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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549



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FORM 10-K



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|  |  |                                                                    
|- |  | -------------------------------------------------------------------
|x |  | ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES    
|  |  | EXCHANGE ACT OF 1934                                               
|  |  | For The Fiscal Year Ended: December 31, 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



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STERLING BANCSHARES, INC.

(Exact name of registrant as specified in its charter)



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|                                                              |  |                                    
|------------------------------------------------------------- |  | -----------------------------------
|Texas                                                         |  | 74-2175590                         
|(State or other jurisdiction ofincorporation or organization) |  | (I.R.S. EmployerIdentification 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)

Securities registered pursuant to
Section 12(b) of the Act:



|                           |  |                                            
|-------------------------- |  | -------------------------------------------
|Common Stock, $1 par value |  | NASDAQ Global Select Market                
|(Title of each class)      |  | (Name of each exchange on which registered)

Securities registered pursuant to Section 12(g) of the Act: None



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Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.

Yes  x    No ̈

Indicate by check mark if the
registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Exchange Act.    Yes ̈No  x

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 if disclosure of
delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrants knowledge, in definitive proxy or information statements incorporated by reference in Part III of this
Form 10-K or any amendment to this Form 10-K. ̈

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

As of June 30, 2006, the last business day of the registrants most recently completed second quarter fiscal quarter, aggregate market value of the registrants common stock
held by non-affiliates of the registrant was $836,303,344 based on the closing sale price of $18.75 on such date as reported on the National Association of Securities Dealers Automated Quotation System Global Select Market. For purposes of this
calculation, affiliates are defined as all directors and executive officers.

As of February 22, 2007, there were 72,065,047 shares of the registrants common stock, $1.00 par value, outstanding.

DOCUMENTS INCORPORATED BY REFERENCE



|                                                                                  |  |                                      
|--------------------------------------------------------------------------------- |  | -------------------------------------
|Document                                                                          |  | Parts Into Which Incorporated        
|Proxy Statement for the Annual Meeting of Shareholders to be held April 30, 2007. |  | Part III, Items 10, 11, 12, 13 and 14



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STERLING BANCSHARES, INC.

2006 ANNUAL REPORT ON FORM 10-K

TABLE OF CONTENTS



|           |  |                                                                                                              |  |   
|---------- |  | ------------------------------------------------------------------------------------------------------------ |  | --
|PART I.    |  |                                                                                                             
|           |  |                                                                                                             
|ITEM 1.    |  | Business                                                                                                     |  | 2 
|ITEM 1A.   |  | Risk Factors                                                                                                 |  | 10
|ITEM 1B.   |  | Unresolved Staff Comments                                                                                    |  | 12
|ITEM 2.    |  | Properties                                                                                                   |  | 12
|ITEM 3.    |  | Legal Proceedings                                                                                            |  | 12
|ITEM 4.    |  | Submission of Matters to a Vote of Security Holders                                                          |  | 12
|           | 
|PART II.   |  |                                                                                                             
|           |  |                                                                                                             
|ITEM 5.    |  | Market for Registrants Common Equity, Related Shareholder Matters and Issuer Purchases of Equity Securities |  | 12
|ITEM 6.    |  | Selected Financial Data                                                                                      |  | 15
|ITEM 7.    |  | Managements Discussion and Analysis of Financial Condition and Results of Operations                        |  | 16
|ITEM 7A.   |  | Quantitative and Qualitative Disclosures About Market Risk                                                   |  | 40
|ITEM 8.    |  | Financial Statements and Supplementary Data                                                                  |  | 40
|ITEM 9.    |  | Changes in and Disagreements with Accountants on Accounting and Financial Disclosure                         |  | 40
|ITEM 9A.   |  | Controls and Procedures                                                                                      |  | 40
|ITEM 9B    |  | Other Information                                                                                            |  | 43
|           | 
|PART III.  |  |                                                                                                             
|           |  |                                                                                                             
|ITEM 10.   |  | Directors, Executive Officers and Corporate Governance of the Registrant                                     |  | 43
|ITEM 11.   |  | Executive Compensation                                                                                       |  | 43
|ITEM 12.   |  | Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters               |  | 43
|ITEM 13.   |  | Certain Relationships and Related Transactions, and Director Independence                                    |  | 44
|ITEM 14.   |  | Principal Accountant Fees and Services                                                                       |  | 44
|           | 
|PART IV.   |  |                                                                                                             
|           |  |                                                                                                             
|ITEM 15.   |  | Exhibits and Financial Statement Schedules                                                                   |  | 44
|SIGNATURES |  | 50                                                                                                          



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PART I

ITEM 1. Business

The disclosures in this item are qualified by the section entitled Forward-Looking
Statements in Managements Discussion and Analysis of Financial Condition and Results of Operations included in Item 7 of this report.

Overview

For more than 32 years, Sterling Bancshares, Inc. and Sterling Bank have served the banking needs of consumers and small to
mid-sized businesses. We provide a broad array of financial services to consumers and Texas businesses through 45 banking centers in the greater metropolitan areas of Houston, San Antonio and Dallas, Texas. These cities are the 4th, 7th and 9th
largest, respectively, in the United States based on population according to the U.S. Census Bureau.

Sterling Bancshares was incorporated under the laws
of the State of Texas in 1980 and became the parent bank holding company of Sterling Bank in 1981. Sterling Bank was chartered in 1974 under the laws of the State of Texas. Our principal executive offices are located at 2550 North Loop West, Suite
600, Houston, Texas, 77092 and our telephone number is (713) 466-8300.

In this filing, we may refer to Sterling Bancshares, Inc., on a parent-only
basis, as Sterling Bancshares and to Sterling Bank as the Bank. Sterling Bancshares, the Bank and other subsidiaries of both may be collectively referred to as the Company.

At December 31, 2006, we had consolidated total assets of $4.1 billion, total loans of $3.1 billion, total deposits of $3.3 billion, and shareholders equity
of $409 million. 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 were included in our
financial results beginning October 1, 2006.

Business Banking Strategy.We offer a broad range of financial products and services for
consumers and small to mid-sized businesses through full service banking centers. Each banking center is managed by experienced banking professionals. These professionals exercise substantial authority over credit and pricing decisions, subject to a
concurrence process and loan committee approval for larger credits. This approach, coupled with continuity of service by the same staff members, enables us to develop long-term customer relationships, maintain high quality service and respond
quickly to customer needs. Our emphasis on local relationship banking, together with a conservative approach to lending, are important factors in our success and growth.

We provide a wide range of consumer and commercial banking services, including demand, savings and time deposits; commercial, real estate and consumer loans; merchant credit card services; letters of credit; and cash
and asset management services. In addition, we facilitate sales of brokerage, mutual fund, alternative financing and insurance products through third-party vendors. Bank deposits are insured up to applicable limits by the Bank Insurance Fund
(BIF) of the Federal Deposit Insurance Corporation (FDIC).

Our primary lending focus is providing commercial loans and real estate
loans to local businesses with annual sales ranging from $300 thousand to $35 million. Typically, these customers have financing requirements between $50 thousand and $5 million. The Banks credit range allows for greater diversity in the loan
portfolio, less competition from larger banks, and better pricing opportunities.

The Bank offers a broad scope of services which include our Treasury
Management, specialized lending (including energy lending and leasing activities) and Private Client Services groups. The Banks Capital Markets group is involved in purchases of government guaranteed loans and wholesale real estate lending
activities. These additional services enable the Bank to be a more comprehensive financial resource dedicated to helping owner-operated businesses meet their financial services needs.



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We maintain a strong community orientation by, among other things, supporting the active participation of our officers
and employees in local charitable, civic, school, religious and community development activities. Each banking center may also appoint selected customers to a business development board that assists in introducing prospective customers to us and in
developing or improving products and services to meet customer needs. Our lending and investing activities are funded primarily by core deposits. This stable source of funding comes to us by developing strong banking relationships with customers
through our broad product offering, competitive pricing, convenience and service. More than 31% of our total deposits are noninterest-bearing demand deposits.

Certain operational and support functions that are transparent to customers have been centralized. This has allowed us to improve consistency and cost efficiencies in the delivery of products and services by each banking office. Centralized
functions include services such as data processing, bookkeeping, accounting and finance, loan administration, loan review, compliance, treasury, risk management and internal auditing. Credit policy and administration, strategic planning, marketing
and other administrative services also are provided centrally. Our banking centers work closely with our operational and support functions to develop new products and services and to introduce enhancements to existing products and services.

Company Growth Strategy

Our growth strategy has been concentrated on increasing our banking presence in the greater Houston, San Antonio and Dallas market areas. We have grown through a combination of internal growth, acquisitions and the opening of new banking
centers. We regularly evaluate opportunities to acquire banks and other financial services companies that complement our existing business, expand our market coverage and enhance our product offerings.

Acquisitions. Acquisitions have been important to our growth. Our acquisitions since 2002 are listed in the following table:



|                                |  |                    |  |                                 |             |                                |   |                                   |  |   |            
|------------------------------- |  | ------------------ |  | ------------------------------- | ----------- | ------------------------------ | - | --------------------------------- |  | - | -----------
|Acquired Entity                 |  | Acquisition Date   |  | Total Assets atAcquisition Date |             | Total Loans atAcquisition Date |   | Total Deposits atAcquisition Date
|BOTH, Inc.                      |  | September 29, 2006 |  | $                               | 328 million |                                | $ | 151 million                       |  | $ | 298 million
|Prestonwood Bancshares, Inc.    |  | September 30, 2005 |  |                                 | 128 million |                                |   | 75 million                        |  |   | 118 million
|South Texas Capital Group, Inc. |  | October 31, 2003   |  |                                 | 83 million  |                                |   | 65 million                        |  |   | 68 million 
|ENB Bankshares, Inc.            |  | September 13, 2002 |  |                                 | 71 million  |                                |   | 64 million                        |  |   | 58 million 

Refer to Note 2 to the Consolidated Financial Statements for more information regarding recent acquisitions. We
have accomplished these acquisitions without substantially altering our balance sheet in a way that would impact the long-term value of our franchise. We continue to seek acquisitions as they become available and prove to be aligned with our
business banking philosophy.

De Novo Offices.De novo offices are new banking centers that we build or lease. Since 2002, we have opened
four new banking centers, all of which are located in Houston.

In some instances when we open a new banking center, we issue a separate series of
convertible preferred stock to local business owners and others who are able to contribute substantially to the business development efforts of the new banking center. These preferred shares typically are convertible into common shares after three
years at ratios based on deposit growth objectives for the new banking center. Refer to Note 15 to the Consolidated Financial Statements for more discussion of these preferred stock issuances. Strategically, this practice is not designed to raise
capital, but rather to attract and retain the foundational relationships that allow a new center to achieve profitability in a shorter period of time.

Strategic Divestitures of Banking Offices.During 2004, we closed one banking center and merged its operations into another location. We retained substantially all of the loans and deposits associated with this location. The
bank building and related fixtures for this location were sold for a pre-tax loss of $27 thousand.



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Competition

The
financial services industry is highly competitive. There are a number of new banking competitors who have entered, or greatly expanded their presence in Texasparticularly in the Houston, San Antonio and Dallas markets in which we operate. We
experience significant competition in attracting and retaining deposits and making loans, as well as in providing other financial services in each of our markets. Product pricing, customer convenience and service capabilities, and breadth of product
lines are significant competitive factors. We also experience significant competition in attracting and retaining qualified banking professionals.

Our
most direct competition for loans comes from other banks. Our most direct competition for deposits comes from other banks, savings institutions and credit unions doing business in our markets. We also experience competition from nonbanking sources,
including mutual funds, corporate and governmental debt securities and other investment alternatives offered within and outside of our primary markets. Many of our competitors are much larger in total assets and capitalization, have greater access
to capital markets and offer a broader range of financial products and services.

Supervision and Regulation

Bank holding companies and banks are extensively regulated under federal and state laws. This regulation is intended primarily for the protection of depositors and the
deposit insurance fund and not for the benefit of shareholders. A summary description of the material laws and regulations that relate to our operations is included below. These descriptions are not intended to be complete and are qualified in their
entirety by reference to such statutes and regulations.

Regulatory Oversight.Sterling Bancshares and its second tier holding company,
Sterling Bancorporation, Inc., are bank holding companies registered under the Bank Holding Company Act of 1956, as amended (BHCA), and are subject to supervision and regulation by the Federal Reserve Board. Federal laws subject bank
holding companies to particular restrictions on the types of activities in which they may engage, and to a range of supervisory requirements and activities, including regulatory enforcement actions for violations of laws and policies. In addition,
Texas law authorizes the Texas Department of Banking to supervise and regulate a holding company controlling a state bank. Further, our securities are registered with the Securities and Exchange Commission (SEC) under the Securities Act
of 1933, as amended (the Securities Act) and are subject to the reporting obligations pursuant to the Securities Exchange Act of 1934, as amended (the Exchange Act). As such, we are subject to the information, proxy
solicitation, insider trading and other requirements and restrictions of the Exchange Act. We are also subject to the provisions of the Sarbanes-Oxley Act of 2002, which primarily addresses corporate governance, internal controls and disclosure
matters.

Bank Holding Company Activities. Sterling Bank is a Texas-chartered banking association and its deposits are insured, up to
applicable limits, by the BIF of the FDIC. The Bank is subject to supervision and regulation by both the Texas Department of Banking and the FDIC, and may be subject to special restrictions, supervisory requirements and potential enforcement
actions. The Bank is not a member of the Federal Reserve System; however, the Federal Reserve Board also has supervisory authority that indirectly affects the Bank. The Bank is a member of the Federal Home Loan Bank and, therefore, is subject also
to compliance with its requirements.

Under the BHCA, Sterling Bancshares activities, as well as the activities of entities which it controls or owns
5% or more of the voting securities, are limited to banking, management and control of banks, furnishing or performing services for its subsidiaries, or any other activity which the Federal Reserve Board determines to be incidental or closely
related to banking or managing or controlling banks. The BHCA provides for certain limited exceptions to this general prohibition. The Gramm-Leach-Bliley Act amended the BHCA and granted certain expanded powers to bank holding companies as discussed
below.

The Gramm-Leach-Bliley Act authorizes affiliations between banking, securities and insurance firms and authorizes bank holding companies and state
banks, if permitted by state law, to engage in a variety of new



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##### Index to Financial Statements

financial activities. Bank holding companies may also elect to become financial holding companies if they meet certain requirements relating to
capitalization and management and have filed a declaration with the Federal Reserve Board. Among the permitted activities by bank holding companies are securities and insurance brokerage, securities underwriting, insurance underwriting and merchant
banking. The Federal Reserve Board, in consultation with the Department of Treasury, may approve additional financial activities. We have not filed an election to be a financial holding company.

Anti-Money Laundering; USA PATRIOT Act. Financial institutions must maintain anti-money laundering programs that include established internal policies,
procedures and controls; a designated compliance officer; an ongoing employee training program; and testing of the program by an independent audit function. Financial institutions are prohibited from entering into specified financial transactions
and account relationships and must meet enhanced standards for due diligence and knowing your customer in their dealings with foreign financial institutions and foreign customers. Financial institutions must take reasonable steps to
conduct enhanced scrutiny of account relationships to guard against money laundering and to report any suspicious transactions. The Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism Act of
2001 is intended to strengthen U.S. law enforcements and the intelligence communities ability to work cohesively to combat terrorism on a variety of fronts. Its impact is significant and wide-ranging and has substantially increased the
Companys anti-money laundering obligations. Failure of a financial institution to maintain and implement adequate programs to combat these matters, or to comply with all of the relevant laws or regulations, could have serious legal and
reputational consequences for the institution.

Safety and Soundness Standards.The Financial Institutions Reform, Recovery and Enforcement
Act of 1989 (FIRREA) expanded the Federal Reserve Boards authority to prohibit activities of bank holding companies and their non-banking subsidiaries which represent unsafe and unsound banking practices or which constitute
violations of laws or regulations. Notably, FIRREA increased the amount of civil monetary penalties that the Federal Reserve Board can assess for certain activities conducted on a knowing and reckless basis, if those activities cause a substantial
loss to a depository institution. The penalties can be as high as $1 million per day. FIRREA also expanded the scope of individuals and entities against which such penalties may be assessed.

The federal agencies that regulate banks and savings associations jointly issued guidelines for safe and sound banking operations as required by Section 132 of the
Federal Deposit Insurance Corporation Improvement Act (FDICIA). The guidelines identify the fundamental standards that the four agencies follow when evaluating the operational and managerial controls at insured institutions. An
institutions performance will be evaluated against these standards during the regulators periodic on-site examinations.

Dividend
Restrictions. It is the policy of the Federal Reserve Board that bank holding companies should pay cash dividends on common stock only out of income available over the past year and only if prospective earnings retention is consistent with
the organizations expected future needs and financial condition. This policy provides that bank holding companies should not maintain a level of cash dividends that undermines the bank holding companys ability to serve as a source of
strength to its banking subsidiaries. Under Federal Reserve Board policy, a bank holding company is expected to act as a source of financial strength to each of its banking subsidiaries and commit resources to their support. Such support may be
required at times when, absent this Federal Reserve Board policy, a bank holding company may not be inclined to provide it.

Capital Adequacy
Requirements.The Federal Reserve Board monitors the capital adequacy of bank holding companies using risk-based capital adequacy guidelines to evaluate their capital adequacy. The Bank is subject to similar requirements promulgated by the
FDIC and the Texas Department of Banking. Under the guidelines, specific categories of assets and certain off-balance sheet assets such as letters of credit are assigned different risk weights, based generally on the perceived credit risk of the
asset. These risk weights are multiplied by corresponding asset balances to determine a risk-weighted asset base. In addition, the guidelines define each of the capital components. Total capital is defined as the sum of core
capital elements (Tier 1) and supplemental capital elements (Tier 2), with Tier 2 being limited to 100% of Tier 1. For bank holding



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companies, Tier 1 capital includes, with certain restrictions, common shareholders equity, noncumulative perpetual preferred stock and
related surplus, a limited amount of cumulative perpetual preferred stock, and a limited amount of cumulative perpetual stock and minority interest in equity accounts of consolidated subsidiaries, less goodwill and other intangible assets.
Tier 2 capital includes, with certain limitations, perpetual preferred stock not meeting the Tier 1 definition, mandatory convertible securities, subordinated debt, and allowances for credit losses, less certain required deductions. The
guidelines require a minimum ratio of total capital-to-risk-weighted assets of 8.0% (of which at least 4.0% is required to be comprised of Tier 1 capital elements).

A minimum Tier 1 leverage ratio is used as an additional tool to evaluate the capital adequacy of banks and bank holding companies. Tier 1 leverage ratio is defined to be Tier 1
capital divided by its average total consolidated assets. Certain highly rated institutions may maintain a minimum leverage ratio of 3.0% Tier 1 capital to total average assets while others are required to maintain a leverage ratio of
4.0% to 5.0%. The Texas Department of Bankings policy requires state chartered banks to maintain a leverage ratio of at least 6%.

Corrective
Measures for Capital Deficiencies. The federal banking regulators are required to take prompt corrective action with respect to capital-deficient institutions. Agency regulations define, for each capital category, the levels at
which institutions are well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized and critically undercapitalized. A well capitalized bank has a
total risk-based capital ratio of 10.0% or higher; a Tier 1 risk-based capital ratio of 6.0% or higher; a leverage ratio of 5.0% or higher; and is not subject to any written agreement, order or directive requiring it to maintain a specific capital
ratio for any capital measure. An adequately capitalized bank has a total risk-based capital ratio of 8.0% or higher; a Tier 1 risk-based capital ratio of 4.0% or higher; a leverage ratio of 4.0% or higher (3.0% or higher if the bank was
rated a composite 1 in its most recent examination report and is not experiencing significant growth). A bank is undercapitalized if it fails to meet any one of the ratios required to be adequately capitalized. The Company believes that
as of December 31, 2006, the Bank was well capitalized based on the guidelines and ratios for purposes of the FDICs prompt corrective action regulations.

In addition to requiring undercapitalized institutions to submit a capital restoration plan, agency regulations contain broad restrictions on certain activities of undercapitalized institutions including asset growth,
acquisition, branch establishment and expansion into new lines of business. With certain exceptions, an insured depository institution is prohibited from making capital distributions, including dividends, and is prohibited from paying management
fees to control persons if the institution would be undercapitalized after any such distribution or payment.

As an institutions capital decreases,
the FDICs enforcement powers become more severe. A significantly undercapitalized institution is subject to mandated capital raising activities, restrictions on interest rates paid and transactions with affiliates, removal of management and
other restrictions. The FDIC has only very limited discretion in dealing with a critically undercapitalized institution and is virtually required to appoint a receiver or conservator.

Banks with risk-based capital and leverage ratios below the required minimums may also be subject to certain administrative actions, including the termination of deposit insurance upon notice and hearing, or a
temporary suspension of insurance without a hearing in the event the institution has no tangible capital.

Imposition of Liability for
Undercapitalized Subsidiaries.A bank holding company that fails to meet the applicable risk-based capital standards will be at a disadvantage. For example, Federal Reserve Board policy discourages the payment of dividends by a bank holding
company from borrowed funds as well as payments that would adversely affect capital adequacy. Failure to meet the capital guidelines may result in the issuance of supervisory or enforcement actions by the Federal Reserve Board. FDICIA requires bank
regulators to take prompt corrective action to resolve problems associated with insured depository institutions whose capital declines below certain levels.



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Acquisitions by Bank Holding Companies.The BHCA requires a bank holding company to obtain the prior
approval of the Federal Reserve Board before it acquires all or substantially all of the assets of any bank, or ownership or control of more than 5% of any class of voting shares of any bank.

Community Reinvestment Act.The Community Reinvestment Act of 1977 (CRA) and the regulations promulgated by the FDIC to implement the CRA are
intended to ensure that banks meet the credit needs of their service area, including low and moderate income communities and individuals, consistent with safe and sound banking practices. The CRA regulations also require the banking regulatory
authorities to evaluate a banks record in meeting the needs of its service area when considering applications to establish new offices or consummate any merger or acquisition transaction. Under FIRREA, the federal banking agencies are required
to rate each insured institutions performance under CRA and to make such information publicly available. In the case of an acquisition by a bank holding company, the CRA performance records of the banks involved in the transaction are reviewed
as part of the processing of the acquisition application. A CRA rating other than outstanding or satisfactory can substantially delay or block a transaction. Based upon our most recent CRA examination, the Bank has an
outstanding CRA rating.

Permissible Activities for State-Chartered Institutions.The Texas Constitution provides that a Texas-chartered bank
has the same rights and privileges that are granted to national banks domiciled in Texas. The Texas Finance Code also contains provisions that expand the powers of Texas-chartered banks. Under these provisions, a Texas-chartered bank may, with
limited exceptions, perform any act, own any property, and offer any product or service that is permissible for any depository institution organized under federal law or the laws of any state, unless (i) prohibited by the FDICIA, or
(ii) the Commissioner of the Texas Banking Department finds that the activity would adversely affect the safety and soundness of the bank. However, FDICIA provides that no state bank or subsidiary thereof may engage as principal in any activity
not permitted for national banks, unless the institution complies with applicable capital requirements and the FDIC determines that the activity poses no significant risk to the Bank Insurance Fund.

Branching.Texas law provides that a Texas-chartered bank can establish a branch anywhere in Texas provided that the branch is approved in advance by the
Commissioner of the Texas Department of Banking. The branch must also be approved by the FDIC, which considers a number of factors, including financial history, capital adequacy, earnings prospects, character of management, needs of the community,
and consistency with corporate powers.

Restrictions on Transactions with Affiliates and Insiders. Transactions between the Bank and its
nonbanking affiliates, including Sterling Bancshares, are subject to Section 23A of the Federal Reserve Act. An affiliate of a bank is any company or entity that controls, is controlled by, or is under common control with the bank. In general,
Section 23A imposes a limit on the amount of such transactions, and also requires certain levels of collateral for loans to affiliated parties. It also limits the amount of advances to third parties which are collateralized by the securities or
obligations of the Bank or its nonbanking affiliates.

Affiliate transactions are also subject to Section 23B of the Federal Reserve Act which
generally requires that certain other transactions between the Bank and its affiliates be on terms substantially the same, or at least as favorable to the Bank, as those prevailing at that time for comparable transactions with or involving other
non-affiliated persons.

The restrictions on loans to directors, executive officers, principal shareholders and their related interests (collectively, the
insiders) contained in the Federal Reserve Act and Regulation O apply to all insured institutions and their subsidiaries and holding companies. These restrictions include limits on loans to one borrower and conditions that must be met
before such a loan can be made. There is also an aggregate limitation on all loans to insiders and their related interests. These loans cannot exceed the institutions total unimpaired capital and surplus, and the FDIC may determine that a
lesser amount is appropriate. Insiders are subject to enforcement actions for knowingly accepting loans in violation of applicable restrictions.



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Brokered Deposit Restrictions. FIRREA and FDICIA generally limit institutions that are not well capitalized
from accepting brokered deposits. In general, undercapitalized institutions may not solicit, accept or renew brokered deposits. Adequately capitalized institutions may not solicit, accept or renew brokered deposits unless they obtain a waiver from
the FDIC. Even in that event, the institution must comply with rate limitations imposed by the Federal Deposit Insurance Act.

Restrictions on
Subsidiary Banks.Dividends paid by the Bank provided substantially all of Sterling Bancshares cash flow during 2006 and will continue to do so in the foreseeable future. Under federal law, a bank may not pay a dividend that results in
an undercapitalized situation. At December 31, 2006, there was an aggregate of approximately $98 million available for payment of dividends by the Bank. At December 31, 2006, the aggregate amount of dividends, which legally
could be paid without prior approval of various regulatory agencies, totaled approximately $22 million.

Other requirements under Texas law affecting the
operation of subsidiary banks include requirements relating to maintenance of reserves against deposits, restrictions on the nature and amount of loans that may be made and the interest that may be charged thereon and limitations relating to
investments and other activities.

Examinations.The FDIC periodically examines and evaluates insured banks. FDIC examinations are conducted
annually. The Texas Banking Commissioner also conducts examinations annually, unless additional examinations are deemed necessary to safeguard the interests of shareholders, depositors and creditors.

Audit Reports.The Company must submit annual audit reports prepared by an independent registered public accounting firm to federal and state regulators.
In some instances, the audit report of the institutions holding company can be used to satisfy this requirement. In addition, financial statements prepared in accordance with generally accepted accounting principles in the United States of
America, managements certifications concerning responsibility for the financial statements, internal controls and compliance with legal requirements designated by the FDIC, and an attestation by the independent registered public accounting
firm regarding the statements of management relating to the internal controls must be submitted. For institutions with total assets of more than $3 billion, an independent registered public accounting firm may be required to review quarterly
financial statements. FDICIA requires that independent audit committees be formed, consisting solely of outside directors. Committees must include members with experience in banking or financial management, must have access to outside counsel, and
must not include representatives of large customers.

Deposit Insurance Assessments.The Bank must pay assessments to the FDIC for federal
deposit insurance protection. The FDIC has adopted a risk-based assessment system as required by FDICIA. Under this system, insured depository institutions pay insurance premiums at rates based on their risk classification. Institutions assigned to
higher-risk classifications pay assessments at higher rates than institutions that pose a lower risk. An institutions risk classification is assigned based on its capital levels and the level of supervisory concern the institution poses to the
regulators. In addition, the FDIC can impose special assessments in certain instances. The FDIC may adjust the assessment rate schedule twice a year without seeking prior public comment, but only within a range of five cents per $100 above or below
the premium schedule adopted. The FDIC can make changes in the rate schedule outside the five-cent range above or below the current schedule only after a full rulemaking with opportunity for public comment.

Expanded Enforcement Authority.Federal banking agencies have broad enforcement powers, including the power to terminate deposit insurance, impose
substantial fines and other civil and criminal penalties, and appoint a conservator or receiver. Failure to comply with applicable laws, regulations, and supervisory agreements could subject the Bank and its affiliates, as well as officers and
directors, to administrative sanctions and potentially substantial civil penalties.

Effect on Economic Environment.The policies of
regulatory authorities, including the monetary policy of the Federal Reserve Board, have a significant effect on the operating results of bank holding companies and their



8



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##### Table of Contents

##### Index to Financial Statements

subsidiaries. Among the means available to the Federal Reserve Board to affect the money supply are open market operations in U.S. government securities,
changes in the discount rate on member bank borrowings and changes in reserve requirements against member bank deposits. These means are used in varying combinations to influence overall growth and distribution of bank loans, investments and
deposits, and their use may affect interest rates charged on loans or paid for deposits. Federal Reserve Board monetary policies have materially affected the operating results of commercial banks in the past and are expected to continue to do so in
the future.

Consumer Laws and Regulations. Banks are also subject to certain consumer laws and regulations that are designed to protect
consumers in transactions with banks. Among the more prominent of such laws and regulations are the Truth in Lending Act, the Truth in Savings Act, the Electronic Funds Transfer Act, the Expedited Funds Availability Act, the Equal Credit Opportunity
Act, the Fair Credit Reporting Act, the Fair Housing Act and consumer privacy protection provisions of the Gramm-Leach-Bliley Act. These laws and regulations mandate certain disclosure requirements and regulate the manner in which financial
institutions must deal with consumers. With respect to consumer privacy, Gramm-Leach-Bliley generally prohibits disclosure of customer information to non-affiliated third parties unless the customer has been given the opportunity to object and has
not objected to such disclosure. Financial institutions are further required to disclose their privacy policies to customers annually.

Employees.The Company had 1,074 full time equivalent employees as of December 31, 2006. The Company added 50 employees as a result of the acquisition of BOTH in September 2006. None of our employees are
represented by collective bargaining agreements and the Company considers its employee relations to be good. In 2006, Sterling was named for the fifth consecutive year as one of the best places to work in Houston by the Houston Business Journal, and
has twice received the Best Award from the American Society of Training and Development.

Available Information

Under the Exchange Act, Sterling Bancshares is required to file annual, quarterly and current reports, proxy statements and other information with the SEC. You may read a
copy of any document we file with the SEC at the SECs Public Reference Room at 100 F Street, N.E., Washington, D.C. 20549. Please call the SEC at 1-800-SEC-0330 for further information about the Public Reference Room. The SEC maintains a web
site at http://www.sec.gov that contains reports, proxy and information statements, and other information we file electronically with the SEC.

We make
available, free of charge through our web site, our reports on Forms 10-K, 10-Q and 8-K, and amendments to those reports, as soon as reasonably practicable after such reports are filed with the SEC. Additionally, we have adopted and posted on our
web site a Code of Ethics for Senior Financial Officers that applies to our principal executive officer, principal financial officer and principal accounting officer. Our web site also includes the charters for our Audit Committee and Corporate
Governance and Nominating Committee. The address for our web site is http://www.banksterling.com. The information contained on or accessible from our website does not constitute a part of this report and is not incorporated by reference herein. We
will also provide a printed copy of any of these aforementioned documents free of charge upon request.



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##### Index to Financial Statements

ITEM 1A. Risk Factors

Risks, Uncertainties and Other Factors That May Affect Our Future Results

Our profitability depends significantly on geographic economic conditions.

Our success depends primarily on the general economic conditions of the nation, the Houston metropolitan area and, to a lesser extent, that of the San Antonio and Dallas metropolitan areas. Unlike larger banks that
are more geographically diversified, we provide banking and financial services to customers primarily in the market areas in which we operate. The local economic conditions of these areas have a significant impact on our commercial, real estate and
construction loans, the ability of the borrowers to repay these loans and the value of the collateral securing these loans. A significant decline in general economic conditions, such as inflation, recession, acts of terrorism, an outbreak of
hostilities, unemployment and other factors beyond our control will impact these local economic conditions and will negatively affect the financial results of our banking operations. In addition, Houston remains largely dependent on the energy
industry. A downturn in the energy industry and energy-related business could indirectly and adversely affect our results of operations and financial condition.

We rely on an owner-operated business market.

Our business development and marketing strategy primarily targets the banking and
financial needs of owner-operated businesses with credit needs of under $5 million. These owner-operated businesses represent a major sector of the Houston and national economies. If general economic conditions negatively impact this economic sector
in the metropolitan areas in which we operate, our results of operations and financial condition will be significantly affected.

If our allowance
for credit losses is not sufficient to cover actual loan losses, our earnings could decrease.

Our loan customers may not repay their loans
according to the terms of these loans, and the collateral securing the payment of these loans may be insufficient to assure repayment. We may experience significant credit losses that could have a material adverse effect on our operating results. We
make various assumptions and judgments about the collectibility of our loan portfolio, including the creditworthiness of our borrowers and the value of the real estate and other assets serving as collateral for the repayment of many of our loans. In
determining the size of the allowance, we rely on our experience and our evaluation of economic conditions. If our assumptions prove to be incorrect, our current allowance may not be sufficient to cover future loan losses and adjustments may be
necessary to allow for different economic conditions or adverse developments in our loan portfolio. Significant additions to our allowance would materially decrease our net income.

In addition, federal and state regulators periodically review our allowance for credit losses and may require us to increase our provision for credit losses or recognize further loan charge-offs, based on judgments
different than those we make. Any increase in our allowance or charge-offs as required by these regulatory agencies could have a negative affect on us.

Fluctuations in interest rates could reduce our profitability.

We realize income primarily from the difference between interest
earned on loans and securities and the interest paid on deposits and borrowings. We expect that we will periodically experience gaps in the interest rate sensitivities of our assets and liabilities, meaning that either our
interest-bearing liabilities will be more sensitive to changes in market interest rates than our interest-earning assets, or vice versa. In either event, if market interest rates should move contrary to our position, this gap will work
against us, and our earnings may be negatively affected.



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##### Index to Financial Statements

We are unable to predict fluctuations of market interest rates, which are affected by the following factors:



| |  |  | inflation;
| | - |  | ----------



| |  |  | recession;
| | - |  | ----------



| |  |  | a rise in unemployment;
| | - |  | -----------------------



| |  |  | tightening money supply;
| | - |  | ------------------------



| |  |  | international disorder; and
| | - |  | ---------------------------



| |  |  | instability in domestic and foreign financial markets.
| | - |  | ------------------------------------------------------

Our asset/liability management strategy, which is designed to address the risk from changes in market interest rates and the shape of the yield curve, may not prevent changes in interest rates from having a material adverse effect on our
results of operations and financial condition.

Competition with other financial institutions could adversely affect our profitability.

We face vigorous competition from banks and other financial institutions, including savings institutions, finance companies and credit unions. A
number of these banks and other financial institutions have substantially greater resources and lending limits, larger branch systems and a wider array of banking services. To a limited extent, we also compete with other providers of financial
services, such as money market mutual funds, brokerage firms, consumer finance companies and insurance companies. This competition may reduce or limit our margins on banking services, reduce our market share and adversely affect our results of
operations and financial condition. Additionally, we face competition primarily from other banks in attracting, developing and retaining qualified banking professionals.

We may not be able to maintain our historical growth rate which may adversely impact our results of operations and financial condition.

We have initiated internal growth programs, completed various acquisitions and opened additional banking centers in the past few years. We may not be able to sustain our historical rate of growth or may not even be
able to grow at all. We may not be able to obtain the financing necessary to fund additional growth and may not be able to find suitable candidates for acquisition. Various factors, such as economic conditions and competition, may impede or prohibit
the opening of new branch centers. Further, our inability to attract and retain experienced bankers may adversely affect our internal growth. A significant decrease in our historical rate of growth may adversely impact our results of operations and
financial condition.

We may be unable to complete acquisitions, and once complete, may not be able to integrate our acquisitions successfully.

Our growth strategy includes our desire to acquire other financial institutions. We may not be able to complete any future acquisitions and, if
completed, we may not be able to successfully integrate the operations, management, products and services of the entities we acquire. We may not realize expected cost savings or make revenue enhancements. Following each acquisition, we must expend
substantial managerial, operating, financial and other resources to integrate these entities. In particular, we may be required to install and standardize adequate operational and control systems, deploy or modify equipment, implement marketing
efforts in new as well as existing locations and employ and maintain qualified personnel. Our failure to successfully integrate the entities we acquire into our existing operations may adversely affect our financial condition and results of
operations.



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##### Index to Financial Statements

We operate in a highly regulated environment and may be adversely affected by changes in federal and local laws and
regulations.

We are subject to extensive regulation, supervision and examination by federal and state banking authorities. Any change in applicable
regulations or federal or state legislation could have a substantial impact on us and our operations. Additional legislation and regulations may be enacted or adopted in the future that could significantly affect our powers, authority and
operations, which could have a material adverse effect on our financial condition and results of operations. Further, regulators have significant discretion and power to prevent or remedy unsafe or unsound practices or violations of laws by banks
and bank holding companies in the performance of their supervisory and enforcement duties. The exercise of this regulatory discretion and power may have a negative impact on us.



|ITEM 1B. | Unresolved Staff Comments
|-------- | -------------------------

None.

ITEM 2. Properties

Our principal executive offices are located at 2550 North Loop West, Suite 600, Houston, Texas, 77092,
in space leased by the Company. In addition to our principal office, we operate the following locations:



|                                                 |  |       |  |        |  |      
|------------------------------------------------ |  | ----- |  | ------ |  | -----
|                                                 |  | Owned |  | Leased |  | Total
|Banking centers in the Houston metropolitan area |  | 2     |  | 24     |  | 26   
|Banking centers in the San Antonio area          |  | 3     |  | 9      |  | 12   
|Banking centers in the Dallas metropolitan area  |  |      |  | 7      |  | 7    
|Central department offices                       |  | 1     |  | 2      |  | 3    
|                                                 |  |       |  |        |  |      
|Total                                            |  | 6     |  | 42     |  | 48   
|                                                 |  |       |  |        |  |      

The Company has options to renew leases at most locations.

ITEM 3. Legal Proceedings

From time to time, the Company is a party to various legal proceedings incident to its business.
Currently, neither Sterling Bancshares nor any of its subsidiaries are involved in any material legal proceedings.

ITEM 4. Submission of Matters to a Vote of Security Holders

No matters were submitted to
a vote of security holders during the fourth quarter of 2006.

PART II

ITEM 5. Market for Registrants Common Equity, Related Shareholder Matters and Issuer Purchases of Equity Securities

Common Stock Market Prices and Dividends

Our stock trades through the NASDAQ National Market System under the symbol SBIB. In
2006, Sterling was named to the NASDAQ Global Select Market Composite Index which is a market capitalization weighted index that measures all NASDAQ domestic and international based common type stocks listed on the Global Select tier



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##### Index to Financial Statements

of The NASDAQ Stock Market. The following table sets forth the high and low sales prices per share of Sterling Bancshares common stock and the
dividends paid thereon for each quarter of the last two years. This information has been restated to reflect all stock splits occurring prior to the issuance of this report.



|               |  |                       |       |          |   |       |  |   |       
|-------------- |  | --------------------- | ----- | -------- | - | ----- |  | - | ------
|               |  | Sales Price Per Share |       | Dividend
|               |  | High                  |       | Low      |  
|               |  |                       |      
|2006           |  |                       |       |          |   |       |  |   |       
|First quarter  |  | $                     | 12.04 |          | $ | 10.12 |  | $ | 0.0467
|Second quarter |  |                       | 12.61 |          |   | 10.67 |  |   | 0.0467
|Third quarter  |  |                       | 13.93 |          |   | 11.79 |  |   | 0.0467
|Fourth quarter |  |                       | 13.84 |          |   | 11.85 |  |   | 0.0467
|               |  |                       |      
|2005           |  |                       |       |          |   |       |  |   |       
|First quarter  |  | $                     | 10.00 |          | $ | 8.68  |  | $ | 0.0400
|Second quarter |  |                       | 10.39 |          |   | 8.58  |  |   | 0.0400
|Third quarter  |  |                       | 10.69 |          |   | 9.33  |  |   | 0.0400
|Fourth quarter |  |                       | 11.00 |          |   | 9.02  |  |   | 0.0400

On January 29, 2007, the Board of Directors declared a quarterly cash dividend of $0.0525 per share payable
on February 23, 2007, to shareholders of record on February 9, 2007. We intend to continue to pay a dividend at a minimum rate of $0.0525 per share quarterly throughout 2007. However, there can be no assurance that we will continue to pay
cash dividends on our common stock in the future or the amount or frequency of any such dividend. The payment of future dividends is dependent on our future earnings, capital requirements and financial condition.

On October 31, 2006, the Companys Board of Directors declared a three-for-two stock split to be effected in the form of a stock dividend on its common stock
to shareholders of record on December 1, 2006. Cash paid in lieu of fractional shares was based on the average of the high and low bids on the record date, as adjusted for the split. The payment date for the stock dividend was December 15,
2006.

For information on the ability of the Bank to pay dividends and make loans to Sterling Bancshares, see Managements Discussion and
Analysis of Financial Condition and Results of OperationsFinancial ConditionInterest Rate Sensitivity and Liquidity and Note 19 to the Consolidated Financial Statements.

As of February 26, 2007, there were 72,075,047 shares of the Companys common stock outstanding held by 1,016 shareholders of record. The closing price per share of
common stock on December 29, 2006, the last trading day of the Companys fiscal year, was $13.02. The number of beneficial shareholders is unknown.

Recent Sales of Unregistered Securities

The Company did not issue any shares which were exempt from the registration under the Securities
Act of 1933 pursuant to Section 3(a)(9) thereunder during 2006.

Issuer Repurchases of Equity Securities

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. On January 29, 2007, the Companys Board of Directors authorized an increase in the number of shares to be repurchased to adjust for the three-for-two stock split approved by the Board on October 30, 2006. The Company
is now authorized to repurchase up to 3,750,000 shares of common stock, not to exceed 750,000 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.



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##### Index to Financial Statements

The table below lists the Companys purchases of its equity securities registered pursuant to Section 12 of the Exchange Act during the fourth
quarter of 2006:



|                                     |  |                                |  |                                     |       |                                                                    |         |                                                |          
|------------------------------------ |  | ------------------------------ |  | ----------------------------------- | ----- | ------------------------------------------------------------------ | ------- | ---------------------------------------------- | ---------
|Period                               |  | Total Number ofSharesPurchased |  | Weighted AveragePrice Paid perShare |       | Total Number of SharesPurchased as Part of PubliclyAnnounced Plans |         | Shares That May Yet BePurchased Under thePlans
|October 1, 2006 toOctober 31, 2006   |  | 60,000                         |  | $                                   | 13.34 |                                                                    | 810,000 |                                                | 2,940,000
|November 1, 2006 toNovember 30, 2006 |  | 99,000                         |  | $                                   | 12.27 |                                                                    | 909,000 |                                                | 2,841,000
|December 1, 2006 toDecember 31, 2006 |  | 28,500                         |  | $                                   | 12.28 |                                                                    | 937,500 |                                                | 2,812,500



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##### Index to Financial Statements

ITEM 6. Selected Financial Data



|                                                        |  |                                                                 |           |   |      |   |           |      |  |   |           |   |  |      |           |   |  |   |           |  
|------------------------------------------------------- |  | --------------------------------------------------------------- | --------- | - | ---- | - | --------- | ---- |  | - | --------- | - |  | ---- | --------- | - |  | - | --------- | -
|                                                        |  | Year Ended December 31,                                         |          
|                                                        |  | 2006                                                            |           |   | 2005 |   |           | 2004 |  |   | 2003      |   |  | 2002 |          
|                                                        |  | (Dollars and shares in thousands, except for per share amounts) |          
|Income Statement Data:                                  |  |                                                                 |           |  
|Net interest income                                     |  | $                                                               | 171,806   |   |      | $ | 150,230   |      |  | $ | 128,972   |   |  | $    | 132,732   |   |  | $ | 135,893   |  
|Provision for credit losses                             |  |                                                                 | 4,058     |   |      |   | 14,371    |      |  |   | 12,250    |   |  |      | 17,698    |   |  |   | 11,700    |  
|Noninterest income                                      |  |                                                                 | 31,217    |   |      |   | 26,959    |      |  |   | 31,025    |   |  |      | 33,187    |   |  |   | 29,706    |  
|Noninterest expense                                     |  |                                                                 | 131,186   |   |      |   | 110,646   |      |  |   | 113,300   |   |  |      | 105,830   |   |  |   | 104,999   |  
|Income from continuing operations before income taxes   |  |                                                                 | 67,779    |   |      |   | 52,172    |      |  |   | 34,447    |   |  |      | 42,391    |   |  |   | 48,900    |  
|Income from continuing operations                       |  |                                                                 | 45,840    |   |      |   | 36,222    |      |  |   | 24,963    |   |  |      | 28,354    |   |  |   | 33,183    |  
|Income from discontinued operations                     |  |                                                                 |          |   |      |   |          |      |  |   |          |   |  |      | 20,756    |   |  |   | 3,368     |  
|Net income                                              |  |                                                                 | 45,840    |   |      |   | 36,222    |      |  |   | 24,963    |   |  |      | 49,110    |   |  |   | 36,551    |  
|                                                        |  |                                                                 |           |   |     
|Balance Sheet Data(at period-end):                      |  |                                                                 |           |   |      |   |           |      |  |   |           |   |  |      |           |   |  |   |           |  
|Total assets                                            |  | $                                                               | 4,117,559 |   |      | $ | 3,726,859 |      |  | $ | 3,336,896 |   |  | $    | 3,206,880 |   |  | $ | 3,585,220 |  
|Total loans                                             |  |                                                                 | 3,132,567 |   |      |   | 2,699,362 |      |  |   | 2,344,977 |   |  |      | 2,157,039 |   |  |   | 2,644,862 |  
|Allowance for loan losses                               |  |                                                                 | 32,027    |   |      |   | 31,230    |      |  |   | 29,406    |   |  |      | 30,722    |   |  |   | 27,248    |  
|Total securities                                        |  |                                                                 | 573,614   |   |      |   | 618,998   |      |  |   | 658,118   |   |  |      | 565,093   |   |  |   | 313,054   |  
|Trading assets                                          |  |                                                                 |          |   |      |   | 28,515    |      |  |   | 36,720    |   |  |      | 172,825   |   |  |   | 142,803   |  
|Total deposits                                          |  |                                                                 | 3,334,611 |   |      |   | 2,838,143 |      |  |   | 2,443,967 |   |  |      | 2,418,369 |   |  |   | 2,673,072 |  
|Short-term borrowings                                   |  |                                                                 | 220,675   |   |      |   | 392,850   |      |  |   | 420,575   |   |  |      | 324,160   |   |  |   | 509,590   |  
|Notes payable                                           |  |                                                                 |          |   |      |   |          |      |  |   |          |   |  |      |          |   |  |   | 21,430    |  
|Subordinated debt                                       |  |                                                                 | 46,135    |   |      |   | 46,238    |      |  |   | 47,162    |   |  |      | 46,533    |   |  |   |          |  
|Junior subordinated debt                                |  |                                                                 | 56,959    |   |      |   | 82,475    |      |  |   | 82,475    |   |  |      | 82,475    |   |  |   | 82,475    |  
|Shareholders equity                                    |  |                                                                 | 409,285   |   |      |   | 334,472   |      |  |   | 313,172   |   |  |      | 292,596   |   |  |   | 249,327   |  
|                                                        |  |                                                                 |           |   |     
|Common Share Data:                                      |  |                                                                 |           |   |      |   |           |      |  |   |           |   |  |      |           |   |  |   |           |  
|Earnings per share from continuing operations (1) (2)   |  |                                                                 |           |   |      |   |           |      |  |   |           |   |  |      |           |   |  |   |           |  
|Basic shares                                            |  | $                                                               | 0.67      |   |      | $ | 0.53      |      |  | $ | 0.37      |   |  | $    | 0.43      |   |  | $ | 0.50      |  
|Diluted shares                                          |  |                                                                 | 0.66      |   |      |   | 0.53      |      |  |   | 0.37      |   |  |      | 0.42      |   |  |   | 0.49      |  
|Earnings per share from discontinued operations (1) (2) |  |                                                                 |           |   |      |   |           |      |  |   |           |   |  |      |           |   |  |   |           |  
|Basic shares                                            |  |                                                                 |          |   |      |   |          |      |  |   |          |   |  |      | 0.31      |   |  |   | 0.05      |  
|Diluted shares                                          |  |                                                                 |          |   |      |   |          |      |  |   |          |   |  |      | 0.31      |   |  |   | 0.05      |  
|Earnings per share (1) (2)                              |  |                                                                 |           |   |      |   |           |      |  |   |           |   |  |      |           |   |  |   |           |  
|Basic shares                                            |  |                                                                 | 0.67      |   |      |   | 0.53      |      |  |   | 0.37      |   |  |      | 0.74      |   |  |   | 0.56      |  
|Diluted shares                                          |  |                                                                 | 0.66      |   |      |   | 0.53      |      |  |   | 0.37      |   |  |      | 0.73      |   |  |   | 0.54      |  
|Shares used in computing earnings per common share (2)  |  |                                                                 |           |   |      |   |           |      |  |   |           |   |  |      |           |   |  |   |           |  
|Basic shares                                            |  |                                                                 | 68,834    |   |      |   | 67,932    |      |  |   | 67,259    |   |  |      | 66,270    |   |  |   | 65,808    |  
|Diluted shares                                          |  |                                                                 | 69,533    |   |      |   | 68,642    |      |  |   | 67,918    |   |  |      | 66,972    |   |  |   | 67,134    |  
|End of period common sharesoutstanding (2)              |  |                                                                 | 71,001    |   |      |   | 68,001    |      |  |   | 67,602    |   |  |      | 66,963    |   |  |   | 65,975    |  
|Book value per common share atperiod-end (2)            |  |                                                                 |           |   |      |   |           |      |  |   |           |   |  |      |           |   |  |   |           |  
|Total                                                   |  | $                                                               | 5.76      |   |      | $ | 4.92      |      |  | $ | 4.63      |   |  | $    | 4.37      |   |  | $ | 3.77      |  
|Tangible                                                |  | $                                                               | 3.78      |   |      | $ | 3.62      |      |  | $ | 3.68      |   |  | $    | 3.39      |   |  | $ | 2.89      |  
|Cash dividends paid per common share (2)                |  | $                                                               | 0.186     |   |      | $ | 0.160     |      |  | $ | 0.133     |   |  | $    | 0.120     |   |  | $ | 0.107     |  
|Common stock dividend payout ratio                      |  |                                                                 | 27.99     | % |      |   | 30.00     | %    |  |   | 35.91     | % |  |      | 16.19     | % |  |   | 19.21     | %



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##### Index to Financial Statements

|                                                               |  |                         |   |  |        |   |  |        |   |  |       |   |  |        |  
|-------------------------------------------------------------- |  | ----------------------- | - |  | ------ | - |  | ------ | - |  | ----- | - |  | ------ | -
|                                                               |  | Year Ended December 31, |  
|                                                               |  | 2006                    |   |  | 2005   |   |  | 2004   |   |  | 2003  |   |  | 2002   |  
|Selected Performance Ratios and Other Data:                    |  |                         |   |  |        |   |  |        |   |  |       |   |  |        |  
|Return on average common equity                                |  |                         |   |  |        |   |  |        |   |  |       |   |  |        |  
|Total                                                          |  | 12.66                   | % |  | 11.07  | % |  | 8.23   | % |  | 18.18 | % |  | 15.48  | %
|Continuing                                                     |  | 12.66                   | % |  | 11.07  | % |  | 8.23   | % |  | 10.50 | % |  | 14.06  | %
|Return on average assets                                       |  |                         |   |  |        |   |  |        |   |  |       |   |  |        |  
|Total                                                          |  | 1.18                    | % |  | 1.02   | % |  | 0.78   | % |  | 1.48  | % |  | 1.21   | %
|Continuing                                                     |  | 1.18                    | % |  | 1.02   | % |  | 0.78   | % |  | 0.86  | % |  | 1.10   | %
|Net interest margin                                            |  | 4.87                    | % |  | 4.63   | % |  | 4.43   | % |  | 4.49  | % |  | 5.13   | %
|Efficiency ratio                                               |  | 64.62                   | % |  | 62.44  | % |  | 70.81  | % |  | 63.78 | % |  | 63.41  | %
|Full-time equivalent employees                                 |  | 1,074                   |   |  | 1,014  |   |  | 961    |   |  | 1,036 |   |  | 1,065  |  
|Number of banking centers                                      |  | 45                      |   |  | 40     |   |  | 36     |   |  | 37    |   |  | 40     |  
|                                                               |  |                         |   |  |       
|Liquidity and Capital Ratios:                                  |  |                         |   |  |        |   |  |        |   |  |       |   |  |        |  
|Average loans to average deposits                              |  | 95.85                   | % |  | 97.67  | % |  | 89.32  | % |  | 99.91 | % |  | 92.74  | %
|Period-end shareholders equity to total assets                |  | 9.94                    | % |  | 8.97   | % |  | 9.39   | % |  | 9.12  | % |  | 6.95   | %
|Average shareholders equity to average assets                 |  | 9.33                    | % |  | 9.19   | % |  | 9.52   | % |  | 8.16  | % |  | 7.83   | %
|Period-end tangible capital to total tangible assets           |  | 6.74                    | % |  | 6.76   | % |  | 7.61   | % |  | 7.24  | % |  | 6.04   | %
|Tier 1 capital to risk weighted assets                         |  | 8.64                    | % |  | 9.99   | % |  | 11.78  | % |  | 12.30 | % |  | 8.41   | %
|Total capital to risk weighted assets                          |  | 10.72                   | % |  | 12.36  | % |  | 14.55  | % |  | 15.40 | % |  | 9.29   | %
|Tier 1 leverage ratio (Tier 1 capital to average assets)       |  | 8.14                    | % |  | 9.11   | % |  | 10.15  | % |  | 10.38 | % |  | 7.81   | %
|                                                               |  |                         |   |  |       
|Asset Quality Ratios:                                          |  |                         |   |  |        |   |  |        |   |  |       |   |  |        |  
|Period-end allowance for credit losses to period-end loans     |  | 1.05                    | % |  | 1.20   | % |  | 1.29   | % |  | 1.42  | % |  | 1.03   | %
|Period-end allowance for loan losses to period-end loans       |  | 1.02                    | % |  | 1.16   | % |  | 1.25   | % |  | 1.42  | % |  | 1.03   | %
|Period-end allowance for loan losses to nonperforming loans    |  | 281.27                  | % |  | 142.99 | % |  | 142.71 | % |  | 90.66 | % |  | 138.64 | %
|Nonperforming assets to period-end loans and foreclosed assets |  | 0.42                    | % |  | 0.83   | % |  | 0.95   | % |  | 1.68  | % |  | 0.87   | %
|Nonperforming loans to period-end loans                        |  | 0.36                    | % |  | 0.81   | % |  | 0.88   | % |  | 1.57  | % |  | 0.74   | %
|Nonperforming assets to period-end assets                      |  | 0.32                    | % |  | 0.60   | % |  | 0.67   | % |  | 1.13  | % |  | 0.64   | %
|Net charge-offs to average loans                               |  | 0.20                    | % |  | 0.51   | % |  | 0.58   | % |  | 0.60  | % |  | 0.37   | %

---

|(1) | The calculation of diluted earnings per share excludes 139,025, 167,663, 328,343, 930,647 and 401,187 options for year 2006, 2005, 2004, 2003 and 2002, respectively, which were
antidilutive.
|--- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(2) | The share and per share information presented reflects the retroactive effect of a three-for-two stock split in the form of a stock dividend effective on December 1, 2006.
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------

ITEM 7. Managements Discussion and Analysis of Financial Condition and Result of Operations

Forward-Looking
Statements

This Annual Report on Form 10-K, 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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##### Index to Financial Statements

materially from those in such statements. These risks and uncertainties include, but are not limited to, the risks identified in Item 1A of this report
and 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.

Overview

Managements Discussion and Analysis of Financial Condition and Results of Operations analyzes major elements of our Consolidated
Financial Statements and provides insight into important areas of managements focus. This introduction highlights selected information in this report and may not contain all of the information that is important to you. For a more complete
understanding of trends, events, commitments, liquidity, capital resources and critical accounting estimates, you should carefully read this entire report.

Our success is highly dependent on economic conditions and market interest rates. Because we operate in the Houston, Dallas and San Antonio metropolitan areas, the local economic conditions in each of these areas are particularly important.
All three of these local economies grew at a steady pace in 2006. Each economy added jobs at a faster pace than the overall U.S. economy. The overall economic outlook for Houston, Dallas, and San Antonio remains favorable, as local economists are
forecasting continued job growth in 2007.

With the help of a solid Texas economy we reported strong earnings growth in 2006 despite operating in a
competitive market and difficult interest rate environment. We realize income primarily from the difference between interest earned on loans and investments and the interest paid on deposits and borrowings. Each of these financial instruments reacts
differently to changes in interest rates. Beginning June 2004 to December 31, 2006, the Federal Reserve Board increased overnight interest rates by 425 basis points to 5.25%. In contrast, the movement of long-term and short-term rates have
produced a flatter interest rate yield curve. More recently, the yield curve has even inverted at certain maturities. While we are impacted significantly by the size and timing of short-term rate increases, as well as the shape of the yield curve
and other competitive factors, our balance sheet is generally positioned to benefit from a gradually rising interest rate environment.

Because of our
double digit growth in loans and deposits and our relatively high percentage of non-interest bearing deposits to total funding we were able to expand our net interest margin for the full year 2006 despite the additional pressure from the interest
rate yield curve. Additionally during 2006, we experienced significant improvements in our asset quality as reflected in the decreases in both nonperforming loans and net charge-offs.



17



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##### Index to Financial Statements

During the year, we strengthened our management team by adding several key executives as well as redeploying members of
the current management team into new roles. These changes position Sterling to better focus on the automating and streamlining of various processes, expanding product lines and increasing our share in the markets we serve.

In 2006, our earnings per share increased 25% compared to 2005. Additionally, during 2006 our overall average earning assets grew by 9% and our average deposits grew by
16%.

We continue to look for fairly-priced strategic acquisitions in Houston, San Antonio and Dallas. On January 24, 2007, the Company entered into a
definitive agreement to acquire Partners Bank of Texas (Partners Bank). The merger is subject to customary closing conditions including receipt of regulatory approval and is expected to occur in the first or second quarter of 2007. The consideration
of the merger is a combination of stock and cash totaling approximately $52.0 million for all of Partners Banks issued and outstanding shares of common stock. The merger agreement has been approved by the respective Boards of Directors of the
Company and Partners Bank, and the transactions contemplated are subject to the approval of the Partners Banks shareholders.

During the third
quarter of 2006, we completed the acquisition of Kerrville, TX-based BOTH, Inc. and its subsidiary bank, Bank of the Hills. During the fourth quarter of 2005, we completed the acquisition of Dallas-based Prestonwood Bancshares, Inc. and its
subsidiary bank of The Oaks Bank & Trust Company.

On October 31, 2006, Sterling Bancshares declared a three-for-two stock split, effected in
the form of a stock dividend, to all shareholders of record on December 1, 2006. All financial information presented reflects the three-for-two split.

Critical Accounting Policies

An understanding of our accounting policies is important to an understanding of our reported results.
Accounting policies are described in detail in Note 1 to the Consolidated Financial Statements in this annual report. Certain of our accounting policies are considered to be critical because they involve subjective judgment, estimation by management
or are particularly complex in their nature.

Allowance for credit losses. The allowance for credit losses is a valuation allowance for
probable losses incurred on loans and binding commitments. Losses are charged to the allowance when the loss actually occurs or when a determination is made that a probable loss has occurred. Recoveries are credited to the allowance at the time of
recovery. Throughout the year, management estimates the probable level of losses to determine whether the allowance for credit losses is adequate to absorb losses in the existing portfolio. Based on these estimates, an amount is charged to the
provision for credit losses and credited to the allowance for credit losses in order to adjust the allowance to a level determined to be adequate to absorb losses. Managements judgment as to the level of probable losses on existing loans
involves the consideration of current economic conditions and their estimated effects on specific borrowers; an evaluation of the existing relationships among loans, potential credit losses and the present level of the allowance; results of
examinations of the loan portfolio by regulatory agencies; and managements internal review of the loan portfolio. In determining the collectibility of certain loans, management also considers the fair value of any underlying collateral. The
amount ultimately realized may differ from the carrying value of these assets because of economic, operating or other conditions beyond our control. Please refer to the subsequent discussion of Allowance for Credit Losses below as well
as in Note 1 to the Consolidated Financial Statements for additional insight into managements approach and methodology in estimating the allowance for credit losses.

Goodwill and Other Intangibles.Goodwill and intangible assets that have indefinite useful lives are subject to an annual evaluation of whether any impairment has occurred. If any such impairment is
determined to have occurred, a writedown would be recorded. Intangible assets consist primarily of core deposits and customer relationships. Intangible assets with definite useful lives are amortized on an accelerated basis over the years



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##### Index to Financial Statements

expected to be benefited, which we believe is approximately 10 years. Based on our annual goodwill impairment test as of December 31, 2006, management
does not believe any of our goodwill is impaired as of December 31, 2006. While we believe no impairment existed at December 31, 2006 under accounting standards applicable at that date, different conditions or assumptions, or changes
in cash flows or profitability, if significantly negative or unfavorable, could have a material adverse effect on the outcome of our impairment evaluation and financial condition or future results of operations.

Derivatives. We may designate a derivative as either an accounting hedge of the fair value of a recognized fixed rate asset or an unrecognized firm
commitment (fair value hedge) or an accounting hedge of a forecasted transaction or of the variability of future cash flows of a floating rate asset or liability (cash flow hedge). All derivatives are recorded as other assets
or other liabilities on the balance sheet at their respective fair values. To the extent of the effectiveness of a hedge, changes in the fair value of a derivative that is designated and qualifies as a cash flow hedge are recorded in other
comprehensive income, net of income taxes. For all hedge relationships, ineffectiveness resulting from differences between the changes in fair value or cash flows of the hedged item and changes in fair value of the derivative are recognized as other
income in the results of operations.

Stock-based Compensation.On January 1, 2006, we adopted the provisions of
SFAS No. 123R, Share-Based Payment (Revised 2004). SFAS 123R applies to new awards and to awards modified, repurchased, or cancelled after January 1, 2006. SFAS 123R eliminated the ability to account for stock-based
compensation using the intrinsic value-based method of accounting, and requires that such transactions be recognized as compensation cost in the income statement based on their fair values on the date of the grant. The grant date fair value of
options is determined using option pricing models based on subjective assumptions which materially affect the fair value estimate. Compensation expense for restricted stock awards is based on the market price of the stock on the date of grant and is
recognized ratably over the vesting period of the award. Please refer to Note 1 to the Consolidated Financial Statements for further information. Disclosures of stock-based compensation are also included in Note 14 to the Consolidated Financial
Statements.

Results of Operations

Performance
Summary.Net income for the year ended December 31, 2006 was $45.8 million, or $0.66 per diluted share, compared with $36.2 million, or $0.53 per diluted share, earned for 2005 and $25.0 million, or $0.37 per diluted share, earned for
2004.

Net Income for 2006 increased $9.6 million or 26.6% compared to 2005. This increase was due primarily to an increase in net interest income of $21.6
million and a decrease in the provision for credit losses of $10.3 million partially offset by an increase in noninterest expense of $20.5 million. Net income for 2005 increased $11.3 million compared to 2004. This increase was due primarily to an
increase in net interest income of $21.3 million and a decrease in noninterest expense of $2.7 million, offset by a decrease in noninterest income of $4.1 million and an increase in the provision for income taxes of $6.5 million.

A banking institutions return on average assets and return on average common equity are two commonly used industry measures of performance. Return on average
assets (ROA) measures net income in relation to average total assets and is an indicator of a companys ability to employ its resources profitably. For 2006, our ROA (from continuing operations) was 1.18%, as compared to 1.02% and
0.78% for 2005 and 2004, respectively.

Return on average common equity (ROE) measures net income in relation to average common equity and is
an indicator of a companys return to its owners. For 2006, our ROE (from continuing operations) was 12.66%, as compared to 11.07% and 8.23% for 2005 and 2004, respectively.

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



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##### Index to Financial Statements

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. Our loan portfolio is
impacted significantly by changes in short-term interest rates. Between 2001 and 2003, overnight interest rates declined to a 40-year low of 1.00%. During this extended period of decreasing interest rates our net interest margin and net interest
income were negatively impacted.

Beginning in June 2004, the Federal Reserve Board increased overnight interest rates by 425 basis points to 5.25% at
June 30, 2006. Since June 2006, overnight interest rates have remained at 5.25%. Our net interest margin benefited from these gradual increases in short-term interest rates through the second quarter of 2006. 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. At December 31, 2006, the market yield on 10-year U.S. Treasury notes was 4.71%
compared with 4.39% at December 31, 2005 and 4.22% at December 31, 2004. This has resulted in a general flattening of the interest rate yield curve. However, in the current interest rate environment, the benefit of the our traditionally
asset-sensitive position has been reduced but not eliminated.

Net interest income increased $21.6 million or 14.4% for 2006 compared to 2005 and $21.3
million or 16.5% for 2005 compared to 2004. Our net interest margin was 4.87% for 2006 compared to 4.63% for 2005 and 4.43% for 2004. Our net interest income and net interest margin continued to increase during 2005 and into 2006, due in large part
to higher deposit balances that were used to fund interest-earning asset growth 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%. Changes in the mix of interest-earning assets and liabilities influence our net interest income and net interest margin.

Average
interest-earning assets for 2006 increased $281.5 million or 8.7% compared to 2005 and $333.9 million or 11.5% for 2005 compared to 2004. The average yield earned on interest-earning assets increased 91 basis points and 82 basis points respectively,
for the same time periods.

The increase in interest-earning assets was due primarily to an increase in average loans held for investment of $333.7 million
or 13.2% for 2006 as compared to 2005 and $355.9 million or 16.3% for 2005 compared to 2004. These increases in average loans held for investment and increases in short-term interest rates, as discussed above, contributed to the $49.9 million
increase in interest income on loans held for investment for 2006 compared to 2005 and to the $43.7 million increase from 2005 compared to 2004. The size of the loan portfolio during 2006 as a percentage of average interest-earning assets increased
from 75% in 2004 to 81% in 2006.

On average, the securities portfolio (including trading assets) was lower by $69.8 million or 10.2% for 2006 compared to
2005 and $23.4 million or 3.3% for 2005 compared to 2004. 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 securities portfolio represent 17% of average interest-earning assets for the year ended December 31, 2006 down from 21% for 2005 and 24% for 2004. Interest income earned on the securities portfolio decreased $1.5 million for 2006 as
compared to 2005 and increased $778 thousand for 2005 compared to 2004. The average yield earned on the securities portfolio increased 23 basis points and 25 basis points during 2006 and 2005, respectively, which offset the decrease in the average
securities portfolio.

Average interest-bearing liabilities for 2006 increased $199.9 million or 8.8% compared to 2005 and $246.4 million or 12.2% compared
to 2004. The average rate paid on interest-bearing liabilities increased 96 basis points during 2006 compared to 2005 and 87 basis points during 2005 compared to 2004.



20



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##### Table of Contents

##### Index to Financial Statements

The increase in interest-bearing liabilities during 2006 was primarily due to an increase in average interest-bearing
deposits and certificates of deposit of $341.1 million in 2006 compared to 2005. The average rate paid on deposits increased 105 basis points for 2006 as compared to 2005 due primarily to increases in interest rates offered on deposit products.
Average short-term borrowings for the year ended December 31, 2006 decreased $121.6 million or 26.1% compared to 2005. The average rate paid on short-term borrowings increased 176 basis points for the year ended December 31, 2006 compared
to the same period in 2005, which offset the benefit of the decrease in average borrowings.

The increase in interest-bearing liabilities for 2005 compared
to 2004 was due, in part, to an increase in average short-term borrowings of $191.7 million. The average cost of short-term borrowings increased 173 basis points for 2005 primarily in response to the increases in overnight interest rates noted
above. The increase in interest expense of $10.9 million for 2005 compared to 2004 on short-term borrowings was partially offset by increases in funding provided by both lower cost interest and noninterest-bearing deposits. Interest and
noninterest-bearing demand deposits increased on average $17.2 million and $100.0 million, respectively, for 2005 compared to 2004. The average cost of interest-bearing demand deposits increased 37 basis points for 2005 compared to 2004.



21



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##### Table of Contents

##### Index to Financial Statements

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



|                                           |  |                         |           |   |          |   |                   |      |      |                |  |   |           |   |                   |   |         |                |      |   |          |   |                   |   |  |   |         |  |      |  
|------------------------------------------ |  | ----------------------- | --------- | - | -------- | - | ----------------- | ---- | ---- | -------------- |  | - | --------- | - | ----------------- | - | ------- | -------------- | ---- | - | -------- | - | ----------------- | - |  | - | ------- |  | ---- | -
|                                           |  | Year Ended December 31, |          
|                                           |  | 2006                    |           |   | 2005     |   |                   | 2004 |     
|                                           |  | AverageBalance          |           |   | Interest |   | AverageYield/Rate |      |      | AverageBalance |  |   | Interest  |   | AverageYield/Rate |   |         | AverageBalance |      |   | Interest |   | AverageYield/Rate |  
|Interest-Earning Assets:                   |  |                         |           |   |          |   |                   |      |      |                |  |   |           |   |                   |   |         |                |      |   |          |   |                   |   |  |   |         |  |      |  
|Loans held for sale (1)                    |  | $                       | 30,400    |   |          | $ | 2,427             |      | 7.98 | %              |  | $ | 10,130    |   |                   | $ | 730     |                | 7.21 | % |          | $ | 10,340            |   |  | $ | 727     |  | 7.02 | %
|Loans held for investment (1):             |  |                         |           |   |          |   |                   |      |      |                |  |   |           |   |                   |   |         |                |      |   |          |   |                   |   |  |   |         |  |      |  
|Taxable                                    |  |                         | 2,867,308 |   |          |   | 224,490           |      | 7.83 | %              |  |   | 2,533,799 |   |                   |   | 174,612 |                | 6.89 | % |          |   | 2,176,445         |   |  |   | 130,851 |  | 6.01 | %
|Non-taxable                                |  |                         | 2,734     |   |          |   | 166               |      | 6.06 | %              |  |   | 2,530     |   |                   |   | 179     |                | 7.06 | % |          |   | 4,021             |   |  |   | 257     |  | 6.40 | %
|Securities:                                |  |                         |           |   |          |   |                   |      |      |                |  |   |           |   |                   |   |         |                |      |   |          |   |                   |   |  |   |         |  |      |  
|Taxable                                    |  |                         | 535,589   |   |          |   | 23,886            |      | 4.46 | %              |  |   | 595,425   |   |                   |   | 24,936  |                | 4.19 | % |          |   | 536,793           |   |  |   | 21,307  |  | 3.97 | %
|Non-taxable                                |  |                         | 69,175    |   |          |   | 2,622             |      | 3.79 | %              |  |   | 62,892    |   |                   |   | 2,442   |                | 3.88 | % |          |   | 48,791            |   |  |   | 2,042   |  | 4.19 | %
|Trading assets                             |  |                         | 11,881    |   |          |   | 696               |      | 5.85 | %              |  |   | 28,114    |   |                   |   | 1,318   |                | 4.69 | % |          |   | 124,272           |   |  |   | 4,569   |  | 3.68 | %
|Federal funds sold                         |  |                         | 5,371     |   |          |   | 261               |      | 4.87 | %              |  |   | 9,460     |   |                   |   | 293     |                | 3.09 | % |          |   | 8,728             |   |  |   | 101     |  | 1.16 | %
|Deposits in financial institutions         |  |                         | 3,970     |   |          |   | 183               |      | 4.61 | %              |  |   | 2,596     |   |                   |   | 93      |                | 3.58 | % |          |   | 1,672             |   |  |   | 55      |  | 3.28 | %
|                                           |  |                         |           |   |          |   |                   |      |      |                |  |   |           |   |                   |   |         |                |      |   |          |   |                   |   |  |   |         |  |      |  
|Total interest-earning assets              |  |                         | 3,526,428 |   |          |   | 254,731           |      | 7.22 | %              |  |   | 3,244,946 |   |                   |   | 204,603 |                | 6.31 | % |          |   | 2,911,062         |   |  |   | 159,909 |  | 5.49 | %
|                                           |  |                         |           |   |          |   |                   |      |     
|Noninterest-earning assets:                |  |                         |           |   |          |   |                   |      |      |                |  |   |           |   |                   |   |         |                |      |   |          |   |                   |   |  |   |         |  |      |  
|Cash and due from banks                    |  |                         | 105,681   |   |          |   |                   |      |      |                |  |   | 99,088    |   |                   |   |         |                |      |   |          |   | 100,292           |   |  |   |         |  |      |  
|Premises and equipment, net                |  |                         | 39,276    |   |          |   |                   |      |      |                |  |   | 39,020    |   |                   |   |         |                |      |   |          |   | 45,284            |   |  |   |         |  |      |  
|Other assets                               |  |                         | 240,678   |   |          |   |                   |      |      |                |  |   | 207,678   |   |                   |   |         |                |      |   |          |   | 162,289           |   |  |   |         |  |      |  
|Allowance for loan losses                  |  |                         | (32,314   | ) |          |   |                   |      |      |                |  |   | (31,467   | ) |                   |   |         |                |      |   |          |   | (27,946           | ) |  |   |         |  |      |  
|                                           |  |                         |           |   |          |   |                   |      |      |                |  |   |           |   |                   |   |         |                |      |   |          |   |                   |   |  |   |         |  |      |  
|Total noninterest-earning assets           |  |                         | 353,321   |   |          |   |                   |      |      |                |  |   | 314,319   |   |                   |   |         |                |      |   |          |   | 279,919           |   |  |   |         |  |      |  
|                                           |  |                         |           |   |          |   |                   |      |      |                |  |   |           |   |                   |   |         |                |      |   |          |   |                   |   |  |   |         |  |      |  
|Total assets                               |  | $                       | 3,879,749 |   |          |   |                   |      |      |                |  | $ | 3,559,265 |   |                   |   |         |                |      |   |          | $ | 3,190,981         |   |  |   |         |  |      |  
|                                           |  |                         |           |   |          |   |                   |      |      |                |  |   |           |   |                   |   |         |                |      |   |          |   |                   |   |  |   |         |  |      |  
|                                           |  |                         |           |   |          |   |                   |      |     
|Interest-bearing liabilities:              |  |                         |           |   |          |   |                   |      |      |                |  |   |           |   |                   |   |         |                |      |   |          |   |                   |   |  |   |         |  |      |  
|Deposits:                                  |  |                         |           |   |          |   |                   |      |      |                |  |   |           |   |                   |   |         |                |      |   |          |   |                   |   |  |   |         |  |      |  
|Demand and savings                         |  | $                       | 1,093,652 |   |          | $ | 17,934            |      | 1.64 | %              |  | $ | 978,218   |   |                   | $ | 8,525   |                | 0.87 | % |          | $ | 961,059           |   |  | $ | 4,785   |  | 0.50 | %
|Certificates and other time                |  |                         | 918,432   |   |          |   | 37,671            |      | 4.10 | %              |  |   | 692,724   |   |                   |   | 20,148  |                | 2.91 | % |          |   | 655,488           |   |  |   | 12,694  |  | 1.94 | %
|Short-term borrowings                      |  |                         | 345,138   |   |          |   | 17,273            |      | 5.00 | %              |  |   | 466,778   |   |                   |   | 15,102  |                | 3.24 | % |          |   | 275,045           |   |  |   | 4,163   |  | 1.51 | %
|Subordinated debt                          |  |                         | 45,522    |   |          |   | 4,476             |      | 9.83 | %              |  |   | 46,897    |   |                   |   | 3,665   |                | 7.82 | % |          |   | 46,647            |   |  |   | 2,744   |  | 5.88 | %
|Junior subordinated debt                   |  |                         | 64,210    |   |          |   | 5,571             |      | 8.68 | %              |  |   | 82,475    |   |                   |   | 6,933   |                | 8.41 | % |          |   | 82,475            |   |  |   | 6,551   |  | 7.94 | %
|                                           |  |                         |           |   |          |   |                   |      |      |                |  |   |           |   |                   |   |         |                |      |   |          |   |                   |   |  |   |         |  |      |  
|Total interest-bearing liabilities         |  |                         | 2,466,954 |   |          |   | 82,925            |      | 3.36 | %              |  |   | 2,267,092 |   |                   |   | 54,373  |                | 2.40 | % |          |   | 2,020,714         |   |  |   | 30,937  |  | 1.53 | %
|                                           |  |                         |           |   |          |   |                   |      |     
|Noninterest-bearing sources:               |  |                         |           |   |          |   |                   |      |      |                |  |   |           |   |                   |   |         |                |      |   |          |   |                   |   |  |   |         |  |      |  
|Demand deposits                            |  |                         | 1,013,788 |   |          |   |                   |      |      |                |  |   | 936,215   |   |                   |   |         |                |      |   |          |   | 836,258           |   |  |   |         |  |      |  
|Other liabilities                          |  |                         | 36,974    |   |          |   |                   |      |      |                |  |   | 28,836    |   |                   |   |         |                |      |   |          |   | 30,385            |   |  |   |         |  |      |  
|                                           |  |                         |           |   |          |   |                   |      |      |                |  |   |           |   |                   |   |         |                |      |   |          |   |                   |   |  |   |         |  |      |  
|Total noninterest-bearing liabilities      |  |                         | 1,050,762 |   |          |   |                   |      |      |                |  |   | 965,051   |   |                   |   |         |                |      |   |          |   | 866,643           |   |  |   |         |  |      |  
|Shareholders equity                       |  |                         | 362,033   |   |          |   |                   |      |      |                |  |   | 327,122   |   |                   |   |         |                |      |   |          |   | 303,624           |   |  |   |         |  |      |  
|                                           |  |                         |           |   |          |   |                   |      |      |                |  |   |           |   |                   |   |         |                |      |   |          |   |                   |   |  |   |         |  |      |  
|Total liabilities and shareholders equity |  | $                       | 3,879,749 |   |          |   |                   |      |      |                |  | $ | 3,559,265 |   |                   |   |         |                |      |   |          | $ | 3,190,981         |   |  |   |         |  |      |  
|                                           |  |                         |           |   |          |   |                   |      |      |                |  |   |           |   |                   |   |         |                |      |   |          |   |                   |   |  |   |         |  |      |  
|Net interest income & margin (2)           |  |                         |           |   |          | $ | 171,806           |      | 4.87 | %              |  |   |           |   |                   | $ | 150,230 |                | 4.63 | % |          |   |                   |   |  | $ | 128,972 |  | 4.43 | %
|                                           |  |                         |           |   |          |   |                   |      |      |                |  |   |           |   |                   |   |         |                |      |   |          |   |                   |   |  |   |         |  |      |  

---

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

|(2) | The net interest margin is equal to net interest income divided by average total interest-earning assets.
|--- | ---------------------------------------------------------------------------------------------------------



22



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##### Table of Contents

##### Index to Financial Statements

The following table shows the portions of the net change in interest income and expense due to changes in volume or rate.
The changes in interest income due to both rate and volume in the analysis have been allocated proportionately to the volume or rate changes (in thousands):



|                                   |  |                                                    |        |   |                                                    |   |        |       |  |   |        |   |  |      |        |   |       |   |        |   |  |   |        |  
|---------------------------------- |  | -------------------------------------------------- | ------ | - | -------------------------------------------------- | - | ------ | ----- |  | - | ------ | - |  | ---- | ------ | - | ----- | - | ------ | - |  | - | ------ | -
|                                   |  | 2006 vs. 2005Increase (Decrease)Due to Changes in: |        |   | 2005 vs. 2004Increase (Decrease)Due to Changes in: |  
|                                   |  | Volume                                             |        |   | Rate                                               |   |        | Total |  |   | Volume |   |  | Rate |        |   | Total |  
|Interest-earning assets:           |  |                                                    |        |   |                                                    |   |        |       |  |   |        |   |  |      |        |   |       |   |        |   |  |   |        |  
|Loans held for sale                |  | $                                                  | 1,610  |   |                                                    | $ | 87     |       |  | $ | 1,697  |   |  | $    | (15    | ) |       | $ | 19     |   |  | $ | 4      |  
|Loans held for investment:         |  |                                                    |        |   |                                                    |   |        |       |  |   |        |   |  |      |        |   |       |   |        |   |  |   |        |  
|Taxable                            |  |                                                    | 24,521 |   |                                                    |   | 25,357 |       |  |   | 49,878 |   |  |      | 21,482 |   |       |   | 22,277 |   |  |   | 43,759 |  
|Non-taxable                        |  |                                                    | 14     |   |                                                    |   | (27    | )     |  |   | (13    | ) |  |      | (95    | ) |       |   | 17     |   |  |   | (78    | )
|Securities:                        |  |                                                    |        |   |                                                    |   |        |       |  |   |        |   |  |      |        |   |       |   |        |   |  |   |        |  
|Taxable                            |  |                                                    | (2,606 | ) |                                                    |   | 1,556  |       |  |   | (1,050 | ) |  |      | 2,327  |   |       |   | 1,301  |   |  |   | 3,628  |  
|Non-taxable                        |  |                                                    | 240    |   |                                                    |   | (60    | )     |  |   | 180    |   |  |      | 590    |   |       |   | (190   | ) |  |   | 400    |  
|Trading assets                     |  |                                                    | (893   | ) |                                                    |   | 271    |       |  |   | (622   | ) |  |      | (3,535 | ) |       |   | 284    |   |  |   | (3,251 | )
|Federal funds sold                 |  |                                                    | (159   | ) |                                                    |   | 127    |       |  |   | (32    | ) |  |      | 8      |   |       |   | 183    |   |  |   | 191    |  
|Deposits in financial institutions |  |                                                    | 58     |   |                                                    |   | 32     |       |  |   | 90     |   |  |      | 30     |   |       |   | 8      |   |  |   | 38     |  
|                                   |  |                                                    |        |   |                                                    |   |        |       |  |   |        |   |  |      |        |   |       |   |        |   |  |   |        |  
|Total interest income              |  |                                                    | 22,785 |   |                                                    |   | 27,343 |       |  |   | 50,128 |   |  |      | 20,792 |   |       |   | 23,899 |   |  |   | 44,691 |  
|                                   |  |                                                    |        |   |                                                    |   |        |       |  |   |        |   |  |      |        |   |       |   |        |   |  |   |        |  
|                                   |  |                                                    |        |   |                                                    |  
|Interest-bearing liabilities:      |  |                                                    |        |   |                                                    |   |        |       |  |   |        |   |  |      |        |   |       |   |        |   |  |   |        |  
|Deposits:                          |  |                                                    |        |   |                                                    |   |        |       |  |   |        |   |  |      |        |   |       |   |        |   |  |   |        |  
|Demand and savings                 |  |                                                    | 1,111  |   |                                                    |   | 8,298  |       |  |   | 9,409  |   |  |      | 85     |   |       |   | 3,654  |   |  |   | 3,739  |  
|Certificates and other time        |  |                                                    | 7,903  |   |                                                    |   | 9,620  |       |  |   | 17,523 |   |  |      | 721    |   |       |   | 6,733  |   |  |   | 7,454  |  
|Short-term borrowings              |  |                                                    | (4,630 | ) |                                                    |   | 6,801  |       |  |   | 2,171  |   |  |      | 2,902  |   |       |   | 8,036  |   |  |   | 10,938 |  
|Subordinated debt                  |  |                                                    | (110   | ) |                                                    |   | 921    |       |  |   | 811    |   |  |      | 15     |   |       |   | 906    |   |  |   | 921    |  
|Junior subordinated debt           |  |                                                    | (1,579 | ) |                                                    |   | 217    |       |  |   | (1,362 | ) |  |      |       |   |       |   | 381    |   |  |   | 381    |  
|                                   |  |                                                    |        |   |                                                    |   |        |       |  |   |        |   |  |      |        |   |       |   |        |   |  |   |        |  
|Total interest expense             |  |                                                    | 2,695  |   |                                                    |   | 25,857 |       |  |   | 28,552 |   |  |      | 3,723  |   |       |   | 19,710 |   |  |   | 23,433 |  
|                                   |  |                                                    |        |   |                                                    |   |        |       |  |   |        |   |  |      |        |   |       |   |        |   |  |   |        |  
|Net interest income                |  | $                                                  | 20,090 |   |                                                    | $ | 1,486  |       |  | $ | 21,576 |   |  | $    | 17,069 |   |       | $ | 4,189  |   |  | $ | 21,258 |  
|                                   |  |                                                    |        |   |                                                    |   |        |       |  |   |        |   |  |      |        |   |       |   |        |   |  |   |        |  

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



|                                  |  |      |        |   |      |   |        |  |   |        |  
|--------------------------------- |  | ---- | ------ | - | ---- | - | ------ |  | - | ------ | -
|                                  |  | 2006 |        |   | 2005 |   | 2004   | 
|Customer service fees             |  | $    | 12,498 |   |      | $ | 11,615 |  | $ | 14,934 |  
|Net gain (loss) on trading assets |  |      | (302   | ) |      |   | 147    |  |   | (474   | )
|Net gain (loss) on securities     |  |      | (358   | ) |      |   | 60     |  |   | 4,941  |  
|Net gain on the sale of loans     |  |      | 1,326  |   |      |   | 1,455  |  |   | 980    |  
|Bank-owned life insurance         |  |      | 2,938  |   |      |   | 3,018  |  |   | 2,163  |  
|Debit card income                 |  |      | 1,988  |   |      |   | 1,727  |  |   | 1,588  |  
|FHLB stock dividends              |  |      | 941    |   |      |   | 981    |  |   | 341    |  
|Other                             |  |      | 12,186 |   |      |   | 7,956  |  |   | 6,552  |  
|                                  |  |      |        |   |      |   |        |  |   |        |  
|                                  |  | $    | 31,217 |   |      | $ | 26,959 |  | $ | 31,025 |  
|                                  |  |      |        |   |      |   |        |  |   |        |  

Customer service fees increased $883 thousand for 2006 compared to 2005 and decreased $3.3 million for 2005
compared to 2004. The increase in 2006 was due to the addition of new deposit products and changes in the routines of applying service charges. The decrease in 2005 was due, in part, to a higher earnings credit rate on certain commercial accounts,
lower insufficient fund fees, increased fee waivers and increased competition for deposits.

Net gains and losses on trading assets were attributable to
the market conditions for these types of assets. Beginning in 2004, we significantly reduced our trading assets portfolio. We may potentially reinvest in these



23



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##### Table of Contents

##### Index to Financial Statements

assets depending on future market conditions. Trading assets are carried at fair market value in our consolidated balance sheets.

Net losses on securities for 2006 were due, in part, to realized losses of $562 thousand recorded on certain interest-only securities. These securities are tied to an
underlying government guaranteed loan and are subject to prepayment and interest rate fluctuations. These securities had been in an unrealized loss position since the fourth quarter of 2005. Given the current prepayment factors for the underlying
loan and managements inability to determine when a full recovery of the value may occur, management considered these securities to be other than temporarily impaired. These losses were offset by a $204 thousand realized gain on investments
which were sold subsequent to the acquisition of BOTH and as part of our routine portfolio management.

Net gains on the sale of securities for 2004 were
primarily the result of two separate securitization transactions during 2004 in which we sold $75.6 million of certain interest-only securities held in our available-for-sale portfolio. We received proceeds of $83.9 million which resulted in net
gains totaling $5.2 million during 2004. We did not retain any interests in these securities, and neither the investors in the securitization trusts nor the trusts have any recourse other than for a breach of customary representations as to
ownership and origination, but not for credit loss or default. These gains were partially offset by a realized loss of $853 thousand for the sale of lower yielding U.S. Treasury Securities during the second quarter of 2004.

Net gains on the sale of loans decreased $129 thousand for 2006 compared to 2005. This decrease for 2006 as compared to 2005 was due primarily to a decrease in the
volume of loan sales.

Other noninterest income increased $4.2 million for 2006 compared to 2005. This increase was due, in part, to an increase in
commission income and other lending fees of $988 thousand. Additionally, during 2006, we completed three separate sale/leaseback transactions resulting in net pre-tax gains of $1.8 million. We sold a multi-tenant office building, which we continue
to occupy, and recognized a gain of $1.1 million. We sold one of our San Antonio locations for a total sales price of $1.8 million which resulted in a pre-tax gain of $1.0 million. In addition, we completed a separate sale/leaseback of 16 bank-owned
locations for a total sales price of $28.3 million resulting in a deferred gain of $9.3 million. This gain will be recognized into income over the next 20 years. As part of this transaction, we recorded a net loss of $281 thousand which reduced
other noninterest income.

Other noninterest income increased $1.4 million for 2005 compared to 2004, due in part, to special distributions totaling $339
thousand received as a result of the merger of PULSE EFT Association with Discover Financial Services.

Noninterest
Expense.The following table shows the detail of noninterest expense (in thousands):



|                                                                                   |  |      |         |   |      |   |         |      |  |   |        
|---------------------------------------------------------------------------------- |  | ---- | ------- | - | ---- | - | ------- | ---- |  | - | -------
|                                                                                   |  | 2006 |         |   | 2005 |   |         | 2004
|Salaries and employee benefits                                                     |  | $    | 76,046  |   |      | $ | 61,229  |      |  | $ | 62,209 
|Occupancy expense                                                                  |  |      | 16,075  |   |      |   | 15,556  |      |  |   | 15,326 
|Technology                                                                         |  |      | 6,882   |   |      |   | 5,524   |      |  |   | 6,127  
|Professional fees                                                                  |  |      | 6,147   |   |      |   | 6,527   |      |  |   | 6,999  
|Postage, delivery and supplies                                                     |  |      | 3,355   |   |      |   | 3,238   |      |  |   | 3,179  
|Marketing                                                                          |  |      | 2,412   |   |      |   | 2,306   |      |  |   | 1,457  
|Core deposit intangible amortization                                               |  |      | 1,012   |   |      |   | 521     |      |  |   | 486    
|Acquisition costs                                                                  |  |      | 638     |   |      |   | 831     |      |  |   |       
|Net losses (gains) and carrying costs of other real estate and foreclosed property |  |      | (109    | ) |      |   | (6      | )    |  |   | 180    
|Other                                                                              |  |      | 18,728  |   |      |   | 14,920  |      |  |   | 17,337 
|                                                                                   |  |      |         |   |      |   |         |      |  |   |        
|Total                                                                              |  | $    | 131,186 |   |      | $ | 110,646 |      |  | $ | 113,300
|                                                                                   |  |      |         |   |      |   |         |      |  |   |        



24



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##### Table of Contents

##### Index to Financial Statements

Salaries and employee benefits for 2006 increased $14.8 million compared to 2005. This increase was due, in part, to an
increase in staffing levels as we added 60 full-time equivalent employees during 2006 principally related to new banking center additions and to support growth. During 2006, we added experienced key officers to further implement our growth strategy.
Additionally, we experienced higher incentive compensation expense as we crossed higher thresholds of production and profitability. As a result, incentive compensation expense increased $4.9 million or 85% for the year ended December 31, 2006
compared to 2005. In addition, profit sharing expense, which we began accruing during 2006 as a 12% return on equity target was attained, increased $2.2 million for 2006 as compared to 2005.

Salaries and employee benefits for 2005 decreased $980 thousand compared to 2004. This decrease was due in part to a reduction in staffing levels through attrition and
modification of certain perquisite benefit programs. Staffing levels increased from 961 full-time equivalent employees at December 31, 2004 to 1,014 at December 2005. We added 53 full-time equivalent employees during the last six months of 2005
principally related to new offices acquired with The Oaks Bank acquisition and to support growth.

Technology expense increased $1.4 million for 2006
compared to 2005. The increase in 2006 was due to additional hardware and customer products including an upgrade in the Banks deposit system. Technology expense decreased $603 thousand for 2005 compared to 2004 as we incurred additional costs
due to the upgrading of certain computer systems in 2004.

Professional fees decreased $380 thousand for 2006 compared to 2005 due, in part, to a decrease
in legal fees primarily related to a decrease in nonperforming assets. Professional fees also decreased $472 thousand for 2005 compared to 2004. In 2004, we recorded charges of $1.2 million related to the termination of certain consulting
agreements.

Marketing expense increased slightly for 2006 compared to 2005 and $849 thousand for 2005 compared to 2004 primarily due to additional
marketing efforts through television, print and radio advertising.

In the third quarter of 2006, we recorded $638 thousand in acquisition-related expenses
incurred in connection with the acquisition of BOTH. In the third quarter of 2005, we recorded $831 thousand in acquisition-related expenses incurred in connection with the acquisition of Prestonwood. Acquisition related expenses include certain
contract termination costs, retention bonuses and data processing costs related to the conversions of computer systems.

Other noninterest expense was
$18.7 million for 2006, up $3.8 million or 25.5% compared to 2005. During the second quarter of 2006, we prepaid $29.6 million of junior subordinated debt that carried a 9.20% interest rate. As a result of calling these securities, we wrote off the
remaining associated unamortized debt issuance costs totaling $1.3 million. Other noninterest expense was $14.9 million for 2005, down $2.4 million or 13.9% compared to 2004. Other noninterest expense for 2004 included impairment charges of $1.4
million related to one bank office building and two tracts of unused land and $1.1 million of losses incurred on the write-off of certain purchased lease interests.

Income Taxes.We provided $21.9 million, $16.0 million and $9.5 million for federal and state income taxes for 2006, 2005 and 2004, respectively. The effective tax rates for 2006, 2005 and 2004 were
approximately 32%, 31% and 28%, respectively. During 2005, the Internal Revenue Service commenced an examination of our 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. During 2005 and 2004, we reduced income tax expense by $851 thousand and $1.2 million, respectively, which resulted in lower effective tax rates for these periods. These reductions were the result of the
expiration of previous tax contingencies and refunds received.



25



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##### Table of Contents

##### Index to Financial Statements

We expect our effective tax rate will be within a range from 34% to 35% for 2007 dependent largely upon the size of our
tax-exempt securities portfolio, bank-owned life insurance income and changes in state margin tax rules imposed by the state of Texas.

Financial
Condition

Loans Held for Investment.The following table summarizes our loan portfolio by type, excluding loans held for sale as of
December 31 (dollars in thousands):



|                          |  |        |           |   |       |   |        |      |           |  |       |        |  |      |           |  |        |   |   |   |           |        |       |   |  |   |           |  |       |  
|------------------------- |  | ------ | --------- | - | ----- | - | ------ | ---- | --------- |  | ----- | ------ |  | ---- | --------- |  | ------ | - | - | - | --------- | ------ | ----- | - |  | - | --------- |  | ----- | -
|                          |  | 2006   |           |   | 2005  |   |        | 2004 |           |  | 2003  |        |  | 2002 |          
|                          |  | Amount |           | % |       |   | Amount |      | %         |  |       | Amount |  | %    |           |  | Amount |   | % |   |           | Amount |       | % | 
|Commercial and industrial |  | $      | 824,494   |   | 26.8  | % |        | $    | 738,061   |  | 27.4  | %      |  | $    | 682,209   |  | 29.2   | % |   | $ | 671,482   |        | 31.5  | % |  | $ | 615,094   |  | 31.7  | %
|Real estate:              |  |        |           |   |       |   |        |      |           |  |       |        |  |      |           |  |        |   |   |   |           |        |       |   |  |   |           |  |       |  
|Commercial                |  |        | 1,336,465 |   | 43.4  | % |        |      | 1,221,610 |  | 45.4  | %      |  |      | 1,043,960 |  | 44.6   | % |   |   | 829,199   |        | 38.9  | % |  |   | 670,459   |  | 34.5  | %
|Construction              |  |        | 597,985   |   | 19.4  | % |        |      | 438,454   |  | 16.3  | %      |  |      | 329,982   |  | 14.1   | % |   |   | 327,295   |        | 15.4  | % |  |   | 323,768   |  | 16.7  | %
|Residential               |  |        | 209,163   |   | 6.8   | % |        |      | 190,701   |  | 7.1   | %      |  |      | 183,839   |  | 7.9    | % |   |   | 195,363   |        | 9.2   | % |  |   | 199,191   |  | 10.2  | %
|Consumer/other            |  |        | 79,642    |   | 2.6   | % |        |      | 72,937    |  | 2.7   | %      |  |      | 72,997    |  | 3.1    | % |   |   | 98,928    |        | 4.6   | % |  |   | 122,616   |  | 6.3   | %
|Foreign loans             |  |        | 30,096    |   | 1.0   | % |        |      | 29,245    |  | 1.1   | %      |  |      | 25,109    |  | 1.1    | % |   |   | 8,464     |        | 0.4   | % |  |   | 12,433    |  | 0.6   | %
|                          |  |        |           |   |       |   |        |      |           |  |       |        |  |      |           |  |        |   |   |   |           |        |       |   |  |   |           |  |       |  
|Total                     |  | $      | 3,077,845 |   | 100.0 | % |        | $    | 2,691,008 |  | 100.0 | %      |  | $    | 2,338,096 |  | 100.0  | % |   | $ | 2,130,731 |        | 100.0 | % |  | $ | 1,943,561 |  | 100.0 | %
|                          |  |        |           |   |       |   |        |      |           |  |       |        |  |      |           |  |        |   |   |   |           |        |       |   |  |   |           |  |       |  

At December 31, 2006, loans held for investment were $3.1 billion, an increase of $386.8 million or 14.4%
over loans held for investment at December 31, 2005. Loans acquired in the acquisition of BOTH on September 29, 2006 totaled $150.9 million. The remaining increase in loans was primarily due to internal loan growth. This increase in
internal loan growth was primarily in real estate loans which increased $292.8 million.

Our primary lending focus is commercial loans and owner-occupied
real estate loans to businesses with annual sales ranging from $300 thousand to $35 million. Typically, our customers have financing requirements between $50 thousand and $5 million. The Banks legal lending limit was $31 million at
December 31, 2006 and was not exceeded by any single loan relationship. At December 31, 2006, commercial real estate loans and commercial and industrial loans were 43.4% and 26.8%, respectively, of loans held for investment.

We make commercial loans primarily to small and mid-sized businesses and to professionals. Our commercial loan products include revolving lines of credit, letters of
credit, working capital loans, loans to finance accounts receivable and inventory and equipment finance leases. Commercial loans typically have floating rates of interest and are for varying terms (generally not exceeding three years). In most
instances, these loans are personally guaranteed by the business owner and are secured by accounts receivable, inventory and/or other business assets. In addition to the commercial loans secured solely by non-real estate business assets, we make
commercial loans that are secured by owner-occupied real estate, as well as other business assets.

Commercial mortgage loans are often secured by first
liens on real estate, typically have floating interest rates, and are most often amortized over a 15-year period with balloon payments due at the end of three years. In underwriting commercial mortgage loans, we give consideration to the
propertys operating history, future operating projections, current and projected occupancy, location and physical condition. The underwriting analysis also includes credit checks, appraisals and a review of the financial condition of the
borrower.

Our Capital Markets group originates, co-originates or purchases first-lien, commercial real estate mortgage loans referred by other financial
institutions nationwide. More than 50% of these loans have variable interest rates and amortize over twenty to twenty-five years. These loans generally have low loan-to-value ratios (below 60%) and many have a U.S. Small Business
Administration second lien behind our first lien. We utilize real estate appraisers familiar with the geographic region in which the property is located in evaluating potential loans. These appraisals are reviewed by a third-party
appraisal review vendor for accuracy and compliance with our underwriting standards and banking regulations. These loans supplement our growth in our niche market segment, small to medium-sized businesses.



26



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##### Table of Contents

##### Index to Financial Statements

We also make loans to finance the construction of residential and nonresidential properties, such as retail shopping
centers and commercial office buildings. Generally, construction loans are secured by first liens on real estate and have floating interest rates. The Bank conducts periodic inspections, either directly or through an architect or other agent, prior
to approval of periodic draws on these loans. Underwriting guidelines similar to those described above are also used in our construction lending activities.

The Bank makes automobile, boat, home improvement and other loans to consumers. These loans are primarily made to customers who have other business relationships with us.

Loan maturities and rate sensitivity of the total loan portfolio excluding residential mortgage and consumer loans, at December 31, 2006 were as follows (in thousands):



|                                    |  |                       |           |                                    |   |                     |  |       |         |  |   |          
|----------------------------------- |  | --------------------- | --------- | ---------------------------------- | - | ------------------- |  | ----- | ------- |  | - | ---------
|                                    |  | Due inOne Yearor Less |           | Due AfterOne YearThroughFive Years |   | Due AfterFive Years |  | Total
|Commercial and industrial           |  | $                     | 631,414   |                                    | $ | 171,104             |  | $     | 21,976  |  | $ | 824,494  
|Real estatecommercial              |  |                       | 531,331   |                                    |   | 621,692             |  |       | 183,442 |  |   | 1,336,465
|Real estateconstruction            |  |                       | 439,460   |                                    |   | 118,224             |  |       | 40,301  |  |   | 597,985  
|Foreign loans                       |  |                       | 28,755    |                                    |   | 1,341               |  |       |        |  |   | 30,096   
|                                    |  |                       |           |                                    |   |                     |  |       |         |  |   |          
|Total loans                         |  | $                     | 1,630,960 |                                    | $ | 912,361             |  | $     | 245,719 |  | $ | 2,789,040
|                                    |  |                       |           |                                    |   |                     |  |       |         |  |   |          
|Loans with a fixed interest rate    |  | $                     | 196,609   |                                    | $ | 752,154             |  | $     | 196,973 |  | $ | 1,145,736
|Loans with a floating interest rate |  |                       | 1,434,351 |                                    |   | 160,207             |  |       | 48,746  |  |   | 1,643,304
|                                    |  |                       |           |                                    |   |                     |  |       |         |  |   |          
|Total loans                         |  | $                     | 1,630,960 |                                    | $ | 912,361             |  | $     | 245,719 |  | $ | 2,789,040
|                                    |  |                       |           |                                    |   |                     |  |       |         |  |   |          

As of December 31, 2006, there was no concentration of loans to any one industry exceeding 10% of total loans
nor were there any loans classified as highly leveraged transactions. The Bank had no material foreign loans outstanding for the years ended December 31, 2002 through 2006 that are not cash secured or Ex-Im Bank guaranteed.

At December 31, 2006, loans held for investment were 92.3% of deposits and 74.7% of total assets. As of December 31, 2006, we had no material concentrations of
loans. Loans held for investment were 94.8% of deposits and 72.2% of total assets at December 31, 2005.

Loans Held for Sale.Loans held for sale totaled $54.7 million at December 31, 2006, as compared with $8.4 million at December 31, 2005. Loans held for sale included the guaranteed portion of Small Business Administration (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. Trading assets decreased $28.5 million during 2006 compared to 2005. 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.



27



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##### Table of Contents

##### Index to Financial Statements

Securities. The carrying amount of securities we held at December 31
is shown below (dollars in thousands).



|                                                                    |  |        |         |   |       |   |        |      |         |  |       |        |  |   |         |  |       |  
|------------------------------------------------------------------- |  | ------ | ------- | - | ----- | - | ------ | ---- | ------- |  | ----- | ------ |  | - | ------- |  | ----- | -
|                                                                    |  | 2006   |         |   | 2005  |   |        | 2004 |        
|                                                                    |  | Amount |         | % |       |   | Amount |      | %       |  |       | Amount |  | % |        
|Available-for-Sale                                                  |  |        |         |   |       |   |        |      |         |  |       |        |  |   |         |  |       |  
|Obligations of the U.S. Treasury and other U.S. government agencies |  | $      | 6,425   |   | 1.6   | % |        | $    | 9,924   |  | 2.0   | %      |  | $ | 8,194   |  | 1.5   | %
|Obligations of states of the U.S. and political subdivisions        |  |        | 2,321   |   | 0.6   | % |        |      | 3,326   |  | 0.7   | %      |  |   | 4,133   |  | 0.8   | %
|Mortgage-backed securities and collateralized mortgage obligations  |  |        | 385,815 |   | 94.3  | % |        |      | 466,728 |  | 94.1  | %      |  |   | 516,325 |  | 95.5  | %
|Other securities                                                    |  |        | 14,790  |   | 3.5   | % |        |      | 15,967  |  | 3.2   | %      |  |   | 12,052  |  | 2.2   | %
|                                                                    |  |        |         |   |       |   |        |      |         |  |       |        |  |   |         |  |       |  
|Total                                                               |  | $      | 409,351 |   | 100.0 | % |        | $    | 495,945 |  | 100.0 | %      |  | $ | 540,704 |  | 100.0 | %
|                                                                    |  |        |         |   |       |   |        |      |         |  |       |        |  |   |         |  |       |  
|Held-to-Maturity                                                    |  |        |         |   |       |   |        |      |         |  |       |        |  |   |         |  |       |  
|Obligations of states of the U.S. and political subdivisions        |  | $      | 91,946  |   | 56.0  | % |        | $    | 58,288  |  | 47.4  | %      |  | $ | 61,956  |  | 52.8  | %
|Mortgage-backed securities and collateralized mortgage obligations  |  |        | 72,317  |   | 44.0  | % |        |      | 64,765  |  | 52.6  | %      |  |   | 55,458  |  | 47.2  | %
|                                                                    |  |        |         |   |       |   |        |      |         |  |       |        |  |   |         |  |       |  
|Total                                                               |  | $      | 164,263 |   | 100.0 | % |        | $    | 123,053 |  | 100.0 | %      |  | $ | 117,414 |  | 100.0 | %
|                                                                    |  |        |         |   |       |   |        |      |         |  |       |        |  |   |         |  |       |  

At December 31, 2006, securities totaled $573.6 million, a decrease of $45.4 million, or 7.3%, from $619.0
million at December 31, 2005. These securities represented 13.9% and 16.6% of total assets as of December 31, 2006 and 2005, respectively. We added $111.3 million to the securities portfolio due to the acquisition of BOTH. Subsequent to
this acquisition and as part of our continued portfolio management, we reduced the securities portfolio $121 million through a combination of portfolio sales and paydowns. 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 $10.2
million at December 31, 2006 as compared to $10.7 million at December 31, 2005. We recorded a realized loss of $562 thousand on certain interest-only securities during the fourth quarter of 2006. These securities are tied to an underlying
government guaranteed loan and are subject to prepayment and interest rate fluctuations. These securities had been in an unrealized loss position since the fourth quarter of 2005. Given the current prepayment factors for the underlying loan and
managements inability to determine when a full recovery of the value may occur, management considered these securities to be other than temporarily impaired. Management believes that the unrealized losses on the remaining securities in the
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 we have the ability and intent to hold those investments until a
recovery of fair value, which may be maturity, we do not consider those investments to be other-than-temporarily impaired at December 31, 2006.



28



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##### Table of Contents

##### Index to Financial Statements

The carrying amount of securities at December 31, 2006, by contractual maturity is shown below (dollars in
thousands):



|                                                                    |  |                        |        |                      |                                     |   |        |                                      |                      |  |                    |        |  |                      |         |  |        |   |                      |   |        |  |      |   |  |   |        
|------------------------------------------------------------------- |  | ---------------------- | ------ | -------------------- | ----------------------------------- | - | ------ | ------------------------------------ | -------------------- |  | ------------------ | ------ |  | -------------------- | ------- |  | ------ | - | -------------------- | - | ------ |  | ---- | - |  | - | -------
|                                                                    |  | Due in One Yearor Less |        |                      | Due after One YearthroughFive Years |   |        | Due After FiveYears throughTen Years |                      |  | Due AfterTen Years |        |  | Total               
|                                                                    |  | Amount                 |        | WeightedAverageYield |                                     |   | Amount |                                      | WeightedAverageYield |  |                    | Amount |  | WeightedAverageYield |         |  | Amount |   | WeightedAverageYield |   |       
|Available-for-Sale                                                  |  |                        |        |                      |                                     |   |        |                                      |                      |  |                    |        |  |                      |         |  |        |   |                      |   |        |  |      |   |  |   |        
|Obligations of the U.S. Treasury and other U.S. government agencies |  | $                      | 1,496  |                      | 3.23                                | % |        | $                                    | 4,929                |  | 4.10               | %      |  | $                    |        |  |       |   |                      | $ |       |  |     |   |  | $ | 6,425  
|Obligations of states of the U.S. and political subdivisions        |  |                        | 862    |                      | 4.13                                | % |        |                                      | 786                  |  | 3.76               | %      |  |                      | 673     |  | 4.64   | % |                      |   |       |  |     |   |  |   | 2,321  
|Mortgage-backed securities and collateralized mortgage obligations  |  |                        | 1,055  |                      | 5.02                                | % |        |                                      | 265,921              |  | 4.36               | %      |  |                      | 103,451 |  | 4.29   | % |                      |   | 15,388 |  | 4.13 | % |  |   | 385,815
|Other securities                                                    |  |                        | 14,790 |                      | 5.13                                | % |        |                                      |                     |  |                   |        |  |                      |        |  |       |   |                      |   |       |  |     |   |  |   | 14,790 
|                                                                    |  |                        |        |                      |                                     |   |        |                                      |                      |  |                    |        |  |                      |         |  |        |   |                      |   |        |  |      |   |  |   |        
|                                                                    |  | $                      | 18,203 |                      | 4.92                                | % |        | $                                    | 271,636              |  | 4.35               | %      |  | $                    | 104,124 |  | 4.29   | % |                      | $ | 15,388 |  | 4.13 | % |  | $ | 409,351
|                                                                    |  |                        |        |                      |                                     |   |        |                                      |                      |  |                    |        |  |                      |         |  |        |   |                      |   |        |  |      |   |  |   |        
|Held-to-Maturity                                                    |  |                        |        |                      |                                     |   |        |                                      |                      |  |                    |        |  |                      |         |  |        |   |                      |   |        |  |      |   |  |   |        
|Obligations of states of the U.S. and political subdivisions        |  | $                      | 5,527  |                      | 4.32                                | % |        | $                                    | 38,408               |  | 3.79               | %      |  | $                    | 48,011  |  | 3.68   | % |                      | $ |       |  |     |   |  | $ | 91,946 
|Mortgage-backed securities and collateralized mortgage obligations  |  |                        | 133    |                      | 4.65                                | % |        |                                      | 50,420               |  | 4.48               | %      |  |                      | 18,165  |  | 5.35   | % |                      |   | 3,599  |  | 5.45 | % |  |   | 72,317 
|                                                                    |  |                        |        |                      |                                     |   |        |                                      |                      |  |                    |        |  |                      |         |  |        |   |                      |   |        |  |      |   |  |   |        
|                                                                    |  | $                      | 5,660  |                      | 4.32                                | % |        | $                                    | 88,828               |  | 4.18               | %      |  | $                    | 66,176  |  | 4.14   | % |                      | $ | 3,599  |  | 5.45 | % |  | $ | 164,263
|                                                                    |  |                        |        |                      |                                     |   |        |                                      |                      |  |                    |        |  |                      |         |  |        |   |                      |   |        |  |      |   |  |   |        

The tax equivalent book yield on the Banks securities portfolio at December 31, 2006 was 4.6%. The
weighted-average life of the portfolio was approximately 3.1 years, and the modified duration was approximately 2.7 years. The tax equivalent book yield on the securities portfolio at December 31, 2005 was 4.2%. At December 31, 2005, the
weighted-average life of the portfolio was approximately 3.4 years, and the modified duration was approximately 2.9 years.

We did not own the securities
of any one issuer (other than the U.S. government and its agencies) of which the aggregate adjusted cost exceeded 10% of consolidated shareholders equity at December 31, 2006.

Deposits.Our lending and investing activities are funded primarily by deposits, approximately 73% of which were core deposits at December 31, 2006. Core deposits exclude brokered deposits and time
deposits over $100,000. These jumbo deposits are characteristically more sensitive to changes in interest rates and, thus we do not consider these a part of our core funding.

Total deposits as of December 31, 2006 increased $496.5 million to $3.3 billion, up 17.5% compared to $2.8 billion at December 31, 2005. Deposits acquired in the acquisition of BOTH on September 29,
2006 totaled $298 million of which $45 million and $253 million were noninterest-bearing and interest-bearing, respectively. The deposit growth we experienced during 2006 was driven primarily by interest-bearing and certificates and other time
deposits.

Interest-bearing deposits at December 31, 2006 were $2.3 billion as compared to $1.8 billion at December 31, 2005, an increase of
$484.3 million or 27.0%. Approximately 68.3% of deposits at December 31, 2006 were interest-bearing and our loan to deposit ratio at December 31, 2006 was 93.9%.



29



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##### Table of Contents

##### Index to Financial Statements

The average balances and weighted average rates paid on deposits for each of the past three years ended December 31
are presented below (dollars in thousands):



|                                             |  |                |           |             |      |   |                |      |             |  |      |                |  |             |           |  |      |  
|-------------------------------------------- |  | -------------- | --------- | ----------- | ---- | - | -------------- | ---- | ----------- |  | ---- | -------------- |  | ----------- | --------- |  | ---- | -
|                                             |  | 2006           |           |             | 2005 |   |                | 2004 |            
|                                             |  | AverageBalance |           | AverageRate |      |   | AverageBalance |      | AverageRate |  |      | AverageBalance |  | AverageRate |          
|Noninterest-bearing demand deposits          |  | $              | 1,013,788 |             |      |   |                | $    | 936,215     |  |      |                |  | $           | 836,258   |  |      |  
|Interest-bearing demand and savings deposits |  |                | 1,093,652 |             | 1.64 | % |                |      | 978,218     |  | 0.87 | %              |  |             | 961,059   |  | 0.50 | %
|Time deposits                                |  |                | 803,698   |             | 4.10 | % |                |      | 641,218     |  | 2.88 | %              |  |             | 554,664   |  | 1.99 | %
|Brokered certificates of deposit             |  |                | 114,734   |             | 4.08 | % |                |      | 51,506      |  | 3.14 | %              |  |             | 100,824   |  | 1.65 | %
|                                             |  |                |           |             |      |   |                |      |             |  |      |                |  |             |           |  |      |  
|Total deposits                               |  | $              | 3,025,872 |             | 2.76 | % |                | $    | 2,607,157   |  | 1.71 | %              |  | $           | 2,452,805 |  | 1.08 | %
|                                             |  |                |           |             |      |   |                |      |             |  |      |                |  |             |           |  |      |  

Average total deposits increased $418.7 million in 2006 compared to 2005. The increase during 2006 was primarily
attributable to internal deposit growth and the acquisition of BOTH completed in September 2006. The changes in deposit mix and interest rates increased the average cost of funds for deposits by 105 basis points in 2006.

Average total deposits increased $154.4 million in 2005 compared to 2004. The increases during 2005 were primarily attributable to internal deposit growth and the
acquisition of The Oaks Bank and Trust completed in September 2005. The changes in deposit mix and interest rates increased the average cost of funds for deposits by 63 basis points in 2005.

Average brokered certificates of deposit totaled $114.7 million in 2006, $51.5 million in 2005 and $100.8 million in 2004. We utilize brokered deposits together with
short-term borrowings as a source of funding for the Banks lending and investment activities.

The maturities of
time deposits of $100 thousand or more at December 31, 2006 are shown below (in thousands):



|                               |  |   |        
|------------------------------ |  | - | -------
|Three months or less           |  | $ | 340,250
|Over three through six months  |  |   | 195,833
|Over six through twelve months |  |   | 145,235
|Thereafter                     |  |   | 54,348 
|                               |  |   |        
|                               |  | $ | 735,666
|                               |  |   |        

Short-Term Borrowings. Deposits are the primary source of funds for our lending, investment
and general business activities. Short-term borrowings decreased by $172.2 million for 2006 compared to 2005 due to solid average deposit growth, securities proceeds and funds received from the sale/leaseback. Federal Home Loan Bank
(FHLB) advances are available to us under a security and pledge agreement. At December 31, 2006, we had total funds of $996.4 million available under this agreement of which $193.5 million was outstanding. We also had other credit
facilities available to us at December 31, 2006 through various correspondent banking and investment dealer relationships.



30



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##### Table of Contents

##### Index to Financial Statements

Details of short-term borrowings are as follows (dollars in thousands):



|                                              |  |                                 |         |   |      |   |         |      |  |   |         |  
|--------------------------------------------- |  | ------------------------------- | ------- | - | ---- | - | ------- | ---- |  | - | ------- | -
|                                              |  | For the Year Ended December 31, |        
|                                              |  | 2006                            |         |   | 2005 |   |         | 2004 | 
|Federal Home Loan Bank advances               |  |                                 |         |   |      |   |         |      |  |   |         |  
|Balance outstanding at period-end             |  | $                               | 193,500 |   |      | $ | 370,000 |      |  | $ | 418,000 |  
|Weighted average interest rate at period-end  |  |                                 | 5.36    | % |      |   | 3.98    | %    |  |   | 2.23    | %
|Maximum outstanding at any month-end          |  | $                               | 381,000 |   |      | $ | 476,000 |      |  | $ | 418,000 |  
|Daily average balance                         |  |                                 | 312,746 |   |      |   | 433,373 |      |  |   | 251,188 |  
|Weighted average interest rate for the period |  |                                 | 4.98    | % |      |   | 3.22    | %    |  |   | 1.50    | %
|Federal funds purchased                       |  |                                 |         |   |      |   |         |      |  |   |         |  
|Balance outstanding at period-end             |  | $                               | 27,175  |   |      | $ | 22,850  |      |  | $ | 2,575   |  
|Weighted average interest rate at period-end  |  |                                 | 5.43    | % |      |   | 4.40    | %    |  |   | 2.31    | %
|Maximum outstanding at any month-end          |  | $                               | 35,050  |   |      | $ | 41,375  |      |  | $ | 25,750  |  
|Daily average balance                         |  |                                 | 32,354  |   |      |   | 33,405  |      |  |   | 23,693  |  
|Weighted average interest rate for the period |  |                                 | 5.23    | % |      |   | 3.46    | %    |  |   | 1.69    | %

At December 31, 2006, borrowings under FHLB advances totaled $193.5 million and had maturities less than 30
days. The average interest rate on these borrowings was 5.36% at December 31, 2006. These borrowings are collateralized by single family residential mortgage loans, certain pledged securities, FHLB stock and any funds on deposit with the FHLB.
We utilize these borrowings to meet liquidity needs. Maturing advances are replaced by drawing on available cash, making additional borrowings or through increased customer deposits.

Notes Payable.We maintain a $20 million line of credit with Wells Fargo Bank. This line of credit is available for general corporate purposes including the funding of potential acquisitions. The credit
facility contains certain restrictive loan covenants, including, among others, covenants limiting our ability to merge with another entity, make any substantial changes in the nature of our business, dispose of a substantial or material amount of
assets other than in the ordinary course of business, guarantee obligations of third parties, make loans or investments in any third party in excess of $15 million and pledge our assets. We did not have any borrowings under our credit facility with
Wells Fargo Bank at December 31, 2006 or 2005.

Subordinated Debt.In April 2003, the Bank raised approximately $50 million through a
private offering of subordinated notes. These subordinated notes bear interest at a fixed rate of 7.375% and mature on April 15, 2013. Interest payments are due semi-annually. The subordinated notes may not be redeemed or called prior to their
maturity. In June 2003, we entered into an interest rate swap agreement in which the Bank swapped the fixed rate to a floating rate. Under the terms of the swap agreement, we receive a fixed coupon rate of 7.375% and pay 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 shortcut method of accounting. The fair value of the swap is currently included in other
liabilities as the hedge is considered effective. If the swap were to become ineffective the change in the fair value would be reflected in our statement of income. The swaps floating rate on December 31, 2006 was 9.00%.



31



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##### Table of Contents

##### Index to Financial Statements

Junior Subordinated Debt/Company Obligated Mandatorily Redeemable Trust Preferred Securities.As of
December 31, 2006, we had the following issues of trust preferred securities outstanding and junior subordinated debt owed to trusts (dollars in thousands):



|                     |  |                    |  |                                     |        |               |                          |                                      |   |                     |  |                   
|-------------------- |  | ------------------ |  | ----------------------------------- | ------ | ------------- | ------------------------ | ------------------------------------ | - | ------------------- |  | ------------------
|Description          |  | Issuance Date      |  | TrustPreferredSecuritiesOutstanding |        | Interest Rate |                          | JuniorSubordinatedDebt Owed ToTrusts |   | 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 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.

On March 1, 2005, the Federal Reserve adopted final rules for the capital treatment of trust preferred securities. The rules, as
applicable to us, 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 December 31, 2006,
the entire amount of the $55.3 million would count as Tier 1 capital. Any excess amount not qualifying for Tier 1 capital may be included in Tier 2 capital. This amount is limited to 50% of Tier 1 capital. There is a five-year transition period for
banks to become compliant with the new rules. Additionally, the rules provide that trust preferred securities no longer qualify for Tier 1 capital within 5 years of their maturity. Refer to Note 19 to the Consolidated Financial Statements for a
discussion of the impact of the final rule on our regulatory capital ratios.

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 December 31, 2006, the rate on these securities was 5.96%.

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.

Potential problem loans are those loans
not classified as nonperforming, but where information known by management indicates serious doubt that the borrower will be able to comply with the present payment terms.



32



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##### Table of Contents

##### Index to Financial Statements

Management identifies these loans through its ongoing loan review process. As of December 31, 2006, potential problem loans decreased $25.8 million to
$32.2 million at December 31, 2006 from $58.0 million at December 31, 2005.

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



|                                                                     |  |      |        |   |      |   |        |      |  |   |        |   |  |      |        |   |  |   |        |  
|-------------------------------------------------------------------- |  | ---- | ------ | - | ---- | - | ------ | ---- |  | - | ------ | - |  | ---- | ------ | - |  | - | ------ | -
|                                                                     |  | 2006 |        |   | 2005 |   |        | 2004 |  |   | 2003   |   |  | 2002 |       
|Nonperforming loans:                                                 |  |      |        |   |      |   |        |      |  |   |        |   |  |      |        |   |  |   |        |  
|Nonaccrual                                                           |  | $    | 10,611 |   |      | $ | 21,841 |      |  | $ | 20,605 |   |  | $    | 33,887 |   |  | $ | 19,654 |  
|Restructured                                                         |  |      | 776    |   |      |   |       |      |  |   |       |   |  |      |       |   |  |   |       |  
|                                                                     |  |      |        |   |      |   |        |      |  |   |        |   |  |      |        |   |  |   |        |  
|Total nonperforming loans                                            |  |      | 11,387 |   |      |   | 21,841 |      |  |   | 20,605 |   |  |      | 33,887 |   |  |   | 19,654 |  
|Foreclosed assets:                                                   |  |      |        |   |      |   |        |      |  |   |        |   |  |      |        |   |  |   |        |  
|Real estate acquired by foreclosure                                  |  |      | 1,465  |   |      |   | 460    |      |  |   | 1,536  |   |  |      | 2,124  |   |  |   | 3,358  |  
|Other repossessed assets                                             |  |      | 404    |   |      |   | 137    |      |  |   | 216    |   |  |      | 169    |   |  |   | 66     |  
|                                                                     |  |      |        |   |      |   |        |      |  |   |        |   |  |      |        |   |  |   |        |  
|Total foreclosed assets                                              |  |      | 1,869  |   |      |   | 597    |      |  |   | 1,752  |   |  |      | 2,293  |   |  |   | 3,424  |  
|                                                                     |  |      |        |   |      |   |        |      |  |   |        |   |  |      |        |   |  |   |        |  
|Total nonperforming assets                                           |  | $    | 13,256 |   |      | $ | 22,438 |      |  | $ | 22,357 |   |  | $    | 36,180 |   |  | $ | 23,078 |  
|                                                                     |  |      |        |   |      |   |        |      |  |   |        |   |  |      |        |   |  |   |        |  
|                                                                     |  |      |        |   |     
|Nonperforming loans to period-end loans                              |  |      | 0.36   | % |      |   | 0.81   | %    |  |   | 0.88   | % |  |      | 1.57   | % |  |   | 0.74   | %
|Nonperforming assets to period-end assets                            |  |      | 0.32   | % |      |   | 0.60   | %    |  |   | 0.67   | % |  |      | 1.13   | % |  |   | 0.64   | %
|Nonperforming assets to total period-end loans and foreclosed assets |  |      | 0.42   | % |      |   | 0.83   | %    |  |   | 0.95   | % |  |      | 1.68   | % |  |   | 0.87   | %
|                                                                     |  |      |        |   |     
|Potential problem loans                                              |  | $    | 32,201 |   |      | $ | 58,011 |      |  | $ | 54,293 |   |  | $    | 66,482 |   |  | $ | 62,189 |  
|                                                                     |  |      |        |   |      |   |        |      |  |   |        |   |  |      |        |   |  |   |        |  
|Accruing loans past due 90 days or more                              |  | $    | 2,731  |   |      | $ | 162    |      |  | $ | 2,395  |   |  | $    | 35     |   |  | $ | 984    |  
|                                                                     |  |      |        |   |      |   |        |      |  |   |        |   |  |      |        |   |  |   |        |  

Nonperforming assets were $13.3 million at December 31, 2006, a $9.2 million decrease from $22.4 million at
December 31, 2005.

Interest foregone on nonaccrual loans was approximately $1.3 million and $1.4 million during 2006 and 2005, respectively. Accruing
loans past due 90 days or more at December 31, 2006 totaled $2.7 million compared to $162 thousand at December 31, 2005.

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 2006 was $4.1 million as compared to $14.4 million for 2005. The
lower provision for credit losses during 2006 was due to a favorable improvement in net charge-offs during the year and is reflective of the general improvement in our asset quality that has been a function of both a healthy Texas economy and a
strengthening in our credit culture. We incurred net charge-offs of $5.7 million or 0.20% of average loans for 2006 compared to $13.0 million or 0.51% of average loans during 2005. Net charge-offs decreased $7.3 million during 2006 as compared to
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. During 2007, we will introduce a system that will measure probability of
default, loss given default and expected losses on all loan assets. This will continue to improve the credit



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##### Index to Financial Statements

quality of the Banks portfolio by eliminating those potential loans that are less desirable from a credit risk perspective.

The allowance for credit losses is a valuation reserve consisting of the allowance for loan losses and the reserve for unfunded lending commitments. It is established
through charges to earnings in the form of a provision for credit losses. Based on an evaluation of the loan portfolio, management presents a quarterly review of the allowance for credit losses to the Banks Board of Directors, indicating any
changes in the allowance since the last review and any recommendations as to adjustments in the allowance. In making our evaluation, we consider the industry diversification of the commercial loan portfolio and the effect of changes in the local
real estate market on collateral values. We also consider the results of recent regulatory examinations, our history of credit experience and our ongoing internal credit reviews.

The allowance for loan losses at December 31, 2006 was $32.0 million and represented 1.02% of total loans. The allowance for loan losses at December 31, 2006 was 281.27% of nonperforming loans, up from
143.0% at December 31, 2005. The reserve for unfunded lending commitments was $927 thousand at December 31, 2006 as compared with $1.2 million at December 31, 2005.

We continually monitor economic conditions in our local market areas and the probable impact on borrowers, past-due amounts, related collateral values, the number and size of non-performing loans and on the resulting
amount of charge-offs for the period.

We have several systems and procedures in place to assist in managing the overall quality of the loan portfolio. In
addition to established underwriting guidelines and approval processes, we monitor delinquency levels for any negative or adverse trends. We also perform reviews of the loan portfolios on a regular basis to identify troubled loans and to assess
their overall probability of collection.

Ongoing portfolio reviews are conducted by our internal loan review department under an established loan review
program. We are targeting a loan review penetration of at least 60-70% annually of the total commercial and real estate loan portfolios.

Through the loan
review process, we maintain an internally classified loan list, which, along with the delinquency list of loans, helps us assess the overall quality of the loan portfolios and the adequacy of the allowance for credit losses. Loans on this listing
are classified as substandard, doubtful or loss based on probability of repayment, collateral valuation and related collectibility.

All doubtful and loss
loans are considered impaired. Substandard loans are defined as impaired when based on current information and events, it is probable that we will be unable to collect all amounts due, both interest and principal, according to the contractual terms
of the loan agreement. The allowance for loan losses related to impaired loans is determined based on the difference between the carrying value of the impaired loan and its fair value. The fair value is determined based on the present value of
expected cash flows discounted at the loans effective interest rate or, as a practical expedient, the loans observable market price or the fair value of the collateral if the loan is collateral dependent.

Loans classified as substandard have clear and defined weaknesses such as highly leveraged positions, unfavorable financial ratios, uncertain repayment
sources or poor financial condition, which may jeopardize the loans recoverability. Loans classified as doubtful have characteristics similar to substandard loans but with an increased risk that a loss may occur or that at least a
portion of the loan may require a charge-off if liquidated at present. Although loans classified as substandard do not duplicate loans classified as doubtful, both substandard and doubtful loans include some loans that are delinquent at least 30
days or on nonaccrual status. Loans classified as loss are those loans that are in the process of being charged off.



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##### Index to Financial Statements

At December 31, 2006, substandard loans totaled $41.5 million, of which $7.4 million were loans designated as
delinquent or nonaccrual; and doubtful loans totaled $1.4 million all of which were designated as delinquent or nonaccrual.

In addition to the internally
classified loan list and delinquency list of loans, we maintain a separate watch list which further aids in monitoring the loan portfolios. Watch list loans show warning elements, deficiencies that require attention in the short run, or
where pertinent ratios of the loan account have weakened to a point where more frequent monitoring is warranted. These loans do not have all the characteristics of a classified loan (substandard or doubtful) but do show weakened elements as compared
with those of a satisfactory credit. We review these loans in assessing the adequacy of the allowance for credit losses. As of December 31, 2006 and 2005, watch list loans totaled $93.4 million and $162.5 million, respectively.

Management assigns loan grades by individual loan and allocations are made within each loan grade. Loans are assigned a grade according to payment history, collateral
values, and financial condition of the borrower.

The Bank maintains an adequate allowance for credit losses through its watchlist classifications,
allocating an increasing reserve amount as the severity of a problem loan increases. The Bank maintains an unallocated reserve for satisfactory non-classified credits based, in part, on the average of the last three years actual net
charge-offs.



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##### Index to Financial Statements

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



|                                                                  |  |                         |        |   |      |   |        |      |  |   |        |   |  |      |        |   |  |   |        |  
|----------------------------------------------------------------- |  | ----------------------- | ------ | - | ---- | - | ------ | ---- |  | - | ------ | - |  | ---- | ------ | - |  | - | ------ | -
|                                                                  |  | Year Ended December 31, |       
|                                                                  |  | 2006                    |        |   | 2005 |   |        | 2004 |  |   | 2003   |   |  | 2002 |       
|Allowance for loan losses at January 1                            |  | $                       | 31,230 |   |      | $ | 29,406 |      |  | $ | 30,722 |   |  | $    | 27,248 |   |  | $ | 22,927 |  
|Charge-offs:                                                      |  |                         |        |   |      |   |        |      |  |   |        |   |  |      |        |   |  |   |        |  
|Commercial and industrial                                         |  |                         | 4,372  |   |      |   | 12,410 |      |  |   | 10,365 |   |  |      | 10,597 |   |  |   | 7,384  |  
|Real estate, mortgage and construction                            |  |                         | 3,879  |   |      |   | 1,768  |      |  |   | 3,405  |   |  |      | 4,486  |   |  |   | 1,249  |  
|Consumer/other                                                    |  |                         | 1,199  |   |      |   | 1,535  |      |  |   | 1,446  |   |  |      | 1,590  |   |  |   | 1,122  |  
|                                                                  |  |                         |        |   |      |   |        |      |  |   |        |   |  |      |        |   |  |   |        |  
|Total charge-offs                                                 |  |                         | 9,450  |   |      |   | 15,713 |      |  |   | 15,216 |   |  |      | 16,673 |   |  |   | 9,755  |  
|Recoveries:                                                       |  |                         |        |   |      |   |        |      |  |   |        |   |  |      |        |   |  |   |        |  
|Commercial and industrial                                         |  |                         | 3,205  |   |      |   | 1,773  |      |  |   | 2,094  |   |  |      | 1,447  |   |  |   | 1,400  |  
|Real estate, mortgage and construction                            |  |                         | 79     |   |      |   | 711    |      |  |   | 159    |   |  |      | 157    |   |  |   | 75     |  
|Consumer/other                                                    |  |                         | 507    |   |      |   | 268    |      |  |   | 223    |   |  |      | 343    |   |  |   | 245    |  
|                                                                  |  |                         |        |   |      |   |        |      |  |   |        |   |  |      |        |   |  |   |        |  
|Total recoveries                                                  |  |                         | 3,791  |   |      |   | 2,752  |      |  |   | 2,476  |   |  |      | 1,947  |   |  |   | 1,720  |  
|                                                                  |  |                         |        |   |      |   |        |      |  |   |        |   |  |      |        |   |  |   |        |  
|Net charge-offs                                                   |  |                         | 5,659  |   |      |   | 12,961 |      |  |   | 12,740 |   |  |      | 14,726 |   |  |   | 8,035  |  
|Allowance for credit losses associated with acquired institutions |  |                         | 2,152  |   |      |   | 761    |      |  |   |       |   |  |      | 855    |   |  |   | 656    |  
|Allowance for loan losses sold with divestiture                   |  |                         |       |   |      |   |       |      |  |   |       |   |  |      | (353   | ) |  |   |       |  
|Provision for loan losses                                         |  |                         | 4,304  |   |      |   | 14,024 |      |  |   | 11,424 |   |  |      | 17,698 |   |  |   | 11,700 |  
|                                                                  |  |                         |        |   |      |   |        |      |  |   |        |   |  |      |        |   |  |   |        |  
|Allowance for loan losses at December 31                          |  | $                       | 32,027 |   |      | $ | 31,230 |      |  | $ | 29,406 |   |  | $    | 30,722 |   |  | $ | 27,248 |  
|                                                                  |  |                         |        |   |      |   |        |      |  |   |        |   |  |      |        |   |  |   |        |  
|Reserve for unfunded loan commitments at January 1                |  |                         | 1,173  |   |      |   | 826    |      |  |   |       |   |  |      |       |   |  |   |       |  
|Provision for losses on unfunded loan commitments                 |  |                         | (246   | ) |      |   | 347    |      |  |   | 826    |   |  |      |       |   |  |   |       |  
|                                                                  |  |                         |        |   |      |   |        |      |  |   |        |   |  |      |        |   |  |   |        |  
|Reserve for unfunded loan commitments at December 31              |  |                         | 927    |   |      |   | 1,173  |      |  |   | 826    |   |  |      |       |   |  |   |       |  
|                                                                  |  |                         |        |   |      |   |        |      |  |   |        |   |  |      |        |   |  |   |        |  
|Total allowance for credit losses at December 31                  |  | $                       | 32,954 |   |      | $ | 32,403 |      |  | $ | 30,232 |   |  | $    | 30,722 |   |  | $ | 27,248 |  
|                                                                  |  |                         |        |   |      |   |        |      |  |   |        |   |  |      |        |   |  |   |        |  
|                                                                  |  |                         |        |   |     
|Ratios:                                                           |  |                         |        |   |      |   |        |      |  |   |        |   |  |      |        |   |  |   |        |  
|Allowance for loan losses to period-end loans                     |  |                         | 1.02   | % |      |   | 1.16   | %    |  |   | 1.25   | % |  |      | 1.42   | % |  |   | 1.03   | %
|Net charge-offs to average loans                                  |  |                         | 0.20   | % |      |   | 0.51   | %    |  |   | 0.58   | % |  |      | 0.60   | % |  |   | 0.37   | %
|Allowance for loan losses to period-end nonperforming loans       |  |                         | 281.27 | % |      |   | 142.99 | %    |  |   | 142.71 | % |  |      | 90.66  | % |  |   | 138.64 | %



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##### Table of Contents

##### Index to Financial Statements

The following table shows the allocation of the allowance for loan losses among various categories of loans. The
allocation is made for analytical purposes and is not necessarily indicative of the categories in which future loan losses may occur. The total allowance is available to absorb losses from any category of loans. In 2006, the Company changed its
allowance methodology to allow more specific allocation of its reserves.



|                                                                     |  |                        |        |                                                           |      |   |        |      |                                                           |  |      |        |  |                                                           |        |  |        |   |                                                           |   |        |        |     |                                                           |  |   |        |  |     |  
|-------------------------------------------------------------------- |  | ---------------------- | ------ | --------------------------------------------------------- | ---- | - | ------ | ---- | --------------------------------------------------------- |  | ---- | ------ |  | --------------------------------------------------------- | ------ |  | ------ | - | --------------------------------------------------------- | - | ------ | ------ | --- | --------------------------------------------------------- |  | - | ------ |  | --- | -
|                                                                     |  | December 31,           |       
|                                                                     |  | 2006                   |        |                                                           | 2005 |   |        | 2004 |                                                           |  | 2003 |        |  | 2002                                                      |       
|                                                                     |  | Amount                 |        | % of loansin eachCategory toTotal LoansHeld forInvestment |      |   | Amount |      | % of loansin eachCategory toTotal LoansHeld forInvestment |  |      | Amount |  | % of loansin eachCategory toTotal LoansHeld forInvestment |        |  | Amount |   | % of loansin eachCategory toTotal LoansHeld forInvestment |   |        | Amount |     | % of loansin eachCategory toTotal LoansHeld forInvestment | 
|                                                                     |  | (dollars in thousands) |       
|Balance of allowance for loan losses at end of period applicable to: |  |                        |        |                                                           |      |   |        |      |                                                           |  |      |        |  |                                                           |        |  |        |   |                                                           |   |        |        |     |                                                           |  |   |        |  |     |  
|Commercial and industrial                                            |  | $                      | 12,101 |                                                           | 28   | % |        | $    | 6,429                                                     |  | 28   | %      |  | $                                                         | 8,925  |  | 30     | % |                                                           | $ | 11,844 |        | 32  | %                                                         |  | $ | 9,188  |  | 32  | %
|Real estate, mortgage and construction                               |  |                        | 16,769 |                                                           | 70   | % |        |      | 8,738                                                     |  | 69   | %      |  |                                                           | 10,647 |  | 67     | % |                                                           |   | 8,855  |        | 64  | %                                                         |  |   | 7,738  |  | 61  | %
|Consumer/other                                                       |  |                        | 2,262  |                                                           | 2    | % |        |      | 730                                                       |  | 3    | %      |  |                                                           | 764    |  | 3      | % |                                                           |   | 1,009  |        | 4   | %                                                         |  |   | 1,323  |  | 7   | %
|Unallocated                                                          |  |                        | 895    |                                                           | N/A  |   |        |      | 15,333                                                    |  | N/A  |        |  |                                                           | 9,070  |  | N/A    |   |                                                           |   | 9,014  |        | N/A |                                                           |  |   | 8,999  |  | N/A |  
|                                                                     |  |                        |        |                                                           |      |   |        |      |                                                           |  |      |        |  |                                                           |        |  |        |   |                                                           |   |        |        |     |                                                           |  |   |        |  |     |  
|Total                                                                |  | $                      | 32,027 |                                                           | 100  | % |        | $    | 31,230                                                    |  | 100  | %      |  | $                                                         | 29,406 |  | 100    | % |                                                           | $ | 30,722 |        | 100 | %                                                         |  | $ | 27,248 |  | 100 | %
|                                                                     |  |                        |        |                                                           |      |   |        |      |                                                           |  |      |        |  |                                                           |        |  |        |   |                                                           |   |        |        |     |                                                           |  |   |        |  |     |  

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 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.



37



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##### Index to Financial Statements

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 December 31, 2006 and 2005:



|                                         |  |                                          |  
|---------------------------------------- |  | ---------------------------------------- | -
|Changes in Interest Rates (Basis Points) |  | Increase (Decrease)in Net InterestIncome |  
|December 31, 2006                        |  |                                          |  
|+200                                     |  | 0.56                                     | %
|+100                                     |  | -0.06                                    | %
|Base                                     |  | 0.00                                     | %
|-100                                     |  | -2.78                                    | %
|-200                                     |  | -5.27                                    | %
|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 us. The interest rate sensitivity analysis includes assumptions that: (i) the composition of our interest sensitive assets and liabilities existing at year 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 us.

During July of 2006, we executed a hedging strategy utilizing interest rate derivatives designed as a means to mitigate some of our asset sensitivity. We purchased an
interest rate floor contract and an interest rate collar contract. These contracts were designated as cash flow hedges of the monthly interest receipts from our portfolio of variable-rate loans.

Off-Balance Sheet Arrangements, Commitments, Guarantees and Contractual Obligations

Our potential obligations associated with commitments to extend credit and outstanding letters of credit as of December 31, 2006 are summarized below (in thousands).



|                             |  |                   |         |           |   |           |  |             |         |       |   |        |  |   |        
|---------------------------- |  | ----------------- | ------- | --------- | - | --------- |  | ----------- | ------- | ----- | - | ------ |  | - | -------
|                             |  | Less thanOne Year |         | 1-3 Years |   | 3-5 Years |  | Over5 Years |         | Total
|Commitments to extend credit |  | $                 | 394,867 |           | $ | 208,531   |  | $           | 149,612 |       | $ | 69,199 |  | $ | 822,209
|Standby letters of credit    |  |                   | 68,975  |           |   | 12,171    |  |             | 2,493   |       |   |       |  |   | 83,639 
|                             |  |                   |         |           |   |           |  |             |         |       |   |        |  |   |        
|Total                        |  | $                 | 463,842 |           | $ | 220,702   |  | $           | 152,105 |       | $ | 69,199 |  | $ | 905,848
|                             |  |                   |         |           |   |           |  |             |         |       |   |        |  |   |        

Since commitments associated with letters of credit and lending and financing arrangements may expire unused, the
amounts shown do not necessarily reflect the actual future cash funding requirements. See Note 18 to the Consolidated Financial Statements for additional discussion of financial instruments with off-balance sheet risk, including a discussion of the
nature, business purpose and importance of off-balance sheet arrangements.



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##### Index to Financial Statements

Off-balance sheet arrangements also include an interest rate swap, an interest rate floor, an interest rate collar which
can be found in Note 12 and our Trust Preferred Securities. Further information regarding the Trust Preferred Securities can be found in Note 11 to the Consolidated Financial Statements.

Our future contractual cash payments are as follows (in thousands):



|                                           |  |                   |         |           |   |          |  |             |        |       |   |         |  |   |          
|------------------------------------------ |  | ----------------- | ------- | --------- | - | -------- |  | ----------- | ------ | ----- | - | ------- |  | - | ---------
|                                           |  | Less thanOne Year |         | 1-3 Years |   | 3-5Years |  | Over5 Years |        | Total
|Junior subordinated debt                   |  | $                 |        |           | $ |         |  | $           |       |       | $ | 56,959  |  | $ | 56,959   
|Subordinated debt                          |  |                   |        |           |   |         |  |             |       |       |   | 50,000  |  |   | 50,000   
|Interest expense related to long-term debt |  |                   | 9,322   |           |   | 18,852   |  |             | 18,900 |       |   | 107,292 |  |   | 154,366  
|Operating leases                           |  |                   | 7,539   |           |   | 12,801   |  |             | 10,999 |       |   | 34,890  |  |   | 66,229   
|Certificates and other time deposits       |  |                   | 947,761 |           |   | 79,223   |  |             | 19,974 |       |   | 205     |  |   | 1,047,163
|                                           |  |                   |         |           |   |          |  |             |        |       |   |         |  |   |          
|Total                                      |  | $                 | 964,622 |           | $ | 110,876  |  | $           | 49,873 |       | $ | 249,346 |  | $ | 1,374,717
|                                           |  |                   |         |           |   |          |  |             |        |       |   |         |  |   |          

The amount shown above for subordinated debt represents our contractual obligation. The subordinated debt is
reflected in the consolidated balance sheet at its fair value. As discussed earlier, the Bank entered into an interest rate swap designated as a fair-value hedge of the subordinated debt. Refer to Note 12 in the Consolidated Financial Statements for
further information.

Interest expense obligations on fixed rate junior subordinated debt are calculated based on the stated contractual interest rates.
Interest expense on variable rate junior subordinated debt is calculated assuming the current 3-month LIBOR rate of 5.36% plus 3.45%. Interest expense on subordinated debt is calculated based on the fixed coupon rate of the debt adjusted for the
associated interest rate swap agreement assuming the current 3-month LIBOR rate. Refer to Notes 11 and 12 in the Consolidated Financial Statements for further information.

Capital and Liquidity

CapitalAt December 31, 2006, shareholders equity totaled $409.3
million or 9.94% 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 as of December 31, 2006 were as follows
(dollars in thousands):



|                                         |  |        |         |       |                              |   |        |   |         |  |     |  
|---------------------------------------- |  | ------ | ------- | ----- | ---------------------------- | - | ------ | - | ------- |  | --- | -
|                                         |  | Actual |         |       | For CapitalAdequacy Purposes |  
|                                         |  | Amount |         | Ratio |                              |   | Amount |   | Ratio   | 
|Total Capital (to Risk Weighted Assets)  |  | $      | 407,079 |       | 10.7                         | % |        | $ | 303,871 |  | 8.0 | %
|Tier 1 Capital (to Risk Weighted Assets) |  |        | 327,991 |       | 8.6                          | % |        |   | 151,936 |  | 4.0 | %
|Tier 1 Capital (to Average Assets)       |  |        | 327,991 |       | 8.1                          | % |        |   | 161,111 |  | 4.0 | %

See Note 19 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 amortizing securities and loan portfolios.

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. At December 31,



39



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##### Table of Contents

##### Index to Financial Statements

2006, there was an aggregate of approximately $98.1 million available for payment of dividends by Sterling Bank. At December 31, 2006, the aggregate
amount of dividends, which legally could be paid without prior approval of various regulatory agencies, totaled approximately $22.2 million. It is not anticipated that such restrictions will have an impact on the ability of Sterling Bancshares to
meet its ongoing cash obligations. Additionally, Sterling Bancshares maintains a $20 million line of credit with Wells Fargo. This line of credit is available for general corporate purposes including the funding of potential acquisitions. As of
December 31, 2006, we have a material commitment of $25.5 million to be paid out in cash related to acquisition of Partners Bank of Texas which is expected to close in the first half of 2007.

During the second quarter of 2006, we prepaid all of our $29.6 million 9.20% Junior Subordinated Deferrable Interest Debentures. The payment of these Debentures was
funded by a dividend from the Bank.

On April 25, 2005, our Board of Directors authorized us to repurchase up to 3,750,000 shares of our common stock,
not to exceed 750,000 shares in any calendar year. We may repurchase our shares of common stock from time to time in the open market or through privately negotiated transactions. We plan to fund any share repurchases from available cash or
short-term borrowings.



|ITEM 7A. | Quantitative and Qualitative Disclosures about Market Risk
|-------- | ----------------------------------------------------------

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 8. | Financial Statements and Supplementary Data
|------- | -------------------------------------------

Refer to the index
included on page F-1 and the Consolidated Financial Statements that begin on page F-3 of this Annual Report on Form 10-K.



|ITEM 9. | Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
|------- | ------------------------------------------------------------------------------------

None.



|ITEM 9A. | Controls and Procedures
|-------- | -----------------------

The Companys Chief Executive Officer
and Chief Financial Officer, after evaluating the effectiveness of the Companys disclosure controls and procedures, as defined in Rule 13a-15(e) of the Securities Exchange Act of 1934, as amended, have concluded that, as of the end of the
fiscal year covered by this Annual Report on Form 10-K, the Companys disclosure controls and procedures were effective to provide reasonable assurances that information required to be disclosed in the reports filed or submitted under such
Act is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commissions rules and forms and such information is accumulated and communicated to management, including the CEO and CFO, as
appropriate, to allow timely decisions regarding required disclosures.

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.



40



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##### Table of Contents

##### Index to Financial Statements

MANAGEMENTS REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING AND COMPLIANCE WITH DESIGNATED
LAWS AND REGULATIONS

Managements Report on Internal Control over Financial Reporting

Management of Sterling Bancshares, Inc. and subsidiaries (the Company) is responsible for preparing the Companys annual financial statements. Management
is also responsible for establishing and maintaining adequate internal control over financial reporting. The Companys internal control over financial reporting is a process designed under the supervision of the Companys Chief Executive
Officer and Chief Financial Officer to provide reasonable assurance regarding the reliability of financial reporting and the preparation of the Companys financial statements for external purposes in accordance with generally accepted
accounting principles. All internal control systems, no matter how well designed, have inherent limitations. Therefore, even those systems determined to be effective can provide only reasonable assurance with respect to financial statement
preparation and presentation.

As of December 31, 2006, management assessed the effectiveness of the Companys internal control over financial
reporting based on the criteria for effective internal control over financial reporting established in Internal ControlIntegrated Framework, issued by the Committee of Sponsoring Organizations of the Treadway Commission. This assessment
included controls over the preparation of the schedules equivalent to the basic financial statements in accordance with the instructions for the Consolidated Financial Statements for Bank Holding Companies (Form FRY-9C) to meet the reporting
requirements of Section 112 of the Federal Deposit Insurance Corporation Improvement Act. Based on the assessment, management determined that the Company maintained effective internal control over financial reporting as of December 31,
2006, based on those criteria.

In September 2006, the Company acquired BOTH, Inc., and its subsidiary, Bank of the Hills. As permitted by the Securities
and Exchange Commission, management excluded BOTH from its assessment of the effectiveness of the Companys internal control over financial reporting as of December 31, 2006. Based on the assessment, which excluded BOTH, as described
above, management determined that the Company maintained effective internal control over financial reporting as of December 31, 2006.

Deloitte & Touche LLP, the independent registered public accounting firm that audited the Companys consolidated financial statements included in this Annual Report on Form 10-K, has issued an attestation report on
managements assessment of the effectiveness of the Companys internal control over financial reporting as of December 31, 2006. The report is included in this Item under the heading Report of Independent Registered Public
Accounting Firm.

Compliance with Designated Laws and Regulations

Management is also responsible for ensuring compliance with the federal laws and regulations concerning loans to insiders and the federal and state laws and regulations concerning dividend restrictions, both of which
are designated by the Federal Deposit Insurance Corporation (FDIC) as safety and soundness laws and regulations.

Management assessed its compliance with
the designated safety and soundness laws and regulations and has maintained records of its determinations and assessments as required by the FDIC. Based on this assessment, management believes that the Company has complied, in all material respects,
with the designated safety and soundness laws and regulations for the year ended December 31, 2006.



|                                                                    
|--------------------------------------------------------------------
|                                                                    
|LOGO                                                                
|J. Downey Bridgwater Chairman, President and Chief Executive Officer
|                                                                    
|LOGO                                                                
|Zach L. Wasson Executive Vice President and Chief Financial Officer 



41



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##### Index to Financial Statements

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and Shareholders of

Sterling Bancshares, Inc.

Houston, Texas

We have audited managements assessment, included in the accompanying Managements Report on Internal
Control over Financial Reporting, that Sterling Bancshares, Inc. and subsidiaries (the Company) maintained effective internal control over financial reporting as of December 31, 2006, based on criteria established in Internal
ControlIntegrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. Because managements assessment and our audit were conducted to meet the reporting requirements of Section 112 of the Federal
Deposit Insurance Corporation Improvement Act (FDICIA), managements assessment and our audit of the Companys internal control over financial reporting included controls over the preparation of the schedules equivalent to the basic
financial statements in accordance with the instructions for the Consolidated Financial Statements for Bank Holding Companies (Form FR Y-9C). As described in Managements Report on Internal Control over Financial Reporting, management excluded from
its assessment the internal control over financial reporting at Bank of the Hills, which was acquired on September 30, 2006 and whose financial statements constitute 4 percent of total assets, 10 percent of total deposits, 7 percent of net
interest income and 6 percent of net income of the consolidated financial statement amounts as of and for the year ended December 31, 2006. Accordingly, our audit did not include the internal control over financial reporting at Bank of the
Hills. The Companys management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express an
opinion on managements assessment and an opinion on the effectiveness of the Companys internal control over financial reporting based on our audit.

We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective
internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, evaluating managements assessment, testing and evaluating the design
and operating effectiveness of internal control, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinions.

A companys internal control over financial reporting is a process designed by, or under the supervision of, the companys principal executive and principal
financial officers, or persons performing similar functions, and effected by the companys board of directors, management, and other personnel to provide reasonable assurance regarding the reliability of financial reporting and the preparation
of financial statements for external purposes in accordance with generally accepted accounting principles. A companys internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of
records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial
statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide
reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the companys assets that could have a material effect on the financial statements.

Because of the inherent limitations of internal control over financial reporting, including the possibility of collusion or improper management override of controls,
material misstatements due to error or fraud may not be prevented or detected on a timely basis. Also, projections of any evaluation of the effectiveness of the internal control over financial reporting to future periods are subject to the risk that
the controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.



42



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##### Index to Financial Statements

In our opinion, managements assessment that the Company maintained effective internal control over financial
reporting as of December 31, 2006, is fairly stated, in all material respects, based on the criteria established in Internal ControlIntegrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. Also
in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2006, based on the criteria established in Internal ControlIntegrated Framework issued by the
Committee of Sponsoring Organizations of the Treadway Commission.

We have also audited, in accordance with the standards of the Public Company Accounting
Oversight Board (United States), the consolidated financial statements as of and for the year ended December 31, 2006 of the Company and our report dated February 26, 2007 expressed an unqualified opinion on those financial statements.

We have not examined and, accordingly, we do not express an opinion or any other form of assurance on managements statement referring to compliance
with laws and regulations.

LOGO

Houston, Texas

February 26, 2007



|ITEM 9B. | Other Information
|-------- | -----------------

None.

PART III



|ITEM 10. | Directors, Executive Officers and Corporate Governance of the Registrant
|-------- | ------------------------------------------------------------------------

The information required by this Item as to the directors and executive officers is hereby incorporated by reference from the information appearing under the captions Election of Directors, Information about the Board of
Directors, Committees of the Board, and Committees of the BankStanding Committees of the Board, Executive Officers and Other Significant Employees, and Section 16 Beneficial Ownership Reporting Compliance in the
Companys definitive proxy statement to be filed with the SEC pursuant to the Securities Exchange Act of 1934 within 120 days of year end. The information required by this Item as to the Code of Ethics for Senior Financial Officers is hereby
incorporated by reference from Item 1BusinessAvailable Information of this report.



|ITEM 11. | Executive Compensation
|-------- | ----------------------

The information required by this Item is
hereby incorporated by reference from the information appearing under the caption Compensation Discussion and Analysis, Report of the Human Resources Programs Committee, Compensation Committee Interlocks and Insider
Participation, Summary Compensation Table, Grants of Plan-Based Awards, and Employment Agreements and Other Compensation Agreements in the Companys definitive proxy statement to be filed with the SEC
pursuant to the Securities Exchange Act of 1934 within 120 days of year end.



|ITEM 12. | Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
|-------- | ----------------------------------------------------------------------------------------------

The information required by this Item is hereby incorporated by reference from the information appearing under the captions Security Ownership of Certain Beneficial Owners and Management and Equity
Compensation



43



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##### Index to Financial Statements

Plan Information in the Companys definitive proxy statement to be filed with the SEC pursuant to the Securities Exchange Act of 1934 within 120
days of year end.



|ITEM 13. | Certain Relationships and Related Transactions, and Director Independence
|-------- | -------------------------------------------------------------------------

The information required by this Item is hereby incorporated by reference from the information appearing under the captions Certain Transactions with Related Persons, and Director Independence in the Companys
definitive proxy to be filed with the SEC pursuant to the Securities Exchange Act of 1934 within 120 days of year end.



|ITEM 14. | Principal Accounting Fees and Services
|-------- | --------------------------------------

The information required by
this Item as to disclosures regarding accounting fees and services is hereby incorporated by reference to such information appearing under the caption Independent Registered Public Accounting Firms Fees in the Companys
definitive proxy to be filed with the SEC pursuant to the Securities and Exchange Act of 1934 within 120 days of year end.

PART IV



|ITEM 15. | Exhibits and Financial Statement Schedules
|-------- | ------------------------------------------

(a) List of documents
filed as part of this report



| | 1. | Consolidated Financial Statements. The following Consolidated Financial Statements and Report of Independent Registered Public Accounting Firm are included in this
Annual Report on Form 10-K.
| | -- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|                                                        |  |    
|------------------------------------------------------- |  | ---
|REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM |  | F-2
|                                                        | 
|CONSOLIDATED FINANCIAL STATEMENTS:                      |  |    
|Consolidated Balance Sheets                             |  | F-3
|Consolidated Statements of Income                       |  | F-4
|Consolidated Statements of Shareholders Equity         |  | F-5
|Consolidated Statements of Cash Flows                   |  | F-6
|Notes to Consolidated Financial Statements              |  | F-7



| | 2. | Consolidated Financial Statement Schedules. These schedules are omitted as the required information is inapplicable or the information is presented in the consolidated
financial statements or related notes.
| | -- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | 3. | Exhibits.
| | -- | ---------



|            |  |                                                                                                                                                                                                                                                                                        
|----------- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit No. |  |                                                                                                                                                                                                                                                                                        
|            | 
|2.1         |  | Agreement and Plan of Merger dated as of October 23, 2000 among the Company, Sterling Bancorporation, Inc. and CaminoReal Bancshares of Texas, Inc., as amended. [Incorporated by reference to
Exhibit 2.5 of the Companys Annual Report on Form 10-K (File No. 000-20750).]          
|            | 
|2.2         |  | Agreement and Plan of Merger dated as of March 1, 2001, by and between Sterling Bancshares, Inc. and Lone Star Bancorporation, Inc., as amended. [Incorporated by reference to Exhibit 2 of the
Companys Quarterly Report on Form 10-Q filed on May 14, 2001 (File No. 000-20750).]   
|            | 
|2.3         |  | Agreement and Plan of Merger dated as of October 1, 2001 by and among Sterling Bancshares, Inc., Sterling Bancorporation, Inc. and Community Bancshares, Inc., as amended. [Incorporated by
reference to Exhibit 2.7 of the Companys Annual Report on Form 10-K (File No. 000-20750).]



44



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##### Index to Financial Statements

|            |  |                                                                                                                                                                                                                                                                                                                                          
|----------- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit No. |  |                                                                                                                                                                                                                                                                                                                                          
|2.4         |  | Agreement and Plan of Merger Among Sterling Bancshares, Inc., Sterling Bancorporation, Inc. and ENB Bankshares Inc. dated as of May 22, 2002. [Incorporated by reference to Exhibit 2.1 of the
Companys Quarterly Report on Form 10-Q filed on August 14, 2002 (File No. 000-20750).]                                                   
|            | 
|2.5         |  | Purchase and Assumption Agreement dated July 12, 2002 between Sterling Bank Inc. and James Wilson as amended by First Amendment to Purchase and Assumption Agreement dated as of August 2,
2002. [Incorporated by reference to Exhibit 2.2 of the Companys Quarterly Report on Form 10-Q filed on August 13, 2002 (File No. 000-20750).]
|            | 
|2.6         |  | Purchase and Assumption Agreement dated as of October 29, 2002 between Sterling Bank Inc. and South Texas National Bank of Laredo. [Incorporated by reference to Exhibit 2.9 of the
Companys Annual Report on Form 10-K (File No. 000-20750).]                                                                                          
|            | 
|2.7         |  | Stock Purchase Agreement dated as of July 16, 2003 by and among Sterling Bancshares, Inc., Sterling Bank, CMCR Holding Company and RBC Mortgage Company. [Incorporated by reference to Exhibit
2.1 to the Companys Current Form 8-K filed on October 15, 2003 (File No. 000-20750).]                                                    
|            | 
|2.8         |  | Amendment No. 1 to Stock Purchase Agreement dated as of September 30, 2003 by and among Sterling Bancshares, Inc., Sterling Bank, CMCR Holding Company and RBC Mortgage Company. [Incorporated
by reference to Exhibit 2.2 to the Companys Current Form 8-K filed on October 15, 2003 (File No. 000-20750).]                            
|            | 
|2.9         |  | Agreement and Plan of Merger dated August 18, 2003 by and among Sterling Bancshares, Inc., SB 2003, Inc. and South Texas Capital Group, Inc. [Incorporated by reference to Exhibit 10.3 of the
Companys Quarterly Report on Form 10-Q filed on November 14, 2003 (File No. 000-20750).]                                                 
|            | 
|2.10        |  | Agreement and Plan of Merger Dated July 7, 2005 by and among Sterling Bancshares, Inc., SBPB, Inc., and Prestonwood Bancshares, Inc. [Incorporated by reference to Exhibit 10.1 of the
Companys Quarterly Report on Form 10-Q filed on November 8, 2005 (File No. 000-20750).]                                                          
|            | 
|2.11        |  | Agreement and Plan of Merger dated July 25, 2006 between 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.]                                                                                                                         
|            | 
|2.12        |  | Agreement and Plan of Merger dated January 24, 2007 between Sterling Bancshares, Inc., Sterling Bank and Partners Bank of Texas. [Incorporated by reference to Exhibit 2.1 of the
Companys Current Report on Form 8-K filed on January 25, 2007.]                                                                                       
|            | 
|3.1         |  | Restated and Amended Articles of Incorporation of the Company, as amended. [Incorporated by reference to Exhibit 3.1 to the Registration Statement on Form S-3 (File Nos. 333-55724,
333-55724-01, and 333-55724-02).]                                                                                                                   
|            | 
|3.2         |  | Articles of Amendment to the Restated and Amended Articles of Incorporation of Sterling Bancshares, Inc. [Incorporated by reference to Exhibit 3.2 of the Companys Quarterly Report on
Form 10-Q filed on August 13, 2002 (File No. 000-20750).]                                                                                        
|            | 
|3.3         |  | Amended and Restated Bylaws of Sterling Bancshares, Inc. [Incorporated by reference to Exhibit 3.1 of the Companys Current Report on Form 8-K filed on October 26, 2004 (File No.
000-20750).]                                                                                                                                          



45



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##### Index to Financial Statements

|            |  |                                                                                                                                                                                                                                                          
|----------- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit No. |  |                                                                                                                                                                                                                                                          
|3.4         |  | Amendment to Bylaws of Sterling Bancshares, Inc. [Incorporated by reference to Exhibit 3.1 of the Companys Current Report on Form 8-K filed on November 17, 2005 (File No.
000-20750).]                                                                 
|            | 
|4.1         |  | Preferred Securities Guarantee Agreement dated March 21, 2001. [Incorporated by reference to Exhibit 4.2 of the Companys Current Report on Form 8-K filed on March 21, 2001 (File
No. 000-20750).]                                                      
|            | 
|4.2         |  | Indenture dated March 21, 2001. [Incorporated by reference to Exhibit 4.4 of the Companys Current Report on Form 8-K filed on March 21, 2001 (File No. 000-20750).]                                                                                     
|            | 
|4.3         |  | First Supplemental Indenture dated March 21, 2001. [Incorporated by reference to Exhibit 4.5 of the Companys Current Report on Form 8-K filed on March 21, 2001 (File No.
000-20750).]                                                                  
|            | 
|4.4         |  | 9.20% Subordinated Deferrable Interest Debenture due March 21, 2031. [Incorporated by reference to Exhibit 4.7 of the Companys Current Report on Form 8-K filed on March 21, 2001 (File
No. 000-20750).]                                                
|            | 
|4.5         |  | Indenture dated August 30, 2002. [Incorporated by reference to Exhibit 4.4 of the Companys Current Report on Form 8-K filed on September 12, 2002 (File
No. 000-20750).]                                                                                
|            | 
|4.6         |  | Junior Subordinated Deferrable Interest Debenture due August 30, 2032. [Incorporated by reference to Exhibit 4.6 of the Companys Current Report on Form 8-K filed on September 12, 2002
(File No. 000-20750).]                                          
|            | 
|4.7         |  | Guarantee Agreement dated August 30, 2002. [Incorporated by reference to Exhibit 4.6 of the Companys Current Report on Form 8-K filed on September 12, 2002 (File
No. 000-20750).]                                                                      
|            | 
|4.8         |  | Preferred Securities Guarantee Agreement dated September 26, 2002. [Incorporated by reference to Exhibit 4.2 of the Companys Current Report on Form 8-K dated September 26, 2002
(File No. 000-20750).]                                                 
|            | 
|4.9         |  | Second Supplemental Indenture dated September 26, 2002. [Incorporated by reference to Exhibit 4.9 of the Companys Current Report on Form 8-K dated September 26, 2002 (File No.
000-20750).]                                                            
|            | 
|4.10        |  | 8.30% Junior Subordinated Deferrable Interest Debenture due September 26, 2032. [Incorporated by reference to Exhibit 4.8 of the Companys Current Report on Form 8-K dated September 26,
2002 (File No. 000-20750).]                                    
|            | 
|4.11        |  | Fiscal and Paying Agency Agreement dated April 10, 2003 between Sterling Bank and Deutsche Bank Trust Company Americas. [Incorporated by reference to Exhibit 4.1 of the Companys Current
Report on Form 8-K filed April 15, 2003 (File No. 000-20750).]
|            | 
|4.12        |  | Form of Global Certificate representing Sterling Banks 7.375% Subordinated Notes due 2013. [Incorporated by reference to Exhibit 4.2 of the Companys Current Report on Form 8-K
filed April 15, 2003 (File No. 000-20750).]                            
|            | 
|10.1***     |  | 1994 Incentive Stock Option Plan of the Company. [Incorporated by reference to Exhibit 10.1 of the Companys Annual Report on Form 10-K for the year ended December 31,
1994.]                                                                           



46



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##### Index to Financial Statements

|            |  |                                                                                                                                                                                                                                                                                                                       
|----------- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit No. |  |                                                                                                                                                                                                                                                                                                                       
|10.2        |  | 1994 Employee Stock Purchase Plan of the Company. [Incorporated by reference to Exhibit 10.2 of the Companys Annual Report on Form 10-K for the year ended December 31,
1994.]                                                                                                                                       
|            | 
|10.3***     |  | 1984 Incentive Stock Option Plan of the Company. [Incorporated by reference to Exhibit 10.1 of the Companys Registration Statement on Form S-1, effective October 22, 1992 (Registration
No. 33-51476).]                                                                                                             
|            | 
|10.4***     |  | 1995 Non-Employee Director Stock Compensation Plan. [Incorporated by reference to Exhibit 4.3 of the Companys Registration Statement on Form S-8 (File
No. 333-16719).]                                                                                                                                              
|            | 
|10.5        |  | Credit Agreement dated October 1, 2004 made by and between Sterling Bancshares, Inc. and Wells Fargo Bank, National Association regarding a line of credit in the amount of $20,000,000.
[Incorporated by reference to Exhibit 10.5 of the Companys Annual Report on Form 10-K for the year ended December 31, 2005.]
|            | 
|10.6        |  | First Amendment to Credit Agreement dated as of March 8, 2005 by and between Sterling Bancshares, Inc. and Wells Fargo Bank, National Association. [Incorporated by reference to Exhibit 10.6
of the Companys Annual Report on Form 10-K for the year ended December 31, 2005.]                                      
|            | 
|10.7        |  | Second Amendment to Credit Agreement between Sterling Bancshares, Inc. and Wells Fargo Bank, National Association, dated September 29, 2005. [Incorporated by reference to Exhibit 10.1 of the
Companys Report on Form 8-K filed on October 5, 2005 (File No. 000-207500).]                                          
|            | 
|10.8***     |  | Employment Agreement between Sterling Bancshares, Inc. and J. Downey Bridgwater executed on October 31, 2001 and effective as of January 1, 2002. [Incorporated by reference to Exhibit 99.3 of
the Companys Report on Form 8-K filed on October 14, 2001 (File No. 000-207500).]                                    
|            | 
|10.9***     |  | Amendment to Employment Agreement between Sterling Bancshares, Inc. and J. Downey Bridgwater dated November 17, 2005. [Incorporated by reference to Exhibit 10.1 of the Companys
Report on Form 8-K filed on November 17, 2005 (File No. 000-207500).]                                                               
|            | 
|10.10***    |  | Employment Agreement between Sterling Bancshares, Inc. and J. Downey Bridgwater dated November 17, 2005. [Incorporated by reference to Exhibit 10.2 of the Companys Report on Form 8-K
filed on November 17, 2005 (File No. 000-207500).]                                                                            
|            | 
|10.11***    |  | Sterling Bancshares, Inc. 2003 Stock Incentive and Compensation Plan. [Incorporated by reference to Exhibit 4.4 of the Companys Registration Statement on Form S-8 (File
No. 333-105307).]                                                                                                                           
|            | 
|10.12***    |  | Consulting Agreement between Sterling Bancshares, Inc. and George Martinez executed on June 9, 2004 and effective as of June 1, 2004. [Incorporated by reference to Exhibit 10.1 of the
Companys Quarterly Report on Form 10-Q filed on August 5, 2004 (File No. 000-207501)].                                       
|            | 
|10.13***    |  | Amendment to Employment and Consulting Agreement between Sterling Bancshares, Inc. and George Martinez dated December 22, 2005. [Incorporated by reference to Exhibit 10.1 of the
Companys Report on Form 8-K filed on December 27, 2005 (File No. 000-207500).]                                                     



47



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|            |     |  |                                                                                                                                               |  |                    
|----------- | --- |  | --------------------------------------------------------------------------------------------------------------------------------------------- |  | -------------------
|Exhibit No. |     |  |                                                                                                                                               |  |                    
|            |    
|10.14       | *** |  | Form of Severance and Non-Competition Agreements between Sterling Bancshares, Inc., Sterling Bank and the following named executive officers:
|            |     | 
|            |     |  | Daryl D. Bohls                                                                                                                                |  | Travis Jaggers     
|            |     |  | Danny L. Buck                                                                                                                                 |  | Graham B. Painter  
|            |     |  | Wanda S. Dalton                                                                                                                               |  | Stephen C. Raffaele
|            |     |  | Clinton Dunn                                                                                                                                  |  | Mike Skowronek     
|            |     |  | James W. Goolsby, Jr.                                                                                                                         |  |                    
|            |    
|            |     |  | [Incorporated by reference to Exhibit 10.2 of the Companys Quarterly Report on Form 10-Q filed on August 5, 2004 (File No. 000-207501)].    

|      |     |  |                                                                                                                                                                                                                                                                                                 
|----- | --- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|      |    
|10.15 | *** |  | Form of Restricted Stock Agreement. [Incorporated by reference to Exhibit 10.1 of the Companys Current Report on Form 8-K filed on February 4, 2005 (File No.
000-207500).]                                                                                                                    
|      |    
|10.16 | *** |  | Form of Incentive Stock Agreement. [Incorporated by reference to Exhibit 10.2 of the Companys Current Report on Form 8-K filed on February 4, 2005 (File No.
000-207500).]                                                                                                                     
|      |    
|10.17 | *** |  | Severance and Non-Competition Agreement between Sterling Bancshares, Inc., Sterling Bank and Allen Brown executed and effective as of December 1, 2004. [Incorporated by reference to Exhibit
10.1 of the Companys Current Report on Form 8-K filed on December 7, 2004 (File No. 000-207500).]
|      |    
|10.18 | *** |  | Short Term Incentive Program for Shared Services. [Incorporated by reference to Exhibit 10.14 of the Companys Annual Report on Form 10-K for the year ended December 31,
2004.]                                                                                                                
|      |    
|10.19 | *** |  | Short Term Incentive Program for Bank Offices. [Incorporated by reference to Exhibit 10.15 of the Companys Annual Report on Form 10-K for the year ended December 31,
2004.]                                                                                                                   
|      |    
|10.20 | *** |  | Severance and Non-Competition Agreement dated effective May 2, 2005, by and among Sterling Bancshares, Inc., Sterling Bank and Sonny B. Lyles. [Incorporated by reference to Exhibit 10.1 of
the Companys Current Report on Form 8-K filed on May 5, 2005 (File No. 000-207500).]              
|      |    
|10.21 | *** |  | Severance and Non-Competition Agreement dated effective January 1, 2005, by and among Sterling Bancshares, Inc., Sterling Bank and Robert S. Smith. [Incorporated by reference to Exhibit 10.1
of the Companys Current Report on Form 8-K filed on January 13, 2005 (File No. 000-207500).]    
|      |    
|10.22 | *** |  | Non-Compete Agreement between Sterling Bancshares, Inc. and Max W. Wells dated July 7, 2005. [Incorporated by reference to Exhibit 10.2 of the Companys Quarterly Report on Form 10-Q
filed on November 8, 2005 (File No. 000-207500).]                                                        
|      |    
|10.23 | *** |  | Severance and Non-Competition Agreement between Sterling Bancshares, Inc. and John A. Rossitto dated January 23, 2006. [Incorporated by reference to Exhibit 10.1 of the Companys Current
Report on Form 8-K filed on January 26, 2006 (File No. 000-207500).]                                 
|      |    
|10.24 | *** |  | Summary Description of Non-Employee Director compensation. [Incorporated by reference to Exhibit 10.2 of the Companys Current Report on Form 8-K filed on April 29, 2005 (File No.
000-207500).]                                                                                               
|      |    
|10.25 | *** |  | Summary of Named Executive Officer Compensation. [Incorporated by reference to Exhibit 10.1 of the Companys Current Report on Form 8-K filed on April 29, 2005 (File No.
000-207500).]                                                                                                         



48



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##### Index to Financial Statements

|            |  |                                                                                                                                                                                                                                                                   
|----------- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit No. |  |                                                                                                                                                                                                                                                                   
|            | 
|10.26***    |  | Summary Description of Compensation - Sonny B. Lyles. [Incorporated by reference to Exhibit 10.1 of the Companys Current Report on Form 8-K filed on May 2, 2005 (File No.
000-207500).]                                                                         
|10.27       |  | Purchase and Sale Agreement, dated November 13, 2006, between Sterling Bank and First States Group, L.P. [Incorporated by reference to Exhibit 10.1 of the Companys Current Report on
Form 8-K filed on November 17, 2006.]                                      
|            | 
|10.28***    |  | 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.]                                         
|            | 
|10.29***    |  | 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].                                         
|            | 
|10.30***    |  | 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].                                              
|            | 
|10.31***    |  | 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].                                              
|            | 
|10.32***    |  | 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.].                                             
|            | 
|10.33***    |  | 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].                                                                                                                
|            | 
|10.34***    |  | Severance and Non-Competition Agreement between Sterling Bancshares, Inc., a Texas corporation, and Deborah Dinsmore, dated February 24, 2006. [Incorporated by reference to Exhibit 10.1 of
the Companys Current Report on Form 8-K filed on February 28, 2006].
|            | 
|10.35***    |  | Severance and Non-Competition Agreement between Sterling Bancshares, Inc., a Texas corporation, and C. Wallis McMath, Jr., dated March 1, 2006. [Incorporated by reference to Exhibit 10.1 of
the Companys Current Report on Form 8-K filed on March 6, 2006].   
|            | 
|10.36***    |  | Severance and Non-Competition Agreement between Sterling Bancshares, Inc., a Texas corporation, and Zach L. Wasson dated December 4, 2006. [Incorporated by reference to Exhibit 10.1 of
the Companys Current Report on Form 8-K filed on December 6, 2006].     
|            | 
|21.1*       |  | Subsidiaries of the Company.                                                                                                                                                                                                                                      
|            | 
|23.1*       |  | Consent of Deloitte & Touche LLP, Independent Registered Public Accounting Firm.                                                                                                                                                                                  
|            | 
|31.1*       |  | Certification of J. Downey Bridgwater, Chairman, President and Chief Executive Officer, as required pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.                                                                                                    
|            | 
|31.2*       |  | Certification of Zach L. Wasson, Executive Vice President and Chief Financial Officer, as required pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.                                                                                                     
|            | 
|32.1**      |  | Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.                                                                                                                                           
|            | 
|32.2**      |  | Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.                                                                                                                                           

---

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

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

|*** | Management Compensation Agreement
|--- | ---------------------------------



49



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##### Index to Financial Statements

SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant
has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.



|                        |  |  |  |                           |  |                             |  |                                                                      
|----------------------- |  |  |  | ------------------------- |  | --------------------------- |  | ---------------------------------------------------------------------
|                        |  |  |  | STERLING BANCSHARES, INC.
|                        |  |  | 
|DATE: February 28, 2007 |  |  |  | by                        |  | /S/    J. DOWNEY
BRIDGWATER
|                        |  |  |  |                           |  |                             |  | J. Downey Bridgwater, Chairman, President and Chief Executive Officer

Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the
following persons on behalf of the registrant in the capacity indicated on this the 27th day of February, 2007.



|                                                             |  |                                                                                                   |  |                                              |  |         
|------------------------------------------------------------ |  | ------------------------------------------------------------------------------------------------- |  | -------------------------------------------- |  | --------
|SIGNATURE                                                    |  | TITLE                                                                                             |  | SIGNATURE                                    |  | TITLE   
|                                                             |  |                                                                                                   | 
|/s/    J. DOWNEY
BRIDGWATER J. Downey Bridgwater             |  | Chairman, President, and Chief Executive Officer (Principal Executive Officer)                    |  | /s/    GLENN H.
JOHNSON Glenn H. Johnson     |  | Director
|                                                             |  |                                                                                                   | 
|/s/    ZACH L.
WASSON Zach L. Wasson                         |  | Executive Vice President and Chief Financial Officer (Principal Financial and Accounting Officer) |  | /s/    R. Bruce
LaBoon R. Bruce LaBoon       |  | Director
|                                                             |  |                                                                                                   | 
|/s/    DAVID L.
HATCHER David L. Hatcher                     |  | Lead Director                                                                                     |  | /s/    G. EDWARD
POWELL G. Edward Powell     |  | Director
|                                                             |  |                                                                                                   | 
|/s/    EDWARD R.
BARDGETT Edward R. Bardgett                 |  | Director                                                                                          |  | /s/    RAIMUNDO E.
RIOJAS Raimundo E. Riojas |  | Director
|                                                             |  |                                                                                                   | 
|/s/    GEORGE BEATTY,
JR George Beatty, Jr                   |  | Director                                                                                          |  | /s/    ROLAND
RODRIGUEZ Roland Rodriguez     |  | Director
|                                                             |  |                                                                                                   | 
|/s/    ANAT
BIRD Anat Bird                                   |  | Director                                                                                          |  | /s/    DAN C.
TUTCHER Dan C. Tutcher         |  | Director
|                                                             |  |                                                                                                   | 
|/s/    JAMES D.
CALAWAY James D. Calaway                     |  | Director                                                                                          |  | /s/    MAX W.
WELLs Max W. Wells             |  | Director
|                                                             |  |                                                                                                   | 
|/s/    BRUCE J.
HARPER Bruce J. Harper                       |  | Director                                                                                          |  |                                              |  |         
|                                                             |  |                                                                                                   | 
|/s/    BERNARD A. HARRIS,
JR., MD Bernard A. Harris, Jr., MD |  | Director                                                                                          |  |                                              |  |         



50



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##### Table of Contents

##### Index to Financial Statements

EXHIBIT TABLE



|            |  |                                                                                                                                                                                                                                                                                                                                          
|----------- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit No. |  |                                                                                                                                                                                                                                                                                                                                          
|2.1         |  | Agreement and Plan of Merger dated as of October 23, 2000 among the Company, Sterling Bancorporation, Inc. and CaminoReal Bancshares of Texas, Inc., as amended. [Incorporated by reference to
Exhibit 2.5 of the Companys Annual Report on Form 10-K (File No. 000-20750).]                                                            
|            | 
|2.2         |  | Agreement and Plan of Merger dated as of March 1, 2001, by and between Sterling Bancshares, Inc. and Lone Star Bancorporation, Inc., as amended. [Incorporated by reference to Exhibit 2 of the
Companys Quarterly Report on Form 10-Q filed on May 14, 2001 (File No. 000-20750).]                                                     
|            | 
|2.3         |  | Agreement and Plan of Merger dated as of October 1, 2001 by and among Sterling Bancshares, Inc., Sterling Bancorporation, Inc. and Community Bancshares, Inc., as amended. [Incorporated by
reference to Exhibit 2.7 of the Companys Annual Report on Form 10-K (File No. 000-20750).]                                                  
|            | 
|2.4         |  | Agreement and Plan of Merger Among Sterling Bancshares, Inc., Sterling Bancorporation, Inc. and ENB Bankshares Inc. dated as of May 22, 2002. [Incorporated by reference to Exhibit 2.1 of the
Companys Quarterly Report on Form 10-Q filed on August 14, 2002 (File No. 000-20750).]                                                   
|            | 
|2.5         |  | Purchase and Assumption Agreement dated July 12, 2002 between Sterling Bank Inc. and James Wilson as amended by First Amendment to Purchase and Assumption Agreement dated as of August 2,
2002. [Incorporated by reference to Exhibit 2.2 of the Companys Quarterly Report on Form 10-Q filed on August 13, 2002 (File No. 000-20750).]
|            | 
|2.6         |  | Purchase and Assumption Agreement dated as of October 29, 2002 between Sterling Bank Inc. and South Texas National Bank of Laredo. [Incorporated by reference to Exhibit 2.9 of the
Companys Annual Report on Form 10-K (File No. 000-20750).]                                                                                          
|            | 
|2.7         |  | Stock Purchase Agreement dated as of July 16, 2003 by and among Sterling Bancshares, Inc., Sterling Bank, CMCR Holding Company and RBC Mortgage Company. [Incorporated by reference to Exhibit
2.1 to the Companys Current Form 8-K filed on October 15, 2003 (File No. 000-20750).]                                                    
|            | 
|2.8         |  | Amendment No. 1 to Stock Purchase Agreement dated as of September 30, 2003 by and among Sterling Bancshares, Inc., Sterling Bank, CMCR Holding Company and RBC Mortgage Company. [Incorporated
by reference to Exhibit 2.2 to the Companys Current Form 8-K filed on October 15, 2003 (File No. 000-20750).]                            
|            | 
|2.9         |  | Agreement and Plan of Merger dated August 18, 2003 by and among Sterling Bancshares, Inc., SB 2003, Inc. and South Texas Capital Group, Inc. [Incorporated by reference to Exhibit 10.3 of the
Companys Quarterly Report on Form 10-Q filed on November 14, 2003 (File No. 000-20750).]                                                 
|            | 
|2.10        |  | Agreement and Plan of Merger Dated July 7, 2005 by and among Sterling Bancshares, Inc., SBPB, Inc., and Prestonwood Bancshares, Inc. [Incorporated by reference to Exhibit 10.1 of the
Companys Quarterly Report on Form 10-Q filed on November 8, 2005 (File No. 000-20750).]                                                          
|            | 
|2.11        |  | Agreement and Plan of Merger dated July 25, 2006 between 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.]                                                                                                                         
|            | 
|2.12        |  | Agreement and Plan of Merger dated January 24, 2007 between Sterling Bancshares, Inc., Sterling Bank and Partners Bank of Texas. [Incorporated by reference to Exhibit 2.1 of the
Companys Current Report on Form 8-K filed on January 25, 2007.]                                                                                       
|            | 
|3.1         |  | Restated and Amended Articles of Incorporation of the Company, as amended. [Incorporated by reference to Exhibit 3.1 to the Registration Statement on Form S-3 (File Nos. 333-55724,
333-55724-01, and 333-55724-02).]                                                                                                                   



51



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##### Index to Financial Statements

|            |  |                                                                                                                                                                                                                                                          
|----------- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit No. |  |                                                                                                                                                                                                                                                          
|3.2         |  | Articles of Amendment to the Restated and Amended Articles of Incorporation of Sterling Bancshares, Inc. [Incorporated by reference to Exhibit 3.2 of the Companys Quarterly Report on
Form 10-Q filed on August 13, 2002 (File No. 000-20750).]        
|            | 
|3.3         |  | Amended and Restated Bylaws of Sterling Bancshares, Inc. [Incorporated by reference to Exhibit 3.1 of the Companys Current Report on Form 8-K filed on October 26, 2004 (File No.
000-20750).]                                                          
|            | 
|3.4         |  | Amendment to Bylaws of Sterling Bancshares, Inc. [Incorporated by reference to Exhibit 3.1 of the Companys Current Report on Form 8-K filed on November 17, 2005 (File No.
000-20750).]                                                                 
|            | 
|4.1         |  | Preferred Securities Guarantee Agreement dated March 21, 2001. [Incorporated by reference to Exhibit 4.2 of the Companys Current Report on Form 8-K filed on March 21, 2001 (File No.
000-20750).]                                                      
|            | 
|4.2         |  | Indenture dated March 21, 2001. [Incorporated by reference to Exhibit 4.4 of the Companys Current Report on Form 8-K filed on March 21, 2001 (File No. 000-20750).]                                                                                     
|            | 
|4.3         |  | First Supplemental Indenture dated March 21, 2001. [Incorporated by reference to Exhibit 4.5 of the Companys Current Report on Form 8-K filed on March 21, 2001 (File No.
000-20750).]                                                                  
|            | 
|4.4         |  | 9.20% Subordinated Deferrable Interest Debenture due March 21, 2031. [Incorporated by reference to Exhibit 4.7 of the Companys Current Report on Form 8-K filed on March 21, 2001 (File
No. 000-20750).]                                                
|            | 
|4.5         |  | Indenture dated August 30, 2002. [Incorporated by reference to Exhibit 4.4 of the Companys Current Report on Form 8-K filed on September 12, 2002 (File No. 000-20750).]                                                                                
|            | 
|4.6         |  | Junior Subordinated Deferrable Interest Debenture due August 30, 2032. [Incorporated by reference to Exhibit 4.6 of the Companys Current Report on Form 8-K filed on September 12, 2002
(File No. 000-20750).]                                          
|            | 
|4.7         |  | Guarantee Agreement dated August 30, 2002. [Incorporated by reference to Exhibit 4.6 of the Companys Current Report on Form 8-K filed on September 12, 2002 (File No.
000-20750).]                                                                      
|            | 
|4.8         |  | Preferred Securities Guarantee Agreement dated September 26, 2002. [Incorporated by reference to Exhibit 4.2 of the Companys Current Report on Form 8-K dated September 26, 2002 (File
No. 000-20750).]                                                 
|            | 
|4.9         |  | Second Supplemental Indenture dated September 26, 2002. [Incorporated by reference to Exhibit 4.9 of the Companys Current Report on Form 8-K dated September 26, 2002 (File
No. 000-20750).]                                                            
|            | 
|4.10        |  | 8.30% Junior Subordinated Deferrable Interest Debenture due September 26, 2032. [Incorporated by reference to Exhibit 4.8 of the Companys Current Report on Form 8-K dated September 26,
2002 (File No. 000-20750).]                                    
|            | 
|4.11        |  | Fiscal and Paying Agency Agreement dated April 10, 2003 between Sterling Bank and Deutsche Bank Trust Company Americas. [Incorporated by reference to Exhibit 4.1 of the Companys Current
Report on Form 8-K filed April 15, 2003 (File No. 000-20750).]
|            | 
|4.12        |  | Form of Global Certificate representing Sterling Banks 7.375% Subordinated Notes due 2013. [Incorporated by reference to Exhibit 4.2 of the Companys Current Report on Form 8-K
filed April 15, 2003 (File No. 000-20750).]                            
|            | 
|10.1***     |  | 1994 Incentive Stock Option Plan of the Company. [Incorporated by reference to Exhibit 10.1 of the Companys Annual Report on Form 10-K for the year ended December 31,
1994.]                                                                           
|            | 
|10.2        |  | 1994 Employee Stock Purchase Plan of the Company. [Incorporated by reference to Exhibit 10.2 of the Companys Annual Report on Form 10-K for the year ended December 31,
1994.]                                                                          



52



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##### Index to Financial Statements

|            |  |                                                                                                                                                                                                                                                                                                                       
|----------- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit No. |  |                                                                                                                                                                                                                                                                                                                       
|            | 
|10.3***     |  | 1984 Incentive Stock Option Plan of the Company. [Incorporated by reference to Exhibit 10.1 of the Companys Registration Statement on Form S-1, effective October 22, 1992 (Registration
No. 33-51476).]                                                                                                             
|            | 
|10.4***     |  | 1995 Non-Employee Director Stock Compensation Plan. [Incorporated by reference to Exhibit 4.3 of the Companys Registration Statement on Form S-8 (File No. 333-16719).]                                                                                                                                              
|            | 
|10.5        |  | Credit Agreement dated October 1, 2004 made by and between Sterling Bancshares, Inc. and Wells Fargo Bank, National Association regarding a line of credit in the amount of $20,000,000.
[Incorporated by reference to Exhibit 10.5 of the Companys Annual Report on Form 10-K for the year ended December 31, 2005.]
|            | 
|10.6        |  | First Amendment to Credit Agreement dated as of March 8, 2005 by and between Sterling Bancshares, Inc. and Wells Fargo Bank, National Association. [Incorporated by reference to Exhibit 10.6
of the Companys Annual Report on Form 10-K for the year ended December 31, 2005.]                                      
|            | 
|10.7        |  | Second Amendment to Credit Agreement between Sterling Bancshares, Inc. and Wells Fargo Bank, National Association, dated September 29, 2005 [Incorporated by reference to Exhibit 10.1 of the
Companys Report on Form 8-K filed on October 5, 2005 (File No. 000-207500).]                                           
|            | 
|10.8***     |  | Employment Agreement between Sterling Bancshares, Inc. and J. Downey Bridgwater executed on October 31, 2001 and effective as of January 1, 2002. [Incorporated by reference to
Exhibit 99.3 of the Companys Report on Form 8-K filed on October 14, 2001 (File No. 000-207500).]                                    
|            | 
|10.9***     |  | Amendment to Employment Agreement between Sterling Bancshares, Inc. and J. Downey Bridgwater dated November 17, 2005. [Incorporated by reference to Exhibit 10.1 of the Companys Report
on Form 8-K filed on November 17, 2005 (File No. 000-207500).]                                                               
|            | 
|10.10***    |  | Employment Agreement between Sterling Bancshares, Inc. and J. Downey Bridgwater dated November 17, 2005. [Incorporated by reference to Exhibit 10.2 of the Companys Report on
Form 8-K filed on November 17, 2005 (File No. 000-207500).]                                                                            
|            | 
|10.11***    |  | Sterling Bancshares, Inc. 2003 Stock Incentive and Compensation Plan. [Incorporated by reference to Exhibit 4.4 of the Companys Registration Statement on Form S-8 (File No.
333-105307).]                                                                                                                           
|            | 
|10.12***    |  | Consulting Agreement between Sterling Bancshares, Inc. and George Martinez executed on June 9, 2004 and effective as of June 1, 2004. [Incorporated by reference to Exhibit 10.1 of the
Companys Quarterly Report on Form 10-Q filed on August 5, 2004 (File No. 000-207501)].                                       
|            | 
|10.13***    |  | Amendment to Employment and Consulting Agreement between Sterling Bancshares, Inc. and George Martinez dated December 22, 2005. [Incorporated by reference to Exhibit 10.1 of the
Companys Report on Form 8-K filed on December 27, 2005 (File No. 000-207500).]                                                     

|         |  |                                                                                                                                               |  |                    
|-------- |  | --------------------------------------------------------------------------------------------------------------------------------------------- |  | -------------------
|         | 
|10.14*** |  | Form of Severance and Non-Competition Agreements between Sterling Bancshares, Inc., Sterling Bank and the following named executive officers:
|         |  |                                                                                                                                              
|         |  | Daryl D. Bohls                                                                                                                                |  | Travis Jaggers     
|         |  | Danny L. Buck                                                                                                                                 |  | Graham B. Painter  
|         |  | Wanda S. Dalton                                                                                                                               |  | Stephen C. Raffaele
|         |  | Clinton Dunn                                                                                                                                  |  | Mike Skowronek     
|         |  | James W. Goolsby, Jr.                                                                                                                         |  |                    
|         | 
|         |  | [Incorporated by reference to Exhibit 10.2 of the Companys Quarterly Report on Form 10-Q filed on August 5, 2004 (File No. 000-207501)].    

|      |     |  |                                                                                                                                                                             
|----- | --- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|      |    
|10.15 | *** |  | Form of Restricted Stock Agreement. [Incorporated by reference to Exhibit 10.1 of the Companys Current Report on Form 8-K filed on February 4, 2005 (File No.
000-207500).]



53



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##### Index to Financial Statements

|            |     |  |                                                                                                                                                                                                                                                                                                 
|----------- | --- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit No. |     |  |                                                                                                                                                                                                                                                                                                 
|10.16       | *** |  | Form of Incentive Stock Agreement. [Incorporated by reference to Exhibit 10.2 of the Companys Current Report on Form 8-K filed on February 4, 2005 (File No.
000-207500).]                                                                                                                     
|            |    
|10.17       | *** |  | Severance and Non-Competition Agreement between Sterling Bancshares, Inc., Sterling Bank and Allen Brown executed and effective as of December 1, 2004. [Incorporated by reference to
Exhibit 10.1 of the Companys Current Report on Form 8-K filed on December 7, 2004 (File No. 000-207500).]
|            |    
|10.18       | *** |  | Short Term Incentive Program for Shared Services. [Incorporated by reference to Exhibit 10.14 of the Companys Annual Report on Form 10-K for the year ended December 31,
2004.]                                                                                                                
|            |    
|10.19       | *** |  | Short Term Incentive Program for Bank Offices. [Incorporated by reference to Exhibit 10.15 of the Companys Annual Report on Form 10-K for the year ended December 31,
2004.]                                                                                                                   
|            |    
|10.20       | *** |  | Severance and Non-Competition Agreement dated effective May 2, 2005, by and among Sterling Bancshares, Inc., Sterling Bank and Sonny B. Lyles. [Incorporated by reference to Exhibit 10.1 of
the Companys Current Report on Form 8-K filed on May 5, 2005 (File No. 000-207500).]              
|            |    
|10.21       | *** |  | Severance and Non-Competition Agreement dated effective January 1, 2005, by and among Sterling Bancshares, Inc., Sterling Bank and Robert S. Smith. [Incorporated by reference to
Exhibit 10.1 of the Companys Current Report on Form 8-K filed on January 13, 2005 (File No. 000-207500).]    
|            |    
|10.22       | *** |  | Non-Compete Agreement between Sterling Bancshares, Inc. and Max W. Wells dated July 7, 2005. [Incorporated by reference to Exhibit 10.2 of the Companys Quarterly Report on
Form 10-Q filed on November 8, 2005 (File No. 000-207500).]                                                        
|            |    
|10.23       | *** |  | Severance and Non-Competition Agreement between Sterling Bancshares, Inc. and John A. Rossitto dated January 23, 2006. [Incorporated by reference to Exhibit 10.1 of the Companys Current
Report on Form 8-K filed on January 26, 2006 (File No. 000-207500).]                                 
|            |    
|10.24       | *** |  | Summary Description of Non-Employee Director compensation. [Incorporated by reference to Exhibit 10.2 of the Companys Current Report on Form 8-K filed on April 29, 2005 (File
No. 000-207500).]                                                                                               
|            |    
|10.25       | *** |  | Summary of Named Executive Officer Compensation. [Incorporated by reference to Exhibit 10.1 of the Companys Current Report on Form 8-K filed on April 29, 2005 (File No.
000-207500).]                                                                                                         
|            |    
|10.26       | *** |  | Summary Description of Compensation - Sonny B. Lyles. [Incorporated by reference to Exhibit 10.1 of the Companys Current Report on Form 8-K filed on May 2, 2005 (File No.
000-207500).]                                                                                                       
|            |    
|10.27       |     |  | Purchase and Sale Agreement, dated November 13, 2006, between Sterling Bank and First States Group, L.P. [Incorporated by reference to Exhibit 10.1 of the Companys Current Report on
Form 8-K filed on November 17, 2006.]                                                                    
|            |    
|10.28       | *** |  | 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.]                                                                       
|            |    
|10.29       | *** |  | 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].                                                                       
|            |    
|10.30       | *** |  | 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].                                                                            
|            |    
|10.31       | *** |  | 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].                                                                            



54



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##### Index to Financial Statements

|            |  |                                                                                                                                                                                                                                                                   
|----------- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit No. |  |                                                                                                                                                                                                                                                                   
|            | 
|10.32***    |  | 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.].                                             
|            | 
|10.33***    |  | 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].                                                                                                                
|            | 
|10.34***    |  | Severance and Non-Competition Agreement between Sterling Bancshares, Inc., a Texas corporation, and Deborah Dinsmore, dated February 24, 2006. [Incorporated by reference to Exhibit 10.1 of
the Companys Current Report on Form 8-K filed on February 28, 2006].
|            | 
|10.35***    |  | Severance and Non-Competition Agreement between Sterling Bancshares, Inc., a Texas corporation, and C. Wallis McMath, Jr., dated March 1, 2006. [Incorporated by reference to Exhibit 10.1 of
the Companys Current Report on Form 8-K filed on March 6, 2006].   
|            | 
|10.36***    |  | Severance and Non-Competition Agreement between Sterling Bancshares, Inc., a Texas corporation, and Zach L. Wasson dated December 4, 2006. [Incorporated by reference to Exhibit 10.1
of the Companys Current Report on Form 8-K filed on December 6, 2006].     
|            | 
|21.1*       |  | Subsidiaries of the Company.                                                                                                                                                                                                                                      
|            | 
|23.1*       |  | Consent of Deloitte & Touche LLP, Independent Registered Public Accounting Firm.                                                                                                                                                                                  
|            | 
|31.1*       |  | Certification of J. Downey Bridgwater, Chairman, President and Chief Executive Officer, as required pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.                                                                                                    
|            | 
|31.2*       |  | Certification of Zach L. Wasson, Executive Vice President and Chief Financial Officer, as required pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.                                                                                                     
|            | 
|32.1**      |  | Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.                                                                                                                                           
|            | 
|32.2**      |  | Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.                                                                                                                                           

---

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

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

|*** | Management Compensation Agreement
|--- | ---------------------------------







55



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##### Table of Contents

##### Index to Financial Statements

STERLING BANCSHARES, INC.

TABLE OF CONTENTS



|                                                        |  |     
|------------------------------------------------------- |  | ----
|                                                        |  | Page
|                                                        | 
|REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM |  | F-2 
|                                                        | 
|CONSOLIDATED FINANCIAL STATEMENTS:                      |  |     
|                                                        | 
|Consolidated Balance Sheets                             |  | F-3 
|                                                        | 
|Consolidated Statements of Income                       |  | F-4 
|                                                        | 
|Consolidated Statements of Shareholders Equity         |  | F-5 
|                                                        | 
|Consolidated Statements of Cash Flows                   |  | F-6 
|                                                        | 
|Notes to Consolidated Financial Statements              |  | F-7 



F-1



---

##### Table of Contents

##### Index to Financial Statements

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and
Shareholders of

Sterling Bancshares, Inc.

Houston, Texas

We have audited the
accompanying consolidated balance sheets of Sterling Bancshares Inc. and subsidiaries (the Company) as of December 31, 2006 and 2005, and the related statements of income, shareholders equity, and cash flows for each of the
three years in the period ended December 31, 2006. These financial statements are the responsibility of the Companys management. Our responsibility is to express an opinion on these financial statements based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An
audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, such financial statements present fairly, in all material respects, the financial position of Sterling Bancshares, Inc. and subsidiaries
as of December 31, 2006 and 2005, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2006, in conformity with accounting principles generally accepted in the United States of
America.

We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of the
Companys internal control over financial reporting as of December 31, 2006, based on the criteria established in Internal ControlIntegrated Framework issued by the Committee of Sponsoring Organizations of the Treadway
Commission and our report dated February 26, 2007, expressed an unqualified opinion on managements assessment of the effectiveness of the Companys internal control over financial reporting and an unqualified opinion on the
effectiveness of the Companys internal control over financial reporting.

LOGO

Houston, Texas

February 26, 2007



F-2



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##### Table of Contents

##### Index to Financial Statements

STERLING BANCSHARES, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

DECEMBER 31, 2006 AND 2005

(In thousands, except share amounts)



|                                                                                                                                                                                  |  |      |           |   |      |   |           |  
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ---- | --------- | - | ---- | - | --------- | -
|                                                                                                                                                                                  |  | 2006 |           |   | 2005 |  
|ASSETS                                                                                                                                                                            |  |      |           |   |      |   |           |  
|Cash and cash equivalents                                                                                                                                                         |  | $    | 134,775   |   |      | $ | 147,154   |  
|Interest-bearing deposits in financial institutions                                                                                                                               |  |      | 198       |   |      |   | 99        |  
|Trading assets                                                                                                                                                                    |  |      |          |   |      |   | 28,515    |  
|Available-for-sale securities, at fair value                                                                                                                                      |  |      | 409,351   |   |      |   | 495,945   |  
|Held-to-maturity securities, at amortized cost                                                                                                                                    |  |      | 164,263   |   |      |   | 123,053   |  
|Loans held for sale                                                                                                                                                               |  |      | 54,722    |   |      |   | 8,354     |  
|Loans held for investment                                                                                                                                                         |  |      | 3,077,845 |   |      |   | 2,691,008 |  
|                                                                                                                                                                                  |  |      |           |   |      |   |           |  
|Total loans                                                                                                                                                                       |  |      | 3,132,567 |   |      |   | 2,699,362 |  
|Allowance for loan losses                                                                                                                                                         |  |      | (32,027   | ) |      |   | (31,230   | )
|                                                                                                                                                                                  |  |      |           |   |      |   |           |  
|Loans, net                                                                                                                                                                        |  |      | 3,100,540 |   |      |   | 2,668,132 |  
|Premises and equipment, net                                                                                                                                                       |  |      | 23,475    |   |      |   | 41,407    |  
|Real estate acquired by foreclosure                                                                                                                                               |  |      | 1,465     |   |      |   | 460       |  
|Goodwill                                                                                                                                                                          |  |      | 130,858   |   |      |   | 85,026    |  
|Core deposit intangibles, net                                                                                                                                                     |  |      | 10,299    |   |      |   | 3,551     |  
|Accrued interest receivable                                                                                                                                                       |  |      | 18,692    |   |      |   | 15,358    |  
|Other assets                                                                                                                                                                      |  |      | 123,643   |   |      |   | 118,159   |  
|                                                                                                                                                                                  |  |      |           |   |      |   |           |  
|TOTAL ASSETS                                                                                                                                                                      |  | $    | 4,117,559 |   |      | $ | 3,726,859 |  
|                                                                                                                                                                                  |  |      |           |   |      |   |           |  
|LIABILITIES AND SHAREHOLDERS' EQUITY                                                                                                                                              |  |      |           |   |      |   |           |  
|LIABILITIES:                                                                                                                                                                      |  |      |           |   |      |   |           |  
|Deposits:                                                                                                                                                                         |  |      |           |   |      |   |           |  
|Noninterest-bearing demand                                                                                                                                                        |  | $    | 1,058,135 |   |      | $ | 1,045,937 |  
|Interest-bearing demand                                                                                                                                                           |  |      | 1,229,313 |   |      |   | 1,017,832 |  
|Certificates and other time deposits                                                                                                                                              |  |      | 1,047,163 |   |      |   | 774,374   |  
|                                                                                                                                                                                  |  |      |           |   |      |   |           |  
|Total deposits                                                                                                                                                                    |  |      | 3,334,611 |   |      |   | 2,838,143 |  
|Short-term borrowings                                                                                                                                                             |  |      | 220,675   |   |      |   | 392,850   |  
|Subordinated debt                                                                                                                                                                 |  |      | 46,135    |   |      |   | 46,238    |  
|Junior subordinated debt                                                                                                                                                          |  |      | 56,959    |   |      |   | 82,475    |  
|Accrued interest payable and other liabilities                                                                                                                                    |  |      | 49,894    |   |      |   | 32,681    |  
|                                                                                                                                                                                  |  |      |           |   |      |   |           |  
|Total liabilities                                                                                                                                                                 |  |      | 3,708,274 |   |      |   | 3,392,387 |  
|                                                                                                                                                                                  |  |     
|COMMITMENTS AND CONTINGENCIES                                                                                                                                                     |  |      |          |   |      |   |          |  
|                                                                                                                                                                                  |  |     
|SHAREHOLDERS' EQUITY:                                                                                                                                                             |  |      |           |   |      |   |           |  
|Convertible preferred stock, $1 par value, 1,000,000 shares authorized, no shares issued and outstanding at December 31, 2006 and
2005                                            |  |      |          |   |      |   |          |  
|Common stock, $1 par value, 100,000,000 shares authorized, 71,938,175 and 68,187,750 issued and 71,000,675 and 68,000,250 outstanding at
December 31, 2006 and 2005, respectively |  |      | 71,938    |   |      |   | 68,187    |  
|Capital surplus                                                                                                                                                                   |  |      | 80,927    |   |      |   | 36,028    |  
|Retained earnings                                                                                                                                                                 |  |      | 272,179   |   |      |   | 239,171   |  
|Treasury stock, at cost, 937,500 and 187,500 shares held at December 31, 2006 and 2005, respectively                                                                              |  |      | (10,902   | ) |      |   | (1,984    | )
|Accumulated other comprehensive loss, net of tax                                                                                                                                  |  |      | (4,857    | ) |      |   | (6,930    | )
|                                                                                                                                                                                  |  |      |           |   |      |   |           |  
|Total shareholders' equity                                                                                                                                                        |  |      | 409,285   |   |      |   | 334,472   |  
|                                                                                                                                                                                  |  |      |           |   |      |   |           |  
|TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY                                                                                                                                        |  | $    | 4,117,559 |   |      | $ | 3,726,859 |  
|                                                                                                                                                                                  |  |      |           |   |      |   |           |  

See notes to consolidated financial statements.



F-3



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##### Table of Contents

##### Index to Financial Statements

STERLING BANCSHARES, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF INCOME

FOR THE YEARS ENDED DECEMBER 31, 2006, 2005, AND 2004

(In thousands, except per share amounts)



|                                                      |  |      |         |   |      |   |         |  |   |         |  
|----------------------------------------------------- |  | ---- | ------- | - | ---- | - | ------- |  | - | ------- | -
|                                                      |  | 2006 |         |   | 2005 |   | 2004    | 
|Interest income:                                      |  |      |         |   |      |   |         |  |   |         |  
|Loans, including fees                                 |  | $    | 227,083 |   |      | $ | 175,521 |  | $ | 131,835 |  
|Securities:                                           |  |      |         |   |      |   |         |  |   |         |  
|Taxable                                               |  |      | 23,886  |   |      |   | 24,936  |  |   | 21,307  |  
|Non-taxable                                           |  |      | 2,622   |   |      |   | 2,442   |  |   | 2,042   |  
|Trading assets                                        |  |      | 696     |   |      |   | 1,318   |  |   | 4,569   |  
|Federal funds sold                                    |  |      | 261     |   |      |   | 293     |  |   | 101     |  
|Deposits in financial institutions                    |  |      | 183     |   |      |   | 93      |  |   | 55      |  
|                                                      |  |      |         |   |      |   |         |  |   |         |  
|Total interest income                                 |  |      | 254,731 |   |      |   | 204,603 |  |   | 159,909 |  
|                                                      |  |      |         |   |      |   |         |  |   |         |  
|Interest expense:                                     |  |      |         |   |      |   |         |  |   |         |  
|Demand and savings deposits                           |  |      | 17,934  |   |      |   | 8,525   |  |   | 4,785   |  
|Certificates and other time deposits                  |  |      | 37,671  |   |      |   | 20,148  |  |   | 12,694  |  
|Short-term borrowings                                 |  |      | 17,273  |   |      |   | 15,102  |  |   | 4,163   |  
|Subordinated debt                                     |  |      | 4,476   |   |      |   | 3,665   |  |   | 2,744   |  
|Junior subordinated debt                              |  |      | 5,571   |   |      |   | 6,933   |  |   | 6,551   |  
|                                                      |  |      |         |   |      |   |         |  |   |         |  
|Total interest expense                                |  |      | 82,925  |   |      |   | 54,373  |  |   | 30,937  |  
|                                                      |  |      |         |   |      |   |         |  |   |         |  
|Net interest income                                   |  |      | 171,806 |   |      |   | 150,230 |  |   | 128,972 |  
|Provision for credit losses                           |  |      | 4,058   |   |      |   | 14,371  |  |   | 12,250  |  
|                                                      |  |      |         |   |      |   |         |  |   |         |  
|Net interest income after provision for credit losses |  |      | 167,748 |   |      |   | 135,859 |  |   | 116,722 |  
|                                                      |  |      |         |   |      |   |         |  |   |         |  
|Noninterest income:                                   |  |      |         |   |      |   |         |  |   |         |  
|Customer service fees                                 |  |      | 12,498  |   |      |   | 11,615  |  |   | 14,934  |  
|Net gain (loss) on trading assets                     |  |      | (302    | ) |      |   | 147     |  |   | (474    | )
|Net gain (loss) on the sale of securities             |  |      | (358    | ) |      |   | 60      |  |   | 4,941   |  
|Net gain on the sale of loans                         |  |      | 1,326   |   |      |   | 1,455   |  |   | 980     |  
|Other                                                 |  |      | 18,053  |   |      |   | 13,682  |  |   | 10,644  |  
|                                                      |  |      |         |   |      |   |         |  |   |         |  
|Total noninterest income                              |  |      | 31,217  |   |      |   | 26,959  |  |   | 31,025  |  
|                                                      |  |      |         |   |      |   |         |  |   |         |  
|Noninterest expense:                                  |  |      |         |   |      |   |         |  |   |         |  
|Salaries and employee benefits                        |  |      | 76,046  |   |      |   | 61,229  |  |   | 62,209  |  
|Occupancy expense                                     |  |      | 16,075  |   |      |   | 15,556  |  |   | 15,326  |  
|Technology                                            |  |      | 6,882   |   |      |   | 5,524   |  |   | 6,127   |  
|Professional fees                                     |  |      | 6,147   |   |      |   | 6,527   |  |   | 6,999   |  
|Postage, delivery and supplies                        |  |      | 3,355   |   |      |   | 3,238   |  |   | 3,179   |  
|Marketing                                             |  |      | 2,412   |   |      |   | 2,306   |  |   | 1,457   |  
|Core deposit intangible amortization                  |  |      | 1,012   |   |      |   | 521     |  |   | 486     |  
|Acquisition costs                                     |  |      | 638     |   |      |   | 831     |  |   |        |  
|Other                                                 |  |      | 18,619  |   |      |   | 14,914  |  |   | 17,517  |  
|                                                      |  |      |         |   |      |   |         |  |   |         |  
|Total noninterest expense                             |  |      | 131,186 |   |      |   | 110,646 |  |   | 113,300 |  
|                                                      |  |      |         |   |      |   |         |  |   |         |  
|Income before income taxes                            |  |      | 67,779  |   |      |   | 52,172  |  |   | 34,447  |  
|Provision for income taxes                            |  |      | 21,939  |   |      |   | 15,950  |  |   | 9,484   |  
|                                                      |  |      |         |   |      |   |         |  |   |         |  
|Net Income                                            |  | $    | 45,840  |   |      | $ | 36,222  |  | $ | 24,963  |  
|                                                      |  |      |         |   |      |   |         |  |   |         |  
|Earnings per share:                                   |  |      |         |   |      |   |         |  |   |         |  
|Basic                                                 |  | $    | 0.67    |   |      | $ | 0.53    |  | $ | 0.37    |  
|                                                      |  |      |         |   |      |   |         |  |   |         |  
|Diluted                                               |  | $    | 0.66    |   |      | $ | 0.53    |  | $ | 0.37    |  
|                                                      |  |      |         |   |      |   |         |  |   |         |  

See notes to consolidated financial statements.



F-4



---

##### Table of Contents

##### Index to Financial Statements

STERLING BANCSHARES, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF SHAREHOLDERS EQUITY

FOR THE YEARS ENDED DECEMBER 31, 2006, 2005, AND 2004

(In thousands)



|                                                                                                           |  |                 |   |  |              |     |                |        |        |                  |   |        |                |   |        |                                   |  |        |         |        |  |     |  |   |         |   |  |   |        |   |  |   |         |  
|---------------------------------------------------------------------------------------------------------- |  | --------------- | - |  | ------------ | --- | -------------- | ------ | ------ | ---------------- | - | ------ | -------------- | - | ------ | --------------------------------- |  | ------ | ------- | ------ |  | --- |  | - | ------- | - |  | - | ------ | - |  | - | ------- | -
|                                                                                                           |  | Preferred Stock |   |  | Common Stock |     | CapitalSurplus |        |        | RetainedEarnings |   |        | Treasury Stock |   |        | AccumulatedOtherComprehensiveLoss |  |        | Total   |       
|                                                                                                           |  | Shares          |   |  | Amount       |     |                | Shares |        | Amount           |   |        |                |   |        |                                   |  | Shares |         | Amount |  |     |  |   |         |   | 
|BALANCE AT JANUARY 1, 2004                                                                                 |  | 20              |   |  | $            | 20  |                |        | 66,963 |                  | $ | 66,963 |                | $ | 26,632 |                                   |  | $      | 197,819 |        |  |    |  | $ |        |   |  | $ | 1,162  |   |  | $ | 292,596 |  
|Comprehensive income:                                                                                      |  |                 |   |  |              |     |                |        |        |                  |   |        |                |   |        |                                   |  |        |         |        |  |     |  |   |         |   |  |   |        |   |  |   |         |  
|Net income                                                                                                 |  |                 |   |  |              |     |                |        |        |                  |   |        |                |   |        |                                   |  |        | 24,963  |        |  |     |  |   |         |   |  |   |        |   |  |   | 24,963  |  
|Net change in unrealized gains and losses on available-for-sale securities, net of taxes of $874           |  |                 |   |  |              |     |                |        |        |                  |   |        |                |   |        |                                   |  |        |         |        |  |     |  |   |         |   |  |   | (1,623 | ) |  |   | (1,623  | )
|Less: Reclassification adjustment for losses included in net income, net of taxes of $123                  |  |                 |   |  |              |     |                |        |        |                  |   |        |                |   |        |                                   |  |        |         |        |  |     |  |   |         |   |  |   | 229    |   |  |   | 229     |  
|                                                                                                           |  |                 |   |  |              |     |                |        |        |                  |   |        |                |   |        |                                   |  |        |         |        |  |     |  |   |         |   |  |   |        |   |  |   |         |  
|Total comprehensive income                                                                                 |  |                 |   |  |              |     |                |        |        |                  |   |        |                |   |        |                                   |  |        |         |        |  |     |  |   |         |   |  |   |        |   |  |   | 23,569  |  
|                                                                                                           |  |                 |   |  |              |     |                |        |        |                  |   |        |                |   |        |                                   |  |        |         |        |  |     |  |   |         |   |  |   |        |   |  |   |         |  
|Issuance of common stock                                                                                   |  |                 |   |  |              |     |                |        | 609    |                  |   | 609    |                |   | 5,366  |                                   |  |        |         |        |  |     |  |   |         |   |  |   |        |   |  |   | 5,975   |  
|Conversion of preferred stock                                                                              |  | (20             | ) |  |              | (20 | )              |        | 30     |                  |   | 30     |                |   | (10    | )                                 |  |        |         |        |  |     |  |   |         |   |  |   |        |   |  |   |        |  
|Cash dividends paid                                                                                        |  |                 |   |  |              |     |                |        |        |                  |   |        |                |   |        |                                   |  |        | (8,968  | )      |  |     |  |   |         |   |  |   |        |   |  |   | (8,968  | )
|                                                                                                           |  |                 |   |  |              |     |                |        |        |                  |   |        |                |   |        |                                   |  |        |         |        |  |     |  |   |         |   |  |   |        |   |  |   |         |  
|BALANCE AT DECEMBER 31, 2004                                                                               |  |                |   |  |              |    |                |        | 67,602 |                  |   | 67,602 |                |   | 31,988 |                                   |  |        | 213,814 |        |  |    |  |   |        |   |  |   | (232   | ) |  |   | 313,172 |  
|Comprehensive income:                                                                                      |  |                 |   |  |              |     |                |        |        |                  |   |        |                |   |        |                                   |  |        |         |        |  |     |  |   |         |   |  |   |        |   |  |   |         |  
|Net income                                                                                                 |  |                 |   |  |              |     |                |        |        |                  |   |        |                |   |        |                                   |  |        | 36,222  |        |  |     |  |   |         |   |  |   |        |   |  |   | 36,222  |  
|Net change in unrealized gains and losses on available-for-sale securities, net of taxes of $3,628         |  |                 |   |  |              |     |                |        |        |                  |   |        |                |   |        |                                   |  |        |         |        |  |     |  |   |         |   |  |   | (6,659 | ) |  |   | (6,659  | )
|Less: Reclassification adjustment for gains included in net income, net of taxes of $21                    |  |                 |   |  |              |     |                |        |        |                  |   |        |                |   |        |                                   |  |        |         |        |  |     |  |   |         |   |  |   | (39    | ) |  |   | (39     | )
|                                                                                                           |  |                 |   |  |              |     |                |        |        |                  |   |        |                |   |        |                                   |  |        |         |        |  |     |  |   |         |   |  |   |        |   |  |   |         |  
|Total comprehensive income                                                                                 |  |                 |   |  |              |     |                |        |        |                  |   |        |                |   |        |                                   |  |        |         |        |  |     |  |   |         |   |  |   |        |   |  |   | 29,524  |  
|                                                                                                           |  |                 |   |  |              |     |                |        |        |                  |   |        |                |   |        |                                   |  |        |         |        |  |     |  |   |         |   |  |   |        |   |  |   |         |  
|Issuance of common stock                                                                                   |  |                 |   |  |              |     |                |        | 585    |                  |   | 585    |                |   | 4,040  |                                   |  |        |         |        |  |     |  |   |         |   |  |   |        |   |  |   | 4,625   |  
|Repurchase of common stock                                                                                 |  |                 |   |  |              |     |                |        |        |                  |   |        |                |   |        |                                   |  |        |         |        |  | 188 |  |   | (1,984  | ) |  |   |        |   |  |   | (1,984  | )
|Cash dividends paid                                                                                        |  |                 |   |  |              |     |                |        |        |                  |   |        |                |   |        |                                   |  |        | (10,865 | )      |  |     |  |   |         |   |  |   |        |   |  |   | (10,865 | )
|                                                                                                           |  |                 |   |  |              |     |                |        |        |                  |   |        |                |   |        |                                   |  |        |         |        |  |     |  |   |         |   |  |   |        |   |  |   |         |  
|BALANCE AT DECEMBER 31, 2005                                                                               |  |                |   |  |              |    |                |        | 68,187 |                  |   | 68,187 |                |   | 36,028 |                                   |  |        | 239,171 |        |  | 188 |  |   | (1,984  | ) |  |   | (6,930 | ) |  |   | 334,472 |  
|Comprehensive income:                                                                                      |  |                 |   |  |              |     |                |        |        |                  |   |        |                |   |        |                                   |  |        |         |        |  |     |  |   |         |   |  |   |        |   |  |   |         |  
|Net income                                                                                                 |  |                 |   |  |              |     |                |        |        |                  |   |        |                |   |        |                                   |  |        | 45,840  |        |  |     |  |   |         |   |  |   |        |   |  |   | 45,840  |  
|Net change in unrealized gains and losses on available-for-sale securities, net of taxes of $24            |  |                 |   |  |              |     |                |        |        |                  |   |        |                |   |        |                                   |  |        |         |        |  |     |  |   |         |   |  |   | 44     |   |  |   | 44      |  
|Net change in unrealized gains and losses on effective cash flow hedging derivatives, net of taxes of $967 |  |                 |   |  |              |     |                |        |        |                  |   |        |                |   |        |                                   |  |        |         |        |  |     |  |   |         |   |  |   | 1,796  |   |  |   | 1,796   |  
|Less: Reclassification adjustment for losses included in net income, net of taxes of $125                  |  |                 |   |  |              |     |                |        |        |                  |   |        |                |   |        |                                   |  |        |         |        |  |     |  |   |         |   |  |   | 233    |   |  |   | 233     |  
|                                                                                                           |  |                 |   |  |              |     |                |        |        |                  |   |        |                |   |        |                                   |  |        |         |        |  |     |  |   |         |   |  |   |        |   |  |   |         |  
|Total comprehensive income                                                                                 |  |                 |   |  |              |     |                |        |        |                  |   |        |                |   |        |                                   |  |        |         |        |  |     |  |   |         |   |  |   |        |   |  |   | 47,913  |  
|                                                                                                           |  |                 |   |  |              |     |                |        |        |                  |   |        |                |   |        |                                   |  |        |         |        |  |     |  |   |         |   |  |   |        |   |  |   |         |  
|Issuance of common stock                                                                                   |  |                 |   |  |              |     |                |        | 728    |                  |   | 728    |                |   | 6,951  |                                   |  |        |         |        |  |     |  |   |         |   |  |   |        |   |  |   | 7,679   |  
|Issuance of common stock in connection with the purchase of BOTH, Inc.                                     |  |                 |   |  |              |     |                |        | 3,023  |                  |   | 3,023  |                |   | 37,948 |                                   |  |        |         |        |  |     |  |   |         |   |  |   |        |   |  |   | 40,971  |  
|Repurchase of common stock                                                                                 |  |                 |   |  |              |     |                |        |        |                  |   |        |                |   |        |                                   |  |        |         |        |  | 750 |  |   | (8,918  | ) |  |   |        |   |  |   | (8,918  | )
|Cash dividends paid                                                                                        |  |                 |   |  |              |     |                |        |        |                  |   |        |                |   |        |                                   |  |        | (12,832 | )      |  |     |  |   |         |   |  |   |        |   |  |   | (12,832 | )
|                                                                                                           |  |                 |   |  |              |     |                |        |        |                  |   |        |                |   |        |                                   |  |        |         |        |  |     |  |   |         |   |  |   |        |   |  |   |         |  
|BALANCE AT DECEMBER 31, 2006                                                                               |  |                |   |  | $            |    |                |        | 71,938 |                  | $ | 71,938 |                | $ | 80,927 |                                   |  | $      | 272,179 |        |  | 938 |  | $ | (10,902 | ) |  | $ | (4,857 | ) |  | $ | 409,285 |  
|                                                                                                           |  |                 |   |  |              |     |                |        |        |                  |   |        |                |   |        |                                   |  |        |         |        |  |     |  |   |         |   |  |   |        |   |  |   |         |  

See notes to consolidated financial statements.



F-5



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##### Table of Contents

##### Index to Financial Statements

STERLING BANCSHARES, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

FOR THE YEARS ENDED DECEMBER 31, 2006, 2005, AND 2004

(In thousands)



|                                                                                  |  |      |          |   |      |   |          |      |  |   |          |  
|--------------------------------------------------------------------------------- |  | ---- | -------- | - | ---- | - | -------- | ---- |  | - | -------- | -
|                                                                                  |  | 2006 |          |   | 2005 |   |          | 2004 | 
|CASH FLOWS FROM OPERATING ACTIVITIES:                                             |  |      |          |   |      |   |          |      |  |   |          |  
|Net income                                                                        |  | $    | 45,840   |   |      | $ | 36,222   |      |  | $ | 24,963   |  
|Adjustments to reconcile net income to net cash provided by operating activities: |  |      |          |   |      |   |          |      |  |   |          |  
|Amortization and accretion of premiums and discounts on securities, net           |  |      | 2,447    |   |      |   | 3,117    |      |  |   | 6,069    |  
|Net loss (gain) on securities                                                     |  |      | 358      |   |      |   | (60      | )    |  |   | (4,941   | )
|Net loss (gain) on trading assets                                                 |  |      | 302      |   |      |   | (147     | )    |  |   | 474      |  
|Net gain on sale of loans                                                         |  |      | (1,326   | ) |      |   | (1,455   | )    |  |   | (980     | )
|Provision for credit losses                                                       |  |      | 4,058    |   |      |   | 14,371   |      |  |   | 12,250   |  
|Writedowns, less gains on sale, of real estate acquired by foreclosure            |  |      | (232     | ) |      |   | (10      | )    |  |   | (58      | )
|Depreciation and amortization                                                     |  |      | 8,530    |   |      |   | 7,760    |      |  |   | 9,206    |  
|Proceeds from principal paydowns of trading securities                            |  |      | 31,790   |   |      |   | 165,374  |      |  |   | 453,735  |  
|Purchases of trading assets                                                       |  |      | (3,811   | ) |      |   | (161,201 | )    |  |   | (341,948 | )
|Deferred income tax expense                                                       |  |      | 259      |   |      |   | (1,481   | )    |  |   | 1,151    |  
|Stock-based compensation expense (net of tax benefit recognized)                  |  |      | 1,589    |   |      |   |         |      |  |   |         |  
|Excess tax benefits from share-based payment arrangements                         |  |      | (620     | ) |      |   |         |      |  |   |         |  
|Net decrease (increase) in loans held for sale                                    |  |      | 1,621    |   |      |   | (321     | )    |  |   | 2,420    |  
|Net gain on sale of bank assets                                                   |  |      | (1,915   | ) |      |   | (259     | )    |  |   | (168     | )
|Write-downs of bank assets                                                        |  |      |         |   |      |   |         |      |  |   | 1,388    |  
|Net (increase) decrease in accrued interest receivable and other assets           |  |      | (8,759   | ) |      |   | 2,519    |      |  |   | (20,763  | )
|Net increase (decrease) in accrued interest payable and other liabilities         |  |      | 15,722   |   |      |   | 1,233    |      |  |   | (13,405  | )
|                                                                                  |  |      |          |   |      |   |          |      |  |   |          |  
|Net cash provided by operating activities                                         |  |      | 95,853   |   |      |   | 65,662   |      |  |   | 129,393  |  
|CASH FLOWS FROM INVESTING ACTIVITIES:                                             |  |      |          |   |      |   |          |      |  |   |          |  
|Proceeds from the maturities or calls and paydowns of held-to-maturity securities |  |      | 15,907   |   |      |   | 22,753   |      |  |   | 9,587    |  
|Proceeds from the sale of available-for-sale securities                           |  |      | 98,498   |   |      |   | 60,049   |      |  |   | 161,834  |  
|Proceeds from maturities or calls and paydowns of available-for-sale securities   |  |      | 103,299  |   |      |   | 143,582  |      |  |   | 141,739  |  
|Purchases of available-for-sale securities                                        |  |      | (45,136  | ) |      |   | (164,853 | )    |  |   | (300,581 | )
|Purchases of held-to-maturity securities                                          |  |      | (18,007  | ) |      |   | (28,565  | )    |  |   | (84,975  | )
|Net increase in loans held for investment                                         |  |      | (371,352 | ) |      |   | (343,218 | )    |  |   | (206,252 | )
|Purchase of bank-owned life insurance                                             |  |      |         |   |      |   |         |      |  |   | (20,000  | )
|Proceeds from sale of real estate acquired by foreclosure                         |  |      | 2,792    |   |      |   | 2,269    |      |  |   | 5,199    |  
|Proceeds from sale of land held for sale                                          |  |      | 1,570    |   |      |   | 615      |      |  |   | 729      |  
|Purchase of Prestonwood Bancshares, Inc. (including transaction costs)            |  |      |         |   |      |   | (34,638  | )    |  |   |         |  
|Cash and cash equivalents acquired with Prestonwood Bancshares, Inc.              |  |      |         |   |      |   | 49,035   |      |  |   |         |  
|Purchase of Bank of the Hills, Inc. (including transaction costs)                 |  |      | (31,730  | ) |      |   |         |      |  |   |         |  
|Cash and cash equivalents acquired with Bank of the Hills, Inc.                   |  |      | 27,860   |   |      |   |         |      |  |   |         |  
|Net change in interest-bearing deposits in financial institutions                 |  |      | 21,469   |   |      |   | 496      |      |  |   | 763      |  
|Proceeds from sale of loans                                                       |  |      | 79,902   |   |      |   | 52,368   |      |  |   |         |  
|Proceeds from sale of premises and equipment                                      |  |      | 31,975   |   |      |   | 379      |      |  |   | 731      |  
|Purchase of premises and equipment                                                |  |      | (5,394   | ) |      |   | (7,741   | )    |  |   | (5,512   | )
|                                                                                  |  |      |          |   |      |   |          |      |  |   |          |  
|Net cash used in investing activities                                             |  |      | (88,347  | ) |      |   | (247,469 | )    |  |   | (296,738 | )
|CASH FLOWS FROM FINANCING ACTIVITIES:                                             |  |      |          |   |      |   |          |      |  |   |          |  
|Net increase in deposit accounts                                                  |  |      | 198,244  |   |      |   | 276,471  |      |  |   | 25,598   |  
|Net (decrease) increase in short-term borrowings                                  |  |      | (172,175 | ) |      |   | (27,725  | )    |  |   | 96,415   |  
|Redemption of junior subordinated debt                                            |  |      | (29,640  | ) |      |   |         |      |  |   |         |  
|Proceeds from issuance of common stock                                            |  |      | 4,816    |   |      |   | 4,625    |      |  |   | 5,975    |  
|Repurchase of common stock                                                        |  |      | (8,918   | ) |      |   | (1,984   | )    |  |   |         |  
|Excess tax benefits from share-based payment arrangements                         |  |      | 620      |   |      |   |         |      |  |   |         |  
|Dividends paid                                                                    |  |      | (12,832  | ) |      |   | (10,865  | )    |  |   | (8,968   | )
|                                                                                  |  |      |          |   |      |   |          |      |  |   |          |  
|Net cash (used in) provided by financing activities                               |  |      | (19,885  | ) |      |   | 240,522  |      |  |   | 119,020  |  
|                                                                                  |  |      |          |   |      |   |          |      |  |   |          |  
|NET (DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS                              |  |      | (12,379  | ) |      |   | 58,715   |      |  |   | (48,325  | )
|CASH AND CASH EQUIVALENTS:                                                        |  |      |          |   |      |   |          |      |  |   |          |  
|Beginning of period                                                               |  |      | 147,154  |   |      |   | 88,439   |      |  |   | 136,764  |  
|                                                                                  |  |      |          |   |      |   |          |      |  |   |          |  
|End of period                                                                     |  | $    | 134,775  |   |      | $ | 147,154  |      |  | $ | 88,439   |  
|                                                                                  |  |      |          |   |      |   |          |      |  |   |          |  
|Supplemental information:                                                         |  |      |          |   |      |   |          |      |  |   |          |  
|Income taxes paid                                                                 |  | $    | 27,098   |   |      | $ | 18,752   |      |  | $ | 29,704   |  
|Interest paid                                                                     |  |      | 75,913   |   |      |   | 51,505   |      |  |   | 30,316   |  
|Noncash investing and financing activities                                       |  |      |          |   |      |   |          |      |  |   |          |  
|Loan to finance the sale of premises and equipment                                |  |      | 1,400    |   |      |   |         |      |  |   | 419      |  
|Acquisition of real estate through foreclosure of collateral                      |  |      | 3,565    |   |      |   | 1,183    |      |  |   | 4,553    |  
|Acquisition of BOTH, Inc.                                                         |  |      |          |   |      |   |          |      |  |   |          |  
|Common Stock issued                                                               |  |      | 40,971   |   |      |   |         |      |  |   |         |  
|Payable to BOTH, Inc shareholders                                                 |  |      | 336      |   |      |   |         |      |  |   |         |  

See notes to consolidated financial statements.



F-6



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##### Table of Contents

##### Index to Financial Statements

STERLING BANCSHARES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

FOR THE YEARS ENDED DECEMBER 31, 2006, 2005 AND 2004



|1. | ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING AND REPORTING POLICIES
|-- | -------------------------------------------------------------------------

OrganizationSterling Bancshares, Inc. (Sterling Bancshares and together with its subsidiaries, the Company), headquartered in Houston, Texas, is a bank holding company that
has served the banking needs of small- to mid-sized businesses for over 32 years. The Company provides commercial and consumer banking services in the greater metropolitan areas of Houston, San Antonio and Dallas, Texas through the 45 banking
centers of Sterling Bank (the Bank), a banking association chartered under the laws of the state of Texas.

Summary of
Significant Accounting and Reporting PoliciesThe accounting and reporting policies of the Company conform to accounting principles generally accepted in the United States of America and the prevailing practices within the financial
services industry. A summary of significant accounting policies follows:

Basis of PresentationThe consolidated
financial statements include the accounts of Sterling Bancshares and its subsidiaries except for those subsidiaries where it has been determined that the Company is not the primary beneficiary. Intercompany transactions have been eliminated in
consolidation.

Use of EstimatesThe preparation of financial statements requires management to make estimates and
assumptions that affect the reported amounts in the financial statements. Actual results could differ from those estimates. Material estimates that are particularly susceptible to significant change in the near term relate to the determination of
the allowance for credit losses, the valuation of foreclosed real estate, deferred tax assets, goodwill and other intangibles, trading activities and stock-based compensation.

Trading AssetsSecurities classified as trading assets are bought with the anticipation of sale in the near term and are carried at
fair market value. Generally, these assets are held up to 120 days. These securities consist primarily of the government-guaranteed portion of SBA loans.

SecuritiesSecurities classified as held-to-maturity are carried at cost, adjusted for the amortization of premiums and the accretion of discounts. Management has the positive intent and the Company
has the ability to hold these assets until their maturities. Under certain circumstances (including the deterioration of the issuers creditworthiness or a change in tax law or statutory or regulatory requirements), these securities may be sold
or transferred to another portfolio.

Securities classified as available-for-sale are carried at fair value. Unrealized gains and losses
are excluded from earnings and reported, net of tax, as accumulated comprehensive income or loss until realized. Declines in the fair value of individual securities below their cost that are determined to be other-than-temporary would result in
writedowns, as a realized loss, of the individual securities to their fair value. In evaluating other-than-temporary impairment losses, management considers several factors including the severity and the duration of time 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. Securities within the available-for-sale portfolio may be used as part of the
Companys asset and liability management strategy and may be sold in response to changes in interest rate risk, prepayment risk or other factors.

Premiums and discounts are amortized and accreted to operations using the level-yield method of accounting, adjusted for prepayments as applicable. The specific identification method of accounting is used to compute
gains or losses on the sales of securities. Interest earned on these assets is included in interest income.



F-7



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##### Table of Contents

##### Index to Financial Statements

STERLING BANCSHARES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)

FOR THE YEARS ENDED DECEMBER 31, 2006 2005 AND 2004



Loans Held for SaleLoans held for sale are carried at the lower of aggregate cost
or market value. Premiums, discounts and loan fees (net of certain direct loan origination costs) on loans held for sale are deferred until the related loans are sold or repaid. Gains or losses on loan sales are recognized at the time of sale and
determined using the specific identification method.

Loans Held for InvestmentLoans held for investment are stated at
the principal amount outstanding, net of unearned discount and net deferred loan fees or costs. Unearned discount relates principally to consumer installment loans. Interest income for loans is recognized principally by the simple interest method.

The Company provides equipment financing to its customers through a variety of lease arrangements. Direct financing leases are included in
loans held for investment and carried at the aggregate of lease payments receivable plus estimated residual value of the leased property, less unearned income.

A loan is defined as impaired when based on current information and events, it is probable that a creditor will be unable to collect all amounts due, both interest and principal, according to the contractual terms of
the loan agreement. The allowance for loan losses related to impaired loans is determined based on the difference between the carrying value of the impaired loan and its fair value. The fair value is determined based on the present value of expected
cash flows discounted at the loans effective interest rate or, as a practical expedient, the loans observable market price or the fair value of the collateral if the loan is collateral dependent. Interest payments on impaired loans are
typically applied to principal unless collectibility of the principal amount is reasonably assured, in which case interest is recognized.

Nonperforming Loans and Past-Due LoansNonperforming loans are loans which have been categorized by management as nonaccrual because collection of interest is doubtful and loans which have been restructured to provide a
reduction in the interest rate or a deferral of interest or principal payments because of a borrowers financial difficulty.

When the
payment of principal or interest on a loan is delinquent for 90 days, or earlier in some cases, the loan is placed on nonaccrual status and classified as impaired unless the loan is in the process of collection and the underlying collateral fully
supports the carrying value of the loan. If the decision is made to continue accruing interest on the loan, periodic reviews are made to evaluate the appropriateness of its accruing status. When a loan is placed on nonaccrual status, all accrued but
unpaid interest is charged to operations. Generally, any payments received on nonaccrual loans are applied first to outstanding loan amounts and next to the recovery of charged-off loan amounts. Any excess is treated as a recovery of lost interest.

Restructured loans are those loans for which concessions in terms have been granted because of a borrowers financial difficulty.
Interest is generally accrued on such loans in accordance with the new terms.

Allowance for Credit LossesThe allowance
for credit losses is a valuation allowance for losses incurred on loans and binding loan commitments. The reserve for losses on unfunded loan commitments is included in other liabilities. All losses are charged to the allowance when the loss
actually occurs or when a determination is made that a loss is probable. Recoveries are credited to the allowance at the time of recovery.

Throughout the year, management estimates the probable level of losses to determine whether the allowance for credit losses is adequate to absorb losses in the existing portfolio. Based on these estimates, an amount is



F-8



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##### Table of Contents

##### Index to Financial Statements

STERLING BANCSHARES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)

FOR THE YEARS ENDED DECEMBER 31, 2006 2005 AND 2004



charged to the provision for credit losses and credited to the allowance for credit losses in order to adjust the allowance to a level determined to be
adequate to absorb losses.

Managements judgment as to the level of probable losses on existing loans involves the consideration of
current and anticipated economic conditions and their potential effects on specific borrowers; an evaluation of the existing relationships among loans, potential credit losses and the present level of the allowance; results of examinations of the
loan portfolio by regulatory agencies; and managements internal review of the loan portfolio. In determining the collectibility of certain loans, management also considers the fair value of any underlying collateral. The amount ultimately
realized may differ from the carrying value of these assets because of economic, operating or other conditions beyond the Companys control.

Estimates of credit losses involve an exercise of judgment. While it is reasonably possible that in the near term the Company may sustain losses which are substantial relative to the allowance for credit losses, it is the judgment of
management that the allowance for credit losses reflected in the consolidated balance sheets is adequate to absorb probable losses that exist in the current loan portfolio.

Premises and EquipmentLand is carried at cost. Premises and equipment are stated at cost, less accumulated depreciation and
amortization. Depreciation expense is computed primarily using the straight-line method over the estimated useful lives (ranging from three to forty years) of the assets. Leasehold improvements are amortized using the straight-line method over the
periods of the leases or the estimated useful lives, whichever is shorter.

The Company evaluates for impairment its long-lived assets to
be held and used, and long-lived assets to be disposed of, whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Impairment is determined using the undiscounted operating cash flows
estimated over the remaining useful life of the related long-lived asset and the eventual disposal. In the event of impairment, the asset is written down to its fair market value. Assets to be disposed of are recorded at the lower of net book value
or fair market value less cost to sell and are classified as assets held for sale on the consolidated balance sheet at the date management commits to a plan of disposal.

Goodwill and Other IntangiblesIntangible assets consist primarily of core deposits and customer relationships. Intangible assets with definite useful lives are amortized on an accelerated basis
over their estimated life. Goodwill and intangible assets that have indefinite useful lives are subject to at least an annual impairment test and more frequently if a triggering event occurs. If any such impairment is determined, a writedown is
recorded.

Real Estate Acquired by ForeclosureThe Company records real estate acquired by foreclosure at fair value
less estimated costs to sell. Adjustments are made to reflect declines in value subsequent to acquisition, if any, below the recorded amounts. Required developmental costs associated with foreclosed property under construction are capitalized and
considered in determining the fair value of the property. Operating expenses of such properties, net of related income, and gains and losses on their disposition are included in noninterest expense.

Derivative Financial InstrumentsThe Companys 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. The Company uses certain derivative instruments to add stability to the
Companys net interest income and to manage the Companys exposure to interest rate movements.



F-9



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##### Table of Contents

##### Index to Financial Statements

STERLING BANCSHARES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)

FOR THE YEARS ENDED DECEMBER 31, 2006 2005 AND 2004



The Company may designate a derivative as either an accounting hedge of the fair value of a
recognized fixed rate asset or an unrecognized firm commitment (fair value hedge) or an accounting hedge of a forecasted transaction or of the variability of future cash flows of a floating rate asset or liability (cash flow
hedge). All derivatives are recorded as other assets or other liabilities on the balance sheet at their respective fair values. To the extent of the effectiveness of a hedge, changes in the fair value of a derivative that is designated and qualifies
as a cash flow hedge are recorded in other comprehensive income, net of income taxes. For all hedge relationships, ineffectiveness resulting from differences between the changes in fair value or cash flows of the hedged item and changes in fair
value of the derivative are recognized as other income in the results of operations.

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.

Income TaxesSterling Bancshares files a consolidated federal income tax return with its
subsidiaries. Each computes income taxes as if it filed a separate return and remits to, or is reimbursed by Sterling Bancshares based on the portion of taxes currently due or refundable.

Deferred income taxes are accounted for by applying statutory tax rates in effect at the balance sheet date to differences between the book basis and the
tax basis of assets and liabilities. The resulting deferred tax assets and liabilities are adjusted to reflect changes in enacted tax laws or rates. The Company has established, and periodically reviews and re-evaluates, an estimated contingent tax
liability on its consolidated balance sheet to provide for the possibility of adverse outcomes in tax matters.

Realization of net deferred
tax assets is dependent on generating sufficient future taxable income. Although realization is not assured, management believes it is more likely than not that all of the net deferred tax assets will be realized.

Stock-based CompensationThe Company accounts for stock-based employee compensation plans using the fair-value-based method of
accounting in accordance with Statement of Accounting Standards No. 123R, Share-Based Payment (Revised 2004) (SFAS 123R)which became effective 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. Compensation expense for
restricted stock awards is based on the market price of the stock on the date of grant and is recognized ratably over the vesting period of the award.



F-10



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##### Table of Contents

##### Index to Financial Statements

STERLING BANCSHARES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)

FOR THE YEARS ENDED DECEMBER 31, 2006 2005 AND 2004



The pro-forma net income and earnings per share information for the years ended December 31,
2005 and 2004 presented below were 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).



|                                                                                                                         |  |      |        |   |      |   |        |  
|------------------------------------------------------------------------------------------------------------------------ |  | ---- | ------ | - | ---- | - | ------ | -
|                                                                                                                         |  | 2005 |        |   | 2004 |  
|Net income, as reported                                                                                                  |  | $    | 36,222 |   |      | $ | 24,963 |  
|Add: Stock-based employee compensation expense included in reported net income, net of related taxes                     |  |      | 457    |   |      |   | 546    |  
|Less: Total stock-based employee compensation expense determined under the fair value based method, net of related taxes |  |      | (952   | ) |      |   | (1,203 | )
|                                                                                                                         |  |      |        |   |      |   |        |  
|Pro-forma net income                                                                                                     |  | $    | 35,727 |   |      | $ | 24,306 |  
|                                                                                                                         |  |      |        |   |      |   |        |  
|Earnings per share:                                                                                                      |  |      |        |   |      |   |        |  
|Basicas reported                                                                                                        |  | $    | 0.53   |   |      | $ | 0.37   |  
|                                                                                                                         |  |      |        |   |      |   |        |  
|Basicpro forma                                                                                                          |  | $    | 0.53   |   |      | $ | 0.36   |  
|                                                                                                                         |  |      |        |   |      |   |        |  
|Dilutedas reported                                                                                                      |  | $    | 0.53   |   |      | $ | 0.37   |  
|                                                                                                                         |  |      |        |   |      |   |        |  
|Dilutedpro forma                                                                                                        |  | $    | 0.52   |   |      | $ | 0.36   |  
|                                                                                                                         |  |      |        |   |      |   |        |  

Profit Sharing PlanThe Company has a profit sharing plan that covers
substantially all employees. Contributions to the plan are accrued and paid only when the bank achieves a minimum 12% return on average equity.

Statements of Cash FlowsCash and cash equivalents include cash, due from banks and federal funds sold. Generally, federal funds are invested for one-day periods.

Earnings Per ShareEarnings per share (EPS) are presented under two formats: basic EPS and diluted EPS. Basic EPS is
computed by dividing net income (after deducting dividends on preferred stock) by the weighted average number of shares outstanding during the year excluding non-vested stock. Diluted EPS is computed by dividing net income by the weighted average
number of shares outstanding and non-vested stock adjusted for the incremental shares issuable upon conversion of preferred stock and issuable upon exercise of outstanding stock options.

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, received 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 was based on the average of the high and
low bids on the record date, as adjusted for the split. This stock split has been given retroactive effect in the accompanying financial statements and related notes. In addition, earnings and dividends per common share data has been restated for
all periods presented.

Comprehensive IncomeComprehensive income includes all changes in equity during the period
presented that result from transactions and other economic events other than transactions with shareholders. The Company reports comprehensive income in the consolidated statements of shareholders equity.

ReclassificationsCertain reclassifications have been made to prior year amounts to conform to current year presentation. All
reclassifications have been applied consistently for the periods presented.



F-11



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##### Table of Contents

##### Index to Financial Statements

STERLING BANCSHARES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)

FOR THE YEARS ENDED DECEMBER 31, 2006 2005 AND 2004



Recent Accounting Standards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 $375 thousand for the year ended December 31, 2006 attributable to stock options and the
Companys employee stock purchase plan. An income tax benefit of $5 thousand was recorded in the Companys income statement for the year ended December 31, 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 this same time period.

In February 2006, the Financial
Accounting Standard Board (FASB) issued SFAS No. 155, Accounting for Certain Hybrid Financial Instruments(SFAS 155), an amendment of SFAS Nos. 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 SFAS 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 SFAS 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. SFAS 155 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 SFAS No. 156, Accounting for Servicing of Financial Assets(SFAS 156), an amendment of SFAS 140.
It establishes, among other things, the accounting for all separately recognized servicing assets and servicing liabilities. SFAS 156 amends SFAS 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, Accounting for Uncertainty in Income Taxes(FIN
48), 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 SFAS No. 109, Accounting for Income Taxes(SFAS 109). FIN 48 clarifies the application of SFAS 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.



F-12



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##### Table of Contents

##### Index to Financial Statements

STERLING BANCSHARES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)

FOR THE YEARS ENDED DECEMBER 31, 2006 2005 AND 2004



In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements(SFAS
157). 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. This Statement is effective for fiscal years beginning after November 15, 2007. The adoption of this accounting standard is not
expected to have a material impact on the Companys financial statements.

In February 2007, the FASB issued SFAS No. 159, The
Fair Value Option for Financial Assets and Financial Liabilities (SFAS 159). This Statement permits entities to choose to measure many financial instruments and certain other items at fair value. The objective is to improve financial
reporting by providing entities with the opportunity to mitigate volatility in reported earnings caused by measuring related assets and liabilities differently without having to apply complex hedge accounting provisions. Management has not completed
its evaluation of the impact of this standard; however, the Company does not expect it to be material to its financial statements.



|2. | ACQUISITIONS AND DIVESTITURES
|-- | -----------------------------

Acquisitions. On September 29, 2006, the Company acquired Kerrville, Texas-based BOTH, Inc., and its subsidiary bank, Bank of the Hills (BOTH). BOTH operated five banking offices in the San Antonio/Kerrville
area. The purchase price of $73.0 million consisted of $41.0 million of the Companys common stock (3.0 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 22, 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 December 31, 2006, the Company had a liability totaling $336 thousand
representing the cash portion of the consideration that had not yet been tendered for cash payment to the BOTH shareholders. The results of operations for this acquisition have been included in the Companys financial results beginning in the
fourth quarter of 2006.



F-13



---

##### Table of Contents

##### Index to Financial Statements

STERLING BANCSHARES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)

FOR THE YEARS ENDED DECEMBER 31, 2006 2005 AND 2004



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 (in thousands).



|                                               |  |   |          |  
|---------------------------------------------- |  | - | -------- | -
|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                         |  |   | 5,731    |  
|Accrued interest receivable                    |  |   | 1,797    |  
|Core deposit intangibles                       |  |   | 7,760    |  
|Goodwill                                       |  |   | 45,832   |  
|Other assets                                   |  |   | 7,659    |  
|                                               |  |   |          |  
|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 are amortized using an economic life method based on deposit attrition
projections. As a result, amortization will decline over time with most of the amortization occurred during the initial years. The weighted average amortization period for core deposit intangibles is approximately 5 years.

On September 30, 2005, the Company acquired Dallas, Texas-based Prestonwood Bancshares, Inc. (Prestonwood), and its subsidiary bank, The
Oaks Bank & Trust Company (The Oaks Bank), in a cash merger. The Oaks Bank operated five banking offices in Dallas and doubled the Companys size in both assets and locations in the Dallas area. One acquired office was
consolidated into an existing Sterling Bank location. The Company paid $34.4 million plus transaction costs for all of Prestonwoods issued and outstanding shares of common stock, of which $500 thousand was deposited into an escrow account to
secure payment of certain obligations related to an insurance agency subsidiary. 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. The results of operations for this acquisition have been included in the Companys financial results beginning in the fourth quarter of 2005.



F-14



---

##### Table of Contents

##### Index to Financial Statements

STERLING BANCSHARES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)

FOR THE YEARS ENDED DECEMBER 31, 2006 2005 AND 2004



|3. | SECURITIES
|-- | ----------

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

|                                                                    |  |                   |         |                      |   |                       |  |   |            |   |  |   |        
|------------------------------------------------------------------- |  | ----------------- | ------- | -------------------- | - | --------------------- |  | - | ---------- | - |  | - | -------
|                                                                    |  | December 31, 2006
|                                                                    |  | AmortizedCost     |         | GrossUnrealizedGains |   | GrossUnrealizedLosses |  |   | Fair Value
|Available-for-Sale                                                  |  |                   |         |                      |   |                       |  |   |            |   |  |   |        
|Obligations of the U.S. Treasury and other U.S. government agencies |  | $                 | 6,501   |                      | $ |                      |  | $ | (76        | ) |  | $ | 6,425  
|Obligations of states of the U.S. and political subdivisions        |  |                   | 2,306   |                      |   | 17                    |  |   | (2         | ) |  |   | 2,321  
|Mortgage-backed securities and collateralized mortgage obligations  |  |                   | 395,614 |                      |   | 56                    |  |   | (9,855     | ) |  |   | 385,815
|Other securities                                                    |  |                   | 15,165  |                      |   |                      |  |   | (375       | ) |  |   | 14,790 
|                                                                    |  |                   |         |                      |   |                       |  |   |            |   |  |   |        
|Total                                                               |  | $                 | 419,586 |                      | $ | 73                    |  | $ | (10,308    | ) |  | $ | 409,351
|                                                                    |  |                   |         |                      |   |                       |  |   |            |   |  |   |        
|Held-to-Maturity                                                    |  |                   |         |                      |   |                       |  |   |            |   |  |   |        
|Obligations of states of the U.S. and political subdivisions        |  | $                 | 91,946  |                      | $ | 495                   |  | $ | (380       | ) |  | $ | 92,061 
|Mortgage-backed securities and collateralized mortgage obligations  |  |                   | 72,317  |                      |   | 91                    |  |   | (934       | ) |  |   | 71,474 
|                                                                    |  |                   |         |                      |   |                       |  |   |            |   |  |   |        
|Total                                                               |  | $                 | 164,263 |                      | $ | 586                   |  | $ | (1,314     | ) |  | $ | 163,535
|                                                                    |  |                   |         |                      |   |                       |  |   |            |   |  |   |        
|                                                                    | 
|                                                                    |  | December 31, 2005
|                                                                    |  | AmortizedCost     |         | GrossUnrealizedGains |   | GrossUnrealizedLosses |  |   | 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
|                                                                    |  |                   |         |                      |   |                       |  |   |            |   |  |   |        



F-15



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##### Table of Contents

##### Index to Financial Statements

STERLING BANCSHARES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)

FOR THE YEARS ENDED DECEMBER 31, 2006 2005 AND 2004



The contractual maturities of securities at December 31, 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                                            |  | $                  | 2,373   |                  | $ | 2,358         |  | $          | 5,527   |  | $ | 5,546  
|Due after one year through five years                              |  |                    | 5,768   |                  |   | 5,715         |  |            | 38,408  |  |   | 38,423 
|Due after five years through ten years                             |  |                    | 666     |                  |   | 673           |  |            | 48,011  |  |   | 48,092 
|Mortgage-backed securities and collateralized mortgage obligations |  |                    | 395,614 |                  |   | 385,815       |  |            | 72,317  |  |   | 71,474 
|Other securities                                                   |  |                    | 15,165  |                  |   | 14,790        |  |            |        |  |   |       
|                                                                   |  |                    |         |                  |   |               |  |            |         |  |   |        
|Total                                                              |  | $                  | 419,586 |                  | $ | 409,351       |  | $          | 164,263 |  | $ | 163,535
|                                                                   |  |                    |         |                  |   |               |  |            |         |  |   |        

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



|                              |  |              |        |   |      |   |        |      |  |   |         |  
|----------------------------- |  | ------------ | ------ | - | ---- | - | ------ | ---- |  | - | ------- | -
|                              |  | December 31, |       
|                              |  | 2006         |        |   | 2005 |   |        | 2004 | 
|Proceeds from sales and calls |  | $            | 98,498 |   |      | $ | 60,049 |      |  | $ | 161,834 |  
|Gross realized gains          |  |              | 204    |   |      |   | 206    |      |  |   | 5,860   |  
|Gross realized losses         |  |              | (562   | ) |      |   | (146   | )    |  |   | (919    | )

During 2004, the Company sold $75.6 million of certain interest-only securities held in its
available-for-sale portfolio in two separate securitization transactions. The Company received proceeds of $83.9 million and recognized net after-tax securitization gains totaling $3.4 million for these transactions. The Company did not retain any
interests in these securities and neither the investors in the securitization trusts nor the trusts have any recourse other than for a breach of customary representations as to ownership and origination, but not for credit loss or default.



F-16



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##### Table of Contents

##### Index to Financial Statements

STERLING BANCSHARES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)

FOR THE YEARS ENDED DECEMBER 31, 2006 2005 AND 2004



Securities with unrealized losses segregated by length of impairment as of December 31, 2006,
were as follows (in thousands):



|                                                                    |  |                     |        |                       |   |      |           |  |               |        |                       |   |         |            |   |        |   |  |   |        
|------------------------------------------------------------------- |  | ------------------- | ------ | --------------------- | - | ---- | --------- |  | ------------- | ------ | --------------------- | - | ------- | ---------- | - | ------ | - |  | - | -------
|                                                                    |  | Less than 12 Months |        | More than 12 Months  
|                                                                    |  | AmortizedCost       |        | GrossUnrealizedLosses |   |      | FairValue |  | AmortizedCost |        | GrossUnrealizedLosses |   |         | Fair Value
|Available-for-Sale                                                  |  |                     |        |                       |   |      |           |  |               |        |                       |   |         |            |   |        |   |  |   |        
|Obligations of the U.S. Treasury and other U.S. government agencies |  | $                   |       |                       | $ |     |           |  | $             |       |                       | $ | 6,501   |            | $ | (76    | ) |  | $ | 6,425  
|Obligations of states of the U.S. and political subdivisions        |  |                     | 96     |                       |   |     |           |  |               | 96     |                       |   | 463     |            |   | (2     | ) |  |   | 461    
|Mortgage-backed securities and collateralized mortgage obligations  |  |                     | 56,439 |                       |   | (613 | )         |  |               | 55,826 |                       |   | 326,012 |            |   | (9,242 | ) |  |   | 316,770
|Other securities                                                    |  |                     |       |                       |   |     |           |  |               |       |                       |   | 8,630   |            |   | (375   | ) |  |   | 8,255  
|                                                                    |  |                     |        |                       |   |      |           |  |               |        |                       |   |         |            |   |        |   |  |   |        
|Total                                                               |  | $                   | 56,535 |                       | $ | (613 | )         |  | $             | 55,922 |                       | $ | 341,606 |            | $ | (9,695 | ) |  | $ | 331,911
|                                                                    |  |                     |        |                       |   |      |           |  |               |        |                       |   |         |            |   |        |   |  |   |        
|Held-to-Maturity                                                    |  |                     |        |                       |   |      |           |  |               |        |                       |   |         |            |   |        |   |  |   |        
|Obligations of states of the U.S. and political subdivisions        |  | $                   | 11,280 |                       | $ | (10  | )         |  | $             | 11,270 |                       | $ | 19,942  |            | $ | (370   | ) |  | $ | 19,572 
|Mortgage-backed securities and collateralized mortgage obligations  |  |                     | 16,437 |                       |   | (94  | )         |  |               | 16,343 |                       |   | 43,801  |            |   | (840   | ) |  |   | 42,961 
|                                                                    |  |                     |        |                       |   |      |           |  |               |        |                       |   |         |            |   |        |   |  |   |        
|Total                                                               |  | $                   | 27,717 |                       | $ | (104 | )         |  | $             | 27,613 |                       | $ | 63,743  |            | $ | (1,210 | ) |  | $ | 62,533 
|                                                                    |  |                     |        |                       |   |      |           |  |               |        |                       |   |         |            |   |        |   |  |   |        

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 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 2.4% of the amortized cost basis at December 31, 2006. During the fourth quarter of 2006, realized losses of $562 thousand were recorded on
certain interest-only securities. These securities are tied to an underlying government guaranteed loan and are subject to prepayment and interest rate fluctuations. These securities had been in an unrealized loss position since the fourth quarter
of 2005. Given the current prepayment factors for the underlying loan and managements inability to determine when a full recovery of the value may occur, management considered these securities to be other than temporarily impaired. 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 December 31, 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



F-17



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##### Table of Contents

##### Index to Financial Statements

STERLING BANCSHARES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)

FOR THE YEARS ENDED DECEMBER 31, 2006 2005 AND 2004



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 December 31, 2006.

The Company does not own any securities of any one issuer (other than the U.S. government and its agencies) for which the aggregate adjusted cost exceeds 10% of the consolidated shareholders equity at December 31, 2006.

Securities with carrying values totaling $355.4 million and fair values totaling $349.0 million were pledged to secure public deposits at
December 31, 2006.



|4. | LOANS
|-- | -----

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



|                                |  |              |           |      |   |          
|------------------------------- |  | ------------ | --------- | ---- | - | ---------
|                                |  | December 31,
|                                |  | 2006         |           | 2005
|Loans held for sale             |  |              |           |      |   |          
|Commercial and industrial       |  | $            | 3,723     |      | $ | 1,242    
|Real estate:                    |  |              |           |      |   |          
|Commercial                      |  |              | 49,099    |      |   | 4,735    
|Construction                    |  |              | 1,900     |      |   | 2,377    
|                                |  |              |           |      |   |          
|Total loans held for sale       |  |              | 54,722    |      |   | 8,354    
|                                |  |              |           |      |   |          
|Loans held for investment       |  |              |           |      |   |          
|Domestic                        |  |              |           |      |   |          
|Commercial and industrial       |  |              | 824,494   |      |   | 738,061  
|Real estate:                    |  |              |           |      |   |          
|Commercial                      |  |              | 1,336,465 |      |   | 1,221,610
|Construction                    |  |              | 597,985   |      |   | 438,454  
|Residential mortgage            |  |              | 209,163   |      |   | 190,701  
|Consumer/other                  |  |              | 79,642    |      |   | 72,937   
|Foreign                         |  |              |           |      |   |          
|Commercial and industrial       |  |              | 27,479    |      |   | 26,080   
|Other loans                     |  |              | 2,617     |      |   | 3,165    
|                                |  |              |           |      |   |          
|Total loans held for investment |  |              | 3,077,845 |      |   | 2,691,008
|                                |  |              |           |      |   |          
|Total loans                     |  | $            | 3,132,567 |      | $ | 2,699,362
|                                |  |              |           |      |   |          



F-18



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##### Table of Contents

##### Index to Financial Statements

STERLING BANCSHARES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)

FOR THE YEARS ENDED DECEMBER 31, 2006 2005 AND 2004



Loan maturities and rate sensitivity of the loans held for investment excluding residential mortgage
and consumer loans, at December 31, 2006 were as follows (in thousands):



|                                    |  |                        |           |                                    |   |                     |  |       |         |  |   |          
|----------------------------------- |  | ---------------------- | --------- | ---------------------------------- | - | ------------------- |  | ----- | ------- |  | - | ---------
|                                    |  | Due in OneYear or Less |           | Due AfterOne YearThroughFive Years |   | Due AfterFive Years |  | Total
|Commercial and industrial           |  | $                      | 631,414   |                                    | $ | 171,104             |  | $     | 21,976  |  | $ | 824,494  
|Real estatecommercial              |  |                        | 531,331   |                                    |   | 621,692             |  |       | 183,442 |  |   | 1,336,465
|Real estateconstruction            |  |                        | 439,460   |                                    |   | 118,224             |  |       | 40,301  |  |   | 597,985  
|Foreign loans                       |  |                        | 28,755    |                                    |   | 1,341               |  |       |        |  |   | 30,096   
|                                    |  |                        |           |                                    |   |                     |  |       |         |  |   |          
|Total loans                         |  | $                      | 1,630,960 |                                    | $ | 912,361             |  | $     | 245,719 |  | $ | 2,789,040
|                                    |  |                        |           |                                    |   |                     |  |       |         |  |   |          
|Loans with a fixed interest rate    |  | $                      | 196,609   |                                    | $ | 752,154             |  | $     | 196,973 |  | $ | 1,145,736
|Loans with a floating interest rate |  |                        | 1,434,351 |                                    |   | 160,207             |  |       | 48,746  |  |   | 1,643,304
|                                    |  |                        |           |                                    |   |                     |  |       |         |  |   |          
|Total loans                         |  | $                      | 1,630,960 |                                    | $ | 912,361             |  | $     | 245,719 |  | $ | 2,789,040
|                                    |  |                        |           |                                    |   |                     |  |       |         |  |   |          

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 December 31, 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.

In the ordinary course of business, the Company has granted loans to certain directors, officers and their affiliates. 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.

An analysis of activity with respect to these related-party loans is as follows (in thousands):



|                                         |  |              |        |   |      |   |        |  
|---------------------------------------- |  | ------------ | ------ | - | ---- | - | ------ | -
|                                         |  | Year Ended   |       
|                                         |  | December 31, |       
|                                         |  | 2006         |        |   | 2005 |  
|Beginning balance                        |  | $            | 9,021  |   |      | $ | 15,273 |  
|New loans                                |  |              |       |   |      |   | 15     |  
|Loans to insiders/directors who resigned |  |              | (2,606 | ) |      |   | (4,574 | )
|Repayments                               |  |              | (4,122 | ) |      |   | (1,693 | )
|                                         |  |              |        |   |      |   |        |  
|Ending balance                           |  | $            | 2,293  |   |      | $ | 9,021  |  
|                                         |  |              |        |   |      |   |        |  

The recorded investment in impaired loans was $11.4 million and $22.4 million, at
December 31, 2006 and 2005, respectively. Such impaired loans required an allowance for loan losses of $1.8 million and $4.2 million, respectively. The average recorded investment in impaired loans for the year ended December 31, 2006,
2005 and 2004 was $17.2 million, $23.0 million and $19.4 million, respectively. Interest income on impaired loans of $57 thousand and $157 thousand were recognized for cash payments received for the year ended December 31, 2004 and 2005,
respectively. No interest on impaired loans was received for the year ended December 31, 2006.

Included in impaired loans are
nonperforming loans of $11.4 million and $21.8 million at December 31, 2006 and December 31, 2005, respectively, which have been categorized by management as nonaccrual



F-19



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##### Table of Contents

##### Index to Financial Statements

STERLING BANCSHARES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)

FOR THE YEARS ENDED DECEMBER 31, 2006 2005 AND 2004



loans. Interest foregone on nonaccrual loans for 2006 and 2005 was approximately $1.3 million and $1.4 million, respectively. The Company had one
restructured loan totaling $776 thousand as of December 31, 2006. The Company did not have any restructured loans as of 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 $2.7 million and $162 thousand at December 31, 2006 and December 31, 2005, respectively.



|5. | ALLOWANCE FOR CREDIT LOSSES
|-- | ---------------------------

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



|                                                                |  |                         |        |   |      |   |        |      |  |   |        |  
|--------------------------------------------------------------- |  | ----------------------- | ------ | - | ---- | - | ------ | ---- |  | - | ------ | -
|                                                                |  | Year Ended December 31, |       
|                                                                |  | 2006                    |        |   | 2005 |   |        | 2004 | 
|Allowance for Credit Losses                                     |  |                         |        |   |      |   |        |      |  |   |        |  
|Allowance for loan losses at beginning of period                |  | $                       | 31,230 |   |      | $ | 29,406 |      |  | $ | 30,722 |  
|Loans charged off                                               |  |                         | 9,450  |   |      |   | 15,713 |      |  |   | 15,216 |  
|Loan recoveries                                                 |  |                         | (3,791 | ) |      |   | (2,752 | )    |  |   | (2,476 | )
|                                                                |  |                         |        |   |      |   |        |      |  |   |        |  
|Net loans charged-off                                           |  |                         | 5,659  |   |      |   | 12,961 |      |  |   | 12,740 |  
|Allowance for loan losses associated with acquired institutions |  |                         | 2,152  |   |      |   | 761    |      |  |   |       |  
|Provision for loan losses                                       |  |                         | 4,304  |   |      |   | 14,024 |      |  |   | 11,424 |  
|                                                                |  |                         |        |   |      |   |        |      |  |   |        |  
|Allowance for loan losses at end of period                      |  |                         | 32,027 |   |      |   | 31,230 |      |  |   | 29,406 |  
|                                                                |  |                         |        |   |      |   |        |      |  |   |        |  
|Reserve for unfunded loan commitments at beginning of period    |  |                         | 1,173  |   |      |   | 826    |      |  |   |       |  
|Provision for losses on unfunded loan commitments               |  |                         | (246   | ) |      |   | 347    |      |  |   | 826    |  
|                                                                |  |                         |        |   |      |   |        |      |  |   |        |  
|Reserve for unfunded loan commitments at end of period          |  |                         | 927    |   |      |   | 1,173  |      |  |   | 826    |  
|                                                                |  |                         |        |   |      |   |        |      |  |   |        |  
|Total allowance for credit losses                               |  | $                       | 32,954 |   |      | $ | 32,403 |      |  | $ | 30,232 |  
|                                                                |  |                         |        |   |      |   |        |      |  |   |        |  



|6. | PREMISES AND EQUIPMENT
|-- | ----------------------

Premises and equipment are
summarized as follows (in thousands):



|                                               |  |              |         |   |      |   |         |  
|---------------------------------------------- |  | ------------ | ------- | - | ---- | - | ------- | -
|                                               |  | December 31, |        
|                                               |  | 2006         |         |   | 2005 |  
|Land                                           |  | $            | 3,876   |   |      | $ | 10,832  |  
|Buildings and improvements                     |  |              | 17,389  |   |      |   | 41,704  |  
|Furniture, fixtures and equipment              |  |              | 47,553  |   |      |   | 44,936  |  
|                                               |  |              |         |   |      |   |         |  
|                                               |  |              | 68,818  |   |      |   | 97,472  |  
|Less accumulated depreciation and amortization |  |              | (45,343 | ) |      |   | (56,065 | )
|                                               |  |              |         |   |      |   |         |  
|Total                                          |  | $            | 23,475  |   |      | $ | 41,407  |  
|                                               |  |              |         |   |      |   |         |  

Depreciation and amortization of premises and equipment totaled $7.5 million in 2006, $7.2 million
in 2005 and $8.7 million in 2004.



F-20



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##### Table of Contents

##### Index to Financial Statements

STERLING BANCSHARES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)

FOR THE YEARS ENDED DECEMBER 31, 2006 2005 AND 2004



The Company completed three separate sale/leaseback transactions during 2006 resulting in total net
pre-tax gains of $1.8 million. A total of 18 properties were sold resulting in premises and equipment with a net book value of $21.9 million being removed from the Companys assets. These properties are being leased over various terms and are
accounted for as operating leases subsequent to the completion of each transaction. During the second quarter of 2006, the Company sold a multi-tenant office building and recognized a gain of $1.1 million. The Company continues to occupy the banking
center located in this building. During the fourth quarter of 2006, the Company completed two separate sale/leaseback transactions. The Company sold one of its San Antonio locations for a total sales price of $1.8 million which resulted in a gain of
$1.0 million. In addition, the Company completed a separate sale/leaseback of 16 bank-owned locations for a total sales price of $28.3 million resulting in a deferred gain of $9.3 million. This gain will be recognized into income over the next 20
years. The Company has no future commitments, obligations, provisions or circumstances that would require or result in its continuing involvement.



|7. | GOODWILL AND OTHER INTANGIBLES
|-- | ------------------------------

The changes in the
carrying amount of goodwill by reporting unit for the years ended December 31, 2006 and 2005 are 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             |  |         |       |            |   | 45,832 |  |       |       |  |   | 45,832 
|                                   |  |         |        |            |   |        |  |       |        |  |   |        
|Balance, December 31, 2006         |  | $       | 29,613 |            | $ | 73,037 |  | $     | 28,208 |  | $ | 130,858
|                                   |  |         |        |            |   |        |  |       |        |  |   |        

The changes in the carrying amounts of the core deposit intangibles for the years ended
December 31, 2006 and 2005 are as follows (in thousands):



|                                   |  |   |        |  
|---------------------------------- |  | - | ------ | -
|Balance, January 1, 2005           |  | $ | 1,839  |  
|Amortization expense               |  |   | (521   | )
|Prestonwood Bancshares acquisition |  |   | 2,233  |  
|                                   |  |   |        |  
|Balance, December 31, 2005         |  |   | 3,551  |  
|Amortization expense               |  |   | (1,012 | )
|BOTH, Inc. acquisition             |  |   | 7,760  |  
|                                   |  |   |        |  
|Balance, December 31, 2006         |  | $ | 10,299 |  
|                                   |  |   |        |  



F-21



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##### Table of Contents

##### Index to Financial Statements

STERLING BANCSHARES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)

FOR THE YEARS ENDED DECEMBER 31, 2006 2005 AND 2004



Core deposit intangibles are amortized on an accelerated basis over their estimated lives of 10
years. The projected amortization for core deposit intangibles as of December 31, 2006 is as follows (in thousands):



|           |  |   |       
|---------- |  | - | ------
|2007       |  | $ | 1,660 
|2008       |  |   | 1,559 
|2009       |  |   | 1,477 
|2010       |  |   | 1,379 
|2011       |  |   | 1,186 
|Thereafter |  |   | 3,038 
|           |  |   |       
|Total      |  | $ | 10,299
|           |  |   |       



|8. | DEPOSITS
|-- | --------

Included in certificates and other time
deposits are individual amounts of $100,000 or more including brokered certificate of deposits. The remaining maturities of these deposits are summarized as of December 31, 2006 as follows (in thousands):



|                               |  |   |        
|------------------------------ |  | - | -------
|Three months or less           |  | $ | 340,250
|Over three through six months  |  |   | 195,833
|Over six through twelve months |  |   | 145,235
|Thereafter                     |  |   | 54,348 
|                               |  |   |        
|                               |  | $ | 735,666
|                               |  |   |        

Interest expense for certificates of deposit in excess of $100,000 was approximately $28.5
million, $14.6 million, and $9.1 million for the years ended December 31, 2006, 2005 and 2004, respectively.

At December 31,
2006, the Bank had $123.7 million in brokered certificates of deposits that were in excess of $100,000, of which $123.2 million will mature in 2007. The remaining balance of these deposits was $453 thousand and will mature in year 2008.

There are no major concentrations of deposits.



|9. | SHORT-TERM BORROWINGS
|-- | ---------------------

Short-term borrowings are
summarized as follows (in thousands):



|                                |  |              |         |      |   |        
|------------------------------- |  | ------------ | ------- | ---- | - | -------
|                                |  | December 31,
|                                |  | 2006         |         | 2005
|Federal Home Loan Bank advances |  | $            | 193,500 |      | $ | 370,000
|Federal funds purchased         |  |              | 27,175  |      |   | 22,850 
|                                |  |              |         |      |   |        
|Total                           |  | $            | 220,675 |      | $ | 392,850
|                                |  |              |         |      |   |        



F-22



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##### Table of Contents

##### Index to Financial Statements

STERLING BANCSHARES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)

FOR THE YEARS ENDED DECEMBER 31, 2006 2005 AND 2004



The Company has an available line of credit with the Federal Home Loan Bank (FHLB) of Dallas, which
allows the Company to borrow on a collateralized basis. At December 31, 2006, we had total funds of $996.4 million available under this agreement of which $193.5 million was outstanding and had maturities from three days to two weeks. The
average interest rate on these borrowings was 5.36% at December 31, 2006. These borrowings are collateralized by single family residential mortgage loans, certain pledged securities, FHLB stock owned by the Company and any funds on deposit with
the FHLB. The Company utilizes these borrowings to meet liquidity needs. Maturing advances are replaced with either additional borrowings or through increased customer deposits.

The Bank has available lines for federal funds purchased at correspondent banks. As of December 31, 2006, federal funds outstanding with a
correspondent bank were $27.2 million, of which $24.0 million will mature in January 2007 while the remaining balance of $3.2 million is payable upon demand.

The Company has a revolving line of credit of $20.0 million with Wells Fargo Bank. This line of credit matures on September 27, 2007, bears interest at 1.25% above the federal funds borrowing rate or LIBOR-based
rate and is subject to certain covenants. There were no borrowings outstanding on this line of credit at December 31, 2006 and 2005.



|10. | SUBORDINATED DEBT
|--- | -----------------

During April 2003, the Bank
raised approximately $50 million through a private offering of subordinated unsecured notes. These subordinated notes bear interest at a fixed rate of 7.375% and mature on April 15, 2013. Interest payments are due semi-annually. The
subordinated notes may not be redeemed or called prior to their maturity. Debt issuance costs of approximately $1.0 million are being amortized over the ten-year term of the notes on a straight-line basis.



|11. | JUNIOR SUBORDINATED DEBT/COMPANY MANDATORILY REDEEMABLE TRUST PREFERRED SECURITIES
|--- | ----------------------------------------------------------------------------------

As of December 31, 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      |  | TrustPreferredSecuritiesOutstanding |        | InterestRate |                        | JuniorSubordinatedDebt OwedTo Trusts |   | Final Maturity Date
|Statutory Trust One  |  | August 30, 2002    |  | $                                   | 20,000 |              | 3-monthLIBOR plus3.45% |                                      | $ | 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-monthLIBOR plus3.10% |                                      |   | 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



F-23



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##### Table of Contents

##### Index to Financial Statements

STERLING BANCSHARES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)

FOR THE YEARS ENDED DECEMBER 31, 2006 2005 AND 2004



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 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). 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 December 31, 2006, the floating rate was 8.81% on these securities 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 December 31, 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.



|12. | DERIVATIVE FINANCIAL INSTRUMENTS
|--- | --------------------------------

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 $3.8 million and $3.7 million with a floating rate of 9.00% and 7.77% on December 31, 2006 and 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.



F-24



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##### Table of Contents

##### Index to Financial Statements

STERLING BANCSHARES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)

FOR THE YEARS ENDED DECEMBER 31, 2006 2005 AND 2004



During the third quarter of 2006, the Company purchased a prime interest rate floor with a notional
amount of $113 million and a strike rate of 8.00% and a prime interest rate collar contract with a notional amount of $250 million and 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 $1.8 million at December 31, 2006. The total fair
value of the interest-rate collar and floor was $3.7 million at December 31, 2006 and is included in other assets.



|13. | INCOME TAXES
|--- | ------------

The components of the provision for
income taxes follow (in thousands):



|                            |  |                         |        |      |   |        |      |  |   |      
|--------------------------- |  | ----------------------- | ------ | ---- | - | ------ | ---- |  | - | -----
|                            |  | Year Ended December 31,
|                            |  | 2006                    |        | 2005 |   |        | 2004
|Current income tax expense  |  | $                       | 21,680 |      | $ | 17,431 |      |  | $ | 8,333
|Deferred income tax expense |  |                         | 259    |      |   | (1,481 | )    |  |   | 1,151
|                            |  |                         |        |      |   |        |      |  |   |      
|Total income tax expense    |  | $                       | 21,939 |      | $ | 15,950 |      |  | $ | 9,484
|                            |  |                         |        |      |   |        |      |  |   |      

The provision for income taxes differs from the amount computed by applying the federal income tax
statutory rate of 35% to income from continuing operations as follows (in thousands):



|                                                 |  |                         |        |   |      |   |        |      |  |   |        |  
|------------------------------------------------ |  | ----------------------- | ------ | - | ---- | - | ------ | ---- |  | - | ------ | -
|                                                 |  | Year Ended December 31, |       
|                                                 |  | 2006                    |        |   | 2005 |   |        | 2004 | 
|Taxes calculated at statutory rate               |  | $                       | 23,723 |   |      | $ | 18,261 |      |  | $ | 12,056 |  
|Increase (decrease) resulting from:              |  |                         |        |   |      |   |        |      |  |   |        |  
|Release of reserves                              |  |                         | (473   | ) |      |   | (851   | )    |  |   | (1,200 | )
|Tax-exempt interest income                       |  |                         | (868   | ) |      |   | (847   | )    |  |   | (762   | )
|Tax-exempt income from bank-owned life insurance |  |                         | (989   | ) |      |   | (1,006 | )    |  |   | (706   | )
|Other, net                                       |  |                         | 546    |   |      |   | 393    |      |  |   | 96     |  
|                                                 |  |                         |        |   |      |   |        |      |  |   |        |  
|Income tax expense, as reported                  |  | $                       | 21,939 |   |      | $ | 15,950 |      |  | $ | 9,484  |  
|                                                 |  |                         |        |   |      |   |        |      |  |   |        |  

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 the Companys
overall tax contingency reserve. During the years ended December 31, 2006, 2005 and 2004, the Company revised its estimate to remove contingent liabilities totaling $473 thousand, $851 thousand and $1.2 million related to the expiration of
previous tax contingencies and refunds received, including the filing of various state tax returns related to the Companys mortgage banking segment which was sold in 2003.



F-25



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##### Table of Contents

##### Index to Financial Statements

STERLING BANCSHARES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)

FOR THE YEARS ENDED DECEMBER 31, 2006 2005 AND 2004



Significant deferred tax assets and liabilities at December 31 were as follows (in thousands):



|                                                 |  |      |        |      |   |       
|------------------------------------------------ |  | ---- | ------ | ---- | - | ------
|                                                 |  | 2006 |        | 2005
|Deferred tax assets:                             |  |      |        |      |   |       
|Real estate acquired by foreclosure              |  | $    | 78     |      | $ | 180   
|Depreciable assets                               |  |      | 3,534  |      |   | 354   
|Allowance for credit losses                      |  |      | 11,533 |      |   | 11,341
|Net operating loss carryforward                  |  |      | 2      |      |   | 13    
|Deferred compensation                            |  |      | 1,525  |      |   | 1,542 
|Unrealized loss on available-for-sale securities |  |      | 3,582  |      |   | 3,732 
|SCMC indemnification reserve                     |  |      | 587    |      |   | 653   
|Other                                            |  |      | 1,084  |      |   | 450   
|                                                 |  |      |        |      |   |       
|Total deferred tax assets                        |  |      | 21,925 |      |   | 18,265
|Deferred tax liabilities:                        |  |      |        |      |   |       
|Federal Home Loan Bank stock dividends           |  |      | 769    |      |   | 511   
|Core deposit intangibles                         |  |      | 3,605  |      |   | 1,243 
|Loan origination fees                            |  |      | 3,138  |      |   |      
|Unrealized gain on cash flow hedge               |  |      | 967    |      |   |      
|Prepaid expenses                                 |  |      | 625    |      |   | 643   
|Other                                            |  |      | 68     |      |   | 388   
|                                                 |  |      |        |      |   |       
|Total deferred tax liabilities                   |  |      | 9,172  |      |   | 2,785 
|                                                 |  |      |        |      |   |       
|Net deferred tax assets                          |  | $    | 12,753 |      | $ | 15,480
|                                                 |  |      |        |      |   |       

The total net deferred tax assets amount is included in the balance sheet in other assets. The
Company has determined that a valuation reserve is not required for deferred tax assets as it is more likely than not that these assets will be primarily realized through future taxable income.



|14. | EMPLOYEE BENEFITS
|--- | -----------------

Profit sharing
planThe Companys profit sharing plan includes substantially all employees. The total contribution to the plan is limited to 10% of the Companys pre-tax net income, subject to Internal Revenue Service limitations.
Contributions to the plan consist of a 401(k) and profit sharing component. The 401(k) contribution is based on a 50% Company match of employee contributions, up to 6 percent of the employees base pay and fully vests after four years of
service. Employee contributions to the 401(k) plan accounts are optional. Contributions to the 401(k) are accrued and funded currently. In 2006, the matching expense for the 401(k) was $1.2 million. The profit sharing contribution is made at the
discretion of the Board of Directors and is based on tiered levels of return on average equity (ROE). The contribution is paid out only when the Bank achieves a minimum 12% ROE. Total profit sharing and matching contribution expense for 2006 and
2004 was approximately $2.2 million and $3.5 million, respectively. During 2005, there was no profit sharing contribution as the Company did not achieve the minimum ROE threshold.

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 3,225,000 shares of common stock. Certain share awards granted under
previous shareholder-approved plans are still outstanding and unvested at December 31, 2006.



F-26



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##### Table of Contents

##### Index to Financial Statements

STERLING BANCSHARES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)

FOR THE YEARS ENDED DECEMBER 31, 2006 2005 AND 2004



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 was $2.2 million, $703 thousand and $840 thousand for the years ended
December 31, 2006, 2005 and 2004, respectively. The total income tax benefit recognized in the income statement for share-based compensation arrangements was $654 thousand, $246 thousand and $294 thousand for the years ended December 31,
2006, 2005 and 2004, respectively.

Cash received for exercises under all share-based payment arrangements during the years ended
December 31, 2006, 2005 and 2004 was $4.9 million, $3.4 million and $2.6 million, respectively. The actual tax benefit realized for the tax deductions under all share-based payment arrangements totaled $620 thousand, $1.0 million and $735
thousand, respectively, for the years ended December 31, 2006, 2005 and 2004.

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:



|                        |  |                 |  |                 |  |                
|----------------------- |  | --------------- |  | --------------- |  | ---------------
|                        |  | 2006            |  | 2005            |  | 2004           
|Expected term (years)   |  | 4.72 - 4.82     |  | 4.33 - 4.99     |  | 4.18 - 4.41    
|Risk-free interest rate |  | 4.34% - 5.23%   |  | 3.70% - 4.36%   |  | 3.19% - 3.49%  
|Historical volatility   |  | 30.01% - 30.38% |  | 19.06% - 28.66% |  | 27.85% - 29.38%
|Dividend yield          |  | 1.39 % - 1.74 % |  | 1.54% - 1.69%   |  | 1.40% - 1.49%  



F-27



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##### Table of Contents

##### Index to Financial Statements

STERLING BANCSHARES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)

FOR THE YEARS ENDED DECEMBER 31, 2006 2005 AND 2004



A summary of changes in outstanding stock options as of December 31, 2006 is as follows:



|                                         |  |                      |   |  |                              |       |                                         |      |                                       |   |      
|---------------------------------------- |  | -------------------- | - |  | ---------------------------- | ----- | --------------------------------------- | ---- | ------------------------------------- | - | -----
|                                         |  | Shares(In thousands) |   |  | WeightedAverageExercisePrice |       | WeightedAverageRemainingContractualTerm |      | AggregateIntrinsicValue(In thousands)
|Shares under option, beginning of period |  | 1,971                |   |  | $                            | 7.30  |                                         |      |                                       |   |      
|Shares granted                           |  | 306                  |   |  |                              | 12.10 |                                         |      |                                       |   |      
|Shares forfeited or expired              |  | (99                  | ) |  |                              | 9.44  |                                         |      |                                       |   |      
|Shares exercised                         |  | (587                 | ) |  |                              | 7.29  |                                         |      |                                       |   |      
|                                         |  |                      |   |  |                              |       |                                         |      |                                       |   |      
|Shares under option, end of period       |  | 1,591                |   |  | $                            | 7.73  |                                         | 4.97 |                                       | $ | 8,432
|                                         |  |                      |   |  |                              |       |                                         |      |                                       |   |      
|Shares exercisable, end of period        |  | 1,266                |   |  | $                            | 6.80  |                                         | 3.66 |                                       | $ | 7,872
|                                         |  |                      |   |  |                              |       |                                         |      |                                       |   |      

The weighted-average grant-date fair value of the options granted during the years ended
December 31, 2006, 2005 and 2004 was $3.55, $2.63 and $2.26. The total intrinsic value of options exercised during the years ended December 31, 2006, 2005 and 2004 was $2.7 million, $1.5 million and $2.1 million.

Share AwardsA summary of the status of the Companys nonvested share awards as of December 31, 2006 is presented below
(shares in thousands):



|                                            |  |        |   |  |                                     |      
|------------------------------------------- |  | ------ | - |  | ----------------------------------- | -----
|                                            |  | Shares |   |  | WeightedAverageGrant DateFair Value
|Nonvested share awards, beginning of period |  | 160    |   |  | $                                   | 9.55 
|Shares granted                              |  | 202    |   |  |                                     | 11.95
|Shares forfeited                            |  | (23    | ) |  |                                     | 9.62 
|Shares vested                               |  | (86    | ) |  |                                     | 10.89
|                                            |  |        |   |  |                                     |      
|Nonvested share awards, end of period       |  | 253    |   |  | $                                   | 11.00
|                                            |  |        |   |  |                                     |      

As of December 31, 2006, there was $2.0 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 2.36 years. The total fair value of shares vested during the year ended December 31, 2006 was $941
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 December 31, 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 3,000 performance-based contingent grants
outstanding at December 31, 2006. There was no unrecognized compensation expense for these grants at December 31, 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



F-28



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##### Table of Contents

##### Index to Financial Statements

STERLING BANCSHARES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)

FOR THE YEARS ENDED DECEMBER 31, 2006 2005 AND 2004



which include equity incentives under the 2003 Stock Plan. The Executive was awarded 187,500 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 187,500 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 December 31, 2006. As of December 31, 2006, there was $2.2 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 three 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) effective July 1, 2004, which superceded the 1994 Employee Stock Purchase Plan (the old ESPP) to eligible employees. An aggregate of 2.3 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 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 year ended December 31, 2006, 35,374 shares were subscribed for through payroll deductions under the Purchase Plan compared to 30,512 shares for the year ended
December 31, 2005.

Under the old ESPP, the employees were given the opportunity to purchase stock outright at time of offering since
the stock price was set in advance of the offer. Under the old ESPP, 7,106 shares were subscribed for through payroll deduction during 2004.



|15. | SHAREHOLDERS EQUITY
|--- | --------------------

Treasury
stock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. On January 29, 2007, the Companys Board of
Directors authorized an increase in the number of shares to be repurchased to adjust for the three-for-two stock split approved by the Board on October 30, 2006. The Company is now authorized to repurchase up to 3,750,000 shares of common stock, not
to exceed 750,000 shares in any calendar year. Under this plan, the Company may repurchase shares of its common stock from time to time in the open market or through privately negotiated transactions. In 2006, the Company repurchased 750,000 shares
at a weighted average cost per share of $11.91, for a total purchase price of $6.7 million.

Preferred stockThe Board
of Directors has approved the sale of convertible preferred stock in series pursuant to confidential private placement memoranda upon the opening of various banking centers. The shares are sold to investors who may assist in the business development
efforts of the opening banking center and are convertible to common shares dependent on that banking center meeting certain performance



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##### Table of Contents

##### Index to Financial Statements

STERLING BANCSHARES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)

FOR THE YEARS ENDED DECEMBER 31, 2006 2005 AND 2004



and deposit growth goals. The conversion ratio into common stock is predetermined at time of placement. On November 7, 2004, each of the 20,000 shares
Series I Preferred Stock, issued on March 7, 2002 in connection to the opening of a Dallas banking center, was converted into one share of common stock based on the performance goals attained.



|16. | EARNINGS PER COMMON SHARE
|--- | -------------------------

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



|                                                                   |  |                         |        |      |   |        |  |   |       
|------------------------------------------------------------------ |  | ----------------------- | ------ | ---- | - | ------ |  | - | ------
|                                                                   |  | Year Ended December 31,
|                                                                   |  | 2006                    |        | 2005 |   | 2004  
|Net income                                                         |  | $                       | 45,840 |      | $ | 36,222 |  | $ | 24,963
|Basic:                                                             |  |                         |        |      |   |        |  |   |       
|Weighted average shares outstanding                                |  |                         | 68,834 |      |   | 67,932 |  |   | 67,259
|Diluted:                                                           |  |                         |        |      |   |        |  |   |       
|Add incremental shares for:                                        |  |                         |        |      |   |        |  |   |       
|Assumed exercise of outstanding options and nonvested share awards |  |                         | 699    |      |   | 710    |  |   | 633   
|Assumed conversion of preferred stock                              |  |                         |       |      |   |       |  |   | 26    
|                                                                   |  |                         |        |      |   |        |  |   |       
|Total                                                              |  | $                       | 69,533 |      | $ | 68,642 |  | $ | 67,918
|                                                                   |  |                         |        |      |   |        |  |   |       
|Earnings per share                                                 |  |                         |        |      |   |        |  |   |       
|Basic                                                              |  | $                       | 0.67   |      | $ | 0.53   |  | $ | 0.37  
|                                                                   |  |                         |        |      |   |        |  |   |       
|Diluted                                                            |  | $                       | 0.66   |      | $ | 0.53   |  | $ | 0.37  
|                                                                   |  |                         |        |      |   |        |  |   |       

The incremental shares for the assumed exercise of the outstanding options were determined by
application of the treasury stock method. The incremental shares for the conversion of the preferred stock were determined assuming applicable performance goals had been met. The calculation of diluted earnings per share excludes 139 thousand,
168 thousand and 328 thousand options outstanding during 2006, 2005, and 2004, respectively, that were anti-dilutive.



|17. | COMMITMENTS AND CONTINGENCIES
|--- | -----------------------------

LeasesA summary as of December 31, 2006, of noncancelable future operating lease commitments is as follows (in thousands):



|           |  |   |       
|---------- |  | - | ------
|2007       |  | $ | 7,539 
|2008       |  |   | 6,682 
|2009       |  |   | 6,119 
|2010       |  |   | 5,773 
|2011       |  |   | 5,226 
|Thereafter |  |   | 34,890
|           |  |   |       
|Total      |  | $ | 66,229
|           |  |   |       

Rent expense under all noncancelable operating lease obligations, net of income from noncancelable
subleases aggregated, was approximately $5.2 million, $4.3 million and $3.4 million for the years ended December 31, 2006, 2005 and 2004, respectively.



F-30



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##### Table of Contents

##### Index to Financial Statements

STERLING BANCSHARES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)

FOR THE YEARS ENDED DECEMBER 31, 2006 2005 AND 2004



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 officers (discussed in Note 14) and certain other executive officers. Under these agreements, 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
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.



|18. | 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):



|                             |  |              |         |      |   |        
|---------------------------- |  | ------------ | ------- | ---- | - | -------
|                             |  | December 31,
|                             |  | 2006         |         | 2005
|Commitments to extend credit |  | $            | 822,209 |      | $ | 832,866
|Standby letters of credit    |  |              | 83,639  |      |   | 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.



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##### Table of Contents

##### Index to Financial Statements

STERLING BANCSHARES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)

FOR THE YEARS ENDED DECEMBER 31, 2006 2005 AND 2004



Off-balance sheet arrangements also include an interest rate swap, an interest rate floor, an
interest rate collar (discussed in Note 12 of this report) and the Companys Trust Preferred Securities (discussed in Note 11 of this report).



|19. | 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 December 31, 2006 and 2005, that Sterling Bancshares and the Bank met all capital adequacy requirements to which they are subject.

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.



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##### Table of Contents

##### Index to Financial Statements

STERLING BANCSHARES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)

FOR THE YEARS ENDED DECEMBER 31, 2006 2005 AND 2004



The Companys consolidated and the Banks capital ratios are presented in the following
table:



|                                         |  |                                           |         |       |                              |   |        |                                                                             |         |  |     |        |  |       |         |  |      |  
|---------------------------------------- |  | ----------------------------------------- | ------- | ----- | ---------------------------- | - | ------ | --------------------------------------------------------------------------- | ------- |  | --- | ------ |  | ----- | ------- |  | ---- | -
|                                         |  | Actual                                    |         |       | For CapitalAdequacy Purposes |   |        | To Be Categorizedas Well CapitalizedUnder PromptCorrective ActionProvisions |        
|                                         |  | Amount                                    |         | Ratio |                              |   | Amount |                                                                             | Ratio   |  |     | Amount |  | Ratio |        
|                                         |  | (In thousands, except percentage amounts) |        
|Consolidated:                            |  |                                           |         |       |                              |   |        |                                                                             |         |  |     |        |  |       |         |  |      |  
|As of December 31, 2006:                 |  |                                           |         |       |                              |   |        |                                                                             |         |  |     |        |  |       |         |  |      |  
|Total capital (to risk weighted assets)  |  | $                                         | 407,079 |       | 10.7                         | % |        | $                                                                           | 303,871 |  | 8.0 | %      |  |       | N/A     |  | N/A  |  
|Tier 1 capital (to risk weighted assets) |  |                                           | 327,991 |       | 8.6                          | % |        |                                                                             | 151,936 |  | 4.0 | %      |  |       | N/A     |  | N/A  |  
|Tier 1 capital (to average assets)       |  |                                           | 327,991 |       | 8.1                          | % |        |                                                                             | 161,111 |  | 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 December 31, 2006:                 |  |                                           |         |       |                              |   |        |                                                                             |         |  |     |        |  |       |         |  |      |  
|Total capital (to risk weighted assets)  |  | $                                         | 401,511 |       | 10.6                         | % |        | $                                                                           | 303,449 |  | 8.0 | %      |  | $     | 379,312 |  | 10.0 | %
|Tier 1 capital (to risk weighted assets) |  |                                           | 322,423 |       | 8.5                          | % |        |                                                                             | 151,725 |  | 4.0 | %      |  |       | 227,587 |  | 6.0  | %
|Tier 1 capital (to average assets)       |  |                                           | 322,423 |       | 8.0                          | % |        |                                                                             | 160,879 |  | 4.0 | %      |  |       | 201,099 |  | 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 December 31, 2006, the entire amount of the $55.3 million of trust
preferred securities outstanding would count as Tier 1 capital. The 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
December 31, 2006.

Dividend restrictionsDividends paid by the Bank are subject to certain restrictions imposed by
regulatory agencies. Under these restrictions there was an aggregate of approximately $98.1 million available for payment of dividends at December 31, 2006 by the Bank. At December 31, 2006 the aggregate amount of dividends, which legally
could be paid without prior approval of various regulatory agencies, totaled approximately $22.2 million by the Bank.



F-33



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##### Table of Contents

##### Index to Financial Statements

STERLING BANCSHARES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)

FOR THE YEARS ENDED DECEMBER 31, 2006 2005 AND 2004



|20. | DISCLOSURES ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS
|--- | -----------------------------------------------------

The estimated fair values of financial instruments were determined by management as of December 31, 2006 and 2005, and required considerable judgment. Accordingly, the estimates presented herein are not necessarily indicative of the
amounts the Company could realize in a current market exchange. The use of different market assumptions and/or estimation methodologies may have a material effect on the estimated fair values presented.

The following methods and assumptions were used to estimate the fair value of cash and of financial instruments for which it is practicable to estimate
that value:

Cash and Short-term investmentsThe carrying amount is a reasonable estimate of fair value.

SecuritiesFair value equals quoted market prices, if available. If a quoted market price is not available, fair value is estimated
using quoted market prices for similar securities.

Trading AssetsSecurities bought with the anticipation of sale in
the near term are carried at fair market value which equals quoted market prices. If a quoted market price is not available, fair value is estimated using quoted market prices for similar securities.

Loans Held for SaleFair value equals quoted market prices, if available. If a quoted market price is not available, the fair value is
estimated by discounting the future cash flows using the current rates at which similar loans would be made to borrowers with similar credit ratings and for the same remaining maturities.

Loans Held for InvestmentThe fair value of loans is estimated by discounting the future cash flows using the current rates at which
similar loans would be made to borrowers with similar credit ratings and for the same remaining maturities.

Deposit
LiabilitiesThe fair value of demand deposits, savings accounts and certain money market deposits is the amount payable on demand at the reporting date. The fair value of certificates of deposit is estimated using the rates currently
offered for deposits of similar remaining maturities.

Subordinated DebtThe subordinated debt is carried at fair value
because this borrowing is hedged fully by an interest rate swap that reprices at market rates on a quarterly basis.

Junior
Subordinated DebtFair value equals quoted market prices, if available. If a quoted market price is not available, fair value is estimated using quoted market prices for similar subordinated debentures.

Short-Term BorrowingsThe carrying amount is a reasonable estimate of fair value because these borrowings reprice at market rates
generally within ninety days.

DerivativesFair value is defined as the amount that the Company would receive or pay to
terminate the contracts at the reporting date. Market quotes are used to value the instruments.

Off-Balance Sheet Financial
InstrumentsThe fair value of commitments is estimated using the fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the present creditworthiness of the counterparties.
For fixed-rate loan commitments, fair value also considers the difference between current levels of interest rates and the committed rates. The fair



F-34



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##### Table of Contents

##### Index to Financial Statements

STERLING BANCSHARES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)

FOR THE YEARS ENDED DECEMBER 31, 2006 2005 AND 2004



value of guarantees and letters of credit is based on fees currently charged for similar agreements or on the estimated cost to terminate them or otherwise
settle the obligations with the counterparties at the reporting date. These amounts were not significant at the reporting dates.

The
estimated fair values of the Companys financial instruments are as follows (in thousands):



|                                |  |                |           |   |                     |   |           |                |  |   |                     |   |  |   |           |  
|------------------------------- |  | -------------- | --------- | - | ------------------- | - | --------- | -------------- |  | - | ------------------- | - |  | - | --------- | -
|                                |  | December 31,   |          
|                                |  | 2006           |           |   | 2005                |  
|                                |  | CarryingAmount |           |   | EstimatedFair Value |   |           | CarryingAmount |  |   | EstimatedFair Value |  
|Financial assets:               |  |                |           |   |                     |   |           |                |  |   |                     |   |  |   |           |  
|Cash and short-term investments |  | $              | 134,973   |   |                     | $ | 134,973   |                |  | $ | 147,253             |   |  | $ | 147,253   |  
|Trading assets                  |  |                |          |   |                     |   |          |                |  |   | 28,515              |   |  |   | 28,515    |  
|Available-for-sale securities   |  |                | 409,351   |   |                     |   | 409,351   |                |  |   | 495,945             |   |  |   | 495,945   |  
|Held-to-maturity securities     |  |                | 164,263   |   |                     |   | 163,535   |                |  |   | 123,053             |   |  |   | 122,015   |  
|Loans held for sale             |  |                | 54,722    |   |                     |   | 54,722    |                |  |   | 8,354               |   |  |   | 8,354     |  
|Loans held for investment       |  |                | 3,077,845 |   |                     |   | 3,130,393 |                |  |   | 2,691,008           |   |  |   | 2,736,886 |  
|Less: allowance for loan losses |  |                | (32,027   | ) |                     |   | (32,027   | )              |  |   | (31,230             | ) |  |   | (31,230   | )
|                                |  |                |           |   |                     |   |           |                |  |   |                     |   |  |   |           |  
|Total                           |  | $              | 3,809,127 |   |                     | $ | 3,860,947 |                |  | $ | 3,462,898           |   |  | $ | 3,507,738 |  
|                                |  |                |           |   |                     |   |           |                |  |   |                     |   |  |   |           |  
|Financial liabilities:          |  |                |           |   |                     |   |           |                |  |   |                     |   |  |   |           |  
|Deposits                        |  | $              | 3,334,611 |   |                     | $ | 3,226,277 |                |  | $ | 2,838,143           |   |  | $ | 2,747,322 |  
|Junior subordinated debt        |  |                | 56,959    |   |                     |   | 56,959    |                |  |   | 82,475              |   |  |   | 82,475    |  
|Subordinated debt               |  |                | 46,135    |   |                     |   | 46,135    |                |  |   | 46,238              |   |  |   | 46,238    |  
|Interest rate swap              |  |                | 3,827     |   |                     |   | 3,827     |                |  |   | 3,718               |   |  |   | 3,718     |  
|Short-term borrowings           |  |                | 220,675   |   |                     |   | 220,672   |                |  |   | 392,850             |   |  |   | 392,786   |  
|                                |  |                |           |   |                     |   |           |                |  |   |                     |   |  |   |           |  
|Total                           |  | $              | 3,662,207 |   |                     | $ | 3,553,870 |                |  | $ | 3,363,424           |   |  | $ | 3,272,539 |  
|                                |  |                |           |   |                     |   |           |                |  |   |                     |   |  |   |           |  



|21. | SUBSEQUENT EVENT
|--- | ----------------

On January 24, 2007, the
Company entered into a definitive agreement to acquire Partners Bank of Texas (Partners Bank). Partners Bank is a privately held bank which operates four banking offices in the Houston area. As of December 31, 2006, Partners Bank had assets of
approximately $186 million, loans of $129 million and deposits totaling $163 million. The consideration of the merger is a combination of stock and cash totaling approximately $52.0 million for all of Partners Banks issued and outstanding
shares of common stock. The merger agreement has been approved by the respective Boards of Directors of the Company and Partners Bank, and the transactions contemplated are subject to the approval of the Partners Banks shareholders. The merger
is subject to customary closing conditions including receipt of regulatory approval and is expected to occur in the first or second quarter of 2007. Additional information regarding this agreement is contained in a Form 8-K, filed with the
Securities and Exchange Commission on January 25, 2007.



F-35



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##### Table of Contents

##### Index to Financial Statements

STERLING BANCSHARES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)

FOR THE YEARS ENDED DECEMBER 31, 2006 2005 AND 2004



|22. | SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED)
|--- | ---------------------------------------------

The
table below sets forth unaudited financial information for each quarter of the last two years (in thousands, except per share amounts):



|                                                      |  |               |        |              |   |               |  |              |        |               |   |              |  |               |        |              |   |        |  |   |        |  |   |       
|----------------------------------------------------- |  | ------------- | ------ | ------------ | - | ------------- |  | ------------ | ------ | ------------- | - | ------------ |  | ------------- | ------ | ------------ | - | ------ |  | - | ------ |  | - | ------
|                                                      |  | 2006          |        | 2005        
|                                                      |  | FourthQuarter |        | ThirdQuarter |   | SecondQuarter |  | FirstQuarter |        | FourthQuarter |   | ThirdQuarter |  | SecondQuarter |        | FirstQuarter
|Interest income                                       |  | $             | 69,863 |              | $ | 64,771        |  | $            | 62,185 |               | $ | 57,912       |  | $             | 57,236 |              | $ | 52,895 |  | $ | 49,340 |  | $ | 45,132
|Interest expense                                      |  |               | 24,467 |              |   | 21,866        |  |              | 19,372 |               |   | 17,220       |  |               | 16,328 |              |   | 14,911 |  |   | 12,795 |  |   | 10,339
|                                                      |  |               |        |              |   |               |  |              |        |               |   |              |  |               |        |              |   |        |  |   |        |  |   |       
|Net interest income                                   |  |               | 45,396 |              |   | 42,905        |  |              | 42,813 |               |   | 40,692       |  |               | 40,908 |              |   | 37,984 |  |   | 36,545 |  |   | 34,793
|Provision for credit losses                           |  |               |       |              |   | 895           |  |              | 1,837  |               |   | 1,326        |  |               | 3,245  |              |   | 4,565  |  |   | 3,221  |  |   | 3,340 
|                                                      |  |               |        |              |   |               |  |              |        |               |   |              |  |               |        |              |   |        |  |   |        |  |   |       
|Net interest income after provision for credit losses |  |               | 45,396 |              |   | 42,010        |  |              | 40,976 |               |   | 39,366       |  |               | 37,663 |              |   | 33,419 |  |   | 33,324 |  |   | 31,453
|Noninterest income                                    |  |               | 8,204  |              |   | 7,504         |  |              | 9,019  |               |   | 6,490        |  |               | 6,559  |              |   | 7,094  |  |   | 6,529  |  |   | 6,777 
|Noninterest expense                                   |  |               | 34,468 |              |   | 32,567        |  |              | 33,193 |               |   | 30,958       |  |               | 28,544 |              |   | 27,712 |  |   | 27,474 |  |   | 26,916
|                                                      |  |               |        |              |   |               |  |              |        |               |   |              |  |               |        |              |   |        |  |   |        |  |   |       
|Income before income taxes                            |  |               | 19,132 |              |   | 16,947        |  |              | 16,802 |               |   | 14,898       |  |               | 15,678 |              |   | 12,801 |  |   | 12,379 |  |   | 11,314
|Provision for income taxes                            |  |               | 6,322  |              |   | 5,218         |  |              | 5,533  |               |   | 4,866        |  |               | 4,416  |              |   | 4,115  |  |   | 3,863  |  |   | 3,556 
|                                                      |  |               |        |              |   |               |  |              |        |               |   |              |  |               |        |              |   |        |  |   |        |  |   |       
|Net income                                            |  | $             | 12,810 |              | $ | 11,729        |  | $            | 11,269 |               | $ | 10,032       |  | $             | 11,262 |              | $ | 8,686  |  | $ | 8,516  |  | $ | 7,758 
|                                                      |  |               |        |              |   |               |  |              |        |               |   |              |  |               |        |              |   |        |  |   |        |  |   |       
|Earnings per share:                                   |  |               |        |              |   |               |  |              |        |               |   |              |  |               |        |              |   |        |  |   |        |  |   |       
|Basic                                                 |  | $             | 0.18   |              | $ | 0.17          |  | $            | 0.17   |               | $ | 0.15         |  | $             | 0.17   |              | $ | 0.13   |  | $ | 0.13   |  | $ | 0.11  
|                                                      |  |               |        |              |   |               |  |              |        |               |   |              |  |               |        |              |   |        |  |   |        |  |   |       
|Diluted                                               |  | $             | 0.18   |              | $ | 0.17          |  | $            | 0.16   |               | $ | 0.15         |  | $             | 0.16   |              | $ | 0.13   |  | $ | 0.12   |  | $ | 0.11  
|                                                      |  |               |        |              |   |               |  |              |        |               |   |              |  |               |        |              |   |        |  |   |        |  |   |       



F-36



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##### Table of Contents

##### Index to Financial Statements

STERLING BANCSHARES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)

FOR THE YEARS ENDED DECEMBER 31, 2006 2005 AND 2004



|23. | PARENT-ONLY FINANCIAL STATEMENTS
|--- | --------------------------------

STERLING
BANCSHARES, INC.

(Parent Company Only)

CONDENSED BALANCE SHEETS

DECEMBER 31, 2006 AND 2005

(In thousands)



|                                                 |  |      |         |   |      |   |         |  
|------------------------------------------------ |  | ---- | ------- | - | ---- | - | ------- | -
|                                                 |  | 2006 |         |   | 2005 |  
|ASSETS                                           |  |      |         |   |      |   |         |  
|Cash and cash equivalents                        |  | $    | 1,582   |   |      | $ | 1,237   |  
|Accrued interest receivable and other assets     |  |      | 4,839   |   |      |   | 3,781   |  
|Investment in subsidiaries                       |  |      | 458,973 |   |      |   | 409,692 |  
|Investment in Sterling Bancshares Capital Trusts |  |      | 1,710   |   |      |   | 2,475   |  
|                                                 |  |      |         |   |      |   |         |  
|TOTAL ASSETS                                     |  | $    | 467,104 |   |      | $ | 417,185 |  
|                                                 |  |      |         |   |      |   |         |  
|LIABILITIES AND SHAREHOLDERS' EQUITY             |  |      |         |   |      |   |         |  
|LIABILITIES:                                     |  |      |         |   |      |   |         |  
|Accrued interest payable and other liabilities   |  | $    | 860     |   |      | $ | 238     |  
|Junior subordinated debt                         |  |      | 56,959  |   |      |   | 82,475  |  
|                                                 |  |      |         |   |      |   |         |  
|Total liabilities                                |  |      | 57,819  |   |      |   | 82,713  |  
|                                                 |  |     
|COMMITMENTS AND CONTINGENCIES                    |  |      |         |   |      |   |         |  
|                                                 |  |     
|SHAREHOLDERS' EQUITY:                            |  |      |         |   |      |   |         |  
|Common stock                                     |  |      | 71,938  |   |      |   | 68,187  |  
|Capital surplus                                  |  |      | 80,927  |   |      |   | 36,028  |  
|Retained earnings                                |  |      | 272,179 |   |      |   | 239,171 |  
|Treasury stock                                   |  |      | (10,902 | ) |      |   | (1,984  | )
|Accumulated other comprehensive loss, net of tax |  |      | (4,857  | ) |      |   | (6,930  | )
|                                                 |  |      |         |   |      |   |         |  
|Total shareholders' equity                       |  |      | 409,285 |   |      |   | 334,472 |  
|                                                 |  |      |         |   |      |   |         |  
|TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY       |  | $    | 467,104 |   |      | $ | 417,185 |  
|                                                 |  |      |         |   |      |   |         |  



F-37



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##### Table of Contents

##### Index to Financial Statements

STERLING BANCSHARES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)

FOR THE YEARS ENDED DECEMBER 31, 2006 2005 AND 2004



STERLING BANCSHARES, INC.

(Parent Company Only)

CONDENSED STATEMENTS OF INCOME

FOR THE YEARS ENDED DECEMBER 31, 2006, 2005 AND 2004

(In thousands)



|                                                                                |  |      |         |   |      |   |        |      |  |   |       
|------------------------------------------------------------------------------- |  | ---- | ------- | - | ---- | - | ------ | ---- |  | - | ------
|                                                                                |  | 2006 |         |   | 2005 |   |        | 2004
|REVENUES:                                                                       |  |      |         |   |      |   |        |      |  |   |       
|Dividends received from bank subsidiaries                                       |  | $    | 78,969  |   |      | $ | 47,170 |      |  | $ | 10,095
|Other income                                                                    |  |      | 173     |   |      |   | 203    |      |  |   | 193   
|                                                                                |  |      |         |   |      |   |        |      |  |   |       
|Total revenues                                                                  |  |      | 79,142  |   |      |   | 47,373 |      |  |   | 10,288
|EXPENSES:                                                                       |  |      |         |   |      |   |        |      |  |   |       
|Interest expense:                                                               |  |      |         |   |      |   |        |      |  |   |       
|Junior subordinated debt                                                        |  |      | 5,571   |   |      |   | 6,933  |      |  |   | 6,431 
|General and administrative                                                      |  |      | 3,350   |   |      |   | 2,580  |      |  |   | 1,666 
|                                                                                |  |      |         |   |      |   |        |      |  |   |       
|Total expenses                                                                  |  |      | 8,921   |   |      |   | 9,513  |      |  |   | 8,097 
|Income before equity in undistributed earnings of subsidiaries and income taxes |  |      | 70,221  |   |      |   | 37,860 |      |  |   | 2,191 
|Equity in undistributed earnings of subsidiaries                                |  |      | (27,410 | ) |      |   | (4,891 | )    |  |   | 20,009
|                                                                                |  |      |         |   |      |   |        |      |  |   |       
|Income before income tax benefit                                                |  |      | 42,811  |   |      |   | 32,969 |      |  |   | 22,200
|Income tax benefit                                                              |  |      | 3,029   |   |      |   | 3,253  |      |  |   | 2,763 
|                                                                                |  |      |         |   |      |   |        |      |  |   |       
|Net income                                                                      |  | $    | 45,840  |   |      | $ | 36,222 |      |  | $ | 24,963
|                                                                                |  |      |         |   |      |   |        |      |  |   |       



F-38



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##### Table of Contents

##### Index to Financial Statements

STERLING BANCSHARES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)

FOR THE YEARS ENDED DECEMBER 31, 2006 2005 AND 2004



STERLING BANCSHARES, INC.

(Parent Company Only)

CONDENSED STATEMENTS OF CASH FLOWS

FOR THE YEARS ENDED DECEMBER 31, 2006, 2005 AND 2004

(In thousands)



|                                                                                  |  |      |         |   |      |   |         |      |  |   |         |  
|--------------------------------------------------------------------------------- |  | ---- | ------- | - | ---- | - | ------- | ---- |  | - | ------- | -
|                                                                                  |  | 2006 |         |   | 2005 |   |         | 2004 | 
|CASH FLOWS FROM OPERATING ACTIVITIES:                                             |  |      |         |   |      |   |         |      |  |   |         |  
|Net income                                                                        |  | $    | 45,840  |   |      | $ | 36,222  |      |  | $ | 24,963  |  
|Adjustments to reconcile net income to net cash provided by operating activities: |  |      |         |   |      |   |         |      |  |   |         |  
|Equity in undistributed earnings of subsidiary                                    |  |      | 27,410  |   |      |   | 4,891   |      |  |   | (20,009 | )
|Change in operating assets and liabilities:                                       |  |      |         |   |      |   |         |      |  |   |         |  
|Accrued interest receivable and other assets                                      |  |      | 2,941   |   |      |   | 448     |      |  |   | (287    | )
|Accrued interest payable and other liabilities                                    |  |      | 948     |   |      |   | 180     |      |  |   | 1       |  
|                                                                                  |  |      |         |   |      |   |         |      |  |   |         |  
|Net cash provided by operating activities                                         |  |      | 77,139  |   |      |   | 41,741  |      |  |   | 4,668   |  
|                                                                                  |  |      |        
|CASH FLOWS FROM INVESTING ACTIVITIES:                                             |  |      |         |   |      |   |         |      |  |   |         |  
|Purchase of BOTH, Inc.                                                            |  |      | (31,730 | ) |      |   |        |      |  |   |        |  
|Purchase of Prestonwood Bancshares, Inc.                                          |  |      |        |   |      |   | (34,638 | )    |  |   |        |  
|Proceeds from sale of Plaza Bank charter                                          |  |      |        |   |      |   |        |      |  |   | 300     |  
|Redemption of investment in Sterling Bancshares Capital Trust II                  |  |      | 889     |   |      |   |        |      |  |   |        |  
|                                                                                  |  |      |         |   |      |   |         |      |  |   |         |  
|Net cash (used in) provided by investing activities                               |  |      | (30,841 | ) |      |   | (34,638 | )    |  |   | 300     |  
|                                                                                  |  |      |        
|CASH FLOWS FROM FINANCING ACTIVITIES:                                             |  |      |         |   |      |   |         |      |  |   |         |  
|Repurchase of common stock                                                        |  |      | (8,918  | ) |      |   | (1,984  | )    |  |   |        |  
|Proceeds from issuance of common stock                                            |  |      | 5,436   |   |      |   | 4,625   |      |  |   | 5,975   |  
|Payments of cash dividends                                                        |  |      | (12,832 | ) |      |   | (10,865 | )    |  |   | (8,968  | )
|Redemption of junior subordinated debentures                                      |  |      | (29,639 | ) |      |   |        |      |  |   |        |  
|                                                                                  |  |      |         |   |      |   |         |      |  |   |         |  
|Net cash used in financing activities                                             |  |      | (45,953 | ) |      |   | (8,224  | )    |  |   | (2,993  | )
|                                                                                  |  |      |         |   |      |   |         |      |  |   |         |  
|NET (DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS                              |  |      | 345     |   |      |   | (1,121  | )    |  |   | 1,975   |  
|                                                                                  |  |      |        
|CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR                                    |  |      | 1,237   |   |      |   | 2,358   |      |  |   | 383     |  
|                                                                                  |  |      |         |   |      |   |         |      |  |   |         |  
|CASH AND CASH EQUIVALENTS AT END OF YEAR                                          |  | $    | 1,582   |   |      | $ | 1,237   |      |  | $ | 2,358   |  
|                                                                                  |  |      |         |   |      |   |         |      |  |   |         |  



F-39