FIRST FINANCIAL BANKSHARES INC - Quarter Report: 2009 September (Form 10-Q)

TABLE OF CONTENTS

PART I

FINANCIAL INFORMATION

Item		Page
1. Financial Statements			3
2. Management’s Discussion and Analysis of Financial Condition and Results of Operations			20
3. Quantitative and Qualitative Disclosures About Market Risk			40
4. Controls and Procedures			41
PART II
OTHER INFORMATION
6. Exhibits			42
Signatures			44
EX-31.1
EX-31.2
EX-32.1
EX-32.2

PART I

FINANCIAL INFORMATION

Item 1.		Financial Statements.

The consolidated balance sheets of First Financial Bankshares, Inc. (the “Company”) at September 30, 2009 and 2008 and December 31, 2008, the consolidated statements of earnings and comprehensive earnings for the three and nine months ended September 30, 2009 and 2008, and changes in shareholders’ equity and cash flows for the nine months ended September 30, 2009 and 2008, follow on pages 4 through 8.

FIRST FINANCIAL BANKSHARES, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS

		September 30,								December 31,
		2009				2008				2008
		(Unaudited)
ASSETS
CASH AND DUE FROM BANKS		$	89,325,775			$	113,067,036			$	137,569,957
FEDERAL FUNDS SOLD			38,045,000				55,675,000				27,660,000
INTEREST-BEARING DEPOSITS IN BANKS			23,883,810				3,922,022				3,658,037
Total cash and cash equivalents			151,254,585				172,664,058				168,887,994
TRADING SECURITIES, at fair value			4,779,483				95,737,085				55,990,882
SECURITIES HELD-TO-MATURITY (fair value of $15,824,051, $24,271,778 and $24,072,925 at September 30, 2009 and 2008 and December 31, 2008, respectively)			15,324,095				23,575,687				23,493,088
SECURITIES AVAILABLE-FOR-SALE, at fair value			1,303,347,263				1,134,632,127				1,238,921,868
LOANS
Held for investment			1,449,342,974				1,522,416,156				1,511,420,878
Held for sale			5,054,300				45,310,536				54,721,837
			1,454,397,274				1,567,726,692				1,566,142,715
Less: Allowance for loan losses			(25,531,939	)			(20,048,219	)			(21,528,860	)
Net loans			1,428,865,335				1,547,678,473				1,544,613,855
BANK PREMISES AND EQUIPMENT, net			63,658,827				65,531,388				65,675,138
INTANGIBLE ASSETS			63,351,265				64,290,370				64,002,968
OTHER ASSETS			45,611,727				44,478,758				50,798,861
Total assets		$	3,076,192,580			$	3,148,587,946			$	3,212,384,654
LIABILITIES AND SHAREHOLDERS’ EQUITY
NONINTEREST-BEARING DEPOSITS		$	719,265,726			$	769,114,908			$	797,077,004
INTEREST-BEARING DEPOSITS			1,739,636,862				1,794,437,339				1,785,676,148
Total deposits			2,458,902,588				2,563,552,247				2,582,753,152
DIVIDENDS PAYABLE			7,079,547				7,069,840				7,071,342
SHORT-TERM BORROWINGS			160,401,097				196,838,548				235,598,268
OTHER LIABILITIES			34,275,422				30,710,467				18,179,664
Total liabilities			2,660,658,654				2,798,171,102				2,843,602,426
COMMITMENTS AND CONTINGENCIES
SHAREHOLDERS’ EQUITY
Common stock — $0.01 par value, authorized 40,000,000 shares; 20,822,396, 20,793,647, and 20,799,198 shares issued at September 30, 2009 and 2008 and December 31, 2008, respectively			208,224				207,936				207,992
Capital surplus			269,073,389				267,927,363				268,087,449
Retained earnings			109,662,745				83,669,522				89,637,172
Treasury stock (shares at cost: 161,546, 158,846, and 158,811 at September 30, 2009 and 2008, and December 31, 2008, respectively)			(3,745,991	)			(3,410,582	)			(3,500,436	)
Deferred compensation			3,745,991				3,410,582				3,500,436
Accumulated other comprehensive earnings (loss)			36,589,568				(1,387,977	)			10,849,615
Total shareholders’ equity			415,533,926				350,416,844				368,782,228
Total liabilities and shareholders’ equity		$	3,076,192,580			$	3,148,587,946			$	3,212,384,654

See notes to consolidated financial statements.

FIRST FINANCIAL BANKSHARES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF EARNINGS — (UNAUDITED)

		Three Months Ended September 30,								Nine Months Ended September 30,
		2009				2008				2009				2008
INTEREST INCOME:
Interest and fees on loans		$	22,640,933			$	25,772,830			$	68,384,432			$	79,814,100
Interest on investment securities:
Taxable			9,144,454				9,269,433				27,950,876				27,657,940
Exempt from federal income tax			4,705,110				3,488,941				13,331,972				10,275,868
Interest on trading securities			10,682				352,487				150,994				457,246
Interest on federal funds sold and interest-bearing deposits in banks			96,149				334,057				209,313				1,709,881
Total interest income			36,597,328				39,217,748				110,027,587				119,915,035
INTEREST EXPENSE:
Interest on deposits			3,835,903				7,312,185				12,767,579				26,891,154
Other			179,104				506,335				633,496				1,774,802
Total interest expense			4,015,007				7,818,520				13,401,075				28,665,956
Net interest income			32,582,321				31,399,228				96,626,512				91,249,079
PROVISION FOR LOAN LOSSES			3,705,500				1,764,547				7,054,006				4,273,798
Net interest income after provision for loan losses			28,876,821				29,634,681				89,572,506				86,975,281
NONINTEREST INCOME:
Trust fees			2,328,205				2,501,240				6,570,494				7,229,598
Service charges on deposit accounts			5,732,386				5,808,933				16,294,274				17,005,316
ATM and credit card fees			2,426,824				2,328,072				7,062,358				6,623,132
Real estate mortgage operations			731,438				648,682				2,177,382				2,017,915
Net gain on securities transactions			897,459				146,269				1,644,811				705,326
Net gain on sale of student loans			272,926				2,665				889,403				1,717,260
Net gain (loss) on sale of foreclosed assets			(127,626	)			26,680				(186,888	)			115,905
Other			617,682				828,093				2,084,419				2,643,717
Total noninterest income			12,879,294				12,290,634				36,536,253				38,058,169
NONINTEREST EXPENSE:
Salaries and employee benefits			12,201,071				12,451,597				36,434,486				37,544,690
Net occupancy expense			1,598,836				1,826,387				4,785,358				5,069,110
Equipment expense			1,919,886				1,890,550				5,827,688				5,602,657
Printing, stationery and supplies			507,978				482,208				1,405,491				1,432,994
FDIC insurance premiums			817,548				162,106				4,073,836				438,273
Amortization of intangible assets			213,672				302,038				651,703				916,799
Other expenses			5,759,375				6,269,816				17,146,205				18,050,659
Total noninterest expense			23,018,366				23,384,702				70,324,767				69,055,182
EARNINGS BEFORE INCOME TAXES			18,737,749				18,540,613				55,783,992				55,978,268
INCOME TAX EXPENSE			4,751,641				5,179,134				14,528,318				15,852,974
NET EARNINGS		$	13,986,108			$	13,361,479			$	41,255,674			$	40,125,294
EARNINGS PER SHARE, BASIC		$	0.67			$	0.64			$	1.98			$	1.93
EARNINGS PER SHARE, ASSUMING DILUTION		$	0.67			$	0.64			$	1.98			$	1.93
DIVIDENDS PER SHARE		$	0.34			$	0.34			$	1.02			$	1.00

See notes to consolidated financial statements.

FIRST FINANCIAL BANKSHARES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE EARNINGS — (UNAUDITED)

		Three Months Ended September 30,								Nine Months Ended September 30,
		2009				2008				2009				2008
NET EARNINGS		$	13,986,108			$	13,361,479			$	41,255,674			$	40,125,294
OTHER ITEMS OF COMPREHENSIVE EARNINGS (LOSS):
Change in unrealized gain (loss) on investment securities available-for-sale, before income taxes			30,594,499				221,754				41,244,739				(7,303,153	)
Reclassification adjustment for realized gains on investment securities included in net earnings, before income tax			(897,459	)			(146,269	)			(1,644,811	)			(705,326	)
Total other items of comprehensive earnings (loss)			29,697,040				75,485				39,599,928				(8,008,479	)
Income tax benefit (expense) related to other items of comprehensive earnings (loss)			(10,393,964	)			(26,420	)			(13,859,975	)			2,802,968
COMPREHENSIVE EARNINGS		$	33,289,184			$	13,410,544			$	66,995,627			$	34,919,783

See notes to consolidated financial statements.

FIRST FINANCIAL BANKSHARES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY

																														Accumulated
																														Other				Total
		Common Stock								Capital				Retained				Treasury Stock								Deferred				Comprehensive				Shareholders’
		Shares				Amount				Surplus				Earnings				Shares				Amounts				Compensation				Earnings				Equity
Balances at December 31, 2007			20,766,848			$	207,669			$	267,136,338			$	64,333,921				(155,415	)		$	(3,170,304	)		$	3,170,304			$	3,817,534			$	335,495,462
Net earnings (unaudited)			—				—				—				40,125,294				—				—				—				—				40,125,294
Stock issuances (unaudited)			26,799				267				519,913								—				—				—				—				520,180
Cash dividends declared, $1.00 per share (unaudited)			—				—				—				(20,789,693	)			—				—				—				—				(20,789,693	)
Change in unrealized gain (loss) in investment securities available-for-sale, net of related income taxes (unaudited)			—				—				—				—				—				—				—				(5,205,511	)			(5,205,511	)
Additional tax benefit related to directors’ deferred compensation plan (unaudited)			—				—				101,801				—				—				—				—				—				101,801
Shares purchased in connection with directors’ deferred compensation plan, net (unaudited)			—				—				—				—				(3,431	)			(240,278	)			240,278				—				—
Stock option expense (unaudited)			—				—				169,311				—				—				—				—				—				169,311
Balances at September 30, 2008 (unaudited)			20,793,647			$	207,936			$	267,927,363			$	83,669,522				(158,846	)		$	(3,410,582	)		$	3,410,582			$	(1,387,977	)		$	350,416,844
Balances at December 31, 2008			20,799,198			$	207,992			$	268,087,449			$	89,637,172				(158,811	)		$	(3,500,436	)		$	3,500,436			$	10,849,615			$	368,782,228
Net earnings (unaudited)			—				—				—				41,255,674				—				—				—				—				41,255,674
Stock issuances (unaudited)			23,198				232				582,488				—				—				—				—				—				582,720
Cash dividends declared, $1.02 per share (unaudited)			—				—				—				(21,230,101	)			—				—				—				—				(21,230,101	)
Change in unrealized gain in investment securities available- for-sale, net of related income taxes (unaudited)			—				—				—				—				—				—				—				25,739,953				25,739,953
Additional tax benefit related to directors’ deferred compensation plan (unaudited)			—				—				195,810				—				—				—				—				—				195,810
Shares purchased in connection with directors’ deferred compensation plan, net (unaudited)			—				—				—				—				(2,735	)			(245,555	)			245,555				—				—
Stock option expense (unaudited)			—				—				207,642				—				—				—				—				—				207,642
Balances at September 30, 2009 (unaudited)			20,822,396			$	208,224			$	269,073,389			$	109,662,745				(161,546	)		$	(3,745,991	)		$	3,745,991			$	36,589,568			$	415,533,926

See notes to consolidated financial statements.

FIRST FINANCIAL BANKSHARES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS — (UNAUDITED)

		Nine Months Ended September 30,
		2009				2008
CASH FLOWS FROM OPERATING ACTIVITIES:
Net earnings		$	41,255,674			$	40,125,294
Adjustments to reconcile net earnings to net cash provided by (used in) operating activities:
Depreciation and amortization			5,842,415				5,985,192
Provision for loan losses			7,054,006				4,273,798
Securities premium amortization (discount accretion), net			923,118				418,416
Gain on sale of assets, net			(2,391,394	)			(2,695,408	)
Deferred federal income tax expense (benefit)			(103,563	)			59,712
Trading securites activity, net			51,211,399				(95,737,085	)
Loans originated for resale			(146,499,682	)			(154,828,708	)
Proceeds from sales of loans held for resale			196,978,623				146,809,643
Change in other assets			5,974,036				4,025,859
Change in other liabilities			3,521,693				3,924,276
Total adjustments			122,510,651				(87,764,305	)
Net cash provided by (used in) operating activities			163,766,325				(47,639,011	)
CASH FLOWS FROM INVESTING ACTIVITIES:
Activity in available-for-sale securities:
Sales			44,903,836				73,150,665
Maturities			144,712,362				179,294,394
Purchases			(214,506,507	)			(286,336,808	)
Activity in held-to-maturity securities — maturities			8,175,238				2,840,503
Net decrease (increase) in loans			55,269,324				(34,181,586	)
Purchases of bank premises and equipment and computer software			(2,504,269	)			(9,523,116	)
Proceeds from sale of other assets			2,237,193				1,974,552
Net cash provided by (used in) investing activities			38,287,177				(72,781,396	)
CASH FLOWS FROM FINANCING ACTIVITIES:
Net increase (decrease) in noninterest-bearing deposits			(77,811,278	)			29,933,928
Net decrease in interest-bearing deposits			(46,039,286	)			(12,464,699	)
Net increase (decrease) in short-term borrowings			(75,197,171	)			30,572,122
Common stock transactions:
Proceeds from stock issuances			582,720				520,180
Dividends paid			(21,221,896	)			(20,365,442	)
Net cash provided by (used in) financing activities			(219,686,911	)			28,196,089
NET DECREASE IN CASH AND CASH EQUIVALENTS			(17,633,409	)			(92,224,318	)
CASH AND CASH EQUIVALENTS, beginning of period			168,887,994				264,888,376
CASH AND CASH EQUIVALENTS, end of period		$	151,254,585				172,664,058
SUPPLEMENTAL INFORMATION AND NONCASH TRANSACTIONS
Interest paid		$	14,190,190				26,615,657
Federal income tax paid			14,146,819				15,507,566
Transfer of loans to foreclosed assets			3,835,652				2,523,712
Investment securities purchased but not settled			—				18,151,271

See notes to consolidated financial statements.

FIRST FINANCIAL BANKSHARES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

Note 1 — Basis of Presentation

The consolidated financial statements include the accounts of the Company, a Texas corporation and a financial holding company registered under the Bank Holding Company Act of 1956, or BHCA, and its wholly-owned subsidiaries: First Financial Bankshares of Delaware, Inc.; First Financial Investments of Delaware, Inc.; First Financial Bank, National Association, Abilene, Texas; First Financial Bank, Hereford, Texas; First Financial Bank, National Association, Sweetwater, Texas; First Financial Bank, National Association, Eastland, Texas; First Financial Bank, National Association, Cleburne, Texas; First Financial Bank, National Association, Stephenville, Texas; First Financial Bank, National Association, San Angelo, Texas; First Financial Bank, National Association, Weatherford, Texas; First Financial Bank, National Association, Southlake, Texas; First Financial Bank, National Association, Mineral Wells, Texas; First Technology Services, Inc.; First Financial Trust & Asset Management Company, National Association; First Financial Investments, Inc.; and First Financial Insurance Agency, Inc.

Through our subsidiary banks, we conduct a full-service commercial banking business. Our service centers are located primarily in North Central and West Texas. Considering the branches and locations of all our bank subsidiaries, as of September 30, 2009, we had 48 financial centers across Texas, with ten locations in Abilene, two locations in Cleburne, three locations in Stephenville, three locations in Granbury, two locations in San Angelo, three locations in Weatherford, and one location each in Mineral Wells, Hereford, Sweetwater, Eastland, Ranger, Rising Star, Southlake, Aledo, Willow Park, Brock, Alvarado, Burleson, Keller, Trophy Club, Boyd, Bridgeport, Decatur, Roby, Trent, Merkel, Clyde, Moran, Albany, Midlothian and Glen Rose. Our trust subsidiary has six locations in Abilene, San Angelo, Stephenville, Sweetwater, Fort Worth and Odessa, all in Texas.

In the opinion of management, the unaudited consolidated financial statements reflect all adjustments necessary for a fair presentation of the Company’s financial position and unaudited results of operations and should be read in conjunction with the Company’s consolidated financial statements, and notes thereto, for the year ended December 31, 2008. All adjustments were of a normal recurring nature. However, the results of operations for the three and nine months ended September 30, 2009, are not necessarily indicative of the results to be expected for the year ending December 31, 2009, due to seasonality, changes in economic conditions and loan credit quality, interest rate fluctuations, regulatory and legislative changes and other factors. Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States (“U.S. GAAP”) have been condensed or omitted under SEC rules and regulations. The Company evaluated subsequent events for potential recognition and/or disclosure through November 3, 2009, the date the consolidated financial statements were issued.

Goodwill and other intangible assets are evaluated annually for impairment as of the end of the second quarter. No such impairment was noted in connection with that evaluation.

Note 2 — Earnings Per Share

Basic earnings per common share is computed by dividing net income available to common shareholders by the weighted average number of shares outstanding during the periods. In computing diluted earnings per common share for the three and nine months ended September 30, 2009 and 2008, the Company assumes that all dilutive outstanding options to purchase common stock have been exercised at the beginning of the period (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 respective periods. The weighted average common shares outstanding used in computing basic earnings per common share for the three months ended September 30, 2009 and 2008, were 20,819,398 and 20,793,197,

respectively. The weighted average common shares outstanding used in computing basic earnings per share for the nine months ended September 30, 2009 and 2008 were 20,810,112 and 20,784,711, respectively. The weighted average common shares outstanding used in computing fully diluted earnings per common share for the three months ended September 30, 2009 and 2008, were 20,844,567 and 20,853,539, respectively. The weighted average common shares outstanding used in computing fully diluted earnings per common share for the nine months ended September 30, 2009 and 2008, were 20,830,932 and 20,831,128, respectively.

Note 3 — Securities

A summary of available-for-sale and held-to-maturity securities is as follows:

		September 30, 2009
						Gross				Gross
		Amortized				Unrealized				Unrealized				Estimated
		Cost Basis				Holding Gains				Holding Losses				Fair Value
Securities held-to-maturity:
Obligations of state and political subdivisions		$	14,651			$	491			$	(3	)		$	15,139
Mortgage-backed securities			673				13				(1	)			685
Total debt securities held-to-maturity		$	15,324			$	504			$	(4	)		$	15,824
Securities available-for-sale:
Obligations of U.S. government sponsored-enterprises and agencies		$	268,628			$	12,321			$	—			$	280,949
Obligations of state and political subdivisions			440,062				28,034				(129	)			467,967
Corporate bonds			71,509				4,803				—				76,312
Mortgage-backed securities			452,298				20,109				(101	)			472,306
Other securities			5,550				263				—				5,813
Total securities available-for-sale		$	1,238,047			$	65,530			$	(230	)		$	1,303,347

		September 30, 2008
						Gross				Gross
		Amortized				Unrealized				Unrealized				Estimated
		Cost Basis				Holding Gains				Holding Losses				Fair Value
Securities held-to-maturity:
Obligations of state and political subdivisions		$	22,573			$	694			$	(7	)		$	23,260
Mortgage-backed securities			1,003				13				(4	)			1,012
Total debt securities held-to-maturity		$	23,576			$	707			$	(11	)		$	24,272
Securities available-for-sale:
U.S. Treasury securities and obligations of U.S. government sponsored-enterprises and agencies			301,626				4,249				(521	)			305,354
Obligations of state and political subdivisions			347,158				3,404				(5,083	)			345,479
Corporate bonds			43,117				188				(1,994	)			41,311
Mortgage-backed securities			434,759				4,062				(1,986	)			436,835
Other securities			5,550				103				—				5,653
Total securities available-for-sale		$	1,132,210			$	12,006			$	(9,584	)		$	1,134,632

The amortized cost and estimated fair value of debt securities at September 30, 2009, by contractual and expected maturity, are shown below (in thousands):

		Held-to-Maturity								Available-for-Sale
		Amortized				Estimated				Amortized				Estimated
		Cost Basis				Fair Value				Cost Basis				Fair Value
Due within one year		$	7,644			$	7,776			$	105,656			$	107,818
Due after one year through five years			6,777				7,133				398,622				419,713
Due after five years through ten years			100				100				265,446				286,028
Due after ten years			130				130				16,025				17,482
Mortgage-backed securities			673				685				452,298				472,306
Total		$	15,324			$	15,824			$	1,238,047			$	1,303,347

During the quarter ended September 30, 2009 and 2008, sales of investment securities that were classified as available-for-sale totaled $9.5 million and $3.5 million, respectively. Gross realized gains from 2009 and 2008 securities sales totaled $897 thousand and $146 thousand, respectively. There were no losses on securities sales during these periods. During the nine months ended September 30, 2009 and 2008, sales of investment securities that were classified as available-for-sale totaled $44.9 million and $73.2 million, respectively. Gross realized gains from 2009 and 2008 securities sales were $1.6 million and $705 thousand, respectively. There were no losses on securities sales during these periods. The specific identification method was used to determine cost on computing the realized gains.

The following tables disclose, as of September 30, 2009 and 2008, our available-for-sale and held-to- maturity securities that have been in a continuous unrealized-loss position for less than 12 months and those that have been in a continuous unrealized-loss position for 12 or more months (in thousands):

		Less than 12 Months								12 Months or Longer								Total
						Unrealized								Unrealized								Unrealized
September 30, 2009		Fair Value				Loss				Fair Value				Loss				Fair Value				Loss
Obligations of state and political subdivisions		$	2,753			$	(65	)		$	2,161			$	(67	)		$	4,914			$	(132	)
Mortgage-backed securities			16,267				(101	)			87				(1	)			16,354				(102	)
Total		$	19,020			$	(166	)		$	2,248			$	(68	)		$	21,268			$	(234	)

		Less than 12 Months								12 Months or Longer								Total
						Unrealized								Unrealized								Unrealized
September 30, 2008		Fair Value				Loss				Fair Value				Loss				Fair Value				Loss
Obligations of U.S. government sponsored-enterprises and agencies		$	81,685			$	(521	)		$	—			$	—			$	81,685			$	(521	)
Obligations of state and political subdivisions			163,246				(5,070	)			912				(20	)			164,158				(5,090	)
Mortgage-backed securities			109,240				(994	)			38,401				(996	)			147,641				(1,990	)
Corporate and other securities			24,223				(1,994	)			—				—				24,223				(1,994	)
Total		$	378,394			$	(8,579	)		$	39,313			$	(1,016	)		$	417,707			$	(9,595	)

The number of investment positions in this unrealized loss position totaled 31 at September 30, 2009. We do not believe these unrealized losses are “other than temporary” as (1) we do not have the intent to sell our securities prior to recovery and (2) it is more likely than not that we will not have to sell our securities prior to recovery. The unrealized losses noted are interest rate related due to the level of interest rates at September 30, 2009. We have reviewed the ratings of the issuers and have not identified any issues related to the ultimate repayment of principal as a result of credit concerns on these securities. Our mortgage related securities are backed by GNMA, FNMA and FHLMC or are collateralized by securities backed by these agencies.

As of September 30, 2009 and 2008, trading securities totaled $4.8 million and $95.7 million, respectively. The trading securities portfolio is a government securities money market fund comprised primarily of U.S. government agency securities and repurchase agreements collateralized by U.S. government agency securities. The trading securities are carried at estimated fair value with unrealized gains and losses included in earnings. The Company began investing in trading securities in 2008 to improve its yield on daily funds and to lower its exposure on Federal funds. However, due to significantly lower interest rates, the Company has deployed these funds in other assets.

Note 4 — Loans And Allowance for Loan Losses

Major classifications of loans are as follows (dollars in thousands):

		September 30,								December 31,
		2009				2008				2008
Commercial, financial and agricultural		$	463,723			$	492,681			$	485,707
Real estate — construction			98,736				164,890				158,000
Real estate — mortgage			709,866				670,553				678,788
Consumer			182,072				239,603				243,648
Total Loans		$	1,454,397			$	1,567,727			$	1,566,143

Included in real estate-mortgage and consumer loans above are $3.5 million and $1.5 million, respectively, in loans held for sale at September 30, 2009, $3.1 million and $42.2 million, respectively, at September 30, 2008 and $2.9 million and $51.8 million, respectively, in loans held for sale at December 31, 2008, in which the carrying amounts approximate fair value.

The Company’s recorded investment in impaired loans and the related valuation allowance are as follows (dollars in thousands):

September 30, 2009								September 30, 2008								December 31, 2008
Recorded				Valuation				Recorded				Valuation				Recorded				Valuation
Investment				Allowance				Investment				Allowance				Investment				Allowance
$	14,585			$	2,907			$	7,947			$	1,250			$	9,893			$	2,040

The allowance for loan losses as of September 30, 2009 and 2008 and December 31, 2008, is presented below. The level of the allowance reflects our periodic evaluation of general economic conditions, the financial condition of our borrowers, the value and liquidity of collateral, delinquencies, prior loan loss experience, and the results of periodic reviews of the portfolio by our independent loan review department and regulatory examiners. Management has evaluated the adequacy of the allowance for loan losses by estimating the probable losses in various categories of the loan portfolio, which are identified below:

		September 30,								December 31,
		2009				2008				2008
Allowance for loan losses provided for:
Loans specifically evaluated as impaired		$	2,906,686			$	1,250,416			$	2,040,323
Remaining portfolio			22,625,253				18,797,803				19,488,537
Total allowance for loan losses		$	25,531,939			$	20,048,219			$	21,528,860

Changes in the allowance for loan losses are summarized as follows:

		Three Months Ended								Nine Months Ended
		September 30,								September 30,
		2009				2008				2009				2008
Balance at beginning of period		$	23,246,778			$	18,676,915			$	21,528,860			$	17,461,514
Add:
Provision for loan losses			3,705,500				1,764,547				7,054,006				4,273,798
Loan recoveries			241,829				253,061				729,110				621,407
Deduct:
Loan charge-offs			(1,662,168	)			(646,304	)			(3,780,037	)			(2,308,500	)
Balance at end of period		$	25,531,939			$	20,048,219			$	25,531,939			$	20,048,219

Nonaccrual, loans still accruing and past due 90 days or more, restructured loans and foreclosed assets are as follows (in thousands, except percentages):

		September 30,								December 31,
		2009				2008				2008
Nonaccrual loans		$	14,585			$	7,947			$	9,893
Loans still accruing and past due 90 days or more			56				212				36
Restructured loans			—				—				—
Foreclosed assets			4,367				2,613				2,602
Total		$	19,008			$	10,772			$	12,531
As a % of total loans and foreclosed assets			1.30	%			0.69	%			0.80	%
As a % of total assets			0.62	%			0.34	%			0.39	%

Note 5 — Income Taxes

Income tax expense was $4.8 million for the third quarter in 2009 as compared to $5.2 million for the same period in 2008. Our effective tax rates on pretax income were 25.36% and 27.93% for the third quarters of 2009 and 2008, respectively. The effective tax rates differ from the statutory federal tax rate of 35% largely due to tax exempt interest income earned on certain investment securities and loans, the deductibility of dividends paid to our employee stock ownership plan and Texas state taxes.

Income tax expense was $14.5 million for the first nine months of 2009 as compared to $15.9 million for the same period in 2008. Our effective tax rates on pretax income were 26.04% and 28.32%, respectively, for the nine-month periods ended September 30, 2009 and 2008. The effective tax rates differ from the statutory federal tax rate of 35% largely due to tax exempt interest income earned on certain investment securities and loans, the deductibility of dividends paid to our employee stock ownership plan and Texas state taxes.

The decreases in the effective tax rates for the third quarter and nine-month periods ended September 30, 2009 over the same periods in 2008 were largely the result of an increase in tax exempt income.

Note 6 — Stock Based Compensation

The Company grants incentive stock options for a fixed number of shares with an exercise price equal to the fair value of the shares at the date of grant to employees. In May 2009, the Company granted incentive stock options to purchase 101,600 shares of Company common stock with an exercise price of $50.33 per share. The fair value of the options granted was estimated using the Black-Scholes options pricing model with the following weighted-average assumptions: risk-free interest rate of 3.24%; expected dividend yield of 2.66%; expected life of 5.79 years; and expected volatility of 41.64%.

The Company recorded stock option expense totaling approximately $71 thousand and $56 thousand, respectively, for the three-month periods ended September 30, 2009 and 2008. The Company recorded stock option expense totaling $208 thousand and $169 thousand, respectively, for the nine-month periods ended September 30, 2009 and 2008.

The additional disclosure requirements under authoritative accounting guidance have been omitted due to immateriality.

Note 7 — Pension Plan

The Company’s defined benefit pension plan was frozen effective January 1, 2004, whereby no additional years of service will accrue to participants, unless the pension plan is reinstated at a future date. The pension plan covered substantially all of the Company’s employees. The benefits for each employee were 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 was and is to contribute annually the amount necessary to satisfy the Internal Revenue Service’s funding standards. Contributions to the pension plan, prior to freezing the plan, were intended to provide not only for benefits attributed to service to date but also for those expected to be earned in the future. As a result of the Pension Protection Act of 2006 (the “Protection Act”), the Company will be required to contribute amounts in future years to fund any shortfalls. The Company evaluated the provisions of the Protection Act as well as the Internal Revenue Service’s funding standards to develop a preliminary plan for funding in future years. The Company made a contribution totaling $1.4 million in April 2009 and $800 thousand in 2008 and continues to evaluate future funding amounts.

Net periodic benefit costs totaling $80 thousand and $79 thousand were recorded, respectively, for the three months ended September 30, 2009 and 2008. Net periodic benefit costs totaling $241 thousand and $236 thousand were recorded, respectively, in the nine months ended September 30, 2009 and 2008.

Note 8 — Recently Issued Authoritative Accounting Guidance

In June 2009, the Financial Accounting Standards Board (FASB) established the FASB Accounting Standards Codification (Codification) as the source of authoritative U. S. generally accepted accounting principles recognized by the FASB to be applied by nongovernmental entities. Rules and interpretative releases of the SEC under authority of federal securities laws are also sources of authoritative guidance for SEC registrants. All non-grandfathered, non-SEC accounting literature not included in the Codification became nonauthoritative. The Codification became effective for the period ended September 30, 2009 and did not have a significant impact on the Company’s financial statements.

In December 2008, the FASB issued authoritative guidance related to an employer’s disclosure about plan assets of defined benefit pension or other post-retirement benefit plans. Under this new guidance, disclosures should provide users of financial statements with an understanding of how investment allocation decisions are made, the factors that are pertinent to an understanding of investment policies and strategies, the major categories of plan assets, the inputs and valuation techniques used to measure the fair value of plan assets, the effect of fair value measurements using significant unobservable inputs on changes in plan assets for the period and significant concentrations of risk within plan assets. The new disclosures will be effective for the Company’s financial statements for the year ending December 31, 2009.

Effective January 1, 2009, with clarifying guidance in April 2009, the FASB issued authoritative guidance that applies to all transactions and other events in which one entity obtains control over one or more other businesses. This guidance requires an acquirer, upon initially obtaining control of another entity, to recognize the assets, liabilities and any non-controlling interest in the acquiree at fair value as of the acquisition date. As a result, an acquired bank’s allowance for loan losses will not be brought over to the Company’s allowance for loan losses but rather be recorded at fair value at date of acquisition. Contingent consideration is required to be recognized and measured at fair value on the date of acquisition if the acquisition fair value of that asset or liability can be determined during the measurement period. If the acquisition date fair value of an asset acquired or a liability assumed in a business combination that arises from a contingency cannot be determined during the measurement period, an asset or a liability shall be recognized at the acquisition date if both the information available for the end of the measurement period indicates that it is probable that an asset existed or that a liability had been incurred at the acquisition date and the amount of the asset or liability can be reasonably estimated. This guidance replaces the cost-allocation process required under previous guidance whereby the cost of an acquisition was allocated to the individual assets acquired and liabilities assumed based on their estimated fair value. This guidance also requires acquirers to expense acquisition-related costs as incurred rather than allocating such costs to the assets acquired and liabilities assumed, as was previously required. The new guidance is expected to have an impact on the Company’s accounting for business combinations closing after January 1, 2009.

In March 2009, the FASB issued additional authoritative accounting guidance to:

•

Amend the other-than-temporary impairment guidance for debt securities to make the guidance more operational and improve the presentation and disclosure in the financial statement. The new guidance specifies that if a company does not have the intent to sell a debt security prior to recovery and it is more likely than not that it will not have to sell the debt security prior to recovery, the security would not be considered other-than-temporary impaired unless there is a credit loss. The credit loss component of an other-than-temporary impaired debt security must be determined based on the entity’s best estimate of cash flows expected to be collected.

•		Provide additional guidance for estimating fair value when the volume and level of activity for the asset and liability have significantly decreased and for identifying circumstances that indicate a transaction is not orderly. The new guidance does not prescribe a methodology for making significant adjustments to transactions or quoted prices when estimating fair value in these situations but states that a change in valuation technique or the use of multiple valuation techniques may be appropriate.
•		Require companies to provide the same fair value of financial instruments disclosures presently required on an annual basis on a quarterly interim basis.

This new guidance was effective for the period ended June 30, 2009 and did not have a significant impact on the Company’s financial position, results of operations or cash flows other than additional disclosures.

In May 2009, the FASB issued authoritative guidance which established general standards of accounting for and disclosure of events that occur after the balance sheet date but before financial statements are issued or available to be issued. This guidance sets forth (i) the period after the balance sheet date during which management of a reporting entity should evaluate events or transactions that may occur for potential recognition or disclosure in the financial statements, (ii) the circumstances under which an entity should recognize events or transactions occurring after the balance sheet date in its financial statements and (iii) the disclosures that an entity should make about events or transactions that occurred after the balance sheet date. This new guidance was effective for the period ended June 30, 2009 and did not have a significant impact on the Company’s financial statements.

In June 2009, the FASB issued authoritative guidance to improve the information a reporting entity provides in its financial statements about a transfer of financial assets, including the effect of a transfer on an entity’s financial position, financial performance and cash flows and the transferor’s continuing involvement in the transferred assets. The guidance eliminates the concept of a qualifying special-purpose entity and changes the guidance for evaluation for consolidation. This guidance is effective January 1, 2010 and is not expected to have a significant impact on the Company’s financial position, results of operations or cash flows.

In June 2009, the FASB issued authoritative guidance to amend previous guidance to replace the quantitative-based risks and rewards calculation for determining which enterprise, if any, has a controlling financial interest in a variable interest entity with an approach focused on identifying which enterprise has the power to direct the activities of a variable interest entity that most significantly impact the entity’s economic performance and (i) the obligation to absorb losses of the entity or (ii) the right to receive benefits from the entity. The guidance is effective January 1, 2010 and is not expected to have a significant impact on the Company’s financial position, results of operations or cash flows.

Note 9 — Fair Value Disclosures

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

The authoritative guidance requires the use of valuation techniques that are consistent with the market approach, the income approach and/or the cost approach. The market approach uses prices and other relevant information generated by market transactions involving identical or comparable assets and liabilities. The income approach uses valuation techniques to convert future amounts, such as cash flows or earnings, to a single present amount on a discounted basis. The cost approach is based on the amount that currently would be required to replace the service capacity of an asset (replacement costs). Valuation techniques should be consistently applied. Inputs to valuation techniques refer to the assumptions that market participants would use in pricing the asset or liability. Inputs may be observable, meaning those that reflect the assumptions market participants would use in pricing the asset or liability developed based on market data obtained from independent sources, or unobservable, meaning those that reflect the reporting entity’s own assumptions about the assumptions market participants would use in pricing the asset or liability developed based on the best information available in the circumstances. In that regard, the authoritative guidance establishes a fair value hierarchy for valuation inputs that gives the highest priority to quoted prices in active markets for identical assets or liabilities and the lowest priority to unobservable inputs. The fair value hierarchy is as follows:

	•		Level 1 Inputs — Unadjusted quoted prices in active markets for identical assets or liabilities that the reporting entity has the ability to access at the measurement date.
	•		Level 2 Inputs — Inputs other than quoted prices included in Level 1 that are observable for the asset or liability, either directly or indirectly. These include quoted prices for similar assets or liabilities in active markets, quoted prices for identical or similar assets or liabilities in markets that are not active, inputs other than quoted prices that are observable for the asset or liability (for example, interest rates, volatilities, prepayment speeds, loss severities, credit risks and default rates) or inputs that are derived principally from or corroborated by observable market data by correlation or other means. Level 2 investments consist primarily of obligations of U.S. government sponsored enterprises and agencies, obligations of state and municipal subdivisions, corporate bonds and mortgage backed securities.
	•		Level 3 Inputs — Significant unobservable inputs that reflect an entity’s own assumptions that market participants would use in pricing the assets or liabilities.

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

In general, fair value is based upon quoted market prices, where available. If such quoted market prices are not available, fair value is based upon internally developed models that primarily use, as inputs, observable market-based parameters. Valuation adjustments may be made to ensure that financial instruments are recorded at fair value. While management believes the Company’s valuation methodologies are appropriate and consistent with other market participants, the use of different methodologies or assumptions to determine the fair value of certain financial instruments could result in a different estimate of fair value at the reporting date.

Securities classified as available for sale and trading are reported at fair value utilizing Level 1 and Level 2 inputs. For these securities, the Company obtains fair value measurements from an independent pricing service. The fair value measurements consider observable data that may include dealer quotes, market spreads, cash flows, the United States Treasury (the “Treasury”) yield curve, live trading levels, trade execution data, market consensus prepayments speeds, credit information and the security’s terms and conditions, among other things.

The following table summarizes financial assets and financial liabilities measured at fair value on a recurring basis as of September 30, 2009, segregated by the level of the valuation inputs within the fair value hierarchy utilized to measure fair value (dollars in thousands):

		Level 1				Level 2				Level 3				Total Fair
		Inputs				Inputs				Inputs				Value
Available for sale investment securities:
Obligations of U. S. government sponsored-enterprises and agencies		$	—			$	280,949			$	—			$	280,949
Obligations of state and political subdivisions			2,164				465,803				—				467,967
Corporate bonds			—				76,312				—				76,312
Mortgage-backed securities			32,179				440,127								472,306
Other securities			5,813				—				—				5,813
		$	40,156			$	1,263,191			$	—			$	1,303,347
Trading investment securities		$	4,779			$	—			$	—			$	4,779

Certain financial assets and financial liabilities are measured at fair value on a nonrecurring basis, that is, the instruments are not measured at fair value on an ongoing basis but are subject to fair value adjustments in certain circumstances (for example, when there is evidence of impairment). Financial assets and financial liabilities measured at fair value on a non-recurring basis include the following at September 30, 2009:

Impaired Loans — Impaired loans are reported at the fair value of the underlying collateral if repayment is expected solely from the collateral. Collateral values are estimated using Level 2 inputs based on observable market data or Level 3 input based on the discounting of the collateral. At September 30, 2009, impaired loans with a carrying value of $14.6 million were reduced by specific valuation allowance totaling $2.9 million resulting in a net fair value of $11.7 million, based on Level 3 inputs.

Loans Held for Sale — Loans held for sale are reported at the lower of cost or fair value. In determining whether the fair value of loans held for sale is less than cost when quoted market prices are not available, the Company considers investor commitments/contracts. These loans are considered Level 2 of the fair value hierarchy. At September 30, 2009, the Company’s mortgage loans held for sale and student loans held for sale were recorded at cost as fair value exceeded cost.

Certain non-financial assets and non-financial liabilities measured at fair value on a recurring and non-recurring basis include other real estate owned, goodwill and other intangible assets and other non-financial long-lived assets. Such amounts were not significant to the Company at September 30, 2009.

The Company is required under current authoritative guidance to disclose the estimated fair value of their financial instrument assets and liabilities including those subject to the requirements discussed above. 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.

The estimated fair value amounts of financial instruments have been determined by the Company using available market information and appropriate valuation methodologies. However, considerable judgment is required to interpret data to develop the estimates of fair value. Accordingly, the estimates presented herein are not necessarily indicative of the amounts the Company could realize in a current market exchange. The use of different market assumptions and/or estimation methodologies may have a material effect on the estimated fair value amounts.

In addition, reasonable comparability between financial institutions may not be likely due to the wide range of permitted valuation techniques and numerous estimates that 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.

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 instruments 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.

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, are not material.

The estimated fair values and carrying values of all financial instruments under current authoritative guidance at September 30, 2009 were as follows (in thousands):

						Estimated
		Carrying Value				Fair Value
Cash and due from banks		$	89,326			$	89,326
Federal funds sold			38,045				38,045
Interest-bearing deposits in banks			23,884				23,884
Trading securities			4,779				4,779
Held to maturity securities			15,324				15,824
Available for sale securities			1,303,347				1,303,347
Net loans			1,428,865				1,420,993
Accrued interest receivable			18,873				18,873
Deposits with stated maturities			686,131				688,924
Deposits with no stated maturities			1,772,772				1,772,772
Short term borrowings			160,401				160,401
Accrued interest payable			1,492				1,492

Item 2.		Management’s Discussion and Analysis of Financial Condition and Results of Operations

Forward-Looking Statements

This Form 10-Q 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-Q, words such as “anticipate,” “believe,” “estimate,” “expect,” “intend,” “predict,” “project,” and similar expressions, as they relate to us or 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, those listed in “Item 1A- Risk Factors” in our Annual Report on Form 10-K and the following:

	•		General economic conditions, including our local and national real estate markets and employment trends;
	•		Volatility and disruption in national and international financial markets;
	•		Legislative, tax and regulatory actions and reforms;
	•		Political instability;
	•		The ability of the Federal government to deal with the national economic slowdown and the terms of any stimulus package enacted by Congress;
	•		Competition from other financial institutions and financial holding companies;
	•		The effects of and changes in trade, monetary and fiscal policies and laws, including interest rate policies of the Governors of the Federal Reserve System;
	•		Changes in the demand for loans;
	•		Fluctuations in the value of collateral securing our loan portfolio and in the level of the allowance for loan losses;
	•		The accuracy of our estimates of future loan losses;
	•		The accuracy of our estimates and assumptions regarding the performance of our securities portfolio;
	•		Soundness of other financial institutions with which we have transactions;
	•		Inflation, interest rate, market and monetary fluctuations;
	•		Changes in consumer spending, borrowing and savings habits;
	•		Anticipated increases in deposit insurance assessments by the Federal Deposit Insurance Corporation (“FDIC”);
	•		Our ability to attract deposits;
	•		Consequences of continued bank mergers and acquisitions in our market area, resulting in fewer but much larger and stronger competitors;
	•		Expansion of operations, including branch openings, new product offerings and expansion into new markets;
	•		Acquisitions and integration of acquired businesses; and
	•		Acts of God or of war or terrorism.

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. We undertake no obligation to publicly update or otherwise revise any forward-looking statements, whether as a result of new information, future events or otherwise.

Introduction

As a multi-bank financial holding company, we generate most of our revenue from interest on loans and investments, trust fees, and service charges. Our primary source of funding for our loans and investments are deposits held by our subsidiary banks. Our largest expenses are interest on these deposits and salaries and related employee benefits. We usually measure our performance by calculating our return on average assets, return on average equity, our regulatory leverage and risk based capital ratios, and our efficiency ratio, which is calculated by dividing noninterest expense by the sum of net interest income on a tax equivalent basis and noninterest income.

The following discussion of operations and financial condition should be read in conjunction with the financial statements and accompanying footnotes included in Item 1 of this Form 10-Q as well as those included in the Company’s 2008 Annual Report on Form 10-K.

Critical Accounting Policies

We prepare consolidated financial statements based on the selection of certain accounting policies, generally accepted accounting principles and customary practices in the banking industry. These policies, in certain areas, require us to make significant estimates and assumptions.

We deem a policy critical if (1) the accounting estimate required us to make assumptions about matters that are highly uncertain at the time we make the accounting estimate; and (2) 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 following discussion addresses (1) our allowance for loan losses and our provision for loan losses and (2) our valuation of securities, which we deem to be our most critical accounting policies. We have other significant accounting policies and continue to evaluate the materiality of their impact on our consolidated financial statements, but we believe these other policies either do not generally require us to make estimates and judgments that are difficult or subjective, or it is less likely they would have a material impact on our reported results for a given period.

Allowance for Loan Losses. The allowance for loan losses is an amount we believe will be adequate to absorb probable losses on existing loans in which full collectibility is unlikely based upon our 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).

Our methodology is based on current accounting authoritative guidance, including guidance from the SEC. We also follow the guidance of the “Interagency Policy Statement on the Allowance for Loan and Lease Losses,” issued jointly by the Office of the Comptroller of the Currency (“OCC”), the Federal Reserve Board, the FDIC, the National Credit Union Administration and the Office of Thrift Supervision. We have developed a loan review methodology that includes allowances assigned to certain classified loans, allowances assigned based upon estimated loss factors and qualitative reserves. The level of the allowance reflects our periodic evaluation of general economic conditions, the financial condition of our borrowers, the value and liquidity of collateral, delinquencies, prior loan loss experience, and the results of periodic reviews of the portfolio by our independent loan review department and regulatory examiners.

Our allowance for loan losses is comprised of three elements: (i) specific reserves based on probable losses on specific classified loans; (ii) general reserves that consider historical loss rates; and (iii) a qualitative reserve based upon general economic conditions and other qualitative risk factors both internal and external to the Company. We regularly evaluate our allowance for loan losses to maintain an adequate level to absorb estimated probable loan losses inherent in the loan portfolio. Factors contributing to the determination of specific reserves include the credit-worthiness of the borrower, changes in the value of pledged collateral, and general economic conditions. All classified loans are specifically reviewed and a specific allocation is assigned based on the losses expected to be realized from those loans. For purposes of determining the general reserve, the loan portfolio less cash secured loans, government guaranteed loans and classified loans is multiplied by the Company’s historical loss rates. The qualitative reserves are determined by evaluating such things as current economic conditions and trends, changes in lending staff, policies or procedures, changes in credit concentrations, changes in the trends and severity of problem loans and changes in trends in volume and terms of loans.

Although we believe 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 nonperforming 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 bank regulatory 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, the borrower’s financial condition is such that collection of principal and interest is doubtful.

Our 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.

Valuation of Securities. The Company records its available-for-sale and trading securities portfolio at fair value.

Fair values of these securities are determined based on methodologies in accordance with current accounting authoritative guidance. Fair values are volatile and may be influenced by a number of factors, including market interest rates, prepayment speeds, discount rates, credit ratings and yield curves. Fair values for investment securities are based on quoted market prices, where available. If quoted market prices are not available, fair values are based on the quoted prices of similar instruments or an estimate of fair value by using a range of fair value estimates in the market place as a result of the illiquid market specific to the type of security.

When the fair value of a security is below its amortized cost, and depending on the length of time the condition exists and the extent the fair value is below amortized cost, additional analysis is performed to determine whether an other-than-temporary impairment condition exists. Available-for-sale and held-to-maturity securities are analyzed quarterly for possible other-than-temporary impairment. The analysis considers (i) whether we have the intent to sell our securities prior to recovery and/or maturity and (ii) whether it is more likely than not that we will have to sell our securities prior to recovery and/or maturity. Often, the information available to conduct these assessments is limited and rapidly changing, making estimates of fair value subject to judgment. If actual information or conditions are different than estimated, the extent of the impairment of the security may be different than previously estimated, which could have a material effect on the Company’s results of operations and financial condition.

Results of Operations

Performance Summary. Net earnings for the third quarter of 2009 were $14.0 million, an increase of $625 thousand, or 4.7%, from the same period in 2008. Net earnings for the third quarter of 2009 compared to the third quarter of 2008 were positively impacted by increases in net interest income and noninterest income and a decrease in noninterest expense, which offset the increase in the provision for loan losses.

On a basic net earnings per share basis, net earnings were $0.67 for the third quarter of 2009, an increase of 4.7% over $0.64 reported for the third quarter of 2008. The return on average assets was 1.81% for the third quarter of 2009, as compared to 1.74% for the same quarter of 2008. The return on average equity was 13.99% for the third quarter of 2009 as compared to 15.31% for the same quarter of 2008.

Net earnings for the nine-month period ended September 30, 2009 were $41.3 million, an increase of $1.1 million, or 2.8%, compared to net earnings for the nine-month period ended September 30, 2008 of $40.1 million. The increase in net earnings for 2009 over 2008 was primarily attributable to an increase in net interest income that offset the impact of (i) an increase in the provision for loan losses, (ii) a decrease in noninterest income and (iii) an increase in noninterest expense, primarily from the special FDIC insurance assessment in the second quarter of 2009.

On a basic net earnings per share basis, net earnings were $1.98 for the nine months of 2009, as compared to $1.93 for the same period of 2008. The return on average assets was 1.78% for the first nine months of 2009, as compared to 1.77% for the same period of 2008. The return on average equity was 14.18% for the first nine months of 2009, as compared to 15.42% for the same period of 2008.

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 $35.2 million for the third quarter of 2009, as compared to $33.2 million for the same period last year. The increase in 2009 compared to 2008 was largely attributable to (i) the decrease in the rate paid on interest-bearing liabilities in an amount greater than the decrease in rates earned on interest earning assets and (ii) an increase in the volume of earning assets. Average earning assets increased $44.2 million for the third quarter of 2009 over the same period in 2008. Average tax exempt securities increased $120.7 million for the third quarter of 2009 over the third quarter of 2008, offsetting a decrease of $64.4 million in average loans. Average interest bearing liabilities decreased $33.3 million for the third quarter of 2009, as compared to the same period in 2008. The yield on earning assets decreased 36 basis points in the third quarter of 2009, whereas the rate paid on interest-bearing liabilities decreased 77 basis points, primarily due to the effects of lower interest rates.

Tax-equivalent net interest income was $103.9 million for the first nine months of 2009, as compared to $96.3 million for the same period last year. The increase in 2009 as compared to 2008 was largely attributable to (i) the decrease in the rate paid on interest-bearing liabilities in an amount greater than the decrease in rates earned on interest earning assets and (ii) an increase in the volume of earning assets. Average earning assets increased $89.9 million for the first nine months of 2009. Average taxable and tax exempt securities increased $158.3 million, offsetting a decrease of $23.9 million in average loans. Average interest bearing liabilities were virtually unchanged for the nine-month period of 2009 from the same period in 2008. The yield on earning assets decreased 54 basis points in the first three quarters of 2009, whereas the rate paid on interest-bearing liabilities decreased 105 basis points.

Table 1 allocates the change in tax-equivalent net interest income between the amount of change attributable to volume and to rate.

     Table 1 — Changes in Interest Income and Interest Expense (in thousands):

		Three Months Ended September 30, 2009												Nine Months Ended September 30, 2009
		Compared to Three Months Ended												Compared to Nine Months Ended
		September 30, 2008												September 30, 2008
		Change Attributable to								Total				Change Attributable to								Total
		Volume				Rate				Change				Volume				Rate				Change
Short-term investments		$	24			$	(262	)		$	(238	)		$	(744	)		$	(757	)		$	(1,501	)
Taxable investment securities (1)			(82	)			(385	)			(467	)			1,929				(1,942	)			(13	)
Tax-exempt investment securities (2)			1,869				83				1,952				4,654				424				5,078
Loans (2) (3)			(1,024	)			(2,059	)			(3,083	)			(1,040	)			(10,183	)			(11,223	)
Interest income			787				(2,623	)			(1,836	)			4,799				(12,458	)			(7,659	)
Interest-bearing deposits			(96	)			(3,381	)			(3,477	)			(323	)			(13,801	)			(14,124	)
Short-term borrowings			(15	)			(312	)			(327	)			275				(1,416	)			(1,141	)
Interest expense			(111	)			(3,693	)			(3,804	)			(48	)			(15,217	)			(15,265	)
Net interest income		$	898			$	1,070			$	1,968			$	4,847			$	2,759			$	7,606