FIRST FINANCIAL BANK

FFIN
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FIRST FINANCIAL BANKSHARES : Management's Discussion and Analysis of Financial Condition and Results of Operations. (form 10-Q)

08/02/2021 | 04:14pm


Forward-Looking Statements
This Form
10-Q
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-Q,
words such as "anticipate," "believe," "estimate," "expect," "intend,"
"indicate," "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 discussed in Part I, Item 1A of the Company's Annual Report on
Form
10-K
for the year ended December 31, 2020, under the heading "Risk Factors," and the
following:


• general economic conditions, including our local, state and national real



estate markets and employment trends;




• effect of the coronavirus ("COVID") on our Company, the communities where



we have our branches, the state of Texas and the United States, related
to the economy and overall financial stability;



• government and regulatory responses to the COVID pandemic;




• effect of severe weather conditions, including hurricanes, tornadoes,



flooding and droughts;




• volatility and disruption in national and international financial and



commodity markets;



• government intervention in the U.S. financial system including the



effects of recent legislative, tax, accounting and regulatory actions and



reforms, including the Coronavirus Aid, Relief, and Economic Security Act



(the "CARES Act"), the Dodd-Frank Wall Street Reform and Consumer
Protection Act (the "Dodd-Frank Act"), the Jumpstart Our Business
Startups Act, the Consumer Financial Protection Bureau ("CFPB"), the



capital ratios of Basel III as adopted by the federal banking authorities



and the Tax Cuts and Jobs Act;



• political and racial instability;




• the ability of the Federal government to address the national economy;



• changes in our competitive environment from other financial institutions



and financial service providers;




• the effects of and changes in trade, monetary and fiscal policies and



laws, including interest rate policies of the Board of Governors of the
Federal Reserve System (the "Federal Reserve Board");




• the effect of changes in accounting policies and practices, as may be



adopted by the regulatory agencies, as well as the Public Company



Accounting Oversight Board ("PCAOB"), the Financial Accounting Standards



Board ("FASB") and other accounting standard setters;



• the effect of changes in laws and regulations (including laws and
regulations concerning taxes, banking, securities and insurance) with
which we and our subsidiaries must comply;




• changes in the demand for loans, including loans originated for sale in



the secondary market;



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• fluctuations in the value of collateral securing our loan portfolio and



in the level of the allowance for credit losses;



• the accuracy of our estimates of future credit losses;




• the accuracy of our estimates and assumptions regarding the performance



of our securities portfolio;




• soundness of other financial institutions with which we have transactions;






• inflation, interest rate, market and monetary fluctuations;



• changes in consumer spending, borrowing and savings habits;




• changes in commodity prices (e.g., oil and gas, cattle, and wind energy);






• our ability to attract deposits and increase market share;



• changes in our liquidity position;




• changes in the reliability of our vendors, internal control system or



information systems;




• cyber attacks on our technology information systems, including fraud from



our customers and external third-party vendors;



• our ability to attract and retain qualified employees;



• acquisitions and integration of acquired businesses;




• the possible impairment of goodwill and other intangibles associated with



our acquisitions;



• consequences of continued bank mergers and acquisitions in our market



area, resulting in fewer but much larger and stronger competitors;



• expansion of operations, including branch openings, new product offerings



and expansion into new markets;



• changes in our compensation and benefit plans;



• acts of God or of war or terrorism;



• potential risk of environmental liability associated with lending
activities; and



• our success at managing the risk involved in the foregoing items.


Such forward-looking 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
strategies 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 (except as required by
law).

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Introduction
As a financial holding company, we generate most of our revenue from interest on
loans and investments, trust fees, gain on sale of mortgage loans and service
charges. Our primary source of funding for our loans and investments are
deposits held by our subsidiary, First Financial Bank, N.A. Our largest expense
are salaries and related employee benefits. We measure our performance by
calculating our return on average assets, return on average equity, regulatory
capital ratios, net interest margin and efficiency ratio, which is calculated by
dividing noninterest expense by the sum of net interest income on a tax
equivalent basis and noninterest income.
The following discussion and analysis of operations and financial condition
should be read in conjunction with the financial statements and accompanying
footnotes included in Item 1 of this Form
10-Q
as well as those included in the Company's 2020 Annual Report on Form
10-K.
Recent Coronavirus Developments
During March 2020, the outbreak of the novel Coronavirus Disease 2019 was
recognized as a pandemic by the World Health Organization and a national
emergency by the President of the United States. The spread of COVID has created
a global public health crisis that has resulted in unprecedented uncertainty,
volatility and disruption in financial markets and in governmental, commercial
and consumer activity in the United States and globally, including the markets
that we serve across the State of Texas. National, state and local governmental
responses to the pandemic have included orders to close or limit businesses
activity not deemed essential and directing individuals to limit their movements
and travel, observe social distancing, and shelter in place. These actions,
together with responses to the pandemic by businesses and individuals, have
resulted in decreases in commercial and consumer activity. These responses and
restrictions have led to a loss of revenues for certain industries and a sudden
increase in unemployment, volatility in oil and gas prices and in business
valuations, market downturns and volatility, changes in consumer behaviors,
related emergency response legislation and an expectation that Federal Reserve
policy will maintain a low interest rate environment for the foreseeable future.
The following is an update on our response through the date of filing:


• The Company assisted borrowers in the second round of the Paycheck



Protection Program ("PPP") under the December 2020 Bipartisan-Bicameral



Omnibus COVID Relief Deal through the expiration of the program on
May 31, 2021. Through June 30, 2021, we had funded approximately 9,700
PPP loans in total from both the first and second rounds of PPP loans



totaling $970.87 million. At June 30, 2021, the Company's total PPP loans



had outstanding net balance of $320.39 million following repayments and



forgiveness by the SBA. We did not participate in the PPP Facility
program.



• We are continuing to encourage our employees to take the COVID
vaccinations when available and allowing employees and customers to wear
a mask on an optional basis based on their preferences.


Recent actions taken by the U.S. government to further mitigate the economic
effects of COVID will also have an impact on our financial position and results
of operations.

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Notwithstanding the foregoing actions, the COVID outbreak could still, among
other things, greatly affect our routine and essential operations due to staff
absenteeism, particularly among key personnel, further limit access to or result
in further closures of our branch facilities and other physical offices,
exacerbate operational, technical or security-related risks arising from a
remote workforce, and result in adverse government or regulatory agency orders.
The business and operations of our third-party service providers, many of whom
perform critical services for our business, could also be significantly
impacted, which in turn could impact us. As a result, we are currently unable to
fully assess or predict the extent of the effects of COVID on our operations as
the ultimate impact will depend on factors that are currently unknown and/or
beyond our control.
Critical Accounting Policies
We prepare consolidated financial statements based on generally accepted
accounting principles ("GAAP") 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.
We deem our most critical accounting policies to be (1) our allowance for credit
losses and our provision for credit losses and (2) our valuation of financial
instruments. 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. A discussion of (1) our allowance for credit losses and our
provision for credit losses and (2) our valuation of financial instruments is
included in Note 1 to our Consolidated Financial Statements beginning on page
11. Additional detailed information is included in Notes 4 and 5 to our notes to
the consolidated financial statements (unaudited) and should be read in
conjunction with this analysis.
Stock Repurchase
On March 12, 2020, the Company's Board of Directors authorized the repurchase of
up to 4.00 million common shares through September 30, 2021. On July 27, 2021,
the Company's Board of Directors renewed the prior authorization and authorized
the repurchase of up to 5.00 million common shares through July 31, 2023. The
stock repurchase plan authorizes management to repurchase and retire the stock
at such time as repurchases are considered beneficial to the Company and its
stockholders. Any repurchase of stock will be made through the open market,
block trades or in privately negotiated transactions in accordance with
applicable laws and regulations. Under the repurchase plan, there is no minimum
number of shares that the Company is required to repurchase. Through June 30,
2021
, the Company repurchased and retired 324.80 thousand shares (all during the
months of March and April of 2020) totaling $8.01 million under this repurchase
plan.
Acquisition
On September 19, 2019, we entered into an agreement and plan of reorganization
to acquire TB&T Bancshares, Inc. and its wholly-owned bank subsidiary, The
Bank & Trust of Bryan/College Station, Texas. On January 1, 2020, the
transaction was completed. Pursuant to the agreement, we issued 6.28 million
shares of the Company's common shares in exchange for all of the outstanding
shares of TB&T Bancshares, Inc. In addition, in accordance with the plan of
reorganization, TB&T Bancshares, Inc. paid a special dividend totaling
$1.92 million to its shareholders prior to the closing of this transaction. At
the closing, Brazos Merger Sub., Inc., a wholly-owned subsidiary of the Company,
merged into TB&T

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Bancshares Inc., with TB&T Bancshares, Inc. surviving as a wholly-owned
subsidiary of the Company. Immediately following such merger, TB&T Bancshares,
Inc.
was merged into the Company and The Bank & Trust of Bryan/College Station,
Texas
was merged into First Financial Bank, N.A., a wholly-owned subsidiary of
the Company. The total purchase price of $220.27 million exceeded the estimated
fair value of the net assets acquired by $141.92 million and the Company
recorded such excess as goodwill. The balance sheet and results of operations of
TB&T Bancshares, Inc. have been included in the financial statements of the
Company effective January 1, 2020. See Note 10 to the consolidated financial
statements for additional information and disclosure.
Participation in PPP Loan Program
The Company elected to participate in the first and second rounds of PPP loan
program processing a total of 9,709 loans and funded $970.87 million from
March 31, 2020 through June 30, 2021. The Company has received fees totaling
approximately $40.16 million and incurred incremental direct origination costs
of $3.62 million related to its participation in the PPP loan program from
March 31, 2020 through June 30, 2021, both of which have been deferred and are
being amortized over the shorter of the repayment period or the contractual life
of these loans. During the first six months of 2021, the Company recognized
$11.49 million in interest income related to PPP loan fees. The remainder of the
PPP loan deferred fees totaled approximately $13.72 million at June 30, 2021,
including approximately $12.62 million for 2021 originations for the second
round of PPP loans. These remaining deferred fees related to the second round of
PPP loans will be amortized over the shorter of the repayment period or the
contractual life of 60 months. Additional information related to the Company's
PPP loan balances are included in the following table (dollars in thousands):

PPP Loans
Originated PPP Amounts as of June 30, 2021
Recognized
Period- Recognized Fees During
Fees During the Six-Months
Number Number End the Quarter
of of Amount, Un-amortized Ended Ended
Loans Amount Loans Net Fees June 30, 2021 June 30, 2021
PPP Round 1 6,530 $ 703,450 724 $ 72,595 $ 1,107 $ 3,912 $ 10,166
PPP Round 2 3,179 267,423 2,997 247,797 12,615 1,326 1,326

PPP Total 9,709 $ 970,873 3,721 $ 320,392 $ 13,722 $ 5,238 $ 11,492



Implementation of New Accounting Standard for Allowance for Credit Losses
On January 1, 2020, Accounting Standards Update ("ASU")
2016-13,
Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses
on Financial Instruments, became effective for the Company. Accounting Standards
Codification ("ASC") Topic 326 ("ASC 326") replaced the previous "incurred loss"
model for measuring credit losses with an expected loss methodology that is
referred to as the current expected credit loss ("CECL") methodology. The
measurement of expected credit losses under the CECL methodology is applicable
to financial assets measured at amortized cost, including loan receivables and
held-to-maturity
debt securities. It also applies to
off-balance-sheet
("OBS", "reserve for unfunded commitments") credit exposures not accounted for
as insurance (loan commitments, standby letters of credit, financial guarantees,
and other similar instruments). In addition, ASC 326 made changes to the
accounting for
available-for-sale
debt securities. One such change is to require credit losses to be presented as
an allowance rather than as a write-down on
available-for-sale
debt securities management does not intend to sell or believes that it is more
likely than not they will be required to sell.

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On March 27, 2020, the CARES Act was signed by the President of the United
States
that included an option for entities to delay the implementation of ASC
326 until the earlier of the termination date of the national emergency
declaration by the President, or December 31, 2020. Under this option, the
Company elected to delay implementation of CECL and calculated and recorded the
provision for credit losses through the nine-months ended September 30, 2020
under the incurred loss model. At December 31, 2020, the Company elected to
adopt ASC 326, effective as of January 1, 2020, through a transition charge to
retained earnings of $589 thousand ($466 thousand net of applicable income
taxes), which was reflected in the consolidated financial statements as of and
for the year ended December 31, 2020. This transition adjustment was comprised
of a decrease of $619 thousand in allowance for credit losses and an increase of
$1.21 million in the reserve for unfunded commitments.
The Company completed its CECL implementation plan by forming a cross-functional
working group, under the direction of our Chief Credit Officer along with our
Chief Accounting Officer, Chief Lending Officer and Chief Financial Officer. The
working group also included individuals from various functional areas including
credit, risk management, accounting and information technology, among others.
The implementation plan included assessment and documentation of processes,
internal controls and data sources, model development, documentation and
validation, and system configuration, among other things. The Company contracted
with a third-party vendor to assist in the implementation of CECL.

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Results of Operations
Performance Summary
. Net earnings for the second quarter of 2021 were $56.38 million, up
$2.91 million or 5.44%, when compared with earnings of $53.47 million for the
second quarter of 2020. Diluted earnings per share was $0.39 for the second
quarter of 2021 compared with $0.38 in the same quarter a year ago. The increase
in earnings for the second quarter of 2021 over the second quarter of 2020 was
primarily attributable to the negative provision for credit losses.
The return on average assets was 1.89% for the second quarter of 2021, as
compared to 2.06% for the second quarter of 2020. The return on average equity
was 13.38% for the second quarter of 2021 as compared to 14.00% for the second
quarter of 2020.
Net earnings for the
six-month
period ended June 30, 2021 were $113.30 million compared to $90.70 million for
the same period in 2020. Diluted earnings per share for the first six months of
2021 were $0.79 compared to $0.64 for the same period in 2020.
The return on average assets was 1.97% for the first six months of 2021 as
compared to 1.86% for the same period a year ago. The return on average equity
was 13.61% for the first six months of 2021 as compared to 12.09% for the first
six months of 2020.
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 $94.58 million for the second quarter of 2021, as
compared to $92.14 million for the same period last year. The increase in 2021
compared to 2020 was largely attributable to the increase in interest-earning
assets primarily derived from an increase in investment securities held and the
impact of the Company's participation in the PPP loan program (see above).
Average earning assets were $11.30 billion for the second quarter of 2021, as
compared to $9.80 billion during the second quarter of 2020. The increase of
$1.50 billion in average earning assets in 2021 when compared to 2020 was
primarily a result of increases of
tax-exempt
securities of $661.59 million, interest-bearing deposits in nonaffiliated banks
of $444.21 million and taxable securities of $256.85 million when compared to
June 30, 2020 balances. Average interest-bearing liabilities were $6.76 billion
for the second quarter of 2021, as compared to $6.01 billion in the same period
in 2020. The increase in average interest-bearing liabilities primarily resulted
from our customers depositing their PPP loan amounts into our Bank and organic
growth. The yield on earning assets decreased 48 basis points while the rate
paid on interest-bearing liabilities decreased ten basis points for the second
quarter of 2021 compared to the second quarter of 2020.
Tax-equivalent
net interest income was $186.95 million for the first six months of 2021 as
compared to $174.87 million for the same period last year. The increase in 2021
compared to 2020 was largely attributable to the increase in interest earning
assets primarily derived from an increase in investment securities held and the
impact of the Company's participation in the PPP loan program. Average earning
assets increased $1.78 billion for the first six months of 2021 over the same
period in 2020. Average tax exempt securities increased $841.94 million,
interest-bearing deposits in nonaffiliated banks increased $426.95 million and
loans increased $382.46 million, respectively, for the first six months of 2021
over the first six months of 2020. Average interest-bearing liabilities
increased $877.55 million for the first six months of 2021, as compared to the
same period in 2020 primarily resulting from our customers depositing their PPP
loan amounts into our Bank and internal organic growth. The yield on earning
assets decreased 55 basis points while the rate paid on interest-bearing
liabilities decreased 25 basis points for the first six months of 2021 compared
to the first six months of 2020.

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Table 1 allocates the change in
tax-equivalent
net interest income between the amount of change attributable to volume and to
rate.
Table 1 - Changes in Interest Income and Interest Expense (in thousands):

Six-Months
Three-Months Ended June 30, 2021 Ended June 30, 2021

Compared to Three-Months Ended June Compared to Six-Months Ended June 30,

30, 2020 2020
Change Attributable to Total Change Attributable to Total
Volume Rate Change Volume Rate Change
Short-term investments $ 111 $ 17


$ 128 $ 1,225 $ (1,690 ) $ (465 )
Taxable investment securities


1,501 (4,082 ) (2,581 ) 1,520 (8,493 ) (6,973 )


Tax-exempt



investment securities (1) 5,414 (2,737 ) 2,677 13,875 (5,419 ) 8,456
Loans (1) (2) 1,712 (800 ) 912 9,997 (5,655 ) 4,342

Interest income 8,738 (7,602 ) 1,136 26,617 (21,257 ) 5,360
Interest-bearing deposits 543 (1,533 ) (990 ) 1,936 (7,912 ) (5,976 )
Short-term borrowings (164 ) (155 ) (319 ) (245 ) (499 ) (744 )

Interest expense 379 (1,688 ) (1,309 ) 1,691 (8,411 ) (6,720 )

Net interest income $ 8,359 $ (5,914 ) $ 2,445 $ 24,926 $ (12,846 ) $ 12,080




(1) Computed on a


tax-equivalent



basis assuming a marginal tax rate of 21%.



(2) Non-accrual



loans are included in loans.





The net interest margin, on a tax equivalent basis, was 3.36% for the second
quarter of 2021, a decrease of 42 basis points from the same period in 2020. The
net interest margin for the first six months of 2021 was 3.45%, a decrease of 39
basis points from the same period in 2020. We have continued to experience
downward pressures on our net interest margin in 2021 and 2020 primarily due to
(i) the extended period of fluctuating historically low levels of short-term
interest rates and (ii) the flat to inverted yield curve currently being
experienced in the bond market. Additionally, the net interest margin was
particularly impacted in the second quarter of 2021 as a result of the overall
level of excess liquidity, which totaled $844.59 million at June 30, 2021,
pending investment. We have been able to somewhat mitigate the impact of these
lower short-term interest rates and the flat/inverted yield curve by
establishing minimum interest rates on certain of our loans, improving the
pricing for loan risk and reducing the rates paid on our interest-bearing
liabilities. In March 2020, as the market experienced volatility, we took
advantage of that volatility to purchase high quality municipal bonds at
favorable
tax-equivalent
interest yields. The Federal Reserve increased rates 100 basis points in 2018
but then decreased rates 75 basis points during the third and fourth quarters of
2019 and then an additional 150 basis points in the first quarter of 2020,
resulting in a current target rate range of zero to 25 basis points.

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The net interest margin, which measures
tax-equivalent
net interest income as a percentage of average earning assets, is illustrated in
Table 2.
Table 2 - Average Balances and Average Yields and Rates (in thousands, except
percentages):

Three-Months Ended June 30,
2021 2020
Average Income/ Yield/ Average Income/ Yield/
Balance Expense Rate Balance Expense Rate
Assets
Short-term investments (1) $ 799,884 $ 215 0.11 % $ 353,468 $ 87 0.10 %
Taxable investment securities (2) 2,656,211 11,449 1.72 2,399,364 14,030 2.34
Tax-exempt
investment securities (2)(3) 2,461,924 17,410 2.83 1,800,339 14,733 3.27
Loans (3)(4) 5,383,781 67,161 5.00 5,248,052 66,249 5.08

Total earning assets 11,301,800 $ 96,235 3.42 % 9,801,223 $ 95,099 3.90 %
Cash and due from banks 197,412 181,752
Bank premises and equipment, net 144,671 138,744
Other assets 95,575 87,091
Goodwill and other intangible
assets, net 317,721 319,200
Allowance for credit losses (63,097 ) (63,192 )

Total assets $ 11,994,082 $ 10,464,818

Liabilities and Shareholders' Equity
Interest-bearing deposits $ 6,229,991 $ 1,560 0.10 % $ 5,135,772 $ 2,550 0.20 %
Short-term borrowings 527,669 93 0.07 877,076 412 0.19

Total interest-bearing liabilities 6,757,660 $ 1,653 0.10 % 6,012,848 $ 2,962 0.20 %
Noninterest-bearing deposits 3,439,683 2,830,960
Other liabilities 106,994 84,501

Total liabilities 10,304,337 8,928,309
Shareholders' equity 1,689,745 1,536,509

Total liabilities and shareholders'
equity $ 11,994,082 $ 10,464,818

Net interest income $ 94,582 $ 92,137

Rate Analysis:
Interest income/earning assets 3.42 % 3.90 %
Interest expense/earning assets (0.06 ) (0.12 )

Net interest margin 3.36 % 3.78 %




(1) Short-term investments are comprised of federal funds sold, interest-bearing



deposits in banks and interest-bearing time deposits in banks.



(2) Average balances include unrealized gains and losses on



available-for-sale
securities.


(3) Computed on a
tax-equivalent



basis assuming a marginal tax rate of 21%.



(4) Non-accrual



loans are included in loans.



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Six-Months
Ended June 30,
2021 2020
Average Income/ Yield/ Average Income/ Yield/
Balance Expense Rate Balance Expense Rate
Assets
Short-term investments (1) $ 719,922 $ 377 0.11 % $ 292,245 $ 842 0.58 %
Taxable investment securities (2) 2,454,933 21,712 1.77 2,331,347 28,685 2.46
Tax-exempt
investment securities (2)(3) 2,415,527 34,389 2.85 1,573,591 25,933 3.30
Loans (3)(4) 5,340,207 133,914 5.06 4,957,744 129,572 5.26

Total earning assets 10,930,589 $ 190,392 3.51 % 9,154,927 $ 185,032 4.06 %
Cash and due from banks 203,392 189,285
Bank premises and equipment, net 143,293 139,520
Other assets 96,931 87,818
Goodwill and other intangible
assets, net 317,930 318,822
Allowance for credit losses (65,153 ) (61,134 )

Total assets $ 11,626,982 $ 9,829,238

Liabilities and Shareholders' Equity
Interest-bearing deposits $ 6,073,981 $ 3,255 0.11 % $ 5,019,929 $ 9,231 0.37 %
Short-term borrowings 492,341 184 0.08 668,840 928 0.28

Total interest-bearing liabilities 6,566,322 $ 3,439 0.11 % 5,688,769 $ 10,159 0.36 %
Noninterest-bearing deposits 3,278,067 2,561,248
Other liabilities 103,307 70,726

Total liabilities 9,947,696 8,320,743
Shareholders' equity 1,679,286 1,508,495

Total liabilities and shareholders'
equity $ 11,626,982 $ 9,829,238

Net interest income $ 186,953 $ 174,873

Rate Analysis:
Interest income/earning assets 3.51 % 4.06 %
Interest expense/earning assets (0.06 ) (0.22 )

Net interest margin 3.45 % 3.84 %





(1) Short-term investments are comprised of federal funds sold, interest-bearing



deposits in banks and interest-bearing time deposits in banks.



(2) Average balances include unrealized gains and losses on



available-for-sale
securities.


(3) Computed on a
tax-equivalent



basis assuming a marginal tax rate of 21%.



(4) Non-accrual



loans are included in loans.





Noninterest Income
. Noninterest income for the second quarter of 2021 was $34.67 million, a
decrease of $2.25 million, or 6.08%, as compared to the same quarter of 2020.
Increases in certain categories of noninterest income included (1) trust fees of
$1.73 million and (2) ATM, interchange and credit card fees of $1.80 million
when compared to the first quarter of 2020. Mortgage related income decreased by
$5.39 million when compared to the second quarter of 2020 due to a decline in
the overall pipeline volumes to $139.63 million at June 30, 2021 from
$194.09 million at June 30, 2020. The increase in trust fees resulted from an
increase in assets under management over the prior year. The fair value of trust
assets managed, which are not reflected in our consolidated balance sheets,
totaled $8.06 billion at June 30, 2021, up 18.88% when compared to $6.78 billion
at June 30, 2020. The increase in ATM, interchange and credit card fees was
driven by continued growth in the number of net new accounts and debit cards
issued and overall customer utilization.
Noninterest income for the
six-month
period ended June 30, 2021 was $69.55 million, an increase of $3.90 million
compared to the same period in 2020. ATM, interchange and credit card fees
increased $3.08 million, or 19.94%, to $18.53 million compared with
$15.45 million in the same period last year due to continued growth in debit
cards. Trust fees increased $2.59 million to $16.99 million for the
six-months
ended 2021 compared to the same period of 2020. The fair value of Trust assets
managed increased to $8.06 billion at June 30, 2021 when compared with
$6.78 billion at June 30, 2020. Offsetting these increases was a decline in gain
on the sale of
available-for-sale
securities of $2.76 million in the for the first
six-months
of 2021 when compared to the same period of 2020.

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ATM and interchange fees are charges that merchants pay to us and other
card-issuing banks for processing electronic payment transactions. ATM and
interchange fees consist of income from debit card usage, point of sale income
for debit card transactions and ATM service fees.
Federal Reserve rules applicable to financial institutions that have assets of
$10 billion or more provide that the maximum permissible interchange fee for an
electronic debit transaction is limited to the sum of 21 cents per transaction
plus 5 basis points multiplied by the value of the transaction. Management has
estimated the impact of this reduction in ATM and interchange fees to
approximate $16.00 million annually
(pre-tax)
once the Federal Reserve rules apply to the Company. Federal Reserve
requirements stipulate that these rules would go into effect on July 1
st
following the
year-end
in which a financial institution's total assets exceeded $10 billion at December
31

st
. At June 30, 2021, the Company's total assets exceeded the $10 billion
threshold, due primarily to the effect of the Company's participation in the PPP
loan program and growth in deposits from related activities. However, on
November 20, 2020, the federal bank regulatory agencies announced an interim
final rule that provides temporary relief for certain community banking
organizations that have crossed this threshold as of December 31, 2020 if they
had less than $10 billion in assets as of December 31, 2019. Under the interim
final rule, these banks, which includes us, will generally have until 2022 to
either reduce their size, or to prepare for the regulatory and reporting
standards under the Dodd-Frank Act. Management will continue to monitor the
Company's balance sheet levels and prepare for the effects of this future loss
of debit card income.
Table 3 - Noninterest Income (in thousands):

Six-Months
Three-Months Ended Ended

June 30, June 30,
Increase Increase
2021 (Decrease) 2020 2021 (Decrease) 2020
Trust fees $ 8,692 $ 1,731 $



6,961 $ 16,991 $ 2,593 $ 14,398
Service charges on deposit accounts 4,928


610 4,318 9,721 (512 ) 10,233
ATM, interchange and credit card fees 9,853 1,804 8,049 18,530 3,081 15,449
Gain on sale and fees on mortgage loans 8,291 (5,385 ) 13,676 18,185 657 17,528
Net gain on sale of
available-for-sale
securities 5 (1,507 ) 1,512 813 (2,761 ) 3,574
Net gain on sale of foreclosed assets 1 (51 ) 52 56 3 53
Net gain on sale of assets 74 98 (24 ) 219 127 92
Interest on loan recoveries 704 550 154 1,086 667 419
Other:
Check printing fees 33 (27 ) 60 67 (55 ) 122
Safe deposit rental fees 192 15 177 498 128 370
Credit life fees 364 (30 ) 394 579 13 566
Brokerage commissions 357 23 334 702 (17 ) 719
Wire transfer fees 354 84 270 670 137 533
Miscellaneous income 825 (161 ) 986 1,431 (164 ) 1,595

Total other 2,125 (96 ) 2,221 3,947 42 3,905

Total Noninterest Income $ 34,673 $ (2,246 ) $ 36,919 $ 69,548 $ 3,897 $ 65,651



Noninterest Expense
. Total noninterest expense for the second quarter of 2021 was $59.37 million,
an increase of $6.05 million, or 11.35%, as compared to the same period of 2020.
An important measure in determining whether a financial institution effectively
manages noninterest expense 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 the second quarter of 2021 was 45.94% compared to 41.32% for the same
quarter in 2020. The decrease in the Company's efficiency ratio for the second
quarter of 2020 primarily resulted from the deferral of $3.62 million in
noninterest expenses related to PPP loan origination costs in the second quarter
of 2020.

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Salaries, commissions and employee benefits for the second quarter of 2021
totaled $35.05 million, compared to $30.81 million for the same period in 2020.
The increase over the prior year was primarily driven by (i) annual merit-based
pay increases that were effective March 1, 2021, (ii) increases in incentive
compensation and profit sharing expenses and (iii) the impact of the deferral of
$3.62 million compensation expenses related to PPP loan origination costs in the
second quarter of 2020. All other categories of noninterest expense for the
second quarter of 2021 totaled $24.33 million, up from $22.51 million in the
same quarter a year ago.
Total noninterest expense for the first six months of 2021 was $117.10 million,
an increase of $8.46 million when compared to $108.64 million in the same period
in 2020. Our efficiency ratio for the first six months of 2021 was 45.65%,
compared to 45.17% for the same period in 2020.
Salaries, commissions and employee benefits for the first six months of 2021
totaled $69.98 million, an increase of $9.52 million when compared to the same
period in 2020. The increase was primarily driven by (i) annual pay increases
that were effective March 1, 2021, (ii) higher mortgage related commission for
the first six months of 2021 and (iii) the deferral of $3.62 million PPP
origination costs in the first six months of 2020. All other categories of
noninterest expense for the first six months of 2021 totaled $47.12 million, a
decrease of $1.06 million when compared to the same period of 2020. Included in
noninterest expense in the first six months of 2020 were technology contract
termination and conversion related costs totaling $4.39 million related to the
TB&T acquisition.

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Table 4 - Noninterest Expense (in thousands):

Six-Months
Three-Months Ended June 30, Ended June 30,
Increase Increase
2021 (Decrease) 2020 2021 (Decrease) 2020



Salaries and commissions $ 26,878 $ 3,608 $ 23,270 $ 52,972 $ 6,999 $ 45,973
Medical 2,755 471 2,284 5,595 614 4,981
Profit sharing 2,110 132 1,978 4,405 1,455 2,950
401(k) match expense 927 30 897 1,890 154 1,736
Payroll taxes 1,713 (1 ) 1,714 3,844 314 3,530
Stock option and stock grant
expense 663 (8 ) 671 1,271 (15 ) 1,286

Total salaries and employee
benefits 35,046 4,232 30,814 69,977 9,521 60,456
Net occupancy expense 3,241 140 3,101 6,388 260 6,128
Equipment expense 2,177 167 2,010 4,341 256 4,085
FDIC assessment fees 766 303 463 1,467 959 508
ATM, interchange and credit card
expense 3,039 429 2,610 5,811 216 5,595
Professional and service fees 2,392 (105 ) 2,497 4,531 (559 ) 5,090
Printing, stationery and
supplies 489 (44 ) 533 814 (285 ) 1,099
Operational and other losses 534 (194 ) 728 821 (483 ) 1,304
Software amortization and
expense 2,829 819 2,010 5,448 1,414 4,034
Amortization of intangible
assets 412 (96 ) 508 824 (193 ) 1,017
Other:
Data processing fees 438 (6 ) 444 844 (23 ) 867
Postage 289 (95 ) 384 666 (19 ) 685
Advertising 605 120 485 1,326 521 805
Correspondent bank service
charges 260 33 227 490 59 431
Telephone 822 (91 ) 913 2,098 222 1,876
Public relations and business
development 787 261 526 1,454 53 1,401
Directors' fees 596 (15 ) 611 1,212 (24 ) 1,236
Audit and accounting fees 481 (289 ) 770 986 (228 ) 1,214
Legal fees and other related
costs 909 505 404 1,431 733 698
Regulatory exam fees 337 60 277 674 121 553
Travel 352 152 200 597 85 512
Courier expense 258 57 201 464 47 417
Other real estate owned 11 (20 ) 31 39 (32 ) 71
Other 2,304 (270 ) 2,574 4,395 (4,163 ) 8,558

Total other 8,449 402 8,047 16,676 (2,648 ) 19,324

Total Noninterest Expense $ 59,374 $ 6,053 $ 53,321 $ 117,098 $ 8,458 $ 108,640




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Balance Sheet Review
Loans
. Our portfolio is comprised of loans made to businesses, professionals,
individuals, and farm and ranch operations located in the primary trade areas
served by our subsidiary bank. As of June 30, 2021, total loans
held-for-investment
were $5.30 billion, an increase of $133.57 million, as compared to December 31,
2020
. During the second quarter of 2021, $243.28 million of PPP loans originated
in 2020 were forgiven and $50.74 million of new PPP loans were originated. Total
PPP loans outstanding were $320.39 million at June 30, 2021, which are included
in the Company's commercial loan totals. PPP loan balances accounted for
$482.00 million in average balances for the quarter ended June 30, 2021. At
June 30, 2021, approximately $13.72 million of deferred loan fees related to PPP
loans, including approximately $12.62 million for 2021 originations, continues
to be amortized over the shorter of the repayment period or the contractual life
of 24 to 60 months.
As compared to
year-end
2020 balances, total real estate loans increased $239.09 million, total
commercial loans decreased $150.25 million, agricultural loans increased
$348 thousand and total consumer loans increased $44.38 million. Loans averaged
$5.38 billion for the second quarter of 2021, an increase of $135.73 million
from the prior year second quarter average balances. Loans averaged
$5.34 billion for the first six months of 2021, an increase of $382.46 million
from the prior year
six-month
period average balances.
In conjunction with the adoption of ASC 326, the Company expanded its four loan
portfolio segments used under its legacy disclosures into the following ten
portfolio segments. For modeling purposes, our loan portfolio segments include
C&I, Municipal, Agricultural, Construction and Development, Farm,
Non-Owner
Occupied and Owner Occupied CRE, Residential, Consumer Auto and Consumer
Non-Auto.
This additional segmentation allows for a more precise pooling of loans with
similar credit risk characteristics and credit monitor procedures for the
Company's calculation of its allowance for credit losses.
The loans originated as a result of the Company's participation in the PPP
program, discussed in further detail on page 52, are included in the C&I loan
portfolio segment as of June 30, 2021 and December 31, 2020.
Table 5 outlines the composition of the Company's
held-for-investment
loans by portfolio segment. For all periods prior to December 31, 2020,
management has elected to maintain its previously disclosed loan portfolio
segments.

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Table 5 - Composition of Loans (in thousands):

June 30, December 31,
2021 2020 2020
Commercial:
C&I $ 983,103 $ N/A $ 1,131,382
Municipal 179,356 N/A 181,325

Total Commercial 1,162,459 1,509,454 1,312,707
Agricultural 95,212 97,448 94,864
Real Estate:
Construction & Development 550,928 N/A 553,959
Farm 185,288 N/A 152,237
Non-Owner
Occupied CRE 673,608 N/A 617,686
Owner Occupied CRE 820,055 N/A 746,974
Residential 1,328,474 N/A 1,248,409

Total Real Estate 3,558,353 3,235,208 3,319,265
Consumer:
Auto 383,764 N/A 353,595
Non-Auto 104,814 N/A 90,602

Total Consumer 488,578 410,957 444,197

Total $ 5,304,602 $ 5,253,067 $ 5,171,033



Loans
held-for-sale,
consisting of secondary market mortgage loans, totaled $61.80 million,
$66.37 million, and $83.97 million at June 30, 2021 and 2020, and December 31,
2020
, respectively. At June 30, 2021 and 2020 and December 31, 2020,
$5.55 million, $3.08 million and $4.38 million, respectively, are valued using
the lower of cost or fair value, and the remaining amounts are valued under the
fair value option.
Asset Quality
. Our loan portfolio is subject to periodic reviews by our centralized
independent loan review group as well as periodic examinations by bank
regulatory agencies. Loans are placed on
non-accrual
status when, in the judgment of management, the collectability of principal or
interest under the original terms becomes doubtful.
Non-accrual,
past due 90 days or more and still accruing, and restructured loans plus
foreclosed assets were $30.11 million at June 30, 2021, as compared to
$39.72 million at June 30, 2020 and $42.90 million at December 31, 2020. As a
percent of loans
held-for-investment
and foreclosed assets, these assets were 0.57% at June 30, 2021, as compared to
0.76% at June 30, 2020 and 0.83% at December 31, 2020. As a percent of total
assets, these assets were 0.24% at June 30, 2021, as compared to 0.38% at
June 30, 2020 and 0.39% at December 31, 2020. We believe the level of these
assets to be manageable and are not aware of any material classified credits not
properly disclosed as nonperforming at June 30, 2021.

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Supplemental Oil and Gas Information
. As of June 30, 2021, the Company's exposure to the oil and gas industry
totaled 2.07% of total loans
held-for-investment,
excluding PPP loans, or $103.17 million, down $3.07 million from December 31,
2020

year-end
levels. These oil and gas loans consisted (based on collateral supporting the
loan) of (i) development and production loans of 12.20%, (ii) oil and gas field
servicing loans of 5.77%, (iii) real estate loans of 55.64%, (iv) accounts
receivable and inventory of 3.53%, (v) automobile of 7.40% and (vi) other of
15.46%. These have warranted additional scrutiny because of fluctuating oil and
gas prices and the COVID pandemic. The Company instituted additional monitoring
procedures for these loans and has classified and downgraded loans as
appropriate. The following oil and gas information is as of and for the quarters
ended June 30, 2021 and 2020, and the year ended December 31, 2020 (in
thousands, except percentages):

June 30,


December 31,



2021 2020 2020
Oil and gas related loans, excluding PPP
loans $ 103,166 $ 128,143 $ 106,237
Oil and gas related loans as a % of total
loans
held-for-investment,
excluding PPP loans 2.07% 2.82% 2.27%
Classified oil and gas related loans $ 13,090 $ 28,366 $ 13,298
Non-accrual
oil and gas related loans 3,986 3,702 4,774
Net charge-offs for oil and gas related loans
for quarter/year then ended 59 195 825


Supplemental
COVID-19
Industry Exposure.
In addition, at June 30, 2021, loan balances in the
retail/restaurant/hospitality industries totaled $483.13 million or 9.69% of the
Company's total loans
held-for-investment,
excluding PPP loans. These loans comprised $42.64 million of classified loans,
including $5.60 million in
non-accrual
loans. There were no net charge-offs related to this portfolio for the three or
six months ended June 30, 2021. Additional information related to the Company's
retail/restaurant/hospitality industries follows below (in thousands, except
percentages):

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June 30, December 31,
2021 2020 2020
Retail loans $ 326,409 $ 216,244 $ 216,244
Restaurant loans 56,997 46,418 48,618
Hotel loans 71,008 51,957 71,716
Other hospitality loans 27,929 23,230 21,970
Travel loans 790 908 780

Total Retail/Restaurant/Hospitality loans,
excluding PPP loans $ 483,133 $ 338,757


$ 359,328




Retail/Restaurant/Hospitality loans as a %
of total loans
held-for-investment,
excluding PPP loans 9.69 % 7.45 % 7.67 %
Classified Retail/Restaurant/Hospitality
loans $ 42,635 $ 15,837 $ 31,192
Non-accrual
Retail/Restaurant/Hospitality loans 5,600 5,752 5,975
Net Charge-Offs for
Retail/Restaurant/Hospitality loans
quarter/year then ended - 178 561


Table 6 -
Non-accrual,
Past Due 90 Days or More and Still Accruing, Restructured Loans and Foreclosed
Assets (in thousands, except percentages):

June 30, December 31,
2021 2020 2020
Non-accrual
loans $ 29,786 $ 39,320 $ 42,619
Loans still accruing and past due 90 days or more - 92 113
Troubled debt restructured loans* 23 25 24

Nonperforming loans 29,809 39,437 42,756
Foreclosed assets 305 287 142

Total nonperforming assets $ 30,114 $ 39,724 $ 42,898

As a % of loans
held-for-investment
and foreclosed assets 0.57 % 0.76 % 0.83 %
As a % of total assets 0.24 0.38 0.39




* Troubled debt restructured loans of $7.31 million, $7.28 million and



$7.41 million, whose interest collection, after considering economic and



business conditions and collection efforts, is doubtful are included in
non-accrual
loans at June 30, 2021 and 2020, and December 31, 2020, respectively.



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We record interest payments received on
non-accrual
loans as reductions of principal. Prior to the loans being placed on
non-accrual,
we recognized interest income on these loans of approximately $255 thousand for
the year ended December 31, 2020. If interest on these loans had been recognized
on a full accrual basis during the year ended December 31, 2020, such income
would have approximated $4.46 million. Such amounts for the 2021 and 2020
interim periods were not significant.
Allowance for Credit Losses
. The allowance for credit losses is the amount we determine as of a specific
date to be appropriate to absorb current expected credit losses on existing
loans in which full collectability is unlikely based on our review and
evaluation of the loan portfolio. For a discussion of our methodology, see our
accounting policies in Note 1 to the consolidated financial statements
(unaudited). The provision for credit losses for the second quarter of 2021 was
a reversal of $1.21 million, which was made up of a reversal of provision for
loan losses of $1.04 million combined with a reversal of $167 thousand of
provision for unfunded commitments for the second quarter of 2021, as compared
to $8.70 million for the second quarter of 2020. The provision for credit losses
for the six months ended June 30, 2021 was a reversal of $3.20 million, which
was made up of a reversal of provision for loan losses of $4.47 million offset
by a $1.27 million provision for unfunded commitments, as compared to
$18.55 million for the same period in 2020. The net reversal of the Company's
provision for credit losses in 2021 reflects the continued improvement in the
economic outlook for our markets across Texas and overall improvements in asset
quality. As a percent of average loans, net loan recoveries were 0.02% for the
second quarter of 2021, as compared to net charge-offs of 0.01% for the second
quarter of 2020. The allowance for credit losses as a percent of loans
held-for-investment
was 1.17% as of June 30, 2021, as compared to 1.31% as of June 30, 2020 and
1.29% as of December 31, 2020. The allowance for credit losses as a percent of
loans
held-for-investment,
excluding PPP loans, was 1.25% as of June 30, 2021, as compared to 1.52% as of
June 30, 2020 and 1.42% as of December 31, 2020.
Table 7 - Loan Loss Experience and Allowance for Credit Losses (in thousands,
except percentages):

Six-Months
Three-Months Ended Ended

June 30, June 30,
2021 2020 2021 2020
Allowance for credit losses at
period-end $ 62,138 $ 68,947 $ 62,138 $ 68,947
Loans
held-for-investment
at
period-end 5,304,602 5,253,067 5,304,602 5,253,067
Average loans for period 5,383,781 5,248,052 5,340,207 4,957,744
Net charge-offs
(recoveries)/average loans
(annualized) (0.02) % 0.01 % 0.00 % 0.09 %
Allowance for loan
losses/period-end
loans
held-for-investment 1.17 % 1.31 % 1.17 % 1.31 %
Allowance for loan
losses/non-accrual
loans, past due 90 days still
accruing and restructured loans 208.45 % 174.83 % 208.45 % 174.83 %


Interest-Bearing Demand Deposits in Banks.
At June 30, 2021, our interest-bearing deposits in banks were $654.53 million
compared to $196.43 million at June 30, 2020 and $517.97 million at December 31,
2020
, respectively. At June 30, 2021, interest-bearing deposits in banks
included $654.03 million maintained at the Federal Reserve Bank of Dallas and
$504 thousand on deposit with the FHLB.

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Available-for-Sale
Securities
. At June 30, 2021, securities with a fair value of $5.58 billion were
classified as securities
available-for-sale.
As compared to December 31, 2020, the
available-for-sale
portfolio at June 30, 2021
reflected (i) an increase of $188.21 million in obligations of states and
political subdivisions, (ii) an increase of $33.25 million in corporate bonds
and other, and (iii) an increase of $963.56 million in mortgage-backed
securities. Our mortgage related securities are backed by GNMA, FNMA or FHLMC or
are collateralized by securities backed by these agencies.
See Note 2 to the consolidated financial statements (unaudited) for additional
disclosures relating to the investment portfolio at June 30, 2021 and 2020, and
December 31, 2020.
Table 8 - Maturities and Yields of
Available-for-Sale
Securities Held at June 30, 2021 (in thousands, except percentages):

Maturing by Contractual Maturity
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
Obligations of states and political
subdivisions $ 131,368 4.57 % $


716,807 3.90 % $ 1,711,491 2.69 % $ 55,421 2.21 %


$ 2,615,087 3.11 %
Corporate bonds and other securities 4,489 1.34 - - 33,318 1.65 - - 37,807 1.61
Mortgage-backed securities 165,678 1.97 1,869,371 1.82 836,745 1.54 53,360 1.96 2,925,154 1.75

Total $ 301,535 3.09 % $



2,586,178 2.39 % $ 2,581,554 2.31 % $ 108,781 2.09 % $ 5,578,048 2.39 %






All yields are computed on a
tax-equivalent
basis assuming a marginal tax rate of 21%. 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. Maturities of other securities are reported at the earlier
of maturity date or call date.
As of June 30, 2021, the investment portfolio had an overall tax equivalent
yield of 2.39%, a weighted average life of 4.87 years and modified duration of
4.38 years.
Deposits
. Deposits held by our subsidiary bank represent our primary source of funding.
Total deposits were $9.78 billion as of June 30, 2021, as compared to
$8.16 billion as of June 30, 2020 and $8.68 billion as of December 31, 2020.
Table 9 provides a breakdown of average deposits and rates paid for the three
and
six-month
periods ended June 30, 2021 and 2020, respectively.

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Table 9 - Composition of Average Deposits (in thousands, except percentages):

Three-Months Ended June 30,
2021 2020
Average Average Average Average
Balance Rate Balance Rate
Noninterest-bearing deposits $ 3,439,683 - % $ 2,830,960 - %
Interest-bearing deposits:
Interest-bearing checking 3,045,255 0.08 2,486,194 0.14
Savings and money market accounts 2,705,925 0.08 2,183,507 0.16
Time deposits under $250,000 319,705 0.28


339,369 0.51
Time deposits of $250,000 or more 159,106 0.50 126,702 1.07




Total interest-bearing deposits 6,229,991 0.10 % 5,135,772 0.20 %

Total average deposits $ 9,669,674 $ 7,966,732

Total cost of deposits 0.06 % 0.13 %




Six-Months
Ended June 30,
2021 2020
Average Average Average Average
Balance Rate Balance Rate
Noninterest-bearing deposits $ 3,278,067 - % $ 2,561,248 - %
Interest-bearing deposits:
Interest-bearing checking 2,973,933 0.08 2,466,112 0.33
Savings and money market accounts 2,621,171 0.09 2,083,604 0.31
Time deposits under $250,000 322,217 0.31


341,172 0.69
Time deposits of $250,000 or more 156,660 0.55 129,041 1.21




Total interest-bearing deposits 6,073,981 0.11 % 5,019,929 0.37 %

Total average deposits $ 9,352,048 $ 7,581,177

Total cost of deposits 0.07 % 0.25 %



Borrowings.
Included in borrowings were federal funds purchased, securities sold under
repurchase agreements and advances from the FHLB of $549.97 million,
$449.22 million and $430.09 million at June 30, 2021 and 2020 and December 31,
2020
, respectively. Securities sold under repurchase agreements are generally
with significant customers of the Company that require short-term liquidity for
their funds for which we pledge certain securities that have a fair value equal
to at least the amount of the short-term borrowings. The average balance of
federal funds purchased, securities sold under repurchase agreements and
advances from the FHLB were $527.67 million and $877.08 million in the second
quarters of 2021 and 2020, respectively. The weighted average interest rates
paid on these borrowings were 0.07% and 0.19% for the second quarters of 2021
and 2020, respectively. The average balance of federal funds purchased,
securities sold under repurchase agreements and advances from the FHLB were
$492.34 million and $668.84 million for the
six-months
ended June 30, 2021 and 2020, respectively. The weighted average interest rates
paid on these borrowings were 0.08% and 0.28% for the
six-month
periods ended June 30, 2021 and 2020, respectively.

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Capital Resources
We evaluate 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.
Total shareholders' equity was $1.72 billion, or 13.95% of total assets at
June 30, 2021, as compared to $1.58 billion, or 15.30% of total assets at
June 30, 2020, and $1.68 billion, or 15.39% of total assets at December 31,
2020
. Included in shareholders' equity at June 30, 2021 and 2020 and
December 31, 2020 were $136.49 million, $151.24 million and $170.40 million,
respectively, in unrealized gains on investment securities
available-for-sale,
net of related income taxes. For the second quarter of 2021, total shareholders'
equity averaged $1.69 billion, or 14.09% of average assets, as compared to
$1.54 billion, or 14.68% of average assets, during the same period in 2020. For
the first six months of 2021, total shareholders' equity averaged $1.68 billion,
or 14.44% of average assets, as compared to $1.51 billion, or 15.35% of average
assets, during the same period in 2020.
Banking regulators measure capital adequacy by means of the risk-based capital
ratios and the leverage ratio under the Basel III regulatory capital framework
and prompt corrective action regulations. The risk-based capital rules provide
for the weighting of assets and
off-balance-sheet
commitments and contingencies according to prescribed risk categories.
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.
Beginning in January 2015, under the Basel III regulatory capital framework, the
implementation of the capital conservation buffer was effective for the Company
starting at the 0.625% level and increasing 0.625% each year thereafter, until
it reached 2.50% on January 1, 2019. The capital conservation buffer is designed
to absorb losses during periods of economic stress and requires increased
capital levels for the purpose of capital distributions and other payments.
Failure to meet the amount of the buffer will result in restrictions on the
Company's ability to make capital distributions, including dividend payments and
stock repurchases, and to pay discretionary bonuses to executive officers.
As of June 30, 2021 and 2020, and December 31, 2020, we had a total capital to
risk-weighted assets ratio of 21.12%, 22.03% and 22.03%, a Tier 1 capital to
risk-weighted assets ratio of 20.04%, 20.78% and 20.79%; a common equity Tier 1
to risk-weighted assets ratio of 20.04%, 20.78% and 20.79% and a leverage ratio
of 11.10%, 11.25% and 11.86%, respectively. The regulatory capital ratios as of
June 30, 2021 and 2020, and December 31, 2020 were calculated under Basel III
rules.

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The regulatory capital ratios of the Company and Bank under the Basel III
regulatory capital framework are as follows:




Required to be
Minimum Capital Considered Well-
Actual Required-Basel III Capitalized
As of June 30, 2021: Amount Ratio Amount Ratio Amount Ratio
Total Capital to Risk-Weighted
Assets:
Consolidated $ 1,347,772 21.12 % $ 669,931 10.50 % $ 638,030 10.00 %
First Financial Bank, N.A $ 1,227,741 19.28 % $ 668,612 10.50 % $ 636,773 10.00 %
Tier 1 Capital to Risk-Weighted
Assets:
Consolidated $ 1,278,883 20.04 % $ 542,325 8.50 % $ 382,818 6.00 %
First Financial Bank, N.A $ 1,158,852 18.20 % $ 541,257 8.50 % $ 509,418 8.00 %
Common Equity Tier 1 Capital to
Risk-Weighted Assets:
Consolidated $ 1,278,883 20.04 % $ 446,621 7.00 % - N/A
First Financial Bank, N.A $ 1,158,852 18.20 % $ 445,741 7.00 % $ 413,902 6.50 %
Leverage Ratio:
Consolidated $ 1,278,883 11.10 % $ 460,851 4.00 % - N/A
First Financial Bank, N.A $ 1,158,852 10.09 % $ 459,483 4.00 % $ 574,353 5.00 %



Required to be
Minimum Capital Considered Well-
Actual Required-Basel III Capitalized
As of June 30, 2020: Amount Ratio Amount Ratio Amount Ratio
Total Capital to Risk-Weighted
Assets:
Consolidated $ 1,191,492 22.03 % $ 567,829 10.50 % $ 540,789 10.00 %
First Financial Bank, N.A $ 1,086,019 20.13 % $ 566,561 10.50 % $ 539,582 10.00 %
Tier 1 Capital to Risk-Weighted
Assets:
Consolidated $ 1,123,866 20.78 % $ 459,671 8.50 % $ 324,474 6.00 %
First Financial Bank, N.A $ 1,018,543 18.88 % $ 458,645 8.50 % $ 431,666 8.00 %
Common Equity Tier 1 Capital to
Risk-Weighted Assets:
Consolidated $ 1,123,866 20.78 % $ 378,552 7.00 % - N/A
First Financial Bank, N.A $ 1,018,543 18.88 % $ 377,708 7.00 % $ 350,728 6.50 %
Leverage Ratio:
Consolidated $ 1,123,866 11.25 % $ 399,750 4.00 % - N/A
First Financial Bank, N.A $ 1,018,543 10.22 % $ 398,459 4.00 % $ 498,074 5.00 %



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Required to be
Minimum Capital Considered Well-
Actual Required Basel III Capitalized
As of December 31, 2020: Amount Ratio Amount Ratio Amount Ratio
Total Capital to Risk-Weighted Assets:
Consolidated $ 1,273,749 22.03 % $ 607,038 10.50 % $ 578,131 10.00 %
First Financial Bank, N.A $ 1,123,275 19.47 % $ 605,830 10.50 % $ 576,981 10.00 %
Tier 1 Capital to Risk-Weighted Assets:
Consolidated $ 1,201,729 20.79 % $ 491,412 8.50 % $ 346,879 6.00 %
First Financial Bank, N.A $ 1,051,255 18.22 % $ 490,434 8.50 % $ 461,585 8.00 %
Common Equity Tier 1 Capital to
Risk-Weighted Assets:
Consolidated $ 1,201,729 20.79 % $ 404,692 7.00 % - N/A
First Financial Bank, N.A $ 1,051,255 18.22 % $ 403,887 7.00 % $ 375,038 6.50 %
Leverage Ratio:
Consolidated $ 1,201,729 11.86 % $ 405,268 4.00 % - N/A
First Financial Bank, N.A $ 1,051,255 10.41 % $


404,002 4.00 % $ 505,002 5.00 %





In connection with the adoption of the Basel III regulatory capital framework,
our subsidiary bank made the election to continue to exclude accumulated other
comprehensive income from
available-for-sale
securities ("AOCI") from capital in connection with its quarterly financial
filing and, in effect, to retain the AOCI treatment under the prior capital
rules.
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.
Our subsidiary bank has an asset liability management committee that monitors
interest rate risk and compliance with investment policies. The subsidiary bank
utilizes an earnings simulation model as the primary quantitative tool in
measuring the amount of interest rate risk associated with changing market
rates. The model quantifies the effects of various interest rate scenarios on
projected net interest income and net income over the next twelve months. The
model measures the impact on net interest income relative to a base case
scenario of hypothetical fluctuations in interest rates over the next
twelve months. These simulations incorporate assumptions regarding balance sheet
growth and mix, pricing and the
re-pricing
and maturity characteristics of the existing and projected balance sheet.
The following analysis depicts the estimated impact on net interest income of
immediate changes in interest rates at the specified levels for period
presented.

Percentage change in net interest income:
Change in interest rates: June 30, December 31,
(in basis points) 2021 2020 2020
+400 11.19 % 16.96 % 18.18 %
+300 8.94 % 13.06 % 13.99 %
+200 6.41 % 8.86 % 9.51 %
+100 3.57 % 4.43 % 4.75 %
-100 (4.98 )% (3.05 )% (3.46 )%
-200 (7.85 )% (5.03 )% (5.44 )%



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The results for the net interest income simulations as of June 30, 2021,
June 30, 2020 and December 31, 2020 resulted in an asset sensitive position.
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 on 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.
As interest-bearing assets and liabilities
re-price
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.
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 committee oversees and
monitors this risk.
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. 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 bank. Other sources of funds include our ability to
borrow from short-term sources, such as purchasing federal funds from
correspondent banks, sales of securities under agreements to repurchase and
advances from the FHLB (see below) and an unfunded $25.00 million revolving line
of credit established with Frost Bank, a nonaffiliated bank, which matures in
June 2023 (see next paragraph).
Our subsidiary bank also has federal funds purchased lines of credit with two
non-affiliated
banks totaling $130.00 million. At June 30, 2021, there were no amounts drawn on
these lines of credit. Our subsidiary bank also has (i) an available line of
credit with the FHLB totaling $1.58 billion at June 30, 2021, secured by
portions of our loan portfolio and certain investment securities and (ii) access
to the Federal Reserve Bank of Dallas lending program. At June 30, 2021, the
Company had no outstanding advances from the FHLB.
The Company renewed its loan agreement, effective June 30, 2021, with Frost
Bank
. Under the loan agreement, as renewed and amended, we are permitted to draw
up to $25.00 million on a revolving line of credit. Prior to June 30, 2023,
interest is paid quarterly at
The Wall Street Journal
Prime Rate and the line of credit matures June 30, 2023. If a balance exists at
June 30, 2023, the principal balance converts to a term facility payable
quarterly over five years and interest is paid quarterly at
The Wall Street Journal
Prime Rate. The line of credit is unsecured. 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, which among others, restricts the payment of
dividends above 55% of consolidated net income, limits the incurrence of debt
(excluding any amounts acquired in an acquisition) and prohibits 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 35% (low) in 2021 to 53% (high) in 2003 and 2006. The Company was
in compliance with the financial and operational covenants at June 30, 2021.
There was no outstanding balance under the line of credit as of June 30, 2021
and 2020, or December 31, 2020.

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In addition, we anticipate that future acquisitions of financial institutions,
expansion of branch locations or offerings of new products could also place a
demand on our cash resources. Available cash and cash equivalents at our parent
company which totaled $105.86 million at June 30, 2021, investment securities
which totaled $2.54 million at June 30, 2021 and mature over 9 to 10 years,
available dividends from our subsidiaries which totaled $316.05 million at
June 30, 2021, 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.
Our liquidity position is continuously monitored and adjustments are made to the
balance between sources and uses of funds as deemed appropriate. Liquidity risk
management is an important element in our asset/liability management process. We
regularly model liquidity stress scenarios to assess potential liquidity
outflows or funding problems resulting from economic disruptions, volatility in
the financial markets, unexpected credit events or other significant occurrences
deemed potentially problematic by management. These scenarios are incorporated
into our contingency funding plan, which provides the basis for the
identification of our liquidity needs. As of June 30, 2021, management is not
aware of any events that are reasonably likely to have a material adverse effect
on our liquidity, capital resources or operations. We are monitoring closely the
economic impact of the coronavirus on our customers and the communities we
serve. Given the strong core deposit base and relatively low loan to deposit
ratios maintained at our subsidiary bank, we consider our current liquidity
position to be adequate to meet our short-term and long-term liquidity needs. In
addition, management is not aware of any regulatory recommendations regarding
liquidity that would have a material adverse effect on us.
Off-Balance
Sheet ("OBS")/Reserve for Unfunded Commitments.
We are a party to financial instruments with OBS 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
federal funds sold to correspondent banks 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. At
June 30, 2021, the Company's reserve for unfunded commitments totaled
$6.75 million which is recorded in other liabilities.
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.

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Table 10 - Commitments as of June 30, 2021 (in thousands):

Total Notional
Amounts
Committed
Unfunded lines of credit $ 858,714
Unfunded commitments to extend credit 805,258
Standby letters of credit 39,655

Total commercial commitments $ 1,703,627



We believe we have no other OBS 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. The above table does
not include balances related to the Company's IRLC and forward mortgage-backed
security trades.
Parent Company Funding
. Our ability to fund various operating expenses, dividends, and cash
acquisitions is generally dependent on our own earnings (without giving effect
to our subsidiaries), cash reserves and funds derived from our subsidiaries.
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 subsidiaries. At June 30, 2021, $316.05 million was
available for the payment of intercompany dividends by our subsidiaries without
the prior approval of regulatory agencies. Our subsidiaries paid aggregate
dividends of $9.00 million and $5.00 million for the
six-month
periods ended June 30, 2021 and 2020, respectively.
Dividends
. Our long-term dividend policy is to pay cash dividends to our shareholders of
approximately 40% of annual net earnings while maintaining adequate capital to
support growth. We are also restricted by a loan covenant within our line of
credit agreement with Frost Bank to dividend no greater than 55% of net income,
as defined in such loan agreement. The cash dividend payout ratios have amounted
to 35.18% and 39.17% of net earnings for the first six months of 2021 and 2020,
respectively. Given our current capital position and projected earnings and
asset growth rates, we do not anticipate any significant change in our current
dividend policy.
Our bank subsidiary, which is a national banking association and a member of the
Federal Reserve System, is required by federal law to obtain the prior approval
of the OCC 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 interpreted by regulation) for the preceding two
calendar years, less any required transfers to surplus.
To pay dividends, we and our subsidiary bank 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, the FDIC 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, 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.

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