13false2019Q312-31FIRST FINANCIAL BANKSHARES INC0000036029falsetrueTroubled debt restructured loans of $3,983,000, $4,577,000 and $3,840,000, whose interest collection, after considering economic and business conditions and collection efforts, is doubtful are included in non-accrual loans at September 30, 2019 and 2018, and December 31, 2018, respectively.Includes $342,000 of purchased credit impaired loans.Includes $2,947,000 of purchased credit impaired loans.Includes $827,000 of purchased credit impaired loans.The Company monitors commercial, agricultural and real estate loans after such loans are 15 days past due. 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Table of Contents
 
 
 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
FORM
10-Q
 
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
 
OF
THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2019
Commission file number
0-7674
 
FIRST FINANCIAL BANKSHARES, INC.
(Exact name of registrant as specified in its charter)
 
     
Texas
 
75-0944023
(State or other jurisdiction of
incorporation or organization)
 
(I.R.S. Employer
Identification No.)
     
400 Pine Street, Abilene, Texas
 
79601
(Address of principal executive offices)
 
(Zip Code)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
(325)
627-7155
(Registrant’s telephone number, including area code)
 
Securities registered pursuant to Section 12(b) of the Act:
         
Title of each class
 
Trading
Symbol(s)
 
Name of each exchange
on which registered
Common Stock, $0.01 par value
 
FFIN
 
NASDAQ Global Select Market
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  
☒
    No  
☐
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation
S-T
(§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).    Yes  
☒
    No  
☐
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a
non-accelerated
filer, a smaller reporting company or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company” and “emerging growth company” in Rule
12b-2
of the Exchange Act.
             
Large accelerated filer
 
☒
  
Accelerated filer
 
☐
             
Non-accelerated
filer
  
☐
  
Smaller reporting company
 
☐
             
 
  
 
  
Emerging growth company
  
☐
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.  
☐
Indicate by check mark whether the registrant is a shell company (as defined in Rule
12b-2
of the Act).    Yes  
☐
    No  
☒
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date:
     
Class
 
Outstanding at October 29, 2019
Common Stock, $0.01 par value per share
 
135,844,644
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Table of Contents
 
TABLE OF
CONTENTS
             
 
 
 
FINANCIAL INFORMATION
 
Item
 
 
Page
 
1.
 
 
 
2
 
 
 
 
3
 
 
 
 
4
 
 
 
 
5
 
 
 
 
6
 
 
 
 
8
 
 
 
 
9
 
 
 
 
 
 
 
 
2.
 
 
 
36
 
 
 
 
 
 
 
 
3.
 
 
 
56
 
 
 
 
 
 
 
 
4.
 
 
 
56
 
 
 
 
 
 
OTHER INFORMATION
 
 
 
 
 
 
 
 
1.
 
 
 
57
 
 
 
 
 
 
 
 
1A.
 
 
 
57
 
 
 
 
 
 
 
 
2.
 
 
 
57
 
 
 
 
 
 
 
 
3.
 
 
 
57
 
 
 
 
 
 
 
 
4.
 
 
 
57
 
 
 
 
 
 
 
 
5.
 
 
 
57
 
 
 
 
 
 
 
 
6.
 
 
 
58
 
 
 
 
 
 
 
 
 
 
 
59
 
 
 
 
 
 
 
 
 
 
 
 
1
 
 
 
Table of Contents
 
 
PART I
FINANCIAL INFORMATION
Item 1. Financial Statements.
The consolidated balance sheets of First Financial Bankshares, Inc. (the “Company” or “we”) at September 30, 2019 and 2018 and December 31, 2018, and the consolidated statements of earnings, comprehensive earnings and shareholders’ equity for the three and nine months ended September 30, 2019 and 2018, and the consolidated statements of cash flows for the nine months ended September 30, 2019 and 2018, follow on pages
3
through
8
.
 
2
 
 
Table of Contents
 
FIRST FINANCIAL BANKSHARES, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Dollars in thousands, except per share amounts)
                         
 
September 30,
   
December 31,
 
 
2019
   
2018
   
2018
 
ASSETS
 
(Unaudited)
 
 
 
 
CASH AND DUE FROM BANKS
  $
198,855
    $
164,998
    $
207,835
 
INTEREST-BEARING DEPOSITS IN BANKS
   
31,410
     
34,511
     
40,812
 
                         
Total cash and cash equivalents
   
230,265
     
199,509
     
248,647
 
INTEREST-BEARING TIME DEPOSITS IN BANKS
   
—  
      
1,458
     
1,458
 
SECURITIES
AVAILABLE-FOR-SALE,
at fair value
    
3,397,156
     
3,144,367
     
3,158,777
 
LOANS:
   
     
     
 
Held for investment
   
4,100,316
     
3,867,040
     
3,953,636
 
Less - allowance for loan losses
   
(51,889
 )    
(50,871
 )    
(51,202
 )
                         
Net loans held for investment
    
4,048,427
     
3,816,169
     
3,902,434
 
Held-for-sale
($39,735, $15,955 and $19,185 at fair value at September 30, 2019 and 2018 and December 31, 2018, respectively)
    
40,499
     
18,496
     
21,672
 
                         
Net loans
    
4,088,926
     
3,834,665
     
3,924,106
 
BANK PREMISES AND EQUIPMENT, net
   
132,367
     
130,815
     
133,421
 
INTANGIBLE ASSETS
   
173,905
     
174,907
     
174,683
 
OTHER ASSETS
   
91,220
     
85,510
     
90,762
 
                         
Total assets
  $
8,113,839
    $
7,571,231
    $
7,731,854
 
                         
LIABILITIES AND SHAREHOLDERS’ EQUITY
   
     
     
 
NONINTEREST-BEARING DEPOSITS
  $
2,210,997
    $
2,146,984
    $
2,116,107
 
INTEREST-BEARING DEPOSITS
   
4,186,686
     
3,998,298
     
4,064,282
 
                         
Total deposits
   
6,397,683
     
6,145,282
     
6,180,389
 
DIVIDENDS PAYABLE
   
16,299
     
14,216
     
14,227
 
BORROWINGS
   
400,155
     
380,760
     
468,706
 
OTHER LIABILITIES
   
94,604
     
35,234
     
15,237
 
                         
Total liabilities
   
6,908,741
     
6,575,492
     
6,678,559
 
                         
COMMITMENTS AND CONTINGENCIES
   
     
     
 
SHAREHOLDERS’ EQUITY:
   
     
     
 
C
ommon stock—($
0.01 par value, authorized 200,000,000 shares; 135,822,456, 67,693,586 and 67,753,133 shares issued at September 30, 2019 and 2018 and December 31, 2018, respectively)
   
1,358
     
677
     
678
 
Capital surplus
   
448,968
     
440,589
     
443,114
 
Retained earnings
   
682,575
     
582,449
     
606,658
 
Treasury stock (shares at cost: 928,287, 471,070 and 467,811 at September 30, 2019 and 2018 and December 31, 2018, respectively)
   
(8,042
 )    
(7,512
 )    
(7,507
 )
Deferred compensation
   
8,042
     
7,512
     
7,507
 
Accumulated other comprehensive earnings (loss)
   
72,197
     
(27,976
 )    
2,845
 
                         
Total shareholders’ equity
   
1,205,098
     
995,739
     
1,053,295
 
 
                        
Total liabilities and shareholders’ equity
  $
8,113,839
    $
7,571,231
    $
7,731,854
 
                         
 
 
 
 
 
 
 
 
 
 
 
See notes to consolidated financial statements.
 
3
 
 
Table of Contents
 
FIRST FINANCIAL BANKSHARES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF EARNINGS - (UNAUDITED)
(Dollars in thousands, except per share amounts)
                                 
 
Three Months Ended September 30,
   
Nine Months Ended September 30,
 
 
2019
   
2018
   
2019
   
2018
 
INTEREST INCOME:
   
     
     
     
 
Interest and fees on loans
  $
57,123
    $
51,428
    $
166,095
    $
147,279
 
Interest on investment securities:
   
     
     
     
 
Taxable
   
14,292
     
12,593
     
41,505
     
36,666
 
Exempt from federal income tax
   
8,795
     
9,558
     
27,801
     
29,882
 
Interest on federal funds sold and interest-bearing deposits in banks
   
381
     
470
     
1,668
     
1,382
 
                                 
Total interest income
    
80,591
     
74,049
     
237,069
     
215,209
 
INTEREST EXPENSE:
   
     
     
     
 
Interest on deposits
   
7,123
     
4,330
     
21,070
     
11,854
 
Other
   
830
     
293
     
2,231
     
869
 
                                 
Total interest expense
    
7,953
     
4,623
     
23,301
     
12,723
 
 
                                
Net interest income
    
72,638
     
69,426
     
213,768
     
202,486
 
PROVISION FOR LOAN LOSSES
   
450
     
1,450
     
2,015
     
3,865
 
                                 
Net interest income after provision for loan losses
    
72,188
     
67,976
     
211,753
     
198,621
 
                                 
NONINTEREST INCOME:
   
     
     
     
 
Trust fees
   
7,051
     
7,291
     
21,057
     
21,265
 
Service charges on deposit accounts
   
5,629
     
5,690
     
16,179
     
15,950
 
ATM, interchange and credit card fees
   
7,728
     
7,533
     
21,920
     
21,570
 
Real estate mortgage operations
   
5,733
     
4,834
     
13,928
     
11,718
 
Net gain on sale of
available-for-sale
securities (includes $52 and $58 for the three months ended September 30, 2019 and 2018, respectively, and $728 and $1,346 for the nine months ended September 30, 2019 and 2018, respectively, related to accumulated other comprehensive earnings reclassifications)
    
52
     
58
     
728
     
1,346
 
Net gain on sale of foreclosed assets
   
71
     
84
     
193
     
201
 
Net gain (loss) on sale of assets
   
235
     
(61
 )    
241
     
(152
 )
Interest on loan recoveries
   
575
     
199
     
1,815
     
607
 
Other
   
1,595
     
1,427
     
5,020
     
4,461
 
                                 
Total noninterest income
    
28,669
     
27,055
     
81,081
     
76,966
 
NONINTEREST EXPENSE:
   
     
     
     
 
Salaries and employee benefits
   
28,550
     
26,377
     
82,468
     
79,442
 
Loss from partial settlement of pension plan
   
—  
      
—  
      
900
     
—  
  
Net occupancy expense
   
2,830
     
2,900
     
8,372
     
8,589
 
Equipment expense
   
2,225
     
2,629
     
7,009
     
7,548
 
FDIC insurance premiums
   
15
     
570
     
1,091
     
1,768
 
ATM, interchange and credit card expenses
   
2,627
     
2,344
     
7,437
     
6,692
 
Professional and service fees
   
1,902
     
2,174
     
5,721
     
6,613
 
Printing, stationery and supplies
   
480
     
387
     
1,348
     
1,485
 
Operational and other losses
   
507
     
981
     
1,253
     
1,852
 
Software amortization and expense
   
1,767
     
1,393
     
5,147
     
4,433
 
Amortization of intangible assets
   
246
     
279
     
778
     
1,049
 
Other
   
7,761
     
7,472
     
23,059
     
22,977
 
                                 
Total noninterest expense
    
48,910
     
47,506
     
144,583
     
142,448
 
                                 
EARNINGS BEFORE INCOME TAXES
   
51,947
     
47,525
     
148,251
     
133,139
 
INCOME TAX EXPENSE
(includes $11 and $12 for the three months ended September 30, 2019 and 2018, respectively, and $153 and $283 for the nine months ended September 30, 2019 and 2018, respectively, related to income tax expense from reclassification items)
    
8,867
     
7,475
     
24,827
     
20,937
 
                                 
NET EARNINGS
  $
43,080
    $
40,050
    $
123,424
    $
112,202
 
EARNINGS PER SHARE, BASIC
  $
0.32
    $
0.30
    $
0.91
    $
0.83
 
EARNINGS PER SHARE, ASSUMING DILUTION
  $
0.32
    $
0.29
    $
0.91
    $
0.83
 
DIVIDENDS PER SHARE
  $
0.12
    $
0.11
    $
0.35
    $
0.31
 
 
 
 
 
 
 
 
 
 
See notes to consolidated financial statements.
 
4
 
 
Table of Contents
 
FIRST FINANCIAL BANKSHARES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE EARNINGS - (UNAUDITED)
(Dollars in thousands)
                                 
 
Three Months Ended September 30,
   
Nine Months Ended September 30,
 
 
2019
   
2018
   
2019
   
2018
 
NET EARNINGS
 
$
43,080
    $
40,050
    $
123,424
    $
112,202
 
OTHER ITEMS OF COMPREHENSIVE EARNINGS (LOSS):
   
     
     
     
 
C
hange in unrealized gain (loss) on investment securities
 
available-for-sale,

before income taxes
    
16,446
     
(20,930
 )    
88,517
     
(75,236
 )
Reclassification adjustment for realized gains on investment securities included in net earnings, before income tax
   
(52
 )    
(58
 )    
(728
 )    
(1,346
 )
                                 
Total other items of comprehensive earnings
   
16,394
     
(20,988
 )    
87,789
     
(76,582
 )
Income tax benefit (expense) related to other items of comprehensive earnings
   
(3,444
 )    
4,407
     
(18,437
 )    
16,082
 
Reclassification of certain income tax effects related to the change in the U.S. statutory federal incoem tax rate under the Tax Cuts and Jobs Act to retained earnings
.
    
—  
      
—  
      
—  
      
5,759
 
                                 
COMPREHENSIVE EARNINGS
 
$
56,030
    $
23,469
    $
192,776
    $
57,461
 
                                 
 
 
 
 
 
 
 
 
 
See notes to consolidated financial statements.
 
5
 
 
Table of Contents
 
FIRST FINANCIAL BANKSHARES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY
(Dollars in thousands, except per share amounts)
                                                                         
 
   
   
   
   
   
   
   
Accumulated
   
 
 
   
   
   
   
   
   
   
Other
   
Total
 
 
Common Stock
   
Capital
   
Retained
   
Treasury Stock
   
Deferred
   
Comprehensive
   
Shareholders’
 
 
Shares
   
Amount
   
Surplus
   
Earnings
   
Shares
   
Amounts
   
Compensation
   
Earnings
   
Equity
 
Balances at June 30, 2018
 
(unaudited)
 
    
67,669,658
    $
677
    $
439,731
    $
556,615
     
(491,170
 )   $
(7,419
 )   $
7,419
    $
(11,395
 )   $
985,628
 
Net earnings (unaudited)
   
—  
      
—  
      
—  
      
40,050
     
—  
      
—  
      
—  
      
—  
      
40,050
 
Stock option exercises (unaudited)
   
23,928
     
—  
      
481
     
—  
      
—  
      
—  
      
—  
      
—  
      
481
 
Cash dividends declared, $0.11 per share (unaudited)
   
—  
      
—  
      
—  
      
(14,216
 )    
—  
      
—  
      
—  
      
—  
      
(14,216
 )
Change in unrealized loss in investment securities
available-for-sale,
net of related income taxes (unaudited)
    
—  
      
—  
      
—  
      
—  
      
—  
      
—  
      
—  
      
(16,581
 )    
(16,581
 )
Shares purchased (redeemed) in connection with directors’ deferred compensation plan, net (unaudited)
   
—  
      
—  
      
—  
      
—  
      
20,100
     
(93
 )    
93
     
—  
      
—  
  
Stock option expense (unaudited)
   
—  
      
—  
      
377
     
—  
      
—  
      
—  
      
—  
      
—  
      
377
 
Balances at September 30, 2018 (unaudited)
   
67,693,586
    $
677
    $
440,589
    $
582,449
     
(471,070
 )   $
(7,512
 )   $
7,512
    $
(27,976
 )   $
995,739
 
Balances at June 30, 2019
 
(unaudited)
    
135,809,224
    $
1,358
    $
448,349
    $
655,794
     
(929,441
 )   $
(7,823
 )   $
7,823
    $
59,247
    $
1,164,748
 
Net earnings (unaudited)
   
—  
      
—  
      
—  
      
43,080
     
—  
      
—  
      
—  
      
—  
      
43,080
 
Stock option exercises (unaudited)
   
13,232
     
—  
      
188
     
—  
      
—  
      
—  
      
—  
      
—  
      
188
 
Cash dividends declared, $0.12 per share (unaudited)
   
—  
      
—  
      
—  
      
(16,299
 )    
—  
      
—  
      
—  
      
—  
      
(16,299
 )
Change in unrealized gain in investment securities
available-for-sale,
net of related income taxes (unaudited)
    
—  
      
—  
      
—  
      
—  
      
—  
      
—  
      
—  
      
12,950
     
12,950
 
Shares purchased (redeemed) in connection with directors’ deferred compensation plan, net (unaudited)
   
—  
      
—  
      
—  
      
—  
      
1,154
     
(219
 )    
219
     
—  
      
—  
  
Stock option expense (unaudited)
   
—  
      
—  
      
431
     
—  
      
—  
      
—  
      
—  
      
—  
      
431
 
Balances at September 30, 2019 (unaudited)
   
135,822,456
    $
1,358
    $
448,968
    $
682,575
     
(928,287
 )   $
(8,042
 )   $
8,042
    $
72,197
    $
1,205,098
 
 
 
 
 
 
 
 
 
 
 
         
 
 
6
 
(continued)
 
 
 
 
 
 
 
 
 
Table of Contents
 
FIRST FINANCIAL BANKSHARES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY
(Dollars in thousands, except per share amounts)
 
                                                                         
 
   
   
   
   
   
   
   
Accumulated
   
 
 
   
   
   
   
   
   
   
Other
   
Total
 
 
Common Stock
   
Capital
   
Retained
   
Treasury Stock
   
Deferred
   
Comprehensive
   
Shareholders’
 
 
Shares
   
Amount
   
Surplus
   
Earnings
   
Shares
   
Amounts
   
Compensation
   
Earnings
   
Equity
 
Balances at December 31, 2017
   
66,260,444
    $
663
    $
378,062
    $
517,257
     
(495,964
 )   $
(7,148
 )   $
7,148
    $
26,786
    $
922,768
 
Net earnings (unaudited)
   
—  
      
—  
      
—  
      
112,202
     
—  
      
—  
      
—  
      
—  
      
112,202
 
Stock option exercises (unaudited)
   
133,061
     
1
     
2,799
     
—  
      
—  
      
—  
      
—  
      
—  
      
2,800
 
Restricted stock grant (unaudited)
   
10,710
     
—  
      
523
     
—  
      
—  
      
—  
      
—  
      
—  
      
523
 
Cash dividends declared, $0.31 per share (unaudited)
   
—  
      
—  
      
—  
      
(41,272
 )    
—  
      
—  
      
—  
      
—  
      
(41,272
 )
Stock issued in acquisition of Commercial Bancshares, Inc.
   
1,289,371
     
13
     
58,074
     
—  
      
—  
      
—  
      
—  
      
—  
      
58,087
 
Change in unrealized
loss
in investment securities
available-for-sale,
net of related income taxes (unaudited)
    
—  
      
—  
      
—  
      
—  
      
—  
      
—  
      
—  
      
(60,500
 )    
(60,500
 )
Shares purchased (redeemed) in connection with directors’ deferred compensation plan, net (unaudited)
   
—  
      
—  
      
—  
      
—  
      
24,894
     
(364
 )    
364
     
—  
      
—  
  
Stock option expense (unaudited)
   
—  
      
—  
      
1,131
     
—  
      
—  
      
—  
      
—  
      
—  
      
1,131
 
Reclassification of certain income tax effects related to the change in the U.S. statutory federal income tax rate under the Tax Cuts and Jobs Act to retained earnings
   
—  
      
—  
      
—  
      
(5,759
 )    
—  
      
—  
      
—  
      
5,759
     
—  
  
Reclassification of unrealized gain in equity securities at December 31, 2017 from accumulated other comprehensive earnings to retained earnings (unaudited)
   
—  
      
—  
      
—  
      
21
     
—  
      
—  
      
—  
      
(21
 )    
—  
  
                                                                         
Balances at September
 30
, 2018 (unaudited)
   
67,693,586
    $
677
    $
440,589
    $
582,449
     
(471,070
 )   $
(7,512
 )   $
7,512
    $
(27,976
 )   $
995,739
 
                                                                         
Balances at December 31, 2018
   
67,753,133
    $
678
    $
443,114
    $
606,658
     
(467,811
 )   $
(7,507
 )   $
7,507
    $
2,845
    $
1,053,295
 
Net earnings (unaudited)
   
—  
      
—  
      
—  
      
123,424
     
—  
      
—  
      
—  
      
—  
      
123,424
 
Stock option exercises (unaudited)
   
185,779
     
2
     
3,491
     
—  
      
—  
      
—  
      
—  
      
—  
      
3,493
 
Restricted stock grant (unaudited)
    
43,334
     
—  
      
1,307
     
—  
      
—  
      
—  
      
—  
      
—  
      
1,307
 
Cash dividends declared, $0.35 per share (unaudited)
   
—  
      
—  
      
—  
      
(46,829
 )    
—  
      
—  
      
—  
      
—  
      
(46,829
 )
Change in unrealized gain in investment securities
available-for-sale,
net of related income taxes (unaudited)
    
—  
      
—  
      
—  
      
—  
      
—  
      
—  
      
—  
      
69,352
     
69,352
 
Shares purchased (redeemed) in connection with directors’ deferred compensation plan, net (unaudited)
   
—  
      
—  
      
—  
      
—  
      
3,863
     
(535
 )    
535
     
—  
      
—
 
Stock option expense (unaudited)
   
—  
      
—  
      
1,056
     
—  
      
—  
      
—  
      
—  
      
—  
      
1,056
 
Two-for-one
stock spllit in the form of a
 
100%
 
stock dividend (unaudited)
    
67,840,210
     
678
     
—  
      
(678
 )    
(464,339
 )    
—  
      
—  
      
—  
      
—
 
                                                                         
Balances at September 30, 2019 (unaudited)
   
135,822,456
    $
1,358
    $
448,968
    $
682,575
     
(928,287
 )   $
(8,042
 )   $
8,042
    $
72,197
    $
1,205,098
 
                                                                         
 
 
See notes to consolidated financial statements.
 
7
 
 
Table of Contents
 
FIRST FINANCIAL BANKSHARES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS - (UNAUDITED)
(Dollars in thousands)
                 
 
Nine Months Ended September 30,
 
 
2019
   
2018
 
CASH FLOWS FROM OPERATING ACTIVITIES:
   
     
 
Net earnings
  $
123,424
    $
112,202
 
Adjustments to reconcile net earnings to net cash provided by operating activities:
   
     
 
Depreciation and amortization
   
8,730
     
9,554
 
Provision for loan losses
   
2,015
     
3,865
 
Securities premium amortization (discount accretion), net
   
18,690
     
21,005
 
Gain on sale of assets, net
   
(1,312
 )    
(1,254
 )
Deferred federal income tax benefit
   
1,720
     
8,107
 
Change in loans
held-for-sale
   
(18,491
 )    
(2,928
 )
Change in other assets
   
1,789
     
2,699
 
Change in other liabilities
   
9,097
     
5,653
 
                 
Total adjustments
   
22,238
     
46,701
 
                 
Net cash provided by operating activities
   
145,662
     
158,903
 
                 
CASH FLOWS FROM INVESTING ACTIVITIES:
   
     
 
Cash received in acquisition of Commercial Bancshares, Inc.
   
—  
      
18,653
 
Net decrease in interest-bearing time deposits in banks
   
1,458
     
—  
  
Activity in
available-for-sale
securities:
    
     
 
Sales
   
67,404
     
220,259
 
Maturities
   
4,342,074
     
3,354,571
 
Purchases
   
(4,526,709
 )    
(3,650,127
 )
Net increase in loans
   
(149,553
 )    
(116,860
 )
Purchases of bank premises and equipment and other assets
   
(7,541
 )    
(12,381
 )
Proceeds from sale of bank premises and equipment and other assets
   
1,344
     
810
 
                 
Net cash used in investing activities
   
(271,523
 )    
(185,075
 )
                 
CASH FLOWS FROM FINANCING ACTIVITIES:
   
     
 
Net increase (decrease) in noninterest-bearing deposits
   
94,890
     
(56,706
 )
Net increase (decrease)
in interest-bearing deposits
   
122,404
     
(102,875
 )
Net increase (decrease) in borrowings
   
(68,551
 )    
49,760
 
Common stock transactions:
   
     
 
Proceeds from stock issuances
   
3,493
     
2,800
 
Dividends paid
   
(44,757
 )    
(39,645
 )
                 
Net cash provided by (used in) financing activities
   
107,479
     
(146,666
 )
                 
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS
   
(18,382
 )    
(172,838
 )
CASH AND CASH EQUIVALENTS, beginning of period
   
248,647
     
372,347
 
                 
CASH AND CASH EQUIVALENTS, end of period
  $
230,265
    $
199,509
 
                 
SUPPLEMENTAL INFORMATION AND NONCASH TRANSACTIONS:
   
     
 
Interest paid
  $
22,963
    $
12,617
 
Federal income taxes paid
   
22,141
     
20,351
 
Transfer of loans and bank premises to other real estate
   
1,208
     
126
 
Investment securities purchased but not settled
   
51,181
     
13,453
 
Restricted stock grant to officers and directors
   
1,307
     
523
 
Stocks issued in acquisition of Commercial Bancshares, Inc.
   
—  
      
58,087
 
 
 
 
 
 
 
 
See notes to consolidated financial statements.
 
8
 
 
Table of Contents
 
FIRST FINANCIAL BANKSHARES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
Note 1
—
Basis of Presentation
The unaudited interim consolidated financial statements include the accounts of the Company, a Texas corporation and a financial holding company registered under the Bank Holding Company Act of 1956, as amended, or BHCA, and its wholly-owned subsidiaries: First Financial Bank, National Association, Abilene, Texas; First Technology Services, Inc.; First Financial Trust & Asset Management Company, National Association; First Financial Investments, Inc.; and First Financial Insurance Agency, Inc.
Through our subsidiary bank, we conduct a full-service commercial banking business. Our banking centers are located primarily in Central, North Central, Southeast and West Texas. As of September 30, 2019, we had 73 financial centers across Texas, with eleven locations in Abilene, three locations in Weatherford, two locations in Cleburne, Conroe, San Angelo, Stephenville and Granbury, and one location each in Acton, Albany, Aledo, Alvarado, Beaumont, Boyd, Bridgeport, Brock, Burleson, Cisco, Clyde, Cut and Shoot, Decatur, Eastland, El Campo, Fort Worth, Fulshear, Glen Rose, Grapevine, Hereford, Huntsville, Keller, Kingwood, Magnolia, Mauriceville, Merkel, Midlothian, Mineral Wells, Montgomery, Moran, New Waverly, Newton, Odessa, Orange, Palacios, Port Arthur, Ranger, Rising Star, Roby, Southlake, Spring, Sweetwater, Tomball, Trent, Trophy Club, Vidor, Waxahachie, Willis and Willow Park, all in Texas. Our trust subsidiary has eight locations which are located in Abilene, Fort Worth, Houston, Odessa, Beaumont, San Angelo, Stephenville and Sweetwater.
In the opinion of management, the unaudited interim consolidated financial statements reflect all adjustments necessary for a fair presentation of the Company’s financial position and unaudited results of operations and should be read in conjunction with the Company’s audited consolidated financial statements and notes thereto in the Company’s Annual Report on Form
10-K,
for the year ended December 31, 2018. All adjustments were of a normal recurring nature. However, the results of operations for the three and nine months ended September 30, 2019, are not necessarily indicative of the results to be expected for the year ending December 31, 2019, due to seasonality, changes in economic conditions and loan credit quality, interest rate fluctuations, regulatory and legislative changes and other factors. The preparation of financial statements in conformity with United States generally accepted accounting principles (“GAAP”) requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the financial statement date. Actual results could vary. Certain information and footnote disclosures normally included in financial statements prepared in accordance with GAAP have been condensed or omitted under U.S. Securities and Exchange Commission (“SEC”) rules and regulations.
In addition, certain reclassifications have been made to the 2018 statements of earnings to conform to the 2019 presentation.
 The Company evaluated subsequent events for potential recognition and/or disclosure through the date the consolidated financial statements were issued.
Goodwill and other intangible assets are evaluated annually for impairment as of the end of the second quarter. No such impairment has been noted in connection with the current or any prior evaluations.
Note 2
 – 
Stock Split and Stock Repurchase
On April 23, 2019, the Company’s Board of Directors declared a two-for-one stock split
of a the Company’s outstanding common shares with
a record date of May 15, 2019 that was distributed on June 3, 2019. All 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 in the consolidated financial statements as of and for the three months ended March 31, 2019 and as of and for the nine months ended September 30, 2019.
On July 25, 2017, the Company’s Board of Directors authorized the repurchase of up to 2,000,000 common shares through September 30, 2020. The shares buyback plan authorizes management to repurchase the shares at such time as repurchases are considered beneficial to shareholders. Any repurchase of shares will be made through the open market, block trades or in privately negotiated transactions in accordance with applicable laws and regulations. Under the repurchase plan, there is no minimum number of shares that the Company is required to repurchase. Through September 30, 2019, no shares were repurchased under this authorization.
 
9
 
 
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Note 3—Earnings Per Share
Basic earnings per common share is computed by dividing net income available to common shareholders by the weighted average number of shares outstanding during the periods presented. In computing diluted earnings per common share for the three months ended September 30, 2019 and 2018, the Company assumes that all dilutive outstanding options to purchase common shares have been exercised at the beginning of the period (or the time of issuance, if later). The dilutive effect of these outstanding options and the restricted shares is reflected by application of the treasury stock method, whereby the proceeds from exercised options and restricted shares are assumed to be used to purchase common shares at the average market price during the respective periods. The weighted average common shares outstanding used in computing basic earnings per common share for the three months ended September 30, 2019 and 2018 were 135,693,901 and 135,270,116 shares, respectively. The weighted average common shares outstanding used in computing basic earnings per common share for the nine months ended September 30, 2019 and 2018 were 135,613,646 and 135,173,686. The weighted average common shares outstanding used in computing fully diluted earnings per common share for the three months ended September 30, 2019 and 2018 were 136,369,328 and 136,107,448 shares, respectively. The weighted average common shares outstanding used in computing fully diluted earnings per common share for the nine months ended September 30, 2019 and 2018 were 136,274,342 and 135,896,840. For the three and nine months ended September 30, 2019 and 2018, there were no stock options that were anti-dilutive that have been excluded from the EPS calculation.
Note 4—Interest-bearing Time Deposits in Banks and Securities
Interest-bearing time deposits in banks totaled $
1,458
,000 at both September 30, 2018 and December 31, 2018,
respectively, and had original maturities ranging from one to six months. At September 30, 2019, all interest-bearing time deposits in banks have matured.
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. Debt securities not classified as
held-to-maturity
or trading are classified as
available-for-sale
and recorded at fair value, with all unrealized gains and unrealized losses judged to be temporary, net of deferred income taxes, excluded from earnings and reported in the consolidated statements of comprehensive earnings.
Available-for-sale
debt securities that have unrealized gains and losses are excluded from earnings and reported net of tax in accumulated other comprehensive income until realized. Declines in the fair value of
available-for-sale
debt securities below their cost that are deemed to be other-than-temporary are reflected in earnings as a realized loss if there is no ability or intent to hold to recovery. If the Company does not intend to sell and will not be required to sell prior to recovery of its amortized cost basis, only the credit component of the impairment is reflected in earnings as a realized loss with the noncredit portion recognized in other comprehensive income. In estimating other-than-temporary impairment losses, we consider (1) the length of time and the extent to which the fair value has been less than cost, (2) the financial condition and near-term prospects of the issuer, and (3) our intent and ability to retain our investment in the issuer for a period of time sufficient to allow for any anticipated recovery in fair value. 
Effective January 1, 2018, in accordance with ASU
2016-01
(see note 13), increases or decreases in the fair value of equity securities are recorded in earnings. Prior to January 1, 2018, such increases or decreases were recorded similar to increases or decreases in debt securities.
 
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The Company records its
available-for-sale
and equity 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 debt 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. 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 debt security may be different than previously estimated, which could have a material effect on the Company’s results of operations and financial condition.
The Company’s investment portfolio consists of U.S. Treasury securities, obligations of state and political subdivisions, mortgage pass-through securities, corporate bonds and general obligation or revenue based municipal bonds. Pricing for such securities is generally readily available and transparent in the market. The Company utilizes independent third-party pricing services to value its investment securities, which the Company reviews as well as the underlying pricing methodologies for reasonableness and to ensure such prices are aligned with pricing matrices. The Company validates prices supplied by the independent pricing services by comparison to prices obtained from other third-party sources on a quarterly basis.
A summary of the Company’s
available-for-sale
securities follows (in thousands):
  
September 30, 2019
 
  
   
Gross
   
Gross
   
 
  
Amortized
   
Unrealized
   
Unrealized
   
Estimated
 
  
Cost Basis
   
Holding Gains
   
Holding Losses
   
Fair Value
 
U.S. Treasury securities
  $
9,990
    $
31
    $
—  
     $
10,021
 
Obligations of states and political subdivisions
   
1,182,549
     
59,734
     
(86
 )    
1,242,197
 
Corporate bonds and other
   
4,643
     
87
     
—  
      
4,730
 
Residential mortgage-backed securities
   
1,597,807
     
27,001
     
(1,428
 )    
1,623,380
 
Commercial mortgage-backed securities
   
509,019
     
8,069
     
(260
 )    
516,828
 
                                 
Total securities
available-for-sale
  $
3,304,008
    $
94,922
    $
(1,774
 )   $
3,397,156
 
                                 
 
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Table of Contents
 
  
September 30, 2018
 
  
   
Gross
   
Gross
   
 
  
Amortized
   
Unrealized
   
Unrealized
   
Estimated
 
  
Cost Basis
   
Holding Gains
   
Holding Losses
   
Fair Value
 
U.S. Treasury securities
   $
9,964
    $
—  
     $
(35
 )   $
9,929
 
Obligations of U.S. government sponsored enterprises and agencies
   
303
     
—  
      
(1
 )    
302
 
Obligations of states and political subdivisions
   
1,174,320
     
21,664
     
(4,097
 )    
1,191,887
 
Corporate bonds and other
   
4,860
     
—  
      
(121
 )    
4,739
 
Residential mortgage-backed securities
   
1,533,302
     
912
     
(39,908
 )    
1,494,306
 
Commercial mortgage-backed securities
   
453,495
     
8
     
(10,299
 )    
443,204
 
                                 
Total securities
available-for-sale
  $
3,176,244
    $
22,584
    $
(54,461
 )   $
3,144,367
 
                                 
 
 
  
December 31, 2018
 
  
   
Gross
   
Gross
   
 
  
Amortized
   
Unrealized
   
Unrealized
   
Estimated
 
  
Cost Basis
   
Holding Gains
   
Holding Losses
   
Fair Value
 
U.S. Treasury securities
  $
9,970
    $
—  
     $
(8
 )   $
9,962
 
Obligations of U.S. government sponsored enterprises and agencies
   
301
     
—  
      
—  
      
301
 
Obligations of states and political subdivisions
   
1,229,828
     
30,013
     
(1,970
 )    
1,257,871
 
Corporate bonds and other
   
4,875
     
—  
      
(77
 )    
4,798
 
Residential mortgage-backed securities
   
1,472,228
     
3,928
     
(21,611
 )    
1,454,545
 
Commercial mortgage-backed securities
   
436,366
     
670
     
(5,736
 )    
431,300
 
                                 
Total securities
available-for-sale
  $
3,153,568
    $
34,611
    $
(29,402
 )   $
3,158,777
 
                                 
The Company invests in mortgage-backed securities that have expected maturities that differ from their contractual maturities. These differences arise because borrowers may have the right to call or prepay obligations with or without a prepayment penalty. These securities include collateralized mortgage obligations (CMOs) and other asset backed securities. The expected maturities of these securities at September 30, 2019 were computed by using scheduled amortization of balances and historical prepayment rates. At September 30, 2019 and 2018, and December 31, 2018, the Company did not hold CMOs that entail higher risks than standard mortgage-backed securities.
The amortized cost and estimated fair value of
available-for-sale
securities at September 30, 2019 by contractual and expected maturity, are shown below (in thousands):
 
Amortized
   
Estimated
 
  
Cost Basis
   
Fair Value
 
Due within one year
 
$
207,121
   
$
208,899
 
Due after one year through five years
   
494,764
     
520,494
 
Due after five years through ten years
   
493,565
     
525,301
 
Due after ten years
   
1,732
     
2,254
 
Mortgage-backed securities
   
2,106,826
 
 
 
2,140,208
 
Total
 
$
3,304,008
 
 
$
3,397,156
 
                 
 
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Table of Contents
The following tables disclose the Company’s investment securities that have been in a continuous
unrealized-loss
position for less than 12 months and for 12 or more months (in thousands):
                                                 
 
Less than 12 Months
   
12 Months or Longer
   
Total
 
September 30, 2019
  
Fair Value
   
Unrealized
Loss
   
Fair Value
   
Unrealized
Loss
   
Fair Value
   
Unrealized
Loss
 
Obligations of states and political subdivisions
  $
11,140
    $
86
    $
828
    $
—  
     $
11,968
    $
86
 
Residential mortgage-backed securities
   
91,850
     
75
     
146,449
     
1,353
     
238,299
     
1,428
 
Commercial mortgage-backed securities
   
42,310
     
115
     
74,873
     
145
     
117,183
     
260
 
                                                 
Total
  $
145,300
    $
276
    $
222,150
    $
1,498
    $
367,450
    $
1,774
 
                                                 
 
 
 
 
 
 
 
                                                 
 
Less than 12 Months
   
12 Months or Longer
   
Total
 
September 30, 2018
  
Fair Value
   
Unrealized
Loss
   
Fair Value
   
Unrealized
Loss
   
Fair Value
   
Unrealized
Loss
 
U.S. Treasury Securities
  $
9,929
    $
35
    $
—  
     $
—  
     $
9,929
    $
35
 
Obligations of U.S. government sponsored enterprises and agencies
   
302
     
1
     
—  
      
—  
      
302
     
1
 
Obligations of states and political subdivisions
   
184,265
     
2,165
     
44,750
     
1,932
     
229,015
     
4,097
 
Corporate bonds and other
   
4,399
     
110
     
449
     
11
     
4,848
     
121
 
Residential mortgage-backed securities
   
962,320
     
20,850
     
461,227
     
19,058
     
1,423,547
     
39,908
 
Commercial mortgage-backed securities
   
270,375
     
5,908
     
167,368
     
4,391
     
437,743
     
10,299
 
                                                 
Total
  $
1,431,590
    $
29,069
    $
673,794
    $
25,392
    $
2,105,384
    $
54,461
 
                                                 
 
 
 
 
 
 
 
                                                 
 
Less than 12 Months
   
12 Months or Longer
   
Total
 
December 31, 2018
  
Fair Value
   
Unrealized
Loss
   
Fair Value
   
Unrealized
Loss
   
Fair Value
   
Unrealized
Loss
 
U.S. Treasury securities
  $
9,962
    $
8
    $
—  
     $
—  
     $
9,962
    $
8
 
Obligations of U.S. government sponsored enterprises and agencies
   
—  
      
—  
      
301
     
—  
      
301
     
—  
  
Obligations of state and political subdivisions
   
27,489
     
107
     
114,461
     
1,863
     
141,950
     
1,970
 
Corporate bonds and other
   
4,348
     
68
     
450
     
9
     
4,798
     
77
 
Residential mortgage-backed securities
   
119,584
     
483
     
922,289
     
21,128
     
1,041,873
     
21,611
 
Commercial mortgage-backed securities
   
1,994
     
5
     
343,015
     
5,731
     
345,009
     
5,736
 
                                                 
Total
  $
163,377
    $
671
    $
1,380,516
    $
28,731
    $
1,543,893
    $
29,402
 
                                                 
 
 
 
 
 
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Table of Contents
The number of investments in an unrealized loss position totaled 77 at September 30, 2019. We do not believe these unrealized losses are “other-than-temporary” as (i) we do not have the intent to sell our securities prior to recovery and/or maturity and (ii) it is more likely than not that we will not have to sell our securities prior to recovery and/or maturity. In making this determination, we also consider the length of time and extent to which fair value has been less than cost and the financial condition of the issuer. The unrealized losses noted are interest rate related due to the level of interest rates at September 30, 2019 compared to the time of purchase. We have reviewed the ratings of the issuers and have not identified any issues related to the ultimate repayment of principal as a result of credit concerns on these securities. Our mortgage related securities are backed by GNMA, FNMA and FHLMC or are collateralized by securities backed by these agencies. At September 30, 2019, 85.33% of our
available-for-sale
securities that are obligations of states and political subdivisions were issued within the State of Texas, of which 36.22% are guaranteed by the Texas Permanent School Fund.
At September 30, 2019, $2,112,193,000 of the Company’s securities were pledged as collateral for public or trust fund deposits, repurchase agreements and for other purposes required or permitted by law.
During the three months ended September 30, 2019 and 2018, sales of investment securities that were classified as
available-for-sale
totaled $1,352,000 and $71,134,000, respectively. Gross realized gains from security sales during the third quarter of 2019 and 2018 totaled $54,000 and $348,000, respectively. Gross realized losses from security sales during third quarter of 2019 and 2018 totaled $2,000 and $290,000, respectively.
During the nine months ended September 30, 2019 and 2018, sales of investment securities classified as
available-for-sale
totaled $67,404,000 and $220,259,000, respectively. Gross realized gains from security sales during the nine-month periods ended September 30, 2019 and 2018 totaled $747,000 and $1,877,000, respectively. Gross realized losses from security sales during the nine-month periods ended September 30, 2019 and 2018 totaled $19,000 and $531,000, respectively.
The specific identification method was used to determine cost in order to compute the realized gains and losses.
Note 5 – Loans Held for Investment 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.
 
14
 
 
Table of Contents
Agricultural loans are subject to underwriting standards and processes similar to commercial loans. These agricultural loans are based primarily on the identified cash flows of the borrower and secondarily on the underlying collateral provided by the borrower. Most agricultural loans are secured by the agriculture related assets being financed, such as farm land, cattle or equipment, and include personal guarantees.
Real estate loans are also subject to underwriting standards and processes similar to commercial and agricultural loans. These loans are underwritten primarily based on projected cash flows and, secondarily, as loans secured by real estate. The repayment of real estate loans is generally largely dependent on the successful operation of the property securing the loans or the business conducted on the property securing the loan. Real estate loans may be more adversely affected by conditions in the real estate markets or in the general economy. The properties securing the Company’s real estate portfolio are generally diverse in terms of type and geographic location within Texas. This diversity helps reduce the exposure to adverse economic events that affect any single market or industry. Generally, real estate loans are owner occupied which further reduces the Company’s risk.
Consumer loan underwriting utilizes methodical credit standards and analysis to supplement the Company’s underwriting policies and procedures. The Company’s loan policy addresses types of consumer loans that may be originated and the collateral, if secured, which must be perfected. The relatively smaller individual dollar amounts of consumer loans that are spread over numerous individual borrowers also minimize the Company’s risk.
The allowance for loan losses is an amount which represents management’s best estimate of probable losses that are inherent in the Company’s loan portfolio as of the balance sheet date. The allowance for loan losses is comprised of three elements: (i) specific reserves determined based on probable losses on specific classified loans; (ii) a historical valuation reserve component that considers historical loss rates and estimated loss emergence periods; and (iii) qualitative reserves based upon general economic conditions and other qualitative risk factors both internal and external to the Company. The allowance for loan losses is increased by charges to income and decreased by
charge-offs
(net of recoveries). Management’s periodic evaluation of the appropriateness of the allowance is based on general economic conditions, the financial condition of borrowers, the value and liquidity of collateral, delinquency, prior loan loss experience, and the results of periodic reviews of the portfolio. For purposes of determining our historical valuation reserve, the loan portfolio, less cash secured loans, government guaranteed loans and classified loans, is multiplied by the Company’s historical loss rate adjusted for the estimated loss emergence period. Specific allocations are increased or decreased in accordance with deterioration or improvement in credit quality and a corresponding increase or decrease in risk of loss on a particular loan. In addition, we adjust our allowance for qualitative factors such as current local economic conditions and trends, including, without limitations, unemployment, oil and gas prices, drought conditions, changes in lending staff, policies and procedures, changes in credit concentrations, changes in the trends and severity of problem loans and changes in trends in volume and terms of loans. This qualitative reserve serves to estimate for additional areas of losses inherent in our portfolio that are not reflected in our historic loss factors.
Although we believe we use the best information available to make loan loss allowance determinations, future adjustments could be necessary if circumstances or economic conditions differ substantially from the assumptions used in making our initial determinations. A decline in the economy could result in increased levels of
non-performing
assets and charge-offs, increased loan provisions and reductions in income. Additionally, bank regulatory agencies periodically review our allowance for loan losses and methodology and could require, in accordance with U.S. GAAP, additional provisions to the allowance for loan losses based on their judgment of information available to them at the time of their examination as well as changes to our methodology.
 
15
 
Table of Contents
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 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 less cost to sell. Other loan impairments for
non-collateral
dependent loans are measured based on the present value of expected future cash flows or the loan’s observable market price. At September 30, 2019 and 2018, and December 31, 2018, all significant impaired loans have been determined to be collateral dependent and the allowance for loss has been measured utilizing the estimated fair value of the collateral less cost to sell.
From time to time, the Company modifies its loan agreement with a borrower. A modified loan is considered a troubled debt restructuring when two conditions are met: (i) the borrower is experiencing financial difficulty and (ii) concessions are made by the Company that would not otherwise be considered for a borrower with similar credit risk characteristics. Modifications to loan terms may include a lower interest rate, a reduction of principal, or a longer term to maturity. For all impaired loans, including the Company’s troubled debt restructurings, the Company performs a periodic, well-documented credit evaluation of the borrower’s financial condition and prospects for repayment to assess the likelihood that all principal and interest payments required under the terms of the agreement will be collected in full. When doubt exists about the ultimate collectability of principal and interest, the troubled debt restructuring remains on
non-accrual
status and payments received are applied to reduce principal to the extent necessary to eliminate such doubt. This determination of accrual status is judgmental and is based on facts and circumstances related to each troubled debt restructuring. Each of these loans is individually evaluated for impairment and a specific reserve is recorded based on probable losses, taking into consideration the related collateral, modified loan terms and cash flow. As of September 30, 2019 and 2018 and December 31, 2018, substantially all of the Company’s troubled debt restructured loans are included in the
non-accrual
totals.
Loans acquired, including loans acquired in a business combination, are initially recorded at fair value with no valuation allowance. Acquired loans are segregated between those considered to be credit impaired and those deemed performing. To make this determination, management considers such factors as past due status,
non-accrual
status and credit risk ratings. The fair value of acquired performing loans is determined by discounting expected cash flows, both principal and interest, at prevailing market interest rates. The difference between the fair value and principal balances at acquisition date, the fair value discount, is accreted into interest income over the estimated life of the acquired portfolio.
 
16
 
 
Table of Contents
Purchased credit impaired loans are those loans that showed evidence of deterioration of credit quality since origination and for which it is probable, at acquisition, that the Company will be unable to collect all amounts contractually owed. Their acquisition fair value, which includes a credit component at the acquisition date, was based on the estimate of cash flows, both principal and interest, expected to be collected or estimated collateral values if cash flows are not estimable, discounted at prevailing market rates of interest. The difference between the discounted cash flows expected at acquisition and the investment in the loan is recognized as interest income on a level-yield method over the life of the loan, unless management was unable to reasonably forecast cash flows in which case the loans were placed on nonaccrual. Subsequent to the acquisition date, increases in expected cash flows will generally result in a recovery of any previously recorded allowance for loan loss, to the extent applicable, and/or a reclassification from the nonaccretable difference to accretable yield, which will be recognized prospectively. Decreases in expected cash flows subsequent to acquisition are
recognized as impairment. Valuation allowances on these impaired loans reflect only losses incurred after the acquisition. The carrying amount of purchased credit impaired loans at September 30, 2019 and 2018 and December 31, 2018 were $342,000, $2,947,000 and $827,000, respectively, compared to a contractual balance of $605,000, $3,898,000 and $1,157,000, respectively. Other purchased credit impaired loan disclosures were omitted due to immateriality.
 
Loans
held-for-investment
by class of financing receivables are as follows (in thousands):
  
September 30,
   
December 31,
 
  
2019
   
2018
   
2018
 
Commercial
  $
836,644
    $
773,924
    $
844,953
 
Agricultural
   
102,054
     
93,953
     
96,677
 
Real estate
   
2,749,552
     
2,614,929
     
2,639,346
 
Consumer
   
412,066
     
384,234
     
372,660
 
                         
Total loans
held-for-investment
  $
 
 
4,100,316
    $
 
 
3,867,040
    $
 
 
3,953,636
 
                         
The Company’s
non-accrual
loans, loans still accruing and past due 90 ​​​​​​​days or more and restructured loans are as follows (in thousands):
  
September 30,
   
December 31,
 
  
2019
   
2018
   
2018
 
Non-accrual
loans*
   $  
25,717
    $
 
 
25,587
    $
27,534
 
Loans still accruing and past due 90 days or more
   
104
     
88
     
1,008
 
Troubled debt restructured loans**
   
27
     
513
     
513
 
                         
Total
  $
 
25,848
    $
 
26,188
    $
29,055
 
                         
* Includes $342,000, $2,947,000 and $827,000 of purchased credit impaired loans as of September 30, 2019 and 2018, and December 31, 2018, respectively.
** Troubled debt restructured loans of $3,983,000, $4,577,000 and $3,840,000, whose interest collection, after considering economic ​​​​​​​and business conditions and collection efforts, is doubtful are included in
non-accrual
loans at September 30, 2019 and 2018, and December 31, 2018, respectively.
The Company’s recorded investment in impaired loans and the related valuation allowance are as follows (in thousands):
September 30, 2019
    
September 30, 2018
    
December 31, 2018
  
Re
 
corded
Investment
   
Valuation
Allowance
   
Recorded
Investment
   
Valuation
Allowance
   
Recorded
Investment
   
Valuation
Allowance
 
$
25,717
    $
4,194
    $
25,587
    $
4,988
    $
27,534
    $
4,069
 
                                             
 
17
 
Table of Contents
The Company had $27,212,000, $26,859,000 and $29,632,000 in
non-accrual,
past due 90 days or more and still accruing, restructured loans and foreclosed assets at September 30, 2019 and 2018, and December 31, 2018, respectively.
Non-accrual
loans at September 30, 2019 and 2018, and December 31, 2018, consisted of the following by class of financing receivables (in thousands):
  
September 30,
   
December 31,
 
  
2019
   
2018
   
2018
 
Commercial
  $
8,802
    $
6,961
    $
9,334
 
Agricultural
   
1,502
     
1,046
     
759
 
Real estate
   
15,095
     
16,682
     
16,714
 
Consumer
   
318
     
898
     
727
 
                         
Total
  $
  
25,717
    $
  
25,587
    $
27,534
 
                         
No significant additional funds are committed to be advanced in connection with impaired loans as of September 30, 2019.
The Company’s impaired loans and related allowance are summarized in the following tables by class of financing receivables (in thousands). No interest income was recognized on impaired loans subsequent to their classification as impaired.
September
30, 2019
  
Unpaid
Contractual
Principal
Balance
   
Recorded
Investment
With No
Allowance*
   
Recorded
Investment
With
Allowance
   
Total
Recorded
Investment
   
Related
Allowance
   
Year 
–to-
D
ate
Average
Recorded
Investment
   
Three-
Month
Average
Recorded
Investment
 
Commercial
  $
10,250
    $
5,885
    $
2,917
    $
8,802
    $
1,448
    $
9,586
    $
9,263
 
Agricultural
   
1,701
     
406
     
1,096
     
1,502
     
247
     
1,707
     
1,609
 
Real Estate
   
22,535
     
4,143
     
10,952
     
15,095
     
2,314
     
16,739
     
15,577
 
Consumer
   
444
     
9
     
309
     
318
     
185
     
416
     
346
 
                                                         
Total
  $
34,930
    $
10,443
    $
 
 
15,274
    $
  
25,717
    $
4,194
    $
28,448
    $
 
 
26,795
 
                                                         
* Includes $342,000 of purchased credit impaired loans.
September
30, 201
8
  
Unpaid
Contractual
Principal
Balance
   
Recorded
Investment
With No
Allowance*
   
Recorded
Investment
With
Allowance
   
Total
Recorded
Investment
   
Related
Allowance
   
Year 
–to-Date
Average
Recorded
Investment
   
Three-
Month
Average
Recorded
Investment
 
Commercial
  $
9,276
    $
3,467
    $
3,494
    $
6,961
    $
1,412
    $
8,339
    $
7,669
 
Agricultural
   
1,062
     
—  
      
1,046
     
1,046
     
528
     
1,506
     
1,101
 
Real Estate
   
22,513
     
4,215
     
12,467
     
16,682
     
2,652
     
18,688
     
17,762
 
Consumer
   
1,088
     
50
     
848
     
898
     
396
     
1,012
     
942
 
                                                         
Total
  $
33,939
    $
7,732
    $
 
 
17,855
    $
 
 
25,587
    $
4,988
    $
29,545
    $
 
 
27,474
 
                                                         
* Includes $2,947,000 of purchased credit impaired loans.
December
31, 2018
  
Unpaid
Contractual
Principal
Balance
   
Recorded
Investment
With No
Allowance*
   
Recorded
Investment
With
Allowance
   
Total
Recorded
Investment
   
Related
Allowance
   
12 Month
Average
Recorded
Investment
 
Commercial
  $
10,808
    $
6,728
    $
2,606
    $
9,334
    $
1,133
    $
7,986
 
Agricultural
   
799
     
213
     
546
     
759
     
170
     
842
 
Real Estate
   
24,072
     
6,699
     
10,015
     
16,714
     
2,409
     
16,042
 
Consumer
   
935
     
101
     
626
     
727
     
357
     
914
 
                                                 
Total
  $
36,614
    $
13,741
    $
13,793
    $
27,534
    $
4,069
    $
25,784
 
                                                 
* Includes $827,000 of purchased credit impaired loans.
 
18
 
 
Table of Contents
The Company recognized interest income on impaired loans prior to being recognized as impaired of approximately $948,000 during the year ended December 31, 2018. Such amounts for the three-month and nine-month periods ended September 30, 2019 and 2018 were not significant.
From a credit risk standpoint, the Company rates its loans in one of four categories: (i) pass, (ii) special mention, (iii) substandard or (iv) doubtful. Loans rated as loss are
charged-off.
The ratings of loans reflect a judgment about the risks of default and loss associated with the loan. The Company reviews the ratings on our credits as part of our
on-going
monitoring of the credit quality of our loan portfolio. Ratings are adjusted to reflect the degree of risk and loss that are felt to be inherent in each credit as of each reporting period. Our methodology is structured so that specific allocations are increased in accordance with deterioration in credit quality (and a corresponding increase in risk and loss) or decreased in accordance with improvement in credit quality (and a corresponding decrease in risk and loss).
Credits rated special mention show clear signs of financial weaknesses or deterioration in credit worthiness, however, such concerns are not so pronounced that the Company generally expects to experience significant loss within the short-term. Such credits typically maintain the ability to perform within standard credit terms and credit exposure is not as prominent as credits rated more harshly.
Credits rated substandard are those in which the normal repayment of principal and interest may be, or has been, jeopardized by reason of adverse trends or developments of a financial, managerial, economic or political nature, or important weaknesses exist in collateral. A protracted workout on these credits is a distinct possibility. Prompt corrective action is therefore required to strengthen the Company’s position, and/or to reduce exposure and to assure that adequate remedial measures are taken by the borrower. Credit exposure becomes more likely in such credits and a serious evaluation of the secondary support to the credit is performed.
Credits rated doubtful are those in which full collection of principal appears highly questionable, and which some degree of loss is anticipated, even though the ultimate amount of loss may not yet be certain and/or other factors exist which could affect collection of debt. Based upon available information, positive action by the Company is required to avert or minimize loss. Credits rated doubtful are generally also placed on
non-accrual.
The following summarizes the Company’s internal ratings of its loans
held-for-investment
by class of financing receivables and portfolio segments, which are the same (in thousands):
                                         
September 30, 2019
  
Pass
 
 
Special
Mention
 
 
Substandard
 
 
Doubtful
 
 
Total
 
Commercial
  $
797,444
    $
24,836
    $
14,364
    $
  —  
     $
836,644
 
Agricultural
   
99,586
     
61
     
2,407
     
—  
      
102,054
 
Real Estate
   
2,673,591
     
21,171
     
54,790
     
—  
      
2,749,552
 
Consumer
   
410,491
     
232
     
1,343
     
—  
      
412,066
 
                                         
Total
  $
 
 
3,981,112
    $
 
 
46,300
    $
72,904
    $
—  
     $
 
 
4,100,316
 
                                         
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
                                         
September 30, 2018
  
Pass
 
 
Special
Mention
 
 
Substandard
 
 
Doubtful
 
 
Total
 
Commercial
  $
747,758
    $
8,817
    $
17,349
    $
  —  
     $
773,924
 
Agricultural
   
89,314
     
68
     
4,571
     
—  
      
93,953
 
Real Estate
   
2,530,673
     
27,241
     
57,015
     
—  
      
2,614,929
 
Consumer
   
381,772
     
324
     
2,138
     
—  
      
384,234
 
                                         
Total
  $
 
 
3,749,517
    $
 
 
36,450
    $
81,073
    $
—  
     $
 
 
3,867,040
 
                                         
 
 
 
 
 
 
 
 
 
 
19
 
 
Table of Contents
                                         
December 31, 2018
 
Pass
 
 
Special
Mention
 
 
Substandard
 
 
Doubtful
 
 
Total
 
Commercial
  $
804,584
    $
23,392
    $
16,977
    $
  —  
     $
844,953
 
Agricultural
   
92,864
     
46
     
3,767
     
—  
      
96,677
 
Real Estate
   
2,559,379
     
26,626
     
53,341
     
—  
      
2,639,346
 
Consumer
   
370,510
     
315
     
1,835
     
—  
      
372,660
 
                                         
Total
  $
3,827,337
    $
  
50,379
    $
75,920
    $
—  
     $
 
 
3,953,636
 
                                         
 
 
 
 
 
 
 
 
 
The Company’s past due loans are as follows (in thousands):
                                                         
September 30, 2019
  
15-59

Days 
Past
Due*
   
60-89

Days
Past Due
   
Greater
Than 90
Days
   
Total
Past Due
   
Current
   
Total Loans
   
90 Days
Past
 
Due
Still
Accruing
 
Commercial
  $
2,740
    $
815
    $
619
    $
4,174
    $
832,470
    $
836,644
    $
 
 
 
 —  
  
Agricultural
   
605
     
232
     
202
     
1,039
     
101,015
     
102,054
     
—  
  
Real Estate
   
14,216
     
1,563
     
239
     
16,018
     
2,733,534
     
2,749,552
     
69
 
Consumer
   
595
     
164
     
40
     
799
     
411,267
     
412,066
     
35
 
                                                         
Total
  $
18,156
    $
  
2,774
    $
  
1,100
    $
22,030
    $
  
4,078,286
    $
  
4,100,316
    $
104
 
                                                         
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
                                                         
September 30, 2018
  
15-59

Days
Past
Due*
   
60-89

Days
Past Due
   
Greater
Than 90
Days
   
Total
 
Past
Due
   
Current
   
Total Loans
   
90 Days
Past
 
Due
Still
Accruing
 
Commercial
  $
3,850
    $
420
    $
3,331
    $
7,601
    $
766,323
    $
773,924
    $
  —  
  
Agricultural
   
442
     
—  
      
287
     
729
     
93,224
     
93,953
     
—  
  
Real Estate
   
15,542
     
2,583
     
661
     
18,786
     
2,596,143
     
2,614,929
     
—  
  
Consumer
   
749
     
173
     
145
     
1,067
     
383,167
     
384,234
     
88
 
                                                         
Total
  $
20,583
    $
  
3,176
    $
  
4,424
    $
28,183
    $
  
3,838,857
    $
  
3,867,040
    $
 
 
 
88
 
                                                         
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
                                                         
December 31, 2018
  
15-59

Days
Past
Due*
   
60-89

Days
Past Due
   
Greater
Than 90
Days
   
Total
Past Due
   
Current
   
Total Loans
   
Total 90
Days
Past Due
Still
Accruing
 
Commercial
  $
3,546
    $
682
    $
677
    $
4,905
    $
840,048
    $
844,953
    $
—  
  
Agricultural
   
791
     
19
     
26
     
836
     
95,841
     
96,677
     
—  
  
Real Estate
   
13,185
     
881
     
2,020
     
16,086
     
2,623,260
     
2,639,346
     
960
 
Consumer
   
782
     
263
     
54
     
1,099
     
371,561
     
372,660
     
48
 
                                                         
Total
  $
18,304
    $
  
1,845
    $
  
2,777
    $
22,926
    $
  
3,930,710
    $
  
3,953,636
    $
  
1,008
 
                                                         
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
* The Company monitors commercial, agricultural and real estate loans after such loans are 15 days past due. Consumer loans are monitored after such loans are 30 days past due.
 
 
 
 
 
 
 
 
 
The following table details the allowance for loan losses by portfolio segment (in thousands). There were no allowances for purchased credit impaired loans at September 30, 2019 and 2018, and December 31, 2018. Allocation of a portion of the allowance to one category of loans does not preclude its availability to absorb losses in other categories.
                                         
September 30, 2019
  
Commercial
   
Agricultural
   
Real Estate
   
Consumer
   
Total
 
Loans individually evaluated for impairment
  $
1,448
    $
247
    $
2,314
    $
185
    $
4,194
 
Loans collectively evaluated for impairment
   
11,018
     
1,000
     
30,022
     
5,655
     
47,695
 
                                         
Total
  $
12,466
    $
1,247
    $
32,336
    $
5,840
    $
  
51,889
 
                                         
 
 
 
 
 
 
 
 
 
 
20
 
                                         
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Table of Contents
September 30, 2018
  
Commercial
   
Agricultural
   
Real Estate
   
Consumer
   
Total
 
Loans individually evaluated for impairment
  $
1,412
    $
528
    $
2,652
    $
396
    $
4,988
 
Loans collectively evaluated for impairment
   
7,549
     
1,106
     
31,713
     
5,515
     
45,883
 
                                         
Total
  $
8,961
    $
1,634
    $
 
34,365
    $
5,911
    $
50,871
 
                                         
                               
December 31, 2018
  
Commercial
   
Agricultural
   
Real Estate
   
Consumer
   
Total
 
Loans individually evaluated for impairment
  $
1,133
    $
170
    $
2,409
    $
357
    $
4,069
 
Loans collectively evaluated for impairment
   
10,815
     
1,276
     
29,933
     
5,109
     
47,133
 
                                         
Total
  $
11,948
    $
1,446
    $
 
32,342
    $
5,466
    $
  
51,202
 
                                         
 
Changes in the allowance for loan losses are summarized as follows by portfolio segment (in thousands):
 
 
Three months ended
September 30, 2019
  
Commercial
   
Agricultural
   
Real Estate
   
Consumer
   
Total
 
Beginning balance
  $
13,899
    $
1,360
    $
30,799
    $
5,762
    $
51,820
 
Provision for loan losses
   
(1,174
 )    
(32
 )    
1,531
     
125
     
450
 
Recoveries
   
90
     
85
     
100
     
111
     
386
 
Charge-offs
   
(349
 )    
(166
 )    
(94
 )    
(158
 )    
(767
 )
                                         
Ending balance
  $
12,466
    $
1,247
    $
32,336
    $
5,840
    $
 
51,889
 
                                         
                               
Three months ended
September 30, 2018
  
Commercial
   
Agricultural
   
Real Estate
   
Consumer
   
Total
 
Beginning balance
  $
9,218
    $
1,402
    $
33,243
    $
6,088
    $
  
49,951
 
Provision for loan losses
   
(24
 )    
229
     
1,091
     
154
     
1,450
 
Recoveries
   
192
     
3
     
85
     
135
     
415
 
Charge-offs
   
(425
 )    
—  
      
(54
 )    
(466
 )    
(945
 )
                                         
Ending balance
  $
8,961
    $
1,634
    $
34,365
    $
5,911
    $
 
 
50,871
 
                                         
                               
Nine months ended
September 30, 2019
  
Commercial
   
Agricultural
   
Real Estate
   
Consumer
   
Total
 
Beginning balance
  $
11,948
    $
1,446
    $
32,342
    $
5,466
    $
51,202
 
Provision for loan losses
   
439
     
10
     
998
     
568
     
2,015
 
Recoveries
   
1,163
     
92
     
250
     
459
     
1,964
 
Charge-offs
   
(1,084
 )    
(301
 )    
(1,254
 )    
(653
 )    
(3,292
 )
                                         
Ending balance
  $
12,466
    $
1,247
    $
32,336
    $
5,840
    $
  
51,889
 
                                         
                               
Nine months ended
September 30, 2018
  
Commercial
   
Agricultural
   
Real Estate
   
Consumer
   
Total
 
Beginning balance
  $
10,865
    $
1,305
    $
29,896
    $
6,090
    $
48,156
 
Provision for loan losses
   
(1,316
 )    
317
     
4,325
     
539
     
3,865
 
Recoveries
   
476
     
12
     
345
     
382
     
1,215
 
Charge-offs
   
(1,064
 )    
—  
      
(201
 )    
(1,100
 )    
(2,365
 )
                                         
Ending balance
  $
8,961
    $
1,634
    $
34,365
    $
5,911
    $
  
50,871
 
                                         
 
21
 
Table of Contents
The Company’s recorded investment in loans related to the balance in the allowance for loan losses on the basis of the Company’s impairment methodology is as follows (in thousands). Purchased credit impaired loans of $342,000, $2,947,000 and $827,000 at September 30, 2019 and 2018, and December 31, 2018, respectively, are included in loans individually evaluated for impairment.
September 30, 2019
  
Commercial
   
Agricultural
   
Real Estate
   
Consumer
   
Total
 
Loans individually evaluated for impairment
  $
8,802
    $
1,502
    $
15,095
    $
318
    $
25,717
 
Loans collectively evaluated for impairment
   
827,842
     
100,552
     
2,734,457
     
411,748
     
4,074,599
 
                                         
Total
  $
 
 
836,644
    $
 
 
102,054
    $
 
 
2,749,552
    $
 
 
412,066
    $
  
4,100,316
 
                                         
September 30, 2018
  
Commercial
   
Agricultural
   
Real Estate
   
Consumer
   
Total
 
Loans individually evaluated for impairment
  $
6,961
    $
1,046
    $
16,682
    $
898
    $
25,587
 
Loans collectively evaluated for impairment
   
766,963
     
92,907
     
2,598,247
     
383,336
     
3,841,453
 
                                         
Total
  $
 
 
773,924
    $
 
 
 
 
93,953
    $
 
 
2,614,929
    $
 
 
384,234
    $
  
3,867,040
 
                                         
December 31, 2018
  
Commercial
   
Agricultural
   
Real Estate
   
Consumer
   
Total
 
Loans individually evaluated for impairment
  $
9,334
    $
759
    $
16,714
    $
727
    $
27,534
 
Loan collectively evaluated for impairment
   
835,619
     
95,918
     
2,622,632
     
371,933
     
3,926,102
 
                                         
Total
  $
 
 
844,953
    $
 
 
 
 
96,677
    $
 
 
2,639,346
    $
 
 
372,660
    $
  
3,953,636
 
                                         
The Company’s loans that were modified and considered troubled debt restructurings are as follows (in thousands):
 
Three Months Ended September 30, 2019
   
Nine Months Ended September 30, 2019
 
  
   
Pre-Modification
   
Post-
Modification
   
   
Pre-Modification
   
Post-
Modification
 
  
   
Recorded
   
Recorded
   
   
Recorded
   
Recorded
 
  
Number
   
Investment
   
Investment
   
Number
   
Investment
   
Investment
 
Commercial
   
2
    $
100
    $
100
     
5
    $
379
    $
379
 
Agricultural
   
—  
      
—  
      
—  
      
10
     
619
     
619
 
Real Estate
   
1
     
42
     
42
   
         
 
 
     
  
5
     
692
     
692
 
Consumer
   
—  
      
—  
      
—  
      
—  
      
—  
      
—  
  
                                                 
Total
   
3
    $
142
    $
142
     
20
    $
1,690
    $
1,690
 
                                                 
             
  
Three Months Ended September 30, 2018
   
Nine Months Ended September 30, 2018
 
  
   
Pre-Modification
   
Post-
Modification
   
   
Pre-Modification
   
Post-
Modification
 
  
   
Recorded
   
Recorded
   
   
Recorded
   
Recorded
 
  
Number
   
Investment
   
Investment
   
Number
   
Investment
   
Investment
 
Commercial
   
2
    $
547
    $
547
     
3
    $
826
    $
826
 
Agricultural
   
—  
      
—  
      
—  
      
1
     
4
     
4
 
Real Estate
   
1
     
117
     
117
   
 
 
 
 
 
 
 
  
5
     
642
     
642
 
Consumer
   
—  
      
—  
      
—  
      
6
     
113
     
113
 
                                                 
Total
   
3
    $
664
    $
664
     
15
    $
1,585
    $
1,585
 
                                                 
 
22
 
 
 
Table of Contents
The balances below provide information as to how the loans were modified as troubled debt restructured loans (in thousands):
                                                 
 
Three Months Ended September 30, 2019
   
Nine Months Ended September 30, 2019
 
 
Adjusted
Interest
Rate
   
Extended
Maturity
   
Combined
Rate and
Maturity
   
Adjusted
Interest
Rate
   
Extended
Maturity
   
Combined
Rate and
Maturity
 
Commercial
  $
—  
     $
—  
     $
100
    $
—  
     $
279
    $
100
 
Agricultural
   
—  
      
—  
      
—  
      
—  
      
354
     
265
 
Real Estate
   
—  
      
—  
      
42
     
—  
      
202
     
490
 
Consumer
   
—  
      
—  
      
—  
      
—  
      
—  
      
—  
  
                                                 
Total
  $
—  
     $
—  
     $
142
    $
—  
     $
835
    $
855
 
                                                 
 
 
 
 
 
 
 
 
 
                                                 
 
Three Months Ended September 30, 2018
   
Nine Months Ended September 30, 2018
 
 
Adjusted
Interest
Rate
   
Extended
Maturity
   
Combined
Rate and
Maturity
   
Adjusted
Interest
Rate
   
Extended
Maturity
   
Combined
Rate and
Maturity
 
Commercial
  $
—  
     $
491
    $
56
   
$
—  
     $
491
    $
335
 
Agricultural
   
—  
      
—  
      
—  
      
—  
      
—  
      
4
 
Real Estate
   
—  
      
117
     
—  
      
—  
      
279
     
363
 
Consumer
   
—  
      
—  
      
—  
      
—  
      
—  
      
113
 
                                                 
Total
  $
—  
     $
608
    $
56
   
$
—  
     $
770
    $
815
 
                                                 
 
 
 
 
During the three and nine months ended September 30, 2019, two loans
 totaling $28,000
 
were modified as a troubled debt restructured loan within the previous 12 months and for which there was a payment default. During the three and nine months ended September 30, 2018, no loans were modified as a troubled debt restricted during loan within the previous 12 months and for which there was a payment default. A default for purposes of this disclosure is a troubled debt restructured loan in which the borrower is 90 days past due or more or results in the foreclosure and repossession of the applicable collateral.
As of September 30, 2019, the Company has no commitments to lend additional funds to loan customers whose terms have been modified in troubled debt restructurings.
Our subsidiary bank has established a line of credit with the Federal Home Loan Bank of Dallas (FHLB) to provide liquidity and meet pledging requirements for those customers eligible to have securities pledged to secure certain uninsured deposits. At September 30, 2019, $2,616,319,000 in loans held by our bank subsidiary were subject to blanket liens as security for this line of credit. At September 30, 2019, there
was $35,000,000
outstanding under this line of credit.
Note 6 - Loans Held for Sale
The Company originates certain mortgage loans for sale in the secondary market. The mortgage loan sales contracts contain indemnification clauses should the loans default, generally in the first three to nine months, or if documentation is determined not to be in compliance with regulations. The Company’s historic losses as a result of these indemnities have been insignificant.
Loans held for sale totaled $
40,499
,000, $
18,496
,000 and $
21,672
,000 at September 30, 2019 and 2018, and December 31, 2018, respectively. At September 30, 2019 and 2018, and December 31, 2018, $764,000, $2,541,000 and $2,487,000 are valued at the lower of cost or fair value, and the remaining amounts are valued under the fair value option. The change to the fair value option for loans held for sale was effective at June 30, 2018 and was done in conjunction with the Company’s move to mandatory delivery in the secondary market and the purchase of forward mortgage-backed securities to manage the changes in fair value (see note 7 for additional information).
 
23
 
Table of Contents
These loans, which are sold on a servicing released basis, are valued using a market approach by utilizing either: (i) the fair value of the securities backed by similar mortgage loans, adjusted for certain factors to approximate the fair value of a whole mortgage loan, including the value attributable to mortgage servicing and credit risk, (ii) current commitments to purchase loans or (iii) recent observable market trades for similar loans, adjusted for credit risk and other individual loan characteristics. As these prices are derived from market observable inputs, the Company classifies these valuations as Level 2 in the fair value disclosures (see note 12). Interest income on mortgage loans held for sale is recognized based on the contractual rates and reflected in interest income on loans in the consolidated statements of earnings. The Company has no continuing ownership in any residential mortgage loans sold.
Note 7 - Derivative Financial Instruments
The Company enters into interest rate lock commitments (“IRLCs”) with customers to originate residential mortgage loans at a specific interest rate that are ultimately sold in the secondary market. These commitments, which contain fixed expiration dates, offer the borrower an interest rate guarantee provided the loan meets underwriting guidelines and closes within the timeframe established by the Company.
Beginning in the second quarter of 2018, the Company purchased forward mortgage-backed securities contracts to manage the changes in fair value associated with changes in interest rates related to a portion of the IRLCs. These instruments are typically entered into at the time the IRLC is made.
These financial instruments are not designated as hedging instruments and are used for asset and liability management needs. All derivatives are carried at fair value in either other assets or other liabilities.
The fair values of IRLCs are based on current secondary market prices for underlying loans and estimated servicing value with similar coupons, maturity and credit quality, subject to the anticipated loan funding probability (pull-through rate). The fair value of IRLCs is subject to change primarily due to changes in interest rates and the estimated pull-through rate. These commitments are classified as Level 2 in the fair value disclosures (see note 12), as the valuations are based on observable market inputs.
Forward mortgage-backed securities contracts are exchange-traded or traded within highly active dealer markets. In order to determine the fair value of these instruments, the Company utilizes the exchange price or dealer market price for the particular derivative contract and these instruments are therefore classified as Level 2 in the fair value disclosures (see note 12). The estimated fair values are subject to change primarily due to changes in interest rates.
The following table provides the outstanding notional balances and fair values of outstanding derivative positions (dollars in thousands):
                         
September 30, 2019:
  
Outstanding
Notional
Balance
   
Asset
Derivative
Fair Value
   
Liability
Derivative
Fair
Value
 
IRLCs
  $
82,330
    $
1,320
    $
 —  
  
Forward mortgage-backed securities trades
   
126,500
     
41
     
—  
  
 
 
 
 
 
24
 
                         
 
 
 
 
 
 
 
 
 
 
Table of Contents
                         
September 30, 2018:
  
Outstanding
Notional
Balance
   
Asset
Derivative
Fair Value
   
Liability
Derivative
Fair Value
 
IRLCs
  $
48,311
    $
715
    $
 —  
  
Forward mortgage-backed securities trades
   
42,500
     
143
     
—  
  
                   
December 31, 2018:
  
Outstanding
Notional
Balance
   
Asset
Derivative
Fair Value
   
Liability
Derivative
Fair Value
 
IRLCs
  $
37,088
    $
765
    $
 —  
  
Forward mortgage-backed securities trades
   
45,500
     
—  
      
403
 
 
 
 
Note 8 – Borrowings
Borrowings consisted of the following (dollars in thousands):
                         
 
September 30,
   
December 31,
 
 
2019
   
2018
   
2018
 
Securities sold under agreements with customers to repurchase
  $
358,155
    $
378,460
    $
409,631
 
Federal funds purchased
   
7,000
     
2,300
     
4,075
 
Advances from Federal Home Loan Bank of Dallas
   
35,000
     
—  
      
55,000
 
                         
Total
  $
  
400,155
    $
  
380,760
    $
468,706
 
                         
 
 
 
Securities sold under repurchase agreements are generally with significant customers of the Company that require short-term liquidity for their funds for which the Company pledges certain securities that have a fair value equal to at least the amount of the borrowings. The agreements mature daily and therefore the risk arising from a decline in the fair value of the collateral pledged is minimal. The securities pledged are mortgage-backed securities. These agreements do not include “right of
set-off”
provisions and therefore the Company does not offset such agreements for financial reporting purposes.
Note 9 - Income Taxes
Income tax expense was $
8,867
,000 for the third quarter of 2019 as compared to $
7,475
,000 for the same period in 2018. The Company’s effective tax rates on pretax income were 17.07% and 15.73% for the third quarters of 2019 and 2018, respectively. Income tax expense was $
24,827
,000 for the nine months ended September 30, 2019 as compared to $
20,937
,000 for the same period in 2018. The Company’s effective tax rates on pretax income were 16.75% and 15.73% for the nine months ended September
 30,
2019 and 2018, respectively. The effective tax rates differ from the statutory federal tax rate of 21% primarily due to tax exempt interest income earned on certain investment securities and loans, the deductibility of dividends paid to our employee stock ownership plan and excess tax benefits related to our directors’ deferred compensation plan.
Note 10 - Stock Option Plan and Restricted Stock Plan
The Company grants incentive stock options for a fixed number of shares with an exercise price equal to the fair value of the shares at the date of grant to employees. On June 26, 2019, the Company granted 398,850 incentive stock options with an exercise price of $29.70 per share. The fair value of the options was $7.31 per share and was estimated using the Black-Scholes options pricing model with the following weighted average assumptions: risk free interest rate of 1.83%; expected dividend yield of 1.62%; expected life of 6.64 years; and expected volatility of 26.69%. No options were granted in 2018.
 
25
 
Table of Contents
The Company recorded stock option expense totaling $431,000 and $377,000 for the three-month periods ended September 30, 2019 and 2018, respectively. The Company recorded stock option expense totaling $1,056,000 and $1,131,000 for the nine months ended September 30, 2019 and 2018, respectively. The additional disclosure requirements under authoritative accounting guidance have been omitted due to the amounts being insignificant.
On April 25, 2017, upon
re-election
of existing directors, 29,300 restricted shares with a total value of $600,000 were granted to the ten
non-employee
directors and were expensed over the period from the grant date to April 24, 2018, the date of the next annual shareholders’ meeting at which these directors’ term expired. On April 24, 2018, upon
re-election
of nine of the existing directors, 21,420 restricted shares with a total value of $523,000 were granted to these
non-employee
directors and were expensed over the period from grant date to April 23, 2019, the date of the next annual shareholders’ meeting at which the directors’ term expired. On April 23, 2019, upon
re-election
of nine of the existing directors and two new directors, 21,714 restricted shares with a total value of $660,000 were granted to these
non-employee
directors and will be expensed over the period from the grant date to April 28, 2020, the Company’s next annual shareholders’ meeting at which the directors’ term expires. The Company recorded director expense related to these restricted share grants of $185,000 and $135,000 for the three-month periods ended September 30, 2019 and 2018, respectively. The Company recorded director expense related to these restricted stock grants of $455,000 and $425,000 for the nine months ended September 30, 2019 and 2018, respectively.
On October 27, 2015, the Company granted 62,546 restricted shares with a total value of $1,060,000 to certain officers that
were
expensed over the vesting period of three years. On October 25, 2016, the Company granted 30,810 restricted stock shares with a total value of $560,000 to certain officers that
are
being expensed over the vesting period of three years. On October 24, 2017, the Company granted 28,382 restricted shares with a total value of $655,000 to certain officers that
are
being expensed over the vesting period of one to three years. On October 23, 2018, the Company granted 52,042 restricted shares with a total value of $1,440,000 to certain officers that
are
being 
expensed over a three-year vesting period. On June 26, 2019, the Company granted 23,428 restricted shares with a total value of $695,000 to certain officers tha
t are b
eing expensed over the vesting period of three years. On October 22, 2019, the Company granted 22,188 restricted shares with a total value of $785,000 to certain officers that
will be
 expensed over a three-year vesting period. The Company recorded restricted stock expense for officers of $248,000 and $175,000 for the three-month periods ended September 30, 2019 and 2018, respectively. The Company recorded restricted stock expense for officers of $661,000 and $501,000 for the nine-month periods ended September 30, 2019 and 2018, respectively.
Note 11 - Pension Plan
The Company’s defined benefit pension plan was frozen effective January 1, 2004, whereby no new participants were added to the plan and no additional years of service were accrued to participants. The pension plan covered substantially all of the Company’s employees at the time. The benefits for each employee were based on years of service and a percentage of the employee’s qualifying compensation during the final years of employment. The Company’s funding policy was and is to contribute annually the amount necessary to satisfy the Internal Revenue Service’s funding standards. As a result of its evaluation of its funding status, the Company made no contribution in 2018, and has not made a contribution through September 30, 2019.
In December 2018, due to the rising interest rate environment, the Company determined it was in the best interest of its shareholders to settle its pension obligation to its retiree group in payout, approximately 53% of the pension benefit obligation on that date, and recorded a loss on settlement totaling $1,546,000 for the year ended December 31, 2018. In 2019, the Company made a decision to terminate and settle the remaining obligation in its pension plan with an effective termination date of
June
 30, 2019, following which date the Company is obligated to settle the Company’s remaining obligations of the plan upon receipt of regulatory approval. Final settlement of the Company’s remaining obligation under the plan is expected to be made in the fourth quarter of 2019 or first quarter of 2020, subject to regulatory approval.
 
26
 
 
Table of Contents
In addition, the Company had a multiple employer pension plan related to its acquisition of Orange Savings Bank in 2013. This plan was likewise frozen. During the first quarter of 2019, the Company made a decision to remove this plan from the multiple employer plan and merge it into the Company’s existing pension plan. The Company recorded $900,000 in pension merger expense for the three months ended March 31, 2019 in connection with this merger of the Orange pension plan. In May 2019, the Company assumed the Orange pension obligation of $2,740,000 and received related assets totaling $1,829,000.
Net periodic benefit costs totaling $31,000 and $65,000 were recorded for the three months ended September 30, 2019 and 2018, respectively. Net periodic benefit costs totaling $973,000 and $177,000 were recorded for the nine months ended September 30, 2019 and 2018, respectively, which includes the Orange pension merger costs discussed above.
Note 12 - Fair Value Disclosures
The authoritative accounting guidance for fair value measurements defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants. A fair value measurement assumes that the transaction to sell the asset or transfer the liability occurs in the principal market for the asset or liability or, in the absence of a principal market, the most advantageous market for the asset or liability. The price in the principal (or most advantageous) market used to measure the fair value of the asset or liability shall not be adjusted for transaction costs. An orderly transaction is a transaction that assumes exposure to the market for a period prior to the measurement date to allow for marketing activities that are usual and customary for transactions involving such assets and liabilities; it is not a forced transaction. Market participants are buyers and sellers in the principal market that are (i) independent, (ii) knowledgeable, (iii) able to transact, and (iv) willing to transact.
The authoritative accounting guidance requires the use of valuation techniques that are consistent with the market approach, the income approach and/or the cost approach. The market approach uses prices and other relevant information generated by market transactions involving identical or comparable assets and liabilities. The income approach uses valuation techniques to convert future amounts, such as cash flows or earnings, to a single present amount on a discounted basis. The cost approach is based on the amount that currently would be required to replace the service capacity of an asset (replacement costs). Valuation techniques should be consistently applied. Inputs to valuation techniques refer to the assumptions that market participants would use in pricing the asset or liability. Inputs may be observable, meaning those that reflect the assumptions market participants would use in pricing the asset or liability developed based on market data obtained from independent sources, or unobservable, meaning those that reflect the reporting entity’s own assumptions about the assumptions market participants would use in pricing the
 
asset or liability developed based on the best information available in the circumstances. In that regard, the authoritative guidance establishes a fair value hierarchy for valuation inputs that gives the highest priority to quoted prices in active markets for identical assets or liabilities and the lowest priority to unobservable inputs. The fair value hierarchy is as follows:
• Level 1 Inputs – Unadjusted quoted prices in active markets for identical assets or liabilities that the reporting entity has the ability to access at the measurement date.
 
 
 
 
 
 
 
 
 
 
 
 
 
• Level 2 Inputs – Inputs other than quoted prices included in Level 1 that are observable for the asset or liability, either directly or indirectly. These include quoted prices for similar assets or liabilities in active markets, quoted prices for identical or similar assets or liabilities in markets that are not active, inputs other than quoted prices that are observable for the asset or liability (for example, interest rates, volatilities, prepayment speeds, loss severities, credit risks and default rates) or inputs that are derived principally from or corroborated by observable market data by correlation or other means.
 
 
 
 
 
 

27
 
Table of Contents
•
Level 3 Inputs – Significant unobservable inputs that reflect an entity’s own assumptions that market participants would use in pricing the assets or liabilities.
 
 
 
 
 
 
 
 
A description of the valuation methodologies used for assets and liabilities measured at fair value, as well as the general classification of such instruments pursuant to the valuation hierarchy, is set forth below.
In general, fair value is based upon quoted market prices, where available. If such quoted market prices are not available, fair value is based upon internally developed models that primarily use, as inputs, observable market-based parameters. Valuation adjustments may be made to ensure that financial instruments are recorded at fair value. While management believes the Company’s valuation methodologies are appropriate and consistent with other market participants, the use of different methodologies or assumptions to determine the fair value of certain financial instruments could result in a different estimate of fair value at the reporting date.
Securities classified as
available-for-sale
and trading are reported at fair value utilizing Level 1 and Level 2 inputs. For these securities, the Company obtains fair value measurements from an independent pricing service. The fair value measurements consider observable data that may include market spreads, cash flows, the United States Treasury yield curve, live trading levels, trade execution data, dealer quotes, market consensus prepayments speeds, credit information and the security’s terms and conditions, among other items.
See notes 6 and 7 related to the determination of fair value for loans
held-for-sale,
IRLCs and forward mortgage-backed securities trades.
There were no transfers between Level 1 and Level 2 or Level 2 and Level 3 during the three and nine months ended September 30, 2019 and 2018, and the year ended December 31, 2018.
The following table summarizes the Company’s
available-for-sale
securities which are measured at fair value on a recurring basis, segregated by the level of the valuation inputs within the fair value hierarchy utilized to measure fair value (dollars in thousands):
September 30, 2019
                                 
 
Level 1
Inputs
   
Level 2
Inputs
   
Level 3
Inputs
   
Total Fair
Value
 
Available-for-sale
investment securities:
    
     
     
     
 
U.S. Treasury securities
  $
  
10,021
     $
—  
     $
  —  
     $
10,021
 
Obligations of states and political subdivisions
   
—  
      
1,242,197
     
—  
      
1,242,197
 
Corporate bonds
   
—  
      
229
     
—  
      
229
 
Residential mortgage-backed securities
   
—  
      
1,623,380
     
—  
      
1,623,380
 
Commercial mortgage-backed securities
   
—  
      
516,828
     
—  
      
516,828
 
Other securities
   
4,501
     
—
     
—  
      
4,501
 
                                 
Total
  $
14,522
    $
  
3,382,634
     $
—  
     $
  
3,397,156
  
Loans
held-for-sale
  $
—  
     $
39,735
    $
—  
     $
39,735
 
IRLCs
  $
—  
     $
1,320
    $
—  
     $
1,320
 
Forward mortgage-backed securities trades
  $
—  
     $
41
    $
—  
     $
41
 
 
 
 
28
 
 
Table of Contents
September 30, 2018
                                 
 
Level 1
Inputs
   
Level 2
Inputs
   
Level 3
Inputs
   
Total Fair
Value
 
U.S. Treasury securities
  $
9,929
    $
—  
     $
  —  
     $
9,929
 
Obligations of U. S. government sponsored enterprises and agencies
   
—  
      
302
     
—  
      
302
 
Obligations of states and political subdivisions
   
—  
      
1,191,887
     
—  
      
1,191,887
 
Corporate bonds
   
—  
      
450
     
—  
      
450
 
Residential mortgage-backed securities
   
—  
      
1,494,306
     
—  
      
1,494,306
 
Commercial mortgage-backed securities
   
—  
      
443,204
     
—  
      
443,204
 
Other securities
   
4,289
     
—  
      
—  
      
4,289
 
                                 
Total
  $
  
14,218
     $
  
3,130,149
     $
—  
     $
  
3,144,367
  
                                 
Loans
held-for-sale
  $
—  
     $
15,955
    $
—  
     $
15,955
 
                                 
IRLCs
  $
—  
     $
715
    $
—  
     $
715
 
                                 
Forward mortgage-backed securities trades
  $
—  
     $
143
    $
—  
     $
143
 
                                 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
December 31, 2018
                                 
 
Level 1
Inputs
   
Level 2
Inputs
   
Level 3
Inputs
   
Total Fair
Value
 
Available-for-sale
investment securities:
    
     
     
     
 
U.S. Treasury securities
  $
9,962
    $
—  
     $
  —  
     $
9,962
 
Obligations of U. S. government sponsored enterprises and agencies
   
—  
      
301
     
—  
      
301
 
Obligations of states and political subdivisions
   
—  
      
1,257,871
     
—  
      
1,257,871
 
Corporate bonds
   
—  
      
450
     
—  
      
450
 
Residential mortgage-backed securities
   
—  
      
1,454,545
     
—  
      
1,454,545
 
Commercial mortgage-backed securities
   
—  
      
431,300
     
—  
      
431,300
 
Other securities
   
4,348
     
—  
      
—  
      
4,348
 
                                 
Total
  $
14,310
     $
  
3,144,467
     $
—  
     $
  
3,158,777
  
                                 
Loans
held-for-sale
  $
—  
     $
19,185
    $
—  
     $
19,185
 
                                 
IRLCs
  $
—  
     $
765
    $
—  
     $
765
 
                                 
Forward mortgage-backed securities trades
  $
—  
     $
(403
 )   $
—  
     $
(403
 )
                                 
 
 
 
 
 
 
 
 
Certain financial assets and financial liabilities are measured at fair value on a nonrecurring basis, that is, the instruments are not measured at fair value on an ongoing basis but are subject to fair value adjustments in certain circumstances (for example, when there is evidence of impairment). 
Impaired loans are reported at the fair value of the underlying collateral less selling costs if repayment is expected solely from the collateral. Collateral values are estimated using Level 2 inputs based on observable market data. At September 30, 2019, impaired loans with a carrying value of $15,274,000 were reduced by specific valuation reserves totaling $4,194,000 resulting in a net fair value of $11,080,000. The Company also had impaired loans of $
10,443
,000 with no specific valuation reserve at September 30, 2019, due to the loans carrying value generally being lower than the value of the collateral associated with the loan.
 
29
 
Table of Contents
Certain
non-financial
assets and
non-financial
liabilities measured at fair value on a
non-recurring
basis include other real estate owned, goodwill and other intangible assets and other
non-financial
long-lived assets.
Non-financial
assets measured at fair value on a
non-recurring
basis during the three months and nine months ended September 30, 2019 and 2018 include other real estate owned which, subsequent to their initial transfer to other real estate owned from loans, were
re-measured
at fair value through a write-down included in gain (loss) on sale of foreclosed assets. During the reported periods, all fair value measurements for foreclosed assets utilized Level 2 inputs based on observable market data, generally third-party appraisals, or Level 3 inputs based on customized discounting criteria. These appraisals are evaluated individually and discounted as necessary due to the age of the appraisal, lack of comparable sales, expected holding periods of property or special use type of the property. Such discounts vary by appraisal based on the above factors but generally range from 5% to 25% of the appraised value.
Re-evaluation
of other real estate owned is performed at least annually as required by regulatory guidelines or more often if particular circumstances arise.
The following table presents other real estate owned that were
re-measured
subsequent to their initial transfer to other real estate owned (dollars in thousands):
 
                 
 
Three Months Ended
September 30,
 
 
2019
   
2018
 
Carrying value of other real estate owned prior to
re-measurement
  $
 
 
—  
     $
—  
  
Write-downs included in gain (loss) on sale of other real estate owned
   
—  
      
—  
  
                 
Fair value
  $
—  
     $
—  
  
                 
       
 
Nine Months Ended
September 30,
 
 
2019
   
2018
 
Carrying value of other real estate owned prior to
re-measurement
  $
 
—  
     $
526
 
Write-downs included in gain (loss) on sale of other real estate owned
   
—  
      
(126
 )
                 
Fair value
  $
—  
     $
400
 
                 
 
 
 
 
 
 
 
 
At September 30, 2019 and 2018, and December 31, 2018, other real estate owned totaled $1,329,000, $593,000 
and $448,000,
 
respectively.
The Company is required under current authoritative accounting guidance to disclose the estimated fair value of their financial instrument assets and liabilities including those subject to the requirements discussed above. For the Company, as for most financial institutions, substantially all of its assets and liabilities are considered financial instruments. Many of the Company’s financial instruments, however, lack an available trading market as characterized by a willing buyer and willing seller engaging in an exchange transaction.
 
30
 
 
Table of Contents
The estimated fair value amounts of financial instruments have been determined by the Company using available market information and appropriate valuation methodologies. However, considerable judgment is required to interpret data to develop the estimates of fair value. Accordingly, the estimates presented herein are not necessarily indicative of the amounts the Company could realize in a current market exchange. The use of different market assumptions and/or estimation methodologies may have a material effect on the estimated fair value amounts.
In addition, reasonable comparability between financial institutions may not be likely due to the wide range of permitted valuation techniques and numerous estimates that must be made given the absence of active secondary markets for many of the financial instruments. This lack of uniform valuation methodologies also introduces a greater degree of subjectivity to these estimated fair values.
Cash and due from banks, federal funds sold, interest-bearing deposits and time deposits in banks and accrued interest receivable and payable are liquid in nature and considered Levels 1 or 2 of the fair value hierarchy.
Financial instruments with stated maturities have been valued using a present value discounted cash flow with a discount rate approximating current market for similar assets and liabilities and are considered Levels 2 and 3 of the fair value hierarchy. Financial instrument liabilities with no stated maturities have an estimated fair value equal to both the amount payable on demand and the carrying value and are considered Level 1 of the fair value hierarchy.
The carrying value and the estimated fair value of the Company’s contractual
off-balance-sheet
unfunded lines of credit, loan commitments and letters of credit, which are generally priced at market at the time of funding, are not material.
 
31
 
Table of Contents
The estimated fair values and carrying values of all financial instruments under current authoritative guidance were as follows (in thousands).
                                                         
 
September 30,
   
December 31,
   
 
 
2019
   
2018
   
2018
   
 
 
Carrying
Value
   
Estimated
Fair Value
   
Carrying
Value
   
Estimated
Fair Value
   
Carrying
Value
   
Estimated
Fair Value
   
Fair Value
Hierarchy
 
Cash and due from banks
  $
198,855
    $
198,855
    $
164,998
    $
164,998
    $
207,835
    $
207,835
     
Level 1
 
Interest-bearing deposits in banks
   
31,410
     
31,410
     
34,511
     
34,511
     
40,812
     
40,812
     
Level 1
 
Interest-bearing time deposits in banks
   
—  
      
—  
      
1,458
     
1,458
     
1,458
     
1,458
     
Level 2
 
Available-for-sale
securities
    
3,397,156
     
3,397,156
     
3,144,367
     
3,144,367
     
3,158,777
     
3,158,777
     
Levels 1 and 2
 
Loans held for investment
   
4,048,427
     
4,068,755
     
3,816,169
     
3,857,059
     
3,902,434
     
3,947,391
     
Level 3
 
Loans held for sale
   
40,499
     
40,542
     
18,496
     
18,517
     
21,672
     
21,779
     
Level 2
 
Accrued interest receivable
   
29,606
     
29,606
     
28,990
     
28,990
     
36,765
     
36,765
     
Level 2
 
Deposits with stated maturities
   
428,192
     
429,522
     
450,667
     
450,409
     
442,161
     
441,727
     
Level 2
 
Deposits with no stated maturities
   
5,969,491
     
5,969,491
     
5,694,615
     
5,694,615
     
5,738,228
     
5,738,228
     
Level 1
 
Borrowings
   
400,155
     
400,155
     
380,760
     
380,760
     
468,706
     
468,706
     
Level 2
 
Accrued interest payable
   
746
     
746
     
303
     
303
     
408
     
408
     
Level 2
 
IRLCs
   
1,320
     
1,320
     
715
     
715
     
765
     
765
     
Level 2
 
Forward mortgage backed securities trades
   
41
     
41
     
143
     
143
     
(403
 )    
(403
 )    
Level 2
 
 
Note 13—Recently Issued Authoritative Accounting Guidance
Accounting Standards Update (“ASU”) 2014-09, “Revenue from Contracts with Customers
.” ASU
2014-09
implemented a comprehensive new revenue recognition standard that supersedes substantially all existing revenue recognition guidance. The new standard’s core principle is that a company will recognize revenue when it transfers promised goods or services to customers in an amount that reflects the consideration to which the company expects to be entitled in exchange for those goods or services. To achieve that core principle, an entity applies the following steps: (i) identify the contract(s) with a customer, (ii) identify the performance obligations in the contract, (iii) determine the transaction price, (iv) allocate the transaction price to the performance obligations in the contract and (v) recognize revenue when (or as) the entity satisfies a performance obligation. ASU
2015-4
“Revenue from Contracts with Customers – Deferral of the Effective Date” deferred the effective date of ASU
2014-09
by one year and as a result, the new standard became effective in the first quarter of 2018. The Company’s revenue is comprised of net interest income on financial assets and financial liabilities, which is explicitly excluded from the scope of ASU
2014-09,
and
non-interest
income. The adoption of the new standard in the first quarter of 2018 did not have a significant impact on the Company’s financial statements and no adjustment to opening retained earnings was recorded.
 
32
 
 
Table of Contents
 
ASU 2016-01, ASU 2016-01 “Financial Instruments – Overall: Recognition and Measurement of Financial Assets and Financial Liabilities
.” ASU
2016-01,
among other things, (i) requires equity investments, with certain exceptions, to be measured at fair value with changes in fair value recognized in net income, (ii) simplified the impairment assessment of equity investments without readily determinable fair values by requiring a qualitative assessment to identify impairment, (iii) eliminated the requirement for public business entities to disclose the methods and significant assumptions used to estimate the fair value that is required to be disclosed for financial instruments measured at amortized cost on the balance sheet, (iv) required public business entities to use the exit price notion when measuring the fair value of financial instruments for disclosure purposes, (v) required an entity to present separately in other comprehensive income the portion of the total change in the fair value of a liability resulting from a change in the instrument-specific credit risk when the entity has elected to measure the liability at fair value in accordance with the fair value option for financial instruments, (vi) required separate presentation of financial assets and financial liabilities by measurement category and form of financial asset on the balance sheet or the accompanying notes to the financial statements and (vii) clarified that an entity should evaluate the need for a valuation allowance on a deferred tax asset related to
available-for-sale
securities. ASU
2016-1
became effective for the Company on January 1, 2018 and did not have a significant impact on the Company’s financial statements.
ASU 2016-02, “Leases
.” ASU
2016-02
amended current lease accounting to require lessees to recognize (i) a lease liability, which is a lessee’s obligation to make lease payments arising from a lease, measured on a discounted basis, and (ii) a
right-of-use
asset, which is an asset that represents the lessee’s right to use, or control the use of, a specified asset for the lease term. ASU
2016-02
does not significantly change lease accounting requirements applicable to lessors; however, certain changes were made to align, where necessary, lessor accounting with the lessee accounting model. The amended guidance became effective in the first quarter of 2019 and required transition using a modified retrospective approach for leases existing at, or entered into after, the beginning of the earliest comparative period presented in the financial statements. The Company evaluated the provisions of the new lease standard and, due to the small dollar amounts and number of lease agreements, the effect for the Company on January 1, 2019 was not significant.
ASU 2016-13, “Financial Instruments – Credit Losses
.” ASU
2016-13
implements a comprehensive change in estimating the allowances for loan losses from the current model of losses inherent in the loan portfolio to a current expected credit loss model that generally is expected to result in earlier recognition of allowances for losses. ASU
2016-13
requires the measurement of all expected credit losses for financial assets held at the reporting date based on historical experience, current conditions, and reasonable and supportable forecasts and requires enhanced disclosures related to the significant estimates and judgments used in estimating credit losses, as well as the credit quality and underwriting standards of an organization’s portfolio. In addition, ASU
2016-13
amends the accounting for credit losses on
available-for-sale
debt securities and purchased financial assets with credit deterioration. ASU
2016-13
will be effective for the Company as of January 1, 2020. The Company has formed a working group comprised of individuals from various functional areas including credit, risk management, finance and information technology, among others to assist in the implementation of ASU
2016-13.
The Company is completing its implementation plan that includes assessment of processes, portfolio segmentation, data validation, model development and internal controls. Additionally, the Company is working with a third-party vendor to assist with implementation and model development. The Company continues to evaluate the potential impact of ASU
2016-13
on the Company’s financial statements, but expects that the impact of adoption will be significantly influenced by the composition, characteristics and quality of our loan and securities portfolios as well as the prevailing economic conditions and forecasts as of the adoption date.
 
ASU 2017-04, “Intangibles – Goodwill and Other
.” ASU
2017-04
will amend and simplify current goodwill impairment testing to eliminate Step 2 from the current provisions. Under the new guidance, an entity should perform the goodwill impairment test by comparing the fair value of a reporting unit with its carrying value and recognize an impairment charge for the amount by which the carrying amount exceeds the reporting unit’s fair value. An entity still has the option to perform the qualitative assessment for a reporting unit to determine if a quantitative impairment test is necessary. ASU
2017-04
will be effective for the Company on January 1, 2020 and is not expected to have a significant impact on the Company’s financial statements.
 
33
 
Table of Contents
ASU 2018-02, “Income Statement – Reporting Comprehensive Income: Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income.”
ASU
2018-02
was issued to address the income tax accounting treatment of the stranded tax effects within other comprehensive income due to the prohibition of backward tracing due to an income tax rate change that was initially recorded in other comprehensive income. This issue came about from the enactment of the Tax Cuts and Jobs Act on December 22, 2017 that changed the Company’s income tax rate from 35% to 21%. The ASU changed current accounting whereby an entity may elect to reclassify the stranded tax effect from accumulated other comprehensive income to retained earnings. The ASU was effective for periods beginning after December 15, 2018 although early adoption was permitted. The Company early adopted ASU
2018-02
in the first quarter of 2018 and reclassified its stranded tax debit of $5,759,000 within accumulated other comprehensive income to retained earnings.
ASU 2018-13, “Fair Value Measurement – Changes to the Disclosure Requirements for Fair Value Measurement
” eliminates the requirements to disclose the amount and reason for transfers between Level 1 and Level 2 fair value methodology, the policy for the timing of transfers between levels and the valuation process for Level 3 fair value measurements. ASU
2018-13
requires an entity to disclose relevant quantitative information used to develop Level 3 fair value measurements. ASU
2018-13
will become effective for the Company on January 1, 2020 and is not expected to have a significant impact on the Company’s financial statements.
Note 14
 
–
 
Acquisition and Proposed Acquisition
On October 12, 2017, we entered into an agreement and plan of reorganization to acquire Commercial Bancshares, Inc. and its wholly owned bank subsidiary, Commercial State Bank, Kingwood, Texas. On January 1, 2018, the transaction was completed. Pursuant to the agreement, we issued 1,289,371 shares of the Company’s common stock in exchange for all of the outstanding shares of Commercial Bancshares, Inc. In addition, Commercial Bancshares, Inc. made a $22,075,000 special dividend to its shareholders prior to closing of the transaction, which was increased for the amount by which Commercial Bancshares, Inc.’s consolidated shareholders’ equity as of January 1, 2018 exceeded $42,402,000, after certain adjustments per the merger agreement.
At closing, Commercial Bancshares, Inc. was merged into the Company and Commercial State Bank, Kingwood, Texas, was merged into First Financial Bank, National Association, Abilene, Texas, a wholly owned subsidiary of the Company. The primary purpose of the acquisition was to expand the Company’s market share around Houston. Factors that contributed to a purchase price resulting in goodwill include Commercial State Bank’s record of earnings, strong management and board of directors, strong local economic environment and opportunity for growth. The results of operations from this acquisition are included in the consolidated earnings of the Company commencing January 1, 2018.
 
34
 
Table of Contents
The following table presents the amounts recorded on the consolidated balance sheet on the acquisition date (dollars in thousands):
         
Fair value of consideration paid:
   
 
Common stock issued (1,289,371 shares)
  $
58,087
 
         
Fair value of identifiable assets acquired:
    
 
Cash and cash equivalents
   
18,653
 
Securities
available-for-sale
   
64,501
 
Loans
   
266,327
 
Identifiable intangible assets
   
3,167
 
Other assets
   
15,375
 
         
Total identifiable assets acquired
    
368,023
 
         
Fair value of liabilities assumed:
    
 
Deposits
   
341,902
 
Other liabilities
   
(373
 )
         
Total liabilities assumed
   
341,529
 
         
Fair value of net identifiable assets acquired
   
26,494
 
         
Goodwill resulting from acquisition
  $
31,593
 
         
 
 
 
 
 
Goodwill recorded in the acquisition was accounted for in accordance with the authoritative business combination guidance. Accordingly, goodwill will not be amortized but will be tested for impairment annually. The goodwill recorded is not deductible for federal income tax purposes.
The fair value of total loans acquired was $266,327,000 at acquisition compared to contractual amounts of $271,714,000. The fair value of purchased credit impaired loans at acquisition was $3,013,000 compared to contractual amounts of $3,806,000. Additional purchased credit impaired loan disclosures were omitted due to immateriality. All other acquired loans were considered performing loans.
On September 19, 2019, we entered into an agreement
and 
plan of reorganization to acquire TB&T Bancshares, Inc. and its wholly owned bank subsidiary, The Bank & Trust of Bryan/College Station. Pursuant to the agreement, we will issue 6,275,806 shares of the Company’s common stock in exchange for all of the outstanding shares of TB&T Bancshares, Inc. At June 30, 2019, The Bank & Trust of Bryan/College Station had gross loans totaling
 
$445,600,000, total deposits of $538,200,000 and total assets of $624,500,000. Pending regulatory and shareholder
approvals,
the acquisition is expected to close in the first quarter of 2020.
 
35
 
 
Table of Contents
Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
 
 
 
 
 
 
Forward-Looking Statements
This Form
10-Q
contains certain forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. When used in this Form
10-Q,
words such as “anticipate,” “believe,” “estimate,” “expect,” “intend,” “predict,” “project,” and similar expressions, as they relate to us or 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” in our Annual Report on Form
10-K
and the following:
  • general economic conditions, including local, state, national and international, and the impact they may have on us and our customers;
 
 
 
 
 
 
  • effect of severe weather conditions, including hurricanes, tornadoes, flooding and droughts;
 
 
 
 
 
 
  • volatility and disruption in national and international financial and commodity markets;
 
 
 
 
 
 
  • government intervention in the U.S. financial system including the effects of recent legislative, tax, accounting and regulatory actions and reforms, including the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”), the Jumpstart Our Business Startups Act, the Consumer Financial Protection Bureau, the capital ratios of Basel III as adopted by the federal banking authorities and the Tax Cuts and Jobs Act;
 
 
 
 
 
 
  • political instability;
 
 
 
 
 
 
  • the ability of the Federal government to address the national economy;
 
 
 
 
 
 
  • changes in our competitive environment from other financial institutions and financial service providers;
 
 
 
 
 
 
  • the effects of and changes in trade, monetary and fiscal policies and laws, including interest rate policies of the Board of Governors of the Federal Reserve System (the “Federal Reserve Board”);
 
 
 
 
 
 
  • the effect of changes in accounting policies and practices, as may be adopted by the regulatory agencies, as well as the Public Company Accounting Oversight Board, the Financial Accounting Standards Board and other accounting standard setters;
 
 
 
 
 
 
 
 • the effect on our financial positions and results of operations from the change in accounting practices from the implementation of ASU 2016-13, “Financial Instruments – Credit Losses as it relates to our allowance for loan losses;
 
 
 
  • the effect of changes in laws and regulations (including laws and regulations concerning taxes, banking, securities and insurance) with which we and our subsidiaries must comply;
 
 
 
 
 
 
  • changes in the demand for loans;
 
 
 
 
 
 
  • fluctuations in the value of collateral securing our loan portfolio and in the level of the allowance for loan losses;
 
 
 
 
 
 
  • potential risk of environmental liability associated with lending activities;
 
 
 
 
 
 
  • the accuracy of our estimates of future loan losses;
 
 
 
 
 
 
  • the accuracy of our estimates and assumptions regarding the performance of our securities portfolio;
 
 
 
 
 
 
  • soundness of other financial institutions with which we have transactions;
 
 
 
 
 
 
  • inflation, interest rate, market and monetary fluctuations;
 
 
 
 
 
 
  • changes in consumer spending, borrowing and savings habits;
 
 
 
 
 
 
  • changes in commodity prices (e.g., oil and gas, cattle and wind energy);
 
 
 
 
 
 
  • our ability to attract deposits and increase market share;
 
 
 
 
 
 
  • changes in our liquidity position;
 
 
 
 
 
 
  • changes in the reliability of our vendors, internal control system or information systems;
 
 
 
 
 
 
  • cyber attacks on our technology information systems, including fraud from our customers and external third party vendors;
 
 
 
 
 
 
  • our ability to attract and retain qualified employees;
 
 
 
 
 
 
  • acquisitions and integration of acquired businesses;
 
 
 
 
 
 
  • the possible impairment of goodwill associated with our acquisitions;
 
 
 
 
 
 
  • consequences of continued bank mergers and acquisitions in our market area, resulting in fewer but much larger and stronger competitors;
 
 
 
 
 
 
  • greater than expected costs or difficulties related to expansion of operations, including branch openings, new product offerings and expansion into new markets;
 
 
 
 
 
 
  • changes in our organization, compensation and benefit plans;
 
 
 
 
 
 
  • acts of God or of war or terrorism; and
 
 
 
 
 
 
  • our success at managing the risk involved in the foregoing items.
 
 
 
 
 
 
 
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Such forward-looking statements reflect the current views of our management with respect to future events and are subject to these and other risks, uncertainties and assumptions relating to our operations, results of operations, growth strategy and liquidity. All subsequent written and oral forward-looking statements attributable to us or persons acting on our behalf are expressly qualified in their entirety by this paragraph. We undertake no obligation to publicly update or otherwise revise any forward-looking statements, whether as a result of new information, future events or otherwise (except as required by law).
Introduction
As a financial holding company, we generate most of our revenue from interest on loans and investments, trust fees, and service charges. Our primary source of funding for our loans and investments are deposits held by our subsidiary, First Financial Bank, National Association, Abilene, Texas. Our largest expense is salaries and related employee benefits. We usually measure our performance by calculating our return on average assets, return on average equity, our regulatory leverage and risk-based capital ratios and our efficiency ratio, which is calculated by dividing noninterest expense by the sum of net interest income on a tax equivalent basis and noninterest income.
The following discussion and analysis of operations and financial condition should be read in conjunction with the financial statements and accompanying footnotes included in Item 1 of this Form
10-Q
as well as those included in the Company’s 2018 Annual Report on Form
10-K.
Critical Accounting Policies
We prepare consolidated financial statements based on GAAP and customary practices in the banking industry. These policies, in certain areas, require us to make significant estimates and assumptions.
We deem a policy critical if (1) the accounting estimate required us to make assumptions about matters that are highly uncertain at the time we make the accounting estimate; and (2) different estimates that reasonably could have been used in the current period, or changes in the accounting estimate that are reasonably likely to occur from period to period, would have a material impact on the financial statements.
We deem our most critical accounting policies to be (1) our allowance for loan losses and our provision for loan losses and (2) our valuation of securities. We have other significant accounting policies and continue to evaluate the materiality of their impact on our consolidated financial statements, but we believe these other policies either do not generally require us to make estimates and judgments that are difficult or subjective, or it is less likely they would have a material impact on our reported results for a given period. A discussion of (1) our allowance for loan losses and our provision for loan losses and (2) our valuation of securities is included in note 5 and note 4, respectively, to our notes to consolidated financial statements (unaudited) which begins on page 11.
 
37
 
Table of Contents
Stock Split
On April 23, 2019, the Company’s Board of Directors declared a
two-for-one
stock split in the form of a 100% stock dividend with a record date of May 15, 2019 that was distributed on June 3, 2019. All 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 shares in the consolidated financial statements as of and for the three months ended March 31, 2019 and as of and for the nine months ended September 30, 2019.
Acquisition and Proposed Acquisition
On October 12, 2017, we entered into an agreement and plan of reorganization to acquire Commercial Bancshares, Inc. and its wholly owned bank subsidiary, Commercial State Bank, Kingwood, Texas. On January 1, 2018, the transaction closed. Pursuant to the agreement, we issued 1.29 million shares of the Company’s common stock in exchange for all of the outstanding shares of Commercial Bancshares, Inc. In addition, in accordance with the plan of reorganization, Commercial Bancshares, Inc. paid a special dividend totaling $22.08 million to its shareholders prior to the closing of this transaction. At the closing, Kingwood Merger Sub., Inc., a wholly-owned subsidiary of the Company, merged into Commercial Bancshares Inc., with Commercial Bancshares, Inc. surviving as a wholly-owned subsidiary of the Company. Immediately following such merger, Commercial Bancshares, Inc. was merged into the Company and Commercial State Bank, Kingwood, Texas was merged into First Financial Bank, National Association, Abilene, Texas, a wholly owned subsidiary of the Company. The total purchase price exceeded the estimated fair value net of assets acquired by approximately $31.59 million and the Company recorded such excess as goodwill. The balance sheet and results of operations of Commercial Bancshares, Inc. have been included in the financial statements of the Company effective January 1, 2018. See note 14 to the consolidated financial statements on page 34 for additional information and disclosure.
On September 19, 2019, the we entered into an agreement and plan of reorganization to acquire TB&T Bancshares, Inc. and its wholly owned bank subsidiary, The Bank & Trust of Bryan/College Station. Pursuant to the agreement, we will issue 6.28 million shares of the Company’s common stock in exchange for all of the outstanding shares of TB&T Bancshares, Inc. At June 30, 2019, The Bank & Trust of Bryan/College Station had gross loans totaling $445.60 million, total deposits of $538.20 million and total assets of $624.50 million. Pending regulatory and shareholder approvals, the acquisition is expected to close in the first quarter of 2020.
 
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Table of Contents
Results of Operations
Performance Summary
. Net earnings for the third quarter of 2019 were $43.08 million, up $3.03 million when compared with earnings of $40.05 million in the same quarter last year. Basic earnings per share were $0.32 for the third quarter of 2019 compared with $0.30 in the same quarter a year ago.
The return on average assets was 2.15% for the third quarter of 2019, as compared to 2.10% for the third quarter of 2018. The return on average equity was 14.46% for the third quarter of 2019 as compared to 16.00% for the third quarter of 2018.
Net earnings for the nine-month period ended September 30, 2019 were $123.42 million compared to $112.20 million for the same period in 2018. Basic earnings per share for the first nine months of 2019 were $0.91 compared to $0.83 for the same period in 2018.
The return on average assets was 2.10% for the first nine months of 2019, as compared to 1.97% for the same period a year ago. The return on average equity was 14.67% for the first nine months of 2019 as compared to 15.43% for the first nine months of 2018.
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 $74.21 million for the third quarter of 2019, as compared to $71.67 million for the same period last year. The increase in 2019 compared to 2018 was largely attributable to the increase in interest earning assets. Average earning assets increased $381.25 million for the third quarter of 2019 over the same period in 2018. Average loans and taxable securities increased $248.40 million and $240.81 million, respectively, for the third quarter of 2019 over the same quarter of 2018.
Average
tax-exempt
securities decreased $80.93 million for the third quarter of 2019 compared to the same period in 2018, primarily due to the Company’s gradual shift away from
tax-exempt
securities due to the change in corporate tax rate to 21% from 35%. Average interest-bearing liabilities increased $110.89 million for the third quarter of 2019, as compared to the same period in 2018. The yield on earning assets increased nine basis points while the rate paid on interest-bearing liabilities increased 28 basis points for the third quarter of 2019 compared to the third quarter of 2018.
Tax-equivalent
net interest income was $218.83 million for the first nine months of 2019, as compared to $209.48 million for the same period last year. The increase in 2019 compared to 2018 was largely attributable to the increase in interest earning assets. Average earning assets increased $253.45 million for the first nine months of 2019 over the same period in 2018. Average loans and
tax-exempt
securities increased $239.64 million and $132.13 million, respectively, for the first nine months of 2019 over the first nine months of 2018.
Average
tax-exempt
securities decreased $106.03 million for the first nine months of 2019 compared to the same period in 2018, primarily due to the Company’s gradual shift away from
tax-exempt
securities due to the change in corporate tax rate to 21% from 35%. Average interest-bearing liabilities increased $77.08 million for the first nine months of 2019, as compared to the same period in 2018. The yield on earning assets increased 22 basis points while the rate paid on interest-bearing liabilities increased 30 basis points for the first nine months of 2019 compared to the first nine months of 2018.
 
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Table 1 allocates the change in
tax-equivalent
net interest income between the amount of change attributable to volume and to rate.
Table 1 - Changes in Interest Income and Interest Expense (in thousands):
                                                 
 
Three Months Ended September 30,
2019 Compared to Three Months Ended
September 30, 2018
   
Nine Months Ended September 30,
2019 Compared to Nine Months Ended
September 30, 2018
 
 
Change Attributable to
   
Total
Change
 
  
Change Attributable to
   
Total
Change
 
 
Volume
 
  
Rate
 
Volume
 
  
Rate
 
Short-term investments
  $
(138
 )   $
51
    $
(87
 )   $
(157
 )   $
443
    $
286
 
Taxable investment securities
   
1,560
     
138
     
1,698
     
2,515
     
2,324
     
4,839
 
Tax-exempt
investment securities (1)
    
(764
 )    
(620
 )    
(1,384
 )    
(2,979
 )    
(1,072
 )    
(4,051
 )
Loans (1) (2)
   
3,343
     
2,305
     
5,648
     
9,348
     
9,499
     
18,847
 
                                                 
Interest income
   
4,001
     
1,874
     
5,875
     
8,727
     
11,194
     
19,921
 
Interest-bearing deposits
   
131
     
2,663
     
2,794
     
239
     
8,978
     
9,217
 
Short-term borrowings
   
(8
 )    
544
     
536
     
(12
 )    
1,373
     
1,361
 
                                                 
Interest expense
   
123
     
3,207
     
3,330
     
227
     
10,351
     
10,578
 
                                                 
Net interest income
  $
  3,878
    $
(1,333
 )   $
2,545
    $
8,500
    $
843
    $
9,343
 
                                                 
 
 
 
 
 
 
(1) Computed on a
tax-equivalent
basis assuming a marginal tax rate of 21%.
 
 
 
 
 
 
(2)
Non-accrual
loans are included in loans.
 
 
 
 
 
 
The net interest margin for the third quarter of 2019 was
3.94%, a decrease of seven basis points from the same period in 2018. The net interest margin for the first nine months of 2019 was 3.97%, an increase of three basis points from the same period in 2018. We continue to experience downward pressures on our net interest margin in 2019 and 2018 primarily due to (i) the change in the income tax rate from 35% to 21% from the Tax Cuts and Jobs Act and its effect on our tax free municipal bonds and tax free loans, (ii) an extended period of fluctuating historically low levels of short-term interest rates, and (iii) flat to inverted yield curve currently being experienced in the bond market. We have been able to somewhat mitigate the impact of these lower short-term interest rates and the flat/inverted yield curve by establishing minimum interest rates on certain of our loans, improving the pricing for loan risk, and minimizing rates paid on interest bearing liabilities. The Federal Reserve increased rates 100 basis points in 2018, 75 basis points in 2017 and 25 basis points in 2016 and 2015 but has recently decreased rates by 50 basis points during the third quarter of 2019.
 
40
 
 
Table of Contents
The net interest margin, which measures
tax-equivalent
net interest income as a percentage of average earning assets, is illustrated in Table 2.
Table 2 - Average Balances and Average Yields and Rates (in thousands, except percentages):
                                                 
 
Three Months Ended September 30,
 
 
2019
   
2018
 
 
Average
Balance
 
  
Income/
Expense
 
  
Yield/
Rate
 
  
Average
Balance
 
  
Income/
Expense
 
  
Yield/
Rate
 
Assets
   
     
     
     
     
     
 
Short-term investments (1)
  $
64,471
    $
382
     
2.35
 %   $
91,495
    $
469
     
2.03
 %
Taxable investment securities (2)
   
2,183,930
     
14,292
     
2.62
     
1,943,125
     
12,594
     
2.59
 
Tax-exempt
investment securities (2)(3)
    
1,132,279
     
10,075
     
3.56
     
1,213,212
     
11,459
     
3.78
 
Loans (3)(4)
   
4,094,235
     
57,417
     
5.56
     
3,845,836
     
51,769
     
5.34
 
                                                 
Total earning assets
   
7,474,915
    $
82,166
     
4.36
 %    
7,093,668
    $
  76,291
     
4.27
 %
Cash and due from banks
   
165,868
     
     
     
171,498
     
     
 
Bank premises and equipment, net
   
133,191
     
     
     
130,898
     
     
 
Other assets
   
68,519
     
     
     
63,094
     
     
 
Goodwill and other intangible assets, net
   
174,005
     
     
     
175,048
     
     
 
Allowance for loan losses
   
(52,137
 )    
     
     
(50,383
 )    
     
 
                                                 
Total assets
  $
  7,964,361
     
     
    $
7,583,823
     
     
 
                                                 
Liabilities and Shareholders’ Equity
   
     
     
     
     
     
 
Interest-bearing deposits
  $
4,156,850
    $
7,123
     
0.68
 %   $
  4,035,174
    $
4,329
     
0.43
 %
Short-term borrowings
   
388,235
     
830
     
0.85
      
399,026
     
294
     
0.29
 
                                                 
Total interest-bearing liabilities
   
4,545,085
    $
7,953
     
0.69
 %    
4,434,200
    $
4,623
     
0.41
 %
Noninterest-bearing deposits
   
2,180,200
     
     
     
2,123,612
     
     
 
Other liabilities
   
57,262
     
     
     
32,646
     
     
 
                                                 
Total liabilities
   
6,782,547
     
     
     
6,590,458
     
     
 
Shareholders’ equity
   
1,181,814
     
     
     
993,365
     
     
 
                                                 
Total liabilities and shareholders’ equity
  $
7,964,361
     
     
    $
7,583,823
     
     
 
                                                 
Net interest income
   
    $
74,213
     
     
    $
71,668
     
 
                                                 
Rate Analysis:
   
     
     
     
     
     
 
Interest income/earning assets
   
     
     
4.36
 %    
     
     
4.27
 %
Interest expense/earning assets
   
     
     
0.42
     
     
     
0.26
 
                                                 
Net interest margin
   
     
     
3.94
 %    
     
     
4.01
 %
                                                 
 
 
 
 
 
 
 
 
 
 
 
41
 
Table of Contents
                                                 
 
Nine Months Ended September 30,
 
 
2019
   
2018
 
 
Average
Balance
 
  
Income/
Expense
 
  
Yield/
Rate
 
  
Average
Balance
 
  
Income/
Expense
 
  
Yield/
Rate
 
Assets
   
     
     
     
     
     
 
Short-term investments (1)
  $
93,997
    $
1,667
     
2.37
 %   $
106,294
    $
1,381
     
1.74
 %
Taxable investment securities (2)
   
2,058,380
     
41,505
     
2.69
     
1,926,249
     
36,666
     
2.54
 
Tax-exempt
investment securities (2)(3)
    
1,175,863
     
31,968
     
3.62
     
1,281,892
     
36,019
     
3.75
 
Loans (3)(4)
   
4,037,243
     
166,987
     
5.53
     
3,797,602
     
148,140
     
5.22
 
                                                 
Total earning assets
   
7,365,483
     
242,127
     
4.40
 %    
7,112,037
    $
222,206
     
4.18
 %
Cash and due from banks
   
173,647
     
     
     
177,190
     
     
 
Bank premises and equipment, net
   
133,886
     
     
     
128,863
     
     
 
Other assets
   
65,525
     
     
     
61,941
     
     
 
Goodwill and other intangible assets, net
   
174,264
     
     
     
171,623
     
     
 
Allowance for loan losses
   
(52,143
 )    
     
     
(49,992
 )    
     
 
                                                 
Total assets
  $
  7,860,662
     
     
    $
  7,601,662
     
     
 
                                                 
Liabilities and Shareholders’ Equity
   
     
     
     
     
     
 
Interest-bearing deposits
  $
4,165,735
    $
21,071
     
0.68
 %   $
4,083,292
    $
11,854
     
0.39
 %
Short-term borrowings
   
391,680
     
2,230
     
0.76
     
397,045
     
869
     
0.29
 
                                                 
Total interest-bearing liabilities
   
4,557,415
     
23,301
     
0.68
 %    
4,480,337
    $
12,723
     
0.38
 %
Noninterest-bearing deposits
   
2,133,418
     
     
     
2,119,208
     
     
 
Other liabilities
   
44,994
     
     
     
30,063
     
     
 
                                                 
Total liabilities
   
6,735,827
     
     
     
6,629,608
     
     
 
Shareholders’ equity
   
1,124,835
     
     
     
972,054
     
     
 
                                                 
Total liabilities and shareholders’ equity
  $
7,860,662
     
     
    $
7,601,662
     
     
 
                                                 
Net interest income
   
    $
218,826
     
     
    $
209,483
     
 
                                                 
Rate Analysis:
   
     
     
     
     
     
 
Interest income/earning assets
   
     
     
4.40
 %    
     
     
4.18
 %
Interest expense/earning assets
   
     
     
0.43
     
     
     
0.24
 
                                                 
Net interest margin
   
     
     
3.97
 %    
     
     
3.94
 %
                                                 
 
 
 
 
 
 
 
 
 
(1) Short-term investments are comprised of Fed Funds sold, interest-bearing deposits in banks and interest-bearing time deposits in banks.
 
 
 
 
 
 
 
 
 
(2) Average balances include unrealized gains and losses on
available-for-sale
securities.
 
 
 
 
 
 
 
 
 
(3) Computed on a
tax-equivalent
basis assuming a marginal tax rate of 21%.
 
 
 
 
 
 
 
 
 
(4)
Non-accrual
loans are included in loans.
 
 
 
 
 
 
 
 
 
Noninterest Income
. Noninterest income for the third quarter of 2019 increased to $28.67 million compared to $27.06 million in same period in 2018. Trust fees were $7.05 million in the third quarter of 2019 compared with $7.29 million in the same quarter last year. The fair value of trust assets managed increased to $6.36 billion from $5.75 billion a year ago; however, the income from the growth in assets was offset by a decrease of $447 thousand in Trust mineral fee and lease bonus income when compared to the same period a year ago primarily due to a decline in oil and gas volume. Real estate mortgage fees increased in the third quarter of 2019 to $5.73 million from $4.83 million in the same quarter a year ago due to an increase in the volume of loans originated. ATM, interchange and credit card fees increased 2.59% to $7.73 million compared with $7.53 million in the same quarter last year due to continued growth in debit cards. Additionally, interest on loan recoveries totaled $575 thousand for the third quarter of 2019 compared to $199 thousand for the same period in 2018 due to the collection of a larger loan that had previously been on non-accrual and gains on the sale of assets totaled $235 thousand for the third quarter of 2019 compared to a $61 thousand loss in the same quarter in 2018.
  
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N
oninterest income for the nine-month period ended September 30, 2019 was $81.08 million, an increase of $4.12 million compared to the same period in 2018. Trust fees were $21.06 million in the first nine months of 2019 compared with $21.27 million in the same period in 2018. The fair value of trust assets managed increased to $6.36 billion from $5.75 billion a year ago; however, the income from the growth in assets was offset by a decrease of $896 thousand in Trust mineral fee and lease bonus income when compared to the same period a year ago primarily due to a decline in oil and gas volumes. Service charges on deposits increased to $16.18 million compared with $15.95 million in the same period last year primarily due to the continued growth in net new accounts. Real estate mortgage fees increased in the first nine months of 2019 to $13.93 million compared to $11.72 million in the same period a year ago due to an increase in the volume of loans originated and additional income from the change to mandatory delivery (see notes 6 and 7 to the consolidated financial statements (unaudited) on pages 23 to 25). ATM, interchange and credit card fees increased to $21.92 million compared with $21.57 million in the same period last year due to continued growth in debit cards. Additionally, interest on loan recoveries totaled $1.82 million for the first nine months of 2019 compared to $607 thousand in the same period in 2018 due to the collection of certain larger loans that had previously been on non-accrual. Offsetting these increases was a decrease in gains on the sale of securities which totaled $728 thousand for the first nine months of 2019 compared to $1.35 million in the same period a year ago
.
ATM and interchange fees are charges that merchants pay to us and other card-issuing banks for processing electronic payment transactions. ATM and interchange fees consist of income from debit card usage, point of sale income for debit card transactions and ATM service fees. Federal Reserve rules applicable to financial institutions that have assets of $10 billion or more provide that the maximum permissible interchange fee for an electronic debit transaction is the sum of 21 cents per transaction and 5 basis points multiplied by the value of the transaction. While we currently have assets under $10 billion, we are monitoring the effect of this reduction in per transaction fee income as we approach the $10 billion asset level.
Table 3 - Noninterest Income (in thousands):
                                                 
 
Three Months Ended
September 30,
   
Nine Months Ended
September 30,
 
 
2019
 
  
Increase
(Decrease)
 
  
2018
 
  
2019
 
  
Increase
(Decrease)
 
  
2018
 
Trust fees
  $
7,051
    $
(240
 )   $
7,291
    $
21,057
    $
(208
 )   $
21,265
 
Service charges on deposit accounts
   
5,629
     
(61
 )    
5,690
     
16,179
     
229
     
15,950
 
ATM, interchange and credit card fees
   
7,728
     
195
     
7,533
     
21,920
     
350
     
21,570
 
Real estate mortgage operations
   
5,733
     
899
     
4,834
     
13,928
     
2,210
     
11,718
 
Net gain on sale of
available-for-sale
securities
    
52
     
(6
 )    
58
     
728
     
(618
 )    
1,346
 
Net gain (loss) on sale of foreclosed assets
   
71
     
(13
 )    
84
     
193
     
(8
 )    
201
 
Net gain (loss) on sale of assets
   
235
     
296
     
(61
 )    
241
     
393
     
(152
 )
Interest on loan recoveries
   
575
     
376
     
199
     
1,815
     
1,208
     
607
 
Other:
   
     
     
     
     
     
 
Check printing fees
   
55
     
1
     
54
     
143
     
(7
 )    
150
 
Safe deposit rental fees
   
115
     
3
     
112
     
429
     
(7
 )    
436
 
Credit life fees
   
184
     
63
     
121
     
798
     
189
     
609
 
Brokerage commissions
   
406
     
(16
 )    
422
     
1,169
     
(117
 )    
1,286
 
Miscellaneous income
   
835
     
117
     
718
     
2,481
     
501
     
1,980
 
                                                 
Total other
   
1,595
     
168
     
1,427
     
5,020
     
559
     
4,461
 
                                                 
Total Noninterest Income
  $
  28,669
    $
  1,614
    $
27,055
    $
  81,081
    $
  4,115
    $
76,966
 
                                                 
 
 
 
 
 
 
 
 
 
Noninterest Expense
. Total noninterest expense for the third quarter of 2019 was $48.91 million, an increase of $1.40 million compared to $47.51 million in the same period of 2018. An important measure in determining whether a financial institution effectively manages noninterest expense is the efficiency ratio, which is calculated by dividing noninterest expense by the sum of net interest income on a
tax-equivalent
basis and noninterest income. Lower ratios indicate better efficiency since more income is generated with a lower noninterest expense total. Our efficiency ratio for the third quarter of 2019 was 47.54% compared to 48.12% for the same quarter in 2018.
 
43
 
Table of Contents
Salaries and employee benefits expense for the third quarter of 2019 totaled $28.55 million, an increase of $2.17 million compared to the same period in 2018. The increase was primarily driven by annual merit-based pay increases that were effective March 1, 2019. All other categories of noninterest expense for the third quarter of 2019 totaled $20.36 million, down from $21.13 million in the same quarter a year ago primarily due to a reduction of $555 thousand in FDIC insurance premiums resulting from credits from prior premiums paid.
Total noninterest expense for the first nine months of 2019 was $144.58 million, an increase of $2.14 million when compared to $142.45 million in the same period in 2018. Our efficiency ratio for the first nine months of 2019 was 48.21%, compared to 49.73% from the same period in 2018.
Salaries and employee benefits expense for the first nine months of 2019 totaled $83.37 million, an increase of $3.93 million when compared to the same period in 2018. The increase was primarily driven by annual merit-based pay increases that were effective March 1, 2019 and the recognition of $900 thousand in pension expense resulting from the Company’s continued efforts to terminate its frozen defined benefits pension plan.
All other categories of noninterest expense for the first nine months of 2019 totaled $61.22 million, a decrease of $1.79 million when compared to the same period in 2018. Included in noninterest expense in the first nine months period of 2018 were technology contract termination and conversion related costs totaling $1.55 million related to the Commercial State Bank acquisition.
 
44
 
Table of Contents
Table 4 - Noninterest Expense (in thousands):
                                                 
 
Three Months Ended September
30,
   
Nine Months Ended September
30,
 
 
2019
 
  
Increase
(Decrease)
 
  
2018
 
  
2019
 
  
Increase
(Decrease)
 
  
2018
 
Salaries
  $
22,197
    $
  2,123
    $
20,074
    $
62,440
    $
  2,807
    $
59,633
 
Medical
   
2,101
     
19
     
2,082
     
6,884
     
290
     
6,594
 
Profit sharing
   
1,520
     
(164
 )    
1,684
     
4,895
     
(315
 )    
5,210
 
Pension
   
31
     
(34
 )    
65
     
73
     
(104
 )    
177
 
401(k) match expense
   
668
     
20
     
648
     
2,094
     
102
     
1,992
 
Payroll taxes
   
1,354
     
82
     
1,272
     
4,365
     
161
     
4,204
 
Stock option and stock grant expense
   
679
     
127
     
552
     
1,717
     
85
     
1,632
 
                                                 
Total salaries and employee benefits
   
28,550
     
2,173
     
26,377
     
82,468
     
3,026
     
79,442
 
Loss from partial settlement of pension plan
   
—  
      
—  
      
—  
      
900
     
900
     
—  
  
Net occupancy expense
   
2,830
     
(70
 )    
2,900
     
8,372
     
(217
 )    
8,589
 
Equipment expense
   
2,225
     
(404
 )    
2,629
     
7,009
     
(539
 )    
7,548
 
FDIC assessment fees
   
15
     
(555
 )    
570
     
1,091
     
(677
 )    
1,768
 
ATM, interchange and credit card expense
   
2,627
     
283
     
2,344
     
7,437
     
745
     
6,692
 
Professional and service fees
   
1,902
     
(272
 )    
2,174
     
5,721
     
(892
 )    
6,613
 
Printing, stationery and supplies
   
480
     
93
     
387
     
1,348
     
(137
 )    
1,485
 
Operational and other losses
   
507
     
(474
 )    
981
     
1,253
     
(599
 )    
1,852
 
Software amortization and expense
   
1,767
     
374
     
1,393
     
5,147
     
714
     
4,433
 
Amortization of intangible assets
   
246
     
(33
 )    
279
     
778
     
(271
 )    
1,049
 
Other:
   
     
     
     
     
     
 
Data processing fees
   
406
     
(34
 )    
440
     
1,174
     
143
     
1,031
 
Postage
   
407
     
(31
 )    
438
     
1,248
     
(29
 )    
1,277
 
Advertising
   
907
     
(36
 )    
943
     
2,669
     
(13
 )    
2,682
 
Correspondent bank service charges
   
171
     
(20
 )    
191
     
518
     
(71
 )    
589
 
Telephone
   
918
     
40
     
878
     
2,841
     
125
     
2,716
 
Public relations and business development
   
838
     
72
     
766
     
2,353
     
175
     
2,178
 
Directors’ fees
   
524
     
100
     
424
     
1,469
     
156
     
1,313
 
Audit and accounting fees
   
357
     
(56
 )    
413
     
1,282
     
(46
 )    
1,328
 
Legal fees
   
356
     
144
     
212
     
938
     
113
     
825
 
Regulatory exam fees
   
298
     
(23
 )    
321
     
881
     
(73
 )    
954
 
Travel
   
364
     
54
     
310
     
1,239
     
164
     
1,075
 
Courier expense
   
221
     
15
     
206
     
611
     
(20
 )    
631
 
Other real estate owned
   
37
     
17
     
20
     
109
     
3
     
106
 
Other miscellaneous expense
   
1,957
     
47
     
1,910
     
5,727
     
(545
 )    
6,272
 
                                                 
Total other
   
7,761
     
289
     
7,472
     
23,059
     
82
     
22,977
 
                                                 
Total Noninterest Expense
  $
48,910
    $
1,404
    $
47,506
    $
144,583
    $
2,135
    $
142,448
 
                                                 
 
 
 
 
 
 
 
 
 
 
45
 
 
Table of Contents
 
Balance Sheet Review
Loans
. Our portfolio is comprised of loans made to businesses, professionals, individuals, and farm and ranch operations located in the primary trade areas served by our subsidiary bank. Real estate loans represent loans primarily for
1-4
family residences and commercial real estate. The structure of loans in the real estate mortgage area generally provides
re-pricing
intervals to minimize the interest rate risk inherent in long-term fixed rate loans. As of September 30, 2019, total loans held for investment were $4.10 billion, an increase of $146.68 million, as compared to December 31, 2018 balances. As compared to December 31, 2018, commercial loans decreased $8.31 million, agricultural loans increased $5.38 million, real estate loans increased $110.21 million and consumer loans increased $39.41 million. Loans averaged $4.09 billion during the third quarter of 2019, an increase of $248.40 million from the prior year third quarter average balances. Loans averaged $4.04 billion during the first nine months of 2019, an increase of $239.64 million from the prior year nine-month period average balances.
Table 5 - Composition of Loans (in thousands):
                         
 
September 30,
   
December 31,
 
 
2019
 
  
2018
 
  
2018
 
Commercial
  $
836,644
    $
773,924
    $
844,953
 
Agricultural
   
102,054
     
93,953
     
96,677
 
Real estate
   
2,749,552
     
2,614,929
     
2,639,346
 
Consumer
   
412,066
     
384,234
     
372,660
 
                         
Total loans
held-for-investment
  $
4,100,316
    $
3,867,040
    $
3,953,636
 
                         
 
 
 
 
 
At September 30, 2019, our real estate loans represent approximately 67.06% of our loan portfolio and are comprised of (i)
1-4
family residence loans of 41.76%, (ii) commercial real estate loans of 29.46%, generally owner occupied, (iii) other loans, which includes ranches, hospitals and universities, of 12.66%, (iv) residential development and construction loans of 9.83%, which includes our custom and speculative home construction loans and (v) commercial development and construction loans of 6.29%.
Loans held for sale, consisting of secondary market mortgage loans, totaled $40.50 million, $18.50 million, and $21.67 million at September 30, 2019 and 2018, and December 31, 2018, respectively. At September 30, 2019 and 2018 and December 31, 2018, $764 thousand, $2.54 million and $2.49 million, respectively, are valued using the lower of cost or fair value method and the remaining amounts are valued under the fair value option method. See notes 6 and 7 to the consolidated financial statements (unaudited) related to the change to mandatory delivery for sales in the secondary mortgage market on pages 23 through 25.
Asset Quality
. Our loan portfolio is subject to periodic reviews by our centralized independent loan review group as well as periodic examinations by bank regulatory agencies. Loans are placed on nonaccrual status when, in the judgment of management, the collectability of principal or interest under the original terms becomes doubtful. Nonaccrual, past due 90 days or more and still accruing, and restructured loans plus foreclosed assets were $27.21 million at September 30, 2019, as compared to $26.86 million at September 30, 2018 and $29.63 million at December 31, 2018. As a percent of loans and foreclosed assets, these assets were 0.66% at September 30, 2019, as compared to 0.69% at September 30, 2018 and 0.75% at December 31, 2018. As a percent of total assets, these assets were 0.34% at September 30, 2019, as compared to 0.35% at September 30, 2018 and 0.38% at December 31, 2018. We believe the level of these assets to be manageable and are not aware of any material classified credits not properly disclosed as nonperforming at September 30, 2019.
 
46
 
Table of Contents
Supplemental Oil and Gas Information
. As of September 30, 2019, the Company’s exposure to the oil and gas industry totaled 2.97% of gross loans, or $122.91 million, up $9.37 million from December 31, 2018
year-end
levels, and consisted (based on collateral supporting the loan) of (i) development and production loans of 11.27%, (ii) oil and gas field servicing loans of 14.97%, (iii) real estate loans of 38.10%, (iv) accounts receivable and inventory of 2.33%, (v) automobile of 26.09% and (vi) other of 7.24%. The following oil and gas information is as of and for the quarters ended September 30, 2019 and 2018, and December 31, 2018:
                         
 
September 30,
   
December 31,
 
 
2019
 
  
2018
 
  
2018
 
Oil and gas related loans
  $
  122,908
    $
  112,039
    $
  113,536
 
Oil and gas related loans as a % of total loans
   
2.97
 %    
2.88
 %    
2.86
 %
Classified oil and gas related loans
  $
7,953
    $
4,861
    $
3,894
 
Non-accrual
oil and gas related loans
   $
519
    $
1,825
    $
1,048
 
Net charge-offs for oil and gas related loans
   $
—  
     $
—  
     $
—  
  
Allowance for oil and gas related loans as a % of oil and gas loans
   
2.87
 %    
3.28
 %    
3.23
 %
 
 
 
 
 
Table 6 –
Non-accrual,
Past Due 90 Days or More and Still Accruing, Restructured Loans and Foreclosed Assets (in thousands, except percentages):
                         
 
September 30,
   
December 31,
 
 
2019
 
  
2018
 
  
2018
 
Non-accrual
loans*
   $
25,717
    $
25,587
    $
27,534
 
Loans still accruing and past due 90 days or more
   
104
     
88
     
1,008
 
Troubled debt restructured loans**
   
27
     
513
     
513
 
                         
Nonperforming Loans
   
25,848
     
26,188
     
29,055
 
Foreclosed assets
   
1,364
     
671
     
577
 
                         
Total nonperforming assets
   
27,212
    $
26,859
    $
29,632
 
                         
As a % of loans and foreclosed assets
   
0.66
 %    
0.69
 %    
0.75
 %
As a % of total assets
   
0.34
 %    
0.35
 %    
0.38
 %
 
 
 
 
 
* Includes $342 thousand, $2.95 million and $827 thousand of purchased credit impaired loans as of September 30, 2019 and 2018, and December 31, 2018, respectively.
 
 
 
 
 
** Other troubled debt restructured loans of $3.98 million, $4.58 million and $3.84 million, whose interest collection, after considering economic and business conditions and collection efforts, is doubtful are included in
non-accrual
loans at September 30, 2019 and 2018, and December 31, 2018, respectively.
 
 
 
 
 
We record interest payments received on
non-accrual
loans as reductions of principal. Prior to the loans being placed on
non-accrual,
we recognized interest income on impaired loans of approximately $395 thousand for the year ended December 31, 2018. If interest on these impaired loans had been recognized on a full accrual basis during the year ended December 31, 2018, such income would have approximated $2.57 million. Such amounts for the 2019 and 2018 interim periods were not significant.
 
47
 
Table of Contents
Provision and Allowance for Loan Losses
. The allowance for loan losses is the amount we determine as of a specific date to be appropriate to absorb probable losses on existing loans in which full collectability is unlikely based on our review and evaluation of the loan portfolio. For a discussion of our methodology, see note 5 to our notes to the consolidated financial statements (unaudited). The provision for loan losses was $450 thousand for the third quarter of 2019, as compared to $1.45 million for the third quarter of 2018. The provision for loan losses was $2.02 million for the nine-month period ended September 30, 2019 as compared to $3.87 million for the same period in 2018. The continued provision for loan losses in 2019 and 2018 reflects primarily the growth in the loan portfolio. As a percent of average loans, net loan charge-offs were 0.04% for the third quarter of 2019, as compared to 0.05% for the third quarter of 2018. As a percentage of average loans, net loan charge-offs were 0.04% for the first nine months of 2019, as compared to 0.04% for the first nine months of 2018. The allowance for loan losses as a percent of loans was 1.25% as of September 30, 2019, as compared to 1.31% as of September 30, 2018 and 1.29% as of December 31, 2018. Included in Table 7 is further analysis of our allowance for loan losses.
Table 7 - Loan Loss Experience and Allowance for Loan Losses (in thousands, except percentages):
                                 
 
Three Months Ended
September 30,
   
Nine Months Ended
September 30,
 
 
2019
 
  
2018
 
  
2019
 
  
2018
 
Allowance for loan losses at
period-end
  $
51,889
    $
50,871
    $
51,889
    $
50,871
 
Loans held for investment at
period-end
  $
4,100,316
    $
3,867,040
    $
4,100,316
    $
3,867,040
 
Average loans for period
  $
4,094,235
    $
3,845,836
    $
4,037,243
    $
3,797,602
 
Net charge-offs/average loans (annualized)
   
0.04
 %    
0.05
 %    
0.04
 %    
0.04
 %
Allowance for loan
losses/period-end
loans
    
1.25
 %    
1.31
 %    
1.25
 %    
1.31
 %
Allowance for loan
losses/non-accrual
loans, past due 90 days still accruing and restructured loans
    
200.75
 %    
194.25
 %    
200.75
 %    
194.25
 %
 
 
 
 
 
Interest-Bearing Deposits in Banks.
At September 30, 2019, our interest-bearing deposits in banks were $31.41 million compared to $35.97 million at September 30, 2018 and $42.27 million at December 31, 2018, respectively. At September 30, 2019, interest-bearing deposits in banks included $30.97 million maintained at the Federal Reserve Bank of Dallas and $437 thousand on deposit with the Federal Home Loan Bank of Dallas (“FHLB”).
Available-for-Sale and Held-to-Maturity Securities
. At September 30, 2019, securities with a fair value of $3.40 billion were classified as securities
available-for-sale.
As compared to December 31, 2018, the
available-for-sale
portfolio at September 30, 2019
reflected (i) an increase in U.S. Treasury securities of $59 thousand, (ii) a decrease of $301 thousand in obligations of U.S. government sponsored enterprises and agencies, (iii) a decrease of $15.67 million in obligations of states and political subdivisions, (iv) a decrease of $68 thousand in corporate bonds and other, and (v) an increase of $254.36 million in mortgage-backed securities. The shift to mortgage-backed securities from obligations of state and political subdivisions was due to the change in the federal income tax rate of 21% from 35% effective January 1, 2018. Our mortgage related securities are backed by GNMA, FNMA or FHLMC or are collateralized by securities backed by these agencies.
See note 4 to the consolidated financial statements (unaudited) for additional disclosures relating to the investment portfolio at September 30, 2019 and 2018, and December 31, 2018.
 
48
 
Table of Contents
Table 8 - Maturities and Yields of
Available-for-Sale
Securities Held at September 30, 2019 (in thousands, except percentages):
                                                                                 
 
Maturing
 
 
One Year
or Less
   
After One Year
Through
Five Years
   
After Five Years
Through
Ten Years
   
After
Ten Years
   
Total
 
Available-for-Sale:
 
Amount
 
  
Yield
 
  
Amount
 
  
Yield
 
  
Amount
 
  
Yield
 
  
Amount
 
  
Yield
 
  
Amount
 
  
Yield
 
U.S. Treasury securities
  $
10,021
     
2.52
 %   $
—  
      
—  
 %   $
—  
      
—  
 %   $
—  
      
—  
 %   $
10,021
     
2.52
 %
Obligations of states and political subdivisions
   
194,379
     
4.61
     
520,263
     
4.26
     
525,301
     
3.80
     
2,254
     
5.66
     
1,242,197
     
4.13
 
Corporate bonds and other securities
   
4,499
     
2.40
     
231
     
2.63
     
—  
      
—  
      
—  
      
—  
      
4,730
     
2.41
 
Mortgage-backed securities
   
47,657
     
1.76
     
1,663,037
     
2.64
     
403,751
     
2.88
     
25,763
     
3.06
     
2,140,208
     
2.67
 
                                                                                 
Total
  $
256,556
     
3.96
 %   $
2,183,531
     
3.03
 %   $
929,052
     
3.39
 %   $
28,017
     
3.27
 %   $
3,397,156
     
3.20
 %
                                                                                 
 
 
 
 
 
All yields are computed on a
tax-equivalent
basis assuming a marginal tax rate of 21%. Yields on
available-for-sale
securities are based on amortized cost. Maturities of mortgage-backed securities are based on contractual maturities and could differ due to prepayments of underlying mortgages. Maturities of other securities are reported at the earlier of maturity date or call date.
As of September 30, 2019, the investment portfolio had an overall tax equivalent yield of 3.20%, a weighted average life of 4.12 years and modified duration of 3.68 years.
Deposits
. Deposits held by our subsidiary bank represent our primary source of funding. Total deposits were $6.40 billion as of September 30, 2019, as compared to $6.15 billion as of September 30, 2018 and $6.18 billion as of December 31, 2018. Table 9 provides a breakdown of average deposits and rates paid for the three and nine-month periods ended September 30, 2019 and 2018, respectively.
Table 9 — Composition of Average Deposits (in thousands, except percentages):
                                 
 
Three Months Ended September 30,
 
 
2019
   
2018
 
 
Average
Balance
 
  
Average
Rate
 
  
Average
Balance
 
  
Average
Rate
 
Noninterest-bearing deposits
  $
2,180,200
     
—  
 %   $
2,123,612
     
—  
 %
Interest-bearing deposits:
   
     
     
     
 
Interest-bearing checking
   
2,046,792
     
0.69
     
1,987,884
     
0.54
 
Savings and money market accounts
   
1,679,684
     
0.58
     
1,582,698
     
0.29
 
Time deposits under $100,000
   
184,843
     
0.79
     
197,713
     
0.24
 
Time deposits of $100,000 or more
   
245,531
     
1.15
     
266,879
     
0.52
 
                                 
Total interest-bearing deposits
   
4,156,850
     
0.68
 %    
4,035,174
     
0.43
 %
                                 
Total average deposits
  $
6,337,050
     
    $
6,158,786
     
 
                                 
 
 
 
 
 
 
49
 
Table of Contents
                                 
 
Nine Months Ended September 30,
 
 
2019
   
2018
 
 
Average
Balance
 
  
Average
Rate
 
  
Average
Balance
 
  
Average
Rate
 
Noninterest-bearing deposits
  $
2,133,418
     
—  
 %   $
2,119,208
     
—  
 %
Interest-bearing deposits:
   
     
     
     
 
Interest-bearing checking
   
2,052,943
     
0.73
     
2,058,071
     
0.52
 
Savings and money market accounts
   
1,677,181
     
0.57
     
1,550,428
     
0.23
 
Time deposits under $100,000
   
188,210
     
0.68
     
211,418
     
0.21
 
Time deposits of $100,000 or more
   
247,401
     
1.01
     
263,375
     
0.43
 
                                 
Total interest-bearing deposits
   
4,165,735
     
0.68
 %    
4,083,292
     
0.39
 %
                                 
Total average deposits
  $
6,299,153
     
    $
6,202,500
     
 
                                 
 
 
 
 
 
Borrowings.
Included in borrowings were federal funds purchased, securities sold under repurchase agreements and advances from the FHLB of $400.16 million, $380.76 million and $468.71 million at September 30, 2019 and 2018 and December 31, 2018, respectively. Securities sold under repurchase agreements are generally with significant customers of the Company that require short-term liquidity for their funds for which we pledge certain securities that have a fair value equal to at least the amount of the borrowings. The average balance of federal funds purchased, securities sold under repurchase agreements and advances from the FHLB were $388.24 million and $399.03 million in the third quarter of 2019 and 2018, respectively. The weighted average interest rates paid on these borrowings were 0.85% and 0.29% for the third quarters of 2019 and 2018, respectively. The average balances of federal funds purchased, securities sold under repurchase agreements and advances from the FHLB was $391.68 million and $397.05 million for the nine-month periods ended September 30, 2019 and 2018, respectively. The weighted average interest rate on these short-term borrowings was 0.76% and 0.29% for the first nine months of 2019 and 2018, 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 $1.21 billion, or 14.85% of total assets at September 30, 2019, as compared to $995.74 million or 13.15% of total assets at September 30, 2018 and $1.05 billion, or 13.62% of total assets at December 31, 2018. Included in shareholders’ equity at September 30, 2019 and 2018 and December 31, 2018, were $73.52 million, ($25.10) million and $4.17 million, respectively, in unrealized gains (losses) on investment securities
available-for-sale,
net of related income taxes. For the third quarter of 2019, total shareholders’ equity averaged $1.18 billion, or 14.84% of average assets, as compared to $993.37 million, or 13.10% of average assets, during the same period in 2018. For the nine months ended September 30, 2019, total shareholders’ equity averaged $1.12 billion or 14.31%, as compared to $972.06 million or 12.79% of total assets during the same period in 2018.
Banking regulators measure capital adequacy by means of the risk-based capital ratios and the leverage ratio under the Basel III regulatory capital framework and prompt corrective action regulations. The risk-based capital rules provide for the weighting of assets and
off-balance-sheet
commitments and contingencies according to prescribed risk categories. Regulatory capital is then divided by risk-weighted assets to determine the risk-adjusted capital ratios. The leverage ratio is computed by dividing shareholders’ equity less intangible assets by
quarter-to-date
average assets less intangible assets.
 
50
 
 
Table of Contents
Beginning in January 2016, under the Basel III regulatory capital framework, the implementation of the capital conservation buffer was effective for the Company starting at the 0.625% level and increasing 0.625% each year thereafter, until it reached 2.50% on January 1, 2019. The capital conservation buffer is designed to absorb losses during periods of economic stress and requires increased capital levels for the purpose of capital distributions and other payments. Failure to meet the amount of the buffer will result in restrictions on the Company’s ability to make capital distributions, including dividend payments and stock repurchases, and to pay discretionary bonuses to executive officers.
As of September 30, 2019 and 2018, and December 31, 2018, we had a total capital to risk-weighted assets ratio of 21.14%, 20.34% and 20.61%, a Tier 1 capital to risk-weighted assets ratio of 20.05%, 19.19% and 19.47%; a common equity Tier 1 to risk-weighted assets ratio of 20.05%, 19.19% and 19.47% and a leverage ratio of 12.58%, 11.57% and 11.85%, respectively. The regulatory capital ratios as of September 30, 2019 and 2018, and December 31, 2018 were calculated under Basel III rules. There is no threshold for well-capitalized status for bank holding companies.
The regulatory capital ratios of the Company and Bank under the Basel III regulatory capital framework are as follows:
                                                 
 
Actual
   
Minimum Capital
Required-Basel III
Fully
Phased-In*
   
Required to be
Considered Well-
Capitalized
 
As of September 30, 2019:
 
Amount
 
  
Ratio
 
  
Amount
 
  
Ratio
 
  
Amount
 
  
Ratio
 
Total Capital to Risk-Weighted Assets:
   
     
     
     
     
     
 
Consolidated
  $
1,023,229
     
21.14
 %   $
508,149
     
10.50
 %    
—  
      
N/A
 
First Financial Bank, N.A
  $
905,495
     
18.75
 %   $
506,957
     
10.50
 %   $
482,816
     
10.00
 %
Tier 1 Capital to Risk-Weighted Assets:
   
     
     
     
     
     
 
Consolidated
  $
970,532
     
20.05
 %   $
411,359
     
8.50
 %    
—  
      
N/A
 
First Financial Bank, N.A
  $
852,798
     
17.66
 %   $
410,394
     
8.50
 %   $
386,253
     
8.00
 %
Common Equity Tier 1 Capital to Risk-Weighted Assets:
   
     
     
     
     
     
 
Consolidated
  $
970,532
     
20.05
 %   $
338,766
     
7.00
 %    
—  
      
N/A
 
First Financial Bank, N.A
  $
852,798
     
17.66
 %   $
337,971
     
7.00
 %   $
313,830
     
6.50
 %
Leverage Ratio:
   
     
     
     
     
     
 
Consolidated
  $
970,532
     
12.58
 %   $
308,675
     
4.00
 %    
—  
      
N/A
 
First Financial Bank, N.A
  $
852,798
     
11.10
 %   $
307,442
     
4.00
 %   $
384,302
     
5.00
 %
 
 
 
 
* At September 30, 2019, the capital conservation buffer under Basel III has been fully
phased-in.
 
 
 
 

51
 
Table of Contents
                                                                 
 
Actual
   
Minimum Capital
Required Under
Basel III
Phase-In
   
Minimum Capital
Required-Basel III
Fully
Phased-In
   
Required to be
Considered Well-
Capitalized
 
As of September 30, 2018:
 
Amount
 
  
Ratio
 
  
Amount
 
  
Ratio
 
  
Amount
 
  
Ratio
 
  
Amount
 
  
Ratio
 
Total Capital to Risk-Weighted Assets:
   
     
     
     
     
     
     
     
 
Consolidated
  $
912,453
     
20.34
 %   $
442,997
     
9.875
 %   $
471,035
     
10.50
 %    
—  
      
N/A
 
First Financial Bank, N.A
  $
819,222
     
18.31
 %   $
441,850
     
9.875
 %   $
469,815
     
10.50
 %   $
447,443
     
10.00
 %
Tier 1 Capital to Risk-Weighted Assets:
   
     
     
     
     
     
     
     
 
Consolidated
  $
860,848
     
19.19
 %   $
353,276
     
7.875
 %   $
381,314
     
8.50
 %    
—  
      
N/A
 
First Financial Bank, N.A
  $
767,617
     
17.16
 %   $
352,362
     
7.875
 %   $
380,327
     
8.50
 %   $
357,955
     
8.00
 %
Common Equity Tier 1 Capital to Risk-Weighted Assets:
   
     
     
     
     
     
     
     
 
Consolidated
  $
860,848
     
19.19
 %   $
285,985
     
6.375
 %   $
314,023
     
7.00
 %    
—  
      
N/A
 
First Financial Bank, N.A
  $
767,617
     
17.16
 %   $
285,245
     
6.375
 %   $
313,210
     
7.00
 %   $
290,838
     
6.50
 %
Leverage Ratio:
   
     
     
     
     
     
     
     
 
Consolidated
  $
860,848
     
11.57
 %   $
297,516
     
4.000
 %   $
297,516
     
4.00
 %    
—  
      
N/A
 
First Financial Bank, N.A
  $
767,617
     
10.36
 %   $
296,444
     
4.000
 %   $
296,444
     
4.00
 %   $
370,554
     
5.00
 %
 
 
 
 
                                                                 
 
Actual
   
Minimum Capital
Required Under
Basel III
Phase-In
   
Minimum Capital
Required-Basel III
Fully
Phased-In
   
Required to be
Considered Well-
Capitalized
 
As of December 31, 2018:
 
Amount
 
  
Ratio
 
  
Amount
 
  
Ratio
 
  
Amount
 
  
Ratio
 
  
Amount
 
  
Ratio
 
Total Capital to Risk-Weighted Assets:
   
     
     
     
     
     
     
     
 
Consolidated
  $
940,026
     
20.61
 %   $
450,459
     
9.875
 %   $
478,969
     
10.50
 %    
—  
      
N/A
 
First Financial Bank, N.A
  $
824,428
     
18.12
 %   $
449,350
     
9.875
 %   $
477,790
     
10.50
 %   $
455,038
     
10.00
 %
Tier 1 Capital to Risk-Weighted Assets:
   
     
     
     
     
     
     
     
 
Consolidated
  $
888,015
     
19.47
 %   $
359,226
     
7.875
 %   $
387,737
     
8.50
 %    
—  
      
N/A
 
First Financial Bank, N.A
  $
772,417
     
16.97
 %   $
358,342
     
7.875
 %   $
386,782
     
8.50
 %   $
364,030
     
8.00
 %
Common Equity Tier 1 Capital to Risk-Weighted Assets:
   
     
     
     
     
     
     
     
 
Consolidated
  $
888,015
     
19.47
 %   $
290,802
     
6.375
 %   $
319,312
     
7.00
 %    
—  
      
N/A
 
First Financial Bank, N.A
  $
772,417
     
16.97
 %   $
290,087
     
6.375
 %   $
318,526
     
7.00
 %   $
295,775
     
6.50
 %
Leverage Ratio:
   
     
     
     
     
     
     
     
 
Consolidated
  $
888,015
     
11.85
 %   $
299,682
     
4.00
 %   $
299,682
     
4.00
 %    
—  
      
N/A
 
First Financial Bank, N.A
  $
772,417
     
10.35
 %   $
298,576
     
4.00
 %   $
298,576
     
4.00
 %   $
373,220
     
5.00
 %
 
 
 
 
In connection with the adoption of the Basel III regulatory capital framework, our subsidiary bank made the election to continue to exclude most accumulated other comprehensive income (“AOCI”) from capital in connection with its quarterly financial filing and, in effect, to retain the AOCI treatment under the prior capital rules.
Interest Rate Risk
Interest rate risk results when the maturity or repricing intervals of interest-earning assets and interest-bearing liabilities are different. Our exposure to interest rate risk is managed primarily through our strategy of selecting the types and terms of interest-earning assets and interest-bearing liabilities that generate favorable earnings while limiting the potential negative effects of changes in market interest rates. We use no
off-balance
sheet financial instruments to manage interest rate risk.
 
52
 
Table of Contents
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 twelve months. The model measures the impact on net interest income relative to a base case scenario of hypothetical fluctuations in interest rates over the next twelve months. These simulations incorporate assumptions regarding balance sheet growth and mix, pricing and the
re-pricing
and maturity characteristics of the existing and projected balance sheet.
As of September 30, 2019, the model simulations projected that 100 and 200 basis point increases in interest rates would result in positive variances in net interest income of 2.69% and 4.43%, respectively, relative to the current financial statement structure over the next twelve months, while a decrease in interest rates of 100 and 200 basis points would result in a negative variance in net interest income of 2.84% and 5.67%, respectively, relative to the current financial statement structure over the next twelve months. Our model simulation as of September 30, 2019 indicates that our balance sheet is relatively asset/liability neutral. These are good faith estimates and assume that the composition of our interest sensitive assets and liabilities existing at each
year-end
will remain constant over the relevant twelve-month measurement period and that changes in market interest rates are instantaneous and sustained across the yield curve regardless of duration of pricing characteristics on specific assets or liabilities. Also, this analysis does not contemplate any actions that we might undertake in response to changes in market interest rates. We believe these estimates are not necessarily indicative of what actually could occur in the event of immediate interest rate increases or decreases of this magnitude. As interest-bearing assets and liabilities
re-price
in different time frames and proportions to market interest rate movements, various assumptions must be made based on historical relationships of these variables in reaching any conclusion. Since these correlations are based on competitive and market conditions, we anticipate that our future results will likely be different from the foregoing estimates, and such differences could be material.
Should we be unable to maintain a reasonable balance of maturities and repricing of our interest-earning assets and our interest-bearing liabilities, we could be required to dispose of our assets in an unfavorable manner or pay a higher than market rate to fund our activities. Our asset liability committee oversees and monitors this risk.
Liquidity
Liquidity is our ability to meet cash demands as they arise. Such needs can develop from loan demand, deposit withdrawals or acquisition opportunities. Potential obligations resulting from the issuance of standby letters of credit and commitments to fund future borrowings to our loan customers are other factors affecting our liquidity needs. Many of these obligations and commitments are expected to expire without being drawn upon; therefore the total commitment amounts do not necessarily represent future cash requirements affecting our liquidity position. The potential need for liquidity arising from these types of financial instruments is represented by the contractual notional amount of the instrument. Asset liquidity is provided by cash and assets which are readily marketable or which will mature in the near future. Liquid assets include cash, federal funds sold, and short-term investments in time deposits in banks. Liquidity is also provided by access to funding sources, which include core depositors and correspondent banks that maintain accounts with and sell federal funds to our subsidiary bank. Other sources of funds include our ability to borrow from short-term sources, such as purchasing federal funds from correspondent banks, sales of securities under agreements to repurchase and advances from the FHLB (see below) and an unfunded $25.00 million revolving line of credit established with Frost Bank, a nonaffiliated bank, which matures in June 2021 (see next paragraph).
Our subsidiary bank also has federal funds purchased lines of credit with two
non-affiliated
banks totaling $130.00 million. At September 30, 2019, no amounts were drawn on these lines of credit. Our subsidiary bank also has available a line of credit with the FHLB totaling $1.24 billion at September 30, 2019, secured by portions of our loan portfolio and certain investment securities. At September 30, 2019, the Company had $35.00 million outstanding under this line of credit.
 
53
 
Table of Contents
The Company renewed its loan agreement, effective June 30, 2019, with Frost Bank. Under the loan agreement, as renewed and amended, we are permitted to draw up to $25.00 million on a revolving line of credit. Prior to June 30, 2021, interest is paid quarterly at
The Wall Street Journal
Prime Rate and the line of credit matures June 30, 2021. If a balance exists at June 30, 2021, the principal balance converts to a term facility payable quarterly over five years and interest is paid quarterly at
The Wall Street Journal
Prime Rate. The line of credit is unsecured. Among other provisions in the credit agreement, we must satisfy certain financial covenants during the term of the loan agreement, including, without limitation, covenants that require us to maintain certain capital, tangible net worth, loan loss reserve,
non-performing
asset and cash flow coverage ratios. In addition, the credit agreement contains certain operational covenants, which among others, restricts the payment of dividends above 55% of consolidated net income, limits the incurrence of debt (excluding any amounts acquired in an acquisition) and prohibits the disposal of assets except in the ordinary course of business. Since 1995, we have historically declared dividends as a percentage of our consolidated net income in a range of 37% (low) in 1995 to 53% (high) in 2003 and 2006. The Company was in compliance with the financial and operational covenants at September 30, 2019. There was no outstanding balance under the line of credit as of September 30, 2019 or December 31, 2018.
In addition, we anticipate that future acquisitions of financial institutions, expansion of branch locations or offerings of new products could also place a demand on our cash resources. Available cash and cash equivalents at our parent company which totaled $101.77 million at September 30, 2019, investment securities which totaled $6.35 million at September 30, 2019 and mature over 9 to 12 years, available dividends from our subsidiaries which totaled $257.67 million at September 30, 2019, utilization of available lines of credit, and future debt or equity offerings are expected to be the source of funding for these potential acquisitions or expansions.
Our liquidity position is continuously monitored and adjustments are made to the balance between sources and uses of funds as deemed appropriate. Liquidity risk management is an important element in our asset/liability management process. We regularly model liquidity stress scenarios to assess potential liquidity outflows or funding problems resulting from economic disruptions, volatility in the financial markets, unexpected credit events or other significant occurrences deemed potentially problematic by management. These scenarios are incorporated into our contingency funding plan, which provides the basis for the identification of our liquidity needs. As of September 30, 2019, management is not aware of any events that are reasonably likely to have a material adverse effect on our liquidity, capital resources or operations. Given the strong core deposit base and relatively low loan to deposit ratios maintained at our subsidiary bank, we consider our current liquidity position to be adequate to meet our short-term and long-term liquidity needs. In addition, management is not aware of any regulatory recommendations regarding liquidity that would have a material adverse effect on us.
Off-Balance Sheet Arrangements.
We are a party to financial instruments with
off-balance
sheet risk in the normal course of business to meet the financing needs of our customers. These financial instruments include unfunded lines of credit, commitments to extend credit and federal funds sold to correspondent banks and standby letters of credit. Those instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in our consolidated balance sheets.
Our exposure to credit loss in the event of nonperformance by the counterparty to the financial instrument for unfunded lines of credit, commitments to extend credit and standby letters of credit is represented by the contractual notional amount of these instruments. We generally use the same credit policies in making commitments and conditional obligations as we do for
on-balance
sheet instruments.
Unfunded lines of credit and commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. These commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. We evaluate each customer’s creditworthiness on a
case-by-case
basis. The amount of collateral obtained, as we deem necessary upon extension of credit, is based on our credit evaluation of the counterparty. Collateral held varies but may include accounts receivable, inventory, property, plant, and equipment and income-producing commercial properties.
 
54
 
Table of Contents
Standby letters of credit are conditional commitments we issue to guarantee the performance of a customer to a third party. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. The average collateral value held on letters of credit usually exceeds the contract amount.
Table 10 – Commitments as of September 30, 2019 (in thousands):
         
 
Total Notional
Amounts
Committed
 
Unfunded lines of credit
  $
695,669
 
Unfunded commitments to extend credit
   
377,790
 
Standby letters of credit
   
35,913
 
         
Total commercial commitments
  $
1,109,372
 
         
 
 
 
 
We believe we have no other
off-balance
sheet arrangements or transactions with unconsolidated, special purpose entities that would expose us to liability that is not reflected on the face of the financial statements.
Parent Company Funding
. Our ability to fund various operating expenses, dividends, and cash acquisitions is generally dependent on our own earnings (without giving effect to our subsidiaries), cash reserves and funds derived from our subsidiaries. These funds historically have been produced by intercompany dividends and management fees that are limited to reimbursement of actual expenses. We anticipate that our recurring cash sources will continue to include dividends and management fees from our subsidiaries. At September 30, 2019, approximately $257.67 million was available for the payment of intercompany dividends by our subsidiaries without the prior approval of regulatory agencies. Our subsidiaries paid aggregate dividends of $44.50 million and $38.95 million for the nine-month periods ended September 30, 2019 and 2018, respectively.
Dividends
. Our long-term dividend policy is to pay cash dividends to our shareholders of approximately 40% of annual net earnings while maintaining adequate capital to support growth. We are also restricted by a loan covenant within our line of credit agreement with Frost Bank to dividend no greater than 55% of net income, as defined in such loan agreement. The cash dividend payout ratios have amounted to 37.94% and 36.79% of net earnings for the first nine months of 2019 and 2018, respectively. Given our current capital position and projected earnings and asset growth rates, we do not anticipate any significant change in our current dividend policy.
We last increased our dividend paid per share in April 2019 when the Board of Directors declared a $0.12 per share cash dividend (post stock split) for the second quarter of 2019, a 14.3% increase over 2018
.
Our bank subsidiary, which is a national banking association and a member of the Federal Reserve System, is required by federal law to obtain the prior approval of the OCC to declare and pay dividends if the total of all dividends declared in any calendar year would exceed the total of (1) such bank’s net profits (as defined and interpreted by regulation) for that year plus (2) its retained net profits (as defined and interpreted by regulation) for the preceding two calendar years, less any required transfers to surplus.
To pay dividends, we and our subsidiary bank must maintain adequate capital above regulatory guidelines. In addition, if the applicable regulatory authority believes that a bank under its jurisdiction is engaged in or is about to engage in an unsafe or unsound practice (which, depending on the financial condition of the bank, could include the payment of dividends), the authority may require, after notice and hearing, that such bank cease and desist from the unsafe practice. The Federal Reserve, the FDIC and the OCC have each indicated that paying dividends that deplete a bank’s capital base to an inadequate level would be an unsafe and unsound banking practice. The Federal Reserve, the OCC and the FDIC have issued policy statements that recommend that bank holding companies and insured banks should generally only pay dividends out of current operating earnings.
 
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Table of Contents
 
Item 3.
Quantitative and Qualitative Disclosures About Market Risk
 
 
 
 
 
 
 
 
 
 
 
 
 
Management considers interest rate risk to be a significant market risk for the Company. See “Item 2—Management’s Discussion and Analysis of Financial Condition and Results of Operations – Capital Resources—Interest Rate Risk” for disclosure regarding this market risk.
Item 4.
Controls and Procedures
 
 
 
 
 
 
 
 
 
 
 
 
 
As of September 30, 2019, we carried out an evaluation, under the supervision and with the participation of our management, including our principal executive officer and principal financial officer, of the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rule
13a-15(e)
or
15d-15(e)
of the Securities Exchange Act of 1934). Our management, which includes our principal executive officer and our principal financial officer, does not expect that our disclosure controls and procedures will prevent all errors and all fraud.
A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the Company have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty and that breakdowns can occur because of simple error or mistake. Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the control. The design of any system of controls also is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions; over time, controls may become inadequate because of changes in conditions or the degree of compliance with the policies or procedures may deteriorate. Because of the inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and not be detected. Our principal executive officer and principal financial officer have concluded, based on our evaluation of our disclosure controls and procedures, that our disclosure controls and procedures were effective at the reasonable assurance level as of September 30, 2019.
Subsequent to our evaluation, there were no significant changes in internal controls over financial reporting or other factors that have materially affected, or are reasonably likely to materially affect, these internal controls.
 
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Table of Contents
PART II
OTHER INFORMATION
Item 1.
Legal Proceedings
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
From time to time we and our subsidiaries are parties to lawsuits arising in the ordinary course of our banking business. However, there are no material pending legal proceedings to which we, our subsidiaries, or any of their properties, are currently subject. Other than regular, routine examinations by state and federal banking authorities, there are no proceedings pending or known to be contemplated by any governmental authorities.
Item 1A.
Risk Factors
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
There has been no material change in the risk factors previously disclosed under Item 1A. of the Company’s 2018 Annual Report on Form
10-K.
Item 2.
Unregistered Sales of Equity Securities and Use of Proceeds
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
None
Item 3.
Defaults Upon Senior Securities
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Not Applicable
Item 4.
Mine Safety Disclosures
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Not Applicable
Item 5.
Other Information
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
None
 
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Table of Contents
Item 6.
Exhibits
 
 
 
 
 
 
 
 
 
                     
                     
 
  2.1
   
—
     
    
  
                     
 
  2.2
   
—
     
 
                     
 
  3.1
   
—
     
 
                     
 
  3.2
   
—
     
 
                     
 
  4.1
   
—
     
 
                     
 
10.1
   
—
     
 
                     
 
10.2
   
—
     
 
                     
 
10.3
   
—
     
 
                     
 
10.4
   
—
     
 
                     
 
10.5
   
—
     
 
                     
 
10.6
   
—
     
 
                     
 
10.7
   
—
     
 
                     
 
10.8
   
—
     
 
                     
 
31.1
   
—
     
 
                     
 
31.2
   
—
     
 
                     
 
32.1
   
—
     
 
                     
 
32.2
   
—
     
 
                     
 
101.INS
   
—
 
XBRL Instance Document.- the instance document does not appear in the Interactive Data File because its XBRL tags are embedded within the Inline XBRL document.*
   
 
                     
 
101.SCH
   
—
 
XBRL Taxonomy Extension Schema Document.*
   
 
                     
 
101.CAL
   
—
 
XBRL Taxonomy Extension Calculation Linkbase Document.*
   
 
                     
 
101.DEF
   
—
 
XBRL Taxonomy Extension Definition Linkbase Document.*
   
 
                     
 
101.LAB
   
—
 
XBRL Taxonomy Extension Label Linkbase Document.*
   
 
                     
 
101.PRE
   
—
 
XBRL Taxonomy Extension Presentation Linkbase Document.*
   
 
 
 
 
 
 
 
 
 
 
* Filed herewith
 
 
 
 
 
 
 
 
 
+ Furnished herewith. This Exhibit shall not be deemed “filed” for purposes of Section 18 of the Securities Exchange Act of 1934, or otherwise subject to the liability of that section, and shall not be deemed to be incorporated into any filing under the Securities Act of 1933 or the Securities Exchange Act of 1934.
 
 
 
 
 
 
 
 
 
++ Management contract or compensatory plan on arrangement.
 
 
 
 
 
 
 
 
 
 
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Table of Contents
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
         
 
FIRST FINANCIAL BANKSHARES, INC.
         
Date: October 29, 2019
  
By:
 
/s/ F. Scott Dueser
 
 
F. Scott Dueser
 
 
President and Chief Executive Officer
         
Date: October 29, 2019
  
By:
 
/s/ J. Bruce Hildebrand
 
 
J. Bruce Hildebrand
 
 
Executive Vice President and
 
 
Chief Financial Officer
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
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