FIRST FINANCIAL BANKSHARES, INC. The following discussion contains forward-looking statements that are subject to risks and uncertainties. Actual results may differ materially from those contemplated by the forward-looking statements as a result of certain factors, including but not limited to those listed in "Item 1A - Risk Factors" and in the "Cautionary Statement Regarding Forward-Looking Statements" notice on page 1. Introduction As a financial holding company, we generate most of our revenue from interest on loans and investments, trust fees, gain on sale of mortgage loans and service charges. Our primary source of funding for our loans and investments are deposits held by our bank subsidiary,First Financial Bank, N.A . Our largest expenses are salaries and related employee benefits. We measure our performance by calculating our return on average assets, return on average equity, regulatory capital ratios, net interest margin and efficiency ratio, which is calculated by dividing noninterest expense by the sum of net interest income on a tax equivalent basis and noninterest income. The following discussion and analysis of the major elements of our consolidated balance sheets as ofDecember 31, 2020 and 2019, and consolidated statements of earnings for the years 2018 through 2020 should be read in conjunction with our consolidated financial statements, accompanying notes, and selected financial data presented elsewhere in this Form 10-K. Critical Accounting Policies We prepare consolidated financial statements based on generally accepted accounting principles ("GAAP") and customary practices in the banking industry. These policies, in certain areas, require us to make significant estimates and assumptions. We deem a policy critical if (1) the accounting estimate required us to make assumptions about matters that are highly uncertain at the time we make the accounting estimate; and (2) different estimates that reasonably could have been used in the current period, or changes in the accounting estimate that are reasonably likely to occur from period to period, would have a material impact on the financial statements. We deem our most critical accounting policies to be (1) our allowance for credit losses and our provision for credit losses and (2) our valuation of financial instruments. We have other significant accounting policies and continue to evaluate the materiality of their impact on our consolidated financial statements, but we believe these other policies either do not generally require us to make estimates and judgments that are difficult or subjective, or it is less likely they would have a material impact on our reported results for a given period. A discussion of (1) our allowance for credit losses and our provision for credit losses and (2) our valuation of financial instruments is included in Notes 1 and 10 to our Consolidated Financial Statements beginning on page F-9. Acquisitions OnSeptember 19, 2019 , we entered into an agreement and plan of reorganization to acquireTB&T Bancshares, Inc. and its wholly-owned bank subsidiary, The Bank & Trust ofBryan/College Station, Texas . OnJanuary 1, 2020 , the transaction was completed. Pursuant to the agreement, we issued 6.28 million shares of the Company's common shares in exchange for all of the outstanding shares ofTB&T Bancshares, Inc. In addition, in accordance with the plan of reorganization,TB&T Bancshares, Inc. paid a special dividend totaling$1.92 million to its shareholders prior to the closing of this transaction. At the closing,Brazos Merger Sub, Inc. , a wholly-owned subsidiary of the Company, merged intoTB&T Bancshares Inc. , withTB&T Bancshares, Inc. surviving as a wholly-owned 40 -------------------------------------------------------------------------------- Table of Contents subsidiary of the Company. Immediately following such merger,TB&T Bancshares, Inc. was merged into the Company and The Bank & Trust ofBryan/College Station, Texas was merged intoFirst Financial Bank, N.A ., a wholly-owned subsidiary of the Company. The total purchase price of$220.27 million exceeded the estimated fair value of the net assets acquired by approximately$141.92 million and the Company recorded such excess as goodwill. The balance sheet and results of operations ofTB&T Bancshares, Inc. have been included in the financial statements of the Company effectiveJanuary 1, 2020 . Stock Split and Increase in Authorized Shares OnApril 23, 2019 , the Company's Board of Directors declared a two-for-one stock split of the Company's outstanding common shares effectiveJune 3, 2019 . In addition, the shareholders of the Company approved an amendment to the Amended and Restated Certificate of Formation to increase the number of authorized shares to 200,000,000. All per share amounts in this report have been restated to reflect this stock split. An amount equal to the par value of the additional common shares to be issued pursuant to the stock split was reflected as a transfer from retained earnings to common stock in the consolidated financial statements as of and for the year endedDecember 31, 2019 . Stock Repurchase OnMarch 12, 2020 , the Company's Board of Directors authorized the repurchase of up to 4,000,000 common shares throughSeptember 30, 2021 . Previously, the Board of Directors had authorized the repurchase of up to 2,000,000 common shares throughSeptember 30, 2020 . The stock repurchase plan authorizes management to repurchase and retire the stock at such time as repurchases are considered beneficial to the Company and its stockholders. Any repurchase of stock will be made through the open market, block trades or in privately negotiated transactions in accordance with applicable laws and regulations. Under the repurchase plan, there is no minimum number of shares that the Company is required to repurchase. ThroughDecember 31, 2020 , 324,802 shares were repurchased and retired (all during the months of March and April of 2020) totaling$8,008,000 under this repurchase plan. Subsequent toDecember 31, 2020 and throughFebruary 22, 2021 , no additional shares were repurchased. For the years endedDecember 31, 2019 and 2018, no shares were repurchased under this repurchase plan or the prior authorization that expiredSeptember 30, 2020 . Implementation of New Accounting Standard for Accounting for Allowance for Credit Losses OnJanuary 1, 2020 , Accounting Standards Update ("ASU") 2016-13, Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments , became effective for the Company. Accounting Standards Codification ("ASC") Topic 326 ("ASC 326") replaced the previous "incurred loss" model for measuring credit losses with an expected loss methodology that is referred to as the current expected credit loss ("CECL") methodology. The measurement of expected credit losses under the CECL methodology is applicable to financial assets measured at amortized cost, including loan receivables and held-to-maturity debt securities. It also applies to off-balance-sheet ("OBS", "reserve for unfunded commitments") credit exposures not accounted for as insurance (loan commitments, standby letters of credit, financial guarantees, and other similar instruments). In addition, ASC 326 made changes to the accounting for available-for-sale debt securities. One such change is to require credit losses to be presented as an allowance rather than as a write-down on available-for-sale debt securities management does not intend to sell or believes that it is more likely than not they will be required to sell. OnMarch 27, 2020 , the CARES Act was signed by the President ofthe United States that included an option for entities to delay the implementation of ASC 326 until the earlier of the termination date of the national emergency declaration by the President, orDecember 31, 2020 . Under this option, the Company elected to delay implementation of CECL and calculated and recorded the provision for credit losses through the nine-months endedSeptember 30, 2020 under the incurred loss model. AtDecember 31, 2020 , the Company elected to adopt ASC 326, effective as ofJanuary 1, 2020 , through a transition charge to retained earnings of$589 thousand ($466 thousand net of applicable income taxes). This transition adjustment was comprised of a decrease of$619 thousand in allowance for credit losses and an increase of$1.21 million in the reserve for unfunded commitments. 41 -------------------------------------------------------------------------------- Table of Contents The Company completed its CECL implementation plan by forming a cross-functional working group, under the direction of ourChief Credit Officer along with our Chief Accounting Officer,Chief Lending Officer and Chief Financial Officer. The working group also included individuals from various functional areas including credit, risk management, accounting and information technology, among others. The implementation plan included assessment and documentation of processes, internal controls and data sources, model development, documentation and validation, and system configuration, among other things. The Company contracted with a third-party vendor to assist in the implementation of CECL. Other New Accounting Standards Issued but Not Yet Effective Accounting Standards Update ("ASU") 2019-12, "Simplifying the Accounting for Income Taxes." InDecember 2019 , FASB released ASU 2019-12 - Income Taxes (Topic 740), which simplifies the accounting for income taxes by removing multiple exceptions to the general principals in Topic 740. The standard is effective for public business entities for fiscal years, and for interim periods within those fiscal years, beginning afterDecember 15, 2020 . The Company does not expect the adoption of this standard to have a material impact on the Company's Consolidated Financial Statements. Accounting Standards Update ("ASU") 2020-04, "Reference Rate Reform." InMarch 2020 , FASB released ASU 2020-04 - Reference Rate Reform (Topic 848), which provides optional guidance to ease the accounting burden in accounting for, or recognizing the effects from, reference rate reform on financial reporting. The new standard is a result of LIBOR likely being discontinued as an available benchmark rate. The standard is elective and provides optional expedients and exceptions for applying GAAP to contracts, hedging relationships, or other transactions that reference LIBOR, or another reference rate expected to be discontinued. The amendments in the update are effective for all entities betweenMarch 12, 2020 andDecember 31, 2022 . The Company has established a cross-functional working group to guide the Company's transition from LIBOR and has begun efforts to transition to alternative rates consistent with industry timelines. The Company has identified its products that utilize LIBOR and has implemented enhanced fallback language to facilitate the transition to alternative reference rates. The Company is evaluating existing platforms and systems and preparing to offer new rates. Results of Operations Performance Summary . Net earnings for 2020 were$202.03 million , an increase of$37.22 million , or 22.58%, over net earnings for 2019 of$164.81 million . Net earnings for 2018 were$150.64 million . The increase in net earnings for 2020 over 2019 and 2019 over 2018 was primarily attributable to the overall growth in net interest income and noninterest income. Net earnings in 2020 also include a provision for credit losses of$19.52 million compared to$2.97 million in 2019 and$5.67 million in 2018. The provision for credit losses in 2020 reflects primarily the stress on our loan portfolio from the increase in unemployment and economic effects of the COVID pandemic. On a diluted net earnings per share basis, net earnings were$1.42 for 2020, as compared to$1.21 for 2019 and$1.11 for 2018. The return on average assets was 1.98% for 2020, as compared to 2.08% for 2019 and 1.98% for 2018. The return on average equity was 12.93% for 2020, as compared to 14.37% for 2019 and to 15.37% for 2018. The return on average tangible equity was 16.25% for 2020, as compared to 16.95% for 2019 and to 18.65% for 2018. Net Interest Income . Net interest income is the difference between interest income on earning assets and interest expense on liabilities incurred to fund those assets. Our earning assets consist primarily of loans and investment securities. Our liabilities to fund those assets consist primarily of noninterest-bearing and interest-bearing deposits. Tax-equivalent net interest income was$361.15 million in 2020, as compared to$295.88 million in 2019, and$281.75 million in 2018. Average earning assets were$9.52 billion in 2020, as compared to$7.44 billion in 2019 and$7.12 billion in 2018. The increase in tax-equivalent net interest income in 2020 compared to 2019 was largely attributable to increases in interest earning assets. The increase of$2.08 billion in average earning assets in 2020 when compared to 2019 was primarily a result of increases in loans of$1.08 billion and tax-exempt securities of$689.80 million when compared to 2019. The increase in tax-equivalent net interest income in 2019 compared to 2018 was also largely attributable to increases in interest earning assets. The increase of$326.97 million in average earning assets in 2019 when compared to 2018 was primarily a result of increases in loans of$246.63 million and 42 -------------------------------------------------------------------------------- Table of Contents taxable securities of$156.33 million . Average interest-bearing liabilities were$5.76 billion in 2020, as compared to$4.61 billion in 2019 and$4.47 billion in 2018. The yield on earning assets decreased forty-four basis points in 2020 when compared to 2019 while the rate paid on interest-bearing liabilities decreased forty basis points. The yield on earning assets increased fifteen basis points in 2019 when compared to 2018 while the rate paid on interest-bearing liabilities increased twenty-three basis points. Table 1 allocates the change in tax-equivalent net interest income between the amount of change attributable to volume and to rate. Table 1 - Changes in Interest Income and Interest Expense (in thousands): 2020 Compared to 2019 2019 Compared to 2018 Change Attributable to Total Change Attributable to Total Volume Rate Change Volume Rate Change Short-term investments$ 3,689 $ (4,628 ) $
(939 )
3,812 (8,026 ) (4,214 ) 4,045 1,573 5,618
Tax-exempt
investment securities (1) 24,671 (8,932 ) 15,739 (2,634 ) (2,203 ) (4,837 )
Loans (1) (2) 59,719 (20,900 ) 38,819 12,983 11,276 24,259
Interest income 91,891 (42,486 ) 49,405 14,288 11,013 25,301
Interest-bearing deposits 6,379 (20,382 ) (14,003 ) 654 9,523 10,177
Short-term borrowings 1,223 (3,079 ) (1,856 ) (99 ) 1,095 996
Interest expense 7,602 (23,461 ) (15,859 ) 555 10,618 11,173
Net interest income $ 84,289 $ (19,025 ) $ 65,264 $ 13,733 $ 395 $ 14,128
(1) Computed on a
tax-equivalentbasis assuming a marginal tax rate of 21%.
(2) Nonaccrual loans are included in loans.
The net interest margin in 2020 was 3.79%, a decrease of nineteen basis points from 2019. The net interest margin for 2019 was 3.98% which was an increase of two basis points from 2018. which increased two basis points from 2018. We continued to experience downward pressures on our net interest margin in 2020 primarily due to (i) the extended period of fluctuating historically low levels of short-term interest rates and (ii) the flat to inverted yield curve currently being experienced in the bond market. We have been able to somewhat mitigate the impact of these lower short-term interest rates and the flat/inverted yield curve by establishing minimum interest rates on certain of our loans, improving the pricing for loan risk, and reducing the rates paid on interest-bearing liabilities. InMarch 2020 , as the market experienced volatility, we took advantage of that volatility to purchase high quality municipal bonds at favorable tax-equivalent interest yields. TheFederal Reserve increased rates 100 basis points in 2018 but then decreased rates 75 basis points during the third and fourth quarters of 2019 and then an additional 150 basis points in the first quarter of 2020, resulting in a current target rate range of zero to 25 basis points. 43 -------------------------------------------------------------------------------- Table of Contents The net interest margin, which measures tax-equivalent net interest income as a percentage of average earning assets, is illustrated in Table 2 for the years 2018 through 2020. Table 2 - Average Balances and Average Yields and Rates (in thousands, except percentages): 2020 2019 2018 Average Income/ Yield/ Average Income/ Yield/ Average Income/ Yield/ Balance Expense Rate Balance Expense Rate Balance Expense Rate Assets Short-term investments (1)$ 251,086 $ 953 0.38 %$ 84,430 $ 1,892 2.24 %$ 90,374 $ 1,631 1.80 % Taxable investment securities (2) 2,233,634 51,456 2.30 2,090,490 55,670 2.66 1,934,160 50,052 2.59 Tax-exempt investment securities (2)(3) 1,882,711 58,403 3.10 1,192,908 42,664 3.58 1,262,947 47,501 3.76 Loans (3)(4) 5,152,531 264,576 5.13 4,074,667 225,757 5.54 3,828,040 201,498 5.26 Total earning assets 9,519,962$ 375,388 3.94 % 7,442,495$ 325,983 4.38 % 7,115,521$ 300,682 4.23 % Cash and due from banks 189,849 175,417 176,799 Bank premises and equipment, net 139,880 133,239 129,715 Other assets 92,612 66,003 62,595Goodwill and other intangible assets, net 318,818 174,138 172,425 Allowance for credit losses (67,606 ) (52,170 ) (50,323 ) Total assets$ 10,193,515 $ 7,939,122 $ 7,606,732 Liabilities and Shareholders' Equity Interest-bearing deposits$ 5,198,554 $ 13,119 0.25 %$ 4,208,666 $ 27,122 0.64 %$ 4,052,614 $ 16,945 0.42 % Short-term borrowings 561,505 1,124 0.20 398,142 2,980 0.75 418,977 1,984 0.47 Total interest-bearing liabilities 5,760,059$ 14,243 0.25 % 4,606,808$ 30,102 0.65 % 4,471,591$ 18,929 0.42 % Noninterest-bearing deposits 2,782,896 2,137,089 2,124,004 Other liabilities 88,550 48,658 30,931 Total liabilities 8,631,505 6,792,555 6,626,526 Shareholders' equity 1,562,010 1,146,567 980,206 Total liabilities and shareholders' equity$ 10,193,515 $ 7,939,122 $ 7,606,732 Net interest income$ 361,145 $ 295,881 $ 281,753 Rate Analysis: Interest income/earning assets 3.94 % 4.38 % 4.23 % Interest expense/earning assets 0.15 0.40 0.27 Net interest margin 3.79 % 3.98 % 3.96 %
(1) Short-term investments are comprised of federal funds sold, interest-bearing
deposits in banks and interest- bearing time deposits in banks.
(2) Average balances include unrealized gains and losses on
available-for-sale
securities.
(3) Computed on a
tax-equivalentbasis assuming a marginal tax rate of 21%.
(4) Nonaccrual loans are included in loans.
Noninterest Income . Noninterest income for 2020 was$139.94 million , an increase of$31.51 million , or 29.06%, as compared to 2019. Increases in certain categories of noninterest income included (1) real estate mortgage operations income of$25.73 million , (2) gain on sale of available-for-sale securities of$2.90 million , (3) ATM, interchange and credit card fees of$2.61 million , (4) miscellaneous income of$2.12 million which includes$1.40 million in Main Street Lending Program fees and (5) trust fees of$1.13 million when compared to 2019. The mortgage related income increase was mainly due to a significant increase in the volume of loans originated to$1.21 billion in 2020 up from$551.77 million in 2019 driven by the lower rate environment and a strong housing market inTexas . The increase in ATM, interchange and credit card fees was driven by continued growth in the number of debit cards issued as well as our TB&T acquisition. The increase in trust fees resulted from an increase in assets under management over the prior year. The fair value of our trust assets managed, which are not reflected in our consolidated balance sheets, totaled$7.51 billion atDecember 31, 2020 , as compared to$6.75 billion atDecember 31, 2019 . Offsetting these increases was a decline in service charge revenue in 2020 when compared with 2019 of$1.47 million that was primarily driven by lower overdraft fees in the current year as a result of the effects of the pandemic and related stimulus programs. Noninterest income for 2019 was$108.43 million , an increase of$6.66 million , or 6.55%, as compared to 2018. Increases in certain categories of noninterest income included (1) real estate mortgage operations income of$2.99 million , (2) ATM, interchange and credit card fees of$1.33 million , (3) interest on loan recoveries of$1.15 million , (4) service charges on deposit accounts of$376 thousand , and (5) trust fees of$220 thousand when compared to 2018. The increase in real estate mortgage fees was a result of an increase in the volume of loans originated and the Company's decision to move to mandatory delivery from best efforts. The increase in ATM, interchange and credit 44 -------------------------------------------------------------------------------- Table of Contents card fees was primarily due to the continued growth in the number of debit cards issued. Interest on loan recoveries increased as a result of several larger loan recoveries in 2019. The increase in service charges on deposit accounts was primarily due to the continued growth in net new accounts. The increase in trust fees resulted from an increase in assets under management over the prior year; however, this was mostly offset by a decrease in income derived from oil and gas production activity when compared to 2018. The fair value of our trust assets managed, which are not reflected in our consolidated balance sheets, totaled$6.75 billion atDecember 31, 2019 , as compared to$5.60 billion atDecember 31, 2018 . Offsetting these increases was a decrease in net gains on sales of available-for-sale securities of$621 thousand . ATM and interchange fees are charges that merchants pay to us and other card-issuing banks for processing electronic payment transactions. ATM and interchange fees consist of income from debit card usage, point of sale income for debit card transactions and ATM service fees.Federal Reserve rules applicable to financial institutions that have assets of$10 billion or more provide that the maximum permissible interchange fee for an electronic debit transaction is limited to the sum of21 cents per transaction plus 5 basis points multiplied by the value of the transaction. Management has estimated the impact of this reduction in ATM and interchange fees to approximate$14.00 million annually (pre-tax) once theFederal Reserve rules apply to the Company.Federal Reserve requirements stipulate that these rules would go into effect onJuly 1st following the year-end in which a financial institution's total assets exceeded$10 billion atDecember 31st . AtDecember 31, 2020 , the Company's total assets exceeded the$10 billion threshold, due primarily to the effect of the Company's participation in the PPP loan program and growth in deposits from related activities. However, onNovember 20, 2020 , the federal bank regulatory agencies announced an interim final rule that provides temporary relief for certain community banking organizations that have crossed this threshold as ofDecember 31, 2020 if they had less than$10 billion in assets as ofDecember 31, 2019 . Under the interim final rule, these banks, which includes us, will generally have until 2022 to either reduce their size, or to prepare for the regulatory and reporting standards under the Dodd-Frank Act. Management will continue to monitor the Company's balance sheet levels and prepare for the effects of this future loss of debit card income. Table 3 - Noninterest Income (in thousands): Increase Increase 2020 (Decrease) 2019 (Decrease) 2018 Trust fees$ 29,531 $ 1,130 $ 28,401 $ 220 $ 28,181 Service charges on deposit accounts 20,572 (1,467 ) 22,039 376 21,663 ATM, interchange and credit card fees 32,469 2,606 29,863 1,331 28,532 Gain on sale and fees of mortgage loans 43,872 25,728 18,144 2,987 15,157 Net gain on sale of available-for-sale securities 3,633 2,900 733 (621 ) 1,354 Net gain (loss) on sale of foreclosed assets 159 (115 ) 274 158 116 Net gain (loss) on sale of assets 112 (207 ) 319 466 (147 ) Interest on loan recoveries 856 (1,236 ) 2,092 1,154 938 Other: Wire transfer fees 1,153 141 1,012 110 902 Check printing fees 293 82 211 (5 ) 216 Safe deposit rental fees 732 197 535 (9 ) 544 Credit life and debt protection fees 876 (102 ) 978 237 741 Brokerage commissions 1,310 (271 ) 1,581 (126 ) 1,707 Miscellaneous income 4,367 2,121 2,246 386 1,860 Total other 8,731 2,168 6,563 593 5,970 Total Noninterest Income$ 139,935 $ 31,507 $ 108,428 $ 6,664 $ 101,764 Noninterest Expense . Total noninterest expense for 2020 was$227.94 million , an increase of$31.42 million , or 15.99%, as compared to 2019. Noninterest expense for 2019 amounted to$196.52 million , an increase of$5.84 million , or 3.06%, as compared to 2018. An important measure in determining whether a financial institution effectively manages noninterest expenses is the efficiency ratio, which is calculated by dividing noninterest expense by the sum of net interest income on a tax-equivalent basis and noninterest income. Lower ratios indicate better efficiency since more income is generated with a lower noninterest expense total. Our efficiency ratio for 2020 was 45.49%, as compared to 48.61% for 2019 and 49.72% for 2018. The reduction in the Company's efficiency ratio during 2020 primarily resulted from the growth in the Company's balance sheet and interest-earning assets as a result of the Company's participation in the PPP loan program and the deferral of$3.62 million in noninterest expenses related to PPP loan origination costs during the second quarter of 2020. 45 -------------------------------------------------------------------------------- Table of Contents Salaries and employee benefits for 2020 totaled$135.12 million , an increase of$22.79 million , or 20.28%, as compared to 2019. The increase was primarily driven by (i) the TB&T acquisition, (ii) annual merit-based pay increases that were effectiveMarch 1, 2020 , (iii) an increase in our profit sharing and other incentive expenses, and (iv) higher mortgage related commissions. Also, in 2019 the Company incurred$2.67 million in expenses related to the termination of its pension plan when compared to$1.55 million in 2018. All other categories of noninterest expense for 2020 totaled$92.82 million , an increase of$8.63 million , or 10.25%, as compared to 2019. Included in noninterest expense in 2020 were technology contract termination and conversion related expenses totaling$4.88 million related to the TB&T acquisition. Also included in noninterest expense during 2020 were increases in net occupancy expenses, professional and service fees and ATM, interchange and credit card expenses when compared to 2019 primarily due to the TB&T acquisition. Salaries and employee benefits for 2019 totaled$112.34 million , an increase of$7.15 million , or 6.79%, as compared to 2018. The increase was primarily driven by (i) annual merit-based pay increases that were effectiveMarch 1, 2019 , (ii) an increase in our profit sharing expenses, (iii) an increase in our pension plan expenses, and (iv) an increase in medical insurance costs. All other categories of noninterest expense for 2019 totaled$84.19 million , a decrease of$1.31 million , or 1.53%, as compared to 2018. Included in noninterest expense in 2019 was$2.67 million , before income tax, in pension settlement expense resulting from the Company's settlement and termination of the remaining portion of its defined benefit pension plan obligation. During 2018, the Company recorded$1.55 million , before income tax, in pension settlement expense for a partial settlement of this defined benefit pension obligation. Also included in noninterest expense during 2019 was an increase of$574 thousand in ATM, interchange and credit card expenses when compared to 2018. Offsetting these increases in noninterest expense for 2019 when compared to 2018 was a decrease inFDIC insurance premiums of$1.24 million due to theFDIC assessment credit previously discussed. 46 -------------------------------------------------------------------------------- Table of Contents Table 4 - Noninterest Expense (in thousands): Increase Increase 2020 (Decrease) 2019 (Decrease) 2018 Salaries$ 101,360 $ 17,079 $ 84,281 $ 4,807 $ 79,474 Medical 10,406 1,281 9,125 426 8,699 Profit sharing 10,740 3,079 7,661 612 7,049 Pension - (351 ) 351 529 (178 ) 401(k) match expense 3,374 615 2,759 171 2,588 Payroll taxes 6,565 890 5,675 306 5,369 Stock option expense 1,377 (112 ) 1,489 (19 ) 1,508 Restricted stock expense 1,301 306 995 315 680 Total salaries and employee benefits 135,123 22,787 112,336 7,147 105,189 Cost related to termination of pension plan - (2,673 ) 2,673 1,127 1,546 Net occupancy expense 12,388 1,232 11,156 (17 ) 11,173 Equipment expense 8,396 (656 ) 9,052 (1,066 ) 10,118 FDIC insurance premiums 1,758 667 1,091 (1,242 ) 2,333 ATM, interchange and credit card expenses 11,235 1,379 9,856 574 9,282 Professional and service fees 9,346 1,493 7,853 (1,041 ) 8,894 Printing, stationery and supplies 2,163 351 1,812 (185 ) 1,997 Amortization of intangible assets 1,990 974 1,016 (256 ) 1,272 Other: Data processing fees 1,619 69 1,550 88 1,462 Postage 1,446 (101 ) 1,547 (202 ) 1,749 Advertising 1,952 (1,655 ) 3,607 4 3,603 Correspondent bank service charges 908 201 707 (65 ) 772 Telephone 3,819 141 3,678 116 3,562 Public relations and business development 2,650 (556 ) 3,206 145 3,061 Directors' fees 2,363 391 1,972 227 1,745 Audit and accounting fees 2,232 772 1,460 (165 ) 1,625 Legal fees 1,276 62 1,214 66 1,148 Regulatory exam fees 1,105 (74 ) 1,179 (96 ) 1,275 Travel 967 (674 ) 1,641 176 1,465 Courier expense 855 (3 ) 858 28 830 Operational and other losses 2,462 583 1,879 (309 ) 2,188 Other real estate 83 (119 ) 202 73 129 Software amortization and expense 8,862 1,557 7,305 1,285 6,020 Other miscellaneous expense 12,940 5,269 7,671 (575 ) 8,246 Total other 45,539 5,863 39,676 796 38,880 Total Noninterest Expense$ 227,938 $ 31,417 $ 196,521 $ 5,837 $ 190,684 Income Taxes . Income tax expense was$40.33 million for 2020, as compared to$33.22 million for 2019 and$27.54 million for 2018. Our effective tax rates on pretax income were 16.64%, 16.78% and 15.46%, respectively, for the years 2020, 2019 and 2018. The effective tax rates differ from the statutory federal tax rate of 21.0% largely due to tax exempt interest income earned on certain investment securities and loans and the deductibility of dividends paid to our employee stock ownership plan. OnDecember 22, 2017 , the Tax Cuts and Jobs Act was signed into law with sweeping modifications to the Internal Revenue Code. The primary change for the Company was to lower the corporate income tax rate to 21% from 35%. The Company's deferred tax assets and liabilities were re-measured based on the income tax rates at which they are expected to reverse in the future, which is generally 21%. The provisional amount recorded related to the re-measurement of the Company's deferred tax balance was$7.65 million , a reduction of income tax expense for the year endedDecember 31, 2017 . However, the Company updated its estimate of the impact to our deferred tax balances based on the proposed regulations issued to date and recorded an additional reduction of income tax expense for the year endedDecember 31, 2018 of$664 thousand . No additional adjustment amounts were recorded for the years endedDecember 31, 2019 and 2020. 47 -------------------------------------------------------------------------------- Table of Contents Balance Sheet Review Loans . Our portfolio is comprised of loans made to businesses, professionals, individuals, and farm and ranch operations located in the primary trade areas served by our subsidiary bank. As ofDecember 31, 2020 , total loans held-for-investment were$5.17 billion , an increase of$976.06 million , as compared toDecember 31, 2019 . The increase in the Company's total loans held-for-investment in 2020 was primarily driven by the TB&T acquisition and the Company's participation in the PPP loan program. OnJanuary 1, 2020 , TB&T had$447.70 million in loan balances. During 2020, the Company originated$703.73 million in PPP loans of which$220.34 were forgiven during the year resulting in a balance of$479.43 million atDecember 31, 2020 , which are included in the Company's commercial loan totals. The average balance of PPP loans was$479.43 million for the year endedDecember 31, 2020 . AtDecember 31, 2020 ,$11.27 million of deferred loan fees related to PPP loans continues to be amortized over the shorter of the repayment period or the contractual life of 24 months. As compared to year-end 2019 balances, total real estate loans increased$495.89 million , total commercial loans increased$456.38 million , agricultural loans decreased$8.78 million and total consumer loans increased$32.57 million . Loans averaged$5.15 billion during 2020, an increase of$1.08 billion over 2019 average balances. In conjunction with the adoption of ASC 326, the Company expanded its four loan portfolio segments used under the legacy disclosure requirements into the following ten portfolio segments. For modeling purposes, our loan portfolio segments include Commercial and Industrial ("C&I"), Municipal, Agricultural, Construction and Development, Farm, Non-Owner Occupied andOwner Occupied Commercial Real Estate ("CRE"), Residential, Consumer Auto and Consumer Non-Auto. This additional segmentation allows for a more precise pooling of loans with similar credit risk characteristics and credit monitor procedures for the Company's calculation of its allowance for credit losses. Table 5 outlines the composition of the Company's held-for-investment loans. by portfolio segment. atDecember 31, 2020 . For all periods prior toDecember 31, 2020 , management has elected to maintain its previously disclosed loan portfolio segments. Table 5 - Composition of Loans Held-For-Investment (in thousands): December 31, 2020 2019 2018 2017 2016 Commercial: C&I$ 1,131,382 $ N/A $ N/A $ N/A $ N/A Municipal 181,325 N/A N/A N/A N/A Total Commercial 1,312,707 856,326 844,953 684,099 674,410 Agricultural 94,864 103,640 96,677 94,543 84,021 Real Estate: Construction & Development 553,959 N/A N/A N/A N/A Farm 152,237 N/A N/A N/A N/A Non-Owner Occupied CRE 617,686 N/A N/A N/A N/A Owner Occupied CRE 746,974 N/A N/A N/A N/A Residential 1,248,409 N/A N/A N/A N/ATotal Real Estate 3,319,265 2,823,372 2,639,346 2,302,998 2,189,844 Consumer: Auto 353,595 N/A N/A N/A N/A Non-Auto 90,602 N/A N/A N/A N/A Total Consumer 444,197 411,631 372,660 403,929 409,032 Total$ 5,171,033 $ 4,194,969 $ 3,953,636 $ 3,485,569 $ 3,357,307 48
-------------------------------------------------------------------------------- Table of Contents Loans held-for-sale, consisting of secondary market mortgage loans, totaled$83.97 million and$28.23 million atDecember 31, 2020 and 2019, respectively. AtDecember 31, 2020 and 2019,$4.38 million and$5.15 million are valued at the lower of cost or fair value, and the remaining amount is valued under the fair value option. The Company has certain lending policies and procedures in place that are designed to maximize loan growth with an acceptable level of risk. Management reviews and approves these policies and procedures on an annual basis and makes changes as appropriate with input from our Board of Directors. Management receives and reviews monthly reports related to loan originations, quality, concentrations, delinquencies, nonperforming and potential problem loans. Diversification in the loan portfolio is a means of managing risk associated with fluctuations in economic conditions, both by type of loan and geographic location. Commercial loans are underwritten after evaluating and understanding the borrower's ability to operate profitably and effectively. Underwriting standards are designed to determine whether the borrower possesses sound business ethics and practices and to evaluate current and projected cash flows to determine the ability of the borrower to repay their obligations as agreed. Commercial loans are primarily made based on the identified cash flows of the borrower and, secondarily, on the underlying collateral provided by the borrower. Most commercial loans are secured by the assets being financed or other business assets, such as accounts receivable or inventory, and include personal guarantees. Agricultural loans are subject to underwriting standards and processes similar to commercial loans. These agricultural loans are based primarily on the identified cash flows of the borrower and secondarily on the underlying collateral provided by the borrower. Most agricultural loans are secured by the agriculture related assets being financed, such as farm land, cattle or equipment, and include personal guarantees. Real estate loans are also subject to underwriting standards and processes similar to commercial and agricultural loans. These loans are underwritten primarily based on projected cash flows and, secondarily, as loans secured by real estate. The repayment of real estate loans is generally largely dependent on the successful operation of the property securing the loans or the business conducted on the property securing the loan. Real estate loans may be more adversely affected by conditions in the real estate markets or in the general economy. The properties securing the Company's real estate portfolio are generally diverse in terms of type and geographic location withinTexas . This diversity helps reduce the exposure to adverse economic events that affect any single market or industry. Generally, real estate loans are owner-occupied which further reduces the Company's risk. Consumer loan underwriting utilizes methodical credit standards and analysis to supplement the Company's underwriting policies and procedures. The Company's loan policy addresses types of consumer loans that may be originated and the collateral, if secured, which must be perfected. The relatively smaller individual dollar amounts of consumer loans that are spread over numerous individual borrowers also minimize the Company's risk. Table 6 - Maturity Distribution and Interest Sensitivity of Loans atDecember 31, 2020 (in thousands): The following tables summarize maturity and repricing information for the commercial and agricultural and the real estate-construction and development portion of our loan portfolio as ofDecember 31, 2020 : After One Year One Year Through After Five or less Five Years Years Total Commercial and agricultural$ 362,416 $ 803,779 $ 241,376 $ 1,407,571 Real estate - construction and development 255,960 91,816 206,183 553,959 Maturities After One Year Loans with fixed interest rates$ 892,141
Loans with floating or adjustable interest rates 451,013
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Asset Quality
. Our loan portfolio is subject to periodic reviews by our centralized
independent loan review group as well as periodic examinations by bank
regulatory agencies. Loans are placed on nonaccrual status when, in the judgment
of management, the collectability of principal or interest under the original
terms becomes doubtful. Nonaccrual, past due 90 days or more and still accruing,
and restructured loans plus foreclosed assets were $42.90 million at
December 31, 2020 , as compared to $25.77 million at December 31, 2019 and
$29.63 million at December 31, 2018 . As a percent of loans
held-for-investment
and foreclosed assets, these assets were 0.83% at December 31, 2020 , as compared
to 0.61% at December 31, 2019 and 0.75% at December 31, 2018 . As a percent of
total assets, these assets were 0.39% at December 31, 2020 , as compared to 0.31%
at December 31, 2019 and 0.38% at December 31, 2018 . We believe the level of
these assets to be manageable and are not aware of any material classified
credits not properly disclosed as nonperforming at December 31, 2020 .
Supplemental Oil and Gas Information.
At December 31, 2020 , the Company's exposure to the oil and gas industry was
2.27% of loans
held-for-investment,
excluding PPP loans, or $106.24 million , compared to 2.86% of loans
held-for-investment,
or $119.79 million at December 31, 2019 . These oil and gas loans consisted
(based on collateral supporting the loan) of (i) development and production
loans of 11.99%, (ii) oil and gas field servicing loans of 6.62%, (iii) real
estate loans of 57.40%, (iv) accounts receivable and inventory of 4.04%, (v)
automobile of 12.09% and (vi) other of 7.86%. These loans have warranted
additional scrutiny because of fluctuating oil and gas prices and the COVID
pandemic. The Company instituted additional monitoring procedures for these
loans and has classified and downgraded loans as appropriate. The following oil
and gas information is as of and for the years ended December 31, 2020 and 2019:
December 31,
2020 2019
Oil and gas related loans, excluding PPP loans $ 106,237 $ 119,789
Oil and gas related loans as a % of total loans
held-for-investment,
excluding PPP loans 2.27 % 2.86 %
Classified oil and gas related loans $ 13,298 $ 7,041
Nonaccrual oil and gas related loans $ 4,774 $ 825
$ -
Supplemental COVID Industry Exposure. In addition, atDecember 31, 2020 , loan balances in the retail/restaurant/hospitality industries totaled$359.33 million or 7.67% of the Company's total loans held-for-investment, excluding PPP loans. Classified and nonperforming loans for these industries combined atDecember 31, 2020 , totaled$31.19 million and$5.98 million , respectively. Net charge-offs related to this portfolio totaled$895 thousand for the year endedDecember 31, 2020 . Additional information related to the Company's retail/restaurant/hospitality industries follows below (in thousands, except percentages): December 31, 2020 Retail loans$ 216,244 Restaurant loans 48,618 Hotel loans 71,716 Other hospitality loans 21,970 Travel loans 780
Total Retail/Restaurant/Hospitality loans, excluding PPP loans
Retail/Restaurant/Hospitality loans as a % of total loans held-for-investment, excluding PPP loans
7.67 %
Classified Retail/Restaurant/Hospitality loans $ 31,192
Nonaccrual Retail/Restaurant/Hospitality loans
5,975
Net Charge-Offs for Retail/Restaurant/Hospitality loans 895
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Table 7 - Nonaccrual, Past Due 90 Days or More and Still Accruing, Restructured
Loans and Foreclosed Assets (in thousands, except percentages):
At December 31,
2020 2019 2018 2017 2016
Nonaccrual loans $ 42,619 $ 24,582 $ 27,534 $ 17,670 $ 27,371
Loans still accruing and past due 90
days or more 113 153 1,008 288 284
Troubled debt restructured loans* 24 26 513 627 701
Nonperforming loans 42,756 24,761 29,055 18,585 28,356
Foreclosed assets 142 1,009 577 1,532 644
Total nonperforming assets $ 42,898 $ 25,770 $ 29,632 $ 20,117 $ 29,000
As a % of loans
held-for-investment
and foreclosed assets 0.83 % 0.61 % 0.75 % 0.58 % 0.86 %
As a % of total assets 0.39 0.31 0.38 0.28 0.43
* Troubled debt restructured loans of
collection, after considering economic and business conditions and collection
efforts, is doubtful are included in nonaccrual loans as of
2019, 2018, 2017 and 2016.
We record interest payments received on nonaccrual loans as reductions of principal. Prior to the loans being placed on nonaccrual, we recognized interest income on these loans as ofDecember 31, 2020 of approximately$255 thousand during the year endedDecember 31, 2020 . If interest on these loans had been recognized on a full accrual basis during the year endedDecember 31, 2020 , such income would have approximated$4.46 million . Included in our loan portfolio are certain other loans not included in Table 7 that are deemed to be potential problem loans. Potential problem loans are those loans that are currently performing, but for which known information about trends, uncertainties or possible credit problems of the borrowers causes management to have serious doubts as to the ability of such borrowers to comply with present repayment terms, possibly resulting in the transfer of such loans to nonperforming status. These potential problem loans totaled$10.76 million as ofDecember 31, 2020 . See Note 3 to the Consolidated Financial Statements beginning on page F-19 for more information on these assets. Allowance for Credit Losses . The allowance for credit losses is the amount we determine as of a specific date to be appropriate to absorb current expected credit losses on existing loans in which full collectability is unlikely based on our review and evaluation of the loan portfolio. For a discussion of our methodology, see our accounting policies in Note 1 to the Consolidated Financial Statements beginning on page F-9. The provision for credit losses was$19.52 million in 2020, as compared to$2.97 million in 2019 and$5.67 million in 2018. The provision for credit losses in 2020 reflects primarily the stress on our loan portfolio from the increase in unemployment and economic effects of the COVID pandemic. As a percent of average loans, net loan charge-offs were 0.06% during 2020, 0.04% during 2019 and 0.07% during 2018. The allowance for credit losses as a percent of loans held-for-investment was 1.29% as ofDecember 31, 2020 , as compared to 1.25% as ofDecember 31, 2019 and 1.30% as ofDecember 31, 2018 . The allowance for credit losses as a percent of loans held-for-investment, excluding PPP loans, was 1.42% as ofDecember 31, 2020 , as compared to 1.25% as ofDecember 31, 2019 and 1.30% as ofDecember 31, 2018 . Included in Tables 8 and 9 are further analysis of our allowance for credit losses. Although we believe we use the best information available to make credit loss allowance determinations, future adjustments could be necessary if circumstances or economic conditions differ substantially from the assumptions used in making our initial determinations. A downturn in the economy or lower employment could result in increased levels of nonaccrual, past due 90 days or more and still accruing, restructured loans, foreclosed assets, charge-offs, increased provision for credit losses and reductions in income. Additionally, as an integral part of their examination process, bank regulatory agencies periodically review the adequacy of our allowance for credit losses. The banking agencies could require additions to our allowance for credit losses based on their judgment of information available to them at the time of their examinations of our bank subsidiary. 51 -------------------------------------------------------------------------------- Table of Contents Table 8 - Loan Loss Experience and Allowance for Credit Losses (in thousands, except percentages): 2020 2019 2018 2017 2016 Balance at January 1,$ 52,499 $ 51,202 $ 48,156 $ 45,779 $ 41,877 Impact of adopting ASC 326 (619 ) - - - - Initial allowance on acquired TB&T PCD loans 1,678 - - - - Charge-offs: Commercial: C&I 2,516 N/A N/A N/A N/A Municipal - N/A N/A N/A N/A Total Commercial 2,516 1,545 1,418 3,018 6,990 Agricultural 372 319 - 71 219 Real estate: Construction & Development - N/A N/A N/A N/A Farm - N/A N/A N/A N/A Non-Owner Occupied CRE 563 N/A N/A N/A N/A Owner Occupied CRE 567 N/A N/A N/A N/A Residential real estate 373 N/A N/A N/A N/A Total real estate 1,503 1,335 1,479 1,215 682 Consumer: Auto 548 N/A N/A N/A N/A Non-Auto 375 N/A N/A N/A N/A Total Consumer 923 927 1,550 1,517 1,925 Total charge-offs 5,314 4,126 4,447 5,821 9,816 Recoveries: Commercial: C&I 1,315 N/A N/A N/A N/A Municipal - N/A N/A N/A N/A Total Commercial 1,315 1,364 839 942 952 Agricultural 31 158 15 33 25 Real estate: Construction & Development - N/A N/A N/A N/A Farm 157 N/A N/A N/A N/A Non-Owner Occupied CRE 131 N/A N/A N/A N/A Owner Occupied CRE 17 N/A N/A N/A N/A Residential real estate 151 N/A N/A N/A N/ATotal Real Estate 456 404 462 192 2,021 Consumer: Auto 269 N/A N/A N/A N/A Non-Auto 171 N/A N/A N/A N/A Total Consumer 440 532 512 501 508 Total recoveries 2,242 2,458 1,828 1,668 3,506 Net charge-offs 3,072 1,668 2,619 4,153 6,310 Provision for credit losses (excluding provision for unfunded commitment) 16,048 2,965 5,665 6,530 10,212 Balance at December 31,$ 66,534 $ 52,499 $ 51,202 $ 48,156 $ 45,779 52
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2020 2019 2018 2017 2016
Loans,
held-for-investment
at
year-end $ 5,171,033 $ 4,194,969 $ 3,953,636 $ 3,485,569 $ 3,357,307
Average loans 5,152,531 4,074,667 3,828,040 3,435,447 3,333,241
Net charge-offs/average loans 0.06 % 0.04 % 0.07 % 0.12 % 0.19 %
Allowance for credit
losses/year-end
loans
held-for-
investment 1.29 % 1.25 % 1.30 % 1.38 % 1.36 %
Allowance for credit
losses/nonaccrual, past due 90 days
still accruing and restructured
loans 155.61 212.02 176.22 259.11 161.44
Table 9 - Allocation of Allowance for Credit Losses (in thousands):
At December 31,
2020 2019 2018 2017 2016
Allocation Allocation Allocation Allocation Allocation
Amount Amount Amount Amount Amount
Commercial:
C&I $ 13,609 $ N/A $ N/A $ N/A $ N/A
Municipal 1,552 N/A N/A N/A N/A
Total Commercial 15,161 12,122 11,948 10,865 11,707
Agricultural 1,255 1,206 1,446 1,305 1,101
Real estate:
Construction & Development 13,512 N/A N/A N/A N/A
Farm 1,876 N/A N/A N/A N/A
Non-Owner
Occupied CRE 8,391 N/A N/A N/A N/A
Owner Occupied CRE 12,347 N/A N/A N/A N/A
Residential real estate 12,601 N/A N/A N/A N/A
Total Real Estate 48,727 33,974 32,342 29,896 26,864
Consumer:
Auto 1,020 N/A N/A N/A N/A
Non-Auto 371 N/A N/A N/A N/A
Total Consumer 1,391 5,197 5,466 6,090 6,107
Total $ 66,534 $ 52,499 $ 51,202 $ 48,156 $ 45,779
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Percent of Loans in Each Category of Total Loans:
2020 2019 2018 2017 2016
Commercial:
C&I 21.78 % N/A N/A N/A N/A
Municipal 3.51 % N/A N/A N/A N/A
Total Commercial 25.29 % 20.41 % 21.37 % 19.63 % 20.09 %
Agricultural 1.83 % 2.47 % 2.45 % 2.71 % 2.50 %
Real estate:
Construction & Development 10.72 % N/A N/A N/A N/A
Farm 2.94 % N/A N/A N/A N/A
Non-Owner
Occupied CRE 10.55 % N/A N/A N/A N/A
Owner Occupied CRE 14.45 % N/A N/A N/A N/A
Residential real estate 25.59 % N/A N/A N/A N/A
Total Real Estate 64.25 % 67.31 % 66.75 % 66.07 % 65.23 %
Consumer:
Auto 6.89 % N/A N/A N/A N/A
Non-Auto 1.74 % N/A N/A N/A N/A
Total Consumer 8.63 % 9.81 % 9.43 % 11.59 % 12.18 %
Total 100.00 % 100.00 % 100.00 % 100.00 % 100.00 %
Interest-Bearing Demand Deposits in Banks.
The Company had interest-bearing demand deposits in banks of $517.97 million at
December 31, 2020 and $47.92 million at December 31, 2019 , respectively. At
December 31, 2020 , our interest-bearing deposits in banks included
$517.57 million maintained at the Federal Reserve Bank of Dallas and
$403 thousand on deposit with the Federal Home Loan Bank of Dallas (FHLB). The
average balance of interest-bearing deposits in banks was $249.70 million ,
$80.81 million and $87.03 million in 2020, 2019 and 2018, respectively. The
average yield on interest-bearing deposits in banks was 0.38%, 2.22% and 1.79%
in 2020, 2019 and 2018, respectively.
Available-for-Sale
Securities
. At December 31, 2020 , securities with a fair value of $4.39 billion were
classified as securities
available-for-sale.
There were no securities classified as
held-to-maturity
at December 31, 2020 and 2019. As compared to December 31, 2019 , the
available-for-sale
portfolio at December 31, 2020 , reflected (1) a decrease of $10.02 million in
U.S. Treasury securities; (2) an increase of $1.14 billion in obligations of
states and political subdivisions; (3) a decrease of $151 thousand in corporate
bonds and other; and (4) a decrease of $148.01 million in mortgage-backed
securities. As compared to December 31, 2018 , the
available-for-sale
portfolio at December 31, 2019 , reflected (1) an increase of $57 thousand in
U.S. Treasury securities; (2) a decrease of $301 thousand in obligations of U.S.
government sponsored enterprises and agencies; (3) an increase of $31.11 million
in obligations of states and political subdivisions; (4) a decrease of
$90 thousand in corporate bonds and other; and (5) an increase of
$223.76 million in mortgage-backed securities.
Securities-available-for-sale
included fair value adjustments of $215.85 million , $84.51 million and
$5.21 million at December 31, 2020 , 2019 and 2018, respectively. Our mortgage
related securities are backed by GNMA, FNMA or FHLMC or are collateralized by
securities backed by these agencies.
See Table 10 and Note 2 to the Consolidated Financial Statements for additional
disclosures relating to the maturities and fair values of the investment
portfolio at December 31, 2020 and 2019.
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Table 10 - Maturities and Yields of
Available-for-Sale
Held at December 31, 2020 (in thousands, except percentages):
Maturing
After One Year After Five Years
One Year Through Through After
or Less Five Years Ten Years Ten Years Total
Available-for-Sale: Amount Yield Amount Yield Amount Yield Amount Yield Amount Yield
Obligations of states and political
subdivisions $ 98,345 4.71 % $
673,036 4.01 %
- - - - - - 4,557 1.86
Mortgage-backed securities 186,698 2.02 1,514,743 2.27 260,155 1.68 - - 1,961,596 2.17
Total$ 289,600 2.93 % $
2,187,779 2.81 %
All yields are computed on a tax-equivalent basis assuming a marginal tax rate of 21%. Yields on available-for-sale securities are based on amortized cost. Maturities of mortgage-backed securities are based on contractual maturities and could differ due to prepayments of underlying mortgages. Maturities of other securities are reported at the earlier of maturity date or call date. As ofDecember 31, 2020 , the investment portfolio had an overall tax equivalent yield of 2.76%, a weighted average life of 4.66 years and modified duration of 4.14 years compared toDecember 31, 2019 , the investment portfolio had an overall tax equivalent yield of 3.17%, a weighted average life of 4.18 years and modified duration of 3.74 years. Deposits . Deposits held by our subsidiary bank represent our primary source of funding. Total deposits were$8.68 billion as ofDecember 31, 2020 , as compared to$6.60 billion as ofDecember 31, 2019 and$6.18 billion as ofDecember 31, 2018 . Table 11 provides a breakdown of average deposits and rates paid over the past three years and the remaining maturity of time deposits of$100,000 or more: Table 11 - Composition of Average Deposits and Remaining Maturity of Time Deposits of$100,000 or More (in thousands, except percentages): 2020 2019 2018 Average Average Average Average Average Average Balance Rate Balance Rate Balance Rate Noninterest-bearing deposits$ 2,782,896 - %$ 2,137,089 - %$ 2,124,005 - % Interest-bearing deposits Interest-bearing checking 2,513,627 0.21
2,097,109 0.68 2,025,810 0.53
Savings and money market accounts 2,214,569 0.20 1,679,168 0.54 1,558,889 0.28
Time deposits under
195,425 0.43
186,709 0.70 204,929 0.25
Time deposits of
274,933 0.88 245,680 1.04 262,986 0.48
Total interest-bearing deposits 5,198,554 0.25 % 4,208,666 0.64 % 4,052,614 0.42 % Total average deposits$ 7,981,450 $ 6,345,755 $ 6,176,619 Total cost of deposits 0.16 % 0.42 % 0.27 % As of December 31, 2020 Three months or less $ 109,096 Over three through six months 54,915 Over six through twelve months 79,159 Over twelve months 43,142 Total time deposits of$100,000 or more $ 286,312
Borrowings.
Included in borrowings were federal funds purchased, securities sold under repurchase agreements and advances from the FHLB of$430.09 million ,$381.36 million and$468.71 million atDecember 31, 2020 , 2019 and 2018, respectively. Securities sold under repurchase agreements are generally with significant customers of the Company that require short-term liquidity for their funds for which we pledge certain securities that have a fair value equal to at least the amount of the short-term borrowing. The average balances of federal funds purchased, securities sold under repurchase agreements and advances from the FHLB were$561.51 million ,$398.14 million , 55 -------------------------------------------------------------------------------- Table of Contents and$418.98 million in 2020, 2019 and 2018, respectively. The average rates paid on federal funds purchased, securities sold under repurchase agreements and advances from the FHLB were 0.20%, 0.75% and 0.47% for the years endedDecember 31, 2020 , 2019 and 2018, respectively. The weighted average interest rate on federal funds purchased, securities sold under repurchase agreements and advances from the FHLB was 0.08%, 0.48% and 0.78% atDecember 31, 2020 , 2019 and 2018, respectively. The highest amount of federal funds purchased, securities sold under repurchase agreements and advances from the FHLB at any month-end during 2020, 2019 and 2018 was$925.42 million ,$423.67 million and$529.64 million , respectively. Capital Resources We evaluate capital resources by our ability to maintain adequate regulatory capital ratios to do business in the banking industry. Issues related to capital resources arise primarily when we are growing at an accelerated rate but not retaining a significant amount of our profits or when we experience significant asset quality deterioration. Total shareholders' equity was$1.68 billion , or 15.39% of total assets atDecember 31, 2020 , as compared to$1.23 billion , or 14.85% of total assets atDecember 31, 2019 . Included in shareholders' equity atDecember 31, 2020 and 2019 were$170.40 million and$67.51 million , respectively, in unrealized gains on investment securities available-for-sale, net of related income taxes. During 2020, total shareholders' equity averaged$1.56 billion , or 15.32% of average assets, as compared to$1.15 billion , or 14.44% of average assets during 2019. Banking regulators measure capital adequacy by means of the risk-based capital ratios and leverage ratio under the Basel III regulatory capital framework and prompt corrective action regulations. The risk-based capital rules provide for the weighting of assets and off-balance-sheet commitments and contingencies according to prescribed risk categories. Regulatory capital is then divided by risk-weighted assets to determine the risk-adjusted capital ratios. The leverage ratio is computed by dividing shareholders' equity less intangible assets by quarter-to-date average assets less intangible assets. Beginning inJanuary 2015 , under the Basel III regulatory capital framework, the implementation of the capital conservation buffer was effective for the Company starting at the 0.625% level and increasing 0.625% each year thereafter, until it reached 2.5% onJanuary 1, 2019 . The capital conservation buffer is designed to absorb losses during periods of economic stress and requires increased capital levels for the purpose of capital distributions and other payments. Failure to meet the amount of the buffer will result in restrictions on the Company's ability to make capital distributions, including divided payments and stock repurchase, and to pay discretionary bonuses to executive officers. As ofDecember 31, 2020 and 2019, we had a total risk-based capital ratio of 22.03% and 21.13%, a Tier 1 capital to risk-weighted assets ratio of 20.79% and 20.06%, a common equity Tier 1 capital to risk-weighted ratio of 20.79% and 20.06% and a Tier 1 leverage ratio of 11.86% and 12.60%, respectively. The regulatory capital ratios as ofDecember 31, 2020 and 2019 were calculated under Basel III rules. Our subsidiary bank made the election to continue to exclude accumulated other comprehensive income from capital in connection with itsMarch 31, 2015 quarterly financial filing and, in effect, to retain the accumulated other comprehensive income treatment under the prior capital rules. Interest Rate Risk . Interest rate risk results when the maturity or repricing intervals of interest-earning assets and interest-bearing liabilities are different. Our exposure to interest rate risk is managed primarily through our strategy of selecting the types and terms of interest-earning assets and interest-bearing liabilities that generate favorable earnings while limiting the potential negative effects of changes in market interest rates. We use no off-balance-sheet financial instruments to manage interest rate risk. Our subsidiary bank has an asset liability management committee that monitors interest rate risk and compliance with investment policies. The subsidiary bank utilizes an earnings simulation model as the primary quantitative tool in measuring the amount of interest rate risk associated with changing market rates. The model quantifies the effects of various interest rate scenarios on projected net interest income and net income over the next twelve months. The model measures the impact on net interest income relative to a base case scenario of hypothetical fluctuations in interest rates over the next twelve months. These simulations incorporate assumptions regarding balance sheet growth and mix, pricing and the re-pricing and maturity characteristics of the existing and projected balance sheet. 56 -------------------------------------------------------------------------------- Table of Contents As ofDecember 31, 2020 , the model simulations projected that 100 and 200 basis point increases in interest rates would result in positive variances in net interest income of 4.75% and 9.51%, respectively, relative to the current financial statement structure over the next twelve months, while a decrease in interest rates of 100 and 200 basis points would result in negative variances in net interest income of 3.46% and 5.44% relative to the current financial statement structure over the next twelve months . Our model simulation as ofDecember 31, 2020 indicates that our balance sheet is relatively asset/liability neutral. These are good faith estimates and assume that the composition of our interest sensitive assets and liabilities existing at each year-end will remain constant over the relevant twelve-month measurement period and that changes in market interest rates are instantaneous and sustained across the yield curve regardless of duration of pricing characteristics on specific assets or liabilities. Also, this analysis does not contemplate any actions that we might undertake in response to changes in market interest rates. We believe these estimates are not necessarily indicative of what actually could occur in the event of immediate interest rate increases or decreases of this magnitude. As interest-bearing assets and liabilities reprice in different time frames and proportions to market interest rate movements, various assumptions must be made based on historical relationships of these variables in reaching any conclusion. Since these correlations are based on competitive and market conditions, we anticipate that our future results will likely be different from the foregoing estimates, and such differences could be material. Should we be unable to maintain a reasonable balance of maturities and repricing of our interest-earning assets and our interest-bearing liabilities, we could be required to dispose of our assets in an unfavorable manner or pay a higher than market rate to fund our activities. Our asset liability committee oversees and monitors this risk. Liquidity Liquidity is our ability to meet cash demands as they arise. Such needs can develop from loan demand, deposit withdrawals or acquisition opportunities. Potential obligations resulting from the issuance of standby letters of credit and commitments to fund future borrowings to our loan customers are other factors affecting our liquidity needs. Many of these obligations and commitments are expected to expire without being drawn upon; therefore the total commitment amounts do not necessarily represent future cash requirements affecting our liquidity position. The potential need for liquidity arising from these types of financial instruments is represented by the contractual notional amount of the instrument, as detailed in Tables 12 and 13. Asset liquidity is provided by cash and assets which are readily marketable or which will mature in the near future. Liquid assets include cash, federal funds sold, and short-term investments in time deposits in banks. Liquidity is also provided by access to funding sources, which include core depositors and correspondent banks that maintain accounts with and sell federal funds to our subsidiary bank. Other sources of funds include our ability to borrow from short-term sources, such as purchasing federal funds from correspondent banks, sales of securities under agreements to repurchase and advances from the FHLB, which amounted to$430.09 million atDecember 31, 2020 , and an unfunded$25.00 million revolving line of credit established withFrost Bank , a nonaffiliated bank, which matures onJune 30, 2021 (see next paragraph). Our subsidiary bank also has federal funds purchased lines of credit with two non-affiliated banks totaling$130.00 million . AtDecember 31, 2020 , there were no amounts drawn on these lines of credit. Our subsidiary bank also has (i) an available line of credit with the FHLB totaling$1.53 billion atDecember 31, 2020 , secured by portions of our loan portfolio and certain investment securities and (ii) access to theFederal Reserve Bank of Dallas lending program. AtDecember 31, 2020 , the Company did not have any balances outstanding under this line of credit. The Company renewed its loan agreement, effectiveJune 30, 2019 , withFrost Bank . Under the loan agreement, as renewed and amended, we are permitted to draw up to$25.00 million on a revolving line of credit. Prior toJune 30, 2021 , interest is paid quarterly atThe Wall Street Journal Prime Rate and the line of credit maturesJune 30, 2021 . If a balance exists atJune 30, 2021 , the principal balance converts to a term facility payable quarterly over five years and interest is paid quarterly atThe Wall Street Journal Prime Rate. The line of credit is unsecured. Among other provisions in the credit agreement, we must satisfy certain financial covenants during the term of the loan agreement, including, without limitation, covenants that require us to maintain certain capital, tangible net worth, loan loss reserve, non-performing asset and cash flow coverage ratios. In addition, the credit agreement contains certain operational covenants, which among others, restricts the payment of dividends above 55% of consolidated net income, limits the incurrence of debt (excluding any amounts acquired in an acquisition) and 57 -------------------------------------------------------------------------------- Table of Contents prohibits the disposal of assets except in the ordinary course of business. Since 1995, we have historically declared dividends as a percentage of our consolidated net income in a range of 37% (low) in 1995 to 53% (high) in 2003 and 2006. The Company was in compliance with the financial and operational covenants atDecember 31, 2020 . There was no outstanding balance under the line of credit as ofDecember 31, 2020 or 2019. In addition, we anticipate that any future acquisition of financial institutions, expansion of branch locations or offering of new products could also place a demand on our cash resources. Available cash and cash equivalents at the Company, which totaled$136.67 million atDecember 31, 2020 , investment securities which totaled$2.61 million atDecember 31, 2020 with maturities over 9 to 10 years, available dividends from our subsidiaries which totaled$289.68 million atDecember 31, 2020 , utilization of available lines of credit, and future debt or equity offerings are expected to be the source of funding for these potential acquisitions or expansions. Given the strong core deposit base and relatively low loan to deposit ratios maintained at our subsidiary bank, we consider our current liquidity position to be adequate to meet our short-term and long-term liquidity needs. Table 12 - Contractual Obligations as ofDecember 31, 2020 (in thousands):
Payment Due by Period
More than 1 More than 3
Less than 1 year but less years but less Over 5
Total Amounts year than 3 years than 5 years years
Deposits with stated maturity dates $ 475,425 $ 391,638 $ 64,495 $ 19,267 $ 25
Operating leases 2,577 1,094 870 535 78
Outsourcing service contracts 15,278 7,469 6,002 1,807 -
Total Contractual Obligations
Amounts above for deposits do not include related accrued interest. The above
table also does not include balances related to the Company's interest rate
locks commitments ("IRLCs") and forward mortgage-backed security trades.
Off-Balance
Sheet/Reserve for Unfunded Commitments.
We are a party to financial instruments with OBS risk in the normal course of
business to meet the financing needs of our customers. These financial
instruments include unfunded lines of credit, commitments to extend credit and
federal funds sold to correspondent banks and standby letters of credit. Those
instruments involve, to varying degrees, elements of credit and interest rate
risk in excess of the amount recognized in the consolidated balance sheets. At
December 31, 2020 , the Company's reserve for unfunded commitments totaled
$5.49 million which is recorded in other liabilities.
Our exposure to credit loss in the event of nonperformance by the counterparty
to the financial instrument for unfunded lines of credit, commitments to extend
credit and standby letters of credit is represented by the contractual notional
amount of these instruments. We generally use the same credit policies in making
commitments and conditional obligations as we do for
on-balance-sheet
instruments.
Unfunded lines of credit and commitments to extend credit are agreements to lend
to a customer as long as there is no violation of any condition established in
the contract. These commitments generally have fixed expiration dates or other
termination clauses and may require payment of a fee. Since many of the
commitments are expected to expire without being drawn upon, the total
commitment amounts do not necessarily represent future cash requirements. We
evaluate each customer's creditworthiness on a
case-by-case
basis. The amount of collateral obtained, as we deem necessary upon extension of
credit, is based on our credit evaluation of the counterparty. Collateral held
varies but may include accounts receivable, inventory, property, plant, and
equipment and income-producing commercial properties.
Standby letters of credit are conditional commitments we issue to guarantee the
performance of a customer to a third party. The credit risk involved in issuing
letters of credit is essentially the same as that involved in extending loan
facilities to customers. The average collateral value held on letters of credit
usually exceeds the contract amount.
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Table 13 - Commitments as of December 31, 2020 (in thousands):
Total Notional More than 1 More than 3
Amounts Less than 1 year but less years but less Over 5
Committed year than 3 years than 5 years years Unfunded lines of credit
$ 871,960 $ 608,972
742,538 426,108 42,010 51,757 222,663
Standby letters of credit 40,050 36,849 3,166 5 30
Total Commercial Commitments $ 1,654,548 $ 1,071,929 $ 197,768 $ 72,608 $ 312,243
We believe we have no other OBS arrangements or transactions with
unconsolidated, special purpose entities that would expose us to liability that
is not reflected on the face of the financial statements. The above table also
does not include balances related to the Company's IRLCs and forward
mortgage-backed security trades.
Parent Company Funding
. Our ability to fund various operating expenses, dividends, and cash
acquisitions is generally dependent on our own earnings (without giving effect
to our subsidiaries), cash reserves and funds derived from our subsidiaries.
These funds historically have been produced by intercompany dividends and
management fees that are limited to reimbursement of actual expenses. We
anticipate that our recurring cash sources will continue to include dividends
and management fees from our subsidiaries. At December 31, 2020 , $289.68 million
was available for the payment of intercompany dividends by our subsidiaries
without the prior approval of regulatory agencies. Our subsidiaries paid
aggregate dividends to us of $87.50 million in 2020 and $84.50 million in 2019.
Dividends
. Our long-term dividend policy is to pay cash dividends to our shareholders of
approximately 35% to 40% of annual net earnings while maintaining adequate
capital to support growth. We are also restricted by a loan covenant within our
line of credit agreement with Frost Bank to dividend no greater than 55% of net
income, as defined in such loan agreement. The cash dividend payout ratios have
amounted to 35.88%, 38.31% and 36.84% of net earnings, respectively, in 2020,
2019 and 2018. Given our current capital position, projected earnings and asset
growth rates, we do not anticipate any significant change in our current
dividend policy.
Our bank subsidiary, which is a national banking association and a member of the
Federal Reserve System , is required by federal law to obtain the prior approval
of the OCC to declare and pay dividends if the total of all dividends declared
in any calendar year would exceed the total of (1) such bank's net profits (as
defined and interpreted by regulation) for that year plus (2) its retained net
profits (as defined and interpreted by regulation) for the preceding two
calendar years, less any required transfers to surplus.
To pay dividends, we and our subsidiary bank must maintain adequate capital
above regulatory guidelines. In addition, if the applicable regulatory authority
believes that a bank under its jurisdiction is engaged in or is about to engage
in an unsafe or unsound practice (which, depending on the financial condition of
the bank, could include the payment of dividends), the authority may require,
after notice and hearing, that such bank cease and desist from the unsafe
practice. The Federal Reserve Board , the FDIC and the OCC have each indicated
that paying dividends that deplete a bank's capital base to an inadequate level
would be an unsafe and unsound banking practice. The Federal Reserve , the OCC
and the FDIC have issued policy statements that recommend that bank holding
companies and insured banks should generally only pay dividends out of current
operating earnings.
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