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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
_____________________________________
 
FORM 10-K
_____________________________________

(Mark One)
þ ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2020
or
¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from                       to                     
Commission File Number: 001-36522
____________________________________________________
ISTR-20201231_G1.JPG
Investar Holding Corporation
(Exact name of registrant as specified in its charter)
____________________________________________________
Louisiana
(State or other jurisdiction of
incorporation or organization)
27-1560715
(I.R.S. Employer
Identification No.)
10500 Coursey Blvd., Baton Rouge, Louisiana 70816
(Address of principal executive offices, including zip code)
(225) 227-2222
(Registrant’s telephone number, including area code)

Securities registered pursuant to Section 12(b) of the Act:
Title of each class Trading Symbol(s) Name of each exchange on which registered
Common stock, $1.00 par value per share ISTR The Nasdaq Global Market
Securities registered pursuant to Section 12(g) of the Act: None
Indicate by check mark whether the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.  Yes  ¨    No  þ
Indicate by check mark whether the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.  Yes  ¨    No  þ
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  þ    No  ¨
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).    Yes  þ    No  ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act:
Large accelerated filer ¨ Accelerated filer ¨
Non-accelerated filer þ Smaller reporting company þ
Emerging growth company ¨
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ¨



Indicate by check mark whether the registrant has filed a report on and attestation to its management’s assessment of the effectiveness of its internal control over financial reporting under Section 404(b) of the Sarbanes-Oxley Act (15 U.S.C. 7262(b)) by the registered public accounting firm that prepared or issued its audit report.
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes      No  þ
The aggregate market value of the voting stock held by non-affiliates of the registrant, computed by reference to the closing price of the common stock as of June 30, 2020, was approximately $146.0 million.
The number of shares outstanding of each of the registrant’s classes of common stock, as of the latest practicable date, is as follows: Common stock, $1.00 par value per share, 10,475,083 shares outstanding as of March 8, 2021.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Definitive Proxy Statement relating to the 2021 Annual Meeting of Shareholders of Investar Holding Corporation are incorporated by reference into Part III of the Form 10-K. Such Definitive Proxy Statement will be filed with the Securities and Exchange Commission within 120 days after the end of the registrant’s fiscal year ended December 31, 2020.



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PART I
 
 
Item 1. Business
General
Investar Holding Corporation (the “Company”), a Louisiana corporation incorporated in 2009, is a financial holding company headquartered in Baton Rouge, Louisiana that conducts its operations primarily through its wholly-owned subsidiary, Investar Bank, National Association (the “Bank”), a national bank chartered by the Office of the Comptroller of Currency (“OCC”). The Bank was originally chartered as a Louisiana commercial bank in 2006 and converted to a national bank in July 2019. Through the Bank, the Company offers a wide range of commercial banking products tailored to meet the needs of individuals and small to medium-sized businesses. Our primary areas of operation are south Louisiana, including Baton Rouge, New Orleans, Lafayette, Lake Charles, and their surrounding areas; southeast Texas, including Houston and its surrounding area and, as of February 21, 2020, Alice and Victoria; and west Alabama, including York and its surrounding area. These markets are served from our executive and operations center located in Baton Rouge and from 31 full service branches located throughout our market areas. We have experienced significant growth since the Bank was chartered, completing six whole-bank acquisitions, as described below in more detail, and establishing additional branches in our market areas. On January 25, 2021, we announced a definitive agreement to acquire Cheaha Financial Group, Inc., with four branches in Calhoun County in northeast Alabama.
As of December 31, 2020, on a consolidated basis, the Company had total assets of $2.3 billion, net loans of $1.8 billion, total deposits of $1.9 billion, and stockholders’ equity of $243.3 million.
Management believes that the current markets present a significant opportunity for growth and franchise expansion, both organically and through strategic acquisitions. Although the financial services industry is rapidly changing and intensely competitive, and likely to remain so, we believe that the Bank competes effectively as a local community bank and possesses the consistency of local leadership, the availability of local access and responsive customer service, coupled with competitively-priced products and services, necessary to successfully compete with other financial institutions for individual and small to medium-sized business customers.
For a discussion of the impacts of the COVID-19 pandemic on the Company, see Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations - Recent Developments Related to COVID-19.
The information set forth in this Annual Report on Form 10-K is as of March 10, 2021, unless otherwise indicated herein.
Operations
General. We offer a full range of commercial and retail lending products throughout our market areas, including business loans to small to medium-sized businesses as well as loans to individuals. Our business lending products include owner-occupied commercial real estate loans, construction loans and commercial and industrial loans, such as term loans, equipment financing and lines of credit, while our loans to individuals include first and second mortgage loans, installment loans, and lines of credit. For business customers, we target small to medium-sized businesses and professional organizations such as law firms, accounting firms and medical practices.
Management considers all of our operations to be aggregated in one reportable operating segment, and accordingly, no separate segment disclosures are presented in this report.
Lending Activities. Income generated by our lending activities represents a substantial portion of our total revenue. For the years ended December 31, 2020, 2019 and 2018, income from our lending activities comprised 83%, 85% and 84%, respectively, of our total revenue. Over the last three fiscal years, we have increased our focus on commercial real estate loans and commercial and industrial loans, including adding and expanding a new Commercial and Industrial division in early 2018.
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Lending to Businesses. Our lending to small to medium-sized businesses falls into three general categories:
Commercial real estate loans. Approximately 48% of our total loans at December 31, 2020 were commercial real estate loans, which include multifamily, farmland and commercial real estate loans, with owner-occupied loans comprising approximately 42% of the commercial real estate loan portfolio. Commercial real estate loan terms generally are 10 years or less, although payments may be structured on a longer amortization basis. Interest rates may be fixed or adjustable, although rates typically will not be fixed for a period exceeding 120 months, and we generally charge an origination fee. We do not offer non-recourse loans. Risks associated with commercial real estate loans include, among other things, fluctuations in the value of real estate, new job creation trends, tenant vacancy rates, and the quality of the borrower’s management. We attempt to limit risk by analyzing a borrower’s cash flow and collateral value on an ongoing basis. Also, we typically require personal guarantees from the principal owners of the property, supported by a review of their personal financial statements, as an additional means of mitigating our risk. We also manage risk by avoiding concentrations in any one business or industry.
Commercial and industrial loans. Commercial and industrial loans primarily consist of working capital lines of credit and equipment loans. The terms of these loans vary by purpose and by type of underlying collateral. We make equipment loans for a term of five years or less at fixed or variable rates, with the loan fully amortized over the term and secured by the relevant piece of equipment. Loans to support working capital typically have terms not exceeding one year, and such loans are secured by accounts receivable or inventory. Fixed rate loans are priced based on collateral, term and amortization. The interest rate for floating rate loans is typically tied to the prime rate published in The Wall Street Journal. Commercial and industrial loans accounted for approximately 21% of our total loans at December 31, 2020.
Commercial lending generally involves different risks from those associated with commercial real estate lending or construction lending. Although commercial loans may be collateralized by equipment or other business assets (including real estate, if available as collateral), the repayment of these types of loans depends primarily on the creditworthiness and projected cash flow of the borrower (and any guarantors). Thus, the general business conditions of the local economy and the borrower’s ability to sell its products and services, thereby generating sufficient operating revenue to repay us under the agreed upon terms and conditions, are the chief considerations when assessing the risk of a commercial loan. The liquidation of collateral, if any, is considered a secondary source of repayment because equipment and other business assets may, among other things, be obsolete or of limited resale value. We actively monitor certain financial measures of the borrower, including advance rate, cash flow, collateral value and other appropriate credit factors.
Construction and development loans. Construction and development loans, which consist of loans for the construction of commercial projects, single family residential properties and multifamily properties, accounted for approximately 11% of our total loans at December 31, 2020. Our construction and development loans are made on both a “pre-sold” basis and on a “speculative” basis. Construction and development loans are generally made with a term of 6 to 18 months, with interest accruing at either a fixed or floating rate and paid monthly. These loans are secured by the underlying project being built. For construction loans, loan to value ratios range from 70% to 80% of the developed/completed value, while for development loans our loan to value ratios typically will not exceed 70% to 75% of such value. Speculative loans are based on the borrower’s financial strength and cash flow position, and we disburse funds in installments based on the percentage of completion and only after the project has been inspected by an experienced construction lender or third-party inspector.
Construction lending entails significant additional risks compared to commercial real estate or residential real estate lending due to the dynamics of construction projects, changes in interest rates, the long-term financing market, and state and local government regulations. One such risk is that loan funds are advanced upon the security of the property under construction, which is of uncertain value prior to the completion of construction. Thus, it is more difficult to accurately evaluate the total loan funds required to complete a project and to calculate related loan-to-value ratios. We attempt to minimize the risks associated with construction lending by limiting loan-to-value ratios as described above. In addition, as to speculative development loans, we generally make such loans only to borrowers that have a positive pre-existing relationship with us. We also manage risk by using specific underwriting policies and procedures for these types of loans and by avoiding excessive concentrations in any one business or industry.
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Lending to Individuals. We make the following types of loans to our individual customers:
Residential real estate. One-to-four family residential real estate loans, including second mortgage loans, comprised approximately 18% of our total loans at December 31, 2020. Second mortgage loans in this category include only loans we make to cover the gap between the purchase price of a residence and the amount of the first mortgage; all other second mortgage loans are considered consumer loans. Loan to value ratios do not typically exceed 80%, although some of the mortgage loans that we retain in our portfolio may have higher loan to value ratios. We use an independent appraiser to establish collateral values. We generate residential real estate mortgage loans through Bank referrals and contacts with real estate agents in our markets. We do not originate subprime residential real estate loans.
Consumer loans. Consumer loans represented 1% of our total loans at December 31, 2020. We make these loans (which are normally fixed-rate loans) to individuals for a variety of personal, family and household purposes, secured and unsecured installment and term loans, second mortgages, home equity loans and home equity lines of credit. Because many consumer loans are secured by depreciable assets such as cars, boats and trailers, the loans are amortized over the useful life of the asset. The amortization of second mortgages generally does not exceed 15 years and the rates generally are not fixed for more than 60 months. As a general matter, in underwriting these loans, our credit analysts review a borrower’s past credit history, credit scores, past income level, debt history and, when applicable, cash flow, debt to income ratio, and payment to income, and determine the impact of all these factors on the ability of the borrower to make future payments as agreed. A comparison of the value of the collateral, if any, to the proposed loan amount, is also a consideration in the underwriting process. Repayment of consumer loans depends upon key consumer economic measures and upon the borrower’s financial stability and is more likely to be adversely affected by divorce, job loss, illness and personal hardships than repayment of other loans. A shortfall in the value of any collateral also may pose a risk of loss to us for these types of loans.
Indirect auto loans historically comprised the largest component of our consumer loans, however, only 22% of our total consumer loans were indirect auto loans at December 31, 2020. We were an indirect lender for our auto loans, meaning that the loans were originated by automobile dealerships and then assigned to us. These dealerships were selected based on our review of their operating history and the dealership’s reputation in the marketplace, which we believe helped to mitigate the risks of fraud or negligence by the dealership. At all times, the decision whether or not to provide financing resided with us.
In November 2015, the Bank announced that it was exiting the indirect auto loan origination business. The Bank discontinued accepting indirect auto loan applications December 31, 2015, but continued to process and fund applications that were accepted on or before that date. The Bank will continue to service the current indirect auto loan portfolio for its duration. At December 31, 2020, the weighted average remaining term of the indirect auto loan portfolio was 1.3 years.
Deposits. We offer a broad base of deposit products and services to our individual and business clients, including savings, checking, and money market accounts, debit cards and mobile banking with smartphone deposit capability, as well as a variety of certificates of deposit and individual retirement accounts. We also offer a reciprocal deposit product, Assured Checking, that allows customers to deposit funds in excess of the Federal Deposit Insurance Corporation’s (“FDIC”) $250,000 insurance limit and have the funds insured by the FDIC. For our business clients, we offer a competitive suite of cash management products which include, but are not limited to, remote deposit capture, virtual vault, electronic statements, positive pay, ACH origination and wire transfer, investment sweep accounts, and enhanced business internet banking.
Other Banking Services. The Bank’s other banking services include cashiers’ checks, direct deposit of payroll and Social Security checks, night depository, bank-by-mail, automated teller machines with deposit automation, debit cards, mobile wallet payment options, Business Electronic Banking for business customers, and Zelle®, a fast, safe and easy way to send money directly between almost any bank account in the United States. In addition, the bank has options for contactless banking including interactive teller machines (ITMs) and video banking. ITMs are an upgrade on traditional ATM technology that allow customers to virtually interact directly with Bank staff for a safer, more secure transaction. Video banking lets customers communicate with Bank staff from a mobile device or computer without visiting a branch.
We have also associated with nationwide networks of automated teller machines, enabling the Bank’s customers to use ATMs throughout our markets and other regions. We offer merchant card services through a third-party vendor and a business credit card product. The Bank does not offer trust services or insurance products.
5


Acquisition Activity
General. To complement our organic growth strategy, from time to time, we evaluate potential acquisition opportunities including whole-bank acquisitions and strategic branch acquisitions. We believe there are many banking institutions that continue to face credit challenges, capital constraints and liquidity issues and that lack the scale and management expertise to manage the increasing regulatory burden. Our management team has a long history of identifying targets, assessing and pricing risk and executing acquisitions in a creative, yet disciplined, manner. We seek acquisitions that provide meaningful financial benefits, long-term organic growth opportunities and expense reductions, without compromising our risk profile. Additionally, we seek banking markets with favorable competitive dynamics and potential consolidation opportunities. All of our acquisition activity is evaluated and overseen by a standing Merger and Acquisition Committee of our board of directors. Acquisitions completed since January 1, 2018 and any pending acquisitions are discussed below.
Acquisition of Mainland Bank. On March 1, 2019, the Company completed its acquisition of Mainland Bank (“Mainland”), headquartered in Texas City, Texas, with two additional branch locations in Houston and Dickinson, Texas. The Company acquired all of the outstanding common stock of the former Mainland shareholders for a total consideration of $18.6 million in the form of 763,849 shares of the Company’s common stock. The Company acquired assets with a fair value of approximately $127.6 million, including $81.3 million in loans, assumed $107.6 million in deposits, and recognized $5.2 million in goodwill.
Acquisition of Bank of York. On November 1, 2019, the Company completed its acquisition of Bank of York, headquartered in York, Alabama, with an additional branch location in Livingston, Alabama. The Company acquired all of the outstanding common stock of the former Bank of York shareholders for a total cash consideration of $15.0 million. Bank of York was also permitted under the terms of the merger agreement to make a special pre-closing cash distribution to its shareholders in an aggregate amount of approximately $1.0 million. The Company acquired assets with a fair value of approximately $101.9 million, including $46.1 million in loans, assumed $85.0 million in deposits, and recognized $5.0 million in goodwill.
Acquisition of two branches from PlainsCapital Bank. On February 21, 2020, the Bank completed its acquisition and assumption of certain assets, deposits and other liabilities associated with the Alice and Victoria, Texas locations of PlainsCapital Bank, a wholly-owned subsidiary of Hilltop Holdings Inc., for an aggregate consideration of approximately $11.2 million. The Bank acquired approximately $45.9 million in loans and $37.3 million in deposits. In addition, the Bank acquired substantially all the fixed assets at the branch locations, and assumed the leases for the branch facilities.
Definitive Agreement with Cheaha Financial Group, Inc. On January 25, 2021 the Company announced that it has entered into a definitive agreement (the “Agreement”) to acquire Cheaha Financial Group, Inc. (“Cheaha”), headquartered in Oxford, Alabama, and its wholly-owned subsidiary, Cheaha Bank. According to the terms of the Agreement, the Company will pay $80.00 in cash consideration for each share of Cheaha common stock, for an aggregate value of approximately $41.1 million. Investar previously executed a definitive agreement to acquire Cheaha in December 2019. However, that agreement was terminated in accordance with its terms after the transaction failed to close by June 30, 2020. The termination of the agreement came in response to the unpredictable economic conditions resulting from the global health crisis caused by the COVID-19 pandemic. At December 31, 2020, Cheaha Bank had approximately $236 million in assets, $126 million in net loans, and $202 million in deposits. Cheaha Bank offers a full range of banking products and services to individuals and small businesses from four branch locations in Calhoun County, Alabama.
De Novo Branches
During our last three fiscal years, we have opened five full-service branch locations in Louisiana, consisting of two locations in the Lake Charles market, one location in the Baton Rouge market, one location in the New Orleans market, and one location in the Lafayette market, in addition to the branches we acquired through our acquisition activity described above. We do not expect to open de novo branches in 2021.
Competition
We face competition in all major product and geographic areas in which we conduct our operations. Through the Bank, we compete for available loans and deposits with state, regional and national banks, as well as savings and loan associations, credit unions, finance companies, mortgage companies, insurance companies, brokerage firms and investment companies. All of these institutions compete in the delivery of services and products through availability, quality and pricing, both with respect to interest rates on loans and deposits and fees charged for banking services. Many of our competitors are larger and have substantially greater resources than we do, including higher total assets and capitalization, greater access to capital markets, and a broader offering of financial services. As larger institutions, many of our competitors can offer more attractive pricing than we can offer and have more extensive branch networks from which they can offer their financial services products.
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While we continually strive to offer competitive pricing for our banking products, we believe that our community bank approach to customers, focusing on quality customer service, and maintaining strong customer relationships affords us the best opportunity to successfully compete with other institutions. In addition, as a smaller institution, we think we can be flexible in developing and implementing new products and services. Further, in recent years there has been consolidation activity involving banks with a presence in our markets. In our view, mergers and other business combinations within our markets provide us with growth opportunities. Many acquisitions, especially when local institutions are acquired by institutions based outside our markets, result not only in customer disruption, but also in a loss of market knowledge and relationships that we believe provide us the opportunity to acquire customers seeking a personalized approach to banking. Furthermore, acquisition activity typically creates opportunities to hire talented personnel from the combining institutions.
The following table sets forth certain information about our total deposits, and our share of total deposits, in specified locations, and is shown as of June 30, 2020, which is the latest date for which such information is available.
Location Investar Total Deposits Investar Share of Deposits
(in millions)
Baton Rouge, Louisiana $ 800  3.7  %
New Orleans, Louisiana 256  1.2 
Lafayette, Louisiana 171  2.5 
Evangeline Parish, Louisiana(1)
200  2.3 
East and West Feliciana Parishes, Louisiana(1)
58  22.5 
Calcasieu Parish, Louisiana(1)
19  0.4 
Houston, Texas 143  0.1 
Alice, Texas 14  2.2 
Victoria, Texas 24  0.9 
Sumter County, Alabama(1)
108  43.9 
(1)Evangeline Parish, Calcasieu Parish, East and West Feliciana Parishes, and Sumter County are not included in Metropolitan Statistical Areas but are included in this table to reflect the deposit balances of our branches in these parishes and county.
Supervision and Regulation
General. Banking is highly regulated under federal and state law. The following is a brief summary of certain aspects of that regulation which are material to us, and does not purport to be a complete description of all regulations that affect us or all aspects of those regulations. To the extent particular statutory and regulatory provisions are described, the description is qualified in its entirety by reference to the particular statute or regulation.
We are a financial holding company registered under the Bank Holding Company Act of 1956, as amended, and are subject to supervision, regulation and examination by the Federal Reserve. The Bank is a national bank chartered under the laws of the United States by the OCC and is subject to supervision, regulation and examination by the OCC. This system of supervision and regulation establishes a comprehensive framework for our operations and, consequently, can have a material impact on our growth and earnings performance.
The primary goals of the bank regulatory scheme are to maintain a safe and sound banking system and to facilitate the conduct of sound monetary policy. This system is intended primarily for the protection of the FDIC’s deposit insurance funds, bank depositors, and the public, rather than our shareholders and creditors. The banking agencies have broad enforcement power over bank holding companies and banks, including the authority, among other things, to enjoin “unsafe or unsound” practices, require affirmative action to correct any violation or practice, issue administrative orders that can be judicially enforced, direct increases in capital, direct the sale of subsidiaries or other assets, limit dividends and distributions, restrict growth, assess civil monetary penalties, remove officers and directors, and, with respect to banks, terminate deposit insurance or place the bank into conservatorship or receivership. In general, these enforcement actions may be initiated for violations of laws and regulations or unsafe or unsound practices.
The Dodd-Frank Act. The Dodd-Frank Act, enacted on July 21, 2010, aims to restore responsibility and accountability to the financial system by significantly altering the regulation of financial institutions and the financial services industry. Full implementation of the Dodd-Frank Act has required many new rules to be issued by federal regulatory agencies over the last several years, and will continue to profoundly affect how financial institutions will be regulated in the future.
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The Dodd-Frank Act, among other things:
established the Consumer Financial Protection Bureau, an independent bureau within the Federal Reserve System with centralized responsibility for promulgating and enforcing federal consumer protection laws applicable to all entities offering consumer financial products or services;
established the Financial Stability Oversight Council, tasked with the authority to identify and monitor institutions and systems that pose a systemic risk to the financial system;
changed the assessment base for federal deposit insurance from the amount of insured deposits held by the depository institution to the institution’s average total consolidated assets less tangible equity;
increased the minimum reserve ratio for the Deposit Insurance Fund from 1.15% to 1.35%;
permanently increased the deposit insurance coverage amount from $100,000 to $250,000;
required the federal banking agencies to make their capital requirements for insured depository institutions countercyclical, so that capital requirements increase in times of economic expansion and decrease in times of economic contraction;
directed the Federal Reserve to establish interchange fees for debit cards under a restrictive “reasonable and proportional cost” per transaction standard;
limited the ability of banking organizations to sponsor or invest in private equity and hedge funds and to engage in proprietary trading;
increased regulation of consumer protections regarding mortgage originations, including originator compensation, minimum repayment standards, prepayment consideration, and mortgage servicing;
restricted the preemption of select state laws by federal banking law applicable to national banks and disallowed subsidiaries and affiliates of national banks from availing themselves of such preemption;
authorized national and state banks to establish de novo branches in any state that would permit a bank chartered in that state to open a branch at that location; and
repealed the federal prohibition on the payment of interest on commercial demand deposits, thereby permitting depository institutions to pay interest on business transaction and other accounts.
Some of these provisions have had and may continue to have the consequence of increasing our expenses, decreasing our revenues, and changing the activities in which we choose to engage. The environment in which banking organizations have operated after the financial crisis, including legislative and regulatory changes affecting capital, liquidity, supervision, permissible activities, corporate governance and compensation, changes in fiscal policy and steps to eliminate government support for banking organizations, may have long-term effects on the business model and profitability of banking organizations that cannot currently be foreseen. The specific impact on our current activities or new financial activities we may consider in the future, our financial performance and the markets in which we operate will depend on the manner in which the relevant agencies develop and implement the required rules and the reaction of market participants to these regulatory developments. Many aspects of the Dodd-Frank Act are subject to ongoing implementation. While we cannot predict what effect any presently contemplated or future changes in the laws or regulations or their interpretations would have on us, these changes could be materially adverse to our financial condition and results of operations.
The Volcker Rule. On December 10, 2013, the Federal Reserve and the other federal banking regulators as well as the SEC each adopted a final rule implementing Section 619 of the Dodd-Frank Act, commonly referred to as the “Volcker Rule.” Generally speaking, the final rule prohibits a bank and its affiliates from engaging in proprietary trading and from sponsoring certain “covered funds” or from acquiring or retaining any ownership interest in such covered funds. Most private equity, venture capital and hedge funds are considered “covered funds” as are bank trust preferred collateralized debt obligations. The final rule requires banking entities to divest disallowed securities by July 21, 2015, subject to extension upon application. The Economic Growth, Regulatory Relief, and Consumer Protection Act which was enacted in 2018 amended Section 619 of the Dodd-Frank Act to exempt from the Volcker Rule any insured depository institution that has $10.0 billion or less in total consolidated assets and whose total trading assets and trading liabilities are 5.0% or less of total consolidated assets.
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Regulatory Capital Requirements
Capital Adequacy. The Federal Reserve Board monitors the capital adequacy of the Company, on a consolidated basis, and the OCC monitors the capital adequacy of the Bank. The regulatory agencies use a combination of risk-based guidelines and a leverage ratio to evaluate capital adequacy and consider these capital levels when taking action on various types of applications and when conducting supervisory activities related to safety and soundness. The risk-based capital standards are designed to make regulatory capital requirements more sensitive to differences in risk profiles among financial institutions and their holding companies, to account for off-balance sheet exposure, and to minimize disincentives for holding liquid assets. A financial institution’s assets and off-balance sheet items, such as letters of credit and unfunded loan commitments, are assigned to broad risk categories, each with appropriate risk weights. Regulatory capital, in turn, is classified in one of two tiers. “Tier 1” capital includes two components: (1) common equity Tier 1 capital and (2) additional Tier 1 capital. Common equity Tier 1 capital consists solely of common stock (plus related surplus), retained earnings and limited amounts of minority interests that are in the form of common stock. Additional Tier 1 capital includes other perpetual instruments historically included in Tier 1 capital, such as non-cumulative perpetual preferred stock. “Tier 2” capital includes, among other things, qualifying subordinated debt and allowances for loan and lease losses, subject to limitations. The resulting capital ratios represent capital as a percentage of total risk-weighted assets and off-balance sheet items.
Under the current regulatory framework, we are required to maintain the following minimum regulatory capital ratios:
A ratio of common equity Tier 1 capital to total risk-weighted assets of at least 4.5%;
A ratio of Tier 1 capital to total risk-weighted assets of at least 6.0%;
A ratio of Tier 1 capital plus Tier 2 capital to total risk-weighted assets of at least 8.0%; and
A leverage ratio (Tier 1 capital to adjusted total assets) of at least 4.0%.
In addition to these minimum regulatory capital ratios, the regulations establish a capital conservation buffer with respect to the first three capital ratios listed above. Specifically, banking organizations must hold common equity Tier 1 capital in excess of their minimum risk-based capital ratios by at least 2.5% of risk-weighted assets in order to avoid limits on capital distributions (including dividend payments, discretionary payments on Tier 1 instruments, and stock buybacks) and certain discretionary bonus payments to executive officers. Thus, when including the 2.5% capital conservation buffer, a bank holding company and bank’s minimum ratio of common equity Tier 1 capital to total risk-weighted assets becomes 7%, its minimum ratio of Tier 1 capital to total risk-weighted assets becomes 8.5%, and its minimum ratio of total capital to total risk-weighted assets becomes 10.5%.
We were in compliance with all applicable minimum regulatory capital requirements as of December 31, 2020.
The required capital ratios set forth above are minimums, and the Federal Reserve and the OCC may determine that a banking organization, based on its size, complexity or risk profile, must maintain a higher level of capital in order to operate in a safe and sound manner. Risks such as concentration of credit risks and the risk arising from non-traditional activities, as well as the institution’s exposure to a decline in the economic value of its capital due to changes in interest rates, and an institution’s ability to manage those risks are important factors that are to be taken into account by the federal banking agencies in assessing an institution’s overall capital adequacy.
The federal banking agencies finalized a rule in 2019 that allows bank holding companies and banks with less than $10.0 billion in total consolidated assets, limited amounts of certain assets and off balance sheet exposures, and a bank leverage ratio of greater than 9% to elect to use the Community Bank Leverage Ratio (“CBLR”) framework. A community banking organization electing to use the CBLR framework would have a simplified capital regime and would be considered well capitalized as long as it had a leverage ratio of greater than 9% (subsequently temporarily reduced to 8% as a COVID-19 relief measure). We have not elected to use the CBLR framework and it is uncertain if we will elect to use the CBLR framework in the future.
Furthermore, the U.S. federal banking agencies have finalized rules that would permit bank holding companies and banks to phase-in, for regulatory capital purposes, the day-one impact of the new current expected credit loss accounting rule in retained earnings over a period of three years commencing with time of adoption of the new standard. For further discussion of the new current expected credit loss accounting rule, see Note 1 to the consolidated financial statements and also see “Our allowance for loan losses may prove to be insufficient to absorb losses inherent in our loan portfolio, and we may be required to further increase our provision for loan losses” in Item 1A. Risk Factors.
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Prompt Corrective Action Regulations. Under the prompt corrective action regulations, the OCC is required and authorized to take supervisory actions against undercapitalized financial institutions. For this purpose, a bank is placed in one of the following five categories based on its capital: well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized, and critically undercapitalized. Under the prompt corrective action regulations, as currently in effect, to be well capitalized, a bank must have a leverage capital ratio of at least 5%, a common equity Tier 1 capital ratio of at least 6.5%, a Tier 1 risk-based capital ratio of at least 8%, and a total risk-based capital ratio of at least 10%, and must not be subject to any order or written agreement or directive by a federal banking agency to meet and maintain a specific capital level for any capital measure.
Federal banking regulators are required to take various mandatory supervisory actions and are authorized to take other discretionary actions with respect to institutions in the three undercapitalized categories that, if undertaken, could have a material adverse effect on the institution’s operations or financial condition. The severity of the action depends upon the capital category in which the institution is placed. Generally, subject to a narrow exception, banking regulators must appoint a receiver or conservator for an institution that is critically undercapitalized. The federal banking agencies have specified by regulation the relevant capital level for each category. An institution that is categorized as undercapitalized, significantly undercapitalized, or critically undercapitalized is required to submit an acceptable capital restoration plan to its appropriate federal banking agency. An undercapitalized institution also is generally prohibited from increasing its average total assets, making acquisitions, establishing any branches or engaging in any new line of business, except under an accepted capital restoration plan or with OCC approval. The regulations also establish procedures for downgrading an institution to a lower capital category based on supervisory factors other than capital. Additionally, only a well-capitalized depository institution may accept brokered deposits without prior regulatory approval.
Furthermore, a bank holding company must guarantee that a subsidiary depository institution meets its capital restoration plan, subject to various limitations. The controlling holding company’s obligation to fund a capital restoration plan is limited to the lesser of 5% of an undercapitalized subsidiary’s assets at the time it became undercapitalized or the amount required to meet regulatory capital requirements.
The capital classification of a bank affects the frequency of regulatory examinations, the bank’s ability to engage in certain activities, and the deposit insurance premiums paid by the bank. As of December 31, 2020, the Bank met the requirements to be categorized as well capitalized under the prompt corrective action framework as currently in effect.
Acquisitions by Bank Holding Companies
Federal laws, including the Bank Holding Company Act and the Change in Bank Control Act, impose additional prior notice or approval requirements and ongoing regulatory requirements on any investor that seeks to acquire direct or indirect “control” of an FDIC-insured depository institution or bank holding company. We must obtain the prior approval of the Federal Reserve before (1) acquiring more than 5% of the voting stock of any bank or other bank holding company, (2) acquiring all or substantially all of the assets of any bank or bank holding company, or (3) merging or consolidating with any other bank holding company. The Federal Reserve may determine not to approve any of these transactions if it would result in or tend to create a monopoly or substantially lessen competition or otherwise function as a restraint of trade, unless the anti-competitive effects of the proposed transaction are clearly outweighed by the public interest in meeting the convenience and needs of the community to be served. The Federal Reserve is also required to consider the financial and managerial resources and future prospects of the bank holding companies and banks concerned, the convenience and needs of the community to be served, and the record of a bank holding company and its subsidiary bank(s) in combating money laundering activities. In addition, a failure to implement and maintain adequate compliance programs could cause the Federal Reserve or other banking regulators not to approve an acquisition when regulatory approval is required or to prohibit an acquisition even if approval is not required.
Scope of Permissible Bank Holding Company Activities
In general, the Bank Holding Company Act limits the activities permissible for bank holding companies to the business of banking, managing or controlling banks, and such other activities as the Federal Reserve has determined to be so closely related to banking as to be properly incident thereto.
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A bank holding company may elect to be treated as a financial holding company and receive expanded powers if it and its depository institution subsidiaries are “well capitalized” and “well managed,” and its subsidiary banks controlled by it have at least a “satisfactory” Community Reinvestment Act rating. We have elected for the Company to be treated as a financial holding company. As a financial holding company, we may engage in a range of activities that are (1) financial in nature or incidental to such financial activity or (2) complementary to a financial activity and which do not pose a substantial risk to the safety and soundness of a depository institution or to the financial system generally. These activities include securities dealing, underwriting and market making, insurance underwriting and agency activities, merchant banking and insurance company portfolio investments. Expanded financial activities of financial holding companies generally will be regulated according to the type of such financial activity: banking activities by banking regulators; securities activities by securities regulators; and insurance activities by insurance regulators.
The Bank Holding Company Act does not place territorial limitations on permissible non-banking activities of bank holding companies. The Federal Reserve has the power to order any bank holding company or its subsidiaries to terminate any activity or to terminate its ownership or control of any subsidiary when the Federal Reserve has reasonable grounds to believe that continuation of such activity or such ownership or control constitutes a serious risk to the financial soundness, safety or stability of any bank subsidiary of the bank holding company.
Source of Strength Doctrine for Bank Holding Companies
Under longstanding Federal Reserve policy which has been codified by the Dodd-Frank Act, we are expected to act as a source of financial strength to, and to commit resources to support, the Bank. This support may be required at times when we may not be inclined to provide it. In addition, any capital loans that we make to the Bank are subordinate in right of payment to deposits and to certain other indebtedness of the Bank. In the event of our bankruptcy, any commitment by us to a federal bank regulatory agency to maintain the capital of the Bank will be assumed by the bankruptcy trustee and entitled to a priority of payment.
Dividends
As a bank holding company, we are subject to certain restrictions on dividends under applicable banking laws and regulations. The Federal Reserve has issued a policy statement that provides that a bank holding company should not pay dividends unless: (1) its net income over the last four quarters (net of dividends paid) has been sufficient to fully fund the dividends; (2) the prospective rate of earnings retention appears to be consistent with the capital needs, asset quality and overall financial condition of the bank holding company and its subsidiaries; and (3) the bank holding company will continue to meet minimum required capital adequacy ratios. Accordingly, a bank holding company should not pay cash dividends that exceed its net income or that can only be funded in ways that weaken the bank holding company’s financial health, such as by borrowing. The Dodd-Frank Act imposes, and Basel III effected, additional restrictions on the ability of banking institutions to pay dividends. In addition, in the current financial and economic environment, the Federal Reserve Board has indicated that bank holding companies should carefully review their dividend policy and has discouraged payment ratios that are at maximum allowable levels unless both asset quality and capital are very strong.
The Bank is also subject to certain restrictions on dividends under federal laws, regulations and policies. In general, under OCC regulations, the Bank may pay dividends to us without the approval of the OCC only so long as the amount of the dividend does not exceed the Bank’s net income earned during the current year (net of dividends paid) combined with its retained net income (net of dividends paid) of the immediately preceding two years. The Bank must obtain the approval of the OCC for any amount in excess of this threshold. Further, a national bank may not pay a dividend in excess of its undivided profits. In addition, under federal law, the Bank may not pay any dividend to us if it is undercapitalized or the payment of the dividend would cause it to become undercapitalized. The OCC may further restrict the payment of dividends by requiring the Bank to maintain a higher level of capital than would otherwise be required to be adequately capitalized for regulatory purposes. Moreover, if, in the opinion of the OCC, the Bank is engaged in an unsound practice (which could include the payment of dividends even within the legal requirements noted above), the OCC may require the Bank to cease such practice. The OCC has indicated that paying dividends that deplete a depository institution’s capital base to an inadequate level would be an unsafe banking practice.
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Restrictions on Transactions with Affiliates and Loans to Insiders
Federal law strictly limits the ability of banks to engage in transactions with their affiliates, including their bank holding companies. Sections 23A and 23B of the Federal Reserve Act, and Federal Reserve Regulation W, impose quantitative limits, qualitative standards, and collateral requirements on certain transactions by a bank with, or for the benefit of, its affiliates, and generally require those transactions to be on terms at least as favorable to the bank as transactions with non-affiliates and to be consistent with safe and sound practices. The Dodd-Frank Act significantly expanded the coverage and scope of the limitations on affiliate transactions within a banking organization, including an expansion of the types of transactions that are covered transactions to include credit exposures related to derivatives, repurchase agreements and securities lending arrangements and an increase in the amount of time for which collateral requirements regarding covered transactions must be satisfied.
Federal law also limits a bank’s authority to extend credit to its directors, executive officers and 10% shareholders, as well as to entities controlled by such persons. Among other things, extensions of credit to insiders are required to be made on terms that are substantially the same as, and follow credit underwriting procedures that are not less stringent than, those prevailing for comparable transactions with unaffiliated persons. Also, the terms of such extensions of credit may not involve more than the normal risk of repayment or present other unfavorable features and may not exceed certain limitations on the amount of credit extended to such persons, individually and in the aggregate, which limits are based, in part, on the amount of the bank’s capital.
Incentive Compensation Guidance
The federal banking agencies have issued comprehensive guidance on incentive compensation policies. This guidance is designed to ensure that a financial institution’s incentive compensation structure does not encourage imprudent risk taking, which may undermine the safety and soundness of the institution. The guidance, which applies to all employees that have the ability to materially affect an institution’s risk profile, either individually or as part of a group, is based upon three primary principles: (1) balanced risk taking incentives; (2) compatibility with effective controls and risk management; and (3) strong corporate governance.
An institution’s supervisory ratings will incorporate any identified deficiencies in an institution’s compensation practices, and it may be subject to an enforcement action if the incentive compensation arrangements pose a risk to the safety and soundness of the institution. Further, regulations may limit discretionary bonus payments to bank executives if the institution’s regulatory capital ratios fail to exceed certain thresholds.
Deposit Insurance Assessments
FDIC insured banks are required to pay deposit insurance assessments to the FDIC. The amount of the assessment is based on the size of the bank’s assessment base, which is equal to its average consolidated total assets less its average tangible equity, and its risk classification under an FDIC risk-based assessment system. Institutions assigned to higher risk classifications (that is, institutions that pose a higher risk of loss to the Deposit Insurance Fund) pay assessments at higher rates than institutions that pose a lower risk. An institution’s risk classification is assigned based on certain financial data and the level of supervisory concern that the institution poses to the regulators. In addition, the FDIC can impose special assessments in certain instances. As noted above, the Dodd-Frank Act changed the way that deposit insurance premiums are calculated. Action by the FDIC to replenish the Deposit Insurance Fund when needed could result in higher assessment rates, which could reduce our profitability or otherwise negatively impact our operations.
Branching and Interstate Banking
Under federal law, the Bank is permitted to establish additional branch offices within Louisiana, subject to the approval of the OCC. As a result of the Dodd-Frank Act, the Bank may also establish additional branch offices outside of Louisiana, subject to prior regulatory approval, so long as the laws of the state where the branch is to be located would permit a state bank chartered in that state to establish a branch. The Bank may also establish offices in other states by merging with banks or by purchasing branches of other banks in other states, subject to certain restrictions.
Community Reinvestment Act
The Bank is required under the Community Reinvestment Act, or CRA, and related OCC regulations to help meet the credit needs of its communities, including low and moderate-income borrowers. In connection with its examination of the Bank, the OCC assesses our record of compliance with the CRA. The Bank’s failure to comply with the provisions of the CRA could, at a minimum, result in denial of certain corporate applications, such as branches or mergers, or in restrictions on its or the
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Company’s activities. The Bank received a “Satisfactory” CRA rating on its most recent CRA Performance Evaluation. The CRA requires all FDIC-insured institutions to publicly disclose their rating.
Concentrated Commercial Real Estate Lending Regulations
The federal bank regulatory agencies have promulgated guidance governing financial institutions with concentrations in commercial real estate lending. The guidance provides that a bank has a concentration in commercial real estate lending if (i) total reported loans for construction, land development, and other land represent 100% or more of total capital or (ii) total reported loans secured by multifamily and nonfarm nonresidential properties and loans for construction, land development, and other land represent 300% or more of total capital and the bank’s commercial real estate loan portfolio has increased 50% or more during the prior 36 months. Owner occupied loans are excluded from this second category. If a concentration is present, management must employ heightened risk management practices that address, among other things, board and management oversight and strategic planning, portfolio management, development of underwriting standards, risk assessment and monitoring through market analysis and stress testing, and maintenance of increased capital levels as needed to support the level of commercial real estate lending. At December 31, 2020, the Company did not have a concentration in commercial real estate as defined by the regulatory guidance.
Financial Privacy and Cybersecurity Requirements
Federal law and regulations limit a financial institution’s ability to share consumer financial information with unaffiliated third parties. Specifically, these provisions require all financial institutions offering financial products or services to retail customers to provide such customers with the financial institution’s privacy policy and provide such customers the opportunity to “opt out” of the sharing of personal financial information with unaffiliated third parties. The sharing of information for marketing purposes is also subject to limitations. The Bank currently has a privacy protection policy in place.
Federal law and regulations also establish certain information security guidelines that require each financial institution, under the supervision and ongoing oversight of its board of directors or an appropriate committee thereof, to develop, implement, and maintain a comprehensive written information security program designed to ensure the security and confidentiality of customer information, to protect against anticipated threats or hazards to the security or integrity of such information, and to protect against unauthorized access to or use of such information that could result in substantial harm or inconvenience to any customer.
Federal banking regulators regularly issue guidance regarding cybersecurity intended to enhance cyber risk management. A financial institution is expected to implement multiple lines of defense against cyber-attacks. Financial institutions are also expected to implement procedures designed to address the risks posed by potential cyber threats, and to allow the institution to respond and recover effectively after a cyber-attack. The Company has adopted procedures designed to comply with the regulatory cybersecurity guidance.
Consumer Laws and Regulations
The Bank is subject to numerous laws and regulations intended to protect consumers in transactions with the Bank, including, among others, laws regarding unfair, deceptive and abusive acts and practices, usury laws, and other federal consumer protection statutes. These federal laws include the Equal Credit Opportunity Act (the “ECOA”), the Electronic Fund Transfer Act, the Fair Credit Reporting Act, the Fair Debt Collection Practices Act, the Real Estate Settlement Procedures Act of 1974, the S.A.F.E. Mortgage Licensing Act of 2008, the Truth in Lending Act and the Truth in Savings Act, among others. Many states and local jurisdictions have consumer protection laws analogous, and in addition, to those enacted under federal law. These laws and regulations mandate certain disclosure requirements and regulate the manner in which financial institutions must deal with customers when taking deposits, making loans and conducting other types of transactions. Failure to comply with these laws and regulations could give rise to regulatory sanctions, customer rescission rights, action by state and local attorneys general and civil or criminal liability.
In addition, the Dodd-Frank Act created the Consumer Financial Protection Bureau that has broad authority to regulate and supervise retail financial services activities of banks and various non-bank providers. The Bureau has authority to promulgate regulations, issue orders, guidance and policy statements, conduct examinations and bring enforcement actions with regard to consumer financial products and services. In general, however, banks with assets of $10 billion or less, such as the Bank, will continue to be examined for consumer compliance by their primary federal bank regulator.
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Mortgage Lending Rules
The Dodd-Frank Act authorized the Consumer Financial Protection Bureau to establish certain minimum standards for the origination of residential mortgages, including a determination of the borrower’s ability to repay. Under the Dodd-Frank Act, financial institutions may not make a residential mortgage loan unless they make a “reasonable and good faith determination” that the consumer has a “reasonable ability” to repay the loan. The Dodd-Frank Act allows borrowers to raise certain defenses to foreclosure but provides a full or partial safe harbor from such defenses for loans that are “qualified mortgages.” The Bureau’s rules, among other things, specify the types of income and assets that may be considered in the ability-to-repay determination, the permissible sources for verification, and the required methods of calculating the loan’s monthly payments. The rules extend the requirement that creditors verify and document a borrower’s income and assets to include all information that creditors rely on in determining repayment ability. The rules also provide further examples of third-party documents that may be relied on for such verification, such as government records and check cashing or funds transfer service receipts. The rules also define “qualified mortgages,” imposing both underwriting standards and limits on the terms of their loans. Points and fees are subject to a relatively stringent cap, and the terms include a wide array of payments that may be made in the course of closing a loan. Certain loans, including interest-only loans and negative amortization loans, cannot be qualified mortgages.
Anti-Money Laundering and OFAC
Under federal law, financial institutions must maintain anti-money laundering programs that include: established internal policies, procedures and controls; a designated compliance officer; an ongoing employee training program; and testing of the program by an independent audit function. Financial institutions are also prohibited from entering into specified financial transactions and account relationships and must meet enhanced standards for due diligence and customer identification in their dealings with foreign financial institutions and foreign customers. Financial institutions must take reasonable steps to conduct enhanced scrutiny of account relationships to guard against money laundering and to report any suspicious transactions, and law enforcement authorities have been granted increased access to financial information maintained by financial institutions.
The Office of Foreign Assets Control, or OFAC, is responsible for helping to insure that U.S. entities do not engage in transactions with certain prohibited parties, as defined by various Executive Orders and Acts of Congress. OFAC publishes lists of persons and organizations suspected of aiding, harboring or engaging in terrorist acts, known as Specially Designated Nationals and Blocked Persons. Generally, if the Bank identifies a transaction, account or wire transfer relating to a person or entity on an OFAC list, it must freeze the account or block the transaction, file a suspicious activity report and notify the appropriate authorities.
Bank regulators routinely examine institutions for compliance with these obligations and they must consider an institution’s compliance in connection with the regulatory review of applications, including applications for banking mergers and acquisitions. Failure of a financial institution to maintain and implement adequate programs to combat money laundering and terrorist financing and comply with OFAC sanctions, or to comply with relevant laws and regulations, could have serious legal, reputational and financial consequences for the institution.
Safety and Soundness Standards
Federal bank regulatory agencies have adopted guidelines that establish general standards relating to internal controls and information systems, internal audit systems, loan documentation, credit underwriting, interest rate exposure, asset growth and compensation, fees and benefits. Additionally, the agencies have adopted regulations that provide the authority to order an institution that has been given notice by an agency that it is not satisfying any of these safety and soundness standards to submit a compliance plan. If, after being so notified, an institution fails to submit an acceptable compliance plan or fails in any material respect to implement an acceptable compliance plan, the agency must issue an order directing action to correct the deficiency and may issue an order directing other actions of the types to which an undercapitalized institution is subject under the “prompt corrective action” provisions of the Federal Deposit Insurance Act. If an institution fails to comply with such an order, the agency may seek to enforce such order in judicial proceedings and to impose civil money penalties.
Bank holding companies are also not permitted to engage in unsound banking practices. For example, the Federal Reserve’s Regulation Y requires a holding company to give the Federal Reserve prior notice of any redemption or repurchase of its own equity securities, if the consideration to be paid, together with the consideration paid for any repurchases in the preceding year, is equal to 10% or more of the company’s consolidated net worth. The Federal Reserve may oppose the transaction if it believes that the transaction would constitute an unsafe or unsound practice or would violate any law or regulation. As another example, a holding company could not impair its subsidiary bank’s soundness by causing it to make funds available to non-banking subsidiaries or their customers if the Federal Reserve believed it not prudent to do so. The Federal Reserve has broad authority
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to prohibit activities of bank holding companies and their nonbanking subsidiaries that represent unsafe and unsound banking practices or that constitute violations of laws or regulations.
Effect of Governmental Monetary Policies
The commercial banking business is affected not only by general economic conditions but also by U.S. fiscal policy and the monetary policies of the Federal Reserve. Some of the instruments of monetary policy available to the Federal Reserve include changes in the discount rate on member bank borrowings, the fluctuating availability of borrowings at the “discount window,” open market operations, the imposition of and changes in reserve requirements against member banks’ deposits and assets of foreign branches, and the imposition of and changes in reserve requirements against certain borrowings by banks and their affiliates. These policies influence to a significant extent the overall growth of bank loans, investments, and deposits and the interest rates charged on loans or paid on deposits. We cannot predict the nature of future fiscal and monetary policies and the effect of these policies on our future business and earnings.
Future Legislation and Regulatory Reform
New laws, regulations and policies are regularly proposed that contain wide-ranging proposals for altering the structures, regulations and competitive relationships of financial institutions operating in the United States. In addition, existing laws, regulations and policies are continually subject to modification or changes in interpretation. We cannot predict whether or in what form any law, regulation or policy will be adopted or modified or the extent to which our operations and activities, financial condition, results of operations, growth plans or future prospects may be affected by its adoption or modification.
The cumulative effect of these laws and regulations add significantly to the cost of our operations and thus have a negative impact on profitability. There has also been a tremendous expansion in recent years of financial service providers that are not subject to the same level of regulation, examination and oversight as we are. Those providers, because they are not so highly regulated, may have a competitive advantage over us and may continue to draw large amounts of funds away from traditional banking institutions, with a continuing adverse effect on the banking industry in general.
Employees
As of December 31, 2020, we had 319 full-time and 7 part-time employees. None of our employees are represented by any collective bargaining unit or are parties to a collective bargaining agreement. We believe that our relations with our employees are good.
Dependence upon a Single Customer
No material portion of our loans has been made to, nor have our deposits been obtained from, a single or small group of customers; the loss of any single customer or small group of customers would not have a materially adverse effect on our business. A discussion of concentrations of credit in our loan portfolio is set forth under the heading Loan Concentrations in “Discussion and Analysis of Financial Condition—Loans” in Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.
Available Information
Our filings with the Securities and Exchange Commission (the “SEC”), including annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and all amendments thereto, are available on our website as soon as reasonably practicable after the reports are filed with or furnished to the SEC. Copies can be obtained free of charge in the “Investor Relations” section of our website at www.investarbank.com. Our SEC filings are also available through the SEC’s website www.sec.gov. Copies of these filings are also available by writing to us at the following address:
Investar Holding Corporation
P.O. Box 84207
Baton Rouge, Louisiana 70884-4207

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Item 1A. Risk Factors
Our business is subject to risk. In addition to the other information contained in this Annual Report on Form 10-K, including management’s discussion and analysis of financial condition and results of operations and our financial statements and the notes thereto, investors should consider the following risks when evaluating whether to invest in our common stock. If any of the following risks occur, whether alone or in combination, our business, financial condition, results of operations, cash flows and growth prospects could be materially and adversely affected. Additional risks that we do not presently know of or currently deem immaterial may also adversely affect our business, financial condition, results of operations, cash flows and growth prospects.
Risks Related to the COVID-19 Pandemic

The COVID-19 pandemic may continue to adversely impact our business and financial results.
The COVID-19 pandemic has created a worldwide public health crisis. The pandemic, and government actions taken to reduce the spread of the virus, have significantly increased economic uncertainty and reduced economic activity. Beginning in the first quarter of 2020, authorities implemented numerous measures to try to contain the virus. Government-mandated travel restrictions, closures of schools and businesses, occupancy restrictions, and stay-at-home orders, including in our market areas, significantly disrupted economic activities. These disruptions also caused steep increases in unemployment and decreases in consumer and business spending. Certain industries have been particularly hard-hit, including the oil and gas industry, the travel and hospitality industry, the restaurant industry and the retail industry. During the second quarter of 2020, many jurisdictions began to slowly lessen restrictions; however, there have since been multiple periods of resurgences in the number of new cases. Authorities have reacted to these resurgences by deferring the phasing out of these restrictions and, in some instances, re-imposing restrictions. Further, on June 8, 2020, the National Bureau of Economic Research indicated that the U.S. economy entered a recession in February 2020, and the duration of this recession is unclear at this time. The United States government has taken steps to attempt to mitigate some of the more severe anticipated economic effects of the pandemic, but there can be no assurance that such steps will be effective or that additional, similar governmental relief will be provided in the future.
The pandemic and related economic consequences have adversely impacted and are likely to further adversely impact our workforce, operations, and financial results. The operations of our borrowers, other customers and suppliers have also been affected. We have already increased our allowance for loan losses to reflect increased risks of losses and provided loan modifications to certain customers affected by COVID-19. We may experience future financial losses due to a number of factors, including but not limited to:
the risk that financial stress on our borrowers will lead to loan defaults at a rate that is higher than we anticipate;
the risk that loans that were modified due to the pandemic and not accounted for as troubled debt restructurings, and on which we continued to accrue interest, will ultimately default, requiring us to reverse related interest income and incur losses;
a further decline in business activity causing decreased demand for our loans and other banking services, which may reduce related income and fees;
further increases in our allowance for loan losses to reflect greater risks of losses;
decreases in income resulting from deferrals of loan payments, increases in loan modifications, and waivers or reductions in ATM, overdraft, interchange and other fees;
reductions in collateral values from their values when the loans were made;
lower market interest rates, which have an adverse impact on our variable rate loans and reduce our interest income;
potential impairment of goodwill;
increased litigation risk from customers and non-customers that approach the Company regarding receiving PPP loans and do not receive the loan they requested;
the risk that the SBA will not guarantee the PPP loans we originate if it determines that there is a deficiency in the manner in which any PPP loan was originated, funded, or serviced by us;
the risk of holding PPP loans at unfavorable interest rates and on terms that are less than favorable than other types of loans, and the Company’s ability to pursue available remedies in the event of a loan default of PPP loans;
increased instability in our deposit base;
the risk that economic conditions may prevent the completion of any of our planned acquisitions;
an increase in costs for additional cleaning, supplies and technology as we work to operate our branches in accordance with the health and safety guidelines imposed due to the pandemic;
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increased cyber and payment fraud risk, as cybercriminals attempt to profit from the disruption, given increased online and remote activity;
third party disruptions, including outages at network providers and other suppliers; and
lack of availability of employees due to illness.
These factors may remain prevalent for a significant period of time and may have a material adverse effect on our business, results of operations and financial condition, even after the COVID-19 outbreak has subsided.
The extent to which the COVID-19 pandemic will impact our business, results of operations and financial condition in the future is difficult to predict, particularly due to the unprecedented nature of the pandemic, and depends upon, among other things, the duration and spread of the outbreak, its severity, actions to contain the virus or treat its impact, the availability, acceptance and effectiveness of the recently approved vaccines, the impact of variants of the virus that have recently been detected in the U.S. and elsewhere, and how quickly and to what extent normal economic and operating conditions can resume.
Risks Related to our Business
As a business operating in the financial services industry, our business and operations may be adversely affected by prevailing economic conditions and geopolitical matters.
Our financial performance generally, and in particular the ability of borrowers to pay interest on and repay principal of outstanding loans and the value of collateral securing those loans, as well as demand for loans and other products and services we offer, is highly dependent upon the business environment in the primary markets where we operate and in the U.S. as a whole. Unfavorable or uncertain economic and market conditions can be caused by declines in economic growth, business activity or investor or business confidence, limitations on the availability or increases in the cost of credit and capital, increases in inflation or interest rates, high unemployment, natural disasters, pandemics (such as the COVID-19 pandemic) or fear of pandemics, or a combination of these or other factors. Additionally, declines in real estate value and sales volumes and high unemployment levels may result in higher than expected loan delinquencies and a decline in demand for our products and services. These negative events may cause us to incur losses and may adversely affect our capital, liquidity and financial condition.
In addition, geopolitical matters, including international political unrest, disruptions in international trade patterns, and slow growth in sectors of the global economy, as well as acts of terrorism, war and other violence could result in disruptions or volatility in the financial markets, which could reduce the value of our assets or reduce liquidity. These negative events could have a material adverse effect on our results of operations and financial condition, including our liquidity position, and may affect our ability to access capital.
Our business strategy includes the continuation of our multi-state growth plans, and our financial condition and results of operations could be negatively affected if we fail to grow or fail to manage our growth effectively.
We have grown our business primarily through de novo branching and through the acquisition of other financial institutions. Since our bank was founded in June 2006, through December 31, 2020, we have opened 14 de novo branches, completed six whole bank acquisitions, and acquired two branch locations. We have also expanded our operations outside our historical south Louisiana base and into Texas and Alabama, progressing towards our goal to build a premier regional community bank. As of January 21, 2021, we had pending the acquisition of Cheaha Financial Group, Inc., with four branch locations in Calhoun County, Alabama. We intend to continue pursuing a multi-state growth strategy for our business through de novo branching and to evaluate attractive acquisition opportunities and to continue to pursue organic growth throughout our franchise. Our growth prospects must be considered in light of the risks, expenses and difficulties frequently encountered by companies when expanding their franchise, including the following:
De Novo Branching; Branch Acquisitions. There are considerable costs involved in opening branches, and new branches generally do not generate sufficient revenues to offset their costs until they have been in operation for at least a year or more. Accordingly, our de novo branches can be expected to negatively impact our earnings for some period of time until the branches reach certain economies of scale. Our expenses could be further increased if we encounter delays in opening any of our de novo branches. We may be unable to accomplish future de novo branch expansion plans due to a lack of available satisfactory sites, difficulties in acquiring such sites, increased expenses or loss of potential sites due to complexities associated with zoning and permitting processes, or other factors. We may also be unable to identify and acquire suitable operating branches. Finally, we have no assurance our de novo branches or branches that we may acquire will maintain or achieve deposit levels, loan balances or other operating results necessary to avoid losses or produce
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profits. Our growth and de novo branching strategy necessarily entails growth in overhead expenses as we routinely add new offices and staff. During the last three fiscal years, we have opened five de novo branches. We do not expect to open de novo branches in 2021.
Expansion into New Markets. Prior to our acquisition of Mainland in the first quarter of 2019, we operated exclusively in Louisiana. With our acquisition of Mainland, we entered Texas, and we subsequently entered Alabama with our acquisition of Bank of York in November 2019. The financial services industry in these areas is highly competitive, and the challenges of operating in new markets and multiple states may be greater than we anticipate.
Acquisition and Integration Risks. An acquisition strategy involves substantial risks and uncertainties including:
the time and costs of evaluating potential acquisition candidates and new markets, negotiating transactions, and related diversion of management’s attention from day-to-day operations;
our ability to continue to finance acquisitions and possible dilution to our existing shareholders;
potential for acquisition agreements, once signed, not to be completed due to inability to obtain required regulatory approvals, third-party litigation, lack of shareholder approval if required, failure of other conditions to closing, agreement of the parties, or other reasons;
unanticipated difficulties in integrating acquired businesses, including potential losses of customers and employees, higher than expected integration costs, and inability to maintain and increase market share at new locations; and
potential differences between management’s expectations regarding how an acquired business will perform and actual results once acquired, which may result in lower than expected revenues, inability to achieve expected cost savings and synergies, higher than expected liabilities and costs, impairments of goodwill, and losses.
Organic Growth Risks. As we continue to pursue organic growth at our existing and new or acquired locations, we may be unable to successfully maintain loan quality, obtain deposits at attractive rates, attract and retain personnel to implement and oversee such growth, or maintain an efficient overhead cost structure. We may also introduce new products and services that do not produce projected profits and may result in losses.
Failure to successfully address these issues relating to our growth strategy could have a material adverse effect on our financial condition and results of operations. Also, if our growth occurs more slowly than anticipated or declines, our operating results could be materially adversely affected.
Our business is concentrated in southern Louisiana, southeast Texas, and western Alabama, and an economic downturn affecting these areas may magnify the adverse effects and consequences to us.
We currently conduct our operations primarily in southern Louisiana, and more specifically, in the Baton Rouge, New Orleans, Lafayette and Lake Charles metropolitan areas, in the greater Houston, Texas area, and in western Alabama. As of December 31, 2020, our primary markets were south Louisiana (approximately 86% of our total deposits of $1.7 billion), southeast Texas (approximately 7% of our total deposits) and west Alabama (approximately 7% of our total deposits). We also have pending our acquisition of Cheaha Financial Group, Inc., with approximately $202 million in deposits in east Alabama as of December 31, 2020. At December 31, 2020, approximately 66%, 6%, and 2% of the secured loans in our total loan portfolio were secured by properties and other collateral located in Louisiana, Texas and Alabama, respectively. Our pending acquisition of Cheaha Financial Group, Inc., if completed, would more than double our loans secured by properties and other collateral in Alabama.
This geographic concentration imposes a greater risk to us than to our competitors in the area who maintain significant operations outside of our selected markets. Accordingly, any regional or local economic downturn, or natural or man-made disaster, that affects southern Louisiana, southeast Texas, Alabama, or existing or prospective property or borrowers in such areas may affect us and our profitability more significantly and more adversely than our more geographically diversified competitors.
Much of our business development and marketing strategy is directed toward fulfilling the banking and financial services needs of small to medium-sized businesses. Such businesses generally have fewer financial resources in terms of capital or borrowing capacity than larger entities. If economic conditions negatively impact our selected markets and these businesses are adversely affected, our financial condition and results of operations may be negatively affected.
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Adverse economic factors affecting particular industries could have a negative effect on our customers and their ability to make payments to us.
Certain industry-specific economic factors may also adversely affect us. For example, the energy sector, which is historically cyclical, has experienced significant volatility and a decline in oil and gas prices. While we consider our direct exposure to the energy sector not to be significant, comprising approximately 2.6% of total loans, excluding PPP loans, at December 31, 2020, continued and further depressed oil prices and increased oil price volatility could have further negative impacts on general economic conditions, particularly in our south Louisiana and southeast Texas markets, which could have a material adverse effect on our business, financial condition, and results of operations.
We have a significant number of loans secured by real estate, and a downturn in the real estate market could result in losses and negatively impact our profitability.
At December 31, 2020, approximately 78% of our total loan portfolio had real estate as a primary or secondary component of the collateral securing the loan. The real estate provides an alternate source of repayment in the event of a default by the borrower, but its value may deteriorate during the time the credit is extended. Declines in real estate values in our markets could significantly impair the value of the particular collateral securing our loans and our ability to sell the collateral upon foreclosure for an amount necessary to satisfy the borrower’s obligations to us. Furthermore, in a declining real estate market, we often will need to further increase our allowance for loan losses to address the deterioration in the value of the real estate securing our loans. Any of the foregoing could have a material adverse effect on our business, financial condition, results of operations, cash flows and growth prospects.
Commercial real estate loans may expose us to greater risks than our other real estate loans.
Our loan portfolio includes commercial real estate loans, which are secured by owner-occupied and nonowner-occupied commercial properties. As of December 31, 2020, our owner-occupied commercial real estate loans totaled $375.4 million, or 20% of our total loan portfolio and our nonowner-occupied commercial real estate loans totaled $437.0 million, or 24% of our total loan portfolio.
Commercial real estate loans typically depend on cash flows from the property to service the debt. Cash flows, either in the form of rental income or the proceeds from sales of commercial real estate, may be affected significantly by general economic conditions. Weak economic conditions may impair the borrower’s business operations and typically slow the execution of new leases. Such economic conditions may also lead to existing lease turnover. As a result of these factors, vacancy rates for retail, office and industrial space may increase. High vacancy rates could also result in rents falling. The combination of these factors could result in deterioration in the fundamentals underlying the commercial real estate market and the deterioration in value of some of our loans. These loans expose a lender to greater credit risk than loans secured by residential real estate because the collateral securing these loans typically cannot be liquidated as easily as residential real estate. If we foreclose on these loans, our holding period for the collateral typically is longer than for a one-to-four family residential property because there are fewer potential purchasers of the collateral. Additionally, nonowner-occupied commercial real estate loans generally involve relatively large balances to single borrowers or related groups of borrowers. Accordingly, charge-offs on nonowner-occupied commercial real estate loans may be larger on a per loan basis than those incurred with our residential or consumer loan portfolios. Unexpected deterioration in the credit quality of our commercial real estate loan portfolio would require us to increase our provision for loan losses, which would reduce our profitability and could materially adversely affect our business, financial condition, results of operations, cash flows and growth prospects.
Commercial and industrial loans may expose us to greater risk than other loans.
Commercial and industrial loans primarily consist of working capital lines of credit and equipment loans, typically secured by accounts receivable or inventory, or the relevant equipment. Repayment of these loans generally comes from the generation of cash flow as the result of the borrower’s business operations. Commercial lending generally involves different risks from those associated with commercial real estate lending or construction lending. Although commercial loans may be collateralized by business assets (including real estate, if available as collateral), the repayment of these types of loans depends primarily on the creditworthiness and projected cash flow of the borrower (and any guarantors). Thus, the general business conditions of the local economy and the borrower’s ability to sell its products and services, thereby generating sufficient operating revenue to repay us under the agreed upon terms and conditions, are the chief considerations when assessing the risk of a commercial and industrial loan. The liquidation of collateral, if any, is considered a secondary source of repayment because equipment and other business assets may, among other things, be obsolete or of limited resale value.
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Changes in interest rates could have an adverse effect on our profitability.
The majority of our assets and liabilities are monetary in nature and, as a result, we are subject to significant risk from changes in interest rates. Changes in interest rates may affect our net interest income as well as the valuation of our assets and liabilities. We cannot predict with certainty changes in interest rates, which are affected by many factors beyond our control, including inflation, recession, unemployment, money supply, competition for loans and deposits, domestic and international events, changes in the United States and other financial markets and the policies of the Federal Reserve. Our earnings depend significantly on our net interest income, which is the difference between interest income on interest-earning assets, such as loans and securities, and interest expense on interest-bearing liabilities, such as deposits and borrowings. We expect to periodically experience “gaps” in the interest rate sensitivities of our assets and liabilities, meaning that either our interest-bearing liabilities will be more sensitive to changes in market interest rates than our interest-earning assets, or vice versa. In either event, if market interest rates move contrary to our position, this “gap” may work against us, and our earnings may be adversely affected. When interest-bearing liabilities mature or reprice more quickly, or to a greater degree than interest-earning assets in a period, an increase in interest rates could reduce net interest income. Similarly, when interest-earning assets mature or reprice more quickly, or to a greater degree than interest-bearing liabilities, falling interest rates could reduce net interest income.
Additionally, an increase in the general level of interest rates may also, among other things, adversely affect our current borrowers’ ability to repay variable rate loans, the demand for and our ability to originate loans, and decrease loan prepayment rates, or could increase the cost of the Company’s deposits and borrowings. These circumstances could not only result in increased loan defaults, foreclosures and charge-offs but also necessitate further increases to the allowance for loan losses. At the same time, the marketability of the property securing a loan may be adversely affected by any reduced demand resulting from higher interest rates. Further, when we place a loan on nonaccrual status, we reverse any accrued but unpaid interest receivable, which decreases interest income, but we continue to have a cost to fund the loan, which is reflected as interest expense, without any interest income to offset the associated funding expense. Thus, an increase in the amount of nonperforming assets would have an adverse impact on net interest income.
Conversely, a decrease in the general level of interest rates may lead to, among other things, prepayments on our loan and mortgage-backed securities portfolios as borrowers refinance their loans at lower rates, lower rates on new loans, lower rates on existing variable rate loans, and lower yields on investment securities, which could result in decreased yields on earning assets. Volatility in interest rates may increase competition for deposits, and raise the cost of deposits.
Although our asset-liability management strategy is designed to control and mitigate exposure to the risks related to changes in the general level of market interest rates, we may not be able to accurately predict the likelihood, nature and magnitude of those changes or how and to what extent they may affect our business. We also may not be able to adequately prepare for or compensate for the consequences of such changes. Any failure to predict and prepare for changes in interest rates or adjust for the consequences of these changes may adversely affect our earnings and capital levels. For additional information, see Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations – Risk Management – Interest Rate Risk.
Our allowance for loan losses may prove to be insufficient to absorb losses inherent in our loan portfolio, and we may be required to further increase our provision for loan losses.
Our business depends on our ability to successfully measure and manage credit risk. As a lender, we are exposed to the risk that the principal of and interest on a loan will not be paid timely or at all and that the value of any collateral supporting a loan will be insufficient to cover any exposure to loss on a loan. Management maintains an allowance for loan losses, which is a reserve established through a provision for loan losses charged to expense, to absorb probable credit losses inherent in the entire loan portfolio. We maintain our allowance for loan losses at a level considered adequate by management to absorb probable loan losses, including collateral impairment, based on our analysis of our portfolio and market environment, using relevant information available to us. Among other considerations in establishing the allowance for loan losses, management considers economic conditions reflected within industry segments, the unemployment rate in our markets, loan segmentation and historical losses that are inherent in the loan portfolio.
As of December 31, 2020, our allowance for loan losses as percentages of total loans and nonperforming loans was 1.09% and 147%, respectively. The determination of the appropriate level of the allowance is inherently subjective, involves a high degree of judgment and complexity, and requires us to make significant estimates of current credit risks and future trends, all of which are subject to material changes, particularly in light of the COVID-19 pandemic. In addition, loans acquired in connection with business combination transactions are measured at fair value, based on management’s estimates related to expected prepayments and the amount and timing of undiscounted expected principal, interest and other cash flows. Because fair value
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measurements incorporate assumptions regarding credit risk, no allowance for loan losses related to the acquired loans is recorded on the acquisition date.
Inaccurate management assumptions, including with respect to the fair value of acquired loans, continuing deterioration of economic conditions affecting borrowers, new information regarding existing loans, identification of additional problem loans and other factors, both within and outside of our control, may require us to increase our allowance for loan losses. In addition, bank regulatory agencies periodically review the allowance for loan losses and may require an increase in the provision for loan losses or the recognition of further loan charge-offs, based on judgments different than those of management. Finally, if actual charge-offs in future periods exceed the allowance for loan losses, we will need additional provisions to increase the allowance for loan losses. Any increases in the allowance for loan losses will result in a decrease in net income and, possibly, capital and may have a material adverse effect on our business, financial condition, results of operations and growth prospects.
Commercial and industrial and commercial real estate loans generally are viewed as having more risk of default than residential real estate loans or other loans or investments. These types of loans are also typically larger than residential real estate loans and other consumer loans. Because the loan portfolio contains a significant number of commercial and industrial and commercial real estate loans with relatively large balances, the deterioration of a material amount of these loans may cause a significant increase in our allowance for loan losses, non-performing assets, TDRs and/or past due loans. An increase in our allowance for loan losses, non-performing assets, TDRs, and/or past due loans could result in a loss of earnings, or an increase in loan charge-offs, which would have an adverse impact on our results of operations and financial condition.
In addition, in June 2016, the Financial Accounting Standards Board (“FASB”) issued a new accounting standard (ASU No. 2016-13), referred to as Current Expected Credit Loss (“CECL”) that requires that the measurement of all expected credit losses for financial assets held at the reporting date be based on historical experience, current conditions, and reasonable and supportable forecasts, and requires enhanced disclosures related to the significant estimates and judgments used in estimating credit losses, as well as the credit quality and underwriting standards of an organization’s portfolio. In addition, the new standard amends the accounting for credit losses on purchased financial assets with credit deterioration. We are currently evaluating the potential impact of this new accounting standard on our financial statements. The adoption of ASU 2016-13 is likely to result in an increase in the allowance for loan losses as a result of changing from an “incurred loss” model, which encompasses allowances for current known and inherent losses within the portfolio, to an “expected loss” model, which encompasses allowances for losses expected to be incurred over the life of the portfolio. While we are currently unable to reasonably estimate the impact of adopting ASU 2016-13, we expect that the impact of adoption will be significantly influenced by the composition, characteristics and quality of our loan portfolio, as well as the prevailing economic conditions and forecasts, as of the adoption date. ASU 2016-13 will currently be effective for us, as a smaller reporting company, on January 1, 2023. We expect to adopt the standard as soon as practicable, based upon progress on our implementation plan. Adoption prior to the revised effective date of January 1, 2023 is permitted by the ASU.
The FDIC, Federal Reserve and the OCC issued a final rule to allow a banking organization to elect to phase in the regulatory capital impact over a three-year period commencing with time of adoption of the new standard. A failure to effectively measure the impact of the new CECL standard may result in significant overstatement or understatement of our allowance for loan and lease losses, and in the event of an understatement, may necessitate that we significantly increase our allowance for loan and lease losses, which could adversely affect our net income.
Loss of our senior executive officers or other key employees and our inability to recruit or retain suitable replacements could adversely affect our business, results of operations and growth prospects.
Our success depends significantly on the continued service and skills of our existing executive management team. The implementation of our business and growth strategies also depends significantly on our ability to retain employees with experience and business relationships within their respective market areas, as well as on our ability to attract, motivate and retain highly qualified senior and middle management. We do not have employment agreements with any of our executive officers, and they may terminate their employment with us at any time. Competition for employees is intense, and we could have difficulty replacing such officers with personnel with the combination of skills and attributes required to execute our business and growth strategies and who have ties to the communities within our market areas. The loss of any of our key personnel could therefore have a material adverse effect on our business, financial condition, results of operations and growth prospects.
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Changes in the method pursuant to which the LIBOR and other benchmark rates are determined could adversely impact our business and results of operations.
Our floating-rate funding, certain hedging transactions and certain of the products we offer, such as floating-rate loans, determine their applicable interest rate or payment amount by reference to a benchmark rate, such as LIBOR, or to an index, currency, basket or other financial metric. The administrator of LIBOR has proposed to extend publication of the most commonly used U.S. Dollar LIBOR settings to June 30, 2023 and to cease publishing other LIBOR settings on December 31, 2021. The U.S. federal banking agencies have issued guidance strongly encouraging banking organizations to cease using U.S. dollar LIBOR as a reference rate in new contracts as soon as practicable and in any event by December 31, 2021. Consequently, at this time, it is not possible to predict whether LIBOR will continue to be viewed as an acceptable market benchmark, what rate or rates may become accepted alternatives to LIBOR, or what the effect of any such changes in views or alternatives may be on the markets for LIBOR-linked financial instruments. Certain of our LIBOR-based financial products and contracts, including, but not limited to, hedging products, debt obligations, investments and loans, extend beyond 2021. We are in the process of assessing the impact that a cessation or market replacement of LIBOR would have on these various products and contracts.
Hurricanes or other adverse weather conditions, as well as man-made disasters, could negatively affect our local markets or disrupt our operations, which may adversely affect our business and results of operations.
Our business is concentrated in southern Louisiana, in southeast Texas, and in west Alabama. Our selected markets are susceptible to major hurricanes, floods, tropical storms, tornadoes and other natural disasters and adverse weather, the nature and severity of which can be difficult to predict. These natural disasters can disrupt our operations, cause widespread property damage, and severely depress the local economies in which we operate. For example, the historic flooding of Baton Rouge and surrounding areas in August 2016 had significant impacts in several markets in which we conduct business. Hurricane Harvey caused significant damage and flooding in Texas when it made landfall in August 2017. The severity and impact of future severe weather events are difficult to predict and may be exacerbated by global climate change. The 2010 Deepwater Horizon oil spill in the Gulf of Mexico illustrated that man-made disasters can also adversely affect economic activity in the markets in which we operate. Any economic decline as a result of a natural disaster, adverse weather, oil spill or other man-made disaster can reduce the demand for loans and our other products and services.
Such events could also affect the stability of our deposit base, impair the ability of borrowers to repay outstanding loans (resulting in increased delinquencies, foreclosures and loan losses), impair the value of collateral securing such loans, cause significant property damage, result in loss of revenue and/or cause us to incur additional expenses. The occurrence of any such event could, therefore, result in decreased revenue and loan losses that have a material adverse effect on our business, financial condition, results of operations and growth prospects.
Our failure to effectively implement new technologies could adversely affect our operations and financial condition.
Our industry is undergoing rapid technological changes with frequent introductions of new technology-driven products and services. Our ability to compete successfully to some extent depends on whether we can implement new technologies to provide products and services to our customers more efficiently while avoiding significant operational challenges that increase our costs or delay full implementation, especially relative to our peers, many of which have greater resources to devote to technological improvements.
We rely on information technology and telecommunications systems, many of which are provided by third-party vendors.
The successful and uninterrupted functioning of our information technology and telecommunications systems is critical to our business. We outsource many of our major systems, such as data processing and deposit processing. If one of these third-party service providers terminates their relationship with us or fails to provide services to us for any reason or provides such services poorly, our business may be materially and adversely affected. In addition, we may be forced to replace such vendors, which could interrupt our operations and result in a higher costs to us.
Cyber-attacks or other security breaches could adversely affect our operations, net income or reputation.
As part of our banking business, we and certain of our third-party vendors collect, use and hold sensitive data concerning individuals and businesses with whom we have a banking relationship. Threats to data security, including unauthorized access and cyber-attacks, rapidly emerge and change and are becoming increasingly sophisticated, exposing us to additional costs to secure our data in accordance with customer expectations and statutory and regulatory requirements. We could also experience a breach by intentional or negligent conduct on the part of our employees or other internal sources or by merchants using our
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customers’ debit and credit cards, software bug, other technical malfunctions, or other causes. As a result of any of these threats, our computer systems and/or our customer accounts could become vulnerable to misappropriation of confidential information, account takeover schemes or cyber-fraud. Our systems and those of our third-party vendors may become vulnerable to damage or disruption due to circumstances beyond our or their control, such as from catastrophic events, power anomalies or outages, natural disasters, network failures, and viruses and malware.
A breach of security that results in unauthorized access to our data could result in violations of applicable privacy and other laws and expose us to disruptions in our daily operations as well as to data loss, litigation, damages, fines and penalties, customer notification requirements, significant increases in compliance and insurance costs, increases in costs for measures to minimize and remediate these risks and breaches, loss of confidence in our security measures, and reputational damage, any of which could individually or in the aggregate have a material adverse effect on our business, results of operations, financial condition, prospects, and shareholder value.
We have attempted to address these concerns by backing up our systems as well as retaining qualified third-party vendors to test and audit our network. However, there can be no guarantees that our efforts and those of our third-party vendors will be successful in avoiding material problems with our information technology and telecommunications systems. We may not be able to anticipate all cyber security breaches or implement effective preventative measures against such breaches.
Loss of deposits or a change in deposit mix could increase the Companys funding costs.
Deposits are a low cost and stable source of funding. We compete with banks and other financial institutions for deposits. Funding costs could increase if the Company loses deposits and replaces them with more expensive sources of funding, if customers shift their deposits into higher cost products, or if the Company needs to raise its interest rates to avoid losing deposits. Higher funding costs reduce the Company’s net interest margin, net interest income and net income.
We may need to raise additional capital in the future to execute our business strategy.
In addition to the liquidity that we require to conduct our day-to-day operations, the Company, on a consolidated basis, and the Bank, on a stand-alone basis, must meet regulatory requirements. Also, we may need capital to finance our growth, including through acquisitions. In 2019, we sold $25.0 million of subordinated notes structured to qualify as tier 2 capital, and $30.0 million of common stock, in part to fund acquisitions.
Our ability to raise additional capital depends on conditions in the capital markets, economic conditions and a number of other factors, including investor perceptions regarding the banking industry, market conditions and governmental activities, and on our financial condition and performance. Accordingly, there can be no assurances that we will be able to raise additional capital if needed or on terms acceptable to us. If we fail to maintain capital to meet regulatory requirements, our business, financial condition, results of operations and growth prospects could be materially and adversely affected.
Competition in our industry is intense, which could adversely affect our growth and profitability.
We face substantial competition in all areas of our operations from a variety of different competitors, many of which are larger and have substantially greater resources than we have, including higher total assets and capitalization, a more extensive and established branch network, greater access to capital markets and a broader offering of financial services. Such competitors primarily include national, regional and community banks within the various markets in which we operate. Because of their scale, many of these competitors can be more aggressive than we can on loan and deposit pricing. We also face competition from many other types of financial institutions, including savings and loans, credit unions, finance companies, brokerage firms, insurance companies, factoring companies and other financial intermediaries. Many of these entities have fewer regulatory constraints and may have lower cost structures than we do.
Our industry could become even more competitive as a result of legislative and regulatory changes as well as continued consolidation. The increased regulatory requirements imposed on financial institutions as well as the economic downturn in the United States in the 2007-2009 time frame, and generally slow recovery thereafter, have already resulted in the consolidation of a number of financial institutions, in addition to acquisitions of failed institutions. We expect additional consolidation to occur. Finally, technology has lowered barriers to entry and made it possible for non-banks to offer products and services traditionally provided by banks, such as automatic transfer and automatic payment systems. Our ability to compete successfully depends on a number of factors, including customer convenience, quality of service, personal contacts, pricing and range of products. If we are unable to successfully compete, our business, financial condition, results of operations and growth prospects will be materially adversely affected.
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If the goodwill that we record in connection with a business acquisition becomes impaired, it could require charges to earnings, which would have a negative impact on our financial condition and results of operations.
Goodwill represents the amount by which the cost of an acquisition exceeded the fair value of net assets we acquired in connection with the purchase of another financial institution. We review goodwill for impairment at least annually, or more frequently if events or changes in circumstances indicate that the carrying value of the asset might be impaired.
We determine impairment by comparing the implied fair value of the reporting unit goodwill with the carrying amount of that goodwill. If the carrying amount of the reporting unit goodwill exceeds the implied fair value of that goodwill, an impairment loss is recognized in an amount equal to that excess. Any such adjustments are reflected in our results of operations in the periods in which they become known. As of December 31, 2020, our goodwill totaled $28.1 million. While we have not recorded any such impairment charges since we initially recorded the goodwill, there can be no assurance that our future evaluations of goodwill will not result in findings of impairment and related write-downs, which may have a material adverse effect on our financial condition and results of operations.
Factors outside our control could result in impairment of or losses with respect to our investment securities.
Under applicable accounting standards, we are required to review our securities portfolio periodically for the presence of other-than-temporary impairment, taking into consideration current market conditions, the extent and nature of changes in fair value, issuer rating changes and trends, volatility of earnings, current analysts’ evaluations, our ability and intent to hold securities until a recovery of fair value, as well as other factors. Adverse developments with respect to one or more of the foregoing factors may require us to deem particular securities to be other-than-temporarily impaired, with the credit related portion of the reduction in the value recognized as a charge to the results of operations in the period in which the impairment occurs. Market volatility may make it difficult to value certain securities. Subsequent valuations, in light of factors prevailing at that time, may result in significant changes in the values of these securities in future periods. Any of these factors could require us to recognize further impairments in the value of our securities portfolio, which may have an adverse effect on our results of operations in future periods.
A lack of liquidity could adversely affect our ability to fund operations and meet our obligations as they become due.
Liquidity is essential to our business. Liquidity risk is the potential that we will be unable to meet our obligations as they come due because of an inability to liquidate assets or obtain adequate funding. The primary source of the Bank’s funds are customer deposits and loan repayments, while borrowings are a secondary source of liquidity. Our access to deposits and other funding sources in adequate amounts and on acceptable terms is affected by a number of factors, including rates paid by competitors, returns available to customers on alternative investments and general economic conditions. Any decline in available funding could adversely impact our ability to originate loans, invest in securities, meet our expenses, pay dividends to our shareholders, or to fulfill obligations such as repaying our borrowings or meeting deposit withdrawal demands, any of which could have a material adverse impact on our business, financial condition, results of operations and growth prospects.
We face significant operational and other risks related to our activities, which could expose us to negative publicity, litigation and/or regulatory action.
We are exposed to many types of operational risks, including, particularly as a financial institution, fraud risks and human error. Our fraud risks include fraud committed by external parties against the Company or our customers and fraud committed internally by our associates. Certain fraud risks, including identity theft and account takeover, may increase as a result of customers’ accounts or personally identifiable information being obtained through breaches of retailers’ or other third parties’ networks. There are inherent limitations to our risk management strategies, as there may exist, or develop in the future, risks that we have not appropriately anticipated, monitored or identified. If our risk management framework proves ineffective, we could suffer unexpected losses, we may have to expend resources detecting and correcting the failure in our systems and we may be subject to potential claims from third parties and government agencies. We may also suffer severe reputational damage. Any of these consequences could materially and adversely affect our business, financial condition or results of operations.
Because the nature of the financial services industry involves a high volume of transactions, certain systems or human errors may be repeated or compounded before they are discovered and successfully rectified. The Company’s necessary dependence upon automated systems to record and process our transaction volume may further increase the risk that technical flaws or associate tampering or manipulation of those systems will result in losses that are difficult to detect. The Company is further exposed to the risk that our third-party vendors may be unable to fulfill their contractual obligations, or will be subject to the same risk of fraud or systems or human errors as we are. These risks include the cyber-security risks discussed above.
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Risks Related to Our Industry
We operate in a highly regulated environment, which could restrain our growth and profitability.
We are subject to extensive regulation and supervision under federal and state banking laws and regulations that govern almost all aspects of our operations, including, among other things, our lending practices, capital structure, investment practices, dividend policy, operations and growth. The level of regulatory scrutiny that we are subject to may fluctuate over time, based on numerous factors, including as a result of the change in the U.S. presidential administration in January 2021. These laws and regulations, and the supervisory framework that oversees the administration of these laws and regulations, are primarily intended to protect consumers, depositors, the Deposit Insurance Fund and the banking system as a whole, and not shareholders and counterparties. Furthermore, new proposals for legislation continue to be introduced in the U.S. Congress that could further substantially increase regulation of the financial services industry, impose restrictions on our operations and our ability to conduct business consistent with historical practices, including in the areas of compensation, interest rates, financial product offerings and disclosures, and have an effect on bankruptcy proceedings with respect to consumer residential real estate mortgages, among other things, which could have a material adverse effect on our business, financial condition, results of operations and growth prospects. Our efforts to comply with these additional laws, regulations and standards are likely to result in increased expenses and a diversion of management time and attention. The information under the heading “Supervision and Regulation” in Item 1. Business, provides more information regarding the regulatory environment in which we and the Bank operate.
Federal regulators periodically examine our business, and we may be required to remediate adverse examination findings.
The financial services industry is subject to intense scrutiny from bank supervisors in the examination process and aggressive enforcement of regulations on both the federal and state levels. The Federal Reserve and the OCC periodically examine our business, including our compliance with laws and regulations. If, as a result of an examination, a federal banking agency were to determine that our financial condition, capital resources, asset quality, earnings prospects, management, liquidity or other aspects of any of our operations had become unsatisfactory, or that we were in violation of any law or regulation, it may take a number of different remedial actions as it deems appropriate. These actions include the power to enjoin “unsafe or unsound” practices, to require affirmative action to correct any conditions resulting from any violation or practice, to issue an administrative order that can be judicially enforced, to direct an increase in our capital, to restrict our growth, to assess civil monetary penalties against our officers or directors, to remove officers and directors and, if it is concluded that such conditions cannot be corrected or there is an imminent risk of loss to depositors, to terminate our deposit insurance and place us into receivership or conservatorship. If we become subject to any regulatory actions, it could have a material adverse effect on our business, results of operations, financial condition and growth prospects. Failure to comply with any applicable regulations and supervisory expectations related thereto could result in fines, penalties, lawsuits, regulatory sanctions, reputation damage or restrictions on business.
We are subject to numerous laws designed to protect consumers, including the Community Reinvestment Act and fair lending laws, and failure to comply with these laws could lead to a wide variety of sanctions.
The ECOA, the Fair Housing Act and other fair lending laws and regulations impose nondiscriminatory lending requirements on financial institutions. The Department of Justice and other federal agencies enforce these laws and regulations, but private parties may also have the ability to challenge an institution’s performance under fair lending laws in private class action litigation. If an institution’s performance under the fair lending laws and regulations is found to be deficient, the institution could be subject to damages and civil money penalties, injunctive relief, restrictions on mergers and acquisitions activity, restrictions on expansion and restrictions on entering new business lines, among other sanctions. In addition, the OCC’s assessment of our compliance with the Community Reinvestment Act (“CRA”) is taken into account when evaluating any application we submit for, among other things, approval of the acquisition or establishment of a branch or other deposit facility, an office relocation, a merger or the acquisition of another financial institution. Our failure to satisfy our CRA obligations could, at a minimum, result in the denial of such applications and limit our growth.
We face a risk of noncompliance and enforcement action with the Bank Secrecy Act and other anti-money laundering statutes and regulations.
The Bank Secrecy Act, the USA PATRIOT Act of 2001, and other laws and regulations require financial institutions, among other duties, to institute and maintain an effective anti-money laundering program and file suspicious activity and currency transaction reports as appropriate. The federal Financial Crimes Enforcement Network is authorized to impose significant civil money penalties for violations of those requirements and has recently engaged in coordinated enforcement efforts with the individual federal banking regulators, as well as the U.S. Department of Justice, Drug Enforcement Administration and Internal
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Revenue Service. We are also subject to increased scrutiny of compliance with the rules enforced by the Office of Foreign Assets Control. If our policies, procedures and systems are deemed deficient, we would be subject to liability, including fines and regulatory actions, which may include restrictions on our ability to pay dividends and the necessity to obtain regulatory approvals to proceed with certain aspects of our business plan, including our acquisition plans. Failure to maintain and implement adequate programs to combat money laundering and terrorist financing could also have serious reputational consequences for us. Any of these results could materially and adversely affect our business, financial condition, results of operations and growth prospects.
In addition, bank regulatory agencies consider the effectiveness of a financial institution’s anti-money laundering activities and other regulatory compliance matters when reviewing bank mergers and bank holding company acquisitions. Accordingly, non-compliance with the applicable regulations could materially impair the Company’s ability to enter into or complete mergers and acquisitions.
Our success depends on our ability to respond to the threats and opportunities of fintech innovation.
Fintech developments, such as bitcoin or other types of cryptocurrency and the development of alternative payment systems, have the potential to disrupt the financial industry and change the way banks do business. Our success depends on our ability to adapt to the pace of the rapidly changing technological environment, which is crucial to retention and acquisition of customers. On July 31, 2018, the OCC announced it will grant limited-purpose national bank charters to fintech companies that offer bank products and services. The federal charter would allow fintech companies to operate nationwide under a single set of national standards, without needing to seek state-by-state licenses or joining with brick-and-mortar banks, which could have the effect of allowing fintech companies to more easily compete with us for financial products and services in the communities we serve. In October 2019, a federal district court blocked the OCC’s ability to issue such charters. The OCC has filed an appeal which is still pending.
We may be required to pay significantly higher FDIC deposit insurance premiums in the future.
The deposits of Investar Bank are insured by the FDIC up to legal limits and, accordingly, subject it to the payment of FDIC deposit insurance assessments. We are generally unable to control the amount of premiums that we are required to pay for FDIC deposit insurance. A bank’s regular assessments are determined by its risk classification, which is based on certain financial information and the level of supervisory concern that it poses. In order to maintain a strong funding position and restore the reserve ratios of the DIF, the FDIC has, in the past, increased deposit insurance assessment rates and charged a special assessment to all FDIC-insured financial institutions. Further increases in assessment rates or special assessments may occur in the future, especially if there are significant financial institution failures. Any future special assessments, increases in assessment rates or required prepayments in FDIC insurance premiums could reduce our profitability or limit our ability to pursue certain business opportunities, which could have an adverse effect on our business, financial condition and results of operations.
Our use of third-party vendors and our other ongoing third-party business relationships are subject to increasing regulatory requirements and attention.
We regularly use third-party vendors as part of our business. We also have substantial ongoing business relationships with other third parties. These types of third-party relationships are subject to increasingly demanding regulatory requirements and attention by our federal bank regulators. Regulation requires us to perform due diligence and ongoing monitoring and control over our third-party vendors and other ongoing third-party business relationships. In certain cases we may be required to renegotiate our agreements with these vendors to meet these requirements, which could increase our costs. We expect that our regulators will hold us responsible for deficiencies in our oversight and control of our third party relationships and in the performance of the parties with which we have these relationships. As a result, if our regulators conclude that we have not exercised adequate oversight and control over our third-party vendors or other ongoing third party business relationships or that such third parties have not performed appropriately, we could be subject to enforcement actions, including civil money penalties or other administrative or judicial penalties or fines as well as requirements for customer remediation, any of which could have a material adverse effect our business, financial condition or results of operations.
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Risks Related to an Investment in our Common Stock
The market price of our common stock may be volatile, which may make it difficult for investors to sell their shares at the volume, prices and times desired.
The market price of our common stock may fluctuate substantially due to a variety of factors, many of which are beyond our control, including, without limitation:
actual or anticipated variations in our quarterly and annual operating results, financial condition or asset quality;
changes in general economic or business conditions, both domestically and internationally;
the effects of, and changes in, trade, monetary and fiscal policies, including the interest rate policies of the Federal Reserve, or in laws and regulations affecting us;
changes in the credit, mortgage and real estate markets;
the number of securities analysts covering us;
our creditworthiness;
publication of research reports about us, our competitors, or the financial services industry generally, or changes in, or failure to meet, securities analysts’ estimates of our financial and operating performance, or lack of research reports by industry analysts or ceasing of coverage;
changes in market valuations or earnings of companies that investors deemed comparable to us;
the average daily trading volume of our common stock;
future issuances of our common stock or other securities;
changes in dividends on our common stock;
additions or departures of key personnel;
perceptions in the marketplace regarding our competitors and/or us;
significant acquisitions or business combinations, strategic partnerships, joint ventures or capital commitments by or involving our competitors or us; and
other news, announcements or disclosures (whether by us or others) related to us, our competitors, our markets or the financial services industry.
The stock market and, in particular, the market for financial institution stocks have experienced significant fluctuations in recent years. For example, the COVID-19 pandemic led to a period of depressed market conditions in the first quarter of 2020, and market conditions have remained volatile since that period. In addition, significant fluctuations in the trading volume in our common stock may cause significant price variations to occur. Increased market volatility may materially and adversely affect the market price of our common stock, which may make it difficult for investors to sell their shares at the volume, prices and times desired.
Shares eligible for future sale could adversely affect market prices of our common stock.
Shares of our common stock eligible for future sale, including those that may be issued in any private or public offering of our common stock, as consideration in acquisition transactions, or as incentives under incentive plans, could adversely affect market prices for our common stock. As of December 31, 2020, we had 10,608,869 shares outstanding and 408,288 shares subject to options granted under our incentive plan. On December 19, 2019, we sold 1,290,323 shares of our common stock in a private placement and have registered those shares for resale under the Securities Act of 1933, as amended (the “Securities Act”). Because our other outstanding shares of common stock either were issued in an offering registered under the Securities Act or have been held for more than one year, such shares are freely tradable, except for shares held by our affiliates (approximately 8% of shares outstanding as of December 31, 2020) and 207,146 shares that represent unvested restricted shares under our incentive plan. Shares issued under our incentive plan will be available for sale into the public market, except for shares held by our affiliates. Shares held by our affiliates may be resold subject to the restrictions in Rule 144 of the Securities Act. In the future, we may issue additional shares of common stock to raise capital for growth or as consideration in acquisition transactions or for other purposes, and such shares may be registered under the Securities Act and freely tradable or may be issued in a private placement and registered for resale under the Securities Act.
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Our dividend policy may change without notice, and our future ability to pay dividends is subject to restrictions.
Holders of our common stock are entitled to receive only such cash dividends as our board of directors may declare out of funds legally available for the payment of dividends. We have no obligation to continue paying dividends, and we may change our dividend policy at any time without notice to our shareholders. In addition, our existing and future debt agreements limit, or may limit, our ability to pay dividends. Under the terms of our 5.125% Fixed-to-Floating Rate Subordinated Notes due 2029, we may not pay a dividend if either our parent company or the Bank, both immediately prior to the declaration of the dividend and after giving effect to the payment of the dividend, would not maintain regulatory capital ratios that are as “well capitalized” levels for regulatory capital purposes. We are also prohibited from paying dividends upon and during the continuance of any Event of Default under such notes.
Since the Company’s primary asset is its stock of Investar Bank, we are dependent upon dividends from the Bank to pay our operating expenses, satisfy our obligations and to pay dividends on the Company’s common stock. Accordingly, any declaration and payment of dividends on common stock will substantially depend upon the Bank’s earnings and financial condition, liquidity and capital requirements, the general economic and regulatory climate and other factors deemed relevant by our board of directors. Furthermore, consistent with our strategic plans, growth initiatives, capital availability, projected liquidity needs, and other factors, we have made, and will continue to make, capital management decisions and policies that could adversely impact the amount of dividends, if any, paid to our common shareholders.
In addition, there are numerous laws and banking regulations that limit our and Investar Bank’s ability to pay dividends. For Investar Bank, federal statutes and regulations require, among other things, that the Bank maintain certain levels of capital in order to pay a dividend. Further, federal banking authorities have the ability to restrict the payment of dividends by supervisory action. At the holding company level, the Federal Reserve Board has indicated that bank holding companies should carefully review their dividend policy in relation to the organization’s overall asset quality, level of current and prospective earnings and level, composition and quality of capital. The guidance requires that a company inform and consult with the Federal Reserve Board prior to declaring and paying a dividend that exceeds earnings for the period for which the dividend is being paid or that could result in an adverse change to its capital structure.
Our Restated Articles of Incorporation and By-laws, and certain banking laws applicable to us, could have an anti-takeover effect that decreases our chances of being acquired, even if our acquisition is in our shareholders’ best interests.
Certain provisions of our restated articles of incorporation and our by-laws, as amended, and federal banking laws, including regulatory approval requirements, could make it more difficult for a third party to acquire control of our organization or conduct a proxy contest, even if those events were perceived by many of our shareholders as beneficial to their interests. These provisions, and the corporate and banking laws and regulations applicable to us:
enable our board of directors to issue additional shares of authorized, but unissued capital stock. In particular, our board may issue “blank check” preferred stock with such designations, rights and preferences as may be determined from time to time by the board;
enable our board of directors to increase the size of the board and fill the vacancies created by the increase;
enable our board of directors to amend our by-laws without shareholder approval;
require advance notice for director nominations and other shareholder proposals; and
require prior regulatory application and approval of any transaction involving control of our organization.
These provisions may discourage potential acquisition proposals and could delay or prevent a change in control, including circumstances in which our shareholders might otherwise receive a premium over the market price of our shares.
Our issuance of preferred stock could adversely affect holders of our common stock and discourage a takeover.
Our shareholders authorized our board of directors to issue up to 5,000,000 shares of preferred stock without any further action on the part of our shareholders. The board also has the power, without shareholder approval, to set the terms of any series of preferred stock that may be issued, including voting rights, dividend rights, preferences over our common stock with respect to dividends or in the event of a dissolution, liquidation or winding up and other terms. In the event that we issue preferred stock in the future that has preference over our common stock with respect to payment of dividends or upon our liquidation, dissolution or winding up, or if we issue preferred stock with voting rights that dilute the voting power of our common stock, the rights of the holders of our common stock or the market price of our common stock could be adversely affected. In addition,
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the ability of our board of directors to issue shares of preferred stock without any action on the part of our shareholders may impede a takeover of us and prevent a transaction perceived to be favorable to our shareholders.
An investment in our common stock is not an insured deposit and is subject to risk of loss.
Our common stock is not a bank deposit and, therefore, is not insured against loss by the FDIC, any 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 Annual Report on Form 10-K and is subject to the same market forces that affect the price of common stock in any company. As a result, an investor may lose some or all of his or her investment in our common stock.

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Item 1B. Unresolved Staff Comments
Not applicable.

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Item 2. Properties
Our main office, which serves as our executive and operations center, is located at 10500 Coursey Boulevard in Baton Rouge, Louisiana. In addition, we operate 31 branches. Our 24 branches in Louisiana are located in Ascension (2), East Baton Rouge (5), West Baton Rouge (1), Jefferson (2), Lafayette (2), Livingston (1), Orleans (1), St. Tammany (1), Tangipahoa (1), East Feliciana (2), West Feliciana (1), Evangeline (3) and Calcasieu (2) Parishes. Our five branches in Texas are located in Galveston (2), Harris (1), Victoria (1) and Jim Wells (1) Counties. In Alabama, two branches are located in Sumter County and one loan production office is located in Tuscaloosa County. We also have one stand-alone automated teller machine in Baton Rouge, Louisiana and one stand-alone interactive teller machine in Morgan City, Louisiana.
We own our main office and all of our branch offices in Louisiana and Alabama, with the exception of two leased branch locations and one leased loan production office. Of the branches acquired from Mainland, located in Texas, one location is owned and two are leased properties. Each of our owned branch facilities is a stand-alone building, equipped with an automated teller machine or interactive teller machine, on-site parking, and drive-up access. Both branches acquired from PlainsCapital, also located in Texas, are leased properties. We believe that our facilities are in good condition and are adequate to meet our operating needs for the foreseeable future.
We also own two tracts of land in East Baton Rouge Parish and a tract of land in each of the following Louisiana parishes: St. Mary Parish; Lafayette Parish; Jefferson Parish; and Ascension Parish. Each tract of land has been designated as either a future branch or standalone interactive teller machine location. The timing of the development of these tracts of land is uncertain.
Item 3. Legal Proceedings
From time to time we are party to ordinary routine litigation matters incidental to the conduct of our business. We are not presently party to, and none of our property is the subject of, any legal proceedings, the resolution of which we believe would have a material adverse effect on our business, financial condition, results of operations, cash flows, growth prospects or capital levels, nor were any such proceedings terminated during the fourth quarter of 2020.
Item 4. Mine Safety Disclosures
Not applicable.
PART II

Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
Market Information
Our common stock is listed on the Nasdaq Global Market (the “Nasdaq”) under the symbol “ISTR.” As of March 8, 2021, there were approximately 724 holders of record of our common stock.
Dividend Policy
The Company has paid a quarterly dividend since 2011 and intends to continue to declare dividends on a quarterly basis. The declaration of dividends is at the discretion of our board of directors and will depend on our financial performance, future prospects, regulatory requirements and other factors deemed relevant by the board of directors.
Since we are a holding company with no material business activities, our ability to pay dividends is substantially dependent upon the ability of Investar Bank to transfer funds to us in the form of dividends, loans and advances. The Bank’s ability to pay dividends and make other distributions and payments to us depends upon the Bank’s earnings, financial condition, general economic conditions, compliance with regulatory requirements and other factors. In addition, the Bank’s ability to pay dividends to us is itself subject to various legal, regulatory and other restrictions. See Item 1. Business — Supervision and Regulation — Dividends, above for a discussion of the restrictions on dividends under federal banking laws and regulations. In addition, as a Louisiana corporation, we are subject to certain restrictions on dividends under the Louisiana Business Corporation Act. Generally, a Louisiana corporation may pay dividends to its shareholders unless, after giving effect to the dividend, either (1) the corporation would not be able to pay its debts as they come due in the usual course of business or (2) the corporations’ total assets are less than the sum of its total liabilities and the amount that would be needed, if the corporation
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were to be dissolved at the time of the payment of the dividend, to satisfy the preferential rights of shareholders whose preferential rights are superior to those receiving the dividend. In addition, our existing and future debt agreements limit, or may limit, our ability to pay dividends. Under the terms of our 5.125% Fixed-to-Floating Rate Subordinated Notes due 2029, we may not pay a dividend if either our parent company or the Bank, both immediately prior to the declaration of the dividend and after giving effect to the payment of the dividend, would not maintain regulatory capital ratios that are at “well capitalized” levels for regulatory capital purposes. We are also prohibited from paying dividends upon and during the continuance of any Event of Default under such notes. Finally, our ability to pay dividends may be limited on account of the junior subordinated debentures that we assumed through acquisitions. We must make payments on the junior subordinated debentures before any dividends can be paid on our common stock.
These restrictions do not, and are not expected in the future to, materially limit the Company’s ability to pay dividends to its shareholders in an amount consistent with the Company’s history of paying dividends.
Stock Performance Graph
The following graph compares the cumulative total shareholder return on the Company’s common stock over a measurement period beginning January 1, 2016 with (i) the cumulative total return on the stocks included in the Russell 3000 Index and (ii) the cumulative total return on the stocks included in the SNL Index of Banks with assets between $1 billion and $5 billion. The performance graph assumes that the value of the investment in our common stock, the Russell 3000 Index and the SNL Index of Banks was $100 at January 1, 2016 and that all dividends were reinvested.
ISTR-20201231_G2.JPG
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Index 12/31/2015 6/30/2016 12/31/2016 6/30/2017
Investar Holding Corporation $ 100.00  $ 87.50  $ 106.24  $ 130.70 
Russell 3000 100.00  103.62  112.74  122.80 
SNL U.S. Bank $1B-$5B 100.00  98.71  143.87  144.16 
12/31/2017 6/30/2018 12/31/2018 6/30/2019
Investar Holding Corporation $ 137.72  $ 158.43  $ 142.83  $ 137.68 
Russell 3000 136.56  140.95  129.40  153.61 
SNL U.S. Bank $1B-$5B 153.37  166.59  134.37  147.44 
12/31/2019 6/30/2020 12/31/2020
Investar Holding Corporation $ 139.56  $ 84.78  $ 97.99 
Russell 3000 169.54  163.64  204.95 
SNL U.S. Bank $1B-$5B 163.35  114.27  138.81 
There can be no assurance that our common stock performance will continue in the future with the same or similar trends depicted in the performance graph above. We will not make or endorse any predictions as to future stock performance.
The information provided under the heading “Stock Performance Graph” shall not be deemed to be “soliciting material” or to be “filed” with the SEC or subject to its proxy regulations or to the liabilities of Section 18 of the Securities Exchange Act of 1934, as amended, other than as provided in Item 201 of Regulation S-K. The information provided in this section shall not be deemed to be incorporated by reference into any filing under the Securities Act of 1933, as amended, or the Securities Exchange Act of 1934, as amended.
Issuer Purchases of Equity Securities
Period
(a) Total Number of Shares (or Units) Purchased(1)
(b) Average Price Paid per Share (or Unit) (c ) Total Number of Shares (or Units) Purchased as Part of Publicly Announced Plans or Programs
(d) Maximum Number (or Approximate Dollar Value) of Shares (or Units) That May Be Purchased Under the Plans or Programs (2)
October 1, 2020 to October 31, 2020 7,700  $ 13.19  7,700  278,029 
November 1, 2020 to November 30, 2020 598  13.57  500  277,529 
December 1, 2020 to December 31, 2020 12,699  16.69  12,699  264,830 
20,997  $ 15.32  20,899  264,830 
 
(1)Includes 98 shares surrendered to cover the payroll taxes due upon the vesting of restricted stock.
(2)On March 10, 2020, the Company announced that its board of directors authorized the repurchase of an additional 300,000 shares of the Company’s common stock under its stock repurchase plan, in addition to the 326,344 shares that were remaining as authorized for repurchase at December 31, 2019. On August 27, 2020, the Company announced that its board of directors authorized the repurchase of an additional 300,000 shares of the Company’s common stock under its stock repurchase plan.
Unregistered Sales of Equity Securities
Not applicable.
Securities Authorized for Issuance under Equity Compensation Plans
Please refer to the information under the heading “Securities Authorized for Issuance under Equity Compensation Plans” in Item 12, Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters, for a discussion of the securities authorized for issuance under the Company’s equity compensation plans.
Item 6. Selected Financial Data
Not applicable.
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Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
This section presents management’s perspective on the financial condition and results of operations of Investar Holding Corporation (the “Company,” “we,” “our,” or “us”) and its wholly-owned subsidiary, Investar Bank, National Association (the “Bank”). The following discussion and analysis should be read in conjunction with the Company’s consolidated financial statements and related notes and other supplemental information included herein. Certain risks, uncertainties and other factors, including those set forth under Item 1A. Risk Factors in Part I, and elsewhere in this Annual Report on Form 10-K, may cause actual results to differ materially from those projected results discussed in the forward-looking statement appearing in this discussion and analysis.
SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS
This annual report on Form 10-K, both in Management’s Discussion and Analysis of Financial Condition and Results of Operations, and elsewhere, contains forward-looking statements within the meaning of Section 27A of the Securities Act and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). These forward-looking statements include statements relating to our projected growth, anticipated future financial performance, financial condition, credit quality and performance goals, as well as statements relating to the anticipated effects on our business, financial condition and results of operations from expected developments, our growth, and potential acquisitions. These statements can typically be identified through the use of words or phrases such as “may,” “should,” “could,” “predict,” “potential,” “believe,” “think,” “will likely result,” “expect,” “continue,” “will,” “anticipate,” “seek,” “estimate,” “intend,” “plan,” “projection,” “would” and “outlook,” or the negative version of those words or other comparable words or phrases of a future or forward-looking nature.
Our forward-looking statements contained herein are based on assumptions and estimates that management believes to be reasonable in light of the information available at this time. However, many of these statements are inherently uncertain and beyond our control and could be affected by many factors. Factors that could have a material effect on our business, financial condition, results of operations, cash flows and future growth prospects can be found in Item 1A. Risk Factors. These factors include, but are not limited to, the following, any one or more of which could materially affect the outcome of future events:
the significant risks and uncertainties for our business, results of operations and financial condition, as well as our regulatory capital and liquidity ratios and other regulatory requirements in the United States caused by the ongoing COVID-19 pandemic, which will depend on several factors, including the scope and duration of the pandemic, its continued influence on the economy and financial markets, the impact on market participants on which we rely, and actions taken by governmental authorities and other third parties in response to the pandemic;
business and economic conditions generally and in the financial services industry in particular, whether nationally, regionally or in the markets in which we operate; including evolving risks to economic activity and our customers posed by the COVID-19 pandemic and government actions taken to address the impact of COVID-19 or contain it;
ongoing disruptions in the oil and gas industry due to the significant decrease in the price of oil;
the risk of holding PPP loans at unfavorable rates and on terms that are less favorable than other types of loans, and the Company’s ability to pursue available remedies in the event of a loan default of PPP loans under the Paycheck Protection Program;
our ability to achieve organic loan and deposit growth, and the composition of that growth;
changes (or the lack of changes) in interest rates, yield curves and interest rate spread relationships that affect our loan and deposit pricing;
possible cessation or market replacement of LIBOR and the related effect on our LIBOR-based financial products and contracts, including, but not limited to, hedging products, debt obligations, investments, and loans;
the extent of continuing client demand for the high level of personalized service that is a key element of our banking approach as well as our ability to execute our strategy generally;
our dependence on our management team, and our ability to attract and retain qualified personnel;
changes in the quality or composition of our loan or investment portfolios, including adverse developments in borrower industries or in the repayment ability of individual borrowers;
inaccuracy of the assumptions and estimates we make in establishing reserves for probable loan losses and other estimates;
the concentration of our business within our geographic areas of operation in Louisiana, Texas and Alabama;
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concentration of credit exposure;
any deterioration in asset quality and higher loan charge-offs, and the time and effort necessary to resolve problem assets;
a reduction in liquidity, including as a result of a reduction in the amount of deposits we hold or other sources of liquidity;
impairment of our goodwill and other intangible assets;
our potential growth, including our entrance or expansion into new markets, and the need for sufficient capital to support that growth;
difficulties in identifying attractive acquisition opportunities and strategic partners that will complement our relationship banking approach;
our ability to complete any pending or future acquisitions and efficiently integrate completed acquisitions into our operations, meet the regulatory requirements related to such acquisitions, retain the customers of acquired businesses and grow the acquired operations;
the impact of litigation and other legal proceedings to which we become subject;
data processing system failures and errors;
cyber attacks and other security breaches;
competitive pressures in the commercial finance, retail banking, mortgage lending and consumer finance industries, as well as the financial resources of, and products offered by, competitors;
the impact of changes in laws and regulations applicable to us, including banking, securities and tax laws and regulations and accounting standards, as well as changes in the interpretation of such laws and regulations by our regulators;
changes in the scope and costs of FDIC insurance and other coverages;
governmental monetary and fiscal policies;
hurricanes (including the recent hurricanes, tropical storms and tropical depressions that have affected the Company’s market areas), floods, winter storms, other natural disasters and adverse weather; oil spills and other man-made disasters; acts of terrorism, an outbreak of hostilities or other international or domestic calamities, acts of God and other matters beyond our control; and
other circumstances, many of which are beyond our control.
The foregoing factors should not be construed as exhaustive and should be read together with the other cautionary statements included herein. If one or more events related to these or other risks or uncertainties materialize, or if our underlying assumptions prove to be incorrect, actual results may differ materially from what we anticipate. Accordingly, you should not place undue reliance on any such forward-looking statements.
Any forward-looking statement speaks only as of the date on which it is made, and we do not undertake any obligation to publicly update or review any forward-looking statement, whether as a result of new information, future developments or otherwise. New factors emerge from time to time, and it is not possible for us to predict which will arise. In addition, we cannot assess the impact of each factor on our business or the extent to which any factor, or combination of factors, may cause actual results to differ materially from those contained in any forward-looking statements. We qualify all of our forward-looking statements by these cautionary statements.
Recent Developments Related to COVID-19
Overview. In March 2020, COVID-19 was declared a pandemic by the World Health Organization and a national emergency by the President of the United States. The global COVID-19 pandemic and the public health response to minimize its impact have had severe adverse and disruptive effects on economic, financial market and oil market conditions beginning in the latter part of the first quarter of 2020, and continuing through the fourth quarter of 2020 and beyond. Beginning in the first quarter of 2020, government responses to the pandemic included mandated closures of businesses not deemed essential, restrictions on other businesses, and stay-at-home orders or recommendations, along with crowd restrictions, which caused steep increases in unemployment and decreases in consumer and business spending. Government authorities in our markets began allowing the re-opening of businesses and easing other restrictions in the second quarter of 2020; however, the country, including areas in which we do business, experienced multiple periods of resurgences of new cases in both the third and fourth quarters of 2020. Authorities reacted to these resurgences by extending or re-imposing some restrictions.
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Legislative and Regulatory Developments. In a measure aimed at lessening the economic impact of COVID-19, the Federal Reserve reduced the federal funds rate to 0% to 0.25% on March 16, 2020. This action by the Federal Reserve followed a prior reduction of the targeted federal funds rates to a range of 1.0% to 1.25% on March 3, 2020. On March 27, 2020, the U.S. government enacted the Coronavirus Aid, Relief, and Economic Security Act (“CARES Act”), the largest economic stimulus package in the nation’s history, which included the Small Business Administration’s (“SBA”) and U.S. Department of Treasury’s Paycheck Protection Program (“PPP”), discussed further below, in an effort to lessen the impact of COVID-19 on consumers and businesses. As funds available under the PPP were quickly depleted, on April 24, 2020, the Paycheck Protection Program and Health Care Enhancement Act was signed into law, which, among other things, increased amounts available under the Program. On June 5, 2020, the Paycheck Protection Program Flexibility Act of 2020 (“Flexibility Act”) was enacted, which among other things, provided expanded relief under the PPP. On December 27, 2020, legislation was enacted providing additional aid to individuals and businesses, which among other things, provided additional funding for the PPP and allowed businesses meeting certain requirements to obtain a second PPP loan.
Paycheck Protection Program. Beginning in the second quarter of 2020, the Bank has participated as a lender in the PPP as established by the CARES Act and enhanced by the Paycheck Protection Program and Health Care Enhancement Act and the Flexibility Act. The PPP was established to provide unsecured low interest rate loans to small businesses that have been impacted by the COVID-19 pandemic. The PPP loans are 100% guaranteed by the SBA. The loans have a fixed interest rate of 1%, and payments are deferred until the date on which the amount of loan forgiveness is remitted to the lender by the SBA, the forgiveness application is otherwise denied, or if no forgiveness application is filed 10 months after the end of the borrower’s covered period. PPP loans made prior to June 5, 2020 mature two years from origination, or if made on or after June 5, 2020, five years from origination. PPP loans are forgiven by the SBA (which makes forgiveness payments directly to the lender) to the extent the borrower uses the proceeds of the loan for certain purposes (primarily to fund payroll costs) during a certain time period following origination and maintains certain employee and compensation levels. Lenders receive processing fees from the SBA for originating the PPP loans which are based on a percentage of the loan amount. The original PPP program ceased taking applications on August 8, 2020. On December 27, 2020, legislation was enacted that renewed the PPP and allocated additional funding for both new first time PPP loans under the original PPP and also authorized second draw PPP loans for certain eligible borrowers that had previously received a PPP loan. The SBA began accepting applications on the next round of the PPP in January 2021, and the application period will last until March 31, 2021, subject to the availability of funds. In April 2020, we began originating loans to qualified small businesses under the PPP. At December 31, 2020, our loan portfolio included PPP loans with a balance of $94.5 million, all of which are included in commercial and industrial loans.
Guidance on Treatment of Pandemic-related Loan Modifications Pursuant to the CARES Act and Interagency Statement. Section 4013 of the CARES Act provides that, from the period beginning March 1, 2020 until the earlier of December 31, 2020 or the date that is 60 days after the date on which the national emergency concerning the COVID-19 pandemic declared by the President of the United States under the National Emergencies Act terminates (the “applicable period”), we may elect to suspend GAAP for loan modifications related to the pandemic that would otherwise be categorized as troubled debt restructurings (“TDRs”) and suspend any determination of a loan modified as a result of the effects of the pandemic as being a TDR, including impairment for accounting purposes. The suspension is applicable for the term of the loan modification that occurs during the applicable period for a loan that was not more than 30 days past due as of December 31, 2019. The suspension is not applicable to any adverse impact on the credit of a borrower that is not related to the pandemic. Legislation enacted on December 27, 2020, extended this relief to the earlier of January 1, 2022 or 60 days after the national emergency termination date.
In addition, our banking regulators and other financial regulators, on March 22, 2020 and revised April 7, 2020, issued a joint interagency statement titled the “Interagency Statement on Loan Modifications and Reporting for Financial Institutions Working with Customers Affected by the Coronavirus” that encourages financial institutions to work prudently with borrowers who are or may be unable to meet their contractual payment obligations due to the effects of the COVID-19 pandemic. Pursuant to the interagency statement, loan modifications that do not meet the conditions of Section 4013 of the CARES Act may still qualify as a modification that does not need to be accounted for as a TDR. Specifically, the agencies confirmed with the staff of the Financial Accounting Standards Board that short-term modifications made in good faith in response to the pandemic to borrowers who were current prior to any relief are not TDRs under GAAP. This includes short-term (e.g. six months) modifications such as payment deferrals, fee waivers, extensions of repayment terms, or delays in payment that are insignificant. Borrowers considered current are those that are less than 30 days past due on their contractual payments at the time a modification program is implemented. Appropriate allowances for loan and lease losses are expected to be maintained. With regard to loans not otherwise reportable as past due, financial institutions are not expected to designate loans with deferrals granted due to the pandemic as past due because of the deferral. The interagency statement also states that during short-term pandemic-related loan modifications, these loans generally should not be reported as nonaccrual.
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Accordingly, during 2020, we offered short-term modifications made in response to COVID-19 to borrowers who were current and otherwise not past due. These include short-term modifications of 90 days or less, in the form of deferrals of payment of principal and interest, principal only, or interest only, and fee waivers. As of December 31, 2020, the balance of loans participating in the 90-day deferral program was approximately $5.9 million, or 0.3% of the total loan portfolio. See further discussion in the Loans section of the Discussion and Analysis of Financial Condition below.
Impact on our Operations. As discussed above, within the states in which we operate, beginning in the first quarter of 2020, many jurisdictions declared health emergencies and executed stay-at-home orders and closed non-essential businesses which impacted our operations as well as the operations of our customers. Though authorities began phasing out certain restrictions in the summer of 2020, resurgences in the number of COVID-19 cases in the second and third quarters of 2020 resulted in the extension and, in some instances, the re-imposition of certain restrictions. For example, in Louisiana, where most of our operations are currently located, a stay-at-home order was issued on March 22, 2020, and the state moved into Phase 1 of recovery on May 15, 2020, Phase 2 on June 4, 2020, and Phase 3 on September 11, 2020. However, the state experienced several resurgences in the number of cases in the fall and winter of 2020, which prompted the issuance of an order reverting back to a modified Phase 2 as of November 25, 2020, which was extended through March 2, 2021, when Louisiana re-entered Phase 3. Under Phase 3, generally speaking, places of public amusement are closed, only bars in qualifying parishes may open with stringent restrictions (except for takeout), most other nonessential businesses are restricted to 75% capacity, crowd sizes are limited to 250 people or 50% capacity for indoor gatherings, face coverings are mandatory and all individuals with a higher risk of severe illness from COVID-19 are urged to stay at home. Additionally, effective March 10, 2021, the Texas governor issued an order lifting the state's mask mandate and rescinding most of its restrictions related to COVID-19.
Financial services have been identified as a Critical Infrastructure Sector by the Department of Homeland Security, and therefore, our business remains open. We continue to service our consumer and business customers from our 31 branch locations and through drive-thrus, ATMs, internet banking, mobile application and telephone.
Impact on our financial results for 2020. As discussed in further detail below, during 2020, we experienced decreased earnings compared to 2019, primarily related to the deterioration in the economy caused by the pandemic. While our net interest income increased, due primarily to an increase in the volume of our interest-earning assets, and lower interest rates on deposits resulting from lower prevailing interest rates, we substantially increased our provision for loan losses.
Overview
Through our wholly-owned subsidiary Investar Bank, National Association, we provide full banking services, excluding trust services, tailored primarily to meet the needs of individuals and small to medium-sized businesses. Our primary areas of operation are south Louisiana (approximately 86% of our total deposits as of December 31, 2020), including Baton Rouge, New Orleans, Lafayette, Lake Charles, and their surrounding areas; southeast Texas, including Houston and its surrounding area, Alice, and Victoria; and west Alabama, including York and its surrounding area. Our Bank commenced operations in 2006 and we completed our initial public offering in July 2014. On July 1, 2019, the Bank changed from a Louisiana state bank charter to a national bank charter and its name changed to Investar Bank, National Association. Our strategy includes organic growth through high quality loans and growth through acquisitions, including whole-bank acquisitions and strategic branch acquisitions. We currently operate 24 full service branches in Louisiana, five full service branches in Texas, and two full service branches in Alabama. We have completed six whole-bank acquisitions since 2011 and regularly review acquisition opportunities. In addition to our branches acquired through acquisitions, during our last three fiscal years, we opened five de novo branch locations.
Our principal business is lending to and accepting deposits from individuals and small to medium-sized businesses in our areas of operation. We generate our income principally from interest on loans and, to a lesser extent, our securities investments, as well as from fees charged in connection with our various loan and deposit services and gains on the sale of securities. Our principal expenses are interest expense on interest-bearing customer deposits and borrowings, salaries, employee benefits, occupancy costs, data processing and other operating expenses. We measure our performance through our net interest margin, return on average assets, and return on average equity, among other metrics, while seeking to maintain appropriate regulatory leverage and risk-based capital ratios.
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For certain GAAP performance measures, see “Certain Performance Indicators” below. We also monitor changes in our tangible equity, tangible assets, tangible book value per share, and our efficiency ratio, shown in the section “Certain Performance Indicators: Non-GAAP Financial Measures” below.
Certain Performance Indicators
(In thousands, except share data) As of and for the year ended December 31,
2020(1)
2019(1)
2018
2017(1)
2016
Financial Information
Total assets $ 2,321,181  $ 2,148,916  $ 1,786,469  $ 1,622,734  $ 1,158,960 
Total stockholders' equity 243,284  241,976  182,262  172,729  112,757 
Net interest income 73,534  64,818  57,370  42,517  34,739 
Net income 13,889  16,839  13,606  8,202  7,880 
Diluted earnings per share 1.27  1.66  1.39  0.96  1.10 
Performance Ratios
Return on average assets 0.61  % 0.85  % 0.81  % 0.62  % 0.71  %
Return on average equity 5.77  8.21  7.68  5.65  6.99 
Net interest margin 3.49  3.51  3.61  3.39  3.32 
Dividend payout ratio 19.69  13.55  12.09  10.78  3.80 
Capital Ratios
Total equity to total assets 10.48  % 11.26  % 10.20  % 10.64  % 9.73  %
Tangible equity to tangible assets 9.22  9.96  9.20  9.53  9.48 
(1)Selected consolidated financial data includes the effect of mergers from the date of each merger. On July 1, 2017, the Company acquired Citizens Bancshares, Inc. and its wholly-owned subsidiary, Citizens Bank, by merger with and into the Company and Bank, respectively. On December 1, 2017, the Company acquired BOJ Bancshares, Inc. and its wholly-owned subsidiary, The Highlands Bank, by merger with and into the Company and Bank, respectively. On March 1, 2019, the Company acquired Mainland Bank, by merger with and into the Bank. On November 1, 2019, the Company acquired Bank of York, by merger with and into the Bank. On February 21, 2020, the Company acquired two branches from PlainsCapital Bank by purchase and assumption agreement with and into the Bank. References in this document to assets purchased and liabilities assumed in acquisition transactions reflect the fair value of such assets and liabilities on the date of acquisition, unless the context indicates otherwise.
Certain Performance Indicators: Non-GAAP Financial Measures
Our accounting and reporting policies conform to accounting principles generally accepted in the United States, or GAAP, and the prevailing practices in the banking industry. However, we also evaluate our performance based on certain additional metrics. The efficiency ratio, tangible book value per share, and the ratio of tangible equity to tangible assets are not financial measures recognized under GAAP and, therefore, are considered non-GAAP financial measures.
Our management, banking regulators, financial analysts and investors use these non-GAAP financial measures to compare the capital adequacy of banking organizations with significant amounts of preferred equity and/or goodwill or other intangible assets, which typically stem from the use of the purchase accounting method of accounting for mergers and acquisitions. Tangible equity, tangible assets, tangible book value per share or related measures should not be considered in isolation or as a substitute for total stockholders’ equity, total assets, book value per share or any other measure calculated in accordance with GAAP. Moreover, the manner in which we calculate tangible equity, tangible assets, tangible book value per share and any other related measures may differ from that of other companies reporting measures with similar names. The following table reconciles, as of the dates set forth below, stockholders’ equity (on a GAAP basis) to tangible equity and total assets (on a GAAP basis) to tangible assets and calculates both our tangible book value per share and efficiency ratio (dollars in thousands).
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As of and for the year ended December 31,
2020 2019 2018 2017 2016
Total stockholders’ equity - GAAP $ 243,284  $ 241,976  $ 182,262  $ 172,729  $ 112,757 
Adjustments:
Goodwill 28,144  26,132  17,424  17,086  2,684 
Core deposit intangible 3,988  4,803  2,263  2,740  450 
Trademark intangible 100  100  100  100  100 
Tangible equity $ 211,052  $ 210,941  $ 162,475  $ 152,803  $ 109,523 
Total assets - GAAP $ 2,321,181  $ 2,148,916  $ 1,786,469  $ 1,622,734  $ 1,158,960 
Adjustments:
Goodwill 28,144  26,132  17,424  17,086  2,684 
Core deposit intangible 3,988  4,803  2,263  2,740  450 
Trademark intangible 100  100  100  100  100 
Tangible assets $ 2,288,949  $ 2,117,881  $ 1,766,682  $ 1,602,808  $ 1,155,726 
Total shares outstanding 10,608,869  11,228,775  9,484,219  9,514,926  7,101,851 
Book value per share $ 22.93  $ 21.55  $ 19.22  $ 18.15  $ 15.88 
Effect of adjustment (3.04) (2.76) (2.09) (2.09) (0.46)
Tangible book value per share $ 19.89  $ 18.79  $ 17.13  $ 16.06  $ 15.42 
Total equity to total assets 10.48  % 11.26  % 10.20  % 10.64  % 9.73  %
Effect of adjustment (1.26) (1.30) (1.00) (1.11) (0.25)
Tangible equity to tangible assets 9.22  % 9.96  % 9.20  % 9.53  % 9.48  %
Efficiency ratio(1)
Noninterest expense $ 57,131  $ 48,168  $ 41,882  $ 32,342  $ 26,639 
Net interest income 73,534  64,818  57,370  42,517  34,739 
Noninterest income 12,096  6,216  4,318  3,815  5,468 
Efficiency ratio 66.72  % 67.81  % 67.89  % 69.80  % 66.25  %
(1)Calculated as noninterest expense divided by the sum of net interest income (before provision for loan losses) and noninterest income.
Critical Accounting Estimates
The preparation of our consolidated financial statements in accordance with GAAP requires us to make estimates and judgments that affect our reported amounts of assets, liabilities, income and expenses and related disclosure of contingent assets and liabilities. Although independent third parties are often engaged to assist us in the estimation process, management evaluates the results, challenges assumptions used and considers other factors which could impact these estimates. Actual results may differ from these estimates under different assumptions or conditions.
For more detailed information about our accounting policies, please refer to Note 1, Summary of Significant Accounting Policies, in the Notes to Consolidated Financial Statements contained in Item 8. Financial Statements and Supplementary Data. The following discussion presents our critical accounting estimates, which are those estimates made in accordance with GAAP that involve a significant level of estimation uncertainty and have had or are reasonably likely to have a material impact on our financial condition or results of operations. We believe that the judgments, estimates and assumptions that we use in the preparation of our consolidated financial statements are appropriate.
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Allowance for Loan Losses. One of the accounting policies most important to the presentation of our financial statements relates to the allowance for loan losses and the related provision for loan losses. The allowance for loan losses is established as losses are estimated through a provision for loan losses charged to earnings. The allowance for loan losses is based on the amount that management believes will be adequate to absorb probable losses inherent in the loan portfolio based on, among other things, evaluations of the collectability of loans and prior loan loss experience. The evaluations take into consideration such factors as changes in the nature and volume of the loan portfolio, overall portfolio quality, review of specific problem loans, and current economic conditions that may affect borrowers’ ability to pay. Another component of the allowance is losses on loans assessed as impaired under Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) Topic 310, Receivables (“ASC 310”). The balance of the loans determined to be impaired under ASC 310 and the related allowance is included in management’s estimation and analysis of the allowance for loan losses. Allowances for impaired loans are generally determined based on collateral values or the present value of estimated cash flows.
The determination of the appropriate level of the allowance is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available. We have an established methodology to determine the adequacy of the allowance for loan losses that assesses the risks and losses inherent in our portfolio and portfolio segments. We have an internally developed model that requires significant judgment to determine the estimation method that fits the credit risk characteristics of the loans in our portfolio and portfolio segments. Qualitative and environmental factors that may not be directly reflected in quantitative estimates include: asset quality trends, changes in loan concentrations, new products and process changes, changes and pressures from competition, changes in lending policies and underwriting practices, trends in the nature and volume of the loan portfolio, and national and regional economic trends. Changes in these factors are considered in determining changes in the allowance for loan losses. The impact of these factors on our qualitative assessment of the allowance for loan losses can change from period to period based on management’s assessment of the extent to which these factors are already reflected in historic loss rates. The uncertainty inherent in the estimation process is also considered in evaluating the allowance for loan losses.
Acquisition Accounting. We account for our acquisitions under ASC Topic 805, Business Combinations (“ASC 805”), which requires the use of the purchase method of accounting. All identifiable assets acquired, including loans, are recorded at fair value (which is discussed below). The excess purchase price over the fair value of net assets acquired is recorded as goodwill. If the fair value of the net assets acquired exceeds the purchase price, a bargain purchase gain is recognized.
Because the fair value measurements incorporate assumptions regarding credit risk, no allowance for loan losses related to the acquired loans is recorded on the acquisition date. The fair value measurements of acquired loans are based on estimates related to expected prepayments and the amount and timing of undiscounted expected principal, interest and other cash flows. The fair value adjustment is amortized over the life of the loan using the effective interest method.
The Company accounts for acquired impaired loans under ASC Topic 310-30, Loans and Debt Securities Acquired with Deteriorated Credit Quality (“ASC 310-30”). An acquired loan is considered impaired when there is evidence of credit deterioration since origination and it is probable at the date of acquisition that we will be unable to collect all contractually required payments. ASC 310-30 prohibits the carryover of an allowance for loan losses for acquired impaired loans. Over the life of the acquired loans, we continually estimate the cash flows expected to be collected on individual loans or on pools of loans sharing common risk characteristics. As of the end of each fiscal quarter, we evaluate the present value of the acquired loans using the effective interest rates. For any increases in cash flows expected to be collected, we adjust the amount of accretable yield recognized on a prospective basis over the loan’s or pool’s remaining life, while we recognize a provision for loan loss in the consolidated statement of operations if the cash flows expected to be collected have decreased.
Overview of Financial Condition and Results of Operations
Net income for the year ended December 31, 2020 totaled $13.9 million, or $1.27 per diluted share, compared to $16.8 million, or $1.66 per diluted share, for the year ended December 31, 2019. This represents a $3.0 million, or a 17.5%, decrease in net income. The decrease can mainly be attributed to the Company’s increased provisions for loan losses during 2020, as a result of the impacts of the pandemic. The Company also experienced an increase in noninterest expense.
Key components of the Company’s performance during the year ended December 31, 2020 are summarized below.
Total assets grew to $2.3 billion at December 31, 2020, an increase of 8.0% from $2.1 billion at December 31, 2019.
Total loans, net of allowance for loan losses at December 31, 2020 were $1.8 billion, an increase of $158.7 million, or 9.4% compared to $1.7 billion at December 31, 2019.
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Total deposits were $1.9 billion at December 31, 2020, an increase of $180.1 million, or 10.5%, compared to deposits of $1.7 billion at December 31, 2019. Noninterest-bearing deposits increased $96.3 million, or 27.4%, to $448.2 million compared to $351.9 million at December 31, 2019.
Net interest income for the year ended December 31, 2020 was $73.5 million, an increase of $8.7 million, or 13.4%, compared to $64.8 million for the year ended December 31, 2019.
On February 21, 2020, the Bank completed its acquisition and assumption of certain assets, deposits and other liabilities associated with the Alice and Victoria, Texas locations of PlainsCapital Bank, a wholly-owned subsidiary of Hilltop Holdings, Inc. See further discussion in Acquisitions below.
Certain Events That Affect Year-over-Year Comparability
COVID-19 Pandemic. As discussed throughout this report, the COVID-19 pandemic impacted our Company during 2020.
Acquisitions. On March 1, 2019, the Company completed the acquisition of Mainland Bank (“Mainland”), a Texas state bank located in Texas City, Texas. The Company acquired 100% of Mainland’s outstanding common shares for approximately $18.6 million in the form of 763,849 shares of the Company’s common stock. The acquisition of Mainland expanded the Company’s branch footprint into Texas and increased the core deposit base to help position the Company to continue to grow. On the date of acquisition, Mainland had total assets with a fair value of approximately $127.6 million, $81.3 million in loans, and $107.6 million in deposits, and served the residents of Harris and Galveston counties through three branch locations. The Company recorded a core deposit intangible and goodwill of $2.4 million and $5.2 million, respectively, related to the acquisition of Mainland.
On November 1, 2019, the Company completed the acquisition of Bank of York, an Alabama state bank located in York, Alabama. All of the issued and outstanding shares of Bank of York common stock were converted into aggregate cash merger consideration of $15.0 million. The acquisition of Bank of York expanded the Company’s branch footprint into Alabama. On the date of acquisition, Bank of York had total assets with a fair value of $101.9 million, $46.1 million in loans, and $85.0 million in deposits, and served the residents of Sumter County through two branch locations and one loan production office in Tuscaloosa County. The Company recorded a core deposit intangible and goodwill of $0.9 million and $5.0 million, respectively, related to the acquisition of Bank of York.
On February 21, 2020, the Bank completed the acquisition and assumption of certain assets, deposits and other liabilities associated with the Alice and Victoria, Texas locations of PlainsCapital Bank, a wholly-owned subsidiary of Hilltop Holdings Inc., for an aggregate consideration of approximately $11.2 million. The Bank acquired approximately $45.3 million in loans and $37.0 million in deposits. In addition, the Bank acquired substantially all the fixed assets at the branch locations, and assumed the leases for the branch facilities. The Company recorded a core deposit intangible and goodwill of $0.2 million and $0.5 million, respectively, related to the acquisition.
Debt and Equity Raise. During the fourth quarter of 2019, we completed both a subordinated debt issuance and a common stock offering. We issued and sold $25.0 million in fixed-to-floating rate subordinated notes due in 2029. The common stock offering generated net proceeds of $28.5 million through the issuance of 1.3 million common shares at a price of $23.25 per share. The proceeds from the subordinated debt issuance and common stock offering were raised for general corporate purposes and potential strategic acquisitions.
Discussion and Analysis of Financial Condition
Total assets were $2.3 billion at December 31, 2020, an increase of 8.0% from total assets of $2.1 billion at December 31, 2019. Our total assets of $2.1 billion at December 31, 2019 represents a 20.3% increase from total assets of $1.8 billion at December 31, 2018. The growth experienced since December 31, 2018 can mainly be attributed to growth in loans, $94.5 million of which is PPP loans originated during 2020, four de novo branch openings, two acquisitions completed in 2019 which added assets with a fair value of $229.5 million, as well as the acquisition of two branch locations in February 2020 which added assets with a fair value of $48.8 million.
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Loans
General. Loans constitute our most significant asset, comprising 80%, 79%, and 78% of our total assets at December 31, 2020, 2019 and 2018, respectively. Loans increased $168.3 million, or 9.9%, to $1.9 billion at December 31, 2020 from $1.7 billion at December 31, 2019. Loans increased $291.2 million, or 20.8%, to $1.7 billion at December 31, 2019 from $1.4 billion at December 31, 2018.
In the second quarter of 2020, the Bank began participating as a lender in the PPP as established by the CARES Act. At December 31, 2020, the balance, net of repayments, of the Bank’s PPP loans originated was $94.5 million, which is included in the commercial and industrial loan portfolio. Eighty-seven percent of the total number of PPP loans we have originated have principal balances of $150,000 or less. Excluding PPP loans, total loans increased $73.8 million, or 4.4%, at December 31, 2020 compared to December 31, 2019.
The table below sets forth the balance of loans outstanding by loan type as of the dates presented, and the percentage of each loan type to total loans (dollars in thousands).
December 31,
2020 2019 2018 2017 2016
Amount Percentage of
Total Loans
Amount Percentage of
Total Loans
Amount Percentage of
Total Loans
Amount Percentage of
Total Loans
Amount Percentage of
Total Loans
Mortgage loans on real estate:
Construction and land development $ 206,011  11.1  % $ 197,797  11.7  % $ 157,946  11.3  % $ 157,667  12.5  % $ 90,737  10.2  %
1-4 Family
339,525  18.2  321,489  19.0  287,137  20.5  276,922  22.0  177,205  19.8 
Multifamily
60,724  3.3  60,617  3.6  50,501  3.6  51,283  4.1  42,759  4.8 
Farmland
26,547  1.4  27,780  1.6  21,356  1.5  23,838  1.9  8,207  0.9 
Commercial real estate
Owner-occupied
375,421  20.2  352,324  20.8  298,222  21.3  272,433  21.6  180,458  20.2 
Nonowner-occupied
436,974  23.5  378,736  22.4  328,782  23.5  264,931  21.0  200,258  22.4 
Commercial and industrial
394,497  21.2  323,786  19.2  210,924  15.0  135,392  10.8  85,377  9.6 
Consumer
20,619  1.1  29,446  1.7  45,957  3.3  76,313  6.1  108,425  12.1 
Total loans
$ 1,860,318  100  % $ 1,691,975  100  % $ 1,400,825  100  % $ 1,258,779  100  % $ 893,426  100  %
Our focus on a relationship-driven banking strategy and the hiring of experienced commercial lenders are the primary reasons for our organic loan growth. Over the last three fiscal years, we have increased our focus on commercial real estate loans and commercial and industrial loans, including adding and expanding a new Commercial and Industrial division in early 2018. Excluding $94.5 million of PPP loans outstanding as of December 31, 2020, which are included in our commercial and industrial loan portfolio, we experienced the greatest loan growth in our commercial real estate portfolio from December 31, 2019 to December 31, 2020. In addition, we completed two acquisitions in 2019, as well as the acquisition of two branch locations in February 2020.
The decrease in the consumer loan portfolio during this period is primarily a result of pay-downs of portfolio loans. At December 31, 2020, indirect auto loans made up 22.2% of the consumer loan portfolio. The Company discontinued accepting indirect auto loan applications on December 31, 2015 and expects its consumer loan portfolio as a percentage of the total loan portfolio to continue to decrease over time. At December 31, 2020, the weighted average remaining term of the indirect auto loan portfolio was 1.3 years.
At December 31, 2020, the Company’s total business lending portfolio, which consists of loans secured by owner-occupied commercial real estate properties and commercial and industrial loans, was $769.9 million, an increase of $93.8 million, or 13.9%, compared to the business lending portfolio of $676.1 million at December 31, 2019. The business lending portfolio at December 31, 2019 increased $167.0 million, or 32.8%, compared to $509.1 million at December 31, 2018. The origination of PPP loans, which are included in the commercial and industrial loan portfolio, was the primary driver of the increase in the business lending portfolio compared to December 31, 2019.
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The following table sets forth loans outstanding at December 31, 2020, which, based on remaining scheduled repayments of principal, are due in the periods indicated, as well as the amount of loans with fixed and variable rates in each maturity range. Loans with balloon payments and longer amortizations are often repriced and extended beyond the initial maturity when credit conditions remain satisfactory. Demand loans, loans having no stated schedule of repayments and no stated maturity, and overdrafts are reported below as due in one year or less.
(dollars in thousands) One Year or
Less
After One
Year Through
Five Years
After Five
Years Through
Ten Years
After Ten
Years Through
Fifteen Years
After Fifteen
Years
Total
Mortgage loans on real estate:
Construction and land development $ 143,943  $ 20,498  $ 32,544  $ 8,786  $ 240  $ 206,011 
1-4 Family 61,081  86,910  43,605  17,681  130,248  339,525 
Multifamily 9,101  49,048  2,199  242  134  60,724 
Farmland 8,080  9,218  9,152  97  —  26,547 
Commercial real estate
Owner-occupied 44,547  128,834  131,889  53,099  17,052  375,421 
Nonowner-occupied 107,020  156,931  152,885  20,138  —  436,974 
Commercial and industrial 166,842  187,223  25,630  6,864  7,938  394,497 
Consumer 5,351  14,069  838  358  20,619 
Total loans $ 545,965  $ 652,731  $ 398,742  $ 107,265  $ 155,615  $ 1,860,318 
Amounts with fixed rates $ 122,784  $ 599,740  $ 329,203  $ 89,603  $ 148,501  $ 1,289,831 
Amounts with variable rates 423,181  52,991  69,539  17,662  7,114  570,487 
Total loans $ 545,965  $ 652,731  $ 398,742  $ 107,265  $ 155,615  $ 1,860,318 
Loan Concentrations. Loan concentrations are considered to exist when there are amounts loaned to multiple borrowers engaged in similar activities that would cause them to be similarly impacted by economic or other conditions. At December 31, 2020 and December 31, 2019, we had no concentrations of loans exceeding 10% of total loans other than loans in the categories listed in the table above.
Our loan portfolio includes loans to businesses in certain industries that may be more significantly affected by the pandemic than others. These loans, including loans related to oil and gas, food services, hospitality, and entertainment, represented approximately 6.6% of our total loan portfolio, or 5.7% excluding PPP loans, at December 31, 2020, as shown below.
Industry Percentage of Loan Portfolio Percentage of Loan Portfolio
(excluding PPP loans)
Oil and gas 3.3  % 2.6  %
Food services 2.5  2.3 
Hospitality 0.4  0.4 
Entertainment 0.4  0.4 
Total 6.6  % 5.7  %
Loan Deferral Program. In response to the COVID-19 pandemic, beginning in the first quarter of 2020, the Bank has offered short-term modifications to borrowers impacted by the pandemic who are current and otherwise not past due. These currently include short-term modifications of 90 days or less, in the form of deferrals of payment of principal and interest, principal only, or interest only, and fee waivers. As of December 31, 2020, the balance of loans participating in the 90-day deferral program was approximately $5.9 million, or 0.3% of the total loan portfolio. Of these loans, 57% have deferrals of principal and interest, 40% have deferrals of principal only, and 3% have deferrals of interest only. As 90-day loan deferrals have expired, most customers have returned to their regular payment schedules. The Bank continues to support borrowers experiencing financial hardships related to the pandemic and expects to process additional deferrals requested by qualified borrowers. Therefore, we may experience fluctuations in the balance of loans participating in the deferral program. In accordance with Section 4013 of the CARES Act and the interagency statement, we have not accounted for such loans as TDRs, nor have we designated them as past due or nonaccrual.
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Investment Securities
We purchase investment securities primarily to provide a source for meeting liquidity needs, with return on investment as a secondary consideration. We also use investment securities as collateral for certain deposits and other types of borrowing. Investment securities represented 12% of our total assets and totaled $280.8 million at December 31, 2020, an increase of $6.6 million, or 2.4%, from $274.2 million at December 31, 2019. The investment securities balance at December 31, 2019 represented a $9.2 million, or 3.5%, increase from $265.0 million at December 31, 2018. The increase in investment securities at December 31, 2020 compared to December 31, 2019 and 2018 resulted from purchases of multiple investment types in our current portfolio.
The table below shows the carrying value of our investment securities portfolio by investment type and the percentage that such investment type comprises of our entire portfolio as of the dates indicated (dollars in thousands).
December 31,
2020 2019 2018
Balance Percentage of
Portfolio
Balance Percentage of
Portfolio
Balance Percentage of
Portfolio
Obligations of U.S. government agencies and corporations
$ 36,821  13.1  % $ 33,651  12.3  % $ 7,870  3.0  %
Obligations of state and political subdivisions 30,362  10.8  42,936  15.7  44,685  16.9 
Corporate bonds 27,708  9.8  19,163  6.9  15,509  5.8 
Residential mortgage-backed securities 126,807  45.2  106,868  39.0  140,294  52.9 
Commercial mortgage-backed securities 59,146  21.1  71,596  26.1  56,689  21.4 
Total investment securities $ 280,844  100  % $ 274,214  100  % $ 265,047  100  %
The investment portfolio consists of available for sale and held to maturity securities. We do not hold any investments classified as trading. We classify debt securities as held to maturity if management has the positive intent and ability to hold the securities to maturity. Held to maturity securities are stated at amortized cost. Securities not classified as held to maturity are classified as available for sale. The carrying values of the Company’s available for sale securities are adjusted for unrealized gains or losses as valuation allowances, and any gains or losses are reported on an after-tax basis as a component of other comprehensive income. Any expected credit loss due to the inability to collect all amounts due according to the security’s contractual terms is recognized as a charge against earnings. Any remaining unrealized loss related to other factors would be recognized in other comprehensive income, net of taxes.
Typically, our investment securities are available for sale. There were no purchases of held to maturity securities during the years ended December 31, 2020, 2019 and 2018. In the year ended December 31, 2020, we purchased $127.1 million of investment securities, compared to purchases of $110.4 million and $72.3 million of investment securities during the years ended December 31, 2019 and 2018, respectively. Mortgage-backed securities represented 58%, 65%, and 68% of the available for sale securities we purchased in 2020, 2019 and 2018, respectively. Of the remaining securities purchased in 2020, 2019 and 2018, 22%, 29%, and 25%, respectively, were U.S. government agency securities, while 7%, 4%, and 1%, respectively, were municipal securities. We only purchase corporate bonds that are investment grade securities issued by seasoned corporations.
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The table below sets forth the stated maturities and weighted average yields of our investment debt securities based on the amortized cost of our investment portfolio as of December 31, 2020 (dollars in thousands).
One Year or Less After One Year
Through Five Years
After Five Years
Through Ten Years
After Ten Years
Amount Yield Amount Yield Amount Yield Amount Yield
Held to maturity:
Obligations of states and political subdivisions
$ 830  5.88  % $ 2,745  5.88  % $ 4,650  3.59  % $ —  —  %
Residential mortgage-backed securities —  —  —  —  —  —  4,209  2.83 
Available for sale:
Obligations of U.S. government agencies and corporations
73  3.13  2,373  2.34  31,579  2.12  2,623  1.64 
Obligations of states and political subdivisions
88  2.96  893  3.06  8,824  2.65  11,845  4.05 
Corporate bonds 1,503  3.51  8,393  1.55  16,687  4.52  1,000  1.95 
Residential mortgage-backed securities 3.00  —  —  335  1.99  119,594  1.36 
Commercial mortgage-backed securities —  —  1,278  2.93  6,734  1.30  50,086  2.11 
$ 2,499  $ 15,682  $ 68,809  $ 189,357 
The maturity of mortgage-backed securities reflects scheduled repayments based upon the contractual maturities of the securities. Weighted average yields on tax-exempt obligations have been computed on a fully tax equivalent basis assuming a federal tax rate of 21%.
Premises and Equipment
Bank premises and equipment increased $5.4 million, or 10.6%, to $56.3 million at December 31, 2020 from $50.9 million at December 31, 2019. The increase was mainly attributable to the acquisition of two branch locations in Alice and Victoria, Texas which added $2.8 million in bank premises and equipment, and the addition of two de novo branches. Bank premises and equipment increased $10.7 million, or 26.6%, to $50.9 million at December 31, 2019 from $40.2 million at December 31, 2018. The increase was mainly attributable to the completion of two acquisitions which added $3.5 million in bank premises and equipment, the addition of right-of-use assets related to leases of $3.3 million, and the addition of two de novo branches.
Deferred Tax Asset/Liability
At December 31, 2020, the net deferred tax asset was $1.4 million, compared to a net deferred tax liability of $0.1 million and a net deferred tax asset of $1.1 million at December 31, 2019 and 2018, respectively. The decrease in the deferred tax liability at December 31, 2019 to a net deferred tax asset at December 31, 2020 was primarily driven by the increased provisioning for loan losses during 2020 compared to 2019. The provision for loan losses is not tax deductible until loans are charged off, causing an increase in the deferred tax asset at December 31, 2020. The decrease in the deferred tax asset to a net deferred tax liability at December 31, 2019 compared to December 31, 2018 is mainly attributable to the increase in the unrealized gain on available for sale (“AFS”) securities during the period.
The Bank acquired net operating loss carryforwards as a result of acquisitions. At December 31, 2020, we held approximately $0.4 million and $1.7 million in net operating loss carryforwards that expire in 2033 and 2039, respectively. U.S. tax law imposes annual limitations under Internal Revenue Code Section 382 on the amount of net operating loss carryforwards that may be used to offset federal taxable income. Under these laws, we may apply up to approximately $0.6 million to offset our taxable income each year. In addition to this limitation, our ability to utilize net operating loss carryforwards depends upon the Company generating taxable income. Given the substantial amount of time before our net operating loss carryforwards begin to expire, we currently expect to utilize these net operating loss carryforwards in full before their expiration.
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Deposits
The following table sets forth the composition of our deposits and the percentage of each deposit type to total deposits at December 31, 2020, 2019 and 2018 (dollars in thousands).
December 31, 
2020 2019 2018
Amount Percentage of
Total
Deposits
Amount Percentage of
Total
Deposits
Amount Percentage of
Total
Deposits
Noninterest-bearing demand deposits
$ 448,230  23.7  % $ 351,905  20.6  % $ 217,457  16.0  %
Interest-bearing demand deposits 496,745  26.3  335,478  19.6  295,212  21.7 
Brokered deposits 80,017  4.2  —  —  —  — 
Money market deposit accounts 186,307  9.9  198,999  11.7  179,340  13.2 
Savings accounts 141,134  7.5  115,324  6.8  104,146  7.6 
Time deposits 535,391  28.4  706,000  41.3  565,576  41.5 
Total deposits $ 1,887,824  100.0  % $ 1,707,706  100.0  % $ 1,361,731  100.0  %
Total deposits were $1.9 billion at December 31, 2020, an increase of $180.1 million, or 10.5%, from total deposits of $1.7 billion at December 31, 2019. The Company acquired approximately $37.0 million in deposits from two branch locations acquired from PlainsCapital Bank in February 2020 and utilized $80.0 million in brokered deposits in the fourth quarter of 2020. The remaining increase of approximately $63.1 million is due to organic growth. Total deposits at December 31, 2019 increased $346.0 million, or 25.4%, from total deposits of $1.4 billion at December 31, 2018. The Company acquired approximately $85.0 million and $107.6 million in deposits from Bank of York and Mainland Bank, respectively, in 2019. The remaining increase is due to organic growth.
Noninterest-bearing and interest-bearing demand deposits experienced the largest increases compared to December 31, 2019. These increases were primarily driven by government stimulus payments, reduced spending by consumer and business customers related to the COVID-19 pandemic, and increases in PPP borrowers’ deposit accounts. We believe these factors may be temporary depending on the future economic effects of the COVID-19 pandemic.
As the state of the economy and financial markets deteriorated during 2020 in response to the global pandemic, customers desired increased security of funds and transferred holdings into fully-insured checking accounts, or our Assured Checking product, shown in interest-bearing demand deposits in the table above. Management also made the strategic decision to either reprice or run-off higher yielding time deposits and other interest-bearing deposit products during the year ended December 31, 2020, which contributed to our decreased cost of deposits compared to the same period in 2019, discussed in Results of Operations below.
The following table shows the contractual maturities of certificates of deposit and other time deposits greater than $100,000 at December 31, 2020 and 2019 (dollars in thousands).
December 31,
2020 2019
Time remaining until maturity: Certificates of Deposit Other Time Deposits Certificates of Deposit Other Time Deposits
Three months or less $ 78,482  $ 1,733  $ 89,995  $ 2,162 
Over three months through six months 73,456  2,619  74,759  1,421 
Over six months through twelve months 108,901  3,128  198,801  1,852 
Over one year through three years 90,101  4,202  90,541  4,954 
Over three years 10,529  283  13,935  1,629 
$ 361,469  $ 11,965  $ 468,031  $ 12,018 
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Borrowings
Total borrowings include securities sold under agreements to repurchase, advances from the Federal Home Loan Bank (“FHLB”), unsecured lines of credit with First National Bankers Bank and The Independent Bankers Bank totaling $60.0 million, subordinated debt issued in 2017 and 2019, and junior subordinated debentures assumed through acquisitions.
Securities sold under agreements to repurchase increased $2.7 million to $5.7 million at December 31, 2020 from $3.0 million at December 31, 2019. Our advances from the FHLB were $120.5 million at December 31, 2020, a decrease of $11.1 million from FHLB advances of $131.6 million at December 31, 2019 as we utilized available cash to pay off a portion of advances. We had no outstanding balances drawn on the unsecured lines of credit at December 31, 2020 or 2019. Junior subordinated debt of $5.9 million at December 31, 2020 and 2019 represents the junior subordinated debentures that we assumed in connection with our acquisitions of BOJ Bancshares, Inc. in 2017 and First Community Bank in 2013.
The average balances and cost of funds of short-term borrowings at December 31, 2020, 2019 and 2018 are summarized in the table below (dollars in thousands).
Average Balances Cost of Funds
December 31, December 31,
2020 2019 2018 2020 2019 2018
Federal funds purchased and other short-term borrowings
$ 60,243  $ 110,603  $ 126,670  1.15  % 2.09  % 1.84  %
Securities sold under agreements to repurchase
5,080  2,936  18,420  0.30  1.32  0.99 
Total short-term borrowings $ 65,323  $ 113,539  $ 145,090  1.09  % 2.07  % 1.73  %

2029 Notes. On November 12, 2019, the Company issued $25.0 million in aggregate principal amount of its 5.125% Fixed-to-Floating Rate Subordinated 2029 Notes due 2029 (“2029 Notes”) at 100% of their face amount in a private placement to certain institutional and other accredited investors. The 2029 Notes have a maturity date of December 30, 2029. From and including the date of issuance to, but excluding December 30, 2024, the 2029 Notes will bear interest at an initial fixed rate of 5.125% per annum, payable semi-annually in arrears. From and including December 30, 2024 and thereafter, the 2029 Notes will bear interest at a floating rate equal to the then-current three-month LIBOR as calculated on each applicable date of determination, or an alternative rate determined in accordance with the terms of the 2029 Notes if the three-month LIBOR cannot be determined, plus 3.490%, payable quarterly in arrears.

The Company may redeem the 2029 Notes, in whole or in part, on or after December 30, 2024 or, in whole but not in part, under certain limited circumstances set forth in the 2029 Notes. Any redemption by the Company would be at a redemption price equal to 100% of the principal balance being redeemed, together with any accrued and unpaid interest to the date of redemption.

Principal and interest on the 2029 Notes are not subject to acceleration, except upon certain bankruptcy-related events. The 2029 Notes are unsecured, subordinated obligations of the Company and rank junior in right of payment to the Company’s current and future senior indebtedness and to the Company’s obligations to its general creditors. The 2029 Notes are obligations of the Company only and are not obligations of, and are not guaranteed by, any of the Company’s subsidiaries. The 2029 Notes are structured to qualify as Tier 2 capital for regulatory capital purposes.

2027 Notes. On March 24, 2017, the Company issued $18.6 million in aggregate principal amount of its 6.00% Fixed-to-Floating Rate Subordinated Notes due 2027 (the “2027 Notes”), at 100% of the aggregate principal amount of the 2027 Notes in an offering registered under the Securities Act of 1933, as amended.

The 2027 Notes will mature on March 30, 2027. From and including the date of issuance, but excluding March 30, 2022, the 2027 Notes will bear interest at an initial fixed rate of 6.00% per annum, payable semi-annually. From and including March 30, 2022 and thereafter, the 2027 Notes will bear interest at a floating rate equal to the then-current three-month LIBOR (but not less than zero) as calculated on each applicable date of determination, plus 3.945%, payable quarterly.

Principal and interest on the 2027 Notes are not subject to acceleration, except upon certain bankruptcy-related events. The 2027 Notes are unsecured subordinated obligations of the Company. The 2027 Notes are subordinated in right of payment to the payment of the Company’s existing and future senior indebtedness, including all of its general creditors. The 2027 Notes are obligations of the Company only and are not obligations of, and are not guaranteed by, any of the Company’s subsidiaries. The
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Company may, beginning with the interest payment date of March 30, 2022, and on any interest payment date thereafter, redeem the 2027 Notes, in whole or in part, at a redemption price equal to 100% of the principal amount of the 2027 Notes to be redeemed plus accrued and unpaid interest to but excluding the date of redemption. The 2027 Notes are structured to qualify as Tier 2 capital for regulatory capital purposes.
Results of Operations
Performance Summary
2020 vs. 2019. For the year ended December 31, 2020, net income was $13.9 million, or $1.27 per basic and diluted common share, compared to net income of $16.8 million, or $1.68 per basic common share and $1.66 per diluted common share, for the year ended December 31, 2019. The primary drivers of the decrease in net income are related to the state of the economy and financial markets during the year ended December 31, 2020 resulting from the pandemic, along with an increase in noninterest expenses primarily related to our growth. As shown on the consolidated statement of income for the year ended December 31, 2020, a provision for loan losses of $11.2 million was recorded, primarily attributable to the COVID-19 pandemic, compared to a provision for loan losses of $1.9 million for the year ended December 31, 2019. Return on average assets decreased to 0.61% for the year ended December 31, 2020 from 0.85% for the year ended December 31, 2019. Return on average equity was 5.77% for the year ended December 31, 2020 compared to 8.21% for the year ended December 31, 2019. The decrease in both return on average assets and return on average equity is mainly attributable to the $2.9 million decrease in net income.
2019 vs. 2018. For the year ended December 31, 2019, net income was $16.8 million, or $1.68 per basic common share and $1.66 per diluted common share, compared to net income of $13.6 million, or $1.41 per basic common share and $1.39 per diluted common share, for the year ended December 31, 2018. The increases in basic and diluted earnings per common share and net income were primarily driven by an increase in net interest income resulting from both organic loan growth and loans acquired during 2019, as well as an increase in the yields on interest-earning assets, offset, in part, by an increase in the cost of funds. The increase in net interest income was partially offset by an increase in noninterest expense. Return on average assets increased to 0.85% for the year ended December 31, 2019 from 0.81% for the year ended December 31, 2018. Return on average equity was 8.21% for the year ended December 31, 2019 compared to 7.68% for the year ended December 31, 2018. The increase in both return on average assets and return on average equity is mainly attributable to the $3.2 million increase in net income.
Net Interest Income and Net Interest Margin
Net interest income, our principal source of earnings, is the difference between the interest income generated by earning assets and the total interest cost of the deposits and borrowings obtained to fund those assets. Factors affecting the level of net interest income include the volume of earning assets and interest-bearing liabilities, yields earned on loans and investments and rates paid on deposits and other borrowings, the level of nonperforming loans, the amount of noninterest-bearing liabilities supporting earning assets, and the interest rate environment.
The primary factors affecting net interest margin are changes in interest rates, competition, and the shape of the interest rate yield curve. The Federal Reserve Board sets various benchmark rates, including the Federal Funds rate, and thereby influences the general market rates of interest, including the deposit and loan rates offered by financial institutions. Since December 31, 2015, the Federal Funds target rate had increased a total of 175 basis points and remained at 2.25% to 2.50%, as of December 19, 2018, until it was lowered to 2.00 to 2.25% on July 31, 2019. The Federal Reserve further reduced the rate by 25 basis points on both September 18, 2019 to 1.75 to 2.00% and October 30, 2019 to 1.50 to 1.75%. On March 3, 2020, the Federal Reserve lowered the Federal Funds target rate to 1.00 to 1.25%, which the Federal Reserve stated was in response to the evolving risks to economic activity posed by the coronavirus. In a measure aimed at lessening the economic impact of COVID-19, the Federal Reserve reduced the federal funds target rate to 0% to 0.25% on March 16, 2020, where it remained as of March 10, 2021.
2020 vs. 2019. Net interest income increased 13.4% to $73.5 million for the year ended December 31, 2020 from $64.8 million for the same period in 2019. Net interest margin was 3.49% for the year ended December 31, 2020, a decrease of two basis points from 3.51% for the year ended December 31, 2019. The increase in net interest income resulted from an increase in the volume of interest-earning assets, and a decrease in the rates paid on interest-bearing liabilities, partially offset by a decrease in the yield earned on interest-earnings assets and increase in the volume of interest-bearing liabilities. For the year ended December 31, 2020, average loans and average investment securities increased approximately $246.4 million and $7.9 million, respectively, while average interest-bearing deposits increased approximately $139.4 million. The increases in average loans, investment securities and interest-bearing deposits was driven by both organic growth and growth through the acquisitions of Bank of York on November 1, 2019 and two branch locations of PlainsCapital Bank on February 21, 2020. Demand deposit
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growth also was driven by the pandemic-related factors discussed above. Average total borrowings decreased approximately $18.1 million compared to the same period in 2019 as we used available cash to pay down a portion of advances from the FHLB. Our yield on interest-earning assets declined as did our rate paid on interest-bearing liabilities primarily as a result of the overall decline in prevailing interest rates.
Interest income was $93.8 million for the year ended December 31, 2020 compared to $89.4 million for the same period in 2019. Loan interest income made up substantially all of our interest income for the years ended December 31, 2020 and 2019. Interest on our commercial real estate loans, commercial and industrial loans, and one-to-four family residential real estate loans constituted the three largest components of our loan interest income for the years ended December 31, 2020 and 2019 at 83% and 81% of total interest income on loans, respectively. The overall yield on interest-earning assets decreased 39 basis points to 4.45% for the year ended December 31, 2020 compared to 4.84% for the same period in 2019. The loan portfolio yielded 4.89% for the year ended December 31, 2020 compared to 5.26% for the year ended December 31, 2019. The PPP loans originated in 2020 have a contractual interest rate of 1% and origination fees based on the loan amount, which contributed to the decline in the yield on our portfolio. In addition, the yield on the investment portfolio was 2.00% for the year ended December 31, 2020 compared to 2.73% for the year ended December 31, 2019.
Interest expense was $20.3 million for the year ended December 31, 2020, a decrease of $4.4 million compared to interest expense of $24.6 million for the year ended December 31, 2019. While there was an increase in the volume of interest-bearing liabilities, the decrease in interest expense is mainly attributable to the decrease in the rate paid for these liabilities for the year ended December 31, 2020 compared to December 31, 2019. As previously mentioned, the federal funds target rate decreased to 0% to 0.25% on March 15, 2020, which affects the rate the Company pays for immediately available overnight funds, long-term borrowings, and deposits. For the year ended December 31, 2020, the cost of interest-bearing deposits decreased 43 basis points to 1.10% and the cost of interest-bearing liabilities decreased 40 basis points to 1.27% compared to the same period in 2019.
2019 vs. 2018. For a detailed discussion of our net interest income and net interest margin performance for 2019 compared to 2018, see our annual report on Form 10-K for the year ended December 31, 2019, Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations – Results of Operations – Net Interest Income and Net Interest Margin – 2019 vs. 2018, and – Volume/Rate Analysis.
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Average Balances and Yields. The following table sets forth average balance sheet data, including all major categories of interest-earning assets and interest-bearing liabilities, together with the interest earned or paid and the average yield or rate paid on each such category as of and for the years ended December 31, 2020, 2019 and 2018. Averages presented below are daily averages (dollars in thousands).
As of and for the year ended December 31,
2020 2019 2018
Average
Balance
Interest
Income/
Expense
(1)
Yield/ Rate(1)
Average
Balance
Interest
Income/
Expense
(1)
Yield/ Rate(1)
Average
Balance
Interest
Income/
Expense
(1)
Yield/ Rate(1)
Assets
Interest-earning assets:
Loans $ 1,786,302  $ 87,365  4.89  % $ 1,539,886  $ 80,954  5.26  % $ 1,306,264  $ 66,750  5.11  %
Securities:
Taxable 255,405  4,927  1.93  240,751  6,650  2.76  222,948  5,793  2.60 
Tax-exempt 25,024  686  2.74  31,780  790  2.49  34,159  815  2.39 
Interest-earning balances with banks 42,852  816  1.90  34,905  1,049  3.00  24,126  533  2.21 
Total interest-earning assets 2,109,583  93,794  4.45  1,847,322  89,443  4.84  1,587,497  73,891  4.65 
Cash and due from banks 27,768  22,969  17,219 
Intangible assets 32,190  26,107  19,927 
Other assets 119,994  90,949  73,472 
Allowance for loan losses (15,272) (9,969) (8,491)
Total assets $ 2,274,263  $ 1,977,378  $ 1,689,624 
Liabilities and stockholders’ equity
Interest-bearing liabilities:
Deposits:
Interest-bearing demand $ 612,000  $ 3,535  0.58  % $ 510,148  $ 5,308  1.04  % $ 394,336  $ 3,206  0.81  %
Brokered Deposits 20,308  177  0.87  —  —  —  —  —  — 
Savings deposits 129,211  401  0.31  110,936  501  0.45  116,544  567  0.49 
Time deposits 640,549  11,263  1.76  641,630  13,498  2.10  530,881  7,621  1.44 
Total interest-bearing deposits 1,402,068  15,376  1.10  1,262,714  19,307  1.53  1,041,761  11,394  1.09 
Short-term borrowings 65,323  710  1.09  113,539  2,348  2.07  145,090  2,511  1.73 
Long-term debt 128,163  4,174  3.26  98,017  2,970  3.03  95,692  2,616  2.73 
Total interest-bearing liabilities 1,595,554  20,260  1.27  1,474,270  24,625  1.67  1,282,543  16,521  1.29 
Noninterest-bearing deposits 418,240  283,274  220,068 
Other liabilities 19,805  14,717  9,817 
Stockholders’ equity 240,664  205,117  177,196 
Total liabilities and stockholders’ equity $ 2,274,263  $ 1,977,378  $ 1,689,624 
Net interest income/net interest margin $ 73,534  3.49  % $ 64,818  3.51  % $ 57,370  3.61  %
(1)Interest income and net interest margin are expressed as a percentage of average interest-earning assets outstanding for the indicated periods. Interest expense is expressed as a percentage of average interest-bearing liabilities for the indicated periods.
Nonaccrual loans were included in the computation of average loan balances but carry a zero yield. The yields include the effect of loan fees of $2.4 million, $1.9 million and $2.1 million for the years ended December 31, 2020, 2019 and 2018, respectively, and discounts and premiums that are amortized or accreted to interest income or expense.
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Volume/Rate Analysis. The following table sets forth a summary of the changes in interest earned and interest paid resulting from changes in volume and rates for the year ended December 31, 2020 compared to the year ended December 31, 2019 (dollars in thousands):
Year ended December 31, 2020 vs.
Year ended December 31, 2019
Volume Rate
Net(1)
Interest income:
Loans $ 12,954  $ (6,543) $ 6,411 
Securities:
Taxable 405  (2,128) (1,723)
Tax-exempt (168) 64  (104)
Interest-earning balances with banks 239  (472) (233)
Total interest-earning assets 13,430  (9,079) 4,351 
Interest expense:
Interest-bearing demand deposits 1,060  (2,833) (1,773)
Brokered deposits —  177  177 
Savings deposits 82  (182) (100)
Time deposits (23) (2,212) (2,235)
Short-term borrowings (997) (641) (1,638)
Long-term debt 913  291  1,204 
Total interest-bearing liabilities 1,035  (5,400) (4,365)
Change in net interest income $ 12,395  $ (3,679) $ 8,716 
(1)Changes in interest due to both volume and rate have been allocated on a pro-rata basis using the absolute ratio value of amounts calculated.
Noninterest Income
Noninterest income includes, among other things, fees generated from our deposit services, gain on sale of securities, fixed assets and other real estate owned, servicing fees and fee income on serviced loans, interchange fees, income from bank owned life insurance, and changes in the fair value of equity securities. We expect to continue to develop new products that generate noninterest income, and enhance our existing products, in order to diversify our revenue sources.
2020 vs. 2019. Total noninterest income increased $5.9 million, or 94.6%, to $12.1 million for the year ended December 31, 2020 compared to $6.2 million for the year ended December 31, 2019. The increase is primarily due to the $3.6 million increase in other operating income and the $2.0 million increase in the gain on sale of investment securities.
Other operating income is the largest component of our noninterest income for the year ended December 31, 2020. Other operating income includes, among other things, credit card, ATM and wire fees, derivative fee income, and rental income. The $3.6 million increase in other operating income for the year ended December 31, 2020 is primarily attributable to a $2.8 million increase in derivative fee income compared to the year ended December 31, 2019. We also experienced an increase in rental income of $0.2 million due to the Company’s purchase in May 2020 of the first floor of its corporate headquarters, which has multiple tenants.
Service charges on deposit accounts include maintenance fees on accounts, account enhancement charges for additional deposit account features, per item charges, overdraft fees, and treasury management charges. Service charges on deposit accounts increased 4.2% to $1.9 million for the year ended December 31, 2020 compared to $1.8 million for the same period in 2019.
Gain on the sale of investment securities for the year ended December 31, 2020 increased to $2.3 million from $0.3 million for the same period in 2019. We sold approximately $56.5 million in securities during the year ended December 31, 2020 compared to sales of $65.6 million during the year ended December 31, 2019.
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Servicing fees and fee income on serviced loans decreased $0.2 million, or 36.1%, to $0.4 million, for the year ended December 31, 2020. This decrease is a result of the Bank exiting the indirect auto loan origination business at the end of 2015. Since the Bank did not originate auto loans for sale during the years ended December 31, 2020 and 2019, the servicing portfolio, which experienced regularly scheduled paydowns, was not replaced with new loans. We expect servicing fees and fee income on serviced loans to decrease over time until all serviced loans are paid off. At December 31, 2020, the weighted average remaining term of the indirect auto loan portfolio was 1.3 years.
Interchange fees, which are fees earned on the usage of the Bank’s credit and debit cards, increased $0.3 million, or 26.9%, to $1.4 million for year ended December 31, 2020 from $1.1 million for same period in 2019. The increase in interchange fees can primarily be attributed to the increase in the volume of debit and credit card transactions.
Income from bank owned life insurance increased $0.2 million to $0.9 million for the year ended December 31, 2020 from $0.7 million for the same period in 2019. This increase reflects increased interest earned on the Company’s bank owned life insurance policies.
Change in the fair value of equity securities for the year ended December 31, 2020 was a decrease of $0.1 million and represents the change in the fair value of marketable equity securities that, prior to January 1, 2018, were included as AFS investment securities in the Company’s consolidated balance sheet. With the adoption of ASU 2016-01 on January 1, 2018, equity securities can no longer be classified as AFS, and, therefore, marketable equity securities are disclosed as equity securities on the balance sheet with changes in the fair value reflected in noninterest income.
2019 vs. 2018. For a detailed discussion of our noninterest income for 2019 compared to 2018, see our annual report on Form 10-K for the year ended December 31, 2019, Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations – Results of Operations – Noninterest Income – 2019 vs. 2018.
Noninterest Expense
Noninterest expense includes salaries and benefits and other costs associated with the conduct of our operations. We are committed to managing our costs within the framework of our operating strategy. However, since we are focused on growth both organically and through acquisition, we expect our expenses to continue to increase as we add employees and physical locations to accommodate our growing franchise. Our goal is to create synergies promptly after completing an acquisition, as this is important to our earnings success.
2020 vs. 2019. Total noninterest expense was $57.1 million for the year ended December 31, 2020, an increase of $9.0 million, or 18.6%, from $48.2 million for the year ended December 31, 2019. This increase was driven by the increases in salaries and employee benefits, depreciation and amortization, and other operating expenses.
Salaries and employee benefits increased $4.7 million, or 16.5%, to $33.4 million for the year ended December 31, 2020, compared to $28.6 million for the year ended December 31, 2019. The increase in salaries and employee benefits is mainly attributable to the increased number of employees as a result of our growth, both organically and through acquisitions. The Company completed the acquisitions of Mainland Bank in March 2019 and Bank of York in November 2019, which added five branch locations and related staff during the year ended December 31, 2019. The Bank also added staff when it opened two de novo branches in October and December 2019. In addition, the Bank acquired two branch locations from PlainsCapital Bank in February 2020 and opened two de novo branches in July and November 2020. Further, as a result of the success of the PPP loan program, the Bank paid a $0.2 million incentive in the fourth quarter of 2020 to recognize the efforts of Bank employees.
Depreciation and amortization increased $1.1 million, or 32.0%, to $4.6 million for the year ended December 31, 2020, compared to $3.5 million for the year ended December 31, 2019. The increase in depreciation and amortization was driven by the addition of approximately $2.8 million in fixed assets acquired from PlainsCapital, as well as various projects throughout the year, including equipment upgrades at acquired branches, opening of a free-standing interactive teller machine in Morgan City, Louisiana in August 2020, and the addition of two de novo branches in July and November 2020.
Other operating expenses include security, business development, FDIC and OCC assessments, bank shares and property taxes, charitable contributions, repair and maintenance costs, personnel training and development, filing fees, and other costs related to the operation of our business. Other operating expenses increased $2.6 million, or 31.7%, to $11.0 million for the year ended December 31, 2020 from $8.3 million for the same period in 2019. The increase in other operating expenses was primarily related to increases in software and telephone expenses, and FDIC and OCC assessment fees.
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Data processing increased $0.7 million, or 30.0%, to $3.1 million for the year ended December 31, 2020 from $2.4 million for the same period in 2019. The increase is mainly attributable to the Bank’s investments in multiple technology enhancements for our customers such as teller capture, Zelle®, and Business Electronic Banking for our more complex business customers’ banking needs. We also experienced an increase in customers due to organic growth, including new PPP customers, and growth from acquisitions.
Occupancy expense increased $0.4 million, or 21.7% to $2.2 million for the year ended December 31, 2020 from $1.8 million for the year ended December 31, 2019. This increase is primarily attributable to building rent, as the Bank acquired leases for the two branch locations acquired from PlainsCapital in February 2020.
2019 vs. 2018. For a detailed discussion of our noninterest expense for 2019 compared to 2018, see our annual report on Form 10-K for the year ended December 31, 2019, Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations – Results of Operations – Noninterest Expense – 2019 vs. 2018.
Income Tax Expense
Income tax expense for the years ended December 31, 2020, 2019 and 2018 was $3.5 million, $4.1 million, and $3.6 million, respectively. The effective tax rates for the years ended December 31, 2020, 2019 and 2018 were 19.9%, 19.7%, and 21.1%, respectively. The effective tax rate differs from the statutory rate of 21% primarily due to tax exempt interest income earned on certain investment securities and bank owned life insurance, and in 2018, a $0.3 million charge related to the Tax Cuts and Jobs Act.
Risk Management
The primary risks associated with our operations are credit, interest rate and liquidity risk. Credit and interest rate risk are discussed below, while liquidity risk is discussed in this section under the heading Liquidity and Capital Resources below.
Credit Risk and the Allowance for Loan Losses
General. The risk of loss should a borrower default on a loan is inherent in any lending activity. Our portfolio and related credit risk are monitored and managed on an ongoing basis by our risk management department, the board of directors’ loan committee and the full board of directors. We utilize a 10 point risk-rating system, which assigns a risk grade to each borrower based on a number of quantitative and qualitative factors associated with a loan transaction. The risk grade categorizes the loan into one of five risk categories, based on information about the ability of borrowers to service the debt. The information includes, among other factors, current financial information about the borrower, historical payment experience, credit documentation, public information and current economic trends. These categories assist management in monitoring our credit quality. The following describes each of the risk categories, which are consistent with the definitions used in guidance promulgated by federal banking regulators:
Pass (Loan grades 1-6)—Loans not meeting the criteria below are considered pass. These loans have high credit characteristics and financial strength. The borrowers at least generate profits and cash flow that are in line with peer and industry standards and have debt service coverage ratios above loan covenants and our policy guidelines. For some of these loans, a guaranty from a financially capable party mitigates characteristics of the borrower that might otherwise result in a lower grade.
Special Mention (grade 7)—Loans classified as special mention possess some credit deficiencies that need to be corrected to avoid a greater risk of default in the future. For example, financial ratios relating to the borrower may have deteriorated. Often, a special mention categorization is temporary while certain factors are analyzed or matters addressed before the loan is re-categorized as either pass or substandard.
Substandard (grade 8)—Loans classified as substandard are inadequately protected by the current net worth and paying capacity of the borrower or the liquidation value of any collateral. If deficiencies are not addressed, it is likely that this category of loan will result in the Bank incurring a loss. Where a borrower has been unable to adjust to industry or general economic conditions, the borrower’s loan is often categorized as substandard.
Doubtful (grade 9)—Doubtful loans are substandard loans with one or more additional negative factors that makes full collection of amounts outstanding, either through repayment or liquidation of collateral, highly questionable and improbable.
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Loss (grade 10)—Loans classified as loss have deteriorated to such a point that it is not practicable to defer writing off the loan. For these loans, all efforts to remediate the loan’s negative characteristics have failed and the value of the collateral, if any, has severely deteriorated relative to the amount outstanding. Although some value may be recovered on such a loan, it is not significant in relation to the amount borrowed.
At December 31, 2020 and December 31, 2019, there were no loans classified as loss, while there were $0.9 million and $0.1 million, respectively, of loans classified as doubtful, $20.1 million and $8.7 million, respectively, of loans classified as substandard, and $16.9 million and $4.4 million, respectively, of loans classified as special mention as of such dates. Of our aggregate $37.9 million and $13.2 million doubtful, substandard and special mention loans at December 31, 2020 and December 31, 2019, respectively, $8.4 million and $7.1 million, respectively, were acquired and marked to fair value at the time of their acquisition. At December 31, 2018, we had no loans classified as loss, and we had doubtful, substandard and special mention loans of $0.1 million, $9.5 million and $0.2 million, respectively.
An independent loan review is conducted annually, whether internally or externally, on at least 40% of commercial loans utilizing a risk-based approach designed to maximize the effectiveness of the review. Internal loan review is independent of the loan underwriting and approval process. In addition, credit analysts periodically review certain commercial loans to identify negative financial trends related to any one borrower, any related groups of borrowers or an industry. All loans not categorized as pass are put on an internal watch list, with quarterly reports to the board of directors. In addition, a written status report is maintained by our special assets division for all commercial loans categorized as substandard or worse. We use this information in connection with our collection efforts.
If our collection efforts are unsuccessful, collateral securing loans may be repossessed and sold or, for loans secured by real estate, foreclosure proceedings initiated. The collateral is sold at public auction for fair market value (based upon recent appraisals), with fees associated with the foreclosure being deducted from the sales price. The purchase price is applied to the outstanding loan balance. If the loan balance is greater than the sales proceeds, the deficient balance is charged-off.
Allowance for Loan Losses. The allowance for loan losses is an amount that management believes will be adequate to absorb probable losses inherent in the entire loan portfolio. The appropriate level of the allowance is based on an ongoing analysis of the loan portfolio and represents an amount that management deems adequate to provide for inherent losses, including collective impairment as recognized under ASC Topic 450, Contingencies. Collective impairment is calculated based on loans grouped by grade. Another component of the allowance is losses on loans assessed as impaired under ASC 310. The balance of these loans and their related allowance is included in management’s estimation and analysis of the allowance for loan losses. Other considerations in establishing the allowance for loan losses include the nature and volume of the loan portfolio, overall portfolio quality, historical loan loss, review of specific problem loans, and current economic conditions that may affect the borrower’s ability to pay, as well as trends within each of these factors. The allowance for loan losses is established after input from management as well as our risk management department and our special assets committee. We evaluate the adequacy of the allowance for loan losses on a quarterly basis. This evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available. The allowance for loan losses was $20.4 million at December 31, 2020, an increase compared to $10.7 million at December 31, 2019 and $9.5 million at December 31, 2018. The primary reason for the increase in the allowance for loan losses at December 31, 2020 compared to prior years is the change in economic conditions in response to the COVID-19 pandemic.
A loan is considered impaired when, based on current information and events, it is probable that we will be unable to collect the scheduled payments of principal and interest when due according to the contractual terms of the loan agreement. Determination of impairment is treated the same across all classes of loans. Impairment is measured on a loan-by-loan basis for, among others, all loans of $500,000 or greater, nonaccrual loans and a sample of loans between $250,000 and $500,000. When we identify a loan as impaired, we measure the extent of the impairment based on the present value of expected future cash flows, discounted at the loan’s effective interest rate, except when the sole (remaining) source of repayment for the