ITEM 1A. RISK FACTORS
Our business, financial condition, operating results and cash flows can be impacted by a number of factors, including but not limited to those set forth below, any one of which could cause our actual results to vary materially from recent results or from our anticipated future results and other forward-looking statements that we make from time to time in our news releases, annual reports and other written communications, as well as oral forward-looking statements, and other statements made from time to time by our representatives.
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Risks Related to Our Business
Interest Rate Risk
We are subject to interest rate risk.
Our profitability is dependent to a large extent on our net interest income, which is the difference between interest income we earn as a result of interest paid to us on loans and investments and interest we pay to third parties such as our depositors and those from which we borrow funds. Like most financial institutions, we are highly sensitive to many factors that are beyond our control, including general economic conditions and policies of various governmental and regulatory agencies and, in particular, the Federal Reserve Board. Changes in monetary policy, including changes in interest rates, could influence not only the interest we receive on loans and securities and the amount of interest we pay on deposits and borrowings, but such changes could also affect (i) our ability to originate loans and obtain deposits, (ii) the fair value of our financial assets and liabilities, (iii) the average duration of our securities portfolio, and (iv) the slope of the overall yield curve and its impact on the value of the investment portfolio and reinvestment income. If the interest rates paid on deposits and other borrowings increase at a faster rate than the interest rates received on loans and investments, our net interest income, and earnings, could be adversely affected. Earnings could also be adversely affected if the interest rates received on loans and investments fall more quickly than the interest rates paid on deposits and other borrowings.
The Federal Reserve increased rates 200 basis points through mid-2019 and as a response to the ongoing COVID pandemic decreased rates 75 basis points during the third and fourth quarters of 2019 and then an additional 150 basis points in the first quarter of 2020, resulting in a current target rate range of zero to 25 basis points. Today, there is substantial uncertainty regarding future interest rates; however, the Federal Reserve has noted they plan to increase rates during 2022. Increases in interest rates can have negative impacts on our business, including reducing our customers’ desire to borrow money from us or adversely affecting their ability to repay their outstanding loans by increasing their debt obligations through the periodic reset of adjustable interest rate loans. If our borrowers’ ability to pay their loans is impaired by increasing interest payment obligations, our level of non-performing assets would increase, producing an adverse effect on operating results. Asset values, especially commercial real estate as collateral, securities or other fixed rate earning assets, can decline significantly with relatively minor changes in interest rates. Conversely, decreases in interest rates can affect the amount of interest we earn on our loans and investment securities, which could have a material adverse effect on the Company’s financial condition and results of operations. Although we have implemented strategies that we believe reduce the potential effects of adverse changes in interest rates on our results of operations, these strategies may not always be successful. Any of these events could adversely affect our results of operations, financial condition and liquidity.
Uncertainty relating to the London interbank offered rate (“LIBOR”) calculation process and potential phasing out of LIBOR may adversely affect us.
On July 27, 2017, the Chief Executive of the United Kingdom Financial Conduct Authority, which regulates LIBOR, announced that it intends to stop persuading or compelling banks to submit rates for the calculation of LIBOR to the administrator of LIBOR after 2021. The announcement indicates that the continuation of LIBOR on the current basis cannot and will not be guaranteed after 2021. It is impossible to predict whether and to what extent banks will continue to provide LIBOR submissions to the administrator of LIBOR or whether any additional reforms to LIBOR may be enacted in the United Kingdom or elsewhere. At this time, no consensus exists as to what rate or rates may become acceptable alternatives to LIBOR and it is impossible to predict the effect of any such alternatives on the value of LIBOR-based securities and variable rate loans, debentures, or other securities or financial arrangements, given LIBOR’s role in determining market interest rates globally. Uncertainty as to the nature of alternative reference rates and as to potential changes or other reforms to LIBOR may adversely affect LIBOR rates and the value of LIBOR-based loans and securities in our portfolio and may impact the availability and cost of hedging instruments and borrowings. If LIBOR rates are no longer available, and we are required to implement substitute indices for the calculation of interest rates under our loan agreements with our borrowers, we may incur significant expenses in effecting the transition, and may be subject to disputes or litigation with customers over the appropriateness or comparability to LIBOR of the substitute indices, which could have an effect on our financial condition or results of operations.
At December 31, 2021, we have 22 loans totaling $100.03 million that have adjustable rates indexed to LIBOR. We continue to work with those customers, the Main Street lending program sponsored by the Federal Reserve and/or the originating bank for loan participations purchased to revise those documents to address the applicable index.
Credit Risk
In our business, we must effectively manage our credit risk.
As a lender, we are exposed to the risk that our borrowers may not repay their loans according to the terms of these loans and the collateral securing the payment of these loans may be inadequately documented or may be insufficient to fully compensate us for the outstanding balance of the loan plus the costs to dispose of the collateral. We may experience significant loan losses, which could have a material adverse effect on our operating results and financial condition. Management makes various assumptions and judgments about
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the collectability of our loan portfolio, including the diversification by industry of our commercial loan portfolio, the amount of nonperforming loans and related collateral, the volume, growth and composition of our loan portfolio, the effects on the loan portfolio of current economic indicators and their probable impact on borrowers and the evaluation of our loan portfolio through our internal loan review process and other relevant factors.
We maintain an allowance for credit losses, which is an allowance established through a provision for credit losses charged to expense that represents management’s best estimate of probable losses inherent in our loan portfolio. Additional credit losses will likely occur in the future and may occur at a rate greater than we have experienced to date. In determining the amount of the allowance, we rely on an analysis of our loan portfolio, our experience and our evaluation of general economic conditions. If our assumptions prove to be incorrect, our current allowance may not be sufficient and adjustments may be necessary to allow for different economic conditions or adverse developments in our loan portfolio. Material additions to the allowance could materially decrease our net income.
In addition, banking regulators periodically review our allowance for credit losses and may require us to increase our provision for credit losses or recognize further charge-offs, based on judgments different than those of our management. Any increase in our allowance for credit losses or charge-offs as required by these regulatory agencies could have a material negative effect on our operating results and financial condition.
Effective January 1, 2020, the Company implemented the provision of Accounting Standards Update (“ASU”) 2016-13,“Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments.” ASU 2016-13 represents a comprehensive change in estimating the allowance for credit losses from the previous “incurred loss” model of losses inherent in the loan portfolio to a current “expected loss” model, which encompasses losses expected to be incurred over the life of the portfolio.
The measurement of expected credit losses under ASU 2016-13 is based on information about past events, including historical experience, current conditions, and reasonable and supportable forecasts that affect the collectability of the reported amount. This measurement will take place at the time the financial asset is first added to the balance sheet and periodically thereafter. This differs significantly from the “incurred loss” model previously required under generally accepted accounting principles, which delays recognition until it is probable a loss has been incurred. Accordingly, we expect that the adoption of ASU 2016-13 could materially affect how we determine our allowance for credit losses and may require us to significantly increase our allowance. Moreover, ASU 2016-13 may create more volatility in the level of our allowance for credit losses. If we are required to materially increase our level of allowance for credit losses for any reason, such increase could adversely affect our business, financial condition and results of operations.
We are subject to environmental liability risk associated with lending activities.
A significant portion of our loan portfolio is secured by real property. During the ordinary course of business, we may foreclose on and take title to properties securing certain loans. In doing so, there is a risk that hazardous or toxic substances could be found on these properties. If hazardous or toxic substances are found, we may be liable for remediation costs, as well as for personal injury and property damage. Environmental laws may require us to incur substantial expenses and may materially reduce the affected property’s value or limit our ability to use or sell the affected property. In addition, future laws or more stringent interpretations or enforcement policies with respect to existing laws may increase our exposure to environmental liability. Environmental reviews of real property before initiating foreclosure actions may not be sufficient to detect all potential environmental hazards. The remediation costs and any other financial liabilities associated with an environmental hazard could have a material adverse effect on our business, financial condition and results of operations.
The value of real estate collateral may fluctuate significantly resulting in an under-collateralized loan portfolio.
The market value of real estate, particularly real estate held-for-investment (“HFI”), can fluctuate significantly in a short period of time as a result of market conditions in the geographic area in which the real estate is located. If the value of the real estate serving as collateral for our loan portfolio were to decline materially, a significant part of our loan portfolio could become under-collateralized. If the loans that are collateralized by real estate become troubled during a time when market conditions are declining or have declined, then, in the event of foreclosure, we may not be able to realize the amount of collateral that we anticipated at the time of originating the loan. This could have a material adverse effect on our provision for credit losses and our operating results and financial condition.
Liquidity Risk
We are subject to liquidity risk.
The Company requires liquidity to meet our deposit and other obligations as they come due. The Company’s access to funding sources in amounts adequate to finance its activities or on terms that are acceptable to it could be impaired by factors that affect it specifically or the financial services industry or the general economy. Factors that could reduce its access to liquidity sources include a
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downturn in the Texas market, difficult credit markets or adverse regulatory actions against the Company. The Company’s access to deposits may also be affected by the liquidity needs of its depositors. In particular, a substantial majority of the Company’s liabilities are demand, savings, interest checking and money market deposits, which are payable on demand or upon several days’ notice, while by comparison, a substantial portion of its assets are loans, which cannot be called or sold in the same time frame. The Company may not be able to replace maturing deposits and advances as necessary in the future, especially if a large number of its depositors sought to withdraw their accounts, regardless of the reason. A failure to maintain adequate liquidity could have a material adverse effect on the Company’s business, financial condition and result of operations.
Operational Risk
Our accounting estimates and risk management processes rely on analytical and forecasting models.
The processes we use to estimate our allowance for credit losses and to measure the fair value of financial instruments, as well as the processes used to estimate the effects of changing interest rates depends upon the use of analytical and forecasting models, including various inputs and assumptions (collectively, the "models"). In addition, these models are used to calculate fair value of our assets and liabilities when we acquire other financial institutions. These models reflect assumptions that may not be accurate, particularly in times of market stress or other unforeseen circumstances. Even if these assumptions are adequate, the models may prove to be inadequate or inaccurate because of other flaws in their design or their implementation. If the models we use for interest rate risk and asset-liability management are inadequate, we may incur increased or unexpected losses upon changes in market interest rates or other market measures. If the models we use for determining our current expected credit losses are inadequate, the allowance for credit losses may not be sufficient to support future charge-offs. If the models we use to measure the fair value of financial instruments is inadequate, the fair value of such financial instruments may fluctuate unexpectedly or may not accurately reflect what we could realize upon sale or settlement of such financial instruments. Such failure in our analytical or forecasting models could have a material adverse effect on our business, financial condition and results of operations.
The value of our goodwill and other intangible assets may decline in the future.
As of December 31, 2021, we had $316.78 million of goodwill and other intangible assets. A significant decline in our financial condition, a significant adverse change in the business climate, slower growth rates or a significant and sustained decline in the price of our common stock may necessitate taking charges in the future related to the impairment of our goodwill and other intangible assets. If we were to conclude that a future write-down of goodwill and other intangible assets is necessary, we would record the appropriate charge, which could have a material adverse effect on our financial condition and results of operations.
Breakdowns in our internal controls and procedures could have an adverse effect on us.
We believe our internal control system as currently documented and functioning is adequate to provide reasonable assurance over our internal controls. Nevertheless, because of the inherent limitation in administering a cost effective control system, misstatements due to error or fraud may occur and not be detected. Breakdowns in our internal controls and procedures could occur in the future, and any such breakdowns could have an adverse effect on us. See “Item 9A – Controls and Procedures” for additional information.
New lines of business or new products and services may subject the Company to additional risks.
From time to time, the Company may implement new lines of business or offer new products and services within existing lines of business. There are substantial risks and uncertainties associated with these efforts, particularly in instances where the markets are not fully developed. In developing and marketing new lines of business and/or products and services, the Company may invest significant time and resources. External factors, such as compliance with regulations, competitive alternatives, and shifting market preferences, may also impact the successful implementation of a new line of business or a new product or service. If we are unable to successfully manage these risks in the development and implementation of new lines of business or new products or services, it could have a material adverse effect on the Company’s business, financial condition and result of operations.
First Financial Bankshares, Inc. relies on dividends from its subsidiaries for most of its revenue.
First Financial Bankshares, Inc. is a separate and distinct legal entity from its subsidiaries. It receives substantially all of its revenue from dividends paid by its subsidiaries. These dividends are the principal source of funds to pay dividends on the Company’s common stock to shareholders and interest and principal on First Financial Bankshares, Inc. debt (to the extent we have balances outstanding). Various federal and/or state laws and regulations limit the amount of dividends that our bank and trust subsidiaries may pay to First Financial Bankshares, Inc. In the event our subsidiaries are unable to pay dividends to First Financial Bankshares, Inc., First Financial Bankshares, Inc. may not be able to service debt, if any, or pay dividends on the Company’s common stock. The inability to receive
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dividends from our subsidiaries could have a material adverse effect on the Company’s business, financial condition, results of operations and liquidity.
Hurricanes, extended drought conditions, severe weather and natural disasters could significantly impact the Company's business.
Hurricanes, extended drought conditions, severe weather and natural disasters and other adverse external events could have a significant impact on the Company's ability to conduct business. Such events affect the stability of the Company's deposit base, impair the ability of borrowers to repay outstanding loans, impair the value of the collateral securing our loans, cause significant property damage, result in loss of revenue and/or cause the Company to incur additional expenses. The occurrence of any such events in the future could have a material adverse effect on the Company's business, which in turn, could have a material adverse effect on the Company's business, financial condition and result of operations.
We rely heavily on our management team, and the unexpected loss of key management or inability to recruit qualified personnel in the future may adversely impact our operations.
Our success to date has been strongly influenced by our ability to attract and retain senior management experienced in banking in the markets we serve. Our ability to retain executive officers and the current management teams will continue to be important to the successful implementation of our strategies. We do not have employment agreements with these key employees other than executive agreements in the event of a change of control and a confidential information, non-solicitation and non-competition agreements related to our stock options and restricted stock. The unexpected loss of services of any key management personnel, or the inability to recruit and retain qualified personnel in the future, could have an adverse effect on our business and financial results. In addition, the scope and content of U.S. banking regulators policies on incentive compensation, could adversely affect our ability to hire, retain and motivate our key employees.
The COVID pandemic continues to adversely impact our business and financial results, and the ultimate impact will depend on future developments, which are highly uncertain and cannot be predicted, including the scope and duration of the pandemic and additional actions taken by governmental authorities in response to the pandemic.
The COVID pandemic is creating extensive disruptions in the global economy and to the lives of individuals throughout the world. Governments, businesses and the public have taken unprecedented actions to contain the spread of COVID and to mitigate its effects, including quarantines, travel bans, shelter-in-place orders, closures of businesses and schools, fiscal stimulus and legislation designed to deliver monetary aid and other relief. While the scope, duration and full effects of COVID continue to evolve and are not fully known, the pandemic and related efforts to contain it have disrupted global economic activity, adversely affected the functioning of financial markets, impacted interest rates, increased economic and market uncertainty, employment and labor markets and disrupted trade and supply chains. If these effects continue for a prolonged period or result in sustained economic stress or recession, many of the risk factors identified in our Form 10-K could be exacerbated and such effects could have a material adverse impact on us in a number of ways related to credit, collateral, customer demand, funding, operations, interest rate risk, human capital and self-insurance, as previously described.
System failure or cybersecurity breaches of our network security could subject us to increased operating costs as well as litigation and other potential losses.
The computer systems and network infrastructure we use could be vulnerable to unforeseen hardware and cybersecurity issues, including “hacking” and “identity theft.” Our operations are dependent upon our ability to protect our computer equipment against damage from fire, power loss, telecommunications failure or a similar catastrophic event. Any damage or failure that causes an interruption in our operations could have an adverse effect on our financial condition and results of operations. In addition, our operations are dependent upon our ability to protect the computer systems and network infrastructure utilized by us, including our Internet banking activities, against damage from physical break-ins, cybersecurity breaches and other disruptive problems caused by the Internet or other users. Such computer break-ins and other disruptions would jeopardize the security of information stored in and transmitted through our computer systems and network infrastructure, which may result in significant liability to us, damage our reputation and inhibit current and potential customers from our Internet banking services. Each year, we add additional security measures to our computer systems and network infrastructure to mitigate the possibility of cybersecurity breaches including firewalls and penetration testing. We continue to investigate cost effective measures as well as insurance protection.
Furthermore, our customers could incorrectly blame the Company and terminate their accounts with the Company for a cyber-incident which occurred on their own system or to an unrelated third party. In addition, a security breach could also subject us to additional regulatory scrutiny and expose us to civil litigation and possible financial liability.
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Our business may be adversely affected by security breaches at third parties.
Our customers interact with their own and other third-party systems, which pose operational risks to us. We may be adversely affected by data breaches at retailers and other third parties who maintain data relating to our customers that involve the theft of customers data, including the theft of customers’ debit card, merchant credit card, wire transfer and other identifying and/or access information used to make purchases or payments at retailers and other third parties.
In the event of a data breach at one or more retailers of considerable magnitude, the Company’s business, financial condition and results of operations may be adversely affected.
We are subject to claims and litigation pertaining to intellectual property.
We rely on technology companies to provide information technology products and services necessary to support our day-to-day operations. Technology companies frequently enter into litigation based on allegations of patent infringement or other violations of intellectual property rights. In addition, patent holding companies seek to monetize patents they have purchased or otherwise obtained. Competitors of our vendors, or other individuals or companies, have from time to time claimed to hold intellectual property sold to us by its vendors. Such claims may increase in the future as the financial services sector becomes more reliant on information technology vendors. The plaintiffs in these actions frequently seek injunctions and substantial damages.
Regardless of the scope or validity of such patents or other intellectual property rights, or the merits of any claims by potential or actual litigants, we may have to engage in litigation that could be expensive, time-consuming, disruptive to our operations, and distracting to management. If we are found to infringe one or more patents or other intellectual property rights, we may be required to pay substantial damages or royalties to a third-party. In certain cases, we may consider entering into licensing agreements for disputed intellectual property, although no assurance can be given that such licenses can be obtained on acceptable terms or that litigation will not occur. These licenses may also significantly increase our operating expenses. If legal matters related to intellectual property claims were resolved against us or settled, we could be required to make payments in amounts that could have a material adverse effect on our business, financial condition and results of operations.
We depend on the accuracy and completeness of information about customers and counterparties.
In deciding whether to extend credit or enter into other transactions, we must rely on information furnished by or on behalf of customers and counterparties, including financial statements, credit reports and other financial information. We also rely on representations of those customers, counterparties or other third parties, such as independent auditors, as to the accuracy and completeness of that information. Reliance on inaccurate or misleading financial statements, credit reports or other financial information could have a material adverse impact on our business, financial condition and results of operations.
We do business with other financial institutions that could experience financial difficulty.
We do business through the purchase and sale of federal funds, check clearing and through the purchase and sale of loan participations with other financial institutions. Because these financial institutions have many risks, as do we, we could be adversely affected should one of these financial institutions experience significant financial difficulties or fail to comply with our agreements with them.
We are subject to possible claims and litigation pertaining to fiduciary responsibility.
From time to time, customers could make claims and take legal actions pertaining to our performance of our fiduciary responsibilities. Whether customer claims and legal actions related to our performance of our fiduciary responsibilities are founded or unfounded, if such claims and legal actions are not resolved in a manner favorable to us, they may result in significant financial liability and/or adversely affect our market perception of our products and services as well as impact customer demand for those products and services. Any financial liability or reputation damage could have a material adverse effect on our business, which, in turn, could have a material adverse effect on our financial condition and results of operations.
Our operations rely on certain external vendors.
We rely on certain external vendors to provide products and services necessary to maintain our day-to-day operations. Accordingly, our operations are exposed to risk that these vendors will not perform in accordance with the contracted agreements under service level agreements. The failure of an external vendor to perform in accordance with the contracted arrangements under service level agreements, because of changes in the vendor’s organizational structure, financial condition, support for existing products or services or strategic focus or for any other reason, could be disruptive to our operations, which could have a material adverse effect on
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our business and, in turn, our financial condition and results of operations. Security breaches at certain external vendors may expose our Company's or customers' data, which poses operational, compliance and reputation risks.
Certain of our investment advisory and wealth management contracts are subject to termination on short notice, and termination of a significant number of investment advisory contracts could have a material adverse impact on our revenue.
Certain of our investment advisory and wealth management clients can terminate, with little or no notice, their relationships with us, reduce their aggregate assets under management, or shift their funds to other types of accounts with different rate structures for any number of reasons, including investment performance, changes in prevailing interest rates, inflation, changes in investment preferences of clients, changes in our reputation in the marketplace, change in management or control of clients, loss of key investment management personnel and financial market performance. We cannot be certain that our trust company subsidiary will be able to retain all of its clients. If its clients terminate their investment advisory and wealth management contracts, our trust company subsidiary, and consequently we, could lose a substantial portion of our revenues.
The trust wealth management fees we receive may decrease as a result of poor investment performance, in either relative or absolute terms, which could decrease our revenues and net earnings.
Our trust company subsidiary derives its revenues primarily from investment management fees based on assets under management. Our ability to maintain or increase assets under management is subject to a number of factors, including investors’ perception of our past performance, in either relative or absolute terms, market and economic conditions, including changes in oil and gas prices, and competition from investment management companies. Financial markets are affected by many factors, all of which are beyond our control, including general economic conditions, including changes in oil and gas prices; securities market conditions; the level and volatility of interest rates and equity prices; competitive conditions; liquidity of global markets; international and regional political conditions; regulatory and legislative developments; monetary and fiscal policy; investor sentiment; availability and cost of capital; technological changes and events; outcome of legal proceedings; changes in currency values; inflation; credit ratings; and the size, volume and timing of transactions. A decline in the fair value of the assets under management, caused by a decline in general economic conditions, would decrease our wealth management fee income.
Investment performance is one of the most important factors in retaining existing clients and competing for new wealth management clients. Poor investment performance could reduce our revenues and impair our growth in the following ways:
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existing clients may withdraw funds from our wealth management business in favor of better performing products;
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asset-based management fees could decline from a decrease in assets under management;
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our ability to attract funds from existing and new clients might diminish; and
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our wealth managers and investment advisors may depart to join a competitor or otherwise.
Even when market conditions are generally favorable, our investment performance may be adversely affected by the investment style of our wealth management and investment advisors and the particular investments that they make. To the extent our future investment performance is perceived to be poor in either relative or absolute terms, the revenues and profitability of our wealth management business will likely be reduced and our ability to attract new clients will likely be impaired. As such, fluctuations in the equity and debt markets can have a direct impact upon our net earnings. In addition, as approximately 12% of trust fees comes from management of oil and gas properties, a decline in the prices of oil and gas could lead to a loss of material amounts of our trust income.
Our reputation and business could be damaged by negative publicity.
Reputation risk, or the risk to our earnings and capital by negative public opinion, is inherent in our business. Negative public opinion could adversely affect our ability to keep and attract customers and expose us to additional liquidity risk as well as adverse legal and regulatory consequences. Negative public opinion could result from our actual or alleged conduct in any number of activities, including lending practices, corporate governance, perception of our environmental, social and governance practices and disclosures, regulatory compliance, mergers and acquisitions, sharing or inadequate protection of customer information, and from actions taken by government regulators and community organizations in response to that conduct. Negative public opinion could also result from adverse news or publicity that impairs the reputation of the financial services industry. In addition, adverse publicity or negative information posted on social media, whether or not factually correct, may adversely impact our business prospects or financial results.
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External and Market Related Risks
Our business faces unpredictable economic conditions, which could have an adverse effect on us.
General economic conditions impact the banking industry. The credit quality of our loan portfolio necessarily reflects, among other things, the general economic conditions in the areas in which we conduct our business. Our continued financial success depends somewhat on factors beyond our control, including:
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general economic conditions, including national and local real estate markets and the price of oil and gas, wind farm subsidies from the federal government and other commodity prices;
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the supply of and demand for investable funds;
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demand for loans and access to credit;
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interest rates; and
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federal, state and local laws affecting these matters.
Any substantial deterioration in any of the foregoing conditions could have a material adverse effect on our financial condition, results of operations and liquidity, which would likely adversely affect the market price of our common stock.
Our business is concentrated in Texas and a downturn in the economy of Texas may adversely affect our business.
Our network of bank regions is concentrated in Texas, primarily in the Central, North Central, Southeast and Western regions of the state. Most of our customers and revenue are derived from these areas. These economies include dynamic centers of higher education, agriculture, energy and natural resources, retail, military, healthcare, tourism, retirement living, manufacturing and distribution. Because we generally do not derive revenue or customers from other parts of the state or nation, our business and operations are dependent on economic conditions in our Texas markets. Any significant decline in one or more segments of the local economies could adversely affect our business, revenue, operations and properties.
The volatility in oil and gas prices results in uncertainty about the Texas economy. While we consider our exposure to credits related to the oil and gas industry to not be significant, at approximately 2.62% net of PPP loans of total loans held-for-investment as of December 31, 2021, should the price of oil and gas decline and/or remain at low prices for an extended period, the general economic conditions in our Texas markets could be negatively affected, which could have a material adverse effect on our business, financial condition and results of operations. Additionally, the Company's trust revenues may be impacted by oil and gas prices which represented approximately 12% and 9% of total trust revenues in 2021 and 2020, respectively.
Our Company lends primarily to small to medium-sized businesses that may have fewer resources to weather a downturn in the economy, which could adversely impact the Company’s operating results.
The Company makes loans to privately-owned businesses, many of which are considered to be small to medium-sized businesses. Small to medium-sized businesses frequently have smaller market share than their competition, may be more vulnerable to economic downturns, often need additional capital to expand or compete and may experience more volatility in operating results. Any one or more of these factors may impair the borrower’s ability to repay a loan. In addition, the success of a small to medium-sized businesses often depends on the management talents and efforts of a small group of persons, and the death, disability or resignation of one or more of these persons could have adverse impact on the business and its ability to repay our loans. Economic downturns, a sustained decline in commodity prices and other events that could negatively impact the businesses could cause the Company to incur credit losses that could negatively affect the Company’s results of operations and financial condition.
If we are unable to continue to originate residential real estate loans and sell them into the secondary market for a profit, our earnings could decrease.
We derive a portion of our noninterest income from the origination of residential real estate loans and the subsequent sale of such loans into the secondary market. If we are unable to continue to originate and sell residential real estate loans at historical or greater levels, our residential real estate loan volume would decrease, which could decrease our earnings. A rising interest rate environment, general economic conditions or other factors beyond our control could adversely affect our ability to originate residential real estate loans. We also are experiencing an increase in regulations and compliance requirements related to mortgage loan originations necessitating technology upgrades and other changes. If new regulations continue to increase and we are unable to make technology upgrades, our ability to originate mortgage loans will be reduced or eliminated. Additionally, we sell a large portion of our residential real estate loans to third party investors, and rising interest rates could negatively affect our ability to generate suitable profits on the sale of such loans. If interest rates increase after we originate the loans, our ability to market those loans is impaired as the profitability
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on the loans decreases. These fluctuations can have an adverse effect on the revenue we generate from residential real estate loans and in certain instances, could result in a loss on the sale of the loans.
We originate the majority of our secondary market loans by issuing interest rate lock commitments ("IRLCs") to the customer based on prevailing rates in the market. We are exposed to changes in interest rates between the date of the IRLC and the closing of the loans. We hedge the price risk of the IRLCs based on various models and other factors using financial instruments which typically, but not always, correlate to the change in value to offset the risk. These hedges may not be equally correlated or effective and expose the Company to risk and loss of earnings.
Further, for the mortgage loans we sell in the secondary market, the mortgage loan sales contracts contain indemnification clauses should the loans default, generally in the first sixty to ninety days, or if documentation is determined not to be in compliance with regulations. While the Company’s historic losses as a result of these indemnities have been insignificant, we could be required to repurchase the mortgage loans or reimburse the purchaser of our loans for losses incurred. Both of these situations could have an adverse effect on the profitability of our mortgage loan activities and negatively impact our net income.
We compete in an industry that continually experiences technological change, and we may have fewer resources than many of our competitors to continue to invest in technological improvements.
The financial services industry is undergoing rapid technological changes, with frequent introductions of new technology-driven products and services and new Fintech companies. In addition to improving the ability to serve customers, the effective use of technology increases efficiency and enables financial institutions to reduce costs. Our future success will depend, in part, upon our ability to address the needs of our customers by using technology to provide products and services that will satisfy customer demands for conveniences, as well as to create additional efficiencies in our operations. Many of our larger competitors have substantially greater resources to invest in technological improvements. We may not be able to effectively implement new technology-driven products and services or be successful in marketing these products and services to our customers.
Difficult or changes in market conditions could adversely affect the financial services industry.
The financial markets have experienced volatility over the past several years. In some cases, the financial markets have produced downward pressure on stock prices and credit availability for certain companies without regard to those companies’ underlying financial strength. If financial market volatility worsens, or there are disruptions in these financial markets, including disruptions to the United States banking systems, there can be no assurance that we will not experience an adverse effect on our ability to access capital and our business, financial condition and result of operations could be adversely impacted.
The value of certain securities in our investment portfolio may be negatively affected by changes or disruptions in the market for these securities.
Our investment portfolio securities include U.S. Treasury securities, obligations of state and political subdivisions, corporate bonds, general obligation or revenue based municipal bonds and mortgage-backed securities guaranteed by government sponsored enterprises such as the Federal National Mortgage Association, the Government National Mortgage Association and the Federal Home Loan Mortgage Corporation or otherwise backed by Federal Housing Administration or Veteran’s Administration guaranteed loans; however, volatility or illiquidity in financial markets may cause investment securities held within our investment portfolio to fall in value or become less liquid. Increases in interest rates may cause a decline in the value of securities held by the Company. Uncertainty surrounding the credit risk associated with mortgage collateral or guarantors may cause material discrepancies in valuation estimates obtained from third parties. Volatile market conditions may reduce valuations due to the perception of heightened credit and liquidity risks in addition to interest rate risk typically associated with these securities. There can be no assurance that declines in market value associated with these disruptions will not result in impairments of these assets, which would lead to accounting charges that could have a material adverse effect on our results of operations, equity and capital ratios.
We may need to raise additional capital and such funds may not be available when needed.
We may need to raise additional capital in the future to provide us with sufficient capital resources to meet our commitments and business needs, particularly if our asset quality or earnings were to deteriorate significantly. Our ability to raise additional capital, if needed, will depend on, among other things, conditions in the capital and financial markets at that time, which are outside of our control, and our financial performance. Economic conditions and the loss of confidence in financial institutions may increase our cost of funding and limit access to certain customary sources of capital, other financial institution borrowings and borrowings from the discount window of the Federal Reserve. Any occurrence that may limit our access to the capital markets, such as a decline in the confidence of other financial institutions, or counterparties participating in the capital markets, may adversely affect our costs and our ability to raise capital.
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An inability to raise additional capital on acceptable terms when needed could have a materially adverse effect on our financial condition and results of operations.
We compete with many larger financial institutions which have substantially greater financial resources than we have.
Competition among financial institutions in Texas is intense. We compete with other bank holding companies, state and national commercial banks, savings and loan associations, consumer financial companies, credit unions, securities brokers, insurance companies, mortgage banking companies, money market mutual funds, asset-based non-bank lenders and other financial institutions. Many of these competitors have substantially greater financial resources, larger lending limits, larger branch networks, enhanced technology and less regulatory oversight than we do, and are able to offer a broader range of products and services than we can. Failure to compete effectively for deposit, loan and other banking customers in our markets could cause us to lose market share, slow our growth rate and may have an adverse effect on our financial condition, results of operations and liquidity.
Compliance and Regulatory Risks
We may be subject to more stringent capital and liquidity requirements which would adversely affect our net income and future growth.
The Federal Reserve Board adopted a final rule that implemented the Basel III Rule changes to the international regulatory capital framework and revised the U.S. risk-based and leverage capital requirements for U.S. banking organizations to strengthen identified areas of weakness in capital rules and to address relevant provisions of the Dodd-Frank Act.
The final rule established a stricter regulatory capital framework that requires banking organizations to hold more and higher-quality capital to act as a financial cushion to absorb losses and help banking organizations better withstand periods of financial stress. The final rule increased capital ratios for all banking organizations and introduced a “capital conservation buffer” which is in addition to each capital ratio. If a banking organization dips into its capital conservation buffer, it may be restricted in its ability to pay dividends and discretionary bonus payments to its executive officers. The final rule assigned a higher risk weight to loans that are more than 90 days past due or are on nonaccrual status and to certain commercial real estate facilities that finance the acquisition, development or construction of real property. The final rule also required unrealized gains and losses on certain “available-for-sale” securities holdings to be included for purposes of calculating regulatory capital requirements unless a one-time opt-out is exercised. We exercised this opt-out right in our March 31, 2015 quarterly financial filing. The final rule also included changes in what constitutes regulatory capital. In addition, Tier 2 capital is no longer limited to the amount of Tier 1 capital included in total capital. Mortgage servicing rights, certain deferred tax assets and investments in unconsolidated subsidiaries over designated percentages of common stock are required to be deducted from capital. The final rule became effective for us on January 1, 2015. As of December 31, 2021, we met all of these new requirements, including the full capital conservation buffer.
Although we currently cannot predict the specific impact and long-term effects that Basel III will have on our Company and the banking industry more generally, the Company may be required to maintain higher regulatory capital levels through the capital conservation buffer which could impact our operations, net income and ability to grow. Furthermore, the Company’s failure to comply with the minimum capital requirements could result in our regulators taking formal or informal actions against us which could restrict our future growth or operations. For example, climate change advocates might not be able to force a regulatory ban on lending to certain industries, but the regulators could increase risk weighting on oil and gas loans.
Legislative and regulatory actions taken now or in the future that impact the financial industry may materially adversely affect us by increasing our costs, adding complexity in doing business, impeding the efficiency of our internal business processes, negatively impacting the recoverability of certain of our recorded assets, requiring us to increase our regulatory capital, limiting our ability to pursue business opportunities, and otherwise resulting in a material adverse impact on our financial condition, results of operation, liquidity, or stock price.
Both the scope of the laws and regulations and the intensity of the supervision to which we are subject may increase in connection with recent legislative and regulatory developments to address perceived unfairness and abuses under current regulations. Regulatory enforcement and fines have also increased across the banking and financial services sector. Compliance with these laws and regulations have resulted in and will continue to result in additional costs, which could be significant, and may have a material and adverse effect on our results of operations. In addition, if we do not appropriately comply with current or future legislation and regulations, especially those that apply to our consumer operations, which has been an area of heightened focus, we may be subject to fines, penalties or judgments, or material regulatory restrictions on our businesses, which could adversely affect operations and, in turn, financial results.
The CRA, the Equal Credit Opportunity Act, the Fair Housing Act and other fair lending laws and regulations impose nondiscriminatory lending requirements on financial institutions. The CFPB, OCC, the Department of Justice and other federal and state
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agencies are responsible for enforcing these laws and regulations. A successful challenge to an institution’s performance under the CRA or fair lending laws and regulations could result in a wide variety of sanctions, including the required payment of damages and civil money penalties, injunctive relief, imposition of restrictions on mergers and acquisitions activity and restrictions on expansion activity. Private parties may also have the ability to challenge an institution’s performance under fair lending laws in private class action litigation.
We are subject to the CRA, fair lending, consumer compliance, and other laws and regulations, and our failure to comply with these laws and regulations could lead to material penalties.
The CRA, the Equal Credit Opportunity Act, the Fair Housing Act and other fair lending laws and regulations impose non-discriminatory lending and other requirements on financial institutions. The U.S. Department of Justice and other federal agencies, including the FDIC and CFPB, are responsible for enforcing these laws and regulations. A successful challenge to an institution's performance under the CRA, fair lending and other compliance laws and regulations could result in a wide variety of sanctions, including the required payment of damages and civil money penalties, injunctive relief, imposition of restrictions on mergers and acquisitions activity and restrictions on expansion. Private parties may also have the ability to challenge an institution's performance under fair lending laws in private class action litigation. The costs of defending, and any adverse outcome from, any such challenge could damage our reputation or could have a material adverse effect on our business, financial condition or results of operations. Our Bank received an overall rating of "satisfactory" in its most recently completed CRA examination.
Violations of applicable consumer protection laws can result in significant potential liability from litigation brought by customers, including actual damages, restitution and attorney's fees. Federal bank regulators, state attorney generals and state and local consumer protection agencies may also seek to enforce consumer protection rescission rights and civil money penalties in the jurisdictions in which we operate. Failure to comply with consumer protection requirements may also result in delays or restrictions on mergers and acquisitions and expansionary activities we may wish to pursue.
Failure to comply with the USA PATRIOT ACT, OFAC, the BSA and related FinCEN and FFIEC Guidelines and regulations could result in material implications.
Regulatory authorities routinely examine financial institutions for compliance with the USA PATRIOT ACT, OFAC, the BSA and related FinCEN and FFIEC Guidelines. Certain products we offer may expose us to enhanced risk in the event of noncompliance, including and not limited to providing our treasury management services to certain money transmitter and money services businesses. Failure to maintain and implement adequate programs as required by these obligations to combat terrorist financing, elder abuse, human trafficking, anti-money laundering and other suspicious activity and to fully comply with all of the relevant laws or regulatory authorities not to approve merger or acquisition transactions when regulatory approval is required or to prohibit such transactions even if approval is not required. Regulatory authorities have imposed cease and desist orders and significant civil money penalties against institutions found to be violating these regulations.
Our business is subject to significant government regulation.
We operate in a highly-regulated environment and are subject to supervision or regulation by a number of governmental regulatory agencies, including the Federal Reserve Board, the OCC, the FDIC and the CFPB. Regulations adopted by these agencies, which are generally intended to provide protection for depositors and customers rather than for the benefit of shareholders, govern a comprehensive range of matters relating to ownership and control of our shares, our acquisition of other companies and businesses, permissible activities for us to engage in, maintenance of adequate capital levels and other aspects of our operations. The bank regulatory agencies possess broad authority to prevent or remedy unsafe or unsound practices or violations of law.
The Dodd-Frank Act, enacted in July 2010, instituted major changes to the banking and financial institutions regulatory regimes in light of the recent performance of and government intervention in the financial services sector. Other changes to statues, regulations or regulatory policies, including changes in interpretation or implementation of statutes, regulations or policies, could affect the Company in substantial and unpredictable ways. Such changes could subject the Company to reduced revenues, additional costs, limit the types of financial services and products the Company may offer and/or increase the ability of non-banks to offer competing financial services and products, among other things. Failure to comply with laws, regulations or policies could result in sanctions by regulatory agencies, civil money penalties and/or reputation damage, which could have a material adverse effect on the Company’s business, financial condition and results of operations. Additionally, the banking regulations could prohibit and significantly delay the Company’s acquisition of other financial institutions.
Included in the Dodd-Frank Act are, for example, changes related to interchange fees and overdraft services. While the changes for interchange fees that can be charged for electronic debit transactions by payment card issuers. Under the interim final rule issued in November 2020, banks will generally have until 2022 to either reduce their size to under $10 billion in assets or prepare for reduced interchange fees; however, we are above $10 billion in assets and will be subject to the limitation effective July 1, 2022. Per Regulation
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E, we are also prohibited from charging customers fees for paying overdrafts on automated teller machine and debit card transactions, unless the consumer opts in. We continue to monitor the impact of new regulations and other developments on our fee income.
Federal income tax reform could have unforeseen effects on our financial condition and results of operations.
The recent changes in the political makeup of the Senate and House of Representatives in the U.S. Congress could result also in the reversal of some or all of the effects of the Tax Cuts and Jobs Act, which may have an adverse effect on our business, financial conditions and results of operations.
Our FDIC deposit insurance assessments could increase substantially resulting in higher operating costs.
We have historically paid the lowest premium rate available due to our sound financial position. In 2019 and 2020, we received certain credits that further reduced the FDIC insurance premium expense. Should the number of bank failures increase or the FDIC insurance fund become depleted in others ways, FDIC premiums could increase or additional special assessments could be imposed. In addition, we are no longer eligible to utilize credits to reduce our FDIC insurance premiums as a result of our exceeding $10 billion in assets. These increased premiums would have an adverse effect on our net income and results of operations.
Risks Related to Acquisition Activities
To continue our growth, we are affected by our ability to identify and acquire other financial institutions.
We intend to continue our current growth strategy, including opening new branches and acquiring other banks. The market for acquisitions remains highly competitive, and we may be unable to find satisfactory acquisition candidates in the future that fit our acquisition and growth strategy. To the extent that we are unable to find suitable acquisition candidates, an important component of our growth strategy may be lost. Additionally, our completed acquisitions, or any future acquisitions, may not produce the revenue, earnings or synergies that we anticipated.
We may not be able to complete future acquisitions, may not be successful in realizing the benefits of any acquisitions that are completed, or may choose not to pursue acquisition opportunities we might find beneficial.
A substantial part of our historical growth has been a result of acquisitions of other financial institutions, and we may, from time to time, evaluate and engage in the acquisition of other financial institutions. We must generally satisfy a number of conditions prior to completing any such transaction, including certain bank regulatory approvals. Bank regulators consider a number of factors with regard to all institutions involved in the transaction when determining whether to approve a proposed transaction, including, among others, condition of the Company, its ratings and compliance history, anti-money laundering and BSA compliance history, CRA evaluation results, fair lending history and the effect of the proposed transaction on the financial stability of the institutions involved and the market as a whole.
The process for obtaining required regulatory approvals has become substantially more difficult, time-consuming and unpredictable. We may fail to pursue, evaluate or complete strategic and competitively significant business opportunities as a result of our inability, or our perceived inability, to obtain required regulatory approvals in a timely manner or at all.
Assuming we are able to successfully complete one or more transactions, we may not be able to successfully integrate and realize the expected synergies from any completed transaction in a timely manner or at all. In particular, we may be charged by federal and state regulators with regulatory and compliance failures at an acquired business prior to the date of the acquisition, and these failures by the acquired company may have negative consequences for us, including the imposition of formal or informal enforcement actions. Completion and integration of any transaction may also divert management’s attention from other matters, result in additional costs and expenses, or adversely affect our relationships with our customers and employees, any of which may adversely affect our business or results of operations. As a result, our financial condition may be affected, and we may become more susceptible to general economic conditions and competitive pressures.
Use of our common stock for future acquisitions or to raise capital may be dilutive to existing stockholders.
When we determine that appropriate strategic opportunities exist, we may acquire other financial institutions and related businesses, subject to applicable regulatory requirements. We may use our common stock for such acquisitions. We may also seek to raise capital through selling additional common stock, although we have not historically done so. It is possible that the issuance of additional common stock in such acquisition or capital transactions may be dilutive to the interests of our existing shareholders.
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Risks Associated with our Common Stock
The trading volume in our common stock is less than other larger financial institutions.
Although the Company’s common stock is listed for trading on the Nasdaq Global Select Market, the trading volume in our common stock is less than that of other, larger financial services companies although such volume has increased in recent years. A public trading market having the desired characteristics of depth, liquidity and orderliness depends on the presence in the marketplace of willing buyers and sellers of the Company’s common stock at any given time. This presence depends on the individual decisions of investors and general economic and market conditions over which the Company has no control. Given the lower trading volume of the Company’s common stock, significant sales of the Company’s common stock, or the expectation of these sales, could cause the Company’s stock price to fall.
Our stock ownership has shifted to larger institutional shareholders.
Our ownership base has shifted over the past several years resulting in institutional investors and indexed funds holding approximately 54% of our shares as compared to shareholders located in our footprint and other retail individual investors. These institutional shareholders could decide to sell their holdings in our common stock and as such could result in lower market prices of our stock.
Certain banking laws may have an anti-takeover effect.
Provisions of federal banking laws, including regulatory approval requirements, could make it more difficult for a third party to acquire us, even if doing so would be perceived to be beneficial to our shareholders. These provisions effectively inhibit a non-negotiated merger or other business combination, which, in turn, could adversely affect the market price of our common stock.
We may not continue to pay dividends on our common stock in the future.
Holders of our common stock are only entitled to receive such dividends as our board of directors may declare out of funds legally available for such payments. Although we have historically declared cash dividends on our common stock, we are not required to do so and may reduce or eliminate our common stock dividends in the future. This could adversely affect the market price of our common stock. Also, we are a bank holding company, and our ability to declare and pay dividends is dependent on certain federal regulatory considerations, including the guidelines of the Federal Reserve Board regarding capital adequacy and dividends.
The Company’s stock price can be volatile.
Stock price volatility may make it more difficult for our shareholders to resell their common stock when they want and at prices they find attractive. The Company’s stock price can fluctuate significantly in response to a variety of factors including, among other things:
•
actual or anticipated variations in quarterly results of operations;
•
recommendations by securities analysts;
•
operating and stock price performance of other companies that investors deem comparable to the Company;
•
new reports relating to trends, concerns and other issues in the financial services industry or Texas economy, including oil and gas and cattle prices;
•
perceptions in the marketplace regarding the Company and/or its competitors;
•
new technology used, or services offered, by competitors;
•
significant acquisitions or business combinations involving the Company or its competitors; and
•
changes in government regulations, including tax laws.
General market fluctuations, industry factors and general economic and political conditions and events, such as economic slowdowns or recessions, interest rate changes or credit loss trends could also cause the Company’s stock price to decrease regardless of operational results.
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An investment in our common stock is not an insured deposit.
Our common stock is not a bank deposit and, therefore, is not insured against loss by the FDIC, any other deposit insurance fund, or by any other public or private entity. Investment in our common stock is inherently risky for the reasons described in this “Risk Factors” section and elsewhere in this Report. As a result, if you acquire our common stock, you may lose some or all of your investment.
General Risk Factors
If we are unable to continue our historical levels of growth, we may not be able to maintain our historical earnings trends.
To achieve our past levels of growth, we have focused on both internal growth and acquisitions. We may not be able to sustain our historical rate of growth or may not be able to grow at all. Additionally, we may not be able to obtain the financing necessary to fund additional growth and may not be able to find suitable acquisition candidates. Various factors, such as economic conditions, competition and heightened regulatory scrutiny, may impede or prohibit the opening of new banking centers and the completion of acquisitions. Further, we may be unable to attract and retain experienced bankers, which could adversely affect our internal growth. If we are not able to continue our historical levels of growth, we may not be able to maintain our historical earnings trends.
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ITEM 1B. UNRESOLVED STAFF COMMENTS
None.
ITEM 2. PROPERTIES
Our principal office is located in the First Financial Bank Building at 400 Pine Street in downtown Abilene, Texas. We lease two spaces in buildings owned by First Financial Bank, N.A. totaling approximately 10,155 square feet. As of December 31, 2021, our subsidiaries collectively own 73 banking, trust and mortgage facilities, some of which are detached drive-ins, and also lease 14 banking facilities and 15 ATM locations. Our management considers all our existing locations to be well-suited for conducting the business of banking. We are in the process of constructing two new branch locations in our existing markets to replace existing facilities in Huntsville and Bryan, Texas and one new facility in Lumberton, Texas, an expansion market. We believe our existing facilities are adequate to meet our requirements and our subsidiaries’ requirements for the foreseeable future.
ITEM 3. 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 our other direct and indirect 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 4. MINE SAFETY DISCLOSURES
Not applicable.
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PART II
Market Information
Our common stock, par value $0.01 per share, is traded on the Nasdaq Global Select Market under the trading symbol "FFIN".
Record Holders
As of February 1, 2022, we had 942 registered shareholders of record with our stock transfer agent.
Dividends
See “Item 8—Financial Statements and Supplementary Data—Quarterly Results of Operations” for the frequency and amount of cash dividends paid by us. Also, see “Item 1 – Business – Supervision and Regulation – Payment of Dividends” and “Item 7 – Management’s Discussion and Analysis of the Financial Condition and Results of Operations – Capital and Liquidity – Dividends” for restrictions on our present or future ability to pay dividends, particularly those restrictions arising under federal and state banking laws.
Equity Compensation Plans
See “Item 12 – Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters”.
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PERFORMANCE GRAPH
The following performance graph compares cumulative total shareholder returns for our common stock, the Russell 3000 Index, and the S&P U.S. BMI Banks Index, which is a banking index prepared by S&P Global Market Intelligence and is comprised of all U.S. domiciled banks, for a five-year period (December 31, 2016 to December 31, 2021). The performance graph assumes $100 invested in our common stock at its closing price on December 31, 2016, and in each of the Russell 3000 Index and the SNL Bank Index on the same date. The performance graph also assumes the reinvestment of all dividends. The dates on the performance graph represent the last trading day of each year indicated. The amounts noted on the performance graph have been adjusted to give effect to all stock splits and stock dividends.
First Financial Bankshares, Inc
Period Ending
Source: S&P Global Market Intelligence
© 2022
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ITEM 6. [RESERVED]
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The following discussion contains forward-looking statements that are subject to risks and uncertainties. Actual results may differ materially from those contemplated by the forward-looking statements as a result of certain factors, including but not limited to those listed in “Item 1A – Risk Factors” and in the “Cautionary Statement Regarding Forward-Looking Statements” notice on page 1.
Introduction
As a financial holding company, we generate most of our revenue from interest on loans and investments, trust fees, gain on sale of mortgage loans and service charges. Our primary source of funding for our loans and investments are deposits held by our bank subsidiary, First Financial Bank, N.A. Our largest expenses are salaries and related employee benefits. We measure our performance by calculating our return on average assets, return on average equity, regulatory capital ratios, net interest margin and efficiency ratio, which is calculated by dividing noninterest expense by the sum of net interest income on a tax equivalent basis and noninterest income.
The following discussion and analysis of the major elements of our consolidated balance sheets as of December 31, 2021 and 2020, and consolidated statements of earnings for the years 2019 through 2021 should be read in conjunction with our consolidated financial statements, accompanying notes, and selected financial data presented elsewhere in this Form 10-K.
Critical Accounting Policies
We prepare consolidated financial statements based on generally accepted accounting principles (“GAAP”) and customary practices in the banking industry. These policies, in certain areas, require us to make significant estimates and assumptions.
We deem a policy critical if (1) the accounting estimate required us to make assumptions about matters that are highly uncertain at the time we make the accounting estimate; and (2) different estimates that reasonably could have been used in the current period, or changes in the accounting estimate that are reasonably likely to occur from period to period, would have a material impact on the financial statements.
We deem our most critical accounting policies to be (1) our allowance for credit losses and our provision for credit losses and (2) our valuation of financial instruments. We have other significant accounting policies and continue to evaluate the materiality of their impact on our consolidated financial statements, but we believe these other policies either do not generally require us to make estimates and judgments that are difficult or subjective, or it is less likely they would have a material impact on our reported results for a given period. A discussion of (1) our allowance for credit losses and our provision for credit losses and (2) our valuation of financial instruments is included in Notes 1 and 10, respectively, to our Consolidated Financial Statements.
Acquisitions
On September 19, 2019, we entered into an agreement and plan of reorganization to acquire TB&T Bancshares, Inc. and its wholly-owned bank subsidiary, The Bank & Trust of Bryan/College Station, Texas. On January 1, 2020, the transaction was completed. Pursuant to the agreement, we issued 6.28 million shares of the Company’s common shares in exchange for all of the outstanding shares of TB&T Bancshares, Inc. In addition, in accordance with the plan of reorganization, TB&T Bancshares, Inc. paid a special dividend totaling $1.92 million to its shareholders prior to the closing of this transaction. At the closing, Brazos Merger Sub, Inc., a wholly-owned subsidiary of the Company, merged into TB&T Bancshares Inc., with TB&T Bancshares, Inc. surviving as a wholly-owned subsidiary of the Company. Immediately following such merger, TB&T Bancshares, Inc. was merged into the Company and The Bank & Trust of Bryan/College Station, Texas was merged into First Financial Bank, N.A., a wholly-owned subsidiary of the Company. The total purchase price of $220.27 million exceeded the estimated fair value of the net assets acquired by approximately $141.92 million and the Company recorded such excess as goodwill. The balance sheet and results of operations of TB&T Bancshares, Inc. have been included in the financial statements of the Company effective January 1, 2020.
Stock Split and Increase in Authorized Shares
On April 23, 2019, the Company’s Board of Directors declared a two-for-one stock split of the Company’s outstanding common shares effective June 3, 2019. In addition, the shareholders of the Company approved an amendment to the Amended and Restated Certificate of Formation to increase the number of authorized shares to 200,000,000. All per share amounts in this report have been restated to reflect this stock split. An amount equal to the par value of the additional common shares to be issued pursuant to the stock split was reflected as a transfer from retained earnings to common stock in the consolidated financial statements as of and for the year ended December 31, 2019.
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Stock Repurchase
On July 27, 2021, the Company's Board of Directors authorized the repurchase of up to 5,000,000 common shares through July 31, 2023. Previously, the Board of Directors had authorized the repurchase of up to 2,000,000 common shares through September 30, 2020. On March 12, 2020, the Company’s Board of Directors increased the authorization for the repurchase of up to 4,000,000 common shares through September 30, 2021. The stock repurchase plan authorizes management to repurchase and retire the stock at such time as repurchases are considered beneficial to the Company and its stockholders. Any repurchase of stock will be made through the open market, block trades or in privately negotiated transactions in accordance with applicable laws and regulations. Under the repurchase plan, there is no minimum number of shares that the Company is required to repurchase. Through July 27, 2021, 324,802 shares were repurchased and retired (all during the months of March and April of 2020) totaling $8,008,000 under the prior repurchase plan. Subsequent to July 27, 2021 and through February 22, 2022, no additional shares were repurchased.
Implementation of New Accounting Standard for Accounting for Allowance for Credit Losses
On January 1, 2020, Accounting Standards Update (“ASU”) 2016-13, Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments, became effective for the Company. Accounting Standards Codification (“ASC”) Topic 326 (“ASC 326”) replaced the previous “incurred loss” model for measuring credit losses with an expected loss methodology that is referred to as the current expected credit loss (“CECL”) methodology. The measurement of expected credit losses under the CECL methodology is applicable to financial assets measured at amortized cost, including loan receivables and held-to-maturity debt securities. It also applies to off-balance-sheet (“OBS”, “reserve for unfunded commitments”) credit exposures not accounted for as insurance (loan commitments, standby letters of credit, financial guarantees, and other similar instruments). In addition, ASC 326 made changes to the accounting for available-for-sale debt securities. One such change is to require credit losses to be presented as an allowance rather than as a write-down on available-for-sale debt securities management does not intend to sell or believes that it is more likely than not they will be required to sell.
On March 27, 2020, the CARES Act was signed by the President of the United States that included an option for entities to delay the implementation of ASC 326 until the earlier of the termination date of the national emergency declaration by the President, or December 31, 2020. Under this option, the Company elected to delay implementation of CECL and calculated and recorded the provision for credit losses through the nine-months ended September 30, 2020 under the incurred loss model. At December 31, 2020, the Company elected to adopt ASC 326, effective as of January 1, 2020, through a transition charge to retained earnings of $589 thousand ($466 thousand net of applicable income taxes), which was reflected in the consolidated financial statements as of and for the year-ended December 31, 2020 . This transition adjustment was comprised of a decrease of $619 thousand in allowance for credit losses and an increase of $1.21 million in the reserve for unfunded commitments.
The Company completed its CECL implementation plan by forming a cross-functional working group, under the direction of our Chief Lending Officer along with our Chief Accounting Officer and Chief Financial Officer. The working group also included individuals from various functional areas including credit, risk management, accounting and information technology, among others. The implementation plan included assessment and documentation of processes, internal controls and data sources, model development, documentation and validation, and system configuration, among other things. The Company contracted with a third-party vendor to assist in the implementation of CECL.
Other Recently Issued and Effective Authoritative Accounting Guidance
ASU 2017-04, “Intangibles – Goodwill and Other.” ASU 2017-04 amended and simplified current goodwill impairment testing to eliminate Step 2 from the current provisions. Under the new guidance, an entity should perform the goodwill impairment test by comparing the fair value of a reporting unit with its carrying value and recognize an impairment charge for the amount by which the carrying amount exceeds the reporting unit’s fair value. An entity still has the option to perform the qualitative assessment for a reporting unit to determine if a quantitative impairment test is necessary. ASU 2017-04 became effective for the Company on January 1, 2020 and did not have a significant impact on the Company’s financial statements.
ASU 2018-13, “Fair Value Measurement (Topic 820). – Disclosure Framework—Changes to the Disclosure Requirements for Fair Value Measurement.” ASU 2018-13 modified the disclosure requirements on fair value measurements in Topic 820. The amendments in ASU 2018-13 remove disclosures that no longer are considered cost beneficial, modify/clarify the specific requirements of certain disclosures, and add disclosure requirements identified as relevant. ASU 2018-13 became effective on January 1, 2020 and did not have a significant impact on the Company’s financial statements.
ASU 2019-12, “Income Taxes (Topic 740): Simplifying the Accounting for Income Taxes.” ASU 2019-12, simplifies the accounting for income taxes by eliminating certain exceptions related to the approach for intra-period tax aspects of the accounting for
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franchise taxes and enacted changes in tax laws or rates and clarifies the accounting for transactions that result in a step-up in the tax basis of goodwill. ASU 2019-12 was effective for the Company for annual reporting periods after December 15, 2020, and interim periods within. Adoption of ASU 2019-12 did not have a significant impact on the Company’s financial statements and related disclosures.
ASU 2020-04, “Reference Rate Reform (Topic 848): Facilitation of the Effects of Reference Rate Reform on Financial Reporting.” ASU 2020-04 provides optional expedients and exceptions for accounting related to contracts, hedging relationships and other transactions affected by reference rate reform if certain criteria are met. ASU 2020-04 applies only to contracts, hedging relationships, and other transactions that reference the London Interbank Offered Rate (“LIBOR”) or another reference rate expected to be discontinued because of reference rate reform and do not apply to contract modifications made and hedging relationships entered into or evaluated after December 31, 2022, except for hedging relationships existing as of December 31, 2022, that an entity has elected certain optional expedients for and that are retained through the end of the hedging relationship. ASU2020-04 was effective upon issuance and generally can be applied through December 31, 2022. The adoption of ASU 2020-04 did not have a significant impact on our financial statements.
ASU 2021-01, “Reference Rate Reform (Topic 848): Scope.” ASU 2021-01 clarifies that certain optional expedients and exceptions in ASC 848 for contract modifications and hedge accounting apply to derivatives that are affected by the discounting transition. ASU 2021-01 also amends the expedients and exceptions in ASC 848 to capture the incremental consequences of the scope clarification and to tailor the existing guidance to derivative instruments affected by the discounting transition. ASU 2021-01 was effective upon issuance and generally can be applied through December 31, 2022. The adoption of ASU 2021-01 did not have a significant impact on our financial statements.
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Selected Financial Data
The selected financial data presented below as of and for the years ended December 31, 2021, 2020, 2019, 2018, and 2017, have been derived from our audited consolidated financial statements. The data set forth below may not be fully comparable from period to period due to acquisitions in 2020 and 2018 and changes in accounting, including the allowance for credit losses in 2020 (see Notes 1, 3 and 21 to the Notes to Consolidated Financial Statements for further information). The results of operations presented below are not necessarily indicative of the results of operations that may be achieved in the future.
Year Ended December 31,
(dollars in thousands, except per share data)
Summary Income Statement Information:
Per Share Data:
Earnings performance ratios:
Summary Balance Sheet Data (Period-end):
Asset quality ratios:
Capital ratios:
(1)
Calculated by dividing at period-end, shareholders’ equity (before accumulated other comprehensive earnings/loss) less intangible assets by fourth quarter average assets less intangible assets.
(2)
Calculated by dividing at period-end, shareholders’ equity (before accumulated other comprehensive earnings/loss) less intangible assets by risk-adjusted assets.
(3)
Calculated by dividing at period-end, shareholders’ equity (before accumulated other comprehensive earnings/loss) less intangible assets by risk-adjusted assets.
(4)
Calculated by dividing at period-end, shareholders’ equity (before accumulated other comprehensive earnings/loss) less intangible assets plus allowance for loan losses to the extent allowed under regulatory guidelines by risk-adjusted assets.
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Results of Operations
Performance Summary. Net earnings for 2021 were $227.56 million, an increase of $25.53 million, or 12.64%, over net earnings for 2020 of $202.03 million. Net earnings for 2019 were $164.81 million. The increase in net earnings for 2021 over 2020 and 2020 over 2019 was primarily attributable to the overall growth in net interest income from the growth in earning assets, lower funding costs and noninterest income from trust, mortgage and deposit related fees as discussed below. Net earnings in 2021 also include a net reversal of provision for credit losses of $1.14 million compared to a positive provision for credit losses of $19.52 million in 2020 and $2.97 million in 2019. The net reversal of the Company's provision for credit losses in 2021 reflects the continued improvement in the economic outlook for our markets across Texas and overall improvements in asset quality offset by loan growth. The provision for credit losses in 2020 reflected primarily the stress on our loan portfolio from the increase in unemployment and economic effects of the COVID pandemic.
On a diluted net earnings per share basis, net earnings were $1.59 for 2021, as compared to $1.42 for 2020 and $1.21 for 2019. The return on average assets was 1.89% for 2021, as compared to 1.98% for 2020 and 2.08% for 2019. The return on average equity was 13.31% for 2021, as compared to 12.93% for 2020 and to 14.37% for 2019. The return on average tangible equity was 16.35% for 2021, as compared to 16.25% for 2020 and to 16.95% for 2019.
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 $385.05 million in 2021, as compared to $361.15 million in 2020, and $295.88 million in 2019. Average earning assets were $11.34 billion in 2021, as compared to $9.52 billion in 2020 and $7.44 billion in 2019. The increase in tax-equivalent net interest income in 2021 compared to 2020 was largely attributable to increases in interest earning assets. The increase of $1.82 billion in average earning assets in 2021 when compared to 2020 was primarily a result of increases in taxable securities of $665.29 million and tax-exempt securities of $620.51 million when compared to 2020. The increase in tax-equivalent net interest income in 2020 compared to 2019 was also largely attributable to increases in interest earning assets. The increase of $2.08 billion in average earning assets in 2020 when compared to 2019 was primarily a result of increases in loans of $1.08 billion and tax-exempt securities of $689.80 million when compared to 2019. Average interest-bearing liabilities were $6.78 billion in 2021, as compared to $5.76 billion in 2020 and $4.61 billion in 2019. The yield on earning assets decreased forty-nine basis points in 2021 when compared to 2020 while the rate paid on interest-bearing liabilities decreased sixteen basis points. The yield on earning assets decreased forty-four basis points in 2020 when compared to 2019 while the rate paid on interest-bearing liabilities decreased forty basis points. Additionally, interest income on loans included PPP related loan fees of $23.49 million and $14.96 million for 2021 and 2020, respectively.
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The table below allocates the change in tax-equivalent net interest income between the amount of change attributable to volume and to rate.
Changes in Interest Income and Interest Expense (in thousands):
Change Attributable to Total Change Attributable to Total
Volume Rate Change Volume Rate Change
(1)
Computed on a tax-equivalent basis assuming a marginal tax rate of 21%.
(2)
Nonaccrual loans are included in loans.
The net interest margin for 2021 was 3.40% which was a decrease of thirty-nine basis points from 2020. The net interest margin in 2020 was 3.79%, a decrease of nineteen basis points from 2019. We continued to experience downward pressures on our net interest margin in 2021 primarily due to (i) the extended period of historically low levels of short-term interest rates and (ii) the flat to inverted yield curve being experienced in the bond market. We have been able to somewhat mitigate the impact of these lower short-term interest rates and the flat/inverted yield curve by establishing minimum interest rates on certain of our loans, improving the pricing for loan risk, and reducing the rates paid on interest-bearing liabilities. In March 2020, as the market experienced volatility, we took advantage of that volatility to purchase high quality municipal bonds at favorable tax-equivalent interest yields. The Federal Reserve decreased rates 75 basis points during the third and fourth quarters of 2019 and then an additional 150 basis points in the first quarter of 2020, resulting in a current target rate range of zero to 25 basis points.
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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 the table below for the years 2019 through 2021.
Average Balances and Average Yields and Rates (in thousands, except percentages):
Assets
Liabilities and Shareholders’ Equity
Rate Analysis:
Interest income/earning assets 3.45 % 3.94 % 4.38 %
Interest expense/earning assets (0.05 ) (0.15 ) (0.40 )
(1)
Short-term investments are comprised of federal funds sold, interest-bearing deposits in banks and interest- bearing time deposits in banks.
(2)
Average balances include unrealized gains and losses on available-for-sale securities.
(3)
Computed on a tax-equivalent basis assuming a marginal tax rate of 21%.
(4)
Nonaccrual loans are included in loans.
Noninterest Income. Noninterest income for 2021 was $142.18 million, an increase of $2.24 million, or 1.60%, as compared to 2020. Increases in certain categories of noninterest income included (1) trust fees of $6.61 million, (2) ATM, interchange and credit card fees of $5.81 million, (3) interest on loan recoveries of $3.18 million and (4) service charges on deposit accounts of $584 thousand when compared to 2020. The increase in trust fees resulted from an increase in assets under management over the prior year and an increase in oil and gas production driven by increasing oil and gas prices. The fair value of our trust assets managed, which are not reflected in our consolidated balance sheets, totaled $8.70 billion at December 31, 2021, as compared to $7.51 billion at December 31, 2020. Oil and gas production income increased related trust fees by $1.87 million in 2021 over 2020. The increase in ATM, interchange and credit card fees was driven by the over 16,000 net new accounts opened in 2021, debit cards issued and overall customer utilization. Interest on loan recoveries increased as a result of several larger loan recoveries in 2021. The increase in service charges on deposit accounts was primarily due to the continued growth in net new accounts and growth in treasury management services. Offsetting these increases was a decrease of $10.63 million in mortgage income due to lower overall origination volumes and declining margins on loan sales.
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Noninterest income for 2020 was $139.94 million, an increase of $31.51 million, or 29.06%, as compared to 2019. Increases in certain categories of noninterest income included (1) real estate mortgage operations income of $25.73 million, (2) gain on sale of available-for-sale securities of $2.90 million, (3) ATM, interchange and credit card fees of $2.61 million, (4) miscellaneous income of $2.12 million which includes $1.40 million in Main Street Lending Program fees and (5) trust fees of $1.13 million when compared to 2019. The mortgage related income increase was mainly due to a significant increase in the volume of loans originated to $1.21 billion in 2020 up from $551.77 million in 2019 driven by the lower rate environment and a strong housing market in Texas. The increase in ATM, interchange and credit card fees was driven by continued growth in the number of debit cards issued as well as our TB&T acquisition. The increase in trust fees resulted from an increase in assets under management over the prior year. The fair value of our trust assets managed, which are not reflected in our consolidated balance sheets, totaled $7.51 billion at December 31, 2020, as compared to $6.75 billion at December 31, 2019. Offsetting these increases was a decline in service charge revenue in 2020 when compared with 2019 of $1.47 million that was primarily driven by lower overdraft fees in the current year as a result of the effects of the pandemic and related stimulus programs.
ATM and interchange fees are charges that merchants pay to us and other card-issuing banks for processing electronic payment transactions. ATM and interchange fees consist of income from debit card usage, point of sale income for debit card transactions and ATM service fees.
Federal Reserve rules applicable to financial institutions that have assets of $10 billion or more provide that the maximum permissible interchange fee for an electronic debit transaction is limited to the sum of 21 cents per transaction plus 5 basis points multiplied by the value of the transaction. Management has estimated the impact of this reduction in ATM and interchange fees to approximate $16 million annually (pre-tax) once the Federal Reserve rules apply to the Company. Federal Reserve requirements stipulate that these rules would go into effect on July 1st following the year-end in which a financial institution’s total assets exceeded $10 billion at December 31st. This effect was delayed to 2021 by the Federal Reserve in late 2020; however, will become effective for the Company on July 1, 2022.
Noninterest Income (in thousands):
Other:
Noninterest Expense. Total noninterest expense for 2021 amounted to $241.71 million, an increase of $13.77 million, or 6.04%, as compared to 2020. Total noninterest expense for 2020 was $227.94 million, an increase of $31.42 million, or 15.99%, as compared to 2019. An important measure in determining whether a financial institution effectively manages noninterest expenses is the efficiency ratio, which is calculated by dividing noninterest expense by the sum of net interest income on a tax-equivalent basis and noninterest income. Lower ratios indicate better efficiency since more income is generated with a lower noninterest expense total. Our efficiency ratio for 2021 was 45.84%, as compared to 45.49% for 2020 and 48.61% for 2019. The reduction in the Company’s efficiency ratio during 2020 primarily resulted from the growth in the Company’s balance sheet and interest-earning assets as a result of the Company’s participation in the PPP loan program and the deferral of $3.62 million in noninterest expenses related to PPP loan origination costs during the second quarter of 2020.
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Salaries and employee benefits for 2021 totaled $142.04 million, an increase of $6.92 million, or 5.12%, as compared to 2020. The increase was primarily driven by annual merit-based pay increases that were effective March 1, 2021 and an increase in medical insurance costs.
All other categories of noninterest expense for 2021 totaled $99.67 million, an increase of $6.85 million, or 7.38%, as compared to 2020. Included in noninterest expense during 2021 was an increase of $1.37 million in FDIC insurance premiums due to FDIC credit applied in 2020 as previously discussed.
Salaries and employee benefits for 2020 totaled $135.12 million, an increase of $22.79 million, or 20.28%, as compared to 2019. The increase was primarily driven by (i) the TB&T acquisition, (ii) annual merit-based pay increases that were effective March 1, 2020, (iii) an increase in our profit sharing and other incentive expenses, and (iv) higher mortgage related commissions.
All other categories of noninterest expense for 2020 totaled $92.82 million, an increase of $8.63 million, or 10.25%, as compared to 2019. Included in noninterest expense in 2020 were technology contract termination and conversion related expenses totaling $4.88 million related to the TB&T acquisition. Also included in noninterest expense during 2020 were increases in net occupancy expenses, professional and service fees and ATM, interchange and credit card expenses when compared to 2019 primarily due to the TB&T acquisition. Also, in 2019 the Company incurred $2.67 million in expenses related to the termination of its pension plan.
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Noninterest Expense (in thousands):
Cost related to termination of pension plan — — — (2,673 ) 2,673
Other:
Income Taxes. Income tax expense was $44.41 million for 2021, as compared to $40.33 million for 2020 and $33.22 million for 2019. Our effective tax rates on pretax income were 16.33%, 16.64% and 16.78%, respectively, for the years 2021, 2020 and 2019. The effective tax rates differ from the statutory federal tax rate of 21.0% largely due to tax exempt interest income earned on certain investment securities and loan.
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 throughout Texas served by our subsidiary bank. As of December 31, 2021, total loans held-for-investment were $5.39 billion, an increase of $217.94 million, as compared to December 31, 2020. During 2021, the Company originated $267.42 million in additional PPP loans and forgave $698.29 million resulting in a balance of $52.79 million at December 31, 2021, which are included in the Company’s commercial loan totals. The average balances of PPP loans were $327.10 million and $479.43 million for the years ended December 31, 2021 and 2020, respectively. At December 31, 2021, $1.80 million of deferred loan fees related to PPP loans continues to be amortized over the shorter of the repayment period or the contractual life of 24 to 60 months.
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As compared to year-end 2020 balances, total real estate loans increased $427.25 million, total commercial loans decreased $297.73 million, agricultural loans increased $3.23 million and total consumer loans increased $85.19 million. Loans averaged $5.34 billion during 2021, an increase of $188.80 million over 2020 average balances.
In conjunction with the adoption of ASC 326, the Company expanded its four loan portfolio segments used under the legacy disclosure requirements into the following ten portfolio segments. For modeling purposes, our loan portfolio segments include Commercial and Industrial (“C&I”), Municipal, Agricultural, Construction and Development, Farm, Non-Owner Occupied and Owner Occupied Commercial Real Estate (“CRE”), Residential, Consumer Auto and Consumer Non-Auto. This additional segmentation allows for a more precise pooling of loans with similar credit risk characteristics and credit monitor procedures for the Company’s calculation of its allowance for credit losses.
The table below outlines the composition of the Company’s held-for-investment loans by portfolio segment. For all periods prior to December 31, 2020, management has elected to maintain its previously disclosed loan portfolio segments.
Composition of Loans Held-For-Investment (in thousands):
December 31,
Commercial:
Real Estate:
Consumer:
Loans held-for-sale, consisting of secondary market mortgage loans, totaled $37.81 million and $83.97 million at December 31, 2021 and 2020, respectively. At December 31, 2021 and 2020, $3.69 million and $4.38 million are valued at the lower of cost or fair value, and the remaining amount is valued under the fair value option.
The Company has certain lending policies and procedures in place that are designed to maximize loan growth with an acceptable level of risk. Management reviews and approves these policies and procedures on an annual basis and makes changes as appropriate with input from our Board of Directors. Management receives and reviews monthly reports related to loan originations, quality, concentrations, delinquencies, nonperforming and potential problem loans. Diversification in the loan portfolio is a means of managing risk associated with fluctuations in economic conditions, both by type of loan and geographic location.
Commercial loans are underwritten after evaluating and understanding the borrower’s ability to operate profitably and effectively. Underwriting standards are designed to determine whether the borrower possesses sound business ethics and practices and to evaluate current and projected cash flows to determine the ability of the borrower to repay their obligations as agreed. Commercial loans are primarily made based on the identified cash flows of the borrower and, secondarily, on the underlying collateral provided by the borrower. Most commercial loans are secured by the assets being financed or other business assets, such as accounts receivable or inventory, and include personal guarantees.
Agricultural loans are subject to underwriting standards and processes similar to commercial loans. These agricultural loans are based primarily on the identified cash flows of the borrower and secondarily on the underlying collateral provided by the borrower. Most agricultural loans are secured by the agriculture related assets being financed, such as farm land, cattle or equipment, and include personal guarantees.
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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.
Maturity Distribution and Interest Sensitivity of Loans at December 31, 2021 (in thousands):
The following tables summarize maturity information of our loan portfolio as of December 31, 2021. The table also presents the portion of loans that have fixed interest rates or variable interest rates that fluctuate over the life of the loans in accordance with changes in an interest rate index.
Commercial:
Real Estate:
Consumer:
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Commercial:
Real Estate:
Consumer:
Commercial:
PPP — — — — —
Real Estate:
Consumer:
Auto — — — — —
Of the $3.14 billion of the floating interest rate loans shown above, loans totaling $1.36 billion mature or reprice over the next twelve months. Of this amount, approximately $340 million will reprice immediately upon changes in the underlying index rate (primarily U.S. prime rate) with the remaining $1.02 billion being subject to floors above the current index.
Asset Quality. Our loan portfolio is subject to periodic reviews by our centralized independent loan review group as well as periodic examinations by bank regulatory agencies. Loans are placed on nonaccrual status when, in the judgment of management, the collectability of principal or interest under the original terms becomes doubtful. Nonaccrual, past due 90 days or more and still accruing, and restructured loans plus foreclosed assets were $34.16 million at December 31, 2021, as compared to $42.90 million at December 31, 2020 and $25.77 million at December 31, 2019. As a percent of loans held-for-investment and foreclosed assets, these assets were 0.63% at December 31, 2021, as compared to 0.83% at December 31, 2020 and 0.61% at December 31, 2019. As a percent of total assets, these assets were 0.26% at December 31, 2021, as compared to 0.39% at December 31, 2020 and 0.31% at December 31, 2019. We believe the level of these assets to be manageable and are not aware of any material classified credits not properly disclosed as nonperforming at December 31, 2021.
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Supplemental Oil and Gas Information. At December 31, 2021, the Company’s exposure to the oil and gas industry was 2.62% of loans held-for-investment, excluding PPP loans, or $140.03 million, compared to 2.27% of loans held-for-investment, or $106.24 million at December 31, 2020. These oil and gas loans consisted (based on collateral supporting the loan) of (i) development and production loans of 11.07%, (ii) oil and gas field servicing loans of 4.21%, (iii) real estate loans of 33.71%, (iv) accounts receivable and inventory of 22.82%, (v) automobile of 24.92% and (vi) other of 3.27%. These loans have warranted additional scrutiny because of fluctuating oil and gas prices and the COVID pandemic. The Company instituted additional monitoring procedures for these loans and has classified and downgraded loans as appropriate. The following oil and gas information is as of and for the years ended December 31, 2021 and 2020:
December 31,
Oil and gas related loans, excluding PPP loans $ 140,034 $ 106,237
Classified oil and gas related loans $ 11,821 $ 13,298
Nonaccrual oil and gas related loans $ 3,701 $ 4,774
Net charge-offs for oil and gas related loans for year then ended $ 28 $ 825
Additionally, the Company's trust revenues may be impacted by oil and gas prices which represented approximately 12% and 9% of total trust revenues in 2021 and 2020, respectively.
Supplemental COVID Industry Exposure. In addition, at December 31, 2021, loan balances in the retail/restaurant/hospitality industries totaled $526.09 million or 9.86% of the Company’s total loans held-for-investment, excluding PPP loans. Classified and nonperforming loans for these industries combined at December 31, 2021, totaled $32.75 million and $1.49 million, respectively. Net recoveries related to this portfolio totaled $464 thousand for the year ended December 31, 2021. Additional information related to the Company’s retail/restaurant/hospitality industries follows below (in thousands, except percentages):
December 31,
Classified Retail/Restaurant/Hospitality loans $ 32,747 $ 31,192
Nonaccrual Retail/Restaurant/Hospitality loans 1,487 5,975
Net Charge-Offs (Recoveries) for Retail/Restaurant/Hospitality loans (464 ) 895
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Nonaccrual, Past Due 90 Days or More and Still Accruing, Restructured Loans and Foreclosed Assets (in thousands, except percentages):
At December 31,
* Troubled debt restructured loans of $6.72 million, $7.41 million, $4.79 million, $3.84 million and $4.63 million, respectively, whose interest collection, after considering economic and business conditions and collection efforts, is doubtful are included in nonaccrual loans as of December 31, 2021, 2020, 2019, 2018 and 2017.
We record interest payments received on nonaccrual loans as reductions of principal. Prior to the loans being placed on nonaccrual, we recognized interest income on these loans as of December 31, 2021 of approximately $1.35 million during the year ended December 31, 2021. If interest on these loans had been recognized on a full accrual basis during the year ended December 31, 2021, such income would have approximated $2.61 million.
Included in our loan portfolio are certain other loans not included in the table above that are deemed to be potential problem loans. Potential problem loans are those loans that are currently performing, but for which known information about trends, uncertainties or possible credit problems of the borrowers causes management to have serious doubts as to the ability of such borrowers to comply with present repayment terms, possibly resulting in the transfer of such loans to nonperforming status. These potential problem loans totaled $6.63 million as of December 31, 2021.
See Note 3 to the Consolidated Financial Statements for more information on these assets.
Allowance for Credit Losses. The allowance for credit losses is the amount we determine as of a specific date to be appropriate to absorb current expected credit losses on existing loans. For a discussion of our methodology, see our accounting policies in Note 1 to the Consolidated Financial Statements. The provision for credit losses was a net reversal of $1.14 million in 2021, as compared to a provision of $19.52 million in 2020 and $2.97 million in 2019. The net reversal of the Company's provision for credit losses in 2021 reflects the continued improvement in the economic outlook for our markets across Texas and overall improvements in asset quality offset by loan growth. The provision for credit losses in 2020 reflected primarily the stress on our loan portfolio from the increase in unemployment and economic effects of the COVID pandemic. As a percent of average loans, net loan charge-offs were 0.02% during 2021, 0.06% during 2020 and 0.04% during 2019. The allowance for credit losses as a percent of loans held-for-investment was 1.18% as of December 31, 2021, as compared to 1.29% as of December 31, 2020 and 1.25% as of December 31, 2019. The allowance for credit losses as a percent of loans held-for-investment, excluding PPP loans, was 1.19% as of December 31, 2021, as compared to 1.42% as of December 31, 2020 and 1.25% as of December 31, 2019. Included in the following tables are further analysis of our allowance for credit losses.
Although we believe we use the best information available to make credit loss allowance determinations, future adjustments could be necessary if circumstances or economic conditions differ substantially from the assumptions used in making our initial determinations. A downturn in the economy or lower employment could result in increased levels of nonaccrual, past due 90 days or more and still accruing, restructured loans, foreclosed assets, charge-offs, increased provision for credit losses and reductions in income. Additionally, as an integral part of their examination process, bank regulatory agencies periodically review the adequacy of our allowance for credit losses. The banking agencies could require additions to our allowance for credit losses based on their judgment of information available to them at the time of their examinations of our bank subsidiary.
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Loan Loss Experience and Allowance for Credit Losses (in thousands, except percentages):
Impact of adopting ASC 326 — (619 ) — — —
Initial allowance on acquired TB&T PCD loans — 1,678 — — —
Charge-offs:
Commercial:
Municipal — — N/A N/A N/A
Real estate:
Construction & Development — — N/A N/A N/A
Farm — — N/A N/A N/A
Non-Owner Occupied CRE (6 ) (563 ) N/A N/A N/A
Owner Occupied CRE (231 ) (567 ) N/A N/A N/A
Residential real estate (93 ) (373 ) N/A N/A N/A
Consumer:
Non-Auto (285 ) (375 ) N/A N/A N/A
Recoveries:
Commercial:
Municipal — — N/A N/A N/A
Real estate:
Construction & Development 1 — N/A N/A N/A
Non-Owner Occupied CRE 702 131 N/A N/A N/A
Owner Occupied CRE 821 17 N/A N/A N/A
Residential real estate 96 151 N/A N/A N/A
Consumer:
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Allocation of Allowance for Credit Losses (in thousands):
At December 31,
Commercial:
Real estate:
Construction & Development 17,627 13,512 N/A N/A N/A
Non-Owner Occupied CRE 10,722 8,391 N/A N/A N/A
Residential real estate 8,133 12,601 N/A N/A N/A
Consumer:
Percent of Loans in Each Category of Total Loans:
Commercial:
Municipal 3.30 3.51 N/A N/A N/A
Real estate:
Construction & Development 13.91 10.71 N/A N/A N/A
Non-Owner Occupied CRE 11.57 11.95 N/A N/A N/A
Owner Occupied CRE 15.25 14.45 N/A N/A N/A
Residential real estate 24.76 24.14 N/A N/A N/A
Consumer:
Interest-Bearing Demand Deposits in Banks. The Company had interest-bearing demand deposits in banks of $323.54 million at December 31, 2021 and $517.97 million at December 31, 2020, respectively. At December 31, 2021, our interest-bearing deposits in banks included $323.12 million maintained at the Federal Reserve Bank of Dallas and $413 thousand on deposit with the Federal Home Loan Bank of Dallas (FHLB). The average balance of interest-bearing deposits in banks was $590.84 million, $249.70 million and $80.81 million in 2021, 2020 and 2019, respectively. The average yield on interest-bearing deposits in banks was 0.12%, 0.38% and 2.22% in 2021, 2020 and 2019, respectively.
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Available-for-Sale Securities. At December 31, 2021, securities with a fair value of $6.57 billion were classified as securities available-for-sale. There were no securities classified as held-to-maturity at December 31, 2021 and 2020. As compared to December 31, 2020, the available-for-sale portfolio at December 31, 2021, reflected (1) an increase of $126.84 million in U.S. Treasury securities; (2) an increase of $326.60 million in obligations of states and political subdivisions; (3) an increase of $63.74 million in corporate bonds and other; and (4) an increase of $1.66 billion in mortgage-backed securities. As compared to December 31, 2019, the available-for-sale portfolio at December 31, 2020, reflected (1) a decrease of $10.02 million in U.S. Treasury securities; (2) an increase of $1.14 billion in obligations of states and political subdivisions; (3) a decrease of $151 thousand in corporate bonds and other securities; and (4) a decrease of $148.01 million in mortgage-backed securities. Securities-available-for-sale included fair value adjustments of $125.67 million, $215.85 million and $84.51 million at December 31, 2021, 2020 and 2019, respectively. Our mortgage related securities are backed by GNMA, FNMA or FHLMC or are collateralized by securities backed by these agencies.
See the below table and Note 2 to the Consolidated Financial Statements for additional disclosures relating to the maturities and fair values of the investment portfolio at December 31, 2021 and 2020.
Maturities and Yields of Available-for-Sale Held at December 31, 2021 (in thousands, except percentages):
Maturing
All yields are computed on a tax-equivalent basis assuming a marginal tax rate of 21%. Yields on available-for-sale securities are based on amortized cost. Maturities of mortgage-backed securities are based on contractual maturities and could differ due to prepayments of underlying mortgages. Maturities of other securities are reported at the earlier of maturity date or call date.
As of December 31, 2021, the investment portfolio had an overall tax equivalent yield of 2.24%, a weighted average life of 5.45 years and modified duration of 4.84 years. At December 31, 2020, the investment portfolio had an overall tax equivalent yield of 2.76%, a weighted average life of 4.66 years and modified duration of 4.14 years.
Deposits. Deposits held by our subsidiary bank represent our primary source of funding. Total deposits were $10.57 billion as of December 31, 2021, as compared to $8.68 billion as of December 31, 2020 and $6.60 billion as of December 31, 2019. The table below provides a breakdown of average deposits and rates paid over the past three years and the remaining maturity of time deposits of $250,000 or more:
Composition of Average Deposits and Remaining Maturity of Time Deposits of $250,000 or More (in thousands, except percentages):
AverageBalance AverageRate AverageBalance AverageRate AverageBalance AverageRate
Interest-bearing deposits
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Three months or less $ 78,564
Over three through six months 24,749
Over six through twelve months 26,629
The estimated amount of uninsured and uncollateralized deposits including related interest accrued and unpaid is approximately $3.86 billion as of December 31, 2021.
Borrowings. Included in borrowings were federal funds purchased, securities sold under repurchase agreements, advances from the FHLB and other borrowings of $671.15 million, $430.09 million and $381.36 million at December 31, 2021, 2020 and 2019, respectively. Securities sold under repurchase agreements are generally with significant customers of the Company that require short-term liquidity for their funds for which we pledge certain securities that have a fair value equal to at least the amount of the short-term borrowing. The average balances of federal funds purchased, securities sold under repurchase agreements and advances from the FHLB were $556.61 million, $561.51 million, and $398.14 million in 2021, 2020 and 2019, respectively. The average rates paid on federal funds purchased, securities sold under repurchase agreements and advances from the FHLB were 0.06%, 0.20% and 0.75% for the years ended December 31, 2021, 2020 and 2019, respectively. The weighted average interest rate on federal funds purchased, securities sold under repurchase agreements and advances from the FHLB was 0.06%, 0.08% and 0.48% at December 31, 2021, 2020 and 2019, respectively. The highest amount of federal funds purchased, securities sold under repurchase agreements and advances from the FHLB at any month-end during 2021, 2020 and 2019 was $674.88 million, $925.42 million and $423.67 million, respectively.
Interest Rate Risk
Interest rate risk results when the maturity or repricing intervals of interest-earning assets and interest-bearing liabilities are different. Our exposure to interest rate risk is managed primarily through our strategy of selecting the types and terms of interest-earning assets and interest-bearing liabilities that generate favorable earnings while limiting the potential negative effects of changes in market interest rates. We use no off-balance-sheet financial instruments to manage interest rate risk.
Our subsidiary bank has an asset liability management committee that monitors interest rate risk and compliance with investment policies. The subsidiary bank utilizes an earnings simulation model as the primary quantitative tool in measuring the amount of interest rate risk associated with changing market rates. The model quantifies the effects of various interest rate scenarios on projected net interest income and net income over the next twelve months. The model measures the impact on net interest income relative to a base case scenario of hypothetical fluctuations in interest rates over the next twelve months. These simulations incorporate assumptions regarding balance sheet growth and mix, pricing and the re-pricing and maturity characteristics of the existing and projected balance sheet.
The following analysis depicts the estimated impact on net interest income of immediate changes in interest rates at the specified levels for the periods presented.
Percentage change in net interest income:
Change in interest rates: December 31,
The results for the net interest income simulations as of December 31, 2021 and December 31, 2020 resulted in an asset sensitive position. These are good faith estimates and assume that the composition of our interest sensitive assets and liabilities existing at each year-end will remain constant over the relevant twelve-month measurement period and that changes in market interest rates are instantaneous and sustained across the yield curve regardless of duration of pricing characteristics on specific assets or liabilities. Also, this analysis does not contemplate any actions that we might undertake in response to changes in market interest rates. We believe these
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estimates are not necessarily indicative of what actually could occur in the event of immediate interest rate increases or decreases of this magnitude. As interest-bearing assets and liabilities reprice in different time frames and proportions to market interest rate movements, various assumptions must be made based on historical relationships of these variables in reaching any conclusion. Since these correlations are based on competitive and market conditions, we anticipate that our future results will likely be different from the foregoing estimates, and such differences could be material.
Should we be unable to maintain a reasonable balance of maturities and repricing of our interest-earning assets and our interest-bearing liabilities, we could be required to dispose of our assets in an unfavorable manner or pay a higher than market rate to fund our activities. Our asset liability committee oversees and monitors this risk.
Capital and Liquidity
Capital. We evaluate capital resources by our ability to maintain adequate regulatory capital ratios to do business in the banking industry. Issues related to capital resources arise primarily when we are growing at an accelerated rate but not retaining a significant amount of our profits or when we experience significant asset quality deterioration.
Total shareholders’ equity was $1.76 billion, or 13.43% of total assets at December 31, 2021, as compared to $1.68 billion, or 15.39% of total assets at December 31, 2020. Included in shareholders’ equity at December 31, 2021 and 2020 were $99.25 million and $170.40 million, respectively, in unrealized gains on investment securities available-for-sale, net of related income taxes. During 2021, total shareholders’ equity averaged $1.71 billion, or 14.20% of average assets, as compared to $1.56 billion, or 15.32% of average assets during 2020.
Banking regulators measure capital adequacy by means of the risk-based capital ratios and leverage ratio under the Basel III Rules and prompt corrective action regulations. The risk-based capital rules provide for the weighting of assets and off-balance-sheet commitments and contingencies according to prescribed risk categories. Regulatory capital is then divided by risk-weighted assets to determine the risk-adjusted capital ratios. The leverage ratio is computed by dividing shareholders’ equity less intangible assets by quarter-to-date average assets less intangible assets.
Beginning in January 2015, under the Basel III Rules, the implementation of the capital conservation buffer was effective for the Company starting at the 0.625% level and increasing 0.625% each year thereafter, until it reached 2.5% on January 1, 2019. The capital conservation buffer is designed to absorb losses during periods of economic stress and requires increased capital levels for the purpose of capital distributions and other payments. Failure to meet the amount of the buffer will result in restrictions on the Company’s ability to make capital distributions, including divided payments and stock repurchase, and to pay discretionary bonuses to executive officers.
As of December 31, 2021 and 2020, we had a total risk-based capital ratio of 20.34% and 22.03%, a Tier 1 capital to risk-weighted assets ratio of 19.35% and 20.79%, a common equity Tier 1 capital to risk-weighted ratio of 19.35% and 20.79% and a Tier 1 leverage ratio of 11.13% and 11.86%, respectively. The regulatory capital ratios as of December 31, 2021 and 2020 were calculated under Basel III Rules.
Our subsidiary bank made the election to continue to exclude accumulated other comprehensive income from capital in connection with its March 31, 2015 quarterly financial filing and, in effect, to retain the accumulated other comprehensive income treatment under the prior capital rules.
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 other borrowings, which amounted to $671.15 million at December 31, 2021, and an unfunded $25.00 million revolving line of credit established with Frost Bank, a nonaffiliated bank, which matures on June 30, 2023 (see next paragraph). Our subsidiary bank also has federal funds purchased lines of credit with two non-affiliated banks totaling $130.00 million. At December 31, 2021, there were no amounts drawn on these lines of credit. Our subsidiary bank also has (i) an available line of credit with the FHLB totaling $2.09 billion
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at December 31, 2021, secured by portions of our loan portfolio and certain investment securities; and (ii) access to the Federal Reserve Bank of Dallas lending program. At December 31, 2021, the Company did not have any balances outstanding under this line of credit.
The Company renewed its loan agreement, effective June 30, 2021, 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. See Note 8 - Line of Credit in the accompanying notes to consolidated financial statements regarding further information on this line of credit.
In addition, we anticipate that any future acquisition of financial institutions, expansion of branch locations or offering of new products could also place a demand on our cash resources. Available cash and cash equivalents at the Company, which totaled $152.36 million at December 31, 2021, investment securities which totaled $2.49 million at December 31, 2021 with maturities over 8 to 9 years, available dividends from our subsidiaries which totaled $348.57 million at December 31, 2021, utilization of available lines of credit, and future debt or equity offerings are expected to be the source of funding for these potential acquisitions or expansions.
Given the strong core deposit base and relatively low loan to deposit ratios maintained at our subsidiary bank, we consider our current liquidity position to be adequate to meet our short-term and long-term liquidity needs.
In the ordinary course of business we have entered into contractual obligations and have made other commitments to make future payments. Refer to the accompanying notes to consolidated financial statements for the expected timing of such payments as of December 31, 2021. These payments related to time deposits with stated maturity dates (Note 7 - Deposits and Borrowings) and operating leases (Note 11 - Commitments and Contingencies). In addition, we have construction contracts with remaining future minimum contractual obligations of approximately $12.33 million in 2022.
Off-Balance Sheet/Reserve for Unfunded Commitments. We are a party to financial instruments with OBS risk in the normal course of business to meet the financing needs of our customers. These financial instruments include unfunded lines of credit, commitments to extend credit and federal funds sold to correspondent banks and standby letters of credit. Those instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the consolidated balance sheets. At December 31, 2021, the Company’s reserve for unfunded commitments totaled $6.44 million which is recorded in other liabilities.
Our exposure to credit loss in the event of nonperformance by the counterparty to the financial instrument for unfunded lines of credit, commitments to extend credit and standby letters of credit is represented by the contractual notional amount of these instruments. We generally use the same credit policies in making commitments and conditional obligations as we do for on-balance-sheet instruments.
Unfunded lines of credit and commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. These commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. We evaluate each customer’s creditworthiness on a case-by-case basis. The amount of collateral obtained, as we deem necessary upon extension of credit, is based on our credit evaluation of the counterparty. Collateral held varies but may include accounts receivable, inventory, property, plant, and equipment and income-producing commercial properties.
Standby letters of credit are conditional commitments we issue to guarantee the performance of a customer to a third party. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. The average collateral value held on letters of credit usually exceeds the contract amount.
See further disclosure of the unfunded lines of credit, unfunded commitments to extend credit and standby letters of credit (Note 12 - Financial Instruments with Off-Balance-Sheet Risk). Future notional amounts committed are $1.03 million in less than one year, $208 thousand in more than one year but less than three years and $465 thousand thereafter.
We believe we have no other OBS arrangements or transactions with unconsolidated, special purpose entities that would expose us to liability that is not reflected on the face of the financial statements.
Parent Company Funding. Our ability to fund various operating expenses, dividends, and cash acquisitions is generally dependent on our own earnings (without giving effect to our subsidiaries), cash reserves and funds derived from our subsidiaries. These funds historically have been produced by intercompany dividends and management fees that are limited to reimbursement of actual expenses. We anticipate that our recurring cash sources will continue to include dividends and management fees from our subsidiaries. At December 31, 2021, $348.57 million was available for the payment of intercompany dividends by our subsidiaries without the prior approval of regulatory agencies. Our subsidiaries paid aggregate dividends to us of $96.50 million in 2021 and $87.50 million in 2020.
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Dividends. Our long-term dividend policy is to pay cash dividends to our shareholders of approximately 35% to 40% of annual net earnings while maintaining adequate capital to support growth. We are also restricted by a loan covenant within our line of credit agreement with Frost Bank to dividend no greater than 55% of net income, as defined in such loan agreement. The cash dividend payout ratios have amounted to 36.30%, 35.88% and 38.31% of net earnings, respectively, in 2021, 2020 and 2019. Given our current capital position, projected earnings and asset growth rates, we do not anticipate any significant change in our current dividend policy.
Our bank subsidiary, which is a national banking association and a member of the Federal Reserve System, is required by federal law to obtain the prior approval of the OCC to declare and pay dividends if the total of all dividends declared in any calendar year would exceed the total of (1) such bank’s net profits (as defined and interpreted by regulation) for that year plus (2) its retained net profits (as defined and interpreted by regulation) for the preceding two calendar years, less any required transfers to surplus.
To pay dividends, we and our subsidiary bank must maintain adequate capital above regulatory guidelines. In addition, if the applicable regulatory authority believes that a bank under its jurisdiction is engaged in or is about to engage in an unsafe or unsound practice (which, depending on the financial condition of the bank, could include the payment of dividends), the authority may require, after notice and hearing, that such bank cease and desist from the unsafe practice. The Federal Reserve Board, the FDIC and the OCC have each indicated that paying dividends that deplete a bank’s capital base to an inadequate level would be an unsafe and unsound banking practice. The Federal Reserve, the OCC and the FDIC have issued policy statements that recommend that bank holding companies and insured banks should generally only pay dividends out of current operating earnings.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Management considers interest rate risk to be a significant market risk for the Company. See “Item 7—Management’s Discussion and Analysis of Financial Condition and Results of Operations—Interest Rate Risk” for disclosure regarding this market risk.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Our consolidated financial statements and the report of our independent registered public accounting firm begin on page F-1.
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Quarterly Results of Operations (in thousands, except per share and common stock data):
The following tables set forth certain unaudited historical quarterly financial data for each of the eight consecutive quarters in the fiscal years of 2021 and 2020. This information is derived from unaudited consolidated financial statements that include, in our opinion, all adjustments (consisting of normal recurring adjustments) necessary for a fair presentation when read in conjunction with our consolidated financial statements and notes thereto included elsewhere in this Form 10-K.
(dollars in thousands, except per share amounts)
Summary Income Statement Information:
Net gain on securities transactions 1 1 5 808
Per Share Data:
Common stock sales price:
(dollars in thousands, except per share amounts)
Summary Income Statement Information:
Per Share Data:
Common stock sales price:
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None.
ITEM 9A. CONTROLS AND PROCEDURES
As of December 31, 2021, 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 (as defined in Rule 13a-15(e) or 15d-15(e) 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.
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 were effective at the reasonable assurance level as of December 31, 2021.
Subsequent to our evaluation, there were no significant changes in our internal control over financial reporting or other factors that has materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
MANAGEMENT’S REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING
The management of First Financial Bankshares, Inc. and subsidiaries is responsible for establishing and maintaining adequate internal control over financial reporting. First Financial Bankshares, Inc. and subsidiaries’ internal control system was designed to provide reasonable assurance to the Company’s management and board of directors regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles.
All internal control systems, no matter how well designed, have inherent limitations. Therefore, even those systems determined to be effective can provide only reasonable assurance with respect to financial statement preparation and presentation.
First Financial Bankshares, Inc. and subsidiaries’ management assessed the effectiveness of the Company’s internal control over financial reporting as of December 31, 2021. In making this assessment, it used the criteria for effective internal control over financial reporting set forth by the Committee of Sponsoring Organizations of the Treadway Commission (2013 Framework) (COSO) in Internal Control – Integrated Framework. Based on our assessment we believe that, as of December 31, 2021, the Company’s internal control over financial reporting, as such term is defined in Rule 13a-15(f) of the Securities Exchange Act of 1934, is effective based on those criteria.
Ernst & Young LLP, Dallas, Texas, (U.S. PCAOB Auditor Firm I.D.: 42), the independent registered public accounting firm that audited our consolidated financial statements included in this Annual Report on Form 10-K, has issued an attestation report on the effectiveness of our internal control over financial reporting as of December 31, 2021. The report, which expresses an opinion on the effectiveness of our internal control over financial reporting as of December 31, 2021, is included below.
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Report of Independent Registered Public Accounting Firm
To the Shareholders and the Board of Directors of First Financial Bankshares, Inc.
Opinion on Internal Control over Financial Reporting
We have audited First Financial Bankshares, Inc. and subsidiaries’ internal control over financial reporting as of December 31, 2021, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework) (the COSO criteria). In our opinion, First Financial Bankshares, Inc. and subsidiaries (the Company) maintained, in all material respects, effective internal control over financial reporting as of December 31, 2021, based on the COSO criteria.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the consolidated balance sheets of the Company as of December 31, 2021 and 2020, the related consolidated statements of earnings, comprehensive earnings, shareholders’ equity, and cash flows for each of the three years in the period ended December 31, 2021 and the related notes and our report dated February 22, 2022 expressed an unqualified opinion thereon.
Basis for Opinion
The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting included in the accompanying Management’s Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects.
Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
Definition and Limitations of Internal Control Over Financial Reporting
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
/s/ Ernst & Young LLP
Dallas, Texas
February 22, 2022
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ITEM 9B. OTHER INFORMATION
None.
ITEM 9C. DISCLOSURE REGARDING FOREIGN JURISDICTIONS THAT PREVENT INSPECTIONS
Not applicable.
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PART III
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
The information required by Item 10 is hereby incorporated by reference from our proxy statement for our 2022 Annual Meeting of Shareholders which will be filed with the SEC not later than 120 days after December 31, 2021.
ITEM 11. EXECUTIVE COMPENSATION
The information required by Item 11 is hereby incorporated by reference from our proxy statement for our 2022 Annual Meeting of Shareholders which will be filed with the SEC not later than 120 days after December 31, 2021.
The information required by Item 12 related to security ownership of certain beneficial owners and management is hereby incorporated by reference from our proxy statement for our 2021 annual meeting of shareholders. The following chart gives aggregate information under our equity compensation plans as of December 31, 2021. Additional information regarding stock-based compensation plans is presented in Note 18 – Stock Based Compensation in the notes to consolidated financial statements.
Equity compensation plans not approved by security holders — — —
(1)
Includes 1,669,976 shares related to stock options, 46,598 shares related to non-vested restricted stock, 22,597 share related to restricted stock units and 45,194 shares related to performance stock units (assuming attainment of the maximum payout rate as set forth by the performance criteria).
(2)
Excludes outstanding restricted stock and stock units which are exercised for no consideration.
The remainder of the information required by Item 12 is incorporated by reference from our proxy statement for our 2022 Annual Meeting of Shareholders.
The information required by Item 13 is hereby incorporated by reference from our proxy statement for our 2022 Annual Meeting of Shareholders which will be filed with the SEC not later than 120 days after December 31, 2021.
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
The information required by Item 14 is hereby incorporated by reference from our proxy statement for our 2022 Annual Meeting of Shareholders which will be filed with the SEC not later than 120 days after December 31, 2021.
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PART IV
ITEM 15. EXHIBIT AND FINANCIAL STATEMENT SCHEDULES
(a)
The following documents are filed as part of this report:
(1)
Financial Statements:
Report of Independent Registered Public Accounting Firm F-1
Consolidated Balance Sheets as of December 31, 2021 and 2020 F-3
Notes to Consolidated Financial Statements F-8
(2)
Financial Statement Schedules:
These schedules have been omitted because they are not required, are not applicable or have been included in our consolidated financial statements.
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(3)
Exhibits:
The following exhibits are included or incorporated by reference in this Annual Report on Form 10-K:
4.2 — Description of Registrant’s Securities*
21.1 — Subsidiaries of Registrant.*
23.1 — Consent of Ernst & Young LLP.*
24.1 — Power of Attorney (included on signature page of this Form 10-K).*
101.SCH — Inline XBRL Taxonomy Extension Schema Document.*
101.CAL — Inline XBRL Taxonomy Extension Calculation Linkbase Document.*