XNAS:SBSI Southside Bancshares Inc Quarterly Report 10-Q Filing - 3/31/2012

Effective Date 3/31/2012

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UNITED STATES
 
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C.  20549

FORM 10-Q

 (Mark One)

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

For the quarterly period ended March 31, 2012

OR

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

For the transition period from ____________ to ____________
 
Commission file number 0-12247
 
SOUTHSIDE BANCSHARES, INC.
(Exact name of registrant as specified in its charter)
 
 
 
TEXAS
 
75-1848732
(State or other jurisdiction of incorporation or organization)
 
(I.R.S. Employer Identification No.)
 
 
 
1201 S. Beckham, Tyler, Texas
 
75701
(Address of principal executive offices)
 
(Zip Code)
903-531-7111
(Registrant's telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes  x    No  o
 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes  x    No  o
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.  See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.  (Check one):

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

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes o  No x
 
The number of shares of the issuer's common stock, par value $1.25, outstanding as of April 27, 2012 was 17,335,587 shares.
 


 
 

 
 
TABLE OF CONTENTS

PART I.  FINANCIAL INFORMATION
 
  1
  35
  52
  53
PART II.  OTHER INFORMATION
 
  53
  54
  54
  54
  54
  54
  54
56
57
EXHIBIT 31.1 – CERTIFICATION PURSUANT TO SECTION 302
 
EXHIBIT 31.2 – CERTIFICATION PURSUANT TO SECTION 302
 
EXHIBIT 32 – CERTIFICATION PURSUANT TO SECTION 906
 
 
 
PART I. FINANCIAL INFORMATION
ITEM 1. 
FINANCIAL STATEMENTS

SOUTHSIDE BANCSHARES, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(UNAUDITED)
(in thousands, except share amounts)
   
March 31,
   
December 31,
 
ASSETS
 
2012
   
2011
 
Cash and due from banks
  $ 42,997     $ 40,989  
Interest earning deposits
    3,211       2,249  
Total cash and cash equivalents
    46,208       43,238  
Investment securities:
               
Available for sale, at estimated fair value
    291,928       282,956  
Held to maturity, at amortized cost
    1,010       1,496  
Mortgage-backed and related securities:
               
Available for sale, at estimated fair value
    1,133,701       716,126  
Securities carried at fair value through income
          647,759  
Held to maturity, at amortized cost
    349,248       365,631  
FHLB stock, at cost
    32,407       33,869  
Other investments, at cost
    2,064       2,064  
Loans held for sale
    1,902       3,552  
Loans:
               
Loans
    1,140,893       1,087,230  
Less:  allowance for loan losses
    (20,074 )     (18,540 )
Net Loans
    1,120,819       1,068,690  
Premises and equipment, net
    50,381       50,595  
Goodwill
    22,034       22,034  
Other intangible assets, net
    467       522  
Interest receivable
    13,935       19,426  
Deferred tax asset
    2,953        
Unsettled trades to sell securities
    104,065        
Other assets
    44,322       45,859  
TOTAL ASSETS
  $ 3,217,444     $ 3,303,817  
LIABILITIES AND SHAREHOLDERS’ EQUITY
               
Deposits:
               
Noninterest bearing
  $ 558,196     $ 505,594  
Interest bearing
    1,752,256       1,816,077  
Total deposits
    2,310,452       2,321,671  
Short-term obligations:
               
Federal funds purchased and repurchase agreements
    1,926       2,945  
FHLB advances
    171,864       361,811  
Other obligations
    219       219  
Total short-term obligations
    174,009       364,975  
Long-term obligations:
               
FHLB  advances
    281,618       260,724  
Long-term debt
    60,311       60,311  
Total long-term obligations
    341,929       321,035  
Deferred tax liability
          3,458  
Unsettled trades to purchase securities
    96,171       1,196  
Other liabilities
    35,004       32,555  
TOTAL LIABILITIES
    2,957,565       3,044,890  
                 
Off-Balance-Sheet Arrangements, Commitments and Contingencies (Note 10)
               
                 
Shareholders' equity:
               
Common stock – ($1.25 par, 40,000,000 shares authorized, 19,359,425 shares issued in 2012 (including 827,828 shares declared on March 29, 2012 as a stock dividend) and 18,517,101 shares issued in 2011)
    24,199       23,146  
Paid-in capital
    193,553       176,791  
Retained earnings
    62,339       72,646  
Treasury stock (2,023,838 shares at cost)
    (28,377 )     (28,377 )
Accumulated other comprehensive income
    8,165       14,721  
TOTAL SHAREHOLDERS’ EQUITY
    259,879       258,927  
TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY
  $ 3,217,444     $ 3,303,817  

The accompanying notes are an integral part of these consolidated financial statements.
 
 
SOUTHSIDE BANCSHARES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(UNAUDITED)
(in thousands, except per share data)
   
Three Months Ended
March 31,
 
   
2012
   
2011
 
Interest income
           
Loans
  $ 16,770     $ 17,271  
Investment securities – taxable
    31       18  
Investment securities – tax exempt
    2,667       3,229  
Mortgage-backed and related securities
    12,163       11,297  
FHLB stock and other investments
    79       80  
Other interest earning assets
    6       10  
Total interest income
    31,716       31,905  
Interest expense
               
Deposits
    3,395       4,036  
Short-term obligations
    1,592       1,729  
Long-term obligations
    2,733       3,881  
Total interest expense
    7,720       9,646  
Net interest income
    23,996       22,259  
Provision for loan losses
    3,052       2,138  
Net interest income after provision for loan losses
    20,944       20,121  
Noninterest income
               
Deposit services
    3,748       3,879  
Gain on sale of securities available for sale
    5,972       1,551  
(Loss) gain on sale of securities carried at fair value through income
    (485 )     254  
                 
Total other-than-temporary impairment losses
           
Portion of loss recognized in other comprehensive income (before taxes)
    (141 )      
Net impairment losses recognized in earnings
    (141 )      
                 
Fair value gain – securities
          1,627  
FHLB advance option impairment charges
    (472 )      
Gain on sale of loans
    131       283  
Trust income
    677       651  
Bank owned life insurance income
    266       286  
Other
    1,111       1,105  
Total noninterest income
    10,807       9,636  
Noninterest expense
               
Salaries and employee benefits
    11,833       11,691  
Occupancy expense
    1,758       1,721  
Equipment expense
    510       493  
Advertising, travel & entertainment
    604       553  
ATM and debit card expense
    279       215  
Director fees
    268       191  
Supplies
    159       224  
Professional fees
    551       555  
Postage
    175       179  
Telephone and communications
    406       337  
FDIC Insurance
    470       763  
Other
    1,509       1,810  
Total noninterest expense
    18,522       18,732  
                 
Income before income tax expense
    13,229       11,025  
Provision for income tax expense
    3,090       1,786  
Net income
    10,139       9,239  
Less: Net income attributable to the noncontrolling interest
          (865 )
Net income attributable to Southside Bancshares, Inc.
  $ 10,139     $ 8,374  
Earnings per common share – basic
  $ 0.58     $ 0.49  
Earnings per common share – diluted
  $ 0.58     $ 0.49  
Dividends paid per common share
  $ 0.18     $ 0.17  

The accompanying notes are an integral part of these consolidated financial statements.
 
 
SOUTHSIDE BANCSHARES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(UNAUDITED)
(in thousands)
   
Three Months Ended
March 31,
 
   
2012
   
2011
 
             
Net income
  $ 10,139     $ 9,239  
                 
Other comprehensive (loss) income:
               
Unrealized holding (losses) gains on available for sale securities during the period
    (4,745 )     6,154  
                 
Reclassification adjustment for gains on sales of available for sale securities included in net income
    (5,972 )     (1,551 )
                 
Reclassification of other-than-temporary impairment charges on available for sale securities included in net income
    141        
                 
Amortization of net actuarial loss, included in net periodic benefit cost
    499       366  
                 
Amortization of prior service credit included in net periodic benefit cost
    (10 )     (11 )
Other comprehensive (loss) income
    (10,087 )     4,958  
                 
Income tax benefit (expense) related to other items of comprehensive income
    3,531       (1,735 )
                 
Other comprehensive income (loss), net of tax     (6,556 )     3,223  
                 
Comprehensive income
  $ 3,583     $ 12,462  

The accompanying notes are an integral part of these consolidated financial statements.
 
 
SOUTHSIDE BANCSHARES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN EQUITY
(UNAUDITED)
               
Accu-
             
(in thousands, except share amounts)
               
mulated-
             
   
Common
Stock
   
Paid In
Capital
   
Retained
Earnings
   
Treasury
Stock
   
Other
Compre-
hensive
Income
(Loss)
   
Noncon-
trolling
Interest
   
Total
Equity
 
                                           
Balance at December 31, 2010
  $ 22,075     $ 162,877     $ 64,179     $ (28,377 )   $ (6,293 )   $ 1,113     $ 215,574  
Net Income
                    8,374                       865       9,239  
Other comprehensive income
                                    3,223               3,223  
Issuance of common stock (14,538 shares)
    18       274                                       292  
Tax benefit of incentive stock options
            2                                       2  
Capital distribution to noncontrolling interest shareholders
                                            (115 )     (115 )
Dividends paid on common stock ($0.17 per share)
                    (2,658 )                             (2,658 )
Stock dividend declared
    988       15,121       (16,109 )                              
Balance at March 31, 2011
  $ 23,081     $ 178,274     $ 53,786     $ (28,377 )   $ (3,070 )   $ 1,863     $ 225,557  
                                                         
                                                         
Balance at December 31, 2011
  $ 23,146     $ 176,791     $ 72,646     $ (28,377 )   $ 14,721     $     $ 258,927  
Net Income
                    10,139                               10,139  
Other comprehensive loss
                                    (6,556 )             (6,556 )
Issuance of common stock (14,496 shares)
    18       282                                       300  
Stock compensation expense
            39                                       39  
Dividends paid on common stock ($0.18 per share)
                    (2,970 )                             (2,970 )
Stock dividend declared
    1,035       16,441       (17,476 )                              
Balance at March 31, 2012
  $ 24,199     $ 193,553     $ 62,339     $ (28,377 )   $ 8,165     $     $ 259,879  

The accompanying notes are an integral part of these consolidated financial statements.
 
 
SOUTHSIDE BANCSHARES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CASH FLOW (UNAUDITED)
(in thousands)

   
Three Months Ended
March 31,
 
   
2012
   
2011
 
OPERATING ACTIVITIES:
           
Net income
  $ 10,139     $ 9,239  
Adjustments to reconcile net income to net cash provided by operations:
               
Depreciation
    870       806  
Amortization of premium
    10,366       8,708  
Accretion of discount and loan fees
    (1,129 )     (1,171 )
Provision for loan losses
    3,052       2,138  
Stock compensation expense
    39        
Deferred tax (benefit) expense
    (2,880 )     308  
Loss (gain) on sale of securities carried at fair value through income
    485       (254 )
Gain on sale of securities available for sale
    (5,972 )     (1,551 )
Net other-than-temporary impairment losses
    141        
Fair value gain – securities
          (1,627 )
FHLB advance option impairment charges
    472        
Loss on retirement of assets
          90  
Impairment on other real estate owned
          130  
Net change in:
               
Interest receivable
    5,491       2,818  
Other assets
    991       (2,299 )
Interest payable
    (289 )     (409 )
Other liabilities
    3,227       1,356  
Loans held for sale
    1,650       3,918  
Net cash provided by operating activities
    26,653       22,200  
                 
INVESTING ACTIVITIES:
               
Securities held to maturity:
               
Purchases
          (5,301 )
Maturities, calls and principal repayments
    15,365       12,554  
Securities available for sale:
               
Purchases
    (618,587 )     (252,881 )
Sales
    127,298       169,172  
Maturities, calls and principal repayments
    58,500       79,645  
Securities carried at fair value through income:
               
Purchases
    (57,606 )     (130,064 )
Sales
    664,224       12,983  
Maturities, calls and principal repayments
    24,872       3,812  
Proceeds from redemption of FHLB stock
    8,533       9,738  
Purchases of FHLB stock and other investments
    (7,071 )     (4,242 )
Net (increase) decrease in loans
    (55,281 )     10,529  
Purchases of premises and equipment
    (656 )     (1,092 )
Proceeds from sales of repossessed assets
    1,002       1,517  
Net cash provided by (used in) investing activities
    160,593       (93,630 )

(continued)

 
SOUTHSIDE BANCSHARES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CASH FLOW (UNAUDITED) (continued)
(in thousands)

   
Three Months Ended
March 31,
 
   
2012
   
2011
 
             
FINANCING ACTIVITIES:
           
Net increase in demand and savings accounts
    71,978       44,367  
Net (decrease) increase in certificates of deposit
    (83,512 )     26,827  
Net decrease in federal funds purchased and repurchase agreements
    (1,019 )     (863 )
Proceeds from FHLB advances
    2,964,409       1,074,136  
Repayment of FHLB advances
    (3,133,462 )     (1,100,011 )
Net capital distributions to noncontrolling interest in consolidated entities
          (115 )
Tax benefit of incentive stock options
          2  
Proceeds from the issuance of common stock
    300       292  
Dividends paid
    (2,970 )     (2,658 )
Net cash (used in) provided by financing activities
    (184,276 )     41,977  
                 
Net increase (decrease) in cash and cash equivalents
    2,970       (29,453 )
Cash and cash equivalents at beginning of period
    43,238       79,073  
Cash and cash equivalents at end of period
  $ 46,208     $ 49,620  
                 
                 
                 
SUPPLEMENTAL DISCLOSURES FOR CASH FLOW INFORMATION:
               
                 
Interest paid
  $ 8,009     $ 10,055  
Income taxes paid
  $ 2,000     $  
                 
SUPPLEMENTAL DISCLOSURES OF NONCASH INVESTING AND FINANCING ACTIVITIES:
               
                 
Acquisition of other repossessed assets and real estate through foreclosure
  $ 872     $ 1,576  
Adjustment to pension liability
  $ (489 )   $ (355 )
Declaration of 5% stock dividend
  $ 17,476     $ 16,109  
Unsettled trades to purchase securities
  $ (96,171 )   $ (52,044 )
Unsettled trades to sell securities
  $ 104,065     $  

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

 
SOUTHSIDE BANCSHARES, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS

1.      Basis of Presentation

In this report, the words “the Company,” “we,” “us,” and “our” refer to the combined entities of Southside Bancshares, Inc. and its subsidiaries.  The words “Southside” and “Southside Bancshares” refer to Southside Bancshares, Inc.  The words “Southside Bank” and “the Bank” refer to Southside Bank (which, subsequent to the internal merger of Fort Worth National Bank (“FWNB”) with and into Southside Bank, includes FWNB).  “FWBS” refers to Fort Worth Bancshares, Inc., a bank holding company acquired by Southside of which FWNB was a wholly-owned subsidiary.  “SFG” refers to SFG Finance, LLC (formerly Southside Financial Group, LLC) which is a wholly-owned subsidiary of the Bank as of July 15, 2011.  “SSI” refers to Southside Securities, Inc., which is a wholly-owned subsidiary of Southside Bancshares, Inc.

The consolidated balance sheet as of March 31, 2012, and the related consolidated statements of income, comprehensive income, equity and cash flows and notes to the financial statements for the three month period ended March 31, 2012 and 2011 are unaudited; in the opinion of management, all adjustments necessary for a fair statement of such financial statements have been included.  Such adjustments consisted only of normal recurring items.  All significant intercompany accounts and transactions are eliminated in consolidation.  The preparation of these consolidated financial statements in conformity with U.S. generally accepted accounting principles (“GAAP”) requires the use of management’s estimates. These estimates are subjective in nature and involve matters of judgment.  Actual amounts could differ from these estimates.

Interim results are not necessarily indicative of results for a full year.  These financial statements should be read in conjunction with the financial statements and notes thereto in our Annual Report on Form 10-K for the year ended December 31, 2011.  All share data has been adjusted to give retroactive recognition to stock splits and stock dividends.  For a description of our significant accounting and reporting policies, refer to Note 1 of the Notes to Financial Statements in our Annual Report on Form 10-K for the year ended December 31, 2011.

Accounting Standards
 
ASU No. 2011-02, “Receivables (Topic 310) A Creditor’s Determination of Whether a Restructuring Is a Troubled Debt Restructuring.”  ASU 2011-02 clarifies which loan modifications constitute troubled debt restructurings and is intended to assist creditors in determining whether a modification of the terms of a receivable meets the criteria to be considered a troubled debt restructuring, both for purposes of recording an impairment loss and for disclosure of troubled debt restructurings.  In evaluating whether a restructuring constitutes a troubled debt restructuring, a creditor must separately conclude, under the guidance clarified by ASU 2011-02, that both of the following exist: (a) the restructuring constitutes a concession; and (b) the debtor is experiencing financial difficulties.  ASU 2011-02 became effective for us on July 1, 2011, and applies retrospectively to restructurings occurring on or after January 1, 2011.  See “Note 5 – Loans and Allowance for Probable Loan Losses.”
 
ASU No. 2011-03, “Transfers and Servicing (Topic 860) Reconsideration of Effective Control for Repurchase Agreements.”  ASU 2011-03 is intended to improve financial reporting of repurchase agreements and other agreements that both entitle and obligate a transferor to repurchase or redeem financial assets before their maturity.  ASU 2011-03 removes from the assessment of effective control (i) the criterion requiring the transferor to have the ability to repurchase or redeem the financial assets on substantially the agreed terms, even in the event of default by the transferee, and (ii) the collateral maintenance guidance related to that criterion.  ASU 2011-03 became effective for us on January 1, 2012 and did not have a significant impact on our consolidated financial statements.
 
ASU 2011-04, “Fair Value Measurement (Topic 820) Amendments to Achieve Common Fair Value Measurements and Disclosure Requirements in U.S. GAAP and IFRSs.”  ASU 2011-04 amends Topic 820, “Fair Value Measurements and Disclosures,” to converge the fair value measurement guidance in U.S. generally accepted accounting principles and International Financial Reporting Standards. ASU 2011-04 clarifies the application of existing fair value measurement requirements, changes certain principles in Topic 820 and requires additional fair value disclosures.  ASU 2011-04 is effective for interim and annual periods beginning after December 15, 2011, and did not have a significant impact on our consolidated financial statements. See “Note 9 - Fair Value Measurement.”
 
ASU 2011-05, “Comprehensive Income (Topic 220) Presentation of Comprehensive Income.”  ASU 2011-05 amends Topic 220, “Comprehensive Income,” to require that all nonowner changes in stockholders’ equity be presented in either a single continuous statement of comprehensive income or in two separate but consecutive statements.  Additionally, ASU 2011-05 requires entities to present, on the face of the financial statements, reclassification adjustments for items that are reclassified from other comprehensive income to net income in the statement or statements where the components of net income and the components of other comprehensive income are presented.  The option to present components of other comprehensive income as part of the statement of changes in stockholders’ equity was eliminated.  ASU 2011-05 is effective for annual and interim periods beginning after December 15, 2011; however, certain provisions related to the presentation of reclassification adjustments have been deferred by ASU 2011-12 “Comprehensive Income (Topic 220) – Deferral of the Effective Date for Amendments to the Presentation of Reclassifications of Items Out of Accumulated Other Comprehensive Income in Accounting Standards Update No. 2011-05,” as further discussed below.  ASU 2011-05 did not have a significant impact on our consolidated financial statements. See “Consolidated Statements of Comprehensive Income” directly following our Consolidated Statements of Income in our consolidated financial statements.
 
 
ASU 2011-08, “Intangibles Goodwill and Other (Topic 350) Testing Goodwill for Impairment.”  ASU 2011-08 amends Topic 350, “Intangibles – Goodwill and Other,” to give entities the option to first assess qualitative factors to determine whether the existence of events or circumstances leads to a determination that it is more likely than not that the fair value of a reporting unit is less than its carrying amount.  If, after assessing the totality of events or circumstances, an entity determines it is not more likely than not that the fair value of a reporting unit is less than its carrying amount, then performing the two-step impairment test is unnecessary.  However, if an entity concludes otherwise, then it is required to perform the first step of the two-step impairment test by calculating the fair value of the reporting unit and comparing the fair value with the carrying amount of the reporting unit.  ASU 2011-08 is effective for annual and interim impairment tests beginning after December 15, 2011, and did not have a significant impact on our consolidated financial statements.

ASU 2011-11, “Balance Sheet (Topic 210) Disclosures about Offsetting Assets and Liabilities.”  ASU 2011-11 amends Topic 210, “Balance Sheet,” to require an entity to disclose both gross and net information about financial instruments, such as sales and repurchase agreements and reverse sale and repurchase agreements and securities borrowing/lending arrangements, and derivative instruments that are eligible for offset in the statement of financial position and/or subject to a master netting arrangement or similar agreement.  ASU 2011-11 is effective for annual and interim periods beginning on January 1, 2013, and is not expected to have a significant impact on our consolidated financial statements.
 

2.      Earnings Per Share

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

   
Three Months Ended
March 31,
 
   
2012
   
2011
 
Basic and Diluted Earnings:
           
Net income – Southside Bancshares, Inc.
  $ 10,139     $ 8,374  
                 
Basic weighted-average shares outstanding
    17,324       17,247  
Add:   Stock options
    9       5  
Diluted weighted-average shares outstanding
    17,333       17,252  
                 
Basic Earnings Per Share:
               
Net Income - Southside Bancshares, Inc.
  $ 0.58     $ 0.49  
                 
Diluted Earnings Per Share:
               
Net Income - Southside Bancshares, Inc.
  $ 0.58     $ 0.49  

On March 29, 2012, our board of directors declared a 5% stock dividend to common stock shareholders of record as of April 18, 2012, and payable on May 9, 2012.

During the second quarter of 2011, our board of directors approved equity grants in the form of stock options and restricted stock units.  These equity grants were made pursuant to the shareholder-approved Southside Bancshares, Inc. 2009 Incentive Plan.

For the three month period ended March 31, 2012, there were approximately 11,000 antidilutive options.  For the three months ended March 31, 2011, there were no antidilutive options.
 
 
3.      Comprehensive (Loss) Income

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

    Three Months Ended March 31, 2012  
    Before-Tax     Tax (Expense)     Net-of-Tax  
   
Amount
   
Benefit
   
Amount
 
Unrealized losses on securities:                        
Unrealized holding losses arising during period
  $ (4,745 )   $ 1,661     $ (3,084 )
Less:  reclassification adjustment for gains included in net income
    5,972       (2,090 )     3,882  
Less:  reclassification of other-than-temporary impairment charges on AFS securities included in net income
    (141 )     49       (92 )
Net unrealized losses on securities
    (10,576 )     3,702       (6,874 )
Change in pension plans
    489       (171 )     318  
Other comprehensive loss
  $ (10,087 )   $ 3,531     $ (6,556 )

    Three Months Ended March 31, 2011  
    Before-Tax     Tax     Net-of-Tax  
   
Amount
   
Expense
   
Amount
 
Unrealized gains on securities:                        
Unrealized holding gains arising during period
  $ 6,154     $ (2,154 )   $ 4,000  
Less:  reclassification adjustment for gains included in net income
    1,551       (543 )     1,008  
Net unrealized gains on securities
    4,603       (1,611 )     2,992  
Change in pension plans
    355       (124 )     231  
Other comprehensive income
  $ 4,958     $ (1,735 )   $ 3,223  
 
4.      Securities
The amortized cost and estimated fair value of investment and mortgage-backed securities as of March 31, 2012 and December 31, 2011, are reflected in the tables below (in thousands):

   
March 31, 2012
 
         
Gross
   
Gross
       
   
Amortized
   
Unrealized
   
Unrealized Losses
   
Estimated
 
AVAILABLE FOR SALE:
 
Cost
   
Gains
   
OTTI
   
Other
   
Fair Value
 
Investment Securities:
                             
State and Political Subdivisions
  $ 267,569     $ 22,929     $     $ 493     $ 290,005  
Other Stocks and Bonds
    4,015       34       2,126             1,923  
Mortgage-backed Securities:
                                       
U.S. Government Agencies
    135,181       4,504             265       139,420  
Government-Sponsored Enterprises
    974,262       20,814             795       994,281  
Total
  $ 1,381,027     $ 48,281     $ 2,126     $ 1,553     $ 1,425,629  

   
March 31, 2012
 
         
Gross
   
Gross
       
   
Amortized
   
Unrealized
   
Unrealized Losses
   
Estimated
 
HELD TO MATURITY:
 
Cost
   
Gains
   
OTTI
   
Other
   
Fair Value
 
Investment Securities:
                             
State and Political Subdivisions
  $ 1,010     $ 133     $     $     $ 1,143  
Mortgage-backed Securities:
                                       
U.S. Government Agencies
    22,436       1,322                   23,758  
Government-Sponsored Enterprises
    326,812       12,886                   339,698  
Total
  $ 350,258     $ 14,341     $     $     $ 364,599  

 
   
December 31, 2011
 
         
Gross
   
Gross
       
   
Amortized
   
Unrealized
   
Unrealized Losses
   
Estimated
 
AVAILABLE FOR SALE:
 
Cost
   
Gains
   
OTTI
   
Other
   
Fair Value
 
Investment Securities:
                             
State and Political Subdivisions
  $ 251,281     $ 31,221     $     $ 45     $ 282,457  
Other Stocks and Bonds
    2,925             2,426             499  
Mortgage-backed Securities:
                                       
U.S. Government Agencies
    99,974       7,158             80       107,052  
Government-Sponsored Enterprises
    589,687       20,127             740       609,074  
Total
  $ 943,867     $ 58,506     $ 2,426     $ 865     $ 999,082  

   
December 31, 2011
 
         
Gross
   
Gross
       
   
Amortized
   
Unrealized
   
Unrealized Losses
   
Estimated
 
HELD TO MATURITY:
 
Cost
   
Gains
   
OTTI
   
Other
   
Fair Value
 
Investment Securities:
                             
State and Political Subdivisions
  $ 1,010     $ 196     $     $     $ 1,206  
Other Stocks and Bonds
    486       15                   501  
Mortgage-backed Securities:
                                       
U.S. Government Agencies
    22,999       1,159             43       24,115  
Government-Sponsored Enterprises
    342,632       14,848             11       357,469  
Total
  $ 367,127     $ 16,218     $     $ 54     $ 383,291  

Securities carried at fair value through income were as follows (in thousands):

   
March 31,
   
December 31,
 
   
2012
   
2011
   
2010
 
Mortgage-backed Securities:
                 
U.S. Government Agencies
  $     $ 30,413     $ 5,392  
Government-Sponsored Enterprises
          617,346       66,784  
Total
  $     $ 647,759     $ 72,176  

Net gains and losses on securities carried at fair value through income were as follows (in thousands):

   
Three Months Ended March 31,
 
   
2012
   
2011
 
             
Net (loss) gain on sales transactions
  $ (485 )   $ 254  
Net mark-to-market gains (losses)
          1,627  
Net (loss) gain on securities carried at fair value through income
  $ (485 )   $ 1,881  


The following table represents the unrealized loss on securities for the three months ended March 31, 2012 and year ended December 31, 2011 (in thousands):

   
Less Than 12 Months
   
More Than 12 Months
   
Total
 
   
Fair Value
   
Unrealized
Loss
   
Fair Value
   
Unrealized
Loss
   
Fair Value
   
Unrealized
Loss
 
As of March 31, 2012:
                                   
                                     
Available for Sale
                                   
State and Political Subdivisions
  $ 27,995     $ 493     $     $     $ 27,995     $ 493  
Other Stocks and Bonds
                658       2,126       658       2,126  
Mortgage-Backed Securities
    226,272       1,016       4,107       44       230,379       1,060  
Total
  $ 254,267     $ 1,509     $ 4,765     $ 2,170     $ 259,032     $ 3,679  
                                                 
As of December 31, 2011:
                                               
                                                 
Available for Sale
                                               
State and Political Subdivisions
  $ 1,668     $ 42     $ 307     $ 3     $ 1,975     $ 45  
Other Stocks and Bonds
                499       2,426       499       2,426  
Mortgage-Backed Securities
    148,171       754       5,322       66       153,493       820  
Total
  $ 149,839     $ 796     $ 6,128     $ 2,495     $ 155,967     $ 3,291  
                                                 
Held to Maturity
                                               
Mortgage-Backed Securities
  $ 8,918     $ 54     $     $     $ 8,918     $ 54  
Total
  $ 8,918     $ 54     $     $     $ 8,918     $ 54  

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

The turmoil in the capital markets had a significant impact on our estimate of fair value for certain of our securities.  We believe the fair values are reflective of illiquidity and credit impairment.  At March 31, 2012, we have in AFS Other Stocks and Bonds, $2.8 million amortized cost basis in pooled trust preferred securities (“TRUPs”).  Those securities are structured products with cash flows dependent upon securities issued by U.S. financial institutions, including banks and insurance companies.  Our estimate of fair value at March 31, 2012 for the TRUPs is approximately $658,000 and reflects the market illiquidity.  With the exception of the TRUPs, to the best of management’s knowledge and based on our consideration of the qualitative factors associated with each security, there were no securities in our investment and mortgage-backed securities portfolio at March 31, 2012 with an other-than-temporary impairment.

Given the facts and circumstances associated with the TRUPs we performed detailed cash flow modeling for each TRUP using an industry-accepted cash flow model.  Prior to loading the required assumptions into the model we reviewed the financial condition of each of the underlying issuing banks within the TRUP collateral pool that had not deferred or defaulted as of March 31, 2012.  Management’s best estimate of a deferral assumption was assigned to each issuing bank based on the category in which it fell.  Our analysis of the underlying cash flows contemplated various default, deferral and recovery scenarios to arrive at our best estimate of cash flows.  Based on that detailed analysis, we have concluded that the other-than-temporary impairment, which captures the credit component, was estimated at $3.2 million at March 31, 2012 and $3.1 million at March 31, 2011.  The noncredit charge to other comprehensive income was estimated at $2.1 million at March 31, 2012 and $2.4 million at December 31, 2011.  Therefore, the carrying amount of the TRUPs was written down with $75,000 and $3.0 million recognized in earnings for the years ended December 31, 2010 and 2009, respectively.  There was an additional write-down of the TRUPs recognized in earnings for the three months ended March 31, 2012 in the amount of $141,400.  The cash flow model assumptions represent management’s best estimate and consider a variety of qualitative factors, which include, among others, the credit rating downgrades, the severity and duration of the mark-to-market loss, and the structural nuances of each TRUP.  Management believes that the detailed review of the collateral and cash flow modeling support the conclusion that the TRUPs had an other-than-temporary impairment at March 31, 2012.  We will continue to update our assumptions and the resulting analysis each reporting period to reflect changing market conditions.  Additionally, we do not currently intend to sell the TRUPs and it is not more likely than not that we will be required to sell the TRUPs before the anticipated recovery of their amortized cost basis.
 
 
The table below provides more detail on the TRUPs at March 31, 2012 (dollars in thousands).

TRUP
   
Par
   
Credit
Loss
   
Amortized Cost
   
Fair Value
   
Tranche
   
Credit Rating
 
                                       
1     $ 2,000     $ 1,216     $ 784     $ 138     C1    
Ca
 
2       2,000       550       1,450       344     B1     C  
3       2,000       1,450       550       176     B2     C  
      $ 6,000     $ 3,216     $ 2,784     $ 658              

The following table presents the impairment related to loss, which is recognized in earnings, and the impairment activity related to all other factors, which are recognized in other comprehensive income (in thousands).
 
   
Three Months Ended March 31, 2012
 
   
Impairment
Related to
Credit Loss
   
Impairment
Related to All
Other Factors
   
Total
Impairment
 
                   
Balance, beginning of the period
  $ 3,075     $ 2,694     $ 5,769  
Charges on securities for which other-than-temporary impairment charges were not previously recognized
                 
Additional charges on securities for which other-than-temporary impairment charges were previously recognized
    141       (141 )      
Balance, end of the period
  $ 3,216     $ 2,553     $ 5,769  

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

   
Three Months Ended March 31,
 
 
 
2012
   
2011
 
U.S. Treasury
 
$
   
$
1
 
State and Political Subdivisions
 
 
2,674
     
3,237
 
Other Stocks and Bonds
 
 
24
     
9
 
Mortgage-backed Securities
   
12,163
     
11,297
 
Total interest income on securities
 
$
14,861
   
$
14,544
 

There were no securities transferred from AFS to HTM during the three months ended March 31, 2012 or 2011.  There were no sales from the HTM portfolio during the three months ended March 31, 2012 or 2011.  There were $350.3 million and $367.1 million of securities classified as HTM at March 31, 2012 and December 31, 2011, respectively.

Of the $6.0 million in net securities gains from the AFS portfolio for the three months ended March 31, 2012, there were $6.0 million in realized gains and approximately $3,000 in realized losses.  Of the $1.6 million in net securities gains from the AFS portfolio for the three months ended March 31, 2011, there were $1.6 million in realized gains and $45,000 in realized losses.
 
 
The amortized cost and fair value of securities at March 31, 2012, are presented below by contractual maturity.  Expected maturities may differ from contractual maturities because issuers may have the right to call or prepay obligations.  Mortgage-backed securities are presented in total by category due to the fact that mortgage-backed securities typically are issued with stated principal amounts, and the securities are backed by pools of mortgages that have loans with varying maturities.  The characteristics of the underlying pool of mortgages, such as fixed-rate or adjustable-rate, as well as prepayment risk, are passed on to the certificate holder.  The term of a mortgage-backed pass-through security thus approximates the term of the underlying mortgages and can vary significantly due to prepayments.

   
March 31, 2012
 
   
Amortized Cost
   
Fair Value
 
Available for sale securities:
 
(in thousands)
 
             
Investment Securities
           
Due in one year or less
  $ 2,245     $ 2,266  
Due after one year through five years
    8,906       9,267  
Due after five years through ten years
    36,440       38,645  
Due after ten years
    223,993       241,750  
      271,584       291,928  
Mortgage-backed securities
    1,109,443       1,133,701  
Total
  $ 1,381,027     $ 1,425,629  
 
   
March 31, 2012
 
   
Amortized Cost
   
Fair Value
 
Held to maturity securities:
 
(in thousands)
 
             
Investment Securities
           
Due in one year or less
  $     $  
Due after one year through five years
           
Due after five years through ten years
           
Due after ten years
    1,010       1,143  
      1,010       1,143  
Mortgage-backed securities
    349,248       363,456  
Total
  $ 350,258     $ 364,599  

Investment and mortgage-backed securities with book values of $831.5 million and $1.04 billion were pledged as of March 31, 2012 and December 31, 2011, respectively, to collateralize FHLB advances, repurchase agreements, public funds and trust deposits or for other purposes as required by law.

Securities with limited marketability, such as FHLB stock and other investments, are carried at cost, which approximates its fair value and assessed for other-than-temporary impairment.  These securities have no maturity date.
 
 
5.
LOANS AND ALLOWANCE FOR PROBABLE LOAN LOSSES

Loans in the accompanying consolidated balance sheets are classified as follows (in thousands):

             
   
March 31,
   
December 31,
 
   
2012
   
2011
 
Real Estate Loans:
           
Construction
  $ 111,924     $ 111,361  
1-4 family residential
    291,020       247,479  
Other
    208,536       206,519  
Commercial loans
    145,730       143,552  
Municipal loans
    206,230       207,261  
Loans to individuals
    177,453       171,058  
Total loans
    1,140,893       1,087,230  
Less:  Allowance for loan losses
    20,074       18,540  
Net loans
  $ 1,120,819     $ 1,068,690  

Allowance for Loan Losses

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

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

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

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

Consumer loans at SFG are reserved for based on general estimates of loss at the time of purchase for current loans.  SFG loans experiencing past due status or extension of maturity characteristics are reserved at significantly higher levels based on the circumstances associated with each specific loan.  In general, the reserves for SFG are calculated based on the past due status of the loan.  For reserve purposes, the portfolio has been segregated by past due status and by the remaining term variance from the original contract.  During repayment, loans that pay late will take longer to pay out than the original contract.  Additionally, some loans may be granted extensions for extenuating payment circumstances.  The remaining term extensions increase the risk of collateral deterioration and, accordingly, reserves are increased to recognize this risk.
 
 
For loans purchased after August 1, 2010, additional reserve methods have been added.  New pools purchased are reserved at their estimated annual loss.  Thereafter, the reserve is adjusted based on the actual performance versus projected performance.  Additionally, beginning with the fourth quarter of 2010, data mining measures were further enhanced to track migration within risk tranches.  Reserves are adjusted quarterly to match the migration metrics.

Credit Quality Indicators

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

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

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

 
·
A lack of, or abnormally extended payment program;
 
·
A heavy degree of concentration of collateral without sufficient margin;
 
·
A vulnerability to competition through lesser or extensive financial leverage; and
 
·
A dependence on a single, or few customers, or sources of supply and materials without suitable substitutes or alternatives.

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

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

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

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

Loans not meeting risk ratings five through nine are reserved for as a group of similar type pass rated credits and included in the general portion of the allowance for loan losses.
 
 
The general portion of the loan loss allowance is reflective of historical charge-off levels for similar loans adjusted for changes in current conditions and other relevant factors.  These factors are likely to cause estimated losses to differ from historical loss experience and include:

 
·
Changes in lending policies or procedures, including underwriting, collection, charge-off, and recovery procedures;
 
·
Changes in local, regional and national economic and business conditions including entry into new markets;
 
·
Changes in the volume or type of credit extended;
 
·
Changes in the experience, ability, and depth of lending management;
 
·
Changes in the volume and severity of past due, nonaccrual, restructured, or classified loans;
 
·
Changes in loan review or Board oversight; and
 
·
Changes in the level of concentrations of credit.

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

   
Three Months Ended March 31, 2012
 
   
Real Estate
                               
   
Construction
   
1-4 Family
Residential
   
Other
   
Commercial
Loans
   
Municipal
Loans
   
Loans to
Individuals
   
Unallocated
   
Total
 
                                                 
Balance at beginning of period
  $ 2,620     $ 1,957     $ 3,051     $ 2,877     $ 619     $ 6,244     $ 1,172     $ 18,540  
Provision (reversal) for loan losses
    49       339       12       355       (11 )     2,311       (3 )     3,052  
Loans charged off
    (8 )     (11 )           (88 )           (2,123 )           (2,230 )
Recoveries of loans charged off
    21       5       2       198             486             712  
Balance at end of period
  $ 2,682     $ 2,290     $ 3,065     $ 3,342     $ 608     $ 6,918     $ 1,169     $ 20,074  

   
Three Months Ended March 31, 2011
 
   
Real Estate
                               
   
Construction
   
1-4 Family
Residential
   
Other
   
Commercial
Loans
   
Municipal
Loans
   
Loans to
Individuals
   
Unallocated
   
Total
 
                                                 
Balance at beginning of period
  $ 2,585     $ 1,988     $ 3,354     $ 3,746     $ 607     $ 7,978     $ 453     $ 20,711  
Provision (reversal) for loan losses
    247       74       (148 )     190       (2 )     1,634       143       2,138  
Loans charged off
          (319 )     (80 )     (550 )           (3,099 )           (4,048 )
Recoveries of loans charged off
          65       195       111             608             979  
Balance at end of period
  $ 2,832     $ 1,808     $ 3,321     $ 3,497     $ 605     $ 7,121     $ 596     $ 19,780  
 
 
The following tables present the balance in the allowance for loan losses and the recorded investment in loans by portfolio segment based on impairment method as described in the allowance for loan losses methodology discussion for the periods presented.  (in thousands):

   
As of March 31, 2012
 
   
Real Estate
                               
   
Construction
   
1-4 Family
Residential
   
Other
   
Commercial
Loans
   
Municipal
Loans
   
Loans to
Individuals
   
Unallocated
   
Total