Table of Contents
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
☒ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2019
or
☐ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from ____ to ____.
Commission File Number: 001-38280
CBTX, INC.
(Exact name of registrant as specified in its charter)
Texas
20‑8339782
(State or other jurisdiction of
(I.R.S. employer
incorporation or organization)
identification no.)
9 Greenway Plaza, Suite 110
Houston, Texas 77046
(Address of principal executive offices)
(713) 210‑7600
(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, par value $0.01 per share
CBTX
The 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 Exchange Act). Yes ☐ No ☒
As of July 22, 2019, there were 26,015,288 shares of the registrant’s common stock outstanding, including 235,153 shares of unvested restricted stock.
Page
PART I — FINANCIAL INFORMATION
Item 1.
Financial Statements – (Unaudited)
1
Condensed Consolidated Balance Sheets as of June 30, 2019 and December 31, 2018
Condensed Consolidated Statements of Income for the Three and Six Months Ended June 30, 2019 and 2018
2
Condensed Consolidated Statements of Comprehensive Income for the Three and Six Months Ended June 30, 2019 and 2018
3
Condensed Consolidated Statements of Changes in Shareholders’ Equity for the Three and Six Months Ended June 30, 2019 and 2018
4
Condensed Consolidated Statements of Cash Flows for the Six Months Ended June 30, 2019 and 2018
6
Notes to Condensed Consolidated Financial Statements
7
Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
33
Cautionary Note Regarding Forward-looking Statements
Overview
34
Results of Operations
35
Financial Condition
41
Liquidity and Capital Resources
50
Interest Rate Sensitivity and Market Risk
53
Impact of Inflation
54
Non-GAAP Financial Measures
Critical Accounting Policies
55
Recently Issued Accounting Pronouncements
56
Item 3.
Quantitative and Qualitative Disclosures about Market Risk
Item 4.
Controls and Procedures
PART II — OTHER INFORMATION
Legal Proceedings
57
Item 1A.
Risk Factors
Unregistered Sales of Equity Securities and Use of Proceeds
Defaults Upon Senior Securities
Mine Safety Disclosures
Item 5.
Other Information
58
Item 6.
Exhibits
SIGNATURES
59
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
CBTX, INC. AND SUBSIDIARY
Condensed Consolidated Balance Sheets (Unaudited)
(Dollars in thousands, except par value and share amounts)
June 30,
December 31,
2019
2018
ASSETS
Cash and due from banks
$
55,213
54,450
Interest-bearing deposits at other financial institutions
211,563
327,620
Total cash and cash equivalents
266,776
382,070
Securities
232,601
229,964
Equity investments
18,922
13,026
Loans held for sale
1,408
—
Loans, net of allowance for loan loss of $25,342 and $23,693 at June 30, 2019 and December 31, 2018, respectively
2,616,947
2,423,130
Premises and equipment, net of accumulated depreciation of $31,388 and $29,867 at June 30, 2019 and December 31, 2018, respectively
51,346
51,622
Goodwill
80,950
Other intangible assets, net of accumulated amortization of $15,372 and $14,915 at June 30, 2019 and December 31, 2018, respectively
5,318
5,775
Bank-owned life insurance
71,021
71,525
Operating lease right-to-use asset
12,355
Deferred tax asset, net
6,430
7,201
Other assets
15,432
13,833
Total assets
3,379,506
3,279,096
LIABILITIES AND SHAREHOLDERS’ EQUITY
Liabilities
Noninterest-bearing deposits
1,201,287
1,183,058
Interest-bearing deposits
1,537,620
1,583,224
Total deposits
2,738,907
2,766,282
Repurchase agreements
805
2,498
Federal Home Loan Bank advances
90,000
Junior subordinated debt
1,571
Operating lease liabilities
14,806
Other liabilities
21,830
21,120
Total liabilities
2,866,348
2,791,471
Commitments and contingencies (Note 17)
Shareholders’ equity
Preferred stock, $0.01 par value, 10,000,000 shares authorized, no shares issued
Common stock, $0.01 par value, 90,000,000 shares authorized, 25,780,135 and 25,777,693 shares issued at June 30, 2019 and December 31, 2018, 24,922,669 and 24,907,421 shares outstanding at June 30, 2019 and December 31, 2018, respectively
258
Additional paid-in capital
345,495
344,497
Retained earnings
180,401
160,626
Treasury stock, at cost, 857,466 and 870,272 shares held at June 30, 2019 and December 31, 2018, respectively
(14,564)
(14,781)
Accumulated other comprehensive gain (loss), net of tax of $417 and ($791) at June 30, 2019 and December 31, 2018, respectively
1,568
(2,975)
Total shareholders’ equity
513,158
487,625
Total liabilities and shareholders’ equity
See accompanying notes to condensed consolidated financial statements.
Condensed Consolidated Statements of Income (Unaudited)
(Dollars in thousands, except per share amounts)
Three Months Ended June 30,
Six Months Ended June 30,
Interest income
Interest and fees on loans
35,608
30,493
69,401
58,955
1,519
1,507
3,076
2,943
Federal Funds and other interest-earning assets
1,359
936
2,842
1,930
163
191
315
384
Total interest income
38,649
33,127
75,634
64,212
Interest expense
Deposits
3,822
2,126
7,406
4,074
Federal Home Loan Bank advances and repurchase agreements
524
13
589
14
Note payable and junior subordinated debt
112
12
209
Total interest expense
4,350
2,251
8,007
4,297
Net interest income
34,299
30,876
67,627
59,915
Provision for loan losses
807
690
1,954
1,555
Net interest income after provision for loan losses
33,492
30,186
65,673
58,360
Noninterest income
Deposit account service charges
1,657
1,497
3,286
2,975
Net gain on sale of assets
69
210
157
340
Card interchange fees
941
971
1,805
1,898
Earnings on bank-owned life insurance
3,721
465
4,151
916
Other
915
363
1,397
738
Total noninterest income
7,303
3,506
10,796
6,867
Noninterest expense
Salaries and employee benefits
14,185
12,496
28,007
25,191
Net occupancy expense
2,338
2,433
4,605
4,698
Regulatory fees
446
513
910
1,058
Data processing
661
666
1,375
1,349
Software
425
403
865
768
Printing, stationery and office
327
303
680
567
Amortization of intangibles
225
248
457
503
Professional and director fees
2,282
686
4,373
1,605
Correspondent bank and customer related transaction expenses
66
68
131
135
Loan processing costs
124
75
219
193
Advertising, marketing and business development
532
475
972
981
Repossessed real estate and other asset expense
5
62
Security and protection expense
367
311
613
Telephone and communications
456
394
834
780
Other expenses
969
1,870
1,793
Total noninterest expense
23,403
20,012
45,988
40,296
Net income before income tax expense
17,392
13,680
30,481
24,931
Income tax expense
3,077
2,638
5,676
4,777
Net income
14,315
11,042
24,805
20,154
Earnings per common share
Basic
0.57
0.44
1.00
0.81
Diluted
0.99
Condensed Consolidated Statements of Comprehensive Income (Unaudited)
(Dollars in thousands)
Change in unrealized gains (losses) on securities available for sale arising during the period, net
2,721
(961)
5,747
(4,626)
Reclassification adjustments for net realized gains included in net income
Change in related deferred income tax
(571)
201
(1,207)
Other comprehensive income (loss), net of tax
2,150
(760)
4,543
(3,655)
Total comprehensive income
16,465
10,282
29,348
16,499
Condensed Consolidated Statements of Changes in Shareholders’ Equity (Unaudited)
(Dollars in thousands, except share amounts)
Accumulated
Additional
Common Stock
Paid-In
Retained
Treasury Stock
Comprehensive
Shares
Amount
Capital
Earnings
Income (Loss)
Total
Six Months Ended June 30, 2018:
Balance at December 31, 2017
25,731,504
257
343,249
118,353
(898,272)
(15,256)
(389)
446,214
Dividends on common stock, $0.10 per share
(2,507)
Exercise of stock options
(181)
25,400
431
250
Stock-based compensation expense
739
Other comprehensive loss, net of tax
Balance at June 30, 2018
343,807
136,000
(872,872)
(14,825)
(4,044)
461,195
Six Months Ended June 30, 2019:
Balance at December 31, 2018
25,777,693
(870,272)
Dividends on common stock, $0.20 per share
(5,030)
Vesting of restricted stock, net of shares withheld for employee tax liabilities
2,442
(19)
Exercise of stock options, net of shares withheld for employee tax liabilities
(95)
12,806
217
122
1,112
Other comprehensive income, net of tax
Balance at June 30, 2019
25,780,135
(857,466)
Condensed Consolidated Statements of Quarterly Changes in Shareholders’ Equity (Unaudited)
Three Months Ended June 30, 2018:
Balance at March 31, 2018
343,641
126,213
(3,284)
451,571
Dividends on common stock, $0.05 per share
(1,255)
347
Three Months Ended June 30, 2019:
Balance at March 31, 2019
25,777,904
344,971
168,603
(859,428)
(14,597)
(582)
498,653
(2,517)
2,231
(17)
(26)
1,962
Condensed Consolidated Statements of Cash Flows (Unaudited)
Cash flows from operating activities:
Adjustments to reconcile consolidated net income to net cash provided by operating activities:
Depreciation
1,635
1,652
Amortization of premiums on securities
534
574
Amortization of lease right-to-use assets
659
Accretion of lease liabilities
262
(4,151)
(916)
Deferred income tax provision
(436)
171
Net realized gains on sales of debt securities
(16)
(12)
Net gains on sales of assets
(157)
(340)
Change in operating assets and liabilities:
(1,325)
1,095
(1,382)
1,055
(907)
1,553
(4,824)
Total adjustments
(208)
1,252
Net cash provided by operating activities
24,597
21,406
Cash flows from investing activities:
Purchases of securities
(312,001)
(175,549)
Proceeds from sales, calls and maturities of securities
303,056
154,050
Principal repayments of securities
11,540
10,397
Net increase in loans
(226,513)
(109,272)
Sales of loan participations
30,330
35,000
Purchases of loan participations
(1,256)
(20,446)
Net contributions to equity investments
(5,896)
(2,812)
Net decrease (increase) in time deposits in other banks
400
Proceeds from sales of U.S. Small Business Administration loans
1,706
1,534
Redemption (purchases) of bank-owned life insurance
4,655
(1,700)
Proceeds from sales of repossessed real estate and other assets
45
719
Net sales (purchases) of premises and equipment
(1,391)
(653)
Proceeds from insurance claims
108
Net cash used in investing activities
(195,617)
(108,332)
Cash flows from financing activities:
Net increase (decrease) in noninterest-bearing deposits
18,229
4,366
Net increase (decrease) in interest-bearing deposits
(45,604)
(46,064)
Net increase (decrease) in securities sold under agreements to repurchase
(1,693)
(77)
Proceeds from exercise of stock options
Payments to tax authorities for stock-based compensation
Net increase in Federal Home Loan Bank advances
50,000
Redemption of trust preferred securities
(1,571)
Dividends paid on common stock
(3,738)
(2,483)
Net cash provided by financing activities
55,726
5,992
Net decrease in cash, cash equivalents and restricted cash
(115,294)
(80,934)
Cash, cash equivalents and restricted cash, beginning
326,199
Cash, cash equivalents and restricted cash, ending
245,265
(Unaudited)
NOTE 1: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Nature of Operations
CBTX, Inc., or the Company, or CBTX, operates 35 branches, 19 in the Houston market area, 15 in the Beaumont/East Texas market area and one in Dallas, through its wholly-owned subsidiary, CommunityBank of Texas, N.A., or the Bank. The Bank provides relationship-driven commercial banking products and services primarily to small and mid-sized businesses and professionals with operations within the Bank’s markets. The Bank operates under a national charter and therefore is subject to regulation by the Office of the Comptroller of the Currency, or OCC, and the Federal Deposit Insurance Corporation, or FDIC. The Company is subject to regulation by the Board of Governors of the Federal Reserve.
Basis of Presentation
The accompanying unaudited condensed consolidated financial statements include the accounts of the Company and the Bank. All material intercompany balances and transactions have been eliminated in consolidation.
The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with generally accepted accounting principles in the United States, or GAAP, but do not include all the information and footnotes required for complete consolidated financial statements. In management’s opinion, these interim unaudited condensed consolidated financial statements include all adjustments of a normal recurring nature necessary for a fair statement of the Company’s consolidated financial position at June 30, 2019 and December 31, 2018, consolidated results of operations and consolidated shareholders’ equity for the three and six months ended June 30, 2019 and 2018 and consolidated cash flows for the six months ended June 30, 2019 and 2018.
Accounting measurements at interim dates inherently involve greater reliance on estimates than at year end and the results for the interim periods shown in this report are not necessarily indicative of results to be expected for the full year due in part to global economic and financial market conditions, interest rates, access to sources of liquidity, market competition and interruptions of business processes. These interim unaudited condensed consolidated financial statements should be read in conjunction with the Company’s audited consolidated financial statements and notes thereto for the year ended December 31, 2018 included within the Company’s Annual Report on Form 10-K.
Reclassification— Within interest income, equity investment income for 2018 has been reclassified from federal funds and other interest-earning assets to a separate line and within interest expense, repurchase agreements and FHLB advance expense have been combined and notes payable and junior subordinated debt have also been combined. On the December 31, 2018 balance sheet, repossessed real estate and other assets were combined with other assets. These reclassifications were made to conform to the 2019 financial statement presentation in the consolidated statements of income and consolidated balance sheets.
Accounting Standards Recently Adopted
The Company adopted Accounting Standards Update, or ASU 2016-02, Leases (Topic 842) on January 1, 2019, using the effective date as the date of initial adoption. The Company elected to apply certain practical expedients for transition, and under those expedients the Company did not reassess prior accounting decisions regarding the identification, classification and initial direct costs for leases existing at the effective date. The Company also elected to use hindsight in determining lease term when considering options to extend the lease and excluded short-term leases (defined as lease terms of 12 months or less). The Company elected to separate non-lease components from lease components in its application of ASU 2016-02. At adoption, the Company recorded right-of-use assets totaling $13.2 million, which represented the Company’s right to use, or control the use of, a specified assets for their lease terms, and the Company recorded lease
liabilities totaling $15.5 million, which represented the Company’s liability to make lease payments under these leases. Accrued lease obligations and lease incentive liabilities totaling $2.3 million that were in other liabilities at December 31, 2018 were reversed as part of the adoption during the first quarter of 2019. The ASU 2016-02 standard applied to all leases existing at the date of initial adoption. The Company’s financial statements and related footnotes were not updated for ASU 2016-02 for dates and periods before the date of adoption. See Note 16.
Accounting Standards Not Yet Adopted
ASU 2016-13, Financial Instruments—Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments. 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 on January 1, 2020.
The Company is in the process of evaluating the potential impact of ASU 2016-13 on the consolidated financial statements. We have developed a functional working group, with the assistance of an outside consultant, that is comprised of individuals from various areas including credit, risk management, and accounting, among others. We are currently working through our implementation plan related to the assessment and documentation of the methodology to be utilized, the processes and internal controls related to the estimation process, model development and validation, as well as system configuration. Existing technology is being adapted to conform to the requirements of ASU 2016-13 and we are in the process of implementing a third-party vendor solution to assist in the application of ASU 2016-13. The adoption of ASU 2016-13 will require changes to the Company’s accounting policies and disclosures for credit losses on financial instruments. The adoption of ASU 2016-13 may result in an increase in the allowance for loan losses as a result of changing from an incurred loss estimate to an expected loss estimate. The Company is continuing to evaluate the impact of this pronouncement on the allowance for credit losses and related future provisions as we progress with our implementation plan.
Cash Flow Reporting
Cash, cash equivalents and restricted cash include cash, interest‑bearing and noninterest‑bearing transaction accounts with other banks and federal funds sold. The Bank is required to maintain regulatory reserves with the Federal Reserve Bank and the reserve requirements for the Bank were $19.7 million and $18.5 million at June 30, 2019 and December 31, 2018, respectively. Additionally, as of June 30, 2019 and December 31, 2018, the Company had $2.2 million and $1.6 million, respectively, in cash collateral for interest rate swap transactions.
Supplemental disclosures of cash flow information are as follows for the periods indicated below:
Supplemental disclosures of cash flow information:
Cash paid for taxes
4,323
3,928
Cash paid for interest
7,789
4,249
Supplemental disclosures of non-cash flow information:
Dividends accrued
1,292
Operating lease right-to-use asset obtained in exchange for lease liabilities
13,208
Repossessed real estate and other assets
77
137
8
NOTE 2: SECURITIES
The amortized cost and fair values of investments in securities as of the dates shown below were as follows:
Gross
Amortized
Unrealized
Cost
Gains
Losses
Fair Value
June 30, 2019
Securities available for sale:
State and municipal securities
54,792
1,447
(72)
56,167
U.S. agency securities:
Debt securities
17,316
(45)
17,276
Collateralized mortgage obligations
63,198
437
(99)
63,536
Mortgage-backed securities
94,139
886
(563)
94,462
Other securities
1,142
1,130
230,587
2,775
(791)
232,571
Securities held to maturity:
30
31
December 31, 2018
57,972
345
(626)
57,691
17,315
(434)
16,881
66,438
98
(1,122)
65,414
90,845
230
(2,216)
88,859
1,129
(41)
1,088
233,699
673
(4,439)
229,933
32
The amortized cost and estimated fair value of securities, by contractual maturities, as of the dates shown below were as follows:
Available for Sale
Held to Maturity
Fair
Value
Amounts maturing in:
1 year or less
3,380
3,381
1 year through 5 years
20,392
20,390
5 years through 10 years
13,993
14,247
After 10 years
192,822
194,553
3,224
3,188
22,784
22,370
13,127
13,062
194,564
191,313
9
Actual maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
Securities with a carrying amount of $358,000 were sold in the six months ended June 30, 2019. There were no securities sold in the six months ended June 30, 2018. At June 30, 2019 and December 31, 2018, securities with a carrying amount of approximately $53.1 million and $49.9 million, respectively, were pledged to secure public deposits, repurchase agreements and for other purposes required or permitted by law.
The Company held 74 securities at June 30, 2019 and 100 securities at December 31, 2018, respectively, that were in a gross unrealized loss position for 12 months or more as illustrated in the table below. The unrealized losses are attributable primarily to changes in market interest rates relative to those available when the securities were acquired. The fair value of these securities is expected to recover as the securities reach their maturity or re‑pricing date, or if changes in market rates for such investments decline. Management does not believe that any of the securities the Company holds are impaired due to reasons of credit quality and believes the unrealized losses detailed in the tables below are temporary. No impairment loss has been recorded in the Company’s condensed consolidated statements of income for the six months ended June 30, 2019 and 2018.
Securities with unrealized losses as of the dates shown below, aggregated by category and the length of time were as follows:
Less Than Twelve Months
Twelve Months or More
421
(5)
5,080
(67)
12,755
1,725
12,913
(94)
50,461
2,148
(10)
82,339
(781)
20,892
(324)
6,584
(302)
16,882
8,854
(81)
46,157
(1,041)
21,745
(368)
46,183
(1,848)
51,491
(773)
116,894
(3,666)
NOTE 3: EQUITY INVESTMENTS
The Company’s unconsolidated investments that are considered equity securities as they represent ownership interests, such as common or preferred stock, were as follows for the dates indicated below.
Federal Reserve stock
9,271
Federal Home Loan Bank stock
6,740
1,250
The Independent Bankers Financial Corporation stock
141
Community Reinvestment Act investments
2,770
2,364
10
Banks that are members of the Federal Home Loan Bank System, or FHLB, are required to maintain a stock investment in the FHLB calculated as a percentage of aggregate outstanding mortgages, outstanding FHLB advances and other financial instruments. Banks that are members of the Federal Reserve System are required to annually subscribe to Federal Reserve Bank stock in specific ratios to the Bank’s equity. Although FHLB and Federal Reserve Bank Stock are considered equity securities, they do not have readily determinable fair values because ownership is restricted, and they lack a market. These investments can be sold back only at their par value of $100 per share and can only be sold to the Federal Home Loan Banks or Federal Reserve Banks or to another member institution. In addition, the equity ownership rights are more limited than would be the case for a public company, because of the oversight role exercised by regulators in the process of budgeting and approving dividends. As a result, these investments are carried at cost and evaluated for impairment.
The Company also holds an investment in the stock of The Independent Bankers Financial Corporation, or TIB. This investment has limited marketability. As a result, these investments are carried at cost and evaluated for impairment. The Company has investments in two private investment funds and a limited partnership. These investments are qualified Community Reinvestment Act, or CRA, investments under the Small Business Investment Company program of the Small Business Administration, or SBA. There are limited to no observable price changes in orderly transactions for identical investments or similar investments from the same issuers that are actively traded and as a result, these investments are stated at cost. At June 30, 2019 and December 31, 2018, the Company had $2.6 million and $3.0 million, respectively, in outstanding unfunded commitments to these funds, which are subject to call.
The Company’s equity investments are evaluated for impairment based on an assessment of qualitative indicators. Impairment indicators to be considered include, but are not limited to (i) a significant deterioration in the earnings, performance, credit rating, asset quality or business prospects of the investee, (ii) a significant adverse change in the regulatory, economic or technological environment of the investee, (iii) a significant adverse change in the general market conditions of either the geographical area or the industry in which the investee operates, (iv) a bona fide offer to purchase, an offer by the investee to sell, or completed auction process for the same or similar investment for an amount less than the carrying amount of that investment. There were no such qualitative indicators as of June 30, 2019.
NOTE 4: LOANS
Loans by loan class as of the dates shown below were as follows:
Commercial and industrial
540,084
519,779
Real estate:
Commercial real estate
854,513
795,733
Construction and development
559,672
515,533
1-4 family residential
281,525
282,011
Multi-family residential
298,887
221,194
Consumer
39,803
39,421
Agriculture
9,923
11,076
65,471
68,382
Total gross loans
2,649,878
2,453,129
Less deferred loan fees and unearned discounts
(6,181)
(6,306)
Less allowance for loan loss
(25,342)
(23,693)
Less loans held for sale
(1,408)
Loans, net
Accrued interest receivable for loans is $7.8 million and $6.8 million at June 30, 2019 and December 31, 2018, respectively, and is included in other assets in the condensed consolidated balance sheets.
11
From time to time, the Company will acquire and dispose of interests in loans under participation agreements with other financial institutions. Loan participations purchased and sold during the six months ending June 30, 2019 and 2018, by loan class, were as follows:
Participations
Purchased
Sold
During the
Period
1,256
June 30, 2018
7,000
13,446
20,446
The Company participates in the SBA loan program. When advantageous, the Company will sell the guaranteed portions of these loans with servicing retained. SBA loans that were sold with servicing retained during the six months ended June 30, 2019 and 2018 totaled $1.7 million and $1.5 million respectively.
NOTE 5: LOAN PERFORMANCE
Nonaccrual loans, segregated by loan class, as of the dates shown below were as follows:
1,795
1,317
850
1,517
624
656
3,269
3,490
Interest income that would have been earned under the original terms of the nonaccrual loans was $87,000 and $139,000 for the six months ended June 30, 2019 and 2018, respectively.
The following is an aging analysis of the Company’s past due loans, segregated by loan class, as of the dates shown below:
90 days or
90 days
30 to 59 days
60 to 89 days
greater
Total past
Total current
past due and
past due
due
loans
Total loans
still accruing
323
1,121
1,771
538,313
479
47
1,216
853,297
106
559,566
254
37
297
281,228
65,462
1,166
407
1,826
3,399
2,646,479
178
881
154
1,213
518,566
1,089
605
1,762
793,971
359
4,204
4,563
510,970
395
111
36
542
281,469
28
39,393
1,028
6,285
795
8,108
2,445,021
Loans restructured due to the borrower’s financial difficulties during the six months ended June 30, 2019 and 2018, which remained outstanding at the end of that period were as follows:
Post-modification recorded investment
Extended Maturity,
Pre-modification
Extended
Restructured
Outstanding
Maturity and
Payments
Number
Recorded
and Adjusted
of Loans
Investment
Maturity
Interest Rate
115
278
986
2,399
3,385
3,335
The recorded investment in troubled debt restructurings was $8.5 million and $11.4 million as of June 30, 2019 and December 31, 2018, respectively. As of June 30, 2019 and December 31, 2018, $1.9 million and $1.8 million of restructured loans were nonaccrual loans and $6.6 million and $9.6 million of restructured loans were accruing interest as of those periods. At June 30, 2019 and December 31, 2018, the Company had an outstanding commitment to potentially fund $4.2 million and $2.1 million, respectively, on a line of credit restructured prior to 2018.
There were no loans modified as a troubled debt restructured loan within the previous 12 months and for which there was a payment default. For purposes of this disclosure, a default is a loan modified as a troubled debt restructuring where the borrower is 90 days past due or results in the foreclosure and repossession of the applicable collateral.
NOTE 6: ALLOWANCE FOR LOAN LOSSES
Activity in the allowance for loan losses segregated by loan class for the periods indicated in the tables below was as follows:
Real Estate
Commercial
Construction
and
1-4 family
Multi-family
industrial
real estate
development
residential
Beginning balance
7,719
6,730
4,298
2,281
1,511
387
705
23,693
Provision (recapture) for loan loss
637
281
(35)
667
143
(7)
Charge-offs
(425)
(87)
(43)
(567)
Recoveries
241
15
Net (charge-offs) recoveries
(184)
(305)
Ending balance
7,792
7,371
4,579
2,236
2,178
458
73
655
25,342
Period-end amount allocated to:
Specific reserve
699
29
46
22
796
General reserve
7,093
7,342
2,190
436
24,546
7,257
10,375
3,482
1,326
1,419
566
285
24,778
989
547
(147)
80
60
(92)
(2)
120
(861)
(4)
(865)
263
(598)
(587)
7,648
10,930
1,404
1,479
405
25,746
814
94
920
6,834
10,918
1,310
24,826
The allowance for loan losses by loan category as of the periods indicated was as follows:
Percent
30.8
%
32.6
29.1
28.4
18.1
8.8
9.6
8.6
6.4
1.8
1.6
Agricultural
0.2
0.3
2.6
3.0
Total allowance for loan losses
100.0
Allocation of a portion of the allowance to one category of loans above does not preclude its availability to absorb losses in other categories. In addition to the amounts indicated in the tables above, the Company has a reserve for loan losses on unfunded commitments of $378,000 recorded in other liabilities as of June 30, 2019 and December 31, 2018.
Risk Grading
As part of the on‑going monitoring of the credit quality of the Company’s loan portfolio and methodology for calculating the allowance for loan losses, management assigns and tracks loan grades as described below that are used as credit quality indicators.
Pass— Credits in this category contain an acceptable amount of risk.
Special Mention—Credits in this category contain more than the normal amount of risk and are referred to as “special mention” in accordance with regulatory guidelines. These credits possess clearly identifiable temporary weaknesses or trends that, if not corrected or revised, may result in a condition that exposes the Company to higher level of risk of loss.
Substandard—Credits in this category are “substandard” in accordance with regulatory guidelines and of unsatisfactory credit quality with well‑defined weaknesses or weaknesses that jeopardize the liquidation of the debt. Credits in this category are inadequately protected by the current sound worth and paying capacity of the obligor or the collateral pledged, if any. Often, the assets in this category will have a valuation allowance representative of management’s estimated loss that is probable to be incurred. Loans deemed substandard and on nonaccrual status are considered impaired and are individually evaluated for impairment.
Doubtful—Credits in this category are considered “doubtful” in accordance with regulatory guidelines, are placed on nonaccrual status and may be dependent upon collateral having a value that is difficult to determine or upon some near‑term event which lacks certainty. Generally, these credits will have a valuation allowance based upon management’s best estimate of the losses probable to occur in the liquidation of the debt.
Loss—Credits in this category are considered “loss” in accordance with regulatory guidelines and are considered uncollectible and of such little value as to question their continued existence as assets on the Company’s financial statements. Such credits are to be charged off or charged down when payment is acknowledged to be uncertain or when the timing or value of payments cannot be determined. This category does not intend to imply that the debt or some portion of it will never be paid, nor does it in any way imply that the debt will be forgiven.
The Company had no loans graded “loss” or “doubtful” at June 30, 2019 and December 31, 2018.
Loans by risk grades and loan class as of the dates shown below were as follows:
Special
Pass
Mention
Substandard
Total Loans
525,614
2,100
12,370
838,009
14,050
2,454
546,077
13,595
275,441
5,279
39,552
251
9,842
60,867
4,604
2,594,289
30,600
24,989
504,425
5,768
9,586
781,035
10,370
4,328
511,329
274,781
2,175
5,055
39,140
246
11,048
61,569
6,813
2,404,521
22,763
25,845
Loan Impairment Assessment
The recorded investment in impaired loans, as of the dates shown below by loan class and disaggregated based on the Company’s impairment methodology was as follows:
Unpaid
Average
Contractual
Principal
with No
Related
Balance
Allowance
with Allowance
Year-to-Date
2,467
1,463
882
2,345
630
3,613
2,385
1,650
581
2,650
4,189
2,254
1,799
4,053
4,069
231
4,603
3,361
1,242
6,658
13,875
8,728
4,735
13,463
17,067
4,378
3,642
635
4,277
525
5,771
4,128
3,374
596
3,970
44
6,135
139
4,551
2,612
1,824
4,436
89
4,597
6,814
5,572
1,241
100
7,841
19,871
15,200
4,296
19,496
758
24,490
Interest income recognized on impaired loans was $359,000 and $540,000 for the six months ended June 30, 2019 and 2018, respectively.
16
The recorded investment in loans as of the dates shown below by loan class and based on the Company’s impairment methodology was as follows:
Individually
Collectively
Evaluated for
Impairment
Loans
537,739
515,502
852,282
791,763
277,472
277,575
39,572
60,868
2,636,415
2,433,633
At June 30, 2019 and December 31, 2018, the allowance allocated to specific reserves for loans individually evaluated for impairment was $796,000 and $758,000 respectively.
NOTE 7: PREMISES AND EQUIPMENT
Premises and equipment are summarized as follows as of the dates shown below:
Land
13,466
Buildings and leasehold improvements
52,814
52,188
Furniture and equipment
15,637
15,426
Vehicles
236
232
Construction in progress
177
82,734
81,489
Less accumulated depreciation
(31,388)
(29,867)
Premises and equipment, net
Depreciation expense was $1.6 million and $1.7 million for the six months ended June 30, 2019 and 2018, respectively, which is included in net occupancy expense on the Company’s condensed consolidated statements of income. A net loss of $32,000 for dispositions of premises and equipment for the six months ended June 30, 2019 was recognized and included in net gain on sale of assets in the condensed consolidated statements of income. There were no dispositions of premises and equipment in the six months ended June 30, 2018.
17
NOTE 8: GOODWILL AND OTHER INTANGIBLE ASSETS
Goodwill was $81.0 million at June 30, 2019 and December 31, 2018 and there have been no changes in goodwill during the six months ended June 30, 2019 or the year ended December 31, 2018. Based on the results of the Company’s assessment, management does not believe any impairment of goodwill or other intangible assets existed at June 30, 2019 or December 31, 2018.
Other intangibles, net of accumulated amortization, were as follows as of the dates shown below:
Weighted
Net
Amortization
Intangible
Assets
Other intangible assets, net
Core deposits
4.7 years
(12,781)
Customer relationships
9.5 years
6,629
(2,430)
4,199
Servicing assets
12.6 years
(161)
150
Total other intangible assets, net
20,690
(15,372)
5.2 years
(12,561)
1,189
10.0 years
(2,209)
4,420
14.4 years
(145)
166
(14,915)
Servicing Assets
Changes in the related servicing assets as of the dates indicated below were as follows:
Balance at beginning of year
Increase from loan sales
Decrease from serviced loans paid off or foreclosed
(30)
(23)
Balance at end of period
203
NOTE 9: BANK OWNED LIFE INSURANCE
The Company has purchased life insurance policies on covered individuals, which are recorded at their cash surrender value. Changes in the cash surrender value of the policies are recorded in noninterest income. Gains or losses and proceeds from maturities are recognized in noninterest income upon the death of a covered employee, on receipt of a death notice or other verified evidence. During the six months ended June 30, 2019, the Company received proceeds in the amount of $4.7 million as the owner and beneficiary under a bank-owned life insurance policy as the result of the death of a former employee, and the Company recorded a gain of $3.3 million.
Bank-owned life insurance policies and the net change in cash surrender value during the periods shown below were as follows:
Balance at beginning of period
68,010
Purchases
1,700
Redemptions
(4,655)
Net change in cash surrender value
1,815
18
NOTE 10: DEPOSITS
Deposits as of the dates shown below were as follows:
Interest-bearing demand accounts
351,326
387,457
Money market accounts
717,883
737,770
Saving accounts
91,828
96,962
Certificates and other time deposits, $100,000 or greater
189,741
189,007
Certificates and other time deposits, less than $100,000
186,842
172,028
Total interest-bearing deposits
At June 30, 2019 and December 31, 2018, the Company had $53.3 million and $51.5 million in deposits from public entities and brokered deposits of $122.4 million and $104.5 million, respectively. The Company had no major concentrations of deposits at June 30, 2019 or December 31, 2018 from any single or related groups of depositors.
NOTE 11: LINES OF CREDIT
Frost Line of Credit
The Company has entered into a loan agreement, or the Loan Agreement, with Frost Bank, which provides for a $30.0 million revolving line of credit, or Line of Credit. The Loan Agreement was amended and restated on December 13, 2018 and, as amended, is referred to as the Amended Agreement. The Company can make draws on the Line of Credit for a period of 12 months which began on December 13, 2018, after which the Company will not be permitted to make further draws and the outstanding balance will amortize over a period of 60 months. Interest accrues on outstanding borrowings at a rate equal to the maximum “Latest” U.S. prime rate of interest per annum and payable quarterly in the first 12 months and thereafter quarterly principal and interest payments are required over a term of 60 months. The entire outstanding balance and unpaid interest is payable in full on December 13, 2024.
The Company may prepay the principal amount of any loan under the Amended Agreement without premium or penalty. The obligations of the Company under the Amended Agreement are secured by a valid and perfected first priority lien on all of the issued and outstanding shares of capital stock of the Bank.
Covenants made under the Amended Agreement include, among other things, the Company maintaining tangible net worth of not less than $300 million, the Company maintaining free cash flow coverage ratio of not less than 1.25 to 1.00, the Bank’s Texas Ratio (as defined under the Amended Agreement) not to exceed 15%, the Bank’s Total Capital Ratio (as defined under the Amended Loan Agreement) of not less than 12% and restrictions on the ability of the Company and its subsidiaries to incur certain additional debt. The Company was in compliance with these covenants at June 30, 2019.
As of June 30, 2019, there were no outstanding borrowings on the Line of Credit and the Company has not drawn on this line since the Company entered into the Amended Agreement.
Additional Lines of Credit
The FHLB allows the Company to borrow on a blanket floating lien status collateralized by certain loans. As of June 30, 2019 and December 31, 2018, total borrowing capacity of $875.7 million and $919.9 million, respectively, was available under this arrangement. During the first and second quarter of 2019 and the second and third quarter of 2018, the Company borrowed under this agreement on a short-term basis. As of June 30, 2019, $90.0 million of FHLB advances were outstanding and they matured in less than thirty days from June 30, 2019. At December 31, 2018, there were no outstanding FHLB advances. The average outstanding balance for FHLB advances for the six months ended June 30, 2019
19
and 2018 was $46.6 million and $1.1 million, respectively. The weighted-average rate for the six months ended June 30, 2019 and 2018 was 2.54% and 2.19%, respectively.
As of June 30, 2019 and December 31, 2018, the Company maintained four federal funds lines of credit with commercial banks that provide for the availability to borrow up to an aggregate of $75.0 million, in federal funds. There were no funds under these lines of credit outstanding as of June 30, 2019 or December 31, 2018.
NOTE 12: JUNIOR SUBORDINATED DEBT
Prior to being acquired in 2007 by the Company, County Bancshares, Inc. received proceeds of junior subordinated debt held by a trust funded by common securities, all of which were purchased by County Bancshares, Inc. and trust preferred securities in the amount of $5.5 million that were held by other investors. Funds raised by the trust totaling $5.7 million were loaned to County Bancshares, Inc. in the form of junior subordinated debt. This debt was transferred to the Company at the date of acquisition. In 2015, the Company purchased $4.1 million of the outstanding preferred securities, reducing the outstanding preferred securities to $1.6 million.
In November 2018, the County Bancshares Trust I, or County Trust, agreed to redeem all of the County Trust’s issued and outstanding trust preferred securities upon concurrent redemption made by the Company of its junior subordinated debt securities held by the County Trust on January 7, 2019. The Company paid $5.7 million to pay its obligation for the junior subordinated debt, including accrued and unpaid interest. The Company received $4.1 million from the redemption of the preferred securities.
NOTE 13: RELATED PARTY TRANSACTIONS
In the ordinary course of business, the Company, through the Bank, has and expects to continue to conduct routine banking business with related parties, including its executive officers and directors. Related parties also include shareholders and their affiliates in which they directly or indirectly have 5% or more beneficial ownership in the Company.
Loans—In the opinion of management, loans to related parties were on substantially the same terms, including interest rates and collateral, as those prevailing at the time of comparable transactions with other persons and did not involve more than a normal risk of collectability or present any other unfavorable features to the Company. The Company had approximately $172.2 million and $169.0 million in loans to related parties at June 30, 2019 and December 31, 2018, respectively. As of June 30, 2019 and December 31, 2018, there were no loans made to related parties deemed nonaccrual, past due, restructured or classified as potential problem loans.
Unfunded Commitments—At June 30, 2019 and December 31, 2018, the Company had approximately $53.9 million and $55.7 million in unfunded loan commitments to related parties, respectively.
Deposits—The Company held related party deposits of approximately $229.8 million and $311.2 million at June 30, 2019 and December 31, 2018, respectively.
NOTE 14: FAIR VALUE DISCLOSURES
The Company uses fair value measurements to record fair value adjustments to certain assets and to determine fair value disclosures. Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction occurring 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. In estimating fair value, the Company uses valuation techniques that are consistent with the market approach, the income approach and/or the cost approach. Such valuation techniques are consistently applied. Inputs to valuation techniques refer to the assumptions used in pricing the asset or liability. Valuation inputs are categorized in a three-level hierarchy, 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 and liabilities that the reporting entity has the ability to access at the measurement date.
20
Level 2 Inputs—Other observable inputs that may 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 or other inputs that are observable for the asset or liability such as interest rates, volatilities, prepayment speeds, loss severities, credit risks and default rates or inputs that are observable or can be corroborated by observable market data.
Level 3 Inputs—Unobservable inputs that reflect an entity’s own assumptions that market participants would use in pricing the assets or liabilities.
During the six months ended June 30, 2019 and the year ended December 31, 2018, there were no transfers of assets or liabilities within the levels of the fair value hierarchy.
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 models that primarily use observable market-based parameters as inputs. Valuation adjustments may be made to ensure that assets and liabilities are recorded at fair value. These adjustments may include amounts to reflect counterparty credit quality and creditworthiness, among other things, as well as unobservable parameters. Any such valuation adjustments are applied consistently over time.
The Company’s valuation methodologies may produce a fair value calculation that may not be indicative of net realizable value or reflective of future fair values. 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 could result in different estimate of fair value. Fair value estimates are based on judgements regarding current economic conditions, risk characteristics of the various instruments and other factors. These estimates are subjective in nature and involve uncertainties and matters of significant judgement and therefore cannot be determined with precision.
Financial Instruments Measured at Fair Value on a Recurring Basis
The Company’s assets and liabilities measured at fair value on a recurring basis include the following:
Securities Available for Sale: Securities classified as available for sale are recorded at fair value. For those securities classified as Level 2, the Company obtains fair value measurements from an independent pricing service. The fair value measurements consider observable data that may include dealer quotes, market spreads, cash flows, the U.S. Treasury yield curve, live trading levels, trade execution data, market consensus prepayments speeds, credit information and the security’s terms and conditions, among other things. The Company reviews the prices supplied by the independent pricing service, as well as their underlying pricing methodologies for reasonableness. The other securities in the table below are mutual funds and the fair value is determined by using unadjusted quoted market prices which are considered Level 1 inputs.
Interest Rate Swaps: The Company obtains fair value measurements for its interest rate swaps from an independent pricing service which uses the income approach. The income approach calls for the utilization of valuation techniques to convert future cash flows as due to be exchanged per the terms of the financial instrument, into a single present value amount. Measurement is based on the value indicated by the market expectations about those future amounts
21
as of the measurement date. The proprietary curves of the independent pricing service utilize pricing models derived from industry standard analytic tools, considering both Level 1 and Level 2 inputs.
Financial assets and financial liabilities measured at fair value on a recurring basis as of the dates shown below were as follows:
Fair value of financial assets:
Level 1 inputs: securities available for sale - other securities
Level 2 inputs:
Securities available for sale
U.S. Agency Securities:
Interest rate swaps
2,568
962
Total fair value of financial assets
235,139
230,895
Fair value of financial liabilities:
Level 2 inputs: interest rate swaps
Total fair value of financial liabilities
Financial Instruments Measured at Fair Value on a Non-recurring Basis
A portion of financial instruments are measured at fair value on a non-recurring basis and are subject to fair value adjustments in certain circumstances. The Company’s financial assets measured at fair value on a non-recurring basis are certain impaired loans and as of the dates shown below were as follows:
Level 3 inputs
Impaired loans:
252
110
552
1,753
1,735
1,173
1,141
Total impaired loans
3,939
3,538
Non-Financial Assets and Non-Financial Liabilities Measured on a Non-recurring Basis
The fair value portion of non-financial assets or non-financial liabilities is measured on a non-recurring basis in certain circumstances, such as when there is evidence of impairment and may be subject to impairment adjustments. The Company’s non-financial assets whose fair value may be measured on a non-recurring basis include repossessed real estate, other foreclosed assets, goodwill and intangible assets, among other assets. There were no write-downs of foreclosed assets for fair value remeasurement subsequent to initial foreclosure during the six months ended June 30, 2019
and during 2018. The fair value of repossessed real estate and other foreclosed assets is estimated using Level 2 inputs and, as of the dates shown below, were as follows:
Foreclosed assets remeasured at initial recognition:
Carrying value of foreclosed assets prior to measurement
Charge-offs recognized in the allowance for loan losses
(1)
Fair value
Financial Instruments Reported at Amortized Cost
Fair market values and carrying amounts of financial instruments that are reported at cost as of the dates shown below were as follows:
Carrying
Financial assets:
Level 1 inputs:
Interest bearing deposits in banks
Securities held to maturity
Accrued interest receivable
9,068
8,227
Servicing asset
Level 3 inputs:
Loans, including held for sale, net
2,646,207
2,618,355
2,432,753
Total financial assets
3,012,175
2,984,322
2,907,799
2,898,175
Financial liabilities:
1,513,498
1,522,366
803
89,879
Accrued interest payable
864
653
Total financial liabilities
2,806,331
2,830,576
2,710,146
2,771,004
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 and as such the fair values shown above are not necessarily indicative of the amounts the Company will realize. The use of different market assumptions and/or estimation methodologies may have a material effect on the estimated fair value amounts.
23
NOTE 15: DERIVATIVE FINANCIAL INSTRUMENTS
The Company has outstanding interest rate swap contracts in which the Bank entered into an interest rate swap with a customer and entered into an offsetting interest rate swap with another financial institution at the same time. These interest rate swap contracts are not designated as hedging instruments for mitigating interest rate risk of the Bank. The objective of the transactions is to allow the Bank’s customers to effectively convert a variable rate loan to a fixed rate.
In connection with each swap transaction, the Bank agrees to pay interest to the customer on a notional amount at a variable interest rate and receive interest from the customer on a similar notional amount at a fixed interest rate. At the same time, the Bank agrees to pay a third-party financial institution the same fixed interest rate on the same notional amount and receive the same variable interest rate on the same notional amount. Because the Bank acts as an intermediary for its customer, changes in the fair value of the underlying derivative contracts are designed to offset each other and would not significantly impact the Company’s operating results except in certain situations where there is a significant deterioration in the customer’s credit worthiness or that of the counterparties. At June 30, 2019 and December 31, 2018, no such deterioration was determined by management.
At June 30, 2019 and December 31, 2018, the Company had 19 and 13 interest rate swap agreements outstanding with borrowers and financial institutions, respectively. These derivative instruments are not designated as accounting hedges and changes in the net fair value are recognized in noninterest income or expense. Fair value amounts are included in other assets and other liabilities. Interest rates on the Company’s swap agreements are based on the London Interbank Offered Rate of the U.S. Dollar deposits in Europe, or LIBOR. Derivative instruments outstanding as of the dates shown below were as follows:
Notional
Classification
Amounts
Fixed Rate
Floating Rate
(Years)
Interest rate swaps with customers
Other Assets
60,887
2,505
4.40% - 7.25%
LIBOR 1M + 2.50% - 3.25%
6.51
Interest rate swaps with financial institution
6,184
63
4.00%
LIBOR 1M + 2.50%
7.22
Other Liabilities
(63)
(2,505)
Total derivatives
134,142
8,901
169
5.45% - 7.25%
LIBOR 1M + 2.50% - 3.20%
6.22
32,923
793
4.00% - 5.37%
7.78
(793)
(169)
83,648
24
NOTE 16: OPERATING LEASES
The Company adopted Accounting Standards Update, or ASU 2016-02, Leases (Topic 842) on January 1, 2019 and the Company’s leases within scope were operating leases of office space, stand-alone buildings and land. The Company’s leases have no variable costs. Right-of-use assets represent the Company’s right to use, or control the use of, leased assets for their lease term and at June 30, 2019, totaled $12.4 million. Lease liabilities represent the Company’s liability to make lease payments under these leases, on a discounted basis and at June 30, 2019, totaled $14.8 million. The weighted-average discount rate for the six months ended June 30, 2019 was 3.58%. The weighted-average remaining lease term for operating leases outstanding at June 30, 2019 was 11.7 years. Cash paid for amounts included in the measurement of operating lease liabilities for the six months ended June 30, 2019 was $907,000.
Lease costs for the period shown below were as follows:
For the Six
Months Ended
Operating lease cost
921
Short-term lease cost
42
Sublease income
Total lease cost
871
A maturity analysis of operating lease liabilities as of the date shown below was as follows:
1,988
2020
2,081
2021
2,186
2022
2,214
2023
1,974
Thereafter
9,941
Total undiscounted lease liability
20,384
Less: Discount on cash flows
(5,578)
Total operating lease liability
NOTE 17: COMMITMENTS AND CONTINGENCIES AND FINANCIAL INSTRUMENTS WITH OFF‑BALANCE‑SHEET RISK
Financial Instruments with Off-Balance-Sheet Risk
In the normal course of business, the Company enters into various transactions, which in accordance with GAAP are not included in its consolidated balance sheets. The Company enters into these transactions to meet the financing needs of its customers. These financial instruments include commitments to extend credit for loans in process and standby letters of credit. The Company uses the same credit policies in making these commitments and conditional obligations as it does for on-balance-sheet instruments.
Commitments to extend credit and standby letters of credit as of the dates shown below were as follows:
Commitments to extend credit, variable interest rate
678,314
726,277
Commitments to extend credit, fixed interest rate
128,884
105,359
807,198
831,636
Standby letters of credit
28,057
31,729
25
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. 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 fully drawn upon, the total commitment amounts disclosed above do not necessarily represent future cash requirements.
Standby letters of credit are conditional commitments issued by the Company 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 the Company’s customers.
Litigation
The Company is subject to claims and lawsuits which arise primarily in the ordinary course of business. Based on information presently available and advice received from legal counsel representing the Company, it is the opinion of management that the disposition or ultimate determination of such claims and lawsuits will not have a material adverse effect on the financial position or results of operations of the Company.
NOTE 18: REVENUE RECOGNITION
ASU 606 requires entities to recognize revenue in a way that depicts the transfer of goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. A majority of the Company’s revenue is derived from interest income on financial assets, which is not within the scope of ASC 606. Income from changes in the cash surrender value of bank-owned life is also not within the scope of ASC 606.
The Company’s revenue-generating activities that are within the scope of ASC 606 are included in noninterest income in the condensed consolidated income statements. The Company generally fully satisfies its performance obligations on its contracts with customers as services are rendered and the transaction prices are typically fixed and charged at a point in time based on activity.
Other noninterest income
NOTE 19: EMPLOYEE BENEFIT PLANS AND DEFERRED COMPENSATION ARRANGEMENTS
Employee Benefit Plans
The Company maintains a 401(k) employee benefit plan and substantially all employees that complete three months of service may participate. The Company, at its discretion, may match a portion of each employee’s contribution and may make additional contributions. For the six months ended June 30, 2019 and 2018, the Company contributed $1.1 million and $1.1 million to the plan, respectively.
Executive Deferred Compensation Arrangements
The Company established an executive incentive compensation arrangement with several officers of the Bank, in which these officers are eligible for performance-based incentive bonus compensation. As part of this compensation arrangement, the Company contributes one‑fourth of the incentive bonus amount into a deferred compensation account. The deferred amounts accrue at a market rate of interest and are payable to the employees upon separation from the Bank provided vesting arrangements have been met. At June 30, 2019 and December 31, 2018, the amount payable, including interest, for this deferred plan was approximately $2.6 million and $2.5 million, respectively, which is included in other liabilities in the condensed consolidated balance sheets.
26
Salary Continuation Agreements
The Company entered into a salary continuation arrangement in 2008 with the Company’s then President and CEO that calls for payments of $100,000 per year for a period of 10 years commencing at age 65. Payments under the plan began during 2014. The Company’s liability was $378,000 and $421,000 at June 30, 2019 and December 31, 2018, respectively, which is included in other liabilities in the condensed consolidated balance sheets and equals the present value of the benefits expected to be provided.
In October 2017, the Company entered into a salary continuation arrangement with the Company’s President and CEO that calls for payments of $200,000 per year payable for a period of 10 years commencing at age 70. Payments under the plan will begin in 2024. The Company’s liability was $328,000 and $219,000 at June 30, 2019 and December 31, 2018, respectively, which is included in other liabilities in the condensed consolidated balance sheets. The liability will continue to accrue over the remaining period until payments commence such that the accrued amount at the eligibility date will equal the present value of all the future benefits expected to be paid.
Change of Control Agreements
In 2017, the Company entered into employment agreements with certain executive officers. These agreements provide for severance benefits if the Company terminates the executive without cause or the executive resigns with good reason, as defined in the agreements. In addition, upon a change of control, as that term is defined in the agreements, these employees will be entitled to an aggregate amount estimated to be $4.4 million at June 30, 2019 and December 31, 2018, in accordance to the terms of their respective agreements. No compensation has been recorded to date as a change of control condition is not deemed probable.
NOTE 20: STOCK-BASED COMPENSATION
The Company acquired a stock option plan which originated under VB Texas, Inc. as a part of a merger of the two companies. The options granted to employees must be exercised within 10 years from the date of grant and vesting schedules are determined on an individual basis. At the merger date, all outstanding options became fully vested and were converted to options of the Company’s common stock at an exchange ratio equal to the acquisition exchange rate for common shares. No options were granted under this plan after October 24, 2016.
In May 2014, the Company adopted the 2014 Stock Option Plan, or the 2014 Plan. The 2014 Plan was approved by the Company’s shareholders and limits the number of shares that may be optioned to 1,127,200. The 2014 Plan provides that no options may be granted after May 20, 2024. Options granted under the 2014 Plan expire 10 years from the date of grant and become exercisable in installments over a period of one to five years, beginning on the first anniversary of the date of grant. At June 30, 2019, 961,200 shares were available for future grant under the 2014 Plan.
In September 2017, the Company adopted the 2017 Omnibus Incentive Plan, or the 2017 Plan. The 2017 Plan authorizes the Company to grant options and performance-based and non-performance based restricted stock awards as well as various other types of stock-based and other awards that are not stock-based to eligible employees, consultants and non‑employee directors up to an aggregate of 600,000 shares of common stock. At June 30, 2019, 316,216 shares were available for future grant under the 2017 Plan.
27
Stock option activity for the periods shown below was as follows:
Number of
Underlying
Exercise
Options
Price
Outstanding at beginning of period
232,322
16.66
260,322
16.00
Granted
Exercised
(14,844)
12.62
(25,400)
9.85
Forfeited
(2,000)
18.25
Outstanding at end of period
215,478
16.93
234,922
16.67
A summary of stock options as of the dates shown below was as follows:
Stock Options
Exercisable
Unvested
Number of shares underlying options
145,279
70,199
Weighted-average exercise price per share
15.43
20.03
Aggregate intrinsic value (in thousands)
1,847
569
2,416
Weighted-average remaining contractual term (years)
5.2
7.5
6.0
The fair value of the Company’s restricted stock awards is estimated based on the market value of the Company’s common stock at the date of grant. Restricted stock shares are considered fully issued at the time of the grant and the grantee becomes the record owner of the restricted stock and has voting, dividend and other shareholder rights. The shares of restricted stock are non-transferable and subject to forfeiture until the restricted stock vests and any dividends with respect to the restricted stock are subject to the same restrictions, including the risk of forfeiture.
Non-performance based restricted stock grants vest over the service period in equal increments over a period of two to five years, beginning on the first anniversary of the date of grant.
The number of shares earned under the Company’s performance-based restricted stock award agreements is based on the achievement of certain branch production goals. Compensation expense for performance-based restricted stock is recognized for the probable award level over the period estimated to achieve the performance conditions and other goals, on a straight-line basis. If the probable award level and/or the period estimated to be achieved change, compensation expense will be adjusted via a cumulative catch-up adjustment to reflect these changes. The performance conditions goals must be achieved within five years or the awards expire. The number of performance-based shares granted presented in the table below is based upon the attainment of the maximum number of shares possible to be earned.
Restricted stock activity for the periods shown below was as follows:
Non-performance Based
Performance-based
Grant Date
Outstanding at December 31, 2017
212,580
26.71
18,500
29.71
Vested
Outstanding at June 30, 2018
231,080
26.95
Outstanding at December 31, 2018
181,773
27.05
24,000
34.46
35,687
32.26
(3,100)
29.69
(3,207)
29.98
Outstanding at June 30, 2019
211,153
27.85
A summary of restricted stock as of the dates shown below was as follows:
Restricted Stock
Number of shares underlying restricted stock
Weighted-average grant date fair value per share
Aggregate fair value (in thousands)
5,942
675
Weighted-average remaining vesting period (years)
3.1
The Company’s stock compensation plans allow employees to elect to have shares withheld to satisfy their tax liabilities related to options exercised or restricted stock vested or to pay the exercise price of the options. During the periods shown below, the shares of stock options exercised and restricted stock vested, shares withheld and shares issued were as follows:
Three Months Ended June 30, 2019
Exercised/Vested
Shares Withheld
Shares Issued
4,000
(2,038)
2,800
(569)
Six Months Ended June 30, 2019
14,844
3,100
(658)
There were no shares withheld for options exercised or restricted stock vested in the six months ended June 30, 2018.
For the three and six months ended June 30, 2019 and 2018, stock compensation expense was $567,000, $347,000, $1.1 million and $739,000, respectively. As of June 30, 2019, there was approximately $5.9 million of total unrecognized compensation expense related to the stock‑based compensation arrangements, which is expected to be recognized in the Company’s consolidated statements of income over a weighted-average period of 3.0 years.
NOTE 21: REGULATORY MATTERS
Regulatory Capital
Banks and bank holding companies are subject to various regulatory capital requirements administered by state and federal banking agencies. Capital adequacy guidelines and, additionally for banks, prompt corrective action regulations, involve quantitative measures of assets, liabilities, and certain off‑balance‑sheet items calculated under regulatory accounting practices. Capital amounts and classifications are also subject to qualitative judgments by regulators about components, risk weighting and other factors.
The Company and the Bank’s Common Equity Tier 1 capital includes common stock and related capital surplus, net of treasury stock, and retained earnings. In connection with the adoption of the Basel III Capital Rules, the Company and the Bank elected to opt‑out of the requirement to include most components of accumulated other comprehensive income in Common Equity Tier 1. Common Equity Tier 1 for both the Company and the Bank is reduced by goodwill and other intangible assets, net of associated deferred tax liabilities, and subject to transition provisions.
The Basel III Capital Rules require the Company and the Bank to maintain (i) a minimum ratio of Common Equity Tier 1 capital to risk‑weighted assets of at least 4.5%, plus a 2.5% “capital conservation buffer” (which is added to the 4.5% Common Equity Tier 1 capital ratio as that buffer is phased in, effectively resulting in a minimum ratio of Common Equity Tier 1 capital to risk‑weighted assets of at least 7.0% upon full implementation), (ii) a minimum ratio of Tier 1 capital to risk‑weighted assets of at least 6.0%, plus the capital conservation buffer (which is added to the 6.0% Tier 1 capital ratio as that buffer is phased in, effectively resulting in a minimum Tier 1 capital ratio of 8.5% upon full implementation), (iii) a minimum ratio of Total capital (that is, Tier 1 plus Tier 2) to risk‑weighted assets of at least 8.0%, plus the capital conservation buffer (which is added to the 8.0% total capital ratio as that buffer is phased in, effectively resulting in a minimum total capital ratio of 10.5% upon full implementation) and (iv) a minimum leverage ratio of 4.0%, calculated as the ratio of Tier 1 capital to average quarterly assets.
The implementation of the capital conservation buffer began on January 1, 2016 at the 0.625% level and was phased in over a four‑year period (increasing by that amount on each subsequent January 1, until it reached 2.5% on January 1, 2019). The Basel III Capital Rules also provide for a “countercyclical capital buffer” that is applicable to only certain covered institutions and does not have any current applicability to the Company and the Bank. The capital conservation buffer is designed to absorb losses during periods of economic stress and, as detailed above, effectively increases the minimum required risk‑weighted capital ratios. Banking institutions with a ratio of Common Equity Tier 1 capital to risk‑weighted assets below the effective minimum (4.5% plus the capital conservation buffer and, if applicable, the countercyclical capital buffer) will face constraints on dividends, equity repurchases, and compensation based on the amount of the shortfall.
The Company and the Bank are subject to the regulatory capital requirements administered by the Federal Reserve and, for the Bank, the OCC. Regulatory authorities can initiate certain mandatory actions if the Company or the Bank fail to meet the minimum capital requirements, which could have a direct material effect on the Company’s financial statements. Management believes, as of June 30, 2019 and December 31, 2018, that the Company and the Bank met all capital adequacy requirements to which they were subject.
Dividend Restrictions
In the ordinary course of business, the Company may be dependent upon dividends from the Bank to provide funds for the payment of dividends to shareholders and to provide for other cash requirements. Banking regulations may limit the amount of dividends that may be paid. Approval by regulatory authorities is required if the effect of dividends declared would cause the regulatory capital of the Bank to fall below specified minimum levels. Approval is also required if dividends declared exceed the net profits for that year combined with the retained net profits for the preceding two years.
As of June 30, 2019 and December 31, 2018, the Company and the Bank, were “well capitalized” based on the ratios presented below. Actual and required capital ratios for the Company and the Bank were as follows for the dates presented:
Minimum
Capital Required
Required to be
for Capital Adequacy
Basel III
Considered Well
Actual
Purposes
Fully Phased-in
Capitalized
Ratio
Common Equity Tier I to Risk-Weighted Assets:
Consolidated
$ 426,397
$ 130,469
$ 202,951
N/A
Bank Only
$ 385,087
$ 130,459
$ 202,936
$ 188,440
Tier I Capital to Risk-Weighted Assets:
$ 173,958
$ 246,441
$ 173,945
$ 246,422
$ 231,927
Total Capital to Risk-Weighted Assets:
$ 452,117
$ 231,945
$ 304,427
$ 410,807
$ 304,404
$ 289,908
Tier 1 Leverage Capital to Average Assets:
$ 129,974
$ 129,953
$ 162,441
$ 405,012
$ 123,885
$ 192,710
$ 363,140
$ 123,877
$ 192,697
$ 178,933
$ 406,257
$ 165,180
$ 234,005
$ 165,169
$ 233,989
$ 220,225
$ 430,238
$ 220,240
$ 289,065
$ 387,211
$ 289,046
$ 275,282
$ 127,350
$ 159,188
NOTE 22: INCOME TAXES
The provision for income tax expense and effective tax rates for the periods shown below were as follows:
Provision for income tax expense
$ 3,077
$ 2,638
$ 5,676
$ 4,777
Effective tax rate
The differences between the federal statutory rate of 21% and the effective tax rates presented in the table above were largely attributable to permanent differences primarily related to tax exempt interest income and bank‑owned life insurance related earnings.
NOTE 23: EARNINGS PER SHARE
The computation of basic and diluted earnings per share for the periods shown was as follows:
(Dollars in thousands, except per share data)
Net income for common shareholders
Weighted-average shares (thousands)
Basic weighted-average shares outstanding
24,921
24,858
24,916
24,845
Dilutive effect of outstanding stock options and unvested restricted stock awards
121
132
Diluted weighted-average shares outstanding
25,042
24,997
25,047
24,977
Earnings per share:
NOTE 24: SUBSEQUENT EVENT
The Company has evaluated subsequent events as of the date these condensed consolidated financial statements were made available and determined there has been no material items that required recognition or disclosure.
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
This Quarterly Report on Form 10-Q contains forward‑looking statements. These forward‑looking statements reflect our current views with respect to, among other things, future events and our financial performance. These statements are often, but not always, made through the use of words or phrases such as “may,” “should,” “could,” “predict,” “potential,” “believe,” “will likely result,” “expect,” “continue,” “will,” “anticipate,” “seek,” “estimate,” “intend,” “plan,” “projection,” “would” and “outlook,” or the negative version of those words or other comparable words or phrases of a future or forward‑looking nature. These forward‑looking statements are not historical facts, and are based on current expectations, estimates and projections about our industry, management’s beliefs and certain assumptions made by management, many of which, by their nature, are inherently uncertain and beyond our control. Accordingly, we caution you that any such forward‑looking statements are not guarantees of future performance and are subject to risks, assumptions and uncertainties that are difficult to predict. Although we believe that the expectations reflected in these forward‑looking statements are reasonable as of the date made, actual results may prove to be materially different from the results expressed or implied by the forward‑looking statements.
There are or will be important factors that could cause our actual results to differ materially from those indicated in these forward‑looking statements, including, but not limited to, the risks described in Part I — Item 1A. — Risk Factors in our Annual Report on Form 10-K and the following:
·
natural disasters and adverse weather, acts of terrorism, an outbreak of hostilities or other international or domestic calamities and other matters beyond our control;
the geographic concentration of our markets in Beaumont and Houston, Texas;
our ability to prudently manage our growth and execute our strategy;
risks associated with our acquisition and de novo branching strategy, including our entry into new markets;
changes in management personnel;
the amount of nonperforming and classified assets that we hold and the time and effort necessary to resolve nonperforming assets;
deterioration of our asset quality;
interest rate risk associated with our business;
business and economic conditions generally and in the financial services industry, nationally and within our primary markets;
volatility and direction of oil prices and the strength of the energy industry, generally and within Texas;
the composition of our loan portfolio, including the identity of our borrowers and the concentration of loans in specialized industries;
changes in the value of collateral securing our loans;
our ability to maintain important deposit customer relationships and our reputation;
our ability to maintain effective internal control over financial reporting;
increased competition in the financial services industry, particularly from regional and national institutions;
volatility and direction of market interest rates;
liquidity risks associated with our business;
systems failures or interruptions involving our information technology and telecommunications systems or third‑party servicers;
interruptions or breaches in our information system security;
the failure of certain third-party vendors to perform;
environmental liability associated with our lending activities;
the institution and outcome of litigation and other legal proceedings against us or to which we may become subject;
the costs and effects of regulatory or other governmental inquiries, the results of regulatory examinations, investigations, or reviews or the ability to obtain required regulatory approvals;
changes in the laws, rules, regulations, interpretations or policies relating to financial institution, accounting, tax, trade, monetary and fiscal matters;
further government intervention in the U.S. financial system;
other risks, uncertainties, and factors that are discussed from time to time in our reports and documents filed with the SEC; and
other factors that are discussed in the section to this Quarterly Report on Form 10-Q entitled “Risk Factors”.
The foregoing factors should not be construed as exhaustive and should be read together with the other cautionary statements included in this Quarterly Report on Form 10-Q. If one or more events related to these or other risks or uncertainties materialize, or if our underlying assumptions prove to be incorrect, actual results may differ materially from what we anticipate. Accordingly, you should not place undue reliance on any such forward‑looking statements. Any forward‑looking statement speaks only as of the date on which it is made, and we do not undertake any obligation to publicly update or review any forward‑looking statement, whether as a result of new information, future developments or otherwise. New factors emerge from time to time, and it is not possible for us to predict which will arise. In addition, we cannot assess the impact of each factor on our business or the extent to which any factor, or combination of factors, may cause actual results to differ materially from those contained in any forward‑looking statements.
The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our condensed consolidated financial statements and the accompanying notes included in Item I of Part I of this Quarterly Report on Form 10-Q, as well as our consolidated financial statements and the accompanying notes for the year ended December 31, 2018, included in our Annual Report on Form 10-K. In this Quarterly Report on Form 10-Q, unless otherwise indicated or the context otherwise requires, all references to “we,” “our,” “us,” “ourselves,” and “the Company” refer to CBTX, Inc., a Texas corporation, and its consolidated subsidiary. All references in this Quarterly Report on Form 10-Q to “CommunityBank of Texas” or “the Bank” refer to CommunityBank of Texas, National Association, our wholly‑owned bank subsidiary.
We operate through one segment, community banking. Our primary source of funds is deposits and our primary use of funds is loans. Most of our revenue is generated from interest on loans and investments. We incur interest expense on deposits and other borrowed funds as well as noninterest expense, such as salaries and employee benefits and occupancy expenses.
Our operating results depend primarily on our net interest income, calculated as the difference between interest income on interest‑earning assets, such as loans and securities, and interest expense on interest‑bearing liabilities, such as deposits and borrowings. Changes in market interest rates and the interest rates we earn on interest‑earning assets or pay on interest‑bearing liabilities, as well as in the volume and types of interest‑earning asset and interest‑bearing liabilities, are usually the largest drivers of periodic changes in net interest spread, net interest margin and net interest income. Fluctuations in market interest rates are driven by many factors, including governmental monetary policies, inflation, deflation, macroeconomic developments, changes in unemployment, the money supply, political and international conditions and conditions in domestic and foreign financial markets.
Periodic changes in the volume and types of loans in our loan portfolio are affected by, among other factors, economic and competitive conditions in Texas, as well as developments affecting the real estate, technology, financial services, insurance, transportation, manufacturing and energy sectors within our target markets and throughout the state of Texas. We maintain diversity in our loan portfolio as a means of managing risk associated with fluctuations in economic conditions. Our focus on lending to small to medium‑sized businesses and professionals in our market areas has resulted in a diverse loan portfolio comprised primarily of core relationships. We carefully monitor exposure to certain asset classes to minimize the impact of a downturn in the value of such assets.
We seek to remain competitive with respect to interest rates on loans and deposits, as well as prices on fee‑based services, which are typically significant competitive factors within the banking and financial services industry. Many of our competitors are much larger financial institutions that have greater financial resources than we do and compete
aggressively for market share. Through our relationship‑driven, community banking strategy, a significant portion of our continued growth has been through referral business from our existing customers and professionals in our markets including attorneys, accountants and other professional service providers.
The Bank is the subject of an investigation by the Financial Crimes Enforcement Network, or FinCEN, of the U.S. Department of the Treasury regarding the Bank’s compliance with the Bank Secrecy Act and anti-money laundering laws and regulations. The Bank is cooperating with this investigation. The costs to respond to and cooperate with FinCEN’s investigation have been material over the course of the period of this report, and the Bank expects to continue to incur material fees and expenses regarding this matter at least through the completion of FinCEN’s investigation.
Net income for the three and six months ended June 30, 2019 increased 29.6% and 23.1%, respectively, compared to the three and six months ended June 30, 2018. These increases are primarily due to increased net interest income and noninterest income, partially offset by higher noninterest expense. See further analysis of these fluctuations in the related discussions that follow.
(Dollars in thousands, except per share data and percentages)
Increase (Decrease)
5,522
16.7%
11,422
17.8%
2,099
93.2%
3,710
86.3%
3,423
11.1%
7,712
12.9%
117
17.0%
399
25.7%
3,797
108.3%
3,929
57.2%
3,391
16.9%
5,692
14.1%
Income before income taxes
3,712
27.1%
5,550
22.3%
439
16.6%
899
18.8%
3,273
29.6%
4,651
23.1%
Earnings per share - basic
Earnings per share - diluted
Dividends declared per share
0.10
0.05
0.20
Dividend payout ratio
Return on average assets (1)
Return on average shareholders' equity (1)
Efficiency ratio (2)
Annualized.
Efficiency ratio represents noninterest expense divided by the sum of net interest income and noninterest income.
Net Interest Income for the Six Months Ended June 30, 2019 Compared to the Six Months Ended June 30, 2018.
Net interest income for the six months ended June 30, 2019 was $67.6 million, compared to $59.9 million for six months ended June 30, 2018, an increase of $7.7 million, or 12.9%. The increase in net interest income in the six months of 2019, compared to the six months of 2018 was primarily due to higher average loans, higher average yields on loans and higher average yields on federal funds sold and other interest-earning assets, partially offset by the impact of average higher rates on interest-bearing deposits. Average loans increased in the first six months of 2019 due to organic growth and the increase in average loan yields reflects rates in the market. The increase in average rates on interest-bearing deposits in the first six months of 2019 was mainly due to competitive stress on rates primarily for certificates of deposit and money market accounts. Although rates have increased on the Company’s interest-bearing deposits, they remain a low cost source of funds compared to other sources such as debt.
The following table presents for the periods indicated, average outstanding balances for each major category of interest-earning assets and interest-bearing liabilities, the interest income or interest expense and the average yield or rate for the periods indicated.
Interest
Earned/
Yield/
Paid
Rate (1)
Interest-earnings assets:
Total loans (2)
2,546,610
2,347,512
232,499
226,008
Federal funds sold and other interest-earning assets
229,405
227,172
13,537
14,763
Total interest-earning assets
3,022,051
2,815,455
Allowance for loan losses
(24,426)
(25,131)
Noninterest-earnings assets
301,065
287,764
3,298,690
3,078,088
Liabilities and Shareholders’ Equity
Interest-bearing liabilities:
1,529,283
1,484,777
FHLB advances and repurchase agreements
47,939
2,585
10,826
Total interest-bearing liabilities
1,577,222
1,498,188
Noninterest-bearing liabilities:
1,185,919
1,104,451
33,764
20,801
Total noninterest-bearing liabilities
1,219,683
1,125,252
501,785
454,648
Net interest spread (3)
Net interest margin (4)
Net interest margin—tax equivalent (5)
Includes average outstanding balances related to loans held for sale.
(3)
Net interest spread is the average yield on interest‑earning assets minus the average rate on interest‑bearing liabilities.
Net interest margin is equal to net interest income divided by average interest‑earning assets.
Tax equivalent adjustments of $513,000 and $537,000 for the six months ended June 30, 2019 and 2018, respectively, were computed using a federal income tax rate of 21%.
The following tables present information regarding changes in interest income and interest expense for the periods indicated for each major component of interest‑earning assets and interest‑bearing liabilities and distinguishes between the changes attributable to changes in volume and changes attributable to changes in interest rates. For purposes of these tables, changes attributable to both rate and volume that cannot be segregated have been allocated to rate.
Six Months Ended June 30, 2019, Compared to
Six Months Ended June 30, 2018
Increase (Decrease) due to
Volume
Rate
Interest-earning assets:
5,000
5,446
10,446
85
48
133
893
912
(32)
(37)
(69)
Total increase in interest income
5,072
6,350
3,210
3,332
494
81
575
(197)
Total increase in interest expense
419
3,291
Increase in net interest income
4,653
3,059
Net Interest Income for the Three Months Ended June 30, 2019 Compared to the Three Months Ended June 30, 2018.
Net interest income for the three months ended June 30, 2019 was $34.3 million, compared to $30.9 million for three months ended June 30, 2018, an increase of $3.4 million, or 11.1%. The increase in net interest income between these periods was primarily due to higher average loans, higher average yields on loans and higher average yields on federal funds sold and other interest-earning assets, partially offset by the impact of average higher rates on interest-bearing deposits.
2,591,928
2,375,253
233,339
228,262
219,639
201,906
15,218
14,823
3,060,124
2,820,244
(24,829)
(25,392)
299,234
288,416
3,334,529
3,083,268
1,514,697
1,478,016
83,899
3,738
1,598,596
1,492,580
1,194,645
1,111,736
32,991
20,441
1,227,636
1,132,177
508,297
458,511
Tax equivalent adjustments of $258,000 and $267,000 for the three months ended June 30, 2019 and 2018, respectively, were computed using a federal income tax rate of 21%.
38
Three Months Ended June 30, 2019, Compared to
Three Months Ended June 30, 2018
2,782
2,333
5,115
(22)
82
341
423
(33)
(28)
2,903
2,619
1,643
1,696
441
70
511
(108)
386
1,713
2,517
906
Provision for Loan Losses
The provision for loan losses is an expense used to maintain an allowance for loan losses at a level which is deemed appropriate by management to absorb inherent losses on existing loans. The provision for loan losses increased $399,000 to $2.0 million for the six months ended June 30, 2019, compared to $1.6 million for the six months ended June 30, 2018, reflecting the increase in loans during those periods.
The provision for loan losses for the three months ended June 30, 2019 was $807,000 compared to $690,000 for the three months ended June 30, 2018. The increase in the provision for loan losses between these periods of $117,000 reflects the increase in loans during those periods.
Noninterest Income
For the three months and six months ended June 30, 2019, noninterest income increased $3.8 million and $3.9 million, respectively, compared to the three and six months ended June 30, 2018, primarily due to increased earnings on bank-owned life insurance. See further analysis of these fluctuations in the related discussions that follow.
160
10.7%
10.5%
(141)
(67.1%)
(183)
(53.8%)
(3.1%)
(93)
(4.9%)
3,256
700.2%
3,235
353.2%
152.1%
89.3%
Deposit Account Service Charges. Service charges on deposit accounts increased $160,000 and $311,000, respectively, for the three and six months ended June 30, 2019, compared to the same periods in 2018, predominately due to an increase in non-sufficient and account analysis charges incurred by the Company’s deposit customers.
39
Net Gain on Sale of Assets. Net gain on sale of assets consists of the gains associated with the sale of fixed assets, loans and other real estate owned, or OREO. Net gain on sale of assets decreased $141,000 and $183,000, respectively, for the three and six months ended June 30, 2019, compared to the same periods in 2018, primarily due to lower gains on sales of loans held for sale during the 2019.
Earnings on bank-owned life insurance. The Company has purchased life insurance policies on certain employees, that are carried at their cash surrender value on the condensed consolidated balance sheet and changes in the cash surrender value of the policies are recorded in noninterest income. Earnings on bank-owned life insurance increased $3.3 million and $3.2 million, respectively, during the three and six months ended June 30, 2019, compared to the same periods of 2018 due to nontaxable death benefit proceeds of $4.7 million received under bank-owned insurance policies. The Company recorded a gain of $3.3 million over the cash surrender value during the three and six months ended June 30, 2019.
Other. This category includes a variety of other income‑producing activities, including partnership and investment fund income, other loan fees, swap origination charges, wire transfer fees, credit card program income and other fee income. Other noninterest income increased during the three and six months ended June 30, 2019, compared to the same periods of the prior year due to increased swap origination charges.
Noninterest Expense
Generally, noninterest expense is composed of employee expenses and costs associated with operating facilities, obtaining and retaining customer relationships and providing bank services. For the three and six months ended June 30, 2019, compared to the same period of the prior year, noninterest expense increased primarily due to increased salaries and employee benefits and professional and director fees. See further analysis of these fluctuations in the related discussions that follow.
$ 14,185
$ 12,496
$ 1,689
13.5%
$ 28,007
$ 25,191
$ 2,816
11.2%
(3.9%)
(2.0%)
(13.1%)
(148)
(14.0%)
(0.8%)
1.9%
5.5%
97
12.6%
7.9%
113
19.9%
(9.3%)
(46)
(9.1%)
1,596
232.7%
2,768
172.5%
Correspondent bank and customer related expense
(2.9%)
(3.0%)
Loan processing
49
65.3%
12.0%
(9)
(0.9%)
(100.0%)
(62)
18.0%
15.7%
6.9%
Other expense
3.5%
4.3%
$ 23,403
$ 20,012
$ 3,391
$ 45,988
$ 40,296
$ 5,692
Salaries and Employee Benefits. Salaries and benefits increased $1.7 million and $2.8 million in the three and six months ended June 30, 2019 as compared to the same periods in the prior year as a result of annual salary increases in 2019, increased headcount and increased stock compensation expense due to restricted stock grants.
Professional and Director Fees. Professional and director fees include legal, audit, loan review and consulting fees. The increase during the three and six months ended June 30, 2019, compared to the same periods in 2018 is primarily due to increased legal fees incurred in the Bank’s responding and cooperating with an investigation by FinCEN regarding
40
the Bank’s compliance with the Bank Secrecy Act and anti-money laundering laws and regulations. The Bank incurred legal fees of $1.4 million and $2.5 million in the three and six months ended June 30, 2019, respectively.
Income Tax Expense
The amount of income tax expense is impacted by the amounts of pre‑tax income, tax‑exempt income and other nondeductible expenses. Deferred tax assets and liabilities are reflected at current income tax rates in effect for the period in which the deferred tax assets and liabilities are expected to be realized or settled. As changes in tax laws or rates are enacted, deferred tax assets and liabilities are adjusted through the provision for income taxes. Valuation allowances are established when necessary to reduce deferred tax assets to the amount expected to be realized.
The differences between the federal statutory rate of 21% and the effective tax rates presented in the table above were largely attributable to the non-taxable gain related to bank‑owned life insurance.
Total assets were $3.4 billion as of June 30, 2019, compared to $3.3 billion as of December 31, 2018, an increase of $100.4 million primarily due to an increase in loans of $193.8 million and a $12.4 million increase due to operating lease right-to-use assets, partially offset by a $115.3 million decrease in cash and cash equivalents. Total liabilities increased $74.9 million primarily due to a $90.0 million increase in FHLB advances and an increase of $14.8 million due to operating lease liabilities, partially offset by a $27.4 million decrease in deposits. Operating lease right-to-use assets and operating lease liabilities were added due to the implementation of the new lease accounting standard. See Note 1 and Note 16 to the condensed consolidated financial statements for further discussion of the new lease accounting standard. See further analysis of the other changes in the related discussions that follow.
Loan Portfolio
As of June 30, 2019, loans were $2.6 billion, an increase of $193.8 million, or 8.0%, compared to $2.4 billion at December 31, 2018. The increase in loans was primarily due to organic growth and increased capital needs of existing customers.
The loan portfolio by loan class as of the dates indicated was as follows:
20,305
3.9%
58,780
7.4%
44,139
8.6%
(486)
(0.2%)
77,693
35.1%
382
1.0%
(1,153)
(10.4%)
(2,911)
(4.3%)
Gross loans
196,749
8.0%
Less allowance for loan losses
(1,649)
Less deferred fees and unearned discount
125
193,817
Loans as a percentage of deposits
Loans as a percentage of total assets
The contractual maturity ranges of loans in the loan portfolio and the amount of such loans with fixed and variable interest rates in each maturity range as of the dates indicated were as follows:
1 Year
1 Year Through
After
or Less
5 Years
251,964
259,914
28,206
96,863
553,106
204,544
153,019
350,247
56,406
13,842
45,443
222,240
36,531
81,011
181,345
25,486
14,317
8,553
1,370
13,601
49,814
2,056
599,859
1,355,222
694,797
Fixed rate loans
176,730
736,556
296,913
1,210,199
Variable rate loans
423,129
618,666
397,884
1,439,679
Nonperforming Assets
Nonperforming assets include nonaccrual loans, loans that are accruing over 90 days past due and foreclosed assets. Generally loans are placed on nonaccrual status when they become more than 90 days past due and/or the collection of principal or interest is in doubt. The components of nonperforming assets as of the dates indicated were as follows:
Nonaccrual loans by category:
$ 1,795
$ 1,317
Total nonaccrual loans
Accruing loans 90 or more days past due
Total nonperforming loans
3,278
Foreclosed assets:
Real estate
Total foreclosed assets
Total nonperforming assets
$ 3,314
$ 3,502
Nonperforming loans to total loans
Nonperforming assets to total assets
Loss— Credits in this category are considered “loss” in accordance with regulatory guidelines and are considered uncollectible and of such little value as to question their continued existence as assets on the Company’s financial statements. Such credits are to be charged off or charged down when payment is acknowledged to be uncertain or when the timing or value of payments cannot be determined. This category does not intend to imply that the debt or some portion of it will never be paid, nor does it in any way imply that the debt will be forgiven.
43
The internal ratings of loans as of the dates indicated were as follows:
Allowance for Loan Losses
The Company maintains an allowance for loan losses that represents management’s best estimate of the loan losses and risks inherent in the loan portfolio. The amount of the allowance for loan losses should not be interpreted as an indication that charge‑offs in future periods will necessarily occur in those amounts. In determining the allowance for loan losses, the Company estimates losses on specific loans, or groups of loans, where the probable loss can be identified and reasonably determined. The balance of the allowance for loan losses is based on internally assigned risk classifications of loans, historical loan loss rates, changes in the loan portfolio, overall portfolio quality, industry concentrations, delinquency trends, current economic factors and the estimated impact of current economic conditions on certain historical loan loss rates. See “—Critical Accounting Policies—Loans and Allowance for Loan Losses.”
In reviewing the loan portfolio, the Company considers risk elements applicable to particular loan types or categories to assess the quality of individual loans. Some of the risk elements considered include:
Commercial and industrial loans—the debt service coverage ratio (income from the business in excess of operating expenses compared to loan repayment requirements), the operating results of the commercial, industrial or professional enterprise, the borrower’s business, professional and financial ability and expertise, the specific risks and volatility of income and operating results typical for businesses in that category and the value, nature and marketability of collateral;
Commercial real estate loans and multi‑family residential loans—the debt service coverage ratio, operating results of the owner in the case of owner‑occupied properties, the loan‑to‑value ratio, the age and condition of the collateral and the volatility of income, property value and future operating results typical of properties of that type;
1‑4 family residential mortgage loans—the borrower’s ability to repay the loan, including a consideration of the debt‑to‑income ratio and employment and income stability, the loan‑to‑value ratio and the age, condition and marketability of the collateral; and
Construction and development loans—the perceived feasibility of the project including the ability to sell developed lots or improvements constructed for resale or the ability to lease property constructed for lease, the quality and nature of contracts for presale or prelease, if any, experience and ability of the developer and loan‑to‑value ratio.
Activity in the allowance for loan losses as of the dates indicated was as follows:
Allowance for loan losses at beginning of period
Charge-offs:
861
87
Total charge-offs
Recoveries:
Total recoveries
Net charge-offs
Allowance for loan losses at end of period
Allowance for loan losses to end of period loans
Net charge-offs to average loans(1)
As of June 30, 2019, the carrying amount of the Company’s securities totaled $232.6 million compared to $230.0 million as of December 31, 2018, an increase of $2.6 million or 1.1%. Amortized cost decreased $3.1 million as a result of maturities, sales, calls and paydowns outpacing purchases. The unrealized gains (losses) of the security portfolio was a net gain of $2.0 million at June 30, 2019 and a net loss of $3.8 million at December 31, 2018. This change of $5.8 million was due to changing market interest rates.
Amortized cost and estimated fair value of investments in securities as of the dates shown was as follows.
The Company’s mortgage‑backed securities at June 30, 2019 and December 31, 2018, were agency securities. The Company does not hold any Fannie Mae or Freddie Mac preferred stock, corporate equity, collateralized debt obligations, collateralized loan obligations, structured investment vehicles, private label collateralized mortgage obligations, subprime, Alt‑A or second lien elements in the securities portfolio.
Contractual maturities and weighted-average yield based on annualized income divided by the average amortized cost of the available for sale securities portfolio as of the date indicated was as follows:
After 1 Year
After 5 Years
to 5 years
to 10 Years
10 Years
Yield
2,181
1,993
6,783
45,210
2.9
1.7
5,044
2.5
58,492
2.3
3.8
2,420
3.4
90,851
2.7
2.2
Total debt securities
2.4
1.9
The contractual maturity of a collateralized mortgage obligation or mortgage‑backed security is the date at which the last underlying mortgage matures and is not a reliable indicator of their expected life because borrowers have the right to prepay their obligations at any time. The weighted-average life of the securities portfolio was 4.1 years with an estimated modified duration of 3.7 years as of June 30, 2019.
A portion of the securities have contractual maturities extending beyond 10 years, bear fixed rates of interest and are collateralized by residential mortgages. Repayment of principal on these bonds is primarily dependent on the cash flows received from payments on the underlying collateral to the bond issuer and therefore, the likelihood of prepayment is impacted by the economic environment. During a period of increasing interest rates, fixed rate mortgage-backed
securities do not tend to experience heavy prepayments and as a result, the average lives of these securities are lengthened. If interest rates fall, prepayments tend to increase and as a result the lives of these securities are shortened.
As of June 30, 2019, the Company did not own securities of any one issuer, other than the U.S. government and its agencies, for which aggregate adjusted cost exceeded 10.0% of consolidated shareholders’ equity.
Total deposits as of June 30, 2019, were $2.7 billion, a decrease of $27.4 million, or 1.0%, compared to December 31, 2018. Noninterest‑bearing deposits as of June 30, 2019, were $1.2 billion, an increase of $18.2 million, or 1.5%, compared to December 31, 2018. Total interest‑bearing account balances as of June 30, 2019, were $1.5 billion, a decrease of $45.6 million, or 2.9% from December 31, 2018. The changes in deposits from December 31, 2018 to June 30, 2019 are due to normal fluctuations in customer activities.
The components of deposits at the dates shown below were as follows:
Certificates of deposit by time remaining until maturity as of the dates indicated were as follows:
Three months or less
77,214
71,817
Over three months through six months
62,988
50,966
Over six months through 12 months
115,907
119,180
Over 12 months through three years
108,957
108,436
Over three years
11,517
10,636
376,583
361,035
Average balances and average rates paid on deposits for the periods indicated are shown in the table below. Average rates paid for the six months ended June 30, 2019 were computed on an annualized basis.
Year Ended December 31, 2018
359,124
0.25
362,498
0.23
Savings accounts
94,607
0.06
94,754
709,782
1.25
714,565
0.87
186,636
1.27
173,160
0.79
179,134
1.55
174,666
1.23
0.98
1,519,643
0.70
1,134,191
2,715,202
0.55
2,653,834
0.40
The ratio of average noninterest‑bearing deposits to average total deposits was 56.3% for the six months ended June 30, 2019 and 42.7% for the year ended December 31, 2018.
Borrowings
Frost Line of Credit. The Company has entered into a loan agreement, or the Loan Agreement, with Frost Bank, which provides for a $30.0 million revolving line of credit, or Line of Credit. The Loan Agreement was amended and restated on December 13, 2018 and, as amended, is referred to as the Amended Agreement. The Company can make draws on the Line of Credit for a period of 12 months beginning on the date of the Amended Agreement, after which the Company will not be permitted to make further draws and the outstanding balance will amortize over a period of 60 months. Interest accrues on outstanding borrowings at a rate equal to the maximum “Latest” U.S. prime rate of interest per annum and payable quarterly in the first 12 months and thereafter quarterly principal and interest payments are required over a term of 60 months. The entire outstanding balance and unpaid interest is payable in full on December 13, 2024.
Covenants made under the Amended Agreement include, among other things, the Company maintaining tangible net worth of not less than $300 million, the Company maintaining free cash flow coverage ratio of not less than 1.25 to 1.00, the Bank’s Texas Ratio (as defined under the Amended Agreement) not to exceed 15%, the Bank’s Total Capital Ratio (as defined under the Amended Agreement) of not less than 12% and restrictions on the ability of the Company and its subsidiaries to incur certain additional debt. The Company was in compliance with these covenants at June 30, 2019.
As of June 30, 2019, there were no outstanding borrowings on the Line of Credit and the Company has not drawn on this line since the Company entered the agreement.
FHLB Advances
The FHLB allows the Company to borrow on a blanket floating lien status collateralized by certain loans. As of June 30, 2019 and December 31, 2018, total borrowing capacity of $875.7 million and $919.9 million, respectively, was available under this arrangement. During the first and second quarter of 2019 and the second and third quarter of 2018, the Company borrowed under this agreement on a short-term basis. As of June 30, 2019, $90.0 million of FHLB advances were outstanding and December 31, 2018, there were no outstanding FHLB advances. The average outstanding balance for FHLB advances for the six months ended June 30, 2019 and 2018 was $46.6 million and $1.1 million, respectively. The weighted-average rate for the six months ended June 30, 2019 and 2018 was 2.54% and 2.19%, respectively.
Liquidity
Liquidity involves our ability to raise funds to support asset growth and acquisitions or reduce assets to meet deposit withdrawals and other payment obligations, to maintain reserve requirements and otherwise to operate on an ongoing basis and manage unexpected events. The Company’s primary source of funds is deposits and the primary use of funds is loans. Historically the cost of the Company’s deposits has been lower than other sources of funds available, such as debt. The Company does not expect a change in the primary source or use of funds in the foreseeable future. The composition of funding sources and uses as a percentage of average total assets for the periods indicated was as follows:
Six Months Ended
Year Ended
Sources of funds:
Deposits:
Interest-bearing
46.4
48.1
Noninterest-bearing
36.0
35.9
1.4
0.4
1.0
0.7
15.2
14.7
Total sources
Uses of funds:
77.2
75.8
7.0
7.2
8.1
Equity securities
0.5
Other noninterest-earning assets
8.4
Total uses
Average loans to average deposits
91.9
90.1
As of June 30, 2019, the Company had $807.2 million in outstanding commitments to extend credit and $28.1 million in commitments associated with outstanding standby and commercial letters of credit. Since commitments associated with letters of credit and commitments to extend credit may expire unused, the total outstanding may not necessarily reflect the actual future cash funding requirements.
As of June 30, 2019, there was no exposure to future cash requirements associated with known uncertainties or capital expenditure of a material nature.
As of June 30, 2019, cash and cash equivalents was of $266.8 million, compared to $382.1 million as of December 31, 2018, a decrease of $115.3 million. The decrease was primarily due to an increase in loans of $193.8 million, a $27.4 million decrease in deposits and net income of $24.8 million. See the condensed consolidated statement of cash flows for the six months ended June 30, 2019 for additional analysis.
Capital Resources
Total shareholders’ equity increased to $513.2 million as of June 30, 2019, compared to $487.6 million as of December 31, 2018, an increase of $25.6 million, or 5.2%, primarily due the current year income of $24.8 million, a $4.5 million increase in other comprehensive income and $1.1 million of stock compensation expense, partially offset by $5.0 million in dividends to common shareholders paid or declared during the six months ended June 30, 2019.
As a general matter, FDIC insured depository institutions and their holding companies are required to maintain minimum capital relative to the amount and types of assets they hold. The Company and the Bank are both subject to regulatory capital requirements. At June 30, 2019 and December 31, 2018, the Company and the Bank were in compliance with all applicable regulatory capital requirements at the bank holding company and bank levels, and the Bank was
classified as “well capitalized” for purposes of the FDIC’s prompt corrective action regulations. The OCC or the FDIC may require the Bank to maintain capital ratios above the required minimums and the Federal Reserve may require the Company to maintain capital ratios above the required minimums. The following table presents the regulatory capital ratios for our Company and the Bank as of the dates indicated.
51
Contractual Obligations
In the normal course of operations, the Company enters into certain contractual obligations, such as obligations for operating leases, certificates of deposits and borrowings. Future cash payments associated with contractual obligations, as of the dates indicated were as follows:
More than
3 years or
1 year or
1 year but less
more but less
5 years or
less
than 3 years
than 5 years
more
Non-cancelable future operating leases
4,267
4,188
Certificates of deposit
256,109
348,097
113,224
15,705
486,967
2,118
4,363
4,565
10,048
21,094
241,963
245,652
112,799
15,201
383,700
In January 2019, the trust preferred securities underlying the junior subordinated debt outstanding at December 31, 2018 were redeemed.
Off‑Balance Sheet Arrangements
In the normal course of business, the Company enters into various transactions, which, in accordance with GAAP, are not included in the consolidated balance sheets. These transactions are entered into to meet the customer financing needs. These transactions include commitments to extend credit and standby and commercial letters of credit, which involve, to varying degrees, elements of credit risk and interest rate risk in excess of the amounts recognized in our consolidated balance sheets.
Commitments associated with outstanding standby and commercial letters of credit and commitments to extend credit expiring by period as of the date indicated are summarized below.
16,937
6,120
Commitments to extend credit
482,509
279,027
39,825
5,837
499,446
285,147
44,825
835,255
22,789
3,940
486,480
267,099
14,415
63,642
509,269
271,039
19,415
863,365
Standby letters of credit are conditional commitments issued to guarantee the performance of a customer to a third party. In the event of nonperformance by the customer, the Company has rights to the underlying collateral, which can include commercial real estate, physical plant and property, inventory, receivables, cash and/or marketable securities. The Company’s credit risk associated with issuing letters of credit is essentially the same as the risk involved in extending loan facilities to our customers.
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. Commitments generally have fixed expiration dates or other termination clauses and
52
may require payment of a fee. Since many of the commitments are expected to expire without being fully drawn upon, the total commitment amounts disclosed above do not necessarily represent future cash requirements.
As a financial institution, the Company’s primary component of market risk is interest rate volatility. The Company’s asset, liability and funds management policy provides management with the guidelines for effective funds management. A measurement system for monitoring net interest rate sensitivity position has been established and the Company has historically managed its sensitivity position within its established guidelines.
Fluctuations in interest rates will ultimately impact both the level of income and expense recorded on most of the Company’s assets and liabilities and the market value of all interest‑earning assets and interest‑bearing liabilities, other than those which have a short-term to maturity. Interest rate risk is the potential of economic losses due to future interest rate changes. These economic losses can be reflected as a loss of future net interest income and/or a decrease in current fair market values. The objective is to measure the effect on net interest income and to adjust the balance sheet to minimize the inherent risk while at the same time maximizing income.
The Company manages exposure to interest rates by structuring our balance sheet in the ordinary course of business. The Company does not enter into instruments such as leveraged derivatives, financial options, financial future contracts or forward delivery contracts to reduce interest rate risk. Based upon the nature of our operations, the Company is not subject to foreign exchange or commodity price risk and does not own any trading assets.
The Company’s exposure to interest rate risk is managed by the Funds Management Committee of the Bank, in accordance with policies approved by the Bank’s Board of Directors. The committee formulates strategies based on appropriate levels of interest rate risk. In determining the appropriate level of interest rate risk, the committee considers the impact on earnings and capital of the current outlook on interest rates, potential changes in interest rates, regional economies, liquidity, business strategies and other factors. The committee meets regularly to review, among other things, the sensitivity of assets and liabilities to interest rate changes, the book and market values of assets and liabilities, unrealized gains and losses, purchase and sale activities, commitments to originate loans and the maturities of investments and borrowings. Additionally, the committee reviews liquidity, cash flow flexibility, maturities of deposits and consumer and commercial deposit activity. Management employs methodologies to manage interest rate risk, which include an analysis of relationships between interest‑earning assets and interest‑bearing liabilities and an interest rate shock simulation model.
The Company uses interest rate risk simulation models and shock analyses to test the interest rate sensitivity of net interest income and fair value of equity and the impact of changes in interest rates on other financial metrics. Contractual maturities and re‑pricing opportunities of loans are incorporated in the model, as are prepayment assumptions, maturity data and call options within the investment portfolio. Average life of non‑maturity deposit accounts are based on standard regulatory decay assumptions and are incorporated into the model. The assumptions used are inherently uncertain and the model cannot precisely measure future net interest income or precisely predict the impact of fluctuations in market interest rates on net interest income. Actual results will differ from the model’s simulated results due to timing, magnitude and frequency of interest rate changes as well as changes in market conditions and the application and timing of various management strategies.
On a quarterly basis, two simulation models are run, including a static balance sheet and dynamic growth balance sheet. These models test the impact on net interest income and fair value of equity from changes in market interest rates under various scenarios. Under the static and dynamic growth models, rates are shocked instantaneously and ramped rate changes over a 12‑month horizon based upon parallel and non‑parallel yield curve shifts. Parallel shock scenarios assume instantaneous parallel movements in the yield curve compared to a flat yield curve scenario. Non‑parallel simulation involves analysis of interest income and expense under various changes in the shape of the yield curve. The Company’s internal policy regarding internal rate risk simulations currently specifies that for instantaneous parallel shifts of the yield curve, estimated net income at risk for the subsequent one‑year period should not decline by more than 10% for a 100 basis-point shift, 20% for a 200‑basis point shift and 30% for a 300‑basis point shift.
Simulated change in net interest income and fair value of equity over a 12‑month horizon as of the dates indicated below were as follows:
Percent Change
Change in Interest
in Net Interest
in Fair Value
Rates (Basis Points)
Income
of Equity
+ 300
13.5
16.7
(3.1)
+ 200
9.5
6.1
11.6
(0.4)
+ 100
5.1
5.6
1.1
Base
−100
(5.4)
(14.0)
(6.8)
(7.6)
The results are primarily due to behavior of demand, money market and savings deposits during such rate fluctuations. Historically, interest rates on these deposits have changed more slowly than changes in the discount and federal funds rates. This assumption is incorporated into the simulation model and is generally not fully reflected in a gap analysis. The assumptions incorporated into the model are inherently uncertain and, as a result, the model cannot precisely measure future net interest income or precisely predict the impact of fluctuations in market interest rates on net interest income. Actual results will differ from the model’s simulated results due to timing, magnitude and frequency of interest rate changes as well as changes in market conditions and the application and timing of various strategies.
The Company’s condensed consolidated financial statements and related notes included elsewhere in this Quarterly Report on Form 10-Q have been prepared in accordance with GAAP. GAAP requires the measurement of financial position and operating results in terms of historical dollars, without considering changes in the relative value of money over time due to inflation or recession.
Unlike many industrial companies, substantially all of the Company’s assets and liabilities are monetary in nature. As a result, interest rates have a more significant impact on our performance than the effects of general levels of inflation. Interest rates may not necessarily move in the same direction or in the same magnitude as the prices of goods and services. However, other operating expenses do reflect general levels of inflation.
The Company’s accounting and reporting policies conform to GAAP and the prevailing practices in the banking industry. However, the Company also evaluates its performance based on certain additional non‑GAAP financial measures. A financial measure is considered to be a non‑GAAP financial measure if that financial measure excludes or includes amounts, or is subject to adjustments that have the effect of excluding or including amounts, that are not included or excluded in the most directly comparable measure calculated and presented in accordance with GAAP as in effect from time to time in the U.S. in the Company’s statements of income, balance sheets or statements of cash flows. Non‑GAAP financial measures do not include operating and other statistical measures or ratios or statistical measures calculated using exclusively financial measures calculated in accordance with GAAP. Non‑GAAP financial measures should not be considered in isolation or as a substitute for the most directly comparable or other financial measures calculated in accordance with GAAP. Moreover, the way the Company calculates the non‑GAAP financial measures may differ from that of other companies reporting measures with similar names.
The Company calculates tangible equity as total shareholders’ equity, less goodwill and other intangible assets, net of accumulated amortization and tangible book value per share as tangible equity divided by shares of common stock outstanding at the end of the relevant period. The most directly comparable GAAP financial measure for tangible book value per share is book value per share. The Company calculates tangible assets as total assets less goodwill and other intangible assets, net of accumulated amortization. The most directly comparable GAAP financial measure for tangible equity to tangible assets is total shareholders’ equity to total assets. The Company believes that tangible book value per share and tangible equity to tangible assets are measures that are important to many investors in the marketplace who are interested in book value per share and total shareholders’ equity to total assets, exclusive of change in intangible assets.
Tangible Equity
Adjustments:
Other intangibles
Tangible equity
426,890
400,900
Tangible Assets
Tangible assets
3,293,238
3,192,371
Common shares outstanding
24,923
24,907
Book value per share
20.59
19.58
Tangible book value per share
17.13
16.10
Total shareholders’ equity to total assets
Tangible equity to tangible assets
The Company’s accounting policies are described in Note 1 to the consolidated financial statements in the Company’s Annual Report on Form 10-K for the year ended December 31, 2018. The Company believes that the following accounting policies involve a higher degree of judgment and complexity:
The allowance for loan losses represents management’s estimate of probable and reasonably estimable credit losses inherent in the loan portfolio. In determining the allowance, the Company estimates losses on individual impaired loans, or groups of loans which are not impaired, where the probable loss can be identified and reasonably estimated. On a quarterly basis, the risk inherent in the loan portfolio based on qualitative and quantitative trends in the portfolio is assessed, including the internal risk classification of loans, historical loss rates, changes in the nature and volume of the loan portfolio, industry or borrower concentrations, delinquency trends, detailed reviews of significant loans with identified weaknesses and the impacts of local, regional and national economic factors on the quality of the loan portfolio.
Determining the amount of the allowance is considered a critical accounting estimate, as it requires significant judgment and the use of subjective measurements, including management’s assessment of overall portfolio quality. The Company maintains the allowance at an amount it believes is sufficient to provide for estimated losses inherent in the loan portfolio at each balance sheet date. Fluctuations in the provision for loan losses may result from management’s assessment of the adequacy of the allowance. Changes in these estimates and assumptions are possible and may have a material impact on the allowance, and therefore the Company’s financial position, liquidity or results of operations. For a description of the factors considered in determining the allowance for loan losses see “Management’s Discussion and Analysis of Financial Condition and Results of Operations —Financial Condition—Allowance for Loan Losses.”
Fair Values of Financial Instruments
The fair values of the Company’s financial instruments are based upon quoted market prices, where available. If quoted market prices are not available, fair value is estimated based upon models that primarily use observable market‑based parameters as inputs. Fair value estimates involve uncertainties and matters of significant judgment regarding interest rates, credit risk, prepayments and other factors, especially in the absence of broad markets for particular items. Changes in assumptions or in market conditions could significantly affect the estimates.
Goodwill and Other Intangibles
Goodwill, which is excess purchase price over the fair value of net assets from acquisitions, is evaluated for impairment at least annually and on an interim basis if events or circumstances indicate that it is likely an impairment has occurred. Qualitative factors are assessed to determine if it is likely that the fair value of a reporting unit is less than its carrying amount. If it is determined that it is likely that the fair value of a reporting unit is less than its carrying amount, the fair value of the reporting unit is compared with the carrying amount of the reporting unit. The fair value of net assets is estimated based on an analysis of market value. Impairment exists if the fair value of the reporting unit at the date of the test is less than the goodwill recorded. If goodwill is impaired, a loss would then be recognized in the consolidated financial statements to the extent of the impairment.
Determining the fair value of goodwill is considered a critical accounting estimate because the allocation of the fair value of goodwill to assets and liabilities requires significant management judgment and the use of subjective measurements. Variability in the market and changes in assumptions or subjective measurements used to allocate fair value are reasonably possible and may have a material impact on the Company’s financial position, liquidity or results of operations.
The Company’s other intangible assets include core deposits, loan servicing assets and customer relationship intangibles, which can be distinguished from goodwill because of contractual or other legal rights or because the asset is capable of being sold or exchanged either on its own or in combination with a related contract, asset, or liability. Other intangible assets are tested for impairment whenever events or changes in circumstances indicate the carrying amount of the assets may not be recoverable from future undiscounted cash flows. If impaired, the assets are recorded at fair value.
Emerging Growth Company
The Jump Start Our Business Start-ups, or JOBS Act permits an “emerging growth company” to take advantage of an extended transition period to comply with new or revised accounting standards applicable to public companies. The Company decided not to take advantage of this provision and is complying with new or revised accounting standards to the same extent that compliance is required for non‑emerging growth companies. The decision to opt out of the extended transition period under the JOBS Act is irrevocable.
See “Note 1 – Summary of Significant Accounting Policies” to the condensed consolidated financial statements.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
The Company manages market risk, which, as a financial institution is primarily interest rate volatility, through the Asset-Liability Committee of the Bank, in accordance with policies approved by its board of directors. The Company uses an interest rate risk simulation model and shock analysis to test the interest rate sensitivity of net interest income and fair value of equity, and the impact of changes in interest rates on other financial metrics. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Interest Rate Sensitivity and Market Risk” herein for a discussion of how the Company manages market risk.
Item 4. Controls and Procedures
Evaluation of disclosure controls and procedures — As of the end of the period covered by this Report, the Company carried out an evaluation, under the supervision and with the participation of its management, including its Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of its disclosure controls and procedures. In designing and evaluating the disclosure controls and procedures, management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and management was required to apply judgment in evaluating its controls and procedures. Based on this evaluation, the Company’s Chief Executive Officer and Chief Financial Officer concluded that the Company’s disclosure controls and procedures (as defined in Rules 13a‑15(e) and 15d‑15(e) under the Securities Exchange Act of 1934, as amended, or the Exchange Act) were effective as of the end of the period covered by this Report.
Changes in internal control over financial reporting —There were no changes in the Company’s internal control over financial reporting (as such term is defined in Rules 13a‑15(f) and 15d‑15(f) under the Exchange Act) during the quarter ended June 30, 2019, that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
The Company is not currently subject to any material legal proceedings. The Company is from time to time subject to claims and litigation arising in the ordinary course of business. These claims and litigation may include, among other things, allegations of violation of banking and other applicable regulations, competition law, labor laws and consumer protection laws, as well as claims or litigation relating to intellectual property, securities, breach of contract and tort. The Company intends to defend itself vigorously against any pending or future claims and litigation.
At this time, in the opinion of management, the likelihood is remote that the impact of such proceedings, either individually or in the aggregate, would have a material adverse effect on the Company’s consolidated results of operations, financial condition or cash flows. However, one or more unfavorable outcomes in any claim or litigation against us could have a material adverse effect for the period in which they are resolved. In addition, regardless of their merits or their ultimate outcomes, such matters are costly, divert management’s attention and may materially and adversely affect the Company’s reputation, even if resolved in our favor.
Item 1A. Risk Factors
None.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
The following table provides information with respect to purchases of shares of the Company’s common stock during the three months ended June 30, 2019 that the Company made or were made on behalf of the Company or any “affiliated purchaser,” as defined in Rule 10b-18(a)(3) under the Securities Exchange Act of 1934.
Maximum
Number of Shares
That May Yet be
Shares Purchased
Purchased Under a
Average Price
as Part of Publicly
Plan at the
Shares Purchased(1)
Paid per Share
Announced Plan
End of the Period
April 1, 2019 - April 30, 2019
$ 33.11
-
May 1, 2019 - May 31, 2019
509
$ 28.02
June 1, 2019 - June 30, 2019
(1) Share repurchases result from vesting of restricted stock awards. None of these purchases were part of a publicly announced program to purchase common stock of the Company.
Item 3. Defaults Upon Senior Securities
Item 4. Mine Safety Disclosures
Not Applicable.
Item 5. Other Information
Item 6. Exhibits
ExhibitNumber
Description of Exhibit
First Amended and Restated Certificate of Formation of CBTX, Inc. (incorporated by reference to Exhibit 3.1 to the Company’s Form S-1 filed with the Commission on October 13, 2018)
3.2
Second Amended and Restated Bylaws of CBTX, Inc. (incorporated by reference to Exhibit 3.2 to the Company’s Form S-1 filed with the Commission on October 13, 2018)
4.1
Specimen Common Stock Certificate (incorporated by reference to Exhibit 4.1 to the Company’s Form S-1 filed with the Commission on October 13, 2018)
31.1*
Certification of Principal Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31.2*
Certification of Principal Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32.1**
Certification of Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
32.2**
Certification of Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
101*
The following materials from CBTX’s Quarterly Report on Form 10‑Q for the quarter ended June 30, 2019, formatted in XBRL (Xtensible Business Reporting Language), filed herewith: (i) Condensed Consolidated Balance Sheets, (ii) Condensed Consolidated Statements of Operations, (iii) Condensed Consolidated Statements of Comprehensive Income (Loss), (iv) Condensed Consolidated Statements of Changes in Shareholders’ Equity, (v) Condensed Consolidated Statements of Cash Flows, and (vi) Notes to Condensed Consolidated Financial Statements.
* Filed with this Quarterly Report on Form 10‑Q
** Furnished with this Quarterly Report on Form 10‑Q
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.
(Registrant)
Date: July 25, 2019
/s/ Robert R. Franklin, Jr.
Robert R. Franklin, Jr.
Chairman, President and Chief Executive Officer
(Principal Executive Officer)
/s/ Robert T. Pigott, Jr.
Senior Executive Vice President and Chief Financial Officer
(Principal Financial and Accounting Officer)