Edgar Filing: SOUTHSIDE BANCSHARES INC

form_10q.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, 2008

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	(I.R.S. Employer
incorporation or organization)	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 is a large accelerated filer, an accelerated filer, or a non-accelerated filer or a small reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “small reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer o	Accelerated filer x
Non-accelerated filer o	Small 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 Act). Yes o No x

The number of shares of the issuer's common stock, par value $1.25, outstanding as of October 24, 2008 was 13,970,710 shares.

	TABLE OF CONTENTS


	PART I. FINANCIAL INFORMATION
	ITEM 1. FINANCIAL STATEMENTS
	ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
	ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
	ITEM 4. CONTROLS AND PROCEDURES
	PART II. OTHER INFORMATION
	ITEM 1. LEGAL PROCEEDINGS
	ITEM 1A. RISK FACTORS
	ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
	ITEM 3. DEFAULTS UPON SENIOR SECURITIES
	ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
	ITEM 5. OTHER INFORMATION
	ITEM 6. EXHIBITS
	SIGNATURES
	Exhibit Index
	Retirement Agreement dated November 7, 2008, by and between Southside Bank, Southside Bancshares, Inc. and B. G. Hartley.
	Certification Pursuant to Section 302
	Certification Pursuant to Section 302
	Certification Pursuant to Section 906

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	2008			2007
Cash and due from banks	$	51,572		$	74,040
Interest earning deposits		4,242			1,414
Federal funds sold		1,475			550
Total cash and cash equivalents		57,289			76,004
Investment securities:
Available for sale, at estimated fair value		121,509			109,928
Held to maturity, at cost		477			475
Mortgage-backed and related securities:
Available for sale, at estimated fair value		1,011,955			727,553
Held to maturity, at cost		165,288			189,965
Federal Home Loan Bank stock, at cost		34,317			19,850
Other investments, at cost		2,067			2,069
Loans held for sale		2,014			3,361
Loans:
Loans		987,375			961,230
Less: allowance for loan loss		(12,928	)		(9,753	)
Net Loans		974,447			951,477
Premises and equipment, net		40,920			40,249
Goodwill		22,034			21,639
Other intangible assets, net		1,585			1,925
Interest receivable		13,025			11,784
Deferred tax asset		8,593			4,320
Other assets		68,578			35,723
TOTAL ASSETS	$	2,524,098		$	2,196,322
LIABILITIES AND SHAREHOLDERS' EQUITY
Deposits:
Noninterest bearing	$	391,812		$	357,083
Interest bearing		1,087,380			1,173,408
Total Deposits		1,479,192			1,530,491
Short-term obligations:
Federal funds purchased and repurchase agreements		10,944			7,023
FHLB advances		271,797			353,792
Other obligations		2,478			2,500
Total Short-term obligations		285,219			363,315
Long-term obligations:
FHLB advances		529,594			86,247
Long-term debt		60,311			60,311
Total Long-term obligations		589,905			146,558
Other liabilities		27,170			23,132
TOTAL LIABILITIES		2,381,486			2,063,496

Off-Balance-Sheet Arrangements, Commitments and Contingencies (Note 12)

Minority interest in Southside Financial Group		185			498

Shareholders' equity:
Common stock - $1.25 par, 20,000,000 shares authorized, 15,702,280 shares
issued in 2008 and 14,865,134 shares issued in 2007		19,628			18,581
Paid-in capital		130,433			115,250
Retained earnings		26,309			26,187
Treasury stock (1,731,570 and 1,724,857 shares at cost)		(23,115	)		(22,983	)
Accumulated other comprehensive loss		(10,828	)		(4,707	)
TOTAL SHAREHOLDERS' EQUITY		142,427			132,328

TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY	$	2,524,098		$	2,196,322

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

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,
	2008		2007		2008		2007
Interest income
Loans	$	18,029	$	13,134	$	54,092	$	38,381
Investment securities – taxable		307		552		1,377		2,004
Investment securities – tax-exempt		851		525		2,829		1,537
Mortgage-backed and related securities		14,883		10,982		38,876		32,079
Federal Home Loan Bank stock and other investments		180		245		656		945
Other interest earning assets		10		37		101		106
Total interest income		34,260		25,475		97,931		75,052
Interest expense
Deposits		7,257		10,391		25,880		29,981
Short-term obligations		1,986		3,049		7,125		9,771
Long-term obligations		5,209		1,800		11,853		4,978
Total interest expense		14,452		15,240		44,858		44,730
Net interest income		19,808		10,235		53,073		30,322
Provision for loan losses		3,150		620		8,336		954
Net interest income after provision for loan losses		16,658		9,615		44,737		29,368
Noninterest income
Deposit services		4,739		4,274		13,823		12,472
Gain on sale of securities available for sale		822		126		6,574		561
Gain on sale of loans		239		424		1,551		1,493
Trust income		678		522		1,890		1,562
Bank owned life insurance income		314		273		1,382		805
Other		827		784		2,388		2,310
Total noninterest income		7,619		6,403		27,608		19,203
Noninterest expense
Salaries and employee benefits		10,002		7,242		27,521		21,644
Occupancy expense		1,449		1,261		4,264		3,619
Equipment expense		327		268		968		738
Advertising, travel & entertainment		447		363		1,407		1,233
ATM and debit card expense		313		247		905		743
Director fees		134		126		425		394
Supplies		201		151		584		487
Professional fees		452		413		1,239		964
Postage		199		165		565		468
Telephone and communications		270		193		785		577
FDIC Insurance		220		38		688		112
Other		1,773		1,075		5,268		3,255
Total noninterest expense		15,787		11,542		44,619		34,234

Income before income tax expense		8,490		4,476		27,726		14,337
Provision for income tax expense		2,240		976		7,399		2,487
Net Income	$	6,250	$	3,500	$	20,327	$	11,850
Earnings per common share – basic	$	0.45	$	0.26	$	1.47	$	0.87
Earnings per common share – diluted	$	0.44	$	0.25	$	1.43	$	0.84
Dividends declared per common share	$	0.16	$	0.12	$	0.41	$	0.35

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

SOUTHSIDE BANCSHARES, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY

(UNAUDITED)

(in thousands, except share amounts)

	Compre-hensive Income			Common Stock		Paid-in Capital		Retained Earnings			Treasury Stock			Accumu-lated Other Compre- hensive Loss			Total Share-holders Equity

Balance at December 31, 2006				$	17,594	$	100,736	$	29,648		$	(22,850	)	$	(14,524	)	$	110,604
Net Income	$	11,850							11,850									11,850
Other comprehensive income, net of tax Unrealized gains on securities, net of reclassification adjustment (see Note 3)		3,643													3,643			3,643
Adjustment to net periodic benefit cost (see Note 3)		260													260			260
Comprehensive income	$	15,753
Common stock issued (138,664 shares)					174		1,089											1,263
Stock compensation expense							20											20
Tax benefit of incentive stock options							87											87
Dividends paid on common stock									(4,498	)								(4,498	)
Purchase of 6,120 shares of common stock												(133	)					(133	)
Stock dividend					776		12,903		(13,679	)								-
Balance at September 30, 2007				$	18,544	$	114,835	$	23,321		$	(22,983	)	$	(10,621	)	$	123,096

Balance at December 31, 2007				$	18,581	$	115,250	$	26,187		$	(22,983	)	$	(4,707	)	$	132,328
Net Income	$	20,327							20,327									20,327
Other comprehensive income, net of tax Unrealized losses on securities, net of reclassification adjustment (see Note 3)		(6,491	)												(6,491	)		(6,491	)
Adjustment to net periodic benefit cost (see Note 3)		370													370			370
Comprehensive income	$	14,206
Common stock issued (177,933 shares)					223		1,344											1,567
Stock compensation expense							7											7
Tax benefit of incentive stock options							410											410
Cumulative effect of adoption of a new accounting principle on January 1, 2008 (see Note 11)									(351	)								(351	)
Dividends paid on common stock									(5,608	)								(5,608	)
Purchase of 6,713 shares of common stock												(132	)					(132	)
Stock dividend					824		13,422		(14,246	)								-
Balance at September 30, 2008				$	19,628	$	130,433	$	26,309		$	(23,115	)	$	(10,828	)	$	142,427

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

SOUTHSIDE BANCSHARES, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(UNAUDITED)

(in thousands)

	Nine Months Ended September 30,
	2008			2007

OPERATING ACTIVITIES:
Net income	$	20,327		$	11,850
Adjustments to reconcile net income to net cash provided by operations:
Depreciation		1,820			1,640
Amortization of premium		5,424			3,658
Accretion of discount and loan fees		(2,579	)		(1,829	)
Provision for loan losses		8,336			954
Stock compensation expense		7			20
(Increase) decrease in interest receivable		(1,241	)		99
(Increase) decrease in other assets		(2,751	)		1,312
Net change in deferred taxes		(867	)		(1,067	)
(Decrease) increase in interest payable		(362	)		166
Increase in other liabilities		1,384			728
Decrease in loans held for sale		1,347			1,678
Gain on sale of securities available for sale		(6,574	)		(561	)
Loss on sale of assets		81			1
Earnings allocated to minority interest		271			(117	)
Net cash provided by operating activities		24,623			18,532

INVESTING ACTIVITIES:
Proceeds from sales of investment securities available for sale		80,139			10,007
Proceeds from sales of mortgage-backed securities available for sale		251,236			68,897
Proceeds from maturities of investment securities available for sale		65,055			75,514
Proceeds from maturities of mortgage-backed securities available for sale		93,864			78,530
Proceeds from maturities of mortgage-backed securities held to maturity		25,770			29,847
Proceeds from redemption of Federal Home Loan Bank and FRB stock		897			10,729
Purchases of investment securities available for sale		(151,318	)		(73,129	)
Purchases of mortgage-backed securities available for sale		(668,188	)		(164,826	)
Purchases of mortgage-backed securities held to maturity		(1,664	)		(2,180	)
Purchases of Federal Home Loan Bank stock and other investments		(15,362	)		(3,201	)
Net increase in loans		(33,870	)		(37,457	)
Purchases of premises and equipment		(2,851	)		(4,030	)
Proceeds from sales of premises and equipment		367			-
Proceeds on bank owned life insurance		713			-
Proceeds from sales of other real estate owned		305			334
Proceeds from sales of repossessed assets		2,870			238
Net cash used in investing activities		(352,037	)		(10,727	)

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

SOUTHSIDE BANCSHARES, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS (continued)

(UNAUDITED)

(in thousands)

	Nine Months Ended
	September 30,
	2008			2007
FINANCING ACTIVITIES:
Net increase in demand and savings accounts		70,022			39,841
Net (decrease) increase in certificates of deposit		(122,249	)		31,792
Net increase (decrease) in federal funds purchased and repurchase agreements		3,921			(5,675	)
Proceeds from FHLB Advances		13,874,696			4,624,601
Repayment of FHLB Advances		(13,513,344	)		(4,732,536	)
Proceeds from issuance of long-term debt		-			36,083
Net capital contributions from minority interest investment in consolidated entities		-			500
Net capital distributions to minority interest investment in consolidated entities		(584	)		-
Tax benefit of incentive stock options		410			87
Purchases of common stock		(132	)		(133	)
Proceeds from the issuance of common stock		1,567			1,263
Dividends paid		(5,608	)		(4,498	)
Net cash provided by (used in) financing activities		308,699			(8,675	)

Net decrease in cash and cash equivalents		(18,715	)		(870	)
Cash and cash equivalents at beginning of period		76,004			55,012
Cash and cash equivalents at end of period	$	57,289		$	54,142

SUPPLEMENTAL DISCLOSURES FOR CASH FLOW INFORMATION:
Interest paid	$	45,220		$	44,564
Income taxes paid		8,125			3,200

SUPPLEMENTAL DISCLOSURES OF NONCASH INVESTING AND FINANCING ACTIVITIES:
Acquisition of other repossessed assets and real estate through foreclosure	$	4,867		$	381
Payment of 5% stock dividend		14,246			13,679
Adjustment to pension liability		(393	)		(394	)
Unsettled trades to purchase securities		(8,441	)		(5,357	)
Unsettled trades to sell securities		29,612			4,882

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

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 with and into Southside Bank, includes Fort Worth National Bank). The word “SFG” refers to Southside Financial Group, LLC., of which Southside owns a 50% interest.

The consolidated balance sheet as of September 30, 2008, and the related consolidated statements of income, shareholders' equity and cash flows and notes to the financial statements for the three and nine month periods ended September 30, 2008 and 2007 are unaudited; in the opinion of management, all adjustments necessary for a fair presentation 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, 2007. 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, 2007.

2. Earnings Per Share

Earnings per share on a basic and diluted basis has 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,

	2008		2007		2008		2007
Basic Earnings and Shares:
Net Income	$	6,250	$	3,500	$	20,327	$	11,850
Weighted-average basic shares outstanding		13,925		13,746		13,858		13,689

Basic Earnings Per Share:
Net Income	$	0.45	$	0.26	$	1.47	$	0.87

Diluted Earnings and Shares:
Net Income	$	6,250	$	3,500	$	20,327	$	11,850
Weighted-average basic shares outstanding		13,925		13,746		13,858		13,689
Add: Stock options		285		381		329		422
Weighted-average diluted shares outstanding		14,210		14,127		14,187		14,111

Diluted Earnings Per Share:
Net Income	$	0.44	$	0.25	$	1.43	$	0.84

For the three and nine month periods ended September 30, 2008 and 2007, there were no antidilutive options.

3. Comprehensive Income (Loss)

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

	Nine Months Ended September 30, 2008
	Before-Tax				Tax (Expense)				Net-of-Tax
	Amount				Benefit				Amount
Unrealized losses on securities:
Unrealized holding losses arising during period		$	(3,346	)		$	1,128			$	(2,218	)
Less: reclassification adjustment for gains
included in net income			6.574				(2,301	)			4,273
Net unrealized losses on securities			(9,920	)			3,429				(6,491	)
Change in pension plans			393				(23	)			370
Other comprehensive loss		$	(9,527	)		$	3,406			$	(6,121	)

	Three Months Ended September 30, 2008
	Before-Tax				Tax (Expense)				Net-of-Tax
	Amount				Benefit				Amount
Unrealized losses on securities:
Unrealized holding losses arising during period		$	(4,683	)		$	1,639			$	(3,044	)
Less: reclassification adjustment for gains
included in net income			822				(288	)			534
Net unrealized losses on securities			(5,505	)			1,927				(3,578	)
Change in pension plans			131				(46	)			85
Other comprehensive loss		$	(5,374	)		$	1,881			$	(3,493	)

	Nine Months Ended September 30, 2007
	Before-Tax			Tax (Expense)				Net-of-Tax
	Amount			Benefit				Amount
Unrealized gains on securities:
Unrealized holding gains arising during period		$	6,081		$	(2,068	)		$	4,013
Less: reclassification adjustment for gains
included in net income			561			(191	)			370
Net unrealized gains on securities			5,520			(1,877	)			3,643
Change in pension plans			394			(134	)			260
Other comprehensive income		$	5,914		$	(2,011	)		$	3,903

	Three Months Ended September 30, 2007
	Before-Tax			Tax (Expense)				Net-of-Tax
	Amount			Benefit				Amount
Unrealized gains on securities:
Unrealized holding gains arising during period		$	7,969		$	(2,710	)		$	5,259
Less: reclassification adjustment for gains
included in net income			126			(43	)			83
Net unrealized gains on securities			7,843			(2,667	)			5,176
Change in pension plans			132			(45	)			87
Other comprehensive income		$	7,975		$	(2,712	)		$	5,263

4. Securities

The amortized cost and estimated market value of investment and mortgage-backed securities as of September 30, 2008 and December 31, 2007, are reflected in the tables below (in thousands):

	September 30, 2008
AVAILABLE FOR SALE:	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses		Estimated Market Value
Investment Securities:
U.S. Treasury	$	4,888	$	8	$	-	$	4,896
Government Sponsored Enterprise Debentures		16,457		-		1		16,456
State and Political Subdivisions		98,689		918		2,037		97,570
Other Stocks and Bonds		6,711		-		4,124		2,587
Mortgage-backed Securities:
U.S. Government Agencies		159,778		1,078		1,275		159,581
Government Sponsored Enterprises		851,306		4,812		3,744		852,374
Total	$	1,137,829	$	6,816	$	11,181	$	1,133,464

	September 30, 2008
HELD TO MATURITY:	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses		Estimated Market Value
Investment Securities:
Other Stocks and Bonds	$	477	$	-	$	52	$	425
Mortgage-backed Securities:
U.S. Government Agencies		23,677		61		-		23,738
Government Sponsored Enterprises		141,611		720		266		142,065
Total	$	165,765	$	781	$	318	$	166,228

	December 31, 2007
AVAILABLE FOR SALE:	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses		Estimated Market Value
Investment Securities:
U.S. Treasury	$	4,880	$	8	$	2	$	4,886
Government Sponsored Enterprise Debentures		31,764		3		8		31,759
State and Political Subdivisions		64,868		1,599		223		66,244
Other Stocks and Bonds		7,586		-		547		7,039
Mortgage-backed Securities:
U.S. Government Agencies		88,937		1,234		451		89,720
Government Sponsored Enterprises		628,768		5,847		1,555		633,060
Other Private Issues		4,773		-		-		4,773
Total	$	831,576	$	8,691	$	2,786	$	837,481

	December 31, 2007
HELD TO MATURITY:	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses		Estimated Market Value
Investment Securities:
Other Stocks and Bonds	$	475	$	2	$	-	$	477
Mortgage-backed Securities:
U.S. Government Agencies		25,965		36		58		25,943
Government Sponsored Enterprises		164,000		501		531		163,970
Total	$	190,440	$	539	$	589	$	190,390

The Company concluded that, based on the creditworthiness of the issuer, the unrealized loss on each security in the above table represents a temporary impairment and does not require adjustment to the carrying amount of any of the individual securities. Additionally, the Company has the ability and the intent to hold such securities through recovery of the unrealized losses.

Investment and mortgage-backed securities with book values of $836.8 million at September 30, 2008 and $496.8 million at December 31, 2007 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.

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 as opposed to credit impairment. At September 30, 2008, we have in AFS Other Stocks and Bonds $6.0 million 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, 2008 is approximately $2.0 million and reflects the market illiquidity. Our analysis of the underlying cash flows contemplates various default, deferral and recovery scenarios, and based on that detailed analysis we have concluded that there is no other than temporary impairment at September 30, 2008. We will continue to reevaluate and update our assumptions over time and if there is higher than expected level of defaults or deferrals, then an other than temporary impairment charge might occur in future periods.

5. Loans and Allowance for Probable Loan Losses

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

	At			At
	September 30,			December 31,
	2008			2007
Real Estate Loans:
Construction		$	99,235	$	107,397
1-4 Family Residential			244,988		237,979
Other			185,248		200,148
Commercial Loans			165,929		154,171
Municipal Loans			118,568		112,523
Loans to Individuals			173,407		149,012
Total Loans		$	987,375	$	961,230

The summaries of the Allowance for Loan Losses and Reserve for Unfunded Loan Commitments are as follows (in thousands):

	Three Months Ended September 30,						Nine Months Ended September 30,
	Three Months Ended September 30,						Nine Months Ended September 30,
	2008			2007			2008			2007
Allowance for Loan Losses

Balance at beginning of period	$	11,527		$	7,367		$	9,753		$	7,193
Provision for loan losses		3,150			620			8,336			954
Loans charged off		(2,258	)		(797	)		(6,658	)		(2,006	)
Recoveries of loans charged off		509			478			1,497			1,527
Balance at end of period	$	12,928		$	7,668		$	12,928		$	7,668

Reserve for Unfunded Loan Commitments

Balance at beginning of period	$	6		$	–		$	50		$	–
Provision for losses on unfunded loan commitments		–			–			(44	)		–
Balance at end of period	$	6		$	–		$	6		$	–

6. Goodwill and Core Deposit Intangible Assets

Goodwill. Goodwill totaled $22.0 million at September 30, 2008 and $21.6 million at December 31, 2007. During the first quarter of 2008, we recorded goodwill totaling $395,000 in connection with the acquisition of Fort Worth Bancshares, Inc.

Core Deposit Intangibles. Core deposit intangible assets totaled $1.6 million at September 30, 2008 and $1.9 million at December 31, 2007.

For the three and nine months ended September 30, 2008, amortization expense related to intangible assets totaled $109,000 and $340,000, respectively. The estimated aggregate future amortization expense for intangible assets remaining as of September 30, 2008 is as follows (in thousands):

Remainder of 2008	$	106
2009		383
2010		319
2011		255
2012		198
Thereafter		324
	$	1,585

7.	Long-term Obligations

Long-term obligations are summarized as follows:

	September 30,		December 31,
	2008		2007
	(dollars in thousands)
Federal Home Loan Bank Advances (1)
Varying maturities to 2028	$	529,594	$	86,247

Long-term Debt (2)
Southside Bancshares Statutory Trust III Due 2033 (3)		20,619		20,619
Southside Statutory Trust IV Due 2037 (4)		23,196		23,196
Southside Statutory Trust V Due 2037 (5)		12,887		12,887
Magnolia Trust Company I Due 2035 (6)		3,609		3,609
Total Long-term Debt		60,311		60,311
Total Long-term Obligations	$	589,905	$	146,558

(1) At September 30, 2008, the weighted average cost of these advances was 3.79%.

(2)

This long-term debt consists of trust preferred securities that qualify under the risk-based capital guidelines as Tier 1 capital, subject to certain limitations.

(3)

This debt carries an adjustable rate of 6.70188% through December 30, 2008 and adjusts quarterly at a rate equal to three-month LIBOR plus 294 basis points.

(4)

This debt carries a fixed rate of 6.518% through October 30, 2012 and thereafter, adjusts quarterly at a rate equal to three-month LIBOR plus 130 basis points.

(5)

This debt carries a fixed rate of 7.48% through December 15, 2012 and thereafter, adjusts quarterly at a rate equal to three-month LIBOR plus 225 basis points.

(6)

This debt carries an adjustable rate of 4.61063% through November 23, 2008 and thereafter, adjusts quarterly at a rate equal to three-month LIBOR plus 180 basis points.

8. Employee Benefit Plans

The components of net periodic benefit cost are as follows (in thousands):

	Nine Months Ended September 30,
	Defined Benefit
	Pension Plan						Restoration Plan
	2008			2007			2008			2007
Service cost	$	930		$	998		$	64		$	46
Interest cost		1,818			1,734			171			126
Expected return on assets		(2,243	)		(1,897	)		–			–
Transition obligation recognition		–			–			–			2
Net loss recognition		313			362			114			64
Prior service credit amortization		(31	)		(31	)		(1	)		(2	)
Net periodic benefit cost	$	787		$	1,166		$	348		$	236

	Three Months Ended September 30,
	Defined Benefit
	Pension Plan						Restoration Plan
	2008			2007			2008		2007
Service cost	$	310		$	333		$	21	$	15
Interest cost		606			578			57		42
Expected return on assets		(748	)		(633	)		–		–
Transition obligation recognition		–			–			–		1
Net loss recognition		105			121			38		22
Prior service credit amortization		(10	)		(10	)		–		(1	)
Net periodic benefit cost	$	263		$	389		$	116	$	79

Employer Contributions

We previously disclosed in our financial statements for the year ended December 31, 2007, that we expected to contribute $3.0 million to our defined benefit pension plan and $80,000 to our post retirement benefit plan in 2008. As of September 30, 2008, we had contributed $3.0 million to the defined benefit pension plan, and contributions of $60,000 had been made to the post retirement benefit plan.

9. Incentive Stock Options

In April 1993, we adopted the Southside Bancshares, Inc. 1993 Incentive Stock Option Plan ("the ISO Plan"), a stock-based incentive compensation plan. The ISO Plan expired March 31, 2003.

A summary of the status of our nonvested shares as of September 30, 2008 is as follows:

	Nine Months Ended September 30, 2008
	Number of Options			Weighted Average Grant-Date Fair Value
Nonvested at beginning of the period		6,030		$	4.91
Vested		(6,030	)	$	4.91
Nonvested at end of period		–		$	–

For the nine months ended September 30, 2008 and 2007, we recorded approximately $7,000 and $20,000, respectively, of stock-based compensation expense. As of September 30, 2008, there was no unrecognized compensation cost related to the ISO Plan for nonvested options granted in March 2003. At September 30, 2007, there was $13,000 of total unrecognized cost.

The fair value of each stock option granted is estimated on the date of grant using the Black-Scholes method of option pricing with the following weighted-average assumptions for grants in 2003: dividend yield of 1.93%; risk-free interest rate of 4.93%; expected life of six years; and expected volatility of 28.90%.

Under the ISO Plan, we were authorized to issue shares of common stock pursuant to "Awards" granted in the form of incentive stock options (intended to qualify under Section 422 of the Internal Revenue Code of 1986, as amended). Before the ISO Plan expired, awards were granted to selected employees and directors. No stock options have been available for grant under the ISO Plan since its expiration in March 2003. Currently, we do not offer stock-based payment programs to our employees or directors.

The ISO Plan provided that the exercise price of any stock option not be less than the fair market value of the common stock on the date of grant. The outstanding stock options have contractual terms of 10 years. All options vest on a graded schedule, 20% per year for five years, beginning on the first anniversary date of the grant date.

A summary of the status of our stock options as of September 30, 2008 and the changes during the nine months ended on those dates is presented below:

	Number of Options		Weighted Average Exercise Prices		Weighted Average Remaining Contract Life (Years)	Aggregate Intrinsic Value (in thousands)

Outstanding at December 31, 2007	500,510		$	5.52	–		–
Exercised	(145,272	)	$	5.77	–		–
Cancelled	–		$	–	–		–
Outstanding at September 30, 2008	355,238		$	5.41	1.63	$	6,865
Exercisable at September 30, 2008	355,238		$	5.41	1.63	$	6,865

The total intrinsic value (i.e., the amount by which the fair value of the underlying common stock exceeds the exercise price of a stock option on exercise date) of stock options exercised during the nine months ended September 30, 2008 and 2007 were $2.3 million and $1.8 million, respectively.

Cash received from stock option exercises for the nine months ended September 30, 2008 and 2007 was $706,000 and $478,000, respectively. The tax benefit realized for the deductions related to the stock option exercises were $410,000 and $87,000 for the nine months ended September 30, 2008 and 2007, respectively.

10. Fair Value Measurement

Effective January 1, 2008, we adopted the provisions of Statement of Financial Accounting Standards (“SFAS”) 157, "Fair Value Measurements," for financial assets. In accordance with Financial Accounting Standards Board (“FASB”) Staff Position (“FSP”) No. 157-2, "Effective Date of FASB Statement No. 157," we will delay application of SFAS 157 for non-financial assets, until January 1, 2009. SFAS 157 defines fair value, establishes a framework for measuring fair value in accordance with GAAP and expands disclosures about fair value measurements. The application of SFAS 157 in situations where the market for a financial asset is not active was clarified by the issuance of FSP No. SFAS 157-3, “Determining the Fair Value of a Financial Asset When the Market for That Asset Is Not Active,” in October 2008. FSP No. SFAS 157-3 became effective for our interim financial statements as of September 30, 2008 and did not significantly impact the methods by which we determine the fair value of our financial assets.

SFAS 157 defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants. A fair value measurement assumes that the transaction to sell the asset or transfer the liability occurs in the principal market for the asset or liability or, in the absence of a principal market, the most advantageous market for the asset or liability. The price in the principal (or most advantageous) market used to measure the fair value of the asset or liability shall not be adjusted for transaction costs. An orderly transaction is a transaction that assumes exposure to the market for a period prior to the measurement date to allow for marketing activities that are usual and customary for transactions involving such assets and liabilities; it is not a forced transaction. Market participants are buyers and sellers in the principal market that are (i) independent, (ii) knowledgeable, (iii) able to transact and (iv) willing to transact.

SFAS 157 requires the use of valuation techniques that are consistent with the market approach, the income approach and/or the cost approach. Inputs to valuation techniques refer to the assumptions that market participants would use in pricing the asset or liability. Inputs may be observable, meaning those that reflect the assumptions market participants would use in pricing the asset or liability developed based on market data obtained from independent sources, or unobservable, meaning those that reflect the reporting entity’s own assumptions about the assumptions market participants would use in pricing the asset or liability developed based on the best information available in the circumstances. SFAS 157 establishes a fair value hierarchy for valuation inputs that gives the highest priority to quoted prices in active markets for identical assets or liabilities and the lowest priority to unobservable inputs. The fair value hierarchy is as follows:

Level 1 Inputs - Unadjusted quoted prices in active markets for identical assets or liabilities that the reporting entity has the ability to access at the measurement date.

Level 2 Inputs - Inputs other than quoted prices included in Level 1 that are observable for the asset or liability, either directly or indirectly. These might include quoted prices for similar assets or liabilities in active markets, quoted prices for identical or similar assets or liabilities in markets that are not active, inputs other than quoted prices that are observable for the asset or liability (such as interest rates, volatilities, prepayment speeds, credit risks, etc.) or inputs that are derived principally from or corroborated by market data by correlation or other means.

Level 3 Inputs - Unobservable inputs for determining the fair values of assets or liabilities that reflect an entity's own assumptions about the assumptions that market participants would use in pricing the assets or liabilities.

A description of the valuation methodologies used for assets and liabilities measured at fair value, as well as the general classification of such instruments pursuant to the valuation hierarchy, is set forth below.

Securities Available for Sale - Securities classified as available for sale primarily consist of U. S. Treasuries, government sponsored enterprise debentures, mortgage-backed securities, and municipal bonds, and to a lesser extent TRUPs and equity securities. We use quoted market prices of identical assets on active exchanges, or Level 1 measurements where possible. Where such quoted market prices are not available, we typically employ quoted market prices of similar instruments (including matrix pricing) and/or discounted cash flows to estimate a value of these securities, or Level 2 measurements. Discounted cash flow analyses are typically based on market interest rates, prepayment speeds and/or option adjusted spreads. Level 3 measurements include a range of fair value estimates in the marketplace as a result of the illiquid market specific to the type of security or discounted cash flow analyses based on assumptions that are not readily observable in the market place. Such assumptions include projections of future cash flows, including loss assumptions, and discount rates.

Certain financial assets are measured at fair value on a potentially recurring basis in accordance with GAAP. Adjustments at fair value of these assets usually result from the application of lower-of -cost-or-market accounting or write-downs of individual assets.

Loans Held for Sale - These loans are reported at the lower of cost or fair value. Fair value is determined based on expected proceeds based on sales contracts and commitments and are considered Level 2 inputs. At September 30, 2008, based on our estimates of fair value no valuation allowance was recognized.

Impaired Loans – Certain impaired loans may be reported at the fair value of the underlying collateral if repayment is expected solely from the collateral. Collateral values are estimated using Level 3 inputs based on customized discounting criteria or appraisals. At September 30, 2008, the impact of loans with specific reserves based on the fair value of the collateral were reflected in our allowance for loan losses.

Certain non-financial assets and non-financial liabilities measured at fair value on a recurring basis include reporting units measured at fair value in the first step of a goodwill impairment test. Certain non-financial assets measured at fair value on a non-recurring basis include non-financial assets and non-financial liabilities measured at fair value in the second step of a goodwill impairment test, as well as intangible assets and other non-financial long-lived assets (such as real estate owned) are measured at fair value in the event of an impairment. While the framework prescribed by SFAS 157 will be applicable to these fair value measurements beginning January 1, 2009.

The following table summarizes financial assets and financial liabilities measured at fair value on a recurring basis as of September 30, 2008, segregated by the level of the valuation inputs within the fair value hierarchy utilized to measure fair value (dollars in thousands):

	Level 1		Level 2		Level 3		Total
	Input		Input		Input		Fair Value

Securities available for sale	$	5,446	$	1,125,981	$	2,037	$	1,133,464

The application of SFAS 157 in situations where the market for a financial asset is not active was clarified by the issuance of FSP No. SFAS 157-3, “Determining the Fair Value of a Financial Asset When the Market for That Asset Is Not Active,” in October 2008. FSP No. SFAS 157-3 became effective for our interim financial statements as of September 30, 2008 and did not significantly impact the methods by which we determine the fair value of our financial assets.

The following table presents additional information about financial assets and liabilities measured at fair value at September 30, 2008 on a recurring basis and for which we have utilized Level 3 inputs to determine fair value:

	Available for sale securities
	(in thousands)
Beginning Balance at January 1, 2008	$	–

Total gains or losses (realized/unrealized):
Included in earnings (or changes in net assets)		–
Included in other comprehensive income (loss)		(3,963	)
Purchases, issuances and settlements		–
Transfers in and/or out of Level 3		6,000
Ending Balance at September 30, 2008	$	2,037

The amount of total gains or losses for the periods included in earnings (or changes in net assets) attributable to the change in unrealized gains or losses relating to assets still held at reporting date.

11. Accounting Pronouncements

Statements of Financial Accounting Standards

SFAS No. 141, “Business Combinations (Revised 2007).” SFAS 141R replaces SFAS 141, “Business Combinations,” and applies to all transactions and other events in which one entity obtains control over one or more other businesses. SFAS 141R requires an acquirer, upon initially obtaining control of another entity, to recognize the assets, liabilities and any non-controlling interest in the acquiree at fair value as of the acquisition date. Contingent consideration is required to be recognized and measured at fair value on the date of acquisition rather than at a later date when the amount of that consideration may be determinable beyond a reasonable doubt. This fair value approach replaces the cost-allocation process required under SFAS 141 whereby the cost of an acquisition was allocated to the individual assets acquired and liabilities assumed. Under SFAS 141R, the requirements of SFAS 146, “Accounting for Costs Associated with Exit or Disposal Activities,” would have to be met in order to accrue for a restructuring plan in purchase accounting. Pre-acquisition contingencies are to be recognized at fair value, unless it is a non-contractual contingency that is not likely to materialize, in which case, nothing should be recognized in purchase accounting and, instead, that contingency would be subject to the probable and estimable recognition criteria of SFAS 5, “Accounting for Contingencies.” SFAS 141R is expected to have a significant impact on our accounting for business combinations closing on or after January 1, 2009.

SFAS No. 160, “Noncontrolling Interest in Consolidated Financial Statements, an amendment of ARB Statement No. 51.” SFAS 160 amends Accounting Research Bulletin (“ARB”) No. 51, “Consolidated Financial Statements,” to establish accounting and reporting standards for the non-controlling interest in a subsidiary and for deconsolidation of a subsidiary. SFAS 160 clarifies that a non-controlling interest in a subsidiary, which is sometimes referred to as minority interest, is an ownership interest in the consolidated entity that should be reported as a component of equity in the consolidated financial statements. Among other requirements, SFAS 160 requires consolidated net income to be reported at amounts that include the amounts attributable to both the parent and the non-controlling interest. It also requires disclosure, on the face of the consolidated income statement, of the amounts of consolidated net income attributable to the parent and to the non-controlling interest. SFAS 160 is effective for us on January 1, 2009 and is not expected to have a significant impact on our financial statements.

SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities, including an amendment of FASB Statement No. 115.” SFAS 159, issued by the FASB in February 2007, allows entities to irrevocably elect fair value as the initial and subsequent measurement attribute for certain financial assets and financial liabilities that are not otherwise required to be measured at fair value, with changes in fair value recognized in earnings as they occur. We adopted SFAS 159 on January 1, 2008. We did not identify any financial assets or liabilities for which we elected the fair value option. In future periods, we will consider if, or to what extent, we will elect to use the fair value option to value our financial assets and liabilities.

SFAS No. 157, “Fair Value Measurements.” SFAS 157 defines fair value, establishes a framework for measuring fair value in GAAP, and expands disclosures about fair value measurements. We adopted SFAS 157 on January 1, 2008 and it did not have a material impact on our consolidated financial statements. The application of SFAS 157 in situations where the market for a financial asset is not active was clarified by the issuance of FSP No. SFAS 157-3, “Determining the Fair Value of a Financial Asset When the Market for That Asset Is Not Active,” in October 2008. FSP No. SFAS 157-3 became effective for our interim financial statements as of September 30, 2008 and did not significantly impact the methods by which we determine the fair value of our financial assets.

Emerging Issues Task Force Consensuses

In September 2006, the Emerging Issues Task Force (“EITF”) reached a final consensus on Issue 06-4, “Accounting for Deferred Compensation and Postretirement Benefit Aspects of Endorsement Split-Dollar Life Insurance Arrangements.” EITF 06-4 requires that for a split-dollar life insurance arrangement, an employer should recognize a liability for future benefits in accordance with SFAS 106, “Employers' Accounting for Postretirement Benefits Other Than Pensions.” Under the guidance, the purchase of an endorsement type policy does not constitute a settlement since the policy does not qualify as nonparticipating because the policyholders are subject to the favorable and unfavorable experience of the insurance company. EITF 06-4 is effective for fiscal years beginning after December 15, 2007. We adopted EITF 06-4 as of January 1, 2008 as a change in accounting principle through a cumulative-effect adjustment to retained earnings. The amount of the adjustment was $351,000.

In September 2006, the EITF reached a final consensus on Issue 06-5, “Accounting for Purchases of Life Insurance.” EITF 06-5 provides guidance on FASB Technical Bulletin No. 85-4, “Accounting for Purchases of Life Insurance.” Under the guidance, the policyholder should consider any additional amounts included in the contractual terms of the policy in determining the amount that could be realized under the insurance contract. In addition, the policyholder should also determine the amount that could be realized under the life insurance contract assuming the surrender of an individual-life by individual-life policy. EITF 06-5 was effective for fiscal years beginning after December 15, 2006. The adoption of EITF 06-5 did not have a material impact on our consolidated financial statements.

SEC Staff Accounting Bulletins (“SAB”)

SAB No. 109, “Written Loan Commitments Recorded at Fair Value Through Earnings.” SAB No. 109 supersedes SAB 105, “Application of Accounting Principles to Loan Commitments,” and indicates that the expected net future cash flows related to the associated servicing of the loan should be included in the measurement of all written loan commitments that are accounted for at fair value through earnings. The guidance in SAB 109 became effective on January 1, 2008 and did not have a material impact on our financial statements.

12. Off-Balance-Sheet Arrangements, Commitments and Contingencies

Financial Instruments with Off-Balance-Sheet-Risk. In the normal course of business, we are a party to certain financial instruments, with off-balance-sheet risk, to meet the financing needs of our customers. These off-balance-sheet instruments include commitments to extend credit and standby letters of credit. These instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount reflected in the financial statements. The contract or notional amounts of these instruments reflect the extent of involvement and exposure to credit loss we have in these particular classes of financial instruments.

Commitments to extend credit are agreements to lend to a customer provided that the terms established in the contract are met. Commitments generally have fixed expiration dates and may require payment of fees. Since some commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. Standby letters of credit are conditional commitments issued to guarantee the performance of a customer to a third party. These guarantees are primarily issued to support public and private

borrowing arrangements. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan commitments to customers.

We had outstanding unused commitments to extend credit of $130.0 million and $115.2 million at September 30, 2008 and 2007, respectively. Each commitment has a maturity date and the commitment expires on that date with the exception of credit card and ready reserve commitments, which have no stated maturity date. Unused commitments for credit card and ready reserve at September 30, 2008 and 2007 were both $8.8 million and are reflected in the due after one year category. We had outstanding standby letters of credit of $4.5 million and $4.0 million at September 30, 2008 and 2007, respectively.

The scheduled maturities of unused commitments as of September 30, 2008 and 2007 were as follows (in thousands):

	September 30,
	2008		2007
Unused commitments:
Due in one year or less	$	73,890	$	87,871
Due after one year		56,155		27,306
Total	$	130,045	$	115,177

We apply the same credit policies in making commitments and standby letters of credit as we do for on-balance-sheet instruments. We evaluate each customer's credit worthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary, upon extension of credit is based on management's credit evaluation of the borrower. Collateral held varies but may include cash or cash equivalents, negotiable instruments, real estate, accounts receivable, oil, gas and mineral interests, inventory and property, plant, and equipment.

Lease Commitments. We lease certain branch facilities and office equipment under operating leases. It is expected that certain leases will be renewed or equipment replaced with new leased equipment as these leases expire.

Securities. In the normal course of business we buy and sell securities. There were $8.4 million of unsettled trades to purchase and $29.6 million of unsettled trades to sell securities at September 30, 2008. At December 31, 2007, there were $6.1 million unsettled trades to purchase securities. There were no unsettled trades to sell securities at December 31, 2007.

Litigation. We are subject to litigation in the normal course of business. Management, after consulting with our legal counsel, believes that any liability resulting from litigation will not have a material effect on our financial position and results of operations or our liquidity.

13. Variable Interest Entities

Effective December 31, 2003, we adopted FASB Interpretation No. 46 (R) (“FIN 46 (R)”), Consolidation of Variable Interest Entities in connection with our consolidated financial statements. FIN 46 (R) requires companies to consolidate “variable interest entities” (“VIEs”) if those companies are the primary beneficiaries of those VIEs.

Southside Bank, our wholly-owned subsidiary, is the sole owner of Southside Venue I, LLC (“Venue”). On August 21, 2007, SFG was formed and is considered a VIE in accordance with FIN 46 (R). Venue has 50% ownership rights and 51% voting rights of SFG based on their investment of $500,000 in the entity. The remaining 50% ownership rights are held by an unrelated third party. Southside Bank currently has extended credit to finance SFG’s activities. Based on the credit facility and investment, Southside Bank and Venue are obligated to absorb the majority of SFG’s expected losses and receive a majority of SFG’s expected residual returns, and therefore Southside Bank is considered the primary beneficiary of SFG. SFG is accordingly consolidated by Southside Bank in accordance with FIN 46 (R).

SFG is a limited liability company that buys consumer loans secured by automobiles, primarily through the purchase of existing automobile loan portfolios from lenders throughout the United States. As of September 30, 2008, the total of SFG’s automobile loan portfolios was approximately $73.8 million.

ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following is a discussion of the consolidated financial condition, changes in financial condition, and results of our operations, and should be read and reviewed in conjunction with the financial statements, and the notes thereto, in this presentation and in our Annual Report on Form 10-K for the year ended December 31, 2007.

We reported an increase in net income for the three and nine months ended September 30, 2008 compared to the same period in 2007. Net income for the three and nine months ended September 30, 2008 was $6.3 million and $20.3 million, respectively, compared to $3.5 million and $11.9 million, respectively, for the same periods in 2007.

All share data has been adjusted to give retroactive recognition to stock splits and stock dividends.

Forward Looking Statements

Certain statements of other than historical fact that are contained in this document and in written material, press releases and oral statements issued by or on behalf of Southside Bancshares, Inc., a bank holding company, may be considered to be “forward-looking statements” within the meaning of and subject to the protections of the Private Securities Litigation Reform Act of 1995. These forward-looking statements are not guarantees of future performance, nor should they be relied upon as representing management’s views as of any subsequent date. These statements may include words such as "expect," "estimate," "project," "anticipate," “appear,” "believe," "could," "should," "may," "intend," "probability," "risk," "target," "objective," “plans,” “potential,” and similar expressions. Forward-looking statements are statements with respect to our beliefs, plans, expectations, objectives, goals, anticipations, assumptions, estimates, intentions and future performance, and are subject to significant known and unknown risks and uncertainties, which could cause our actual results to differ materially from the results discussed in the forward-looking statements. For example, discussions of the effect of our expansion, trends in asset quality and earnings from growth, and certain market risk disclosures are based upon information presently available to management and are dependent on choices about key model characteristics and assumptions and are subject to various limitations. By their nature, certain of the market risk disclosures are only estimates and could be materially different from what actually occurs in the future. As a result, actual income gains and losses could materially differ from those that have been estimated. Other factors that could cause actual results to differ materially from forward-looking statements include, but are not limited to, the following:

·	general economic conditions, either globally, nationally, in the State of Texas, or in the specific markets

in which we operate, including, without limitation, the recent deterioration of the subprime, mortgage, credit and liquidity markets, which could cause compression of the Company’s net interest margin, or a decline in the value of the Company’s assets, which could result in realized losses;

·	legislation, regulatory changes or changes in monetary or fiscal policy that adversely affect the businesses in which we are engaged, including the Federal Reserve’s actions with respect to interest rates and other regulatory responses to current economic conditions;

·	adverse changes in the status or financial condition of the Government Sponsored Enterprises (the “GSEs”) impacting the GSEs’ guarantees or ability to pay or issue debt;

·	adverse changes in the credit portfolio of other U. S. financial institutions relative to the performance of certain of our investment securities;

·	impact of future legislation and increases in depositors insurance premiums due to FDIC regulation changes;

·	economic or other disruptions caused by acts of terrorism in the United States, Europe or other areas;

·	changes in the interest rate yield curve such as flat, inverted or steep yield curves, or changes in the interest rate environment that impact interest margins and may impact prepayments on the mortgage-backed securities portfolio;

·	increases in the Company’s non-performing assets;

·	the Company’s ability to maintain adequate liquidity to fund its operations and growth;

·	failure of assumptions underlying allowance for loan losses and other estimates;

·	unexpected outcomes of, and the costs associated with, existing or new litigation involving us;

·	changes impacting the leverage strategy;

·	our ability to monitor interest rate risk;

·	significant increases in competition in the banking and financial services industry;

·	changes in consumer spending, borrowing and saving habits;

·	technological changes;

·	our ability to increase market share and control expenses;

·	the effect of changes in federal or state tax laws;

·	the effect of compliance with legislation or regulatory changes;

·	the effect of changes in accounting policies and practices;

·	risks of mergers and acquisitions including the related time and cost of implementing transactions and the potential failure to achieve expected gains, revenue growth or expense savings;

·	credit risks of borrowers, including any increase in those risks due to changing economic conditions; and

·	risks related to loans secured by real estate, including the risk that the value and marketability of collateral could decline.

Additional information concerning us and our business, including additional factors that could materially affect our financial results, is included in our filings with the Securities and Exchange Commission. All written or oral forward-looking statements made by us or attributable to us are expressly qualified by this cautionary notice. We disclaim any obligation to update any factors or to announce publicly the result of revisions to any of the forward-looking statements included herein to reflect future events or developments.

Critical Accounting Estimates

Our accounting and reporting estimates conform with accounting principles generally accepted in the United States (“GAAP”) and general practices within the financial services industry. The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates. We consider our critical accounting policies to include the following:

Allowance for Losses on Loans. The allowance for losses on loans represents our best estimate of probable losses inherent in the existing loan portfolio. The allowance for losses on loans is increased by the provision for losses on loans charged to expense and reduced by loans charged-off, net of recoveries. The provision for losses on loans is determined based on our assessment of several factors: reviews and evaluations of specific loans, changes in the nature and volume of the loan portfolio, and current economic conditions and the related impact on specific borrowers and industry groups, historical loan loss experience, the level of classified and nonperforming loans and the results of regulatory examinations.

The loan loss allowance is based on the most current review of the loan portfolio. The servicing officer has the primary responsibility for updating significant changes in a customer's financial position. Each officer prepares status updates on any credit deemed to be experiencing repayment difficulties which, in the officer's opinion, would place the collection of principal or interest in doubt. Our internal loan review department is responsible for an ongoing review of our loan portfolio with specific goals set for the loans to be reviewed on an annual basis.

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 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 loans or loan relationships of $50,000 or more is updated on a periodic basis in order to properly allocate necessary allowance and keep management informed on the status of attempts to correct the deficiencies noted with respect to the loan.

Loans are considered impaired if, based on current information and events, it is probable that we will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. The measurement of impaired loans is generally based on the present value of expected future cash flows discounted at the historical effective interest rate stipulated in the loan agreement, except that all collateral-dependent loans are measured for impairment based on fair value of the collateral. In measuring the fair value of the collateral, we use assumptions, such as discount rates, and methodologies, such as comparison to the recent selling price of similar assets, consistent with those that would be utilized by unrelated third parties performing a valuation.

Changes in the financial condition of individual borrowers, economic conditions, historical loss experience and the conditions of the various markets in which collateral may be sold may all affect the required level of the allowance for losses on loans and the associated provision for loan losses.

As of September 30, 2008, our review of the loan portfolio indicated that a loan loss allowance of $12.9 million was adequate to cover probable losses in the portfolio.

Refer to “Part II - Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations - Loan Loss Experience and Allowance for Loan Losses” and “Note 1 – Summary of Significant Accounting and Reporting Policies” of the Notes to Consolidated Financial Statements in our Annual Report on Form 10-K for the year ended December 31, 2007 for a detailed description of our estimation process and methodology related to the allowance for loan losses.

Estimation of Fair Value. On January 1, 2008, we adopted SFAS 157, “Fair Value Measurements”, as presented in “Note 10 – Fair Value Measurement” in the accompanying Notes to Financial Statements included in this report. We also adopted FAS 157-3, which was released on October 10, 2008. The estimation of fair value is significant to a number of our assets and liabilities. GAAP requires disclosure of the fair value of financial instruments as a part of the notes to the consolidated financial statements. Fair values are volatile and may be influenced by a number of factors, including market interest rates, prepayment speeds, discount rates and the shape of yield curves. Fair values for most investment and mortgage-backed securities are based on quoted market prices, where available. If quoted market prices are not available, fair values are based on the quoted prices of similar instruments or our estimate of fair value by using a range of fair value estimates in the market place as a result of the illiquid market specific to the type of security.

At September 30, 2008, the valuation inputs for our available for sale ("AFS") TRUPs became unobservable as a result of the significant market dislocation and illiquidity in the marketplace. Although we continue to rely on non-binding prices compiled by third party vendors, the visibility of the observable market data (Level 2) to determine the values of these securities has become less clear. SFAS 157 assumes that fair values of financial assets are determined in an orderly transaction and not a forced liquidation or distressed sale at the measurement date. While we feel the financial market conditions at September 30, 2008 reflect the market illiquidity from forced liquidation or distressed sales for these TRUPs, we determined that the fair value provided by our pricing service continues to be an appropriate fair value for financial statement measurement and therefore, as we verified the reasonableness of that fair value, we have not otherwise adjusted the fair value provided by our vendor. However, the severe decline in estimated fair value caused by the significant illiquidity in this market contrasts sharply with our assessment of the fundamental performance of these securities. Therefore, we believe the estimated fair value is no longer clearly based on observable market data and is based on a range of fair value data points from the market place as a result of the illiquid market specific to this type of security. Accordingly, we have now determined that the TRUPs security valuation is based on Level 3 inputs in accordance with SFAS 157.

Impairment of Investment Securities and Mortgage-backed Securities. Investment and mortgage-backed securities classified as AFS are carried at fair value and the impact of changes in fair value are recorded on our consolidated balance sheet as an unrealized gain or loss in “Accumulated other comprehensive income (loss),” a separate component of shareholders’ equity. Securities classified as AFS or held to maturity (“HTM”) are subject to our review to identify when a decline in value is other than temporary. Factors considered in determining whether a decline in value is other than temporary include: whether the decline is substantial; the duration of the decline; the reasons for the decline in value; whether the decline is related to a credit event or to a change in interest rate; our ability and intent to hold the investment for a period of time that will allow for a recovery of value; and the financial condition and near-term prospects of the issuer. When it is determined that a decline in value is other than temporary, the carrying value of the security is reduced to its estimated fair value, with a corresponding charge to earnings. For certain assets we consider expected cash flows of the investment in determining if impairment exists. Our analysis of the underlying cash flows contemplates various default, deferral and recovery scenarios. While our analysis demonstrates that there is no other than temporary impairment at September 30, 2008, we will continue to update our estimates and the resulting analysis each reporting period.

Defined Benefit Pension Plan. The plan obligations and related assets of the defined benefit pension plan (the “Plan”) are presented in “Note 14 – Employee Benefits” of the Notes to Consolidated Financial Statements in our Annual Report on Form 10-K for the year ended December 31, 2007. Entrance into this plan by new employees was frozen effective December 31, 2005. Plan assets, which consist primarily of marketable equity and debt instruments, are valued using market quotations. Plan obligations and the annual pension expense are determined by independent actuaries and through the use of a number of assumptions. Key assumptions in measuring the plan obligations include the discount rate, the rate of salary increases and the estimated future return on plan assets. In determining the discount rate, we utilized a cash flow matching analysis to determine a range of appropriate discount rates for our defined benefit pension and restoration plans. In developing the cash flow matching analysis, we constructed a portfolio of high quality non-callable bonds (rated AA- or better) to match as closely as possible the timing of future benefit payments of the Plan at December 31, 2007. Based on this cash flow matching analysis, we were able to determine an appropriate discount rate.

Salary increase assumptions are based upon historical experience and our anticipated future actions. The expected long-term rate of return assumption reflects the average return expected based on the investment strategies and asset allocation on the assets invested to provide for the Plan’s liabilities. We considered broad equity and bond indices, long-term return projections, and actual long-term historical Plan performance when evaluating the expected long-term rate of return assumption. At September 30, 2008, the weighted-average actuarial assumptions of the Plan were: a discount rate of 6.25%; a long-term rate of return on plan assets of 7.50%; and assumed salary increases of 4.50%. Material changes in pension benefit costs may occur in the future due to changes in these assumptions. Future annual amounts could be impacted by changes in the number of Plan participants, changes in the level of benefits provided, changes in the discount rates, changes in the expected long-term rate of return, changes in the level of contributions to the Plan and other factors.

Off-Balance-Sheet Arrangements, Commitments and Contingencies

Details of our off-balance-sheet arrangements, commitments and contingencies as of September 30, 2008 and 2007, are included in “Note 12 – Off-Balance-Sheet Arrangements, Commitments and Contingencies” in the accompanying Notes