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UNITED STATES SECURITIES AND EXCHANGE COMMISSIONWashington, D.C. 20549

**Form 10-Q**

**[X]**   **QUARTERLY REPORT PURSUANT TO  SECTION 13 OR 15(d) OF THE  SECURITIES EXCHANGE ACT OF 1934**

**For the Quarter Ended September 30, 2000**

**[X]**   **TRANSITION REPORT PURSUANT TO  SECTION 13 OR 15(d) OF THE  SECURITIES EXCHANGE ACT OF 1934**

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**Commission file number:   000-22007**

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**Southwest Bancorporation of Texas, Inc.**(Exact Name of Registrant as Specified in its Charter)
            **Texas**    **76-0519693**            (State or Other Jurisdiction ofIncorporation or Organization)     (I.R.S. EmployerIdentification No.) 
**4400 Post Oak ParkwayHouston, Texas 77027**(Address of Principal Executive Offices, including zip code)

**(713) 235-8800**(Registrant's telephone number, including area code)

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 [  ]

There were 28,652,862 shares of the Registrant's Common Stock  outstanding as of the close of business on November 13, 2000.

 

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**SOUTHWEST BANCORPORATION OF TEXAS, INC. AND SUBSIDIARIES  INDEX TO FORM 10-Q**
  **Page****PART I.   FINANCIAL INFORMATION**    
 Item 1.   Financial Statements 
    
 Report of Independent Accountants
     2  
 Condensed Consolidated Balance Sheet as of September 30, 2000 and          December 31, 1999 (unaudited)
     3  
 Condensed Consolidated Statement of Income for the Three Months Ended          September 30, 2000 and 1999, and for the Nine Months Ended September          30, 2000 and 1999 (unaudited)
     4  
 Condensed Consolidated Statement of Changes in Shareholders' Equity          for the Nine Months Ended September 30, 2000 (unaudited)
     5  
 Condensed Consolidated Statement of Cash Flows for the Nine Months          Ended September 30, 2000 and 1999 (unaudited)
     6  
 Notes to Condensed Consolidated Financial Statements
     7  
 Item 2.   Management's Discussion and Analysis of Financial        Condition and Results of Operations
     9  
 Item 3.   Quantitative and Qualitative Disclosures About        Market Risk
     22 
**PART II.   OTHER INFORMATION**
Item 1.   Legal Proceedings     23 Item 2.   Changes in Securities and Use of Proceeds     23 Item 3.   Default upon Senior Securities     23 Item 4.   Submission of Matters to a Vote of Security Holders     23 Item 5.   Other Information     23 Item 6.   Exhibits and Reports on Form 8-K     23 Signatures     24 
 

**PART I.   FINANCIAL INFORMATION**

**Item 1.   *****Financial Statements***

****REPORT OF INDEPENDENT ACCOUNTANTS**

Board of DirectorsSouthwest Bancorporation of Texas, Inc.:

 We have reviewed the accompanying condensed consolidated balance  sheet of Southwest Bancorporation of Texas, Inc. and Subsidiaries (the “Company”)  as of September 30, 2000, the related condensed consolidated statement  of income for the three- and nine-month periods ended September 30, 2000  and 1999, the condensed consolidated statement of changes in shareholders' equity  for the nine-month period ended September 30, 2000 and the condensed consolidated  statement of cash flows for the nine-month periods ended September 30,  2000 and 1999. These financial statements are the responsibility of the Company's  management.

We conducted our review in accordance with standards established by the American Institute of Certified Public Accountants. A review of interim financial information consists principally of applying analytical procedures to financial dataand making inquiries of persons responsible for financial and accounting matters. It is substantially less in scope than an audit conducted in accordance with generally accepted auditing standards, the objective of which is the expression of an opinionregarding the financial statements taken as a whole. Accordingly, we do not express such an opinion.

Based on our review, we are not aware of any material modifications that should be made to the accompanying condensed consolidated interim financial statements for them to be in conformity with accounting principles generally accepted inthe United States of America.

We have previously audited, in accordance with auditing standards generally accepted in the United States of America, the consolidated balance sheet as of December 31, 1999, and the related consolidated statements of income, ofchanges in shareholders' equity, and of cash flows for the year then ended (not presented herein); and, in our report dated February 11, 2000, we expressed an unqualified opinion on those consolidated financial statements. In our opinion, theinformation set forth in the accompanying condensed consolidated balance sheet as of December 31, 1999, is fairly stated, in all material respects in relation to the consolidated financial statements from which it has been derived.
PricewaterhouseCoopers LLP
Houston, Texas  October 17, 2000

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**SOUTHWEST BANCORPORATION OF TEXAS, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED BALANCE SHEET(In thousands, except share amounts)(unaudited)**

ASSETS
  **September 30,2000** **December 31,1999**Cash and due from banks    $139,936        $148,710 Federal funds sold and other cash equivalents     45,375         20,517                Total cash and cash equivalents     185,311         169,227  Securities — available for sale     648,138         652,539  Loans held for sale     95,515         77,047  Loans held for investment, net     2,158,825         1,817,094  Premises and equipment, net     37,721         31,912  Accrued interest receivable     23,029         17,546  Prepaid expenses and other assets     115,913         86,831                 Total assets    $3,264,452        $2,852,196                 
LIABILITIES AND SHAREHOLDERS' EQUITY
Deposits:         Demand — noninterest-bearing    $701,133        $605,997  Demand — interest-bearing     20,112         30,483  Money market accounts     1,023,609         906,762  Savings     40,104         35,904  Time, $100 and over     576,385         336,974  Other time     273,761         256,634                 Total deposits     2,635,104         2,172,754  Securities sold under repurchase agreements     241,834         216,838  Other borrowings     125,841         248,346  Accrued interest payable     4,347         3,034  Other liabilities     25,782         16,227                 Total liabilities     3,032,908         2,657,199                 Commitments and contingencies         Shareholders' equity:         Common stock — $1 par value, 75,000,000 shares authorized and 28,635,969 issued and outstanding at September 30, 2000 and 50,000,000 shares authorized and 28,018,783 outstanding at December 31, 1999     28,636         28,019  Additional paid-in capital     70,130         63,182  Retained earnings     144,859         115,417  Accumulated other comprehensive loss     (12,081)        (11,621)                Total shareholders' equity     231,544         194,997                 Total liabilities and shareholders' equity    $3,264,452        $2,852,196                
The accompanying notes are an integral part of the condensed  consolidated financial statements.

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**SOUTHWEST BANCORPORATION OF TEXAS, INC. AND SUBSIDIARIESCONDENSED CONSOLIDATED STATEMENT OF INCOME(In thousands, except per share amounts)(unaudited)**
  **Three Months EndedSeptember 30,** **Nine Months EndedSeptember 30,**  **2000** **1999** **2000** **1999**Interest income:                 Loans    $52,757          $36,332          $143,638          $100,886 Securities     10,980           10,922           32,422           33,306 Federal funds sold and other     453           259           1,318           1,411                                      Total interest income     64,190           47,513           177,378           135,603 Interest expense on deposits and otherborrowings     30,193           20,180           80,549           57,866                                      Net interest income     33,997           27,333           96,829           77,737 Provision for loan losses     1,750           1,500           5,000           4,560                                      Net interest income after provision for loan losses     32,247           25,833           91,829           73,177                                      Other income:                 Service charges     3,231           2,620           9,672           7,748 Investment services     1,214           1,062           3,757           3,137 Other fee income     2,010          2,094          5,879          5,269 Other operating income     1,669          1,177          4,337          4,082 Gain (loss) on sale of securities, net     (3)          10           (5)          (139)                                     Total other income     8,121           6,963           23,640           20,097                                      Other expenses:                 Salaries and employee benefits     14,866           12,488           42,583           36,197 Occupancy expense     3,687           3,356           10,530           9,327 Merger-related expenses      —             —             —            4,474 Other operating expenses     5,692           4,839           17,731           14,057                                      Total other expenses     24,245           20,683           70,844           64,055                                      Income before income taxes and minority interest     16,123           12,113           44,625           29,219 Provision for income taxes     5,404           4,305           15,183           10,854                                      Income before minority interest     10,719           7,808           29,442           18,365 Minority interest      —             —             —            (19)                                     Net income available for common shareholders    $10,719          $7,808          $29,442          $18,384                                      Earnings per common share:                 Basic    $0.38          $0.28          $1.04          $0.66                                      Diluted    $0.36          $0.27          $1.00          $0.64                                      
The accompanying notes are an integral part of the condensed  consolidated financial statements.

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**SOUTHWEST BANCORPORATION OF TEXAS, INC. AND SUBSIDARIESCONDENSED CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS' EQUITY(Dollars in thousands, except share amounts)(unaudited)**
  **Common Stock**                  **Shares** **Dollars** **AdditionalPaid-inCapital** **RetainedEarnings** **AccumulatedOtherComprehensiveLoss** **TotalShareholders'Equity****BALANCE, DECEMBER 31, 1999**   28,018,783     $28,019     $63,182     $115,417     $(11,621)    $194,997  Exercise of stock options   617,186     617     6,954             7,571 Deferred compensation amortization            (6)             (6) Comprehensive income:                        Net income for the nine months endedSeptember 30, 2000                29,442         29,442 Net change in unrealized depreciation on securities available for sale, net of deferred taxes of $251                    (460)     (460)                           Total comprehensive income                        28,982                               **BALANCE, SEPTEMBER 30, 2000**   28,635,969    $28,636    $70,130    $144,859    $(12,081)    $231,544                               
The accompanying notes are an integral part of the condensed  consolidated financial statements.

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**SOUTHWEST BANCORPORATION OF TEXAS, INC. AND SUBSIDIARIESCONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS(In thousands)(unaudited)**
  **Nine Months      Ended September 30,**  **2000** **1999** Cash flows from operating activities:          Net income      $ 29,442           $ 18,384  Adjustments to reconcile net income to net      cash provided by (used in) operating activities:          Provision for loan losses       5,000            4,560  Depreciation       5,252            5,217  Realized loss on securities available for      sale, net       5            139  Amortization       1,392            2,797  Minority interest in net loss of consolidated      subsidiary       —              (19 )  Gain on sale of loans, net       (158 )           (444 ) Dividends on Federal Home Loan Bank stock       (751 )           (416 ) Origination of loans held for sale and mortgage      servicing rights       (69,529 )           (115,031 )  Proceeds from sales of loans       45,246            62,848  Increase in accrued interest receivable,      prepaid expenses and other assets       (29,983 )           (23,393 )  Increase in accrued interest payable and      other liabilities       15,154            1,492  Other, net       —              80                     Net cash provided by (used in) operating      activities       1,070            (43,786 )                     Cash flows from investing activities:          Proceeds from maturity of securities available      for sale       4,000            48,372  Principal paydowns of mortgage-backed securities      available for sale       55,758            93,642   Proceeds from sale of securities available      for sale       295,518            237,641  Purchase of securities available for sale       350,929             (351,024 ) Net increase in loans receivable       (346,341 )           (154,458 )  Purchase of premises and equipment       (10,417 )           (7,259 )  Other, net       (696 )           684                     Net cash used in investing activities       (353,107 )           (132,402 )                     Cash flows from financing activities:          Net increase in noninterest-bearing demand      deposits       95,136            19,485  Net increase in time deposits       256,538            14,361  Net increase in other interest-bearing deposits       110,676            91,685  Net increase (decrease) in securities sold      under repurchase agreements       24,996            (22,538 ) Net (decrease) increase in other short-term      borrowings       (118,737 )           38,401  Payments on long term borrowings       (3,768 )           (93 )  Net proceeds from exercise of stock options       3,280            997  Payment of dividends to minority stockholders       —             (328 )                     Net cash provided by financing activities       368,121            141,970                     Net increase (decrease) in cash and cash      equivalents       16,084            (34,218 )  Cash and cash equivalents at beginning of      period       169,227            187,493                      Cash and cash equivalents at end of period      $ 185,311           $ 153,275                    
The accompanying notes are an integral part of the condensed  consolidated financial statements.

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**SOUTHWEST BANCORPORATION OF TEXAS, INC. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS(unaudited)**

**1.   Basis of Presentation**

The condensed consolidated financial statements include the accounts of Southwest Bancorporation of Texas, Inc. (the “Company”) and its direct and indirect wholly-owned subsidiaries Southwest Holding Delaware, Inc. (the “Delaware Company”), Southwest Bank of Texas National Association (the “Bank”), and Mitchell Mortgage Company, LLC (“Mitchell”). These financial statements give retroactive effect to the merger of Fort Bend Holding Corp., (“Fort Bend”) on April 1, 1999 in a transaction accounted for as a pooling of interests. All material intercompany accounts and transactions have been eliminated. In the opinion of management, the unaudited condensed consolidated financialstatements reflect all adjustments, consisting only of normal and recurring adjustments, necessary to present fairly the Company's consolidated financial position at September 30, 2000 and December 31, 1999, consolidated income for the three-month andnine-month periods ended September 30, 2000 and 1999, consolidated cash flows for the nine months ended September 30, 2000 and 1999 and the consolidated changes in shareholders' equity for the nine months ended September 30, 2000. Interimperiod results are not necessarily indicative of results of operations or cash flows for a full-year period.

These financial statements and the notes thereto should be read in conjunction with the Company's annual report on Form 10-K for the year ended December 31, 1999.

PricewaterhouseCoopers LLP is not subject to the liability provisions of Section 11 of the Securities Act of 1933 for their report on the unaudited financial information as of September 30, 2000 and for the three months and nine monthsthen ended, because that report is not a “report” or a “part” of the registration statement prepared or certified by PricewaterhouseCoopers LLP within the meaning of Sections 7 and 11 of the Act.

*New Accounting Pronouncements*

In June 1998, Statement of Financial Accounting Standards (SFAS) No. 133, *Accounting for Derivative Instruments and Hedging Activities,* as amended, was issued by the Financial Accounting Standards Board to establishaccounting and reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts, and for hedging activities. SFAS No. 133 requires that an entity recognize those instruments at fair value. Ifcertain conditions are met, a derivative may be specifically designated as (a)  a hedge of the exposure to changes in the fair value of a recognized asset or liability or an unrecognized firm commitment, (b) a hedge of the exposure to variablecash flows of a forecasted transaction, or (c)  a hedge of the foreign currency exposure of a net investment in a foreign operation, an unrecognized firm commitment, an available-for-sale security, or a foreign-currency-denominated forecastedtransaction. Theaccounting for the changes in the fair value of a derivative depends on the intended use of the derivative and the resulting designation. The standard is effective for all fiscal years beginning after June  15, 2000. The Company does not believeadoption of this pronouncement will materially effect the Company's consolidated financial position, results of operations or cash flows.

In December 1999, the Securities and Exchange Commission issued  Staff Accounting Bulletin No. 101, “Revenue Recognition in Financial  Statements” (SAB No. 101). SAB No. 101, as amended, is required to be implemented  in the fourth quarter of 2000 and is not expected to have a material effect  on the Company's consolidated financial position, results of operations or cash  flows.

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**SOUTHWEST BANCORPORATION OF TEXAS, INC. AND SUBSIDIARIES    NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)  (unaudited)**

**2.   Comprehensive Income**

Comprehensive income consists of the following:
   **Three Months EndedSeptember 30,** **Nine Months EndedSeptember 30,**   **2000** **1999** **2000** **1999**       Net income    $10,719     $7,808     $29,442     $18,384        Net change in unrealized appreciation/(depreciation) on securities available for sale, net of tax     2,973      (4,260)      (460)      (13,358)                                  Total comprehensive income     $13,692     $3,548     $28,982     $5,026                           
**3.   Earnings per Common Share**

Earnings per common share is computed as follows:
   **Three Months EndedSeptember 30,** **Nine Months EndedSeptember 30,**   **2000** **1999** **2000** **1999**   **(In thousands, except per share amounts)**       Net income   $10,719       $7,808         $29,442       $18,384        Minority interest in net loss of Mitchell, net of tax     —           —             —          (19)                                         Net income, adjusted   $10,719       $7,808         $29,442       $18,365                                         Divided by average common shares andcommon share equivalents:                        Average common shares    28,524        27,947          28,310        27,664        Average common shares issuable under the stock option plan    1,268        1,063          1,130        1,037        Average common shares issuable with the conversion of the minority interest of Mitchell     —           —             —          197                                         Total average common shares and commonshare equivalents    29,792        29,010          29,440        28,898                                         Basic earnings per common share   $0.38       $0.28         $1.04       $0.66                                         Diluted earnings per common share   $0.36       $0.27         $1.00       $0.64                                  
**4.   Supplemental Noncash Financing Activities**

During the nine months ended September 30, 2000 and September 30, 1999, the Company reduced its federal current income tax liability by approximately $4.3 million and $706,000, respectively, and recorded a corresponding increaseto additional paid-in capital representing the tax benefit related to the exercise of certain stock options.

**5.   Subsequent Event**

On October 17, 2000, the Company and the Bank entered into an  Agreement and Plan of Merger (the “Merger Agreement”) with Citizens  Bankers, Inc. (“Citizens”), whereby Citizens will merge into the Company.  Citizens is the parent company of Citizens Bank and Trust of Baytown, Texas,  Pasadena State Bank, Baytown State Bank and a majority owner of First National  Bank of Bay City. In connection with the Merger Agreement, the Company has entered  into a separate agreement to acquire all of the assets and liabilities of a  related partnership that owns the office building currently used by Citizens  and its lead bank. The transaction, which is subject to approval of the shareholders  of Citizens and various regulatory authorities, provides for the issuance of  between 4,000,000 and 4,300,000 shares of the Company's common stock for Citizens  and its related partnership depending on the average price of the Company's

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common stock during the period of 15 trading days ending five  business days preceding the closing date of the merger. The number of shares  issued will be determined based on a measurement price of $130 million  provided that the stock price is between $30.2326 and $32.50. An average price  equal to or greater than $32.50 will result in the issuance of 4,000,000 shares  and an average price equal to or less than $30.2326 will result in the issuance  of 4,300,000 shares. An average price between $30.2326 and $32.50 will  result the issuance of a number of shares equal to $130 million divided by the  average share price.

As of September 30, 2000, Citizens had total assets of $425 million, loans of $131 million, and deposits of $374 million. The transaction is expected to be accounted for as a pooling of interests.

**ITEM 2.   *****Management's Discussion and Analysis of Financial Condition and Results of Operations***

****Special Cautionary Notice Regarding Forward-Looking Statements**

Certain of the matters discussed in this document and in documents incorporated by reference herein, including matters discussed under the caption “Management's Discussion and Analysis of Financial Condition and Results ofOperations,” may constitute forward-looking statements for purposes of the Securities Act of 1933, as amended, and the Securities Exchange Act of 1934, as amended, and as such may involve known and unknown risks, uncertainties and other factors whichmay cause the actual results, performance or achievements of Southwest Bancorporation of Texas, Inc. (the “Company”) to be materially different from future results, performance or achievements expressed or implied by such forward-lookingstatements. The words “expect,” “anticipate,” “intend,” “plan,” “believe,” “seek,” “estimate,” and similar expressions are intended to identify such forward-looking statements. TheCompany's actualresults may differ materially from the results anticipated in these forward-looking statements due to a variety of factors, including, without limitation: (a) the effects of future economic conditions on the Company and its customers; (b) governmental monetary and fiscal policies, as well as legislative and regulatory changes; (c) the risks of changes in interest rates on the level and composition of deposits, loan demand, and the values of loan collateral, securities and interestrate protection agreements, as well as interest rate risks; (d) the effects of competition from other commercial banks, thrifts, mortgage banking firms, consumer finance companies, credit unions, securities brokerage firms, insurance companies, moneymarket and other mutual funds and other financial institutions operating in the Company's market area and elsewhere, including institutions operating locally, regionally, nationally and internationally, together with such competitors offering bankingproductsand services by mail, telephone, computer and the Internet; and (e) the failure of assumptions underlying the establishment of reserves for loan losses and estimations of values of collateral and various financial assets and liabilities. All writtenor oral forward-looking statements attributable to the Company are expressly qualified in their entirety by these cautionary statements.

*Overview*

Total assets at September 30, 2000 and December 31, 1999 were $3.26 billion and $2.85 billion, respectively. Gross loans were $2.28 billion at September 30, 2000, an increase of $364.4 million or 19% from$1.91 billion at December 31, 1999. This growth was a result of a strong local economy, and the Company's style of relationship banking. Shareholders' equity was $231.5 million and $195.0 million at September 30, 2000 andDecember 31, 1999, respectively.

For the nine months ended September 30, 2000, net income was $29.4 million ($1.00 per diluted share) compared to $18.4 million ($0.64 per diluted share) for the same period in 1999, an increase of 60%. For the three monthsended September 30, 2000, net income was $10.7 million ($0.36 per diluted share) compared to $7.8 million ($0.27 per diluted share) for the same period in 1999, an increase of 37%. Return on average assets and return on average commonshareholders' equity for the three months ended September 30, 2000 was 1.33%, and 19.23%, respectively.

**Results of Operations**

*   Interest Income*

Interest income for the three months ended September 30,  2000 was $64.2 million, an increase of $16.7 million, or 35% from  the three months ended September 30, 1999. This increase in interest income  is due to a $527.9 million increase in average earning assets to $2.93 billion  for the three months ended September 30, 2000, a 22% increase from the  same period last year. For the nine months ended 

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September 30, 2000, interest income was $177.4 million,  a $41.8 million, or 31% increase from the same period a year ago. This  increase in interest income is due to a $420.5 million increase in average  earning assets to $2.77 billion for the nine months ended September 30,  2000, a 18% increase from the same period last year.

Interest income on loans increased $16.4 million to $52.8 million for the three months ended September 30, 2000. This was due to a $557.7 million increase in average loans outstanding during the same period. Theaverage yield on loans was 9.36% for the three months ended September 30, 2000, an increase of 80 basis points when compared to the same period in 1999. Interest income on securities increased $58,000 from the three month period ended September 30, 1999. This increase was partially due to a $37.4 million decrease in average securities outstanding, down 5% when compared to the three months ended September  30, 1999. Partially offsetting the decrease in average balances was a 41 basispoint increase in the average yield on securities to 6.66% for the three months ended September 30, 2000 when compared to the same period in 1999.

For the nine months ended September 30, 2000, interest income  on loans increased 42% to $143.6 million, up from $100.9 million for  the same period last year. This was due to a $496.8 million increase in  average loans outstanding during the same period. The average yield on loans  was 9.15% for the nine months ended September 30, 2000, an increase of  72 basis points when compared to the same period in 1999. Interest income on  securities decreased to $32.4 million, a decrease of $884,000 or 3% from  the nine month period ended September 30, 1999. This decrease was attributable  to a $66.5 million decrease in average securities outstanding, down 9%  when compared to the nine months ended September 30, 1999. This decrease  was partially offset by an increase in the average yield on securities to 6.69%  for the nine months ended September 30, 2000 compared to 6.24% for the  same period in 1999.

*   Interest Expense*

Interest expense on deposits and other borrowings was $30.2 million for the three months ended September 30, 2000, compared to $20.2 million for the same period in 1999. For the nine months ended September 30, 2000,interest expense on deposits and other borrowings was $80.5 million compared to $57.9 million for the same period a year ago. The increase in interest expense was attributable to a $424.3 million and $343.4 million respective increasein average interest-bearing liabilities for the three- and nine-month comparable periods. The average yield on interest bearing liabilities was 5.25% for the three months ended September 30, 2000, an increase of 95 basis points when compared to thesame period in 1999. For the nine months ended September 30, 2000, the average yield on interest bearing liabilities was 4.96%, an increase of 73 basis points when compared to the same period in 1999.

*   Net Interest Income*

Net interest income was $34.0 million for the three months ended September 30, 2000, compared with $27.3 million for the same period in 1999, an increase of 25%. For the nine months ended September 30, 2000, netinterest income increased 25% from the same period in 1999 to $96.8 million. The increase in net interest income during the three- and nine-months ended September 30, 2000 was largely due to growth in average interest-earning assets, primarilyloans.

The net interest margin was 4.59% for the three months ended September 30,  2000, compared with 4.50% in the second quarter of 1999. This increase resulted  from an increase in the yield on earning assets of 87 basis points from 7.86%  for the three months ended September 30, 1999 to 8.73% for the three months  ended September 30, 2000. This increase in the yield on earning assets  was partially offset by an increase in the cost of funds of 95 basis points,  from 4.30% for the three months ended September 30, 1999, to 5.25% for  the three months ended September 30, 2000. The net interest margin was  4.62% for the nine months ended September 30, 2000, up from 4.41% for the  first nine months of 1999. This increase resulted from an increase in the yield  on earning assets of 83 basis points from 7.71% for the nine months ended September 30,  1999 to 8.54% for the nine months ended September 30, 2000. This increase  in the yield on earning assets was partially offset by an increase in the cost  of funds of 73 basis points, from 4.23% for the nine months ended September 30,  1999, to 4.96% for the nine months ended September 30, 2000.

 

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The following table presents for the periods indicated the total dollar amount of interest income from average interest-earning assets and the resultant yields, as well as the interest expense on average interest-bearing liabilities,expressed both in dollars and rates. No tax equivalent adjustments were made and all average balances are daily average balances. Nonaccruing loans have been included in the table as loans carrying a zero yield.
  **Three Months EndedSeptember 30, 2000** **Three Months EndedSeptember 30, 1999**  **AverageOutstandingBalance** **InterestEarned/Paid** **AverageYield/Rate** **AverageOutstandingBalance** **InterestEarned/Paid** **AverageYield/Rate**  **(Dollars in thousands)**ASSETS                        Interest-earning assets:                         Loans   $2,242,027    $52,757     9.36%    $1,684,357    $36,332     8.56% Securities    656,092     10,980     6.66     693,481     10,922     6.25 Federal funds sold and other    27,507     453     6.55     19,847     259     5.18                                Total interest-earning assets    2,925,626     64,190     8.73%     2,397,685     47,513     7.86%                              Less allowance for loan losses    (23,106)             (18,112)                                    Total earning assets, net ofallowance    2,902,520             2,379,573         Nonearning assets    296,011             237,359                                    Total assets   $3,198,531            $2,616,932                                    LIABILITIES AND SHAREHOLDERS' EQUITY                        Interest-bearing liabilities:                         Money market and savings deposits   $1,067,468     11,739     4.37%    $837,307     7,541     3.57% Certificates of deposits    807,275     12,402     6.11     618,792     7,752     4.97 Repurchase agreements and borrowed funds    412,603     6,052     5.84     406,942     4,887     4.76                                Total interest-bearing liabilities    2,287,346     30,193     5.25%     1,863,041     20,180     4.30%                              Noninterest-bearing liabilities:                         Noninterest-bearing demand deposits    658,142             547,276         Other liabilities    31,337             21,790                                    Total liabilities    2,976,825             2,432,107         Shareholders' equity    221,706             184,825                                    Total liabilities and shareholder's equity   $3,198,531            $2,616,932                                    Net interest income       $33,997            $27,333                                Net interest spread            3.48%             3.56%                            Net interest margin            4.59%             4.50%                            
 

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  **Nine Months EndedSeptember 30, 2000** **Nine Months EndedSeptember 30, 1999**  **AverageOutstandingBalance** **InterestEarned/Paid** **AverageYield/Rate** **AverageOutstandingBalance** **InterestEarned/Paid** **AverageYield/Rate**  **(Dollars in thousands)**ASSETS                        Interest-earning assets:                         Loans   $2,096,618    $143,638     9.15%    $1,599,825    $100,886     8.43% Securities    647,161     32,422     6.69     713,647     33,306     6.24 Federal funds sold and other    29,558     1,318     5.96     39,320     1,411     4.80                                Total interest-earning assets    2,773,337     177,378     8.54%     2,352,792     135,603     7.71%                              Less allowance for loan losses    (21,766)             (16,933)                                    Total earning assets, net ofallowance    2,751,571             2,335,859         Nonearning assets    287,075             218,199                                    Total assets   $3,038,646            $2,554,058                                    LIABILITIES AND SHAREHOLDERS' EQUITY                        Interest-bearing liabilities:                         Money market and savings deposits   $1,051,631     33,128     4.21%    $843,241     22,365     3.55% Certificates of deposits    687,639     29,693     5.77     610,479     22,490     4.93 Repurchase agreements and borrowed funds    431,747     17,728     5.48     373,932     13,011     4.65                                Total interest-bearing liabilities    2,171,017     80,549     4.96%     1,827,652     57,866     4.23%                              Noninterest-bearing liabilities:                         Noninterest-bearing demand deposits    632,687             530,684         Other liabilities    27,764             24,212                                    Total liabilities    2,831,468             2,382,548         Shareholders' equity    207,178             171,510                                    Total liabilities and shareholders' equity   $3,038,646            $2,554,058                                    Net interest income       $96,829            $77,737                                Net interest spread            3.58%             3.48%                            Net interest margin            4.62%             4.41%                            
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The following table presents the dollar amount of changes in interest income and interest expense for the major components of interest-earning assets and interest-bearing liabilities and distinguishes between the increase (decrease)related to outstanding balances, the volatility of interest rates, and the change in number of days due to leap year. For purposes of this table, changes attributable to both rate and volume which cannot be segregated have been allocated.
  **Three Months EndedSeptember 30,** **Nine Months EndedSeptember 30,**  **2000 vs. 1999** **2000 vs. 1999**  **Increase (Decrease) Due to** **Increase (Decrease) Due to**  **Volume** **Rate** **Total** **Volume** **Rate** **Days** **Total**  **(Dollars in thousands)****Interest-earning assets:**                            Loans  $12,029    $4,396    $16,425      $31,482    $10,900    $370    $42,752 Securities   (589)    647     58       (3,114)    2,108     122     (884)Federal funds sold and other   100     94     194       (351)    253     5     (93)                                     Total increase in interest income   11,540     5,137     16,677       28,017     13,261     497     41,775                                      **Interest-bearing liabilities:**                            Money market and savingsdeposits   2,073     2,125     4,198       5,547     5,134     82     10,763 Certificates of deposits   2,361     2,289     4,650       2,853     4,268     82     7,203 Repurchase agreements and borrowed funds   68     1,097     1,165       2,019     2,650     48     4,717                                      Total increase in interest expense   4,502     5,511     10,013       10,419     12,052     212     22,683                                      Increase (decrease) in net interest income  $7,038    $(374)    $6,664      $17,598    $1,209    $285    $19,092                                      
*   Provision for Loan Losses*

The provision for loan losses was $1.8 million for the three months  ended September 30, 2000 as compared to $1.5 million for the three months  ended September 30, 1999. The provision for loan losses was $5.0 million  for the nine months ended September 30, 2000 as compared to $4.6 million for  the nine months ended September 30, 1999. Although no assurance can be given,  management believes that the present allowance for loan losses is adequate considering  loss experience, delinquency trends and current economic conditions. Management  regularly reviews the Company's loan loss allowance as its loan portfolio grows  and diversifies. (See — Financial Condition — Loan Review and Allowance  for Loan Losses.)

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*   Noninterest Income*

Noninterest income for the three months ended September 30, 2000 was $8.1 million, an increase of $1.2 million or 17% over the same period in 1999. Noninterest income for the nine months ended September 30, 2000 was $23.6 million, an increase of 18%, from $20.1 million during the comparable period in 1999. The following table presents for the periods indicated the composition of noninterest income.
   **Three Months EndedSeptember 30,** **Nine Months EndedSeptember 30,**   **2000** **1999** **2000** **1999**   **(Dollars in thousands)**       Service charges on deposit accounts    $3,231         $2,620           $9,672         $7,748        Investment services     1,214          1,062            3,757          3,137        Factoring fee income     1,058          892            2,885          2,234        Loan fee income     739          966            2,311          2,444        Bank-owned life insurance income     405          365            1,254          991        Letters of credit fee income     213          236            683          591        Gain (loss) on sale of securities, net     (3)         10            (5)         (139)       Other income     1,264          812            3,083          3,091                                                Total noninterest income    $8,121         $6,963           $23,640         $20,097                                         
Service charges were $3.2 million for the three months ended September 30, 2000, compared to $2.6 million for the three months ended September 30, 1999, an increase of $611,000 or 23%. Service charges were $9.7 million for the nine months ended September 30, 2000 compared to $7.7 million for the same period in 1999, an increase of $1.9 million, or 25%. The deposit accounts serviced increased to 91,572 at September 30, 2000 from 74,653 atSeptember 30, 1999.

For the three months ended September 30, 2000, investment services income grew to $1.2 million, an increase of 14% over the 1999 level. For the nine months ended September 30, 2000, investment services income grew to$3.8 million or 20% from the $3.1 million level during the 1999 period. This increase is attributable to the expanding international and foreign exchange departments, as well as the continued strategic focus by the Company to increase itscompetitive position in providing investment services.

For the three months ended September 30, 2000, factoring fee income was up $166,000, or 19%. For the nine months ended September 30, 2000, factoring fee income was up $651,000, or 29%.

*   Noninterest Expenses*

For the three months ended September 30, 2000, noninterest expenses totaled $24.2 million, an increase of $3.6 million, or 17%, from $20.7 million during 1999. For the nine months ended September 30, 2000, noninterest expenses totaled$70.8 million, an increase of $6.8 million, or 11%, from the same period in 1999.  Included in noninterest expense for nine months ended September 30, 1999 is $4.5 million in merger-related expenses and other charges (including investment banking fees,other professional fees, and severance expense) in connection with the merger with Fort Bend.

Salaries and employee benefits for the three months ended September 30, 2000 was $14.9 million, an increase of $2.4 million or 19% from the three months ended September 30, 1999. Salaries and employee benefits for the nine months endedSeptember 30, 2000 was $42.6 million, an increase of $6.4 million or 18% from the same period in 1999. This increase was due primarily to hiring of additional personnel required to accommodate the Company's growth. Total full-time employees at September30, 2000 and 1999 were 1,057 and 912, respectively.

Occupancy expense increased $331,000, or 10% to $3.7 million for  the three months ended September 30, 2000. For the nine months ended September  30, 2000, occupancy expense increased $1.2 million, or 13% from the same  period a year ago to $10.5 million. Major categories within occupancy expense  are building lease expense and maintenance contract expense. Building lease  expense increased to $1.1 million 

 

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for the three months ended September 30, 2000 from $888,000 for  the same period in 1999. For the nine months ended September 30, 2000, building  lease expense was $3.1 million, an increase of 24%, or $600,000 from $2.5  million for the first nine months of 1999. This increase resulted from increasing  the rentable square feet at the corporate office to accommodate the Company's  growth. Maintenance contract expense for the three months ended September 30,  2000 was $548,000, a 44% or $167,000 increase from $381,000 for the same period  last year. For the nine months ended September 30, 2000, maintenance contract  expense increased $491,000, or 48%, for the same period a year ago to $1.5 million.  This increase was primarily due to new maintenance contracts purchased for technology  upgrades throughout the organization. The Company purchases maintenance contracts  for major operating systems throughout the organization.

*   Income Taxes*

Income tax expense includes the regular federal income tax at the statutory rate, plus the income tax component of the Texas franchise tax. The amount of federal income tax expense is influenced by the amount of taxable income, the amountof tax-exempt income, the amount of nondeductible interest expense, and the amount of other nondeductible expenses. Taxable income for the income tax component of the Texas franchise tax is the federal pre-tax income, plus certain officer salaries, lessinterest income from federal securities. For the three months ended September 30, 2000, the provision for income taxes was $5.4 million, an increase of $1.1 million or 26% from the $4.3 million provided for the same period in 1999. For the ninemonths ended September 30, 2000, income tax expense was $15.2 million, an increase of $4.3 million or 39% from the $10.9 million provided for the same period in 1999.

**Financial Condition**

*Loans Held for Investment*

Loans were $2.18 billion at September 30, 2000, an increase of $346 million or 18% from $1.84 billion at December 31, 1999.

The following table summarizes the loan portfolio of the Company by type of loan as of September 30, 2000 and December 31, 1999:
   **September 30, 2000** **December 31, 1999**   **Amount** **Percent** **Amount** **Percent**   **(Dollars in thousands)**       Commercial and industrial real estate    $853,285      39.09%       $721,229       39.27%        Real estate:                        Construction and land development     635,572      29.12        494,755       26.94         1-4 family     303,167      13.89        268,349       14.61         Commercial owner occupied     216,107      9.90        185,679       10.11         Farmland     6,384      0.29        13,056       0.71         Other     31,710      1.45        20,447       1.10         Consumer     136,549      6.26        133,295       7.26                                     Gross loans held for investment    $2,182,774      100.0%      $1,836,810       100.0%                             
The primary lending focus of the Company is on small- and medium-sized commercial, construction and land development, residential mortgage and consumer loans. The Company offers a variety of commercial lending products including termloans, lines of credit and equipment financing. A broad range of short- to medium-term commercial loans, both collateralized and uncollateralized, are made available to businesses for working capital (including inventory and receivables), businessexpansion (including acquisitions of real estate and improvements) and the purchase of equipment and machinery. The purpose of a particular loan generally determines its structure.

Generally, the Company's commercial loans are underwritten in  the Company's primary market area on the basis of the borrower's ability to  service such debt from cash flow. As a general practice, the 

 

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Company takes as collateral a lien on any available real estate,  equipment or other assets. Working capital loans are primarily collateralized  by short-term assets whereas term loans are primarily collateralized by long-term  assets.

A substantial portion of the Company's real estate loans consists of loans collateralized by real estate and other assets of commercial customers. Additionally, a portion of the Company's lending activity consists of the origination ofsingle-family residential mortgage loans collateralized by owner-occupied properties located in the Company's primary market area. The Company offers a variety of mortgage loan products which generally are amortized over five to 30 years.

Loans collateralized by single-family residential real estate generally have been originated in amounts of no more than 90% of appraised value. The Company requires mortgage title insurance and hazard insurance in the amount of the loan.Although the contractual loan payment periods for single-family residential real estate loans are generally for a three to five year period, such loans often remain outstanding for significantly shorter periods than their contractual terms.

The Bank originates and purchases residential and commercial mortgage loans to sell to investors with servicing rights retained. The Bank also provides residential and commercial construction financing to builders and developers and actsas a broker in the origination of multi-family and commercial real estate loans.

Consumer loans made by the Company include automobile loans, recreational vehicle loans, boat loans, home improvement loans, personal loans (collateralized and uncollateralized) and deposit account collateralized loans. The terms of theseloans typically range from 12 to 84 months and vary based upon the nature of collateral and size of loan.

The contractual maturity ranges of the commercial and industrial and real estate construction loan portfolio and the amount of such loans with fixed interest rates and floating rates in each maturity range as of September 30, 2000are summarized in the following table:
   **September 30, 2000**   **One YearOr Less** **After OneThroughFive Years** **After Five Years** **Total**   **(Dollars in thousands)**       Commercial and industrial    $568,972     $266,634      $17,679      $853,285        Real estate construction and land development     405,838       194,414       35,320       635,572                                  Total    $974,810     $461,048      $52,999      $1,488,857                                  Loans with a fixed interest rate    $346,260     $155,219      $13,949      $515,428        Loans with a floating interest rate     628,550       305,829       39,050       973,429                                  Total    $974,810     $461,048      $52,999      $1,488,857                           
*Loans Held for Sale*

Loans held for sale of $95.5 million at September 30, 2000 increased from $77.0 million at December 31, 1999. These loans are typically sold to investors within one month of origination. Approximately $42 million of these loanswere previously recorded as loans held for investment and reclassified after the merger of Fort Bend.

*   Loan Review and Allowance for Loan Losses*

The Company's loan review procedures include a Credit Quality  Assurance Process that begins with approval of lending policies and underwriting  guidelines by the Board of Directors, an independent loan review department  staffed with OCC experienced personnel, low individual lending limits for officers,  Senior Loan Committee approval for large credit relationships and quality loan  documentation procedures. The Company also maintains a well developed monitoring  process for credit extensions in excess of 

 

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$100,000. The Company performs monthly and quarterly concentration  analyses based on various factors such as industries, collateral types, business  lines, large credit sizes, international investments and officer portfolio loads.  The Company has established underwriting guidelines to be followed by its officers.  The Company also monitors its delinquency levels for any negative or adverse  trends. There can be no assurance, however, that the Company's loan portfolio  will not become subject to increasing pressures from deteriorating borrower  credits due to general economic conditions.

Historically, the Houston metropolitan area has been affected by the state of the energy business, but since the mid 1980's the economic impact has been reduced by a combination of increased industry diversification and less reliance ondebt to finance expansion. When energy prices fluctuate, it is the Company's practice to review and adjust underwriting standards with respect to companies affected by oil and gas price volatility, and to continuously monitor existing credit exposure tocompanies which are impacted by this price volatility.

The allowance for loan losses is established through charges to earnings in the form of a provision for loan losses. Based on an evaluation of the loan portfolio, management presents a quarterly review of the allowance for loan losses tothe Board of Directors, indicating any changes in the allowance since the last review and any recommendations as to adjustments in the allowance. In making its evaluation, management considers growth in the loan portfolio, the diversification by industryof the Company's commercial loan portfolio, the effect of changes in the local real estate market on collateral values, the results of recent regulatory examinations, the effects on the loan portfolio of current economic indicators and their probableimpact on borrowers, the amount of charge-offs for the period, the amount of nonperforming loans and related collateral security and the evaluation of its loan portfolio by the loan review function. Charge-offs occur when loans are deemed to beuncollectible.

In order to determine the adequacy of the allowance for loan losses, management considers the risk classification or delinquency status of loans and other factors, such as collateral value, portfolio composition, trends in economicconditions and the financial strength of borrowers. Management establishes specific allowances for loans which management believes require reserves greater than those allocated according to their classification or delinquent status. The Company thencharges to operations a provision for loan losses determined on an annualized basis to maintain the allowance for loan losses at an adequate level determined according to the foregoing methodology.

Management believes that the allowance for loan losses at September 30, 2000 is adequate to cover losses inherent in the portfolio as of such date. There can be no assurance, however, that the Company will not sustain losses infuture periods, which could be greater than the size of the allowance at September 30, 2000.

The following table presents, for the periods indicated, an analysis of the allowance for loan losses and other related data:
   **Nine MonthsEndedSeptember 30, 2000** **Year EndedDecember 31,1999**   **(Dollars in thousands)**       Allowance for loan losses beginning of period    $19,716      $14,980         Provision for loan losses     5,000      6,060         Charge-offs     (1,024)      (1,536)        Recoveries     257      212                       Allowance for loan losses end of period    $23,949     $19,716                       Allowance to period-end loans     1.10%      1.07%        Net charge-offs to average loans     0.05%      0.08%        Allowance to period-end nonperforming loans     537.70%      650.91% 
 

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The following table describes the allocation of the allowance  for loan losses among various categories of loans and certain other information  for the dates indicated. Portions of the allowance for loan losses are allocated  to cover the estimated losses inherent in particular risk categories of loans.  The allocation of the allowance for loan losses is based upon the Company's  loss experience over a period of years and is adjusted for subjective factors  such as economic trends, performance trends, portfolio age and concentrations  of credit. 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 segment of loans.
  **September 30, 2000** **December 31, 1999**  **Amount** **Percent ofLoans toTotal Loans** **Amount** **Percent ofLoans toTotal Loans**  **(Dollars in thousands)**Balance of allowance for loan losses applicable to:                 Commercial and industrial    $10,575      39.09%      $10,125       39.27% Real estate:                 Construction and land development     5,784       29.12        4,054       26.94  1-4 family residential     2,600       13.89        2,012       14.61  Commercial owner occupied     1,755       9.90        1,364       10.11  Farmland     42       0.29        89       0.71  Other     1,201       1.45        140       1.10  Consumer     1,992       6.26        1,932       7.26                            Total allowance for loan losses    $23,949       100.0%      $19,716       100.0%                            
*   Nonperforming Assets and Impaired Loans*

The Company generally places a loan on nonaccrual status and ceases  accruing interest when loan payment performance is deemed unsatisfactory. All  loans past due 90 days, however, are placed on nonaccrual status, unless the  loan is both well collateralized and in the process of collection. Cash payments  received while a loan is classified as nonaccrual are recorded as a reduction  of principal as long as doubt exists as to collection. In some instances, the  bank chooses to revise a loan's payment terms and classify the loan as troubled  debt restructuring.

Nonperforming assets were $4.8 million at September 30, 2000 compared with $4.4 million at December 31, 1999. This resulted in a ratio of nonperforming assets to loans plus other real estate of 0.22% and 0.24% atSeptember 30, 2000 and December 31, 1999, respectively.

The following table presents information regarding nonperforming assets as of the dates indicated:
   **September 30,2000** **December 31,1999**   **(Dollars in thousands)**       Nonaccrual loans    $2,770       $2,388         Accruing loans 90 or more days past due     1,684        641         Other real estate and foreclosed property     296        1,337                         Total nonperforming assets    $4,750       $4,366                         Nonperforming assets to total loans and other real estate     0.22%        0.24% 
The Company regularly updates appraisals on loans collateralized by real estate, particularly those categorized as nonperforming loans and potential problem loans. In 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 writedowns or appropriate additions to the allowance for loan losses.

A loan is considered impaired when, based upon current information  and events, it is probable that the Company will be unable to collect the scheduled  payments of principal and interest when due according to the original contractual  terms of the loan agreement. The Company's impaired loans were approximately

 

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$9.0 million and $13.7 million at September 30,  2000 and December 31, 1999, respectively. At December 31, 1999, the largest  component of imparied loans was a commercial energy related loan of approximately  $10.8 million. This loan was not considered impaired at September 30, 2000 as  a result of payments in accordance with terms for a period of at least twelve  months. The largest component of impaired loans at September 30, 2000 is a commercial  loan of approximately $5.4 million specializing in products and services for  fluids handling. The average recorded investment in impaired loans during the  nine months ended September 30, 2000 and the year ended December 31, 1999  was $8.7 million and $13.9 million, respectively. The total required  allowance for loan losses related to these loans was $0 for each reported period.  Interest income on impaired loans of $737,000 and $1.5 million was recognized  for cash payments received during the nine months ended September 30, 2000  and the year ended December 31, 1999, respectively.

*   Securities*

At the date of purchase, the Company classifies debt and equity securities into one of three categories: held to maturity, trading or available for sale. At each reporting date, the appropriateness of the classification is reassessed.Investments in debt securities are classified as held to maturity and measured at amortized cost in the financial statements only if management has the positive intent and ability to hold those securities to maturity. Securities that are bought and heldprincipally for the purpose of selling them in the near term are classified as trading and measured at fair value in the financial statements with unrealized gains and losses included in earnings. Securities not classified as either held to maturity ortrading are classified as available for sale and measured at fair value in the financial statements with unrealized gains and losses reported, net of tax, as a component of accumulated other comprehensive income (loss) until realized. Gains and losses onsales of securities are determined using the specific-identification method. The Company has classified all securities as available for sale at September 30, 2000. This allows the Company to manage its investment portfolio more effectively and toenhance the average yield on the portfolio.

The amortized cost and approximate fair value of securities classified as available for sale is as follows:
  **September 30, 2000**      **Gross Unrealized**      **AmortizedCost** **Gain** **Loss** **FairValue**  **(Dollars in thousands)****Available for Sale**                U.S. Government securities    $101,405         $395         $(1,646)        $100,154 Mortgage-backed securities     518,082          310          (17,799)         500,593 Federal Reserve Bank stock     3,324           —             —            3,324 Federal Home Loan Bank stock     16,437           —             —            16,437 Other securities     27,607          31          (8)         27,630                                      **Total securities available for sale**    $666,855         $736         $(19,453)        $648,138                                        **December 31, 1999**      **Gross Unrealized**      **AmortizedCost** **Gain** **Loss** **FairValue**  **(Dollars in thousands)****Available for Sale**                   U.S. Government securities    $78,527          $35          $(1,567)         $76,995  Mortgage-backed securities     560,471           356           (16,852)          543,975  Federal Reserve Bank stock     2,408            —             —            2,408  Federal Home Loan Bank stock     14,886            —             —            14,886  Other securities     14,253           22            —            14,275                                       **Total securities available for sale**    $670,545          $413          $(18,419)         $652,539                                       
 

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Securities totaled $648.1 million at September 30, 2000,  a decrease of $4.4 million from $652.5 million at December 31, 1999. The yield on the securities portfolio for the nine months ended September 30,2000 was 6.69% while the yield was 6.24% for the nine months ended September 30, 1999.

The Company has no mortgage-backed securities that have been issued by non-agency entities. Included in the Company's mortgage-backed securities at September 30, 2000 were $243.3 million in agency issued collateral mortgageobligations.

At September 30, 2000, $463.1 million of the mortgage-backed securities held by the Company had final maturities of more than 10 years. At September 30, 2000, approximately $43.8 million of the Company'smortgage-backed securities earned interest at floating rates and repriced within one year, and accordingly were less susceptible to declines in value should interest rates increase.

The following table summarizes the contractual maturity of investments (including securities, federal funds sold and interest-bearing deposits) and their weighted average yields at September 30, 2000. The yield on the securitiesportfolio is based on average historical cost balances and does not give effect to changes in fair value that are reflected as a component of other comprehensive income.
  **September 30, 2000**  **WithinOne Year** **After OneYear ButWithinFive Years** **After FiveYears ButWithinTen Years** **AfterTen Years**          **AmortizedCost** **Yield** **AmortizedCost** **Yield** **AmortizedCost** **Yield** **AmortizedCost** **Yield** **Total** **Yield**  **(Dollars in thousands)**U.S. Government securities    $945      6.59%    $100,460      6.27%    $ —        — %    $ —        — %    $101,405      6.28%Mortgage-backed securities     3,520      5.56      17,149      6.90      34,352      6.44      463,061      6.48      518,082      6.48 Federal Reserve Bank stock     3,324      6.00       —        —        —        —        —        —       3,324      6.00 Federal Home Loan Bank stock     16,437      6.60       —        —        —        —        —        —       16,437      6.60 Other securities     16,208      6.26      175      8.03      606      7.00      10,618      7.53      27,607      6.78 Federal funds sold     42,528      6.61       —        —        —        —        —        —       42,528      6.61 Interest-bearing deposits     2,847      6.61       —        —        —        —        —        —       2,847      6.61                                                              Total investments    $85,809      6.47%    $117,784      6.37%    $34,958      6.45%    $473,679      6.50%    $712,230      6.47%                                                             
*   Prepaid Expenses and Other Assets*

Total prepaid expenses and other assets were $115.9 million at September 30, 2000, an increase of $29.1 million from $86.8 million at December 31, 1999. Significant components within prepaid expenses and otherassets include the cash value of bank owned life insurance of $27.7 million and accounts receivable purchased of $25.8 million.

*   Deposits*

The Company offers a variety of deposit accounts having a wide range of interest rates and terms. The Company's deposits consist of demand, savings, NOW accounts, money market and time accounts. The Company relies primarily onadvertising, competitive pricing policies and customer service to attract and retain these deposits. As of September 30, 2000, the Company had less than 6% of its deposits classified as brokered funds and does not anticipate any significant increase.Deposits provide the primary source of funding for the Company's lending and investment activities, and the interest paid for deposits must be managed carefully to control the level of interest expense.

The Company's ratio of average non-interest bearing demand deposits  to average total deposits for the periods ended September 30, 2000 and  December 31, 1999, was 27% for both periods.

 

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The average daily balances and weighted average rates paid on deposits for the nine months ended September 30, 2000 and the year ended December 31, 1999, are presented below:
  **September 30, 2000** **December 31, 1999**   **AverageOutstandingBalance** **Rate** **AverageOutstandingBalance** **Rate**   **(Dollars in thousands)** NOW accounts    $19,977        0.87%         $28,807         2.31%  Regular savings     38,283        2.49          36,201         2.44   Premium Yield     632,057        5.13          472,501         4.24   Money market savings     361,314        2.96          332,525         2.92   CD's less than $100,000     218,297        5.35          221,161         4.92   CD's $100,000 and over     414,685        6.01          345,060         4.97   IRA's, QRP's and other     54,657        5.59          43,201         5.43                                     Total interest-bearing deposits     1,739,270        4.82%          1,479,456         4.17%                            Noninterest-bearing deposits     632,687              543,961                                 Total deposits    $2,371,957             $2,023,417                                 
The following table sets forth the maturity of the Company's time deposits that are $100,000 or greater as of the dates indicated:
   **September 30, 2000** **December 31, 1999**   **(Dollars in thousands)**       3 months or less    $362,421     $177,432         Between 3 months and 6 months     88,265      68,476         Between 6 months and 1 year     89,501      67,388         Over 1 year     36,198      23,678                       Total time deposits $100,000 and over    $576,385     $336,974                
*   Borrowings*

Securities sold under repurchase agreements and other short-term borrowings, consisting of federal funds purchased and other bank borrowings, generally represent borrowings with maturities ranging from one to thirty days. Informationrelating to these borrowings is summarized as follows:
   **September 30,2000** **December 31,1999**   **(Dollars in thousands)**       Securities sold under repurchase agreements:                Average    $206,926         $184,815         Period-end     241,834          216,838         Maximum month-end balance during period     241,834          216,838         Interest rate:                Average     4.60%          4.06%        Period-end     4.89%          4.03%        Other short-term borrowings:                Average    $224,821         $189,929         Period-end     125,841          248,346         Maximum month-end balance during period     371,841          265,440         Interest rate:                Average     6.30%          5.33%        Period-end     6.68%          5.23% 
Securities sold under repurchase agreements are maintained in  safekeeping by correspondent banks.

 

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*   Liquidity and Capital Resources*

Liquidity involves the Company's ability to raise funds to support asset growth or reduce assets to meet deposit withdrawals and other payment obligations, to maintain reserve requirements and otherwise to operate the Company on anongoing basis. For the nine months ended September 30, 2000, the Company's liquidity needs have primarily been met by growth in deposits.

The Company's risk-based capital ratios including Leverage Capital, Tier 1 Risk-Based Capital and the Total Risk-Based Capital Ratio were 7.82%, 9.55% and 10.48%, respectively, at September 30, 2000.

*   Other Matters*

In June 1998, Statement of Financial Accounting Standards (SFAS) No. 133, *Accounting for Derivative Instruments and Hedging Activities,* as amended, was issued by the Financial Accounting Standards Board to establishaccounting and reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts, and for hedging activities. SFAS No. 133 requires that an entity recognize those instruments at fair value. Ifcertain conditions are met, a derivative may be specifically designated as (a)  a hedge of the exposure to changes in the fair value of a recognized asset or liability or an unrecognized firm commitment, (b) a hedge of the exposure to variablecash flows of a forecasted transaction, or (c)  a hedge of the foreign currency exposure of a net investment in a foreign operation, an unrecognized firm commitment, an available-for-sale security, or a foreign-currency-denominated forecastedtransaction. Theaccounting for the changes in the fair value of a derivative depends on the intended use of the derivative and the resulting designation. The standard is effective for all fiscal years beginning after June  15, 2000. The Company does not believeadoption of this pronouncement will materially effect the Company's consolidated financial position, results of operations or cash flows.

In December 1999, the Securities and Exchange Commission issued Staff Accounting Bulletin No. 101, “Revenue Recognition in Financial Statements” (SAB No. 101). SAB No. 101, as amended, is required to be implemented in thefourth quarter of 2000 and is not expected to be material.

**ITEM 3.   *****Quantitative and Qualitative Disclosures About Market Risk.***

**There have been no material changes since December 31,  1999. See the Company's Annual Report on Form 10-K, “Item 7. Management's  Discussion and Analysis of Financial Condition and Results of Operations —  Financial Condition — Interest Rate Sensitivity and Liquidity.”

 

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**PART II — OTHER INFORMATION**

**ITEM 1.   *****Legal Proceedings***

**None.

**ITEM 2.   *****Changes in Securities and Use of Proceeds***

**None.

**ITEM 3.   *****Defaults Upon Senior Securities***

**None.

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

**None.

**ITEM 5.   *****Other Information***

None.

**ITEM 6.   *****Exhibits and Reports on Form 8-K***

**(a)   Exhibits:

Exhibit 2.1 — Purchase Agreement, dated November 9, 2000, among the    Company, Southwest Bank of Texas National Association, Citizens Bankers Limited    Partnership and Baytown Land I, Ltd.

Exhibit 15.1 — Awareness Letter of PricewaterhouseCoopers LLP

Exhibit 27   — Financial Data Schedule

(b)   Reports on Form 8-K

No report on Form 8-K was filed by the Company during the three  months ended September 30, 2000.

 

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**SIGNATURES**

**Pursuant to the requirements of the Securities Exchange Act of 1934, as amended, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.**
**Signature**    **Title**    **Date**      /s/   PAUL B. MURPHY, JR.            **Paul B. Murphy, Jr.**    Chief Executive Officerand President(Principal Executive Officer)     November 13, 2000       /s/   DAVID C. FARRIES            **David C. Farries**    Executive Vice President,Treasurer and Secretary(Principal Financial Officer)     November 13, 2000       /s/   R. JOHN McWHORTER            **R. John McWhorter**    Senior Vice President andController (PrincipalAccounting Officer)     November 13, 2000 
****