10-K 1 d638795d10k.htm FORM 10-K Form 10-K
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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-K

 

 

 

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

For the fiscal year ended December 31, 2013

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)

Registrant’s telephone number, including area code: (325) 627-7155

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

 

Title of Class

 

Name of Exchange on Which Registered

Common Stock, par value $0.01 per share   Nasdaq Global Select Market

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

None

 

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.    Yes  x    No  ¨

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.    Yes  ¨    No  x

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  x    No  ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  x    No  ¨

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.

 

Large accelerated filer   x    Accelerated filer   ¨
Non-accelerated filer   ¨    Smaller reporting company   ¨

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

As of June 30, 2013, the last business day of the registrant’s most recently completed second fiscal quarter, the aggregate market value of the registrant’s voting and non-voting common stock held by non-affiliates was $1.69 billion.

As of February 21, 2014, there were 31,999,043 shares of common stock outstanding.

Documents Incorporated by Reference

Certain information called for by Part III is incorporated by reference to the proxy statement for our 2014 annual meeting of shareholders, which will be filed with the Securities and Exchange Commission not later than 120 days after December 31, 2013.

 

 

 


Table of Contents

TABLE OF CONTENTS

 

        Page  

CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS

    1   

PART I

   

ITEM 1.

  Business     3   

ITEM 1A.

  Risk Factors     21   

ITEM 1B.

  Unresolved Staff Comments     31   

ITEM 2.

  Properties     31   

ITEM 3.

  Legal Proceedings     31   

ITEM 4.

  Mine Safety Disclosures     31   

PART II

   

ITEM 5.

  Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities     32   

ITEM 6.

  Selected Financial Data     34   

ITEM 7.

  Management’s Discussion and Analysis of Financial Condition and Results of Operations     36   

ITEM 7A.

  Quantitative and Qualitative Disclosures About Market Risk     51   

ITEM 8.

  Financial Statements and Supplementary Data     51   

ITEM 9.

  Changes in and Disagreements with Accountants on Accounting and Financial Disclosure     52   

ITEM 9A.

  Controls and Procedures     52   

ITEM 9B.

  Other Information     55   

PART III

   

ITEM 10.

  Directors, Executive Officers and Corporate Governance     56   

ITEM 11.

  Executive Compensation     56   

ITEM 12.

  Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters     56   

ITEM 13.

  Certain Relationships and Related Transactions, and Director Independence     56   

ITEM 14.

  Principal Accounting Fees and Services     56   

PART IV

   

ITEM 15.

  Exhibits, Financial Statement Schedules     57   

SIGNATURES

    58   

EXHIBITS INDEX

    60   

 

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CAUTIONARY STATEMENT REGARDING

FORWARD-LOOKING STATEMENTS

This Form 10-K 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-K, words such as “anticipate,” “believe,” “estimate,” “expect,” “intend,” “predict,” “project,” and similar expressions, as they relate to us or our 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” 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 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 deal with the slowdown of the national economy and the fiscal cliff;

 

    competition from other financial institutions and financial holding companies;

 

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

 

    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;

 

    our ability to attract deposits;

 

    changes in our liquidity position;

 

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

 

    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 our operations, including branch openings, new product offerings and expansion into new markets;

 

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    changes in our compensation and benefit plans; and

 

    acts of God or of war or terrorism.

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.

 

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PART I

 

ITEM 1. BUSINESS

General

First Financial Bankshares, Inc., a Texas corporation (the “Company”), is a financial holding company registered under the Bank Holding Company Act of 1956, as amended, or BHCA. As such, we are supervised by the Federal Reserve Board, as well as several other bank regulators. We were formed as a bank holding company in 1956 under the original name F & M Operating Company, but our banking operations date back to 1890, when Farmers and Merchants National Bank opened for business in Abilene, Texas. Up to December 30, 2012, we owned eleven banks, a trust company, a technology operating company, and an insurance agency, all organized and located in Texas. Effective December 30, 2012, we consolidated our eleven bank charters into our Abilene bank charter, First Financial Bank, National Association, to reduce certain operating costs and make more efficient our technology and compliance operations. In addition, on May 31, 2013, we acquired Orange Savings Bank, SSB and merged Orange Savings Bank, SSB with and into our subsidiary bank. As of December 31, 2013, our subsidiaries are:

 

    First Financial Bank, National Association, Abilene, Texas;

 

    First Technology Services, Inc., Abilene, Texas;

 

    First Financial Trust & Asset Management Company, National Association, Abilene, Texas; and

 

    First Financial Insurance Agency, Inc., Abilene, Texas.

Through our subsidiaries, we conduct full-service commercial banking business. Our banking centers are located primarily in Central, North Central, Southeast and West Texas. As of December 31, 2013, we had 60 financial centers across Texas, with eleven locations in Abilene, three locations in San Angelo and Weatherford, two locations in Cleburne, Stephenville, and Granbury, and one location each in Acton, Albany, Aledo, Alvarado, Boyd, Bridgeport, Brock, Burleson, Cisco, Clyde, Decatur, Eastland, Fort Worth, Glen Rose, Grapevine, Hereford, Huntsville, Keller, Mauriceville, Merkel, Midlothian, Mineral Wells, Moran, Newton, Odessa, Orange, Port Arthur, Ranger, Rising Star, Roby, Southlake, Sweetwater, Trent, Trophy Club, Vidor, Waxahachie, and Willow Park, all in Texas.

Even though we operate in a growing number of Texas markets, we continue to believe that decisions are best made at the local level. Although we consolidated our bank charters into one charter effective December 30, 2012, we continue to operate as twelve bank regions (effective May 31, 2013, we added our twelfth region in Orange, Texas) with local advisory boards of directors, local bank region presidents and local decision-making. We have consolidated many of the backroom operations, such as investment securities, accounting, check processing, technology and employee benefits, which improves our efficiency and frees management of our bank regions to concentrate on serving the banking needs of their local communities. We call this our “one bank, twelve regions” concept.

 

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In the past, we have chosen to keep our Company focused on the State of Texas, one of the nation’s largest, fastest-growing and most economically diverse states. With approximately 26.1 million residents, Texas has more people than any other state except California. The population of Texas grew 19.7% from 2002-2012 according to the U.S. Census Bureau. Many of the communities in which we operate are growing faster than the statewide average, as shown below:

Population Growth 2002-2012*

 

Bridgeport and Wise County

     24.6   

Weatherford, Willow Park, Aledo and Parker County

     29.6

Fort Worth and Tarrant County

     25.8      

Cleburne and Johnson County

     31.8    Stephenville and Erath County      22.6

Granbury and Hood County

     31.8    *Source: U.S. Census Bureau   

These economies include dynamic centers of higher education, agriculture, energy and natural resources, retail, military, healthcare, tourism, retirement living, manufacturing and distribution.

We believe our community approach to doing business works best for us in small and mid-size markets, where we can play a prominent role in the economic, civic and cultural life of the community. Our goal is to serve these communities well and to experience growth as these markets continue to expand. In many instances, banking competition is less intense in smaller markets, making it easier for us to operate rationally and attract and retain high-caliber employees who prefer not only our community-banker concept but the high quality of life in smaller cities.

Over the years, we have grown in three ways: by growing internally, by opening new branch locations and by acquiring other banks. Since 1997, we have completed twelve bank acquisitions and have increased our total assets from $1.57 billion to $5.22 billion. We have also established a trust and asset management company and a technology services company, both of which operate as subsidiaries of First Financial Bankshares, Inc. Looking ahead, we intend to continue to grow organically by better serving the needs of our customers and putting them first in all of our decisions. We continually look for new branch locations, so we can provide more convenient service to our customers, and we are actively pursuing acquisition opportunities by calling on banks that we are interested in possibly acquiring.

When targeting a bank for acquisition, the subject bank generally needs to be located in the type of community that fits our profile, which is well managed and profitable. We like growing communities with good amenities—schools, infrastructure, commerce and lifestyle. We prefer non-metropolitan markets, either around Dallas/Fort Worth, Houston, San Antonio or Austin or along the Interstate 35, 45, 10 and 20 corridors in Texas. We might also consider the acquisition of banks in East Texas or the Texas Hill Country area. Banks between $100 million and $1.0 billion in asset size fit our “sweet spot” for acquisition, but we will consider banks that are larger or smaller, or that are in other areas of Texas if we believe they would be a good fit for our Company.

Information on our revenues, profits and losses and total assets appears in the discussion of our Results of Operations contained in Item 7 hereof.

First Financial Bankshares, Inc.

We provide management and technical resources and policy direction to our subsidiaries, which enable them to improve or expand their banking services while continuing their local activity and identity. Each of our subsidiaries operates under the day-to-day management of its own board of directors and officers, including advisory boards of directors for our bank regions. We provide resources and policy direction in, among other things, the following areas:

 

    asset and liability management;

 

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    investments;

 

    accounting;

 

    budgeting;

 

    training;

 

    marketing;

 

    planning;

 

    risk management;

 

    loan review;

 

    human resources;

 

    insurance;

 

    capitalization;

 

    regulatory compliance; and

 

    internal audit.

In particular, we assist our subsidiaries with, among other things, decisions concerning major capital expenditures, employee fringe benefits, including retirement plans and group medical coverage, dividend policies, and appointment of officers and directors, including advisory directors, and their compensation. We also perform, through corporate staff groups or by outsourcing to third parties, internal audits, compliance oversight and loan reviews of our subsidiaries. We provide advice and specialized services for our bank regions related to lending, investing, purchasing, advertising, public relations, and computer services.

We evaluate various potential financial institution acquisition opportunities and approve potential locations for new branch offices. We anticipate that funding for any acquisitions or expansions would be provided from our existing cash balances, available dividends from our subsidiaries, utilization of available lines of credit and future debt or equity offerings.

Services Offered by Our Subsidiaries

Our subsidiary bank is a separate legal entity that operates under the day-to-day management of its board of directors and officers. Our twelve bank regions operating under our subsidiary bank each have separate advisory boards that make recommendations and provide assistance to regional management of the bank regarding the operations of their respective region. Each of our bank regions provides general commercial banking services, which include accepting and holding checking, savings and time deposits, making loans, automated teller machines, drive-in and night deposit services, safe deposit facilities, remote deposit capture, internet banking, mobile banking, payroll cards, transmitting funds, and performing other customary commercial banking services. We also conduct full service trust activities through First Financial Trust & Asset Management Company, National Association, our trust company. Through our trust company, we offer personal trust services, which include the administration of estates, testamentary trusts, revocable and irrevocable trusts and agency accounts. We also administer all types of retirement and employee benefit accounts, which include 401(k) profit sharing plans and IRAs. In addition, we provide securities brokerage services through arrangements with an unrelated third party in our Abilene, San Angelo and Weatherford bank regions.

Competition

Commercial banking in Texas is highly competitive, and because we hold less than 1% of the state’s deposits, we represent only a minor segment of the industry. To succeed in this industry, we believe that we must

 

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have the capability to compete effectively in the areas of (1) interest rates paid or charged; (2) scope of services offered; and (3) prices charged for such services. Our bank regions compete in their respective service areas against highly competitive banks, thrifts, savings and loan associations, small loan companies, credit unions, mortgage companies, insurance companies, and brokerage firms, all of which are engaged in providing financial products and services and some of which are larger than us in terms of capital, resources and personnel.

Our business does not depend on any single customer or any few customers, and the loss of any one would not have a materially adverse effect upon our business. Although we have a broad base of customers that are not related to us, our customers also occasionally include our officers and directors, as well as other entities with which we are affiliated. Through our bank regions we may make loans to our officers and directors, and entities with which we are affiliated, in the ordinary course of business. We make these loans on substantially the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with other persons. Loans to our directors, officers and their affiliates are also subject to numerous restrictions under federal and state banking laws, which we describe in greater detail below.

Employees

Including all of our subsidiaries, we employed approximately 1,100 full-time equivalent employees at December 31, 2013. Our management believes that our employee relations have been and will continue to be good.

Supervision and Regulation

Both federal and state laws extensively regulate bank holding companies, financial holding companies and banks. These laws (and the regulations promulgated thereunder) are primarily intended to protect depositors and the deposit insurance fund (the “DIF”) of the Federal Deposit Insurance Corporation, or the FDIC. The following information describes particular laws and regulatory provisions relating to financial holding companies and banks. This discussion is qualified in its entirety by reference to the particular laws and regulatory provisions. A change in any of these laws or regulations may have a material effect on our business and the business of our subsidiaries.

Bank Holding Companies and Financial Holding Companies

Historically, the activities of bank holding companies were limited to the business of banking and activities closely related or incidental to banking. Bank holding companies were generally prohibited from acquiring control of any company that was not a bank and from engaging in any business other than the business of banking or managing and controlling banks. The Gramm-Leach-Bliley Act, which took effect on March 12, 2000, dismantled many Depression-era restrictions against affiliations between banking, securities and insurance firms by permitting bank holding companies to engage in a broader range of financial activities, so long as certain safeguards are observed. Specifically, bank holding companies may elect to become “financial holding companies” that may affiliate with securities firms and insurance companies and engage in other activities that are financial in nature or incidental to a financial activity. Thus, with the enactment of the Gramm-Leach-Bliley Act, banks, security firms and insurance companies find it easier to acquire or affiliate with each other and cross-sell financial products. The Gramm-Leach-Bliley Act permits a single financial services organization to offer a more complete array of financial products and services than historically was permitted.

A financial holding company is essentially a bank holding company with significantly expanded powers. Under the Gramm-Leach-Bliley Act, in addition to traditional lending activities, the following activities are among those that are deemed “financial in nature” for financial holding companies: securities underwriting, dealing in or making a market in securities, sponsoring mutual funds and investment companies, insurance underwriting and agency activities, activities which the Federal Reserve Board determines to be closely related to banking, and certain merchant banking activities.

 

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We elected to become a financial holding company in September 2001. As a financial holding company, we have very broad discretion to affiliate with securities firms and insurance companies, make merchant banking investments, and engage in other activities that the Federal Reserve Board has deemed financial in nature. In order to continue as a financial holding company, we must continue to be well-capitalized, well-managed and maintain compliance with the Community Reinvestment Act. Depending on the types of financial activities that we may elect to engage in, under the Gramm-Leach-Bliley Act’s functional regulation principles, we may become subject to supervision by additional government agencies. The election to be treated as a financial holding company increases our ability to offer financial products and services that historically we were either unable to provide or were only able to provide on a limited basis. As a result, we will face increased competition in the markets for any new financial products and services that we may offer. Likewise, an increased amount of consolidation among banks and securities firms or banks and insurance firms could result in a growing number of large financial institutions that could compete aggressively with us.

Mergers and Acquisitions

We generally must obtain approval from the banking regulators before we can acquire other financial institutions. We may not engage in certain acquisitions if we are undercapitalized. Furthermore, the BHCA provides that the Federal Reserve Board cannot approve any acquisition, merger or consolidation that may substantially lessen competition in the banking industry, create a monopoly in any section of the country, or be a restraint of trade. However, the Federal Reserve Board may approve such a transaction if the convenience and needs of the community clearly outweigh any anti-competitive effects. Specifically, the Federal Reserve Board would consider, among other factors, the expected benefits to the public (greater convenience, increased competition, greater efficiency, etc.) against the risks of possible adverse effects (undue concentration of resources, decreased or unfair competition, conflicts of interest, unsound banking practices, etc.).

Under the BHCA, the Company must obtain the prior approval of the Federal Reserve Board, or acting under delegated authority, the Federal Reserve Bank of Dallas before (1) acquiring direct or indirect ownership or control of any class of voting securities of any bank or bank holding company if, after the acquisition, the Company would directly or indirectly own or control 5% or more of the class; (2) acquiring all or substantially all of the assets of another bank or bank holding company; or (3) merging or consolidating with another bank holding company.

The Change in Bank Control Act of 1978, as amended, or the CIBCA, and the related regulations of the Federal Reserve Board require any person or groups of persons acting in concert (except for companies required to make application under the BHCA), to file a written notice with the Federal Reserve Board before the person or group acquires control of the Company. The CIBCA defines “control” as the direct or indirect power to vote 25% or more of any class of voting securities or to direct the management or policies of a bank holding company or an insured bank. A rebuttable presumption of control arises under the CIBCA where a person or group controls 10% or more, but less than 25%, of a class of the voting stock of a company or insured bank which is a reporting company under the Securities Exchange Act of 1934, as amended, such as the Company, or such ownership interest is greater than the ownership interest held by any other person or group.

Banks

Federal and state laws and regulations that govern banks have the effect of, among other things, regulating the scope of business, investments, cash reserves, the purpose and nature of loans, the maximum interest rate chargeable on loans, the amount of dividends declared, and required capitalization ratios.

 

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National Banking Associations. Banks organized as national banking associations under the National Bank Act are subject to regulation and examination by the Office of the Comptroller of the Currency, or OCC. Effective December 30, 2012, we consolidated our eleven bank charters into one, that being our Abilene charter. As a result, the OCC now supervises, regulates and regularly examines the following subsidiaries:

 

    First Financial Bank, National Association, Abilene, Texas;

 

    First Financial Trust & Asset Management Company, National Association; and

 

    First Technology Services, Inc.

The OCC’s supervision and regulation of banks is primarily intended to protect the interests of depositors. The National Bank Act:

 

    requires each national banking association to maintain reserves against deposits,

 

    restricts the nature and amount of loans that may be made and the interest that may be charged, and

 

    restricts investments and other activities.

State Banks. Banks that are organized as state banks under Texas law are subject to regulation and examination by the Texas Department of Banking (the “Banking Department”). Prior to December 30, 2012, the Banking Department regulated, supervised and regularly examined our two subsidiary state banks, First Financial Bank, Hereford and First Financial Bank, Huntsville. The Banking Department’s supervision and regulation of banks is primarily designed to protect the interests of depositors. Texas law:

 

    restricts the nature and amount of loans that may be made and the interest that may be charged, and

 

    restricts investments and other activities.

State banks are also subject to regulation by either the FDIC or the Federal Reserve Board. First Financial Bank, Hereford and First Financial Bank, Huntsville were non-member banks of the Federal Reserve, and as such their federal regulator was the FDIC and were subject to most of the federal laws described below.

Deposit Insurance Coverage and Assessments

Our subsidiary bank is a member of the FDIC. Through the DIF, the FDIC provides deposit insurance protection that covers all deposit accounts in FDIC-insured depository institutions up to applicable limits (currently, $250,000 per depositor).

Our subsidiary bank must pay assessments to the FDIC under a risk-based assessment system for this federal deposit insurance protection. FDIC-insured depository institutions that are members of the Bank Insurance Fund pay insurance premiums at rates based on their risk classification. Institutions assigned to higher risk classifications (i.e., institutions that pose a greater risk of loss to the DIF) pay assessments at higher rates than institutions assigned to lower risk classifications. An institution’s risk classification is assigned based on its capital levels and the level of supervisory concern the institution poses to bank regulators. As of December 31, 2013, the assessment rate for our subsidiary bank was at the lowest risk-based premium available, which was 5.00% of the assessment base per annum.

In addition, the FDIC can impose special assessments to cover shortages in the DIF. The FDIC required insured depository institutions to prepay on December 30, 2009 their estimated quarterly assessments for 2010, 2011 and 2012, including a three basis point increase in premium rates for 2011 and 2012. (The three basis point increase was later cancelled under the Restoration Plan described below.) The Company’s prepayment amount on December 31, 2009 totaled $11.60 million in the aggregate and was expensed based on quarterly assessment calculations. In June 2013, the unused portion of our prepaid assessment totaling $3.72 million was refunded by FDIC to our subsidiary bank.

 

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In October 2010, the FDIC adopted a new Restoration Plan for the DIF to ensure that the fund reserve ratio reaches 1.35% by September 30, 2020, as required by the Dodd-Frank Act. Under the Restoration Plan, the FDIC did not institute the uniform three-basis point increase in assessment rates scheduled to take place on January 1, 2011 and maintained the current schedule of assessment rates for all depository institutions. At least semi-annually, the FDIC will update its loss and income projections for the DIF and, if needed, will increase or decrease assessment rates, following notice-and-comment rulemaking, if required. The Dodd-Frank Act also eliminated the requirement that the FDIC pay dividends to insured depository institutions when the reserve ratio exceeds certain thresholds. The Dodd-Frank Act requires the FDIC to offset the effect of increasing the reserve ratio on institutions with total consolidated assets of less than $10 billion, such as the Company.

As required by the Dodd-Frank Act, the FDIC also revised the deposit insurance assessment system, effective April 1, 2011, to base assessments on the average total consolidated assets of insured depository institutions during the assessment period, less the average tangible equity of the institution during the assessment period as opposed to solely bank deposits at an institution. This base assessment change necessitated that the FDIC adjust the assessment rates to ensure that the revenue collected under the new assessment system will approximately equal that under the existing assessment system.

Under the Financial Institutions Reform, Recovery, and Enforcement Act of 1989, or FIRREA, an FDIC-insured depository institution can be held liable for any losses incurred by the FDIC in connection with (1) the “default” of one of its FDIC-insured subsidiaries or (2) any assistance provided by the FDIC to one of its FDIC-receivers, and “in danger of default” is defined generally as the existence of certain conditions indicating that a default is likely to occur in the absence of regulatory assistance.

The FDIC is also empowered to regulate interest rates paid by insured banks. Approval of the FDIC is also required before an insured bank retires any part of its common or preferred stock, or any capital notes or debentures.

Payment of Dividends

We are a legal entity separate and distinct from our banking and other subsidiaries. We receive most of our revenue from dividends paid to us by our bank and trust company subsidiaries. Described below are some of the laws and regulations that apply when either we or our subsidiaries pay or paid dividends.

The Federal Reserve Board, the OCC and the FDIC have issued policy statements that recommend that bank holding companies and insured banks should generally only pay dividends to the extent net income is sufficient to cover both cash dividends and a rate of earnings retention consistent with capital needs, asset quality and overall financial condition. Further, the Federal Reserve Board’s policy provides that bank holding companies should not maintain a level of cash dividends that undermines the bank holding company’s ability to serve as a source of strength to its banking subsidiaries. In addition, the Federal Reserve Board has indicated that each bank holding company should carefully review its dividend policy, and has discouraged payment ratios that are at maximum allowable levels, which is the maximum dividend amount that may be issued and allow the company to still maintain its target Tier 1 capital ratio, unless both asset quality and capital are very strong.

To pay dividends, our subsidiaries must maintain adequate capital above regulatory guidelines. Under federal law, our subsidiary bank cannot pay a dividend if, after paying the dividend, the bank would be “undercapitalized.” In addition, if the FDIC believes that a bank under its jurisdiction is engaged in, or is about to engage in, an unsafe or unsound practice (which, depending on the financial condition of the bank, could include the payment of dividends), the FDIC may require, after notice and hearing, that such bank cease and desist from the unsafe practice. The FDIC and the OCC have each indicated paying dividends that deplete a bank’s capital base to an inadequate level would be an unsafe and unsound banking practice.

National banks are required by federal law to obtain the prior approval of the OCC in order to declare and pay dividends if the total of all dividends declared in any calendar year would exceed the total of (1) such bank’s

 

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net profits (as defined and interpreted by regulation) for that year plus (2) its retained net profits (as defined and interpreted by regulation) for the preceding two calendar years, less any required transfers to surplus. In addition, these banks may only pay dividends to the extent that retained net profits (including the portion transferred to surplus) exceed bad debts (as defined by regulation). Prior to December 30, 2012, First Financial Bank, Hereford and First Financial Bank, Huntsville, as Texas state banking associations, could not pay a dividend that would reduce its capital and surplus without the prior approval of the Banking Department.

Our subsidiaries paid aggregate dividends of approximately $64.20 million in 2013 and approximately $58.35 million in 2012. Under the dividend restrictions discussed above, as of December 31, 2013, our subsidiaries could have declared in the aggregate additional dividends of approximately $57.46 million from retained net profits, without obtaining regulatory approvals.

Affiliate Transactions

The Federal Reserve Act, the FDIA and the rules adopted under these statutes restrict the extent to which we can borrow or otherwise obtain credit from, or engage in certain other transactions with, our subsidiaries. These laws regulate “covered transactions” between insured depository institutions and their subsidiaries, on the one hand, and their nondepository affiliates, on the other hand. The Dodd-Frank Act expanded the definition of affiliate to make any investment fund, including a mutual fund, for which a depository institution or its affiliates serve as investment advisor an affiliate of the depository institution. “Covered transactions” include a loan or extension of credit to a nondepository affiliate, a purchase of securities issued by such an affiliate, a purchase of assets from such an affiliate (unless otherwise exempted by the Federal Reserve Board), an acceptance of securities issued by such an affiliate as collateral for a loan, and an issuance of a guarantee, acceptance, or letter of credit for the benefit of such an affiliate. The Dodd-Frank Act extended the limitations to derivative transactions, repurchase agreements and securities lending and borrowing transactions that create credit exposure to an affiliate or an insider. The “covered transactions” that an insured depository institution and its subsidiaries are permitted to engage in with their nondepository affiliates are limited to the following amounts: (1) in the case of any one such affiliate, the aggregate amount of “covered transactions” cannot exceed ten percent of the capital stock and the surplus of the insured depository institution; and (2) in the case of all affiliates, the aggregate amount of “covered transactions” cannot exceed twenty percent of the capital stock and surplus of the insured depository institution. In addition, extensions of credit that constitute “covered transactions” must be collateralized in prescribed amounts. Further, a bank holding company and its subsidiaries are prohibited from engaging in certain tie-in arrangements in connection with any extension of credit, lease or sale of property or furnishing of services. Finally, when we and our subsidiaries conduct transactions internally among us, we are required to do so at arm’s length.

Loans to Directors, Executive Officers and Principal Shareholders

The authority of our subsidiary bank to extend credit to our directors, executive officers and principal shareholders, including their immediate family members, corporations and other entities that they control, is subject to substantial restrictions and requirements under Sections 22(g) and 22(h) of the Federal Reserve Act and Regulation O promulgated thereunder, as well as the Sarbanes-Oxley Act of 2002. These statutes and regulations impose specific limits on the amount of loans our subsidiary bank may make to directors and other insiders, and specified approval procedures must be followed in making loans that exceed certain amounts. In addition, all loans our subsidiary bank makes to directors and other insiders must satisfy the following requirements:

 

    the loans must be made on substantially the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with persons not affiliated with us or our subsidiary bank;

 

    the subsidiary bank must follow credit underwriting procedures at least as stringent as those applicable to comparable transactions with persons who are not affiliated with us or our subsidiary bank; and

 

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    the loans must not involve a greater than normal risk of non-payment or include other features not favorable to our subsidiary bank.

Furthermore, our subsidiary bank must periodically report all loans made to directors and other insiders to the bank regulators, and these loans are closely scrutinized by the regulators for compliance with Sections 22(g) and 22(h) of the Federal Reserve Act and Regulation O. Each loan to directors or other insiders must be pre-approved by the bank’s board of directors with the interested director abstaining from voting.

Capital

Bank Holding Companies and Financial Holding Companies. The Federal Reserve Board has adopted risk-based capital guidelines for bank holding companies and financial holding companies. Under these guidelines, specific categories of assets are assigned different risk weights, based generally on the perceived risk of the asset. These risk weights are multiplied by corresponding asset balances to determine a “risk-weighted” asset base. The ratio of total capital to risk weighted assets (including certain off-balance-sheet activities, such as standby letters of credit) must be a minimum of eight percent. At least half of the total capital is to be composed of common shareholders’ equity, minority interests in the equity accounts of consolidated subsidiaries and a limited amount of perpetual preferred stock, less goodwill, which is collectively referred to as Tier 1 Capital. The remainder of total capital may consist of subordinated debt, other preferred stock and a limited amount of loan loss reserves. These guidelines will change over the next several years as the new Basel III rules are implemented. See “New Capital Adequacy Requirements under Basel III” below.

In addition, the Federal Reserve Board has established minimum leverage ratio guidelines for bank holding companies and financial holding companies. Bank holding companies and financial holding companies that meet certain specified criteria, including having the highest regulatory rating, must maintain a minimum Tier 1 Capital leverage ratio (Tier 1 Capital to average assets for the current quarter, less goodwill) of three percent. Bank holding companies and financial holding companies that do not have the highest regulatory rating will generally be required to maintain a higher Tier 1 Capital leverage ratio of three percent plus an additional cushion of 100 to 200 basis points. The guidelines also provide that bank holding companies and financial holding companies experiencing internal growth or making acquisitions will be expected to maintain strong capital positions. Such strong capital positions must be kept substantially above the minimum supervisory levels without significant reliance on intangible assets (e.g., goodwill and core deposit intangibles). As of December 31, 2013, our capital ratios were as follows: (1) Tier 1 Capital to Risk-Weighted Assets Ratio, 15.82%; (2) Total Capital to Risk-Weighted Assets Ratio, 16.92%; and (3) Tier 1 Capital Leverage Ratio, 9.84%.

Banks. The Federal Deposit Insurance Corporation Improvement Act of 1991, or FDICIA, established five capital tiers with respect to depository institutions: “well-capitalized,” “adequately capitalized,” “undercapitalized,” “significantly undercapitalized,” and “critically undercapitalized.” A depository institution’s capital tier will depend upon where its capital levels are in relation to various relevant capital measures, including (1) risk-based capital measures, (2) a leverage ratio capital measure and (3) certain other factors. Regulations establishing the specific capital tiers provide that a “well-capitalized” institution will have a total risk-based capital ratio of ten percent or greater, a Tier 1 risk-based capital ratio of six percent or greater, and a Tier 1 leverage ratio of five percent or greater, and not be subject to any written regulatory enforcement agreement, order, capital directive or prompt corrective action derivative. For an institution to be “adequately capitalized,” it will have a total risk-based capital ratio of eight percent or greater, a Tier 1 risk-based capital ratio of four percent or greater, and a Tier 1 leverage ratio of four percent or greater (in some cases three percent). For an institution to be “undercapitalized,” it will have a total risk-based capital ratio that is less than eight percent, a Tier 1 risk-based capital ratio less than four percent or a Tier 1 leverage ratio less than four percent (or a leverage ratio less than three percent if the institution’s composite rating is 1 in its most recent report of examination, subject to appropriate federal banking agency guidelines). For an institution to be “significantly undercapitalized,” it will have a total risk-based capital ratio less than six percent, a Tier 1 risk-based capital ratio less than three percent, or a Tier 1 leverage ratio less than three percent. For an institution to be “critically

 

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undercapitalized,” it will have a ratio of tangible equity to total assets equal to or less than two percent. FDICIA requires federal banking agencies to take “prompt corrective action” against depository institutions that do not meet minimum capital requirements. The various regulatory agencies, including the OCC, have adopted substantially similar regulations that define the five categories identified by FDICIA, using the total risk-based capital, Tier 1 risk based capital and Tier 1 leverage ratios as relevant capital measures. Under current regulations, our subsidiary bank was “well capitalized” as of December 31, 2013.

The Dodd-Frank Act requires the FDIC to establish minimum leverage and risk-based capital requirements to apply to insured depository institutions. The Dodd-Frank Act additionally requires capital requirements to be countercyclical so that the required amount of capital increases in times of economic expansion and decreases in times of economic contraction, consistent with safety and soundness practices.

FDICIA generally prohibits a depository institution from making any capital distribution (including payment of a dividend) or paying any management fee to its holding company if the depository institution would thereafter be “undercapitalized.” An “undercapitalized” institution must develop a capital restoration plan and its parent holding company must guarantee that institution’s compliance with such plan. The liability of the parent holding company under any such guarantee is limited to the lesser of five percent of the institution’s assets at the time it became “undercapitalized” or the amount needed to bring the institution into compliance with all capital standards. Furthermore, in the event of the bankruptcy of the parent holding company, such guarantee would take priority over the parent’s general unsecured creditors. If a depository institution fails to submit an acceptable capital restoration plan, it shall be treated as if it is “significantly undercapitalized.” “Significantly undercapitalized” depository institutions may be subject to a number of requirements and restrictions, including orders to sell sufficient voting stock to become “adequately capitalized,” requirements to reduce total assets, and cessation of receipt of deposits from correspondent banks. “Critically undercapitalized” institutions are subject to the appointment of a receiver or conservator. Finally, FDICIA requires the various regulatory agencies to set forth certain standards that do not relate to capital. Such standards relate to the safety and soundness of operations and management and to asset quality and executive compensation, and permit regulatory action against a financial institution that does not meet such standards.

If an insured bank fails to meet its capital guidelines, it may be subject to a variety of other enforcement remedies, including a prohibition on the taking of brokered deposits and the termination of deposit insurance by the FDIC. Bank regulators continue to indicate their desire to raise capital requirements beyond their current levels.

In addition to FDICIA capital standards, Texas-chartered banks must also comply with the capital requirements imposed by the Banking Department. Neither the Texas Finance Code nor its regulations specify any minimum capital-to-assets ratio that must be maintained by a Texas-chartered bank. Instead, the Banking Department determines the appropriate ratio on a bank by bank basis, considering factors such as the nature of a bank’s business, its total revenue, and the bank’s total assets. Prior to December 30, 2012, our two Texas-chartered banks exceeded the minimum ratios applied to them.

New Capital Adequacy Requirements Under Basel III

On July 2, 2013, the Federal Reserve Board, and on July 9, 2013, the FDIC and OCC, adopted a final rule that implements the Basel III changes to the international regulatory capital framework, referred to as the “Basel III Rules.” The Basel III Rules apply to both depository institutions and (subject to certain exceptions not applicable to the Company) their holding companies. Although parts of the Basel III Rules apply only to large, complex financial institutions, substantial portions of the Basel III Rules apply to the Company and our subsidiary bank. The Basel III Rules include requirements contemplated by the Dodd-Frank Act as well as certain standards initially adopted by the Basel Committee on Banking Supervision in December 2010.

The Basel III Rules include new risk-based and leverage capital ratio requirements which refine the definition of what constitutes “capital” for purposes of calculating those ratios. The minimum capital level requirements applicable to the Company and our subsidiary bank under the Basel III Rules are: (i) a new

 

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common equity Tier 1 risk-based capital ratio of 4.5%; (ii) a Tier 1 risk-based capital ratio of 6% (increased from 4%); (iii) a total risk-based capital ratio of 8% (unchanged from current rules); and (iv) a Tier 1 leverage ratio of 4% for all institutions. Common equity Tier 1 capital will consist of retained earnings and common stock instruments, subject to certain adjustments.

The Basel III Rules will also establish a “capital conservation buffer” of 2.5% above the new regulatory minimum risk-based capital requirements. The conservation buffer, when added to the capital requirements, will result in the following minimum ratios: (i) a common equity Tier 1 risk-based capital ratio of 7.0%, (ii) a Tier 1 risk-based capital ratio of 8.5%, and (iii) a total risk-based capital ratio of 10.5%. The new capital conservation buffer requirement is to be phased in beginning in January 2016 at 0.625% of risk-weighted assets and will increase by that amount each year until fully implemented in January 2019. An institution would be subject to limitations on certain activities including payment of dividends, share repurchases and discretionary bonuses to executive officers if its capital level is below the buffer amount.

The Basel III Rules also revise the prompt corrective action framework, which is designed to place restrictions on insured depository institutions, including our subsidiary bank, if their capital levels do not meet certain thresholds. These revisions are to be effective January 1, 2015. The prompt corrective action rules will be modified to include a common equity Tier 1 capital component and to increase certain other capital requirements for the various thresholds. For example, under the proposed prompt corrective action rules, insured depository institutions will be required to meet the following capital levels in order to qualify as “well capitalized:” (i) a new common equity Tier 1 risk-based capital ratio of 6.5%; (ii) a Tier 1 risk-based capital ratio of 8% (increased from 6%); (iii) a total risk-based capital ratio of 10% (unchanged from current rules); and (iv) a Tier 1 leverage ratio of 5% (unchanged from current rules).

The Basel III Rules set forth certain changes in the methods of calculating certain risk-weighted assets, which in turn will affect the calculation of risk based ratios. Under the Basel III Rules, higher or more sensitive risk weights would be assigned to various categories of assets, including, certain credit facilities that finance the acquisition, development or construction of real property, certain exposures or credits that are 90 days past due or on nonaccrual, foreign exposures and certain corporate exposures. In addition, the Basel III Rules include (i) alternative standards of credit worthiness consistent with the Dodd-Frank Act; (ii) greater recognition of collateral and guarantees; and (iii) revised capital treatment for derivatives and repo-style transactions.

In addition, the final rule includes certain exemptions to address concerns about the regulatory burden on community banks. For example, banking organizations with less than $15 billion in consolidated assets as of December 31, 2009 are permitted to include in Tier 1 capital trust preferred securities and cumulative perpetual preferred stock issued and included in Tier 1 capital prior to May 19, 2010 on a permanent basis, without any phase out. Community banks may also elect on a one time basis in their March 31, 2015 quarterly filings to opt-out out of the onerous requirement to include most accumulated other comprehensive income (“AOCI”) components in the calculation of CET1 capital and, in effect, retain the AOCI treatment under the current capital rules. Under the Final Capital Rule, the Company may make a one-time, permanent election to continue to exclude accumulated other comprehensive income from capital. If the Company does not make this election, unrealized gains and losses would be included in the calculation of its regulatory capital. Overall, the rule provides some important concessions for smaller, less complex financial institutions.

The Basel III Rules generally become effective beginning January 1, 2015. The conservation buffer will be phased in beginning in 2016 and will take full effect on January 1, 2019. Certain calculations under the Basel III Rules will also have phase-in periods. The Company must comply with the final Basel III Rules beginning on January 1, 2015.

Our Support of Our Subsidiaries

Under Federal Reserve Board policy, we are expected to commit resources to act as a source of strength to support each of our subsidiaries. The Dodd-Frank Act codified this policy as a statutory requirement. This

 

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support may be required at times when, absent such Federal Reserve Board policy, we would not otherwise be required to provide it. In addition, any loans we make to our subsidiaries would be subordinate in right of payment to deposits and to other indebtedness of our subsidiaries. In the event of a bank holding company’s bankruptcy, any commitment by the bank holding company to a federal bank regulatory agency to maintain the capital of a subsidiary bank will be assumed by the bankruptcy trustee and be subject to a priority of payment.

Under the Federal Deposit Insurance Act, in the event of a loss suffered or anticipated by the FDIC (either as a result of the default of a banking subsidiary or related to FDIC assistance provided to a subsidiary in danger of default) our other subsidiaries may be assessed for the FDIC’s loss.

Safe and Sound Banking Practices.

Bank holding companies are not permitted to engage in unsafe and unsound banking practices. The Federal Reserve Board’s Regulation Y, for example, generally requires a holding company to give the Federal Reserve Board prior notice of any redemption or repurchase of its own equity securities, if the consideration to be paid, together with the consideration paid for any repurchases or redemptions in the preceding year, is equal to 10% or more of the bank holding company’s consolidated net worth. The Federal Reserve Board may oppose the transaction if it believes that the transaction would constitute an unsafe or unsound practice or would violate any law or regulation. Depending upon the circumstances, the Federal Reserve Board could take the position that paying a dividend would constitute an unsafe or unsound banking practice.

The Federal Reserve Board has broad authority to prohibit activities of bank holding companies and their nonbanking subsidiaries which represent unsafe and unsound banking practices or which constitute violations of laws or regulations, and can assess civil money penalties for certain activities conducted on a knowing and reckless basis, if those activities caused a substantial loss to a depository institution. The penalties can be as high as $1.0 million for each day the activity continues.

Interstate Banking and Branching

Effective June 1, 1997, the Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 amended the Federal Deposit Insurance Act and certain other statutes to permit state and national banks with different home states to merge across state lines, with approval of the appropriate federal banking agency, unless the home state of a participating bank had passed legislation prior to May 31, 1997 expressly prohibiting interstate mergers. Under the Riegle-Neal Act amendments, once a state or national bank has established branches in a state, that bank may establish and acquire additional branches at any location in the state at which any bank involved in the interstate merger transaction could have established or acquired branches under applicable federal or state law. If a state opts out of interstate branching within the specified time period, no bank in any other state may establish a branch in the state which has opted out, whether through an acquisition or de novo.

However, under the Dodd-Frank Act, the national branching requirements have been relaxed and national banks and state banks are able to establish branches in any state if that state would permit the establishment of the branch by a state bank chartered in that state.

The Federal Deposit Insurance Act, or FDIA, requires that the FDIC review (1) any merger or consolidation by or with an insured bank, or (2) any establishment of branches by an insured bank. Additionally, the Banking Department accepts applications for interstate merger and branching transactions, subject to certain limitations on ages of the banks to be acquired and the total amount of deposits within the state a bank or financial holding company may control. Since our primary service area is Texas, we do not expect that the ability to operate in other states will have any material impact on our growth strategy. We may, however, face increased competition from out-of-state banks that branch or make acquisitions in our primary markets in Texas.

 

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Community Reinvestment Act of 1977

The Community Reinvestment Act of 1977, or CRA, subjects a bank to regulatory assessment to determine if the institution meets the credit needs of its entire community, including low- and moderate-income neighborhoods served by the bank, and to take that determination into account in its evaluation of any application made by such bank for, among other things, approval of the acquisition or establishment of a branch or other depository facility, an office relocation, a merger, or the acquisition of shares of capital stock of another financial institution. The regulatory authority prepares a written evaluation of an institution’s record of meeting the credit needs of its entire community and assigns a rating. These ratings are “Outstanding,” “Satisfactory,” “Needs Improvement” and “Substantial Non-Compliance.” Institutions with ratings lower than “Satisfactory” may be restricted from engaging in the aforementioned activities. We believe our subsidiary bank has taken and takes significant actions to comply with the CRA, and received a “satisfactory” rating in its most recent review by federal regulators with respect to its compliance with the CRA.

Monitoring and Reporting Suspicious Activity

Under the Bank Secrecy Act, or BSA, we are required to monitor and report unusual or suspicious account activity that might signify money laundering, tax evasion or other criminal activities, as well as transactions involving the transfer or withdrawal of amounts in excess of prescribed limits. The BSA is sometimes referred to as an “anti-money laundering” law (“AML”). Several AML acts, including provisions in Title III of the USA PATRIOT Act of 2001, have been enacted up to the present to amend the BSA. Under the USA PATRIOT Act, financial institutions are subject to prohibitions against specified financial transactions and account relationships as well as enhanced due diligence and “know your customer” standards in their dealings with financial institutions and foreign customers. For example, the enhanced due diligence policies, procedures and controls generally require financial institutions to take reasonable steps:

 

    to conduct enhanced scrutiny of account relationships to guard against money laundering and report any suspicious transaction;

 

    to ascertain the identity of the nominal and beneficial owners of, and the source of funds deposited into, each account as needed to guard against money laundering and report any suspicious transactions;

 

    to ascertain for any foreign bank, the shares of which are not publicly traded, the identity of the owners of the foreign bank, and the nature and extent of the ownership interest of each such owner; and

 

    to ascertain whether any foreign bank provides correspondent accounts to other foreign banks and, if so, the identity of those foreign banks and related due diligence information.

Under the USA PATRIOT Act, financial institutions are also required to establish anti-money laundering programs. The USA PATRIOT Act sets forth minimum standards for these programs, including:

 

    the development of internal policies, procedures, and controls;

 

    the designation of a compliance officer;

 

    an ongoing employee training program; and

 

    an independent audit function to test the programs.

In addition, under the USA PATRIOT Act, the Secretary of the U.S. Department of the Treasury, or Treasury, has adopted rules addressing a number of related issues, including increasing the cooperation and information sharing between financial institutions, regulators, and law enforcement authorities regarding individuals, entities and organizations engaged in, or reasonably suspected based on credible evidence of engaging in, terrorist acts or money laundering activities. Any financial institution complying with these rules will not be deemed to violate the privacy provisions of the Gramm-Leach-Bliley Act that are discussed below. Finally, under the regulations of the Office of Foreign Asset Control, or OFAC, we are required to monitor and block transactions with certain “specially designated nationals” who OFAC has determined pose a risk to U.S. national security.

 

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Incentive Compensation

In June 2010, the Federal Reserve Board, OCC and FDIC issued comprehensive final guidance on incentive compensation policies intended to ensure that the incentive compensation policies of banking organizations do not undermine the safety and soundness of such organizations by encouraging excessive risk-taking. The guidance, which covers all employees that have the ability to materially affect the risk profile of an organization, either individually or as part of a group, is based upon the key principles that a banking organization’s incentive compensation arrangements should (i) provide incentives that do not encourage risk-taking beyond the organization’s ability to effectively identify and manage risks, (ii) be compatible with effective internal controls and risk management, and (iii) be supported by strong corporate governance, including active and effective oversight by the organization’s board of directors.

The Federal Reserve Board will review, as part of the regular, risk-focused examination process, the incentive compensation arrangements of banking organizations, such as the Company, that are not “large, complex banking organizations.” These reviews will be tailored to each organization based on the scope and complexity of the organization’s activities and the prevalence of incentive compensation arrangements. The findings of the supervisory initiatives will be included in reports of examination. Deficiencies will be incorporated into the organization’s supervisory ratings, which can affect the organization’s ability to make acquisitions and take other actions. Enforcement actions may be taken against a banking organization if its incentive compensation arrangements, or related risk-management control or governance processes, pose a risk to the organization’s safety and soundness and the organization is not taking prompt and effective measures to correct the deficiencies.

In addition, Section 956 of the Dodd-Frank Act required certain regulators (including the FDIC, SEC and Federal Reserve Board) to adopt requirements or guidelines prohibiting excessive compensation. On April 14, 2011, these regulators published a joint proposed rulemaking to implement Section 956 of the Dodd-Frank Act for depository institutions, their holding companies and various other financial institutions with $1 billion or more in assets. The proposed rule would (i) prohibit incentive-based compensation arrangements for covered persons that would encourage inappropriate risks by providing excess compensation; (ii) prohibit incentive-based compensation arrangements for covered persons that would expose the institution to inappropriate risks by providing compensation that could lead to a material financial loss; (iii) require policies and procedures for incentive-based compensation arrangements that are commensurate with the size and complexity of the institutions; and (iv) require annual reports on incentive compensation structures to the institution’s appropriate federal regulator. The comment period to the proposed rule ended on March 31, 2011. As of the date of this document, the final rule has not yet been published by these regulators.

In addition, the Dodd-Frank Act requires publicly traded companies to give stockholders a non-binding vote on executive compensation at their first annual meeting taking place six months after the date of enactment and at least every three years thereafter and on so-called “golden parachute” payments in connection with approvals of mergers and acquisitions unless previously voted on by shareholders. The new legislation also authorizes the Securities and Exchange Commission (“SEC”) to promulgate rules that would allow stockholders to nominate their own candidates using a company’s proxy materials. Additionally, the Dodd-Frank Act directs the federal banking regulators to promulgate rules prohibiting excessive compensation paid to executives of depository institutions and their holding companies with assets in excess of $1.0 billion, regardless of whether the company is publicly traded or not. The Dodd-Frank Act gives the SEC authority to prohibit broker discretionary voting on elections of directors and executive compensation matters.

Consumer Laws and Regulations

We are also subject to certain consumer laws and regulations that are designed to protect consumers in transactions with banks. While the following list is not exhaustive, these laws and regulations include the Truth in Lending Act, the Truth in Savings Act, the Electronic Funds Transfer Act, the Expedited Funds Availability Act, the Equal Credit Opportunity Act, The Fair and Accurate Credit Transactions Act, The Real Estate

 

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Settlement Procedures Act and the Fair Housing Act, among others. These laws and regulations, among other things, prohibit discrimination on the basis of race, gender or other designated characteristics and mandate various disclosure requirements and regulate the manner in which financial institutions must deal with customers when taking deposits or making loans to such customers. These and other laws also limit finance charges or other fees or charges earned in our activities. We must comply with the applicable provisions of these consumer protection laws and regulations as part of our ongoing customer relations.

Consumer Financial Protection Bureau

The Dodd-Frank Act creates a new, independent federal agency called the Consumer Financial Protection Bureau (“CFPB”), which is granted broad rulemaking, supervisory and enforcement powers under various federal consumer financial protection laws, including the Equal Credit Opportunity Act, Truth in Lending Act, Real Estate Settlement Procedures Act, Fair Credit Reporting Act, Fair Debt Collection Act, the Consumer Financial Privacy provisions of the Gramm-Leach-Bliley Act and certain other statutes. The CFPB has examination and primary enforcement authority with respect to depository institutions with $10 billion or more in assets. Smaller institutions are subject to rules promulgated by the CFPB but continue to be examined and supervised by federal banking regulators for consumer compliance purposes. The CFPB has authority to prevent unfair, deceptive or abusive practices in connection with the offering of consumer financial products. The Dodd-Frank Act permits states to adopt consumer protection laws and standards that are more stringent than those adopted at the federal level and, in certain circumstances, permits the state attorney general to enforce compliance with both the state and federal laws and regulations.

The CFPB has already finalized rules relating to, among other things, remittance transfers under the Electronic Fund Transfer Act, which requires companies to provide consumers with certain disclosures before the consumer pays for a remittance transfer. These new rules became effective in October 2013. The CFPB has also amended certain rules under Regulation C relating to home mortgage disclosure to reflect a change in the asset-size exemption threshold for depository institutions based on the annual percentage change in the Consumer Price Index for Urban Wage Earners and Clerical Workers. In addition, on January 10, 2013, the CFPB released its final “Ability-to-Repay/Qualified Mortgage” rules, which amend the Truth in Lending Act (Regulation Z). Regulation Z currently prohibits a creditor from making a higher-priced mortgage loan without regard to the consumer’s ability to repay the loan. The final rule implements sections 1411 and 1412 of the Dodd-Frank Act, which generally require creditors to make a reasonable, good faith determination of a consumer’s ability to repay any consumer credit transaction secured by a dwelling (excluding an open-end credit plan, timeshare plan, reverse mortgage, or temporary loan) and establishes certain protections from liability under this requirement for “qualified mortgages.” The final rule also implements section 1414 of the Dodd-Frank Act, which limits prepayment penalties. Finally, the final rule requires creditors to retain evidence of compliance with the rule for three years after a covered loan is consummated. This rule became effective January 10, 2014.

Technology Risk Management and Consumer Privacy

State and federal banking regulators have issued various policy statements emphasizing the importance of technology risk management and supervision in evaluating the safety and soundness of depository institutions with respect to banks that contract with outside vendors to provide data processing and core banking functions. The use of technology-related products, services, delivery channels and processes exposes a bank to various risks, particularly operational, privacy, security, strategic, reputation and compliance risk. Banks are generally expected to prudently manage technology-related risks as part of their comprehensive risk management policies by identifying, measuring, monitoring and controlling risks associated with the use of technology.

Under Section 501 of the Gramm-Leach-Bliley Act, the federal banking agencies have established appropriate standards for financial institutions regarding the implementation of safeguards to ensure the security and confidentiality of customer records and information, protection against any anticipated threats or hazards to the security or integrity of such records and protection against unauthorized access to or use of such records or

 

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information in a way that could result in substantial harm or inconvenience to a customer. Among other matters, the rules require each bank to implement a comprehensive written information security program that includes administrative, technical and physical safeguards relating to customer information.

Under the Gramm-Leach-Bliley Act, a financial institution must also provide its customers with a notice of privacy policies and practices. Section 502 prohibits a financial institution from disclosing nonpublic personal information about a customer to nonaffiliated third parties unless the institution satisfies various notice and opt-out requirements and the customer has not elected to opt out of the disclosure. Under Section 504, the agencies are authorized to issue regulations as necessary to implement notice requirements and restrictions on a financial institution’s ability to disclose nonpublic personal information about customers to nonaffiliated third parties. Under the final rule the regulators adopted, all banks must develop initial and annual privacy notices which describe in general terms the bank’s information sharing practices. Banks that share nonpublic personal information about customers with nonaffiliated third parties must also provide customers with an opt-out notice and a reasonable period of time for the customer to opt out of any such disclosure (with certain exceptions). Limitations are placed on the extent to which a bank can disclose an account number or access code for credit card, deposit or transaction accounts to any nonaffiliated third party for use in marketing.

Concentrated Commercial Real Estate Lending Regulations

The federal banking agencies, including the FDIC, have promulgated guidance governing financial institutions with concentrations in commercial real estate lending. The guidance provides that a bank has a concentration in commercial real estate lending if (i) total reported loans for construction, land development, and other land represent 100% or more of total capital or (ii) total reported loans secured by multifamily and non-farm residential properties and loans for construction, land development, and other land represent 300% or more of total capital and the bank’s commercial real estate loan portfolio has increased 50% or more during the prior 36 months. Owner occupied loans are excluded from this second category. If a concentration is present, management must employ heightened risk management practices that address the following key elements: including board and management oversight and strategic planning, portfolio management, development of underwriting standards, risk assessment and monitoring through market analysis and stress testing, and maintenance of increased capital levels as needed to support the level of commercial real estate lending.

UDAP and UDAAP

Recently, banking regulatory agencies have increasingly used a general consumer protection statute to address “unethical” or otherwise “bad” business practices that may not necessarily fall directly under the purview of a specific banking or consumer finance law. The law of choice for enforcement against such business practices has been Section 5 of the Federal Trade Commission Act, referred to as the FTC Act, which is the primary federal law that prohibits unfair or deceptive acts or practices, referred to as UDAP, and unfair methods of competition in or affecting commerce. “Unjustified consumer injury” is the principal focus of the FTC Act. Prior to the Dodd-Frank Act, there was little formal guidance to provide insight to the parameters for compliance with UDAP laws and regulations. However, UDAP laws and regulations have been expanded under the Dodd-Frank Act to apply to “unfair, deceptive or abusive acts or practices,” referred to as UDAAP, which have been delegated to the CFPB for supervision. The CFPB has published its first Supervision and Examination Manual that addresses compliance with and the examination of UDAAP.

Monetary Policy

Banks are affected by the credit policies of monetary authorities, including the Federal Reserve Board, that affect the national supply of credit. The Federal Reserve Board regulates the supply of credit in order to influence general economic conditions, primarily through open market operations in United States government obligations, varying the discount rate on financial institution borrowings, varying reserve requirements against financial

 

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institution deposits, and restricting certain borrowings by financial institutions and their subsidiaries. The monetary policies of the Federal Reserve Board have had a significant effect on the operating results of banks in the past and are expected to continue to do so in the future.

Enforcement Powers of Federal Banking Agencies

The Federal Reserve and other state and federal banking agencies and regulators have broad enforcement powers, including the power to terminate deposit insurance, issue cease-and-desist orders, impose substantial fines and other civil and criminal penalties and appoint a conservator or receiver. Our failure to comply with applicable laws, regulations and other regulatory pronouncements could subject us, as well as our officers and directors, to administrative sanctions and potentially substantial civil penalties.

Regulatory Reform and Legislation

From time to time, various legislative and regulatory initiatives are introduced in Congress and state legislatures, as well as by regulatory agencies. Such initiatives may include proposals to expand or contract the powers of bank holding companies and depository institutions or proposals to substantially change the financial institution regulatory system. Such legislation could change banking statutes and the operating environment of the Company in substantial and unpredictable ways. If enacted, such legislation could increase or decrease the cost of doing business, limit or expand permissible activities or affect the competitive balance among banks, savings associations, credit unions, and other financial institutions. The Company cannot predict whether any such legislation will be enacted, and, if enacted, the effect that it, or any implementing regulations, would have on the financial condition or results of operations of the Company. A change in statutes, regulations or regulatory policies applicable to the Company or our subsidiaries could have a material effect on the Company’s business, financial condition and results of operations.

Dodd-Frank Wall Street Reform and Consumer Protection Act

The Dodd-Frank Act, which was enacted in July 2010, effected a fundamental restructuring of federal banking regulation. In addition to those provisions discussed above, among the Dodd-Frank Act provisions that have affected us are the following:

 

    creation of a new Financial Stability Oversight Council to identify systemic risks in the financial system and gives federal regulators new authority to take control of and liquidate financial firms;

 

    elimination of the federal statutory prohibition against the payment of interest on business checking accounts;

 

    prohibition on state-chartered banks engaging in derivatives transactions unless the loans to one borrower of the state in which the bank is chartered takes into consideration credit exposure to derivative transactions. For this purpose, derivative transactions include any contract, agreement, swap, warrant, note or option that is based in whole or in part on the value of, any interest in, or any quantitative measure or the occurrence of any event relating to, one or more commodity securities, currencies, interest or other rates, indices or other assets;

 

    requirement that the amount of any interchange fee charged by a debit card issuer with respect to a debit card transaction must be reasonable and proportional to the cost incurred by the issuer. On June 29, 2011, the Federal Reserve Board set the interchange rate cap at $0.24 per transaction. While the restrictions on interchange fees do not apply to banks that, together with their affiliates, have assets of less than $10 billion, the rule could affect the competitiveness of debit cards issued by smaller banks; and

 

    restrictions under the Volcker Rule of the Company’s ability to engage in proprietary trading and to invest in, sponsor and engage in certain types of transactions with certain private funds. The Company has until July 15, 2015 to fully conform to the Volcker Rules restrictions.

 

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Many of the Dodd-Frank Act’s provisions are still subject to the final rulemaking by federal banking agencies, and the implication of the Dodd-Frank Act for the Company’s business will depend to a large extent on how such rules are adopted and implemented. The Company’s management continues to review actively the provisions of the Dodd–Frank Act and assess its probable impact on its business, financial condition, and results of operations.

Available Information

We file annual, quarterly and current reports, proxy statements and other information with the SEC. You may read and copy any document we file at the SEC’s Public Reference Room at 100 F Street, N.E., Washington, D.C. 20549. Please call the SEC at 1-800-SEC-0330 for further information on the public reference room. Our SEC filings are also available to the public at the SEC’s web site at http://www.sec.gov. Our web site is http://www.ffin.com. You may also obtain copies of our annual, quarterly and special reports, proxy statements and certain other information filed with the SEC, as well as amendments thereto, free of charge from our web site. These documents are posted to our web site after we have filed them with the SEC. Our corporate governance guidelines, including our code of conduct applicable to all our employees, officers and directors, as well as the charters of our audit and nominating committees, are available at www.ffin.com. The foregoing information is also available in print to any shareholder who requests it. Except as explicitly provided, information on any web site is not incorporated into this Form 10-K or our other securities filings and is not a part of them.

 

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ITEM 1A. RISK FACTORS

Our business, financial condition, operating results and cash flows can be impacted by a number of factors, including but not limited to those set forth below, any one of which could cause our actual results to vary materially from recent results or from our anticipated future results and other forward-looking statements that we make from time to time in our news releases, annual reports and other written communications, as well as oral forward-looking statements, and other statements made from time to time by our representatives.

Our business faces unpredictable economic conditions, which could have an adverse effect on us.

General economic conditions impact the banking industry. The credit quality of our loan portfolio necessarily reflects, among other things, the general economic conditions in the areas in which we conduct our business. Our continued financial success depends somewhat on factors beyond our control, including:

 

    general economic conditions, including national and local real estate markets;

 

    the supply of and demand for investable funds;

 

    demand for loans and access to credit;

 

    interest rates; and

 

    federal, state and local laws affecting these matters.

Any substantial deterioration in any of the foregoing conditions could have a material adverse effect on our financial condition, results of operations and liquidity, which would likely adversely affect the market price of our common stock.

In our business, we must effectively manage our credit risk.

As a lender, we are exposed to the risk that our loan customers may not repay their loans according to the terms of these loans and the collateral securing the payment of these loans may be insufficient to fully compensate us for the outstanding balance of the loan plus the costs to dispose of the collateral. We may experience significant loan losses, which could have a material adverse effect on our operating results and financial condition. Management makes various assumptions and judgments about the collectibility of our loan portfolio, including the diversification by industry of our commercial loan portfolio, the amount of nonperforming loans and related collateral, the volume, growth and composition of our loan portfolio, the effects on the loan portfolio of current economic indicators and their probable impact on borrowers and the evaluation of our loan portfolio through our internal loan review process and other relevant factors.

We maintain an allowance for credit losses, which is an allowance established through a provision for loan losses charged to expense that represents management’s best estimate of probable losses inherent in our loan portfolio. Additional credit losses will likely occur in the future and may occur at a rate greater than we have experienced to date. In determining the amount of the allowance, we rely on an analysis of our loan portfolio, our experience and our evaluation of general economic conditions. If our assumptions prove to be incorrect, our current allowance may not be sufficient and adjustments may be necessary to allow for different economic conditions or adverse developments in our loan portfolio. Material additions to the allowance could materially decrease our net income.

In addition, banking regulators periodically review our allowance for credit losses and may require us to increase our provision for credit losses or recognize further charge-offs, based on judgments different than those of our management. Any increase in our allowance for credit losses or charge-offs as required by these regulatory agencies could have a material negative effect on our operating results, financial condition and liquidity.

 

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Our business is concentrated in Texas and a downturn in the economy of Texas may adversely affect our business.

Our network of bank regions is concentrated in Texas, primarily in the Central, North Central, Southeast and Western regions of the state. Most of our customers and revenue are derived from this area. These economies include dynamic centers of higher education, agriculture, energy and natural resources, retail, military, healthcare, tourism, retirement living, manufacturing and distribution. Because we generally do not derive revenue or customers from other parts of the state or nation, our business and operations are dependent on economic conditions in this part of Texas. Any significant decline in one or more segments of the local economy could adversely affect our business, revenue, operations and properties.

Changes in economic conditions could cause an increase in delinquencies and non-performing assets, including loan charge-offs, which could depress our net income and growth.

Our loan portfolio includes many real estate secured loans, demand for which may decrease during economic downturns as a result of, among other things, an increase in unemployment, a decrease in real estate values and, a slowdown in housing. If we see negative economic conditions develop in the United States as a whole or in the portions of Texas that we serve, we could experience higher delinquencies and loan charge-offs, which would reduce our net income and adversely affect our financial condition. Furthermore, to the extent that real estate collateral is obtained through foreclosure, the costs of holding and marketing the real estate collateral, as well as the ultimate values obtained from disposition, could reduce our earnings and adversely affect our financial condition.

The value of real estate collateral may fluctuate significantly resulting in an under-collateralized loan portfolio.

The market value of real estate, particularly real estate held for investment, can fluctuate significantly in a short period of time as a result of market conditions in the geographic area in which the real estate is located. If the value of the real estate serving as collateral for our loan portfolio were to decline materially, a significant part of our loan portfolio could become under-collateralized. If the loans that are collateralized by real estate become troubled during a time when market conditions are declining or have declined, then, in the event of foreclosure, we may not be able to realize the amount of collateral that we anticipated at the time of originating the loan. This could have a material adverse effect on our provision for loan losses and our operating results and financial condition.

We are subject to environmental liability risk associated with lending activities.

A significant portion of our loan portfolio is secured by real property. During the ordinary course of business, we may foreclose on and take title to properties securing certain loans. In doing so, there is a risk that hazardous or toxic substances could be found on these properties. If hazardous or toxic substances are found, we may be liable for remediation costs, as well as for personal injury and property damage. Environmental laws may require us to incur substantial expenses and may materially reduce the affected property’s value or limit our ability to use or sell the affected property. In addition, future laws or more stringent interpretations or enforcement policies with respect to existing laws may increase our exposure to environmental liability. Environmental reviews of real property before initiating foreclosure actions may not be sufficient to detect all potential environmental hazards. The remediation costs and any other financial liabilities associated with an environmental hazard could have a material adverse effect on our business, financial condition and results of operations.

We depend on the accuracy and completeness of information about customers and counterparties.

In deciding whether to extend credit or enter into other transactions, we must rely on information furnished by or on behalf of customers and counterparties, including financial statements, credit reports and other financial

 

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information. We also rely on representations of those customers, counterparties or other third parties, such as independent auditors, as to the accuracy and completeness of that information. Reliance on inaccurate or misleading financial statements, credit reports or other financial information could have a material adverse impact on our business, financial condition and results of operations.

The repeal of prohibitions on paying interest on demand deposits could increase our interest expense.

Effective July 2011, all federal prohibitions on financial institutions paying interest on demand deposit accounts were repealed as part of the Dodd-Frank Act. As a result, some financial institutions have commenced and are considering offering interest on demand deposits to compete for customers. Our interest expense could increase and our net interest margin could decrease if we begin offering interest on demand deposits to maintain current customers or attract new customers, which could have a material adverse effect on our financial condition and results of operations.

We do business with other financial institutions that could experience financial difficulty.

We do business through the purchase and sale of Federal funds, check clearing and through the purchase and sale of loan participations with other financial institutions. Because these financial institutions have many risks, as do we, we could be adversely affected should one of these financial institutions experience significant financial difficulties or fail to comply with our agreements with them.

Recent developments in the mortgage market may affect our ability to originate loans and the profitability of loans in our mortgage pipeline.

During the past several years, the real estate housing market throughout the United States softened resulting in an industry-wide increase in borrowers unable to make their mortgage payments and increased foreclosure rates. In addition, government regulations related to mortgage lending has significantly increased complexity that has made qualifying customers for mortgages more difficult. Lenders in certain sections of the housing and mortgage markets were forced to close or limit their operations or seek additional capital. In response, financial institutions have tightened their underwriting standards, limiting the availability of sources of credit and liquidity. If the housing/real estate market continues to have problems in the future, there could be a prolonged decrease in the demand for our loans in the secondary market, adversely affecting our earnings.

If we are unable to continue to originate residential real estate loans and sell them into the secondary market for a profit, our earnings could decrease.

We derive a portion of our noninterest income from the origination of residential real estate loans and the subsequent sale of such loans into the secondary market. If we are unable to continue to originate and sell residential real estate loans at historical or greater levels, our residential real estate loan volume would decrease, which could decrease our earnings. A rising interest rate environment, general economic conditions or other factors beyond our control could adversely affect our ability to originate residential real estate loans. We also are experiencing an increase in regulations and compliance requirements related to mortgage loan originations necessitating technology upgrades and other changes. If new regulations continue to increase and we are unable to make technology upgrades, our ability to originate mortgage loans will be reduced or eliminated. Additionally, we sell a large portion of our residential real estate loans to third party investors, and rising interest rates could negatively affect our ability to generate suitable profits on the sale of such loans. If interest rates increase after we originate the loans, our ability to market those loans is impaired as the profitability on the loans decreases. These fluctuations can have an adverse effect on the revenue we generate from residential real estate loans and in certain instances, could result in a loss on the sale of the loans.

Further, for the mortgage loans we sell in the secondary market, the mortgage loan sales contracts contain indemnification clauses should the loans default, generally in the first sixty to ninety days, or if documentation is

 

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determined not to be in compliance with regulations. While the Company’s historic losses as a result of these indemnities have been insignificant, we could be required to repurchase the mortgage loans or reimburse the purchaser of our loans for losses incurred. Both of these situations could have an adverse effect on the profitability of our mortgage loan activities and negatively impact our net income.

We may need to raise additional capital/liquidity and such funds may not be available when needed.

We may need to raise additional capital/liquidity in the future to provide us with sufficient capital resources and liquidity to meet our commitments and business needs, particularly if our asset quality or earnings were to deteriorate significantly. Our ability to raise additional capital/liquidity, if needed, will depend on, among other things, conditions in the capital and financial markets at that time, which are outside of our control, and our financial performance. Economic conditions and the loss of confidence in financial institutions may increase our cost of funding and limit access to certain customary sources of capital/liquidity, including depositors, other financial institution borrowings, repurchase agreements and borrowings from the discount window of the Federal Reserve. Any occurrence that may limit our access to the capital/liquidity markets, such as a decline in the confidence of other financial institutions, depositors or counterparties participating in the capital markets, may adversely affect our costs and our ability to raise capital/liquidity. An inability to raise additional capital/liquidity on acceptable terms when needed could have a materially adverse effect on our financial condition, results of operations and liquidity.

We may be subject to more stringent capital and liquidity requirements which would adversely affect our net income and future growth.

On July 2, 2013, the Federal Reserve Board, and on July 9, 2013, the FDIC and OCC, adopted a final rule that implements the Basel III changes to the international regulatory capital framework and revises the U.S. risk-based and leverage capital requirements for U.S. banking organizations to strengthen identified areas of weakness in capital rules and to address relevant provisions of the Dodd-Frank Act.

The final rule establishes a stricter regulatory capital framework that requires banking organizations to hold more and higher-quality capital to act as a financial cushion to absorb losses and help banking organizations better withstand periods of financial stress. The final rule increases capital ratios for all banking organizations and introduces a “capital conservation buffer” which is in addition to each capital ratio. If a banking organization dips into its capital conservation buffer, it may be restricted in its ability to pay dividends and discretionary bonus payments to its executive officers. The final rule assigns a higher risk weight (150%) to exposures that are more than 90 days past due or are on nonaccrual status and to certain commercial real estate facilities that finance the acquisition, development or construction of real property. The final rule also requires unrealized gains and losses on certain “available-for-sale” securities holdings to be included for purposes of calculating regulatory capital requirements unless a one-time opt-out is exercised. We have the one-time option in the first quarter of 2015 to permanently opt-out of the inclusion of accumulated other comprehensive income in our capital calculation. The Company is considering whether to opt-out in order to reduce the impact of market volatility on our regulatory capital levels. The final rule also includes changes in what constitutes regulatory capital, some of which are subject to a two-year transition period. These changes include the phasing-out of certain instruments as qualifying capital. In addition, Tier 2 capital is no longer limited to the amount of Tier 1 capital included in total capital. Mortgage servicing rights, certain deferred tax assets and investments in unconsolidated subsidiaries over designated percentages of common stock will be required to be deducted from capital, subject to a two-year transition period.

The final rule becomes effective for us on January 1, 2015. We have conducted a pro forma analysis of the application of these new capital requirements as of December 31, 2013 and have determined that we meet all of these new requirements, including the full capital conservation buffer, as if these new requirements had been in effect on that date.

 

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Although we currently cannot predict the specific impact and long-term effects that Basel III will have on our Company and the banking industry more generally, the Company will be required to maintain higher regulatory capital levels which could impact our operations, net income and ability to grow. Furthermore, the Company’s failure to comply with the minimum capital requirements could result in our regulators taking formal or informal actions against us which could restrict our future growth or operations.

The trust wealth management fees we receive may decrease as a result of poor investment performance, in either relative or absolute terms, which could decrease our revenues and net earnings.

Our trust company subsidiary derives its revenues primarily from investment management fees based on assets under management. Our ability to maintain or increase assets under management is subject to a number of factors, including investors’ perception of our past performance, in either relative or absolute terms, market and economic conditions, including changes in oil and gas prices, and competition from investment management companies. Financial markets are affected by many factors, all of which are beyond our control, including general economic conditions, including changes in oil and gas prices; securities market conditions; the level and volatility of interest rates and equity prices; competitive conditions; liquidity of global markets; international and regional political conditions; regulatory and legislative developments; monetary and fiscal policy; investor sentiment; availability and cost of capital; technological changes and events; outcome of legal proceedings; changes in currency values; inflation; credit ratings; and the size, volume and timing of transactions. A decline in the fair value of the assets under management, caused by a decline in general economic conditions, would decrease our wealth management fee income.

Investment performance is one of the most important factors in retaining existing clients and competing for new wealth management clients. Poor investment performance could reduce our revenues and impair our growth in the following ways:

 

    existing clients may withdraw funds from our wealth management business in favor of better performing products;

 

    asset-based management fees could decline from a decrease in assets under management;

 

    our ability to attract funds from existing and new clients might diminish; and

 

    our wealth managers and investment advisors may depart, to join a competitor or otherwise.

Even when market conditions are generally favorable, our investment performance may be adversely affected by the investment style of our wealth management and investment advisors and the particular investments that they make. To the extent our future investment performance is perceived to be poor in either relative or absolute terms, the revenues and profitability of our wealth management business will likely be reduced and our ability to attract new clients will likely be impaired. As such, fluctuations in the equity and debt markets can have a direct impact upon our net earnings.

Certain of our investment advisory and wealth management contracts are subject to termination on short notice, and termination of a significant number of investment advisory contracts could have a material adverse impact on our revenue.

Certain of our investment advisory and wealth management clients can terminate, with little or no notice, their relationships with us, reduce their aggregate assets under management, or shift their funds to other types of accounts with different rate structures for any number of reasons, including investment performance, changes in prevailing interest rates, inflation, changes in investment preferences of clients, changes in our reputation in the marketplace, change in management or control of clients, loss of key investment management personnel and financial market performance. We cannot be certain that our trust company subsidiary will be able to retain all of its clients. If its clients terminate their investment advisory and wealth management contracts, our trust company subsidiary, and consequently we, could lose a substantial portion of our revenues.

 

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We are subject to possible claims and litigation pertaining to fiduciary responsibility.

From time to time, customers could make claims and take legal action pertaining to our performance of our fiduciary responsibilities. Whether customer claims and legal action related to our performance of our fiduciary responsibilities are founded or unfounded, if such claims and legal actions are not resolved in a manner favorable to us, they may result in significant financial liability and/or adversely affect our market perception of our products and services as well as impact customer demand for those products and services. Any financial liability or reputation damage could have a material adverse effect on our business, which, in turn, could have a material adverse effect on our financial condition and results of operations.

Our business is subject to significant government regulation.

We operate in a highly regulated environment and are subject to supervision and regulation by a number of governmental regulatory agencies, including the Texas Department of Banking, the Federal Reserve Board, the OCC, and the FDIC. Regulations adopted by these agencies, which are generally intended to provide protection for depositors and customers rather than for the benefit of shareholders, govern a comprehensive range of matters relating to ownership and control of our shares, our acquisition of other companies and businesses, permissible activities for us to engage in, maintenance of adequate capital levels and other aspects of our operations. The bank regulatory agencies possess broad authority to prevent or remedy unsafe or unsound practices or violations of law.

The Dodd-Frank Act, enacted in July 2010, instituted major changes to the banking and financial institutions regulatory regimes in light of the recent performance of and government intervention in the financial services sector. Other changes to statues, regulations or regulatory policies, including changes in interpretation or implementation of statutes, regulations or policies, could affect the Company in substantial and unpredictable ways. Such changes could subject the Company to reduced revenues, additional costs, limit the types of financial services and products the Company may offer and/or increase the ability of non-banks to offer competing financial services and products, among other things. Failure to comply with laws, regulations or policies could result in sanctions by regulatory agencies, civil money penalties and/or reputation damage, which could have a material adverse effect on the Company’s business, financial condition and results of operations.

Included in the Dodd-Frank Act are, for example, changes related to interchange fees and overdraft services. While the changes for interchange fees that can be charged for electronic debit transactions by payment card issuers relate only to banks with assets greater than $10 billion, concern exists that the regulations will also impact our Company. Beginning in the third quarter of 2010, we were prohibited from charging customers fees for paying overdrafts on automated teller machine and debit card transactions, unless the consumer opts in. We continue to monitor the impact of these new regulations and other developments on our service charge revenue.

Our FDIC insurance assessments could increase substantially resulting in higher operating costs.

We have historically paid the lowest premium rate available due to our sound financial position. In 2009, a special assessment ($1.4 million for the Company) was paid by the Company. Should bank failures continue to occur, FDIC premiums could increase or additional special assessments could be imposed. These increased premiums would have an adverse effect on our net income and results of operations.

We compete with many larger financial institutions which have substantially greater financial resources than we have.

Competition among financial institutions in Texas is intense. We compete with other bank holding companies, state and national commercial banks, savings and loan associations, consumer financial companies, credit unions, securities brokers, insurance companies, mortgage banking companies, money market mutual funds, asset-based non-bank lenders and other financial institutions. Many of these competitors have substantially greater financial resources, larger lending limits, larger branch networks and less regulatory

 

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oversight than we do, and are able to offer a broader range of products and services than we can. Failure to compete effectively for deposit, loan and other banking customers in our markets could cause us to lose market share, slow our growth rate and may have an adverse effect on our financial condition, results of operations and liquidity.

We are subject to interest rate risk.

Our profitability is dependent to a large extent on our net interest income, which is the difference between interest income we earn as a result of interest paid to us on loans and investments and interest we pay to third parties such as our depositors and those from whom we borrow funds. Like most financial institutions, we are highly sensitive to many factors that are beyond our control, including general economic conditions and policies of various governmental and regulatory agencies and, in particular, the Federal Reserve Board. Changes in monetary policy, including changes in interest rates, could influence not only the interest we receive on loans and securities and the amount of interest we pay on deposits and borrowings, but such changes could also affect (i) our ability to originate loans and obtain deposits, (ii) the fair value of our financial assets and liabilities, and (iii) the average duration of the Company’s securities portfolio. If the interest rates paid on deposits and other borrowings increase at a faster rate than the interest rates received on loans and investments, our net interest income, and earnings, could be adversely affected. Earnings could also be adversely affected if the interest rates received on loans and investments fall more quickly than the interest rates paid on deposits and other borrowings.

Although we have implemented strategies which we believe reduce the potential effects of adverse changes in interest rates on our results of operations, these strategies may not always be successful. In addition, any substantial and prolonged increase in market interest rates could reduce our customers’ desire to borrow money from us or adversely affect their ability to repay their outstanding loans by increasing their credit costs since most of our loans have adjustable interest rates that reset periodically. Any of these events could adversely affect our results of operations, financial condition and liquidity.

The value of certain securities in our investment portfolio may be negatively affected by changes or disruptions in the market for these securities.

Our investment portfolio securities include obligations of, and mortgage-backed securities guaranteed by, government sponsored enterprises such as the Federal National Mortgage Association, referred to as Fannie Mae, the Government National Mortgage Association, referred to as Ginnie Mae, the Federal Home Loan Mortgage Corporation, referred to as Freddie Mac, and the Federal Home Loan Bank or otherwise backed by Federal Housing Administration or Veteran’s Administration guaranteed loans; however, volatility or illiquidity in financial markets may cause investment securities held within our investment portfolio to fall in value or become less liquid. The FRB’s actions to increase the money supply (sometimes referred to as quantitative easing) may be curtailed or ended which may cause a decline in the value of securities held by the Company. Uncertainty surrounding the credit risk associated with mortgage collateral or guarantors may cause material discrepancies in valuation estimates obtained from third parties. Volatile market conditions may reduce valuations due to the perception of heightened credit and liquidity risks in addition to interest rate risk typically associated with these securities. There can be no assurance that declines in market value associated with these disruptions will not result in impairments of these assets, which would lead to accounting charges that could have a material adverse effect on our results of operations, equity and capital ratios.

The downgrade of U.S. government securities by the credit rating agencies could have a material adverse effect on our operations, results of operations and financial condition.

The recent debates in Congress regarding the national debt ceiling, federal budget deficit concerns and overall weakness in the economy resulted in actual and threatened downgrades of United States government securities by the various major credit ratings agencies, including Standard and Poor’s and Fitch Ratings. While the federal banking agencies, including the Federal Reserve Board and the FDIC, have issued guidance indicating that, for risk-based capital purposes, the risk weights for United States Treasury securities and other securities issued or guaranteed by the United States government, government agencies and government-sponsored entities

 

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will not be affected by the downgrade, the downgrade of United States government securities by Standard and Poor’s and the possible future downgrade of the federal government’s credit rating by one or both of the other two major rating agencies (which has been forewarned by Fitch Ratings), could create uncertainty in the United States and global financial markets and cause other events which, directly or indirectly, could adversely affect our operations, results of operations and financial condition.

First Financial Bankshares, Inc. relies on dividends from its subsidiaries for most of its revenue.

First Financial Bankshares, Inc. is a separate and distinct legal entity from its subsidiaries. It receives substantially all of its revenue from dividends paid by its subsidiaries. These dividends are the principal source of funds to pay dividends on the Company’s common stock and interest and principal on First Financial Bankshares, Inc. debt (if we had balances outstanding). Various federal and/or state laws and regulations limit the amount of dividends that our bank and trust subsidiaries may pay to First Financial Bankshares, Inc. In the event our subsidiaries are unable to pay dividends to First Financial Bankshares, Inc., First Financial Bankshares, Inc. may not be able to service debt or pay dividends on the Company’s common stock. The inability to receive dividends from our subsidiaries could have a material adverse effect on the Company’s business, financial condition, results of operations and liquidity.

To continue our growth, we are affected by our ability to identify and acquire other financial institutions.

We intend to continue our current growth strategy. This strategy includes opening new branches and acquiring other banks that serve customers or markets we find desirable. The market for acquisitions remains highly competitive, and we may be unable to find satisfactory acquisition candidates in the future that fit our acquisition and growth strategy. To the extent that we are unable to find suitable acquisition candidates, an important component of our growth strategy may be lost. Additionally, our completed acquisitions, or any future acquisitions, may not produce the revenue, earnings or synergies that we anticipated.

Our operational and financial results are affected by our ability to successfully integrate our acquisitions.

Acquisitions of financial institutions involve operational risks and uncertainties and acquired companies may have unforeseen liabilities, exposure to asset quality problems, key employee and customer retention problems and other problems that could negatively affect our organization. We may not be able to successfully integrate the operations, management, products and services of the entities that we acquire nor eliminate redundancies. The integration process may also require significant time and attention from our management that they would otherwise direct at servicing existing business and developing new business. Our failure to successfully integrate the entities we acquire into our existing operations may increase our operating costs significantly and adversely affect our business and earnings.

Use of our common stock for future acquisitions or to raise capital may be dilutive to existing stockholders.

When we determine that appropriate strategic opportunities exist, we may acquire other financial institutions and related businesses, subject to applicable regulatory requirements. We may use our common stock for such acquisitions. From time to time, we may also seek to raise capital through selling additional common stock. It is possible that the issuance of additional common stock in such acquisition or capital transactions may be dilutive to the interests of our existing shareholders.

Our accounting estimates and risk management processes rely on analytical and forecasting models.

The processes we use to estimate our allowance for loan losses and to measure the fair value of financial instruments, as well as the processes used to estimate the effects of changing interest rates depends upon the use of analytical and forecasting models. In addition, these models are used to calculate fair value of our assets and liabilities when we acquire other financial institutions. These models reflect assumptions that may not be accurate, particularly in times of market stress or other unforeseen circumstances. Even if these assumptions are adequate, the models may prove to be inadequate or inaccurate because of other flaws in their design or their implementation. If

 

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the models we use for interest rate risk and asset-liability management are inadequate, we may incur increased or unexpected losses upon changes in market interest rates or other market measures. If the models we use for determining our probable loan losses are inadequate, the allowance for loan losses may not be sufficient to support future charge-offs. If the models we use to measure the fair value financial instruments is inadequate, the fair value of such financial instruments may fluctuate unexpectedly or may not accurately reflect what we could realize upon sale or settlement of such financial instruments. Such failure in our analytical or forecasting models could have a material adverse effect on our business, financial condition and results of operations.

The value of our goodwill and other intangible assets may decline in the future.

As of December 31, 2013, we had $97.48 million of goodwill and other intangible assets. A significant decline in our financial condition, a significant adverse change in the business climate, slower growth rates or a significant and sustained decline in the price of our common stock may necessitate taking charges in the future related to the impairment of our goodwill and other intangible assets. If we were to conclude that a future write-down of goodwill and other intangible assets is necessary, we would record the appropriate charge, which could have a material adverse effect on our financial condition and results of operations.

We rely heavily on our management team, and the unexpected loss of key management may adversely affect our operations.

Our success to date has been strongly influenced by our ability to attract and to retain senior management experienced in banking in the markets we serve. Our ability to retain executive officers and the current management teams will continue to be important to the successful implementation of our strategies. We do not have employment agreements with these key employees other than executive agreements in the event of a change of control and a confidential information, non-solicitation and non-competition agreement related to our stock options. The unexpected loss of services of any key management personnel, or the inability to recruit and retain qualified personnel in the future, could have an adverse effect on our business and financial results.

The Company may not be able to attract and retain skilled people.

The Company’s success depends, in large part, on its ability to attract and retain key people. Competition for the best people in most activities engaged in by the Company can be intense and the Company may not be able to hire people or to retain them. The unexpected loss of services of one or more of the Corporation’s key personnel could have a material adverse impact on the Company’s business because of their skills, knowledge of the Company’s market, years of industry experience and the difficulty of promptly finding qualified replacement personnel.

The Company’s stock price can be volatile.

Stock price volatility may make it more difficult for you to resell your common stock when you want and at prices you find attractive. The Company’s stock price can fluctuate significantly in response to a variety of factors including, among other things:

 

    actual or anticipated variations in quarterly results of operations;

 

    recommendations by securities analysts;

 

    operating and stock price performance of other companies that investors deem comparable to the Company;

 

    new reports relating to trends, concerns and other issues in the financial services industry;

 

    perceptions in the marketplace regarding the Company and/or its competitors;

 

    new technology used, or services offered, by competitors;

 

    significant acquisitions or business combinations involving the Company or its competitors; and

 

    changes in government regulations, including tax laws.

 

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General market fluctuations, industry factors and general economic and political conditions and events, such as economic slowdowns or recessions, interest rate changes or credit loss trends could also cause the Company’s stock price to decrease regardless of operational results.

Breakdowns in our internal controls and procedures could have an adverse effect on us.

We believe our internal control system as currently documented and functioning is adequate to provide reasonable assurance over our internal controls. Nevertheless, because of the inherent limitation in administering a cost effective control system, misstatements due to error or fraud may occur and not be detected. Breakdowns in our internal controls and procedures could occur in the future, and any such breakdowns could have an adverse effect on us. See “Item 9A—Controls and Procedures” for additional information.

We compete in an industry that continually experiences technological change, and we may have fewer resources than many of our competitors to continue to invest in technological improvements.

The financial services industry is undergoing rapid technological changes, with frequent introductions of new technology-driven products and services. In addition to improving the ability to serve customers, the effective use of technology increases efficiency and enables financial institutions to reduce costs. Our future success will depend, in part, upon our ability to address the needs of our customers by using technology to provide products and services that will satisfy customer demands for conveniences, as well as to create additional efficiencies in our operations. Many of our larger competitors have substantially greater resources to invest in technological improvements. We may not be able to effectively implement new technology-driven products and services or be successful in marketing these products and services to our customers.

System failure or cybersecurity breaches of our network security could subject us to increased operating costs as well as litigation and other potential losses.

The computer systems and network infrastructure we use could be vulnerable to unforeseen hardware and cybersecurity issues, including “hacking” and “identity theft.” Our operations are dependent upon our ability to protect our computer equipment against damage from fire, power loss, telecommunications failure or a similar catastrophic event. Any damage or failure that causes an interruption in our operations could have an adverse effect on our financial condition and results of operations. In addition, our operations are dependent upon our ability to protect the computer systems and network infrastructure utilized by us, including our Internet banking activities, against damage from physical break-ins, cybersecurity breaches and other disruptive problems caused by the Internet or other users. Such computer break-ins and other disruptions would jeopardize the security of information stored in and transmitted through our computer systems and network infrastructure, which may result in significant liability to us, damage our reputation and inhibit current and potential customers from our Internet banking services. Each year, we add additional security measures to our computer systems and network infrastructure to mitigate the possibility of cybersecurity breaches including firewalls and penetration testing. We continue to investigate cost effective measures as well as insurance protection.

Furthermore, our customers could incorrectly blame the Company and terminate their accounts with the Company for a cyber-incident which occurred on their own system or with that of an unrelated third party. In addition, a security breach could also subject us to additional regulatory scrutiny and expose us to civil litigation and possible financial liability.

Finally, on February 12, 2013, the Obama Administration released an executive order, Improving Critical Infrastructure Cybersecurity, referred to as the Executive Order, which is focused primarily on government actions to support critical infrastructure owners and operators in protecting their systems and networks from cyber threats. The Executive Order requires the development of risk-based cybersecurity standards, methodologies, procedures, and processes, a so-called “Cybersecurity Framework,” that can be used voluntarily by critical infrastructure companies to address cyber risks. The Executive Order also will steer certain private sector companies to comply voluntarily with the Cybersecurity Framework. It is unclear at this time what impact the Executive Order will have on our internet-based systems and online commerce security.

 

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We are subject to claims and litigation pertaining to intellectual property.

We rely on technology companies to provide information technology products and services necessary to support our day-to-day operations. Technology companies frequently enter into litigation based on allegations of patent infringement or other violations of intellectual property rights. In addition, patent holding companies seek to monetize patents they have purchased or otherwise obtained. Competitors of our vendors, or other individuals or companies, have from time to time claimed to hold intellectual property sold to us by its vendors. Such claims may increase in the future as the financial services sector becomes more reliant on information technology vendors. The plaintiffs in these actions frequently seek injunctions and substantial damages.

Regardless of the scope or validity of such patents or other intellectual property rights, or the merits of any claims by potential or actual litigants, we may have to engage in litigation that could be expensive, time-consuming, disruptive to our operations, and distracting to management. If we are found to infringe one or more patents or other intellectual property rights, we may be required to pay substantial damages or royalties to a third-party. In certain cases, we may consider entering into licensing agreements for disputed intellectual property, although no assurance can be given that such licenses can be obtained on acceptable terms or that litigation will not occur. These licenses may also significantly increase our operating expenses. If legal matters related to intellectual property claims were resolved against us or settled, we could be required to make payments in amounts that could have a material adverse effect on our business, financial condition and results of operations.

An investment in our common stock is not an insured deposit.

Our common stock is not a bank deposit and, therefore, is not insured against loss by the FDIC, any other deposit insurance fund, or by any other public or private entity. Investment in our common stock is inherently risky for the reasons described in this “Risk Factors” section and elsewhere in this Report. As a result, if you acquire our common stock, you may lose some or all of your investment.

 

ITEM 1B. UNRESOLVED STAFF COMMENTS

None.

 

ITEM 2. PROPERTIES

Our principal office is located in the First Financial Bank Building at 400 Pine Street in downtown Abilene, Texas. We lease four spaces in buildings owned by First Financial Bank, National Association, Abilene totaling approximately 7,600 square feet. Our subsidiaries collectively own 53 banking facilities, some of which are detached drive-ins, and also lease 9 banking facilities and 16 ATM locations. Our management considers all our existing locations to be well-suited for conducting the business of banking. We believe our existing facilities are adequate to meet our requirements and our subsidiaries’ requirements for the foreseeable future.

 

ITEM 3. LEGAL PROCEEDINGS

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

 

ITEM 4. MINE SAFETY DISCLOSURES

Not Applicable.

 

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PART II

 

ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

Market Information

Our common stock, par value $0.01 per share, is traded on the Nasdaq Global Select Market under the trading symbol FFIN. See “Item 8—Financial Statements and Supplementary Data—Quarterly Financial Data” for the high, low and closing sales prices as reported by the Nasdaq Global Select Market for our common stock for the periods indicated.

Record Holders

As of February 1, 2014, we had approximately 1,200 shareholders of record.

Dividends

See “Item 8—Financial Statements and Supplementary Data—Quarterly Results of Operations” for the frequency and amount of cash dividends paid by us. Also, see “Item 1—Business—Supervision and Regulation—Payment of Dividends” and “Item 7—Management’s Discussion and Analysis of the Financial Condition and Results of Operations—Liquidity—Dividends” for restrictions on our present or future ability to pay dividends, particularly those restrictions arising under federal and state banking laws.

Equity Compensation Plans

See “Item 12—Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters”.

 

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PERFORMANCE GRAPH

The following performance graph compares cumulative total shareholder returns for our common stock, the Russell 3000 Index, and the SNL Bank Index, which is a banking index prepared by SNL Financial LC and is comprised of banks with $1 billion to $5 billion in total assets, for a five-year period (December 31, 2008 to December 31, 2013). The performance graph assumes $100 invested in our common stock at its closing price on December 31, 2008, and in each of the Russell 3000 Index and the SNL Bank Index on the same date. The performance graph also assumes the reinvestment of all dividends. The dates on the performance graph represent the last trading day of each year indicated. The amounts noted on the performance graph have been adjusted to give effect to all stock splits and stock dividends.

First Financial Bankshares, Inc.

 

LOGO

 

     Period Ending  

Index

   12/31/08      12/31/09      12/31/10      12/31/11      12/31/12      12/31/13  

First Financial Bankshares, Inc.

     100.00         100.99         98.07         98.91         118.68         204.93   

Russell 3000

     100.00         128.34         150.07         151.61         176.49         235.71   

SNL Bank $1B-$5B

     100.00         71.68         81.25         74.10         91.37         132.87   

SNL Bank $5B-$10B Index

     100.00         76.88         83.40         82.77         97.36         150.21   

Source : SNL Financial LC, Charlottesville, VA

© 2014

www.snl.com

 

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ITEM 6. SELECTED FINANCIAL DATA

The selected financial data presented below as of and for the years ended December 31, 2013, 2012, 2011, 2010, and 2009, have been derived from our audited consolidated financial statements. The selected financial data should be read in conjunction with “Item 7—Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our consolidated financial statements and accompanying notes presented elsewhere in this Form 10-K. The results of operations presented below are not necessarily indicative of the results of operations that may be achieved in the future. Management’s Discussion and Analysis of Financial Condition and Results of Operations incorporates information required to be disclosed by the SEC’s Industry Guide 3, “Statistical Disclosure by Bank Holding Companies.”

 

    Year Ended December 31,  
    2013     2012     2011     2010     2009  
    (dollars in thousands, except per share data)  

Summary Income Statement Information:

         

Interest income

  $ 176,369      $ 159,796      $ 160,021      $ 149,699      $ 146,445   

Interest expense

    4,088        5,112        8,024        13,528        17,274   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net interest income

    172,281        154,684        151,997        136,171        129,171   

Provision for loan losses

    3,753        3,484        6,626        8,962        11,419   

Noninterest income

    62,052        57,209        51,438        49,478        48,598   

Noninterest expense

    126,012        109,049        104,624        98,256        94,000   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Earnings before income taxes and extraordinary item

    104,568        99,360        92,185        78,431        72,350   

Income tax expense

    25,700        25,135        23,816        20,068        18,553   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net earnings before extraordinary item

    78,868        74,225        68,369        58,363        53,797   

Extraordinary item

    —          —          —          1,296        —     
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net earnings

  $ 78,868      $ 74,225      $ 68,369      $ 59,659      $ 53,797   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Per Share Data:

         

Earnings per share, basic before extraordinary item

  $ 2.48      $ 2.36      $ 2.17      $ 1.87      $ 1.72   

Earnings per share, assuming dilution before extraordinary item

    2.47        2.36        2.17        1.87        1.72   

Earnings per share, basic

    2.48        2.36        2.17        1.91        1.72   

Earnings per share, assuming dilution

    2.47        2.36        2.17        1.91        1.72   

Cash dividends declared

    1.03        0 .99        0.95        0.91        0.91   

Book value at period-end

    18.37        17.68        16.16        14.06        13.31   

Earnings performance ratios:

         

Return on average assets

    1.64     1.75     1.78     1.75     1.72

Return on average equity

    13.75        13.85        14.44        13.74        13.63   

Summary Balance Sheet Data (Period-end):

         

Securities

  $ 2,058,407      $ 1,820,096      $ 1,844,998      $ 1,546,242      $ 1,285,377   

Loans

    2,689,448        2,088,623        1,786,544        1,690,346        1,514,369   

Total assets

    5,222,208        4,502,012        4,120,531        3,776,367        3,279,456   

Deposits

    4,135,075        3,632,584        3,334,798        3,113,301        2,684,757   

Total liabilities

    4,634,561        3,945,049        3,611,994        3,334,679        2,863,754   

Total shareholders’ equity

    587,647        556,963        508,537        441,688        415,702   

Asset quality ratios:

         

Allowance for loan losses/period-end loans

    1.26     1.67     1.92     1.84     1.82

Nonperforming assets/period-end loans plus foreclosed assets

    1.16        1.22        1.64        1.53        1.46   

Net charge offs/average loans

    0.15        0.15        0.20        0.35        0.36   

Capital ratios:

         

Average shareholders’ equity/average assets

    11.95     12.62     12.30     12.76     12.63

Leverage ratio (1)

    9.84        10.60        10.33        10.28        10.69   

Tier 1 risk-based capital (2)

    15.82        17.43        17.49        17.01        17.73   

Total risk-based capital (3)

    16.92        18.68        18.74        18.26        18.99   

Dividend payout ratio

    41.62        41.99        43.57        47.58        52.63   

 

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(1) Calculated by dividing at period-end, shareholders’ equity (before accumulated other comprehensive earnings/loss) less intangible assets by fourth quarter average assets less intangible assets.
(2) Calculated by dividing at period-end, shareholders’ equity (before accumulated other comprehensive earnings/loss) less intangible assets by risk-adjusted assets.
(3) Calculated by dividing at period-end, shareholders’ equity (before accumulated other comprehensive earnings/loss) less intangible assets plus allowance for loan losses to the extent allowed under regulatory guidelines by risk-adjusted assets.

 

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ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Introduction

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

The following discussion and analysis of the major elements of our consolidated balance sheets as of December 31, 2013 and 2012, and consolidated statements of earnings for the years 2011 through 2013 should be read in conjunction with our consolidated financial statements, accompanying notes, and selected financial data presented elsewhere in this Form 10-K.

Critical Accounting Policies

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

We deem a policy critical if (1) the accounting estimate required us to make assumptions about matters that are highly uncertain at the time we make the accounting estimate; and (2) different estimates that reasonably could have been used in the current period, or changes in the accounting estimate that are reasonably likely to occur from period to period, would have a material impact on the financial statements.

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 1 to our Consolidated Financial Statements.

Acquisition of Orange Savings Bank, SSB

On February 9, 2013, we entered into an agreement and plan of merger to acquire Orange Savings Bank, SSB. On May 31, 2013, the transaction was completed. Pursuant to the agreement, we paid $39.20 million in cash and issued 420,000 shares of the Company’s common stock in exchange for all of the outstanding shares of Orange Savings Bank, SSB.

At closing, Orange Savings Bank, SSB was merged into First Financial Bank, N.A., Abilene, Texas, a wholly owned subsidiary of the Company. The total purchase price exceeded the estimated fair value of assets acquired by approximately $23.02 million and was recorded by the Company as goodwill.

Consolidation of Bank Charters

Effective December 30, 2012, the Company consolidated its eleven bank charters into one charter. The Company cited regulatory, compliance and technology complexities and the opportunity for cost savings as its reason for making this change. The Company operates the one charter as it previously did with eleven charters, with local management and board decisions to benefit the customers and communities it serves.

 

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Stock Split

On April 26, 2011, the Company’s Board of Directors declared a three-for-two stock split in the form of a 50% stock dividend effective for shareholders of record on May 16, 2011 that was distributed on June 1, 2011. All share and per share amounts in this report have been restated to reflect this stock split. An amount equal to the par value of the additional common shares to be issued pursuant to the stock split was reflected as a transfer from retained earnings to common stock on the consolidated financial statements as of and for the year ended December 31, 2011.

Results of Operations

Performance Summary. Net earnings for 2013 were $78.87 million, an increase of $4.64 million, or 6.26%, over net earnings for 2012 of $74.23 million. Net earnings for 2011 were $68.37 million. The increases in net earnings for 2013 over 2012 and 2012 over 2011 were primarily attributable to growth in net interest income and noninterest income.

On a basic net earnings per share basis, net earnings were $2.48 for 2013 as compared to $2.36 for 2012 and $2.17 for 2011. The return on average assets was 1.64% for 2013 as compared to 1.75% for 2012 and 1.78% for 2011. The return on average equity was 13.75% for 2013 as compared to 13.85% for 2012 and 14.44% for 2011.

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 $189.00 million in 2013 as compared to $169.32 million in 2012 and $164.85 million in 2011. The increase in 2013 compared to 2012 was largely attributable to an increase in the volume of earning assets. Average earning assets were $4.48 billion in 2013, as compared to $3.95 billion in 2012 and $3.57 billion in 2011. Average earning assets increased $525.62 million in 2013 with increases in all categories of earning assets, except for short-term investments and taxable investment securities. The yield on earning assets decreased ten basis points in 2013, whereas the rate paid on interest-bearing liabilities decreased six basis points. The increase in 2012 compared to 2011 also resulted from an increase in the volume of earnings assets and from the decrease in the rates paid on interest-bearing liabilities.

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):

 

     2013 Compared to 2012     2012 Compared to 2011  
     Change Attributable to     Total
Change
    Change Attributable to     Total
Change
 
     Volume     Rate       Volume     Rate    

Short-term investments

   $ (327   $ 81      $ (246   $ (369   $ (97   $ (466

Taxable investment securities

     (2,525     (3,288     (5,813     1,451        (7,854     (6,403

Tax-exempt investment securities (1)

     7,613        (2,519     5,094        11,259        (6,185     5,074   

Loans (1) (2)

     28,236        (8,612     19,624        11,342        (7,985     3,357   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Interest income

     32,997        (14,338     18,659        23,683        (22,121     1,562   

Interest-bearing deposits

     559        (1,727     (1,168     323        (3,268     (2,945

Short-term borrowings

     129        15        144        65        (31     34   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Interest expense

     688        (1,712     (1,024     388        (3,299     (2,911
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net interest income

   $ 32,309      $ (12,626   $ 19,683      $ 23,295      $ (18,822   $ 4,473   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

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

 

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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 for the years 2011 through 2013. The net interest margin in 2013 was 4.22%, a decrease of six basis points from 2012 which also decreased an additional 34 basis points from 2011. The decrease in our net interest margin in 2013 was largely the result of the extended period of historically low levels of short-term interest rates. The Federal funds rate remained at zero to 0.25% during 2011 to 2013. We have been able to somewhat mitigate the impact of low short-term interest rates by establishing minimum interest rates on certain of our loans, improving the pricing for loan risk, and reducing rates paid on interest bearing liabilities. We expect interest rates to remain at the current low levels until 2015 as announced by the Federal Reserve Board which will continue to place pressure on our interest margin.

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):

 

    2013     2012     2011  
    Average
Balance
    Income/
Expense
    Yield/
Rate
    Average
Balance
    Income/
Expense
    Yield/
Rate
    Average
Balance
    Income/
Expense
    Yield/
Rate
 

Assets

                 

Short-term investments (1)

  $ 81,822      $ 509        0.62   $ 134,588      $ 754        0.61   $ 181,068      $ 1,221        0.69

Taxable investment securities (2)

    1,052,453        25,505        2.42        1,144,763        31,318        2.74        1,102,356        37,721        3.42   

Tax-exempt investment securities (2)(3)

    911,472        44,143        4.84        762,754        39,049        5.12        572,895        33,975        5.93   

Loans (3)(4)

    2,431,872        122,935        5.06        1,909,890        103,312        5.41        1,715,266        99,955        5.83   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total earning assets

    4,477,619        193,092        4.31        3,951,995        174,433        4.41        3,571,585        172,872        4.84   

Cash and due from banks

    129,222            120,477            113,423       

Bank premises and equipment, net

    91,341            80,315            72,381       

Other assets

    49,084            47,891            51,870       

Goodwill and other intangible assets, net

    86,809            72,041            72,312       

Allowance for loan losses

    (34,815         (34,802         (33,244    
 

 

 

       

 

 

       

 

 

     

Total assets

  $ 4,799,260          $ 4,237,917          $ 3,848,327       
 

 

 

       

 

 

       

 

 

     

Liabilities and Shareholders’ Equity

                 

Interest-bearing deposits

  $ 2,513,674      $ 3,709        0.15   $ 2,255,239      $ 4,877        0.22   $ 2,165,750      $ 7,822        0.36

Short-term borrowings

    400,545        379        0.09        258,863        235        0.09        196,230        202        0.10   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total interest-bearing liabilities

    2,914,219        4,088        0.14        2,514,102        5,112        0.20        2,361,980        8,024        0.34   

Noninterest-bearing deposits

    1,266,135            1,132,862            973,588       

Other liabilities

    45,521            55,021            39,354       
 

 

 

       

 

 

       

 

 

     

Total liabilities

    4,225,875            3,701,985            3,374,922       

Shareholders’ equity

    573,385            535,932            473,405       
 

 

 

       

 

 

       

 

 

     

Total liabilities and shareholders’ equity

  $ 4,799,260          $ 4,237,917          $ 3,848,327       
 

 

 

       

 

 

       

 

 

     

Net interest income

    $ 189,004          $ 169,321          $ 164,848     
   

 

 

       

 

 

       

 

 

   

Rate Analysis:

                 

Interest income/earning assets

        4.31         4.41         4.84

Interest expense/earning assets

        0.09            0.13            0.22   
     

 

 

       

 

 

       

 

 

 

Net yield on earning assets

        4.22         4.28         4.62
     

 

 

       

 

 

       

 

 

 

 

(1) Short-term investments are comprised of Fed Funds sold, interest bearing deposits in banks and interest bearing time deposits in banks.

 

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(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) Nonaccrual loans are included in loans.

Noninterest Income. Noninterest income for 2013 was $62.05 million, an increase of $4.84 million, or 8.47%, as compared to 2012. Increases in certain categories of noninterest income included (1) ATM, interchange and credit card fees of $1.56 million principally as a result of increased use of debit cards, (2) trust fees of $1.85 million, (3) real estate mortgage operations of $1.26 million and (4) service charges on deposit accounts of $853 thousand. Under the Dodd-Frank Act, the Federal Reserve Board was authorized to establish rules regarding interchange fees charged for electronic debit transactions by payment card issuers. While the changes relate only to banks with assets greater than $10 billion, concern exists that the regulation will also impact our Company in the future. The increase in trust fees was primarily due to the growth in assets under management over the prior year as well as higher fees generated from oil and gas management. The fair value of our trust assets, which are not reflected in our consolidated balance sheets, totaled $3.36 billion at December 31, 2013 compared to $2.85 billion at December 31, 2012. The increases in income from real estate secondary market mortgage operations reflected a higher level of new home and home sale financing from additional resources devoted to expanding the Company’s mortgage loan operations although we experienced a decrease in such fees in the fourth quarter of 2013. The increase in service charges on deposit accounts was primarily due to our Orange acquisition and to an increase in the number of deposit accounts offset by changes in overdraft regulations. Beginning in the third quarter of 2010, a new rule issued by the Federal Reserve Board prohibits financial institutions from charging consumers fees for paying overdrafts on automated teller machine and debit card transactions, unless a consumer consents, or opts in, to the overdraft service for those types of transactions. Consumers must be provided a notice that explains the financial institution’s overdraft services, including the fees associated with the service, and the consumer’s choices. We continue to monitor the impact of these new regulations and other related developments on our service charge revenue.

These increases in noninterest income were offset by a decrease of $2.63 million in net gain on sale of available-for-sale securities when compared to amounts recorded in 2012.

Noninterest income for 2012 was $57.21 million, an increase of $5.77 million, or 11.22%, as compared to 2011. Increases in certain categories of noninterest income included (1) ATM, interchange and credit card fees of $1.60 million principally as a result of increased use of debit cards, (2) trust fees of $1.79 million, (3) real estate mortgage operations of $1.15 million and (4) the net gain on sale of available-for-sale securities of $2.28 million. The increase in trust fees was primarily due to the growth in assets under management over the prior year as well as higher fees generated from oil and gas management. The fair value of our trust assets, which are not reflected in our consolidated balance sheets, totaled $2.85 billion at December 31, 2012 compared to $2.43 billion at December 31, 2011. The increases in income from real estate mortgage operations reflected a higher level of refinancing activity due to the favorable interest rate environment and additional resources devoted to expanding the Company’s mortgage loan operations.

These increases in noninterest income were offset by a $996 thousand decrease in service charges on deposit accounts and a decrease of $690 thousand in net gains on sale of assets when compared to amounts recorded in 2011. The decrease in service charges on deposit accounts was primarily due to a reduction in customer use of overdraft services and changes in overdraft regulations. The reduction in gains on the sales of assets resulted from a $1.00 million gain recorded in 2011 relating to the sale of the former banking facilities in Cleburne and Southlake.

 

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Table 3—Noninterest Income (in thousands):

 

     2013     Increase
(Decrease)
    2012     Increase
(Decrease)
    2011  

Trust fees

   $ 16,317      $ 1,853      $ 14,464      $ 1,793      $ 12,671   

Service charges on deposit accounts

     17,546        853        16,693        (996     17,689   

ATM, interchange and credit card fees

     16,750        1,563        15,187        1,600        13,587   

Real estate mortgage operations

     6,349        1,255        5,094        1,151        3,943   

Net gain on sale of available-for-sale securities

     147        (2,625     2,772        2,280        492   

Net gain (loss) on sale of foreclosed assets

     (152     198        (350     965        (1,315

Other:

          

Check printing fees

     229        24        205        (4     209   

Safe deposit rental fees

     503        50        453        —          453   

Credit life and debt protection fees

     226        (3     229        (17     246   

Brokerage commissions

     697        519        178        (48     226   

Interest on loan recoveries

     468        151        317        (281     598   

Gain on sales of assets, net

     183        (24     207        (690     897   

Miscellaneous income

     2,789        1,029        1,760        18        1,742   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total other

     5,095        1,746        3,349        (1,022     4,371   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total Noninterest Income

   $ 62,052      $ 4,843      $ 57,209      $ 5,771      $ 51,438   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Noninterest Expense. Total noninterest expense for 2013 was $126.01 million, an increase of $16.96 million, or 15.56%, as compared to 2012. Noninterest expense for 2012 amounted to $109.05 million, an increase of $4.43 million, or 4.23%, as compared to 2011. An important measure in determining whether a banking company effectively manages noninterest expenses 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 2013 was 50.19% compared to 48.14% for 2012, and 48.37% for 2011. The primary reason for the increase in 2013 was costs related to acquisitions and conversion for our Orange acquisition.

Salaries and employee benefits for 2013 totaled $66.53 million, an increase of $8.26 million, or 14.18%, as compared to 2012. The principal causes of this increase were (1) additional salaries from our Orange acquisition, (2) additional employees to staff new branches, (3) an increase in profit sharing expense, and (4) an increase in medical claims.

All other categories of noninterest expense for 2013 totaled $59.48 million, an increase of $8.70 million, or 17.14%, as compared to 2012. The increase in noninterest expense was largely the result of increases in other miscellaneous expense of $3.55 million, net occupancy expense of $1.02 million, professional and service fees of $1.10 million and equipment expense of $883 thousand. The increases in other miscellaneous expense and professional and service fees were largely attributable to IT termination and conversion costs associated with our Orange acquisition. The increases in net occupancy and equipment costs were likewise primarily from increased costs from our Orange acquisition.

Salaries and employee benefits for 2012 totaled $58.27 million, an increase of $2.01 million, or 3.58%, as compared to 2011. The principal causes of this increase were additional employees to staff new branches, increases in salaries and related payroll taxes and pension expense. The increase in salaries and related payroll taxes were largely the result of annual merit increases.

All other categories of noninterest expense for 2012 totaled $50.78 million, an increase of $2.41 million, or 4.99%, as compared to 2011. The increase in noninterest expense was largely the result of increases in ATM, interchange and credit card expenses of $530 thousand, net occupancy expense of $214 thousand, equipment

 

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expense of $990 thousand, software amortization and expense of $808 thousand and legal expense of $164 thousand. The increase in ATM, interchange and credit card expenses was largely the result of increased use of debit cards discussed above. The increases in net occupancy and equipment expenses were the result of the Company’s investment in several new branches. The software expense and legal expense increase was due primarily to costs related to combining the databases of our eleven charters into one charter. Partially offsetting these increases were a reduction in FDIC insurance premiums of $426 thousand, other real estate expense reduction of $532 thousand and reductions in several other categories of noninterest expense. The decrease in FDIC insurance premiums resulted from changes in the insurance assessment base and rates under the Dodd-Frank Act. The decrease in other real estate expense is a result of less foreclosure activities and other real estate held.

Table 4—Noninterest Expense (in thousands):

 

     2013      Increase
(Decrease)
    2012      Increase
(Decrease)
    2011  

Salaries

   $ 49,866       $ 5,374      $ 44,492       $ 1,825      $ 42,667   

Medical

     4,826         1,396        3,430         (217     3,647   

Profit sharing

     5,686         975        4,711         23        4,688   

Pension

     556         (76     632         278        354   

401(k) match expense

     1,560         177        1,383         78        1,305   

Payroll taxes

     3,624         337        3,287         119        3,168   

Stock option expense

     411         77        334         (93     427   
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

 

Total salaries and employee benefits

     66,529         8,260        58,269         2,013        56,256   

Net occupancy expense

     8,095         1,019        7,076         214        6,862   

Equipment expense

     9,673         883        8,790         990        7,800   

FDIC insurance premiums

     2,418         198        2,220         (426     2,646   

ATM, interchange and credit card expenses

     5,660         212        5,448         530        4,918   

Professional and service fees

     4,143         1,099        3,044         (188     3,232   

Printing, stationery and supplies

     2,066         96        1,970         139        1,831   

Amortization of intangible assets

     197         48        149         (253     402   

Other:

            

Data processing fees

     249         (7     256         (241     497   

Postage

     1,534         131        1,403         22        1,381   

Advertising

     2,774         551        2,223         121        2,102   

Correspondent bank service charges

     915         59        856         52        804   

Telephone

     2,067         513        1,554         69        1,485   

Public relations and business development

     2,059         305        1,754         39        1,715   

Directors’ fees

     867         98        769         13        756   

Audit and accounting fees

     1,719         326        1,393         47        1,346   

Legal fees

     725         (231     956         164        792   

Regulatory exam fees

     825         (246     1,071         122        949   

Travel

     993         218        775         80        695   

Courier expense

     732         (34     766         108        658   

Operational and other losses

     1,353         237        1,116         52        1,064   

Other real estate

     525         12        513         (532     1,045   

Software amortization and expense

     1,832         (336     2,168         808        1,360   

Other miscellaneous expense

     8,062         3,552        4,510         482        4,028   
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

 

Total other

     27,231         5,148        22,083         1,406        20,677   
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

 

Total Noninterest Expense

   $ 126,012       $ 16,963      $ 109,049       $ 4,425      $ 104,624   
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

 

 

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Income Taxes. Income tax expense was $25.70 million for 2013 as compared to $25.14 million for 2012 and $23.82 million for 2011. Our effective tax rates on pretax income were 24.58%, 25.30%, and 25.84%, respectively, for the years 2013, 2012 and 2011. The effective tax rates differ from the statutory federal tax rate of 35.0% largely due to tax exempt interest income earned on certain investment securities and loans and the deductibility of dividends paid to our employee stock ownership plan.

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 new home construction and owner-occupied commercial real estate. The structure of loans in the real estate mortgage classification generally provides repricing intervals to minimize the interest rate risk inherent in long-term fixed rate loans. As of December 31, 2013, total loans held for investment were $2.68 billion, an increase of $607.12 million, as compared to December 31, 2012. As compared to year-end 2012, real estate loans increased $451.69 million, commercial loans increased $87.12 million, agricultural loans increased $7.62 million and consumer loans increased $60.69 million. Loans averaged $2.43 billion during 2013, an increase of $521.98 million over the 2012 average balances.

Table 5—Composition of Loans (in thousands):

 

     December 31,  
     2013      2012      2011      2010      2009  

Commercial

   $ 596,730       $ 509,609       $ 454,087       $ 442,377       $ 434,506   

Agricultural

     75,928         68,306         68,122         82,380         73,925   

Real estate

     1,678,514         1,226,823         1,041,396         962,366         826,123   

Consumer

     333,113         272,428         212,310         190,064         175,492   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total loans held-for-investment

   $ 2,684,285       $ 2,077,166       $ 1,775,915       $ 1,677,187       $ 1,510,046   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

As of December 31, 2013, our real estate loans represent approximately 62.53% of our loan portfolio and are comprised of (i) commercial real estate loans of 29.94%, generally owner occupied, (ii) 1-4 family residence loans of 46.14%, (iii) residential development and construction loans of 6.34%, which includes our custom and speculation home construction loans, (iv) commercial development and construction loans of 2.86% and (v) other of 14.72%.

Loans held for sale, consisting of secondary market mortgage loans, totaled $5.16 million and $11.46 million at December 31, 2013 and 2012, respectively, in which the carrying amounts approximate market.

Table 6—Maturity Distribution and Interest Sensitivity of Loans at December 31, 2013 (in thousands):

The following tables summarize maturity and repricing information for the commercial and agricultural and the real estate-construction portion of our loan portfolio as of December 31, 2013:

 

     One Year
or less
     After One
Year
Through
Five Years
     After Five
Years
     Total  

Commercial and agricultural

   $ 267,197       $ 225,970       $ 179,491       $ 672,658   

Real estate—construction

     70,883         29,917         83,192         183,992   

 

     Maturities
After One Year
 

Loans with fixed interest rates

   $ 395,858   

Loans with floating or adjustable interest rates

     122,712   

 

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Asset Quality. The loan portfolio of our bank subsidiary 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 collectibility of principal or interest under the original terms becomes doubtful. Nonaccrual, past due 90 days still accruing and restructured loans plus foreclosed assets, were $31.13 million at December 31, 2013, as compared to $25.46 million at December 31, 2012 and $29.54 million at December 31, 2011. As a percent of loans and foreclosed assets, these assets were 1.16% at December 31, 2013, as compared to 1.22% at December 31, 2012 and 1.64% at December 31, 2011. As a percent of total assets, these assets were 0.60% at December 31, 2013, as compared to 0.57% at December 31, 2012 and 0.72% at December 31, 2011. 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 December 31, 2013. The increase in dollar amount of nonperforming loans was primarily from our Orange acquisition.

Table 7—Nonaccrual, Past Due 90 Days Still Accruing and Restructured Loans and Foreclosed Assets (in thousands, except percentages):

 

     At December 31,  
     2013     2012     2011     2010     2009  

Nonaccrual loans*

   $ 27,926      $ 21,800      $ 19,975      $ 15,445      $ 18,540   

Loans still accruing and past due 90 days or more

     133        97        96        2,196        15   

Restructured loans**

     —          —          —          —          —     
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Nonperforming loans

     28,059        21,897        20,071        17,641        18,555   

Foreclosed assets

     3,069        3,565        9,464        8,309        3,533   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total nonperforming assets

   $ 31,128      $ 25,462      $ 29,535      $ 25,950      $ 22,088   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

As a % of loans and foreclosed assets

     1.16     1.22     1.64     1.53     1.46

As a % of total assets

     0.60        0.57        0.72        0.69        0.67   

 

* Includes $2.71 million of purchased credit impaired loans as of December 31, 2013. There were no purchased credit impaired loan balances in prior periods.
** Restructured loans whose interest collection, after considering economic and business conditions and collection efforts, is doubtful are included in non-accrual loans.

We record interest payments received on nonaccrual loans as reductions of principal. Prior to the loans being placed on nonaccrual, we recognized interest income on the December 31, 2013 impaired loans above of approximately $486 thousand during the year ended December 31, 2013. If interest on these impaired loans had been recognized on a full accrual basis during the year ended December 31, 2013, such income would have approximated $2.53 million.

See Note 3 to the Consolidated Financial Statements beginning on page F-16 for more information on these assets.

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 our accounting policies in Note 1 to the Consolidated Financial Statements beginning on page F-7. The continued provision for loan losses in 2013 reflects the growth in loans and levels of nonperforming assets. However the general stability of our balances in non-accrual loans and reductions in net charge-offs as a percentage of average loans enabled the Company to not significantly increase provisions in 2013 due to the overall loan growth. As a percent of average loans, net loan charge-offs were 0.15% during 2013, 0.15% during 2012 and 0.20% during 2011. The allowance for loan losses as a percent of loans was 1.26% as of December 31, 2013, as compared to 1.67% as of December 31, 2012. The decrease in the allowance for loan losses percentage is due primarily to the impact of loans acquired in the Orange acquisition, which were initially recorded at fair value with no allocated allowance for loan losses. Included in Tables 8 and 9 are further analysis of our allowance for loan losses.

 

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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. The current downturn in the economy or lower employment could result in increased levels of nonaccrual, past due 90 days still accruing and restructured loans and foreclosed assets, charge-offs, increased loan loss provisions and reductions in income. Additionally, as an integral part of their examination process, bank regulatory agencies periodically review the adequacy of our allowance for loan losses. The banking agencies could require additions to the loan loss allowance based on their judgment of information available to them at the time of their examinations of our bank subsidiary.

Table 8—Loan Loss Experience and Allowance for Loan Losses (in thousands, except percentages):

 

     2013     2012     2011     2010     2009  

Balance at January 1,

   $ 34,839      $ 34,315      $ 31,106      $ 27,612      $ 21,529   

Charge-offs:

          

Commercial

     1,283        499        640        2,598        1,010   

Agricultural

     100        53        95        113        178   

Real estate

     1,970        2,951        3,682        2,231        3,072   

Consumer

     1,268        852        907        1,505        1,950   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total charge-offs

     4,621        4,355        5,324        6,447        6,210   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Recoveries:

          

Commercial

     402        281        610        234        183   

Agricultural

     39        54        33        56        7   

Real estate

     239        639        874        238        122   

Consumer

     337        421        390        451        562   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total recoveries

     1,017        1,395        1,907        979        874   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net charge-offs

     3,604        2,960        3,417        5,468        5,336   

Transfer of off-balance sheet exposure to other liabilities

     (1,088     —          —          —          —     

Provision for loan losses

     3,753        3,484        6,626        8,962        11,419   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance at December 31,

   $ 33,900      $ 34,839      $ 34,315      $ 31,106      $ 27,612   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Loans at year-end

   $ 2,689,448      $ 2,088,623      $ 1,786,544      $ 1,690,346      $ 1,514,369   

Average loans

     2,431,872        1,909,890        1,715,266        1,543,537        1,494,876   

Net charge-offs/average loans

     0.15     0.15     0.20     0.35     0.36

Allowance for loan losses/year-end loans*

     1.26       1.67        1.92        1.84        1.82   

Allowance for loan losses/nonaccrual, past due 90 days still accruing and restructured loans

     120.82        159.10        171.00        176.33        148.81   

 

* Reflects the impact of loans acquired in the Orange Savings Bank, SSB acquisition, which were initially recorded at fair value with no allocated allowance for loan losses.

 

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Table 9—Allocation of Allowance for Loan Losses (in thousands):

 

     2013      2012      2011      2010      2009  
     Allocation
Amount
     Allocation
Amount
     Allocation
Amount
     Allocation
Amount
     Allocation
Amount
 

Commercial

   $ 6,440       $ 7,343       $ 9,664       $ 7,745       $ 8,840   

Agricultural

     383         1,541         1,482         2,299         1,489   

Real estate

     24,940         24,063         21,533         19,101         16,378   

Consumer

     2,137         1,892         1,636         1,961         905   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 33,900       $ 34,839       $ 34,315       $ 31,106       $ 27,612   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Percent of Loans in Each Category of Total Loans:

 

     2013     2012     2011     2010     2009  

Commercial

     22.23     24.53     26.37     26.17     28.73

Agricultural

     2.83        3.29        4.02        4.87        4.84   

Real estate

     62.53        59.06        57.66        57.71        54.84   

Consumer

     12.41        13.12        11.95        11.25        11.59   

Included in our loan portfolio are certain other loans not included in Table 7 that are deemed to be potential problem loans. Potential problem loans are those loans that are currently performing, but for which known information about trends, uncertainties or possible credit problems of the borrowers causes management to have serious doubts as to the ability of such borrowers to comply with present repayment terms, possibly resulting in the transfer of such loans to nonperforming status. These potential problem loans totaled $4.24 million as of December 31, 2013.

Interest-Bearing Deposits in Banks. The Company had interest-bearing deposits in banks of $57.42 million, $188.68 million, and $165.77 million at December 31, 2013, 2012, and 2011, respectively. At December 31, 2013, our interest-bearing deposits in banks included $25.22 million maintained at the Federal Reserve Bank of Dallas, $28.32 million invested in FDIC-insured certificates of deposit and $275 thousand on deposit with the Federal Home Loan Bank of Dallas. The average balance of interest-bearing deposits in banks was $69.17 million, $123.00 million and $176.57 million in 2013, 2012 and 2011, respectively. The average yield on interest-bearing deposits in banks was 0.67%, 0.61% and 0.69% in 2013, 2012 and 2011, respectively.

Available-for-Sale and Held-to-Maturity Securities. At December 31, 2013, securities with a fair value of $2.06 billion were classified as securities available-for-sale and securities with an amortized cost of $684 thousand were classified as securities held-to-maturity. As compared to December 31, 2012, the available-for-sale portfolio at December 31, 2013, reflected (1) a decrease of $6.09 million in U. S. Treasury securities; (2) a decrease of $85.39 million in obligations of U.S. government sponsored-enterprises and agencies; (3) an increase of $147.58 million in obligations of states and political subdivisions; (4) a decrease of $14.15 million in corporate bonds and other; and (5) an increase of $196.74 million in mortgage-backed securities. As compared to December 31, 2011, the available-for-sale portfolio at December 31, 2012, reflected (1) a decrease of $9.26 million in U. S. Treasury securities; (2) a decrease of $37.86 million in obligations of U.S. government sponsored-enterprises and agencies; (3) an increase of $139.02 million in obligations of states and political subdivisions; (4) a decrease of $8.28 million in corporate bonds and other; and (5) a decrease of $105.97 million in mortgage-backed securities. Securities-available-for-sale included fair value adjustments of $22.60 million, $91.80 million and $83.95 million at December 31, 2013, 2012, and 2011, respectively. We did not hold any collateralized mortgage obligations or structured notes as of December 31, 2013 that we consider to be high risk. Our mortgage related securities are backed by GNMA, FNMA or FHLMC or are collateralized by securities backed by these agencies.

 

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See Table 10 and Note 2 to the Consolidated Financial Statements for additional disclosures relating to the maturities and fair values of the investment portfolio at December 31, 2013 and 2012.

Table 10—Maturities and Yields of Available-for-Sale Held at December 31, 2013 (in thousands, except percentages):

 

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

Available-for-Sale:

  Amount     Yield     Amount     Yield     Amount     Yield     Amount     Yield     Amount     Yield  

Obligations of U.S. government sponsored-enterprises and agencies

  $ 32,473        1.71   $ 105,615        1.29   $ —          —     $ —          —     $ 138,088        1.39

Obligations of states and political subdivisions

    33,227        4.27        361,838        4.65        559,376        5.44        36,828        5.81        991,269        5.13   

Corporate bonds and other securities

    12,046        4.35        96,994        2.48        —          —          —          —          109,040        2.69   

Mortgage-backed securities

    7,040        4.69        492,025        2.83        319,873        2.55        388        2.33        819,326        2.74   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total

  $ 84,786        3.33   $ 1,056,472        3.27   $ 879,249        4.39   $ 37,216        5.77   $ 2,057,723        3.80
 

 

 

     

 

 

     

 

 

     

 

 

     

 

 

   

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

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

As of December 31, 2013, the investment portfolio had an overall tax equivalent yield of 3.77%, a weighted average life of 5.01 years and modified duration of 4.38 years.

Deposits. Deposits held by our subsidiary bank represent our primary source of funding. Total deposits were $4.14 billion as of December 31, 2013, as compared to $3.63 billion as of December 31, 2012 and $3.33 billion as of December 31, 2011. Table 11 provides a breakdown of average deposits and rates paid over the past three years and the remaining maturity of time deposits of $100,000 or more:

Table 11—Composition of Average Deposits and Remaining Maturity of Time Deposits of $100,000 or More (in thousands, except percentages):

 

    2013     2012     2011  
    Average
Balance
    Average
Rate
    Average
Balance
    Average
Rate
    Average
Balance
    Average
Rate
 

Noninterest-bearing deposits

  $ 1,266,135        —        $ 1,132,862        —        $ 973,588        —     

Interest-bearing deposits

           

Interest-bearing checking

    1,094,897        0.11     899,204        0.11     801,816        0.13

Savings and money market accounts

    754,493        0.07        648,815        0.11        577,519        0.16   

Time deposits under $100,000

    291,026        0.25        299,902        0.42        352,865        0.70   

Time deposits of $100,000 or more

    373,258        0.34        407,318        0.47        433,550        0.78   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total interest-bearing deposits

    2,513,674        0.15     2,255,239        0.22     2,165,750        0.36
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total average deposits

  $ 3,779,809        $ 3,388,101        $ 3,139,338     
 

 

 

     

 

 

     

 

 

   

 

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     As of December 31,
2013
 

Three months or less

   $ 135,788   

Over three through six months

     107,143   

Over six through twelve months

     104,846   

Over twelve months

     50,244   
  

 

 

 

Total time deposits of $100,000 or more

   $ 398,021   
  

 

 

 

Short-Term Borrowings. Included in short-term borrowings were federal funds purchased, securities sold under repurchase agreements and advances from the Federal Home Loan Bank of Dallas (FHLB) of $463.89 million, $259.70 million and $207.76 million at December 31, 2013, 2012 and 2011, respectively. Securities sold under repurchase agreements are generally with significant customers of the Company that require short-term liquidity for their funds which we pledge certain securities that have a fair value equal to at least the amount of the short-term borrowing. The average balances of federal funds purchased, securities sold under repurchase agreements and advances from the FHLB were $400.55 million, $247.98 million and $196.23 million in 2013, 2012 and 2011, respectively. The average rates paid on federal funds purchased and securities sold under repurchase agreements were 0.09%, 0.09% and 0.10% in 2013, 2012 and 2011, respectively. The weighted average interest rate paid on federal funds purchased, securities sold under repurchase agreements and advances from the FHLB was 0.10%, 0.05% and 0.10% at December 31, 2013, 2012 and 2011, respectively. The highest amount of federal funds purchased, securities sold under repurchase agreements and advances from the FHLB at any month end during 2013, 2012 and 2011 was $532.39 million, $263.35 million and $215.78 million, respectively.

Capital Resources

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

Total shareholders’ equity was $587.65 million, or 11.25% of total assets, at December 31, 2013, as compared to $556.96 million, or 12.37% of total assets, at December 31, 2012. During 2013, total shareholders’ equity averaged $573.39 million, or 11.95% of average assets, as compared to $535.93 million, or 12.62% of average assets, during 2012.

Banking regulators measure capital adequacy by means of the risk-based capital ratios and leverage ratio. The risk-based capital rules provide for the weighting of assets and off-balance-sheet commitments and contingencies according to prescribed risk categories ranging from 0% to 100%. Regulatory capital is then divided by risk-weighted assets to determine the risk-adjusted capital ratios. The leverage ratio is computed by dividing shareholders’ equity less intangible assets by quarter-to-date average assets less intangible assets. Regulatory minimums for total risk-based, Tier 1 risked-based and leverage ratios are 8.00%, 4.00% and 3.00%, respectively. As of December 31, 2013, our total risk-based, Tier 1 risked-based and leverage capital ratios on a consolidated basis were 16.92%, 15.82% and 9.84%, respectively, as compared to total risk-based, Tier 1 risked-based and leverage capital ratios of 18.68%, 17.43% and 10.60% as of December 31, 2012. We believe by all measurements our capital ratios remain well above regulatory minimums.

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

 

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Our subsidiary bank has an asset liability management committee that monitors interest rate risk and compliance with investment policies. The subsidiary bank utilizes an earnings simulation model as the primary quantitative tool in measuring the amount of interest rate risk associated with changing market rates. The model quantifies the effects of various interest rate scenarios on projected net interest income and net income over the next 12 months. The model measures the impact on net interest income relative to a base case scenario of hypothetical fluctuations in interest rates over the next 12 months. These simulations incorporate assumptions regarding balance sheet growth and mix, pricing and the repricing and maturity characteristics of the existing and projected balance sheet.

As of December 31, 2013, the model simulations projected that 100 and 200 basis point increases in interest rates would result in negative variances in net interest income of 0.54% and 1.38%, respectively, relative to the base case over the next 12 months, while decreases in interest rates of 100 basis points would result in a negative variance in a net interest income of 4.14% relative to the base case over the next 12 months. The likelihood of a decrease in interest rates beyond 50 basis points as of December 31, 2013 is considered remote given current interest rate levels. Such a decrease would be largely attributable reinvesting proceeds from investment security maturities and pay downs at current market interest rates. These are good faith estimates and assume that the composition of our interest sensitive assets and liabilities existing at each year-end will remain constant over the relevant twelve month measurement period and that changes in market interest rates are instantaneous and sustained across the yield curve regardless of duration of pricing characteristics of specific assets or liabilities. Also, this analysis does not contemplate any actions that we might undertake in response to changes in market interest rates. We believe these estimates are not necessarily indicative of what actually could occur in the event of immediate interest rate increases or decreases of this magnitude. As interest-bearing assets and liabilities reprice in different time frames and proportions to market interest rate movements, various assumptions must be made based on historical relationships of these variables in reaching any conclusion. Since these correlations are based on competitive and market conditions, we anticipate that our future results will likely be different from the foregoing estimates, and such differences could be material.

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

Liquidity

Liquidity is our ability to meet cash demands as they arise. Such needs can develop from loan demand, deposit withdrawals or acquisition opportunities. Potential obligations resulting from the issuance of standby letters of credit and commitments to fund future borrowings to our loan customers are other factors affecting our liquidity needs. Many of these obligations and commitments are expected to expire without being drawn upon; therefore the total commitment amounts do not necessarily represent future cash requirements affecting our liquidity position. The potential need for liquidity arising from these types of financial instruments is represented by the contractual notional amount of the instrument, as detailed in Tables 12 and 13. Asset liquidity is provided by cash and assets which are readily marketable or which will mature in the near future. Liquid assets include cash, federal funds sold, and short-term investments in time deposits in banks. Liquidity is also provided by access to funding sources, which include core depositors and correspondent banks that maintain accounts with and sell federal funds to our subsidiary bank. Other sources of funds include our ability to borrow from short-term sources, such as purchasing federal funds from correspondent banks and sales of securities under agreements to repurchase, which amounted to $463.89 million at December 31, 2013, and an unfunded $25.00 million revolving line of credit established with Frost Bank, a nonaffiliated bank, which matures on June 30, 2015 (see next paragraph). Our subsidiary bank also has federal funds purchased lines of credit with two non-affiliated banks totaling $100.00 million. At December 31, 2013, there were no amounts drawn on these lines of credit. Our subsidiary bank also has available a line of credit with the FHLB totaling $878.89 million at December 31, 2013, secured by portions of our portfolio and certain investment securities. At December 31, 2013, $191.12 million in advances and $50.10 million in letters of credit issued by the FHLB were

 

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outstanding under these lines of credit. These letters of credit were pledged as collateral for public funds held by our subsidiary bank.

The Company renewed its loan agreement, effective June 30, 2013, with Frost Bank. Under the loan agreement, as renewed and amended, the Company is permitted to draw up to $25.0 million on a revolving line of credit. Prior to June 30, 2015, interest is paid quarterly at the Wall Street Journal Prime Rate and the line of credit matures June 30, 2015. If a balance exists at June 30, 2015, the principal balance converts to a term facility payable quarterly over five years and interest is paid quarterly at our election at the Wall Street Journal Prime Rate plus 50 basis points or LIBOR plus 250 basis points. The line of credit is unsecured. Among other provisions in the credit agreement, we must satisfy certain financial covenants during the term of the loan agreement, including, without limitation, covenants that require us to maintain certain capital, tangible net worth, loan loss reserve, non-performing asset and cash flow coverage ratio. In addition, the credit agreement contains certain operational covenants, which among others, restricts the payment of dividends above 55% of consolidated net income, limits the incurrence of debt (excluding any amounts acquired in an acquisition) and prohibits the disposal of assets except in the ordinary course of business. Since 1995, we have historically declared dividends as a percentage of consolidated net income in a range of 37% (low) in 1995 to 53% (high) in 2003 and 2006. The Company was in compliance with the financial and operational covenants at December 31, 2013. There was no outstanding balance under the line of credit as of December 31, 2013 or 2012.

In addition, we anticipate that any future acquisition of financial institutions, expansion of branch locations or offering of new products could also place a demand on our cash resources. Available cash and cash equivalents at our parent company, which totaled $64.59 million at December 31, 2013, available dividends from subsidiaries which totaled $57.46 million at December 31, 2013, utilization of available lines of credit, and future debt or equity offerings are expected to be the source of funding for these potential acquisitions or expansions. Existing cash resources at our subsidiary bank may also be used as a source of funding for these potential acquisitions or expansions.

Given the strong core deposit base and relatively low loan to deposit ratios maintained at our subsidiary bank, we consider our current liquidity position to be adequate to meet our short- and long-term liquidity needs.

Table 12—Contractual Obligations as of December 31, 2013 (in thousands):

 

     Payment Due by Period  
     Total
Amounts
     Less than
1 year
     2 - 3
years
     4 - 5
years
     Over 5
years
 

Deposits with stated maturity dates

   $ 686,626       $ 594,297       $ 66,099       $ 24,767       $ 1,463   

Pension obligation

     16,355         1,449         2,936         3,257         8,713   

Operating leases

     2,302         807         1,157         338         —     

Outsourcing service contracts

     1,017         1,017         —           —           —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total Contractual Obligations

   $ 706,300       $ 597,570       $ 70,192       $ 28,362       $ 10,176   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Amounts above for deposits do not include related accrued interest.

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

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

 

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

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

Table 13—Commitments as of December 31, 2013 (in thousands):

 

     Total Notional
Amounts
Committed
     Less than
1 year
     2 - 3
years
     4 - 5
years
     Over 5
years
 

Unfunded lines of credit

   $ 453,568       $ 431,835       $ 5,123       $ 5,809       $ 10,801   

Unfunded commitments to extend credit

     118,192         57,356         12,326         2,098         46,412   

Standby letters of credit

     32,945         31,081         1,864         —           —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total Commercial Commitments

   $ 604,705       $ 520,272       $ 19,313       $ 7,907       $ 57,213   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

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

Parent Company Funding. Our ability to fund various operating expenses, dividends, and cash acquisitions is generally dependent on our own earnings (without giving effect to our subsidiaries), cash reserves and funds derived from our subsidiary bank. These funds historically have been produced by intercompany dividends and management fees that are limited to reimbursement of actual expenses. We anticipate that our recurring cash sources will continue to include dividends and management fees from our subsidiary bank. At December 31, 2013, approximately $57.46 million was available for the payment of intercompany dividends by the subsidiaries without the prior approval of regulatory agencies. Our subsidiaries paid aggregate dividends of $64.20 million in 2013 and $58.40 million in 2012.

Dividends. Our long-term dividend policy is to pay cash dividends to our shareholders of approximately 40% of annual net earnings while maintaining adequate capital to support growth. We are also restricted by a loan covenant within our line of credit agreement with Frost Bank to dividend no greater than 55% of net income, as defined in such loan agreement. The cash dividend payout ratios have amounted to 41.62%, 41.99% and 43.57% of net earnings, respectively, in 2013, 2012 and 2011. Given our current capital position and projected earnings and asset growth rates, we do not anticipate any significant change in our current dividend policy.

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

 

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

 

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Management considers interest rate risk to be a significant market risk for the Company. See “Item 7—Management’s Discussion and Analysis of Financial Condition and Results of Operations—Capital Resources—Interest Rate Risk” for disclosure regarding this market risk.

 

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

Our consolidated financial statements begin on page F-1.

Quarterly Results of Operations (in thousands, except per share and common stock data):

The following tables set forth certain unaudited historical quarterly financial data for each of the eight consecutive quarters in fiscal 2013 and 2012. This information is derived from unaudited consolidated financial statements that include, in our opinion, all adjustments (consisting of normal recurring adjustments) necessary for a fair presentation when read in conjunction with our consolidated financial statements and notes thereto included elsewhere in this Form 10-K.

 

     2013  
     4th      3rd     2nd      1st  
     (dollars in thousands, except per share
amounts)
 

Summary Income Statement Information:

          

Interest income

   $ 47,756       $ 46,655      $ 42,446       $ 39,575   

Interest expense

     1,066         1,164        946         904   
  

 

 

    

 

 

   

 

 

    

 

 

 

Net interest income

     46,690         45,491        41,500         38,671   

Provision for loan losses

     1,171         1,349        832         401   
  

 

 

    

 

 

   

 

 

    

 

 

 

Net interest income after provision for loan losses

     45,519         44,142        40,668         38,270   

Noninterest income

     15,792         17,183        15,120         13,738   

Net gain (loss) on securities transactions

     —           (108     33         222   

Noninterest expense

     33,096         35,534        29,911         27,471   
  

 

 

    

 

 

   

 

 

    

 

 

 

Earnings before income taxes

     28,215         25,683        25,910         24,759   

Income tax expense

     6,977         6,121        6,420         6,182   
  

 

 

    

 

 

   

 

 

    

 

 

 

Net earnings

   $ 21,238       $ 19,562      $ 19,490       $ 18,577   
  

 

 

    

 

 

   

 

 

    

 

 

 

Per Share Data:

          

Earnings per share, basic

   $ 0.66       $ 0.61      $ 0.62       $ 0.59   

Earnings per share, assuming dilution

     0.66         0.61        0.61         0.59   

Cash dividends declared

     0.26         0.26        0.26         0.25   

Book value at period-end

     18.37         17.77        18.01         17.90   

Common stock sales price:

          

High

   $ 67.52       $ 63.99      $ 56.90       $ 49.00   

Low

     56.51         55.68        45.92         39.86   

Close

     66.11         58.85        55.66         48.60   

 

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     2012  
     4th      3rd      2nd      1st  

Summary Income Statement Information:

           

Interest income

   $ 39,801       $ 40,287       $ 39,911       $ 39,797   

Interest expense

     1,049         1,168         1,355         1,540   
  

 

 

    

 

 

    

 

 

    

 

 

 

Net interest income

     38,752         39,119         38,556         38,257   

Provision for loan losses

     642         787         759         1,296   
  

 

 

    

 

 

    

 

 

    

 

 

 

Net interest income after provision for loan losses

     38,110         38,332         37,797         36,961   

Noninterest income

     14,383         14,020         13,082         12,952   

Net gain on securities transactions

     565         1,479         382         346   

Noninterest expense

     28,633         27,203         26,745         26,468   
  

 

 

    

 

 

    

 

 

    

 

 

 

Earnings before income taxes

     24,425         26,628         24,516         23,791   

Income tax expense

     6,107         6,828         6,165         6,035   
  

 

 

    

 

 

    

 

 

    

 

 

 

Net earnings

   $ 18,318       $ 19,800       $ 18,351       $ 17,756   
  

 

 

    

 

 

    

 

 

    

 

 

 

Per Share Data:

           

Earnings per share, basic

   $ 0.58       $ 0.63       $ 0.58       $ 0.56   

Earnings per share, assuming dilution

     0.58         0.63         0.58         0.56   

Cash dividends declared

     0.25         0.25         0.25         0.24   

Book value at period-end

     17.68         17.46         16.97         16.42   

Common stock sales price:

           

High

   $ 41.45       $ 37.00       $ 36.18       $ 37.25   

Low

     34.66         33.49         30.50         33.07   

Close

     39.01         36.03         34.56         35.21   

 

ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE

None.

 

ITEM 9A. CONTROLS AND PROCEDURES

As of December 31, 2013, we carried out an evaluation, under the supervision and with the participation of our management, including our principal executive officer and principal financial officer, of the effectiveness of the design and operation of our disclosure controls and procedures pursuant to Securities Exchange Act Rule 15d-15. Our management, including the principal executive officer and principal financial officer, does not expect that our disclosure controls and procedures will prevent all errors and all fraud.

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

 

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have concluded, based on our evaluation of our disclosure controls and procedures, that our disclosure controls and procedures under Rule 13a-14(c) and Rule 15d-14(c) of the Securities Exchange Act of 1934 are effective at the reasonable assurance level as of December 31, 2013.

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

 

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MANAGEMENT’S REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING

The management of First Financial Bankshares, Inc. and subsidiaries is responsible for establishing and maintaining adequate internal control over financial reporting. First Financial Bankshares, Inc. and subsidiaries’ internal control system was designed to provide reasonable assurance to the Company’s management and board of directors regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles.

All internal control systems, no matter how well designed, have inherent limitations. Therefore, even those systems determined to be effective can provide only reasonable assurance with respect to financial statement preparation and presentation.

First Financial Bankshares, Inc. and subsidiaries’ management assessed the effectiveness of the Company’s internal control over financial reporting as of December 31, 2013. In making this assessment, it used the criteria for effective internal control over financial reporting set forth by the Committee of Sponsoring Organizations of the Treadway Commission (1992 Framework) (COSO) in Internal Control—Integrated Framework. Based on our assessment we believe that, as of December 31, 2013, the Company’s internal control over financial reporting, as such term is defined in Exchange Act Rule 13a-15(f), is effective based on those criteria.

First Financial Bankshares, Inc. and subsidiaries’ independent auditors have issued an audit report, dated February 21, 2014, on the effectiveness of the Company’s internal control over financial reporting as of December 31, 2013.

 

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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and Shareholders of

First Financial Bankshares, Inc.

We have audited First Financial Bankshares, Inc. and subsidiaries’ internal control over financial reporting as of December 31, 2013, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (1992 Framework) (the COSO criteria). First Financial Bankshares, Inc. and subsidiaries’ management is responsible for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting included in the accompanying Management’s Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the company’s internal control over financial reporting based on our audit.

We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.

A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

In our opinion, First Financial Bankshares, Inc. and subsidiaries maintained, in all material respects, effective internal control over financial reporting as of December 31, 2013, based on the COSO criteria.

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the 2013 consolidated financial statements of First Financial Bankshares, Inc. and subsidiaries and our report dated February 21, 2014 expressed an unqualified opinion thereon.

/s/ Ernst & Young LLP

Dallas, Texas

February 21, 2014

 

ITEM 9B. OTHER INFORMATION

None.

 

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PART III

 

ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE

The information required by Item 10 is hereby incorporated by reference from our proxy statement for our 2014 annual meeting of shareholders.

 

ITEM 11. EXECUTIVE COMPENSATION

The information required by Item 11 is hereby incorporated by reference from our proxy statement for our 2014 annual meeting of shareholders.

 

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS

The information required by Item 12 related to security ownership of certain beneficial owners and management is hereby incorporated by reference from our proxy statement for our 2014 annual meeting of shareholders. The following chart gives aggregate information under our equity compensation plans as of December 31, 2013.

 

     Number of Securities
To be Issued Upon
Exercise of
Outstanding Options,
Warrants and Rights
     Weighted Average
Exercise Price of
Outstanding Options,
Warrants and Rights
     Number of Securities
Remaining Available
For Future Issuance
Under Equity
Compensation Plans
(Excluding Securities
Reflected in

Far Left Column)
 

Equity compensation plans approved by security holders

     532,032       $ 41.97         1,303,500   

Equity compensation plans not approved by security holders

     —           —           —     
  

 

 

    

 

 

    

 

 

 

Total

     532,032       $ 41.97         1,303,500   
  

 

 

    

 

 

    

 

 

 

The remainder of the information required by Item 12 is incorporated by reference from our proxy statement for our 2014 annual meeting of shareholders.

 

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE

The information required by Item 13 is hereby incorporated by reference from our proxy statement for our 2014 annual meeting of shareholders.

 

ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES

The information required by Item 14 is hereby incorporated by reference from our proxy statement for our 2014 annual meeting of shareholders.

 

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PART IV

 

ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES

 

(a) The following documents are filed as part of this report:

 

  (1) Financial Statements -

Report of Independent Registered Public Accounting Firm

Consolidated Balance Sheets as of December 31, 2013 and 2012

Consolidated Statements of Earnings for the years ended December 31, 2013, 2012 and 2011

Consolidated Statements of Comprehensive Earnings for the years ended December 31, 2013, 2012 and 2011

Consolidated Statements of Shareholders’ Equity for the years ended December 31, 2013, 2012 and 2011

Consolidated Statements of Cash Flows for the years ended December 31, 2013, 2012 and 2011

Notes to the Consolidated Financial Statements

 

  (2) Financial Statement Schedules -

These schedules have been omitted because they are not required, are not applicable or have been included in our consolidated financial statements.

 

  (3) Exhibits -

The information required by this Item 15(a)(3) is set forth in the Exhibit Index immediately following our signature pages. The exhibits listed herein will be furnished upon written request to J. Bruce Hildebrand, Executive Vice President, First Financial Bankshares, Inc., 400 Pine Street, Abilene, Texas 79601, and payment of a reasonable fee that will be limited to our reasonable expense in furnishing such exhibits.

 

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SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

 

    FIRST FINANCIAL BANKSHARES, INC.

Date: February 21, 2014

   

By:

 

 

/s/ F. SCOTT DUESER

      F. SCOTT DUESER
      Chairman of the Board, Director, President and
      Chief Executive Officer
      (Principal Executive Officer)

The undersigned directors and officers of First Financial Bankshares, Inc. hereby constitute and appoint J. Bruce Hildebrand, with full power to act and with full power of substitution and resubstitution, our true and lawful attorney-in-fact with full power to execute in our name and behalf in the capacities indicated below any and all amendments to this report and to file the same, with all exhibits thereto and other documents in connection therewith with the Securities and Exchange Commission and hereby ratify and confirm all that such attorney-in-fact or his substitute shall lawfully do or cause to be done by virtue hereof.

Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.

 

Name

  

Title

 

Date

/s/ F. SCOTT DUESER

F. Scott Dueser

  

Chairman of the Board, Director,
President, and Chief Executive Officer
(Principal Executive Officer)

  February 21, 2014

/s/ J. BRUCE HILDEBRAND

J. Bruce Hildebrand

  

Executive Vice President and Chief
Financial Officer
(Principal Financial Officer and
Principal Accounting Officer)

  February 21, 2014

/s/ STEVEN L. BEAL

Steven L. Beal

  

Director

  February 21, 2014

/s/ TUCKER S. BRIDWELL

Tucker S. Bridwell

  

Director

  February 21, 2014

/s/ JOSEPH E. CANON

Joseph E. Canon

  

Director

  February 21, 2014

/s/ DAVID COPELAND

David Copeland

  

Director

  February 21, 2014

/s/ MURRAY EDWARDS

Murray Edwards

  

Director

  February 21, 2014

/s/ RONALD GIDDIENS

Ronald Giddiens

  

Director

  February 21, 2014

 

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Name

  

Title

 

Date

/s/ TIM LANCASTER

Tim Lancaster

  

Director

  February 21, 2014

/s/ KADE L. MATTHEWS

Kade L. Matthews

  

Director

  February 21, 2014

/s/ JOHNNY TROTTER

Johnny Trotter

  

Director

  February 21, 2014

 

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Exhibits Index

The following exhibits are filed as part of this report:

 

    2.1       Agreement and Plan of Merger between First Financial Bankshares, Inc., First Financial Bank, N.A., OSB Financial Services, Inc. and Orange Savings Bank, SSB, dated as of February 20, 2013 (Schedules have been omitted pursuant to Item 601(b)(2) of Regulation S-K) (incorporated by reference from Exhibit 2.1 to Registrant’s Form 8-K filed February 26, 2013).
    3.1       Amended and Restated Certificate of Formation (incorporated by reference from Exhibit 3.1 of the Registrant’s Form 8-K filed April 25, 2012).
    3.2       Amended and Restated Bylaws of the Registrant (incorporated by reference from Exhibit 3.2 of the Registrant’s Form 8-K filed January 24, 2012).
    4.1       Specimen certificate of First Financial Common Stock (incorporated by reference from Exhibit 3 of the Registrant’s Amendment No. 1 to Form 8-A filed on Form 8-A/A No. 1 on January 7, 1994).
  10.1       Executive Recognition Agreement (incorporated by reference from Exhibit 10.1 of the Registrant’s Form 8-K Report filed June 29, 2012).
  10.2       2002 Incentive Stock Option Plan (incorporated by reference from Exhibit 10.3 of the Registrant’s Form 10-Q filed May 4, 2010).
  10.3       2012 Incentive Stock Option Plan (incorporated by reference from Appendix A of the Registrant’s Definitive Proxy Statement Pursuant to Section 14(a) of the Securities Exchange Act of 1934 filed March 1, 2012).
  10.4       Loan Agreement dated June 30, 2013, between First Financial Bankshares, Inc. and Frost Bank (incorporated by reference from Exhibit 10.1 of the Registrant’s Form 8-K filed July 1, 2013).
  21.1       Subsidiaries of the Registrant.*
  23.1       Consent of Ernst & Young LLP.*
  24.1       Power of Attorney (included on signature page of this Form 10-K).*
  31.1       Rule 13a-14(a) / 15(d)-14(a) Certification of Chief Executive Officer of First Financial Bankshares, Inc.*
  31.2       Rule 13a-14(a) / 15(d)-14(a) Certification of Chief Financial Officer of First Financial Bankshares, Inc.*
  32.1       Section 1350 Certification of Chief Executive Officer of First Financial Bankshares, Inc.*
  32.2       Section 1350 Certification of Chief Financial Officer of First Financial Bankshares, Inc.*
101.INS       XBRL Instance Document.*
101.SCH       XBRL Taxonomy Extension Schema Document.*
101.CAL       XBRL Taxonomy Extension Calculation Linkbase Document.*
101.DEF       XBRL Taxonomy Extension Definition Linkbase Document.*
101.LAB       XBRL Taxonomy Extension Label Linkbase Document.*
101.PRE       XBRL Taxonomy Extension Presentation Linkbase Document.*

 

* Filed herewith

 

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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and Shareholders of

First Financial Bankshares, Inc.

We have audited the accompanying consolidated balance sheets of First Financial Bankshares, Inc. (a Texas corporation) and subsidiaries as of December 31, 2013 and 2012, and the related consolidated statements of earnings, comprehensive earnings, shareholders’ equity, and cash flows for each of the three years in the period ended December 31, 2013. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of First Financial Bankshares, Inc. and subsidiaries at December 31, 2013 and 2012, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 2013, in conformity with U. S. generally accepted accounting principles.

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), First Financial Bankshares, Inc.’s internal control over financial reporting as of December 31, 2013, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (1992 Framework) and our report dated February 21, 2014, expressed an unqualified opinion thereon.

/s/ Ernst & Young LLP

Dallas, Texas

February 21, 2014

 

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FIRST FINANCIAL BANKSHARES, INC. AND SUBSIDIARIES

Consolidated Balance Sheets

December 31, 2013 and 2012

(Dollars in thousands, except share and per share amounts)

 

     2013     2012  
ASSETS     

CASH AND DUE FROM BANKS

   $ 183,084      $ 207,018   

FEDERAL FUNDS SOLD

     3,430        14,045   

INTEREST-BEARING DEPOSITS IN BANKS

     25,498        139,676   
  

 

 

   

 

 

 

Total cash and cash equivalents

     212,012        360,739   

INTEREST-BEARING TIME DEPOSITS IN BANKS

     31,917        49,005   

SECURITIES AVAILABLE-FOR-SALE, at fair value

     2,057,723        1,819,035   

SECURITIES HELD-TO-MATURITY (fair value of $694 and $1,080 at December 31, 2013 and 2012, respectively)

     684        1,061   

LOANS:

    

Held for investment

     2,684,285        2,077,166   

Less—allowance for loan losses

     (33,900     (34,839
  

 

 

   

 

 

 

Net loans held for investment

     2,650,385        2,042,327   

Held for sale

     5,163        11,457   
  

 

 

   

 

 

 

Net loans

     2,655,548        2,053,784   

BANK PREMISES AND EQUIPMENT, net

     95,505        84,122   

INTANGIBLE ASSETS

     97,485        71,973   

OTHER ASSETS

     71,334        62,293   
  

 

 

   

 

 

 

Total assets

   $ 5,222,208      $ 4,502,012   
  

 

 

   

 

 

 
LIABILITIES AND SHAREHOLDERS’ EQUITY     

NONINTEREST-BEARING DEPOSITS

   $ 1,362,184      $ 1,311,708   

INTEREST-BEARING DEPOSITS

     2,772,891        2,320,876   
  

 

 

   

 

 

 

Total deposits

     4,135,075        3,632,584   

DIVIDENDS PAYABLE

     8,318        —     

SHORT-TERM BORROWINGS

     463,888        259,697   

OTHER LIABILITIES

     27,280        52,768   
  

 

 

   

 

 

 

Total liabilities

     4,634,561        3,945,049   
  

 

 

   

 

 

 

COMMITMENTS AND CONTINGENCIES

    

SHAREHOLDERS’ EQUITY:

    

Common stock, $0.01 par value; authorized 80,000,000 shares; 31,992,497 and 31,496,881 issued at December 31, 2013 and 2012, respectively

     320        315   

Capital surplus

     302,991        277,412   

Retained earnings

     273,972        227,927   

Treasury stock (shares at cost: 269,467 and 266,845 at

    

December 31, 2013 and 2012, respectively)

     (5,490     (5,007

Deferred Compensation

     5,490        5,007   

Accumulated other comprehensive earnings

     10,364        51,309   
  

 

 

   

 

 

 

Total shareholders’ equity

     587,647        556,963   
  

 

 

   

 

 

 

Total liabilities and shareholders’ equity

   $ 5,222,208      $ 4,502,012   
  

 

 

   

 

 

 

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

 

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FIRST FINANCIAL BANKSHARES, INC. AND SUBSIDIARIES

Consolidated Statements of Earnings

Years Ended December 31, 2013, 2012 and 2011

(Dollars in thousands, except per share amounts)

 

     2013     2012     2011  

INTEREST INCOME:

      

Interest and fees on loans

   $ 121,512      $ 102,172      $ 98,767   

Interest on investment securities:

      

Taxable

     25,505        31,318        37,721   

Exempt from federal income tax

     28,843        25,552        22,312   

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

     509        754        1,221   
  

 

 

   

 

 

   

 

 

 

Total interest income

     176,369        159,796        160,021   
  

 

 

   

 

 

   

 

 

 

INTEREST EXPENSE:

      

Interest on deposits

     3,709        4,877        7,822   

Other

     379        235        202   
  

 

 

   

 

 

   

 

 

 

Total interest expense

     4,088        5,112        8,024   
  

 

 

   

 

 

   

 

 

 

Net interest income

     172,281        154,684        151,997   

PROVISION FOR LOAN LOSSES

     3,753        3,484        6,626   
  

 

 

   

 

 

   

 

 

 

Net interest income after provision for loan losses

     168,528        151,200        145,371   
  

 

 

   

 

 

   

 

 

 

NONINTEREST INCOME:

      

Trust fees

     16,317        14,464        12,671   

Service charges on deposit accounts

     17,546        16,693        17,689   

ATM, interchange and credit card fees

     16,750        15,187        13,587   

Real estate mortgage operations

     6,349        5,094        3,943   

Net gain on sale of available-for-sale securities (includes $147, $2,772 and $492 for the years ended December 31, 2013, 2012 and 2011, respectively, related to accumulated comprehensive earnings reclassifications)

     147        2,772        492   

Net gain (loss) on sale of foreclosed assets

     (152     (350     (1,315

Other

     5,095        3,349        4,371   
  

 

 

   

 

 

   

 

 

 

Total noninterest income

     62,052        57,209        51,438   
  

 

 

   

 

 

   

 

 

 

NONINTEREST EXPENSE:

      

Salaries and employee benefits

     66,529        58,269        56,256   

Net occupancy expense

     8,095        7,076        6,862   

Equipment expense

     9,673        8,790        7,800   

FDIC insurance premiums

     2,418        2,220        2,646   

ATM, interchange and credit card expenses

     5,660        5,448        4,918   

Professional and service fees

     4,143        3,044        3,232   

Printing, stationery and supplies

     2,066        1,970        1,831   

Amortization of intangible assets

     197        149        402   

Other expenses

     27,231        22,083        20,677   
  

 

 

   

 

 

   

 

 

 

Total noninterest expense

     126,012        109,049        104,624   
  

 

 

   

 

 

   

 

 

 

EARNINGS BEFORE INCOME TAXES

     104,568        99,360        92,185   

INCOME TAX EXPENSE (includes $51, $970 and $172 for the years ended December 31, 2013, 2012 and 2011, respectively, related to income tax expense from reclassification items)

     25,700        25,135        23,816   
  

 

 

   

 

 

   

 

 

 

NET EARNINGS

   $ 78,868      $ 74,225      $ 68,369   
  

 

 

   

 

 

   

 

 

 

NET EARNINGS PER SHARE, BASIC

   $ 2.48      $ 2.36      $ 2.17   
  

 

 

   

 

 

   

 

 

 

NET EARNINGS PER SHARE, ASSUMING DILUTION

   $ 2.47      $ 2.36      $ 2.17   
  

 

 

   

 

 

   

 

 

 

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

 

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FIRST FINANCIAL BANKSHARES, INC. AND SUBSIDIARIES

Consolidated Statements of Comprehensive Earnings

Years Ended December 31, 2013, 2012 and 2011

(Dollars in thousands)

 

     2013     2012     2011  

NET EARNINGS

   $ 78,868      $ 74,225      $ 68,369   

OTHER ITEMS OF COMPREHENSIVE EARNINGS (LOSS):

      

Change in unrealized gain (loss) on investment securities available-for-sale, before income tax

     (69,054     10,619        44,279   

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

     (147     (2,772     (492

Minimum liability pension adjustment, before income tax

     6,209        (1,564     (2,599
  

 

 

   

 

 

   

 

 

 

Total other items of comprehensive earnings (losses)

     (62,992     6,283        41,188   

Income tax benefit (expense) related to:

      

Investment securities

     24,220        (2,746     (15,325

Minimum liability pension adjustment

     (2,173     547        909   
  

 

 

   

 

 

   

 

 

 

Total income tax benefit (expense)

     22,047        (2,199     (14,416
  

 

 

   

 

 

   

 

 

 

COMPREHENSIVE EARNINGS

   $ 37,923      $ 78,309      $ 95,141   
  

 

 

   

 

 

   

 

 

 

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

 

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FIRST FINANCIAL BANKSHARES, INC. AND SUBSIDIARIES

Consolidated Statements of Shareholders’ Equity

Years Ended December 31, 2013, 2012 and 2011

(Dollars in thousands, except per share amounts)

 

    Common Stock     Capital
Surplus
    Retained
Earnings
    Treasury Stock     Deferred
Compensation
    Accumulated
Other
Comprehensive
Earnings
(Losses)
    Total
Shareholders’
Equity
 
  Shares     Amount         Shares     Amounts        

BALANCE, December 31, 2010

    20,942,141      $ 209      $ 274,629      $ 146,397        (166,329   $ (4,207   $ 4,207      $ 20,453      $ 441,688   

Net earnings

    —          —          —          68,369                68,369   

Stock option exercises

    36,317        —          950        —          —          —          —          —          950   

Cash dividends declared, $0.95 per share

    —          —          —          (29,790     —          —          —          —          (29,790

Minimum liability pension adjustment, net of related income taxes

    —          —          —          —          —          —          —          (1,690     (1,690

Change in unrealized gain on investment insecurities available-for-sale, net of related income taxes

    —          —          —          —          —          —          —          28,462        28,462   

Additional tax benefit related to directors’ deferred compensation plan

    —          —          121        —          —          —          —          —          121   

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

    —          —          —          —          (8,760     (390     390        —          —     

Stock option expense

    —          —          427        —          —          —          —          —          427   

Three-for-two stock split in the form of a 50% stock dividend

    10,481,177        105        —          (105     (83,146     —          —          —          —     
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

BALANCE, December 31, 2011

    31,459,635        314        276,127        184,871        (258,235     (4,597     4,597        47,225        508,537   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net earnings

    —          —          —          74,225        —          —          —          —          74,225   

Stock option exercises

    37,246        1        824        —          —          —          —          —          825   

Cash dividends declared, $0.99 per share

    —          —          —          (31,169     —          —          —          —          (31,169

Minimum liability pension adjustment, net of related income taxes

    —          —          —          —          —          —          —          (1,017     (1,017

Change in unrealized gain on investment insecurities available-for-sale, net of related income taxes

    —          —          —          —          —          —          —          5,101        5,101   

Additional tax benefit related to directors’ deferred compensation plan

    —          —          127        —          —          —          —          —          127   

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

    —          —          —          —          (8,610     (410     410        —          —     

Stock option expense

    —          —          334        —          —          —          —          —          334   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

BALANCE, December 31, 2012

    31,496,881        315        277,412        227,927        (266,845     (5,007     5,007        51,309        556,963   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net earnings

    —          —          —          78,868        —          —          —          —          78,868   

Stock issued in acquisition of Orange Savings Bank, SSB

    420,000        4        23,096        —          —          —          —          —          23,100   

Stock option exercises

    75,616        1        1,957        —          —          —          —          —          1,958   

Cash dividends declared, $1.03 per share

    —          —          —          (32,823     —          —          —          —          (32,823

Minimum liability pension adjustment, net of related income taxes

    —          —          —          —          —          —          —          4,036        4,036   

Change in unrealized gain (loss) on investment insecurities available-for-sale, net of related income taxes

    —          —          —          —          —          —          —          (44,981     (44,981

Additional tax benefit related to directors’ deferred compensation plan

    —          —          115        —          —          —          —          —          115   

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

    —          —          —          —          (2,622     (483     483        —          —     

Stock option expense

    —          —          411        —          —          —          —          —          411   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

BALANCE, December 31, 2013

    31,992,497      $ 320      $ 302,991      $ 273,972        (269,467   $ (5,490   $ 5,490      $ 10,364      $ 587,647   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

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

 

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FIRST FINANCIAL BANKSHARES, INC. AND SUBSIDIARIES

Consolidated Statements of Cash Flows

Years Ended December 31, 2013, 2012 and 2011

(Dollars in thousands)

 

     2013     2012     2011  

CASH FLOWS FROM OPERATING ACTIVITIES:

      

Net earnings

   $ 78,868      $ 74,225      $ 68,369   

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

      

Depreciation and amortization

     8,638        7,920        7,352   

Provision for loan losses

     3,753        3,484        6,626   

Securities premium amortization (discount accretion), net

     18,235        15,757        8,251   

Gain on sale of assets, net

     (178     (2,628     (80

Deferred federal income tax expense (benefit)

     754        1,517        2,005   

Change in loans held for sale

     6,292        (827     2,531   

Change in other assets

     (6,254     (5,170     (1,075

Change in other liabilities

     (250     (1,216     1,132   
  

 

 

   

 

 

   

 

 

 

Total adjustments

     30,990        18,837        26,742   
  

 

 

   

 

 

   

 

 

 

Net cash provided by operating activities

     109,858        93,062        95,111   
  

 

 

   

 

 

   

 

 

 

CASH FLOWS FROM INVESTING ACTIVITIES:

      

Cash paid for acquisition of bank, less cash acquired

     (25,706     —          —     

Net decrease in interest-bearing time deposits in banks

     17,088        12,170        42,511   

Activity in available-for-sale securities:

      

Sales

     122,025        144,144        22,970   

Maturities

     2,181,684        1,909,635        1,886,632   

Purchases

     (2,525,499     (2,049,275     (2,171,404

Activity in held-to-maturity securities—maturities

     377        2,557        5,458   

Net increase in loans

     (320,136     (306,412     (108,152

Purchases of bank premises and equipment and other assets

     (11,324     (16,180     (14,777

Proceeds from sale of bank premises and equipment and other assets

     4,721        8,370        5,732   
  

 

 

   

 

 

   

 

 

 

Net cash used in investing activities

     (556,770     (294,991     (331,030
  

 

 

   

 

 

   

 

 

 

CASH FLOWS FROM FINANCING ACTIVITIES:

      

Net increase (decrease) in noninterest-bearing deposits

     (17,053     210,132        142,103   

Net increase in interest-bearing deposits

     133,594        87,654        79,394   

Net increase in short-term borrowings

     204,191        51,941        29,400   

Common stock transactions:

      

Proceeds from stock issuances

     1,958        824        950   

Dividends paid

     (24,505     (38,719     (29,359
  

 

 

   

 

 

   

 

 

 

Net cash provided by financing activities

     298,185        311,832        222,488   
  

 

 

   

 

 

   

 

 

 

NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS

     (148,727     109,903        (13,431

CASH AND CASH EQUIVALENTS, beginning of year

     360,739        250,836        264,267   
  

 

 

   

 

 

   

 

 

 

CASH AND CASH EQUIVALENTS, end of year

   $ 212,012      $ 360,739      $ 250,836   
  

 

 

   

 

 

   

 

 

 

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

 

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Table of Contents

FIRST FINANCIAL BANKSHARES, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements

December 31, 2013, 2012 and 2011

 

1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:

Nature of Operations

First Financial Bankshares, Inc. (a Texas corporation) (“Bankshares”, “Company”, “we” or “us”) is a financial holding company which owns all of the capital stock of one bank with 60 locations located in Texas as of December 31, 2013. The subsidiary bank is First Financial Bank, National Association, Abilene. The bank’s primary source of revenue is providing loans and banking services to consumers and commercial customers in the market area in which the subsidiary is located. In addition, the Company also owns First Financial Trust & Asset Management Company, National Association, First Financial Insurance Agency, Inc., and First Technology Services, Inc. During 2011, First Financial Bankshares of Delaware, Inc and First Financial Investments of Delaware, Inc. were merged into the Company.

A summary of significant accounting policies of Bankshares and subsidiaries applied in the preparation of the accompanying consolidated financial statements follows. The accounting principles followed by the Company and the methods of applying them are in conformity with both U. S. generally accepted accounting principles and prevailing practices of the banking industry.

The Company evaluated subsequent events for potential recognition through the date the consolidated financial statements were issued.

Use of Estimates in Preparation of Financial Statements

The preparation of financial statements in conformity with U. S. generally accepted accounting principles 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 reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

Consolidation

The accompanying consolidated financial statements include the accounts of Bankshares and its subsidiaries, all of which are wholly-owned. All significant intercompany accounts and transactions have been eliminated.

Acquisition

On May 31, 2013, the Company acquired 100% of the outstanding capital stock of Orange Savings Bank, SSB, a wholly-owned subsidiary of OSB Financial Services, Inc. The results of operations of Orange Savings Bank, SSB, subsequent to the acquisition date, are included in the consolidated earnings of the Company. See Note 18 for additional information.

Consolidation of Bank Charters

Effective December 30, 2012, the Company consolidated its eleven bank charters into one charter. The Company cited regulatory, compliance and technology complexities and the opportunity for cost savings as its reason for making this change. The Company operates the one charter as it previously did with eleven charters, with local management and board decisions to benefit the customers and communities it serves.

Increase in Authorized Shares

On April 24, 2012, the Company’s shareholders approved an amendment to the Company’s Amended and Restated Certificate of Formation to increase the number of authorized common shares to 80,000,000.

 

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FIRST FINANCIAL BANKSHARES, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements

December 31, 2013, 2012 and 2011

 

Stock Repurchase

On October 26, 2011, the Company’s Board of Directors authorized the repurchase of up to 750,000 common shares through September 30, 2014. The stock buyback plan authorizes management to repurchase the stock at such time as repurchases are considered beneficial to stockholders. 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 December 31, 2013, no shares have been repurchased under this authorization.

Stock Split

On April 26, 2011, the Company’s Board of Directors declared a three-for-two stock split in the form of a 50% stock dividend effective for shareholders of record on May 16, 2011 that was distributed on June 1, 2011. All share and per share amounts in this report have been restated to reflect this stock split. An amount equal to the par value of the additional common shares issued pursuant to the stock split was reflected as a transfer from retained earnings to common stock on the consolidated financial statements as of and for the year ended December 31, 2011.

Investment Securities

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 estimated 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 estimated 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.

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.

 

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Table of Contents

FIRST FINANCIAL BANKSHARES, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements

December 31, 2013, 2012 and 2011

 

The Company’s investment portfolio consists of obligations of U. S. government sponsored-enterprises and agencies, 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. The Company reviews the prices supplied by the independent pricing services 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.

Loans and Allowance for Loan Losses

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

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

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

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

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

 

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FIRST FINANCIAL BANKSHARES, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements

December 31, 2013, 2012 and 2011

 

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 management believes is appropriate to absorb probable losses that have been incurred on existing loans as of the balance sheet date based upon management’s review and evaluation of the loan portfolio. The allowance for loan losses is comprised of three elements: (i) specific reserves determined in accordance with current authoritative accounting guidance based on probable losses on specific classified loans; (ii) a general reserve determined in accordance with current authoritative accounting guidance that considers historical loss rates; and (iii) qualitative reserves determined in accordance with current authoritative accounting guidance 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 general 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 in accordance with deterioration in credit quality and a corresponding increase 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, 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 compensate for additional areas of uncertainty 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 further downturn in the economy and employment 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 additions to the loan loss allowance based on their judgment of information available to them at the time of their examination.

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

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 original contractual terms of 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 are measured based on the present value of expected

 

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Table of Contents

FIRST FINANCIAL BANKSHARES, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements

December 31, 2013, 2012 and 2011

 

future cash flows or the loan’s observable market price. At December 31, 2013 and 2012, 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. To date, these troubled debt restructurings have been such that, after considering economic and business conditions and collection efforts, the collection of interest is doubtful and therefore the loan has been placed on non-accrual. Each of these loans is evaluated for impairment and a specific reserve is recorded based on probable losses, taking into consideration the related collateral and modified loan terms and cash flow. As of December 31, 2013 and 2012, 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 six 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, nonaccrual 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 due at acquisition date, the fair value discount, is accreted into income over the estimated life of each loan.

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 fair value was initially based on the estimate of cash flows, both principal and interest, expected to be collected or estimated collateral values if cash flows are not estimable, discounted at prevailing market rates of interest. The difference between the undiscounted cash flows expected at acquisition and the fair value at acquisition 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 undiscounted 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 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 December 31, 2013 was $2,707,000 compared to a contractual balance of $3,970,000. Other purchased credit impaired loan disclosures were omitted due to immateriality.

Other Real Estate

Other real estate is foreclosed property held pending disposition and is initially recorded at fair value, less estimated costs to sell. At foreclosure, if the fair value of the real estate, less estimated costs to sell, is less than

 

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Table of Contents

FIRST FINANCIAL BANKSHARES, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements

December 31, 2013, 2012 and 2011

 

the Company’s recorded investment in the related loan, a write-down is recognized through a charge to the allowance for loan losses. Any subsequent reduction in value is recognized by a charge to income. Operating and holding expenses of such properties, net of related income, and gains and losses on their disposition are included in net gain (loss) on sale of foreclosed assets as incurred.

Bank Premises and Equipment

Bank premises and equipment are stated at cost less accumulated depreciation and amortization. Depreciation and amortization are computed principally on a straight-line basis over the estimated useful lives of the related assets. Leasehold improvements are amortized over the life of the respective lease or the estimated useful lives of the improvements, whichever is shorter.

Business Combinations, Goodwill and Other Intangible Assets

The Company accounts for all business combinations under the purchase method of accounting. Tangible and intangible assets and liabilities of the acquired entity are recorded at fair value. Intangible assets with finite useful lives represent the future benefit associated with the acquisition of the core deposits and are amortized over seven years, utilizing a method that approximates the expected attrition of the deposits. Goodwill with an indefinite life is not amortized, but rather tested annually for impairment as of June 30 each year and totaled $94,882,000 and $71,865,000 at December 31, 2013 and 2012, respectively. There was no impairment recorded for the years ended December 31, 2013, 2012 and 2011.

The carrying amount of goodwill arising from acquisitions that qualify as an asset purchase for federal income tax purposes was $72,626,000 and $49,609,000 at December 31, 2013 and 2012, respectively, and is deductible for federal income tax purposes.

Also included in other intangible assets are mortgage servicing rights totaling $1,684,000 at December 31, 2013.

Securities Sold Under Agreements To Repurchase

Securities sold under agreements to repurchase, which are classified as short-term borrowings, generally mature within one to four days from the transaction date. Securities sold under agreements to repurchase are reflected at the amount of the cash received in connection with the transaction. The Company may be required to provide additional collateral based on the estimated fair value of the underlying securities.

Segment Reporting

The Company has determined that its banking regions meet the aggregation criteria of the current authoritative accounting guidance since each of its banking regions offers similar products and services, operates in a similar manner, has similar customers and reports to the same regulatory authority, and therefore operates one line of business (community banking) located in a single geographic area (Texas).

Statements of Cash Flows

For purposes of reporting cash flows, cash and cash equivalents include cash on hand, amounts due from banks, including interest-bearing deposits in banks with original maturity of 90 days or less, and federal funds sold.

Accumulated Other Comprehensive Income (Loss)

Unrealized gains on the Company’s available-for-sale securities (after applicable income tax expense) totaling $14,688,000 and $59,669,000 at December 31, 2013 and 2012, respectively, and the minimum pension liability

 

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Table of Contents

FIRST FINANCIAL BANKSHARES, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements

December 31, 2013, 2012 and 2011

 

totaled (after applicable income tax benefit) totaling $4,324,000 and $8,360,000 at December 31, 2013 and 2012, respectively, are included in accumulated other comprehensive income.

Income Taxes

The Company’s provision for income taxes is based on income before income taxes adjusted for permanent differences between financial reporting and taxable income. Deferred tax assets and liabilities are determined using the liability (or balance sheet) method. Under this method, the net deferred tax asset or liability is determined based on the tax effects of the temporary differences between the book and tax bases of the various balance sheet assets and liabilities and gives current recognition to changes in tax rates and laws.

Stock Based Compensation

The Company grants stock options for a fixed number of shares to employees with an exercise price equal to the fair value of the shares at the grant date. The Company recorded stock option expense totaling $411,000, $334,000 and $427,000 for the years ended December 31, 2013, 2012 and 2011, respectively.

Advertising Costs

Advertising costs are expensed as incurred.

Per Share Data

Net earnings per share (“EPS”) are computed by dividing net earnings by the weighted average number of common stock shares outstanding during the period. The Company calculates dilutive EPS assuming all outstanding options to purchase common stock have been exercised at the beginning of the year (or the time of issuance, if later.) The dilutive effect of the outstanding options is reflected by application of the treasury stock method, whereby the proceeds from the exercised options are assumed to be used to purchase common stock at the average market price during the period. The following table reconciles the computation of basic EPS to dilutive EPS:

 

     Net
Earnings
(in thousands)
     Weighted
Average
Shares
     Per Share
Amount
 

For the year ended December 31, 2013:

        

Net earnings per share, basic

   $ 78,868         31,787,974       $ 2.48   

Effect of stock options

     —           140,408         (0.01
  

 

 

    

 

 

    

 

 

 

Net earnings per share, assuming dilution

   $ 78,868         31,928,382       $ 2.47   
  

 

 

    

 

 

    

 

 

 

For the year ended December 31, 2012:

        

Net earnings per share, basic

   $ 74,225         31,480,155       $ 2.36   

Effect of stock options

     —           21,112         —     
  

 

 

    

 

 

    

 

 

 

Net earnings per share, assuming dilution

   $ 74,225         31,501,267       $ 2.36   
  

 

 

    

 

 

    

 

 

 

For the year ended December 31, 2011:

        

Net earnings per share, basic

   $ 68,369         31,443,712       $ 2.17   

Effect of stock options

     —           18,252         —     
  

 

 

    

 

 

    

 

 

 

Net earnings per share, assuming dilution

   $ 68,369         31,461,964       $ 2.17   
  

 

 

    

 

 

    

 

 

 

 

F-13


Table of Contents

FIRST FINANCIAL BANKSHARES, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements

December 31, 2013, 2012 and 2011

 

Recently Issued Authoritative Accounting Guidance

In 2011 and 2013, the Financial Accounting Standards Board (the “FASB”) amended its authoritative guidance related to offsetting assets and liabilities to require an entity to disclose both gross and net information about financial instruments, such as sales and repurchase agreements, reverse sales, repurchase agreements and securities borrowing/lending arrangements and derivative instruments that are eligible for offset in the statement of financial position and/or subject to a master netting arrangement or similar agreement. The new guidance was effective January 1, 2013, and did not have a significant impact on the Company’s financial statements.

In 2013, the FASB amended its authoritative guidance related to reporting of reclassifications out of other comprehensive earnings. The new guidance sets requirements for presentation for significant items reclassified to net earnings during the period presented. The new guidance was effective January 1, 2013 and has been included in these financial statements.

 

2. INTEREST-BEARING TIME DEPOSITS IN BANKS AND SECURITIES:

Interest-bearing time deposits in banks totaled $31,917,000 and $49,005,000 at December 31, 2013 and 2012, respectively, and have original maturities generally ranging from one to two years. Of these amounts, $29,002,000 and $44,776,000, respectively, are time deposits with balances greater than $100,000 at December 31, 2013 and 2012.

A summary of the Company’s available-for-sale securities as of December 31, 2013 and 2012 are as follows (in thousands):

 

     December 31, 2013  
     Amortized
Cost Basis
     Gross
Unrealized
Holding Gains
     Gross
Unrealized
Holding Losses
    Estimated
Fair Value
 

Securities available-for-sale:

          

Obligations of U.S. government sponsored-enterprises and agencies

   $ 136,416       $ 1,672       $ —        $ 138,088   

Obligations of state and political subdivisions

     974,608         27,980         (11,319     991,269   

Corporate bonds and other

     105,490         3,550         —          109,040   

Residential mortgage-backed securities

     706,289         12,253         (7,922     710,620   

Commercial mortgage-backed securities

     112,323         —           (3,617     108,706   
  

 

 

    

 

 

    

 

 

   

 

 

 

Total securities available-for-sale

   $ 2,035,126       $ 45,455       $ (22,858   $ 2,057,723   
  

 

 

    

 

 

    

 

 

   

 

 

 

 

     December 31, 2012  
     Amortized
Cost Basis
     Gross
Unrealized
Holding Gains
     Gross
Unrealized
Holding Losses
    Estimated
Fair Value
 

Securities available-for-sale:

          

U. S. Treasury Securities

   $ 6,042       $ 48       $ —        $ 6,090   

Obligations of U.S. government sponsored-enterprises and agencies

     219,420         4,060         —          223,480   

Obligations of state and political subdivisions

     786,278         57,541         (129     843,690   

Corporate bonds and other

     117,244         6,020         (73     123,191   

Residential mortgage-backed securities

     564,434         23,285         (443     587,276   

Commercial mortgage-backed securities

     33,819         1,739         (250     35,308   
  

 

 

    

 

 

    

 

 

   

 

 

 

Total securities available-for-sale

   $ 1,727,237       $ 92,693       $ (895   $ 1,819,035   
  

 

 

    

 

 

    

 

 

   

 

 

 

 

F-14


Table of Contents

FIRST FINANCIAL BANKSHARES, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements

December 31, 2013, 2012 and 2011

 

Disclosures related to the Company’s held-to-maturity securities, which totaled $684,000 and $1,061,000 at December 31, 2013 and 2012, 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 December 31, 2013, were computed by using scheduled amortization of balances and historical prepayment rates. At December 31, 2013 and 2012, the Company did not hold any CMOs that entail higher risks than standard mortgage-backed securities.

The amortized cost and estimated fair value of available-for-sale securities at December 31, 2013, by contractual and expected maturity, are shown below (in thousands):

 

     Amortized
Cost Basis
     Estimated
Fair Value
 

Due within one year

   $ 77,075       $ 77,746   

Due after one year through five years

     546,557         564,447   

Due after five years through ten years

     555,386         559,376   

Due after ten years

     37,496         36,828   

Mortgage-backed securities

     818,612         819,326   
  

 

 

    

 

 

 

Total

   $ 2,035,126       $ 2,057,723   
  

 

 

    

 

 

 

The following table discloses, as of December 31, 2013 and 2012, 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  

December 31, 2013

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

Obligations of state and political subdivisions

   $ 316,394       $ 10,973       $ 4,153       $ 346       $ 320,547       $ 11,319   

Residential mortgage-backed securities

     228,423         7,623         5,624         299         234,047         7,922   

Commercial mortgage-backed securities

     108,706         3,617         —           —           108,706         3,617   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 653,523       $ 22,213       $ 9,777       $ 645       $ 663,300       $ 22,858   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

     Less than 12 Months      12 Months or Longer      Total  

December 31, 2012

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

Obligations of state and political subdivisions

   $ 36,480       $ 129       $ —         $ —         $ 36,480       $ 129   

Residential mortgage-backed securities

     17,344         401         3,574         42         20,918         443   

Commercial mortgage-backed securities

     12,453         250         —           —           12,453         250   

Corporate bonds and other

     4,994         73         —           —           4,994         73   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 71,271       $ 853       $ 3,574       $ 42       $ 74,845       $ 895