ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Except where the context otherwise requires or where otherwise indicated, in this Quarterly Report on Form 10-Q the terms “we,” “us,” “our,” “Company” and “our business” refer to Allegiance Bancshares, Inc. and our wholly-owned banking subsidiary, Allegiance Bank, a Texas banking association, and the terms “Allegiance Bank” or the “Bank” refer to Allegiance Bank. In this Quarterly Report on Form 10-Q, we refer to the Houston-The Woodlands-Sugar Land metropolitan statistical area, or MSA, and the Beaumont-Port Arthur MSA as the “Houston region.”
Cautionary Notice Regarding Forward-Looking Statements
Statements and financial discussion and analysis contained in this Quarterly Report on Form 10-Q that are not historical facts are forward-looking statements and are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. We also may make forward-looking statements in our other documents filed with or furnished to the SEC. In addition, our senior management may make forward-looking statements orally to investors, analysts, representatives of the media and others. Statements preceded by, followed by or that otherwise include the words “believes,” “expects,” “continues,” “anticipates,” “intends,” “projects,” “estimates,” “potential,” “plans” and similar expressions or future or conditional verbs such as “will,” “should,” “would,” “may” and “could” are generally forward-looking in nature and not historical facts, although not all forward-looking statements include the foregoing words. Forward-looking statements are based on assumptions and involve a number of risks and uncertainties, many of which are beyond our control, particularly with regard to developments related to the coronavirus (COVID-19) pandemic. Many possible events or factors could affect our future financial results and performance and could cause such results or performance to differ materially from those expressed in our forward-looking statements.
While there is no assurance that any list of risks and uncertainties or risk factors is complete, below are certain factors which could cause our actual results to differ from those in our forward-looking statements:
•risks related to the pending merger with CBTX, Inc. (“CBTX”), including that its consummation is contingent upon the satisfaction of a number of conditions, including regulatory approvals, that may be outside of our or CBTX’s control and that we and CBTX may be unable to satisfy or obtain or which may delay the consummation of the merger or result in the imposition of conditions that could reduce the anticipated benefits from the merger or cause the parties to abandon the merger;
•risks related to the concentration of our business in the Houston region, including risks associated with volatility or decreases in oil and gas prices or prolonged periods of lower oil and gas prices;
•general market conditions and economic trends nationally, regionally and particularly in the Houston region;
•the impact of the COVID-19 pandemic on our business, including the impact of the actions taken by governmental authorities to try and contain the virus or address the impact of the virus on the United States economy (including, without limitation, the CARES Act), and the resulting effect of all of such items on our operations, liquidity and capital position, and on the financial condition of our borrowers and other customers;
•our ability to retain executive officers and key employees and their customer and community relationships;
•our ability to recruit and retain successful bankers that meet our expectations in terms of customer and community relationships and profitability;
•risks related to our strategic focus on lending to small to medium-sized businesses;
•our ability to implement our growth strategy, including through the identification of acquisition candidates that will be accretive to our financial condition and results of operations, as well as permitting decision-making authority at the branch level;
•risks related to any businesses we acquire in the future, including exposure to potential asset and credit quality risks and unknown or contingent liabilities, the time and costs associated with integrating systems, technology platforms, procedures and personnel, the need for additional capital to finance such transactions and possible failures in realizing the anticipated benefits from such acquisitions;
•risks associated with our owner-occupied commercial real estate loan and other commercial real estate loan portfolios, including the risks inherent in the valuation of the collateral securing such loans;
•risks associated with our commercial and industrial loan portfolio, including the risk for deterioration in value of the general business assets that generally secure such loans;
•the accuracy and sufficiency of the assumptions and estimates we make in establishing reserves for potential loan losses and other estimates;
•risk of deteriorating asset quality and higher loan charge-offs, as well as the time and effort necessary to resolve nonperforming assets;
•potential changes in the prices, values and sales volumes of commercial and residential real estate securing our real estate loans;
•risks related to loans originated and serviced under the Small Business Administration’s guidelines;
•changes in market interest rates that affect the pricing of our loans and deposits and our net interest income;
•potential fluctuations in the market value and liquidity of the securities we hold for sale;
•risk of impairment of investment securities, goodwill, other intangible assets or deferred tax assets;
•the effects of competition from a wide variety of local, regional, national and other providers of financial, investment and insurance services, which may adversely affect our pricing and terms;
•risks associated with negative public perception of the Company;
•our ability to maintain an effective system of disclosure controls and procedures and internal controls over financial reporting;
•risks associated with fraudulent and negligent acts by our customers, employees or vendors;
•our ability to keep pace with technological change or difficulties when implementing new technologies;
•risks associated with system failures or failures to protect against cybersecurity threats, such as breaches of our network security;
•our ability to comply with privacy laws and properly safeguard personal, confidential or proprietary information;
•risks associated with data processing system failures and errors;
•potential risk of environmental liability related to owning or foreclosing on real property;
•the institution and outcome of litigation and other legal proceeding against us or to which we become subject;
•our ability to maintain adequate liquidity and to raise necessary capital to fund our acquisition strategy and operations or to meet increased minimum regulatory capital levels;
•our ability to comply with various governmental and regulatory requirements applicable to financial institutions;
•the impact of recent and future legislative and regulatory changes, including changes in banking, securities and tax laws and regulations and their application by our regulators;
•governmental monetary and fiscal policies, including the policies of the Federal Reserve;
•our ability to comply with supervisory actions by federal and state banking agencies;
•changes in the scope and cost of FDIC insurance and other coverage;
•systemic risks associated with the soundness of other financial institutions;
•the effects of war or other conflicts, acts of terrorism (including cyberattacks) or other catastrophic events, including hurricanes, pandemics, storms, droughts, tornadoes and flooding, that may affect general economic conditions; and
•other risks and uncertainties listed from time to time in our reports and documents filed with the SEC.
Further, these forward-looking statements speak only as of the date on which they were made and we disclaim any obligation to update or revise any forward-looking statements to reflect events or circumstances after the date on which any such statement is made or to reflect the occurrence of unanticipated events, unless required to do so under the federal securities laws. Other factors not identified above, including those described under the headings “Risk Factors”, "Quantitative and Qualitative Disclosures about Market Risk" and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in this Quarterly Report on Form 10-Q for the quarter ended June 30, 2022, and in our Annual Report on Form 10-K for the year ended December 31, 2021 may also cause actual results to differ materially from those described in our forward-looking statements. Most of these factors are difficult to anticipate and are generally beyond our control. You should consider these factors in connection with considering any forward-looking statements that may be made by us. Because of these uncertainties, you should not place undue reliance on any forward-looking statement.
Overview
We generate most of our income from interest income on loans, service charges on customer accounts and interest income from investments in securities. We incur interest expense on deposits and other borrowed funds and noninterest expenses such as salaries and employee benefits and occupancy expenses. Net interest income is the difference between interest income on earning assets such as loans and securities and interest expense on liabilities such as deposits and borrowings that are used to fund those assets. Net interest income is our largest source of revenue. To evaluate net interest income, we measure and monitor (1) yields on our loans and other interest-earning assets, (2) the interest expenses of our deposits and other funding sources, (3) our net interest spread and (4) our net interest margin. Net interest spread is the difference between rates earned on interest-earning assets and rates paid on interest-bearing liabilities. Net interest margin is calculated as net interest income divided by average interest-earning assets. Because noninterest-bearing sources of funds, such as noninterest-bearing deposits and shareholders’ equity, also fund interest-earning assets, net interest margin includes the benefit of these noninterest-bearing sources.
Our net interest income is affected by changes in the amount and mix of interest-earning assets and interest-bearing liabilities, referred to as a “volume change.” Periodic changes in the volume and types of loans in our loan portfolio are affected by, among other factors, economic and competitive conditions in Texas and specifically in the Houston region, as well as developments affecting the real estate, technology, financial services, insurance, transportation, manufacturing and energy sectors within our target market and throughout the state of Texas.
Our net interest income is also affected by changes in yields earned on interest-earning assets and rates paid on interest-bearing deposits and borrowed funds, referred to as a “rate change.” Fluctuations in market interest rates are driven by many factors, including governmental monetary policies, inflation, deflation, macroeconomic developments, changes in unemployment, the money supply, political and international conditions and conditions in domestic and foreign financial markets.
Our objective is to grow and strengthen our community banking franchise by deploying our super-community banking strategy and pursuing select strategic acquisitions. We are strategically focused on the Houston region because of our deep roots and experience operating through a variety of economic cycles in this large and vibrant market. We are positioned to be a leading provider of customized commercial banking services by emphasizing the strength and capabilities of local bank office management and by providing superior customer service.
Super-community banking strategy. Our super-community banking strategy emphasizes local delivery of the excellent customer service associated with community banking combined with the products, efficiencies and scale associated with larger banks. By empowering our personnel to make certain business decisions at a local level in order to respond quickly to customers’ needs, we are able to establish and foster strong relationships with customers through superior service. We operate full-service bank offices and employ bankers with strong underwriting credentials who are authorized to make loan and underwriting decisions up to prescribed limits at the bank office level. We support bank office operations with a centralized credit approval process for larger credit relationships, loan operations, information technology, core data processing, accounting, finance, treasury and treasury management support, deposit operations and executive and board oversight. We emphasize lending to and banking with small to medium-sized businesses, with which we believe we can establish stronger relationships through excellent service and provide lending that can be priced on terms that are more attractive to the Company than would be achieved by lending to larger businesses. We believe this approach produces a clear competitive advantage by delivering an extraordinary customer experience and fostering a culture dedicated to achieving superior external and internal service levels.
We plan to continue to emphasize our super-community banking strategy to organically grow our presence in the Houston region through:
•increasing the productivity of existing bankers, as measured by loans, deposits and fee income per banker, while enhancing profitability by leveraging our existing operating platform;
•focusing on local and individualized decision-making, allowing us to provide customers with rapid decisions on loan requests, which we believe allows us to effectively compete with larger financial institutions;
•identifying and hiring additional seasoned bankers who will thrive within our super-community banking model, and opening additional branches where we are able to attract seasoned bankers; and
•developing new products designed to serve a diversified economy, while preserving our strong culture of risk management.
Select strategic acquisitions. We intend to continue to expand our presence through organic growth and a disciplined acquisition strategy. We focus on like-minded community banks with similar lending strategies to our own when evaluating
acquisition opportunities. We believe that our management’s experience in assessing, executing and integrating target institutions will allow us to capitalize on acquisition opportunities.
Pending Merger of Equals with CBTX, Inc.
On November 8, 2021, Allegiance and CBTX, Inc., jointly announced that they entered into a definitive merger agreement pursuant to which the companies will combine in an all-stock merger of equals. Under the terms of the definitive merger agreement, Allegiance shareholders will receive 1.4184 shares of CBTX, Inc. common stock for each share of Allegiance common stock they own. Following the completion of the merger, we estimate that former Allegiance shareholders will own approximately 54% and former CBTX, Inc. shareholders will own approximately 46% of the combined company. The companies have received the requisite approvals from the Federal Deposit Insurance Corporation, Texas Department of Banking and both companies' shareholders and, subject to receipt of the approval of the Board of Governors of the Federal Reserve System and the satisfaction or in some cases waiver of the closing conditions, the parties anticipate closing in the third quarter of the year.
Critical Accounting Policies
Our accounting policies are integral to understanding our results of operations. Our accounting policies are described in detail in Note 1 to our Annual Report on Form 10-K for the year ended December 31, 2021.
We believe that of our accounting policies, the following may involve a higher degree of judgment and complexity:
Securities
Debt securities are classified as available for sale when they might be sold before maturity. Securities available for sale are carried at fair value. Unrealized gains and losses are excluded from earnings and reported, net of tax, as a separate component of shareholders’ equity until realized. Securities within the available for sale portfolio may be used as part of the Company’s asset/liability strategy and may be sold in response to changes in interest rate risk, prepayment risk or other similar economic factors.
Interest earned on these assets is included in interest income. Interest income includes amortization of purchase premium or discount. Premiums and discounts on securities are amortized on the level-yield method, except for mortgage backed securities where prepayments are anticipated. Gains and losses on sales are recorded on the trade date and determined using the specific identification method.
Nonperforming and Past Due Loans
The Company has several procedures in place to assist it in maintaining the overall quality of its loan portfolio. The Company has established underwriting guidelines to be followed by its officers, and monitors its delinquency levels for any negative or adverse trends. There can be no assurance, however, that the Company’s loan portfolio will not become subject to increasing pressures from deteriorating borrower credit due to general economic conditions or other factors.
Past due status is based on the contractual terms of the loan. Loans are considered past due if the required principal and interest payments have not been received as of the date such payments were due. The Company generally classifies a loan as nonperforming, automatically places the loan on nonaccrual status, ceases accruing interest and reverses all unpaid accrued interest against interest income, when, in management’s opinion, the borrower may be unable to meet payment obligations, when the payment of principal or interest on a loan is delinquent for 90 days, as well as when required by regulatory provisions, unless the loan is in the process of collection and the underlying collateral fully supports the carrying value of the loan. Any payments received on nonaccrual loans are applied first to outstanding loan amounts. Interest income is subsequently recognized only to the extent cash payments are received in excess of principal due. Any excess is treated as recovery of lost interest. Loans are returned to accrual status when all of the principal and interest amounts contractually due are brought current and future payments are reasonably assured.
In all cases, loans are placed on nonaccrual or charged-off at an earlier date if collection of principal or interest is considered doubtful. If the decision is made to continue accruing interest on the loan, periodic reviews are made to confirm the accruing status of the loan. Nonaccrual loans and loans past due 90 days include both smaller balance homogeneous loans that are collectively and individually evaluated. When available information confirms that specific loans, or portions thereof, are uncollectible, these amounts are charged-off against the allowance. All loan types are considered delinquent after 30 days past due and are typically charged-off or charged-down no later than 120 days past due, with consideration of, but not limited to, the following criteria in determining the need and timing of the charge-off or charge-down: (1) the Bank is in the process of repossession or foreclosure and there appears to be a likely deficiency; (2) the collateral securing the loan has been sold and there is an actual deficiency; (3) the Bank is proceeding with
lengthy legal action to collect its balance; (4) the borrower is unable to be located; or (5) the borrower has filed bankruptcy. Charge-offs occur when the Company confirms a loss on a loan.
Allowance for Credit Losses
The allowance for credit losses is a valuation account that is established through a provision for credit losses charged to expense, which represents management’s best estimate of lifetime expected losses based on reasonable and supportable forecasts, historical loss experience, and other qualitative considerations. The allowance for credit losses includes the allowance for credit losses on loans, which is deducted from the loans’ amortized cost basis to present the net amount expected to be collected on loans, the allowance for credit losses on unfunded commitments reported in other liabilities and the allowance for credit losses on securities available for sale.
Allowance for Credit Losses on Loans
The level of the allowance is based upon management's evaluation of historical default and loss experience, current and projected economic conditions, asset quality trends, known and inherent risks in the portfolio, adverse situations that may affect the borrower’s ability to repay a loan (including the timing of future payments), the estimated value of any underlying collateral, composition of the loan portfolio, industry and peer bank loan quality indications and other pertinent factors, including regulatory recommendations. The allowance for credit losses on loans maintained by management is believed adequate to absorb all expected future losses in the loan portfolio at the balance sheet date. The Company disaggregates the loan portfolio into pools for purposes of determining the allowance for credit losses. These pools are based on the level at which the Company develops, documents and applies a systematic methodology to determine the allowance for credit losses.
Loans with similar risk characteristics are collectively evaluated resulting in loss estimates as determined by applying reserve factors, such as historical lifetime loan loss experience, concentration risk of specific loan types, the volume, growth and composition of the Company’s loan portfolio, current economic conditions and reasonable and supportable forecasted economic conditions that may affect the borrower’s ability to pay and the value of collateral, the evaluation of the Company’s loan portfolio through its internal loan review process, general economic conditions and other qualitative risk factors both internal and external to the Company and other relevant factors, designed to estimate current expected credit losses, to amortized cost balances over the remaining contractual life of the collectively evaluated portfolio. Loans with similar risk characteristics are aggregated into homogeneous pools for assessment. Historical lifetime loan loss experience is determined by utilizing an open-pool (“cumulative loss rate”) methodology. Adjustments to the historical lifetime loan loss experience are made for differences in current loan pool risk characteristics such as portfolio concentrations, delinquency, nonaccrual, and watch list levels, as well as changes in current and forecasted economic conditions such as unemployment rates, property and collateral values, and other indices relating to economic activity. Losses are predicted over a period of time determined to be reasonable and supportable, and at the end of the reasonable and supportable period losses are reverted to long term historical averages. The reasonable and supportable period and reversion period are re-evaluated each year by the Company and are dependent on the current economic environment among other factors. A reasonable and supportable period of twelve months was utilized for all loan pools, followed by an immediate reversion to long term averages. Based on a review of these factors for each loan type, the Company applies an estimated percentage to the outstanding balance of each loan type.
Loans that no longer share risk characteristics with the collectively evaluated loan pools are evaluated on an individual basis and are excluded from the collectively evaluated pools. In order to assess which loans are to be individually evaluated, the Company follows a loan review program to evaluate the credit risk in the total loan portfolio and assigns risk grades to each loan. Individual credit loss estimates are typically performed for nonaccrual loans, modified loans classified as troubled debt restructurings and all other loans identified by management. All loans deemed as being individually evaluated are reviewed on a quarterly basis in order to determine whether a specific reserve is required. The Company considers certain loans to be collateral dependent if the borrower is experiencing financial difficulty and management expects repayment for the loan to be substantially through the operation or sale of the collateral. For collateral dependent loans, loss estimates are based on the fair value of collateral, less estimated cost to sell (if applicable). Collateral values supporting individually evaluated loans are assessed quarterly and appraisals are typically obtained at least annually. The Company allocates a specific loan loss reserve on an individual loan basis primarily based on the value of the collateral securing the individually evaluated loan. Through this loan review process, the Company assesses the overall quality of the loan portfolio and the adequacy of the allowance for credit losses on loans while considering risk elements attributable to particular loan types in assessing the quality of individual loans. In addition, for each category of loans, the Company considers secondary sources of income and the financial strength and credit history of the borrower and any guarantors.
A change in the allowance for credit losses on loans can be attributable to several factors, most notably specific reserves for individually evaluated loans, historical lifetime loan loss information, and changes in economic factors and growth in the loan portfolio. Specific reserves that are calculated on an individual basis and the qualitative assessment of all other loans reflect current
changes in the credit quality of the loan portfolio. Historical lifetime credit losses, on the other hand, are based on an open-pool (“cumulative loss rate”) methodology, which is then applied to estimate lifetime credit losses in the loan portfolio. The allowance for credit losses on loans is further determined by the size of the loan portfolio subject to the allowance methodology and factors that include Company-specific risk indicators and general economic conditions, both of which are constantly changing. The Company evaluates the economic and portfolio-specific factors on a quarterly basis to determine a qualitative component of the general valuation allowance. These factors include current economic metrics, reasonable and supportable forecasted economic metrics, delinquency trends, credit concentrations, nature and volume of the portfolio and other adjustments for items not covered by specific reserves and historical lifetime loss experience. Based on the Company’s actual historical lifetime loan loss experience relative to economic and loan portfolio-specific factors at the time the losses occurred, management is able to identify the probable level of lifetime losses as of the date of measurement. The Company’s analysis of qualitative, or economic, factors on pools of loans with common risk characteristics, in combination with the quantitative historical lifetime loss information and specific reserves, provides the Company with an estimate of lifetime losses.
The calculation of current expected credit losses is inherently subjective, as it requires management to exercise judgment in determining appropriate factors used to determine the allowance. The estimated loan losses for all loan pools are adjusted for changes in qualitative factors not inherently considered in the quantitative analyses to bring the allowance to the level management believes is appropriate based on factors that have not otherwise been fully accounted for, including adjustments for foresight risk, input imprecision and model imprecision. The qualitative categories and the measurements used to quantify the risks within each of these categories are subjectively selected by management, but measured by objective measurements period over period. The data for each measurement may be obtained from internal or external sources. The current period measurements are evaluated and assigned a factor commensurate with the current level of risk relative to past measurements over time. The resulting qualitative adjustments are applied to the relevant collectively evaluated loan portfolios. These adjustments are based upon quarterly trend assessments in portfolio concentrations, changes in lending policies and procedures, policy exceptions, independent loan review results, internal risk ratings and peer group credit quality trends. The qualitative allowance allocation, as determined by the processes noted above, is increased or decreased for each loan pool based on the assessment of these various qualitative factors. The determination of the appropriate qualitative adjustment is based on management's analysis of current and expected economic conditions and their impact to the portfolio, as well as internal credit risk movements and a qualitative assessment of the lending environment, including underwriting standards. Management recognizes the sensitivity of various assumptions made in the quantitative modeling of expected losses and may adjust reserves depending upon the level of uncertainty that currently exists in one or more assumptions.
While policies and procedures used to estimate the allowance for credit losses on loans, as well as the resultant provision for credit losses charged to income, are considered adequate by management and are reviewed periodically by regulators and internal audit, they are approximate and could materially change based on changes within the loan portfolio and effects from economic factors. There are factors beyond the Company’s control, such as changes in projected economic conditions, including political instability or global events affecting the U.S. economy, real estate markets or particular industry conditions which could cause changes to expectations for current conditions and economic forecasts that could result in an unanticipated increase in the allowance and may materially impact asset quality and the adequacy of the allowance for credit losses and thus the resulting provision for credit losses.
In assessing the adequacy of the allowance for credit losses on loans, the Company considers the results of its ongoing independent loan review process. The Company undertakes this process both to ascertain those loans in the portfolio with elevated credit risk and to assist in its overall evaluation of the risk characteristics of the entire loan portfolio. Its loan review process includes the judgment of management, independent internal loan reviewers and reviews that may have been conducted by third-party reviewers including regulatory examiners. The Company incorporates relevant loan review results in the allowance.
In accordance with CECL, losses are estimated over the remaining contractual terms of loans, adjusted for prepayments. The contractual term excludes expected extensions, renewals and modifications unless management has a reasonable expectation at the reporting date that a troubled debt restructuring will be executed or such renewals, extensions or modifications are included in the original loan agreement and are not unconditionally cancellable by the Company.
Credit losses are estimated on the amortized cost basis of loans, which includes the principal balance outstanding, purchase discounts and premiums and deferred loan fees and costs. Loan losses are not estimated for accrued interest receivable as interest that is deemed uncollectible is written off through interest income in a timely manner. Accrued interest is presented separately on the balance sheets and as allowed under ASC Topic 326 is excluded from the tabular loan disclosures in Note 4 – Loans and Allowance for Credit Losses.
Allowance for Credit Losses on Unfunded Commitments
The Company estimates expected credit losses over the contractual term in which the Company is exposed to credit risk through a contractual obligation to extend credit, unless the obligation is unconditionally cancellable by the Company. The allowance for credit losses on unfunded commitments is adjusted as a provision for credit loss expense. The estimates are determined based on the likelihood of funding during the contractual term and an estimate of credit losses subsequent to funding. Estimated credit losses on subsequently funded balances are based on the same assumptions as used to estimate credit losses on existing funded loans.
Allowance for Credit Losses on Securities Available for Sale
For securities classified as available for sale that are in an unrealized loss position at the balance sheet date, the Company first assesses whether or not it intends to sell the security, or more likely than not will be required to sell the security, before recovery of its amortized cost basis. If either criteria is met, the security's amortized cost basis is written down to fair value through net income. If neither criteria is met, the Company evaluates whether any portion of the decline in fair value is the result of credit deterioration. Such evaluations consider the extent to which the amortized cost of the security exceeds its fair value, changes in credit ratings and any other known adverse conditions related to the specific security. If the evaluation indicates that a credit loss exists, an allowance for credit losses is recorded through provisions for credit losses for the amount by which the amortized cost basis of the security exceeds the present value of cash flows expected to be collected, limited by the amount by which the amortized cost exceeds fair value. Losses are charged against the allowance when management believes the uncollectibility of an available for sale security is confirmed or when either of the criteria regarding intent or requirement to sell is met. Any impairment not recognized in the allowance for credit losses is recognized in other comprehensive income. For certain types of debt securities, such as U.S. Treasuries and other securities with government guarantees, entities may expect zero credit losses. The zero-loss expectation applies to all of the Company’s securities and no allowance for credit losses was recorded on its available for sale securities portfolio at transition.
Accrued interest receivable on available for sale securities totaled $8.1 million at June 30, 2022 and is excluded from the estimate of credit losses.
Goodwill
Goodwill resulting from business combinations is generally determined as the excess of the fair value of the consideration transferred, plus the fair value of any noncontrolling interests in the acquiree, over the fair value of the net assets acquired and liabilities assumed as of the acquisition date. Goodwill is assessed annually on October 1 for impairment or more frequently if events and circumstances exist that indicate that the carrying amount of the asset may not be recoverable and a goodwill impairment test should be performed. A significant amount of judgment is involved in determining if an indicator of impairment has occurred. Such indicators may include, among others: a significant decline in our expected future cash flows; a sustained, significant decline in our stock price and market capitalization; a significant adverse change in legal factors or in the business climate; adverse action or assessment by a regulator; and unanticipated competition. Any adverse change in these factors could have a significant impact on the recoverability of these assets and could have a material impact on the Company’s consolidated financial statements.
Goodwill is the only intangible asset with an indefinite life on the Company’s balance sheet.
Participation in PPP Loan Program
We elected to participate in the first and second rounds of the Small Business Administration Paycheck Protection Program (PPP) under the Coronavirus Aid, Relief and Economic Security Act (CARES Act) program funding over $1.08 billion in loans. We have received fees and incurred incremental direct origination costs related to our participation in the PPP loan program, both of which have been deferred and are being amortized over the shorter of the repayment period or the contractual life of these loans. During the three and six months ended June 30, 2022, we recognized total net fee revenue into interest income of $1.4 million and $4.0 million, respectively, related to PPP fees compared to $6.4 million and $13.3 million, respectively, for the same periods in 2021. The remainder of the PPP loan deferred fees totaled approximately $934 thousand at June 30, 2022. These remaining deferred fees will be amortized over the shorter of the repayment period or the contractual life of the loans.
Recently Issued Accounting Pronouncements
We have evaluated new accounting pronouncements that have recently been issued. Refer to Note 1 of the Company’s consolidated financial statements for a discussion of recent accounting pronouncements that have been adopted by the Company or that will require enhanced disclosures in the Company’s financial statements in future periods.
Results of Operations
Net income was $16.4 million, or $0.80 per diluted share, for the second quarter 2022 compared to $22.9 million, or $1.12 per diluted share, for the second quarter 2021 primarily due to a $2.2 million operational loss and $1.7 million of acquisition and merger-related expenses recorded during the second quarter 2022, partially offset by increased net interest income, which included higher interest income on securities and lower interest income on loans due to the impact of $5.0 million less PPP loan revenue. Annualized returns on average assets, average equity and average tangible equity were 0.94%, 8.86% and 13.00%, respectively, compared to 1.42%, 11.87% and 17.20%, respectively, for the three months ended June 30, 2022 and 2021, respectively. Return on average tangible equity is a non-GAAP financial measure. See the GAAP to non-GAAP reconciliation table provided for a more detailed analysis. The efficiency ratio increased to 62.96% for the second quarter 2022 from 57.07% for the second quarter 2021 primarily due to the operational loss and acquisition and merger-related expenses recorded in the second quarter 2022. The efficiency ratio is calculated by dividing total noninterest expense by the sum of net interest income plus noninterest income, excluding net gains and losses on the sale of loans, securities and assets. Additionally, taxes and provision for loan losses are not part of the efficiency ratio calculation.
Net income was $35.1 million, or $1.71 per diluted share, for the six months ended June 30, 2022 compared to $40.9 million, or $2.01 per diluted share, for the six months ended June 30, 2021. The six months ended June 30, 2022 results included a provision for credit losses compared to a recapture of provision for credit losses, the $2.2 million operational loss, $2.1 million of acquisition and merger-related expenses related to the pending merger of equals with CBTX and lower interest income due to the decreased impact of PPP loan revenue of $9.3 million partially offset by higher interest income on securities compared to the same period in 2021. Annualized returns on average assets, average shareholders’ equity and average tangible shareholders’ equity were 0.99%, 9.14% and 13.19%, respectively, compared to 1.30%, 10.75% and 15.65%, respectively, for the six months ended June 30, 2022 and 2021, respectively. The efficiency ratio increased to 60.66% for the six months ended June 30, 2022 from 58.93% for the six months ended June 30, 2021 primarily due to the operational loss and acquisition and merger-related expenses.
Net Interest Income
Three months ended June 30, 2022 compared with three months ended June 30, 2021. Net interest income before the provision for credit losses for the three months ended June 30, 2022 was $57.5 million compared with $56.6 million for the three months ended June 30, 2021, a slight increase of $886 thousand, or 1.6%. This increase in net interest income was primarily due to increased interest income on securities and decreased interest expense partially offset by decreased interest income on loans due to the decreased impact of PPP loans and changes in market interest rates.
Interest income was $62.8 million for the three months ended June 30, 2022, remaining relatively flat, compared to the three months ended June 30, 2021, primarily due to decreased PPP fee income recognition into interest income offset by increased core loan interest income and increased interest income on securities and deposits in other financial institutions. Average securities outstanding increased $902.6 million and deposits in other financial institutions increased $241.4 million while average loans outstanding decreased $239.4 million primarily due to paydowns of PPP loans partially offset by the origination of core loans for the three months ended June 30, 2022 compared to the three months ended June 30, 2021. The net increase in total average interest-earning asset balances was partially offset by the decrease in average yield on securities to 1.83% from 2.31% due to the impact of lower interest rates and the decrease in average yield on loans to 5.02% for the three months ended June 30, 2022 from 5.09% for the same period in 2021. This decrease in average yield on loans was primarily due to $1.4 million of PPP fee income recognition during the three months ended June 30, 2022 compared to $6.4 million recognized for the three months ended June 30, 2021.
Interest expense was $5.4 million for the three months ended June 30, 2022, a decrease of $878 thousand, or 14.1%, compared to the three months ended June 30, 2021. This decrease was primarily due to lower funding costs on interest-bearing deposits partially offset by an increase in average interest-bearing liabilities. The cost of average interest-bearing liabilities decreased to 56 basis points for the three months ended June 30, 2022 compared to 67 basis points for the same period in 2021. Average interest-bearing liabilities increased $143.9 million, or 3.9%, for the three months ended June 30, 2022 compared to the three months ended June 30, 2021 due in part to funds from government stimulus programs such as the PPP and consumer economic impact payments received along with organic deposit growth.
Tax equivalent net interest margin, defined as net interest income adjusted for tax-free income divided by average interest-earning assets, for the three months ended June 30, 2022 was 3.53%, a decrease of 49 basis points compared to 4.02% for the three months ended June 30, 2021. The decrease in the margin over the prior year was primarily due to the decrease in the average yield on interest-earning assets, driven by decreased PPP revenue recognition and changes in the composition of earnings assets, partially offset by decreased funding costs. The average yield on interest-earning assets and the average rate paid on interest-bearing liabilities are primarily impacted by changes in market interest rates and changes in the volume and relative mix of the underlying assets and liabilities. The average yield on interest-earning assets of 3.81% and the average rate paid on interest-bearing liabilities of 0.56% for
the second quarter 2022 decreased by 60 basis points and 11 basis points, respectively, over the same period in 2021. Tax equivalent adjustments to net interest margin are the result of increasing income from tax-free securities and loans by an amount equal to the taxes that would have been paid if the income were fully taxable based on a 21% federal tax rate for the three months ended June 30, 2022 and 2021, thus making tax-exempt yields comparable to taxable asset yields.
The following table presents, for the periods indicated, the total dollar amount of average balances, interest income from average interest-earning assets and the annualized resultant yields, as well as the interest expense on average interest-bearing liabilities, expressed in both dollars and rates. Any nonaccruing loans have been included in the table as loans carrying a zero yield.
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Three Months Ended June 30, |
| 2022 | | 2021 |
| Average
Balance | | Interest
Earned/
Interest
Paid | | Average
Yield/ Rate | | Average
Balance | | Interest
Earned/
Interest
Paid | | Average
Yield/ Rate |
| (Dollars in thousands) |
| Assets | | | | | | | | | | | |
| Interest-earning Assets: | | | | | | | | | | | |
| Loans | $ | 4,303,714 | | | $ | 53,835 | | | 5.02 | % | | $ | 4,543,142 | | | $ | 57,691 | | | 5.09 | % |
| Securities | 1,778,745 | | | 8,128 | | | 1.83 | % | | 876,099 | | | 5,047 | | | 2.31 | % |
| Deposits in other financial institutions | 535,546 | | | 877 | | | 0.66 | % | | 294,188 | | | 94 | | | 0.13 | % |
| Total interest-earning assets | 6,618,005 | | | $ | 62,840 | | | 3.81 | % | | 5,713,429 | | | $ | 62,832 | | | 4.41 | % |
| Allowance for credit losses on loans | (49,290) | | | | | | | (52,699) | | | | | |
| Noninterest-earning assets | 450,584 | | | | | | | 835,801 | | | | | |
| Total assets | $ | 7,019,299 | | | | | | | $ | 6,496,531 | | | | | |
| | | | | | | | | | | |
| Liabilities and Shareholders' Equity | | | | | | | | | | | |
| Interest-bearing Liabilities: | | | | | | | | | | | |
| Interest-bearing demand deposits | $ | 1,044,493 | | | $ | 927 | | | 0.36 | % | | $ | 534,314 | | | $ | 326 | | | 0.24 | % |
| Money market and savings deposits | 1,566,376 | | | 932 | | | 0.24 | % | | 1,561,987 | | | 1,011 | | | 0.26 | % |
| Certificates and other time deposits | 1,088,664 | | | 1,922 | | | 0.71 | % | | 1,365,881 | | | 2,989 | | | 0.88 | % |
| Borrowed funds | 50,116 | | | 114 | | | 0.91 | % | | 144,126 | | | 469 | | | 1.31 | % |
| Subordinated debt | 109,045 | | | 1,463 | | | 5.38 | % | | 108,523 | | | 1,441 | | | 5.33 | % |
| Total interest-bearing liabilities | 3,858,694 | | | $ | 5,358 | | | 0.56 | % | | 3,714,831 | | | $ | 6,236 | | | 0.67 | % |
| | | | | | | | | | | |
| Noninterest-Bearing Liabilities: | | | | | | | | | | | |
| Noninterest-bearing demand deposits | 2,382,230 | | | | | | | 1,968,714 | | | | | |
| Other liabilities | 34,249 | | | | | | | 38,183 | | | | | |
| Total liabilities | 6,275,173 | | | | | | | 5,721,728 | | | | | |
| Shareholders' equity | 744,126 | | | | | | | 774,803 | | | | | |
| Total liabilities and shareholders' equity | $ | 7,019,299 | | | | | | | $ | 6,496,531 | | | | | |
| | | | | | | | | | | |
| Net interest rate spread | | | | | 3.25 | % | | | | | | 3.74 | % |
| | | | | | | | | | | |
Net interest income and margin(1) | | | $ | 57,482 | | | 3.48 | % | | | | $ | 56,596 | | | 3.97 | % |
| | | | | | | | | | | |
Net interest income and margin (tax equivalent)(2) | | | $ | 58,238 | | | 3.53 | % | | | | $ | 57,287 | | | 4.02 | % |
(1)The net interest margin is equal to annualized net interest income divided by average interest-earning assets.
(2)In order to make pretax income and resultant yields on tax-exempt investments and loans comparable to those on taxable investments and loans, a tax-equivalent adjustment has been computed using a federal income tax rate of 21% for the three months ended June 30, 2022 and 2021 and other applicable effective tax rates.
Six months ended June 30, 2022 compared with six months ended June 30, 2021. Net interest income before the provision for credit losses for the six months ended June 30, 2022 was $112.7 million compared with $112.3 million for the six months ended June 30, 2021, an increase of $360 thousand, or 0.3%. The increase in net interest income was primarily due to lower funding costs on interest-bearing liabilities and higher interest income from securities and deposits in other financial institutions partially offset by lower interest income on loans due to lower PPP fee income recognition.
Interest income was $123.1 million for the six months ended June 30, 2022, a decrease of $2.5 million, or 2.0%, compared with the six months ended June 30, 2021, primarily due to the decreased impact of PPP loan revenue on interest income on loans partially offset by increased interest income from securities income and deposits in other financial institutions. Average securities outstanding increased $974.1 million, or 117.0%, for the same period. The resulting increase in interest income was partially offset by the decrease in the average yield on securities to 1.75% for the six months ended June 30, 2022 from 2.38% for the same period in 2021 due to lower interest rates. Average loans outstanding decreased $289.2 million, or 6.3%, for the six months ended June 30, 2022 compared to the six months ended June 30, 2021 primarily due to forgiveness of PPP loans offset by origination of core loans over the prior year. Interest income also decreased as a result of PPP fee income recognition of $4.0 million during the six months ended June 30, 2022 compared to $13.3 million recognized for the same period in 2021.
Interest expense was $10.5 million for the six months ended June 30, 2022, a decrease of $2.9 million, or 21.5%, compared to the six months ended June 30, 2021. This decrease was primarily due to lower funding costs on interest-bearing deposits partially offset by an increase in average interest-bearing liabilities. The cost of average interest-bearing liabilities decreased to 53 basis points for the six months ended June 30, 2022 compared to 74 basis points for the same period in 2021. Average interest-bearing liabilities increased $324.0 million for the six months ended June 30, 2022 compared to the six months ended June 30, 2021 primarily due in part to funds from government stimulus programs such as the PPP and consumer economic impact payments received along with organic deposit growth.
Tax equivalent net interest margin for the six months ended June 30, 2022 was 3.41%, a decrease of 69 basis points compared to 4.10% for the six months ended June 30, 2021. The decrease in the net interest margin on a tax equivalent basis was primarily due to the decrease in the average yield on interest-earning assets, driven by decreased PPP revenue recognition and changes in the composition of earnings assets, partially offset by decreased funding costs. The average yield on interest-earning assets and the average rate paid on interest-bearing liabilities are primarily impacted by changes in market interest rates and changes in the volume and relative mix of the underlying assets and liabilities. The average rate paid on interest-bearing liabilities of 0.53% and the average yield on interest-earning assets of 3.68% for the six months ended June 30, 2022 decreased by 21 basis points and 86 basis points, respectively, over the same period in 2021.
The following table presents, for the periods indicated, the total dollar amount of average balances, interest income from average interest-earning assets and the annualized resultant yields, as well as the interest expense on average interest-bearing liabilities, expressed in both dollars and rates. Any nonaccruing loans have been included in the table as loans carrying a zero yield.
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Six Months Ended June 30, |
| 2022 | | 2021 |
| Average
Balance | | Interest
Earned/
Interest Paid | | Average
Yield/ Rate | | Average
Balance | | Interest
Earned/
Interest Paid | | Average
Yield/ Rate |
| (Dollars in thousands) |
| Assets | | | | | | | | | | | |
| Interest-Earning Assets: | | | | | | | | | | | |
| Loans | $ | 4,267,810 | | | $ | 106,205 | | | 5.02 | % | | $ | 4,557,016 | | | $ | 115,682 | | | 5.12 | % |
| Securities | 1,807,024 | | | 15,721 | | | 1.75 | % | | 832,884 | | | 9,843 | | | 2.38 | % |
| Deposits in other financial institutions | 670,316 | | | 1,217 | | | 0.37 | % | | 195,768 | | | 135 | | | 0.14 | % |
| Total interest-earning assets | 6,745,150 | | | $ | 123,143 | | | 3.68 | % | | $ | 5,585,668 | | | $ | 125,660 | | | 4.54 | % |
| Allowance for credit losses on loans | (48,819) | | | | | | | (53,033) | | | | | |
| Noninterest-earning assets | 441,390 | | | | | | | 798,468 | | | | | |
| Total assets | $ | 7,137,721 | | | | | | | $ | 6,331,103 | | | | | |
| | | | | | | | | | | |
| Liabilities and Shareholders' Equity | | | | | | | | | | | |
| Interest-Bearing Liabilities: | | | | | | | | | | | |
| Interest-bearing demand deposits | $ | 1,057,678 | | | $ | 1,476 | | | 0.28 | % | | $ | 496,399 | | | $ | 697 | | | 0.28 | % |
| Money market and savings deposits | 1,575,325 | | | 1,730 | | | 0.22 | % | | 1,550,620 | | | 2,124 | | | 0.28 | % |
| Certificates and other time deposits | 1,166,490 | | | 4,078 | | | 0.70 | % | | 1,349,364 | | | 6,654 | | | 0.99 | % |
| Borrowed funds | 69,868 | | | 300 | | | 0.87 | % | | 149,496 | | | 1,008 | | | 1.36 | % |
| Subordinated debt | 108,979 | | | 2,905 | | | 5.38 | % | | 108,455 | | | 2,883 | | | 5.36 | % |
| Total interest-bearing liabilities | 3,978,340 | | | $ | 10,489 | | | 0.53 | % | | 3,654,334 | | | $ | 13,366 | | | 0.74 | % |
| | | | | | | | | | | |
| Noninterest-Bearing Liabilities: | | | | | | | | | | | |
| Noninterest-bearing demand deposits | 2,347,366 | | | | | | | 1,868,783 | | | | | |
| Other liabilities | 37,767 | | | | | | | 39,748 | | | | | |
| Total liabilities | 6,363,473 | | | | | | | 5,562,865 | | | | | |
| Shareholders' equity | 774,248 | | | | | | | 768,238 | | | | | |
| Total liabilities and shareholders' equity | $ | 7,137,721 | | | | | | | $ | 6,331,103 | | | | | |
| | | | | | | | | | | |
| Net interest rate spread | | | | | 3.15 | % | | | | | | 3.80 | % |
| | | | | | | | | | | |
| Net interest income and margin | | | $ | 112,654 | | | 3.37 | % | | | | $ | 112,294 | | | 4.05 | % |
| | | | | | | | | | | |
| Net interest income and net interest margin (tax equivalent) | | | $ | 114,160 | | | 3.41 | % | | | | $ | 113,604 | | | 4.10 | % |
(1)The net interest margin is equal to annualized net interest income divided by average interest-earning assets.
(2)In order to make pretax income and resultant yields on tax-exempt investments and loans comparable to those on taxable investments and loans, a tax-equivalent adjustment has been computed using a federal income tax rate of 21% for the six months ended June 30, 2022 and 2021 and other applicable effective tax rates.
The following table presents information regarding the dollar amount of changes in interest income and interest expense for the periods indicated for each major component of interest-earnings assets and interest-bearing liabilities and distinguishes between the changes attributable to changes in volume and changes in interest rates. For purposes of this table, changes attributable to both rate and volume that cannot be segregated have been allocated to rate.
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | For the Three Months Ended June 30, | | For the Six Months Ended June 30, |
| | 2022 vs. 2021 | | 2022 vs. 2021 |
| | Increase
(Decrease)
Due to Change in | | | | Increase
(Decrease)
Due to Change in | | |
| | Volume | | Rate | | Total | | Volume | | Rate | | Total |
| | (Dollars in thousands) |
| Interest-earning Assets: | | | | | | | | | | | |
| Loans | $ | (3,040) | | | $ | (816) | | | $ | (3,856) | | | $ | (7,342) | | | $ | (2,135) | | | $ | (9,477) | |
| Securities | 5,200 | | | (2,119) | | | 3,081 | | | 11,512 | | | (5,634) | | | 5,878 | |
| Deposits in other financial institutions | 77 | | | 706 | | | 783 | | | 327 | | | 755 | | | 1,082 | |
| Total increase (decrease) in interest income | 2,237 | | | (2,229) | | | 8 | | | 4,497 | | | (7,014) | | | (2,517) | |
| | | | | | | | | | | |
| Interest-bearing Liabilities: | | | | | | | | | | | |
| Interest-bearing demand deposits | 311 | | | 290 | | | 601 | | | 788 | | | (9) | | | 779 | |
| Money market and savings deposits | 3 | | | (82) | | | (79) | | | 34 | | | (428) | | | (394) | |
| Certificates and other time deposits | (607) | | | (460) | | | (1,067) | | | (902) | | | (1,674) | | | (2,576) | |
| Borrowed funds | (306) | | | (49) | | | (355) | | | (537) | | | (171) | | | (708) | |
| Subordinated debt | 7 | | | 15 | | | 22 | | | 14 | | | 8 | | | 22 | |
| Total (decrease) increase in interest expense | (592) | | | (286) | | | (878) | | | (603) | | | (2,274) | | | (2,877) | |
| Increase (decrease) in net interest income | $ | 2,829 | | | $ | (1,943) | | | 886 | | | $ | 5,100 | | | $ | (4,740) | | | 360 | |
Provision for Credit Losses
Our allowance for credit losses is established through charges to income in the form of the provision in order to bring our allowance for credit losses for various types of financial instruments including loans, unfunded commitments and securities to a level deemed appropriate by management. We recorded a $2.1 million provision for credit losses and a $2.7 million recapture of provision for credit losses for the three months ended June 30, 2022 and 2021, respectively, and recorded a provision for credit losses of $4.0 million and a $2.0 million recapture of provision for credit losses for the six months ended June 30, 2022 and 2021, respectively. The provision for credit losses for the three and six months ended June 30, 2022 compared to the same period in 2021 reflects the increase in core loans during the first half of 2022. Core loans exclude PPP loans.
Noninterest Income
Our primary sources of noninterest income are debit card and ATM card income, service charges on deposit accounts, income earned on bank owned life insurance and nonsufficient funds fees. Noninterest income does not include loan origination fees which are recognized over the life of the related loan as an adjustment to yield using the interest method.
Three months ended June 30, 2022 compared with three months ended June 30, 2021. Noninterest income totaled $2.7 million for the three months ended June 30, 2022 compared with $2.3 million for the same period in 2021, an increase of $431 thousand, or 19.0%, primarily due to increased service charges on deposit accounts, debit card and ATM card income and bank owned life insurance.
Six months ended June 30, 2022 compared with six months ended June 30, 2021. Noninterest income totaled $6.7 million for the six months ended June 30, 2022 compared with $4.0 million for the same period in 2021, an increase of $2.7 million, or 67.7% due primarily to $1.3 million in income from Small Business Investment Company investments along with increased service charges and debit card and ATM card income.
The following table presents, for the periods indicated, the major categories of noninterest income: | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | For the Three Months Ended June 30, | | Increase
(Decrease) | | For the Six Months Ended June 30, | | Increase
(Decrease) |
| | 2022 | | 2021 | | | 2022 | | 2021 | |
| | (Dollars in thousands) |
| Nonsufficient funds fees | $ | 126 | | | $ | 94 | | | $ | 32 | | | $ | 242 | | | $ | 177 | | | $ | 65 | |
| Service charges on deposit accounts | 560 | | | 382 | | | 178 | | | 1,087 | | | 770 | | | 317 | |
| (Loss) gain on securities | (17) | | | — | | | (17) | | | (17) | | | 49 | | | (66) | |
| Loss on sale of other real estate and repossessed assets | — | | | — | | | — | | | — | | | (176) | | | 176 | |
| Bank owned life insurance income | 342 | | | 151 | | | 191 | | | 475 | | | 290 | | | 185 | |
| Debit card and ATM card income | 880 | | | 761 | | | 119 | | | 1,699 | | | 1,391 | | | 308 | |
| Rebate from correspondent bank | — | | | 73 | | | (73) | | | — | | | 205 | | | (205) | |
Other(1) | 813 | | | 812 | | | 1 | | | 3,236 | | | 1,303 | | | 1,933 | |
| Total noninterest income | $ | 2,704 | | | $ | 2,273 | | | $ | 431 | | | $ | 6,722 | | | $ | 4,009 | | | $ | 2,713 | |
(1)Other includes wire transfer and letter of credit fees, among other items.
Noninterest Expense
Three months ended June 30, 2022 compared with three months ended June 30, 2021. Noninterest expense was $37.9 million for the three months ended June 30, 2022 compared to $33.6 million for the three months ended June 30, 2021, an increase of $4.3 million or 12.8%, primarily due a $2.2 million operational loss along with $1.7 million of acquisition and merger-related expenses associated with the pending merger with CBTX during the second quarter 2022.
Six months ended June 30, 2022 compared with six months ended June 30, 2021. Noninterest expense was $72.4 million for the six months ended June 30, 2022 compared to $68.5 million for the six months ended June 30, 2021, an increase of $3.9 million, or 5.7%. This increase was primarily due to a $2.2 million operational loss along with $2.1 million of acquisition and merger-related expenses during the six months ended June 30, 2022.
The following table presents, for the periods indicated, the major categories of noninterest expense:
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | For the Three Months Ended June 30, | | Increase
(Decrease) | | For the Six Months Ended June 30, | | Increase
(Decrease) |
| | 2022 | | 2021 | | | 2022 | | 2021 | |
| | (Dollars in thousands) |
Salaries and employee benefits(1) | $ | 21,864 | | | $ | 22,472 | | | $ | (608) | | | $ | 44,592 | | | $ | 44,924 | | | $ | (332) | |
| Net occupancy and equipment | 2,220 | | 2,225 | | (5) | | 4,425 | | 4,615 | | (190) | |
| Depreciation | 1,012 | | 1,057 | | (45) | | 2,045 | | 2,091 | | (46) | |
| Data processing and software amortization | 2,522 | | 2,176 | | 346 | | 5,020 | | 4,376 | | 644 | |
| Professional fees | 662 | | 608 | | 54 | | 800 | | 1,397 | | (597) | |
Regulatory assessments and FDIC insurance | 1,256 | | 768 | | 488 | | 2,517 | | 1,575 | | 942 | |
Core deposit intangibles amortization | 751 | | 824 | | (73) | | 1,502 | | 1,648 | | (146) | |
| Communications | 363 | | 332 | | 31 | | 704 | | 653 | | 51 | |
| Advertising | 483 | | 432 | | 51 | | 945 | | 730 | | 215 | |
| Other real estate expense | 65 | | 229 | | (164) | | 124 | | 342 | | (218) | |
| Acquisition and merger-related expenses | 1,667 | | — | | 1,667 | | 2,118 | | — | | 2,118 |
| Printing and supplies | 55 | | 67 | | (12) | | 117 | | 140 | | (23) | |
| Other | 4,984 | | 2,405 | | 2,579 | | 7,512 | | 6,023 | | 1,489 | |
| Total noninterest expense | $ | 37,904 | | | $ | 33,595 | | | $ | 4,309 | | | $ | 72,421 | | | $ | 68,514 | | | $ | 3,907 | |
(1)Total salaries and employee benefits includes $931 thousand and $1.0 million for the three months ended June 30, 2022 and 2021, respectively, and $1.9 million for each of the six months ended June 30, 2022 and 2021, of stock based compensation expense.
Salaries and employee benefits. Salaries and benefits decreased $332 thousand, or 0.7%, for the six months ended June 30, 2022, compared to the same period in 2021 primarily due to decreased performance-based bonus and profit sharing accruals.
Acquisition and merger-related expenses. Acquisition and merger-related expenses of $2.1 million incurred during the six months ended June 30, 2022 were primarily legal and advisory fees associated with the pending merger with CBTX.
Other. Other noninterest expenses increased $1.5 million for the six months ended June 30, 2022 compared to the same period in 2021 primarily due to a $2.2 million operational loss during the second quarter partially offset by a $1.3 million write-down of assets related to the closure of a bank office during the first quarter 2021.
Efficiency Ratio
The efficiency ratio is a supplemental financial measure utilized in management’s internal evaluation of our performance. We calculate our efficiency ratio by dividing total noninterest expense by the sum of net interest income and noninterest income, excluding net gains and losses on the sale of loans, securities and assets. Additionally, taxes and provision for loan losses are not part of this calculation. An increase in the efficiency ratio indicates that more resources are being utilized to generate the same volume of income, while a decrease would indicate a more efficient allocation of resources. Our efficiency ratio was to 62.96% and 60.66% for the three and six months ended June 30, 2022, compared to 57.07% and 58.93% for the three and six months ended June 30, 2021, respectively.
We monitor the efficiency ratio in comparison with changes in our total assets and loans, and we believe that maintaining or reducing the efficiency ratio during periods of growth demonstrates the scalability of our operating platform. We expect to continue to benefit from our scalable platform in future periods as we continue to monitor overhead expenses necessary to support our growth.
Income Taxes
The amount of federal and state income tax expense is influenced by the amount of pre-tax income, tax-exempt income and other nondeductible expenses. Income tax expense decreased $1.3 million to $3.7 million for the three months ended June 30, 2022 compared with $5.0 million for the same period in 2021 and decreased $990 thousand to $7.9 million for the six months ended June 30, 2022 compared with $8.9 million for the same period in 2021 primarily due to the decrease in pre-tax net income. Our effective tax rate was 18.4% for the three and six months ended June 30, 2022 compared to 18.0% and 17.8% for the three and six months ended June 30, 2021, respectively.
Financial Condition
Loan Portfolio
At June 30, 2022, total loans were $4.35 billion, an increase of $128.3 million, or 3.0%, compared with December 31, 2021, primarily due to organic growth within our loan portfolio partially offset by paydowns of PPP loans during the six months ended June 30, 2022.
Total loans as a percentage of deposits were 74.0% and 69.8% as of June 30, 2022 and December 31, 2021, respectively. Total loans as a percentage of assets were 64.6% and 59.4% as of June 30, 2022 and December 31, 2021, respectively.
The following table summarizes our loan portfolio by type of loan as of the dates indicated:
| | | | | | | | | | | | | | | | | | | | | | | |
| | June 30, 2022 | | December 31, 2021 |
| | Amount | | Percent | | Amount | | Percent |
| | (Dollars in thousands) |
| Commercial and industrial | $ | 727,068 | | | 16.7 | % | | $ | 693,559 | | | 16.4 | % |
| Paycheck Protection Program (PPP) | 31,855 | | | 0.7 | % | | 145,942 | | | 3.5 | % |
| Real estate: | | | | | | | |
Commercial real estate (including
multi-family residential) | 2,265,155 | | | 52.1 | % | | 2,104,621 | | | 49.9 | % |
Commercial real estate construction and
land development | 450,694 | | | 10.4 | % | | 439,125 | | | 10.4 | % |
| 1-4 family residential (including home equity) | 682,066 | | | 15.7 | % | | 685,071 | | | 16.2 | % |
| Residential construction | 155,017 | | | 3.6 | % | | 117,901 | | | 2.8 | % |
| Consumer and other | 36,978 | | | 0.8 | % | | 34,267 | | | 0.8 | % |
| Total loans | 4,348,833 | | | 100.0 | % | | 4,220,486 | | | 100.0 | % |
| Allowance for credit losses on loans | (50,242) | | | | | (47,940) | | | |
| Loans, net | $ | 4,298,591 | | | | | $ | 4,172,546 | | | |
Lending activities originate from the efforts of our lenders, with an emphasis on lending to small to medium-sized businesses and companies, professionals and individuals located in the Houston region.
The principal categories of our loan portfolio are discussed below:
Commercial and Industrial. We make commercial and industrial loans in our market area that are underwritten primarily on the basis of the borrower’s ability to service the debt from income. In general, commercial loans involve more credit risk than residential mortgage loans and commercial mortgage loans and therefore typically yield a higher return. The increased risk in commercial loans derives from the expectation that commercial and industrial loans generally are serviced principally from the operations of the business, which may not be successful and from the type of collateral securing these loans. As a result, commercial and industrial loans require more extensive underwriting and servicing than other types of loans. Our commercial and industrial loan portfolio increased by $33.5 million, or 4.8%, to $727.1 million as of June 30, 2022 from $693.6 million as of December 31, 2021.
Paycheck Protection Program (PPP). The CARES Act authorized the Small Business Administration (SBA) to guarantee loans under a new 7(a) loan program called the Paycheck Protection Program (PPP). As a preferred SBA lender, we were automatically authorized to originate PPP loans. An eligible business could apply for a PPP loan up to the greater of: (1) 2.5 times its average monthly “payroll costs;” or (2) $10.0 million. PPP loans have: (a) an interest rate of 1.0%, (b) a two-year or five-year loan term to maturity; and (c) principal and interest payments deferred for six months from the date of disbursement. The SBA provides a 100% guarantee of the PPP loan made to an eligible borrower. The principal balance of the borrower’s PPP loan, including any accrued interest, is eligible to be reduced in full, so long as employee and compensation levels of the business are maintained and 60% of the loan proceeds are used for payroll expenses, with the remaining 40% of the loan proceeds used for other qualifying expenses. The balance of PPP loans decreased $114.1 million to $31.9 million as of June 30, 2022 from $145.9 million as of December 31, 2021 due to loan forgiveness.
Commercial Real Estate (Including Multi-Family Residential). We make loans collateralized by owner-occupied, nonowner-occupied and multi-family real estate to finance the purchase or ownership of real estate. As of June 30, 2022 and December 31, 2021, 54.4% and 54.6%, respectively, of our commercial real estate loans were owner-occupied. Our commercial real estate loan portfolio increased $160.5 million, or 7.6%, to $2.27 billion as of June 30, 2022 from $2.10 billion as of December 31, 2021, primarily as a result of organic loan growth. Included in our commercial real estate portfolio are multi-family residential loans. Our multi-family loans increased to $91.4 million as of June 30, 2022 from $77.1 million as of December 31, 2021. We had 134 multi-family loans with an average loan size of $682 thousand as of June 30, 2022.
Commercial Real Estate Construction and Land Development. We make commercial real estate construction and land development loans to fund commercial construction, land acquisition and real estate development construction. Construction loans involve additional risks as they often involve the disbursement of funds with the repayment dependent on the ultimate success of the project’s completion. Sources of repayment for these loans may be pre-committed permanent financing or sale of the developed property. The loans in this portfolio are monitored closely by management. Due to uncertainties inherent in estimating construction costs, the market value of the completed project and the effects of governmental regulation on real property, it can be difficult to accurately evaluate the total funds required to complete a project and the related loan to value ratio. As a result of these uncertainties, construction lending often includes the disbursement of substantial funds with repayment dependent, in part, on the success of the ultimate project rather than the ability of a borrower or guarantor to repay the loan. As of June 30, 2022 and December 31, 2021, 18.9% and 22.3%, respectively, of our commercial real estate construction and land development loans were owner-occupied. Commercial real estate construction and land development loans increased $11.6 million, or 2.6%, to $450.7 million as of June 30, 2022 compared to $439.1 million as of December 31, 2021.
1-4 Family Residential (Including Home Equity). Our residential real estate loans include the origination of 1-4 family residential mortgage loans (including home equity and home improvement loans and home equity lines of credit) collateralized by owner-occupied residential properties located in our market area. Our residential real estate portfolio (including home equity) decreased $3.0 million, or 0.4%, to $682.1 million as of June 30, 2022 from $685.1 million as of December 31, 2021. The home equity, home improvement and home equity lines of credit portion of our residential real estate portfolio decreased $6.0 million, or 5.0%, to $113.0 million as of June 30, 2022 from $119.0 million as of December 31, 2021.
Residential Construction. We make residential construction loans to home builders and individuals to fund the construction of single-family residences with the understanding that such loans will be repaid from the proceeds of the sale of the homes by builders or with the proceeds of a mortgage loan. These loans are secured by the real property being built and are made based on our assessment of the value of the property on an as-completed basis. Our residential construction loans portfolio increased $37.1 million, or 31.5%, to $155.0 million as of June 30, 2022 from $117.9 million as of December 31, 2021.
Consumer and Other. Our consumer and other loan portfolio is made up of loans made to individuals for personal purposes and deferred fees and costs on all loan types. Our consumer and other loan portfolio increased $2.7 million, or 7.9%, to $37.0 million as of June 30, 2022 from $34.3 million as of December 31, 2021.
Asset Quality
Nonperforming Assets
We have procedures in place to assist us in maintaining the overall quality of our loan portfolio. We have established underwriting guidelines to be followed by our officers and monitor our delinquency levels for any negative or adverse trends.
We had $28.2 million and $24.1 million in nonperforming loans as of June 30, 2022 and December 31, 2021, respectively.
The following table presents information regarding nonperforming assets as of the dates indicated.
| | | | | | | | | | | |
| | As of June 30, 2022 | | As of December 31, 2021 |
| | (Dollars in thousands) |
| Nonaccrual loans: | | | |
| Commercial and industrial | $ | 9,145 | | | $ | 8,358 | |
| Paycheck Protection Program (PPP) | — | | | — | |
| Real estate: | | | |
| Commercial real estate (including multi-family residential) | 14,409 | | | 12,639 | |
| Commercial real estate construction and land development | 1,511 | | | 63 | |
| 1-4 family residential (including home equity) | 3,040 | | | 2,875 | |
| Residential construction | — | | | — | |
| Consumer and other | 120 | | | 192 | |
| Total nonaccrual loans | 28,225 | | | 24,127 | |
| Accruing loans 90 or more days past due | — | | | — | |
| Total nonperforming loans | 28,225 | | | 24,127 | |
| Other real estate | — | | | — | |
| Total nonperforming assets | $ | 28,225 | | | $ | 24,127 | |
Restructured loans(1) | $ | 11,351 | | | $ | 9,068 | |
| Nonperforming assets to total assets | 0.42 | % | | 0.34 | % |
| Nonperforming loans to total loans | 0.65 | % | | 0.57 | % |
(1)Restructured loans represent the balance at the end of the respective period for those loans modified in a troubled debt restructuring that are not already presented as a nonperforming loan.
Potential problem loans are included in the loans that are accruing, restructured and impaired that are performing in accordance with contractual terms but for which management has concerns about the ability of an obligor to continue to comply with repayment terms because of the obligor’s potential operating or financial difficulties. Management monitors these loans closely and reviews their performance on a regular basis. Potential problem loans contain potential weaknesses that could improve, persist or further deteriorate. At June 30, 2022 and December 31, 2021, we had $53.0 million and $47.1 million, respectively, in loans of this type which are not included in any of the nonaccrual or 90 days past due loan categories. At June 30, 2022, potential problem loans consisted of 31 credit relationships. Of the total outstanding balance at June 30, 2022, 35.4% to four customers in the hotel industry, 20.6% to four customers in the daycare industry, 19.7% to four customers in the fitness industry, 6.4% to one customer in the car wash industry, 5.4% to five customers in the energy industry, 3.8% to one customer in the event center industry, 2.6% to one customer in the convenience store industry, 2.4% to one customer in the CRE investments industry, 1.6% to one customer in the legal industry, 1.2% to four customers in the commercial services industry, 0.3% to one customer in the wholesale industry, 0.3% to one customer in the consumer services industry, 0.2% to two customers in the consumer real estate industry and 0.1% to one customer in the medical industry. Weakness in these organizations’ operating performance, financial condition and borrowing base deficits for certain energy-related credits, among other factors, have caused us to heighten the attention given to these credits.
The Company granted initial principal and interest deferrals on outstanding loan balances to borrowers in connection with the COVID-19 relief provided by the CARES Act and subsequent deferrals upon request and after meeting certain conditions. These deferrals were generally no more than 90 days in duration.
We have also actively participated in assisting with applications for resources through the PPP. PPP loans have a two-year or five-year term and earn interest at 1%. We believe that the majority of these loans will ultimately be forgiven by the SBA in accordance with the terms of the program. As of June 30, 2022, we had funded over $1.08 billion in PPP loans. The balance of the PPP loans decreased to $31.9 million at June 30, 2022 as a result of loan forgiveness. It is our understanding that loans funded through the PPP are fully guaranteed by the U.S. government. Should those circumstances change, we could be required to establish additional allowance for credit loss through additional provision expense charged to earnings.
Allowance for Credit Losses
The allowance for credit losses is a valuation allowance that is established through charges to earnings in the form of a provision for credit losses calculated in accordance with ASC 326 that is deducted from the amortized cost basis of certain assets to present the net amount expected to be collected. The amount of each allowance account represents management's best estimate of CECL on these financial instruments considering available information, from internal and external sources, relevant to assessing exposure to credit loss over the contractual term of the instrument. Relevant available information includes historical credit loss experience, current conditions and reasonable and supportable forecasts. While historical credit loss experience provides the basis for the estimation of expected credit losses, adjustments to historical loss information may be made for differences in current portfolio-specific risk characteristics, environmental conditions or other relevant factors. While management utilizes its best judgment and information available, the ultimate adequacy of our allowance accounts is dependent upon a variety of factors beyond our control, including the performance of our portfolios, the economy, changes in interest rates and the view of the regulatory authorities toward classification of assets. For additional information regarding critical accounting policies, refer to Note 1 – Nature of Operations and Summary of Significant Accounting and Reporting Policies and Note 4 – Loans and Allowance for Credit Losses in the accompanying notes to consolidated financial statements.
Allowance for Credit Losses on Loans
The allowance for credit losses on loans represents management’s estimates of current expected credit losses in the Company’s loan portfolio. Pools of loans with similar risk characteristics are collectively evaluated, while loans that no longer share risk characteristics with loan pools are evaluated individually.
At June 30, 2022, our allowance for credit losses on loans amounted to $50.2 million, or 1.16% of total loans, compared with $47.9 million, or 1.14%, of total loans as of December 31, 2021. The increase in the allowance for credit losses on loans during the second quarter of 2022 reflected an increase in core loans.
Collective loss estimates are determined by applying reserve factors, designed to estimate current expected credit losses, to amortized cost balances over the remaining contractual life of the collectively evaluated portfolio. Loans with similar risk characteristics are aggregated into homogeneous pools. The allowance for credit losses on loans also includes qualitative adjustments to bring the allowance to the level management believes is appropriate based on factors that have not otherwise been fully accounted for, including adjustments for foresight risk, input imprecisions and model imprecision. Credit losses for loans that no longer share risk characteristics with the loan pools are estimated on an individual basis. Individual credit loss estimates are typically performed for nonaccrual loans and modified loans classified as TDRs and are based on one of several methods, including the estimated fair value of the underlying collateral, observable market value of similar debt or the present value of expected cash flows.
The following table presents, as of and for the periods indicated, an analysis of the allowance for loan losses and other related data:
| | | | | | | | | | | |
| | As of and for the Six Months Ended June 30, |
| | 2022 | | 2021 |
| | (Dollars in thousands) |
| Average loans outstanding | $ | 4,267,810 | | $ | 4,557,016 |
| Gross loans outstanding at end of period | 4,348,833 | | 4,460,743 |
Allowance for credit losses on loans at beginning of period | 47,940 | | 53,173 |
| Provision for credit losses on loans | 3,190 | | (3,080) |
| Charge-offs: | | | |
| Commercial and industrial loans | (956) | | (559) |
| Real estate: | | | |
Commercial real estate (including multi-family residential) | (327) | | — |
Commercial real estate construction and land development | (63) | | — |
| 1-4 family residential (including home equity) | — | | (21) |
| Residential construction | — | | — |
| Consumer and other | (48) | | (4) |
| Total charge-offs for all loan types | (1,394) | | (584) |
| Recoveries: | | | |
| Commercial and industrial loans | 401 | | 77 |
| Real estate: | | | |
Commercial real estate (including multi-family residential) | 50 | | — |
Commercial real estate construction and land development | 55 | | — |
| 1-4 family residential (including home equity) | — | | — |
| Residential construction | — | | — |
| Consumer and other | — | | — |
| Total recoveries for all loan types | 506 | | 77 |
| Net charge-offs | (888) | | (507) |
| Allowance for credit losses on loans at end of period | $ | 50,242 | | $ | 49,586 |
| Allowance for credit losses on loans to total loans | 1.16 | % | | 1.11 | % |
Net charge-offs to average loans(1) | 0.04 | % | | 0.02 | % |
Allowance for credit losses on loans to nonperforming loans | 178.01 | % | | 135.32 | % |
(1)Interim periods annualized.
Available for Sale Securities
We use our securities portfolio to provide a source of liquidity, to provide an appropriate return on funds invested, to manage interest rate risk and to meet pledging and regulatory capital requirements. As of June 30, 2022, the carrying amount of investment securities totaled $1.71 billion, a decrease of $64.4 million, or 3.6%, compared with $1.77 billion as of December 31, 2021. Securities represented 25.4% and 25.0% of total assets as of June 30, 2022 and December 31, 2021, respectively.
All of the securities in our securities portfolio are classified as available for sale. Securities classified as available for sale are measured at fair value in the financial statements with unrealized gains and losses reported, net of tax, as accumulated comprehensive income or loss until realized. Interest earned on securities is included in interest income.
The following table summarizes the amortized cost and fair value of the securities in our securities portfolio as of the dates shown:
| | | | | | | | | | | | | | | | | | | | | | | |
| June 30, 2022 |
| Amortized
Cost | | Gross
Unrealized
Gains | | Gross
Unrealized
Losses | | Fair
Value |
| (Dollars in thousands) |
| Available for Sale | | | | | | | |
| U.S. government and agency securities | $ | 418,708 | | | $ | 143 | | | $ | (14,876) | | | $ | 403,975 | |
| Municipal securities | 479,941 | | | 1,223 | | | (37,705) | | | 443,459 | |
| Agency mortgage-backed pass-through securities | 326,050 | | | 12 | | | (33,729) | | | 292,333 | |
| Agency collateralized mortgage obligations | 503,458 | | | 5 | | | (56,059) | | | 447,404 | |
| Corporate bonds and other | 127,314 | | | 422 | | | (5,586) | | | 122,150 | |
| Total | $ | 1,855,471 | | | $ | 1,805 | | | $ | (147,955) | | | $ | 1,709,321 | |
| | | | | | | | | | | | | | | | | | | | | | | |
| | December 31, 2021 |
| Amortized
Cost | | Gross
Unrealized
Gains | | Gross
Unrealized
Losses | | Fair
Value |
| | (Dollars in thousands) |
| Available for Sale | | | | | | | |
| U.S. government and agency securities | $ | 401,811 | | | $ | 414 | | | $ | (1,674) | | | $ | 400,551 | |
| Municipal securities | 468,164 | | | 30,483 | | | (1,547) | | | 497,100 | |
| Agency mortgage-backed pass-through securities | 307,097 | | | 2,075 | | | (6,576) | | | 302,596 | |
| Agency collateralized mortgage obligations | 443,277 | | | 2,026 | | | (4,247) | | | 441,056 | |
| Corporate bonds and other | 130,314 | | | 2,922 | | | (774) | | | 132,462 | |
| Total | $ | 1,750,663 | | | $ | 37,920 | | | $ | (14,818) | | | $ | 1,773,765 | |
Investment securities classified as available for sale or held to maturity are evaluated for expected credit losses under ASC Topic 326, “Financial Instruments – Credit Losses.” At June 30, 2022, the Company had 381 available for sale debt securities in an unrealized loss position without an allowance for credit losses. Management does not have the intent to sell any of these securities and believes that it is more likely than not that the Company will not have to sell any such securities before a recovery of cost. The fair value is expected to recover as the securities approach their maturity date or repricing date or if market yields for such investments decline. Accordingly, as of June 30, 2022, management believes that the unrealized losses detailed in the previous table are due to noncredit-related factors, including changes in interest rates and other market conditions, and therefore no losses have been recognized in the Company’s consolidated statements of income.
The following table summarizes the contractual maturity of securities and their weighted average yields as of the dates indicated. The contractual maturity of a mortgage-backed security is the date at which the last underlying mortgage matures. Available for sale securities are shown at amortized cost. For purposes of the table below, municipal securities are calculated on a tax equivalent basis.
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | June 30, 2022 |
| | Within One Year | | After One Year but Within Five Years | | After Five Years but Within Ten Years | | After Ten Years | | Total |
| | Amount | | Yield | | Amount | | Yield | | Amount | | Yield | | Amount | | Yield | | Total | | Yield |
| | (Dollars in thousands) |
| Available for Sale | | | | | | | | | | | | | | | | | | | |
U.S. government and agency securities | $ | 4,152 | | | 3.25 | % | | $ | 249,502 | | | 0.80 | % | | $ | 19,317 | | | 2.59 | % | | $ | 145,737 | | | 2.38 | % | | $ | 418,708 | | | 1.46 | % |
| Municipal securities | 1,353 | | | 2.50 | % | | 14,863 | | | 3.35 | % | | 84,607 | | | 2.82 | % | | 379,118 | | | 3.09 | % | | 479,941 | | | 3.05 | % |
Agency mortgage-backed pass-through securities | — | | | 0.00 | % | | 4,828 | | | 2.95 | % | | 4,129 | | | 3.21 | % | | 317,093 | | | 1.88 | % | | 326,050 | | | 1.92 | % |
Agency collateralized mortgage obligations | — | | | 0.00 | % | | 17,330 | | | 2.80 | % | | 7,840 | | | 2.64 | % | | 478,288 | | | 1.50 | % | | 503,458 | | | 1.57 | % |
| Corporate bonds and other | — | | | 0.00 | % | | 4,000 | | | 6.31 | % | | 64,928 | | | 4.60 | % | | 58,386 | | | 2.41 | % | | 127,314 | | | 3.65 | % |
| Total | $ | 5,505 | | | 3.06 | % | | $ | 290,523 | | | 1.17 | % | | $ | 180,821 | | | 3.44 | % | | $ | 1,378,622 | | | 2.16 | % | | $ | 1,855,471 | | | 2.13 | % |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| December 31, 2021 |
| Within One Year | | After One Year but Within Five Years | | After Five Years but Within Ten Years | | After Ten Years | | Total |
| Amount | | Yield | | Amount | | Yield | | Amount | | Yield | | Amount | | Yield | | Total | | Yield |
| (Dollars in thousands) |
| Available for Sale | | | | | | | | | | | | | | | | | | | |
U.S. government and agency securities | $ | 4,127 | | | 3.25 | % | | $ | 249,188 | | | 0.80 | % | | $ | 22,752 | | | 1.29 | % | | $ | 125,744 | | | 0.98 | % | | $ | 401,811 | | | 0.91 | % |
| Municipal securities | 2,383 | | | 3.16 | % | | 5,548 | | | 3.63 | % | | 73,369 | | | 2.93 | % | | 386,864 | | | 3.06 | % | | 468,164 | | | 3.05 | % |
Agency mortgage-backed pass-through securities | — | | | 0.00 | % | | 4,954 | | | 2.96 | % | | 4,805 | | | 3.21 | % | | 297,338 | | | 1.35 | % | | 307,097 | | | 1.41 | % |
Agency collateralized mortgage obligations | — | | | 0.00 | % | | 11,212 | | | 2.80 | % | | 14,020 | | | 2.72 | % | | 418,045 | | | 1.34 | % | | 443,277 | | | 1.42 | % |
| Corporate bonds and other | — | | | 0.00 | % | | 3,000 | | | 5.75 | % | | 50,388 | | | 4.72 | % | | 76,926 | | | 2.33 | % | | 130,314 | | | 3.34 | % |
| Total | $ | 6,510 | | | 3.22 | % | | $ | 273,902 | | | 1.04 | % | | $ | 165,334 | | | 3.24 | % | | $ | 1,304,917 | | | 1.88 | % | | $ | 1,750,663 | | | 1.88 | % |
The contractual maturity of mortgage-backed securities and collateralized mortgage obligations is not a reliable indicator of their expected life because borrowers may have the right to prepay their obligations. Mortgage-backed securities and collateralized mortgage obligations are typically issued with stated principal amounts and are backed by pools of mortgage loans with varying maturities. The term of the underlying mortgages and loans may vary significantly due to the ability of a borrower to prepay and, in particular, monthly pay downs on mortgage-backed securities tend to cause the average life of the securities to be much different than the stated contractual maturity. During a period of increasing interest rates, fixed rate mortgage-backed securities do not tend to experience heavy prepayments of principal and, consequently, the average life of this security will be lengthened. If interest rates begin to fall, prepayments may increase, thereby shortening the estimated life of this security.
As of June 30, 2022 and December 31, 2021, we did not own securities of any one issuer (other than the U.S. government and its agencies or sponsored entities) for which the aggregate adjusted cost exceeded 10% of our consolidated shareholders’ equity.
The average yield of our securities portfolio was 1.75% during the six months ended June 30, 2022 compared with 2.38% for the six months ended June 30, 2021. The decrease in average yield during 2022 compared to the same period in 2021 was primarily due to the mix of lower-yielding securities within the portfolio.
Goodwill and Core Deposit Intangible Assets
Our goodwill was $223.6 million as of June 30, 2022 and December 31, 2021. Goodwill resulting from business combinations represents the excess of the consideration paid over the fair value of the net assets acquired and liabilities assumed.
Goodwill is assessed annually for impairment or when events or changes in circumstances indicate that the carrying amount of the asset may not be recoverable.
Our core deposit intangible assets, net as of June 30, 2022 and December 31, 2021, was $13.2 million and $14.7 million, respectively. Core deposit intangible assets are amortized over their estimated useful life of seven to ten years.
Premises and Equipment, net
Premises and equipment, net was $58.5 million and $63.7 million at June 30, 2022 and December 31, 2021, respectively.
Deposits
Our lending and investing activities are primarily funded by deposits. We offer a variety of deposit accounts having a wide range of interest rates and terms including demand, savings, money market and certificates and other time accounts. We rely primarily on convenient locations, personalized service and our customer relationships to attract and retain these deposits. We seek customers that will engage in both a lending and deposit relationship with us.
Total deposits at June 30, 2022 were $5.88 billion, a decrease of $167.0 million, or 2.8%, compared with $6.05 billion at December 31, 2021 primarily due to overall balance sheet optimization with a reduction in brokered deposits, municipal certificates of deposit and financial institution deposits. Noninterest-bearing deposits at June 30, 2022 were $2.39 billion, an increase of $151.6 million, or 6.8%, compared with $2.24 billion at December 31, 2021. Interest-bearing deposits at June 30, 2022 were $3.49 billion, a decrease of $318.6 million, or 8.4%, compared with $3.80 billion at December 31, 2021.
Borrowings
We have an available line of credit with the Federal Home Loan Bank ("FHLB") of Dallas, which allows us to borrow on a collateralized basis. FHLB advances are used to manage liquidity as needed. The advances are secured by a blanket lien on certain loans. Maturing advances are replaced by drawing on available cash, making additional borrowings or through increased customer deposits. At June 30, 2022, we had a total borrowing capacity of $2.25 billion, of which $1.73 billion was available and $522.0 million was outstanding. There were no FHLB advances of were outstanding at June 30, 2022. Letters of credit were $522.0 million at June 30, 2022, of which $328.2 million will expire during the remaining months of 2022, $119.9 million will expire in 2023, $57.9 million will expire in 2024 and $16.0 million will expire in 2025.
Credit Agreement
At June 30, 2022, the balance of the revolving credit agreement was zero. The interest rate on the debt is the Prime Rate minus 25 basis points, or 4.50%, at June 30, 2022, and is paid quarterly. On December 28, 2018, we amended our revolving credit agreement to increase the maximum commitment to advance funds to $45.0 million which reduces annually by $7.5 million beginning in December 2020 and on December 22nd of each year thereafter. We are required to repay any outstanding balance in excess of the then-current maximum commitment amount. The revised agreement will mature in December 2025 and is secured by 100% of the capital stock of the Bank.
Our credit agreement contains certain restrictive covenants, including limitations on our ability to incur additional indebtedness or engage in certain fundamental corporate transactions, such as mergers, reorganizations and recapitalizations. Additionally, the Bank is required to maintain a “well-capitalized” rating, a minimum return on assets of 0.65%, measured quarterly, a ratio of loan loss reserve to nonperforming loans equal to or greater than 75%, measured quarterly, and a ratio of nonperforming assets to aggregate equity plus loan loss reserves minus intangible assets of less than 35%, measured quarterly. As of June 30, 2022, we believe we were in compliance with all such debt covenants.
Off-Balance Sheet Items
In the normal course of business, we enter into various transactions, which, in accordance with accounting principles generally accepted in the United States, are not included in our consolidated balance sheets. We enter into these transactions to meet the financing needs of our customers. These transactions include commitments to extend credit and standby and commercial letters of credit, which involve, to varying degrees, elements of credit risk and interest rate risk in excess of the amounts recognized in our consolidated balance sheets.
Commitments to Extend Credit. We enter into contractual commitments to extend credit, normally with fixed expiration dates or termination clauses, at specified rates and for specific purposes. Substantially all of our commitments to extend credit are
contingent upon customers maintaining specific credit standards at the time of loan funding. We minimize our exposure to loss under these commitments by subjecting them to credit approval and monitoring procedures. The amount and type of collateral obtained, if considered necessary by us, upon extension of credit, is based on management’s credit evaluation of the customer. Management assesses the credit risk associated with certain commitments to extend credit in determining the level of the allowance for credit losses.
Standby Letters of Credit. Standby letters of credit are conditional commitments issued by us to guarantee the performance of a customer to a third party. If the customer does not perform in accordance with the terms of the agreement with the third party, we would be required to fund the commitment and we would have the rights to the underlying collateral. The maximum potential amount of future payments we could be required to make is represented by the contractual amount of the commitment. Our policies generally require that standby letter of credit arrangements contain security and debt covenants similar to those contained in loan agreements.
As of June 30, 2022 and December 31, 2021, we had outstanding $1.20 billion and $1.09 billion, respectively, in commitments to extend credit and $20.8 million and $21.2 million, respectively, in commitments associated with outstanding letters of credit. Since commitments associated with letters of credit and commitments to extend credit may expire unused, the total outstanding may not necessarily reflect the actual future cash funding requirements.
Liquidity and Capital Resources
Liquidity
Liquidity is the measure of our ability to meet the cash flow requirements of depositors and borrowers, while at the same time meeting our operating, capital, strategic cash flow needs and to maintain reserve requirements to operate on an ongoing basis and manage unexpected events, all at a reasonable cost. During the six months ended June 30, 2022 and the year ended December 31, 2021, our liquidity needs have been primarily met by deposits, borrowed funds, security and loan maturities and amortizing investment and loan portfolios. The Bank has access to purchased funds from correspondent banks, and advances from the FHLB are available under a security and pledge agreement to take advantage of investment opportunities.
Our largest source of funds is deposits, and our largest use of funds is loans. Our average deposits increased $881.7 million, or 16.7%, and our average loans decreased $289.2 million, or 6.3%, for the six months ended June 30, 2022 compared with the six months ended June 30, 2021. We predominantly invest excess deposits in Federal Reserve Bank of Dallas balances, securities, interest-bearing deposits at other banks or other short-term liquid investments until the funds are needed to fund loan growth. Our securities portfolio had a weighted average life of 7.2 years and modified duration of 4.9 years at June 30, 2022, and a weighted average life of 6.5 years and modified duration of 4.6 years at December 31, 2021.
As of June 30, 2022 and December 31, 2021, we had no exposure to future cash requirements associated with known uncertainties or capital expenditures of a material nature.
Capital Resources
Capital management consists of providing equity to support our current and future operations. We are subject to capital adequacy requirements imposed by the Federal Reserve, and the Bank is subject to capital adequacy requirements imposed by the FDIC. Both the Federal Reserve and the FDIC have adopted risk-based capital requirements for assessing bank holding company and bank capital adequacy. These standards define capital and establish minimum capital requirements in relation to assets and off-balance sheet exposure, adjusted for credit risk. The risk-based capital standards currently in effect are designed to make regulatory capital requirements more sensitive to differences in risk profiles among bank holding companies and banks, to account for off-balance sheet exposure and to minimize disincentives for holding liquid assets. Assets and off-balance sheet items are assigned to broad risk categories, each with appropriate relative risk weights. The resulting capital ratios represent capital as a percentage of total risk-weighted assets and off-balance sheet items.
Under current guidelines, the minimum ratio of total capital to risk-weighted assets (which are primarily the credit risk equivalents of balance sheet assets and certain off-balance sheet items such as standby letters of credit) is 8.0%. At least half of total capital must be composed of tier 1 capital, which includes common shareholders’ equity (including retained earnings), less goodwill, other disallowed intangible assets, and disallowed deferred tax assets, among other items. The Federal Reserve also has adopted a minimum leverage ratio, requiring tier 1 capital of at least 4.0% of average quarterly total consolidated assets, net of goodwill and certain other intangible assets, for all but the most highly rated bank holding companies. The federal banking agencies have also established risk-based and leverage capital guidelines that FDIC-insured depository institutions are required to meet. These regulations are generally similar to those established by the Federal Reserve for bank holding companies.
Under the Federal Deposit Insurance Act, the federal bank regulatory agencies must take “prompt corrective action” against undercapitalized U.S. depository institutions. U.S. depository institutions are assigned one of five capital categories: “well-capitalized,” “adequately capitalized,” “undercapitalized,” “significantly undercapitalized” and “critically undercapitalized,” and are subjected to different regulation corresponding to the capital category within which the institution falls. A depository institution is deemed to be “well-capitalized” if the banking institution has a total risk-based capital ratio of 10.0% or greater, a tier 1 risk-based capital ratio of 8.0% or greater, a common equity tier 1 capital ratio of 6.5% and a leverage ratio of 5.0% or greater, and the institution is not subject to an order, written agreement, capital directive or prompt corrective action directive to meet and maintain a specific level for any capital measure. Under certain circumstances, a well-capitalized, adequately capitalized or undercapitalized institution may be treated as if the institution were in the next lower capital category.
Failure to meet capital guidelines could subject the institution to a variety of enforcement remedies by federal bank regulatory agencies, including: termination of deposit insurance by the FDIC, restrictions on certain business activities and appointment of the FDIC as conservator or receiver.
As of June 30, 2022 and December 31, 2021, the Bank was well-capitalized. Total shareholder’s equity was $705.3 million at June 30, 2022, compared with $816.5 million at December 31, 2021, a decrease of $111.1 million. This decrease was primarily due the decrease in accumulated other comprehensive income of $133.7 million along with the $0.28 per common share dividend paid partially offset by net income of $35.1 million for the six months ended June 30, 2022.
The following table provides a comparison of our leverage and risk-weighted capital ratios as of the dates indicated to the minimum and well-capitalized regulatory standards, as well as with the capital conservation buffer:
| | | | | | | | | | | | | | | | | | | | | | | |
| | Actual
Ratio | | Minimum
Required
For Capital
Adequacy
Purposes | | Minimum
Required
Plus Capital
Conservation
Buffer | | To Be
Categorized As
Well-Capitalized
Under Prompt
Corrective
Action Provisions |
| Allegiance Bancshares, Inc. (Consolidated) | | | | | | | |
As of June 30, 2022 | | | | | | | |
| Total capital (to risk weighted assets) | 15.47 | % | | 8.00 | % | | 10.50 | % | | N/A |
| Common equity Tier 1 capital (to risk weighted assets) | 12.06 | % | | 4.50 | % | | 7.00 | % | | N/A |
| Tier 1 capital (to risk weighted assets) | 12.26 | % | | 6.00 | % | | 8.50 | % | | N/A |
| Tier 1 capital (to average assets) | 8.65 | % | | 4.00 | % | | 4.00 | % | | N/A |
As of December 31, 2021 | | | | | | | |
| Total capital (to risk weighted assets) | 16.08 | % | | 8.00 | % | | 10.50 | % | | N/A |
| Common equity Tier 1 capital (to risk weighted assets) | 12.47 | % | | 4.50 | % | | 7.00 | % | | N/A |
| Tier 1 capital (to risk weighted assets) | 12.69 | % | | 6.00 | % | | 8.50 | % | | N/A |
| Tier 1 capital (to average tangible assets) | 8.53 | % | | 4.00 | % | | 4.00 | % | | N/A |
| Allegiance Bank | | | | | | | |
As of June 30, 2022 | | | | | | | |
| Total capital (to risk weighted assets) | 14.50 | % | | 8.00 | % | | 10.50 | % | | 10.00 | % |
| Common equity Tier 1 capital (to risk weighted assets) | 12.51 | % | | 4.50 | % | | 7.00 | % | | 6.50 | % |
| Tier 1 capital (to risk weighted assets) | 12.51 | % | | 6.00 | % | | 8.50 | % | | 8.00 | % |
| Tier 1 capital (to average tangible assets) | 8.83 | % | | 4.00 | % | | 4.00 | % | | 5.00 | % |
As of December 31, 2021 | | | | | | | |
| Total capital (to risk weighted assets) | 14.71 | % | | 8.00 | % | | 10.50 | % | | 10.00 | % |
| Common equity Tier 1 capital (to risk weighted assets) | 12.63 | % | | 4.50 | % | | 7.00 | % | | 6.50 | % |
| Tier 1 capital (to risk weighted assets) | 12.63 | % | | 6.00 | % | | 8.50 | % | | 8.00 | % |
| Tier 1 capital (to average tangible assets) | 8.49 | % | | 4.00 | % | | 4.00 | % | | 5.00 | % |
GAAP Reconciliation and Management’s Explanation of Non-GAAP Financial Measures
We identify certain financial measures discussed in this Quarterly Report on Form 10-Q as being “non-GAAP financial measures.” In accordance with the SEC’s rules, we classify a financial measure as being a non-GAAP financial measure if that financial measure excludes or includes amounts, or is subject to adjustments that have the effect of excluding or including amounts, that are included or excluded, as the case may be, in the most directly comparable measure calculated and presented in accordance with GAAP as in effect from time to time in the United States in our statements of income, balance sheet or statements of cash flows. Non-GAAP financial measures do not include operating and other statistical measures or ratios or statistical measures calculated using exclusively either financial measures calculated in accordance with GAAP, operating measures or other measures that are not non-GAAP financial measures or both.
The non-GAAP financial measures that we discuss in this Quarterly Report on Form 10-Q should not be considered in isolation or as a substitute for the most directly comparable or other financial measures calculated in accordance with GAAP. Moreover, the manner in which we calculate the non-GAAP financial measures that we discuss in this Quarterly Report on Form 10-Q may differ from that of other companies reporting measures with similar names. You should understand how such other banking organizations calculate their financial measures similar or with names similar to the non-GAAP financial measures we have discussed in this Quarterly Report on Form 10-Q when comparing such non-GAAP financial measures.
Our management, financial analysts and investment bankers use the non-GAAP financial measure “Return on Average Tangible Shareholders’ Equity” in their analysis of our performance. Return on average tangible shareholders’ equity is computed by dividing net earnings by average total shareholders’ equity reduced by average goodwill and core deposit intangibles, net of accumulated amortization. For return on average tangible shareholders’ equity, the most directly comparable financial measure calculated in accordance with GAAP is return on average shareholders’ equity. This measure is important to investors because it measures the performance of the business consistently, exclusive of changes in intangible assets.
We believe this non-GAAP financial measure provides useful information to management and investors that is supplementary to our financial condition, results of operations and cash flows computed in accordance with GAAP; however, we acknowledge that non-GAAP financial measures have a number of limitations. As such, you should not view these disclosures as a substitute for results determined in accordance with GAAP, and they are not necessarily comparable to non-GAAP financial measures that other companies use. The following reconciliation tables provide a more detailed analysis of this non-GAAP financial measure:
| | | | | | | | | | | | | | | | | | | | | | | |
| | Three Months Ended June 30, | | Six Months Ended June 30, |
| | 2022 | | 2021 | | 2022 | | 2021 |
| | (Dollars in thousands) |
| Net income | $ | 16,437 | | $ | 22,925 | | $ | 35,094 | | $ | 40,935 |
| | | | | | | |
| Average shareholders' equity | $ | 744,126 | | $ | 774,803 | | $ | 774,248 | | $ | 768,238 |
Less: Average goodwill and core deposit intangibles, net | 237,153 | | 240,331 | | 237,537 | | 240,746 |
| Average tangible shareholders’ equity | $ | 506,973 | | $ | 534,472 | | $ | 536,711 | | $ | 527,492 |
| | | | | | | |
Return on average tangible shareholders' equity(1) | 13.00 | % | | 17.20 | % | | 13.19 | % | | 15.65 | % |
(1)Annualized.