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;
•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.
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.
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.
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
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(In thousands, except share data)
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As of and for the year ended December 31,
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2020(1)
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2019(1)
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2018
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2017(1)
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2016
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Financial Information
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Total assets
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$
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2,321,181
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$
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2,148,916
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$
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1,786,469
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$
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1,622,734
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$
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1,158,960
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Total stockholders' equity
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243,284
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241,976
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182,262
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|
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172,729
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112,757
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Net interest income
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73,534
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64,818
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57,370
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42,517
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34,739
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Net income
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13,889
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16,839
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13,606
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8,202
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7,880
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Diluted earnings per share
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1.27
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1.66
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1.39
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0.96
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1.10
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Performance Ratios
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Return on average assets
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0.61
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%
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0.85
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%
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0.81
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%
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0.62
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%
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|
0.71
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%
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Return on average equity
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5.77
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8.21
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7.68
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5.65
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6.99
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Net interest margin
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3.49
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3.51
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3.61
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|
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3.39
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3.32
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Dividend payout ratio
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19.69
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13.55
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|
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12.09
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10.78
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3.80
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Capital Ratios
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Total equity to total assets
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10.48
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%
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11.26
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%
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10.20
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%
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10.64
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%
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9.73
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%
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Tangible equity to tangible assets
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9.22
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9.96
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9.20
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9.53
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9.48
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(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,
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2020
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2019
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2018
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2017
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2016
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Total stockholders’ equity - GAAP
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$
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243,284
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$
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241,976
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|
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$
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182,262
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$
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172,729
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$
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112,757
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Adjustments:
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Goodwill
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28,144
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26,132
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17,424
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17,086
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2,684
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Core deposit intangible
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3,988
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4,803
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2,263
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2,740
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450
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Trademark intangible
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100
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100
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100
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100
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100
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Tangible equity
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$
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211,052
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$
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210,941
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$
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162,475
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$
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152,803
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$
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109,523
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Total assets - GAAP
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$
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2,321,181
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$
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2,148,916
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$
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1,786,469
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$
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1,622,734
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$
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1,158,960
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Adjustments:
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Goodwill
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28,144
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26,132
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17,424
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17,086
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2,684
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Core deposit intangible
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3,988
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4,803
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2,263
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2,740
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450
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Trademark intangible
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100
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100
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100
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100
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100
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Tangible assets
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$
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2,288,949
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$
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2,117,881
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$
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1,766,682
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$
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1,602,808
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$
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1,155,726
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Total shares outstanding
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10,608,869
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11,228,775
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9,484,219
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9,514,926
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7,101,851
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Book value per share
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$
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22.93
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$
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21.55
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$
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19.22
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$
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18.15
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$
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15.88
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Effect of adjustment
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(3.04)
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(2.76)
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(2.09)
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(2.09)
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(0.46)
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Tangible book value per share
|
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$
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19.89
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|
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$
|
18.79
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$
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17.13
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$
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16.06
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$
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15.42
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Total equity to total assets
|
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10.48
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%
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11.26
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%
|
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10.20
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%
|
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10.64
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%
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9.73
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%
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Effect of adjustment
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(1.26)
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(1.30)
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(1.00)
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|
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(1.11)
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|
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(0.25)
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Tangible equity to tangible assets
|
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9.22
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%
|
|
9.96
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%
|
|
9.20
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%
|
|
9.53
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%
|
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9.48
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%
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Efficiency ratio(1)
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|
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|
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Noninterest expense
|
|
$
|
57,131
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|
|
$
|
48,168
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|
|
$
|
41,882
|
|
|
$
|
32,342
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|
|
$
|
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.
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.
•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.
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.
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
|
|
|
3
|
|
|
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.
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.
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
|
|
5
|
|
|
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.
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
|
|
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
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
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.
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).
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As of and for the year ended December 31,
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2020
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2019
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2018
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Average
Balance
|
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Interest
Income/
Expense(1)
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|
Yield/ Rate(1)
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|
Average
Balance
|
|
Interest
Income/
Expense(1)
|
|
Yield/ Rate(1)
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|
Average
Balance
|
|
Interest
Income/
Expense(1)
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|
Yield/ Rate(1)
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Assets
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Interest-earning assets:
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|
|
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|
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Loans
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$
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1,786,302
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|
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$
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87,365
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4.89
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%
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$
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1,539,886
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$
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80,954
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5.26
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%
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$
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1,306,264
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$
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66,750
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5.11
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%
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Securities:
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Taxable
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255,405
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4,927
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|
|
1.93
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|
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240,751
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6,650
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|
2.76
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222,948
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5,793
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|
2.60
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Tax-exempt
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25,024
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|
686
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|
|
2.74
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31,780
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|
790
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|
2.49
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34,159
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815
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|
|
2.39
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Interest-earning balances with banks
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|
42,852
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|
|
816
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|
|
1.90
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|
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34,905
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|
|
1,049
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|
|
3.00
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|
|
24,126
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|
|
533
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|
|
2.21
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Total interest-earning assets
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2,109,583
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|
|
93,794
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|
|
4.45
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|
|
1,847,322
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|
|
89,443
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|
|
4.84
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|
|
1,587,497
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|
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73,891
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|
|
4.65
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Cash and due from banks
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27,768
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|
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22,969
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17,219
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Intangible assets
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32,190
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26,107
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19,927
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Other assets
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119,994
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90,949
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|
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73,472
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|
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Allowance for loan losses
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(15,272)
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|
|
(9,969)
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|
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(8,491)
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Total assets
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$
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2,274,263
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|
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$
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1,977,378
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$
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1,689,624
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Liabilities and stockholders’ equity
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Interest-bearing liabilities:
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Deposits:
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Interest-bearing demand
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$
|
612,000
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|
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$
|
3,535
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|
|
0.58
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%
|
|
$
|
510,148
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|
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$
|
5,308
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|
|
1.04
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%
|
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$
|
394,336
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|
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$
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3,206
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|
|
0.81
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%
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Brokered Deposits
|
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20,308
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|
|
177
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|
|
0.87
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|
|
—
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|
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—
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|
|
—
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|
|
—
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|
|
—
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|
|
—
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Savings deposits
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129,211
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|
|
401
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|
|
0.31
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|
|
110,936
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|
|
501
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|
|
0.45
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|
|
116,544
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|
|
567
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|
|
0.49
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Time deposits
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|
640,549
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|
|
11,263
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|
|
1.76
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|
|
641,630
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|
|
13,498
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|
|
2.10
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|
|
530,881
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|
|
7,621
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|
|
1.44
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Total interest-bearing deposits
|
|
1,402,068
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|
|
15,376
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|
|
1.10
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|
|
1,262,714
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|
|
19,307
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|
|
1.53
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|
|
1,041,761
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|
|
11,394
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|
|
1.09
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Short-term borrowings
|
|
65,323
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|
|
710
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|
|
1.09
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|
|
113,539
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|
|
2,348
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|
|
2.07
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|
|
145,090
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|
|
2,511
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|
|
1.73
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Long-term debt
|
|
128,163
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|
|
4,174
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|
|
3.26
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|
|
98,017
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|
|
2,970
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|
|
3.03
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|
|
95,692
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|
|
2,616
|
|
|
2.73
|
|
Total interest-bearing liabilities
|
|
1,595,554
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|
|
20,260
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|
|
1.27
|
|
|
1,474,270
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|
|
24,625
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|
|
1.67
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|
|
1,282,543
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|
|
16,521
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|
|
1.29
|
|
Noninterest-bearing deposits
|
|
418,240
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|
|
|
|
|
|
283,274
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|
|
|
|
|
|
220,068
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|
|
|
|
|
Other liabilities
|
|
19,805
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|
|
|
|
|
|
14,717
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|
|
|
|
|
|
9,817
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|
|
|
|
|
Stockholders’ equity
|
|
240,664
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|
|
|
|
|
|
205,117
|
|
|
|
|
|
|
177,196
|
|
|
|
|
|
Total liabilities and stockholders’ equity
|
|
$
|
2,274,263
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|
|
|
|
|
|
$
|
1,977,378
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|
|
|
|
|
|
$
|
1,689,624
|
|
|
|
|
|
Net interest income/net interest margin
|
|
|
|
$
|
73,534
|
|
|
3.49
|
%
|
|
|
|
$
|
64,818
|
|
|
3.51
|
%
|
|
|
|
$
|
57,370
|
|
|
3.61
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%
|
(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.
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):
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|
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|
|
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|
|
|
|
|
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|
|
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.
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.
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.
•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, ov