Form 10-Q
Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-Q

 

 

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF

THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2017

Commission file number 0-7674

 

 

FIRST FINANCIAL BANKSHARES, INC.

(Exact name of registrant as specified in its charter)

 

 

 

Texas   75-0944023

(State or other jurisdiction of

incorporation or organization)

 

(I.R.S. Employer

Identification No.)

400 Pine Street, Abilene, Texas   79601
(Address of principal executive offices)   (Zip Code)

(325) 627-7155

(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  ☒    No  ☐

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 Regulations 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  ☒    No  ☐

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer      Accelerated filer    
Non-accelerated filer   ☐  (Do not check if a smaller reporting company)    Smaller reporting company    
     Emerging growth company    

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.    ☐

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).    Yes  ☐    No  ☒

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date:

 

Class

 

Outstanding at October 31, 2017

Common Stock, $0.01 par value per share   66,226,057

 

 

 


Table of Contents

TABLE OF CONTENTS

PART I

FINANCIAL INFORMATION

 

Item

       Page  
1.  

Financial Statements

     3  
 

Consolidated Balance Sheets – Unaudited

     4  
 

Consolidated Statements of Earnings – Unaudited

     5  
 

Consolidated Statements of Comprehensive Earnings – Unaudited

     6  
 

Consolidated Statements of Shareholders’ Equity – Unaudited

     7  
 

Consolidated Statements of Cash Flows – Unaudited

     8  
 

Notes to Consolidated Financial Statements – Unaudited

     9  
2.  

Management’s Discussion and Analysis of Financial Condition and Results of Operations

     33  
3.  

Quantitative and Qualitative Disclosures About Market Risk

     52  
4.  

Controls and Procedures

     52  
PART II  
OTHER INFORMATION  
1.  

Legal Proceedings

     53  
1A.  

Risk Factors

     53  
2.  

Unregistered Sales of Equity Securities and Use of Proceeds

     53  
3.  

Defaults Upon Senior Securities

     53  
4.  

Mine Safety Disclosures

     53  
5.  

Other Information

     53  
6.  

Exhibits

     54  
 

Signatures

     55  

 

2


Table of Contents

PART I

FINANCIAL INFORMATION

 

Item 1. Financial Statements.

The consolidated balance sheets of First Financial Bankshares, Inc. (the “Company” or “we”) at September 30, 2017 and 2016 and December 31, 2016, and the consolidated statements of earnings and comprehensive earnings for the three and nine months ended September 30, 2017 and 2016, and the consolidated statements of shareholders’ equity and cash flows for the nine months ended September 30, 2017 and 2016, follow on pages 4 through 8.

 

3


Table of Contents

FIRST FINANCIAL BANKSHARES, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(Dollars in thousands, except per share amounts)

 

     Septembere 30,     December 31,  
     2017     2016     2016  
ASSETS    (Unaudited)        

CASH AND DUE FROM BANKS

   $ 177,615     $ 166,981     $ 204,782  

FEDERAL FUNDS SOLD

     —         3,400       3,130  

INTEREST-BEARING DEPOSITS IN BANKS

     166,820       117,334       48,574  
  

 

 

   

 

 

   

 

 

 

Total cash and cash equivalents

     344,435       287,715       256,486  

INTEREST-BEARING TIME DEPOSITS IN BANKS

     1,458       1,707       1,707  

SECURITIES AVAILABLE-FOR-SALE, at fair value

     2,885,483       2,729,030       2,860,837  

SECURITIES HELD-TO-MATURITY (fair value of $133 and $124 at September 30, 2016, and December 31, 2016, respectively)

     —         129       121  

LOANS:

      

Held for investment

     3,472,227       3,337,793       3,357,307  

Less - allowance for loan losses

     (47,922     (45,298     (45,779
  

 

 

   

 

 

   

 

 

 

Net loans held for investment

     3,424,305       3,292,495       3,311,528  

Held for sale

     19,119       31,591       26,898  
  

 

 

   

 

 

   

 

 

 

Net loans

     3,443,424       3,324,086       3,338,426  

BANK PREMISES AND EQUIPMENT, net

     125,668       122,725       122,685  

INTANGIBLE ASSETS

     141,355       143,729       143,603  

OTHER ASSETS

     67,341       77,615       86,066  
  

 

 

   

 

 

   

 

 

 

Total assets

   $ 7,009,164     $ 6,686,736     $ 6,809,931  
  

 

 

   

 

 

   

 

 

 
LIABILITIES AND SHAREHOLDERS’ EQUITY       

NONINTEREST-BEARING DEPOSITS

   $ 1,949,174     $ 1,702,993     $ 1,717,722  

INTEREST-BEARING DEPOSITS

     3,748,286       3,532,471       3,760,817  
  

 

 

   

 

 

   

 

 

 

Total deposits

     5,697,460       5,235,464       5,478,539  

DIVIDENDS PAYABLE

     12,580       11,891       11,897  

BORROWINGS

     351,435       513,759       445,770  

OTHER LIABILITIES

     41,133       57,678       35,840  
  

 

 

   

 

 

   

 

 

 

Total liabilities

     6,102,608       5,818,792       5,972,046  
  

 

 

   

 

 

   

 

 

 

COMMITMENTS AND CONTINGENCIES

      

SHAREHOLDERS’ EQUITY:

      

Common stock - ($0.01 par value, authorized 120,000,000 shares; 66,223,957, 66,063,285, and 66,094,695 shares issued at September 30, 2017 and 2016, and December 31, 2016, respectively)

     662       661       661  

Capital surplus

     376,286       371,170       372,245  

Retained earnings

     493,706       431,765       446,534  

Treasury stock (shares at cost: 498,459, 510,955, and 507,409 at September 30, 2017 and 2016, and December 31, 2016, respectively)

     (7,028 )       (6,566     (6,671

Deferred compensation

     7,028       6,566       6,671  

Accumulated other comprehensive earnings

     35,902       64,348       18,445  
  

 

 

   

 

 

   

 

 

 

Total shareholders’ equity

     906,556       867,944       837,885  
  

 

 

   

 

 

   

 

 

 

Total liabilities and shareholders’ equity

   $ 7,009,164     $ 6,686,736     $ 6,809,931  
  

 

 

   

 

 

   

 

 

 

See notes to consolidated financial statements.

 

4


Table of Contents

FIRST FINANCIAL BANKSHARES, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF EARNINGS - (UNAUDITED)

(Dollars in thousands, except per share amounts)

 

     Three Months Ended
September 30,
    Nine Months Ended
September 30,
 
     2017     2016     2017     2016  

INTEREST INCOME:

        

Interest and fees on loans

   $ 42,749     $ 40,411     $ 123,643     $ 120,700  

Interest on investment securities:

        

Taxable

     8,074       6,775       23,848       21,167  

Exempt from federal income tax

     11,091       10,808       33,991       32,220  

Interest on federal funds sold and interest-bearing deposits in banks

     640       99       1,037       222  
  

 

 

   

 

 

   

 

 

   

 

 

 

Total interest income

     62,554       58,093       182,519       174,309  

INTEREST EXPENSE:

        

Interest on deposits

     2,228       1,112       5,748       3,197  

Other

     638       254       978       811  
  

 

 

   

 

 

   

 

 

   

 

 

 

Total interest expense

     2,866       1,366       6,726       4,008  
  

 

 

   

 

 

   

 

 

   

 

 

 

Net interest income

     59,688       56,727       175,793       170,301  

PROVISION FOR LOAN LOSSES

     1,415       3,833       5,090       8,219  
  

 

 

   

 

 

   

 

 

   

 

 

 

Net interest income after provision for loan losses

     58,273       52,894       170,703       162,082  
  

 

 

   

 

 

   

 

 

   

 

 

 

NONINTEREST INCOME:

        

Trust fees

     6,040       5,066       17,804       14,446  

Service charges on deposit accounts

     5,083       4,796       14,517       13,614  

ATM, interchange and credit card fees

     6,340       6,000       19,102       17,521  

Real estate mortgage operations

     3,891       4,697       11,496       11,849  

Net gain on sale of available-for-sale securities (includes $1,075 and $239 for the three months ended September 30, 2017 and 2016, respectively, and $1,825 and $1,153 for the nine months ended September 30, 2017 and 2016, respectively, related to accumulated other comprehensive earnings reclassifications)

     1,075       239       1,825       1,153  

Net gain (loss) on sale of foreclosed assets

     (11     (10     (42     343  

Net gain (loss) on sale of assets

     (15     (168     (211     271  

Interest on loan recoveries

     405       709       896       1,970  

Other

     1,452       823       3,328       2,243  
  

 

 

   

 

 

   

 

 

   

 

 

 

Total noninterest income

     24,260       22,152       68,715       63,410  

NONINTEREST EXPENSE:

        

Salaries and employee benefits

     24,143       22,931       70,867       67,668  

Net occupancy expense

     2,711       2,672       8,081       7,886  

Equipment expense

     3,294       3,420       10,397       10,186  

FDIC insurance premiums

     561       513       1,657       2,155  

ATM, interchange and credit card expenses

     2,001       1,859       5,517       5,352  

Professional and service fees

     2,036       1,883       5,878       5,099  

Printing, stationery and supplies

     449       536       1,423       1,504  

Operational and other losses

     1,081       533       2,639       1,452  

Amortization of intangible assets

     143       172       477       570  

Other

     7,545       7,484       22,955       21,968  
  

 

 

   

 

 

   

 

 

   

 

 

 

Total noninterest expense

     43,964       42,003       129,891       123,840  
  

 

 

   

 

 

   

 

 

   

 

 

 

EARNINGS BEFORE INCOME TAXES

     38,569       33,043       109,527       101,652  

INCOME TAX EXPENSE (includes $376 and $84 for the three months ended September 30, 2017 and 2016, respectively, and $639 and $404 for the nine months ended September 30, 2017 and 2016, respectively, related to income tax expense from reclassification items)

     9,195       7,440       25,300       23,544  
  

 

 

   

 

 

   

 

 

   

 

 

 

NET EARNINGS

   $ 29,374     $ 25,603     $ 84,227     $ 78,108  
  

 

 

   

 

 

   

 

 

   

 

 

 

EARNINGS PER SHARE, BASIC

   $ 0.44     $ 0.39     $ 1.27     $ 1.18  
  

 

 

   

 

 

   

 

 

   

 

 

 

EARNINGS PER SHARE, ASSUMING DILUTION

   $ 0.44     $ 0.39     $ 1.27     $ 1.18  
  

 

 

   

 

 

   

 

 

   

 

 

 

DIVIDENDS PER SHARE

   $ 0.19     $ 0.18     $ 0.56     $ 0.52  
  

 

 

   

 

 

   

 

 

   

 

 

 

See notes to consolidated financial statements.

 

5


Table of Contents

FIRST FINANCIAL BANKSHARES, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF COMPREHENSIVE EARNINGS - (UNAUDITED)

(Dollars in thousands)

 

     Three Months Ended
September 30,
    Nine Months Ended
September 30,
 
     2017     2016     2017     2016  

NET EARNINGS

   $ 29,374     $ 25,603     $ 84,227     $ 78,108  

OTHER ITEMS OF COMPREHENSIVE EARNINGS (LOSS):

        

Change in unrealized gain on investment securities available-for-sale, before income taxes

     1,729       (18,984     28,682       27,235  

Reclassification adjustment for realized gains on investment securities included in net earnings, before income tax

     (1,075     (239     (1,825     (1,153
  

 

 

   

 

 

   

 

 

   

 

 

 

Total other items of comprehensive earnings

     654       (19,223     26,857       26,082  

Income tax benefit (expense) related to other items of comprehensive earnings

     (229     6,728       (9,400     (9,129
  

 

 

   

 

 

   

 

 

   

 

 

 

COMPREHENSIVE EARNINGS

   $ 29,799     $ 13,108     $ 101,684     $ 95,061  
  

 

 

   

 

 

   

 

 

   

 

 

 

See notes to consolidated financial statements.

 

6


Table of Contents

FIRST FINANCIAL BANKSHARES, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY

(Dollars in thousands, except per share amounts)

 

                                                   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, 2015

     65,990,234      $ 660      $ 368,925      $ 388,006       (520,651   $ (6,296   $ 6,296      $ 47,395      $ 804,986  

Net earnings (unaudited)

     —          —          —          78,108       —         —         —          —          78,108  

Stock option exercises (unaudited)

     66,866        1        988        —         —         —         —          —          989  

Restricted stock grant (unaudited)

     6,185        —          250        —         —         —         —          —          250  

Cash dividends declared, $0.52 per share (unaudited)

     —          —          —          (34,349     —         —         —          —          (34,349

Change in unrealized gain in investment securities available-for-sale, net of related income taxes (unaudited)

     —          —          —          —         —         —         —          16,953        16,953  

Additional tax benefit related to directors’ deferred compensation plan (unaudited)

     —          —          345        —         —         —         —          —          345  

Shares purchased in connection with directors’ deferred compensation plan, net (unaudited)

     —          —          —          —         9,696       (270     270        —          —    

Stock option expense (unaudited)

     —          —          662        —         —         —         —          —          662  
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

   

 

 

   

 

 

    

 

 

    

 

 

 

Balances at September 30, 2016 (unaudited)

     66,063,285      $ 661      $ 371,170      $ 431,765       (510,955   $ (6,566   $ 6,566      $ 64,348      $ 867,944  
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

   

 

 

   

 

 

    

 

 

    

 

 

 

Balances at December 31, 2016

     66,094,695      $ 661      $ 372,245      $ 446,534       (507,409   $ (6,671   $ 6,671      $ 18,445      $ 837,885  

Net earnings (unaudited)

     —          —          —          84,227       —         —         —          —          84,227  

Stock option exercises (unaudited)

     114,612        1        2,259        —         —         —         —          —          2,260  

Restricted stock grant (unaudited)

     14,650        —          600        —         —         —         —          —          600  

Cash dividends declared, $.056 per share (unaudited)

     —          —          —          (37,055     —         —         —          —          (37,055

Change in unrealized gain in investment securities available-for-sale, net of related income taxes (unaudited)

     —          —          —          —         —         —         —          17,457        17,457  

Shares purchased in connection with directors’ deferred compensation plan, net (unaudited)

     —          —          —          —         8,950       (357     357        —          —    

Stock option expense (unaudited)

     —          —          1,182        —         —         —         —          —          1,182  
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

   

 

 

   

 

 

    

 

 

    

 

 

 

Balances at September 30, 2017 (unaudited)

     66,223,957      $ 662      $ 376,286      $ 493,706       (498,459   $ (7,028   $ 7,028      $ 35,902      $ 906,556  
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

   

 

 

   

 

 

    

 

 

    

 

 

 

See notes to consolidated financial statements.    

 

7


Table of Contents

FIRST FINANCIAL BANKSHARES, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS - (UNAUDITED)

(Dollars in thousands)

 

     Nine Months Ended September 30,  
     2017     2016  

CASH FLOWS FROM OPERATING ACTIVITIES:

    

Net earnings

   $ 84,227     $ 78,108  

Adjustments to reconcile net earnings to net cash provided by operating activities:

    

Depreciation and amortization

     9,447       8,627  

Provision for loan losses

     5,090       8,219  

Securities premium amortization (discount accretion), net

     23,009       21,275  

Gain on sale of assets, net

     (1,572     (1,767

Deferred federal income tax benefit

     1,290       825  

Change in loans held-for-sale

     7,779       1,952  

Change in other assets

     18,703       10,059  

Change in other liabilities

     7,172       530  
  

 

 

   

 

 

 

Total adjustments

     70,918       49,720  
  

 

 

   

 

 

 

Net cash provided by operating activities

     155,145       127,828  
  

 

 

   

 

 

 

CASH FLOWS FROM INVESTING ACTIVITIES:

    

Net decrease in interest-bearing time deposits in banks

     249       1,788  

Activity in available-for-sale securities:

    

Sales

     120,576       20,792  

Maturities

     4,299,781       2,830,522  

Purchases

     (4,450,719     (2,835,964

Activity in held-to-maturity securities - maturities

     124       148  

Net increase in loans

     (119,911     (27,446

Purchases of bank premises and equipment and other assets

     (12,626     (17,151

Proceeds from sale of other assets

     4,857       2,960  
  

 

 

   

 

 

 

Net cash used in investing activities

     (157,669     (24,351
  

 

 

   

 

 

 

CASH FLOWS FROM FINANCING ACTIVITIES:

    

Net increase (decrease) in noninterest-bearing deposits

     231,452       (42,959

Net increase (decrease) in interest-bearing deposits

     (12,531     88,254  

Net decrease in borrowings

     (94,335     (101,916

Common stock transactions:

    

Proceeds from stock issuances

     2,260       989  

Dividends paid

     (36,373     (33,016
  

 

 

   

 

 

 

Net cash provided by (used in) financing activities

     90,473       (88,648
  

 

 

   

 

 

 

NET DECREASE IN CASH AND CASH EQUIVALENTS

     87,949       14,829  

CASH AND CASH EQUIVALENTS, beginning of period

     256,486       272,886  
  

 

 

   

 

 

 

CASH AND CASH EQUIVALENTS, end of period

   $ 344,435     $ 287,715  
  

 

 

   

 

 

 

SUPPLEMENTAL INFORMATION AND NONCASH TRANSACTIONS:

    

Interest paid

   $ 6,772     $ 4,018  

Federal income tax paid

     21,896       21,631  

Transfer of loans and bank premises to other real estate owned

     2,044       1,905  

Investment securities purchased but not settled

     993       4,521  

Restricted stock grant to officers and directors

     600       250  

See notes to consolidated financial statements.

 

8


Table of Contents

FIRST FINANCIAL BANKSHARES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

Note 1 - Basis of Presentation

The unaudited interim 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, as amended, or BHCA, and its wholly-owned subsidiaries: First Financial Bank, National Association, Abilene, 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 bank, we conduct a full-service commercial banking business. Our banking centers are located primarily in Central, North Central, Southeast and West Texas. As of September 30, 2017, we had 69 financial centers across Texas, with eleven locations in Abilene, three locations in San Angelo and Weatherford, two locations in Cleburne, Conroe, Stephenville and Granbury, and one location each in Acton, Albany, Aledo, Alvarado, Beaumont, Boyd, Bridgeport, Brock, Burleson, Cisco, Clyde, Cut and Shoot, Decatur, Eastland, Fort Worth, Glen Rose, Grapevine, Hereford, Huntsville, Keller, Magnolia, Mauriceville, Merkel, Midlothian, Mineral Wells, Montgomery, Moran, New Waverly, Newton, Odessa, Orange, Port Arthur, Ranger, Rising Star, Roby, Southlake, Sweetwater, Tomball, Trent, Trophy Club, Vidor, Waxahachie, Willis and Willow Park, all in Texas. Our trust subsidiary has seven locations which are located in Abilene, Fort Worth, Odessa, Beaumont, San Angelo, Stephenville and Sweetwater.

In the opinion of management, the unaudited interim 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 audited consolidated financial statements, and notes thereto in the Company’s Annual Report on Form 10-K, for the year ended December 31, 2016. All adjustments were of a normal recurring nature. However, the results of operations for the three and nine months ended September 30, 2017, are not necessarily indicative of the results to be expected for the year ending December 31, 2017, due to seasonality, changes in economic conditions and loan credit quality, interest rate fluctuations, regulatory and legislative changes and other factors. The preparation of financial statements in conformity with United States generally accepted accounting principles (“GAAP”) require management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the financial statement date. Actual results could vary. Certain information and footnote disclosures normally included in financial statements prepared in accordance with GAAP have been condensed or omitted under U.S. Securities and Exchange Commission (“SEC”) rules and regulations. The Company evaluated subsequent events for potential recognition and/or disclosure through 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 has been noted in connection with the current or any prior evaluations.

 

9


Table of Contents

Note 2 - Stock Repurchase

On July 25, 2017, the Company’s Board of Directors authorized the repurchase of up to 2,000,000 common shares through September 30, 2020. Previously, the Board had authorized the repurchase of up to 1,500,000 common shares through September 30, 2017. The shares buyback plan authorizes management to repurchase the shares at such time as repurchases are considered beneficial to shareholders. Any repurchase of shares will be made through the open market, block trades or in privately negotiated transactions in accordance with applicable laws and regulations. Under the repurchase plan, there is no minimum number of shares that the Company is required to repurchase. Through October 27, 2017, no shares were repurchased under this authorization or the previous authorization.

Note 3 - 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 presented. In computing diluted earnings per common share for the three months and nine months ended September 30, 2017 and 2016, the Company assumes that all dilutive outstanding options to purchase common shares have been exercised at the beginning of the period (or the time of issuance, if later). The dilutive effect of the outstanding options and the restricted shares is reflected by application of the treasury stock method, whereby the proceeds from exercised options and restricted shares 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, 2017 and 2016 were 66,140,518 and 66,023,069 shares, respectively. The weighted average common shares outstanding used in computing basic earnings per common share for the nine months ended September 30, 2017 and 2016 were 66,104,914 and 66,004,797 shares, respectively. The weighted average common shares outstanding used in computing fully diluted earnings per common share for the three months ended September 30, 2017 and 2016 were 66,417,281 and 66,147,202 shares, respectively. The weighted average common shares outstanding used in computing fully diluted earnings per common share for the nine months ended September 30, 2017 and 2016 were 66,392,210 and 66,135,918 shares, respectively.

Note 4 - Interest-bearing Time Deposits in Banks and Securities

Interest-bearing time deposits in banks totaled $1,458,000, $1,707,000 and $1,707,000 at September 30, 2017 and 2016 and December 31, 2016, respectively, and have original maturities generally ranging from one to two years.

Management classifies debt and equity securities as held-to-maturity, available-for-sale, or trading based on its intent. Debt securities that management has the positive intent and ability to hold to maturity are classified as held-to-maturity and recorded at cost, adjusted for amortization of premiums and accretion of discounts, which are recognized as adjustments to interest income using the interest method. Securities not classified as held-to-maturity or trading are classified as available-for-sale and recorded at fair value, with all unrealized gains and unrealized losses judged to be temporary, net of deferred income taxes, excluded from earnings and reported in the consolidated statements of comprehensive earnings. Available-for-sale securities that have unrealized losses that are judged other-than-temporary are included in gain (loss) on sale of securities and a new cost basis is established. Securities classified as trading are recorded at fair value with unrealized gains and losses included in earnings.

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 authoritative accounting 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.

 

10


Table of Contents

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, (ii) whether it is more likely than not that we will have to sell our securities prior to recovery and/or maturity, (iii) the length of time and extent to which the fair value has been less than amortized cost, and (iv) the financial condition of the issuer. 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.

The Company’s investment portfolio consists of U.S. Treasury securities, obligations of U.S. government sponsored enterprises and agencies, obligations of states and political subdivisions, mortgage pass-through securities, corporate bonds and general obligation or revenue based municipal bonds. Pricing for such securities is generally readily available and transparent in the market. The Company utilizes independent third-party pricing services to value its investment securities, which the Company reviews as well as the underlying pricing methodologies for reasonableness and to ensure such prices are aligned with pricing matrices. The Company validates quarterly, on a sample basis, prices supplied by the independent pricing services by comparison to prices obtained from other third-party sources.

A summary of the Company’s available-for-sale securities follows (in thousands):

 

     September 30, 2017  
     Amortized
Cost Basis
     Gross
Unrealized
Holding
Gains
     Gross
Unrealized
Holding
Losses
     Estimated
Fair Value
 

Obligations of U.S. government sponsored enterprises and agencies

   $ 73,583      $ 35      $ (30    $ 73,588  

Obligations of states and political subdivisions

     1,379,117        56,671        (1,594      1,434,194  

Corporate bonds and other

     19,439        118        (2      19,555  

Residential mortgage-backed securities

     1,024,615        8,466        (3,797      1,029,284  

Commercial mortgage-backed securities

     328,806        945        (889      328,862  
  

 

 

    

 

 

    

 

 

    

 

 

 

Total securities available-for-sale

   $ 2,825,560      $ 66,235      $ (6,312    $ 2,885,483  
  

 

 

    

 

 

    

 

 

    

 

 

 

 

11


Table of Contents
     September 30, 2016  
     Amortized
Cost Basis
     Gross
Unrealized
Holding
Gains
     Gross
Unrealized
Holding
Losses
     Estimated
Fair Value
 

U.S. Treasury securities

   $ 10,685      $ 54      $ —        $ 10,739  

Obligations of U.S. government sponsored enterprises and agencies

     114,918        802        —          115,720  

Obligations of states and political subdivisions

     1,419,737        83,694        (715      1,502,716  

Corporate bonds and other

     68,285        1,325        (1      69,609  

Residential mortgage-backed securities

     750,673        17,125        (1,299      766,499  

Commercial mortgage-backed securities

     259,636        4,200        (89      263,747  
  

 

 

    

 

 

    

 

 

    

 

 

 

Total securities available-for-sale

   $ 2,623,934      $ 107,200      $ (2,104    $ 2,729,030  
  

 

 

    

 

 

    

 

 

    

 

 

 

 

     December 31, 2016  
     Amortized
Cost Basis
     Gross
Unrealized
Holding
Gains
     Gross
Unrealized
Holding
Losses
     Estimated
Fair Value
 

U.S. Treasury securities

   $ 10,649      $ 19      $ —        $ 10,668  

Obligations of U.S. government sponsored enterprises and agencies

     113,450        253        —          113,703  

Obligations of states and political subdivisions

     1,534,095        40,194        (10,013      1,564,276  

Corporate bonds and other

     51,920        476        (3      52,393  

Residential mortgage-backed securities

     848,614        8,260        (5,513      851,361  

Commercial mortgage-backed securities

     269,044        622        (1,230      268,436  
  

 

 

    

 

 

    

 

 

    

 

 

 

Total securities available-for-sale

   $ 2,827,772      $ 49,824      $ (16,759    $ 2,860,837  
  

 

 

    

 

 

    

 

 

    

 

 

 

Disclosures related to the Company’s held-to-maturity securities, which totaled $129,000 and $121,000 at September 30, 2016, and December 31, 2016, respectively, have not been presented due to insignificance. There were no held-to-maturity securities owned by the Company at September 30, 2017.

The Company invests in mortgage-backed securities that have expected maturities that differ from their contractual maturities. These differences arise because borrowers may have the right to call or prepay obligations with or without a prepayment penalty. These securities include collateralized mortgage obligations (CMOs) and other asset backed securities. The expected maturities of these securities at September 30, 2017 were computed by using scheduled amortization of balances and historical prepayment rates. At September 30, 2017 and 2016, and December 31, 2016, the Company did not hold CMOs that entail higher risks than standard mortgage-backed securities.

The amortized cost and estimated fair value of available-for-sale securities at September 30, 2017, by contractual and expected maturity, are shown below (in thousands):

 

12


Table of Contents
     Amortized
Cost Basis
     Estimated
Fair Value
 
Due within one year    $ 187,370      $ 189,136  
Due after one year through five years      650,523        679,535  
Due after five years through ten years      632,562        656,623  
Due after ten years      1,684        2,043  
Mortgage-backed securities      1,353,421        1,358,146  
  

 

 

    

 

 

 

Total

   $ 2,825,560      $ 2,885,483  
  

 

 

    

 

 

 

The following tables disclose, as of September 30, 2017 and 2016, and December 31, 2016, the Company’s investment securities that have been in a continuous unrealized-loss position for less than 12 months and for 12 or more months (in thousands):

 

     Less than 12 Months      12 Months or Longer      Total  

September 30, 2017

   Fair Value      Unrealized
Loss
     Fair Value      Unrealized
Loss
     Fair Value      Unrealized
Loss
 

Obligations of U.S.government sponsored enterprises and agencies

   $ 45,050      $ 30      $ —        $ —        $ 45,050      $ 30  

Obligations of states and political subdivisions

     54,983        309        45,217        1,285        100,200        1,594  

Corporate bonds and other

     —          —          240        2        240        2  

Residential mortgage-backed securities

     225,369        1,531        131,849        2,266        357,218        3,797  

Commercial mortgage-backed securities

     170,146        751        21,001        138        191,147        889  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 495,548      $ 2,621      $ 198,307      $ 3,691      $ 693,855      $ 6,312  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 
     Less than 12 Months      12 Months or Longer      Total  

September 30, 2016

   Fair Value      Unrealized
Loss
     Fair Value      Unrealized
Loss
     Fair Value      Unrealized
Loss
 

Obligations of states and political subdivisions

   $ 82,131      $ 711      $ 741      $ 4      $ 82,872      $ 715  

Corporate bonds and other

     12,257        1        —          —          12,257        1  

Residential mortgage-backed securities

     80,015        267        57,334        1,032        137,349        1,299  

Commercial mortgage-backed securities

     10,213        25        13,692        64        23,905        89  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 184,616      $ 1,004      $ 71,767      $ 1,100      $ 256,383      $ 2,104  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 
     Less than 12 Months      12 Months or Longer      Total  

December 31, 2016

   Fair Value      Unrealized
Loss
     Fair Value      Unrealized
Loss
     Fair Value      Unrealized
Loss
 

Obligations of state and political subdivisions

   $ 446,052      $ 9,997      $ 1,209      $ 16      $ 447,261      $ 10,013  

Corporate bonds and other

     244        3        —          —          244        3  

Residential mortgage-backed securities

     372,331        4,532        33,227        981        405,558        5,513  

Commercial mortgage-backed securities

     193,495        1,180        13,263        50        206,758        1,230  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 1,012,122      $ 15,712      $ 47,699      $ 1,047      $ 1,059,821      $ 16,759  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

13


Table of Contents

The number of investments in an unrealized loss position totaled 179 at September 30, 2017. We do not believe these unrealized losses are “other-than-temporary” as (i) we do not have the intent to sell our securities prior to recovery and/or maturity and (ii) it is more likely than not that we will not have to sell our securities prior to recovery and/or maturity. In making this determination, we also consider the length of time and extent to which fair value has been less than cost and the financial condition of the issuer. The unrealized losses noted are interest rate related due to the level of interest rates at September 30, 2017 compared to the time of purchase. 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. At September 30, 2017, 82.70% of our available-for-sale securities that are obligations of states and political subdivisions were issued within the State of Texas, of which 31.16% are guaranteed by the Texas Permanent School Fund.

At September 30, 2017, $1,787,958,000 of the Company’s securities were pledged as collateral for public or trust fund deposits, repurchase agreements and for other purposes required or permitted by law.

During the quarters ended September 30, 2017 and 2016, sales of investment securities that were classified as available-for-sale totaled $83,605,000 and $7,410,000, respectively. Gross realized gains from security sales during the third quarter of 2017 and 2016 totaled $1,750,000 and $239,000, respectively. Gross realized losses from security sales during the third quarter of 2017 totaled $675,000. There were no gross realized losses during the third quarter of 2016.

During the nine months ended September 30, 2017 and 2016, sale of investment securities were classified as available-for-sale totaled $120,576,000 and $20,792,000, respectively. Gross realized gains from security sales during the nine-month period ended September 30, 2017 and 2016 totaled $2,550,000 and $1,158,000, respectively. Gross realized losses from security sales during the nine-month periods ended September 30, 2017 and 2016 totaled $725,000 and $5,000, respectively.

The specific identification method was used to determine cost in order to compute the realized gains and losses.

Note 5 - Loans and Allowance for Loan Losses

Loans held for investment are stated at the amount of unpaid principal, reduced by unearned income and an allowance for loan losses. Interest on loans is calculated by using the simple interest method on daily balances of the principal amounts outstanding. The Company defers and amortizes net loan origination fees and costs as an adjustment to yield. The allowance for loan losses is established through a provision for loan losses charged to expense. Loans are charged against the allowance for loan losses when management believes the collectability of the principal is unlikely.

The Company has certain lending policies and procedures in place that are designed to maximize loan income with an acceptable level of risk. Management reviews and approves these policies and procedures on an annual basis and makes changes as appropriate. Management receives and reviews monthly reports related to loan originations, quality, concentrations, delinquencies, nonperforming and potential problem loans. Diversification in the loan portfolio is a means of managing risk associated with fluctuations in economic conditions, both by type of loan and geographic location.

Commercial loans are underwritten after evaluating and understanding the borrower’s ability to operate profitably and effectively. Underwriting standards are designed to determine whether the borrower possesses sound business ethics and practices and to evaluate current and projected cash flows to determine the ability of the borrower to repay their obligations as agreed. Commercial loans are primarily made based on the identified cash flows of the borrower and, secondarily, on the underlying collateral provided by the borrower. Most commercial loans are secured by the assets being financed or other business assets, such as accounts receivable or inventory, and include personal guarantees.

Agricultural loans are subject to underwriting standards and processes similar to commercial loans. These agricultural loans are based primarily on the identified cash flows of the borrower and secondarily on the underlying collateral provided by the borrower. Most agricultural loans are secured by the agriculture related assets being financed, such as farm land, cattle or equipment, and include personal guarantees.

 

14


Table of Contents

Real estate loans are also subject to underwriting standards and processes similar to commercial and agricultural loans. These loans are underwritten primarily based on projected cash flows and, secondarily, as loans secured by real estate. The repayment of real estate loans is generally largely dependent on the successful operation of the property securing the loans or the business conducted on the property securing the loan. Real estate loans may be more adversely affected by conditions in the real estate markets or in the general economy. The properties securing the Company’s real estate portfolio are generally diverse in terms of type and geographic location within Texas. This diversity helps reduce the exposure to adverse economic events that affect any single market or industry. Generally, real estate loans are owner occupied which further reduces the Company’s risk.

Consumer loan underwriting utilizes methodical credit standards and analysis to supplement the Company’s underwriting policies and procedures. The Company’s loan policy addresses types of consumer loans that may be originated and the collateral, if secured, which must be perfected. The relatively smaller individual dollar amounts of consumer loans that are spread over numerous individual borrowers also minimize the Company’s risk.

The allowance for loan losses is an amount which represents management’s best estimate of probable losses that are inherent in the Company’s loan portfolio as of the balance sheet date. The allowance for loan losses is comprised of three elements: (i) specific reserves determined based on probable losses on specific classified loans; (ii) a historical valuation reserve component that considers historical loss rates; and (iii) qualitative reserves based upon general economic conditions and other qualitative risk factors both internal and external to the Company. The allowance for loan losses is increased by charges to income and decreased by charge-offs (net of recoveries). Management’s periodic evaluation of the appropriateness of the allowance is based on general economic conditions, the financial condition of borrowers, the value and liquidity of collateral, delinquency, prior loan loss experience, and the results of periodic reviews of the portfolio. For purposes of determining our historical valuation reserve, the loan portfolio, less cash secured loans, government guaranteed loans and classified loans, is multiplied by the Company’s historical loss rate. Specific allocations are increased or decreased in accordance with deterioration or improvement in credit quality and a corresponding increase or decrease in risk of loss on a particular loan. In addition, we adjust our allowance for qualitative factors such as current local economic conditions and trends, including, without limitations, unemployment, oil and gas prices, flood and drought conditions, changes in lending staff, policies and procedures, changes in credit concentrations, changes in the trends and severity of problem loans and changes in trends in volume and terms of loans. This qualitative reserve serves to estimate for additional areas of losses inherent in our portfolio that are not reflected in our historic loss factors.

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 decline in the economy and employment rates could result in increased levels of non-performing assets and charge-offs, increased loan provisions and reductions in income. Additionally, bank regulatory agencies periodically review our allowance for loan losses and methodology and could require, in accordance with generally accepted accounting principles, additional provisions to the allowance for loan losses based on their judgment of information available to them at the time of their examination as well as changes to our methodology.

Accrual of interest is discontinued on a loan and payments are applied to principal when management believes, after considering economic and business conditions and collection efforts, the borrower’s financial condition is such that collection of interest is doubtful. Except consumer loans, generally all loans past due greater than 90 days, based on contractual terms, are placed on non-accrual. Loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured. Consumer loans are generally charged-off when a loan becomes past due 90 days. For other loans in the portfolio, facts and circumstances are evaluated in making charge-off decisions.

 

15


Table of Contents

Loans are considered impaired when, based on current information and events, management determines that it is probable we will be unable to collect all amounts due in accordance with the loan agreement, including scheduled principal and interest payments. If a loan is impaired, a specific valuation allowance is allocated, if necessary. Interest payments on impaired loans are typically applied to principal unless collectability of the principal amount is reasonably assured, in which case interest is recognized on a cash basis. Impaired loans, or portions thereof, are charged off when deemed uncollectable.

The Company’s policy requires measurement of the allowance for an impaired, collateral dependent loan based on the fair value of the collateral. Other loan impairments for non-collateral dependent loans are measured based on the present value of expected future cash flows or the loan’s observable market price. At September 30, 2017 and 2016, and December 31, 2016, all significant impaired loans have been determined to be collateral dependent and the allowance for loss has been measured utilizing the estimated fair value of the collateral less costs to sell.

From time to time, the Company modifies its loan agreement with a borrower. A modified loan is considered a troubled debt restructuring when two conditions are met: (i) the borrower is experiencing financial difficulty and (ii) concessions are made by the Company that would not otherwise be considered for a borrower with similar credit risk characteristics. Modifications to loan terms may include a lower interest rate, a reduction of principal, or a longer term to maturity. For all impaired loans, including the Company’s troubled debt restructurings, the Company performs a periodic, well-documented credit evaluation of the borrower’s financial condition and prospects for repayment to assess the likelihood that all principal and interest payments required under the terms of the agreement will be collected in full. When doubt exists about the ultimate collectability of principal and interest, the troubled debt restructuring remains on non-accrual status and payments received are applied to reduce principal to the extent necessary to eliminate such doubt. This determination of accrual status is judgmental and is based on facts and circumstances related to each troubled debt restructuring. Each of these loans is individually evaluated for impairment and a specific reserve is recorded based on probable losses, taking into consideration the related collateral, modified loan terms and cash flow. As of September 30, 2017 and 2016, and December 31, 2016, substantially all of the Company’s troubled debt restructured loans are included in the non-accrual totals.

The Company originates certain mortgage loans for sale in the secondary market. Accordingly, these loans are classified as held-for-sale and are carried at the lower of cost or fair value on an aggregate basis. The mortgage loan sales contracts contain indemnification clauses should the loans default, generally in the first three to nine months, or if documentation is determined not to be in compliance with regulations. The Company’s historic losses as a result of these indemnities have been insignificant.

Loans acquired, including loans acquired in a business combination, are initially recorded at fair value with no valuation allowance. Acquired loans are segregated between those considered to be credit impaired and those deemed performing. To make this determination, management considers such factors as past due status, non-accrual status and credit risk ratings. The fair value of acquired performing loans is determined by discounting expected cash flows, both principal and interest, at prevailing market interest rates. The difference between the fair value and principal balances at acquisition date, the fair value discount, is accreted into interest income over the estimated life of the acquired loan portfolio.

Purchased credit impaired loans are those loans that showed evidence of deterioration of credit quality since origination and for which it is probable, at acquisition, that the Company will be unable to collect all amounts contractually owed. Their acquisition fair value, which includes a credit component at the acquisition date, was based on the estimate of cash flows, both principal and interest, expected to be collected or estimated collateral values if cash flows are not estimable, discounted at prevailing market rates of interest. The difference between the discounted cash flows expected at acquisition and the investment in the loan is recognized as interest income on a level-yield method over the life of the loan, unless management was unable to reasonably forecast cash flows in which case the loans were placed on

 

16


Table of Contents

nonaccrual. Contractually required payments for interest and principal that exceed the cash flows expected at acquisition are not recognized as a yield adjustment. Increases in expected cash flows subsequent to the initial investment are recognized prospectively through adjustment of the yield on the loan over its remaining life. Decreases in expected cash flows subsequent to acquisition are recognized as impairment. Valuation allowances on these impaired loans reflect only losses incurred after the acquisition. The carrying amount of purchased credit impaired loans at September 30, 2017 and 2016, and December 31, 2016, was $736,000, $1,853,000 and $1,256,000, respectively, compared to a contractual balance of $932,000, $2,528,000, and $1,865,000, respectively. Other purchased credit impaired loan disclosures were omitted due to immateriality.

Loans held-for-investment by class of financing receivables are as follows (in thousands):    

 

     September 30,      December 31,  
     2017      2016      2016  

Commercial

   $ 674,947      $ 663,581      $ 674,410  

Agricultural

     83,005        84,716        84,021  

Real estate

     2,297,556        2,191,260        2,189,844  

Consumer

     416,719        398,236        409,032  
  

 

 

    

 

 

    

 

 

 

Total loans held-for-investment

   $ 3,472,227      $ 3,337,793      $ 3,357,307  
  

 

 

    

 

 

    

 

 

 

Loans held for sale totaled $19,119,000, $31,591,000 and $26,898,000 at September 30, 2017 and 2016, and December 31, 2016, respectively, which are valued using the lower of cost or fair value.

The Company’s non-accrual loans, loans still accruing and past due 90 days or more and restructured loans are as follows (in thousands):

 

     September 30,      December 31,  
     2017      2016      2016  

Non-accrual loans*

   $ 18,750      $ 33,712      $ 27,371  

Loans still accruing and past due 90 days or more

     257        107        284  

Troubled debt restructured loans**

     668        750        701  
  

 

 

    

 

 

    

 

 

 

Total

   $ 19,675      $ 34,569      $ 28,356  
  

 

 

    

 

 

    

 

 

 

*Includes $736,000, $1,853,000 and $1,256,000 of purchased credit impaired loans as of September 30, 2017 and 2016, and December 31, 2016, respectively.

**Troubled debt restructured loans of $5,277,000, $7,513,000 and $6,863,000, whose interest collection, after considering economic and business conditions and collection efforts, is doubtful are included in non-accrual loans at September 30, 2017 and 2016, and December 31, 2016, respectively.

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

 

September 30, 2017   September 30, 2016   December 31, 2016
Recorded
Investment
  Valuation
Allowance
  Recorded
Investment
  Valuation
Allowance
  Recorded
Investment
  Valuation
Allowance
$18,750   $4,177   $33,712   $7,042   $27,371   $5,012

 

 

 

 

 

 

 

 

 

 

 

The Company had $22,076,000, $34,938,000 and $29,000,000 in non-accrual, past due 90 days or more and still accruing, restructured loans and foreclosed assets at September 30, 2017 and 2016, and December 31, 2016, respectively. Non-accrual loans at September 30, 2017 and 2016, and December 31, 2016, consisted of the following by class of financing receivables (in thousands):

 

17


Table of Contents
     September 30,      December 31,  
     2017      2016      2016  

Commercial

   $ 4,133      $ 12,714      $ 7,284  

Agricultural

     60        167        99  

Real estate

     13,386        19,582        18,754  

Consumer

     1,171        1,249        1,234  
  

 

 

    

 

 

    

 

 

 

Total

   $ 18,750      $ 33,712      $ 27,371  
  

 

 

    

 

 

    

 

 

 

No significant additional funds are committed to be advanced in connection with impaired loans as of September 30, 2017.

The Company’s impaired loans and related allowance as of September 30, 2017 and 2016, and December 31, 2016, are summarized in the following tables by class of financing receivables (in thousands). No interest income was recognized on impaired loans subsequent to their classification as impaired.

 

September 30, 2017

   Unpaid
Contractual
Principal
Balance
     Recorded
Investment
With No
Allowance*
     Recorded
Investment
With
Allowance
     Total
Recorded
Investment
     Related
Allowance
     Year-to-
Date
Average
Recorded
Investment
     Three-
Month
Average
Recorded
Investment
 

Commercial

   $ 10,989      $ 617      $ 3,516      $ 4,133      $ 1,671      $ 7,313      $ 5,866  

Agricultural

     66        —          60        60        17        66        60  

Real Estate

     17,306        3,742        9,644        13,386        1,984        14,279        13,829  

Consumer

     1,388        262        909        1,171        505        1,341        1,238  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 29,749      $ 4,621      $ 14,129      $ 18,750      $ 4,177      $ 22,999      $ 20,993  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

*Includes $736,000 of purchased credit impaired loans.

 

September 30, 2016

   Unpaid
Contractual
Principal
Balance
     Recorded
Investment
With No
Allowance*
     Recorded
Investment
With
Allowance
     Total
Recorded
Investment
     Related
Allowance
     Year-to-
Date
Average
Recorded
Investment
     Three-
Month
Average
Recorded
Investment
 

Commercial

   $ 21,696      $ 1,067      $ 11,647      $ 12,714      $ 3,983      $ 8,421      $ 14,238  

Agricultural

     168        —          167        167        41        83        84  

Real Estate

     24,130        5,626        13,956        19,582        2,566        17,021        19,436  

Consumer

     1,479        324        925        1,249        452        989        1,166  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 47,473      $ 7,017      $ 26,695      $ 33,712      $ 7,042      $ 26,514      $ 34,924  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

*Includes $1,853,000 of purchased credit impaired loans.

 

December 31, 2016

   Unpaid
Contractual
Principal
Balance
     Recorded
Investment
With No
Allowance*
     Recorded
Investment
With
Allowance
     Total
Recorded
Investment
     Related
Allowance
     Year
Average
Recorded
Investment
 

Commercial

   $ 13,389      $ 1,148      $ 6,136      $ 7,284      $ 2,128      $ 4,921  

Agricultural

     103        —          99        99        25        50  

Real Estate

     23,466        6,229        12,525        18,754        2,428        16,170  

Consumer

     1,421        280        954        1,234        431        914  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 38,379      $ 7,657      $ 19,714      $ 27,371      $ 5,012      $ 22,055  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

*Includes $1,256,000 of purchased credit impaired loans.

The Company recognized interest income on impaired loans prior to being recognized as impaired of approximately $829,000 during the year ended December 31, 2016. Such amounts for the three-month and nine-month periods ended September 30, 2017 and 2016 were not significant.

 

18


Table of Contents

From a credit risk standpoint, the Company rates its loans in one of four categories: (i) pass, (ii) special mention, (iii) substandard or (iv) doubtful. Loans rated as loss are charged-off.

The ratings of loans reflect a judgment about the risks of default and loss associated with the loan. The Company reviews the ratings on our credits as part of our on-going monitoring of the credit quality of our loan portfolio. Ratings are adjusted to reflect the degree of risk and loss that are felt to be inherent in each credit as of each reporting period. Our methodology is structured so that specific allocations are increased in accordance with deterioration in credit quality (and a corresponding increase in risk and loss) or decreased in accordance with improvement in credit quality (and a corresponding decrease in risk and loss).

Credits rated special mention show clear signs of financial weaknesses or deterioration in credit worthiness, however, such concerns are not so pronounced that the Company generally expects to experience significant loss within the short-term. Such credits typically maintain the ability to perform within standard credit terms and credit exposure is not as prominent as credits rated more harshly.

Credits rated substandard are those in which the normal repayment of principal and interest may be, or has been, jeopardized by reason of adverse trends or developments of a financial, managerial, economic or political nature, or important weaknesses exist in collateral. A protracted workout on these credits is a distinct possibility. Prompt corrective action is therefore required to strengthen the Company’s position, and/or to reduce exposure and to assure that adequate remedial measures are taken by the borrower. Credit exposure becomes more likely in such credits and a serious evaluation of the secondary support to the credit is performed.

Credits rated doubtful are those in which full collection of principal appears highly questionable, and which some degree of loss is anticipated, even though the ultimate amount of loss may not yet be certain and/or other factors exist which could affect collection of debt. Based upon available information, positive action by the Company is required to avert or minimize loss. Credits rated doubtful are generally also placed on non-accrual.

The following summarizes the Company’s internal ratings of its loans held-for-investment by class of financing receivables and portfolio segments, which are the same, at September 30, 2017 and 2016, and December 31, 2016 (in thousands):

 

September 30, 2017

   Pass      Special
Mention
     Substandard      Doubtful      Total  

Commercial

   $ 632,693      $ 7,997      $ 34,257      $ —        $ 674,947  

Agricultural

     79,227        841        2,937        —          83,005  

Real Estate

     2,224,970        26,231        46,355        —          2,297,556  

Consumer

     414,043        168        2,508        —          416,719  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 3,350,933      $ 35,237      $ 86,057      $ —        $ 3,472,227  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

September 30, 2016

   Pass      Special
Mention
     Substandard      Doubtful      Total  

Commercial

   $ 614,900      $ 6,108      $ 42,573      $ —        $ 663,581  

Agricultural

     82,400        —          2,316        —          84,716  

Real Estate

     2,118,807        19,064        53,389        —          2,191,260  

Consumer

     395,086        316        2,832        2        398,236  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 3,211,193      $ 25,488      $ 101,110      $ 2      $ 3,337,793  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

December 31, 2016

   Pass      Special
Mention
     Substandard      Doubtful      Total  

Commercial

   $ 629,756      $ 5,769      $ 38,885      $ —        $ 674,410  

Agricultural

     81,620        715        1,686        —          84,021  

Real Estate

     2,111,947        18,091        59,806        —          2,189,844  

Consumer

     406,182        212        2,638        —          409,032  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 3,229,505      $ 24,787      $ 103,015      $ —        $ 3,357,307  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

19


Table of Contents

At September 30, 2017 and 2016, and December 31, 2016, the Company’s past due loans are as follows (in thousands):

 

September 30, 2017

   15-59
Days
Past
Due*
     60-89
Days
Past
Due
     Greater
Than 90
Days
     Total Past
Due
     Current      Total Loans      90 Days
Past Due
Still
Accruing
 

Commercial

   $ 3,288      $ 585      $ 1,495      $ 5,368      $ 669,579      $ 674,947      $ 212  

Agricultural

     322        —          —          322        82,683        83,005        —    

Real Estate

     12,636        984        2,293        15,913        2,281,643        2,297,556        —    

Consumer

     1,211        457        176        1,844        414,875        416,719        45  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 17,457      $ 2,026      $ 3,964      $ 23,447      $ 3,448,780      $ 3,472,227      $ 257  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

September 30, 2016

   15-59
Days
Past
Due*
     60-89
Days
Past
Due
     Greater
Than 90
Days
     Total Past
Due
     Current      Total Loans      90 Days
Past Due
Still
Accruing
 

Commercial

   $ 4,707      $ 841      $ 6,950      $ 12,498      $ 651,083      $ 663,581      $ 61  

Agricultural

     523        63        —          586        84,130        84,716        —    

Real Estate

     13,444        1,496        3,376        18,316        2,172,944        2,191,260        34  

Consumer

     1,418        314        180        1,912        396,324        398,236        12  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 20,092      $ 2,714      $ 10,506      $ 33,312      $ 3,304,481      $ 3,337,793      $ 107  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

December 31, 2016

   15-59
Days
Past
Due*
     60-89
Days
Past
Due
     Greater
Than 90
Days
     Total Past
Due
     Total Current      Total Loans      Total 90
Days
Past Due
Still
Accruing
 

Commercial

   $ 3,908      $ 1,122      $ 2,220      $ 7,250      $ 667,160      $ 674,410      $ 10  

Agricultural

     185        —          —          185        83,836        84,021        —    

Real Estate

     13,172        1,301        5,268        19,741        2,170,103        2,189,844        272  

Consumer

     1,845        368        122        2,335        406,697        409,032        2  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 19,110      $ 2,791      $ 7,610      $ 29,511      $ 3,327,796      $ 3,357,307      $ 284  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

*The Company monitors commercial, agricultural and real estate loans after such loans are 15 days past due. Consumer loans are monitored after such loans are 30 days past due.

The following table details the allowance for loan losses at September 30, 2017 and 2016, and December 31, 2016, by portfolio segment (in thousands). There were no allowances for purchased credit impaired loans at September 30, 2017 and 2016, and December 31, 2016. Allocation of a portion of the allowance to one category of loans does not preclude its availability to absorb losses in other categories.

 

September 30, 2017

   Commercial      Agricultural      Real
Estate
     Consumer      Total  

Loans individually evaluated for impairment

   $ 1,671      $ 17      $ 1,984      $ 505      $ 4,177  

Loans collectively evaluated for impairment

     10,201        1,284        26,484        5,776        43,745  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 11,872      $ 1,301      $ 28,468      $ 6,281      $ 47,922  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

September 30, 2016

   Commercial      Agricultural      Real
Estate
     Consumer      Total  

Loans individually evaluated for impairment

   $ 3,983      $ 41      $ 2,566      $ 452      $ 7,042  

Loans collectively evaluated for impairment

     9,733        1,027        23,655        3,841        38,256  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 13,716      $ 1,068      $ 26,221      $ 4,293      $ 45,298  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

20


Table of Contents

December 31, 2016

   Commercial      Agricultural      Real
Estate
     Consumer      Total  

Loans individually evaluated for impairment

   $ 2,128      $ 25      $ 2,428      $ 431      $ 5,012  

Loans collectively evaluated for impairment

     9,579        1,076        24,436        5,676        40,767  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 11,707      $ 1,101      $ 26,864      $ 6,107      $ 45,779  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Changes in the allowance for loan losses for the three and nine months ended September 30, 2017 and 2016, are summarized as follows by portfolio segment (in thousands):

 

Three months ended September 30, 2017

   Commercial     Agricultural     Real
Estate
    Consumer     Total  

Beginning balance

   $ 11,935     $ 1,127     $ 28,023     $ 6,325     $ 47,410  

Provision for loan losses

     557       157       424       277       1,415  

Recoveries

     119       17       50       91       277  

Charge-offs

     (739     —         (29     (412     (1,180
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Ending balance

   $ 11,872     $ 1,301     $ 28,468     $ 6,281     $ 47,922  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Three months ended September 30, 2016

   Commercial     Agricultural     Real
Estate
    Consumer     Total  

Beginning balance

   $ 14,026     $ 1,451     $ 25,644     $ 3,939     $ 45,060  

Provision for loan losses

     3,248       (358     296       647       3,833  

Recoveries

     298       4       367       108       777  

Charge-offs

     (3,856     (29     (86     (401     (4,372
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Ending balance

   $ 13,716     $ 1,068     $ 26,221     $ 4,293     $ 45,298  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Nine months ended September 30, 2017

   Commercial     Agricultural     Real
Estate
    Consumer     Total  

Beginning balance

   $ 11,707     $ 1,101     $ 26,864     $ 6,107     $ 45,779  

Provision for loan losses

     1,485       211       2,556       838       5,090  

Recoveries

     868       25       141       400       1,434  

Charge-offs

     (2,188     (36     (1,093     (1,064     (4,381
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Ending balance

   $ 11,872     $ 1,301     $ 28,468     $ 6,281     $ 47,922  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Nine months ended September 30, 2016

   Commercial     Agricultural     Real
Estate
    Consumer     Total  

Beginning balance

   $ 12,644     $ 1,191     $ 24,375     $ 3,667     $ 41,877  

Provision for loan losses

     6,239       41       367       1,572       8,219  

Recoveries

     839       20       1,957       427       3,243  

Charge-offs

     (6,006     (184     (478     (1,373     (8,041
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Ending balance

   $ 13,716     $ 1,068     $ 26,221     $ 4,293     $ 45,298  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

The Company’s recorded investment in loans as of September 30, 2017 and 2016, and December 31, 2016 related to the balance in the allowance for loan losses on the basis of the Company’s impairment methodology was as follows (in thousands). Purchased credit impaired loans of $736,000, $1,853,000 and $1,256,000 at September 30, 2017 and 2016, and December 31, 2016, respectively, are included in loans individually evaluated for impairment.

 

21


Table of Contents

September 30, 2017

   Commercial      Agricultural      Real
Estate
     Consumer      Total  

Loans individually evaluated for impairment

   $ 4,133      $ 60      $ 13,386      $ 1,171      $ 18,750  

Loans collectively evaluated for impairment

     670,814        82,945        2,284,170        415,548        3,453,477  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 674,947      $ 83,005      $ 2,297,556      $ 416,719      $ 3,472,227  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

September 30, 2016

   Commercial      Agricultural      Real
Estate
     Consumer      Total  

Loans individually evaluated for impairment

   $ 12,714      $ 167      $ 19,582      $ 1,249      $ 33,712  

Loans collectively evaluated for impairment

     650,867        84,549        2,171,678        396,987        3,304,081  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 663,581      $ 84,716      $ 2,191,260      $ 398,236      $ 3,337,793  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

December 31, 2016

   Commercial      Agricultural      Real
Estate
     Consumer      Total  

Loans individually evaluated for impairment

   $ 7,284      $ 99      $ 18,754      $ 1,234      $ 27,371  

Loan collectively evaluated for impairment

     667,126        83,922        2,171,090        407,798        3,329,936  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 674,410      $ 84,021      $ 2,189,844      $ 409,032      $ 3,357,307  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

The Company’s loans that were modified in the three and nine months ended September 30, 2017 and 2016 and considered troubled debt restructurings are as follows (in thousands):

 

     Three Months Ended September 30,
2017
     Nine Months Ended September 30,
2017
 
     Number      Pre-
Modification
Recorded
Investment
     Post-
Modification
Recorded
Investment
     Number      Pre-
Modification
Recorded
Investment
     Post-
Modification
Recorded
Investment
 

Commercial

     3      $ 514      $ 514        9      $ 838      $ 838  

Agricultural

     —          —          —          —          —          —    

Real Estate

     1        256        256        3        473        473  

Consumer

     —          —          —          1        25        25  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

     4      $ 770      $ 770        13      $ 1,336      $ 1,336  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 
     Three Months Ended September 30,
2016
     Nine Months Ended September 30,
2016
 
     Number      Pre-
Modification
Recorded
Investment
     Post-
Modification
Recorded
Investment
     Number      Pre-
Modification
Recorded
Investment
     Post-
Modification
Recorded
Investment
 

Commercial

     3      $ 230      $ 230        14      $ 3,156      $ 3,156  

Agricultural

     —          —          —          —          —          —    

Real Estate

     3        706        706        5        1,169        1,169  

Consumer

     1        44        44        5        162        162  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

     7      $ 980      $ 980        24      $ 4,487      $ 4,487  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

The balances below provide information as to how the loans were modified as troubled debt restructured loans during the three and nine months ended September 30, 2017 and 2016 (in thousands):

 

     Three Months Ended September 30, 2017      Nine Months Ended September 30, 2017  
     Adjusted
Interest
Rate
     Extended
Maturity
     Combined
Rate and
Maturity
     Adjusted
Interest
Rate
     Extended
Maturity
     Combined
Rate and
Maturity
 

Commercial

   $ —        $ —        $ 514        —        $ 181      $ 657  

Agricultural

     —          —          —          —          —          —    

Real Estate

     —          256        —          —          312        161  

Consumer

     —          —          —          —          25        —    
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ —        $ 256      $ 514        —        $ 518      $ 818  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

22


Table of Contents
     Three Months Ended September 30, 2016      Nine Months Ended September 30, 2016  
     Adjusted
Interest
Rate
     Extended
Maturity
     Combined
Rate and
Maturity
     Adjusted
Interest
Rate
     Extended
Maturity
     Combined
Rate and
Maturity
 

Commercial

   $ —        $ 112      $ 118        —        $ 2,561      $ 595  

Agricultural

     —          —          —          —          —          —    

Real Estate

     —          185        521        —          298        871  

Consumer

     —          —          44        —          43        119  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ —        $ 297      $ 683        —        $ 2,902      $ 1,585  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

During the three months ended September 30, 2017 and 2016, two loans and two loans, respectively, were modified as troubled debt restructured loan within the previous 12 months and for which there was a payment default. During the nine months ended September 30, 2017 and 2016, four loans and three loans, respectively, were modified as troubled debt restructured loan within the previous 12 months and for which there was a payment default. A default for purposes of this disclosure is a troubled debt restructured loan in which the borrower is 90 days past due or more or results in the foreclosure and repossession of the applicable collateral. The loans with payment default are as follows (dollars in thousands):

 

     Three Months Ended
September 30, 2017
     Nine Months Ended
September 30, 2017
 
     Number      Balance      Number      Balance  

Commercial

     2      $ 88        3      $ 141  

Agriculture

     —          —          —          —    

Real Estate

     —          —          1        62  

Consumer

     —          —          —          —    
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

     2      $ 88        4      $ 203  
  

 

 

    

 

 

    

 

 

    

 

 

 
     Three Months Ended
September 30, 2016
     Nine Months Ended
September 30, 2016
 
     Number      Balance      Number      Balance  

Commercial

     1      $ 62        1      $ 62  

Agriculture

     —          —          —          —    

Real Estate

     1        112        2        462  

Consumer

     —          —          —          —    
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

     2      $ 174        3      $ 524  
  

 

 

    

 

 

    

 

 

    

 

 

 

As of September 30, 2017, the Company has no commitments to lend additional funds to loan customers whose terms have been modified in troubled debt restructurings.

Our subsidiary bank has established a line of credit with the Federal Home Loan Bank of Dallas (FHLB) to provide liquidity and meet pledging requirements for those customers eligible to have securities pledged to secure certain uninsured deposits. At September 30, 2017, $2,140,557,000 in loans held by our bank subsidiary were subject to blanket liens as security for this line of credit. At September 30, 2017, there was no balance outstanding under this line of credit.

 

23


Table of Contents

Note 6 - Borrowings

Borrowings at September 30, 2017 and 2016, and December 31, 2016 consisted of the following (dollars in thousands):

 

     September 30,      December 31,  
     2017      2016      2016  

Securities sold under agreements with customers to repurchase

   $ 339,660      $ 345,559      $ 360,820  

Federal funds purchased

     11,775        8,200        9,950  

Advances from Federal Home Loan Bank of Dallas

     —          160,000        75,000  
  

 

 

    

 

 

    

 

 

 

Total

   $ 351,435      $ 513,759      $ 445,770  
  

 

 

    

 

 

    

 

 

 

Securities sold under repurchase agreements are generally with significant customers of the Company that require short-term liquidity for their funds for which the Company pledges certain securities that have a fair value equal to at least the amount of the borrowings. The agreements mature daily and therefore the risk arising from a decline in the fair value of the collateral pledged is minimal. The securities pledged are mortgage-backed securities. These agreements do not include “right of set-off” provisions and therefore the Company does not offset such agreements for financial reporting purposes.

Note 7 - Income Taxes

Income tax expense was $9,195,000 for the third quarter of 2017 as compared to $7,440,000 for the same period in 2016. The Company’s effective tax rates on pretax income were 23.84% and 22.52% for the third quarters of 2017 and 2016, respectively. Income tax expense was $25,300,000 for the nine months ended September 30, 2017 as compared to $23,544,000 for the same period in 2016. The Company’s effective tax rates on pretax income were 23.10% and 23.16% for the nine months ended September 2017 and 2016, respectively. The effective tax rates differ from the statutory federal tax rate of 35% primarily 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 excess tax benefits related to our directors’ deferred compensation plan.

Note 8 - Stock Option Plan and Restricted Stock Plan

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 June 2017, the Company granted 452,450 incentive stock options with an exercise price of $42.35 per share. The fair value of the options was $9.90 per option and was estimated using the Black-Scholes options pricing model with the following weighted average assumptions: risk-free interest rate of 1.89%; expected dividend yield of 1.79%; expected life of 6.24 years; and expected volatility of 26.51%. No options were granted in 2016.

The Company recorded stock option expense totaling $750,000 and $221,000 for the three-month periods ended September 30, 2017 and 2016, respectively. The Company recorded stock option expense totaling $1,182,000 and $662,000 for the nine months ended September 30, 2017 and 2016, respectively. The additional disclosure requirements under authoritative accounting guidance have been omitted due to the amounts being insignificant.

On July 21, 2015, 7,070 restricted shares were granted to the ten non-employee directors. Total value of these restricted shares totaled $250,000 and was expensed over the period from grant date to April 26, 2016, the annual shareholders’ meeting at which these director’s term expired. On April 26, 2016, upon re-election of existing directors, 7,660 restricted shares with a total value of $250,000 were granted to the ten non-employee directors and was expensed over the period from grant day to April 25, 2017, the annual shareholders’ meeting at which these directors’ term expired. On April 25, 2017, upon re-election of existing directors, 14,650 restricted shares with a total value of $600,000 were granted to the ten non-employee directors and is being expensed over the period from the grant date to April 24, 2018, the Company’s next shareholders’ meeting at which the directors’ term expires.

 

24


Table of Contents

The Company recorded director expense related to these restricted share grants of $150,000 and $63,000 for the three-month periods ended September 30, 2017 and 2016, respectively. The Company recorded director expense related to these restricted share grants of $333,000 and $215,000 for the nine-month periods ended September 30, 2017 and 2016, respectively.

On October 27, 2015, the Company granted 31,273 restricted shares with a total value of $1,060,000 to certain officers that is being expensed over the vesting period of three years. On October 25, 2016, the Company granted 15,405 restricted shares with a total value of $560,000 to certain officers that is being expensed over the vesting period of three years. The Company recorded restricted stock expense for officers of $133,000 and $88,000, for the three-month periods ended September 30, 2017 and 2016, respectively. The Company recorded restricted share expense for officers of $399,000 and $262,000 for the nine-month periods ended September 30, 2017 and 2016, respectively.

On October 24, 2017, the Company granted 14,191 restricted shares with a total value of $655,000 to certain officers that will be expensed over the vesting period of one to three years.

Note 9 - Pension Plan

The Company’s defined benefit pension plan was frozen effective January 1, 2004, whereby no new participants will be added to the plan and 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 at the time. 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 has evaluated the provisions of the Protection Act as well as the Internal Revenue Service’s funding standards to develop a plan for funding in future years. The Company made a contribution totaling $500,000 in 2016, and has made no contribution through September 30, 2017.

Net periodic benefit costs totaling $84,000 and $82,000 were recorded for the three months ended September 30, 2017 and 2016, respectively. Net periodic benefit costs totaling $253,000 and $247,000 were recorded for the nine months ended September 30, 2017 and 2016, respectively.

Note 10 - Fair Value Disclosures

The authoritative accounting 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 accounting 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

 

25


Table of Contents

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 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 market spreads, cash flows, the United States Treasury yield curve, live trading levels, trade execution data, dealer quotes, market consensus prepayments speeds, credit information and the security’s terms and conditions, among other items.

There were no transfers between Level 1 and Level 2 or Level 2 and Level 3 during the three and nine months ended September 30, 2017 and 2016, and the year ended December 31, 2016.

 

26


Table of Contents

The following table summarizes financial assets and financial liabilities measured at fair value on a recurring basis as of September 30, 2017 and 2016, and December 31, 2016, respectively, segregated by the level of the valuation inputs within the fair value hierarchy utilized to measure fair value (dollars in thousands):

 

September 30, 2017

                           
     Level 1
Inputs
     Level 2
Inputs
     Level 3
Inputs
     Total Fair
Value
 
Available-for-sale investment securities:            

Obligations of U. S. government sponsored enterprises and agencies

   $ —        $ 73,588      $ —        $ 73,588  

Obligations of states and political subdivisions

     —          1,434,194        —          1,434,194  

Corporate bonds

     —          15,099        —          15,099  

Residential mortgage-backed securities

     —          1,029,284        —          1,029,284  

Commercial mortgage-backed securities

     —          328,862        —          328,862  

Other securities

     4,456        —          —          4,456  
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 4,456      $ 2,881,027      $ —        $ 2,885,483  
  

 

 

    

 

 

    

 

 

    

 

 

 

September 30, 2016

                           
     Level 1
Inputs
     Level 2
Inputs
     Level 3
Inputs
     Total Fair
Value
 

Available-for-sale investment securities:

           

U.S. Treasury securities

   $ 10,739      $ —        $ —        $ 10,739  

Obligations of U. S. government sponsored enterprises and agencies

     —          115,720        —          115,720  

Obligations of states and political subdivisions

     —          1,502,716        —          1,502,716  

Corporate bonds

     —          65,037        —          65,037  

Residential mortgage-backed securities

     —          766,499        —          766,499  

Commercial mortgage-backed securities

     —          263,747        —          263,747  

Other securities

     4,572        —          —          4,572  
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 15,311      $ 2,713,719      $ —        $ 2,729,030  
  

 

 

    

 

 

    

 

 

    

 

 

 

December 31, 2016

           
     Level 1
Inputs
     Level 2
Inputs
     Level 3
Inputs
     Total Fair
Value
 

Available-for-sale investment securities:

           

U.S. Treasury securities

   $ 10,668      $ —        $ —        $ 10,668  

Obligations of U. S. government sponsored enterprises and agencies

     —          113,703        —          113,703  

Obligations of states and political subdivisions

     —          1,564,276        —          1,564,276  

Corporate bonds

     —          47,965        —          47,965  

Residential mortgage-backed securities

     —          851,361        —          851,361  

Commercial mortgage-backed securities

     —          268,436        —          268,436  

Other securities

     4,428        —          —          4,428  
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 15,096      $ 2,845,741      $ —        $ 2,860,837  
  

 

 

    

 

 

    

 

 

    

 

 

 

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, 2017:

Impaired Loans – Impaired loans are reported at the fair value of the underlying collateral if repayment is expected solely from the collateral less costs to sell. Collateral values are estimated using Level 2 inputs based on observable market data. At September 30, 2017, impaired loans with a carrying value of $14,129,000 were reduced by specific valuation reserves totaling $4,177,000 resulting in a net fair value of $9,952,000. The Company also had impaired loans of $4,621,000 with no specific valuation reserve at September 30, 2017, due to the loans carrying value generally being lower than the value of the collateral associated with the loan.

 

27


Table of Contents

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, 2017, the Company’s mortgage 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 non-recurring basis include other real estate owned, goodwill and other intangible assets and other non-financial long-lived assets. Non-financial assets measured at fair value on a non-recurring basis during the three months and nine months ended September 30, 2017 and 2016 include other real estate owned which, subsequent to their initial transfer to other real estate owned from loans, were re-measured at fair value through a write-down included in gain (loss) on sale of foreclosed assets. During the reported periods, all fair value measurements for foreclosed assets utilized Level 2 inputs based on observable market data, generally third-party appraisals, or Level 3 inputs based on customized discounting criteria. These appraisals are evaluated individually and discounted as necessary due to the age of the appraisal, lack of comparable sales, expected holding periods of property or special use type of the property. Such discounts vary by appraisal based on the above factors but generally range from 5% to 25% of the appraised value. Re-evaluation of other real estate owned is performed at least annually as required by regulatory guidelines or more often if particular circumstances arise. The following table presents other real estate owned that were re-measured subsequent to their initial transfer to other real estate owned (dollars in thousands):

 

     Three Months
Ended
September 30,
 
     2017      2016  

Carrying value of other real estate owned prior to re-measurement

   $ 937      $ —    

Write-downs included in gain (loss) on sale of other real estate owned

     (288      —    
  

 

 

    

 

 

 

Fair value

   $ 649      $ —    
  

 

 

    

 

 

 
     Nine Months
Ended
September 30,
 
     2017      2016  

Carrying value of other real estate owned prior to re-measurement

   $ 1,025      $ —    

Write-downs included in gain (loss) on sale of other real estate owned

     (296      —    
  

 

 

    

 

 

 

Fair value

   $ 729      $ —    
  

 

 

    

 

 

 

At September 30, 2017 and 2016, and December 31, 2016, other real estate owned totaled $2,176,000, $241,000, and $413,000, respectively.

The Company is required under current authoritative accounting 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. 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.

 

28


Table of Contents

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.

Cash and due from banks, federal funds sold, interest-bearing deposits and time deposits in banks and accrued interest receivable and payable are liquid in nature and considered Levels 1 or 2 of the fair value hierarchy.

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 and are considered Levels 2 and 3 of the fair value hierarchy. Financial instrument liabilities with no stated maturities have an estimated fair value equal to both the amount payable on demand and the carrying value and are considered Level 1 of the fair value hierarchy.

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, 2017 and 2016, and December 31, 2016, were as follows (in thousands):

 

     September 30,      December 31,
     2017      2016      2016
     Carrying
Value
     Estimated
Fair Value
     Carrying
Value
     Estimated
Fair Value
     Carrying
Value
     Estimated
Fair Value
     Fair Value
Hierarchy

Cash and due from banks

   $ 177,615      $ 177,615      $ 166,981      $ 166,981      $ 204,782      $ 204,782      Level 1

Federal funds sold

     —          —          3,400        3,400        3,130        3,130      Level 1

Interest-bearing deposits in banks

     166,820        166,820        117,334        117,334        48,574        48,574      Level 1

Interest-bearing time deposits in banks

     1,458        1,458        1,707        1,709        1,707        1,709      Level 2

Available-for-sale Securities

     2,885,483        2,885,483        2,729,030        2,729,030        2,860,837        2,860,837      Levels 1

and 2

Held-to-maturity securities

     —          —          129        133        121        124      Level 2

Loans

     3,443,424        3,458,603        3,324,086        3,334,965        3,338,426        3,361,735      Level 3

Accrued interest receivable

     26,321        26,321        26,209        26,209        36,469        36,469      Level 2

Deposits with stated maturities

     464,782        465,655        535,793        537,167        508,996        510,304      Level 2

Deposits with no stated maturities

     5,232,678        5,232,678        4,699,671        4,699,671        4,969,543        4,969,543      Level 1

Borrowings

     351,435        351,435        513,759        513,759        445,770        445,770      Level 2

Accrued interest Payable

     179        179        230        230        225        225      Level 2

 

29


Table of Contents

Note 11 - Recently Issued Authoritative Accounting Guidance

Accounting Standards Update (“ASU”) 2014-09, “Revenue from Contracts with Customers.” ASU 2014-09 implements a comprehensive new revenue recognition standard that will supersede substantially all existing revenue recognition guidance. The new standard’s core principle is that a company will recognize revenue when it transfers promised goods or services to customers in an amount that reflects the consideration to which the company expects to be entitled in exchange for those goods or services. To achieve that core principle, an entity should apply the following steps: (i) identify the contract(s) with a customer, (ii) identify the performance obligations in the contract, (iii) determine the transaction price, (iv) allocate the transaction price to the performance obligations in the contract and (v) recognize revenue when (or as) the entity satisfies a performance obligation. ASU 2015-4 “Revenue from Contracts with Customers – Deferral of the Effective Date” deferred the effective date of ASU 2014-09 by one year and as a result, the new standard will be effective the first quarter of 2018. The Company’s revenue is comprised of net interest income on financial assets and financial liabilities, which is explicitly excluded from the scope of ASU 2014-09, and non-interest income. Based on the Company’s analysis of the effect of the new standard on its recurring revenue streams, the Company does not expect these changes to have a significant impact on the Company’s financial statement. Upon adoption in the first quarter of 2018, no significant adjustment to opening retained earnings is expected.

ASU 2014-15, “Presentation of Financial Statements – Going Concern.” ASU 2014-15 requires management to evaluate an entity’s ability to continue as a going concern within one year after the date that the financial statements are issued. Management must evaluate whether conditions and events raise substantial doubt about an entity’s ability to continue as a going concern and then whether its plans alleviate that doubt. ASU 2014-15 was effective in 2016 and management has performed and continues to perform such required evaluation and has concluded there are no such conditions or events that raise substantial doubt about the Company’s ability to continue as a going concern.

ASU 2015-01, “Income Statement – Extraordinary and Unusual Items.” ASU 2015-01 eliminated from U.S. GAAP the concept of extraordinary items, which, among other things, required an entity to show the item separately in the income statement, net of tax, after income from continuing operations. The new guidance became effective for the Company beginning January 1, 2016 and did not have a significant impact on the Company’s financial statements.

 

30


Table of Contents

ASU 2015-05, “Intangibles – Goodwill and Other – Internal-Use Software – Customer’s Accounting for Fees Paid in a Cloud Computing Arrangement.” ASU 2015-05 addresses accounting for fees paid by a customer in cloud computing arrangements such as (i) software as a service, (ii) platform as a service, (iii) infrastructure as a service and (iv) other similar hosting arrangements. ASU 2015-05 provides guidance to customers about whether a cloud computing arrangement includes a software license. If a cloud computing arrangement includes a software license, then the customer should account for the software license element of the arrangement consistent with the acquisition of other software licenses. If a cloud computing arrangement does not include a software license, the customer should account for the arrangement as a service contract. ASU 2015-05 became effective on January 1, 2016 and did not have a significant impact on the Company’s financial statements.

ASU 2015-16, “Business Combinations – Simplifying the Accounting Measurement Period Adjustments.” ASU 2015-16 amended business combination guidance to require that an acquirer recognize adjustments to provisional amounts that are identified during the measurement period in the reporting period in which the adjustment amounts are determined. The acquirer must record, in the same period’s financial statements, the effect of earnings on changes in depreciation, amortization, or other income effects, if any, as a result of the changes to the provisional amounts, calculated as if the accounting had been completed at the acquisition date. Additionally, the entity is required to present separately on the face of the income statement or disclose in the notes the portion of the amount recorded in current-period earnings by line item that would have been recorded in previous reporting periods if the adjustment to the provisional amounts had been recognized as of the acquisition date. The amended guidance became effective for the Company on January 1, 2016 and did not have a significant impact on the Company’s financial statements.

ASU 2016-1, “Financial Instruments – Overall: Recognition and Measurement of Financial Assets and Financial Liabilities.” ASU 2016-1, among other things, (i) requires equity investments, with certain exceptions, to be measured at fair value with changes in fair value recognized in net income, (ii) simplifies the impairment assessment of equity investments without readily determinable fair values by requiring a qualitative assessment to identify impairment, (iii) eliminates the requirement for public business entities to disclose the methods and significant assumptions used to estimate the fair value that is required to be disclosed for financial instruments measured at amortized cost on the balance sheet, (iv) requires public business entities to use the exit price notion when measuring the fair value of financial instruments for disclosure purposes, (v) requires an entity to present separately in other comprehensive income the portion of the total change in the fair value of a liability resulting from a change in the instrument-specific credit risk when the entity has elected to measure the liability at fair value in accordance with the fair value option for financial instruments, (vi) requires separate presentation of financial assets and financial liabilities by measurement category and form of financial asset on the balance sheet or the accompanying notes to the financial statements and (vii) clarifies that an entity should evaluate the need for a valuation allowance on a deferred tax asset related to available-for-sale securities. ASU 2016-1 will be effective for the Company on January 1, 2018 and is not expected to have a significant impact on the Company’s financial statements.

ASU 2016-02, “Leases.” ASU 2016-02 will amend current lease accounting to require lessees to recognize (i) a lease liability, which is a lessee’s obligation to make lease payments arising from a lease, measured on a discounted basis, and (ii) a right-of-use asset, which is an asset that represents the lessee’s right to use, or control the use of, a specified asset for the lease term. ASU 2016-02 does not significantly change lease accounting requirements applicable to lessors; however, certain changes were made to align, where necessary, lessor accounting with the lessee accounting model. The amended guidance will be effective in the first quarter of 2019 and will require transition using a modified retrospective approach for leases existing at, or entered into after, the beginning of the earliest comparative period presented in the financial statements. The Company continues to evaluate the provision of the new lease standard but, due to the small number and dollar amount of lease agreements presently in effect for the Company, has concluded the new guidance will not have a significant impact on the Company’s financial statements.

 

31


Table of Contents

ASU 2016-09, “Compensation – Stock Compensation: Improvements to Employee Share-Based Payment Accounting.” ASU 2016-09 amends current guidance such that all excess tax benefits and tax deficiencies related to share-based payment awards will be recognized as income tax expense or benefit in the income statement during the period in which they occur. Previously, such amounts were recorded in capital surplus. Additionally, excess tax benefits will be classified along with other income tax cash flows as an operating activity rather than a financing activity, as was previously the case. ASU 2016-09 also provides that any entity can make an entity-wide accounting policy election to either estimate the number of awards that are expected to vest, which is the current requirement, or account for forfeitures when they occur. ASU 2016-09 became effective January 1, 2017 and did not have a significant impact on the Company’s financial statements.

ASU 2016-13, “Financial Instruments – Credit Losses.” ASU 2016-13 implements a comprehensive change in estimating the allowances for loan losses from the current model of losses inherent in the loan portfolio to a current expected credit loss model that generally is expected to result in earlier recognition of allowances for losses. Additionally, purchase accounting rules have been modified as well as credit losses on held-to-maturity debt securities. ASU 2016-13 will be effective in the first quarter of 2020. While the Company generally expects that the implementation of ASU 2016-13 will increase their allowance for loan losses balance, the Company is continuing to evaluate the potential impact on the Company’s financial statements.

ASU 2017-04, “Intangibles – Goodwill and Other.” ASU 2017-04 will amend and simplify current goodwill impairment testing to eliminate Step 2 from the current provisions. Under the new guidance, an entity should perform the goodwill impairment test by comparing the fair value of a reporting unit with its carrying value and recognize an impairment charge for the amount by which the carrying amount exceeds the reporting unit’s fair value. An entity still has the option to perform the quantitative assessment for a reporting unit to determine if a quantitative impairment test is necessary. ASU 2017-04 will be effective for the Company on January 1, 2020 and is not expected to have a significant impact on the Company’s financial statements.

ASU 2017-07, “Compensation – Retirement Benefits, Improving the Presentation of Net Periodic Pension Cost and Net Periodic Post-Retirement Benefit Cost.” ASU 2017-17 will require employers that sponsor defined benefit pension plans to present the service cost component of net periodic benefit cost in the same income statement line item as other employee compensation costs arising from services rendered during the period. Other components of the net periodic benefit cost will be presented separately from the service cost component. ASU 2017-17 will be effective in 2018 and, as the Company froze its defined benefit pension plan in 2004, there is no service cost component of its net periodic benefit cost and therefore will not have an impact on the Company’s financial statements.

ASU 2017-08, “Receivables – Nonrefundable Fees and Other Costs: Premium Amortization on Purchased Callable Debt Securities.” ASU 2017-08 addresses the amortization method for all callable bonds purchased at a premium to par. Under the revised guidance, entities will be required to amortize premiums on callable bonds to the earliest call date. ASU 2017-08 is effective in 2019 although early adoption is permitted. The Company elected to early adopt ASU 2017-08 in the first quarter of 2017. The adoption of this guidance did not have a material impact on the Company’s financial statements.

Note 12 - Acquisition Definitive Agreement Signed

On October 12, 2017, the Company announced that it has entered into a definitive agreement to acquire Commercial Bancshares, Inc. and its wholly owned bank subsidiary, Commercial State Bank, El Campo, Texas pursuant to an Agreement and Plan of Reorganization (the “Reorganization Agreement”) dated October 12, 2017, by and among the Company, Kingwood Merger Sub, Inc., a wholly owned subsidiary of the company, and Commercial Bancshares, Inc. for consideration to be paid in shares of Common Stock with an aggregate value of approximately $59,400,000. In addition, Commercial Bancshares, Inc. will make a $15,600,000 special dividend to its shareholders prior to closing of the transaction, which may be increased or decreased for the amount by which Commercial Bancshares, Inc.’s consolidated shareholders’ equity as of the closing date exceeds or is less than $42,400,000, after certain adjustments described in the Reorganization Agreement. At September 30, 2017 Commercial State Bank, Kingwood, Texas had gross loans totaling $263,800,000, total deposits of $322,100,000 and total assets of $366,800,000. Pending regulatory and shareholder approval, the acquisition is expected to close in the first quarter of 2018.

 

32


Table of Contents

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, state and national real estate markets and employment trends;

 

    effect of severe weather conditions, including hurricanes, tornadoes, flooding and drought;

 

    volatility and disruption in national and international financial and commodity markets;

 

    government intervention in the U.S. financial system including the effects of recent legislative, tax, accounting and regulatory actions and reforms, including the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”), the Jumpstart Our Business Startups Act, the Consumer Financial Protection Bureau and the capital ratios of Basel III as adopted by the federal banking authorities;

 

    political instability;

 

    the ability of the Federal government to address the national economy;

 

    changes in our competitive environment from other financial institutions and financial service providers;

 

    the effects of and changes in trade, monetary and fiscal policies and laws, including interest rate policies of the Board of Governors of the Federal Reserve System (the “Federal Reserve Board”);

 

    the effect of changes in accounting policies and practices, as may be adopted by the regulatory agencies, as well as the Public Company Accounting Oversight Board, the Financial Accounting Standards Board and other accounting standard setters;

 

    the effect of changes in laws and regulations (including laws and regulations concerning taxes, banking, securities and insurance) with which we and our subsidiaries must comply;

 

    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;

 

    changes in commodity prices (e.g., oil and gas, cattle and wind energy);

 

    our ability to attract deposits and increase market share;

 

    changes in our liquidity position;

 

    changes in the reliability of our vendors, internal control system or information systems;

 

    cyber attacks on our technology information systems, including fraud from our customers and external third party vendors;

 

    our ability to attract and retain qualified employees;

 

    acquisitions and integration of acquired businesses;

 

    the possible impairment of goodwill associated with our acquisitions;

 

    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;

 

    changes in compensation and benefit plans; and

 

    acts of God or of war or terrorism.

 

33


Table of Contents

Such forward-looking 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 (except as required by law).

Introduction

As a 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, First Financial Bank, National Association, Abilene, Texas. Our largest expense is 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 and analysis 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 2016 Annual Report on Form 10-K.

Critical Accounting Policies

We prepare consolidated financial statements based on GAAP 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.

We deem our most critical accounting policies to be (1) our allowance for loan losses and our provision for loan losses and (2) our valuation of securities. 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. A discussion of (1) our allowance for loan losses and our provision for loan losses and (2) our valuation of securities is included in note 5 and note 4, respectively, to our notes to consolidated financial statements (unaudited) which begins on page 9.

Recent Development

Houston and surrounding areas around the Gulf Coast were significantly affected by Hurricane Harvey beginning in late August 2017 and continuing into September 2017. Our Company has regional locations (i) north of Houston in Conroe, Willis, Tomball, Huntsville, Montgomery, Magnolia and Cut and Shoot and (ii) in Southeast Texas in Orange, Beaumont, Vidor, Newton, Mauriceville and Port Arthur. We continue to evaluate the effect of the hurricane on our branch facilities and our loan and investment portfolios. Our initial assessment of our physical buildings and equipment indicates damage primarily at our Mauriceville branch, and amounts not covered by insurance do not appear to be significant. At September 30, 2017, we have loans totaling $448.82 million in our Conroe region and $397.63 million in the Southeast Texas/Orange region. We are evaluating these loans and the related collateral and business operations underlying such loans. At September 30, 2017, we provided additional allowance for loan and lease losses as deemed appropriate based on this analysis. We continue to evaluate these loans and expect some changes, plus or minus, as we learn more information about to the damage caused by the hurricane. Our tax exempt municipal bonds in the counties of Texas effected by the hurricane have been evaluated, including insurance on the bonds. At September 30, 2017, our municipal bonds in these counties totaled $254.48 million but only $9.13 million does not have bond insurance. Based on analysis of these bonds and the related municipality, at September 30, 2017, we do not believe we have any credit related losses other than temporary impairment.

 

34


Table of Contents

Results of Operations

Performance Summary. Net earnings for the third quarter of 2017 were $29.37 million compared to $25.60 million for the same quarter in 2016, or a 14.73% increase.

Basic earnings per share for the third quarter of 2017 were $0.44 compared to $0.39 for the same quarter last year. The return on average assets was 1.65% for the third quarter of 2017, as compared to 1.54% for the third quarter of 2016. The return on average equity was 12.95% for the third quarter of 2017 as compared to 11.72% for the third quarter of 2016.

Net earnings for the nine-month period ended September 30, 2017 were $84.23 million compared to $78.11 million for the same period in 2016, or a 7.83% increase.

Basic earnings per share for the first nine months of 2017 were $1.27 compared to $1.18 for the same period in 2016. The return on average assets was 1.62% for the first nine months of 2017 as compared to 1.59% for the same period in 2016. The return on average equity was 12.88% for the first nine months of 2017, as compared to 12.33% a year ago.

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 $66.00 million for the third quarter of 2017, as compared to $63.00 million for the same period last year. The increase in 2017 compared to 2016 was largely attributable to the increase in interest earning assets, particularly loans and taxable securities. Average earning assets increased $431.96 million for the third quarter of 2017 over the same period in 2016. Average loans and taxable securities increased $119.07 million and $187.14 million, respectively, for the third quarter of 2017 over the same quarter of 2016. Average interest-bearing liabilities increased $222.71 million for the third quarter of 2017, as compared to the same period in 2016. The yield on earning assets decreased one basis points and the rate paid on interest-bearing liabilities increased fourteen basis points for the third quarter of 2017 compared to the third quarter of 2016.

Tax-equivalent net interest income was $195.16 million for the first nine months of 2017, as compared to $188.86 million for the same period last year. The increase in 2017 compared to 2016 was largely attributable to the increase in volume of interest earning assets. Average earning assets increased $363.44 million for the first nine months of 2017 over the same period in 2016. Average loans and taxable securities increased $99.77 million and $125.78 million, respectively, for the first nine months of 2017 over the same period of 2016. Average interest-bearing liabilities increased $223.70 million for the first nine months of 2017, as compared to the same period in 2016. The yield on earning assets decreased five basis points and the rate paid on interest-bearing liabilities increased eight basis points for the first nine months of 2017 over the first nine months of 2016.

 

35


Table of Contents

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, 2017 Compared to
Three Months Ended

September 30, 2016
     Nine Months Ended
September 30, 2017 Compared to
Nine Months Ended

September 30, 2016
 
     Change
Attributable to
     Total
Change
     Change
Attributable to
    Total
Change
 
     Volume     Rate         Volume     Rate    

Short-term investments

   $ 175     $ 364      $ 539      $ 312     $ 503     $ 815  

Taxable investment securities

     971       328        1,299        2,008       673       2,681  

Tax-exempt investment securities (1)

     (13     356        343        2,139       407       2,546  

Loans (1) (2)

     1,456       866        2,322        3,672       (687     2,985  
  

 

 

   

 

 

    

 

 

    

 

 

   

 

 

   

 

 

 

Interest income

     2,589       1,914        4,503        8,131       896       9,027  

Interest-bearing deposits

     86       1,031        1,117        325       2,226       2,551  

Short-term borrowings

     (20     404        384        (176     343       167  
  

 

 

   

 

 

    

 

 

    

 

 

   

 

 

   

 

 

 

Interest expense

     66       1,435        1,501        149       2,569       2,718  
  

 

 

   

 

 

    

 

 

    

 

 

   

 

 

   

 

 

 

Net interest income

   $ 2,523     $ 479      $ 3,002      $ 7,982     $ (1,673   $ 6,309  
  

 

 

   

 

 

    

 

 

    

 

 

   

 

 

   

 

 

 

 

(1) Computed on a tax-equivalent basis assuming a marginal tax rate of 35%.
(2) Non-accrual loans are included in loans.

The net interest margin for the third quarter of 2017 was 3.94%, a decrease of ten basis points from the same period in 2016. The continued decrease in our net interest margin in 2017 and 2016 was largely the result of the extended period of historically low levels of short-term interest rates. We have been able to somewhat mitigate the impact of lower short-term interest rates by establishing minimum interest rates on certain of our loans, improving the pricing for loan risk, and minimizing rates paid on interest bearing liabilities.

The net interest margin for the nine months ending September 30, 2017 was 4.01%, a decrease of nine basis points from the same period in 2016. The continued decrease in our net interest margin in 2017 and 2016 was largely the result of the extended period of historically low levels of short-term interest rates. We have been able to somewhat mitigate the impact of lower short-term interest rates by establishing minimum interest rates on certain of our loans, improving the pricing for loan risk, and minimizing rates paid on interest bearing liabilities.

 

36


Table of Contents

The net interest margin, which measures tax-equivalent net interest income as a percentage of average earning assets, is illustrated in Table 2.

Table 2 - Average Balances and Average Yields and Rates (in thousands, except percentages):

 

     Three Months Ended September 30,  
     2017     2016  
     Average
Balance
    Income/
Expense
     Yield/
Rate
    Average
Balance
    Income/
Expense
     Yield/
Rate
 

Assets

              

Short-term investments (1)

   $ 200,789     $ 638        1.26   $ 73,881     $ 99        0.53

Taxable investment securities (2)

     1,492,246       8,074        2.16       1,305,103       6,775        2.08  

Tax-exempt investment securities (2)(3)

     1,477,559       16,884        4.57       1,478,719       16,541        4.47  

Loans (3)(4)

     3,468,524       43,270        4.95       3,349,458       40,948        4.86  
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

    

 

 

 

Total earning assets

     6,639,118     $ 68,866        4.12     6,207,161     $ 64,363        4.13

Cash and due from banks

     157,983            152,080       

Bank premises and equipment, net

     123,550            122,944       

Other assets

     55,428            55,358       

Goodwill and other intangible assets, net

     141,776            143,854       

Allowance for loan losses

     (47,667          (45,997     
  

 

 

        

 

 

      

Total assets

   $ 7,070,188          $ 6,635,400       
  

 

 

        

 

 

      

Liabilities and Shareholders’ Equity

              

Interest-bearing deposits

   $ 3,728,442     $ 2,228        0.24   $ 3,460,208     $ 1,111        0.13

Short-term borrowings

     524,357       638        0.48       569,883       254        0.18  
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

    

 

 

 

Total interest-bearing liabilities

     4,252,799     $ 2,866        0.27     4,030,091     $ 1,365        0.13

Noninterest-bearing deposits

     1,864,144            1,663,460       

Other liabilities

     53,537            72,611       
  

 

 

        

 

 

      

Total liabilities

     6,170,480            5,766,162       

Shareholders’ equity

     899,708            869,238       
  

 

 

        

 

 

      

Total liabilities and shareholders’ equity

   $ 7,070,188          $ 6,635,400       
  

 

 

        

 

 

      

Net interest income

     $ 66,000          $ 62,998     
    

 

 

        

 

 

    

Rate Analysis:

              

Interest income/earning assets

          4.12          4.13

Interest expense/earning assets

          0.18            0.09  
       

 

 

        

 

 

 

Net yield on earning assets

          3.94          4.04
       

 

 

        

 

 

 

 

 

37


Table of Contents
     Nine Months Ended September 30,  
     2017     2016  
     Average
Balance
    Income/
Expense
     Yield/
Rate
    Average
Balance
    Income/
Expense
     Yield/
Rate
 

Assets

              

Short-term investments (1)

   $ 129,945     $ 1,036        1.07   $ 54,908     $ 221        0.54

Taxable investment securities (2)

     1,451,712       23,848        2.19       1,325,935       21,167        2.13  

Tax-exempt investment securities (2)(3)

     1,511,786       51,859        4.57       1,448,933       49,313        4.54  

Loans (3)(4)

     3,419,105       125,147        4.89       3,319,337       122,162        4.92  
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

    

 

 

 

Total earning assets

     6,512,548     $ 201,890        4.14     6,149,113     $ 192,863        4.19

Cash and due from banks

     159,202            151,485       

Bank premises and equipment, net

     123,110            119,664       

Other assets

     57,191            55,094       

Goodwill and other intangible assets, net

     142,885            144,091       

Allowance for loan losses

     (47,021          (44,487     
  

 

 

        

 

 

      

Total assets

   $ 6,947,915          $ 6,574,960       
  

 

 

        

 

 

      

Liabilities and Shareholders’ Equity

              

Interest-bearing deposits

   $ 3,779,967     $ 5,748        0.20   $ 3,431,572     $ 3,197        0.12

Short-term borrowings

     448,773       978        0.29       573,464       811        0.19  
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

    

 

 

 

Total interest-bearing liabilities

     4,228,740     $ 6,726        0.21     4,005,036     $ 4,008        0.13

Noninterest-bearing deposits

     1,797,174            1,656,935       

Other liabilities

     47,720            66,855       
  

 

 

        

 

 

      

Total liabilities

     6,073,634            5,728,826       

Shareholders’ equity

     874,281            846,134       
  

 

 

        

 

 

      

Total liabilities and shareholders’ equity

   $ 6,947,915          $ 6,574,960       
  

 

 

        

 

 

      

Net interest income

     $ 195,164          $ 188,855     
    

 

 

        

 

 

    

Rate Analysis:

              

Interest income/earning assets

          4.14          4.19

Interest expense/earning assets

          0.13            0.09  
       

 

 

        

 

 

 

Net yield on earning assets

          4.01          4.10
              

 

(1) Short-term investments are comprised of Fed Funds sold, interest-bearing deposits in banks and interest-bearing time deposits in banks.
(2) Average balances include unrealized gains and losses on available-for-sale securities.
(3) Computed on a tax-equivalent basis assuming a marginal tax rate of 35%.
(4) Non-accrual loans are included in loans.

Noninterest Income. Noninterest income for the third quarter of 2017 was $24.26 million, an increase of $2.11 million compared to the same period in 2016. Trust fees increased 19.23 percent to $6.04 million in the third quarter of 2017 compared with $5.07 million in the same quarter last year, due to continued growth in the fair value of trust assets managed to $4.92 billion from $4.22 billion a year ago and an increase in Trust fees. Service charges on deposit accounts increased 5.98 percent to $5.08 million compared with $4.80 million in the same quarter last year due to continued growth in net new accounts. ATM, interchange and credit card fees increased 5.67 percent to $6.34 million compared with $6.00 million in the same quarter last year due to continued growth in debit cards. Also included in noninterest income during the third quarter of 2017 were gains on the sale of securities of $1.08 million, an increase of $836 thousand when compared to the same quarter in 2016, and an increase of $629 thousand in other noninterest income when compared to the same period a year ago which largely resulted from a $505 thousand litigation settlement in the third quarter of 2017. Real estate mortgage fees decreased in the third quarter of 2017 to $3.89 million compared with $4.70 million in the same quarter a year ago and interest on loan recoveries decreased $304 thousand in the third quarter of 2017 compared to the same period in 2016.

Noninterest income for the nine-month period ended September 30, 2017 was $68.72 million, an increase of $5.31 million compared to the same period in 2016. Trust fees increased 23.25 percent to $17.80 million in the first nine months of 2017 compared with $14.45 million in the same period in 2016 due primarily to continued growth in the fair value of trust assets managed to $4.92 billion from $4.22 billion a year ago and an increase in Trust fees. Service charges on deposits increased 6.63 percent to $14.52

 

38


Table of Contents

million compared with $13.61 million in the same period last year due primarily to the continued growth in net new accounts. ATM, interchange and credit card fees increased 9.02 percent to $19.10 million compared with $17.52 million in the same period last year due to continued growth in debit cards. Also included in noninterest income for the nine-month period ended September 30, 2017 were gains on the sale of securities of $1.83 million, an increase of $672 thousand when compared to the same period in 2016, and an increase of $524 thousand in other noninterest income when compared to the same period a year ago which largely resulted from a $505 thousand litigation settlement in the third quarter of 2017. Real estate mortgage fees and interest on loan recoveries decreased $353 thousand and $1.07 million, respectively for the nine-month period ending September 30, 2017 when compared to the same period a year ago.

ATM and interchange fees are charges that merchants pay to us and other card-issuing banks for processing electronic payment transactions. ATM and interchange fees consist of income from debit card usage, point of sale income for debit card transactions and ATM service fees. Federal Reserve rules applicable to financial institutions that have assets of $10 billion or more provide that the maximum permissible interchange fee for an electronic debit transaction is the sum of 21 cents per transaction and 5 basis points multiplied by the value of the transaction. While we currently have assets under $10 billion, we are monitoring the effect of this reduction in per transaction fee income as we approach the $10 billion asset level.

Table 3 - Noninterest Income (in thousands):

 

     Three Months Ended
September 30,
    Nine Months Ended
September 30,
 
     2017     Increase
(Decrease)
    2016     2017     Increase
(Decrease)
    2016  

Trust fees

   $ 6,040     $ 974     $ 5,066     $ 17,804     $ 3,358     $ 14,446  

Service charges on deposit accounts

     5,083       287       4,796       14,517       903       13,614  

ATM, interchange and credit card fees

     6,340       340       6,000       19,102       1,581       17,521  

Real estate mortgage operations

     3,891       (806     4,697       11,496       (353     11,849  

Net gain on sale of available-for-sale securities

     1,075       836       239       1,825       672       1,153  

Net gain (loss) on sale of foreclosed assets

     (11     (1     (10     (42     (385     343  

Net gain (loss) on sale of assets

     (15     153       (168     (211     (482     271  

Interest on loan recoveries

     405       (304     709       896       (1,074     1,970  

Other:

            

Check printing fees

     40       (11     51       121       (16     137  

Safe deposit rental fees

     108       (7     115       424       (2     426  

Credit life fees

     156       (83     239       439       (29     468  

Brokerage commissions

     323       276       47       908       608       300  

Miscellaneous income

     825       454       371       1,436       524       912  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total other

     1,452       629       823       3,328       1,085       2,243  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total Noninterest Income

   $ 24,260     $ 2,108     $ 22,152     $ 68,715     $ 5,305     $ 63,410  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Noninterest Expense. Total noninterest expense for the third quarter of 2017 was $43.96 million, an increase of $1.96 million compared to $42.00 million in the same period of 2016. An important measure in determining whether a financial institution effectively manages noninterest expense is the efficiency ratio, which is calculated by dividing noninterest expense by the sum of net interest income on a tax-equivalent basis and noninterest income. Lower ratios indicate better efficiency since more income is generated with a lower noninterest expense total. Our efficiency ratio for the third quarter of 2017 was 48.71%, compared to 49.33% for the same period in 2016.

Salaries and employee benefits for the third quarter of 2017 totaled $24.14 million, an increase of $1.21 million compared to the same period in 2016. The increase was primarily driven by (i) annual merit pay increases that were effective March 1, 2017 (ii) an increase in our profit sharing expenses of $353 thousand over the same quarter in 2016 and (iii) an increase in stock option and stock grant expense of $574 thousand due to the stock option grant in June 2017.

 

39


Table of Contents

All other categories of noninterest expense for the third quarter of 2017 totaled $19.82 million, an increase of $749 thousand compared to the same quarter in 2016. This increase primarily resulted from increases in operational and other losses of $548 thousand due to fraud and weather related losses and software amortization and expense of $252 thousand from the write-off of software costs as compared to the same period in 2016.

Total noninterest expense for the first nine months of 2017 was $129.89 million, an increase of $6.05 million, compared to $123.84 million in the same period of 2016. Our efficiency ratio for the first nine months of 2017 was 49.22%, compared to 49.09% from the same period in 2016.

Salaries and employee benefits for the first nine months of 2017 totaled $70.87 million, an increase of $3.20 million compared to the same period in 2016. The increase was primarily driven by (i) annual pay increases that were effective March 1, 2017 (ii) an increase in our profit sharing expense over the same period in 2016 and (iii) an increase in stock option and stock grant expense of $657 thousand due to the stock option grant in June 2017.

All other categories of noninterest expense for the first nine months of 2017 totaled $59.02 million, an increase of approximately $2.85 million, as compared to the same period in 2016. The increase primarily resulted from increases in operational and other losses of $1.19 million due to fraud and weather related losses, professional and services fees of $779 thousand and software amortization and expense of $756 thousand from the write-off of software costs as compared to the same period in 2016.

 

40


Table of Contents

Table 4 - Noninterest Expense (in thousands):                

 

     Three Months Ended September 30,      Nine Months Ended September 30,  
     2017      Increase
(Decrease)
    2016      2017      Increase
(Decrease)
    2016  

Salaries

   $ 18,166      $ 320     $ 17,846      $ 54,022      $ 1,439     $ 52,583  

Medical

     2,125        (97     2,222        6,201        (248     6,449  

Profit sharing

     1,091        353       738        3,074        1,181       1,893  

Pension

     84        2       82        253        6       247  

401(k) match expense

     603        12       591        1,829        35       1,794  

Payroll taxes

     1,191        48       1,143        3,907        129       3,778  

Stock option and stock grant expense

     883        574       309        1,581        657       924  
  

 

 

    

 

 

   

 

 

    

 

 

    

 

 

   

 

 

 

Total salaries and employee benefits

     24,143        1,212       22,931        70,867        3,199       67,668  

Net occupancy expense

     2,711        39       2,672        8,081        195       7,886  

Equipment expense

     3,294        (126     3,420        10,397        211       10,186  

FDIC assessment fees

     561        48       513        1,657        (498     2,155  

ATM, interchange and credit card expense

     2,001        142       1,859        5,517        165       5,352  

Professional and service fees

     2,036        153       1,883        5,878        779       5,099  

Printing, stationery and supplies

     449        (87     536        1,423        (81     1,504  

Operational and other losses

     1,081        548       533        2,639        1,187       1,452  

Amortization of intangible assets

     143        (29     172        477        (93     570  

Other:

               

Data processing fees

     349        230       119        896        563       333  

Postage

     399        (7     406        1,232        9       1,223  

Advertising

     894        (30     924        2,649        (6     2,655  

Correspondent bank service charges

     215        (25     240        662        (64     726  

Telephone

     737        (146     883        2,303        (185     2,488  

Public relations and business development

     633        (172     805        1,997        (58     2,055  

Directors’ fees

     387        86       301        1,125        125       1,000  

Audit and accounting fees

     385        (55     440        1,246        (94     1,340  

Legal fees

     331        (148     479        1,429        (103     1,532  

Regulatory exam fees

     296        15       281        880        32       848  

Software amortization and expense

     742        252       490        2,237        756       1,481  

Travel

     276        (56     332        892        (46     938  

Courier expense

     237        15       222        657        32       625  

Other real estate

     14        (20     34        102        (74     176  

Other miscellaneous expense

     1,650        122       1,528        4,648        100       4,548  
  

 

 

    

 

 

   

 

 

    

 

 

    

 

 

   

 

 

 

Total other

     7,545        61       7,484        22,955        987       21,968  
  

 

 

    

 

 

   

 

 

    

 

 

    

 

 

   

 

 

 

Total Noninterest Expense

   $ 43,964      $ 1,961     $ 42,003      $ 129,891      $ 6,051     $ 123,840  
  

 

 

    

 

 

   

 

 

    

 

 

    

 

 

   

 

 

 

 

41


Table of Contents

Balance Sheet Review

Loans. Our portfolio is comprised of loans made to businesses, professionals, individuals, and farm and ranch operations located in the primary trade areas served by our subsidiary bank. Real estate loans represent loans primarily for 1-4 family residences and commercial real estate. The structure of loans in the real estate mortgage area generally provides re-pricing intervals to minimize the interest rate risk inherent in long-term fixed rate loans. As of September 30, 2017, total loans held for investment were $3.47 billion, an increase of $114.92 million, as compared to December 31, 2016 balances. As compared to December 31, 2016, commercial loans increased $537 thousand, agricultural loans decreased $1.02 million, real estate loans increased $107.71 million, and consumer loans increased $7.69 million. Loans averaged $3.47 billion during the third quarter of 2017, an increase of $119.07 million from the prior year third quarter average balances. Loans averaged $3.42 billion during the nine-month period ended September 30, 2017, an increase of $99.77 million from the prior year nine-month average balances.

Table 5 - Composition of Loans (in thousands):

 

     September 30,      December 31,  
     2017      2016      2016  

Commercial

   $ 674,947      $ 663,581      $ 674,410  

Agricultural

     83,005        84,716        84,021  

Real estate

     2,297,556        2,191,260        2,189,844  

Consumer

     416,719        398,236        409,032  
  

 

 

    

 

 

    

 

 

 

Total loans held-for-investment

   $ 3,472,227      $ 3,337,793      $ 3,357,307  
  

 

 

    

 

 

    

 

 

 

At September 30, 2017, our real estate loans represent approximately 66.17% of our loan portfolio and are comprised of (i) 1-4 family residence loans of 45.83%, (ii) commercial real estate loans of 23.91%, generally owner occupied, (iii) other loans, which includes ranches, hospitals and universities, of 16.09%, (iv) residential development and construction loans of 7.88%, which includes our custom and speculation home construction loans and (v) commercial development and construction loans of 6.29%.

Loans held for sale, consisting of secondary market mortgage loans, totaled $19.12 million, $31.59 million, and $26.90 million at September 30, 2017 and 2016, and December 31, 2016 respectively, which are valued using the lower of cost or market method.

Asset Quality. Our loan portfolio is subject to periodic reviews by our centralized independent loan review group as well as periodic examinations by bank regulatory agencies. Loans are placed on nonaccrual status when, in the judgment of management, the collectability of principal or interest under the original terms becomes doubtful. Nonaccrual, past due 90 days or more and still accruing, and restructured loans plus foreclosed assets were $22.08 million at September 30, 2017, as compared to $34.94 million at September 30, 2016 and $29.00 million at December 31, 2016. As a percent of loans and foreclosed assets, these assets were 0.63% at September 30, 2017, as compared to 1.04% at September 30, 2016 and 0.86% at December 31, 2016. As a percent of total assets, these assets were 0.31% at September 30, 2017, as compared to 0.52% at September 30, 2016 and 0.43% at December 31, 2016. We believe the level of these assets to be manageable and are not aware of any material classified credits not properly disclosed as nonperforming at September 30, 2017.

 

42


Table of Contents

Supplemental Oil and Gas Information. As of September 30, 2017, the Company’s exposure to the oil and gas industry totaled 1.99% of gross loans, or $69.43 million, down $9.05 million from December 31, 2016 year-end levels, and consisted (based on collateral supporting the loan) of (i) development and production loans of 2.65%, (ii) oil and gas field servicing loans of 6.91%, (iii) real estate loans of 40.77%, (iv) accounts receivable and inventory of 24.40% and (v) other of 25.27%. While the overall state of the Company’s oil and gas portfolio has improved, price fluctuations from the upper $40 to lower $50 continue to cause stress on several of our credits. The Company instituted additional monitoring procedures for these loans and classified, downgraded and charged-off loans as appropriate. The following oil and gas information is as of and for the quarters ended September 30, 2017 and 2016, and December 31, 2016:

 

     September 30,     December 31,  
     2017     2016     2016  

Oil and gas related loans

   $ 69,433     $ 86,785     $ 78,483  

Oil and gas related loans as a % of total loans

     1.99     2.58     2.32

Classified oil and gas related loans

     21,817     $ 31,541     $ 32,518  

Nonaccrual oil and gas related loans

     1,569       5,140       4,092  

Net charge-offs for oil and gas related loans for quarter/year then ended

     —         104       1,145  

Allowance for oil and gas related loans as a % of oil and gas loans

     6.03     5.60     6.28

Table 6 - Non-accrual, Past Due 90 Days or More and Still Accruing, Restructured Loans and Foreclosed Assets (in thousands, except percentages):

 

     September 30,     December 31,  
     2017     2016     2016  

Non-accrual loans*

   $ 18,750     $ 33,712     $ 27,371  

Loans still accruing and past due 90 days or more

     257       107       284  

Troubled debt restructured loans**

     668       750       701  
  

 

 

   

 

 

   

 

 

 

Nonperforming Loans

     19,675       34,569       28,356  

Foreclosed assets

     2,401       369       644  
  

 

 

   

 

 

   

 

 

 

Total nonperforming assets

   $ 22,076     $ 34,938     $ 29,000  
  

 

 

   

 

 

   

 

 

 

As a % of loans and foreclosed assets

     0.63     1.04     0.86

As a % of total assets

     0.31     0.52     0.43

* Includes $736 thousand, $1.85 million and $1.26 million of purchased credit impaired loans as of September 30, 2017 and 2016, and December 31, 2016, respectively.

** Other troubled debt restructured loans of $5.28 million, $7.51 million and $6.86 million, whose interest collection, after considering economic and business conditions and collection efforts, is doubtful are included in non-accrual loans at September 30, 2017 and 2016, and December 31, 2016, respectively.

We record interest payments received on non-accrual loans as reductions of principal. Prior to the loans being placed on non-accrual, we recognized interest income on impaired loans of approximately $790 thousand for the year ended December 31, 2016. If interest on these impaired loans had been recognized on a full accrual basis during the year ended December 31, 2016, such income would have approximated $2.90 million. Such amounts for the 2017 and 2016 interim periods were not significant.

 

43


Table of Contents

Provision and Allowance for Loan Losses. The allowance for loan losses is the amount we determine as of a specific date to be appropriate to absorb probable losses on existing loans in which full collectability is unlikely based on our review and evaluation of the loan portfolio. For a discussion of our methodology, see note 5 to our notes to the consolidated financial statements (unaudited). The provision for loan losses was $1.42 million for the third quarter of 2017, as compared to $3.83 million for the third quarter of 2016. The provision for loan losses was $5.09 million for the nine-month period ended 2017 as compared to $8.22 million for the same period in 2016. The continued provision for loan losses in 2017 and 2016 reflects the growth in the loan portfolio, the continued levels of gross charge-offs and the effects related to Hurricane Harvey on the loan portfolio. As a percent of average loans, net loan charge-offs were 0.10% for the third quarter of 2017, as compared to 0.43% for the third quarter of 2016. As a percent of average loans, net loan charge-offs were 0.12% for the first nine months of 2017, as compared to 0.19% for the first nine months of 2016. The allowance for loan losses as a percent of loans was 1.37% as of September 30, 2017, as compared to 1.34% as of September 30, 2016 and 1.35% as of December 31, 2016. Included in Table 7 is further analysis of our allowance for loan losses.

Table 7 - Loan Loss Experience and Allowance for Loan Losses (in thousands, except percentages):

 

     Three Months Ended
September 30,
    Nine Months Ended
September 30,
 
     2017     2016     2017     2016  

Allowance for loan losses at period-end

   $ 47,922     $ 45,298     $ 47,922     $ 45,298  

Loans held for investment at period-end

     3,472,227       3,337,793       3,472,227       3,337,793  

Average loans for period

   $ 3,468,524     $ 3,349,458     $ 3,419,105     $ 3,319,337  

Net charge-offs/average loans (annualized)

     0.10     0.43     0.12     0.19

Allowance for loan losses/period-end loans

     1.37     1.34     1.37     1.34

Allowance for loan losses/non-accrual loans, past due 90 days still accruing and restructured loans

     243.57     131.04     243.57     131.04

Interest-Bearing Deposits in Banks. At September 30, 2017, our interest-bearing deposits in banks were $168.28 million compared to $119.04 million at September 30, 2016 and $50.28 million at December 31, 2016, respectively. At September 30, 2017, interest-bearing deposits in banks included $1.46 million invested in FDIC-insured certificates of deposit, $166.26 million maintained at the Federal Reserve Bank of Dallas and $556 thousand on deposit with the Federal Home Loan Bank of Dallas (“FHLB”).

Available-for-Sale and Held-to-Maturity Securities. At September 30, 2017, securities with a fair value of $2.89 billion were classified as securities available-for-sale. As compared to December 31, 2016, the available-for-sale portfolio at September 30, 2017 reflected (i) a decrease of $10.67 million in U.S. Treasury securities (ii) a decrease of $40.12 million in obligations of U.S. government sponsored enterprises and agencies, (iii) a decrease of $130.08 million in obligations of states and political subdivisions, (iv) a decrease of $32.84 million in corporate bonds and other, and (v) an increase of $238.35 million in mortgage-backed securities. Our mortgage related securities are backed by GNMA, FNMA or FHLMC or are collateralized by securities backed by these agencies.

See note 4 to the consolidated financial statements (unaudited) for additional disclosures relating to the investment portfolio at September 30, 2017 and 2016, and December 31, 2016.

 

44


Table of Contents

Table 8 - Maturities and Yields of Available-for-Sale Securities Held at September 30, 2017 (in thousands, except percentages):

 

     Maturing  
     One Year
or Less
    After One Year
Through
Five Years
    After Five Years
Through
Ten Years
    After
Ten Years
    Total  

Available-for-Sale:

   Amount      Yield     Amount      Yield     Amount      Yield     Amount      Yield     Amount      Yield  

Obligations of U.S. government sponsored enterprises and agencies

   $ 33,038        1.16   $ 40,550        1.47   $ —          —     $ —          —     $ 73,588        1.33

Obligations of states and political subdivisions

     136,783        5.02       638,745        5.14       656,623        4.73       2,043        6.86       1,434,194        4.94  

Corporate bonds and other securities

     19,315        2.72       240        1.15       —          —         —          —         19,555        2.70  

Mortgage-backed securities

     18,469        2.31       1,062,189        2.24       227,721        2.64       49,767        2.80       1,358,146        2.33  
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Total

   $ 207,605        3.95   $ 1,741,724        3.28   $ 884,344        4.19   $ 51,810        2.96   $ 2,885,483        3.60
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Amounts for held-to-maturity securities are not included herein due to insignificance.

All yields are computed on a tax-equivalent basis assuming a marginal tax rate of 35%. Yields on available-for-sale securities are based on amortized cost. Maturities of mortgage-backed securities are based on contractual maturities and could differ due to prepayments of underlying mortgages. Maturities of other securities are reported at the earlier of maturity date or call date.

As of September 30, 2017, the investment portfolio had an overall tax equivalent yield of 3.60%, a weighted average life of 4.18 years and modified duration of 3.74 years.

Deposits. Deposits held by our subsidiary bank represent our primary source of funding. Total deposits were $5.70 billion as of September 30, 2017, as compared to $5.24 billion as of September 30, 2016 and $5.48 billion as of December 31, 2016. Table 9 provides a breakdown of average deposits and rates paid for the three and nine months periods ended September 30, 2017 and 2016.

Table 9 - Composition of Average Deposits (in thousands, except percentages):

 

     Three Months Ended September 30,  
     2017     2016  
     Average
Balance
     Average
Rate
    Average
Balance
     Average
Rate
 

Noninterest-bearing deposits

   $ 1,864,144        —     $ 1,663,460        —  

Interest-bearing deposits:

          

Interest-bearing checking

     1,878,400        0.31       1,688,540        0.11  

Savings and money market accounts

     1,378,258        0.14       1,230,111        0.09  

Time deposits under $100,000

     208,848        0.17       233,443        0.18  

Time deposits of $100,000 or more

     262,936        0.32       308,114        0.32  
  

 

 

    

 

 

   

 

 

    

 

 

 

Total interest-bearing deposits

     3,728,442        0.24     3,460,208        0.13
  

 

 

    

 

 

   

 

 

    

 

 

 

Total average deposits

   $ 5,592,586        $ 5,123,668     
  

 

 

      

 

 

    

 

45


Table of Contents
     Nine Months Ended September 30,  
     2017     2016  
     Average
Balance
     Average
Rate
    Average
Balance
     Average
Rate
 

Noninterest-bearing deposits

   $ 1,797,174        —     $ 1,656,935        —  

Interest-bearing deposits:

          

Interest-bearing checking

     1,882,295        0.25       1,712,095        0.11  

Savings and money market accounts

     1,410,824        0.13       1,146,368        0.07  

Time deposits under $100,000

     214,653        0.17       241,031        0.18  

Time deposits of $100,000 or more

     272,195        0.32       332,078        0.31  
  

 

 

    

 

 

   

 

 

    

 

 

 

Total interest-bearing deposits

     3,779,967        0.20       3,431,572        0.12
  

 

 

    

 

 

   

 

 

    

 

 

 

Total average deposits

   $ 5,577,141        $ 5,088,507     
  

 

 

      

 

 

    

Borrowings. Included in borrowings were federal funds purchased, securities sold under repurchase agreements and advances from the FHLB of $351.44 million, $513.76 million and $445.77 million at September 30, 2017 and 2016 and December 31, 2016, respectively. Securities sold under repurchase agreements are generally with significant customers of the Company that require short-term liquidity for their funds for which we pledge certain securities that have a fair value equal to at least the amount of the borrowings. The average balance of federal funds purchased, securities sold under repurchase agreements and advances from the FHLB were $524.36 million and $569.88 million in the third quarter of 2017 and 2016, respectively. The weighted average interest rates paid on these borrowings were 0.48% and 0.18% for the third quarters of 2017 and 2016, respectively. The average balances of federal funds purchased, securities sold under repurchase agreements and advances from the FHLB was $448.77 million and $573.46 million for the nine-month periods ended September 30, 2017 and 2016, respectively. The weighted average interest rate paid on these short-term borrowings was 0.29% and 0.19% for the first nine months of 2017 and 2016, respectively.

Capital Resources

We evaluate capital resources by our ability to maintain adequate regulatory capital ratios to do business in the banking industry. Issues related to capital resources arise primarily when we are growing at an accelerated rate but not retaining a significant amount of our profits or when we experience significant asset quality deterioration.

Total shareholders’ equity was $906.56 million, or 12.93% of total assets at September 30, 2017, as compared to $867.94 million, or 12.98% of total assets at September 30, 2016 and $837.89 million, or 12.30% of total assets at December 31, 2016. Included in shareholders’ equity at September 30, 2017 and 2016 and December 31, 2016, were $38.95 million, $68.31 million and $21.49 million, respectively, in unrealized gains on investment securities available-for-sale, net of related income taxes. For the third quarter of 2017, total shareholders’ equity averaged $899.71 million, or 12.73% of average assets, as compared to $869.24 million, or 13.10% of average assets, during the same period in 2016. For the nine months ended September 30, 2017, total shareholders’ equity averaged $874.28 million, or 12.58%, as compared to $846.13 million or 12.87% of total assets during the same period in 2016.

Banking regulators measure capital adequacy by means of the risk-based capital ratios and the leverage ratio under the Basel III regulatory capital framework and prompt corrective action regulations. The risk-based capital rules provide for the weighting of assets and off-balance-sheet commitments and contingencies according to prescribed risk categories. Regulatory capital is then divided by risk-weighted assets to determine the risk-adjusted capital ratios. The leverage ratio is computed by dividing shareholders’ equity less intangible assets by quarter-to-date average assets less intangible assets.

 

46


Table of Contents

Beginning in January 2016, under the Basel III regulatory capital framework, the implementation of the capital conservation buffer was effective for the Company starting at the 0.625% level and increasing 0.625% each year thereafter, until it reaches 2.5% on January 1, 2019. The capital conservation buffer is designed to absorb losses during periods of economic stress and requires increased capital levels for the purpose of capital distributions and other payments. Failure to meet the amount of the buffer will result in restrictions on the Company’s ability to make capital distributions, including dividend payments and stock repurchases, and to pay discretionary bonuses to executive officers.

As of September 30, 2017 and 2016, and December 31, 2016, we had a total capital to risk-weighted assets ratio of 19.54%, 18.28% and 18.45%, a Tier 1 capital to risk-weighted assets ratio of 18.35%, 17.12% and 17.30%; a common equity Tier 1 to risk-weighted assets ratio of 18.35%, 17.12% and 17.30% and a leverage ratio of 10.84%, 10.60% and 10.71%, respectively. The regulatory capital ratios as of September 30, 2017 and 2016, and December 31, 2016 were calculated under Basel III rules. There is no threshold for well-capitalized status for bank holding companies.

As of September 30, 2017 and 2016, and December 31, 2016, the regulatory capital ratios of the Company and Bank under the Basel III regulatory capital framework are as follows:    

 

     Actual     Minimum Capital
Required Under
Basel III Phase-In
    Minimum Capital
Required-Basel III
Fully Phased-In
    Required to be
Considered Well-
Capitalized
 

As of September 30, 2017:

   Amount      Ratio     Amount      Ratio     Amount      Ratio     Amount      Ratio  

Total Capital to Risk-Weighted Assets:

                    

Consolidated

   $ 794,388        19.54   $ 376,053        9.25   $ 426,872        10.50     —          N/A  

First Financial Bank, N.A

   $ 693,155        17.10   $ 375,032        9.25   $ 425,712        10.50   $ 405,440        10.00

Tier 1 Capital to Risk-Weighted Assets:

                    

Consolidated

   $ 745,856        18.35   $ 294,745        7.25   $ 345,563        8.50     —          N/A  

First Financial Bank, N.A

   $ 644,623        15.90   $ 293,944        7.25   $ 344,624        8.50   $ 324,352        8.00

Common Equity Tier 1 Capital to Risk-Weighted Assets:

                    

Consolidated

   $ 745,856        18.35   $ 233,763        5.75   $ 284,581        7.00     —          N/A  

First Financial Bank, N.A

   $ 644,623        15.90   $ 233,128        5.75   $ 283,808        7.00   $ 263,536        6.50

Leverage Ratio:

                    

Consolidated

   $ 745,856        10.84   $ 275,265        4.00   $ 275,265        4.00     —          N/A  

First Financial Bank, N.A

   $ 644,623        9.40   $ 274,314        4.00   $ 274,314        4.00   $ 342,893        5.00

 

47


Table of Contents
     Actual     Minimum Capital
Required Under
Basel III Phase-In
    Minimum Capital
Required-Basel III
Fully Phased-In
    Required to be
Considered Well-
Capitalized
 

As of September 30, 2016:

   Amount      Ratio     Amount      Ratio     Amount      Ratio     Amount      Ratio  

Total Capital to Risk-Weighted Assets

                    

Consolidated

   $ 723,248        18.28   $ 341,309        8.625   $ 415,506        10.50     —          N/A  

First Financial Bank, N.A

   $ 629,168        15.94   $ 340,429        8.625   $ 414,436        10.50   $ 394,701        10.00

Tier 1 Capital to Risk-Weighted Assets

                    

Consolidated

   $ 677,289        17.12   $ 262,165        6.625   $ 336,362        8.50     —          N/A  

First Financial Bank, N.A

   $ 583,209        14.78   $ 261,489        6.625   $ 335,496        8.50   $ 315,760        8.00

Common Equity Tier 1 Capital to Risk-Weighted Assets

                    

Consolidated

   $ 677,289        17.12   $ 202,807        5.125   $ 277,004        7.00     —          N/A  

First Financial Bank, N.A

   $ 583,209        14.78   $ 202,284        5.125   $ 276,290        7.00   $ 256,555        6.50

Leverage Ratio

                    

Consolidated

   $ 677,289        10.60   $ 255,659        4.00   $ 255,659        4.00     —          N/A  

First Financial Bank, N.A

   $ 583,209        9.16   $ 254,799        4.00   $ 254,799        4.00   $ 318,499        5.00

As of December 31, 2016:

                                                    

Total Capital to Risk-Weighted Assets:

                    

Consolidated

   $ 739,959        18.45   $ 345,827        8.625   $ 421,007        10.50     —          N/A  

First Financial Bank, N.A

   $ 633,403        15.84   $ 344,930        8.625   $ 419,915        10.50   $ 399,919        10.00

Tier 1 Capital to Risk-Weighted Assets:

                    

Consolidated

   $ 693,584        17.30   $ 265,635        6.625   $ 340,815        8.50     —          N/A  

First Financial Bank, N.A

   $ 587,028        14.68   $ 264,946        6.625   $ 339,931        8.50   $ 319,935        8.00

Common Equity Tier 1 Capital to Risk-Weighted Assets:

                    

Consolidated

   $ 693,584        17.30   $ 205,491        5.125   $ 280,671        7.00     —          N/A  

First Financial Bank, N.A

   $ 587,028        14.68   $ 204,959        5.125   $ 279,943        7.00   $ 259,947        6.50

Leverage Ratio:

                    

Consolidated

   $ 693,584        10.71   $ 258,978        4.00   $ 258,978        4.00     —          N/A  

First Financial Bank, N.A

   $ 587,028        9.10   $ 257,941        4.00   $ 257,941        4.00   $ 322,426        5.00

We have performed a preliminary assessment using the regulatory capital estimation tool made available by the OCC and believe the Company and Bank are prepared to meet the new requirements upon full adoption of Basel III that will be effective December 31, 2019.

In connection with the adoption of the Basel III regulatory capital framework, our subsidiary bank made the election to continue to exclude most accumulated other comprehensive income (“AOCI”) from capital in connection with its quarterly financial filing and, in effect, to retain the AOCI treatment under the prior capital rules.

Interest Rate Risk

Interest rate risk results when the maturity or repricing intervals of interest-earning assets and interest-bearing liabilities are different. Our exposure to interest rate risk is managed primarily through our strategy of selecting the types and terms of interest-earning assets and interest-bearing liabilities that generate favorable earnings while limiting the potential negative effects of changes in market interest rates. We use no off-balance sheet financial instruments to manage interest rate risk.

Our subsidiary bank has an asset liability management committee that monitors interest rate risk and compliance with investment policies. The subsidiary bank utilizes an earnings simulation model as the

 

48


Table of Contents

primary quantitative tool in measuring the amount of interest rate risk associated with changing market rates. The model quantifies the effects of various interest rate scenarios on projected net interest income and net income over the next twelve months. The model measures the impact on net interest income relative to a base case scenario of hypothetical fluctuations in interest rates over the next twelve months. These simulations incorporate assumptions regarding balance sheet growth and mix, pricing and the re-pricing and maturity characteristics of the existing and projected balance sheet.

As of September 30, 2017, the model simulations projected that 100 and 200 basis point increases in interest rates would result in negative variances in net interest income of 0.80% and 2.33%, respectively, relative to the current financial statement structure over the next twelve months, while a decrease in interest rates of 100 basis points would result in a negative variance in net interest income of 3.89% relative to the current financial statement structure over the next twelve months. We consider the likelihood of a decrease in interest rates beyond 100 basis points as of September 30, 2017 remote given the Federal Reserves proposed rate increase. Our model simulation as of September 30, 2017 indicates that our balance sheet is more liability sensitive in the short-term categories. These are good faith estimates and assume that the composition of our interest sensitive assets and liabilities existing at each year-end will remain constant over the relevant twelve-month measurement period and that changes in market interest rates are instantaneous and sustained across the yield curve regardless of duration of pricing characteristics on specific assets or liabilities. Also, this analysis does not contemplate any actions that we might undertake in response to changes in market interest rates. We believe these estimates are not necessarily indicative of what actually could occur in the event of immediate interest rate increases or decreases of this magnitude. As interest-bearing assets and liabilities re-price in different time frames and proportions to market interest rate movements, various assumptions must be made based on historical relationships of these variables in reaching any conclusion. Since these correlations are based on competitive and market conditions, we anticipate that our future results will likely be different from the foregoing estimates, and such differences could be material.

Should we be unable to maintain a reasonable balance of maturities and repricing of our interest-earning assets and our interest-bearing liabilities, we could be required to dispose of our assets in an unfavorable manner or pay a higher than market rate to fund our activities. Our asset liability committee oversees and monitors this risk.

Liquidity

Liquidity is our ability to meet cash demands as they arise. Such needs can develop from loan demand, deposit withdrawals or acquisition opportunities. Potential obligations resulting from the issuance of standby letters of credit and commitments to fund future borrowings to our loan customers are other factors affecting our liquidity needs. Many of these obligations and commitments are expected to expire without being drawn upon; therefore the total commitment amounts do not necessarily represent future cash requirements affecting our liquidity position. The potential need for liquidity arising from these types of financial instruments is represented by the contractual notional amount of the instrument. Asset liquidity is provided by cash and assets which are readily marketable or which will mature in the near future. Liquid assets include cash, federal funds sold, and short-term investments in time deposits in banks. Liquidity is also provided by access to funding sources, which include core depositors and correspondent banks that maintain accounts with and sell federal funds to our subsidiary bank. Other sources of funds include our ability to borrow from short-term sources, such as purchasing federal funds from correspondent banks, sales of securities under agreements to repurchase and advances from the FHLB (see below) and an unfunded $25.00 million revolving line of credit established with Frost Bank, a nonaffiliated bank, which matures in June 2019 (see next paragraph). Our subsidiary bank also has federal funds purchased lines of credit with two non-affiliated banks totaling $130.00 million. At September 30, 2017, no amounts were drawn on these lines of credit. Our subsidiary bank also has available a line of credit with the FHLB totaling $1.18 billion, at September 30, 2017, secured by portions of our loan portfolio and certain investment securities. At September 30, 2017, the Company did not have any balances outstanding under this line of credit.

 

49


Table of Contents

The Company renewed its loan agreement, effective June 30, 2017, with Frost Bank. Under the loan agreement, as renewed and amended, we are permitted to draw up to $25.00 million on a revolving line of credit. Prior to June 30, 2019, interest is paid quarterly at The Wall Street Journal Prime Rate and the line of credit matures June 30, 2019. If a balance exists at June 30, 2019, the principal balance converts to a term facility payable quarterly over five years and interest is paid quarterly at our election at The Wall Street Journal Prime Rate plus 50 basis points or LIBOR plus 250 basis points. The line of credit is unsecured. Among other provisions in the credit agreement, we must satisfy certain financial covenants during the term of the loan agreement, including, without limitation, covenants that require us to maintain certain capital, tangible net worth, loan loss reserve, non-performing asset and cash flow coverage ratios. In addition, the credit agreement contains certain operational covenants, which among others, restricts the payment of dividends above 55% of consolidated net income, limits the incurrence of debt (excluding any amounts acquired in an acquisition) and prohibits the disposal of assets except in the ordinary course of business. Since 1995, we have historically declared dividends as a percentage of our consolidated net income in a range of 37% (low) in 1995 to 53% (high) in 2003 and 2006. The Company was in compliance with the financial and operational covenants at September 30, 2017. There was no outstanding balance under the line of credit as of September 30, 2017 or December 31, 2016.

In addition, we anticipate that future acquisitions of financial institutions, expansion of branch locations or offerings of new products could also place a demand on our cash resources. Available cash and cash equivalents at our parent company which totaled $72.19 million at September 30, 2017, investment securities which totaled $8.58 million at September 30, 2017 and mature over 6 to 13 years, available dividends from our subsidiaries which totaled $170.03 million at September 30, 2017, utilization of available lines of credit, and future debt or equity offerings are expected to be the source of funding for these potential acquisitions or expansions.

Our liquidity position is continuously monitored and adjustments are made to the balance between sources and uses of funds as deemed appropriate. Liquidity risk management is an important element in our asset/liability management process. We regularly model liquidity stress scenarios to assess potential liquidity outflows or funding problems resulting from economic disruptions, volatility in the financial markets, unexpected credit events or other significant occurrences deemed potentially problematic by management. These scenarios are incorporated into our contingency funding plan, which provides the basis for the identification of our liquidity needs. As of September 30, 2017, management is not aware of any events that are reasonably likely to have a material adverse effect on our liquidity, capital resources or operations. Given the strong core deposit base and relatively low loan to deposit ratios maintained at our subsidiary bank, we consider our current liquidity position to be adequate to meet our short-term and long-term liquidity needs. In addition, management is not aware of any regulatory recommendations regarding liquidity that would have a material adverse effect on us.

Off-Balance Sheet Arrangements. We are a party to financial instruments with off-balance-sheet risk in the normal course of business to meet the financing needs of our customers. These financial instruments include unfunded lines of credit, commitments to extend credit and federal funds sold to correspondent banks and standby letters of credit. Those instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in our consolidated balance sheets.

Our exposure to credit loss in the event of nonperformance by the counterparty to the financial instrument for unfunded lines of credit, commitments to extend credit and standby letters of credit is represented by the contractual notional amount of these instruments. We generally use the same credit policies in making commitments and conditional obligations as we do for on-balance-sheet instruments.

Unfunded lines of credit and commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. These commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. We evaluate each customer’s creditworthiness on a case-by-case basis. The amount of collateral obtained, as we deem necessary upon extension of credit, is based on our credit evaluation of the counterparty. Collateral held varies but may include accounts receivable, inventory, property, plant, and equipment and income-producing commercial properties.

 

50


Table of Contents

Standby letters of credit are conditional commitments we issue to guarantee the performance of a customer to a third party. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. The average collateral value held on letters of credit usually exceeds the contract amount.

Table 10 - Commitments as of September 30, 2017 (in thousands):

 

     Total
Notional
Amounts
Committed
 

Unfunded lines of credit

   $ 519,764  

Unfunded commitments to extend credit

     267,856  

Standby letters of credit

     32,649  
  

 

 

 

Total commercial commitments

   $ 820,269  
  

 

 

 

We believe we have no other off-balance sheet arrangements or transactions with unconsolidated, special purpose entities that would expose us to liability that is not reflected on the face of the financial statements.

Parent Company Funding. Our ability to fund various operating expenses, dividends, and cash acquisitions is generally dependent on our own earnings (without giving effect to our subsidiaries), cash reserves and funds derived from our subsidiaries. These funds historically have been produced by intercompany dividends and management fees that are limited to reimbursement of actual expenses. We anticipate that our recurring cash sources will continue to include dividends and management fees from our subsidiaries. At September 30, 2017, approximately $170.03 million was available for the payment of intercompany dividends by our subsidiaries without the prior approval of regulatory agencies. Our subsidiaries paid aggregate dividends of $29.00 million and $25.60 million for the nine-month periods ended September 30, 2017 and 2016, respectively.

Dividends. Our long-term dividend policy is to pay cash dividends to our shareholders of approximately 40% of annual net earnings while maintaining adequate capital to support growth. We are also restricted by a loan covenant within our line of credit agreement with Frost Bank to dividend no greater than 55% of net income, as defined in such loan agreement. The cash dividend payout ratios have amounted to 43.99% and 43.98% of net earnings for the first nine months of 2017 and 2016, respectively. Given our current capital position and projected earnings and asset growth rates, we do not anticipate any significant change in our current dividend policy.

Our bank subsidiary, which is a national banking association and a member of the Federal Reserve System, is required by federal law to obtain the prior approval of the OCC to declare and pay dividends if the total of all dividends declared in any calendar year would exceed the total of (1) such bank’s net profits (as defined and interpreted by regulation) for that year plus (2) its retained net profits (as defined and interpreted by regulation) for the preceding two calendar years, less any required transfers to surplus.

To pay dividends, we and our subsidiary bank must maintain adequate capital above regulatory guidelines. In addition, if the applicable regulatory authority believes that a bank under its jurisdiction is engaged in or is about to engage in an unsafe or unsound practice (which, depending on the financial condition of the bank, could include the payment of dividends), the authority may require, after notice and hearing, that such bank cease and desist from the unsafe practice. The Federal Reserve, the FDIC and the OCC have each indicated that paying dividends that deplete a bank’s capital base to an inadequate level would be an unsafe and unsound banking practice. The Federal Reserve, the OCC and the FDIC have issued policy statements that recommend that bank holding companies and insured banks should generally only pay dividends out of current operating earnings.

 

51


Table of Contents
Item 3. Quantitative and Qualitative Disclosures About Market Risk

Management considers interest rate risk to be a significant market risk for the Company. See “Item 2 – Management’s Discussion and Analysis of Financial Condition and Results of Operations – Capital Resources – Interest Rate Risk” for disclosure regarding this market risk.

 

Item 4. Controls and Procedures

As of September 30, 2017, we carried out an evaluation, under the supervision and with the participation of our management, including our principal executive officer and principal financial officer, of the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rule 13a-15(e) or 15d-15(e) of the Securities Exchange Act of 1934). Our management, which includes our principal executive officer and our principal financial officer, does not expect that our disclosure controls and procedures will prevent all errors and all fraud.

A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the Company have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty and that breakdowns can occur because of simple error or mistake. Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the control. The design of any system of controls also is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions; over time, controls may become inadequate because of changes in conditions or the degree of compliance with the policies or procedures may deteriorate. Because of the inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and not be detected. Our principal executive officer and principal financial officer have concluded, based on our evaluation of our disclosure controls and procedures, that our disclosure controls and procedures were effective at the reasonable assurance level as of September 30, 2017.

Subsequent to our evaluation, there were no significant changes in internal controls over financial reporting or other factors that have materially affected, or are reasonably likely to materially affect, these internal controls.

 

52


Table of Contents

PART II

OTHER INFORMATION

 

Item 1. Legal Proceedings

From time to time we and our subsidiaries are parties to lawsuits arising in the ordinary course of our banking business. However, there are no material pending legal proceedings to which we, our subsidiaries, or any of their properties, are currently subject. Other than regular, routine examinations by state and federal banking authorities, there are no proceedings pending or known to be contemplated by any governmental authorities.

 

Item 1A. Risk Factors

There has been no material change in the risk factors previously disclosed under Item 1A. of the Company’s 2016 Annual Report on Form 10-K.

 

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

None

 

Item 3. Defaults Upon Senior Securities

Not Applicable

 

Item 4. Mine Safety Disclosures

Not Applicable

 

Item 5. Other Information

None

 

53


Table of Contents
Item 6. Exhibits

 

    2.1    

Agreement and Plan of Reorganization, dated October 12, 2017, by and among First Financial Bankshares, Inc., Kingwood Merger Sub, Inc., and Commercial Bancshares, Inc. (schedules have been omitted pursuant to Item 601 (b)(2) of Regulation S-K) ( incorporated by reference from Exhibit 2.1 to Registrant’s Form 8-K filed October 12, 2017).

    3.1     Amended and Restated Certificate of Formation (incorporated by reference from Exhibit 3.1 of the Registrant’s Form 8-K filed April 28, 2015).
    3.2     Amended and Restated Bylaws of the Registrant (incorporated by reference from Exhibit 99.1 of the Registrant’s Form 8-K filed January 24, 2012).
    4.1     Specimen certificate of First Financial Common Stock (incorporated by reference from Exhibit 3 of the Registrant’s Amendment No. 1 to Form 8-A filed on Form 8-A/A No. 1 on January 7, 1994).
  10.1     2002 Incentive Stock Option Plan (incorporated by reference from Exhibit 10.3 of the Registrant’s Form 10-Q filed May 4, 2010)++
  10.2     2012 Incentive Stock Option Plan (incorporated by reference from Appendix  A of the Registrant’s Definitive Proxy Statement Pursuant to Section 14(a) of the Securities Exchange Act of 1934 filed March 1, 2012).++
  10.3     Loan agreement dated June  30, 2013, between First Financial Bankshares, Inc. and Frost Bank (incorporated by reference from Exhibit 10.1 of the Registrant’s Form 8-K filed July 1, 2013).
  10.4     First Amendment to Loan Agreement, dated June  30, 2015, between First Financial Bankshares, Inc. and Frost Bank (incorporated by reference from Exhibit 10.1 of the Registrant’s Form 8-K filed June 30, 2015).
  10.5     2015 Restricted Stock Plan (incorporated by reference from Appendix  A of the Registrant’s Definitive Proxy Statement Pursuant to Section 14(a) of the Securities Exchange Act of 1934 filed March 2, 2015).++
  10.6     Form of Executive Recognition Agreement (incorporated by reference from Exhibit 10.1 of the Registrant’s Form 8-K filed August 26, 2016).++
  10.7     Second Amendment to Loan Agreement, dated June  30, 2017, between First Financial Bankshares, Inc. and Frost Bank (incorporated by reference from Exhibit 10.1 of the Registrant’s Form 8-K filed June 30, 2017).
  31.1     Rule 13a-14(a) / 15(d)-14(a) Certification of Chief Executive Officer of First Financial Bankshares, Inc.*
  31.2     Rule 13a-14(a) / 15(d)-14(a) Certification of Chief Financial Officer of First Financial Bankshares, Inc.*
  32.1     Section 1350 Certification of Chief Executive Officer of First Financial Bankshares, Inc.+
  32.2     Section 1350 Certification of Chief Financial Officer of First Financial Bankshares, Inc.+
101.INS     XBRL Instance Document.*
101.SCH     XBRL Taxonomy Extension Schema Document.*
101.CAL     XBRL Taxonomy Extension Calculation Linkbase Document.*
101.DEF     XBRL Taxonomy Extension Definition Linkbase Document.*
101.LAB     XBRL Taxonomy Extension Label Linkbase Document.*
101.PRE     XBRL Taxonomy Extension Presentation Linkbase Document.*

* Filed herewith

+ Furnished herewith. This Exhibit shall not be deemed “filed” for purposes of Section 18 of the Securities Exchange Act of 1934, or otherwise subject to the liability of that section, and shall not be deemed to be incorporated into any filing under the Securities Act of 1933 or the Securities Exchange Act of 1934.

++ Management contract or compensatory plan on arrangement.

 

54


Table of Contents

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

    FIRST FINANCIAL BANKSHARES, INC.
Date: October 31, 2017     By:   /s/ F. Scott Dueser
      F. Scott Dueser
      President and Chief Executive Officer
Date: October 31, 2017     By:   /s/ J. Bruce Hildebrand
      J. Bruce Hildebrand
      Executive Vice President and
      Chief Financial Officer

 

55