SOUTH PLAINS FINANCIAL, INC. - FORM 10-Q

Attached files

file	filename
EX-32.2 - EXHIBIT 32.2 - SOUTH PLAINS FINANCIAL, INC.	brhc10014344_ex32-2.htm
EX-32.1 - EXHIBIT 32.1 - SOUTH PLAINS FINANCIAL, INC.	brhc10014344_ex32-1.htm
EX-31.2 - EXHIBIT 31.2 - SOUTH PLAINS FINANCIAL, INC.	brhc10014344_ex31-2.htm
EX-31.1 - EXHIBIT 31.1 - SOUTH PLAINS FINANCIAL, INC.	brhc10014344_ex31-1.htm

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

FORM 10-Q

(Mark One)

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

For the quarterly period ended June 30, 2020

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

For the transition period from ______ to ______

Commission File Number: 001-38895

South Plains Financial, Inc.

(Exact name of registrant as specified in its charter)

Texas		75-2453320
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)

5219 City Bank Parkway Lubbock, Texas		79407
(Address of principal executive offices)		(Zip Code)

Registrant’s telephone number, including area code: (806) 792-7101

Securities registered pursuant to Section 12(b) of the Act:

Title of each class	Trading Symbol(s)	Name of each exchange on which registered
Common Stock, $1.00 par value per share	SPFI	The Nasdaq Stock Market, LLC

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 every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit 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	☒	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 Exchange Act). Yes ☐ No ☒

As of August 14, 2020, the registrant had 18,059,174 shares of common stock, par value $1.00 per share, outstanding.

TABLE OF CONTENTS

		Page
PART I.	FINANCIAL INFORMATION	3
Item 1.	Consolidated Financial Statements	3
	Consolidated Balance Sheets (Unaudited)	3
	Consolidated Statements of Comprehensive Income (Unaudited)	4
	Consolidated Statements of Changes in Stockholders’ Equity (Unaudited)	6
	Consolidated Statements of Cash Flows (Unaudited)	7
	Notes to Consolidated Financial Statements (Unaudited)	8
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	26
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	48
Item 4.	Controls and Procedures	49
PART II.	OTHER INFORMATION	50
Item 1.	Legal Proceedings	50
Item 1A.	Risk Factors	50
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	52
Item 3.	Defaults Upon Senior Securities	52
Item 4.	Mine Safety Disclosures	52
Item 5.	Other Information	52
Item 6.	Exhibits	53
Signatures		54

Table of Contents

PART I. FINANCIAL INFORMATION

Item 1.

Consolidated Financial Statements

SOUTH PLAINS FINANCIAL, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(Dollars in thousands, except per share data)

	June 30, 2020			December 31, 2019
	(Unaudited)
ASSETS
Cash and due from banks	$	51,256		$	56,246
Interest-bearing deposits in banks		204,845			101,853
Cash and cash equivalents		256,101			158,099
Securities available for sale		730,674			707,650
Loans held for sale		92,774			49,035
Loans held for investment		2,331,716			2,143,623
Allowance for loan losses		(40,635	)		(24,197	)
Accrued interest receivable		13,598			13,924
Premises and equipment, net		61,883			61,873
Bank-owned life insurance		70,071			69,397
Goodwill		19,968			18,757
Intangible assets		8,446			8,632
Mortgage servicing rights		3,776			2,054
Other assets		36,160			28,320
Total assets	$	3,584,532		$	3,237,167

LIABILITIES AND STOCKHOLDERS’ EQUITY

Deposits:
Noninterest-bearing	$	940,853		$	790,921
Interest-bearing		2,006,984			1,905,936
Total deposits		2,947,837			2,696,857
Short-term borrowings		9,565			37,165
Accrued expenses and other liabilities		47,731			29,098
Notes payable & other borrowings		170,000			95,000
Subordinated debt securities		26,472			26,472
Junior subordinated deferrable interest debentures		46,393			46,393
Total liabilities		3,247,998			2,930,985

Stockholders’ equity:
Common stock, $1.00 par value per share, 30,000,000 shares authorized; 18,059,174 and 18,036,115 issued and outstanding at June 30, 2020 and December 31, 2019, respectively		18,059			18,036
Additional paid-in capital		140,620			140,492
Retained earnings		158,311			146,696
Accumulated other comprehensive income		19,544			958
Total stockholders’ equity		336,534			306,182

Total liabilities and stockholders’ equity	$	3,584,532		$	3,237,167

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

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SOUTH PLAINS FINANCIAL, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(Unaudited)

(Dollars in thousands, except per share data)

	Three Months Ended June 30,				Six Months Ended June 30,
	2020		2019		2020		2019
Interest income:
Loans, including fees	$	29,861	$	28,592	$	60,876	$	56,690
Securities:
Taxable		3,170		1,816		6,950		3,992
Non taxable		942		218		1,338		443
Federal funds sold and interest-bearing deposits in banks		34		1,883		580		3,388
Total interest income		34,007		32,509		69,744		64,513
Interest expense:
Deposits		2,760		6,139		7,043		12,028
Notes payable & other borrowings		102		618		552		1,268
Subordinated debt securities		403		403		807		809
Junior subordinated deferrable interest debentures		294		512		695		1,025
Total interest expense		3,559		7,672		9,097		15,130
Net interest income		30,448		24,837		60,647		49,383
Provision for loan losses		13,133		875		19,367		1,483
Net interest income, after provision for loan losses		17,315		23,962		41,280		47,900
Noninterest income:
Service charges on deposit accounts		1,439		1,979		3,422		3,884
Income from insurance activities		1,022		1,210		2,181		2,960
Net gain on sales of loans		17,797		6,235		26,337		10,895
Bank card services and interchange fees		2,344		2,071		4,582		4,081
Realized gain on sale of securities		—		—		2,318		—
Investment commissions		365		493		820		826
Fiduciary fees		776		367		1,605		743
Other		1,153		1,348		2,506		2,389
Total noninterest income		24,896		13,703		43,771		25,778
Noninterest expense:
Salaries and employee benefits		21,621		18,784		42,431		37,909
Occupancy and equipment, net		3,586		3,416		7,186		6,823
Professional services		1,961		1,611		3,533		3,317
Marketing and development		806		796		1,574		1,513
IT and data services		1,079		689		1,926		1,382
Bank card expenses		1,017		806		2,069		1,530
Appraisal expenses		638		407		1,093		730
Other		4,499		3,421		9,406		6,762
Total noninterest expense		35,207		29,930		69,218		59,966
Income before income taxes		7,004		7,735		15,833		13,712
Income tax expense (benefit)		1,389		1,655		3,135		2,859
Net income	$	5,615	$	6,080	$	12,698	$	10,853

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

Table of Contents

SOUTH PLAINS FINANCIAL, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (CONTINUED)

(Unaudited)

(Dollars in thousands, except per share data)

	Three Months Ended June 30,						Six Months Ended June 30,
	2020			2019			2020			2019
Earnings per share:
Basic	$	0.31		$	0.37		$	0.70		$	0.69
Diluted	$	0.31		$	0.37		$	0.69		$	0.69

Net income	$	5,615		$	6,080		$	12,698		$	10,853
Other comprehensive income (loss):
Change in net unrealized loss on securities available for sale		6,813			4,410			28,002			7,317
Change in net losses on cash flow hedges		(931	)		—			(2,158	)		—
Reclassification adjustment for (gain) loss included in net income		—			—			(2,318	)		—
Tax effect		(1,235	)		(926	)		(4,940	)		(1,537	)
Other comprehensive income (loss)		4,647			3,484			18,586			5,780
Comprehensive income	$	10,262		$	9,564		$	31,284		$	16,633

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

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SOUTH PLAINS FINANCIAL, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY

(Unaudited)

(Dollars in thousands, except per share data)

	Common Stock						Additional Paid-in			Retained			Accumulated Other Comprehensive			Treasury			Less: ESOP Owned
	Shares			Amount			Capital			Earnings			Income (Loss)			Stock			Shares			Total
Six Months Ended June 30,
Balance at January 1, 2019		14,771,520		$	14,772		$	80,412		$	119,834		$	(2,243	)	$	—		$	(58,195	)	$	154,580
Issuance of common stock, net		3,207,000			3,207			48,185			—			—			—			—			51,392
Net income		—			—			—			10,853			—			—			—			10,853
Other comprehensive (loss), (net of tax)		—			—			—			—			5,780			—			—			5,780
Terminated ESOP put option		—			—			—			—			—			—			58,195			58,195
Stock based compensation		—			—			142			—			—			—			—			142
Share-based liability awards modified to equity awards		—			—			11,450			—			—			—			—			11,450
Cumulative change in accounting principle		—			—			—			(1,279	)		—			—			—			(1,279	)
Balance at June 30, 2019		17,978,520		$	17,979		$	140,189		$	129,408		$	3,537		$	—		$	—		$	291,113

Balance at January 1, 2020		18,036,115		$	18,036		$	140,492		$	146,696		$	958		$	—		$	—		$	306,182
Net income		—			—			—			12,698			—			—			—			12,698
Cash dividends:
Common - $0.03 per share		—			—			—			(1,083	)		—			—			—			(1,083	)
Other comprehensive income, (net of tax)		—			—			—			—			18,586			—			—			18,586
Exercise of employee stock options and vesting of restricted stock units, net of 17,178 shares for cashless exercise and net of 7,608 shares for taxes		27,759			28			(157	)		—			—			—			—			(129	)
Purchase of treasury stock		—			—			—			—			—			(61	)		—			(61	)
Extinguish treasury stock		(4,700	)		(5	)		(56	)		—			—			61			—			-
Stock based compensation		—			—			341			—			—			—			—			341
Balance at June 30, 2020		18,059,174		$	18,059		$	140,620		$	158,311		$	19,544		$	—		$	—		$	336,534

Three Months Ended June 30,
Balance at March 31, 2019		14,771,520		$	14,772		$	80,412		$	123,328		$	53		$	—		$	(58,195	)	$	160,370
Issuance of common stock, net		3,207,000			3,207			48,185			—			—			—			—			51,392
Net income		—			—			—			6,080			—			—			—			6,080
Other comprehensive income, (net of tax)		—			—			—			—			3,484			—			—			3,484
Terminated ESOP put option		—			—			—			—			—			—			58,195			58,195
Stock based compensation		—			—			142			—			—			—			—			142
Share-based liability awards modified to equity awards		—			—			11,450			—			—			—			—			11,450
Balance at June 30, 2019		17,978,520		$	17,979		$	140,189		$	129,408		$	3,537		$	—		$	—		$	291,113

Balance at March 31, 2020		18,056,014		$	18,056		$	140,699		$	153,238		$	14,897		$	—		$	—		$	326,890
Net income		—			—			—			5,615			—			—			—			5,615
Cash dividends:
Common - $0.03		—			—			—			(542	)		—			—			—			(542	)
Other comprehensive income, (net of tax)		—			—			—			—			4,647			—			—			4,647
Exercise of employee stock options and vesting of restricted stock units, net of 16,518 shares for cashless exercise and net of 2,622 shares for taxes		7,860			8			(54	)		—			—			—			—			(46	)
Purchase of treasury stock		—			—			—			—			—			(61	)		—			(61	)
Extinguish treasury stock		(4,700	)		(5	)		(56	)		—			—			61			—			—
Stock based compensation		—			—			31			—			—			—			—			31
Balance at June 30, 2020		18,059,174		$	18,059		$	140,620		$	158,311		$	19,544		$	—		$	—		$	336,534

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

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SOUTH PLAINS FINANCIAL, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

(Dollars in thousands)

	For the Six Months Ended June 30,
	2020			2019
Cash flows from operating activities:
Net income	$	12,698		$	10,853
Adjustments to reconcile net income to net cash from operating activities:
Provision for loan losses		19,367			1,483
Depreciation and amortization		3,257			2,474
Accretion and amortization		1,130			(296	)
Other gains, net		(2,441	)		(149	)
Net gain on sales of loans		(26,337	)		(10,895	)
Proceeds from sales of loans held for sale		567,294			274,021
Loans originated for sale		(584,696	)		(263,676	)
Earnings on bank-owned life insurance		(674	)		(622	)
Stock based compensation		341			142
Net change in:
Accrued interest receivable and other assets		(16,859	)		45
Accrued expenses and other liabilities		18,340			8,279
Net cash from operating activities		(8,580	)		21,659

Cash flows from investing activities:
Activity in securities available for sale:
Purchases		(121,254	)		(11,233	)
Sales		94,514			—
Maturities, prepayments, and calls		30,588			93,478
Loan originations and principal collections, net		(193,060	)		19,940
Cash paid for acquisition		(687	)		—
Purchases of premises and equipment, net		(2,402	)		(2,406	)
Proceeds from sales of premises and equipment		87			74
Proceeds from sales of foreclosed assets		1,689			1,244
Net cash from investing activities		(190,525	)		101,097

Cash flows from financing activities:
Net change in deposits		250,980			4,404
Net change in short-term borrowings		(27,600	)		(8,895	)
Proceeds from common stock issuance, net		—			51,392
Proceeds from notes payable & other borrowings		75,000			—
Payments to tax authorities for stock-based compensation		(129	)		—
Payments made on notes payable and other borrowings		—			(7,530	)
Cash dividends on common stock		(1,083	)		—
Purchase of treasury stock		(61	)		—
Net cash from financing activities		297,107			39,371

Net change in cash and cash equivalents	$	98,002		$	162,127
Beginning cash and cash equivalents		158,099			245,989
Ending cash and cash equivalents	$	256,101		$	408,116

Supplemental disclosures of cash flow information:
Interest paid on deposits and borrowed funds	$	9,623		$	14,866
Income taxes paid		—			2,853
Supplemental schedule of noncash investing and financing activities:
Loans transferred to foreclosed assets	$	1,088		$	1,166
Share-based liability awards modified to equity awards		—			11,450

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

Table of Contents

SOUTH PLAINS FINANCIAL, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

(Dollars in thousands except per share data)

1.	SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Nature of Operations – South Plains Financial, Inc. (“SPFI”) is a Texas corporation and registered bank holding company that conducts its principal activities through its subsidiaries from offices located throughout Texas and Eastern New Mexico. Principal activities include commercial and retail banking, along with insurance, investment, trust, and mortgage services. The following are subsidiaries of SPFI:

Wholly Owned, Consolidated Subsidiaries:
City Bank	Bank subsidiary
Windmark Insurance Agency, Inc. (“Windmark”)	Non-bank subsidiary
Ruidoso Retail, Inc.	Non-bank subsidiary
CB Provence, LLC	Non-bank subsidiary
CBT Brushy Creek, LLC	Non-bank subsidiary
CBT Properties, LLC	Non-bank subsidiary
Wholly Owned, Equity Method Subsidiaries:
South Plains Financial Capital Trusts (SPFCT) III-V	Non-bank subsidiaries

Basis of Presentation and Consolidation – The consolidated financial statements in this Quarterly Report on Form 10-Q (this “Form 10-Q”) include the accounts of SPFI and its wholly owned consolidated subsidiaries (collectively referred to as the “Company”) identified above. All significant intercompany balances and transactions have been eliminated in consolidation.

The interim consolidated financial statements in this Form 10-Q have not been audited by an independent registered public accounting firm, but in the opinion of management, reflect all adjustments necessary for a fair presentation of the Company’s financial position and results of operations. All such adjustments were of a normal and recurring nature. The consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) for interim financial information and with the instructions to Form 10-Q adopted by the Securities and Exchange Commission (“SEC”). Accordingly, the financial statements do not include all of the information and footnotes required by GAAP for complete financial statements 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, 2019. Operating results for the interim periods disclosed herein are not necessarily indicative of the results that may be expected for a full year or any future period.

Use of Estimates – The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Determination of the adequacy of the allowance for loan losses is a material estimate that is particularly susceptible to significant change in the near term; the assumptions used in stock-based compensation, the valuation of foreclosed assets, and fair values of financial instruments can also involve significant management estimates.

Change in Capital Structure

On March 11, 2019, the Company amended and restated its Certificate of Formation. The Amended and Restated Certificate of Formation increased the number of authorized shares of common stock, par value $1.00 per share, from 1,000,000 to 30,000,000.

The Company completed a 29-to-1 stock split of the Company’s outstanding shares of common stock for shareholders of record as of March 11, 2019. The stock split was payable in the form of a dividend on or about March 11, 2019. Shareholders received 29 additional shares for each share held as of the record date. All share and per share amounts in the consolidated financial statements have been retroactively adjusted to reflect this stock split for all periods presented.

Loans – Loans that management has the intent and ability to hold for the foreseeable future or until maturity or payoff are reported at their outstanding principal balances net of any unearned income, charge-offs, unamortized deferred fees and costs on originated loans, and premiums or discounts on purchased loans. Interest income is accrued on the unpaid principal balance. Loan origination fees, net of certain direct origination costs, are deferred and recognized as an adjustment of the related loan yield using the straight-line method, which is not materially different from the effective interest method required by GAAP.

Loans are placed on nonaccrual status when, in management’s opinion, collection of interest is unlikely, which typically occurs when principal or interest payments are more than ninety days past due. When interest accrual is discontinued, all unpaid accrued interest is reversed against interest income. The interest on these loans is accounted for on the cash-basis or cost-recovery method, until qualifying for return to 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.

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Allowance for Loan Losses – The allowance for loan losses is established as losses are estimated to have occurred through a provision for loan losses charged to earnings. Loan losses are charged against the allowance when management believes the uncollectibility of a loan balance is confirmed. Subsequent recoveries, if any, are credited to the allowance. The Company’s allowance for loan losses consists of specific valuation allowances established for probable losses on specific loans and general valuation allowances calculated based on historical loan loss experience for similar loans with similar characteristics and trends, judgmentally adjusted for general economic conditions and other qualitative risk factors internal and external to the Company.

The allowance for loan losses is evaluated on a quarterly basis by management and is based upon management’s review of the collectibility of the loans in light of historical experience, the nature and volume of the loan portfolio, adverse situations that may affect the borrower’s ability to repay, estimated value of any underlying collateral, and prevailing economic conditions. This evaluation is inherently subjective, as it requires estimates that are susceptible to significant revision as more information becomes available. The determination of the adequacy of the allowance for loan losses is based on estimates that are particularly susceptible to significant changes in the economic environment and market conditions. In connection with the determination of the estimated losses on loans, management obtains independent appraisals for significant collateral. Loans originated by the bank subsidiary are generally secured by specific items of collateral including real property, crops, livestock, consumer assets, and other business assets.

While management uses available information to recognize losses on loans, further reductions in the carrying amounts of loans may be necessary based on various factors. In addition, regulatory agencies, as an integral part of their examination process, periodically review the estimated losses on loans. Such agencies may require the bank subsidiary to recognize additional losses based on their judgments about information available to them at the time of their examination. Because of these factors, it is reasonably possible that the estimated losses on loans may change materially in the near term. However, the amount of the change that is reasonably possible cannot be estimated.

A loan is considered impaired when, based on current information and events, it is probable that the Company will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. All loans rated substandard or worse and greater than $250,000 are specifically reviewed to determine if they are impaired. Factors considered by management in determining whether a loan is impaired include payment status and the sources, amounts, and probabilities of estimated cash flow available to service debt in relation to amounts due according to contractual terms. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment record, and the amount of the shortfall in relation to the principal and interest owed.

Loans that are determined to be impaired are then evaluated to determine estimated impairment, if any. GAAP allows impairment to be measured on a loan-by-loan basis by either the present value of expected future cash flows discounted at the loan’s effective interest rate, the loan’s obtainable market price, or the fair value of the collateral if the loan is collateral dependent. Loans that are not individually determined to be impaired or are not subject to the specific review of impaired status are subject to the general valuation allowance portion of the allowance for loan loss.

The Company may modify its loan agreement with a borrower. The modification will be considered a troubled debt restructuring if the following criteria are met: (1) the borrower is experiencing a financial difficulty and (2) the Company makes a concession that it would not otherwise make. Concessions may include debt forgiveness, interest rate change, or maturity extension. Each of these loans is impaired and is evaluated for impairment, with a specific reserve recorded as necessary based on probable losses related to collateral and cash flow. A loan will no longer be required to be reported as restructured in calendar years following the restructure if the interest rate at the time of restructure is greater than or equal to the rate the Company was willing to accept for a new extension of credit with similar risk and the loan is in compliance with its modified terms.

Acquired Loans – Loans that the Company acquires in connection with business combinations are recorded at fair value with no carryover of the acquired entity’s related allowance for loan losses. The fair value of the acquired loans involves estimating the amount and timing of principal and interest cash flows expected to be collected on the loans and discounting those cash flows at a market rate of interest.

The excess of cash flows expected at acquisition over the estimated fair value is referred to as the accretable discount and is recognized into interest income over the remaining life of the loan. The difference between contractually required payments at acquisition and the cash flows expected to be collected at acquisition is referred to as the nonaccretable discount. These loans are accounted for under ASC 310-30, Loans and Debt Securities Acquired with Deteriorated Credit Quality. The nonaccretable discount includes estimated future credit losses expected to be incurred over the life of the loan. Subsequent decreases to the expected cash flows will require the Company to evaluate the need for an additional allowance. Subsequent improvement in expected cash flows will result in the reversal of a corresponding amount of the nonaccretable discount which the Company will then reclassify as accretable discount that will be recognized into interest income over the remaining life of the loan.

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Loans acquired through business combinations that meet the specific criteria of ASC 310-30 are individually evaluated each period to analyze expected cash flows. To the extent that the expected cash flows of a loan have decreased due to credit deterioration, the Company then establishes an allowance.

Loans acquired through business combinations that do not meet the specific criteria of ASC 310-30 are accounted for under ASC 310-20. These loans are initially recorded at fair value, and include credit and interest rate marks associated with acquisition accounting adjustments. Purchase premiums or discounts are subsequently amortized as an adjustment to yield over the estimated contractual lives of the loans. There is no allowance for loan losses established at the acquisition date for acquired performing loans. An allowance for loan losses is recorded for any credit deterioration in these loans subsequent to acquisition.

Acquired loans that met the criteria for impaired or nonaccrual of interest prior to the acquisition may be considered performing upon acquisition, regardless of whether the customer is contractually delinquent, if the Company expects to fully collect the new carrying value (i.e. fair value) of the loans. As such, the Company may no longer consider the loan to be nonaccrual or nonperforming at the date of acquisition and may accrue interest on these loans, including the impact of any accretable discount. In addition, charge-offs on such loans would be first applied to the nonaccretable difference portion of the fair value adjustment.

Goodwill and Other Intangible Assets – Goodwill resulting from business combinations is generally determined as the excess of the fair value of the consideration transferred over the fair value of the net assets acquired and liabilities assumed as of the acquisition date. Goodwill is not amortized, but is tested for impairment at least annually or more frequently if events and circumstances exist that indicate that an impairment test should be performed. Intangible assets with definite lives are amortized over their estimated useful lives.

Core deposit intangible (“CDI”) is a measure of the value of checking and savings deposit relationships acquired in a business combination. The fair value of the CDI stemming from any given business combination is based on the present value of the expected cost savings attributable to the core deposit funding relative to an alternative source of funding. CDI is amortized over the estimated useful lives of the existing deposit relationships acquired, but does not exceed 10 years. Significantly all CDI is amortized using the sum of the years digits method.

The remaining other intangible assets consist of customer relationship and employment agreement intangible assets and are amortized over their estimated useful lives of 5 years.

Stock-based Compensation – The Company sponsors an equity incentive plan under which options to acquire shares of the Company’s common stock may be granted periodically to all full-time employees and directors of the Company or its affiliates at a specific exercise price. Shares are issued out of authorized and unissued common shares that have been reserved for issuance under such plan. Compensation cost is measured based on the estimated fair value of the award at the grant date and is recognized in earnings on a straight-line basis over the requisite service period. The fair value of stock options is estimated at the date of grant using the Black-Scholes option pricing model. This model requires assumptions as to the expected stock volatility, dividends, terms and risk-free rates. The expected volatility is based on the combination of the Company’s historical volatility and the volatility of comparable peer banks. The expected term represents the period of time that options are expected to be outstanding from the grant date. The risk-free interest rate is based on the U.S. Treasury yield curve in effect at the time of grant for the appropriate life of each stock option.

Reclassification – Certain amounts in the Company’s Annual Report on Form 10-K, for the year ended December 31, 2019 have been reclassified to conform to the 2020 presentation.

Recent Accounting Pronouncements – Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) constitutes GAAP for nongovernmental entities. Updates to ASC are prescribed in Accounting Standards Updates (“ASU”), which are not authoritative until incorporated into ASC.

ASU 2016-02 Leases (Topic 842). The FASB amended existing guidance that requires that lessees recognize lease assets and lease liabilities on the balance sheet and disclose key information about leasing arrangements. The Company is in the process of determining the effect of the standard on its consolidated operating results and financial condition. These amendments are effective for the Company for annual periods beginning after December 15, 2021 and interim periods beginning after December 15, 2022.

ASU 2016-13 Financial Instruments - Credit Losses (Topic 326). The FASB issued guidance to replace the incurred loss model with an expected loss model, which is referred to as the current expected credit loss (“CECL”) model. The CECL model is applicable to the measurement of credit losses on financial assets measured at amortized cost, including loan receivables, held to maturity securities, and debt securities. ASU 2016-13 is effective for the Company for annual periods beginning after December 15, 2022, including interim periods within those fiscal years. Entities will apply the standard’s provisions as a cumulative-effect adjustment to retained earnings as of the beginning of the first reporting period in which the guidance is adopted. The Company is currently evaluating the impact adoption of ASU 2016-13 will have on its consolidated operating results and financial condition.

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ASU 2017-04, Intangibles - Goodwill and Other (Topic 350). This ASU simplifies the accounting for goodwill impairment for all entities by eliminating 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. The Company elected to early adopt ASU 2017-04 on January 1, 2020, and it did not have a significant impact on its financial statements. The Company’s policy is to test goodwill for impairment annually or on an interim basis if an event triggering impairment may have occurred. During the period ended June 30, 2020, the economic disruption and uncertainty surrounding the ongoing COVID-19 pandemic and the recent volatility in the market price of crude oil resulted in a decrease in the Company’s stock price. The Company believed this resulted in a triggering event requiring an interim goodwill impairment quantitative analysis. Under the new simplified guidance, the Company’s estimated fair value as of June 30, 2020, exceeded its carrying amount resulting in no impairment charge for the period. Management will continue to evaluate the economic conditions at future reporting periods for applicable changes.

Subsequent Events – The Company has evaluated subsequent events and transactions from June 30, 2020 through the date of this Form 10-Q was filed with the SEC for potential recognition or disclosure as required by GAAP and determined that there were no material subsequent events requiring recognition or disclosure.

2.	SECURITIES

The amortized cost and fair value of securities, with gross unrealized gains and losses, at period-end follow:

	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Fair Value
June 30, 2020
Available for sale:
U.S. government and agencies	$	4,750	$	66	$	—		$	4,816
State and municipal		214,576		9,474		(18	)		224,032
Mortgage-backed securities		343,716		14,588		—			358,304
Collateralized mortgage obligations		107,319		243		—			107,562
Asset-backed and other amortizing securities		33,416		2,544		—			35,960
	$	703,777	$	26,915	$	(18	)	$	730,674

	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Fair Value
December 31, 2019
Available for sale:
U.S. government and agencies	$	4,750	$	57	$	—		$	4,807
State and municipal		94,512		1,091		(911	)		94,692
Mortgage-backed securities		463,899		3,727		(3,110	)		464,516
Collateralized mortgage obligations		107,443		15		(169	)		107,289
Asset-backed and other amortizing securities		35,833		522		(9	)		36,346
	$	706,437	$	5,412	$	(4,199	)	$	707,650

The amortized cost and fair value of securities at June 30, 2020 are presented below by contractual maturity. Expected maturities may differ from contractual maturities because issuers may have the right to call or prepay obligations. Other securities are shown separately since they are not due at a single maturity date.

	Available for Sale
	Amortized Cost		Fair Value
Within 1 year	$	6,267	$	6,343
After 1 year through 5 years		—		—
After 5 years through 10 years		15,672		16,456
After 10 years		197,387		206,050
Other		484,451		501,825
	$	703,777	$	730,674

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At both June 30, 2020 and December 31, 2019, there were no holdings of securities of any one issuer, other than the U.S. government and its agencies, in an amount greater than 10% of stockholders’ equity.

Securities with a carrying value of approximately $268.0 million and $211.0 million at June 30, 2020 and December 31, 2019, respectively, were pledged to collateralize public deposits and for other purposes as required or permitted by law.

The following table segregates securities with unrealized losses at the periods indicated, by the duration they have been in a loss position:

	Less than 12 Months				12 Months or More				Total
	Fair Value		Unrealized Loss		Fair Value		Unrealized Loss		Fair Value		Unrealized Loss
June 30, 2020
U.S. government and agencies	$	—	$	—	$	—	$	—	$	—	$	—
State and municipal		4,742		18		—		—		4,742		18
Mortgage-backed securities		—		—		—		—		—		—
Collateralized mortgage obligations		—		—		—		—		—		—
Asset-backed and other amortizing securities		—		—		—		—		—		—
	$	4,742	$	18	$	—	$	—	$	4,742	$	18

December 31, 2019
U.S. government and agencies	$	—	$	—	$	—	$	—	$	—	$	—
State and municipal		58,389		910		387		1		58,776		911
Mortgage-backed securities		284,120		3,070		4,661		40		288,781		3,110
Collateralized mortgage obligations		60,039		169		—		—		60,039		169
Asset-backed and other amortizing securities		2,661		9		—		—		2,661		9
	$	405,209	$	4,158	$	5,048	$	41	$	410,257	$	4,199

There were two securities with an unrealized loss at June 30, 2020. Management does not believe that these losses are other than temporary as there is no intent to sell any of these securities before recovery and it is not probable that we will be required to sell any of these securities before recovery, and credit loss, if any, is not material. Any unrealized losses are largely due to increases in market interest rates over the yields available at the time the underlying securities were purchased. The fair value is expected to recover as the securities approach their maturity date or if market yields for such investments decline. Management does not believe any of the securities are impaired due to reasons of credit quality. Accordingly, as of June 30, 2020, management believes the impairments detailed in the table above are temporary and no impairment loss has been realized in the Company’s consolidated financial statements.

3.	LOANS HELD FOR INVESTMENT

Loans held for investment are summarized by category as of the periods presented below:

	June 30, 2020			December 31, 2019
Commercial real estate	$	655,906		$	658,195
Commercial - specialized		325,942			309,505
Commercial - general		620,905			441,398
Consumer:
1-4 family residential		360,308			362,796
Auto loans		202,263			215,209
Other consumer		69,754			74,000
Construction		96,638			82,520
		2,331,716			2,143,623
Allowance for loan losses		(40,635	)		(24,197	)
Loans, net	$	2,291,081		$	2,119,426

The Company has certain lending policies, underwriting standards, and procedures in place that are designed to maximize loan income with an acceptable level of risk. Management reviews and approves these policies, underwriting standards, and procedures on a regular basis and makes changes as appropriate. Management receives frequent reports related to loan originations, quality, concentrations, delinquencies, non-performing, 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 geography.

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Commercial – General and Specialized – Commercial loans are underwritten after evaluating and understanding the borrower’s ability to operate profitably. Underwriting standards have been designed to determine whether the borrower possesses sound business ethics and practices, evaluate current and projected cash flows to determine the ability of the borrower to repay their obligations, as agreed and ensure appropriate collateral is obtained to secure the loan. 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 real estate, accounts receivable, or inventory, and include personal guarantees. Owner-occupied real estate is included in commercial loans, as the repayment of these loans is generally dependent on the operations of the commercial borrower’s business rather than on income-producing properties or the sale of the properties. Commercial loans are grouped into two distinct sub-categories: specialized and general. Commercial related segments that are considered “specialized” include agricultural production and real estate loans, energy loans, and finance, investment, and insurance loans. Commercial related segments that contain a broader diversity of borrowers, sub-industries, or serviced industries are grouped into the “general category.” These include goods, services, restaurant & retail, construction, and other industries.

Commercial Real Estate – Commercial real estate loans are also subject to underwriting standards and processes similar to commercial loans. These loans are underwritten primarily based on projected cash flows for income-producing properties and collateral values for non-income-producing properties. The repayment of these loans is generally dependent on the successful operation of the property securing the loans or the sale or refinancing of the property. Real estate loans may be adversely affected by conditions in the real estate markets or in the general economy. The properties securing the Company’s real estate portfolio are diversified by type and geographic location. This diversity helps reduce the exposure to adverse economic events that affect any single market or industry.

Construction – Loans for residential construction are for single-family properties to developers, builders, or end-users. These loans are underwritten based on estimates of costs and completed value of the project. Funds are advanced based on estimated percentage of completion for the project. Performance of these loans is affected by economic conditions as well as the ability to control costs of the projects.

Consumer – Loans to consumers include 1-4 family residential loans, auto loans, and other loans for recreational vehicles or other purposes. The Company utilizes a computer-based credit scoring analysis to supplement its policies and procedures in underwriting consumer loans. 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 minimizes the Company’s risk. The Company generally requires mortgage title insurance and hazard insurance on 1-4 family residential loans.

The allowance for loan losses was $40.6 million at June 30, 2020, compared to $24.2 million at December 31, 2019. The allowance for loan losses to loans held for investment was 1.74% at June 30, 2020 and 1.13% at December 31, 2019. The increase in the allowance for loan losses in the second quarter of 2020 compared to the second quarter of 2019 is a result of economic effects from the ongoing COVID-19 pandemic as well as the decline in oil and gas prices that started in the first quarter of 2020. The increase in the provision for loan losses in the second quarter 2020 compared to the first quarter 2020 is a result of a further worsening of the economy and continued uncertainty from the ongoing COVID-19 pandemic. The full extent of the impact of the COVID-19 pandemic on the economy and the Company’s customers is still unknown at this time. Accordingly, additional provisions for loan losses may be necessary in future periods.

The following table details the activity in the allowance for loan losses. Allocation of a portion of the allowance to one category of loans does not preclude its availability to absorb losses in other categories.

	Beginning Balance		Provision for Loan Losses			Charge-offs			Recoveries		Ending Balance
For the three months ended June 30, 2020
Commercial real estate	$	7,192	$	7,856		$	—		$	108	$	15,156
Commercial - specialized		4,555		2,872			(836	)		23		6,614
Commercial - general		7,980		1,773			(532	)		72		9,293
Consumer:
1-4 family residential		2,744		181			—			1		2,926
Auto loans		4,312		(168	)		(262	)		57		3,939
Other consumer		1,639		205			(383	)		179		1,640
Construction		652		414			—			1		1,067
Total	$	29,074	$	13,133		$	(2,013	)	$	441	$	40,635

For the three months ended June 30, 2019
Commercial real estate	$	5,335	$	(28	)	$	—		$	108	$	5,415
Commercial - specialized		2,327		985			(5	)		39		3,346
Commercial - general		8,504		(324	)		(60	)		205		8,325
Consumer:
1-4 family residential		2,416		(127	)		—			21		2,310
Auto loans		3,067		202			(248	)		46		3,067
Other consumer		1,174		216			(233	)		42		1,199
Construction		558		(49	)		—			—		509
Total	$	23,381	$	875		$	(546	)	$	461	$	24,171

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	Beginning Balance		Provision for Loan Losses			Charge-offs			Recoveries		Ending Balance
For the six months ended June 30, 2020
Commercial real estate	$	5,049	$	9,892		$	—		$	215	$	15,156
Commercial - specialized		2,287		5,090			(850	)		87		6,614
Commercial - general		9,609		975			(1,380	)		89		9,293
Consumer:
1-4 family residential		2,093		832			—			1		2,926
Auto loans		3,385		1,149			(704	)		109		3,939
Other consumer		1,341		796			(749	)		252		1,640
Construction		433		633			—			1		1,067

Total	$	24,197	$	19,367		$	(3,683	)	$	754	$	40,635

For the six months ended June 30, 2019
Commercial real estate	$	5,579	$	(379	)	$	—		$	215	$	5,415
Commercial - specialized		2,516		804			(37	)		63		3,346
Commercial - general		8,173		(60	)		(65	)		277		8,325
Consumer:
1-4 family residential		2,249		28			(19	)		52		2,310
Auto loans		2,994		500			(506	)		79		3,067
Other consumer		1,192		429			(513	)		91		1,199
Construction		423		161			(75	)		—		509

Total	$	23,126	$	1,483		$	(1,215	)	$	777	$	24,171

The following table shows the Company’s investment in loans disaggregated based on the method of evaluating impairment:

	Recorded Investment				Allowance for Loan Losses
	Individually Evaluated		Collectively Evaluated		Individually Evaluated		Collectively Evaluated
June 30, 2020
Commercial real estate	$	4,379	$	651,527	$	560	$	14,596
Commercial - specialized		1,074		324,868		190		6,424
Commercial - general		878		620,027		126		9,167
Consumer:
1-4 family residential		1,837		358,471		—		2,926
Auto loans		—		202,263		—		3,939
Other consumer		—		69,754		—		1,640
Construction		—		96,638		—		1,067

Total	$	8,168	$	2,323,548	$	876	$	39,759

December 31, 2019
Commercial real estate	$	299	$	657,896	$	—	$	5,049
Commercial - specialized		573		308,932		—		2,287
Commercial - general		1,396		440,002		525		9,084
Consumer:
1-4 family residential		1,899		360,897		—		2,093
Auto loans		—		215,209		—		3,385
Other consumer		—		74,000		—		1,341
Construction		—		82,520		—		433

Total	$	4,167	$	2,139,456	$	525	$	23,672

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Impaired loan information follows:

	Unpaid Contractual Principal Balance		Recorded Investment With No Allowance		Recorded Investment With Allowance		Total Recorded Investment		Related Allowance		Average Recorded Investment
June 30, 2020
Commercial real estate	$	4,379	$	1,898	$	2,481	$	4,379	$	560	$	2,719
Commercial - specialized		1,074		617		457		1,074		190		1,210
Commercial - general		878		385		493		878		126		1,526
Consumer:
1-4 family		2,256		1,837		—		1,837		—		2,012
Auto loans		—		—		—		—		—		—
Other consumer		—		—		—		—		—		—
Construction		—		—		—		—		—		—

Total	$	8,587	$	4,737	$	3,431	$	8,168	$	876	$	7,467

December 31, 2019
Commercial real estate	$	754	$	299	$	—	$	299	$	—	$	1,059
Commercial - specialized		573		573		—		573		—		1,345
Commercial - general		1,839		—		1,396		1,396		525		2,173
Consumer:
1-4 family		2,318		1,899		—		1,899		—		2,187
Auto loans		—		—		—		—		—		—
Other consumer		—		—		—		—		—		—
Construction		—		—		—		—		—

SOUTH PLAINS FINANCIAL, INC. - FORM 10-Q - August 14, 2020

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