10-Q 1 brhc10037308_10q.htm 10-Q

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549



FORM 10-Q



(Mark One)

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

For the quarterly period ended March 31, 2022

OR

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

For the transition period from ______ to ______

Commission File Number: 001-38895



South Plains Financial, Inc.
(Exact name of registrant as specified in its charter)

 Texas
 
75-2453320
(State or other jurisdiction of incorporation or organization)
 
(I.R.S. Employer Identification No.)
     
5219 City Bank Parkway
Lubbock, Texas
 
79407
(Address of principal executive offices)
 
(Zip Code)

Registrant’s telephone number, including area code: (806) 792-7101

Securities registered pursuant to Section 12(b) of the Act:

Title of each class
Trading Symbol(s)
Name of each exchange on which registered
Common Stock, $1.00 par value per share
SPFI
The Nasdaq Stock Market, LLC

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.     Yes      No 

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).    Yes      No 

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

Large accelerated filer
 
Accelerated filer
Non-accelerated filer
 
Smaller reporting company

     
Emerging growth company

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.

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

As of May 6, 2022, the registrant had 17,618,573 shares of common stock, par value $1.00 per share, outstanding.



TABLE OF CONTENTS

 
Page
PART I.
3
Item 1.
3
 
3
 
4
 
6
 
7
 
8
Item 2.
27
Item 3.
48
Item 4.
48
PART II.
49
Item 1.
49
Item 1A.
49
Item 2.
49
Item 3.
49
Item 4.
49
Item 5.
49
Item 6.
50
51
 
PART I. FINANCIAL INFORMATION
Item 1.
Consolidated Financial Statements

SOUTH PLAINS FINANCIAL, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Dollars in thousands, except per share data)

 
March 31,
2022
   
December 31,
2021
 
   
(Unaudited)
       
ASSETS
           
Cash and due from banks
 
$
65,717
   
$
68,425
 
Interest-bearing deposits in banks
   
462,895
     
418,396
 
Cash and cash equivalents
   
528,612
     
486,821
 
Securities available for sale
   
793,404
     
724,504
 
Loans held for sale
   
29,599
     
76,507
 
Loans held for investment
   
2,453,631
     
2,437,577
 
Allowance for loan losses
   
(39,649
)
   
(42,098
)
Loans held for investment, net
    2,413,982       2,395,479  
Accrued interest receivable
   
10,512
     
13,900
 
Premises and equipment, net
   
57,387
     
57,699
 
Bank-owned life insurance
   
72,274
     
71,978
 
Goodwill
   
19,508
     
19,508
 
Intangible assets, net
   
5,503
     
5,895
 
Mortgage servicing rights
   
25,425
     
19,700
 
Deferred tax asset, net
   
8,393
     
3,038
 
Other assets
   
35,145
     
26,826
 
Total assets
 
$
3,999,744
   
$
3,901,855
 
                 
LIABILITIES AND STOCKHOLDERS’ EQUITY
               
                 
Deposits:
               
Noninterest-bearing
 
$
1,131,215
   
$
1,071,367
 
Interest-bearing
   
2,318,942
     
2,269,855
 
Total deposits
   
3,450,157
     
3,341,222
 
Accrued expenses and other liabilities
   
40,305
     
31,038
 
Subordinated debt securities
   
75,821
     
75,775
 
Junior subordinated deferrable interest debentures
   
46,393
     
46,393
 
Total liabilities
   
3,612,676
     
3,494,428
 
                 
Stockholders’ equity:
               
Common stock, $1.00 par value per share, 30,000,000 shares authorized; 17,673,407 and 17,760,243 issued and outstanding at March 31, 2022 and December 31, 2021, respectively
   
17,673
     
17,760
 
Additional paid-in capital
   
130,618
     
133,215
 
Retained earnings
   
255,078
     
242,750
 
Accumulated other comprehensive income (loss)
   
(16,301
)
   
13,702
 
Total stockholders’ equity
   
387,068
     
407,427
 
                 
Total liabilities and stockholders’ equity
 
$
3,999,744
   
$
3,901,855
 

The accompanying notes are an integral part of these consolidated financial statements.

SOUTH PLAINS FINANCIAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
(Unaudited)
(Dollars in thousands, except per share data)

 
Three Months Ended
March 31,
 
   
2022
   
2021
 
Interest income:
           
Loans, including fees
 
$
29,378
   
$
29,280
 
Securities:
               
Taxable
   
2,376
     
2,460
 
Non-taxable
   
1,144
     
1,170
 
Federal funds sold and interest-bearing deposits in banks
   
182
     
72
 
Total interest income
   
33,080
     
32,982
 
Interest expense:
               
Deposits
   
1,890
     
2,157
 
Notes payable & other borrowings
   
     
39
 
Subordinated debt securities
   
1,012
     
1,019
 
Junior subordinated deferrable interest debentures
   
231
     
223
 
Total interest expense
   
3,133
     
3,438
 
Net interest income
   
29,947
     
29,544
 
Provision for loan losses
   
(2,085
)
   
89
 
Net interest income, after provision for loan losses
   
32,032
     
29,455
 
Noninterest income:
               
Service charges on deposit accounts
   
1,773
     
1,573
 
Income from insurance activities
   
1,570
     
1,112
 
Net gain on sales of loans
   
7,493
     
15,943
 
Bank card services and interchange fees
   
3,222
     
2,642
 
Other mortgage banking income
    6,144       2,873  
Investment commissions
   
546
     
430
 
Fiduciary fees
   
612
     
836
 
Other
   
2,337
     
1,091
 
Total noninterest income
   
23,697
     
26,500
 
Noninterest expense:
               
Salaries and employee benefits
   
22,703
     
24,318
 
Occupancy and equipment, net
   
3,737
     
3,565
 
Professional services
   
2,625
     
1,573
 
Marketing and development
   
720
     
568
 
IT and data services
   
1,053
     
1,054
 
Bank card expenses
   
1,323
     
1,049
 
Appraisal expenses
   
565
     
681
 
Other
   
5,198
     
4,249
 
Total noninterest expense
   
37,924
     
37,057
 
Income before income taxes
   
17,805
     
18,898
 
Income tax expense
   
3,527
     
3,738
 
Net income
 
$
14,278
   
$
15,160
 

The accompanying notes are an integral part of these consolidated financial statements.

SOUTH PLAINS FINANCIAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS) (CONTINUED)
(Unaudited)
(Dollars in thousands, except per share data)

 
Three Months Ended
March 31,
 
   
2022
   
2021
 
Earnings per share:
           
Basic
 
$
0.81
   
$
0.84
 
Diluted
 
$
0.78
   
$
0.82
 
                 
Net income
 
$
14,278
   
$
15,160
 
Other comprehensive loss:
               
Unrealized losses on securities available for sale
   
(44,877
)
   
(18,492
)
Less: Change in fair value on hedged state and municipal securities
   
6,899
     
6,933
 
Tax effect
   
7,975
     
2,428
 
Other comprehensive loss
   
(30,003
)
   
(9,131
)
Comprehensive income (loss)
 
$
(15,725
)
 
$
6,029
 

The accompanying notes are an integral part of these consolidated financial statements.



SOUTH PLAINS FINANCIAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY
(Unaudited)
(Dollars in thousands, except per share data)

 
Common Stock
   
Additional
Paid-in
   
Retained
   
Accumulated
Other
Comprehensive
       
   
Shares
   
Amount
   
Capital
   
Earnings
   
Income (Loss)
   
Total
 
Three Months Ended March 31,
                                   
Balance at January 1, 2021
    18,076,364     $ 18,076     $ 141,112     $ 189,521     $ 21,339     $ 370,048  
Net income
   
                  15,160             15,160  
Cash dividends:
   
                                         
Common - $0.05 per share
   
                  (904 )           (904 )
Other comprehensive loss
   
                        (9,131 )     (9,131 )
Exercise of employee stock options and vesting of restricted stock units, net of 1,100 shares for cashless exercise and net of 5,013 shares for taxes
    20,049       20       (126 )                 (106 )
Repurchases of common stock     (43,184 )     (43 )     (743 )                 (786 )
Stock based compensation
   
            390                   390  
Balance at March 312021
    18,053,229     $ 18,053     $ 140,633     $ 203,777     $ 12,208     $ 374,671  
                                                 
Balance at January 1, 2022
    17,760,243     $ 17,760     $ 133,215     $ 242,750     $ 13,702     $ 407,427  
Net income
   
                  14,278             14,278  
Cash dividends:
                                               
Common - $0.11 per share
   
                  (1,950 )           (1,950 )
Other comprehensive loss
   
                        (30,003 )     (30,003 )
Exercise of employee stock options and vesting of restricted stock units, net of 4,824 shares for cashless exercise and net of 6,857 shares for taxes
    19,662       19       (214 )                 (195 )
Repurchases of common stock     (106,498 )     (106 )     (2,911 )                 (3,017 )
Stock based compensation
   
            528                   528  
Balance at March 312022
    17,673,407     $ 17,673     $ 130,618     $ 255,078     $ (16,301 )   $ 387,068  

The accompanying notes are an integral part of these consolidated financial statements.



SOUTH PLAINS FINANCIAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(Dollars in thousands)

 
Three Months Ended
March 31,
 
   
2022
   
2021
 
Cash flows from operating activities:
           
Net income
 
$
14,278
   
$
15,160
 
Adjustments to reconcile net income to net cash from operating activities:
               
Provision for loan losses
   
(2,085
)
   
89
 
Depreciation and amortization
   
1,705
     
1,617
 
Accretion and amortization
   
1,063
     
1,129
 
Other gains, net
   
358
     
(2
)
Net gain on sales of loans
   
(7,493
)
   
(15,943
)
Proceeds from sales of loans held for sale
   
288,280
     
434,582
 
Loans originated for sale
   
(235,129
)
   
(436,176
)
Deferred income tax expense (benefit)
    2,620       885  
Earnings on bank-owned life insurance
   
(296
)
   
(330
)
Stock-based compensation
   
528
     
390
 
Change in valuation of mortgage servicing rights
   
(4,475
)
   
(1,287
)
Net change in:
               
Accrued interest receivable and other assets
   
1,995
   
(418
)
Accrued expenses and other liabilities
   
9,267
     
8,452
 
Net cash provided by operating activities
   
70,616
     
8,148
 
                 
Cash flows from investing activities:
               
Activity in securities available for sale:
               
Purchases
   
(132,412
)
   
(37,046
)
Maturities, prepayments, and calls
   
17,618
     
43,350
 
Loan originations and principal collections, net
   
(16,660
)
   
(22,094
)
Purchases of premises and equipment
   
(1,316
)
   
(90
)
Proceeds from sales of premises and equipment
   
39
     
17
 
Proceeds from sales of foreclosed assets
   
133
     
354
 
Net cash used in investing activities
   
(132,598
)
   
(15,509
)
                 
Cash flows from financing activities:
               
Net change in deposits
   
108,935
     
181,281
 
Net change in short-term borrowings
   
     
(9,025
)
Payments to tax authorities for stock-based compensation
   
(195
)
   
(106
)
Payments made on notes payable and other borrowings
   
     
(50,000
)
Cash dividends on common stock
   
(1,950
)
   
(904
)
Payments to repurchase common stock
   
(3,017
)
   
(786
)
Net cash provided by financing activities
   
103,773
     
120,460
 
                 
Net change in cash and cash equivalents
 
$
41,791
   
$
113,099
 
Beginning cash and cash equivalents
   
486,821
     
300,307
 
Ending cash and cash equivalents
 
$
528,612
   
$
413,406
 

               
Supplemental disclosures of cash flow information:
               
Interest paid on deposits and borrowed funds
 
$
3,553
   
$
4,070
 
Income taxes paid
           
Supplemental schedule of noncash activities:
               
Loans transferred to foreclosed assets
 
$
242
   
$
378
 
Additions to mortgage servicing rights
   
1,250
     
3,222
 

The accompanying notes are an integral part of these consolidated financial statements.

SOUTH PLAINS FINANCIAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
1.  SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES


Nature of Operations – South Plains Financial, Inc. (“SPFI”) is a Texas corporation and registered bank holding company that conducts its principal activities through its subsidiaries from offices located throughout Texas and Eastern New Mexico. Principal activities include commercial and retail banking, along with insurance, investment, trust, and mortgage services. The following are subsidiaries of SPFI:

Wholly-Owned, Consolidated Subsidiaries:
 
City Bank
Bank subsidiary
Windmark Insurance Agency, Inc. (“Windmark”)
Non-bank subsidiary
Ruidoso Retail, Inc.
Non-bank subsidiary
CB Provence, LLC
Non-bank subsidiary
CBT Brushy Creek, LLC
Non-bank subsidiary
CBT Properties, LLC
Non-bank subsidiary
Wholly-Owned, Equity Method Subsidiaries:
 
South Plains Financial Capital Trusts (SPFCT) III-V
Non-bank subsidiaries

Basis of Presentation and Consolidation – The consolidated financial statements in this Quarterly Report on Form 10-Q for the quarter ended March 31, 2022 (this “Form 10-Q”) include the accounts of SPFI and its wholly-owned consolidated subsidiaries (collectively referred to as the “Company”) identified above. All significant intercompany balances and transactions have been eliminated in consolidation.

The interim consolidated financial statements in this Form 10-Q have not been audited by an independent registered public accounting firm, but in the opinion of management, reflect all adjustments necessary for a fair presentation of the Company’s financial position, results of operations, and cash flows. All such adjustments were of a normal and recurring nature. The consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) for interim financial information and with the instructions to Form 10-Q adopted by the Securities and Exchange Commission (“SEC”). Accordingly, the financial statements do not include all of the information and notes required by GAAP for complete financial statements and should be read in conjunction with the Company’s audited consolidated financial statements, and notes thereto in the Company’s Annual Report on Form 10-K for the year ended December 31, 2021. Operating results for the interim periods disclosed herein are not necessarily indicative of the results that may be expected for a full year or any future period.

Use of Estimates – 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 financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Determination of the adequacy of the allowance for loan losses is a material estimate that is particularly susceptible to significant change in the near term; the assumptions used in stock-based compensation, derivatives, mortgage servicing rights, the valuation of foreclosed assets, and fair values of financial instruments can also involve significant management estimates.

Securities – Investment securities may be classified into trading, held to maturity (“HTM”) or available for sale (“AFS”) portfolios. Securities that are held principally for resale in the near term are classified as trading. Securities that management has the ability and positive intent to hold to maturity are classified as HTM and recorded at amortized cost. Securities not classified as trading or HTM are AFS and are reported at fair value with unrealized gains and losses excluded from earnings, but included in the determination of other comprehensive income (loss). Management uses these assets as part of its asset/liability management strategy; they may be sold in response to changes in liquidity needs, interest rates, resultant prepayment risk changes, and other factors. Management determines the appropriate classification of securities at the time of purchase. Purchase premiums and discounts are recognized in interest income using the interest method over the terms of the securities. Realized gains and losses and declines in value judged to be other-than-temporary are included in gain (loss) on sale of securities. The cost of securities sold is based on the specific identification method.

When the fair value of a security is below its amortized cost, additional analysis is performed to determine whether an other-than-temporary impairment condition exists. The analysis considers (i) whether there is intent to sell securities prior to recovery and/or maturity, (ii) whether it is more likely than not that securities will have to be sold prior to recovery and/or maturity, and (iii) whether there is a credit loss component to the impairment. Often, the information available to conduct these assessments is limited and rapidly changing, making estimates of fair value subject to judgment. If actual information or conditions are different than estimated, the extent of the impairment of a security may be different than previously estimated, which could have a material effect on the Company’s results of operations and financial condition.

Loans – Loans that management has the intent and ability to hold for the foreseeable future or until maturity or payoff are reported at their outstanding principal balances net of any unearned income, charge-offs, unamortized deferred fees and costs on originated loans, and premiums or discounts on purchased loans. Interest income is accrued on the unpaid principal balance. Loan origination fees, net of certain direct origination costs, are deferred and recognized as an adjustment of the related loan yield using the straight-line method, which is not materially different from the effective interest method required by GAAP.

Loans are placed on nonaccrual status when, in management’s opinion, collection of interest is unlikely, which typically occurs when principal or interest payments are more than ninety days past due. When interest accrual is discontinued, all unpaid accrued interest is reversed against interest income. The interest on these loans is accounted for on the cash-basis or cost-recovery method, until qualifying for return to accrual. Loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured.

Allowance for Loan Losses – The allowance for loan losses is established by management as an estimate to cover probable loan losses through a provision for loan losses charged to earnings. Loan losses are charged against the allowance when management believes the uncollectibility of a loan balance is confirmed. Subsequent recoveries, if any, are credited to the allowance. The Company’s allowance for loan losses consists of specific valuation allowances established for probable losses on specific loans and general valuation allowances calculated based on historical loan loss experience for similar loans with similar characteristics and trends, judgmentally adjusted for general economic conditions and other qualitative risk factors internal and external to the Company.

The allowance for loan losses is evaluated on a quarterly basis by management and is based upon management’s review of the collectability of the loans in the Company’s loan portfolio in light of historical experience, the nature and volume of the loan portfolio, adverse situations that may affect the borrower’s ability to repay, estimated value of any underlying collateral, and prevailing economic conditions. This evaluation is inherently subjective, as it requires estimates that are susceptible to significant revision as more information becomes available. The determination of the adequacy of the allowance for loan losses is based on estimates that are particularly susceptible to significant changes in the economic environment and market conditions. In connection with the determination of the estimated losses on loans, management obtains independent appraisals for significant collateral. Loans originated by the bank subsidiary are generally secured by specific items of collateral including real property, crops, livestock, consumer assets, and other business assets.

While management uses available information to recognize losses on loans, further reductions in the carrying amounts of loans may be necessary based on various factors. In addition, regulatory agencies, as an integral part of their examination process, periodically review the estimated losses on loans. Such agencies may require the bank subsidiary to recognize additional losses based on their judgments about information available to them at the time of their examination. Because of these factors, it is reasonably possible that the estimated losses on loans may change materially in the near term. However, the amount of the change that is reasonably possible cannot be estimated.

A loan is considered impaired when, based on current information and events, it is probable that the Company will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. All loans rated substandard or worse and greater than $250 thousand are specifically reviewed to determine if they are impaired. Factors considered by management in determining whether a loan is impaired include payment status and the sources, amounts, and probabilities of estimated cash flow available to service debt in relation to amounts due according to contractual terms. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment record, and the amount of the shortfall in relation to the principal and interest owed.

Loans that are determined to be impaired are then evaluated to determine estimated impairment, if any. GAAP allows impairment to be measured on a loan-by-loan basis by either the present value of expected future cash flows discounted at the loan’s effective interest rate, the loan’s obtainable market price, or the fair value of the collateral if the loan is collateral dependent. Loans that are not individually determined to be impaired or are not subject to the specific review of impaired status are subject to the general valuation allowance portion of the allowance for loan losses.

The Company may modify its loan agreement with a borrower. The modification will be considered a troubled debt restructuring (“TDR”) if the following criteria are met: (1) the borrower is experiencing a financial difficulty and (2) the Company makes a concession that it would not otherwise make. Concessions may include debt forgiveness, interest rate change, or maturity extension. Each of these loans is impaired and is evaluated for impairment, with a specific reserve recorded as necessary based on probable losses related to collateral and cash flow. A loan will no longer be required to be reported as restructured in calendar years following the restructure if the interest rate at the time of restructure is greater than or equal to the rate the Company was willing to accept for a new extension of credit with similar risk and the loan is in compliance with its modified terms.

Acquired Loans – Loans that the Company acquires in connection with business combinations are recorded at fair value with no carryover of the acquired entity’s related allowance for loan losses. The fair value of the acquired loans involves estimating the amount and timing of principal and interest cash flows expected to be collected on the loans and discounting those cash flows at a market rate of interest.

Any loans the Company determines have evidence of deterioration of credit quality since origination, and it is probable, at acquisition, that all contractually required payments will not be collected, are considered to be purchase credit impaired loans.The excess of cash flows expected at acquisition over the estimated fair value is referred to as the accretable discount and is recognized into interest income over the remaining life of the loan. The difference between contractually required payments at acquisition and the cash flows expected to be collected at acquisition is referred to as the nonaccretable discount. These loans are accounted for under Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) 310-30, Loans and Debt Securities Acquired with Deteriorated Credit Quality. The nonaccretable discount includes estimated future credit losses expected to be incurred over the life of the loan. Subsequent decreases to the expected cash flows will require the Company to evaluate the need for an additional allowance. Subsequent improvement in expected cash flows will result in the reversal of a corresponding amount of the nonaccretable discount which the Company will then reclassify as accretable discount that will be recognized into interest income over the remaining life of the loan.

Loans acquired through business combinations that do not meet the specific criteria of ASC 310-30 are accounted for under ASC 310-20, Receivables—Nonrefundable Fees and Other Costs. These loans are initially recorded at fair value, and include credit and interest rate marks associated with acquisition accounting adjustments. Purchase premiums or discounts are subsequently amortized as an adjustment to yield over the estimated contractual lives of the loans. There is no allowance for loan losses established at the acquisition date for acquired performing loans. An allowance for loan losses is recorded for any credit deterioration in these loans subsequent to acquisition.

Acquired loans that met the criteria for impaired or nonaccrual of interest prior to the acquisition may be considered performing upon acquisition, regardless of whether the customer is contractually delinquent, if the Company expects to fully collect the new carrying value (i.e., fair value) of the loans. As such, the Company may no longer consider the loan to be nonaccrual or nonperforming at the date of acquisition and may accrue interest on these loans, including the impact of any accretable discount. In addition, charge-offs on such loans would be first applied to the nonaccretable difference portion of the fair value adjustment.


Mortgage Servicing Rights – When mortgage loans are sold with servicing retained, servicing rights are initially recorded at fair value with the income statement effect recorded in net gain on sale of loans. Fair value is based on market prices for comparable mortgage servicing contracts, when available, or alternatively, is based on a valuation model that calculates present value of estimated future servicing income.



Under the fair value measurement method, the Company measures servicing rights at fair value at each reporting date and reports change in fair value of servicing assets in earnings in the period in which the changes occur, and are included with other noninterest income in the combined financial statements. The fair values of servicing rights are subject to significant fluctuations as a result of changes in estimated and actual prepayment speeds and default rates and losses.

Goodwill and Other Intangible Assets – Goodwill resulting from business combinations is generally determined as the excess of the fair value of the consideration transferred over the fair value of the net assets acquired and liabilities assumed as of the acquisition date. Goodwill is not amortized, but is tested for impairment on October 31 of each year or more frequently if events and circumstances exist that indicate that an impairment test should be performed. There was no goodwill impairment recorded for the three months ended March 31, 2022 and the year ended December 31, 2021, respectively.

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 10 years. Substantially all CDI is amortized using the sum of the years’ digits method.

The remaining other intangible assets consist of customer relationship and employment agreement intangible assets and are amortized over their estimated useful lives of 5 years using the straight-line method.

Mortgage Banking Derivatives – Commitments to fund mortgage loans (interest rate locks) to be sold into the secondary market, forward commitments for the future delivery of these mortgage loans, and forward sales of mortgage-backed securities are accounted for as free standing derivatives. At the time of the interest rate lock, the Company determines whether the loan will be sold through a best efforts contract or a mandatory delivery contract.

In order to hedge the change in interest rates resulting from the commitments to fund the loans that will be sold through a best efforts contract, the Company enters into forward loans sales commitments for the future delivery of mortgage loans when interest rate locks are entered. At inception, these interest rate locks and the related forward loan sales commitments, adjusted for the expected exercise of the commitment before the loan is funded, are recorded with a zero value. Subsequent changes in fair value are estimated based on changes in mortgage interest rates from the date the interest on the loan is locked.

In order to hedge the change in interest rates resulting from all other mortgage commitments to funds loans, the Company enters into forward sales of mortgage-backed securities contracts. At inception, these interest rate locks are recorded at fair value and are adjusted for the expected exercise of the commitment before the loan is funded. Subsequent changes in fair value are estimated based on changes in mortgage interest rates from the date the interest on the loan is locked. Changes in the fair values of these derivatives are included in net gain on sales of loans in the consolidated financial statements.

Derivatives – At the inception of a derivative contract, the Company designates the derivative as one of three types based on the Company’s intentions and belief as to likely effectiveness as a hedge. These three types are (1) a hedge of the fair value of a recognized asset or liability or of an unrecognized firm commitment (“fair value hedge”), (2) a hedge of a forecasted transaction or the variability of cash flows to be received or paid related to a recognized asset or liability (“cash flow hedge”), or (3) an instrument with no hedging designation (“stand-alone derivative”). For a fair value hedge, the gain or loss on the derivative, as well as the offsetting loss or gain on the hedged item, are recognized in current earnings as fair values change. For a cash flow hedge, the gain or loss on the derivative is reported in other comprehensive income and is reclassified into earnings in the same periods during which the hedged transaction affects earnings. For both types of hedges, changes in the fair value of derivatives that are not highly effective in hedging the changes in fair value or expected cash flows of the hedged item are recognized immediately in current earnings. Changes in the fair value of derivatives that do not qualify for hedge accounting are reported currently in earnings, as noninterest income.

Net cash settlements on derivatives that qualify for hedge accounting are recorded in interest income or interest expense, based on the item being hedged. Net cash settlements on derivatives that do not qualify for hedge accounting are reported in noninterest income. Cash flows on hedges are classified in the cash flow statement the same as the cash flows of the items being hedged.

The Company formally documents the relationship between derivatives and hedged items, as well as the risk-management objective and the strategy for undertaking hedge transactions at the inception of the hedging relationship. This documentation includes linking fair value or cash flow hedges to specific assets and liabilities on the balance sheet or to specific firm commitments or forecasted transactions. The Company also formally assesses, both at the hedge’s inception and on an ongoing basis, whether the derivative instruments that are used are highly effective in offsetting changes in fair values or cash flows of the hedged items. The Company discontinues hedge accounting when it determines that the derivative is no longer effective in offsetting changes in the fair value or cash flows of the hedged item, the derivative is settled or terminates, a hedged forecasted transaction is no longer probable, a hedged firm commitment is no longer firm, or treatment of the derivative as a hedge is no longer appropriate or intended.

When hedge accounting is discontinued, subsequent changes in fair value of the derivative are recorded as noninterest income. When a fair value hedge is discontinued, the hedged asset or liability is no longer adjusted for changes in fair value and the existing basis adjustment is amortized or accreted over the remaining life of the asset or liability. When a cash flow hedge is discontinued but the hedged cash flows or forecasted transactions are still expected to occur, gains or losses that were accumulated in other comprehensive income are amortized into earnings over the same periods which the hedged transactions will affect earnings.

Stock-Based Compensation – The Company sponsors an equity incentive plan under which options to acquire shares of the Company’s common stock may be granted periodically to all full-time employees and directors of the Company or its affiliates at a specific exercise price. Shares are issued out of authorized and unissued common shares that have been reserved for issuance under such plan. Compensation cost is measured based on the estimated fair value of the award at the grant date and is recognized in earnings on a straight-line basis over the requisite service period. The fair value of stock options is estimated at the date of grant using a closed form option valuation (“Black-Scholes”) option pricing model. This model requires assumptions as to the expected stock volatility, dividends, terms and risk-free rates. The expected volatility is based on the combination of the Company’s historical volatility and the volatility of comparable peer banks. The expected term represents the period of time that options are expected to be outstanding from the grant date. The risk-free interest rate is based on the U.S. Treasury yield curve in effect at the time of grant for the appropriate life of each stock option.

Earnings per Share – Basic earnings per share is net income divided by the weighted average number of common shares outstanding during the period. Employee Stock Ownership Plan (“ESOP”) shares are considered outstanding for this calculation unless unearned. Diluted earnings per share includes the dilutive effect of unearned ESOP shares, if applicable. Diluted earnings per share includes the dilutive effect of additional potential shares issuable under stock options. Earnings and dividends per share are restated for all stock splits and stock dividends through the date of issuance of the financial statements.

Segment Information – The Company has two reportable segments: banking and insurance. The accounting policies of the segments are the same as those described in the summary of significant accounting policies. The Company’s reportable segments are strategic business units that offer different products and services. Operations are managed and financial performance is evaluated on a Company-wide basis.

Reclassifications – Certain amounts from the 2021 consolidated financial statements have been reclassified to conform to the March 31, 2022 presentation.

Recent Accounting Pronouncements – FASB ASC constitutes GAAP for nongovernmental entities. Updates to ASC are prescribed in Accounting Standards Updates (“ASU”), which are not authoritative until incorporated into ASC.

ASU 2021-01, Reference Rate Reform (Topic 848). In January 2021, the FASB issued ASU No. 2021-01 to clarify the scope of Topic 848 so that derivatives affected by the discounting transition are explicitly eligible for certain optional expedients and exceptions in Topic 848. This update additionally clarified that a receive-variable-rate, pay-variable-rate cross-currency interest rate swap may be considered an eligible hedging instrument in a net investment hedge if both legs of the swap do not have the same repricing intervals and dates as a result of reference rate reform. This update was effective upon issuance and generally can be applied through December 31, 2022. See the discussion regarding the adoption of ASU 2020-04 below.

ASU 2020-04, Reference Rate Reform (Topic 848): Facilitation of the Effects of Reference Rate Reform on Financial Reporting. In March 2020, the FASB issued ASU 2020-04 and it provides optional expedients and exceptions for accounting related to contracts, hedging relationships and other transactions affected by reference rate reform if certain criteria are met. This update applies only to contracts, hedging relationships and other transactions that reference LIBOR or another reference rate expected to be discontinued because of reference rate reform and do not apply to contract modifications made and hedging relationships entered into or evaluated after December 31, 2022, except for hedging relationships existing as of December 31, 2022, that an entity has elected certain optional expedients for and that are retained through the end of the hedging relationship. The expedients and exceptions in this update are available to all entities starting March 12, 2020 through December 31, 2022. The adoption of ASU 2020-04 did not significantly impact the Company’s consolidated financial statements.

ASU 2019-12, Income Taxes, Simplifying the Accounting for Income Taxes (Topic 740). In December 2019, the FASB issued ASU 2019-12 to simplify the accounting for income taxes by removing certain exceptions to the approach for intraperiod tax allocation, the methodology for calculating income taxes in an interim period and the recognition for deferred tax liabilities for outside basis differences. This update is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2020. The adoption of ASU 2019-12 did not have a material effect on the Company’s financial statements.

ASU 2016-13 Financial Instruments - Credit Losses (Topic 326). The FASB issued guidance to replace the incurred loss model with an expected loss model, which is referred to as the current expected credit loss (“CECL”) model. The CECL model is applicable to the measurement of credit losses on financial assets measured at amortized cost, including loan receivables, held to maturity securities, and debt securities. ASU 2016-13 is effective for the Company for annual periods beginning after December 15, 2022, including interim periods within those fiscal years. Entities will apply the standard’s provisions as a cumulative-effect adjustment to retained earnings as of the beginning of the first reporting period in which the guidance is adopted. The Company has contracted with a third-party vendor to assist in the implementation of CECL. The model has been developed and validation is underway. The Company expects to adopt CECL effective January 1, 2023.

ASU 2016-02 Leases (Topic 842). The FASB amended existing guidance that requires that lessees recognize lease assets and lease liabilities on the balance sheet and disclose key information about leasing arrangements. These amendments are effective for the Company for annual periods beginning after December 15, 2021, and interim periods beginning after December 15, 2022.  Based upon an analysis performed, the Company estimates that the right of use asset and corresponding lease liability at adoption will be between $10.8 million and $11.3 million.

Subsequent EventsThe Company has evaluated subsequent events and transactions from March 31, 2022 through the date this Form 10-Q was filed with the SEC for potential recognition or disclosure as required by GAAP.

2.  SECURITIES

The amortized cost and fair value of securities, with gross unrealized gains and losses, at the dates indicated follows (dollars in thousands):

 
Amortized
Cost
   
Gross
Unrealized
Gains
   
Gross
Unrealized
Losses
   
Fair
Value
 
March 312022
                       
Available for sale:
                       
U.S. government and agencies
 
$
   
$
   
$
   
$
 
State and municipal
   
263,318
     
223
     
(10,533
)
   
253,008
 
Mortgage-backed securities
   
422,603
     
106
     
(24,276
)
   
398,433
 
Collateralized mortgage obligations
   
103,976
     
1,043
     
     
105,019
 
Asset-backed and other amortizing securities
   
24,775
     
3
     
(243
)
   
24,535
 
Other securities
   
12,000
     
428
     
(19
)
   
12,409
 
   
$
826,672
   
$
1,803
   
$
(35,071
)
 
$
793,404
 

 
Amortized
Cost
   
Gross
Unrealized
Gains
   
Gross
Unrealized
Losses
   
Fair
Value
 
December 312021
                       
Available for sale:
                       
U.S. government and agencies
 
$
   
$
   
$
   
$
 
State and municipal
   
265,143
     
10,615
     
(86
)
   
275,672
 
Mortgage-backed securities
   
302,973
     
4,230
     
(4,114
)
   
303,089
 
Collateralized mortgage obligations
   
106,733
     
     
(413
)
   
106,320
 
Asset-backed and other amortizing securities
   
26,046
     
1,108
     
(218
)
   
26,936
 
Other securities
   
12,000
     
487
     
     
12,487
 
   
$
712,895
   
$
16,440
   
$
(4,831
)
 
$
724,504
 

The amortized cost and fair value of securities at March 31, 2022 are presented below by contractual maturity (dollars in thousands). Expected maturities may differ from contractual maturities because issuers may have the right to call or prepay obligations. Other securities are shown separately since they are not due at a single maturity date.

 
Available for Sale
 
   
Amortized
Cost
   
Fair
Value
 
Within 1 year
 
$
954
   
$
962
 
After 1 year through 5 years
   
8,480
     
8,571
 
After 5 years through 10 years
   
22,185
     
22,574
 
After 10 years
   
243,699
     
233,310
 
Other
   
551,354
     
527,987
 
   
$
826,672
   
$
793,404
 

At both March 31, 2022 and December 31, 2021, there were no holdings of securities of any one issuer, other than the U.S. government, its agencies, or its sponsored enterprises, in an amount greater than 10% of stockholders’ equity.

Securities with a carrying value of approximately $479.2 million and $474.5 million at March 31, 2022 and December 31, 2021, respectively, were pledged to collateralize public deposits and for other purposes as required or permitted by law.

The following table segregates securities with unrealized losses at the periods indicated, by the duration they have been in a loss position (dollars in thousands):

 
Less than 12 Months
   
12 Months or More
   
Total
 
   
Fair
Value
   
Unrealized
Loss
   
Fair
Value
   
Unrealized
Loss
   
Fair
Value
   
Unrealized
Loss
 
March 312022
                                   
U.S. government and agencies
 
$
   
$
   
$
   
$
   
$
   
$
 
State and municipal
   
231,142
     
10,099
     
4,323
     
434
     
235,465
     
10,533
 
Mortgage-backed securities
   
318,090
     
14,524
     
74,294
     
9,752
     
392,384
     
24,276
 
Collateralized mortgage obligations
   
     
     
     
     
     
 
Asset-backed and other amortizing securities
   
22,964
     
243
     
     
     
22,964
     
243
 
Other securities
   
1,481
     
19
     
     
     
1,481
     
19
 
   
$
573,677
   
$
24,885
   
$
78,617
   
$
10,186
   
$
652,294
   
$
35,071
 
                                                 
December 312021
                                               
U.S. government and agencies
 
$
   
$
   
$
   
$
   
$
   
$
 
State and municipal
   
21,255
     
86
     
     
     
21,255
     
86
 
Mortgage-backed securities
   
56,398
     
1,197
     
64,764
     
2,917
     
121,162
     
4,114
 
Collateralized mortgage obligations
   
106,320
     
413
     
     
     
106,320
     
413
 
Asset-backed and other amortizing securities
   
1,624
     
218
     
     
     
1,624
     
218
 
Other securities
   
     
     
     
     
     
 
   
$
185,597
   
$
1,914
   
$
64,764
   
$
2,917
   
$
250,361
   
$
4,831
 

There were 130 securities with an unrealized loss at March 31, 2022. Management does not believe that these losses are other than temporary as there is no intent to sell any of these securities before recovery and it is not probable the Company will be required to sell any of these securities before recovery, and credit loss, if any, is not material. These unrealized losses are largely due to recent significant increases in market interest rates over the yields available at the time the underlying securities were purchased. The fair value is expected to recover as the securities approach their maturity date or if market yields for such investments decline in future periods. Management does not believe any of the securities are impaired due to reasons of credit quality. Accordingly, as of March 31, 2022, management believes the impairments detailed in the table above are temporary and no impairment loss has been realized in the Company’s combined financial statements.


3.  LOANS HELD FOR INVESTMENT

Loans are summarized by category as of the periods presented below (dollars in thousands):

 
March 31,
2022
   
December 31,
2021
 
Commercial real estate
 
$
771,490
   
$
755,444
 
Commercial - specialized
   
350,143
     
378,725
 
Commercial - general
   
475,593
     
460,024
 
Consumer:
               
1-4 family residential
   
378,361
     
387,690
 
Auto loans
   
255,703
     
240,719
 
Other consumer
   
73,245
     
68,113
 
Construction
   
149,096
     
146,862
 
     
2,453,631
     
2,437,577
 
Allowance for loan losses
   
(39,649
)
   
(42,098
)
Loans, net
 
$
2,413,982
   
$
2,395,479
 

The Company has certain lending policies, underwriting standards, and procedures in place that are designed to maximize loan income with an acceptable level of risk. Management reviews and approves these policies, underwriting standards, and procedures on a regular basis and makes changes as appropriate. Management receives frequent reports related to loan originations, quality, concentrations, delinquencies, non-performing, and potential problem loans. Diversification in the loan portfolio is a means of managing risk associated with fluctuations in economic conditions, both by type of loan and geography.

Commercial – General and Specialized – Commercial loans are underwritten after evaluating and understanding the borrower’s ability to operate profitably. Underwriting standards have been designed to determine whether the borrower possesses sound business ethics and practices, evaluate current and projected cash flows to determine the ability of the borrower to repay their obligations, as agreed and ensure appropriate collateral is obtained to secure the loan. Commercial loans are primarily made based on the identified cash flows of the borrower and, secondarily, on the underlying collateral provided by the borrower. Most commercial loans are secured by the assets being financed or other business assets, such as real estate, accounts receivable, or inventory, and include personal guarantees. Owner-occupied real estate is included in commercial loans, as the repayment of these loans is generally dependent on the operations of the commercial borrower’s business rather than on income-producing properties or the sale of the properties. Commercial loans are grouped into two distinct sub-categories: specialized and general. Commercial related segments that are considered “specialized” include agricultural production and real estate loans, energy loans, and finance, investment, and insurance loans. Commercial related segments that contain a broader diversity of borrowers, sub-industries, or serviced industries are grouped into the “general category.” These include goods, services, restaurant & retail, construction, and other industries.

Commercial Real Estate – Commercial real estate loans are also subject to underwriting standards and processes similar to commercial loans. These loans are underwritten primarily based on projected cash flows for income-producing properties and collateral values for non-income-producing properties. The repayment of these loans is generally dependent on the successful operation of the property securing the loans or the sale or refinancing of the property. Real estate loans may be adversely affected by conditions in the real estate markets or in the general economy. The properties securing the Company’s real estate portfolio are diversified by type and geographic location. This diversity helps reduce the exposure to adverse economic events that affect any single market or industry.

Construction – Loans for residential construction are for single-family properties to developers, builders, or end-users. These loans are underwritten based on estimates of costs and completed value of the project. Funds are advanced based on estimated percentage of completion for the project. Performance of these loans is affected by economic conditions as well as the ability to control costs of the projects.

Consumer – Loans to consumers include 1-4 family residential loans, auto loans, and other loans for recreational vehicles or other purposes. The Company utilizes a computer-based credit scoring analysis to supplement its policies and procedures in underwriting consumer loans. The Company’s loan policy addresses types of consumer loans that may be originated and the collateral, if secured, which must be perfected. The relatively smaller individual dollar amounts of consumer loans that are spread over numerous individual borrowers also minimizes the Company’s risk. The Company generally requires mortgage title insurance and hazard insurance on 1-4 family residential loans.

The allowance for loan losses was $39.6 million at March 31, 2022, compared to $42.1 million at December 31, 2021. The allowance for loan losses to loans held for investment was 1.62% at March 31, 2022 and 1.73% at December 31, 2021.

The following table details the activity in the allowance for loan losses for the periods indicated (dollars in thousands). Allocation of a portion of the allowance to one category of loans does not preclude its availability to absorb losses in other categories.

 
Beginning
Balance
   
Provision for
Loan Losses
   
Charge-offs
   
Recoveries
   
Ending
Balance
 
For the three months ended March 312022
                             
Commercial real estate
 
$
17,245
   
$
(2,649
)
 
$
   
$
25
   
$
14,621
 
Commercial - specialized
   
4,363
     
(1,083
)
   
(39
)
   
34
     
3,275
 
Commercial - general
   
8,466
     
1,659
     
(307
)
   
122
     
9,940
 
Consumer:
                                       
1-4 family residential
   
5,268
     
(298
)
   
(40
)
   
1
     
4,931
 
Auto loans
   
3,653
     
68
     
(86
)
   
46
     
3,681
 
Other consumer
   
1,357
     
147
     
(185
)
   
65
     
1,384
 
Construction
   
1,746