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.
15
Table of Contents
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 Board 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 target rate range of zero to 25 basis points throughout the remainder of 2020 and 2021. The Federal Reserve Board began increasing interest rates by raising rates 25 basis points in March 2022, 50 basis points in May 2022, and 75 basis points in June, July, September and November 2022, respectively, 50 basis points in December 2022, and 25 basis points in February, March, May, and July 2023, respectively, resulting in a target rate range of 5.25% to 5.50% at December 31, 2023. Today, there continues to be uncertainty regarding future interest rates. 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.
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 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 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.
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
16
Table of Contents
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. To remediate these risks, often we will obtain a phase 1 and if deemed necessary, a phase 2 inspection report to evaluate potential environmental risks before making loans secured by real property and before considering foreclosing on these assets. 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 reasonable terms 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 downturn in the Texas market, difficult credit markets, depreciation in investment security values, 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.
On March 9, 2023, Silvergate Bank, La Jolla, California, announced its decision to voluntarily liquidate its assets and wind down operations. On March 10, 2023, Silicon Valley Bank, Santa Clara, California, was closed by the California Department of Financial Protection and Innovation (the “DFPI”), on March 12, 2023, Signature Bank, New York, New York, was closed by the New York State Department of Financial Services and on May 1, 2023, First Republic Bank, San Francisco, California, was closed by the DFPI, and in each case the FDIC was appointed receiver for the failed institution. These banks had elevated levels of uninsured deposits, which may be less likely to remain at the bank over time and less stable as a source of funding than insured deposits. These failures led to volatility and declines in the market for bank stocks and questions about depositor confidence in depository institutions.
These events have led to a greater focus by institutions, investors and regulators on the on-balance sheet liquidity of and funding sources for financial institutions, the composition of their deposits, including the amount of uninsured deposits, the amount of accumulated other comprehensive loss, capital levels and interest rate risk management.
If we are unable to adequately manage our liquidity, we may experience a material adverse effect on our financial condition and results of operations. We must maintain sufficient funds to respond to the needs of depositors and borrowers. Deposits have traditionally been our primary source of funds for use in lending and investment activities. We also receive funds from loan repayments, investment maturities and income on other interest-earning assets. While we emphasize the generation of low-cost core deposits as a source of funding, there is strong competition for such deposits in our market area. Additionally, deposit balances can decrease if customers perceive alternative investments as providing a better risk/return tradeoff. Accordingly, as a part of our liquidity management, we must use a number of funding sources in addition to deposits and repayments and maturities of loans and investments, which may include Federal Home Loan Bank of Dallas advances, federal funds purchased and brokered certificates of deposit. Adverse operating results or changes in industry conditions could lead to difficulty or an inability to access these additional funding sources.
Any decline in available funding could adversely impact our ability to originate loans, invest in securities, pay our expenses, or fulfill obligations such as repaying our borrowings or meeting deposit withdrawal demands, any of which could have a material adverse impact on our liquidity, business, financial condition and results of operations.
A lack of liquidity could also attract increased regulatory scrutiny and potential restraints imposed on us by regulators. Depending on the capitalization status and regulatory treatment of depository institutions, including whether an institution is subject to a supervisory prompt corrective action directive, certain additional regulatory restrictions and prohibitions may apply, including restrictions on growth, restrictions on interest rates paid on deposits, restrictions or prohibitions on payment of dividends and restrictions on the acceptance of brokered deposits.
17
Table of Contents
Our financial flexibility would be severely constrained if we were unable to maintain our access to funding or if adequate financing were not available at acceptable interest rates. Further, if we were required to rely more heavily on more expensive funding sources to support liquidity, our revenues may not increase proportionately to cover our increased costs. In this case, our operating margins and profitability would be adversely affected. If alternative funding sources were no longer available to us, we may need to sell a portion of our investment and/or loan portfolio to raise funds, which, depending upon market conditions, could result in us realizing a loss on the sale of such assets. As of December 31, 2023, we had a net unrealized loss of $403.30 million on our available for-sale investment securities portfolio as a result of the rising interest rate environment. Our investment securities totaled $4.73 billion, or 36.11% of total assets, at December 31, 2023. The details of this portfolio are included in Note 2 to the consolidated financial statements.
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 the 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, 2023, we had $314.62 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., the Company may not be able to service debt, if any,
18
Table of Contents
or pay dividends on the Company’s common stock. The inability to receive 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 agreement related to our stock options and restricted stock award, restricted stock unit and performance stock unit grants. 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.
World events such as the Russia-Ukraine conflict, the Israel-Palestine conflict and other world events, including health related events, may adversely impact our business and our financial results, and the ultimate impact will depend on future developments, which are highly uncertain and cannot be predicted.
The Russia-Ukraine conflict, the Israel-Palestine conflict and other world events, including health-related events, are creating extensive disruptions in the global economy and to the lives of individuals throughout the world. While the effects of COVID have reduced, 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. In addition, financial markets and global supply chains may be adversely affected by the current or anticipated impact of military conflict, including the current Russian invasion of Ukraine, the Israel-Palestine conflict, terrorism or other geopolitical events. 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.
19
Table of Contents
Disruptions in our information technology systems or a compromise of security with respect to our systems could adversely affect our operating results by limiting our ability to effectively monitor and control our operations, adjust to changing market conditions, implement strategic initiatives, or support our customer transactions.
We rely on our information technology systems to be able to monitor and control our operations, adjust to changing market conditions, implement strategic initiatives, and support our online banking system. Any disruptions in these systems or the failure of these systems to operate as expected have in the past adversely affected, and could in the future adversely affect, our ability to access and use certain applications and could, depending on the nature and magnitude of the problem, adversely affect our operating results by limiting our ability to effectively monitor and control our operations, adjust to changing market conditions, implement strategic initiatives, and service customers. Although such disruptions and failures have not been material to date, we cannot guarantee that they will not be material in the future. In addition, the security measures we employ to protect our systems have in the past not detected or prevented, and may in the future not detect or prevent, all attempts to hack our systems, denial-of-service attacks, viruses, malicious software (malware), employee error or malfeasance, phishing attacks, security breaches, disruptions during the process of upgrading or replacing computer software or hardware or integrating systems of acquired businesses or assets or other attacks and similar disruptions that may jeopardize the security of information stored in or transmitted by the sites, networks, and systems that we otherwise maintain, which include cloud-based networks and data center storage.
We have, from time to time, experienced threats to and breaches of our data and systems, including malware and computer virus attacks. We are continuously developing and enhancing our controls, processes and practices designed to protect our systems, computers, software, data and networks from attack, damage, or unauthorized access. This continued development and enhancement requires us to expend significant resources. However, we may not anticipate or combat all types of future attacks until after they have been launched. If any of these breaches of security occur or are anticipated in the future, we could be required to expend additional capital and other resources, including costs to deploy additional personnel and protection technologies, train employees and engage third-party experts and consultants. Our response to attacks, and our investments in our technology and our controls, processes, and practices, may not be sufficient to shield us from significant losses or liability. Further, given the increasing sophistication of bad actors and complexity of the techniques used to obtain unauthorized access or disable systems, a breach or attack could potentially persist for an extended period of time before being detected. As a result, we may not be able to anticipate the attack or respond adequately or timely, and the extent of a particular incident, and the steps that we may need to take to investigate the incident, may not be immediately clear. It could take a significant amount of time before an investigation can be completed and full, reliable information about the incident becomes known. During an investigation, it is possible we may not necessarily know the extent of the harm or how to remediate it, which could further adversely impact us, and new regulations could result in us being required to disclose information about a material cybersecurity incident before it has been mitigated or resolved, or even fully investigated. We also face cybersecurity risks due to our reliance on internet technology and hybrid work arrangements, which could strain our technology resources or create additional opportunities for cybercriminals to exploit vulnerabilities.
In addition, because our systems contain information about individuals and businesses, our failure to appropriately maintain the security of the data we hold, whether as a result of our own error or the malfeasance or errors could lead to unauthorized release of confidential or otherwise protected information or corruption of data. Our failure to appropriately maintain the security of the data we hold could also violate applicable privacy, data security and other laws and subject us to lawsuits, fines, and other means of regulatory enforcement.
Any compromise or breach of our systems could result in adverse publicity, harm our reputation, lead to claims against us and affect our relationships with our customers and employees, any of which could have a material adverse effect on our business. Although we maintain insurance coverage for various cybersecurity risks, there can be no guarantee that all costs or losses incurred will be fully insured.
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 on 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.
20
Table of Contents
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 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, 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.
21
Table of Contents
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:
•
existing clients may withdraw funds from our wealth management business in favor of better performing products;
•
asset-based management fees could decline from a decrease in assets under management;
•
our ability to attract funds from existing and new clients might diminish; and
•
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 15% of trust fees came from management of oil and gas properties in 2023, 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 or investigations, 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.
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:
•
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;
•
the supply of and demand for investable funds;
•
demand for loans and access to credit;
•
interest rates; and
•
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 have an adverse affect on 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 2.79%, of total loans HFI as of December 31, 2023, 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,
22
Table of Contents
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 15% and 18% of total trust revenues in 2023 and 2022, 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 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 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. We may experience operational challenges in connection with the adoption of, or failure to adopt, new technology, such as artificial intelligence, which could result in unintended consequences or expenses as a result of the technology's limitations, our failure to use new technology effectively or at all, not fully realizing the anticipated benefits from such new technology, or the cost to implement or remedy any challenges associated with the adoption of new technology in a timely manner. 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.
23
Table of Contents
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.
Inflationary pressures and rising prices may affect our results of operations and financial conditions.
Inflation rose in 2022 at levels not seen for over 40 years, and such inflationary pressures continued into 2023. Inflation could lead to increased costs to our customers, making it more difficult for them to repay their loans or other obligations increasing our credit risk. In general, the impact of inflation on the banking industry differs significantly from that of other industries in which a large portion of total resources are invested in fixed assets such as property, plant and equipment. Assets and liabilities of financial institutions are primarily all monetary in nature, and therefore are principally impacted by interest rates rather than changing prices. While the general level of inflation underlies most interest rates, interest rates react more to changes in the expected rate of inflation and to changes in monetary and fiscal policy.
Sustained higher interest rates by the Federal Reserve Board may be needed to tame persistent inflationary price pressures, which could depress asset prices and weaken economic activity. A deterioration in economic conditions in the United States and our markets could result in an increase in loan delinquencies and non-performing assets, decreases in loan collateral values and a decrease in demand for our products and services, all of which, in turn, would adversely affect our business, financial condition and results of operations.
Our financial instruments expose us to certain market risks and may increase the volatility of earnings and AOCI.
We hold certain financial instruments measured at fair value. For those financial instruments measured at fair value, we are required to recognize the changes in the fair value of such instruments in earnings or accumulated other comprehensive income ("AOCI") each quarter. Therefore, any increases or decreases in the fair value of these financial instruments have a corresponding impact on reported earnings or AOCI. Fair value can be affected by a variety of factors, many of which are beyond our control, including our credit position, interest rate volatility, capital markets volatility, and other economic factors. Accordingly, we are subject to mark-to-market risk and the application of fair value accounting may cause our earnings and AOCI to be more volatile than would be suggested by our underlying performance.
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 Board. 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. 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.
Climate change, and related legislative and regulatory initiatives, have the potential to disrupt our business and adversely impact the operations and creditworthiness of our customers.
Climate change may lead to more frequent and more extreme weather events, such as prolonged droughts or flooding, hurricanes, wildfires and extreme seasonal weather, which could disrupt operations at one or more of our locations and our ability to provide financial products and services to our customers. Such events could also have a negative effect on the financial status and creditworthiness of our customers, which may decrease revenues and business activities from those customers and increase the credit risk associated with loans and other credit exposures to such customers. In addition, weather disasters, shifts in local climates and other disruptions related to climate change may adversely affect the value of real properties securing our loans, which could diminish the value of our loan portfolio. Such events may also cause reductions in regional and local economic activity that may have an adverse effect on our customers, which could limit our ability to raise and invest capital in these areas and communities, each of which could have a material effect on our financial conditions and results of operations.
Political and social attention to the issue of climate change has increased. The federal and state legislatures and regulatory agencies have proposed legislative and regulatory initiatives seeking to mitigate the effects of climate change. These agreements and measures may result in the imposition of taxes and fees, the required purchase of emission credits, and the implementation of significant operational changes. In addition, the federal banking agencies may address climate-related issues in their agendas in various ways, including by increasing supervisory expectations with respect to banks' risk management practices, accounting for the effects of climate change in stress testing scenarios and systemic risk assessments, revising expectations for credit portfolio concentrations based on climate-related factors, and encouraging investment by banks in
24
Table of Contents
climate-related initiatives and lending to communities disproportionately impacted by the effects of climate change. We may incur compliance, operating, maintenance and remediation costs.
Increasing scrutiny and evolving expectations from customers, regulators, investors, and other stakeholders with respect to our environmental, social and governance practices may impose additional costs on us or expose us to new or additional risks.
Companies are facing increasing scrutiny from customers, regulators, investors, and other stakeholders related to their environmental, social and governance ("ESG") practices and disclosure. Investor advocacy groups, investment funds and influential investors are also increasingly focused on these practices, especially as they relate to the environmental, health and safety, diversity, labor conditions and human risks. Increased ESG related compliance costs could result in increases to our overall operational costs. Failure to adapt to or comply with regulatory requirements or investor or stakeholder expectations and standards could negatively impact our reputation, ability to do business with certain partners, and our stock price. New government regulations could also result in new or more stringent forms of ESG oversight and expanding mandatory and voluntary reporting, diligence, and disclosure.
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 non-bank 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 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 ("AFS") 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, 2023, 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 legislative and regulatory developments to address perceived unfairness and abuses under current regulations. Regulatory enforcement and fines
25
Table of Contents
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 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 direct and indirect negative consequence sanctions, including the required payment of damages and civil money penalties, injunctive relief, 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. Such actions, or even the threat of such actions, could have a material adverse effect on the Company's business, financial condition or results of operations.
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.
We are subject to heightened regulatory requirements as our total assets exceed $10 billion.
Our total assets were approximately $13.11 billion as of December 31, 2023. The Dodd-Frank Act and its associated regulations impose various additional requirements on banks and bank holding companies with $10 billion or more in total assets, including a more frequent and enhanced regulatory examination regime. In addition, banks with $10 billion or more in total assets (including our bank) are primarily examined by the CFPB with respect to various federal consumer financial protection laws and regulations, with the Federal Reserve Board maintaining supervision over some consumer related regulations. In light of evolving priorities among government and agency leaders, there is some uncertainty as to how the CFPB examination and regulatory authorities might impact our business in the near and medium terms.
Debit card interchange fee restrictions set forth in the Dodd-Frank Act, which is known as the Durbin Amendment, as implemented by regulations of the Federal Reserve Board, cap the maximum debit interchange fee that a debit card issuer with $10 billion or more in total assets may receive per transaction at the sum of $0.21 plus five basis points of the transaction. A debit card issuer that adopts certain fraud prevention procedures may charge an additional $0.01 per transaction. In July 2022, the Company became subject to the Durbin Amendment which reduced our interchange income per transaction in 2022 and going forward.
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. 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
26
Table of Contents
imposed. These increased premiums would have an adverse effect on our net income and results of operations. In the fourth quarter of 2023, the FDIC imposed a $1.75 million special assessment on the Bank in response to the FDIC-insured financial institutions that failed in March 2023.
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.
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 56% 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.
27
Table of Contents
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;
•
governmental investigations of the Company or administrative actions imposed by bank regulatory agencies;
•
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.
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.
ITEM 1B. UNRESOLVED STAFF COMMENTS
None.
28
Table of Contents
ITEM 1C. CYBERSECURITY
Risk Management and Strategy
The Company’s Information Security Program (“Program”) uses a variety of safeguards to protect the confidentiality, integrity, and availability of information. The Program is designed to identify, prevent, or mitigate the risks from cybersecurity threats. The Program leverages recognized security frameworks, such as National Institute of Standards and Technology (NIST) and Federal Financial Institutions Examination Council (FFEIC), to organize, improve, and assess the program and to better manage and reduce cybersecurity risk. The Program is assessed and updated annually and as needed.
The Program is integrated into the Company’s enterprise risk management program. The Company regularly assesses the threats and vulnerabilities to its environment so it can update and maintain its systems and controls to effectively mitigate these risks. Layered security controls are designed to complement each other to protect customer information and transactions. The Company periodically engages third-party experts and consultants to conduct evaluations of our security controls, whether through penetration testing, audits, assessments, or consulting on best practices to address new challenges. Results are used to help drive priorities and initiatives to improve the Program. Additionally, as a regulated entity, bank regulators assess the quality of our information security program during their regular examinations of the Company and its compliance with federal regulations and requirements.
The Company’s third-party risk management program is designed to oversee and identify the cybersecurity threats associated with the use of third-party service providers. While the optics into a third-party’s operation are limited, the Company performs risk-based evaluations of third-party service providers. These evaluations including reviewing information including, but not limited to, security assessment questionnaires, security testing summaries, audit reports performed under the SSAE 18 Audit Standard, and information security policies.
We view security awareness as a continuous program. All Company employees receive cybersecurity and fraud training at required new employee orientation and subsequently receive information security tips via email each business day. Employees also receive monthly security awareness video training and are required to complete annual computer-based training. The Company also provides information security awareness training to business customers and individuals in our communities.
During the fiscal year of this Report, the Company has not identified risks from cybersecurity threats that individually or in the aggregate have materially affected or are reasonably anticipated to materially affect the organization. Nevertheless, the Company recognizes cybersecurity threats are ongoing and evolving, and we continue to remain vigilant.
Governance
The Company’s system of internal controls also incorporates a protocol for the appropriate reporting and escalation of information and cyber security matters to management and the Board of Directors for resolution and, if necessary, disclosure of any material incidents. The Board of Directors is actively engaged in the oversight of the Company’s continuous efforts to reinforce and enhance its operational resilience and receives education to enhance their oversight efforts accommodate for the ever-evolving information and cyber security threat landscape. The Chief Information Security Officer (“CISO”) regularly updates these committees on the information and cyber security risks, threats, exposures, and mitigation measures. The Company’s incident response process is periodically tested and includes cybersecurity scenarios.
The Program is included in the Company’s enterprise risk management program. The CISO is responsible for developing and implementing our Program and reporting on cybersecurity matters to the Board. Our CISO has over 20 years of related experience, and others on our Corporate Information Security team have cybersecurity experience or certifications, such as the Certified Information Systems Security Professional certification. We view cybersecurity as a shared responsibility, and we periodically perform simulations and tabletop exercises at a management level and incorporate external resources and advisors as needed.
The Program is overseen by the Company’s Risk Committee, First Technology Services Board of Directors, Technology Risk Committee, and Security Advisory Committee. Additionally, the First Financial Trust and Asset Management Board of Directors oversee the Program as it relates to the trust subsidiary. Operational committees that manage risks associated with cybersecurity are Change Control Committee and Patch Management Committee.
The Company’s Board of Directors and subsidiary technology and trust companies’ Boards of Directors monitor the Program including policies and practices. The Company’s Risk Committee and technology company’s Board of Directors oversees areas of operational risk such as information technology activities; risks associated with development, infrastructure, and cybersecurity; oversight of information security risk assessments, strategies, policies, and programs; and disaster recovery, business continuity, and incident response process. The CISO also provides periodic cybersecurity updates to the Audit Committee and the Audit Committee Chairman is member of the Risk Committee. The management-level Technology Risk Committee and Security Advisory Committee oversee management of the Program and related assessments. Operational committees that manage risks associated with cybersecurity are Change Control Committee and Patch Management Committee.
29
Table of Contents
We face a number of cybersecurity risks in connection with our business. Although such risks have not materially affected us, including our business strategy, results of operations or financial condition, to date, we have, from time to time, experienced threats to and breaches of our data and systems, including malware and computer virus attacks. For more information about the cybersecurity risks we face, see the risk factor entitled “Disruptions in our information technology systems or a compromise of security with respect to our systems could adversely affect our operating results by limiting our ability to effectively monitor and control our operations, adjust to changing market conditions, implement strategic initiatives or support our customer transactions” and “Our business may be adversely affected by security breaches at third-parties.” in Item 1A- Risk Factors.
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, 2023, our subsidiaries
collectively own 78 banking, trust and mortgage facilities, some of which are detached drive-ins, and also lease 12 banking facilities and 12 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 a new branch location in our existing market in Bryan, Texas.
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 material proceedings pending or known to be contemplated by any governmental authorities.
ITEM 4. MINE SAFETY DISCLOSURES
Not applicable.
30
Table of Contents
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, 2024, we had 874 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”.
31
Table of Contents
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, 2018 to December 31, 2023). The performance graph assumes $100 invested in our common stock at its closing price on December 31, 2018, and in each of the Russell 3000 Index and the S&P U.S. BMI Banks 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
© 2024
32
Table of Contents
ITEM 6. [RESERVED]
33
Table of Contents
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 and fees on deposit accounts. 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, 2023 and 2022, and consolidated statements of earnings for the years 2021 through 2023 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.
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. On July 25, 2023, the Company's Board of Directors renewed the prior authorization through July 31, 2024.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. Under the prior authorization, 244,559 shares were repurchased and retired (all during the months of June and July 2022) at an average price of $38.61 per share. Under the current authorization, the Company has repurchased and retired 101,337 shares (all during September 2023) at an average price of $26.99 per share.
Other Recently Issued and Effective Authoritative Accounting Guidance
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. ASU 2020-04 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
34
Table of Contents
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.
ASU 2022-02, "Financial Instruments - Credit Losses (Topic 326): Troubled Debt Restructurings and Vintage Disclosures." ASU 2022-02 eliminates the accounting guidance for troubled debt restructurings in ASC Subtopic 310-40, Receivables - Troubled Debt Restructurings by Creditors, while enhancing disclosure requirements for certain loan refinancing and restructurings by creditors when a borrower is experiencing financial difficulty. ASU 2022-02 will also require that an entity disclosure current-period gross charge-offs by year of origination for financial receivables and net investment leases within scope of ASC Subtopic 326-20, Financial Instruments - Credit Losses - Measured at Amortized Cost. ASU 2022-02 will become effected for fiscal years beginning after December 15, 2022, including interim periods within those fiscal years, though early adoption is permitted. The adoption of ASU 2022-02 is not expected to have a significant impact on our financial statements.
ASU 2022-06, "Reference Rate Reform (Topic 848): Deferral of the Sunset Date of Topic 848." ASU 2022-06 extends the period of time preparers can utilize the reference rate reform relief guidance provided by ASU 2020-04 and ASU 2021-01, which are discussed above. ASU 2022-06, which was effective upon issuance, defers the sunset date of this prior guidance from December 31, 2022 to December 31, 2024, after which entities will no longer be permitted to apply the relief guidance in Topic 848. The adoption of ASU 2022-06 did not have a significant impact on our financial statements.
ASU 2023-02, "Investments - Equity Method and Joint Ventures (Topic 323): Accounting for Investments in Tax Credit Structures Using the Proportional Amortization Method." ASU 2023-02 is intended to improve the accounting and disclosures for investments in tax credit structures. ASU 2023-02 allows entities to elect to account for qualifying tax equity investments using the proportional amortization method, regardless of the program giving rise to the related income tax credits. Previously, this method was only available for qualifying tax equity investments in low-income housing tax credit structures. ASU 2023-02 has been early adopted by the Company as it relates to the qualifying investments that are generating New Market Tax Credits. The adoption of ASU 2023-02 did not have a significant impact on our financial statements.
ASU 2023-09, “Income Taxes (Topic 740): Improvements to Income Tax Disclosures.” ASU 2023-09 requires entities to disclose more detailed information in their reconciliation of their statutory tax rate to their effective tax rate. Public business entities (PBEs) are required to provide this incremental detail in a numerical, tabular format. The ASU also requires entities to disclose more detailed information about income taxes paid, including by jurisdiction; pretax income (or loss) from continuing operations; and income tax expense (or benefit). PBEs will be required to adopt the new requirements in annual reporting periods beginning after December 15, 2024, and interim periods beginning after December 15, 2025.The adoption of ASU 2023-09 is not expected to have a significant impact on our financial statements.
35
Table of Contents
Selected Financial Data
The selected financial data presented below as of and for the years ended December 31, 2023, 2022, 2021, 2020, and 2019, 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 an acquisition in 2020 and changes in accounting, including the allowance for credit losses in 2020 (see Notes 1 and 3 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.
36
Table of Contents
Results of Operations
Performance Summary. Net earnings for 2023 were $198.98 million compared to net earnings of $234.48 million for 2022. Included in earnings for the year ended December 31, 2023, when compared to the year ended December 31, 2022, were (i) a decrease of $17.61 million in net interest income, (ii) a decrease in debit card revenues of $8.56 million, (iii) a decrease in mortgage revenues of $7.15 million, (iv) a $9.26 million decline in gains on sales of securities, and (v) an increase of $4.04 million in FDIC insurance premiums, which includes a $1.75 million special assessment. Offsetting these reductions to earnings were (i) a decline of $6.80 million in the provision for credit losses and (ii) a decline of $5.30 million in incentive and profit sharing expenses.
Net earnings for 2022 were $234.48 million compared to $227.56 million for 2021. The increase in net earnings for 2022 over 2021 was primarily attributable to the overall growth in net interest income from the growth in earning assets. Net earnings in 2022 also include a provision for credit losses of $17.43 million compared to a net reversal of provision for credit losses of $1.14 million in 2021. The increased provision for credit losses in 2022 over 2021 was driven by strong organic loan growth, increases in unfunded commitments and a slight decline in the projected economic forecast metrics post pandemic highs.
On a diluted net earnings per share basis, net earnings were $1.39 for 2023, as compared to $1.64 for 2022 and $1.59 for 2021. The return on average assets was 1.55% for 2023, as compared to 1.76% for 2022 and 1.89% for 2021. The return on average equity was 14.99% for 2023, as compared to 16.72% for 2022 and to 13.31% for 2021.
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 $395.36 million in 2023, as compared to $416.84 million in 2022, and $385.05 million in 2021. Average earning assets were $12.00 billion in 2023, as compared to $12.46 billion in 2022 and $11.34 billion in 2021. The decrease in tax-equivalent net interest income in 2023 compared to 2022 was largely attributable to the increases in the rates paid on deposits and borrowings and a change in the mix of interest earning assets. The decrease of $461.72 million in average earning assets in 2023 when compared to 2022 was primarily a result of a decrease in taxable securities of $531.39 million and tax-exempt securities of $689.37 million offset by an increase in loans of $860.76 million when compared to 2022. The increase in tax-equivalent net interest income in 2022 compared to 2021 was largely attributable to increases in interest earning assets. The increase of $1.13 billion in average earning assets in 2022 when compared to 2021 was primarily a result of increases in taxable securities of $1.13 billion and loans of $582.26 million offset by a decrease in short-term investments of $372.77 million and tax-exempt securities of $216.64 million when compared to 2021. Average interest-bearing liabilities were $7.84 billion in 2023, as compared to $7.76 billion in 2022 and $6.78 billion in 2021. The yield on earning assets increased 90 basis points in 2023 when compared to 2022 while the rate paid on interest-bearing liabilities increased 143 basis points. The yield on earning assets increased 15 basis points in 2022 when compared to 2021 while the rate paid on interest-bearing liabilities increased 32 basis points.
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.
37
Table of Contents
The net interest margin for 2023 was 3.29% which was a decrease of five basis points from 2022. The net interest margin in 2022 was 3.34%, a decrease of six basis points from 2021. We experienced downward pressure on our net interest margin the majority of 2023 compared to 2022 primarily due to (i) the effects of the Federal Reserve Board's accelerated rate of raising interest rates in 2022 and 2023, which was preceded by the extended period of historically low levels of short-term interest rates leading up to the first quarter of 2022, and (ii) the shift in the mix of interest-earning assets and interest-bearing deposits. The Federal Reserve Board began increasing interest rates by raising rates 25 basis points in March 2022, 50 basis points in May 2022, and 75 basis points in June, July, September and November 2022, respectively, 50 basis points in December 2022, and 25 basis points in February, March, May, and July 2023, respectively, resulting in a target rate range of 5.25% to 5.50% at December 31, 2023.
Loan rates on variable loans have increased as the majority of such loans are indexed to the applicable prime rate (8.50% at December 31, 2023), subject to underlying floors. With the latest increase in the federal funds rate, the majority of variable rate loans have increased (see additional discussion beginning on page 43).
During 2022, we increased rates on each of the primary depository products in response to the increasing federal funds rate. Additionally, we have approximately $985 million of municipal and related deposits which are indexed to short-term treasury rates which have continued to increase with the changes in the applicable rate index. Average municipal and related deposits totaled $1.46 billion and $1.48 billion for the years ended December 31, 2023 and 2022, respectively, with an average rate paid of 3.13% and 1.01%, for the respective years then ended.
38
Table of Contents
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 2021 through 2023.
Average Balances and Average Yields and Rates (in thousands, except percentages):
Assets
Liabilities and Shareholders’ Equity
Rate Analysis:
Interest income/earning assets 4.50 % 3.60 % 3.45 %
Interest expense/earning assets (1.21 ) (0.26 ) (0.05 )
(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 AFS securities.
(3)
Includes tax-equivalent yield adjustment of approximately $11.55 million, $15.42 million and $14.69 million for the years ended December 31, 2023, 2022 and 2021, respectively, using an effective tax rate of 21%.
(4)
Includes nonaccrual loans.
(5)
Calculations for 2023 and 2022 have been adjusted to remove the effect of TEFRA allowance
Noninterest Income. Noninterest income for 2023 was $108.00 million compared to $131.67 million in 2022. Changes in certain categories of noninterest income included (1) a decline in gains on sales of AFS securities of $9.26 million, (2) a decrease in debit card fees of $8.56 million, and (3) a decrease in gain on sale and fees of mortgage loans of $7.15 million when compared to 2022. Available for sale securities totaling $411.13 million with an average book yield of 2.91% were sold during 2023. The proceeds from the sales of these securities are being used to fund organic loan growth that is yielding approximately 8%, resulting in an anticipated earn back period of less than 18 months. The decrease in debit card fees was due to the impact of becoming subject to regulations imposed by the Federal Reserve Board that limits debit card interchange revenue which became effective for the Company as of July 1, 2022, and is consistent with our previously disclosed expectations. Mortgage income declined due to lower overall origination volumes and declining margins on loan sales as a result of the increases in mortgage interest rates during the year.
39
Table of Contents
Noninterest income for 2022 was $131.67 million, a decrease of $10.51 million, or 7.39%, as compared to 2021. Changes in certain categories of noninterest income included (1) an increase in trust fees of $3.85 million, (2) an increase in service charges on deposit accounts of $3.38 million, (3) an increase in the net gain on sale of AFS securities of $1.33 million, offset by (4) a decrease in gain on sale and fees of mortgage loans of $14.21 million, and (5) a decrease in debit card fees of $5.63 million. 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 fees 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 $8.75 billion at December 31, 2022. Oil and gas production fees increased related trust fees by $2.77 million in 2022 over 2021. The increase in service charges on deposits was driven by more than 10,500 net new accounts opened in 2022 and growth in treasury management services. Mortgage income declined due to lower overall origination volumes and declining margins on loan sales as a result of the increase in interest rates. The decrease in debit card fees was due to the impact of becoming subject to regulations imposed by the Federal Reserve Board that limits debit card interchange revenue which became effective for the Company as of July 1, 2022, and is consistent with our previously disclosed expectation.
Debit card fees are charges that merchants pay to us and other card-issuing banks for processing electronic payment transactions. Debit card fees consist of income from debit card usage, point of sale income for debit card transactions and ATM service fees.
Federal Reserve Board 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. Based on the applicable Federal Reserve Board rules, as amended, the Company became subject to the limitation effective July 1, 2022, which reduced debit card fees during 2023 compared to 2022, as discussed above.
Noninterest Income (in thousands):
Other:
Noninterest Expense. Total noninterest expense for 2023 amounted to $237.88 million, an increase of $3.10 million, or 1.32%, as compared to 2022. Total noninterest expense for 2022 was $234.78 million, a decrease of $6.93 million, or 2.87%, as compared to 2021. 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 2023 was 47.26%, as compared to 42.80% for 2022 and 45.84% for 2021.
Salaries and employee benefits for 2023 totaled $131.92 million, a decrease of $2.22 million, or 1.65%, as compared to 2022. The net decrease reflected a decrease of $2.86 million in profit sharing expenses and lower mortgage compensation expenses of $2.40 million offset by annual merit-based and other market-based pay increases that were effective March 1, 2023.
All other categories of noninterest expense for 2023 totaled $105.97 million, an increase of $5.32 million, or 5.29%, as compared to 2022. Included in noninterest expense during 2023, excluding salary and employee benefit related costs, were increases in FDIC insurance premiums of $4.04 million primarily due to the recognition of $1.75 million related to the special assessment in the fourth quarter of 2023.
40
Table of Contents
Salaries and employee benefits for 2022 totaled $134.13 million, a decrease of $7.91 million, or 5.57%, as compared to 2021. The change reflected a decrease of $5.90 million in profit sharing expenses and lower mortgage compensation expenses of $4.94 million offset by annual merit-based and other market-based pay increases that were effective March 1, 2022.
All other categories of noninterest expense for 2022 totaled $100.65 million, an increase of $979 thousand, or 0.98%, as compared to 2021. Included in noninterest expense during 2022, excluding salary and employee benefit related costs, during 2022 were decreases of $1.16 million in software amortization and expense offset by increases in FDIC insurance premiums of $851 thousand due to the increase in the average assets with tangible equity and loan related fees within other miscellaneous expense of $745 thousand due to the increase in the loan portfolio during 2022.
Noninterest Expense (in thousands):
Other:
Income Taxes. Income tax expense was $44.32 million for 2023, as compared to $46.40 million for 2022 and $44.41 million for 2021. Our effective tax rates on pretax income were 18.22%, 16.52% and 16.33%, respectively, for the years 2023, 2022 and 2021. The effective tax rates differ from the statutory federal tax rate of 21.0% largely due to tax exempt interest income earned on certain investment securities and loans, the deductibility of dividends paid to our employee stock ownership plan, excess tax benefits for distribution under our deferred compensation plan and vesting of equity awards, and New Market Tax Credit ("NMTC") benefits.
41
Table of Contents
Balance Sheet Review
Loans. Our portfolio is comprised of loans made to businesses, professionals, individuals, and farm and ranch operations located in the primary trade areas served by our subsidiary bank. As of December 31, 2023, total loans HFI were $7.15 billion, an increase of $706.92 million as compared to December 31, 2022.
As compared to year-end 2022 balances, total commercial loans increased $241.25 million, agricultural loans increased $7.94 million, total real estate loans increased $479.96 million, and total consumer loans decreased $22.23 million. Loans averaged $6.78 billion during 2023, an increase of $860 million over 2022 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 HFI 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 HFS, consisting of secondary market mortgage loans, totaled $14.25 million and $11.97 million at December 31, 2023 and 2022, respectively. At December 31, 2023 and 2022, $3.18 million and $1.47 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.
42
Table of Contents
Agricultural loans are subject to underwriting standards and processes similar to commercial loans. These agricultural loans are based primarily on the identified cash flows of the borrower and, secondarily, on the underlying collateral provided by the borrower. Most agricultural loans are secured by the agriculture related assets being financed, such as farm land, cattle or equipment, and include personal guarantees.
Real estate loans are also subject to underwriting standards and processes similar to commercial and agricultural loans. These loans are underwritten primarily based on projected cash flows and, secondarily, as loans secured by real estate. The repayment of real estate loans is generally largely dependent on the successful operation of the property securing the loans or the business conducted on the property securing the loan. Real estate loans may be more adversely affected by conditions in the real estate markets or in the general economy. The properties securing the Company’s real estate portfolio are generally diverse in terms of type and geographic location within Texas. This diversity helps reduce the exposure to adverse economic events that affect any single market or industry.
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, 2023 (in thousands):
The following tables summarize maturity information of our loan portfolio as of December 31, 2023. 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:
43
Table of Contents
Commercial:
Real Estate:
Consumer:
Commercial:
Real Estate:
Consumer:
Of the $4.17 billion of the variable interest rate loans shown above, loans totaling $1.66 billion mature or reprice over the next twelve months. Of this amount, approximately $1.37 billion will reprice immediately upon changes in the underlying index rate (primarily U.S. prime rate) with the remaining $287 million being subject to floors above or ceilings below 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 $35.10 million at December 31, 2023, as compared to $24.33 million at December 31, 2022 and $34.16 million at December 31, 2021. As a percent of loans HFI and foreclosed assets, these assets were 0.49% at December 31, 2023, as compared to 0.38% at December 31, 2022 and 0.63% at December 31, 2021. As a percent of total assets, these assets were 0.27% at December 31, 2023, as compared to 0.19% at December 31, 2022 and 0.26% at December 31, 2021. 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, 2023.
44
Table of Contents
Nonaccrual, Past Due 90 Days or More and Still Accruing, Restructured Loans and Foreclosed Assets (in thousands, except percentages):
At December 31,
Loans still accruing and past due 90 days or more 1,004 — 8 113 153
(1) With the adoption of ASU 2022-02, effective January 1, 2023, TDR accounting has been eliminated.
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, 2023 of approximately $913 thousand during the year ended December 31, 2023. If interest on these loans had been recognized on a full accrual basis during the year ended December 31, 2023, such income would have approximated $3.22 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 $5.46 million as of December 31, 2023.
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 $10.63 million in 2023, a provision of $17.43 million in 2022, as compared to a reversal of provision of $1.14 million in 2021. The Company's provision for credit losses during 2023 was driven by strong organic loan growth offset by a decrease in construction and development unfunded commitments. The increase in the Company's provision for credit losses during 2022 was driven by strong organic loan growth, increases in unfunded commitments and a slight decline in the projected economic forecast metrics. The net reversal of the Company's provision for credit losses in 2021 reflected improvement in the economic outlook for our markets across Texas and overall improvements in asset quality offset by loan growth.
As a percent of average loans, net loan charge-offs were 0.03% during 2023, net recoveries of 0.01% during 2022, and net loan charge-offs of 0.02% during 2021. The allowance for credit losses as a percent of loans HFI was 1.24% as of December 31, 2023, as compared to 1.18% as of December 31, 2022, and 1.18% as of December 31, 2021. 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, 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.
45
Table of Contents
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
Real estate:
Construction & Development — (100 ) — — N/A
Farm — — — — N/A
Non-Owner Occupied CRE — — (6 ) (563 ) N/A
Consumer:
Recoveries:
Commercial:
Municipal — — — — N/A
Real estate:
Construction & Development 106 — 1 — N/A
Consumer:
Net (recoveries) charge-offs/average loans 0.03 % (0.01 )% 0.02 % 0.06 % 0.04 %
46
Table of Contents
Allocation of Allowance for Credit Losses (in thousands):
At December 31,
Commercial:
Real estate:
Consumer:
Percent of Loans in Each Category of Total Loans:
At December 31,
Commercial:
Real estate:
Consumer:
Interest-Bearing Demand Deposits in Banks. The Company had interest-bearing demand deposits in banks of $255.24 million at December 31, 2023 and $37.39 million at December 31, 2022, respectively. At December 31, 2023, our interest-bearing deposits in banks included $248.24 million maintained at the Federal Reserve Bank of Dallas and $7.00 million on deposit with the Federal Home Loan Bank of Dallas (FHLB). The average balance of interest-bearing deposits in banks was $115.79 million, $217.53 million and $590.84 million in 2023, 2022 and 2021, respectively. The average yield on interest-bearing deposits in banks was 5.09%, 1.67% and 0.12% in 2023, 2022 and 2021, respectively.
47
Table of Contents
Available-for-Sale Securities. At December 31, 2023, securities with a fair value of $4.73 billion were classified as securities AFS. There were no securities classified as held-to-maturity at December 31, 2023 and 2022. As compared to December 31, 2022, the AFS portfolio at December 31, 2023, reflected (1) a decrease of $315 thousand in U.S. Treasury securities; (2) a decrease of $401.45 million in obligations of states and political subdivisions; (3) an increase of $3.19 million in corporate bonds and other securities; and (4) a decrease of $343.02 million in mortgage-backed securities. As compared to December 31, 2021, the AFS portfolio at December 31, 2022, reflected (1) an increase of $355.71 million in U.S. Treasury securities; (2) a decrease of $854.86 million in obligations of states and political subdivisions; (3) an increase of $33.47 million in corporate bonds and other securities; and (4) a decrease of $633.13 million in mortgage-backed securities. Securities-AFS included an unrealized loss fair value adjustment of $510.92 million and $677.99 million at December 31, 2023 and 2022, respectively, and an unrealized gain fair value adjustments of $125.67 million at December 31, 2021. 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, 2023 and 2022.
Maturities and Yields of Available-for-Sale Held at December 31, 2023 (in thousands, except percentages):
Maturing
All yields are computed on a tax-equivalent basis assuming a marginal tax rate of 21%. Yields on AFS 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, 2023, the investment portfolio had an overall tax equivalent yield of 2.23%, a weighted average life of 6.07 years and modified duration of 5.30 years. At December 31, 2022, the investment portfolio had an overall tax equivalent yield of 2.31%, a weighted average life of 7.76 years and modified duration of 6.33 years.
Deposits. Deposits held by our subsidiary bank represent our primary source of funding. Total deposits were $11.14 billion as of December 31, 2023, as compared to $11.01 billion as of December 31, 2022 and $10.57 billion as of December 31, 2021. 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
48
Table of Contents
The table below outlines the maturity of time deposits of $250,000 or more (in thousands):
Over three through six months 52,165
Over six through twelve months 127,718
The estimated amount of uninsured and uncollateralized deposits including related interest accrued and unpaid is approximately $5.38 billion as of December 31, 2023.
Borrowings. Included in borrowings were federal funds purchased, securities sold under repurchase agreements, advances from the FHLB and other borrowings of $404.08 million, $642.51 million and $671.15 million at December 31, 2023, 2022 and 2021, 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 securities sold under repurchase agreements were $568.21 million, $674.23 million and $535.07 million in 2023, 2022 and 2021, respectively. The average rates paid on securities sold under repurchase agreements were 2.84%, 0.31% and 0.06% for the years ended December 31, 2023, 2022 and 2021, respectively. The average balances of federal funds purchased and advances from the FHLB were $81.26 million, $127.87 million, and $21.54 million in 2023, 2022 and 2021, respectively. The average rates paid on federal funds purchased and advances from the FHLB were 4.05%, 2.45% and 0.05% for the years ended December 31, 2023, 2022 and 2021, respectively. The weighted average interest rate on federal funds purchased, securities sold under repurchase agreements and advances from the FHLB was 3.27%, 1.96% and 0.06% at December 31, 2023, 2022 and 2021, respectively. The highest amount of federal funds purchased, securities sold under repurchase agreements and advances from the FHLB at any month-end during 2023, 2022 and 2021 was $822.98 million, $1.04 billion and $674.88 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,
49
Table of Contents
The results for the net interest income simulations as of December 31, 2023 and December 31, 2022 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 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.
The fair value of our investment securities classified as available-for-sale totaled $4.73 billion at December 31, 2023. During the year ended December 31, 2023, the corresponding unrealized loss before taxes on the portfolio of $677.99 million at December 31, 2022, changed to an unrealized loss before taxes of $510.92 million at December 31, 2023, which is recorded net of taxes in accumulated other comprehensive earnings (loss) in shareholders' equity. The unrealized gains or losses, net of taxes, on the portfolio are excluded from the calculation of all regulatory capital ratios. The changes in the fair value were driven by sales of securities and changes in interest rates based on expected actions by the Federal Reserve Board and other market conditions. The overall valuation of the portfolio is most correlated to the 5-year U.S. Treasury rates based on the composition and duration of the portfolio. At December 31, 2023, the 5-year U.S. Treasury rate was 3.84% compared to 4.01% at December 31, 2022, representing a 17 basis point decrease during the year. As of December 31, 2023, an increase of 100 basis points in the 5-year U.S. Treasury rate would result in an increase to unrealized losses by approximately $225 million before taxes, while a 100 basis point decrease in the same rate would result in a decrease to unrealized losses by approximately $198 million before taxes. We believe that we have the ability to hold these securities based on our overall liquidity and intent to hold the portfolio.
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 $1.50 billion, or 11.44% of total assets at December 31, 2023, as compared to $1.27 billion, or 9.76% of total assets at December 31, 2022. Included in shareholders’ equity were $403.30 million and $535.23 million at December 31, 2023 and 2022, respectively, in unrealized losses on investment securities AFS, net of related income taxes. Unrealized gains and losses on investment securities AFS are excluded from and do not impact regulatory capital. During 2023, total shareholders’ equity averaged $1.33 billion, or 10.32% of average assets, as compared to $1.40 billion, or 10.55% of average assets during 2022.
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, 2023 and 2022, we had a total risk-based capital ratio of 19.62% and 19.29%, a Tier 1 capital to risk-weighted assets ratio of 18.50% and 18.22%, a common equity Tier 1 capital to risk-weighted ratio of 18.50% and 18.22% and a Tier 1 leverage ratio of 12.06% and 10.96%, respectively. The regulatory capital ratios as of December 31, 2023 and 2022 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.
50
Table of Contents
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 $404.08 million at December 31, 2023, and an unfunded $25.00 million revolving line of credit established with Frost Bank, a nonaffiliated bank, which matures on June 30, 2025 (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, 2023, there were no amounts drawn on these lines of credit. Our subsidiary bank also has (i) an available line of credit with the FHLB totaling $1.86 billion at December 31, 2023, secured by portions of our loan portfolio and certain investment securities; and (ii) access to the Federal Reserve Bank of Dallas lending program, including the Bank Term Funding Program, secured by portions of certain investment securities. At December 31, 2023, there was $813 million used on the FHLB line advance for undisbursed commitments (letters of credit) used to secure public funds.
The Company renewed its loan agreement, effective June 30, 2023, 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 $143.32 million at December 31, 2023, investment securities which totaled $2.20 million at December 31, 2023 with maturities over 6 to 7 years, available dividends from our subsidiaries which totaled $387.33 million at December 31, 2023, 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.
The Company continuously monitors the Company's liquidity position to ensure that assets and liabilities are managed in a manner that will meet all of the Company's short-term and long-term cash requirements. The Company manages the Company's liquidity position to meet the daily cash flow needs of customers, while maintaining an appropriate balance between assets and liabilities to meet the return on investment objectives of the Company's shareholders. The Company also monitors its liquidity requirements in light of interest rate trends, changes in the economy, and the scheduled maturity and interest rate sensitivity of the investment and loan portfolios and deposits.
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, 2023. 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 $624 thousand in 2024.
Off-Balance Sheet/Reserve for Unfunded Commitments. We are a party to financial instruments with off-balance sheet (“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, 2023, the Company’s reserve for unfunded commitments totaled $7.90 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.
51
Table of Contents
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 $466.25 million in less than one year, $868.47 million in more than one year but less than three years and $588.37 million 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, 2023, $387.33 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 $133.50 million in 2023 and $67.50 million in 2022.
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 50.96%, 40.18% and 36.30% of net earnings, respectively, in 2023, 2022 and 2021. 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 Board, 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.
52
Table of Contents
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 2023 and 2022. 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:
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:
53
Table of Contents
None.
ITEM 9A. CONTROLS AND PROCEDURES
As of December 31, 2023, 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, 2023.
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.