| Item 2. | Management’s Discussion and Analysis of Financial Condition and Results of Operations |
The following discussion and analysis is intended to assist readers in understanding our financial condition as of and results of operations for the period covered by this Quarterly Report on Form 10-Q (this “Form 10-Q”) and should be read in conjunction with our consolidated financial statements and the accompanying notes thereto included in this Form 10-Q and in our Annual Report on Form 10-K for the year ended December 31, 2022 (the “2022 Annual Report on Form 10-K”) filed with the Securities and Exchange Commission (the “SEC”) pursuant to Rule 424(b) of the Securities Act of 1933, as amended (the “Securities Act”), on March 13, 2023. Unless we state otherwise or the context otherwise requires, references in this Form 10-Q to “we,” “our,” “us” and “the Company” refer to South Plains Financial, Inc., a Texas corporation, our wholly-owned banking subsidiary, City Bank, a Texas banking association and our other consolidated subsidiaries. References in this Form 10-Q to the “Bank” refer to City Bank.
Cautionary Notice Regarding Forward-Looking Statements
This Form 10-Q contains statements that we believe are “forward-looking statements” within the meaning of Section 27A of the Securities Act and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). These forward-looking statements reflect our current views with respect to, among other things, future events and our financial performance. These statements are often, but not always, made through the use of words or phrases such as “may,” “might,” “should,” “could,” “predict,” “potential,” “believe,” “expect,” “continue,” “will,” “anticipate,” “seek,” “estimate,” “intend,” “plan,” “strive,” “projection,” “goal,” “target,” “outlook,” “aim,” “would,” “annualized” and “outlook,” or the negative version of those words or other comparable words or phrases of a future or forward-looking nature. These forward-looking statements are not historical facts, and are based on current expectations, estimates and projections about our industry, management’s beliefs and certain assumptions made by management, many of which, by their nature, are inherently uncertain and beyond our control. Accordingly, we caution you that any such forward-looking statements are not guarantees of future performance and are subject to risks, assumptions, estimates and uncertainties that are difficult to predict. Although we believe that the expectations reflected in these forward-looking statements are reasonable as of the date made, actual results may prove to be materially different from the results expressed or implied by the forward-looking statements.
There are or will be important factors that could cause our actual results to differ materially from those indicated in these forward-looking statements, including, but not limited to, the following:
| ● | potential recession in the United States and our market areas; |
| ● | the impacts related to or resulting from recent bank failures and any continuation of the recent uncertainty in the banking industry, including the associated impact to the Company and other financial institutions of any regulatory changes or other mitigation efforts taken by government agencies in response thereto; |
| ● | increased competition for deposits and related changes in deposit customer behavior; |
| ● | the persistence of the current inflationary environment in the United States and our market areas, and its impact on market interest rates, the economy and credit quality; |
| ● | the adequacy of the allowance for credit losses; |
| ● | our ability to effectively execute our expansion strategy and manage our growth, including identifying and consummating suitable acquisitions; |
| ● | business and economic conditions, particularly those affecting our market areas, as well as the concentration of our business in such market areas; |
| ● | high concentrations of loans secured by real estate located in our market areas; |
| ● | risks associated with our commercial loan portfolio, including the risk of declines in commercial real estate prices or deterioration in value of the general business assets that secure such loans; |
| ● | potential changes in the prices, values and sales volumes of commercial and residential real estate securing our real estate loans; |
| ● | increases in unemployment rates in the United States and our market areas; |
| ● | risks associated with our agricultural loan portfolio, including the heightened sensitivity to weather conditions, commodity prices, and other factors generally outside the borrowers and our control; |
| ● | risks related to the significant amount of credit that we have extended to a limited number of borrowers and in a limited geographic area; |
| ● | public funds deposits comprising a relatively high percentage of our deposits; |
| ● | potential impairment on the goodwill we have recorded or may record in connection with business acquisitions; |
| ● | our ability to maintain our reputation; |
| ● | our ability to successfully manage our credit risk and the sufficiency of our allowance for credit losses; |
| ● | our ability to attract, hire and retain qualified management personnel; |
| ● | our dependence on our management team, including our ability to retain executive officers and key employees and their customer and community relationships; |
| ● | interest rate fluctuations, which could have an adverse effect on our profitability; |
| ● | competition from banks, credit unions and other financial services providers; |
| ● | our ability to keep pace with technological change or difficulties we may experience when implementing new technologies; |
| ● | risks related to cyber incidents or other system failures, such as service denials, cyber-attacks, security breaches and data breaches; |
| ● | our ability to maintain effective internal control over financial reporting; |
| ● | employee error, fraudulent activity by employees or customers and inaccurate or incomplete information about our customers and counterparties; |
| ● | increased capital requirements imposed by banking regulators, which may require us to raise capital at a time when capital is not available on favorable terms or at all; |
| ● | 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; |
| ● | costs and effects of litigation, investigations or similar matters to which we may be subject, including any effect on our reputation; |
| ● | natural disasters, severe weather, acts of god, acts of war or terrorism, outbreaks of hostilities, public health outbreaks (such as the COVID-19 pandemic or any future pandemic), other international or domestic calamities, and other external events or matters beyond our control; |
| ● | uncertainty regarding United States fiscal debt and budget matters; |
| ● | tariffs and trade barriers; |
| ● | compliance with governmental and regulatory requirements, including the Dodd-Frank Act Wall Street Reform and Consumer Protection Act, the Economic Growth, Regulatory Relief, and Consumer Protection Act (“EGRRCPA”), and others relating to banking, consumer protection, securities and tax matters; and |
| ● | changes in the laws, rules, regulations, interpretations or policies relating to financial institutions, accounting, tax, trade, current and future governmental monetary and fiscal policies, including the uncertain impacts of ongoing quantitative tightening and current and future policies of the Board of Governors of the Federal Reserve System (“Federal Reserve”) and as a result of initiatives of the Biden administration. |
The foregoing factors should not be construed as exhaustive and should be read together with the other cautionary statements included in this Form 10-Q and the risk factors set forth in our 2022 Annual Report on Form 10-K. Because of these risks and other uncertainties, our actual future results, performance or achievements, or industry results, may be materially different from the results indicated by the forward-looking statements in this Form 10-Q. In addition, our past results of operations are not necessarily indicative of our future results. Accordingly, you should not rely on any forward-looking statements, which represent our beliefs, assumptions and estimates only as of the dates on which such forward-looking statements were made. Any forward-looking statement speaks only as of the date on which it is made, and we do not undertake any obligation to update or review any forward-looking statement, whether as a result of new information, future developments or otherwise, except as required by applicable law.
Available Information
The Company maintains an Internet web site at www.spfi.bank. The Company makes available, free of charge, on its web site (under www.spfi.bank/financials-filings/sec-filings ) the Company’s annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports filed or furnished pursuant to Section 13(a) or Section 15(d) of the Exchange Act as soon as reasonably practicable after the Company files such material with, or furnishes it to, the SEC. The Company also makes available, free of charge, through its web site (under www.spfi.bank/corporate-governance/documents-charters ) links to the Company’s Code of Conduct and the charters for its board committees. In addition, the SEC maintains an Internet site (at www.sec.gov ) that contains reports, proxy and information statements, and other information regarding issuers that file electronically with the SEC.
The Company routinely posts important information for investors on its web site (under www.spfi.bank and, more specifically, under the News & Events tab at www.spfi.bank/news-events/press-releases ). The Company intends to use its web site as a means of disclosing material non-public information and for complying with its disclosure obligations under SEC Regulation FD (Fair Disclosure). Accordingly, investors should monitor the Company’s web site, in addition to following the Company’s press releases, SEC filings, public conference calls, presentations and webcasts.
The information contained on, or that may be accessed through, the Company’s web site is not incorporated by reference into, and is not a part of, this Form 10-Q.
Overview
We are a bank holding company headquartered in Lubbock, Texas, and our wholly-owned subsidiary, City Bank is one of the largest independent banks in West Texas and has additional banking operations in the Dallas, El Paso, Greater Houston, the Permian Basin, and College Station, Texas markets, and the Ruidoso, New Mexico market. Through City Bank, we provide a wide range of commercial and consumer financial services to small and medium-sized businesses and individuals in our market areas. Our principal business activities include commercial and retail banking, along with investment, trust and mortgage services.
Recent Developments
Economic Conditions
Our financial condition at September 30, 2023, as well as the results of operations for the three and nine months ended September 30, 2023, have been impacted by significant increases in market interest rates due to the increases in the prime lending rate since March 2022 by the Federal Reserve in response to the persistent inflationary environment in the United States. In addition, recent events in other parts of the banking industry have brought additional focus on investment securities portfolios, interest rate risk, liquidity management and capital. As a result, we are providing additional information on our deposits and liquidity position at September 30, 2023 to help illustrate the more traditional and stable nature of our banking model compared to other financial institutions who have recently experienced liquidity and capital challenges.
Deposits
Total deposits were $3.62 billion at September 30, 2023, an increase of $214.2 million during the nine months ended September 30, 2023. Total deposits were comprised of 29% of noninterest-bearing deposits, 10% of time deposits and 61% of interest-bearing nonmaturity deposits. Retail customers accounted for approximately 44% of total deposits, with commercial and public funds accounting for approximately 47% and 9%, respectively. Our average deposit account size was approximately $36 thousand. An estimated 16% of total deposits were uninsured or uncollateralized at September 30, 2023.
Liquidity
We had available borrowing capacity of up to approximately $1.89 billion through the FHLB, the FRB’s Discount Window, and access to the FRB’s Term Funding Program (“BTFP”) at September 30, 2023. The unused line with the FHLB was $1.09 billion and the unused line with the FRB was $612 million at September 30, 2023. No advances were made on these lines during the first three quarters of 2023 and there are no outstanding advances as of September 30, 2023. We have not pledged any securities for the BTFP but have approximately $179 million of available securities that can be used as collateral. Additionally, we have uncollateralized lines with multiple banks totaling $140 million at September 30, 2023. These lines are not guaranteed and we are not placing reliance on them.
Results of Operations
We had net income of $13.5 million, or $0.78 per diluted common share, for the three months ended September 30, 2023, compared to net income of $15.5 million, or $0.86 per diluted common share for the three months ended September 30, 2022. Return on average equity (annualized) was 14.01% and return on average assets (annualized) was 1.27% for the three months ended September 30, 2023, compared to 17.37% and 1.53%, respectively, for the three months ended September 30, 2022.
We had net income of $52.4 million, or $3.01 per diluted common share for the nine months ended September 30, 2023, compared to net income of $45.6 million, or $2.52 per diluted common share for the nine months ended September 30, 2022. Return on average equity (annualized) was 18.70% and return on average assets (annualized) was 1.73% for the nine months ended September 30, 2023, compared to 16.25% and 1.53%, respectively, for the nine months ended September 30, 2022.
Net Interest Income
Net interest income is the principal source of the Company’s net income and represents the difference between interest income (interest and fees earned on assets, primarily loans and investment securities) and interest expense (interest paid on deposits and borrowed funds). We generate interest income from interest-earning assets that we own, including loans and investment securities. We incur interest expense from interest-bearing liabilities, including interest-bearing deposits and other borrowings, notably FHLB advances and subordinated notes. To evaluate net interest income, we measure and monitor (i) yields on our loans and other interest-earning assets, (ii) the costs of our deposits and other funding sources, (iii) our net interest spread and (iv) 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 the annualized net interest income on a fully tax-equivalent basis divided by average interest-earning assets.
Changes in the market interest rates and interest rates we earn on interest-earning assets or pay on interest-bearing liabilities, as well as the volume and types of interest-earning assets, interest-bearing and noninterest-bearing liabilities, are usually the largest drivers of periodic changes in net interest spread, net interest margin and net interest income.
The following tables present, for the periods indicated, information about: (i) weighted average balances, the total dollar amount of interest income from interest-earning assets and the resultant average yields; (ii) average balances, the total dollar amount of interest expense on interest-bearing liabilities and the resultant average rates; (iii) net interest income; (iv) the interest rate spread; and (v) the net interest margin. For purposes of this table, interest income, net interest margin and net interest spread are shown on a fully tax-equivalent basis.
| | | Three Months Ended September 30, | |
| | | 2023 | | | 2022 | |
| | | Average Balance | | | Interest | | | Yield/ Rate | | | Average Balance | | | Interest | | | Yield/ Rate | |
| | | (Dollars in thousands) | |
| Assets: | | | | | | | | | | | | | | | | | | |
| Interest-earning assets: | | | | | | | | | | | | | | | | | | |
Loans(1) | | $ | 3,005,699 | | | $ | 46,250 | | | | 6.10 | % | | $ | 2,671,183 | | | $ | 34,464 | | | | 5.12 | % |
| Investment securities – taxable | | | 561,068 | | | | 5,422 | | | | 3.83 | | | | 617,722 | | | | 4,166 | | | | 2.68 | |
| Investment securities – non-taxable | | | 159,577 | | | | 1,054 | | | | 2.62 | | | | 215,508 | | | | 1,428 | | | | 2.63 | |
Other interest-earning assets(2) | | | 325,201 | | | | 4,031 | | | | 4.92 | | | | 293,636 | | | | 1,351 | | | | 1.83 | |
| Total interest-earning assets | | | 4,051,545 | | | | 56,757 | | | | 5.56 | | | | 3,798,049 | | | | 41,409 | | | | 4.33 | |
| Noninterest-earning assets | | | 177,216 | | | | | | | | | | | | 208,135 | | | | | | | | | |
| Total assets | | $ | 4,228,761 | | | | | | | | | | | $ | 4,006,184 | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Liabilities and Stockholders’ Equity: | | | | | | | | | | | | | | | | | | | | | | | | |
| Interest-bearing liabilities: | | | | | | | | | | | | | | | | | | | | | | | | |
| NOW, savings and money market deposits | | $ | 2,223,014 | | | $ | 16,061 | | | | 2.87 | % | | $ | 1,873,786 | | | $ | 3,514 | | | | 0.74 | % |
| Time deposits | | | 344,395 | | | | 2,904 | | | | 3.35 | | | | 330,133 | | | | 1,023 | | | | 1.23 | |
| Short-term borrowings | | | 3 | | | | — | | | | 0.00 | | | | 4 | | | | — | | | | 0.00 | |
| Notes payable & other longer-term borrowings | | | — | | | | — | | | | 0.00 | | | | — | | | | — | | | | 0.00 | |
| Subordinated debt securities | | | 76,077 | | | | 1,012 | | | | 5.28 | | | | 75,914 | | | | 1,012 | | | | 5.29 | |
| Junior subordinated deferrable interest debentures | | | 46,393 | | | | 862 | | | | 7.37 | | | | 46,393 | | | | 457 | | | | 3.91 | |
| Total interest-bearing liabilities | | $ | 2,689,882 | | | $ | 20,839 | | | | 3.07 | % | | $ | 2,326,230 | | | $ | 6,006 | | | | 1.02 | % |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Noninterest-bearing liabilities: | | | | | | | | | | | | | | | | | | | | | | | | |
| Noninterest-bearing deposits | | $ | 1,071,175 | | | | | | | | | | | $ | 1,248,804 | | | | | | | | | |
| Other liabilities | | | 85,713 | | | | | | | | | | | | 78,139 | | | | | | | | | |
| Total noninterest-bearing liabilities | | | 1,156,888 | | | | | | | | | | | | 1,326,943 | | | | | | | | | |
| Stockholders’ equity | | | 381,991 | | | | | | | | | | | | 353,011 | | | | | | | | | |
| Total liabilities and stockholders’ equity | | $ | 4,228,761 | | | | | | | | | | | $ | 4,006,184 | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Net interest income | | | | | | $ | 35,918 | | | | | | | | | | | $ | 35,403 | | | | | |
| Net interest spread | | | | | | | | | | | 2.48 | % | | | | | | | | | | | 3.30 | % |
Net interest margin(3) | | | | | | | | | | | 3.52 | % | | | | | | | | | | | 3.70 | % |
| | | Nine Months Ended September 30, | |
| | | 2023 | | | 2022 | |
| | | Average Balance | | | Interest | | | Yield/ Rate | | | Average Balance | | | Interest | | | Yield/ Rate | |
| | | (Dollars in thousands) | |
| Assets: | | | | | | | | | | | | | | | | | | |
| Interest-earning assets: | | | | | | | | | | | | | | | | | | |
Loans(1) | | $ | 2,892,887 | | | $ | 128,724 | | | | 5.95 | % | | $ | 2,567,683 | | | $ | 99,262 | | | | 5.17 | % |
| Investment securities – taxable | | | 574,159 | | | | 16,027 | | | | 3.73 | | | | 592,069 | | | | 10,058 | | | | 2.27 | |
| Investment securities – non-taxable | | | 194,492 | | | | 3,870 | | | | 2.66 | | | | 216,951 | | | | 4,315 | | | | 2.66 | |
Other interest-earning assets(2) | | | 212,384 | | | | 7,010 | | | | 4.41 | | | | 363,659 | | | | 2,213 | | | | 0.81 | |
| Total interest-earning assets | | | 3,873,922 | | | | 155,631 | | | | 5.37 | | | | 3,740,362 | | | | 115,848 | | | | 4.14 | |
| Noninterest-earning assets | | | 183,149 | | | | | | | | | | | | 236,296 | | | | | | | | | |
| Total assets | | $ | 4,057,071 | | | | | | | | | | | $ | 3,976,658 | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Liabilities and Shareholders’ Equity: | | | | | | | | | | | | | | | | | | | | | | | | |
| Interest-bearing liabilities: | | | | | | | | | | | | | | | | | | | | | | | | |
| NOW, savings and money market deposits | | $ | 2,090,250 | | | $ | 38,529 | | | | 2.46 | % | | $ | 1,905,000 | | | $ | 5,782 | | | | 0.41 | % |
| Time deposits | | | 309,250 | | | | 6,239 | | | | 2.70 | | | | 334,686 | | | | 2,962 | | | | 1.18 | |
| Short-term borrowings | | | 111 | | | | 5 | | | | 6.02 | | | | 4 | | | | — | | | | 0.00 | |
| Notes payable & other longer-term borrowings | | | — | | | | — | | | | 0.00 | | | | — | | | | — | | | | 0.00 | |
| Subordinated debt securities | | | 76,031 | | | | 3,037 | | | | 5.34 | | | | 75,852 | | | | 3,037 | | | | 5.35 | |
| Junior subordinated deferrable interest debentures | | | 46,393 | | | | 2,402 | | | | 6.92 | | | | 46,393 | | | | 1,005 | | | | 2.90 | |
| Total interest-bearing liabilities | | $ | 2,522,035 | | | $ | 50,212 | | | | 2.66 | % | | $ | 2,361,935 | | | $ | 12,786 | | | | 0.72 | % |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Noninterest-bearing liabilities: | | | | | | | | | | | | | | | | | | | | | | | | |
| Noninterest-bearing deposits | | $ | 1,085,345 | | | | | | | | | | | $ | 1,174,783 | | | | | | | | | |
| Other liabilities | | | 74,865 | | | | | | | | | | | | 64,639 | | | | | | | | | |
| Total noninterest-bearing liabilities | | | 1,160,210 | | | | | | | | | | | | 1,239,422 | | | | | | | | | |
| Shareholders’ equity | | | 374,826 | | | | | | | | | | | | 375,301 | | | | | | | | | |
| Total liabilities and shareholders’ equity | | $ | 4,057,071 | | | | | | | | | | | $ | 3,976,658 | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Net interest income | | | | | | $ | 105,419 | | | | | | | | | | | $ | 103,062 | | | | | |
| Net interest spread | | | | | | | | | | | 2.71 | % | | | | | | | | | | | 3.42 | % |
Net interest margin(3) | | | | | | | | | | | 3.64 | % | | | | | | | | | | | 3.68 | % |
| (1) | Average loan balances include nonaccrual loans and loans held for sale. |
| (2) | Includes income and average balances for interest-earning deposits at other banks, federal funds sold and other miscellaneous interest-earning assets. |
| (3) | Net interest margin is calculated as the annualized net interest income, on a fully tax-equivalent basis, divided by average interest-earning assets. |
Increases and decreases in interest income and interest expense result from changes in average balances (volume) of interest-earning assets and interest-bearing liabilities, as well as changes in average interest rates. The following tables set forth the effects of changing rates and volumes on our net interest income during the period shown. Information is provided with respect to (i) effects on interest income attributable to changes in volume (change in volume multiplied by prior rate) and (ii) effects on interest income attributable to changes in rate (changes in rate multiplied by prior volume). Change applicable to both volume and rate have been allocated to volume.
| | | Three Months Ended September 30, | |
| | | 2023 over 2022 | |
| | | Change due to: | | | Total | |
| | | Volume | | | Rate | | | Variance | |
| | | (Dollars in thousands) | |
| Interest-earning assets: | | | | | | | | | |
| Loans | | $ | 4,316 | | | $ | 7,470 | | | $ | 11,786 | |
| Investment securities – taxable | | | (382 | ) | | | 1,638 | | | | 1,256 | |
| Investment securities – non-taxable | | | (371 | ) | | | (3 | ) | | | (374 | ) |
| Other interest-earning assets | | | 145 | | | | 2,535 | | | | 2,680 | |
| Total increase (decrease) in interest income | | | 3,708 | | | | 11,640 | | | | 15,348 | |
| | | | | | | | | | | | | |
| Interest-bearing liabilities: | | | | | | | | | | | | |
| NOW, Savings, MMDAs | | | 655 | | | | 11,892 | | | | 12,547 | |
| Time deposits | | | 44 | | | | 1,837 | | | | 1,881 | |
| Short-term borrowings | | | — | | | | — | | | | — | |
| Notes payable & other borrowings | | | — | | | | — | | | | — | |
| Subordinated debt securities | | | 2 | | | | (2 | ) | | | — | |
| Junior subordinated deferrable interest debentures | | | — | | | | 405 | | | | 405 | |
| Total increase (decrease) interest expense: | | | 701 | | | | 14,132 | | | | 14,833 | |
| | | | | | | | | | | | | |
Increase (decrease) in net interest income | | $ | 3,007 | | | $ | (2,492 | ) | | $ | 515 | |
| | | Nine Months Ended September 30, | |
| | | 2023 over 2022 | |
| | | Change due to: | | | Total | |
| | | Volume | | | Rate | | | Variance | |
| | | (Dollars in thousands) | |
| Interest-earning assets: | | | | | | | | | |
| Loan | | $ | 12,572 | | | $ | 16,890 | | | $ | 29,462 | |
| Investment securities – taxable | | | (304 | ) | | | 6,273 | | | | 5,969 | |
| Investment securities – non-taxable | | | (447 | ) | | | 2 | | | | (445 | ) |
| Other interest-earning assets | | | (921 | ) | | | 5,718 | | | | 4,797 | |
| Total increase (decrease) in interest income | | | 10,900 | | | | 28,883 | | | | 39,783 | |
| | | | | | | | | | | | | |
| Interest-bearing liabilities: | | | | | | | | | | | | |
| NOW, Savings, MMDAs | | | 562 | | | | 32,185 | | | | 32,747 | |
| Time deposits | | | (225 | ) | | | 3,502 | | | | 3,277 | |
| Short-term borrowings | | | — | | | | 5 | | | | 5 | |
| Notes payable & other borrowings | | | — | | | | — | | | | — | |
| Subordinated debt securities | | | 7 | | | | (7 | ) | | | — | |
| Junior subordinated deferrable interest debentures | | | — | | | | 1,397 | | | | 1,397 | |
| Total increase (decrease) interest expense: | | | 344 | | | | 37,082 | | | | 37,426 | |
| | | | | | | | | | | | | |
Increase (decrease) in net interest income | | $ | 10,556 | | | $ | (8,199 | ) | | $ | 2,357 | |
Net interest income for the three months ended September 30, 2023 was $35.7 million, compared to $35.1 million for the three months ended September 30, 2022, an increase of $0.6 million, or 1.7%. This change in net interest income was primarily due to increased income on interest-earning assets, principally loans and securities, net of increased funding costs on deposits, as market interest rates continued to rise during the period. This rise in rates is attributed to the Federal Open Market Committee (“FOMC”) of the Federal Reserve repeatedly raising their target benchmark interest rate since March 2022 in response to the persistent inflationary environment in the United States. Average interest-earning assets increased $253.5 million, or 6.7%, to $4.05 billion for the three months ended September 30, 2023 compared to $3.80 billion for the three months ended September 30, 2022. The increase is due to growth in both average loans outstanding of $334.5 million, partially offset by a decrease in average investment securities of $112.6 million. The yield on average interest-earning assets increased 123 basis points from 4.33% for the three months ended September 30, 2022 to 5.56% for the three months ended September 30, 2023. The increase in asset yield from the prior year is primarily a result of increased market interest rates and from deploying excess liquidity from lower yielding interest-earning cash and investment securities to higher yielding loans. Average interest-bearing liabilities increased $363.7 million, or 15.6%, to $2.69 billion for the three months ended September 30, 2023 compared to $2.33 billion for the three months ended September 30, 2022. The increase is primarily growth in average interest-bearing deposits of $363.5 million due to funding for higher loan demand and increased focus on deposits and liquidity. The average cost of interest-bearing liabilities increased 205 basis points to 3.07% for the three months ended September 30, 2023 compared to 1.02% for the three months ended September 30, 2022. The increase is primarily a result of higher deposit funding costs as market interest rates have risen significantly since the start of the second quarter of 2022. These changes caused net interest margin to decline 18 basis points to 3.52% for the three months ended September 30, 2023 from 3.70% for the same three-month period in 2022.
Net interest income for the nine months ended September 30, 2023 was $104.6 million, compared to $102.2 million for the nine months ended September 30, 2022, an increase of $2.4 million, or 2.4%. The increase in net interest income was primarily due to increased income on interest-earning assets, principally loans and securities, net of increased funding costs on deposits, as market interest rates continued to rise during the period, which is attributed to the FOMC repeatedly raising their target benchmark interest rate since March 2022. The increase was partially offset by $4.4 million of interest income received related to four credits for the recovery of interest on previously charged-off credits, purchase discount principal recovery, and prepayment penalties during the second quarter of 2022. Average interest-earning assets increased $133.6 million or 3.6%, to $3.88 billion for the nine months ended September 30, 2023 compared to $3.74 billion for the nine months ended September 30, 2022. The increase is primarily due to growth in average loans outstanding of $325.2 million, partially offset by a decrease in average interest-bearing cash balances of $151.3 million. The yield on average interest-earning assets, excluding the $4.4 million recoveries noted above, increased 139 basis points from 3.98% for the nine months ended September 30, 2022 to 5.37% for the nine months ended September 30, 2023. The increase in asset yield from the prior year is a primarily a result of increased market interest rates and from deploying excess liquidity from lower yielding interest-earning cash to higher yielding loans. Average interest-bearing liabilities increased $160.1 million, or 6.8%, to $2.52 billion for the nine months ended September 30, 2023 compared to $2.36 billion for the nine months ended September 30, 2022. The increase is primarily growth in average interest-bearing deposits of $159.8 million due to funding for higher loan demand and increased focus on deposits and liquidity, given recent events in the banking industry. The average cost of interest-bearing liabilities increased 194 basis points to 2.66% for the nine months ended September 30, 2023 compared to 0.72% for the nine months ended September 30, 2022. The increase is primarily a result of higher deposit funding costs as market rates have risen significantly since the start of the second quarter of 2022. These changes caused net interest margin to decrease 4 basis points to 3.64% for the nine months ended September 30, 2023 from 3.68% for the same nine-month period in 2022.
Provision for Credit Losses
Credit risk is inherent in the business of making loans. We establish an allowance for credit losses (“ACL”) through charges to earnings, which are shown in the consolidated statements of comprehensive income (loss) as the provision for credit losses. Credit losses on loans are charged against the allowance when management believes the uncollectibility of a loan balance is confirmed. The provision for credit losses is determined by conducting a quarterly evaluation of the adequacy of our ACL and charging the shortfall or excess, if any, to the current quarter’s expense. This has the effect of creating variability in the amount and frequency of charges to our earnings. The provision for credit losses and the amount of allowance for each period are dependent upon many factors, including loan growth, net charge offs, changes in the composition of the loan portfolio, delinquencies, management’s assessment of the quality of the loan portfolio, the valuation of problem loans and the general economic conditions in our market areas.
The Company recorded a negative provision for credit losses of $0.7 million for the three months ended September 30, 2023, compared to a negative provision of $0.8 million for the three months ended September 30, 2022. The negative provision during the third quarter of 2023 was largely attributable to a reduction of $1.3 million in specific reserves, partially offset by organic loan growth and net charge-off activity during the period. The reduction in specific reserves was a result of the full repayment of a $13.3 million nonaccrual relationship in the period. The negative provision in the third quarter of 2022 was largely due to a loan loss recovery of $822 thousand of a direct energy credit during that quarter.
The Company recorded a provision for credit losses for the nine months ended September 30, 2023 of $4.0 million, compared to a negative provision of $2.9 million for the nine months ended September 30, 2022. The provision during the nine months ended September 30, 2023 was largely attributable to organic growth of $303.2 million in loans held for investment. The negative provision for credit losses in the same period of 2022 was based on improved credit metrics in the loan portfolio, specifically in the hotel segment, direct energy segment, and other Permian Basin-related credits during the period, as well as a decline in the amount of loans that were actively under a pandemic-related modification experienced during that period.
Noninterest Income
While interest income remains the largest single component of total revenues, noninterest income is an important contributing component. The largest portion of our noninterest income is associated with our mortgage banking activities. Other sources of noninterest income include service charges on deposit accounts, bank card services and interchange fees, and income from insurance activities.
The following table sets forth the major components of our noninterest income for the periods indicated:
| | | Three Months Ended September 30, | | | Nine Months Ended September 30, | |
| | | 2023 | | | 2022 | | | Increase (Decrease) | | | 2023 | | | 2022 | | | Increase (Decrease) | |
| | | (Dollars in thousands) | |
| Noninterest income: | | | | | | | | | | | | | | | | | | |
| Service charges on deposit accounts | | $ | 1,840 | | | $ | 1,764 | | | $ | 76 | | | $ | 5,286 | | | $ | 5,149 | | | $ | 137 | |
| Income from insurance activities | | | 30 | | | | 4,856 | | | | (4,826 | ) | | | 1,478 | | | | 8,003 | | | | (6,525 | ) |
| Bank card services and interchange fees | | | 3,157 | | | | 3,156 | | | | 1 | | | | 10,156 | | | | 9,856 | | | | 300 | |
| Mortgage banking activities | | | 4,602 | | | | 6,287 | | | | (1,685 | ) | | | 12,146 | | | | 28,593 | | | | (16,447 | ) |
| Investment commissions | | | 430 | | | | 391 | | | | 39 | | | | 1,239 | | | | 1,403 | | | | (164 | ) |
| Fiduciary income | | | 582 | | | | 568 | | | | 14 | | | | 1,779 | | | | 1,815 | | | | (36 | ) |
| Gain on sale of subsidiary | | | 290 | | | | — | | | | 290 | | | | 33,778 | | | | — | | | | 33,778 | |
Other income and fees(1) | | | 1,346 | | | | 3,915 | | | | (2,569 | ) | | | 4,218 | | | | 8,650 | | | | (4,432 | ) |
| Total noninterest income | | $ | 12,277 | | | $ | 20,937 | | | $ | (8,660 | ) | | $ | 70,080 | | | $ | 63,469 | | | $ | 6,611 | |
| (1) | Other income and fees includes income and fees associated with the increase in the cash surrender value of life insurance, safe deposit box rental, check printing, collections, wire transfer, Small Business Investment Company (“SBIC”) investments, and other miscellaneous services. |
Noninterest income for the three months ended September 30, 2023 was $12.3 million, compared to $20.9 million for the three months ended September 30, 2022, a decrease of $8.7 million, or 41.4%. Significant changes in the components of noninterest income are detailed below.
Mortgage banking activities - Income from mortgage banking activities decreased $1.7 million, or 26.8%, to $4.6 million for the three months ended September 30, 2023 from $6.3 million for the three months ended September 30, 2022. This decrease was mainly the result of mortgage loan originations declining $50.1 million, or 32.9%, in the current year period as compared to the prior year period as mortgage interest rates have risen and overall mortgage lending has slowed.
Income from insurance activities - Due to the sale of Windmark Insurance Agency, Inc. (“Windmark”) in the second quarter of 2023, there was a decline of $4.8 million in income from insurance activities for the three months ended September 30, 2023 as compared to the same period in 2022.
Other income and fees - Other noninterest income and fees decreased for the three months ended September 30, 2023 largely as a result of $2.1 million of income related to legal settlements recorded in the third quarter of 2022.
Noninterest income for the nine months ended September 30, 2023 was $70.1 million, compared to $63.5 million for the nine months ended September 30, 2022, an increase of $6.6 million, or 10.4%. Significant changes in the components of noninterest income are detailed below.
Gain on sale of subsidiary - A $33.8 million gain from the sale of Windmark was recorded in the second quarter of 2023.
Mortgage banking activities - Income from mortgage banking activities decreased $16.4 million, or 57.5%, to $12.1 million for the nine months ended September 30, 2023 from $28.6 million for the nine months ended September 30, 2022. This decrease was primarily a result of a decrease of $273.1 million, or 46.0%, in mortgage loan originations in the current year period as compared to the prior year period as mortgage interest rates have risen and refinance activity, which was still occurring in the first and second quarters of 2022, has subsided. There was also an $875 thousand decrease in the fair value of the Company’s mortgage servicing rights portfolio for the nine months ended September 30, 2023 as compared to a $6.0 million increase for the same period in 2022, given the changes in market interest rates during the periods.
Income from insurance activities - Due to the sale of Windmark, there was a decline of $6.5 million in income from insurance activities for the nine months ended September 30, 2023 as compared to the same period in 2022.
Other income and fees - Other noninterest income and fees increased in the nine months ended September 30, 2022 from earnings on SBIC investments of $2.3 million as compared to $310 thousand in the same period of 2023 and $2.1 million of income related to legal settlements recorded in the third quarter of 2022.
Noninterest Expense
The following table sets forth the major components of our noninterest expense for the periods indicated:
| | | Three Months Ended September 30, | | | Nine Months Ended September 30, | |
| | | 2023 | | | 2022 | | | Increase (Decrease) | | | 2023 | | | 2022 | | | Increase (Decrease) | |
| | | (Dollars in thousands) | |
| Noninterest expense: | | | | | | | | | | | | | | | | | | |
| Salaries and employee benefits | | $ | 18,709 | | | $ | 22,927 | | | $ | (4,218 | ) | | $ | 61,400 | | | $ | 67,620 | | | $ | (6,220 | ) |
| Occupancy expense, net | | | 4,111 | | | | 4,132 | | | | (21 | ) | | | 12,246 | | | | 11,902 | | | | 344 | |
| Professional services | | | 1,560 | | | | 2,523 | | | | (963 | ) | | | 4,924 | | | | 7,795 | | | | (2,871 | ) |
| Marketing and development | | | 853 | | | | 913 | | | | (60 | ) | | | 2,573 | | | | 2,391 | | | | 182 | |
| IT and data services | | | 818 | | | | 908 | | | | (90 | ) | | | 2,570 | | | | 2,902 | | | | (332 | ) |
| Bankcard expenses | | | 1,451 | | | | 1,399 | | | | 52 | | | | 4,119 | | | | 4,050 | | | | 69 | |
| Appraisal expenses | | | 283 | | | | 359 | | | | (76 | ) | | | 862 | | | | 1,432 | | | | (570 | ) |
| Loss on sale of securities | | | — | | | | — | | | | — | | | | 3,409 | | | | — | | | | 3,409 | |
Other expenses(1) | | | 3,704 | | | | 4,240 | | | | (536 | ) | | | 12,246 | | | | 13,289 | | | | (1,043 | ) |
| Total noninterest expense | | $ | 31,489 | | | $ | 37,401 | | | $ | (5,912 | ) | | $ | 104,349 | | | $ | 111,381 | | | $ | (7,032 | ) |
| (1) | Other expenses include items such as banking regulatory assessments, telephone expenses, postage, courier fees, directors’ fees, supplies, and insurance. |
Noninterest expense for the three months ended September 30, 2023 was $31.5 million compared to $37.4 million for the three months ended September 30, 2022, a decrease of $5.9 million, or 15.8%. Significant changes in the components of noninterest expense are detailed below.
Salaries and employee benefits - Salaries and employee benefits decreased $4.2 million, or 18.4%, from $22.9 million for the three months ended September 30, 2022 to $18.7 million for the three months ended September 30, 2023. This decrease was primarily driven by approximately $1.8 million in lower mortgage personnel costs, due to the reduction in mortgage loan originations and operations, and also lower core Windmark personnel costs of $2.7 million due to the sale in the second quarter of 2023.
Professional services - Professional services decreased $963 thousand during the three months ended September 30, 2023, as compared to the same period in 2022, primarily from a reduction of approximately $842 thousand in legal fees incurred largely as a result of a vendor dispute, which was resolved and accounted for by the end of 2022.
Other expenses – Other noninterest expenses declined in the current year period primarily from reduced expenses from mortgage operations, as mortgage originations declined, and Windmark expenses, due to the sale, as compared to the prior year period.
Noninterest expense for the nine months ended September 30, 2023 was $104.3 million, compared to $111.4 million for the nine months ended September 30, 2022, a decrease of $7.0 million, or 6.3%. Significant changes in the components of noninterest expense are detailed below.
Salaries and employee benefits - Salaries and employee benefits decreased $6.2 million, or 9.2%, from $67.6 million for the nine months ended September 30, 2022 to $61.4 million for the nine months ended September 30, 2023. This was primarily driven by approximately $5.9 million in lower mortgage personnel costs, due to the reduction in mortgage loan originations and operations. Also, there was lower core Windmark personnel costs due to the sale, partially offset by Windmark transaction and related incentive-based compensation expenses incurred in the first and second quarters of 2023.
Professional services - Professional services decreased $2.9 million during the nine months ended September 30, 2023, as compared to the same period in 2022, primarily from a reduction of $2.4 million in legal fees incurred largely as a result of a vendor dispute, which was resolved and accounted for by the end of 2022.
Loss on sale of securities - The Company sold approximately $56.2 million of available for sale securities in the second quarter of 2023. This resulted in a loss on sale of $3.4 million.
Other expenses - Other variable mortgage-based expenses also declined during the nine months ended September 30, 2023, as compared to the same period in 2022, as mortgage originations declined. Additionally, the FDIC assessment increased approximately $676 thousand as the assessment rates charged by the FDIC were increased as well as growth in the assessment base for the nine months ended September 30, 2023 as compared to the same period in 2022.
Financial Condition
Our total assets increased $242.4 million, or 6.1%, to $4.19 billion at September 30, 2023, compared to $3.94 billion at December 31, 2022. Our gross loans held for investment increased $245.5 million, or 8.9%, to $2.99 billion at September 30, 2023, compared to $2.75 billion at December 31, 2022. Our securities portfolio decreased $116.7 million, or 16.6%, to $585.0 million at September 30, 2023, compared to $701.7 million at December 31, 2022. Total deposits increased $214.2 million, or 6.3%, to $3.62 billion at September 30, 2023, compared to $3.41 billion at December 31, 2022.
Loan Portfolio
Our loans represent the largest portion of earning assets, greater than our securities portfolio or any other asset category, and the quality and diversification of the loan portfolio is an important consideration when reviewing the Company’s financial condition. We originate substantially all of the loans in our portfolio, except certain loan participations that are independently underwritten by the Company prior to purchase.
Loans held for investment increased $245.5 million, or 8.9%, to $2.99 billion at September 30, 2023, compared to $2.75 billion at December 31, 2022. This increase in our loans was primarily the result of organic net loan growth based on strong loan demand. The organic loan growth remained relationship-focused and occurred primarily in commercial real estate loans, residential mortgage loans, and commercial loans.
The following table shows the contractual maturities of our loans held for investment portfolio at September 30, 2023:
| | | Due in One Year or Less | | | Due after One Year Through Five Years | | | Due after Five Years Through Fifteen Years | | | Due after Fifteen Years | | | Total | |
| | | (Dollars in thousands) | |
Commercial real estate | | $ | 94,042 | | | $ | 579,187 | | | $ | 286,365 | | | $ | 86,668 | | | $ | 1,046,262 | |
Commercial - specialized | | | 124,069 | | | | 125,068 | | | | 64,504 | | | | 52,764 | | | | 366,405 | |
Commercial - general | | | 81,376 | | | | 159,153 | | | | 148,345 | | | | 125,693 | | | | 514,567 | |
Consumer: | | | | | | | | | | | | | | | | | | | | |
| 1-4 family residential | | | 48,452 | | | | 100,338 | | | | 75,056 | | | | 310,665 | | | | 534,511 | |
| Auto loans | | | 3,036 | | | | 192,234 | | | | 120,754 | | | | — | | | | 316,024 | |
| Other consumer | | | 8,354 | | | | 47,850 | | | | 21,121 | | | | — | | | | 77,325 | |
Construction | | | 124,558 | | | | 4,707 | | | | 791 | | | | 8,413 | | | | 138,469 | |
| Total loans | | $ | 483,887 | | | $ | 1,208,537 | | | $ | 716,936 | | | $ | 584,203 | | | $ | 2,993,563 | |
The following table shows the distribution between fixed and adjustable interest rate loans for maturities greater than one year as of September 30, 2023:
| | | Fixed Rate | | | Adjustable Rate | |
| | | (Dollars in thousands) | |
Commercial real estate | | $ | 443,378 | | | $ | 508,842 | |
Commercial - specialized | | | 89,556 | | | | 152,780 | |
Commercial - general | | | 155,865 | | | | 277,326 | |
Consumer: | | | | | | | | |
| 1-4 family residential | | | 301,267 | | | | 184,792 | |
| Auto loans | | | 312,988 | | | | — | |
| Other consumer | | | 68,971 | | | | — | |
Construction | | | 4,082 | | | | 9,829 | |
| Total loans | | $ | 1,376,107 | | | $ | 1,133,569 | |
At September 30, 2023, there was $1.45 billion in adjustable rate loans, with $704.8 million of these loans that mature or reprice in the next twelve months. Of these loans that mature or reprice in the next twelve months, $463.6 million will reprice immediately upon changes in the underlying index rate, with the remaining $241.2 million being subject to rate floors above the current index or a future repricing date. The Wall Street Journal prime rate is the predominate index used by the Bank.
The Bank is primarily involved in real estate, commercial, agricultural and consumer lending activities with customers throughout Texas and Eastern New Mexico. We have a collateral concentration, as 64.1% of our loans were secured by real property as of September 30, 2023, compared to 69.8% as of December 31, 2022. We believe that these loans are not concentrated in any one single property type and that they are geographically dispersed throughout the areas we serve. Although the Bank has diversified portfolios, its debtors’ ability to honor their contracts is substantially dependent upon the general economic conditions of the markets in which it operates, which consist primarily of agribusiness, wholesale/retail, oil and gas and related businesses, healthcare industries and institutions of higher education. Commercial real estate loans represent 39.5% of loans held for investment as of September 30, 2023 and represented 38.7% of loans held for investment as of December 31, 2022. Further, these loans are geographically diversified, primarily throughout the state of Texas as well as Eastern New Mexico.
We have established concentration limits in the loan portfolio for commercial real estate loans and unsecured lending, among other loan types. All loan types are within established limits. We use underwriting guidelines to assess the borrowers’ historical cash flow to determine debt service, and we further stress test the debt service under higher interest rate scenarios. Financial and performance covenants are used in commercial lending to allow us to react to a borrower’s deteriorating financial condition, should that occur.
Commercial Real Estate. Our commercial real estate portfolio includes loans for commercial property that is owned by real estate investors, construction loans to build owner-occupied properties, and loans to developers of commercial real estate investment properties and residential developments. Commercial real estate loans are subject to underwriting standards and processes similar to our commercial loans. These loans are underwritten primarily based on projected cash flows for income-producing properties and collateral values for non-income-producing properties. The repayment of these loans is generally dependent on the successful operation of the property securing the loans or the sale or refinancing of the property. Real estate loans may be adversely affected by conditions in the real estate markets or in the general economy. The properties securing our real estate portfolio are diversified by type and geographic location. This diversity helps reduce the exposure to adverse economic events that affect any single market or industry.
Commercial real estate loans increased $126.9 million, or 13.8%, to $1.05 billion as of September 30, 2023 from $919.4 million as of December 31, 2022. The increase was primarily driven by an increase of $60.7 million in multifamily property loans and growth of $56.2 million in other income-producing commercial real estate loans.
Commercial – General and Specialized. Commercial loans are underwritten after evaluating and understanding the borrower’s ability to operate profitably. Underwriting standards have been designed to determine whether the borrower possesses sound business ethics and practices, to evaluate current and projected cash flows to determine the ability of the borrower to repay their obligations as agreed, and to ensure appropriate collateral is obtained to secure the loan. Commercial loans are primarily made based on the identified cash flows of the borrower and, secondarily, on the underlying collateral provided by the borrower. Most commercial loans are secured by the assets being financed or other business assets, such as real estate, accounts receivable, or inventory, and typically include personal guarantees. Owner-occupied real estate is included in commercial loans, as the repayment of these loans is generally dependent on the operations of the commercial borrower’s business rather than on income-producing properties or the sale of the properties. Commercial loans are grouped into two distinct sub-categories: specialized and general. Commercial related loans that are considered “specialized” include agricultural production and real estate loans, energy loans, and finance, investment, and insurance loans. Commercial related loans that contain a broader diversity of borrowers, sub-industries, or serviced industries are grouped into the “general category.” These include goods, services, restaurant & retail, construction, and other industries. Performance of these loans is subject to operating and cash flow results of the borrower, with risk in the volatility of operating results for particular industries.
Commercial general loans increased $29.8 million, or 6.1%, to $514.6 million as of September 30, 2023 from $484.8 million as of December 31, 2022. The increase in commercial general loans was primarily due to organic loan growth in service-based commercial loans and more broadly throughout general commercial loans.
Commercial specialized loans increased $38.9 million, or 11.9%, to $366.4 million as of September 30, 2023 from $327.5 million as of December 31, 2022. This increase was primarily due to the funding of $36.3 million in seasonal agricultural production loans and growth of $22.7 million in direct energy loans, partially offset by a net reduction of $23.4 million in finance, investment, and insurance loans.
Consumer. We utilize a computer-based credit scoring analysis to supplement our policies and procedures in underwriting consumer loans. Our loan policy addresses types of consumer loans that may be originated and the collateral, if secured, which must be perfected. The relatively smaller individual dollar amounts of consumer loans that are spread over numerous individual borrowers also minimize our risk. Residential real estate loans are included in consumer loans. We generally require mortgage title insurance and hazard insurance on these residential real estate loans. All consumer loans are generally dependent on the risk characteristics of the borrower’s ability to repay the loan, a consideration of the debt to income ratio, employment and income stability, the loan-to-value ratio, and the age, condition and marketability of the collateral.
Consumer and other loans increased $65.0 million, or 7.5%, to $927.9 million as of September 30, 2023, from $862.9 million as of December 31, 2022. The increase in these loans was primarily a result of a $74.4 million increase in residential mortgage loans, partially offset by a $5.5 million decrease in consumer auto loans. As of September 30, 2023, our consumer loan portfolio was comprised of $534.5 million in 1-4 family residential loans, $316.0 million in auto loans, and $77.3 million in other consumer loans.
Construction. Loans for residential construction are for single-family properties to developers, builders, or end-users. These loans are underwritten based on estimates of costs and completed value of the project. Funds are advanced based on estimated percentage of completion for the project. Performance of these loans is affected by economic conditions as well as the ability to control costs of the projects.
Construction loans decreased $15.1 million, or 9.8%, to $138.5 million as of September 30, 2023 from $153.5 million as of December 31, 2022. The decrease resulted from contraction after higher demand for residential construction as a result of home shortages in many of our markets peaked in the first quarter of 2023 and the continued completion of projects.
Non-owner occupied office real estate loans are included in commercial real estate loans and totaled $130.6 million at September 30, 2023. Owner occupied office real estate loans are included in commercial loans and totaled $55.4 million at September 30, 2023.
We are a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of our customers. These financial instruments include commitments to extend credit and standby letters of credit. Those instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the Company’s Consolidated Balance Sheets. The Company’s exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit and standby letters of credit to our customers is represented by the contractual or notional amount of those instruments. Commitments to extend credit and standby letters of credit are not recorded as an asset or liability by the Company until the instrument is exercised. The contractual or notional amounts of those instruments reflect the extent of involvement we have in particular classes of financial instruments.
Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The Company uses the same credit policies in making commitments and conditional obligations as they do for on-balance sheet instruments. The amount and nature of collateral obtained, if deemed necessary by the Company upon extension of credit, is based on management’s credit evaluation of the potential borrower.
Standby letters of credit are conditional commitments issued by the Company to guarantee the performance of a customer to a third party. Those guarantees are primarily issued to support public and private short-term borrowing arrangements. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. The Company holds collateral supporting those commitments for which collateral is deemed necessary.
The following table summarizes commitments we have made as of the dates presented.
| | | September 30, 2023 | | | December 31, 2022 | |
| | | (Dollars in thousands) | |
| Commitments to grant loans and unfunded commitments under lines of credit | | $ | 669,931 | | | $ | 682,296 | |
| Standby letters of credit | | | 9,946 | | | | 13,864 | |
| Total | | $ | 679,877 | | | $ | 696,160 | |
Allowance for Credit Losses for Loans
The ACL provides a reserve against which loan losses are charged for current expected credit losses. Management evaluates the appropriate level of the ACL on a quarterly basis. The analysis takes into consideration the results of an ongoing loan review process, the purpose of which is to determine the level of credit risk within the portfolio and to ensure proper adherence to underwriting and documentation standards. Additional allowances are provided to those loans which appear to represent a greater than normal exposure to risk. The quality of the loan portfolio and the adequacy of the ACL is assessed by regulatory examinations and the Company’s internal and external loan reviews. The ACL consists of two elements: (1) specific valuation allowances established for expected losses on specifically analyzed loans and (2) collective valuation allowances calculated using comparable and quantifiable information from both internal and external sources about past events, including historical experience, current conditions, and reasonable and supportable forecasts that affect the collectability of the reported amount. Expected credit losses are estimated over the contractual term of the loans and adjusted for expected prepayments.
To determine the adequacy of the ACL on loans, the Company applied a dual credit risk rating (“DCRR”) methodology that estimates each loan’s probability of default and loss given default to calculate the expected credit loss to non-analyzed loans. The DCRR process quantifies the expected credit loss at the loan level for the entire loan portfolio. Loan grades are assigned by a customized scorecard that risk rates each loan based on multiple probability of default and loss given default elements to measure the risk of the loan portfolio. The ACL estimate incorporates the Company’s DCRR loan level risk rating methodology and the expected default rate frequency term structure to derive loan level life of loan estimates of credit losses for every loan in the portfolio. The estimated credit loss for each loan is adjusted based on one-year through the cycle estimate of expected credit loss to a life of loan measurement that reflects current conditions and forecasts. The life of loan expected loss is determined using the contractual weighted average life of the loan adjusted for prepayments. Prepayment speeds are determined by grouping the loans into pools based on segments and risk rating. After the life of loan expected losses are determined, they are adjusted to reflect the Company’s reasonable and supportable economic forecast over a selected range of a one to two years. The Company has developed regression models to project net charge-off rates based on macroeconomic variables (“MEVs”), typically a one-year period is used. MEV’s considered in the analysis consist of data gathered from the St. Louis Federal Reserve Research Database (“FRED”), such as, federal funds rate, 10-year treasury rates, 30-year mortgage rates, crude oil prices, consumer price index, housing price index, unemployment rates, housing starts, gross domestic product, and disposable personal income. These regression models are applied to the Company’s economic forecast to determine the corresponding net charge-off rates. The projected net charge-off rates for the given economic scenario are used to adjust the through the cycle expected losses. Qualitative adjustments are also made to ACL results for additional risk factors that are relevant in assessing the expected credit losses within our loan segments. These qualitative factor (“Q-Factor”) adjustments may increase or decrease management’s estimate of the ACL by a calculated percentage based upon the estimated level of risk within a particular segment. Q-Factor risk decisions consider concentrations of the loan portfolio, expected changes to the economic forecasts, large relationships, and other factors related to credit administration, such as borrower’s risk rating and the potential effect of delayed credit score migrations. Management quantifiably identifies segment percentage Q-Factor adjustments using a scorecard risk rating system scaled to historical loss experience within a segment and management’s perceived risk for that particular segment. In addition to the loan level evaluations, nonaccrual loans with a balance of $250 thousand or more are individually analyzed based on facts and circumstances of the loan to determine if a specific allowance amount may be necessary. Specific allowances may also be established for loans whose outstanding balances are below the above threshold when it is determined that the risk associated with the loan differs significantly from the risk factor amounts established for its loan category.
Effective January 1, 2023, we adopted the CECL model and recognized a cumulative effect adjustment to the ACL for loans and off-balance sheet credit exposures of $1.3 million. The CECL model requires recording life-of-loan projected losses in the loan portfolio based on future economic events and related loan portfolio credit performance. The prior accounting standard recorded reserves based on incurred losses at the balance sheet date.
The ACL for loans was $42.1 million at September 30, 2023, compared to $39.3 million at December 31, 2022, an increase of $2.8 million, or 7.1%. The increase is primarily a result of a provision for credit losses of $4.0 million being recorded during the nine months ended September 30, 2023 largely attributable to growth of $245.5 million in loans held for investment. Uncertainty regarding forecasted economic conditions remains, due to the continued rising interest rate environment and persistent high inflation levels in the United States, and provisions for credit losses may be necessary in future periods.
The following table provides an analysis of the ACL for loans during the periods indicated.
| | | Three Months Ended September 30, | | | Nine Months Ended September 30, | |
| | | 2023 | | | 2022 | | | 2023 | | | 2022 | |
| | | (Dollars in thousands) | |
| Average loans outstanding during the periods | | | | | | | | | | | | |
| Commercial real estate | | $ | 1,029,888 | | | $ | 839,930 | | | $ | 962,767 | | | $ | 796,146 | |
| Commercial – specialized | | | 365,258 | | | | 360,296 | | | | 342,355 | | | | 353,465 | |
| Commercial – general | | | 528,668 | | | | 475,383 | | | | 519,375 | | | | 475,056 | |
| Consumer: | | | | | | | | | | | | | | | | |
| 1-4 family residential | | | 528,835 | | | | 416,546 | | | | 503,878 | | | | 396,460 | |
| Auto loans | | | 316,895 | | | | 303,912 | | | | 319,617 | | | | 275,707 | |
| Other consumer | | | 78,787 | | | | 88,736 | | | | 79,912 | | | | 84,400 | |
| Construction | | | 139,761 | | | | 155,393 | | | | 143,970 | | | | 149,011 | |
| Loans held for sale | | | 17,607 | | | | 30,987 | | | | 21,013 | | | | 37,438 | |
| Total average loans outstanding during the periods | | $ | 3,005,699 | | | $ | 2,671,183 | | | $ | 2,892,887 | | | $ | 2,567,683 | |
| | | | | | | | | | | | | | | | | |
| Net charge-offs (recoveries) during the periods | | | | | | | | | | | | | | | | |
| Commercial real estate | | $ | — | | | $ | — | | | $ | — | | | $ | (418 | ) |
| Commercial – specialized | | | (59 | ) | | | (831 | ) | | | (139 | ) | | | (836 | ) |
| Commercial – general | | | 12 | | | | (135 | ) | | | 259 | | | | (76 | ) |
| Consumer: | | | | | | | | | | | | | | | | |
| 1-4 family residential | | | (1 | ) | | | 15 | | | | (4 | ) | | | 53 | |
| Auto loans | | | 111 | | | | 27 | | | | 437 | | | | 105 | |
| Other consumer | | | 299 | | | | 270 | | | | 550 | | | | 580 | |
| Construction | | | — | | | | — | | | | 272 | | | | 166 | |
| Total net charge-offs (recoveries) during the periods | | $ | 362 | | | $ | (654 | ) | | $ | 1,375 | | | $ | (426 | ) |
| | | | | | | | | | | | | | | | | |
| Ratio of net charge-offs (recoveries) to average loans during the periods | | | | | | | | | | | | | | | | |
| Commercial real estate | | | 0.00 | % | | | 0.00 | % | | | 0.00 | % | | | (0.05 | )% |
| Commercial – specialized | | | (0.02 | )% | | | (0.23 | )% | | | (0.04 | )% | | | (0.24 | )% |
| Commercial – general | | | 0.00 | % | | | (0.03 | )% | | | 0.05 | % | | | (0.02 | )% |
| Consumer: | | | | | | | | | | | | | | | | |
| 1-4 family residential | | | 0.00 | % | | | 0.00 | % | | | 0.00 | % | | | 0.01 | % |
| Auto loans | | | 0.04 | % | | | 0.01 | % | | | 0.14 | % | | | 0.04 | % |
| Other consumer | | | 0.38 | % | | | 0.30 | % | | | 0.69 | % | | | 0.69 | % |
| Construction | | | 0.00 | % | | | 0.00 | % | | | 0.19 | % | | | 0.11 | % |
| Total ratio of net charge-offs (recoveries) to average loans during the periods | | | 0.01 | % | | | (0.02 | )% | | | 0.05 | % | | | (0.02 | )% |
The following table provides other loan data as of the dates indicated.
| | | September 30, | | | December 31, | |
| | | 2023 | | | 2022 | |
| | | (Dollars in thousands) | |
| Total loans held for investment outstanding | | $ | 2,993,563 | | | $ | 2,748,081 | |
| Nonaccrual loans | | $ | 2,978 | | | $ | 5,802 | |
| Allowance for credit losses on loans | | $ | 42,075 | | | $ | 39,288 | |
| Ratio of allowance to total loans held for investment | | | 1.41 | % | | | 1.43 | % |
| Ratio of allowance to nonaccrual loans | | | 1,412.86 | % | | | 677.15 | % |
| Ratio of nonaccrual loans to total loans held for investment | | | 0.10 | % | | | 0.21 | % |
Net charge-offs (recoveries) totaled $362 thousand and were 0.05% (annualized) of average loans outstanding for the three months ended September 30, 2023, compared to $(654) thousand and (0.10)% (annualized) for the three months ended September 30, 2022. Net charge-offs totaled $1.4 million and were 0.06% (annualized) of average loans outstanding for the nine months ended September 30, 2023, compared to $(426) thousand and (0.02)% (annualized) for the nine months ended September 30, 2022. There was an $822 thousand recovery of a direct energy credit during the third quarter of 2022 that affected both of the period comparisons. There was also a $400 thousand recovery on a commercial tenant relationship in the second quarter of 2022 that affected the nine-month period comparison. The allowance for credit losses on loans as a percentage of loans held for investment was 1.41% at September 30, 2023 and 1.43% at December 31, 2022.
While the entire ACL for loans is available to absorb losses from any part of our loan portfolio, the following table sets forth the allocation of the ACL for loans for the periods presented and the percentage of allowance in each classification to total allowance:
| | | September 30, 2023 | | | December 31, 2022 | |
| | | Amount | | | % of Total | | | Amount | | | % of Total | |
| | | (Dollars in thousands) | |
| Commercial real estate | | $ | 14,945 | | | | 35.5 | % | | $ | 13,029 | | | | 33.1 | % |
| Commercial – specialized | | | 3,943 | | | | 9.4 | | | | 3,425 | | | | 8.7 | |
| Commercial – general | | | 6,370 | | | | 15.1 | | | | 9,215 | | | | 23.5 | |
| Consumer: | | | | | | | | | | | | | | | | |
| 1-4 family residential | | | 8,990 | | | | 21.4 | | | | 6,194 | | | | 15.8 | |
| Auto loans | | | 3,786 | | | | 9.0 | | | | 3,926 | | | | 10.0 | |
| Other consumer | | | 1,022 | | | | 2.4 | | | | 1,376 | | | | 3.5 | |
| Construction | | | 3,019 | | | | 7.2 | | | | 2,123 | | | | 5.4 | |
| Total allowance for credit losses | | $ | 42,075 | | | | 100.0 | % | | $ | 39,288 | | | | 100.0 | % |
Asset Quality
Loans are considered delinquent when principal or interest payments are past due 30 days or more. Delinquent loans may remain on accrual status between 30 days and 90 days past due. Loans on which the accrual of interest has been discontinued are designated as nonaccrual loans. Typically, the accrual of interest on loans is discontinued when principal or interest payments are past due 90 days or when, in the opinion of management, there is a reasonable doubt as to collectability in the normal course of business. When loans are placed on nonaccrual status, all interest previously accrued but not collected is reversed against current period interest income. Income on nonaccrual loans is subsequently recognized only to the extent that cash is received and the loan’s principal balance is deemed collectible. Loans are restored to accrual status when loans become well-secured and management believes full collectability of principal and interest is probable.
Loans that exhibit characteristics different from their pool characteristics are evaluated on an individual basis. Loans evaluated individually are not included in the collective ACL evaluation. Income from loans on nonaccrual status is recognized to the extent cash is received and when the loan’s principal balance is deemed collectible. Depending on a particular loan’s circumstances, we analyze loans for specific allowance based upon either the present value of expected future cash flows discounted at the loan’s effective interest rate, the loan’s observable market price, or the fair value of the collateral less estimated costs to sell if the loan is collateral dependent. A loan is considered collateral dependent when repayment of the loan is based solely on the liquidation of the collateral. Fair value, where possible, is determined by independent appraisals, typically on an annual basis. Between appraisal periods, the fair value may be adjusted based on specific events, such as if deterioration of quality of the collateral comes to our attention as part of our problem loan monitoring process, or if discussions with the borrower lead us to believe the last appraised value no longer reflects the actual market for the collateral. The specific allowance amount on a collateral-dependent loan is charged-off to the allowance if deemed not collectible and the impairment amount on a loan that is not collateral-dependent is set up as a specific reserve.
Real estate we acquire as a result of foreclosure or by deed-in-lieu of foreclosure is classified as other real estate owned (“OREO”) until sold and is initially recorded at fair value less costs to sell when acquired, establishing a new cost basis.
Nonperforming loans include nonaccrual loans and loans past due 90 days or more. Nonperforming assets consist of nonperforming loans plus OREO.
At September 30, 2023, our total nonaccrual loans were $3.0 million, or 0.10% of total loans held for investment, as compared to $5.8 million, or 0.21% of total loans held for investment, at December 31, 2022. These loans within this amount that exceeded $250 thousand were specifically analyzed and specific valuation allowances were established as necessary and included in the ACL for loans as of September 30, 2023 to cover any probable loss. One relationship totaling $13.3 million that was placed on nonaccrual during the second quarter of 2023 with a specific reserve of $1.3 million, was fully collected during the third quarter of 2023.
Nonperforming loans were $4.8 million at September 30, 2023 and $7.8 million at December 31, 2022. In addition to the $13.3 million collection noted above, there was a full repayment during the third quarter of 2023 of one relationship totaling $3.3 million that was nonperforming but still accruing.
Occasionally, the Company modifies loans to borrowers in financial distress by providing principal forgiveness, term extensions, an other than insignificant payment delay, or interest rate reduction. When principal forgiveness is provided, the amount of forgiveness is charged-off against the ACL for loans. Typically, one type of concession, such as term extension, is granted initially. If the borrower continues to experience financial difficulty, another concession, such as principal forgiveness, may be granted. In some cases, the Company provides multiple types of concessions on one loan. The Company closely monitors the performance of loans that are modified to borrowers experiencing financial difficulty to understand the effectiveness of its modification efforts. Upon the Company’s determination that a modified loan has subsequently been deemed to not be fully collectible, the uncollectible amount is written off. Therefore, the amortized cost basis of the loan is reduced by the uncollectible amount and the ACL for loans is adjusted by the same amount.
If a borrower on a restructured accruing loan has demonstrated performance under the previous terms, is not experiencing financial difficulty and shows the capacity to continue to perform under the restructured terms, the loan will remain on accrual status. Otherwise, the loan will be placed on nonaccrual status until the borrower demonstrates a sustained period of performance, which generally requires six consecutive months of payments.
Securities Portfolio
The securities portfolio is the second largest component of the Company’s interest-earning assets, and the structure and composition of this portfolio is important to an analysis of the financial condition of the Company. The securities portfolio serves the following purposes: (i) it provides a source of pledged assets for securing certain deposits and borrowed funds, as may be required by law or by specific agreement with a depositor or lender; (ii) it provides liquidity to even out cash flows from the loan and deposit activities of customers; (iii) it can be used as an interest rate risk management tool, since it provides a large base of assets, the maturity and interest rate characteristics of which can be changed more readily than the loan portfolio to better match changes in the deposit base and other funding sources of the Company; and (iv) it is an alternative interest-earning asset when loan demand is weak or when deposits grow more rapidly than loans.
The securities portfolio consists of securities classified as either held-to-maturity or available-for-sale. Securities consist primarily of state and municipal securities, mortgage-backed securities and U.S. government sponsored agency securities. We determine the appropriate classification at the time of purchase. All held-to-maturity securities are reported at amortized cost, adjusted for premiums and discounts that are recognized in interest income using the interest method over the period to maturity. All available-for-sale securities are reported at fair value.
Our securities portfolio decreased $116.7 million, or 16.6%, to $585.0 million at September 30, 2023, compared to $701.7 million at December 31, 2022. The decrease was primarily due to $84.8 million in sales, maturities, prepayments, and calls during the nine months ended September 30, 2023. The Company sold approximately $56.2 million of available for sale securities in the second quarter of 2023. This resulted in a loss on sale of $3.4 million. The average book yield of these securities was approximately 2.71%. The proceeds from the sale were used to help fund loan growth during that quarter.
Certain securities have fair values less than amortized cost and, therefore, contain unrealized losses. During the three months ended September 30, 2023, the fair value of the Company’s available for sale securities declined by $30.9 million. At September 30, 2023, the Company evaluated whether the decline in fair value has resulted from credit losses or other factors. Within this evaluation, management considers the extent to which fair value is less than amortized cost, any changes to the rating of the security by rating agency, and adverse conditions specifically related to the security, among other factors. Based on management’s evaluation no unrealized losses on securities were determined to be due to credit loss. Additionally, we anticipate full recovery of amortized cost with respect to these securities by maturity, or sooner in the event of a more favorable market interest rate environment. We do not intend to sell these securities and it is not probable that we will be required to sell them before recovery of the amortized cost basis, which may be at maturity, thus no losses have been recognized in the consolidated financial statements for securities in the portfolio.
The following table sets forth certain information regarding contractual maturities and the weighted average yields of our investment securities as of the date presented. Expected maturities may differ from contractual maturities if borrowers have the right to call or prepay an obligation with or without call or prepayment penalties.
| | | As of September 30, 2023 | |
| | | Due in One Year or Less | | | Due after One Year Through Five Years | | | Due after Five Years Through Ten Years | | | Due after Ten Years | |
| | | Amortized Cost | | | Weighted Average Yield | | | Amortized Cost | | | Weighted Average Yield | | | Amortized Cost | | | Weighted Average Yield | | | Amortized Cost | | | Weighted Average Yield | |
| | | (Dollars in thousands) | |
| Available-for-sale | | | | | | | | | | | | | | | | | | | | | | | | |
| State and municipal | | $ | 736 | | | | 3.65 | % | | $ | 6,143 | | | | 1.93 | % | | $ | 4,918 | | | | 2.15 | % | | $ | 191,636 | | | | 2.28 | % |
| Residential mortgage-backed securities | | | 14 | | | | 0.93 | | | | 3,344 | | | | 2.04 | | | | 973 | | | | 2.78 | | | | 354,074 | | | | 2.19 | |
| Commercial mortgage-backed securities | | | — | | | | — | | | | — | | | | — | | | | 48,219 | | | | 2.22 | | | | — | | | | — | |
| Commercial collateralized mortgage obligations | | | — | | | | — | | | | — | | | | — | | | | 72,612 | | | | 5.98 | | | | — | | | | — | |
| Asset-backed and other amortizing securities | | | — | | | | — | | | | — | | | | — | | | | 2,393 | | | | 3.07 | | | | 16,648 | | | | 2.78 | |
| Other securities | | | — | | | | — | | | | — | | | | — | | | | 12,000 | | | | 4.47 | | | | — | | | | — | |
| Total available-for-sale | | $ | 750 | | | | 3.60 | % | | $ | 9,487 | | | | 1.97 | % | | $ | 141,115 | | | | 4.36 | % | | $ | 562,358 | | | | 2.24 | % |
| | | As of December 31, 2022 | |
| | | Due in One Year or Less | | | Due after One Year Through Five Years | | | Due after Five Years Through Ten Years | | | Due after Ten Years | |
| | | Amortized Cost | | | Weighted Average Yield | | | Amortized Cost | | | Weighted Average Yield | | | Amortized Cost | | | Weighted Average Yield | | | Amortized Cost | | | Weighted Average Yield | |
| | | (Dollars in thousands) | |
| Available-for-sale | | | | | | | | | | | | | | | | | | | | | | | | |
| State and municipal | | $ | 1,898 | | | | 3.43 | % | | $ | 8,663 | | | | 2.17 | % | | $ | 7,508 | | | | 2.22 | % | | $ | 241,360 | | | | 2.24 | % |
| Residential mortgage-backed securities | | | 3 | | | | 1.90 | % | | | 3,037 | | | | 1.88 | | | | 3,993 | | | | 2.37 | | | | 379,750 | | | | 2.22 | |
| Commercial mortgage-backed securities | | | — | | | | — | | | | — | | | | — | | | | 49,161 | | | | 2.21 | | | | — | | | | — | |
| Commercial collateralized mortgage obligations | | | — | | | | — | | | | — | | | | — | | | | 76,189 | | | | 4.89 | | | | — | | | | — | |
| Asset-backed and other amortizing securities | | | — | | | | — | | | | — | | | | — | | | | 1,689 | | | | 2.93 | | | | 19,218 | | | | 2.81 | |
| Other securities | | | — | | | | — | | | | — | | | | — | | | | 12,000 | | | | 4.47 | | | | — | | | | — | |
| Total available-for-sale | | $ | 1,901 | | | | 3.43 | % | | $ | 11,700 | | | | 2.09 | % | | $ | 150,540 | | | | 3.76 | % | | $ | 640,328 | | | | 2.24 | % |
Deposits
Deposits represent the Company’s primary and most vital source of funds. We offer a variety of deposit products including demand deposits accounts, interest-bearing products, savings accounts and certificate of deposits. We put continued effort into gathering noninterest-bearing demand deposit accounts through loan production, customer referrals, marketing staffs, mobile and online banking and various involvements with community networks.
Total deposits at September 30, 2023 were $3.62 billion, representing an increase of $214.2 million, or 6.3%, compared to $3.41 billion at December 31, 2022. The increase in total deposits since December 31, 2022 was largely in brokered deposits, which grew $152 million, and in public fund deposits, which grew approximately $31 million. As of September 30, 2023, 28.9% of total deposits were comprised of noninterest-bearing demand accounts, 61.4% of interest-bearing non-maturity accounts and 9.7% of time deposits.
The following table shows the deposit mix as of the dates presented:
| | | September 30, 2023 | | | December 31, 2022 | |
| | | Amount | | | % of Total | | | Amount | | | % of Total | |
| | | (Dollars in thousands) | |
Noninterest-bearing deposits | | $ | 1,046,253 | | | | 28.9 | % | | $ | 1,150,488 | | | | 33.8 | % |
NOW and other transaction accounts | | | 499,344 | | | | 13.8 | | | | 350,910 | | | | 10.3 | |
Money market and other savings | | | 1,724,457 | | | | 47.6 | | | | 1,618,833 | | | | 47.5 | |
Time deposits | | | 350,560 | | | | 9.7 | | | | 286,199 | | | | 8.4 | |
| Total deposits | | $ | 3,620,614 | | | | 100.0 | % | | $ | 3,406,430 | | | | 100.0 | % |
Average deposit balances and weighted average rates paid on deposits, on an annualized basis, for the periods indicated are shown below.
| | | Three Months Ended September 30, | |
| | | 2023 | | | 2022 | |
| | | Average Balance | | | Weighted Average Rate | | | Average Balance | | | Weighted Average Rate | |
| | | (Dollars in thousands) | |
| Noninterest-bearing deposits | | $ | 1,071,175 | | | | 0.00 | % | | $ | 1,248,804 | | | | 0.00 | % |
| Interest-bearing deposits: | | | | | | | | | | | | | | | | |
| NOW and interest-bearing demand accounts | | | 472,180 | | | | 3.51 | % | | | 345,048 | | | | 0.62 | % |
| Savings accounts | | | 143,919 | | | | 0.92 | % | | | 153,848 | | | | 0.34 | % |
| Money market accounts | | | 1,606,915 | | | | 2.85 | % | | | 1,374,890 | | | | 0.82 | % |
| Time deposits | | | 344,395 | | | | 3.35 | % | | | 330,133 | | | | 1.23 | % |
| Total interest-bearing deposits | | | 2,567,409 | | | | 2.93 | % | | | 2,203,919 | | | | 0.70 | % |
| Total deposits | | $ | 3,638,584 | | | | 2.07 | % | | $ | 3,452,723 | | | | 0.52 | % |
| | | Nine Months Ended September 30, | |
| | | 2023 | | | 2022 | |
| | | Average Balance | | | Weighted Average Rate | | | Average Balance | | | Weighted Average Rate | |
| | | (Dollars in thousands) | |
| Noninterest-bearing deposits | | $ | 1,085,345 | | | | 0.00 | % | | $ | 1,174,783 | | | | 0.00 | % |
| Interest-bearing deposits: | | | | | | | | | | | | | | | | |
| NOW and interest-bearing demand accounts | | | 371,526 | | | | 2.62 | % | | | 357,547 | | | | 0.31 | % |
| Savings accounts | | | 147,802 | | | | 0.86 | % | | | 150,133 | | | | 0.18 | % |
| Money market accounts | | | 1,570,922 | | | | 2.58 | % | | | 1,397,321 | | | | 0.45 | % |
| Time deposits | | | 309,250 | | | | 2.70 | % | | | 334,686 | | | | 1.18 | % |
| Total interest-bearing deposits | | | 2,399,500 | | | | 2.49 | % | | | 2,239,687 | | | | 0.52 | % |
| Total deposits | | $ | 3,484,845 | | | | 1.72 | % | | $ | 3,414,470 | | | | 0.34 | % |
The scheduled maturities of uninsured certificates of deposits or other time deposits as of September 30, 2023 follows:
| (Dollars in thousands) | | Three Months | | | Three to Six Months | | | Six to 12 Months | | | After 12 Months | | | Total | |
| | | $ | 9,515 | | | $ | 39,076 | | | $ | 18,394 | | | $ | 10,908 | | | $ | 77,893 | |
The estimated amount of uninsured and uncollateralized deposits as of September 30, 2023 was $590.1 million. This represented approximately 16% of total deposits and excludes $336.1 million of collateralized public fund deposits.
Time deposits in amounts of more than $250 thousand represent the type of deposit most likely to affect the Company’s future earnings because of interest rate sensitivity. The effective cost of these funds is generally higher than other time deposits because the funds are usually obtained at premium rates of interest. Time deposits in amounts of more than $250 thousand totaled $143.1 million at September 30, 2023.
Borrowed Funds
In addition to deposits, we may utilize advances from the FHLB and other borrowings as a supplementary funding source to finance our operations.
FHLB Advances. The FHLB allows us to borrow, both short and long-term, on a blanket floating lien status collateralized by first mortgage loans and commercial real estate loans as well as FHLB stock. At September 30, 2023 and December 31, 2022, we had total available borrowing capacity from the FHLB of $1.09 billion and $920.2 million, respectively.
We had no FHLB borrowings during the nine months ended September 30, 2023 or 2022.
Federal Reserve Bank of Dallas. The Bank has a line of credit with the Federal Reserve Bank of Dallas (the “FRB”). The amount of the line is determined on a monthly basis by the FRB. The line is collateralized by a blanket floating lien on all agriculture, commercial and consumer loans. The amount of the line was $612.4 million and $648.3 million at September 30, 2023 and December 31, 2022, respectively.
We had no long-term FRB borrowings during the nine months ended September 30, 2023 or 2022.
In addition, we have access to the FRB’s BTFP. As of September 30, 2023, the Company has not pledged any securities for the BTFP but has approximately $179 million of available securities that can be used as collateral for additional borrowings through the program.
Lines of Credit. The Bank has uncollateralized lines of credit with multiple banks as a source of funding for liquidity management. The total amount of the lines was $140.0 million and $160.0 million as of September 30, 2023 and December 31, 2022, respectively. The lines of credit were not used, other than testing, during the three or nine months ended September 30, 2023 or the three or nine months ended September 30, 2022.
Subordinated Debt. In December 2018, the Company issued $26.5 million in subordinated notes. Notes totaling $12.4 million have a maturity date of December 2028 and an average fixed rate of 5.74% for the first five years. The remaining $14.1 million of notes have a maturity date of December 2030 and an average fixed rate of 6.41% for the first seven years. After the fixed rate periods, all notes will float at the Wall Street Journal prime rate, with a floor of 4.0% and a ceiling of 7.5%. These notes pay interest quarterly, are unsecured, and may be called by the Company at any time after the remaining maturity is five years or less. Additionally, these notes are intended to qualify for Tier 2 capital treatment, subject to regulatory limitations.
On September 29, 2020, the Company issued $50.0 million in subordinated notes. Proceeds were reduced by approximately $926 thousand in debt issuance costs. The notes have a maturity date of September 2030 with a fixed rate of 4.50% for the first five years. After the expiration of the fixed rate period, the notes will reset quarterly at a variable rate equal to the then current three-month Secured Overnight Financing Rate, as published by the Federal Reserve Bank of New York, plus 438 basis points. These notes pay interest semi-annually, are unsecured, and may be called by the Company at any time after the remaining maturity is five years or less. Additionally, these notes are intended to qualify for Tier 2 capital treatment, subject to regulatory limitations.
As of September 30, 2023, the total amount of subordinated debt outstanding was $76.5 million less approximately $372 thousand of remaining debt issuance costs for a total balance of $76.1 million.
Junior Subordinated Deferrable Interest Debentures and Trust Preferred Securities. Between March 2004 and June 2007, the Company formed three wholly-owned statutory business trusts solely for the purpose of issuing trust preferred securities, the proceeds of which were invested in junior subordinated deferrable interest debentures. The trusts are not consolidated and the debentures issued by the Company to the trusts are reflected in the Consolidated Balance Sheets. The Company records interest expense on the debentures in its consolidated financial statements. The amount of debentures outstanding was $46.4 million at September 30, 2023 and December 31, 2022. The Company has the right, as has been exercised in the past, to defer payments of interest on the securities for up to twenty consecutive quarters. During such time, corporate dividends may not be paid. The Company is current in its interest payments on the debentures.
The chart below indicates certain information, as of September 30, 2023, about each of the statutory trusts and the junior subordinated deferrable interest debentures, including the date the junior subordinated deferrable interest debentures were issued, outstanding amounts of trust preferred securities and junior subordinated deferrable interest debentures, the maturity date of the junior subordinated deferrable interest debentures, and the interest rates on the junior subordinated deferrable interest debentures.
| Name of Trust | | Issue Date | | Amount of Trust Preferred Securities | | | Amount of Debentures | | | Stated Maturity Date of Trust Preferred Securities and Debentures(1) | | Interest Rate of Trust Preferred Securities and Debentures(2)(3) |
| | | (Dollars in thousands) |
| South Plains Financial Capital Trust III | | 2004 | | $ | 10,000 | | | $ | 10,310 | | | | 2034 | | 3-mo CME Term SOFR + 291 bps; 8.26% |
| South Plains Financial Capital Trust IV | | 2005 | | | 20,000 | | | | 20,619 | | | | 2035 | | 3-mo CME Term SOFR + 165 bps; 7.06% |
| South Plains Financial Capital Trust V | | 2007 | | | 15,000 | | | | 15,464 | | | | 2037 | | 3-mo CME Term SOFR + 176 bps; 7.17% |
| Total | | | | $ | 45,000 | | | $ | 46,393 | | | | | | |
| (1) | May be redeemed at the Company’s option. |
| (2) | Interest payable quarterly with principal due at maturity. |
| (3) | Rate as of last reset date, prior to September 30, 2023. |
Liquidity and Capital Resources
Liquidity
Liquidity refers to the measure of our ability to meet the cash flow requirements of depositors and borrowers, while at the same time meeting our operating, capital and strategic cash flow needs, all at a reasonable cost. We continuously monitor our liquidity position to ensure that assets and liabilities are managed in a manner that will meet all short-term and long-term cash requirements. We manage our liquidity position to meet the daily cash flow needs of customers, while maintaining an appropriate balance between assets and liabilities to meet the return on investment objectives of our shareholders.
Our liquidity position is supported by management of liquid assets and access to alternative sources of funds. Our liquid assets include cash, interest-bearing deposits in correspondent banks, federal funds sold, and fair value of unpledged investment securities. Other available sources of liquidity include wholesale deposits, and additional borrowings from correspondent banks, FHLB advances, and the Federal Reserve discount window. At September 30, 2023, the Bank had the capacity to borrow additional funds from the FHLB and Federal Reserve discount window of up to approximately $1.09 billion and $612.4 million, respectively.
Our short-term and long-term liquidity requirements are primarily met through cash flow from operations, redeployment of prepaying and maturing balances in our loan and investment portfolios, and increases in customer deposits. Other alternative sources of funds will supplement these primary sources to the extent necessary to meet additional liquidity requirements on either a short-term or long-term basis.
Management believes that the Company has adequate liquidity to meet its obligations. However, if general economic conditions, potential recession in the United States and our market areas, the impacts related to or resulting from recent bank failures and any continuation of the recent uncertainty in the banking industry, including the associated impact to the Company and other financial institutions of any regulatory changes or other mitigation efforts taken by government agencies in response thereto, increased competition for deposits and related changes in deposit customer behavior, changes in market interest rates, the persistence of the current inflationary environment in the United States and our market areas, or other events, cause these sources of external funding to become restricted or are eliminated, the Company may not be able to raise adequate funds or may incur substantially higher funding costs or operating restrictions in order to raise the necessary funds to support the Company’s operations and growth.
Capital
Total stockholders’ equity increased to $371.7 million as of September 30, 2023, compared to $357.0 million as of December 31, 2022, an increase of $14.7 million, or 4.1%. The increase from December 31, 2022 was primarily the result of $52.4 million in net earnings for the nine months ended September 30, 2023, partially offset by a decrease in accumulated other comprehensive income (“AOCI”) of $19.5 million, net of tax, repurchases of common stock of $11.9 million, and $6.6 million of dividends paid. The decrease in AOCI was attributed to the decrease in fair value of our available for sale securities and fair value hedges, net of tax, as a result of the continued rising interest rate environment experienced during the period.
We are subject to various regulatory capital requirements administered by the federal and state banking regulators. Failure to meet regulatory capital requirements may result in certain mandatory and possible additional discretionary actions by regulators that, if undertaken, could have a direct material effect on our financial statements. Under capital adequacy guidelines and the regulatory framework for “prompt corrective action” (described below), we must meet specific capital guidelines that involve quantitative measures of our assets, liabilities and certain off-balance sheet items as calculated under regulatory accounting policies. The capital amounts and classifications are subject to qualitative judgments by the federal banking regulators about components, risk weightings and other factors. Qualitative measures established by regulation to ensure capital adequacy required us to maintain minimum amounts and ratio of common equity tier 1 (“CET1”) capital, tier 1 capital and total capital to risk-weighted assets and of tier 1 capital to average consolidated assets, referred to as the “leverage ratio.”
The risk-based capital ratios measure the adequacy of a bank’s capital against the riskiness of its assets and off-balance sheet activities. Failure to maintain adequate capital is a basis for “prompt corrective action” or other regulatory enforcement action. In assessing a bank’s capital adequacy, regulators also consider other factors such as interest rate risk exposure; liquidity, funding and market risks; quality and level of earnings; concentrations of credit, quality of loans and investments; risks of any nontraditional activities; effectiveness of bank policies; and management’s overall ability to monitor and control risks.
At September 30, 2023 and December 31, 2022, the Company met the definition of “well-capitalized” under the applicable regulations of the Board of Governors of the Federal Reserve System and the Bank was “well capitalized” under the FDIC’s regulatory framework for prompt corrective action and the Basel III capital guidelines. Management believes that no conditions or events have occurred since September 30, 2023 that would materially adversely change such capital classifications. From time to time, we may need to raise additional capital to support our and the Bank’s further growth and to maintain our “well capitalized” status.
The following table presents our and the Bank’s regulatory capital ratios as of the dates indicated.
| | | September 30, 2023 | | | December 31, 2022 | |
| | | Amount | | | Ratio | | | Amount | | | Ratio | |
| | | (Dollars in thousands) | |
South Plains Financial, Inc.: | | | | | | | | | | | | |
| Total capital (to risk-weighted assets) | | $ | 599,238 | | | | 16.82 | % | | $ | 559,094 | | | | 16.58 | % |
| Tier 1 capital (to risk-weighted assets) | | | 479,373 | | | | 13.46 | | | | 443,265 | | | | 13.15 | |
| CET 1 capital (to risk-weighted assets) | | | 434,373 | | | | 12.19 | | | | 398,265 | | | | 11.81 | |
| Tier 1 capital (to average assets) | | | 479,373 | | | | 11.13 | | | | 443,265 | | | | 11.03 | |
| | | | | | | | | | | | | | | | | |
| City Bank: | | | | | | | | | | | | | | | | |
| Total capital (to risk-weighted assets) | | $ | 502,003 | | | | 14.10 | % | | $ | 454,427 | | | | 13.48 | % |
| Tier 1 capital (to risk-weighted assets) | | | 458,239 | | | | 12.87 | | | | 414,559 | | | | 12.30 | |
| CET 1 capital (to risk-weighted assets) | | | 458,239 | | | | 12.87 | | | | 414,559 | | | | 12.30 | |
| Tier 1 capital (to average assets) | | | 458,239 | | | | 10.65 | | | | 414,559 | | | | 10.32 | |
Community Bank Leverage Ratio
On September 17, 2019, the federal banking agencies jointly finalized a rule to be effective January 1, 2020 and intended to simplify the regulatory capital requirements described above for qualifying community banking organizations that opt into the Community Bank Leverage Ratio (“CBLR”) framework, as required by Section 201 of the EGRRCPA. The final rule became effective on January 1, 2020, and the CBLR framework became available for banks to use beginning with their March 31, 2020 Call Reports. Under the final rule, if a qualifying community banking organization opts into the CBLR framework and meets all requirements under the framework, it will be considered to have met the well-capitalized ratio requirements under the “prompt corrective action” regulations described above and will not be required to report or calculate risk-based capital. In order to qualify for the CBLR framework, a community banking organization must have a tier 1 leverage ratio of greater than 9%, less than $10 billion in total consolidated assets, and limited amounts of off-balance sheet exposures and trading assets and liabilities. Although the Company and the Bank are qualifying community banking organizations, the Company and the Bank have elected not to opt in to the CBLR framework at this time and will continue to follow the Basel III capital requirements as described above.
Treasury Stock
The Company repurchased stock in accordance with its previously-announced stock repurchase program during the three and nine months ended September 30, 2023. For the three months ended September 30, 2023, we repurchased 354,521 shares of common stock for a total of $9.3 million. For the nine months ended September 30, 2023, we repurchased 467,475 share of common stock for a total of $11.9 million. These shares were retired immediately upon repurchase by the Company and not included in treasury stock. See Part II, Item 2, “Unregistered Sales of Equity Securities and Use of Proceeds,” of this Form 10-Q for further information.
Interest Rate Sensitivity and Market Risk
As a financial institution, our primary component of market risk is interest rate volatility. Our interest rate risk policy provides management with the guidelines for effective funds management, and we have established a measurement system for monitoring our net interest rate sensitivity position. We have historically managed our sensitivity position within our established guidelines.
Interest rate sensitivity involves the relationships between rate-sensitive assets and liabilities and is an indication of the probable effects of interest rate fluctuations on the Company’s net interest income. Interest rate-sensitive assets and liabilities are those with yields or rates that are subject to change within a future time period due to maturity or changes in market rates. The model is used to project future net interest income under a set of possible interest rate movements. The Company’s Investment/Asset Liability Committee (“ALCO Committee”) reviews this information to determine compliance with the limits set by the Bank’s board of directors.
Fluctuations in interest rates will ultimately impact both the level of income and expense recorded on most of our assets and liabilities, and the market value of all interest-earning assets and interest-bearing liabilities, other than those which have a short term to maturity. Interest rate risk is the potential of economic losses due to future interest rate changes. These economic losses can be reflected as a loss of future net interest income and/or a loss of current fair market values. The objective is to measure the effect on net interest income and to adjust the balance sheet to minimize the inherent risk while at the same time maximizing income.
We manage our exposure to interest rates by structuring our balance sheet in the ordinary course of business. Based upon the nature of our operations, we are not subject to foreign exchange or commodity price risk. We do not own any trading assets.
Our exposure to interest rate risk is managed by the ALCO Committee, in accordance with policies approved by the Bank’s board of directors. The ALCO Committee formulates strategies based on appropriate levels of interest rate risk. In determining the appropriate level of interest rate risk, the ALCO Committee considers the impact on earnings and capital on the current outlook on interest rates, potential changes in interest rates, regional economies, liquidity, business strategies and other factors. The ALCO Committee meets regularly to review, among other things, the sensitivity of assets and liabilities to interest rate changes, the book and market values of assets and liabilities, commitments to originate loans and the maturities of investments and borrowings. Additionally, the ALCO Committee reviews liquidity, cash flow flexibility, maturities of deposits and consumer and commercial deposit activity. Management employs methodologies to manage interest rate risk, which include an analysis of relationships between interest-earning assets and interest-bearing liabilities and an interest rate shock simulation model.
We use interest rate risk simulation models and shock analyses to test the interest rate sensitivity of net interest income and fair value of equity, and the impact of changes in interest rates on other financial metrics. Contractual maturities and re-pricing opportunities of loans are incorporated in the model. The average lives of non-maturity deposit accounts are based on decay assumptions and are incorporated into the model. All of the assumptions used in our analyses are inherently uncertain and, as a result, the model cannot precisely measure future net interest income or precisely predict the impact of fluctuations in market interest rates on net interest income. Actual results will differ from the model’s simulated results due to timing, magnitude and frequency of interest rate changes as well as changes in market conditions and the application and timing of various management strategies.
On a quarterly basis, we run a simulation model for a static balance sheet and other scenarios. These models test the impact on net interest income from changes in market interest rates under various scenarios. Under the static model, rates are shocked instantaneously and ramped rates change over a 12-month and 24-month horizon based upon parallel and non-parallel yield curve shifts. Parallel shock scenarios assume instantaneous parallel movements in the yield curve compared to a flat yield curve scenario. Non-parallel simulation involves analysis of interest income and expense under various changes in the shape of the yield curve. Our internal policy regarding internal rate risk simulations currently specifies that for gradual parallel shifts of the yield curve, estimated net interest income at risk for the subsequent one-year period should not decline by more than 7.5% for a 100 basis point shift, 15% for a 200 basis point shift, and 22.5% for a 300 basis point shift.
The following tables summarize the simulated change in net interest income over a 12-month horizon as of the dates indicated:
| | | | September 30, 2023 | | | December 31, 2022 | |
| Change in Interest Rates (Basis Points) | | | Percent Change in Net Interest Income | | | Percent Change in Net Interest Income | |
| +300 | | | | (8.09 | )% | | | (1.50 | )% |
| +200 | | | | (5.33 | )% | | | (0.96 | )% |
| +100 | | | | (2.59 | )% | | | (0.61 | )% |
| -100 | | | | 2.73 | % | | | (1.50 | )% |
| -200 | | | | 5.55 | % | | | (2.81 | )% |
Impact of Inflation
Our consolidated financial statements and related notes included elsewhere in this Form 10-Q have been prepared in accordance with U.S. generally accepted accounting principles (“GAAP”). GAAP requires the measurement of financial position and operating results in terms of historical dollars, without considering changes in the relative value of money over time due to inflation or recession.
The Company’s asset and liability structure is substantially different from that of an industrial company in that virtually all assets and liabilities of the Company are monetary in nature. Management believes the impact of inflation on financial results depends upon the Company’s ability to react to changes in interest rates and by such reaction, reduce the inflationary impact on performance. Interest rates do not necessarily move in the same direction, or at the same magnitude, as the prices of other goods and services. However, other operating expenses do reflect general levels of inflation. Management seeks to manage the relationship between interest rate-sensitive assets and liabilities in order to protect against wide net interest income fluctuations, including those resulting from inflation.
Various information shown elsewhere in this Report will assist in the understanding of how well the Company is positioned to react to changing interest rates and inflationary trends. In particular, additional information related to the Company’s interest rate-sensitive assets and liabilities is contained in this Item 2, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” of this Report under the heading “Interest Rate Sensitivity and Market Risk.”
Non-GAAP Financial Measures
Our accounting and reporting policies conform to GAAP and the prevailing practices in the banking industry. However, we also evaluate our performance based on certain additional financial measures discussed in this Report as being non-GAAP financial measures. 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 U.S. in our statements of comprehensive income (loss), balance sheets 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 Report 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 Report may differ from that of other companies reporting measures with similar names. It is important to understand how other banking organizations calculate their financial measures with names similar to the non-GAAP financial measures we have discussed in this Report when comparing such non-GAAP financial measures.
Tangible Book Value Per Common Share. Tangible book value per share is a non-GAAP measure generally used by investors, financial analysts and investment bankers to evaluate financial institutions. The most directly comparable GAAP financial measure for tangible book value per common share is book value per common share. We believe that the tangible book value per common share measure is important to many investors in the marketplace who are interested in changes from period to period in book value per common share exclusive of changes in intangible assets. Goodwill and other intangible assets have the effect of increasing total book value while not increasing our tangible book value.
Tangible Common Equity to Tangible Assets. Tangible common equity to tangible assets is a non-GAAP measure generally used by investors, financial analysts and investment bankers to evaluate financial institutions. We calculate tangible common equity, as described above, and tangible assets as total assets less goodwill, core deposit intangibles and other intangible assets, net of accumulated amortization. The most directly comparable GAAP financial measure for tangible common equity to tangible assets is total common stockholders’ equity to total assets. We believe that this measure is important to many investors in the marketplace who are interested in the relative changes from period to period of tangible common equity to tangible assets, each exclusive of changes in intangible assets. Goodwill and other intangible assets have the effect of increasing both total stockholders’ equity and assets while not increasing our tangible common equity or tangible assets.
The following table reconciles, as of the dates set forth below, total stockholders’ equity to tangible common equity and total assets to tangible assets and then presents book value per common share, tangible book value per common share, total stockholders’ equity to total assets, and tangible common equity to tangible assets:
| | | September 30, 2023 | | | December 31, 2022 | |
| | | (Dollars in thousands) | |
| Total stockholders’ equity | | $ | 371,716 | | | $ | 357,014 | |
| Less: Goodwill and other intangibles | | | (21,936 | ) | | | (23,857 | ) |
| Tangible common equity | | $ | 349,780 | | | $ | 333,157 | |
| | | | | | | | | |
| Total assets | | $ | 4,186,440 | | | $ | 3,944,063 | |
| Less: Goodwill and other intangibles | | | (21,936 | ) | | | (23,857 | ) |
| Tangible assets | | $ | 4,164,504 | | | $ | 3,920,206 | |
| | | | | | | | | |
| Shares outstanding | | | 16,600,442 | | | | 17,027,197 | |
| | | | | | | | | |
| Total stockholders’ equity to total assets | | | 8.88 | % | | | 9.05 | % |
| Tangible common equity to tangible assets | | | 8.40 | % | | | 8.50 | % |
| Book value per share | | $ | 22.39 | | | $ | 20.97 | |
| Tangible book value per share | | $ | 21.07 | | | $ | 19.57 | |
Critical Accounting Policies and Estimates
Our accounting and reporting policies conform to GAAP and conform to general practices within the industry in which we operate. To prepare financial statements in conformity with GAAP, management makes estimates, assumptions and judgments based on available information. These estimates, assumptions and judgments affect the amounts reported in the consolidated financial statements and accompanying notes. These estimates, assumptions and judgments are based on information available as of the date of the consolidated financial statements and, as this information changes, actual results could differ from the estimates, assumptions and judgments reflected in the consolidated financial statements. In particular, management has identified several accounting policies that, due to the estimates, assumptions and judgments inherent in those policies, are critical in understanding our consolidated financial statements.
The Jumpstart Our Business Startups Act (the “JOBS Act”) permits us an extended transition period for complying with new or revised accounting standards affecting public companies. We have elected to take advantage of this extended transition period, which means that the consolidated financial statements included in this Form 10-Q, as well as any financial statements that we file in the future, will not be subject to all new or revised accounting standards generally applicable to public companies for the transition period for so long as we remain an emerging growth company or until we affirmatively and irrevocably opt out of the extended transition period under the JOBS Act.
The following is a discussion of the critical accounting policies and significant estimates that we believe require us to make the most complex or subjective decisions or assessments. Additional information about these policies can be found in Note 1 of the 2022 Annual Report on Form 10-K or the Company’s consolidated financial statements as of September 30, 2023.
Securities. Investment securities may be classified into trading, held-to-maturity, or available-for-sale portfolios. Securities that are held principally for resale in the near term are classified as trading. Securities that management has the ability and positive intent to hold to maturity are classified as held-to-maturity and recorded at amortized cost. Securities not classified as trading or held-to-maturity are available-for-sale and are reported at fair value with unrealized gains and losses excluded from earnings, but included in the determination of other comprehensive income (loss). Management uses these assets as part of its asset/liability management strategy; they may be sold in response to changes in liquidity needs, interest rates, resultant prepayment risk changes, and other factors. Management determines the appropriate classification of securities at the time of purchase. Purchase premiums and discounts are recognized in interest income using the interest method over the terms of the securities. The cost of securities sold is based on the specific identification method.
Loans. Loans that management has the intent and ability to hold for the foreseeable future or until maturity or payoff are reported at their outstanding principal balances net of any unearned income, charge-offs, unamortized deferred fees and costs on originated loans, and premiums or discounts on purchased loans. Interest income is accrued on the unpaid principal balance. Loan origination fees, net of certain direct origination costs, are deferred and recognized as an adjustment of the related loan yield using the straight-line method, which is not materially different from the effective interest method required by GAAP.
Loans are placed on non-accrual status when, in management’s opinion, collection of interest is unlikely, which typically occurs when principal or interest payments are more than ninety days past due. When interest accrual is discontinued, all unpaid accrued interest is reversed against interest income. The interest on these loans is accounted for on the cash-basis or cost-recovery method, until qualifying for return to accrual. Loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured.
Allowance for Credit Losses. The ACL for loans is established for future expected credit losses through a provision for credit losses charged to earnings. Expected losses are calculated using comparable and quantifiable information both internal and external about past events, including historical experience, current conditions, and reasonable and supportable forecasts that affect the collectability of the reported amount. Expected credit losses are estimated over the contractual term of the loans and adjusted for expected prepayments when appropriate. Loan losses are charged against the allowance when management believes the uncollectibility of a loan balance is confirmed. Subsequent recoveries, if any, are credited to the allowance. The Company’s ACL for loans consists of specific valuation allowances established for probable losses on specifically analyzed loans and collective valuation allowances calculated using comparable and quantifiable information both internal and external about past events, including historical experience, current conditions, and reasonable and supportable forecasts that affect the collectability of the reported amount.
The ACL for loans is evaluated on a quarterly basis by management and is based upon management’s review of the collectability of the loans in light of historical experience, the nature and volume of the loan portfolio, adverse situations that may affect the borrower’s ability to repay, estimated value of any underlying collateral, and prevailing economic conditions. This evaluation is inherently subjective, as it requires estimates that are susceptible to significant revision as more information becomes available. The determination of the adequacy of the ACL for loans is based on estimates that are particularly susceptible to significant changes in the economic environment and market conditions. In connection with the determination of the estimated losses on loans, management obtains independent appraisals for significant collateral. The Bank’s loans are generally secured by specific items of collateral including real property, crops, livestock, consumer assets, and other business assets.
While management uses available information to recognize losses on loans, further reductions in the carrying amounts of loans may be necessary based on various factors. In addition, regulatory agencies, as an integral part of their examination process, periodically review the estimated losses on loans. Such agencies may require the Bank to recognize additional losses based on their judgments about information available to them at the time of their examination. Because of these factors, it is reasonably possible that the estimated losses on loans may change materially in the near term. However, the amount of the change that is reasonably possible cannot be estimated.
Loans that exhibit characteristics different from their pool characteristics are evaluated on an individual basis. Loans evaluated individually are not included in the collective ACL for loans evaluation. Certain of these loans are considered to be collateral dependent with the borrower experiencing financial difficulty. For these loans, the fair value of collateral practical expedient is elected whereby the allowance is calculated as the amount by which the amortized cost exceeds the fair value of collateral, less costs to sell. All non-accrual loans $250 thousand or greater are analyzed for a specific ACL.
Prior to the adoption of the CECL model, the ACL for loans was established through a provision for loan losses charged to expense, which represented management’s best estimate of inherent losses that had been incurred within the existing portfolio of loans. In addition, a loan was considered impaired when, based on current information and events, it was probable that the Company would be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. All loans rated substandard or worse and greater than $250 thousand were specifically reviewed to determine if they were impaired. Loans that were determined to be impaired were then evaluated to determine estimated impairment, if any. Impairment was measured on a loan-by-loan basis by either the present value of expected future cash flows discounted at the loan’s effective interest rate, the loan’s obtainable market price, or the fair value of the collateral if the loan was collateral dependent. Loans that were not individually determined to be impaired or were not subject to the specific review of impaired status were subject to the general valuation allowance portion of the ACL.
The Company estimates expected credit losses on off-balance sheet credit exposures over the contractual period in which the Company is exposed to credit risk via a contractual obligation to extend credit, unless that obligation is unconditionally cancellable by the Company. The ACL for off-balance sheet credit exposures is adjusted through provision for credit losses. The estimate includes consideration of the likelihood that funding will occur and an estimate of expected credit losses on commitments expected to be funded over its estimated life. Utilization rates are determined based on a two-year rolling average of historical usage. Expected loss rates for all pass rated loans are used to determine the ACL for off-balance sheet credit exposures.
For securities in an unrealized loss position, the Company first assesses whether it intends to sell, or it is more likely than not that it will be required to sell the security before recovery of its amortized cost basis. If either of the criteria regarding intent or requirement to sell is met, the security’s amortized costs basis is written down to fair value through income. For AFS securities that do not meet the aforementioned criteria, the Company evaluates whether the decline in fair value has resulted from credit losses or other factors. In making this assessment, management considers the extent to which fair value is less than amortized cost, any changes to the rating of the security by rating agency, and adverse conditions specifically related to the security, among other factors. If this assessment indicates that a credit loss exists, the present value of cash flows expected to be collected from the security are compared to the amortized cost basis of the security. If the present value of cash flows expected to be collected is less than the amortized cost basis, a credit loss exists and an ACL is recorded for the credit loss, limited by the amount that the fair value is less than the amortized cost basis. Any impairment that has not been recorded through an ACL is recognized in other comprehensive income (loss). Changes in the ACL are recorded as provision for credit losses. Losses are charged against the allowance when management believes the uncollectibility of an AFS security is confirmed or when either of the criteria regarding intent or requirement to sell is met. Accrued interest is excluded from the estimate of credit losses on securities.
Loans Held for Sale. Loans held for sale are comprised of residential mortgage loans. Loans that are originated for best efforts delivery are carried at the lower of aggregate cost or fair value as determined by aggregate outstanding commitments from investors or current investor yield requirements. All other loans held for sale are carried at fair value. Loans sold are typically subject to certain indemnification provisions with the investor; management does not believe these provisions will have any significant consequences.
Mortgage Servicing Rights Asset. When mortgage loans are sold with servicing retained, servicing rights are initially recorded at fair value with the consolidated statement of comprehensive income (loss) effect recorded in net gain on sale of loans. Fair value is based on market prices for comparable mortgage servicing contracts, when available, or alternatively, is based on a valuation model that calculates present value of estimated future servicing income.
Under the fair value measurement method, the Company measures servicing rights at fair value at each reporting date and reports change in fair value of servicing assets in earnings in the period in which the changes occur, and are included with other noninterest income in the consolidated financial statements. The fair values of servicing rights are subject to significant fluctuations as a result of changes in estimated and actual prepayment speeds and default rates and losses.
Goodwill and Other Intangible Assets. Goodwill resulting from business combinations is generally determined as the excess of the fair value of the consideration transferred over the fair value of the net assets acquired and liabilities assumed as of the acquisition date. Goodwill is not amortized, but is tested for impairment at least annually or more frequently if events and circumstances exist that indicate that an impairment test should be performed. Intangible assets with definite lives are amortized over their estimated useful lives.
Recently Issued Accounting Pronouncements
See Note 1, Summary of Significant Accounting Policies, in the notes to the consolidated financial statements included elsewhere in this Form 10-Q regarding the impact of new accounting pronouncements which we have adopted.
| Item 3. | Quantitative and Qualitative Disclosure about Market Risk |
The Company manages market risk, which, as a financial institution is primarily interest rate volatility, through the ALCO Committee of the Bank, in accordance with policies approved by its board of directors. The Company uses an interest rate risk simulation model and shock analysis to test the interest rate sensitivity of net interest income and fair value of equity, and the impact of changes in interest rates on other financial metrics. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Interest Rate Sensitivity and Market Risk” herein for a discussion of how we manage market risk.
| Item 4. | Controls and Procedures |
Evaluation of Disclosure Controls and Procedures
As of the end of the period covered by this Form 10-Q, the Company carried out an evaluation, under the supervision and with the participation of its management, including its Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of its disclosure controls and procedures. In designing and evaluating the disclosure controls and procedures, management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and management was required to apply judgment in evaluating its controls and procedures. Based on this evaluation, the Company’s Chief Executive Officer and Chief Financial Officer concluded that the Company’s disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended, or the Exchange Act) were effective as of the end of the period covered by this Form 10-Q.
Internal Control over Financial Reporting
There were no changes in the Company’s internal control over financial reporting (as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) that occurred during the three months ended September 30, 2023 that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.
PART II. OTHER INFORMATION
The Company and its subsidiaries are subject to various legal actions, as described in our Annual Report on Form 10-K for the year ended December 31, 2022 (the “2022 Annual Report on Form 10-K”) filed with the SEC on March 13, 2023. Except as described above or in our 2022 Annual Report on Form 10-K, we are not presently involved in any other litigation, nor to our knowledge is any litigation threatened against us, that in management’s opinion would result in any material adverse effect on our financial position or results of operations or that is not expected to be covered by insurance.
In evaluating an investment in any of our securities, investors should consider carefully, among other things, information under the heading “Cautionary Notice Regarding Forward-Looking Statements” in Part I, Item 2, “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” of this Form 10-Q and the risk factors previously disclosed under the heading “Risk Factors” in Part I, Item 1A of our 2022 Annual Report on Form 10-K and under the heading “Risk Factors” in Part II, Item 1A of our Quarterly Report on Form 10-Q for the quarterly period ended March 31, 2023, filed with the SEC on May 8, 2023. Other than the risk factors set forth in our Quarterly Report on Form 10-Q for the quarterly period ended March 31, 2023, filed with the SEC on May 8, 2023, management believes there have been no material changes in the risk factors disclosed by the Company in the 2022 Annual Report on Form 10-K.
| Item 2. | Unregistered Sales of Equity Securities and Use of Proceeds |
Issuer Purchases of Equity Securities
On May 5, 2023, the Company’s board of directors approved a stock repurchase program pursuant to which the Company may, from time to time, purchase up to $15.0 million of its outstanding shares of common stock (the “Program”). The shares may be repurchased from time to time in privately negotiated transactions or the open market, including pursuant to Rule 10b5-1 trading plans, and in accordance with applicable regulations of the SEC. The Company is not obligated to purchase any shares of its common stock under the Program and the timing and exact amount of any repurchases will depend on various factors including, the performance of the Company’s stock price, general market and other conditions, applicable legal requirements and other factors. The Program may be terminated or amended by the Company’s board of directors at any time prior to the expiration date of May 5, 2024.
The following table summarizes the Company’s share repurchase activity for the three months ended September 30, 2023.
| | | Total Shares Repurchased | | | Average Price Paid Per Share | | | Total Dollar Amount Purchased Pursuant to Publicly-Announced Plan | | | Maximum Dollar Amount Remaining Available for Repurchase Pursuant to Publicly-Announced Plan | |
| July 2023 | | | 38,386 | | | $ | 23.37 | | | $ | 896,996 | | | $ | 11,554,884 | |
| August 2023 | | | 164,525 | | | | 26.77 | | | | 4,404,344 | | | | 7,150,540 | |
| September 2023 | | | 151,610 | | | | 26.51 | | | | 4,019,466 | | | | 3,131,074 | |
| Total | | | 354,521 | | | | | | | | | | | | | |
| Item 3. | Defaults upon Senior Securities |
| Item 4. | Mine Safety Disclosures |
