Item 7. Management ’ Discussion and Analysis of Financial Condition and Results of Operations

Management ’ Discussion and Analysis of Financial Condition and Results of Operations analyzes the major elements of the Company’s consolidated financial statements and should be read in conjunction with the Consolidated Financial Statements of the Company and Notes thereto and other detailed information appearing elsewhere in this Annual Report.

For the Years Ended December 31, 2000, 1999 and 1998

Overview

On December 29, 2000, Southwest Bancorporation of Texas, Inc. (the ‘‘Company") and Citizens Bankers, Inc. (‘‘Citizens") completed their merger, which was accounted for as a pooling of interests. The merger agreement provided for the exchange of 249.443 shares of the Company’s Common Stock for each share of Citizens Stock, resulting in the issuance of approximately 3.9 million shares of Company Common Stock on a fully diluted basis. In connection with this merger, the Company incurred approximately $4.1 million in pretax merger-related expenses and other charges including investment banking fees, other professional fees and severance expenses (the ‘‘special charge") .

In a related transaction, the Company, Citizens Bankers Limited Partnership (‘‘CBLP") and Baytown Land I, Ltd. , the general partner of CBLP, entered into an agreement pursuant to which the Company acquired the assets and assumed the liabilities of CBLP. CBLP' s primary assets and liabilities were the bank building located at 1300 Rollingbrook and the related debt to third parties. In connection with this agreement, the Company issued approximately 106,000 shares of the Company’s Common Stock on a fully diluted basis. The historical financial data has been restated to include the accounts and operations of Citizens and CBLP for all periods presented.

Total assets at December 31, 2000, 1999 and 1998 were $3.94 billion, $3.27 billion, and $2.94 billion, respectively. This growth was a result of a strong local economy, the addition of new loan officers, aggressive marketing, and the Company’s overall growth strategy. Loans were $2.51 billion at December 31, 2000, an increase of $476.1 million or 23% from $2.04 billion at the end of 1999, marking the third consecutive year that total loan growth exceeded $350 million. Loans were $1.63 billion at year end 1998. Deposits increased to $3.09 billion at year end 2000 from $2.53 billion at year end 1999 and $2.37 billion at year end 1998.

Net income available for common shareholders was $43.5 million, $32.0 million, and $29.0 million and diluted earnings per common share was $1.29, $0.97, and $0.91 for the years ended 2000, 1999 and 1998, respectively. This increase in net income was primarily the result of strong loan growth, maintaining strong asset quality and expense control and resulted in returns on average assets (‘‘ROA") of 1.23%, 1.06%, and 1.12% and returns on average common equity (‘‘ROE") of 17.00%, 14.70%, and 15.10% for the years ended 2000, 1999 and 1998, respectively.

Results for 2000 include the impact of the special charge taken in the fourth quarter. On an operating basis, excluding this special charge, the Company’s net income was $46.9 million, resulting in an ROA of 1.33%, ROE of 18.34%, and an efficiency ratio of 60.00%. Results for 1999 include $4.5 million of merger-related expenses and other charges. On an operating basis, excluding these charges, the Company’s net income was $35.7 million, resulting in an ROA of 1.19%, ROE of 16.41%, and an efficiency ratio of 62.29%.

Results of Operations

Net Interest Income

Net interest income represents the amount by which interest income on interest-earning assets, including securities and loans, exceeds interest expense incurred on interest-bearing liabilities, including deposits and other borrowed funds. Net interest income is the principal source of the Company’s earnings. In 2000, net interest income provided 77.8% of the Company’s net revenues, compared with 76.7% in 1999 and 77.0% in 1998. Interest rate fluctuations, as well as changes in the amount and type of earning assets and liabilities, combine to affect net interest income.