10-Q 1 brhc10043771_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 September 30, 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 November 7, 2022, the registrant had 16,999,841 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.
30
Item 3.
52
Item 4.
52
PART II.
53
Item 1.
53
Item 1A.
53
Item 2.
53
Item 3.
53
Item 4.
53
Item 5.
53
Item 6.
54
55


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)

 
September 30,
2022
   
December 31,
2021
 
   
(Unaudited)
       
ASSETS
           
Cash and due from banks
 
$
52,749
   
$
68,425
 
Interest-bearing deposits in banks
   
277,213
     
418,396
 
Cash and cash equivalents
   
329,962
     
486,821
 
Securities available for sale
   
711,412
     
724,504
 
Loans held for sale
   
26,922
     
76,507
 
Loans held for investment
   
2,690,366
     
2,437,577
 
Allowance for loan losses
   
(39,657
)
   
(42,098
)
Loans held for investment, net
    2,650,709       2,395,479  
Accrued interest receivable
   
12,408
     
13,900
 
Premises and equipment, net
   
56,532
     
57,699
 
Bank-owned life insurance
   
72,874
     
71,978
 
Goodwill
   
19,508
     
19,508
 
Intangible assets, net
   
4,720
     
5,895
 
Mortgage servicing rights
   
28,424
     
19,700
 
Deferred tax asset, net
   
24,317
     
3,038
 
Other assets
   
54,902
     
26,826
 
Total assets
 
$
3,992,690
   
$
3,901,855
 
                 
LIABILITIES AND STOCKHOLDERS’ EQUITY
               
                 
Deposits:
               
Noninterest-bearing
 
$
1,262,072
   
$
1,071,367
 
Interest-bearing
   
2,198,464
     
2,269,855
 
Total deposits
   
3,460,536
     
3,341,222
 
Accrued expenses and other liabilities
   
68,048
     
31,038
 
Subordinated debt securities
   
75,914
     
75,775
 
Junior subordinated deferrable interest debentures
   
46,393
     
46,393
 
Total liabilities
   
3,650,891
     
3,494,428
 
                 
Stockholders’ equity:
               
Common stock, $1.00 par value per share, 30,000,000 shares authorized; 17,064,640 and 17,760,243 issued and outstanding at September 30, 2022 and December 31, 2021, respectively
   
17,065
     
17,760
 
Additional paid-in capital
   
116,565
     
133,215
 
Retained earnings
   
281,679
     
242,750
 
Accumulated other comprehensive income (loss)
   
(73,510
)
   
13,702
 
Total stockholders’ equity
   
341,799
     
407,427
 
Total liabilities and stockholders’ equity
 
$
3,992,690
   
$
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
September 30,
   
Nine Months Ended
September 30,
 
   
2022
   
2021
   
2022
   
2021
 
Interest income:
                       
Loans, including fees
 
$
34,463
   
$
30,818
   
$
99,260
   
$
89,458
 
Securities:
                               
Taxable
   
4,224
     
2,346
     
10,142
     
7,219
 
Non-taxable
   
1,128
     
1,160
     
3,409
     
3,487
 
Federal funds sold and interest-bearing deposits in banks
   
1,293
     
114
     
2,129
     
272
 
Total interest income
   
41,108
     
34,438
     
114,940
     
100,436
 
Interest expense:
                               
Deposits
   
4,537
     
2,030
     
8,744
     
6,373
 
Notes payable & other borrowings
   
     
     
     
43
 
Subordinated debt securities
   
1,012
     
1,013
     
3,037
     
3,044
 
Junior subordinated deferrable interest debentures
   
457
     
217
     
1,005
     
661
 
Total interest expense
   
6,006
     
3,260
     
12,786
     
10,121
 
Net interest income
   
35,102
     
31,178
     
102,154
     
90,315
 
Provision for loan losses
   
(782
)
   
     
(2,867
)
   
(1,918
)
Net interest income, after provision for loan losses
   
35,884
     
31,178
     
105,021
     
92,233
 
Noninterest income:
                               
Service charges on deposit accounts
   
1,764
     
1,851
     
5,149
     
5,023
 
Income from insurance activities
   
4,856
     
3,794
     
8,003
     
6,146
 
Net gain on sales of loans
   
4,452
     
12,848
     
17,924
     
41,108
 
Bank card services and interchange fees
   
3,156
     
3,045
     
9,856
     
8,760
 
Other mortgage banking income
   
1,836
     
1,954
      10,670       6,221  
Investment commissions
   
391
     
430
     
1,403
     
1,390
 
Fiduciary fees
   
568
     
556
     
1,815
     
2,234
 
Other
   
3,914
     
1,313
     
8,649
     
3,659
 
Total noninterest income
   
20,937
     
25,791
     
63,469
     
74,541
 
Noninterest expense:
                               
Salaries and employee benefits
   
22,927
     
24,116
     
67,620
     
71,811
 
Occupancy and equipment, net
   
4,132
     
3,896
     
11,902
     
10,960
 
Professional services
   
2,523
     
1,388
     
7,795
     
4,483
 
Marketing and development
   
913
     
777
     
2,391
     
2,157
 
IT and data services
   
908
     
1,068
     
2,902
     
3,029
 
Bank card expenses
   
1,399
     
1,339
     
4,050
     
3,640
 
Appraisal expenses
   
359
     
790
     
1,432
     
2,350
 
Other
   
4,240
     
4,689
     
13,289
     
13,468
 
Total noninterest expense
   
37,401
     
38,063
     
111,381
     
111,898
 
Income before income taxes
   
19,420
     
18,906
     
57,109
     
54,876
 
Income tax expense
   
3,962
     
3,716
     
11,490
     
10,876
 
Net income
 
$
15,458
   
$
15,190
   
$
45,619
   
$
44,000
 

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
September 30,
   
Nine Months Ended
September 30,
 
   
2022
   
2021
   
2022
   
2021
 
Earnings per share:
                       
Basic
 
$
0.89
   
$
0.85
   
$
2.61
   
$
2.44
 
Diluted
 
$
0.86
   
$
0.82
   
$
2.52
   
$
2.38
 
                                 
Net income
 
$
15,458
   
$
15,190
   
$
45,619
   
$
44,000
 
Other comprehensive income (loss):                                
Unrealized gain (loss) on securities available for sale    
(39,102
)
   
(5,964
)
   
(126,076
)
   
(13,835
)
Less: Change in fair value on hedged state and municipal securities
   
5,332
     
760
     
15,681
     
4,943
 
Tax effect
   
7,092
     
1,093
     
23,183
     
1,867
 
Other comprehensive income (loss)
   
(26,678
)
   
(4,111
)
   
(87,212
)
   
(7,025
)
Comprehensive income (loss)
 
$
(11,220
)
 
$
11,079
   
$
(41,593
)
 
$
36,975
 

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
 
Nine Months Ended September 30,
                                   
Balance at December 31, 2020
   
18,076,364
   
$
18,076
   
$
141,112
   
$
189,521
   
$
21,339
   
$
370,048
 
Net income
   
     
     
     
44,000
     
     
44,000
 
Cash dividends declared  - $0.21 per share
   
     
     
     
(3,784
)
   
     
(3,784
)
Other comprehensive loss
   
     
     
     
     
(7,025
)
   
(7,025
)
Exercise of employee stock options and vesting of restricted stock units, net of 2,906 shares for cashless exercise and net of 5,013 shares for taxes
   
20,552
     
21
     
(127
)
   
     
     
(106
)
Repurchases of common stock
   
(272,822
)
   
(273
)
   
(5,809
)
   
     
     
(6,082
)
Stock-based compensation
   
     
     
1,225
     
     
     
1,225
 
Balance at September 302021
   
17,824,094
   
$
17,824
   
$
136,401
   
$
229,737
   
$
14,314
   
$
398,276
 
                                                 
Balance at December 31, 2021
   
17,760,243
   
$
17,760
   
$
133,215
   
$
242,750
   
$
13,702
   
$
407,427
 
Net income
   
     
     
     
45,619
     
     
45,619
 
Cash dividends declared  - $0.34 per share
   
     
     
     
(5,973
)
   
     
(5,973
)
Other comprehensive loss
   
     
     
     
     
(87,212
)
   
(87,212
)
Impact of adoption of Topic 842 related to leases
                      (717 )           (717 )
Exercise of employee stock options and vesting of restricted stock units, net of 16,255 shares for cashless exercise and net of 11,126 shares for taxes
   
34,010
     
34
     
(319
)
   
     
     
(285
)
Repurchases of common stock
   
(729,613
)
   
(729
)
   
(18,197
)
   
     
     
(18,926
)
Stock-based compensation
   
     
     
1,866
     
     
     
1,866
 
Balance at September 302022
   
17,064,640
   
$
17,065
   
$
116,565
   
$
281,679
   
$
(73,510
)
 
$
341,799
 
                                                 
Three Months Ended September 30,
                                               
Balance at June 30, 2021
   
18,014,398
   
$
18,014
   
$
140,212
   
$
216,164
   
$
18,425
   
$
392,815
 
Net income
   
     
     
     
15,190
     
     
15,190
 
Cash dividends declared  - $0.09 per share
   
     
     
     
(1,617
)
   
     
(1,617
)
Other comprehensive loss
   
     
     
     
     
(4,111
)
   
(4,111
)
Repurchases of common stock
   
(190,304
)
   
(190
)
   
(4,214
)
   
     
     
(4,404
)
Stock-based compensation
   
     
     
403
     
     
     
403
 
Balance at September 302021
   
17,824,094
   
$
17,824
   
$
136,401
   
$
229,737
   
$
14,314
   
$
398,276
 
                                                 
Balance at June 30, 2022
   
17,417,094
   
$
17,417
   
$
125,332
   
$
268,305
   
$
(46,832
)
 
$
364,222
 
Net income
   
     
     
     
15,458
     
     
15,458
 
Cash dividends declared  - $0.12 per share
   
     
     
     
(2,084
)
   
     
(2,084
)
Other comprehensive loss
   
     
     
     
     
(26,678
)
   
(26,678
)
Exercise of employee stock options and vesting of restricted stock units, net of 11,431 shares for cashless exercise and net of 3,997 shares for taxes     13,673       14       (104 )                 (90 )
Repurchases of common stock
   
(366,127
)
   
(366
)
   
(9,352
)
   
     
     
(9,718
)
Stock-based compensation
   
     
     
689
     
     
     
689
 
Balance at September 302022
   
17,064,640
   
$
17,065
   
$
116,565
   
$
281,679
   
$
(73,510
)
 
$
341,799
 

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)

 
Nine Months Ended
September 30,
 
   
2022
   
2021
 
Cash flows from operating activities:
           
Net income
 
$
45,619
   
$
44,000
 
Adjustments to reconcile net income to net cash from operating activities:
               
Provision for loan losses
   
(2,867
)
   
(1,918
)
Depreciation and amortization
   
5,277
     
4,837
 
Accretion and amortization
   
3,089
     
3,399
 
Other gains, net
   
(65
)
   
(139
)
Net gain on sales of loans
   
(17,924
)
   
(41,108
)
Proceeds from sales of loans held for sale
   
659,061
     
1,243,380
 
Loans originated for sale
   
(594,246
)
   
(1,189,693
)
Deferred income tax expense
    2,093       1,730  
Earnings on bank-owned life insurance
   
(896
)
   
(945
)
Stock-based compensation
   
1,866
     
1,225
 
Change in valuation of mortgage servicing rights
   
(6,030
)
   
(1,055
)
Net change in:
               
Accrued interest receivable and other assets
   
(2,734
)
   
3,683
 
Accrued expenses and other liabilities
   
26,702
     
10,305
 
Net cash provided by operating activities
   
118,945
     
77,701
 
                 
Cash flows from investing activities:
               
Activity in securities available for sale:
               
Purchases
   
(176,713
)
   
(61,548
)
Maturities, prepayments, and calls
   
60,772
     
94,978
 
Loan originations and principal collections, net
   
(252,828
)
   
(209,047
)
Purchases of premises and equipment
   
(3,294
)
   
(2,319
)
Proceeds from sales of premises and equipment
   
245
     
108
 
Proceeds from sales of foreclosed assets
   
1,884
     
1,048
 
Net cash used in investing activities
   
(369,934
)
   
(176,780
)
                 
Cash flows from financing activities:
               
Net change in deposits
   
119,314
     
237,894
 
Net change in short-term borrowings
   
     
(26,550
)
Payments to tax authorities for stock-based compensation
   
(285
)
   
(106
)
Payments made on notes payable and other borrowings
   
     
(75,000
)
Cash dividends on common stock
   
(5,973
)
   
(3,784
)
Payments to repurchase common stock
   
(18,926
)
   
(6,082
)
Net cash provided by financing activities
   
94,130
     
126,372
 
                 
Net change in cash and cash equivalents
   
(156,859
)
   
27,293
 
Beginning cash and cash equivalents
   
486,821
     
300,307
 
Ending cash and cash equivalents
 
$
329,962
   
$
327,600
 

               
Supplemental disclosures of cash flow information:
               
Interest paid on deposits and borrowed funds
 
$
12,953
   
$
10,774
 
Income taxes paid
    8,488       8,842  
Supplemental schedule of noncash activities:
               
Loans transferred to foreclosed assets
 
$
465
   
$
722
 
Additions to mortgage servicing rights
   
2,694
     
8,018
 

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 ConsolidationThe consolidated financial statements in this Quarterly Report on Form 10-Q for the three and nine months ended September 30, 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 nine months ended September 30, 2022 and the year ended December 31, 2021.

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 (loss) 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 (loss) are amortized into earnings over the same periods which the hedged transactions will affect earnings.


Leases – During the second quarter of 2022, the Company adopted Accounting Standards Update (ASU”) No. 2016-02 — Leases (Topic 842), effective as of January 1, 2022, using the alternative transition method under the option to apply the lease standard at its effective date without adjusting the prior period comparative financial statements. The Company elected the package of practical expedients to not reassess: (i) whether any existing contracts are or contain a lease, (ii) the lease classification of any existing leases, and (iii) initial direct costs related to existing leases. The Company also elected to apply additional practical expedients to include both the lease and nonlease components of all leases as a single component and account for it as a lease and to use hindsight for leases existing at the adoption date. The Company recorded a $9.4 million right-of-use (“ROU”) asset, offset by a $10.3 million lease liability, and a $717 thousand, net of tax, cumulative effect adjustment debit to retained earnings.



The Company determines if an arrangement is a lease at inception. Operating leases with a term of greater than one year are included in other assets and other liabilities on the Company’s Consolidated Balance Sheets. Finance leases, if any, are included in premises and equipment and other liabilities on the Company’s Consolidated Balance Sheets. The Company has lease agreements with lease and nonlease components, which are generally accounted for as a single lease component. The Company has made an accounting policy election not to recognize short-term lease assets and liabilities (less than a 12-month term) or equipment leases (deemed not significant) on its Consolidated Balance Sheets; instead, the Company recognizes the lease expense for these leases on a straight-line basis over the life of the lease.



ROU assets represent the Company’s right to use an underlying asset for the lease term and lease liabilities represent its obligation to make lease payments arising from the lease. Operating lease ROU assets and liabilities are recognized on the lease commencement date based on the present value of lease payments over the lease term. As most of the Company’s leases do not provide an implicit rate, the Company uses an estimated incremental collateralized borrowing rate at lease inception, on a collateralized basis, over a similar term, when determining the present value of lease payments.



No significant judgments or assumptions were involved in developing the estimated operating lease liabilities as the Company’s operating lease liabilities largely represent the future rental expenses associated with operating leases, and the incremental borrowing rates are based on publicly available interest rates. The operating lease ROU asset also includes any lease payments made and excludes lease incentives. The Company’s lease terms may include options to extend or terminate the lease. These options to extend or terminate are assessed on a lease-by-lease basis, and the ROU assets and lease liabilities are adjusted when it is reasonably certain that an option will be exercised. Rental expense for lease payments is recognized on a straight-line basis over the lease term and is included in occupancy and equipment, net within our Consolidated Statements of Comprehensive Income (Loss).



The Company leases and subleases certain facilities and office space to outside parties; however, these leases are not significant.



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. 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 September 30, 2022 presentation.

Recent Accounting Pronouncements – FASB ASC constitutes GAAP for nongovernmental entities. Updates to ASC are prescribed in ASUs, which are not authoritative until incorporated into the ASC.


ASU 2021-01, Reference Rate Reform (Topic 848). In January 2021, the FASB issued ASU 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.

Subsequent EventsThe Company has evaluated subsequent events and transactions from September 30, 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
 
September 302022
                       
Available for sale:
                       
State and municipal
 
$
260,281
   
$
14
   
$
(40,142
)
 
$
220,153
 
Mortgage-backed securities
   
445,312
     
     
(71,340
)
   
373,972
 
Collateralized mortgage obligations
   
86,120
     
     
(310
)
   
85,810
 
Asset-backed and other amortizing securities
   
22,166
     
     
(2,066
)
   
20,100
 
Other securities
   
12,000
     
     
(623
)
   
11,377
 
   
$
825,879
   
$
14
   
$
(114,481
)
 
$
711,412
 

 
Amortized
Cost
   
Gross
Unrealized
Gains
   
Gross
Unrealized
Losses
   
Fair
Value
 
December 312021