UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
X ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2005
Commission file number 0-7674
First Financial Bankshares, Inc.
(Exact Name of Registrant as Specified in Its Charter)
Texas 75-0944023
(State or Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification No.)
400 Pine Street
Abilene, Texas 79601
(Address of Principal Executive Offices) (Zip Code)
Registrant's telephone number, including area code: (325) 627-7155
Securities registered pursuant to Section 12(b) of the Act:
Title of Class Name of Exchange on Which Registered
-------------- ------------------------------------
None N/A
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, par value $10.00 per share
Indicate by check mark if the registrant is a well-known seasoned issuer,
as defined in Rule 405 of the Securities Act. Yes No X
Indicate by check mark if the registrant is not required to file reports
pursuant to Section 13 or Section 15(d) of the Act. Yes No X
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes X No
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K.
Indicate by check mark whether the registrant is a large accelerated filer,
an accelerated filer, or a non-accelerated filer.
Large accelerated filer Accelerated filer X Non-accelerated filer
Indicate by check mark whether the registrant is a shell company (as
defined in Rule 12b-2 of the Act). Yes No X
As of June 30, 2005, the last business day of the registrant's most
recently completed second fiscal quarter, the aggregate market value of voting
and non-voting common stock held by non-affiliates was $623,000,000.
As of February 20, 2006, there were 20,714,826 shares of Common Stock
outstanding.
Documents Incorporated by Reference
Certain information called for by Part III is incorporated by reference to
the Proxy Statement for the 2006 Annual Meeting of our shareholders, which will
be filed with the Securities and Exchange Commission not later than 120 days
after December 31, 2005.
TABLE OF CONTENTS
Page
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CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS....................1
PART I
ITEM 1. Business.................................................1
ITEM 1A. Risk Factors............................................11
ITEM 1B. Unresolved Staff Comments ..............................15
ITEM 2. Properties..............................................15
ITEM 3. Legal Proceedings.......................................15
ITEM 4. Submission of Matters to a Vote of Security Holders.....15
PART II
ITEM 5. Market for Registrant's Common Equity and Related
Stockholder Matters.....................................15
ITEM 6. Selected Financial Data.................................17
ITEM 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations.....................18
ITEM 7A. Quantitative and Qualitative Disclosures About
Market Risk.............................................35
ITEM 8. Financial Statements and Supplementary Data.............36
ITEM 9. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure.....................37
ITEM 9A. Controls and Procedures.................................37
ITEM 9B. Other Information...................................... 39
PART III
ITEM 10. Directors and Executive Officers of the Registrant......40
ITEM 11. Executive Compensation..................................40
ITEM 12. Security Ownership of Certain Beneficial Owners
and Management .........................................40
ITEM 13. Certain Relationships and Related Transactions..........40
ITEM 14. Principal Accounting Fees and Services..................40
PART IV
ITEM 15. Exhibits and Financial Statement Schedules.............41
SIGNATURES..................................................................42
EXHIBIT INDEX...............................................................44
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CAUTIONARY STATEMENT REGARDING
FORWARD-LOOKING STATEMENTS
This Form 10-K contains certain forward-looking statements within the
meaning of Section 27A of the Securities Act of 1933 and Section 21E of the
Securities Exchange Act of 1934. When used in this Form 10-K, words such as
"anticipate," "believe," "estimate," "expect," "intend," "predict," "project,"
and similar expressions, as they relate to us or our management, identify
forward-looking statements. These forward-looking statements are based on
information currently available to our management. Actual results could differ
materially from those contemplated by the forward-looking statements as a result
of certain factors, including but not limited, to those listed in "Item 1A-Risk
Factors" and the following:
o General economic conditions;
o Legislative and regulatory actions and reforms;
o Competition from other financial institutions and financial holding
companies;
o The effects of and changes in trade, monetary and fiscal policies and
laws, including interest rate policies of the Federal Reserve Board;
o Changes in the demand for loans;
o Fluctuations in value of collateral and loan reserves;
o Inflation, interest rate, market and monetary fluctuations;
o Changes in consumer spending, borrowing and savings habits;
o Our ability to attract deposits;
o Consequences of continued bank mergers and acquisitions in our market
area, resulting in fewer but much larger and stronger competitors; and
o Acquisitions and integration of acquired businesses.
Such statements reflect the current views of our management with respect to
future events and are subject to these and other risks, uncertainties and
assumptions relating to our operations, results of operations, growth strategy
and liquidity. All subsequent written and oral forward-looking statements
attributable to us or persons acting on our behalf are expressly qualified in
their entirety by this paragraph. We undertake no obligation to publicly update
or otherwise revise any forward-looking statements, whether as a result of new
information, future events or otherwise.
PART I
ITEM 1. BUSINESS
General
First Financial Bankshares, Inc., a Texas corporation, is a financial
holding company registered under the Bank Holding Company Act of 1956, or BHCA.
As such, we are supervised by the Board of Governors of the Federal Reserve
System, or Federal Reserve Board, as well as several other state and federal
regulators. We were formed as a bank holding company in 1956 under the original
name F & M Operating Company, but our banking operations date back to 1890, when
Farmers and Merchants National Bank opened for business in Abilene, Texas. By
virtue of a series of reorganizations, mergers, and acquisitions since 1956, we
now own, through our wholly-owned Delaware subsidiary, First Financial
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Bankshares of Delaware, Inc., ten banks, a trust company and a technology
operating company, all organized and located in Texas. These subsidiaries are:
o First Financial Bank, National Association, Abilene, Texas;
o First Technology Services, Inc., Abilene, Texas;
o First Financial Trust & Asset Management Company, National
Association, Abilene, Texas;
o Hereford State Bank, Hereford, Texas;
o First National Bank, Sweetwater, Texas;
o First Financial Bank, National Association, Eastland, Texas;
o First Financial Bank, National Association, Cleburne, Texas;
o First Financial Bank, National Association, Stephenville, Texas;
o San Angelo National Bank, San Angelo, Texas;
o Weatherford National Bank, Weatherford, Texas;
o First Financial Bank, National Association, Southlake, Texas; and
o City National Bank, Mineral Wells, Texas.
Through our subsidiary banks, we conduct a full-service commercial banking
business. Our service centers are located primarily in North Central and West
Texas. Considering the branches and locations of all our subsidiaries, as of
December 31, 2005, we had 44 financial centers across Texas, with ten locations
in Abilene, two locations in Cleburne, three locations in Stephenville, two
locations in Granbury, two locations in San Angelo, three locations in
Weatherford, and one location each in Mineral Wells, Hereford, Sweetwater,
Eastland, Ranger, Rising Star, Southlake, Aledo, Willow Park, Alvarado,
Burleson, Keller, Trophy Club, Boyd, Bridgeport, Decatur, Roby, Trent, Clyde,
Moran, Midlothian and Glen Rose.
Information on our revenues, profits and losses and total assets appears in
the discussion of our Results of Operations contained in Item 7 hereof.
First Financial Bankshares, Inc.
We provide management and technical resources and policy direction to our
subsidiaries, which enables them to improve or expand their banking services
while continuing their local activity and identity. Each of our subsidiaries
operates under the day-to-day management of its own board of directors and
officers, with substantial authority in making decisions concerning their own
investments, loan policies, interest rates, and service charges. We provide
resources and policy direction in, among other things, the following areas:
o asset and liability management;
o accounting, budgeting, planning, risk management, loan review, human
resources and insurance;
o capitalization; and
o regulatory compliance.
In particular, we assist our subsidiaries with, among other things,
decisions concerning major capital expenditures, employee fringe benefits,
including retirement plans and group medical, dividend policies, and appointment
of officers and directors and their compensation. We also perform, through
corporate staff groups or by outsourcing to third parties, internal audits,
compliance oversight and loan reviews of our subsidiaries. We provide advice and
specialized services for our banks related to lending, investing, purchasing,
advertising, public relations, and computer services.
We evaluate various potential financial institution acquisition
opportunities and approve potential locations for new branch offices. We
anticipate that funding for any acquisitions or expansions would be provided
from our existing cash balances, available dividends from subsidiary banks,
utilization of available lines of credit and future debt or equity offerings.
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Services Offered by Our Subsidiary Banks
Each of our subsidiary banks is a separate legal entity that operates under
the day-to-day management of its own board of directors and officers. Each of
our subsidiary banks provides general commercial banking services, which include
accepting and holding checking, savings and time deposits, making loans,
automated teller machines, drive-in and night deposit services, safe deposit
facilities, transmitting funds, and performing other customary commercial
banking services. We also conduct full service trust activities through First
Financial Trust & Asset Management Company, National Association. Through this
trust company, we administer pension plans, profit sharing plans and other
employee benefit plans as well as administering estates, testamentary trusts,
various types of living trusts, and agency accounts. In addition, First
Financial Bank, National Association, Abilene, and San Angelo National Bank
provide securities brokerage services through arrangements with an unrelated
third party.
Competition
Commercial banking in Texas is highly competitive, and because we hold less
than 1% of the state's deposits, we represent only a minor segment of the
industry. To succeed in this industry, we believe that our banks must have the
capability to compete in the areas of (1) interest rates paid or charged; (2)
scope of services offered; and (3) prices charged for such services. Our
subsidiary banks compete in their respective service areas against highly
competitive banks, thrifts, savings and loan associations, small loan companies,
credit unions, mortgage companies, insurance companies, and brokerage firms, all
of which are engaged in providing financial products and services and some of
which are larger than our subsidiary banks in terms of capital, resources and
personnel.
Our business does not depend on any single customer or any few customers,
the loss of any one of which would have a materially adverse effect upon our
business. Although we have a broad base of customers that are not related to us,
our customers also occasionally include our officers and directors, as well as
other entities with which we are affiliated. With our subsidiary banks we may
make loans to officers and directors, and entities with which we are affiliated,
in the ordinary course of business. We make these loans on substantially the
same terms, including interest rates and collateral, as those prevailing at the
time for comparable transactions with other persons. Loans to directors,
officers and their affiliates are also subject to numerous restrictions under
federal and state banking laws which we describe in greater detail below.
Employees
With our subsidiary banks we employed approximately 975 full-time
equivalent employees at January 31, 2006. Our management believes that our
employee relations have been and will continue to be good.
Supervision and Regulation
Both federal and state laws extensively regulate bank holding companies,
financial holding companies and banks. These laws (and the regulations
promulgated thereunder) are primarily intended to protect depositors and the
deposit insurance fund of the Federal Deposit Insurance Corporation, or FDIC,
although shareholders may also benefit. The following information describes
particular laws and regulatory provisions relating to financial holding
companies and banks. This discussion is qualified in its entirety by reference
to the particular laws and regulatory provisions. A change in any of these laws
or regulations may have a material effect on our business and the business of
our subsidiary banks.
Bank Holding Companies and Financial Holding Companies
Historically, the activities of bank holding companies were limited to the
business of banking and activities closely related or incidental to banking.
Bank holding companies were generally prohibited from acquiring control of any
company which was not a bank and from engaging in any business other than the
business of banking or managing and controlling banks. The Gramm-Leach-Bliley
Act, which took effect on March 12, 2000, dismantled many Depression-era
restrictions against affiliation between banking, securities and insurance firms
by permitting bank holding companies to engage in a broader range of financial
activities, so long as certain safeguards are observed. Specifically, bank
holding companies may elect to become "financial holding companies" that may
affiliate with securities firms and insurance companies and engage in other
activities that are financial in nature or incidental to a financial activity.
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Thus, with the enactment of the Gramm-Leach-Bliley Act, banks, securities firms
and insurance companies find it easier to acquire or affiliate with each other
and cross-sell financial products. The Act permits a single financial services
organization to offer a more complete array of financial products and services
than historically was permitted.
A financial holding company is essentially a bank holding company with
significantly expanded powers. Under the Gramm-Leach-Bliley Act, in addition to
traditional lending activities, the following activities are among those that
will be deemed "financial in nature" for financial holding companies: securities
underwriting, dealing in or making a market in securities, sponsoring mutual
funds and investment companies, insurance underwriting and agency activities,
activities which the Federal Reserve Board determines to be closely related to
banking, and certain merchant banking activities.
We elected to become a financial holding company in September 2001. As a
financial holding company, we have very broad discretion to affiliate with
securities firms and insurance companies, make merchant banking investments, and
engage in other activities that the Federal Reserve Board has deemed financial
in nature. In order to continue as a financial holding company, we must continue
to be well-capitalized, well-managed and maintain compliance with the Community
Reinvestment Act. Depending on the types of financial activities that we may
elect to engage in, under Gramm-Leach-Bliley's fractional regulation principles,
we may become subject to supervision by additional government agencies. The
election to be treated as a financial holding company increases our ability to
offer financial products and services that historically we were either unable to
provide or were only able to provide on a limited basis. As a result, we will
face increased competition in the markets for any new financial products and
services that we may offer. Likewise, an increased amount of consolidation among
banks and securities firms or banks and insurance firms could result in a
growing number of large financial institutions that could compete aggressively
with us.
Mergers and Acquisitions
We generally must obtain approval from the banking regulators before we can
acquire other financial institutions. We may not engage in certain acquisitions
if we are undercapitalized. Furthermore, the BHCA provides that the Federal
Reserve Board cannot approve any acquisition, merger or consolidation that may
substantially lessen competition in the banking industry, create a monopoly in
any section of the country, or be a restraint of trade. However, the Federal
Reserve Board may approve such a transaction if the convenience and needs of the
community clearly outweigh any anti-competitive effects. Specifically, the
Federal Reserve Board would consider, among other factors, the expected benefits
to the public (greater convenience, increased competition, greater efficiency,
etc.) against the risks of possible adverse effects (undue concentration of
resources, decreased or unfair competition, conflicts of interest, unsound
banking practices, etc.).
Banks
Federal and state laws and regulations that govern banks have the effect
of, among other things, regulating the scope of business, investments, cash
reserves, the purpose and nature of loans, the maximum interest rate chargeable
on loans, the amount of dividends declared, and required capitalization ratios.
National Banking Associations. Banks organized as national banking
associations under the National Bank Act are subject to regulation and
examination by the Office of the Comptroller of the Currency, or OCC. The OCC
supervises, regulates and regularly examines First Financial Bank, National
Association, Abilene, First National Bank, Sweetwater, First Financial Bank,
National Association, Cleburne, First Financial Bank, National Association,
Eastland, San Angelo National Bank, Weatherford National Bank, First Financial
Bank, National Association, Southlake, First Financial Bank, National
Association, Stephenville and City National Bank, Mineral Wells, as well as
First Financial Trust & Asset Management Company, National Association and First
Technology Services, Inc. The OCC's supervision and regulation of banks is
primarily intended to protect the interests of depositors. The National Bank
Act:
o requires each national banking association to maintain reserves
against deposits,
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o restricts the nature and amount of loans that may be made and the
interest that may be charged, and
o restricts investments and other activities.
State Banks. Banks that are organized as state banks under Texas law are
subject to regulation and examination by the Banking Commissioner of the State
of Texas. The Commissioner regulates and supervises, and the Texas Banking
Department regularly examines our one subsidiary state bank, Hereford State
Bank. The Commissioner's supervision and regulation of banks is primarily
designed to protect the interests of depositors. Texas law
o requires each state bank to maintain reserves against deposits,
o restricts the nature and amount of loans that may be made and the
interest that may be charged, and
o restricts investments and other activities.
Because Hereford State Bank is a member of the FDIC, it is also subject to
regulation at the federal level by the FDIC, and is subject to most of the
federal laws described below.
Deposit Insurance
Each of our subsidiary banks is a member of the FDIC. The FDIC provides
deposit insurance protection that covers all deposit accounts in FDIC-insured
depository institutions and generally does not exceed $100,000 per depositor.
Our subsidiary banks must pay assessments to the FDIC under a risk-based
assessment system for federal deposit insurance protection. FDIC-insured
depository institutions that are members of the Bank Insurance Fund pay
insurance premiums at rates based on their risk classification. Institutions
assigned to higher risk classifications (i.e., institutions that pose a greater
risk of loss to their respective deposit insurance fund) pay assessments at
higher rates than institutions assigned to lower risk classifications. An
institution's risk classification is assigned based on its capital levels and
the level of supervisory concern the institution poses to bank regulators. In
addition, the FDIC can impose special assessments to cover the costs of
borrowings from the U.S. Treasury, the Federal Financing Bank and the Bank
Insurance Fund member banks. As of December 31, 2005, the assessment rate for
each of our subsidiary banks is at the lowest level risk-based premium
available.
Under the Financial Institutions Reform, Recovery, and Enforcement Act of
1989, or FIRREA, an FDIC-insured depository institution can be held liable for
any losses incurred by the FDIC in connection with (1) the "default" of one of
its FDIC-insured subsidiaries or (2) any assistance provided by the FDIC to one
of its FDIC-insured subsidiaries "in danger of default." "Default" is defined
generally as the appointment of a conservator or receiver, and "in danger of
default" is defined generally as the existence of certain conditions indicating
that a default is likely to occur in the absence of regulatory assistance.
The Federal Deposit Insurance Act, or FDIA, requires that the FDIC review
(1) any merger or consolidation by or with an insured bank, or (2) any
establishment of branches by an insured bank. The FDIC is also empowered to
regulate interest rates paid by insured banks. Approval of the FDIC is also
required before an insured bank retires any part of its common or preferred
stock, or any capital notes or debentures. Insured banks that are also members
of the Federal Reserve System, however, are regulated with respect to the
foregoing matters by the Federal Reserve System.
Payment of Dividends
We are a legal entity separate and distinct from our banking and other
subsidiaries. We receive most of our revenue from dividends paid to us by our
Delaware holding company subsidiary. Similarly, the Delaware holding company
subsidiary receives dividends from our bank subsidiaries. Described below are
some of the laws and regulations that apply when either we or our subsidiary
banks pay dividends.
Each state bank that is a member of the Federal Reserve System and each
national banking association is required by federal law to obtain the prior
approval of the Federal Reserve Board and the OCC, respectively, to declare and
pay dividends if the total of all dividends declared in any calendar year would
exceed the total of (1) such bank's net profits (as defined and interpreted by
regulation) for that year plus (2) its retained net profits (as defined and
5
interpreted by regulation) for the preceding two calendar years, less any
required transfers to surplus. In addition, these banks may only pay dividends
to the extent that retained net profits (including the portion transferred to
surplus) exceed bad debts (as defined by regulation).
Our subsidiary banks paid aggregate dividends of approximately $29.3
million in 2005 and approximately $37.4 million in 2004. Under the dividend
restrictions discussed above, as of December 31, 2005, our subsidiary banks,
without obtaining regulatory approvals, could have declared in the aggregate
additional dividends of approximately $17.1 million from retained net profits.
In connection with our acquisition of Southwestern Bancshares, Inc., First
Financial Bank, National Association, Stephenville is restricted from declaring
a dividend until its Tier 1 Capital Leverage ratio exceeds 7.35%. In addition,
in connection with our acquisition of Clyde Financial Corporation, First
Financial Bank, National Association, Eastland is also restricted from declaring
a dividend until its Tier I Capital Leverage ratio exceeds 7.35%.
In each case, the 7.35% limitation was imposed by the Office of the
Comptroller of the Currency as a condition for granting its approval of the
underlying acquisitions. In the short term, these restrictions will have the
effect of limiting the amount of cash that may move from these subsidiary banks
to us, which may in turn limit our ability to pay dividends to our shareholders,
but we do not believe the restrictions will have a material adverse affect on
our operations. We anticipate that the Tier 1 Capital Leverage ratio for these
subsidiaries will exceed 7.35% by the middle of our 2006 fiscal year.
To pay dividends, we and our subsidiary banks must maintain adequate
capital above regulatory guidelines. In addition, if the applicable regulatory
authority believes that a bank under its jurisdiction is engaged in, or is about
to engage in, an unsafe or unsound practice (which, depending on the financial
condition of the bank, could include the payment of dividends), the authority
may require, after notice and hearing, that such bank cease and desist from the
unsafe practice. The Federal Reserve Board and the OCC have each indicated
paying dividends that deplete a bank's capital base to an inadequate level would
be an unsafe and unsound banking practice. The Federal Reserve Board, the OCC
and the FDIC have issued policy statements that recommend that bank holding
companies and insured banks should generally only pay dividends to the extent
net income is sufficient to cover both cash dividends and a rate of earnings
retention consistent with capital needs, asset quality and overall financial
condition. No undercapitalized institution may pay a dividend.
Affiliate Transactions
The Federal Reserve Act, the FDIA and the rules adopted under these
statutes restrict the extent to which we can borrow or otherwise obtain credit
from, or engage in certain other transactions with, our depository subsidiaries.
These laws regulate "covered transactions" between insured depository
institutions and their subsidiaries, on the one hand, and their nondepository
affiliates, on the other hand. "Covered transactions" include a loan or
extension of credit to a nondepository affiliate, a purchase of securities
issued by such an affiliate, a purchase of assets from such an affiliate (unless
otherwise exempted by the Federal Reserve Board), an acceptance of securities
issued by such an affiliate as collateral for a loan, and an issuance of a
guarantee, acceptance, or letter of credit for the benefit of such an affiliate.
The "covered transactions" that an insured depository institution and its
subsidiaries are permitted to engage in with their nondepository affiliates are
limited to the following amounts: (1) in the case of any one such affiliate, the
aggregate amount of "covered transactions" cannot exceed ten percent of the
capital stock and the surplus of the insured depository institution; and (2) in
the case of all affiliates, the aggregate amount of "covered transactions"
cannot exceed twenty percent of the capital stock and surplus of the insured
depository institution. In addition, extensions of credit that constitute
"covered transactions" must be collateralized in prescribed amounts. Further, a
bank holding company and its subsidiaries are prohibited from engaging in
certain tie-in arrangements in connection with any extension of credit, lease or
sale of property or furnishing of services. Finally, when we and our subsidiary
banks conduct transactions internally among us, we are required to do so at
arm's length.
Loans to Directors, Executive Officers and Principal Shareholders
The authority of our subsidiary banks to extend credit to our directors,
executive officers and principal shareholders, including their immediate family
members and corporations and other entities that they control, is subject to
substantial restrictions and requirements under Sections 22(g) and 22(h) of the
Federal Reserve Act and Regulation O promulgated thereunder, as well as the
Sarbanes-Oxley Act of 2002. These statutes and regulations impose specific
6
limits on the amount of loans our subsidiary banks may make to directors and
other insiders, and specified approval procedures must be followed in making
loans that exceed certain amounts. In addition, all loans our subsidiary banks
make to directors and other insiders must satisfy the following requirements:
o The loans must be made on substantially the same terms, including
interest rates and collateral, as prevailing at the time for
comparable transactions with persons not affiliated with us or the
subsidiary banks;
o The subsidiary banks must follow credit underwriting procedures at
least as stringent as those applicable to comparable transactions with
persons who are not affiliated with us or the subsidiary banks; and
o The loans must not involve a greater than normal risk of non-payment
or include other features not favorable to the bank.
Furthermore, each subsidiary bank must periodically report all loans made
to directors and other insiders to the bank regulators, and these loans are
closely scrutinized by the regulators for compliance with Sections 22(g) and
22(h) of the Federal Reserve Act and Regulation O. Each loan to directors or
other insiders must be pre-approved by the bank's board of directors with the
applicable director abstaining from voting.
Capital
Bank Holding Companies and Financial Holding Companies. The Federal Reserve
Board has adopted risk-based capital guidelines for bank holding companies and
financial holding companies. The ratio of total capital to risk weighted assets
(including certain off-balance-sheet activities, such as standby letters of
credit) must be a minimum of eight percent. At least half of the total capital
is to be composed of common shareholders' equity, minority interests in the
equity accounts of consolidated subsidiaries and a limited amount of perpetual
preferred stock, less goodwill, which is collectively referred to as Tier 1
Capital. The remainder of total capital may consist of subordinated debt, other
preferred stock and a limited amount of loan loss reserves.
In addition, the Federal Reserve Board has established minimum leverage
ratio guidelines for bank holding companies and financial holding companies.
Bank holding companies and financial holding companies that meet certain
specified criteria, including having the highest regulatory rating, must
maintain a minimum Tier 1 Capital leverage ratio (Tier 1 Capital to average
assets for the current quarter, less goodwill) of three percent. Bank holding
companies and financial holding companies that do not have the highest
regulatory rating will generally be required to maintain a higher Tier 1 Capital
leverage ratio of three percent plus an additional cushion of 100 to 200 basis
points. The Federal Reserve Board has not advised us of any specific minimum
leverage ratio applicable to us. The guidelines also provide that bank holding
companies and financial holding companies experiencing internal growth or making
acquisitions will be expected to maintain strong capital positions. Such strong
capital positions must be kept substantially above the minimum supervisory
levels without significant reliance on intangible assets (e.g., goodwill and
core deposit intangibles). As of December 31, 2005, our capital ratios were as
follows: (1) Tier 1 Capital to Risk-Weighted Assets Ratio, 14.17%; (2) Total
Capital to Risk-Weighted Assets Ratio, 15.13%; and (3) Tier 1 Capital Leverage
Ratio, 8.56%.
Banks. The Federal Deposit Insurance Corporation Improvement Act of 1991,
or FDICIA, established five capital tiers with respect to depository
institutions: "well-capitalized," "adequately capitalized," "undercapitalized,"
"significantly undercapitalized," and "critically undercapitalized." A
depository institution's capital tier will depend upon where its capital levels
are in relation to various relevant capital measures, including (1) risk-based
capital measures, (2) a leverage ratio capital measure and (3) certain other
factors. Regulations establishing the specific capital tiers provide that a
"well-capitalized" institution will have a total risk-based capital ratio of ten
percent or greater, a Tier 1 risk-based capital ratio of six percent or greater,
and a Tier 1 leverage ratio of five percent or greater, and not be subject to
any written regulatory enforcement agreement, order, capital directive or prompt
corrective action derivative. For an institution to be "adequately capitalized,"
it will have a total risk-based capital ratio of eight percent or greater, a
Tier 1 risk-based capital ratio of four percent or greater, and a Tier 1
leverage ratio of four percent or greater (in some cases three percent). For an
institution to be "undercapitalized," it will have a total risk-based capital
ratio that is less than eight percent, a Tier 1 risk-based capital ratio less
than four percent or a Tier 1 leverage ratio less than four percent (or a
leverage ratio less than three percent if the institution's composite rating is
7
1 in its most recent report of examination, subject to appropriate federal
banking agency guidelines). For an institution to be "significantly
undercapitalized," it will have a total risk-based capital ratio less than six
percent, a Tier 1 risk-based capital ratio less than three percent, or a Tier 1
leverage ratio less than three percent. For an institution to be "critically
undercapitalized," it will have a ratio of tangible equity to total assets equal
to or less than two percent. FDICIA requires federal banking agencies to take
"prompt corrective action" against depository institutions that do not meet
minimum capital requirements. Under current regulations, we were "well
capitalized" as of December 31, 2005 at all of our subsidiary banks, with the
exception of First Financial Bank, Stephenville which was adequately
capitalized.
FDICIA generally prohibits a depository institution from making any capital
distribution (including payment of a dividend) or paying any management fee to
its holding company if the depository institution would thereafter be
"undercapitalized." An "undercapitalized" institution must develop a capital
restoration plan and its parent holding company must guarantee that
institution's compliance with such plan. The liability of the parent holding
company under any such guarantee is limited to the lesser of five percent of the
institution's assets at the time it became "undercapitalized" or the amount
needed to bring the institution into compliance with all capital standards.
Furthermore, in the event of the bankruptcy of the parent holding company, such
guarantee would take priority over the parent's general unsecured creditors. If
a depository institution fails to submit an acceptable capital restoration plan,
it shall be treated as if it is "significantly undercapitalized." "Significantly
undercapitalized" depository institutions may be subject to a number of
requirements and restrictions, including orders to sell sufficient voting stock
to become "adequately capitalized," requirements to reduce total assets, and
cessation of receipt of deposits from correspondent banks. "Critically
undercapitalized" institutions are subject to the appointment of a receiver or
conservator. Finally, FDICIA requires the various regulatory agencies to set
forth certain standards that do not relate to capital. Such standards relate to
the safety and soundness of operations and management and to asset quality and
executive compensation, and permit regulatory action against a financial
institution that does not meet such standards.
If an insured bank fails to meet its capital guidelines, it may be subject
to a variety of other enforcement remedies, including a prohibition on the
taking of brokered deposits and the termination of deposit insurance by the
FDIC. Bank regulators continue to indicate their desire to raise capital
requirements beyond their current levels.
In addition to FDICIA capital standards, Texas-chartered banks must also
comply with the capital requirements imposed by the Texas Banking Department.
Neither the Texas Finance Code nor its regulations specify any minimum
capital-to-assets ratio that must be maintained by a Texas-chartered bank.
Instead, the Texas Banking Department determines the appropriate ratio on a bank
by bank basis, considering factors such as the nature of a bank's business, its
total revenue, and the bank's total assets. As of December 31, 2005, our
Texas-chartered bank exceeded the minimum ratios applied to it.
Our Support of Our Subsidiary Banks
Under Federal Reserve Board policy, we are expected to commit resources to
act as a source of strength to support each of our subsidiary banks. This
support may be required at times when, absent such Federal Reserve Board policy,
we would not otherwise be required to provide it. In addition, any loans we make
to our subsidiary banks would be subordinate in right of payment to deposits and
to other indebtedness of our banks. In the event of a bank holding company's
bankruptcy, any commitment by the bank holding company to a federal bank
regulatory agency to maintain the capital of a subsidiary bank will be assumed
by the bankruptcy trustee and be subject to a priority of payment.
Under the National Bank Act, if the capital stock of a national bank is
impaired by losses or otherwise, the OCC is authorized to require the bank's
shareholders to pay the deficiency on a pro-rata basis. If any shareholder
refuses to pay the pro-rata assessment after three months notice, then the
bank's board of directors must sell an appropriate amount of the shareholder's
stock at a public auction to make up the deficiency. To the extent necessary, if
a deficiency in capital still exists and the bank refuses to go into
liquidation, then a receiver may be appointed to wind up the bank's affairs.
Additionally, under the Federal Deposit Insurance Act, in the event of a loss
suffered or anticipated by the FDIC (either as a result of the default of a
banking subsidiary or related to FDIC assistance provided to a subsidiary in
danger of default) our other banking subsidiaries may be assessed for the FDIC's
loss.
8
Interstate Banking and Branching Act
Pursuant to the Riegle-Neal Interstate Banking and Branching Efficiency Act
of 1994, or Riegle-Neal Act, a bank holding company or financial holding company
is able to acquire banks in states other than its home state. The Riegle-Neal
Act also authorized banks to merge across state lines, thereby creating
interstate branches. Furthermore, under this act, a bank is also able to open
new branches in a state in which it does not already have banking operations, if
the laws of such state permit it to do so. Accordingly, both the OCC and the
Texas Banking Department accept applications for interstate merger and branching
transactions, subject to certain limitations on ages of the banks to be acquired
and the total amount of deposits within the state a bank or financial holding
company may control. Since our primary service area is Texas, we do not expect
that the ability to operate in other states will have any material impact on our
growth strategy. We may, however, face increased competition from out-of-state
banks that branch or make acquisitions in our primary markets in Texas.
Community Reinvestment Act of 1977
The Community Reinvestment Act of 1977, or CRA, subjects a bank to
regulatory assessment to determine if the institution meets the credit needs of
its entire community, including low- and moderate-income neighborhoods served by
the bank, and to take that determination into account in its evaluation of any
application made by such bank for, among other things, approval of the
acquisition or establishment of a branch or other deposit facility, an office
relocation, a merger, or the acquisition of shares of capital stock of another
financial institution. The regulatory authority prepares a written evaluation of
an institution's record of meeting the credit needs of its entire community and
assigns a rating. These ratings are "Outstanding", "Satisfactory", "Needs
Improvement" and "Substantial Non-Compliance." Institutions with ratings lower
than "Satisfactory" may be restricted from engaging in the aforementioned
activities. We believe our subsidiary banks have taken significant actions to
comply with the CRA, and each has received at least a "satisfactory" rating in
its most recent review by federal regulators with respect to its compliance with
the CRA.
Monitoring and Reporting Suspicious Activity
Under the Bank Secrecy Act, IRS rules and other regulations, we are
required to monitor and report unusual or suspicious account activity as well as
transactions involving the transfer or withdrawal of amounts in excess of
prescribed limits. In the wake of the tragic events of September 11, 2001, on
October 26, 2001, the President signed the Uniting and Strengthening America by
Providing Appropriate Tools Required to Intercept and Obstruct Terrorism, or USA
PATRIOT, Act of 2001. Under the USA PATRIOT Act, financial institutions are
subject to prohibitions against specified financial transactions and account
relationships as well as enhanced due diligence and "know your customer"
standards in their dealings with financial institutions and foreign customers.
For example, the enhanced due diligence policies, procedures and controls
generally require financial institutions to take reasonable steps:
o to conduct enhanced scrutiny of account relationships to guard against
money laundering and report any suspicious transaction;
o to ascertain the identity of the nominal and beneficial owners of, and
the source of funds deposited into, each account as needed to guard
against money laundering and report any suspicious transactions;
o to ascertain for any foreign bank, the shares of which are not
publicly traded, the identity of the owners of the foreign bank, and
the nature and extent of the ownership interest of each such owner;
and
o to ascertain whether any foreign bank provides correspondent accounts
to other foreign banks and, if so, the identity of those foreign banks
and related due diligence information.
Under the USA PATRIOT Act, financial institutions are also required to
establish anti-money laundering programs. The USA PATRIOT Act sets forth minimum
standards for these programs, including:
9
o the development of internal policies, procedures, and controls;
o the designation of a compliance officer;
o an ongoing employee training program; and
o an independent audit function to test the programs.
In addition, under the USA PATRIOT Act, the Secretary of the Treasury has
adopted rules addressing a number of related issues, including increasing the
cooperation and information sharing between financial institutions, regulators,
and law enforcement authorities regarding individuals, entities and
organizations engaged in, or reasonably suspected based on credible evidence of
engaging in, terrorist acts or money laundering activities. Any financial
institution complying with these rules will not be deemed to violate the privacy
provisions of the Gramm-Leach-Bliley Act that are discussed below. Finally,
under the regulations of the Office of Foreign Asset Control, we are required to
monitor and block transactions with certain "specially designated nationals" who
OFAC has determined pose a risk to U.S. national security.
Consumer Laws and Regulations
We are also subject to certain consumer laws and regulations that are
designed to protect consumers in transactions with banks. While the following
list is not exhaustive, these laws and regulations include the Truth in Lending
Act, the Truth in Savings Act, the Electronic Funds Transfer Act, the Expedited
Funds Availability Act, the Equal Credit Opportunity Act, The Fair and Accurate
Credit Transactions Act and the Fair Housing Act, among others. These laws and
regulations, among other things, prohibit discrimination on the basis of race,
gender or other designated characteristics and mandate various disclosure
requirements and regulate the manner in which financial institutions must deal
with customers when taking deposits or making loans to such customers. These and
other laws also limit finance charges or other fees or charges earned in our
activities. We must comply with the applicable provisions of these consumer
protection laws and regulations as part of our ongoing customer relations.
Technology Risk Management and Consumer Privacy
State and federal banking regulators have issued various policy statements
emphasizing the importance of technology risk management and supervision in
evaluating the safety and soundness of depository institutions with respect to
banks that contract with outside vendors to provide data processing and core
banking functions. The use of technology-related products, services, delivery
channels and processes exposes a bank to various risks, particularly
operational, privacy, security, strategic, reputation and compliance risk. Banks
are generally expected to prudently manage technology-related risks as part of
their comprehensive risk management policies by identifying, measuring,
monitoring and controlling risks associated with the use of technology.
Under Section 501 of the Gramm-Leach-Bliley Act, the federal banking
agencies have established appropriate standards for financial institutions
regarding the implementation of safeguards to ensure the security and
confidentiality of customer records and information, protection against any
anticipated threats or hazards to the security or integrity of such records and
protection against unauthorized access to or use of such records or information
in a way that could result in substantial harm or inconvenience to a customer.
Among other matters, the rules require each bank to implement a comprehensive
written information security program that includes administrative, technical and
physical safeguards relating to customer information.
Under the Gramm-Leach-Bliley Act, a financial institution must also provide
its customers with a notice of privacy policies and practices. Section 502
prohibits a financial institution from disclosing nonpublic personal information
about a customer to nonaffiliated third parties unless the institution satisfies
various notice and opt-out requirements and the customer has not elected to opt
out of the disclosure. Under Section 504, the agencies are authorized to issue
regulations as necessary to implement notice requirements and restrictions on a
financial institution's ability to disclose nonpublic personal information about
customers to nonaffiliated third parties. Under the final rule the regulators
adopted, all banks must develop initial and annual privacy notices which
describe in general terms the bank's information sharing practices. Banks that
10
share nonpublic personal information about customers with nonaffiliated third
parties must also provide customers with an opt-out notice and a reasonable
period of time for the customer to opt out of any such disclosure (with certain
exceptions). Limitations are placed on the extent to which a bank can disclose
an account number or access code for credit card, deposit or transaction
accounts to any nonaffiliated third party for use in marketing.
Monetary Policy
Banks are affected by the credit policies of monetary authorities,
including the Federal Reserve Board, that affect the national supply of credit.
The Federal Reserve Board regulates the supply of credit in order to influence
general economic conditions, primarily through open market operations in United
States government obligations, varying the discount rate on financial
institution borrowings, varying reserve requirements against financial
institution deposits, and restricting certain borrowings by financial
institutions and their subsidiaries. The monetary policies of the Federal
Reserve Board have had a significant effect on the operating results of banks in
the past and are expected to continue to do so in the future.
Pending and Proposed Legislation
New regulations and statutes are regularly proposed containing wide-ranging
proposals for altering the structures, regulations and competitive relationships
of financial institutions operating in the United States. We cannot predict
whether, or in what form, any proposed regulation or statute will be adopted or
the extent to which our business may be affected by any new regulation or
statute.
Enforcement Powers of Federal Banking Agencies
The Federal Reserve and other state and federal banking agencies and
regulators have broad enforcement powers, including the power to terminate
deposit insurance, issue cease-and-desist orders, impose substantial fines and
other civil and criminal penalties and appoint a conservator or receiver. Our
failure to comply with applicable laws, regulations and other regulatory
pronouncements could subject us, as well as our officers and directors, to
administrative sanctions and potentially substantial civil penalties.
Available Information
We file annual, quarterly and special reports, proxy statements and other
information with the Securities and Exchange Commission. You may read and copy
any document we file at the Securities and Exchange Commission's Public
Reference Room at 100 F Street, N.E., Washington, D.C. 20549. Please call the
Securities and Exchange Commission at 1-800-SEC-0330 for further information on
the public reference room. Our SEC filings are also available to the public at
the Securities and Exchange Commission's web site at http://www.sec.gov. Our web
site is http://www.ffin.com. You may also obtain copies of our annual, quarterly
and special reports, proxy statements and certain other information filed with
the SEC, as well as amendments thereto, free of charge from our web site. These
documents are posted to our web site as soon as reasonably practicable after we
have filed them with the SEC. Our corporate governance guidelines, including our
code of conduct applicable to all our employees, officers and directors, as well
as the charters of our audit and nominating committees, are available at
www.ffin.com. The foregoing information is also available in print to any
shareholder who requests it. Except as explicitly provided, information on any
web site is not incorporated into this Form 10-K or our other securities filings
and is not a part of them.
ITEM 1A. RISK FACTORS
Our business, financial condition, operating results and cash flows can be
impacted by a number of factors, including but not limited to those set forth
below, any one of which could cause our actual results to vary materially from
recent results or from our anticipated future results and other forward looking
statements that we make from time to time in our news releases, annual reports
and other written communications, as well as oral forward looking statements,
and other statements made from time to time by our representatives.
11
Our Business Faces Unpredictable Economic Conditions
General economic conditions impact the banking industry. The credit quality
of our loan portfolio necessarily reflects, among other things, the general
economic conditions in the areas in which we conduct our business. Our continued
financial success depends somewhat on factors beyond our control, including:
o national and local economic conditions:
o the supply of and demand for investable funds;
o demand for loans;
o interest rates; and
o federal, state and local laws affecting these matters.
Any substantial deterioration in any of the foregoing conditions could have
a material adverse effect on our financial condition and results of operations,
which would likely adversely affect the market price of our common stock.
Our Business Is Concentrated In Texas And A Downturn In The Economy Of Texas May
Adversely Affect Our Business
Our network of subsidiary banks is concentrated in Texas, primarily in the
Western and North Central regions of the state. Most of our customers and
revenue are derived from this area. The economy of this region is focused on
agriculture (including farming and ranching), oil and gas production, and real
estate development. Historically, these industries have fluctuated widely
between boom and bust. Because we generally do not derive revenue or customers
from other parts of the state or nation, our business and operations are
dependent on economic conditions in this part of Texas. Any decline in one or
more segments of the local economy could adversely affect our business, revenue,
operations and properties.
The Value Of Real Estate Collateral May Fluctuate Significantly
The market value of real estate, particularly real estate held for
investment, can fluctuate significantly in a short period of time as a result of
market conditions in the geographic area in which the real estate is located. If
the value of the real estate serving as collateral for our loan portfolio were
to decline materially, a significant part of our loan portfolio could become
under-collateralized. If the loans that are collateralized by real estate become
troubled during a time when market conditions are declining or have declined,
then, in the event of foreclosure, we may not be able to realize the amount of
collateral that we anticipated at the time of originating the loan, which could
have a material adverse effect on our provision for loan losses and our
operating results and financial condition.
Our Business Is Subject To Significant Government Regulation
We operate in a highly regulated environment and are subject to supervision
and regulation by a number of governmental regulatory agencies, including the
Texas Department of Banking, the Federal Reserve, the Office of the Comptroller
of the Currency, and the Federal Deposit Insurance Corporation. Regulations
adopted by these agencies, which are generally intended to provide protection
for depositors and customers rather than for the benefit of shareholders, govern
a comprehensive range of matters relating to ownership and control of our
shares, our acquisition of other companies and businesses, permissible
activities for us to engage in, maintenance of adequate capital levels and other
aspects of our operations. The bank regulatory agencies possess broad authority
to prevent or remedy unsafe or unsound practices or violations of law.
In addition, future legislation and government policy could adversely
affect the banking industry as a whole, including our results of operations. For
example, new legislation or regulation may limit the manner in which we may
conduct our business, including our ability to offer new products, obtain
financing, attract deposits, make loans and achieve satisfactory interest
spreads.
12
We Compete With Many Larger Financial Institutions Which Have Substantially
Greater Financial Resources Than We Have
Competition among financial institutions in Texas is intense. We compete
with other bank holding companies, state and national commercial banks, savings
and loan associations, consumer financial companies, credit unions, securities
brokers, insurance companies, mortgage banking companies, money market mutual
funds, asset-based non-bank lenders and other financial institutions. Many of
these competitors have substantially greater financial resources, larger lending
limits, larger branch networks and less regulatory oversight than we do, and are
able to offer a broader range of products and services than we can. Failure to
compete effectively for deposit, loan and other banking customers in our markets
could cause us to lose market share, slow our growth rate and may have an
adverse effect on our financial condition and results of operations.
In Our Business, We Must Effectively Manage Our Credit Risk
As a lender, we are exposed to the risk that our loan customers may not
repay their loans according to the terms of these loans and the collateral
securing the payment of these loans may be insufficient to fully compensate us
for the outstanding balance of the loan plus the costs to dispose of the
collateral. We may experience significant loan losses which could have a
material adverse effect on our operating results and financial condition.
Management makes various assumptions and judgments about the collectibility of
our loan portfolio, including the diversification by industry of our commercial
loan portfolio, the amount of nonperforming loans and related collateral, the
volume, growth and composition of our loan portfolio, the effects on the loan
portfolio of current economic indicators and their probable impact on borrowers
and the evaluation of our loan portfolio through our internal loan review
process and other relevant factors.
We maintain an allowance for credit losses in an attempt to cover credit
losses inherent in our loan portfolio. Additional credit losses will likely
occur in the future and may occur at a rate greater than we have experienced to
date. In determining the amount of the allowance, we rely on an analysis of our
loan portfolio, our experience and our evaluation of general economic
conditions. If our assumptions prove to be incorrect, our current allowance may
not be sufficient and adjustments may be necessary to allow for different
economic conditions or adverse developments in our loan portfolio. Material
additions to the allowance could materially decrease net income.
In addition, federal and state regulators periodically review our allowance
for credit losses and may require us to increase our provision for credit losses
or recognize further charge-offs, based on judgments different than those of our
management. Any increase in our allowance for credit losses or charge-offs as
required by these regulatory agencies could have a material negative effect on
our operating results and financial condition.
Our Operations Are Significantly Affected By Interest Rate Levels
Our profitability is dependent to a large extent on our net interest
income, which is the difference between interest income we earn as a result of
interest paid to us on loans and investments and interest we pay to third
parties such as our depositors and those from whom we borrow funds. Like most
financial institutions, we are affected by changes in general interest rate
levels, which are currently rising and by other economic factors beyond our
control. Interest rate risk can result from mismatches between the dollar amount
of repricing or maturing assets and liabilities and from mismatches in the
timing and rate at which our assets and liabilities reprice. Although we have
implemented strategies which we believe reduce the potential effects of changes
in interest rates on our results of operations, these strategies may not always
be successful. In addition, any substantial and prolonged increase in market
interest rates could reduce our customers' desire to borrow money from us or
adversely affect their ability to repay their outstanding loans by increasing
their credit costs since most of our loans have adjustable interest rates that
reset periodically. Any of these events could adversely affect our results of
operations or financial condition.
13
To Continue Our Growth, We Are Affected By Our Ability To Identify And Acquire
Other Financial Institutions
We intend to continue our current growth strategy. This strategy includes
opening new branches and acquiring other banks that serve customers or markets
we find desirable. The market for acquisitions remains highly competitive, and
we may be unable to find satisfactory acquisition candidates in the future that
fit our acquisition and growth strategy. To the extent that we are unable to
find suitable acquisition candidates, an important component of our growth
strategy may be lost. Additionally, our completed acquisitions, or any future
acquisitions, may not produce the revenue, earnings or synergies that we
anticipated.
Our Operational And Financial Results Are Affected By Our Ability To
Successfully Integrate Our Acquisitions
Acquisitions of financial institutions involve operational risks and
uncertainties and acquired companies may have unforeseen liabilities, exposure
to asset quality problems, key employee and customer retention problems and
other problems that could negatively affect our organization. We may not be able
to successfully integrate the operations, management, products and services of
the entities that we acquire and eliminate redundancies. The integration process
may also require significant time and attention from our management that they
would otherwise direct at servicing existing business and developing new
business. Our failure to successfully integrate the entities we acquire into our
existing operations may increase our operating costs significantly and adversely
affect our business and earnings.
We Rely Heavily On Our Management Team, And The Unexpected Loss of Key
Management May Adversely Affect Our Operations
Our success to date has been strongly influenced by our ability to attract
and to retain senior management experienced in banking in the markets we serve.
Our ability to retain executive officers and the current management teams will
continue to be important to successful implementation of our strategies. We do
not have employment agreements with these key employees other than severance
agreements in the event of a change of control. The unexpected loss of services
of any key management personnel, or the inability to recruit and retain
qualified personnel in the future, could have an adverse effect on our business
and financial results.
Although Publicly Traded, Our Common Stock Does Not Have A Significant Amount Of
Trading Liquidity.
A relatively small percentage of our outstanding common stock is actively
traded on the Nasdaq Stock Market. The risks of low liquidity include increased
volatility of the price of our common stock. Low liquidity may also limit
holders of our common stock in their ability to sell or transfer our shares at
the price, time and quantity desired.
Breakdowns In Our Internal Controls And Procedures Could Have An Adverse Effect
On Us
We believe our internal control system as currently documented and
functioning is adequate to provide reasonable assurance over our internal
controls. Nevertheless, because of the inherent limitation in administering a
cost effective control system, misstatements due to error or fraud may occur and
not be detected. Breakdowns in our internal controls and procedures could occur
in the future, and any such breakdowns could have an adverse effect on us. See
"Item 9A - Controls and Procedures" for additional information.
We Compete In An Industry That Continually Experiences Technological Change, And
We May Have Fewer Resources Than Many Of Our Competitors To Continue To Invest
In Technological Improvements
The financial services industry is undergoing rapid technological changes,
with frequent introductions of new technology-driven products and services. In
addition to improving the ability to serve customers, the effective use of
technology increases efficiency and enables financial institutions to reduce
costs. Our future success will depend, in part, upon our ability to address the
needs of our customers by using technology to provide products and services that
will satisfy customer demands for conveniences, as well as to create additional
efficiencies in our operations. Many of our competitors have substantially
greater resources to invest in technological improvements. We may not be able to
effectively implement new technology-driven products and services or be
successful in marketing these products and services to our customers.
14
System Failure Or Breaches Of Our Network Security Could Subject Us To Increased
Operating Costs As Well As Litigation And Other Liabilities
The computer systems and network infrastructure we use could be vulnerable
to unforeseen problems. Our operations are dependent upon our ability to protect
our computer equipment against damage from fire, power loss, telecommunications
failure or a similar catastrophic event. Any damage or failure that causes an
interruption in our operations could have an adverse effect on our financial
condition and results of operations. In addition, our operations are dependent
upon our ability to protect the computer systems and network infrastructure
utilized by us against damage from physical break-ins, security breaches and
other disruptive problems caused by the Internet or other users. Such computer
break-ins and other disruptions would jeopardize the security of information
stored in and transmitted through our computer systems and network
infrastructure, which may result in significant liability to us and deter
potential customers. Although we, with the help of third-party service
providers, intend to continue to implement security technology and establish
operational procedures to prevent such damage, there can be no assurance that
these security measures will be successful.
ITEM 1B. UNRESOLVED STAFF COMMENTS
None.
ITEM 2. PROPERTIES
Our principal office is located in the First Financial Bank Building at 400
Pine Street in downtown Abilene, Texas. We lease two spaces in a building owned
by First Financial Bank, National Association, Abilene. The lease of
approximately 3,300 square feet of space expires December 31, 2010. The lease of
approximately 1,135 square feet of space expires May 31, 2006. Our subsidiary
banks collectively own 39 banking facilities, some of which are detached
drive-ins, and also lease five banking facilities and 13 ATM locations. Our
management considers all our existing locations to be well-suited for conducting
the business of banking. We believe our existing facilities are adequate to meet
our requirements and our subsidiary banks' requirements for the foreseeable
future.
ITEM 3. LEGAL PROCEEDINGS
From time to time we and our subsidiary banks are parties to lawsuits
arising in the ordinary course of our banking business. However, there are no
material pending legal proceedings to which we, our subsidiary banks or our
other direct and indirect subsidiaries, or any of their properties, are
currently subject. Other than regular, routine examinations by state and federal
banking authorities, there are no proceedings pending or known to be
contemplated by any governmental authorities.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of our security holders during the
fourth quarter of our fiscal year ended December 31, 2005.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND
ISSUER PURCHASES OF EQUITY SECURITIES
Market Information
Our common stock, par value $10.00 per share, is traded on the Nasdaq Stock
Market under the trading symbol FFIN. See "Item 8-Financial Statements and
Supplementary Data-Quarterly Financial Data" for the high, low and closing sales
prices as reported by the Nasdaq National Market for our common stock for the
periods indicated.
Holders
As of February 1, 2006, we had approximately 1,575 shareholders of record.
15
Dividends
See "Item 8-Financial Statements and Supplementary Data-Quarterly Results
of Operations" for the frequency and amount of cash dividends paid by us. Also,
see "Item 1 - Business - Supervision and Regulation - Payment of Dividends" and
"Item 7 - Management's Discussion and Analysis of the Financial Condition and
Results of Operations - Liquidity - Dividends" for restrictions on our present
or future ability to pay dividends, particularly those restrictions arising
under federal and state banking laws.
16
ITEM 6. SELECTED FINANCIAL DATA
The selected financial data presented below as of and for the years ended
December 31, 2005, 2004, 2003, 2002, and 2001, have been derived from our
audited consolidated financial statements. The selected financial data should be
read in conjunction with "Item 7-Management's Discussion and Analysis of
Financial Condition and Results of Operations" and our consolidated financial
statements. The results of operations presented below are not necessarily
indicative of the results of operations that may be achieved in the future. The
amounts related to shares of our common stock have been adjusted to give effect
to all stock dividends and stock splits. Management's Discussion and Analysis of
Financial Condition and Results of Operations incorporated information required
to be disclosed by the Securities and Exchange Commission's Industry Guide 3,
"Statistical Disclosure by Bank Holding Companies."
Year Ended December 31,
---------------------------------------------------------------------
2005 2004 2003 2002 2001
----------- ---------- ---------- ---------- ----------
(dollars in thousands, except per share data)
Summary Income Statement Information:
Interest income $ 123,944 $ 99,973 $ 95,285 $ 104,286 $ 115,874
Interest expense 28,757 16,077 17,131 24,380 44,834
----------- ---------- ---------- ---------- ----------
Net interest income 95,187 83,896 78,154 79,906 71,040
Provision for loan losses 1,320 1,633 1,178 2,370 1,964
Noninterest income 44,180 38,823 34,109 30,129 28,177
Noninterest expense 75,649 66,128 61,154 59,082 55,071
----------- ---------- ---------- ---------- ----------
Earnings before income taxes 62,398 54,958 49,931 48,583 42,182
Income tax expense 18,375 15,787 14,626 14,630 12,827
----------- ---------- ---------- ---------- ----------
Net earnings $ 44,023 $ 39,171 $ 35,305 $ 33,953 $ 29,355
=========== ========== ========== ========== ==========
Per Share Data:
Net earnings per share, basic $ 2.13 $ 1.90 $ 1.71 $ 1.65 $ 1.43
Net earnings per share, assuming dilution 2.12 1.89 1.70 1.64 1.42
Cash dividends declared 1.10 1.00 0.91 0.81 0.70
Book value at period-end 13.34 12.84 12.19 11.59 10.40
Earnings performance ratios:
Return on average assets 1.80% 1.82% 1.75% 1.78% 1.62%
Return on average equity 16.17 15.09 14.40 14.97 14.35
Summary Balance Sheet Data (Period-end):
Investment securities $ 1,046,121 $ 854,334 $ 910,302 $ 772,256 $ 721,694
Loans 1,288,604 1,164,223 987,523 964,040 940,131
Total assets 2,733,827 2,315,224 2,092,571 1,993,183 1,929,694
Deposits 2,366,277 1,994,312 1,796,271 1,711,562 1,685,163
Total liabilities 2,457,551 2,049,679 1,841,085 1,754,415 1,716,040
Total shareholders' equity 276,276 265,545 251,487 238,768 213,654
Asset quality ratios:
Allowance for loan losses/period-end loans 1.14% 1.19% 1.17% 1.16% 1.13%
Nonperforming assets/period-end loans plus
foreclosed assets 0.33 0.43 0.32 0.44 0.51
Net charge offs/average loans 0.10 0.12 0.09 0.19 0.18
Capital ratios:
Average shareholders' equity/average assets 11.11% 12.08% 12.13% 11.89% 11.29%
Leverage ratio (1) 8.56 9.80 10.60 10.51 9.92
Tier 1 risk-based capital (2) 14.17 16.46 18.83 18.42 17.10
Total risk-based capital (3) 15.13 17.49 19.83 19.47 18.08
Dividend payout ratio 51.55 52.62 53.10 49.13 48.94
- --------------------------------------------------------------------------------
(1) Calculated by dividing, at period-end, shareholders' equity (before
unrealized gain/loss on securities available-for-sale) less intangible
assets by fourth quarter average assets less intangible assets.
(2) Calculated by dividing, at period-end, shareholders' equity (before
unrealized gain/loss on securities available-for-sale) less intangible
assets by risk-adjusted assets.
(3) Calculated by dividing, at period-end, shareholders' equity (before
unrealized gain/loss on securities available for sale) less intangible
assets plus allowance for loan losses to the extent allowed under
regulatory guidelines by risk-adjusted assets.
17
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
Introduction
As a multi-bank financial holding company, we generate most of our revenue
from interest on loans and investments, trust fees, and service charges. Our
primary source of funding for our loans and investments are deposits held by our
subsidiary banks. Our largest expenses are interest on these deposits and
salaries and related employee benefits. We usually measure our performance by
calculating our return on average assets, return on average equity, our
regulatory leverage and risk based capital ratios, and our efficiency ratio,
which is calculated by dividing noninterest expense by the sum of net interest
income on a tax equivalent basis and noninterest income.
You should read the following discussion and analysis of the major elements
of our consolidated balance sheets as of December 31, 2005 and 2004, and
consolidated statements of earnings for the years 2003 through 2005 in
conjunction with our consolidated financial statements, accompanying notes, and
selected financial data presented elsewhere in this Form 10-K. Average share
information and earnings per share data related to our common stock have been
adjusted to give effect to all stock splits and stock dividends, including the
four-for-three stock split in the form of a 33% stock dividend effective June 1,
2005.
Critical Accounting Policies
We prepare consolidated financial statements based on the selection of
certain accounting policies, generally accepted accounting principles and
customary practices in the banking industry. These policies, in certain areas,
require us to make significant estimates and assumptions.
We deem a policy critical if (1) the accounting estimate required us to
make assumptions about matters that are highly uncertain at the time we make the
accounting estimate; and (2) different estimates that reasonably could have been
used in the current period, or changes in the accounting estimate that are
reasonably likely to occur from period to period, would have a material impact
on the financial statements.
The following discussion addresses our allowance for loan losses and its
provision for loan losses, which we deem to be our most critical accounting
policy. We have other significant accounting policies and continue to evaluate
the materiality of their impact on our consolidated financial statements, but we
believe these other policies either do not generally require us to make
estimates and judgments that are difficult or subjective, or it is less likely
they would have a material impact on our reported results for a given period.
The allowance for loan losses is an amount we believe will be adequate to
absorb inherent estimated losses on existing loans in which full collectibility
is unlikely based upon our review and evaluation of the loan portfolio. The
allowance for loan losses is increased by charges to income and decreased by
charge-offs (net of recoveries).
Our methodology is based on guidance provided in SEC Staff Accounting
Bulletin No. 102, "Selected Loan Loss Allowance Methodology and Documentation
Issues" and includes allowance allocations calculated in accordance with
Statement of Financial Accounting Standards (SFAS) No. 114, "Accounting by
Creditors for Impairment of a Loan," as amended by SFAS 118, and allowance
allocations determined in accordance with SFAS No. 5, "Accounting for
Contingencies." We have developed a consistent, well-documented loan review
methodology that includes allowances assigned to certain classified loans,
allowances assigned based upon estimated loss factors and qualitative reserves.
The level of the allowance reflects our periodic evaluation of general economic
conditions, the financial condition of our borrowers, the value and liquidity of
collateral, delinquencies, prior loan loss experience, and the results of
periodic reviews of the portfolio by our independent loan review department and
regulatory examiners.
Our allowance for loan losses is comprised of three elements: (i) specific
reserves determined in accordance with SFAS 114 based on probable losses on
specific loans; (ii) general reserves determined in accordance with SFAS 5 that
consider historical loss rates, loan classifications and other factors; and
(iii) a qualitative reserve determined in accordance with SFAS 5 based upon
general economic conditions and other qualitative risk factors both internal and
external to the Company. We regularly evaluate our allowance for loan losses to
18
maintain an adequate level to absorb estimated loan losses inherent in the loan
portfolio. Factors contributing to the determination of specific reserves
include the credit worthiness of the borrower, changes in the value of pledged
collateral, and general economic conditions. All nonaccrual loans rated
substandard or worse and greater than $50,000 are specifically reviewed and a
specific allocation is assigned based on the losses expected to be realized from
those loans. For purposes of determining the general reserve, a certain portion
of the loan portfolio is assigned a reserve allocation percentage. The reserve
allocation percentage is multiplied by the outstanding loan principal balance,
less cash secured loans, government guaranteed loans and classified loans to
calculate the required general reserve. The general reserve allocation
percentages assigned to groups of loans considers historical loss rates, loan
classifications and other factors. The qualitative reserves are determined by
evaluating such things as current economic conditions and trends, changes in
lending staff, policies or procedures, changes in credit concentrations, changes
in the trends and severity of problem loans and changes in trends in volume and
terms of loans. The portion of the allowance that is not derived by the general
reserve allocation percentages compensate for the uncertainty and complexity in
estimating loan losses including factors and conditions that may not be fully
reflected in the determination and application of the general reserve allocation
percentages.
Although we believe we use the best information available to make loan loss
allowance determinations, future adjustments could be necessary if circumstances
or economic conditions differ substantially from the assumptions used in making
our initial determinations. A downturn in the economy and employment could
result in increased levels of nonperforming assets and charge-offs, increased
loan loss provisions and reductions in income. Additionally, as an integral part
of their examination process, bank regulatory agencies periodically review our
allowance for loan losses. The bank regulatory agencies could require the
recognition of additions to the loan loss allowance based on their judgment of
information available to them at the time of their examination.
Accrual of interest is discontinued on a loan when management believes,
after considering economic and business conditions and collection efforts, the
borrower's financial condition is such that collection of interest is doubtful.
Our policy requires measurement of the allowance for an impaired collateral
dependent loan based on the fair value of the collateral. Other loan impairments
are measured based on the present value of expected future cash flows or the
loan's observable market price.
Acquisitions
On March 4, 2004, we entered into a stock purchase agreement with the
principal shareholders of Liberty National Bank, Granbury, Texas. On July 26,
2004 the transaction was completed. Pursuant to the purchase agreement, we paid
approximately $12.3 million for all of the outstanding shares of Liberty
National Bank. At closing, Liberty National Bank became a direct subsidiary of
First Financial Bankshares of Delaware, Inc., our wholly owned Delaware bank
holding company and, effective November 1, 2004, it was merged with our wholly
owned bank subsidiary, First Financial Bank, National Association, Stephenville.
The total purchase price exceeded the estimated fair value of tangible net
assets acquired by approximately $7.5 million, of which approximately $359,000
was assigned to an identifiable intangible asset with the balance recorded as
goodwill. The primary purpose of the acquisition was to expand the Company's
market share in areas with close proximity to Dallas/Ft. Worth, Texas. Factors
that contributed to a purchase price resulting in goodwill include Liberty's
historic record of earnings, capable management, the Granbury market and its
geographic location, which complements the Company's existing service locations.
On September 7, 2004, we entered into a stock purchase agreement with the
shareholders of Southwestern Bancshares, Inc., the parent company of The First
National Bank, Glen Rose, Texas. On December 1, 2004, the transaction was
completed. Pursuant to the purchase agreement, we paid approximately $13.4
million for all outstanding shares of Southwestern Bancshares, Inc. At closing,
Southwestern Bancshares and The First National Bank, Glen Rose, were merged into
our wholly-owned bank subsidiary, First Financial Bank, National Association,
Stephenville. The total purchase price exceeded the estimated fair value of
tangible net assets acquired by approximately $8.7 million, of which
approximately $433,000 was assigned to an identifiable intangible asset with the
balance recorded as goodwill. The primary purpose of the acquisition was to
expand the Company's market share in areas with close proximity to Dallas/Ft.
Worth, Texas. Factors that contributed to a purchase price resulting in goodwill
19
include First National Bank, Glen Rose's historic record of earnings, capable
management, the growth potential for Glen Rose and its geographic location,
which complements the Company's existing service locations.
On October 25, 2004, we entered into a stock purchase agreement with the
shareholders of Clyde Financial Corporation, the parent company of The Peoples
State Bank in Clyde, Texas. On February 1, 2005, the transaction was completed.
Pursuant to the purchase agreement, we paid approximately $25.4 million for all
outstanding shares of Clyde Financial Corporation. At closing, Clyde Financial
Corporation and The Peoples State Bank were merged into our wholly owned bank
subsidiary, First Financial Bank, National Association, Abilene. The total
purchase price exceeded the estimated fair value of tangible net assets acquired
by approximately $13.2 million, of which approximately $1.9 million was assigned
to an identifiable intangible asset with the balance recorded as goodwill. The
primary purpose of the acquisition was to expand the Company's market share near
Abilene and along Interstate Highway 20 in West Texas. Factors that contributed
to a purchase price resulting in goodwill include Peoples' historic record of
earnings, capable management and its geographic location which complements the
Company's existing service locations.
On August 10, 2005, we entered into an agreement and plan of merger with
Bridgeport Financial Corporation, the parent company of The First National Bank
of Bridgeport, Bridgeport, Texas. On December 1, 2005, the transaction was
completed. Pursuant to the agreement, we paid $20.1 million, plus the assumption
of $5.5 million in debt and trust preferred securities, for all of the
outstanding shares of Bridgeport Financial Corporation. At closing, Bridgeport
Financial Corporation was merged into First Financial Bankshares of Delaware,
Inc. and the First National Bank of Bridgeport was merged with our wholly owned
bank subsidiary, First Financial Bank, National Association, Southlake. The
total purchase price exceeded the estimated fair value of tangible net assets
acquired by approximately $14.7 million, of which approximately $2.3 million was
assigned to an identifiable intangible asset with the balance recorded as
goodwill. The primary purpose of the acquisition was to expand the Company's
market share near Dallas/Ft. Worth, Texas and along Interstate Highway 35 in
North Central Texas. Factors that contributed to a purchase price resulting in
goodwill include Bridgeport's historic record of earnings, capable management
and its geographic location which complements the Company's existing service
locations.
Results of Operations
Performance Summary. Net earnings for 2005 were $44.0 million, an increase
of $4.9 million, or 12.4% over net earnings for 2004 of $39.2 million. Net
earnings for 2003 were $35.3 million. The increase in net earnings for 2005 over
2004 was primarily attributable to growth in net interest income and noninterest
income, including a gain of $3.9 million, before tax, on the sale of our
ownership rights in the PULSE financial network. The increase in net earnings
for 2004 over 2003 was also primarily attributable to growth in net interest
income and noninterest income.
On a basic net earnings per share basis, net earnings were $2.13 for 2005
as compared to $1.90 for 2004 and $1.71 for 2003. Return on average assets was
1.80% for 2005 as compared to 1.82% for 2004 and 1.75% for 2003. Return on
average equity was 16.17% for 2005 as compared to 15.09% for 2004 and 14.40% for
2003.
Net Interest Income. Net interest income is the difference between interest
income on earning assets and interest expense on liabilities incurred to fund
those assets. Our earning assets consist primarily of loans and investment
securities. Our liabilities to fund those assets consist primarily of
noninterest-bearing and interest-bearing deposits. Tax-equivalent net interest
income was $100.0 million in 2005 as compared to $88.9 million in 2004 and $82.3
million in 2003. The increase in 2005 compared to 2004 was the result primarily
from the increase in the volume of our earning assets. The increase in 2004
compared to 2003 was the result of improving net interest spreads and increases
in volume of earning assets. Average earning assets were $2.229 billion in 2005,
as compared to $1.979 billion in 2004 and $1.856 billion in 2003. The 2005
increase in average earning assets is primarily attributable to our
acquisitions. The 2004 increase in average earning assets was attributable to
our acquisitions and strong loan growth. Table 1 allocates the change in
tax-equivalent net interest income between the amount of change attributable to
volume and to rate.
20
Table 1 - Changes in Interest Income and Interest Expense (in thousands):
2005 Compared to 2004 2004 Compared to 2003
------------------------------ -----------------------------
Change Attributable to Change Attributable to
------------------ Total ------------------ Total
Volume Rate Change Volume Rate Change
------- -------- -------- ------- ------- -------
Short-term investments .......... $ 493 $ 1,050 $ 1,543 $ (162) $ 111 $ (51)
Taxable investment securities ... 2,104 201 2,305 136 (734) (598)
Tax-exempt investment securities (1) 96 (337) (241) 2,484 (238) 2,246
Loans (1) ....................... 9,768 10,392 20,160 5,973 (2,052) 3,921
------- -------- -------- ------- ------- -------
Interest income ............. 12,461 11,306 23,767 8,431 (2,913) 5,518
Interest-bearing deposits ....... 2,464 9,066 11,530 551 (2,158) (1,607)
Short-term borrowings ........... 35 1,115 1,150 298 255 553
------- -------- -------- ------- ------- -------
Interest expense ............ 2,499 10,181 12,680 849 (1,903) (1,054)
------- -------- -------- ------- ------- -------
Net interest income (expense) $ 9,962 $ 1,125 $ 11,087 $ 7,582 $(1,010) $ 6,572
======= ======== ======== ======= ======= =======
______________
(1) Computed on a tax-equivalent basis assuming a marginal tax rate of 35%.
The net interest margin, which measures tax-equivalent net interest income
as a percentage of average earning assets, is illustrated in Table 2 for the
years 2003 through 2005. As the prime rate increased from 4.00% to 7.25% in 2004
and 2005, we repriced our earning assets where we were able and raised rates on
interest bearing deposits accordingly as the market allowed or required. However
due to the flat yield curve and the fact that almost half of our assets are
investment securities, our ability to maintain our net interest margin at 2004
levels came under pressure.
Table 2 - Average Balances and Average Yields and Rates (in thousands,
except percentages):
2005 2004 2003
------------------------- ------------------------- ------------------------
Average Income/ Yield/ Average Income/ Yield/ Average Income/ Yield/
Balance Expense Rate Balance Expense Rate Balance Expense Rate
--------- -------- ---- --------- ------ ---- --------- -------- ----
Assets
Short-term investments..... $ 61,059 $ 1,960 3.21% $ 28,032 $ 416 1.48% $ 42,643 $ 467 1.10%
Taxable investment securities 742,092 30,849 4.16 691,384 28,545 4.13 688,178 29,143 4.23
Tax-exempt investment
securities (1)............ 216,787 14,079 6.49 215,268 14,320 6.65 178,541 12,075 6.76
Loans (1)(2)............... 1,209,095 81,849 6.77 1,044,010 61,690 5.91 946,173 57,768 6.11
---------- -------- ---------- ------- ---------- --------
Total earning assets...... 2,229,033 128,737 5.78 1,978,694 104,971 5.31 1,855,535 99,453 5.36
Cash and due from banks.... 100,718 86,470 88,518
Bank premises and equipment 55,228 45,722 41,866
Other assets............... 26,155 23,292 21,825
Goodwill, net.............. 53,148 26,759 23,866
Allowance for loan losses.. (14,437) (12,596) (11,425)
---------- ---------- ----------
Total assets.............. $2,449,845 $2,148,341 $2,020,185
========== ========== ==========
Liabilities and Shareholders'
Equity
Interest-bearing deposits.. $1,563,709 $ 26,892 1.72% $1,350,992 $15,362 1.14 $1,308,485 $ 16,968 1.30
Short-term borrowings......
58,162 1,865 3.21 55,636 715 1.29 19,615 163 0.83
---------- -------- ---------- ------- ---------- --------
Total interest-bearing 1,621,871 28,757 1.77 1,406,628 16,077 1.14 1,328,100 17,131 1.29
-------- ------- --------
liabilities...............
Noninterest-bearing deposits 537,228 465,470 430,747
Other liabilities..........
18,448 16,741 16,210
---------- ---------- ----------
Total liabilities......... 2,177,547 1,888,839 1,775,057
Shareholders' equity.........
272,298 259,502 245,128
---------- ---------- ----------
Total liabilities and
shareholders' equity...... $2,449,845 $2,148,341 $2,020,185
========== ========== ==========
Net interest income.......... $ 99,980 $88,894 $ 82,322
======== ======= ========
Rate Analysis:
Interest income/earning
assets..................... 5.78% 5.31% 5.36%
Interest expense/earning
assets..................... 1.29 0.82 0.92
---- ---- ----
Net yield on earning assets 4.49% 4.49% 4.44%
==== ==== ====
_______________
(1) Computed on a tax-equivalent basis assuming a marginal tax rate of 35%.
(2) Nonaccrual loans are included in loans.
21
Noninterest Income. Noninterest income for 2005 was $44.2 million, an
increase of $5.4 million, or 13.8%, as compared to 2004. The increase is
primarily attributable to an increase in (1) service charges on deposits of $951
thousand as a result of our enhanced overdraft protection product, begun in the
second quarter of 2004, (2) gain on sale of PULSE ownership rights of $3.9
million, (3) an increase of $694 thousand in trust fees and (4) an increase of
$1.1 million in ATM and credit card fees primarily as a result of increased use
of debit cards. These increases were partially offset by (1) a $790 thousand
decrease in gain on sale of student loans and (2) a decrease of $241 thousand in
printed check income. The decline in student loan gain was due to the sale of
fewer loans, $61 million in 2005 as compared $80 million in 2004.
Noninterest income for 2004 was $38.8 million, an increase of $4.7 million,
or 13.8%, as compared to 2003. The increase was primarily attributable to an
increase in (1) service charges on deposits of $4.7 million as a result of our
enhanced overdraft protection product, (2) gain on sale of student loans of $696
thousand resulting from sales of $80 million in student loans in 2004 versus $70
million in 2003 and (3) securities gains of $363 thousand from sales of
securities to provide necessary liquidity for our acquisitions. These increases
were partially offset by (1) a $941 thousand decrease in mortgage origination
fees as rates rose and refinancing activity significantly declined and (2)
nonrecurring other real estate sales in 2003.
Table 3 provides comparisons for other categories of noninterest income.
Table 3 - Noninterest Income (in thousands):
Increase Increase
2005 (Decrease) 2004 (Decrease) 2003
------- ------- -------- ------- -------
Trust fees ..................................... $ 7,068 $ 694 $ 6,374 $ 356 $ 6,018
Service fees on deposit accounts ............... 21,381 951 20,430 4,683 15,747
Real estate mortgage fees ...................... 2,081 99 1,982 (941) 2,923
Net gain on sale of student loans .............. 1,802 (790) 2,592 696 1,896
ATM and credit card fees ....................... 4,961 1,053 3,908 372 3,536
Net gain on securities transactions ............ 235 (153) 388 363 25
Gain on sale of PULSE ownership rights ......... 3,895 3,985 -- -- --
Other:
Net gain on foreclosed assets ................ 60 (112) 172 (571) 743
Check printing fees .......................... 654 (241) 895 (16) 911
Safe deposit rental fees ..................... 419 24 395 (1) 396
Exchange fees ................................ 214 25 189 5 184
Credit life fees ............................. 84 (54) 138 8 130
Data processing fees ......................... 192 (2) 194 (55) 249
Brokerage commissions ........................ 227 (116) 343 32 311
Interest on loan recoveries .................. 235 121 (55)
114 169
Miscellaneous income ......................... 672 (37) 709 (162) 871
------- ------- -------- ------- -------
Total other ............................... 2,757 (392) 3,149 (815) 3,964
------- ------- -------- ------- -------
Total Noninterest Income ..................... $44,180 $ 5,357 $ 38,823 $ 4,714 $34,109
======= ======= ======== ======= =======
Noninterest Expense. Total noninterest expense for 2005 was $75.6 million,
an increase of $9.5 million, or 14.4%, as compared to 2004. Noninterest expense
for 2004 amounted to $66.1 million, an increase of $5.0 million or 8.1% as
compared to 2003. An important measure in determining whether a banking company
effectively manages noninterest expenses is the efficiency ratio, which is
calculated by dividing noninterest expense by the sum of net interest income on
a tax-equivalent basis and noninterest income. Lower ratios indicate better
efficiency since more income is generated with a lower noninterest expense
total. Our efficiency ratio for 2005 was 52.48% compared to 51.78% for 2004, and
52.52% for 2003. This increase in 2005 is primarily a result of our recent
acquisitions of less efficient banks, resulting in increased operating and
integration costs.
Salaries and employee benefits for 2005 totaled $40.3 million, an increase
of $4.8 million, or 13.5%, as compared to 2004. Salaries for 2005 were up $5.4
million with the increase attributable to normal pay increases and a higher
number of full time equivalent employees due to our acquisitions. Medical and
other benefits decreased $311 thousand in 2005 from 2004 due primarily to
favorable claims experience in the Company's self insured health plan. Profit
22
sharing expense for 2005 decreased $665 thousand, due to a lower overall
percentage increase in net income for 2005 compared to 2004. No profit sharing
was calculated on the PULSE gain.
Net occupancy expense for 2005 was up $847 thousand from the prior year,
principally due to higher utility costs, which reflect the current energy
market, higher real estate taxes and our acquisitions. Equipment expense was up
$658 thousand in 2005 over 2004 due to increased equipment depreciation expense
as a result of our continued investment in our technology infrastructure and our
acquisitions. Intangible asset amortization resulting from the core deposit
intangibles related to our acquisitions increased $518 thousand. Our ATM
expenses were $534 thousand more in 2005 than in 2004, primarily due to
increased debit card usage by our customers, as seen in the increase in income
above. Other professional fees in 2005 were $420 thousand more than in 2004,
principally due to costs associated with our internet banking products and
information technology consulting. Telephone expense was $203 thousand more in
2005 than in 2004 as a result of upgrading our voice and data network
infrastructure. Operational losses were $181 thousand more in 2005 than in 2004;
this increase is attributable to the increase in charge offs in our enhanced
overdraft product, which was also largely responsible for the $951 million
increase in service fees on deposit accounts noted above.
During 2005, the Company incurred conversion costs totaling approximately
$600 thousand related to the Clyde and Bridgeport acquisitions. Such amounts in
2004 for the Granbury and Glen Rose acquisition totaled approximately $210
thousand and were less due to the size and number of branches acquired. In
addition, in December 2004 and carrying through October 2005, we added branches
in Willow Park, Midlothian, Granbury, an in-store branch in Abilene and a
limited-service branch in a retirement center in Abilene that combined had a
negative impact on 2005 earnings due to start-up costs and relatively high
overhead for the initial volume of business.
Salaries and employee benefits for 2004 totaled $35.5 million, an increase
of $2.2 million, or 6.5%, as compared to 2003. Salaries for 2004 were up $1.6
million with the increase attributable to normal pay increases and a higher
number of full time equivalent employees due to our acquisitions. Medical and
other benefits decreased $190 thousand in 2004 from 2003 due primarily to lower
claims experience in the Company's self insured health plan. Profit sharing
expense for 2004 increased $1.3 million, due to the overall percentage increase
in net income for 2004 over 2003. Pension expense was $1.3 million less in 2004
than in 2003 as a result of our freezing the pension plan effective January 1,
2004, whereby no additional service costs will accrue in the future (unless the
plan is reinstated). This decrease in partially offset by the cost of our
matching of employee deferrals into our 401(k) plan, which amounted to $708
thousand in 2004. Effective January 1, 2004, we began matching a maximum of 4%
on employee deferrals of 5% of their compensation.
Net occupancy expense for 2004 was up $255 thousand from the prior year,
principally due to higher utility costs, which reflect the current energy market
and higher real estate taxes. Equipment expense was up $664 thousand in 2004
over 2003 due to increased equipment depreciation expense as a result of our
continued investment in our technology infrastructure and our expansion.
Intangible asset amortization resulting from the core deposit intangibles
related to our acquisitions increased by $27 thousand in connection with the
acquisitions by our Stephenville subsidiary. Data processing and operations fees
decreased $635 thousand due to our terminating a third party data processing
contract for item processing services for our eastern banks and bringing those
services in house as a part of our technology company. Costs associated with
these services are included in salaries and employee benefits and equipment
expense in 2004. Our ATM expenses were $262 thousand more in 2004 than in 2003,
primarily due to increased debit card usage by our customers. Other professional
fees in 2004 were $500 thousand more than in 2003, principally due to costs
associated with our enhanced overdraft protection products and information
technology consulting. Telephone expense was $137 thousand more in 2004 than in
2003 as a result of upgrading our voice and data network infrastructure.
Operational losses were $604 thousand more in 2004 than in 2003; this increase
is attributable to the increase in charge offs in our enhanced overdraft
product, which was also largely responsible for the $4.7 million increase in
service fees on deposit accounts noted above.
23
Table 4 - Noninterest Expense (in thousands):
Increase Increase
2005 (Decrease) 2004 (Decrease) 2003
-------- ------- -------- ------- --------
Salaries..................................... $ 32,388 $ 5,353 $ 27,035 $ 1,563 $ 25,472
Medical and other benefits................... 2,484 (311) 2,795 (190) 2,985
Profit sharing............................... 2,072 (665) 2,737 1,264 1,473
Pension...................................... 12 (80) 92 (1,277) 1,369
401(k) match expense......................... 868 160 708 708 -
Payroll taxes................................ 2,493 331 2,162 112 2,050
-------- ------- -------- ------- --------
Total salaries and employee benefits....... 40,317 4,788 35,529 2,180 33,349
Net occupancy expense........................ 5,043 847 4,196 255 3,941
Equipment expense............................ 6,191 658 5,533 664 4,869
Intangible amortization...................... 680 518 162 27 135
Other:
Data processing and operation fees......... 338 (67) 405 (635) 1,040
Postage.................................... 1,243 83 1,160 42 1,118
Printing, stationery and supplies.......... 1,988 272 1,716 5 1,711
Advertising................................ 1,453 186 1,267 81 1,186
Correspondent bank service charges......... 1,438 (139) 1,577 76 1,501
ATM expense................................ 2,311 534 1,777 262 1,515
Credit card fees........................... 597 67 530 24 506
Telephone.................................. 1,223 203 1,020 137 883
Public relations and business development.. 1,105 226 879 87 792
Directors' fees............................ 645 37 608 12 596
Audit and accounting fees.................. 1,334 266 1,068 178 890
Legal fees................................. 411 (23) 434 8 426
Professional and service fees.............. 2,056 420 1,636 500 1,136
Regulatory exam fees....................... 672 83 589 54 535
Travel..................................... 478 116 362 64 298
Courier expense............................ 799 62 737 (66) 803
Operational and other losses............... 1,327 181 1,146 604 542
Other miscellaneous expense................ 4,000 203 3,797 415 3,382
-------- ------- -------- ------- --------
Total other............................. 23,418 2,710 20,708 1,848 18,860
-------- ------- -------- ------- --------
Total Noninterest Expense.................... $ 75,649 $ 9,521 $ 66,128 $ 4,974 $ 61,154
======== ======= ======== ======= ========
Income Taxes. Income tax expense was $18.4 million for 2005 as compared to
$15.8 million for 2004 and $14.6 million for 2003. Our effective tax rates on
pretax income were 29.4%, 28.7% and 29.3%, respectively, for the years 2005,
2004 and 2003. The increase in the effective rate from 2004 to 2005 was
primarily due to less tax exempt investment and loan income as a percentage of
total income. The decrease in the effective tax rates from 2003 to 2004 was a
result of an increase in interest earned on tax exempt securities and the
deductibility of dividends paid to our employee stock ownership plan implemented
effective July 1, 2003.
Balance Sheet Review
Loans. Our portfolio is comprised of loans made to businesses, individuals,
and farm and ranch operations located in the primary trade areas served by our
subsidiary banks. Real estate loans represent loans primarily for new home
construction and owner-occupied real estate. The structure of loans in the real
estate mortgage classification generally provides repricing intervals to
minimize the interest rate risk inherent in long-term fixed rate mortgage loans.
As of December 31, 2005, total loans were $1,288.6 million, an increase of
$124.4 million, as compared to December 31, 2004. The increase is substantially
all from our Clyde and Bridgeport acquisitions. Increased competition in our
markets has had a negative impact on our ability to grow our loan portfolio. As
compared to year-end 2004, real estate loans increased $80.0 million and
commercial, financial and agriculture loans increased $25.0 million. Consumer
loans as of year-end 2005 increased $19.4 million as compared to 2004. Loans
averaged $1,209.1 million during 2005, an increase of $165.1 million over the
prior year average.
24
Table 5 - Composition of Loans (in thousands):
December 31,
-----------------------------------------------------------------
2005 2004 2003 2002 2001
------------ ----------- --------- --------- ---------
Commercial, financial and agricultural..... $ 410,191 $ 385,193 $ 333,840 $ 311,743 $ 312,053
Real estate - construction................. 112,892 107,148 77,834 50,911 47,173
Real estate - mortgage..................... 568,793 494,524 385,770 375,256 350,382
Consumer, net of unearned income........... 196,728 177,358 190,079 226,130 230,523
------------ ----------- --------- --------- ---------
$ 1,288,604 $ 1,164,223 $ 987,523 $ 964,040 $ 940,131
============ =========== ========= ========= =========
Table 6 - Maturity Distribution and Interest Sensitivity of Loans at
December 31, 2005 (in thousands):
The following tables summarize maturity and yield information for the
commercial, financial, and agricultural and the real estate-construction portion
of our loan portfolio as of December 31, 2005:
After One
Year
One Year Through After Five
or less Five Years Years Total
---------- ----------- ------------ ----------
Commercial, financial, and agricultural $ 249,477 $ 124,736 $ 35,978 $ 410,191
Real estate - construction........... 67,468 27,644 17,780 112,892
---------- ----------- ------------ ----------
$ 316,945 $ 152,380 $ 53,758 $ 523,083
========== =========== ============ ==========
Maturities
After One Year
------------
Loans with fixed interest rates.................... $ 101,304
Loans with floating or adjustable interest rates... 104,834
------------
$ 206,138
============
Asset Quality. Loan portfolios of each of our subsidiary banks are subject
to periodic reviews by our centralized independent loan review group as well as
periodic examinations by state and federal bank regulatory agencies. Loans are
placed on nonaccrual status when, in the judgment of management, the
collectibility of principal or interest under the original terms becomes
doubtful. Nonperforming assets, which consist of nonperforming loans and
foreclosed assets, were $4.2 million at December 31, 2005, as compared to $5.0
million at December 31, 2004 and $3.2 million at December 31, 2003. As a percent
of loans and foreclosed assets, nonperforming assets were 0.33% at December 31,
2005, as compared to 0.43% at December 31, 2004 and 0.32% at December 31, 2003.
The decrease in nonperforming assets is primarily due to collection of several
of our previously nonperforming assets. We consider the level of nonperforming
assets to be manageable and are not aware of any material classified credit not
properly disclosed as nonperforming at December 31, 2005.
Table 7 - Nonperforming Assets (in thousands, except percentages):
At December 31,
--------------------------------------------------------------
2005 2004 2003 2002 2001
------- ------- -------- ---------- ----------
Nonaccrual loans............................. $ 3,524 $ 4,142 $ 1,690 $ 3,716 $ 3,727
Loans still accruing and past due 90 days or more 15 120 61 14 66
Restructured loans........................... - - - - -
------- ------- -------- ---------- ----------
Nonperforming loans..................... 3,539 4,262 1,751 3,730 3,793
Foreclosed assets............................ 705 779 1,420 536 1,031
------- ------- -------- ---------- ----------
Total nonperforming assets.............. $ 4,244 $ 5,041 $ 3,171 $ 4,266 $ 4,824
======= ======= ======== ========== ==========
As a % of loans and foreclosed assets........ 0.33% 0.43% 0.32% 0.44% 0.51%
25
We record interest payments received on impaired loans as interest income
unless collections of the remaining recorded investment are doubtful, at which
time we record payments received as reductions of principal. We recognized
interest income on impaired loans of approximately $62,000, $127,000 and $46,000
during the years ended December 31, 2005, 2004, and 2003, respectively. For the
year ended December 31, 2005, there were no cash interest payments received and
recorded as interest income. For the years ended December 31, 2004 and 2003,
approximately $1,000 and $4,000, respectively, represented cash interest
payments received and recorded as interest income. If interest on impaired loans
had been recognized on a full accrual basis during the years ended December 31,
2005, 2004, and 2003, respectively, such income would have approximated
$163,000, $320,000 and $207,000.
Provision and Allowance for Loan Losses. The allowance for loan losses is
the amount we determine as of a specific date to be adequate to provide for
losses on loans that we deem are uncollectible. We determine the allowance and
the required provision expense by reviewing general loss experiences and the
performances of specific credits. The provision for loan losses was $1.3 million
for 2005 as compared to $1.6 million for 2004 and $1.2 million for 2003. The
decrease in 2005 over 2004 in our provision was due to favorable collection
activities and less loan growth than 2004. As a percent of average loans, net
loan charge-offs were 0.10% during 2005, 0.12% during 2004 and 0.09% during
2003. The allowance for loan losses as a percent of loans was 1.14% as of
December 31, 2005, as compared to 1.19% as of December 31, 2004. A key indicator
of the adequacy of the allowance for loan losses is the ratio of the allowance
to nonperforming loans, which consist of nonaccrual loans, loans past due 90
days, and restructured loans. This ratio for the past five years is disclosed in
Table 8. Table 9 provides an allocation of the allowance for loan losses based
on loan type and the percent of total loans that each major loan type
represents. Other than the loan types presented in Table 9, we had no loan
concentration at December 31, 2005 that represented more than 10% of total
loans.
Although we believe we use the best information available to make loan loss
allowance determinations, future adjustments could be necessary if circumstances
or economic conditions differ substantially from the assumptions used in making
our initial determinations. A downturn in the economy and employment could
result in increased levels of nonperforming assets and charge-offs, increased
loan loss provisions and reductions in income. Additionally, as an integral part
of their examination process, bank regulatory agencies periodically review our
allowance for loan losses. The banking agencies could require the recognition of
additions to the loan loss allowance based on their judgment of information
available to them at the time of their examination.
26
Table 8 - Loan Loss Experience and Allowance for Loan Losses (in thousands,
except percentages):
2005 2004 2003 2002 2001
---------- ---------- --------- --------- ---------
Balance at January 1,.............................. $ 13,837 $ 11,576 $ 11,219 $ 10,602 $ 9,888
Allowance established from purchase acquisitions... 793 1,858 - - 407
---------- ---------- --------- --------- ---------
14,630 13,434 11,219 10,602 10,295
Charge-offs:
Commercial, financial and agricultural........... 867 873 990 1,116 1,094
Consumer......................................... 1,088 1,075 1,186 1,471 1,498
All other........................................ 2 41 1 - 33
---------- ---------- --------- --------- ---------
Total charge-offs.................................. 1,957 1,989 2,177 2,587 2,625
Recoveries:
Commercial, financial and agricultural........... 213 342 867 288 269
Consumer......................................... 507 402 482 535 688
All other........................................ 6 15 7 11 11
---------- ---------- --------- --------- ---------
Total recoveries................................... 726 759 1,356 834 968
---------- ---------- --------- --------- ---------
Net charge-offs.................................... 1,231 1,230 821 1,753 1,657
Provision for loan losses.......................... 1,320 1,633 1,178 2,370 1,964
---------- ---------- --------- --------- ---------
Balance at December 31,............................ $ 14,719 $ 13,837 $ 11,576 $ 11,219 $ 10,602
========== ========== ========= ========= =========
Loans at year-end.................................. $1,288,604 $1,164,223 $ 987,523 $ 964,040 $ 940,131
Average loans...................................... 1,209,095 1,044,010 946,173 942,101 897,616
Net charge-offs/average loans...................... 0.10% 0.12% 0.09% 0.19% 0.18%
Allowance for loan losses/year-end loans........... 1.14 1.19 1.17 1.16 1.13
Allowance for loan losses/nonperforming loans...... 415.91 324.67 661.10 300.78 279.51
Table 9 - Allocation of Allowance for Loan Losses (in thousands):
2005 2004 2003 2002 2001
--------- -------- -------- --------- ---------
Allocation Allocation Allocation Allocation Allocation
Amount Amount Amount Amount Amount
--------- -------- -------- --------- ---------
Commercial, financial and agricultural........ $ 5,962 $ 6,293 $ 5,293 $ 3,628 $ 4,966
Real estate - construction.................... 855 922 669 592 415
Real estate - mortgage........................ 6,572 4,636 3,754 4,368 2,710
Consumer...................................... 1,330 1,986 1,860 2,631 2,511
--------- -------- -------- --------- ---------
Total..................................... $ 14,719 $ 13,837 $ 11,576 $ 11,219 $ 10,602
========= ======== ======== ========= =========
Percent of Total Loans:
2005 2004 2003 2002 2001
------ ------ ------ ------ ------
Commercial, financial and agricultural................ 31.83% 33.09% 33.81% 32.34% 33.19%
Real estate - construction............................ 8.76 9.20 7.88 5.28 5.02
Real estate - mortgage................................ 44.14 42.48 39.06 38.93 37.27
Consumer, net of unearned income...................... 15.27 15.23 19.25 23.45 24.52
Certain loans classified for regulatory purposes as doubtful, substandard,
or special mention are included in the nonperforming asset table. Also included
in classified loans are certain other loans that are deemed to be potential
problems. Potential problem loans are those loans that are currently performing
but for which known information about trends or uncertainties or possible credit
problems of the borrowers causes management to have serious doubts as to the
ability of such borrowers to comply with present repayment terms, possibly
resulting in the transfer of such loans to nonperforming status. These potential
problem loans totaled $842 thousand as of December 31, 2005.
27
Investment Securities. Investment securities totaled $1.046 billion as of
December 31, 2005, as compared to $854.3 million at December 31, 2004 and $910.3
million at December 31, 2003. At December 31, 2005, securities with an amortized
cost of $53.2 million were classified as securities held-to-maturity and
securities with a market value of $993.0 million were classified as securities
available-for-sale. As compared to December 31, 2004, the overall portfolio at
December 31, 2005, reflected (1) an increase of $72.8 million in U.S. Treasury
securities and obligations of U.S. government sponsored-enterprises and
agencies; (2) an increase of $11.5 million in obligations of states and
political subdivisions; (3) a $27.8 million increase in corporate bonds and
other securities; and (4) a $79.7 million increase in mortgage-backed
securities. These increases were due to our acquisitions and our investing our
funds to supplement our lower loan demand. As compared to December 31, 2003, the
portfolio at December 31, 2004 reflected (1) a decrease of $14.8 million in U.S.
Treasury securities and obligations of U.S. government sponsored-enterprises and
agencies; (2) a decrease of $6.8 million in obligations of states and political
subdivisions; (3) a $12.0 million decrease in corporate bonds and other
securities; and (4) a $22.4 million decrease in mortgage-backed securities. The
overall portfolio yield of 4.70 % at the end of 2005 was down slightly from the
prior year-end yield of 4.73% due to lower average interest rates offset by
somewhat higher rates earned on securities held by our acquired banks. We did
not hold any high risk collateralized mortgage obligations or structured notes
as of December 31, 2005. See Note 2 to the Consolidated Financial Statements for
additional disclosures relating to the maturities and fair values of the
investment portfolio at December 31, 2005 and 2004.
Table 10 - Composition of Investment Securities (dollars in thousands):
At December 31,
--------------------------------------------------------------------------------------
2005 2004 2003
-------------------------- ------------------------- -------------------------
Amortized Amortized Amortized
Held-to-Maturity: Cost Fair Value Cost Fair Value Cost Fair Value
----------------- ----------- ------------ ---------- ---------- ---------- ----------
U.S. Treasury securities
and obligations of
U.S. government
sponsored-enterprises
and agencies........... $ 21,749 $ 21,814 $ 52,387 $ 53,580 $ 78,224 $ 82,405
Obligations of states and
political subdivisions. 27,991 29,175 32,739 34,719 43,325 45,885
Corporate bonds........... 503 507 504 523 503 545
Mortgage-backed securities 2,919 2,981 4,436 4,648 9,274 9,759
Other securities.......... - - - - - -
----------- ------------ ---------- ---------- ---------- ----------
$ 53,162 $ 54,477 $ 90,066 $ 93,470 $ 131,326 $ 138,594
----------- ------------ ---------- ---------- ---------- ----------
Available-for-Sale:
-------------------
U.S. Treasury securities
and obligations of
U.S. government
sponsored-enterprises
and agencies........... $ 379,440 $ 373,529 $ 270,429 $ 270,079 $ 253,515 $ 259,000
Obligations of states and
political subdivisions. 200,997 203,997 181,453 187,728 178,287 183,904
Corporate bonds........... 53,774 53,521 22,135 22,635 36,103 37,798
Mortgage-backed securities 361,269 355,072 274,044 273,888 291,809 291,481
Other securities.......... 6,840 6,840 9,882 9,937 6,720 6,793
----------- ------------ ---------- ---------- ---------- ----------
1,002,320 992,959 757,943 764,267 766,434 778,976
----------- ------------ ---------- ---------- ---------- ----------
$ 1,055,482 $ 1,047,436 $ 848,009 $ 857,737 $ 897,760 $ 917,570
=========== ============ ========== ========== ========== ==========
28
Table 11 - Maturities and Yields of Investment Securities Held at
December 31, 2005 (in thousands, except percentages):
Maturing
----------------------------------------------------------------------------------------
After One Year After Five Years
One Year Through Through After
or Less Five Years Ten Years Ten Years Total
--------------- --------------- --------------- ---------------- ------------------
Held-to-Maturity: Amount Yield Amount Yield Amount Yield Amount Yield Amount Yield
- ----------------- -------- ----- -------- ----- -------- ----- -------- ----- -------- -----
Obligations of U.S.
government
sponsored-enterprises and
agencies.............. $ 21,749 5.37% - - - - - - $ 21,749 5.37%
Obligations of states and
political subdivisions.. 3,306 6.38% $ 18,236 7.30% $ 5,918 7.04% $ 531 6.98% 27,991 7.13%
Corporate bonds and other
securities.............. 500 6.17% - - - - 3 0.00% 503 6.12%
Mortgage-backed securities. 111 6.47% 2,350 6.02% 458 4.62% - - 2,919 5.82%
-------- ----- -------- ----- -------- ----- -------- ----- -------- -----
Total................... $ 25,666 5.52% $ 20,586 7.15% $ 6,376 6.87% $ 534 6.93% $ 53,162 6.33%
======== ======== ======== ======== ========
Maturing
----------------------------------------------------------------------------------------
After One Year After Five Years
One Year Through Through After
or Less Five Years Ten Years Ten Years Total
--------------- --------------- --------------- ---------------- ------------------
Available-for-Sale: Amount Yield Amount Yield Amount Yield Amount Yield Amount Yield
- ------------------- -------- ----- -------- ----- -------- ----- -------- ----- -------- -----
U.S. Treasury obligations.. $ 986 3.03% - - - - - - $ 986 3.03%
Obligations of U.S.
government
sponsored-enterprises and
agencies.............. 90,669 4.31% $281,874 3.68% - - - - 372,543 3.83%
Obligations of states and
political subdivisions.. 4,772 3.47% 58,703 6.71% $ 77,113 6.37% $ 63,409 5.77% 203,997 6.22%
Corporate bonds and other
securities.............. 11,632 4.49% 41,893 4.80% - - 6,836 4.58% 60,361 4.71%
Mortgage-backed
securities................. 49,576 4.22% 243,623 4.45% 61,847 4.93% 26 4.25% 355,072 4.50%
-------- ----- -------- ----- -------- ----- -------- ----- -------- -----
Total................... $157,635 4.26% $626,093 4.32% $138,960 5.73% $ 70,271 5.66% $992,959 4.61%
======== ======== ======== ======== ========
Maturing
----------------------------------------------------------------------------------------
After One Year After Five Years
One Year Through Through After
or Less Five Years Ten Years Ten Years Total
--------------- --------------- --------------- ---------------- ------------------
Total Investment Securities: Amount Yield Amount Yield Amount Yield Amount Yield Amount Yield
- ---------------------------- -------- ----- -------- ----- -------- ----- -------- ----- ---------- -----
U.S. Treasury obligations.. $ 986 3.03% - - - - - - $ 986 3.03%
Obligations of U.S.
government
sponsored-enterprises and
agencies.............. 112,418 4.52% 281,874 3.68% - - - - 394,292 3.92%
Obligations of states and
political subdivisions.. 8,078 4.66% 76,939 6.85% $ 83,031 6.42% $ 63,940 5.78% 231,988 6.33%
Corporate bonds and other
securities.............. 12,132 4.56% 41,893 4.80% - - 6,839 4.57% 60,864 4.72%
Mortgage-backed
securities................. 49,687 4.22% 245,973 4.47% 62,305 4.92% 26 4.25% 357,991 4.51%
-------- ----- -------- ----- -------- ----- -------- ----- ---------- -----
Total................. $183,301 4.44% $646,679 4.41% $145,336 5.78% $ 70,805 5.67% $1,046,121 4.70%
======== ======== ======== ======== ==========
All yields are computed on a tax-equivalent basis assuming a marginal tax rate
of 35%. Yields on available-for-sale securities are based on amortized cost.
Maturities of mortgage-backed securities are based on contractual maturities and
could differ due to prepayments of underlying mortgages.
29
Table 12 - Disclosure of Investment Securities with Continuous Unrealized Loss
The following table discloses, as of December 31, 2005, our investment
securities that have been in a continuous unrealized-loss position for less than
12 months and those that have been in a continuous unrealized-loss position for
12 or more months (in thousands):
Less than 12 Months 12 Months or Longer Total
----------------- ----------------- ------------------
Fair Unrealized Fair Unrealized Fair Unrealized
Value Loss Value Loss Value Loss
-------- ------ -------- ------ -------- -------
U. S. Treasury securities and
obligations of U.S. government
sponsored-enterprises
and agencies ................. $135,865 $1,470 $153,276 $4,536 $289,141 $ 6,006
Obligations of state and
political subdivisions ....... 42,665 493 28,479 1,072 71,144 1,565
Mortgage-backed securities ..... 231,215 2,636 101,289 3,634 332,504 6,270
Corporate and other securities . 34,583 326 -- -- 34,583 326
-------- ------ -------- ------ -------- -------
Total ....................... $444,328 $4,925 $283,044 $9,242 $727,372 $14,167
======== ====== ======== ====== ======== =======
The number of investment positions in this unrealized loss position totals
752. We do not believe these unrealized losses are "other than temporary" as (1)
we have the ability and intent to hold the investments to maturity, or a period
of time sufficient to allow for a recovery in market value, (2) it is not
probable that we will be unable to collect the amounts contractually due and (3)
no decision to dispose of the investments was made prior to the balance sheet
date. The unrealized losses noted are interest rate related due to rising
short-term and intermediate interest rates at December 31, 2005. The duration of
these investments is less than 5 years for all securities other than the
municipal bonds, which is less than 15 years. We have not identified any issues
related to the ultimate repayment of principal as a result of credit concerns on
these securities.
Deposits. Deposits held by subsidiary banks represent our primary source of
funding. Total deposits were $2.366 billion as of December 31, 2005, as compared
to $1.994 billion as of December 31, 2004 and $1.796 billion as of December 31,
2003. Table 13 provides a breakdown of average deposits and rates paid over the
past three years and the remaining maturity of time deposits of $100,000 or
more.
Table 13 - Composition of Average Deposits and Remaining Maturity of
Time Deposits of $100,000 or More (in thousands, except
percentages):
2005 2004 2003
------------------------ ------------------------- ------------------------
Average Average Average Average Average Average
Balance Rate Balance Rate Balance Rate
---------- ----- ---------- ----- ---------- -----
Noninterest-bearing deposits.... $ 537,228 - $ 465,470 - $ 430,747 -
Interest-bearing deposits
Interest-bearing checking.... 497,743 1.10% 373,733 0.48% 306,259 0.38%
Savings and money market
accounts................... 414,307 1.03 424,011 0.74 434,574 0.79
Time deposits under $100,000. 363,384 2.75 322,809 1.83 340,384 2.20
Time deposits of $100,000 or
more....................... 288,275 2.53 230,439 1.95 227,268 2.15
---------- ----- ---------- ----- ---------- -----
Total interest-bearing deposits 1,563,709 1.72% 1,350,992 1.14% 1,308,485 1.30%
---------- ===== ---------- ===== ---------- =====
Total average deposits.......... $2,100,937 $1,816,462 $1,739,232
========== ========== ==========
December 31, 2005
-----------------
Three months or less............................... $ 113,842
Over three through six months...................... 97,104
Over six through twelve months..................... 76,049
Over twelve months................................. 43,608
---------
Total time deposits of $100,000 or more.......... $ 330,603
=========
30
Capital Resources
We assess capital resources by our ability to maintain adequate regulatory
capital ratios to do business in the banking industry. Issues related to capital
resources arise primarily when we are growing at an accelerated rate but not
retaining a significant amount of our profits or when we experience significant
asset quality deterioration.
By way of background, total shareholders' equity was $276.3 million, or
10.1% of total assets, at December 31, 2005, as compared to $265.5 million, or
11.47% of total assets, at December 31, 2004. During 2005, total shareholders'
equity averaged $272.3 million, or 11.1% of average assets, as compared to
$259.5 million, or 12.08% of average assets, during 2004.
Banking regulators measure capital adequacy by means of the risk-based
capital ratio and leverage ratio. The risk-based capital rules provide for the
weighting of assets and off-balance-sheet commitments and contingencies
according to prescribed risk categories ranging from 0% to 100%. Regulatory
capital is then divided by risk-weighted assets to determine the risk-adjusted
capital ratios. The leverage ratio is computed by dividing shareholders' equity
less intangible assets by quarter-to-date average assets less intangible assets.
Regulatory minimums for risk-based and leverage ratios are 8.00% and 3.00%,
respectively. As of December 31, 2005, our total risk-based and leverage ratios
were 14.17% and 8.6%, respectively, as compared to total risk-based and leverage
ratios of 17.49% and 9.80% as of December 31, 2004. The decline in these ratios
is due to the regulatory treatment for intangible assets from our Clyde and
Bridgeport bank acquisitions in 2005. We believe by all measurements our capital
ratios remain well above regulatory minimums.
Interest Rate Risk. Interest rate risk results when the maturity or
repricing intervals of interest-earning assets and interest-bearing liabilities
are different. Our exposure to interest rate risk is managed primarily through
our strategy of selecting the types and terms of interest-earning assets and
interest-bearing liabilities that generate favorable earnings while limiting the
potential negative effects of changes in market interest rates. We use no
off-balance-sheet financial instruments to manage interest rate risk.
Each of our subsidiary banks has an asset liability committee that monitors
interest rate risk and compliance with investment policies; there is also a
holding company-wide committee that monitors the aggregate company's interest
rate risk and compliance with investment policies. Each subsidiary bank tracks
interest rate risk by, among other things, interest-sensitivity gap and
simulation analysis. Table 14 sets forth the interest rate sensitivity of our
consolidated assets and liabilities as of December 31, 2005, and sets forth the
repricing dates of our consolidated interest-earning assets and interest-bearing
liabilities as of that date, as well as our projected consolidated interest rate
sensitivity gap percentages for the periods presented. The table is based on our
estimates and assumptions as to when assets and liabilities will reprice in a
changing interest rate environment. Assets and liabilities indicated as maturing
or otherwise repricing within a stated period may, in fact, mature or reprice at
different times and at different volumes than those estimated. Also, the renewal
or repricing of certain assets and liabilities can be discretionary and subject
to competitive and other pressures. Therefore, the following table does not, and
cannot, necessarily indicate the actual future impact of general interest rate
movements on our consolidated net interest income.
Should we be unable to maintain a reasonable balance of maturities and
repricing of our interest-earning assets and our interest-bearing liabilities,
we could be required to dispose of our assets in an unfavorable manner or pay a
higher than market rate to fund our activities. Our asset liability committees
oversee and monitor this risk.
31
Table 14 - Interest Sensitivity Analysis (in thousands, except percentages):
December 31,
2005
Estimated
2006 2007 2008 2009 2010 Beyond Total Fair Value
---------- ---------- ---------- --------- --------- --------- ---------- ----------
Loans:
Fixed rate loans...... $ 148,189 $ 70,680 $ 99,865 $ 103,455 $ 88,009 $ 93,156 $ 603,354 $ 602,120
Average interest rate 6.99% 7.34% 6.91% 6.35% 6.91% 6.92% 6.89%
Adjustable rate loans 611,400 16,726 23,118 20,966 12,461 580 685,250 685,250
Average interest rate 7.55% 6.22% 6.41% 5.94% 7.15% 7.00% 7.08%
Investment securities:
Fixed rate securities 183,301 198,140 189,410 134,715 124,413 216,141 1,046,121 1,047,436
Average interest rate 4.40% 4.05% 4.14% 4.98% 4.87% 5.74% 4.70%
Adjustable rate
securities..........
Average interest rate
Other earning assets: 121,745
Adjustable rate other 121,745 - - - - - 121,745
Average interest rate 3.99% - - - - - 3.99%
---------- ---------- ---------- --------- --------- --------- ---------- ----------
Total interest sensitive 1,064,635 285,546 312,393 259,136 224,883 309,877 2,456,470 2,456,551
assets................
Average interest rate 6.52% 4.99% 5.19% 5.60% 5.80% 6.10% 5.87%
Interest-bearing
Deposits:
Fixed rate deposits. 602,419 69,139 12,302 14,070 10,915 191 709,036 706,788
Average interest rate 3.13% 3.61% 3.55% 4.10% 4.26% 2.37% 3.22%
Adjustable rate 1,028,992 4,854 195 38 7 - 1,034,086 1,034,086
deposits..............
Average interest rate 1.30% 3.93% 5.17% 1.25% 1.25% - 1.31%
Other interest-bearing
liabilities:
Adjustable rate other 74,239 - - - - - 74,239 74,239
Average interest rate 3.96% - - - - - 3.96%
---------- ---------- ---------- --------- --------- --------- ---------- ----------
Total interest sensitive
liabilities......... $1,705,650 $ 73,993 $ 12,497 $ 14,108 $ 10,922 $ 191 $1,817,361 $1,815,113
Average interest rate 2.06% 3.63% 3.58% 4.10% 4.26% 2.37% 2.16%
Interest sensitivity gap $ (641,015)$ 211,553 $ 299,896 $ 245,028 $ 213,961 $ 309,686 $ 639,109
Cumulative interest
sensitivity gap..... (641,015) (429,462) (129,566) 115,462 329,423 639,109
Ratio of interest
sensitive assets to
interest sensitive
liabilities......... 62.42%
Cumulative ratio of
interest sensitive
assets to interest
sensitive liabilities 62.42% 75.87% 92.77% 106.39% 118.13% 135.17%
Cumulative interest
sensitivity gap as a
percent of earning
assets.............. (26.09)% (17.48)% (5.27)% 4.70% 13.41% 26.02%
As of December 31, 2004, our 2005 interest-sensitivity gap was $482.1
million and our 2005 ratio of interest sensitive assets to interest sensitive
liabilities was 65.94%.
We estimate that, as of December 31, 2005, an upward shift of interest
rates by 150 basis points would result in a 2.7% increase in projected net
interest income over the next twelve months, and a downward shift of interest
rates by 150 basis points would result in a 5.4% reduction in projected net
interest income over the next twelve months. These are good faith estimates and
assume that the composition of our interest sensitive assets and liabilities
existing at each year-end will remain constant over the relevant twelve month
measurement period and that changes in market interest rates are instantaneous
and sustained across the yield curve regardless of duration of pricing
characteristics of specific assets or liabilities. Also, this analysis does not
contemplate any actions that we might undertake in response to changes in market
interest rates. We believe these estimates are not necessarily indicative of
what actually could occur in the event of immediate interest rate increases or
decreases of this magnitude. We also believe that it is unlikely that such
changes would occur in a short time period. As interest-bearing assets and
liabilities reprice in different time frames and proportions to market interest
rate movements, various assumptions must be made based on historical
relationships of these variables in reaching any conclusion. Since these
correlations are based on competitive and market conditions, we anticipate that
our future results will likely be different from the foregoing estimates, and
such differences could be material.
32
Liquidity
Liquidity is our ability to meet cash demands as they arise. Such needs can
develop from loan demand, deposit withdrawals or acquisition opportunities.
Potential obligations resulting from the issuance of standby letters of credit
and commitments to fund future borrowings to our loan customers are other
factors affecting our liquidity needs. Many of these obligations and commitments
are expected to expire without being drawn upon; therefore the total commitment
amounts do not necessarily represent future cash requirements affecting our
liquidity position. The potential need for liquidity arising from these types of
financial instruments is represented by the contractual notional amount of the
instrument, as detailed in Tables 15 and 16. Asset liquidity is provided by cash
and assets which are readily marketable or which will mature in the near future.
Liquid assets include cash, federal funds sold, and short-term investments in
time deposits in banks. Liquidity is also provided by access to funding sources,
which include core depositors and correspondent banks that maintain accounts
with and sell federal funds to our subsidiary banks. Other sources of funds
include our ability to borrow from short-term sources, such as purchasing
federal funds from correspondents and sales of securities under agreements to
repurchase, which amounted to $74.2 million at December 31, 2005, and an
unfunded $50.0 million line of credit established with a nonaffiliated bank
which matures on December 31, 2006.
On December 31, 2005, we renewed our loan agreement with The Frost National
Bank, pursuant to which the Company is permitted to draw up to $50.0 million on
a revolving line of credit. Interest is paid quarterly at LIBOR plus 100 basis
points. If a balance exists at December 31, 2006, the principal balance coverts
to a term facility payable quarterly over five years. The line of credit is
unsecured for an outstanding balance up to $25.0 million and secured by the
stock of a subsidiary bank should the balance exceed $25.0 million. Among other
provisions in the credit agreement, we must satisfy certain financial covenants
during the term of the loan agreement, including, without limitation, covenants
that require us to maintain certain capital, tangible net worth, loan loss
reserve, non-performing asset and cash flow coverage ratios. In addition, the
credit agreement contains certain operational covenants, that among others,
restrict the payment of dividends above 55% of consolidated net income, limit
the incurrence of debt (excluding any amounts acquired in an acquisition) and
prohibit the disposal of assets except in the ordinary course of business. Since
1995, we have historically declared dividends as a percentage of our
consolidated net income in a range of 37% (low) in 1995 to 53% (high) in 2003.
There was no outstanding balance under the line of credit as of December 31,
2005 or 2004. On December 2, 2005, we borrowed $1.5 million in connection with
our acquisition of Bridgeport Financial Corporation. The amount was repaid in
full on December 30, 2005.
Given the strong core deposit base and relatively low loan to deposit
ratios maintained at our subsidiary banks, we consider our current liquidity
position to be adequate to meet our short- and long-term liquidity needs.
In addition, we anticipate that any future acquisition of financial
institutions and expansion of branch locations could also place a demand on our
cash resources. Available cash at our parent company, which totaled $8.0 million
at December 31, 2005, available dividends from subsidiary banks which totaled
$17.1 million at December 31, 2005, utilization of available lines of credit,
and future debt or equity offerings are expected to be the source of funding for
these potential acquisitions or expansions.
-
Table 15 - Contractual Obligations As of December 31, 2005 (in thousands):
Payment Due by Period
-------------------------------------------------------------------
Less than 1 Over 5
Total Amounts year 1-3 years 4-5 years years
-------- -------- -------- -------- -------
Deposits with stated maturity dates... $728,589 $616,879 $ 86,490 $ 25,029 $ 191
Operating Leases...................... 1,475 564 662 241 8
Outsourcing Service Contracts......... 2,265 915 720 630 -
Long Term Debt........................ 4,000 - - - 4,000
-------- -------- -------- -------- -------
Total Contractual Obligations..... $736,329 $618,358 $ 87,872 $ 25,900 $ 4,199
======== ======== ======== ======== =======
Amounts above for deposits and long-term debt do not include related
accrued interest.
33
Off-Balance Sheet Arrangements. 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 unfunded
lines of credit, 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 our consolidated balance sheets.
Our exposure to credit loss in the event of nonperformance by the
counterparty to the financial instrument for unfunded lines of credit,
commitments to extend credit and standby letters of credit is represented by the
contractual notional amount of these instruments. We generally use the same
credit policies in making commitments and conditional obligations as we do for
on-balance-sheet instruments.
Unfunded lines of credit and commitments to extend credit are agreements to
lend to a customer as long as there is no violation of any condition established
in the contract. These commitments generally have fixed expiration dates or
other termination clauses and may require payment of a fee. Since many of the
commitments are expected to expire without being drawn upon, the total
commitment amounts do not necessarily represent future cash requirements. We
evaluate each customer's creditworthiness on a case-by-case basis. The amount of
collateral obtained, as we deem necessary upon extension of credit, is based on
our credit evaluation of the counterparty. Collateral held varies but may
include accounts receivable, inventory, property, plant, and equipment and
income-producing commercial properties.
Standby letters of credit are conditional commitments we issue to guarantee
the performance of a customer to a third party. The credit risk involved in
issuing letters of credit is essentially the same as that involved in extending
loan facilities to customers. The average collateral value held on letters of
credit usually exceeds the contract amount.
Table 16 - Commitments As of December 31, 2005 (in thousands):
Total Notional Less than 1 Over 5
Amounts Committed year 1-3 years 4-5 years years
-------- -------- ------- ------- --------
Unfunded lines of credit.............. $297,986 $291,547 $ 2,283 $ 188 $ 3,968
Unfunded commitments to extend credit. 72,337 54,186 5,105 5,683 7,363
Standby letters of credit............. 14,786 12,735 2,011 40 -
-------- -------- ------- ------- --------
Total Commercial Commitments $385,109 $358,468 $ 9,399 $ 5,911 $ 11,331
======== ======== ======= ======= ========
We believe we have no other off-balance sheet arrangements or transactions
with unconsolidated, special purpose entities that would expose us to liability
that is not reflected on the face of the financial statements.
Parent Company Funding. Our ability to fund various operating expenses,
dividends, and cash acquisitions is generally dependent solely on our own
earnings (without giving effect to our subsidiaries), cash reserves and funds
derived from our subsidiary banks. These funds historically have been produced
by intercompany dividends and management fees that are limited to reimbursement
of actual expenses. We anticipate that our recurring cash sources will continue
to include dividends and management fees from our subsidiary banks. At December
31, 2005, approximately $17.1 million was available for the payment of
intercompany dividends by the subsidiary banks without the prior approval of
regulatory agencies. Our subsidiary banks paid aggregate dividends of $29.3
million in 2005 and $37.4 million in 2004.
Dividends. Our long-term dividend policy is to pay cash dividends to our
shareholders of between 40% and 55% of net earnings while maintaining adequate
capital to support growth. The cash dividend payout ratios have amounted to
51.6%, 52.6% and 53.1% of net earnings, respectively, in 2005, 2004 and 2003.
Given our current strong capital position and projected earnings and asset
growth rates, we do not anticipate any significant change in our current
dividend policy. Also see "Payments of Dividends" on page 6.
Each state bank that is a member of the Federal Reserve System and each
national banking association is required by federal law to obtain the prior
approval of the Federal Reserve Board and the OCC, respectively, to declare and
pay dividends if the total of all dividends declared in any calendar year would
34
exceed the total of (1) such bank's net profits (as defined and interpreted by
regulation) for that year plus (2) its retained net profits (as defined and
interpreted by regulation) for the preceding two calendar years, less any
required transfers to surplus. In addition, these banks may only pay dividends
to the extent that retained net profits (including the portion transferred to
surplus) exceed bad debts (as defined by regulation).
To pay dividends, we and our subsidiary banks must maintain adequate
capital above regulatory guidelines. In addition, if the applicable regulatory
authority believes that a bank under its jurisdiction is engaged in or is about
to engage in an unsafe or unsound practice (which, depending on the financial
condition of the bank, could include the payment of dividends), the authority
may require, after notice and hearing, that such bank cease and desist from the
unsafe practice. The Federal Reserve Board and the OCC have each indicated that
paying dividends that deplete a bank's capital base to an inadequate level would
be an unsafe and unsound banking practice. The Federal Reserve Board, the OCC
and the FDIC have issued policy statements that recommend that bank holding
companies and insured banks should generally only pay dividends out of current
operating earnings.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Our management considers interest rate risk to be a significant market risk
for us. See "Item 7-Management's Discussion and Analysis of Financial Condition
and Results of Operations-Balance Sheet Review-Interest Rate Risk" for
disclosure regarding this market risk.
35
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Our consolidated financial statements begin on page F-1.
Quarterly Results of Operations (in thousands, except per share and common stock
data):
The following tables set forth certain unaudited historical quarterly
financial data for each of the eight consecutive quarters in fiscal 2005 and
2004. This information is derived from unaudited consolidated financial
statements that include, in our opinion, all adjustments (consisting of normal
recurring adjustments) necessary for a fair presentation when read in
conjunction with our consolidated financial statements and notes thereto
included elsewhere in this Form 10-K. All prices and per share data related to
our common stock have been adjusted to give effect to all stock splits and stock
dividends, including the four-for-three stock split in the form of a 33% stock
dividend effective June 1, 2005 for shareholders of record on May 16, 2005.
2005
---------------------------------------------------
4th 3rd 2nd 1st
--------- --------- --------- ---------
Summary Income Statement Information:
Interest income $ 33,811 $ 31,305 $ 30,294 $ 28,534
Interest expense 9,023 7,488 6,569 5,677
--------- --------- --------- ---------
Net interest income 24,788 23,817 23,725 22,857
Provision for loan losses 269 317 324 410
--------- --------- --------- ---------
Net interest income after provision for loan losses 24,519 23,500 23,401 22,447
Noninterest income 9,960 10,280 10,396 13,309
Net gain (loss) on securities transactions 6 46 143 40
Noninterest expense 19,521 18,725 18,861 18,542
--------- --------- --------- ---------
Earnings before income taxes 14,964 15,101 15,079 17,254
Income tax expense 4,383 4,338 4,475 5,179
--------- --------- --------- ---------
Net earnings $ 10,581 $ 10,763 $ 10,604 $ 12,075
========= ========= ========= =========
Per Share Data:
Net earnings per share, basic $ 0.51 $ 0.52 $ 0.51 $ 0.58
Net earnings per share, assuming dilution 0.51 0.52 0.51 0.58
Cash dividends declared 0.28 0.28 0.28 0.26
Book value at period-end 13.34 13.35 13.24 12.88
Common stock sales price: (1)
High $ 38.88 $ 36.22 $ 34.46 $ 34.99
Low 33.31 32.20 29.06 32.14
Close 35.06 34.83 33.84 33.47
36
2004
---------------------------------------------------
4th 3rd 2nd 1st
--------- --------- --------- ---------
Summary Income Statement Information:
Interest income $ 26,662 $ 25,391 $ 23,828 $ 24,011
Interest expense 4,699 4,094 3,575 3,627
--------- --------- --------- ---------
Net interest income 21,963 21,297 20,253 20,384
Provision for loan losses 614 532 308 178
--------- --------- --------- ---------
Net interest income after provision for loan losses 21,349 20,765 19,945 20,206
Noninterest income 9,380 9,818 9,353 9,885
Net gain (loss) on securities transactions 336 33 - 18
Noninterest expense 16,929 16,812 16,498 15,890
--------- --------- --------- ---------
Earnings before income taxes 14,136 13,804 12,800 14,219
Income tax expense 4,078 3,951 3,632 4,126
--------- --------- --------- ---------
Net earnings $ 10,058 $ 9,853 $ 9,168 $ 10,093
========= ========= ========= =========
Per Share Data:
Net earnings per share, basic $ 0.49 $ 0.48 $ 0.44 $ 0.49
Net earnings per share, assuming dilution 0.48 0.47 0.44 0.49
Cash dividends declared 0.26 0.26 0.26 0.23
Book value at period-end 12.84 12.79 12.07 12.75
Common stock sales price: (1)
High $ 34.46 $ 32.28 $ 31.97 $ 32.93
Low 30.00 28.51 28.53 28.31
Close 33.61 30.12 31.45 30.14
(1) These quotations reflect inter-dealer prices without retail mark-up,
mark-down or commission, and may not necessarily represent actual
transactions.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None
ITEM 9A. CONTROLS AND PROCEDURES
As of December 31, 2005, we carried out an evaluation, under the
supervision and with the participation of our management, including our
principal executive officer and principal financial officer, of the
effectiveness of the design and operation of our disclosure controls and
procedures pursuant to Securities Exchange Act Rule 15d-15. Our management,
including the principal executive officer and principal financial officer, does
not expect that our disclosure controls and procedures will prevent all errors
and all fraud.
A control system, no matter how well conceived and operated, can provide
only reasonable not absolute, assurance that the objectives of the control
system are met. Further, the design of a control system must reflect the fact
that there are resource constraints, and the benefits of controls must be
considered relative to their costs. Because of the inherent limitations in all
control systems, no evaluation of controls can provide absolute assurance that
all control issues and instances of fraud, if any, within the Company have been
detected. These inherent limitations include the realities that judgments in
decision-making can be faulty and that breakdowns can occur because of simple
error or mistake. Additionally, controls can be circumvented by the individual
acts of some persons, by collusion of two or more people, or by management
override of the control. The design of any system of controls also is based in
part upon certain assumptions about the likelihood of future events, and there
can be no assurance that any design will succeed in achieving its stated goals
under all potential future conditions; over time, controls may become inadequate
because of changes in conditions or the degree of compliance with the policies
or procedures may deteriorate. Because of the inherent limitations in a
cost-effective control system, misstatements due to error or fraud may occur and
not be detected. Our principal executive officer and principal financial officer
have concluded, based on our evaluation of our disclosure controls and
procedures, that our disclosure controls and procedures under Rule 13a-14 (c)
and Rule 15d-14 (c) of the Securities Exchange Act of 1934 are effective at the
reasonable assurance level as of December 31, 2005.
37
During the last fiscal quarter and subsequent to our evaluation, there were
no significant changes in internal controls or other factors that could
significantly affect these internal controls.
MANAGEMENT'S REPORT ON INTERNAL CONTROL OVER FINANICAL REPORTING
The Management of First Financial Bankshares, Inc. and subsidiaries is
responsible for establishing and maintaining adequate internal control over
financial reporting. First Financial Bankshares, Inc. and subsidiaries' internal
control system was designed to provide reasonable assurance to the Company's
management and board of directors regarding the preparation and fair
presentation of published financial statements.
All internal control systems, no matter how well designed, have inherent
limitations. Therefore, even those systems determined to be effective can
provide only reasonable assurance with respect to financial statement
preparation and presentation.
First Financial Bankshares, Inc. and subsidiaries' management assessed the
effectiveness of the Company's internal control over financial reporting as of
December 31, 2005. In making this assessment, it used the criteria set forth by
the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in
Internal Control - Integrated Framework. Based on our assessment we believe
that, as of December 31, 2005, the Company's internal control over financial
reporting, as such term is defined in Exchange Act Rule 13a-15(f), is effective
based on those criteria.
First Financial Bankshares, Inc. and subsidiaries' independent auditors have
issued an audit report, dated February 20, 2006, on our assessment of the
Company's internal control over financial reporting.
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
ON INTERNAL CONTROL OVER FINANCIAL REPORTING
To the Board of Directors and Shareholders of
First Financial Bankshares, Inc.
We have audited management's assessment, included in the accompanying
Management's Report on Internal Control over Financial Reporting, that First
Financial Bankshares, Inc. maintained effective internal control over financial
reporting as of December 31, 2005, based on criteria established in Internal
Control-Integrated Framework issued by the Committee of Sponsoring Organizations
of the Treadway Commission (the COSO criteria). First Financial Bankshares,
Inc.'s management is responsible for maintaining effective internal control over
financial reporting and for its assessment of the effectiveness of internal
control over financial reporting. Our responsibility is to express an opinion on
management's assessment and an opinion on the effectiveness of the Company's
internal control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether effective
internal control over financial reporting was maintained in all material
respects. Our audit included obtaining an understanding of internal control over
financial reporting, evaluating management's assessment, testing and evaluating
the design and operating effectiveness of internal control, and performing such
other procedures as we considered necessary in the circumstances. We believe
that our audit provides a reasonable basis for our opinion.
A company's internal control over financial reporting is a process designed to
provide reasonable assurance regarding the reliability of financial reporting
and the preparation of financial statements for external purposes in accordance
with generally accepted accounting principles. A company's internal control over
financial reporting includes those policies and procedures that (1) pertain to
the maintenance of records that, in reasonable detail, accurately and fairly
reflect the transactions and dispositions of the assets of the company; (2)
provide reasonable assurance that transactions are recorded as necessary to
permit preparation of financial statements in accordance with generally accepted
38
accounting principles, and that receipts and expenditures of the company are
being made only in accordance with authorizations of management and directors of
the company; and (3) provide reasonable assurance regarding prevention or timely
detection of unauthorized acquisition, use, or disposition of the company's
assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting
may not prevent or detect misstatements. Also, projections of any evaluation of
effectiveness to future periods are subject to the risk that controls may become
inadequate because of changes in conditions, or that the degree of compliance
with the policies or procedures may deteriorate.
In our opinion, management's assessment that First Financial Bankshares, Inc.
maintained effective internal control over financial reporting as of December
31, 2005, is fairly stated, in all material respects, based on the COSO
criteria. Also, in our opinion, First Financial Bankshares, Inc. maintained, in
all material respects, effective internal control over financial reporting as of
December 31, 2005, based on the COSO criteria.
We also have audited, in accordance with the standards of the Public Company
Accounting Oversight Board (United States), the 2005 consolidated financial
statements of First Financial Bankshares, Inc. and our report dated February 20,
2006 expressed an unqualified opinion thereon.
/s/ Ernst & Young LLP
Dallas, Texas
February 20, 2006
ITEM 9B. OTHER INFORMATION
None
39
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information required by Item 10 is hereby incorporated by reference
from our proxy statement for our 2006 annual meeting of shareholders.
ITEM 11. EXECUTIVE COMPENSATION
The information required by Item 11 is hereby incorporated by reference
from our 2006 proxy statement.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by Item 12 related to security ownership of
certain beneficial owners and management is hereby incorporated by reference
from our 2006 proxy statement. The following chart gives aggregate information
under our equity compensation plans as of December 31, 2005.
Number of Securities
Remaining Available
For Future Issuance
Number of Securities Under Equity
To be Issued Upon Weighted Average Compensation Plans
Exercise of Exercise Price of (Excluding Securities
Outstanding Options, Outstanding Options, Reflected in
Warrants and Rights Warrants and Rights Far Left Column)
------------------- ------------------- ----------------
Equity compensation plans
approved by security holders 241,485 $ 24.56 658,325
Equity compensation plans not
approved by security holders - - -
------- -------------- -------
Total 241,485 $ 24.56 658,325
======= ============== =======
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by Item 13 is hereby incorporated by reference
from our 2006 proxy statement.
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
The information required by Item 14 is hereby incorporated by reference
from our 2006 proxy statement.
40
PART IV
ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
(a) The following documents are filed as part of this report:
(1) Financial Statements -
Report of Independent Registered Public Accounting Firm
Report of Independent Registered Public Accounting Firm on Internal
Control Over Financial Reporting
Consolidated Balance Sheets as of December 31, 2005 and 2004
Consolidated Statements of Earnings for the years ended December 31,
2005, 2004 and 2003
Consolidated Statements of Comprehensive Earnings for the years
ended December 31, 2005, 2004 and 2003
Consolidated Statements of Shareholders' Equity for the years ended
December 31, 2005, 2004 and 2003
Consolidated Statements of Cash Flows for the years ended December 31,
2005, 2004 and 2003
Notes to the Consolidated Financial Statements
(2) Financial Statement Schedules -
These schedules have been omitted because they are not required, are
not applicable or have been included in our consolidated financial
statements.
(3) Exhibits -
The information required by this Item 15(a)(3) is set forth in the
Exhibit Index immediately following our signature pages. The exhibits
listed herein will be furnished upon written request to J. Bruce
Hildebrand, Executive Vice President, First Financial Bankshares,
Inc., 400 Pine Street, Abilene, Texas 79601, and payment of a
reasonable fee that will be limited to our reasonable expense in
furnishing such exhibits.
41
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
FIRST FINANCIAL BANKSHARES, INC.
Date: February 23, 2006 By: /s/ F. SCOTT DUESER
-----------------------------------------------
F. SCOTT DUESER
President, Chief Executive Officer and Director
The undersigned directors and officers of First Financial Bankshares, Inc.
hereby constitute and appoint J. Bruce Hildebrand, with full power to act and
with full power of substitution and resubstitution, our true and lawful
attorney-in-fact with full power to execute in our name and behalf in the
capacities indicated below any and all amendments to this report and to file the
same, with all exhibits thereto and other documents in connection therewith with
the Securities and Exchange Commission and hereby ratify and confirm all that
such attorney-in-fact or his substitute shall lawfully do or cause to be done by
virtue hereof.
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.
Name Title Date
---- ----- ----
/s/ KENNETH T. MURPHY Chairman of the Board and Director February 23, 2006
- ------------------------------------
Kenneth T. Murphy
/s/ F. SCOTT DUESER President, Chief Executive Officer February 23, 2006
- ------------------------------------ and Director
F. Scott Dueser (Principal Executive Officer)
/s/ J. BRUCE HILDEBRAND Executive Vice President and Chief February 23, 2006
- ------------------------------------ Financial Officer
J. Bruce Hildebrand (Principal Financial Officer and
Principal Accounting Officer)
/s/ JOSEPH E. CANON Director February 23, 2006
- ------------------------------------
Joseph E. Canon
/s/ MAC A. COALSON Director February 23, 2006
- ------------------------------------
Mac A. Coalson
/s/ DAVID COPELAND Director February 23, 2006
- ------------------------------------
David Copeland
42
Name Title Date
---- ----- ----
/s/ DERRELL E. JOHNSON Director February 23, 2006
- ------------------------------------
Derrell E. Johnson
/s/ KADE L. MATTHEWS Director February 23, 2006
- ------------------------------------
Kade L. Matthews
/s/ RAYMOND A. MCDANIEL, JR. Director February 23, 2006
- ------------------------------------
Raymond A. McDaniel, Jr.
/s/ BYNUM MIERS Director February 23, 2006
- ------------------------------------
Bynum Miers
/s/ JAMES M. PARKER Director February 23, 2006
- ------------------------------------
James M. Parker
/s/ JACK D. RAMSEY Director February 23, 2006
- ------------------------------------
Jack D. Ramsey
/s/ DIAN GRAVES STAI Director February 23, 2006
- ------------------------------------
Dian Graves Stai
/s/ F. L. STEPHENS Director February 23, 2006
- ------------------------------------
F. L. Stephens
/s/ JOHNNY TROTTER Director February 23, 2006
- ------------------------------------
Johnny Trotter
43
Item 6. Exhibits
(a) The following exhibits are filed as part of this report:
3.1 - Articles of Incorporation, and all amendments thereto, of the
Registrant (incorporated by reference from Exhibit 1 of the
Registrant' Amendment No. 2 to Form 8-A filed on Form 8-A/A No. 2 on
November 21, 1995).
3.2 - Amended and Restated Bylaws, and all amendments thereto, of the
Registrant (incorporated by reference from Exhibit 2 of the
Registrant's Amendment No. 1 to Form 8-A filed on Form 8-A/A No. 1 on
January 7, 1994).
3.3 - Amendment to the Articles of Incorporation of the Registrant, dated
April 27, 2004 (incorporated by reference from Exhibit 3.3 of the
Registrant's Form 10-Q Quarterly Report for the quarter ended March
31, 2004).
3.4 - Amendment to Amended and Restated Bylaws of the Registrant, dated
April 27, 1994 (incorporated by reference from Exhibit 3.4 of the
Registrant's Form 10-Q Quarterly Report for the quarter ended March
31, 2004).
3.5 - Amendment to Amended and Restated Bylaws of the Registrant, dated
October 23, 2001 (incorporated by reference from Exhibit 3.5 of the
Registrant's Form 10-Q Quarterly Report for the quarter ended March
31, 2004).
4.1 - Specimen certificate of First Financial Common Stock (incorporated
by reference from Exhibit 3 of the Registrant's Amendment No. 1 to
Form 8-A filed on Form 8-A/A No. 1 on January 7, 1994).
10.1 - Deferred Compensation Agreement, dated October 28, 1992, between the
Registrant and Kenneth T. Murphy (incorporated by reference from
Exhibit 10.1 of the Registrant's Form 10-K Annual Report for the year
ended December 31, 2002).
10.2 - Revised Deferred Compensation Agreement, dated December 28, 1995,
between the Registrant and Kenneth T. Murphy (incorporated by
reference from Exhibit 10.2 of the Registrant's Form 10-K Annual
Report for the year ended December 31, 2002).
10.3 - Executive Recognition Plan (incorporated by reference from Exhibit
10.3 of the Registrant's Form 10-K Annual Report for year ended
December 31, 2002).
10.4 - Form of Executive Recognition Agreement (incorporated by reference
from Exhibit 10.4 of the Registrant's Form 10-K Annual Report for the
year ended December 31, 2002).
10.5 - 1992 Incentive Stock Option Plan (incorporated by reference from
Exhibit 10.5 of the Registrant's Form 10-K Annual Report for the
fiscal year ended December 31, 1998).
10.6 - 2002 Incentive Stock Option Plan (incorporated by reference from
Appendix A of the Registrant's Schedule 14a Definitive Proxy Statement
for the 2002 Annual Meeting of Shareholders)
*10.7 - Revised Consulting Agreement dated January 1, 2006 between the
Registrant and Kenneth T. Murphy.
*21.1 - Subsidiaries of the Registrant.
23.1 - Consent of Ernst & Young LLP.
24.1 - Power of Attorney (included on signature page of this Form 10-K).
*31.1 - Rule 13a-14(a) / 15(d)-14(a) Certification of Chief Executive
Officer of First Financial Bankshares, Inc.
*31.2 - Rule 13a-14(a) / 15(d)-14(a) Certification of Chief Financial
Officer of First Financial Bankshares, Inc.
*32.1 - Section 1350 Certification of Chief Executive Officer of First
Financial Bankshares, Inc.
*32.2 - Section 1350 Certification of Chief Financial Officer of First
Financial Bankshares, Inc.
_____________
*Filed herewith
44
Exhibit 10.7
------------
CONSULTING AGREEMENT
This Consulting Agreement (the "Agreement") is made and entered into as of
the 1st day of January, 2006 (the "Effective Date"), by and between FIRST
FINANCIAL BANKSHARES, INC. (the "Company"), and KENNETH T. MURPHY ("Murphy").
WITNESSETH:
WHEREAS, following December 31, 2002, Murphy retired as an officer of the
Company, and served in a consulting capacity during the calendar years 2003
through 2005; and
WHEREAS, the Company recognizes the experience, leadership, knowledge and
relationships of Murphy continue to be of great value to the Company and its
Shareholders; and
WHEREAS, the Company desires to retain Murphy's services as a consultant to
be accessible to the executive management of the Company for advice as to
opportunities for growth and expansion, to review planning decisions, to build
relationships and develop strategies which are intended to enhance the business
interests of the Company for the benefit of its Shareholders (the "Services");
and
WHEREAS, Murphy is willing to provide the Services to the Company; and
WHEREAS, the parties desire to enter into this Agreement in a spirit of
mutual respect, congeniality, and a desire to work together in harmony for the
continued success of the Company;
NOW, THEREFORE, for and in consideration of the premises and of the mutual
representation, warranties, covenants and agreements contained herein, and of
other good and valuable consideration, the receipt and sufficiency of which are
hereby acknowledged, and upon the terms and subject to the conditions
hereinafter set forth, the parties, intending to be legally bound, hereby agree
as follows:
1. Duties and Term of Consultancy. The Company hereby engages Murphy, and
Murphy hereby accepts engagement, as a consultant to provide the Services as
reasonably requested by the Company. The term of this Agreement shall commence
on the Effective Date and continue for a period of twelve (12) months ending on
December 31, 2006.
2. Commitment of Time. No specific time requirement shall be a part of this
Agreement. Rather, Murphy shall be reasonably available during the term of this
Agreement, whether it be in his office or by telephone conference, to provide
the Services as requested by the Company.
3. Means to Perform Services. Murphy shall be provided the necessary means
for the performance of the Services, including an office and secretarial
support, use of the Company's aircraft for travel related to the provision of
the Services, use of membership in Abilene Country Club, and membership(s) in
appropriate state and national banking organizations as determined by the
Company.
4. Compensation for Services. As compensation for the Services rendered
under this Agreement, the Company shall pay Murphy a fee of $2,500.00 per month
and shall reimburse Murphy for his reasonable business expenses incurred in the
provision of the Services.
5. Termination. Either party hereto may terminate this Agreement without
cause upon thirty (30) days written notice to the other party. In the event of
termination of this Agreement prior to December 31, 2006, the Company shall pay
Murphy the amount earned through the date of termination. This Agreement and the
obligations of the Company shall terminate in the event of the death of Murphy
as of the date of death.
Consulting Agreement
Page 2
IN WITNESS WHEREOF, the parties hereto have signed this Agreement to take
effect as of January 1, 2006.
FIRST FINANCIAL BANKSHARES, INC.
By: /s/ F. Scott Dueser
-------------------
Name: F. Scott Dueser
Title: President and Chief Executive Officer
"Company"
/s/ Kenneth T. Murphy
---------------------
KENNETH T. MURPHY
"Murphy"
Exhibit 21.1
------------
SUBSIDIARIES OF REGISTRANT
Percentage of Voting
Names of Subsidiary Place of Organization Securities Owned
------------------- --------------------- ----------------
First Financial Bankshares of Delaware, Inc. Delaware 100%
First Financial Investments, Inc. Texas 100%
First Technology Services, Inc. Texas 100%**
Abilene, Texas
First Financial Trust & Asset Management Texas 100%**
Company, National Association*
Abilene, Texas
First Financial Bank, National Association* Texas 100%**
Abilene, Texas
Hereford State Bank Texas 100%**
Hereford, Texas
First National Bank, Sweetwater* Texas 100%**
Sweetwater, Texas
First Financial Bank, National Association* Texas 100%**
Eastland, Texas
First Financial Bank, National Association* Texas 100%**
Cleburne, Texas
First Financial Bank, National Association* Texas 100%**
Stephenville, Texas
San Angelo National Bank* Texas 100%**
San Angelo, Texas
Weatherford National Bank* Texas 100%**
Weatherford, Texas
First Financial Bank, National Association* Texas 100%**
Southlake, Texas
City National Bank* Texas 100%**
Mineral Wells, Texas
First Financial Insurance Agency, Inc. Texas 100%**
Abilene, Texas
*Federal charter.
**By First Financial Bankshares of Delaware, Inc.
Exhibit 23.1
------------
Consent of Independent Registered Public Accounting Firm
We consent to the incorporation by reference in the Registration Statement
(Form S-8 No. 333-114121) pertaining to the 2002 Incentive Stock Option Plan and
1992 Incentive Stock Option Plan for Key Employees of First Financial
Bankshares, Inc. and its Subsidiaries of our reports dated February 20, 2006,
with respect to the consolidated financial statements of First Financial
Bankshares, Inc., First Financial Bankshares, Inc.'s management's assessment of
the effectiveness of internal control over financial reporting, and the
effectiveness of internal control over financial reporting of First Financial
Bankshares, Inc. included in this Annual Report (Form 10-K) for the year ended
December 31, 2005.
/s/Ernst & Young LLP
Dallas, Texas
February 24, 2006
Exhibit 31.1
------------
Certification of
Chief Executive Officer
of First Financial Bankshares, Inc.
I, F. Scott Dueser, President and Chief Executive Officer of First
Financial Bankshares, Inc., certify that:
1. I have reviewed this Form 10-K of First Financial Bankshares, Inc.;
2. Based on my knowledge, this report does not contain any untrue statement
of a material fact or omit to state a material fact necessary to make the
statements made, in light of the circumstances under which such statements were
made, not misleading with respect to the period covered by this report;
3. Based on my knowledge, the financial statements, and other financial
information included in this report, fairly present in all material respects the
financial condition, results of operations and cash flows of the registrant as
of, and for the periods presented in this report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-15 (e) and 15d-15(e)) for the registrant and have:
a. Designed such disclosure controls and procedures, or caused such
disclosure controls and procedures to be designed under our
supervision, to ensure that material information relating to the
registrant, including its consolidated subsidiaries, is made known to
us by others within those entities, particularly during the period in
which this report is being prepared;
b. Designed such internal control over financial reporting, or caused
such internal control over financial reporting to be designed under
our supervision, to provide reasonable assurance regarding the
reliability of financial reporting and the preparation of financial
statements for external purposes in accordance with generally accepted
accounting principles;
c. Evaluated the effectiveness of the registrant's disclosure controls
and procedures and presented in this report our conclusions about the
effectiveness of the disclosure controls and procedures, as of the end
of the period covered by this report based on such evaluation; and
d. Disclosed in this report any change in the registrant's internal
control over financial reporting that occurred during the registrant's
most recent fiscal quarter that has materially affected, or is
reasonably likely to materially affect, the registrant's internal
control over financial reporting.
5. The registrant's other certifying officers and I have disclosed, based
on our most recent evaluation of internal control over financial reporting, to
the registrant's auditors and the audit committee of registrant's board of
directors (or persons performing the equivalent functions):
a. All significant deficiencies and material weaknesses in the design
or operation of internal control over financial reporting which are
reasonably likely to adversely affect the registrant's ability to
record, process, summarize and report financial information; and
b. Any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal control over financial reporting.
Date: February 20, 2006
By: /s/ F. SCOTT DUESER
-------------------
F. Scott Dueser
President and Chief Executive Officer
Exhibit 31.2
------------
Certification of
Chief Financial Officer
of First Financial Bankshares, Inc.
I, J. Bruce Hildebrand, Executive Vice President and Chief Financial
Officer of First Financial Bankshares, Inc., certify that:
1. I have reviewed this Form 10-K of First Financial Bankshares, Inc.;
2. Based on my knowledge, this report does not contain any untrue statement
of a material fact or omit to state a material fact necessary to make the
statements made, in light of the circumstances under which such statements were
made, not misleading with respect to the period covered by this report;
3. Based on my knowledge, the financial statements, and other financial
information included in this report, fairly present in all material respects the
financial condition, results of operations and cash flows of the registrant as
of, and for the periods presented in this report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-15 (e) and 15d-15(e)) for the registrant and have:
a. Designed such disclosure controls and procedures, or caused such
disclosure controls and procedures to be designed under our
supervision, to ensure that material information relating to the
registrant, including its consolidated subsidiaries, is made known to
us by others within those entities, particularly during the period in
which this report is being prepared;
b. Designed such internal control over financial reporting, or caused
such internal control over financial reporting to be designed under
our supervision, to provide reasonable assurance regarding the
reliability of financial reporting and the preparation of financial
statements for external purposes in accordance with generally accepted
accounting principles;
c. Evaluated the effectiveness of the registrant's disclosure controls
and procedures and presented in this report our conclusions about the
effectiveness of the disclosure controls and procedures, as of the end
of the period covered by this report based on such evaluation; and
d. Disclosed in this report any change in the registrant's internal
control over financial reporting that occurred during the registrant's
most recent fiscal quarter that has materially affected, or is
reasonably likely to materially affect, the registrant's internal
control over financial reporting.
5. The registrant's other certifying officers and I have disclosed, based
on our most recent evaluation of internal control over financial reporting, to
the registrant's auditors and the audit committee of registrant's board of
directors (or persons performing the equivalent functions):
a. All significant deficiencies and material weaknesses in the design
or operation of internal control over financial reporting which are
reasonably likely to adversely affect the registrant's ability to
record, process, summarize and report financial information; and
b. Any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal control over financial reporting.
Date: February 20, 2006
By: /s/ J. Bruce Hildebrand
-----------------------
J. Bruce Hildebrand
Executive Vice President and Chief Financial Officer
Exhibit 32.1
------------
Certification of
Chief Executive Officer
of First Financial Bankshares, Inc.
This certification is provided pursuant to Section 906 of the Sarbanes-Oxley Act
of 2002 (subsections (a) and (b) of Section 1350, Chapter 63 of Title 18, United
States code) and accompanies the annual report on Form 10-K (the "Form 10-K")
for the year ended December 31, 2005 of First Financial Bankshares, Inc.
I, F. Scott Dueser, the President and Chief Executive Officer of the Issuer
certify that:
1. the Form 10-K fully complies with the requirements of section 13(a) or
section 15(d) of the Securities Exchange Act of 1934 (15 U.S.C. 78m(a) or
78o(d)); and
2. the information contained in the Form 10-K fairly presents, in all material
respects, the financial condition and results of operations of the Company.
Dated: February 20, 2006
By: /s/ F. SCOTT DUESER
---------------------------
F. Scott Dueser
Chief Executive Officer
Subscribed and sworn to before me this 20th day of February, 2006.
/s/ Gaila N. Kilpatrick
- -----------------------
Gaila N. Kilpatrick
Notary Public
My commission expires: April 15, 2009
Exhibit 32.2
------------
Certification of
Chief Financial Officer
of First Financial Bankshares, Inc.
This certification is provided pursuant to Section 906 of the Sarbanes-Oxley Act
of 2002 (subsections (a) and (b) of Section 1350, Chapter 63 of Title 18, United
States code) and accompanies the annual report on Form 10-K (the "Form 10-K")
for the year ended December 31, 2005 of First Financial Bankshares, Inc.
I, J. Bruce Hildebrand, the Executive Vice President and Chief Financial Officer
of the Issuer certify that:
1. the Form 10-K fully complies with the requirements of section 13(a) or
section 15(d) of the Securities Exchange Act of 1934 (15 U.S.C. 78m(a) or
78o(d)); and
2. the information contained in the Form 10-K fairly presents, in all material
respects, the financial condition and results of operations of the Company.
Dated: February 20, 2006
By: /s/ J. Bruce Hildebrand
-----------------------
J. Bruce Hildebrand
Chief Financial Officer
Subscribed and sworn to before me this 20th day of February, 2006.
/s/ Gaila N. Kilpatrick
- -----------------------
Gaila N. Kilpatrick
Notary Public
My commission expires: April 15, 2009
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Shareholders of
First Financial Bankshares, Inc.
We have audited the accompanying consolidated balance sheets of First Financial
Bankshares, Inc. (a Texas corporation) and subsidiaries as of December 31, 2005
and 2004, and the related consolidated statements of earnings, comprehensive
earnings, shareholders' equity, and cash flows for each of the three years in
the period ended December 31, 2005. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of First Financial
Bankshares, Inc. and subsidiaries at December 31, 2005 and 2004, and the
consolidated results of their operations and their cash flows for each of the
three years in the period ended December 31, 2005, in conformity with U. S.
generally accepted accounting principles.
We also have audited, in accordance with the standards of the Public Company
Accounting Oversight Board (United States), the effectiveness of First Financial
Bankshares, Inc.'s internal control over financial reporting as of December 31,
2005, based on criteria established in Internal Control - Integrated Framework
issued by the Committee of Sponsoring Organizations of the Treadway Commission
and our report dated February 20, 2006, expressed an unqualified opinion
thereon.
/s/ Ernst & Young LLP
Dallas, Texas
February 20, 2006
F-1
FIRST FINANCIAL BANKSHARES, INC. AND SUBSIDIARIES
Consolidated Balance Sheets
December 31, 2005 and 2004
ASSETS 2005 2004
------ ---------------- ---------------
CASH AND DUE FROM BANKS $ 129,563,433 $ 94,508,165
FEDERAL FUNDS SOLD 120,950,000 99,750,000
---------------- ---------------
Total cash and cash equivalents 250,513,433 194,258,165
INTEREST-BEARING DEPOSITS IN BANKS 795,427 489,957
INVESTMENT SECURITIES:
Securities held-to-maturity (fair value of $54,476,828 in
2005 and $93,470,201 in 2004) 53,162,272 90,066,367
Securities available-for-sale, at fair value 992,958,988 764,267,168
---------------- ---------------
Total investment securities 1,046,121,260 854,333,535
LOANS 1,288,604,372 1,164,223,381
Less- allowance for loan losses (14,719,140) (13,837,133)
---------------- ---------------
Net loans 1,273,885,232 1,150,386,248
BANK PREMISES AND EQUIPMENT, net 60,093,497 49,740,268
INTANGIBLE ASSETS 68,326,158 40,546,052
OTHER ASSETS 34,092,096 25,470,206
---------------- ---------------
Total assets $ 2,733,827,103 $ 2,315,224,431
================ ===============
LIABILITIES AND SHAREHOLDERS' EQUITY
------------------------------------
NONINTEREST-BEARING DEPOSITS $ 623,155,842 $ 512,009,366
INTEREST-BEARING DEPOSITS 1,743,121,290 1,482,302,826
---------------- ---------------
Total deposits 2,366,277,132 1,994,312,192
DIVIDENDS PAYABLE 4,964,781 5,273,808
SHORT TERM BORROWINGS 74,238,976 35,691,608
OTHER LIABILITIES 12,070,407 14,401,439
---------------- ---------------
Total liabilities 2,457,551,296 2,049,679,047
---------------- ---------------
COMMITMENTS AND CONTINGENCIES
SHAREHOLDERS' EQUITY:
Common stock, $10 par value; authorized 40,000,000 shares;
20,714,401 and 15,511,576 issued and outstanding at
December 31, 2005 and 2004, respectively 207,144,010 155,115,760
Capital surplus 58,712,508 58,529,113
Retained earnings 19,434,606 49,834,536
Treasury stock (shares at cost: 145,322 and 100,189 at
December 31, 2005 and 2004, respectively) (2,592,413) (2,289,729)
Deferred Compensation 2,592,413 2,289,729
Accumulated other comprehensive earnings (loss) (9,015,317) 2,065,975
---------------- ---------------
Total shareholders' equity 276,275,807 265,545,384
---------------- ---------------
Total liabilities and shareholders' equity $ 2,733,827,103 $ 2,315,224,431
================ ===============
The accompanying notes are an integral part of these consolidated financial
statements.
F-2
FIRST FINANCIAL BANKSHARES, INC. AND SUBSIDIARIES
Consolidated Statements of Earnings
Years Ended December 31, 2005, 2004 and 2003
2005 2004 2003
------------- ------------- ------------
INTEREST INCOME:
Interest and fees on loans $ 81,486,600 $ 61,388,812 $ 57,531,240
Interest on investment securities:
Taxable 30,849,490 28,544,750 29,142,980
Exempt from federal income tax 9,648,054 9,623,939 8,143,832
Interest on federal funds sold and interest-bearing
deposits in banks 1,959,906 415,799 466,615
------------- ------------- ------------
Total interest income 123,944,050 99,973,300 95,284,667
------------- ------------- ------------
INTEREST EXPENSE:
Interest on deposits 26,892,197 15,361,968 16,968,469
Other 1,864,969 715,256 162,402
------------- ------------- ------------
Total interest expense 28,757,166 16,077,224 17,130,871
------------- ------------- ------------
Net interest income 95,186,884 83,896,076 78,153,796
PROVISION FOR LOAN LOSSES 1,319,816 1,633,236 1,177,868
------------- ------------- ------------
Net interest income after provision for loan losses 93,867,068 82,262,840 76,975,928
------------- ------------- ------------
NONINTEREST INCOME:
Trust fees 7,068,138 6,374,257 6,017,962
Service fees on deposit accounts 21,380,623 20,430,157 15,747,288
ATM and credit card fees 4,960,988 3,907,913 3,535,751
Real estate mortgage fees 2,081,003 1,982,230 2,923,360
Net gain on securities transactions 235,367 387,554 24,984
Net gain on sale of student loans 1,801,899 2,591,506 1,895,977
Net gain on sale of PULSE ownership rights 3,894,684 - -
Net gain on sale of other real estate 60,517 172,482 743,180
Other 2,696,806 2,977,204 3,220,119
------------- ------------- ------------
Total noninterest income 44,180,025 38,823,303 34,108,621
------------- ------------- ------------
NONINTEREST EXPENSE:
Salaries and employee benefits 40,317,256 35,528,605 33,349,068
Net occupancy expense 5,043,187 4,195,906 3,941,428
Equipment expense 6,190,906 5,533,239 4,868,583
Printing, stationery and supplies 1,988,454 1,715,806 1,710,648
Correspondent bank service charges 1,438,010 1,577,009 1,501,142
Amortization of intangible assets 680,259 161,536 135,156
Other expenses 19,990,649 17,416,171 15,647,675
------------- ------------- ------------
Total noninterest expense 75,648,721 66,128,272 61,153,700
------------- ------------- ------------
EARNINGS BEFORE INCOME TAXES 62,398,372 54,957,871 49,930,849
INCOME TAX EXPENSE 18,375,392 15,786,632 14,626,049
------------- ------------- ------------
NET EARNINGS $ 44,022,980 $ 39,171,239 $ 35,304,800
============= ============= ============
NET EARNINGS PER SHARE, BASIC $ 2.13 $ 1.90 $ 1.71
============= ============= ============
NET EARNINGS PER SHARE, ASSUMING DILUTION $ 2.12 $ 1.89 $ 1.70
============= ============= ============
The accompanying notes are an integral part of these consolidated financial
statements.
F-3
FIRST FINANCIAL BANKSHARES, INC. AND SUBSIDIARIES
Consolidated Statements of Comprehensive Earnings
Years Ended December 31, 2005, 2004 and 2003
2005 2004 2003
------------- ------------- -------------
NET EARNINGS $ 44,022,980 $ 39,171,239 $ 35,304,800
OTHER ITEMS OF COMPREHENSIVE EARNINGS:
Change in unrealized gain/loss on investment securities
available-for-sale, before income tax (15,449,135) (5,830,474) (7,172,878)
Reclassification adjustment for realized gains on investment
securities included in net earnings, before income tax (235,367) (387,554) (24,984)
Minimum liability pension adjustment, before income tax (1,363,640) (1,604,046) 674,626
------------- ------------- -------------
Total other items of comprehensive earnings (17,048,142) (7,822,074) (6,523,236)
Income tax benefit related to other items of
comprehensive earnings 5,966,850 2,737,726 2,283,133
------------- ------------- -------------
COMPREHENSIVE EARNINGS $ 32,941,688 $ 34,086,891 $ 31,064,697
============= ============= =============
The accompanying notes are an integral part of these consolidated financial
statements.
F-4
FIRST FINANCIAL BANKSHARES, INC. AND SUBSIDIARIES
Consolidated Statements of Shareholders' Equity
Years Ended December 31, 2005, 2004 and 2003
Accumulated
Other
Comprehensive Total
Common Stock Capital Retained Treasury Stock Deferred Earnings Shareholders'
Shares Amount Surplus Earnings Shares Amounts Compensation (Losses) Equity
---------- ------------ ----------- ----------- ------- ----------- ---------- ----------- ------------
BALANCE, December 31,2002 12,364,201 $123,642,010 $58,087,687 $45,647,522 (78,758)$(1,567,605) $1,567,605 $11,390,426 $238,767,645
Net earnings - - - 35,304,800 - - - - 35,304,800
Five for four stock
split, effected in the
form of a 25% stock
dividend 3,092,995 30,929,950 - (30,929,950) - - - - -
Cash dividends declared,
$0.91 per share - - - (18,745,908) - - - - (18,745,908)
Stock issuances 23,483 234,830 165,493 - - - - - 400,323
Minimum liability pension
adjustment, net of
related income taxes - - - - - - - 438,507 438,507
Change in unrealized
gain(loss)on investment
in securities available-
for-sale, net of related
taxes - - - - - - - (4,678,610) (4,678,610)
Shares purchased in
connection with
directors' deferred
compensation plan, net - - - - (12,160) (366,999) 366,999 - -
---------- ------------ ----------- ----------- ------- ----------- ---------- ----------- ------------
BALANCE, December 31,2003 15,480,679 $154,806,790 $58,253,180 $31,276,464 (90,918)$(1,934,604) $1,934,604 $ 7,150,323 $251,486,757
Net earnings - - - 39,171,239 - - - - 39,171,239
Stock issuances 30,897 308,970 275,933 - - - - - 584,903
Cash dividends declared,
$1.00 per share - - - (20,613,167) - - - - (20,613,167)
Minimum liability pension
adjustment, net of
related income taxes - - - - - - - (1,042,630) (1,042,630)
Change in unrealized
gain(loss)on investment
in securities available-
for-sale, net of related
taxes - - - - - - - (4,041,718) (4,041,718)
Shares purchased in
connection with
directors' deferred
compensation plan, net - - - - (9,271) (355,125) 355,125 - -
---------- ------------ ----------- ----------- ------- ----------- ---------- ----------- ------------
BALANCE, December 31,2004 15,511,576 $155,115,760 $58,529,113 $49,834,536(100,189)$(2,289,729) $2,289,729 $ 2,065,975 $265,545,384
(Continued)
F-5
Accumulated
Other
Comprehensive Total
Common Stock Capital Retained Treasury Stock Deferred Earnings Shareholders'
Shares Amount Surplus Earnings Shares Amounts Compensation (Losses) Equity
---------- ------------ ----------- ----------- ------- ----------- ---------- ----------- ------------
Four-for-three stock
split effected in the
form of a 33% stock
dividend 5,172,871 51,728,710 - (51,728,710)(35,298) - - - -
Net earnings - - - 44,022,980 - - - - 44,022,980
Stock issuances 29,954 299,540 128,636 - - - - - 428,176
Cash dividends declared,
$1.10 per share - - - (22,694,200) - - - - (22,694,200)
Minimum liability pension
adjustment, net of
related income taxes - - - - - - - (886,366) (886,366)
Change in unrealized
gain(loss)on investment
in securities available-
for-sale, net of related
taxes - - - - - - - (10,194,926) (10,194,926)
Additional tax benefit
related to directors'
deferred compensation
plan - - 54,759 - - - - - 54,759
Shares purchased in
connection with
directors' deferred
compensation plan, net - - - - (9,835) (302,684) 302,684 - -
---------- ------------ ----------- ----------- ------- ----------- ---------- ----------- ------------
BALANCE, December 31,2005 20,714,401 $207,144,010 $58,712,508 $19,434,606(145,322)$(2,592,413) $2,592,413 $(9,015,317) $276,275,807
========== ============ =========== =========== ======= =========== ========== =========== ============
The accompanying notes are an integral part of these consolidated financial
statements.
F-6
FIRST FINANCIAL BANKSHARES, INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows
Years Ended December 31, 2005, 2004 and 2003
2005 2004 2003
-------------- ------------- --------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net earnings $ 44,022,980 $ 39,171,239 $ 35,304,800
Adjustments to reconcile net earnings to net cash
provided by operating activities:
Depreciation and amortization 6,273,204 5,021,447 4,303,567
Provision for loan losses 1,319,816 1,633,236 1,177,868
Premium amortization, net of discount accretion 3,087,581 3,663,554 5,162,940
Gain on sale of assets (5,992,469) (3,151,539) (2,664,141)
Deferred federal income tax expense (benefit) 277,545 429,607 (90,828)
Loans originated for resale (158,121,586) (146,437,780) (149,873,382)
Proceeds from sale of loans held for resale 156,683,818 167,322,417 179,123,330
Change in other assets 1,095,506 (394,200) (158,175)
Change in other liabilities (7,709,073) 1,018,800 2,289,231
-------------- ------------- --------------
Total adjustments (3,085,658) 29,105,542 39,270,410
-------------- ------------- --------------
Net cash provided by operating activities 40,937,322 68,276,781 74,575,210
-------------- ------------- --------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Net decrease (increase) in interest-bearing deposits in banks (305,470) 386,882 1,447,587
Cash paid for acquisition of banks, less cash acquired 6,627,197 (6,297,264) -
Activity in available-for-sale securities:
Sales 85,032,949 22,590,627 50,617,175
Maturities 1,915,359,555 1,182,032,849 875,368,243
Purchases (2,167,727,922) (1,189,101,888) (1,148,629,137)
Activity in held-to-maturity securities:
Maturities 37,442,670 41,140,124 74,627,202
Purchases (620,000) - (2,365,000)
Net increase in loans (737,957) (118,447,031) (52,296,199)
Purchases of bank premises and equipment (10,316,540) (8,840,226) (7,108,990)
Proceeds from sale of other assets 5,639,596 85,538 66,722
-------------- ------------- --------------
Net cash used in investing activities (129,605,922) (76,450,389) (208,272,397)
-------------- ------------- --------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net increase in noninterest-bearing deposits 56,687,234 22,432,060 47,101,236
Net increase in interest-bearing deposits 77,889,442 78,996,103 37,607,717
Net increase in short-term borrowings 32,922,243 6,716,441 2,266,173
Common stock transactions:
Proceeds of stock issuances 428,176 584,903 400,323
Dividends paid (23,003,227) (20,138,307) (18,274,334)
-------------- ------------- --------------
Net cash provided by financing activities 144,923,868 88,591,200 69,101,115
-------------- ------------- --------------
NET (DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS 56,255,268 80,417,592 (64,596,072)
CASH AND CASH EQUIVALENTS, beginning of year 194,258,165 113,840,573 178,436,645
-------------- ------------- --------------
CASH AND CASH EQUIVALENTS, end of year $ 250,513,433 $ 194,258,165 $ 113,840,573
============== ============= ==============
The accompanying notes are an integral part of these consolidated financial
statements.
F-7
FIRST FINANCIAL BANKSHARES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2005, 2004 and 2003
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
-------------------------------------------
Nature of Operations
- --------------------
First Financial Bankshares, Inc. (a Texas corporation) ("Bankshares", "Company",
"we" or "us") is a financial holding company which owns (through its
wholly-owned Delaware subsidiary) all of the capital stock of ten banks located
in Texas as of December 31, 2005. Those subsidiary banks are First Financial
Bank, National Association, Abilene; Hereford State Bank; First National Bank,
Sweetwater; First Financial Bank, National Association, Eastland; First
Financial Bank, National Association, Cleburne; First Financial Bank, National
Association, Stephenville; San Angelo National Bank; Weatherford National Bank;
First Financial Bank, National Association, Southlake and City National Bank,
Mineral Wells. Each subsidiary bank's primary source of revenue is providing
loans and banking services to consumers and commercial customers in the market
area in which the subsidiary is located. In addition, the Company owns First
Financial Trust & Asset Management Company, National Association and First
Technology Services, Inc., an information technology subsidiary.
A summary of significant accounting policies of Bankshares and subsidiaries
(collectively, the "Company") applied in the preparation of the accompanying
consolidated financial statements follows. The accounting principles followed by
the Company and the methods of applying them are in conformity with both
accounting principles generally accepted in the United States and prevailing
practices of the banking industry.
Stock Split
- -----------
Average share information and earnings per share data related to our common
stock have been adjusted to give effect to all stock splits and stock dividends,
including the four-for-three stock split in the form of a 33% stock dividend
effective June 1, 2005 for shareholders of record on May 16, 2005.
Use of Estimates in Preparation of Financial Statements
- -------------------------------------------------------
The preparation of financial statements in conformity with accounting principles
generally accepted in the United States requires management to make estimates
and assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and reported amounts of revenues and expenses during the reporting
period. Actual results could differ from those estimates. Material estimates
that are particularly susceptible to significant change in the near term relate
to the determination of the allowance for loan losses, the valuations of
foreclosed real estate, deferred income tax assets, and the fair value of
financial instruments.
Consolidation
- -------------
The accompanying consolidated financial statements include the accounts of
Bankshares and its subsidiaries, all of which are wholly-owned. All significant
intercompany accounts and transactions have been eliminated.
Investment Securities
- ---------------------
Management classifies debt and equity securities as held-to-maturity,
available-for-sale, or trading based on its intent. Debt securities that
management has the positive intent and ability to hold to maturity are
classified as held-to-maturity and recorded at cost, adjusted for amortization
of premiums and accretion of discounts, which are recognized as adjustments to
interest income using the interest method. Securities not classified as
held-to-maturity or trading are classified as available-for-sale and recorded at
estimated fair value, adjusted for amortization of premiums and accretion of
discounts, with all unrealized gains and unrealized losses judged to be
temporary, net of deferred income taxes, excluded from earnings and reported as
a separate component of shareholders' equity. Available for-sale securities that
have unrealized losses that are judged other than temporary are included in gain
(loss) on sale of securities and a new cost basis is established. Securities
classified as trading are recorded at estimated fair value, with unrealized
gains and losses included in earnings. The Company had no trading securities at
December 31, 2005, 2004, or 2003.
F-8
Loans and Allowance for Loan Losses
- -----------------------------------
Loans are stated at the amount of unpaid principal, reduced by unearned income
and an allowance for loan losses. Interest on loans is calculated by using the
simple interest method on daily balances of the principal amounts outstanding.
Beginning in 2004, the Company defers and amortizes net loan origination fees
and costs as an adjustment to yield. Prior to 2004, the Company expensed its net
loan origination fees and costs, a method which did not materially differ from
deferring and amortizing such amounts as an adjustment to yield. The allowance
for loan losses is established through a provision for loan losses charged to
expense. Loans are charged against the allowance for loan losses when management
believes the collectibility of the principal is unlikely.
The allowance is an amount management believes will be adequate to absorb
estimated inherent losses on existing loans that are deemed uncollectible based
upon management's review and evaluation of the loan portfolio. The allowance for
loan losses is comprised of three elements: (i) specific reserves determined in
accordance with Statement of Financial Accounting Standards (SFAS) No. 114,
"Accounting by Creditors for Impairment of a Loan", as amended by SFAS 118 based
on probable losses on specific loans; (ii) general reserves determined in
accordance with SFAS No. 5, "Accounting for Contingencies", that consider
historical loss rates, loan classifications and other factors; and (iii) a
qualitative reserve determined in accordance with SFAS 5 based upon general
economic conditions and other qualitative risk factors both internal and
external to the Company. The allowance for loan losses is increased by charges
to income and decreased by charge-offs (net of recoveries). Management's
periodic evaluation of the adequacy of the allowance is based on general
economic conditions, the financial condition of borrowers, the value and
liquidity of collateral, delinquency, prior loan loss experience, and the
results of periodic reviews of the portfolio. For purposes of determining our
general allocations, all loans, other than consumer, are segregated by credit
grades which are assigned an allocation percentage. Our methodology is
constructed so that specific allocations are increased in accordance with
deterioration in credit quality and a corresponding increase in risk of loss. In
addition, we adjust our allowance for qualitative factors such as current
economic conditions and trends, changes in lending staff, policies and
procedures, changes in credit concentrations, changes in the trends and severity
of problem loans and changes in trends in volume and terms of loans. This
additional allocation based on qualitative factors serves to compensate for
additional areas of uncertainty inherent in our portfolio. Accrual of interest
is discontinued on a loan when management believes, after considering economic
and business conditions and collection efforts, the borrower's financial
condition is such that collection of interest is doubtful. Generally all loans
past due greater than 90 days are placed on non-accrual.
The Company's policy requires measurement of the allowance for an impaired
collateral dependent loan based on the fair value of the collateral. Other loan
impairments are measured based on the present value of expected future cash
flows or the loan's observable market price. At December 31, 2005 and 2004, all
significant impaired loans have been determined to be collateral dependent and
the allowance for loss has been measured utilizing the estimated fair value of
the collateral.
Loans Acquired in Acquisitions
- ------------------------------
Statement of Position (SOP) 03-3, "Accounting for Certain Loans or Debt
Securities Acquired in a Transfer" was issued in December 2003 and was effective
January 1, 2005. SOP 03-3 addresses the accounting for differences between
contractual cash flows and cash flows expected to be collected from a company's
initial investment in loans acquired if those differences are attributable, at
least in part, to credit quality. SOP 03-3 limits the yield that may be accreted
to the excess of the investor's estimate of undiscounted cash flows expected at
acquisition to be collected over the investor's initial investment in the loan.
SOP 03-3 requires that the excess of contractual cash flows over cash flows
expected to be collected not be recognized as an adjustment of yield, loss
accrual, or valuation allowance. SOP 03-3 prohibits the "carrying over" or
creating of a valuation allowance in the initial accounting for loans included
in the scope of SOP 03-3. We were required to apply the provisions of this SOP
in conjunction with our acquisition of Clyde Financial Corporation completed on
February 1, 2005 and Bridgeport Financial Corporation on December 1, 2005.
The Company's valuation allowances for all acquired loans subject to SOP 03-3
reflect only those losses incurred after acquisition; that is, the cash flows
expected at acquisition that are no longer expected to be collected.
F-9
Beginning in 2005, for certain acquired loans that have experienced
deterioration of credit quality between origination and the Company's
acquisition of the loans, the amount paid for the loans reflects our
determination that it is probable we will be unable to collect all amounts due
under the loan's contractual terms. At acquisition, we review each loan to
determine whether there is evidence of deterioration of credit quality since
origination and whether it is probable that we will be unable to collect all
amounts due according to the loan's contractual terms. We consider all
information, including expected prepayments, and estimate the amount and timing
of undiscounted expected principal, interest, and other cash flows (expected at
acquisition) for each loan. As these loans are generally problem loans, we
believe the estimation of cash flows is highly subjective. We estimate the
excess of the loan's scheduled contractual principal and contractual interest
payments over all cash flows expected at acquisition as an amount that should
not be accreted (nonaccretable difference). The remaining amount - representing
the excess of the loan's cash flows expected to be collected over the amount
paid - is accreted into interest income over the remaining life of the loan
(accretable yield).
Over the life of the loan, we continue to estimate cash flows expected to be
collected. We evaluate at the balance sheet date whether the present value of
our loans determined using the effective interest rates has decreased and if so,
recognize a loss. The present value of any subsequent increase in the loan's
actual cash flows or cash flows expected to be collected is used first to
reverse any existing valuation allowance for that loan. For any remaining
increases in cash flows expected to be collected, we adjust the amount of
accretable yield recognized on a prospective basis over the loan's remaining
life.
Other Real Estate
- -----------------
Other real estate is foreclosed property held pending disposition and is valued
at the lower of its fair value, less estimated costs to sell, or the recorded
investment in the related loan. At foreclosure, if the fair value, less
estimated costs to sell, of the real estate acquired is less than the Company's
recorded investment in the related loan, a write-down is recognized through a
charge to the allowance for loan losses. Any subsequent reduction in value is
recognized by a charge to income. Operating and holding expenses of such
properties, net of related income, and gains and losses on their disposition are
included in noninterest expense.
Bank Premises and Equipment
- ---------------------------
Bank premises and equipment are stated at cost less accumulated depreciation and
amortization. Depreciation and amortization are computed principally on a
straight-line basis over the estimated useful lives of the related assets.
Leasehold improvements are amortized over the life of the respective lease or
the estimated useful lives of the improvements, whichever is shorter.
Business Combinations, Goodwill and Other Intangible Assets
- -----------------------------------------------------------
The Company accounts for all business combinations under the purchase method of
accounting. Tangible and intangible assets and liabilities of the acquired
entity are recorded at fair value on the purchase date. Intangible assets with
finite useful lives continue to be amortized and goodwill and intangible assets
with indefinite lives are not amortized, but rather tested annually for
impairment.
Other identifiable intangible assets recorded by the Company represent the
future benefit associated with the acquisition of the core deposits and are
being amortized over seven years, utilizing a method that approximates the
expected attrition of the deposits.
The carrying amount of goodwill and other intangible assets arising from
acquisitions that qualify as an asset purchase for federal income tax purposes
amounting to approximately $43,600,000 and $29,000,000, respectively, at
December 31, 2005 and 2004, is deductible for federal income tax purposes.
F-10
Securities Sold Under Agreements To Repurchase
- ----------------------------------------------
Securities sold under agreements to repurchase, which are classified as short
term borrowings, generally mature within one to four days from the transaction
date. Securities sold under agreements to repurchase are reflected at the amount
of the cash received in connection with the transaction. The Company may be
required to provide additional collateral based on the estimated fair value of
the underlying securities.
Segment Reporting
- -----------------
The Company has determined that its banking subsidiaries meet the aggregation
criteria of SFAS No. 131, "Segment Disclosures and Related Information" since
each of its community banks offer similar products and services, operate in a
similar manner, have similar customers and report to the same regulatory
authority, and therefore operates one line of business (community banking)
located in a single geographic area (Texas).
Statements of Cash Flows
- ------------------------
For purposes of reporting cash flows, cash and cash equivalents include cash on
hand, amounts due from banks, and federal funds sold.
Accounting for Income Taxes
- ---------------------------
The Company's provision for income taxes is based on income before income taxes
adjusted for permanent differences between financial reporting and taxable
income. Deferred tax assets and liabilities are determined using the liability
(or balance sheet) method. Under this method, the net deferred tax asset or
liability is determined based on the tax effects of the temporary differences
between the book and tax bases of the various balance sheet assets and
liabilities and gives current recognition to changes in tax rates and laws.
Stock Based Compensation
- ------------------------
The Company grants stock options for a fixed number of shares to employees with
an exercise price equal to the fair value of the shares at the date of grant.
The Company accounts for stock option grants using the intrinsic value method
prescribed by APB Opinion No. 25, "Accounting for Stock Issued to Employees"
("APB 25"). Under APB 25, because the exercise price of the Company's employee
stock options equals the market price of the underlying stock on the date of
grant, no compensation expense is recognized. Had compensation cost for the plan
been determined consistent with SFAS No. 123, "Accounting for Stock-Based
Compensation," the Company's net earnings and earnings per share would have been
reduced by insignificant amounts on a pro forma basis for the years ended
December 31, 2005, 2004 and 2003. Note 15 provides additional information on the
Company's stock option plan.
In December 2004, SFAS No. 123R, "Share-Based Payment," was issued. SFAS No.
123R requires companies to recognize in the statement of earnings the grant-date
fair value of stock options issued to employees. The statement is effective for
the first quarter of 2006 and, due to the low volume of stock options granted
and outstanding, will not have a significant effect on the Company's earnings.
The Company will utilize the modified prospective method for transition to the
new rules whereby grants after January 1, 2006 will be measured and accounted
for under SFAS No. 123R, as will unvested awards granted prior to January 1,
2006.
Stock Repurchase
- ----------------
On April 22, 2003, the Company's Board of Directors authorized the repurchase of
up to 500,000 shares of common stock over the next three years. The plan
authorizes management to repurchase the stock at such time as repurchases are
considered beneficial to stockholders. Any repurchases of the stock will be
through the open market or in privately negotiated transactions in accordance
with applicable laws and regulations. No stock has been repurchased under this
plan as of December 31, 2005.
F-11
Per Share Data
- --------------
Net earnings per share ("EPS") are computed by dividing net earnings by the
weighted average number of shares of common stock outstanding during the period.
The Company calculates dilutive EPS assuming all outstanding options to purchase
common stock have been exercised at the beginning of the year (or the time of
issuance, if later.) The dilutive effect of the outstanding options is reflected
by application of the treasury stock method, whereby the proceeds from the
exercised options are assumed to be used to purchase common stock at the average
market price during the period. The following table reconciles the computation
of basic EPS to dilutive EPS:
Weighted
Net Average Per Share
Earnings Shares Amount
-------------- ---------- --------
For the year ended December 31, 2005:
Net earnings per share, basic $ 44,022,980 20,696,980 $ 2.13
Effect of stock options - 80,538
-------------- ----------
Net earnings per share, assuming dilution $ 44,022,980 20,777,518 $ 2.12
============== ========== ========
For the year ended December 31, 2004:
Net earnings per share, basic $ 39,171,239 20,659,020 $ 1.90
Effect of stock options - 92,880
-------------- ----------
Net earnings per share, assuming dilution $ 39,171,239 20,751,900 $ 1.89
============== ========== ========
For the year ended December 31, 2003:
Net earnings per share, basic $ 35,304,800 20,625,003 $ 1.71
Effect of stock options - 84,844
-------------- ----------
Net earnings per share, assuming dilution $ 35,304,800 20,709,847 $ 1.70
============== ========== ========
F-12
2. CASH AND INVESTMENT SECURITIES:
-------------------------------
The amortized cost, estimated fair values, and gross unrealized gains and losses
of the Company's investment securities as of December 31, 2005 and 2004, are as
follows:
December 31, 2005
--------------------------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Estimated
Cost Basis Holding Gains Holding Losses Fair Value
-------------- ---------- ------------ ------------
Securities held-to-maturity:
U.S. Treasury securities and
obligations of U.S. government
sponsored-enterprises and
agencies $ 21,748,608 $ 65,801 $ - $ 21,814,409
Obligations of state and
political subdivisions 27,990,540 1,242,555 (57,970) 29,175,125
Corporate bonds and other 503,904 2,470 - 506,374
Mortgage-backed securities 2,919,220 66,340 (4,640) 2,980,920
-------------- ---------- ------------ ------------
Total debt securities
held-to-maturity $ 53,162,272 $1,377,166 $ (62,610) $ 54,476,828
============== ========== ============ ============
Securities available-for-sale:
U.S. Treasury securities and
obligations of U.S.
government
sponsored-enterprises and
agencies $ 379,439,953 $ 95,659 $ (6,006,260) $373,529,352
Obligations of state and
political subdivisions 200,997,133 4,508,013 (1,507,653) 203,997,493
Corporate bonds and other 60,613,436 72,445 (326,012) 60,359,869
Mortgage-backed securities 361,269,041 68,542 (6,265,309) 355,072,274
-------------- ---------- ------------ ------------
Total securities available-for-sale $1,002,319,563 $4,744,659 $(14,105,234) $992,958,988
============== ========== ============ ============
F-13
December 31, 2004
------------------------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Estimated
Cost Basis Holding Gains Holding Losses Fair Value
------------ ----------- ----------- ------------
Securities held-to-maturity:
U.S. Treasury securities and
obligations of U.S. government
sponsored-enterprises and
agencies $ 52,387,273 $ 1,192,248 $ - $ 53,579,521
Obligations of state and
political subdivisions 32,739,113 2,007,304 (27,149) 34,719,268
Corporate bonds and other 503,574 19,211 - 522,785
Mortgage-backed securities 4,436,407 213,585 (1,365) 4,648,627
------------ ----------- ----------- ------------
Total debt securities
held-to-maturity $ 90,066,367 $ 3,432,348 ($28,514) $ 93,470,201
============ =========== =========== ============
Securities available-for-sale:
U.S. Treasury securities and
obligations of U.S.
government
sponsored-enterprises and
agencies $270,428,725 $ 1,665,048 ($2,014,637) $270,079,136
Obligations of state and
political subdivisions 181,453,403 7,175,105 (900,361) 187,728,147
Corporate bonds and other 32,017,330 555,062 - 32,572,392
Mortgage-backed securities 274,043,824 1,577,136 (1,733,467) 273,887,493
------------ ----------- ----------- ------------
Total securities available-for-sale $757,943,282 $10,972,351 ($4,648,465) $764,267,168
============ =========== =========== ============
The Company invests in mortgage-backed securities that have expected maturities
that differ from their contractual maturities. These differences arise because
borrowers may have the right to call or prepay obligations with or without a
prepayment penalty. These securities include collateralized mortgage obligations
(CMOs) and other asset backed securities. The expected maturities of these
securities at December 31, 2005 and 2004, were computed by using scheduled
amortization of balances and historical prepayment rates. At December 31, 2005
and 2004, the Company did not hold any CMOs that entail higher risks than
standard mortgage-backed securities.
F-14
The amortized cost and estimated fair value of debt securities at December 31,
2005, by contractual and expected maturity, are shown below.
Held-to-Maturity Available-for-Sale
----------------------------------------------------------------
Amortized Estimated Amortized Estimated
Cost Basis Fair Value Cost Basis Fair Value
----------- ----------- -------------- ------------
Due within one year $25,555,135 $25,636,024 $108,233,080 $108,058,910
Due after one year through five years 18,235,765 19,147,867 386,371,741 382,471,056
Due after five years through ten years 5,918,152 6,177,961 75,232,770 77,112,679
Due after ten years 534,000 534,056 71,212,931 70,244,069
----------- ----------- -------------- ------------
50,243,052 51,495,908 641,050,522 637,886,714
----------- ----------- -------------- ------------
Mortgage-backed securities 2,919,220 2,980,920 361,269,041 355,072,274
----------- ----------- -------------- ------------
Total $53,162,272 $54,476,828 $1,002,319,563 $992,958,988
=========== =========== ============== ============
The following table discloses, as of December 31, 2005, the Company's investment
securities that have been in a continuous unrealized-loss position for less than
12 months and those that have been in a continuous unrealized-loss position for
12 or more months (in thousands):
Less than 12 Months 12 Months or Longer Total
--------------------- ---------------------- ---------------------
Fair Unrealized Fair Unrealized Fair Unrealized
December 31, 2005 Value Loss Value Loss Value Loss
- ----------------- -------- ------ -------- ------ -------- -------
U. S. Treasury securities and
obligations of U.S. government
sponsored-enterprises
and agencies $135,865 $1,470 $153,276 $4,536 $ 289,141 $ 6,006
Obligations of state and
political subdivisions 42,665 493 28,479 1,072 71,144 1,565
Mortgage-backed securities 231,215 2,636 101,289 3,634 332,504 6,270
Corporate bonds 34,583 326 - - 34,583 326
-------- ------ -------- ------ -------- -------
Total $444,328 $4,925 $283,044 $9,242 $727,372 $14,167
======== ====== ======== ====== ======== =======
December 31, 2004
- -----------------
U. S. Treasury securities and
obligations of U.S. government
sponsored-enterprises
and agencies $148,525 $1,459 $ 15,669 $ 555 $164,194 $ 2,014
Obligations of state and
political subdivisions 22,598 265 19,635 662 42,233 927
Mortgage-backed securities 50,631 344 66,571 1,391 117,202 1,735
-------- ------ -------- ------ -------- -------
Total $221,754 $2,068 $101,875 $2,608 $323,629 $ 4,676
======== ====== ======== ====== ======== =======
The number of investment positions in this unrealized loss position totals 752.
We do not believe these unrealized losses are "other than temporary" as (1) the
Company has the ability and intent to hold the investments to maturity, or a
period of time sufficient to allow for a recovery in market value, (2) it is not
probable that the Company will be unable to collect the amounts contractually
due and (3) no decision to dispose of the investment were made prior to the
balance sheet date. The unrealized losses noted are interest rate related due to
rising short-term and intermediate interest rates at December 31, 2005. The
duration of these investments is less than 5 years for all securities other than
the municipal bonds, which is less than 15 years. We have not identified any
issues related to the ultimate repayment of principal as a result of credit
concerns on these securities.
F-15
Securities, carried at approximately $355,790,000 and $304,917,000 at December
31, 2005 and 2004, respectively, were pledged as collateral for public or trust
fund deposits and for other purposes required or permitted by law.
During 2005, 2004, and 2003, sales of investment securities that were classified
as available-for-sale totaled approximately $85,033,000, $22,591,000, and
$50,617,000 respectively. Gross realized gains and losses from 2005 securities
sales were approximately $401,000 and $166,000, respectively. Gross realized
gains for 2004 sales were approximately $388,000. There were no sales at losses
during 2004. Gross realized gains and losses from 2003 sales were approximately
$296,000 and $271,000, respectively. The specific identification method was used
to determine cost in computing the realized gains and losses.
Certain subsidiary banks are required to maintain reserve balances with the
Federal Reserve Bank. At December 31, 2005 and 2004, such balances totaled
approximately $4,828,000 and $8,298,000, respectively.
3. LOANS AND ALLOWANCE FOR LOAN LOSSES:
------------------------------------
Major classifications of loans are as follows:
December 31,
--------------------------------
2005 2004
-------------- --------------
Commercial, financial and agricultural $ 410,191,123 $ 385,193,304
Real estate - construction 112,892,111 107,148,495
Real estate - mortgage 568,792,718 494,524,409
Consumer 196,728,420 177,357,173
-------------- --------------
Total loans $1,288,604,372 $1,164,223,381
============== ==============
Included in real estate-mortgage and consumer loans above are $2.3 million and
$37.4 million, respectively, in loans held for sale at December 31, 2005 and
$2.6 million and $32.4 million, respectively, in loans held for sale at December
31, 2004 in which the carrying amounts approximate market.
The Company's recorded investment in impaired loans and the related valuation
allowance are as follows:
December 31, 2005 December 31, 2004
-------------------------- -------------------------
Recorded Valuation Recorded Valuation
Investment Allowance Investment Allowance
---------- ---------- ---------- ----------
$2,410,027 $ 528,068 $4,174,317 $ 941,989
========== ========== ========== ==========
F-16
The average recorded investment in impaired loans for the years ended December
31, 2005 and 2004, was approximately $3,292,000 and $2,958,000, respectively.
The Company had approximately $4,244,000 and $5,041,000 in nonperforming assets
at December 31, 2005 and 2004, respectively. No additional funds are committed
to be advanced in connection with impaired loans.
Interest payments received on impaired loans are recorded as interest income
unless collections of the remaining recorded investment are doubtful, at which
time payments received are recorded as reductions of principal. The Company
recognized interest income on impaired loans of approximately $62,000, $127,000
and $46,000 during the years ended December 31, 2005, 2004, and 2003,
respectively. For the year ended December 31, 2005, there were no cash interest
payments received and recorded as interest income. For the years ended December
31, 2004 and 2003, approximately $1,000 and $4,000, respectively, represented
cash interest payments received and recorded as interest income. If interest on
impaired loans had been recognized on a full accrual basis during the years
ended December 31, 2005, 2004, and 2003, respectively, such income would have
approximated $163,000, $320,000 and $207,000.
The allowance for loan losses as of December 31, 2005 and 2004, is presented
below. Management has evaluated the adequacy of the allowance for loan losses by
estimating the losses in various categories of the loan portfolio which are
identified below:
2005 2004
----------- -----------
Allowance for loan losses provided for:
Loans specifically evaluated as impaired $ 528,068 $ 941,989
Remaining portfolio 14,191,072 12,895,144
----------- -----------
Total allowance for loan losses $14,719,140 $13,837,133
=========== ===========
Changes in the allowance for loan losses are summarized as follows:
December 31,
-----------------------------------------------
2005 2004 2003
----------- ----------- -----------
Balance at beginning of year $13,837,133 $11,576,299 $11,218,729
Add:
Provision for loan losses 1,319,816 1,633,236 1,177,868
Loan recoveries 726,445 759,313 1,356,625
Allowance established from purchase acquisition 792,640 1,857,519 -
Deduct:
Loan charge-offs (1,956,894) (1,989,234) (2,176,923)
----------- ----------- -----------
Balance at end of year $14,719,140 $13,837,133 $11,576,299
=========== =========== ===========
An analysis of the changes in loans to officers, directors, principal
shareholders, or associates of such persons for the year ended December 31, 2005
(determined as of each respective year-end) follows:
Beginning Additional Ending
Balance Loans Payments Balance
----------- ----------- ------------ -----------
Year ended December 31, 2005 $61,252,634 $96,002,716 $101,701,620 $55,553,730
=========== =========== ============ ===========
In the opinion of management, those loans are on substantially the same terms,
including interest rates and collateral requirements, as those prevailing at the
time for comparable transactions with unaffiliated persons.
Certain of our subsidiary banks have established lines of credit with the
Federal Home Loan Bank of Dallas to provide liquidity and meet pledging
requirements for those customers eligible to have securities pledged to secure
F-17
certain uninsured deposits. At December 31, 2005, approximately $96,906,000 in
loans held by these subsidiaries were subject to blanket liens as security for
letters of credit issued under these lines of credit.
One of our subsidiary banks has a $20,000,000 unsecured line of credit with an
unrelated bank for liquidity purposes. This line is priced at the Federal funds
rate plus 100 basis points. There was no balance outstanding on this line of
credit at December 31, 2005.
During the year ended December 31, 2005, the Company sold student loans totaling
$61.3 million, recognizing a net profit of $1.8 million, to a financial
institution of which an executive officer of one of our wholly owned subsidiary
banks became a board member during 2005. In the opinion of management, these
loan sales are on substantially the same terms as those prevailing at the time
for comparable transactions with unaffiliated persons.
Loans within the scope of SOP 03-3 had an outstanding contractual balance of
$3,960,000 and carrying amount of $3,002,000 at December 31, 2005. The amount of
contractually required payments receivable totaled $6,311,000 and cash flows
expected to be collected totaled $5,088,000 as of December 31, 2005. No
accretion was recognized on loans with a carrying value of $848,000 due to
significant doubts regarding their collectibility.
The contractual required payments receivable, cash flows expected to be
collected, fair value of loans acquired and carrying value of loans in which no
accretion is being recognized, all at the applicable acquisition dates were
$4,315,000, $3,782,000, $2,603,000 and $144,000 for the Clyde acquisition and
$2,306,000, $1,727,000, $1,062,000 and $369,000 for the Bridgeport acquisition,
respectively.
4. BANK PREMISES AND EQUIPMENT:
----------------------------
The following is a summary of bank premises and equipment:
Useful Life December 31,
------------------------------------ -----------------------------
2005 2004
----------- -----------
Land $12,035,669 $10,703,363
Buildings 20 to 40 years 59,188,731 52,385,394
Furniture and equipment 3 to 10 years 40,076,756 32,949,949
Leasehold improvements Lesser of lease term or 5 to 15 years 8,461,958 8,313,171
----------- -----------
119,763,114 104,351,877
Less- accumulated depreciation and amortization (59,669,617) (54,611,609)
----------- -----------
$60,093,497 $49,740,268
=========== ===========
Depreciation expense for the years ended December 31, 2005, 2004 and 2003
amounted to $5,592,945, $4,859,912, and $4,168,411, respectively and is included
in the captions net occupancy expense and equipment expense in the accompanying
consolidated statements of earnings.
The Company is lessor for portions of its banking premises. Total rental income
for all leases included in net occupancy expense is approximately $1,675,000,
$1,630,000 and $1,605,000, for the years ended December 31, 2005, 2004, and
2003, respectively.
F-18
5. TIME DEPOSITS
-------------
Time deposits of $100,000 or more totaled approximately $330,603,000 and
$280,482,000 at December 31, 2005 and 2004, respectively. Interest expense on
these deposits was approximately $7,298,000, $4,500,000, and $4,885,000 during
2005, 2004, and 2003, respectively.
At December 31, 2005, the scheduled maturities of time deposits (in thousands)
were, as follows:
Year ending December 31,
------------------------
2006 $616,879
2007 73,993
2008 12,497
2009 14,108
2010 10,921
Thereafter 191
--------
$728,589
========
6. LINE OF CREDIT
--------------
Effective December 31, 2005, the Company renewed its line of credit with a
nonaffiliated bank under which it can borrow up to $50.0 million. The line of
credit is unsecured for outstanding balances less than $25 million and secured
by stock of a subsidiary bank if amounts borrowed exceed $25.0 million. The line
of credit matures on December 31, 2006. The Company paid no fee to secure the
unused line of credit and, accordingly, did not estimate a fair value of the
unused line of credit at December 31, 2005 or 2004. The line of credit carries
an interest rate of the London Interbank Offering Rate plus 1.0%. If a balance
exists at December 31, 2006, the principal balance converts to a term facility
payable quarterly over five years. Among other provisions in the credit
agreement, the Company must satisfy certain financial covenants during the term
of the loan agreement, including without limitation, covenants that require the
Company to maintain certain capital, tangible net worth, loan loss reserve,
non-performing asset and cash flow coverage ratios. In addition, the credit
agreement contains certain operational covenants, that among others, restrict
the payment of dividends above 55% of consolidated net income, limit the
incurrence of debt (excluding any amounts acquired in an acquisition) and
prohibit the disposal of assets except in the ordinary course of business.
Management believes the Company was in compliance with the financial covenants
at December 31, 2005. There was no outstanding balance under the line of credit
as of December 31, 2005 or 2004. On December 2, 2005, the Company borrowed $1.5
million in connection with its acquisition of Bridgeport Financial Corporation.
The amount was repaid in full on December 30, 2005.
F-19
7. INCOME TAXES:
-------------
The Company files a consolidated federal income tax return. Income tax expense
is comprised of the following:
Year Ended December 31,
-----------------------------------------------
2005 2004 2003
----------- ----------- -----------
Current federal income tax $18,097,847 $15,357,025 $14,716,877
Deferred federal income tax expense (benefit) 277,545 429,607 (90,828)
----------- ----------- -----------
Income tax expense $18,375,392 $15,786,632 $14,626,049
=========== =========== ===========
Income tax expense, as a percentage of pretax earnings, differs from the
statutory federal income tax rate as follows:
As a Percent of Pretax Earnings
-----------------------------------------------
2005 2004 2003
----------- ----------- -----------
Statutory federal income tax rate 35.0% 35.0% 35.0%
Reductions in tax rate resulting from
interest income exempt from
federal income tax (5.4)% (6.3)% (5.9)%
ESOP tax credit (0.3)% (0.4)% (0.2)%
Other 0.1% 0.4% 0.4 %
------ ------ ------
Effective income tax rate 29.4% 28.7% 29.3%
====== ====== ======
F-20
The approximate effects of each type of difference that gave rise to the
Company's deferred tax assets and liabilities at December 31, 2005 and 2004 are
as follows:
2005 2004
---------- ----------
Deferred tax assets:
Tax basis of loans in excess of financial statement basis $4,585,696 $4,279,065
Minimum liability in defined benefit plan 1,578,109 1,100,835
Recognized for financial reporting purposes but not
for tax purposes:
Deferred compensation 1,225,908 1,162,962
Write-downs and adjustments to other
real estate owned and repossessed assets 25,620 15,750
Net unrealized loss on investment securities
available-for-sale 3,276,293 -
Other deferred tax assets 224,318 223,972
---------- ----------
Total deferred tax assets 10,915,944 6,782,584
---------- ----------
Deferred tax liabilities:
Financial statement basis of fixed assets in excess of
tax basis 1,532,977 2,026,128
Intangible asset amortization deductible for tax purposes,
but not for financial reporting purposes 2,998,692 1,282,674
Recognized for financial reporting purposes but not
for tax purposes:
Accretion on investment securities 498,193 446,291
Pension plan contributions 322,452 326,757
Net unrealized gain on investment securities
available-for-sale - 2,213,282
Other deferred tax liabilities 195,567 117,829
---------- ----------
Total deferred tax liabilities 5,547,881 6,412,961
---------- ----------
Net deferred tax asset $5,368,063 $ 369,623
========== ==========
8. FAIR VALUE OF FINANCIAL INSTRUMENTS:
------------------------------------
The Company is required to disclose the estimated fair value of its financial
instrument assets and liabilities. For the Company, as for most financial
institutions, substantially all of its assets and liabilities are considered
financial instruments as defined. Many of the Company's financial instruments,
however, lack an available trading market as characterized by a willing buyer
and willing seller engaging in an exchange transaction.
Estimated fair values have been determined by the Company using the best
available data, as generally provided in the Company's regulatory reports, and
an estimation methodology suitable for each category of financial instruments.
For those loans and deposits with floating interest rates, it is presumed that
estimated fair values generally approximate the carrying value.
F-21
The estimated fair values and carrying values at December 31, 2005 and 2004,
were as follows:
2005 2004
----------------------------- ------------------------------
Carrying Estimated Carrying Estimated
Value Fair Value Value Fair Value
------------ ------------ ------------ -----------
Cash and due from banks $129,563,433 $129,563,433 $ 94,508,165 $94,508,165
Federal funds sold 120,950,000 120,950,000 99,750,000 99,750,000
Interest-bearing deposits in banks 795,427 795,427 489,957 489,957
Investment securities 1,046,121,260 1,047,435,816 854,333,535 857,737,369
Net loans 1,273,885,232 1,272,651,329 1,150,386,248 1,149,620,539
Accrued interest receivable 19,247,082 19,247,082 14,585,373 14,585,373
Deposits with stated maturities 709,035,509 706,788,465 590,458,655 591,035,189
Deposits with no stated
maturities 1,657,241,623 1,657,241,623 1,403,853,537 1,403,853,537
Short term borrowings 74,238,976 74,238,976 35,691,608 35,691,608
Accrued interest payable 3,337,888 3,337,888 1,545,678 1,545,678
Financial instruments actively traded in a secondary market have been valued
using quoted available market prices. Financial instruments with stated
maturities have been valued using a present value discounted cash flow with a
discount rate approximating current market for similar assets and liabilities.
Financial instrument assets with variable rates and financial instrument
liabilities with no stated maturities have an estimated fair value equal to both
the amount payable on demand and the carrying value. Changes in assumptions or
estimation methodologies may have a material effect on these estimated fair
values.
The carrying value and the estimated fair value of the Company's contractual
off-balance-sheet unfunded lines of credit, loan commitments and letters of
credit, which are generally priced at market at the time of funding, are not
material.
Reasonable comparability between financial institutions may not be likely due to
the wide range of permitted valuation techniques and numerous estimates which
must be made given the absence of active secondary markets for many of the
financial instruments. This lack of uniform valuation methodologies also
introduces a greater degree of subjectivity to these estimated fair values.
F-22
9. COMMITMENTS AND CONTINGENCIES:
------------------------------
The Company is engaged in legal actions arising from the normal course of
business. In management's opinion, the Company has adequate legal defenses with
respect to these actions, and the resolution of these matters will have no
material adverse effects upon the results of operations or financial condition
of the Company.
The Company leases a portion of its bank premises and equipment under operating
leases. At December 31, 2005, future minimum lease commitments were: 2006 -
$564,000; 2007 - $409,000; 2008 - $253,000; 2009 - $187,000; 2010 - $55,000 and
thereafter - $8,000.
10. FINANCIAL INSTRUMENTS WITH OFF-BALANCE-SHEET RISK:
--------------------------------------------------
The Company is a party to financial instruments with off-balance-sheet risk in
the normal course of business to meet the financing needs of its customers.
These financial instruments include unfunded lines of credit, 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 consolidated balance sheets.
The Company's exposure to credit loss in the event of nonperformance by the
other party to the financial instrument for unfunded lines of credit,
commitments to extend credit and standby letters of credit is represented by the
contractual notional amount of these instruments. The Company generally uses the
same credit policies in making commitments and conditional obligations as it
does for on-balance-sheet instruments.
Contract or
Notional Amount at
December 31, 2005
-----------------
Financial instruments whose contract amounts
represent credit risk:
Unfunded lines of credit $297,985,536
Unfunded commitments to extend credit 72,337,466
Standby letters of credit 14,786,440
------------
$385,109,442
============
Unfunded lines of credit and commitments to extend credit are agreements to lend
to a customer as long as there is no violation of any condition established in
the contract. These commitments generally have fixed expiration dates or other
termination clauses and may require payment of a fee. Since many of the
commitments are expected to expire without being drawn upon, the total
commitment amounts do not necessarily represent future cash requirements. The
Company evaluates each customer's creditworthiness on a case-by-case basis. The
amount of collateral obtained, if deemed necessary by the Company upon extension
of credit, is based on management's credit evaluation of the counterparty.
Collateral held varies but may include accounts receivable, inventory, property,
plant, and equipment, livestock, and income-producing commercial properties.
Standby letters of credit are conditional commitments issued by the Company to
guarantee the performance of a customer to a third party. The credit risk
involved in issuing letters of credit is essentially the same as that involved
in extending loan facilities to customers. The average collateral value held on
letters of credit usually exceeds the contract amount.
The Company has no other off-balance sheet arrangements or transactions that
would expose the Company to liability that is not reflected on the face of the
financial statements.
F-23
11. CONCENTRATION OF CREDIT RISK:
-----------------------------
The Company grants commercial, retail, agriculture and residential loans to
customers primarily in North Central and West Texas. Although the Company has a
diversified loan portfolio, a substantial portion of its debtors' ability to
honor their contracts is dependent upon this local economic sector.
12. PENSION AND PROFIT SHARING PLANS:
---------------------------------
The Company's defined benefit pension plan was frozen effective January 1, 2004
whereby no additional years of service accrue to participants, unless the
pension plan is reinstated at a future date. The pension plan covered
substantially all of the Company's employees. The benefits were based on years
of service and a percentage of the employee's qualifying compensation during the
final years of employment. The Company's funding policy was and is to contribute
annually the amount necessary to satisfy the Internal Revenue Service's funding
standards. Contributions to the pension plan, prior to freezing the plan, were
intended to provide not only for benefits attributed to service to date but also
for those expected to be earned in the future. As a result of freezing the
pension plan, we do not expect contributions or pension expense to be
significant in future years.
Using an actuarial measurement date of September 30, benefit obligation activity
and fair value of plan assets for the years ended December 31, 2005 and 2004,
and a statement of the funded status as of December 31, 2005 and 2004 are as
follows:
2005 2004
------------ ------------
Reconciliation of benefit obligations:
Benefit obligation at January 1 $ 16,396,300 $ 18,027,060
Interest cost on projected benefit obligation 1,013,104 991,728
Plan amendment - (3,473,440)
Actuarial loss 1,368,162 1,628,495
Benefits paid (834,980) (777,543)
------------ ------------
Benefit obligation at December 31 17,942,586 16,396,300
------------ ------------
Reconciliation of fair value of plan assets:
Fair value of plan assets at January 1 14,184,648 13,495,652
Actual return on plan assets 1,005,325 1,210,244
Employer contributions - 256,295
Benefits paid (834,980) (777,543)
------------ ------------
Fair value of plan assets at December 31 14,354,993 14,184,648
------------ ------------
Funded status $ (3,587,593) $ (2,211,652)
============ ============
Reconciliation of funded status to accrued
pension liability:
Funded status at December 31 $ (3,587,593) $ (2,211,652)
Unrecognized loss from past experience different than
that assumed and effects of changes in assumptions 4,831,688 3,468,046
Additional minimum liability recorded (4,831,688) (3,145,241)
Other - (322,805)
------------ ------------
Accrued pension liability $ (3,587,593) $ (2,211,652)
============ ============
The Company recorded an additional minimum liability in the year ended December
31, 2005 and 2004 to reflect the underfunded status of the plan. The accrued
pension liability at December 31, 2005 and 2004 represents the difference
between the fair value of plan assets and the accumulated benefit obligation.
The accumulated benefit obligation is the actuarial present value of benefits
attributed by the pension benefit formula to employee service rendered prior to
F-24
that date and based on current and past compensation levels. The accumulated
benefit obligation differs from the projected benefit obligation in that it
assumes no increase in future compensation. As the plan was frozen effective in
2004, the projected benefit obligation and the accumulated benefit obligation
are the same.
Net periodic pension cost for the years ended December 31, 2005, 2004, and 2003,
included:
Year Ended December 31,
---------------------------------------------
2005 2004 2003
--------- --------- ----------
Service cost - benefits earned during the period $ - $ - $1,118,607
Interest cost on projected benefit obligation 1,013,104 991,728 1,078,485
Expected return on plan assets (1,117,278) (1,102,084) (1,072,853)
Amortization of unrecognized net loss 116,473 26,421 226,405
Amortization of prior-service cost - - 17,961
Curtailment adjustment - 176,014 -
--------- --------- ----------
Net periodic pension cost $ 12,299 $ 92,079 $1,368,605
========= ========= ==========
The following table sets forth the rates used in the actuarial calculations of
the present value of benefit obligations and net periodic pension cost and the
rate of return on plan assets:
2005 2004 2003
----- ----- -----
Weighted average discount rate 5.85% 6.25% 6.50%
Rate of increase in future compensation levels - - 4.00%
Expected long-term rate of return on assets 7.75% 7.75% 8.50%
The expected long-term rate of return on plan assets is based on historical
returns and expectations of future returns based on asset mix, after
consultation with our investment advisors and actuaries. The expected long-term
rate of return was adjusted to 7.75% for 2004 after discussions with our
actuaries and investment advisors and taking into account the impact on
investment strategies from the plan being frozen. The weighted average discount
rate has been adjusted downward likewise to take into account declining
long-term bond yield rates.
The major type of plan assets in the pension plan and the targeted allocation
percentage as of December 31, 2005 and 2004 is as follows:
December 31, 2005 December 31, 2004 Targeted
Allocation Allocation Allocation
---------- ---------- ----------
Equity securities 58% 60% 60%
Debt securities 39% 33% 40%
Cash and equivalents 3% 7% -
The range and weighted average maturities of debt securities held in the pension
plan as of December 31, 2005 are one month to 15 years and approximately 4.6
years, respectively.
First Financial Trust & Asset Management Company, National Association, a wholly
owned subsidiary of the Company, manages the pension plan assets as well as the
profit sharing plan assets (see below). The investment strategy and targeted
allocations are based on similar strategies First Financial Trust & Asset
Management Company, National Association employs for most of its managed
accounts whereby appropriate diversification is achieved. First Financial Trust
& Asset Management Company, National Association is prohibited from holding
investments deemed to be high risk by the Office of the Comptroller of the
Currency.
F-25
An estimate of the undiscounted projected future payments to eligible
participants for the next five years and the following five years in the
aggregate is as follows (dollars in thousands):
Year Ending December 31,
------------------------
2006 $ 995
2007 1,068
2008 1,145
2009 1,213
2010 1,282
2011 and thereafter 7,320
-------
$13,023
=======
No contribution was made to the pension plan in 2005 or 2004 and no
contribution, either discretionary or by regulation, is expected in 2006.
As of December 31, 2005 and 2004, the pension plan's assets included Company
common stock valued at approximately $720,000 and $690,000, respectively.
The Company also provides a profit sharing plan, which covers substantially all
full-time employees. The profit sharing plan is a defined contribution plan and
allows employees to contribute up to 5% of their base annual salary. Employees
are fully vested to the extent of their contributions and become fully vested in
the Company's contributions over a seven-year vesting period. Costs related to
the Company's defined contribution plan totaled approximately $2,072,000,
$2,737,000 and $1,473,000 in 2005, 2004 and 2003, respectively, and are included
in salaries and employee benefits in the accompanying consolidated statements of
earnings. As of December 31, 2005 and 2004, the profit sharing plan's assets
included Company common stock valued at approximately $19,617,000 and
$19,035,000, respectively.
In 2004, we replaced our frozen pension plan with a matching of employee salary
deferrals into the 401(k) plan. Effective January 1, 2004, we match a maximum of
4% on employee deferrals of 5% of their employee compensation. Total expense for
this matching in 2005 and 2004 was $868,000 and $708,000 and is included in
salaries and employee benefits in the statement of earnings.
The Company has a directors' deferred compensation plan whereby the directors
may elect to defer up to 100% of their directors' fees. All deferred
compensation is invested in the Company's common stock held in a rabbi trust.
The stock is held in the name of the trustee, and the principal and earnings of
the trust are held separate and apart from other funds of the Company, and are
used exclusively for the uses and purposes of the deferred compensation
agreement. The accounts of the trust have been consolidated in the financial
statements of the Company.
13. DIVIDENDS FROM SUBSIDIARIES:
----------------------------
At December 31, 2005, approximately $17.1 million was available for the
declaration of dividends by the Company's subsidiary banks without the prior
approval of regulatory agencies.
14. REGULATORY MATTERS:
-------------------
The Company is subject to various regulatory capital requirements administered
by the federal banking agencies. Failure to meet minimum capital requirements
can initiate certain mandatory, and possibly additional discretionary, actions
by regulators that, if undertaken, could have a direct material effect on the
Company's financial statements. Under capital adequacy guidelines and the
regulatory framework for prompt corrective action, each of Bankshares'
subsidiaries must meet specific capital guidelines that involve quantitative
measures of the subsidiaries' assets, liabilities, and certain off-balance-sheet
items as calculated under regulatory accounting practices. The subsidiaries'
capital amounts and classification are also subject to qualitative judgments by
the regulators about components, risk weightings, and other factors.
F-26
Quantitative measures established by regulation to ensure capital adequacy
require Bankshares and each of its subsidiaries to maintain minimum amounts and
ratios (set forth in the table below) of total and Tier I capital (as defined in
the regulations) to risk-weighted assets (as defined), and of Tier I capital (as
defined) to average assets (as defined). Management believes as of December 31,
2005 and 2004, that Bankshares and each of its subsidiaries meet all capital
adequacy requirements to which they are subject.
As of December 31, 2005 and 2004, the most recent notification from each
respective subsidiaries' primary regulator categorized each of Bankshares'
subsidiaries as well-capitalized, with the exception of First Financial Bank,
N.A., Stephenville at December 31, 2004, under the regulatory framework for
prompt corrective action. To be categorized as well-capitalized, the
subsidiaries must maintain minimum total risk-based, Tier I risk-based, and
Tier I leverage ratios as set forth in the following table.
There are no conditions or events since that notification that management
believes have changed the institutions' categories. Bankshares' and its
significant subsidiaries' actual capital amounts and ratios are presented in the
table below:
To Be Well
Capitalized Under
For Capital Prompt Corrective
Actual Adequacy Purposes: Action Provisions:
---------------------- ----------------------- --------------------
Amount Ratio Amount Ratio Amount Ratio
------------ ----- -------------- ----- ------------- -----
As of December 31, 2005:
- ------------------------
Total Capital (to Risk-Weighted Assets):
Consolidated $233,666,000 15% =>$123,576,000 => 8% N/A N/A
First Financial Bank-Abilene $ 68,577,000 14% =>$ 39,875,000 => 8% =>$49,843,000 =>10%
San Angelo National Bank $ 31,362,000 21% =>$ 12,060,000 => 8% =>$15,075,000 =>10%
Weatherford National Bank $ 20,915,000 14% =>$ 11,707,000 => 8% =>$14,634,000 =>10%
First Financial Bank-Stephenville $ 20,942,000 12% =>$ 14,487,000 => 8% =>$18,108,000 =>10%
First Financial Bank-Southlake $ 19,480,000 12% =>$ 12,833,000 => 8% =>$16,041,000 =>10%
Tier I Capital (to Risk-Weighted Assets):
Consolidated $218,931,000 14% =>$ 61,788,000 => 4% N/A N/A
First Financial Bank-Abilene $ 64,692,000 13% =>$ 19,937,000 => 4% =>$29,905,000 => 6%
San Angelo National Bank $ 30,033,000 20% =>$ 6,030,000 => 4% =>$ 9,045,000 => 6%
Weatherford National Bank $ 19,472,000 13% =>$ 5,853,000 => 4% =>$ 8,780,000 => 6%
First Financial Bank-Stephenville $ 18,679,000 10% =>$ 7,243,000 => 4% =>$10,865,000 => 6%
First Financial Bank-Southlake $ 18,109,000 11% =>$ 6,417,000 => 4% =>$ 9,625,000 => 6%
Tier I Capital (to Average Assets):
Consolidated $218,931,000 9% =>$ 76,767,000 => 3% N/A N/A
First Financial Bank-Abilene $ 64,692,000 8% =>$ 25,868,000 => 3% =>$43,113,000 => 5%
San Angelo National Bank $ 30,033,000 10% =>$ 8,645,000 => 3% =>$14,409,000 => 5%
Weatherford National Bank $ 19,472,000 8% =>$ 7,769,000 => 3% =>$12,948,000 => 5%
First Financial Bank-Stephenville $ 18,679,000 7% =>$ 8,144,000 => 3% =>$13,574,000 => 5%
First Financial Bank-Southlake $ 18,109,000 23% =>$ 2,382,000 => 3% =>$ 3,971,000 => 5%
The First Financial Bank, N. A., Stephenville total capital ratio at December
31, 2004 was 9.84% which is under amounts to be considered well capitalized.
This was increased above 10% in 2005 through retaining their earnings.
F-27
To Be Well
Capitalized Under
For Capital Prompt Corrective
Actual Adequacy Purposes: Action Provisions:
---------------------- ----------------------- --------------------
Amount Ratio Amount Ratio Amount Ratio
------------ ----- -------------- ----- ------------- -----
As of December 31, 2004:
- ------------------------
Total Capital (to Risk-Weighted Assets):
Consolidated $234,751,000 17% =>$107,349,000 => 8% N/A N/A
First Financial Bank-Abilene $ 69,352,000 16% =>$ 35,692,000 => 8% =>$44,616,000 =>10%
San Angelo National Bank $ 30,987,000 20% =>$ 12,460,000 => 8% =>$15,574,000 =>10%
Weatherford National Bank $ 20,463,000 15% =>$ 10,857,000 => 8% =>$13,571,000 =>10%
First Financial Bank-Stephenville $ 16,335,000 10% =>$ 13,273,000 => 8% =>$16,591,000 =>10%
Tier I Capital (to Risk-Weighted Assets):
Consolidated $220,889,000 16% =>$ 53,674,000 => 4% N/A N/A
First Financial Bank-Abilene $ 65,542,000 15% =>$ 17,846,000 => 4% =>$26,769,000 => 6%
San Angelo National Bank $ 29,569,000 19% =>$ 6,229,000 => 4% =>$ 9,345,000 => 6%
Weatherford National Bank $ 19,010,000 14% =>$ 5,429,000 => 4% =>$ 8,143,000 => 6%
First Financial Bank-Stephenville $ 13,915,000 8% =>$ 6,636,000 => 4% =>$ 9,955,000 => 6%
Tier I Capital (to Average Assets):
Consolidated $220,889,000 10% =>$ 67,626,000 => 3% N/A N/A
First Financial Bank-Abilene $ 65,542,000 9% =>$ 22,789,000 => 3% =>$37,983,000 => 5%
San Angelo National Bank $ 29,569,000 10% =>$ 9,054,000 => 3% =>$15,091,000 => 5%
Weatherford National Bank $ 19,010,000 8% =>$ 7,061,000 => 3% =>$11,769,000 => 5%
First Financial Bank-Stephenville $ 13,915,000 6% =>$ 6,628,000 => 3% =>$11,046,000 => 5%
In connection with our Trust Company's application to obtain our trust charter,
we are required to maintain tangible net assets of $2.0 million at all times. As
of December 31, 2005, our Trust Company had tangible assets totaling $4.8
million.
F-28
15. STOCK OPTION PLAN:
------------------
The Company has an incentive stock plan to provide for the granting of options
to senior management of the Company at prices not less than market at the date
of grant. At December 31, 2005, the Company had allocated 899,810 shares of
stock for issuance under the plan. The plan provides that options granted are
exercisable after two years from date of grant at a rate of 20% each year
cumulatively during the 10-year term of the option. An analysis of stock option
activity for the years ended December 31, 2005, 2004, and 2003, is presented in
the table and narrative below:
2005 2004 2003
------------------- ------------------- -------------------
Wtd. Avg. Wtd. Avg. Wtd. Avg.
Shares Ex. Price Shares Ex. Price Shares Ex. Price
------- ------ ------- ------ ------- ------
Outstanding, beginning of year 192,352 $18.20 241,466 $17.57 190,466 $13.49
Granted 101,066 33.08 - - 95,413 23.10
Exercised (33,148) 12.92 (41,196) 14.20 (34,916) 11.47
Cancelled (18,785) 25.89 (7,918) 19.85 (9,497) 13.56
------- ------- -------
Outstanding, end of year 241,485 $24.56 192,352 $18.20 241,466 $17.57
======= ====== ======= ====== ======= ======
Exercisable at end of year 69,380 $16.72 72,670 $14.10 88,010 $13.89
======= ====== ======= ====== ======= ======
Weighted average fair value of
options granted at date of issue $6.23 N/A $4.91
===== === =====
The options outstanding at December 31, 2005, have exercise prices between
$12.48 and $33.08 with a weighted average remaining contractual life of
5.74 years. Stock options have been adjusted retroactively for the effects of
stock dividends and splits.
The following table summarizes information concerning outstanding and vested
stock options as of December 31, 2005:
Remaining
Number Contracted
Exercise Price Outstanding Life (Years) Number Vested
-------------- ----------- ------------ -------------
$17.57 22,115 2.2 22,115
12.48 40,688 4.2 29,347
17.90 1,666 5.5 999
18.30 3,332 6.1 1,332
23.10 80,394 7.4 15,321
33.08 93,290 9.1 266
From inception of the plan until December 31, 2005, the Company accounted for
this plan under APB 25 under which no compensation cost has been recognized for
options granted. The fair value of the options granted in 2005 and 2003, was
estimated using the Black-Scholes options pricing model with the following
weighted-average assumptions: risk-free interest rate of 4.40% and 4.08%
respectively; expected dividend yield of 3.02% and 3.93% respectively; expected
life of 5.6 and 5.6 years, respectively; and expected volatility of 20.5% and
27.2%, respectively.
F-29
16. CONDENSED FINANCIAL INFORMATION - PARENT COMPANY:
-------------------------------------------------
Condensed Balance Sheets-December 31, 2005 and 2004
- ---------------------------------------------------
ASSETS 2005 2004
------ ------------ ------------
Cash in subsidiary bank $ 1,411,640 $ 1,003,888
Cash in unaffiliated bank 4,627 4,627
Interest-bearing deposits in subsidiary bank 6,356,216 30,018,299
------------ ------------
Total cash and cash equivalents 7,772,483 31,026,814
Investment in and advances to subsidiaries, at equity 275,953,978 241,804,585
Intangible assets 723,375 723,375
Other assets 2,261,152 2,647,793
------------ ------------
Total assets $286,710,988 $276,202,567
============ ============
LIABILITIES AND SHAREHOLDERS' EQUITY
------------------------------------
Total liabilities $ 10,435,181 $ 10,657,183
Shareholders' equity:
Common stock 207,144,010 155,115,760
Capital surplus 58,712,508 58,529,113
Retained earnings 19,434,606 49,834,536
Accumulated other comprehensive earnings (loss) (9,015,317) 2,065,975
------------ ------------
Total shareholders' equity 276,275,807 265,545,384
------------ ------------
Total liabilities and shareholders' equity $286,710,988 $276,202,567
============ ============
Condensed Statements of Earnings-
For the Years Ended December 31, 2005, 2004, and 2003
-----------------------------------------------------
2005 2004 2003
----------- ----------- -----------
Income:
Cash dividends from subsidiary banks $29,312,753 $37,370,000 $ 34,625,000
Excess of earnings over dividends of
subsidiary banks 15,963,918 2,985,413 1,713,407
Other income 1,148,038 1,119,243 1,065,245
----------- ----------- -----------
46,424,709 41,474,656 37,403,652
----------- ----------- -----------
Expenses:
Salaries and employee benefits 1,488,550 1,354,493 1,191,453
Other operating expenses 1,899,697 1,872,147 1,602,354
----------- ----------- -----------
3,388,247 3,226,640 2,793,807
----------- ----------- -----------
Earnings before income taxes 43,036,462 38,248,016 34,609,845
Income tax benefit 986,518 923,223 694,955
----------- ----------- -----------
Net earnings $44,022,980 $39,171,239 $35,304,800
=========== =========== ===========
F-30
Condensed Statements of Cash Flows-
For the Years Ended December 31, 2005, 2004, and 2003
-----------------------------------------------------
2005 2004 2003
------------ ----------- -----------
Cash flows from operating activities:
Net earnings $44,022,980 $39,171,239 $35,304,800
Adjustments to reconcile net earnings to net
cash provided by operating activities:
Excess of earnings over
dividends of subsidiary banks (15,963,918) (2,985,413) (1,713,407)
Depreciation 54,192 55,224 53,778
Increase in other assets (13,894) (1,220,474) (491,762)
(Decrease) increase in liabilities (187,836) 1,202,291 1,758,948
------------ ----------- -----------
Net cash provided by operating activities 27,911,524 36,222,867 34,912,357
------------ ----------- -----------
Cash flows from investing activities:
Purchases of bank premises and equipment (21,371) (43,844) (76,598)
Investment in and advances to subsidiaries (28,569,433) (19,823,558) (5,852,378)
------------ ----------- -----------
Net cash used in investing activities (28,590,804) (19,867,402) (5,928,976)
------------ ----------- -----------
Cash flows from financing activities:
Proceeds of stock issuances 428,176 584,903 400,323
Cash dividends paid (23,003,227) (20,138,307) (18,274,334)
------------ ----------- -----------
Net cash used in financing activities (22,575,051) (19,553,404) (17,874,011)
------------ ----------- -----------
Net increase (decrease) in cash and cash equivalents (23,254,331) (3,197,939) 11,109,370
Cash and cash equivalents, beginning of year 31,026,814 34,224,753 23,115,383
------------ ----------- -----------
Cash and cash equivalents, end of year $ 7,772,483 $31,026,814 $34,224,753
============ =========== ===========
F-31
17. ACQUISITIONS:
-------------
On March 4, 2004, we entered into a stock purchase agreement with the principal
shareholders of Liberty National Bank, Granbury, Texas. On July 26, 2004 the
transaction was completed. Pursuant to the purchase agreement, the Company paid
approximately $12.3 million for all of the outstanding shares of Liberty
National Bank. At closing, Liberty National Bank became a direct subsidiary of
First Financial Bankshares of Delaware, Inc., our wholly owned Delaware bank
holding company and effective November 1, 2004, it was merged with our wholly
owned bank subsidiary, First Financial Bank, National Association, Stephenville.
The total purchase price exceeded the estimated fair value of tangible net
assets acquired by approximately $7.5 million, of which approximately $359,000
was assigned to an identifiable intangible asset with the balance recorded by
the Company as goodwill. The identifiable intangible asset represents the future
benefit associated with the acquisition of the core deposits and is being
amortized over seven years utilizing a method that approximates the expected
attrition of the deposits.
The primary purpose of the acquisition was to expand the Company's market share
in areas with close proximity to Dallas/Ft. Worth, Texas. Factors that
contributed to a purchase price resulting in goodwill include Liberty's historic
record of earnings, capable management, the Granbury market and its geographic
location, which complements the Company's existing service locations. The
results of operations of Liberty National Bank are included in the consolidated
earnings of the Company commencing July 27, 2004.
The following is a condensed balance sheet disclosing the preliminary estimated
fair value amounts assigned to the major asset and liability captions at the
acquisition date.
ASSETS
Cash and cash equivalents $ 3,763,765
Investment in securities 7,954,831
Loans, net 45,689,723
Goodwill 7,139,535
Identifiable intangible asset 359,176
Other assets 3,089,372
-----------
Total assets $67,996,402
===========
LIABILITIES AND SHAREHOLDERS' EQUITY
Noninterest-bearing deposits $ 6,509,685
Interest-bearing deposits 46,849,196
Other liabilities 2,341,372
Shareholders' equity 12,296,149
-----------
Total liabilities and shareholders' equity $67,996,402
===========
Goodwill recorded in the acquisition of Liberty will be accounted for in
accordance with SFAS No. 142. Accordingly, goodwill will not be amortized,
rather it will be tested for impairment annually. The goodwill and identifiable
intangible asset recorded are expected to be deductible for federal income tax
purposes.
F-32
Cash flow information relative to the acquisition of Liberty is as follows:
Fair value of assets acquired $67,996,402
Cash paid for the capital stock of Liberty 12,296,149
-----------
Liabilities assumed $55,700,253
===========
The proforma impact of this acquisition to the Company's financial statements is
insignificant.
On September 7, 2004, we entered into a stock purchase agreement with the
shareholders of Southwestern Bancshares, Inc., the parent company of The First
National Bank, Glen Rose, Texas. On December 1, 2004, the transaction was
completed. Pursuant to the purchase agreement, the Company paid approximately
$13.38 million for all of the outstanding shares of Southwestern Bancshares,
Inc. At closing, Southwestern Bancshares and The First National Bank, Glen Rose,
were merged into our wholly owned bank subsidiary, First Financial Bank,
National Association, Stephenville. The total purchase price exceeded the
estimated fair value of tangible net assets acquired by approximately $8.7
million, of which approximately $433,000 was assigned to an identifiable
intangible asset with the balance recorded by the Company as goodwill. The
identifiable intangible asset represents the future benefit associated with the
acquisition of the core deposits and is being amortized over seven years
utilizing a method that approximates the expected attrition of the deposits.
The primary purpose of the acquisition was to expand the Company's market share
in areas with close proximity to Dallas/Ft. Worth, Texas. Factors that
contributed to a purchase price resulting in goodwill include First National
Bank, Glen Rose's historic record of earnings, capable management, the growth
potential for Glen Rose and its geographic location, which complements the
Company's existing service locations. The results of operations of First
National Bank are included in the consolidated earnings of the Company
commencing December 1, 2004.
The following is a condensed balance sheet disclosing the preliminary estimated
fair value amounts assigned to the major asset and liability captions at the
acquisition date.
ASSETS
Cash and cash equivalents $15,612,964
Investment in securities 2,232,328
Loans, net 29,390,798
Goodwill 8,234,680
Identifiable intangible asset 432,539
Other assets 1,302,651
-----------
Total assets $57,205,960
===========
LIABILITIES AND SHAREHOLDERS' EQUITY
Deposits $43,253,978
Other liabilities 574,138
Shareholders' equity 13,377,844
-----------
Total liabilities and shareholders' equity $57,205,960
===========
Goodwill recorded in the acquisition of First National Bank will be accounted
for in accordance with SFAS No. 142. Accordingly, goodwill will not be
amortized, rather it will be tested for impairment annually. The goodwill and
identifiable intangible asset recorded are expected to be deductible for federal
income tax purposes.
F-33
Cash flow information relative to the acquisition of First National Bank is as
follows:
Fair value of assets acquired $57,205,960
Cash paid for the capital stock of First National Bank 13,377,844
-----------
Liabilities assumed $43,828,116
===========
The proforma impact of this acquisition to the Company's financial statements is
insignificant.
On October 25, 2004, we entered into a stock purchase agreement with the
shareholders of Clyde Financial Corporation, the parent company of The Peoples
State Bank in Clyde, Texas. On February 1, 2005, the transaction was completed.
Pursuant to the purchase agreement, we paid approximately $25.4 million for all
of the outstanding shares of Clyde Financial Corporation.
At closing, Clyde Financial Corporation and The Peoples State bank were merged
into our wholly owned bank subsidiary, First Financial Bank, National
Association, Abilene. The total purchase price exceeded the estimated fair value
of tangible net assets acquired by approximately $13.2 million, of which
approximately $1.9 million was assigned to an identifiable intangible asset with
the balance recorded by the Company as goodwill. The identifiable intangible
asset represents the future benefit associated with the acquisition of the core
deposits and is being amortized over seven years, utilizing a method that
approximates the expected attrition of the deposits.
The primary purpose of the acquisition was to expand the Company's market share
near Abilene and along Interstate Highway 20 in West Texas. Factors that
contributed to a purchase price resulting in goodwill include Peoples' historic
record of earnings, capable management and its geographic location which
complements the Company's existing service locations. The results of operations
from this acquisition are included in the consolidated earnings of the Company
commencing February 1, 2005.
The following is a condensed balance sheet disclosing the preliminary estimated
fair value amounts assigned to the major asset and liability categories at the
acquisition date.
ASSETS
Cash and cash equivalents $24,269,306
Interest-bearing deposit in banks 8,500,000
Investment in securities 34,480,602
Loans, net 56,267,932
Goodwill 11,312,847
Identifiable intangible asset 1,914,606
Other assets 3,151,450
------------
Total assets $139,896,743
============
LIABILITIES AND SHAREHOLDERS' EQUITY
Deposits $113,890,662
Other liabilities 610,081
Shareholders' equity 25,396,000
------------
Total liabilities and shareholders' equity $139,896,743
============
Goodwill recorded in the acquisition of The Peoples State Bank will be accounted
for in accordance with SFAS No. 142. Accordingly, goodwill will not be
amortized, but will be tested for impairment annually. The goodwill and
identifiable intangible asset recorded are not expected to be deductible for
federal income tax purposes.
F-34
Cash flow information relative to the acquisition of Clyde Financial Corporation
is as follows:
Fair value of assets acquired $139,896,743
Cash paid for the capital stock of Clyde Financial Corporation 25,396,000
------------
Liabilities assumed $114,500,743
============
We believe the proforma impact of this acquisition to the Company's financial
statements is insignificant.
The main office of the former The Peoples State Bank was located in the City of
Clyde, Callahan County, Texas, approximately 12 miles east of Abilene, Texas.
The bank also operated offices in Moran, Ranger and Rising Star, Texas, for a
total of 4 banking offices. Effective April 1, 2005, First Financial Bank,
National Association, Abilene sold the Ranger and Rising Star banking offices
acquired from The Peoples State Bank to another of our wholly owned banking
subsidiaries, First Financial Bank, National Association, Eastland, Texas. The
Ranger, Rising Star and Eastland offices are located in Eastland County. This
transaction had no impact on our consolidated financial statements.
On August 10, 2005, we entered into an agreement and plan of merger with
Bridgeport Financial Corporation, the parent company of The First National Bank
of Bridgeport, Bridgeport, Texas. On December 1, 2005, the transaction was
completed. Pursuant to the agreement, we paid $20.1 million, plus the assumption
of $5.5 million in debt and trust preferred securities, for all of the
outstanding shares of Bridgeport Financial Corporation.
At closing, Bridgeport Financial Corporation was merged into First Financial
Bankshares of Delaware, Inc. and The First National Bank of Bridgeport was
merged with our wholly owned bank subsidiary, First Financial Bank, National
Association, Southlake. The total purchase price exceeded the estimated fair
value of tangible net assets acquired by approximately $14.7 million, of which
approximately $2.3 million was assigned to an identifiable intangible asset with
the balance recorded by the Company as goodwill. The identifiable intangible
asset represents the future benefit associated with the acquisition of the core
deposits and is being amortized over seven years, utilizing a method that
approximates the expected attrition of the deposits.
The primary purpose of the acquisition was to expand the Company's market share
near Dallas/Ft. Worth, Texas and along Interstate Highway 35 in North Central
Texas. Factors that contributed to a purchase price resulting in goodwill
include Bridgeport's historic record of earnings, capable management and its
geographic location which complements the Company's existing service locations.
The results of operations from this acquisition are included in the consolidated
earnings of the Company commencing December 1, 2005.
The following is a condensed balance sheet disclosing the preliminary estimated
fair value amounts assigned to the major asset and liability categories at the
acquisition date.
ASSETS
Cash and cash equivalents $ 27,805,513
Investment in securities 45,334,311
Loans, net 65,863,055
Goodwill 12,409,306
Identifiable intangible asset 2,309,958
Other assets 7,411,284
------------
Total assets $161,133,427
============
F-35
LIABILITIES AND SHAREHOLDERS' EQUITY
Deposits $131,997,602
Other liabilities 9,084,203
Shareholders' equity 20,051,622
------------
Total liabilities and shareholders' equity $161,133,427
============
Goodwill recorded in the acquisition of Bridgeport will be accounted for in
accordance with SFAS No. 142. Accordingly, goodwill will not be amortized, but
will be tested for impairment annually. The goodwill and identifiable intangible
asset recorded are expected to be deductible for federal income tax purposes.
Cash flow information relative to the acquisition of Bridgeport is as follows:
Fair value of assets acquired $161,133,427
Cash paid for the capital stock of
Bridgeport Financial Corporation 20,051,622
------------
Liabilities assumed $141,081,805
============
We believe the proforma impact of this acquisition to the Company's financial
statements is insignificant.
The First National Bank of Bridgeport is located in the City of Bridgeport, Wise
County, Texas, approximately 35 miles northwest of Fort Worth, Texas. The bank
also operated offices in Boyd and Decatur, Texas, for a total of three offices.
The First National Bank of Bridgeport was established in 1907.
18. CASH FLOW INFORMATION:
----------------------
Supplemental information on cash flows and noncash transactions is as follows:
Year Ended December 31,
---------------------------------------------
2005 2004 2003
----------- ----------- -----------
Supplemental cash flow information:
Interest paid $26,964,956 $16,254,763 $17,572,092
Federal income taxes paid 18,292,335 15,208,678 14,063,418
Schedule of noncash investing and financing activities:
Assets acquired through foreclosure 1,289,814 147,124 1,117,256
Loans to finance the sale of other real estate - 1,065,854 19,400
F-36