UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

_____________________________

 

FORM 10-Q

_____________________________

 

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2016

 

OR

 

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

FOR THE TRANSITION PERIOD FROM              TO             

 

COMMISSION FILE NUMBER: 001-37585

_____________________________

Allegiance Bancshares, Inc.

(Exact name of registrant as specified in its charter)

_____________________________

 

   
Texas 26-3564100

(State or other jurisdiction

of incorporation or organization)

(I.R.S. Employer

Identification No.)

 

8847 West Sam Houston Parkway, N., Suite 200

Houston, Texas 77040

(Address of principal executive offices, including zip code)

 

(281) 894-3200

(Registrant’s telephone number, including area code)

_____________________________

 

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  ☒   No  ☐

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  ☒    No   ☐

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See definitions of “accelerated filer”, “large accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act:

 

       
Large Accelerated Filer   Accelerated Filer
       
Non-accelerated Filer   (Do not check if a smaller reporting company) Smaller Reporting Company

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ☐    No  ☒

 

As of August 5, 2016, there were 12,875,660 outstanding shares of the registrant’s Common Stock, par value $1.00 per share.

 

 

ALLEGIANCE BANCSHARES, INC.

INDEX TO FORM 10-Q

JUNE 30, 2016

 

PART I—FINANCIAL INFORMATION  
     
Item 1. Interim Consolidated Financial Statements  
  Consolidated Balance Sheets (unaudited) 3
  Consolidated Statements of Income 4
  Consolidated Statements of Comprehensive Income (unaudited) 5
  Consolidated Statements of Changes in Stockholders’ Equity (unaudited) 6
  Consolidated Statements of Cash Flows (unaudited) 7
  Condensed Notes to Interim Consolidated Financial Statements (unaudited) 8
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations 31
Item 3. Quantitative and Qualitative Disclosures about Market Risk 54
Item 4. Controls and Procedures 55
   
PART II—OTHER INFORMATION  
     
Item 1. Legal Proceedings 56
Item 1A. Risk Factors 56
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 56
Item 3. Defaults upon Senior Securities 56
Item 4. Mine Safety Disclosures 56
Item 5. Other Information 56
Item 6. Exhibits 57
Signatures 58

 

 

2 

Table of Contents

PART I—FINANCIAL INFORMATION

ITEM 1. INTERIM CONSOLIDATED FINANCIAL STATEMENTS

 

ALLEGIANCE BANCSHARES, INC.

CONSOLIDATED BALANCE SHEETS

 

   June 30,
2016
  December 31,
2015
   (Unaudited)   
   (Dollars in thousands, except share data)
ASSETS          
Cash and due from banks  $121,913   $63,380 
Interest-bearing deposits at other financial institutions   88,950    85,051 
Total cash and cash equivalents   210,863    148,431 
           
Available for sale securities, at fair value   303,463    165,097 
           
Loans held for sale   -    27,887 
Loans held for investment   1,753,683    1,653,165 
Less: allowance for loan losses   (14,917)   (13,098)
Loans, net   1,738,766    1,667,954 
           
Accrued interest receivable   7,969    6,518 
Premises and equipment, net   17,821    18,471 
Other real estate owned   1,397    - 
Federal Home Loan Bank stock   13,155    2,569 
Branch assets held for sale   -    1,398 
Bank owned life insurance   21,530    21,211 
Goodwill   39,389    39,389 
Core deposit intangibles, net   4,446    5,230 
Other assets   8,782    8,311 
TOTAL ASSETS  $2,367,581   $2,084,579 
           
LIABILITIES AND STOCKHOLDERS’ EQUITY          
LIABILITIES:          
Deposits:          
Noninterest-bearing  $630,689   $620,320 
Interest-bearing          
Demand   111,214    97,826 
Money market and savings   451,950    431,305 
Certificates and other time   649,486    609,682 
Total interest-bearing deposits   1,212,650    1,138,813 
Total deposits   1,843,339    1,759,133 
           
Accrued interest payable   223    124 
Short-term borrowings   30,000    50,000 
Other borrowed funds   200,569    569 
Subordinated debentures   9,142    9,089 
Other liabilities   8,057    7,174 
Total liabilities   2,091,330    1,826,089 
           
COMMITMENTS AND CONTINGENCIES (See Note 12)          
STOCKHOLDERS’ EQUITY:          
Preferred stock, $1 par value; 1,000,000 shares authorized; there were no shares issued and outstanding of Series A or Series B, each has a $1,000 liquidation value   -    - 
Common stock, $1 par value; 40,000,000 shares authorized; 12,869,410 shares issued and outstanding at June 30, 2016 and 12,814,696 shares issued and 12,812,985 shares outstanding at December 31, 2015   12,869    12,815 
Capital surplus   210,512    209,285 
Retained earnings   46,020    34,411 
Accumulated other comprehensive income   6,850    2,017 
Less: Treasury stock, at cost, 1,711 shares at December 31, 2015.  There were no treasury shares outstanding at June 30, 2016.   -    (38)
Total stockholders’ equity   276,251    258,490 
TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY  $2,367,581   $2,084,579 

 

See condensed notes to interim consolidated financial statements.

3 

Table of Contents

ALLEGIANCE BANCSHARES, INC.

CONSOLIDATED STATEMENTS OF INCOME

(Unaudited)

 

   Three Months Ended June 30,  Six Months Ended June 30,
   2016  2015  2016  2015
   (Dollars in thousands, except per share data)
INTEREST INCOME:                    
Loans, including fees  $22,839   $21,079   $45,067   $41,385 
Securities:                    
Taxable   452    337    723    776 
Tax-exempt   1,086    384    1,896    384 
Deposits in other financial institutions   150    50    292    124 
Total interest income   24,527    21,850    47,978    42,669 
                     
INTEREST EXPENSE:                    
Demand, money market and savings deposits   569    525    1,113    1,037 
Certificates and other time deposits   1,665    1,211    3,225    2,355 
Short-term borrowings   106    2    245    2 
Subordinated debentures   120    162    237    325 
Other borrowed funds   118    216    125    446 
Total interest expense   2,578    2,116    4,945    4,165 
                     
NET INTEREST INCOME   21,949    19,734    43,033    38,504 
Provision for loan losses   1,645    1,420    2,355    2,103 
Net interest income after provision for loan losses   20,304    18,314    40,678    36,401 
NONINTEREST INCOME:                    
Nonsufficient funds fees   145    168    308    333 
Service charges on deposit accounts   173    176    318    351 
Gain on sale of branch assets   -    -    2,050    - 
Loss on sale of other real estate   -    -    -    (6)
Bank owned life insurance income   153    174    319    266 
Other   741    429    1,521    869 
Total noninterest income   1,212    947    4,516    1,813 
NONINTEREST EXPENSE:                    
Salaries and employee benefits   9,177    8,481    18,450    17,423 
Net occupancy and equipment   1,214    1,274    2,446    2,358 
Depreciation   415    409    832    776 
Data processing and software amortization   622    827    1,275    1,453 
Professional fees   401    397    935    877 
Regulatory assessments and FDIC insurance   355    320    700    694 
Core deposit intangibles amortization   195    207    394    415 
Communications   274    358    554    692 
Advertising   197    184    398    322 
Other   1,073    965    2,192    1,998 
Total noninterest expense   13,923    13,422    28,176    27,008 
INCOME BEFORE INCOME TAXES   7,593    5,839    17,018    11,206 
Provision for income taxes   2,339    1,956    5,409    3,852 
NET INCOME   5,254    3,883    11,609    7,354 
Preferred stock dividends   -    260    -    386 
NET INCOME ATTRIBUTABLE TO COMMON STOCKHOLDERS  $5,254   $3,623   $11,609   $6,968 
                     
EARNINGS PER COMMON SHARE:                    
Basic  $0.41   $0.37   $0.90   $0.71 
Diluted  $0.40   $0.36   $0.89   $0.70 

 

See condensed notes to interim consolidated financial statements.

 

4 

Table of Contents

ALLEGIANCE BANCSHARES, INC.

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(Unaudited)

 

   Three Months Ended June 30,  Six Months Ended June 30,
   2016  2015  2016  2015
   (Dollars in thousands)
Net income  $5,254   $3,883   $11,609   $7,354 
Other comprehensive income (loss), before tax:                    
Unrealized gain (loss) on securities:                    
Change in unrealized holding gain (loss) on available for sale securities during the period   6,232    (1,722)   7,435    (965)
Reclassification of amount realized through the sale of securities   -    -    -    - 
Total other comprehensive income (loss)   6,232    (1,722)   7,435    (965)
Deferred tax expense (benefit) related to other comprehensive income (loss)   (2,181)   601    (2,602)   329 
Other comprehensive income (loss), net of tax   4,051    (1,121)   4,833    (636)
Comprehensive income  $9,305   $2,762   $16,442   $6,718 

 

See condensed notes to interim consolidated financial statements.

 

 

 

5 

Table of Contents

ALLEGIANCE BANCSHARES, INC.

CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY

(Unaudited)

   Preferred Stock  Common Stock  Capital  Retained  Accumulated
Other
Comprehensive
  Treasury  Total
Stockholders’
   Shares  Amount  Shares  Amount  Surplus  Earnings  Income (Loss)  Stock  Equity
   (In thousands, except share data)
BALANCE AT JANUARY 1, 2015   -   $-    7,477,309   $7,477   $104,568   $19,184   $549   $-   $131,778 
Net income                            7,354              7,354 
Other comprehensive loss                                 (636)        (636)
Common stock issued in connection with the exercise of stock options and restricted stock awards             3,983    4    7              -    11 
Repurchase of treasury stock                                      (51)   (51)
Issuance of common stock             4,884    5    103              13    121 
Common stock issued in connection with the acquisition of F&M Bancshares, Inc.             2,338,520    2,339    49,108                   51,447 
Preferred stock issued in connection with the acquisition of F&M Bancshares, Inc.   11,550    11,550                                  11,550 
Preferred stock dividends                            (386)             (386)
Stock based compensation expense                       642                   642 
BALANCE AT JUNE 30, 2015   11,550   $11,550    9,824,696   $9,825   $154,428   $26,152   $(87)  $(38)  $201,830 
                                              
BALANCE AT JANUARY 1, 2016   -   $-    12,814,696   $12,815   $209,285   $34,411   $2,017   $(38)  $258,490 
Net income                            11,609              11,609 
Other comprehensive income                                 4,833         4,833 
Common stock issued in connection with the exercise of stock options and restricted stock awards             54,714    54    520                   574 
Issuance of treasury stock                                      38    38 
Stock based compensation expense                       707                   707 
BALANCE AT JUNE 30, 2016   -   $-    12,869,410   $12,869   $210,512   $46,020   $6,850   $-   $276,251 

 

See condensed notes to interim consolidated financial statements.

6 

Table of Contents

ALLEGIANCE BANCSHARES, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

 

   Six Months Ended June 30,
   2016  2015
   (Dollars in thousands)
CASH FLOWS FROM OPERATING ACTIVITIES:          
Net income  $11,609   $7,354 
Adjustments to reconcile net income to net cash provided by operating activities:          
Depreciation and core deposit intangibles amortization   1,226    1,190 
Provision for loan losses   2,355    2,103 
Net amortization of premium on investments   1,329    455 
Bank owned life insurance   (319)   (266)
Net accretion of discount on loans   (904)   (2,350)
Net amortization of discount on subordinated debentures   53    161 
Net amortization of discount on certificates of deposit   (175)   (460)
Net loss on sale or write down of premises, equipment and other real estate   -    6 
Net gain on sale of branch assets   (2,050)   - 
Federal Home Loan Bank stock dividends   (32)   - 
Stock based compensation expense   707    642 
(Increase) decrease in accrued interest receivable and other assets   (3,549)   214
Increase (decrease) in accrued interest payable and other liabilities   1,246    (434)
Net cash provided by operating activities   11,496    8,615 
           
CASH FLOWS FROM INVESTING ACTIVITIES:          
Proceeds from maturities and principal paydowns of available for sale securities   1,962,150    474,189 
Proceeds from sales of available for sale securities   -    14,748 
Purchase of available for sale securities   (2,094,410)   (542,335)
Net change in total loans   (91,751)   (152,652)
Purchase of bank premises and equipment   (196)   (1,531)
Purchase of bank owned life insurance   -    (10,000)
Net purchases of Federal Home Loan Bank stock   (10,985)   (2,898)
Net cash paid for the sale of branch assets   (5,250)   - 
Net cash and cash equivalents acquired in the purchase of F&M Bancshares, Inc.   -    106,486 
Net cash used in investing activities   (240,442)   (113,993)
           
CASH FLOWS FROM FINANCING ACTIVITIES:          
Net increase (decrease) in noninterest-bearing deposits   16,897    (2,822)
Net increase in interest-bearing deposits   93,869    4,650 
Paydowns of long-term borrowings   -    (18,000)
Proceeds from long-term borrowings   200,000    18,000 
Paydowns of short-term borrowings   (20,000)   - 
Proceeds from short-term borrowings   -    75,000 
Preferred stock dividends   -    (386)
Proceeds from the issuance of common stock, stock option exercises, restricted stock awards and the ESPP   574    132 
Issuance (repurchase) of treasury stock   38    (51)
Net cash provided by financing activities   291,378    76,523 
           
NET CHANGE IN CASH AND CASH EQUIVALENTS   62,432    (28,855)
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD   148,431    167,540 
CASH AND CASH EQUIVALENTS, END OF PERIOD  $210,863   $138,685 
           
NONCASH ACTIVITIES:          
Acquired loans transferred to loans held for sale  $-   $33,409 
Acquired premises and equipment and accrued interest receivable transferred to branch assets held for sale   -    1,662 
           
SUPPLEMENTAL INFORMATION:          
Income taxes paid  $6,100   $3,400 
Interest paid   2,298    3,647 

 

See Note 2 regarding non-cash transactions included in the F&M Bancshares, Inc. acquisition      

 

See condensed notes to interim consolidated financial statements.

7 

Table of Contents

ALLEGIANCE BANCSHARES, INC.

CONDENSED NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2016

(Unaudited)

 

1. NATURE OF OPERATIONS AND SUMMARY OF SIGNIFICANT ACCOUNTING AND REPORTING POLICIES

 

Nature of Operations-Allegiance Bancshares, Inc. (“Allegiance”) and its wholly-owned subsidiary, Allegiance Bank, a Texas state bank, (the “Bank”, and together with Allegiance, collectively referred to as the “Company”) provide commercial and retail loans and commercial banking services. The Company derives substantially all of its revenues and income from the operation of the Bank. The Company is focused on delivering a wide variety of relationship-driven commercial banking products and community-oriented services tailored to meet the needs of small to mid-sized businesses, professionals and individuals through its 16 offices in Houston, Texas and the surrounding region. The Bank provides its customers with a variety of banking services including checking accounts, savings accounts and certificates of deposit, and its primary lending products are commercial, personal, automobile, mortgage and home improvement loans. The Bank also offers safe deposit boxes, automated teller machines, drive-through services and 24-hour depository facilities.

 

Basis of Presentation-The accompanying unaudited condensed consolidated financial statements of the Company have been prepared in accordance with United States Generally Accepted Accounting Principles (GAAP) for interim financial information and in accordance with guidance provided by the Securities and Exchange Commission. Accordingly, the condensed financial statements do not include all of the information and footnotes required by GAAP for complete financial statements. The preparation of consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes. Actual results could differ from those estimates.

 

In the opinion of management, the accompanying unaudited condensed consolidated financial statements reflect all adjustments considered necessary for a fair presentation of the financial position, results of operations and cash flows of the Company on a consolidated basis, and all such adjustments are of a normal recurring nature. Transactions with Allegiance have been eliminated. The condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements and footnotes thereto included in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2015. Operating results for the three and six months ended June 30, 2016 are not necessarily indicative of the results that may be expected for the year ending December 31, 2016. Furthermore, the acquisition of F&M Bancshares, Inc. during the first quarter of 2015 may impact the comparability of year to date 2016 versus year to date 2015 comparable information.

 

Significant Accounting and Reporting Policies

 

The Company’s significant accounting and reporting policies can be found in Note 1 of the Company’s annual financial statements included the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2015.

 

New Accounting Standards

 

Adoption of New Accounting Standards

 

On January 1, 2016, the Company adopted ASU 2015-16, “Business Combinations (Topic 805) – Simplifying the Accounting for Measurement-Period Adjustments.” ASU 2015-16 requires that an acquirer recognize adjustments to provisional amounts that are identified during the measurement period in the reporting period in which the adjustment amounts are determined. The acquirer must record, in the same period’s financial statements, the effect on earnings of changes in depreciation, amortization, or other income effects, if any, as a result of the change to the provisional amounts, calculated as if the accounting had been completed at the acquisition date. Additionally, the entity is required to present separately on the face of the income statement or disclose in the notes the portion of the amount recorded in current-period earnings by line item that would have been recorded in previous reporting periods if the adjustment to the provisional amounts had been recognized as of the acquisition date. The adoption of ASU 2015-16 did not have a significant impact on the Company’s financial statements.

8 

Table of Contents

ALLEGIANCE BANCSHARES, INC.

CONDENSED NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2016

(Unaudited)

 

Newly Issued But Not Yet Effective Accounting Standards

 

ASU 2014-09 “Revenue from Contract with Customers (Topic 606).” ASU 2014-09 supersedes the revenue recognition requirements in Revenue Recognition (Topic 605), and most industry-specific guidance throughout the Industry Topics of the Codification. The core principle of ASU 2014-09 is that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. ASU 2014-09 is currently effective for the Company beginning on January 1, 2018 with retrospective application to each prior reporting period presented. The Company is currently evaluating the potential impact of ASU 2014-09 on the Company’s financial statements.

 

ASU 2016-02 “Leases (Topic 842).” ASU 2016-02 will, among other things, require lessees to recognize a lease liability, which is a lessee’s obligation to make lease payments arising from a lease, measured on a discounted basis; and a right-of-use asset, which is an asset that represents the lessee’s right to use, or control the use of, a specified asset for the lease term. ASU 2016-02 does not significantly change lease accounting requirements applicable to lessors; however, certain changes were made to align, where necessary, lessor accounting with the lessee accounting model and ASC Topic 606, “Revenue from Contracts with Customers.” ASU 2016-02 will be effective for the Company on January 1, 2019 and will require transition using a modified retrospective approach for leases existing at, or entered into after, the beginning of the earliest comparative period presented in the financial statements. The Company is currently evaluating the potential impact of ASU 2016-02 on the Company’s financial statements.

 

ASU 2016-09, “Compensation - Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting.” Under ASU 2016-09 all excess tax benefits and tax deficiencies related to share-based payment awards should be recognized as income tax expense or benefit in the income statement during the period in which they occur. Previously, such amounts were recorded in the pool of excess tax benefits included in additional paid-in capital, if such pool was available. Because excess tax benefits are no longer recognized in additional paid-in capital, the assumed proceeds from applying the treasury stock method when computing earnings per share should exclude the amount of excess tax benefits that would have previously been recognized in additional paid-in capital. Additionally, excess tax benefits should be classified along with other income tax cash flows as an operating activity rather than a financing activity, as was previously the case. ASU 2016-09 also provides that an entity can make an entity-wide accounting policy election to either estimate the number of awards that are expected to vest (current GAAP) or account for forfeitures when they occur. ASU 2016-09 changes the threshold to qualify for equity classification (rather than as a liability) to permit withholding up to the maximum statutory tax rates (rather than the minimum as was previously the case) in the applicable jurisdictions. ASU 2016-09 will be effective on January 1, 2017 and is not expected to have a significant impact on the Company’s financial statements.

 

ASU No. 2016-10, “Revenue from Contracts with Customers (Topic 606): Identifying Performance Obligations and Licensing.” ASU 2016-10 was issued to clarify ASC Topic 606, “Revenue from Contracts with Customers” related to (i) identifying performance obligations; and (ii) the licensing implementation guidance. The effective date and transition of ASU 2016-10 is the same as the effective date and transition of ASU 2014-09, “Revenue from Contracts with Customers (Topic 606),” as discussed above. The Company is currently evaluating the potential impact of ASU 2016-10 on the Company’s financial statements.

 

2. ACQUISITIONS

 

2015 Acquisition

 

Acquisition of F&M Bancshares - On January 1, 2015, the Company completed the acquisition of F&M Bancshares, Inc. (“F&M Bancshares”) and its wholly-owned subsidiary Enterprise Bank (“Enterprise”) headquartered in Houston, Texas. Enterprise operated nine banking locations, seven in Houston, Texas and two in Central Texas: one in Rosebud, Texas and one in Mart, Texas. During the first quarter of 2015, the Company consolidated two of the seven acquired Houston area locations due to the close proximity of these locations to the Company’s existing banking locations. The Company acquired F&M Bancshares to further expand its Houston, Texas area market. During the first quarter of 2016, Allegiance completed the sale of the two Central Texas branch locations that were acquired as part of the F&M Bancshares acquisition. Allegiance sold $18.2 million and $26.6 million of loans and deposits, respectively, and recorded an after tax gain of approximately $1.3 million on the sale of these branches.

 

9 

Table of Contents

ALLEGIANCE BANCSHARES, INC.

CONDENSED NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2016

(Unaudited)

 

Pursuant to the merger agreement, the Company issued 2,338,520 shares of Company common stock for all outstanding shares of F&M Bancshares capital stock and paid $642 thousand in cash for any fractional and out of state shares held by F&M Bancshares shareholders. The Company recognized initial goodwill of $28.2 million, which is calculated as the excess of both the consideration exchanged and liabilities assumed as compared to the fair value of identifiable assets acquired, none of which is expected to be deductible for tax purposes. F&M Bancshares results of operations were included in the Company’s results beginning January 1, 2015.

 

The Company finalized its valuation of all assets and liabilities acquired, resulting in no changes to purchase accounting adjustments. A summary of the final purchase price allocation is as follows (dollars in thousands):

 

Fair value of consideration paid:     
Common shares issued (2,338,520 shares)  $51,447 
Preferred shares issued (11,550 shares)   11,550 
Cash consideration   642 
Total consideration paid  $63,639 
      
Fair value of assets acquired:     
Cash and cash equivalents  $107,128 
Investment Securities   14,722 
Loans, net   404,637 
Premises and equipment   7,699 
Core deposit intangibles   4,313 
Other assets   15,896 
Total assets acquired  $554,395 
      
Fair value of liabilities assumed:     
Deposits  $489,556 
Subordinated debt   8,871 
Other borrowed funds   18,000 
Other liabilities   2,574 
Total liabilities assumed   519,001 
Fair value of net assets acquired  $35,394 
Goodwill resulting from acquisition  $28,245 

 

Subsequent to the acquisition, the Company paid off the $18.0 million of borrowed funds from F&M Bancshares shareholders by drawing on its borrowing facility with another financial institution. Additionally, the securities acquired from F&M Bancshares were sold subsequent to the acquisition with no income statement impact.

 

On July 15, 2015, the Company redeemed all of the outstanding shares of the Company’s Series A and Series B preferred stock for an aggregate redemption price of $11.7 million (which is the sum of the liquidation amount plus accrued and unpaid dividends up to but excluding the redemption date). The Company issued the shares of Series A and Series B preferred stock in connection with the F&M Bancshares acquisition, which had preferred stock pursuant to the U.S. Treasury’s Troubled Asset Relief Program.

 

The Company incurred approximately $941 thousand of pre-tax merger related expenses during the year ended December 31, 2015. The merger expenses are reflected on the Company’s income statement for the applicable period and are reported primarily in the categories of salaries and benefits and professional fees.

 

10 

Table of Contents

ALLEGIANCE BANCSHARES, INC.

CONDENSED NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2016

(Unaudited)

 

3. GOODWILL AND CORE DEPOSIT INTANGIBLE ASSETS

 

Changes in the carrying amount of the Company’s goodwill and core deposit intangible assets were as follows:

 

   Goodwill  Core Deposit
Intangible Assets
   (Dollars in thousands)
       
Balance as of January 1, 2015  $11,144   $1,747 
Acquisition of F&M Bancshares   28,245    4,313 
Amortization   -    (830)
Balance as of December 31, 2015   39,389    5,230 
Sale of branch assets   -    (390)
Amortization   -    (394)
Balance as of June 30, 2016  $39,389   $4,446 

 

Goodwill is recorded on the acquisition date of an entity. Management performs an evaluation annually, and more frequently if a triggering event occurs, of whether any impairment of the goodwill and other intangible assets has occurred. If any such impairment is determined, a write-down is recorded. As of June 30, 2016, there were no impairments recorded on goodwill and other intangible assets. During the first quarter of 2016, the Bank completed the sale of the two Central Texas branch locations acquired from F&M Bancshares in 2015 and wrote-down the core deposit intangible assets related to those locations.

 

The estimated aggregate future amortization expense for core deposit intangible assets remaining as of June 30, 2016 is as follows (dollars in thousands):

 

Remaining 2016  $391 
2017   781 
2018   781 
2019   781 
2020   744 
Thereafter   968 
Total  $4,446 

 

11 

Table of Contents

ALLEGIANCE BANCSHARES, INC.

CONDENSED NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2016

(Unaudited)

 

4. SECURITIES

 

The amortized cost and fair value of investment securities were as follows:

 

   June 30, 2016
   Amortized
Cost
  Gross
Unrealized
Gains
  Gross
Unrealized
Losses
  Fair
Value
   (Dollars in thousands)
Available for Sale                    
U.S. Government and agency securities  $8,708   $656   $-   $9,364 
Municipal securities   209,540    8,953    -    218,493 
Agency mortgage-backed pass-through securities   26,556    651    (102)   27,105 
Corporate bonds   48,121    401    (21)   48,501 
Total  $292,925   $10,661   $(123)  $303,463 

 

   December 31, 2015
   Amortized
Cost
  Gross
Unrealized
Gains
  Gross
Unrealized
Losses
  Fair
Value
   (Dollars in thousands)
Available for Sale                    
U.S. Government and agency securities  $8,674   $412   $-   $9,086 
Municipal securities   123,809    2,575    (35)   126,349 
Agency mortgage-backed pass-through securities   29,511    397    (246)   29,662 
Total  $161,994   $3,384   $(281)  $165,097 

 

The amortized cost and fair value of investment securities at June 30, 2016, by contractual maturity, are shown below. Expected maturities may differ from contractual maturities if borrowers have the right to call or prepay obligations at any time with or without call or prepayment penalties.

 

 

   Amortized
Cost
  Fair
Value
   (Dollars in thousands)
Due in one year or less  $5,090   $5,110 
Due after one year through five years   67,854    68,636 
Due after five years through ten years   74,430    77,123 
Due after ten years   118,995    125,489 
Subtotal   266,369    276,358 
Agency mortgage-backed pass through securities   26,556    27,105 
Total  $292,925   $303,463 

 

As of June 30, 2016, the Company’s management does not expect to sell any securities classified as available for sale with material unrealized losses; and the Company believes that the Company more likely than not will not be required to sell any of these securities before their anticipated recovery, at which time the Company will receive full value for the securities. The fair value is expected to recover as the securities approach their maturity date or repricing date or if market yields for such investments decline. Management does not believe any of the securities are impaired due to reasons of credit quality. Accordingly, as of June 30, 2016, management believes the unrealized losses in the previous table are temporary and no other than temporary impairment loss has been realized in the Company’s consolidated statements of income.

12 

Table of Contents

ALLEGIANCE BANCSHARES, INC.

CONDENSED NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2016

(Unaudited)

 

Securities with unrealized losses segregated by length of time such securities have been in a continuous loss position are as follows:

 

   June 30, 2016
   Less than 12 Months  More than 12 Months  Total
   Estimated
Fair Value
  Unrealized
Losses
  Estimated
Fair Value
  Unrealized
Losses
  Estimated
Fair Value
  Unrealized
Losses
   (Dollars in thousands)
Available for Sale                              
U.S. Government and agency securities  $-   $-   $-   $-   $-   $- 
Municipal securities   229    -    185    -    414    - 
Agency mortgage-backed pass-through securities   826    (4)   6,841    (98)   7,667    (102)
Corporate bonds   7,752    (21)   -    -    7,752    (21)
Total  $8,807   $(25)  $7,026   $(98)  $15,833   $(123)

 

   December 31, 2015
   Less than 12 Months  More than 12 Months  Total
   Estimated
Fair Value
  Unrealized
Losses
  Estimated
Fair Value
  Unrealized
Losses
  Estimated
Fair Value
  Unrealized
Losses
   (Dollars in thousands)
Available for Sale                              
U.S. Government and agency securities  $-   $-   $-   $-   $-   $- 
Municipal securities   6,867    (30)   298    (5)   7,165    (35)
Agency mortgage-backed pass-through securities   4,952    (36)   9,519    (210)   14,471    (246)
Total  $11,819   $(66)  $9,817   $(215)  $21,636   $(281)

 

During the first quarter of 2015, the Company sold all securities acquired in the F&M Bancshares acquisition, resulting in gross proceeds of approximately $15.0 million. No gains or losses were recognized. No securities were sold during the three and six months ended June 30, 2016.

 

At June 30, 2016 and December 31, 2015, the Company did not own securities of any one issuer, other than the U.S government and its agencies, in an amount greater than 10% of consolidated stockholders’ equity at such respective dates.

 

The carrying value of pledged securities was $4.9 million at June 30, 2016. The securities are pledged to further collateralize letters of credit issued by the Bank but confirmed by another financial institution. The Company did not have pledged securities at December 31, 2015.

13 

Table of Contents

ALLEGIANCE BANCSHARES, INC.

CONDENSED NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2016

(Unaudited)

 

5. LOANS AND ALLOWANCE FOR LOAN LOSSES

 

The loan portfolio balances, net of unearned income and fees, consist of various types of loans primarily made to borrowers located within Texas and are classified by major type as follows:

 

   June 30,
2016
  December 31,
2015
   (Dollars in thousands)
       
Loans held for sale (1)  $-   $27,887 
           
Commercial and industrial   382,795    383,044 
Mortgage warehouse   75,554    59,071 
Real estate:          
Commercial real estate (including multi-family residential)   806,771    745,595 
Commercial real estate construction and land development   161,572    154,646 
1-4 family residential (including home equity)   214,442    205,200 
Residential construction   101,677    93,848 
Consumer and other   10,872    11,761 
Total loans held for investment   1,753,683    1,653,165 
Total loans   1,753,683    1,681,052 
Allowance for loan losses   (14,917)   (13,098)
Loans, net  $1,738,766   $1,667,954 

 

(1)Consisted of loans at two former F&M Bancshares locations acquired in 2015 and sold during the first quarter of 2016. At December 31, 2015, loans held for sale consisted of $13.2 million of commercial and industrial loans, $11.6 million of commercial real estate (including multi-family residential) loans, $2.3 million of 1-4 family residential (including home equity) loans and $803 thousand of consumer and other loans. Loans held for sale were carried at the lower of aggregate cost or fair value.

 

14 

Table of Contents

ALLEGIANCE BANCSHARES, INC.

CONDENSED NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2016

(Unaudited)

 

Nonaccrual and Past Due Loans

 

An aging analysis of the recorded investment in past due loans, segregated by class of loans, is as follows:

 

   June 30, 2016
   Loans Past Due and Still Accruing         
   30-89
Days
  90 or More
Days
  Total Past
Due Loans
  Nonaccrual
Loans
  Current
Loans
  Total
Loans
   (Dollars in thousands)
Commercial and industrial  $956   $-   $956   $2,723   $379,116   $382,795 
Mortgage warehouse   -    -    -    -    75,554    75,554 
Real estate:                              
Commercial real estate (including multi-family residential)   628    -    628    4,141    802,002    806,771 
Commercial real estate construction and land development   890    -    890    -    160,682    161,572 
1-4 family residential (including home equity)   213    -    213    227    214,002    214,442 
Residential construction   -    -    -    -    101,677    101,677 
Consumer and other   -    -    -    33    10,839    10,872 
Total loans  $2,687   $-   $2,687   $7,124   $1,743,872   $1,753,683 

 

   December 31, 2015
   Loans Past Due and Still Accruing         
   30-89
Days
  90 or More
Days
  Total Past
Due Loans
  Nonaccrual
Loans
  Current
Loans
  Total
Loans
   (Dollars in thousands)
Loans held for sale  $539   $-   $539   $209   $27,139   $27,887 
                               
Commercial and industrial   1,474    -    1,474    2,664    378,906    383,044 
Mortgage warehouse   -    -    -    -    59,071    59,071 
Real estate:                              
Commercial real estate (including multi-family residential)   1,866    -    1,866    2,006    741,723    745,595 
Commercial real estate construction and land development   77    -    77    -    154,569    154,646 
1-4 family residential (including home equity)   1,904    -    1,904    239    203,057    205,200 
Residential construction   -    -    -    -    93,848    93,848 
Consumer and other   36    -    36    66    11,659    11,761 
Total loans held for investment   5,357    -    5,357    4,975    1,642,833    1,653,165 
Total loans  $5,896   $-   $5,896   $5,184   $1,669,972   $1,681,052 

 

15 

Table of Contents

ALLEGIANCE BANCSHARES, INC.

CONDENSED NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2016

(Unaudited)

 

Impaired Loans

 

Impaired loans by class of loans are set forth in the following tables. The average recorded investment presented in the table below is reported on a year-to-date basis.

 

   June 30, 2016
   Recorded
Investment
  Unpaid
Principal
Balance
  Related
Allowance
  Average
Recorded
Investment
  Interest
Income
Recognized
   (Dollars in thousands)
With no related allowance recorded:                         
Commercial and industrial  $3,037   $3,782   $-   $3,548   $98 
Mortgage warehouse   -    -    -    -    - 
Real estate:                         
Commercial real estate (including multi-family residential)   11,154    11,240    -    11,599    222 
Commercial real estate construction and land development   -    -    -    -    - 
1-4 family residential (including home equity)   227    227    -    233    8 
Residential construction   -    -    -    -    - 
Consumer and other   11    11    -    13    - 
Total   14,429    15,260    -    15,393    328 
                          
With an allowance recorded:                         
Commercial and industrial   2,365    2,365    936    2,411    66 
Mortgage warehouse   -    -    -    -    - 
Real estate:                         
Commercial real estate (including multi-family residential)   -    -    -    -    - 
Commercial real estate construction and land development   -    -    -    -    - 
1-4 family residential (including home equity)   -    -    -    -    - 
Residential construction   -    -    -    -    - 
Consumer and other   22    22    13    25    1 
Total   2,387    2,387    949    2,436    67 
                          
Total:                         
Commercial and industrial   5,402    6,147    936    5,959    164 
Mortgage warehouse   -    -    -    -    - 
Real estate:                         
Commercial real estate (including multi-family residential)   11,154    11,240    -    11,599    222 
Commercial real estate construction and land development   -    -    -    -    - 
1-4 family residential (including home equity)   227    227    -    233    8 
Residential construction   -    -    -    -    - 
Consumer and other   33    33    13    38    1 
   $16,816   $17,647   $949   $17,829   $395 

 

16 

Table of Contents

ALLEGIANCE BANCSHARES, INC.

CONDENSED NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2016

(Unaudited)

 

   Year Ended December 31, 2015
   Recorded
Investment
  Unpaid
Principal
Balance
  Related
Allowance
  Average
Recorded
Investment
  Interest
Income
Recognized
   (Dollars in thousands)
With no related allowance recorded:                         
Commercial and industrial  $3,842   $4,216   $-   $3,698   $222 
Mortgage warehouse   -    -    -    -    - 
Real estate:                         
Commercial real estate (including multi-family residential)   4,700    4,700    -    4,833    285 
Commercial real estate construction and land development   -    -    -    -    - 
1-4 family residential (including home equity)   239    239    -    248    13 
Residential construction   -    -    -    -    - 
Consumer and other   82    97    -    102    8 
Total   8,863    9,252    -    8,881    528 
                          
With an allowance recorded:                         
Commercial and industrial   1,573    1,573    670    2,040    87 
Mortgage warehouse   -    -    -    -    - 
Real estate:                         
Commercial real estate (including multi-family residential)   1,146    1,146    180    1,122    77 
Commercial real estate construction and land development   -    -    -    -    - 
1-4 family residential (including home equity)   -    -    -    -    - 
Residential construction   -    -    -    -    - 
Consumer and other   19    19    9    21    1 
Total   2,738    2,738    859    3,183    165 
                          
Total:                         
Commercial and industrial   5,415    5,789    670    5,738    309 
Mortgage warehouse   -    -    -    -    - 
Real estate:                         
Commercial real estate (including multi-family residential)   5,846    5,846    180    5,955    362 
Commercial real estate construction and land development   -    -    -    -    - 
1-4 family residential (including home equity)   239    239    -    248    13 
Residential construction   -    -    -    -    - 
Consumer and other   101    116    9    123    9 
   $11,601   $11,990   $859   $12,064   $693 

 

The total average recorded investment of impaired loans for the six months ended June 30, 2015 was $7.1 million. Total interest income recognized for the six months ended June 30, 2015 on impaired loans was $186 thousand.

17 

Table of Contents

ALLEGIANCE BANCSHARES, INC.

CONDENSED NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2016

(Unaudited)

 

Credit Quality Indicators

 

The company categorizes loans into risk categories based on relevant information about the ability of borrowers to service their debt, including factors such as: current financial information, historical payment experience, credit documentation, public information, and current economic trends. The Company analyzes loans individually by classifying the loans by credit risk. As part of the ongoing monitoring of the credit quality of the Company’s loan portfolio and methodology for calculating the allowance for credit losses, management assigns and tracks risk ratings to be used as credit quality indicators.

 

The following is a general description of the risk ratings used:

 

Watch—Loans classified as watch loans may still be of high quality, but have an element of risk added to the credit such as declining payment history, deteriorating financial position of the borrower or a decrease in collateral value.

 

Special Mention—Loans classified as special mention have a potential weakness that deserves management’s close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the loan or of the institution’s credit position at some future date. They are characterized by the distinct possibility that the institution will sustain some loss if the deficiencies are not corrected.

 

Substandard—Loans classified as substandard have well-defined weaknesses on a continuing basis and are inadequately protected by the current net worth and paying capacity of the borrower, impaired or declining collateral values, or a continuing downturn in their industry which is reducing their profits to below zero and having a significantly negative impact on their cash flow. These classified loans are characterized by the distinct possibility that the institution will sustain some loss if the deficiencies are not corrected.

 

Doubtful—Loans classified as doubtful have all the weaknesses inherent in those classified as substandard with the added characteristic that the weaknesses make collection or liquidation in full on the basis of currently existing facts, conditions, and values, highly questionable and improbable.

 

Loans not meeting the criteria above that are analyzed individually as part of the above described process are considered to be pass rated loans.

 

Based on the most recent analysis performed, the risk category of loans by class of loan at June 30, 2016 is as follows:

 

   Pass  Watch  Special Mention  Substandard  Doubtful  Total
   (Dollars in thousands)
Commercial and industrial  $358,753   $2,683   $7,001   $14,358   $-   $382,795 
Mortgage warehouse   75,554    -    -    -    -    75,554 
Real estate:                              
Commercial real estate (including multi-family residential)   766,685    7,620    5,378    27,088    -    806,771 
Commercial real estate construction and land development   152,267    7,410    -    1,895    -    161,572 
1-4 family residential (including home equity)   210,009    300    2,054    2,079    -    214,442 
Residential construction   101,677    -    -    -    -    101,677 
Consumer and other   10,480    262    3    127    -    10,872 
Total loans  $1,675,425   $18,275   $14,436   $45,547   $-   $1,753,683 

 

18 

Table of Contents

ALLEGIANCE BANCSHARES, INC.

CONDENSED NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2016

(Unaudited)

 

The following table presents the risk category of loans by class of loan at December 31, 2015:

 

   Pass  Watch  Special Mention  Substandard  Doubtful  Total
   (Dollars in thousands)
Loans held for sale  $26,570   $477   $19   $821   $-   $27,887 
                               
Commercial and industrial   366,479    8,094    1,253    7,218    -    383,044 
Mortgage warehouse   59,071    -    -    -    -    59,071 
Real estate:                              
Commercial real estate (including multi-family residential)   721,781    7,186    790    15,838    -    745,595 
Commercial real estate construction and land development   152,380    1,846    -    420    -    154,646 
1-4 family residential (including home equity)   200,262    2,385    390    2,163    -    205,200 
Residential construction   93,848    -    -    -    -    93,848 
Consumer and other   11,522    155    18    66    -    11,761 
Total loans held for investment   1,605,343    19,666    2,451    25,705    -    1,653,165 
Total loans  $1,631,913   $20,143   $2,470   $26,526   $-   $1,681,052 

 

Allowance for Loan Losses

 

The following table presents the activity in the allowance for loan losses by portfolio type for the three and six months ended June 30, 2016 and June 30, 2015:

 

   Commercial
and
industrial 
  Mortgage
warehouse
  Commercial real
estate (including
multi-family
residential)
  Commercial real
estate construction
and land
development
  1-4 family
residential
(including
home equity)
  Residential
construction
  Consumer
and other 
  Total 
   (Dollars in thousands)
Allowance for loan losses:                                        
Three Months Ended                                        
Balance March 31, 2016  $4,057   $-   $5,905   $1,352   $1,484   $889   $70   $13,757 
Provision for loan losses   480    -    984    16    158    (2)   9    1,645 
                                         
Charge-offs   (442)   -    (43)   -    -    -    (12)   (497)
Recoveries   10    -    -    -    -    -    2    12 
Net charge-offs   (432)   -    (43)   -    -    -    (10)   (485)
                                         
Balance June 30, 2016  $4,105   $-   $6,846   $1,368   $1,642   $887   $69   $14,917 
                                         
Six Months Ended                                        
Balance January 1, 2016  $3,644   $-   $5,914   $1,221   $1,432   $820   $67   $13,098 
Provision for loan losses   859    -    1,061    147    200    67    21    2,355 
                                         
Charge-offs   (443)   -    (129)   -    -    -    (22)   (594)
Recoveries   45    -    -    -    10    -    3    58 
Net charge-offs   (398)   -    (129)   -    10    -    (19)   (536)
                                         
Balance June 30, 2016  $4,105   $-   $6,846   $1,368   $1,642   $887   $69   $14,917 

 

19 

Table of Contents

ALLEGIANCE BANCSHARES, INC.

CONDENSED NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2016

(Unaudited)

 

   Commercial
and
industrial 
  Mortgage
warehouse
  Commercial real
estate (including
multi-family
residential)
  Commercial real
estate construction
and land
development
  1-4 family
residential
(including
home equity)
  Residential
construction
  Consumer
and other 
  Total 
   (Dollars in thousands)
Allowance for loan losses:                                        
Three Months Ended                                        
Balance March 31, 2015  $2,960   $-   $3,551   $646   $1,130   $596   $57   $8,940 
Provision for loan losses   (6)   -    982    196    125    111    12    1,420 
                                         
Charge-offs   (70)   -    -    -    -    -    (2)   (72)
Recoveries   21    -    -    -    -    3    -    24 
Net charge-offs   (49)   -    -    -    -    3    (2)   (48)
                                         
Balance June 30, 2015  $2,905   $-   $4,533   $842   $1,255   $710   $67   $10,312 
                                         
Six Months Ended                                        
Balance January 1, 2015  $2,334   $-   $3,799   $578   $1,008   $475   $52   $8,246 
Provision for loan losses   614    -    734    264    247    213    31    2,103 
                                         
Charge-offs   (82)   -    -    -    -    -    (18)   (100)
Recoveries   39    -    -    -    -    22    2    63 
Net charge-offs   (43)   -    -    -    -    22    (16)   (37)
                                         
Balance June 30, 2015  $2,905   $-   $4,533   $842   $1,255   $710   $67   $10,312 

 

The following table presents the balance in the allowance for loan losses by portfolio type based on the impairment method as of June 30, 2016 and December 31, 2015:

 

   Commercial
and
industrial 
  Mortgage
warehouse
  Commercial real
estate (including
multi-family
residential)
  Commercial real
estate construction
and land
development
  1-4 family
residential
(including
home equity)
  Residential
construction
  Consumer
and other 
  Total 
   (Dollars in thousands)
Allowance for loan losses related to:                                        
June 30, 2016                                        
Individually evaluated for impairment  $936   $-   $-   $-   $-   $-   $13   $949 
Collectively evaluated for impairment   3,169    -    6,846    1,368    1,642    887    56    13,968 
Total allowance for loan losses  $4,105   $-   $6,846   $1,368   $1,642   $887   $69   $14,917 
                                         
December 31, 2015                                        
Individually evaluated for impairment  $670   $-   $180   $-   $-   $-   $9   $859 
Collectively evaluated for impairment   2,974    -    5,734    1,221    1,432    820    58    12,239 
Total allowance for loan losses  $3,644   $-   $5,914   $1,221   $1,432   $820   $67   $13,098 

 

20 

Table of Contents

ALLEGIANCE BANCSHARES, INC.

CONDENSED NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2016

(Unaudited)

 

The following table presents the recorded investment in loans held for investment by portfolio type based on the impairment method as of June 30, 2016 and December 31, 2015:

 

   Commercial
and
industrial 
  Mortgage
warehouse
  Commercial real
estate (including
multi-family
residential)
  Commercial real
estate construction
and land
development
  1-4 family
residential
(including
home equity)
  Residential
construction
  Consumer
and other 
  Total 
   (Dollars in thousands)
Recorded investment in loans:                                        
June 30, 2016                                        
Individually evaluated for impairment  $5,402   $-   $11,154   $-   $227   $-   $33   $16,816 
Collectively evaluated for impairment   377,393    75,554    795,617    161,572    214,215    101,677    10,839    1,736,867 
Total loans evaluated for impairment  $382,795   $75,554   $806,771   $161,572   $214,442   $101,677   $10,872   $1,753,683 
                                         
                                         
December 31, 2015                                        
Individually evaluated for impairment  $5,415   $-   $5,846   $-   $239   $-   $101   $11,601 
Collectively evaluated for impairment   377,629    59,071    739,749    154,646    204,961    93,848    11,660    1,641,564 
Total loans evaluated for impairment  $383,044   $59,071   $745,595   $154,646   $205,200   $93,848   $11,761   $1,653,165 

 

Troubled Debt Restructurings

 

Following is a summary of loans modified under troubled debt restructurings during the six months ended June 30, 2016 and June 30, 2015:

 

   As of June 30,
   2016  2015
   Number of
Contracts
  Pre-
Modification of
Outstanding
Recorded
Investment
  Post-
Modification of
Outstanding
Recorded
Investment
  Number of
Contracts
  Pre-
Modification of
Outstanding
Recorded
Investment
  Post-
Modification of
Outstanding
Recorded
Investment
   (Dollars in thousands)
Troubled Debt Restructurings                              
Commercial and industrial   12   $2,931   $2,931    3   $2,049   $2,043 
Mortgage warehouse                              
Real estate:                              
Commercial real estate (including multi-family residential)   6    6,250    6,250    -    -    - 
Commercial real estate construction and land development   -    -    -    -    -    - 
1-4 family residential (including home equity)   -    -    -    -    -    - 
Residential construction   -    -    -    -    -    - 
Consumer and other   1    7    7    -    -    - 
Total   19   $9,188   $9,188    3   $2,049   $2,043 

 

As of June 30, 2016 and December 31, 2015, the Company had a recorded investment in troubled debt restructurings of $11.7 million and $3.1 million, respectively. The Company allocated $642 thousand and $681 thousand of specific reserves for troubled debt restructurings at June 30, 2016 and December 31, 2015, respectively, and did not commit to lend additional amounts on these loans. As of June 30, 2016 and June 30, 2015, there were no loans modified under troubled debt restructurings during the previous twelve month period that subsequently defaulted during the six months ended June 30, 2016 and June 30, 2015, respectively. The modifications primarily related to extending the amortization periods of the loans. Default is determined at 90 or more days past due.

21 

Table of Contents

ALLEGIANCE BANCSHARES, INC.

CONDENSED NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2016

(Unaudited)

 

6. FAIR VALUE

 

The Company uses fair value measurements to record fair value adjustments to certain assets and to determine fair value disclosures. Fair value represents the exchange price that would be received from selling an asset or paid to transfer a liability, otherwise known as an “exit price”, in the principal or most advantageous market available to the entity in an orderly transaction between market participants on the measurement date.

 

Fair Value Hierarchy

 

The Company groups financial assets and financial liabilities measured at fair value in three levels, based on the markets in which the assets and liabilities are traded and the reliability of the assumptions used to determine fair value. These levels are:

 

Level 1—Quoted prices for identical assets or liabilities in active markets that the entity has the ability to access as of the measurement date.

 

Level 2—Significant other observable inputs other than Level 1 prices such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data.

 

Level 3—Significant unobservable inputs that reflect management’s judgment and assumptions that market participants would use in pricing an asset or liability that are supported by little or no market activity.

 

The carrying amounts and estimated fair values of financial instruments that are reported on the balance sheet are as follows:

 

   As of June 30, 2016
   Carrying  Estimated Fair Value
   Amount  Level 1  Level 2  Level 3  Total
Financial assets  (Dollars in thousands)
Cash and cash equivalents  $210,863   $210,863   $-   $-   $210,863 
Available for sale securities   303,463    -    303,463    -    303,463 
Loans held for investment, net of allowance   1,738,766    -    -    1,743,626    1,743,626 
Accrued interest receivable   7,969    7    2,766    5,196    7,969 
                          
Financial liabilities                         
Total deposits  $1,843,339   $-   $1,846,235    -   $1,846,235 
Accrued interest payable   223    -    223    -    223 
Short-term borrowings   30,000    -    30,000    -    30,000 
Other borrowed funds   200,569    -    200,569    -    200,569 
Subordinated debentures   9,142    -    9,142    -    9,142 

 

   As of December 31, 2015
   Carrying  Estimated Fair Value
   Amount  Level 1  Level 2  Level 3  Total
Financial assets  (Dollars in thousands)
Cash and cash equivalents  $148,431   $148,431   $-   $-   $148,431 
Available for sale securities   165,097    -    165,097    -    165,097 
Loans held for sale   27,887    -    -    27,887    27,887 
Loans held for investment, net of allowance   1,640,067    -    -    1,641,862    1,641,862 
Accrued interest receivable   6,518    -    1,780    4,738    6,518 
                          
Financial liabilities                         
Total deposits  $1,759,133   $-   $1,759,728   $-   $1,759,728 
Accrued interest payable   124    -    124    -    124 
Short-term borrowings   50,000    -    50,000    -    50,000 
Other borrowed funds   569    -    569    -    569 
Subordinated debentures   9,089    -    9,089    -    9,089 

 

The fair value estimates presented above are based on pertinent information available to management as of the dates indicated. The methods used to determine fair value are described in our audited financial statements which are presented in the Company’s Annual Report on Form 10-K for the year ended December 31, 2015.

22 

Table of Contents

ALLEGIANCE BANCSHARES, INC.

CONDENSED NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2016

(Unaudited)

 

The following tables present fair values for assets measured at fair value on a recurring basis:

 

   As of June 30, 2016
   Level 1  Level 2  Level 3  Total
   (Dollars in thousands)
Available for sale securities:                    
U.S. Government and agency securities  $-   $9,364   $-   $9,364 
Municipal securities   -    218,493    -    218,493 
Agency mortgage-backed pass-through securities   -    27,105    -    27,105 
Corporate bonds   -    48,501    -    48,501 
   $-   $303,463   $-   $303,463 

 

   As of December 31, 2015
   Level 1  Level 2  Level 3  Total
   (Dollars in thousands)
Available for sale securities:                    
U.S. Government and agency securities  $-   $9,086   $-   $9,086 
Municipal securities   -    126,349    -    126,349 
Agency mortgage-backed pass-through securities   -    29,662    -    29,662 
   $-   $165,097   $-   $165,097 

 

There were no liabilities measured at fair value on a recurring basis as of June 30, 2016 or December 31, 2015. There were no transfers between levels during the six months ended June 30, 2016 or June 30, 2015.

 

Certain assets and liabilities are measured at fair value on a nonrecurring basis; that is, the instruments are not measured at fair value on an ongoing basis but are subject to fair value adjustments in certain circumstances such as evidence of impairment.

 

   As of June 30, 2016
   Level 1  Level 2  Level 3
   (Dollars in thousands)
Impaired loans:               
Commercial and industrial  $-   $-   $1,429 
Commercial real estate (including multi-family residential)   -    -    - 
Consumer and other   -    -    9 
Other real estate owned   -    -    - 
   $-   $-   $1,438 

 

   As of December 31, 2015
   Level 1  Level 2  Level 3
   (Dollars in thousands)
Impaired loans:               
Commercial and industrial  $-   $-   $903 
Commercial real estate (including multi-family residential)   -    -    966 
Consumer and other   -    -    10 
   $-   $-   $1,879 

 

23 

Table of Contents

ALLEGIANCE BANCSHARES, INC.

CONDENSED NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2016

(Unaudited)

 

Historically, we measure fair value for certain loans and other real estate owned on a nonrecurring basis.

 

Impaired Loans

 

During the six months ended June 30, 2016 and the year ended December 31, 2015, certain impaired loans were reevaluated and reported at fair value through a specific allocation of the allowance for loan losses. At June 30, 2016, the total reported fair value of impaired loans of $1.4 million based on collateral valuations utilizing Level 3 valuation inputs had a carrying value of $2.4 million that was reduced by specific allowance allocations totaling $949 thousand. At December 31, 2015, the total reported fair value of impaired loans of $1.9 million based on collateral valuations utilizing Level 3 valuation inputs had a carrying value of $2.7 million that was reduced by specific allowance allocations totaling $859 thousand.

 

Other Real Estate Owned

 

At June 30, 2016, the balance of other real estate owned included $1.4 million of foreclosed commercial real estate properties recorded as a result of obtaining physical possession of the property. The Company did not have any other real estate owned at December 31, 2015.

 

7. DEPOSITS

 

Time deposits that meet or exceed the Federal Deposit Insurance Corporation Insurance limit of $250 thousand at June 30, 2016 and December 31, 2015 were $177.0 million and $164.7 million, respectively.

 

Scheduled maturities of time deposits for the next five years are as follows (dollars in thousands):

 

Within one year  $424,731 
After one but within two years   101,392 
After two but within three years   89,490 
After three but within four years   13,018 
After four but within five years   20,855 
Total  $649,486 

 

8. BORROWINGS

 

The Company has an available line of credit with the Federal Home Loan Bank (“FHLB”) of Dallas, which allows the Company to borrow on a collateralized basis. FHLB advances are short-term borrowings and are used to manage liquidity as needed. Maturing advances are replaced by drawing on available cash, making additional borrowings or through increased customer deposits. At June 30, 2016, the Company had a total borrowing capacity of $624.2 million, of which $363.7 million was available and $260.5 million was outstanding. Short-term FHLB advances of $30.0 million were outstanding at June 30, 2016, at a weighted average rate of 0.56%. Long-term FHLB borrowings of $200.0 million were outstanding at June 30, 2016, at a weighted average rate of 0.36%. Letters of credit were $30.5 million at June 30, 2016, of which $2.5 million will expire in August 2016, $25.0 million will expire in October 2016 and $3.0 million will expire in February 2017.

24 

Table of Contents

ALLEGIANCE BANCSHARES, INC.

CONDENSED NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2016

(Unaudited)

 

In 2015, the Company borrowed an additional $18.0 million under a revolving credit agreement with another financial institution. The borrowing under this revolving credit agreement matures in December 2021. The Company used the funds borrowed in 2015 under this revolving credit agreement to repay amounts owed by F&M Bancshares under a previous borrowing agreement with another financial institution entered into during 2013 in conjunction with the purchase of Independence Bank. In October 2015, the Company paid down $27.5 million under this revolving credit agreement with a portion of the proceeds from the Company’s initial public offering. The revolving credit agreement requires the Company to meet certain restrictive covenants. At June 30, 2016, the Company believes it is in compliance with all such covenants and had not been made aware of any noncompliance by the lender. The interest rate on the debt is the Prime rate minus 25 basis points, or 3.25%, at June 30, 2016, and is paid quarterly. Scheduled principal maturities are as follows (dollars in thousands):

 

 Remaining 2016  $- 
2017   - 
2018   - 
2019   - 
2020 and thereafter   569 
Total  $569 

 

9. SUBORDINATED DEBENTURES

 

On January 1, 2015, the Company acquired F&M Bancshares and assumed Farmers & Merchants Capital Trust II and Farmers & Merchants Capital Trust III. Each of these trusts is a capital or statutory business trust organized for the sole purpose of issuing trust securities and investing the proceeds in the Company’s junior subordinated debentures. The preferred trust securities of each trust represent preferred beneficial interests in the assets of the respective trusts and are subject to mandatory redemption upon payment of the junior subordinated debentures held by the trust. The common securities of each trust are wholly owned by the Company. Each trust’s ability to pay amounts due on the trust preferred securities is solely dependent upon the Company making payment on the related junior subordinated debentures. The debentures, which are the only assets of each trust, are subordinate and junior in right of payment to all of the Company’s present and future senior indebtedness. The Company has fully and unconditionally guaranteed each trust’s obligations under the trust securities issued by such trust to the extent not paid or made by such trust, provided such trust has funds available for such obligations.

 

Under the provisions of each issue of the debentures, the Company has the right to defer payment of interest on the debentures at any time, or from time to time, for periods not exceeding five years. If interest payments on either issue of the debentures are deferred, the distributions on the applicable trust preferred securities and common securities will also be deferred.

 

The Company assumed the junior subordinated debentures with an aggregate original principal amount of $11.3 million and a current fair value at June 30, 2016 of $9.1 million. At acquisition, the Company recorded a discount of $2.5 million on the debentures. The difference between the carrying value and contractual balance will be recognized as a yield adjustment over the remaining term for the debentures. At June 30, 2016, the Company had $11.3 million outstanding in junior subordinated debentures issued to the Company’s unconsolidated subsidiary trusts. The junior subordinated debentures are included in Tier 1 capital under current regulatory guidelines and interpretations.

25 

Table of Contents

ALLEGIANCE BANCSHARES, INC.

CONDENSED NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2016

(Unaudited)

 

A summary of pertinent information related to the Company’s issues of junior subordinated debentures outstanding at June 30, 2016 is set forth in the table below:

 

Description  Issuance Date  Trust
Preferred
Securities
Outstanding
  Interest Rate (1)  Junior
Subordinated
Debt Owed to
Trusts
  Maturity Date (2)
(Dollars in thousands)
                
Farmers & Merchants Capital Trust II  November 13, 2003  $7,500   3 month LIBOR + 3.00%  $7,732   November 8, 2033
Farmers & Merchants Capital Trust III  June 30, 2005   3,500   3 month LIBOR + 1.80%   3,609   July 7, 2035
              $11,341    

 

(1)The 3-month LIBOR in effect as of June 30, 2016 was 0.6516%.
(2)All debentures are currently callable.

 

10. INCOME TAXES

 

The amount of the Company’s federal and state income tax expense is influenced by the amount of the Company’s pre-tax income, the amount of tax-exempt income and the amount of other nondeductible items. For the three and six months ended June 30, 2016, income tax expense was $2.3 million and $5.4 million, respectively, compared with $2.0 million and $3.9 million, respectively, for the three and six months ended June 30, 2015, respectively. The increase in income tax expense year over year was primarily attributable to higher pre-tax earnings. The effective income tax rate for the three and six months ended June 30, 2016 was 30.8% and 31.8%, respectively, compared to 33.5% and 34.4%, respectively, for the three and six months ended June 30, 2015. The effective tax rate decreased for the three and six months ended June 30, 2016 compared to the same periods in 2015 primarily due to the increase in tax free income from the purchase of additional municipal securities.

 

Interest and penalties related to tax positions are recognized in the period in which they begin accruing or when the entity claims the position that does not meet the minimum statutory thresholds. The Company has not recorded any interest and penalties in its income statement for the three and six months ended June 30, 2016 and June 30, 2015. The Company is no longer subject to examination by the U.S. Federal Tax Jurisdiction for the years prior to 2012.

 

11. STOCK BASED COMPENSATION

 

During 2008, the Company’s Board of Directors and shareholders approved the 2008 Stock Awards and Incentive Plan (the “Plan”) that permits certain key employees to purchase shares of the Company’s stock. The Plan was amended in 2015 as the shareholders authorized a maximum aggregate number of shares of stock to be issued of 1,460,000, any or all of which may be issued through incentive stock options. The Company accounts for stock based employee compensation plans using the fair value-based method of accounting.  The Company recognized total stock based compensation expense of $354 thousand and $707 thousand for the three and six months ended June 30, 2016, respectively, and $330 thousand and $642 thousand for the three and six months ended June 30, 2015, respectively.

 

Stock Option Plan

 

Options to purchase a total of 1,185,381 shares of Company stock have been granted as of June 30, 2016. Under the stock option plan, options are exercisable up to 10 years from the date of the grant, unless otherwise provided by the Board of Directors, and are fully vested 4 years after the date of grant.

 

The fair value of stock options granted is estimated at the date of grant using the Black-Scholes option-pricing model.

 

26 

Table of Contents

ALLEGIANCE BANCSHARES, INC.

CONDENSED NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2016

(Unaudited)

 

A summary of the activity in the stock option plan during the six months ended June 30, 2016 is set forth below:  

 

   Number of
Options
  Weighted
Average
Exercise
Price
  Weighted
Average
Remaining
Contractual Term
  Aggregate
Intrinsic
Value
   (In thousands)     (In years)  (In thousands)
Options outstanding, January 1, 2016   969   $17.45    6.62   $6,006 
Options granted   51    19.64           
Options exercised   (25)   12.68           
Options forfeited   (19)   21.78           
Options outstanding, June 30, 2016   976   $17.59    6.35   $7,113 
Options vested and exercisable, June 30, 2016   580   $15.18    4.90   $5,625 

 

Share Award Plan

 

During 2016, the Company issued 14,401 shares of restricted stock. The restricted stock shares will vest over a period of 4 years but are considered outstanding at the date of issuance. The Company accounts for restricted stock grants by recording the fair value of the grant as compensation expense over the vesting period.

 

A summary of the activity of the nonvested shares of restricted stock during the six months ended June 30, 2016 is as follows:

 

   Number of
Shares
  Weighted
Average Grant
Date Fair
Value
   (Shares in thousands)
Nonvested share awards outstanding, January 1, 2016   18   $19.68 
Share awards granted   14    19.71 
Share awards vested   (7)   19.06 
Unvested share awards forfeited   -    - 
Nonvested share awards outstanding, June 30, 2016   25   $18.31 

 

12. OFF-BALANCE SHEET ARRANGEMENTS, COMMITMENTS AND CONTINGENCIES

 

In the normal course of business, the Company enters into various transactions, which, in accordance with accounting principles generally accepted in the United States, are not included in the Company’s consolidated balance sheets. The Company enters into these transactions to meet the financing needs of its customers. These transactions include commitments to extend credit and standby and commercial letters of credit, which involve to varying degrees elements of credit risk and interest rate risk in excess of the amounts recognized in the consolidated balance sheets. The Company uses the same credit policies in making commitments and conditional obligations as it does for on balance sheet instruments.

 

27 

Table of Contents

ALLEGIANCE BANCSHARES, INC.

CONDENSED NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2016

(Unaudited)

 

The contractual amounts of financial instruments with off-balance sheet risk at June 30, 2016 are as follows:

 

   June 30,
2016
  December 31,
2015
   Fixed
Rate
  Variable
Rate
  Fixed
Rate
  Variable
Rate
   (Dollars in thousands)
Commitments to extend credit  $392,810   $160,272   $252,662   $222,198 
Standby letters of credit   8,172    -    9,456    - 
Total  $400,982   $160,272   $262,118   $222,198 

 

Commitments to make loans are generally made for an approval period of 120 days or fewer. As of June 30, 2016, the funded fixed rate loan commitments have interest rates ranging from 1.60% to 7.50% with a weighted average maturity and rate of 1.78 years and 4.55%, respectively.

 

Litigation

 

From time to time, the Company is subject to claims and litigation arising in the ordinary course of business. In the opinion of management, the Company is not party to any legal proceedings the resolution of which it believes would have a material adverse effect on the Company’s business, prospects, financial condition, liquidity, results of operation, cash flows or capital levels. However, one or more unfavorable outcomes in any claim or litigation against the Company could have a material adverse effect for the period in which such claim or litigation is resolved. In addition, regardless of their merits or their ultimate outcomes, such matters are costly, divert management’s attention and may materially adversely affect the Company’s reputation, even if resolved in its favor. The Company intends to defend itself vigorously against any future claims or litigation.

 

13. REGULATORY CAPITAL MATTERS

 

The Company and the Bank are subject to various regulatory capital requirements administered by the federal banking agencies. Capital adequacy guidelines include prompt corrective action regulations and involve quantitative measures of assets, liabilities and certain off balance sheet items calculated under regulatory accounting practices. Capital amounts and classifications are also subject to qualitative judgments by regulators about components, risk weightings, and other factors. Any institution that fails to meet its minimum capital requirements is subject to actions by regulators that could have a direct material effect on the Company’s financial statements. The Company is subject to the Basel III regulatory capital framework (the "Basel III Rules").The Basel III Rules became effective for the Company on January 1, 2015, with full compliance with all of the requirements being phased in over a multi-year schedule, and fully phased in by January 1, 2019. Starting in January 2016, 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 reaches 2.5% 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 full 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. Management believes as of June 30, 2016 and December 31, 2015 the Company and the Bank met all capital adequacy requirements to which they were then subject.

 

28 

Table of Contents

ALLEGIANCE BANCSHARES, INC.

CONDENSED NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2016

(Unaudited)

 

Prompt corrective action regulations provide five classifications: well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized, and critically undercapitalized, although these terms are not used to represent overall financial condition. If adequately capitalized, regulatory approval is required to accept brokered deposits. If undercapitalized, capital distributions are limited, as is asset growth and expansion, and capital restoration plans are required.

 

The following is a summary of the Company’s and the Bank’s actual and required capital ratios at June 30, 2016 and December 31, 2015:

 

   Actual  For Capital
Adequacy Purposes
  To Be Categorized As
Well Capitalized Under
Prompt Corrective
Action Provisions
   Amount  Ratio  Amount  Ratio  Amount  Ratio
   (Dollars in thousands)
ALLEGIANCE BANCSHARES, INC.                              
(Consolidated)                              
As of June 30, 2016                              
Total Capital (to Risk Weighted Assets)  $251,405    12.92%  $155,639    8.00%   N/A    N/A 
Common Equity Tier 1 Capital (to Risk Weighted Assets)   227,346    11.69%   87,547    4.50%   N/A    N/A 
Tier I Capital (to Risk Weighted Assets)   236,488    12.16%   116,729    6.00%   N/A    N/A 
Tier I Capital (to Average Tangible Assets)   236,488    10.43%   90,690    4.00%   N/A    N/A 
                               
As of December 31, 2015                              
Total Capital (to Risk Weighted Assets)  $237,178    12.92%  $146,811    8.00%   N/A    N/A 
Common Equity Tier 1 Capital (to Risk Weighted Assets)   214,991    11.72%   82,581    4.50%   N/A    N/A 
Tier I Capital (to Risk Weighted Assets)   224,080    12.21%   110,109    6.00%   N/A    N/A 
Tier I Capital (to Average Tangible Assets)   224,080    11.02%   81,315    4.00%   N/A    N/A 
                               
ALLEGIANCE BANK                              
As of June 30, 2016                              
Total Capital (to Risk Weighted Assets)  $232,737    11.97%  $155,590    8.00%  $194,488    10.00%
Common Equity Tier 1 Capital (to Risk Weighted Assets)   217,820    11.20%   87,519    4.50%   126,417    6.50%
Tier I Capital (to Risk Weighted Assets)   217,820    11.20%   116,693    6.00%   155,590    8.00%
Tier I Capital (to Average Tangible Assets)   217,820    9.61%   90,668    4.00%   113,335    5.00%
                               
As of December 31, 2015                              
Total Capital (to Risk Weighted Assets)  $219,487    11.96%  $146,779    8.00%  $183,474    10.00%
Common Equity Tier 1 Capital (to Risk Weighted Assets)   206,389    11.25%   82,563    4.50%   119,258    6.50%
Tier I Capital (to Risk Weighted Assets)   206,389    11.25%   110,084    6.00%   146,779    8.00%
Tier I Capital (to Average Tangible Assets)   206,389    10.16%   81,291    4.00%   101,614    5.00%

 

29 

Table of Contents

ALLEGIANCE BANCSHARES, INC.

CONDENSED NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2016

(Unaudited)

 

14. EARNINGS PER COMMON SHARE

 

Diluted earnings per common share is computed using the weighted-average number of common shares determined for the basic earnings per common share computation plus the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock using the treasury stock method. Outstanding stock options issued by the Company represent the only dilutive effect reflected in diluted weighted average shares. Restricted shares are considered outstanding at the date of grant and are included in basic and diluted weighted average common shares outstanding.

 

   Three Months Ended June 30,  Six Months Ended June 30,
   2016  2015  2016  2015
   (Dollars in thousands)
   Amount  Per Share
Amount
  Amount  Per Share
Amount
  Amount  Per Share
Amount
  Amount  Per Share
Amount
                         
Net income attributable to common stockholders  $5,254        $3,623        $11,609        $6,968      
Basic:                                        
Weighted average common shares outstanding   12,857   $0.41    9,825   $0.37    12,849   $0.90    9,824   $0.71 
                                         
Diluted:                                        
Add incremental shares for:                                        
Dilutive effect of stock option exercises   182         179         154         177      
Total   13,039   $0.40    10,004   $0.36    13,003   $0.89    10,001   $0.70 

 

Stock options for 267 thousand shares were not considered in computing diluted earnings per common share as of June 30, 2015 because they were antidilutive. There were no antidilutive shares as of June 30, 2016.

 

 

 

 

 

 

30 

Table of Contents

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

Except where the context otherwise requires or where otherwise indicated, in this Quarterly Report on Form 10-Q the terms “we,” “us,” “our,” “Company” and “our business” refer to Allegiance Bancshares, Inc. and our wholly-owned banking subsidiary, Allegiance Bank, a Texas banking association, and the terms “Allegiance Bank” or the “Bank” refer to Allegiance Bank. In this Quarterly Report on Form 10-Q, we refer to the Houston-The Woodlands-Sugar Land metropolitan statistical area as the “Houston metropolitan area.”

 

Cautionary Notice Regarding Forward-Looking Statements

 

Statements and financial discussion and analysis contained in this Quarterly Report on Form 10-Q that are not historical facts are forward-looking statements made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. We also may make forward-looking statements in our other documents filed or furnished with the SEC. In addition, our senior management may make forward-looking statements orally to investors, analysts, representatives of the media and others. Statements preceded by, followed by or that otherwise include the words “believes,” “expects,” “anticipates,” “intends,” “projects,” “estimates,” “plans” and similar expressions or future or conditional verbs such as “will,” “should,” “would,” “may” and “could” are generally forward-looking in nature and not historical facts, although not all forward looking statements include the foregoing. Forward-looking statements are based on assumptions and involve a number of risks and uncertainties, many of which are beyond our control. Many possible events or factors could affect our future financial results and performance and could cause such results or performance to differ materially from those expressed in our forward-looking statements.

 

While there is no assurance that any list of risks and uncertainties or risk factors is complete, below are certain factors which could cause our actual results to differ from those in our forward-looking statements:

 

risks related to the concentration of our business in the Houston metropolitan area, including risks associated with volatility or decreases in oil and gas prices or prolonged periods of lower oil and gas prices;
general market conditions and economic trends nationally, regionally and particularly in the Houston metropolitan area;
our ability to retain executive officers and key employees and their customer and community relationships;
our ability to recruit and retain successful bankers that meet our expectations in terms of customer and community relationships and profitability;
risks related to our strategic focus on lending to small to medium-sized businesses;
our ability to implement our growth strategy, including through the identification of acquisition candidates that will be accretive to our financial condition and results of operations;
risks related to any businesses we acquire in the future, including exposure to potential asset and credit quality risks and unknown or contingent liabilities, the time and costs associated with integrating systems, technology platforms, procedures and personnel, the need for additional capital to finance such transactions and possible failures in realizing the anticipated benefits from such acquisitions;
potential impairment on the goodwill we have recorded or may record in connection with business acquisitions;
risks associated with our owner-occupied commercial real estate loan and other commercial real estate loan portfolios, including the risks inherent in the valuation of the collateral securing such loans;
risks associated with our commercial and industrial loan portfolio, including the risk for deterioration in value of the general business assets that generally secure such loans;
the accuracy and sufficiency of the assumptions and estimates we make in establishing reserves for potential loan losses and other estimates;
risk of deteriorating asset quality and higher loan charge-offs;
time and effort necessary to resolve nonperforming assets;
potential changes in the prices, values and sales volumes of commercial and residential real estate securing our real estate loans;
changes in market interest rates that affect the pricing of our loans and deposits and our net interest income;
potential fluctuations in the market value and liquidity of the securities we hold for sale;
risk of impairment of investment securities, goodwill, other intangible assets or deferred tax assets;

 

31 

Table of Contents

the effects of competition from a wide variety of local, regional, national and other providers of financial, investment and insurance services, which may adversely affect our pricing and terms;
our ability to maintain an effective system of disclosure controls and procedures and internal controls over financial reporting;
risks associated with fraudulent and negligent acts by our customers, employees or vendors;
our ability to keep pace with technological change or difficulties when implementing new technologies;
risks associated with system failures or failures to protect against cybersecurity threats, such as breaches of our network security;
risks associated with data processing system failures and errors;
the institution and outcome of litigation and other legal proceeding against us or to which we become subject;
our ability to maintain adequate liquidity and to raise necessary capital to fund our acquisition strategy and operations or to meet increased minimum regulatory capital levels;
our ability to comply with various governmental and regulatory requirements applicable to financial institutions;
the impact of recent and future legislative and regulatory changes, including changes in banking, securities and tax laws and regulations and their application by our regulators, such as the further implementation of the Dodd-Frank Act;
governmental monetary and fiscal policies, including the policies of the Federal Reserve;
our ability to comply with supervisory actions by federal and state banking agencies;
changes in the scope and cost of FDIC insurance and other coverage;
systemic risks associated with the soundness of other financial institutions; and
other risks and uncertainties listed from time to time in our reports and documents filed with the SEC.

 

Further, these forward-looking statements speak only as of the date on which they were made and we undertake no obligation to update or revise any forward-looking statements to reflect events or circumstances after the date on which these statements are made or to reflect the occurrence of unanticipated events, unless required to do so under the federal securities laws. Other factors not identified above, including those described under the headings “Risk Factors” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” may also cause actual results to differ materially from those described in our forward looking statements. Most of these factors are difficult to anticipate and are generally beyond our control. You should consider these factors in connection with considering any forward-looking statements that may be made by us.

 

Overview

 

We generate most of our revenues from interest income on loans, service charges on customer accounts and interest income from investments in securities. We incur interest expense on deposits and other borrowed funds and noninterest expenses such as salaries and employee benefits and occupancy expenses. Net interest income is the difference between interest income on earning assets such as loans and securities and interest expense on liabilities such as deposits and borrowings that are used to fund those assets. Net interest income is our largest source of revenue. To evaluate net interest income, we measure and monitor (1) yields on our loans and other interest-earning assets, (2) the interest expenses of our deposits and other funding sources, (3) our net interest spread and (4) our net interest margin. Net interest spread is the difference between rates earned on interest-earning assets and rates paid on interest-bearing liabilities. Net interest margin is calculated as net interest income divided by average interest-earning assets. Because noninterest-bearing sources of funds, such as noninterest-bearing deposits and stockholders’ equity, also fund interest-earning assets, net interest margin includes the benefit of these noninterest-bearing sources.

 

Our net interest income is affected by changes in the amount and mix of interest-earning assets and interest-bearing liabilities, referred to as a “volume change.” Periodic changes in the volume and types of loans in our loan portfolio are affected by, among other factors, economic and competitive conditions in Texas and specifically in the Houston metropolitan area, as well as developments affecting the real estate, technology, financial services, insurance, transportation, manufacturing and energy sectors within our target market and throughout the state of Texas.

 

Our net interest income is also affected by changes in yields earned on interest-earning assets and rates paid on interest-bearing deposits and other borrowed funds, referred to as a “rate change.” Fluctuations in market interest rates are driven by many factors, including governmental monetary policies, inflation, deflation, macroeconomic developments, changes in unemployment, the money supply, political and international conditions and conditions in domestic and foreign financial markets.

 

32 

Table of Contents

Our objective is to grow and strengthen our community banking franchise by deploying our super-community banking strategy and pursuing select strategic acquisitions in the Houston metropolitan area. We are positioning the Bank to be a leading provider of personalized commercial banking services by emphasizing the strength and capabilities of local bank office management and providing superior customer service. We have made the strategic decision to focus on the Houston metropolitan area because of our deep roots and experience operating through a variety of economic cycles in this large and vibrant market.

 

Super-community banking strategy. Our super-community banking strategy emphasizes community involvement by its directors, officers and employees, which allows us to be responsive in developing our products and services. Our approach produces a clear competitive advantage by delivering an extraordinary customer experience and fostering a culture dedicated to achieving both superior external and internal service levels. Greater efficiency results from our focus on serving a select, but significant, portion of the overall banking market, and on the operational leverage that results from a market share driven by geographic concentration. We focus on establishing personal relationships with customers through superior service, which is accomplished in part by empowering our personnel to make certain business decisions at a local level in order to respond quickly to customers’ needs. We emphasize lending to and banking with small to medium-sized businesses, for which we believe loans can be priced on terms that are more attractive to us than would be achieved by lending to larger businesses. We operate full-service decentralized branches and employ lenders with strong underwriting credentials who are authorized to make loan and underwriting decisions up to prescribed limits at the branch level. We support branch operations with a centralized credit approval process for larger credit relationships, loan operations, information technology, core data processing, accounting, finance, treasury and treasury management support, deposit operations and executive and board oversight.

 

We plan to continue to emphasize the super-community banking strategy to organically grow our presence in the Houston metropolitan area through:

 

increasing the productivity of existing bankers, as measured by loans, deposits and fee income per banker, while enhancing profitability by leveraging our existing operating platform;
   
focusing on local and individualized decision-making, allowing us to provide customers with rapid decisions on loan requests, which we believe allows us to effectively compete with larger financial institutions;
   
identifying and hiring additional seasoned bankers in our existing and target markets in the Houston metropolitan area who will thrive utilizing our super-community banking model, and opening additional branches where we are able to attract seasoned bankers; and
   
developing new products designed to serve the increasingly diversified Houston economy, while preserving our strong culture of risk management.

 

Select strategic acquisitions. We intend to continue to expand our market position in the Houston metropolitan area through organic growth, including with the establishment of de novo branch locations, and through a disciplined acquisition strategy. We focus on like-minded community banks with similar lending strategies to our own when evaluating acquisition opportunities. We believe that our management’s experience in assessing, executing and integrating target institutions will allow us to capitalize on acquisition opportunities. On January 1, 2015, we completed the acquisition of F&M Bancshares Inc. (“F&M Bancshares”) and its subsidiary bank, Enterprise Bank (“Enterprise”). The results for the three and six months ended June 30, 2016 and June 30, 2015 reflect the combined entity.

 

Recent Developments

 

On January 31, 2016, the Bank completed the sale of its two Central Texas branch locations that were acquired as part of the F&M Bancshares acquisition, to Incommons Bank, N.A., a national banking association headquartered in Mexia, Texas. Under the terms of the purchase and assumption agreement, Incommons Bank, N.A. acquired certain assets and assumed certain liabilities associated with the Mart branch location at 714 Texas Avenue in Mart, Texas and the Rosebud branch location at 339 Main Street in Rosebud, Texas. Allegiance sold $18.2 million and $26.6 million of loans and deposits, respectively, and recorded an after tax gain of approximately $1.3 million on the sale of these branches.

 

Critical Accounting Policies

 

Our accounting policies are integral to understanding our results of operations. Our accounting policies are described in detail in Note 1 to our Annual Report on Form 10-K for the year ended December 31, 2015. We believe that of our accounting policies, the following may involve a higher degree of judgment and complexity:

 

33 

Table of Contents

Securities

 

Securities are classified as available for sale when they might be sold before maturity. Securities available for sale are carried at fair value. Unrealized gains and losses are excluded from earnings and reported, net of tax, as a separate component of stockholders’ equity until realized. Securities within the available for sale portfolio may be used as part of our asset/liability strategy and may be sold in response to changes in interest rate risk, prepayment risk or other similar economic factors.

 

Interest earned on these assets is included in interest income. Interest income includes amortization of purchase premium or discount. Premiums and discounts on securities are amortized on the level-yield method, except for mortgage backed securities where prepayments are anticipated. Gains and losses on sales are recorded on the trade date and determined using the specific identification method.

 

Management evaluates securities for other-than-temporary impairment (“OTTI”) on at least a quarterly basis, and more frequently when economic or market conditions warrant such an evaluation. For securities in an unrealized loss position, management considers the extent and duration of the unrealized loss and the financial condition and near-term prospects of the issuer. Management also assesses whether it intends to sell, or it is more likely than not that it will be required to sell, a security in an unrealized loss position before recovery of its amortized cost basis. If either of the criteria regarding intent or requirement to sell is met, the entire difference between amortized cost and fair value is recognized as impairment through earnings. For debt securities that do not meet the aforementioned criteria, the amount of impairment is split into two components as follows: (1) OTTI related to credit loss, which must be recognized in the income statement, and (2) OTTI related to other factors, which is recognized in other comprehensive income, net of applicable taxes. The credit loss is defined as the difference between the present value of the cash flows expected to be collected and the amortized cost basis. The previous amortized cost basis less the OTTI recognized in earnings becomes the new amortized cost basis of the security.

 

Nonperforming and Past Due Loans

 

Loans are placed on nonaccrual status when payment in full of principal or interest is not expected or upon which principal or interest has been in default for a period of 90 days or more unless the asset is both well secured and in the process of collection. If the decision is made to continue accruing interest on the loan, periodic reviews are made to confirm the accruing status of the loan. Nonaccrual loans and loans past due 90 days include both smaller balance homogeneous loans that are collectively evaluated for impairment and individually classified impaired loans.

 

When available information confirms that specific loans, or portions thereof, are uncollectible, these amounts are charged off against the allowance. All loan types are considered delinquent after 30 days past due and are typically charged off or charged down no later than 120 days past due, with consideration of, but not limited to, the following criteria in determining the need and optional timing of the charge-off or charge-down: 1) the Bank is in the process of repossession or foreclosure and there appears to be a likely deficiency, 2) the collateral securing the loan has been sold and there is an actual deficiency, 3) the Bank is proceeding with lengthy legal action to collect its balance, 4) the borrower is unable to be located or 5) the borrower has filed bankruptcy. Events requiring charge-offs occur when a shortfall is identified between the recorded investment in the loan and the underlying value of the collateral.

 

Allowance for Loan Losses

 

The allowance for loan losses is a valuation allowance that is established through charges to earnings in the form of a provision for loan losses. The amount of the allowance for loan losses is affected by the following: (1) charge-off of loans that decrease the allowance, (2) subsequent recoveries on loans previously charged off that increase the allowance and (3) provisions for loan losses charged to earnings that increase the allowance.

 

Throughout the year, management estimates the probable incurred losses in the loan portfolio to determine if the allowance for loan losses is adequate to absorb such losses. The allowance for loan losses consists of specific and general components. The specific component relates to loans that are individually classified as impaired. We follow a loan review program to evaluate the credit risk in the loan portfolio. Loans that have been identified as impaired are reviewed on a quarterly basis in order to determine whether a specific reserve is required. The general component covers non-impaired loans and is based on industry and our specific historical loan loss experience, volume, growth and composition of the loan portfolio, the evaluation of our loan portfolio through our internal loan review process, general current economic conditions both internal and external to us that may affect the borrower’s ability to pay, value of collateral and other qualitative relevant risk factors. Based on a review of these estimates, we adjust the allowance for loan losses to a level determined by management to be adequate. Estimates of loan losses are inherently subjective as they involve an exercise of judgment.

 

Our allowance for loan losses, both in dollars and as a percentage of total loans, may not be comparable to other similar sized institutions due to the impact of acquisition accounting. As part of acquisition accounting, acquired loans are initially recognized at fair value with no corresponding allowance for loan losses. Initial fair value of the loans includes consideration of expected credit losses.

 

34 

Table of Contents

Loans for which the terms have been modified, and for which the borrower is experiencing financial difficulties, are considered troubled debt restructurings and therefore classified as impaired. Subsequent to identification as a troubled debt restructuring, such loans are then evaluated for impairment on an individual basis whereby we determine the amount of reserve in accordance with the accounting policy for the impaired loans as part of our allowance for loan losses calculation. If a loan is impaired, a specific valuation allowance is allocated, if necessary, so that the loan is reported net, at the present value of estimated future cash flows using the loan’s existing rate or at the fair value of collateral if repayment is expected solely from the collateral.

 

Accounting for Acquired Loans

 

At the time of an acquisition, we evaluate loans to determine if they are purchase credit impaired loans. Purchased credit impaired loans are those acquired loans with evidence of credit deterioration for which it was probable at acquisition that we would be unable to collect all contractual payments. We make this determination by considering past due and/or nonaccrual status, prior designation of a troubled debt restructuring, or other factors that may suggest we will not be able to collect all contractual payments. Purchased credit impaired loans are initially recorded at fair value with the difference between fair value and estimated future cash flows accreted over the expected cash flow period as income only to the extent we can reasonably estimate the timing and amount of future cash flows. In this case, these loans would be classified as accruing. In the event we are unable to reasonably estimate timing and amount of future cash flows, the loan is classified as non-accrual. An acquired loan previously classified by the seller as a troubled debt restructuring is no longer classified as such at the date of acquisition. Past due status is reported based on contractual payment status.

 

Our purchase credit impaired loans have generally been de minimis and comprised 0.1% of our loan portfolio at June 30, 2016. Historically, purchased credit impaired loans have been placed on nonaccrual status and reported as such until we were able to reasonably estimate the timing and amount of future expected cash flows. Income associated with purchased credit impaired loans for the three and six months ended June 30, 2016 and prior periods has been immaterial.

 

All loans not otherwise classified as purchase credit impaired are recorded at fair value with the discount to contractual value accreted over the life of the loan. When determining the allowance for loan losses on acquired loans, we bifurcate the allowance between legacy loans and acquired loans. Loans remain designated as acquired until either (i) loan is renewed or (ii) loan is substantially modified whereby modification results in a new loan. When determining the allowance on acquired loans, the Company estimates principal losses as compared to the Company’s recorded investment, with the recorded investment being net of any unaccreted discounts from the acquisition. At June 30, 2016, we had $226.6 million in acquired loans that have not been renewed or substantially modified, which is net of an unaccreted discount of $1.4 million or 0.62%.

 

Goodwill

 

Goodwill resulting from business combinations is generally determined as the excess of the fair value of the consideration transferred, plus the fair value of any noncontrolling interests in the acquiree, over the fair value of the net assets acquired and liabilities assumed as of the acquisition date. Goodwill is assessed annually for impairment or when events or changes in circumstances indicate that the carrying amount of the asset may not be recoverable. Goodwill acquired in a purchase business combination that is determined to have an indefinite useful life, is not amortized, but tested for impairment. We perform our annual impairment test on October 1st. Goodwill is the only intangible asset with an indefinite life on our balance sheet.

 

Recently Issued Accounting Pronouncements

 

ASU 2015-16, “Business Combinations (Topic 805) – Simplifying the Accounting for Measurement-Period Adjustments.” ASU 2015-16 requires that an acquirer recognize adjustments to provisional amounts that are identified during the measurement period in the reporting period in which the adjustment amounts are determined. The acquirer must record, in the same period’s financial statements, the effect on earnings of changes in depreciation, amortization, or other income effects, if any, as a result of the change to the provisional amounts, calculated as if the accounting had been completed at the acquisition date. Additionally, the entity is required to present separately on the face of the income statement or disclose in the notes the portion of the amount recorded in current-period earnings by line item that would have been recorded in previous reporting periods if the adjustment to the provisional amounts had been recognized as of the acquisition date. The adoption of this ASU 2015-16 did not have a significant impact on the Company’s financial statements.

 

ASU 2014-09 “Revenue from Contract with Customers (Topic 606).”  ASU 2014-09 supersedes the revenue recognition requirements in Revenue Recognition (Topic 605), and most industry-specific guidance throughout the Industry Topics of the Codification.  The core principle of ASU 2014-09 is that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services.  ASU 2014-09 is currently effective for us beginning on January 1, 2018 with retrospective application to each prior reporting period presented. We are currently evaluating the potential impact of ASU 2014-09 on our financial statements.

 

35 

Table of Contents

ASU 2016-02 “Leases (Topic 842).” ASU 2016-02 will, among other things, require lessees to recognize a lease liability, which is a lessee‘s obligation to make lease payments arising from a lease, measured on a discounted basis; and a right-of-use asset, which is an asset that represents the lessee’s right to use, or control the use of, a specified asset for the lease term. ASU 2016-02 does not significantly change lease accounting requirements applicable to lessors; however, certain changes were made to align, where necessary, lessor accounting with the lessee accounting model and ASC Topic 606, “Revenue from Contracts with Customers.” ASU 2016-02 will be effective for us beginning on January 1, 2019 and will require transition using a modified retrospective approach for leases existing at, or entered into after, the beginning of the earliest comparative period presented in the financial statements. We are currently evaluating the potential impact of ASU 2016-02 on our financial statements.

 

ASU 2016-09, “Compensation - Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting.” Under ASU 2016-09 all excess tax benefits and tax deficiencies related to share-based payment awards should be recognized as income tax expense or benefit in the income statement during the period in which they occur. Previously, such amounts were recorded in the pool of excess tax benefits included in additional paid-in capital, if such pool was available. Because excess tax benefits are no longer recognized in additional paid-in capital, the assumed proceeds from applying the treasury stock method when computing earnings per share should exclude the amount of excess tax benefits that would have previously been recognized in additional paid-in capital. Additionally, excess tax benefits should be classified along with other income tax cash flows as an operating activity rather than a financing activity, as was previously the case. ASU 2016-09 also provides that an entity can make an entity-wide accounting policy election to either estimate the number of awards that are expected to vest (current GAAP) or account for forfeitures when they occur. ASU 2016-09 changes the threshold to qualify for equity classification (rather than as a liability) to permit withholding up to the maximum statutory tax rates (rather than the minimum as was previously the case) in the applicable jurisdictions. ASU 2016-09 will be effective for us January 1, 2017 and is not expected to have a significant impact on our financial statements.

 

ASU No. 2016-10, “Revenue from Contracts with Customers (Topic 606): Identifying Performance Obligations and Licensing.” ASU 2016-10 was issued to clarify ASC Topic 606, “Revenue from Contracts with Customers” related to (i) identifying performance obligations; and (ii) the licensing implementation guidance. The effective date and transition of ASU 2016-10 is the same as the effective date and transition of ASU 2014-09, “Revenue from Contracts with Customers (Topic 606),” as discussed above. We are currently evaluating the potential impact of ASU 2016-10 on our financial statements.

 

ASU No. 2016-13, “Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments.” ASU 2016-13 requires the measurement of all expected credit losses for financial assets held at the reporting date based on historical experience, current conditions, and reasonable and supportable forecasts and requires enhanced disclosures related to the significant estimates and judgments used in estimating credit losses, as well as the credit quality and underwriting standards of an organization’s portfolio. In addition, ASU 2016-13 amends the accounting for credit losses on available-for-sale debt securities and purchased financial assets with credit deterioration. ASU 2016-13 will be effective on January 1, 2020. We are currently evaluating the potential impact of ASU 2016-13 on our financial statements.

 

Results of Operations

 

Net income attributable to common stockholders was $5.3 million ($0.40 per diluted common share) for the three months ended June 30, 2016 compared with $3.6 million ($0.36 per diluted common share) for the three months ended June 30, 2015, an increase in net income attributable to common stockholders of $1.6 million or 45.0%. Annualized returns on average common equity were 7.79% and 8.20%, annualized returns on average tangible common equity were 9.30% and 10.04%, annualized returns on average assets were 0.91% and 0.84%, and efficiency ratios were 60.11% and 64.90% for the three months ended June 30, 2016 and June 30, 2015, respectively. The efficiency ratio is calculated by dividing total noninterest expense by the sum of net interest income plus noninterest income, excluding net gains and losses on the sale of branch assets, loans and securities. Additionally, taxes and provision for loan losses are not part of this calculation.

 

Net income attributable to common stockholders was $11.6 million ($0.89 per diluted common share) for the six months ended June 30, 2016 compared with $7.0 million ($0.70 per diluted common share) for the six months ended June 30, 2015, an increase in net income attributable to common stockholders of $4.6 million or 66.6%. This increase was primarily the result of the increase in average interest-earning assets due to organic growth within the loan portfolio and the increase in the securities portfolio. Additionally, net income increased partially due to the sale of two Central Texas branch locations during the first quarter 2016, resulting in after tax gain of $1.3 million. Excluding the gain on the sale of the two Central Texas branch locations, net income attributable to common stockholders would have been $10.3 million and net income per diluted common share would have been $0.79 for the six months ended June 30, 2016. Annualized returns on average common equity were 8.74% and 7.47%, annualized returns on average tangible common equity were 10.46% and 9.83% and annualized returns on average assets were 1.04% and 0.80% for the six months ended June 30, 2016 and June 30, 2015, respectively. Excluding the gain on the sale of the two Central Texas branch locations, the average common equity, average tangible common equity and annualized returns on average assets for the six months ended June 30, 2016 would have been 7.73%, 9.26% and 0.92%, respectively. Our efficiency ratio was 61.93% and 66.99% for the six months ended June 30, 2016 and June 30, 2015, respectively.

 

36 

Table of Contents

Net Interest Income

 

Three months ended June 30, 2016 compared with three months ended June 30, 2015. Net interest income before the provision for loan losses for the three months ended June 30, 2016 was $21.9 million compared with $19.7 million for the three months ended June 30, 2015, an increase of $2.2 million, or 11.2%. The increase in net interest income was primarily due to the increase in average interest-earning assets of $422.4 million or 25.3% for the three months ended June 30, 2016 compared with the three months ended June 30, 2015. This increase in average interest-earning assets during the three months ended June 30, 2016 as compared to the same period in 2015 was primarily due to organic loan growth and the increase in the securities portfolio.

 

Interest income was $24.5 million for the three months ended June 30, 2016, an increase of $2.7 million, or 12.3%, compared with the three months ended June 30, 2015, primarily due to an increase of $1.8 million, or 8.3%, in interest income and fees on loans during the three months ended June 30, 2016 compared to the same period in 2015 as a result of the increase in average loans outstanding of $245.6 million for the same period. Additionally, during the three months ended June 30, 2016 and June 30, 2015, we benefitted from acquisition accounting loan discount accretion of $351 thousand and $1.1 million, respectively.

 

Interest expense was $2.6 million for the three months ended June 30, 2016, an increase of $462 thousand compared to the three months ended June 30, 2015. This increase was primarily due to an increase in average interest-bearing liabilities of $270.4 million for the three months ended June 30, 2016 compared to the three months ended June 30, 2015. This increase in average interest-bearing liabilities was primarily attributable to the increase in long-term borrowings of $90.2 million, short-term borrowings of $83.8 million and certificates and other time deposits of $79.9 million.

 

Tax equivalent net interest margin, defined as net interest income adjusted for tax-free income divided by average interest-earning assets, for the three months ended June 30, 2016 was 4.32%, a decrease of 47 basis points compared to 4.79% for the three months ended June 30, 2015. Tax equivalent adjustments to net interest margin are the result of increasing income from tax-free securities by an amount equal to the taxes that would have been paid if the income were fully taxable based on a 35% federal tax rate, thus making tax-exempt yields comparable to taxable asset yields. The impact of net acquisition accounting adjustments of $407 thousand and $1.3 million on the tax equivalent net interest margin was an increase of 8 basis points and 30 basis points for the three months ended June 30, 2016 and June 30, 2015, respectively.

 

 

37 

Table of Contents

The following table presents, for the periods indicated, the total dollar amount of average balances, interest income from average interest-earning assets and the annualized resultant yields, as well as the interest expense on average interest-bearing liabilities, expressed in both dollars and rates. Any nonaccruing loans have been included in the table as loans carrying a zero yield.

 

   Three Months Ended June 30,
   2016  2015
   Average
Balance
  Interest
Earned/
Interest
Paid
  Average
Yield/ Rate
  Average
Balance
  Interest
Earned/
Interest
Paid
  Average
Yield/ Rate
   (Dollars in thousands)
Assets                              
Interest-Earning Assets:                              
Loans(3)  $1,724,346   $22,839    5.33%  $1,478,752   $21,079    5.72%
Securities   270,619    1,538    2.29%   127,882    721    2.26%
Deposits in other financial institutions   96,358    150    0.62%   62,247    50    0.32%
Total interest-earning assets   2,091,323   $24,527    4.72%   1,668,881   $21,850    5.25%
Allowance for loan losses   (14,129)             (9,265)          
Noninterest-earning assets   236,857              195,341           
Total assets  $2,314,051             $1,854,957           
                               
Liabilities and Stockholders' Equity                              
Interest-Bearing Liabilities:                              
Interest-bearing demand deposits  $102,550   $88    0.34%  $101,029   $83    0.33%
Money market and savings deposits   435,851    481    0.44%   420,992    442    0.42%
Certificates and other time deposits   627,982    1,665    1.07%   548,076    1,211    0.89%
Short-term borrowings   88,242    106    0.48%   4,451    2    0.16%
Subordinated debt   9,125    120    5.28%   8,981    162    7.24%
Other borrowed funds   118,629    118    0.40%   28,415    216    3.05%
Total interest-bearing liabilities   1,382,379   $2,578    0.75%   1,111,944   $2,116    0.76%
                               
Noninterest-Bearing liabilities:                              
Noninterest-bearing demand deposits   652,405              534,688           
Other liabilities   8,139              6,868           
Total liabilities   2,042,923              1,653,500           
Stockholders' equity   271,128              201,457           
Total liabilities and stockholders' equity  $2,314,051             $1,854,957           
                               
Net interest rate spread             3.97%             4.49%
                               
Net interest income and margin(1)       $21,949    4.22%       $19,734    4.74%
                               
Net interest income and margin (tax equivalent)(2)       $22,481    4.32%       $19,923    4.79%

___________________

(1)The net interest margin is equal to annualized net interest income divided by average interest-earning assets.
(2)In order to make pretax income and resultant yields on tax-exempt investments and loans comparable to those on taxable investments and loans, a tax-equivalent adjustment has been computed using a federal income tax rate of 35% for the three months ended June 30, 2016 and June 30, 2015 and other applicable effective tax rates.
(3)Includes loans held for sale at June 30, 2015.

 

38 

Table of Contents

Six months ended June 30, 2016 compared with six months ended June 30, 2015. Net interest income before provision for loan losses for the six months ended June 30, 2016 was $43.0 million compared with $38.5 million for the six months ended June 30, 2015, an increase of $4.5 million, or 11.8%. The increase in net interest income was primarily due to the increase in average interest-earning assets of $373.5 million or 22.7% for the six months ended June 30, 2016 compared with the six months ended June 30, 2015. This increase in average interest-earning assets during the six months ended June 30, 2016 as compared to the same period in 2015 was primarily due to organic growth within the loan portfolio and the increase in the securities portfolio during the six months ended June 30, 2016.

 

Interest income was $48.0 million for the six months ended June 30, 2016, an increase of $5.3 million, or 12.4%, compared with the six months ended June 30, 2015, primarily due to an increase of $3.7 million in interest income and fees on loans during the six months ended June 30, 2016 compared to the same period in 2015 as a result of the increase in average loans outstanding of $246.4 million, or 17.0% for the same period. Additionally, during the six months ended June 30, 2016 and June 30, 2015, we benefitted from acquisition accounting loan discount accretion of $773 thousand and $2.4 million, respectively.

 

Interest expense was $4.9 million for the six months ended June 30, 2016, an increase of $780 thousand compared to the six months ended June 30, 2015. This increase was primarily due to an increase in average interest-bearing liabilities of $225.5 million for the six months ended June 30, 2016 compared to the six months ended June 30, 2015. This increase in average interest-bearing liabilities was primarily attributable to the increase in short-term borrowings of $105.1 million and certificates and other time deposits of $72.4 million.

 

Tax equivalent net interest margin, defined as net interest income adjusted for tax-free income divided by average interest-earning assets, for the six months ended June 30, 2016 was 4.38%, a decrease of 38 basis points compared to 4.76% for the six months ended June 30, 2015. The impact of net acquisition accounting adjustments of $898 thousand and $2.6 million on the tax equivalent net interest margin was an increase of 8 basis points and 33 basis points for the six months ended June 30, 2016 and June 30, 2015, respectively.

 

 

 

39 

Table of Contents

The following table presents, for the periods indicated, the total dollar amount of average balances, interest income from average interest-earning assets and the annualized resultant yields, as well as the interest expense on average interest-bearing liabilities, expressed in both dollars and rates. Any nonaccruing loans have been included in the table as loans carrying a zero yield.

 

   For the Six Months Ended June 30,
   2016  2015
   Average
Balance
  Interest
Earned/
Interest
Paid
  Average
Yield/
Rate
  Average
Balance
  Interest
Earned/
Interest
Paid
  Average
Yield/
Rate
   (Dollars in thousands)
Assets                              
Interest-Earning Assets:                              
Loans(3)  $1,694,029   $45,067    5.35%  $1,447,629   $41,385    5.77%
Securities   228,540    2,619    2.30%   110,355    1,160    2.12%
Deposits in other financial institutions   94,091    292    0.62%   85,162    124    0.29%
Total interest-earning assets   2,016,660   $47,978    4.78%   1,643,146   $42,669    5.24%
Allowance for loan losses   (13,808)             (8,881)          
Noninterest-earning assets   231,901              210,533           
Total assets  $2,234,753             $1,844,798           
                               
Liabilities and Stockholders' Equity                              
Interest-Bearing Liabilities:                              
Interest-bearing demand deposits  $99,028   $155    0.31%  $103,744   $179    0.35%
Money market and savings deposits   434,495    958    0.44%   413,287    858    0.42%
Certificates and other time deposits   621,099    3,225    1.04%   548,679    2,355    0.87%
Short-term borrowings   107,308    245    0.46%   2,238    2    0.16%
Subordinated debt   9,111    237    5.23%   8,940    325    7.33%
Other borrowed funds   59,599    125    0.42%   28,243    446    3.18%
Total interest-bearing liabilities   1,330,640   $4,945    0.75%   1,105,131   $4,165    0.76%
                               
Noninterest-Bearing liabilities:                              
Noninterest-bearing demand deposits   629,187              533,098           
Other liabilities   7,663              6,907           
Total liabilities   1,967,490              1,645,136           
Stockholders' equity   267,263              199,662           
Total liabilities and stockholders' equity  $2,234,753             $1,844,798           
                               
Net interest rate spread             4.03%             4.48%
                               
Net interest income and margin       $43,033    4.29%       $38,504    4.73%
                               
Net interest income and margin (tax equivalent)       $43,964    4.38%       $38,762    4.76%

___________________

(1)The net interest margin is equal to annualized net interest income divided by average interest-earning assets.
(2)In order to make pretax income and resultant yields on tax-exempt investments and loans comparable to those on taxable investments and loans, a tax-equivalent adjustment has been computed using a federal income tax rate of 35% for the six months ended June 30, 2016 and June 30, 2015 and other applicable effective tax rates.
(3)Includes loans held for sale at June 30, 2015.

 

40 

Table of Contents

The following table presents information regarding the dollar amount of changes in interest income and interest expense for the periods indicated for each major component of interest-earning assets and interest-bearing liabilities and distinguishes between the changes attributable to changes in volume and changes in interest rates. For purposes of this table, changes attributable to both rate and volume that cannot be segregated have been allocated to rate.

 

   For the Three Months Ended June 30,  For the Six Months Ended June 30,
   2016 vs. 2015   2016 vs. 2015 
   Increase
(Decrease)
Due to Change in
     Increase
(Decrease)
Due to Change in
   
   Volume  Rate  Total  Volume  Rate  Days  Total
   (Dollars in thousands)
Interest-Earning assets:                                   
Loans  $3,501   $(1,741)  $1,760   $7,064   $(3,497)  $115   $3,682 
Securities   801    17    818    1,246    210    3    1,459 
Deposits in other financial institutions   27    72    99    13    154    1    168 
Total increase (decrease) in interest income   4,329    (1,652)   2,677    8,323    (3,133)   119    5,309 
                                    
Interest-Bearing liabilities:                                   
Interest-bearing demand deposits   1    4    5    (8)   (16)   -    (24)
Money market and savings deposits   16    24    40    44    54    2    100 
Certificates and other time deposits   176    277    453    312    551    7    870 
Short-term borrowings   33    71    104    84    159    -    243 
Subordinated debt   3    (44)   (41)   6    (95)   1    (88)
Other borrowed funds   682    (781)   (99)   497    (819)   1    (321)
Total increase (decrease) in interest expense   911    (449)   462    935    (166)   11    780 
Increase (decrease) in net interest income  $3,418   $(1,203)  $2,215   $7,388   $(2,967)  $108   $4,529 

 

Provision for Loan Losses

 

Our allowance for loan losses is established through charges to income in the form of the provision in order to bring our allowance for loan losses to a level deemed appropriate by management. The allowance for loan losses at June 30, 2016 and December 31, 2015 was $14.9 million and $13.1 million, respectively, representing 0.85% and 0.78% of total loans as of such dates. Acquired loans are initially recorded at fair value based on a discounted cash flow valuation methodology that considers, among other things, projected default rates, losses given existing defaults, and recovery rates. No carryover of any allowance for loan losses occurs when loans are acquired. We recorded a $1.6 million provision for loan losses for the quarter ended June 30, 2016 and a $1.4 million provision for the quarter ended June 30, 2015. The increase in the provision was primarily due to organic loan growth and the increase in potential problem loans for the quarter ended June 30, 2016 compared to the quarter ended June 30, 2015.

 

We recorded a $2.4 million provision for loan losses for the six months ended June 30, 2016 and a $2.1 million provision for the six months ended June 30, 2015. The increase in the provision was primarily due to organic loan growth and the increase in potential problem loans for the six months ended June 30, 2016 compared to the six months ended June 30, 2015.

 

Noninterest Income

 

Our primary sources of noninterest income are service charges on deposit accounts and nonsufficient funds fees. Noninterest income does not include loan origination fees which are recognized over the life of the related loan as an adjustment to yield using the interest method.

 

Three months ended June 30, 2016 compared with three months ended June 30, 2015. Noninterest income totaled $1.2 million for the three months ended June 30, 2016 compared with $947 thousand for the same period in 2015, an increase of $265 thousand, or 28.0%.

 

41 

Table of Contents

Six months ended June 30, 2016 compared with six months ended June 30, 2015. Noninterest income totaled $4.5 million for the six months ended June 30, 2016 compared with $1.8 million for the same period in 2015, an increase of $2.7 million, or 149.1%. This increase was primarily due to the after tax gain of $1.3 million on the sale of the two Central Texas branch locations completed during the first quarter of 2016.

 

The following table presents, for the periods indicated, the major categories of noninterest income:

 

   For the Three Months     For the Six Months   
   Ended June 30,  Increase  Ended June 30,  Increase
   2016  2015  (Decrease)  2016  2015  (Decrease)
   (Dollars in thousands)
Nonsufficient funds fees  $145   $168   $(23)  $308   $333   $(25)
Service charges on deposit accounts   173    176    (3)   318    351    (33)
Debit card and ATM card income   178    160    18    344    292    52 
Gain on sale of branch assets   -    -    -    2,050    -    2,050 
Loss on sales of other real estate   -    -    -    -    (6)   6 
Bank owned life insurance income   154    174    (20)   320    266    54 
Rebate from correspondent bank   158    31    127    307    101    206 
Other(1)   404    238    166    869    476    393 
Total noninterest income  $1,212   $947   $265   $4,516   $1,813   $2,703 

 

(1)Other includes wire transfer and letter of credit fees, among other items.

 

Noninterest Expense

 

Three months ended June 30, 2016 compared with three months ended June 30, 2015. Noninterest expense was

$13.9 million for the three months ended June 30, 2016 compared to $13.4 million for the three months ended June 30, 2015, an increase of $501 thousand, or 3.7%. This increase was primarily attributable to additional salaries and benefits related to the hiring of several key income producing employees over the last year.

 

Six months ended June 30, 2016 compared with six months ended June 30, 2015. Noninterest expense was $28.2 million for the six months ended June 30, 2016 compared to $27.0 million for the six months ended June 30, 2015, an increase of $1.2 million, or 4.3%. This increase was primarily attributable to additional salaries and benefits related to the hiring of several key income producing employees over the last year.

 

42 

Table of Contents

The following table presents, for the periods indicated, the major categories of noninterest expense:

 

   For the Three Months     For the Six Months   
   Ended June 30,  Increase  Ended June 30,  Increase
   2016  2015  (Decrease)  2016  2015  (Decrease)
   (Dollars in thousands)
Salaries and employee benefits(1)  $9,177   $8,481   $696   $18,450   $17,423   $1,027 
Net occupancy and equipment   1,214    1,274    (60)   2,446    2,358    88 
Depreciation   415    409    6    832    776    56 
Data processing and software amortization   622    827    (205)   1,275    1,453    (178)
Professional fees   401    397    4    935    877    58 
Regulatory assessments and FDIC insurance   355    320    35    700    694    6 
Core deposit intangibles amortization   195    207    (12)   394    415    (21)
Communications   274    358    (84)   554    692    (138)
Advertising   197    184    13    398    322    76 
Other real estate expense   29    44    (15)   80    44    36 
Printing and supplies   49    75    (26)   95    188    (93)
Other   995    846    149    2,017    1,766    251 
Total noninterest expense    $13,923   $13,422   $501   $28,176   $27,008   $1,168 

 

(1)Total salaries and employee benefits includes $354 thousand and $330 thousand for the three months ended June 30, 2016 and 2015, respectively, and $707 thousand and $642 thousand for the six months ended June 30, 2016 and 2015, respectively, in stock based compensation expense.

 

Salaries and Employee Benefits. Salaries and benefits increased $696 thousand, or 8.2%, for the three months ended June 30, 2016 compared to the same period in 2015 and increased $1.0 million, or 5.9% for the six months ended June 30, 2016 as compared to the six months ended June 30, 2015. These increases for the three and six months ended June 30, 2016 over the same periods in 2015 were primarily due to additional income-producing employees hired to support our growth over the past year.

 

Net Occupancy and Equipment. Net occupancy and equipment expenses decreased $60 thousand, or 4.7%, for the three months ended June 30, 2016 compared to the same period in 2015 and increased $88 thousand, or 3.7%, for the six months ended June 30, 2016 as compared to the six months ended June 30, 2015. The increase for the six months ended June 30, 2016 over the same period in 2015 was primarily attributable to a CAM catch-up for our West Belt branch location.

 

Efficiency Ratio

 

The efficiency ratio is a supplemental financial measure utilized in management’s internal evaluation of our performance and is not defined under generally accepted accounting principles. We calculate our efficiency ratio by dividing total noninterest expense, excluding loan loss provisions, by net interest income plus noninterest income, excluding net gains and losses on the sale of branch assets, loans and securities. Additionally, taxes are not part of this calculation. An increase in the efficiency ratio indicates that more resources are being utilized to generate the same volume of income, while a decrease would indicate a more efficient allocation of resources. Our efficiency ratio was 60.11% and 61.93% for the three and six months ended June 30, 2016, respectively, compared to 64.90% and 66.99% for the three and six months ended June 30, 2015, respectively.

 

We monitor the efficiency ratio in comparison with changes in our total assets and loans, and we believe that maintaining or reducing the efficiency ratio during periods of growth, as we did from 2015 to 2016, demonstrates the scalability of our operating platform. We expect to continue to benefit from our scalable platform in future periods as we believe we have already incurred a significant portion of the overhead expense necessary to support our growth.

 

43 

Table of Contents

Income Taxes

 

The amount of federal income tax expense is influenced by the amount of pre-tax income, the amount of tax-exempt income and the amount of other nondeductible expenses. Income tax expense increased $383 thousand, or 19.6%, to $2.3 million for the three months ended June 30, 2016 compared with $2.0 million for the same period in 2015. For the six months ended June 30, 2016, income tax expense totaled $5.4 million, an increase of $1.6 million, or 40.4%, compared with $3.9 million for the same period in 2015. Our effective tax rates were 30.8% and 31.8% for the three and six months ended June 30, 2016, respectively, and 33.5% and 34.4% for the three and six months ended June 30, 2015, respectively. Our effective tax rate decreased for the three and six months ended June 30, 2016 compared to the same period in 2015 primarily due to the increase in tax free income from the purchase of additional municipal securities.

 

Financial Condition

 

Loan Portfolio

 

At June 30, 2016, total loans (including loans held for sale) were $1.75 billion, an increase of $72.6 million, or 4.3%, compared with December 31, 2015, primarily due to organic growth in our loan portfolio.

 

Total loans (including loans held for sale) as a percentage of deposits were 95.1% and 95.6% as of June 30, 2016 and December 31, 2015, respectively. Our capital positions in 2015 and year to date 2016 have allowed us to grow our loan portfolio at a faster rate than we grew our deposits. Total loans as a percentage of assets were 74.1% and 80.6% as of June 30, 2016 and December 31, 2015, respectively.

 

Lending activities originate from the efforts of our lenders, with an emphasis on lending to small to medium-sized businesses and companies, professionals and individuals located in the Houston metropolitan area.

 

44 

Table of Contents

The following table summarizes our loan portfolio by type of loan as of the dates indicated:

 

   June 30,  December 31,
   2016  2015
   (Dollars in thousands)
       
Loans held for sale (1)  $-   $27,887 
           
Commercial and industrial   382,795    383,044 
Mortgage warehouse   75,554    59,071 
Real estate:          
Commercial real estate (including multi-family residential)   806,771    745,595 
Commercial real estate construction and land development   161,572    154,646 
1-4 family residential (including home equity)   214,442    205,200 
Residential construction   101,677    93,848 
Consumer and other   10,872    11,761 
Total loans held for investment   1,753,683    1,653,165 
Total loans   1,753,683    1,681,052 
Allowance for loan losses   (14,917)   (13,098)
Loans, net  $1,738,766   $1,667,954 

 

(1)Consisted of loans at two former F&M Bancshares locations acquired in 2015 and sold during the first quarter of 2016. At December 31, 2015, loans held for sale consisted of $13.2 million of commercial and industrial loans, $11.6 million of commercial real estate (including multi-family residential) loans, $2.3 million of 1-4 family residential (including home equity) loans and $803 thousand of consumer and other loans. Loans held for sale were carried at the lower of aggregate cost or fair value.

 

The principal categories of our loan portfolio (including loans held for sale) are discussed below:

 

Commercial and Industrial. We make commercial loans in our market area that are underwritten on the basis of the borrower’s ability to service the debt from income. Our commercial and industrial loan portfolio slightly decreased by $249 thousand, or 0.1%, to $382.8 million as of June 30, 2016 compared to $383.0 million as of December 31, 2015.

 

Our exposure to oil and gas exploration and production companies is roughly 3.4% of our total loan portfolio as of June 30, 2016. We define these customers as those on whom the prices of oil and gas have a significant operational or financial impact. These loans carry an overall allowance of 2.5% at June 30, 2016. The collateral on these loans includes industrial commercial real estate, working capital assets, machining equipment, drilling equipment, general industrial equipment, vehicles, airplanes, ranch property, insurance policies, notes receivable and a hotel. In addition, substantially all of these loans are personally guaranteed by the owner or owners of the borrower companies.

 

Mortgage warehouse. We make loans to unaffiliated mortgage loan originators collateralized by mortgage promissory notes which are segregated in our mortgage warehouse portfolio.  These promissory notes originated by our mortgage warehouse customers carry terms and conditions as would be expected in the competitive permanent mortgage market and serve as collateral under a traditional mortgage warehouse arrangement whereby such promissory notes are warehoused under a revolving credit facility to allow for the end investor (or purchaser) of the note to receive a complete loan package and remit funds to the bank.  For mortgage promissory notes secured by residential property, the warehouse time is normally 10 to 20 days.  For mortgage promissory notes secured by commercial property, the warehouse time is normally 40 to 50 days.  The funded balance of the mortgage warehouse portfolio can have significant fluctuation based upon market demand for the product, level of home sales and refinancing activity, market interest rates, and velocity of end investor processing times. Our mortgage warehouse portfolio increased $16.5 million, or 27.9%, to $75.6 million as of June 30, 2016 compared to $59.1 million as of December 31, 2015. Volumes fluctuate based on the level of market demand for the product, as well as overall market interest rates, and tend to peak at the end of each month.

 

Commercial Real Estate (Including Multi-Family Residential). We make loans collateralized by owner-occupied, nonowner-occupied and multi-family real estate to finance the purchase or ownership of real estate. As of June 30, 2016 and December 31, 2015, 55.6% and 52.8%, respectively, of our commercial real estate loans were owner-occupied. Our commercial real estate loan portfolio increased $61.2 million, or 8.2%, to $806.8 million as of June 30, 2016 from $745.6 million as of December 31, 2015, as a result of organic loan growth in the commercial real estate portfolio during the first six months of 2016.

 

45 

Table of Contents

Commercial Real Estate Construction and Land Development. We make commercial real estate construction and land development loans to fund commercial construction, land acquisition and real estate development construction. Commercial real estate construction and land development loans increased $6.9 million, or 4.5%, to $161.6 million as of June 30, 2016 compared to $154.6 million as of December 31, 2015 as a result of organic loan growth in the commercial real estate construction portfolio during the first six months of 2016.

 

1-4 Family Residential (Including Home Equity). Our residential real estate loans include the origination of 1-4 family residential mortgage loans (including home equity and home improvement loans and home equity lines of credit) collateralized by owner-occupied residential properties located in our market areas. Our residential real estate portfolio (including home equity) increased $9.2 million, or 4.5%, to $214.4 million as of June 30, 2016 from $205.2 million as of December 31, 2015 as a result of organic loan growth in the 1-4 family residential portfolio during the first six months of 2016.

 

Residential Construction. We make residential construction loans to home builders and individuals to fund the construction of single-family residences with the understanding that such loans will be repaid from the proceeds of the sale of the homes by builders or with the proceeds of a mortgage loan. These loans are secured by the real property being built and are made based on our assessment of the value of the property on an as-completed basis. Our residential construction loans portfolio increased $7.8 million, or 8.3%, to $101.7 million as of June 30, 2016 from $93.8 million as of December 31, 2015 as a result of organic loan growth in the residential construction portfolio during the first six months of 2016.

 

Consumer and Other. Our consumer and other loan portfolio is made up of loans made to individuals for personal purposes. Our consumer and other loan portfolio decreased $889 thousand, or 7.6%, to $10.9 million as of June 30, 2016 from $11.8 million as of December 31, 2015.

 

Asset Quality

 

Nonperforming Assets

 

We have procedures in place to assist us in maintaining the overall quality of our loan portfolio. We have established underwriting guidelines to be followed by our officers, and monitor our delinquency levels for any negative or adverse trends.

 

We had $7.1 million and $5.2 million in nonperforming loans as of June 30, 2016 and December 31, 2015, respectively.

 

 

46 

Table of Contents

The following table presents information regarding nonperforming assets as of the dates indicated.

 

   As of June 30,  As of December 31,
   2016  2015
   (Dollars in thousands)
Nonaccrual loans:          
Loans held for sale  $-   $209 
Commercial and industrial   2,723    2,664 
Mortgage warehouse   -    - 
Real estate:          
Commercial real estate (including multi-family residential)   4,141    2,006 
Commercial real estate construction and land development   -    - 
1-4 family residential (including home equity)   227    239 
Residential construction   -    - 
Consumer and other   33    66 
Total nonaccrual loans   7,124    5,184 
Accruing loans 90 or more days past due   -    - 
Total nonperforming loans   7,124    5,184 
Repossessed assets   128    131 
Other real estate   1,397    - 
Total nonperforming assets  $8,649   $5,315 
Restructured loans(1)  $9,640   $491 
Nonperforming assets to total assets   0.37%   0.25%
Nonperforming loans to total loans   0.41%   0.31%

 

(1)Restructured loans represent the balance at the end of the respective period for those loans modified in a troubled debt restructuring that are not already presented as a nonperforming loan.

 

Potential problem loans consist of loans that are performing in accordance with contractual terms but for which management has concerns about the ability of an obligor to continue to comply with repayment terms because of the obligor’s potential operating or financial difficulties. Management monitors these loans closely and reviews their performance on a regular basis. Potential problem loans contain potential weaknesses that could improve, persist or further deteriorate. At June 30, 2016 and December 31, 2015, we had $9.7 million and $6.4 million, respectively, in loans of this type which are not included in any of the nonaccrual or 90 days past due loan categories. At June 30, 2016, potential problem loans consisted of eight credit relationships. Of the total outstanding balance at June 30, 2016, 96.7% related to six customers in the energy related industry, 2.5% related to one customer in the automotive repair industry and 0.8% related to one customer in the clothing manufacturing industry. Weakness in these organizations’ operating performance, financial condition and borrowing base deficits for certain energy related credits, among other factors, have caused us to heighten the attention given to these credits. As such, all of the loans identified as potential problem loans at June 30, 2016 were graded as substandard accruing loans. Potential problem loans impact the allocation of our allowance for loan losses as a result of our risk grade allocation methodology.

 

Allowance for Credit Losses

 

The allowance for loan losses is a valuation allowance that is established through charges to earnings in the form of a provision for loan losses. The amount of the allowance for loan losses is affected by the following: (1) provisions for loan losses charged to earnings that increase the allowance, (2) charge-offs of loans that occur when loans are deemed uncollectible and decrease the allowance and (3) recoveries on loans previously charged off that increase the allowance.

 

All loans acquired from F&M Bancshares were recorded at fair value without a carryover of the F&M Bancshares allowance for loan losses. The discount recognized on acquired loans is prospectively accreted, increasing our basis in such loans. Due to acquisition accounting, our allowance for loan losses to total loans may not be comparable to our peers particularly as it relates to the allowance to gross loan percentage and the allowance to nonperforming loans. Recognizing that acquired purchased credit impaired loans have been de minimis, we monitor credit quality trends on a post-acquisition basis with an emphasis on past due, charge-off, classified loan, and nonperforming trends. The amount of discount recorded by the Company on the date of the F&M Bancshares acquisition was $6.0 million, or 1.47%, on loans acquired. The remaining discount on F&M Bancshares acquired loans as of June 30, 2016 was $1.5 million, or 0.83%. The discount on purchased loans considers anticipated credit losses on that portfolio, therefore no allowance for credit losses was established on the acquisition date. The unaccreted discount represents additional protection against potential losses and is presented as a reduction of the recorded investment in the loans rather than an allowance for loan losses. We will continue to look at the portfolio for credit deterioration and establish additional allowances over the remaining discount as needed.

 

47 

Table of Contents

At June 30, 2016, our allowance for loan losses amounted to $14.9 million, or 0.85%, of total loans compared with $13.1 million, or 0.78%, as of December 31, 2015. Excluding the acquired loans at June 30, 2016, the allowance would have been 0.98% of total loans. The increase in the allowance of $1.8 million for the six months ended June 30, 2016 as compared to the year ended December 31, 2015 was primarily due to an increase in the required reserve associated with organic loan growth and the increase in potential problem loans. We believe that the allowance for loan losses at June 30, 2016 and December 31, 2015 was adequate to cover probable incurred losses in the loan portfolio as of such dates. The ratio of annualized net charge-offs to average loans outstanding was 0.06% for the six months ended June 30, 2016 compared to 0.01% for the six months ended June 30, 2015 and 0.06% for the year ended December 31, 2015.

 

The following table presents, as of and for the periods indicated, an analysis of the allowance for loan losses and other related data:  

 

   As of and for the Six Months Ended
June 30,
   2016  2015
   (Dollars in thousands)
       
Average loans outstanding  $1,694,029   $1,447,629 
Gross loans outstanding at end of period   1,753,683    1,561,657 
Allowance for loan losses at beginning of period   13,098    8,246 
Provision for loan losses   2,355    2,103 
Charge-offs:          
Commercial and industrial loans   (443)   (82)
Mortgage warehouse   -    - 
Real estate:          
Commercial real estate (including multi-family residential)   (129)   - 
Commercial real estate construction and land development   -    - 
1-4 family residential (including home equity)   -    - 
Residential construction   -    - 
Consumer and other   (22)   (18)
Total charge-offs for all loan types   (594)   (100)
Recoveries:          
Commercial and industrial loans   45    39 
Mortgage warehouse   -    - 
Real estate:          
Commercial real estate (including multi-family residential)   -    - 
Commercial real estate construction and land development   -    - 
1-4 family residential (including home equity)   10    - 
Residential construction   -    22 
Consumer and other   3    2 
Total recoveries for all loan types   58    63 
Net charge-offs   (536)   (37)
Allowance for loan losses at end of period  $14,917   $10,312 
Allowance for loan losses to total loans   0.85%   0.66%
Net charge-offs to average loans (1)   0.06%   0.01%
Allowance for loan losses to nonperforming loans   209.39%   180.22%

 

(1)Interim period annualized.

 

48 

Table of Contents

Available for Sale Securities

 

We use our securities portfolio to provide a source of liquidity, to provide an appropriate return on funds invested, to manage interest rate risk, to meet pledging requirements, and to meet regulatory capital requirements. As of June 30, 2016, the carrying amount of investment securities totaled $303.5 million, an increase of $138.4 million, or 83.8%, compared with $165.1 million as of December 31, 2015. Securities represented 12.8% and 7.9% of total assets as of June 30, 2016 and December 31, 2015, respectively.

 

All of the securities in our securities portfolio are classified as available for sale. Securities classified as available for sale are measured at fair value in the financial statements with unrealized gains and losses reported, net of tax, as accumulated comprehensive income or loss until realized. Interest earned on securities is included in interest income.

 

The following table summarizes the amortized cost and fair value of the securities in our securities portfolio as of the dates shown:

 

   June 30, 2016
      Gross  Gross   
   Amortized  Unrealized  Unrealized  Fair
   Cost  Gains  Losses  Value
   (Dollars in thousands)
Available for Sale                    
U.S. Government and agency securities  $8,708   $656   $-   $9,364 
Municipal securities   209,540    8,953    -    218,493 
Agency mortgage-backed pass-through securities   26,556    651    (102)   27,105 
Corporate bonds   48,121    401    (21)   48,501 
Total  $292,925   $10,661   $(123)  $303,463 

 

   December 31, 2015
      Gross  Gross   
   Amortized  Unrealized  Unrealized  Fair
   Cost  Gains  Losses  Value
   (Dollars in thousands)
Available for Sale                    
U.S. Government and agency securities  $8,674   $412   $-   $9,086 
Municipal securities   123,809    2,575    (35)   126,349 
Agency mortgage-backed pass-through securities   29,511    397    (246)   29,662 
Total  $161,994   $3,384   $(281)  $165,097 

 

As of June 30, 2016, we do not expect to sell any securities classified as available for sale with material unrealized losses; and management believes that we more likely than not will not be required to sell any securities before their anticipated recovery, at which time we will receive full value for the securities. The unrealized losses are largely due to increases in market interest rates over the yields available at the time the underlying securities were purchased. Management does not believe any of the securities are impaired due to reasons of credit quality. The fair value is expected to recover as the securities approach their maturity date or repricing date or if market yields for such investments decline. Accordingly, as of June 30, 2016, management believes any impairment in our securities is temporary, and no impairment loss has been realized in our consolidated statements of income.

 

49 

Table of Contents

The following table summarizes the contractual maturity of securities and their weighted average yields as of the dates indicated. The contractual maturity of a mortgage-backed security is the date at which the last underlying mortgage matures. Available for sale securities are shown at amortized cost. For purposes of the table below, municipal securities are calculated on a tax equivalent basis.

 

   June 30, 2016
   Within One
Year
  After One Year
but
Within Five Years
  After Five Years but Within
Ten Years
  After Ten
Years
  Total
   Amount  Yield  Amount  Yield  Amount  Yield  Amount  Yield  Total  Yield
   (Dollars in thousands)
Available for Sale                                                  
U.S. government and agency securities  $-    0.00%  $2,012    1.46%  $6,696    3.23%  $-    0.00%  $8,708    2.82%
Municipal securities   5,090    1.65%   17,720    2.63%   67,735    3.07%   118,995    4.29%   209,540    3.69%
Agency mortgage-backed pass-through securities   -    0.00%   -    0.00%   4,576    2.21%   21,980    2.26%   26,556    2.25%
Other securities   -    0.00%   48,121    2.35%   -    0.00%   -    0.00%   48,121    2.35%
Total  $5,090    1.65%  $67,853    2.40%  $79,007    3.03%  $140,975    3.97%  $292,925    3.31%

 

   December 31, 2015
   Within One
Year
  After One Year
but
Within Five Years
  After Five Years but Within
Ten Years
  After Ten
Years
  Total
   Amount  Yield  Amount  Yield  Amount  Yield  Amount  Yield  Total  Yield
   (Dollars in thousands)
Available for Sale                                                  
U.S. government and agency securities  $-    0.00%  $2,010    1.46%  $6,664    3.23%  $-    0.00%  $8,674    2.82%
Municipal securities   7,176    1.48%   15,290    2.53%   32,078    3.22%   69,265    4.75%   123,809    3.89%
Agency mortgage-backed pass-through securities   -    0.00%   -    0.00%   4,328    2.22%   25,183    2.54%   29,511    2.49%
Agency collateralized mortgage obligations   -    0.00%   -    0.00%   -    0.00%   -    0.00%   -    0.00%
Total  $7,176    1.48%  $17,300    2.41%  $43,070    3.12%  $94,448    4.16%  $161,994    3.58%

 

The contractual maturity of mortgage-backed securities and collateralized mortgage obligations is not a reliable indicator of their expected life because borrowers may have the right to prepay their obligations. Mortgage-backed securities and collateralized mortgage obligations are typically issued with stated principal amounts and are backed by pools of mortgage loans with varying maturities. The term of the underlying mortgages and loans may vary significantly due to the ability of a borrower to prepay and, in particular, monthly pay downs on mortgage-backed securities tend to cause the average life of the securities to be much different than the stated contractual maturity. During a period of increasing interest rates, fixed rate mortgage-backed securities do not tend to experience heavy prepayments of principal and, consequently, the average life of this security will be lengthened. If interest rates begin to fall, prepayments may increase, thereby shortening the estimated life of this security.

 

As of June 30, 2016 and December 31, 2015, we did not own securities of any one issuer (other than the U.S. government and its agencies or sponsored entities) for which the aggregate adjusted cost exceeded 10% of our consolidated stockholders’ equity.

 

The average yield of our securities portfolio was 2.30% during the six months ended June 30, 2016 compared with 2.12% for the six months ended June 30, 2015. The increase in average yield during the first six months of 2016 compared to the same period in 2015 was primarily due to our investment in higher-yielding, longer-duration securities.

 

Goodwill and Core Deposit Intangible Assets

 

Our goodwill as of June 30, 2016 and December 31, 2015 was $39.4 million for both periods. Goodwill resulting from business combinations represents the excess of the consideration paid over the fair value of the net assets acquired and liabilities assumed. Goodwill is assessed annually for impairment or when events or changes in circumstances indicate that the carrying amount of the asset may not be recoverable.

 

50 

Table of Contents

Our core deposit intangible assets, net as of June 30, 2016 and December 31, 2015, was $4.4 million and $5.2 million, respectively, and decreased primarily as a result of the sale of the two Central Texas branch locations during the first quarter of 2016. Core deposit intangible assets arising from the F&M Bancshares acquisition and the Independence acquisition are amortized using a straight-line amortization method over its estimated useful life of seven to nine years.

 

Deposits

 

Our lending and investing activities are primarily funded by deposits. We offer a variety of deposit accounts having a wide range of interest rates and terms including demand, savings, money market and certificates and other time accounts. We rely primarily on convenient locations, personalized service and our customer relationships to attract and retain these deposits. We seek customers that will both engage in a lending and deposit relationship with us.

 

Total deposits at June 30, 2016 were $1.84 billion, an increase of $84.2 million, or 4.8%, compared with $1.76 billion at December 31, 2015. Noninterest-bearing deposits at June 30, 2016 were $630.7 million, an increase of $10.4 million, or 1.7%, compared with $620.3 million at December 31, 2015. Interest-bearing deposits at June 30, 2016 were $1.21 billion, an increase of $73.8 million, or 6.5%, compared with $1.14 billion at December 31, 2015.

 

Borrowings

 

We have an available line of credit with the FHLB of Dallas, which allows us to borrow on a collateralized basis. Our FHLB advances are short-term borrowings and are used to manage liquidity as needed. Maturing advances are replaced by drawing on available cash, making additional borrowings or through increased customer deposits. At June 30, 2016, we had a total borrowing capacity of $624.2 million, of which $363.7 million was available and $260.5 million was outstanding. Short-term FHLB advances of $30.0 million were outstanding at June 30, 2016, at a weighted average rate of 0.56%. Long-term FHLB borrowings of $200.0 million were outstanding at June 30, 2016, at a weighted average rate of 0.36%. Letters of credit were $30.5 million at June 30, 2016, of which $2.5 million will expire in August 2016, $25.0 million will expire in October 2016 and $3.0 million will expire in February 2017.

 

Credit Agreement

 

As of June 30, 2016 and December 31, 2015, we had $569 thousand of indebtedness owed to another financial institution. On December 22, 2014, in connection with the acquisition of F&M Bancshares, we entered into a revolving credit agreement. Pursuant to this agreement, we borrowed approximately $10.1 million in December 2014 to pay off the prior indebtedness. In January 2015, we borrowed an additional $18.0 million under the revolving credit agreement to repay debt that F&M Bancshares owed. In October 2015, we paid down $27.5 million under the revolving credit agreement with a portion of the proceeds from the Company’s initial public offering.

 

Our borrowing under the revolving credit agreement matures in December 2021. Interest accrues on borrowed funds at the Prime Rate minus 25 basis points, which equated to approximately 3.25% at June 30, 2016. Interest payments are due quarterly. The revolving credit agreement is secured by 100% of the capital stock of the Bank.

 

The maximum commitment to advance funds under the revolving credit agreement is $30.0 million, which is reduced by $4.3 million on each December 22nd, beginning on December 22, 2015. We are required to repay any outstanding balance in excess of the then-current maximum commitment amount.

 

The revolving credit agreement contains certain restrictive covenants, including limitations on our ability to incur additional indebtedness or engage in certain fundamental corporate transactions, such as mergers, reorganizations and recapitalizations. Additionally, the Bank is required to maintain a “well-capitalized” rating, a minimum return on assets of 0.65%, measured quarterly, a ratio of loan loss reserve to non-performing loans equal to or greater than 75%, measured quarterly, and a ratio of non-performing assets to aggregate equity plus loan loss reserves minus intangible assets of less than 35%, measured quarterly. As of June 30, 2016, we believe we are in compliance with all such debt covenants and the lender has not delivered any notice of noncompliance under the terms of the applicable credit documents.

 

Contractual Obligations

 

The following table summarizes our contractual obligations and other commitments to make future payments as of June 30, 2016 and December 31, 2015 (other than deposit obligations), which consist of our future cash payments associated with our contractual obligations pursuant to our non-cancelable operating leases and our indebtedness owed to