Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
The following discussion and analysis of our financial condition and results of operations should be read in conjunction with “Selected Historical Consolidated Financial Data” and our consolidated financial statements and the accompanying notes included elsewhere in this Annual Report on Form 10-K. This discussion and analysis contains forward-looking statements that are subject to certain risks and uncertainties and are based on certain assumptions that we believe are reasonable but may prove to be inaccurate. Certain risks, uncertainties and other factors, including those set forth under “Cautionary Note Regarding Forward-Looking Statements,” “Risk Factors” and elsewhere in this Annual Report on Form 10-K, may cause actual results to differ materially from those projected results discussed in the forward-looking statements appearing in this discussion and analysis. Except as required by law, we assume no obligation to update any of these forward-looking statements.
Overview
We are a Texas corporation and a registered bank holding company located in the Houston metropolitan area with headquarters in Conroe, Texas. We offer a broad range of commercial and retail banking services through our wholly-owned bank subsidiary, Spirit of Texas Bank SSB. We operate through 35 full-service branches located primarily in the Houston, Dallas/Fort Worth, Bryan/College Station, San Antonio-New Braunfels, Corpus Christi, Tyler, and Austin metropolitan areas metropolitan areas. As of December 31, 2021, we had total assets of $3.27 billion, loans held for investment of $2.32 billion, total deposits of $2.78 billion and total stockholders’ equity of $393.82 million.
As a bank holding company, we generate most of our revenues from interest income on loans, gains on sale of the guaranteed portion of SBA loans, customer service and loan fees, brokerage fees derived from secondary mortgage originations 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. Our goal is to maximize income generated from interest earning assets, while also minimizing interest expense associated with our funding base to widen net interest spread and drive net interest margin expansion. Net interest margin is a ratio calculated as net interest income divided by average interest-earning assets. Net interest income is the difference between interest income on interest-earning assets, such as loans and securities, and interest expense on interest-bearing liabilities, such as deposits and borrowings that are used to fund those assets. Net interest spread is the difference between rates earned on interest-earning assets and rates paid on interest-bearing liabilities.
Changes in market interest rates and the interest rates we earn on interest-earning assets or pay on interest-bearing liabilities, as well as the volume and types of interest-earning assets, interest-bearing and noninterest-bearing liabilities and stockholders’ equity, are usually the largest drivers of periodic changes in net interest spread, net interest margin and net interest income. 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. 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, as well as developments affecting the real estate, technology, financial services, insurance, transportation, manufacturing and energy sectors within our target markets and throughout Texas.
Pending Merger of Simmons First National Corporation and Spirit of Texas Bancshares, Inc.
On November 18, 2021, we entered into an Agreement and Plan of Merger (the “merger agreement”) with Simmons First National Corporation (“Simmons”), parent company of Simmons Bank, pursuant to which the companies will combine in an all‐stock transaction. Under the terms of the merger agreement, which was approved by both companies’ Boards of Directors, Spirit will merge with and into Simmons, with Simmons surviving (the “Proposed Merger”), and the combined holding company and bank will operate under the Simmons name and brand with the company’s headquarters remaining in Little Rock, Arkansas. Pending regulatory approvals and the satisfaction of the closing conditions set forth in the merger agreement, the Proposed Merger is expected to close during the second calendar quarter of 2022.
COVID-19 Pandemic
In December 2019, a novel strain of coronavirus (“COVID-19”) was reported to have surfaced in Wuhan, China, and has since spread worldwide. In March 2020, the World Health Organization declared COVID-19 a global pandemic and the United States declared a National Public Health Emergency. In addition, the “Delta” and “Omicron” variants of COVID-19, which are the most transmissible variants identified to date, have spread in the United States in 2021. The impact of these variants, or any other new variants of COVID-19, cannot be predicted at this time, and could depend on numerous factors, including vaccination rates among the population, the effectiveness of COVID-19 vaccines against variants, and the response by governmental bodies and regulators. The ongoing COVID-19 pandemic has severely impacted the level of economic activity in the local, national and global economies and financial markets. As a result, the Company and certain of its customers have been adversely affected by the COVID-19 pandemic. The extent to which the COVID-19 pandemic, or any current or future variant thereof, negatively impacts the Company's business, results of operations, and financial condition, as well as its regulatory capital and liquidity ratios, is unknown at this time and will depend on future developments, including the scope and duration of the pandemic and actions taken by governmental authorities and other third parties in response to the pandemic, or any current or future variant thereof. If the pandemic is sustained for a prolonged period of time, it may further adversely impact the Company and impair the ability of the Company's customers to fulfill their contractual obligations to the Company. This could cause the Company to experience a material adverse effect on its business operations, asset valuations, financial condition, and results of operations. Please refer to Part I, Item 1A, “Risk Factors” of this Annual Report on Form 10-K.
In April 2020, we began originating loans to qualified small businesses under the PPP administered by the SBA under the provisions of the CARES Act. Loans covered by the PPP may be eligible for loan forgiveness for certain costs incurred related to payroll, group health care benefit costs and qualifying mortgage, rent and utility payments. The remaining loan balance after forgiveness of any amounts is still fully guaranteed by the SBA. Terms of the PPP loans include the following (i) maximum amount limited to the lesser of $10 million or an amount calculated using a payroll-based formula, (ii) maximum loan term of two years, (iii) interest rate of 1.00%, (iv) no collateral or personal guarantees are required, (v) no payments are required for six months following the loan disbursement date and (vi) loan forgiveness up to the full principal amount of the loan and any accrued interest, subject to certain requirements including that no more than 25% of the loan forgiveness amount may be attributable to non-payroll costs. In return for processing and booking the loan, the SBA will pay the lender a processing fee tiered by the size of the loan (5% for loans of not more than $350 thousand; 3% for loans more than $350 thousand and less than $2 million; and 1% for loans of at least $2 million). At December 31, 2021, PPP loans totaled $43.9 million which are included in commercial and industrial loans.
The Economic Aid Act, signed into law on December 27, 2020, authorized new PPP funding and extended the authority of lenders to make PPP loans through March 31, 2021. Under the revised terms of the PPP, loans may be made to first time borrowers as well as certain businesses that previously received a PPP loan and experienced a significant reduction in revenue.
During the year ended December 31, 2021, we also participated in the Federal Reserve's PPPLF, which expired on July 30, 2021. As of December 31, 2021, we had no borrowings under the PPPLF. The maturity date of a borrowing under the PPPLF was equal to the maturity date of the PPP loan pledged to secure the borrowing and would be accelerated (i) if the underlying PPP loan goes into default and is sold to the SBA to realize on the SBA guarantee or (ii) to the extent that any PPP loan forgiveness reimbursement is received from the SBA. Borrowings under the PPPLF bear interest at a rate of 0.35% and there were no fees to us.
Federal bank regulatory agencies have issued an interim final rule that permits banks to neutralize the regulatory capital effects of participating in the PPP and, if applicable, the PPPLF. Specifically, all PPP loans have a zero percent risk weight under applicable risk-based capital rules. Additionally, a bank may exclude all PPP loans pledged as collateral to the PPPLF from its average total consolidated assets for the purposes of calculating its leverage ratio, while PPP loans that are not pledged as collateral to the PPPLF will be included.
Simmons Branch Acquisition
On February 28, 2020, Spirit completed its acquisition of certain assets and assumption of certain liabilities associated with five banking offices of Simmons Bank. The offices are located in Austin, San Antonio and Tilden, Texas. The Company paid total consideration of $131.6 million in the Simmons branch acquisition. For more information about the acquisition, see “Note 3. Business Combinations” in the notes to our consolidated financial statements included elsewhere in this Annual Report on Form 10-K.
Results of Operations
Our results of operations depend substantially on net interest income and noninterest income. Other factors contributing to our results of operations include our level of noninterest expenses, such as salaries and employee benefits, occupancy and equipment and other miscellaneous operating expenses.
Net Interest Income
Net interest income represents interest income less interest expense. We generate interest income from interest, dividends and fees received on interest-earning assets, including loans and investment securities we own. We incur interest expense from interest paid on interest-bearing liabilities, including interest-bearing deposits and borrowings. To evaluate net interest income, we measure and monitor (1) yields on our loans and other interest-earning assets, (2) the costs of our deposits and other funding sources, (3) our net interest spread, (4) our net interest margin and (5) our provisions for loan losses. Net interest spread is the difference between rates earned on interest-earning assets and rates paid on interest-bearing liabilities. Net interest margin is calculated as the annualized net interest income 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.
Changes in market interest rates and the interest rates we earn on interest-earning assets or pay on interest-bearing liabilities, as well as the volume and types of interest-earning assets, interest-bearing and noninterest-bearing deposits and stockholders’ equity, are usually the largest drivers of periodic changes in net interest spread, net interest margin and net interest income. We measure net interest income before and after provision for loan losses required to maintain our allowance for loan and lease losses at acceptable levels.
Noninterest Income
Our noninterest income includes the following: (1) service charges and fees; (2) SBA loan servicing fees; (3) mortgage referral fees; (4) gain on the sales of loans, net; (5) gain (loss) on sales of investment securities; (6) swap fees; (7) swap referral fees; and (8) other.
Noninterest Expense
Our noninterest expense includes the following: (1) salaries and employee benefits; (2) occupancy and equipment expenses; (3) professional services; (4) data processing and network; (5) regulatory assessments and insurance; (6) amortization of core deposit intangibles; (7) advertising; (8) marketing; (9) telephone expenses; (10) conversion expense; and (11) other.
Financial Condition
The primary factors we use to evaluate and manage our financial condition include liquidity, asset quality and capital.
Liquidity
We manage liquidity based upon factors that include the amount of core deposits as a percentage of total deposits, the level of diversification of our funding sources, the allocation and amount of our deposits among deposit types, the short-term funding sources used to fund assets, the amount of non-deposit funding used to fund assets, the availability of unused funding sources, off-balance sheet obligations, the availability of assets to be readily converted into cash without undue loss, the amount of cash and liquid securities we hold, and the repricing characteristics and maturities of our assets when compared to the repricing characteristics of our liabilities, the ability to securitize and sell certain pools of assets and other factors.
Asset Quality
We manage the diversification and quality of our assets based upon factors that include the level, distribution, severity and trend of problem, classified, delinquent, nonaccrual, nonperforming and restructured assets, the adequacy of our allowance for loan and lease losses, discounts and reserves for unfunded loan commitments, the diversification and quality of loan and investment portfolios and credit risk concentrations.
Capital
We manage capital based upon factors that include the level and quality of capital and our overall financial condition, the trend and volume of problem assets, the adequacy of discounts and reserves, the level and quality of earnings, the risk exposures in our balance sheet, the levels of tier 1 (core), risk-based and tangible common equity capital, the ratios of tier 1 (core), risk-based and tangible common equity capital to total assets and risk-weighted assets and other factors.
Analysis of Results of Operations
Net income for the year ended December 31, 2021 totaled $42.1 million, which generated diluted earnings per common share of $2.38 and adjusted diluted earnings per common share, which is a non-GAAP financial measure that excludes gain on sale of securities and expenses related to the Proposed Merger, of $2.42 for the year ended December 31, 2021. Net income for the year ended December 31, 2020 totaled $31.3 million, which generated diluted earnings per common share of $1.77 and adjusted diluted earnings per common share of $1.79 for the year ended December 31, 2020. The increase in net income was driven by an increase in interest income of $2.0 million that was primarily attributable to organic loan growth and origination fees net of costs recognized on Paycheck Protection Program loans. In addition, interest expense decreased $6.2 million primarily due to market rate resets which occurred on all products during the year ended December 31, 2021. Increased interest income was partially offset by a decrease of non-interest income of $4.8 million primarily due to a decrease in gain on sale of loans of $4.4 million offset by an increase in Swap fees of $1.0 million. Our results of operations for the year ended December 31, 2021 produced a return on average assets of 1.34% compared to a return on average assets of 1.11% for the year ended December 31, 2020. We had a return on average stockholders’ equity of 11.17% compared to a return on average stockholders’ equity of 8.98% for the year ended December 31, 2020.
Net income for the year ended December 31, 2020 totaled $31.3 million, which generated diluted earnings per common share of $1.77 and adjusted diluted earnings per common share, which is a non-GAAP financial measure that excludes gain on sale of securities and acquisition-related expenses, of $1.79 for the year ended December 31, 2020. Net income for the year ended December 31, 2019 totaled $21.1 million, which generated diluted earnings per common share of $1.40 and adjusted diluted earnings per common share of $1.43 for the year ended December 31, 2019. The increase in net income was driven by an increase in interest income of $37.9 million that was primarily attributable to acquired loan growth, partially offset by an increase in interest expense of $7.0 million, which was mainly the result of increased deposit balances from acquisitions. Our results of operations for the year ended December 31, 2020 produced a return on average assets of 1.11% compared to a return on average assets of 1.14% for the year ended December 31, 2019. We had a return on average stockholders’ equity of 8.98% compared to a return on average stockholders’ equity of 8.38% for the year ended December 31, 2019.
Net Interest Income and Net Interest Margin
The following table presents, for the periods indicated, information about (1) average balances, the total dollar amount of interest income from interest-earning assets and the resultant average yields; (2) average balances, the total dollar amount of interest expense on interest-bearing liabilities and the resultant average rates; (3) the interest rate spread; (4) net interest income and margin; and (5) net interest income and margin (tax equivalent). Interest earned on loans that are classified as nonaccrual is not recognized in income, however the balances are reflected in
average outstanding balances for that period. Any nonaccrual loans have been included in the table as loans carrying a zero yield.
Years Ended December 31,
Average
Balance(1)
Interest/
Expense
Yield/ Rate
Average
Balance(1)
Interest/
Expense
Yield/ Rate
Average
Balance(1)
Interest/
Expense
Yield/ Rate
(Dollars in thousands)
Interest-earning assets:
Interest-earning deposits in
other banks
Loans, including loans held
for sale(2)
Investment securities and
other
Total interest-earning
assets
Noninterest-earning assets
Total assets
Interest-bearing liabilities:
Interest-bearing demand
deposits
Interest-bearing NOW
accounts
Savings and money market
accounts
Time deposits
FHLB advances and other
borrowings
Total interest-bearing
liabilities
Noninterest-bearing liabilities
and shareholders' equity
Noninterest-bearing
demand deposits
Other liabilities
Stockholders' equity
Total liabilities and
stockholders' equity
Net interest rate spread
Net interest income and margin
Net interest income and margin
(tax equivalent)(3)
Average balances presented are derived from daily average balances.
Includes loans on nonaccrual status.
In order to make pretax income and resultant yields on tax-exempt loans comparable to those on taxable loans, a tax-equivalent adjustment has been computed using a federal tax rate of 21% for the years ended December 31, 2021, 2020 and 2019, which is a non-GAAP financial measure. See our reconciliation of non-GAAP financial measures to their most directly comparable GAAP financial measures under the caption “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Non-GAAP Financial Measures.”
Increases and decreases in interest income and interest expense result from changes in average balances (volume) of interest-earning assets and liabilities, as well as changes in average interest rates. The following table shows the effect that these factors had on the interest earned on our interest-earning assets and the interest incurred on our interest-bearing liabilities for the periods indicated. The effect of changes in volume is determined by multiplying the change in volume by the prior period’s average rate. Similarly, the effect of rate changes is calculated by multiplying the change in average rate by the previous period’s volume.
A summary of increases and decreases in interest income and interest expense resulting from changes in average balances (volume) and average interest rates follows:
Years Ended December 31, 2021
Compared to 2020
Years Ended December 31, 2020
Compared to 2019
Increase (Decrease)
Due to
Increase (Decrease)
Due to
Volume(1)
Rate(1)
Total
Volume(1)
Rate(1)
Total
(Dollars in thousands)
Interest-earning assets:
Interest-earning deposits in other banks
Loans, including loans held for sale(2)
Investment securities and other
Total change in interest income
Interest-bearing liabilities:
Interest-bearing demand deposits
Interest-bearing NOW accounts
Savings and money market accounts
Time deposits
FHLB advances and other borrowings
Total change in interest expenses
Total change in net interest income
Variances attributable to both volume and rate are allocated on a consistent basis between rate and volume based on the absolute value of the variances in each category.
Includes loans on nonaccrual status.
Year ended December 31, 2021 compared to Year ended December 31, 2020
Net interest income was $114.1 million for the year ended December 31, 2021 compared to $105.9 million for the year ended December 31, 2020, representing an increase of 8.2 million, or 7.7%. The increase in net interest income was primarily due to an increase in interest income of $2.0 million due to organic loan growth and origination fees net of costs recognized on Paycheck Protection Program loans and by a decrease in interest expense of $6.2 million due to market rate resets which occurred on all products during the year ended December 31, 2021. Interest income on loans decreased by $982 thousand for the year ended December 31, 2021. The effects of growth in average loans of $59.0 million, including loans held for sale, for the year ended December 31, 2021 was more than offset by declines in interest rates during the year.
Interest expense was $11.4 million for the year ended December 31, 2021 compared to $17.6 million for the year ended December 31, 2020, representing a decrease of $6.2 million, or 35.2%. This decrease was mainly due to a decrease in interest expense on deposits. Interest expense on FHLB advances and other borrowings totaled $3.7 million for the year ended December 31, 2021 compared to $3.0 million for the year ended December 31, 2020, representing an increase of $642 thousand, resulting primarily from interest expense on subordinated debt issued during the year ended December 31, 2020 which yields 6.0%. Interest on subordinated debt was offset by declines in interest expense on deposits related to lower overall market interest rates.
Interest expense on deposits decreased by $6.8 million for the year ended December 31, 2021 compared to the year ended December 31, 2020. The decrease was primarily attributable to a decrease in overall market rates offset by an increase in the average balance of interest bearing deposits of $228.0 million. The average cost of deposits for the year ended December 31, 2021 was 0.30% compared to the average cost of deposits of 0.64% for the year ended December 31, 2020. The decrease in cost of deposits was primarily attributable to the decrease in interest rates by the Federal Open Market Committee during the year ended December 31, 2020. For the year ended December 31, 2021, the average rate paid on time deposits was 0.75% compared to 1.54% for the year ended December 31, 2020.
N et interest margin was 3.95 % for the year ended December 31, 202 1 , compared to 4. 14 % for the year ended December 31, 20 20 , representing a decrease of 19 basis points . The tax equivalent net inter est margin (which is a non-GAAP measure) was 3.96 % for the year ended December 31, 202 1 compared to 4. 21 % for the year ended December 31, 20 20 , representing a decr ease of 25 basis points . See our reconciliation of non-GAAP financial measures to their most directly comparable GAAP financial measures under the caption “Management ’s Discussion and Analysis of Financial Condition and Results of Operations—Non-GAAP Financial Measures.” The average yield on interes t-earning assets decreased by 49 basis points for the year ended December 31, 202 1 , compared to the year ended December 31, 20 20 and the average rate paid on interest-bea ring liabilities decreased by 4 0 basis points, resulting in 8 basis point decrease in the interest rate spread.
We currently expect volatility within our net interest income and net interest margin throughout the year ending December 31, 2022 as competition for loans places downward pressure on loan yields offset by any Federal Rate hikes during the year ending December 31, 2022 and the deployment of excess cash into higher yielding loans.
Year ended December 31, 2020 compared to Year ended December 31, 2019
Net interest income was $105.9 million for the year ended December 31, 2020, compared to $77.9 million for the year ended December 31, 2019, representing an increase of $28.0 million, or 36.0%. The increase in net interest income was primarily due to an increase in interest income of $28.3 million partially offset by an increase in interest expense of $240 thousand. Interest income on loans increased by $32.4 million for the year ended December 31, 2020. The effects of growth in average loans of $843.7 million, including loans held for sale, for the year ended December 31, 2020 was more than offset by declines in interest rates during the year and the primary driver of the increase in interest income on loans of $6.8 million was origination fees recognized in conjunction with the PPP.
Interest expense was $17.6 million for the year ended December 31, 2020 compared to $17.4 million for the year ended December 31, 2019, representing an increase of $240 thousand, or 1.4%. This increase was mainly due to an increase in interest expense on FHLB advances and other borrowings. Interest expense on FHLB advances and other borrowings totaled $3.0 million for the year ended December 31, 2020 compared to $1.8 million for the year ended December 31, 2019, representing an increase of $1.2 million, resulting primarily from interest expense on subordinated debt issued during the year ended December 31, 2020 which yields 6.0%. Interest on subordinated debt was offset by declines in interest expense on deposits related to lower overall market interest rates.
Interest expense on deposits decreased by $970 thousand for the year ended December 31, 2020 compared to the year ended December 31, 2019. The decrease was primarily attributable to a decrease in overall market rates offset by an increase in the average balance of interest bearing deposits of $433.6 million. The average cost of deposits for the year ended December 31, 2020 was 0.64% compared to the average cost of deposits of 1.01% for the year ended December 31, 2019. The decrease in cost of deposits was primarily attributable to the decrease in interest rates by the Federal Open Market Committee during the year ended December 31, 2020. For the year ended December 31, 2020, the average rate paid on time deposits was 1.54% compared to 1.90% for the year ended December 31, 2019.
Provision for Loan Losses
The provision for loan losses represents the amount determined by management to be necessary to maintain the allowance for loan and lease losses at a level capable of absorbing inherent losses in the loan portfolio. See the discussion under “—Critical Accounting Policies—Allowance for Loan and Lease Losses.” Our management and board of directors review the adequacy of the allowance for loan and lease losses on a quarterly basis. The allowance for loan and lease losses calculation is segregated by call report code and then further segregated into various segments that include classified loans, loans with specific allocations and pass rated loans. A pass rated loan is generally characterized by a very low to average risk of default and in which management perceives there is a minimal risk of loss. Loans are rated using a nine-point risk grade scale by loan officers that are subject to validation by a third-party loan review or our internal credit committee. Risk ratings are categorized as pass, watch, special mention, substandard, doubtful and loss, with some general allocation of reserves based on these grades. Impaired loans are reviewed specifically and separately under the FASB’s Accounting Standards Codification (“ASC”) 310, “Receivables”, to determine the appropriate reserve allocation. Management compares the investment in an impaired loan with the present value of expected future cash flow discounted at the loan’s effective interest rate, the loan’s
observable market price or the fair value of the collateral, if the loan is collateral-dependent, to determine the specific reserve allowance. Reserve percentages assigned to non-impaired loans are based on historical charge-off experience adjusted for other risk factors. To evaluate the overall adequacy of the allowance to absorb losses inherent in our loan portfolio, our management considers historical loss experience based on volume and types of loans, trends in classifications, volume and trends in delinquencies and nonaccruals, economic conditions and other pertinent information. Loan s egments negatively impact ed by COVID-19 and deferrals granted to customers impacted by the COVID-19 pandemic do not have a direct impact on the provision; however, adjustments to qualitative factors and loan downgrades within these populations have been made which do impact the provision. Based on future evaluations, additional provisions for loan losses may be necessary to maintain the allowance for loan and lease losses at an appropriate level.
Year ended December 31, 2021 compared to Year ended December 31, 2020
The provision for loan losses was $3.7 million for the year ended December 31, 2021 and $11.3 million for the year ended December 31, 2020. The decrease of the provision for the year ended December 31, 2021 was primarily due to decreased qualitative reserves in response to improved economic indicators. Currently, the qualitative reserve calculation is based upon ten external and internal factors. The COVID-19 pandemic did not significantly impact internal qualitative factors via changes to underwriting guidelines, staffing, and compliance; however, external factors which are developed based upon GDP growth, unemployment, and oil prices were significantly impacted. It was the rebound in these macroeconomic conditions during the year ended December 31, 2021 which translated into lower qualitative scores and thus lower reserves.
Our management maintains a proactive approach in managing nonperforming loans, which were $5.1 million, or 0.22% of loans held for investment, at December 31, 2021, and $8.6 million, or 0.36% of loans held for investment, at December 31, 2020. During the year ended December 31, 2021, we had net charged-off loans totaling $3.3 million, compared to net charged-off loans of $2.0 million for the year ended December 31, 2020. The ratio of net charged-off loans to average loans was 0.15% for 2021, compared to 0.09% for 2020. The allowance for loan and lease losses totaled $16.4 million, or 0.71% of loans held for investment, at December 31, 2021, compared to $16.0 million, or 0.67% of loans held for investment, at December 31, 2020. The ratio of allowance for loan and lease losses to nonperforming loans was 318.4% at December 31, 2021, compared to 186.4% at December 31, 2020.
Year ended December 31, 2020 compared to Year ended December 31, 2019
The provision for loan losses was $11.3 million for the year ended December 31, 2020 and $2.9 million for the year ended December 31, 2019. The increase of the provision for the year ended December 31, 2020 was primarily due to increased qualitative reserves in response to the global COVID-19 pandemic. Currently, the qualitative reserve calculation is based upon ten external and internal factors. The COVID-19 pandemic did not significantly impact internal qualitative factors via changes to underwriting guidelines, staffing, and compliance; however, external factors which are developed based upon GDP growth, unemployment, and oil prices were significantly impacted. It was the deterioration in these macroeconomic conditions which translated into higher qualitative scores and thus higher reserves.
Our management maintains a proactive approach in managing nonperforming loans, which were $8.6 million, or 0.36% of loans held for investment, at December 31, 2020, and $6.5 million, or 0.37% of loans held for investment, at December 31, 2019. During the year ended December 31, 2020, we had net charged-off loans totaling $2.0 million, compared to net charged-off loans of $2.4 million for the year ended December 31, 2019. The ratio of net charged-off loans to average loans was 0.09% for 2020, compared to 0.17% for 2019. The allowance for loan and lease losses totaled $16.0 million, or 0.67% of loans held for investment, at December 31, 2020, compared to $6.7 million, or 0.38% of loans held for investment, at December 31, 2019. The ratio of allowance for loan and lease losses to nonperforming loans was 186.4% at December 31, 2020, compared to 104.18% at December 31, 2019.
Noninterest Income
Our noninterest income includes the following: (1) service charges and fees; (2) SBA loan servicing fees; (3) mortgage referral fees; (4) gain on the sales of loans, net; (5) gain (loss) on sales of investment securities; (6) swap fees; (7) swap referral fees; and (8) other.
The following table presents a summary of noninterest income by category, including the percentage change in each category, for the periods indicated:
Years Ended December 31, 2021
Compared to 2020
Years Ended December 31, 2020
Compared to 2019
Change
from the
Prior Year
Change
from the
Prior Year
(Dollars in thousands)
Noninterest income:
Service charges and fees
SBA loan servicing fees
Mortgage referral fees
Gain on sales of loans, net
Gain (loss) on sales of investment securities
Swap Fees
Swap Referral Fees
Other noninterest income
Total noninterest income
Year ended December 31, 2021 compared to Year ended December 31, 2020
For the year ended December 31, 2021, noninterest income totaled $14.1 million, a $4.8 million, or 25.5%, decrease from $18.9 million for the prior year. This decrease was primarily due to a decrease in gain on sales of loans of $4.4 million. During the year ended December 31, 2020, the Company recorded a gain on sale of Main Street loans of $3.6 million compared to only $99 thousand in the year ended December 31, 2021. Lower gain on sale of loans was partially offset by an increase in swap fees of $1.0 million. We currently expect noninterest income to show signs of strength in the coming quarters as borrowers get ready for possible rate hikes.
Service charges and fees were $6.3 million for the year ended December 31, 2021, compared to $5.7 million for the year ended December 31, 2020. The $1.6 million increase was due to increased deposit accounts associated with government lending programs.
Gain on sales of loans, net, was $1.1 million for the year ended December 31, 2021, compared to $5.5 million for the year ended December 31, 2020, a decrease of $4.4 million. The decrease was due to declines in gain on sale of SBA loans.
Year ended December 31, 2020 compared to Year ended December 31, 2019
For the year ended December 31, 2020, noninterest income totaled $18.9 million, a $4.3 million, or 29.6%, increase from $14.6 million for the prior year. This increase was primarily due to fees on two new swap products offered to commercial loan customers, increased service charges related to an increase in number of accounts, and an increase in gain on sale of loans recorded in conjunction with the Main Street Lending Program. This was partially offset by a decrease in gains on sale of investment securities of $3.6 million. We currently expect noninterest income to remain at reduced levels due to less loan sales and fewer swap agreements in response to the COVID-19 pandemic; however, these revenue streams are beginning to show signs of improvement.
Both swap fees and swap referral fees represented new product offerings in 2020. The decision to offer these products was based upon customer demand and the need to structure some lending deals in a manner that is as competitive as other financial institutions in our market. Depending on the pace of the economic recovery and prevailing views regarding when interest rates might rise, demand for these products will increase or decrease accordingly.
SBA loans servicing fees were $1.2 million for the year ended December 31, 2020, compared to $929 thousand for the year ended December 31, 2019. The $263 thousand increase was primarily due to fair value market adjustments on the SBA servicing asset.
Service charges and fees were $5.7 million for the year ended December 31, 2020 , compared to $3.7 million for the year ended December 31, 2019. The $2.0 million increase was due to increased deposit accounts associated with acquired institutions and accounts related to government lending programs .
Gain on sales of loans, net, was $5.5 million for the year ended December 31, 2020, compared to $4.0 million for the year ended December 31, 2019, an increase of $1.5 million. The increase was due to gain on sale of Main Street Lending Program loans of $3.7 million offset by declines in gain on sale of SBA loans.
Noninterest Expense
Our noninterest expense includes the following: (1) salaries and employee benefits; (2) occupancy and equipment expenses; (3) professional services; (4) data processing and network; (5) regulatory assessments and insurance; (6) amortization of core deposit intangibles; (7) advertising; (8) marketing; (9) telephone expense; (10) conversion expense; and (11) other.
The following table presents a summary of noninterest expenses by category, including the percentage change in each category, for the periods indicated:
Years Ended December 31, 2021
Compared to 2020
Years Ended December 31, 2020
Compared to 2019
Change
from the
Prior Year
Change
from the
Prior Year
(Dollars in thousands)
Noninterest expense:
Salaries and employee benefits
Occupancy and equipment expenses
Professional services
Data processing and network
Regulatory assessments and insurance
Amortization of intangibles
Advertising
Marketing
Telephone expense
Conversion expenses
Other operating expenses
Total noninterest expense
Year ended December 31, 2021 compared to Year ended December 31, 2020
For the year ended December 31, 2021, noninterest expense totaled $71.8 million, a $3.0 million, or 4.1%, decrease from $74.8 million for the prior year. This decrease was primarily due to lack of conversion expenses in the year ended December 31, 2021 compared to conversion expenses of $1.8 million in the year ended December 31, 2020, a decrease in other operating expenses of $772 thousand, a decrease in amortization on intangibles of 596 thousand, partially offset by increases in professional services of $306 thousand and telephone expense of $237 thousand.
Professional services increased $306 thousand to $3.0 million for the year ended December 31, 2021, compared to $2.7 million for the year ended December 31, 2020. The increase was primarily due to increase professional fees associated with the Proposed Merger with Simmons.
Telephone expense increased $237 thousand or 11.8% during the year ended December 31, 2021 primarily due to expenses related to communications upgrades at various branches. These upgrades should help to improve reliability and connectivity while lowering telephone expense in future years.
Other operating expense decreased $ 772 thousand for the yea r ended December 31, 202 1 , compared to the year ended December 31, 2020, primarily due to prepayment penalties paid on FHLB advances which were incurred as part of an overall balance sheet strateg y in 2020 .
Year ended December 31, 2020 compared to Year ended December 31, 2019
For the year ended December 31, 2020, noninterest expense totaled $74.8 million, an $11.7 million, or 18.6%, increase from $63.0 million for the prior year. This increase was primarily due to increases in salaries and employee benefits of $5.6 million, occupancy and equipment expenses of $3.2 million, regulatory assessments and insurance of $1.4 million, other operating expenses of $1.3 million, and telephone expense of $1.0 million.
Salaries and employee benefits totaled $41.8 million for the year ended December 31, 2020, which included $979 thousand of stock-based compensation expense. By comparison, salaries and employee benefits totaled $36.2 million for the year ended December 31, 2019, which included $665 thousand of stock-based compensation expense. During the year ended December 31, 2020, we experienced higher salary and employee benefit costs primarily due to increased employee count resulting from the Simmons branch acquisition and acquisition-related and Paycheck Protection Program bonuses paid.
Professional services decreased $1.4 million to $2.7 million for the year ended December 31, 2020, compared to $4.1 million for the year ended December 31, 2019. The decrease was primarily due to increased legal and consulting expenses in 2019 related to the Beeville and Citizens acquisitions compared to expenses in 2020 related to only the Simmons branch acquisition.
Increases in occupancy and equipment, regulatory assessments and insurance, and telephone expense are all related to a larger branch network due to our merger activity.
Other operating expense increased $1.3 million for the year ended December 31, 2020, compared to the year ended December 31, 2019, primarily due to prepayment penalties paid on FHLB advances which were incurred as part of an overall balance sheet strategy.
Income Tax Expense
The provision for income taxes includes both federal and state taxes. Fluctuations in effective tax rates reflect the differences in the inclusion or deductibility of certain income and expenses for income tax purposes. Our future effective income tax rate will fluctuate based on the mix of taxable and tax-free investments we make, periodic increases in surrender value of bank-owned life insurance policies for certain former executive officers and our overall taxable income.
Year ended December 31, 2021 compared to Year ended December 31, 2020
Income tax expense was $10.7 million, an increase of $3.2 million for the year ended December 31, 2021, compared to income tax expense of $7.5 million for the year ended December 31, 2020. Our effective tax rates for the years ended December 31, 2021 and 2020 were 20.16% and 19.24%, respectively. The effective tax rate was favorably impacted in the year ended December 31, 2020 due to the income tax benefit associated with a net operating loss carryback claim that was allowed under the CARES Act. The effective tax rate for December 31, 2021 represents a more normalized rate based on recurring permanent differences.
Year ended December 31, 2020 compared to Year ended December 31, 2019
Income tax expense was $7.5 million, an increase of $2.0 million for the year ended December 31, 2020, compared to income tax expense of $5.4 million for the year ended December 31, 2019. Our effective tax rates for the years ended December 31, 2020 and 2019 were 19.24% and 20.41%, respectively. The effective tax rate was lower at December 31, 2020 due to the income tax benefit associated with a net operating loss carryback claim that was allowed under the CARES Act. The effective tax rate for December 31, 2019 represents a more normalized rate based on recurring permanent differences.
Financial Condition
Our total assets increased $181.3 million, or 5.9%, from $3.08 billion as of December 31, 2020 to $3.27 billion as of December 31, 2021. Our asset growth was mainly due to organic loan demand.
Investment Securities
We use our securities portfolio to provide a source of liquidity, provide an appropriate return on funds invested, manage interest rate risk, meet collateral requirements and meet regulatory capital requirements. The securities portfolio grew to $424.4 million during the year ended December 31, 2021 as a result of deploying excess liquidity resulting from PPP loan forgiveness. The average balance of the securities portfolio including FHLB, FRB and The Independent BankersBank (“TIB”) stock for the years ended December 31, 2021 and 2020 was $429.1 million and $117.9 million, respectively, with a pre-tax yield of 1.48% and 1.98%, respectively. We held 105 securities classified as available for sale with an amortized cost of $407.6 million as of December 31, 2021. Additionally, we held one equity security carried at fair value totaling $23.7 million.
Management evaluates securities for other-than-temporary impairment (“OTTI”) at least on a quarterly basis, and more frequently when economic or market conditions warrant such an evaluation. No securities were determined to be OTTI as of December 31, 2021 or 2020.
The following table summarizes our available for sale securities portfolio as of the dates presented.
As of December 31,
Fair
Value
Fair
Value
Available for sale:
State and municipal obligations
Residential mortgage-backed securities
Corporate bonds and other debt securities
Total available for sale
The following table shows contractual maturities and the weighted average yields on our investment securities as of the date presented. Expected maturities may differ from contractual maturities because issuers may have the right to call or prepay obligations with or without call or prepayment penalties. Weighted average yields are not presented on a taxable equivalent basis:
Maturity as of December 31, 2021
One Year or Less
One to Five Years
Five to Ten Years
After Ten Years
Amortized
Cost
Weighted
Average
Yield
Amortized
Cost
Weighted
Average
Yield
Amortized
Cost
Weighted
Average
Yield
Amortized
Cost
Weighted
Average
Yield
(Dollars in thousands)
Available for sale:
State and municipal obligations
Residential mortgage-
backed securities
Corporate bonds and other debt
securities
Total available for sale
As a member institution of the FHLB and TIB, the Bank is required to own capital stock in the FHLB and TIB. As of December 31, 2021 and 2020, the Bank held approximately $3.7 million and $5.7 million, respectively, in FHLB and TIB stock. No market exists for this stock, and the Bank’s investment can be liquidated only through repurchase by the FHLB or TIB. Such repurchases have historically been at par value. We monitor our investment in FHLB and TIB stock for impairment through review of recent financial results, dividend payment history and information from credit agencies. As of December 31, 2021 and 2020, management did not identify any indicators of impairment of FHLB or TIB stock.
Equity investments at fair value consist of an investment in the CRA Qualified Investment Fund. Investment in the fund allows the Bank to earn a return on invested funds while obtaining CRA credit. At December 31, 2021, the fair value of equity securities totalled $23.7 million.
Our securities portfolio had a weighted average life of 5.3 years and an effective duration of 4.7 years as of December 31, 2021 and a weighted average life of 5.11 years and an effective duration of 4.58 years as of December 31, 2020.
Loans Held for Sale
Loans held for sale consist of the guaranteed portion of SBA loans that we intend to sell after origination. Our loans held for sale were $3.5 million as of December 31, 2021 and $1.5 million as of December 31, 2020.
Loan Concentrations
Our primary source of income is interest on loans to individuals, professionals, small and medium-sized businesses and commercial companies located in the Houston, Dallas/Fort Worth, Bryan/College Station, San Antonio/New Braunfels, Corpus Christi, Tyler and Austin metropolitan areas. Our loan portfolio consists primarily of commercial and industrial loans, 1-4 single family residential real estate loans and loans secured by commercial real estate properties located in our primary market areas. Our loan portfolio represents the highest yielding component of our earning asset base.
Our loans of $2.32 billion as of December 31, 2021 represented a decrease of $66.4 million, or 2.8%, compared to $2.39 billion as of December 31, 2020. This decrease was primarily due to a reduction of PPP loans from $277.8 million at December 31, 2020 to $43.9 million at December 31, 2021 offset by organic loan growth.
Our loans as a percentage of assets were 71.1% and 77.4% as of December 31, 2021 and 2020, respectively.
The current concentrations in our loan portfolio may not be indicative of concentrations in our loan portfolio in the future. We plan to maintain a relatively diversified loan portfolio to help reduce the risk inherent in concentration in certain types of collateral. The following table summarizes the allocation of loans by type as of the dates presented.
As of December 31,
Amount
Total
Amount
Total
Commercial and industrial loans(1)
Real estate:
1-4 single family residential loans
Construction, land and development loans
Commercial real estate loans (including multifamily)
Consumer loans and leases
Municipal and other loans
Total loans held in portfolio
Balance includes $53.5 million and $70.8 million of the unguaranteed portion of SBA loans as of December 31, 2021 and 2020, respectively.
Commercial and Industrial Loans
Commercial and industrial loans are underwritten after evaluating and understanding the borrower’s ability to repay the loan through operating profitably and effectively growing its business. Our management examines current and projected cash flows to determine the ability of the borrower to repay their obligations as agreed. Commercial loans are primarily made based on the credit quality and cash flows of the borrower and secondarily on the underlying collateral provided by the borrower. The cash flows of borrowers, however, may not be as expected and the collateral securing these loans may fluctuate in value. Most commercial loans are secured by the assets being financed or other business assets such as accounts receivable or inventory and may incorporate a personal guarantee to add strength to the credit and reduce the risk on a transaction to an acceptable level; however, some short-term loans may be made on an unsecured basis to the most credit worthy borrowers.
In the case of loans secured by accounts receivable, the availability of funds for the repayment of these loans may be substantially dependent on the ability of the borrower to collect amounts due from its customers. Due to the nature of accounts receivable and inventory secured loans, we closely monitor credit availability and collateral through the use of various tools, including but not limited to borrowing-base formulas, periodic accounts receivable agings, periodic inventory audits, and/or collateral inspections.
Commercial and industrial loans, including SBA and PPP loans discussed below, totaled $464.7 million as of December 31, 2021 and represented a decrease of $110.3 million, or 19.2%, from $575.0 million as of December 31, 2020. This decrease was primarily due to loans outstanding related to the PPP decreasing to $43.9 million at December 31, 2021 from $277.8 million at December 31, 2020.
SBA Loans
SBA loans are included in commercial and industrial loans. The primary focus of our SBA lending program is financing well-known national franchises for which the United States generally will guarantee between 75% and 85% of the loan. We are an SBA preferred lender, and originate SBA loans to national franchises in Texas and nationwide. We routinely sell the guaranteed portion of SBA loans to third parties for a premium and retain the servicing rights, for which we earn a 1% fee, and maintain the nonguaranteed portion in our loan portfolio.
SBA loans held in our loan portfolio totaled $53.5 million and $70.8 million at December 31, 2021 and 2020, respectively. We intend to continue to lend under the SBA lending program at volumes determined by market demand.
Paycheck Protection Program
In April 2020, we began originating loans to qualified small businesses under the PPP administered by the SBA under the provisions of the CARES Act. These loans are included in commercial and industrial loans and may be eligible for loan forgiveness for certain costs incurred related to payroll, group health care benefit costs and qualifying mortgage, rent and utility payments. The remaining loan balance after forgiveness of any amounts is still fully guaranteed by the SBA. Terms of the PPP loans include the following (i) maximum amount limited to the lesser of $10 million or an amount calculated using a payroll-based formula, (ii) maximum loan term of two years, (iii) interest rate of 1.00%, (iv) no collateral or personal guarantees are required, (v) no payments are required for six months following the loan disbursement date and (vi) loan forgiveness up to the full principal amount of the loan and any accrued interest, subject to certain requirements including that no more than 25% of the loan forgiveness amount may be attributable to non-payroll costs. In return for processing and booking the loan, the SBA will pay the lender a processing fee tiered by the size of the loan (5% for loans of not more than $350 thousand; 3% for loans more than $350 thousand and less than $2 million; and 1% for loans of at least $2 million). At December 31, 2021, PPP loans totaled $43.9 million which are included in commercial and industrial loans compared to $277.8 million at December 31, 2020.
We also participated in the Federal Reserve's PPPLF, which expired on July 30, 2021. At December 31, 2021, all amounts outstanding under PPPLF had been repaid compared to $149.8 million outstanding at December 31, 2020. The maturity date of a borrowing under the PPPLF was equal to the maturity date of the PPP loan pledged to secure the borrowing and would be accelerated (i) if the underlying PPP loan goes into default and is sold to the SBA to realize on the SBA guarantee or (ii) to the extent that any PPP loan forgiveness reimbursement is received from the SBA. Borrowings under the PPPLF bear interest at a rate of 0.35% and there were no fees to us.
Federal bank regulatory agencies have issued an interim final rule that permits banks to neutralize the regulatory capital effects of participating in the PPP and, if applicable, the PPPLF . Specifically, all PPP loans have a zero percent risk weight under applicable risk-based capital rules. Additionally, a bank may exclude all PPP loans pledged as collateral to the PPPLF from its average total consolidated assets for the purposes of calculating its leverage ratio, while PPP loans that are not pledged as collateral to the PPPLF will be included.
Real estate loans
1-4 single family residential real estate loans (including loans to foreign nationals)
1-4 single family residential real estate loans, including foreign national loans, are subject to underwriting standards and processes similar to commercial and industrial loans. We provide mortgages for the financing of 1-4 single family residential homes for primary occupancy, vacation or rental purposes. The borrowers on these loans generally qualify for traditional market financing. We also specialize in 1-4 single family residential real estate loans to foreign national customers, in which the borrower does not qualify for traditional market financing.
We define our foreign national loans as loans to borrowers who derive more than 50% of their personal income from outside the United States. We provide mortgages for these foreign nationals in Texas for primary occupancy or secondary homes while travelling to the United States. Because more than 50 percent of the borrower’s income is derived from outside of the United States, they do not qualify for traditional market financing. We have developed an enhanced due diligence process for foreign national loans that includes larger down payments than a traditional mortgage, as well as minimum reserves equal to an amount of mortgage payments over a specified period held in the Bank and monthly escrows for taxes and insurance.
1-4 single family residential real estate loans totaled $362.2 million as of December 31, 2021 and represented a decrease of $1.9 million, or 0.54%, from $364.1 million as of December 31, 2020. Foreign national loans comprised $143.3 million, or 39.6%, of 1-4 single family residential real estate loans as of December 31, 2021, compared to $124.6 million, or 34.2%, of 1-4 single family residential real estate loans as of December 31, 2020. The decrease was primarily due to refinance competition in response to overall lower interest rates.
Construction, land and development loans
With respect to loans to developers and builders, we generally require the borrower to have a proven record of success and expertise in the building industry. Construction loans are underwritten utilizing feasibility studies, independent appraisal reviews, sensitivity analysis of absorption and lease rates and financial analysis of the developers and property owners. Construction loans are generally based upon estimates of costs and value associated with the complete project. These estimates may be inaccurate. Construction loans often involve the disbursement of substantial funds with repayment primarily dependent on the success of the ultimate project.
Sources of repayment for these types of loans may be pre-committed permanent loans from approved long-term lenders, sales of developed property or an interim loan commitment from us until permanent financing is obtained. These loans are closely monitored by on-site inspections and are considered to have higher risks than other real estate loans due to their ultimate repayment being sensitive to interest rate changes, governmental regulation of real property, general economic conditions and the availability of long-term financing. Due to the nature of the real estate industry, we evaluate the borrower’s ability to service the interest of the debt from other sources other than the sale of the constructed property.
Construction loans totaled $401.0 million as of December 31, 2021 and represented a decrease of $14.5 million, or 3.5%, from $415.5 million as of December 31, 2020. The decrease was primarily due the transition of loans into permanent financing.
Commercial real estate loans
Commercial real estate loans are subject to underwriting standards and processes similar to commercial loans. Commercial real estate lending typically involves higher loan principal amounts and the repayment of these loans is generally largely dependent on the successful operation of the property securing the loan or the business conducted on the property securing the loan.
Commercial real estate loans may be more adversely affected by conditions in the real estate markets or in the general economy. Management monitors and evaluates commercial real estate loans based on collateral and risk grade criteria. As a general rule, we avoid financing special use projects unless strong secondary support is present to help mitigate risk.
Commercial real estate loans consist of owner and nonowner-occupied commercial real estate loans, multifamily loans and farmland. Total commercial real estate loans of $1.03 billion as of December 31, 2021 represented an increase of $74.1 million, or 7.8%, from $956.7 million as of December 31, 2020. The increase was primarily due to strong loan demand in the second half of 2021.
Owner and nonowner-occupied commercial real estate loans
Owner-occupied commercial real estate loans totaled $257.0 million as of December 31, 2021 and $243.1 million as of December 31, 2020. Owner-occupied real estate loans comprised 24.9% and 25.4% of total commercial real estate loans as of December 31, 2021 and 2020, respectively.
Nonowner-occupied commercial real estate loans totaled $663.2 million as of December 31, 2021 and $600.6 million as of December 31, 2020. Nonowner-occupied commercial real estate loans comprised 64.3% and 62.8% of total commercial real estate loans as of December 31, 2021 and 2020, respectively.
Multifamily loans and farmland
Multifamily loans totaled $42.9 million at December 31, 2021 and $55.3 million at December 31, 2020. Multifamily loans comprised 4.2% and 5.8% of total commercial real estate loans as of December 31, 2021 and 2020, respectively.
Multifamily loans are not a focus of the Bank, and we do not expect this portion of the portfolio to represent a large portion of our growth going forward. Farmland loans totaled $68.3 million at December 31, 2021 and $57.8 million at December 31, 2020.
Consumer loans and leases
Our non-real estate consumer loans are based on the borrower’s proven earning capacity over the term of the loan. We monitor payment performance periodically for consumer loans to identify any deterioration in the borrower’s financial strength. To monitor and manage consumer loan risk, management develops and adjusts policies and procedures as needed. This activity, coupled with a relatively small volume of consumer loans, minimizes risk.
All of our leases are related to the financing of vehicle leases to individuals. These loans are originated by a well-known third - party leasing company and subsequently purchased by us after our final credit review. We limit our exposure to individuals living in Texas, within our defined local markets. We do not intend on growing this portfolio going forward as we believe current pricing on these loans does not adequately cover the inherent risk.
Consumer loans and leases totaled $6.3 million as of December 31, 2021 and represented a decrease of $5.4 million, or 46.3%, from $11.7 million as of December 31, 2020. Leases comprised $182 thousand and $1.8 million of total consumer loans and leases at December 31, 2021 and 2020, respectively.
Municipal and other loans
Municipal and other loans consist primarily of loans made to municipalities and emergency service, hospital and school districts as well as agricultural loans.
We make loans to municipalities and emergency service, hospital and school districts primarily throughout Texas. The majority of these loans have tax or revenue pledges and in some cases are additionally supported by collateral. Municipal loans made without a direct pledge of taxes or revenues are usually made based on some type of collateral that represents an essential service. Lending money directly to these municipalities allows us to earn a higher yield for similar durations than we could if we purchased municipal securities. Total loans to municipalities and emergency service, hospital and school districts and others were $57.1 million and $65.4 million as of December 31, 2021 and 2020, respectively.
For a more detailed discussion of the type of loans in our loan portfolio, see “Business—Lending Activities.”
The following table summarizes the loan contractual maturity distribution by type and by related interest rate characteristics as of the date indicated:
As of December 31, 2021
One Year
or Less
After One but
Within Five Years
Five to
Fifteen
Years
After
Fifteen
Years
Total
(Dollars in thousands)
Commercial and industrial loans
Real estate:
1-4 single family residential loans
Construction, land and development loans
Commercial real estate loans (including
multifamily)
Consumer loans and leases
Municipal and other loans
Total loans held in portfolio
Predetermined (fixed) interest rates
Floating interest rates
Total
The information in the table above is limited to contractual maturities of the underlying loans. The expected life of our loan portfolio will differ from contractual maturities because borrowers may have the right to curtail or prepay their loans with or without prepayment penalties.
Asset Quality
The following table sets forth the composition of our nonperforming assets, including nonaccrual loans, accruing loans 90 days or more days past due, other real estate owned and repossessed assets and restructured loans as of the dates indicated:
For the Years Ended December 31,
Asset and Credit Quality Ratios:
Nonaccrual loans
Accruing loans 90 days or more past due
Total nonperforming loans
Other real estate owned and repossessed assets
Total nonperforming assets
Loans held for investment
Total Assets
Allowance for Loan Lease
Nonperforming loans to loans held for investment(1)
Nonperforming assets to loans plus OREO
Nonperforming assets to total assets(2)
Allowance for loan and lease losses to nonperforming loans
Allowance for loan and lease losses to loans held for investment
Net charge-offs (recoveries) to average loans:
Commercial and industrial loans
Net charge offs
Average loans
1-4 single family residential
Net charge offs (recoveries)
Average loans
Construction, land and development
Net charge offs
Average loans
Commercial real estate (including multifamily)
Net charge offs
Average loans
Consumer loans and leases
Net charge offs (recoveries)
Average loans
Municipal and other loans
Net charge offs (recoveries)
Average loans
Total loans held in portfolio
Net charge offs
Average loans
Performing troubled debt restructurings represent the balance at the end of the respective period for those performing loans modified in a troubled debt restructuring that are not already presented as a nonperforming loan.
Nonperforming loans include loans on nonaccrual status and accruing loans 90 or more days past due.
Nonperforming assets include loans on nonaccrual status, accruing loans 90 days or more past due and other real estate owned and repossessed assets.
Nonperforming loans tot aled $ 5.1 million at December 31, 20 2 1 , a decrease of $ 3.5 million , or 67.0 %, from $ 8.6 million at December 31, 20 20 . N on performing assets totaled $ 5.3 million at December 31, 20 2 1 , a de crease of $ 3.4 million, or 38.9 %, from $ 8.7 million at December 31, 20 20 . This decrea s e was primarily due to charge offs on previously impaired loans .
We classify loans as past due when the payment of principal or interest is greater than 30 days delinquent based on the contractual next payment due date. Our policies related to when loans are placed on nonaccrual status conform to guidelines prescribed by bank regulatory authorities. Loans are placed on nonaccrual status when it is probable that principal or interest is not fully collectible, or when principal or interest becomes 90 days past due, whichever occurs first. Loans are removed from nonaccrual status when they become current as to both principal and interest and concern no longer exists as to the collectability of principal and interest.
Loans are identified for restructuring based on their delinquency status, risk rating downgrade, or at the request of the borrower. Borrowers that are 90 days delinquent and/or have a history of being delinquent, or experience a risk rating downgrade, are contacted to discuss options to bring the loan current, cure credit risk deficiencies, or other potential restructuring options that will reduce the inherent risk and improve collectability of the loan. In some instances, a borrower will initiate a request for loan restructure. We require borrowers to provide current financial information to establish the need for financial assistance and satisfy applicable prerequisite conditions required by us. We may also require the borrower to enter into a forbearance agreement.
Modification of loan terms may include the following: reduction of the stated interest rate; extension of maturity date or other payment dates; reduction of the face amount or maturity amount of the loan; reduction in accrued interest; forgiveness of past-due interest; or a combination of the foregoing.
We engage an external consulting firm to complete an independent loan review and validate our credit risk program on a periodic basis. Results of these reviews are presented to management. The loan review process complements and reinforces the risk ratings and credit quality assessment decisions made by lenders and credit personnel, as well as our policies and procedures.
Throughout the year ended December 31, 2021, certain borrowers were unable to meet their contractual payment obligations because of the effects of the ongoing COVID-19 pandemic. In an effort to mitigate the adverse effects of the COVID-19 pandemic on our loan customers, we have provided certain customers the opportunity to defer payments, or portions thereof, for up to 90 days, should they so request. As of December 31, 2021, we had $13.9 million of loans with active COVID-related deferrals, all of which the Company expects to return to active payment status at the end of their respective deferral periods. In the absence of other intervening factors, such short-term modifications made on a good faith basis are not categorized as troubled debt restructurings, nor are loans granted payment deferrals related to the COVID-19 pandemic reported as past due or placed on non-accrual status (provided the loans were not past due or on non-accrual status prior to the deferral. We continue to monitor industries that have experienced more lasting effects from the COVID-19 pandemic. At December 31, 2021 no alterations were made to the allowance for loan loss calculation specifically for any industry.
For a more detailed discussion of nonperforming loans, see “Business—Lending Activities—Nonperforming Loans.”
Analysis of the Allowance for Loan and Lease Losses
Allowance for loan and lease losses reflects management’s estimate of probable credit losses inherent in the loan portfolio. The computation of the allowance for loan and lease losses includes elements of judgment and high levels of subjectivity.
In determining the allowance for loan and lease losses, we estimate losses on specific loans, or groups of loans, where the probable loss can be identified and reasonably determined. The balance of the allowance for loan and lease losses is based on internally assigned risk classifications of loans, historical loan loss rates, changes in the nature of the loan portfolio, overall portfolio quality, industry concentrations, delinquency trends, current economic factors and the estimated impact of current economic conditions on certain historical loan loss rates.
On November 14, 2018, we closed the Comanche acquisition. At the date of acquisition, Comanche had $117.2 million in loans. In accordance with ASC 805 , “ Business Combinations ” , we utilized a third party to value the loan portfolio as of the acquisition date. Based upon the third party valuation, the fair value of the loans was approximately $116. 2 million at the acquisition date. The overall discount calculated was $946 thousand and is being accreted into interest inc ome over the life of the loans.
On April 2, 2019, we completed the acquisition of First Beeville Financial Corporation and its subsidiary, The First National Bank of Beeville. At the date of acquisition, Beeville had $298.9 million in loans. Based upon a third party valuation the fair value of the loan portfolio was approximately $296.4 million. The overall discount calculated was $2.5 million and is being accreted into interest income over the life of the loans.
On November 5, 2019, the Company completed its acquisition of Chandler Bancorp Inc. and its subsidiary, Citizens State Bank. At the date of acquisition, Citizens had $253.1 million in loans. Based upon a third party valuation the fair value of the loan portfolio was approximately $252.0 million. The overall discount calculated was $1.1 million and is being accreted into interest income over the life of the loans.
On February 28, 2020, the Company completed its acquisition of certain assets and assumption of certain liabilities associated with five branch offices of Simmons Bank. At the date of acquisition, Simmons had $260.3 million in loans. Based upon a third party valuation the fair value of the loan portfolio was approximately $255.5 million. The overall discount calculated was $4.8 million and is being accreted into interest income over the life of the loans.
Purchased credit impaired loans related to the Comanche acquisition were insignificant, and the Bank did no t identify any purchased credit impaired loans related to the Beeville acquisition or the Simmons branch acquisition. Management identified purchased credit impaired loans related to the Citizens of approximately $ 3.2 million and estimated that expected cash flows were equal to contractual cash flows at the acquisition date. The remaining recorded investment in purchased credit impaired loans related to the Citizens acquisition was $455 thousand at December 31, 2021 and the Company believes that all contractual principal and interest will be received.
The allowance for loan and lease losses increased $369 thousand to $16.4 million at December 31, 2021 from $16.0 million at December 31, 2020, primarily due to organic loan growth. The allowance for loan and lease losses as a percentage of nonperforming loans and allowance for loan and lease losses as a percentage of loans held for investment was 318.4% and 0.71%, respectively, as of December 31, 2021, compared to 186.4% and 0.67%, respectively, as of December 31, 2020.
Net loan charge-offs for the year ended December 31, 2021 totaled $3.3 million, an increase from $2.4 million of net loan charge-offs for the same period of 2020. The increase in net charge-offs for the year ended December 31, 2021 primarily related to charge-offs in our SBA loan portfolio. The ratio of net loan charge-offs to average loans outstanding during the years ended December 31, 2021 and 2020 was 0.14% and 0.09%, respectively.
The following table provides the allocation of the allowance for loan and lease losses as of the dates presented:
As of December 31,
Amount
% Loans
in each
category
Amount
% Loans
in each
category
Commercial and industrial loans
Real estate:
1-4 single family residential loans
Construction, land and development loans
Commercial real estate loans (including multifamily)
Consumer loans and leases
Municipal and other loans
Ending allowance balance
Bank-owned Life Insurance (“BOLI”)
BOLI policies are held in order to insure key, active employees and former directors the Bank. Policies are recorded at the cash surrender value adjusted for other charges or other amounts due that are probable at settlement, if applicable.
The following table summarizes the changes in the cash surrender value of BOLI for the periods presented:
For the Years Ended December 31,
(Dollars in thousands)
Balance at beginning of period
Additions from premium payments
Net gain in cash surrender value
Balance at end of period
As of December 31, 2021 and 2020, the BOLI cash surrender value was $36.6 million and $16.0 million, respectively. We recognized $675 thousand, $359 thousand and $306 thousand of BOLI income for the years ended December 31, 2021, 2020 and 2019, respectively. The total death benefit of the BOLI policies at December 31, 2021 was $80.7 million.
Deposits
We expect deposits to be our primary funding source in the future as we optimize our deposit mix by continuing to shift our deposit composition from higher cost time deposits to lower cost demand deposits. Non-time deposits include demand deposits, NOW accounts, and savings and money market accounts.
The following table shows the deposit mix as of the dates presented:
As of December 31,
Amount
Total
Amount
Total
(Dollars in thousands)
Noninterest-bearing demand deposits
Interest-bearing demand deposits
Interest-bearing NOW accounts
Savings and money market accounts
Time deposits
Total deposits
Total deposits at December 31, 2021 were $2.78 billion, an increase of $323.3 million, or 13.1%, from total deposits at December 31, 2020 of $2.46 billion.
The average cost of deposits for the year ended December 31, 2021 was 0.30%. This represents a decrease of 34 basis points compared to the average cost of deposits of 0.64% for the year ended December 31, 2020. The decrease in cost of deposits was primarily attributable to the decrease in interest rates by the Federal Open Market Committee during the year ended December 31, 2020. For the year ended December 31, 2021, the average rate paid on time deposits was 0.75% compared to 1.54% for the year ended December 31, 2020.
Total deposits that exceeded the FDIC insurance limit of $250 thousand at December 31, 2021 were $1.2 billion. The maturities of time deposits that exceeded the FDIC insurance limit of $250 thousand at December 31, 2021 are as follows:
As of December 31,
(Dollars in thousands)
Three months or less
After three months through six months
After six months through twelve months
After twelve months
Total time deposits in excess of FDIC insurance limit
Borrowings
In addition to deposits, we utilize advances from the FHLB and other borrowings as a supplementary funding source to finance our operations.
FHLB borrowings : The FHLB allows us to borrow, both short and long-term, on a blanket floating lien status collateralized by certain securities and loans. As of December 31, 2021 and 2020, total remaining borrowing capacity of $841.9 million and $654.9 million, respectively, was available under this arrangement. As of December 31, 2021 we had no short-term FHLB borrowings. As of December 31, 2020, we had short-term FHLB borrowings of $10 million, with an average interest rate of 0.70%. We had long-term FHLB borrowings of $38.5 million and $51.9 million as of December 31, 2021 and 2020, respectively, with an average interest rate of 2.44% and 2.29%, respectively.
PPPLF: In conjunction with the PPP, we also participated in the Federal Reserve's PPPLF, which expired on July 30, 2021. At December 31, 2021, all amounts outstanding under PPPLF had been repaid compared to $149.8 million outstanding at December 31, 2020. The maturity date of a borrowing under the PPPLF was equal the maturity date of the PPP loan pledged to secure the borrowing and would be accelerated (i) if the underlying PPP loan goes into default and is sold to the SBA to realize on the SBA guarantee or (ii) to the extent that any PPP loan forgiveness reimbursement is received from the SBA. Borrowings under the PPPLF bear interest at a rate of 0.35% and there were no fees to us.
Subordinated Notes: On July 24, 2020, the Company issued $37 million aggregate principal amount of 6.00% fixed-to-floating rate subordinated notes due 2030. The Notes will initially bear interest at a fixed annual rate of 6.00%, payable quarterly, in arrears, to, but excluding, July 31, 2025. From and including July 31, 2025, to, but excluding, the maturity date or earlier redemption date, the interest rate will reset quarterly to an interest rate per annum equal to a benchmark rate, which is expected to be the then-current three-month Secured Overnight Financing Rate, as published by the Federal Reserve Bank of New York (provided, that in the event the benchmark rate is less than zero, the benchmark rate will be deemed to be zero) plus 592 basis points, payable quarterly, in arrears. The amount outstanding at December 31, 2021 and 2020 was $37.0 million .
Secured borrowings : Due to the rights retained on certain loan participations sold, the Company is deemed to have retained effective control over these loans under ASC Topic 860, “Transfers and Servicing”, and therefore these participations sold must be accounted for as a secured borrowing. At December 31, 2021, the Company had no secured borrowings. At December 31, 2020, total secured borrowings were $4.0 million representing an increase in loans held for investment and matching increase in long-term borrowings.
Line of credit : We entered into a line of credit with a third party lender in May 2017 that allows us to borrow up to $20 .0 million. The interest rate on this line of credit is based upon 90-day LIBOR plus 4.0%, and unpaid principal and interest is due at the stated maturity of May 12, 2022. This line of credit is secured by a pledge of all of the common stock of the Bank. This line of credit may be prepaid at any time without penalty, so long as such prepayment includes the payment of all interest accrued through the date of the repayments, and, in the case of prepayment of the entire loan, the amount of attorneys’ fees and disbursements of the lender. During 2019, the line of credit was increased to a total borrowing capacity of $50.0 million all of which wa s available at December 31, 202 1 and at December 31, 20 20 .
Total borrowings consisted of the following as of the dates presented:
As of December 31,
(Dollars in thousands)
Short-term FHLB borrowings
Long-term FHLB borrowings
PPPLF
Subordinated Notes
Secured borrowings
Total borrowings
At December 31, 2021, total borrowings were $74.9 million, a decrease of $177.1 million, or 70.3%, from $252.0 million at December 31, 2020. The decrease in total borrowings was primarily driven by repayment of Paycheck Protection Program Liquidity Facility advances.
Short-term borrowings consist of debt with maturities of one year or less. Our short-term borrowings consist of FHLB borrowings and a third party line of credit. The following table is a summary of short-term borrowings as of and for the periods presented:
As of and for the years ended
December 31,
(Dollars in thousands)
Short-term borrowings:
Maximum outstanding at any month-end during the period
Balance outstanding at end of period
Average outstanding during the period
Average interest rate during the period
Average interest rate at the end of the period
We maintained five, unsecured Federal Funds lines of credit with commercial banks which provide for extensions of credit with an availability to borrow up to an aggregate $115.0 million as of December 31, 2021. We maintained five, unsecured Federal Funds lines of credit with commercial banks with an availability to borrow up to an aggregate $105.0 million as of December 31, 2020. There were no advances under these lines of credit outstanding as of December 31, 2021 or 2020.
Stockholders’ Equity
The following table summarizes the changes in our stockholders’ equity for the periods indicated:
Years Ended December 31,
(Dollars in thousands)
Balance at beginning of period
Net income
Common stock dividends declared ($0.42 and $0.16 per share, respectively)
Shares issued in offering, net(1)
Shares issued in business combination
Exercise of stock options and warrants
Stock-based compensation
Treasury Stock Purchases
Other comprehensive income (loss)
Balance at end of period
Shares issued in offering were net of expenses of $442 thousand for 2019.
Net income totaled $42.1 million for the year ended December 31, 2021, an increase of $10.7 million, compared to $31.3 million for the year ended December 31, 2020. Our results of operations for the year ended December 31, 2021, produced a return on average assets of 1.13% compared to 1.11% for the prior year. Our results of operations for the year ended December 31, 2021 produced a return on average stockholders’ equity of 9.25% compared to 8.98% for the prior year.
Stockholders’ equity was $393.8 million as of December 31, 2021, an increase of $33.0 million from $360.8 million as of December 31, 2020. The increase was primarily driven by net income of $42.1 million offset by dividends of $7.2 million and other comprehensive loss of $5.1 million.
Net income totaled $31.3 million for the year ended December 31, 2020, an increase of $10.2 million, compared to $21.1 million for the year ended December 31, 2019. Our results of operations for the year ended December 31, 2020 produced a return on average assets of 1.11% compared to 1.14% for the prior year. Our results of operations for the year ended December 31, 2020 produced a return on average stockholders’ equity of 8.98% compared to 8.38% for the prior year.
Stockholders’ equity was $360.8 million as of December 31, 2020, an increase of $15.1 million from $345.7 million as of December 31, 2019. The increase was primarily driven by net income of $31.3 million offset by share repurchases of $15.5 million.
Capital Resources and Liquidity
Capital Resources
We are required to comply with certain “risk-based” capital adequacy guidelines issued by the Federal Reserve and the FDIC. The risk-based capital guidelines assign varying risk weights to the individual assets held by a bank. The guidelines also assign weights to the “credit-equivalent” amounts of certain off-balance sheet items, such as letters of credit and interest rate and currency swap contracts.
Under the Basel III Capital Rules, we are required to maintain the following minimum capital to risk-adjusted assets requirements: (i) a common equity tier 1 capital ratio of 4.5% (6.5% to be considered “well capitalized”); (ii) a tier 1 capital ratio of 6.0% (8.0% to be considered “well capitalized”), and (iii) a total capital ratio of 8.0% (10.0% to be considered “well capitalized”). Under the Basel III rules there is a requirement for a common phased-in equity tier 1 capital conservation buffer of 2.5% of risk-weighted assets which is in addition to the other minimum risk-based capital standards in the rule. Institutions that do not maintain this required capital buffer will become subject
to progressively more stringent limitations on the percentage of earnings that can be paid out in dividends or used for stock repurchases and on the payment of discretionary bonuses to senior executive management. The capital buffer requirement effectively raises the minimum required common equity tier 1 capital ratio to 7.0%, the tier 1 capital ratio to 8.5%, and the total capital ratio to 10. 5% on a fully phased-in basis as of January 1, 2019.
The risk-based capital ratios measure the adequacy of a bank’s capital against the riskiness of its assets and off-balance sheet activities. Failure to maintain adequate capital is a basis for “prompt corrective action” or other regulatory enforcement action. In assessing a bank’s capital adequacy, regulators also consider other factors such as interest rate risk exposure; liquidity, funding and market risks; quality and level of earnings; concentrations of credit, quality of loans and investments; risks of any nontraditional activities; effectiveness of bank policies; and management’s overall ability to monitor and control risks.
The following table sets forth the regulatory capital ratios, excluding the impact of the capital conservation buffer, as of the dates indicated:
Minimum
Capital
Requirement
Minimum
Capital
Requirement
with
Capital
Buffer
Minimum
to Be Well
Capitalized
December 31,
Capital ratios (Company):
Tier 1 leverage ratio
Common equity tier 1 capital ratio
Tier 1 risk-based capital ratio
Total risk-based capital ratio
Capital ratios (Bank):
Tier 1 leverage ratio
Common equity tier 1 capital ratio
Tier 1 risk-based capital ratio
Total risk-based capital ratio
At December 31, 2021, both we and the Bank met all the capital adequacy requirements to which we and the Bank were subject. At December 31, 2021, the Bank was “well capitalized” under the regulatory framework for prompt corrective action. Management believes that no conditions or events have occurred since December 31, 2020 that would materially adversely change such capital classifications. From time to time, we may need to raise additional capital to support our and the Bank’s further growth and to maintain our “well capitalized” status.
As of December 31, 2021, we had a tier 1 leverage ratio of 10.64 %. As of December 31, 2021, the Bank had a tier 1 leverage ratio of 10.65%, which provided $178.9 million of excess capital relative to the minimum requirements to be considered well capitalized.
For a discussion of the changes in our total stockholders’ equity at December 31, 2021 as compared with December 31, 2020, please see the discussion under “—Stockholders’ Equity” above.
Liquidity
Liquidity involves our ability to raise funds to support asset growth and acquisitions or reduce assets to meet deposit withdrawals and other payment obligations, to maintain reserve requirements and otherwise to operate on an ongoing basis and manage unexpected events. For the years ended December 31, 2021 and 2020, our liquidity needs were primarily met by core deposits, security and loan maturities and amortizing investment and loan portfolios. Although access to brokered deposits, purchased funds from correspondent banks and overnight advances from the FHLB are available and have been utilized on occasion to take advantage of investment opportunities, we do not generally rely on these external funding sources. The Bank maintained five unsecured Federal Funds lines of credit
with commercial banks which provide for extensions of credit with an availability to borrow up to an aggregate $ 115.0 million as of December 31, 202 1 . We maintained five , unsecured Federal Funds lines of credit with commercial banks with an availability to borrow up to an aggregate $ 105.0 million as of December 31, 20 20 . The Company drew $ 10 million on the line of credit during the year ended December 31, 20 20 to fund general corporate needs and repaid the outstanding amount plus interest in July 20 20 . There were no advances under these lines of credit outstanding as of December 31, 202 1 or 2019 .
The following table illustrates, during the periods presented, the mix of our funding sources and the average assets in which those funds are invested as a percentage of our average total assets for the periods indicated. Average assets were $3.15 billion for the year ended December 31, 2021 and $2.82 billion for the year ended December 31, 2020.
As of and for the Years Ended
December 31,
Sources of funds:
Deposits:
Noninterest-bearing
Interest-bearing
Advances from FHLB and other borrowings
Other liabilities
Stockholders' equity
Total
Uses of funds:
Loans
Investment securities and other
Interest-bearing deposits in other banks
Other noninterest-earning assets
Total
Average noninterest-bearing deposits to average deposits
Average loans to average deposits
Our primary source of funds is deposits and our primary use of funds is loans. We do not expect a change in the primary source or use of our funds in the foreseeable future. Our average loans, including loans held for sale, increased 2.6% for the year ended December 31, 2021 compared to the year ended December 31, 2020. We predominantly invest excess deposits in overnight deposits with the Federal Reserve, securities, interest-bearing deposits at other banks or other short-term liquid investments until needed to fund loan growth. Our securities portfolio had a weighted average life of 5.3 years and an effective duration of 4.7 years as of December 31, 2021.
In the normal course of business, we enter into various transactions, which, in accordance with GAAP, are not included on our consolidated balance sheets. We enter into these transactions to meet the financing needs of our customers. These transactions include commitments to extend credit and commercial and standby letters of credit, which involve, to varying degrees, elements of credit risk and interest rate risk in excess of the amounts recognized on our consolidated balance sheets.
We enter into contractual loan commitments to extend credit, normally with fixed expiration dates or termination clauses, at specified rates and for specific purposes. Since a portion of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent our future cash requirements. Substantially all of our commitments to extend credit are contingent upon customers maintaining specific credit standards until the time of loan funding. We seek to minimize our exposure to loss under these commitments by subjecting them to prior credit approval and ongoing monitoring procedures. We assess the credit risk associated with certain commitments to extend credit and establish a liability for probable credit losses. As of December 31, 2021 and 2020, our reserve for unfunded commitments totaled $76 thousand and $90 thousand, respectively.
Commercial and standby letters of credit are written conditional commitments issued by us to guarantee the performance of a customer to a third party. In the event the customer does not perform in accordance with the terms of the agreement with the third party, we would be required to fund the commitment. The maximum potential amount of future payments we could be required to make is represented by the contractual amount of the commitment. If the commitment is funded, we would be entitled to seek recovery from the customer. Our policies generally require that standby letter of credit arrangements contain security and debt covenants similar to those contained in loan agreements.
The following table summarizes our commitments as of the dates presented:
December 31,
(Dollars in thousands)
Unfunded loan commitments
Commercial and standby letters of credit
Total
Management believes that we have adequate liquidity to meet all known contractual obligations and unfunded commitments, including loan commitments over the next twelve months. Additionally, management believes that our off-balance sheet arrangements have not had or are not reasonably likely to have a current or future material effect on our financial condition, revenues, expenses, results of operations, liquidity, capital expenditures or capital resources.
As of December 31, 2021, we had outstanding $550.6 million in commitments to extend credit and $3.4 million in commitments associated with outstanding commercial and standby letters of credit. Since commitments associated with letters of credit and commitments to extend credit may expire unused, the total outstanding may not necessarily reflect the actual future cash funding requirements.
As of December 31, 2021, we believe we had no exposure to future cash requirements associated with known uncertainties. Capital expenditures, including buildings and construction in process, for the years ended December 31, 2021 and 2020 were $2.0 million and $10.2 million, respectively.
We had cash and cash equivalents of $305.8 million and $263.0 million as of December 31, 2021 and 2020, respectively. The increase was primarily due to PPP loan forgiveness received during the year ended December 31, 2021.
Interest Rate Sensitivity and Market Risk
As a financial institution, our primary component of market risk is interest rate volatility. Our asset liability and funds management policy provides management with the guidelines for effective funds management, and we have established a measurement system for monitoring our net interest rate sensitivity position. We manage our sensitivity position within our established guidelines.
Fluctuations in interest rates will ultimately impact both the level of income and expense recorded on most of our assets and liabilities, and the market value of all interest-earning assets and interest-bearing liabilities, other than those which have a short term to maturity. Interest rate risk is the potential for economic losses due to future interest rate changes. These economic losses can be reflected as a loss of future net interest income and/or a loss of current fair market values. The objective is to measure the effect on net interest income and to adjust the balance sheet to minimize the inherent risk while at the same time maximizing income.
We manage our exposure to interest rates by structuring our balance sheet in the ordinary course of business. We do not enter into instruments such as leveraged derivatives, interest rate swaps, financial options, financial future contracts or forward delivery contracts for the purpose of reducing interest rate risk. Based upon the nature of our operations, we are not subject to foreign exchange or commodity price risk. We do not own any trading assets.
Our exposure to interest rate risk is managed by the Asset-Liability Management Committee of the Bank in accordance with policies approved by its board of directors. The committee formulates strategies based on appropriate levels of interest rate risk. In determining the appropriate level of interest rate risk, the committee
considers the impact on earnings and capital of the current outlook on interest rates, potential changes in interest rates, regional economies, liquidity, business strategies and other factors. The committee meets regularly to review, among other things, the sensitivity of assets and liabilities to interest rate changes, the book and market values of assets and liabilities, unrealized gains and losses, purchase and sale activities, commitments to originate loans and the maturities of investments and borrowings. Additionally, the committee reviews liquidity, cash flow flexibility, maturities of deposits and consumer and commercial deposit activity. Management employs methodologies to manage interest rate risk which include an analysis of relationships between interest-earning assets and interest-bearing liabilities, and an interest rate shock simulation model.
We use interest rate risk simulation models and shock analysis to test the interest rate sensitivity of net interest income and fair value of equity, and the impact of changes in interest rates on other financial metrics. Contractual maturities, prepayment assumptions and repricing opportunities of loans are incorporated in the model as are prepayment assumptions, maturity data and call options within the investment portfolio. Average life of our non-maturity deposit accounts are based on standard regulatory decay assumptions and are incorporated into the model. The assumptions used are inherently uncertain and, as a result, the model cannot precisely measure future net interest income or precisely predict the impact of fluctuations in market interest rates on net interest income. Actual results will differ from the model’s simulated results due to timing, magnitude and frequency of interest rate changes as well as changes in market conditions and the application and timing of various management strategies.
On a quarterly basis, we run two simulation models including a static balance sheet and dynamic growth balance sheet. These models test the impact on net interest income and fair value of equity from changes in market interest rates under various scenarios. Under the static and dynamic growth models, rates are shocked instantaneously and ramped rate changes over a 12-month horizon based upon parallel and non-parallel yield curve shifts. Parallel shock scenarios assume instantaneous parallel movements in the yield curve compared to a flat yield curve scenario. Non-parallel simulation involves analysis of interest income and expense under various changes in the shape of the yield curve. Internal policy regarding internal rate risk simulations currently specifies that for instantaneous parallel shifts of the yield curve, estimated net income at risk for the subsequent one-year period should not decline by more than 5.0% for a 100 basis point shift, 10.0% for a 200 basis point shift, and 15.0% for a 300 basis point shift.
The following table summarizes the simulated change in net interest income over a 12-month horizon:
December 31,
Change in interest rates (basis points)
% Change
in Net
Interest Income
Base
The following table summarizes an immediate shock in the fair value of equity as of the date indicated:
December 31,
Change in interest rates (basis points)
% Change
in Fair
Value of Equity
Base
The results are primarily due to behavior of demand, money market and savings deposits during such rate fluctuations. We have found that, historically, interest rates on these deposits change more slowly than changes in
the discount and federal funds rates. This assumption is incorporated into the simulation model and is generally not fully reflected in a gap analysis. The assumptions incorporated into the model are inherently uncertain and, as a result, the model cannot precisely measure future net interest income or precisely predict the impact of fluctuations in market interest rates on net interest income. Actual results will differ from the model’s simulated results due to timing, magnitude and frequency of interest rate changes as well as changes in market conditions and the application and timing of various strategies.
Some of our financial instruments are currently tied to LIBOR. LIBOR is a benchmark interest rate referenced in a variety of agreements that are used by numerous entities. On March 5, 2021, the U.K. Financial Conduct Authority (“FCA”) announced that the majority of LIBOR rates will no longer be published after December 31, 2021, although a number of key settings will continue until June 2023, to support the rundown of legacy contracts only. As a result, LIBOR should be discontinued as a reference rate. Other interest rates used globally could also be discontinued for similar reasons.
In response to reference rate reform, the Company formed a LIBOR Transition Team in 2020, has created standard LIBOR replacement language for new and modified loan notes, and is monitoring the remaining loans with LIBOR rates monthly to ensure progress in updating these loans with acceptable LIBOR replacement language or converting them to other interest rates. The Company has not been offering LIBOR-indexed rates originated by other banks, subject to the Company’s determination that the LIBOR replacement language in the loan documents meets the Company’s standards. Pursuant to the Interagency Statement on LIBOR Transition issued in November 2020, the Company will not enter into any new LIBOR-based credit agreements after December 31, 2021.
Impact of Inflation
Our consolidated financial statements and related notes included elsewhere in this Annual Report on Form 10-K have been prepared in accordance with GAAP. These require the measurement of financial position and operating results in terms of historical dollars, without considering changes in the relative value of money over time due to inflation or recession.
Unlike many industrial companies, substantially all of our assets and liabilities are monetary in nature. As a result, interest rates have a more significant impact on our performance than the effects of general levels of inflation. Interest rates may not necessarily move in the same direction or in the same magnitude as the prices of goods and services. However, other operating expenses do reflect general levels of inflation.
Non-GAAP Financial Measures
Our accounting and reporting policies conform to GAAP, and the prevailing practices in the banking industry. However, we also evaluate our performance based on certain additional financial measures discussed in this Annual Report on Form 10-K as being non-GAAP financial measures. We classify a financial measure as being a non-GAAP financial measure if that financial measure excludes or includes amounts, or is subject to adjustments that have the effect of excluding or including amounts, that are included or excluded, as the case may be, in the most directly comparable measure calculated and presented in accordance with GAAP as in effect from time to time in the United States in our statements of income, balance sheets or statements of cash flows. Non-GAAP financial measures do not include operating and other statistical measures or ratios or statistical measures calculated using exclusively financial measures calculated in accordance with GAAP.
The non-GAAP financial measures that we discuss in this Annual Report on Form 10-K should not be considered in isolation or as a substitute for the most directly comparable or other financial measures calculated in accordance with GAAP. Moreover, the manner in which we calculate the non-GAAP financial measures that we discuss in this Annual Report on Form 10-K may differ from that of other banking organizations reporting measures with similar names. You should understand how such other banking organizations calculate their financial measures similar or with names similar to the non-GAAP financial measures we have discussed in this Annual Report on Form 10-K when comparing such non-GAAP financial measures.
Adjusted Earnings per Common Share – Basic and Diluted
Adjusted earnings per common share – basic and diluted is a non-GAAP financial measure that excludes gains on security sales, merger related expenses, and non-recurring tax benefits related to recently enacted legislation. In our judgment, the adjustments made to net income allow investors and analysts to better assess our basic and diluted earnings per common share by removing the volatility that is associated with items that are unrelated to our core business.
The following table reconciles, as of the date set forth below, basic and diluted earnings per common share and presents our basic and diluted earnings per common share exclusive of the impact of non-core transactions:
As of or for the Years Ended December 31,
(Dollars in thousands, except per share data)
Basic and diluted earnings per share - GAAP basis:
Net income
Less:
Participated securities share of undistributed earnings
Net income available to common stockholders
Weighted average number of common shares - basic
Weighted average number of common shares - diluted
Basic earnings per common share
Diluted earnings per common share
Basic and diluted earnings per share - Non-GAAP basis:
Net income available to common stockholders
Pre-tax adjustments:
Noninterest income
Gain on sale of investment securities
Noninterest expense
Merger related expenses
Taxes:
NOL carryback claim
Tax effect of adjustments
Adjusted net income
Weighted average number of common shares - basic
Weighted average number of common shares - diluted
Basic earnings per common share
Diluted earnings per common share
Tangible Book Value Per Share
Tangible book value per share is a non-GAAP financial measure generally used by investors, financial analysts and investment bankers to evaluate financial institutions. We calculate (1) tangible book value per share as tangible equity divided by shares of common stock outstanding at the end of the respective period, and (2) tangible equity as common stockholders’ equity less goodwill and other intangible assets, net of accumulated amortization. The most directly comparable GAAP financial measure for tangible book value per share is book value per share.
We believe that this measure is important to many investors in the marketplace who are interested in changes from period to period in book value per share exclusive of changes in intangible assets. Goodwill and other intangible assets have the effect of increasing total book value while not increasing our tangible book value.
The following table reconciles, as of the dates set forth below, total stockholders’ equity to tangible equity and presents our tangible book value per share compared to our book value per share:
As of December 31,
(Dollars in thousands, except per share
data)
Total stockholders' equity
Less:
Goodwill and other intangible assets
Tangible stockholders' equity
Shares outstanding(1)
Book value per share(1)(2)
Less:
Goodwill and other intangible assets per share(1)(3)
Tangible book value per share
Reflects the issuance of 170,236 shares of common stock to our holders of Series A preferred stock in connection with the conversion of 170,236 shares of our issued and outstanding Series A preferred stock into common stock on February 23, 2017 and the one-for-two reverse stock split that occurred on March 16, 2017.
We calculate book value per share as total stockholders’ equity at the end of the relevant period divided by the outstanding number of shares of our common stock at the end of the relevant period.
We calculate goodwill and other intangible assets per share as total goodwill and other intangible assets at the end of the relevant period divided by the outstanding number of shares of our common stock at the end of the relevant period.
Tangible Equity to Tangible Assets
Tangible equity to tangible assets is a non-GAAP financial measure generally used by investors, financial analysts and investment bankers to evaluate financial institutions. We calculate tangible equity, as described above in “—Tangible Book Value Per Share”, and tangible assets as total assets less goodwill and core deposit intangibles and other intangible assets, net of accumulated amortization. The most directly comparable GAAP financial measure for tangible equity to tangible assets is total common stockholders’ equity to total assets.
We believe that this measure is important to many investors in the marketplace who are interested in the relative changes from period to period in common equity and total assets, each exclusive of changes in intangible assets. Goodwill and other intangible assets have the effect of increasing both total stockholders’ equity and assets while not increasing our tangible equity or tangible assets.
The following table reconciles, as of the dates set forth below, total stockholders’ equity to tangible equity and total assets to tangible assets:
As of December 31,
(Dollars in thousands)
Total stockholders' equity to total assets - GAAP basis:
Total stockholders' equity (numerator)
Total assets (denominator)
Total stockholders' equity to total assets
Tangible equity to tangible assets - Non-GAAP basis:
Tangible equity:
Total stockholders' equity
Less:
Goodwill and other intangible assets
Total tangible common equity (numerator)
Tangible assets:
Total assets
Less:
Goodwill and other intangible assets
Total tangible assets (denominator)
Tangible equity to tangible assets
Net Interest Margin
We show net interest margin on a fully taxable equivalent basis, which is a non-GAAP financial measure.
We believe the fully tax equivalent basis is the preferred industry measurement basis for net interest margin and that it enhances comparability of net interest income arising from taxable and tax-exempt sources.
The following table reconciles, as of the dates set forth below, net interest margin on a fully taxable equivalent basis:
As of and for the Years Ended
December 31,
(Dollars in thousands)
Net interest margin - GAAP basis:
Net interest income
Average interest-earning assets
Net interest margin
Net interest margin - Non-GAAP basis:
Net interest income
Plus:
Impact of fully taxable equivalent adjustment
Net interest income on a fully taxable equivalent basis
Average interest-earning assets
Net interest margin on a fully taxable equivalent basis -
Non-GAAP basis
Critical Accounting Policies and Estimates
Our financial reporting and accounting policies conform to GAAP. The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
Our accounting policies and estimates are described in greater detail in “Note 1. Summary of Significant Accounting Policies” in the notes to our consolidated financial statements included elsewhere in this Annual Report on Form 10-K. See “Risk Factors” for a discussion of information that should be considered in connection with an investment in our securities.
We have identified the following accounting policies and estimates that, due to the difficult, subjective or complex judgments and assumptions inherent in those policies and estimates and the potential sensitivity of our financial statements to those judgments and assumptions, are critical to an understanding of our financial condition and results of operations. We believe that the judgments, estimates and assumptions used in the preparation of our financial statements are appropriate. Our accounting policies are integral to understanding our results of operations.
Allowance for Loan and Lease Losses
Management’s ongoing evaluation of the adequacy of the allowance for loan and lease losses is based on our past loan loss experience, the volume and composition of our lending, adverse situations that may affect a borrower’s ability to repay, the estimated value of any underlying collateral, current economic conditions and other factors affecting the known and inherent risk in the portfolio. The allowance for loan and lease losses is increased by charges to income through the provision for loan and lease losses and decreased by charge-offs (net of recoveries). The allowance is maintained at a level that management, based upon its evaluation, considers adequate to absorb losses inherent in the loan portfolio. This evaluation is inherently subjective as it requires material estimates including, among others, the amount and timing of expected future cash flows on impacted loans, exposure at default, value of collateral, and estimated losses on our loan portfolio. All of these estimates may be susceptible to significant change.
The allowance consists of specific allowances for impaired loans and a general allowance on the remainder of the portfolio. Although management determines the amount of each element of the allowance separately, the allowance for loan and lease losses is available for the entire loan portfolio.
Management establishes an allowance on certain impaired loans for the amount by which the discounted cash flows, observable market price, or fair value of collateral if the loan is collateral dependent, is lower than the carrying value of the loan. A loan is considered to be impaired when, based upon current information and events, it is probable that we will be unable to collect all amounts due according to the contractual terms of the loan. A delay or shortfall in amount of payments does not necessarily result in the loan being identified as impaired.
Management also establishes a general allowance on non-impaired loans to recognize the inherent losses associated with lending activities, but which, unlike specific allowances, have not been allocated to particular loans. This general valuation allowance is determined by segregating the loans by loan category and assigning allowance percentages based on our historical loss experience, delinquency trends, and management’s evaluation of the collectability of the loan portfolio.
The allowance is adjusted for significant factors that, in management’s judgment, affect the collectability of the portfolio as of the evaluation date. These significant factors may include changes in lending policies and procedures, changes in existing general economic and business conditions affecting its primary lending areas, credit quality trends, collateral value, loan volumes and concentrations, seasoning of the loan portfolio, loss experience in particular segments of the portfolio, duration of the current business cycle, and bank regulatory examination results. The applied loss factors are re-evaluated each reporting period to ensure their relevance in the current economic environment.
While management uses the best information known to it in order to make loan loss allowance valuations, adjustments to the allowance may be necessary based on changes in economic and other conditions, changes in the composition of the loan portfolio, or changes in accounting guidance. In times of economic slowdown, either regional or national, the risk inherent in the loan portfolio could increase resulting in the need for additional provisions to the allowance for loan and lease losses in future periods. An increase could also be necessitated by an increase in the size of the loan portfolio or in any of its components even though the credit quality of the overall portfolio may be improving. Historically, the estimates of the allowance for loan and lease losses have provided adequate coverage against actual losses incurred.
Goodwill and Other Intangible Assets
Goodwill represents the excess of consideration transferred in business combinations over the fair value of tangible and identifiable intangible assets acquired. Goodwill is assessed annually for impairment or more frequently if events or circumstances indicate that impairment may have occurred.
Goodwill acquired in a purchase business combination that is determined to have an indefinite useful life, is not amortized, but tested for impairment as described above. We perform our annual impairment test in the fourth quarter. Goodwill is the only intangible asset with an indefinite life on our balance sheet.
Core deposit intangible (“CDI”) is a measure of the value of checking and savings deposit relationships acquired in a business combination. The fair value of the CDI stemming from any given business combination is based on the present value of the expected cost savings attributable to the core deposit funding relative to an alternative source of funding. CDI is amortized over the estimated useful lives of the existing deposit relationships acquired, but does not exceed 12 years. We evaluate such identifiable intangibles for impairment when events and circumstances indicate that its carrying amount may not be recoverable.
Income Taxes
Management makes estimates and judgments to calculate various tax liabilities and determine the recoverability of various deferred tax assets, which arise from temporary differences between the tax and financial statement recognition of revenues and expenses. Management also estimates a reserve for deferred tax assets if, based on the available evidence, it is more likely than not that some portion or all of the recorded deferred tax assets will not be realized in future periods. These estimates and judgments are inherently subjective. Historically, management’s estimates and judgments to calculate the deferred tax accounts have not required significant revision.
In evaluating our ability to recover deferred tax assets, management considers all available positive and negative evidence, including the past operating results and forecasts of future taxable income. In determining future taxable income, management makes assumptions for the amount of taxable income, the reversal of temporary differences and the implementation of feasible and prudent tax planning strategies. These assumptions require management to make judgments about the future taxable income and are consistent with the plans and estimates used to manage the business. Any reduction in estimated future taxable income may require management to record a valuation allowance against the deferred tax assets. An increase in the valuation allowance would result in additional income tax expense in the period and could have a significant impact on future earnings.
SBA Servicing Asset
A servicing asset related to SBA loans is initially recorded when these loans are sold and the servicing rights are retained. The servicing asset is recorded on the balance sheet. An updated fair value of the servicing asset is obtained from an independent third party on a quarterly basis and any necessary adjustments are included in SBA loan servicing fees on the consolidated statements of income. The valuation begins with the projection of future cash flows for each asset based on their unique characteristics, market-based assumptions for prepayment speeds and estimated losses and recoveries. The present value of the future cash flows are then calculated utilizing market-based discount ratio assumptions. In all cases, we model expected payments for every loan for each quarterly period in order to create the most detailed cash flow stream possible. We use various assumptions and estimates in determining the impairment of the SBA servicing asset. These assumptions include prepayment speeds and discount rates commensurate with the risks involved and comparable to assumptions used by participants to value and bid serving rights available for sale in the market.
Recently Issued Accounting Pronouncements
See “Note 1. Summary of Significant Accounting Policies” in the notes to the consolidated financial statements included elsewhere in this Annual Report on Form 10-K regarding the impact of new accounting pronouncements which we have adopted.
