Form 10-Q
Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-Q

 

 

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF

THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2014

Commission file number 0-7674

 

 

FIRST FINANCIAL BANKSHARES, INC.

(Exact name of registrant as specified in its charter)

 

 

 

Texas   75-0944023
(State or other jurisdiction of incorporation   (I.R.S. Employer
or organization)   Identification No.)
400 Pine Street, Abilene, Texas   79601
(Address of principal executive offices)   (Zip Code)

(325) 627-7155

(Registrant’s telephone number, including area code)

 

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    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 Regulations 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  x    No  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer   x    Accelerated filer   ¨
Non-accelerated filer   ¨  (Do not check if a smaller reporting company)    Smaller reporting company   ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).    Yes  ¨    No  x

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date:

 

Class

 

Outstanding at November 4, 2014

Common Stock, $0.01 par value per share   64,065,828

 

 

 


Table of Contents

TABLE OF CONTENTS

PART I

FINANCIAL INFORMATION

 

Item

       Page  

1.

  Financial Statements      3   
 

Consolidated Balance Sheets – Unaudited

     4   
 

Consolidated Statements of Earnings – Unaudited

     5   
 

Consolidated Statements of Comprehensive Earnings – Unaudited

     6   
 

Consolidated Statements of Shareholders’ Equity – Unaudited

     7   
 

Consolidated Statements of Cash Flows – Unaudited

     8   
 

Notes to Consolidated Financial Statements – Unaudited

     9   

2.

  Management’s Discussion and Analysis of Financial Condition and Results of Operations      30   

3.

  Quantitative and Qualitative Disclosures About Market Risk      47   

4.

  Controls and Procedures      47   
PART II   
OTHER INFORMATION   

1.

  Legal Proceedings      49   

1A.

  Risk Factors      49   

2.

  Unregistered Sales of Equity Securities and Use of Proceeds      49   

3.

  Defaults Upon Senior Securities      49   

4.

  Mine Safety Disclosures      49   

5.

  Other Information      49   

6.

  Exhibits      50   
  Signatures      51   

 

2


Table of Contents

PART I

FINANCIAL INFORMATION

Item 1. Financial Statements.

The consolidated balance sheets of First Financial Bankshares, Inc. (the “Company”) at September 30, 2014 and 2013 and December 31, 2013, and the consolidated statements of earnings and comprehensive earnings for the three and nine months ended September 30, 2014 and 2013, and the consolidated statements of shareholders’ equity and cash flows for the nine months ended September 30, 2014 and 2013, follow on pages 4 through 8.

 

3


Table of Contents

FIRST FINANCIAL BANKSHARES, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(Dollars in thousands, except per share amounts)

 

     September 30, 2014     December 31,  
     2014     2013     2013  
     (Unaudited)        

ASSETS

    

CASH AND DUE FROM BANKS

   $ 149,957      $ 164,666      $ 183,084   

FEDERAL FUNDS SOLD

     4,785        14,300        3,430   

INTEREST-BEARING DEPOSITS IN BANKS

     83,994        48,634        25,498   
  

 

 

   

 

 

   

 

 

 

Total cash and cash equivalents

     238,736        227,600        212,012   

INTEREST-BEARING TIME DEPOSITS IN BANKS

     19,234        34,352        31,917   

SECURITIES AVAILABLE-FOR-SALE, at fair value

     2,253,762        1,975,303        2,057,723   

SECURITIES HELD-TO-MATURITY (fair value of $560, $810 and $694 at September 30, 2014 and 2013, and December 31, 2013, respectively)

     554        798        684   

LOANS

      

Held for investment

     2,828,430        2,609,085        2,684,285   

Less - allowance for loan losses

     (36,388     (34,800     (33,900
  

 

 

   

 

 

   

 

 

 

Net loans held for investment

     2,792,042        2,574,285        2,650,385   

Held for sale

     11,266        5,724        5,163   
  

 

 

   

 

 

   

 

 

 

Net loans

     2,803,308        2,580,009        2,655,548   

BANK PREMISES AND EQUIPMENT, net

     101,437        94,676        95,505   

INTANGIBLE ASSETS

     97,429        97,429        97,485   

OTHER ASSETS

     61,351        65,468        71,334   
  

 

 

   

 

 

   

 

 

 

Total assets

   $ 5,575,811      $ 5,075,635      $ 5,222,208   
  

 

 

   

 

 

   

 

 

 

LIABILITIES AND SHAREHOLDERS’ EQUITY

      

NONINTEREST-BEARING DEPOSITS

   $ 1,505,847      $ 1,371,835      $ 1,362,184   

INTEREST-BEARING DEPOSITS

     2,958,517        2,628,722        2,772,891   
  

 

 

   

 

 

   

 

 

 

Total deposits

     4,464,364        4,000,557        4,135,075   

DIVIDENDS PAYABLE

     8,969        8,314        8,318   

SHORT-TERM BORROWINGS

     341,909        466,500        463,888   

OTHER LIABILITIES

     101,804        32,023        27,280   
  

 

 

   

 

 

   

 

 

 

Total liabilities

     4,917,046        4,507,394        4,634,561   
  

 

 

   

 

 

   

 

 

 

COMMITMENTS AND CONTINGENCIES

      

SHAREHOLDERS’ EQUITY

      

Common stock - $0.01 par value, authorized 80,000,000 shares; 64,065,828, 31,977,670, and 31,992,497 shares issued at September 30, 2014 and 2013, and December 31, 2013, respectively

     641        320        320   

Capital surplus

     304,866        302,320        302,991   

Retained earnings

     314,363        261,052        273,972   

Treasury stock (shares at cost: 532,256, 269,334, and 269,467 at September 30, 2014 and 2013, and December 31, 2013, respectively)

     (5,797     (5,364     (5,490

Deferred compensation

     5,797        5,364        5,490   

Accumulated other comprehensive earnings

     38,895        4,549        10,364   
  

 

 

   

 

 

   

 

 

 

Total shareholders’ equity

     658,765        568,241        587,647   
  

 

 

   

 

 

   

 

 

 

Total liabilities and shareholders’ equity

   $ 5,575,811      $ 5,075,635      $ 5,222,208   
  

 

 

   

 

 

   

 

 

 

See notes to consolidated financial statements.

 

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Table of Contents

FIRST FINANCIAL BANKSHARES, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF EARNINGS - (UNAUDITED)

(Dollars in thousands, except per share amounts)

 

     Three Months Ended September 30,     Nine Months Ended September 30,  
     2014      2013     2014     2013  

INTEREST INCOME:

         

Interest and fees on loans

   $ 34,682       $ 32,936      $ 101,586      $ 88,260   

Interest on investment securities:

         

Taxable

     6,858         6,130        21,032        18,818   

Exempt from federal income tax

     8,335         7,480        24,543        21,122   

Interest on federal funds sold and interest-bearing deposits in banks

     80         109        257        405   
  

 

 

    

 

 

   

 

 

   

 

 

 

Total interest income

     49,955         46,655        147,418        128,605   

INTEREST EXPENSE:

         

Interest on deposits

     999         1,038        2,894        2,758   

Other

     70         126        249        256   
  

 

 

    

 

 

   

 

 

   

 

 

 

Total interest expense

     1,069         1,164        3,143        3,014   
  

 

 

    

 

 

   

 

 

   

 

 

 

Net interest income

     48,886         45,491        144,275        125,591   

PROVISION FOR LOAN LOSSES

     896         1,349        3,710        2,582   
  

 

 

    

 

 

   

 

 

   

 

 

 

Net interest income after provision for loan losses

     47,990         44,142        140,565        123,009   
  

 

 

    

 

 

   

 

 

   

 

 

 

NONINTEREST INCOME:

         

Trust fees

     4,772         4,138        13,897        11,884   

Service charges on deposit accounts

     4,402         4,798        12,623        13,009   

ATM, interchange and credit card fees

     5,093         4,404        14,291        12,315   

Real estate mortgage operations

     1,813         2,008        4,174        5,149   

Net gain (loss) on sale of available-for-sale securities (includes $1 and ($108) for the three months ended September 30, 2014 and 2013, respectively, and ($4) and $147 for the nine months ended September 30, 2014 and 2013, respectively, related to accumulated other comprehensive earnings reclassification

     1         (108     (4     147   

Net gain (loss) on sale of foreclosed assets

     305         36        804        (263

Other

     938         1,799        3,816        4,019   
  

 

 

    

 

 

   

 

 

   

 

 

 

Total noninterest income

     17,324         17,075        49,601        46,260   

NONINTEREST EXPENSE:

         

Salaries and employee benefits

     17,950         17,501        52,638        48,831   

Net occupancy expense

     2,297         2,164        6,804        5,995   

Equipment expense

     2,758         2,490        8,045        7,146   

FDIC insurance premiums

     693         640        2,035        1,781   

ATM, interchange and credit card expenses

     1,819         1,474        4,995        4,161   

Professional and service fees

     1,205         1,363        3,249        3,198   

Printing, stationery and supplies

     632         534        1,960        1,504   

Amortization of intangible assets

     62         77        210        120   

Other

     6,624         9,291        21,553        20,181   
  

 

 

    

 

 

   

 

 

   

 

 

 

Total noninterest expense

     34,040         35,534        101,489        92,917   
  

 

 

    

 

 

   

 

 

   

 

 

 

EARNINGS BEFORE INCOME TAXES

     31,274         25,683        88,677        76,352   

INCOME TAX EXPENSE (includes $0 and ($38) for the three months ended September 30, 2014 and 2013, respectively, and ($1) and $51 for the nine months ended September 30, 2014 and 2013, respectively, related to income tax expense from reclassification items)

     7,843         6,121        21,705        18,723   
  

 

 

    

 

 

   

 

 

   

 

 

 

NET EARNINGS

   $ 23,431       $ 19,562      $ 66,972      $ 57,629   
  

 

 

    

 

 

   

 

 

   

 

 

 

EARNINGS PER SHARE, BASIC

   $ 0.37       $ 0.31      $ 1.05      $ 0.91   
  

 

 

    

 

 

   

 

 

   

 

 

 

EARNINGS PER SHARE, ASSUMING DILUTION

   $ 0.36       $ 0.30      $ 1.04      $ 0.90   
  

 

 

    

 

 

   

 

 

   

 

 

 

DIVIDENDS PER SHARE

   $ 0.14       $ 0.13      $ 0.41      $ 0.39   
  

 

 

    

 

 

   

 

 

   

 

 

 

See notes to consolidated financial statements.

 

5


Table of Contents

FIRST FINANCIAL BANKSHARES, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF COMPREHENSIVE EARNINGS - (UNAUDITED)

(Dollars in thousands)

 

     Three Months Ended September 30,     Nine Months Ended September 30,  
     2014     2013     2014     2013  

NET EARNINGS

   $ 23,431      $ 19,562      $ 66,972      $ 57,629   

OTHER ITEMS OF COMPREHENSIVE EARNINGS:

        

Change in unrealized gain (loss) on investment securities available-for-sale, before income taxes

     5,707        (29,688     43,889        (71,791

Reclassification adjustment for realized losses (gains) on investment securities included in net earnings, before income tax

     (1     108        4        (147
  

 

 

   

 

 

   

 

 

   

 

 

 

Total other items of comprehensive earnings (losses)

     5,706        (29,580     43,893        (71,938

Income tax benefit (expense) related to other items of comprehensive earnings

     (1,997     10,352        (15,362     25,178   
  

 

 

   

 

 

   

 

 

   

 

 

 

COMPREHENSIVE EARNINGS:

   $ 27,140      $ 334      $ 95,503      $ 10,869   
  

 

 

   

 

 

   

 

 

   

 

 

 

See notes to consolidated financial statements.

 

6


Table of Contents

FIRST FINANCIAL BANKSHARES, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY

(Dollars in thousands, except per share amounts)

 

     Common Stock      Capital
Surplus
     Retained
Earnings
    Treasury Stock     Deferred
Compensation
     Accumulated
Other
Comprehensive
Earnings
    Total
Shareholders’
Equity
 
     Shares      Amount           Shares     Amounts         

Balances at December 31, 2012

     31,496,881       $ 315       $ 277,412       $ 227,927        (266,845   $ (5,007   $ 5,007       $ 51,309      $ 556,963   

Net earnings (unaudited)

     —           —           —           57,629        —          —          —           —          57,629   

Stock issued in acquisition of Orange Savings Bank, SSB (unaudited)

     420,000         4         23,096         —          —          —          —           —          23,100   

Stock option exercises (unaudited)

     60,789         1         1,518         —          —          —          —           —          1,519   

Cash dividends declared, $0.39 per share (unaudited)

     —           —           —           (24,504     —          —          —           —          (24,504

Change in unrealized gain in investment securities available-for-sale, net of related income taxes (unaudited)

     —           —           —           —          —          —          —           (46,760     (46,760

Additional tax benefit related to directors’ deferred compensation plan (unaudited)

     —           —           30         —          —          —          —           —          30   

Shares purchased in connection with directors’ deferred compensation plan, net (unaudited)

     —           —           —           —          (2,489     (357     357         —          —     

Stock option expense (unaudited)

     —           —           264         —          —          —          —           —          264   
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

   

 

 

   

 

 

    

 

 

   

 

 

 

Balances at September 30, 2013 (unaudited)

     31,977,670       $ 320       $ 302,320       $ 261,052        (269,334   $ (5,364   $ 5,364       $ 4,549      $ 568,241   
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

   

 

 

   

 

 

    

 

 

   

 

 

 

Balances at December 31, 2013

     31,992,497       $ 320       $ 302,991       $ 273,972        (269,467   $ (5,490   $ 5,490       $ 10,364      $ 587,647   

Net earnings (unaudited)

     —           —           —           66,972        —          —          —           —          66,972   

Stock option exercises (unaudited)

     50,571         1         1,076         —          —          —          —           —          1,077   

Cash dividends declared, $0.41 per share (unaudited)

     —           —           —           (26,261     —          —          —           —          (26,261

Change in unrealized gain in investment securities available-for-sale, net of related income taxes (unaudited)

     —           —           —           —          —          —          —           28,531        28,531   

Additional tax benefit related to directors’ deferred compensation plan (unaudited)

     —           —           267         —          —          —          —           —          267   

Shares purchased in connection with directors’ deferred compensation plan, net (unaudited)

     —           —           —           —          5,345        (307     307         —          —     

Stock option expense (unaudited)

     —           —           532         —          —          —          —           —          532   

Two-for-one stock split in the form of a 100% stock dividend (unaudited)

     32,022,760         320         —           (320     (268,134     —          —           —          —     
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

   

 

 

   

 

 

    

 

 

   

 

 

 

Balances at September 30, 2014 (unaudited)

     64,065,828       $ 641       $ 304,866       $ 314,363        (532,256   $ (5,797   $ 5,797       $ 38,895      $ 658,765   
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

   

 

 

   

 

 

    

 

 

   

 

 

 

See notes to consolidated financial statements.

 

7


Table of Contents

FIRST FINANCIAL BANKSHARES, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS - (UNAUDITED)

(Dollars in thousands)

 

     Nine Months Ended September 30,  
     2014     2013  

CASH FLOWS FROM OPERATING ACTIVITIES:

    

Net earnings

   $ 66,972      $ 57,629   

Adjustments to reconcile net earnings to net cash provided by operating activities:

    

Depreciation and amortization

     6,244        6,376   

Provision for loan losses

     3,710        2,582   

Securities premium amortization (discount accretion), net

     14,739        13,680   

Gain on sale of assets, net

     (815     (62

Deferred federal income tax benefit

     (844     (309

Change in loans held for sale

     (6,103     5,731   

Change in other assets

     8,936        2,642   

Change in other liabilities

     6,721        5,996   
  

 

 

   

 

 

 

Total adjustments

     32,588        36,636   
  

 

 

   

 

 

 

Net cash provided by operating activities

     99,560        94,265   
  

 

 

   

 

 

 

CASH FLOWS FROM INVESTING ACTIVITIES:

    

Cash paid fror acquisition of Orange Savings Bank, SSB, less cash acquired

     —          (25,706

Net decrease in interest-bearing time deposits in banks

     12,683        14,653   

Activity in available-for-sale securities:

    

Sales

     3,590        121,420   

Maturities

     1,677,839        248,750   

Purchases

     (1,794,233     (511,471

Activity in held-to-maturity securities - maturities

     130        263   

Net increase in loans

     (146,452     (242,860

Purchases of bank premises and equipment and other assets

     (12,993     (8,492

Proceeds from sale of other assets

     3,823        1,885   
  

 

 

   

 

 

 

Net cash used in investing activities

     (255,613     (401,558
  

 

 

   

 

 

 

CASH FLOWS FROM FINANCING ACTIVITIES:

    

Net increase (decrease) in noninterest-bearing deposits

     143,663        (7,402

Net increase (decrease) in interest-bearing deposits

     185,626        (10,575

Net increase (decrease) in short-term borrowings

     (121,979     206,803   

Common stock transactions:

    

Proceeds from stock issuances

     1,076        1,519   

Dividends paid

     (25,609     (16,191
  

 

 

   

 

 

 

Net cash provided by financing activities

     182,777        174,154   
  

 

 

   

 

 

 

NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS

     26,724        (133,139

CASH AND CASH EQUIVALENTS, beginning of period

     212,012        360,739   
  

 

 

   

 

 

 

CASH AND CASH EQUIVALENTS, end of period

   $ 238,736      $ 227,600   
  

 

 

   

 

 

 

SUPPLEMENTAL INFORMATION AND NONCASH TRANSACTIONS

    

Interest paid

   $ 3,155      $ 2,988   

Federal income tax paid

     21,281        17,386   

Transfer of loans to foreclosed assets

     1,085        1,610   

Investment securities purchased but not settled

     61,332        3,496   

See notes to consolidated financial statements.

 

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Table of Contents

FIRST FINANCIAL BANKSHARES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

Note 1 - Basis of Presentation

The unaudited interim consolidated financial statements include the accounts of the Company, a Texas corporation and a financial holding company registered under the Bank Holding Company Act of 1956, as amended, or BHCA, and its wholly-owned subsidiaries: First Financial Bank, National Association, Abilene, Texas; First Technology Services, Inc.; First Financial Trust & Asset Management Company, National Association; First Financial Investments, Inc.; and First Financial Insurance Agency, Inc.

Through our subsidiary bank, we conduct a full-service commercial banking business. Our banking centers are located primarily in Central, North Central, Southeast and West Texas. As of September 30, 2014, we had 62 financial centers across Texas, with eleven locations in Abilene, three locations in San Angelo and Weatherford, two locations in Cleburne, Stephenville and Granbury, and one location each in Acton, Albany, Aledo, Alvarado, Beaumont, Boyd, Bridgeport, Brock, Burleson, Cisco, Clyde, Decatur, Eastland, Fort Worth, Glen Rose, Grapevine, Hereford, Huntsville, Keller, Mauriceville, Merkel, Midlothian, Mineral Wells, Moran, New Waverly, Newton, Odessa, Orange, Port Arthur, Ranger, Rising Star, Roby, Southlake, Sweetwater, Trent, Trophy Club, Vidor, Waxahachie, and Willow Park. Our trust subsidiary has eight locations which are located in Abilene, Fort Worth, Lubbock, Odessa, Orange, San Angelo, Stephenville and Sweetwater, all in Texas.

In the opinion of management, the unaudited interim consolidated financial statements reflect all adjustments necessary for a fair presentation of the Company’s financial position and unaudited results of operations and should be read in conjunction with the Company’s audited consolidated financial statements, and notes thereto in the Company’s Annual Report on Form 10-K, for the year ended December 31, 2013. All adjustments were of a normal recurring nature. However, the results of operations for the three and nine months ended September 30, 2014, are not necessarily indicative of the results to be expected for the year ending December 31, 2014, due to seasonality, changes in economic conditions and loan credit quality, interest rate fluctuations, regulatory and legislative changes and other factors. Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States have been condensed or omitted under U. S. Securities and Exchange Commission (“SEC”) rules and regulations. The Company evaluated subsequent events for potential recognition and/or disclosure through the date the consolidated financial statements were issued.

On May 31, 2013, the Company acquired 100% of the outstanding capital stock of Orange Savings Bank, SSB, a wholly-owned subsidiary of OSB Financial Services, Inc. The results of operations of Orange Savings Bank, SSB, subsequent to the acquisition date, are included in the consolidated earnings of the Company.

On October 28, 2014, the Company’s Board of Directors authorized the repurchase of up to 1,500,000 common shares through September 30, 2017. The stock buyback plan authorizes management to repurchase the stock at such time as repurchases are considered beneficial to shareholders. Any repurchase of stock will be made through the open market, block trades or in privately negotiated transactions in accordance with applicable laws and regulations. Under the repurchase plan, there is no minimum number of shares that the Company is required to repurchase. Through September 30, 2014, no shares have been repurchased under the prior authorization that expired September 30, 2014.

Goodwill and other intangible assets are evaluated annually for impairment as of the end of the second quarter. No such impairment has been noted in connection with the current or any prior evaluations.

 

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Note 2 - Stock Split

On April 22, 2014, the Company’s Board of Directors declared a two-for-one stock split in the form of a 100% stock dividend effective for shareholders of record on May 15, 2014 that was distributed on June 2, 2014. All per share amounts in this report have been restated to reflect this stock split. An amount equal to the par value of the additional common shares issued pursuant to the stock split was reflected as a transfer from retained earnings to common stock on the consolidated financial statements as of and for the nine months ended September 30, 2014.

Note 3 - Earnings Per Share

Basic earnings per common share is computed by dividing net income available to common shareholders by the weighted average number of shares outstanding during the periods presented. In computing diluted earnings per common share for the three and nine months ended September 30, 2014 and 2013, the Company assumes that all dilutive outstanding options to purchase common stock have been exercised at the beginning of the period (or the time of issuance, if later). The dilutive effect of the outstanding options is reflected by application of the treasury stock method, whereby the proceeds from the exercised options are assumed to be used to purchase common stock at the average market price during the respective periods. The weighted average common shares outstanding used in computing basic earnings per common share for the three months ended September 30, 2014 and 2013 were 64,059,675 and 63,940,810 shares, respectively. The weighted average common shares outstanding used in computing basic earnings per common share for the nine months ended September 30, 2014 and 2013 were 64,038,526 and 63,444,544 shares, respectively. The weighted average common shares outstanding used in computing fully diluted earnings per common share for the three months ended September 30, 2014 and 2013 were 64,304,985 and 64,243,542 shares, respectively. The weighted average common shares outstanding used in computing fully diluted earnings per common share for the nine months ended September 30, 2014 and 2013 were 64,302,615 and 63,706,588 shares, respectively.

Note 4 - Interest-bearing Time Deposits in Banks and Securities

Interest-bearing time deposits in banks totaled $19,234,000 and $31,917,000 at September 30, 2014 and December 31, 2013, respectively, and have original maturities generally ranging from one to two years. Of these amounts, $17,699,000 and $29,002,000 are time deposits with balances greater than $100,000 at September 30, 2014 and December 31, 2013, respectively.

Management classifies debt and equity securities as held-to-maturity, available-for-sale, or trading based on its intent. Debt securities that management has the positive intent and ability to hold to maturity are classified as held-to-maturity and recorded at cost, adjusted for amortization of premiums and accretion of discounts, which are recognized as adjustments to interest income using the interest method. Securities not classified as held-to-maturity or trading are classified as available-for-sale and recorded at fair value, with all unrealized gains and unrealized losses judged to be temporary, net of deferred income taxes, excluded from earnings and reported in the consolidated statements of comprehensive earnings. Available-for-sale securities that have unrealized losses that are judged other-than-temporary are included in gain (loss) on sale of securities and a new cost basis is established. Securities classified as trading are recorded at fair value with unrealized gains and losses included in earnings.

The Company records its available-for-sale and trading securities portfolio at fair value. Fair values of these securities are determined based on methodologies in accordance with current authoritative accounting guidance. Fair values are volatile and may be influenced by a number of factors, including market interest rates, prepayment speeds, discount rates, credit ratings and yield curves. Fair values for investment securities are based on quoted market prices, where available. If quoted market prices are not available, fair values are based on the quoted prices of similar instruments or an estimate of fair value by using a range of fair value estimates in the market place as a result of the illiquid market specific to the type of security.

 

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When the fair value of a security is below its amortized cost, and depending on the length of time the condition exists and the extent the fair value is below amortized cost, additional analysis is performed to determine whether an other-than-temporary impairment condition exists. Available-for-sale and held-to-maturity securities are analyzed quarterly for possible other-than-temporary impairment. The analysis considers (i) whether we have the intent to sell our securities prior to recovery and/or maturity, (ii) whether it is more likely than not that we will have to sell our securities prior to recovery and/or maturity, (iii) the length of time and extent to which the fair value has been less than amortized cost, and (iv) the financial condition of the issuer. Often, the information available to conduct these assessments is limited and rapidly changing, making estimates of fair value subject to judgment. If actual information or conditions are different than estimated, the extent of the impairment of the security may be different than previously estimated, which could have a material effect on the Company’s results of operations and financial condition.

The Company’s investment portfolio consists of obligations of U. S. government sponsored-enterprises and agencies, mortgage pass-through securities, corporate bonds and general obligation or revenue based municipal bonds. Pricing for such securities is generally readily available and transparent in the market. The Company utilizes independent third party pricing services to value its investment securities, which the Company reviews as well as the underlying pricing methodologies for reasonableness and to ensure such prices are aligned with pricing matrices. The Company validates quarterly, on a sample basis, prices supplied by the independent pricing services by comparison to prices obtained from other third party sources.

 

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A summary of the Company’s available-for-sale securities follows (in thousands):

 

     September 30, 2014  
     Amortized
Cost Basis
     Gross
Unrealized
Holding Gains
     Gross
Unrealized
Holding Losses
    Estimated
Fair Value
 

U.S. Treasury securities

   $ 520       $ —         $ —        $ 520   

Obligations of U.S. government sponsored enterprises and agencies

     106,339         964         (2     107,301   

Obligations of states and political subdivisions

     1,046,148         56,398         (577     1,101,969   

Corporate bonds and other

     96,424         3,269         —          99,693   

Residential mortgage-backed securities

     803,072         14,395         (5,600     811,867   

Commercial mortgage-backed securities

     134,769         31         (2,388     132,412   
  

 

 

    

 

 

    

 

 

   

 

 

 

Total securities available-for-sale

   $ 2,187,272       $ 75,057       $ (8,567   $ 2,253,762   
  

 

 

    

 

 

    

 

 

   

 

 

 
     December 31, 2013  
     Amortized
Cost Basis
     Gross
Unrealized
Holding Gains
     Gross
Unrealized
Holding Losses
    Estimated
Fair Value
 

Obligations of U.S. government sponsored-enterprises and agencies

   $ 136,416       $ 1,672       $ —        $ 138,088   

Obligations of states and political subdivisions

     974,608         27,980         (11,319     991,269   

Corporate bonds and other

     105,490         3,550         —          109,040   

Residential mortgage-backed securities

     706,289         12,253         (7,922     710,620   

Commercial mortgage-backed securities

     112,323         —           (3,617     108,706   
  

 

 

    

 

 

    

 

 

   

 

 

 

Total securities available-for-sale

   $ 2,035,126       $ 45,455       $ (22,858   $ 2,057,723   
  

 

 

    

 

 

    

 

 

   

 

 

 

Disclosures related to the Company’s held-to-maturity securities, which totaled $554,000 and $684,000 at September 30, 2014 and December 31, 2013, respectively, have not been presented due to insignificance.

 

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The Company invests in mortgage-backed securities that have expected maturities that differ from their contractual maturities. These differences arise because borrowers may have the right to call or prepay these obligations with or without a prepayment penalty. These securities include collateralized mortgage obligations (CMOs) and other asset backed securities. The expected maturities of these securities at September 30, 2014 were computed by using scheduled amortization of balances and historical prepayment rates.

The amortized cost and estimated fair value of available-for-sale securities at September 30, 2014, by contractual or expected maturity, as applicable, are shown below (in thousands):

 

     Amortized
Cost Basis
     Estimated
Fair Value
 

Due within one year

   $ 76,858       $ 77,722   

Due after one year through five years

     663,151         695,484   

Due after five years through ten years

     502,028         527,658   

Due after ten years

     7,394         8,619   

Mortgage-backed securities

     937,841         944,279   
  

 

 

    

 

 

 

Total

   $ 2,187,272       $ 2,253,762   
  

 

 

    

 

 

 

The following tables disclose, as of September 30, 2014 and December 31, 2013, the Company’s investment securities that have been in a continuous unrealized-loss position for less than 12 months and for 12 months or longer (in thousands):

 

     Less than 12 Months      12 Months or Longer      Total  

September 30, 2014

   Fair Value      Unrealized
Loss
     Fair Value      Unrealized
Loss
     Fair Value      Unrealized
Loss
 

Obligations of U.S. Government sponsored enterprises and Agencies

   $ 876       $ 2       $ —         $ —         $ 876       $ 2   

Obligations of states and political subdivisions

     17,871         38         50,158         539         68,029         577   

Residential mortgage-backed securities

     82,382         450         134,271         5,150         216,653         5,600   

Commercial mortgage-backed securities

     6,435         15         102,353         2,373         108,788         2,388   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 107,564       $ 505       $ 286,782       $ 8,062       $ 394,346       $ 8,567   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

     Less than 12 Months      12 Months or Longer      Total  

December 31, 2013

   Fair Value      Unrealized
Loss
     Fair
Value
     Unrealized
Loss
     Fair Value      Unrealized
Loss
 

Obligations of states and political subdivisions

   $ 316,394       $ 10,973       $ 4,153       $ 346       $ 320,547       $ 11,319   

Residential mortgage-backed securities

     228,423         7,623         5,624         299         234,047         7,922   

Commercial mortgage-backed securities

     108,706         3,617         —           —           108,706         3,617   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 653,523       $ 22,213       $ 9,777       $ 645       $ 663,300       $ 22,858   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

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The number of investments in an unrealized loss position totaled 114 at September 30, 2014. We do not believe these unrealized losses are “other-than-temporary” as (i) we do not have the intent to sell our securities prior to recovery and/or maturity and (ii) it is more likely than not that we will not have to sell our securities prior to recovery and/or maturity. In making the determination, we also consider the length of time and extent to which fair value has been less than cost and the financial condition of the issuer. The unrealized losses noted are interest rate related due to the level of interest rates at September 30, 2014 compared to the time of purchase. We have reviewed the ratings of the issuers and have not identified any issues related to the ultimate repayment of principal as a result of credit concerns on these securities. Our mortgage related securities are backed by GNMA, FNMA and FHLMC or are collateralized by securities backed by these agencies.

At September 30, 2014, $1,430,183,000 of the Company’s securities were pledged as collateral for public or trust fund deposits, repurchase agreements and for other purposes required or permitted by law.

During the third quarter ended September 30, 2014 and 2013, sales and calls of investment securities that were classified as available-for-sale totaled $2,145,000 and $50,065,000, respectively. Gross realized gains from security sales and calls during the third quarter of 2014 and 2013 totaled $1,000 and $1,114,000, respectively. Gross realized losses from security sales and calls during the third quarter of 2013 totaled $1,222,000. There were no gross realized losses from security sales or calls in the third quarter of 2014. During the nine months ended September 30, 2014 and 2013, sales and calls of investment securities that were classified as available-for-sale totaled $3,590,000 and $121,420,000, respectively. Gross realized gains from security sales and calls during the nine month periods ended September 30, 2014 and 2013 totaled $1,000 and $1,371,000, respectively. Gross realized losses from security sales and calls during the nine month periods ended September 30, 2014 and 2013 totaled $5,000 and $1,224,000, respectively. The specific identification method was used to determine cost in order to compute the realized gains and losses.

Note 5 - Loans and Allowance for Loan Losses

Loans held for investment are stated at the amount of unpaid principal, reduced by unearned income and an allowance for loan losses. Interest on loans is calculated by using the simple interest method on daily balances of the principal amounts outstanding. The Company defers and amortizes net loan origination fees and costs as an adjustment to yield. The allowance for loan losses is established through a provision for loan losses charged to expense. Loans are charged against the allowance for loan losses when management believes the collectability of the principal is unlikely.

The Company has lending policies and procedures in place that are designed to maximize loan income with an acceptable level of risk. Management reviews and approves these policies and procedures on an annual basis and makes changes as appropriate. Management receives and reviews monthly reports related to loan originations, quality, concentrations, delinquencies, nonperforming and potential problem loans. Diversification in the loan portfolio is a means of managing risk associated with fluctuations in economic conditions, both by type of loan and geographic location.

Commercial loans are underwritten after evaluating and understanding the borrower’s ability to operate profitably and effectively. Underwriting standards are designed to determine whether the borrower possesses sound business ethics and practices and to evaluate current and projected cash flows to determine the ability of the borrower to repay their obligations as agreed. Commercial loans are primarily made based on the identified cash flows of the borrower and, secondarily, on the underlying collateral provided by the borrower. Most commercial loans are secured by the assets being financed or other business assets, such as accounts receivable or inventory, and include personal guarantees.

 

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Agricultural loans are subject to underwriting standards and processes similar to commercial loans. These agricultural loans are based primarily on the identified cash flows of the borrower and secondarily on the underlying collateral provided by the borrower. Most agricultural loans are secured by the agriculture related assets being financed, such as farm, land, cattle or equipment, and include personal guarantees.

Real estate loans are also subject to underwriting standards and processes similar to commercial and agricultural loans. These loans are underwritten primarily based on projected cash flows and, secondarily, as loans secured by real estate. The repayment of real estate loans is generally largely dependent on the successful operation of the property securing the loans or the business conducted on the property securing the loan. Real estate loans may be more adversely affected by conditions in the real estate markets or in the general economy. The properties securing the Company’s real estate portfolio are generally diverse in terms of type and geographic location within Texas. This diversity helps reduce the exposure to adverse economic events that affect any single market or industry. Generally, real estate loans are owner occupied which further reduces the Company’s risk.

Consumer loan underwriting utilizes methodical credit standards and analysis to supplement the Company’s underwriting policies and procedures. The Company’s loan policy addresses types of consumer loans that may be originated and the collateral, if secured, which must be perfected. The relatively smaller individual dollar amounts of consumer loans that are spread over numerous individual borrowers also minimize the Company’s risk.

The allowance for loan losses is an amount management believes is appropriate to absorb probable losses that have been incurred on existing loans as of the balance sheet date based upon management’s review and evaluation of the loan portfolio. The allowance for loan losses is comprised of three elements: (i) specific reserves determined based on probable losses on specific classified loans; (ii) a general reserve that considers historical loss rates; and (iii) qualitative reserves based upon general economic conditions and other qualitative risk factors both internal and external to the Company. The allowance for loan losses is increased by charges to income and decreased by charge-offs (net of recoveries). Management’s periodic evaluation of the appropriateness of the allowance is based on general economic conditions, the financial condition of borrowers, the value and liquidity of collateral, delinquency, prior loan loss experience, and the results of periodic reviews of the portfolio. For purposes of determining our general reserve, the loan portfolio, less cash secured loans, government guaranteed loans and classified loans, is multiplied by the Company’s historical loss rate. Specific allocations are increased in accordance with deterioration in credit quality and a corresponding increase in risk of loss on a particular loan. In addition, we adjust our allowance for qualitative factors such as current local economic conditions and trends, including, without limitations, unemployment, drought conditions, changes in lending staff, policies and procedures, changes in credit concentrations, changes in the trends and severity of problem loans and changes in trends in volume and terms of loans. This qualitative reserve serves to estimate for additional areas of incurred losses in our portfolio that are not reflected in our historic loss factors.

Although we believe we use the best information available to make loan loss allowance determinations, future adjustments could be necessary if circumstances or economic conditions differ substantially from the assumptions used in making our initial determinations. A further downturn in the economy and employment could result in increased levels of non-performing assets and charge-offs, increased loan provisions and reductions in income. Additionally, bank regulatory agencies periodically review our allowance for loan losses and methodology and could require, in accordance with generally accepted accounting principles, additional provisions to the allowance for loan losses is based on their judgment of information available to them at the time of their examination as well as changes to our methodology.

 

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Accrual of interest is discontinued on a loan and payments are applied to principal when management believes, after considering economic and business conditions and collection efforts, the borrower’s financial condition is such that collection of interest is doubtful. Except consumer loans, generally all loans past due greater than 90 days, based on contractual terms, are placed on non-accrual. Loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured. Consumer loans are generally charged-off when a loan becomes past due 90 days. For other loans in the portfolio, facts and circumstances are evaluated in making charge-off decisions.

Loans are considered impaired when, based on current information and events, management determines that it is probable we will be unable to collect all amounts due in accordance with the loan agreement, including scheduled principal and interest payments. If a loan is impaired, a specific valuation allowance is allocated, if necessary. Interest payments on impaired loans are typically applied to principal unless collectability of the principal amount is reasonably assured, in which case interest is recognized on a cash basis. Impaired loans, or portions thereof, are charged off when deemed uncollectable.

The Company’s policy requires measurement of the allowance for an impaired, collateral dependent loan based on the fair value of the collateral. Other loan impairments are measured based on the present value of expected future cash flows or the loan’s observable market price. At September 30, 2014 and 2013, and December 31, 2013, all significant impaired loans have been determined to be collateral dependent and the allowance for loss has been measured utilizing the estimated fair value of the collateral.

From time to time, the Company modifies its loan agreement with a borrower. A modified loan is considered a troubled debt restructuring when two conditions are met: (i) the borrower is experiencing financial difficulty and (ii) concessions are made by the Company that would not otherwise be considered for a borrower with similar credit risk characteristics. Modifications to loan terms may include a lower interest rate, a reduction of principal, or a longer term to maturity. For all impaired loans, including the Company’s troubled debt restructurings, the Company performs a periodic, well-documented credit evaluation of the borrower’s financial condition and prospects for repayment to assess the likelihood that all principal and interest payments required under the terms of the agreement will be collected in full. When doubt exists about the ultimate collectability of principal and interest, the troubled debt restructuring remains on non-accrual status and payments received are applied to reduce principal to the extent necessary to eliminate such doubt. This determination of accrual status is judgmental and is based on facts and circumstances related to each troubled debt restructuring. To date, all of the troubled debt restructurings have been such that, after considering economic and business conditions and collection efforts, the collection of interest is doubtful and therefore remain on non-accrual. Each of these loans is individually evaluated for impairment and a specific reserve is recorded based on probable losses, taking into consideration the related collateral, modified loan terms and cash flow. As of September 30, 2014 and 2013, and December 31, 2013, all of the Company’s troubled debt restructured loans are included in the non-accrual totals.

The Company originates certain mortgage loans for sale in the secondary market. Accordingly, these loans are classified as held for sale and are carried at the lower of cost or fair value on an aggregate basis. The mortgage loan sales contracts contain indemnification clauses should the loans default, generally in the first three to six months, or if documentation is determined not to be in compliance with regulations. The Company’s historic losses as a result of these indemnities have been insignificant.

Loans acquired, including loans acquired in a business combination, are initially recorded at fair value with no valuation allowance. Acquired loans are segregated between those considered to be credit impaired and those deemed performing. To make this determination, management considers such factors as past due status, non-accrual status and credit risk ratings. The fair value of acquired performing loans is determined by discounting expected cash flows, both principal and interest, at prevailing market interest rates. The difference between the fair value and principal balances at acquisition date, the fair value discount, is accreted into interest income over the estimated life of each loan.

 

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Purchased credit impaired loans are those loans that showed evidence of deterioration of credit quality since origination and for which it is probable, at acquisition, that the Company will be unable to collect all amounts contractually owed. Their acquisition fair value was based on the estimate of cash flows, both principal and interest, expected to be collected or estimated collateral values if cash flows are not estimable, discounted at prevailing market rates of interest. The difference between the cash flows expected at acquisition and the investment in the loan, is recognized as interest income on a level-yield method over the life of the loan, unless management was unable to reasonably forecast cash flows in which case the loans were placed on non-accrual. Contractually required payments for interest and principal that exceed the cash flows expected at acquisition are not recognized as a yield adjustment. Increases in expected cash flows subsequent to the initial investment are recognized prospectively through adjustment of the yield on the loan over its remaining life. Decreases in expected cash flows are recognized as impairment. Valuation allowances on these impaired loans reflect only losses incurred after the acquisition. The carrying amount of purchased credit impaired loans at September 30, 2014 and 2013, and December 31, 2013 was $2,383,000, $2,954,000 and $2,707,000, respectively, compared to a contractual balance of $3,525,000, $4,218,000 and $3,970,000, respectively. Other purchased credit impaired loan disclosures were omitted due to immateriality.

Loans held-for-investment by class of financing receivables are as follows (in thousands):

 

     September 30,      December 31,
2013
 
     2014      2013     

Commercial

   $ 612,092       $ 571,973       $ 596,730   

Agricultural

     86,718         66,758         75,928   

Real estate

     1,774,639         1,640,308         1,678,514   

Consumer

     354,981         330,046         333,113   
  

 

 

    

 

 

    

 

 

 

Total loans held-for-investment

   $ 2,828,430       $ 2,609,085       $ 2,684,285   
  

 

 

    

 

 

    

 

 

 

Loans held for sale totaled $11,266,000, $5,724,000 and $5,163,000 at September 30, 2014 and 2013, and December 31, 2013, respectively, which were recorded at cost as fair value exceeded cost.

The Company’s non-accrual loans, loans still accruing and past due 90 days or more and restructured loans are as follows (in thousands):

 

     September 30,      December 31,
2013
 
     2014      2013     

Non-accrual loans*

   $ 22,093       $ 22,809       $ 27,926   

Loans still accruing and past due 90 days or more

     263         54         133   

Troubled debt restructured loans**

     —           —           —     
  

 

 

    

 

 

    

 

 

 

Total

   $ 22,356       $ 22,863       $ 28,059   
  

 

 

    

 

 

    

 

 

 

 

* Includes $2,383,000, $2,954,000 and $2,707,000 of purchased credit impaired loans as of September 30, 2014 and 2013, and December 31, 2013, respectively.
** Troubled debt restructured loans of $10,114,000, $14,737,000 and $13,298,000, whose interest collection, after considering economic and business conditions and collection efforts, is doubtful are included in non-accrual loans at September 30, 2014 and 2013, and December 31, 2013, respectively. At this time, all of our restructured loans are included in non-accrual loans.

 

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The Company’s recorded investment in impaired loans and the related valuation allowance are as follows (in thousands):

 

September 30, 2014     September 30, 2013     December 31, 2013  

Recorded

Investment

    Valuation
Allowance
    Recorded
Investment
    Valuation
Allowance
    Recorded
Investment
    Valuation
Allowance
 
  $ 22,093      $ 4,634      $ 22,809      $ 4,605      $ 27,926      $ 5,338   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

The average recorded investment in impaired loans for the three and nine months ended September 30, 2014, and the year ended December 31, 2013 was approximately $24,893,000, $26,524,000 and $31,293,000, respectively. The Company had $23,629,000, $28,535,000 and $31,128,000 in non-accrual, past due 90 days still accruing and restructured loans and foreclosed assets at September 30, 2014 and 2013, and December 31, 2013, respectively. Non-accrual loans at September 30, 2014 and 2013, and December 31, 2013, consisted of the following by class of financing receivables (in thousands):

 

     September 30,      December 31,
2013
 
     2014      2013     

Commercial

   $ 3,481       $ 1,986       $ 4,281   

Agricultural

     102         97         131   

Real estate

     17,712         20,036         22,548   

Consumer

     798         690         966   
  

 

 

    

 

 

    

 

 

 

Total

   $ 22,093       $ 22,809       $ 27,926   
  

 

 

    

 

 

    

 

 

 

No significant additional funds are committed to be advanced in connection with impaired loans as of September 30, 2014.

The Company’s impaired loans and related allowance as of September 30, 2014 and 2013, and December 31, 2013, are summarized in the following tables by class of financing receivables (in thousands). No interest income was recognized on impaired loans subsequent to their classification as impaired.

 

September 30,

2014

   Unpaid
Contractual
Principal
Balance
     Recorded
Investment
With No
Allowance*
     Recorded
Investment
With
Allowance
     Total
Recorded
Investment
     Related
Allowance
     Year-to-Date
Average
Recorded
Investment
     Three-month
Average
Recorded
Investment
 

Commercial

   $ 3,928       $ 278       $ 3,203       $ 3,481       $ 1,160       $ 3,990       $ 3,713   

Agricultural

     113         —           102         102         37         113         104   

Real Estate

     23,559         5,546         12,166         17,712         3,256         21,510         20,212   

Consumer

     977         467         331         798         181         911         864   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 28,577       $ 6,291       $ 15,802       $ 22,093       $ 4,634       $ 26,524       $ 24,893   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

* Includes $2,383,000 of purchased credit impaired loans.

 

September 30,

2013

   Unpaid
Contractual
Principal
Balance
     Recorded
Investment
With No
Allowance*
     Recorded
Investment
With
Allowance
     Total
Recorded
Investment
     Related
Allowance
     Year-to-Date
Average
Recorded
Investment
     Three-month
Average
Recorded
Investment
 

Commercial

   $ 2,545       $ 701       $ 1,285       $ 1,986       $ 710       $ 1,779       $ 2,113   

Agricultural

     105         91         6         97         6         104         99   

Real Estate

     25,085         4,290         15,746         20,036         3,628         19,985         20,757   

Consumer

     824         212         478         690         261         662         799   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 28,559       $ 5,294       $ 17,515       $ 22,809       $ 4,605       $ 22,530       $ 23,768   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

* Includes $2,954,000 of purchased credit impaired loans.

 

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Table of Contents

December 31,

2013

   Unpaid
Contractual
Principal
Balance
     Recorded
Investment With
No Allowance*
     Recorded
Investment
With
Allowance
     Total
Recorded
Investment
     Related
Allowance
     Average
Recorded
Investment
 

Commercial

   $ 4,764       $ 934       $ 3,348       $ 4,282       $ 1,079       $ 5,017   

Agricultural

     139         17         114         131         41         144   

Real Estate

     31,704         5,794         16,753         22,547         4,006         25,060   

Consumer

     1,117         545         421         966         212         1,072   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 37,724       $ 7,290       $ 20,636       $ 27,926       $ 5,338       $ 31,293   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

* Includes $2,707,000 of purchased credit impaired loans.

The Company recognized interest income on impaired loans prior to being classified as impaired of approximately $685,000 during the year ended December 31, 2013. Such amounts for the three-month and nine-month periods ended September 30, 2014 and 2013 were not significant.

From a credit risk standpoint, the Company rates its loans in one of four categories: (i) pass, (ii) special mention, (iii) substandard or (iv) doubtful. Loans rated as loss are charged-off.

The ratings of loans reflect a judgment about the risks of default and loss associated with the loan. The Company reviews the ratings on our credits as part of our on-going monitoring of the credit quality of our loan portfolio. Ratings are adjusted to reflect the degree of risk and loss that are felt to be inherent in each credit as of each reporting period. Our methodology is structured so that specific allocations are increased in accordance with deterioration in credit quality (and a corresponding increase in risk and loss) or decreased in accordance with improvement in credit quality (and a corresponding decrease in risk and loss).

Credits rated special mention show clear signs of financial weakness or deterioration in credit worthiness, however, such concerns are not so pronounced that the Company generally expects to experience significant loss within the short-term. Such credits typically maintain the ability to perform within standard credit terms and credit exposure is not as prominent as credits rated more harshly.

Credits rated substandard are those in which the normal repayment of principal and interest may be, or has been, jeopardized by reason of adverse trends or developments of a financial, managerial, economic or political nature, or important weaknesses exist in collateral. A protracted workout on these credits is a distinct possibility. Prompt corrective action is therefore required to strengthen the Company’s position, and/or to reduce exposure and to assure that adequate remedial measures are taken by the borrower. Credit exposure becomes more likely in such credits and a serious evaluation of the secondary support to the credit is performed.

Credits rated doubtful are those in which full collection of principal appears highly questionable, and which some degree of loss is anticipated, even though the ultimate amount of loss may not yet be certain and/or other factors exist which could affect collection of debt. Based upon available information, positive action by the Company is required to avert or minimize loss. Credits rated doubtful are generally also placed on non-accrual.

The following summarizes the Company’s internal ratings of its loans held-for-investment by class of financing receivables and portfolio segments, which are the same, at September 30, 2014 and December 31, 2013 (in thousands):

 

September 30,

2014

   Pass      Special
Mention
     Substandard      Doubtful      Total  

Commercial

   $ 597,717       $ 3,649       $ 10,726       $ —         $ 612,092   

Agricultural

     86,272         93         353         —           86,718   

Real Estate

     1,710,201         18,741         45,613         84         1,774,639   

Consumer

     352,850         601         1,527         3         354,981   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 2,747,040       $ 23,084       $ 58,219       $ 87       $ 2,828,430   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

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Table of Contents

December 31,

2013

   Pass      Special
Mention
     Substandard      Doubtful      Total  

Commercial

   $ 584,547       $ 3,032       $ 9,151       $ —         $ 596,730   

Agricultural

     75,382         245         298         3         75,928   

Real Estate

     1,609,242         20,773         48,352         147         1,678,514   

Consumer

     330,870         639         1,595         9         333,113   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 2,600,041       $ 24,689       $ 59,396       $ 159       $ 2,684,285   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

At September 30, 2014 and December 31, 2013, the Company’s past due loans are as follows (in thousands):

 

September 30,

2014

   15-59
Days
Past
Due*
     60-89
Days
Past
Due
     Greater
Than 90
Days
     Total Past
Due
     Current      Total Loans      90 Days
Past Due
Still
Accruing
 

Commercial

   $ 2,726       $ 110       $ 316       $ 3,152       $ 608,940       $ 612,092       $ 111   

Agricultural

     294         59         —           353         86,365         86,718         —     

Real Estate

     15,404         930         2,216         18,550         1,756,089         1,774,639         102   

Consumer

     1,742         292         297         2,331         352,650         354,981         50   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 20,166       $ 1,391       $ 2,829       $ 24,386       $ 2,804,044       $ 2,828,430       $ 263   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

December 31,

2013

   15-59
Days
Past
Due*
     60-89
Days
Past
Due
     Greater
Than 90
Days
     Total Past
Due
     Current      Total Loans      90 Days
Past Due
Still
Accruing
 

Commercial

   $ 5,303       $ 287       $ 420       $ 6,010       $ 590,720       $ 596,730       $ —     

Agricultural

     355         —           —           355         75,573         75,928         —     

Real Estate

     13,787         2,489         1,876         18,152         1,660,362         1,678,514         55   

Consumer

     2,708         582         277         3,567         329,546         333,113         78   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 22,153       $ 3,358       $ 2,573       $ 28,084       $ 2,656,201       $ 2,684,285       $ 133   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

* The Company monitors commercial, agricultural and real estate loans after such loans are 15 days past due. Consumer loans are monitored after such loans are 30 days past due.

The allowance for loan losses as of September 30, 2014 and 2013, and December 31, 2013, is presented below. Management has evaluated the appropriateness of the allowance for loan losses by estimating the probable losses in various categories of the loan portfolio, which are identified below (in thousands):

 

     September 30,      December 31,  
     2014      2013      2013  

Allowance for loan losses provided for:

        

Loans specifically evaluated as impaired

   $ 4,634       $ 4,605       $ 5,338   

Remaining portfolio

     31,754         30,195         28,562   
  

 

 

    

 

 

    

 

 

 

Total allowance for loan losses

   $ 36,388       $ 34,800       $ 33,900   
  

 

 

    

 

 

    

 

 

 

The following table details the allowance for loan losses at September 30, 2014 and December 31, 2013 by portfolio segment (in thousands). There were no allowances for purchased credit impaired loans at September 30, 2014 or December 31, 2013. Allocation of a portion of the allowance to one category of loans does not preclude its availability to absorb losses in other categories.

 

September 30, 2014

   Commercial      Agricultural      Real Estate      Consumer      Total  

Loans individually evaluated for impairment

   $ 2,837       $ 127       $ 7,081       $ 388       $ 10,433   

Loans collectively evaluated for impairment

     4,649         258         19,218         1,830         25,955   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 7,486       $ 385       $ 26,299       $ 2,218       $ 36,388   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

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Table of Contents

December 31, 2013

   Commercial      Agricultural      Real Estate      Consumer      Total  

Loans individually evaluated for impairment

   $ 2,755       $ 125       $ 7,215       $ 378       $ 10,473   

Loans collectively evaluated for impairment

     3,685         258         17,725         1,759         23,427   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 6,440       $ 383       $ 24,940       $ 2,137       $ 33,900   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Changes in the allowance for loan losses for the three and nine months ended September 30, 2014 and 2013 are summarized as follows by portfolio segment (in thousands):

 

Three months ended

September 30, 2014

   Commercial     Agricultural      Real Estate     Consumer     Total  

Beginning balance

   $ 6,861      $ 364       $ 26,561      $ 2,106      $ 35,892   

Provision for loan losses

     635        7         (80     334        896   

Recoveries

     72        14         42        86        214   

Charge-offs

     (82     —           (224     (308     (614
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

 

Ending balance

   $ 7,486      $ 385       $ 26,299      $ 2,218      $ 36,388   
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

 

 

Three months ended

September 30, 2013

   Commercial     Agricultural     Real Estate     Consumer     Total  

Beginning balance

   $ 6,736      $ 1,493      $ 23,902      $ 1,968      $ 34,099   

Provision for loan losses

     354        (999     1,644        350        1,349   

Recoveries

     141        10        42        104        297   

Charge-offs

     (218     (86     (294     (347     (945
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Ending balance

   $ 7,013      $ 418      $ 25,294      $ 2,075      $ 34,800   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

Nine months ended

September 30, 2014

   Commercial     Agricultural     Real Estate     Consumer     Total  

Beginning balance

   $ 6,440      $ 383      $ 24,940      $ 2,137      $ 33,900   

Provision for loan losses

     1,189        (14     1,988        547        3,710   

Recoveries

     225        17        361        386        989   

Charge-offs

     (368     (1     (990     (852     (2,211
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Ending balance

   $ 7,486      $ 385      $ 26,299      $ 2,218      $ 36,388   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

Nine months ended

September 30, 2013

   Commercial     Agricultural     Real Estate     Consumer     Total  

Beginning balance

   $ 7,343      $ 1,541      $ 24,063      $ 1,892      $ 34,839   

Provision for loan losses

     (77     (1,056     3,035        680        2,582   

Recoveries

     329        29        95        266        719   

Charge-offs

     (582     (96     (1,899     (763     (3,340
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Ending balance

   $ 7,013      $ 418      $ 25,294      $ 2,075      $ 34,800   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

The Company’s recorded investment in loans as of September 30, 2014 and December 31, 2013 related to the balance in the allowance for loan losses on the basis of the Company’s impairment methodology was as follows (in thousands). Purchased credit impaired loans of $2,383,000 and $2,707,000 at September 30, 2014 and December 31, 2013, respectively, are included in loans individually evaluated for impairment.

 

September 30, 2014

   Commercial      Agricultural      Real Estate      Consumer      Total  

Loans individually evaluated for impairment

   $ 14,375       $ 446       $ 64,438       $ 2,131       $ 81,390   

Loans collectively evaluated for impairment

     597,717         86,272         1,710,201         352,850         2,747,040   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 612,092       $ 86,718       $ 1,774,639       $ 354,981       $ 2,828,430   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

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Table of Contents

December 31, 2013

   Commercial      Agricultural      Real Estate      Consumer      Total  

Loans individually evaluated for impairment

   $ 12,183       $ 546       $ 69,272       $ 2,243       $ 84,244   

Loans collectively evaluated for impairment

     584,547         75,382         1,609,242         330,870         2,600,041   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 596,730       $ 75,928       $ 1,678,514       $ 333,113       $ 2,684,285   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

The Company’s loans that were modified in the three and nine months ended September 30, 2014 and 2013 and considered troubled debt restructurings are as follows (in thousands):

 

     Three Months Ended September 30, 2014      Nine Months Ended September 30, 2014  
            Pre-Modification      Post-Modification             Pre-Modification      Post-Modification  
            Recorded      Recorded             Recorded      Recorded  
     Number      Investment      Investment      Number      Investment      Investment  

Commercial

     1       $ 158       $ 158         6       $ 557       $ 557   

Agricultural

     —           —           —           1         39         39   

Real Estate

     1         40         40         5         630         630   

Consumer

     —           —           —           3         11         11   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

     2       $ 198       $ 198         15       $ 1,237       $ 1,237   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 
     Three Months Ended September 30, 2013      Nine Months Ended September 30, 2013  
            Pre-Modification      Post-Modification             Pre-Modification      Post-Modification  
            Recorded      Recorded             Recorded      Recorded  
     Number      Investment      Investment      Number      Investment      Investment  

Commercial

     —         $ —         $ —           3       $ 218       $ 218   

Agricultural

     —           —           —           1         24         24   

Real Estate

     —           —           —           8         3,779         3,779   

Consumer

     4         86         86         5         123         123   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

     4       $ 86       $ 86         17       $ 4,144       $ 4,144   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

The balances below provide information as to how the loans were modified as troubled debt restructured loans during the three and nine months ended September 30, 2014 and 2013 (in thousands):

 

     Three Months Ended September 30, 2014      Nine Months Ended September 30, 2014  
     Adjusted
Interest
Rate
     Extended
Maturity
     Combined
Rate and
Maturity
     Adjusted
Interest
Rate
     Extended
Maturity
     Combined
Rate and
Maturity
 

Commercial

   $ —         $ 158       $ —         $ —         $ 255       $ 302   

Agricultural

     —           —           —           —           —           39   

Real Estate

     —           —           40         —           118         512   

Consumer

     —           —           —           —           8         3   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ —         $ 158       $ 40       $ —         $ 381       $ 856   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

     Three Months Ended September 30, 2013      Nine Months Ended September 30, 2013  
     Adjusted
Interest
Rate
     Extended
Maturity
     Combined
Rate and
Maturity
     Adjusted
Interest
Rate
     Extended
Maturity
     Combined
Rate and
Maturity
 

Commercial

   $ —         $ —         $ —         $ —         $ 218       $ —     

Agricultural

     —           —           —           —           24         —     

Real Estate

     —           —           —           420         350         3,009   

Consumer

     —           82         4         —           119         4   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ —         $ 82       $ 4       $ 420       $ 711       $ 3,013   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

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Table of Contents

Certain loans were modified as troubled debt restructured loans within the previous 12 months and for which there was a payment default. A default for purposes of this disclosure is a troubled debt restructured loan in which the borrower is 90 days past due or more or results in the foreclosure and repossession of the applicable collateral. The loans with payment default are as follows (dollars in thousands):

 

     Three Months Ended September 30,
2014
     Nine Months Ended September 30,
2014
 
     Number      Balance      Number      Balance  

Commercial

     —         $ —           —         $ —     

Agriculture

     —           —           —           —     

Real Estate

     —           —           —           —     

Consumer

     —           —           1         32   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

     —         $ —           1       $ 32   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

     Three Months Ended September 30,
2013
     Nine Months Ended September 30,
2013
 
     Number      Balance      Number      Balance  

Commercial

     1       $ 71         6       $ 316   

Agriculture

     —           —           —           —     

Real Estate

     —           —           —           —     

Consumer

     —           —           —           —     
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

     1       $ 71         6       $ 316   
  

 

 

    

 

 

    

 

 

    

 

 

 

As of September 30, 2014, the Company has no commitments to lend additional funds to loan customers whose terms have been modified in troubled debt restructurings.

Our subsidiary bank has established a line of credit with the Federal Home Loan Bank of Dallas to provide liquidity and meet pledging requirements for those customers eligible to have securities pledged to secure certain uninsured deposits. At September 30, 2014, $1,634,405,000 in loans held by our bank subsidiary were subject to blanket liens as security for this line of credit. At September 30, 2014, $1,038,000 in advances were outstanding and $7,000,000 in letters of credit were outstanding under this line of credit. The letters of credit were pledged as collateral for public funds held by our bank subsidiary.

Note 6 - Income Taxes

Income tax expense was $7,843,000 for the third quarter of 2014 as compared to $6,121,000 for the same period in 2013. The Company’s effective tax rates on pretax income were 25.08% and 23.83% for the third quarter of 2014 and 2013, respectively. Income tax expense was $21,705,000 for nine months ended September 30, 2014 as compared to $18,723,000 for same period in 2013. The Company’s effective tax rate on pretax income was 24.48% and 24.52% for the nine months ended September 30, 2014 and 2013, respectively. The effective tax rates differ from the statutory federal tax rate of 35% primarily due to tax exempt interest income earned on certain investment securities and loans, the deductibility of dividends paid to our employee stock ownership plan and the settlement of a bank owned life insurance contract.

Note 7 - Stock Based Compensation

The Company grants incentive stock options for a fixed number of shares with an exercise price equal to the fair value of the shares at the date of grant to employees. At September 30, 2014, no options have been granted in 2014. On October 22, 2013, the Company granted 395,000 shares in incentive stock options at an exercise price of $30.85 to its employees. The Company recorded stock option expense totaling $174,000 and $88,000 for the three months ended September 30, 2014 and 2013, respectively.

 

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Table of Contents

The Company recorded stock option expense totaling $532,000 and $264,000 for the nine-month periods ended September 30, 2014 and 2013, respectively. The additional disclosure requirements under authoritative accounting guidance have been omitted due to immateriality.

Note 8 - Pension Plan

The Company’s defined benefit pension plan was frozen effective January 1, 2004, whereby no new participants will be added to the plan and no additional years of service will accrue to participants, unless the pension plan is reinstated at a future date. The pension plan covered substantially all of the Company’s employees at the time. The benefits for each employee were based on years of service and a percentage of the employee’s qualifying compensation during the final years of employment. The Company’s funding policy was and is to contribute annually the amount necessary to satisfy the Internal Revenue Service’s funding standards. Contributions to the pension plan, prior to freezing the plan, were intended to provide not only for benefits attributed to service to date but also for those expected to be earned in the future. As a result of the Pension Protection Act of 2006 (the “Protection Act”), the Company will be required to contribute amounts in future years to fund any shortfalls. The Company has evaluated the provisions of the Protection Act as well as the Internal Revenue Service’s funding standards to develop a plan for funding in future years. The Company made a contribution totaling $1,000,000 in 2013 and has to date made no contributions in 2014.

In October 2014, the Company approved a plan to offer plan participants that are no longer employed by the Company the option to receive a one-time lump sum payment in lieu of future benefits to be received under the plan. The lump sum payment offered approximates the respective participant’s pension benefit obligation and is not expected to have a significant impact on the Company’s financial statements.

Net periodic benefit costs totaling $107,000 and $208,000 were recorded for the three months ended September 30, 2014 and 2013, respectively. Net periodic benefit costs totaling $321,000 and $623,000 were recorded for the nine months ended September 30, 2014 and 2013, respectively.

Note 9 - Fair Value Disclosures

The authoritative accounting guidance for fair value measurements defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants. A fair value measurement assumes that the transaction to sell the asset or transfer the liability occurs in the principal market for the asset or liability or, in the absence of a principal market, the most advantageous market for the asset or liability. The price in the principal (or most advantageous) market used to measure the fair value of the asset or liability shall not be adjusted for transaction costs. An orderly transaction is a transaction that assumes exposure to the market for a period prior to the measurement date to allow for marketing activities that are usual and customary for transactions involving such assets and liabilities; it is not a forced transaction. Market participants are buyers and sellers in the principal market that are (i) independent, (ii) knowledgeable, (iii) able to transact, and (iv) willing to transact.

The authoritative accounting guidance requires the use of valuation techniques that are consistent with the market approach, the income approach and/or the cost approach. The market approach uses prices and other relevant information generated by market transactions involving identical or comparable assets and liabilities. The income approach uses valuation techniques to convert future amounts, such as cash flows or earnings, to a single present amount on a discounted basis. The cost approach is based on the amount that currently would be required to replace the service capacity of an asset (replacement costs). Valuation techniques should be consistently applied. Inputs to valuation techniques refer to the assumptions that market participants would use in pricing the asset or liability. Inputs may be observable, meaning those that reflect the assumptions market participants would use in pricing the asset or liability developed based on market data obtained from independent sources, or unobservable, meaning those that reflect the reporting entity’s own assumptions about the assumptions market participants would use in pricing the asset or liability developed based on the best information available in the circumstances. In that regard,

 

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the authoritative guidance establishes a fair value hierarchy for valuation inputs that gives the highest priority to quoted prices in active markets for identical assets or liabilities and the lowest priority to unobservable inputs. The fair value hierarchy is as follows:

 

    Level 1 Inputs – Unadjusted quoted prices in active markets for identical assets or liabilities that the reporting entity has the ability to access at the measurement date.

 

    Level 2 Inputs – Inputs other than quoted prices included in Level 1 that are observable for the asset or liability, either directly or indirectly. These include quoted prices for similar assets or liabilities in active markets, quoted prices for identical or similar assets or liabilities in markets that are not active, inputs other than quoted prices that are observable for the asset or liability (for example, interest rates, volatilities, prepayment speeds, loss severities, credit risks and default rates) or inputs that are derived principally from or corroborated by observable market data by correlation or other means.

 

    Level 3 Inputs – Significant unobservable inputs that reflect an entity’s own assumptions that market participants would use in pricing the assets or liabilities.

A description of the valuation methodologies used for assets and liabilities measured at fair value, as well as the general classification of such instruments pursuant to the valuation hierarchy, is set forth below.

In general, fair value is based upon quoted market prices, where available. If such quoted market prices are not available, fair value is based upon internally developed models that primarily use, as inputs, observable market-based parameters. Valuation adjustments may be made to ensure that financial instruments are recorded at fair value. While management believes the Company’s valuation methodologies are appropriate and consistent with other market participants, the use of different methodologies or assumptions to determine the fair value of certain financial instruments could result in a different estimate of fair value at the reporting date.

Securities classified as available-for-sale and trading are reported at fair value utilizing Level 1 and Level 2 inputs. For these securities, the Company obtains fair value measurements from an independent pricing service. The fair value measurements consider observable data that may include market spreads, cash flows, the United States Treasury yield curve, live trading levels, trade execution data, dealer quotes, market consensus prepayments speeds, credit information and the security’s terms and conditions, among other items. Securities are considered to be measured with Level 1 inputs at the time of purchase and for 30 days following. After 30 days, the majority of securities are transferred to Level 2 as they are considered to be measured with Level 2 inputs, with the exception of U. S. Treasury securities and any other security for which there remain Level 1 inputs. Transfers are recognized on the actual date of transfer.

There were no transfers between Level 2 and Level 3 during the three and nine months ended September 30, 2014 or 2013.

 

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The following table summarizes financial assets and financial liabilities measured at fair value on a recurring basis as of September 30, 2014, segregated by the level of the valuation inputs within the fair value hierarchy utilized to measure fair value (dollars in thousands):

 

     Level 1
Inputs
     Level 2
Inputs
     Level 3
Inputs
     Total Fair
Value
 

Available-for-sale investment securities:

           

U.S. Treasury securities

   $ 520       $ —         $ —         $ 520   

Obligations of U. S. government sponsored-enterprises and agencies

     —           107,301         —           107,301   

Obligations of states and political subdivisions

     18,546         1,083,423         —           1,101,969   

Corporate bonds

     —           95,038         —           95,038   

Residential mortgage-backed securities

     45,769         766,098         —           811,867   

Commercial mortgage-backed securities

     —           132,412         —           132,412   

Other securities

     4,655         —           —           4,655   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 69,490       $ 2,184,272       $ —         $ 2,253,762   
  

 

 

    

 

 

    

 

 

    

 

 

 

Certain financial assets and financial liabilities are measured at fair value on a nonrecurring basis, that is, the instruments are not measured at fair value on an ongoing basis but are subject to fair value adjustments in certain circumstances (for example, when there is evidence of impairment). Financial assets and financial liabilities measured at fair value on a non-recurring basis include the following at September 30, 2014:

Impaired Loans – Impaired loans are reported at the fair value of the underlying collateral if repayment is expected solely from the collateral. Collateral values are estimated using Level 2 inputs based on observable market data, or Level 3 inputs based on the discounting of the collateral. At September 30, 2014, impaired loans with a carrying value of $22,093,000 were reduced by specific valuation reserves totaling $4,634,000 resulting in a net fair value of $17,459,000.

Loans Held for Sale – Loans held for sale are reported at the lower of cost or fair value. In determining whether the fair value of loans held for sale is less than cost when quoted market prices are not available, the Company considers investor commitments/contracts. These loans are considered Level 2 of the fair value hierarchy. At September 30, 2014, the Company’s mortgage loans held for sale were recorded at cost as fair value exceeded cost.

Certain non-financial assets and non-financial liabilities measured at fair value on a non-recurring basis include other real estate owned, goodwill and other intangible assets and other non-financial long-lived assets. Non-financial assets measured at fair value on a non-recurring basis during the three and nine months ended September 30, 2014 and 2013 include other real estate owned which, subsequent to their initial transfer to other real estate owned from loans, were re-measured at fair value through a write-down included in gain (loss) on sale of foreclosed assets. During the reported periods, all fair value measurements for foreclosed assets utilized Level 2 inputs based on observable market data, generally third-party appraisals, or Level 3 inputs based on customized discounting criteria. These appraisals are evaluated individually and discounted as necessary due to the age of the appraisal, lack of comparable sales, expected holding periods of property or special use type of the property. Such discounts vary by appraisal based on the above factors but generally range from 5% to 25% of the appraised value. Reevaluation of other real estate owned is performed at least annually as required by regulatory guidelines or more often if particular circumstances arise. The following table presents other real estate owned that were re-measured subsequent to their initial transfer to other real estate owned (dollars in thousands):

 

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     Three Months Ended
September 30,
 
     2014     2013  

Carrying value of other real estate owned prior to re-measurement

   $ 173      $ 238   

Write-downs included in gain (loss) on sale of other real estate owned

     (46     (65
  

 

 

   

 

 

 

Fair value

   $ 127      $ 173   
  

 

 

   

 

 

 

 

     Nine Months Ended
September 30,
 
     2014     2013  

Carrying value of other real estate owned prior to re-measurement

   $ 881      $ 2,065   

Write-downs included in gain (loss) on sale of other real estate owned

     (135     (369
  

 

 

   

 

 

 

Fair value

   $ 746      $ 1,696   
  

 

 

   

 

 

 

At September 30, 2014 and 2013, and December 31, 2013, other real estate owned totaled $1,185,000, $5,490,000 and $2,903,000, respectively.

The Company is required under current authoritative accounting guidance to disclose the estimated fair value of their financial instrument assets and liabilities including those subject to the requirements discussed above. For the Company, as for most financial institutions, substantially all of its assets and liabilities are considered financial instruments. Many of the Company’s financial instruments, however, lack an available trading market as characterized by a willing buyer and willing seller engaging in an exchange transaction.

The estimated fair value amounts of financial instruments have been determined by the Company using available market information and appropriate valuation methodologies. However, considerable judgment is required to interpret data to develop the estimates of fair value. Accordingly, the estimates presented herein are not necessarily indicative of the amounts the Company could realize in a current market exchange. The use of different market assumptions and/or estimation methodologies may have a material effect on the estimated fair value amounts.

In addition, reasonable comparability between financial institutions may not be likely due to the wide range of permitted valuation techniques and numerous estimates that must be made given the absence of active secondary markets for many of the financial instruments. This lack of uniform valuation methodologies also introduces a greater degree of subjectivity to these estimated fair values.

Cash and due from banks, federal funds sold, interest-bearing deposits and time deposits in banks and accrued interest receivable and payable are liquid in nature and considered Levels 1 or 2 of the fair value hierarchy.

Financial instruments with stated maturities have been valued using a present value discounted cash flow with a discount rate approximating current market for similar assets and liabilities and are considered Levels 2 and 3 of the fair value hierarchy. Financial instrument liabilities with no stated maturities have an estimated fair value equal to both the amount payable on demand and the carrying value and are considered Level 1 of the fair value hierarchy.

The carrying value and the estimated fair value of the Company’s contractual off-balance-sheet unfunded lines of credit, loan commitments and letters of credit, which are generally priced at market at the time of funding, are not material.

 

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The estimated fair values and carrying values of all financial instruments under current authoritative guidance at September 30, 2014 and December 31, 2013, were as follows (in thousands):

 

     September 30,      December 31,       
     2014      2013       
     Carrying      Estimated      Carrying      Estimated      Fair Value
     Value      Fair Value      Value      Fair Value      Hierarchy

Cash and due from banks

   $ 149,957       $ 149,957       $ 183,084       $ 183,084       Level 1

Federal funds sold

     4,785         4,785         3,430         3,430       Level 1

Interest-bearing deposits in banks

     83,994         83,994         25,498         25,498       Level 1

Interest-bearing time deposits in banks

     19,234         19,285         31,917         32,059       Level 2

Available-for-sale securities

     2,253,762         2,253,762         2,057,723         2,057,723       Levels 1 and 2

Held-to-maturity securities

     554         560         684         694       Level 2

Loans

     2,803,308         2,815,509         2,655,548         2,667,743       Level 3

Accrued interest receivable

     23,420         23,420         26,865         26,865       Level 2

Deposits with stated maturities

     664,221         666,123         686,627         688,876       Level 2

Deposits with no stated maturities

     3,800,143         3,800,143         3,448,448         3,448,448       Level 1

Short term borrowings

     341,909         341,909         463,888         463,888       Level 2

Accrued interest payable

     275         275         299         299       Level 2

Note 10 - Recently Issued Authoritative Accounting Guidance

In 2014, the Financial Accounting Standards Board (the “FASB”) amended its authoritative guidance related to residential real estate to clarify that an in substance repossession or foreclosure occurs, and a creditor is considered to have received physical possession of residential real estate property collateralizing a consumer mortgage loan, upon either (1) the creditor obtaining legal title to the residential real estate property upon completion of a foreclosure or (2) the borrower conveying all interest in the residential real estate property to the creditor to satisfy that loan through completion of a deed in lieu of foreclosure or through a similar legal agreement. Additionally, the amendment requires interim and annual disclosure of both (1) the amount of foreclosed residential real estate property held by the creditor and (2) the recorded investment in consumer mortgage loans collateralized by residential real estate property that are in the process of foreclosure according to local requirements of the applicable jurisdiction. The new guidance is effective for the Company on January 1, 2015 and is not expected to have a significant impact to the Company’s financial statements.

In 2014, the FASB issued a comprehensive new revenue recognition standard that will supersede substantially all existing revenue recognition guidance. The new standard’s core principle is that a company will recognize revenue when it transfers promised goods or services to customers in an amount that reflects the consideration to which the company expects to be entitled in exchange for those goods or services. In doing so, companies will need to use more judgment and make more estimates than under existing guidance. These may include identifying performance obligations in the contract, estimating the

 

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amount of variable consideration to include in the transaction price and allocating the transaction price to each separate performance obligation. The new standard will be effective in the first quarter of 2017 and is not expected to have a significant impact to the Company’s financial statements.

In 2014, the FASB amended its authoritative guidance related to repurchase-to-maturity transaction to require that repurchase-to-maturity transactions be accounted for as secured borrowings consistent with the accounting for other repurchase agreements. In addition, the amendment requires separate accounting for repurchase financings, which entails the transfer of a financial asset executed contemporaneously with a repurchase agreement with the same counterparty. The amendment requires entities to disclose certain information about transfers accounted for as sales in transactions that economically similar to repurchase agreements. In addition, the amendment requires disclosures related to collateral, remaining contractual tenor and of the potential risks associated with repurchase agreements, securities lending transactions and repurchase-to-maturity transactions. The amendment will be effective on January 1, 2015 and is not expected to have a significant impact on the Company’s financial statements.

 

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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Forward-Looking Statements

This Form 10-Q contains certain forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. When used in this Form 10-Q, words such as “anticipate,” “believe,” “estimate,” “expect,” “intend,” “predict,” “project,” and similar expressions, as they relate to us or management, identify forward-looking statements. These forward-looking statements are based on information currently available to our management. Actual results could differ materially from those contemplated by the forward-looking statements as a result of certain factors, including, but not limited to, those listed in “Item 1A- Risk Factors” in our Annual Report on Form 10-K and the following:

 

    general economic conditions, including our local, state and national real estate markets and employment trends;

 

    volatility and disruption in national and international financial markets;

 

    government intervention in the U.S. financial system including the effects of recent legislative, tax, accounting and regulatory actions and reforms, including the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”), the Jumpstart Our Business Startups Act, the Consumer Financial Protection Bureau and the capital ratios of Basel III as adopted by the federal banking authorities;

 

    political instability;

 

    the ability of the Federal government to address the national economy and the fiscal cliff;

 

    competition from other financial institutions and financial holding companies;

 

    the effects of and changes in trade, monetary and fiscal policies and laws, including interest rate policies of the Board of Governors of the Federal Reserve System (the “Federal Reserve”);

 

    changes in the demand for loans;

 

    fluctuations in the value of collateral securing our loan portfolio and in the level of the allowance for loan losses;

 

    the accuracy of our estimates of future loan losses;

 

    the accuracy of our estimates and assumptions regarding the performance of our securities portfolio;

 

    soundness of other financial institutions with which we have transactions;

 

    inflation, interest rate, market and monetary fluctuations;

 

    changes in consumer spending, borrowing and savings habits;

 

    our ability to attract deposits;

 

    changes in our liquidity position;

 

    changes in the reliability of our vendors, internal control system or information systems;

 

    our ability to attract and retain qualified employees;

 

    acquisitions and integration of acquired businesses;

 

    the possible impairment of goodwill associated with our acquisitions;

 

    consequences of continued bank mergers and acquisitions in our market area, resulting in fewer but much larger and stronger competitors;

 

    expansion of operations, including branch openings, new product offerings and expansion into new markets;

 

    changes in compensation and benefit plans; and

 

    acts of God or of war or terrorism.

 

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Such forward-looking statements reflect the current views of our management with respect to future events and are subject to these and other risks, uncertainties and assumptions relating to our operations, results of operations, growth strategy and liquidity. All subsequent written and oral forward-looking statements attributable to us or persons acting on our behalf are expressly qualified in their entirety by this paragraph. We undertake no obligation to publicly update or otherwise revise any forward-looking statements, whether as a result of new information, future events or otherwise (except as required by law).

Introduction

As a financial holding company, we generate most of our revenue from interest on loans and investments, trust fees, and service charges. Our primary source of funding for our loans and investments are deposits held by our subsidiary bank. Our largest expenses are interest on these deposits, salaries and related employee benefits. We usually measure our performance by calculating our return on average assets, return on average equity, our regulatory leverage and risk based capital ratios and our efficiency ratio, which is calculated by dividing noninterest expense by the sum of net interest income on a tax equivalent basis and noninterest income.

The following discussion of operations and financial condition should be read in conjunction with the financial statements and accompanying footnotes included in Item 1 of this Form 10-Q as well as those included in the Company’s 2013 Annual Report on Form 10-K.

Critical Accounting Policies

We prepare consolidated financial statements based on generally accepted accounting principles and customary practices in the banking industry. These policies, in certain areas, require us to make significant estimates and assumptions.

We deem a policy critical if (1) the accounting estimate required us to make assumptions about matters that are highly uncertain at the time we make the accounting estimate; and (2) different estimates that reasonably could have been used in the current period, or changes in the accounting estimate that are reasonably likely to occur from period to period, would have a material impact on the financial statements.

We deem our most critical accounting policies to be (1) our allowance for loan losses and our provision for loan losses and (2) our valuation of securities. We have other significant accounting policies and continue to evaluate the materiality of their impact on our consolidated financial statements, but we believe these other policies either do not generally require us to make estimates and judgments that are difficult or subjective, or it is less likely they would have a material impact on our reported results for a given period. A discussion of (1) our allowance for loan losses and our provision for loan losses and (2) our valuation of securities is included in note 5 and note 4, respectively, to our notes to consolidated financial statements (unaudited) which begins on page 9.

Stock Split

On April 22, 2014, the Company’s Board of Directors declared a two-for-one stock split in the form of a 100% stock dividend effective for shareholders of record on May 15, 2014 that was distributed on June 2, 2014. All per share amounts in this report have been restated to reflect this stock split. An amount equal to the par value of the additional common shares issued pursuant to the stock split was reflected as a transfer from retained earnings to common stock on the consolidated financial statements as of and for the nine months ended September 30, 2014.

 

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Acquisition of Orange Savings Bank, SSB

On February 9, 2013, we entered into an agreement and plan of merger to acquire Orange Savings Bank, SSB. On May 31, 2013, the transaction was completed, which we refer to herein as the “Orange acquisition”. Pursuant to the agreement, we paid $39.20 million in cash and issued 420,000 shares of the Company’s common stock in exchange for all of the outstanding shares of Orange Savings Bank, SSB.

At closing, Orange Savings Bank, SSB, was merged into First Financial Bank, N.A., Abilene, Texas, a wholly owned subsidiary of the Company. The total purchase price exceeded the estimated fair value of assets acquired by approximately $23.02 million and was recorded by the Company as goodwill.

Results of Operations

Performance Summary. Net earnings for the third quarter of 2014 were $23.43 million compared to $19.56 million for the same quarter in 2013, or a 19.78% increase.

Basic earnings per share for the third quarter of 2014 were $0.37 compared to $0.31 for the same quarter last year. The return on average assets was 1.71% for the third quarter of 2014, as compared to 1.56% for the same quarter of 2013. The return on average equity was 14.27% for the third quarter of 2014 as compared to 13.64% for the same quarter a year ago.

Net earnings for the nine-month period ended September 30, 2014 were $66.97 million compared to $57.63 million for the same period in 2013, or a 16.21% increase.

Basic earnings per share for the first nine months of 2014 were $1.05 compared to $0.91 for the same period last year. The return on average assets was 1.68% for the first nine months of 2014, as compared to 1.64% for the same period in 2013. The return on average equity was 14.24% for the first nine months of 2014 as compared to 13.53% a year ago.

Net Interest Income. Net interest income is the difference between interest income on earning assets and interest expense on liabilities incurred to fund those assets. Our earning assets consist primarily of loans and investment securities. Our liabilities to fund those assets consist primarily of noninterest-bearing and interest-bearing deposits.

Tax-equivalent net interest income was $53.70 million for the third quarter of 2014, as compared to $49.85 million for the same period last year. The increase in 2014 compared to 2013 was largely attributable to the increase in volume of interest earning assets. Average earning assets increased $444.91 million for the third quarter of 2014 over the same period in 2013. Average tax exempt securities, taxable securities and average loans increased $114.09 million, $155.20 million and $177.83 million, respectively, for the third quarter of 2014 over the third quarter of 2013. Average interest bearing liabilities increased $187.06 million for the third quarter of 2014, as compared to the same period in 2013. The yield on earning assets decreased 9 basis points during the third quarter of 2014, whereas the rate paid on interest-bearing liabilities decreased 2 basis points in the third quarter of 2014 primarily due to the effects of lower interest rates.

 

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Tax-equivalent net interest income was $158.47 million for the first nine months of 2014, as compared to $137.83 million for the same period last year. The increase in 2014 compared to 2013 was largely attributable to the increase in volume of interest earning assets. Average earning assets increased $606.19 million for the first nine months of 2014 over the same period in 2013. Average tax exempt securities, taxable securities and average loans increased $133.88 million, $110.48 million and $391.77 million, respectively, for the first nine months of 2014 over the same period in 2013. Average interest bearing liabilities increased $432.94 million for the first nine months period of 2014, as compared to the same period in 2013. The yield on earning assets increased 3 basis points during the first nine months of 2014, whereas the rate paid on interest-bearing liabilities decreased 1 basis point in the first nine months of 2014 primarily due to the effects of lower interest rates.

Table 1 allocates the change in tax-equivalent net interest income between the amount of change attributable to volume and to rate.

Table 1 - Changes in Interest Income and Interest Expense (in thousands):

 

     Three Months Ended September 30,
2014 Compared to Three Months Ended
September  30, 2013
    Nine Months Ended September 30, 2014
Compared to Nine Months Ended
September 30, 2013
 
     Change Attributable to     Total
Change
    Change Attributable to     Total
Change
 
     Volume     Rate       Volume     Rate    

Short-term investments

   $ (2   $ (27   $ (29   $ (142   $ (6   $ (148

Taxable investment securities

     941        (215     726        2,001        213        2,214   

Tax-exempt investment securities (1)

     1,383        (61     1,322        4,832        421        5,253   

Loans (1) (2)

     2,249        (512     1,737        14,828        (1,372     13,456   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Interest income

     4,571        (815     3,756        21,519        (744     20,775   

Interest-bearing deposits

     103        (142     (39     456        (320     136   

Short-term borrowings

     (20     (36     (56     18        (25     (7
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Interest expense

     83        (178     (95     474        (345     129   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net interest income

   $ 4,488      $ (637   $ 3,851      $ 21,045      $ (399   $ 20,646   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

(1) Computed on a tax-equivalent basis assuming a marginal tax rate of 35%.
(2) Non-accrual loans are included in loans.

The net interest margin for the third quarter of 2014 was 4.18%, a decrease of 7 basis points from the same period in 2013. The net interest margin for the nine months ended September 30, 2014 was 4.25%, an increase of 4 basis points from the same period in 2013. We expect interest rates to remain at the current low levels based on comments made by the Federal Reserve, which will continue to place pressure on our interest margin.

 

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The net interest margin, which measures tax-equivalent net interest income as a percentage of average earning assets, is illustrated in Table 2.

Table 2 - Average Balances and Average Yields and Rates (in thousands, except percentages):

 

     Three Months Ended September 30,  
     2014     2013  
     Average
Balance
    Income/
Expense
     Yield/
Rate
    Average
Balance
    Income/
Expense
     Yield/
Rate
 

Assets

              

Short-term investments (1)

   $ 60,832      $ 80         0.55   $ 63,045      $ 109         0.76

Taxable investment securities (2)

     1,166,248        6,856         2.35        1,011,050        6,130         2.43   

Tax-exempt investment securities (2)(3)

     1,057,715        12,763         4.83        943,623        11,441         4.85   

Loans (3)(4)

     2,814,083        35,070         4.94        2,636,253        33,333         5.02   
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

    

 

 

 

Total earning assets

     5,098,878      $ 54,769         4.26     4,653,971      $ 51,013         4.35

Cash and due from banks

     143,102             127,800        

Bank premises and equipment, net

     100,266             94,864        

Other assets

     43,670             48,988        

Goodwill and other intangible assets, net

     97,424             97,297        

Allowance for loan losses

     (36,093          (34,428     
  

 

 

        

 

 

      

Total assets

   $ 5,447,247           $ 4,988,492        
  

 

 

        

 

 

      

Liabilities and Shareholders’ Equity

              

Interest-bearing deposits

   $ 2,892,065      $ 999         0.14   $ 2,631,862      $ 1,038         0.16

Short-term borrowings

     384,768        70         0.07        457,914        126         0.11   
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

    

 

 

 

Total interest-bearing liabilities

     3,276,833      $ 1,069         0.13     3,089,776      $ 1,164         0.15

Noninterest-bearing deposits

     1,470,682             1,292,491        

Other liabilities

     48,225             37,091        
  

 

 

        

 

 

      

Total liabilities

     4,795,740             4,419,358        

Shareholders’ equity

     651,507             569,134        
  

 

 

        

 

 

      

Total liabilities and shareholders’ equity

   $ 5,447,247           $ 4,988,492        
  

 

 

        

 

 

      

Net interest income

     $ 53,700           $ 49,849      
    

 

 

        

 

 

    

Rate Analysis:

              

Interest income/earning assets

          4.26          4.35

Interest expense/earning assets

          0.08             0.10   
       

 

 

        

 

 

 

Net yield on earning assets

          4.18          4.25
              

 

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Table of Contents
     Nine Months Ended September 30,  
     2014     2013  
     Average
Balance
    Income/
Expense
     Yield/
Rate
    Average
Balance
    Income/
Expense
     Yield/
Rate
 

Assets

              

Short-term investments (1)

   $ 58,538      $ 257         0.62   $ 88,475      $ 405         0.65

Taxable investment securities (2)

     1,149,156        21,032         2.44        1,038,679        18,818         2.42   

Tax-exempt investment securities (2)(3)

     1,029,661        37,579         4.87        895,778        32,326         4.81   

Loans (3)(4)

     2,750,983        102,747         4.99        2,359,216        89,291         5.06   
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

    

 

 

 

Total earning assets

     4,988,338      $ 161,615         4.33     4,382,148      $ 140,840         4.30

Cash and due from banks

     142,023             126,198        

Bank premises and equipment, net

     97,436             90,147        

Other assets

     43,457             47,821        

Goodwill and other intangible assets, net

     97,458             83,319        

Allowance for loan losses

     (35,276          (34,552     
  

 

 

        

 

 

      

Total assets

   $ 5,333,436           $ 4,695,081        
  

 

 

        

 

 

      

Liabilities and Shareholders’ Equity

              

Interest-bearing deposits

   $ 2,859,269      $ 2,894         0.14   $ 2,453,370      $ 2,758         0.15

Short-term borrowings

     405,811        249         0.08        378,775        256         0.09   
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

    

 

 

 

Total interest-bearing liabilities

     3,265,080      $ 3,143         0.13     2,832,145      $ 3,014         0.14

Noninterest-bearing deposits

     1,397,909             1,245,434        

Other liabilities

     41,473             47,939        
  

 

 

        

 

 

      

Total liabilities

     4,704,462             4,125,518        

Shareholders’ equity

     628,974             569,563        
  

 

 

        

 

 

      

Total liabilities and shareholders’ equity

   $ 5,333,436           $ 4,695,081        
  

 

 

        

 

 

      

Net interest income

     $ 158,472           $ 137,826      
    

 

 

        

 

 

    

Rate Analysis:

              

Interest income/earning assets

          4.33          4.30

Interest expense/earning assets

          0.08             0.09   
       

 

 

        

 

 

 

Net yield on earning assets

          4.25          4.21
              

 

(1) Short-term investments are comprised of Fed Funds sold, interest-bearing deposits in banks and interest-bearing time deposits in banks.
(2) Average balances include unrealized gains and losses on available-for-sale securities.
(3) Computed on a tax-equivalent basis assuming a marginal tax rate of 35%.
(4) Non-accrual loans are included in loans.

Noninterest Income. Noninterest income for the third quarter of 2014 was $17.32 million, an increase of $249 thousand over the same period in 2013. Trust fees increased $634 thousand, and ATM, interchange and credit card fees increased $689 thousand. The increase in trust fees reflects an increase in fees from mineral management as well as assets under management over the prior year from both market value growth and growth in assets managed. The fair value of our trust assets managed, which are not reflected in our consolidated balance sheets, totaled $3.66 billion at September 30, 2014 as compared to $3.20 billion a year ago. The increases in ATM, interchange and credit card fees are primarily a result of increases in the number of net new accounts and debit cards.

Offsetting these increases were decreases in real estate mortgage fees of $195 thousand and service charges on deposits of $396 thousand. The decline in real estate mortgage fees is a result of the overall decline in mortgage refinance activity.

 

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Table of Contents

Noninterest income for the nine month period ended September 30, 2014 was $49.60 million, an increase of $3.34 million over the same period in 2013. Trust fees increased $2.01 million, ATM, interchange and credit card fees increased $1.98 million and net gain on sale of foreclosed assets increased $1.07 million. The increase in trust fees reflects an increase in fees from mineral management as well as assets under management over the prior year from both market value growth and growth in assets managed. The increases in ATM, interchange and credit card fees are primarily a result of increases in the number of net new accounts and debit cards. The increase in net gain on sale of foreclosed assets is a result of several gains recognized on sales of foreclosed properties in our Orange and Weatherford regions. Also included in noninterest income in the first nine months of 2014 was a $605 thousand gain on the settlement of a bank owned life insurance contract.

Offsetting these increases was a decrease in real estate mortgage fees of $975 thousand, primarily resulting from the overall decline in mortgage refinance activity.

Table 3 - Noninterest Income (in thousands):

 

     Three Months Ended
September 30,
    Nine Months Ended
September 30,
 
     2014     Increase
(Decrease)
    2013     2014     Increase
(Decrease)
    2013  

Trust fees

   $ 4,772      $ 634      $ 4,138      $ 13,897      $ 2,013      $ 11,884   

Service charges on deposit accounts

     4,402        (396     4,798        12,623        (386     13,009   

ATM, interchange and credit card fees

     5,093        689        4,404        14,291        1,976        12,315   

Real estate mortgage operations

     1,813        (195     2,008        4,174        (975     5,149   

Net gain (loss) on sale of available-for-sale securities

     1        109        (108     (4     (151     147   

Net gain (loss) on sale of foreclosed assets

     305        269        36        804        1,067        (263

Other:

        

Check printing fees

     55        (16     71        158        (12     170   

Safe deposit rental fees

     115        (1     116        423        30        393   

Credit life and debt protection fees

     49        (3     52        115        (31     146   

Brokerage commissions

     212        (5     217        670        159        511   

Interest on loan recoveries

     50        (54     104        437        27        410   

Gain on sale of assets

     (31     (40     9        15        (102     117   

Miscellaneous income

     488        (742     1,230        1,998        (274     2,272   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total other

     938        (861     1,799        3,816        (203     4,019   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total Noninterest Income

   $ 17,324      $ 249      $ 17,075      $ 49,601      $ 3,341      $ 46,260   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Noninterest Expense. Total noninterest expense for the third quarter of 2014 was $34.04 million, a decrease of $1.49 million, or 4.20%, as compared to the same period in 2013. An important measure in determining whether a financial institution effectively manages noninterest expense is the efficiency ratio, which is calculated by dividing noninterest expense by the sum of net interest income on a tax-equivalent basis and noninterest income. Lower ratios indicate better efficiency since more income is generated with a lower noninterest expense total. Our efficiency ratio for the third quarter of 2014 was 47.93%, compared to 53.10% from the same period in 2013.

Salaries and employee benefits for the third quarter of 2014 totaled $17.95 million, an increase of $449 thousand compared to 2013. The increase was largely the result of additional employees to staff new branches and annual pay increases.

 

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Table of Contents

All other categories of noninterest expense for the third quarter of 2014 totaled $16.09 million, a decrease of $1.94 million, or 10.77%, as compared to the same period in 2013. The decrease in non-interest expense was largely attributable to the Company’s recognition of $3.40 million in technology contract termination costs related to the Orange acquisition in the third quarter of 2013. There were no such costs in 2014. Offsetting this decrease were increases in net occupancy and equipment expense and ATM, interchange and credit card expense. The increases in net occupancy and equipment expenses primarily resulted from the addition of several new branches and ATMs. ATM, interchange and credit card expenses increased due to a large growth in net new accounts and debit cards.

Total noninterest expense for the first nine months of 2014 was $101.49 million, an increase of $8.57 million, or 9.23%, as compared to the same period in 2013. Our efficiency ratio for the first nine months of 2014 was 48.78%, compared to 50.47% from the same period in 2013.

Salaries and employee benefits for the first nine months of 2014 totaled $52.64 million, an increase of $3.81 million compared to 2013. The increase was largely the result of additional employees to staff new branches, annual pay increases, our Orange acquisition and an increase in health care expenses.

All other categories of noninterest expense for the first nine months of 2014 totaled $48.85 million, an increase of $4.77 million, or 5.13%, as compared to the same period in 2013. The increase in non-interest expense was largely attributable to the Company’s recognition of $2.39 million related to a litigation settlement and the deductible from damage sustained in a hail storm in Abilene. Other categories of noninterest expense with increases included net occupancy and equipment expense, printing, stationary and supplies expense, ATM, interchange and credit card expense and advertising. These increases primarily resulted from the Orange acquisition, the addition of several new branches and ATMs and significant growth in net new accounts and debit cards.

 

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Table of Contents

Table 4 - Noninterest Expense (in thousands):

 

     Three Months Ended
September 30,
     Nine Months Ended
September 30,
 
     2014      Increase
(Decrease)
    2013      2014      Increase
(Decrease)
    2013  

Salaries

   $ 13,580       $ 414      $ 13,166       $ 39,623       $ 2,938      $ 36,685   

Medical

     1,145         (178     1,323         4,046         429        3,617   

Profit sharing

     1,596         119        1,477         3,808         70        3,738   

Pension

     107         (101     208         321         (302     623   

401(k) match expense

     430         65        365         1,289         167        1,122   

Payroll taxes

     918         44        874         3,019         237        2,782   

Stock option expense

     174         86        88         532         268        264   
  

 

 

    

 

 

   

 

 

    

 

 

    

 

 

   

 

 

 

Total salaries and employee benefits

     17,950         449        17,501         52,638         3,807        48,831   

Net occupancy expense

     2,297         133        2,164         6,804         809        5,995   

Equipment expense

     2,758         268        2,490         8,045         899        7,146   

FDIC assessment fees

     693         53        640         2,035         254        1,781   

ATM, interchange and credit card expense

     1,819         345        1,474         4,995         834        4,161   

Professional and service fees

     1,205         (158     1,363         3,249         51        3,198   

Printing, stationery and supplies

     632         98        534         1,960         456        1,504   

Amortization of intangible assets

     62         (15     77         210         90        120   

Other:

               

Data processing fees

     76         12        64         219         37        182   

Postage

     420         25        395         1,252         139        1,113   

Advertising

     918         219        699         2,721         861        1,860   

Correspondent bank service charges

     222         (28     250         666         (8     674   

Telephone

     515         (72     587         1,616         190        1,426   

Public relations and business development

     673         127        546         1,710         231        1,479   

Directors’ fees

     193         (9     202         661         19        642   

Audit and accounting fees

     439         33        406         1,243         69        1,174   

Legal fees

     221         47        174         591         64        527   

Regulatory exam fees

     232         8        224         691         73        618   

Travel

     254         (51     305         692         (8     700   

Courier expense

     235         43        192         600         30        570   

Operational and other losses

     393         (92     485         3,470         2,634        836   

Other real estate

     128         2        126         397         19        378   

Other miscellaneous expense

     1,705         (2,931     4,636         5,024         (2,978     8,002   
  

 

 

    

 

 

   

 

 

    

 

 

    

 

 

   

 

 

 

Total other

     6,624         (2,667     9,291         21,553         1,372        20,181   
  

 

 

    

 

 

   

 

 

    

 

 

    

 

 

   

 

 

 

Total Noninterest Expense

   $ 34,040       $ (1,494   $ 35,534       $ 101,489       $ 8,572      $ 92,917   
  

 

 

    

 

 

   

 

 

    

 

 

    

 

 

   

 

 

 

 

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Table of Contents

Balance Sheet Review

Loans. Our portfolio is comprised of loans made to businesses, professionals, individuals, and farm and ranch operations located in the primary trade areas served by our subsidiary bank. Real estate loans represent loans primarily for 1-4 family residences and owner-occupied commercial real estate. The structure of loans in the real estate mortgage area generally provides re-pricing intervals to minimize the interest rate risk inherent in long-term fixed rate loans. As of September 30, 2014, total loans held for investment were $2.83 billion, an increase of $144.15 million, as compared to December 31, 2013. As compared to December 31, 2013, commercial loans increased $15.36 million, agricultural loans increased $10.79 million, real estate loans increased $96.13 million, and consumer loans increased $21.87 million. Loans averaged $2.81 billion during the third quarter of 2014, an increase of $177.83 million from the prior year third quarter average balances. Loans averaged $2.75 billion during the nine month period ending September 30, 2014, an increase of $391.77 million from the same period average balances of 2013.

Table 5 - Composition of Loans (in thousands):

 

     September 30,      December 31,
2013
 
     2014      2013     

Commercial

   $ 612,092       $ 571,973       $ 596,730   

Agricultural

     86,718         66,758         75,928   

Real estate

     1,774,639         1,640,308         1,678,514   

Consumer

     354,981         330,046         333,113   
  

 

 

    

 

 

    

 

 

 

Total loans held-for-investment

   $ 2,828,430       $ 2,609,085       $ 2,684,285   
  

 

 

    

 

 

    

 

 

 

At September 30, 2014, our real estate loans represent approximately 62.74% of our loan portfolio and are comprised of (i) 1-4 family residence loans of 46.66%, (ii) commercial real estate loans of 28.33%, generally owner occupied, (iii) other loans, which includes ranches, hospitals and universities, of 14.45%, (iv) residential development and construction loans of 7.33%, which includes our custom and speculation home construction loans and (v) commercial development and construction loans of 3.23%.

Loans held for sale, consisting of secondary market mortgage loans, totaled $11.27 million, $5.72 million and $5.16 million at September 30, 2014 and 2013, and December 31, 2013, respectively, which were recorded at cost as fair value exceeded cost.

Asset Quality. The loan portfolio of our bank subsidiary is subject to periodic reviews by our centralized independent loan review group as well as periodic examinations by bank regulatory agencies. Loans are placed on non-accrual status when, in the judgment of management, the collectability of principal or interest under the original terms becomes doubtful. Non-accrual, past due 90 days or more and still accruing and restructured loans plus foreclosed assets were $23.63 million at September 30, 2014, as compared to $28.54 million at September 30, 2013 and $31.13 million at December 31, 2013. As a percent of loans and foreclosed assets, these assets were 0.83% at September 30, 2014, as compared to 1.09% at September 30, 2013 and 1.16% at December 31, 2013. As a percent of total assets, these assets were 0.42% at September 30, 2014 as compared to 0.56% at September 30, 2013 and 0.60% at December 31, 2013. We believe the level of these assets to be manageable and are not aware of any material classified credits not properly disclosed as nonperforming at September 30, 2014.

 

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Table of Contents

Table 6 – Non-accrual, Past Due 90 Days or More and Still Accruing, Restructured Loans and Foreclosed Assets (in thousands, except percentages):

 

     September 30,     December 31,
2013
 
     2014     2013    

Non-accrual loans*

   $ 22,093      $ 22,809      $ 27,926   

Loans still accruing and past due 90 days or more

     263        54        133   

Troubled debt restructured loans**

     —          —          —     

Foreclosed assets

     1,273        5,672        3,069   
  

 

 

   

 

 

   

 

 

 

Total

   $ 23,629      $ 28,535      $ 31,128   
  

 

 

   

 

 

   

 

 

 

As a % of loans and foreclosed assets

     0.83     1.09     1.16

As a % of total assets

     0.42     0.56     0.60

 

* Includes $2.38 million, $2.95 million and $2.71 million of purchased credit impaired loans as of September 30, 2014 and 2013, and December 31, 2013, respectively.
** Troubled debt restructured loans of $10.11 million, $14.74 million and $13.30 million, whose interest collection, after considering economic and business conditions and collection efforts, is doubtful are included in non-accrual loans at September 30, 2014 and 2013, and December 31, 2013, respectively. At this time, all of our restructured loans are included in non-accrual loans.

We record interest payments received on non-accrual loans as reductions of principal. Prior to the loans being placed on non-accrual, we recognized interest income on the December 31, 2013 impaired loans above of approximately $486 thousand during the year ended December 31, 2013. If interest on these impaired loans had been recognized on a full accrual basis during the year ended December 31, 2013, such income would have approximated $2.53 million. Such amounts for the 2014 and 2013 interim periods were insignificant.

Provision and Allowance for Loan Losses. The allowance for loan losses is the amount we determine as of a specific date to be appropriate to absorb probable losses on existing loans in which full collectability is unlikely based on our review and evaluation of the loan portfolio. For a discussion of our methodology, see note 5 to our notes to the consolidated financial statements (unaudited). The provision for loan losses was $896 thousand for the third quarter of 2014, as compared to $1.35 million for the third quarter of 2013. The provision for loan losses was $3.71 million for the first nine months of 2014, compared to $2.58 million for the same period in 2013. The continued provision for loan losses in 2014 and 2013 reflects the growth in loans and continuing levels of nonperforming and classified assets. As a percent of average loans, net loan charge-offs were 0.06% for the third quarter of 2014 compared to 0.10% during the third quarter of 2013. As a percent of average loans, net loan charge-offs were 0.06% for the first nine months of 2014, compared to 0.15% for the same period of 2013. The allowance for loan losses as a percent of loans was 1.28% as of September 30, 2014, as compared to 1.26% as of December 31, 2013 and 1.33% as of September 30, 2013. Included in Table 7 is further analysis of our allowance for loan losses.

 

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Table of Contents

Table 7 - Loan Loss Experience and Allowance for Loan Losses (in thousands, except percentages):

 

     Three Months Ended
September 30,
    Nine Months Ended
September 30,
 
     2014     2013     2014     2013  

Allowance for loan losses at period end

   $ 36,388      $ 34,800      $ 36,388      $ 34,800   

Loans held for investment at period end

     2,828,430        2,609,085        2,828,430        2,609,085   

Average loans for period

     2,814,083        2,636,253        2,750,983        2,359,216   

Net charge-offs/average loans (annualized)

     0.06     0.10     0.06     0.15

Allowance for loan losses/period-end loans

     1.28     1.33     1.28     1.33

Allowance for loan losses/non-accrual loans, past due 90 days still accruing and restructured loans

     162.77     152.21     162.77     152.21

Interest-Bearing Deposits in Banks. At September 30, 2014, our interest-bearing deposits in banks were $103.23 million compared with $82.99 million and $57.42 million as of September 30, 2013 and December 31, 2013, respectively. At September 30, 2014, interest-bearing deposits in banks included $19.23 million invested in FDIC-insured certificates of deposit, $83.70 million maintained at the Federal Reserve Bank of Dallas and $296 thousand on deposit with the Federal Home Loan Bank of Dallas (“FHLB”).

Available-for-Sale and Held-to-Maturity Securities. At September 30, 2014, securities with a fair value of $2.25 billion were classified as securities available-for-sale and securities with an amortized cost of $554 thousand were classified as securities held-to-maturity. As compared to December 31, 2013, the available-for-sale portfolio at September 30, 2014 reflected (i) a decrease of $30.79 million in obligations of U.S. government sponsored-enterprises and agencies, (ii) an increase of $110.70 million in obligations of states and political subdivisions, (iii) a decrease of $9.35 million in corporate and other bonds, (iv) an increase of $124.95 million in mortgage-backed securities and (v) an increase of $520 thousand in U.S. Treasury securities. Our mortgage related securities are backed by GNMA, FNMA or FHLMC or are collateralized by securities guaranteed by these agencies.

See note 4 to the consolidated financial statements (unaudited) for additional disclosures relating to the maturities and fair values of the investment portfolio at September 30, 2014 and December 31, 2013.

 

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Table of Contents

Table 8 - Maturities and Yields of Available-for-Sale Securities Held at September 30, 2014 (in thousands, except percentages):

 

     Maturing  
     One Year
or Less
    After One Year
Through
Five Years
    After Five Years
Through
Ten Years
    After
Ten Years
    Total  

Available-for-Sale:

   Amount      Yield     Amount      Yield     Amount      Yield     Amount      Yield     Amount      Yield  

U.S. Treasury securities

   $ —           —     $ 520         1.17   $ —           —     $ —           —     $ 520         1.17

Obligations of U.S. government sponsored-enterprises and agencies

     22,011         1.85        85,290         1.17        —           —          —           —          107,301         1.31   

Obligations of states and political subdivisions

     45,482         3.78        520,210         5.07        527,658         5.35        8,619         7.60        1,101,969         5.17   

Corporate bonds and other securities

     10,229         1.77        89,464         2.57        —           —          —           —          99,693         2.49   

Mortgage-backed securities

     4,637         4.59        628,363         2.54        311,066         2.54        213         2.57        944,279         2.55   
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Total

   $ 82,359         3.06   $ 1,323,847         3.45   $ 838,724         4.31   $ 8,832         7.48   $ 2,253,762         3.77
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Amounts for held-to-maturity securities are not included herein due to insignificance.

All yields are computed on a tax-equivalent basis assuming a marginal tax rate of 35%. Yields on available-for-sale securities are based on amortized cost. Maturities of mortgage-backed securities are based on contractual maturities and could differ due to prepayments of underlying mortgages. Maturities of other securities are reported at the earlier of maturity date or call date.

As of September 30, 2014, the investment portfolio had an overall tax equivalent yield of 3.77%, a weighted average life of 4.61 years and modified duration of 4.10 years.

Deposits. Deposits held by our subsidiary bank represent our primary source of funding. Total deposits were $4.46 billion as of September 30, 2014, as compared to $4.00 billion as of September 30, 2013. Table 9 provides a breakdown of average deposits and rates paid for the three and nine month periods ended September 30, 2014 and 2013.

 

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Table 9 - Composition of Average Deposits (in thousands, except percentages):

 

     Three Months Ended September 30,  
     2014     2013  
     Average
Balance
     Average
Rate
    Average
Balance
     Average
Rate
 

Noninterest-bearing deposits

   $ 1,470,682         —     $ 1,292,491         —  

Interest-bearing deposits:

          

Interest-bearing checking

     1,317,199         0.10        1,145,687         0.13   

Savings and money market accounts

     897,391         0.06        789,311         0.06   

Time deposits under $100,000

     277,113         0.25        298,815         0.25   

Time deposits of $100,000 or more

     400,362         0.34        398,049         0.34   
  

 

 

    

 

 

   

 

 

    

 

 

 

Total interest-bearing deposits

     2,892,065         0.14     2,631,862         0.16
  

 

 

    

 

 

   

 

 

    

 

 

 

Total average deposits

   $ 4,362,747         $ 3,924,353      
  

 

 

      

 

 

    

 

     Nine Months Ended September 30,  
     2014     2013  
     Average
Balance
     Average
Rate
    Average
Balance
     Average
Rate
 

Noninterest-bearing deposits

   $ 1,397,909         —     $ 1,245,434         —  

Interest-bearing deposits:

          

Interest-bearing checking

     1,307,362         0.11        1,062,035         0.11   

Savings and money market accounts

     869,072         0.06        733,626         0.06   

Time deposits under $100,000

     283,469         0.23        286,240         0.26   

Time deposits of $100,000 or more

     399,366         0.31        371,469         0.34   
  

 

 

    

 

 

   

 

 

    

 

 

 

Total interest-bearing deposits

     2,859,269         0.14     2,453,370         0.15
  

 

 

    

 

 

   

 

 

    

 

 

 

Total average deposits

   $ 4,257,178         $ 3,698,804      
  

 

 

      

 

 

    

Short-Term Borrowings. Included in short-term borrowings were federal funds purchased, securities sold under repurchase agreements and advances from the FHLB of $341.91 million and $466.50 million at September 30, 2014 and 2013, respectively. Securities sold under repurchase agreements are generally with significant customers of the Company that require short-term liquidity for their funds for which we pledge certain securities that have a fair value equal to at least the amount of the short-term borrowing. The average balance of federal funds purchased, securities sold under repurchase agreements and advances from the FHLB was $384.77 million and $457.91 million in the third quarter of 2014 and 2013, respectively. The weighted average interest rate paid on these short-term borrowings was 0.07% and 0.11% for the third quarter of 2014 and 2013, respectively. The average balances of federal funds purchased, securities sold under repurchase agreements and advances from the FHLB was $405.81 million and $378.77 million for the nine month periods ended September 30, 2014 and 2013, respectively. The weighted average interest rate paid on these short-term borrowings was 0.08% and 0.09% for the first nine months of 2014 and 2013, respectively.

 

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Capital Resources

We evaluate capital resources by our ability to maintain adequate regulatory capital ratios to do business in the banking industry. Issues related to capital resources arise primarily when we are growing at an accelerated rate but not retaining a significant amount of our profits or when we experience significant asset quality deterioration.

Total shareholders’ equity was $658.77 million, or 11.81% of total assets at September 30, 2014, as compared to $568.24 million, or 11.20% of total assets, at September 30, 2013. Included in shareholders’ equity at September 30, 2014 and September 30, 2013, were $43.22 million and $12.91 million, respectively, in unrealized gains on investment securities available-for-sale, net of related income taxes. For the third quarter of 2014, total shareholders’ equity averaged $651.51 million, or 11.96% of average assets, as compared to $569.13 million, or 11.41% of average assets, during the same period in 2013. For the nine months ended September 30, 2014, total shareholders’ equity averaged $628.97 million, or 11.79% of total assets, compared to $569.56 million, or 12.13% of total assets, during the same period in 2013.

Banking regulators measure capital adequacy by means of the risk-based capital ratio and leverage ratio. The risk-based capital rules provide for the weighting of assets and off-balance-sheet commitments and contingencies according to prescribed risk categories ranging from 0% to 100%. Regulatory capital is then divided by risk-weighted assets to determine the risk-adjusted capital ratios. The leverage ratio is computed by dividing shareholders’ equity less intangible assets by quarter-to-date average assets less intangible assets. Regulatory minimums to be designated “well capitalized” for total risk-based, Tier 1 risk-based and leverage ratios are 10.00%, 6.00% and 5.00% respectively. As of September 30, 2014, our total risk-based, Tier 1 risk-based and leverage capital ratios on a consolidated basis were 17.20%, 16.07% and 10.10%, respectively, as compared to total risk-based, Tier 1 risk-based and leverage capital ratios of 16.49%, 15.37% and 9.77% as of September 30, 2013. We believe by all measurements our capital ratios remain well above regulatory requirements to be considered “well capitalized” by the regulators.

Interest Rate Risk

Interest rate risk results when the maturity or re-pricing intervals of interest-earning assets and interest-bearing liabilities are different. Our exposure to interest rate risk is managed primarily through our strategy of selecting the types and terms of interest-earning assets and interest-bearing liabilities that generate favorable earnings while limiting the potential negative effects of changes in market interest rates. We use no off-balance-sheet financial instruments to manage interest rate risk.

Our subsidiary bank has an asset liability management committee that monitors interest rate risk and compliance with investment policies. The subsidiary bank utilizes an earnings simulation model as the primary quantitative tool in measuring the amount of interest rate risk associated with changing market rates. The model quantifies the effects of various interest rate scenarios on projected net interest income and net income over the next twelve months. The model measures the impact on net interest income relative to a base case scenario of hypothetical fluctuations in interest rates over the next twelve months. These simulations incorporate assumptions regarding balance sheet growth and mix, pricing and the re-pricing and maturity characteristics of the existing and projected balance sheet.

As of September 30, 2014, the model simulations projected that 100 and 200 basis point increases in interest rates would result in positive variances in net interest income of 0.31% and 0.46%, respectively, relative to the base case over the next twelve months, while decreases in interest rates of 50 basis points would result in a negative variance in net interest income of 2.32% relative to the base case over the next twelve months. The likelihood of a decrease in interest rates beyond 50 basis points as of September 30, 2014 is considered remote given current interest rate levels. These are good faith estimates and assume that the composition of our interest sensitive assets and liabilities existing at each year-end will remain constant over the relevant twelve month measurement period and that changes in market interest rates are

 

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instantaneous and sustained across the yield curve regardless of duration of pricing characteristics on specific assets or liabilities. Also, this analysis does not contemplate any actions that we might undertake in response to changes in market interest rates. We believe these estimates are not necessarily indicative of what actually could occur in the event of immediate interest rate increases or decreases of this magnitude. As interest-bearing assets and liabilities re-price in different time frames and proportions to market interest rate movements, various assumptions must be made based on historical relationships of these variables in reaching any conclusion. Since these correlations are based on competitive and market conditions, we anticipate that our future results will likely be different from the foregoing estimates, and such differences could be material.

Should we be unable to maintain a reasonable balance of maturities and re-pricing of our interest-earning assets and our interest-bearing liabilities, we could be required to dispose of our assets in an unfavorable manner or pay a higher than market rate to fund our activities. Our asset liability committee oversees and monitors this risk.

Liquidity

Liquidity is our ability to meet cash demands as they arise. Such needs can develop from loan demand, deposit withdrawals or acquisition opportunities. Potential obligations resulting from the issuance of standby letters of credit and commitments to fund future borrowings to our loan customers are other factors affecting our liquidity needs. Many of these obligations and commitments are expected to expire without being drawn upon; therefore the total commitment amounts do not necessarily represent future cash requirements affecting our liquidity position. The potential need for liquidity arising from these types of financial instruments is represented by the contractual notional amount of the instrument. Asset liquidity is provided by cash and assets which are readily marketable or which will mature in the near future. Liquid assets include cash, federal funds sold, and short-term investments in time deposits in banks. Liquidity is also provided by access to funding sources, which include core depositors and correspondent banks that maintain accounts with and sell federal funds to our subsidiary bank. Other sources of funds include our ability to borrow from short-term sources, such as purchasing federal funds from correspondent banks, sales of securities under agreements to repurchase and advances from the FHLB, which amounted to $341.91 million at September 30, 2014, and an unfunded $25.00 million revolving line of credit established with Frost Bank, a nonaffiliated bank, which matures on June 30, 2015 (see next paragraph). Our subsidiary bank also has federal funds purchased lines of credit with two non-affiliated banks totaling $100.00 million. At September 30, 2014, there were no amounts drawn on these lines of credit. Our subsidiary bank also has available a line of credit with the FHLB totaling $881.56 million, at September 30, 2014, secured by portions of our loan portfolio and certain investment securities. At September 30, 2014, $1.04 million in advances and $7.00 million in letters of credit issued by the FHLB were outstanding under this line of credit. The letters of credit were pledged as collateral for public funds held by our subsidiary bank.

The Company renewed its loan agreement, effective June 30, 2013, with Frost Bank. Under the loan agreement, as renewed and amended, we are permitted to draw up to $25.00 million on a revolving line of credit. Prior to June 30, 2015, interest is paid quarterly at Wall Street Journal Prime Rate and the line of credit matures June 30, 2015. If a balance exists at June 30, 2015, the principal balance converts to a term facility payable quarterly over five years and interest is paid quarterly at our election at Wall Street Journal Prime Rate plus 50 basis points or LIBOR plus 250 basis points. The line of credit is unsecured. Among other provisions in the credit agreement, we must satisfy certain financial covenants during the term of the loan agreement, including, without limitation, covenants that require us to maintain certain capital, tangible net worth, loan loss reserve, non-performing asset and cash flow coverage ratios. In addition, the credit agreement contains certain operational covenants, which among others, restricts the payment of dividends above 55% of consolidated net income, limits the incurrence of debt (excluding any amounts acquired in an acquisition) and prohibits the disposal of assets except in the ordinary course of business. Since 1995, we have historically declared dividends as a percentage of our consolidated net income in a range of 37% (low) in 1995 to 53% (high) in 2003 and 2006. The Company was in compliance with the financial and operational covenants at September 30, 2014. There was no outstanding balance under the line of credit as of September 30, 2014 or December 31, 2013.

 

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In addition, we anticipate that future acquisitions of financial institutions, expansion of branch locations or offerings of new products could also place a demand on our cash resources. Available cash and cash equivalents at our parent company which totaled $69.43 million at September 30, 2014, investment securities which totaled $12.18 million at September 30, 2014 which matures over 9 to 16 years, available dividends from our subsidiaries which totaled $69.45 million at September 30, 2014, utilization of available lines of credit, and future debt or equity offerings are expected to be the source of funding for these potential acquisitions or expansions. Existing cash resources at our subsidiary bank may also be used as a source of funding for these potential acquisitions or expansions.

Given the strong core deposit base and relatively low loan to deposit ratios maintained at our subsidiary bank, we consider our current liquidity position to be adequate to meet our short- and long-term liquidity needs.

Off-Balance Sheet Arrangements. We are a party to financial instruments with off-balance-sheet risk in the normal course of business to meet the financing needs of our customers. These financial instruments include unfunded lines of credit, commitments to extend credit and federal funds sold to correspondent banks and standby letters of credit. Those instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in our consolidated balance sheets.

Our exposure to credit loss in the event of nonperformance by the counterparty to the financial instrument for unfunded lines of credit, commitments to extend credit and standby letters of credit is represented by the contractual notional amount of these instruments. We generally use the same credit policies in making commitments and conditional obligations as we do for on-balance-sheet instruments.

Unfunded lines of credit and commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. These commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. We evaluate each customer’s creditworthiness on a case-by-case basis. The amount of collateral obtained, as we deem necessary upon extension of credit, is based on our credit evaluation of the counterparty. Collateral held varies but may include accounts receivable, inventory, property, plant, and equipment and income-producing commercial properties.

Standby letters of credit are conditional commitments we issue to guarantee the performance of a customer to a third party. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. The average collateral value held on letters of credit usually exceeds the contract amount.

Table 10 – Commitments as of September 30, 2014 (in thousands):

 

     Total Notional
Amounts
Committed
 

Unfunded lines of credit

   $ 463,915   

Unfunded commitments to extend credit

     130,928   

Standby letters of credit

     27,829   
  

 

 

 

Total commercial commitments

   $ 622,672   
  

 

 

 

We believe we have no other off-balance sheet arrangements or transactions with unconsolidated, special purpose entities that would expose us to liability that is not reflected on the face of the financial statements.

 

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Parent Company Funding. Our ability to fund various operating expenses, dividends, and cash acquisitions is generally dependent on our own earnings (without giving effect to our subsidiaries), cash reserves and funds derived from our subsidiaries. These funds historically have been produced by intercompany dividends and management fees that are limited to reimbursement of actual expenses. We anticipate that our recurring cash sources will continue to include dividends and management fees from our subsidiaries. At September 30, 2014, approximately $69.45 million was available for the payment of intercompany dividends by our subsidiaries without the prior approval of regulatory agencies. Our subsidiaries paid aggregate dividends of $34.00 million and $30.80 million for the nine-month periods ended September 30, 2014 and 2013, respectively.

Dividends. Our long-term dividend policy is to pay cash dividends to our shareholders of approximately 40% of annual net earnings while maintaining adequate capital to support growth. We are also restricted by a loan covenant within our line of credit agreement with Frost Bank to dividend no greater than 55% of net income as defined in such loan agreement. The cash dividend payout ratios have amounted to 39.21% and 42.52% of net earnings for the first nine months of 2014 and the same period in 2013, respectively. Given our current capital position and projected earnings and asset growth rates, we do not anticipate any significant change in our current dividend policy. On April 22, 2014, the Board of Directors declared a $0.14 (post split) per share cash dividend that was paid July 1, 2014 to shareholders of record on June 16, 2014. This represented a 7.69 percent increase in quarterly dividends from the third quarter of 2013.

Our bank subsidiary, which is a national banking association and a member of the Federal Reserve System, is required by federal law to obtain the prior approval of the Office of the Comptroller of the Currency (the “OCC”) to declare and pay dividends if the total of all dividends declared in any calendar year would exceed the total of (1) such bank’s net profits (as defined and interpreted by regulation) for that year plus (2) its retained net profits (as defined and interpreted by regulation) for the preceding two calendar years, less any required transfers to surplus.

To pay dividends, we and our subsidiary bank must maintain adequate capital above regulatory guidelines. In addition, if the applicable regulatory authority believes that a bank under its jurisdiction is engaged in or is about to engage in an unsafe or unsound practice (which, depending on the financial condition of the bank, could include the payment of dividends), the authority may require, after notice and hearing, that such bank cease and desist from the unsafe practice. The Federal Reserve, the Federal Deposit Insurance Corporation (the “FDIC”) and the OCC have each indicated that paying dividends that deplete a bank’s capital base to an inadequate level would be an unsafe and unsound banking practice. The Federal Reserve, the FDIC and the OCC have issued policy statements that recommend that bank holding companies and insured banks should generally only pay dividends out of current operating earnings.

Item 3. Quantitative and Qualitative Disclosures About Market Risk

Management considers interest rate risk to be a significant market risk for the Company. See “Item 2 - Management’s Discussion and Analysis of Financial Condition and Results of Operations – Capital Resources - Interest Rate Risk” for disclosure regarding this market risk.

Item 4. Controls and Procedures

As of September 30, 2014, we carried out an evaluation, under the supervision and with the participation of our management, including our principal executive officer and principal financial officer, of the effectiveness of the design and operation of our disclosure controls and procedures pursuant to Rule 13a-15 or 15d-15 of the Securities Exchange Act of 1934. Our management, which includes our principal executive officer and our principal financial officer, does not expect that our disclosure controls and procedures will prevent all errors and all fraud.

 

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A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the Company have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty and that breakdowns can occur because of simple error or mistake. Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the control. The design of any system of controls also is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions; over time, controls may become inadequate because of changes in conditions or the degree of compliance with the policies or procedures may deteriorate. Because of the inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and not be detected. Our principal executive officer and principal financial officer have concluded, based on our evaluation of our disclosure controls and procedures, that our disclosure controls and procedures under Rule 13a-15 or 15d-15 of the Securities Exchange Act of 1934, are effective at the reasonable assurance level as of September 30, 2014.

Subsequent to our evaluation, there were no significant changes in internal controls over financial reporting or other factors that have materially affected, or are reasonably likely to materially affect, these internal controls.

 

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PART II

OTHER INFORMATION

Item 1. Legal Proceedings

From time to time we and our subsidiaries are parties to lawsuits arising in the ordinary course of our banking business. However, there are no material pending legal proceedings to which we, our subsidiaries, or any of their properties, are currently subject. Other than regular, routine examinations by state and federal banking authorities, there are no proceedings pending or known to be contemplated by any governmental authorities.

Item 1A. Risk Factors

There has been no material change in the risk factors previously disclosed under Item 1A. of the Company’s 2013 Annual Report on Form 10-K.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

None

Item 3. Defaults Upon Senior Securities

Not Applicable

Item 4. Mine Safety Disclosures

Not Applicable

Item 5. Other Information

None

 

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Item 6. Exhibits

The following exhibits are filed as part of this report:

 

    2.1       Agreement and Plan of Merger between First Financial Bankshares, Inc., First Financial Bank, N.A., OSB Financial Services, Inc. and Orange Savings Bank, SSB, dated as of February 20, 2013 (Schedules have been omitted pursuant to Item 601(b)(2) of Regulation S-K) (incorporated by reference from Exhibit 2.1 to Registrant’s Form 8-K filed February 26, 2013).
    3.1       Amended and Restated Certificate of Formation (incorporated by reference from Exhibit 3.1 of the Registrant’s Form 8-K filed April 25, 2012).
    3.2       Amended and Restated Bylaws of the Registrant (incorporated by reference from Exhibit 3.2 of the Registrant’s Form 8-K filed January 24, 2012).
    4.1       Specimen certificate of First Financial Common Stock (incorporated by reference from Exhibit 3 of the Registrant’s Amendment No. 1 to Form 8-A filed on Form 8-A/A No. 1 on January 7, 1994).
  10.1       Executive Recognition Agreement (incorporated by reference from Exhibit 10.1 of the Registrant’s Form 8-K Report filed June 30, 2014).
  10.2       2002 Incentive Stock Option Plan (incorporated by reference from Exhibit 10.3 of the Registrant’s Form 10-Q filed May 4, 2010).
  10.3       2012 Incentive Stock Option Plan (incorporated by reference from Appendix A of the Registrant’s Definitive Proxy Statement Pursuant to Section 14(a) of the Securities Exchange Act of 1934 filed March 1, 2012).
  10.4       Loan agreement dated June 30, 2013, between First Financial Bankshares, Inc. and Frost Bank (incorporated by reference from Exhibit 10.1 of the Registrant’s Form 8-K filed July 1, 2013).
  31.1       Rule 13a-14(a) / 15(d)-14(a) Certification of Chief Executive Officer of First Financial Bankshares, Inc.*
  31.2       Rule 13a-14(a) / 15(d)-14(a) Certification of Chief Financial Officer of First Financial Bankshares, Inc.*
  32.1       Section 1350 Certification of Chief Executive Officer of First Financial Bankshares, Inc.*
  32.2       Section 1350 Certification of Chief Financial Officer of First Financial Bankshares, Inc.*
101.INS       XBRL Instance Document.*
101.SCH       XBRL Taxonomy Extension Schema Document.*
101.CAL       XBRL Taxonomy Extension Calculation Linkbase Document.*
101.DEF       XBRL Taxonomy Extension Definition Linkbase Document.*
101.LAB       XBRL Taxonomy Extension Label Linkbase Document.*
101.PRE       XBRL Taxonomy Extension Presentation Linkbase Document.*

 

* Filed herewith

 

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

    FIRST FINANCIAL BANKSHARES, INC.
Date: November 4, 2014     By:  

/s/ F. Scott Dueser

      F. Scott Dueser
      President and Chief Executive Officer
Date: November 4, 2014     By:  

/s/ J. Bruce Hildebrand

      J. Bruce Hildebrand
      Executive Vice President and
      Chief Financial Officer

 

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