider those investments to be other-than-temporarily impaired at September 30, 2006.

The Company does not own any securities of any one issuer (other than U.S. government and its agencies) for which the aggregate adjusted cost exceeds 10% of the
consolidated shareholders equity at September 30, 2006.

Securities with carrying values totaling $315.3 million and fair values totaling $309.5
million were pledged to secure public deposits at September 30, 2006.

4.    LOANS

The loan portfolio classified by major type was as follows (dollars in thousands):



|                                |  |                    |           |   |                   |   |        |   |           |  |       |  
|------------------------------- |  | ------------------ | --------- | - | ----------------- | - | ------ | - | --------- |  | ----- | -
|                                |  | September 30, 2006 |           |   | December 31, 2005 |  
|                                |  | Amount             |           | % |                   |   | Amount |   | %         | 
|Loans held for sale             |  | $                  | 72,789    |   | 2.3               | % |        | $ | 8,354     |  | 0.3   | %
|Loans held for investment       |  |                    |           |   |                   |   |        |   |           |  |       |  
|Domestic                        |  |                    |           |   |                   |   |        |   |           |  |       |  
|Commercial and industrial       |  |                    | 770,438   |   | 24.8              | % |        |   | 738,061   |  | 27.3  | %
|Real estate:                    |  |                    |           |   |                   |   |        |   |           |  |       |  
|Commercial                      |  |                    | 1,324,322 |   | 42.7              | % |        |   | 1,221,610 |  | 45.3  | %
|Construction                    |  |                    | 601,381   |   | 19.4              | % |        |   | 438,454   |  | 16.2  | %
|Residential mortgage            |  |                    | 220,220   |   | 7.1               | % |        |   | 190,701   |  | 7.1   | %
|Consumer/other                  |  |                    | 82,814    |   | 2.7               | % |        |   | 72,937    |  | 2.7   | %
|Foreign                         |  |                    |           |   |                   |   |        |   |           |  |       |  
|Commercial and industrial       |  |                    | 28,490    |   | 0.9               | % |        |   | 26,080    |  | 1.0   | %
|Other loans                     |  |                    | 2,679     |   | 0.1               | % |        |   | 3,165     |  | 0.1   | %
|                                |  |                    |           |   |                   |   |        |   |           |  |       |  
|Total loans held for investment |  |                    | 3,030,344 |   | 97.7              | % |        |   | 2,691,008 |  | 99.7  | %
|                                |  |                    |           |   |                   |   |        |   |           |  |       |  
|Total loans                     |  | $                  | 3,103,133 |   | 100.0             | % |        | $ | 2,699,362 |  | 100.0 | %
|                                |  |                    |           |   |                   |   |        |   |           |  |       |  

Loan maturities and rate sensitivity of the loans held for investment excluding residential mortgage and consumer
loans, at September 30, 2006 were as follows (in thousands):



|                                    |  |                         |           |                                       |   |                      |  |       |         |  |   |          
|----------------------------------- |  | ----------------------- | --------- | ------------------------------------- | - | -------------------- |  | ----- | ------- |  | - | ---------
|                                    |  | Due in One Year or Less |           | Due After One Year Through Five Years |   | Due After Five Years |  | Total
|Commercial and industrial           |  | $                       | 590,811   |                                       | $ | 161,024              |  | $     | 18,603  |  | $ | 770,438  
|Real estatecommercial              |  |                         | 654,020   |                                       |   | 511,753              |  |       | 158,549 |  |   | 1,324,322
|Real estateconstruction            |  |                         | 444,761   |                                       |   | 118,345              |  |       | 38,275  |  |   | 601,381  
|Foreign loans                       |  |                         | 29,782    |                                       |   | 1,387                |  |       |        |  |   | 31,169   
|                                    |  |                         |           |                                       |   |                      |  |       |         |  |   |          
|Total                               |  | $                       | 1,719,374 |                                       | $ | 792,509              |  | $     | 215,427 |  | $ | 2,727,310
|                                    |  |                         |           |                                       |   |                      |  |       |         |  |   |          
|                                    |  |                         |           |                                      
|Loans with a fixed interest rate    |  | $                       | 180,472   |                                       | $ | 646,723              |  | $     | 186,546 |  | $ | 1,013,741
|Loans with a floating interest rate |  |                         | 1,538,902 |                                       |   | 145,786              |  |       | 28,881  |  |   | 1,713,569
|                                    |  |                         |           |                                       |   |                      |  |       |         |  |   |          
|Total                               |  | $                       | 1,719,374 |                                       | $ | 792,509              |  | $     | 215,427 |  | $ | 2,727,310
|                                    |  |                         |           |                                       |   |                      |  |       |         |  |   |          



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The loan portfolio consists of various types of loans made principally to borrowers located in the Houston, Dallas and
San Antonio metropolitan areas. As of September 30, 2006, there was no concentration of loans to any one type of industry exceeding 10% of total loans nor were there any loans classified as highly leveraged transactions.

As of September 30, 2006 and December 31, 2005, loans from Sterling Bank outstanding to directors, officers and their affiliates were $8.0 million and $9.0
million, respectively. In the opinion of management, all transactions entered into between Sterling Bank and such related parties have been and are in the ordinary course of business, made on the same terms and conditions as similar transactions
with unaffiliated persons. For the nine months ended September 30, 2006, there were principal payments of $171 thousand. As a result of the BOTH acquisition, insider loans increased by $1.1 million at September 30, 2006. Insider loans were
reduced by $2.0 million as two directors with insider loans were no longer serving on the board as of September 30, 2006 as compared to December 31, 2005.

The recorded investment in impaired loans was $14.8 million and $22.4 million at September 30, 2006 and December 31, 2005, respectively. Such impaired loans required an allowance for loan losses of $2.7
million and $4.2 million, respectively. The average recorded investment in impaired loans for the three and nine months ended September 30, 2006 was $13.9 million and $17.5 million, respectively, and for the three and nine months ended
September 30, 2005 was $24.7 million and $22.3 million, respectively. Interest income on impaired loans of $64 thousand was recognized for the nine months ended September 30, 2005. There was no interest income recognized during the three
months ended September 30, 2005. No interest on impaired loans was received for the three and nine months ended September 30, 2006.

Included in
impaired loans are nonperforming loans of $14.8 million and $21.8 million at September 30, 2006 and December 31, 2005, respectively, which have been categorized by management as nonaccrual loans. Interest foregone on nonaccrual loans for
the nine months ended September 30, 2006 and 2005 was approximately $1.3 million and $1.1 million, respectively. The Company did not have any restructured loans as of September 30, 2006 or December 31, 2005.

When management doubts a borrowers ability to meet payment obligations, which typically occurs when principal or interest payments are more than 90 days past due,
the loans are placed on nonaccrual status. Loans 90 days or more past due, not on nonaccrual were $308 thousand and $162 thousand at September 30, 2006 and December 31, 2005, respectively.

5.    ALLOWANCE FOR CREDIT LOSSES

An analysis of
activity in the allowance for credit losses was as follows (in thousands):



|                                                                       |  |                                  |        |   |                                 |   |        |      |  |   |        |   |  |   |        |  
|---------------------------------------------------------------------- |  | -------------------------------- | ------ | - | ------------------------------- | - | ------ | ---- |  | - | ------ | - |  | - | ------ | -
|                                                                       |  | Three Months Ended September 30, |        |   | Nine Months Ended September 30, |  
|                                                                       |  | 2006                             |        |   | 2005                            |   |        | 2006 |  |   | 2005   |  
|Allowance for loan losses at beginning of the period                   |  | $                                | 31,882 |   |                                 | $ | 32,209 |      |  | $ | 31,230 |   |  | $ | 29,406 |  
|Loans charged-off                                                      |  |                                  | 1,669  |   |                                 |   | 6,688  |      |  |   | 5,900  |   |  |   | 12,322 |  
|Loan recoveries                                                        |  |                                  | (923   | ) |                                 |   | (595   | )    |  |   | (2,360 | ) |  |   | (2,391 | )
|                                                                       |  |                                  |        |   |                                 |   |        |      |  |   |        |   |  |   |        |  
|Net loans charged-off                                                  |  |                                  | 746    |   |                                 |   | 6,093  |      |  |   | 3,540  |   |  |   | 9,931  |  
|Allowance for credit losses associated with acquired institutions      |  |                                  | 2,152  |   |                                 |   | 761    |      |  |   | 2,152  |   |  |   | 761    |  
|Provision for loan losses                                              |  |                                  | 858    |   |                                 |   | 4,350  |      |  |   | 4,304  |   |  |   | 10,991 |  
|                                                                       |  |                                  |        |   |                                 |   |        |      |  |   |        |   |  |   |        |  
|Allowance for loan losses at end of the period                         |  |                                  | 34,146 |   |                                 |   | 31,227 |      |  |   | 34,146 |   |  |   | 31,227 |  
|                                                                       |  |                                  |        |   |                                 |   |        |      |  |   |        |   |  |   |        |  
|Reserve for losses on unfunded loan commitments at beginning of period |  |                                  | 890    |   |                                 |   | 746    |      |  |   | 1,173  |   |  |   | 826    |  
|Provision for losses on unfunded loan commitments                      |  |                                  | 37     |   |                                 |   | 215    |      |  |   | (246   | ) |  |   | 135    |  
|                                                                       |  |                                  |        |   |                                 |   |        |      |  |   |        |   |  |   |        |  
|Reserve for unfunded loan commitments at end of period                 |  |                                  | 927    |   |                                 |   | 961    |      |  |   | 927    |   |  |   | 961    |  
|                                                                       |  |                                  |        |   |                                 |   |        |      |  |   |        |   |  |   |        |  
|Total allowance for credit losses                                      |  | $                                | 35,073 |   |                                 | $ | 32,188 |      |  | $ | 35,073 |   |  | $ | 32,188 |  
|                                                                       |  |                                  |        |   |                                 |   |        |      |  |   |        |   |  |   |        |  



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6.    GOODWILL AND OTHER INTANGIBLES

The changes in the carrying amount of goodwill by reporting unit for the year ended December 31, 2005, and the period ended September 30, 2006, were as follows
(in thousands):



|                                   |  |         |        |            |   |        |  |       |        |  |   |        
|---------------------------------- |  | ------- | ------ | ---------- | - | ------ |  | ----- | ------ |  | - | -------
|                                   |  | Houston |        | SanAntonio |   | Dallas |  | Total
|Balance, January 1, 2005           |  | $       | 29,613 |            | $ | 27,205 |  | $     | 5,662  |  | $ | 62,480 
|Prestonwood Bancshares acquisition |  |         |       |            |   |       |  |       | 22,546 |  |   | 22,546 
|                                   |  |         |        |            |   |        |  |       |        |  |   |        
|Balance, December 31, 2005         |  |         | 29,613 |            |   | 27,205 |  |       | 28,208 |  |   | 85,026 
|BOTH, Inc. acquisition             |  |         |       |            |   | 44,105 |  |       |       |  |   | 44,105 
|                                   |  |         |        |            |   |        |  |       |        |  |   |        
|Balance, September 30, 2006        |  | $       | 29,613 |            | $ | 71,310 |  | $     | 28,208 |  | $ | 129,131
|                                   |  |         |        |            |   |        |  |       |        |  |   |        

The changes in the carrying amounts of core deposit intangibles for the year ended December 31, 2005, and the
period ended September 30, 2006, were as follows (in thousands):



|                                   |  |                          |        |  
|---------------------------------- |  | ------------------------ | ------ | -
|                                   |  | Core Deposit Intangibles |       
|Balance, January 1, 2005           |  | $                        | 1,839  |  
|Amortization expense               |  |                          | (521   | )
|Prestonwood Bancshares acquisition |  |                          | 2,233  |  
|                                   |  |                          |        |  
|Balance, December 31, 2005         |  |                          | 3,551  |  
|Amortization expense               |  |                          | (584   | )
|BOTH, Inc. acquisition             |  |                          | 7,761  |  
|                                   |  |                          |        |  
|Balance, September 30, 2006        |  | $                        | 10,728 |  
|                                   |  |                          |        |  

7.    JUNIOR SUBORDINATED DEBT/COMPANY MANDATORILY
REDEEMABLE TRUST PREFERRED SECURITIES

As of September 30, 2006, the Company had the following issues of trust preferred securities outstanding and
junior subordinated debt owed to trusts (dollars in thousands):



|                     |  |                    |  |                                        |        |               |                          |                                         |   |                     |  |                   
|-------------------- |  | ------------------ |  | -------------------------------------- | ------ | ------------- | ------------------------ | --------------------------------------- | - | ------------------- |  | ------------------
|Description          |  | Issuance Date      |  | Trust Preferred Securities
Outstanding |        | Interest Rate |                          | Junior Subordinated Debt Owed
To Trusts |   | Final Maturity Date
|Statutory Trust One  |  | August 30, 2002    |  | $                                      | 20,000 |               | 3-month LIBOR plus 3.45% |                                         | $ | 20,619              |  | August 30, 2032   
|Capital Trust III    |  | September 26, 2002 |  |                                        | 31,250 |               | 8.30% Fixed              |                                         |   | 32,217              |  | September 26, 2032
|BOTH Capital Trust I |  | June 30, 2003      |  |                                        | 4,000  |               | 3-month LIBOR plus 3.10% |                                         |   | 4,123               |  | July 7, 2033      
|                     |  |                    |  |                                        |        |               |                          |                                         |   |                     |  |                   
|Total                |  |                    |  | $                                      | 55,250 |               |                          |                                         | $ | 56,959              |  |                   
|                     |  |                    |  |                                        |        |               |                          |                                         |   |                     |  |                   

Each of the trusts is a statutory business trust organized for the sole purpose of issuing trust securities and
investing the proceeds thereof in junior subordinated debentures of Sterling Bancshares for Statutory Trust One and Capital Trust III and BOTH, Inc. for BOTH Capital Trust I, the sole asset of each trust. The preferred trust securities of each trust
represent preferred beneficial interests in the assets of the respective trusts and are subject to mandatory redemption upon payment of the junior subordinated debentures held by the trust. The common securities of each trust are wholly-owned by
Sterling Bancshares. Each trusts ability to pay amounts due on the



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trust preferred securities is solely dependent upon Sterling Bancshares making payment on the related junior subordinated debentures. Sterling
Bancshares obligations under the junior subordinated debentures and other relevant trust agreements, in aggregate, constitute a full and unconditional guarantee by Sterling Bancshares of each respective trusts obligations under the trust
securities issued by each respective trust.

Each issuance of trust preferred securities outstanding is mandatorily redeemable 30 years after issuance and
is callable beginning five years after issuance if certain conditions are met (including the receipt of appropriate regulatory approvals). A redemption premium is applicable for the period of August 1, 2006 through July 31, 2011 for BOTH
Capital Trust I. The trust preferred securities may be prepaid earlier upon the occurrence and continuation of certain events including a change in their tax status or regulatory capital treatment. In each case, the redemption price is equal to 100%
of the face amount of the trust preferred securities, plus the accrued and unpaid distributions thereon through the redemption date.

The trust preferred
securities issued under Statutory Trust One were privately placed. The interest on these securities is a floating rate that resets quarterly. Until August 30, 2007, there is a ceiling on the three-month LIBOR of 8.50% resulting in a ceiling on
the floating rate of 11.95% during this period. As of September 30, 2006, the floating rate on these securities was 8.95% as compared to 7.47% at December 31, 2005.

The BOTH Capital Trust I preferred securities bear interest at a floating rate equal to the three-month LIBOR, plus 3.10%; however, the calculated interest rate will not exceed 5.96% in the period to July 7, 2008. As
of September 30, 2006, the rate on these securities was 5.96%.

During the second quarter of 2006, Sterling Bancshares Capital Trust II (the
Trust), a subsidiary of the Company, redeemed all 1.2 million of its 9.20% Cumulative Trust Preferred Securities (Nasdaq: SBIBO) and all 35,567 of its 9.20% Common Securities at a redemption price equal to the $25.00 liquidation
amount of each security, plus all accrued and unpaid distributions per security to the redemption date.

The Trust took such action in connection with the
concurrent prepayment by the Company of all of its $29.6 million 9.20% Junior Subordinated Deferrable Interest Debentures (the Debentures) due March 21, 2031 which were held exclusively by the Trust. The Debentures were prepaid on
the redemption date at a prepayment price equal to the principal outstanding amount of the Debentures plus accrued and unpaid interest to the redemption date. During the second quarter of 2006, the Company wrote off the remaining unamortized debt
issuance costs associated with these Debentures totaling $1.3 million.

8.    STOCK-BASED COMPENSATION

The 2003 Stock Incentive and Compensation Plan (the 2003 Stock Plan), which has been approved by the shareholders, permits the grant of unrestricted stock
units, restricted stock unit awards, phantom stock awards, stock appreciation rights or stock options for up to 2,150,000 shares of common stock. Certain share awards granted under previous shareholder-approved plans are still outstanding and
unvested at September 30, 2006.

Options are granted to officers and employees at exercise prices determined by the Human Resources Programs Committee
(Committee) of the Board of Directors. These options generally have exercise prices equal to the fair market value of the common stock at the date of grant, vest ratably over a four-year period and must be exercised within ten years from
the date of grant. Phantom share awards generally vest over four years. Certain awards provide for accelerated vesting if there is a change in control (as defined in the 2003 Stock Plan).

Total stock-based compensation expense that was charged against income for the three and nine-month periods ended September 30, 2006 was $428 thousand and $1.7
million, respectively. The total income tax benefit recognized in the income statement for share-based compensation arrangements was $122 thousand and $487 thousand for the three and nine months ended September 30, 2006. Income tax benefit of
$57 thousand and $187 thousand was recognized for the three and nine-month periods ended September 30, 2005.



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Cash received for exercises under all share-based payment arrangements during the three and nine-month periods ended
September 30, 2006 was $868 thousand and $4.3 million, respectively, and for the three and nine-month periods ended September 30, 2005 was $689 thousand and $2.7 million, respectively. The actual tax benefit realized for the tax
deductions under all share-based payment arrangements totaled $92 thousand and $562 thousand, respectively, for the three and nine-month periods ended September 30, 2006 and $219 thousand and $789 thousand, respectively, for the three and
nine-month periods ended September 30, 2005.

The Company issues new shares upon the exercise of all share-based payment arrangements.

Stock Options  The fair value of each option award is estimated on the date of grant using a Black-Scholes-Merton option valuation model. The
Black-Scholes-Merton formula assumes that option exercises occur at the end of an options contractual term, and that expected volatility, expected dividends, and risk-free interest rates are constant over the options term. The
Black-Scholes-Merton formula is adjusted to take into account certain characteristics of employee share options and similar instruments that are not consistent with the models assumptions. Because of the nature of the formula, those
adjustments take the form of weighted-average assumptions about those characteristics. The expected term represents the period of time that options granted are expected to be outstanding. The risk-free interest rate of the option is based on the
U.S. Treasury zero-coupon with a remaining term equal to the expected term used in the assumption model. The historical volatility is a measure of fluctuations in the Companys share price. The fair value of options was estimated using the
following range of assumptions:



|                        |  |                                 |  |                
|----------------------- |  | ------------------------------- |  | ---------------
|                        |  | Nine Months Ended September 30,
|                        |  | 2006                            |  | 2005           
|Expected term (years)   |  | 4.72  4.82                     |  | 4.33  4.99    
|Risk-free interest rate |  | 4.34%  5.23%                   |  | 4.08%  4.19%  
|Historical volatility   |  | 30.01%  30.21%                 |  | 19.06%  23.69%
|Dividend yield          |  | 1.39%  1.74%                   |  | 1.63%  1.69%  

A summary of changes in outstanding stock options during the nine months ended September 30, 2006 were as
follows:



|                                         |  |                       |   |  |                                 |       |                                             |      |                                          |   |      
|---------------------------------------- |  | --------------------- | - |  | ------------------------------- | ----- | ------------------------------------------- | ---- | ---------------------------------------- | - | -----
|                                         |  | Shares (In thousands) |   |  | Weighted Average Exercise Price |       | Weighted Average Remaining Contractual Term |      | Aggregate Intrinsic Value (In thousands)
|Shares under option, beginning of period |  | 1,314                 |   |  | $                               | 10.95 |                                             |      |                                          |   |      
|Shares granted                           |  | 178                   |   |  |                                 | 17.61 |                                             |      |                                          |   |      
|Shares forfeited or expired              |  | (61                   | ) |  |                                 | 14.13 |                                             |      |                                          |   |      
|Shares exercised                         |  | (343                  | ) |  |                                 | 11.08 |                                             |      |                                          |   |      
|                                         |  |                       |   |  |                                 |       |                                             |      |                                          |   |      
|Shares under option, end of period       |  | 1,088                 |   |  | $                               | 11.32 |                                             | 5.03 |                                          | $ | 9,710
|                                         |  |                       |   |  |                                 |       |                                             |      |                                          |   |      
|Shares exercisable, end of period        |  | 857                   |   |  | $                               | 10.09 |                                             | 3.75 |                                          | $ | 8,713
|                                         |  |                       |   |  |                                 |       |                                             |      |                                          |   |      

The weighted-average grant-date fair value of the options granted during the nine-month period ended
September 30, 2006 was $5.13, compared to $3.41 for the same time period in 2005. The total intrinsic value of options exercised during the nine-month period ended September 30, 2006 was $2.3 million compared to $1.2 million for the
comparable time period in 2005.



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Share Awards A summary of the status of the Companys nonvested share awards is presented below
(shares in thousands):



|                                            |  |                                 |   |      |                                        |       |        |    |   |                                        |   |      
|------------------------------------------- |  | ------------------------------- | - | ---- | -------------------------------------- | ----- | ------ | -- | - | -------------------------------------- | - | -----
|                                            |  | Nine months ended September 30,
|                                            |  | 2006                            |   | 2005
|                                            |  | Shares                          |   |      | Weighted Average Grant-Date Fair Value |       | Shares |    |   | Weighted Average Grant-Date Fair Value
|Nonvested share awards, beginning of period |  | 106                             |   |      | $                                      | 14.33 |        | 41 |   |                                        | $ | 13.53
|Shares granted                              |  | 114                             |   |      |                                        | 17.50 |        | 61 |   |                                        |   | 14.63
|Shares forfeited                            |  | (15                             | ) |      |                                        | 14.43 |        | (4 | ) |                                        |   | 14.20
|Shares vested                               |  | (48                             | ) |      |                                        | 16.29 |        | (9 | ) |                                        |   | 14.08
|                                            |  |                                 |   |      |                                        |       |        |    |   |                                        |   |      
|Nonvested share awards, end of period       |  | 157                             |   |      | $                                      | 15.96 |        | 89 |   |                                        | $ | 14.20
|                                            |  |                                 |   |      |                                        |       |        |    |   |                                        |   |      

As of September 30, 2006, there was $1.9 million of total unrecognized compensation expense related to
nonvested share-based compensation arrangements. That cost is expected to be recognized over a weighted-average period of 2.46 years. The total fair value of shares vested during the nine months ended September 30, 2006 was $782
thousand.

The Company grants certain executives and other key employees restricted stock unit awards whose vesting is contingent upon meeting various
office, departmental and company-wide annual performance goals. The fair value of each grant was estimated using the current public market price of the Companys common stock on September 30, 2006 and assumes that performance goals will be
achieved. If such goals are not met, no future compensation expense will be recognized and any previously recognized compensation expense will be reversed. There were 2,000 performance-based contingent grants outstanding at September 30,
2006. There was no unrecognized compensation expense for these grants at September 30, 2006.

Effective January 1, 2006, the Company entered into
an employment agreement with its chief executive officer (Executive). This agreement establishes, among other things, certain incentive compensation terms which include equity incentives under the 2003 Stock Plan. The Executive was
awarded 125,000 Performance Restricted Share Units (PRSU). The PRSUs will be earned subject to certain performance measures over a four-year period. These performance measures include annual growth in earnings per share, average return
on equity and an overall board evaluation. Based on these criteria, the Executive will earn a specific number of the eligible share units. In addition to the PRSUs, the Executive will earn up to 125,000 bonus shares subject to the same performance
measures. The employment agreement also includes a severance and non-competition agreement. Under this agreement, upon termination of employment under the circumstances described in the agreement, the Executive would become vested in a specified
number of bonus shares. The fair value of each PRSU and bonus share was estimated based on expected performance goals being attained and using the current public market price of the Companys common stock at September 30, 2006. As of
September 30, 2006, there was $2.4 million of total unrecognized compensation expense related to the PRSUs and bonus shares. This cost is expected to be recognized over a remaining period of 3.25 years. If performance measures are not met,
no future compensation expense will be recognized and any previously recognized compensation expense will be reversed.

Stock purchase plan
 The Company offers the 2004 Employee Stock Purchase Plan (the Purchase Plan) to eligible employees. An aggregate of 1.5 million shares of Company common stock may be issued under this plan subject to adjustment upon changes
in capitalization. The Purchase Plan is a compensatory benefit plan to all employees who are employed for more than 20 hours per week and meet minimum length-of-service requirements of three months. The Purchase Plan is subscribed through payroll
deductions which may not exceed 10% of the eligible employees compensation. The purchase price for shares available under the Purchase Plan is 90% of the lower of the fair market value on either the first or last day of each quarter.
Compensation expense



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associated with the Purchase Plan was determined using a Black-Scholes-Merton option pricing formula. Assumptions used in this formula were the same as
disclosed above for incentive stock options except that an expected term of three months was used. During the three and nine months ended September 30, 2006, 5,957 shares and 17,910 shares, respectively, were subscribed for through payroll
deductions under the Purchase Plan compared to 4,852 and 15,461 shares for the same periods in 2005.

9.    EARNINGS PER COMMON
SHARE

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



|                                        |  |                                  |        |                                 |   |        |  |      |        |  |   |       
|--------------------------------------- |  | -------------------------------- | ------ | ------------------------------- | - | ------ |  | ---- | ------ |  | - | ------
|                                        |  | Three months ended September 30, |        | Nine months ended September 30,
|                                        |  | 2006                             |        | 2005                            |   | 2006   |  | 2005
|Net income                              |  | $                                | 11,729 |                                 | $ | 8,686  |  | $    | 33,030 |  | $ | 24,960
|Basic:                                  |  |                                  |        |                                 |   |        |  |      |        |  |   |       
|Weighted average shares outstanding     |  |                                  | 45,428 |                                 |   | 45,362 |  |      | 45,396 |  |   | 45,255
|Diluted:                                |  |                                  |        |                                 |   |        |  |      |        |  |   |       
|Add incremental shares for:             |  |                                  |        |                                 |   |        |  |      |        |  |   |       
|Assumed exercise of outstanding options |  |                                  | 517    |                                 |   | 498    |  |      | 465    |  |   | 458   
|                                        |  |                                  |        |                                 |   |        |  |      |        |  |   |       
|Total                                   |  | $                                | 45,945 |                                 | $ | 45,860 |  | $    | 45,861 |  | $ | 45,713
|                                        |  |                                  |        |                                 |   |        |  |      |        |  |   |       
|Earnings per share:                     |  |                                  |        |                                 |   |        |  |      |        |  |   |       
|Basic                                   |  | $                                | 0.26   |                                 | $ | 0.19   |  | $    | 0.73   |  | $ | 0.55  
|                                        |  |                                  |        |                                 |   |        |  |      |        |  |   |       
|Diluted                                 |  | $                                | 0.26   |                                 | $ | 0.19   |  | $    | 0.72   |  | $ | 0.55  
|                                        |  |                                  |        |                                 |   |        |  |      |        |  |   |       

The incremental shares for the assumed exercise of the outstanding options were determined by application of the
treasury stock method. The calculation of diluted earnings per share excludes 90,320 and 83,691 options outstanding for the three and nine months ended September 30, 2006, and 78,675 and 89,975 options outstanding for the three and nine-month
periods ended September 30, 2005, which were antidilutive.

10.    COMMITMENTS AND CONTINGENCIES

Leases  The Company leases certain office facilities and equipment under operating leases. Rent expense under all noncancelable operating lease
obligations, net of income from noncancelable subleases aggregated, was approximately $1.4 million and $3.7 million for the three and nine months ended September 30, 2006 and $1.1 million and $3.1 million for the three and nine months ended
September 30, 2005. There have been no significant changes in future minimum lease payments by the Company since December 31, 2005. Refer to the 2005 Form 10-K for information regarding these commitments.

Litigation  The Company has been named as a defendant in various legal actions arising in the normal course of business. In the opinion of
management, after reviewing such claims with outside counsel, resolution of these matters will not have a material adverse impact on the consolidated financial statements.

Severance and non-competition agreements  The Company has entered into severance and non-competition agreements with its chief executive officer (discussed in Note 8) and certain other executive
officers. Under the agreements with other executive officers, upon a termination of employment under the circumstances described in the agreements, each would receive: (i) two years base pay; (ii) an annual bonus for two years in an
amount equal to the highest annual bonus paid to the respective executive officer during the three years preceding termination or change in control (as defined in the agreement); (iii) continued eligibility for Company perquisites, welfare and
life insurance benefit plans, to the extent permitted, and in the event participation is not permitted, payment of the cost of such welfare benefits for a period of two years following termination of



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employment; (iv) payment of up to $20,000 in job placement fees; and (v) to the extent permitted by law or the applicable plan, accelerated vesting
and termination of all forfeiture provisions under all benefit plans, options, restricted stock grants or other similar awards.

11.    FINANCIAL INSTRUMENTS WITH OFF-BALANCE SHEET RISK

The Company is a party to various financial instruments with
off-balance sheet risk in the normal course of business to meet the financial needs of its customers. These financial instruments include commitments to extend credit and standby letters of credit. These instruments involve, to varying degrees,
elements of credit and interest rate risk in excess of the amounts recognized in the consolidated balance sheets. The Companys exposure to credit loss in the event of nonperformance by the other party to the financial instrument for
commitments to extend credit is represented by the contractual or notional amount of these instruments. The Company uses the same credit policies in making these commitments and conditional obligations as it does for on-balance sheet instruments.

The following is a summary of the various financial instruments entered into by the Company (in thousands):



|                             |  |                    |         |                   |   |        
|---------------------------- |  | ------------------ | ------- | ----------------- | - | -------
|                             |  | September 30, 2006 |         | December 31, 2005
|Commitments to extend credit |  | $                  | 854,119 |                   | $ | 832,866
|Standby letters of credit    |  |                    | 76,780  |                   |   | 53,252 

Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any
condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments are expected to expire without being fully drawn upon, the total
commitment amounts disclosed above do not necessarily represent future cash requirements. The Company evaluates each customers creditworthiness on a case-by-case basis. The amount of collateral obtained, if considered necessary by the Company,
upon extension of credit, is based on managements credit evaluation of the customer.

Standby letters of credit are conditional commitments issued by
the Company to guarantee the performance of a customer to a third party. The credit risk to the Company in issuing letters of credit is essentially the same as that involved in extending loan facilities to its customers.

Off-balance sheet arrangements also include an interest rate swap, an interest rate floor, an interest rate collar (discussed in Note 13) and the Companys Trust
Preferred Securities (discussed in Note 7).

12.    REGULATORY MATTERS

Capital requirements  The Company is subject to various regulatory capital requirements administered by the state and federal banking agencies. Any
institution that fails to meet its minimum capital requirements is subject to actions by regulators that could have a direct material effect on its financial statements. Under the capital adequacy guidelines and the regulatory framework for prompt
corrective action, the Bank must meet specific capital guidelines based on the Banks assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices. The Companys capital amount and
classification under the regulatory framework for prompt corrective action are also subject to qualitative judgments by the regulators.

To meet the
capital adequacy requirements, Sterling Bancshares and the Bank must maintain minimum capital amounts and ratios as defined in the regulations. Management believes, as of September 30, 2006 and December 31, 2005, that Sterling Bancshares
and the Bank met all capital adequacy requirements to which they are subject.



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The most recent notification from the regulatory banking agencies categorized Sterling Bank as well
capitalized under the regulatory capital framework for prompt corrective action and there have been no events since that notification that management believes have changed the Banks category. The Companys consolidated and the
Banks capital ratios are presented in the following table:



|                                         |  |                                           |         |       |                               |   |        |                                                                                 |         |  |     |        |  |       |         |  |      |  
|---------------------------------------- |  | ----------------------------------------- | ------- | ----- | ----------------------------- | - | ------ | ------------------------------------------------------------------------------- | ------- |  | --- | ------ |  | ----- | ------- |  | ---- | -
|                                         |  | Actual                                    |         |       | For Capital Adequacy Purposes |   |        | To Be Categorized as Well Capitalized Under Prompt Corrective Action Provisions |        
|                                         |  | Amount                                    |         | Ratio |                               |   | Amount |                                                                                 | Ratio   |  |     | Amount |  | Ratio |        
|                                         |  | (In thousands, except percentage amounts) |        
|CONSOLIDATED:                            |  |                                           |         |       |                               |   |        |                                                                                 |         |  |     |        |  |       |         |  |      |  
|As of September 30, 2006:                |  |                                           |         |       |                               |   |        |                                                                                 |         |  |     |        |  |       |         |  |      |  
|Total capital (to risk weighted assets)  |  | $                                         | 402,018 |       | 10.7                          | % |        | $                                                                               | 301,009 |  | 8.0 | %      |  |       | N/A     |  | N/A  |  
|Tier 1 capital (to risk weighted assets) |  |                                           | 320,929 |       | 8.5                           | % |        |                                                                                 | 150,504 |  | 4.0 | %      |  |       | N/A     |  | N/A  |  
|Tier 1 capital (to average assets)       |  |                                           | 320,929 |       | 8.7                           | % |        |                                                                                 | 147,800 |  | 4.0 | %      |  |       | N/A     |  | N/A  |  
|                                         |  |                                           |         |       |                               |  
|As of December 31, 2005:                 |  |                                           |         |       |                               |   |        |                                                                                 |         |  |     |        |  |       |         |  |      |  
|Total capital (to risk weighted assets)  |  | $                                         | 411,229 |       | 12.4                          | % |        | $                                                                               | 266,220 |  | 8.0 | %      |  |       | N/A     |  | N/A  |  
|Tier 1 capital (to risk weighted assets) |  |                                           | 332,590 |       | 10.0                          | % |        |                                                                                 | 133,110 |  | 4.0 | %      |  |       | N/A     |  | N/A  |  
|Tier 1 capital (to average assets)       |  |                                           | 332,590 |       | 9.1                           | % |        |                                                                                 | 145,980 |  | 4.0 | %      |  |       | N/A     |  | N/A  |  
|                                         |  |                                           |         |       |                               |  
|STERLING BANK:                           |  |                                           |         |       |                               |   |        |                                                                                 |         |  |     |        |  |       |         |  |      |  
|As of September 30, 2006:                |  |                                           |         |       |                               |   |        |                                                                                 |         |  |     |        |  |       |         |  |      |  
|Total capital (to risk weighted assets)  |  | $                                         | 428,615 |       | 11.4                          | % |        | $                                                                               | 300,588 |  | 8.0 | %      |  | $     | 375,735 |  | 10.0 | %
|Tier 1 capital (to risk weighted assets) |  |                                           | 347,526 |       | 9.2                           | % |        |                                                                                 | 150,294 |  | 4.0 | %      |  |       | 225,441 |  | 6.0  | %
|Tier 1 capital (to average assets)       |  |                                           | 347,526 |       | 9.4                           | % |        |                                                                                 | 147,552 |  | 4.0 | %      |  |       | 184,440 |  | 5.0  | %
|                                         |  |                                           |         |       |                               |  
|As of December 31, 2005:                 |  |                                           |         |       |                               |   |        |                                                                                 |         |  |     |        |  |       |         |  |      |  
|Total capital (to risk weighted assets)  |  | $                                         | 406,444 |       | 12.2                          | % |        | $                                                                               | 265,767 |  | 8.0 | %      |  | $     | 332,209 |  | 10.0 | %
|Tier 1 capital (to risk weighted assets) |  |                                           | 327,804 |       | 9.9                           | % |        |                                                                                 | 132,884 |  | 4.0 | %      |  |       | 199,326 |  | 6.0  | %
|Tier 1 capital (to average assets)       |  |                                           | 327,804 |       | 9.0                           | % |        |                                                                                 | 145,709 |  | 4.0 | %      |  |       | 182,137 |  | 5.0  | %

On January 1, 2004 the Company deconsolidated the outstanding trust preferred securities from its
Consolidated Financial Statements. However, trust preferred securities are still considered in calculating the Companys Tier 1 capital ratios as permitted by the Federal Reserve rules. These rules, when fully transitioned and applicable on
March 31, 2009, will limit the aggregate amount of trust preferred securities and certain other capital elements to 25% of Tier 1 capital, net of goodwill. At September 30, 2006 the entire amount of the $55.3 million of trust preferred
securities outstanding would count as Tier 1 capital. Any excess amount of trust preferred securities not qualifying for Tier 1 capital may be included in Tier 2 capital. This amount is limited to 50% of Tier 1 capital. Additionally, the final rules
provide that trust preferred securities no longer qualify for Tier 1 capital within 5 years of their maturity. Under the final transitioned rules, there would not be a material impact on the Companys consolidated capital ratios at
September 30, 2006.

Dividend restrictionsDividends paid by Sterling Bank are subject to certain restrictions
imposed by regulatory agencies. Under these restrictions there was an aggregate of approximately $132.2 million available for payment of dividends at September 30, 2006 by the Bank. At September 30, 2006, the aggregate amount of dividends,
which legally could be paid without prior approval of various regulatory agencies, totaled approximately $58.0 million by the Bank.

13.    DERIVATIVE FINANCIAL INSTRUMENTS

Our interest rate risk management strategy includes hedging the repricing
characteristics of certain assets and liabilities so as to mitigate adverse effects on the Companys net interest margin and cash flows from changes in interest rates. We use certain derivative instruments to add stability to the Companys
net interest income and to manage the Companys exposure to interest rate movements.



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The Company estimates its interest rate derivatives using a standardized methodology that nets the discounted expected
future cash receipts and cash payments (based on observable market inputs). These future net cash flows, however, are susceptible to change due primarily to fluctuations in interest rates. As a result, the estimated values of these derivatives will
typically change over time as cash is received and paid and also as market conditions change. As these changes take place, they may have a positive or negative impact on our estimated valuations.

In June 2003, the Bank entered into an interest rate swap agreement with a notional amount of $50.0 million in which the Bank swapped the fixed rate to a floating rate.
Under the terms of the swap agreement, the Bank receives a fixed coupon rate of 7.375% and pays a variable interest rate equal to the three-month LIBOR that is reset on a quarterly basis, plus 3.62%. This swap is designated as a fair-value hedge
that qualifies for the short-cut method of accounting. The swaps fair value is included in other liabilities and was $3.9 million and $3.7 million with a floating rate of 9.13% and 7.77% on September 30, 2006 and
December 31, 2005, respectively. The Companys credit exposure on the interest rate swap is limited to its net favorable fair value, if any, and the interest payment receivable from the counterparty.

During the third quarter of 2006, the Company purchased a prime interest rate floor with a strike rate of 8.00% and a prime interest rate collar contract with an 8.42%
interest rate cap and an 8.00% interest rate floor. These contracts are designated as cash flow hedges of the monthly interest receipts from a portion of the Companys portfolio of prime-based variable-rate loans. The interest rate floor and
interest rate collar have termination dates of August 1, 2009 and August 1, 2010, respectively.

For cash flow hedges, the effective portion of
the gain or loss on the derivative hedging instrument is reported in other comprehensive income, while the ineffective portion (indicated by the excess of the cumulative change in the fair value of the derivative over that which is necessary to
offset the cumulative change in expected future cash flows on the hedge transaction) is recorded in current earnings as other income or other expense. The accumulated net after-tax gain on the floor and collar contracts included in accumulated other
comprehensive income totaled $2.3 million at September 30, 2006. The total fair value of the interest-rate collar and floor was $3.6 million at September 30, 2006 and is included in other assets.

14.    SUBSEQUENT EVENT

On October 31, 2006, the
Company declared a three-for-two stock split to be effected in the form of a 50% stock dividend on its common stock. Stockholders of record on December 1, 2006, will be entitled to one additional share of common stock for every two shares of the
Companys common stock held on that date. Cash paid in lieu of fractional shares will be based on the average of the high and low bids on the record date, as adjusted for the split.



|ITEM 2. | MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
|------- | -------------------------------------------------------------------------------------

FORWARD-LOOKING STATEMENTS

This report, other periodic reports filed by us under the Exchange Act, and other written
or oral statements made by or on behalf of the Company contain certain statements relating to future events and our future results which constitute forward-looking statements under the Private Securities Litigation Reform Act of 1995. These
forward-looking statements are typically identified by words such as expects, anticipates, intends, plans, believes, seeks, estimates, or words of
similar meaning, or future or conditional verbs such as should, could, or may.

Forward-looking statements reflect our
expectation or predictions of future conditions, events or results based on information currently available and involve risks and uncertainties that may cause actual results to differ



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materially from those in such statements. These risks and uncertainties include, but are not limited to, the following:



| |  |  | general business and economic conditions in the markets we serve may be less favorable than anticipated which could decrease the demand for loan, deposit and other financial
services and increase loan delinquencies and defaults;
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | changes in market rates and prices may adversely impact the value of securities, loans, deposits and other financial instruments and the interest rate sensitivity of our balance
sheet;
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | our liquidity requirements could be adversely affected by changes in our assets and liabilities;
| | - |  | ------------------------------------------------------------------------------------------------



| |  |  | the effect of legislative or regulatory developments including changes in laws concerning taxes, banking, securities, insurance and other aspects of the financial securities
industry;
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | competitive factors among financial services organizations, including product and pricing pressures and our ability to attract, develop and retain qualified banking professionals;
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | the effect of changes in accounting policies and practices, as may be adopted by the Financial Accounting Standards Board, the Securities and Exchange Commission, the Public Company
Accounting Oversight Board and other regulatory agencies; and
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | the effect of fiscal and governmental policies of the United States federal government.
| | - |  | ---------------------------------------------------------------------------------------

Forward-looking statements speak only as of the date of this report. We do not undertake to update forward-looking statements to reflect circumstances or events that occur after the date of this report or to reflect
the occurrence of unanticipated events except as required by federal securities laws.

For additional discussion of such risks, uncertainties and
assumptions, see the Companys Annual Report on Form 10-K for the year ended December 31, 2005, filed with the Securities and Exchange Commission.

OVERVIEW

For more than 31 years, Sterling Bancshares, Inc. and Sterling Bank have served the banking needs of small to mid-sized
businesses. We provide a broad array of financial services to Texas businesses and consumers through 45 banking centers in the greater metropolitan areas of Houston, San Antonio and Dallas, Texas. These cities are the 4th, 7thand 9thlargest, respectively, in the United States based on population according to the U.S.
Census Bureau. On September 29, 2006, the Company completed its acquisition of Kerrville, Texas-based BOTH, Inc. (BOTH) and its subsidiary, Bank of the Hills. The results of operations for this acquisition will be included in our
financial results for the fourth quarter of 2006. At September 30, 2006, we had consolidated total assets of $4.3 billion, total loans of $3.1 billion, total deposits of $3.3 billion and shareholders equity of $399.8 million.

We reported net income of $11.7 million for the third quarter ended September 30, 2006, a 35% increase compared to $8.7 million reported for the third quarter of
2005. Third quarter 2006 earnings were $0.26 per diluted share, up from $0.19 per diluted share for the same quarter of 2005. Net income for the third quarter of 2006 included after-tax acquisition costs of $415 thousand or $0.01 per diluted share
and a reduction in income tax expense of $473 thousand, or $0.01 per diluted share as a result of the expiration of previously recorded tax contingencies. Net income for the third quarter of 2005 included after-tax acquisition costs of $540 thousand
or $0.01 per diluted share.

Net income for the nine months ended September 30, 2006 was $33.0 million, or $0.72 per diluted share, compared with
$25.0 million, or $0.55 per diluted share earned for the same period in 2005.

Our third quarter results continue to reflect improvements in asset quality.
As a result of these improvements, net charge-offs have decreased during each of the last four quarters. Additionally, with the completion of the



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acquisition of Bank of the Hills, we have further expanded our presence into the San Antonio/Kerrville area enabling us to add to our core deposit base.

CRITICAL ACCOUNTING POLICIES

The preparation of
financial statements in accordance with accounting principles generally accepted in the United States of America requires management to make a number of judgments, estimates and assumptions that affect the reported amount of assets, liabilities,
income and expenses in our Consolidated Financial Statements and accompanying notes. We believe that the judgments, estimates and assumptions used in the preparation of our Consolidated Financial Statements are appropriate given the factual
circumstances as of September 30, 2006.

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

These policies and the judgments, estimates and assumptions are described in greater detail in the Companys
2005 Annual Report on Form 10-K in the Critical Accounting Policies section of Managements Discussion and Analysis and in Note 1 to the Consolidated Financial Statements  Organization and Summary of Significant
Accounting and Reporting Policies.

RECENT ACCOUNTING STANDARDS

Statement of Accounting StandardsNo. 123R, Share-Based Payment (Revised 2004) (SFAS 123R) established standards for accounting for transactions in which an enterprise receives employee
services in exchange for (a) equity instruments of the enterprise or (b) liabilities that are based on the fair value of the enterprises equity instruments or that may be settled by the issuance of such equity instruments.
SFAS 123R applies to new awards and to awards modified, repurchased, or cancelled after January 1, 2006. The Company used the modified prospective application in implementing SFAS 123R. Beginning in 2006, the Companys results of
operations reflect compensation expense for all employee stock-based compensation, including the unvested portion of stock options granted prior to 2006. Prior to 2006, the Company accounted for stock-based employee compensation using the intrinsic
value-based method of accounting, as permitted. Under the intrinsic value-based method of accounting, no compensation expense was recognized for the Companys incentive stock options or for the Companys employee stock purchase plan. The
adoption of this accounting standard resulted in additional stock-based compensation expense of $80 thousand and $284 thousand for the three and nine-month periods ended September 30, 2006, respectively, attributable to stock options and the
Companys employee stock purchase plan. There was no income tax benefit recorded in the Companys income statement for the three and nine months ended September 30, 2006 for this additional stock-based compensation expense. The
adoption of this accounting standard did not have a meaningful impact on earnings per share for the same time periods.

In February 2006, the Financial
Accounting Standard Board (FASB) issued Statement of Accounting Standards No. 155 (SFAS 155) Accounting for Certain Hybrid Financial Instruments, an amendment of FASB Statements No. 133 and 140. It
establishes, among other things, the accounting for certain derivatives embedded in other financial instruments. The primary objective of this Statement with respect to FASB Statement No. 133, Accounting for Derivative Instruments and
Hedging Activities, is to simplify accounting for any hybrid financial instrument that contains an embedded derivative that would otherwise require bifurcation. The primary objective of this Statement with respect to FASB Statement No. 140,
Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities, is to eliminate a restriction on the passive derivative instruments that a qualifying special-purpose entity (QSPE) may hold. This Statement is
effective for all financial instruments



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acquired or issued after the beginning of an entitys first fiscal year that begins after September 15, 2006. The adoption of this accounting
standard is not expected to have a material impact on the Companys financial statements.

In March 2006, the FASB issued Statement of Accounting
Standards No. 156 (SFAS 156) Accounting for Servicing of Financial Assets, an amendment of FASB Statement No. 140. It establishes, among other things, the accounting for all separately recognized servicing assets and
servicing liabilities. This Statement amends Statement 140 to require that all separately recognized servicing assets and servicing liabilities be initially measured at fair value, if practicable. This Statement is effective for fiscal years
beginning after September 15, 2006. The adoption of this accounting standard is not expected to have a material impact on the Companys financial statements.

In June 2006, the FASB issued FASB Interpretation No. 48 (FIN 48) Accounting for Uncertainty in Income Taxes, an interpretation of FASB Statement No. 109. FIN 48 clarifies the accounting
for uncertainty in income taxes recognized in an enterprises financial statements in accordance with FASB Statement No. 109 (FAS 109), Accounting for Income Taxes. FIN 48 clarifies the application of FAS 109 by defining
a criterion that an individual tax position must meet for any part of the benefit of that position to be recognized in an enterprises financial statements. Additionally, FIN 48 provides guidance on measurement, derecognition, classification,
interest and penalties, accounting in interim periods, disclosure, and transition. FIN 48 is effective for fiscal years beginning after December 15, 2006. The adoption of this accounting standard is not expected to have a material impact on the
Companys financial statements.

In September 2006, the FASB issued Statement of Accounting Standards No. 157 (SFAS 157) Fair
Value Measurements. This Statement defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles (GAAP), and expands disclosures about fair value measurements. This Statement is effective for
financial statements issued for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years. The adoption of this accounting standard is not expected to have a material impact on the Companys financial
statements.



23



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##### Table of Contents

SELECTED FINANCIAL DATA



|                                                               |  |                                                                 |           |   |                                |   |           |                        |  |   |           |   |  |      |           |   |  |   |           |  
|-------------------------------------------------------------- |  | --------------------------------------------------------------- | --------- | - | ------------------------------ | - | --------- | ---------------------- |  | - | --------- | - |  | ---- | --------- | - |  | - | --------- | -
|                                                               |  | Three Months EndedSeptember 30,                                 |           |   | Nine Months EndedSeptember 30, |   |           | Year EndedDecember 31, | 
|                                                               |  | 2006                                                            |           |   | 2005                           |   |           | 2006                   |  |   | 2005      |   |  | 2005 |          
|                                                               |  | (Dollars and shares in thousands, except for per share amounts) |          
|INCOME STATEMENT DATA:                                         |  |                                                                 |           |  
|Net interest income                                            |  | $                                                               | 42,905    |   |                                | $ | 37,984    |                        |  | $ | 126,410   |   |  | $    | 109,322   |   |  | $ | 150,230   |  
|Provision for credit losses                                    |  |                                                                 | 895       |   |                                |   | 4,565     |                        |  |   | 4,058     |   |  |      | 11,126    |   |  |   | 14,371    |  
|Noninterest income                                             |  |                                                                 | 7,504     |   |                                |   | 7,094     |                        |  |   | 23,013    |   |  |      | 20,400    |   |  |   | 26,959    |  
|Noninterest expense                                            |  |                                                                 | 32,567    |   |                                |   | 27,712    |                        |  |   | 96,718    |   |  |      | 82,102    |   |  |   | 110,646   |  
|Income before income taxes                                     |  |                                                                 | 16,947    |   |                                |   | 12,801    |                        |  |   | 48,647    |   |  |      | 36,494    |   |  |   | 52,172    |  
|Net income                                                     |  |                                                                 | 11,729    |   |                                |   | 8,686     |                        |  |   | 33,030    |   |  |      | 24,960    |   |  |   | 36,222    |  
|BALANCE SHEET DATA (at period-end):                            |  |                                                                 |           |   |                                |   |           |                        |  |   |           |   |  |      |           |   |  |   |           |  
|Total assets                                                   |  | $                                                               | 4,264,124 |   |                                | $ | 3,730,024 |                        |  | $ | 4,264,124 |   |  | $    | 3,730,024 |   |  | $ | 3,726,859 |  
|Total loans                                                    |  |                                                                 | 3,103,133 |   |                                |   | 2,700,524 |                        |  |   | 3,103,133 |   |  |      | 2,700,524 |   |  |   | 2,699,362 |  
|Allowance for loan losses                                      |  |                                                                 | 34,146    |   |                                |   | 31,227    |                        |  |   | 34,146    |   |  |      | 31,227    |   |  |   | 31,230    |  
|Total securities                                               |  |                                                                 | 695,049   |   |                                |   | 635,200   |                        |  |   | 695,049   |   |  |      | 635,200   |   |  |   | 618,998   |  
|Trading assets                                                 |  |                                                                 |          |   |                                |   | 21,019    |                        |  |   |          |   |  |      | 21,019    |   |  |   | 28,515    |  
|Total deposits                                                 |  |                                                                 | 3,318,510 |   |                                |   | 2,769,009 |                        |  |   | 3,318,510 |   |  |      | 2,769,009 |   |  |   | 2,838,143 |  
|Short-term borrowings                                          |  |                                                                 | 372,250   |   |                                |   | 473,050   |                        |  |   | 372,250   |   |  |      | 473,050   |   |  |   | 392,850   |  
|Subordinated debt                                              |  |                                                                 | 46,018    |   |                                |   | 46,635    |                        |  |   | 46,018    |   |  |      | 46,635    |   |  |   | 46,238    |  
|Junior subordinated debt                                       |  |                                                                 | 56,959    |   |                                |   | 82,475    |                        |  |   | 56,959    |   |  |      | 82,475    |   |  |   | 82,475    |  
|Shareholders equity                                           |  |                                                                 | 399,776   |   |                                |   | 329,180   |                        |  |   | 399,776   |   |  |      | 329,180   |   |  |   | 334,472   |  
|COMMON SHARE DATA:                                             |  |                                                                 |           |   |                                |   |           |                        |  |   |           |   |  |      |           |   |  |   |           |  
|Earnings per share (1)                                         |  |                                                                 |           |   |                                |   |           |                        |  |   |           |   |  |      |           |   |  |   |           |  
|Basic                                                          |  | $                                                               | 0.26      |   |                                | $ | 0.19      |                        |  | $ | 0.73      |   |  | $    | 0.55      |   |  | $ | 0.80      |  
|Diluted                                                        |  |                                                                 | 0.26      |   |                                |   | 0.19      |                        |  |   | 0.72      |   |  |      | 0.55      |   |  |   | 0.79      |  
|Shares used in computing earnings per common share             |  |                                                                 |           |   |                                |   |           |                        |  |   |           |   |  |      |           |   |  |   |           |  
|Basic                                                          |  |                                                                 | 45,428    |   |                                |   | 45,362    |                        |  |   | 45,396    |   |  |      | 45,255    |   |  |   | 45,288    |  
|Diluted                                                        |  |                                                                 | 45,945    |   |                                |   | 45,860    |                        |  |   | 45,861    |   |  |      | 45,713    |   |  |   | 45,761    |  
|End of period common shares outstanding                        |  |                                                                 | 47,393    |   |                                |   | 45,392    |                        |  |   | 47,393    |   |  |      | 45,392    |   |  |   | 45,334    |  
|Book value per common share at period-end                      |  |                                                                 |           |   |                                |   |           |                        |  |   |           |   |  |      |           |   |  |   |           |  
|Total                                                          |  | $                                                               | 8.44      |   |                                | $ | 7.25      |                        |  | $ | 8.44      |   |  | $    | 7.25      |   |  | $ | 7.38      |  
|Tangible                                                       |  |                                                                 | 5.48      |   |                                |   | 5.31      |                        |  |   | 5.48      |   |  |      | 5.31      |   |  |   | 5.42      |  
|Cash dividends paid per common share                           |  |                                                                 | 0.07      |   |                                |   | 0.06      |                        |  |   | 0.21      |   |  |      | 0.18      |   |  |   | 0.24      |  
|Common stock dividend payout ratio                             |  |                                                                 | 27.08     | % |                                |   | 31.33     | %                      |  |   | 28.83     | % |  |      | 32.62     | % |  |   | 30.00     | %
|SELECTED PERFORMANCE RATIOS AND OTHER DATA:                    |  |                                                                 |           |   |                                |   |           |                        |  |   |           |   |  |      |           |   |  |   |           |  
|Return on average common equity (2)                            |  |                                                                 | 13.11     | % |                                |   | 10.41     | %                      |  |   | 12.74     | % |  |      | 10.28     | % |  |   | 11.07     | %
|Return on average assets (2)                                   |  |                                                                 | 1.21      | % |                                |   | 0.96      | %                      |  |   | 1.17      | % |  |      | 0.95      | % |  |   | 1.02      | %
|Net interest margin                                            |  |                                                                 | 4.87      | % |                                |   | 4.57      | %                      |  |   | 4.91      | % |  |      | 4.57      | % |  |   | 4.63      | %
|Efficiency ratio                                               |  |                                                                 | 64.61     | % |                                |   | 61.48     | %                      |  |   | 64.73     | % |  |      | 63.29     | % |  |   | 62.44     | %
|Full-time equivalent employees                                 |  |                                                                 | 1,068     |   |                                |   | 984       |                        |  |   | 1,068     |   |  |      | 984       |   |  |   | 1,014     |  
|Number of banking offices                                      |  |                                                                 | 45        |   |                                |   | 41        |                        |  |   | 45        |   |  |      | 41        |   |  |   | 40        |  
|LIQUIDITY AND CAPITAL RATIOS:                                  |  |                                                                 |           |   |                                |   |           |                        |  |   |           |   |  |      |           |   |  |   |           |  
|Average loans to average deposits                              |  |                                                                 | 97.04     | % |                                |   | 99.70     | %                      |  |   | 96.35     | % |  |      | 98.05     | % |  |   | 97.67     | %
|Period-end shareholders equity to total assets                |  |                                                                 | 9.38      | % |                                |   | 8.83      | %                      |  |   | 9.38      | % |  |      | 8.83      | % |  |   | 8.97      | %
|Average shareholders equity to average assets                 |  |                                                                 | 9.27      | % |                                |   | 9.19      | %                      |  |   | 9.16      | % |  |      | 9.26      | % |  |   | 9.19      | %
|Period-end tangible capital to total tangible assets           |  |                                                                 | 6.30      | % |                                |   | 6.62      | %                      |  |   | 6.30      | % |  |      | 6.62      | % |  |   | 6.76      | %
|Tier 1 capital to risk-weighted assets                         |  |                                                                 | 8.65      | % |                                |   | 9.93      | %                      |  |   | 8.65      | % |  |      | 9.93      | % |  |   | 9.99      | %
|Total capital to risk-weighted assets                          |  |                                                                 | 10.83     | % |                                |   | 12.34     | %                      |  |   | 10.83     | % |  |      | 12.34     | % |  |   | 12.36     | %
|Tier 1 leverage ratio (Tier 1 capital to average assets)       |  |                                                                 | 8.69      | % |                                |   | 9.21      | %                      |  |   | 8.69      | % |  |      | 9.21      | % |  |   | 9.11      | %
|ASSET QUALITY RATIOS:                                          |  |                                                                 |           |   |                                |   |           |                        |  |   |           |   |  |      |           |   |  |   |           |  
|Period-end allowance for credit losses to period-end loans     |  |                                                                 | 1.13      | % |                                |   | 1.19      | %                      |  |   | 1.13      | % |  |      | 1.19      | % |  |   | 1.20      | %
|Period-end allowance for loan losses to period-end loans       |  |                                                                 | 1.10      | % |                                |   | 1.16      | %                      |  |   | 1.10      | % |  |      | 1.16      | % |  |   | 1.16      | %
|Period-end allowance for loan losses to nonperforming loans    |  |                                                                 | 231.50    | % |                                |   | 129.24    | %                      |  |   | 231.50    | % |  |      | 129.24    | % |  |   | 142.99    | %
|Nonperforming assets to period-end loans and foreclosed assets |  |                                                                 | 0.54      | % |                                |   | 0.93      | %                      |  |   | 0.54      | % |  |      | 0.93      | % |  |   | 0.83      | %
|Nonperforming loans to period-end loans                        |  |                                                                 | 0.48      | % |                                |   | 0.89      | %                      |  |   | 0.48      | % |  |      | 0.89      | % |  |   | 0.81      | %
|Nonperforming assets to period-end assets                      |  |                                                                 | 0.39      | % |                                |   | 0.67      | %                      |  |   | 0.39      | % |  |      | 0.67      | % |  |   | 0.60      | %
|Net charge-offs to average loans (2)                           |  |                                                                 | 0.10      | % |                                |   | 0.93      | %                      |  |   | 0.17      | % |  |      | 0.53      | % |  |   | 0.51      | %

---

|(1) | The calculation of diluted EPS excludes 90,320 and 83,691 options outstanding for the three and nine months ended September 30, 2006 and 78,675 and 89,975 options outstanding
for the three and nine-month periods ended September 30, 2005, which were antidilutive.
|--- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(2) | Interim periods annualized
|--- | --------------------------



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##### Table of Contents

RESULTS OF OPERATIONS

Net IncomeNet income was $11.7 million for the quarter ended September 30, 2006, a 35% increase compared to $8.7 million reported for the third quarter of 2005. Earnings were $0.26 per diluted share
for the third quarter of 2006, up from $0.19 per diluted share for the third quarter of 2005. Net income for the third quarter of 2006 included after-tax acquisition costs of $415 thousand or $0.01 per diluted share and a reduction in income tax
expense of $473 thousand, or $0.01 per diluted share as a result of the expiration of previously recorded tax contingencies. Net income for the third quarter of 2005 included after-tax acquisition costs of $540 thousand or $0.01 per diluted share.

Net income for the nine months ended September 30, 2006 was $33.0 million, or $0.72 per diluted share, compared with $25.0 million, or $0.55 per
diluted share, earned for the same period in 2005.

Details of the changes in the various components of net income are discussed below.

Net Interest Income  Net interest income represents the amount by which interest income on interest-earning assets, including loans and securities,
exceeds interest paid on interest-bearing liabilities, including deposits and borrowings. Net interest income is our principal source of earnings. Interest rate fluctuations, as well as changes in the amount and type of earning assets and
liabilities, combine to affect net interest income.

The Federal Reserve Board significantly influences market interest rates, including rates offered for
loans and deposits by many financial institutions. Generally, when the Federal Reserve Board changes the target overnight interest rate charged by banks, the market responds with a similar change in the prime lending rate. Beginning in June 2004,
the Federal Reserve Board increased overnight interest rates by 425 basis points to 5.25% at September 30, 2006. Our net interest margin has continued to benefit from these gradual increases in short-term interest rates. In contrast, long-term
interest rates, which are impacted by various forces including national and world-wide economies and political and monetary policies, have not increased by the same amount. This has resulted in a general flattening of the interest rate yield curve.
Since our balance sheet is asset sensitive, our interest-earning assets generally reprice more quickly than our interest-bearing liabilities. However, in the current interest rate environment, the benefit of the Companys traditionally
asset-sensitive position has been negatively impacted but not eliminated.

Net interest income was $42.9 million for the three-month period ended
September 30, 2006, an increase of $4.9 million or 13.0% compared to the same period in 2005. For the nine-month period ended September 30, 2006, net interest income was $126 million, an increase of $17.1 million or 15.6% compared to the
same period in 2005. Our net interest margin was 4.87% and 4.91% for the three and nine-month periods ended September 30, 2006, respectively, compared to 4.57% for both the three and nine-month periods ended September 30, 2005. Overall,
our net interest income and net interest margin were higher during the 2006 periods, as compared with 2005, due in large part to higher deposit balances that were used to fund interest-earning asset growth and reduce short-term borrowings and the
increases in short-term interest rates. Additionally, during the second quarter of 2006, we repaid $29.6 million of junior subordinated debt with an interest rate of 9.20%. The expansion of the net interest margin has been partially offset by a
flatter interest rate yield curve and higher rates paid on borrowings and deposits. Changes in the mix of interest-earning assets and liabilities influence our net interest income and net interest margin.

Average interest-earning assets for the three and nine-month periods ended September 30, 2006 increased $202 million or 6.1% and $242 million or 7.6%, respectively,
over the comparable periods in 2005. The average yield earned on interest-earning assets increased 98 basis points and 103 basis points, respectively, for the same periods. The increase in interest-earning assets was due primarily to an increase in
average loans held for investment of $281 million or 10.9% and $322 million or 13.0% for the three and nine months ended September 30, 2006, respectively, over the comparable periods in 2005. This increase in average loans held for investment
and increases in short-term interest rates contributed to the $12.0 million and $38.1 million increase



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in interest income on loans held for investment for the three and nine months ended September 30, 2006 over the comparable periods in 2005. The size of
the loan portfolio during 2006 as a percentage of average interest-earning assets increased from 78% for the first nine months of 2005 to 82% for the same period in 2006.

On average, the securities portfolio (including trading assets) was lower by $106 million or 15.2% and $84.5 million or 12.1% for the three and nine-month periods ended September 30, 2006, respectively, compared
to the same periods in 2005. We decreased the securities portfolio as a percentage of interest-earning assets through a combination of scheduled maturities, paydowns and sales of securities beginning in 2005. On average, the available-for-sale and
held-to-maturity portfolios represent 17% of average interest-earning assets for the nine-month period ended September 30, 2006, down from 21% for the same time period in 2005. Interest income earned on the securities portfolio decreased $743
thousand and $1.2 million for the three and nine-month periods ended September 30, 2006, respectively, compared to the same time periods in 2005. The average yield earned on the securities portfolio increased 24 basis points and 31 basis
points, respectively, during the same time periods, which offset the decrease in the average securities portfolio.

Average interest-bearing liabilities for
the three and nine-month periods ended September 30, 2006 increased $124 million or 5.4% and $149 million or 6.6%, respectively, compared to the same periods in 2005. The average rate paid on interest-bearing liabilities increased 101 basis
points and 100 basis points for the same time frames. These increases in interest-bearing liabilities were primarily due to an increase in average interest-bearing deposits and certificates of deposit of $123 million and $198 million, respectively,
for the three-month period ended September 30, 2006 and $87.5 million and $201 million, respectively, for the nine-month period ended September 30, 2006, compared to the same periods in 2005. The average rate paid on deposits increased 113
basis points and 102 basis points for the same time periods due primarily to increases in interest rates offered on deposit products and the increase of certificates of deposit as a percentage of total deposits. The increase in average deposit
balances and interest rates paid resulted in additional interest expense of $7.2 million and $18.1 million for the three and nine-month periods ended September 30, 2006 compared to the same periods in 2005.

Average short-term borrowings for the three and nine-month periods ended September 30, 2006 decreased $164 million or 31.9% and $122 million or 25.2%, respectively,
compared to the same periods in 2005. These decreases in average short-term borrowings were due to increases in both average interest-bearing and noninterest-bearing deposits. The average rate paid on short-term borrowings increased 184 basis points
and 191 basis points for the three and nine-month periods ended September 30, 2006, respectively, compared to the same periods in 2005, resulting in an increase in interest expense of $192 thousand and $2.4 million during the same periods.



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##### Table of Contents

Certain average balances, together with the total dollar amounts of interest income and expense and the average interest
yields/rates are included below. No tax equivalent adjustments were made.



|                                           |  |                                  |           |   |          |   |                    |  |       |                 |  |   |           |   |                    |   |        |  |      |  
|------------------------------------------ |  | -------------------------------- | --------- | - | -------- | - | ------------------ |  | ----- | --------------- |  | - | --------- | - | ------------------ | - | ------ |  | ---- | -
|                                           |  | Three Months Ended September 30, |          
|                                           |  | (Dollars in thousands)           |          
|                                           |  | 2006                             |           |   | 2005     |  
|                                           |  | Average Balance                  |           |   | Interest |   | Average Yield/Rate |  |       | Average Balance |  |   | Interest  |   | Average Yield/Rate |  
|Interest-Earning Assets:                   |  |                                  |           |   |          |   |                    |  |       |                 |  |   |           |   |                    |   |        |  |      |  
|Loans held for sale (1)                    |  | $                                | 39,729    |   |          | $ | 799                |  | 7.98  | %               |  | $ | 10,788    |   |                    | $ | 212    |  | 7.80 | %
|Loans held for investment (1):             |  |                                  |           |   |          |   |                    |  |       |                 |  |   |           |   |                    |   |        |  |      |  
|Taxable                                    |  |                                  | 2,860,125 |   |          |   | 57,323             |  | 7.95  | %               |  |   | 2,579,501 |   |                    |   | 45,296 |  | 6.97 | %
|Non-taxable                                |  |                                  | 2,299     |   |          |   | 36                 |  | 6.20  | %               |  |   | 2,316     |   |                    |   | 37     |  | 6.29 | %
|Securities:                                |  |                                  |           |   |          |   |                    |  |       |                 |  |   |           |   |                    |   |        |  |      |  
|Taxable                                    |  |                                  | 524,572   |   |          |   | 5,902              |  | 4.46  | %               |  |   | 608,671   |   |                    |   | 6,404  |  | 4.17 | %
|Non-taxable                                |  |                                  | 57,965    |   |          |   | 549                |  | 3.76  | %               |  |   | 62,069    |   |                    |   | 604    |  | 3.86 | %
|Trading assets                             |  |                                  | 6,642     |   |          |   | 73                 |  | 4.35  | %               |  |   | 24,027    |   |                    |   | 259    |  | 4.27 | %
|Federal funds sold                         |  |                                  | 4,487     |   |          |   | 55                 |  | 4.83  | %               |  |   | 6,983     |   |                    |   | 59     |  | 3.34 | %
|Deposits in financial institutions         |  |                                  | 2,965     |   |          |   | 34                 |  | 4.51  | %               |  |   | 2,698     |   |                    |   | 24     |  | 3.54 | %
|                                           |  |                                  |           |   |          |   |                    |  |       |                 |  |   |           |   |                    |   |        |  |      |  
|Total interest-earning assets              |  |                                  | 3,498,784 |   |          |   | 64,771             |  | 7.34  | %               |  |   | 3,297,053 |   |                    |   | 52,895 |  | 6.36 | %
|                                           |  |                                  |           |   |          |  
|Noninterest-earning assets:                |  |                                  |           |   |          |   |                    |  |       |                 |  |   |           |   |                    |   |        |  |      |  
|Cash and due from banks                    |  |                                  | 100,986   |   |          |   |                    |  |       |                 |  |   | 96,329    |   |                    |   |        |  |      |  
|Premises and equipment, net                |  |                                  | 37,104    |   |          |   |                    |  |       |                 |  |   | 38,305    |   |                    |   |        |  |      |  
|Other assets                               |  |                                  | 225,312   |   |          |   |                    |  |       |                 |  |   | 204,607   |   |                    |   |        |  |      |  
|Allowance for loan losses                  |  |                                  | (32,132   | ) |          |   |                    |  |       |                 |  |   | (32,652   | ) |                    |   |        |  |      |  
|                                           |  |                                  |           |   |          |   |                    |  |       |                 |  |   |           |   |                    |   |        |  |      |  
|Total noninterest-earning assets           |  |                                  | 331,270   |   |          |   |                    |  |       |                 |  |   | 306,589   |   |                    |   |        |  |      |  
|                                           |  |                                  |           |   |          |   |                    |  |       |                 |  |   |           |   |                    |   |        |  |      |  
|Total assets                               |  | $                                | 3,830,054 |   |          |   |                    |  |       |                 |  | $ | 3,603,642 |   |                    |   |        |  |      |  
|                                           |  |                                  |           |   |          |   |                    |  |       |                 |  |   |           |   |                    |   |        |  |      |  
|Interest-bearing liabilities:              |  |                                  |           |   |          |   |                    |  |       |                 |  |   |           |   |                    |   |        |  |      |  
|Deposits:                                  |  |                                  |           |   |          |   |                    |  |       |                 |  |   |           |   |                    |   |        |  |      |  
|Demand and savings                         |  | $                                | 1,071,169 |   |          | $ | 4,971              |  | 1.84  | %               |  | $ | 948,507   |   |                    | $ | 2,145  |  | 0.90 | %
|Certificates and other time                |  |                                  | 920,615   |   |          |   | 9,898              |  | 4.27  | %               |  |   | 723,113   |   |                    |   | 5,572  |  | 3.06 | %
|Short-term borrowings                      |  |                                  | 350,233   |   |          |   | 4,690              |  | 5.31  | %               |  |   | 514,155   |   |                    |   | 4,498  |  | 3.47 | %
|Subordinated debt                          |  |                                  | 44,999    |   |          |   | 1,155              |  | 10.18 | %               |  |   | 47,417    |   |                    |   | 950    |  | 7.95 | %
|Junior subordinated debt                   |  |                                  | 52,925    |   |          |   | 1,152              |  | 8.64  | %               |  |   | 82,475    |   |                    |   | 1,746  |  | 8.40 | %
|                                           |  |                                  |           |   |          |   |                    |  |       |                 |  |   |           |   |                    |   |        |  |      |  
|Total interest-bearing liabilities         |  |                                  | 2,439,941 |   |          |   | 21,866             |  | 3.56  | %               |  |   | 2,315,667 |   |                    |   | 14,911 |  | 2.55 | %
|                                           |  |                                  |           |   |          |  
|Noninterest-bearing sources:               |  |                                  |           |   |          |   |                    |  |       |                 |  |   |           |   |                    |   |        |  |      |  
|Demand deposits                            |  |                                  | 998,856   |   |          |   |                    |  |       |                 |  |   | 928,828   |   |                    |   |        |  |      |  
|Other liabilities                          |  |                                  | 36,335    |   |          |   |                    |  |       |                 |  |   | 28,012    |   |                    |   |        |  |      |  
|                                           |  |                                  |           |   |          |   |                    |  |       |                 |  |   |           |   |                    |   |        |  |      |  
|Total noninterest-bearing liabilities      |  |                                  | 1,035,191 |   |          |   |                    |  |       |                 |  |   | 956,840   |   |                    |   |        |  |      |  
|Shareholders equity                       |  |                                  | 354,922   |   |          |   |                    |  |       |                 |  |   | 331,135   |   |                    |   |        |  |      |  
|                                           |  |                                  |           |   |          |   |                    |  |       |                 |  |   |           |   |                    |   |        |  |      |  
|Total liabilities and shareholders equity |  | $                                | 3,830,054 |   |          |   |                    |  |       |                 |  | $ | 3,603,642 |   |                    |   |        |  |      |  
|                                           |  |                                  |           |   |          |   |                    |  |       |                 |  |   |           |   |                    |   |        |  |      |  
|Net interest income & margin               |  |                                  |           |   |          | $ | 42,905             |  | 4.87  | %               |  |   |           |   |                    | $ | 37,984 |  | 4.57 | %
|                                           |  |                                  |           |   |          |   |                    |  |       |                 |  |   |           |   |                    |   |        |  |      |  

---

|(1) | For the purpose of calculating loan yields, average loan balances include nonaccrual loans with no related interest income.
|--- | ---------------------------------------------------------------------------------------------------------------------------



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|                                           |  |                                 |           |   |          |   |                    |  |      |                 |  |   |           |   |                    |   |         |  |      |  
|------------------------------------------ |  | ------------------------------- | --------- | - | -------- | - | ------------------ |  | ---- | --------------- |  | - | --------- | - | ------------------ | - | ------- |  | ---- | -
|                                           |  | Nine Months Ended September 30, |          
|                                           |  | (Dollars in thousands)          |          
|                                           |  | 2006                            |           |   | 2005     |  
|                                           |  | Average Balance                 |           |   | Interest |   | Average Yield/Rate |  |      | Average Balance |  |   | Interest  |   | Average Yield/Rate |  
|Interest-Earning Assets:                   |  |                                 |           |   |          |   |                    |  |      |                 |  |   |           |   |                    |   |         |  |      |  
|Loans held for sale (1)                    |  | $                               | 19,019    |   |          | $ | 1,149              |  | 8.07 | %               |  | $ | 10,138    |   |                    | $ | 559     |  | 7.37 | %
|Loans held for investment (1):             |  |                                 |           |   |          |   |                    |  |      |                 |  |   |           |   |                    |   |         |  |      |  
|Taxable                                    |  |                                 | 2,801,457 |   |          |   | 162,937            |  | 7.78 | %               |  |   | 2,479,256 |   |                    |   | 124,769 |  | 6.73 | %
|Non-taxable                                |  |                                 | 2,402     |   |          |   | 113                |  | 6.30 | %               |  |   | 2,579     |   |                    |   | 141     |  | 7.29 | %
|Securities:                                |  |                                 |           |   |          |   |                    |  |      |                 |  |   |           |   |                    |   |         |  |      |  
|Taxable                                    |  |                                 | 540,033   |   |          |   | 18,062             |  | 4.47 | %               |  |   | 607,830   |   |                    |   | 18,904  |  | 4.16 | %
|Non-taxable                                |  |                                 | 59,071    |   |          |   | 1,700              |  | 3.85 | %               |  |   | 63,317    |   |                    |   | 1,844   |  | 3.89 | %
|Trading assets                             |  |                                 | 14,416    |   |          |   | 643                |  | 5.96 | %               |  |   | 26,905    |   |                    |   | 893     |  | 4.44 | %
|Federal funds sold                         |  |                                 | 4,041     |   |          |   | 140                |  | 4.63 | %               |  |   | 10,048    |   |                    |   | 218     |  | 2.90 | %
|Deposits in financial institutions         |  |                                 | 3,649     |   |          |   | 124                |  | 4.54 | %               |  |   | 1,568     |   |                    |   | 39      |  | 3.35 | %
|                                           |  |                                 |           |   |          |   |                    |  |      |                 |  |   |           |   |                    |   |         |  |      |  
|Total interest-earning assets              |  |                                 | 3,444,088 |   |          |   | 184,868            |  | 7.18 | %               |  |   | 3,201,641 |   |                    |   | 147,367 |  | 6.15 | %
|                                           |  |                                 |           |   |          |  
|Noninterest-earning assets:                |  |                                 |           |   |          |   |                    |  |      |                 |  |   |           |   |                    |   |         |  |      |  
|Cash and due from banks                    |  |                                 | 106,181   |   |          |   |                    |  |      |                 |  |   | 96,065    |   |                    |   |         |  |      |  
|Premises and equipment, net                |  |                                 | 39,258    |   |          |   |                    |  |      |                 |  |   | 39,079    |   |                    |   |         |  |      |  
|Other assets                               |  |                                 | 225,246   |   |          |   |                    |  |      |                 |  |   | 200,293   |   |                    |   |         |  |      |  
|Allowance for loan losses                  |  |                                 | (31,672   | ) |          |   |                    |  |      |                 |  |   | (31,425   | ) |                    |   |         |  |      |  
|                                           |  |                                 |           |   |          |   |                    |  |      |                 |  |   |           |   |                    |   |         |  |      |  
|Total noninterest-earning assets           |  |                                 | 339,013   |   |          |   |                    |  |      |                 |  |   | 304,012   |   |                    |   |         |  |      |  
|                                           |  |                                 |           |   |          |   |                    |  |      |                 |  |   |           |   |                    |   |         |  |      |  
|Total assets                               |  | $                               | 3,783,101 |   |          |   |                    |  |      |                 |  | $ | 3,505,653 |   |                    |   |         |  |      |  
|                                           |  |                                 |           |   |          |   |                    |  |      |                 |  |   |           |   |                    |   |         |  |      |  
|Interest-bearing liabilities:              |  |                                 |           |   |          |   |                    |  |      |                 |  |   |           |   |                    |   |         |  |      |  
|Deposits:                                  |  |                                 |           |   |          |   |                    |  |      |                 |  |   |           |   |                    |   |         |  |      |  
|Demand and savings                         |  | $                               | 1,059,854 |   |          | $ | 11,931             |  | 1.51 | %               |  | $ | 972,343   |   |                    | $ | 5,772   |  | 0.79 | %
|Certificates and other time                |  |                                 | 866,890   |   |          |   | 25,574             |  | 3.94 | %               |  |   | 665,778   |   |                    |   | 13,613  |  | 2.73 | %
|Short-term borrowings                      |  |                                 | 360,462   |   |          |   | 13,265             |  | 4.92 | %               |  |   | 482,003   |   |                    |   | 10,857  |  | 3.01 | %
|Subordinated debt                          |  |                                 | 45,264    |   |          |   | 3,335              |  | 9.85 | %               |  |   | 47,154    |   |                    |   | 2,645   |  | 7.50 | %
|Junior subordinated debt                   |  |                                 | 66,654    |   |          |   | 4,353              |  | 8.73 | %               |  |   | 82,475    |   |                    |   | 5,158   |  | 8.36 | %
|                                           |  |                                 |           |   |          |   |                    |  |      |                 |  |   |           |   |                    |   |         |  |      |  
|Total interest-bearing liabilities         |  |                                 | 2,399,124 |   |          |   | 58,458             |  | 3.26 | %               |  |   | 2,249,753 |   |                    |   | 38,045  |  | 2.26 | %
|                                           |  |                                 |           |   |          |  
|Noninterest-bearing sources:               |  |                                 |           |   |          |   |                    |  |      |                 |  |   |           |   |                    |   |         |  |      |  
|Demand deposits                            |  |                                 | 1,002,972 |   |          |   |                    |  |      |                 |  |   | 903,327   |   |                    |   |         |  |      |  
|Other liabilities                          |  |                                 | 34,292    |   |          |   |                    |  |      |                 |  |   | 28,108    |   |                    |   |         |  |      |  
|                                           |  |                                 |           |   |          |   |                    |  |      |                 |  |   |           |   |                    |   |         |  |      |  
|Total noninterest-bearing liabilities      |  |                                 | 1,037,264 |   |          |   |                    |  |      |                 |  |   | 931,435   |   |                    |   |         |  |      |  
|Shareholders equity                       |  |                                 | 346,713   |   |          |   |                    |  |      |                 |  |   | 324,465   |   |                    |   |         |  |      |  
|                                           |  |                                 |           |   |          |   |                    |  |      |                 |  |   |           |   |                    |   |         |  |      |  
|Total liabilities and shareholders equity |  | $                               | 3,783,101 |   |          |   |                    |  |      |                 |  | $ | 3,505,653 |   |                    |   |         |  |      |  
|                                           |  |                                 |           |   |          |   |                    |  |      |                 |  |   |           |   |                    |   |         |  |      |  
|Net interest income & margin               |  |                                 |           |   |          | $ | 126,410            |  | 4.91 | %               |  |   |           |   |                    | $ | 109,322 |  | 4.57 | %
|                                           |  |                                 |           |   |          |   |                    |  |      |                 |  |   |           |   |                    |   |         |  |      |  

---

|(1) | For the purpose of calculating loan yields, average loan balances include nonaccrual loans with no related interest income.
|--- | ---------------------------------------------------------------------------------------------------------------------------



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Noninterest IncomeNoninterest income consisted of the following (in thousands):



|                                   |  |                            |       |                           |   |                    |  |   |                    |   |  |   |       
|---------------------------------- |  | -------------------------- | ----- | ------------------------- | - | ------------------ |  | - | ------------------ | - |  | - | ------
|                                   |  | For the Three Months Ended |       | For the Nine Months Ended
|                                   |  | September 30, 2006         |       | September 30, 2005        |   | September 30, 2006 |  |   | September 30, 2005
|Customer service fees              |  | $                          | 3,313 |                           | $ | 2,840              |  | $ | 8,951              |   |  | $ | 8,720 
|Net gain (loss) on trading assets  |  |                            |      |                           |   | 34                 |  |   | (302               | ) |  |   | 132   
|Net gain on the sale of securities |  |                            |      |                           |   | 6                  |  |   |                   |   |  |   | 60    
|Net gain on the sale of loans      |  |                            | 292   |                           |   | 626                |  |   | 802                |   |  |   | 1,300 
|Bank owned life insurance          |  |                            | 813   |                           |   | 753                |  |   | 2,257              |   |  |   | 2,288 
|Debit card income                  |  |                            | 501   |                           |   | 442                |  |   | 1,456              |   |  |   | 1,293 
|Other                              |  |                            | 2,585 |                           |   | 2,393              |  |   | 9,849              |   |  |   | 6,607 
|                                   |  |                            |       |                           |   |                    |  |   |                    |   |  |   |       
|                                   |  | $                          | 7,504 |                           | $ | 7,094              |  | $ | 23,013             |   |  | $ | 20,400
|                                   |  |                            |       |                           |   |                    |  |   |                    |   |  |   |       

Net losses on trading assets for the three and nine months ended September 30, 2006 were attributable to the
market conditions for these types of assets and our desire to reduce our holdings in these securities. During 2006, we significantly reduced our trading assets but may potentially reinvest in these assets based on future market conditions. Trading
assets are carried at fair market value in our consolidated balance sheets.

Net gains on the sale of loans decreased $334 thousand and $498 thousand for
the three and nine-month periods ended September 30, 2006, respectively, compared to the same periods in 2005. The decrease was due primarily to a decrease in the volume of loan sales.

Other noninterest income increased $192 thousand and $3.2 million, respectively, for the three and nine months ended September 30, 2006 compared to the same periods
in 2005. This increase was due, in part, to an increase in commission income and other lending fees of $183 thousand and $1.2 million for the three and nine months ended September 30, 2006, respectively, compared to the same periods in 2005.
Additionally, the increase for the nine months ended September 30, 2006 compared to the same period in 2005 was primarily due to a gain of $1.1 million on the sale of a multi-tenant office building during the second quarter of 2006. The Company
continues to occupy the banking center located in this building.

Noninterest Expense  Noninterest expense consisted of the following
(in thousands):



|                                                                                   |  |                            |        |                           |   |                    |  |   |                    |   |  |   |       
|---------------------------------------------------------------------------------- |  | -------------------------- | ------ | ------------------------- | - | ------------------ |  | - | ------------------ | - |  | - | ------
|                                                                                   |  | For the Three Months Ended |        | For the Nine Months Ended
|                                                                                   |  | September 30, 2006         |        | September 30, 2005        |   | September 30, 2006 |  |   | September 30, 2005
|Salaries and employee benefits                                                     |  | $                          | 18,843 |                           | $ | 14,794             |  | $ | 56,340             |   |  | $ | 45,466
|Occupancy expense                                                                  |  |                            | 4,018  |                           |   | 3,841              |  |   | 11,922             |   |  |   | 11,392
|Technology                                                                         |  |                            | 1,695  |                           |   | 1,409              |  |   | 4,784              |   |  |   | 4,004 
|Professional fees                                                                  |  |                            | 1,408  |                           |   | 1,870              |  |   | 4,306              |   |  |   | 4,796 
|Postage, delivery and supplies                                                     |  |                            | 801    |                           |   | 809                |  |   | 2,494              |   |  |   | 2,337 
|Marketing                                                                          |  |                            | 675    |                           |   | 542                |  |   | 1,768              |   |  |   | 1,804 
|Acquisition costs                                                                  |  |                            | 638    |                           |   | 831                |  |   | 638                |   |  |   | 831   
|Core deposit intangibles amortization                                              |  |                            | 195    |                           |   | 102                |  |   | 584                |   |  |   | 316   
|Net losses (gains) and carrying costs of other real estate and foreclosed property |  |                            | 49     |                           |   | 40                 |  |   | (170               | ) |  |   | 138   
|Other                                                                              |  |                            | 4,245  |                           |   | 3,474              |  |   | 14,052             |   |  |   | 11,018
|                                                                                   |  |                            |        |                           |   |                    |  |   |                    |   |  |   |       
|                                                                                   |  | $                          | 32,567 |                           | $ | 27,712             |  | $ | 96,718             |   |  | $ | 82,102
|                                                                                   |  |                            |        |                           |   |                    |  |   |                    |   |  |   |       

Salaries and employee benefits for the three and nine-month periods ended September 30, 2006 increased $4.0
million and $10.9 million, respectively, compared to the same periods in 2005. The Company added 33 full-time



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equivalent employees since September 30, 2005, principally related to new office additions and to support growth. During the first quarter of 2006, the
Company added experienced key officers to further implement its growth strategy. Additionally, during 2006, the Company experienced higher incentive compensation expense as we crossed higher thresholds of production and profitability. As a result,
incentive compensation expense increased $1.6 million or 111% and $3.5 million or 81% for the three and nine-month periods ended September 30, 2006, respectively, compared to the same periods in 2005. In addition, profit sharing expense, which
we began accruing during 2006 as a 12% ROE target was attained, increased $593 thousand and $1.6 million for the three and nine-month periods ended September 30, 2006, respectively, compared to the same periods in 2005.

Technology expense increased $286 thousand or 20% and $780 thousand or 19%, respectively, for the three and nine-month periods ended September 30, 2006 compared to
the same periods in 2005. These increases were due to additional hardware and customer products including an upgrade in the Banks deposit system.

Professional fees decreased $462 thousand or 25% and $490 thousand or 10% for the three and nine-month periods ended September 30, 2006, respectively, compared to the same periods in 2005 due in part to a decrease in legal fees
primarily related to a decrease in nonperforming assets.

Other noninterest expense was $4.2 million and $14.1 million for the three and nine months ended
September 30, 2006, respectively, up $771 thousand or 22% and $3.0 million or 28% compared with the same periods in 2005. During the second quarter of 2006, the Company prepaid $29.6 million of junior subordinated debt that carried a 9.20%
interest rate. As the result of calling these securities, the Company wrote off the remaining associated unamortized debt issuance costs totaling $1.3 million.

Income Taxes  We provided $5.2 million and $15.6 million for federal and state income taxes during the three and nine-month periods ended September 30, 2006, respectively, and $4.1 million and $11.5 million,
respectively, for the same periods of 2005. The effective tax rate for the three and nine-month periods in 2006 was approximately 31% and 32% as compared to 32% for the same periods in 2005. During 2005, the Internal Revenue Service commenced an
examination of the Companys federal income tax return for the 2003 tax year. This examination was completed during the third quarter of 2006, resulting in an additional federal income tax obligation of $1.2 million. This obligation was
previously accrued as part of our overall tax contingency reserve. As a result of the completion of the examination, we released $473 thousand of remaining contingency reserves during the third quarter of 2006.

FINANCIAL CONDITION

Loans Held for InvestmentThe following table summarizes our loan portfolio by type, excluding loans held for sale (dollars in thousands):



|                                |  |                    |           |   |                   |   |        |   |           |  |       |  
|------------------------------- |  | ------------------ | --------- | - | ----------------- | - | ------ | - | --------- |  | ----- | -
|                                |  | September 30, 2006 |           |   | December 31, 2005 |  
|                                |  | Amount             |           | % |                   |   | Amount |   | %         | 
|Commercial and industrial       |  | $                  | 770,438   |   | 25.4              | % |        | $ | 738,061   |  | 27.4  | %
|Real estate:                    |  |                    |           |   |                   |   |        |   |           |  |       |  
|Commercial                      |  |                    | 1,324,322 |   | 43.8              | % |        |   | 1,221,610 |  | 45.4  | %
|Construction                    |  |                    | 601,381   |   | 19.8              | % |        |   | 438,454   |  | 16.3  | %
|Residential mortgage            |  |                    | 220,220   |   | 7.3               | % |        |   | 190,701   |  | 7.1   | %
|Consumer/other                  |  |                    | 82,814    |   | 2.7               | % |        |   | 72,937    |  | 2.7   | %
|Foreign loans                   |  |                    | 31,169    |   | 1.0               | % |        |   | 29,245    |  | 1.1   | %
|                                |  |                    |           |   |                   |   |        |   |           |  |       |  
|Total loans held for investment |  | $                  | 3,030,344 |   | 100.0             | % |        | $ | 2,691,008 |  | 100.0 | %
|                                |  |                    |           |   |                   |   |        |   |           |  |       |  



30



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At September 30, 2006, loans held for investment were $3.0 billion, an increase of $339.3 million or 12.6% over
loans held for investment at December 31, 2005. Loans acquired in the acquisition of BOTH totaled $149.9 million. The remaining increase in loans was due to internal loan growth. This increase in internal loan growth was primarily in real
estate loans which increased $175 million.

Our primary lending focus is commercial loans and owner-occupied real estate loans to businesses with annual
sales ranging from $300 thousand to $30 million. At September 30, 2006, commercial real estate loans and commercial and industrial loans were 43.8% and 25.4%, respectively, of loans held for investment.

At September 30, 2006, loans held for investment were 91.3% of total deposits and 71.1% of total assets. As of September 30, 2006, we had no material
concentrations of loans.

Loans Held for Sale  Loans held for sale were $72.8 million at September 30, 2006, as compared with $8.4
million at December 31, 2005. Loans held for sale includes the guaranteed portion of SBA loans originated by the Bank and loans originated as part of the Banks wholesale lending operations. Due to the timing of the purchases and sales of
SBA and other loans to investors, the balance of loans in the held for sale category at any given time may vary.

Trading Assets 
During 2006, we significantly reduced our holdings of trading assets in response to current market conditions and our desire to reduce our holdings in these securities. We may potentially reinvest in these assets based on future market conditions.

SecuritiesThe Companys securities portfolio at September 30, 2006 totaled $695.0 million, as
compared to $619.0 million at December 31, 2005, an increase of $76.0 million or 12.2%. The increase in period-end securities was primarily due to the addition of BOTH with a total securities portfolio of $111.3 million. Subsequent to the BOTH
acquisition we sold approximately $70 million of the BOTH investment portfolio to further reduce borrowings. We plan for minimal near-term growth in the investment portfolio based on the need to maintain adequate liquidity and depending on the
short-term rate cycle.

Net unrealized losses on the available-for-sale securities were $12.8 million at September 30, 2006 as compared to $10.7
million at December 31, 2005. Management believes that the unrealized losses on the Companys securities portfolio were caused primarily by interest rate increases. Because the decline in market value is attributable to changes in
interest rates and not credit quality, and because the Company has the ability and intent to hold those investments until a recovery of fair value, which may be at maturity, the Company does not consider those investments to be
other-than-temporarily impaired at September 30, 2006.

DepositsThe following
table summarizes the Companys deposit portfolio by type (dollars in thousands):



|                                     |  |                    |           |   |                   |   |        |   |           |  |       |  
|------------------------------------ |  | ------------------ | --------- | - | ----------------- | - | ------ | - | --------- |  | ----- | -
|                                     |  | September 30, 2006 |           |   | December 31, 2005 |  
|                                     |  | Amount             |           | % |                   |   | Amount |   | %         | 
|Noninterest-bearing demand           |  | $                  | 1,045,416 |   | 31.5              | % |        | $ | 1,045,937 |  | 36.8  | %
|Interest-bearing demand              |  |                    | 1,207,722 |   | 36.4              | % |        |   | 1,017,832 |  | 35.9  | %
|Certificates and other time deposits |  |                    |           |   |                   |   |        |   |           |  |       |  
|Jumbo                                |  |                    | 633,745   |   | 19.1              | % |        |   | 467,672   |  | 16.5  | %
|Regular                              |  |                    | 312,834   |   | 9.4               | % |        |   | 216,585   |  | 7.6   | %
|Brokered                             |  |                    | 118,793   |   | 3.6               | % |        |   | 90,117    |  | 3.2   | %
|                                     |  |                    |           |   |                   |   |        |   |           |  |       |  
|Total deposits                       |  | $                  | 3,318,510 |   | 100.0             | % |        | $ | 2,838,143 |  | 100.0 | %
|                                     |  |                    |           |   |                   |   |        |   |           |  |       |  

Total deposits as of September 30, 2006 increased $480 million to $3.3 billion, up 16.9% compared to $2.8
billion at December 31, 2005. Deposits acquired in the acquisition of BOTH totaled $298.2 million. The deposit growth we experienced during the first nine months of 2006 was driven primarily by interest-bearing and



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certificates and other time deposits. The percentage of interest-bearing and noninterest-bearing deposits to total deposits as of September 30, 2006 was
31.5% and 36.4%, respectively, and our loan to deposit ratio remained at 93.5%.

Short-term borrowings  As of September 30, 2006,
we had $372.3 million in short-term borrowings compared to $392.9 million at December 31, 2005, a decrease of $20.6 million or 5.2%. The Companys primary source of short-term borrowings is the Federal Home Loan Bank. At September 30,
2006, borrowings under FHLB advances totaled $345 million and had maturities less than 30 days. The average interest rate on these borrowings was 5.19% at September 30, 2006. The Company utilizes these borrowings to meet liquidity needs.
Maturing advances are replaced by drawing on available cash, making additional borrowings or through increased customer deposits.

ASSET QUALITY

Risk Elements Our nonperforming and past due loans are substantially collateralized by assets, with any excess of
loan balances over collateral values specifically allocated in the allowance for loan losses. On an ongoing basis we receive updated appraisals on loans secured by real estate, particularly those categorized as nonperforming loans and potential
problem loans. In those instances where updated appraisals reflect reduced collateral values, an evaluation of the borrowers overall financial condition is made to determine the need, if any, for possible write-downs or appropriate additions
to the allowance for loan losses.

Nonperforming assets and potential problem loans consisted of the following (dollars in thousands):



|                                                               |  |                   |        |   |                  |   |        |  
|-------------------------------------------------------------- |  | ----------------- | ------ | - | ---------------- | - | ------ | -
|                                                               |  | September 30,2006 |        |   | December 31,2005 |  
|Nonperforming and nonaccrual loans                             |  | $                 | 14,750 |   |                  | $ | 21,841 |  
|Real estate acquired by foreclosure                            |  |                   | 1,764  |   |                  |   | 460    |  
|Other repossessed assets                                       |  |                   | 291    |   |                  |   | 137    |  
|                                                               |  |                   |        |   |                  |   |        |  
|Total nonperforming assets                                     |  | $                 | 16,805 |   |                  | $ | 22,438 |  
|                                                               |  |                   |        |   |                  |   |        |  
|Potential problem loans                                        |  | $                 | 38,761 |   |                  | $ | 58,011 |  
|                                                               |  |                   |        |   |                  |   |        |  
|Accruing loans past due 90 days or more                        |  | $                 | 308    |   |                  | $ | 162    |  
|                                                               |  |                   |        |   |                  |   |        |  
|Period-end allowance for loan losses to nonperforming loans    |  |                   | 231.50 | % |                  |   | 142.99 | %
|Nonperforming loans to period-end loans                        |  |                   | 0.48   | % |                  |   | 0.81   | %
|Nonperforming assets to period-end assets                      |  |                   | 0.39   | % |                  |   | 0.60   | %
|Nonperforming assets to period-end loans and foreclosed assets |  |                   | 0.54   | % |                  |   | 0.83   | %

Nonperforming assets were $16.8 million at September 30, 2006, a $5.6 million decrease from December 31,
2005. Accruing loans past due 90 days or more at September 30, 2006 totaled $308 thousand.

Allowance for Credit LossesThe allowance for credit losses and the related provision for credit losses are determined based on the historical credit loss experience, changes in the loan portfolio, including size, mix and risk of the individual loans, and current
economic conditions. We monitor economic conditions in our local market areas and the probable impact on borrowers, on past-due amounts, on related collateral values, on the number and size of the non-performing loans and on the resulting amount of
charges-offs for the period.

The provision for credit losses for the three and nine months ended September 30, 2006 was $895 thousand
and $4.1 million, respectively, as compared to $4.6 million and $11.1 million for the same periods in 2005. The lower provision for credit losses during the three and nine months ended September 30, 2006 was due to a favorable



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improvement in net charge-offs for this same time period and is reflective of the general improvement in asset quality in the Company that has been a
function of both a healthy Texas economy and a strengthening in our credit culture.

Net charge-offs were $746 thousand or 0.10% (annualized) and $3.5
million or 0.17% (annualized) of average loans for the three and nine months ended September 30, 2006, respectively. Net charge-offs decreased $5.3 million and $6.4 million for the three and nine months ended September 30, 2006,
respectively, compared to the same periods in 2005. These improvements in asset quality are primarily attributable to several internal changes during the past year. Some of these changes include: implementing a consumer and micro-business loan
credit scoring system, updating and revising our loan policy, standardizing our loan funding process, improving our loan approval process and enhancing our credit culture to take a more value-added risk management approach.

The allowance for loan losses at September 30, 2006 was $34.1 million and represented 1.10% of total loans. The allowance for loan losses at September 30, 2006
was 231.50% of nonperforming loans, up from 142.99% at December 31, 2005, primarily the result of improvements in asset quality. The reserve for unfunded lending commitments was $927 thousand at September 30, 2006 as compared with $1.2
million at December 31, 2005.

The following table presents an analysis of the allowance for credit losses and other related data (dollars in
thousands):



|                                                                       |  |                                  |        |   |                                 |   |        |      |  |   |        |   |  |   |        |  
|---------------------------------------------------------------------- |  | -------------------------------- | ------ | - | ------------------------------- | - | ------ | ---- |  | - | ------ | - |  | - | ------ | -
|                                                                       |  | Three Months Ended September 30, |        |   | Nine Months Ended September 30, |  
|                                                                       |  | 2006                             |        |   | 2005                            |   |        | 2006 |  |   | 2005   |  
|Allowance for loan losses at beginning of period                       |  | $                                | 31,882 |   |                                 | $ | 32,209 |      |  | $ | 31,230 |   |  | $ | 29,406 |  
|Charge-offs:                                                           |  |                                  |        |   |                                 |   |        |      |  |   |        |   |  |   |        |  
|Commercial, financial, and industrial                                  |  |                                  | 458    |   |                                 |   | 6,192  |      |  |   | 2,879  |   |  |   | 9,412  |  
|Real estate, mortgage and construction                                 |  |                                  | 798    |   |                                 |   | 163    |      |  |   | 2,242  |   |  |   | 1,739  |  
|Consumer                                                               |  |                                  | 413    |   |                                 |   | 333    |      |  |   | 779    |   |  |   | 1,171  |  
|                                                                       |  |                                  |        |   |                                 |   |        |      |  |   |        |   |  |   |        |  
|Total charge-offs                                                      |  |                                  | 1,669  |   |                                 |   | 6,688  |      |  |   | 5,900  |   |  |   | 12,322 |  
|                                                                       |  |                                  |        |   |                                 |   |        |      |  |   |        |   |  |   |        |  
|Recoveries                                                             |  |                                  |        |   |                                 |   |        |      |  |   |        |   |  |   |        |  
|Commercial, financial, and industrial                                  |  |                                  | 777    |   |                                 |   | 420    |      |  |   | 1,944  |   |  |   | 1,454  |  
|Real estate, mortgage and construction                                 |  |                                  | 3      |   |                                 |   | 97     |      |  |   | 8      |   |  |   | 707    |  
|Consumer                                                               |  |                                  | 143    |   |                                 |   | 78     |      |  |   | 408    |   |  |   | 230    |  
|                                                                       |  |                                  |        |   |                                 |   |        |      |  |   |        |   |  |   |        |  
|Total recoveries                                                       |  |                                  | 923    |   |                                 |   | 595    |      |  |   | 2,360  |   |  |   | 2,391  |  
|                                                                       |  |                                  |        |   |                                 |   |        |      |  |   |        |   |  |   |        |  
|Net charge-offs                                                        |  |                                  | 746    |   |                                 |   | 6,093  |      |  |   | 3,540  |   |  |   | 9,931  |  
|Allowance for credit losses associated with acquired institution       |  |                                  | 2,152  |   |                                 |   | 761    |      |  |   | 2,152  |   |  |   | 761    |  
|Provision for loan losses                                              |  |                                  | 858    |   |                                 |   | 4,350  |      |  |   | 4,304  |   |  |   | 10,991 |  
|                                                                       |  |                                  |        |   |                                 |   |        |      |  |   |        |   |  |   |        |  
|Allowance for loan losses at end of period                             |  |                                  | 34,146 |   |                                 |   | 31,227 |      |  |   | 34,146 |   |  |   | 31,227 |  
|                                                                       |  |                                  |        |   |                                 |   |        |      |  |   |        |   |  |   |        |  
|Reserve for losses on unfunded loan commitments at beginning of period |  |                                  | 890    |   |                                 |   | 746    |      |  |   | 1,173  |   |  |   | 826    |  
|Provision for losses on unfunded loan commitments                      |  |                                  | 37     |   |                                 |   | 215    |      |  |   | (246   | ) |  |   | 135    |  
|                                                                       |  |                                  |        |   |                                 |   |        |      |  |   |        |   |  |   |        |  
|Reserve for losses on unfunded loan commitments at end of period       |  |                                  | 927    |   |                                 |   | 961    |      |  |   | 927    |   |  |   | 961    |  
|                                                                       |  |                                  |        |   |                                 |   |        |      |  |   |        |   |  |   |        |  
|Total allowance for credit losses                                      |  | $                                | 35,073 |   |                                 | $ | 32,188 |      |  | $ | 35,073 |   |  | $ | 32,188 |  
|                                                                       |  |                                  |        |   |                                 |   |        |      |  |   |        |   |  |   |        |  
|Period-end allowance for credit losses to period-end loans             |  |                                  | 1.13   | % |                                 |   | 1.19   | %    |  |   | 1.13   | % |  |   | 1.19   | %
|Period-end allowance for loan losses to period-end loans               |  |                                  | 1.10   | % |                                 |   | 1.16   | %    |  |   | 1.10   | % |  |   | 1.16   | %
|Period-end allowance for loan losses to non performing loans           |  |                                  | 231.50 | % |                                 |   | 129.24 | %    |  |   | 231.50 | % |  |   | 129.24 | %
|Nonperforming assets to period-end loans and foreclosed assets         |  |                                  | 0.54   | % |                                 |   | 0.93   | %    |  |   | 0.54   | % |  |   | 0.93   | %
|Nonperforming loans to period-end loans                                |  |                                  | 0.48   | % |                                 |   | 0.89   | %    |  |   | 0.48   | % |  |   | 0.89   | %
|Nonperforming assets to period-end assets                              |  |                                  | 0.39   | % |                                 |   | 0.67   | %    |  |   | 0.39   | % |  |   | 0.67   | %
|Net charge-offs to average loans (annualized)                          |  |                                  | 0.10   | % |                                 |   | 0.93   | %    |  |   | 0.17   | % |  |   | 0.53   | %



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INTEREST RATE SENSITIVITY

Interest rate risk is the risk to interest income attributed to the repricing characteristics of interest sensitive assets and liabilities. An interest sensitive asset or liability is one that experiences changes in cashflows as a direct
result of changes in market interest rates.

We manage interest rate risk by positioning the balance sheet to maximize net interest income while
maintaining an acceptable level of risk, remaining mindful of the relationship between profitability, liquidity and interest rate risk. The overall interest rate risk position and strategies for the management of interest rate risk are reviewed by
senior management, the Asset/Liability Management Committee and our Board of Directors on an ongoing basis.

We measure interest rate risk using a variety
of methodologies including, but not limited to, dynamic simulation analysis, gap analysis and static balance sheet rate shocks. Dynamic simulation analysis is the primary tool used to measure interest rate risk and allow us to model the effects of
non-parallel movements in multiple yield curves, changes in borrower and depositor behaviors, changes in loan and deposit pricing, and changes in loan and deposit portfolio compositions and growth rates over a 24-month horizon.

We utilize static balance sheet rate shocks to estimate the potential impact on net interest income of changes in interest rates under various rate scenarios. This
analysis estimates a percentage of change in these metrics from the stable rate base scenario versus alternative scenarios of rising and falling market interest rates by instantaneously shocking a static balance sheet. The following table summarizes
the simulated change over a 12-month horizon as of September 30, 2006 and December 31, 2005:



|                   |  |                                          |  |                                        |  
|------------------ |  | ---------------------------------------- |  | -------------------------------------- | -
|                   |  | Changes in Interest
Rates (Basis Points) |  | Increase(Decrease)in NetInterestIncome |  
|September 30, 2006 |  |                                          | 
|                   |  | +200                                     |  | 0.31                                   | %
|                   |  | +100                                     |  | 0.23                                   | %
|                   |  | Base                                     |  | 0.00                                   | %
|                   |  | -100                                     |  | -1.38                                  | %
|                   |  | -200                                     |  | -3.08                                  | %
|                   | 
|December 31, 2005  |  |                                          | 
|                   |  | +200                                     |  | 6.59                                   | %
|                   |  | +100                                     |  | 3.45                                   | %
|                   |  | Base                                     |  | 0.00                                   | %
|                   |  | -100                                     |  | -3.43                                  | %
|                   |  | -200                                     |  | -10.68                                 | %

Each rate scenario reflects unique prepayment and repricing assumptions. Because of uncertainties related to
customer behaviors, loan and deposit pricing levels, competitor behaviors, and socio-economic factors that could effect the shape of the yield curves, this analysis is not intended to and does not provide a precise forecast of the affect actual
changes in market rates will have on the Company. The interest rate sensitivity analysis includes assumptions that (i) the composition of our interest sensitive assets and liabilities existing at period-end will remain constant over the
measurement period; and (ii) changes in market rates are parallel and instantaneous across the yield curve regardless of duration or repricing characteristics of specific assets or liabilities. Further, this analysis does not contemplate any
actions that we might undertake in response to changes in market factors. Accordingly, this analysis is not intended to and does not provide a precise forecast of the affect actual changes in market rates will have on the Company.

During July of 2006, the Company executed a hedging strategy utilizing interest rate derivatives designed as a means to mitigate some of the Companys asset
sensitivity. The Company purchased a prime interest rate floor



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##### Table of Contents

contract with a notional amount of $113 million with a strike rate of 8.00% and a prime interest rate collar contract with a notional amount of $250 million
with an 8.42% interest rate cap and an 8.00% interest rate floor. These contracts were designated as cash flow hedges of the monthly interest receipts from the Companys portfolio of prime rate based variable-rate loans. The interest rate floor
and interest rate collar contracts have termination dates of August 1, 2009 and August 1, 2010, respectively.

CAPITAL AND LIQUIDITY

Capital  At September 30, 2006, shareholders equity totaled $399.8 million or 9.38% of total assets, as compared to
$334.5 million or 8.97% of total assets at December 31, 2005. Our risk-based capital ratios together with the minimum capital amounts and ratios at September 30, 2006 were as follows (dollars in thousands):



|                                         |  |        |         |       |                                       |   |        |   |         |  |     |  
|---------------------------------------- |  | ------ | ------- | ----- | ------------------------------------- | - | ------ | - | ------- |  | --- | -
|                                         |  | Actual |         |       | For Minimum Capital Adequacy Purposes |  
|                                         |  | Amount |         | Ratio |                                       |   | Amount |   | Ratio   | 
|Total capital (to risk weighted assets)  |  | $      | 402,018 |       | 10.7                                  | % |        | $ | 301,009 |  | 8.0 | %
|Tier 1 capital (to risk weighted assets) |  |        | 320,929 |       | 8.5                                   | % |        |   | 150,504 |  | 4.0 | %
|Tier 1 capital (to average assets)       |  |        | 320,929 |       | 8.7                                   | % |        |   | 147,800 |  | 4.0 | %

See Note 12 to our Consolidated Financial Statements for further discussion of regulatory capital requirements.

Liquidity  The objectives of our liquidity management is to maintain our ability to meet day-to-day deposit withdrawals and other
payment obligations, to raise funds to support asset growth, to maintain reserve requirements and otherwise operate on an ongoing basis. We strive to manage a liquidity position sufficient to meet operating requirements while maintaining an
appropriate balance between assets and liabilities to meet the expectations of our shareholders. In recent years, our liquidity needs have primarily been met by growth in deposits including brokered certificates of deposit. In addition to deposits,
we have access to funds from correspondent banks and from the Federal Home Loan Bank, supplemented by cash flows from amortizing securities and loan portfolios. For more information regarding liquidity, please refer to our 2005 Annual Report on Form
10-K.

Sterling Bancshares must provide for its own liquidity and fund its own obligations. The primary source of Sterling Bancshares revenues is
from dividends declared by the Bank. There are statutory and regulatory provisions that could limit the ability of the Bank to pay dividends to Sterling Bancshares. Under these provisions, there was an aggregate of approximately $132.2 million
available for payment of dividends at September 30, 2006, by the Bank. At September 30, 2006, the aggregate amount of dividends, which legally could be paid without prior approval of various regulatory agencies, totaled $58.0 million. It
is not anticipated that such restrictions will have an impact on the ability of Sterling Bancshares to meet its ongoing cash obligations. As of September 30, 2006, we did not have any material commitments for capital expenditures.

On May 8, 2006, Sterling Bancshares prepaid all of its $29.6 million 9.20% Junior Subordinated Deferrable Interest Debentures. The payment of these Debentures
was funded by a dividend from the Bank.



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##### Table of Contents

ITEM 3.    QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.

There have been no material
changes in market risk we face since December 31, 2005. For information regarding the market risk of our financial instruments, see Managements Discussion and Analysis of Financial Condition and Results of Operations  Interest
Rate Sensitivity. Our principal market risk exposure is to interest rates.

ITEM 4.    CONTROLS AND PROCEDURES.

Evaluation of Disclosure Controls and Procedures
 As of the end of the period covered by this report, an evaluation was made by the Companys management, with the participation of its Chief Executive Officer and Chief Financial Officer, of the effectiveness of the Companys
disclosure controls and procedures (as defined in Rule 13a-15(e) under the Securities and Exchange Act of 1934. Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that the Companys disclosure controls
and procedures were effective as of the end of the period.

There were no changes in the Companys internal control over financial reporting (as
defined in Rule 13a-15(f) under the Securities Exchange Act of 1934) during the most recent fiscal quarter that materially affected, or are reasonably likely to materially affect, the Companys internal control over financial reporting.



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##### Table of Contents

PART II. OTHER INFORMATION

ITEM 1.    LEGAL PROCEEDINGS.

Not applicable.



|ITEM 1A.    RISK | FACTORS
|---------------- | -------

Information regarding risk factors appears in
Managements Discussion and Analysis of Financial Condition and Results of Operations  Forward-Looking Statements, in Part I  Item 2 of this Form 10-Q and in Part I  Item 1A of our Annual Report on Form 10-K for
the fiscal year ended December 31, 2005. There have been no material changes from the risk factors previously disclosed in our Annual Report on Form 10-K.

ITEM 2.    UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS.

On April 25, 2005, the
Companys Board of Directors authorized the repurchase of up to 2,500,000 shares of common stock, not to exceed 500,000 shares in any calendar year. The Company may repurchase shares of its common stock from time to time in the open market or
through privately negotiated transactions. The table below lists the Companys purchases of its equity securities registered pursuant to Section 12 of the Exchange Act during the quarter ended September 30, 2006:



|                                       |  |                                  |  |                                       |       |                                                                      |         |                                                  |          
|-------------------------------------- |  | -------------------------------- |  | ------------------------------------- | ----- | -------------------------------------------------------------------- | ------- | ------------------------------------------------ | ---------
|Period                                 |  | Total Number of Shares Purchased |  | Weighted Average Price Paid per Share |       | Total Number of Shares Purchased as Part of Publicly Announced Plans |         | Shares That May Yet Be Purchased Under the Plans
|July 1, 2006 toJuly 31, 2006           |  | 55,500                           |  | $                                     | 18.44 |                                                                      | 430,500 |                                                  | 2,069,500
|August 1, 2006 toAugust 31, 2006       |  | 46,000                           |  | $                                     | 20.08 |                                                                      | 476,500 |                                                  | 2,023,500
|September 1, 2006 toSeptember 30, 2006 |  | 23,500                           |  | $                                     | 20.50 |                                                                      | 500,000 |                                                  | 2,000,000

ITEM 3.    DEFAULTS UPON SENIOR SECURITIES.

Not applicable.

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

Not applicable.

ITEM 5.    OTHER INFORMATION.

Not applicable.



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##### Table of Contents

ITEM 6.    EXHIBITS.



|         |  |                                                                                                                                                                                                                          
|-------- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|10.1     |  | Agreement and Plan of Merger dated July 25, 2006, by and among Sterling Bancshares, Inc. and BOTH, Inc. (incorporated by reference to Exhibit 2.1 of the Companys Current
Report on Form 8-K filed on July 26, 2006).   
|         | 
|10.2    |  | Phantom Share Agreement dated August 9, 2006 between Sterling Bancshares, Inc. and Stephen C. Raffaele. (incorporated by reference to Exhibit 10.1 of the Companys Current Report on
Form 8-K filed on August 15, 2006).
|         | 
|10.3    |  | Phantom Share Agreement dated August 9, 2006 between Sterling Bancshares, Inc. and Stephen C. Raffaele (incorporated by reference to Exhibit 10.2 of the Companys Current Report on
Form 8-K filed on August 15, 2006). 
|         | 
|10.4    |  | Phantom Share Agreement dated August 9, 2006 between Sterling Bancshares, Inc. and Sonny B. Lyles (incorporated by reference to Exhibit 10.3 of the Companys Current Report on
Form 8-K filed on August 15, 2006).      
|         | 
|10.5    |  | Phantom Share Agreement dated August 9, 2006 between Sterling Bancshares, Inc. and Allen D. Brown (incorporated by reference to Exhibit 10.4 of the Companys Current Report on
Form 8-K filed on August 15, 2006).      
|         | 
|10.6    |  | Phantom Share Agreement dated August 9, 2006 between Sterling Bancshares, Inc. and Allen D. Brown (incorporated by reference to Exhibit 10.5 of the Companys Current Report on
Form 8-K filed on August 15, 2006).      
|         | 
|10.7    |  | Form of Phantom Share Agreement (incorporated by reference to Exhibit 10.6 of the Companys Current Report on Form 8-K filed on August 15, 2006).                                                                        
|         | 
|11      |  | Statement Regarding Computation of Earnings Per Share (included as Note (9) to Consolidated Financial Statements on page 16 of this Quarterly Report on Form 10-Q).                                                      
|         | 
|*31.1   |  | Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 of J. Downey Bridgwater, Chairman, President and Chief Executive Officer.                                                                        
|         | 
|*31.2   |  | Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 of Stephen C. Raffaele, Executive Vice President and Chief Financial Officer.                                                                    
|         | 
|**32.1  |  | Section 1350 Certification of the Chief Executive Officer.                                                                                                                                                               
|         | 
|**32.2  |  | Section 1350 Certification of the Chief Financial Officer.                                                                                                                                                               

---

|* | As filed herewith.
|- | ------------------

|** | As furnished herewith.
|-- | ----------------------

| | Management Compensation Agreement
|- | ---------------------------------



38



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##### Table of Contents

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused the report to
be signed on its behalf by the undersigned thereunto duly authorized.



|                       |  |  |  |                           |  |                                                                                                   |  | 
|---------------------- |  |  |  | ------------------------- |  | ------------------------------------------------------------------------------------------------- |  | 
|                       |  |  |  | STERLING BANCSHARES, INC.
|                       |  |  | 
|Date: November 8, 2006 |  |  |  | By:                       |  | /s/ J. Downey Bridgwater                                                                         
|                       |  |  |  |                           |  | J. Downey Bridgwater                                                                             
|                       |  |  |  |                           |  | Chairman, President and Chief Executive
Officer (Principal Executive Officer)                    
|                       |  |  | 
|Date: November 8, 2006 |  |  |  | By:                       |  | /s/ Stephen C. Raffaele                                                                          
|                       |  |  |  |                           |  | Stephen C. Raffaele                                                                              
|                       |  |  |  |                           |  | Executive Vice President and Chief
Financial Officer (Principal Financial and Accounting Officer)



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##### Table of Contents

EXHIBIT INDEX



|         |  |                                                                                                                                                                                                                          
|-------- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit  |  | Description                                                                                                                                                                                                              
|10.1     |  | Agreement and Plan of Merger dated July 25, 2006, by and among Sterling Bancshares, Inc. and BOTH, Inc. (incorporated by reference to Exhibit 2.1 of the Companys Current
Report on Form 8-K filed on July 26, 2006).   
|         | 
|10.2    |  | Phantom Share Agreement dated August 9, 2006 between Sterling Bancshares, Inc. and Stephen C. Raffaele. (incorporated by reference to Exhibit 10.1 of the Companys Current Report on
Form 8-K filed on August 15, 2006).
|         | 
|10.3    |  | Phantom Share Agreement dated August 9, 2006 between Sterling Bancshares, Inc. and Stephen C. Raffaele (incorporated by reference to Exhibit 10.2 of the Companys Current Report on
Form 8-K filed on August 15, 2006). 
|         | 
|10.4    |  | Phantom Share Agreement dated August 9, 2006 between Sterling Bancshares, Inc. and Sonny B. Lyles (incorporated by reference to Exhibit 10.3 of the Companys Current Report on
Form 8-K filed on August 15, 2006).      
|         | 
|10.5    |  | Phantom Share Agreement dated August 9, 2006 between Sterling Bancshares, Inc. and Allen D. Brown (incorporated by reference to Exhibit 10.4 of the Companys Current Report on
Form 8-K filed on August 15, 2006).      
|         | 
|10.6    |  | Phantom Share Agreement dated August 9, 2006 between Sterling Bancshares, Inc. and Allen D. Brown (incorporated by reference to Exhibit 10.5 of the Companys Current Report on
Form 8-K filed on August 15, 2006).      
|         | 
|10.7    |  | Form of Phantom Share Agreement (incorporated by reference to Exhibit 10.6 of the Companys Current Report on Form 8-K filed on August 15, 2006).                                                                        
|         | 
|11      |  | Statement Regarding Computation of Earnings Per Share (included as Note (9) to Consolidated Financial Statements on page 16 of this Quarterly Report on Form 10-Q).                                                      
|         | 
|*31.1   |  | Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 of J. Downey Bridgwater, Chairman, President and Chief Executive Officer.                                                                        
|         | 
|*31.2   |  | Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 of Stephen C. Raffaele, Executive Vice President and Chief Financial Officer.                                                                    
|         | 
|**32.1  |  | Section 1350 Certification of the Chief Executive Officer.                                                                                                                                                               
|         | 
|**32.2  |  | Section 1350 Certification of the Chief Financial Officer.                                                                                                                                                               

---

|* | As filed herewith.
|- | ------------------

|** | As furnished herewith.
|-- | ----------------------

| | Management Compensation Agreement
|- | ---------------------------------



40