Edgar Filing: SOUTHSIDE BANCSHARES INC

form10q.htm

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

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

For the quarterly period ended September 30, 2011

o	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 0-12247

SOUTHSIDE BANCSHARES, INC. (Exact name of registrant as specified in its charter)

TEXAS		75-1848732
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)

1201 S. Beckham, Tyler, Texas		75701
(Address of principal executive offices)		(Zip Code)

903-531-7111

(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 o

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer o	Accelerated filer x
Non-accelerated filer o	Smaller reporting company o
(Do not check if a smaller reporting company)

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No x

The number of shares of the issuer's common stock, par value $1.25, outstanding as of October 31, 2011 was 16,465,690 shares.

TABLE OF CONTENTS

PART I. FINANCIAL INFORMATION
	ITEM 1. FINANCIAL STATEMENTS	1
	ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS	32
	ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK	50
	ITEM 4. CONTROLS AND PROCEDURES	51
PART II. OTHER INFORMATION
	ITEM 1. LEGAL PROCEEDINGS	51
	ITEM 1A.RISK FACTORS	51
	ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS	51
	ITEM 3. DEFAULTS UPON SENIOR SECURITIES	51
	ITEM 4. (REMOVED AND RESERVED)	51
	ITEM 5. OTHER INFORMATION	51
	ITEM 6. EXHIBITS	51
SIGNATURES		53
EXHIBIT INDEX		54
EXHIBIT 31.1 – CERTIFICATION PURSUANT TO SECTION 302
EXHIBIT 31.2 – CERTIFICATION PURSUANT TO SECTION 302
EXHIBIT 32 – CERTIFICATION PURSUANT TO SECTION 906

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PART I. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

SOUTHSIDE BANCSHARES, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(UNAUDITED)

(in thousands, except share amounts)

	September 30,			December 31,
ASSETS	2011			2010
Cash and due from banks	$	42,527		$	56,188
Interest earning deposits		4,604			22,885
Total cash and cash equivalents		47,131			79,073
Investment securities:
Available for sale, at estimated fair value		304,994			299,344
Held to maturity, at amortized cost		1,496			1,495
Mortgage-backed and related securities:
Available for sale, at estimated fair value		1,263,528			946,043
Held to maturity, at amortized cost		389,178			417,862
FHLB stock, at cost		29,057			34,712
Other investments, at cost		2,064			2,064
Loans held for sale		5,491			6,583
Loans:
Loans		1,040,471			1,077,920
Less: allowance for loan losses		(18,189	)		(20,711	)
Net Loans		1,022,282			1,057,209
Premises and equipment, net		50,481			50,144
Goodwill		22,034			22,034
Other intangible assets, net		580			777
Interest receivable		15,957			18,033
Deferred tax asset		–			6,677
Other assets		56,006			57,571
TOTAL ASSETS	$	3,210,279		$	2,999,621
LIABILITIES AND EQUITY
Deposits:
Noninterest bearing	$	477,128		$	423,304
Interest bearing		1,816,632			1,711,124
Total Deposits		2,293,760			2,134,428
Short-term obligations:
Federal funds purchased and repurchase agreements		2,997			3,844
FHLB advances		287,204			189,094
Other obligations		2,226			2,651
Total Short-term obligations		292,427			195,589
Long-term obligations:
FHLB advances		275,458			373,479
Long-term debt		60,311			60,311
Total Long-term obligations		335,769			433,790
Deferred tax liability		7,030			–
Other liabilities		23,150			20,378
TOTAL LIABILITIES		2,952,136			2,784,185

Off-Balance-Sheet Arrangements, Commitments and Contingencies (Note 10)

Shareholders' equity:
Common stock - $1.25 par, 40,000,000 shares authorized, 18,489,528 shares issued in 2011 and 17,660,312 shares issued in 2010		23,112			22,075
Paid-in capital		176,086			162,877
Retained earnings		70,028			64,567
Treasury stock (2,023,838 shares at cost)		(28,377	)		(28,377	)
Accumulated other comprehensive income (loss)		17,294			(6,819	)
TOTAL SHAREHOLDERS' EQUITY		258,143			214,323
Noncontrolling interest		–			1,113
TOTAL EQUITY		258,143			215,436
TOTAL LIABILITIES AND EQUITY	$	3,210,279		$	2,999,621

The accompanying notes are an integral part of these consolidated financial statements.

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SOUTHSIDE BANCSHARES, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF INCOME

(UNAUDITED)

(in thousands, except per share data)

	Three Months					Nine Months
	Ended September 30,					Ended September 30,
	2011		2010			2011			2010
Interest income
Loans	$	16,229	$	16,926		$	50,630		$	52,128
Investment securities – taxable		11		20			49			72
Investment securities – tax-exempt		3,069		2,366			9,507			8,209
Mortgage-backed and related securities		13,292		13,378			37,899			37,937
FHLB stock and other investments		50		59			182			200
Other interest earning assets		2		4			15			19
Total interest income		32,653		32,753			98,282			98,565
Interest expense
Deposits		3,879		4,874			11,966			14,612
Short-term obligations		1,643		2,086			5,077			5,633
Long-term obligations		3,115		4,504			10,397			14,585
Total interest expense		8,637		11,464			27,440			34,830
Net interest income		24,016		21,289			70,842			63,735
Provision for loan losses		1,454		3,201			5,452			9,328
Net interest income after provision for loan losses		22,562		18,088			65,390			54,407
Noninterest income
Deposit services		4,098		4,280			12,005			12,744
Gain on sale of securities available for sale		3,863		8,008			9,672			23,024

Total other-than-temporary impairment losses		–		–			–			(39	)
Portion of loss recognized in other comprehensive income (before taxes)		–		–			–			(36	)
Net impairment losses recognized in earnings		–		–			–			(75	)

Gain on sale of loans		402		517			967			1,197
Trust income		672		645			1,968			1,736
Bank owned life insurance income		288		297			835			867
Other		957		931			3,021			2,728
Total noninterest income		10,280		14,678			28,468			42,221
Noninterest expense
Salaries and employee benefits		11,280		10,891			34,593			33,048
Occupancy expense		1,866		1,720			5,365			5,025
Equipment expense		540		532			1,558			1,441
Advertising, travel & entertainment		591		616			1,694			1,697
ATM and debit card expense		235		223			716			602
Director fees		193		197			584			590
Supplies		186		189			571			665
Professional fees		571		418			1,583			1,363
Postage		178		195			543			612
Telephone and communications		285		349			967			1,068
FDIC Insurance		212		804			1,710			2,172
Other		1,559		1,521			4,660			4,803
Total noninterest expense		17,696		17,655			54,544			53,086

Income before income tax expense		15,146		15,111			39,314			43,542
Provision for income tax expense		3,629		3,811			8,086			10,296
Net income		11,517		11,300			31,228			33,246
Less: Net income attributable to the noncontrolling interest		–		(252	)		(1,358	)		(1,301	)
Net income attributable to Southside Bancshares, Inc.	$	11,517	$	11,048		$	29,870		$	31,945
Earnings per common share – basic	$	0.70	$	0.67		$	1.82		$	1.93
Earnings per common share – diluted	$	0.70	$	0.67		$	1.82		$	1.93
Dividends paid per common share	$	0.18	$	0.17		$	0.52		$	0.51

The accompanying notes are an integral part of these consolidated financial statements.

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SOUTHSIDE BANCSHARES, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CHANGES IN EQUITY

(UNAUDITED)

(in thousands, except share amounts)

	Nine Months Ended September 30,
	2011			2010
Common Stock
Balance, beginning of period	$	22,075		$	20,928
Issuance of common stock (44,352 shares in 2011 and 136,419 shares in 2010)		56			171
Stock dividend declared		981			943
Balance, end of period		23,112			22,042
Paid-in capital
Balance, beginning of period		162,877			146,357
Issuance of common stock (44,352 shares in 2011 and 136,419 shares in 2010)		804			1,080
Stock compensation expense		143			–
Tax benefit of incentive stock options		2			328
Purchase of noncontrolling interest		(2,754	)		–
Stock dividend declared		15,014			14,570
Balance, end of period		176,086			162,335
Retained earnings
Balance, beginning of period		64,567			53,812
Net income attributable to Southside Bancshares, Inc.		29,870			31,945
Dividends paid on common stock ($0.52 per share in 2011 and $0.51 per share in 2010)		(8,414	)		(7,916	)
Stock dividend declared		(15,995	)		(15,513	)
Balance, end of period		70,028			62,328
Treasury Stock
Balance, beginning of period		(28,377	)		(23,545	)
Purchase of common stock (255,377 shares in 2010)		–			(4,716	)
Balance, end of period		(28,377	)		(28,261	)
Accumulated other comprehensive income (loss)
Balance, beginning of period		(6,819	)		4,229
Net unrealized gains on available for sale securities, net of tax		29,707			13,669
Reclassification adjustment for gains on sales of available for sale securities included in net income, net of tax		(6,287	)		(14,966	)
Noncredit portion of other-than-temporary impairment losses on available for sale securities, net of tax		–			23
Reclassification of other-than-temporary impairment charges on available for sale securities included in net income, net of tax		–			49
Adjustment to net periodic benefit cost, net of tax		693			611
Net change in accumulated other comprehensive income (loss)		24,113			(614	)
Balance, end of period		17,294			3,615
Total shareholders’ equity		258,143			222,059
Noncontrolling interest
Balance, beginning of period		1,113			468
Net income attributable to noncontrolling interest shareholders		1,358			1,301
Capital distribution to noncontrolling interest shareholders		(475	)		(310	)
Purchase of noncontrolling interest		(1,996	)		–
Balance, end of period		–			1,459
Total equity	$	258,143		$	223,518

Comprehensive income
Net income	$	31,228		$	33,246
Net change in accumulated other comprehensive income (loss)		24,113			(614	)
Comprehensive income		55,341			32,632
Comprehensive income attributable to the noncontrolling interest		(1,358	)		(1,301	)
Comprehensive income attributable to Southside Bancshares, Inc.	$	53,983		$	31,331

The accompanying notes are an integral part of these consolidated financial statements.

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SOUTHSIDE BANCSHARES, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(UNAUDITED)

(in thousands)

	Nine Months Ended September 30,
	2011			2010

OPERATING ACTIVITIES:
Net income	$	31,228		$	33,246
Adjustments to reconcile net income to net cash provided by operations:
Depreciation		2,515			2,397
Amortization of premium		26,175			25,982
Accretion of discount and loan fees		(3,386	)		(3,497	)
Provision for loan losses		5,452			9,328
Stock compensation expense		143			–
Decrease in interest receivable		2,076			3,417
Increase in other assets		(2,413	)		(4,726	)
Net change in deferred taxes		723			998
Decrease in interest payable		(861	)		(696	)
Increase in other liabilities		3,598			3,504
Decrease (increase) in loans held for sale		1,092			(3,241	)
Gain on sale of securities available for sale		(9,672	)		(23,024	)
Net other-than-temporary impairment losses		–			75
Loss (gain) on sale of assets		3			(7	)
Loss on retirement of assets		90			–
Impairment on other real estate owned		184			20
Gain on sale of other real estate owned		(242	)		(26	)
Net cash provided by operating activities		56,705			43,750

INVESTING ACTIVITIES:
Proceeds from sales of investment securities available for sale		54,351			103,953
Proceeds from sales of mortgage-backed securities available for sale		642,943			956,496
Proceeds from maturities of investment securities available for sale		15,622			17,271
Proceeds from maturities of investment securities held to maturity		500			–
Proceeds from maturities of mortgage-backed securities available for sale		209,828			263,335
Proceeds from maturities of mortgage-backed securities held to maturity		35,376			55,656
Proceeds from redemption of FHLB stock		16,461			2,638
Purchases of investment securities available for sale		(42,576	)		(75,697	)
Purchases of investment securities held to maturity		(500	)		–
Purchases of mortgage-backed securities available for sale		(1,177,556	)		(1,026,453	)
Purchases of mortgage-backed securities held to maturity		(11,375	)		(258,935	)
Purchases of FHLB stock and other investments		(10,806	)		(139	)
Net decrease (increase) in loans		27,344			(15,193	)
Purchases of premises and equipment		(2,951	)		(5,582	)
Proceeds from sales of premises and equipment		6			38
Proceeds from sales of other real estate owned		676			948
Proceeds from sales of repossessed assets		3,933			3,713
Net cash (used in) provided by investing activities		(238,724	)		22,049

The accompanying notes are an integral part of these consolidated financial statements.

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SOUTHSIDE BANCSHARES, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS (continued)

(UNAUDITED)

(in thousands)

	Nine Months Ended September 30,
	2011			2010
FINANCING ACTIVITIES:
Net increase in demand and savings accounts		133,513			117,405
Net increase in certificates of deposit		30,099			49,927
Net decrease in federal funds purchased and repurchase agreements		(847	)		(9,514	)
Proceeds from FHLB advances		8,005,080			6,119,530
Repayment of FHLB advances		(8,004,991	)		(6,304,778	)
Net capital distributions to noncontrolling interest in consolidated entities		(475	)		(310	)
Purchase of noncontrolling interest		(4,750	)		–
Tax benefit of incentive stock options		2			328
Purchase of common stock		–			(4,716	)
Proceeds from the issuance of common stock		860			1,251
Dividends paid		(8,414	)		(7,916	)
Net cash provided by (used in) financing activities		150,077			(38,793	)

Net (decrease) increase in cash and cash equivalents		(31,942	)		27,006
Cash and cash equivalents at beginning of period		79,073			52,166
Cash and cash equivalents at end of period	$	47,131		$	79,172

SUPPLEMENTAL DISCLOSURES FOR CASH FLOW INFORMATION:
Interest paid	$	28,301		$	35,525
Income taxes paid		6,500			9,550

SUPPLEMENTAL DISCLOSURES OF NONCASH INVESTING AND FINANCING ACTIVITIES:
Acquisition of other repossessed assets and real estate through foreclosure	$	4,790		$	5,416
5% stock dividend		15,995			15,513
Adjustment to pension liability		(1,066	)		(939	)
Unsettled trades to purchase securities		–			(18,160	)
Unsettled trades to sell securities		–			18,723

The accompanying notes are an integral part of these consolidated financial statements.

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SOUTHSIDE BANCSHARES, INC. AND SUBSIDIARIES

NOTES TO FINANCIAL STATEMENTS

1.	Basis of Presentation

In this report, the words “the Company,” “we,” “us,” and “our” refer to the combined entities of Southside Bancshares, Inc. and its subsidiaries. The words “Southside” and “Southside Bancshares” refer to Southside Bancshares, Inc. The words “Southside Bank” and “the Bank” refer to Southside Bank (which, subsequent to the internal merger of Fort Worth National Bank (“FWNB”) with and into Southside Bank, includes FWNB). “FWBS” refers to Fort Worth Bancshares, Inc., a bank holding company acquired by Southside of which FWNB was a wholly-owned subsidiary. “SFG” refers to Southside Financial Group, LLC, of which Southside Bank owns a 100% interest as of September 30, 2011. On July 15, 2011, Southside Bank acquired the remaining 50% interest in SFG increasing our ownership to 100%. The purchase price was $4.8 million and resulted in a decrease to shareholders’ equity of approximately $2.8 million and the elimination of the noncontrolling interest. SFG is consolidated in our financial statements and this purchase will not limit or change our ability to allocate capital.

The consolidated balance sheet as of September 30, 2011, and the related consolidated statements of income, equity and cash flows and notes to the financial statements for the three and nine month periods ended September 30, 2011 and 2010 are unaudited; in the opinion of management, all adjustments necessary for a fair statement of such financial statements have been included. Such adjustments consisted only of normal recurring items. All significant intercompany accounts and transactions are eliminated in consolidation. The preparation of these consolidated financial statements in conformity with U.S. generally accepted accounting principles (“GAAP”) requires the use of management’s estimates. These estimates are subjective in nature and involve matters of judgment. Actual amounts could differ from these estimates.

Interim results are not necessarily indicative of results for a full year. These financial statements should be read in conjunction with the financial statements and notes thereto in our Annual Report on Form 10-K for the year ended December 31, 2010. All share data has been adjusted to give retroactive recognition to stock splits and stock dividends. For a description of our significant accounting and reporting policies, refer to Note 1 of the Notes to Financial Statements in our Annual Report on Form 10-K for the year ended December 31, 2010.

Accounting Standards

ASU No. 2011-01, “Deferral of the Effective Date of Disclosures about Troubled Debt Restructurings in Update No. 2010-20 (Topic 310)”, was issued January 2011 deferring the new disclosure requirements (paragraphs 310-10-50-31 through 50-34 of the FASB Accounting Standards Codification) about troubled debt restructurings to be concurrent with the effective date of the guidance for determining what constitutes a troubled debt restructuring, as presented in proposed Accounting Standards Update, Receivables (Topic 310): Clarifications to Accounting for Troubled Debt Restructurings by Creditors. As a result of the issuance of Update 2011-02, the provisions of Update 2011-01 became effective for us on September 30, 2011, and was applied retrospectively to the beginning of the annual period of adoption. The adoption of the Update did not have a material effect on our consolidated financial statements.

ASU No. 2011-02, “Receivables (Topic 310) - A Creditor’s Determination of Whether a Restructuring Is a Troubled Debt Restructuring.” ASU 2011-02 clarifies which loan modifications constitute troubled debt restructurings and is intended to assist creditors in determining whether a modification of the terms of a receivable meets the criteria to be considered a troubled debt restructuring, both for purposes of recording an impairment loss and for disclosure of troubled debt restructurings. In evaluating whether a restructuring constitutes a troubled debt restructuring, a creditor must separately conclude, under the guidance clarified by ASU 2011-02, that both of the following exist: (a) the restructuring constitutes a concession; and (b) the debtor is experiencing financial difficulties. ASU 2011-02 became effective for us on July 1, 2011, and was applied retrospectively to restructurings occurring on or after January 1, 2011. The adoption of ASU 2011-02 did not have a significant impact on our consolidated financial statements.

ASU No. 2011-03, “Transfers and Servicing (Topic 860) - Reconsideration of Effective Control for Repurchase Agreements.” ASU 2011-03 is intended to improve financial reporting of repurchase agreements and other agreements that both entitle and obligate a transferor to repurchase or redeem financial assets before their maturity. ASU 2011-03 removes from the assessment of effective control (i) the criterion requiring the transferor to have the ability to repurchase or redeem the financial assets on substantially the agreed terms, even in the event of default by the transferee, and (ii) the collateral maintenance guidance related to that criterion. ASU 2011-03 will be effective for us on January 1, 2012 and is not expected to have a significant impact on our consolidated financial statements.

ASU 2011-04, “Fair Value Measurement (Topic 820) - Amendments to Achieve Common Fair Value Measurements and Disclosure Requirements in U.S. GAAP and IFRSs.” ASU 2011-04 amends Topic 820, “Fair Value Measurements and Disclosures,” to converge the fair value measurement guidance in U.S. generally accepted accounting principles and International Financial Reporting Standards. ASU 2011-04 clarifies the application of existing fair value measurement requirements, changes certain principles in Topic 820 and requires additional fair value disclosures. ASU 2011-04 is effective for annual periods beginning after December 15, 2011, and is not expected to have a significant impact on our consolidated financial statements.

ASU 2011-05, “Comprehensive Income (Topic 220) - Presentation of Comprehensive Income.” ASU 2011-05 amends Topic 220, “Comprehensive Income,” to require that all nonowner changes in stockholders’ equity be presented in either a single continuous statement of comprehensive income or in two separate but consecutive statements. Additionally, ASU 2011-05 requires entities to present, on the face of the financial statements, reclassification adjustments for items that are reclassified from other comprehensive income to net income in the statement or statements where the components of net income and the components of other comprehensive income are presented. The option to present components of other comprehensive income as part of the statement of changes in stockholders’ equity was eliminated. ASU 2011-05 is effective for annual periods beginning after December 15, 2011, and is not expected to have a significant impact on our consolidated financial statements.

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ASU 2011-08, “Intangibles - Goodwill and Other (Topic 350) - Testing Goodwill for Impairment.” ASU 2011-08 amends Topic 350, “Intangibles – Goodwill and Other,” to give entities the option to first assess qualitative factors to determine whether the existence of events or circumstances leads to a determination that it is more likely than not that the fair value of a reporting unit is less than its carrying amount. If, after assessing the totality of events or circumstances, an entity determines it is not more likely than not that the fair value of a reporting unit is less than its carrying amount, then performing the two-step impairment test is unnecessary. However, if an entity concludes otherwise, then it is required to perform the first step of the two-step impairment test by calculating the fair value of the reporting unit and comparing the fair value with the carrying amount of the reporting unit. ASU 2011-08 is effective for annual and interim impairment tests beginning after December 15, 2011, and is not expected to have a significant impact on our consolidated financial statements.

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2.	Earnings Per Share

Earnings per share attributable to Southside Bancshares, Inc. on a basic and diluted basis have been adjusted to give retroactive recognition to stock splits and stock dividends and is calculated as follows (in thousands, except per share amounts):

	Three Months				Nine Months
	Ended September 30,				Ended September 30,
	2011		2010		2011		2010
Basic and Diluted Earnings:
Net income – Southside Bancshares, Inc.	$	11,517	$	11,048	$	29,870	$	31,945

Basic weighted-average shares outstanding		16,454		16,543		16,439		16,563
Add: Stock options		7		10		7		35
Diluted weighted-average shares outstanding		16,461		16,553		16,446		16,598

Basic Earnings Per Share:
Net Income - Southside Bancshares, Inc.	$	0.70	$	0.67	$	1.82	$	1.93

Diluted Earnings Per Share:
Net Income - Southside Bancshares, Inc.	$	0.70	$	0.67	$	1.82	$	1.93

On March 31, 2011, our board of directors declared a 5% stock dividend to common stock shareholders of record as of April 20, 2011, and payable on May 11, 2011.

During the second quarter, our board of directors approved equity grants in the form of stock options and restricted stock units. These equity grants were made pursuant to the shareholder-approved Southside Bancshares, Inc. 2009 Incentive Plan.

For the three and nine month periods ended September 30, 2011, there were approximately 28,000 and 9,000 antidilutive options, respectively. For the three and nine months ended September 30, 2010, there were no antidilutive options.

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3.	Comprehensive Income (Loss)

The components of other comprehensive income (loss) are as follows (in thousands):

	Nine Months Ended September 30, 2011
	Before-Tax		Tax			Net-of-Tax
	Amount		Expense			Amount
Unrealized gains on securities:
Unrealized holding gains arising during period	$	45,703	$	(15,996	)	$	29,707
Less: reclassification adjustment for gains included in net income		9,672		(3,385	)		6,287
Net unrealized gains on securities		36,031		(12,611	)		23,420
Change in pension plans		1,066		(373	)		693
Other comprehensive income	$	37,097	$	(12,984	)	$	24,113

	Three Months Ended September 30, 2011
	Before-Tax		Tax			Net-of-Tax
	Amount		Expense			Amount
Unrealized gains on securities:
Unrealized holding gains arising during period	$	18,050	$	(6,318	)	$	11,732
Less: reclassification adjustment for gains included in net income		3,863		(1,352	)		2,511
Net unrealized gains on securities		14,187		(4,966	)		9,221
Change in pension plans		355		(124	)		231
Other comprehensive income	$	14,542	$	(5,090	)	$	9,452

	Nine Months Ended September 30, 2010
	Before-Tax			Tax (Expense)			Net-of-Tax
	Amount			Benefit			Amount
Unrealized losses on securities:
Unrealized holding gains arising during period	$	21,029		$	(7,360	)	$	13,669
Noncredit portion of other-than-temporary impairment losses on the AFS securities		36			(13	)		23
Less: reclassification adjustment for gains included in net income		23,024			(8,058	)		14,966
Less: reclassification of other-than-temporary impairment charges on AFS securities included in net income		(75	)		26			(49	)
Net unrealized losses on securities		(1,884	)		659			(1,225	)
Change in pension plans		939			(328	)		611
Other comprehensive loss	$	(945	)	$	331		$	(614	)

	Three Months Ended September 30, 2010
	Before-Tax			Tax (Expense)			Net-of-Tax
	Amount			Benefit			Amount
Unrealized losses on securities:
Unrealized holding gains arising during period	$	7,170		$	(2,509	)	$	4,661
Noncredit portion of other-than-temporary impairment losses on the AFS securities		–			–			–
Less: reclassification adjustment for gains included in net income		8,008			(2,802	)		5,206
Less: reclassification of other-than-temporary impairment charges on AFS securities included in net income		–			–			–
Net unrealized losses on securities		(838	)		293			(545	)
Change in pension plans		313			(109	)		204
Other comprehensive loss	$	(525	)	$	184		$	(341	)

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4.	Securities

The amortized cost and estimated market value of investment and mortgage-backed securities as of September 30, 2011 and December 31, 2010, are reflected in the tables below (in thousands):

	September 30, 2011
			Gross		Gross Unrealized Losses
	Amortized		Unrealized		Noncredit				Estimated
AVAILABLE FOR SALE:	Cost		Gains		OTTI		Other		Fair Value
Investment Securities:
State and Political Subdivisions	$	275,170	$	28,906	$	–	$	29	$	304,047
Other Stocks and Bonds		2,925		–		1,978		–		947
Mortgage-backed Securities:
U.S. Government Agencies		145,247		7,283		–		114		152,416
Government-Sponsored Enterprises		1,095,417		20,949		–		5,254		1,111,112
Total	$	1,518,759	$	57,138	$	1,978	$	5,397	$	1,568,522

	September 30, 2011
			Gross		Gross Unrealized Losses
	Amortized		Unrealized		Noncredit				Estimated
HELD TO MATURITY:	Cost		Gains		OTTI		Other		Fair Value
Investment Securities:
State and Political Subdivisions	$	1,011	$	188	$	–	$	–	$	1,199
Other Stocks and Bonds		485		18		–		–		503
Mortgage-backed Securities:
U.S. Government Agencies		24,675		1,374		–		75		25,974
Government-Sponsored Enterprises		364,503		14,412		–		10		378,905
Total	$	390,674	$	15,992	$	–	$	85	$	406,581

	December 31, 2010
			Gross		Gross Unrealized Losses
	Amortized		Unrealized		Noncredit				Estimated
AVAILABLE FOR SALE:	Cost		Gains		OTTI		Other		Fair Value
Investment Securities:
U.S. Treasury	$	4,700	$	–	$	–	$	–	$	4,700
State and Political Subdivisions		296,357		4,445		–		6,540		294,262
Other Stocks and Bonds		3,117		1		2,736		–		382
Mortgage-backed Securities:
U.S. Government Agencies		149,402		5,311		–		179		154,534
Government-Sponsored Enterprises		777,921		16,049		–		2,461		791,509
Total	$	1,231,497	$	25,806	$	2,736	$	9,180	$	1,245,387

	December 31, 2010
			Gross		Gross Unrealized Losses
	Amortized		Unrealized		Noncredit				Estimated
HELD TO MATURITY:	Cost		Gains		OTTI		Other		Fair Value
Investment Securities:
State and Political Subdivisions	$	1,012	$	44	$	–	$	–	$	1,056
Other Stocks and Bonds		483		14		–		–		497
Mortgage-backed Securities:						–
U.S. Government Agencies		21,888		631		–		55		22,464
Government-Sponsored Enterprises		395,974		8,743		–		609		404,108
Total	$	419,357	$	9,432	$	–	$	664	$	428,125

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The following table represents the unrealized loss on securities for the nine months ended September 30, 2011 and year ended December 31, 2010 (in thousands):

	Less Than 12 Months				More Than 12 Months				Total
			Unrealized				Unrealized				Unrealized
	Fair Value		Loss		Fair Value		Loss		Fair Value		Loss
As of September 30, 2011:

Available for Sale
State and Political Subdivisions	$	925	$	12	$	293	$	17	$	1,218	$	29
Other Stocks and Bonds		–		–		947		1,978		947		1,978
Mortgage-Backed Securities		533,508		5,290		6,444		78		539,952		5,368
Total	$	534,433	$	5,302	$	7,684	$	2,073	$	542,117	$	7,375

Held to Maturity
Mortgage-Backed Securities	$	8,661	$	85	$	–	$	–	$	8,661	$	85
Total	$	8,661	$	85	$	–	$	–	$	8,661	$	85

As of December 31, 2010:

Available for Sale
State and Political Subdivisions	$	136,671	$	6,501	$	270	$	39	$	136,941	$	6,540
Other Stocks and Bonds		–		–		189		2,736		189		2,736
Mortgage-Backed Securities		312,985		2,475		21,779		165		334,764		2,640
Total	$	449,656	$	8,976	$	22,238	$	2,940	$	471,894	$	11,916

Held to Maturity
Mortgage-Backed Securities	$	52,676	$	644	$	1,104	$	20	$	53,780	$	664
Total	$	52,676	$	644	$	1,104	$	20	$	53,780	$	664

When it is determined that a decline in fair value of Held to Maturity (“HTM”) and Available for Sale (“AFS”) securities is other-than-temporary, the carrying value of the security is reduced to its estimated fair value, with a corresponding charge to earnings for the credit portion and the noncredit portion to other comprehensive income. In estimating other-than-temporary impairment losses, management considers, among other things, the length of time and the extent to which the fair value has been less than cost and the financial condition and near-term prospects of the issuer. Additionally, we do not currently intend to sell the securities and it is not more likely than not that we will be required to sell the security before the anticipated recovery of its amortized cost basis.

The turmoil in the capital markets had a significant impact on our estimate of fair value for certain of our securities. We believe the market values are reflective of illiquidity and credit impairment. At September 30, 2011, we have in AFS Other Stocks and Bonds, $2.9 million amortized cost basis in pooled trust preferred securities (“TRUPs”). Those securities are structured products with cash flows dependent upon securities issued by U.S. financial institutions, including banks and insurance companies. Our estimate of fair value at September 30, 2011 for the TRUPs is approximately $947,000 and reflects the market illiquidity. With the exception of the TRUPs, to the best of management’s knowledge and based on our consideration of the qualitative factors associated with each security, there were no securities in our investment and mortgage-backed securities portfolio at September 30, 2011 with an other-than-temporary impairment.

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Given the facts and circumstances associated with the TRUPs we performed detailed cash flow modeling for each TRUP using an industry-accepted cash flow model. Prior to loading the required assumptions into the model we reviewed the financial condition of each of the underlying issuing banks within the TRUP collateral pool that had not deferred or defaulted as of September 30, 2011. Management’s best estimate of a deferral assumption was assigned to each issuing bank based on the category in which it fell. Our analysis of the underlying cash flows contemplated various default, deferral and recovery scenarios to arrive at our best estimate of cash flows. Based on that detailed analysis, we have concluded that the other-than-temporary impairment, which captures the credit component in compliance with FASB ASC Topic 320, “Investments – Debt and Equity Securities,” was estimated at $3.1 million at both September 30, 2011 and December 31, 2010. The noncredit charge to other comprehensive income was estimated at $2.0 million and $2.7 million at September 30, 2011 and December 31, 2010, respectively. The carrying amount of the TRUPs was written down with $75,000 and $3.0 million recognized in earnings for the nine months ended September 30, 2010 and for the year ended December 31, 2009, respectively. There was no additional write-down of the TRUPs recognized in earnings for the nine months ended September 30, 2011. The cash flow model assumptions represent management’s best estimate and consider a variety of qualitative factors, which include, among others, the credit rating downgrades, the severity and duration of the mark-to-market loss, and the structural nuances of each TRUP. Management believes that the detailed review of the collateral and cash flow modeling support the conclusion that the TRUPs had an other-than-temporary impairment at September 30, 2011. We will continue to update our assumptions and the resulting analysis each reporting period to reflect changing market conditions. Additionally, we do not currently intend to sell the TRUPs and it is not more likely than not that we will be required to sell the TRUPs before the anticipated recovery of their amortized cost basis.

The table below provides more detail on the TRUPs at September 30, 2011 (in thousands).

TRUP	Par		Credit Loss		Amortized Cost		Fair Value		Tranche		Credit Rating

1	$	2,000	$	1,075	$	925	$	300		C1	Ca
2		2,000		550		1,450		348		B1	C
3		2,000		1,450		550		299		B2	C
	$	6,000	$	3,075	$	2,925	$	947

The following table presents the impairment activity related to credit loss, which is recognized in earnings, and the impairment activity related to all other factors, which are recognized in other comprehensive income (in thousands).

	Nine Months Ended September 30, 2011
	Impairment Related to Credit Loss		Impairment Related to All Other Factors		Total Impairment

Balance, beginning of the period	$	3,075	$	2,694	$	5,769
Charges on securities for which other-than-temporary impairment charges were not previously recognized		–		–		–
Additional charges on securities for which other-than-temporary impairment charges were previously recognized		–		–		–
Balance, end of the period	$	3,075	$	2,694	$	5,769

	Three Months Ended September 30, 2011
	Impairment Related to Credit Loss		Impairment Related to All Other Factors		Total Impairment

Balance, beginning of the period	$	3,075	$	2,694	$	5,769
Charges on securities for which other-than-temporary impairment charges were not previously recognized		–		–		–
Additional charges on securities for which other-than-temporary impairment charges were previously recognized		–		–		–
Balance, end of the period	$	3,075	$	2,694	$	5,769

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Interest income recognized on AFS and HTM securities for the periods presented (in thousands):

	Nine Months Ended
	September 30, 2011		September 30, 2010
U.S. Treasury	$	6	$	7
State and Political Subdivisions		9,525		8,239
Other Stocks and Bonds		25		35
Mortgage-backed Securities		37,899		37,937
Total interest income on securities	$	47,455	$	46,218

	Three Months Ended
	September 30, 2011		September 30, 2010
U.S. Treasury	$	–	$	3
State and Political Subdivisions		3,073		2,375
Other Stocks and Bonds		7		8
Mortgage-backed Securities		13,292		13,378
Total interest income on securities	$	16,372	$	15,764

There were no securities transferred from AFS to HTM during the nine months ended September 30, 2011 or 2010. There were no sales from the HTM portfolio during the nine months ended September 30, 2011 or 2010. There were $390.7 million of securities classified as HTM at September 30, 2011 compared to $419.4 million of securities classified as HTM at December 31, 2010.

Of the $9.7 million in net securities gains from the AFS portfolio for the nine months ended September 30, 2011, there were $10.2 million in realized gains and $486,000 in realized losses. Of the $23.0 million in net securities gains from the AFS portfolio for the nine months ended September 30, 2010, there were $25.5 million in realized gains and $2.5 million in realized losses.

The amortized cost and fair value of securities at September 30, 2011 are presented below by contractual maturity. Expected maturities may differ from contractual maturities because issuers may have the right to call or prepay obligations. Mortgage-backed securities are presented in total by category due to the fact that mortgage-backed securities typically are issued with stated principal amounts, and the securities are backed by pools of mortgages that have loans with varying maturities. The characteristics of the underlying pool of mortgages, such as fixed-rate or adjustable-rate, as well as prepayment risk, are passed on to the certificate holder. The term of a mortgage-backed pass-through security thus approximates the term of the underlying mortgages and can vary significantly due to prepayments.

	September 30, 2011
	Amortized Cost		Fair Value
Available for sale securities:	(in thousands)

Investment Securities
Due in one year or less	$	1,968	$	1,989
Due after one year through five years		6,929		7,196
Due after five years through ten years		27,988		30,455
Due after ten years		241,210		265,354
		278,095		304,994
Mortgage-backed securities		1,240,664		1,263,528
Total	$	1,518,759	$	1,568,522

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	September 30, 2011
	Amortized Cost		Fair Value
Held to maturity securities:	(in thousands)

Investment Securities
Due in one year or less	$	–	$	–
Due after one year through five years		–		–
Due after five years through ten years		485		503
Due after ten years		1,011		1,199
		1,496		1,702
Mortgage-backed securities		389,178		404,879
Total	$	390,674	$	406,581

Investment and mortgage-backed securities with book values of $999.8 million at September 30, 2011 and $977.4 million at December 31, 2010 were pledged to collateralize Federal Home Loan Bank (“FHLB”) advances, repurchase agreements, public funds and trust deposits or for other purposes as required by law.

Securities with limited marketability, such as FHLB stock and other investments, are carried at cost, which approximates its fair value and assessed for other-than-temporary impairment. These securities have no maturity date.

5.	Loans and Allowance for Probable Loan Losses

The following table sets forth loan totals for the periods presented (in thousands):

	At		At
	September 30,		December 31,
	2011		2010
Real Estate Loans:
Construction	$	103,859	$	115,094
1-4 Family residential		228,248		219,031
Other		202,595		200,723
Commercial loans		140,115		148,761
Municipal loans		199,122		196,594
Loans to individuals		166,532		197,717
Total loans	$	1,040,471	$	1,077,920

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Allowance for Loan Losses

The allowance for loan losses is based on the most current review of the loan portfolio and is validated by multiple processes. First, the bank utilizes historical data to establish general reserve amounts for each class of loans. While we track several years of data, we primarily review one year data because we found during the 1980’s that longer periods would not respond quickly enough to market conditions. Second, our lenders have the primary responsibility for identifying problem loans and estimating necessary reserves based on customer financial stress and underlying collateral. These recommendations are reviewed by the Senior lender, the Special Assets department, and the Loan Review department and are signed off on by the President. Third, the Loan Review department does independent reviews of the portfolio on an annual basis. The Loan Review department follows a board-approved annual loan review scope. The loan review scope encompasses a number of metrics that takes into consideration the size of the loan, the type of credit extended, the seasoning of the loan and the performance of the loan. The loan review scope as it relates to size, focuses more on larger dollar loan relationships, typically, for example, aggregate debt of $500,000 or greater. The Loan Review officer also tracks specific reserves for loans by type compared to general reserves to determine trends in comparative reserves as well as losses not reserved for prior to charge off to determine the efficiency of the specific reserve process.

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

For loans to individuals, the methodology associated with determining the appropriate allowance for losses on loans primarily consists of an evaluation of individual payment histories, remaining term to maturity and underlying collateral support.

Industry experience indicates that a portion of our loans will become delinquent and a portion of the loans will require partial or entire charge-off. Regardless of the underwriting criteria utilized, losses may be experienced as a result of various factors beyond our control, including, among other things, changes in market conditions affecting the value of properties used as collateral for loans and problems affecting the credit of the borrower and the ability of the borrower to make payments on the loan. Our determination of the adequacy of allowance for loan losses is based on various considerations, including an analysis of the risk characteristics of various classifications of loans, previous loan loss experience, specific loans which would have loan loss potential, delinquency trends, estimated fair value of the underlying collateral, current economic conditions, the views of the bank regulators (who have the authority to require additional allowances), and geographic and industry loan concentration.

Consumer loans at SFG are reserved for based on general estimates of loss at the time of purchase for current loans. SFG loans experiencing past due status or extension of maturity characteristics are reserved for at significantly higher levels based on the circumstances associated with each specific loan. In general the reserves for SFG are calculated based on the past due status of the loan. For reserve purposes, the portfolio has been segregated by past due status and by the remaining term variance from the original contract. During repayment, loans that pay late will take longer to pay out than the original contract. Additionally, some loans may be granted extensions for extenuating payment circumstances. The remaining term extensions increase the risk of collateral deterioration and accordingly, reserves are increased to recognize this risk.

For SFG automobile loan pools purchased after August 1, 2010, additional reserve methods have been added. New pools purchased are reserved at their estimated annual loss. Thereafter, the reserve is adjusted based on the actual performance versus projected performance. Additionally, during the fourth quarter of 2010, data mining measures were further enhanced to track migration within risk tranches. Reserves are adjusted quarterly to match the migration metrics.

Credit Quality Indicators

We categorize loans into risk categories based on relevant information about the ability of borrowers to service their debt such as: current financial information, historical payment experience, credit documentation, public information, and current economic trends, among other factors. We use the following definitions for risk ratings:

Satisfactory (Rating 1 – 4) – This rating is assigned to all satisfactory loans. This category, by definition, should consist of completely acceptable credit. Credit and collateral exceptions should not be present, although their presence would not necessarily prohibit a loan from being rated Satisfactory, if deficiencies are in process of correction. These loans will not be included in the Watch List.

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Satisfactory (Rating 5) – Special Treatment Required – (Pass Watch) – These loans require some degree of special treatment, but not due to credit quality. This category does not include loans specially mentioned or adversely classified by the Loan Review Officer or regulatory authorities; however, particular attention must be accorded such credits due to characteristics such as:

A lack of, or abnormally extended payment program;

A heavy degree of concentration of collateral without sufficient margin;

A vulnerability to competition through lesser or extensive financial leverage;

A dependence on a single, or few customers, or sources of supply and materials without suitable substitutes or alternatives.

Special Mention (Rating 6) – A Special Mention asset has potential weaknesses that deserve management’s close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the asset or in the institution’s credit position at some future date. Special Mention assets are not adversely classified and do not expose an institution to sufficient risk to warrant adverse classification.

Substandard (Rating 7) – Substandard loans are inadequately protected by the current sound worth and paying capacity of the obligor or of the collateral pledged, if any. Loans so classified must have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt. They are characterized by the distinct possibility that the Bank will sustain some loss if the deficiencies are not corrected.

Doubtful (Rating 8) – Loans classified Doubtful have all the weaknesses inherent in those classified Substandard with the added characteristic that the weaknesses make collection or liquidation, in full, on the basis of currently known facts, conditions and values, highly questionable and improbable.

Loss (Rating 9) – Loans classified Loss are considered uncollectible or of such little value that their continuance as bankable assets is not warranted. This classification does not mean that the loan has absolutely no recovery or salvage value but rather it is not practical or desirable to defer writing off this basically worthless asset even though partial recovery may be affected in the future.

Loans not meeting risk ratings six through nine are reserved for as a group of similar type pass rated credits and included in the general portion of the allowance for loan losses.

The general portion of the loan loss allowance is reflective of historical charge-off levels for similar loans adjusted for changes in current conditions and other relevant factors. These factors are likely to cause estimated losses to differ from historical loss experience and include:

Changes in lending policies or procedures, including underwriting, collection, charge-off, and recovery procedures;

Changes in local, regional and national economic and business conditions including entry into new markets;

Changes in the volume or type of credit extended;

Changes in the experience, ability, and depth of lending management;

Changes in the volume and severity of past due, nonaccrual, restructured, or classified loans;

Changes in loan review or Board oversight; and,

Changes in the level of concentrations of credit.

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The following table details activity in the Allowance for Loan Losses by portfolio segment for the periods presented (in thousands):

	Nine Months Ended September 30, 2011
	Real Estate
	Construction			1-4 Family Residential			Other			Commercial Loans			Municipal Loans			Loans to Individuals			Unallocated		Total

Balance at beginning of period	$	2,585		$	1,988		$	3,354		$	3,746		$	607		$	7,978		$	453	$	20,711
Provision (reversal) for loan losses		(25	)		397			(318	)		(65	)		(9	)		4,628			844		5,452
Loans charged off		(9	)		(654	)		(271	)		(1,231	)		–			(8,085	)		–		(10,250	)
Recoveries of loans charged off		38			96			274			397			–			1,471			–		2,276
Balance at end of period	$	2,589		$	1,827		$	3,039		$	2,847