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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 June 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 July 28, 2017

Common Stock, $0.01 par value per share   66,170,312

 

 

 


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 June 30, 2017 and 2016 and December 31, 2016, and the consolidated statements of earnings and comprehensive earnings for the three and six months ended June 30, 2017 and 2016, and the consolidated statements of shareholders’ equity and cash flows for the six months ended June 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)

 

     June 30,     December 31,  

ASSETS

   2017     2016     2016  
   (Unaudited)        

CASH AND DUE FROM BANKS

   $ 163,435     $ 135,092     $ 204,782  

FEDERAL FUNDS SOLD

     3,740       2,960       3,130  

INTEREST-BEARING DEPOSITS IN BANKS

     53,336       67,746       48,574  
  

 

 

   

 

 

   

 

 

 

Total cash and cash equivalents

     220,511       205,798       256,486  

INTEREST-BEARING TIME DEPOSITS IN BANKS

     1,458       2,427       1,707  

SECURITIES AVAILABLE-FOR-SALE, at fair value

     2,964,513       2,795,356       2,860,837  

SECURITIES HELD-TO-MATURITY (fair value of $107, $141 and $124 at June 30, 2017 and 2016, and December 31, 2016, respectively)

     105       137       121  

LOANS:

      

Held for investment

     3,439,352       3,283,655       3,357,307  

Less - allowance for loan losses

     (47,410     (45,060     (45,779
  

 

 

   

 

 

   

 

 

 

Net loans held for investment

     3,391,942       3,238,595       3,311,528  

Held for sale

     18,327       25,733       26,898  
  

 

 

   

 

 

   

 

 

 

Net loans

     3,410,269       3,264,328       3,338,426  

BANK PREMISES AND EQUIPMENT, net

     123,620       122,326       122,685  

INTANGIBLE ASSETS

     143,120       143,930       143,603  

OTHER ASSETS

     83,796       80,688       86,066  
  

 

 

   

 

 

   

 

 

 

Total assets

   $ 6,947,392     $ 6,614,990     $ 6,809,931  
  

 

 

   

 

 

   

 

 

 
LIABILITIES AND SHAREHOLDERS’ EQUITY       

NONINTEREST-BEARING DEPOSITS

   $ 1,856,439     $ 1,644,812     $ 1,717,722  

INTEREST-BEARING DEPOSITS

     3,770,170       3,411,477       3,760,817  
  

 

 

   

 

 

   

 

 

 

Total deposits

     5,626,609       5,056,289       5,478,539  

DIVIDENDS PAYABLE

     12,572       11,891       11,897  

BORROWINGS

     379,324       556,924       445,770  

OTHER LIABILITIES

     41,445       123,728       35,840  
  

 

 

   

 

 

   

 

 

 

Total liabilities

     6,059,950       5,748,832       5,972,046  
  

 

 

   

 

 

   

 

 

 

COMMITMENTS AND CONTINGENCIES

      

SHAREHOLDERS’ EQUITY:

      

Common stock - ($0.01 par value, authorized 120,000,000 shares; 66,170,312, 66,059,912, and 66,094,695 shares issued at June 30, 2017 and 2016, and December 31, 2016, respectively)

     662       661       661  

Capital surplus

     374,391       370,601       372,245  

Retained earnings

     476,912       418,053       446,534  

Treasury stock (shares at cost: 501,198, 516,955, and 507,409 at June 30, 2017 and 2016, and December 31, 2016, respectively)

     (6,948     (6,517     (6,671

Deferred compensation

     6,948       6,517       6,671  

Accumulated other comprehensive earnings

     35,477       76,843       18,445  
  

 

 

   

 

 

   

 

 

 

Total shareholders’ equity

     887,442       866,158       837,885  
  

 

 

   

 

 

   

 

 

 

Total liabilities and shareholders’ equity

   $ 6,947,392     $ 6,614,990     $ 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
June 30,
    Six Months Ended
June 30,
 
     2017     2016     2017     2016  

INTEREST INCOME:

        

Interest and fees on loans

   $ 41,311     $ 39,942     $ 80,894     $ 80,289  

Interest on investment securities:

        

Taxable

     8,343       7,130       15,774       14,392  

Exempt from federal income tax

     11,408       10,745       22,900       21,411  

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

     120       64       397       124  
  

 

 

   

 

 

   

 

 

   

 

 

 

Total interest income

     61,182       57,881       119,965       116,216  

INTEREST EXPENSE:

        

Interest on deposits

     1,930       1,033       3,520       2,086  

Other

     167       297       340       556  
  

 

 

   

 

 

   

 

 

   

 

 

 

Total interest expense

     2,097       1,330       3,860       2,642  
  

 

 

   

 

 

   

 

 

   

 

 

 

Net interest income

     59,085       56,551       116,105       113,574  

PROVISION FOR LOAN LOSSES

     1,725       2,058       3,675       4,386  
  

 

 

   

 

 

   

 

 

   

 

 

 

Net interest income after provision for loan losses

     57,360       54,493       112,430       109,188  
  

 

 

   

 

 

   

 

 

   

 

 

 

NONINTEREST INCOME:

        

Trust fees

     5,747       4,726       11,764       9,380  

Service charges on deposit accounts

     4,883       4,404       9,433       8,818  

ATM, interchange and credit card fees

     6,598       5,840       12,762       11,521  

Real estate mortgage operations

     4,188       4,013       7,605       7,153  

Net gain on sale of available-for-sale securities (includes $747 and $912 for the three months ended June 30, 2017 and 2016, respectively, and $750 and $914 for the six months ended June 30, 2017 and 2016, respectively, related to accumulated other comprehensive earnings reclassifications)

     747       912       750       914  

Net gain (loss) on sale of foreclosed assets

     (72     278       (31     353  

Net gain (loss) on sale of assets

     (200     (74     (196     439  

Interest on loan recoveries

     337       629       491       1,261  

Other

     942       710       1,877       1,419  
  

 

 

   

 

 

   

 

 

   

 

 

 

Total noninterest income

     23,170       21,438       44,455       41,258  

NONINTEREST EXPENSE:

        

Salaries and employee benefits

     23,465       22,147       46,724       44,737  

Net occupancy expense

     2,771       2,583       5,370       5,214  

Equipment expense

     3,665       3,386       7,102       6,766  

FDIC insurance premiums

     550       818       1,097       1,642  

ATM, interchange and credit card expenses

     1,803       1,806       3,516       3,492  

Professional and service fees

     2,025       1,650       3,842       3,215  

Printing, stationery and supplies

     536       464       974       967  

Operational and other losses

     574       433       1,559       920  

Amortization of intangible assets

     165       199       333       398  

Other

     8,221       7,270       15,409       14,485  
  

 

 

   

 

 

   

 

 

   

 

 

 

Total noninterest expense

     43,775       40,756       85,926       81,836  
  

 

 

   

 

 

   

 

 

   

 

 

 

EARNINGS BEFORE INCOME TAXES

     36,755       35,175       70,959       68,610  

INCOME TAX EXPENSE (includes $261 and $319 for the three months ended June 30, 2017 and 2016, respectively, and $263 and $320 for the six months ended June 30, 2017 and 2016, respectively, related to income tax expense from reclassification items)

     8,500       8,366       16,105       16,105  
  

 

 

   

 

 

   

 

 

   

 

 

 

NET EARNINGS

   $ 28,255     $ 26,809     $ 54,854     $ 52,505  
  

 

 

   

 

 

   

 

 

   

 

 

 

EARNINGS PER SHARE, BASIC

   $ 0.43     $ 0.41     $ 0.83     $ 0.80  
  

 

 

   

 

 

   

 

 

   

 

 

 

EARNINGS PER SHARE, ASSUMING DILUTION

   $ 0.43     $ 0.41     $ 0.83     $ 0.79  
  

 

 

   

 

 

   

 

 

   

 

 

 

DIVIDENDS PER SHARE

   $ 0.19     $ 0.18     $ 0.37     $ 0.34  
  

 

 

   

 

 

   

 

 

   

 

 

 

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
June 30,
    Six Months Ended
June 30,
 
     2017     2016     2017     2016  

NET EARNINGS

   $ 28,255     $ 26,809     $ 54,854     $ 52,505  

OTHER ITEMS OF COMPREHENSIVE EARNINGS (LOSS):

        

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

     17,725       19,377       26,953       46,219  

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

     (747     (912     (750     (914
  

 

 

   

 

 

   

 

 

   

 

 

 

Total other items of comprehensive earnings

     16,978       18,465       26,203       45,305  

Income tax expense related to other items of comprehensive earnings

     (5,842     (6,463     (9,171     (15,857
  

 

 

   

 

 

   

 

 

   

 

 

 

COMPREHENSIVE EARNINGS

   $ 39,391     $ 38,811     $ 71,886     $ 81,953  
  

 

 

   

 

 

   

 

 

   

 

 

 

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
Comprehensive
Earnings
     Total
Shareholders’
Equity
 
     Common Stock      Capital
Surplus
     Retained
Earnings
    Treasury Stock     Deferred
Compensation
       
     Shares      Amount           Shares     Amounts          

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)

     —          —          —          52,505       —         —         —          —          52,505  

Stock option exercises (unaudited)

     62,018        1        935        —         —         —         —          —          936  

Restricted stock grant (unaudited)

     7,660        —          250        —           —         —          —          250  

Cash dividends declared, $0.34 per share (unaudited)

     —          —          —          (22,458     —         —         —          —          (22,458

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

     —          —          —          —         —         —         —          29,448        29,448  

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

     —          —          50        —         —         —         —          —          50  

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

     —          —          —          —         3,696       (221     221        —          —    

Stock option expense (unaudited)

     —          —          441        —         —         —         —          —          441  
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

   

 

 

   

 

 

    

 

 

    

 

 

 

Balances at June 30, 2016 (unaudited)

     66,059,912      $ 661      $ 370,601      $ 418,053       (516,955   $ (6,517   $ 6,517      $ 76,843      $ 866,158  
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

   

 

 

   

 

 

    

 

 

    

 

 

 

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)

     —          —          —          54,854       —         —         —          —          54,854  

Stock option exercises (unaudited)

     60,967        1        1,114        —         —         —         —          —          1,115  

Restricted stock grant (unaudited)

     14,650        —          600        —         —         —         —          —          600  

Cash dividends declared, $0.37 per share (unaudited)

     —          —          —          (24,476     —         —         —          —          (24,476

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

     —          —          —          —         —         —         —          17,032        17,032  

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

     —          —          —          —         6,211       (277     277        —          —    

Stock option expense (unaudited)

     —          —          432        —         —         —         —          —          432  
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

   

 

 

   

 

 

    

 

 

    

 

 

 

Balances at June 30, 2017 (unaudited)

     66,170,312      $ 662      $ 374,391      $ 476,912       (501,198   $ (6,948   $ 6,948      $ 35,477      $ 887,442  
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

   

 

 

   

 

 

    

 

 

    

 

 

 

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)

 

     Six Months Ended June 30,  
     2017     2016  

CASH FLOWS FROM OPERATING ACTIVITIES:

    

Net earnings

   $ 54,854     $ 52,505  

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

    

Depreciation and amortization

     6,209       5,687  

Provision for loan losses

     3,675       4,386  

Securities premium amortization (discount accretion), net

     15,592       13,912  

Gain on sale of assets, net

     (523     (1,706

Deferred federal income tax benefit

     (614     (1,288

Change in loans held-for-sale

     8,572       7,810  

Change in other assets

     4,210       5,861  

Change in other liabilities

     5,533       3,843  
  

 

 

   

 

 

 

Total adjustments

     42,654       38,505  
  

 

 

   

 

 

 

Net cash provided by operating activities

     97,508       91,010  
  

 

 

   

 

 

 

CASH FLOWS FROM INVESTING ACTIVITIES:

    

Net decrease in interest-bearing time deposits in banks

     249       1,068  

Activity in available-for-sale securities:

    

Sales

     36,971       13,382  

Maturities

     604,582       2,151,678  

Purchases

     (741,922     (2,132,087

Activity in held-to-maturity securities - maturities

     17       141  

Net increase in loans

     (85,212     30,500  

Purchases of bank premises and equipment and other assets

     (7,705     (12,130

Proceeds from sale of other assets

     599       2,170  
  

 

 

   

 

 

 

Net cash provided by (used in) investing activities

     (192,421     54,722  
  

 

 

   

 

 

 

CASH FLOWS FROM FINANCING ACTIVITIES:

    

Net increase (decrease) in noninterest-bearing deposits

     138,717       (101,140

Net increase (decrease) in interest-bearing deposits

     9,353       (32,740

Net decrease in borrowings

     (66,446     (58,751

Common stock transactions:

    

Proceeds from stock issuances

     1,115       936  

Dividends paid

     (23,801     (21,125
  

 

 

   

 

 

 

Net cash provided by (used in) financing activities

     58,938       (212,820
  

 

 

   

 

 

 

NET DECREASE IN CASH AND CASH EQUIVALENTS

     (35,975     (67,088

CASH AND CASH EQUIVALENTS, beginning of period

     256,486       272,886  
  

 

 

   

 

 

 

CASH AND CASH EQUIVALENTS, end of period

   $ 220,511     $ 205,798  
  

 

 

   

 

 

 

SUPPLEMENTAL INFORMATION AND NONCASH TRANSACTIONS:

    

Interest paid

   $ 3,921     $ 2,599  

Federal income tax paid

     13,348       13,874  

Transfer of loans and bank premises to other real estate owned

     1,916       1,692  

Investment securities purchased but not settled

     4,325       62,124  

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 June 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 six months ended June 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.

 

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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 stock buyback plan authorizes management to repurchase the stock at such time as repurchases are considered beneficial to shareholders. Any repurchase of stock 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 July 28, 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 six months ended June 30, 2017 and 2016, the Company assumes that all dilutive outstanding options to purchase common stock have been exercised at the beginning of the period (or the time of issuance, if later). The dilutive effect of the outstanding options and the restricted stock is reflected by application of the treasury stock method, whereby the proceeds from exercised options and restricted stock 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 June 30, 2017 and 2016 were 66,100,089 and 66,016,562 shares, respectively. The weighted average common shares outstanding used in computing basic earnings per common share for the six months ended June 30, 2017 and 2016 were 66,086,817 and 65,995,560 shares, respectively. The weighted average common shares outstanding used in computing fully diluted earnings per common share for the three months ended June 30, 2017 and 2016 were 66,344,943 and 66,138,275 shares, respectively. The weighted average common shares outstanding used in computing fully diluted earnings per common share for the six months ended June 30, 2017 and 2016 were 66,362,191 and 66,153,579 shares, respectively.

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

Interest-bearing time deposits in banks totaled $1,458,000, $2,427,000 and $1,707,000 at June 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.

 

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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):

 

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

U.S. Treasury securities

   $ 10,578      $ —        $ (5    $ 10,573  

Obligations of U.S. government sponsored enterprises and agencies

     73,666        60        (21      73,705  

Obligations of states and political subdivisions

     1,476,714        58,707        (3,548      1,531,873  

Corporate bonds and other

     30,079        163        (2      30,240  

Residential mortgage-backed securities

     971,557        8,083        (4,558      975,082  

Commercial mortgage-backed securities

     342,651        1,202        (813      343,040  
  

 

 

    

 

 

    

 

 

    

 

 

 

Total securities available-for-sale

   $ 2,905,245      $ 68,215      $ (8,947    $ 2,964,513  
  

 

 

    

 

 

    

 

 

    

 

 

 

 

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     June 30, 2016  
     Amortized
Cost Basis
     Gross
Unrealized
Holding
Gains
     Gross
Unrealized
Holding
Losses
     Estimated
Fair Value
 

U.S. Treasury securities

   $ 10,721      $ 90      $ —        $ 10,811  

Obligations of U.S. government sponsored enterprises and agencies

     121,174        1,178        —          122,352  

Obligations of states and political subdivisions

     1,418,342        97,980        (10      1,516,312  

Corporate bonds and other

     71,687        1,723        —          73,410  

Residential mortgage-backed securities

     787,451        18,928        (606      805,773  

Commercial mortgage-backed securities

     261,662        5,068        (32      266,698  
  

 

 

    

 

 

    

 

 

    

 

 

 

Total securities available-for-sale

   $ 2,671,037      $ 124,967      $ (648    $ 2,795,356  
  

 

 

    

 

 

    

 

 

    

 

 

 
     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 $105,000, $137,000 and $121,000 at June 30, 2017 and 2016, and December 31, 2016, respectively, have not been presented due to insignificance.

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 June 30, 2017 were computed by using scheduled amortization of balances and historical prepayment rates. At June 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 June 30, 2017, by contractual and expected maturity, are shown below (in thousands):

 

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     Amortized
Cost Basis
     Estimated
Fair Value
 

Due within one year

   $ 177,217      $ 178,504  

Due after one year through five years

     671,763        700,451  

Due after five years through ten years

     740,378        765,419  

Due after ten years

     1,679        2,017  

Mortgage-backed securities

     1,314,208        1,318,122  
  

 

 

    

 

 

 

Total

   $ 2,905,245      $ 2,964,513  
  

 

 

    

 

 

 

The following tables disclose, as of June 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  

June 30, 2017

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

U.S. Treasury securities

   $ 10,321      $ 5      $ —        $ —        $ 10,321      $ 5  

Obligations of U.S. government sponsored enterprises and agencies

     30,062        21        —          —          30,062        21  

Obligations of states and political subdivisions

     110,706        1,906        37,851        1,642        148,557        3,548  

Corporate bonds and other

     241        2        —          —          241        2  

Residential mortgage-backed securities

     422,087        3,387        60,410        1,171        482,497        4,558  

Commercial mortgage-backed securities

     150,805        745        20,120        68        170,925        813  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 724,222      $ 6,066      $ 118,381      $ 2,881      $ 842,603      $ 8,947  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 
     Less than 12 Months      12 Months or Longer      Total  

June 30, 2016

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

Obligations of states and political subdivisions

   $ 5,959      $ 7      $ 745      $ 3      $ 6,704      $ 10  

Residential mortgage-backed securities

     16,085        14        60,360        592        76,445        606  

Commercial mortgage-backed securities

     —          —          14,152        32        14,152        32  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 22,044      $ 21      $ 75,257      $ 627      $ 97,301      $ 648  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 
     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  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

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The number of investments in an unrealized loss position totaled 215 at June 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 June 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 June 30, 2017, 81.61% of our available-for-sale securities that are obligations of states and political subdivisions were issued within the State of Texas, of which 33.14% are guaranteed by the Texas Permanent School Fund.

At June 30, 2017, $1,865,800,000 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 June 30, 2017 and 2016, sales of investment securities that were classified as available-for-sale totaled $30,791,000 and $12,829,000, respectively. Gross realized gains from security sales during the second quarter of 2017 and 2016 totaled $795,000 and $912,000, respectively. Gross realized losses from security sales during the second quarter of 2017 totaled $48,000. There were no gross realized losses during the second quarter of 2016. During the six months ended June 30, 2017 and 2016, sale of investment securities were classified as available-for-sale totaled $36,971,000 and $13,382,000, respectively. Gross realized gains from security sales during the six-month period ended June 30, 2017 and 2016 totaled $800,000 and $919,000, respectively. Gross realized losses from security sales during the six-month periods ended June 30, 2017 and 2016 totaled $50,000 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.

 

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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.

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, 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

 

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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.

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 June 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.

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 June 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

 

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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 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 June 30, 2017 and 2016, and December 31, 2016, was $889,000, $1,654,000 and $1,256,000, respectively, compared to a contractual balance of $1,174,290, $2,362,000, 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):

 

     June 30,      December 31,  
     2017      2016      2016  

Commercial

   $ 668,049      $ 661,659      $ 674,410  

Agricultural

     77,342        80,812        84,021  

Real estate

     2,271,100        2,154,388        2,189,844  

Consumer

     422,861        386,796        409,032  
  

 

 

    

 

 

    

 

 

 

Total loans held-for-investment

   $ 3,439,352      $ 3,283,655      $ 3,357,307  
  

 

 

    

 

 

    

 

 

 

Loans held for sale totaled $18,327,000, $25,733,000 and $26,898,000 at June 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):

 

     June 30,      December 31,  
     2017      2016      2016  

Non-accrual loans*

   $ 21,489      $ 38,904      $ 27,371  

Loans still accruing and past due 90 days or more

     314        237        284  

Troubled debt restructured loans**

     672        961        701  
  

 

 

    

 

 

    

 

 

 

Total

   $ 22,475      $ 40,102      $ 28,356  
  

 

 

    

 

 

    

 

 

 

*Includes $889,000, $1,654,000 and $1,256,000 of purchased credit impaired loans as of June 30, 2017 and 2016, and December 31, 2016, respectively.

**Troubled debt restructured loans of $5,417,000, $7,454,000 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 June 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):

 

June 30, 2017   June 30, 2016   December 31, 2016
Recorded
Investment
  Valuation
Allowance
  Recorded
Investment
  Valuation
Allowance
  Recorded
Investment
  Valuation
Allowance
$21,489   $4,543   $38,904   $7,102   $27,371   $5,012

 

 

 

 

 

 

 

 

 

 

 

 

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Table of Contents

The Company had $24,720,000, $40,387,000 and $29,000,000 in non-accrual, past due 90 days or more and still accruing, restructured loans and foreclosed assets at June 30, 2017 and 2016, and December 31, 2016, respectively. Non-accrual loans at June 30, 2017 and 2016, and December 31, 2016, consisted of the following by class of financing receivables (in thousands):

 

     June 30,      December 31,  
     2017      2016      2016  

Commercial

   $ 5,404      $ 17,254      $ 7,284  

Agricultural

     61        20        99  

Real estate

     14,801        20,435        18,754  

Consumer

     1,223        1,195        1,234  
  

 

 

    

 

 

    

 

 

 

Total

   $ 21,489      $ 38,904      $ 27,371  
  

 

 

    

 

 

    

 

 

 

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

The Company’s impaired loans and related allowance as of June 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.

 

June 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

   $ 9,362      $ 708      $ 4,696      $ 5,404      $ 1,683      $ 13,590      $ 7,985  

Agricultural

     66        —          61        61        17        69        66  

Real Estate

     19,071        3,755        11,046        14,801        2,369        17,769        15,473  

Consumer

     1,432        309        914        1,223        474        1,457        1,294  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 29,931      $ 4,772      $ 16,717      $ 21,489      $ 4,543      $ 32,885      $ 24,818  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

*Includes $889,000 of purchased credit impaired loans.

 

June 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

   $ 19,571      $ 1,103      $ 16,151      $ 17,254      $ 4,144      $ 16,970      $ 17,319  

Agricultural

     20        —          20        20        20        22        21  

Real Estate

     25,241        7,427        13,008        20,435        2,565        20,856        21,227  

Consumer

     1,375        254        941        1,195        373        1,148        1,288  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 46,207      $ 8,784      $ 30,120      $ 38,904      $ 7,102      $ 38,996      $ 39,855  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

*Includes $1,654,000 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.

 

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Table of Contents

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 six-month periods ended June 30, 2017 and 2016 were not significant.

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 June 30, 2017 and 2016, and December 31, 2016 (in thousands):

 

June 30, 2017

   Pass      Special
Mention
     Substandard      Doubtful      Total  

Commercial

   $ 627,812      $ 5,965      $ 34,272      $ —        $ 668,049  

Agricultural

     73,727        859        2,756        —          77,342  

Real Estate

     2,200,067        20,978        50,055        —          2,271,100  

Consumer

     420,138        197        2,526        —          422,861  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 3,321,744      $ 27,999      $ 89,609      $ —        $ 3,439,352  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

June 30, 2016

   Pass      Special
Mention
     Substandard      Doubtful      Total  

Commercial

   $ 608,758      $ 5,027      $ 47,874      $ —        $ 661,659  

Agricultural

     77,870        —          2,942        —          80,812  

Real Estate

     2,080,544        20,852        52,992        —          2,154,388  

Consumer

     383,818        246        2,732        —          386,796  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 3,150,990      $ 26,125      $ 106,540      $ —        $ 3,283,655  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

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Table of Contents

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  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

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

 

June 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

   $ 3,026      $ 872      $ 2,673      $ 6,571      $ 661,478      $ 668,049      $ 150  

Agricultural

     633        —          8        641        76,701        77,342        8  

Real Estate

     12,794        1,713        4,661        19,168        2,251,932        2,271,100        99  

Consumer

     1,134        414        99        1,647        421,214        422,861        57  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 17,587      $ 2,999      $ 7,441      $ 28,027      $ 3,411,325      $ 3,439,352      $ 314  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

June 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

   $ 13,948      $ 1,032      $ 937      $ 15,917      $ 645,742      $ 661,659      $ —    

Agricultural

     350        2        —          352        80,460        80,812        —    

Real Estate

     14,640        984        3,784        19,408        2,134,980        2,154,388        187  

Consumer

     1,786        262        182        2,230        384,566        386,796        50  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 30,724      $ 2,280      $ 4,903      $ 37,907      $ 3,245,748      $ 3,283,655      $ 237  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

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 June 30, 2017 and 2016, and December 31, 2016, by portfolio segment (in thousands). There were no allowances for purchased credit impaired loans at June 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.

 

20


Table of Contents

June 30, 2017

   Commercial      Agricultural      Real
Estate
     Consumer      Total  

Loans individually evaluated for impairment

   $ 1,683      $ 17      $ 2,369      $ 474      $ 4,543  

Loans collectively evaluated for impairment

     10,252        1,110        25,654        5,851        42,867  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

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

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

June 30, 2016

   Commercial      Agricultural      Real
Estate
     Consumer      Total  

Loans individually evaluated for impairment

   $ 4,144      $ 20      $ 2,565      $ 373      $ 7,102  

Loans collectively evaluated for impairment

     9,882        1,431        23,079        3,566        37,958  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

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

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

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 six months ended June 30, 2017 and 2016, are summarized as follows by portfolio segment (in thousands):

 

Three months ended June 30, 2017

   Commercial     Agricultural     Real
Estate
    Consumer     Total  

Beginning balance

   $ 11,682     $ 946     $ 27,279     $ 6,285     $ 46,192  

Provision for loan losses

     (76     207       1,359       235       1,725  

Recoveries

     522       2       39       104       667  

Charge-offs

     (193     (28     (654     (299     (1,174
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Ending balance

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

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Three months ended June 30, 2016

   Commercial     Agricultural     Real
Estate
    Consumer     Total  

Beginning balance

   $ 12,905     $ 1,255     $ 26,099     $ 3,813     $ 44,072  

Provision for loan losses

     2,142       203       (760     473       2,058  

Recoveries

     255       5       363       195       818  

Charge-offs

     (1,276     (12     (58     (542     (1,888
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Ending balance

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

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Six months ended June 30, 2017

   Commercial     Agricultural     Real
Estate
    Consumer     Total  

Beginning balance

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

Provision for loan losses

     927       54       2,132       562       3,675  

Recoveries

     749       8       91       309       1,157  

Charge-offs

     (1,448     (36     (1,064     (653     (3,201
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Ending balance

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

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

21


Table of Contents

Six months ended June 30, 2016

   Commercial     Agricultural     Real
Estate
    Consumer     Total  

Beginning balance

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

Provision for loan losses

     2,989       400       71       926       4,386  

Recoveries

     542       15       1,590       319       2,466  

Charge-offs

     (2,149     (155     (392     (973     (3,669
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Ending balance

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

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

The Company’s recorded investment in loans as of June 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 $889,000, $1,654,000 and $1,256,000 at June 30, 2017 and 2016, and December 31, 2016, respectively, are included in loans individually evaluated for impairment.

 

June 30, 2017

   Commercial      Agricultural      Real Estate      Consumer      Total  

Loans individually evaluated for impairment

   $ 5,404      $ 61      $ 14,801      $ 1,223      $ 21,489  

Loans collectively evaluated for impairment

     662,645        77,281        2,256,299        421,638        3,417,863  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 668,049      $ 77,342      $ 2,271,100      $ 422,861      $ 3,439,352  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

June 30, 2016

   Commercial      Agricultural      Real Estate      Consumer      Total  

Loans individually evaluated for impairment

   $ 17,254      $ 20      $ 20,435      $ 1,195      $ 38,904  

Loans collectively evaluated for impairment

     644,405        80,792        2,133,953        385,601        3,244,751  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 661,659      $ 80,812      $ 2,154,388      $ 386,796      $ 3,283,655  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

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 six months ended June 30, 2017 and 2016 and considered troubled debt restructurings are as follows (in thousands):

 

     Three Months Ended June 30, 2017      Six Months Ended June 30, 2017  
     Number      Pre-Modification
Recorded
Investment
     Post-
Modification
Recorded
Investment
     Number      Pre-Modification
Recorded
Investment
     Post-
Modification
Recorded
Investment
 

Commercial

     2      $ 90      $ 90        6      $ 324      $ 324  

Agricultural

     —          —          —          —          —          —    

Real Estate

     1        161        161        2        217        217  

Consumer

     1        25        25        1        25        25  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

     4      $ 276      $ 276        9      $ 566      $ 566  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

22


Table of Contents
     Three Months Ended June 30, 2016      Six Months Ended June 30, 2016  
     Number      Pre-Modification
Recorded
Investment
     Post-
Modification
Recorded
Investment
     Number      Pre-Modification
Recorded
Investment
     Post-
Modification
Recorded
Investment
 

Commercial

     4      $ 286      $ 286        11      $ 2,926      $ 2,926  

Agricultural

     —          —          —          —          —          —    

Real Estate

     —          —          —          2        463        463  

Consumer

     2        98        98        4        118        118  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

     6      $ 384      $ 384        17      $ 3,507      $ 3,507  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

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

 

     Three Months Ended June 30, 2017      Six Months Ended June 30, 2017  
     Adjusted
Interest
Rate
     Extended
Maturity
     Combined
Rate and
Maturity
     Adjusted
Interest
Rate
     Extended
Maturity
     Combined
Rate and
Maturity
 

Commercial

   $ —        $ 90      $ —        $ —        $ 180      $ 144  

Agricultural

     —          —          —          —          —          —    

Real Estate

     —          —          161        —          56        161  

Consumer

     —          25        —          —          25        —    
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ —        $ 115      $ 161      $ —        $ 261      $ 305  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 
     Three Months Ended June 30, 2016      Six Months Ended June 30, 2016  
     Adjusted
Interest
Rate
     Extended
Maturity
     Combined
Rate and
Maturity
     Adjusted
Interest
Rate
     Extended
Maturity
     Combined
Rate and
Maturity
 

Commercial

   $ —        $ 212      $ 74      $ —        $ 2,449      $ 477  

Agricultural

     —          —          —          —          —          —    

Real Estate

     —          —          —          —          113        350  

Consumer

     —          39        59        —          43        75  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ —        $ 251      $ 133      $ —        $ 2,605      $ 902  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

During the three months ended June 30, 2016, one loan was modified as troubled debt restructured loan within the previous 12 months and for which there was a payment default. There were no such defaults during the three months ended June 30, 2017. During the six months ended June 30, 2017 and 2016, two and one loans were modified in each six-month period as a 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):

 

     Six Months Ended
June 30, 2017
 
     Number      Balance  

Commercial

     1      $ 53  

Agriculture

     —          —    

Real Estate

     1        63  

Consumer

     —          —    
  

 

 

    

 

 

 

Total

     2      $ 116  
  

 

 

    

 

 

 

 

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Table of Contents
     Three Months Ended
June 30, 2016
     Six Months Ended
June 30, 2016
 
     Number      Balance      Number      Balance  

Commercial

     —        $ —          —        $ —    

Agriculture

     —          —          —          —    

Real Estate

     1        350        1        350  

Consumer

     —          —          —          —    
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

     1      $ 350        1      $ 350  
  

 

 

    

 

 

    

 

 

    

 

 

 

As of June 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 June 30, 2017, $2,080,527,000 in loans held by our bank subsidiary were subject to blanket liens as security for this line of credit. At June 30, 2017, $50,000,000 was outstanding under this line of credit.

Note 6 - Borrowings

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

 

     June 30,      December 31,  
     2017      2016      2016  

Securities sold under agreements with customers to repurchase

   $ 309,524      $ 339,799      $ 360,820  

Federal funds purchased

     19,800        7,125        9,950  

Advances from Federal Home

        

Loan Bank of Dallas

     50,000        210,000        75,000  
  

 

 

    

 

 

    

 

 

 

Total

   $ 379,324      $ 556,924      $ 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 $8,500,000 for the second quarter of 2017 as compared to $8,366,000 for the same period in 2016. The Company’s effective tax rates on pretax income were 23.13% and 23.78% for the second quarters of 2017 and 2016, respectively. Income tax expense was $16,105,000 for the six months ended June 30, 2017 as compared to $16,105,000 for the same period in 2016. The Company’s effective tax rates on pretax income were 22.70% and 23.47% for the six months ended June 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 $9.99 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 6.40 years; and expected volatility of 26.51%. No options were granted in 2016.

 

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Table of Contents

The Company recorded stock option expense totaling $217,000 and $220,000 for the three-month periods ended June 30, 2017 and 2016, respectively. The Company recorded stock option expense totaling $432,000 and $441,000 for the six months ended June 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 stock shares were granted to the ten non-employee directors. Total value of these 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 stock 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 stock 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.

The Company recorded director expense related to these restricted stock grants of $121,000 and $69,000 for the three-month periods ended June 30, 2017 and 2016, respectively. The Company recorded director expense related to these restricted stock grants of $183,000 and $153,000 for the six-month periods ended June 30, 2017 and 2016, respectively.

On October 27, 2015, the Company granted 31,273 restricted stock 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 stock 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 $89,000, for the three-month periods ended June 30, 2017 and 2016, respectively. The Company recorded restricted stock expense for officers of $266,000 and $174,000 for the six-month periods ended June 30, 2017 and 2016, respectively.

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 June 30, 2017.

Net periodic benefit costs totaling $84,000 and $82,000 were recorded for the three months ended June 30, 2017 and 2016, respectively. Net periodic benefit costs totaling $168,000 and $165,000 were recorded for the six months ended June 30, 2017 and 2016, respectively.

 

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Table of Contents

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 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

 

26


Table of Contents

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 six months ended June 30, 2017 and 2016, and the year ended December 31, 2016.

The following table summarizes financial assets and financial liabilities measured at fair value on a recurring basis as of June 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):

 

June 30, 2017

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

Available-for-sale investment securities:

           

U.S. Treasury securities

   $ 10,573      $ —        $ —        $ 10,573  

Obligations of U. S. government sponsored enterprises and agencies

     —          73,705        —          73,705  

Obligations of states and political subdivisions

     —          1,531,873        —          1,531,873  

Corporate bonds

     —          25,788        —          25,788  

Residential mortgage-backed securities

     —          975,082        —          975,082  

Commercial mortgage-backed securities

     —          343,040        —          343,040  

Other securities

     4,452        —          —          4,452  
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 15,025      $ 2,949,488      $ —        $ 2,964,513  
  

 

 

    

 

 

    

 

 

    

 

 

 

June 30, 2016

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

Available-for-sale investment securities:

           

U.S. Treasury securities

   $ 10,811      $ —        $ —        $ 10,811  

Obligations of U. S. government sponsored enterprises and agencies

     —          122,352        —          122,352  

Obligations of states and political subdivisions

     —          1,516,312        —          1,516,312  

Corporate bonds

     —          65,550        —          65,550  

Residential mortgage-backed securities

     —          805,773        —          805,773  

Commercial mortgage-backed securities

     —          266,698        —          266,698  

Other securities

     7,860        —          —          7,860  
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 18,671      $ 2,776,685      $ —        $ 2,795,356  
  

 

 

    

 

 

    

 

 

    

 

 

 

 

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Table of Contents

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 June 30, 2017:

Impaired Loans – Impaired loans are reported at the fair value of the underlying collateral if repayment is expected solely from the collateral. Collateral values are estimated using Level 2 inputs based on observable market data. At June 30, 2017, impaired loans with a carrying value of $21,489,000 were reduced by specific valuation reserves totaling $4,543,000 resulting in a net fair value of $16,946,000.

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 June 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 six months ended June 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):

 

28


Table of Contents
     Three Months
Ended
June 30,
 
     2017      2016  

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

   $ 88      $ —    

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

     (8      —    
  

 

 

    

 

 

 

Fair value

   $ 80      $ —    
  

 

 

    
     Six Months
Ended
June 30,
 
     2017      2016  

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

   $ 88      $ —    

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

     (8      —    
  

 

 

    

 

 

 

Fair value

   $ 80      $ —    
  

 

 

    

At June 30, 2017 and 2016, and December 31, 2016, other real estate owned totaled $2,023,000, $124,000, 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.

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 June 30, 2017 and 2016, and December 31, 2016, were as follows (in thousands):

 

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Table of Contents
     June 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

   $ 163,435      $ 163,435      $ 135,092      $ 135,092      $ 204,782      $ 204,782      Level 1

Federal funds sold

     3,740        3,740        2,960        2,960        3,130        3,130      Level 1

Interest-bearing deposits in banks

     53,336        53,336        67,746        67,746        48,574        48,574      Level 1

Interest-bearing time deposits in banks

     1,458        1,458        2,427        2,429        1,707        1,709      Level 2

Available-for-sale Securities

     2,964,513        2,964,513        2,795,356        2,795,356        2,860,837        2,860,837      Levels 1
and 2

Held-to-maturity securities

     105        107        137        141        121        124      Level 2

Loans

     3,410,269        3,466,431        3,264,328        3,269,221        3,338,426        3,361,735      Level 3

Accrued interest receivable

     35,600        35,600        33,516        33,516        36,469        36,469      Level 2

Deposits with stated maturities

     477,441        478,393        554,753        556,224        508,996        510,304      Level 2

Deposits with no stated maturities

     5,149,168        5,149,168        4,501,536        4,501,536        4,969,543        4,969,543      Level 1

Borrowings

     379,324        379,324        556,924        556,924        445,770        445,770      Level 2

Accrued interest Payable

     164        164        283        283        225        225      Level 2

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. The Company expects that ASU 2014-09 will require a change in how the Company recognizes certain recurring revenue streams within trust management fees; however, these changes are not expected to have a significant impact on the Company’s financial statements. The Company continues to evaluate the impact of ASU 2014-09 on other components of non-interest income and expects to adopt the standard in the first quarter of 2018 with a cumulative effective adjustment to opening retained earnings, if such adjustment is deemed to be significant.

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 raised substantial doubt about the Company’s ability to continue as a going concern.

 

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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.

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

 

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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 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.

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.

 

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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;

 

    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.

 

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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.

 

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Results of Operations

Performance Summary. Net earnings for the second quarter of 2017 were $28.26 million compared to $26.81 million for the same quarter in 2016, or a 5.39% increase.

Basic earnings per share for the second quarter of 2017 were $0.43 compared to $0.41 for the same quarter last year. The return on average assets was 1.64% for the second quarter of 2017, as compared to 1.65% for the second quarter of 2016. The return on average equity was 12.94% for the second quarter of 2017 as compared to 12.76% for the second quarter of 2016.

Net earnings for the six-month period ended June 30, 2017 were $54.85 million compared to $52.51 million for the same period in 2016, or a 4.47% increase.

Basic earnings per share for the first six months of 2017 were $0.83 compared to $0.80 for the same period in 2016. The return on average assets was 1.61% for the first six months of 2017, the same percentage for the first six months period in 2016. The return on average equity was 12.84% for the first six months of 2017, as compared to 12.65% 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 $65.59 million for the second quarter of 2017, as compared to $62.72 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 tax-exempt securities. Average earning assets increased $364.01 million for the second quarter of 2017 over the same period in 2016. Average loans and tax-exempt securities increased $122.55 million and $89.19 million, respectively, for the second quarter of 2017 over the same quarter of 2016. Average interest-bearing liabilities increased $199.77 million for the second quarter of 2017, as compared to the same period in 2016. The yield on earning assets decreased two basis points and the rate paid on interest-bearing liabilities increased six basis points for the second quarter of 2017 compared to the second quarter of 2016.

Tax-equivalent net interest income was $129.16 million for the first six months of 2017, as compared to $125.86 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 $328.44 million for the first six months of 2017 over the same period in 2016. Average loans and tax-exempt securities increased $89.88 million and $95.31 million, respectively, for the first six months of 2017 over the same period of 2016. Average interest-bearing liabilities increased $224.14 million for the first six months of 2017, as compared to the same period in 2016. The yield on earning assets decreased six basis points and the rate paid on interest-bearing liabilities increased four basis points for the first six months of 2017 over the first six months of 2016.

 

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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
June 30, 2017 Compared to
Three Months Ended

June 30, 2016
    Six Months Ended
June 30, 2017 Compared to
Six Months Ended

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

Short-term investments

   $ 12     $ 45     $ 57     $ 137     $ 136     $ 273  

Taxable investment securities

     765       448       1,213       1,019       363       1,382  

Tax-exempt investment securities (1)

     1,019       (51     968       2,178       25       2,203  

Loans (1) (2)

     1,503       (99     1,404       2,208       (1,543     665  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Interest income

     3,299       343       3,642       5,542       (1,019     4,523  

Interest-bearing deposits

     126       771       897       237       1,198       1,435  

Short-term borrowings

     (109     (21     (130     (160     (57     (217
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Interest expense

     17       750       767       77       1,141       1,218  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net interest income

   $ 3,282     $ (407   $ 2,875     $ 5,465     $ (2,160   $ 3,305  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

(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 second quarter of 2017 was 4.05%, a decrease of seven 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.

 

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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 June 30,  
     2017      2016  
     Average
Balance
    Income/
Expense
     Yield/
Rate
     Average
Balance
    Income/
Expense
     Yield/
Rate
 

Assets

               

Short-term investments (1)

   $ 50,272     $ 120        0.96    $ 42,860     $ 63        0.59

Taxable investment securities (2)

     1,494,187       8,343        2.23        1,349,325       7,130        2.11  

Tax-exempt investment securities (2)(3)

     1,528,760       17,414        4.56        1,439,575       16,446        4.57  

Loans (3)(4)

     3,418,105       41,814        4.91        3,295,557       40,410        4.93  
  

 

 

   

 

 

    

 

 

    

 

 

   

 

 

    

 

 

 

Total earning assets

     6,491,324     $ 67,691        4.18      6,127,317     $ 64,049        4.20

Cash and due from banks

     152,198             144,051       

Bank premises and equipment, net

     122,980             119,779       

Other assets

     56,795             53,323       

Goodwill and other intangible assets, net

     143,361             144,075       

Allowance for loan losses

     (47,089           (44,814     
  

 

 

         

 

 

      

Total assets

   $ 6,919,569           $ 6,543,731       
  

 

 

         

 

 

      

Liabilities and Shareholders’ Equity

               

Interest-bearing deposits

   $ 3,803,412     $ 1,930        0.20    $ 3,388,572     $ 1,033        0.12

Short-term borrowings

     372,910       167        0.18        587,981       297        0.20  
  

 

 

   

 

 

    

 

 

    

 

 

   

 

 

    

 

 

 

Total interest-bearing liabilities

     4,176,322     $ 2,097        0.20      3,976,553     $ 1,330        0.14
               

Noninterest-bearing deposits

     1,816,380             1,655,091       

Other liabilities

     51,216             66,946       
  

 

 

         

 

 

      

Total liabilities

     6,043,918             5,698,590       

Shareholders’ equity

     875,651             845,141       
  

 

 

         

 

 

      

Total liabilities and shareholders’ equity

   $ 6,919,569           $ 6,543,731       
  

 

 

         

 

 

      

Net interest income

     $ 65,594           $ 62,719     
    

 

 

         

 

 

    

Rate Analysis:

               

Interest income/earning assets

          4.18           4.20

Interest expense/earning assets

          (0.13           (0.08
       

 

 

         

 

 

 

Net yield on earning assets

          4.05           4.12
       

 

 

         

 

 

 

 

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     Six Months Ended June 30,  
     2017      2016  
     Average
Balance
    Income/
Expense
     Yield/
Rate
     Average
Balance
    Income/
Expense
     Yield/
Rate
 

Assets

               

Short-term investments (1)

   $ 93,936     $ 397        0.85    $ 45,317     $ 124        0.55

Taxable investment securities (2)

     1,431,110       15,774        2.20        1,336,466       14,392        2.15  

Tax-exempt investment securities (2)(3)

     1,529,183       34,975        4.57        1,433,877       32,772        4.57  

Loans (3)(4)

     3,393,986       81,877        4.86        3,304,111       81,212        4.94  
  

 

 

   

 

 

    

 

 

    

 

 

   

 

 

    

 

 

 

Total earning assets

     6,448,215     $ 133,023        4.16      6,119,771     $ 128,500        4.22

Cash and due from banks

     159,822             151,183       

Bank premises and equipment, net

     122,887             118,004       

Other assets

     58,086             54,960       

Goodwill and other intangible assets, net

     143,447             144,212       

Allowance for loan losses

     (46,692           (43,723     
  

 

 

         

 

 

      

Total assets

   $ 6,885,765           $ 6,544,407       
  

 

 

         

 

 

      

Liabilities and Shareholders’ Equity

               

Interest-bearing deposits

   $ 3,806,157     $ 3,520        0.19    $ 3,417,096     $ 2,085        0.12

Short-term borrowings

     410,355       340        0.17        575,275       557        0.19  
  

 

 

   

 

 

    

 

 

    

 

 

   

 

 

    

 

 

 

Total interest-bearing liabilities

     4,216,512     $ 3,860        0.18      3,992,371     $ 2,642        0.14

Noninterest-bearing deposits

     1,763,133             1,653,637       

Other liabilities

     44,763             63,944       
  

 

 

         

 

 

      

Total liabilities

     6,024,408             5,709,952       

Shareholders’ equity

     861,357             834,455       
  

 

 

         

 

 

      

Total liabilities and shareholders’ equity

   $ 6,885,765           $ 6,544,407       
  

 

 

         

 

 

      

Net interest income

     $ 129,163           $ 125,858     
    

 

 

         

 

 

    

Rate Analysis:

               

Interest income/earning assets

          4.16           4.22

Interest expense/earning assets

          (0.12           (0.08
       

 

 

         

 

 

 

Net yield on earning assets

          4.04           4.14
               

 

(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 second quarter of 2017 was $23.17 million, an increase of $1.73 million compared to the same period in 2016. Trust fees increased 21.60 percent to $5.75 million in the second quarter of 2017 compared with $4.73 million in the same quarter last year, due to continued growth in the fair value of trust assets managed to $4.73 billion from $4.11 billion a year ago and an increase in trust account fees. Service charges on deposit accounts increased 10.88 percent to $4.88 million compared with $4.40 million in the same quarter last year due to continued growth in net new accounts. ATM, interchange and credit card fees increased 12.98 percent to $6.60 million compared with $5.84 million in the same quarter last year due to continued growth in debit cards. Real estate mortgage fees increased 4.36 percent in the second quarter of 2017 to $4.19 million compared with $4.01 million in the same quarter a year ago. Interest on loan recoveries decreased $292 thousand in the second quarter of 2017 compared to the same period in 2016.

Noninterest income for the six-month period ended June 30, 2017 was $44.46 million, an increase of $3.20 million compared to the same period in 2016. Trust fees increased 25.42 percent to $11.76 million in the first six months of 2017 compared with $9.38 million in the same period in 2016 due primarily to continued growth in the fair value of trust assets managed to $4.73 billion from $4.11 billion a year ago, an increase of $689 thousand in real estate and lease bonus fees over the same period last year and an increase in trust account fees. Service charges on deposits increased 6.97 percent to $9.43 million compared with $8.82 million in the same period last year due primarily to the continued growth in net new accounts. ATM, interchange and credit card fees increased 10.77 percent to $12.76 million compared with $11.52 million in the same period last year due to continued growth in debit cards. Real estate mortgage fees increased 6.32 percent

 

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in the second quarter of 2017 to $7.61 million compared with $7.15 million in the same period a year ago. Gain on sale of available-for-sale securities totaled $750 thousand in the first six months of 2017 compared to $914 thousand in the same period in 2016. Net gains (losses) on the sale of assets decreased $635 thousand due primarily to a $150 thousand loss recorded in 2017 from the pending sale of the Company’s mortgage servicing assets versus a gain on sale of the Weatherford branch building in 2016 of $529 thousand. Interest on loan recoveries decreased $770 thousand for the six-month period ending June 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
June 30,
  Six Months Ended
June 30,
     2017   Increase
(Decrease)
  2016   2017   Increase
(Decrease)
  2016

Trust fees

     $ 5,747     $ 1,021     $ 4,726     $ 11,764     $ 2,384     $ 9,380

Service charges on deposit accounts

       4,883       479       4,404       9,433       615       8,818

ATM, interchange and credit card fees

       6,598       758       5,840       12,762       1,241       11,521

Real estate mortgage operations

       4,188       175       4,013       7,605       452       7,153

Net gain on sale of available-for-sale securities

       747       (165 )       912       750       (164 )       914

Net gain (loss) on sale of foreclosed assets

       (72 )       (350 )       278       (31 )       (384 )       353

Net gain (loss) on sale of assets

       (200 )       (126 )       (74 )       (196 )       (635 )       439

Interest on loan recoveries

       337       (292 )       629       491       (770 )       1,261

Other:

                

Check printing fees

       43       4       39       81       (5 )       86

Safe deposit rental fees

       123       6       117       316       5       311

Credit life fees

       156       47       109       283       54       229

Brokerage commissions

       304       144       160       586       333       253

Miscellaneous income

       316       31       285       611       71       540
    

 

 

     

 

 

     

 

 

     

 

 

     

 

 

     

 

 

 

Total other

       942       232       710       1,877       458       1,419
    

 

 

     

 

 

     

 

 

     

 

 

     

 

 

     

 

 

 

Total Noninterest Income

     $ 23,170     $ 1,732     $ 21,438     $ 44,455     $ 3,197     $ 41,258
    

 

 

     

 

 

     

 

 

     

 

 

     

 

 

     

 

 

 

Noninterest Expense. Total noninterest expense for the second quarter of 2017 was $43.78 million, an increase of $3.02 million compared to the same period in 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 second quarter of 2017 was 49.32%, compared to 48.43% for the same period in 2016.

Salaries and employee benefits for the second quarter of 2017 totaled $23.47 million, an increase of $1.32 million compared to the same period in 2016. The increase was primarily driven by annual merit pay increases that were effective March 1, 2017 and an increase in our profit sharing expenses of $848 thousand over the same quarter in 2016.

All other categories of noninterest expense for the second quarter of 2017 totaled $20.31 million, an increase of $1.70 million compared to the same quarter in 2016. This increase primarily resulted from increases in professional and service fees of $375 thousand, data processing fees of $306 thousand from the implementation of a new Trust technology platform and software amortization and expense of $518 thousand from the write-off of software costs as compared to the same period in 2016.

 

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Total noninterest expense for the first six months of 2017 was $85.93 million, an increase of $4.09 million, compared to $81.84 million in the same period of 2016. Our efficiency ratio for the first six months of 2017 was 49.49%, compared to 48.97% from the same period in 2016.

Salaries and employee benefits for the first six months of 2017 totaled $46.72 million, an increase of $1.99 million compared to the same period in 2016. The increase was primarily driven by annual pay increases that were effective March 1, 2017 and an increase in our profit sharing expense over the same period in 2016.

All other categories of noninterest expense for the first six months of 2017 totaled $39.20 million, an increase of approximately $2.10 million, as compared to the same period in 2016. The increase primarily resulted from increases in operational and other losses of $639 thousand, professional and services fees of $627 thousand, data processing fees of $333 thousand from the implementation of a new trust technology platform and software amortization and expense of $507 thousand from the write-off of software costs as compared to the same period in 2016.

 

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Table 4 - Noninterest Expense (in thousands):

 

     Three Months Ended June 30,      Six Months Ended June 30,  
     2017      Increase
(Decrease)
    2016      2017      Increase
(Decrease)
    2016  

Salaries

   $ 18,295      $ 640     $ 17,655      $ 35,855      $ 1,118     $ 34,737  

Medical

     1,906        (292     2,198        4,075        (151     4,226  

Profit sharing

     957        848       109        1,983        829       1,154  

Pension

     84        2       82        168        3       165  

401(k) match expense

     617        25       592        1,226        23       1,203  

Payroll taxes

     1,256        54       1,202        2,719        82       2,637  

Stock option and stock grant expense

     350        41       309        698        83       615  
  

 

 

    

 

 

   

 

 

    

 

 

    

 

 

   

 

 

 

Total salaries and employee benefits

     23,465        1,318       22,147        46,724        1,987       44,737  

Net occupancy expense

     2,771        188       2,583        5,370        156       5,214  

Equipment expense

     3,665        279       3,386        7,102        336       6,766  

FDIC assessment fees

     550        (268     818        1,097        (545     1,642  

ATM, interchange and credit card expense

     1,803        (3     1,806        3,516        24       3,492  

Professional and service fees

     2,025        375       1,650        3,842        627       3,215  

Printing, stationery and supplies

     536        72       464        974        7       967  

Operational and other losses

     574        141       433        1,559        639       920  

Amortization of intangible assets

     165        (34     199        333        (65     398  

Other:

               

Data processing fees

     416        306       110        546        333       213  

Postage

     413        24       389        833        17       816  

Advertising

     893        (24     917        1,755        23       1,732  

Correspondent bank service charges

     231        (8     239        448        (38     486  

Telephone

     782        (92     874        1,567        (38     1,605  

Public relations and business development

     683        63       620        1,364        114       1,250  

Directors’ fees

     404        66       338        738        39       699  

Audit and accounting fees

     408        (15     423        862        (38     900  

Legal fees

     472        37       435        1,098        45       1,053  

Regulatory exam fees

     292        9       283        584        18       566  

Software amortization and expense

     995        518       477        1,495        507       988  

Travel

     345        6       339        617        11       606  

Courier expense

     215        (2     217        420        17       403  

Other real estate

     65        (36     101        88        (54     142  

Other miscellaneous expense

     1,607        99       1,508        2,994        (32     3,026  
  

 

 

    

 

 

   

 

 

    

 

 

    

 

 

   

 

 

 

Total other

     8,221        951       7,270        15,409        924       14,485  
  

 

 

    

 

 

   

 

 

    

 

 

    

 

 

   

 

 

 

Total Noninterest Expense

   $ 43,775      $ 3,019     $ 40,756      $ 85,926      $ 4,090     $ 81,836  
  

 

 

    

 

 

   

 

 

    

 

 

    

 

 

   

 

 

 

 

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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 June 30, 2017, total loans held for investment were $3.44 billion, an increase of $82.05 million, as compared to December 31, 2016 balances. As compared to December 31, 2016, commercial loans decreased $6.36 million, agricultural loans decreased $6.68 million, real estate loans increased $81.26 million, and consumer loans increased $13.83 million. Loans averaged $3.42 billion during the second quarter of 2017, an increase of $122.55 million from the prior year second quarter average balances. Loans averaged $3.39 billion during the six-month period ended June 30, 2017, an increase of $89.88 million from the prior year six-month average balances.

Table 5 - Composition of Loans (in thousands):

 

     June 30,      December 31,
2016
 
     2017      2016     

Commercial

   $ 668,049      $ 661,659      $ 674,410  

Agricultural

     77,342        80,812        84,021  

Real estate

     2,271,100        2,154,388        2,189,844  

Consumer

     422,861        386,796        409,032  
  

 

 

    

 

 

    

 

 

 

Total loans held-for-investment

   $ 3,439,352      $ 3,283,655      $ 3,357,307  
  

 

 

    

 

 

    

 

 

 

At June 30, 2017, our real estate loans represent approximately 66.03% of our loan portfolio and are comprised of (i) 1-4 family residence loans of 45.44%, (ii) commercial real estate loans of 24.39%, generally owner occupied, (iii) other loans, which includes ranches, hospitals and universities, of 16.71%, (iv) residential development and construction loans of 7.67%, which includes our custom and speculation home construction loans and (v) commercial development and construction loans of 5.79%.

Loans held for sale, consisting of secondary market mortgage loans, totaled $18.33 million, $25.73 million, and $26.90 million at June 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 $24.72 million at June 30, 2017, as compared to $40.39 million at June 30, 2016 and $29.00 million at December 31, 2016. As a percent of loans and foreclosed assets, these assets were 0.71% at June 30, 2017, as compared to 1.22% at June 30, 2016 and 0.86% at December 31, 2016. As a percent of total assets, these assets were 0.36% at June 30, 2017, as compared to 0.61% at June 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 June 30, 2017.

 

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Supplemental Oil and Gas Information. As of June 30, 2017, the Company’s exposure to the oil and gas industry totaled 2.03% of gross loans, or $70.19 million, down $8.30 million from December 31, 2016 year-end levels, and consisted (based on collateral supporting the loan) of (i) development and production loans of 3.52%, (ii) oil and gas field servicing loans of 7.98%, (iii) real estate loans of 43.96%, (iv) accounts receivable and inventory of 25.52% and (v) other of 19.02%. As oil and gas prices have fluctuated in the upper $40 to lower $50 per barrel range, several of our credits continue to experience stress. 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 June 30, 2017 and 2016, and December 31, 2016:

 

     June 30,   December 31,
2016
     2017   2016  

Oil and gas related loans

     $ 70,187     $ 87,857     $ 78,483

Oil and gas related loans as a % of total loans

       2.03 %       2.65 %       2.32 %

Classified oil and gas related loans

     $ 24,404     $ 32,674     $ 32,518

Nonaccrual oil and gas related loans

       2,860       5,763       4,092

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

       50       419       1,145

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

       7.24 %       6.57 %       6.28 %

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

 

     June 30,   December 31,
2016
     2017   2016  

Non-accrual loans*

     $ 21,489     $ 38,904     $ 27,371

Loans still accruing and past due 90 days or more

       314       237       284

Troubled debt restructured loans**

       672       961       701
    

 

 

     

 

 

     

 

 

 

Nonperforming Loans

       22,475       40,102       28,356

Foreclosed assets

       2,245       285       644
    

 

 

     

 

 

     

 

 

 

Total nonperforming assets

     $ 24,720     $ 40,387     $ 29,000
    

 

 

     

 

 

     

 

 

 

As a % of loans and foreclosed assets

       0.71 %       1.22 %       0.86 %

As a % of total assets

       0.36 %       0.61 %       0.43 %

*Includes $889 thousand, $1.65 million and $1.26 million of purchased credit impaired loans as of June 30, 2017 and 2016, and December 31, 2016, respectively.

**Other troubled debt restructured loans of $5.42 million, $7.45 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 June 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 as of December 31, 2016 of approximately $790 thousand during 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.

 

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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 $1.73 million for the second quarter of 2017, as compared to $2.06 million for the second quarter of 2016. The provision for loan losses was $3.68 million for the six-month period ended 2017 as compared to $4.39 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, as well as the continued economic effects related to the oil and gas industry. As a percent of average loans, net loan charge-offs were 0.06% for the second quarter of 2017, as compared to 0.13% for the second quarter of 2016. As a percent of average loans, net loan charge-offs were 0.12% for the first six months of 2017, as compared to 0.07% for the first six months of 2016. The allowance for loan losses as a percent of loans was 1.37% as of June 30, 2017, as compared to 1.36% as of June 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
June 30,
    Six Months Ended
June 30,
 
     2017     2016     2017     2016  

Allowance for loan losses at period-end

   $ 47,410     $ 45,060     $ 47,410     $ 45,060  

Loans held for investment at period-end

     3,439,352       3,283,655       3,439,352       3,283,655  

Average loans for period

     3,418,105       3,295,557       3,393,986       3,304,111  

Net charge-offs/average loans (annualized)

     0.06     0.13     0.12     0.07

Allowance for loan losses/period-end loans

     1.37     1.36     1.37     1.36

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

     210.95     112.36     210.95     112.36

Interest-Bearing Deposits in Banks. At June 30, 2017, our interest-bearing deposits in banks were $54.79 million compared to $70.17 million at June 30, 2016 and $50.28 million at December 31, 2016, respectively. At June 30, 2017, interest-bearing deposits in banks included $1.46 million invested in FDIC-insured certificates of deposit, $52.46 million maintained at the Federal Reserve Bank of Dallas and $870 thousand on deposit with the Federal Home Loan Bank of Dallas (“FHLB”).

Available-for-Sale and Held-to-Maturity Securities. At June 30, 2017, securities with a fair value of $2.96 billion were classified as securities available-for-sale and securities with an amortized cost of $105 thousand were classified as securities held-to-maturity. As compared to December 31, 2016, the available-for-sale portfolio at June 30, 2017 reflected (i) a decrease of $95 thousand in U.S. Treasury securities (ii) a decrease of $40.00 million in obligations of U.S. government sponsored enterprises and agencies, (iii) a decrease of $32.40 million in obligations of states and political subdivisions, (iv) a decrease of $22.15 million in corporate bonds and other, and (v) an increase of $198.33 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 June 30, 2017 and 2016, and December 31, 2016.

 

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Table 8 - Maturities and Yields of Available-for-Sale Securities Held at June 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  

U.S. Treasury securities

   $ 10,573        1.14   $ —          —     $ —          —     $ —          —     $ 10,573        1.14

Obligations of U.S. government sponsored enterprises and agencies

     28,038        1.12       45,667        1.46       —          —         —          —         73,705        1.33  

Obligations of states and political subdivisions

     109,894        4.78       654,543        5.10       765,419        4.71       2,017        6.86       1,531,873        4.88  

Corporate bonds and other securities

     29,999        2.62       241        1.14       —          —         —          —         30,240        2.60  

Mortgage-backed securities

     29,239        1.97       1,007,816        2.27       281,067      &