Quarterly Report Pursuant to Section13 or 15(d) of the Securities Exchange Act of 1934.
For the quarterly period ended September 30, 2021.
or
☐
Transition Report Pursuant to Section13 or 15(d) of the Securities Exchange Act of 1934.
For the transition period fromto.
Commission file number 001-35854
Independent Bank Group, Inc.
(Exact name of registrant as specified in its charter)
Texas
13-4219346
(State or other jurisdiction of incorporation or organization)
(I.R.S. Employer Identification No.)
7777 Henneman Way
McKinney,
Texas
75070-1711
(Address of principal executive offices)
(Zip Code)
(972)562-9004
(Registrant’s telephone number, including area code)
Not applicable
(Former name, former address and former fiscal year, if changed since last report)
Securities registered pursuant to Section 12(b) of the Act:
Title of Each Class
Trading Symbol(s)
Name of Exchange on Which Registered
Common Stock, par value $0.01 per share
IBTX
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 such shorter periods 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 and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted 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 and post such files). Yes☒No☐
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See 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
☐
(Do not check if a smaller reporting company)
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 pursuant to Section 13(a) of the Exchange Act. ☐
Indicate by a check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes☐No☒
Applicable Only to Corporate Issuers
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practical date.
Common Stock, Par Value $0.01 Per Share –42,936,460 shares as of October 26, 2021.
Notes to Consolidated Financial Statements (unaudited)
(Dollars in thousands, except for share and per share information)
Note 1. Summary of Significant Accounting Policies
Nature of operations: Independent Bank Group, Inc. (IBG) through its subsidiary, Independent Bank, a Texas state banking corporation, doing business as Independent Financial, (Bank) (collectively known as the Company), provides a full range of banking services to individual and corporate customers in the North, Central and Southeast, Texas areas and along the Colorado Front Range, through its various branch locations in those areas. The Company is engaged in traditional community banking activities, which include commercial and retail lending, deposit gathering, investment and liquidity management activities. The Company’s primary deposit products are demand deposits, money market accounts and certificates of deposit and its primary lending products are commercial business and real estate, real estate mortgage and consumer loans.
Basis of presentation: The accompanying consolidated financial statements include the accounts of IBG and all other entities in which IBG has controlling financial interest. All material intercompany transactions and balances have been eliminated in consolidation. In addition, the Company wholly-owns nine statutory business trusts that were formed for the purpose of issuing trust preferred securities and do not meet the criteria for consolidation.
The consolidated interim financial statements are unaudited, but include all adjustments, which, in the opinion of management, are necessary for a fair presentation of the results of the periods presented. All such adjustments were of a normal and recurring nature. These financial statements should be read in conjunction with the financial statements and the notes thereto in the Company's Annual Report on Form 10-K for the year ended December 31, 2020. The consolidated balance sheet at December 31, 2020 has been derived from the audited financial statements as of that date, but does not include all of the information and footnotes required by accounting principles generally accepted in the United States of America for complete financial statements.
Accounting standards codification: The Financial Accounting Standards Board's (FASB) Accounting Standards Codification (ASC) is the officially recognized source of authoritative U.S. generally accepted accounting principles (GAAP) applicable to all public and non-public non-governmental entities. Rules and interpretive releases of the SEC under the authority of federal securities laws are also sources of authoritative GAAP for SEC registrants. All other accounting literature is considered non-authoritative. Citing particular content in the ASC involves specifying the unique numeric path to the content through the Topic, Subtopic, Section and Paragraph structure.
Segment reporting: The Company has one reportable segment. The Company’s chief operating decision-maker uses consolidated results to make operating and strategic decisions.
Reclassifications: Certain prior period financial statement and disclosure amounts have been reclassified to conform to current period presentation. The reclassifications have no effect on net income or stockholders' equity as previously reported.
Use of estimates: The preparation of financial statements in conformity with U.S. generally accepted accounting principles requires management to make estimates and assumptions that affect certain reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. Accordingly, actual results could differ from those estimates. The material estimates included in the financial statements relate to the allowance for credit losses, the valuation of goodwill and valuation of assets and liabilities acquired in business combinations.
Notes to Consolidated Financial Statements (unaudited)
(Dollars in thousands, except for share and per share information)
Accounting changes: On January 1, 2020,ASU 2016-13, Financial Instruments - Credit Losses (Topic 326) (ASC 326): Measurement of Credit Losses on Financial Instruments (ASU 2016-13), as amended,became effective for the Company.ASU 2016-13 replaces the incurred loss methodology 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 credit exposures not accounted for as insurance (loan commitments, standby letters of credit, financial guarantees, and other similar instruments). The CECL model requires the measurement of all expected credit losses on applicable financial assets based on historical experience, current conditions, and reasonable and supportable forecasts. In addition, ASU 2016-13 includes certain changes to the accounting for available-for-sale securities such as requiring credit-related impairments to be recognized as an allowance for credit losses rather than as a direct write-down of the securities amortized cost basis when management does not intend to sell or believes that it is more likely than not they will be required to sell securities prior to recovery of the securities amortized cost basis.
On March 27, 2020, the Coronavirus Aid, Relief, and Economic Security Act (CARES Act) was signed by the President of the United States that included an option for financial institutions to delay the implementation of ASU 2016-13 until the earlier of the termination date of the national emergency declaration by the President or December 31, 2020. On December 27, 2020, the Consolidated Appropriations Act, 2021 (Act 2021), was signed into law which further extended the implementation date of CECL to the earlier of the first day of the entity’s fiscal year that begins after the date on which the COVID-19 national emergency terminates or January 1, 2022. Under this option, the Company elected to delay implementation of ASU 2016-13 and calculated and recorded its provision for loan losses under the incurred loss model that existed prior to ASU 2016-13 for the year ended December 31, 2020. With regard to Act 2021 amendments, the SEC staff indicated it would not object to a registrant early adopting on December 31, 2020, retrospective to January 1, 2020, or January 1, 2021, effective as of January 1, 2021. Under this guidance, the Company elected to adopt ASU 2016-13 with an effective implementation date of January 1, 2021.
The Company adopted ASU 2016-13 using the modified retrospective method for all financial assets measured at amortized cost and off-balance sheet credit exposures. As a result of this adoption, the Company recognized a cumulative effect reduction to retained earnings totaling $53,880, net of a recorded deferred tax asset of $15,113, and reclassed $13,035 of allowance for credit loss related to financial assets purchased with credit deterioration (PCD) that were previously classified as purchased credit impaired (PCI) and accounted for under ASC 310-30 as discussed below. Results for periods beginning after January 1, 2021 are presented in accordance with ASU 2016-13 while prior period amounts continue to be reported in accordance with previously applicable GAAP.
The Company adopted ASU 2016-13 using the prospective transition approach for PCD assets. In accordance with the standard, management did not reassess whether PCI assets met the criteria of PCD assets as of the date of adoption. On January 1, 2021, the amortized cost basis of the PCD assets were adjusted to reflect the addition of the allowance for credit losses. The remaining noncredit discount (based on the adjusted amortized cost basis) will be accreted into interest income at the effective interest rate as of January 1, 2021.
Notes to Consolidated Financial Statements (unaudited)
(Dollars in thousands, except for share and per share information)
The following table illustrates the impact of ASU 2016-13 on the allowances for credit losses as of January 1, 2021, the date of adoption:
January 1, 2021
Pre-Adoption Allowance
Impact of Adoption
Post-Adoption Allowance
Assets:
Allowance for credit losses on Loans:
Commercial
$
27,311
$
17,103
$
44,414
Commercial real estate, construction, land and land development
50,123
59,683
109,806
Residential real estate
6,786
(2,115)
4,671
Single-family interim construction
2,156
7,179
9,335
Agricultural
337
(178)
159
Consumer
442
(110)
332
Other
242
(224)
18
Unallocated
423
(423)
—
$
87,820
$
80,915
$
168,735
Liabilities:
Allowance for credit losses on off-balance-sheet credit exposures
$
—
$
1,113
$
1,113
In connection with the adoption of ASC 326, the Company revised certain accounting policies and implemented certain accounting policy elections. The revised accounting policies are described below.
Securities: Securities classified as available for sale are those debt securities that the Company intends to hold for an indefinite period of time, but not necessarily to maturity. Any decision to sell a security classified as available for sale would be based on various factors, including significant movements in interest rates, changes in the maturity mix of the Company's assets and liabilities, liquidity needs, regulatory capital considerations and other similar factors.
Securities available for sale are reported at fair value with unrealized gains or losses reported as a separate component of other comprehensive income, net of tax. The amortization of premiums and accretion of discounts, computed by the interest method generally over their contractual lives, are recognized in interest income. Premiums on callable securities are amortized to their earliest call date. Realized gains or losses, determined on the basis of the cost of specific securities sold, are included in earnings on the trade date.
Allowance for credit losses - available-for-sale securities: For available-for-sale securities in an unrealized loss position, the Company first assesses whether it intends to sell or it is more-likely-than-not that we will be required to sell the securities before recovery of the amortized cost basis. If either of these criteria is met, the securities amortized cost basis is written down to fair value as a current period expense. If either of the above criteria is not met, the Company evaluates whether the decline in fair value is the result of credit losses or other factors. In making this assessment, management may consider various factors including the extent to which fair value is less than amortized cost, performance of any underlying collateral and adverse conditions specifically related to the security, among other factors. If this assessment indicates that a credit loss exists, the present value of cash flows expected to be collected are compared to the amortized cost basis of the security and any excess of the amortized cost basis over the present value of expected cash flows is recorded as an allowance for credit loss, limited to the amount by which the fair value is less than the amortized cost basis. Any impairment not recorded through an allowance for credit loss is recognized in other comprehensive income as a non credit-related impairment.
Notes to Consolidated Financial Statements (unaudited)
(Dollars in thousands, except for share and per share information)
Management has made a policy election to exclude accrued interest receivable on available-for-sale securities from the estimate of credit losses and report accrued interest separately in other assets in the consolidated balance sheets. Changes in the allowance for credit losses are recorded as provision for (or reversal of) credit losses. Available-for-sale securities are charged-off against the allowance or, in the absence of any allowance, written down through income when deemed uncollectible by management or when either of the aforementioned criteria regarding intent or requirement to sell is met.
Acquired loans: Loans acquired in connection with a business combination are recorded at their acquisition-date fair value. The allowance for credit losses related to the acquired loan portfolio is not carried over. Acquired loans are classified into two categories based on the credit risk characteristics of the underlying borrowers as either purchased credit deteriorated (PCD) loans, or loans with no evidence of credit deterioration (non-PCD).
PCD loans are defined as a loan or pool of loans that have experienced more-than-insignificant credit deterioration since the origination date. For PCD loans, an initial allowance is established on the acquisition date using the same methodology as other loans held for investment and combined with the fair value of the loan to arrive at acquisition date amortized cost. Accordingly, no provision for credit losses is recognized on PCD loans at the acquisition date. Subsequent to the acquisition date, changes to the allowance are recognized in the provision for credit losses.
Non-PCD loans are pooled into segments together with originated held for investment loans that share similar risk characteristics and have an allowance established on the acquisition date, which is recognized in the current period provision for credit losses.
Determining the fair value of the acquired loans involves estimating the principal and interest payment cash flows expected to be collected on the loans and discounting those cash flows at a market rate of interest. For PCD loans, the non-credit discount or premium is allocated to individual loans as determined by the difference between the loan’s unpaid principal balance and amortized cost basis. The non-credit premium or discount is recognized into interest income on a level yield basis over the remaining expected life of the loan. For non-PCD loans, the fair value discount or premium is allocated to individual loans and recognized into interest income on a level yield basis over the remaining expected life of the loan.
Prior to January 1, 2021, loans acquired in a business combination that had evidence of credit impairment and for which it was probable, at acquisition, that the Company would be unable to collect all contractually required payments receivable were considered PCI. PCI loans were accounted for individually or aggregated into pools of loans based on common risk characteristics such as credit grade, loan type, and date of origination.
Loans, net: Loans that management has the intent and ability to hold for the foreseeable future or until maturity or pay-off are reported at their outstanding principal balance, net of unearned interest, purchase premiums and discounts, deferred loan fees or costs and an allowance for credit losses. Loan origination fees, net of direct origination costs, are deferred and recognized as an adjustment to the related loan yield using the effective interest method without anticipating prepayments. Further information regarding the Company's accounting policies related to past due loans, non-accrual loans, collateral dependent loans and troubled debt restructurings is presented in Note 4 - Loans, Net and Allowance for Credit Losses on Loans.
Allowance for credit losses on loans: In accordance with ASC 326, the allowance for credit losses on loans is a valuation account that is deducted from the amortized cost basis of loans to present management's best estimate of the net amount expected to be collected on the loans. Loans are charged against the allowance for credit losses when management believes that collectability of the principal is unlikely. Subsequent recoveries, if any, are credited to the allowance. The allowance is increased (decreased) by provisions (or reversals of) reported in the income statement as a component of provision for credit losses. Management has made the accounting policy election to exclude accrued interest receivable on loans from the estimate of credit losses and reports accrued interest separately in other assets in the consolidated balance sheets. Further information regarding Company policies and methodology used to estimate the allowance for credit losses on loans is presented in Note 4 - Loans, Net and Allowance for Credit Losses on Loans.
Notes to Consolidated Financial Statements (unaudited)
(Dollars in thousands, except for share and per share information)
Allowance for credit losses on off-balance-sheet credit exposures: The allowance for credit losses on off-balance-sheet credit exposures is a liability account, calculated in accordance with ASC 326, representing expected credit losses over the contractual period for which the Company is exposed to credit risk resulting from a contractual obligation to extend credit. No allowance is recognized if we have the unconditional right to cancel the obligation. The allowance is reported as a component of other liabilities in the consolidated balance sheets. Adjustments to the allowance are reported in the income statement as a component of provision for credit losses. Further information regarding Company policies and methodology used to estimate the allowance for credit losses on off-balance-sheet credit exposures is presented in Note 6 - Off-Balance Sheet Arrangements, Commitments and Contingencies.
Subsequent events: Companies are required to evaluate events and transactions that occur after the balance sheet date but before the date the financial statements are issued. They must recognize in the financial statements the effect of all events or transactions that provide additional evidence of conditions that existed at the balance sheet date, including the estimates inherent in the financial statement preparation process. Entities shall not recognize the impact of events or transactions that provide evidence about conditions that did not exist at the balance sheet date but arose after that date. The Company has evaluated subsequent events through the date of filing these financial statements with the Securities and Exchange Commission (SEC) and noted no subsequent events requiring financial statement recognition or disclosure, except as disclosed in Note 12.
Earnings per share: Basic earnings per common share is calculated as net income available to common shareholders divided by the weighted average number of common shares outstanding during the period. The unvested share-based payment awards that contain rights to nonforfeitable dividends are considered participating securities for this calculation. Diluted earnings per common share includes the dilutive effect of additional potential common shares issuable under participating nonvested restricted stock awards as well as performance stock units (PSUs). The participating nonvested restricted stock awards were not included in dilutive shares as they were anti-dilutive for the three and nine months ended September 30, 2021 and for the three months ended September 30, 2020. Proceeds from the assumed exercise of dilutive participating nonvested restricted stock awards and PSUs are assumed to be used to repurchase common stock at the average market price.
The following table presents a reconciliation of net income available to common shareholders and the number of shares used in the calculation of basic and diluted earnings per common share:
Three Months Ended September 30,
Nine Months Ended September 30,
2021
2020
2021
2020
Basic earnings per share:
Net income
$
52,340
$
60,075
$
170,563
$
142,935
Less:
Undistributed earnings allocated to participating securities
Notes to Consolidated Financial Statements (unaudited)
(Dollars in thousands, except for share and per share information)
Note 2. Statement of Cash Flows
As allowed by the accounting standards, the Company has chosen to report, on a net basis, its cash receipts and cash payments for time deposits accepted and repayments of those deposits, and loans made to customers and principal collections on those loans. The Company uses the indirect method to present cash flows from operating activities. Other supplemental cash flow information is presented below:
Nine Months Ended September 30,
2021
2020
Cash transactions:
Interest expense paid
$
54,209
$
80,462
Income taxes paid
$
44,833
$
35,538
Noncash transactions:
Deferred dividend equivalents
$
156
$
—
Transfers of loans to other real estate owned
$
—
$
5,239
Loans to facilitate the sale of other real estate owned
$
—
$
1,564
Securities purchased, not yet settled
$
25,667
$
17,782
Right-of-use assets obtained in exchange for lease liabilities
Notes to Consolidated Financial Statements (unaudited)
(Dollars in thousands, except for share and per share information)
Note 3. Securities Available for Sale
Securities available for sale have been classified in the consolidated balance sheets according to management’s intent. The amortized cost of securities and their approximate fair values at September 30, 2021 and December 31, 2020 are as follows:
Amortized
Cost (1)
Gross Unrealized Gains
Gross Unrealized Losses
Fair Value
Securities Available for Sale
September 30, 2021
U.S. treasuries
$
61,116
$
1,210
$
(41)
$
62,285
Government agency securities
463,613
2,254
(4,618)
461,249
Obligations of state and municipal subdivisions
386,333
17,401
(346)
403,388
Corporate bonds
29,992
957
(42)
30,907
Mortgage-backed securities guaranteed by FHLMC, FNMA and GNMA
811,763
15,153
(4,246)
822,670
Other securities
1,075
—
—
1,075
$
1,753,892
$
36,975
$
(9,293)
$
1,781,574
December 31, 2020
U.S. treasuries
$
43,060
$
1,648
$
—
$
44,708
Government agency securities
247,764
3,169
(1,916)
249,017
Obligations of state and municipal subdivisions
373,017
20,168
(20)
393,165
Corporate bonds
21,496
608
(2)
22,102
Mortgage-backed securities guaranteed by FHLMC, FNMA and GNMA
421,916
21,678
(93)
443,501
Other securities
1,200
—
—
1,200
$
1,108,453
$
47,271
$
(2,031)
$
1,153,693
____________
(1) Excludes accrued interest receivable of $6,480 and $6,242 at September 30, 2021 and December 31, 2020, respectively, that is recorded in other assets on the accompanying consolidated balance sheets.
Securities with a carrying amount of approximately $945,512 and $738,519 at September 30, 2021 and December 31, 2020, respectively, were pledged primarily to secure deposits.
Proceeds from sale of securities available for sale and gross gains and gross losses for the three and nine months ended September 30, 2021 and 2020 were as follows:
Notes to Consolidated Financial Statements (unaudited)
(Dollars in thousands, except for share and per share information)
The amortized cost and estimated fair value of securities available for sale at September 30, 2021, by contractual maturity, are shown below. Maturities of mortgage-backed securities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
September 30, 2021
Securities Available for Sale
Amortized Cost (1)
Fair Value
Due in one year or less
$
32,464
$
32,782
Due from one year to five years
131,110
136,335
Due from five to ten years
419,558
423,908
Thereafter
358,997
365,879
942,129
958,904
Mortgage-backed securities guaranteed by FHLMC, FNMA and GNMA
811,763
822,670
$
1,753,892
$
1,781,574
____________
(1)Excludes accrued interest receivable of $6,480 at September 30, 2021 that is recorded in other assets on the accompanying consolidated balance sheets.
The number of securities, unrealized losses and fair value, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, as of September 30, 2021 and December 31, 2020, are summarized as follows:
Less Than 12 Months
Greater Than 12 Months
Total
Description of Securities
Number of Securities
Estimated Fair Value
Unrealized Losses
Number of Securities
Estimated Fair Value
Unrealized Losses
Estimated Fair Value
Unrealized Losses
Securities Available for Sale
September 30, 2021
U.S. treasuries
1
$
10,316
$
(41)
—
$
—
$
—
$
10,316
$
(41)
Government agency securities
35
235,996
(3,045)
11
58,413
(1,573)
294,409
(4,618)
Obligations of state and municipal subdivisions
10
35,951
(331)
1
1,008
(15)
36,959
(346)
Corporate bonds
2
4,458
(42)
—
—
—
4,458
(42)
Mortgage-backed securities guaranteed by FHLMC, FNMA and GNMA
59
324,855
(4,081)
1
4,778
(165)
329,633
(4,246)
107
$
611,576
$
(7,540)
13
$
64,199
$
(1,753)
$
675,775
$
(9,293)
December 31, 2020
Government agency securities
20
$
112,897
$
(1,916)
—
$
—
$
—
$
112,897
$
(1,916)
Obligations of state and municipal subdivisions
2
3,786
(20)
—
—
—
3,786
(20)
Corporate bonds
1
998
(2)
—
—
—
998
(2)
Mortgage-backed securities guaranteed by FHLMC, FNMA and GNMA
Notes to Consolidated Financial Statements (unaudited)
(Dollars in thousands, except for share and per share information)
At September 30, 2021, management's review of all available for sale securities at an unrealized loss position determined that the losses resulted from factors not related to credit quality. This conclusion is based on management's analysis of the underlying risk characteristics, including credit ratings, and other qualitative factors for each security type in our portfolio. The unrealized losses are generally due to increases in market interest rates. Furthermore, the Company has the intent to hold these securities until maturity or a forecasted recovery, and it is more likely than not that the Company will not have to sell the securities before the recovery of their cost basis. As such, there is no allowance for credit losses on available for sale securities recognized as of September 30, 2021.
Note 4. Loans, Net and Allowance for Credit Losses on Loans
Loans, net, at September 30, 2021 and December 31, 2020, consisted of the following:
September 30,
December 31,
2021
2020
Commercial
$
2,999,980
$
3,902,496
Real estate:
Commercial
6,414,199
6,096,676
Commercial construction, land and land development
1,216,195
1,245,801
Residential
1,296,871
1,352,465
Single-family interim construction
350,112
326,575
Agricultural
82,278
85,014
Consumer
81,879
67,068
Total loans (1)(2)
12,441,514
13,076,095
Deferred loan fees, net(1)
—
(10,037)
Allowance for credit losses
(150,281)
(87,820)
Total loans, net(2)
$
12,291,233
$
12,978,238
____________
(1) Loan class amounts are shown at amortized cost, net of deferred loan fees of $11,336, in accordance with ASC 326 at September 30, 2021 and shown at recorded investment at December 31, 2020.
(2) Excludes accrued interest receivable of $44,953 and $54,328 at September 30, 2021 and December 31, 2020, respectively, that is recorded in other assets on the accompanying consolidated balance sheets.
Loans with carrying amounts of $6,842,932 and $6,743,350 at September 30, 2021 and December 31, 2020, respectively, were pledged to secure Federal Home Loan Bank borrowing capacity and Federal Reserve Bank discount window borrowing capacity.
The Company has certain lending policies and procedures in place that are designed to maximize loan income within an acceptable level of risk. Management reviews and approves these policies and procedures on a regular basis. A reporting system supplements the review process by providing management with frequent reports related to loan production, loan quality, concentrations of credit, loan delinquencies and nonperforming and potential problem loans.
Notes to Consolidated Financial Statements (unaudited)
(Dollars in thousands, except for share and per share information)
Commercial loans are underwritten after evaluating and understanding the borrower’s ability to operate profitably and prudently expand its business. The Company’s management examines 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. These cash flows, however, may not be as expected and the value of collateral securing the loans may fluctuate. Most commercial loans are secured by the assets being financed or other business assets such as accounts receivable or inventory and may incorporate a personal guarantee; however, some short term loans may be made on an unsecured basis. Additionally, our commercial loan portfolio includes loans made to customers in the energy industry, which is a complex, technical and cyclical industry. Experienced bankers with specialized energy lending experience originate our energy loans. Companies in this industry produce, extract, develop, exploit and explore for oil and natural gas. Loans are primarily collateralized with proven producing oil and gas reserves based on a technical evaluation of these reserves. At September 30, 2021 and December 31, 2020, there were approximately $280,277 and $205,496, of energy related loans outstanding, respectively. The Company has a mortgage warehouse purchase program providing mortgage inventory financing for residential mortgage loans originated by mortgage banker clients across a broad geographic scale. Proceeds from the sale of mortgages are the primary source of repayment for warehouse inventory financing via approved investor takeout commitments. These loans typically have a very short duration ranging between a few days to 15 days. In some cases, loans to larger mortgage originators may be financed for up to 60 days. These loans are reported as commercial loans since the loans are secured by notes receivable, not real estate. As of September 30, 2021 and December 31, 2020, mortgage warehouse purchase loans outstanding totaled $977,800 and $1,453,797, respectively.
With the passage of the CARES Act Paycheck Protection Program (PPP), administered by the Small Business Administration (SBA), the Company has participated in originating loans to its customers through the program. PPP loans have terms of two to five years and earn interest at 1%. In return for processing and funding loans, the SBA paid the lenders a processing fee tiered by the size of the loan. At September 30, 2021 and December 31, 2020, there were approximately $243,919 and $804,397 in PPP loans outstanding included in the commercial loan portfolio, respectively. In addition, the Company has recorded net deferred fees associated with PPP loans of $6,521 and $9,770 as of September 30, 2021 and December 31, 2020, respectively. Based on published program guidelines, these loans funded through the PPP are fully guaranteed by the U.S. government. Management believes that the majority of these loans will ultimately be forgiven by the SBA in accordance with the terms of the program with any remaining balances, after the forgiveness of any amounts, still fully guaranteed by the SBA.
Commercial real estate loans are subject to underwriting standards and processes similar to commercial loans. These loans are viewed primarily as cash flow loans and secondarily as loans secured by real estate. Commercial real estate lending typically involves higher loan principal amounts, and the repayment of these loans is generally largely dependent on the successful operation of the property or the business conducted on the property securing the loan. Commercial 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 commercial real estate portfolio are diverse in terms of type and geographic location. Management monitors the diversification of the portfolio on a quarterly basis by type and geographic location. Management also tracks the level of owner occupied property versus non-owner occupied property. At September 30, 2021, the portfolio consisted of approximately 27% of owner occupied property.
Land and commercial land development loans are underwritten using feasibility studies, independent appraisal reviews and financial analysis of the developers or property owners. Generally, borrowers must have a proven track record of success. Commercial construction loans are generally based upon estimates of cost and value of the completed project. These estimates may not be accurate. Commercial construction loans often involve the disbursement of substantial funds with the repayment dependent on the success of the ultimate project. Sources of repayment for these loans may be pre-committed permanent financing or sale of the developed property. The loans in this portfolio are geographically diverse and due to the increased risk are monitored closely by management and the board of directors on a quarterly basis.
Residential real estate and single-family interim construction loans are underwritten primarily based on borrowers’ credit scores, documented income and minimum collateral values. Relatively small loan amounts are spread across many individual borrowers, which minimizes risk in the residential portfolio. In addition, management evaluates trends in past dues and current economic factors on a regular basis.
Notes to Consolidated Financial Statements (unaudited)
(Dollars in thousands, except for share and per share information)
Agricultural loans are collateralized by real estate and/or agricultural-related assets. Agricultural real estate loans are primarily comprised of loans for the purchase of farmland. Loan-to-value ratios on loans secured by farmland generally do not exceed 80% and have amortization periods limited to twenty years. Agricultural non-real estate loans are generally comprised of term loans to fund the purchase of equipment, livestock and seasonal operating lines to grain farmers to plant and harvest corn and soybeans. Specific underwriting standards have been established for agricultural-related loans including the establishment of projections for each operating year based on industry developed estimates of farm input costs and expected commodity yields and prices. Operating lines are typically written for one year and secured by the crop and other farm assets as considered necessary.
Agricultural loans carry significant credit risks as they involve larger balances concentrated with single borrowers or groups of related borrowers. In addition, repayment of such loans depends on the successful operation or management of the farm property securing the loan or for which an operating loan is utilized. Farming operations may be affected by adverse weather conditions such as drought, hail or floods that can severely limit crop yields.
Consumer loans represent less than 1% of the outstanding total loan portfolio. Collateral consists primarily of automobiles and other personal assets. Credit score analysis is used to supplement the underwriting process.
Most of the Company’s lending activity occurs within the State of Texas, primarily in the north, central and southeast Texas regions and the State of Colorado, specifically along the Front Range area. As of September 30, 2021, loans in the Colorado region represented about 24% of the total portfolio. A large percentage of the Company’s portfolio consists of commercial and residential real estate loans. As of September 30, 2021 and December 31, 2020, there were no concentrations of loans related to a single industry in excess of 10% of total loans.
On January 1, 2021, the Company adopted ASU 2016-13, Financial Instruments - Credit Losses (Topic 326) (ASC 326). Under ASC 326, the allowance for credit losses is a valuation account that is deducted from the amortized cost basis of loans to present the net amount expected to be collected on the loans. Loans, or portions thereof, are charged off against the allowance when they are deemed uncollectible. Expected recoveries do not exceed the aggregate of amounts previously charged-off and expected to be charged-off. The amount of the allowance represents management's best estimate of current expected credit losses on loans considering available information relevant to assessing collectibility over the loans' contractual terms, adjusted for expected prepayments when appropriate. The contractual term excludes expected extensions, renewals and modifications unless either of the following applies: management has a reasonable expectation that a troubled debt restructuring will be executed with an individual borrower, or the extension or renewal options are included in the borrower contract and are not unconditionally cancellable by the Company.
The Company's allowance balance is estimated using relevant available information, from internal and external sources, relating to past events, current conditions and reasonable and supportable forecasts. Historical credit loss experience provides the basis for the estimation of expected credit losses. Adjustments to historical loss information are made for differences in current loan-specific risk characteristics such as differences in underwriting standards, portfolio mix, credit quality, or term as well as for changes in environmental conditions, such as changes in unemployment rates, gross domestic product, property values or other relevant factors. The Company utilizes Moody’s Analytics economic forecast scenarios and assigns probability weighting to those scenarios which best reflect management’s views on the economic forecast.
Management continually evaluates the allowance for credit losses based upon the factors noted above. Should any of the factors considered by management change, the Company’s estimate of credit losses could also change and would affect the level of future provision for credit losses. Portions of the allowance may be allocated for specific credits; however, the entire allowance is available for any credit that, in management’s judgment, should be charged off. While the calculation of the allowance for credit losses utilizes management’s best judgment and all the information available, the adequacy of the allowance for credit losses is dependent on a variety of factors beyond the Company’s control, including, among other things, the performance of the entire loan portfolio, the economy, changes in interest rates and the view of regulatory authorities towards loan classifications.
Notes to Consolidated Financial Statements (unaudited)
(Dollars in thousands, except for share and per share information)
The allowance for credit losses is measured on a collective basis for portfolios of loans when similar risk characteristics exist. Loans that do not share risk characteristics are evaluated for expected credit losses on an individual basis and excluded from the collective evaluation. For determining the appropriate allowance for credit losses on a collective basis, the loan portfolio is segmented into pools based upon similar risk characteristics and a lifetime loss-rate model is utilized. For modeling purposes, loan pools include: commercial and industrial, energy, commercial real estate - construction/land development, commercial real estate - owner occupied, commercial real estate - non-owner occupied, agricultural, residential real estate, HELOCs, single-family interim construction, and consumer. Management periodically reassesses each pool to ensure the loans within the pool continue to share similar characteristics and risk profiles and to determine whether further segmentation is necessary. The measurement of expected credit losses is impacted by loan/borrower attributes and certain macroeconomic variables. Management has determined that they are reasonably able to forecast the macroeconomic variables used in the modeling processes with an acceptable degree of confidence for a total of two years then encompassing a reversion process whereby the forecasted macroeconomic variables are reverted to their historical mean utilizing a rational, systematic basis. Management qualitatively adjusts model results for risk factors that are not considered within the modeling processes but are nonetheless relevant in assessing the expected credit losses within the loan pools. These qualitative factor (Q-Factor) adjustments may increase or decrease management's estimate of expected credit losses by a calculated percentage or amount based upon the estimated level of risk.
Loans exhibiting unique risk characteristics and requiring an individual allowance are generally identified at the servicing officer level based on review of weekly past due reports and/or the loan officer’s communication with borrowers. In addition, the status of past due loans are routinely discussed within each lending region as well as credit committee meetings to determine if classification is warranted. The Company’s internal loan review department has implemented an internal risk-based loan review process to identify potential internally classified loans that supplements the independent external loan review. External loan reviews cover a wide range of the loan portfolio, including large lending relationships, specifically targeted loan types, and if applicable recently acquired loan portfolios. As such, the external loan review generally covers loans exceeding $3,000. These reviews include analysis of borrower’s financial condition, payment histories, review of loan documentation and collateral values to determine if a loan should be internally classified. Generally, once classified, an analysis is completed by the credit department to determine the amount of allocated allowance for credit loss required. Expected credit losses for collateral dependent loans, including loans where the borrower is experiencing financial difficulty but foreclosure is not probable, are based on the fair value of the collateral at the reporting date, adjusted for selling costs as appropriate.
Prior to the adoption of ASU 2016-13, the allowance for credit losses on loans was a contra-asset valuation account established through a provision for loan losses charged to expense, which represented management’s best estimate of inherent losses that had been incurred within the existing portfolio of loans. The allowance for credit losses on loans included allowance allocations calculated in accordance with ASC Topic 310, Receivables, and allowance allocations calculated in accordance with ASC Topic 450, Contingencies.
Following unprecedented declines caused by the pandemic and volatile energy prices, the Texas economy, specifically in the Company’s lending areas of north, central and southeast Texas economy continued to expand at a solid pace into the third quarter of 2021, though surging COVID-19 cases added uncertainty to outlooks. The Colorado economy grew at a moderate pace. The stronger sectors of the economy of late include manufacturing, transportation, nonfinancial services and residential real estate, while other sectors of the economy where growth slowed were those constrained by supply disruptions and labor shortages. Energy activity and agricultural conditions improved further. Activity in the single-family housing market moderated during the reporting period and sales were mostly solid but not as abundant as earlier in the year, partly due to seasonality. Overall, the economy is being impacted by the surging Delta variant, persistent labor and supply shortages, and rising costs, which are expected to dampen the recovery. Previous forecasts for a strong return of business travel and events this fall have been adjusted downward by the pandemic resurgence. The pandemic crisis has been impactful and the timing and magnitude of recovery cannot be predicted. The risk of loss associated with all segments of the portfolio could increase due to these factors.
Notes to Consolidated Financial Statements (unaudited)
(Dollars in thousands, except for share and per share information)
The economy and other risk factors are minimized by the Company’s underwriting standards, which include the following principles: 1) financial strength of the borrower including strong earnings, high net worth, significant liquidity and acceptable debt to worth ratio, 2) managerial business competence, 3) ability to repay, 4) loan to value, 5) projected cash flow and 6) guarantor financial statements, as applicable.
The following is a summary of the activity in the allowance for credit losses on loans by class for the three and nine months ended September 30, 2021 and 2020:
Commercial
Commercial Real Estate
Commercial Construction, Land and Land Development
Residential Real Estate
Single-Family Interim Construction
Agricultural
Consumer
Unallocated
Total
Three months ended September 30, 2021
Balance at beginning of period
$
46,957
$
67,696
$
27,842
$
3,638
$
8,129
$
86
$
443
$
—
$
154,791
Provision for credit losses
2,190
(6,212)
915
(1,293)
(66)
(18)
73
—
(4,411)
Charge-offs
(78)
—
—
—
—
—
(48)
—
(126)
Recoveries
17
—
—
—
—
—
10
—
27
Balance at end of period
$
49,086
$
61,484
$
28,757
$
2,345
$
8,063
$
68
$
478
$
—
$
150,281
Nine months ended September 30, 2021
Balance at beginning of period
$
27,311
$
36,698
$
13,425
$
6,786
$
2,156
$
337
$
684
$
423
$
87,820
Impact of adopting ASC 326
12,775
29,108
22,008
(2,255)
7,179
(178)
(334)
(423)
67,880
Initial allowance on loans purchased with credit deterioration
4,328
7,640
927
140
—
—
—
—
13,035
Provision for credit losses
8,466
(11,587)
(7,477)
(2,326)
(1,272)
(91)
256
—
(14,031)
Charge-offs
(3,832)
(375)
(126)
—
—
—
(173)
—
(4,506)
Recoveries
38
—
—
—
—
—
45
—
83
Balance at end of period
$
49,086
$
61,484
$
28,757
$
2,345
$
8,063
$
68
$
478
$
—
$
150,281
Three months ended September 30, 2020
Balance at beginning of period
$
25,498
$
32,944
$
12,932
$
5,911
$
1,998
$
379
$
431
$
(38)
$
80,055
Provision for credit losses
476
5,205
624
532
(152)
(31)
211
755
7,620
Charge-offs
(117)
—
—
—
—
—
(106)
—
(223)
Recoveries
16
4
—
—
—
—
19
—
39
Balance at end of period
$
25,873
$
38,153
$
13,556
$
6,443
$
1,846
$
348
$
555
$
717
$
87,491
Nine months ended September 30, 2020
Balance at beginning of period
$
12,844
$
24,371
$
8,714
$
3,678
$
1,606
$
332
$
231
$
(315)
$
51,461
Provision for credit losses
15,111
14,513
4,842
2,765
322
16
521
1,032
39,122
Charge-offs
(2,170)
(735)
—
—
(82)
—
(306)
—
(3,293)
Recoveries
88
4
—
—
—
—
109
—
201
Balance at end of period
$
25,873
$
38,153
$
13,556
$
6,443
$
1,846
$
348
$
555
$
717
$
87,491
The Company will charge-off that portion of any loan which management considers a loss. Commercial and real estate loans are generally considered for charge-off when exposure beyond collateral coverage is apparent and when no further collection of the loss portion is anticipated based on the borrower’s financial condition.
Notes to Consolidated Financial Statements (unaudited)
(Dollars in thousands, except for share and per share information)
The following table presents loans that were evaluated for expected credit losses on an individual basis and the related specific credit loss allocations, by loan class as of September 30, 2021 and December 31, 2020:
September 30, 2021
December 31, 2020
Loan Balance - Amortized Cost Basis
Specific Allocations
Loan Balance - Recorded Investment
Specific Allocations
Commercial
$
43,038
$
19,365
$
39,298
$
8,281
Commercial real estate
40,235
1,955
21,848
243
Commercial construction, land and land development
1,365
581
32
—
Residential real estate
—
—
2,550
—
Single-family Interim construction
—
—
—
—
Agricultural
—
—
613
—
Consumer
—
—
42
—
$
84,638
$
21,901
$
64,383
$
8,524
Nonperforming loans by loan class at September 30, 2021 (at amortized cost) and December 31, 2020 (at recorded investment), are summarized as follows:
Commercial
Commercial Real Estate
Commercial Construction, Land and Land Development
Residential Real Estate
Single-Family Interim Construction
Agricultural
Consumer
Total
September 30, 2021
Nonaccrual loans (1)
$
44,712
$
34,291
$
25
$
1,460
$
—
$
—
$
43
$
80,531
Loans past due 90 days and still accruing
77
—
—
201
—
—
2
280
Troubled debt restructurings (not included in nonaccrual or loans past due and still accruing)
—
1,738
—
165
—
—
—
1,903
$
44,789
$
36,029
$
25
$
1,826
$
—
$
—
$
45
$
82,714
December 31, 2020 (2)
Nonaccrual loans
$
25,898
$
20,040
$
32
$
2,372
$
—
$
613
$
42
$
48,997
Loans past due 90 days and still accruing
433
—
—
—
—
—
—
433
Troubled debt restructurings (not included in nonaccrual or loans past due and still accruing)
—
1,808
—
178
—
—
—
1,986
$
26,331
$
21,848
$
32
$
2,550
$
—
$
613
$
42
$
51,416
____________
(1) There are $552 in loans on nonaccrual without an allowance for credit loss as of September 30, 2021. Additionally, no interest income was recognized on nonaccrual loans. No significant amounts of accrued interest was reversed during the three and nine months ended September 30, 2021.
(2) Excluded loans acquired with deteriorated credit quality under prior GAAP.
Notes to Consolidated Financial Statements (unaudited)
(Dollars in thousands, except for share and per share information)
The accrual of interest is discontinued on a loan when management believes that, after considering collection efforts and other factors, the borrower's financial condition is such that collection of interest is doubtful, as well as when required by regulatory provisions. Regulatory provisions would typically require the placement of a loan on non-accrual status if 1) principal or interest has been in default for a period of 90 days or more unless the loan is both well secured and in the process of collection or 2) full payment of principal and interest is not expected. All interest accrued but not collected for loans that are placed on nonaccrual status or charged-off is reversed against interest income. Cash collections on nonaccrual loans are generally credited to the loan receivable balance, and no interest income is recognized on those loans until the principal balance has been collected. Loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured.
The restructuring of a loan is considered a “troubled debt restructuring” (TDR) if both 1) the borrower is experiencing financial difficulties and 2) the creditor has granted a concession. Concessions may include interest rate reductions or below market interest rates, principal forgiveness, extending amortization and other actions intended to minimize potential losses. Modifications primarily relate to extending the amortization periods of the loans and interest rate concessions. The modifications during the reported periods did not materially impact the Company’s determination of the allowance for credit losses. The amortized cost basis and recorded investment in troubled debt restructurings, including those on nonaccrual, was $2,971 and $2,564 as of September 30, 2021 and December 31, 2020, respectively.
Following is a summary of loans modified under troubled debt restructurings during the three and nine months ended September 30, 2021 and 2020:
Commercial
Commercial Real Estate
Commercial Construction, Land and Land Development
Residential Real Estate
Single-Family Interim Construction
Agricultural
Consumer
Total
Troubled debt restructurings during the three months ended September 30, 2021
Number of contracts
—
—
—
—
—
—
—
—
Pre-restructuring outstanding recorded investment
$
—
$
—
$
—
$
—
$
—
$
—
$
—
$
—
Post-restructuring outstanding recorded investment
$
—
$
—
$
—
$
—
$
—
$
—
$
—
$
—
Troubled debt restructurings during the nine months ended September 30, 2021
Number of contracts
2
—
—
—
—
—
1
3
Pre-restructuring outstanding recorded investment
$
1,789
$
—
$
—
$
—
$
—
$
—
$
6
$
1,795
Post-restructuring outstanding recorded investment
$
570
$
—
$
—
$
—
$
—
$
—
$
6
$
576
Troubled debt restructurings during the three months ended September 30, 2020
Number of contracts
—
—
—
—
—
—
—
—
Pre-restructuring outstanding recorded investment
$
—
$
—
$
—
$
—
$
—
$
—
$
—
$
—
Post-restructuring outstanding recorded investment
$
—
$
—
$
—
$
—
$
—
$
—
$
—
$
—
Troubled debt restructurings during the nine months ended September 30, 2020
Number of contracts
—
1
—
—
—
—
—
1
Pre-restructuring outstanding recorded investment
$
—
$
1,517
$
—
$
—
$
—
$
—
$
—
$
1,517
Post-restructuring outstanding recorded investment
Notes to Consolidated Financial Statements (unaudited)
(Dollars in thousands, except for share and per share information)
At September 30, 2021 and 2020, there were no loans modified under troubled debt restructurings during the previous twelve month period that subsequently defaulted during the three and nine months ended September 30, 2021 and 2020, respectively.
At September 30, 2021 and 2020, the Company had no commitments to lend additional funds to any borrowers with loans whose terms have been modified under troubled debt restructurings.
Under ASC Subtopic 310-40 and federal banking agencies interagency guidance, certain short-term loan modifications made on a good faith basis in response to COVID-19 (as defined by the guidance) are not considered TDRs. Additionally, under section 4013 of the CARES Act, and as amended, banks may elect to suspend the requirement for certain loan modifications to be categorized as a TDR. In response to the COVID-19 pandemic, the Company has implemented prudent modifications allowing for primarily short-term payment deferrals or other payment relief to borrowers with pandemic-related economic hardships, where appropriate, that complies with the above guidance. As such, the Company's TDR loans noted above do not include loans that are modifications to borrowers impacted by COVID-19. As of September 30, 2021, the amount of loans remaining in COVID-19 related deferment was not significant.
Notes to Consolidated Financial Statements (unaudited)
(Dollars in thousands, except for share and per share information)
Loans are considered past due if the required principal and interest payments have not been received as of the date such payments were due.The following table presents information regarding the aging of past due loans by loan class as of September 30, 2021 (at amortized cost) and as of December 31, 2020 (at recorded investment):
Loans 30-89 Days Past Due
Loans 90 Days or More Past Due
Total Past Due Loans
Current Loans
Total Loans
September 30, 2021
Commercial
$
704
$
31,792
$
32,496
$
2,967,484
$
2,999,980
Commercial real estate
19,706
16,540
36,246
6,377,953
6,414,199
Commercial construction, land and land development
868
—
868
1,215,327
1,216,195
Residential real estate
2,267
529
2,796
1,294,075
1,296,871
Single-family interim construction
269
—
269
349,843
350,112
Agricultural
595
—
595
81,683
82,278
Consumer
99
40
139
81,740
81,879
$
24,508
$
48,901
$
73,409
$
12,368,105
$
12,441,514
December 31, 2020 (1)
Commercial
$
3,243
$
13,227
$
16,470
$
3,846,810
$
3,863,280
Commercial real estate
2,434
16,790
19,224
5,921,723
5,940,947
Commercial construction, land and land development
19
—
19
1,230,524
1,230,543
Residential real estate
5,169
1,028
6,197
1,341,587
1,347,784
Single-family interim construction
—
—
—
326,575
326,575
Agricultural
—
1
1
84,896
84,897
Consumer
86
41
127
67,156
67,283
10,951
31,087
42,038
12,819,271
12,861,309
Acquired with deteriorated credit quality
624
3,219
3,843
210,943
214,786
$
11,575
$
34,306
$
45,881
$
13,030,214
$
13,076,095
____________
(1) Presented under prior GAAP.
The Company’s internal classified report is segregated into the following categories: 1) Pass/Watch, 2) Special Mention, 3) Substandard and 4) Doubtful. The loans placed in the Pass/Watch category reflect the Company’s opinion that the loans reflect potential weakness that requires monitoring on a more frequent basis. The loans in the Special Mention category reflect the Company’s opinion that the credit contains weaknesses which represent a greater degree of risk and warrant extra attention. These loans are reviewed monthly by officers and senior management to determine if a change in category is warranted. The loans placed in the Substandard category are considered to be potentially inadequately protected by the current debt service capacity of the borrower and/or the pledged collateral. These credits, even if apparently protected by collateral value, have shown weakness related to adverse financial, managerial, economic, market or political conditions, which may jeopardize repayment of principal and interest and may be considered impaired. There is a possibility that some future loss could be sustained by the Company if such weakness is not corrected. The Doubtful category includes loans that are in default or principal exposure is probable and the possibility of loss is extremely high.
Notes to Consolidated Financial Statements (unaudited)
(Dollars in thousands, except for share and per share information)
Management considers the guidance in ASC 310-20 when determining whether a modification, extension or renewal of a loan constitutes a current period origination. Generally, current period renewals of credit are re-underwritten at the point of renewal and considered current period originations for purposes of the table below. The following summarizes the amortized cost basis of loans by year of origination/renewal and credit quality indicator by class of loan as of September 30, 2021:
Revolving Loans Converted to Term Loans
Term Loans by Year of Origination or Renewal
Revolving Loans
September 30, 2021
2021
2020
2019
2018
2017
Prior
Total
Commercial
Pass
$
500,792
$
205,018
$
127,779
$
102,993
$
107,046
$
173,621
$
1,589,766
$
4,971
$
2,811,986
Pass/Watch
405
3,171
761
14,267
10,224
7,398
26,533
3,538
66,297
Special Mention
1,852
1,404
11,620
767
4,371
15
3,684
—
23,713
Substandard
16,647
3,110
35,195
5,927
3,512
7,073
16,620
3
88,087
Doubtful
—
—
—
—
—
—
9,897
—
9,897
Total commercial
$
519,696
$
212,703
$
175,355
$
123,954
$
125,153
$
188,107
$
1,646,500
$
8,512
$
2,999,980
Commercial real estate
Pass
$
1,481,214
$
1,278,477
$
885,209
$
706,642
$
585,905
$
724,951
$
63,240
$
1,299
$
5,726,937
Pass/Watch
63,129
25,453
63,473
79,563
19,205
86,177
452
1,358
338,810
Special Mention
24,537
29,042
40,808
69,181
41,044
40,794
—
—
245,406
Substandard
24,042
31,148
2,338
11,910
1,571
30,968
1,069
—
103,046
Doubtful
—
—
—
—
—
—
—
—
—
Total commercial real estate
$
1,592,922
$
1,364,120
$
991,828
$
867,296
$
647,725
$
882,890
$
64,761
$
2,657
$
6,414,199
Commercial construction, land and land development
Pass
$
484,572
$
292,360
$
207,346
$
108,119
$
21,627
$
16,240
$
12,655
$
—
$
1,142,919
Pass/Watch
19,886
1,472
6,104
4,280
—
87
—
—
31,829
Special Mention
—
9,000
—
—
1,928
—
—
—
10,928
Substandard
15,379
—
417
12,741
29
1,953
—
—
30,519
Doubtful
—
—
—
—
—
—
—
—
—
Total commercial construction, land and land development
Notes to Consolidated Financial Statements (unaudited)
(Dollars in thousands, except for share and per share information)
Note 5. Other Borrowings
Other borrowings totaled $281,697 and $312,175 at September 30, 2021 and December 31, 2020, respectively.
On July 20, 2021, the Company redeemed $40,000 of its outstanding 5.75% fixed-to-floating rate subordinated debentures due July 20, 2026.
There were $15,500 borrowings outstanding as of September 30, 2021 and $6,500 as of December 31, 2020 against the Company's revolving line of credit with an unrelated commercial bank.
Note 6. Off-Balance Sheet Arrangements, Commitments and Contingencies
Financial Instruments with Off-Balance Sheet Risk
The Company is a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers. The commitments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the balance sheet.
The Company’s exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit is represented by the contractual amount of this instrument. The Company uses the same credit policies in making commitments and conditional obligations as it does for on-balance sheet instruments.
At September 30, 2021 and December 31, 2020, the approximate amounts of these financial instruments were as follows:
September 30,
December 31,
2021
2020
Commitments to extend credit
$
2,717,859
$
2,268,216
Standby letters of credit
31,160
25,917
$
2,749,019
$
2,294,133
Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The Company evaluates each customer’s credit worthiness on a case-by-case basis. The amount of collateral obtained if deemed necessary by the Company upon extension of credit is based on management’s credit evaluation of the counterparty. Collateral held varies but may include accounts receivable, inventory, farm crops, property, plant and equipment and income-producing commercial properties.
Letters of credit are written conditional commitments used by the Company to guarantee the performance of a customer to a third party. The Company’s policies generally require that letter of credit arrangements contain security and debt covenants similar to those contained in loan arrangements. In the event the customer does not perform in accordance with the terms of the agreement with the third party, the Company would be required to fund the commitment. The maximum potential amount of future payments the Company could be required to make is represented by the contractual amount shown in the table above. If the commitment is funded, the Company would be entitled to seek recovery from the customer.
Notes to Consolidated Financial Statements (unaudited)
(Dollars in thousands, except for share and per share information)
Allowance For Credit Losses on Off-Balance Sheet Credit Exposures
The allowance for credit losses on off-balance-sheet credit exposures is calculated under ASC 326, representing expected credit losses over the contractual period for which the Company is exposed to credit risk resulting from a contractual obligation to extend credit. Off-balance sheet credit exposures primarily consist of amounts available under outstanding lines of credit and letters of credit detailed in the table above. The allowance for credit losses on off-balance sheet credit exposures is estimated by loan segment at each balance sheet date using the same methodologies as portfolio loans, taking into consideration the likelihood that funding will occur based on historical utilization rates. The allowance is included in other liabilities on the Company’s consolidated balance sheets.
The allowance for credit losses on off-balance sheet commitments were as follows:
Three Months Ended September 30,
Nine Months Ended September 30,
2021
2020
2021
2020
Balance at beginning of period
$
1,733
$
—
$
—
$
—
Impact of CECL adoption
—
—
1,113
—
Provision for off-balance sheet credit exposure
4,411
—
5,031
—
Balance at end of period
$
6,144
$
—
$
6,144
$
—
Litigation
The Company is involved in certain legal actions arising from normal business activities. Management believes that the outcome of such proceedings will not materially affect the financial position, results of operations or cash flows of the Company. A legal proceeding that the Company believes could become material is described below.
The Bank is a party to a legal proceeding inherited in connection with its acquisition of BOH Holdings, Inc. and its subsidiary, Bank of Houston (BOH). The plaintiffs in the case are alleging that the Bank aided and abetted or participated in a fraudulent scheme. The Bank is pursuing insurance coverage for these claims, including reimbursement for defense costs. The Company believes the claims made in this lawsuit are without merit and is vigorously defending the lawsuit. The Company is unable to predict when the matter will be resolved, the ultimate outcome or potential costs or damages to be incurred.
Note 7. Income Taxes
Income tax expense for the three and nine months ended September 30, 2021 and 2020 was as follows:
Three Months Ended September 30,
Nine Months Ended September 30,
2021
2020
2021
2020
Income tax expense for the period
$
12,629
$
16,068
$
43,841
$
35,807
Effective tax rate
19.4
%
21.1
%
20.4
%
20.0
%
The effective tax rates for 2021 and 2020 differ from the statutory federal tax rate of 21% largely due to tax exempt interest income earned on certain investment securities and loans, the nontaxable earnings on bank owned life insurance, nondeductible compensation, acquisition-related expenses, and state income tax. The lower effective tax rate for the three months ended September 30, 2021 was primarily a result of the prior year provision to return adjustment and current period adjustments related to state income taxes.
Notes to Consolidated Financial Statements (unaudited)
(Dollars in thousands, except for share and per share information)
Note 8. Fair Value Measurements
The fair value of an asset or liability is the price that would be received to sell that asset or paid to transfer that liability in an orderly transaction occurring in the principal market (or most advantageous market in the absence of a principal market) for such asset or liability. In estimating fair value, the Company utilizes 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 include the assumptions that market participants would use in pricing an asset or liability. ASC Topic 820, Fair Value Measurements and Disclosures, establishes a fair value hierarchy for valuation inputs that gives the highest priority to quoted prices in active markets for identical assets or liabilities and the lowest priority to unobservable inputs. The fair value hierarchy is as follows:
Level 1 Inputs – Unadjusted quoted prices in active markets for identical assets or liabilities that the reporting entity has the ability to access at the measurement date.
Level 2 Inputs – Inputs other than quoted prices included in Level 1 that are observable for the asset or liability, either directly or indirectly. These might include quoted prices for similar assets or liabilities in active markets, quoted prices for identical or similar assets or liabilities in markets that are not active, inputs other than quoted prices that are observable for the asset or liability (such as interest rates, volatilities, prepayment speeds, credit risks, etc.) or inputs that are derived principally from or corroborated by market data by correlation or other means.
Level 3 Inputs – Unobservable inputs for determining the fair values of assets or liabilities that reflect an entity’s own assumptions about the assumptions that market participants would use in pricing the assets or liabilities.
The Company elected the fair value option for certain residential mortgage loans held for sale in accordance with ASC 825, Financial Instruments. This election allows for a more effective offset of the changes in fair values of the loans and the derivative instruments used to economically hedge them without the burden of complying with the requirements for hedge accounting under ASC 815, Derivatives and Hedging. The Company has not elected the fair value option for other residential mortgage loans held for sale primarily because they are not economically hedged using derivative instruments. See below and Note 9, Derivative Financial Instruments, for additional information.
Notes to Consolidated Financial Statements (unaudited)
(Dollars in thousands, except for share and per share information)
Assets and Liabilities Measured on a Recurring Basis
The following table represents assets and liabilities reported on the consolidated balance sheets at their fair value on a recurring basis as of September 30, 2021 and December 31, 2020 by level within the ASC Topic 820 fair value measurement hierarchy:
Fair Value Measurements at Reporting Date Using
Assets/ Liabilities Measured at Fair Value
Quoted Prices in Active Markets for Identical Assets (Level 1)
Significant Other Observable Inputs (Level 2)
Significant Unobservable Inputs (Level 3)
September 30, 2021
Assets:
Investment securities available for sale:
U.S. treasuries
$
62,285
$
—
$
62,285
$
—
Government agency securities
461,249
—
461,249
—
Obligations of state and municipal subdivisions
403,388
—
403,388
—
Corporate bonds
30,907
—
30,907
—
Mortgage-backed securities guaranteed by FHLMC, FNMA and GNMA
822,670
—
822,670
—
Other securities
1,075
—
1,075
—
Loans held for sale, fair value option elected (1)
27,331
—
27,331
—
Derivative financial instruments:
Interest rate swaps - cash flow hedge
140
—
140
—
Interest rate lock commitments
1,566
—
1,566
—
Forward mortgage-backed securities trades
132
—
132
—
Loan customer counterparty
9,631
—
9,631
—
Financial institution counterparty
595
—
595
—
Liabilities:
Derivative financial instruments:
Interest rate swaps - cash flow hedge
210
—
210
—
Interest rate lock commitments
2
—
2
—
Forward mortgage-backed securities trades
44
—
44
—
Loan customer counterparty
577
—
577
—
Financial institution counterparty
10,064
—
10,064
—
December 31, 2020
Assets:
Investment securities available for sale:
U.S. treasuries
$
44,708
$
—
$
44,708
$
—
Government agency securities
249,017
—
249,017
—
Obligations of state and municipal subdivisions
393,165
—
393,165
—
Corporate bonds
22,102
—
22,102
—
Mortgage-backed securities guaranteed by FHLMC, FNMA and GNMA
443,501
—
443,501
—
Other securities
1,200
—
1,200
—
Loans held for sale, fair value option elected (1)
71,769
—
71,769
—
Derivative financial instruments:
Interest rate lock commitments
3,515
—
3,515
—
Loan customer counterparty
20,159
—
20,159
—
Liabilities:
Derivative financial instruments:
Forward mortgage-backed securities trades
568
—
568
—
Financial institution counterparty
21,306
—
21,306
—
__________
(1) At September 30, 2021 and December 31, 2020, loans held for sale for which the fair value option was elected had an aggregate outstanding principal balance of $26,244 and $68,670, respectively. There were no mortgage loans held for sale under the fair value option that were 90 days or greater past due or on nonaccrual at September 30, 2021.
Notes to Consolidated Financial Statements (unaudited)
(Dollars in thousands, except for share and per share information)
A description of the valuation methodologies used for instruments measured at fair value, as well as the general classification of such instruments pursuant to the valuation hierarchy, is set forth below.
Investment securities
Securities classified as available for sale are reported at fair value utilizing Level 1 and Level 2 inputs. Securities are classified within Level 1 when quoted market prices are available in an active market. Inputs include securities that have quoted prices in active markets for identical assets. For securities utilizing Level 2 inputs, 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 and other yield curves, live trading levels, trade execution data, market consensus prepayment speeds, credit information and the security’s terms and conditions, among other things.
Loans held for sale
Certain mortgage loans held for sale are measured at fair value on a recurring basis due to the Company's election to adopt fair value accounting treatment for those loans originated for which the Company has entered into certain derivative financial instruments as part of its mortgage banking and related risk management activities. These instruments include interest rate lock commitments and mandatory forward commitments to sell these loans to investors known as forward mortgage-backed securities trades. This election allows for a more effective offset of the changes in fair values of the assets and the mortgage related derivative instruments used to economically hedge them without the burden of complying with the requirements for hedge accounting under ASC 815, Derivatives and Hedging. Mortgage loans held for sale, for which the fair value option was elected, which are sold on a servicing released basis, are valued using a market approach by utilizing either: (i) the fair value of securities backed by similar mortgage loans, adjusted for certain factors to approximate the fair value of a whole mortgage loan, including the value attributable to mortgage servicing and credit risk, (ii) current commitments to purchase loans or (iii) recent observable market trades for similar loans, adjusted to credit risk and other individual loan characteristics. As these prices are derived from market observable inputs, the Company classifies these valuations as Level 2 in the fair value disclosures. For mortgage loans held for sale for which the fair value option was elected, the earned current contractual interest payment is recognized in interest income, loan origination costs and fees on fair value option loans are recognized in earnings as incurred and not deferred. The Company has no continuing involvement in any residential mortgage loans sold.
Derivatives
The Company utilizes interest rate swaps to hedge exposure to interest rate risk and variability of cash flows associated to changes in the underlying interest rate of the hedged item. These hedging interest rate swaps are classified as a cash flow hedge. The Company utilizes a third-party vendor for derivative valuation purposes. These vendors determine the appropriate fair value based on a net present value calculation of the cash flows related to the interest rate swaps using primarily observable market inputs such as interest rate yield curves (Level 2 inputs).
The estimated fair values of interest rate lock commitments utilize current secondary market prices for underlying loans and estimated servicing value with similar coupons, maturity and credit quality, subject to the anticipated loan funding probability (pull-through rate). The fair value of interest rate lock commitments is subject to change primarily due to changes in interest rates and the estimated pull-through rate. These commitments are classified as Level 2 in the fair value disclosures, as the valuations are based on observable market inputs.
Forward mortgage-backed securities trades are exchange-traded or traded within highly active dealer markets. In order to determine the fair value of these instruments, the Company utilized the exchange price or dealer market price for the particular derivative contract; therefore these contracts are classified as Level 2. The estimated fair values are subject to change primarily due to changes in interest rates.
The Company also enters into certain interest rate derivative positions that are not designated as hedging instruments. The estimated fair value of these commercial loan interest rate swaps are obtained from a pricing service that provides the swaps' unwind value (Level 2 inputs).See Note 9, Derivative Financial Instruments, for more information.
Notes to Consolidated Financial Statements (unaudited)
(Dollars in thousands, except for share and per share information)
Assets and Liabilities Measured on a Nonrecurring Basis
In accordance with ASC Topic 820, certain assets and liabilities are measured at fair value on a nonrecurring basis; that is, the assets and liabilities are not measured at fair value on an ongoing basis but are subject to fair value adjustments in certain circumstances (for example, when there is evidence of impairment).The following table presents the assets carried on the consolidated balance sheet by caption and by level in the fair value hierarchy at September 30, 2021 and December 31, 2020, for which a nonrecurring change in fair value has been recorded:
Fair Value Measurements at Reporting Date Using
Assets Measured at Fair Value
Quoted Prices in Active Markets for Identical Assets (Level 1)
Significant Other Observable Inputs (Level 2)
Significant Unobservable Inputs (Level 3)
Period Ended Total Losses
September 30, 2021
Assets:
Individually evaluated loans
$
18,883
$
—
$
—
$
18,883
$
3,813
December 31, 2020
Assets:
Individually evaluated loans
$
16,903
$
—
$
—
$
16,903
$
13,041
Individually evaluated loans, which are collateral dependent, are measured at an observable market price (if available) or at the fair value of the loan’s underlying collateral. Fair value of the loan’s collateral is determined by appraisals or independent valuation, which is then adjusted for the estimated costs related to liquidation of the collateral. Management’s ongoing review of appraisal information may result in additional discounts or adjustments to valuation based upon more recent market sales activity or more current appraisal information derived from properties of similar type and/or locale. In addition, management's discounting criteria may vary for loans secured by non-real estate collateral such as inventory, oil and gas reserves, accounts receivable, equipment or other business assets. Therefore, the Company has categorized its individually evaluated loans as Level 3.
Other real estate owned is measured at fair value on a nonrecurring basis (upon initial recognition or subsequent impairment). Other real estate is classified within Level 3 of the valuation hierarchy. When transferred from the loan portfolio, other real estate owned is adjusted to fair value less estimated selling costs and is subsequently carried at the lower of carrying value or fair value less estimated selling costs. The fair value is determined using an external appraisal process, discounted based on internal criteria. Therefore, the Company has categorized its other real estate as Level 3. There was no other real estate owned remeasured during the nine months ended September 30, 2021 and the year ended December 31, 2020.
In addition, mortgage loans held for sale not recorded under the fair value option are required to be measured at the lower of cost or fair value. The fair value of these loans is based upon binding quotes or bids from third party investors. As of September 30, 2021 and December 31, 2020, all mortgage loans held for sale not recorded under the fair value option were recorded at cost.
Notes to Consolidated Financial Statements (unaudited)
(Dollars in thousands, except for share and per share information)
Fair Value of Financial Instruments not Recorded at Fair Value
The carrying amount, estimated fair value and the level of the fair value hierarchy of the Company’s financial instruments that are reported at amortized cost on the Company's consolidated balance sheets were as follows at September 30, 2021 and December 31, 2020:
Fair Value Measurements at Reporting Date Using
Carrying Amount
Estimated Fair Value
Quoted Prices in Active Markets for Identical Assets (Level 1)
Notes to Consolidated Financial Statements (unaudited)
(Dollars in thousands, except for share and per share information)
The methods and assumptions used by the Company in estimating fair values of financial instruments as disclosed herein in accordance with ASC Topic 825, Financial Instruments, other than for those measured at fair value on a recurring and nonrecurring basis discussed above, are as follows:
Cash and cash equivalents: The carrying amounts of cash and cash equivalents approximate their fair value.
Certificates of deposit held in other banks:The fair value of certificates of deposit held in other banks is based upon current market rates.
Loans held for sale, at cost:The fair value of loans held for sale is determined based upon commitments on hand from investors.
Loans:A discounted cash flow model is used to estimate the fair value of the loans. The discounted cash flow approach models the credit losses directly in the projected cash flows, applying various assumptions regarding credit, interest and prepayment risks for the loans based on loan types, payment types and fixed or variable classifications.
Federal Home Loan Bank of Dallas and other restricted stock: The carrying value of restricted securities such as stock in the Federal Home Loan Bank of Dallas and Independent Bankers Financial Corporation approximates fair value.
Deposits: The fair values disclosed for demand deposits are, by definition, equal to the amount payable on demand at the reporting date (that is their carrying amounts). The carrying amounts of variable-rate certificates of deposit (CDs) approximate their fair values at the reporting date. Fair values for fixed-rate CDs are estimated using a discounted cash flow calculation that applies interest rates currently being offered on certificates to a schedule of aggregated expected monthly maturities on time deposits.
Federal Home Loan Bank advances, line of credit and federal funds purchased: The fair value of advances maturing within 90 days approximates carrying value. Fair value of other advances is based on the Company’s current borrowing rate for similar arrangements.
Other borrowings: The estimated fair value approximates carrying value for short-term borrowings. The fair value of private subordinated debentures are based upon prevailing rates on similar debt in the market place. The subordinated debentures that are publicly traded are valued based on indicative bid prices based upon market pricing observations in the current market.
Junior subordinated debentures: The fair value of junior subordinated debentures is estimated using discounted cash flow analyses based on the published Bloomberg US Financials BB rated corporate bond index yield.
Accrued interest: The carrying amounts of accrued interest approximate their fair values.
Off-balance sheet instruments: Fair values for off-balance sheet, credit-related financial instruments are based on fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the counterparties' credit standing. The fair value of commitments is not material.
Notes to Consolidated Financial Statements (unaudited)
(Dollars in thousands, except for share and per share information)
Note 9. Derivative Financial Instruments
The Company enters into certain derivative financial instruments as part of its hedging strategy. The Company accounts for its derivative financial instruments in accordance with ASC Topic 815 which requires all derivative instruments to be carried at fair value on the balance sheet. The Company has designated certain derivative instruments used to manage interest rate risk as hedge relationships with certain assets, liabilities or cash flows being hedged. Certain derivatives used for interest rate risk management are not designated in a hedge relationship and are used for asset and liability management related to the Company's mortgage banking activities and commercial customers' financing needs. All derivatives are carried at fair value in either other assets or other liabilities.
Derivative instruments designated in a hedge relationship to mitigate exposure to changes in the fair value of an asset, liability, or firm commitment attributable to a particular risk, such as interest rate risk, are considered fair value hedges. Derivative instruments designated in a hedge relationship to mitigate exposure to variability in expected future cash flows, or other types of forecasted transactions, are considered cash flow hedges.
The Company's objectives in using interest rate derivatives are to add stability to interest income and to manage its exposure to interest rate movements. To accomplish this objective, the Company uses interest rate swaps as part of its interest rate risk management strategy. Interest rate swaps designated as cash flow hedges involve the receipt of fixed-rate amounts from a counterparty in exchange for the Company making variable-rate payments over the life of the agreements without exchange of the underlying notional amount. During the second quarter of 2021, the Company entered into two interest rate swap derivatives with an aggregated notional amount of $100,000 that were designated as cash flow hedges. The derivatives are intended to hedge the variable cash flows associated with certain existing variable-interest rate loans.
For derivatives designated and that qualify as cash flow hedges of interest rate risk, the gain or loss on the derivative is recorded in accumulated other comprehensive income and subsequently reclassified into interest income in the same period that the hedged transaction affects earnings. Amounts reported in accumulated other comprehensive income related to derivatives will be reclassified to interest income as interest payments are received on the Company’s variable-rate loans. During the next twelve months, the Company estimates that $853 will be reclassified as an increase to interest income.
Through the normal course of business, the Company enters into interest rate lock commitments with consumers to originate mortgage loans at a specified interest rate. These commitments, which contain fixed expiration dates, offer the borrower an interest rate guarantee provided the loan meets underwriting guidelines and closes within the timeframe established by the Company. The Company manages the changes in fair value associated with changes in interest rates related to interest rate lock commitments by using forward sold commitments known as forward mortgage-backed securities trades. These instruments are typically entered into at the time the interest rate lock commitment is made.
The Company offers certain derivatives products, primarily interest rate swaps, directly to qualified commercial banking customers to facilitate their risk management strategies. The interest rate swap derivative positions relate to transactions in which the Company enters into an interest rate swap with a customer, while at the same time entering into an offsetting interest rate swap with another financial institution. An interest rate swap transaction allows customers to effectively convert a variable rate loan to a fixed rate. In connection with each swap, the Company agrees to pay interest to the customer on a notional amount at a variable interest rate and receive interest from the customer on a similar notional amount at a fixed interest rate. At the same time, the Company agrees to pay another financial institution the same fixed interest rate on the same notional amount and receive the same variable interest rate on the same notional amount.
Notes to Consolidated Financial Statements (unaudited)
(Dollars in thousands, except for share and per share information)
The following table provides the outstanding notional balances and fair values of outstanding derivative positions at September 30, 2021 and December 31, 2020:
Outstanding Notional Balance
Asset Derivative Fair Value
Liability Derivative Fair Value
September 30, 2021
Derivatives designated as hedging instruments:
Interest rate swaps - cash flow hedge
$
100,000
$
140
$
210
Derivatives not designated as hedging instruments:
Interest rate lock commitments
51,676
1,566
2
Forward mortgage-backed securities trades
48,000
132
44
Commercial loan interest rate swaps:
Loan customer counterparty
276,030
9,631
577
Financial institution counterparty
276,030
595
10,064
December 31, 2020
Derivatives not designated as hedging instruments:
Interest rate lock commitments
$
116,795
$
3,515
$
—
Forward mortgage-backed securities trades
104,000
—
568
Commercial loan interest rate swaps:
Loan customer counterparty
335,370
20,159
—
Financial institution counterparty
335,370
—
21,306
The commercial loan customer counterparty weighted average received and paid interest rates for interest rate swaps outstanding were as follows:
Weighted Average Interest Rate
September 30, 2021
December 31, 2020
Received
Paid
Received
Paid
Loan customer counterparty
4.09
%
2.30
%
4.08
%
2.32
%
The credit exposure related to interest rate swaps is limited to the net favorable value of all swaps by each counterparty, which was approximately $10,366 at September 30, 2021. In some cases collateral may be required from the counterparties involved if the net value of the derivative instruments exceeds a nominal amount. Collateral levels are monitored and adjusted on a regular basis for changes in interest rate swap values. At September 30, 2021, cash of $20,757 and securities of $3,250 were pledged as collateral for these derivatives.
The Company has entered into credit risk participation agreements with financial institution counterparties for interest rate swaps related to loans in which the Company is either a participant or a lead bank. Risk participation agreements entered into as a participant bank provide credit protection to the financial institution counterparty should the borrower fail to perform on its interest rate derivative contract with that financial institution. The Company is party to one risk participation agreement as a participant bank having a notional amount of $5,251 at September 30, 2021. Risk participation agreements entered into as the lead bank provide credit protection to the Company should the borrower fail to perform on its interest rate derivative contract. The Company is party to one risk participation agreement as the lead bank having a notional amount of $9,414 at September 30, 2021.
Notes to Consolidated Financial Statements (unaudited)
(Dollars in thousands, except for share and per share information)
The changes in the fair value of interest rate lock commitments and the forward sales of mortgage-backed securities are recorded in mortgage banking revenue. These gains and losses were not attributable to instrument-specific credit risk. For commercial interest rate swaps, because the Company acts as an intermediary for our customer, changes in the fair value of the underlying derivative contracts substantially offset each other and do not have a material impact on the results of operations.
A summary of derivative activity and the related impact on the consolidated statements of income for the three and nine months ended September 30, 2021 and 2020 is as follows:
Income Statement Location
Three Months Ended September 30,
Nine Months Ended September 30,
2021
2020
2021
2020
Derivatives designated as hedging instruments
Interest rate swaps - cash flow hedges
Interest and fees on loans
$
215
$
—
$
369
$
—
Derivatives not designated as hedging instruments
Interest rate lock commitments
Mortgage banking revenue
(502)
1,517
(1,951)
4,262
Forward mortgage-backed securities trades
Mortgage banking revenue
148
192
656
(249)
Note 10. Stock Awards
The Company grants common stock awards to certain employees of the Company. In connection with the Company's initial public offering in April 2013, the Board of Directors adopted the 2013 Equity Incentive Plan (2013 Plan). All stock awards issued under expired plans prior to 2013 are fully vested. Under the 2013 Plan, the Compensation Committee may grant awards to certain employees of the Company in the form of restricted stock, restricted stock rights, restricted stock units, qualified and nonqualified stock options, performance share awards and other equity-based awards. The 2013 Plan, as amended, has 2,300,000 reserved shares of common stock to be awarded by the Company’s compensation committee. As of September 30, 2021, there were 1,088,726 shares remaining available for grant for future awards.
The shares currently issued under the 2013 Plan are restricted stock awards and performance stock units. Restricted stock awarded to employees vest evenly over the required employment period, generally ranging from one to five years. Performance stock units awarded have a three to four year cliff vesting period. As defined in the plan, outstanding awards may immediately vest upon a change-in-control in the Company. Restricted stock granted under the 2013 Plan are issued at the date of grant and receive dividends. Performance stock units are eligible to receive dividend equivalents as such dividends are declared on the Company's common stock during the performance period. Equivalent dividend payments are based upon the number of shares issued under each performance award and are deferred until such time that the units vest and the shares are issued.
Notes to Consolidated Financial Statements (unaudited)
(Dollars in thousands, except for share and per share information)
Restricted Stock Awards
The following table summarizes the activity in nonvested restricted stock awards for the nine months ended September 30, 2021 and 2020:
Restricted Stock Awards
Number of Shares
Weighted Average Grant Date Fair Value
Nonvested shares, December 31, 2020
468,800
$
49.01
Granted during the period
96,713
64.91
Vested during the period
(176,689)
51.43
Forfeited during the period
(34,822)
50.10
Nonvested shares, September 30, 2021
354,002
$
51.96
Nonvested shares, December 31, 2019
284,861
$
58.63
Granted during the period
304,790
43.38
Vested during the period
(112,914)
58.28
Forfeited during the period
(7,270)
51.97
Nonvested shares, September 30, 2020
469,467
$
48.91
Compensation expense related to these awards is recorded based on the fair value of the award at the date of grant and totaled $2,087 and $6,613 for the three and nine months ended September 30, 2021, respectively, and $1,970 and $6,333 for the three and nine months ended September 30, 2020, respectively. Compensation expense is recorded in salaries and employee benefits in the accompanying consolidated statements of income. At September 30, 2021, future compensation expense is estimated to be $13,743 and will be recognized over a remaining weighted average period of 2.21 years.
The fair value of common stock awards that vested during the nine months ended September 30, 2021 and 2020 was $12,019 and $5,469, respectively. The Company has recorded $421 and $647 in excess tax benefit on vested restricted stock to income tax expense for the three and nine months ended September 30, 2021, respectively, and $44 and $246 in excess tax expense for the three and nine months ended September 30, 2020, respectively.
There were no modifications of stock agreements during the nine months ended September 30, 2021 and 2020 that resulted in significant additional incremental compensation costs.
At September 30, 2021, the future vesting schedule of the nonvested restricted stock awards is as follows:
First year
158,055
Second year
116,569
Third year
75,303
Fourth year
4,075
Total nonvested shares
354,002
Performance Stock Units
Performance stock units represent shares potentially issuable in the future. The number of shares issued is based upon the measure of the Company's achievement of its relative adjusted return on average tangible common equity, as defined by the Company, over the award's performance period as compared to an identified peer group's achievement over the same performance period. The number of shares issuable under each performance award is the product of the award target and the award payout percentage for the given level of achievement which ranges from 0% to 150% of the target.
Notes to Consolidated Financial Statements (unaudited)
(Dollars in thousands, except for share and per share information)
The following table summarizes the activity in nonvested performance stock units at target award level for the nine months ended September 30, 2021:
Performance-based Restricted Stock Units
Number of Shares
Weighted Average Grant Date Fair Value
Nonvested shares, December 31, 2020
89,300
$
38.29
Granted during the period
25,198
63.92
Nonvested shares, September 30, 2021
114,498
$
43.93
Compensation expense related to performance stock units is estimated each period based on the fair value of the target stock unit at the grant date and the most probable level of achievement of the performance condition, adjusted for the passage of time within the vesting periods of the awards. Compensation expense related to these awards was $336 and $1,364 for the three and nine months ended September 30, 2021, respectively. As of September 30, 2021, the unrecognized compensation expense assuming the target attainment is estimated to be $3,666, while the estimated maximum payout rate is $6,181. The remaining performance period over which the expense will be recognized is 2.74 years.
Notes to Consolidated Financial Statements (unaudited)
(Dollars in thousands, except for share and per share information)
Note 11. Regulatory Matters
Under banking law, there are legal restrictions limiting the amount of dividends the Bank can declare. Approval of the regulatory authorities is required if the effect of dividends declared would cause the regulatory capital of the Bank to fall below specified minimum levels. For state banks, subject to regulatory capital requirements, payment of dividends is generally allowed to the extent of net profits.
The Company (on a consolidated basis) and the Bank are subject to various regulatory capital requirements administered by federal and state banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Company’s consolidated financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Company and the Bank must meet specific capital guidelines that involve quantitative measures of assets, liabilities and certain off-balance sheet items as calculated under regulatory accounting practices. The capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings and other factors. Tier 2 capital for the Company includes permissible portions of the Company's subordinated notes. The permissible portion of qualified subordinated notes decreases 20% per year during the final five years of the term of the notes.
The Company is subject to the Basel III regulatory capital framework (the Basel III Capital Rules). The Basel III Capital Rules require that the Company maintain a 2.5% capital conservation buffer above the minimum risk-based capital adequacy requirements. 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 full amount of the buffer will result in restrictions on the Company's ability to make capital distributions, including dividend payments and stock repurchases and to pay discretionary bonuses to executive officers.
As discussed in Note 1 - Summary of Significant Accounting Policies,in connection with the adoption of ASC 326, the Company recognized an after-tax cumulative effect reduction to retained earnings of $53,880 on January 1, 2021. In February 2019, the federal bank regulatory agencies issued a final rule that revised certain capital regulations under CECL and included a transition option that allows banking organizations to phase in, over a three-year period, the day-one adverse effects of CECL on their regulatory capital ratios (three-year transition option). The Company elected to adopt the three-year transition option and the deferral has been applied in the September 30, 2021 capital ratios presented below.
Quantitative measures established by regulation to ensure capital adequacy require the Company and the Bank to maintain minimum amounts and ratios (set forth in the table below) of total, Common Equity Tier 1 (CET1) and Tier 1 capital (as defined in the regulations) to risk weighted assets (as defined), and of Tier 1 capital (as defined) to average assets (as defined). Management believes, as of September 30, 2021 and December 31, 2020, the Company and the Bank meet all capital adequacy requirements to which they are subject, including the capital buffer requirement.
As of September 30, 2021 and December 31, 2020, the Bank’s capital ratios exceeded those levels necessary to be categorized as “well capitalized” under the regulatory framework for prompt corrective action. To be categorized as “well capitalized,” the Bank must maintain minimum total risk based, CET1, Tier 1 risk based and Tier 1 leverage ratios as set forth in the table. There are no conditions or events that management believes have changed the Bank’s category.
Notes to Consolidated Financial Statements (unaudited)
(Dollars in thousands, except for share and per share information)
The following table presents actual capital amounts and required ratios under Basel III Capital Rules for the Company and Bank as of September 30, 2021 and December 31, 2020.
Actual
Minimum Capital Required - Basel III
To Be Well Capitalized Under Prompt Corrective Action Provisions
Amount
Ratio
Amount
Ratio
Amount
Ratio
September 30, 2021
Total capital to risk weighted assets:
Consolidated
$
1,884,618
13.64
%
$
1,450,815
10.50
%
N/A
N/A
Bank
1,953,355
14.14
1,450,381
10.50
$
1,381,316
10.00
%
Tier 1 capital to risk weighted assets:
Consolidated
1,583,950
11.46
1,174,470
8.50
N/A
N/A
Bank
1,856,687
13.44
1,174,118
8.50
1,105,052
8.00
Common equity tier 1 to risk weighted assets:
Consolidated
1,528,350
11.06
967,210
7.00
N/A
N/A
Bank
1,856,687
13.44
966,921
7.00
897,855
6.50
Tier 1 capital to average assets:
Consolidated
1,583,950
8.94
708,732
4.00
N/A
N/A
Bank
1,856,687
10.48
708,581
4.00
885,726
5.00
December 31, 2020
Total capital to risk weighted assets:
Consolidated
$
1,825,661
13.32
%
$
1,438,939
10.50
%
N/A
N/A
Bank
1,864,240
13.61
1,438,385
10.50
$
1,369,891
10.00
%
Tier 1 capital to risk weighted assets:
Consolidated
1,471,841
10.74
1,164,855
8.50
N/A
N/A
Bank
1,776,420
12.97
1,164,407
8.50
1,095,913
8.00
Common equity tier 1 to risk weighted assets:
Consolidated
1,416,241
10.33
959,293
7.00
N/A
N/A
Bank
1,776,420
12.97
958,924
7.00
890,429
6.50
Tier 1 capital to average assets:
Consolidated
1,471,841
9.12
645,730
4.00
N/A
N/A
Bank
1,776,420
11.01
645,539
4.00
806,924
5.00
Stock repurchase program: From time to time, the Company's board of directors has authorized stock repurchase programs which allow the Company to purchase its common stock generally over a one-year period at various prices in the open market or in privately negotiated transactions. On October 22, 2020, the Company's board of directors authorized a $150,000 stock repurchase program allowing the Company to purchase shares of its common stock through October 31, 2021. On August 26, 2021, the Company extended the stock repurchase program through December 31, 2021. Under this program, the Company repurchased 217,772 shares at a total cost of $15,207 for the three and nine months ended September 30, 2021. There were no shares repurchased for the three and nine months ended September 30, 2020. In July 2019, the federal bank regulators adopted final rules that, among other things, eliminated the standalone prior approval requirement for any repurchase of common stock. However, the Company remains subject to a Federal Reserve Board guideline that requires consultation with the Federal Reserve regarding plans for share repurchases. The Company’s repurchases of its common stock may be subject to a prior approval or notice requirement under other regulations, policies or supervisory expectations of the Federal Reserve Board. The Federal Reserve Board has approved share repurchases through the remainder of 2021.
Notes to Consolidated Financial Statements (unaudited)
(Dollars in thousands, except for share and per share information)
Company stock repurchased to settle employee tax withholding related to vesting of stock awards totaled 14,297 and 39,508 shares at a total cost of $1,049 and $2,714 for the three and nine months ended September 30, 2021, respectively, and 291 and 2,951 shares at a total cost of $13 and $159 for the three and nine months ended September 30, 2020, respectively, and were not included under the repurchase program.
Note 12. Subsequent Event
Declaration of Dividends
On October 28, 2021, the Company declared a quarterly cash dividend in the amount of $0.36 per share of common stock to the stockholders of record on November 11, 2021. The dividend will be paid on November 24, 2021.
The Quarterly Report on Form 10-Q, our other filings with the SEC, and other press releases, documents, reports and announcements that we make, issue or publish may contain statements that we believe are “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995 that are subject to risks and uncertainties and are made pursuant to the safe harbor provisions of Section 27A of the Securities Act, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, and other related federal security laws.These forward-looking statements include information about our possible or assumed future results of operations, including our future revenues, income, expenses, provision for taxes, effective tax rate, earnings per share and cash flows, our future capital expenditures and dividends, our future financial condition and changes therein, including changes in our loan portfolio and allowance for credit losses, our future capital structure or changes therein, the plan and objectives of management for future operations, our future or proposed acquisitions, the future or expected effect of acquisitions on our operations, results of operations and financial condition, our future economic performance and the statements of the assumptions underlying any such statement. Such statements are typically, but not exclusively, identified by the use in the statements of words or phrases such as “aim,” “anticipate,” “estimate,” “expect,” “goal,” “guidance,” “intend,” “is anticipated,” “is estimated,” “is expected,” “is intended,” “objective,” “plan,” “projected,” “projection,” “will affect,” “will be,” “will continue,” “will decrease,” “will grow,” “will impact,” “will increase,” “will incur,” “will reduce,” “will remain,” “will result,” “would be,” variations of such words or phrases (including where the word “could,” “may” or “would” is used rather than the word “will” in a phrase) and similar words and phrases indicating that the statement addresses some future result, occurrence, plan or objective. The forward-looking statements that we make are based on the Company's current expectations and assumptions regarding its business, the economy, and other future conditions. Because forward-looking statements relate to future results and occurrences, they are subject to inherent uncertainties, risks, and changes in circumstances that are difficult to predict. The Company’s actual results may differ materially from those contemplated by the forward looking statements, which are neither statements of historical fact nor guarantees or assurances of future performance.Many possible events or factors could affect our future financial results and performance and could cause those results or performance to differ materially from those expressed in the forward-looking statements. These possible events or factors include, but are not limited to:
•the disruption to local, regional, national and global economic activity caused by infectious disease outbreaks, including the recent outbreak of coronavirus, or COVID-19, and the significant impact that such outbreak has had and may have on our growth, operations, earnings and asset quality;
•our ability to sustain our current internal growth rate and total growth rate;
•changes in geopolitical, business and economic events, occurrences and conditions, including changes in rates of inflation or deflation, nationally, regionally and in our target markets, particularly in Texas and Colorado;
•worsening business and economic conditions nationally, regionally and in our target markets, particularly in Texas and Colorado, and the geographic areas in those states in which we operate;
•our dependence on our management team and our ability to attract, motivate and retain qualified personnel;
•the concentration of our business within our geographic areas of operation in Texas and Colorado;
•changes in asset quality, including increases in default rates on loans and higher levels of nonperforming loans and loan charge-offs generally, and specifically resulting from the economic dislocation caused by the COVID-19 pandemic;
•concentration of the loan portfolio of the Bank, before and after the completion of acquisitions of financial institutions, in commercial and residential real estate loans and changes in the prices, values and sales volumes of commercial and residential real estate;
•the ability of the Bank to make loans with acceptable net interest margins and levels of risk of repayment and to otherwise invest in assets at acceptable yields and presenting acceptable investment risks;
•inaccuracy of the assumptions and estimates that the managements of our Company and the financial institutions that we acquire make in establishing reserves for credit losses and other estimates generally, and specifically as a result of the effect of the COVID-19 pandemic;
•lack of liquidity, including as a result of a reduction in the amount of sources of liquidity we currently have;
•material increases or decreases in the amount of deposits held by the Bank or other financial institutions that we acquire and the cost of those deposits;
•our access to the debt and equity markets and the overall cost of funding our operations;
•regulatory requirements to maintain minimum capital levels or maintenance of capital at levels sufficient to support our anticipated growth;
•changes in market interest rates that affect the pricing of the loans and deposits of each of the Bank and the financial institutions that we acquire and that affect the net interest income, other future cash flows, or the market value of the assets of each of the Bank and the financial institutions that we acquire, including investment securities;
•fluctuations in the market value and liquidity of the securities we hold for sale, including as a result of changes in market interest rates;
•effects of competition from a wide variety of local, regional, national and other providers of financial, investment and insurance services;
•changes in economic and market conditions, including the economic dislocation resulting from the COVID-19 pandemic, that affect the amount and value of the assets of the Bank and of financial institutions that we acquire;
•the institution and outcome of, and costs associated with, litigation and other legal proceedings against one or more of the Company, the Bank and financial institutions that we acquire or to which any of such entities is subject;
•the occurrence of market conditions adversely affecting the financial industry generally, including the economic dislocation resulting from the COVID-19 pandemic;
•the impact of recent and future legislative regulatory changes, including changes in banking, securities, and tax laws and regulations and their application by the Company’s regulators, and changes in federal government policies, as well as regulatory requirements applicable to, and resulting from regulatory supervision of, the Company and the Bank as a financial institution with total assets greater than $10 billion;
•changes in accounting policies, practices, principles and guidelines, as may be adopted by the bank regulatory agencies, the Financial Accounting Standards Board, the SEC and the Public Company Accounting Oversight Board, as the case may be; including changes resulting from the implementation of the new Current Expected Credit Loss accounting standard;
•governmental monetary and fiscal policies;
•changes in the scope and cost of FDIC insurance and other coverage;
•the effects of war or other conflicts, acts of terrorism (including cyber attacks) or other catastrophic events, including natural disasters such as storms, droughts, tornadoes, hurricanes and flooding, that may affect general economic conditions;
•our actual cost savings resulting from previous or future acquisitions are less than expected, we are unable to realize those cost savings as soon as expected, or we incur additional or unexpected costs;
•our revenues after previous or future acquisitions are less than expected;
•the liquidity of, and changes in the amounts and sources of liquidity available to, us, before and after the acquisition of any financial institutions that we acquire;
•deposit attrition, operating costs, customer loss and business disruption before and after our completed acquisitions, including, without limitation, difficulties in maintaining relationships with employees, may be greater than we expected;
•the effects of the combination of the operations of financial institutions that we have acquired in the recent past or may acquire in the future with our operations and the operations of the Bank, the effects of the integration of such operations being unsuccessful, and the effects of such integration being more difficult, time consuming, or costly than expected or not yielding the cost savings we expect;
•the impact of investments that the Company or the Bank may have made or may make and the changes in the value of those investments;
•the quality of the assets of financial institutions and companies that we have acquired in the recent past or may acquire in the future being different than we determined or determine in our due diligence investigation in connection with the acquisition of such financial institutions and any inadequacy of credit loss reserves relating to, and exposure to unrecoverable losses on, loans acquired;
•our ability to continue to identify acquisition targets and successfully acquire desirable financial institutions to sustain our growth, to expand our presence in our markets and to enter new markets;
•general business and economic conditions in our markets change or are less favorable than expected generally, and specifically as a result of the COVID-19 pandemic;
•changes occur in business conditions and inflation generally, and specifically as a result of the COVID-19 pandemic;
•an increase in the rate of personal or commercial customers’ bankruptcies generally, and specifically as a result of the COVID-19 pandemic;
•technology-related changes are harder to make or are more expensive than expected;
•attacks on the security of, and breaches of, the Company's and the Bank's digital information systems, the costs we or the Bank incur to provide security against such attacks and any costs and liability the Company or the Bank incurs in connection with any breach of those systems;
•the potential impact of technology and “FinTech” entities on the banking industry generally;
•the other factors that are described or referenced in Part I, Item 1A, of the Company’s Annual Report on Form 10-K filed with the SEC on March 1, 2021, under the caption “Risk Factors”; and
•other economic, competitive, governmental, regulatory, technological and geopolitical factors affecting the Company’s operations, pricing and services.
We urge you to consider all of these risks, uncertainties and other factors carefully in evaluating all such forward-looking statements made by us. As a result of these and other matters, including changes in facts and assumptions not being realized or other factors, the actual results relating to the subject matter of any forward-looking statement may differ materially from the anticipated results expressed or implied in that forward-looking statement. Any forward-looking statement made in this prospectus or made by us in any report, filing, document or information incorporated by reference in this prospectus, speaks only as of the date on which it is made. The Company undertakes no obligation to update any such forward-looking statement, whether as a result of new information, future developments or otherwise, except as may be required by law.
A forward-looking statement may include a statement of the assumptions or bases underlying the forward-looking statement. The Company believes that these assumptions or bases have been chosen in good faith and that they are reasonable. However, the Company cautions you that assumptions as to future occurrences or results almost always vary from actual future occurrences or results, and the differences between assumptions and actual occurrences and results can be material. Therefore, the Company cautions you not to place undue reliance on the forward-looking statements contained in this prospectus or incorporated by reference herein.
This Management’s Discussion and Analysis (MD&A) of Financial Condition and Results of Operations analyzes the major elements of the Company’s financial condition and results of operation as reflected in the interim consolidated financial statements and accompanying notes appearing in this Quarterly Report on Form 10-Q. This section should be read in conjunction with the Company’s interim consolidated financial statements and accompanying notes included elsewhere in this report and with the consolidated financial statements included in the Annual Report on Form 10-K for the year ended December 31, 2020.
The Company was organized as a bank holding company in 2002. On January 1, 2009, the Company was merged with Independent Bank Group Central Texas, Inc., and, since that time, has pursued a strategy to create long-term shareholder value through organic growth of our community banking franchise in our market areas and through selective acquisitions of complementary banking institutions with operations in the Company’s market areas or in new market areas. On April 8, 2013, the Company consummated the initial public offering, or IPO, of its common stock which is traded on the Nasdaq Global Select Market.
As of September 30, 2021, the Company operated 93 full service banking locations in north, central and southeast Texas regions, and along the Colorado Front Range region, with 61 Texas locations and 32 Colorado locations.
The Company’s headquarters are located at 7777 Henneman Way, McKinney, Texas 75070 and its telephone number is (972) 562-9004. The Company’s website address is www.ifinancial.com. Information contained on the Company’s website is not incorporated by reference into this Quarterly Report on Form 10-Q and is not part of this or any other report.
The Company’s principal business is lending to and accepting deposits from businesses, professionals and individuals. The Company conducts all of the Company’s banking operations through its principal bank subsidiary. The Company derives its income principally from interest earned on loans and, to a lesser extent, income from securities available for sale. The Company also derives income from non-interest sources, such as fees received in connection with various deposit services, mortgage banking operations and investment advisory services. From time to time, the Company also realizes gains on the sale of assets. The Company’s principal expenses include interest expense on interest-bearing customer deposits, advances from the Federal Home Loan Bank of Dallas (FHLB) and other borrowings, operating expenses such as salaries, employee benefits, occupancy costs, communication and technology costs, expenses associated with other real estate owned, other administrative expenses, amortization of intangibles, acquisition expenses, provisions for credit losses and the Company’s assessment for FDIC deposit insurance.
Recent Developments
NEW ACCOUNTING STANDARD
As discussed in Note 1 - Summary of Significant Accounting Policies, the Company adopted ASU 2016-13, Financial Instruments - Credit Losses (Topic 326) (ASC 326): Measurement of Credit Losses on Financial Instruments on January 1, 2021, pursuant to the delayed adoption allowable under the CARES Act. Upon adoption of CECL, the Company recorded an increase of $80.9 million to the allowance for credit losses for loans and $1.1 million to the allowance for credit losses for unfunded commitments. In addition, the Company recognized a cumulative effect reduction to retained earnings totaling $53.9 million, net of a recorded deferred tax asset of $15.1 million, and reclassed $13.0 million of allowance for credit losses related to PCD loans that were previously classified as PCI under prior accounting guidance. See discussion inNote 1 - Summary of Significant Accounting Policiesand Note 4 - Loans, Net and Allowance for Credit Losses for more details on the impact of CECL, including related accounting policies.
In 2021, restrictive measures related to the COVID-19 pandemic continued to ease, both on a national level and more specifically in the Company's markets of Texas and Colorado. Most businesses have reopened at full capacity, which has improved commercial and consumer activity but still has not returned to pre-pandemic levels. While the overall outlook has improved based on the availability of the vaccine to all adults and older children, there has been a recent rise in hospitalization and infection rates caused by the Delta variant, a rapidly spreading strain of coronavirus. Therefore, the risk of further resurgence and possible reimplementation of restrictions remains.
The Company continues to closely monitor the impact of COVID-19 on its employees, customers, the communities it serves and the economy as a whole; however, the extent to which the pandemic will continue to impact operations and financial results in 2021 and beyond is uncertain.
Discussion and Analysis of Results of Operations for the Three and Nine Months Ended September 30, 2021 and 2020
The following discussion and analysis of the Company's results of operations compares the operations for the three and nine months ended September 30, 2021 with the three and nine months ended September 30, 2020. The results of operations for the three and nine months ended September 30, 2021 are not necessarily indicative of the results of operations that may be expected for all of the year ending December 31, 2021.
Results of Operations
For the three months ended September 30, 2021, net income was $52.3 million ($1.21 per common share on a diluted basis) compared with net income of $60.1 million ($1.39 per common share on a diluted basis) for the three months ended September 30, 2020. The Company posted annualized returns on average equity of 8.10% and 9.73%, returns on average assets of 1.11% and 1.43% and efficiency ratios of 53.20% and 44.69% for the three months ended September 30, 2021 and 2020, respectively. The efficiency ratio is calculated by dividing total noninterest expense (which excludes the provision for credit losses and the amortization of other intangible assets) by net interest income plus noninterest income.
For the nine months ended September 30, 2021, net income was $170.6 million ($3.95 per common share on a diluted basis) compared with $142.9 million ($3.31 per common share on a diluted basis) for the nine months ended September 30, 2020. The Company posted annualized returns on average equity of 9.04% and 7.91%, returns on average assets of 1.25% and 1.19% and efficiency ratios of 51.07% and 49.33% for the nine months ended September 30, 2021 and 2020, respectively.
Net Interest Income
The Company’s net interest income is its interest income, net of interest expenses. Changes in the balances of the Company’s earning assets and its deposits, FHLB advances and other borrowings, as well as changes in the market interest rates, affect the Company’s net interest income. The difference between the Company’s average yield on earning assets and its average rate paid for interest-bearing liabilities is its net interest spread. Noninterest-bearing sources of funds, such as demand deposits and stockholders’ equity, also support the Company’s earning assets. The impact of the noninterest-bearing sources of funds is reflected in the Company’s net interest margin, which is calculated as annualized net interest income divided by average earning assets.
Net interest income was $128.6 million for the three months ended September 30, 2021, a decrease of $3.4 million, or 2.5%, from $132.0 million for the three months ended September 30, 2020. This decrease in net interest income was driven by decreased earnings on assets due to lower yields and accretion offset by overall decreased funding costs for the year over year period. Average interest earning assets increased $2.0 billion or 13.7%, to $17.0 billion for the three months ended September 30, 2021 compared to $14.9 billion for the three months ended September 30, 2020. The increase is primarily due to the continued growth of average interest bearing cash balances over the past year, increasing $1.7 billion from prior year and also due to continued increases in average taxable securities. Offsetting these changes is a net decrease in average loan balances, due primarily to the forgiveness of Paycheck Protection Program (PPP) loans. The yield on average interest earning assets decreased 67 basis points from 4.04% for the three months ended September 30, 2020 to 3.37% for the three months ended September 30, 2021. The decrease from the prior year was due to the increase in lower-yielding interest bearing cash balances mentioned above as well as lower loans and securities yields for the year over year period. The average cost of interest-bearing liabilities decreased 23 basis points to 0.54% for the three months ended September 30, 2021 compared to 0.77% for the three months ended September 30, 2020. The decrease is primarily due to lower rates offered on our deposit products as well as rate decreases on other borrowings and trust preferred securities. The aforementioned changes resulted in a 51 basis point decrease in the net interest margin for the three months ended September 30, 2021 at 3.01% compared to 3.52% for the three months ended September 30, 2020. The decrease was primarily due to lower asset yields, increased liquidity and a decrease of $3.2 million in loan accretion income offset by the lower cost of funds on interest bearing liabilities.
Net interest income was $387.7 million for the nine months ended September 30, 2021, an increase of $4.1 million, or 1.1%, from $383.6 million for the nine months ended September 30, 2020. The increase is due to a $2.2 billion increase, or 15.6%, in average interest-earning assets to $16.5 billion for the nine months ended September 30, 2021 compared to $14.3 billion for nine months ended September 30, 2020, as well as decreased funding costs due to a declining rate environment during the year over year period offset by decreased earnings on assets due to lower yields and accretion. The increase in average interest-earning assets is primarily related to the increases of $1.4 billion in average interest bearing deposits and $366.2 thousand in average taxable securities due to excess liquidity but also in part to increased average non-PPP loan balances due to organic growth. The average yield on interest earning assets decreased 75 basis points from 4.30% for the nine months ended September 30, 2020 to 3.55% for the nine months ended September 30, 2021 while the average rate paid on interest bearing liabilities decreased 42 basis points from 1.02% to 0.60% over the same period. The decrease from the prior year was primarily due to overall lower rates on interest-earning assets and liabilities due to the declining rate environment for the year over year period, as well as the significant increase in lower yielding interest bearing balances and lower loan accretion. The net interest margin for the nine months ended September 30, 2021 decreased 45 basis points to 3.14% compared to 3.59% for the nine months ended September 30, 2020 as a result of excess liquidity, decreased loan accretion and lower asset yields offset by lower rates paid on all interest bearing liabilities.
Average Balance Sheet Amounts, Interest Earned and Yield Analysis. The following table present average balance sheet information, interest income, interest expense and the corresponding average yields earned and rates paid for the three and nine months ended September 30, 2021 and 2020. The average balances are principally daily averages and, for loans, include both performing and nonperforming balances.
Three Months Ended September 30,
2021
2020
(dollars in thousands)
Average Outstanding Balance
Interest
Yield/ Rate (4)
Average Outstanding Balance
Interest
Yield/ Rate (4)
Interest-earning assets:
Loans (1)
$
12,358,349
$
134,540
4.32
%
$
12,586,647
$
144,138
4.56
%
Taxable securities
1,300,953
6,059
1.85
705,918
4,507
2.54
Nontaxable securities
354,661
2,077
2.32
351,759
2,126
2.40
Interest bearing deposits and other
2,959,653
1,356
0.18
1,287,320
1,027
0.32
Total interest-earning assets
16,973,616
144,032
3.37
14,931,644
151,798
4.04
Noninterest-earning assets
1,792,728
1,782,251
Total assets
$
18,766,344
$
16,713,895
Interest-bearing liabilities:
Checking accounts
$
6,179,715
$
5,764
0.37
%
$
4,619,454
$
5,512
0.47
%
Savings accounts
722,493
278
0.15
631,862
270
0.17
Money market accounts
2,508,767
3,392
0.54
2,471,550
4,361
0.70
Certificates of deposit
1,226,854
1,413
0.46
1,590,734
5,536
1.38
Total deposits
10,637,829
10,847
0.40
9,313,600
15,679
0.67
FHLB advances
351,359
463
0.52
594,022
714
0.48
Other borrowings
285,473
3,640
5.06
209,532
2,928
5.56
Junior subordinated debentures
54,154
437
3.20
53,955
470
3.47
Total interest-bearing liabilities
11,328,815
15,387
0.54
10,171,109
19,791
0.77
Noninterest-bearing checking accounts
4,772,525
3,991,014
Noninterest-bearing liabilities
101,018
94,349
Stockholders’ equity
2,563,986
2,457,423
Total liabilities and equity
$
18,766,344
$
16,713,895
Net interest income
$
128,645
$
132,007
Interest rate spread
2.83
%
3.27
%
Net interest margin (2)
3.01
3.52
Net interest income and margin (tax equivalent basis) (3)
$
129,623
3.03
$
132,978
3.54
Average interest-earning assets to interest-bearing liabilities
Net interest income and margin (tax equivalent basis) (3)
$
390,579
3.17
$
386,476
3.62
Average interest-earning assets to interest-bearing liabilities
148.14
143.35
____________
(1) Average loan balances include nonaccrual loans.
(2) Net interest margins for the periods presented represent: (i) the difference between interest income on interest-earning assets and the interest expense on interest-bearing liabilities, divided by (ii) average interest-earning assets for the period.
(3) A tax-equivalent adjustment has been computed using a federal income tax rate of 21% for the three and nine months ended September 30, 2021 and 2020.
(4) Yield and rates for the three and nine month periods are annualized.
As discussed in Note 1 - Summary of Significant Accounting Policies, the Company adopted the CECL accounting standard on January 1, 2021. The measurement of expected credit losses under the CECL methodology is applicable to financial assets measured at amortized cost, including loans and held-to-maturity debt securities, as well as off-balance sheet credit exposures. Provision for credit losses is determined by management as the amount to be added to the allowance for credit loss accounts for various types of financial instruments to bring the allowance to a level deemed appropriate by management to absorb expected credit losses over the lives of the respective financial instruments. Management actively monitors the Company’s asset quality and provides appropriate provisions based on such factors as historical loss experience, current conditions and reasonable and supportable forecasts.
Financial instruments are charged-off against the allowance for credit losses when appropriate. Although management believes it uses the best information available to make determinations with respect to the provision for credit losses, future adjustments may be necessary if economic conditions differ from the assumptions used in making the determination.
The Company recorded a $4.4 million negative provision for credit losses on loans for the three months ended September 30, 2021 compared to $7.6 million provision for credit losses for the comparable period in 2020. Provision expense for the nine months ended September 30, 2021 was negative $14.0 million compared to $39.1 million for the same period in 2020. Provision expense for loans is generally reflective of organic loan growth as well as charge-offs or specific reserves taken during the respective period. Provision expense will also be impacted by the economic outlook and changes in macroeconomic variables. The negative provisions recorded for the three and nine months ended September 30, 2021 were primarily related to improvements in the economic forecast, while the prior year provision for the same periods was elevated due to general provision expense incurred due to economic factors related to the COVID-19 crisis. Net charge-offs were $99 thousand and $184 thousand for the three months ended September 30, 2021 and 2020, respectively, and $4.4 million and $3.1 million for the nine months ended September 30, 2021 and 2020, respectively.
There was $4.4 million and $5.0 million provision for credit losses recorded on off-balance sheet credit exposures during the three and nine months ended September 30, 2021. The provision expense was elevated in the current period primarily due to higher remaining expected utilization on increased unfunded commitments related to growth in the Company's construction loan and energy portfolios.
Noninterest Income
The following table sets forth the components of noninterest income for the three and nine months ended September 30, 2021 and 2020 and the period-over-period variations in such categories of noninterest income:
Three Months Ended September 30,
Variance
Nine Months Ended September 30,
Variance
(dollars in thousands)
2021
2020
2021 v. 2020
2021
2020
2021 v. 2020
Noninterest Income
Service charges on deposit accounts
$
2,619
$
2,173
$
446
20.5
%
$
7,130
$
6,881
$
249
3.6
%
Investment management fees
2,210
1,924
286
14.9
6,339
5,556
783
14.1
%
Mortgage banking revenue
5,982
14,722
(8,740)
(59.4)
18,714
27,726
(9,012)
(32.5)
%
Gain on sale of loans
—
—
—
—
26
647
(621)
N/M
Gain on sale of other real estate
63
—
63
N/M
63
37
26
N/M
Gain on sale of securities available for sale
—
—
—
—
—
382
(382)
N/M
(Loss) gain on sale and disposal of premises and equipment
Total noninterest income decreased $8.3 million, or 32.9% and $13.7 million, or 21.1% for the three and nine months ended September 30, 2021 over same periods in 2020, respectively. Significant changes in the components of noninterest income are discussed below.
Mortgage banking revenue. Mortgage banking revenue decreased $8.7 million, or 59.4% and $9.0 million, or 32.5% for the three and nine months ended September 30, 2021, respectively, as compared to the same periods in 2020. The decrease was primarily reflective of lower volumes related to rate increases during the year over year periods. Revenue was also negatively impacted for the year over year period as there were losses on derivative hedging instruments of $1.0 million and $2.0 million for the three and nine months ended September 30, 2021 compared to gains of $982 thousand and $2.7 million for the same periods in 2020.
Other noninterest income. Other noninterest income decreased $196 thousand, or 3.9% and $4.2 million, or 21.6% for the three and nine months ended September 30, 2021, respectively, as compared to the same periods in 2020. The decrease for the nine month period was mainly due to the recovery of a $3.5 million contingency reserve on an acquired SBA loan in 2020 in addition to lower interchange fees due to the Durbin Amendment, which was effective July 2020 offset by higher mortgage warehouse fees and swap income during 2021.
Noninterest Expense
Noninterest expense increased $7.2 million, or 9.8% and increased $2.8 million, or 1.2% for the three and nine months ended September 30, 2021, respectively, as compared to the same periods in 2020. The following table sets forth the components of the Company’s noninterest expense for the three and nine months ended September 30, 2021 and 2020 and the period-over-period variations in such categories of noninterest expense:
Salaries and employee benefits.Salaries and employee benefits increased $4.3 million, or 10.2% and $18.7 million, or 16.2% for the three and nine months ended September 30, 2021, respectively, compared to the same periods in 2020. The increase for the three and nine months ended September 30, 2021 compared to the same periods in 2020 is primarily due to $4.3 million and $9.0 million, respectively, in higher salaries, bonus and insurance expense related to additional headcount in addition to $1.0 million and $3.0 million, respectively, in higher contract labor costs related to PPP and various ongoing departmental and bank-wide infrastructure projects. In addition, deferred salaries expense was $450 thousand and $6.3 million lower for the three and ninth month periods due to the PPP loans and other COVID-related modifications that occurred during 2020 and reduced overall salary expense for those periods. The three months ended September 30, 2021 is also reflective of $1.5 million lower mortgage commissions and incentives due to lower mortgage production for the year over year period. Additionally, stock grant amortization expense for the nine month period was $1.6 million higher than 2020 offset by $1.9 million lower severance and retention expense related departmental and business line restructurings in 2020.
Occupancy. Occupancy increased $541 thousand, or 5.6% and $1.6 million, or 5.4% for the three and nine months ended September 30, 2021, respectively, compared to the same periods in 2020. The increase for both periods is due to an increase in various non-capitalizable small furniture and equipment as well as increased building and equipment repairs and maintenance expenses.
Advertising and public relations. Advertising and public relations decreased $226 thousand, or 45.9% and $1.1 million or 55.2% for the three and nine months ended September 30, 2021, compared to the same periods in 2020. Advertising and public relations expenses were higher in the prior year periods primarily due to rebranding expenses which occurred in 2020 as well as advertising related to the COVID-19 pandemic.
Professional fees. Professional fees increased $1.7 million, or 58.3% and increased $2.7 million, or 29.2% for the three and nine months ended September 30, 2021, respectively, compared to the same periods in 2020. The change for both periods is due to increased consulting expenses related to the various infrastructure projects and PPP forgiveness.
Acquisition expense, including legal. Acquisition expense decreased $16.2 million for the nine months ended September 30, 2021, compared to the same period in 2020. The change is related to the merger termination in second quarter 2020.
Other noninterest expense. Other noninterest expense increased $1.5 million, or 20.6% and decreased $150 thousand, or 0.6% for the three and nine months ended September 30, 2021, respectively, compared to the same periods in 2020. The increase in other noninterest expense for the three month period is due to increases of $543 thousand in charitable contributions and $430 thousand in business meals, entertainment and travel expenses primarily due to returning to work in second quarter 2021.
Income Tax Expense
Income tax expense was $12.6 million and $43.8 million for the three and nine months ended September 30, 2021, respectively, and $16.1 million and $35.8 million for the same periods in 2020. The effective tax rates were 19.4% and 20.4% for the three and nine months ended September 30, 2021, respectively, compared to 21.1% and 20.0% for the same periods in 2020. The lower effective tax rate for the the three months ended September 30, 2021 was primarily a result of the 2020 provision to return adjustment and current period adjustments related to state income taxes.
Discussion and Analysis of Financial Condition
The following discussion and analysis of the Company’s financial condition summarizes the financial condition of the Company as of September 30, 2021 and certain changes from December 31, 2020.
Assets
The Company’s total assets increased by $1.2 billion, or 6.6%, to $18.9 billion as of September 30, 2021 from $17.8 billion at December 31, 2020. The increase is due primarily to an increase in interest-bearing deposits and investment securities resulting from increased liquidity due to deposit growth in 2021 offset by a decrease in loan balances.
The Company’s loan portfolio is the largest category of the Company’s earning assets. The following table presents the balance and associated percentage of each major category in the Company's loan portfolio as of September 30, 2021 and December 31, 2020:
(dollars in thousands)
September 30, 2021
December 31, 2020
Amount
% of Total
Amount
% of Total
Commercial (1)(2)
$
2,999,980
24.1
%
$
3,902,496
29.7
%
Real estate:
Commercial
6,414,199
51.4
6,096,676
46.3
Commercial construction, land and land development
1,216,195
9.8
1,245,801
9.5
Residential (3)
1,328,342
10.5
1,435,112
10.9
Single-family interim construction
350,112
2.8
326,575
2.5
Agricultural
82,278
0.7
85,014
0.6
Consumer
81,879
0.7
67,068
0.5
Total loans (5)
12,472,985
100.0
%
13,158,742
100.0
%
Deferred loan fees (4)(5)
—
(10,037)
Allowance for credit losses
(150,281)
(87,820)
Total loans, net
$
12,322,704
$
13,060,885
____________
(1) Includes mortgage warehouse purchase loans of $977.8 million and $1.5 billion at September 30, 2021 and December 31, 2020, respectively.
(2) Includes SBA PPP loans of $243.9 million net of deferred loan fees of $6.5 million at September 30, 2021 and $804.4 million at December 31, 2020.
(3) Includes loans held for sale of $31.5 million and $82.6 million at September 30, 2021 and December 31, 2020, respectively.
(4) Includes SBA PPP net deferred loan fees of $9.8 million at December 31, 2020.
(5) Loan class amounts are shown at amortized cost, net of deferred loan fees of $11.3 million in accordance with CECL at September 30, 2021 and shown at recorded investment at December 31, 2020.
As of September 30, 2021 and December 31, 2020, total loans, net of allowance for credit losses and net deferred fees, totaled $12.3 billion and $13.1 billion, respectively, which is a decrease of 5.7% between the two periods. The decrease is primarily due to a decline in mortgage warehouse of $476.0 million due to lower volumes related to rate increases and shorter hold times, a decrease of $560.5 million in SBA PPP loans due the forgiveness of loans and the increase in the allowance for credit losses, primarily due to the day-one CECL adjustment of $67.9 million, net of the PCD reclassification, offset by organic growth of the loan portfolio.
Asset Quality
Nonperforming Assets. The Company has established procedures to assist the Company in maintaining the overall quality of the Company’s loan portfolio. In addition, the Company has adopted underwriting guidelines to be followed by the Company’s lending officers and require significant senior management review of proposed extensions of credit exceeding certain thresholds. When delinquencies exist, the Company rigorously monitors the levels of such delinquencies for any negative or adverse trends. The Company’s loan review procedures include approval of lending policies and underwriting guidelines by the Company’s board of directors, an annual independent loan review, approval of large credit relationships by the Bank’s Executive Loan Committee and loan quality documentation procedures. The Company, like other financial institutions, is subject to the risk that its loan portfolio will be subject to increasing pressures from deteriorating borrower credit due to general economic conditions.
The Company discontinues accruing interest on a loan when management of the Company believes, after considering the Company’s collection efforts and other factors, that the borrower’s financial condition is such that collection of interest of that loan is doubtful, as well as when required by regulatory provisions. Loans are placed on nonaccrual status or charged-off at an earlier date if collection of principal or interest is considered doubtful. All interest accrued but not collected for loans, including troubled debt restructurings, that are placed on nonaccrual status or charged-off is reversed against interest income. Cash collections on nonaccrual loans are generally credited to the loan receivable balance, and no interest income is recognized on those loans until the principal balance has been collected. Loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured.
Placing a loan on nonaccrual status has a two-fold impact on net interest earnings. First, it may cause a charge against earnings for the interest which had been accrued in the current year but not yet collected on the loan. Second, it eliminates future interest income with respect to that particular loan from the Company’s revenues. Interest on such loans are not recognized until the entire principal is collected or until the loan is returned to performing status.
Real estate the Company has acquired as a result of foreclosure or by deed-in-lieu-of foreclosure is classified as other real estate owned until sold. The Company's policy is to initially record other real estate owned at fair value less estimated costs to sell at the date of foreclosure. After foreclosure, other real estate is carried at the lower of the initial carrying amount (fair value less estimated costs to sell or lease), or at the value determined by subsequent appraisals or internal valuations of the other real estate.
The Company obtains appraisals of real property that secure loans and may update such appraisals of real property securing loans categorized as nonperforming loans and potential problem loans, in each case as required by regulatory guidelines. In instances where updated appraisals reflect reduced collateral values, an evaluation of the borrower’s overall financial condition is made to determine the need, if any, for possible write-downs or appropriate additions to the allowance for credit losses.
The Company periodically modifies loans to extend the term or make other concessions to help a borrower with a deteriorating financial condition stay current on their loan and to avoid foreclosure. The Company generally does not forgive principal or interest on loans or modify the interest rates on loans to rates that are below market rates. Under applicable accounting standards, such loan modifications are generally classified as troubled debt restructurings.
As a result of the economic environment caused by the COVID-19 outbreak, the Company worked with its borrowers on an individual, one-on-one basis to assess and understand the impact of pandemic-related economic hardship on the borrowers and provide prudent modifications allowing for short-term payment deferrals or other payment relief where appropriate. The deferred payments along with interest accrued during the deferral period are due and payable on the maturity date. Under applicable accounting and regulatory guidance, such modifications are not considered troubled debt restructurings. It is possible that the Company’s asset quality measures could worsen at future measurement periods if the effects of COVID-19 are prolonged and/or if the borrower is not able to recover as the economy rebounds.
Further information regarding the Company's accounting policies related to past due loans, non-accrual loans, collateral dependent loans and troubled debt restructurings is presented in Note 4 - Loans, Net and Allowance for Credit Losses on Loans.
The following table sets forth the allocation of the Company’s nonperforming assets among the Company’s different asset categories as of the dates indicated. The Company classifies nonperforming loans as nonaccrual loans, loans past due 90 days or more and still accruing interest or loans modified under restructurings as a result of the borrower experiencing financial difficulties. The balances of nonperforming loans reflect the net investment in these assets.
(dollars in thousands)
September 30, 2021
December 31, 2020
Nonaccrual loans
Commercial
$
44,712
$
25,898
Real estate:
Commercial real estate
34,291
20,040
Commercial construction, land and land development
25
32
Residential real estate
1,460
2,372
Agricultural
—
613
Consumer
43
42
Total nonaccrual loans (1)
80,531
48,997
Loans delinquent 90 days or more and still accruing
Commercial
77
433
Real estate:
Residential real estate
201
—
Consumer
2
—
Total loans delinquent 90 days or more and still accruing
280
433
Troubled debt restructurings, not included in nonaccrual loans
Real estate:
Commercial real estate
1,738
1,808
Residential real estate
165
178
Total troubled debt restructurings, not included in nonaccrual loans
1,903
1,986
Total nonperforming loans (2)
82,714
51,416
Other real estate owned and other repossessed assets:
Real estate:
Single family interim construction
—
475
Consumer
115
114
Total other real estate owned and other repossessed assets
115
589
Total nonperforming assets
$
82,829
$
52,005
Ratio of nonperforming loans to total loans held for investment (3)
0.72
%
0.44
%
Ratio of nonperforming assets to total assets
0.44
0.29
____________
(1) Nonaccrual loans include troubled debt restructurings of $1.1 million and $578 thousand at September 30, 2021 and December 31, 2020, respectively. Excludes loans acquired with deteriorated credit quality of $6.7 million as of December 31, 2020 presented under prior GAAP.
(2) Due to the adoption of CECL, amounts are shown at amortized cost, net of deferred loan fees at September 30, 2021.
(3) Excluding mortgage warehouse purchase loans of $977.8 million and $1.5 billion as of September 30, 2021 and December 31, 2020, respectively.
Nonaccrual loans increased to $80.5 million at September 30, 2021 from $49.0 million as of December 31, 2020. Troubled debt restructurings that were not on nonaccrual status totaled $1.9 million at September 30, 2021 and $2.0 million December 31, 2020. The increase in nonaccrual loans was primarily due to two commercial loan relationships totaling $17.8 million and one commercial real estate loan totaling $11.7 million, as well as the net addition of $7.1 million in purchased credit deteriorated (PCD) loans, which were excluded prior to CECL adoption, offset by payoffs and principal reductions as well as two charge-offs totaling $2.4 million during the period.
As of September 30, 2021, the Company had a total of 104 substandard and doubtful loans with an aggregate principal balance of $132.9 million that were not currently individually evaluated loans, nonaccrual loans, 90 days past due loans or troubled debt restructurings, but where the Company had information about possible credit problems of the borrowers that caused the Company’s management to have serious concerns as to the ability of the borrowers to comply with present loan repayment terms and that could result in those loans becoming nonaccrual loans, 90 days past due loans or troubled debt restructurings in the future.
The Company generally continues to use the classification of acquired loans classified as nonaccrual or 90 days and accruing as of the acquisition date. The Company does not classify acquired loans as troubled debt restructurings, or TDRs, unless the Company modifies an acquired loan subsequent to acquisition that meets the TDR criteria. Reported delinquency of the Company’s purchased loan portfolio is based upon the contractual terms of the loans.
Allowance for Credit Losses on Loans. As discussed elsewhere in this discussion and analysis, the Company adopted the CECL accounting standard on January 1, 2021 and has accounted for the allowance for credit losses under the CECL model for the three and nine months ended September 30, 2021. The Company applied the incurred loss methodology for estimating the allowance and applicable provision for all periods prior to 2021. The allowance is increased by provisions reported in the income statement as a component of provisions for credit losses. The allowance for credit losses on loans is a valuation account that is deducted from the amortized cost basis of loans to present management's best estimate of the net amount expected to be collected on the loans. Loans are charged against the allowance for credit losses when management believes that collectibility of the principal is unlikely. Subsequent recoveries, if any, are credited to the allowance. As of September 30, 2021, the allowance for credit losses on loans totaled $150.3 million, or 1.31% of total loans held for investment, excluding mortgage warehouse purchase loans and loans held for sale, compared with $87.8 million, or 0.76% as of December 31, 2020. The dollar and percentage increases from year end is primarily due to the adoption of CECL, which increased the allowance for credit losses on loans by $80.9 million offset by negative provision of $14.0 million and net charge-offs of $4.4 million for the nine month period.
The allowance for credit losses on loans to nonperforming loans has increased from 170.80% at December 31, 2020 to 181.69% at September 30, 2021, due primarily to the adoption of CECL offset by the increase in nonperforming loans from $51.4 million at December 31, 2020 to $82.7 million at September 30, 2021.
Securities Available for Sale
The Company’s investment strategy aims to maximize earnings while maintaining liquidity in securities with minimal credit, interest rate and duration risk. The types and maturities of securities purchased are primarily based on the Company’s current and projected liquidity and interest rate sensitivity positions.
The Company recognized no gains on the sale of securities for the three and nine months ended September 30, 2021, respectively, and a net gain of $0 and $382 thousand on the sale of securities for the three and nine month ended September 30, 2020, respectively. Securities represented 9.4% and 6.5% of the Company’s total assets at September 30, 2021 and December 31, 2020, respectively.
Certain investment securities are valued at less than their amortized cost. At September 30, 2021, the Company's review of all available for sale securities at an unrealized loss position determined that the losses resulted from factors not related to credit quality. This conclusion is based on the Company's analysis of the underlying risk characteristics, including credit ratings, and other qualitative factors for each security type in the portfolio. The unrealized losses are generally due to increases in market interest rates. Furthermore, the Company has the intent to hold these securities until maturity or a forecasted recovery, and it is more likely than not that the Company will not have to sell the securities before the recovery of their cost basis. The fair value is expected to recover as the securities approach their maturity date. As such, there is no allowance for credit losses on available for sale securities recognized as of September 30, 2021.
Capital Resources and Regulatory Capital Requirements
Total stockholder’s equity was $2.6 billion at September 30, 2021, an increase of approximately $51.3 million from December 31, 2020. The increase was primarily due to net income of $170.6 million earned by the Company during the nine months ended September 30, 2021 and stock based compensation of $8.0 million, offset by the day-one CECL transition adjustment to retained earnings of $53.9 million, net of tax, a decrease of $13.8 million in unrealized gain on available for sale securities, common stock repurchased of $17.9 million and dividends of $41.6 million.
In February 2019, the federal bank regulatory agencies issued a final rule that revised certain capital regulations under CECL and included a transition option that allows banking organizations to phase in, over a three-year period, the day-one adverse effects of CECL on their regulatory capital ratios (three-year transition option). The Company elected to adopt the three-year transition option and the deferral has been applied in the September 30, 2021 capital ratios presented below. As of September 30, 2021, the Company and the Bank exceeded the Basel III capital ratio requirements under prompt corrective action and other regulatory requirements, as detailed in the table below:
As of September 30, 2021
Actual Consolidated
Actual Bank
Required minimum capital - Basel III
Required to be considered well capitalized (Bank only)
Ratio
Ratio
Ratio
Ratio
Tier 1 capital to average assets ratio
8.94
%
10.48
%
4.00
%
≥5.00%
Common equity tier 1 capital to risk weighted assets ratio
11.06
13.44
7.00
≥6.50
Tier 1 capital to risk weighted assets ratio
11.46
13.44
8.50
≥8.00
Total capital to risk weighted assets ratio
13.64
14.14
10.50
≥10.00
Stock Repurchase Program. From time to time, the Company's board of directors has authorized stock repurchase programs which allow the Company to purchase its common stock generally over a one-year period at various prices in the open market or in privately negotiated transactions. On October 22, 2020, the Company's board of directors authorized a $150 million stock repurchase program allowing the Company to purchase shares of its common stock through October 31, 2021. On August 26, 2021, the Company extended the stock repurchase program through December 31, 2021. Under this program, the Company has repurchased an aggregate 351,069 shares at a total cost of $22.5 million including 241,521 shares repurchased during 2021 at a total cost of $16.9 million through October 26, 2021. In July 2019, the federal bank regulators adopted final rules that, among other things, eliminated the standalone prior approval requirement for any repurchase of common stock. However, the Company remains subject to a Federal Reserve Board guideline that requires consultation with the Federal Reserve regarding plans for share repurchases. The Company’s repurchases of its common stock may be subject to a prior approval or notice requirement under other regulations, policies or supervisory expectations of the Federal Reserve Board. The Federal Reserve Board has approved share repurchases through the remainder of 2021. See Part II, Item 2 - Unregistered Sales of Equity and Use of Proceeds, in this report for additional information.
Liquidity Management
The Company continuously monitors the Company’s liquidity position to ensure that assets and liabilities are managed in a manner that will meet all of the Company’s short-term and long-term cash requirements. The Company manages the Company’s liquidity position to meet the daily cash flow needs of customers, while maintaining an appropriate balance between assets and liabilities to meet the return on investment objectives of the Company’s shareholders. The Company also monitors its liquidity requirements in light of interest rate trends, changes in the economy and the scheduled maturity and interest rate sensitivity of the investment and loan portfolios and deposits.
Liquidity risk management is an important element in the Company’s asset/liability management process. The Company’s short-term and long-term liquidity requirements are primarily to fund on-going operations, including payment of interest on deposits and debt, extensions of credit to borrowers, capital expenditures and shareholder dividends. These liquidity requirements are met primarily through cash flow from operations, redeployment of pre-paid and maturing balances in the Company’s loan and investment portfolios, debt financing and increases in customer deposits. The Company’s liquidity position is supported by management of liquid assets and liabilities and access to alternative sources of funds. Liquid assets include cash, interest-bearing deposits in banks, federal funds sold, securities available for sale and maturing or prepaying balances in the Company’s investment and loan portfolios. Liquid liabilities include core deposits, brokered deposits, federal funds purchased, securities sold under repurchase agreements and other borrowings. Other sources of liquidity include the sale of loans, the ability to acquire additional national market non-core deposits, the issuance of additional collateralized borrowings such as FHLB advances, the issuance of debt securities, borrowings through the Federal Reserve’s discount window and the issuance of equity securities. For additional information regarding the Company’s operating, investing and financing cash flows, see theConsolidated Statements of Cash Flowsprovided in the Company’s consolidated financial statements.
In addition to the liquidity provided by the sources described above, the Company maintains correspondent relationships with other banks in order to sell loans or purchase overnight funds should additional liquidity be needed. As of September 30, 2021, the Company had established federal funds lines of credit with 11 unaffiliated banks totaling $400.0 million with no borrowings against the lines at that time. The Company also participates in an exchange that provides direct overnight borrowings with other financial institutions with a borrowing capacity of $819.0 million with none outstanding as of September 30, 2021. The Company has an unsecured line of credit totaling $100.0 million with an unrelated commercial bank with $15.5 million borrowings against the line as of September 30, 2021. Based on the values of stock, securities, and loans pledged as collateral, as of September 30, 2021, the Company had additional borrowing capacity with the FHLB of $3.9 billion. In addition, the Company maintains a secured line of credit with the Federal Reserve Bank with availability to borrow $796.3 million at September 30, 2021.
Contractual Obligations
In the ordinary course of the Company’s operations, the Company enters into certain contractual obligations, such as obligations for operating leases and other arrangements with respect to deposit liabilities, FHLB advances and other borrowed funds. The Company believes that it will be able to meet its contractual obligations as they come due through the maintenance of adequate cash levels. The Company expects to maintain adequate cash levels through profitability, loan and securities repayment and maturity activity and continued deposit gathering activities. The Company has in place various borrowing mechanisms for both short-term and long-term liquidity needs.
On July 20, 2021, the Company redeemed $40 million in subordinated debentures at a redemption price equal to 100% of the principal amount plus accrued and unpaid interest.
Other than normal changes in the ordinary course of business and the redemption above, there have been no significant changes in the types of contractual obligations or amounts due since December 31, 2020.
Off-Balance Sheet Arrangements
In the normal course of business, the Company enters into various transactions, which, in accordance with accounting principles generally accepted in the United States, are not included in the Company’s consolidated balance sheets. However, the Company has only limited off-balance sheet arrangements that have, or are reasonably likely to have, a current or future material effect on the Company’s financial condition, revenues, expenses, results of operations, liquidity, capital expenditures or capital resources. The Bank enters into these transactions to meet the financing needs of the Company’s customers. These transactions include commitments to extend credit and issue standby letters of credit, which involve, to varying degrees, elements of credit risk and interest rate risk in excess of the amounts recognized in the consolidated balance sheets.
Commitments to Extend Credit. The Bank enters into contractual commitments to extend credit, normally with fixed expiration dates or termination clauses, at specified rates and for specific purposes. Substantially all of the Bank’s commitments to extend credit are contingent upon customers maintaining specific credit standards at the time of loan funding. The Bank minimizes its exposure to loss under these commitments by subjecting them to credit approval and monitoring procedures.
Standby Letters of Credit. Standby letters of credit are written conditional commitments that the Bank issues to guarantee the performance of a customer to a third party. In the event that the customer does not perform in accordance with the terms of the agreement with the third party, the Bank would be required to fund the commitment. The maximum potential amount of future payments the Bank could be required to make is represented by the contractual amount of the commitment. If the commitment is funded, the customer is obligated to reimburse the Bank for the amount paid under this standby letter of credit.
Commitments to extend credit and outstanding standby letters of credit were $2.7 billion and $31.2 million, respectively, as of September 30, 2021. Since commitments associated with letters of credit and commitments to extend credit may expire unused, the amounts shown do not necessarily reflect the actual future cash funding requirements. The Company manages the Company’s liquidity in light of the aggregate amounts of commitments to extend credit and outstanding standby letters of credit in effect from time to time to ensure that the Company will have adequate sources of liquidity to fund such commitments and honor drafts under such letters of credit.
Allowance for Credit Losses on Off-Balance Sheet Credit Exposures. The allowance for credit losses on off-balance sheet credit exposures is calculated under the CECL model, representing expected credit losses over the contractual period for which the Company is exposed to credit risk resulting from a contractual obligation to extend credit. Off-balance sheet credit exposures primarily consist of amounts available under outstanding lines of credit and letters of credit detailed below. The allowance for credit losses on off-balance sheet credit exposures is estimated by loan segment at each balance sheet date using the same methodologies as portfolio loans, taking into consideration the likelihood that funding will occur based on historical utilization rates. At September 30, 2021, the allowance for credit losses on off-balance sheet credit exposures was $6.1 million.
Critical Accounting Policies and Estimates
The preparation of the Company’s consolidated financial statements in accordance with U.S. generally accepted accounting principles, or GAAP, requires the Company to make estimates and judgments that affect the Company’s reported amounts of assets, liabilities, income and expenses and related disclosure of contingent assets and liabilities. The Company bases its estimates on historical experience and on various other assumptions that are believed to be reasonable under current circumstances, results of which form the basis for making judgments about the carrying value of certain assets and liabilities that are not readily available from other sources. The Company evaluates its estimates on an ongoing basis. Actual results may differ from these estimates under different assumptions or conditions.
Accounting policies, as described in detail in the notes to the Company’s audited consolidated financial statements, are an integral part of the Company’s financial statements. A thorough understanding of these accounting policies is essential when reviewing the Company’s reported results of operations and the Company’s financial position. The Company believes that the critical accounting policies and estimates discussed below require the Company to make difficult, subjective or complex judgments about matters that are inherently uncertain. Changes in these estimates, that are likely to occur from period to period, or the use of different estimates that the Company could have reasonably used in the current period, would have a material impact on the Company’s financial position, results of operations or liquidity.
Acquired loans. Loans acquired in connection with a business combination are recorded at their acquisition-date fair value. The allowance for credit losses related to the acquired loan portfolio is not carried over. Acquired loans are classified into two categories based on the credit risk characteristics of the underlying borrowers as either PCD loans, or non-PCD.
PCD loans are defined as a loan or pool of loans that have experienced more-than-insignificant credit deterioration since the origination date. For PCD loans, an initial allowance is established on the acquisition date using the same methodology as other loans held for investment and combined with the fair value of the loan to arrive at acquisition date amortized cost. Accordingly, no provision for credit losses is recognized on PCD loans at the acquisition date. Subsequent to the acquisition date, changes to the allowance are recognized in the provision for credit losses.
Non-PCD loans are pooled into segments together with originated held for investment loans that share similar risk characteristics and have an allowance established on the acquisition date, which is recognized in the current period provision for credit losses.
Determining the fair value of the acquired loans involves estimating the principal and interest payment cash flows expected to be collected on the loans and discounting those cash flows at a market rate of interest. For PCD loans, the non-credit discount or premium is allocated to individual loans as determined by the difference between the loan’s unpaid principal balance and amortized cost basis. The non-credit premium or discount is recognized into interest income on a level yield basis over the remaining expected life of the loan. For non-PCD loans, the fair value discount or premium is allocated to individual loans and recognized into interest income on a level yield basis over the remaining expected life of the loan.
Prior to January 1, 2021, loans acquired in a business combination that had evidence of credit impairment and for which it was probable, at acquisition, that the Company would be unable to collect all contractually required payments receivable were considered PCI. PCI loans were accounted for individually or aggregated into pools of loans based on common risk characteristics such as credit grade, loan type, and date of origination.
Allowance For Credit Losses on Loans. In accordance with ASC 326, the allowance for credit losses on loans is a valuation account that is deducted from the amortized cost basis of loans to present management's best estimate of the net amount expected to be collected on the loans. Loans are charged against the allowance for credit losses when management believes that collectability of the principal is unlikely. Subsequent recoveries, if any, are credited to the allowance. The allowance is increased by provisions reported in the income statement as a component of provisions for credit loss. Management has made the accounting policy election to exclude accrued interest receivable on loans from the estimate of credit losses and reports accrued interest separately in other assets in the consolidated balance sheets. Further information regarding our policies and methodology used to estimate the allowance for credit losses on loans is presented in Note 4 - Loans, Net and Allowance for Credit Losses on Loans.
Goodwill and Other Intangible Assets. The excess purchase price over the fair value of net assets from acquisitions, or goodwill, is evaluated for impairment at least annually and on an interim basis if an event or circumstance indicates that it is likely an impairment has occurred. The Company first assesses qualitative factors to determine whether the existence of events or circumstances leads to a determination that it is more likely than not that the fair value of a reporting unit is less than its carrying amount. If, after assessing the totality of events or circumstances, the Company determines it is not more likely than not that the fair value of a reporting unit is less than its carrying amount, then performing a quantitative impairment test is unnecessary. If the Company concludes otherwise, then it is required to perform an impairment test by calculating the fair value of the reporting unit and comparing the fair value with the carrying amount of the reporting unit. The Company performs its impairment test annually as of December 31. There have been no circumstances since December 31, 2020 that would indicate any impairment has occurred, therefore, management does not believe goodwill is impaired as of September 30, 2021.
Determining the fair value of goodwill is considered a critical accounting estimate because the allocation of the fair value of goodwill to assets and liabilities requires significant management judgment and the use of subjective measurements. Variability in the market and changes in assumptions or subjective measurements used to allocate fair value are reasonably possible and may have a material impact on the Company’s financial position, liquidity or results of operations.
Core deposit intangibles and other acquired customer relationship intangibles lack physical substance but can be distinguished from goodwill because of contractual or other legal rights or because the asset is capable of being sold or exchanged either on its own or in combination with a related contract, asset, or liability. Other intangible assets are being amortized on a straight-line basis over their estimated useful lives ranging from ten to thirteen years. Other intangible assets are tested for impairment whenever events or changes in circumstances indicate the carrying amount of the assets may not be recoverable from future undiscounted cash flows. If impaired, the assets are recorded at fair value.
Recently Issued Accounting Pronouncements
The Company has evaluated new accounting pronouncements that have recently been issued and have determined that there are no new accounting pronouncements that should be described in this section that will materially impact the Company’s operations, financial condition or liquidity in future periods. Refer to Note 1 - Summary of Significant Accounting Policies, of the Company’s consolidated financial statements for a discussion of recent accounting pronouncements that have been adopted by the Company or that will require enhanced disclosures in the Company’s financial statements in future periods.
ITEM 3.QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The principal objective of the Company’s asset and liability management function is to evaluate the interest rate risk within the balance sheet and pursue a controlled assumption of interest rate risk while maximizing net income and preserving adequate levels of liquidity and capital. The Risk Oversight Committee of the Board of Directors has oversight of the asset and liability management function, which is managed by the Company's Treasurer. The Treasurer meets with our Chief Financial Officer and senior executive management team regularly to review, among other things, the sensitivity of the Company’s assets and liabilities to market interest rate changes, local and national market conditions and market interest rates. That group also reviews the liquidity, capital, deposit mix, loan mix and investment positions of the Company.
The Company's management and the Board of Directors are responsible for managing interest rate risk and employing risk management policies that monitor and limit the Company's exposure to interest rate risk. Interest rate risk is measured using net interest income simulations and market value of portfolio equity analyses. These analyses use various assumptions, including the nature and timing of interest rate changes, yield curve shape, prepayments on loans, securities and deposits, deposit decay rates, pricing decisions on loans and deposits, reinvestment and replacement of asset and liability cash flows.
Instantaneous parallel rate shift scenarios are modeled and utilized to evaluate risk and establish exposure limits for acceptable changes in net interest margin. These scenarios, known as rate shocks, simulate an instantaneous change in interest rates and use various assumptions, including, but not limited to, prepayments on loans and securities, deposit decay rates, pricing decisions on loans and deposits, reinvestment and replacement of asset and liability cash flows.
The Company also analyzes the economic value of equity as a secondary measure of interest rate risk. This is a complementary measure to net interest income where the calculated value is the result of the market value of assets less the market value of liabilities. The economic value of equity is a longer term view of interest rate risk because it measures the present value of the future cash flows. The impact of changes in interest rates on this calculation is analyzed for the risk to the Company's future earnings and is used in conjunction with the analyses on net interest income.
The Company conducts periodic analyses of its sensitivity to interest rate risks through the use of a third-party proprietary interest-rate sensitivity model. That model has been customized to the Company's specifications. The analyses conducted by use of that model are based on current information regarding the Company's actual interest-earnings assets, interest-bearing liabilities, capital and other financial information that it supplies. The Company uses the information in the model to estimate the its sensitivity to interest rate risk.
The Company's interest rate risk model indicated that it was in an asset sensitive position in terms of interest rate sensitivity as of September 30, 2021. The table below illustrates the impact of an immediate and sustained 200 and 100 basis point increase and a 100 basis point decrease in interest rates on net interest income based on the interest rate risk model as of September 30, 2021:
Hypothetical Shift in Interest Rates (in bps)
% Change in Projected Net Interest Income
200
15.46%
100
7.33
(100)
(3.71)
The Company's model indicates that its projected balance sheet at September 30, 2021 is more asset sensitive in comparison to its balance sheet as of December 31, 2020 and prior periods. The shift to a more asset sensitive position was primarily due to an increase in the relative proportion of interest bearing deposits (primarily amounts held in an interest-bearing account at the Federal Reserve). Interest-bearing deposits are more immediately impacted by changes in interest rates in comparison to our other categories of earning assets.
These are good faith estimates and assume that the composition of the Company's interest sensitive assets and liabilities existing at each period-end and is based on future maturities and market pricing over the relevant twelve month measurement period and that changes in market interest rates are instantaneous and sustained across the yield curve regardless of duration of pricing characteristics of specific assets or liabilities. Also, this analysis does not contemplate any actions that the Company might undertake in response to changes in market interest rates. The Company believes these estimates are not necessarily indicative of what actually could occur in the event of immediate interest rate increases or decreases of this magnitude. As interest-bearing assets and liabilities re-price in different time frames and proportions to market interest rate movements, various assumptions must be made based on historical relationships of these variables in reaching any conclusion. Since these correlations are based on competitive and market conditions, the Company anticipates that our future results will likely be different from the foregoing estimates, and such differences could be material.
ITEM 4.CONTROLS AND PROCEDURES
Evaluation of disclosure controls and procedures. An evaluation of the effectiveness of the design and operation of our disclosure controls and procedures as of the end of the period covered by this Quarterly Report on Form 10-Q was performed under the supervision and with the participation of management, including its Chief Executive Officer and Chief Financial Officer. Based upon that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that the Company's disclosure controls and procedures are effective to provide reasonable assurance that information required to be disclosed by the Company in the reports that it files or submits under the Securities Exchange Act of 1934, as amended, is accumulated and communicated to management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure and are effective to provide reasonable assurance that such information is recorded, processed, summarized and reported within the time periods specified by the SEC's rules and forms.
All internal control systems, no matter how well designed, have inherent limitations. Therefore, even those systems determined to be effective can provide only reasonable assurance with respect to financial statement preparation and presentation.
Changes in internal control over financial reporting. There were no changes in the Company’s internal control over financial reporting during the period covered by this report that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.
In the normal course of business, the Company and the Bank are named as defendants in various lawsuits. Management of the Company and the Bank, following consultation with legal counsel, do not expect the ultimate disposition of any, or a combination, of these matters to have a material adverse effect on the business of the Company or the Bank. A legal proceeding that the Company believes could become material is described below.
The Bank is a party to a legal proceeding inherited in connection with the Company's acquisition of BOH Holdings, Inc. and its subsidiary, Bank of Houston, or BOH, that was completed on April 15, 2014. Several entities related to R. A. Stanford, or the Stanford Entities, including Stanford International Bank, Ltd., or SIBL, had deposit accounts at BOH. Certain individuals who had purchased certificates of deposit from SIBL filed a class action lawsuit against several banks, including BOH, on November 11, 2009 in the U.S. District Court Northern District of Texas, Dallas Division, in a case styled Peggy Roif Rotstain, et al. on behalf of themselves and all others similarly situated, v. Trustmark National Bank, et al., Civil Action No. 3:09-CV-02384-N-BG. The suit alleges, among other things, that the plaintiffs were victims of fraud by SIBL and other Stanford Entities and seeks to recover damages and alleged fraudulent transfers by the defendant banks.
On May 1, 2015, the plaintiffs filed a motion requesting permission to file a Second Amended Class Action Complaint in this case, which motion was subsequently granted. The Second Amended Class Action Complaint presents previously unasserted claims, including aiding and abetting or participation in a fraudulent scheme based upon the large amount of deposits that the Stanford Entities held at BOH and the alleged knowledge of certain BOH officers. The plaintiffs seek recovery from the Bank and other defendants for their losses. The case was inactive due to a court-ordered discovery stay issued March 2, 2015 pending the Court’s ruling on plaintiff’s motion for class certification and designation of class representatives and counsel. On November 7, 2017, the Court issued an order denying the plaintiff’s motion. In addition, the Court lifted the previously ordered discovery stay. On January 11, 2018, the Court entered a scheduling order providing that the case be ready for trial on January 27, 2020. Due to agreed upon extensions of discovery on July 25, 2019, the Court amended the scheduling order to provide that the case be ready for trial on January 11, 2021. In light of additional agreed upon extensions of discovery deadlines, the Court entered a new scheduling order on March 9, 2020, which now provides that the case be ready for trial March 15, 2021. In light of delays in discovery associated with the COVID-19 pandemic, the parties agreed to amend the scheduling order with new ready for trial date of May 6, 2021. On September 10, 2020, Defendants filed a motion for suggestion of remand in order to remand the case to the Southern District of Texas. On March 11, 2021, Defendants filed a motion to amend the scheduling order, which was granted, effectively vacating the May 6, 2021 trial date, with a new trial date to be determined upon remand. On April 5, 2021, Defendants re-urged the motion for suggestion of remand, the outcome of which is still pending. In February 2021, the Bank filed its motion for summary judgment and also joined in on an omnibus motion for summary judgment on procedural issues common to all Defendants. In their reply brief, plaintiffs appear to have abandoned five of the seven causes of action against BOH. Parties are awaiting a ruling on the summary judgment briefing to determine the final causes of action to be addressed at trial. The Company has experienced an increase in legal fees associated with the defense of this claim and anticipates further increases in legal fees as the case proceeds to trial.
The Bank notified its insurance carriers of the claims made in the Second Amended Complaint. The insurance carriers have initially indicated that the claims are not covered by the policies or that a “loss” has not yet occurred. The Bank pursued insurance coverage as well as reimbursement of defense costs through the initiation of litigation and other means. On November 6, 2018, the Company settled claims under its Financial Institutions Select Policy pursuant to which the Company received payment of an amount which is not material to the operations of the Company. The Company did not settle any claims under its Financial Institution Bond Policy.
The Company believes that the claims made in this lawsuit are without merit and is vigorously defending this lawsuit. This is complex litigation involving a number of procedural matters and issues. As such, the Company is unable to predict when this matter may be resolved and, given the uncertainty of litigation, the ultimate outcome of, or potential costs or damages arising from, this case.
In evaluating an investment in the Company's common stock, investors should consider carefully, among other things, the risk factors previously disclosed in Part I, Item 1A of our Annual Report on Form 10-K for the year ended December 31, 2020,and in the information contained in this Quarterly Report on Form 10-Q and our other reports and registration statements.
Item 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
Purchases of Equity Securities by the Issuer and Affiliated Purchasers
Share Repurchase Program. The Company established a share repurchase program which allows the Company to purchase its common stock in the open market or in privately negotiated transactions. In general, the share repurchase program allows the Company to proactively manage its capital position and return excess capital to shareholders. On October 22, 2020, the Company's board of directors authorized a $150.0 million stock repurchase program allowing the Company to purchase shares of its common stock through October 31, 2021. On August 26, 2021, the Company extended the stock repurchase program through December 31, 2021. Under this program, the Company repurchased 109,548 shares at a total cost of $5.7 million through 2020, and 217,772 shares at a total cost of $15.2 million during the nine months endedSeptember 30, 2021.
The following table summarizes the Company's repurchase activity during the three months ended September 30, 2021:
Total Number of Shares Purchased (1)
Average Price Paid Per Share
Total Number of Shares Purchased as Part of Publicly Announced Repurchase Plan
Maximum Dollar Value of Shares that May Yet Be Purchased Under the Plan (thousands)
Total first quarter 2021
22,835
$
65.17
—
$
144,344
Total second quarter 2021
2,376
74.77
—
144,344
July 2021
56,714
70.78
43,785
141,281
August 2021
174,999
69.77
173,987
129,143
September 2021
356
67.80
—
129,143
Total third quarter 2021
232,069
70.02
217,772
129,143
Total 2021 year-to-date
257,280
$
69.63
217,772
$
129,143
____________
(1) Includes 39,508 shares purchased to settle employee tax withholding related to vesting of restricted stock awards. These transactions are not considered part of the Company's repurchase program.
XBRL Instance Document-the XBRL Instance Document does not appear in the Interactive Data File because its XBRL tags are embedded within the Inline XBRL document.
Cover page from the Company’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2021 is formatted as Inline XBRL and contained within Inline XBRL Instance Document in Exhibit 101.
*
Filed herewith.
**
Furnished herewith (such certification shall not be deemed “filed” for purposes of Section 18 of the Securities Exchange Act of 1934, as amended, except to the extent that the Company specifically incorporates it by reference)
67
Signatures
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
