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 March 31, 2021
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 April 26, 2021, there were 24,594,299 shares of the registrant’s common stock outstanding, including 151,833 shares of unvested restricted stock.
CBTX, INC.
Page
PART I — FINANCIAL INFORMATION
Item 1.
Financial Statements – (Unaudited)
1
Condensed Consolidated Balance Sheets as of March 31, 2021 and December 31, 2020
Condensed Consolidated Statements of Income for the Three Months Ended March 31, 2021 and 2020
2
Condensed Consolidated Statements of Comprehensive Income for the Three Months Ended March 31, 2021 and 2020
3
Condensed Consolidated Statements of Changes in Shareholders’ Equity for the Three Months Ended March 31, 2021 and 2020
4
Condensed Consolidated Statements of Cash Flows for the Three Months Ended March 31, 2021 and 2020
5
Notes to Condensed Consolidated Financial Statements
6
Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
37
Cautionary Note Regarding Forward-Looking Statements
Overview
38
Information Regarding COVID-19 Impact and Uncertain Economic Outlook
39
Results of Operations
41
Financial Condition
45
Liquidity and Capital Resources
54
Interest Rate Sensitivity and Market Risk
56
Non-GAAP Financial Measures
58
Critical Accounting Policies
59
Recently Issued Accounting Pronouncements
Item 3.
Quantitative and Qualitative Disclosures about Market Risk
Item 4.
Controls and Procedures
PART II — OTHER INFORMATION
Legal Proceedings
Item 1A.
Risk Factors
60
Unregistered Sales of Equity Securities and Use of Proceeds
Defaults Upon Senior Securities
Mine Safety Disclosures
Item 5.
Other Information
Item 6.
Exhibits
61
SIGNATURES
62
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)
March 31, 2021
December 31, 2020
Assets:
Cash and due from banks
$
52,472
46,814
Interest-bearing deposits at other financial institutions
552,199
491,193
Total cash and cash equivalents
604,671
538,007
Securities
289,091
237,281
Equity investments
18,786
18,652
Loans held for sale
1,005
2,673
Loans, net of allowance for credit losses of $40,874 and $40,637 at March 31, 2021 and December 31, 2020, respectively
2,850,758
2,883,480
Premises and equipment, net of accumulated depreciation of $36,666 and $35,826 at March 31, 2021 and December 31, 2020, respectively
60,551
61,152
Goodwill
80,950
Other intangible assets, net of accumulated amortization of $16,798 and $16,607 at March 31, 2021 and December 31, 2020, respectively
3,991
4,171
Bank-owned life insurance
72,728
72,338
Operating lease right-to-use assets
12,900
13,285
Deferred tax assets, net
11,000
10,700
Other assets
22,208
26,528
Total assets
4,028,639
3,949,217
Liabilities:
Noninterest-bearing deposits
1,621,408
1,476,425
Interest-bearing deposits
1,763,339
1,825,369
Total deposits
3,384,747
3,301,794
Federal Home Loan Bank advances
50,000
Operating lease liabilities
16,060
16,447
Other liabilities
32,483
34,525
Total liabilities
3,483,290
3,402,766
Commitments and contingencies (Note 16)
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, 25,288,454 and 25,458,816 shares issued at March 31, 2021 and December 31, 2020, respectively; 24,442,466 and 24,612,828 shares outstanding at March 31, 2021 and December 31, 2020, respectively
253
255
Additional paid-in capital
334,839
339,334
Retained earnings
221,279
214,456
Treasury stock, at cost, 845,988 shares held at both March 31, 2021 and December 31, 2020, respectively
(14,369)
Accumulated other comprehensive income, net of tax of $890 and $1,801 at March 31, 2021 and December 31, 2020, respectively
3,347
6,775
Total shareholders’ equity
545,349
546,451
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 March 31,
2021
2020
Interest income:
Interest and fees on loans
33,165
33,617
1,173
1,363
Other interest-earning assets
177
1,055
146
176
Total interest income
34,661
36,211
Interest expense:
Deposits
1,350
3,766
221
Other interest-bearing liabilities
Total interest expense
1,571
Net interest income
33,090
32,220
Provision for credit losses:
Provision for credit losses for loans
286
4,739
Provision for credit losses for unfunded commitments
126
310
Total provision for credit losses
412
5,049
Net interest income after provision for credit losses
32,678
27,171
Noninterest income:
Deposit account service charges
1,193
1,485
Card interchange fees
976
922
Earnings on bank-owned life insurance
390
416
Net gain on sales of assets
192
123
Other
360
1,381
Total noninterest income
3,111
4,327
Noninterest expense:
Salaries and employee benefits
14,188
14,223
Occupancy expense
2,521
2,424
Professional and director fees
1,703
1,152
Data processing and software
1,576
1,222
Regulatory fees
556
103
Advertising, marketing and business development
285
364
Telephone and communications
463
419
Security and protection expense
374
Amortization of intangibles
191
Other expenses
1,412
1,587
Total noninterest expense
23,285
22,089
Net income before income tax expense
12,504
9,409
Income tax expense
2,485
1,868
Net income
10,019
7,541
Earnings per common share
Basic
0.41
0.30
Diluted
Condensed Consolidated Statements of Comprehensive Income (Unaudited)
(Dollars in thousands)
Change in unrealized gains (losses) on securities available for sale arising during the period
(4,339)
5,023
Reclassification adjustments for net realized gains included in net income
10
Change in related deferred income tax
911
(1,058)
Other comprehensive income (loss), net of tax
(3,428)
3,975
Total comprehensive income
6,591
11,516
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
Balance at December 31, 2019
25,837,048
258
346,559
201,080
(857,346)
(14,562)
2,386
535,721
Cumulative effect of accounting changes from adoption of CECL, net of deferred tax asset
(3,045)
Dividends on common stock, $0.10 per share
(2,496)
Stock-based compensation expense
557
Vesting of restricted stock, net of shares withheld for employee tax liabilities
5,232
(35)
Exercise of stock options, net of shares withheld for employee tax liabilities
(10)
1,524
26
16
Shares repurchased
(240,445)
(2)
(5,358)
(5,360)
Other comprehensive income, net of tax
Balance at March 31, 2020
25,601,835
256
341,713
203,080
(855,822)
(14,536)
6,361
536,874
Balance at December 31, 2020
25,458,816
(845,988)
Dividends on common stock, $0.13 per share
(3,196)
541
10,727
(70)
(181,089)
(4,966)
(4,968)
Balance at March 31, 2021
25,288,454
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:
Provision for credit losses
Depreciation expense
863
775
Amortization of premiums on securities
400
368
Amortization of lease right-to-use assets
385
349
Accretion of lease liabilities
100
133
(390)
(416)
Deferred income tax provision
611
158
(192)
(123)
Earnings on securities
(24)
Change in operating assets and liabilities:
1,900
670
4,426
(6,625)
(3,382)
1,759
Total adjustments
5,881
2,851
Net cash provided by operating activities
15,900
10,392
Cash flows from investing activities:
Purchases of securities
(227,793)
(160,580)
Proceeds from sales, calls and maturities of securities
152,530
153,005
Principal repayments of securities
18,698
9,522
Net (increase) decrease in loans
31,956
(30,168)
Purchases of loan participations
(2,500)
Proceeds from sales of Small Business Administration loans
508
Net contributions to equity investments
(134)
(97)
Net purchases of premises and equipment
(313)
(143)
Net cash used in investing activities
(24,682)
(30,453)
Cash flows from financing activities:
Net increase in noninterest-bearing deposits
144,983
10,680
Net decrease in interest-bearing deposits
(62,030)
(70,835)
Net increase in securities sold under agreements to repurchase
930
Dividends paid on common stock
(2,469)
(2,501)
Payments to tax authorities for stock-based compensation
Proceeds from exercise of stock options
Repurchase of common stock
Net cash provided by financing activities
75,446
(67,105)
Net increase (decrease) in cash, cash equivalents and restricted cash
66,664
(87,166)
Cash, cash equivalents and restricted cash, beginning
372,064
Cash, cash equivalents and restricted cash, ending
284,898
(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.
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 March 31, 2021 and December 31, 2020, consolidated results of operations, consolidated cash flow and consolidated shareholders’ equity for the three months ended March 31, 2021 and 2020.
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, 2020 included within the Company’s Annual Report on Form 10-K.
Reclassification—Within interest expense for 2020, repurchase agreements and note payable and junior subordinated debt have been combined together under the caption “other interest-bearing liabilities”. These reclassifications were made to conform to the 2021 financial statement presentation in the condensed consolidated statements of income.
Share Repurchase Program—During the three months ended March 31, 2021, 181,089 shares were repurchased under the Company’s share repurchase program at an average price of $27.44 per share and during the three months ended March 31, 2020, 240,445 shares were repurchased at an average price of $22.29. Shares repurchased during 2021 and 2020 were retired and returned to the status of authorized but unissued shares.
Accounting Standards Recently Adopted—Accounting standards update, or ASU, 2020-04, Reference Rate Reform (Topic 848): Facilitation of the Effects of Reference Rate Reform on Financial Reporting provides optional expedients and exceptions for applying generally accepted accounting principles to contracts, hedging relationships and other transactions that reference the London Interbank Offered Rate, or LIBOR, or another reference rate expected to be discontinued, if certain criteria are met. LIBOR is used as an index rate for a majority of the Company’s interest-rate swaps and 7.5% of the Company’s loans as of March 31, 2021.
If reference rates are discontinued, the existing contracts will be modified to replace the discontinued rate with a replacement rate. For accounting purposes, such contract modifications would have to be evaluated to determine whether the modified contract is a new contract or a continuation of an existing contract. If they are considered new contracts, the previous contract would be extinguished resulting in the acceleration of previously deferred fees and costs. Under one of the optional expedients of ASU 2020-04, modifications of contracts within the scope of Topic 310, Receivables, and 470, Debt, will be accounted for by prospectively adjusting the effective interest rates and no such evaluation is required. When elected, the optional expedient for contract modifications must be applied consistently for all eligible contracts or eligible
transactions. The expedients and exceptions in this update are available to all entities starting March 12, 2020 through December 31, 2022. The Company began modifying LIBOR based loans during 2020 and applied the expedients and exceptions.
Cash Flow Reporting—Historically, the Bank has been required to maintain regulatory reserves with the Federal Reserve Bank of Dallas, or the Federal Reserve Bank. On March 15, 2020, the Board of Governors of the Federal Reserve System announced that it had reduced the required regulatory reserve balance to 0% effective on March 26, 2020 in reaction to the economic dislocation caused by the COVID-19 pandemic.
As of March 31, 2021 and December 31, 2020, the Company had $4.5 million and $8.4 million, respectively, in cash held as collateral on deposit with other financial institution counterparties related to interest rate swap transactions. Reserves maintained with the Federal Reserve Bank and cash held as collateral for interest rate swap transactions are considered restricted cash.
Supplemental disclosures of cash flow information were as follows for the periods indicated below:
March 31,
Supplemental disclosures of cash flow information:
Cash paid for taxes
Cash paid for interest
1,688
3,944
Supplemental disclosures of non-cash flow information:
Change in liability for dividends accrued
(727)
Repossessed real estate and other assets
106
NOTE 2: SECURITIES
The amortized cost, related gross unrealized gains and losses and fair values of investments in securities as of the dates shown below were as follows:
Gross
Amortized
Unrealized
Cost
Gains
Losses
Fair Value
Debt securities available for sale:
State and municipal securities
103,358
3,391
(564)
106,185
U.S. Treasury securities
11,878
(57)
11,821
U.S. agency securities:
Callable debentures
3,000
(49)
2,951
Collateralized mortgage obligations
34,166
233
(405)
33,994
Mortgage-backed securities
131,275
2,725
(1,036)
132,964
Equity securities
1,180
(4)
1,176
284,857
6,349
(2,115)
88,741
4,296
93,037
35,085
347
(30)
35,402
103,686
3,963
107,649
17
228,688
8,623
7
The amortized cost and estimated fair value of securities, by contractual maturities, as of the dates shown below were as follows:
1 Year or Less
After 1 Year to 5 Years
After 5 Years to 10 Years
After 10 Years
Amortized cost:
989
9,542
92,827
4,729
29,437
1,302
726
129,231
2,185
29,875
251,495
Fair value:
994
10,007
95,184
4,867
29,127
1,371
758
130,819
2,186
30,404
255,130
509
1,292
9,154
77,786
4,910
30,175
33
798
101,370
1,718
2,777
14,862
209,331
512
1,298
9,540
81,687
5,075
30,327
1,565
829
105,222
1,738
2,863
15,444
217,236
Actual maturities may differ from contractual maturities as borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
No securities were sold in the three months ended March 31, 2021 and 2020. At March 31, 2021 and December 31, 2020, securities with a carrying amount of $28.8 million and $27.3 million, respectively, were pledged to secure public deposits and for other purposes required or permitted by law.
8
There are multiple qualitative factors the Company considers to determine if an allowance for credit losses, or ACL, is necessary for those securities where the amortized cost basis exceeds the fair value. These factors include, among other things: (i) the extent to which the fair value was less than the amortized cost basis of the security and the length of time; (ii) the structure of the payments and likelihood that the issuer has the ability to make future payments; (iii) adverse conditions related to the security, industry or geographic area; (iv) changes in any credit ratings or financial conditions of the issuer; (v) failure by the issuer to make previous payments; and (vi) past events related to the security, current economic conditions and reasonable and supportable forecasts. Management did not believe that any of the securities the Company held at March 31, 2021 or December 31, 2020 were impaired due to reasons of credit quality and believed any unrealized losses were temporary. No ACL for available for sale securities was recorded in the Company’s condensed consolidated balance sheets at March 31, 2021 or during 2020.
Amortized costs, as defined by GAAP, include acquisition costs, applicable accrued interest and accretion or amortization of premiums and discounts. The Company made a policy election to exclude accrued interest from amortized costs in the determination of ACL. The Company continues its policy of reversing previously accrued interest when it has been deemed uncollectible. Accrued interest receivable for securities was $797,000 and $1.2 million at March 31, 2021 and December 31, 2020, respectively, and is included in other assets in the condensed consolidated balance sheets.
The Company held 101 and 18 securities at March 31, 2021 and December 31, 2020, respectively, that were in a gross unrealized loss position. 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
Fair
Value
29,712
20,975
53,680
120,315
263
6,913
7,176
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:
December 31,
Federal Reserve Bank stock
9,271
Federal Home Loan Bank stock
5,948
5,941
The Independent Bankers Financial Corporation stock
141
Community Reinvestment Act investments
3,426
3,299
9
Banks that are members of the Federal Home Loan Bank are required to maintain a stock investment in the Federal Home Loan Bank calculated as a percentage of aggregate outstanding mortgages, outstanding Federal Home Loan Bank advances and other financial instruments. As a member of the Federal Reserve, the Bank is required to annually subscribe to Federal Reserve Bank stock in specific ratios to the Bank’s equity. Although Federal Home Loan Bank 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 readily-available 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 the 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, which has limited marketability. As a result, this investment is carried at cost and evaluated for impairment.
The Company has investments in investment funds and limited partnerships that are qualified Community Reinvestment Act, or CRA, investments and 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 March 31, 2021 and December 31, 2020, the Company had $4.2 million and $4.4 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; and (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 the investment. There were no such qualitative indicators as of March 31, 2021.
NOTE 4: LOANS
Loans by loan class, or major loan category, as of the dates shown below were as follows:
Commercial and industrial
756,707
26.1%
742,957
25.3%
Real estate:
Commercial real estate
1,072,263
36.9%
1,041,998
35.5%
Construction and development
464,091
16.0%
522,705
17.8%
1-4 family residential
224,880
7.7%
239,872
8.2%
Multi-family residential
271,719
9.4%
258,346
8.8%
Consumer
32,767
1.1%
33,884
Agriculture
6,974
0.2%
8,670
0.3%
74,387
2.6%
88,238
3.0%
Total gross loans
2,903,788
100.0%
2,936,670
Less allowance for credit losses for loans
(40,874)
(40,637)
Less deferred loan fees and unearned discounts
(11,151)
(9,880)
Less loans held for sale
(1,005)
(2,673)
Loans, net
Accrued interest receivable for loans was $11.8 million and $12.1 million at March 31, 2021 and December 31, 2020, respectively, and is included in other assets in the condensed consolidated balance sheets.
From time to time, the Company will acquire and dispose of interests in loans under participation agreements with other financial institutions. The Company did not purchase or sell loan participations during the three months ended March 31, 2021. Loan participations purchased and sold during the three months ending March 31, 2020, by loan class, were as follows:
Participations
Purchased
Sold
March 31, 2020
2,500
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 three months ended March 31, 2021 and 2020, totaled $374,000 and $508,000, respectively.
NOTE 5: LOAN PERFORMANCE
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
Past Due and
Past Due
Current Loans
Total Loans
Still Accruing
154
241
3,913
4,308
752,399
1,071,978
236
463,855
938
18
1,062
223,818
Total loans
1,377
495
4,019
5,891
2,897,897
51
2,055
2,269
4,375
738,582
1,357
19
1,482
238,390
33,879
50
8,620
1,463
2,074
2,375
5,912
2,930,758
11
The Company places loans on nonaccrual status because of delinquency or because collection of principal or interest is doubtful. Nonaccrual loans, segregated by loan class, as of the dates shown below were as follows:
12,230
12,588
10,664
10,665
238
378
526
Total nonaccrual loans
23,508
24,017
Interest income that would have been earned under the original terms of the nonaccrual loans was $191,000 and $33,000 for the three months ended March 31, 2021 and 2020, respectively.
Loans restructured due to the borrower’s financial difficulties, or troubled debt restructurings, during the periods indicated below which remain outstanding as of the end of those periods 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
1,206
1,548
2,754
657
426
231
4,813
5,470
5,239
Loan modifications related to a loan refinancing or restructuring other than a troubled debt restructuring are accounted for as a new loan if the terms provided to the borrower are at least as favorable to the Company as terms for comparable loans to other borrowers with similar collection risks that is not a loan refinancing or restructuring. If the loan refinancing or restructuring does not meet this condition or if only minor modifications are made to the original loan contract, it is not considered a new loan and is considered a renewal or modification of the original contract. Restructured or modified loans are not considered past due if they are performing under the terms of the modified or restructured payment schedule.
A troubled debt restructuring is considered in default when a payment in accordance with the terms of the restructuring is more than 30 days past due. All loans restructured in a troubled debt restructuring are individually evaluated based on the underlying collateral for the determination of an ACL. See Note 6: Allowance for Credit Losses for further discussions on specific reserves.
12
Troubled debt restructuring during the twelve months ended indicated below with payment defaults were as follows:
Balance
7,904
8,114
11,882
102
109
14
28,002
340
Loans individually evaluated for credit losses were as follows for the dates indicated below:
Troubled Debt Restructurings
Accruing
Non-Accrual
Other Non-Accrual
Other Accruing
Total Loans Individually Evaluated
2,537
7,886
10,423
4,344
746
15,513
7,265
10,601
17,866
63
17,929
12,498
12,734
3,150
190
3,340
188
3,528
90
2,259
27,709
18,913
46,622
4,595
836
52,053
2,594
8,228
10,822
4,360
15,928
8,103
18,704
64
18,768
12,648
12,886
1,684
1,790
420
2,210
7,851
32,880
19,173
4,844
57,643
At March 31, 2021 and December 31, 2020, the Company had an outstanding commitment to fund $6.0 million and $593,000, respectively, for loans that were previously restructured.
NOTE 6: ALLOWANCE FOR CREDIT LOSSES
The Company primarily manages credit quality and credit risk associated with its loan portfolio based on the risk grading assigned to each individual loan within the loan class. Each loan class is a grouping of loan receivables within the portfolio based on risk characteristics and the method for monitoring and assessing the associated credit risks. The Company’s ACL for the loan portfolio has two main components: (i) a reserve based on expected losses on loans with similar risk characteristics, or general reserve; and (ii) an ACL for individually evaluated loans that do not share similar risk characteristics with other loans, or specific reserve. To determine the specific ACL, the Company utilizes various methods including discounted cash flow analysis and appraisal valuation on collateral to determine any expected credit losses requiring an ACL.
To estimate the general ACL, the Company utilizes an age-based vintage model, or the Vintage Model, where it has divided the loan portfolio into portfolio segments of loans with similar risk characteristics and further subdivided the portfolio segments by the age of the loan or vintage. The vintage of a loan is determined based on the credit decision date, which is defined as the more recent of the origination date or the last renewal date. The factors considered to determine
13
portfolio segments include: (i) loan class or major category of loans based on call codes; (ii) vintage; (iii) interest rate; (iv) loan size; (v) payment structure or term; (vi) risk ratings; (vii) loan to value; (viii) collateral type; (ix) geographical pattern; and (x) industrial sector. The Company has limited specific historical loss experience to directly tie to an attribute and thus the use of one factor over another is based on management’s perceived risk of the identified factor in combination with the data analyzed. The Company believes that this segmentation best represents the portfolio segments at a level to develop the systematic methodology in the determination of the ACL.
Historical loss rates are adjusted for internal and external qualitative risk factors to determine a total expected loss rate for each vintage within each portfolio segment. The various internal factors that may be considered include, among other things: (i) effectiveness of loan policies, procedures and internal controls; (ii) portfolio growth and changes in loan concentrations; (iii) changes in loan quality; (iv) experience, ability and effectiveness of lending management and staff; (v) legal and regulatory compliance requirements associated with underwriting, originating and servicing a loan and the impact of exceptions; and (vi) the effectiveness of the internal loan review function. The various external factors that may be considered include, among other things: (i) current national and local economic conditions; (ii) changes in the political, legal and regulatory landscape; (iii) industry trends, in particular those related to loan quality; and (iv) forecasted changes in the economy. The economic indicators and indexes the Company use include, but are not limited to: (i) inflation indexes; (ii) unemployment rates; (iii) fluctuations of interest rates, economic growth and government expenditure; (iv) gross domestic product indexes; (v) productivity indicators; (vi) leading indexes including debt levels; and (vii) narratives such as those supplied by the Federal Reserve’s beige book and Moody’s Analytics that provide information for determining an appropriate impact ratio for macro-economic conditions. The Company determined that a two-year forecast period provides a balance between the level of forecast periods reasonably available and forecast accuracy and choose to revert to historical levels immediately afterward as adjusted current loss history is the more relevant indicator of expected losses beyond the forecast period. For portfolio segments of loans with no historical losses, the Company uses the weighted average of its annual historical loss rates as a proxy loss rate floor, or specifically, for oil and gas and oil and gas real estate portfolio segments, historical average loss rate based on peer group data.
The Company excludes accrued interest and deferred fees and costs in the determination of an ACL and reverses previously accrued interest when it has been deemed uncollectible. Loans held for sale are excluded from the computation of expected credit losses as they are carried at the lower of cost or market value.
At March 31, 2021 and December 31, 2020, the ratio of the ACL for loans to loans excluding loans held for sale was 1.41% and 1.39%, respectively. The ACL continues to reflect the impact of the COVID-19 pandemic and the sustained instability in the oil and gas industry on the local and national economy and on current and forecasted expected credit losses. At March 31, 2021, there were minimal adjustments to the qualitative factors utilized in calculating the ACL. The increase in the ACL from December 31, 2020 to March 31, 2021 was primarily due to an increase in specific reserves for loans individually evaluated within the portfolio and a slight increase in the general reserve. Although the collectively evaluated loan portfolio decreased $27.3 million compared to December 31, 2020, the general reserve increased $14,000 because balances in certain portfolio segments with higher historical loss rates and higher qualitative factor rates increased as a component of the overall portfolio resulting in an increase in the ACL. The total of the Company’s qualitative and quantitative factors ranged from 0.99% to 2.41% and 0.92% to 2.48% at March 31, 2021 and December 31, 2020, respectively. All factors are reassessed at the end of each quarter.
The review of the appropriateness of the ACL, which includes evaluation of historical loss trends, qualitative adjustments and forecasted economic conditions applied to general reserves, is performed by executive management and presented to the Board of Directors for its review on a quarterly basis. The ACL at March 31, 2021, reflects the Company’s assessment based on the information available at that time.
Risk Grading
The credit quality of the loan portfolio is assessed through different processes. At origination, a risk grade is assigned to each loan based on underwriting procedures and criteria. The risk grades used are described below. The Company monitors the credit quality of the loan portfolio on an on-going basis by performing loan reviews, both internally and through a third-party vendor, on loans meeting certain risk and exposure criteria. Any risk grade changes determined based on these loan reviews, including those related to criticized and classified loans, and any changes to specific reserves related to individually evaluated loans are approved by executive management.
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 a 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.
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 little value. 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 March 31, 2021 and December 31, 2020.
15
The loans by risk grades, loan class and vintage, at March 31, 2021 were as follows:
2019
2018
2017
Prior
Revolving Loans
Converted Revolving Loans
Commercial and industrial:
Pass
165,037
223,735
75,534
42,431
11,942
10,078
202,063
3,810
734,630
Special mention
29
3,144
3,173
Substandard
1,000
2,332
5,980
2,083
1,168
6,331
18,904
Total commercial and industrial
224,735
77,866
48,440
11,952
12,161
206,375
10,141
Commercial real estate:
43,076
245,780
222,588
202,685
135,414
133,357
37,718
4,556
1,025,174
889
4,721
5,764
1,334
11,475
14,867
371
2,278
41,325
Total commercial real estate
247,114
234,952
217,552
135,785
135,789
53,439
Construction and development:
35,351
144,641
137,884
47,309
19,280
4,343
60,521
486
449,815
3,042
10,382
616
14,276
Total construction and development
138,120
50,351
29,662
4,959
1-4 family residential:
5,098
23,698
33,598
41,763
31,356
75,089
5,972
625
217,199
83
529
996
293
1,155
1,506
6,110
Total 1-4 family residential
5,181
25,246
34,127
42,759
31,649
77,815
2,131
Multi-family residential:
11,177
20,734
3,071
52,102
10,376
174,178
81
Total multi-family residential
Consumer:
2,607
6,609
2,461
1,580
1,674
80
17,245
421
32,677
Total consumer
17,335
Agriculture:
1,791
134
78
4,254
6,907
22
67
Total agriculture
35
4,299
Other:
6,319
9,950
1,979
2,835
20
1,300
49,724
72,127
1,037
1,223
2,260
Total other
10,987
2,523
269,050
676,938
477,175
390,839
210,140
398,438
377,578
10,090
2,810,248
1,725
7,865
10,508
4,919
14,572
24,885
11,056
7,377
12,303
7,837
83,032
269,133
681,857
492,636
415,753
221,196
407,540
397,746
17,927
The loans by risk grades, loan class and vintage, at December 31, 2020 were as follows:
2016
349,697
81,131
46,973
13,161
8,349
3,432
214,160
3,562
720,465
3,371
3,404
1,001
2,633
6,177
2,021
779
6,442
19,088
350,698
83,764
53,183
13,176
8,369
5,453
218,310
10,004
262,072
210,954
196,630
138,424
68,468
84,453
30,020
9,482
1,000,503
1,224
1,390
4,905
7,519
11,532
9,599
476
1,059
1,985
9,325
33,976
223,710
206,229
138,900
69,527
87,828
39,345
14,387
165,894
163,658
92,455
20,146
6,707
273
53,800
502,933
8,386
10,532
19,772
163,896
100,841
30,678
27,002
30,978
48,561
34,970
24,386
57,122
7,004
631
230,654
1,617
3,165
534
1,211
1,215
1,507
6,053
28,550
31,512
49,772
36,541
26,018
58,337
2,138
20,823
3,119
36,971
10,655
2,153
184,539
86
8,937
3,073
1,855
1,875
23
17,573
402
3,937
105
338
4,108
8,597
73
4,158
14,624
3,239
24
84
1,250
57,603
80,386
1,232
5,409
7,852
15,835
1,316
63,012
852,986
496,257
427,345
219,341
110,309
331,092
384,354
14,084
2,835,768
14,088
2,212
14,937
25,373
12,594
2,326
5,860
15,563
7,949
86,814
856,746
512,418
452,751
231,935
114,252
338,342
403,288
26,938
Loans by risk grades and loan class as of the dates shown below were as follows:
Special Mention
Loans individually evaluated and collectively evaluated as of the dates shown below were as follows:
Individually
Collectively
Evaluated
Loans
741,194
727,029
1,054,334
1,023,230
451,357
509,819
221,352
237,662
72,128
80,387
2,851,735
2,879,027
Nonaccrual loans are included in individually evaluated loans and $10.8 million and $11.2 million of nonaccrual loans had no related ACL at March 31, 2021 and December 31, 2020, respectively.
The Company had collateral dependent loans totaling $366,000 pending foreclosure at March 31, 2021.
Activity in the ACL for loans, segregated by loan class for the three months ended March 31, 2021 and 2020, was as follows:
Real Estate
Commercial
Construction
and
1-4 Family
Multi-family
Industrial
Development
Residential
Beginning balance
13,035
13,798
6,089
2,578
2,513
440
137
2,047
40,637
Provision (recapture)
872
482
(644)
(120)
201
(72)
(423)
Charge-offs
(309)
Recoveries
214
42
260
Net (charge-offs) recoveries
(95)
Ending balance
13,812
14,280
5,445
2,458
2,714
434
107
1,624
40,874
Period-end amount allocated to:
Specific reserve
5,476
274
5,756
General reserve
8,336
14,006
428
35,118
7,671
7,975
4,446
2,257
1,699
388
74
770
25,280
Impact of CECL adoption
852
(140)
(275)
294
(25)
874
614
1,741
1,249
447
213
(9)
(103)
(133)
398
(99)
301
9,535
9,576
5,795
2,430
2,413
477
129
839
31,194
409
9,126
30,785
The ACL for loans by loan class as of the periods indicated was as follows:
Percent
33.8
%
32.1
34.9
34.0
13.3
15.0
6.0
6.3
6.6
6.2
1.1
0.3
4.0
5.0
Total allowance for credit losses for loans
100.0
Loans excluding loans held for sale
2,891,632
2,924,117
Allowance for credit losses for loans excluding loans held for sale
1.41%
1.39%
Allocation of a portion of the ACL to one class of loans above does not preclude its availability to absorb losses in other classes.
Charge-offs and recoveries by loan class and vintage for the three months ended March 31, 2021 were as follows:
Charge-off
(191)
(74)
(44)
Recovery
(190)
(61)
Total:
200
(189)
Charge-offs and recoveries by loan class and vintage for the three months ended March 31, 2020 were as follows:
(29)
(1)
87
180
(13)
179
(8)
(124)
135
79
(107)
The Company has unfunded commitments, comprised of letters of credit and commitments to extend credit that are not unconditionally cancellable by the Company. See Note 16: Commitments and Contingencies and Financial Instruments with Off-Balance-Sheet Risk. Unfunded commitments have similar characteristics as loans and their ACL was determined using the model and methodology for loans noted above as well as historical and expected utilization levels.
Activity in the ACL for unfunded commitments for the three months ended March 31, 2021 and 2020, was as follows:
4,177
2,981
4,303
3,669
NOTE 7: PREMISES AND EQUIPMENT
The components of premises and equipment as of the dates shown below were as follows:
Land
15,484
Buildings and leasehold improvements
64,113
Furniture and equipment
16,852
16,777
Vehicles
211
216
Construction in progress
97,216
96,978
Less accumulated depreciation
(36,665)
(35,826)
Premises and equipment, net
Depreciation expense was $863,000 and $775,000 for the three months ended March 31, 2021 and 2020, respectively, which is included in net occupancy expense in the Company’s condensed consolidated statements of income.
NOTE 8: GOODWILL AND OTHER INTANGIBLE ASSETS
Goodwill was $81.0 million at March 31, 2021 and December 31, 2020 and there were no changes in goodwill during the three months ended March 31, 2021 or the year ended December 31, 2020. During the three months ended March 31, 2021, the Company continued to evaluate potential triggering events, including the economic disruption and uncertainties related to the COVID-19 pandemic and the sustained instability in the oil and gas industry, that could be indicators of impairment. Based on the results of the Company’s evaluation, management does not believe any triggering events occurred that would indicate there was a potential impairment of goodwill or other intangible assets at March 31, 2021.
Other intangibles were as follows as of the dates shown below:
Weighted-
Average
Remaining
Net
Amortization
Intangible
Period
Assets
Core deposits
3.0 years
13,750
(13,372)
Customer relationships
7.8 years
6,629
(3,204)
3,425
Servicing assets
10.7 years
410
(222)
Total other intangible assets, net
20,789
(16,798)
3.2 years
(13,305)
445
8.0 years
(3,093)
3,536
10.4 years
399
(209)
20,778
(16,607)
21
Servicing Assets
Changes in servicing assets as of the dates indicated below were as follows:
Balance at beginning of year
189
Increase from loan sales
Decrease from serviced loans paid off or foreclosed
(26)
(20)
Balance at end of period
152
NOTE 9: BANK-OWNED LIFE INSURANCE
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
71,881
Purchases
Redemptions
Net change in cash surrender value
72,297
NOTE 10: DEPOSITS
Deposits as of the dates shown below were as follows:
Interest-bearing demand accounts
368,124
380,175
Money market accounts
995,945
1,039,617
Saving accounts
112,467
108,167
Certificates and other time deposits, $100,000 or greater
145,762
152,592
Certificates and other time deposits, less than $100,000
141,041
144,818
Total interest-bearing deposits
At March 31, 2021 and December 31, 2020, the Company had $30.9 million and $29.3 million in deposits from public entities and brokered deposits of $84.7 million and $88.0 million, respectively. At March 31, 2021 and December 31, 2020, overdrafts of $391,000 and $336,000, respectively, were reclassified to loans. Accrued interest payable for deposits was $208,000 and $324,000 at March 31, 2021 and December 31, 2020, respectively, and is included in other liabilities in the condensed consolidated balance sheets. The Company had no major concentrations of deposits at March 31, 2021 or December 31, 2020 from any single or related groups of depositors. At March 31, 2021, $70.5 million of certificates of deposits or other time deposits were uninsured. Securities pledged and the letter of credit issued under the Company’s Federal Home Loan blanket lien arrangement which secure public deposits were not considered in determining the amount of uninsured time deposits.
NOTE 11: LINES OF CREDIT
Frost Line of Credit
The Company has entered into a loan agreement with Frost Bank, or Loan Agreement, which has been periodically amended and provides for a $30.0 million revolving line of credit. At March 31, 2021, there were no outstanding borrowings on this line of credit and the Company did not draw on this line of credit during 2021 or 2020. The Company can make draws on the line of credit for a period of 24 months, which began on December 13, 2019, 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 over 24 months beginning December 13, 2019, 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, 2026.
The Company may prepay the principal amount of the line of credit without premium or penalty. The obligations of the Company under the Loan 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 Loan Agreement include, among other things, the Company maintaining tangible net worth of not less than $300 million, the Company maintaining a free cash flow coverage ratio of not less than 1.25 to 1.00, the Bank’s Texas Ratio (as defined in the Loan Agreement) not to exceed 15%, the Bank’s Total Capital Ratio (as defined under the 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 March 31, 2021.
Additional Lines of Credit
The Federal Home Loan Bank allows the Company to borrow on a blanket floating lien status collateralized by certain loans and the blanket lien amount was $1.1 billion at both March 31, 2021 and December 31, 2020. Federal Home Loan Bank advances outstanding totaled $50.0 million at both March 31, 2021 and December 31, 2020, and these borrowings were on a long-term basis. See maturity information below. At March 31, 2021 and December 31, 2020, there was a $10.8 million letter of credit outstanding that was issued under this agreement and used as collateral to secure certain public deposits. After considering the outstanding advances and letter of credit, the net capacity available under the Federal Home Loan Bank facility was $1.1 billion at March 31, 2021 and $1.0 billion at December 31, 2020.
The Company does borrow under this agreement on a short-term basis as needed but did not during the three months ended March 31, 2021 and 2020.
The scheduled maturities of Federal Home Loan Bank advances as of the date shown below were as follows:
2022
10,000
2023
20,000
2024
2025
Thereafter
At March 31, 2021 and December 31, 2020, the Company maintained federal funds lines of credit with commercial banks that provided for the availability to borrow up to an aggregate of $65.0 million. There were no funds under these lines of credit outstanding at March 31, 2021 or December 31, 2020.
NOTE 12: 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 who 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 $172.6 million and $167.6 million in loans to related parties at March 31, 2021 and December 31, 2020, respectively. At March 31, 2021 and December 31, 2020, there were no loans made to related parties deemed nonaccrual, past due, restructured in a troubled debt restructuring or classified as potential problem loans.
Unfunded Commitments—At March 31, 2021 and December 31, 2020, the Company had approximately $45.4 million and $47.3 million in unfunded loan commitments to related parties, respectively.
Deposits—The Company held related party deposits of approximately $212.8 million and $210.1 million at March 31, 2021 and December 31, 2020, respectively.
NOTE 13: FAIR VALUE DISCLOSURES
The Company uses fair value measurements to record fair value adjustments to certain assets and liabilities 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.
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 three months ended March 31, 2021 and the year ended December 31, 2020, 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 estimates of fair value. Fair value estimates are based on judgments 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 judgment 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:
Debt Securities Available for Sale—Debt securities classified as available for sale are recorded at fair value. For those debt securities classified as Level 1 and 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.
Equity Securities Available for Sale—Equity securities are classified as available for sale and are recorded at fair value. The fair value measurements are based on observable data obtained from a third-party pricing service. The Company reviews the prices supplied by the service against publicly available information. The equity securities are mutual funds publicly traded on the National Association of Securities Dealers Automated Quotations 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 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. Interest rate swaps are classified as Level 2.
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:
Debt securities available for sale - U.S. Treasury securities
Level 2 inputs:
Interest rate swaps
5,902
8,618
Level 3 inputs:
Credit risk participation agreement
40
Total fair value of financial assets
295,004
245,939
Fair value of financial liabilities:
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. Financial assets measured at fair value on a non-recurring basis during the dates shown below include certain loans reported at the fair value of the underlying collateral if repayment is expected solely
25
from the collateral or a discounted cash flow method if not. Prior to foreclosure, estimated fair values for collateral is estimated based on Level 3 inputs based on customized discounting criteria. The Company’s financial assets measured at fair value on a non-recurring basis are certain individually evaluated loans and as of the dates shown below were as follows:
Recorded Investment
Specific ACL
Loans evaluated individually
10,373
4,897
10,509
5,004
5,505
5,727
323
5,404
205
1,027
16,190
10,434
17,468
5,532
11,936
Non-Financial Assets and Non-Financial Liabilities Measured at Fair Value on a Non-recurring Basis
The Company’s non-financial assets measured at fair value on a non-recurring basis for the periods reported are foreclosed assets (upon initial recognition or subsequent impairment). The Company’s other non-financial assets whose fair value may be measured on a non-recurring basis when there is evidence of impairment and may be subject to impairment adjustments include goodwill and intangible assets, among other assets.
The fair value of foreclosed assets may be estimated using Level 2 inputs based on observable market data or Level 3 inputs based on customized discounting criteria less estimated selling costs. There were no write-downs of foreclosed assets for fair value remeasurement subsequent to initial foreclosure during the three months ended March 31, 2021 or during 2020. Foreclosed assets were $106,000 at March 31, 2021 and there were no outstanding foreclosed assets at December 31, 2020.
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:
Accrued interest receivable
12,719
13,350
Servicing asset
Loans, including held for sale, net
2,889,936
2,851,763
2,919,854
2,886,153
Other investments
Total financial assets
3,599,028
3,560,855
3,562,391
3,528,690
Financial liabilities:
1,775,351
1,894,558
51,390
51,726
Accrued interest payable
281
Total financial liabilities
3,448,430
3,435,028
3,423,107
3,352,192
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.
NOTE 14: DERIVATIVE FINANCIAL INSTRUMENTS
The Company has outstanding interest rate swap contracts with certain customers and equal and offsetting interest rate swaps with other financial institutions entered into at the same time. These interest rate swap contracts are not designated as hedging instruments for mitigating interest rate risk. The objective of the transactions is to allow customers to effectively convert a variable rate loan to a fixed rate.
In connection with each swap transaction, the Company agreed 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 Company agreed 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 Company acts as an intermediary for its customer, changes in the fair value of the underlying derivative contracts are designed to offset each other and do 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 March 31, 2021 and December 31, 2020, management determined there was no such deterioration.
At March 31, 2021 and December 31, 2020, the Company had 23 and 23 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 other noninterest income. Fair value amounts are included in other assets and other liabilities.
The Company has a credit risk participation agreement with another financial institution that is associated with an interest rate swap related to a loan for which the Company is the lead agent bank and the other financial institution provides credit protection to the Company should the borrower fail to perform under the terms of the interest rate swap agreement. The fair value of the agreement is determined based on the market value of the underlying interest rate swap adjusted for credit spreads and recovery rates.
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Derivative instruments outstanding as of the dates shown below were as follows:
Weighted
Notional
Classification
Amounts
Fixed Rate
Floating Rate
(Years)
Interest rate swaps with customers
102,973
4,568
3.25% - 5.89%
LIBOR 1M + 2.50% - 3.00%
4.77
Interest rate swaps with financial institutions
37,210
1,105
3.50%
LIBOR 1M + 2.50%
8.99
5,223
229
4.99%
U.S. Prime
6.71
(229)
(4,568)
(1,105)
Credit risk participation agreement with financial institution
13,954
Total derivatives
304,766
141,241
8,146
6.14
5,250
472
6.96
(472)
(8,146)
9.24
307,066
NOTE 15: OPERATING LEASES
The Company leases certain office space, stand-alone buildings and land, which are recognized as operating lease right-of-use assets in the consolidated balance sheets and operating lease liabilities in the consolidated balance sheets represent the Company’s liability to make lease payments under these operating leases, on a discounted basis. The Company excludes short-term leases, defined as lease terms of 12 months or less from its operating lease right-of-use assets and operating lease liabilities.
Lease costs for the period shown below were as follows:
Operating lease cost
485
481
Short-term lease cost
Sublease income
(161)
Total lease cost
328
473
Other information related to operating leases for the periods shown below was as follows:
Amortization of lease right-to-use asset
Cash paid for amounts included in the measurement of lease liabilities
487
Weighted-average discount rate
2.64%
Weighted-average remaining lease term in years
10.7
11.1
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A maturity analysis of operating lease liabilities as of the date shown below was as follows:
2,036
2,233
2,220
1,826
1,807
8,907
Total undiscounted lease liability
19,029
Less:
Discount on cash flows
(2,969)
Total operating lease liability
NOTE 16: COMMITMENTS AND CONTINGENCIES AND FINANCIAL INSTRUMENTS WITH OFF-BALANCE-SHEET RISK
Financial Instruments with Off-Balance-Sheet Risk
The Company enters into commitments to extend credit and standby letters of credit to meet customer financing needs and, in accordance with GAAP, these commitments are not reflected as liabilities in the consolidated balance sheets. Due to the nature of these commitments, the amounts disclosed in the tables below do not necessarily represent future cash requirements.
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
656,809
659,385
Commitments to extend credit, fixed interest rate
67,233
80,346
Total commitments
724,042
739,731
Standby letters of credit
27,200
26,078
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, generally have fixed expiration dates or other termination clauses and may expire without being fully drawn upon.
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 17: 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 matches a portion of each employee’s contribution and may, at its discretion, make additional contributions. During the three months ended March 31, 2021 and 2020, the Company contributed $726,000 and $758,000 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 March 31, 2021 and December 31, 2020, the amount payable, including interest, for this deferred plan was approximately $2.1 million and $2.0 million, respectively, which is included in other liabilities in the condensed consolidated balance sheets.
Salary Continuation Agreements
The Company entered into a salary continuation arrangement in 2008 with the Company’s then President and Chief Executive Officer, or 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 $223,000 and $246,000 at March 31, 2021 and December 31, 2020, 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 $694,000 and $640,000 at March 31, 2021 and December 31, 2020, 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.
NOTE 18: 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, or the 2006 Plan. At the merger date, all outstanding options under this plan became fully vested and exercisable. The plan expired in 2016 and no additional options may be granted under its terms. As of March 31, 2021, there were options outstanding to acquire 45,720 shares of the Company’s common stock under the 2006 Plan, all of which will expire in 2022 if not exercised.
In 2014, the Company adopted the 2014 Stock Option Plan, or the 2014 Plan, which 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. As of March 31, 2021, 963,200 shares were available for future grant. No options have been issued under the 2014 Plan since 2017.
In 2017, the Company adopted the 2017 Omnibus Incentive Plan, or the 2017 Plan. The 2017 Plan authorizes the Company to grant options, performance-based and non-performance based restricted stock awards as well as various other types of stock-based awards 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. As of March 31, 2021, 278,214 shares were available for future grant under the 2017 Plan.
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Stock option activity for the periods shown below was as follows:
Number of
Underlying
Exercise
Options
Price
Outstanding at beginning of period
201,720
17.22
213,078
16.92
Granted
Exercised
(1,524)
10.34
Forfeited/expired
Outstanding at end of period
211,554
16.97
A summary of stock options as of the date shown below was as follows:
Stock Options
Exercisable
Unvested
Number of shares underlying options
169,721
31,999
Weighted-average exercise price per share
16.51
21.00
Aggregate intrinsic value (in thousands)
2,412
311
2,723
Weighted-average remaining contractual term (years)
4.4
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 and 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, 2019
161,443
28.20
18,000
34.46
37,107
29.55
Vested
(6,450)
32.11
Forfeited
(204)
30.64
Outstanding at March 31, 2020
191,896
28.33
Outstanding at December 31, 2020
129,667
28.22
2,250
34.40
33,285
26.32
(13,369)
30.72
Outstanding at March 31, 2021
149,583
27.58
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A summary of restricted stock as of the date 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)
69
Weighted-average remaining vesting period (years)
1.8
2.5
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 subject to options exercised, restricted stock vested, shares withheld, and shares issued were as follows:
Exercised/Vested
Shares Withheld
Shares Issued
Three Months Ended March 31, 2021
Stock options
Non-performance based restricted stock
13,369
(2,642)
Three Months Ended March 31, 2020
6,450
(1,218)
For the three months ended March 31, 2021 and 2020, stock compensation expense was $541,000 and $557,000, respectively. As of March 31, 2021, there was approximately $3.5 million of total unrecognized compensation expense related to the unvested stock options, non-performance based restricted stock and performance-based restricted stock, which is expected to be recognized in the Company’s consolidated statements of income over a weighted-average period of 1.8 years.
NOTE 19: REGULATORY MATTERS
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 capital. Common Equity Tier 1 capital for both the Company and the Bank is reduced by goodwill and other intangible assets, net of associated deferred tax liabilities.
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, effectively resulting in a minimum ratio of Common Equity Tier 1 capital to risk-weighted assets of at least 7.0%); (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, effectively resulting in a minimum Tier 1 capital ratio of 8.5%); (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, effectively resulting in a minimum total capital ratio of 10.5%); and (iv) a minimum leverage ratio of 4.0%, calculated as the ratio of Tier 1 capital to average quarterly assets.
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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.
In November 2019, the federal bank regulatory agencies published a final rule, the Community Bank Leverage Ratio Framework, or the Framework, to simplify capital calculations for community banks. The Framework provides for a simple measure of capital adequacy for certain community banking organizations. The Framework is optional and is designed to reduce burden by removing requirements for calculating and reporting risk-based capital ratios. Depository institutions and depository institution holding companies that have less than $10.0 billion in total consolidated assets and meet other qualifying criteria, including a leverage ratio of greater than 9.0%, are considered qualifying community banking organizations and are eligible to opt into the Framework. A qualifying community banking organization that elects to use the community bank leverage ratio framework and that maintains a Tier 1 capital-to-adjusted total assets ratio, or leverage capital ratio, of greater than 9.0% is considered to have satisfied the generally applicable risk-based and leverage capital requirements under the Basel III Capital Rules and, if applicable, is considered to have met the “well capitalized” ratio requirements for purposes of its primary federal regulator’s prompt corrective action rules. The final rule became effective January 1, 2020, and organizations that opt into the Framework and meet the criteria established by the rule can use the Framework for regulatory reports for the year ended December 31, 2020. In April 2020, the federal bank regulatory agencies announced two interim final rules to provide relief associated with Section 4012 of the Coronavirus Aid Relief and Economic Security Act, or CARES Act. For institutions that elect the Framework, the interim rules temporarily lowered the leverage ratio requirement to 8.0% for the second quarter of 2020 through the end of calendar year 2020 and to 8.5% for the 2021 calendar year. An institution will have until January 1, 2022 before the 9.0% leverage ratio requirement is re-established. The Company determined not to opt into the Framework and will continue to compute regulatory capital ratios based on the Basel III Capital Rules discussed above.
In September 2020, the federal bank regulatory agencies finalized an interim final rule that allows banking organizations to mitigate the effects of CECL on their regulatory capital computations. The rule permits banking organizations that were required to adopt CECL for purposes of GAAP (as in effect January 1, 2020) for a fiscal year beginning during the calendar year 2020, the option to delay for up to two years an estimate of CECL’s effect on regulatory capital, followed by a three-year transition period (i.e., a transition period of five years in total). The Company determined not to use the transition provision and has reported the full effect of CECL upon adoption and for each reporting period thereafter in its regulatory capital calculation and ratios.
The Company is subject to the regulatory capital requirements administered by the Board of Governors of the Federal Reserve System and, for the Bank, those administered by the Office of Comptroller of Currency, or 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 March 31, 2021 and December 31, 2020, that the Company and the Bank met all capital adequacy requirements to which they were subject.
On June 18, 2020, the Bank and the OCC entered into a formal agreement, or the Agreement, with regard to Bank Secrecy Act, or BSA, and anti-money laundering, or AML, compliance matters. The Agreement generally requires that the Bank enhance its policies and procedures to comply with BSA/AML laws and regulations. Specifically, the Agreement requires the Bank to take certain actions, including, but not limited to: (i) establishing a Compliance Committee to oversee the Bank’s compliance with the Agreement; (ii) ensuring that the BSA/AML staff has sufficient authority and resources to fulfill its responsibilities; (iii) developing, implementing, and adhering to a written program of policies and procedures to provide for compliance with the BSA, including with respect to model risk management for automated monitoring systems; (iv) establishing policies and procedures for performing customer due diligence/enhanced due diligence and customer risk identification processes; (v) adopting and adhering to an independent BSA/AML audit program; (vi) developing, implementing, and adhering to a comprehensive training program for all appropriate Bank employees to ensure their awareness of their responsibility for compliance with the requirements of the BSA, the Bank’s relevant policies, procedures, and processes, and of relevant examples of red flags for money laundering, terrorist
financing, and suspicious activity; and (vii) performing a review of account and transaction activity for certain time periods.
The Board of Directors and management are committed to taking the necessary actions to fully address the provisions of the Agreement. The Bank has appointed a Compliance Committee to oversee the Bank’s compliance with the Agreement and is working to promptly address the requirements of the Agreement. Numerous actions have already been taken or commenced by the Bank to strengthen its BSA/AML compliance practices, policies, procedures and controls and comply with the terms of the Agreement. The Bank has hired and may continue to hire third-party consultants and advisors to assist in complying with the Agreement. While subject to the Agreement, the Company expects that management and the Board of Directors will be required to focus considerable time and attention on taking corrective actions to comply with its terms.
If the Bank does not successfully address the OCC’s concerns in the Agreement or fully comply with the provisions of the Agreement, the Bank could be subject to further regulatory scrutiny, civil monetary penalties, further regulatory sanctions and/or other enforcement actions. The Company or the Bank may also become subject to formal or informal enforcement actions by other regulatory agencies. Any of those events could have a material adverse impact on the Company’s future operations, financial condition, growth, or other aspects.
34
At March 31, 2021 and December 31, 2020, 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
Required to be
Capital Required
Considered Well
Actual
Basel III
Capitalized
Ratio
Common Equity Tier 1 to Risk-Weighted Assets:
Consolidated
$ 457,859
15.75%
$ 203,495
7.00%
N/A
Bank Only
$ 430,055
14.79%
$ 203,477
$ 188,943
6.50%
Tier 1 Capital to Risk-Weighted Assets:
$ 247,101
8.50%
$ 247,080
$ 232,546
8.00%
Total Capital to Risk-Weighted Assets:
$ 494,307
17.00%
$ 305,242
10.50%
$ 466,499
16.05%
$ 305,216
$ 290,682
10.00%
Tier 1 Leverage Capital to Average Assets:
11.90%
$ 153,895
4.00%
11.18%
$ 153,825
$ 192,282
5.00%
$ 455,391
15.45%
$ 206,296
$ 421,952
14.32%
$ 206,281
$ 191,547
$ 250,502
$ 250,484
$ 235,750
$ 492,328
16.71%
$ 309,444
$ 458,886
15.57%
$ 309,421
$ 294,687
12.00%
$ 151,797
11.12%
$ 151,772
$ 189,715
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.
NOTE 20: INCOME TAXES
The provision for income tax expense and effective tax rates for the periods shown below were as follows:
$ 2,485
$ 1,868
Effective tax rate
19.87%
19.85%
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 21: EARNINGS PER SHARE
The computation of basic and diluted earnings per share for the periods shown below was as follows:
(Dollars in thousands, except per share data)
Net income for common shareholders
Weighted-average shares (thousands)
Basic weighted-average shares outstanding
24,508
24,926
Dilutive effect of outstanding stock options and unvested restricted stock awards
108
127
Diluted weighted-average shares outstanding
24,616
25,053
Earnings per share:
For the three months ended March 31, 2021 and 2020, the Company excluded the impact of 1,800 and 47,007 shares of unvested restricted stock, respectively, from diluted weighted-average shares as they are anti-dilutive. For the three months ended March 31, 2021 and 2020, the Company also excluded the impact of 2,250 and 18,000 performance based restricted stock awards, respectively, as they are contingently issuable and the performance conditions for these issuances have not been met.
36
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 the Company’s current views with respect to, among other things, future events and the Company’s 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 the Company’s industry, management’s beliefs and certain assumptions made by management, many of which, by their nature, are inherently uncertain and beyond the Company’s control. Accordingly, the Company cautions 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 the Company believes 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 the Company’s 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 the Company’s Annual Report on Form 10-K, this Quarterly Report on Form 10-Q and the following:
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 the Company’s underlying assumptions prove to be incorrect, actual results may differ materially from what is anticipated. Additionally, many of these risks and uncertainties are currently elevated by and may continue to be elevated by the COVID-19 pandemic and the sustained instability of the oil and gas industry. Undue reliance should not be placed on any such forward-looking statements. Any forward-looking statement speaks only as of the date made, and the Company does 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 to predict which will arise. In addition, the Company cannot assess the impact of each factor on its 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 presents what the Company believes is the material information relevant to and assessment of its financial condition and results of operations for the periods presented and should be read in conjunction with the Company’s condensed consolidated financial statements and the accompanying notes included in “Part I—Item 1—Financial Statements” of this Quarterly Report on Form 10-Q, as well as the Company’s consolidated financial statements and the accompanying notes for the year ended December 31, 2020, included in the Company’s Annual Report on Form 10-K.
The Company operates through one segment, community banking. The Company’s primary source of funds is deposits and its primary use of funds is loans. Most of the Company’s revenue is generated from interest on loans and investments. The Company incurs interest expense on deposits and other borrowed funds as well as noninterest expense, such as salaries and employee benefits and occupancy expenses.
The Company’s operating results depend primarily on 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 earned on interest-earning assets or paid on interest-bearing liabilities, as well as in the volume and types of interest-earning assets 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 the Company’s 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 the Company’s target markets and throughout the state of Texas. The Company maintains diversity in its loan portfolio as a means of managing risk associated with fluctuations in economic conditions. The Company’s focus on lending to small to medium-sized businesses and professionals in its market areas has resulted in a diverse loan portfolio comprised primarily of core relationships. The Company carefully monitors exposure to certain asset classes to minimize the impact of a downturn in the value of such assets.
The Company seeks 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 the Company’s competitors are much larger financial institutions that have greater financial resources and compete aggressively for market share. Through the Company’s relationship-driven, community banking strategy, a significant portion of its growth has been through referral business from its existing customers and professionals in the Company’s markets including attorneys, accountants and other professional service providers.
The Bank is the subject of an investigation by FinCEN regarding the Bank’s compliance with the Bank Secrecy Act and anti-money laundering laws and regulations, or BSA/AML. 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 the investigation, and the Bank may continue to incur material fees and expenses regarding this matter at least through the completion of FinCEN’s investigation.
On June 18, 2020, the Bank and the OCC entered into an Agreement with regard to BSA/AML compliance matters. The Agreement generally requires that the Bank enhance its policies and procedures to comply with BSA/AML laws and regulations. Specifically, the Agreement requires the Bank to take certain actions, including, but not limited to: (i) establishing a Compliance Committee to oversee the Bank’s compliance with the Agreement; (ii) ensuring that the BSA/AML staff has sufficient authority and resources to fulfill its responsibilities; (iii) developing, implementing, and adhering to a written program of policies and procedures to provide for compliance with the BSA, including with respect to model risk management for automated monitoring systems; (iv) establishing policies and procedures for performing customer due diligence/enhanced due diligence and customer risk identification processes; (v) adopting and adhering to an independent BSA/AML audit program; (vi) developing, implementing, and adhering to a comprehensive training program for all appropriate Bank employees to ensure their awareness of their responsibility for compliance with the requirements of the BSA, the Bank’s relevant policies, procedures, and processes, and of relevant examples of red flags for money laundering, terrorist financing, and suspicious activity; and (vii) performing a review of account and transaction activity for certain time periods.
The Bank’s Board of Directors and management are committed to taking the necessary actions to fully address the provisions of the Agreement within the timeframes identified in the Agreement. Numerous actions have already been taken or commenced by the Bank to strengthen its BSA/AML compliance practices, policies, procedures and controls. However, a finding by the OCC that the Bank failed to comply with the Agreement could result in additional regulatory scrutiny, further constraints on the Bank’s business, or a further enforcement action, including civil money penalties. Any of those events could have a material adverse impact on the Company’s future operations, financial condition, growth or other aspects of its business. Further, the Bank has hired and expects to continue to hire third-party consultants and advisors to assist in complying with the Agreement, which will increase non-interest expense and reduce earnings.
Since the latter half of the first quarter of 2020, the COVID-19 pandemic and actions taken in response to it, combined with the sustained instability in the oil and gas industry, have negatively impacted the global economy and financial markets. The Company’s markets, including its primary markets in Houston and Beaumont are particularly subject to the financial impact of the sustained instability in the oil and gas industry. As a result of these factors and the impact on the loan portfolio, the Company increased the ACL and provision for credit losses during 2020, which negatively impacted the Company’s net income. The COVID-19 pandemic is ongoing, and the future impact cannot be determined at this point, but it could materially affect the Company’s future financial and operational results. See “Part II—Item 1A.—Risk Factors.”
The risk grades of the Company’s loan portfolio, past due loans, loans individually evaluated and nonperforming loans, or loan performance indicators, as of the dates indicated below were as follows:
September 30,
June 30,
Risk Grades:
2,883,026
2,874,412
2,613,087
5,953
3,245
14,155
89,348
70,110
51,169
Gross loans
2,978,327
2,947,767
2,678,411
Past due loans:
30 to 59 days past due
14,629
5,329
6,202
60 to 89 days past due
7,464
90 days or greater past due
5,103
57
Total past due loans
27,196
5,386
6,241
Loans individually evaluated:
Accruing troubled debt restructurings
35,494
33,781
14,858
Non-accrual troubled debt restructurings
10,123
1,019
1,044
Total troubled debt restructurings
45,617
34,800
15,902
Other non-accrual
10,149
404
Other accruing
9,844
3,530
Total loans individually evaluated
60,914
47,407
19,836
Nonperforming assets:
Nonaccrual loans
15,576
11,168
1,448
Accruing loans 90 or more days past due
Total nonperforming loans
Foreclosed assets
Total nonperforming assets
23,614
The table above shows the trend of loan performance indicators over the past five reporting periods. Loan performance indicators reflected worsening loan performance during 2020, primarily as a result of the impact of the COVID-19 pandemic and sustained instability in the oil and gas industry on the Company’s borrowers. All of the loan performance indicators have shown improvement somewhat in the three months ended March 31, 2021. As the COVID-19 pandemic is ongoing, and the oil and gas industry is still experiencing instability, the Company cannot predict the future trends of loan performance indicators. If loan performance indicators worsen in the future this could result in the need to increase the ACL through additional provisions for credit losses which would negatively impact net income.
In support of customers impacted by the COVID-19 pandemic, the Company offered relief through payment deferrals during 2020 and the first quarter of 2021. As of March 31, 2021, the Company had 16 loans subject to such deferral arrangements with total outstanding principal balances of $34.3 million and at December 31, 2020, the Company had 21 loans subject to deferral arrangements with total outstanding principal balances of $38.4 million.
The Company participated in PPP lending under the CARES Act, which facilitates loans to small businesses. See “Part I—Item 2.—Management’s Discussion and Analysis of Financial Condition and Results of Operations—Financial Condition—Loan Portfolio.”
The increase in net income of $2.5 million during the three months ended March 31, 2021, compared to the three months ended March 31, 2020, were primarily due to the decrease in the provision for credit losses and an increase in net interest income, partially offset by a decrease in noninterest income and an increase in noninterest expense. See further analysis of the material fluctuations in the related discussions that follow.
(Dollars in thousands, except per share data and percentages)
Increase (Decrease)
Interest income
(1,550)
(4.3)%
Interest expense
(2,420)
(60.6)%
870
2.7%
(4,637)
(91.8)%
Noninterest income
(1,216)
(28.1)%
Noninterest expense
1,196
5.4%
Income before income taxes
3,095
32.9%
617
33.0%
2,478
Earnings per share - basic
Earnings per share - diluted
Dividends per share
0.13
0.10
Net Interest Income for the Three Months Ended March 31, 2021 Compared to the Three Months Ended March 31, 2020
Net interest income increased $870,000 during the first quarter of 2021, compared to the first quarter of 2020, primarily due to higher average loans, securities and other interest-earning assets and lower deposit rates, partially offset by lower rates on loans, securities and other interest-earning assets and the impact of one less day in the first quarter of 2021.
The yield on interest-earning assets was 3.85% for the first quarter of 2021, compared to 4.56% for the first quarter of 2020. The cost of interest-bearing liabilities was 0.34% for the first quarter of 2021 and 0.94% for the first quarter of 2020. Yields on interest-earning assets decreased and the costs of interest-bearing liabilities did not decrease to the same extent, which caused compression of the Company’s net interest margin on a tax equivalent basis to 3.71% for the first quarter of 2021, compared to 4.06% for the first quarter of 2020. Although competitive pressures have caused the costs of interest-bearing deposits to not drop in tandem with decreases in market rates for interest-earning assets, they remain a low-cost source of funds, as compared to other sources of funds.
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/
Interest Paid
Rate(1)
Interest-earning assets:
Total loans(2)
2,901,291
4.64%
2,634,507
5.13%
259,341
1.84%
233,917
2.34%
475,279
0.15%
315,099
1.35%
15,353
3.86%
13,661
5.18%
Total interest-earning assets
3,651,264
3.85%
3,197,184
4.56%
Allowance for credit losses for loans
(41,078)
(25,831)
Noninterest-earning assets
321,334
296,698
3,931,520
3,468,051
Liabilities and Shareholders’ Equity
Interest-bearing liabilities:
1,802,175
0.30%
1,650,064
0.92%
1.79%
1.78%
763
Total interest-bearing liabilities
1,852,175
0.34%
1,700,827
0.94%
Noninterest-bearing liabilities:
1,478,183
1,184,776
51,634
44,620
Total noninterest-bearing liabilities
1,529,817
1,229,396
Shareholders’ equity
549,528
537,828
Net interest spread(3)
3.51%
3.62%
Net interest margin(4)
3.68%
4.05%
Net interest margin - tax equivalent(5)
3.71%
4.06%
The following table presents 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 in interest rates. For purposes of this table, changes attributable to both rate and volume that cannot be segregated have been allocated to rate.
Three Months Ended March 31, 2021,
Compared to Three Months Ended March 31, 2020
Increase (Decrease) due to
Rate
Volume
Days
(3,484)
3,403
(371)
(452)
(322)
148
(16)
(1,404)
538
(12)
(878)
(50)
Total increase (decrease) in interest income
(5,260)
4,111
(401)
(2,722)
348
(42)
(2,416)
Total increase (decrease) in interest expense
(2,724)
Increase (decrease) in net interest income
(2,536)
3,763
(357)
Provision for Credit Losses
The provision for credit losses was $412,000 for the first quarter of 2021, compared to $5.0 million for the first quarter of 2020.
The provision for credit losses for the first quarter of 2021 was primarily due to increases of $237,000 and $126,000 in the ACL for loans and unfunded commitments, respectively, in addition to $49,000 in net loan charge-offs. At March 31, 2021, there were minimal adjustments to the qualitative factors utilized in calculating the ACL. The increase in the ACL from December 31, 2020 to March 31, 2021 was primarily due to an increase in specific reserves for loans individually evaluated within the portfolio and a slight increase in the general reserve. Although the collectively evaluated loan portfolio decreased $27.3 million compared to December 31, 2020, the general reserve increased $14,000 because balances in certain portfolio segments with higher historical loss rates and higher qualitative factor rates increased as a component of the overall portfolio resulting in an increase in the ACL.
The provision for credit losses for the first quarter of 2020 was impacted by the uncertainties associated with the COVID-19 pandemic, sustained instability in the oil and gas industry, resultant economic conditions and the impact on the Company’s loan portfolio, which led the Company to adjust certain factors utilized to determine the ACL. As a result of these factors, the Company increased the ACL and the related provision for credit losses, which negatively impacted the Company’s net income during 2020.
Further or prolonged deterioration of the national and local economies and the oil and gas industry, a prolonged COVID-19 pandemic and increases in the Company’s adversely graded loans could result in additional increases in the ACL and additional provisions for credit losses.
43
Noninterest Income
The following table presents components of noninterest income for the first quarters of 2021 and 2020 and the period-over-period changes in the categories of noninterest income:
(292)
(19.7)%
5.9%
(6.3)%
56.1%
(1,021)
(73.9)%
The decrease in noninterest income of $1.2 million during the first quarter of 2021, compared to the first quarter of 2020, was primarily due to swap fee income recognized in the first quarter of 2020. There were no swap transactions in the first quarter of 2021.
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. See further analysis of these changes in the related discussions that follow.
(0.2)%
97
4.0%
551
47.8%
354
29.0%
453
439.8%
(79)
(21.7)%
44
10.5%
4.3%
(13.6)%
(175)
(11.0)%
The increase in noninterest expense of $1.2 million during the first quarter of 2021, compared to the first quarter of 2020, was primarily due to a $551,000 increase in professional and director fees, a $354,000 increase in data processing and software costs and a $453,000 increase in regulatory fees. The increase in professional and director fees during the first quarter of 2021 was primarily due to $661,000 in consulting related fees associated with BSA/AML compliance matters with no such fees being incurred in the first quarter of 2020.
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. Income tax expense and effective tax rates for the periods shown below were as follows:
The differences between the federal statutory rate of 21% and the effective tax rates presented in the table above were primarily related to tax exempt interest and bank-owned life insurance.
Total assets were $4.0 billion as of March 31, 2021, compared to $3.9 billion as of December 31, 2020. The increase of $79.4 million, or 2.0%, was primarily due to a $66.7 million increase in cash and cash equivalents and a $51.8 million increase in securities, partially offset by a $32.7 million decrease in loans. Total liabilities were $3.5 billion as of March 31, 2021, compared to $3.4 billion as of December 31, 2020, an increase of $80.5 million, or 2.4%, primarily due to an increase in deposits of $83.0 million. See further analysis in the related discussions that follow.
(32,485)
(1.1)%
Allowance for credit losses
237
0.6%
(32,722)
Cash and equivalents
12.4%
51,810
21.8%
(601)
(1.0)%
Other intangibles
(180)
(1,668)
(62.4)%
Operating lease right-to-use asset
(385)
(2.9)%
124,722
128,218
(3,496)
(2.7)%
79,422
2.0%
82,953
2.5%
(387)
(2.4)%
(2,042)
(5.9)%
80,524
2.4%
Shareholders' equity
(1,102)
Total liabilities and shareholders' equity
Loan Portfolio
The loan portfolio by loan class as of the dates indicated was as follows:
1.9%
30,265
2.9%
(58,614)
(11.2)%
(14,992)
13,373
5.2%
(1,117)
(3.3)%
(1,696)
(19.6)%
(13,851)
(15.7)%
(32,882)
Less deferred fees and unearned discount
1,271
12.9%
62.4%
As of March 31, 2021, loans excluding loans held for sale were $2.9 billion, a decrease of $32.7 million, or 1.1%, compared to December 31, 2020, primarily due to paydowns during the first quarter of 2021 of $460.5 million, partially offset by originations and line of credit drawdowns of $427.5 million during the same period.
At March 31, 2021, the Company had 1,642 PPP loans totaling $268.8 million, net of deferred loan fees and unearned discounts, and at December 31, 2020, the Company had 1,766 PPP loans totaling $271.2 million, net of deferred loan fees and unearned discounts. The Company recognized a net yield of 6.21% during the first quarter of 2021 on PPP loans, including $3.2 million of origination fee income. During the quarter ended March 31, 2021, there were payments received totaling $123.4 million associated with PPP loans and $122.3 million of PPP loans originated.
The Company’s PPP loans have either a two-year term or a five-year term, earn interest at 1.00% and are fully guaranteed by the SBA. PPP loans are subject to the regulatory requirements that would require forbearance of loan payments for a specified time or that would limit the Company’s ability to pursue all available remedies in the event of a loan default. If the borrower under the PPP loan fails to qualify for loan forgiveness, the Company is at heightened risk of holding these loans at unfavorable interest rates and underwriting standards as compared to the loans to customers to whom the Company would have otherwise lent.
46
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 date indicated were as follows:
1 Year
5 Years
After
Through 5 Years
Through 15 Years
15 years
Fixed rate
60,229
378,649
19,675
458,553
Variable rate
188,512
95,682
13,451
298,154
248,741
474,331
33,126
55,518
434,611
18,944
509,073
98,165
281,080
161,117
22,828
563,190
153,683
715,691
180,061
60,784
81,590
4,998
147,372
87,740
201,704
15,374
11,901
316,719
148,524
283,294
20,372
6,626
33,003
22,329
15,424
77,382
5,001
3,735
14,618
124,144
147,498
11,627
36,738
36,947
139,568
4,218
5,092
186,523
195,833
44,304
29,568
2,014
75,886
48,522
34,660
188,537
8,543
9,735
18,342
12,195
2,196
14,425
20,738
11,931
98
3,272
1,009
4,281
2,643
2,693
5,915
2,604
2,367
448
5,419
24,234
44,734
68,968
26,838
47,101
Fixed rate loans
201,794
946,056
252,981
1,416,255
Variable rate loans
462,794
658,749
206,608
159,382
1,487,533
664,588
1,604,805
459,589
174,806
47
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:
Allowance for credit losses for loans to nonaccrual loans
173.87%
169.20%
Nonperforming loans to loans excluding loans held for sale
0.81%
0.82%
Nonperforming assets to total assets
0.59%
0.61%
Nonperforming assets remain relatively low at $23.6 million, or 0.59%, of total assets at March 31, 2021 and $24.0 million, or 0.61% of total assets, at December 31, 2020. The nonperforming assets decreased $403,000 during the first quarter of 2021 due largely to repayments. Further or prolonged deterioration of the national and local economies and the oil and gas industry and a prolonged COVID-19 pandemic could cause nonperforming loans to increase during 2021. Please see “Part I—Item 2.—Management’s Discussion and Analysis of Financial Condition and Results of Operations—Information Regarding COVID-19 and Uncertain Economic Outlook.”
48
Further or prolonged deterioration of the national and local economies and the oil and gas industry and a prolonged COVID-19 pandemic could cause troubled debt restructurings to increase during 2021. Please see “Part I—Item 2.—Management’s Discussion and Analysis of Financial Condition and Results of Operations—Information Regarding COVID-19 and Uncertain Economic Outlook.”
Risk Gradings
As part of the on-going monitoring of the credit quality of the Company’s loan portfolio and methodology for calculating the ACL, management assigns and tracks loan grades as described below that are used as credit quality indicators. See description of the risk grades in “Part I—Item 1.—Financial Statements—Note 6.”
The internal ratings of loans as of the dates indicated were as follows:
Special
Mention
During the first quarter of 2021, loans with an internal rating of pass decreased $25.5 million primarily due to loan payoffs and payments collected. Loans with an internal rating of special mention decreased $3.6 million and loans with an internal rating of substandard decreased $3.8 million during the same period.
Further or prolonged deterioration of the national and local economies and the oil and gas industry and a prolonged COVID-19 pandemic could cause loans with adverse risk grades to increase during 2021. Please see “Part I—Item 2.—Management’s Discussion and Analysis of Financial Condition and Results of Operations—Information Regarding COVID-19 and Uncertain Economic Outlook.”
Allowance for Credit Losses
The Company maintains an ACL that represents management’s best estimate of the expected credit losses and risks inherent in the loan portfolio. The amount of the ACLs should not be interpreted as an indication that charge-offs in future periods will necessarily occur in those amounts. In determining the ACL, the Company estimates losses on specific loans, or groups of loans, where the probable loss can be identified and reasonably determined. The balance of
49
the ACL 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 and forecasted economic factors and the estimated impact of current economic conditions on certain historical loan loss rates. Please refer to “Part I—Item 1.—Financial Statements—Note 6” for a description of the model, factors and the methodology used by the Company to determine the ACL. Also see “Part I—Item 2.—Management’s Discussion and Analysis—Critical Accounting Policies—Allowance for Credit Losses for Loans.”
The ACL by loan category as of the dates indicated was as follows:
The ACL for loans was $40.9 million, or 1.41% of loans excluding loans held for sale, at March 31, 2021, compared to $40.6 million, or 1.39% of loans excluding loans held for sale, at December 31, 2020. At March 31, 2021, there were minimal adjustments to the qualitative factors utilized in calculating the ACL. The increase in the ACL from December 31, 2020 to March 31, 2021 was primarily due to an increase in specific reserves for loans individually evaluated within the portfolio and a slight increase in the general reserve. Although the collectively evaluated loan portfolio decreased $27.3 million compared to December 31, 2020, the general reserve increased $14,000 because balances in certain portfolio segments with higher historical loss rates and higher qualitative factor rates increased as a component of the overall portfolio resulting in an increase in the ACL.
Activity in the ACL for loans for the periods indicated was as follows:
Provision (recapture):
Total provision (recapture)
Net (charge-offs) recoveries:
Total net (charge-offs) recoveries
Total average loans
Annualized net charge-offs (recoveries) to total average loans
0.01%
(0.05)%
Annualized net charge-off recoveries to average loans by loan category for the periods shown below were as follows:
0.05%
(0.30)%
1.06%
(2.18)%
As of March 31, 2021, the fair value of the Company’s securities totaled $289.1 million, compared to $237.3 million as of December 31, 2020, an increase of $51.8 million, or 21.8%. Amortized cost increased $56.2 million during 2021 primarily as a result of purchases totaling $227.8 million outpacing maturities, sales, calls and paydowns totaling $171.2 million. Net unrealized gains on the securities portfolio was $4.2 million at March 31, 2021, compared to $8.6 million at December 31, 2020. This decrease of $4.4 million was due to a reduction in fair value as a result of market fluctuations.
The Company’s mortgage-backed securities at March 31, 2021 and December 31, 2020, were agency securities. The Company does not hold any Federal National Mortgage Loan Association, or Fannie Mae, or Federal Home Mortgage Corporation, 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.
The weighted-average life of the securities portfolio was 5.3 years with an estimated modified duration of 4.9 years as of March 31, 2021. See “Part I—Item 1.—Financial Statements—Note 2” for securities by contractual maturity.
52
Weighted-average yields by security type and maturity based on estimated annual income divided by the average amortized cost of the Company’s available for sale securities portfolio as of the date indicated was as follows:
Debt securities:
2.47%
2.81%
2.32%
2.37%
1.13%
1.37%
2.59%
1.57%
3.84%
3.58%
2.46%
2.00%
2.02%
Equity securities:
1.36%
Total securities
1.88%
1.95%
2.05%
2.04%
At March 31, 2021 and December 31, 2020, securities with a carrying amount of approximately $28.8 million and $27.3 million, respectively, were pledged to secure public deposits and for other purposes required or permitted by law.
Total deposits as of March 31, 2021 were $3.4 billion, an increase of $83.0 million, or 2.5%, compared to December 31, 2020. Noninterest-bearing deposits as of March 31, 2021 were $1.6 billion, an increase of $145.0 million, or 9.8%, compared to December 31, 2020. Total interest-bearing account balances as of March 31, 2021 were $1.8 billion, a decrease of $62.0 million, or 3.4%, from December 31, 2020, primarily due to decreases in interest-bearing demand accounts, money market accounts and certificates and other time deposits, partially offset by an increase in savings accounts.
The components of deposits as of the dates shown below were as follows:
(12,051)
(3.2)%
(43,672)
(4.2)%
4,300
(6,830)
(4.5)%
(3,777)
(2.6)%
(3.4)%
9.8%
53
The scheduled maturities of uninsured certificates of deposit or other time deposits as of the date indicated were as follows:
Three months or less
8,528
Over three months through six months
11,522
Over six months through 12 months
35,034
Over 12 months
15,454
70,538
Securities pledged and the letter of credit issued under the Company’s Federal Home Loan blanket lien arrangement which secure certain public deposits were not considered in determining the amount of uninsured deposits.
Other Assets
Other assets decreased $3.5 million from December 31, 2020 to March 31, 2021, primarily due to a reduction in the fair value of the Company’s interest rate swap contracts of $2.7 million and a decrease in interest receivable of $631,000. See “Part I—Item 1.—Financial Statements—Note 14” for further discussion of the Company’s interest rate swap contracts.
Other Liabilities
Other liabilities decreased $2.0 million from December 31, 2020 to March 31, 2021, primarily due to a reduction in the fair value of the Company’s interest rate swap contracts of $2.7 million. See “Part I—Item 1.—Financial Statements—Note 14” for further discussion of the Company’s interest rate swap contracts.
The Company monitors its liquidity and may seek to obtain additional financing to further support its business if necessary. The Company’s primary source of funds has been customer deposits and the primary use of funds has been funding of loans.
At March 31, 2021, the Company had $604.7 million in cash and cash equivalents and $289.1 million of securities, which are considered to be liquid assets, compared to $538.0 million in cash and cash equivalents and $237.3 million of securities at December 31, 2020. This increase in liquid assets of $118.5 million during the first quarter of 2021 was primarily due to a $83.0 million increase in deposits and a decrease of $32.5 million in loans excluding loans held for sale.
Historically, the cost of the Company’s deposits has been lower than other sources of funds available. Average balances and average rates paid on deposits for the periods indicated are shown in the table below. Average rates paid for the three months ended March 31, 2021 were computed on an annualized basis.
Three Months Ended
Year Ended
368,000
0.05
363,014
1,032,062
0.26
868,915
0.42
Savings accounts
108,231
0.03
97,982
0.04
149,586
0.56
192,268
1.27
144,296
1.17
181,364
1.50
1,703,543
0.54
1,404,027
3,280,358
0.17
3,107,570
The ratio of average noninterest-bearing deposits to average total deposits was 45.1% for the three months ended March 31, 2021 and 45.2% for the year ended December 31, 2020.
In addition to the liquid assets discussed above, the Company had $1.2 billion and $1.1 billion of available funds under various borrowing arrangements at March 31, 2021 and December 31, 2020, respectively. See “Part I—Item 1.—Financial Statements—Note 11” for additional details of these arrangements. At March 31, 2021, the capacity, amounts outstanding and availability under these arrangements were as follows:
Capacity
Availability
Federal Home Loan Bank Facility(1)
1,126,145
(60,800)
1,065,345
Frost Facility
30,000
Federal Funds
65,000
1,221,145
1,160,345
The composition of funding sources and uses as a percentage of average total assets for the periods indicated was as follows:
Sources of funds:
Deposits:
Interest-bearing
45.8
45.3
Noninterest-bearing
37.6
37.4
1.3
1.5
14.0
14.5
Total sources
Uses of funds:
73.8
76.2
12.1
9.7
0.4
Other noninterest-earning assets
7.1
7.4
Total uses
Average loans to average deposits
88.4
92.1
A portion of the Company’s liquidity capacity will be used for contractual obligations entered into in the normal course of business, such as obligations for operating leases, certificates of deposits and borrowings. Future cash payments associated with the Company’s contractual obligations, as of the dates indicated were as follows:
Less than
1 Year to
3 Years
than 3 Years
Non-cancellable future operating leases
4,453
12,540
Certificates of deposit
197,352
68,709
20,742
286,803
199,388
103,162
53,282
355,832
1,968
4,452
13,092
19,512
204,165
74,708
18,537
297,410
206,133
109,160
51,629
366,922
55
As of March 31, 2021, the Company had no exposure to future cash requirements associated with known uncertainties or capital expenditure of a material nature.
The Company also enters into commitments to extend credit and standby letters of credit to meet customer financing needs and, in accordance with GAAP, these commitments are not reflected as liabilities in the consolidated balance sheets. Due to the nature of these commitments, the amounts disclosed in the table below do not necessarily represent future cash requirements.
Standby letters of credit are conditional commitments issued 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.
Commitments to extend credit and standby letters of credit expiring by period as of the dates indicated were as follows:
Commitments to extend credit
459,133
213,866
51,043
19,799
7,401
478,932
221,267
751,242
498,238
177,710
63,783
18,713
7,365
516,951
185,075
765,809
As a general matter, Federal Deposit Insurance Corporation, or 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 March 31, 2021 and December 31, 2020, 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. See “Part I—Item 1.—Financial Statements—Note 19.”
Market risk refers to the risk of loss arising from adverse changes in interest rates, foreign currency exchange rates, commodity prices and other relevant market rates and prices. As a financial institution, the Company’s primary component of market risk is interest rate risk due to future interest rate changes. Fluctuations in interest rates impact both 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 period.
The Company manages exposure to interest rates by structuring its 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. The Company enters into interest rate swaps as an accommodation to customers. The Company is not subject to foreign exchange or commodity price risk and does not own any trading assets.
The Company has asset, liability and funds management policies that provide the guidelines for effective funds management and has established a measurement system for monitoring the net interest rate sensitivity position. The Company’s exposure to interest rate risk is managed by the Funds Management Committee of the Bank. The committee
formulates strategies based on appropriate levels of interest rate risk with consideration of 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 relationships between interest-earning assets and interest-bearing liabilities, 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.
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 may 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.
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. The results from these models are impacted by the behavior of interest-rate sensitive assets and liabilities as well as the mixture of those assets and liabilities. 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 10.0% for a 100 basis-point shift, 20.0% for a 200-basis point shift and 30.0% 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:
Change in Interest
Percent Change in
Percent Change
Rates (Basis Points)
Net Interest Income
Fair Value of Equity
+ 300
24.6
16.9
21.5
35.7
+ 200
16.1
18.2
14.1
32.8
+ 100
7.3
12.7
6.5
21.0
Base
−100
(1.5)
(32.8)
(37.0)
The model simulation as of March 31, 2021 indicates that the Company’s projected balance sheet was more asset sensitive in comparison to December 31, 2020. The shift to a more asset sensitive position during the first quarter of 2021 was primarily due to a decrease in interest-bearing deposits of $62.0 million, an increase in interest-bearing deposits held at other financial institutions of $61.0 million and an increase in securities of $51.8 million. The increase of $145.0 million in noninterest-bearing deposits contributed to the increase in interest-earning assets during 2021, which had the effect of creating a higher economic value of equity. Subsequent rate shocks due to the change in interest rates result in differing percentages given the level of economic equity.
LIBOR Transition
The London Interbank Offered Rate, or LIBOR, is used as an index rate for a majority of the Company’s interest-rate swaps and approximately 7.5% of the Company’s loans at March 31, 2021. It is expected that a number of private-sector banks that have been reporting information used to set LIBOR will stop doing so after June 30, 2023 when their reporting commitment ends and bank regulatory agencies have issued guidance that banks should generally cease entering into new contracts with LIBOR as an index rate by the end of 2021.
The Company has created a taskforce to identify and evaluate loans and interest-rate swaps that are indexed to LIBOR. For new loan originations and interest-rate swaps, the Company has transitioned away from utilizing LIBOR as a variable rate index and has started utilizing U.S. prime rate or other appropriate reference rates. The Company is evaluating the risks related to this transition and its evaluation and mitigation of risks related to the discontinuation of LIBOR may span several reporting periods through 2022.
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. The Company classifies a financial measure as being 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 statements of income, balance sheets or statements of cash flows. Non-GAAP financial measures do not include operating, other statistical measures or ratios 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 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.
The following table reconciles, as of the dates set forth below, total shareholders’ equity to tangible equity, total assets to tangible assets and presents book value per share, tangible book value per share, total shareholders’ equity to total assets and tangible equity to tangible assets:
Tangible Equity
Adjustments:
Tangible equity
460,408
461,330
Tangible Assets
Tangible assets
3,943,698
3,864,096
Common shares outstanding
24,442
24,613
Book value per share
22.31
22.20
Tangible book value per share
18.84
18.74
Total shareholders’ equity to total assets
13.54%
13.84%
Tangible equity to tangible assets
11.67%
11.94%
The Company’s accounting policies are described in “Part II—Item 8.—Financial Statements and Supplementary Data—Note 1” in the Company’s Annual Report on Form 10-K for the year ended December 31, 2020. The Company’s accounting policies that it considers critical because they involve a higher degree of judgment and complexity are described in “Part II—Item 7.—Management’s Discussion and Analysis of Financial Condition and Results of Operations—Critical Accounting Policies” in the Company’s Annual Report on Form 10-K for the year ended December 31, 2020.
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 “Part I—Item 1.—Financial Statements—Note 1.”
Item 3. Quantitative and Qualitative Disclosures About Market Risk
See “Part I—Item 2.—Management’s Discussion and Analysis of Financial Condition and Results of Operations—Interest Rate Sensitivity and Market Risk” 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 Quarterly Report on Form 10-Q , 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 Quarterly Report on Form 10-Q.
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 March 31, 2021, 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.
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 results of operations, financial condition or cash flows. However, one or more unfavorable outcomes in any claim or litigation against the Company 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 the Company’s favor.
Item 1A. Risk Factors
None.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
Unregistered Sales of Equity Securities
Purchases of Equity Securities by the Issuer and Affiliated Purchasers
In 2020, the Company’s Board of Directors authorized a share repurchase program, or the 2020 Repurchase Program, under which the Company may repurchase up to $40.0 million of the Company’s common stock starting October 1, 2020 through September 30, 2021. Repurchases under the 2020 Repurchase Program may be made from time to time at the Company’s discretion in open market transactions, through block trades, in privately negotiated transactions, and pursuant to any trading plan that may be adopted by the Company’s management in accordance with Rule 10b5-1 of the Exchange Act or otherwise. The timing and actual number of shares repurchased will depend on a variety of factors including price, corporate and regulatory requirements, market conditions, and other corporate liquidity requirements and priorities. The repurchase program does not obligate the Company to acquire a specific dollar amount or number of shares and may be modified, suspended or discontinued at any time.
The following table provides information with respect to purchases of shares of the Company’s common stock during the three months ended March 31, 2021 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 Exchange Act.
Total Number of
Maximum
Shares Purchased
Number of Shares That
Average Price
as Part of Publicly
May Yet be Purchased
Shares Purchased(1)
Paid per Share
Announced Plan(2)
Under the Plan
January 1, 2021 - January 31, 2021
$ 27.57
74,821
1,435,632
February 1, 2021 - February 28, 2021
2,553
$ 27.32
106,268
1,195,640
March 1, 2021 - March 31, 2021
89
$ 30.70
1,135,313
Item 3. Defaults Upon Senior Securities
Item 4. Mine Safety Disclosures
Not Applicable.
Item 5. Other Information
Item 6. Exhibits
Exhibit
Description of Exhibit
3.1
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, 2017, File No. 333-220930)
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, 2017, File No. 333-220930)
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, 2017, File No. 333-220930)
31.1*
Certification of Principal Executive Officer pursuant to Rule 13a-14(a) under the Securities and Exchange Act of 1934
31.2*
Certification of Principal Financial Officer pursuant to Rule 13a-14(a) under the Securities and Exchange Act of 1934
32.1**
Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350
32.2**
Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350
101*
The following materials from CBTX’s Quarterly Report on Form 10‑Q for the quarter ended March 31, 2021, formatted in Inline XBRL (Inline eXtensible Business Reporting Language): (i) Consolidated Balance Sheets, (ii) Consolidated Statements of Operations, (iii) Consolidated Statements of Comprehensive Income, (iv) Consolidated Statements of Changes in Shareholders’ Equity, (v) Consolidated Statements of Cash Flows and (vi) Notes to Consolidated Financial Statements.
104*
Cover Page Interactive Data File (formatted as Inline XBRL and contained in Exhibit 101)
* 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: April 28, 2021
/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)