10-K 1 ffin10k2002.txt FIRST FINANCIAL BANKSHARES, INC. 2002 10-K SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-K FOR ANNUAL AND TRANSITION REPORTS PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 (Mark One) [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended December 31, 2002 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from _______ to ________ Commission file number 0-7674 First Financial Bankshares, Inc. (Exact Name of Registrant as Specified in Its Charter) Texas 75-0944023 (State or Other Jurisdiction of (I.R.S. Employer Incorporation or Organization) Identification No.) 400 Pine Street Abilene, Texas 79601 (Address of Principal Executive Offices) (Zip Code) Registrant's telephone number, including area code: (915) 627-7155 Securities registered pursuant to Section 12(b) of the Act: Title of Class Name of Exchange on Which Registered -------------- ------------------------------------ None N/A Securities registered pursuant to Section 12(g) of the Act: Common Stock, par value $10.00 per share Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ] Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [ ] Indicate by check mark whether the registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2). Yes [X] No [ ] As of June 30, 2002, the last business day of the registrant's most recently completed second fiscal quarter, the aggregate market value of voting stock held by non-affiliates was $458,357,747. As of February 25, 2003, there were 12,364,642 shares of Common Stock outstanding. Documents Incorporated by Reference Certain information called for by Part III is incorporated by reference to the Proxy Statement for the 2003 Annual Meeting of our shareholders, which will be filed with the Securities and Exchange Commission not later than 120 days after December 31, 2002. TABLE OF CONTENTS Page ---- CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS....................1 PART I ITEM 1. Business.................................................1 ITEM 2. Properties..............................................11 ITEM 3. Legal Proceedings.......................................11 ITEM 4. Submission of Matters to a Vote of Security Holders........................................11 PART II ITEM 5. Market for Registrant's Common Equity and Related Stockholder Matters.............................12 ITEM 6. Selected Financial Data.................................14 ITEM 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.....................15 ITEM 7A. Quantitative and Qualitative Disclosures about Market Risk.............................................28 ITEM 8. Financial Statements and Supplementary Data.............29 ITEM 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.....................30 PART III ITEM 10. Directors and Executive Officers of the Registrant......30 ITEM 11. Executive Compensation..................................30 ITEM 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters..........30 ITEM 13. Certain Relationships and Related Transactions..........30 ITEM 14. Controls and Procedures.................................31 ITEM 15. Exhibits, Financial Statement Schedules and Reports on Form 8-K.....................................31 SIGNATURES..................................................................33 CERTIFICATIONS..............................................................35 i CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS This Form 10-K contains certain forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. When used in this Form 10-K, words such as "anticipate," "believe," "estimate," "expect," "intend," "predict," "project," and similar expressions, as they relate to us or our management, identify forward-looking statements. These forward-looking statements are based on information currently available to our management. Actual results could differ materially from those contemplated by the forward-looking statements as a result of certain factors, including but not limited to: o general economic conditions; o legislative and regulatory actions and reforms; o competition from other financial institutions and financial holding companies; o the effects of and changes in trade, monetary and fiscal policies and laws, including interest rate policies of the Federal Reserve Board; o changes in the demand for loans; o fluctuations in value of collateral and loan reserves; o inflation, interest rate, market and monetary fluctuations; o changes in consumer spending, borrowing and savings habits; o acquisitions and integration of acquired businesses; and o other factors described in "PART II, Item 7 -- Management's Discussion and Analysis of Financial Condition and Results of Operations." Such statements reflect the current views of our management with respect to future events and are subject to these and other risks, uncertainties and assumptions relating to our operations, results of operations, growth strategy and liquidity. All subsequent written and oral forward-looking statements attributable to us or persons acting on our behalf are expressly qualified in their entirety by this paragraph. PART I ITEM 1. BUSINESS General First Financial Bankshares, Inc., a Texas corporation, is a financial holding company registered under the Bank Holding Company Act of 1956, or BHCA. As such, we are supervised by the Board of Governors of the Federal Reserve System, or Federal Reserve Board, as well as several other state and federal regulators. We were formed as a bank holding company in 1956 under the original name F & M Operating Company, but our banking operations date back to 1890, when Farmers and Merchants National Bank opened for business in Abilene, Texas. By virtue of a series of reorganizations, mergers, and acquisitions since 1956, we now own, through our wholly-owned Delaware subsidiary, First Financial Bankshares of Delaware, Inc., ten banks organized and located in Texas. These ten banks are: o First National Bank of Abilene, Abilene, Texas; o Hereford State Bank, Hereford, Texas; o First National Bank, Sweetwater, Texas; 1 o Eastland National Bank, Eastland, Texas; o First Financial Bank, National Association, Cleburne, Texas; o Stephenville Bank and Trust Co., Stephenville, Texas; o San Angelo National Bank, San Angelo, Texas; o Weatherford National Bank, Weatherford, Texas; o First Financial Bank, National Association, Southlake, Texas; and o City National Bank, Mineral Wells, Texas. As described in more detail below, we elected to be treated as a financial holding company in September 2001. Our service centers are located primarily in North Central and West Texas. Considering the branches and locations of all our subsidiary banks, as of December 31, 2002, we had 28 financial centers across Texas, with seven locations in Abilene, two locations in Cleburne, two locations in Stephenville, two locations in San Angelo, three locations in Weatherford, and one location each in Mineral Wells, Hereford, Sweetwater, Eastland, Southlake, Aledo, Alvarado, Burleson, Keller, Trophy Club, Roby, and Trent. Information on our revenues, profits and losses and total assets appears in the discussion of our Results of Operations contained in Item 7 hereof. First Financial Bankshares, Inc. We provide management and technical resources and policy direction to our subsidiary banks, which enables them to improve or expand their banking services while continuing their local activity and identity. Each of our subsidiary banks operates under the day-to-day management of its own board of directors and officers, with substantial authority in making decisions concerning their own investments, loan policies, interest rates, and service charges. We provide resources and policy direction in, among other things, the following areas: o asset and liability management; o accounting, budgeting, planning and insurance; o capitalization; and o regulatory compliance. In particular, we assist our subsidiary banks with, among other things, decisions concerning major capital expenditures, employee fringe benefits, including pension plans and group insurance, dividend policies, and appointment of officers and directors and their compensation. We also perform, through corporate staff groups or by outsourcing to third parties, internal audits and loan reviews of our subsidiary banks. Through First National Bank of Abilene, we provide advice and specialized services for our banks related to lending, investing, purchasing, advertising, public relations, and computer services. While we have no specific acquisition agreements in place or commitments to expand our branch network, we periodically evaluate various potential financial institution acquisition opportunities and also periodically evaluate potential locations for new branch offices. We anticipate that funding for any acquisitions or expansions would be provided from our existing cash balances, available dividends from subsidiary banks, utilization of available lines of credit and future debt or equity offerings. Services Offered by Our Subsidiary Banks Each of our subsidiary banks is a separate legal entity that operates under the day-to-day management of its own board of directors and officers. Each of our subsidiary banks provides general commercial banking services, which include accepting and holding checking, savings and time deposits, making loans, automated teller machines, drive-in and night deposit services, safe deposit facilities, transmitting funds, and performing other customary commercial banking services. Certain of our subsidiary banks also administer pension plans, profit sharing plans and other employee benefit plans. First National Bank of Abilene, First National Bank, Sweetwater, Stephenville Bank and Trust Co. and San Angelo National Bank have active trust departments. The trust departments 2 offer a complete range of services to individuals, associations, and corporations. These services include administering estates, testamentary trusts, various types of living trusts, and agency accounts. In addition, First National Bank of Abilene, First Financial Bank, Cleburne, San Angelo National Bank and First Financial Bank, National Association, Southlake, Texas provide securities brokerage services through arrangements with various third parties. We have filed an application with the office of the Comptroller of the Currency to form a limited purpose national bank under which we will consolidate the management of our current trust departments. The new entity will operate as a subsidiary of our subsidiary holding company, First Financial Bankshares of Delaware, Inc. We believe that with this structure we can more effectively manage our current trust operations and provide trust services to customers of our banks that do not currently have trust departments. We anticipate that the new trust company will begin operations in the latter part of 2003. Competition Commercial banking in Texas is highly competitive, and because we hold less than 1% of the state's deposits, we represent only a minor segment of the industry. To succeed in this industry, our management believes that our banks must have the capability to compete in the areas of (1) interest rates paid or charged; (2) scope of services offered; and (3) prices charged for such services. Our subsidiary banks compete in their respective service areas against highly competitive banks, thrifts, savings and loan associations, small loan companies, credit unions, mortgage companies, and brokerage firms, all of which are engaged in providing financial products and services and some of which are larger than our subsidiary banks in terms of capital, resources and personnel. Our business does not depend on any single customer or any few customers, the loss of any one of which would have a materially adverse effect upon our business. Although we have a broad base of customers that are not related to us, our customers also occasionally include our officers and directors, as well as other entities with which we are affiliated. With our subsidiary banks we may make loans to officers and directors, and entities with which we are affiliated, in the ordinary course of business. We make these loans on substantially the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with other persons. Loans to directors, officers and their affiliates are also subject to numerous restrictions under federal and state banking laws which we describe in greater detail below. Employees With our subsidiary banks we employed approximately 750 full-time equivalent employees at February 1, 2003. Our management believes that our employee relations have been and will continue to be good. Supervision and Regulation Both federal and state laws extensively regulate bank holding companies, financial holding companies and banks. These laws (and the regulations promulgated thereunder) are primarily intended to protect depositors and the deposit insurance fund of the Federal Deposit Insurance Corporation, or FDIC, although shareholders may also benefit. The following information describes particular laws and regulatory provisions relating to financial holding companies and banks. This discussion is qualified in its entirety by reference to the particular laws and regulatory provisions. A change in any of these laws or regulations may have a material effect on our business and the business of our subsidiary banks. Bank Holding Companies and Financial Holding Companies Traditionally, the activities of bank holding companies were limited to the business of banking and activities closely related or incidental to banking. Bank holding companies were generally prohibited from acquiring control of any company which was not a bank and from engaging in any business other than the business of banking or managing and controlling banks. The Gramm-Leach-Bliley Act, which took effect on March 12, 2000, dismantled many Depression-era restrictions against affiliation between banking, securities and insurance firms by permitting bank holding companies to engage in a broader range of financial activities, so long as certain safeguards are observed. Specifically, bank holding companies may elect to become "financial holding companies" that may affiliate with securities firms and insurance companies and engage in other activities that are financial in nature or incidental to a financial activity. 3 Thus, with the enactment of the Gramm-Leach-Bliley Act, banks, securities firms and insurance companies find it easier to acquire or affiliate with each other and cross-sell financial products. The act permits a single financial services organization to offer a more complete array of financial products and services than historically was permitted. A financial holding company is essentially a bank holding company with significantly expanded powers. Under the Gramm-Leach-Bliley Act, among the activities that will be deemed "financial in nature" for financial holding companies are, in addition to traditional lending activities, securities underwriting, dealing in or making a market in securities, sponsoring mutual funds and investment companies, insurance underwriting and agency activities, activities which the Federal Reserve Board determines to be closely related to banking, and certain merchant banking activities. The Federal Reserve Board has proposed permitting a number of additional financial activities, but we cannot predict whether any of these additional proposals will be adopted or the form any final rule will take. We elected to become a financial holding company in September 2001. As a financial holding company, we have very broad discretion to affiliate with securities firms and insurance companies, make merchant banking investments, and engage in other activities that the Federal Reserve Board has deemed financial in nature. In order to continue as a financial holding company, we must continue to be well-capitalized, well-managed and maintain compliance with the Community Reinvestment Act. Depending on the types of financial activities that we may engage in in the future, under Gramm-Leach-Bliley's fractional regulation principles, we may become subject to supervision by additional government agencies. The election to be treated as a financial holding company increases our ability to offer financial products and services that historically we were either unable to provide or were only able to provide on a limited basis. As a result, we will face increased competition in the markets for any new financial products and services that we may offer. Likewise, an increased amount of consolidation among banks and securities firms or banks and insurance firms could result in a growing number of large financial institutions that could compete aggressively with us. Mergers and Acquisitions We generally must obtain approval from the banking regulators before we can acquire other financial institutions. We must not engage in certain acquisitions if we are undercapitalized. Furthermore, the BHCA provides that the Federal Reserve Board cannot approve any acquisition, merger or consolidation that may substantially lessen competition in the banking industry, create a monopoly in any section of the country, or be a restraint of trade. However, the Federal Reserve Board may approve such a transaction if the convenience and needs of the community clearly outweigh any anti-competitive effects. Specifically, the Federal Reserve Board would consider, among other factors, the expected benefits to the public (greater convenience, increased competition, greater efficiency, etc.) against the risks of possible adverse effects (undue concentration of resources, decreased or unfair competition, conflicts of interest, unsound banking practices, etc.). Banks Federal and state laws and regulations that govern banks have the effect of, among other things, regulating the scope of business, investments, cash reserves, the purpose and nature of loans, the maximum interest rate chargeable on loans, the amount of dividends declared, and required capitalization ratios. National Banking Associations. Banks that are organized as national banking associations under the National Bank Act are subject to regulation and examination by the Office of the Comptroller of the Currency, or OCC. The OCC supervises, regulates and regularly examines the First National Bank of Abilene, First National Bank, Sweetwater, First Financial Bank, National Association, Cleburne, Eastland National Bank, San Angelo National Bank, Weatherford National Bank, First Financial Bank, National Association, Southlake and City National Bank, Mineral Wells. The OCC's supervision and regulation of banks is primarily intended to protect the interests of depositors. The National Bank Act: o requires each national banking association to maintain reserves against deposits, o restricts the nature and amount of loans that may be made and the interest that may be charged, and o restricts investments and other activities. 4 State Banks. Banks that are organized as state banks under Texas law are subject to regulation and examination by the Banking Commissioner of the State of Texas. The Commissioner regulates and supervises, and the Texas Banking Department regularly examines, Hereford State Bank and Stephenville Bank and Trust Co. The Commissioner's supervision and regulation of banks is primarily designed to protect the interests of depositors. Texas law o requires each state bank to maintain reserves against deposits, o restricts the nature and amount of loans that may be made and the interest that may be charged, and o restricts investments and other activities. Because our Texas-chartered banks are members of the FDIC, they are also subject to regulation at the federal level by the FDIC, and are subject to most of the federal laws described below. Deposit Insurance Each of our subsidiary banks is a member of the FDIC. The FDIC provides deposit insurance protection that covers all deposit accounts in FDIC-insured depository institutions and generally does not exceed $100,000 per depositor. Our subsidiary banks must pay assessments to the FDIC under a risk-based assessment system for federal deposit insurance protection. FDIC-insured depository institutions that are members of the Bank Insurance Fund pay insurance premiums at rates based on their risk classification. Institutions assigned to higher risk classifications (i.e., institutions that pose a greater risk of loss to their respective deposit insurance funds) pay assessments at higher rates than institutions that pose a lower risk. An institution's risk classification is assigned based on its capital levels and the level of supervisory concern the institution poses to bank regulators. In addition, the FDIC can impose special assessments to cover the costs of borrowings from the U.S. Treasury, the Federal Financing Bank and the Bank Insurance Fund member banks. As of December 31, 2002, the assessment rate for each of our subsidiary banks is at the lowest level risk-based premium available. Under the Financial Institutions Reform, Recovery, and Enforcement Act of 1989, or FIRREA, an FDIC-insured depository institution can be held liable for any losses incurred by the FDIC in connection with (1) the "default" of one of its FDIC-insured subsidiaries or (2) any assistance provided by the FDIC to one of its FDIC-insured subsidiaries "in danger of default." "Default" is defined generally as the appointment of a conservator or receiver, and "in danger of default" is defined generally as the existence of certain conditions indicating that a default is likely to occur in the absence of regulatory assistance. The Federal Deposit Insurance Act, or FDIA requires that the FDIC review (1) any merger or consolidation by or with an insured bank, or (2) any establishment of branches by an insured bank. The FDIC is also empowered to regulate interest rates paid by insured banks. Approval of the FDIC is also required before an insured bank retires any part of its common or preferred stock, or any capital notes or debentures. Insured banks that are also members of the Federal Reserve System, however, are regulated with respect to the foregoing matters by the Federal Reserve System. Payment of Dividends We are a legal entity separate and distinct from our banking and other subsidiaries. We receive most of our revenue from dividends paid to us by our Delaware holding company subsidiary. Similarly, the Delaware holding company subsidiary receives dividends from our bank subsidiaries. Described below are some of the laws and regulations that apply when either we or our subsidiary banks pay dividends. Each state bank that is a member of the Federal Reserve System and each national banking association is required by federal law to obtain the prior approval of the Federal Reserve Board and the OCC, respectively, to declare and pay dividends if the total of all dividends declared in any calendar year would exceed the total of (1) such bank's net profits (as defined and interpreted by regulation) for that year plus (2) its retained net profits (as defined and interpreted by regulation) for the preceding two calendar years, less any required transfers to surplus. In addition, these banks may only pay dividends to the extent that retained net profits (including the portion transferred to surplus) exceed bad debts (as defined by regulation). 5 Our subsidiary banks paid aggregate dividends of approximately $26.6 million in 2002 and approximately $25.5 million in 2001. Under the dividend restrictions discussed above, as of December 31, 2002, our subsidiary banks, without obtaining governmental approvals, could have declared in the aggregate additional dividends of approximately $20.7 million from retained net profits. To pay dividends, we and our subsidiary banks must maintain adequate capital above regulatory guidelines. In addition, if the applicable regulatory authority believes that a bank under its jurisdiction is engaged in or is about to engage in an unsafe or unsound practice (which, depending on the financial condition of the bank, could include the payment of dividends), the authority may require, after notice and hearing, that such bank cease and desist from the unsafe practice. The Federal Reserve Board and the OCC have each indicated that paying dividends that deplete a bank's capital base to an inadequate level would be an unsafe and unsound banking practice. The Federal Reserve Board, the OCC and the FDIC have issued policy statements that recommend that bank holding companies and insured banks should generally only pay dividends to the extent that net income is sufficient to cover both cash dividends and rate of earnings retention consistent with capital needs, asset quality and overall financial condition. No undercapitalized institution may pay a dividend. Affiliate Transactions The Federal Reserve Act, the FDIA and the rules adopted under these statutes restrict the extent to which we can borrow or otherwise obtain credit from, or engage in certain other transactions with, our depository subsidiaries. These laws regulate "covered transactions" between insured depository institutions and their subsidiaries, on the one hand, and their nondepository affiliates, on the other hand. "Covered transactions" include a loan or extension of credit to a nondepository affiliate, a purchase of securities issued by such an affiliate, a purchase of assets from such an affiliate (unless otherwise exempted by the Federal Reserve Board), an acceptance of securities issued by such an affiliate as collateral for a loan, and an issuance of a guarantee, acceptance, or letter of credit for the benefit of such an affiliate. The "covered transactions" that an insured depository institution and its subsidiaries are permitted to engage in with their nondepository affiliates are limited to the following amounts: (1) in the case of any one such affiliate, the aggregate amount of "covered transactions" cannot exceed ten percent of the capital stock and the surplus of the insured depository institution; and (2) in the case of all affiliates, the aggregate amount of "covered transactions" cannot exceed twenty percent of the capital stock and surplus of the insured depository institution. In addition, extensions of credit that constitute "covered transactions" must be collateralized in prescribed amounts. Further, a bank holding company and its subsidiaries are prohibited from engaging in certain tie-in arrangements in connection with any extension of credit, lease or sale of property or furnishing of services. Finally, when we and our subsidiary banks conduct transactions internally among us, we are required to do so at arm's length. Loans to Directors, Executive Officers and Principal Shareholders The authority of our subsidiary banks to extend credit to our directors, executive officers and principal shareholders, including their immediate family members and corporations and other entities that they control, is subject to substantial restrictions and requirements under Sections 22(g) and 22(h) of the Federal Reserve Act and Regulation O promulgated thereunder. These statutes and regulations impose specific limits on the amount of loans our subsidiary banks may make to directors and other insiders, and specified approval procedures must be followed in making loans that exceed certain amounts. In addition, all loans our subsidiary banks make to directors and other insiders must satisfy the following requirements: o The loans must be made on substantially the same terms, including interest rates and collateral, as prevailing at the time for comparable transactions with persons not affiliated with us or the subsidiary banks; o The subsidiary banks must follow credit underwriting procedures at least as stringent as those applicable to comparable transactions with persons who are not affiliated with us or the subsidiary banks; and o The loans must not involve a greater than normal risk of repayment or other unfavorable features. 6 Furthermore, each subsidiary bank must periodically report all loans made to directors and other insiders to the bank regulators, and these loans are closely scrutinized by the regulators for compliance with Sections 22(g) and 22(h) of the Federal Reserve Ace and Regulation O. Capital Bank Holding Companies and Financial Holding Companies. The Federal Reserve Board has adopted risk-based capital guidelines for bank holding companies and financial holding companies. The ratio of total capital to risk weighted assets (including certain off-balance-sheet activities, such as standby letters of credit) must be a minimum of eight percent. At least half of the total capital is to be composed of common shareholders' equity, minority interests in the equity accounts of consolidated subsidiaries and a limited amount of perpetual preferred stock, less goodwill, which is collectively referred to as Tier 1 Capital. The remainder of total capital may consist of subordinated debt, other preferred stock and a limited amount of loan loss reserves. In addition, the Federal Reserve Board has established minimum leverage ratio guidelines for bank holding companies and financial holding companies. Bank holding companies and financial holding companies that meet certain specified criteria, including having the highest regulatory rating, must maintain a minimum Tier 1 Capital leverage ratio (Tier 1 Capital to average assets for the current quarter, less goodwill) of three percent. Bank holding companies and financial holding companies that do not have the highest regulatory rating will generally be required to maintain a higher Tier 1 Capital leverage ratio of three percent plus an additional cushion of 100 to 200 basis points. The Federal Reserve Board has not advised us of any specific minimum leverage ratio applicable to us. The guidelines also provide that bank holding companies and financial holding companies experiencing internal growth or making acquisitions will be expected to maintain strong capital positions. Such strong capital positions must be kept substantially above the minimum supervisory levels without significant reliance on intangible assets (e.g., goodwill, core deposit intangibles and purchased mortgage servicing rights). As of December 31, 2002, our capital ratios were as follows: (1) Tier 1 Capital to Risk-Weighted Assets Ratio, 18.50%; (2) Total Capital to Risk-Weighted Assets Ratio, 19.52%; and (3) Tier 1 Capital Leverage Ratio, 10.51%. Banks. The Federal Deposit Insurance Corporation Improvement Act of 1991, or FDICIA established five capital tiers with respect to depository institutions: "well-capitalized," "adequately capitalized," "undercapitalized," "significantly undercapitalized," and "critically undercapitalized." A depository institution's capital tier will depend upon where its capital levels are in relation to various relevant capital measures, including (1) risk-based capital measures, (2) a leverage ratio capital measure and (3) certain other factors. Regulations establishing the specific capital tiers provide that a "well-capitalized" institution will have a total risk-based capital ratio of ten percent or greater, a Tier 1 risk-based capital ratio of six percent or greater, and a Tier 1 leverage ratio of five percent or greater, and not be subject to any written regulatory enforcement agreement, order, capital directive or prompt corrective action derivative. For an institution to be "adequately capitalized," it will have a total risk-based capital ratio of eight percent or greater, a Tier 1 risk-based capital ratio of four percent or greater, and a Tier 1 leverage ratio of four percent or greater (in some cases three percent). For an institution to be "undercapitalized," it will have a total risk-based capital ratio that is less than eight percent, a Tier 1 risk-based capital ratio less than four percent or a Tier 1 leverage ratio less than four percent (or a leverage ratio less than three percent if the institution is rated composite 1 in its most recent report of examination, subject to appropriate federal banking agency guidelines). For an institution to be "significantly undercapitalized," it will have a total risk-based capital ratio less than six percent, a Tier 1 risk-based capital ratio less than three percent, or a Tier 1 leverage ratio less than three percent. For an institution to be "critically undercapitalized," it will have a ratio of tangible equity to total assets equal to or less than two percent. FDICIA requires federal banking agencies to take "prompt corrective action" against depository institutions that do not meet minimum capital requirements. Under current regulations, we were "well capitalized" as of December 31, 2002. FDICIA generally prohibits a depository institution from making any capital distribution (including payment of a dividend) or paying any management fee to its holding company if the depository institution would thereafter be "undercapitalized." An "undercapitalized" institution must develop a capital restoration plan and its parent holding company must guarantee that institution's compliance with such plan. The liability of the parent holding company under any such guarantee is limited to the lesser of five percent of the institution's assets at the time it became "undercapitalized" or the amount needed to bring the institution into compliance with all capital standards. Furthermore, in the event of the bankruptcy of the parent holding company, such 7 guarantee would take priority over the parent's general unsecured creditors. If a depository institution fails to submit an acceptable capital restoration plan, it shall be treated as if it is significantly undercapitalized. "Significantly undercapitalized" depository institutions may be subject to a number of requirements and restrictions, including orders to sell sufficient voting stock to become "adequately capitalized," requirements to reduce total assets, and cessation of receipt of deposits from correspondent banks. "Critically undercapitalized" institutions are subject to the appointment of a receiver or conservator. Finally, FDICIA requires the various regulatory agencies to set forth certain standards that do not relate to capital. Such standards relate to the safety and soundness of operations and management and to asset quality and executive compensation, and permit regulatory action against a financial institution that does not meet such standards. If an insured bank fails to meet its capital guidelines, it may be subject to a variety of other enforcement remedies, including a prohibition on the taking of brokered deposits and the termination of deposit insurance by the FDIC. Bank regulators continue to indicate their desire to raise capital requirements beyond their current levels. In addition to FDICIA capital standards, Texas-chartered banks must also comply with the capital requirements imposed by the Texas Banking Department. Neither the Texas Finance Code nor its regulations specify any minimum capital-to-assets ratio that must be maintained by a Texas-chartered bank. Instead, the Texas Banking Department determines the appropriate ratio on a bank by bank basis, considering factors such as the nature of a bank's business, its total revenue, and the bank's total assets. As of December 31, 2002, all of our Texas-chartered banks exceeded the minimum ratios applied to them. Our Support of Our Subsidiary Banks Under Federal Reserve Board policy, we are expected to commit resources to act as a source of strength to support each of our subsidiary banks. This support may be required at times when, absent such Federal Reserve Board policy, we would not otherwise be required to provide it. In addition, any loans we make to our subsidiary banks would be subordinate in right of payment to deposits and to other indebtedness of our banks. In the event of a bank holding company's bankruptcy, any commitment by the bank holding company to a federal bank regulatory agency to maintain the capital of a subsidiary bank will be assumed by the bankruptcy trustee and be subject to a priority of payment. Under the National Bank Act, if the capital stock of a national bank is impaired by losses or otherwise, the OCC is authorized to require the bank's shareholders to pay the deficiency on a pro-rata basis. If any shareholder refuses to pay the pro-rata assessment after three months notice, then the bank's board of directors must sell an appropriate amount of the shareholder's stock at a public auction to make up the deficiency. To the extent necessary, if a deficiency in capital still exists and the bank refuses to go into liquidation, then a receiver may be appointed to wind up the bank's affairs. Additionally, under the Federal Deposit Insurance Act, in the event of a loss suffered or anticipated by the FDIC (either as a result of the default of a banking subsidiary or related to FDIC assistance provided to a subsidiary in danger of default) our other banking subsidiaries may be assessed for the FDIC's loss. Interstate Banking and Branching Act Pursuant to the Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994, or Riegle-Neal Act, a bank holding company or financial holding company is able to acquire banks in states other than its home state. The Riegle-Neal Act also authorized banks to merge across state lines, thereby creating interstate branches, beginning June 1, 1997. Furthermore, under this act, a bank is now able to open new branches in a state in which it does not already have banking operations, if the laws of such state permit it to do so. Accordingly, both the OCC and the Texas Banking Department accept applications for interstate merger and branching transactions, subject to certain limitations on ages of the banks to be acquired and the total amount of deposits within the state a bank or financial holding company may control. Since our primary service area is Texas, we do not expect that the ability to operate in other states will have any material impact on our growth strategy. We may, however, face increased competition from out-of-state banks that branch or make acquisitions in our primary markets in Texas. 8 Community Reinvestment Act of 1977 The Community Reinvestment Act of 1977, or CRA subjects a bank to regulatory assessment to determine if the institution meets the credit needs of its entire community, including low- and moderate-income neighborhoods served by the bank, and to take that determination into account in its evaluation of any application made by such bank for, among other things, approval of the acquisition or establishment of a branch or other deposit facility, an office relocation, a merger, or the acquisition of shares of capital stock of another financial institution. The regulatory authority prepares a written evaluation of an institution's record of meeting the credit needs of its entire community and assigns a rating. We believe our subsidiary banks have taken significant actions to comply with the CRA, and each has received at least a "satisfactory" commendation in its most recent review by federal regulators with respect to its compliance with the CRA. Monitoring and Reporting Suspicious Activity Under the Bank Secrecy Act, IRS rules and other regulations, we are required to monitor and report unusual or suspicious account activity as well as transactions involving the transfer or withdrawal of amounts in excess of prescribed limits. In the wake of the tragic events of September 11th, on October 26, 2001, the President signed the Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism, or USA PATRIOT Act, of 2001. Under the USA PATRIOT Act, financial institutions are subject to prohibitions against specified financial transactions and account relationships as well as enhanced due diligence and "know your customer" standards in their dealings with foreign financial institutions and foreign customers. For example, the enhanced due diligence policies, procedures, and controls generally require financial institutions to take reasonable steps to: o to conduct enhanced scrutiny of account relationships to guard against money laundering and report any suspicious transaction; o to ascertain the identity of the nominal and beneficial owners of, and the source of funds deposited into, each account as needed to guard against money laundering and report any suspicious transactions; o to ascertain for any foreign bank, the shares of which are not publicly traded, the identity of the owners of the foreign bank, and the nature and extent of the ownership interest of each such owner; and o to ascertain whether any foreign bank provides correspondent accounts to other foreign banks and, if so, the identity of those foreign banks and related due diligence information. Under the USA PATRIOT Act, financial institutions are also required to establish anti-money laundering programs. The USA PATRIOT Act sets forth minimum standards for these programs, including: o the development of internal policies, procedures, and controls; o the designation of a compliance officer; o an ongoing employee training program; and o an independent audit function to test the programs. In addition, the USA PATRIOT Act also requires the Secretary of the Treasury to adopt rules addressing a number of related issues, including increasing the cooperation and information sharing between financial institutions, regulators, and law enforcement authorities regarding individuals, entities and organizations engaged in, or reasonably suspected based on credible evidence of engaging in, terrorist acts or money laundering activities. Any financial institution complying with these rules will not be deemed to violate the privacy provisions of the Gramm-Leach-Bliley Act that are discussed below. Finally, under the regulations of the Office of Foreign Asset Control, we are required to monitor and block transactions with certain "specially designated nationals" who OFAC has determined pose a risk to U.S. national security. 9 Consumer Laws and Regulations We are also subject to certain consumer laws and regulations that are designed to protect consumers in transactions with banks. While the following list is not exhaustive, these laws and regulations include the Truth in Lending Act, the Truth in Savings Act, the Electronic Funds Transfer Act, the Expedited Funds Availability Act, the Equal Credit Opportunity Act, and the Fair Housing Act, among others. These laws and regulations among other things prohibit discrimination on the basis of race, gender or other designated characteristics and mandate various disclosure requirements and regulate the manner in which financial institutions must deal with customers when taking deposits or making loans to such customers. These and other laws also limit finance charges or other fees or charges earned in our activities. We must comply with the applicable provisions of these consumer protection laws and regulations as part of our ongoing customer relations. Technology Risk Management and Consumer Privacy State and federal banking regulators have issued various policy statements emphasizing the importance of technology risk management and supervision in evaluating the safety and soundness of depository institutions with respect to banks that contract with outside vendors to provide data processing and core banking functions. The use of technology-related products, services, delivery channels and processes expose a bank to various risks, particularly operational, privacy, security, strategic, reputation and compliance risk. Banks are generally expected to prudently manage technology-related risks as part of their comprehensive risk management policies by identifying, measuring, monitoring and controlling risks associated with the use of technology. Under Section 501 of the Gramm-Leach-Bliley Act, the federal banking agencies have established appropriate standards for financial institutions regarding the implementation of safeguards to ensure the security and confidentiality of customer records and information, protection against any anticipated threats or hazards to the security or integrity of such records and protection against unauthorized access to or use of such records or information in a way that could result in substantial harm or inconvenience to a customer. Among other matters, the rules require each bank to implement a comprehensive written information security program that includes administrative, technical and physical safeguards relating to customer information. Under the Gramm-Leach-Bliley Act, a financial institution must also provide its customers with a notice of privacy policies and practices. Section 502 prohibits a financial institution from disclosing nonpublic personal information about a consumer to nonaffiliated third parties unless the institution satisfies various notice and opt-out requirements and the customer has not elected to opt out of the disclosure. Under Section 504, the agencies are authorized to issue regulations as necessary to implement notice requirements and restrictions on a financial institution's ability to disclose nonpublic personal information about consumers to nonaffiliated third parties. Under the final rule the regulators adopted, all banks must develop initial and annual privacy notices which describe in general terms the bank's information sharing practices. Banks that share nonpublic personal information about customers with nonaffiliated third parties must also provide customers with an opt-out notice and a reasonable period of time for the customer to opt out of any such disclosure (with certain exceptions). Limitations are placed on the extent to which a bank can disclose an account number or access code for credit card, deposit, or transaction accounts to any nonaffiliated third party for use in marketing. Monetary Policy Banks are affected by the credit policies of other monetary authorities, including the Federal Reserve Board, that affect the national supply of credit. The Federal Reserve Board regulates the supply of credit in order to influence general economic conditions, primarily through open market operations in United States government obligations, varying the discount rate on financial institution borrowings, varying reserve requirements against financial institution deposits, and restricting certain borrowings by financial institutions and their subsidiaries. The monetary policies of the Federal Reserve Board have had a significant effect on the operating results of banks in the past and are expected to continue to do so in the future. 10 Pending and Proposed Legislation New regulations and statutes are regularly proposed containing wide-ranging proposals for altering the structures, regulations and competitive relationships of financial institutions operating in the United States. We cannot predict whether or in what form any proposed regulation or statute will be adopted or the extent to which our business may be affected by any new regulation or statute. Enforcement Powers of Federal Banking Agencies The Federal Reserve and other state and federal banking agencies and regulators have broad enforcement powers, including the power to terminate deposit insurance, issue cease-and-desist orders, impose substantial fees and other civil and criminal penalties and appoint a conservator or receiver. Our failure to comply with applicable laws, regulations and other regulatory pronouncements could subject us, as well as our officers and directors, to administrative sanctions and potentially substantial civil penalties. Available Information We file annual, quarterly and special reports, proxy statements and other information with the Securities and Exchange Commission. You may read and copy any document we file at the Securities and Exchange Commission's Public Reference Room at 450 Fifth Street, N.W., Washington, D.C. 20549. Please call the Securities and Exchange Commission at 1-800-SEC-0330 for further information on the public reference room. Our SEC filings are also available to the public at the Securities and Exchange Commission's web site at http://www.sec.gov. No information from this web page is incorporated by reference herein. Our web site is http://www.ffin.com. You may also obtain copies of our annual, quarterly and special reports, proxy statements and certain other information filed with the SEC, as well as amendments thereto, free of charge from our web site. These documents are posted to our web site as soon as reasonably practicable after we have filed them with the SEC. ITEM 2. PROPERTIES Our principal office is located in the First National Bank Building at 400 Pine Street in downtown Abilene, Texas. We lease two spaces in a building owned by First National Bank of Abilene. The lease for approximately 2,300 square feet of space expires December 31, 2004. The lease for approximately 1,100 square feet of space expires May 31, 2006. Our subsidiary banks collectively own 22 banking facilities, some of which are detached drive-ins, and they also lease six banking facilities. Our management considers all of our existing locations to be well-suited for conducting the business of banking. We believe that our existing facilities are adequate to meet our requirements and our subsidiary banks' requirements for the foreseeable future. ITEM 3. LEGAL PROCEEDINGS From time to time we and our subsidiary banks are parties to lawsuits arising in the ordinary course of our banking business. However, there are no material pending legal proceedings to which we, our subsidiary banks or our other direct and indirect subsidiaries, or any of their properties, are currently subject. Other than regular, routine examinations by state and federal banking authorities, there are no proceedings pending or known to be contemplated by any governmental authorities. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS No matters were submitted to a vote of our security holders during the fourth quarter of our fiscal year ended December 31, 2002. 11 PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS Market Information Our common stock, par value $10.00 per share, is traded on the Nasdaq Stock Market under the trading symbol FFIN. See "Item 8--Financial Statements and Supplementary Data--Quarterly Financial Data" for the high, low and closing sales prices as reported by the Nasdaq Stock Market for our common stock for the periods indicated. Holders As of February 13, 2003, we had 1,604 shareholders of record. Dividends See "Item 8--Financial Statements and Supplementary Data--Quarterly Results of Operations" for the frequency and amount of cash dividends paid by us. Also, see "Item 1 - Business - Supervision and Regulation - Payment of Dividends" and "Item 7 - Management's Discussion and Analysis of the Financial Condition and Results of Operations - Liquidity - Dividends" for restrictions on our present or future ability to pay dividends, particularly those restrictions arising under federal and state banking laws. 12 Recent Sales of Unregistered Securities During the year ended December 31, 2002, the following sales of unregistered shares of common stock were made to employees in connection with their exercise of stock options:
Number of Common Aggregate Sales Date Shares Price Per Share Price -------- -------- --------------- ------------- 01-25-02 3,702 $ 14.90 $ 55,159.80 02-04-02 4,830 14.90 71,967.00 02-22-02 2,147 14.90 31,990.30 02-27-02 1,073 14.90 15,987.70 02-27-02 220 29.27 6,439.40 04-11-02 309 29.27 9,044.43 04-15-02 75 20.80 1,560.00 04-19-02 110 29.27 3,219.70 05-20-02 400 14.90 5,960.00 05-21-02 1,073 14.90 15,987.70 06-05-02 353 14.90 5,259.70 06-05-02 150 20.80 3,120.00 06-05-02 1,514 29.27 44,314.78 06-06-02 2,343 20.80 48,734.40 06-06-02 860 14.90 12,814.00 06-07-02 450 14.90 6,705.00 06-11-02 673 14.90 10,027.70 06-13-02 247 29.27 7,229.69 06-28-02 330 29.27 9,659.10 07-02-02 330 29.27 9,659.10 07-16-02 1,341 14.90 19,980.90 08-26-02 330 29.27 9,659.10 08-26-02 2,414 14.90 35,968.60 09-11-02 75 20.80 1,560.00 09-12-02 309 29.27 9,044.43 11-05-02 257 14.90 3,829.30 12-05-02 350 14.90 5,215.00 12-06-02 200 14.90 2,980.00 12-06-02 1,815 29.27 53,125.05 12-12-02 50 14.90 745.00 12-16-02 2,344 20.80 48,755.20 12-20-02 75 20.80 1,560.00 12-20-02 200 29.27 5,854.00 ------ ---------- ------------ Totals 30,949 $ 18.52 $ 573,116.08 ====== ============
Each of the foregoing sales were made in reliance upon the exemption provided by Section 4(2) of the Securities Act of 1933, as amended. 13 ITEM 6. SELECTED FINANCIAL DATA The selected financial data presented below as of and for the years ended December 31, 2002, 2001, 2000, 1999, and 1998, have been derived from our audited consolidated financial statements. The selected financial data should be read in conjunction with "Item 7--Management's Discussion and Analysis of Financial Condition and Results of Operations" and our consolidated financial statements. The results of operations presented below are not necessarily indicative of the results of operations that may be achieved in the future. The amounts related to shares of our common stock have been adjusted to give effect to all stock dividends and stock splits. Management's Discussion and Analysis of Financial Condition and Results of Operations incorporated information required to be disclosed by the Securities and Exchange Commissions' Industry Guide 3, "Statistical Disclosure by Bank Holding Companies."
Year Ended December 31, -------------------------------------------------------------------- 2002 2001 2000 1999 1998 ---------- ---------- ---------- ---------- ---------- (dollars in thousands, except per share data) Summary Income Statement Information: Interest income $ 104,862 $ 116,473 $ 117,951 $ 110,013 $ 111,868 Interest expense 24,380 44,834 48,829 43,338 46,292 ---------- ---------- ---------- ---------- ---------- Net interest income 80,482 71,639 69,122 66,675 65,576 Provision for loan losses 2,370 1,964 2,398 2,031 1,140 Noninterest income 29,553 27,579 25,947 24,484 22,351 Noninterest expense 59,082 55,072 51,692 51,934 52,422 ---------- ---------- ---------- ---------- ---------- Earnings before income taxes 48,583 42,182 40,979 37,194 34,365 Income tax expense 14,630 12,827 12,663 11,504 11,111 ---------- ---------- ---------- ---------- ---------- Net earnings $ 33,953 $ 29,355 $ 28,316 $ 25,690 $ 23,254 ========== ========== ========== ========== ========== Per Share Data: Net earnings per share, basic $ 2.75 $ 2.38 $ 2.28 $ 2.06 $ 1.87 Net earnings per share, assuming dilution 2.74 2.37 2.27 2.05 1.86 Cash dividends declared 1.35 1.16 1.03 .90 .80 Book value at period-end 19.31 17.32 15.92 14.33 13.62 Earnings performance ratios: Return on average assets 1.78% 1.62% 1.67% 1.53% 1.44% Return on average equity 15.13 14.35 15.39 14.84 14.51 Summary Balance Sheet Data (Period-end): Investment securities $ 772,256 $ 721,694 $ 654,253 $ 656,218 $ 625,891 Loans 964,040 940,131 859,271 797,275 779,544 Total assets 1,993,183 1,929,694 1,753,814 1,723,369 1,686,647 Deposits 1,711,562 1,685,163 1,519,874 1,524,704 1,504,856 Total liabilities 1,754,415 1,716,040 1,557,693 1,544,706 1,517,198 Total shareholders' equity 238,768 213,654 196,121 178,663 169,449 Asset quality ratios: Allowance for loan losses/period-end loans 1.16% 1.13% 1.15% 1.12% 1.15% Nonperforming assets/period-end loans plus foreclosed assets 0.44 0.51 0.48 0.26 0.41 Net charge offs/average loans 0.19 0.18 0.18 0.27 0.36 Capital ratios: Average shareholders' equity/average assets 11.76% 11.29% 10.86% 10.30% 9.89% Leverage ratio (1) 10.51 9.92 10.40 9.62 9.02 Tier 1 risk-based capital (2) 18.50 17.10 17.75 17.19 16.03 Total risk-based capital (3) 19.52 18.08 18.74 18.13 17.01 Dividend payout ratio 49.13 48.94 45.23 43.64 41.66 -------------------------------------------------------------------------------- (1) Calculated by dividing, at period-end, shareholders' equity (before unrealized gain/loss on securities available-for-sale) less intangible assets by fourth quarter average assets less intangible assets. (2) Calculated by dividing, at period-end, shareholders' equity (before unrealized gain/loss on securities available-for-sale) less intangible assets by risk-adjusted assets. (3) Calculated by dividing, at period-end, shareholders' equity (before unrealized gain/loss on securities available for sale) less intangible assets plus allowance for loan losses to the extent allowed under regulatory guidelines by risk-adjusted assets.
14 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Introduction Management's discussion and analysis of the major elements of our consolidated balance sheets as of December 31, 2002 and 2001, and consolidated statements of earnings for the years 2000 through 2002 should be reviewed in conjunction with our consolidated financial statements, accompanying notes, and selected financial data presented elsewhere in this Form 10-K. All amounts, prices and per share data related to our common stock have been adjusted to give effect to all stock splits and stock dividends. On July 3, 2001, we acquired City Bancshares, Inc. and its subsidiary City National Bank, Mineral Wells, Texas for $16.5 million in cash. The results of City National Bank are included in our consolidated financial statements beginning July 1, 2001 and may to some extent affect the comparisons to the prior period amounts and 2002 operating results which include a full year of City National Bank's operations. Critical Accounting Policies The preparation of the Company's consolidated financial statements is based on the selection of certain accounting policies, based on generally accepted accounting principles and customary practices in the banking industry. These policies, in certain areas, require management to make significant estimates and assumptions. The following discussion addresses the Company's allowance for loan loss and its provision for loan losses which is deemed by management to be its most critical accounting policy. We have other key accounting policies and continue to evaluate the materiality of their impact on our consolidated financial statements, but we believe that these other policies either do not generally require us to make estimates and judgments that are difficult or subjective, or it is less likely that they would have a material impact on our reported results for a given period. A policy is deemed critical if (i) the accounting estimate required the Company to make assumptions about matters that are highly uncertain at the time the accounting estimate was made; and (ii) different estimates that reasonably could have been used in the current period, or changes in the accounting estimate that are reasonably likely to occur from period to period, would have a material impact on the financial statements. The allowance for loan losses is an amount that management believes will be adequate to absorb inherent estimated losses on existing loans in which collectibility is unlikely based upon management's review and evaluation of the loan portfolio, including letters of credit, lines of credit and unused commitments to provide financing. The allowance for loan losses is increased by charges to income and decreased by charge-offs (net of recoveries). Management's periodic evaluation of the adequacy of the allowance is based on general economic conditions, the financial condition of the borrower, the value and liquidity of collateral, delinquency, prior loan loss experience, and the results of periodic reviews of the portfolio by our loan review department and regulatory examiners. A consistent, well documented loan review methodology has been developed that includes allowances assigned to specific loans and nonspecific allowances that are based on the factors noted in the prior sentence. Our independent loan review department is responsible for performing this evaluation for all of our subsidiary banks to ensure consistent methodology. Although we believe that we use the best information available to make loan loss allowance determinations, future adjustments could be necessary if circumstances or economic conditions differ substantially from the assumptions used in making our initial determinations. A downturn in the economy and employment could result in increased levels of non-performing assets and charge-offs, increased loan loss provisions and reductions in income. Additionally, as an integral part of their examination process, bank regulatory agencies periodically review our allowance for loan losses. The banking agencies could require the recognition of additions to the loan loss allowance based on their judgment of information available to them at the time of their examination. Accrual of interest is discontinued on a loan when management believes, after considering economic and business conditions and collection efforts, that the borrower's financial condition is such that collection of interest is doubtful. 15 The Company's policy requires measurement of the allowance for an impaired collateral dependent loan based on the fair value of the collateral. Other loan impairments are measured based on the present value of expected future cash flows or the loan's observable market price. Results of Operations Performance Summary. Net earnings for 2002 were $34.0 million, an increase of $4.6 million, or 15.7%, over net earnings for 2001 of $29.4 million. Net earnings for 2000 were $28.3 million. The increase in net earnings for 2002 over 2001 was primarily attributable to an increase in net interest income resulting primarily from growth in average earning assets and an improved net interest margin. The increase in net earnings for 2001 over 2000 was primarily attributable to an increase in net interest income resulting primarily from the growth in average earning assets and an increase in noninterest income resulting primarily from increases in service fees on deposit accounts and real estate mortgage fees. On a basic net earnings per share basis, net earnings were $2.75 for 2002 as compared to $2.38 for 2001 and $2.28 for 2000. Return on average assets was 1.78% for 2002 as compared to 1.62% for 2001 and 1.67% for 2000. Return on average equity was 15.13% for 2002 as compared to 14.35% for 2001 and 15.39% for 2000. Affecting our 2002 net earnings and basic and diluted earnings per share is the implementation of Statement of Financial Accounting Standards No. 141, "Business Combinations" ("SFAS No. 141") and Statement of Financial Accounting Standards No. 142, "Goodwill and Other Intangible Assets" ("SFAS No. 142"). SFAS No. 141 requires that all business combinations initiated after June 30, 2001 be accounted for under the purchase method and addresses the initial recognition and measurement of goodwill and other intangible assets acquired in a business combination. SFAS No. 142 addresses the initial recognition and measurement of intangible assets acquired outside of a business combination and the accounting for goodwill and other intangible assets subsequent to their acquisition. SFAS No. 142 provides that intangible assets with finite useful lives be amortized and that goodwill and intangible assets with indefinite lives not be amortized, but rather be tested at least annually for impairment. SFAS No. 142 was effective January 1, 2002 for calendar year companies; however, acquired goodwill and intangible assets recorded in the acquisition of City Bancshares, Inc. closed subsequent to June 30, 2001 were subject immediately to its provisions. On January 1, 2002, goodwill amounting to $23,765,896 was not subject to further amortization as a result of SFAS No. 142. The Company conducted its initial impairment test in 2002, with no reduction of recorded goodwill resulting from the test. A reconciliation adjusting comparative net earnings and earnings per share for the years ended December 31, 2001 and 2000, to show the effect of no longer amortizing the Company's goodwill, follows:
2001 2000 ------------ ------------ Reported net earnings $ 29,354,505 $ 28,316,047 Add back: goodwill amortization Goodwill amortization, before income tax 1,641,367 1,641,367 Income tax benefit (420,000) (420,000) ------------ ------------ Adjusted net earnings $ 30,575,872 $ 29,537,414 ============ ============ Basic earnings per share: Reported net earnings $ 2.38 $ 2.28 Goodwill amortization, net of income tax benefit .10 .10 ------------ ------------ Adjusted net earnings $ 2.48 $ 2.38 ============ ============ Earnings per share, assuming dilution: Reported net earnings $ 2.37 $ 2.27 Goodwill amortization, net of income tax benefit .10 .10 ------------ ------------ Adjusted net earnings $ 2.47 $ 2.37 ============ ============
Net Interest Income. Net interest income is the difference between interest income on earning assets and interest expense on liabilities incurred to fund those assets. Our earning assets consist primarily of loans and investment securities. Our liabilities to fund those assets consist primarily of noninterest-bearing and interest-bearing deposits. Tax-equivalent net interest income was $84.2 million in 2002 as compared to $74.8 million in 2001 and $71.9 16 million in 2000. These increases were primarily due to growth in the volume of earning assets, and for 2002, an improved net interest margin. Average earning assets were $1.748 billion in 2002, as compared to $1.653 billion in 2001 and $1.538 billion in 2000. The 2002 increase in average earning assets is attributable to higher average investment securities we held, which increased $72.3 million, and higher average loans we made, which increased $44.5 million. These increases were partially offset by a $22.4 million decrease in the 2002 average of short-term investments, which consist of primarily Federal funds sold. The 2001 increase in average earning assets was due primarily to an increase in average short-term investments, which increased $28.9 million, and higher average loans, which increased $80.0 million. Table 1 allocates the increases in tax-equivalent net interest income for 2002 and 2001 between the amount of increase attributable to volume and rate. Table 1 -- Changes in Interest Income and Interest Expense (in thousands):
2002 Compared to 2001 2001 Compared to 2000 -------------------------------------- ----------------------------------- Change Attributable to Total Change Attributable to Total ------------------------ ---------------------- Volume Rate Change Volume Rate Change ---------- ---------- ---------- --------- --------- --------- Short-term investments.......... $ (905) $ (1,359) $ (2,264) $ 1,799 $ (1,736) $ 63 Taxable investment securities... 3,394 (3,300) 94 (233) (1,154) (1,387) Tax-exempt investment securities(1) 1,032 241 1,273 707 106 813 Loans (1)....................... 3,720 (13,911) (10,191) 7,404 (7,993) (589) ---------- ---------- ---------- --------- --------- --------- Interest income............. 7,241 (18,329) (11,088) 9,678 (10,778) (1,100) Interest-bearing deposits....... 1,169 (21,052) (19,883) 2,688 (6,455) (3,767) Short-term borrowings........... (26) (545) (571) 481 (709) (228) ---------- ---------- ---------- --------- --------- --------- Interest expense............ 1,143 (21,597) (20,454) 3,169 (7,164) (3,995) ---------- ---------- ---------- --------- --------- --------- Net interest income......... $ 6,098 $ 3,268 $ 9,366 $ 6,508 $ (3,613) $ 2,895 ========== ========== ========== ========= ========= ========= --------------- (1) Computed on a tax-equivalent basis assuming a marginal tax rate of 35%.
The net interest margin, which measures tax-equivalent net interest income as a percentage of average earning assets, is illustrated below in Table 2 for the years 2000 through 2002. As the prime rate declined from 9.50% to 4.75% in 2001, our earning assets re-priced in advance of interest bearing deposits, which resulted in a lower net interest margin. As we re-priced our interest bearing deposits in 2002, the net interest margin improved to 4.82% as compared to 4.52% for 2001. 17 Table 2 -- Average Balances and Average Yields and Rates (in thousands, except percentages):
2002 2001 2000 -------------------------- -------------------------- -------------------------- Average Income/ Yield/ Average Income/ Yield/ Average Income/ Yield/ Balance Expense Rate Balance Expense Rate Balance Expense Rate ---------- --------- ---- ---------- -------- ---- ---------- -------- ---- Assets Short-term investments..... $ 57,030 $ 947 1.66% $ 79,424 $ 3,211 4.04% $ 50,538 $ 3,148 6.23% Taxable investment securities 597,830 32,264 5.40 540,771 32,170 5.95 544,546 33,557 6.16 Tax-exempt investment 150,824 10,475 6.95 135,620 9,202 6.79 125,072 8,389 6.71 securities (1)............ Loans (1)(2)............... 942,101 64,872 6.89 897,616 75,063 8.36 817,603 75,652 9.25 ---------- --------- ---------- -------- ---------- -------- Total earning assets...... 1,747,785 108,558 6.21 1,653,431 119,646 7.24 1,537,759 120,746 7.85 Cash and due from banks.... 81,016 80,032 77,727 Bank premises and equipment 41,195 40,903 40,400 Other assets............... 24,458 17,693 28,212 Goodwill, net.............. 24,644 29,178 19,335 Allowance for loan losses.. (11,099) (10,107) (9,420) ----------- ---------- ---------- Total assets.............. $1,907,999 $1,811,130 $1,694,013 ========== ========== ========== Liabilities and Shareholders' Equity Interest-bearing deposits.. $1,259,158 $ 24,088 1.91% $1,226,560 $ 43,971 3.58% $1,161,175 $ 47,738 4.11% Short-term borrowings...... 24,628 292 1.19 25,392 3.40 17,621 1,091 6.19 ---------- --------- ---------- -------- ---------- -------- 292 863 ----- -------- Total interest-bearing 1,283,786 24,380 1.90 1,251,952 44,834 3.58 1,178,796 48,829 4.14 --------- -------- -------- liabilities............... Noninterest-bearing deposits 385,012 339,800 317,659 Other liabilities.......... 14,846 14,861 13,529 ---------- ---------- ---------- Total liabilities......... 1,683,644 1,606,613 1,509,984 Shareholders' equity......... 224,355 204,517 184,029 ---------- ---------- ---------- Total liabilities and shareholders' equity...... $1,907,999 $1,811,130 $1,694,013 ========== ========== ========== Net interest income.......... $ 84,178 $ 74,812 $ 71,917 ========= ======== ======== Rate Analysis: Interest income/earning assets..................... 6.21% 7.24% 7.85% Interest expense/earning assets..................... 1.39 2.71 3.18 ---- ---- ---- Net yield on earning assets 4.82% 4.52% 4.68% ==== ==== ==== --------------- (1) Computed on a tax-equivalent basis assuming a marginal tax rate of 35%. (2) Nonaccrual loans are included in loans.
Noninterest Income. Noninterest income for 2002 was $29.6 million, an increase of $2.0 million, or 7.2%, as compared to 2001. The increase resulted primarily from (i) an increase in service fees on deposit accounts of $692 thousand which reflects growth in number of accounts and transactions processed; (ii) an increase in real estate mortgage fees of $248 thousand which reflects a continued high volume of mortgage originations and refinancing transactions generated by low mortgage rates; (iii) an increase of $429 thousand in ATM transaction fees which reflects the Company's focus to increase the cardholder base and the usage of check cards; and (iv) $735 thousand in check printing fees that, in periods prior to 2002, were recorded as a reduction in printing and supplies expense. The change in classification for check printing fees was made in response to a change in bank regulatory financial reporting guidelines. Noninterest income for 2001 was $27.6 million, an increase of $1.6 million, or 6.3%, as compared to 2000. This increase was primarily a result of; (i) an increase in trust fees of $397 thousand; (ii) an increase in service fees on deposit accounts of $669 thousand; and (iii) an increase of $588 thousand in real estate mortgage fees. Table 3 provides comparisons for other categories of noninterest income. 18 Table 3 -- Noninterest Income (in thousands):
Increase Increase 2002 (Decrease) 2001 (Decrease) 2000 ---------- ---------- ---------- ---------- ---------- Trust fees................................... $ 5,836 $ (55) $ 5,891 $ 397 $ 5,494 Service fees on deposit accounts............. 15,435 692 14,743 669 14,074 Real estate mortgage fees.................... 1,858 248 1,610 588 1,022 Net securities gains (losses)................ 16 (52) 68 (462) 530 ATM fees..................................... 2,370 429 1,941 387 1,554 Other: Mastercard fees............................ 980 26 954 124 830 Check printing fees........................ 735 735 - - - Miscellaneous income....................... 708 (95) 803 (114) 917 Safe deposit rental fees................... 403 9 394 (1) 395 Exchange fees.............................. 196 11 185 (39) 224 Credit life fees........................... 200 (16) 216 (21) 237 Data processing fees....................... 245 (16) 261 113 148 Brokerage commissions...................... 340 46 294 42 252 Interest on loan recoveries................ 230 12 218 (52) 270 ---------- ---------- ---------- ---------- ---------- Total other............................. 4,037 712 3,325 52 3,273 ---------- ---------- ---------- ---------- ---------- Total Noninterest Income................... $ 29,552 $ 1,974 $ 27,578 $ 1,631 $ 25,947 ========== ========== ========== ========== ==========
Noninterest Expense. Total noninterest expense for 2002 was $59.1 million, an increase of $4.0 million, or 7.3%, as compared to 2001. Noninterest expense for 2001 amounted to $55.1 million, an increase of $3.4 million or 6.3% as compared to 2000. An important measure in determining whether a banking company effectively managed noninterest expenses is the efficiency ratio, which is calculated by dividing noninterest expense by the sum of net interest income on a tax-equivalent basis and noninterest income. Our efficiency ratio for 2002 was 51.96% which represented improvement when compared to 53.82% for 2001, and 53.11% for 2000. Salaries and employee benefits for 2002 totaled $32.0 million, an increase of $3.3 million, or 11.5%, as compared to 2001. Salaries for 2002 were up $1.6 million with the increase attributable to normal pay increases, a higher number of full time equivalent employees, and higher performance incentive payments. Profit sharing and pension expenses for 2002 increased $823 thousand and $549 thousand, respectively, as compared to the prior year. The higher profit sharing expense related to the Company's 2002 increase in net earnings. In 2002, the Company lowered the expected long-term rate of return on pension plan assets from 8.5% to 6.5%; this change is the primary factor contributing to higher pension expense in the current year as compared to the prior year. Net occupancy expense for 2002 was virtually unchanged from the prior year and equipment expense was up $343 thousand over the 2001 amount. The higher equipment expense resulted primarily from higher depreciation and higher repairs and maintenance expense as compared to 2001. Intangible asset amortization for 2002 decreased $1.5 million and resulted primarily from the change in accounting principle that became effective January 1, 2002 and which eliminated the amortization of goodwill. Printing, stationery and supplies expense for 2002 increased $391 thousand over the prior year amount. The increase for 2002 was due to $735 thousand in check printing fees being included in noninterest income for 2002 versus a reduction in printing expense in prior years. ATM expense for 2002 was $266 thousand higher than the 2001 amount and reflects increased customer usage in 2002. Salaries and employee benefits for 2001 totaled $28.7 million, an increase of $1.6 million as compared to 2000. The increase resulted primarily from normal salary increases and the addition of employees from our acquisition finalized in July 2001. Net occupancy and equipment expense in the aggregate for 2001 increased by $710 thousand and resulted primarily from higher utilities and repair and maintenance expense. Other professional fees for 2001 increased $302 thousand as compared to the prior year. The increase resulted primarily from; (i) executive search fees; (ii) leasehold improvement design fees; and (iii) technology systems conversions. Printing, stationery, and supplies expense for 2001 increased $202 thousand as compared to 2000 and reflects expense related to the printing of additional customer disclosures and supplies related to implementation of check imaging at a number of our subsidiary banks. 19 Table 4 -- Noninterest Expense (in thousands):
Increase Increase 2002 (Decrease) 2001 (Decrease) 2000 ---------- ---------- ---------- ---------- ---------- Salaries..................................... $ 23,984 $ 1,604 $ 22,380 $ 1,417 $ 20,963 Medical and other benefits................... 2,297 180 2,117 133 1,984 Profit sharing............................... 2,681 823 1,858 (16) 1,874 Pension...................................... 1,173 549 624 (56) 680 Payroll taxes................................ 1,858 152 1,706 130 1,576 ---------- ---------- ---------- ---------- ---------- Total salaries and employee benefits....... 31,993 3,308 28,685 1,608 27,077 Net occupancy expense........................ 3,909 (87) 3,996 433 3,563 Equipment expense............................ 4,801 343 4,458 277 4,181 Intangible amortization...................... 135 (1,506) 1,641 - 1,641 Other: Data processing and operation fees......... 1,078 (38) 1,116 (147) 1,263 Postage.................................... 1,094 (80) 1,174 128 1,046 Printing, stationery and supplies.......... 1,475 391 1,084 202 882 Advertising................................ 1,169 64 1,105 51 1,054 Correspondent bank service charges......... 1,491 162 1,329 67 1,262 ATM expense................................ 1,361 266 1,095 145 950 Credit card fees........................... 696 27 669 65 604 Telephone.................................. 870 (8) 878 124 754 Public relations and business development.. 758 43 715 12 703 Directors' fees............................ 516 30 486 33 453 Audit and accounting fees.................. 785 39 746 80 666 Legal fees................................. 383 50 333 54 279 Other professional and service fees........ 796 (37) 833 302 531 Regulatory exam fees....................... 526 83 443 19 424 Travel..................................... 311 7 304 54 250 Courier expense............................ 676 127 549 101 448 Operational and other losses............... 743 203 540 (205) 745 Other miscellaneous expense................ 3,516 623 2,893 (23) 2,916 ---------- ---------- ---------- ----------- ---------- Total other............................. 18,244 1,952 16,292 1,062 15,230 ---------- ---------- ---------- ---------- ---------- Total Noninterest Expense.................... $ 59,082 $ 4,010 $ 55,072 $ 3,380 $ 51,692 ========== ========== ========== ========== ==========
Income Taxes. Income tax expense was $14.6 million for 2002 as compared to $12.8 million for 2001 and $12.7 million for 2000. Our effective tax rates on pretax income were 30.1%, 30.4% and 30.9%, respectively, for the years 2002, 2001 and 2000. Balance Sheet Review Loans. The loan portfolio is comprised of loans made to businesses, individuals, and farm and ranch operations located in the primary trade areas served by our subsidiary banks. Real estate loans represent loans primarily for new home construction and owner-occupied real estate. The structure of loans in the real estate mortgage classification generally provides repricing intervals to minimize the interest rate risk inherent in long-term fixed rate mortgage loans. As of December 31, 2002, total loans were $964.0 million, an increase of $23.9 million, as compared to December 31, 2001. As compared to year-end 2001, real estate loans increased $28.6 million and consumer loans decreased $4.4 million. Commercial, financial and agricultural loans as of year-end 2002 were virtually unchanged from one year ago. Loans averaged $942.1 million during 2002, an increase of $44.5 million over the prior year average. 20 Table 5 -- Composition of Loans (in thousands):
December 31, --------------------------------------------------------------- 2002 2001 2000 1999 1998 --------- --------- --------- --------- -------- Commercial, financial and agricultural..... $ 311,743 $ 312,053 $ 295,032 $ 297,966 $278,647 Real estate-- construction................. 50,911 47,173 40,610 43,039 36,721 Real estate-- mortgage..................... 375,256 350,382 290,920 208,895 198,447 Consumer, net of unearned income........... 226,130 230,523 232,709 247,375 265,729 --------- --------- --------- --------- -------- $ 964,040 $ 940,131 $ 859,271 $ 797,275 $779,544 ========= ========= ========= ========= ========
Table 6 -- Maturity Distribution and Interest Sensitivity of Loans at December 31, 2002 (in thousands): The following tables summarize maturity and yield information for the commercial, financial, and agricultural and the real estate-construction portion of the loan portfolio as of December 31, 2002:
After One Year One Year Through After Five or less Five Years Years Total ------------- ------------- ----------- ----------- Commercial, financial, and agricultural $ 216,797 $ 76,860 $ 18,086 $ 311,743 Real estate-- construction........... 35,292 15,619 - 50,911 ------------- ------------- ----------- ----------- $ 252,089 $ 92,479 $ 18,086 $ 362,654 ============= ============= =========== ===========
Maturities After One Year ----------- Loans with fixed interest rates.................... $ 55,354 Loans with floating or adjustable interest rates... 55,211 ----------- $ 110,565 =========== Asset Quality. Loan portfolios of each of our subsidiary banks are subject to periodic reviews by our centralized independent loan review group as well as periodic examinations by state and federal bank regulatory agencies. Loans are placed on nonaccrual status when, in the judgment of management, the collectibility of principal or interest under the original terms becomes doubtful. Nonperforming assets, which consist of nonperforming loans and foreclosed assets, were $4.3 million at December 31, 2002, as compared to $4.8 million at December 31, 2001 and $4.1 million at December 31, 2000. As a percent of loans and foreclosed assets, nonperforming assets were 0.44% at December 31, 2002, as compared to 0.51% at December 31, 2001 and 0.48% at December 31, 2000. Management considers the level of nonperforming assets to be manageable and is not aware of any material classified credit not properly disclosed as nonperforming at December 31, 2002. Table 7 -- Nonperforming Assets (in thousands, except percentages):
At December 31, ----------------------------------------------------------------- 2002 2001 2000 1999 1998 ---------- ---------- ---------- --------- --------- Nonaccrual loans............................. $ 3,716 $ 3,727 $ 3,512 $ 1,389 $ 2,717 Loans still accruing and past due 90 days or 14 66 34 63 67 more......................................... Restructured loans........................... - - - - - ---------- ---------- ---------- --------- --------- Nonperforming loans..................... 3,730 3,793 3,546 1,452 2,784 Foreclosed assets............................ 536 1,031 546 637 385 ---------- ---------- ---------- --------- --------- Total nonperforming assets.............. $ 4,266 $ 4,824 $ 4,092 $ 2,089 $ 3,169 ========== ========== ========== ========= ========= As a % of loans and foreclosed assets........ 0.44% 0.51% 0.48% 0.26% 0.41%
Provision and Allowance for Loan Losses. The allowance for loan losses is the amount deemed by management as of a specific date to be adequate to provide for losses on loans that are deemed uncollectible. Management determines the allowance and the required provision expense by reviewing general loss experiences and the performances of specific credits. The provision for loan losses was $2.4 million for 2002 as compared to $2.0 million for 2001 and $2.4 million for 2000. As a percent of average loans, net loan charge-offs were 0.19% during 2002, and 0.18% during 2001 and 2000. The allowance for loan losses as a percent of loans was 1.16% as of December 31, 2002, as compared to 1.13% as of 21 December 31, 2001. A key indicator of the adequacy of the allowance for loan losses is the ratio of the allowance to nonperforming loans, which consist of nonaccrual loans, loans past due 90 days, and restructured loans. This ratio for the past five years is disclosed in Table 8. Table 9 provides an allocation of the allowance for loan losses based on loan type and the percent of total loans that each major loan type represents. Other than the loan types presented in Table 9, we had no loan concentration at December 31, 2002 that represented more than 10% of total loans. Although we believe that we use the best information available to make loan loss allowance determinations, future adjustments could be necessary if circumstances or economic conditions differ substantially from the assumptions used in making our initial determinations. A downturn in the economy and employment could result in increased levels of non-performing assets and charge-offs, increased loan loss provisions and reductions in income. Additionally, as an integral part of their examination process, bank regulatory agencies periodically review our allowance for loan losses. The banking agencies could require the recognition of additions to the loan loss allowance based on their judgment of information available to them at the time of their examination. Table 8 -- Loan Loss Experience and Allowance for Loan Losses (in thousands, except percentages):
2002 2001 2000 1999 1998 --------- --------- --------- --------- --------- Balance at January 1,.............................. $ 10,602 $ 9,888 $ 8,938 $ 8,988 $ 10,632 Allowance established from purchase acquisitions... - 407 - - - --------- --------- --------- --------- --------- 10,602 10,295 8,938 8,988 10,632 Charge-offs: Commercial, financial and agricultural........... 1,116 1,094 950 1,038 1,267 Consumer......................................... 1,471 1,498 1,998 2,747 2,786 All other........................................ - 33 45 36 106 --------- --------- --------- --------- --------- Total loans charged off............................ 2,587 2,625 2,993 3,821 4,159 Recoveries: Commercial, financial and agricultural........... 288 269 391 632 532 Consumer......................................... 535 688 855 936 811 All other........................................ 11 11 299 172 32 --------- --------- --------- --------- --------- Total recoveries................................... 834 968 1,545 1,740 1,375 --------- --------- --------- --------- --------- Net charge-offs.................................... 1,753 1,657 1,448 2,081 2,784 Provision for loan losses.......................... 2,370 1,964 2,398 2,031 1,140 --------- --------- --------- --------- --------- Balance at December 31,............................ $ 11,219 $ 10,602 $ 9,888 $ 8,938 $ 8,988 ========= ========= ========= ========= ========= Loans at year-end.................................. $ 964,040 $ 940,131 $ 859,271 $ 797,275 $ 779,544 Average loans...................................... 942,101 897,616 817,603 779,283 770,183 Net charge-offs/average loans...................... 0.19% 0.18% 0.18% 0.27% 0.36% Allowance for loan losses/year-end loans........... 1.16 1.13 1.15 1.12 1.15 Allowance for loan losses/nonperforming loans...... 300.78 279.51 278.85 615.55 322.84
Table 9 -- Allocation of Allowance for Loan Losses (in thousands):
2002 2001 2000 1999 1998 --------- --------- --------- ---------- ---------- Allocation Allocation Allocation Allocation Allocation Amount Amount Amount Amount Amount --------- --------- --------- ---------- ---------- Commercial, financial and agricultural........ $ 3,628 $ 4,966 $ 3,394 $ 3,340 $ 3,213 Real estate-- construction.................... 592 415 468 483 423 Real estate-- mortgage........................ 4,368 2,710 3,348 2,342 2,288 Consumer...................................... 2,631 2,511 2,678 2,773 3,064 --------- --------- --------- ---------- ---------- Total..................................... $ 11,219 $ 10,602 $ 9,888 $ 8,938 $ 8,988 ========= ========= ========= ========== ==========
22 Percent of Total Loans:
2002 2001 2000 1999 1998 ----- ----- ----- ----- ----- Commercial, financial and agricultural................ 32.34% 33.19% 34.33% 37.37% 35.74% Real estate-- construction............................ 5.28 5.02 4.73 5.40 4.71 Real estate-- mortgage................................ 38.93 37.27 33.86 26.20 25.46 Consumer, net of unearned income...................... 23.45 24.52 27.08 31.03 34.09
Certain loans classified for regulatory purposes as doubtful, substandard, or special mention are included in the nonperforming asset table. Also included in classified loans are certain other loans that are deemed to be potential problems. Potential problem loans are those loans that are currently performing but where known information about trends or uncertainties or possible credit problems of the borrowers causes management to have serious doubts as to the ability of such borrowers to comply with present repayment terms, possibly resulting in the transfer of such loans to nonperforming status. These potential problem loans totaled $12.0 million as of December 31, 2002. Investment Securities. Investment securities totaled $772.3 million as of December 31, 2002, as compared to $721.7 million at December 31, 2001 and $654.3 million at December 31, 2000. At December 31, 2002, securities with an amortized cost of $200.4 million were classified as securities held-to-maturity and securities with a market value of $571.8 million were classified as securities available-for-sale. As compared to December 31, 2001, the portfolio at December 31, 2002, reflected (i) an increase of $14.8 million in U.S. Treasury; (ii) an increase of $12.8 million in tax-exempt obligations of states and political subdivisions; (iii) a $4.2 million decrease in corporate bonds and other securities; and (iv) a $27.2 million increase in mortgage-backed securities. As compared to December 31, 2000, the portfolio at December 31, 2001 reflected (i) a decrease of $86.9 million in U.S. Treasury and U.S. Government corporations and agency securities; (ii) an increase of $16.8 million in tax-exempt obligations of states and political subdivisions; (iii) an $6.6 million increase in other securities, primarily corporate bonds; and (iv) a $130.9 million increase in mortgage-backed securities. The overall portfolio yield of 5.62% at the end of 2002 was down from the prior year-end yield of 6.06% due to lower average interest rates. We did not hold collateralized mortgage obligations that entail higher risks than other mortgage-backed securities without complex payment features nor did we hold any structured notes. See Note 2 to the Consolidated Financial Statements for additional disclosures relating to the maturities and fair values of the investment portfolio at December 31, 2002 and 2001. Table 10 -- Composition of Investment Securities (dollars in thousands):
At December 31, ------------------------------------------------------------------------------------ 2002 2001 2000 ------------------------ ------------------------ ------------------------ Amortized Amortized Amortized Held-to-Maturity: Cost Fair Value Cost Fair Value Cost Fair Value ---------------- --------- --------- --------- --------- --------- --------- U.S. Treasury securities and obligations of U.S. Government corporations and agencies............. $ 110,939 $ 117,808 $ 172,880 $ 177,872 $ 251,418 $ 251,922 Obligations of states and political subdivisions... 60,836 64,050 75,959 77,495 82,344 83,067 Corporate bonds............. 499 540 498 512 4,615 4,597 Mortgage-backed securities.. 28,176 29,464 41,333 42,687 53,541 54,005 Other securities............ - - 4 4 - - --------- --------- --------- --------- --------- --------- 200,450 211,862 290,674 298,570 391,918 393,591
23
At December 31, ------------------------------------------------------------------------------------ 2002 2001 2000 ------------------------ ------------------------ ------------------------ Amortized Amortized Amortized Available-for-Sale: Cost Fair Value Cost Fair Value Cost Fair Value ------------------ --------- --------- --------- --------- --------- --------- U.S. Treasury securities and obligations of U.S. Government corporations and agencies............. $ 164,090 $ 171,619 $ 93,151 $ 94,919 $ 102,872 $ 103,321 Obligations of states and political subdivisions... 104,800 110,741 82,546 82,851 58,544 59,610 Corporate bonds............. 49,234 51,812 56,553 58,522 47,326 47,715 Mortgage-backed securities 228,490 232,106 189,421 191,720 47,963 48,551 Other securities............ 5,453 5,529 3,007 3,007 3,137 3,137 --------- --------- --------- --------- --------- --------- 552,067 571,807 424,678 431,019 259,842 262,334 --------- --------- --------- --------- --------- --------- $ 752,517 $ 783,669 $ 715,352 $ 729,589 $ 651,760 $ 655,925 ========= ========= ========= ========= ========= =========
Table 11 -- Maturities and Yields of Investment Securities Held at December 31, 2002 (in thousands, except percentages):
Maturing -------------------------------------------------------------------------------------- After One Year After Five Years One Year Through Through After or Less Five Years Ten Years Ten Years Total -------------- --------------- ------------- -------------- --------------- Held-to-Maturity: Amount Yield Amount Yield Amount Yield Amount Yield Amount Yield ---------------- ------- ---- -------- ---- ------ ---- ------- ---- -------- ---- U.S. Treasury obligations.. $ 1,002 5.38% $ - -% $ - -% $ - -% $ 1,002 5.38% Obligations of U.S. Government corporations and agencies.......... 31,627 5.33 78,310 5.70 - - - - 109,937 5.59 Obligations of states and political subdivisions.. 18,476 6.12 19,953 6.57 8,275 7.44 14,132 7.76 60,836 6.83 Corporate bonds and other securities.............. - - 499 6.17 - - - - 499 6.17 Mortgage-backed securities. 4,855 6.91 22,290 6.72 1,031 5.44 - - 28,176 6.71 ------- ---- -------- ---- ------ ---- ------- ---- -------- ---- Total................... $55,960 5.73% $121,052 6.01% $9,306 7.22% $14,132 7.76% $200,450 6.12% ======= ==== ======== ==== ====== ==== ======= ==== ======== ====
Maturing -------------------------------------------------------------------------------------- After One Year After Five Years One Year Through Through After or Less Five Years Ten Years Ten Years Total -------------- --------------- ------------- -------------- --------------- Available-for-Sale: Amount Yield Amount Yield Amount Yield Amount Yield Amount Yield ------------------ ------- ---- -------- ---- ------ ---- ------- ---- -------- ---- U.S. Treasury obligations.. $ - -% $ 1,005 1.89% $ - -% $ - -% $ 1,005 1.89% Obligations of U.S. Government corporations and agencies............ 12,418 5.12 158,196 4.32 - - - - 170,614 4.38 Obligations of states and political subdivisions.. 4,211 6.38 8,133 5.71 34,469 7.26 63,928 7.24 110,741 7.10 Corporate bonds and other securities.............. 12,586 5.94 40,647 6.01 - - 4,108 6.00 57,341 5.99 Mortgage-backed securities. 17,910 5.49 182,752 5.40 31,444 4.93 - - 232,106 5.34 ------- ---- -------- ---- ------- ---- ------- ---- -------- ---- Total................... $47,125 5.59% $390,733 5.02% $65,913 6.06% $68,036 7.17% $571,807 5.44% ======= ==== ======== ==== ======= ==== ======= ==== ======== ====
24
Maturing -------------------------------------------------------------------------------------- After One Year After Five Years One Year Through Through After or Less Five Years Ten Years Ten Years Total -------------- --------------- ------------- -------------- --------------- Total Investment Securities: Amount Yield Amount Yield Amount Yield Amount Yield Amount Yield --------------------------- ------- ---- -------- ---- ------ ---- ------- ---- -------- ---- U.S. Treasury obligations.. $ 1,002 5.38% $ 1,005 1.89% $ - -% $ - -% $ 2,007 3.63% Obligations of U.S. Government corporations and agencies............ 44,045 5.27 236,506 4.78 - - - - 280,551 4.85 Obligations of states and political subdivisions.. 22,687 6.17 28,086 6.32 42,744 7.30 78,060 7.33 171,577 7.00 Corporate bonds and other securities.............. 12,586 5.94 41,146 6.01 - - 4,108 6.00 57,840 5.99 Mortgage-backed securities. 22,765 5.79 205,042 5.54 32,475 4.95 - - 260,282 5.48 -------- ---- -------- ---- ------- ---- ------- ---- -------- ---- Total................... $103,085 5.67% $511,785 5.26% $75,219 6.20% $82,168 7.27% $772,257 5.62% ======== ==== ======== ==== ======= ==== ======= ==== ======== ====
Deposits. Deposits held by subsidiary banks represent our primary source of funding. Total deposits were $1.712 billion as of December 31, 2002, as compared to $1.685 billion as of December 31, 2001 and $1.520 billion as of December 31, 2000. Table 12 provides a breakdown of average deposits and rates paid over the past three years and the remaining maturity of time deposits of $100 thousand or more. Table 12 -- Composition of Average Deposits and Remaining Maturity of Time Deposits of $100,000 or More (in thousands, except percentages):
2002 2001 2000 ---------------------- ----------------------- ---------------------- Average Average Average Average Average Average Balance Rate Balance Rate Balance Rate ---------- ---- ---------- ---- ---------- ---- Noninterest-bearing deposits.... $ 385,012 - $ 339,800 - $ 317,659 - Interest-bearing deposits Interest-bearing checking.... 315,688 0.71% 279,585 1.43% 252,281 1.59% Savings and money market accounts................... 389,337 1.18 366,412 2.58 374,396 3.93 Time deposits under $100,000. 371,970 3.11 384,576 5.30 370,093 5.29 Time deposits of $100,000 or more....................... 182,163 3.13 195,987 5.19 164,405 5.74 ---------- ---- ---------- ---- ---------- ---- Total interest-bearing deposits 1,259,158 1.91% 1,226,560 3.58% 1,161,175 4.11% ---------- ---------- ---------- Total average deposits.......... $1,644,170 $1,566,360 $1,478,834 ========== ========== ==========
December 31, 2002 ----------- Three months or less............................... $ 75,477 Over three through six months...................... 39,710 Over six through twelve months..................... 57,785 Over twelve months................................. 22,782 ----------- Total time deposits of $100,000 or more.......... $ 195,754 =========== Capital Resources Total shareholders' equity was $238.8 million, or 11.98% of total assets, at December 31, 2002, as compared to $213.6 million, or 11.07% of total assets, at December 31, 2001. During 2002, total shareholders' equity averaged $224.4 million, or 11.76% of average assets, as compared to $204.5 million, or 11.29% of average assets, during 2001. Banking regulators measure capital adequacy by means of the risk-based capital ratio and leverage ratio. The risk-based capital rules provide for the weighting of assets and off-balance-sheet commitments and contingencies according to prescribed risk categories ranging from 0% to 100%. Regulatory capital is then divided by risk-weighted assets to determine the risk-adjusted capital ratios. The leverage ratio is computed by dividing shareholders' equity less intangible assets by quarter-to-date average assets less intangible assets. Regulatory minimums for risk-based and leverage ratios are 8.00% and 3.00%, respectively. As of December 31, 2002, our total risk-based and leverage ratios were 19.52% and 10.51%, respectively, as compared to total risk-based and leverage ratios of 18.08% and 9.92% as of December 31, 2001. We believe by all measurements our capital ratios remain above regulatory minimums. Interest Rate Risk. Interest rate risk results when the maturity or repricing intervals of interest-earning assets and interest-bearing liabilities are different. Our exposure to interest rate risk is managed primarily through our strategy of selecting the types and terms of interest-earning assets and 25 interest-bearing liabilities that generate favorable earnings while limiting the potential negative effects of changes in market interest rates. We use no off-balance-sheet financial instruments to manage interest rate risk. Each of our subsidiary banks has an asset/liability committee that monitors interest rate risk and compliance with investment policies. Each subsidiary bank tracks interest rate risk by, among other things, interest-sensitivity gap and simulation analysis. Table 13 sets forth the interest rate sensitivity of our consolidated assets and liabilities as of December 31, 2002, and sets forth the repricing dates of our consolidated interest-earning assets and interest-bearing liabilities as of that date, as well as our projected consolidated interest rate sensitivity gap percentages for the periods presented. The table is based upon assumptions as to when assets and liabilities will reprice in a changing interest rate environment. These assumptions are estimates made by management. Assets and liabilities indicated as maturing or otherwise repricing within a stated period may, in fact, mature or reprice at different times and at different volumes than those estimated. Also, the renewal or repricing of certain assets and liabilities can be discretionary and subject to competitive and other pressures. Therefore, the following table does not and cannot necessarily indicate the actual future impact of general interest rate movements on our consolidated net interest income. Table 13 -- Interest Sensitivity Analysis (in thousands, except percentages):
December 31, 2002 Estimated 2002 2003 2004 2005 2006 Beyond Total Fair Value ---------- -------- -------- -------- -------- -------- ---------- ---------- Loans Fixed rate loans........ $ 95,936 $ 65,864 $ 82,400 $ 79,104 $ 70,057 $ 89,516 $ 482,877 $ 492,042 Average interest rate.. 7.00% 8.42% 8.02% 7.23% 7.17% 7.80% 7.58% Adjustable rate loans... 451,626 5,725 3,552 10,087 9,898 275 481,163 481,163 Average interest rate.. 4.87 -- -- -- -- -- 4.57 Investment securities Fixed rate securities... 102,770 163,451 185,336 149,146 9,990 157,308 768,001 779,414 Average interest rate.. 5.65 5.62 5.22 4.86 5.61 6.75 5.61 Adjustable rate securities............ 4,255 -- -- -- -- -- 4,255 4,255 Average interest rate.. 4.81 -- -- -- -- -- 4.81 Other earning assets Adjustable rate other... 72,325 -- -- -- -- -- 72,325 72,325 Average interest rate.. 1.23 -- -- -- -- -- 1.23 ---------- -------- -------- -------- -------- -------- ---------- ---------- Total interest sensitive assets................. $ 726,912 $235,040 $271,288 $238,337 $ 89,945 $247,099 $1,808,621 $1,828,364 Average interest rate.. 4.76% 6.43% 6.08% 5.68% 6.98% 7.13% 5.73% Deposits Fixed rate deposits..... 466,285 42,008 12,232 2,223 10,879 -- 533,627 537,171 Average interest rate.. 2.41% 3.31% 5.28% 4.40% 4.25% -- 2.59% Adjustable rate deposits.............. 750,041 2,421 -- -- -- -- 752,462 752,462 Average interest rate.. 0.79 -- -- -- -- -- 0.79 Other interest-bearing liabilities Adjustable rate other... 26,709 -- -- -- -- -- 26,709 26,709 Average interest rate.. 0.67 -- -- -- -- -- 0.67 ---------- -------- -------- -------- -------- -------- ---------- ---------- Total interest sensitive liabilities............. 1,243,035 44,429 12,232 2,223 10,879 -- 1,312,798 1,316,342 Average interest rate.. 1.39% 3.13% 5.28% 4.40% 4.25% -- 1.52% Interest sensitivity gap.. $ (516,123) $190,611 $259,056 $236,114 $ 79,066 $247,099 $ 495,823 $ 512,022 Cumulative interest sensitivity gap......... (516,123) (325,512) (66,456) 169,658 248,724 495,823 Ratio of interest sensitive assets to interest sensitive liabilities............. 58.48% Cumulative ratio of interest sensitive assets to interest sensitive liabilities... 58.48% 74.72% 94.89% 113.03% 118.95% 137.77% Cumulative interest sensitivity gap as a percent of earning assets.................. (28.54)% (18.00)% (3.67)% 9.38% 13.75% 27.41%
As of December 31, 2001, our 2002 interest-sensitivity gap was ($518.8) million and our 2002 ratio of interest sensitive assets to interest sensitive liabilities was 58.73%. Management estimates that, as of December 31, 2002, an upward shift of interest rates by 150 basis points would result in a 4.5% increase in projected net interest income over the next twelve months, and a downward shift of interest rates by 150 basis points would result in a 7.1% reduction in projected net interest income over the next twelve months. These are good faith estimates 26 and assume that the composition of our interest sensitive assets and liabilities existing at each year-end will remain constant over the relevant twelve month measurement period and that changes in market interest rates are instantaneous and sustained across the yield curve regardless of duration of pricing characteristics of specific assets or liabilities. Also, this analysis does not contemplate any actions that we might undertake in response to changes in market interest rates. In management's belief, these estimates are not necessarily indicative of what actually could occur in the event of immediate interest rate increases or decreases of this magnitude. Management believes that it is unlikely that such changes would occur in a short time period. As interest-bearing assets and liabilities reprice at different time frames and proportions to market interest rate movements, various assumptions must be made based on historical relationships of these variables in reaching any conclusion. Since these correlations are based on competitive and market conditions, our future results would, in management's belief, be different from the foregoing estimates, and such differences could be material. Liquidity Liquidity is our ability to meet cash demands as they arise. Such needs can develop from loan demand, deposit withdrawals or acquisition opportunities. Potential obligations resulting from the issuance of standby letters of credit and commitments to fund future borrowings to our loan customers are other factors affecting our liquidity needs. Many of these obligations and commitments are expected to expire without being drawn upon; therefore the total commitment amounts do not necessarily represents future cash requirements affecting our liquidity position. The potential need for liquidity arising from these types of financial instruments is represented by the contractual notional amount of the instrument, as detailed in Table 14. Asset liquidity is provided by cash and assets, which are readily marketable or which will mature in the near future. Liquid assets include cash, federal funds sold, and short-term investments in time deposits in banks. Liquidity is also provided by access to funding sources, which include core depositors and correspondent banks that maintain accounts with and sell federal funds to our subsidiary banks. Other sources of funds include our ability to sell securities under agreement to repurchase, which amounted to $26.7 million at December 31, 2002, and an unfunded $25.0 million line of credit established with a nonaffiliated bank which matures on June 30, 2003. We believe the line of credit will be renewed upon maturity. Given the strong core deposit base and relatively low loan to deposit ratios maintained at the subsidiary banks, management considers the current liquidity position to be adequate to meet short- and long-term liquidity needs. In addition, we anticipate that any future acquisition of financial institutions and expansion of branch locations could also place a demand on our cash resources. Available cash at our parent company which totaled $23.1 million at December 31, 2002, available dividends from subsidiary banks which totaled $20.7 million at December 31, 2002, utilization of available lines of credit, and future debt or equity offerings are expected to be the source of funding for these potential acquisitions or expansions. Table 14 -- Commercial Commitments As of December 31, 2002 (in thousands):
Total Amounts Less than 1 Over 5 Committed year 1-3 years 4-5 years years ------------ ------------- ------------ --------- ---------- Commitments to extend credit.......... $ 185,895 $ 176,758 $ 4,779 $ 2,491 $ 1,867 Standby letters of credit............. 6,068 5,253 806 9 - ------------ ------------- ------------ --------- ---------- Total Commercial Commitments.......... $ 191,963 $ 182,011 $ 5,585 $ 2,500 $ 1,867 ============ ============= ============ ========= ==========
The Company has no other off-balance sheet arrangements or transactions with unconsolidated, special purpose entities that would expose the Company to liability that is not reflected on the face of the financial statements. Parent Company Funding. Our ability to fund various operating expenses, dividends, and cash acquisitions is generally dependent solely on our own earnings (without giving effect to our subsidiaries), cash reserves and funds derived from our subsidiary banks. These funds historically have been produced by intercompany dividends and management fees that are limited to reimbursement of actual expenses. We anticipate that our recurring cash sources will continue to include dividends and management fees from our subsidiary banks. At December 31, 2002, approximately $20.7 million was available for the payment of intercompany dividends by the subsidiary banks without the prior approval of regulatory agencies. Our subsidiary banks paid aggregate dividends of $26.6 million in 2002 and $25.5 million in 2001. Also at December 31, 2002, we had $25.0 million available under a line of credit with an unaffiliated financial institution. Dividends. Our long-term dividend policy is to pay cash dividends to our shareholders of between 40% and 50% of net earnings while maintaining adequate capital to support growth. The cash dividend payout ratios have amounted to 27 49.1%, 48.9% and 45.2% of net earnings, respectively, in 2002, 2001 and 2000. Given our current strong capital position and projected earnings and asset growth rates, we do not anticipate any change in our current dividend policy. Each state bank that is a member of the Federal Reserve System and each national banking association is required by federal law to obtain the prior approval of the Federal Reserve Board and the OCC, respectively, to declare and pay dividends if the total of all dividends declared in any calendar year would exceed the total of (1) such bank's net profits (as defined and interpreted by regulation) for that year plus (2) its retained net profits (as defined and interpreted by regulation) for the preceding two calendar years, less any required transfers to surplus. In addition, these banks may only pay dividends to the extent that retained net profits (including the portion transferred to surplus) exceed bad debts (as defined by regulation). To pay dividends, we and our subsidiary banks must maintain adequate capital above regulatory guidelines. In addition, if the applicable regulatory authority believes that a bank under its jurisdiction is engaged in or is about to engage in an unsafe or unsound practice (which, depending on the financial condition of the bank, could include the payment of dividends), the authority may require, after notice and hearing, that such bank cease and desist from the unsafe practice. The Federal Reserve Board and the OCC have each indicated that paying dividends that deplete a bank's capital base to an inadequate level would be an unsafe and unsound banking practice. The Federal Reserve Board, the OCC and the FDIC have issued policy statements that recommend that bank holding companies and insured banks should generally only pay dividends out of current operating earnings. ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Our management considers interest rate risk to be a significant market risk for us. See "Item 7--Management's Discussion and Analysis of Financial Condition and Results of Operations--Balance Sheet Review--Interest Rate Risk" for disclosure regarding this market risk. 28 ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA Our consolidated financial statements begin on page F-1. Quarterly Results of Operations (in thousands, except per share and common stock data): The following tables set forth certain unaudited historical quarterly financial data for each of the eight consecutive quarters in fiscal 2002 and 2001. This information is derived from unaudited consolidated financial statements that include, in our opinion, all adjustments (consisting of normal recurring adjustments) necessary for a fair presentation when read in conjunction with our consolidated financial statements and notes thereto included elsewhere in this Form 10-K.
2002 --------------------------------------------------- 4th 3rd 2nd 1st ---------- --------- ---------- --------- Summary Income Statement Information: Interest income $ 25,687 $ 26,316 $ 26,414 $ 26,445 Interest expense 5,244 5,818 6,246 7,072 ---------- --------- ---------- --------- Net interest income 20,443 20,498 20,168 19,373 Provision for loan losses 809 652 510 399 ---------- --------- ---------- --------- Net interest income after provision for loan losses 19,634 19,846 19,658 18,974 Noninterest income 7,858 7,527 7,177 6,975 Net gain (loss) on securities transactions - (3) 19 - Noninterest expense 15,247 14,902 14,677 14,256 ---------- --------- ---------- --------- Earnings before income taxes 12,245 12,468 12,177 11,693 Income tax expense 3,694 3,768 3,655 3,513 ---------- --------- ---------- --------- Net earnings $ 8,551 $ 8,700 $ 8,522 $ 8,180 ========== ========= ========== ========= Per Share Data: Net earnings per share, basic $ 0.69 $ 0.70 $ 0.69 $ 0.66 Net earnings per share, assuming dilution 0.69 0.70 0.69 0.66 Cash dividends declared 0.35 0.35 0.35 0.30 Book value at period-end 19.31 19.25 18.43 17.60 Common stock sales price: (1) High $ 42.00 $ 41.73 $ 43.00 $ 34.30 Low 34.65 34.85 33.00 29.30 Close 38.00 36.44 41.84 33.21
2001 --------------------------------------------------- 4th 3rd 2nd 1st ---------- --------- ---------- --------- Summary Income Statement Information: Interest income $ 27,814 $ 29,500 $ 29,213 $ 29,946 Interest expense 9,071 10,958 11,779 13,026 ---------- --------- ---------- --------- Net interest income 18,743 18,542 17,434 16,920 Provision for loan losses 562 539 497 366 ---------- --------- ---------- --------- Net interest income after provision for loan losses 18,181 18,003 16,937 16,554 Noninterest income 6,972 6,847 7,046 6,646 Net gain on securities transactions - - 14 54 Noninterest expense 14,364 14,047 13,507 13,154 ---------- --------- ---------- --------- Earnings before income taxes 10,789 10,803 10,490 10,100 Income tax expense 3,258 3,270 3,203 3,096 ---------- --------- ---------- --------- Net earnings $ 7,531 $ 7,533 $ 7,287 $ 7,004 ========== ========= ========== ========= Per Share Data: Net earnings per share, basic $ 0.61 $ 0.61 $ 0.59 $ 0.57 Net earnings per share, assuming dilution 0.61 0.61 0.59 0.56 Cash dividends declared 0.30 0.30 0.30 0.264 Book value at period-end 17.32 17.31 16.77 16.40 Common stock sales price: (1) High $ 31.88 $ 32.91 $ 31.44 $ 27.15 Low 27.20 27.00 25.00 23.40 Close 30.10 29.03 31.00 26.60 (1) These quotations reflect inter-dealer prices without retail mark-up, mark-down or commission, and may not necessarily represent actual transactions.
29 ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE On March 25, 2002, we determined not to renew the engagement of our independent accountants, Arthur Andersen LLP. Arthur Andersen had served as our independent auditors since 1990. The decision not to renew the engagement of Arthur Andersen was made by the executive committee of our board of directors following the recommendation of our audit committee. Arthur Andersen's report on our 2001 financial statements was filed with the Securities and Exchange Commission on March 20, 2002 in conjunction with the filing of our Annual Report on Form 10-K for the year ended December 31, 2001. During the two fiscal years ended December 31, 2001, and through the subsequent interim period through March 25, 2002, there were no disagreements between Arthur Andersen and us on any matter of accounting principles or practices, financial statement disclosure, or auditing scope or procedure, which disagreements if not resolved to Arthur Andersen's satisfaction would have caused them to make reference to the subject matter of the disagreement in connection with their reports. None of the reportable events defined under Item 304(a)(1)(v) of Regulation S-K occurred within our two fiscal years ended December 31, 2001 and through the subsequent interim period through March 25, 2002. The audit reports of Arthur Andersen on our consolidated financial statements as of and for the fiscal years ended December 31, 2001 and 2000 did not contain any adverse opinion or disclaimer of opinion, nor were they qualified or modified as to uncertainty, audit scope, or accounting principles. We provided Arthur Andersen with a copy of the foregoing disclosure, and a copy of its letter stating its agreement with these statements was filed as an exhibit to our Form 8-K dated March 25, 2002. The executive committee of our board of directors, upon the recommendation of our audit committee, elected to appoint Ernst & Young LLP as our independent auditors, effective May 16, 2002. During our two fiscal years ended December 31, 2001, and through the subsequent interim periods through May 16, 2002, we did not consult with Ernst & Young regarding any of the matters or events set forth in Items 304(a)(2)(i) and (ii) of Regulation S-K. PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT The information required by Item 10 is hereby incorporated by reference from our proxy statement for our 2003 annual meeting of shareholders or our 2003 proxy statement, under the captions "Proposal 1 -- Election of Directors" and "Section 16(a) Beneficial Ownership Reporting Compliance." ITEM 11. EXECUTIVE COMPENSATION The information required by Item 11 is hereby incorporated by reference from our 2003 proxy statement under the caption "Management." ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS The information required by Item 12 is hereby incorporated by reference from our 2003 proxy statement under the captions "Proposal 1 -- Election of Directors" and "Security Ownership of Certain Beneficial Owners and Management." ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS The information required by Item 13 is hereby incorporated by reference from our 2003 proxy statement under the caption "Interest in Certain Transactions." 30 ITEM 14. CONTROLS AND PROCEDURES Within the 90 days prior to the filing date of this report, we carried out an evaluation, under the supervision and with the participation of our management, including our principal executive officer and principal financial officer, of the effectiveness of the design and operation of our disclosure controls and procedures pursuant to Securities Exchange Act Rule 15d-15. Our management, including the principal executive officer and principal financial officer, does not expect that our disclosure controls and procedures will prevent all errors and all fraud. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the Company have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty, and that breakdowns can occur because of simple error or mistake. Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the control. The design of any system of controls also is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions; over time, controls may become inadequate because of changes in conditions, or the degree of compliance with the policies or procedures may deteriorate. Because of the inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and not be detected. Our principal executive officer and principal financial officer have concluded, based on our evaluation of our disclosure controls and procedures, that our disclosure controls and procedures under Rule 13a-14(c) and Rule 15d-14(c) of the Securities Exchange Act of 1934 are effective. Subsequent to our evaluation, there were no significant changes in internal controls or other factors that could significantly affect these internal controls. ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K A. The following documents are filed as part of this report: (1) Financial Statements Report of Independent Auditors Report of Independent Public Accountants Management's Report on Responsibility for the Financial Statements Consolidated Balance Sheets as of December 31, 2002 and 2001 Consolidated Statements of Earnings for the years ended December 31, 2002, 2001 and 2000 Consolidated Statements of Comprehensive Earnings for the years ended December 31, 2002, 2001 and 2000 Consolidated Statements of Shareholders' Equity for the years ended December 31, 2002, 2001 and 2000 Consolidated Statements of Cash Flows for the years ended December 31, 2002, 2001 and 2000 Notes to the Consolidated Financial Statements (2) Financial Statement Schedules These schedules have been omitted because they are not required, are not applicable or have been included in our consolidated financial statements. (3) Exhibits The information required by this Item 15(a)(3) is set forth in the Exhibit Index immediately following our financial statements. The exhibits listed herein will be furnished upon written request to J. Bruce Hildebrand, Executive Vice President, First Financial Bankshares, Inc., 400 Pine Street, Abilene, Texas 79601, and payment of a reasonable fee that will be limited to our reasonable expense in furnishing such exhibits. 31 B. Reports on Form 8-K. On October 1, 2002, we filed a Form 8-K announcing the hiring of J. Bruce Hildebrand as our next chief financial officer replacing Curtis R. Harvey during the first quarter of 2003. No financial statements were reported as part of this Form 8-K. 32 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, as amended, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. FIRST FINANCIAL BANKSHARES, INC. Date: March 10, 2003 By: /S/ F. SCOTT DUESER ------------------- F. SCOTT DUESER President, Chief Executive Officer and Director The undersigned directors and officers of First Financial Bankshares, Inc. hereby constitute and appoint Curtis R. Harvey, with full power to act and with full power of substitution and resubstitution, our true and lawful attorney-in-fact with full power to execute in our name and behalf in the capacities indicated below any and all amendments to this report and to file the same, with all exhibits thereto and other documents in connection therewith with the Securities and Exchange Commission and hereby ratify and confirm all that such attorney-in-fact or his substitute shall lawfully do or cause to be done by virtue hereof. Pursuant to the requirements of the Securities Exchange Act of 1934, as amended, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
Name Title Date ---- ----- ---- /S/ KENNETH T. MURPHY Chairman of the Board and Director March 10, 2003 ----------------------------------------------- Kenneth T. Murphy /S/ F. SCOTT DUESER President, Chief Executive Officer March 10, 2003 ----------------------------------------------- F. Scott Dueser and Director (Principal Executive Officer) /S/ CURTIS R. HARVEY Executive Vice President and Chief March 10, 2003 ----------------------------------------------- Curtis R. Harvey Financial Officer (Principal Financial Officer and Principal Accounting Officer) /S/ JOSEPH E. CANON Director March 18, 2003 ----------------------------------------------- Joseph E. Canon /S/ MAC A. COALSON Director March 25, 2003 ----------------------------------------------- Mac A. Coalson /S/ DAVID COPELAND Director March 18, 2003 ----------------------------------------------- David Copeland 33 Name Title Date ---- ----- ---- /S/ DERRELL E. JOHNSON Director March 13, 2003 ----------------------------------------------- Derrell E. Johnson /S/ KADE L. MATTHEWS Director March 25, 2003 ----------------------------------------------- Kade L. Matthews /S/ RAYMOND A. MCDANIEL, JR. Director March 18, 2003 ----------------------------------------------- Raymond A. McDaniel, Jr. /S/ BYNUM MIERS Director March 18, 2003 ----------------------------------------------- Bynum Miers /S/ JAMES M. PARKER Director March 18, 2003 ----------------------------------------------- James M. Parker /S/ JACK D. RAMSEY Director March 18, 2003 ----------------------------------------------- Jack D. Ramsey Director March __, 2003 ----------------------------------------------- Craig Smith /S/ DIAN GRAVES STAI Director March 18, 2003 ----------------------------------------------- Dian Graves Stai /S/ F. L. STEPHENS Director March 25, 2003 ----------------------------------------------- F. L. Stephens
34 CERTIFICATIONS I, F. Scott Dueser, certify that: 1. I have reviewed this annual report on Form 10-K of First Financial Bankshares, Inc.; 2. Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report; 3. Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report; 4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and have; a. Designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this annual report is being prepared; b. Evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this annual report (the "Evaluation Date"); and c. Presented in this annual report our conclusions about the effectiveness of this disclosure controls and procedures based on our evaluation as of the Evaluation Date; 5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent functions): a. All significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and b. Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and 6. The registrant's other certifying officers and I have indicated in this annual report whether there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. Date: March 10, 2003 By: /S/ F. SCOTT DUESER -------------------------------------------- F. Scott Dueser President, Chief Executive Officer and Director 35 I, Curtis R. Harvey, certify that: 1. I have reviewed this annual report on Form 10-K of First Financial Bankshares, Inc.; 2. Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report; 3. Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report; 4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and have; a. Designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this annual report is being prepared; b. Evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this annual report (the "Evaluation Date"); and c. Presented in this annual report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; 5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent functions): a. All significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and b. Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and 6. The registrant's other certifying officers and I have indicated in this annual report whether there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. Date: March 10, 2003 By: /S/ Curtis R. Harvey ----------------------------------- Curtis R. Harvey Executive Vice President and Chief Financial Officer 36 EXHIBIT INDEX
Item 601 Regulation S-K Exhibit Reference Number Exhibits ------ -------- 3.1 -- Articles of Incorporation, and all amendments thereto, of the Registrant (incorporated by reference from Exhibit 1 of the Registrant's Amendment No. 2 to Form 8-A filed on Form 8-A/A No. 2 on November 21, 1995). 3.2 -- Amended and Restated Bylaws, and all amendments thereto, of the Registrant (incorporated by reference from Exhibit 2 of the Registrant's Amendment No. 1 to Form 8-A filed on Form 8-A/A No. 1 on January 7, 1994). 4.1 -- Specimen certificate of First Financial Common Stock (incorporated by reference from Exhibit 3 of the Registrant's Amendment No. 1 to Form 8-A filed on Form 8-A/A No. 1 on January 7, 1994). *10.1 -- Deferred Compensation Agreement, dated October 28, 1992, between the Registrant and Kenneth T. Murphy. *10.2 -- Revised Deferred Compensation Agreement, dated December 28, 1995, between the Registrant and Kenneth T. Murphy. *10.3 -- Executive Recognition Plan. *10.4 -- Form of Executive Recognition Agreement. 10.5 -- 1992 Incentive Stock Option Plan (incorporated by reference from Exhibit 10.5 of the Registrant's Form 10-K Annual Report for the fiscal year ended December 31, 1998). 10.6 -- 2002 Incentive Stock Option Plan (incorporated by reference from Appendix A of the Registrant's Schedule 14a Definitive Proxy Statement for the 2002 Annual Meeting of Shareholders) *10.7 -- Consulting Agreement dated January 1, 2003 between the Registrant and Kenneth T. Murphy. 16.1 -- Letter regarding Change in Certifying Accountant (incorporated by reference from Exhibit 16.1 of the Registrant's Form 8-K filed on March 25, 2002). *21.1 -- Subsidiaries of the Registrant. 24.1 -- Power of Attorney (included on signature page of this Form 10-K). *99.1 -- Certification pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. *99.2 -- Certification pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. --------------- *Filed herewith
REPORT OF INDEPENDENT AUDITORS To the Board of Directors and Shareholders of First Financial Bankshares, Inc. We have audited the accompanying consolidated balance sheet of First Financial Bankshares, Inc. (a Texas corporation) and subsidiaries as of December 31, 2002, and the related consolidated statements of earnings, comprehensive earnings, shareholders' equity, and cash flows for the year then ended. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audit. The consolidated financial statements of First Financial Bankshares, Inc. and subsidiaries as of December 31, 2001 and for each of the two years then ended, were audited by other auditors who have ceased operations and whose report dated January 11, 2002, expressed an unqualified opinion on those statements. We conducted our audit in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of First Financial Bankshares, Inc. and subsidiaries at December 31, 2002, and the consolidated results of their operations and their cash flows for the year then ended in conformity with accounting principles generally accepted in the United States. As discussed above, the financial statements of First Financial Bankshares, Inc. as of December 31, 2001 and the two years then ended were audited by other auditors who have ceased operations. As described in Note 1, these financial statements have been revised to include the transitional disclosures required by Statement of Financial Accounting Standards No. 142, Goodwill and Other Intangible Assets, which was adopted by the Company as of January 1, 2002. Our audit procedures with respect to the disclosures in Note 1 with respect to 2001 and 2000 included (a) agreeing the previously reported net income to the previously issued financial statements and the adjustments to reported net income representing amortization expense including related tax effects recognized in those periods related to goodwill to the Company's underlying records obtained from management, and (b) testing the mathematical accuracy of the reconciliation of adjusted net income to reported net income, and the related earnings per share amounts. In our opinion, the disclosures for 2001 and 2000 are appropriate. However, we were not engaged to audit, review, or apply any procedures to the 2001 and 2000 financial statements of the Company other than with respect to such disclosures and, accordingly, we do not express an opinion or any other form of assurance on the 2001 and 2000 financial statements taken as a whole. Ernst & Young LLP Dallas, Texas January 14, 2003 F-1 REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS To the Board of Directors and Shareholders of First Financial Bankshares, Inc. We have audited the accompanying consolidated balance sheets of First Financial Bankshares, Inc. (a Texas corporation) and subsidiaries as of December 31, 2001 and 2000, and the related consolidated statements of earnings, comprehensive earnings, shareholders' equity, and cash flows for each of the three years in the period ended December 31, 2001. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of First Financial Bankshares, Inc. and subsidiaries as of December 31, 2001 and 2000, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2001, in conformity with accounting principles generally accepted in the United States. Arthur Andersen LLP Dallas, Texas, January 11, 2002 NOTE: THIS IS A COPY OF A REPORT PREVIOUSLY ISSUED BY ARTHUR ANDERSEN LLP WHICH CEASED OPERATIONS. THIS REPORT ADDRESSES CERTAIN FINANCIAL STATEMENTS FOR PERIODS THAT ARE NOT OTHERWISE REQUIRED TO BE INCLUDED IN THIS FORM 10-K. F-2 MANAGEMENT'S REPORT ON RESPONSIBILITY FOR THE FINANCIAL STATEMENTS The Management of First Financial Bankshares, Inc. and subsidiaries is responsible for the preparation, integrity, and fair presentation of its annual consolidated financial statements as of December 31, 2002 and 2001, and for each of the three years in the period ended December 31, 2002. The financial statements have been prepared in accordance with accounting principles generally accepted in the United States and, as such, include amounts based on judgments and estimates made by Management. Management has also prepared the other information included in this Annual Report and is responsible for its accuracy and consistency with the consolidated financial statements. The annual consolidated financial statements as of and for the year ended December 31, 2002 have been audited by Ernst & Young LLP, who have been given unrestricted access to all financial records and related data, including minutes of all meetings of shareholders and the Board of Directors. Management believes that all representations made to Ernst & Young LLP during the audit were valid and appropriate. The annual consolidated financial statements as of December 31, 2001, and for the years ended December 31, 2001 and 2000, were audited by Arthur Andersen LLP, who were given unrestricted access to all financial records and related data, including minutes of all meetings of shareholders and the Board of Directors. Management believes that all representations made to Arthur Andersen LLP during the audits were valid and appropriate. Arthur Andersen LLP subsequently ceased operations. F. Scott Dueser Curtis R. Harvey President and Chief Executive Officer Executive Vice President and Chief Financial Officer F-3 FIRST FINANCIAL BANKSHARES, INC. AND SUBSIDIARIES Consolidated Balance Sheets December 31, 2002 and 2001
ASSETS 2002 2001 ------ -------------- -------------- CASH AND DUE FROM BANKS $ 108,436,645 $ 112,150,214 FEDERAL FUNDS SOLD 70,000,000 72,975,000 -------------- -------------- Total cash and cash equivalents 178,436,645 185,125,214 INTEREST-BEARING DEPOSITS IN BANKS 2,324,425 1,374,285 INVESTMENT SECURITIES: Securities held-to-maturity (fair value of $211,862,151 in 2002 and $298,569,794 in 2001) 200,449,784 290,674,490 Securities available-for-sale, at fair value 571,806,629 431,019,205 -------------- -------------- Total investment securities 772,256,413 721,693,695 LOANS 964,039,773 940,130,975 Less- allowance for loan losses 11,218,729 10,602,419 -------------- -------------- Net loans 952,821,044 929,528,556 BANK PREMISES AND EQUIPMENT, net 40,605,401 42,012,431 INTANGIBLE ASSETS 24,870,788 24,711,969 OTHER ASSETS 21,868,220 25,247,980 -------------- -------------- Total assets $1,993,182,936 $1,929,694,130 ============== ============== LIABILITIES AND SHAREHOLDERS' EQUITY ------------------------------------ NONINTEREST-BEARING DEPOSITS $ 425,473,353 $ 389,406,666 INTEREST-BEARING DEPOSITS 1,286,088,863 1,295,755,932 -------------- -------------- Total deposits 1,711,562,216 1,685,162,598 DIVIDENDS PAYABLE 4,327,374 3,699,976 SECURITIES SOLD UNDER AGREEMENTS TO REPURCHASE 26,708,994 19,847,067 OTHER LIABILITIES 11,816,707 7,330,476 -------------- -------------- Total liabilities 1,754,415,291 1,716,040,117 -------------- -------------- COMMITMENTS AND CONTINGENCIES SHAREHOLDERS' EQUITY: Common stock, $10 par value; authorized 20,000,000 shares; 12,364,201 and 12,333,252 issued and outstanding at December 31, 2002 and 2001, respectively 123,642,010 123,332,520 Capital surplus 58,087,687 57,824,061 Retained earnings 45,647,522 28,375,353 Accumulated other comprehensive earnings 11,390,426 4,122,079 -------------- -------------- Total shareholders' equity 238,767,645 213,654,013 -------------- -------------- Total liabilities and shareholders' equity $1,993,182,936 $1,929,694,130 ============== ============== The accompanying notes are an integral part of these consolidated financial statements.
F-4 FIRST FINANCIAL BANKSHARES, INC. AND SUBSIDIARIES Consolidated Statements of Earnings December 31, 2002, 2001 and 2000
2002 2001 2000 --------------- ------------- ----------- INTEREST INCOME: Interest and fees on loans $ 64,609,189 $ 74,881,682 $75,474,661 Interest on investment securities: Taxable 32,263,763 32,169,874 33,556,796 Exempt from federal income tax 7,042,102 6,279,973 5,770,861 Interest on federal funds sold and interest-bearing deposits in banks 946,861 3,211,316 3,148,277 --------------- ------------- ----------- Total interest income 104,861,915 116,472,845 117,950,595 --------------- ------------- ----------- INTEREST EXPENSE: Interest on deposits 24,087,911 43,970,532 47,737,862 Other 291,793 863,480 1,091,180 --------------- ------------- ----------- Total interest expense 24,379,704 44,834,012 48,829,042 --------------- ------------- ----------- Net interest income 80,482,211 71,638,833 69,121,553 PROVISION FOR LOAN LOSSES 2,369,634 1,964,050 2,397,750 --------------- ------------- ----------- Net interest income after provision for loan losses 78,112,577 69,674,783 66,723,803 --------------- ------------- ----------- NONINTEREST INCOME: Trust department income 5,835,909 5,890,600 5,494,246 Service fees on deposit accounts 15,435,137 14,743,217 14,073,514 ATM fees 2,370,313 1,941,508 1,554,437 Real estate mortgage fees 1,858,378 1,609,518 1,021,590 Net gain on securities transactions 16,373 67,789 530,097 Other 4,036,366 3,325,858 3,273,445 --------------- ------------- ----------- Total noninterest income 29,552,476 27,578,490 25,947,329 --------------- ------------- ----------- NONINTEREST EXPENSE: Salaries and employee benefits 31,992,733 28,685,294 27,077,436 Net occupancy expense 3,908,856 3,995,597 3,563,289 Equipment expense 4,800,768 4,457,909 4,180,782 Printing, stationary and supplies 1,474,683 1,084,134 882,470 Correspondent bank service charges 1,491,132 1,329,134 1,261,811 Amortization of intangible assets 135,156 1,641,367 1,641,367 Other expenses 15,278,722 13,878,262 13,085,333 --------------- ------------- ----------- Total noninterest expense 59,082,050 55,071,697 51,692,488 --------------- ------------- ----------- EARNINGS BEFORE INCOME TAXES 48,583,003 42,181,576 40,978,644 INCOME TAX EXPENSE 14,630,453 12,827,071 12,662,597 --------------- ------------- ----------- NET EARNINGS $ 33,952,550 $ 29,354,505 $28,316,047 =============== ============= =========== NET EARNINGS PER SHARE, BASIC $ 2.75 $ 2.38 $ 2.28 =============== ============= =========== NET EARNINGS PER SHARE, ASSUMING DILUTION $ 2.74 $ 2.37 $ 2.27 =============== ============= =========== The accompanying notes are an integral part of these consolidated financial statements.
F-5 FIRST FINANCIAL BANKSHARES, INC. AND SUBSIDIARIES Consolidated Statements of Comprehensive Earnings December 31, 2002, 2001 and 2000
2002 2001 2000 ------------ ------------ ------------ NET EARNINGS $ 33,952,550 $ 29,354,505 $ 28,316,047 OTHER ITEMS OF COMPREHENSIVE EARNINGS: Change in unrealized gain on investment securities available-for-sale, before income tax 13,414,265 3,916,477 9,319,576 Reclassification adjustment for realized gains on investment securities included in net earnings, before income tax (16,373) (67,789) (530,097) Minimum liability pension adjustment, before income tax (2,215,820) - - ------------ ------------ ------------ Total other items of comprehensive earnings 11,182,072 3,848,688 8,789,479 Income tax expense related to other items of comprehensive earnings (3,913,725) (1,347,041) (3,076,320) ------------ ------------ ------------ COMPREHENSIVE EARNINGS $ 41,220,897 $ 31,856,152 $ 34,029,206 ============ ============ ============ The accompanying notes are an integral part of these consolidated financial statements.
F-6 FIRST FINANCIAL BANKSHARES, INC. AND SUBSIDIARIES Consolidated Statements of Shareholders' Equity December 31, 2002, 2001 and 2000
Accumulated Common Stock Other ------------------------ Treasury Comprehensive Total Capital Retained Stock, Earnings Shareholders' Shares Amount Surplus Earnings at cost (Losses) Equity ---------- ------------ ----------- ----------- ----------- ----------- ------------ BALANCE, December 31, 1999 9,972,193 $99,721,930 $60,538,481 $22,495,259 $ - $(4,092,727) $178,662,943 Net earnings - - - 28,316,047 - - 28,316,047 Cash dividends declared, $1.03 per share - - - (12,808,111) - - (12,808,111) Acquisition of treasury stock - - - - (3,925,069) - (3,925,069) Stock issuances 10,809 108,090 53,829 - - - 161,919 Change in unrealized gain (loss) on investment in securities available-for-sale, net of related income taxes - - - - - 5,713,159 5,713,159 ---------- ------------ ----------- ----------- ----------- ----------- ------------ BALANCE, December 31, 2000 9,983,002 $99,830,020 $60,592,310 $38,003,195 $(3,925,069) $ 1,620,432 $196,120,888 Net earnings - - - 29,354,505 - - 29,354,505 Stock split, effected in the form of a 25% stock dividend 2,461,770 24,617,700 - (24,617,700) - - - Cash dividends declared, $1.16 per share - - - (14,364,647) - - (14,364,647) Acquisition of treasury stock - - - - (315,050) - (315,050) Retirement of treasury stock (136,000) (1,360,000) (2,880,119) - 4,240,119 - - Stock issuances 24,480 244,800 111,870 - - - 356,670 Change in unrealized gain on investment in securities available-for-sale, net of related income taxes - - - - - 2,501,647 2,501,647 ---------- ------------ ----------- ----------- ----------- ----------- ------------ BALANCE, December 31, 2001 12,333,252 $123,332,520 $57,824,061 $28,375,353 $ - $ 4,122,079 $213,654,013 Net earnings - - - 33,952,550 - - 33,952,550 Cash dividends declared, $1.35 per share - - - (16,680,381) - - (16,680,381) Stock issuances 30,949 309,490 263,626 - - - 573,116 Minimum liability pension adjustment, net of related income taxes - - - - - (1,440,283) (1,440,283) Change in unrealized gain on investment in securities available-for-sale, net of related income taxes - - - - - 8,708,630 8,708,630 ---------- ------------ ----------- ----------- ----------- ----------- ------------ BALANCE, December 31, 2002 12,364,201 $123,642,010 $58,087,687 $45,647,522 $ - $11,390,426 $238,767,645 ========== ============ =========== =========== =========== =========== ============ The accompanying notes are an integral part of these consolidated financial statements.
F-7 FIRST FINANCIAL BANKSHARES, INC. AND SUBSIDIARIES Consolidated Statements of Cash Flows December 31, 2002, 2001 and 2000
2002 2001 2000 ------------- ------------- ------------- CASH FLOWS FROM OPERATING ACTIVITIES: Net earnings $ 33,952,550 $ 29,354,505 $ 28,316,047 Adjustments to reconcile net earnings to net cash provided by operating activities: Depreciation and amortization 4,125,655 5,679,082 5,502,224 Provision for loan losses 2,369,634 1,964,050 2,397,750 Premium amortization, net of discount accretion 2,077,358 1,662,108 1,359,124 Loss (gain) on sale of assets 42,890 (52,815) (540,304) Deferred federal income tax expense (benefit) 350,415 (188,982) (304,240) (Increase) decrease in other assets (1,508,089) 3,565,172 (2,567,832) Increase (decrease) in other liabilities 2,695,533 (1,778,326) 1,026,945 ------------- ------------- ------------- Total adjustments 10,153,396 10,850,289 6,873,667 ------------- ------------- ------------- Net cash provided by operating activities 44,105,946 40,204,794 35,189,714 CASH FLOWS FROM INVESTING ACTIVITIES: Net increase in interest-bearing deposits in banks (950,140) (1,269,947) (100,258) Payment for stock of City Bancshares, Inc., net of cash acquired - (6,848,231) - Activity in available-for-sale securities: Sales 30,077,478 57,925,815 530,097 Maturities 814,880,024 660,484,725 21,660,247 Purchases (972,026,050) (854,748,980) (41,804,532) Activity in held-to-maturity securities: Maturities 90,203,464 176,972,321 87,167,939 Purchases (2,360,727) (76,102,656) (57,628,266) Net increase in loans (26,012,420) (31,639,533) (63,728,244) Purchases of bank premises and equipment (2,913,886) (5,151,260) (2,507,214) Proceeds from sale of other assets 526,065 200,461 392,305 ------------- ------------- ------------- Net cash used in investing activities (68,576,192) (80,177,285) (56,017,926) CASH FLOWS FROM FINANCING ACTIVITIES: Net increase (decrease) in noninterest-bearing deposits 36,066,687 41,179,967 (4,236,804) Net (decrease) increase in interest-bearing deposits (9,667,069) 41,583,909 (593,942) Net increase (decrease) in securities sold under agreements to repurchase 6,861,927 (6,317,292) 16,526,625 Common stock transactions: Acquisition of treasury stock - (315,050) (3,925,069) Proceeds of stock issuances 573,116 356,670 161,919 Dividends paid (16,052,983) (13,921,211) (12,543,863) ------------- ------------- ------------- Net cash provided by (used in) financing activities 17,781,678 62,566,993 (4,611,134) ------------- ------------- ------------- NET (DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS (6,688,569) 22,594,502 (25,439,346) CASH AND CASH EQUIVALENTS, beginning of year 185,125,214 162,530,712 187,970,058 ------------- ------------- ------------- CASH AND CASH EQUIVALENTS, end of year $ 178,436,645 $ 185,125,214 $ 162,530,712 ============= ============= ============= The accompanying notes are an integral part of these consolidated financial statements.
F-8 FIRST FINANCIAL BANKSHARES, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements December 31, 2002, 2001 and 2000 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES: ------------------------------------------- Nature of Operations -------------------- First Financial Bankshares, Inc. (a Texas corporation) ("Bankshares") is a financial holding company which owns (through its wholly-owned Delaware subsidiary) all of the capital stock of ten banks located in Texas as of December 31, 2002. Those subsidiary banks are First National Bank of Abilene; Hereford State Bank; First National Bank, Sweetwater; Eastland National Bank; First Financial Bank, National Association, Cleburne; Stephenville Bank & Trust Co.; San Angelo National Bank; Weatherford National Bank; First Financial Bank, National Association, Southlake and City National Bank, Mineral Wells. Each subsidiary bank's primary source of revenue is providing loans and banking services to consumers and commercial customers in the market area in which the subsidiary is located. A summary of significant accounting policies of Bankshares and subsidiaries (collectively, the "Company") applied in the preparation of the accompanying consolidated financial statements follows. The accounting principles followed by the Company and the methods of applying them are in conformity with both accounting principles generally accepted in the United States of America and prevailing practices of the banking industry. Use of Estimates in Preparation of Financial Statements ------------------------------------------------------- The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Material estimates that are particularly susceptible to significant change in the near term relate to the determination of the allowance for loan losses, the valuations of foreclosed real estate, deferred income tax assets, and the fair value of financial instruments. Consolidation ------------- The accompanying consolidated financial statements include the accounts of Bankshares and its subsidiaries, all of which are wholly-owned. All significant intercompany accounts and transactions have been eliminated. Investment Securities --------------------- Management classifies debt and equity securities as held-to-maturity, available-for-sale, or trading based on its intent. Debt securities that management has the positive intent and ability to hold to maturity are classified as held-to-maturity and recorded at cost, adjusted for amortization of premiums and accretion of discounts, which are recognized as adjustments to interest income using the interest method. Securities not classified as held-to-maturity or trading are classified as available-for-sale and recorded at estimated fair value, with unrealized gains and losses, net of deferred income taxes, excluded from earnings and reported in a separate component of shareholders' equity. Securities classified as trading are recorded at estimated fair value, with unrealized gains and losses included in earnings. The Company had no trading securities at December 31, 2002, 2001, or 2000. Loans and Allowance for Loan Losses ----------------------------------- Loans are stated at the amount of unpaid principal, reduced by unearned income and an allowance for loan losses. Unearned income on installment loans is recognized in income over the terms of the loans in decreasing amounts using a method which approximates the interest method. Interest on other loans is calculated by using the simple interest method on daily balances of the principal amounts outstanding. The Company expenses its net loan origination costs, a method which does not materially differ from deferring and amortizing such amounts as an adjustment to yield. The allowance for loan losses is F-9 established through a provision for loan losses charged to expense. Loans are charged against the allowance for loan losses when management believes the collectibility of the principal is unlikely. The allowance is an amount that management believes will be adequate to absorb estimated inherent losses on existing loans that are deemed uncollectible based upon management's review and evaluation of the loan portfolio. The allowance for loan losses is increased by charges to income and decreased by charge-offs (net of recoveries). Management's periodic evaluation of the adequacy of the allowance is based on general economic conditions, the financial condition of the borrower, the value and liquidity of collateral, delinquency, prior loan loss experience, and the results of periodic reviews of the portfolio. Accrual of interest is discontinued on a loan when management believes, after considering economic and business conditions and collection efforts, that the borrower's financial condition is such that collection of interest is doubtful. The Company's policy requires measurement of the allowance for an impaired collateral dependent loan based on the fair value of the collateral. Other loan impairments are measured based on the present value of expected future cash flows or the loan's observable market price. At December 31, 2002 and 2001, all significant impaired loans have been determined to be collateral dependent and the allowance for loss has been measured utilizing the estimated fair value of the collateral. Other Real Estate ----------------- Other real estate is foreclosed property held pending disposition and is valued at the lower of its fair value or the recorded investment in the related loan. At foreclosure, if the fair value, less estimated costs to sell, of the real estate acquired is less than the Company's recorded investment in the related loan, a write-down is recognized through a charge to the allowance for loan losses. Any subsequent reduction in value is recognized by a charge to income. Operating expenses of such properties, net of related income, and gains and losses on their disposition are included in noninterest expense. Bank Premises and Equipment --------------------------- Bank premises and equipment are stated at cost less accumulated depreciation and amortization. Depreciation and amortization are computed principally on a straight-line basis over the estimated useful lives of the related assets. Leasehold improvements are amortized over the life of the respective lease or the estimated useful lives of the improvements, whichever is shorter. Business Combinations, Goodwill and Other Intangible Assets ----------------------------------------------------------- Goodwill, relating to acquisitions of certain subsidiary banks, was amortized by the straight-line method over periods of 15 and 40 years during the years ended December 31, 2001 and 2000. In June 2001, Statement of Financial Accounting Standards No. 141, "Business Combinations" ("SFAS No. 141") and Statement of Financial Accounting Standards No. 142, "Goodwill and Other Intangible Assets" ("SFAS No. 142") were issued. SFAS No. 141 requires that all business combinations initiated after June 30, 2001 be accounted for under the purchase method and addresses the initial recognition and measurement of goodwill and other intangible assets acquired in a business combination. SFAS No. 142 addresses the initial recognition and measurement of intangible assets acquired outside of a business combination and the accounting for goodwill and other intangible assets subsequent to their acquisition. SFAS No. 142 provides that intangible assets with finite useful lives be amortized and that goodwill and intangible assets with indefinite lives not be amortized, but rather be tested at least annually for impairment. SFAS No. 142 was effective January 1, 2002 for calendar year companies; however, acquired goodwill or intangible assets recorded in our acquisition of City Bancshares, Inc. closed subsequent to June 30, 2001 were subject immediately to its provisions. F-10 On January 1, 2002, goodwill amounting to $23,765,896 was not subject to further amortization as a result of SFAS No. 142. The Company conducted its initial impairment test in 2002, with no reduction of recorded goodwill resulting from the test. A reconciliation adjusting comparative net earnings and earnings per share for the years ended December 31, 2001 and 2000, to show the effect of no longer amortizing the Company's goodwill, follows:
2001 2000 ------------ ------------ Reported net earnings $ 29,354,505 $ 28,316,047 Add back: goodwill amortization Goodwill amortization, before income tax 1,641,367 1,641,367 Income tax benefit (420,000) (420,000) ------------ ------------ Adjusted net earnings $ 30,575,872 $ 29,537,414 ============ ============ Basic earnings per share: Reported net earnings $ 2.38 $ 2.28 Goodwill amortization, net of income tax benefit .10 .10 ------------ ------------ Adjusted net earnings $ 2.48 $ 2.38 ============ ============ Earnings per share, assuming dilution: Reported net earnings $ 2.37 $ 2.27 Goodwill amortization, net of income tax benefit .10 .10 ------------ ------------ Adjusted net earnings $ 2.47 $ 2.37 ============ ============
Goodwill arising from acquisitions of assets and liabilities, rather than acquisitions of stock, amounting to $13,000,000, is deductible for federal income tax purposes. Other identifiable intangible assets recorded by the Company represent the future benefit associated with the acquisition of the core deposits of City Bancshares, Inc. (Note 17) and is being amortized over seven years utilizing a method that approximates the expected attrition of the deposits. Securities Sold Under Agreements To Repurchase ---------------------------------------------- Securities sold under agreements to repurchase, which are classified as secured borrowings, generally mature within one to four days from the transaction date. Securities sold under agreements to repurchase are reflected at the amount of the cash received in connection with the transaction. The Company may be required to provide additional collateral based on the estimated fair value of the underlying securities. Segment Reporting ----------------- The Company has determined that it operates one line of business (community banking) located in a single geographic area (Texas). Statements of Cash Flows ------------------------ For purposes of reporting cash flows, cash and cash equivalents include cash on hand, amounts due from banks, and federal funds sold. Accounting for Income Taxes --------------------------- The Company's provision for income taxes is based on income before income taxes adjusted for permanent differences between financial reporting and taxable income. Deferred tax assets and liabilities are determined using the liability (or balance sheet) method. Under this method, the net deferred tax asset or liability is determined based on the tax effects of the temporary differences between the book and tax bases of the various balance sheet assets and liabilities and gives current recognition to changes in tax rates and laws. F-11 Stock Based Compensation ------------------------ The Company grants stock options for a fixed number of shares to employees with an exercise price equal to the fair value of the shares at the date of grant. The Company accounts for stock option grants using the intrinsic value method prescribed by APB Opinion No. 25, "Accounting for Stock Issued to Employees" ("APB 25"). Under APB 25, because the exercise price of the Company's employee stock options equals the market price of the underlying stock on the date of grant, no compensation expense is recognized. Had compensation cost for the plan been determined consistent with Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based Compensation," the Company's net earnings and earnings per share would have been reduced by insignificant amounts on a pro forma basis for the years ended December 31, 2002, 2001 and 2000. Note 15 provides additional information on the Company's stock option plan. Stock Repurchase ---------------- On July 25, 2000, the Company approved a stock repurchase plan, authorizing the repurchase of up to 740,690 shares of the Company's common stock. During the years ended December 31, 2001 and 2000, the Company repurchased 9,900 and 126,100 shares, respectively. The treasury shares were purchased for $4,240,119, which represented an average purchase price of $31.18 per share. The treasury shares were retired in 2001. Per Share Data -------------- Net earnings per share ("EPS") are computed by dividing net earnings by the weighted average number of shares of common stock outstanding during the period. The Company calculates dilutive EPS assuming all outstanding options to purchase common stock have been exercised at the beginning of the year (or the time of issuance, if later.) The dilutive effect of the outstanding options is reflected by application of the treasury stock method, whereby the proceeds from the exercised options are assumed to be used to purchase common stock at the average market price during the period. The following table reconciles the computation of basic EPS to dilutive EPS:
Weighted Net Average Per Share Earnings Shares Amount ----------- ---------- --------- For the year ended December 31, 2002: Net earnings per share, basic $33,952,550 12,359,966 $ 2.75 ========= Effect of stock options - 47,523 ----------- ---------- Net earnings per share, assuming dilution $33,952,550 12,409,489 $ 2.74 =========== ========== ========= For the year ended December 31, 2001: Net earnings per share, basic $29,354,505 12,318,346 $ 2.38 ========= Effect of stock options - 45,323 ----------- ---------- Net earnings per share, assuming dilution $29,354,505 12,363,669 $ 2.37 =========== ========== ========= For the year ended December 31, 2000: Net earnings per share, basic $28,316,047 12,426,344 $ 2.28 ========= Effect of stock options - 28,355 ----------- ---------- Net earnings per share, assuming dilution $28,316,047 12,454,699 $ 2.27 =========== ========== =========
Reclassifications ----------------- Certain 2001 and 2000 amounts have been reclassified to conform to the 2002 presentation. F-12 2. CASH AND INVESTMENT SECURITIES: ------------------------------- The amortized cost, estimated fair values, and gross unrealized gains and losses of the Company's investment securities as of December 31, 2002 and 2001, are as follows:
December 31, 2002 ----------------------------------------------------------------- Gross Gross Amortized Unrealized Unrealized Estimated Cost Basis Holding Gains Holding Losses Fair Value ------------ ----------- --------- ------------ Securities held-to-maturity: U.S. Treasury securities and obligations of U.S. government corporations and agencies $110,939,173 $ 6,868,716 $ - $117,807,889 Obligations of state and political subdivisions 60,835,676 3,214,571 - 64,050,247 Corporate bonds 498,936 41,064 - 540,000 Mortgage-backed securities 28,175,999 1,288,594 (578) 29,464,015 ------------ ----------- --------- ------------ Total debt securities held-to-maturity $200,449,784 $11,412,945 $ (578) $211,862,151 ============ =========== ========= ============ Securities available-for-sale: U.S. Treasury securities and obligations of U.S. government corporations and agencies $164,090,045 $ 7,545,917 $ (16,670) $171,619,292 Obligations of state and political subdivisions 104,800,319 5,952,505 (12,189) 110,740,635 Corporate bonds 49,234,116 2,577,468 - 51,811,584 Mortgage-backed securities 228,489,406 4,066,253 (449,560) 232,106,099 ------------ ----------- --------- ------------ Total debt securities available-for-sale 546,613,886 20,142,143 (478,419) 566,277,610 Other securities 5,453,100 75,919 - 5,529,019 ------------ ----------- --------- ------------ Total securities available-for-sale $552,066,986 $20,218,062 $(478,419) $571,806,629 ============ =========== ========= ============
F-13
December 31, 2001 Gross Gross Amortized Unrealized Unrealized Estimated Cost Basis Holding Gains Holding Losses Fair Value ------------ ---------- ----------- ------------ Securities held-to-maturity: U.S. Treasury securities and obligations of U.S. government corporations and agencies $172,879,974 $5,039,045 $ (47,536) $177,871,483 Obligations of state and political subdivisions 75,959,059 1,670,635 (134,439) 77,495,255 Corporate bonds 498,483 13,867 - 512,350 Mortgage-backed securities 41,332,974 1,354,710 (978) 42,686,706 Other securities 4,000 - - 4,000 ------------ ---------- ----------- ------------ Total debt securities held-to-maturity $290,674,490 $8,078,257 $ (182,953) $298,569,794 ============ ========== =========== ============ Securities available-for-sale: U.S. Treasury securities and obligations of U.S. government corporations and agencies $93,150,557 $2,025,482 $(257,163) $94,918,876 Obligations of state and political subdivisions 82,545,879 1,140,522 (835,320) 82,851,081 Corporate bonds 56,553,112 2,000,708 (31,141) 58,522,679 Mortgage-backed securities 189,421,296 2,982,733 (684,161) 191,719,868 ------------ ---------- ----------- ------------ Total debt securities available-for-sale 421,670,844 8,149,445 (1,807,785) 428,012,504 Other securities 3,006,701 - - 3,006,701 ------------ ---------- ----------- ------------ Total securities available-for-sale $424,677,545 $8,149,445 $(1,807,785) $431,019,205 ============ ========== =========== ============
The Company invests in mortgage-backed securities that have expected maturities that differ from their contractual maturities. These differences arise because borrowers may have the right to call or prepay obligations with or without a prepayment penalty. These securities include collateralized mortgage obligations (CMOs) and other asset backed securities. The expected maturities of these securities at December 31, 2002 and 2001, were computed by using scheduled amortization of balances and historical prepayment rates. At December 31, 2002 and 2001, the Company did not hold any CMOs that entail higher risks than standard mortgage-backed securities. F-14 The amortized cost and estimated fair value of debt securities at December 31, 2002, by contractual and expected maturity, are shown below.
Held-to-Maturity Available-for-Sale ---------------- ---------------------- Amortized Estimated Amortized Estimated Cost Basis Fair Value Cost Basis Fair Value ------------ ------------ ------------ ------------ Due within one year $ 55,959,878 $ 57,124,507 $ 46,281,321 $ 47,124,793 Due after one year through five years 121,052,000 129,421,284 377,002,918 390,627,675 Due after five years through ten years 9,305,724 10,071,540 63,803,688 65,913,832 Due after ten years 14,132,182 15,244,820 59,525,959 62,611,310 ------------ ------------ ------------ ------------ Total debt securities $200,449,784 $211,862,151 $546,613,886 $566,277,610 ============ ============ ============ ============
Securities, carried at approximately $239,971,000 and $243,316,000 at December 31, 2002 and 2001, respectively, were pledged as collateral for public or trust fund deposits and for other purposes required or permitted by law. During 2002 and 2001, sales of investment securities that were classified as available-for-sale totaled $30,077,478 and $57,925,815, respectively. Gross realized gains and losses from sales in 2002 were $23,773 and $7,400, respectively. Gross realized gains and losses from 2001 sales were $104,779 and $36,990, respectively. Gross realized gains from 2000 sales were $530,097. The specific identification method was used to determine cost in computing the realized gains and losses. Certain subsidiary banks are required to maintain reserve balances with the Federal Reserve Bank. During 2002 and 2001, such average balances totaled approximately $12,776,000 and $9,017,000, respectively. 3. LOANS AND ALLOWANCE FOR LOAN LOSSES: ------------------------------------ Major classifications of loans are as follows:
December 31, ------------------------------ 2002 2001 ------------ ------------ Commercial, financial, and agricultural $311,743,212 $312,053,042 Real estate - construction 50,911,156 47,173,297 Real estate - mortgage 375,255,678 350,381,887 Consumer 226,140,626 230,616,297 ------------ ------------ 964,050,672 940,224,523 Unearned income (10,899) (93,548) ------------ ------------ Total loans $964,039,773 $940,130,975 ============ ============
The Company's recorded investment in impaired loans and the related valuation allowance are as follows: December 31, 2002 December 31, 2001 ----------------- ----------------- Recorded Valuation Recorded Valuation Investment Allowance Investment Allowance ---------- ---------- ---------- ---------- $3,734,261 $ 752,385 $3,817,683 $ 926,636 ========== ========== ========== ========== F-15 The average recorded investment in impaired loans for the years ended December 31, 2002 and 2001, was approximately $3,776,000 and $3,773,000, respectively. The Company had approximately $4,266,000 and $4,824,000 in nonperforming assets at December 31, 2002 and 2001, respectively. No additional funds are committed to be advanced in connection with impaired loans. Interest payments received on impaired loans are recorded as interest income unless collections of the remaining recorded investment are doubtful, at which time payments received are recorded as reductions of principal. The Company recognized interest income on impaired loans of approximately $111,000, $136,000 and $213,000 during the years ended December 31, 2002, 2001, and 2000, respectively, of which approximately $2,000, $9,000 and $16,000 represented cash interest payments received and recorded as interest income. If interest on impaired loans had been recognized on a full accrual basis during the years ended December 31, 2002, 2001, and 2000, respectively, such income would have approximated $317,000, $399,000 and $449,000. The allowance for loan losses as of December 31, 2002 and 2001, is presented below. Management has evaluated the adequacy of the allowance for loan losses by estimating the losses in various categories of the loan portfolio which are identified below:
2002 2001 ----------- ----------- Allowance for loan losses provided for: Loans specifically evaluated as impaired $ 752,385 $ 926,636 Remaining portfolio 10,466,344 9,675,783 ----------- ----------- Total allowance for loan losses $11,218,729 $10,602,419 =========== ===========
Changes in the allowance for loan losses are summarized as follows:
December 31, ----------------------------------------------- 2002 2001 2000 ----------- ----------- ------------ Balance at beginning of year $10,602,419 $ 9,887,646 $ 8,937,542 Add: Provision for loan losses 2,369,634 1,964,050 2,397,750 Loan recoveries 834,150 968,535 1,545,080 Allowance established at acquisition - 407,129 - Deduct: Loan charge-offs (2,587,474) (2,624,941) (2,992,726) ----------- ----------- ------------ Balance at end of year $11,218,729 $10,602,419 $ 9,887,646 =========== =========== ============
An analysis of the changes in loans to officers, directors, principal shareholders, or associates of such persons for the years ended December 31, 2002 and 2001 (determined as of each respective year-end) follows:
Beginning Additional Ending Balance Loans Payments Balance ----------- ------------ ----------- ----------- Year ended December 31, 2002 $44,426,313 $27,349,995 $44,235,855 $27,540,453 =========== =========== =========== =========== Year ended December 31, 2001 $35,575,573 $51,556,164 $42,970,581 $44,161,156 =========== =========== =========== ===========
In the opinion of management, those loans are on substantially the same terms, including interest rates and collateral requirements, as those prevailing at the time for comparable transactions with unaffiliated persons. F-16 4. BANK PREMISES AND EQUIPMENT: ---------------------------- The following is a summary of bank premises and equipment:
Useful Life December 31, ----------------------------------- ----------------------------- 2002 2001 ----------- ----------- Land - $ 7,362,814 $ 7,104,759 Buildings 20 to 40 years 50,560,723 49,885,954 Furniture and equipment 3 to 10 years 26,347,819 27,249,965 Leasehold improvements Lesser of lease term or 5 to 15 years 4,385,288 4,105,350 ----------- ----------- 88,656,644 88,346,028 Less- accumulated depreciation and amortization (48,051,243) (46,333,597) ----------- ----------- $40,605,401 $42,012,431 =========== ===========
Depreciation expense for the years ended December 31, 2002, 2001 and 2000 amounted to $4,284,473, $3,755,878, and $3,700,474, respectively and is included in the captions net occupancy expense and equipment expense in the accompanying consolidated statements of earnings. The Company is lessor for portions of its banking premises. Total rental income for all leases included in net occupancy expense is approximately $1,578,000, $1,432,000 and $1,387,000, for the years ended December 31, 2002, 2001, and 2000, respectively. 5. TIME DEPOSITS ------------- Time deposits of $100,000 or more totaled approximately $195,754,000 and $196,905,000 at December 31, 2002 and 2001, respectively. Interest expense on these deposits was approximately $11,559,000, $10,163,000, and $10,022,000 during 2002, 2001, and 2000, respectively. At December 31, 2002, the scheduled maturities of time deposits were, as follows: Year ending December 31, ------------------------ 2003 $466,285,411 2004 42,007,875 2005 12,232,334 2006 2,222,764 2007 10,878,020 ------------ $533,626,404 6. LINE OF CREDIT -------------- The Company has a line of credit with a nonaffiliated bank under which it could borrow up to $25,000,000. The line of credit is unsecured and matures on June 30, 2003. Bankshares paid no fee to secure the unused line of credit and, accordingly, did not estimate a fair value of the unused line of credit at December 31, 2002 and 2001. The line of credit carries an interest rate of the London Interbank Offering Rate plus 1.0%. There was no outstanding balance under the line of credit as of December 31, 2002 and 2001. F-17 7. INCOME TAXES: ------------- The Company files a consolidated federal income tax return. Income tax expense (benefit) is comprised of the following:
Year Ended December 31, ----------------------------------------------- 2002 2001 2000 ----------- ----------- ----------- Current federal income tax $14,280,038 $13,016,053 $12,966,837 Deferred federal income tax expense (benefit) 350,415 (188,982) (304,240) ----------- ----------- ----------- Income tax expense $14,630,453 $12,827,071 $12,662,597 =========== =========== ===========
Income tax expense, as a percentage of pretax earnings, differs from the statutory federal income tax rate as follows:
As a Percent of Pretax Earnings --------------------------------------------------- 2002 2001 2000 ---------------- ---------------- ---------------- Statutory federal income tax rate 35.0 % 35.0 % 35.0 % Reductions in tax rate resulting from interest income exempt from federal income tax (5.6)% (5.2)% (4.9)% Other 0.7 % 0.6 % 0.8 % ---- ---- ---- Effective income tax rate 30.1 % 30.4 % 30.9 % ==== ==== ====
F-18 The approximate effects of each type of difference that gave rise to the Company's deferred tax assets and liabilities at December 31, 2002 and 2001, are as follows:
2002 2001 ----------- ------------ Deferred tax assets- Tax basis of loans in excess of financial statement basis $ 3,940,576 $ 3,766,408 Minimum liability in defined benefit plan 775,537 - Recognized for financial reporting purposes but not for tax purposes- Deferred compensation 686,098 590,462 Write-downs and adjustments to other real estate owned and repossessed assets 133,000 112,000 Other deferred tax assets 343,527 258,448 ----------- ------------ Total deferred tax assets 5,878,738 4,727,318 Deferred tax liabilities- Financial statement basis of fixed assets in excess of tax basis 1,442,962 1,334,565 Intangible asset amortization deductible for tax purposes, but not for financial reporting purposes 832,527 - Recognized for financial reporting purposes but not for tax purposes: Accretion on investment securities 437,660 385,191 Pension plan contributions 497,869 610,869 Net unrealized gain on investment securities available-for-sale 6,908,875 2,219,581 Other deferred tax liabilities 71,334 225,429 ----------- ------------ Total deferred tax liabilities 10,191,227 4,775,635 ----------- ------------ Net deferred tax liability $(4,312,489) $ (48,317) =========== ============
8. FAIR VALUE OF FINANCIAL INSTRUMENTS: ------------------------------------ The Company is required to disclose the estimated fair value of its financial instrument assets and liabilities. For the Company, as for most financial institutions, substantially all of its assets and liabilities are considered financial instruments as defined. Many of the Company's financial instruments, however, lack an available trading market as characterized by a willing buyer and willing seller engaging in an exchange transaction. Estimated fair values have been determined by the Company using the best available data, as generally provided in the Company's regulatory reports, and an estimation methodology suitable for each category of financial instruments. For those loans and deposits with floating interest rates, it is presumed that estimated fair values generally approximate the carrying value. F-19 The estimated fair values, and carrying values at December 31, 2002 and 2001, were as follows:
2002 2001 ----------------------------- ------------------------------- Carrying Estimated Carrying Estimated Value Fair Value Value Fair Value ------------- ------------- ------------- ------------- Cash and due from banks $108,436,645 $108,436,645 $112,150,214 $112,150,214 Federal funds sold 70,000,000 70,000,000 72,975,000 72,975,000 Interest-bearing deposits in banks 2,324,425 2,324,425 1,374,285 1,374,285 Investment securities 772,256,413 783,668,780 721,693,695 729,588,999 Net loans 952,821,044 964,782,729 929,528,556 938,431,998 Accrued interest receivable 15,360,833 15,360,833 17,636,608 17,636,608 Deposits with stated maturities 541,031,072 544,575,352 575,069,375 580,467,556 Deposits with no stated maturities 1,170,531,144 1,170,531,144 1,110,093,223 1,110,093,223 Securities sold under agreements to repurchase 26,708,994 26,708,994 19,847,067 19,847,067 Accrued interest payable 2,150,309 2,150,309 3,475,555 3,475,555
Financial instruments actively traded in a secondary market have been valued using quoted available market prices. Financial instruments with stated maturities have been valued using a present value discounted cash flow with a discount rate approximating current market for similar assets and liabilities. Financial instrument assets with variable rates and financial instrument liabilities with no stated maturities have an estimated fair value equal to both the amount payable on demand and the carrying value. Changes in assumptions or estimation methodologies may have a material effect on these estimated fair values. The Company's remaining assets and liabilities, which are not considered financial instruments, have not been valued differently than customary with historical cost accounting. There is no material difference between the carrying value and the estimated fair value of the Company's contractual off-balance-sheet unfunded lines of credit, loan commitments and letters of credit which are generally priced at market at the time of funding. Reasonable comparability between financial institutions may not be likely due to the wide range of permitted valuation techniques and numerous estimates which must be made given the absence of active secondary markets for many of the financial instruments. This lack of uniform valuation methodologies also introduces a greater degree of subjectivity to these estimated fair values. 9. COMMITMENTS AND CONTINGENCIES: ------------------------------ The Company is engaged in legal actions arising from the normal course of business. In management's opinion, the Company has adequate legal defenses with respect to these actions, and the resolution of these matters will have no material adverse effects upon the results of operations or financial condition of the Company. The Company leases a portion of its bank premises and equipment under operating leases. At December 31, 2002, future minimum lease commitments are not significant. 10. FINANCIAL INSTRUMENTS WITH OFF-BALANCE-SHEET RISK: --------------------------------------------------- The Company is a party to financial instruments with off-balance-sheet risk in the normal course of business to meet the financing needs of its customers. F-20 These financial instruments include unfunded lines of credit, commitments to extend credit and standby letters of credit. Those instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the consolidated balance sheets. The Company's exposure to credit loss in the event of nonperformance by the other party to the financial instrument for unfunded lines of credit, commitments to extend credit and standby letters of credit is represented by the contractual notional amount of these instruments. The Company uses the same credit policies in making commitments and conditional obligations as it does for on-balance-sheet instruments. Contract or Notional Amount at December 31, 2002 ----------------- Financial instruments whose contract amounts represent credit risk: Unfunded lines of credit $123,803,128 Commitments to extend credit 62,092,132 Standby letters of credit 6,067,787 Unfunded lines of credit and commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. These commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The Company evaluates each customer's creditworthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by the Company upon extension of credit, is based on management's credit evaluation of the counterparty. Collateral held varies but may include accounts receivable, inventory, property, plant, and equipment, and income-producing commercial properties. Standby letters of credit are conditional commitments issued by the Company to guarantee the performance of a customer to a third party. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. The average collateral value held on letters of credit exceeds the contract amount. The Company has no other off-balance sheet arrangements or transactions that would expose the Company to liability that is not reflected on the face of the financial statements. 11. CONCENTRATION OF CREDIT RISK: ------------------------------ The Company grants commercial, retail, agriculture, and residential loans to customers primarily in North Central and West Texas. Although the Company has a diversified loan portfolio, a substantial portion of its debtors' ability to honor their contracts is dependent upon this local economic sector. 12. PENSION AND PROFIT SHARING PLANS: ---------------------------------- The Company has a defined benefit pension plan covering substantially all of its employees. The benefits are based on years of service and a percentage of the employee's qualifying compensation during the final years of employment. The Company's funding policy is to contribute annually the amount necessary to satisfy the Internal Revenue Service's funding standards. Contributions are intended to provide not only for benefits attributed to service to date but also for those expected to be earned in the future. F-21 The following table provides a reconciliation of the plan's benefit obligations and fair value of plan assets for the years ended December 31, 2002 and 2001, and a statement of the funded status as of December 31, 2002 and 2001:
2002 2001 ------------ ------------ Reconciliation of benefit obligations: Benefit obligation at January 1 $ 14,183,582 $ 11,885,661 Service cost - benefits earned during the period 994,630 847,620 Interest cost on projected benefit obligation 983,977 970,710 Actuarial loss 45,731 1,117,567 Benefits paid (667,523) (637,976) ------------ ------------ Benefit obligation at December 31 15,540,397 14,183,582 ------------ ------------ Reconciliation of fair value of plan assets: Fair value of plan assets at January 1 12,631,250 12,864,027 Actual return on plan assets (1,031,005) (337,724) Employer contributions 726,989 742,923 Benefits paid (667,523) (637,976) ------------ ------------ Fair value of plan assets at December 31 11,659,711 12,631,250 ------------ ------------ Funded status $ (3,880,686) $ (1,552,332) ============= ============= Reconciliation of funded status to accrued pension (liability) asset: Funded status at December 31 $ (3,880,686) $ (1,552,332) Unrecognized loss from past experience different than that assumed and effects of changes in assumptions 5,109,193 3,268,617 Additional minimum liability recorded (2,409,795) - Unrecognized prior-service cost 193,975 211,935 Other (36,644) - ------------ ------------ Accrued pension (liability) asset $ (1,023,957) $ 1,928,220 ============ ============
The Company recorded an additional minimum liability in the year ended December 31, 2002 to reflect the underfunded status of the plan. The accrued pension liability at December 31, 2002 represents the difference between the fair value of plan assets and the accumulated benefit obligation. The accumulated benefit obligation is the actuarial present value of benefits attributed by the pension benefit formula to employee service rendered prior to that date and based on current and past compensation levels. The accumulated benefit obligation differs from the projected benefit obligation in that it assumes no increase in future compensation. The following table details the financial statement captions affected by recording the minimum liability:
2002 2001 ----------- ---------- Prepaid pension asset before adjustment $ 1,385,838 $1,928,220 Intangible asset recorded (included in other assets) (193,975) - Minimum liability adjustment (2,215,820) - ----------- ---------- Accrued pension (liability) asset $(1,023,957) $1,928,220 =========== ==========
F-22 Net periodic pension cost for the years ended December 31, 2002, 2001, and 2000, included:
Year Ended December 31, ---------------------------------------------- 2002 2001 2000 ---------- ---------- ---------- Service cost - benefits earned during the period $ 994,630 $ 847,620 $ 845,372 Interest cost on projected benefit obligation 983,977 970,710 816,583 Expected return on plan assets (880,562) (1,153,733) (1,058,787) Amortization of unrecognized net loss 116,722 - - Amortization of prior-service cost 17,960 17,961 17,961 Other (59,405) (58,954) 58,779 ---------- ---------- ---------- Net periodic pension cost $1,173,322 $ 623,604 $ 679,908 ========== ========== ==========
The following table sets forth the rates used in the actuarial calculations of the present value of benefit obligations and the rate of return on plan assets:
2002 2001 2000 ---- ---- ---- Weighted average discount rate 6.9% 6.9% 7.5% Rate of increase in future compensation levels 4% 4% 4% Expected long-term rate of return on assets 6.5% 8.5% 8.5%
As of December 31, 2002 and 2001, the fair value of the plan's assets included Company common stock valued at approximately $468,000 and $297,000, respectively. The Company also provides a profit sharing plan, which covers substantially all full-time employees. The profit sharing plan is a defined contribution plan and allows employees to contribute up to 5% of their base annual salary. Employees are fully vested to the extent of their contributions and become fully vested in the Company's contributions over a seven-year vesting period. Costs related to the Company's defined contribution plan totaled approximately $2,681,000, $1,858,000 and $1,874,000 in 2002, 2001 and 2000, respectively, and are included in salaries and employee benefits in the accompanying consolidated statements of earnings. As of December 31, 2002 and 2001, the fair value of the plan's assets included Company common stock valued at approximately $14,323,000 and $10,881,000, respectively. 13. DIVIDENDS FROM SUBSIDIARIES: ----------------------------- At December 31, 2002, approximately $20,728,000 was available for the declaration of dividends by the Company's subsidiary banks without the prior approval of regulatory agencies. 14. REGULATORY MATTERS: -------------------- The Company is subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory, and possibly additional discretionary, actions by regulators that, if undertaken, could have a direct material effect on the Company's financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, each of Bankshares' subsidiaries must meet specific capital guidelines that involve quantitative measures of the subsidiaries' assets, liabilities, and certain off-balance-sheet items as calculated under regulatory accounting practices. The subsidiaries' capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors. F-23 Quantitative measures established by regulation to ensure capital adequacy require Bankshares and each of its subsidiaries to maintain minimum amounts and ratios (set forth in the table below) of total and Tier I capital (as defined in the regulations) to risk-weighted assets (as defined), and of Tier I capital (as defined), to average assets (as defined). Management believes as of December 31, 2002 and 2001, that Bankshares and each of its subsidiaries meet all capital adequacy requirements to which they are subject. As of December 31, 2002 and 2001, the most recent notification from each respective subsidiaries' primary regulator categorized each of Bankshares' subsidiaries as well-capitalized under the regulatory framework for prompt corrective action. To be categorized as well capitalized, the subsidiaries must maintain minimum total risk-based, Tier I risk-based, and Tier I leverage ratios as set forth in the table. There are no conditions or events since that notification that management believes have changed the institutions' categories. Bankshares' and its significant subsidiaries' actual capital amounts and ratios are presented in the table below:
To Be Well Capitalized Under For Capital Prompt Corrective Actual Adequacy Purposes: Action Provisions: ---------------------- ---------------------- ---------------------- Amount Ratio Amount Ratio Amount Ratio ------------- --- -------------- ----- -------------- ------ As of December 31, 2002: Total Capital (to Risk- Weighted Assets): Consolidated $ 213,725,000 20% =>$ 87,579,000 => 8% N/A N/A First National Bank of Abilene $ 68,874,000 17% =>$ 32,153,000 => 8% =>$ 40,191,000 => 10% San Angelo National Bank $ 16,039,000 12% =>$ 10,816,000 => 8% =>$ 13,520,000 => 10% Weatherford National Bank $ 19,758,000 18% =>$ 8,802,000 => 8% =>$ 11,002,000 => 10% Tier I Capital (to Risk- Weighted Assets): Consolidated $ 202,507,000 18% =>$ 43,790,000 => 4% N/A N/A First National Bank of Abilene $ 64,971,000 16% =>$ 16,077,000 => 4% =>$ 24,115,000 => 6% San Angelo National Bank $ 14,703,000 11% =>$ 5,408,000 => 4% =>$ 8,112,000 => 6% Weatherford National Bank $ 18,757,000 17% =>$ 4,401,000 => 4% =>$ 6,601,000 => 6% Tier I Capital (to Average Assets): Consolidated $ 202,507,000 11% =>$ 57,856,000 => 3% N/A N/A First National Bank of Abilene $ 64,971,000 9% =>$ 20,626,000 => 3% =>$ 34,377,000 => 5% San Angelo National Bank $ 14,703,000 5% =>$ 8,410,000 => 3% =>$ 14,016,000 => 5% Weatherford National Bank $ 18,757,000 10% =>$ 5,884,000 => 3% =>$ 9,807,000 => 5%
F-24
To Be Well Capitalized Under For Capital Prompt Corrective Actual Adequacy Purposes: Action Provisions: ---------------------- ---------------------- ---------------------- Amount Ratio Amount Ratio Amount Ratio ------------- --- -------------- ----- -------------- ------ As of December 31, 2001: Total Capital (to Risk- Weighted Assets): Consolidated $ 195,422,000 18% =>$ 86,380,000 => 8% N/A N/A First National Bank of Abilene $ 65,676,000 17% =>$ 31,594,000 => 8% =>$ 39,492,000 => 10% San Angelo National Bank $ 27,945,000 20% =>$ 10,925,000 => 8% =>$ 13,656,000 => 10% Weatherford National Bank $ 18,931,000 18% =>$ 8,624,000 => 8% =>$ 10,780,000 => 10% Tier I Capital (to Risk- Weighted Assets): Consolidated $ 184,820,000 17% =>$ 43,190,000 => 4% N/A N/A First National Bank of Abilene $ 61,895,000 16% =>$ 15,797,000 => 4% =>$ 23,695,000 => 6% San Angelo National Bank $ 26,672,000 20% =>$ 4,312,000 => 4% =>$ 8,194,000 => 6% Weatherford National Bank $ 18,019,000 17% =>$ 5,462,000 => 4% =>$ 6,468,000 => 6% Tier I Capital(to Average Assets): Consolidated $ 184,820,000 10% =>$ 56,060,000 => 3% N/A N/A First National Bank of Abilene $ 61,895,000 9% =>$ 19,728,000 => 3% =>$ 32,880,000 => 5% San Angelo National Bank $ 26,672,000 9% =>$ 8,800,000 => 3% =>$ 14,667,000 => 5% Weatherford National Bank $ 18,019,000 9% =>$ 5,788,000 => 3% =>$ 9,647,000 => 5%
15. STOCK OPTION PLAN: ------------------- The Company has an incentive stock plan to provide for the granting of options to senior management of the Company at prices not less than market at the date of grant. At December 31, 2002, the Company had allocated 740,690 shares of stock for issuance under the plan. The plan provides that options granted are exercisable after two years from date of grant at a rate of 20% each year cumulatively during the 10-year term of the option. An analysis of stock option activity for the years ended December 31, 2002, 2001, and 2000, is presented in the table and narrative below:
2002 2001 2000 ------------------- ------------------- ------------------ Wtd. Avg. Wtd. Avg. Wtd. Avg. Shares Ex. Price Shares Ex. Price Shares Ex. Price ------- ------ ------- ------ ------- ------ Outstanding, beginning of year 150,057 $21.60 174,959 $20.51 137,354 $20.18 Granted 2,000 30.50 3,700 29.82 60,597 20.80 Exercised (30,949) 18.52 (24,480) 14.57 (10,809) 14.98 Canceled (6,828) 23.48 (4,122) 24.95 (12,183) 24.02 ------- ------- ------- Outstanding, end of year 114,280 $22.47 150,057 $21.60 174,959 $20.51 ======= ====== ======= ====== ======= ====== Exercisable at end of year 57,825 $21.15 66,210 $18.94 70,872 $16.37 ======= ====== ======= ====== ======= ====== Weighted average fair value of options granted at date of issue $6.06 $6.13 $4.44 ===== ===== =====
F-25 The options outstanding at December 31, 2002, have exercise prices between $14.90 and $30.50 with a weighted average remaining contractual life of 5 years. Stock options have been adjusted retroactively for the effects of stock dividends and splits. The Company accounts for this plan under APB 25 under which no compensation cost has been recognized for options granted. The fair value of the options granted in 2002, 2001 and 2000, was estimated using the Black-Scholes options pricing model with the following weighted-average assumptions: risk-free interest rate of 4.75%, 5.23% and 6.33% respectively; expected dividend yield of 4.43%, 3.89% and 5.18% respectively; expected life of 6.0, 6.0 and 6.0 years, respectively; and expected volatility of 26.9%, 26.5% and 28.3%, respectively. F-26 16. CONDENSED FINANCIAL INFORMATION - PARENT COMPANY: -------------------------------------------------- Condensed Balance Sheets-December 31, 2002 and 2001 ---------------------------------------------------
ASSETS 2002 2001 ------ ------------ ------------ Cash in subsidiary bank $ 903,319 $ 579,686 Interest-bearing deposits in subsidiary banks 22,212,064 13,796,338 ------------ ------------ Total cash and cash equivalents 23,115,383 14,376,024 Investment in subsidiaries, at equity 219,947,550 202,758,981 Intangible assets 917,350 723,375 Other assets 950,708 932,986 ------------ ------------ Total assets $244,930,991 $218,791,366 ============ ============ LIABILITIES AND SHAREHOLDERS' EQUITY ------------------------------------ Total liabilities $ 6,163,346 $ 5,137,353 Shareholders' equity: Common stock 123,642,010 123,332,520 Capital surplus 58,087,687 57,824,061 Retained earnings 45,647,522 28,375,353 Accumulated other comprehensive earnings 11,390,426 4,122,079 ------------ ------------ Total shareholders' equity 238,767,645 213,654,013 ------------ ------------ Total liabilities and shareholders' equity $244,930,991 $218,791,366 ============ ============
Condensed Statements of Earnings- For the Years Ended December 31, 2002, 2001, and 2000 -----------------------------------------------------
2002 2001 2000 ----------- ----------- ----------- Income: Cash dividends from subsidiary banks $26,550,000 $ 25,500,000 $ 21,000,000 Excess of earnings over dividends of subsidiary banks 8,479,939 4,582,993 7,383,516 Gain on sale of investment securities available-for-sale - - 530,097 Other income 944,911 1,092,375 1,325,613 ----------- ----------- ----------- 35,974,850 31,175,368 30,239,226 ----------- ----------- ----------- Expenses: Salaries and employee benefits 1,451,136 1,160,903 1,067,664 Other operating expenses 1,142,832 1,015,184 1,288,508 ----------- ----------- ----------- 2,593,968 2,176,087 2,356,172 ----------- ----------- ----------- Earnings before income taxes 33,380,882 28,999,281 27,883,054 Income tax benefit 571,668 355,224 432,993 ----------- ----------- ----------- Net earnings $33,952,550 $29,354,505 $28,316,047 =========== =========== ===========
F-27 Condensed Statements of Cash Flows- For the Years Ended December 31, 2002, 2001, and 2000 -----------------------------------------------------
2002 2001 2000 ----------- ----------- ----------- Cash flows from operating activities: Net earnings $33,952,550 $29,354,505 $28,316,047 Adjustments to reconcile net earnings to net cash provided by operating activities: Excess of earnings over dividends of subsidiary banks (8,479,939) (4,582,993) (7,383,516) Depreciation 54,219 32,658 26,222 Discount accretion, net of premium amortization - (4,667) (12,133) Amortization of excess of cost over fair value of assets acquired - 55,576 55,576 Gain on sale of securities - - (530,097) (Increase) decrease in other assets (215,435) 559,515 (178,092) (Decrease) increase in liabilities (1,041,688) 186,391 448,225 ----------- ----------- ----------- Net cash provided by operating activities 24,269,707 25,600,985 20,742,232 ----------- ----------- ----------- Cash flows from investing activities: Purchases of bank premises and equipment (50,481) (157,291) (2,266) Activity in available-for-sale securities: Sales - - 530,097 Maturities - 10,000,000 - Purchases - - (9,983,200) Cash payment for stock acquisition - (16,500,000) - ----------- ----------- ----------- Net cash used in investing activities (50,481) (6,657,291) (9,455,369) ----------- ----------- ----------- Cash flows from financing activities: Proceeds of stock issuances 573,116 356,670 161,919 Acquisition of treasury stock - (315,050) (3,925,069) Cash dividends paid (16,052,983) (13,921,211) (12,543,863) ----------- ----------- ----------- Net cash used in financing activities (15,479,867) (13,879,591) (16,307,013) ----------- ----------- ----------- Net increase (decrease) in cash and cash equivalents 8,739,359 5,064,103 (5,020,150) Cash and cash equivalents, beginning of year 14,376,024 9,311,921 14,332,071 ----------- ----------- ----------- Cash and cash equivalents, end of year $23,115,383 $14,376,024 $ 9,311,921 =========== =========== ===========
F-28 17. BUSINESS COMBINATION: ---------------------- In July 2001, the Company purchased all of the outstanding stock of City Bancshares, Inc. ("City") and its subsidiary, City National Bank for $16,500,000 in cash. The total purchase price exceeded the estimated fair market value of net assets acquired by approximately $7,800,000, of which approximately $950,000 was assigned to an identifiable intangible asset with the balance recorded by the Company as goodwill. The identifiable intangible asset represents the future benefit associated with the acquisition of the core deposits of City and is being amortized over seven years utilizing a method that approximates the expected attrition of the deposits. The primary purpose of the acquisition was to expand the Company's market share in areas with close proximity to Dallas/Ft. Worth, Texas. Factors that contributed to a purchase price resulting in goodwill include City's historically stable record of earnings, capable management and its geographic location, which complements the Company's existing service locations. Subsequent to the acquisition, the Company liquidated the stock of City and City National Bank is operating as a subsidiary of the Company. The results of operations of City National Bank are included in the consolidated earnings of the Company commencing July 1, 2001. The following is a condensed consolidated balance sheet disclosing the preliminary estimated fair value amounts assigned to the major asset and liability captions at the acquisition date. ASSETS Cash and cash equivalents $ 9,651,769 Investment securities 29,717,834 Loans, net 51,061,735 Goodwill 6,891,959 Identifiable intangible asset 946,073 Other assets 1,465,727 ------------- Total assets $ 99,735,097 ============= LIABILITIES AND SHAREHOLDER'S EQUITY Noninterest-bearing deposits $ 11,949,766 Interest-bearing deposits 70,575,256 Other liabilities 710,075 Shareholders' equity 16,500,000 ------------- Total liabilities and shareholder's equity $ 99,735,097 ============= Goodwill recorded in the acquisition of City has been accounted for in accordance with SFAS No. 142. Accordingly, goodwill has not been amortized, rather it has been tested for impairment. The goodwill and identifiable intangible asset recorded are not deductible for federal income tax purposes. The proforma impact of City is insignificant to the Company's financial statements. Cash flow information relative to the acquisition of City is, as follows: Fair value of assets acquired $ 99,735,097 Cash paid for the capital stock of City 16,500,000 -------------- Liabilities assumed $ 83,235,097 ============== F-29 18. CASH FLOW INFORMATION: ----------------------- Supplemental information on cash flows and noncash transactions is as follows:
Year Ended December 31, --------------------------------------------- 2002 2001 2000 ----------- ----------- ----------- Supplemental cash flow information: Interest paid $25,704,950 $46,243,602 $48,123,200 Federal income taxes paid 14,682,343 13,227,101 13,227,192 Schedule of noncash investing and financing activities: Assets acquired through foreclosure 553,840 628,797 285,195 Retirement of treasury stock - 4,240,119 -
F-30 Exhibit 10.1 ------------ DEFERRED COMPENSATION AGREEMENT ------------------------------- THIS AGREEMENT is made this 28th day of October, 1992, by and between FIRST ABILENE BANKSHARES, INC., a Texas corporation, with its principal place of business in Abilene, Taylor County, Texas, hereinafter called "Corporation," and KENNETH T. MURPHY, a resident of Abilene, Taylor County, Texas, hereinafter called "Employee." RECITALS: A. Employee has been a director of Corporation since its inception and has been employed as its Chief Executive Officer since 1986. B. Employee has managed Corporation in a capable and efficient manner resulting in substantial profits to the Corporation and has acquired experience, knowledge and contacts of considerable value to Corporation. C. Corporation has been satisfied with the manner in which Employee has performed his duties as an officer and desires to offer an inducement to Employee to remain in its employ (subject, however, to the discretion of the Board of Directors of Corporation) by compensating him beyond his regular salary for services which he has rendered or will hereafter render. D. Employee is willing to continue in the employ of the Corporation in accordance with the provisions of this Agreement. NOW THEREFORE, in consideration of the provisions hereinafter set forth, the parties agree as follows 1. Continuation of Employment. At the discretion of the Board of Directors of Corporation, Employee shall continue in the employ of the Corporation until December 31, 2002, or until such later date as may be mutually agreed upon by the parties. 2. Compensation. The Corporation shall pay the Employee such salary as the Board of Directors of Corporation may from time to time determine, together with such amount of deferred compensation payable as provided in provisions hereinafter set forth, unless forfeited by the occurrence of any of the events of forfeiture hereinafter set forth. 3. Deferred Compensation. Commencing on the 1st day of January, 2003, or the first day of the month following Employee's retirement, whichever occurs later (except as hereinafter qualified in paragraph 4 hereof), the Corporation shall pay the following deferred compensation (unless forfeited by the occurrence of any of the events of forfeiture hereinafter set forth in paragraph 5 below): a. The Corporation shall pay to Employee the sum of SIX THOUSAND TWO HUNDRED FIFTY DOLLARS ($6,250) per month for a period of 84 months. In the event of the death of Employee before all 84 monthly installments are made, the unpaid balance will continue to be paid in installments for the unexpired portion of such 84-month period to his designated beneficiary in the same manner as set forth above. b. If the Employee's employment is terminated because of death or disability prior to the commencement of the payment of deferred compensation to Employee, the Corporation shall pay to the beneficiary designated by the Employee or to the Employee, as the case may be, SIX THOUSAND TWO HUNDRED FIFTY DOLLARS ($6,250) for a period of 84 months. For purposes of this Agreement, the Employee shall be considered disabled on the date the Board of Directors determines the Employee, because of a physical or mental disability, will be unable to perform the duties of his customary position of employment for an indefinite period which the Board of Directors considers will be of long continued duration. c. If the designated beneficiary shall die before a total of 84 monthly installments are made by the Corporation, the unpaid balance will continue to be paid in installments for the unexpired portion of such 84-month period to the estate of such designated beneficiary. d. The beneficiary referred to in this paragraph may be designated or changed by Employee (without the consent of any prior beneficiary) on the form provided by the Corporation and delivered to the Corporation before his death. If no such beneficiary shall have been designated or if no designated beneficiary shall survive the Employee, the installment payments payable hereunder shall be payable to the Employee's estate. e. During the period of deferred compensation, other employee benefits of the Corporation shall be provided to Employee at the sole election and determination of the Board of Directors of Corporation. 4. Early Commencement of Deferred Compensation. If Employee's employment terminates prior to his attaining age 65, but after he has attained age 62, for any reason other than death or disability, then commencing on the first day of the month following such termination, the Corporation shall pay deferred compensation in accordance with the provisions of paragraph 3 above, with the exception that the amount of deferred compensation shall be reduced in accordance with the following schedule: Percent of Deferred Compensation Called for Under Age of Employee Paragraph 3 --------------- ----------- 62 70% 63 80% 64 90% 5. Forfeiture of Benefits and Payments. a. No payment of deferred compensation shall be made to Employee if his employment terminates prior to his attaining age 62 for any reason other than death or disability. b. No payment of any then unpaid installments of deferred compensation shall be made, and all rights under the Agreement of the Employee, his designated beneficiary, executors or administrators, or any other person to receive payments thereof shall be forfeited, if the Employee shall engage in any activity of conduct which in the opinion of the Board is adverse to the best interest of the Corporation. 6. Rights of Employee and Any Beneficiary. Nothing contained, in this Agreement and no action taken pursuant to the provisions of this Agreement shall create or be construed to create a trust of any kind or a fiduciary relationship between the Corporation and the Employee, his designated beneficiary or any other person. Any funds which may be set aside by the Corporation to meet its obligations under this Agreement shall continue for all purposes to be a part of the general funds of the Corporation and no persons other than the Corporation shall by virtue of the provisions of this Agreement have any interest in such funds. To the extent that any person acquires a right to receive payments from the Corporation under this Agreement, such rights shall be no greater than the right of any unsecured general creditor of the Corporation. The Employee and any beneficiary of the Employee shall have no vested, secured or preferred interest in any of the Corporation's assets, but will only have a contractual right to receive payments provided for in this Agreement. The right to receive payments under this Agreement may not be anticipated, commuted, transferred, assigned or otherwise encumbered. The rights of the Employee under this Agreement and/or of any beneficiary of the Employee shall be solely those of an unsecured creditor of the Corporation. 7. Effect of Benefits. The benefits provided hereunder shall be in addition to Employee's annual salary as determined by the Board of Directors of the Corporation and shall not affect the right of Employee to participate in any current or future Corporation retirement plan or in any supplemental compensation arrangement which constitutes a part of the Corporation's regular compensation structure. Any deferred compensation payable under this Agreement shall not be deemed salary or other compensation to the Employee for the purpose of computing benefits to which he may be entitled under any pension plan or other arrangement of the Corporation for the benefit of its employees. Nothing contained herein shall be construed as conferring upon the Employee the right to continue in the employ of the Corporation as an officer or in any other capacity. 8. Reorganization. The Corporation agrees that it will not merge or consolidate with any other company or organization, or permit its business activities to be taken over by any other organization unless and until the succeeding or continuing company or other organization shall expressly assume all obligations and liabilities herein set forth. 9. Amendment. This Agreement may be revoked or amended in hole or in part only by a written instrument signed by both of the parties hereto. 10. Interpretation. The Board of Directors of the Corporation shall have full power and authority to interpret, construe and administer this Agreement, and the Board's interpretation and construction thereof, and actions thereunder shall be binding and conclusive to all persons for all purposes. No members of the Board shall be liable to any person for any action taken or omitted in connection with the interpretation and administration of this Agreement unless attributable to his own willful misconduct or lack of good faith. 11. Binding Effect. This Agreement shall be binding upon and inure to the benefit of the Corporation, its successors and assigns, and the Employee, his designated beneficiary, heirs, executors, administrators and legal representatives. IN WITNESS WHEREOF, the parties have executed this Agreement as of the day and year first above written. FIRST ABILENE BANKSHARES, INC. ATTEST: By: /S/ SANDY LESTER By: /S/ CURTIS HARVEY --------------------------- --------------------------------- Secretary CURTIS HARVEY Executive Vice President "CORPORATION" /S/ KENNETH T. MURPHY --------------------------------- KENNETH T. MURPHY "EMPLOYEE" Exhibit 10.2 ------------ DEFERRED COMPENSATION AGREEMENT THIS AGREEMENT is made and restated this 28th day of December, 1995, by and between FIRST FINANCIAL BANKSHARES, INC. (formerly FIRST ABILENE BANKSHARES, INC.), a Texas corporation, with its principal place of business in Abilene, Taylor County, Texas, hereinafter called "Corporation," and KENNETH T. MURPHY, a resident of Abilene, Taylor County, Texas, hereinafter called "Employee." RECITALS: A. On or about October 28, 1992, Corporation and Employee entered into that certain Deferred Compensation Agreement (the "Compensation Agreement") in recognition of the capable and efficient manner in which Employee, as Corporation's Chief Executive Officer, has managed the business of Corporation and as an inducement to Employee to remain in the employ of Corporation (subject, however, to the discretion of the Corporation's Board of Directors) by compensating Employee beyond his regular salary and other benefits for services rendered or to be rendered to Corporation. B. On or about November 28, 1994, Corporation, as a further inducement to Employee to remain in the employ of Corporation, did amend the Compensation Agreement so as to provide assurance to Employee that any change in control of Corporation which may result, directly or indirectly, in termination of Employee's employment by Corporation (or any successor in interest to the Corporation) would not result in loss of, or any reduction in the amount of, the deferred compensation which Employee would otherwise be entitled to receive under the Compensation Agreement. C. Employee has continued to serve as a Director of Corporation and as its Chief Executive Officer at all times since the date of the Compensation Agreement and has fulfilled all of his obligations thereunder as of the date hereof. D. Corporation, being satisfied with the manner in which Employee has continued to perform his duties and carry out his responsibilities as an officer and Director of Corporation, and as a further inducement to Employee to remain in the employ of Corporation, desires to restate the Compensation Agreement, as heretofore amended, and to further amend said Agreement to provide an increase of TWO THOUSAND FIVE HUNDRED DOLLARS ($2,500) per month to be paid to Employee in the event he achieves the condition for full payment under the Compensation Agreement. NOW, THEREFORE, in consideration of the premises and of the provisions hereinafter set forth, the parties agree as follows: 1. Continuation of Employment. At the discretion of the Board of Directors of Corporation, Employee shall continue in the employ of the Corporation until December 31, 2002, or until such later date as may be mutually agreed upon by the parties. 2. Compensation. The Corporation shall pay the Employee such salary as the Board of Directors of Corporation may from time to time determine, together with such amount of deferred compensation payable as provided in provisions hereinafter set forth, unless forfeited by the occurrence of any of the events of forfeiture hereinafter set forth. 3. Deferred Compensation. a. Subject to the provisions of Paragraphs 4 and 5 below, commencing on the 1st day of January, 2003, or the first day of the month following Employee's retirement, whichever occurs later, the Corporation shall pay to the Employee as deferred compensation the sum of EIGHT THOUSAND SEVEN HUNDRED FIFTY DOLLARS ($8,750) per month for a period of 84 months. b. In the event of the death of Employee before all 84 monthly installments are made, the unpaid balance will continue to be paid in installments for the unexpired portion of such 84-month period to his designated beneficiary in the same manner as set forth above. c. If the Employee's employment is terminated because of death or disability prior to the commencement of the payment of deferred compensation to Employee, the Corporation shall pay to the beneficiary designated by the Employee or to the Employee, as the case may be, on the first day of the month following such termination, EIGHT THOUSAND SEVEN HUNDRED FIFTY DOLLARS ($8,750) for a period of 84 months. For purposes of this Agreement, the Employee shall be considered disabled on the date the Board of Directors determines the Employee, because of a physical or mental disability, will be unable to perform the duties of his customary position of employment for an indefinite period which the Board of Directors considers will be of long continued duration. d. If the designated beneficiary shall die before a total of 84 monthly installments are made by the Corporation, the unpaid balance will continue to be paid in installments for the unexpired portion of such 84-month period to the estate of such designated beneficiary. e. The beneficiary referred to in this paragraph may be designated or changed by Employee (without the consent of any prior beneficiary) on the form provided by the Corporation and delivered to the Corporation before his death. If no such beneficiary shall have been designated or if no designated beneficiary shall survive the Employee, the installment payments payable hereunder shall be payable to the Employee's estate. f. During the period of deferred compensation, other employee benefits of the Corporation shall be provided to Employee at the sole election and determination of the Board of Directors of Corporation. 4. Early Commencement of Deferred Compensation. a. No payment of deferred compensation shall be made to Employee if his employment terminates prior to his attaining age 62 for any reason other than death or disability. b. Subject to the provisions of Paragraph 5 below, if Employee's employment terminates prior to his attaining age 65, but after he has attained age 62, for any reason other than death or disability, then commencing on the first day of the month following such termination, the Corporation shall pay deferred compensation in accordance with the provisions of Paragraph 3 above, with the exception that the amount of deferred compensation payable shall be reduced for the term of payout in accordance with the following schedule: Age of Employee Percentage of Deferred at Termination Compensation Payable of Employment Under Paragraph 3 62 70% 63 80% 64 90% c. Notwithstanding the provisions of Subparagraphs a. and b. above, but subject to the provisions of Paragraph 5 below, Employee shall, on the first day of the month following termination of employment, be entitled to receive all of the deferred compensation described in Paragraph 3 above in the event (1) that the Corporation shall be merged or consolidated with another corporation or other organization, or (2) that all, or substantially all, of the assets of the Corporation (including, but not limited to, the shares of the Corporation's subsidiary banks) shall be acquired by another corporation or other organization, or (3) that majority ownership or control of the Corporation shall be otherwise transferred to, or acquired by, any one or more persons, firms or corporations as the result of a single transaction or closely-related series of transactions; provided, that there shall be excluded from the transactions or occurrences described in (1)-(3) any merger, consolidation, sale, transfer or other change in ownership or control of the Corporation or its principal assets as a result of any reorganization of the Corporation and its subsidiaries effected by the Corporation itself. 5. Forfeiture of Deferred Compensation. No payment of deferred compensation shall be made to Employee, and all rights under this Agreement shall be forfeited, if his employment shall be terminated by the Corporation as a result of the Employee's action or failure to act which in the opinion of the Board is materially adverse to the best interest of the Corporation. 6. Rights of Employee and Any Beneficiary. Nothing contained in this Agreement and no action taken pursuant to the provisions of this Agreement shall create or be construed to create a trust of any kind or a fiduciary relationship between the Corporation and the Employee, his designated beneficiary or any other person. Any funds which may be set aside by the Corporation to meet its obligations under this Agreement shall continue for all purposes to be a part of the general funds of the Corporation and no persons other than the Corporation shall by virtue of the provisions of this Agreement have any interest in such funds. To the extent that any person acquires a right to receive payments from the Corporation under this Agreement, such rights shall be no greater than the right of any unsecured general creditor of the Corporation. The Employee and any beneficiary of the Employee shall have no vested, secured or preferred interest in any of the Corporation's assets, but will only have a contractual right to receive payments provided for in this Agreement. The right to receive payments under this Agreement may not be anticipated, commuted, transferred, assigned or otherwise encumbered. The rights of the Employee under this Agreement and/or of any beneficiary of the Employee shall be solely those of an unsecured creditor of the Corporation. 7. Effect of Benefits. The benefits to be provided hereunder are future and contingent, and shall be in addition to Employee's annual salary as determined by the Board of Directors of the Corporation. This Agreement shall not affect the right of Employee to participate in any current or future Corporation retirement plan or in any supplemental compensation arrangement which constitutes a part of the Corporation's regular compensation structure. Any deferred compensation payable under this Agreement shall not be deemed salary or other compensation to the Employee for the purpose of computing benefits to which he may be entitled under any pension plan or other arrangement of the Corporation for the benefit of its employees. 8. No Promise of Future Employment. Nothing contained herein shall be construed as conferring upon the Employee the right to continue in the employ of the Corporation as an officer or in any other capacity. 9. Reorganization. The Corporation agrees that it will not merge or consolidate with any other company or organization, or permit its business activities to be taken over by any other organization unless and until the succeeding or continuing company or other organization shall expressly assume all obligations and liabilities herein set forth. 10. Amendment. This Agreement may be revoked or amended in whole or in part only by a written instrument signed by both of the parties hereto. 11. Interpretation. The Board of Directors of the Corporation shall have full power and authority to interpret, construe and administer this Agreement, and the Board's interpretation and construction thereof, and actions thereunder shall be binding and conclusive to all persons for all purposes. No members of the Board shall be liable to any person for any action taken or omitted in connection with the interpretation and administration of this Agreement unless attributable to his own willful misconduct or lack of good faith. 12. Binding Effect. This Agreement shall be binding upon and inure to the benefit of the Corporation, its successors and assigns, and the Employee, his designated beneficiary, heirs, executors, administrators and legal representatives. IN WITNESS WHEREOF, the parties have executed this Agreement as of the day and year first above written. ATTEST: FIRST FINANCIAL BANKSHARES, INC. By: /S/ SANDY LESTER By: /S/ CURTIS R. HARVEY --------------------------- ------------------------------ SANDY LESTER CURTIS R HARVEY Secretary Executive Vice President "CORPORATION" By: /S/ KENNETH T. MURPHY ------------------------------ KENNETH T. MURPHY "EMPLOYEE" Exhibit 10.3 ------------ EXECUTIVE RECOGNITION PLAN FIRST FINANCIAL BANKSHARES, INC., a Texas corporation, (the "Company") establishes this Executive Recognition Plan (the "Plan") effective April 23, 1996. 1. PURPOSE The purpose of the Plan is to enable the Company to provide some assurance in the form of economic protection to a limited number of key executive employees of the Company and its subsidiaries who might be most vulnerable to job loss in the event of a "Change in Control" of the Company. 2. DEFINITIONS In this Plan the following definitions shall apply: (a) "Agreement" shall mean an Executive Recognition Agreement generally in the form of Exhibit "A" attached hereto and incorporated herein by reference. (b) "Change in Control" shall have the same meaning as defined in Section 1 of the Agreement. (c) "Committee" shall mean the Compensation Committee appointed by the Board of Directors of the Company. 3. ELIGIBILITY The Committee shall select those key executive employees of the Company and its subsidiaries who may thereafter be offered an Agreement by the Committee. 4. ADMINISTRATION The Committee shall: (a) construe and interpret the Plan; (b) decide all questions of eligibility; and (c) determine the compensation provisions to be offered an eligible key executive employee under the terms of the Agreement. 5. BENEFITS The Committee may offer an eligible key executive employee a benefit payable under the terms of the Agreement of not less than fifty percent (50%) nor more than two (2) times the employee's annual base salary payable by the Company or a subsidiary of the Company during the period immediately preceding the "Date of Termination" as determined under the provisions of the Agreement following a Change in Control. 6. FUNDING The Company shall have no obligation to establish a trust or reserve fund for the payment of benefits under any Agreement accepted by a key executive employee of the Company or a subsidiary of the Company. 7. AMENDMENTS The Company shall have the sole right to alter, amend or terminate this Plan. Notwithstanding the preceding sentence, no act altering, amending or terminating this Plan shall affect the terms of any Agreement theretofore offered to and accepted by a key executive employee of the Company or a subsidiary of the Company. 8. MISCELLANEOUS This Plan shall be construed, administered and governed in all respects under applicable federal law, and to the extent not preempted by federal law, under the laws of the State of Texas. If any provision of this Plan shall be held by a court of competent jurisdiction to be invalid or unenforceable, the remaining provisions hereof shall continue in full effect. IN WITNESS WHEREOF, this Plan is adopted by execution hereof to be effective as of the date first above written. ATTEST: FIRST FINANCIAL BANKSHARES, INC. By: --------------------------------- -------------------------------- Name: -------------------------------- Title: -------------------------------- "COMPANY" THE STATE OF TEXAS COUNTY OF TAYLOR This instrument was acknowledged before me on ______________, 19____, by___________________________, ___________________________ of FIRST FINANCIAL BANKSHARES, INC., a Texas corporation, on behalf of said corporation. --------------------------------- NOTARY PUBLIC, STATE OF TEXAS My Commission Expires: --------------------- --------------------------------- Printed/Stamped Name of Notary Exhibit 10.4 ------------ EXECUTIVE RECOGNITION AGREEMENT THIS EXECUTIVE RECOGNITION AGREEMENT (this "Agreement") between FIRST FINANCIAL BANKSHARES, INC., a Texas corporation (the "Company"), and _____________________ (the "Employee") is dated effective __________________, 19____ (the "Effective Date"). WITNESSETH: WHEREAS, the Company considers it essential to the best interests of its stockholders to foster the continuous employment of key executives of the Company; and WHEREAS, the Employee is a key executive of the Company; and WHEREAS, the parties recognize that, as is the case with many publicly-held corporations, the possibility of a "Change in Control" (as such term is defined in Section 1 hereof) may exist and that such possibility, and the uncertainty and questions which it may raise among management, may result in the departure or distraction of a key executive at a critical time, and to the detriment of the Company and its stockholders; and WHEREAS, the Company recognizes that the Employee, as a key executive, could suffer financial and professional detriments if a Change in Control of the Company were to occur; and WHEREAS, in order to protect the Employee in the event of a Change in Control of the Company, the Company agrees that the Employee shall receive the benefits set forth in this Agreement in the event the Employee's employment with the Company is terminated subsequent to a Change in Control of the Company under the circumstances described below; NOW, THEREFORE, the parties hereby agree as follows: 1. Employment in General; Change in Control. This Agreement does not affect the Employee's employment arrangements with the Company except for the conditions contained herein pertaining to a Change in Control of the Company. Absent a Change in Control of the Company, the Employee's continued employment with the Company shall at all times be subject to the will of the Board of Directors of the Company. For purposes of this Agreement, a "Change in Control" of the Company shall be deemed to have occurred at the time (a) a report on Schedule 13D is filed with the Securities and Exchange Commission pursuant to Section 13(d) of the Securities Exchange Act of 1934, as amended (the "Exchange Act") disclosing that any Person (as hereinafter defined) is the beneficial owner (as such term is defined in Rule 13d-3 under the Exchange Act), directly or indirectly of securities of the Company representing more than fifty percent (50%) of the combined voting power entitled to vote generally in the election of directors of the then outstanding securities of the Company; or (b) any Person shall purchase securities pursuant to a tender offer or exchange offer to acquire any common stock of the Company (or securities convertible into common stock) for cash, securities or any other consideration, provided that after consummation of the offer, the person in question is the beneficial owner (as such term is defined in Rule 13d-3 under the Exchange Act), directly or indirectly, of securities of the Company representing more than fifty percent (50%) of the combined voting power entitled to vote generally in the election of directors of the then outstanding securities of the Company; or (c) the stockholders of the Company shall approve a reorganization, merger, consolidation, recapitalization, exchange offer, purchase of assets or other transaction, in each case, with respect to which the persons who were the beneficial owners of the Company immediately prior to such a transaction do not, immediately after consummation thereof, own more than fifty percent (50%) of the combined voting power entitled to vote generally in the election of directors of the reorganized, merged, recapitalized or resulting company's then outstanding securities; or (d) the stockholders of the Company shall approve a liquidation or dissolution of the Company; or (e) the Company shall sell or otherwise transfer (or one or more of its subsidiaries shall sell or otherwise transfer), in one or more related transactions, assets aggregating fifty percent (50%) or more of the book value of the assets of the Company and its subsidiaries (taken as a whole). For purposes of this Agreement, the term "Person" shall mean and include any individual, corporation, partnership, group, association or other "person", as such term is used in Sections 13(d) and 14(d) of the Exchange Act, other than the Company, a wholly-owned subsidiary of the Company or any employee benefit plan(s) sponsored by the Company or a subsidiary of the Company. 2. Term of Agreement. Unless extended pursuant to the provisions of this Section 2, the term of this Agreement shall be for the period commencing as of the Effective Date and continuing thereafter until the earliest to occur of (a) the Employee's death, Disability (as defined in Subsection 3(i) hereof) or Retirement (as defined in Subsection 3(ii) hereof), (b) the termination of the Employee's employment with the Company prior to a Change in Control of the Company, or (c) the second anniversary of this Agreement. The foregoing notwithstanding, if a Change in Control of the Company shall have occurred during the term of this Agreement, this Agreement shall continue in effect for a period of two (2) years from the date of any such Change in Control of the Company; and further, if a second Change in Control occurs within a period of two (2) years from the date of the first Change in Control, this Agreement shall continue in effect for a period of two (2) years from the date of the second Change in Control of the Company; and if any benefit accrues and remains unpaid at the time this Agreement would otherwise have terminated, this Agreement shall remain in effect until such benefit is paid in full solely for the purpose of permitting the Employee to enforce the full payment of such benefit. 3. Termination Following Change in Control. If a Change in Control of the Company occurs, the Employee shall be entitled to the benefits provided in Subsection 4(iii) hereof upon the subsequent termination of the Employee's employment during the term of this Agreement, unless such termination is (a) because of the Employee's death, Disability or Retirement, (b) by the Company for Cause, or (c) by the Employee other than for Good Reason. The parties hereto expressly acknowledge and agree that notwithstanding anything contained in this Agreement to the contrary, the Employee is entitled to any and all benefits due to the Employee as determined in accordance with the terms of the Company's benefit plans (without reference to this Agreement), including, without limitation, all qualified and nonqualified deferred compensation plans, and all medical, dental, disability, accident and insurance plans, then in effect whether the Employee is terminated by the Company for Cause or for other than Cause, by the Employee for Good Reason or for other than Good Reason, because of the Retirement, Disability or death of the Employee or for any other reason, and the benefits provided in Subsection 4(iii) hereof shall be determined in accordance with this Agreement without any impact, impairment, reduction or other effect on the Employee's rights or benefits under such benefit plan(s). For purposes of this Agreement the following definitions shall apply: (i) Disability. Termination by the Company of the Employee's employment based on "Disability" shall mean termination because of the Employee's absence from his duties with the Company on a full-time basis for ninety (90) consecutive days as a result of the Employee's physical or mental incapacity due to injury or illness, unless within thirty (30) days after Notice of Termination (as hereinafter defined) is given to the Employee following such absence the Employee shall have returned to the full-time performance of his duties. (ii) Retirement. Termination by the Employee of the Employee's employment based on "Retirement" shall mean termination on or after the normal retirement date established under the terms of any qualified plan or plans of the Company in effect prior to a Change in Control. (iii)Cause. Termination by the Company of the Employee's employment for "Cause" shall mean termination upon (A) the willful and continued failure by the Employee to substantially perform his duties with the Company (other than any such failure resulting from the Employee's physical or mental incapacity due to injury or illness) after written demand for substantial performance is delivered to the Employee by the Company, which demand specifically identifies the manner in which the Employee has not substantially performed his duties, or (B) the willful engaging by the Employee in conduct which is demonstrably injurious to the Company, monetarily or otherwise. For purposes of this Subsection (iii), no act, or failure to act, on the Employee's part shall be deemed "willful" unless done, or omitted to be done, by the Employee in bad faith and without "reasonable belief" (as hereinafter defined) that his action or omission was in, or not opposed to, the best interests of the Company. The phrase "reasonable belief" shall mean the belief that a reasonable and prudent man would have had in the same or similar circumstances as to the act or failure to act. Any act, or failure to act, based upon authority given pursuant to a resolution duly adopted by the Board or based upon the advice of counsel for the Company shall be conclusively presumed to be done, or omitted to be done, by the Employee in good faith, and in the best interests of the Company. Notwithstanding the foregoing the Employee shall not be deemed to have been terminated for Cause unless and until there shall have been delivered to the Employee a copy of a resolution duly adopted by the affirmative vote of not less than a majority of the entire membership of the Board at a meeting of the Board called for such purpose (after reasonable notice to you and an opportunity for you, together with your counsel, to be heard before the Board), finding that in the good faith opinion of the Board the Employee was guilty of the conduct set forth above in (A) or (B) of this Subsection (iii) and specifying the particulars thereof in detail. (iv) Good Reason. The Employee shall be entitled to terminate his employment for Good Reason. Termination by the Employee of his employment for "Good Reason" shall mean termination based on: (A) a determination by the Employee, made in good faith and based on the Employee's reasonable belief, that there has been a materially adverse change in his status or position as an executive officer of the Company as in effect immediately prior to the Change in Control, including, without limitation, any material change in the Employee's status or position as a result of a diminution in the Employee's duties or responsibilities or the assignment to the Employee of any duties or responsibilities which are inconsistent with such status or position(s), or any removal of the Employee from or any failure to reappoint or reelect the Employee to such position(s) (except in connection with the termination of the Employee's employment for Cause, Disability or Retirement or as a result of the Employee's death or by the Employee other than for Good Reason). The phrase "reasonable belief" shall mean the belief that a reasonable and prudent man would have had in the same or similar circumstances as to the change in status or position; (B) a reduction by the Company in the Employee's annual base salary in effect immediately prior to the Change in Control (C) the relocation of the Employee's principal office outside of the city or metropolitan area in which the Employee is residing at the time of any Change in Control of the Company; (D) the failure by the Company to continue in effect any Plan (as hereinafter defined) in which the Employee participates at the time of the Change in Control of the Company (or Plans providing the Employee with at least substantially similar benefits) other than as a result of the normal expiration of any such Plan in accordance with its terms as in effect at the time of the Change in Control. For purposes of this Agreement, "Plan" shall mean any compensation plan such as an incentive, stock option or restricted stock plan or any benefit plan, including, without limitation, all qualified and nonqualified deferred compensation plans; all medical, dental, disability, accident and life insurance plans; and any relocation plan or policy or any other material plan, program or policy of the Company intended to benefit employees; (E) the failure by the Company to provide and credit the Employee with the number of paid vacation days to which the Employee is then entitled in accordance with the Company's normal vacation policy as in effect immediately prior to the Change in Control; (F) the failure by the Company to obtain from any Successor (as hereinafter defined) the assent to this Agreement contemplated by Section 5 hereof; or (G) any purported termination by the Company of the Employee's employment which is not effected pursuant to a Notice of Termination satisfying the requirements of Subsection (v) below (and, if applicable, Subsection (iii) above); and for purposes of this Agreement, no such purported termination shall be effective. (v) Notice of Termination. Any purported termination of the Employee's employment by the Company or by the Employee following a Change in Control of the Company shall be communicated by written Notice of Termination to the other party hereto in accordance with Section 9 hereof. For purposes of this Agreement, a "Notice of Termination" shall mean a notice which shall indicate the specific termination provision in this Agreement relied upon and, if the termination provision is claimed to relieve the Company of its obligation to pay the benefits provided by this Agreement, the notice shall set forth in reasonable detail the facts and circumstances claimed to provide a basis for the denial of the payment of the benefits provided by this Agreement. (vi) Date of Termination. "Date of Termination" following a Change in Control shall mean (A) if the Employee's employment is to be terminated for Disability, thirty (30) days after Notice of Termination is given (provided that the Employee shall not have returned to the performance of his duties on a full-time basis during such thirty (30) day period), (B) if the Employee's employment is to be terminated by the Company for Cause or by the Employee for Good Reason, the date specified in the Notice of Termination, or (C) if the Employee's employment is to be terminated by the Company for any reason other than Cause, the date specified in the Notice of Termination, which in no event shall be a date earlier than sixty (60) days after the date on which a Notice of Termination is given, unless an earlier date has been expressly agreed to by the Employee in writing. 4. Compensation Upon Termination; Other Agreements. (i) If the Employee's employment shall be terminated for Disability following a Change in Control of the Company, the Company shall pay the Employee's salary through the Date of Termination at the rate in effect just prior to the time a Notice of Termination is given plus any benefits or awards under any Plans which pursuant to the terms of any Plans have been earned or become payable, but which have not been paid to the Employee. Thereafter, benefits shall be determined in accordance with the Plans then in effect. (ii) If the Employee's employment shall be terminated for Cause following a Change in Control of the Company, the Company shall pay the Employee's salary through the Date of Termination at the rate in effect just prior to the time a Notice of Termination is given plus any benefits or awards (including both the cash and stock components) which pursuant to the terms of any Plans have been earned or become payable, but which have not yet been paid to the Employee. Thereupon the Company shall have no further obligations to the Employee under this Agreement. (iii)Subject to Section 7 hereof, if, within twenty-four (24) months following a Change in Control of the Company, employment by the Company shall be terminated by the Company other than for Cause, death, Disability or Retirement, or shall be terminated by the Employee for Good Reason, then the Company shall pay or provide to the Employee, without regard to any contrary provisions of any Plan, the following: (A) ___________ percent (____ %) of the Employee's annual base salary payable by the Company immediately preceding the Date of Termination; (B) for a period of two (2) years after the Date of Termination, continuation of all insured and self-insured medical, life insurance and disability benefit Plans in which the Employee participated immediately prior to the Date of Termination, at no cost to the Employee. In the event that the Employee's participation in any such Plan is barred, the Company, at its sole cost and expense, shall arrange to have issued for the benefit of the Employee and his dependents, individual policies of insurance providing benefits substantially similar (on an after tax basis) to those which the Employee otherwise would have been entitled to receive under such Plans pursuant to this Subsection (iii) or, if such insurance is not available at a reasonable cost to the Company, the Company shall otherwise provide you and your dependents with equivalent benefits (on an after tax basis); and (C) a lump sum payment of Employee's accrued vacation pay. (iv) The amount of any payment provided for in this Section 4 shall not be reduced, offset or subject to recovery by the Company by reason of any compensation earned by the Employee as the result of employment by another employer after the Date of Termination, or otherwise. 5. Successors; Binding Agreement. (i) The Company will seek, by written request at least five (5) business days prior to the time a Person becomes a Successor (as hereinafter defined), to have such Person assent to the fulfillment of the Company's obligations under this Agreement. Failure of such Person to furnish such assent by the later of (A) three (3) business days prior to the time such Person becomes a Successor or (B) two (2) business days after such Person receives a written request to so assent shall constitute Good Reason for termination by the Employee of his employment if a Change in Control of the Company occurs or has occurred. For purposes of this Agreement, "Successor" shall mean any Person that succeeds to, or has the practical ability to control (either immediately or with the passage of time), the Company's business directly, by merger or consolidation, or indirectly, by purchase of the Company's Voting Securities or otherwise. (ii) This Agreement shall inure to the benefit of and be enforceable by the Employee's personal or legal representatives, executors, administrators, heirs, distributees, and legatees. If the Employee should die while any amount would still be payable to him hereunder if the Employee had continued to live, all such amounts, unless otherwise provided herein, shall be paid in accordance with the terms of this Agreement to the Employee's legatee or other designee or, if there is no such designee, to the Employee's estate. (iii)For purposes of this Agreement, the "Company" shall include any corporation or other entity which is the surviving or continuing entity in respect of any merger, consolidation or form of business combination in which the Company ceases to exist. 6. Fees and Expenses. The Company shall reimburse the Employee for all reasonable legal fees and related expenses, if any, incurred by the Employee in the successful enforcement of any right or benefit provided by this Agreement. 7. Taxes. (i) All payments to be made to the Employee under this Agreement will be subject to required withholding of federal, state and local income and employment taxes. (ii) Notwithstanding anything in the foregoing to the contrary, if any of the payments provided for in this Agreement, together with any other payments which the Employee has the right to receive from the Company or any corporation which is a member of an "affiliated group" (as defined in Section 1504(a) of the Internal Revenue Code of 1986, as amended from time to time (the "Code") without regard to Section 1504(b) of the Code) of which the Company is a member, would constitute a "parachute payment" (as defined in Section 280G(b)(2) of the Code), the payments pursuant to this Agreement shall be reduced to the largest amount as will result in no portion of such payments being subject to the excise tax imposed by Section 4999 of the Code; provided, however, that the determination as to whether any reduction in the payments under this Agreement pursuant to this Subsection (ii) is necessary shall be made by the Employee in good faith, and such determination shall be conclusive and binding on the Company with respect to its treatment of the payment for tax reporting purposes and, provided further that the Employee may determine in his discretion what payment or payments provided for herein shall be reduced. 8. Survival. The respective obligations of, and benefits afforded to, the Company and the Employee as provided in Sections 4, 5, 6, 7, 11 and 15 of this Agreement shall survive termination of this Agreement. 9. Notice. For purposes of this Agreement, notices and all other communications provided for in the Agreement shall be in writing and shall be deemed to have been duly given when delivered or when mailed by United States registered mail, return receipt requested, postage prepaid to the address set forth below: Employee Address: _________________________ Company Address: _________________________ provided that all notices to the Company shall be directed to the attention of an executive officer of the Company other than Employee, with a copy to the Secretary of the Company, or to such other address as either party may have furnished to the other in writing in accordance herewith, except that notice of change of address shall be effective only upon receipt. 10. Employment with Subsidiaries. Employment with the Company for purposes of this Agreement includes employment with any corporation in which the Company has a direct or indirect ownership interest of fifty percent (50%) or more of the total combined voting power of all classes of stock in such corporation. 11. Confidential Information. The Employee shall hold in a fiduciary capacity for the benefit of the Company all secret or confidential information, knowledge or data relating to the Company or any of its affiliated companies, and their respective businesses, which shall have been obtained by the Employee during the Employee's employment by the Company or any of its affiliated companies and which shall not be or become public knowledge (other than by acts by the Employee or his representatives in violation of this Agreement). After termination of the Employee's employment with the Company, the Employee shall not, without the prior written consent of the Company, communicate or divulge any such information, knowledge or data to anyone other than the Company and those designated by it. In no event shall an asserted violation of the provisions of this Section 11 constitute a basis for deferring or withholding any amounts otherwise payable to the Employee under this Agreement. 12. Miscellaneous; Governing Law. No provision of this Agreement may be amended, waived or discharged following a Change in Control of the Company unless such amendment, waiver or discharge is agreed to in writing and signed by all of the parties affected thereby. No waiver by either party at any time of any breach by the other party hereto of, or compliance with, any condition or provision of this Agreement to be performed by such other party shall be deemed to be a waiver of similar or dissimilar provisions or conditions at the same or at any prior or subsequent time. No agreements or representations, oral or otherwise, express or implied, with respect to the subject matter hereof have been made by either party which are not expressly set forth in this Agreement. The validity, interpretation, construction and performance of this Agreement shall be governed by the laws of the State of Texas. 13. Severability. The invalidity or unenforceability of any provision of this Agreement shall not affect the validity or enforceability of any other provision of this Agreement, which shall remain in full force and effect. 14. Headings. The headings of Sections of this Agreement are included solely for convenience of reference and shall not control the meaning or interpretation of any of the provisions of this Agreement. 15. Arbitration. Any dispute or controversy arising under or in connection with this Agreement shall be settled by arbitration, conducted by a panel of three arbitrators in a location selected by the Employee within fifty (50) miles from the location of his job with the Company, in accordance with the rules of the American Arbitration Association then in effect. Judgment may be entered on the arbitrators' award in any court having jurisdiction; provided, however, that the Employee shall be entitled to seek specific performance of his right to be paid until the Date of Termination during the pendency of any dispute or controversy arising under or in connection with this Agreement. 16. Counterparts. This Agreement may be executed in several counterparts, each of which shall be deemed to be an original but all of which together will constitute one and the same instrument. IN WITNESS WHEREOF, the undersigned have executed this Agreement to be effective as of the date first written above. FIRST FINANCIAL BANKSHARES, INC. By: ------------------------------- Name: ------------------------------- Title: ------------------------------- "Company" ACCEPTED AND AGREED TO THIS ______ DAY OF 19 . ----------------- ------ By: ------------------------------- Name: ------------------------------- "Employee" Exhibit 10.7 ------------ CONSULTING AGREEMENT This Consulting Agreement (the "Agreement") is made and entered into as of the 1st day of January, 2003 (the "Effective Date"), by and between FIRST FINANCIAL BANKSHARES, INC. (the "Company"), and KENNETH T. MURPHY ("Murphy"). WITNESSETH: WHEREAS, following December 31, 2002, Murphy will no longer be an employee of the Company; and WHEREAS, the Company recognizes the experience, leadership, knowledge and relationships of Murphy are of great value to the Company and its Shareholders; and WHEREAS, the Company desires to retain Murphy's services as a consultant to: (i) participate in the identification and evaluation of prospects for acquisition or merger with the Company or a subsidiary of the Company; (ii) negotiate with potential sellers and recommend terms and conditions of such transaction(s); (iii) meet at least once annually with the boards of directors of each of the Company's subsidiary banking institutions and discuss any issues as to matters involving the Company; and (iv) be accessible to the executive management of the Company for advice as to opportunities for growth and expansion, to review planning decisions, to build relationships and develop strategies which are intended to enhance the business interests of the Company for the benefit of its Shareholders (the "Services"); and WHEREAS, Murphy is willing to provide the Services to the Company, and by doing so Murphy may have to forego other employment or consulting opportunities; and WHEREAS, the parties desire to enter into this Agreement in a spirit of mutual respect, congeniality, and a desire to work together in harmony for the continued success of the Company; NOW, THEREFORE, for and in consideration of the premises and of the mutual representations, warranties, covenants and agreements contained herein, and of other good and valuable consideration, the receipt and sufficiency of which are hereby acknowledged, and upon the terms and subject to the conditions hereinafter set forth, the parties, intending to be legally bound, hereby agree as follows: 1. Duties and Term of Consultancy. The Company hereby engages Murphy, and Murphy hereby accepts engagement, as a consultant to provide the Services as reasonably requested by the Company. The term of this Agreement shall commence on the Effective Date and continue for a period of twelve (12) months ending on December 31, 2003. 2. Commitment of Time. Murphy shall be reasonably available during the term of this Agreement to provide the Services as requested by the Company and shall devote a reasonable amount of time in carrying out the Services. 3. Means to Perform Services. Murphy shall be provided the necessary means for the performance of the Services, including an office and secretarial support, a Company automobile, use of the Company's aircraft for travel related to the provision of the Services, use of membership in Abilene Country Club, and membership(s) in appropriate state and national banking organizations as determined by the Company. 4. Compensation for Services. As compensation for the Services rendered under this Agreement, the Company shall pay Murphy a fee of $14,583.33 per month, and shall reimburse Murphy for his reasonable business expenses incurred in the provision of the Services. 5. Termination. Neither party hereto may terminate this Agreement without cause upon thirty (30) days written notice to the other party. In the event of termination of this Agreement prior to December 31, 2003, the Company shall pay Murphy the amount earned through the date of termination. This Agreement and the obligations of the Company shall terminate in the event of the death of Murphy as of the date of death. IN WITNESS WHEREOF, the parties hereto have signed this Agreement to take effect as of January 1, 2003. FIRST FINANCIAL BANKSHARES, INC. By: /S/ F. SCOTT DUESER -------------------------- Name: F. Scott Dueser -------------------------- Title: Chief Executive Officer -------------------------- "Company" /S/ KENNETH T. MURPHY ---------------------------------- KENNETH T. MURPHY "Murphy" Exhibit 21.1 ------------ SUBSIDIARIES OF REGISTRANT
Percentage of Voting Name of Subsidiary Place of Organization Securities Owned ------------------ --------------------- ---------------- First Financial Bankshares of Delaware, Inc. Delaware 100% First Financial Investments, Inc. Texas 100% First National Bank of Abilene* Texas 100%** Abilene, Texas Hereford State Bank Texas 100%** Hereford, Texas First National Bank, Sweetwater* Texas 100%** Sweetwater, Texas Eastland National Bank* Texas 100%** Eastland, Texas First Financial Bank, National Association* Texas 100%** Cleburne, Texas Stephenville Bank & Trust Co. Texas 100%** Stephenville, Texas San Angelo National Bank* Texas 100%** San Angelo, Texas Weatherford National Bank* Texas 100%** Weatherford, Texas First Financial Bank, National Association* Texas 100%** Southlake, Texas City National Bank* Texas 100%** Mineral Wells, Texas *Federal charter. **By First Financial Bankshares of Delaware, Inc.
All subsidiaries (other than First Financial Investments, Inc. which, as of December 31, 2001, had not yet begun operations) are included in the consolidated financial statements. Exhibit 99.1 ------------ Certification of Chief Executive Officer of First Financial Bankshares, Inc. This certification is provided pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 and accompanies the quarterly report on Form 10-K (the "Form 10-K") for the year ended December 31, 2002 of First Financial Bankshares, Inc. (the "Issuer"). I, F. Scott Dueser, the President and Chief Executive Officer of the Issuer certify that: (i) the Form 10-K fully complies with the requirements of section 13(a) or section 15(d) of the Securities Exchange Act of 1934 (15 U.S.C. 78m(a) or 78o(d)); and (ii)the information contained in the Form 10-K fairly presents, in all material respects, the financial condition and results of operations of the Issuer. Date: March 10, 2003 /S/ F. SCOTT DUESER -------------------------------------------- Name: F. Scott Dueser Title: President and Chief Executive Officer Subscribed and sworn to before me this 10th day of March, 2003. -------------------------------------------- Name: ------------------------------------- Title: Notary Public My commission expires: -------------------------------------------- Exhibit 99.2 ------------ Certification of Chief Financial Officer of First Financial Bankshares, Inc. This certification is provided pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 and accompanies the quarterly report on Form 10-K (the "Form 10-K") for the year ended December 31, 2002 of First Financial Bankshares, Inc. (the "Issuer"). I, Curtis R. Harvey, the Executive Vice President and Chief Financial Officer of the Issuer certify that: (i) the Form 10-K fully complies with the requirements of section 13(a) or section 15(d) of the Securities Exchange Act of 1934 (15 U.S.C. 78m(a) or 78o(d)); and (ii)the information contained in the Form 10-K fairly presents, in all material respects, the financial condition and results of operations of the Issuer. Date: March 10, 2003 /S/ Curtis R. Harvey ------------------------------------------- Name: Curtis R. Harvey Title: Executive Vice President and Chief Financial Officer Subscribed and sworn to before me this 10th day of March, 2003. -------------------------------------------- Name: ------------------------------------- Title: Notary Public My commission expires: -------------------------------------------