Allegiance Bancshares, Inc. - Quarter Report: 2021 September (Form 10-Q)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

_______________________________________________

FORM 10-Q

_______________________________________________


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

FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2021


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

FOR THE TRANSITION PERIOD FROM TO

COMMISSION FILE NUMBER: 001-37585

_______________________________________________

Allegiance Bancshares, Inc.

(Exact name of registrant as specified in its charter)

_______________________________________________


Texas			26-3564100
(State or other jurisdiction of incorporation or organization)			(I.R.S. Employer Identification No.)

8847 West Sam Houston Parkway, N., Suite 200

Houston, Texas 77040

(Address of principal executive offices, including zip code)

(281) 894-3200

(Registrant’s telephone number, including area code)

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, par value, $1.00 per share

ABTX

NASDAQ Global Market

Securities registered pursuant to Section 12(g) of the Act: None

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 x No o

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 x No o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company or an emerging growth company. See definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting,” 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. o

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

As of October 26, 2021, the registrant had 20,247,480 shares common stock, $1.00 par value per share, outstanding.

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ALLEGIANCE BANCSHARES, INC.

INDEX TO FORM 10-Q

September 30, 2021


PART I—FINANCIAL INFORMATION

Item 1.	Interim Consolidated Financial Statements	3
	Consolidated Balance Sheets (unaudited)	3
	Consolidated Statements of Income (unaudited)	4
	Consolidated Statements of Comprehensive Income (unaudited)	5
	Consolidated Statements of Changes in Shareholders' Equity (unaudited)	6
	Consolidated Statements of Cash Flows (unaudited)	7
	Condensed Notes to Interim Consolidated Financial Statements (unaudited)	8
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	34
Item 3.	Quantitative and Qualitative Disclosures about Market Risk	61
Item 4.	Controls and Procedures	62

PART II—OTHER INFORMATION

Item 1.	Legal Proceedings	63
Item 1A.	Risk Factors	63
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	63
Item 3.	Defaults upon Senior Securities	63
Item 4.	Mine Safety Disclosures	63
Item 5.	Other Information	63
Item 6.	Exhibits	64
Signatures		65

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PART I—FINANCIAL INFORMATION

ITEM 1. INTERIM CONSOLIDATED FINANCIAL STATEMENTS

ALLEGIANCE BANCSHARES, INC.

CONSOLIDATED BALANCE SHEETS

(Unaudited)


	September 30, 2021		December 31, 2020
	(Dollars in thousands, except par value)
ASSETS
Cash and due from banks	$	23,903	$	122,897
Interest-bearing deposits at other financial institutions	879,858		299,869
Total cash and cash equivalents	903,761		422,766
Available for sale securities, at fair value	1,211,476		772,890
Loans held for investment	4,289,469		4,491,764
Less: allowance for credit losses on loans	(50,491)		(53,173)
Loans, net	4,238,978		4,438,591
Accrued interest receivable	33,523		40,053
Premises and equipment, net	65,140		70,685
Other real estate owned	1,397		9,196
Federal Home Loan Bank stock	8,326		7,756
Bank owned life insurance	28,101		27,686
Goodwill	223,642		223,642
Core deposit intangibles, net	15,482		17,954
Other assets	29,935		18,909
TOTAL ASSETS	$	6,759,761	$	6,050,128
LIABILITIES AND SHAREHOLDERS’ EQUITY
LIABILITIES:
Deposits:
Noninterest-bearing	$	2,086,683	$	1,704,567
Interest-bearing
Demand	594,959		437,328
Money market and savings	1,604,222		1,499,938
Certificates and other time	1,381,014		1,346,649
Total interest-bearing deposits	3,580,195		3,283,915
Total deposits	5,666,878		4,988,482
Accrued interest payable	3,296		2,701
Borrowed funds	139,954		155,515
Subordinated debt	108,715		108,322
Other liabilities	42,326		36,439
Total liabilities	5,961,169		5,291,459
COMMITMENTS AND CONTINGENCIES (See Note 13)
SHAREHOLDERS’ EQUITY:
Preferred stock, $1 par value; 1,000,000 shares authorized; no shares issued or outstanding	—		—
Common stock, $1 par value; 80,000,000 shares authorized; 20,218,175 shares issued and outstanding at September 30, 2021 and 20,208,323 shares issued and outstanding at December 31, 2020	20,218		20,208
Capital surplus	507,948		508,794
Retained earnings	247,966		195,236
Accumulated other comprehensive income	22,460		34,431
Total shareholders’ equity	798,592		758,669
TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY	$	6,759,761	$	6,050,128

See condensed notes to interim consolidated financial statements.

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ALLEGIANCE BANCSHARES, INC.

CONSOLIDATED STATEMENTS OF INCOME

(Unaudited)


	Three Months Ended September 30,				Nine Months Ended September 30,
	2021		2020		2021		2020
	(Dollars in thousands, except per share data)
INTEREST INCOME:
Loans, including fees	$	58,176	$	56,418	$	173,858	$	167,463
Securities:
Taxable	2,998		2,095		7,956		6,024
Tax-exempt	2,498		2,280		7,383		4,995
Deposits in other financial institutions	221		18		356		233
Total interest income	63,893		60,811		189,553		178,715
INTEREST EXPENSE:
Demand, money market and savings deposits	1,267		1,657		4,088		7,750
Certificates and other time deposits	2,583		5,239		9,237		17,168
Borrowed funds	436		558		1,444		1,626
Subordinated debt	1,441		1,448		4,324		4,390
Total interest expense	5,727		8,902		19,093		30,934
NET INTEREST INCOME	58,166		51,909		170,460		147,781
Provision for credit losses	2,295		1,347		255		23,006
Net interest income after provision for credit losses	55,871		50,562		170,205		124,775
NONINTEREST INCOME:
Nonsufficient funds fees	131		75		308		304
Service charges on deposit accounts	425		325		1,195		1,125
Gain on sale of securities	—		—		49		287
Loss on sale of other real estate and other repossessed assets	—		117		(176)		(258)
Bank owned life insurance income	125		144		415		438
Debit card and ATM card income	771		574		2,162		1,568
Other	647		615		2,155		2,673
Total noninterest income	2,099		1,850		6,108		6,137
NONINTEREST EXPENSE:
Salaries and employee benefits	22,335		20,034		67,259		59,149
Net occupancy and equipment	2,335		2,057		6,950		5,890
Depreciation	1,060		946		3,151		2,697
Data processing and software amortization	2,222		2,125		6,598		5,885
Professional fees	1,223		756		2,620		2,129
Regulatory assessments and FDIC insurance	883		875		2,458		2,116
Core deposit intangibles amortization	824		989		2,472		2,969
Communications	358		355		1,011		1,162
Advertising	481		327		1,211		1,218
Other real estate expense	137		2,017		479		4,780
Other	2,438		2,084		8,601		6,750
Total noninterest expense	34,296		32,565		102,810		94,745
INCOME BEFORE INCOME TAXES	23,674		19,847		73,503		36,167
Provision for income taxes	4,614		3,677		13,508		6,574
NET INCOME	$	19,060	$	16,170	$	59,995	$	29,593
EARNINGS PER SHARE:
Basic	$	0.94	$	0.79	$	2.97	$	1.45
Diluted	$	0.93	$	0.79	$	2.95	$	1.44
DIVIDENDS PER SHARE	$	0.12	$	0.10	$	0.36	$	0.30

See condensed notes to interim consolidated financial statements.

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ALLEGIANCE BANCSHARES, INC.

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(Unaudited)


	Three Months Ended September 30,				Nine Months Ended September 30,
	2021		2020		2021		2020
	(Dollars in thousands)
Net income	$	19,060	$	16,170	$	59,995	$	29,593
Other comprehensive (loss) income:
Unrealized (loss) gain on securities:
Change in unrealized holding (loss) gain on available for sale securities during the period	(10,548)		2,004		(16,356)		33,036
Reclassification of gain realized through the sale of securities	—		—		(49)		(287)
Unrealized gain (loss) on cash flow hedge:
Change in fair value of cash flow hedge	—		80		1,477		(1,495)
Reclassification of gain realized through the termination of cash flow hedge	—		—		(225)		—
Total other comprehensive (loss) income	(10,548)		2,084		(15,153)		31,254
Deferred tax benefit (expense) related to other comprehensive income	2,214		(437)		3,182		(6,563)
Other comprehensive (loss) income, net of tax	(8,334)		1,647		(11,971)		24,691
Comprehensive income	$	10,726	$	17,817	$	48,024	$	54,284

See condensed notes to interim consolidated financial statements.

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ALLEGIANCE BANCSHARES, INC.

CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY

(Unaudited)


	Common Stock			Capital Surplus		Retained Earnings		Accumulated Other Comprehensive Income (Loss)		Total Shareholders’ Equity
	Shares	Amount
	(Dollars in thousands, except per share data)
BALANCE AT JUNE 30, 2020	20,430,836	$	20,431	$	515,045	$	172,723	$	27,944	$	736,143
Net income						16,170				16,170
Other comprehensive income								1,647		1,647
Cash dividends declared, $0.10 per share						(2,027)				(2,027)
Common stock issued in connection with the exercise of stock options and restricted stock awards	13,794	14		243						257
Stock based compensation expense				863						863
BALANCE AT SEPTEMBER 30, 2020	20,444,630	$	20,445	$	516,151	$	186,866	$	29,591	$	753,053

BALANCE AT JUNE 30, 2021	20,212,534	$	20,213	$	506,810	$	231,333	$	30,794	$	789,150
Net income						19,060				19,060
Other comprehensive loss								(8,334)		(8,334)
Cash dividends declared, $0.12 per share						(2,427)				(2,427)
Common stock issued in connection with the exercise of stock options and restricted stock awards	5,641	5		106						111
Stock based compensation expense				1,032						1,032
BALANCE AT SEPTEMBER 30, 2021	20,218,175	$	20,218	$	507,948	$	247,966	$	22,460	$	798,592

BALANCE AT DECEMBER 31, 2019	20,523,816	$	20,524	$	521,066	$	163,375	$	4,900	$	709,865
Net income						29,593				29,593
Other comprehensive income								24,691		24,691
Cash dividends declared, $0.30 per share						(6,102)				(6,102)
Common stock issued in connection with the exercise of stock options and restricted stock awards	165,148	165		1,562						1,727
Repurchase of common stock	(244,334)	(244)		(9,058)						(9,302)
Stock based compensation expense				2,581						2,581
BALANCE AT SEPTEMBER 30, 2020	20,444,630	$	20,445	$	516,151	$	186,866	$	29,591	$	753,053

BALANCE AT DECEMBER 31, 2020	20,208,323	$	20,208	$	508,794	$	195,236	$	34,431	$	758,669
Net income						59,995				59,995
Other comprehensive loss								(11,971)		(11,971)
Cash dividends declared, $0.36 per share						(7,265)				(7,265)
Common stock issued in connection with the exercise of stock options and restricted stock awards	171,058	171		1,761						1,932
Repurchase of common stock	(161,206)	(161)		(5,498)						(5,659)
Stock based compensation expense				2,891						2,891
BALANCE AT SEPTEMBER 30, 2021	20,218,175	$	20,218	$	507,948	$	247,966	$	22,460	$	798,592

See condensed notes to interim consolidated financial statements.

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ALLEGIANCE BANCSHARES, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)


	Nine Months Ended September 30,
	2021		2020
	(Dollars in thousands)
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income	$	59,995	$	29,593
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and core deposit intangibles amortization	5,623		5,666
Provision for credit losses	255		23,006
Deferred income tax expense (benefit)	434		(5,123)
Net amortization of premium on investments	5,295		2,498
Excess tax benefit from stock based compensation	(262)		(65)
Bank owned life insurance income	(415)		(438)
Net accretion of discount on loans	(385)		(2,227)
Net amortization of discount on subordinated debt	86		84
Net accretion of discount on certificates of deposit	(122)		(295)
Loss on sale of other real estate and other repossessed assets	176		258
Loss on write-downs of premises, equipment and other real estate	1,317		4,065
Net gain on sale of securities	(49)		(287)
Federal Home Loan Bank stock dividends	(52)		(170)
Stock based compensation expense	2,891		2,581
Net change in operating leases	2,155		1,947
Increase in accrued interest receivable and other assets	(2,919)		(21,070)
Increase (decrease) in accrued interest payable and other liabilities	7,633		(2,397)
Net cash provided by operating activities	81,656		37,626
CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds from maturities and principal paydowns of available for sale securities	3,249,803		3,548,616
Proceeds from sales and calls of available for sale securities	4,898		30,790
Purchase of available for sale securities	(3,714,411)		(3,839,758)
Net change in total loans	209,737		(687,460)
Purchase of bank premises and equipment	(2,557)		(5,520)
Proceeds from sale of bank premises, equipment and other real estate	430		4,027
Net purchases of Federal Home Loan Bank stock	(518)		(3,304)
Net cash used in investing activities	(252,618)		(952,609)
CASH FLOWS FROM FINANCING ACTIVITIES:
Net increase in noninterest-bearing deposits	382,116		520,468
Net increase in interest-bearing deposits	296,402		329,092
Net change in other borrowed funds	—		65,000
Net (paydown) increase in borrowings under credit agreement	(15,569)		15,000
Dividends paid to common shareholders	(7,265)		(6,102)
Proceeds from the issuance of common stock and stock option exercises	1,932		1,727
Repurchase of common stock	(5,659)		(9,302)
Net cash provided by financing activities	651,957		915,883
NET CHANGE IN CASH AND CASH EQUIVALENTS	480,995		900
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD	422,766		346,248
CASH AND CASH EQUIVALENTS, END OF PERIOD	$	903,761	$	347,148
SUPPLEMENTAL CASH FLOW INFORMATION:
Income taxes paid	$	16,250	$	5,800
Interest paid	18,498		32,178
Cash paid for operating lease liabilities	2,596		2,438
SUPPLEMENTAL NONCASH DISCLOSURE:
Lease right-of-use asset obtained in exchange for lessee operating lease liabilities	$	1,446	$	2,221
Loans transferred to other real estate	821		539
Bank-financed sales of other real estate	8,125		2,315

See condensed notes to interim consolidated financial statements.

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ALLEGIANCE BANCSHARES, INC.

CONDENSED NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2021

(Unaudited)

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

Nature of Operations-Allegiance Bancshares, Inc. (“Allegiance”) and its wholly-owned subsidiary, Allegiance Bank, (the “Bank”, and together with Allegiance, collectively referred to as the “Company”) provide commercial and retail loans and commercial banking services. The Company derives substantially all of its revenues and income from the operation of the Bank. The Company is focused on delivering a wide variety of relationship-driven commercial banking products and community-oriented services tailored to meet the needs of small to medium-sized businesses, professionals and individual customers. The Company operated 27 full-service banking locations in the Houston region, which it defines as the Houston-The Woodlands-Sugar Land and Beaumont-Port Arthur metropolitan statistical areas, with 26 bank offices in the Houston metropolitan area and one bank office location in Beaumont, just outside of the Houston metropolitan area as of September 30, 2021. The Bank provides its customers with a variety of banking services including checking accounts, savings accounts and certificates of deposit, and its primary lending products are commercial, personal, automobile, mortgage and home improvement loans. The Bank also offers safe deposit boxes, automated teller machines, drive-through services and 24-hour depository facilities.

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

In the opinion of management, the accompanying unaudited condensed consolidated financial statements reflect all adjustments considered necessary for a fair presentation of the financial position, results of operations and cash flows of the Company on a consolidated basis, and all such adjustments are of a normal recurring nature. Transactions between the Company and the Bank have been eliminated. The condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements and footnotes thereto included in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2020. Operating results for the three and nine months ended September 30, 2021 are not necessarily indicative of the results that may be expected for the year ending December 31, 2021.

Significant Accounting and Reporting Policies

The Company’s significant accounting and reporting policies can be found in Note 1 of the Company’s annual financial statements included in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2020.

New Accounting Standards

Adoption of New Accounting Standards

ASU 2021-01, “Reference Rate Reform (Topic 848): Scope.” ASU 2021-01 clarifies that certain optional expedients and exceptions in ASC 848 for contract modifications and hedge accounting apply to derivatives that are affected by the discounting transition. ASU 2021-01 also amends the expedients and exceptions in ASC 848 to capture the incremental consequences of the scope clarification and to tailor the existing guidance to derivative instruments affected by the discounting transition. ASU 2021-01 was effective upon issuance and generally can be applied through December 31, 2022. The adoption of ASU 2021-01 did not significantly impact the Company's financial statements.

ASU 2020-09, “Debt (Topic 470): Amendments to SEC Paragraphs Pursuant to SEC Release No. 33-10762.” ASU 2020-09 amends the ASC to reflect the issuance of an SEC rule related to financial disclosure requirements for subsidiary issuers and guarantors of registered debt securities and affiliates whose securities are pledged as collateral for registered securities. ASU 2020-09 became effective for the Company on January 4, 2021, concurrent with the effective date of the SEC release, and did not have a significant impact on the Company's financial statements.

ASU 2020-08, “Codification Improvements to Subtopic 310-20, Receivables - Nonrefundable Fees and Other Costs.” ASU 2020-08 clarifies the accounting for the amortization of purchase premiums for callable debt securities with multiple call dates. ASU 2020-08 became effective for the Company on January 1, 2021 and did not have a significant impact on the Company's financial statements.

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ASU No. 2019-12, Income Taxes (Topic 740): Simplifying the Accounting for Income Taxes (“ASU 2019-12”), that removes certain exceptions for investments, intraperiod allocations and interim calculations, and adds guidance to reduce complexity in accounting for income taxes. ASU 2019-12 introduces the following new guidance: (i) guidance to evaluate whether a step-up in tax basis of goodwill relates to a business combination in which book goodwill was recognized or a separate transaction and (ii) a policy election to not allocate consolidated income taxes when a member of a consolidated tax return is not subject to income tax. Additionally, ASU 2019-12 changes the following current guidance: (i) making an intraperiod allocation, if there is a loss in continuing operations and gains outside of continuing operations, (ii) determining when a deferred tax liability is recognized after an investor in a foreign entity transitions to or from the equity method of accounting, (iii) accounting for tax law changes and year-to-date losses in interim periods, and (iv) determining how to apply the income tax guidance to franchise taxes that are partially based on income. The Company adopted ASU 2019-12 on January 1, 2021, which did not have a material impact on the Company’s results of operations, financial position or disclosures.

ASU 2016-13, “Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments (“ASC Topic 326”), was issued by the FASB in June 2016 along with subsequent amendments thereto, which introduce the current expected credit losses (“CECL”) methodology. The measurement of expected credit losses under the CECL methodology utilizes a lifetime “expected credit loss” measurement objective for the recognition of credit losses for loans, held-to-maturity debt securities measured at amortized cost. ASC Topic 326 also applies to off-balance sheet credit exposures. This methodology replaces the multiple existing impairment methods in current guidance, which generally require that a loss be incurred before it is recognized. Within the life cycle of a loan or other financial asset, this new guidance will generally result in the earlier recognition of the provision for credit losses and the related allowance for credit losses than previous practice. For available for sale debt securities that the Company intends to hold and where fair value is less than cost, credit-related impairment, if any, will be recognized through an allowance for credit losses and adjusted each period for changes in credit risk. CECL became effective for the Company on January 1, 2020; however, on March 27, 2020, the Coronavirus Aid, Relief, and Economic Security Act (“CARES Act”) was signed in to law by the President of the United States and allowed the option to temporarily defer or suspend the adoption of ASC Topic 326. The Company elected to temporarily defer the adoption of CECL due to the uncertainty of the impact of COVID-19 and the volatility of crude oil prices, which can be impactful to the Houston market. During the deferral, the Company calculated and recorded its provision for loan losses under the incurred loss model that existed prior to ASC Topic 326. The Company adopted the new standard as of January 1, 2020, during the fourth quarter of 2020, using the modified retrospective method such that prior period amounts were not adjusted, but were reported in accordance with previously applicable generally accepted accounting principles and a cumulative effect adjustment to the opening balance of retained earnings was recognized.

Upon adoption of ASC Topic 326, the Company recognized an increase in allowance for credit losses on loans of $3.1 million and the establishment of an allowance for credit losses for off-balance sheet exposure of $3.9 million and a corresponding decrease in retained earnings of $5.5 million, after-tax. The Company adopted ASC Topic 326 using the prospective transition approach for purchased credit deteriorated (“PCD”) loans, which did not require re-evaluation of whether loans previously classified as purchased credit impaired (“PCI”) loans met the criteria of PCD assets at the date of adoption. The Company recognized an increase in the allowance for credit losses for loans of $2.1 million, due to the reclassification of PCD discounts previously classified as PCI with a corresponding adjustment to the gross carrying amount of the loans. The remaining noncredit discount was accreted into interest income at the effective interest rate as of January 1, 2020. See Note 4 “Loans and Allowance for Credit Losses” for additional information.

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The following table illustrates the impact of adopting ASC Topic 326:


	As of January 1, 2020
	As Reported Under ASC Topic 326		Pre-ASC Topic 326 Adoption		Impact of ASC Topic 326 Adoption
	(Dollars in thousands)
Assets:
Allowance for credit losses on loans:
Commercial and industrial	$	15,840	$	8,818	$	7,022
Paycheck Protection Program (PPP)	—		—		—
Real estate:
Commercial real estate (including multi-family residential)	6,007		11,170		(5,163)
Commercial real estate construction and land development	6,051		4,421		1,630
1-4 family residential (including home equity)	5,452		3,852		1,600
Residential construction	1,056		1,057		(1)
Consumer and other	257		120		137
Allowance for credit losses on loans	$	34,663	$	29,438	$	5,225
Liabilities:
Allowance for credit losses on unfunded commitments	$	3,866	$	—	$	3,866

ASC Topic 326 also requires expected credit losses on available for sale (“AFS”) debt securities to be recorded as an allowance for credit losses. For certain types of debt securities, such as U.S. Treasuries and other securities with government guarantees, entities may expect zero credit losses. The zero-loss expectation generally applies to the Company’s securities and no allowance for credit losses were recorded on its AFS securities portfolio at transition. See Note 3 “Securities” for additional information.

Newly Issued But Not Yet Effective Accounting Standards

ASU 2020-04, "Reference Rate Reform: Facilitation of the Effects of Reference Rate Reform on Financial Reporting - Accounting Standards Codification (“ASC”) Topic 848." ASU 2020-04 provides optional expedients and exceptions for applying GAAP to loan and lease agreements, derivative contracts, and other transactions affected by the anticipated transition away from LIBOR toward new interest rate benchmarks. The guidance allows for companies to: (i) account for certain contract modifications as a continuation of the existing contract without additional analysis; (ii) continue hedge accounting when certain critical terms of a hedging relationship change and assess effectiveness in ways that disregard certain potential sources of ineffectiveness; and (iii) make a one-time sale and/or transfer of certain debt securities from held-to-maturity to available for sale or trading. This ASU is available for adoption effective March 12, 2020 through December 31, 2022. An entity may elect to apply ASU 2020-04 for contract modifications as of January 1, 2020, or prospectively from a date within an interim period that includes or is subsequent to March 12, 2020, up to the date that the financial statements are available to be issued. Once elected for a Topic or an Industry Subtopic within ASU 2020-04, the amendments must be applied prospectively for all eligible contract modifications for that Topic or Industry Subtopic. The one-time election to sell and/or transfer debt securities classified as held-to-maturity may be made at any time after March 12, 2020. The Company anticipates this ASU will simplify any modifications it executes between the selected start date (yet to be determined) and December 31, 2022 that are directly related to the LIBOR transition by allowing prospective recognition of the continuation of the contract, rather than extinguishment of the old contract resulting in writing off unamortized fees and costs. ASU 2020-04 is not expected to have a significant impact on the Company’s financial statements.

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2. GOODWILL AND CORE DEPOSIT INTANGIBLE ASSETS

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


	Goodwill		Core Deposit Intangibles
	(Dollars in thousands)
Balance as of December 31, 2019	$	223,642	$	21,876
Amortization	—		(3,922)
Balance as of December 31, 2020	223,642		17,954
Amortization	—		(2,472)
Balance as of September 30, 2021	$	223,642	$	15,482

Goodwill is recorded on the acquisition date of an entity. During the measurement period, the Company may record subsequent adjustments to goodwill for provisional amounts recorded at the acquisition date.

Management performs an evaluation annually, and more frequently if a triggering event occurs, of whether any impairment of the goodwill and other intangible assets has occurred. If any such impairment is determined, a write-down is recorded. As of September 30, 2021, there were no impairments recorded on goodwill and other intangible assets.

The estimated aggregate future amortization expense for core deposit intangible assets remaining as of September 30, 2021 is as follows (dollars in thousands):


Remaining 2021	$	824
2022	3,003
2023	2,323
2024	2,188
2025	2,061
Thereafter	5,083
Total	$	15,482

3. SECURITIES

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


	September 30, 2021
	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses		Fair Value
	(Dollars in thousands)
Available for Sale
U.S. government and agency securities	$	132,434	$	487	$	(928)	$	131,993
Municipal securities	455,816		28,142		(1,686)		482,272
Agency mortgage-backed pass-through securities	250,913		2,585		(3,651)		249,847
Agency collateralized mortgage obligations	230,273		2,585		(2,111)		230,747
Corporate bonds and other	113,598		3,420		(401)		116,617
Total	$	1,183,034	$	37,219	$	(8,777)	$	1,211,476

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	December 31, 2020
	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses		Fair Value
	(Dollars in thousands)
Available for Sale
U.S. government and agency securities	$	25,545	$	654	$	—	$	26,199
Municipal securities	392,586		35,079		(60)		427,605
Agency mortgage-backed pass-through securities	167,606		3,829		(146)		171,289
Agency collateralized mortgage obligations	80,182		4,263		(75)		84,370
Corporate bonds and other	62,124		1,352		(49)		63,427
Total	$	728,043	$	45,177	$	(330)	$	772,890

As of September 30, 2021, no allowance for credit losses has been recognized on available for sale securities in an unrealized loss position as management does not believe any of the securities are impaired due to reasons of credit quality. This is based upon the Company’s analysis of the underlying risk characteristics, including credit ratings, and other qualitative factors related to its available for sale securities and in consideration of our historical credit loss experience and internal forecasts. The issuers of these securities continue to make timely principal and interest payments under the contractual terms of the securities. Furthermore, management does not have the intent to sell any of the securities classified as available for sale in the table above and believes that it is more likely than not that we will not have to sell any such securities before a recovery of cost. The unrealized losses are due to 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 repricing date or if market yields for such investments decline.

The amortized cost and fair value of investment securities at September 30, 2021, by contractual maturity, are shown below. Expected maturities may differ from contractual maturities if borrowers have the right to call or prepay obligations at any time with or without call or prepayment penalties.


	Amortized Cost		Fair Value
	(Dollars in thousands)
Due in one year or less	$	3,879	$	3,939
Due after one year through five years	13,365		14,012
Due after five years through ten years	136,698		141,890
Due after ten years	547,906		571,041
Subtotal	701,848		730,882
Agency mortgage-backed pass-through securities and collateralized mortgage obligations	481,186		480,594
Total	$	1,183,034	$	1,211,476

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


	September 30, 2021
	Less than 12 Months				More than 12 Months				Total
	Estimated Fair Value		Unrealized Losses		Estimated Fair Value		Unrealized Losses		Estimated Fair Value		Unrealized Losses
	(Dollars in thousands)
Available for Sale
U.S. government and agency securities	$	98,257	$	(928)	$	—	$	—	$	98,257	$	(928)
Municipal securities	73,698		(1,380)		8,513		(306)		82,211		(1,686)
Agency mortgage-backed pass-through securities	121,593		(3,450)		7,958		(201)		129,551		(3,651)
Agency collateralized mortgage obligations	117,355		(1,977)		10,402		(134)		127,757		(2,111)
Corporate bonds and other	25,430		(401)		—		—		25,430		(401)
Total	$	436,333	$	(8,136)	$	26,873	$	(641)	$	463,206	$	(8,777)


	December 31, 2020
	Less than 12 Months				More than 12 Months				Total
	Estimated Fair Value		Unrealized Losses		Estimated Fair Value		Unrealized Losses		Estimated Fair Value		Unrealized Losses
	(Dollars in thousands)
Available for Sale
Municipal securities	$	8,844	$	(60)	$	—	$	—	$	8,844	$	(60)
Agency mortgage-backed pass-through securities	28,659		(146)		—		—		28,659		(146)
Agency collateralized mortgage obligations	11,629		(39)		4,203		(36)		15,832		(75)
Corporate bonds and other	15,951		(49)		—		—		15,951		(49)
Total	$	65,083	$	(294)	$	4,203	$	(36)	$	69,286	$	(330)

The Company sold $4.9 million of securities recording gross gains of $49 thousand for the nine months ended September 30, 2021 with none of these securities sold during the three months ended September 30, 2021. There were no securities sold during the three months ended September 30, 2020. The Company sold $30.8 million and had calls of $7.1 million of securities recording gross gains of $391 thousand and gross losses of $104 thousand for a net gain of $287 thousand for the nine months ended September 30, 2020. At September 30, 2021 and December 31, 2020, the Company did not own securities of any one issuer, other than the U.S government and its agencies, in an amount greater than 10% of consolidated shareholders’ equity at such respective dates.

The carrying value of pledged securities was $11.7 million at September 30, 2021 and $18.5 million at December 31, 2020, respectively. The majority of the securities were pledged to collateralize public fund deposits.

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4. LOANS AND ALLOWANCE FOR CREDIT LOSSES

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


	September 30, 2021		December 31, 2020
	(Dollars in thousands)
Commercial and industrial	$	728,897	$	667,079
Paycheck Protection Program (PPP)	290,028		569,901
Real estate:
Commercial real estate (including multi-family residential)	2,073,521		1,999,877
Commercial real estate construction and land development	382,610		367,213
1-4 family residential (including home equity)	683,919		737,605
Residential construction	104,638		127,522
Consumer and other	25,856		22,567
Total loans	4,289,469		4,491,764
Allowance for credit losses on loans	(50,491)		(53,173)
Loans, net	$	4,238,978	$	4,438,591

Nonaccrual and Past Due Loans

An aging analysis of the recorded investment in past due loans, segregated by class of loans, is included below. The Company defines recorded investment as the outstanding loan balances including net deferred loan fees, and excluding accrued interest receivable of $27.4 million and $34.5 million as of September 30, 2021 and December 31, 2020, respectively, due to immateriality.


	September 30, 2021
	Loans Past Due and Still Accruing						Nonaccrual Loans		Current Loans		Total Loans
	30-89 Days		90 or More Days		Total Past Due Loans
	(Dollars in thousands)
Commercial and industrial	$	5,479	$	—	$	5,479	$	10,247	$	713,171	$	728,897
Paycheck Protection Program (PPP)	—		—		—		—		290,028		290,028
Real estate:
Commercial real estate (including multi-family residential)	11,021		—		11,021		14,629		2,047,871		2,073,521
Commercial real estate construction and land development	653		—		653		53		381,904		382,610
1-4 family residential (including home equity)	2,428		—		2,428		3,224		678,267		683,919
Residential construction	1,191		—		1,191		—		103,447		104,638
Consumer and other	23		—		23		216		25,617		25,856
Total loans	$	20,795	$	—	$	20,795	$	28,369	$	4,240,305	$	4,289,469

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	December 31, 2020
	Loans Past Due and Still Accruing						Nonaccrual Loans		Current Loans		Total Loans
	30-89 Days		90 or More Days		Total Past Due Loans
	(Dollars in thousands)
Commercial and industrial	$	2,486	$	—	$	2,486	$	10,747	$	653,846	$	667,079
Paycheck Protection Program (PPP)	—		—		—		—		569,901		569,901
Real estate:
Commercial real estate (including multi-family residential)	3,063		—		3,063		10,081		1,986,733		1,999,877
Commercial real estate construction and land development	2,930		—		2,930		3,011		361,272		367,213
1-4 family residential (including home equity)	3,000		—		3,000		4,525		730,080		737,605
Residential construction	—		—		—		—		127,522		127,522
Consumer and other	46		—		46		529		21,992		22,567
Total loans	$	11,525	$	—	$	11,525	$	28,893	$	4,451,346	$	4,491,764

Credit Quality Indicators

The Company categorizes loans into risk categories based on relevant information about the ability of borrowers to service their debt. The Company utilizes a risk rating matrix to assign a risk rating to each of its loans. Loans are rated on a scale of 1 to 9. Risk ratings are updated on an ongoing basis and are subject to change by continuous loan monitoring processes including lending management monitoring, executive management and board committee oversight, and independent credit review. As part of the ongoing monitoring of the credit quality of the Company’s loan portfolio and methodology for calculating the allowance for credit losses, management assigns and tracks certain risk ratings to be used as credit quality indicators including trends related to (i) the weighted-average risk grade of loans, (ii) the level of classified loans, (iii) the delinquency status of loans (iv) nonperforming loans and (vi) the general economic conditions in the Houston region. Individual bankers, under the oversight of credit administration, review updated financial information for all pass grade commercial loans to reassess the risk grade on at least an annual basis. When a loan has a risk grade of Pass/Watch (4), it is still considered a pass grade loan; however, it is considered to be on management’s “watch list,” where a significant risk-modifying action is anticipated in the near term. When a loan reaches a set of internally designated criteria, including Substandard-nonperforming (7) or higher, a special assets officer generally will be involved in the monitoring of the loan on an on-going basis.

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

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

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

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

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

Loss—Loans classified as loss are to be charged-off or charged-down when payment is acknowledged to be uncertain or when the timing or value of payments cannot be determined. “Loss” is not intended to imply that the loan or some portion of it will never be paid, nor does it in any way imply that there has been a forgiveness of debt.

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The following table presents risk ratings by category of loan as of September 30, 2021 and December 31, 2020:


	As of September 30, 2021																		As of December 31, 2020
	Term Loans Amortized Cost Basis by Origination Year												Revolving Loans		Revolving Loans Converted to Term Loans		Total		Total
	2021		2020		2019		2018		2017		Prior
	(Dollars in thousands)
Commercial and industrial
Pass	$	159,566	$	94,424	$	50,231	$	30,160	$	12,645	$	14,707	$	294,765	$	206	$	656,704	$	562,518
Watch	14,143		4,144		6,446		3,772		724		1,912		6,702		—		37,843		41,026
Special Mention	1,466		313		793		1,344		352		—		2,075		—		6,343		25,010
Substandard	12,059		5,336		1,891		1,768		2,015		842		3,990		—		27,901		38,385
Doubtful	106		—		—		—		—		—		—		—		106		140
Total commercial and industrial loans	$	187,340	$	104,217	$	59,361	$	37,044	$	15,736	$	17,461	$	307,532	$	206	$	728,897	$	667,079

Paycheck Protection Program (PPP)
Pass	$	263,719	$	26,309	$	—	$	—	$	—	$	—	$	—	$	—	$	290,028	$	569,901
Watch	—		—		—		—		—		—		—		—		—		—
Special Mention	—		—		—		—		—		—		—		—		—		—
Substandard	—		—		—		—		—		—		—		—		—		—
Doubtful	—		—		—		—		—		—		—		—		—		—
Total PPP loans	$	263,719	$	26,309	$	—	$	—	$	—	$	—	$	—	$	—	$	290,028	$	569,901

Commercial real estate (including multi-family residential)
Pass	$	572,881	$	505,844	$	243,402	$	154,344	$	151,428	$	112,031	$	40,746	$	488	$	1,781,164	$	1,629,023
Watch	30,209		17,837		21,763		13,473		21,973		20,315		1,675		—		127,245		177,651
Special Mention	10,383		9,197		6,379		4,697		5,602		5,302		1,847		—		43,407		68,276
Substandard	17,993		22,948		25,437		15,893		16,944		21,211		1,086		193		121,705		124,927
Doubtful	—		—		—		—		—		—		—		—		—		—
Total commercial real estate (including multi-family residential) loans	$	631,466	$	555,826	$	296,981	$	188,407	$	195,947	$	158,859	$	45,354	$	681	$	2,073,521	$	1,999,877

Commercial real estate construction and land development
Pass	$	163,027	$	111,059	$	37,062	$	15,751	$	7,625	$	6,550	$	13,381	$	—	$	354,455	$	320,133
Watch	3,498		5,432		2,133		2,789		5,000		—		—		—		18,852		39,021
Special Mention	4,124		165		1,633		366		865		250		—		—		7,403		2,880
Substandard	534		98		472		654		—		—		142		—		1,900		5,179
Doubtful	—		—		—		—		—		—		—		—		—		—
Total commercial real estate construction and land development	$	171,183	$	116,754	$	41,300	$	19,560	$	13,490	$	6,800	$	13,523	$	—	$	382,610	$	367,213

1-4 family residential (including home equity)
Pass	$	152,421	$	163,538	$	91,396	$	58,739	$	47,500	$	33,771	$	77,540	$	2,212	$	627,117	$	670,074
Watch	4,722		5,826		2,843		5,705		4,006		3,220		6,448		2,337		35,107		37,667
Special Mention	2,202		261		972		487		331		2,346		2,497		53		9,149		18,790
Substandard	1,093		1,384		2,791		2,823		1,460		2,780		215		—		12,546		11,074
Doubtful	—		—		—		—		—		—		—		—		—		—
Total 1-4 family residential (including home equity)	$	160,438	$	171,009	$	98,002	$	67,754	$	53,297	$	42,117	$	86,700	$	4,602	$	683,919	$	737,605

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	As of September 30, 2021																		As of December 31, 2020
	Term Loans Amortized Cost Basis by Origination Year												Revolving Loans		Revolving Loans Converted to Term Loans
	2021		2020		2019		2018		2017		Prior						Total		Total
	(Dollars in thousands)
Residential construction
Pass	$	60,063	$	33,376	$	1,598	$	5,208	$	715	$	—	$	—	$	—	$	100,960	$	124,737
Watch	2,033		—		741		—		—		—		—		—		2,774		2,785
Special Mention	—		—		—		—		—		—		—		—		—		—
Substandard	904		—		—		—		—		—		—		—		904		—
Doubtful	—		—		—		—		—		—		—		—		—		—
Total residential construction	$	63,000	$	33,376	$	2,339	$	5,208	$	715	$	—	$	—	$	—	$	104,638	$	127,522

Consumer and other
Pass(1)	(2,304)		21,098		1,507		983		394		64		3,236		—		24,978		21,359
Watch	110		252		191		—		—		—		63		—		616		389
Special Mention	—		—		4		18		—		—		16		—		38		270
Substandard	—		9		208		7		—		—		—		—		224		549
Doubtful	—		—		—		—		—		—		—		—		—		—
Total consumer and other	$	(2,194)	$	21,359	$	1,910	$	1,008	$	394	$	64	$	3,315	$	—	$	25,856	$	22,567

Total loans
Pass	1,369,373		955,648		425,196		265,185		220,307		167,123		429,668		2,906		3,835,406		3,897,745
Watch	54,715		33,491		34,117		25,739		31,703		25,447		14,888		2,337		222,437		298,539
Special Mention	18,175		9,936		9,781		6,912		7,150		7,898		6,435		53		66,340		115,226
Substandard	32,583		29,775		30,799		21,145		20,419		24,833		5,433		193		165,180		180,114
Doubtful	106		—		—		—		—		—		—		—		106		140
Total loans	$	1,474,952	$	1,028,850	$	499,893	$	318,981	$	279,579	$	225,301	$	456,424	$	5,489	$	4,289,469	$	4,491,764


(1)			Includes net deferred fees of $10.8 million and $13.9 million on PPP loans as of September 30, 2021 and December 31, 2020, respectively.

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The following table presents the activity in the allowance for credit losses on loans by portfolio type for the three and nine months ended September 30, 2021 and 2020:


	Commercial and industrial		Paycheck Protection Program (PPP)		Commercial real estate (including multi-family residential)		Commercial real estate construction and land development		1-4 family residential (including home equity)		Residential construction		Consumer and other		Total
	(Dollars in thousands)
Allowance for credit losses on loans:
Three Months Ended
Balance June 30, 2021	$	18,254	$	—	$	22,909	$	6,006	$	1,304	$	840	$	273	$	49,586
Provision for credit losses on loans	565		—		423		822		(381)		34		(108)		1,355
Charge-offs	(50)		—		(457)		—		—		—		(20)		(527)
Recoveries	70		—		—		—		—		—		7		77
Net charge-offs	20		—		(457)		—		—		—		(13)		(450)
Balance September 30, 2021	$	18,839	$	—	$	22,875	$	6,828	$	923	$	874	$	152	$	50,491

Nine Months Ended
Balance December 31, 2020	$	17,738	$	—	$	23,934	$	6,939	$	3,279	$	870	$	413	$	53,173
Recapture of credit losses on loans	1,563		—		(602)		(111)		(2,335)		4		(244)		(1,725)
Charge-offs	(609)		—		(457)		—		(21)		—		(24)		(1,111)
Recoveries	147		—		—		—		—		—		7		154
Net charge-offs	(462)		—		(457)		—		(21)		—		(17)		(957)
Balance September 30, 2021	$	18,839	$	—	$	22,875	$	6,828	$	923	$	874	$	152	$	50,491

Allowance for loan losses:
Three Months Ended
Balance June 30, 2020	$	13,367	$	—	$	20,889	$	3,865	$	7,542	$	1,803	$	176	$	47,642
Provision for loan losses	(126)		—		2,453		(379)		(349)		(471)		219		1,347
Charge-offs	(350)		—		—		(71)		—		—		—		(421)
Recoveries	122		—		8		—		—		—		—		130
Net charge-offs	(228)		—		8		(71)		—		—		—		(291)
Balance September 30, 2020	$	13,013	$	—	$	23,350	$	3,415	$	7,193	$	1,332	$	395	$	48,698

Nine Months Ended
Balance December 31, 2019	$	8,818	$	—	$	11,170	$	4,421	$	3,852	$	1,057	$	120	$	29,438
Provision for loan losses	5,256		—		12,309		1,335		3,556		275		275		23,006
Charge-offs	(1,442)		—		(137)		(2,341)		(215)		—		—		(4,135)
Recoveries	381		—		8		—		—		—		—		389
Net charge-offs	(1,061)		—		(129)		(2,341)		(215)		—		—		(3,746)
Balance September 30, 2020	$	13,013	$	—	$	23,350	$	3,415	$	7,193	$	1,332	$	395	$	48,698

Allowance for Credit Losses on Unfunded Commitments. In addition to the allowance for credit losses on loans, the Company has established an allowance for credit losses on unfunded commitments, classified in other liabilities and adjusted as a provision for credit loss expense. The allowance represents estimates of expected credit losses over the contractual period in which there is exposure to credit risk via a contractual obligation to extend credit, unless that obligation is unconditionally cancellable by the Company. The estimate includes consideration of the likelihood that funding will occur and an estimate of expected credit losses on the commitments expected to fund. The estimate of commitments expected to fund is informed by historical analysis looking at utilization rates. The expected credit loss rates applied to the commitments expected to fund is informed by the general valuation allowance utilized for outstanding balances with the same underlying assumptions and drivers. The allowance for credit losses on unfunded commitments as of September 30, 2021 and December 31, 2020 was $6.7 million and $4.7 million, respectively. The establishment of an allowance as of December 31, 2020 was due to the adoption of CECL and as such was not considered at September 30, 2020. This reserve is maintained at a level management believes to be sufficient to absorb losses arising from unfunded loan commitments.

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The following table details activity in the allowance for credit losses on unfunded commitments is as follows (dollars in thousands):


Balance at June 30, 2021	$	5,737
Provision for credit losses on unfunded commitments	939
Balance at September 30, 2021	$	6,676

Balance at December 31, 2020	$	4,697
Provision for credit losses on unfunded commitments	1,979
Balance at September 30, 2021	$	6,676

Collateral dependent loans are secured by real estate assets, accounts receivable, inventory and equipment. For a collateral dependent loan, the Company’s evaluation process includes a valuation by appraisal or other collateral analysis adjusted for selling costs, when appropriate. This valuation is compared to the remaining outstanding principal balance of the loan. If a loss is determined to be probable, the loss is included in the allowance for credit losses on loans as a specific allocation. The following table presents the amortized cost basis of collateral dependent loans, which are individually evaluated to determine expected credit losses as of September 30, 2021 and December 31, 2020:


	As of September 30, 2021
	Real Estate		Business Assets		Other		Total
	(Dollars in thousands)
Commercial and industrial	$	—	$	4,517	$	—	$	4,517
Paycheck Protection Program (PPP)	—		—		—		—
Real estate:
Commercial real estate (including multi-family residential)	1,343		—		—		1,343
Commercial real estate construction and land development	53		—		—		53
1-4 family residential (including home equity)	4,104		—		—		4,104
Residential construction	—		—		—		—
Consumer and other	175		—		—		175
Total	$	5,675	$	4,517	$	—	$	10,192


	As of December 31, 2020
	Real Estate		Business Assets		Other		Total
	(Dollars in thousands)
Commercial and industrial	$	—	$	5,157	$	—	$	5,157
Paycheck Protection Program (PPP)	—		—		—		—
Real estate:
Commercial real estate (including multi-family residential)	425		—		—		425
Commercial real estate construction and land development	—		—		—		—
1-4 family residential (including home equity)	3,101		—		—		3,101
Residential construction	—		—		—		—
Consumer and other	—		—		—		—
Total	$	3,526	$	5,157	$	—	$	8,683

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The following table presents additional information regarding nonaccrual loans. No interest income was recognized on nonaccrual loans as of September 30, 2021 and December 31, 2020.


	As of September 30, 2021
	Nonaccrual Loans with No Related Allowance		Nonaccrual Loans with Related Allowance		Total Nonaccrual Loans
	(Dollars in thousands)
Commercial and industrial	$	2,179	$	8,068	$	10,247
Paycheck Protection Program (PPP)	—		—		—
Real estate:
Commercial real estate (including multi-family residential)	11,788		2,841		14,629
Commercial real estate construction and land development	53		—		53
1-4 family residential (including home equity)	2,667		557		3,224
Residential construction	—		—		—
Consumer and other	175		41		216
Total loans	$	16,862	$	11,507	$	28,369


	As of December 31, 2020
	Nonaccrual Loans with No Related Allowance		Nonaccrual Loans with Related Allowance		Total Nonaccrual Loans
	(Dollars in thousands)
Commercial and industrial	$	2,097	$	8,650	$	10,747
Paycheck Protection Program (PPP)	—		—		—
Real estate:
Commercial real estate (including multi-family residential)	7,487		2,594		10,081
Commercial real estate construction and land development	2,958		53		3,011
1-4 family residential (including home equity)	2,652		1,873		4,525
Residential construction	—		—		—
Consumer and other	—		529		529
Total loans	$	15,194	$	13,699	$	28,893

Troubled Debt Restructurings

As of September 30, 2021 and December 31, 2020, the Company had a recorded investment in troubled debt restructurings of $21.4 million and $25.8 million, respectively. The Company allocated $2.3 million and $3.3 million of specific reserves for troubled debt restructurings at September 30, 2021 and December 31, 2020, respectively.

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The following table presents information regarding loans modified in a troubled debt restructuring during the three and nine months ended September 30, 2021 and 2020:


	Three Months Ended September 30,
	2021					2020
	Number of Contracts	Pre-Modification of Outstanding Recorded Investment		Post Modification of Outstanding Recorded Investment		Number of Contracts	Pre-Modification of Outstanding Recorded Investment		Post Modification of Outstanding Recorded Investment
	(Dollars in thousands)
Troubled Debt Restructurings
Commercial and industrial	4	$	300	$	300	5	$	1,133	$	1,133
Paycheck Protection Program (PPP)	—	—		—		—	—		—
Real estate:
Commercial real estate (including multi-family residential)	—	—		—		3	1,983		1,983
Commercial real estate construction and land development	—	—		—		—	—		—
1-4 family residential (including home equity)	—	—		—		1	1,081		1,081
Residential construction	—	—		—		—	—		—
Consumer and other	—	—		—		—	—		—
Total	4	$	300	$	300	9	$	4,197	$	4,197


	Nine Months Ended September 30,
	2021					2020
	Number of Contracts	Pre-Modification of Outstanding Recorded Investment		Post Modification of Outstanding Recorded Investment		Number of Contracts	Pre-Modification of Outstanding Recorded Investment		Post Modification of Outstanding Recorded Investment
	(Dollars in thousands)
Troubled Debt Restructurings
Commercial and industrial	7	$	1,105	$	1,105	16	$	3,137	$	3,137
Paycheck Protection Program (PPP)	—	—		—		—	—		—
Real estate:
Commercial real estate (including multi-family residential)	1	545		545		3	1,983		1,983
Commercial real estate construction and land development	—	—		—		1	830		830
1-4 family residential (including home equity)	—	—		—		4	2,021		2,021
Residential construction	—	—		—		—	—		—
Consumer and other	—	—		—		1	30		30
Total	8	$	1,650	$	1,650	25	$	8,001	$	8,001

Troubled debt restructurings resulted in $21 thousand of charge-offs during the nine months ended September 30, 2021 and $632 thousand of charge-offs during the nine months ended September 30, 2020.

As of September 30, 2021, three loans for $247 thousand were modified under a troubled debt restructuring during the previous twelve-month period that subsequently defaulted during the nine months ended September 30, 2021. As of September 30, 2020, there was one loan for $22 thousand modified under a troubled debt restructuring during the previous twelve-month period that

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subsequently defaulted during the nine months ended September 30, 2020. Default is determined at 90 or more days past due. The modifications primarily related to extending the amortization periods of the loans. The Company did not grant principal reductions on any restructured loans. There were no commitments to lend additional amounts to troubled debt restructured loans for the three and nine months ended September 30, 2021 and 2020. During the nine months ended September 30, 2021, the Company added $1.7 million in new troubled debt restructurings, of which $1.6 million was still outstanding on September 30, 2021. During the nine months ended September 30, 2020, the Company added $8.0 million in new troubled debt restructurings, of which $6.7 million was still outstanding on September 30, 2020.

The Company granted principal and interest deferrals on outstanding loan balances to customers affected by the COVID-19 pandemic. Additionally, upon request and after meeting certain conditions, borrowers could be granted additional payment deferrals subsequent to the first deferral. In addition to the short-term modification program implemented by the Company, Section 4013 of the CARES Act and bank regulatory interagency guidance gave entities temporary relief from the accounting and disclosure requirements for troubled debt restructurings (“TDR”) indicating that a lender could conclude that the modifications are not a TDR if the borrower was less than 30 days past due as of December 31, 2019. As of September 30, 2021, 37 loans with outstanding loan balances of $37.4 million remained on deferral. If the impact of COVID-19 persists, borrower operations do not improve or if other negative events occur, such modified loans could transition to potential problem loans or into problem loans.

The following table presents information regarding loans with principal and/or interest deferrals as of September 30, 2021 associated with loan modifications related to COVID-19:


			Inside of Deferral Period				Outside of Deferral Period				Total Loans That Have Had a Deferral
	Outstanding Loan Balance		Loan Balance		Percent		Loan Balance		Percent		Loan Balance		Percent
	(Dollars in thousands)
Commercial and industrial	$	728,897	$	979	2.6	%	$	78,871	10.1	%	$	79,850	9.7	%
Paycheck Protection Program (PPP)	290,028		—		—	%	—		—	%	—		—	%
Real estate:
Commercial real estate (including multi-family residential)	2,073,521		32,780		87.6	%	587,195		75.0	%	619,975		75.7	%
Commercial real estate construction and land development	382,610		1,987		5.3	%	40,294		5.2	%	42,281		5.1	%
1-4 family residential (including home equity)	683,919		1,688		4.5	%	73,530		9.4	%	75,218		9.2	%
Residential construction	104,638		—		—	%	1,321		0.2	%	1,321		0.2	%
Consumer and other	25,856		—		—	%	522		0.1	%	522		0.1	%
Total loans	$	4,289,469	$	37,434	100.0	%	$	781,733	100.0	%	$	819,167	100.0	%

5. LEASES

Lease payments over the expected term are discounted using the Company’s incremental borrowing rate for borrowings of similar terms. Generally, the Company cannot be reasonably certain about whether or not it will renew a lease until such time as the lease is within the last two years of the existing lease term. When the Company is reasonably certain that a renewal option will be exercised, it measures/remeasures the right-of-use asset and related lease liability using the lease payments specified for the renewal period or, if such amounts are unspecified, the Company generally assumes an increase (evaluated on a case-by-case basis in light of prevailing market conditions) in the lease payment over the final period of the existing lease term.

There were no sale and leaseback transactions, leveraged leases or lease transactions with related parties during the three and nine months ended September 30, 2021 and 2020.

At September 30, 2021, the Company had 16 leases consisting of branch locations and office space. On the September 30, 2021 balance sheet, the right-of-use asset is classified within premises and equipment and the lease liability is included in other liabilities. The Company also owns certain office facilities which it leases to outside parties under operating lessor leases; however, such leases are not significant. All leases were classified as operating leases. Leases with an initial term of 12 months or less are not recorded on the balance sheet and the related lease expense is recognized on a straight-line basis over the lease term.

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Certain leases include options to renew, with renewal terms that can extend the lease term from one to five years. Lease assets and liabilities include related options that are reasonably certain of being exercised. The depreciable life of leased assets are limited by the expected lease term.

Supplemental lease information at the dates indicated is as follows:


	September 30, 2021			December 31, 2020
	(Dollars in thousands)
Balance Sheet:
Operating lease right of use asset classified as premises and equipment	$	10,901		$	11,610
Operating lease liability classified as other liabilities	$	11,091		$	11,850
Weighted average lease term, in years	5.10			5.56
Weighted average discount rate	2.63		%	2.86		%

Lease costs for the dates indicated is as follows:


	Three Months Ended September 30,				Nine Months Ended September 30,
	2021		2020		2021		2020
	(Dollars in thousands)
Income Statement:
Operating lease cost	$	884	$	839	$	2,617	$	2,422
Short-term lease cost	3		14		34		64
Sublease income	(19)		(18)		(55)		(48)
Total operating lease costs	$	868	$	835	$	2,596	$	2,438

A maturity analysis of the Company’s lease liabilities is as follows:


	September 30, 2021		December 31, 2020
	(Dollars in thousands)
Lease payments due:
Within one year	$	3,173	$	3,068
After one but within two years	2,388		2,664
After two but within three years	2,097		2,056
After three but within four years	1,400		1,591
After four but within five years	1,020		1,057
After five years	1,759		2,355
Total lease payments	11,837		12,791
Less: discount on cash flows	746		941
Total lease liability	$	11,091	$	11,850

6. FAIR VALUE

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

Fair Value Hierarchy

Fair value is the exchange price that would be received for an asset or paid to transfer a liability (exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. The

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

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

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

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

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


	As of September 30, 2021
			Estimated Fair Value
	Carrying Amount		Level 1		Level 2		Level 3		Total
	(Dollars in thousands)
Financial assets
Cash and cash equivalents	$	903,761	$	903,761	$	—	$	—	$	903,761
Available for sale securities	1,211,476		—		1,211,476		—		1,211,476
Loans held for investment, net of allowance	4,238,978		—		—		4,236,403		4,236,403
Accrued interest receivable	33,523		25		6,055		27,443		33,523
Financial liabilities
Deposits	$	5,666,878	$	—	$	5,674,027	$	—	$	5,674,027
Accrued interest payable	3,296		—		3,296		—		3,296
Borrowed funds	139,954		—		126,333		—		126,333
Subordinated debt	108,715		—		112,898		—		112,898


	As of December 31, 2020
			Estimated Fair Value
	Carrying Amount		Level 1		Level 2		Level 3		Total
	(Dollars in thousands)
Financial assets
Cash and cash equivalents	$	422,766	$	422,766	$	—	$	—	$	422,766
Available for sale securities	772,890		—		772,890		—		772,890
Loans held for investment, net of allowance	4,438,591		—		—		4,431,816		4,431,816
Accrued interest receivable	40,053		2		5,531		34,520		40,053
Financial liabilities
Deposits	$	4,988,482	$	—	$	5,003,594	$	—	$	5,003,594
Interest rate swap	1,252		—		1,252		—		1,252
Accrued interest payable	2,701		—		2,701		—		2,701
Borrowed funds	155,515		—		144,629		—		144,629
Subordinated debt	108,322		—		109,832		—		109,832

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The following tables present fair values for assets and liabilities measured at fair value on a recurring basis. There were no liabilities measured at fair value on a recurring basis as of September 30, 2021.


	September 30, 2021
	Level 1		Level 2		Level 3		Total
	(Dollars in thousands)
Financial assets
Available for sale securities:
U.S. government and agency securities	$	—	$	131,993	$	—	$	131,993
Municipal securities	—		482,272		—		482,272
Agency mortgage-backed pass-through securities	—		249,847		—		249,847
Agency collateralized mortgage obligations	—		230,747		—		230,747
Corporate bonds and other	—		116,617		—		116,617
Total available for sale securities	$	—	$	1,211,476	$	—	$	1,211,476


	December 31, 2020
	Level 1		Level 2		Level 3		Total
	(Dollars in thousands)
Financial assets
Available for sale securities:
U.S. government and agency securities	$	—	$	26,199	$	—	$	26,199
Municipal securities	—		427,605		—		427,605
Agency mortgage-backed pass-through securities	—		171,289		—		171,289
Agency collateralized mortgage obligations	—		84,370		—		84,370
Corporate bonds and other	—		63,427		—		63,427
Total available for sale securities	$	—	$	772,890	$	—	$	772,890

Financial liabilities
Interest rate swap	$	—	$	1,252	$	—	$	1,252

There were no transfers between levels during the nine months ended September 30, 2021 or 2020.

Assets measured at fair value on a nonrecurring basis are summarized in the table below. There were no liabilities measured at fair value on a nonrecurring basis at September 30, 2021 and December 31, 2020.


	As of September 30, 2021
	Level 1		Level 2		Level 3
	(Dollars in thousands)
Loans:
Commercial and industrial	$	—	$	—	$	6,230
Commercial real estate (including multi- family residential)	—		—		41,891
Commercial real estate construction and land development	—		—		—
1-4 family residential (including home equity)	—		—		3,801
Residential construction	—		—		532
Consumer and other	—		—		453
Other real estate owned	—		—		1,397
	$	—	$	—	$	54,304

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	As of December 31, 2020
	Level 1		Level 2		Level 3
	(Dollars in thousands)
Loans:
Commercial and industrial	$	—	$	—	$	8,650
Commercial real estate (including multi- family residential)	—		—		2,594
Commercial real estate construction and land development	—		—		53
1-4 family residential (including home equity)	—		—		1,873
Residential construction	—		—		—
Consumer and other	—		—		529
Other real estate owned	—		—		9,196
	$	—	$	—	$	22,895

Individually Evaluated Loans with Specific Allocation of Allowance for Credit Losses on Loans

A loan is considered to be a collateral dependent loan when, based on current information and events, the Company expects repayment of the financial assets to be provided substantially through the operation or sale of the collateral and the Company has determined that the borrower is experiencing financial difficulty as of the measurement date. The allowance for credit losses on loans is measured by estimating the fair value of the loan based on the present value of expected cash flows, the market price of the loan, or the underlying fair value of the loan’s collateral. For real estate loans, fair value of the loan’s collateral is generally determined by third-party appraisals or internal evaluations, which are then adjusted for the estimated selling and closing costs related to liquidation of the collateral. For this asset class, the actual valuation methods (income, sales comparable, or cost) vary based on the status of the project or property. For example, land is generally based on the sales comparable method while construction is based on the income and/or sales comparable methods. The unobservable inputs may vary depending on the individual assets with no one of the three methods being the predominant approach. The Company reviews the third-party appraisal for appropriateness and adjusts the value downward to consider selling and closing costs, which typically range from 5% to 10% of the appraised value. For non-real estate loans, fair value of the loan’s collateral may be determined using an appraisal, net book value per the borrower’s financial statements, or aging reports, adjusted or discounted based on management’s historical knowledge, changes in market conditions from the time of the valuation, and management’s expertise and knowledge of the client and client’s business.

Other Real Estate Owned

Other real estate owned is comprised of real estate acquired in partial or full satisfaction of loans. Other real estate owned is recorded at its estimated fair value less estimated selling and closing costs at the date of transfer. Any excess of the related loan balance over the fair value less expected selling costs is charged to the allowance. Subsequent declines in fair value are reported as adjustments to the carrying amount and are recorded against earnings. The fair value of other real estate owned is determined using third-party appraisals or other indications of value based on recent comparable sales of similar properties or assumptions generally observable in the marketplace. For this asset class, the actual valuation methods (income, sales comparable or cost) vary based on the status of the project or property. For example, land is generally based on the sales comparable method while construction is based on the income and/or sales comparable methods. The unobservable inputs may vary depending on the individual assets with no one of the three methods being the predominant approach. The Company reviews the third party appraisal for appropriateness and adjusts the value downward to consider selling and closing costs, which typically range from 5% to 10% of the appraised value.

At September 30, 2021, the $1.4 million balance of other real estate owned consisted of two foreclosed residential properties recorded as a result of obtaining physical possession of the properties. The Company had $9.2 million of other real estate owned at December 31, 2020 consisting primarily of foreclosed commercial real estate properties and one foreclosed residential property recorded as a result of obtaining physical possession of the property.

7. DEPOSITS

Time deposits that met or exceeded the Federal Deposit Insurance Corporation insurance limit of $250 thousand at September 30, 2021 and December 31, 2020 were $783.3 million and $726.8 million, respectively.

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


Within one year	$	1,017,921
After one but within two years	242,059
After two but within three years	61,317
After three but within four years	34,594
After four but within five years	25,123
Total	$	1,381,014

The Company had $303.7 million and $453.8 million of brokered deposits as of September 30, 2021 and December 31, 2020, respectively. There were no concentrations of deposits with any one depositor at September 30, 2021 and December 31, 2020.

8. DERIVATIVE INSTRUMENTS

The Company entered into a financial derivative in 2020. Financial derivatives are reported at fair value in other assets or other liabilities. The accounting for changes in the fair value of a derivative depends on whether it has been designated and qualifies as part of a hedging relationship.

Derivatives designated as cash flow hedges

For derivative instruments that are designated and qualify as a cash flow hedge, the aggregate fair value of the derivative instrument is recorded in other assets or other liabilities with any gain or loss related to changes in fair value recorded in accumulated other comprehensive income, net of tax. The gain or loss is reclassified into earnings in the same period during which the hedged asset or liability affects earnings and is presented in the same income statement line item as the earnings effect of the hedged asset or liability. The Company uses forward cash flow hedges in an effort to manage future interest rate exposure on liabilities. The hedging strategy converts the variable interest rate on liabilities to a fixed interest rate and is used in an effort to protect the Company from floating interest rate variability.

During the quarter ended June 30, 2021, the Company terminated the interest rate swap designated as a cash flow hedge prior to its maturity date resulting in a net gain of approximately $225 thousand recognized into other noninterest expenses as the forecasted transaction will not occur. The Company did not have any derivatives designated as cash flow hedges outstanding at September 30, 2021.

The effects of the Company’s cash flow hedge relationship on the statement of comprehensive income during the three and nine months ended September 30, 2021 and 2020 were as follows, before tax:


	Amount of Gain (Loss) Recognized in Other Comprehensive (Loss) Income
	Three Months Ended September 30,				Nine Months Ended September 30,
	2021		2020		2021		2020
	(Dollars in thousands)
Liability derivatives
Interest rate swaps	$	—	$	80	$	1,252	$	(1,495)

The cash flow hedge was determined to be effective during the periods presented and as a result qualified for hedge accounting treatment. The hedge would no longer be considered effective if a portion of the hedge becomes ineffective, the item hedged is no longer in existence or the Company discontinues hedge accounting.

9. BORROWINGS AND BORROWING CAPACITY

The Company has an available line of credit with the Federal Home Loan Bank (“FHLB”) of Dallas, which allows the Company to borrow on a collateralized basis. FHLB advances are used to manage liquidity as needed. The advances are secured by a blanket lien on certain loans. Maturing advances are replaced by drawing on available cash, making additional borrowings or through increased customer deposits. At September 30, 2021, the Company had a total borrowing capacity of $1.91 billion, of which $1.15 billion was available and $761.8 million was outstanding. FHLB advances of $140.0 million were outstanding at September 30, 2021,

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at a weighted average interest rate of 1.19%. Letters of credit were $621.8 million at September 30, 2021, of which $70.7 million will expire during the remaining months of 2021, $423.3 million will expire in 2022, $60.9 million will expire in 2023, $55.9 million will expire in 2024 and $11.0 million will expire in 2025.

On December 28, 2018, the Company amended its revolving credit agreement to increase the maximum commitment to advance funds to$45.0 million which reduces annually by $7.5 million beginning in December 2020 and on each December 22nd each year thereafter. The Company is required to repay any outstanding balance in excess of the then-current maximum commitment amount. The revised agreement will mature in December 2025 and is secured by 100% of the capital stock of the Bank. At September 30, 2021, the balance on the revolving credit agreement was zero. The credit agreement contains certain restrictive covenants. At September 30, 2021, the Company believes it was in compliance with all such debt covenants. The interest rate on the debt is the Prime Rate minus 25 basis points, or 3.00% at September 30, 2021, and is paid quarterly.

10. SUBORDINATED DEBT

Junior Subordinated Debentures

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

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

The Company assumed the junior subordinated debentures with an aggregate original principal amount of $11.3 million and a current carrying value at September 30, 2021 of $9.7 million. At acquisition, the Company recorded a discount of $2.5 million on the debentures. The difference between the carrying value and contractual balance will be recognized as a yield adjustment over the remaining term for the debentures. At September 30, 2021, the Company had $11.3 million outstanding in junior subordinated debentures issued to the Company’s unconsolidated subsidiary trusts. The junior subordinated debentures are included in tier 1 capital under current regulatory guidelines and interpretations.

A summary of pertinent information related to the Company’s issues of junior subordinated debentures outstanding at September 30, 2021 is set forth in the table below:

Description

Issuance

Date

Trust

Preferred

Securities

Outstanding

Interest Rate(1)

Junior

Subordinated

Debt Owed

to Trusts

Maturity

Date(2)

(Dollars in thousands)

Farmers & Merchants Capital Trust II

November 13, 2003

7,500

3 month LIBOR + 3.00%

7,732

November 8, 2033

Farmers & Merchants Capital Trust III

June 30, 2005

3,500

3 month LIBOR + 1.80%

3,609

July 7, 2035

11,341


(1)			The 3-month LIBOR in effect as of September 30, 2021 was 0.1227%.
(2)			All debentures are currently callable.

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Subordinated Notes

In December 2017, the Bank completed the issuance, through a private placement, of $40.0 million aggregate principal amount of Fixed-to-Floating Rate Subordinated Notes (the "Bank Notes") due December 15, 2027. The Bank Notes were issued at a price equal to 100% of the principal amount, resulting in net proceeds to the Bank of $39.4 million.

The Bank Notes bear a fixed interest rate of 5.25% per annum until (but excluding) December 15, 2022, payable semi-annually in arrears. From December 15, 2022, the Bank Notes will bear a floating rate of interest equal to 3-Month LIBOR + 3.03% until the Bank Notes mature on December 15, 2027, or such earlier redemption date, payable quarterly in arrears. The Bank Notes will be redeemable by the Bank, in whole or in part, on or after December 15, 2022 or, in whole but not in part, upon the occurrence of certain specified tax events, capital events or investment company events. Any redemption will be at a redemption price equal to 100% of the principal amount of Bank Notes being redeemed, plus accrued and unpaid interest, and will be subject to, and require, prior regulatory approval. The Bank Notes are not subject to redemption at the option of the holders.

In September 2019, the Company completed the issuance of $60.0 million aggregate principal amount of Fixed-to-Floating Rate Subordinated Notes (the "Company Notes") due October 1, 2029. The Company Notes were issued at a price equal to 100% of the principal amount, resulting in net proceeds to the Company of $58.6 million. The Company used the net proceeds from the offering to support its growth and for general corporate purposes.

The Company Notes bear a fixed interest rate of 4.70% per annum until (but excluding) October 1, 2024, payable semi-annually in arrears on April 1 and October 1, commencing on April 1, 2020. Thereafter, from October 1, 2024 through the maturity date, October 1, 2029, or earlier redemption date, the Company Notes will bear interest at a floating rate equal to the then-current three-month LIBOR, plus 313 basis points (3.13%) for each quarterly interest period (subject to certain provisions set forth under “Description of the Notes—Interest Rates and Interest Payment Dates” included in the Prospectus Supplement), payable quarterly in arrears on January 1, April 1, July 1 and October 1 of each year. Any redemption will be at a redemption price equal to 100% of the principal amount of Company Notes being redeemed, plus accrued and unpaid interest, and will be subject to, and require, prior regulatory approval. The Company Notes are not subject to redemption at the option of the holders.

11. INCOME TAXES

The amount of the Company’s federal and state income tax expense is influenced by the amount of pre-tax income, the amount of tax-exempt income and the amount of other nondeductible items. For the three and nine months ended September 30, 2021, income tax expense was $4.6 million and $13.5 million, respectively, compared with $3.7 million and $6.6 million, respectively, for the three and nine months ended September 30, 2020. The effective income tax rate for the three and nine months ended September 30, 2021 was 19.5% and 18.4%, respectively, compared to 18.5% and 18.2%, respectively, for the three and nine months ended September 30, 2020.

Interest and penalties related to tax positions are recognized in the period in which they begin accruing or when the entity claims the position that does not meet the minimum statutory thresholds. The Company does not have any uncertain tax positions and does not have any interest or penalties recorded in the income statement for the three and nine months ended September 30, 2021. The Company is no longer subject to examination by the U.S. Federal Tax Jurisdiction for the years prior to 2017.

12. STOCK BASED COMPENSATION

At September 30, 2021, the Company had two stock-based employee compensation plans with awards outstanding. In connection with the acquisition of Post Oak Bancshares, Inc. on October 1, 2018, the Company assumed the Post Oak Bancshares, Inc. Stock Option Plan, under which no additional awards will be issued. During 2019, the Company’s Board of Directors and shareholders approved the 2019 Amended and Restated Stock Awards and Incentive Plan (the “Plan”) covering certain awards of stock-based compensation to key employees and directors of the Company. Under the Plan, the Company is authorized to issue a maximum aggregate of 3,200,000 shares of stock, up to 1,800,000 of which may be issued through incentive stock options. The Company accounts for stock based employee compensation plans using the fair value-based method of accounting. The Company recognized total stock based compensation expense of $1.0 million and $2.9 million for the three and nine months ended September 30, 2021, respectively, and $863 thousand and $2.6 million for the three and nine months ended September 30, 2020, respectively.

Stock Options

Options to purchase a total of 1,309,231 shares of Company stock have been granted as of September 30, 2021. Options are exercisable for up to 10 years from the date of the grant and, dependent on the terms of the applicable award agreement generally vest

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

A summary of the activity in the stock option plans during the nine months ended September 30, 2021 is set forth below:


	Number of Options	Weighted Average Exercise Price		Weighted Average Remaining Contractual Term	Aggregate Intrinsic Value
	(Shares in thousands)			(In years)	(Dollars in thousands)
Options outstanding, January 1, 2021	469	$	21.08	3.43	$	6,118
Options granted	—	—
Options exercised	(109)	18.48
Options forfeited	(1)	37.55
Options outstanding, September 30, 2021	359	$	21.77	2.96	$	5,865
Options vested and exercisable, September 30, 2021	361	$	21.61	2.96	$	5,975

As of September 30, 2021, there was $12 thousand of total unrecognized compensation cost related to nonvested stock options granted under the Plan. The cost is expected to be recognized over a weighted-average period of 0.42 years.

Restricted Stock Awards

During the nine months ended September 30, 2021, the Company issued 80,649 of restricted stock. The shares of restricted stock generally vest over a period of four years and are considered outstanding at the date of issuance. The Company accounts for shares of restricted stock by recording the fair value of the grant on the award date as compensation expense over the vesting period.

A summary of the activity of the nonvested shares of restricted stock during the nine months ended September 30, 2021 is as follows:


	Number of Shares	Weighted Average Grant Date Fair Value
	(Shares in thousands)
Nonvested share awards outstanding, January 1, 2021	158	$	30.78
Share awards granted	81	38.65
Share awards vested	(49)	29.28
Unvested share awards forfeited or cancelled	(8)	37.04
Nonvested share awards outstanding, September 30, 2021	182	$	34.43

As of September 30, 2021, there was $5.7 million of total unrecognized compensation cost related to the restricted stock awards which is expected to be recognized over a weighted-average period of 2.32 years.

Performance Share Units (“PSUs”)

PSUs are earned subject to certain performance goals being met after the two-year performance period and will be settled in shares of Allegiance Common Stock following a one-year service period. The Company awarded 56,255 and 46,243 PSUs during the nine months ended September 30, 2021 and 2020, respectively. The grant date fair value of the PSUs is based on the probable outcome of the applicable performance conditions and is calculated at target based on a combination of the closing market price of our common stock on the grant date and a Monte Carlo simulated fair value in accordance with ASC 718. At September 30, 2021, there was $2.6 million of unrecognized compensation expense related to the PSUs, which is expected to be recognized over a weighted-average period of 2.05 years.

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13. OFF-BALANCE SHEET ARRANGEMENTS, COMMITMENTS AND CONTINGENCIES

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

The contractual amounts of financial instruments with off-balance sheet risk are as follows:


	September 30, 2021				December 31, 2020
	Fixed Rate		Variable Rate		Fixed Rate		Variable Rate
	(Dollars in thousands)
Commitments to extend credit	$	1,088,080	$	540,650	$	761,938	$	480,067
Standby letters of credit	9,226		13,537		9,252		8,003
Total	$	1,097,306	$	554,187	$	771,190	$	488,070

Commitments to extend credit include lines of credit as well as commitments to make new loans. Commitments to make loans are generally made for an approval period of 120 days or fewer. As of September 30, 2021, the funded fixed rate loan commitments had interest rates ranging from 1.00% to 13.49% with a weighted average maturity and rate of 3.72 years and 4.56% , respectively. As of December 31, 2020, the funded fixed rate loan commitments had interest rates ranging from 1.20% to 18.00% with a weighted average maturity and rate of 3.53 years and 5.13% , respectively.

Litigation

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

14. REGULATORY CAPITAL MATTERS

The Company and the Bank are subject to various regulatory capital requirements administered by the federal banking agencies. Capital adequacy guidelines, and for banks, prompt corrective action regulations, involve quantitative measures of assets, liabilities and certain off balance sheet items calculated under regulatory accounting practices. Capital amounts and classifications are also subject to qualitative judgments by regulators about components, risk weightings and other factors. Failure to meet minimum capital requirements can cause regulators to initiate actions that, if undertaken, could have a direct material effect on the Company’s consolidated financial statements. The final rules implementing Basel Committee on Banking Supervision's capital guideline for U.S. Banks (Basel III Rules) were fully phased in when the capital conservation buffer reached 2.5%. Management believes as of September 30, 2021 and December 31, 2020, the Company and the Bank met all capital adequacy requirements to which they were then subject.

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

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The following is a summary of the Company’s and the Bank’s actual and required capital ratios as of September 30, 2021 and December 31, 2020:


	Actual				Minimum Required for Capital Adequacy Purposes				Minimum Required Plus Capital Conservation Buffer				To Be Categorized As Well-Capitalized Under Prompt Corrective Action Provisions
	Amount		Ratio		Amount		Ratio		Amount		Ratio		Amount		Ratio
	(Dollars in thousands)
ALLEGIANCE BANCSHARES, INC.
(Consolidated)
As of September 30, 2021
Total Capital (to risk weighted assets)	$	700,013	16.13	%	$	347,221	8.00	%	$	455,728	10.50	%	N/A		N/A
Common Equity Tier 1 Capital (to risk weighted assets)	537,008		12.37	%	195,312		4.50	%	303,819		7.00	%	N/A		N/A
Tier 1 Capital (to risk weighted assets)	546,732		12.60	%	260,416		6.00	%	368,923		8.50	%	N/A		N/A
Tier 1 Capital (to average tangible assets)	546,732		8.76	%	249,563		4.00	%	249,563		4.00	%	N/A		N/A
As of December 31, 2020
Total Capital (to risk weighted assets)	$	642,155	15.71	%	$	327,084	8.00	%	$	429,298	10.50	%	N/A		N/A
Common Equity Tier 1 Capital (to risk weighted assets)	482,643		11.80	%	183,985		4.50	%	286,199		7.00	%	N/A		N/A
Tier 1 Capital (to risk weighted assets)	492,281		12.04	%	245,313		6.00	%	347,527		8.50	%	N/A		N/A
Tier 1 Capital (to average tangible assets)	492,281		8.51	%	231,518		4.00	%	231,518		4.00	%	N/A		N/A

ALLEGIANCE BANK
As of September 30, 2021
Total Capital (to risk weighted assets)	$	649,294	14.98	%	$	346,812	8.00	%	$	455,191	10.50	%	$	433,515	10.00	%
Common Equity Tier 1 Capital (to risk weighted assets)	555,225		12.81	%	195,082		4.50	%	303,461		7.00	%	281,785		6.50	%
Tier 1 Capital (to risk weighted assets)	555,225		12.81	%	260,109		6.00	%	368,488		8.50	%	346,812		8.00	%
Tier 1 Capital (to average tangible assets)	555,225		8.91	%	249,237		4.00	%	249,237		4.00	%	311,547		5.00	%
As of December 31, 2020
Total Capital (to risk weighted assets)	$	635,223	15.55	%	$	326,804	8.00	%	$	428,931	10.50	%	$	408,506	10.00	%
Common Equity Tier 1 Capital (to risk weighted assets)	544,331		13.32	%	183,828		4.50	%	285,954		7.00	%	265,529		6.50	%
Tier 1 Capital (to risk weighted assets)	544,331		13.32	%	245,103		6.00	%	347,230		8.50	%	326,804		8.00	%
Tier 1 Capital (to average tangible assets)	544,331		9.41	%	231,334		4.00	%	231,334		4.00	%	289,167		5.00	%

15. EARNINGS PER COMMON SHARE

Diluted earnings per common share is computed using the weighted-average number of common shares determined for the basic earnings per common share computation plus the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock using the treasury stock method. Outstanding stock options and PSUs issued by the Company represent the only dilutive effect reflected in diluted weighted average shares. Restricted shares are considered outstanding at the date of grant, accounted for as participating securities and included in basic and diluted weighted average common shares outstanding. Performance share units that vest based on the Company’s performance and service conditions that have not been achieved as of the end of the period are not included in basic and diluted weighted average common shares outstanding.

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	Three Months Ended September 30,								Nine Months Ended September 30,
	2021				2020				2021				2020
	Amount		Per Share Amount		Amount		Per Share Amount		Amount		Per Share Amount		Amount		Per Share Amount
	(Amounts in thousands, except per share data)
Net income attributable to shareholders	$	19,060			$	16,170			$	59,995			$	29,593
Basic:
Weighted average shares outstanding	20,221		$	0.94	20,439		$	0.79	20,188		$	2.97	20,421		$	1.45
Diluted:
Add incremental shares for:
Dilutive effect of stock option exercises and performance share units	190				93				181				130
Total	20,411		$	0.93	20,532		$	0.79	20,369		$	2.95	20,551		$	1.44

There were 22,800 antidilutive shares as of September 30, 2021. Stock options for 71,990 shares were not considered in computing diluted earnings per common share as of September 30, 2020 as they were antidilutive.

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

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

Cautionary Notice Regarding Forward-Looking Statements

Statements and financial discussion and analysis contained in this Quarterly Report on Form 10-Q that are not historical facts are forward-looking statements and are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. We also may make forward-looking statements in our other documents filed with or furnished to the SEC. In addition, our senior management may make forward-looking statements orally to investors, analysts, representatives of the media and others. Statements preceded by, followed by or that otherwise include the words “believes,” “expects,” “continues,” “anticipates,” “intends,” “projects,” “estimates,” “potential,” “plans” and similar expressions or future or conditional verbs such as “will,” “should,” “would,” “may” and “could” are generally forward-looking in nature and not historical facts, although not all forward-looking statements include the foregoing words. Forward-looking statements are based on assumptions and involve a number of risks and uncertainties, many of which are beyond our control, particularly with regard to developments related to the coronavirus (COVID-19) pandemic. Many possible events or factors could affect our future financial results and performance and could cause such results or performance to differ materially from those expressed in our forward-looking statements.

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

•risks related to the concentration of our business in the Houston region, including risks associated with volatility or decreases in oil and gas prices or prolonged periods of lower oil and gas prices;

•general market conditions and economic trends nationally, regionally and particularly in the Houston region;

•the impact of the COVID-19 pandemic on our business, including the impact of the actions taken by governmental authorities to try and contain the virus or address the impact of the virus on the United States economy (including, without limitation, the CARES Act), and the resulting effect of all of such items on our operations, liquidity and capital position, and on the financial condition of our borrowers and other customers;

•our ability to retain executive officers and key employees and their customer and community relationships;

•our ability to recruit and retain successful bankers that meet our expectations in terms of customer and community relationships and profitability;

•risks related to our strategic focus on lending to small to medium-sized businesses;

•our ability to implement our growth strategy, including through the identification of acquisition candidates that will be accretive to our financial condition and results of operations, as well as permitting decision-making authority at the branch level;

•risks related to any businesses we acquire in the future, including exposure to potential asset and credit quality risks and unknown or contingent liabilities, the time and costs associated with integrating systems, technology platforms, procedures and personnel, the need for additional capital to finance such transactions and possible failures in realizing the anticipated benefits from such acquisitions;

•risks associated with our owner-occupied commercial real estate loan and other commercial real estate loan portfolios, including the risks inherent in the valuation of the collateral securing such loans;

•risks associated with our commercial and industrial loan portfolio, including the risk for deterioration in value of the general business assets that generally secure such loans;

•the accuracy and sufficiency of the assumptions and estimates we make in establishing reserves for potential loan losses and other estimates;

•risk of deteriorating asset quality and higher loan charge-offs, as well as the time and effort necessary to resolve nonperforming assets;

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•potential changes in the prices, values and sales volumes of commercial and residential real estate securing our real estate loans;

•risks related to loans originated and serviced under the Small Business Administration’s guidelines;

•changes in market interest rates that affect the pricing of our loans and deposits and our net interest income;

•potential fluctuations in the market value and liquidity of the securities we hold for sale;

•risk of impairment of investment securities, goodwill, other intangible assets or deferred tax assets;

•the effects of competition from a wide variety of local, regional, national and other providers of financial, investment and insurance services, which may adversely affect our pricing and terms;

•risks associated with negative public perception of the Company;

•our ability to maintain an effective system of disclosure controls and procedures and internal controls over financial reporting;

•risks associated with fraudulent and negligent acts by our customers, employees or vendors;

•our ability to keep pace with technological change or difficulties when implementing new technologies;

•risks associated with system failures or failures to protect against cybersecurity threats, such as breaches of our network security;

•our ability to comply with privacy laws and properly safeguard personal, confidential or proprietary information;

•risks associated with data processing system failures and errors;

•potential risk of environmental liability related to owning or foreclosing on real property;

•the institution and outcome of litigation and other legal proceeding against us or to which we become subject;

•our ability to maintain adequate liquidity and to raise necessary capital to fund our acquisition strategy and operations or to meet increased minimum regulatory capital levels;

•our ability to comply with various governmental and regulatory requirements applicable to financial institutions;

•the impact of recent and future legislative and regulatory changes, including changes in banking, securities and tax laws and regulations and their application by our regulators;

•governmental monetary and fiscal policies, including the policies of the Federal Reserve;

•our ability to comply with supervisory actions by federal and state banking agencies;

•changes in the scope and cost of FDIC insurance and other coverage;

•systemic risks associated with the soundness of other financial institutions;

•the effects of war or other conflicts, acts of terrorism (including cyberattacks) or other catastrophic events, including hurricanes, pandemics, storms, droughts, tornadoes and flooding, that may affect general economic conditions; and

•other risks and uncertainties listed from time to time in our reports and documents filed with the SEC.

Further, these forward-looking statements speak only as of the date on which they were made and we disclaim any obligation to update or revise any forward-looking statements to reflect events or circumstances after the date on which any such statement is made or to reflect the occurrence of unanticipated events, unless required to do so under the federal securities laws. Other factors not identified above, including those described under the headings “Risk Factors”, "Quantitative and Qualitative Disclosures about Market Risk" and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in this Quarterly Report on Form 10-Q for the quarter ended September 30, 2021, and in our Annual Report on Form 10-K for the year ended December 31, 2020 may also cause actual results to differ materially from those described in our forward-looking statements. Most of these factors are difficult to anticipate and are generally beyond our control. You should consider these factors in connection with considering any forward-looking statements that may be made by us. Because of these uncertainties, you should not place undue reliance on any forward-looking statement.

Overview

We generate most of our income from interest income on loans, service charges on customer accounts and interest income from investments in securities. We incur interest expense on deposits and other borrowed funds and noninterest expenses such as

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

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

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

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

Super-community banking strategy. Our super-community banking strategy emphasizes local delivery of the excellent customer service associated with community banking combined with the products, efficiencies and scale associated with larger banks. By empowering our personnel to make certain business decisions at a local level in order to respond quickly to customers’ needs, we are able to establish and foster strong relationships with customers through superior service. We operate full-service bank offices and employ bankers with strong underwriting credentials who are authorized to make loan and underwriting decisions up to prescribed limits at the bank office level. We support bank office operations with a centralized credit approval process for larger credit relationships, loan operations, information technology, core data processing, accounting, finance, treasury and treasury management support, deposit operations and executive and board oversight. We emphasize lending to and banking with small to medium-sized businesses, with which we believe we can establish stronger relationships through excellent service and provide lending that can be priced on terms that are more attractive to the Company than would be achieved by lending to larger businesses. We believe this approach produces a clear competitive advantage by delivering an extraordinary customer experience and fostering a culture dedicated to achieving superior external and internal service levels.

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

•increasing the productivity of existing bankers, as measured by loans, deposits and fee income per banker, while enhancing profitability by leveraging our existing operating platform;

•focusing on local and individualized decision-making, allowing us to provide customers with rapid decisions on loan requests, which we believe allows us to effectively compete with larger financial institutions;

•identifying and hiring additional seasoned bankers who will thrive within our super-community banking model, and opening additional branches where we are able to attract seasoned bankers; and

•developing new products designed to serve a diversified economy, while preserving our strong culture of risk management.

Select strategic acquisitions. We intend to continue to expand our presence through organic growth and a disciplined acquisition strategy. We focus on like-minded community banks with similar lending strategies to our own when evaluating acquisition opportunities. We believe that our management’s experience in assessing, executing and integrating target institutions will allow us to capitalize on acquisition opportunities.

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COVID-19 Update

The COVID-19 pandemic continues to place significant health, economic and other major pressure throughout the Houston region we serve, the state of Texas, the United States and the entire world.

•While all of our bank offices generally remain open to customers, we have taken steps to address safety issues by offering in-person visits by appointment, added social distancing markers and plexiglass and are encouraging most of our traffic to leverage our drive-thrus, following the guidelines of the Centers for Disease Control and Prevention (“CDC”).

•We continue to encourage the use of available eBanking tools and financial education resources.

•We have provided extensions and deferrals to our loan customers in accordance with the CARES Act.

•We have participated in assisting with applications for resources through the CARES Act’s PPP, administered by the SBA, which provides government guaranteed and forgivable loans. As of September 30, 2021, we funded over $1.08 billion PPP loans. We believe these loans and our participation in the program will provide support for our customers and small businesses in the communities we serve.

•Our team is at full-strength with some employees utilizing the work-from-home program implemented pursuant to the pre-existing pandemic plan.

•We are working to ensure the health and safety of our in-office teams providing CDC-recommended supplies and implementing additional routine cleaning measures to all offices and departments.

•We continue to closely monitor this pandemic and its effects and expect to continue to adjust our operations in response to the pandemic as the situation evolves.

Critical Accounting Policies

Our accounting policies are integral to understanding our results of operations. Our accounting policies are described in detail in Note 1 to our Annual Report on Form 10-K for the year ended December 31, 2020.

We believe that of our accounting policies, the following may involve a higher degree of judgment and complexity:

Securities

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

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

Nonperforming and Past Due Loans

The Company has several procedures in place to assist it in maintaining the overall quality of its loan portfolio. The Company has established underwriting guidelines to be followed by its officers, and monitors its delinquency levels for any negative or adverse trends. There can be no assurance, however, that the Company’s loan portfolio will not become subject to increasing pressures from deteriorating borrower credit due to general economic conditions or other factors.

Past due status is based on the contractual terms of the loan. Loans are considered past due if the required principal and interest payments have not been received as of the date such payments were due. The Company generally classifies a loan as nonperforming, automatically places the loan on nonaccrual status, ceases accruing interest and reverses all unpaid accrued interest against interest income, when, in management’s opinion, the borrower may be unable to meet payment obligations, when the payment of principal or interest on a loan is delinquent for 90 days, as well as when required by regulatory provisions, unless the loan is in the process of collection and the underlying collateral fully supports the carrying value of the loan. Any payments received on nonaccrual loans are applied first to outstanding loan amounts. Interest income is subsequently recognized only to the extent cash payments are received in excess of principal due. Any excess is treated as recovery of lost interest. Loans are returned to accrual status when all of the principal and interest amounts contractually due are brought current and future payments are reasonably assured.

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In all cases, loans are placed on nonaccrual or charged-off at an earlier date if collection of principal or interest is considered doubtful. If the decision is made to continue accruing interest on the loan, periodic reviews are made to confirm the accruing status of the loan. Nonaccrual loans and loans past due 90 days include both smaller balance homogeneous loans that are collectively and individually evaluated. When available information confirms that specific loans, or portions thereof, are uncollectible, these amounts are charged-off against the allowance. All loan types are considered delinquent after 30 days past due and are typically charged-off or charged-down no later than 120 days past due, with consideration of, but not limited to, the following criteria in determining the need and timing of the charge-off or charge-down: (1) the Bank is in the process of repossession or foreclosure and there appears to be a likely deficiency; (2) the collateral securing the loan has been sold and there is an actual deficiency; (3) the Bank is proceeding with lengthy legal action to collect its balance; (4) the borrower is unable to be located; or (5) the borrower has filed bankruptcy. Charge-offs occur when the Company confirms a loss on a loan.

Allowance for Credit Losses

The allowance for credit losses is a valuation account that is established through a provision for credit losses charged to expense, which represents management’s best estimate of lifetime expected losses based on reasonable and supportable forecasts, historical loss experience, and other qualitative considerations. The allowance for credit losses includes the allowance for credit losses on loans, which is deducted from the loans’ amortized cost basis to present the net amount expected to be collected on loans, the allowance for credit losses on unfunded commitments reported in other liabilities and the allowance for credit losses on securities available for sale.

Allowance for Credit Losses on Loans

The Company adopted ASU 2016-13 Financial Instruments – Credit Losses (ASC Topic 326): Measurement of Credit Losses on Financial Instruments, which replaced the incurred loss methodology with an expected loss methodology that is referred to as the CECL methodology. During the fourth quarter of 2020, the Company adopted ASC Topic 326 as of January 1, 2020, using the modified retrospective method such that prior period amounts were not adjusted, but were reported in accordance with previously applicable generally accepted accounting principles and a cumulative effect adjustment to the opening balance of retained earnings was recognized. The level of the allowance is based upon management's evaluation of historical default and loss experience, current and projected economic conditions, asset quality trends, known and inherent risks in the portfolio, adverse situations that may affect the borrower’s ability to repay a loan (including the timing of future payments), the estimated value of any underlying collateral, composition of the loan portfolio, industry and peer bank loan quality indications and other pertinent factors, including regulatory recommendations. The allowance for credit losses on loans maintained by management is believed adequate to absorb all expected future losses in the loan portfolio at the balance sheet date. The Company disaggregates the loan portfolio into pools for purposes of determining the allowance for credit losses. These pools are based on the level at which the Company develops, documents and applies a systematic methodology to determine the allowance for credit losses.

Loans with similar risk characteristics are collectively evaluated resulting in loss estimates as determined by applying reserve factors, such as historical lifetime loan loss experience, concentration risk of specific loan types, the volume, growth and composition of the Company’s loan portfolio, current economic conditions and reasonable and supportable forecasted economic conditions that may affect the borrower’s ability to pay and the value of collateral, the evaluation of the Company’s loan portfolio through its internal loan review process, general economic conditions and other qualitative risk factors both internal and external to the Company and other relevant factors, designed to estimate current expected credit losses, to amortized cost balances over the remaining contractual life of the collectively evaluated portfolio. Loans with similar risk characteristics are aggregated into homogeneous pools for assessment. Historical lifetime loan loss experience is determined by utilizing an open-pool (“cumulative loss rate”) methodology. Adjustments to the historical lifetime loan loss experience are made for differences in current loan pool risk characteristics such as portfolio concentrations, delinquency, nonaccrual, and watch list levels, as well as changes in current and forecasted economic conditions such as unemployment rates, property and collateral values, and other indices relating to economic activity. Losses are predicted over a period of time determined to be reasonable and supportable, and at the end of the reasonable and supportable period losses are reverted to long term historical averages. The reasonable and supportable period and reversion period are re-evaluated each year by the Company and are dependent on the current economic environment among other factors. A reasonable and supportable period of twelve months was utilized for all loan pools, followed by an immediate reversion to long term averages. Based on a review of these factors for each loan type, the Company applies an estimated percentage to the outstanding balance of each loan type.

Loans that no longer share risk characteristics with the collectively evaluated loan pools are evaluated on an individual basis and are excluded from the collectively evaluated pools. In order to assess which loans are to be individually evaluated, the Company follows a loan review program to evaluate the credit risk in the total loan portfolio and assigns risk grades to each loan. Individual credit loss estimates are typically performed for nonaccrual loans, modified loans classified as troubled debt restructurings and all other loans identified by management. All loans deemed as being individually evaluated are reviewed on a quarterly basis in order to

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determine whether a specific reserve is required. The Company considers certain loans to be collateral dependent if the borrower is experiencing financial difficulty and management expects repayment for the loan to be substantially through the operation or sale of the collateral. For collateral dependent loans, loss estimates are based on the fair value of collateral, less estimated cost to sell (if applicable). Collateral values supporting individually evaluated loans are assessed quarterly and appraisals are typically obtained at least annually. The Company allocates a specific loan loss reserve on an individual loan basis primarily based on the value of the collateral securing the individually evaluated loan. Through this loan review process, the Company assesses the overall quality of the loan portfolio and the adequacy of the allowance for credit losses on loans while considering risk elements attributable to particular loan types in assessing the quality of individual loans. In addition, for each category of loans, the Company considers secondary sources of income and the financial strength and credit history of the borrower and any guarantors.

A change in the allowance for credit losses on loans can be attributable to several factors, most notably specific reserves for individually evaluated loans, historical lifetime loan loss information, and changes in economic factors and growth in the loan portfolio. Specific reserves that are calculated on an individual basis and the qualitative assessment of all other loans reflect current changes in the credit quality of the loan portfolio. Historical lifetime credit losses, on the other hand, are based on an open-pool (“cumulative loss rate”) methodology, which is then applied to estimate lifetime credit losses in the loan portfolio. The allowance for credit losses on loans is further determined by the size of the loan portfolio subject to the allowance methodology and factors that include Company-specific risk indicators and general economic conditions, both of which are constantly changing. The Company evaluates the economic and portfolio-specific factors on a quarterly basis to determine a qualitative component of the general valuation allowance. These factors include current economic metrics, reasonable and supportable forecasted economic metrics, delinquency trends, credit concentrations, nature and volume of the portfolio and other adjustments for items not covered by specific reserves and historical lifetime loss experience. Based on the Company’s actual historical lifetime loan loss experience relative to economic and loan portfolio-specific factors at the time the losses occurred, management is able to identify the probable level of lifetime losses as of the date of measurement. The Company’s analysis of qualitative, or economic, factors on pools of loans with common risk characteristics, in combination with the quantitative historical lifetime loss information and specific reserves, provides the Company with an estimate of lifetime losses.

The calculation of current expected credit losses is inherently subjective, as it requires management to exercise judgment in determining appropriate factors used to determine the allowance. The estimated loan losses for all loan pools are adjusted for changes in qualitative factors not inherently considered in the quantitative analyses to bring the allowance to the level management believes is appropriate based on factors that have not otherwise been fully accounted for, including adjustments for foresight risk, input imprecision and model imprecision. The qualitative categories and the measurements used to quantify the risks within each of these categories are subjectively selected by management, but measured by objective measurements period over period. The data for each measurement may be obtained from internal or external sources. The current period measurements are evaluated and assigned a factor commensurate with the current level of risk relative to past measurements over time. The resulting qualitative adjustments are applied to the relevant collectively evaluated loan portfolios. These adjustments are based upon quarterly trend assessments in portfolio concentrations, changes in lending policies and procedures, policy exceptions, independent loan review results, internal risk ratings and peer group credit quality trends. The qualitative allowance allocation, as determined by the processes noted above, is increased or decreased for each loan pool based on the assessment of these various qualitative factors. The determination of the appropriate qualitative adjustment is based on management's analysis of current and expected economic conditions and their impact to the portfolio, as well as internal credit risk movements and a qualitative assessment of the lending environment, including underwriting standards. Management recognizes the sensitivity of various assumptions made in the quantitative modeling of expected losses and may adjust reserves depending upon the level of uncertainty that currently exists in one or more assumptions.

While policies and procedures used to estimate the allowance for credit losses on loans, as well as the resultant provision for credit losses charged to income, are considered adequate by management and are reviewed periodically by regulators and internal audit, they are approximate and could materially change based on changes within the loan portfolio and effects from economic factors. There are factors beyond the Company’s control, such as changes in projected economic conditions, including political instability or global events affecting the U.S. economy, real estate markets or particular industry conditions which could cause changes to expectations for current conditions and economic forecasts that could result in an unanticipated increase in the allowance and may materially impact asset quality and the adequacy of the allowance for credit losses and thus the resulting provision for credit losses.

In assessing the adequacy of the allowance for credit losses on loans, the Company considers the results of its ongoing independent loan review process. The Company undertakes this process both to ascertain those loans in the portfolio with elevated credit risk and to assist in its overall evaluation of the risk characteristics of the entire loan portfolio. Its loan review process includes the judgment of management, independent internal loan reviewers and reviews that may have been conducted by third-party reviewers including regulatory examiners. The Company incorporates relevant loan review results in the allowance.

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In accordance with CECL, losses are estimated over the remaining contractual terms of loans, adjusted for prepayments. The contractual term excludes expected extensions, renewals and modifications unless management has a reasonable expectation at the reporting date that a troubled debt restructuring will be executed or such renewals, extensions or modifications are included in the original loan agreement and are not unconditionally cancellable by the Company.

Credit losses are estimated on the amortized cost basis of loans, which includes the principal balance outstanding, purchase discounts and premiums and deferred loan fees and costs. Loan losses are not estimated for accrued interest receivable as interest that is deemed uncollectible is written off through interest income in a timely manner. Accrued interest is presented separately on the balance sheets and as allowed under ASC Topic 326 is excluded from the tabular loan disclosures in Note 4 – Loans and Allowance for Credit Losses.

Allowance for Credit Losses on Unfunded Commitments

The Company estimates expected credit losses over the contractual term in which the Company is exposed to credit risk through a contractual obligation to extend credit, unless the obligation is unconditionally cancellable by the Company. The allowance for credit losses on unfunded commitments is adjusted as a provision for credit loss expense. The estimates are determined based on the likelihood of funding during the contractual term and an estimate of credit losses subsequent to funding. Estimated credit losses on subsequently funded balances are based on the same assumptions as used to estimate credit losses on existing funded loans.

Allowance for Credit Losses on Securities Available for Sale

For securities classified as available for sale that are in an unrealized loss position at the balance sheet date, the Company first assesses whether or not it intends to sell the security, or more likely than not will be required to sell the security, before recovery of its amortized cost basis. If either criteria is met, the security's amortized cost basis is written down to fair value through net income. If neither criteria is met, the Company evaluates whether any portion of the decline in fair value is the result of credit deterioration. Such evaluations consider the extent to which the amortized cost of the security exceeds its fair value, changes in credit ratings and any other known adverse conditions related to the specific security. If the evaluation indicates that a credit loss exists, an allowance for credit losses is recorded through provisions for credit losses for the amount by which the amortized cost basis of the security exceeds the present value of cash flows expected to be collected, limited by the amount by which the amortized cost exceeds fair value. Losses are charged against the allowance when management believes the uncollectibility of an available for sale security is confirmed or when either of the criteria regarding intent or requirement to sell is met. Any impairment not recognized in the allowance for credit losses is recognized in other comprehensive income. For certain types of debt securities, such as U.S. Treasuries and other securities with government guarantees, entities may expect zero credit losses. The zero-loss expectation applies to all of the Company’s securities and no allowance for credit losses was recorded on its available for sale securities portfolio at transition.

Accrued interest receivable on available for sale securities totaled $6.1 million at September 30, 2021 and is excluded from the estimate of credit losses.

Goodwill

Goodwill resulting from business combinations is generally determined as the excess of the fair value of the consideration transferred, plus the fair value of any noncontrolling interests in the acquiree, over the fair value of the net assets acquired and liabilities assumed as of the acquisition date. Goodwill is assessed annually on October 1 for impairment or more frequently if events and circumstances exist that indicate that the carrying amount of the asset may not be recoverable and a goodwill impairment test should be performed. A significant amount of judgment is involved in determining if an indicator of impairment has occurred. Such indicators may include, among others: a significant decline in our expected future cash flows; a sustained, significant decline in our stock price and market capitalization; a significant adverse change in legal factors or in the business climate; adverse action or assessment by a regulator; and unanticipated competition. Any adverse change in these factors could have a significant impact on the recoverability of these assets and could have a material impact on the Company’s consolidated financial statements.

Goodwill is the only intangible asset with an indefinite life on the Company’s balance sheet.

Participation in PPP Loan Program

We elected to participate in the first and second rounds of the Small Business Administration Paycheck Protection Program (PPP) under the Coronavirus Aid, Relief and Economic Security Act (CARES Act) program funding over $1.08 billion in loans. We have received fees and incurred incremental direct origination costs related to our participation in the PPP loan program, both of which

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have been deferred and are being amortized over the shorter of the repayment period or the contractual life of these loans. During the three and nine months ended September 30, 2021, we recognized total net fee revenue into interest income of $7.4 million and $20.7 million, respectively, related to PPP fees compared to $3.0 million and $5.1 million, respectively, for the same periods in 2020. The remainder of the PPP loan deferred fees totaled approximately $10.8 million at September 30, 2021. These remaining deferred fees will be amortized over the shorter of the repayment period or the contractual life of the loans.

Recently Issued Accounting Pronouncements

We have evaluated new accounting pronouncements that have recently been issued and have determined that there are no new accounting pronouncements that should be described in this section that will impact the Company’s operations, financial condition or liquidity in future periods. Refer to Note 1 of the Company’s consolidated financial statements for a discussion of recent accounting pronouncements that have been adopted by the Company or that will require enhanced disclosures in the Company’s financial statements in future periods.

Results of Operations

Net income was $19.1 million, or $0.93 per diluted share, for the third quarter 2021 compared to $16.2 million, or $0.79 per diluted share, for the third quarter 2020 as results were primarily driven by increased net interest income, which included the impact of our participation in the PPP loan program, partially offset by an increased provision for credit losses and noninterest expenses. Annualized returns on average assets, average equity and average tangible equity were 1.14%, 9.45% and 13.49%, respectively, compared to 1.09%, 8.59% and 12.72%, respectively, for the three months ended September 30, 2021 and 2020, respectively. Return on average tangible equity is a non-GAAP financial measure. See the GAAP to non-GAAP reconciliation table provided for a more detailed analysis. The efficiency ratio decreased to 56.91% for the third quarter 2021 from 60.58% for the third quarter 2020. The efficiency ratio is calculated by dividing total noninterest expense by the sum of net interest income plus noninterest income, excluding net gains and losses on the sale of loans, securities and assets. Additionally, taxes and provision for loan losses are not part of the efficiency ratio calculation.

Net income was $60.0 million, or $2.95 per diluted share, for the nine months ended September 30, 2021 compared to $29.6 million, or $1.44 per diluted share, for the nine months ended September 30, 2020. The nine months ended September 30, 2021 results were impacted by increased net interest income, which included the impact of our participation in the PPP loan program, and lower provision expense partially offset by higher noninterest expenses compared to the nine months ended September 30, 2020 results which featured significant provision expense and write-downs in other real estate in response to COVID-19-related uncertainties in the economic environment. Annualized returns on average assets, average shareholders’ equity and average tangible shareholders’ equity were 1.25%, 10.30% and 14.89%, respectively, compared to 0.72%, 5.43% and 8.16%, respectively, for the nine months ended September 30, 2021 and 2020, respectively. The efficiency ratio decreased to 58.24% for the nine months ended September 30, 2021 from 61.67% for the nine months ended September 30, 2020 primarily due the increase in net interest income.

Net Interest Income

Three months ended September 30, 2021 compared with three months ended September 30, 2020. Net interest income before the provision for credit losses for the three months ended September 30, 2021 was $58.2 million compared with $51.9 million for the three months ended September 30, 2020, an increase of $6.3 million, or 12.1%. The increase in net interest income was primarily due to changes in the volume and relative mix of the underlying assets, the impact of PPP loans as well as lower costs on interest-bearing liabilities.

Interest income was $63.9 million for the three months ended September 30, 2021, an increase of $3.1 million, or 5.1%, compared with the three months ended September 30, 2020, primarily due to increased average interest-earning asset balances and PPP fee income partially offset by a decrease in yield on interest-earning assets driven by changes in interest rates and the mix of average interest-earning asset balances. Average securities outstanding increased $403.8 million, 60.5%, and deposits in other financial institutions increased $568.7 million while average loans outstanding decreased $257.9 million, or 5.6%, primarily due to the paydowns of PPP and core loans partially offset by the origination of core loans for the three months ended September 30, 2021 compared to the three months ended September 30, 2020. The net increase in average interest-earning asset balances were partially offset by the decrease in average yield on securities to 2.04% from 2.61%, along with the decrease in yield on deposits in financial institutions to 0.15% from 0.35% for the three months ended September 30, 2021 due to the impact of lower interest rates. These decreases were partially offset by the increase in average yield on loans to 5.32% for the three months ended September 30, 2021 from 4.89% for the same period in 2020. This increase in average yield on loans was primarily due to $7.4 million of PPP fee income recognition during the three months ended September 30, 2021 compared to $3.0 million recognized for the three months ended September 30, 2020.

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Interest expense was $5.7 million for the three months ended September 30, 2021, a decrease of $3.2 million, or 35.7%, compared to the three months ended September 30, 2020. This decrease was primarily due to lower funding costs on interest-bearing deposits partially offset by an increase in average interest-bearing liabilities. The cost of average interest-bearing liabilities decreased to 61 basis points for the three months ended September 30, 2021 compared to 105 basis points for the same period in 2020. Average interest-bearing liabilities increased $377.7 million, or 11.2%, for the three months ended September 30, 2021 compared to the three months ended September 30, 2020 due in part to funds from government stimulus programs such as the PPP and consumer economic impact payments received along with organic deposit growth.

Tax equivalent net interest margin, defined as net interest income adjusted for tax-free income divided by average interest-earning assets, for the three months ended September 30, 2021 was 3.90%, a decrease of 5 basis points compared to 3.95% for the three months ended September 30, 2020. The decrease in the net interest margin on a tax equivalent basis was primarily due to the decrease in average yield on interest-earning assets driven by the increase in securities and cash partially offset by the decrease in funding costs. The average yield on interest-earning assets and the average rate paid on interest-bearing liabilities are primarily impacted by changes in the volume and relative mix of the underlying assets and liabilities as well as changes in market interest rates. The average yield on interest-earning assets of 4.23% and the average rate paid on interest-bearing liabilities of 0.61% for the third quarter 2021 decreased by 35 basis points and 44 basis points, respectively, over the same period in 2020. Tax equivalent adjustments to net interest margin are the result of increasing income from tax-free securities and loans by an amount equal to the taxes that would have been paid if the income were fully taxable based on a 21% federal tax rate for the three months ended September 30, 2021 and 2020, thus making tax-exempt yields comparable to taxable asset yields.

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


	Three Months Ended September 30,
	2021						2020
	Average Balance		Interest Earned/ Interest Paid		Average Yield/ Rate		Average Balance		Interest Earned/ Interest Paid		Average Yield/ Rate
	(Dollars in thousands)
Assets
Interest-earning Assets:
Loans	$	4,336,443	$	58,176	5.32	%	$	4,594,333	$	56,418	4.89	%
Securities	1,070,851		5,496		2.04	%	667,008		4,375		2.61	%
Deposits in other financial institutions	588,859		221		0.15	%	20,176		18		0.35	%
Total interest-earning assets	5,996,153		$	63,893	4.23	%	5,281,517		$	60,811	4.58	%
Allowance for credit losses on loans	(49,381)						(47,593)
Noninterest-earning assets	680,682						679,750
Total assets	$	6,627,454					$	5,913,674

Liabilities and Shareholders' Equity
Interest-bearing Liabilities:
Interest-bearing demand deposits	$	576,144	$	324	0.22	%	$	394,612	$	392	0.40	%
Money market and savings deposits	1,565,965		943		0.24	%	1,409,969		1,265		0.36	%
Certificates and other time deposits	1,363,121		2,583		0.75	%	1,291,536		5,239		1.61	%
Borrowed funds	139,844		436		1.24	%	171,804		558		1.29	%
Subordinated debt	108,652		1,441		5.26	%	108,130		1,448		5.33	%
Total interest-bearing liabilities	3,753,726		$	5,727	0.61	%	3,376,051		$	8,902	1.05	%

Noninterest-Bearing Liabilities:
Noninterest-bearing demand deposits	2,031,399						1,752,404
Other liabilities	42,183						36,572
Total liabilities	5,827,308						5,165,027
Shareholders' equity	800,146						748,647
Total liabilities and shareholders' equity	$	6,627,454					$	5,913,674

Net interest rate spread					3.62	%					3.53	%

Net interest income and margin(1)			$	58,166	3.85	%			$	51,909	3.91	%

Net interest income and margin (tax equivalent)(2)			$	58,873	3.90	%			$	52,446	3.95	%

(1)The net interest margin is equal to annualized net interest income divided by average interest-earning assets.

(2)In order to make pretax income and resultant yields on tax-exempt investments and loans comparable to those on taxable investments and loans, a tax-equivalent adjustment has been computed using a federal income tax rate of 21% for the three months ended September 30, 2021 and 2020 and other applicable effective tax rates.

Nine months ended September 30, 2021 compared with nine months ended September 30, 2020. Net interest income before the provision for credit losses for the nine months ended September 30, 2021 was $170.5 million compared with $147.8 million for the nine months ended September 30, 2020, an increase of $22.7 million, or 15.3%. The increase in net interest income was primarily due to lower funding costs on interest-bearing liabilities, the impact of PPP loans and the increase in average interest-earning asset balances.

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Interest income was $189.6 million for the nine months ended September 30, 2021, an increase of $10.8 million, or 6.1%, compared with the nine months ended September 30, 2020, primarily due to the increase in average interest-earning asset balances and PPP fee income recognition partially offset by lower yields on interest-earning assets driven by changes in interest rates and the mix of average interest-earning asset balances. Average securities outstanding increased $362.7 million, or 65.9%, for the same period. Average loans outstanding increased $164.1 million, or 3.8%, for the nine months ended September 30, 2021 compared to the nine months ended September 30, 2020 primarily due to the origination of PPP and core loans over the prior year. These increases were partially offset by the decrease in the average yield on securities to 2.25% for the nine months ended September 30, 2021 from 2.67% for the same period in 2020 due to the impact of lower interest rates. Interest income also increased as a result of PPP fee income recognition of $20.7 million during the nine months ended September 30, 2021 compared to $5.1 million recognized for the same period in 2020. Additionally, acquisition accounting loan discount accretion had a lower impact on interest income on loans as $385 thousand was recognized during the nine months ended September 30, 2021 compared to $2.2 million for the same period in 2020.

Interest expense was $19.1 million for the nine months ended September 30, 2021, a decrease of $11.8 million, or 38.3%, compared to the nine months ended September 30, 2020. This decrease was primarily due to lower funding costs on interest-bearing deposits partially offset by an increase in average interest-bearing liabilities. The cost of average interest-bearing liabilities decreased to 69 basis points for the nine months ended September 30, 2021 compared to 129 basis points for the same period in 2020. Average interest-bearing liabilities increased $485.9 million for the nine months ended September 30, 2021 compared to the nine months ended September 30, 2020 primarily due in part to funds from government stimulus programs such as the PPP and consumer economic impact payments received along with organic deposit growth.

Tax equivalent net interest margin for the nine months ended September 30, 2021 was 4.03%, a decrease of 3 basis points compared to 4.06% for the nine months ended September 30, 2020. The decrease in the net interest margin on a tax equivalent basis was primarily due to the decrease in the average yield on interest-earning assets, driven by the increase in cash and securities, partially offset by the decrease in funding costs. The average yield on interest-earning assets and the average rate paid on interest-bearing liabilities are primarily impacted by changes in the volume and relative mix of the underlying assets and liabilities as well as changes in market interest rates. The average rate paid on interest-bearing liabilities of 0.69% and the average yield on interest-earning assets of 4.43% for the nine months ended September 30, 2021 decreased by 60 basis points and 44 basis points, respectively, over the same period in 2020.

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	Nine Months Ended September 30,
	2021						2020
	Average Balance		Interest Earned/ Interest Paid		Average Yield/ Rate		Average Balance		Interest Earned/ Interest Paid		Average Yield/ Rate
	(Dollars in thousands)
Assets
Interest-Earning Assets:
Loans	$	4,482,684	$	173,858	5.19	%	$	4,318,564	$	167,463	5.18	%
Securities	913,078		15,339		2.25	%	550,405		11,019		2.67	%
Deposits in other financial institutions	328,238		356		0.15	%	29,652		233		1.05	%
Total interest-earning assets	5,724,000		$	189,553	4.43	%	$	4,898,621	$	178,715	4.87	%
Allowance for credit losses on loans	(51,802)						(39,245)
Noninterest-earning assets	758,774						639,606
Total assets	$	6,430,972					$	5,498,982

Liabilities and Shareholders' Equity
Interest-Bearing Liabilities:
Interest-bearing demand deposits	$	523,272	$	1,021	0.26	%	$	370,485	$	1,659	0.60	%
Money market and savings deposits	1,555,791		3,067		0.26	%	1,249,832		6,091		0.65	%
Certificates and other time deposits	1,354,000		9,237		0.91	%	1,262,674		17,168		1.82	%
Borrowed funds	146,244		1,444		1.32	%	210,902		1,626		1.03	%
Subordinated debt	108,522		4,324		5.33	%	107,998		4,390		5.43	%
Total interest-bearing liabilities	3,687,829		$	19,093	0.69	%	3,201,891		$	30,934	1.29	%

Noninterest-Bearing Liabilities:
Noninterest-bearing demand deposits	1,923,584						1,535,107
Other liabilities	40,568						33,482
Total liabilities	5,651,981						4,770,480
Shareholders' equity	778,991						728,502
Total liabilities and shareholders' equity	$	6,430,972					$	5,498,982

Net interest rate spread					3.74	%					3.58	%

Net interest income and margin			$	170,460	3.98	%			$	147,781	4.03	%

Net interest income and net interest margin (tax equivalent)			$	172,477	4.03	%			$	148,939	4.06	%

(1)The net interest margin is equal to annualized net interest income divided by average interest-earning assets.

(2)In order to make pretax income and resultant yields on tax-exempt investments and loans comparable to those on taxable investments and loans, a tax-equivalent adjustment has been computed using a federal income tax rate of 21% for the nine months ended September 30, 2021 and 2020 and other applicable effective tax rates.

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


	For the Three Months Ended September 30,						For the Nine Months Ended September 30,
	2021 vs. 2020						2021 vs. 2020
	Increase (Decrease) Due to Change in						Increase (Decrease) Due to Change in
	Volume		Rate		Total		Volume		Rate		Total
	(Dollars in thousands)
Interest-earning Assets:
Loans	$	(3,167)	$	4,925	$	1,758	$	5,721	$	665	$	6,386
Securities	2,649		(1,528)		1,121		7,205		(2,874)		4,331
Deposits in other financial institutions	507		(304)		203		2,340		(2,214)		126
Total (decrease) increase in interest income	(11)		3,093		3,082		15,266		(4,423)		10,843

Interest-bearing Liabilities:
Interest-bearing demand deposits	180		(248)		(68)		676		(1,314)		(638)
Money market and savings deposits	140		(462)		(322)		1,459		(4,487)		(3,028)
Certificates and other time deposits	290		(2,946)		(2,656)		1,173		(9,106)		(7,933)
Borrowed funds	(104)		(18)		(122)		(503)		321		(182)
Subordinated debt	7		(14)		(7)		5		(71)		(66)
Total increase (decrease) in interest expense	513		(3,688)		(3,175)		2,810		(14,657)		(11,847)
(Decrease) increase in net interest income	$	(524)	$	6,781	6,257		$	12,456	$	10,234	22,690

Provision for Credit Losses

Our allowance for credit losses is established through charges to income in the form of the provision in order to bring our allowance for credit losses for various types of financial instruments including loans, unfunded commitments and securities to a level deemed appropriate by management. We recorded a $2.3 million and $1.3 million provision for credit losses for the three months ended September 30, 2021 and 2020, respectively, and a $255 thousand and $23.0 million provision for credit losses for the nine months ended September 30, 2021 and 2020, respectively. The provision for credit losses for the three months ended September 30, 2021 compared to the same period in 2020 reflects the recent uncertainty surrounding the potential economic impact caused by the COVID-19 pandemic and increased net charge-offs during the three months ended September 30, 2021. The provision for credit losses for the nine months ended September 30, 2021 compared to the nine months ended September 30, 2020 reflected recent improvements in economic factors and lower net charge-offs compared to the elevated provision expense in 2020 driven by the probable incurred losses expected within our loan portfolio from the increase in unemployment and economic effects of the COVID-19 pandemic and volatility of crude oil prices.

Noninterest Income

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

Three months ended September 30, 2021 compared with three months ended September 30, 2020. Noninterest income totaled $2.1 million for the three months ended September 30, 2021 compared with $1.9 million for the same period in 2020, an increase of $249 thousand, or 13.5%, primarily due to decreased losses on the sales of other real estate and increased debit card and ATM card income.

Nine months ended September 30, 2021 compared with nine months ended September 30, 2020. Noninterest income totaled $6.1 million for the nine months ended September 30, 2021 and 2020.

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


	For the Three Months Ended September 30,				Increase (Decrease)		For the Nine Months Ended September 30,				Increase (Decrease)
	2021		2020				2021		2020
	(Dollars in thousands)
Nonsufficient funds fees	$	131	$	75	$	56	$	308	$	304	$	4
Service charges on deposit accounts	425		325		100		1,195		1,125		70
Gain on sale of securities	—		—		—		49		287		(238)
Gain (loss) on sale of other real estate	—		117		(117)		(176)		(258)		82
Bank owned life insurance income	125		144		(19)		415		438		(23)
Debit card and ATM card income	771		574		197		2,162		1,568		594
Rebate from correspondent bank	(5)		98		(103)		200		680		(480)
Other(1)	652		517		135		1,955		1,993		(38)
Total noninterest income	$	2,099	$	1,850	$	249	$	6,108	$	6,137	$	(29)

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

Noninterest Expense

Three months ended September 30, 2021 compared with three months ended September 30, 2020. Noninterest expense was $34.3 million for the three months ended September 30, 2021 compared to $32.6 million for the three months ended September 30, 2020, an increase of $1.7 million, or 5.3%, primarily due to increased salaries and benefits, as a result of increased performance-based bonus and profit sharing accruals, net occupancy and equipment, professional fees and other expenses partially offset by decreased other real estate expenses as $1.9 million of other real estate write-downs were recorded in the third quarter 2020.

Nine months ended September 30, 2021 compared with nine months ended September 30, 2020. Noninterest expense was $102.8 million for the nine months ended September 30, 2021 compared to $94.7 million for the nine months ended September 30, 2020, an increase of $8.1 million, or 8.5%. This increase was primarily due to increased salaries and benefits, as a result of increased performance-based bonus and profit sharing accruals, a reduced amount of deferred PPP loan origination costs, increased other expenses and the write-down of assets related to the closure of a bank office partially offset by lower other real estate expenses as $4.1 million of other real estate write-downs were recorded during the prior year 2020.

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


	For the Three Months Ended September 30,				Increase (Decrease)		For the Nine Months Ended September 30,				Increase (Decrease)
	2021		2020				2021		2020
	(Dollars in thousands)
Salaries and employee benefits(1)	$	22,335	$	20,034	$	2,301	$	67,259	$	59,149	$	8,110
Net occupancy and equipment	2,335		2,057		278		6,950		5,890		1,060
Depreciation	1,060		946		114		3,151		2,697		454
Data processing and software amortization	2,222		2,125		97		6,598		5,885		713
Professional fees	1,223		756		467		2,620		2,129		491
Regulatory assessments and FDIC insurance	883		875		8		2,458		2,116		342
Core deposit intangibles amortization	824		989		(165)		2,472		2,969		(497)
Communications	358		355		3		1,011		1,162		(151)
Advertising	481		327		154		1,211		1,218		(7)
Other real estate expense	137		2,017		(1,880)		479		4,780		(4,301)
Printing and supplies	74		88		(14)		214		307		(93)
Other	2,364		1,996		368		8,387		6,443		1,944
Total noninterest expense	$	34,296	$	32,565	$	1,731	$	102,810	$	94,745	$	8,065

(1)Total salaries and employee benefits includes $1.0 million and $863 thousand for the three months ended September 30, 2021 and 2020, respectively, and $2.9 million and $2.6 million for the nine months ended September 30, 2021 and 2020, respectively, of stock based compensation expense.

Salaries and employee benefits. Salaries and benefits increased $2.3 million, or 11.5%, and $8.1 million, or 13.7%, for the three and nine months ended September 30, 2021, respectively, compared to the same period in 2020 primarily due to increased performance-based bonus and profit sharing accruals related to increased net income and changes in deferred origination costs on PPP loans recorded within salaries and benefits.

Other real estate expense. Other real estate expense decreased $1.9 million, or 93.2%, and $4.3 million, or 90.0%, for the three and nine months ended September 30, 2021, respectively, compared to the same period in 2020 primarily due to write-downs on several foreclosed properties and related expenses associated with these properties during the three and nine months ended September 30, 2020.

Other. Other noninterest expenses increased $1.9 million, or 30.2%, for the nine months ended September 30, 2021 compared to the same period in 2020 primarily due to a $1.3 million write-down of assets related to the closure of a bank office during the first quarter 2021.

Efficiency Ratio

The efficiency ratio is a supplemental financial measure utilized in management’s internal evaluation of our performance. We calculate our efficiency ratio by dividing total noninterest expense by the sum of net interest income and noninterest income, excluding net gains and losses on the sale of loans, securities and assets. Additionally, taxes and provision for loan losses are not part of this calculation. An increase in the efficiency ratio indicates that more resources are being utilized to generate the same volume of income, while a decrease would indicate a more efficient allocation of resources. Our efficiency ratio decreased to 56.91% and 58.24% for the three and nine months ended September 30, 2021, respectively, compared to 60.58% and 61.67% for the three and nine months ended September 30, 2020, respectively.

We monitor the efficiency ratio in comparison with changes in our total assets and loans, and we believe that maintaining or reducing the efficiency ratio during periods of growth demonstrates the scalability of our operating platform. We expect to continue to benefit from our scalable platform in future periods as we continue to monitor overhead expenses necessary to support our growth.

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Income Taxes

The amount of federal and state income tax expense is influenced by the amount of pre-tax income, tax-exempt income and other nondeductible expenses. Income tax expense increased $937 thousand to $4.6 million for the three months ended September 30, 2021 compared with $3.7 million for the same period in 2020 primarily due to the increase in pre-tax net income. Income tax expense increased $6.9 million to $13.5 million for the nine months ended September 30, 2021 compared with $6.6 million for the same period in 2020. Our effective tax rate was 19.5% and 18.4% for the three and nine months ended September 30, 2021, respectively, compared to 18.5% and 18.2% for the three and nine months ended September 30, 2020, respectively.

Financial Condition

Loan Portfolio

At September 30, 2021, total loans were $4.29 billion, a decrease of $202.3 million, or 4.5%, compared with December 31, 2020, primarily due to paydowns of PPP and core loans during the nine months ended September 30, 2021 partially offset by organic growth within our loan portfolio.

Total loans as a percentage of deposits were 75.6% and 90.0% as of September 30, 2021 and December 31, 2020, respectively. Total loans as a percentage of assets were 63.5% and 74.2% as of September 30, 2021 and December 31, 2020, respectively.

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


	September 30, 2021						December 31, 2020
	Amount				Percent		Amount		Percent
	(Dollars in thousands)
Commercial and industrial	$	728,897			17.0	%	$	667,079	14.9	%
Paycheck Protection Program (PPP)	290,028				6.8	%	569,901		12.7	%
Real estate:
Commercial real estate (including multi-family residential)	2,073,521				48.3	%	1,999,877		44.5	%
Commercial real estate construction and land development	382,610				8.9	%	367,213		8.2	%
1-4 family residential (including home equity)	683,919				16.0	%	737,605		16.4	%
Residential construction	104,638				2.4	%	127,522		2.8	%
Consumer and other	25,856				0.6	%	22,567		0.5	%
Total loans	4,289,469				100.0	%	4,491,764		100.0	%
Allowance for credit losses on loans	(50,491)		$	(6,655.00)			(53,173)
Loans, net	$	4,238,978					$	4,438,591

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

The principal categories of our loan portfolio are discussed below:

Commercial and Industrial. We make commercial and industrial loans in our market area that are underwritten primarily on the basis of the borrower’s ability to service the debt from income. In general, commercial loans involve more credit risk than residential mortgage loans and commercial mortgage loans and therefore typically yield a higher return. The increased risk in commercial loans derives from the expectation that commercial and industrial loans generally are serviced principally from the operations of the business, which may not be successful and from the type of collateral securing these loans. As a result, commercial and industrial loans require more extensive underwriting and servicing than other types of loans. Our commercial and industrial loan portfolio increased by $61.8 million, or 9.3%, to $728.9 million as of September 30, 2021 from $667.1 million as of December 31, 2020.

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Paycheck Protection Program (PPP). The CARES Act authorized the Small Business Administration (SBA) to guarantee loans under a new 7(a) loan program called the Paycheck Protection Program (PPP). As a preferred SBA lender, we were automatically authorized to originate PPP loans. An eligible business could apply for a PPP loan up to the greater of: (1) 2.5 times its average monthly “payroll costs;” or (2) $10.0 million. PPP loans have: (a) an interest rate of 1.0%, (b) a two-year or five-year loan term to maturity; and (c) principal and interest payments deferred for six months from the date of disbursement. The SBA provides a 100% guarantee of the PPP loan made to an eligible borrower. The principal balance of the borrower’s PPP loan, including any accrued interest, is eligible to be reduced in full, so long as employee and compensation levels of the business are maintained and 60% of the loan proceeds are used for payroll expenses, with the remaining 40% of the loan proceeds used for other qualifying expenses. During the nine months ended September 30, 2021, Allegiance Bank funded PPP loans totaling over $374.6 million. The balance of PPP loans decreased $279.9 million to $290.0 million as of September 30, 2021 from $569.9 million as of December 31, 2020 due to loan forgiveness.

Commercial Real Estate (Including Multi-Family Residential). We make loans collateralized by owner-occupied, nonowner-occupied and multi-family real estate to finance the purchase or ownership of real estate. As of September 30, 2021 and December 31, 2020, 54.1% and 54.6%, respectively, of our commercial real estate loans were owner-occupied. Our commercial real estate loan portfolio increased $73.6 million, or 3.7%, to $2.07 billion as of September 30, 2021 from $2.00 billion as of December 31, 2020, primarily as a result of organic loan growth. Included in our commercial real estate portfolio are multi-family residential loans. Our multi-family loans increased to $78.7 million as of September 30, 2021 from $75.9 million as of December 31, 2020. We had 135 multi-family loans with an average loan size of $583 thousand as of September 30, 2021.

Commercial Real Estate Construction and Land Development. We make commercial real estate construction and land development loans to fund commercial construction, land acquisition and real estate development construction. Construction loans involve additional risks as they often involve the disbursement of funds with the repayment dependent on the ultimate success of the project’s completion. Sources of repayment for these loans may be pre-committed permanent financing or sale of the developed property. The loans in this portfolio are monitored closely by management. Due to uncertainties inherent in estimating construction costs, the market value of the completed project and the effects of governmental regulation on real property, it can be difficult to accurately evaluate the total funds required to complete a project and the related loan to value ratio. As a result of these uncertainties, construction lending often includes the disbursement of substantial funds with repayment dependent, in part, on the success of the ultimate project rather than the ability of a borrower or guarantor to repay the loan. As of September 30, 2021 and December 31, 2020, 25.6% and 26.8%, respectively, of our commercial real estate construction and land development loans were owner-occupied. Commercial real estate construction and land development loans increased $15.4 million, or 4.2%, to $382.6 million as of September 30, 2021 compared to $367.2 million as of December 31, 2020.

1-4 Family Residential (Including Home Equity). Our residential real estate loans include the origination of 1-4 family residential mortgage loans (including home equity and home improvement loans and home equity lines of credit) collateralized by owner-occupied residential properties located in our market area. Our residential real estate portfolio (including home equity) decreased $53.7 million, or 7.3%, to $683.9 million as of September 30, 2021 from $737.6 million as of December 31, 2020. The home equity, home improvement and home equity lines of credit portion of our residential real estate portfolio decreased $9.9 million, or 8.4%, to $107.6 million as of September 30, 2021 from $117.5 million as of December 31, 2020.

Residential Construction. We make residential construction loans to home builders and individuals to fund the construction of single-family residences with the understanding that such loans will be repaid from the proceeds of the sale of the homes by builders or with the proceeds of a mortgage loan. These loans are secured by the real property being built and are made based on our assessment of the value of the property on an as-completed basis. Our residential construction loans portfolio decreased $22.9 million, or 17.9%, to $104.6 million as of September 30, 2021 from $127.5 million as of December 31, 2020.

Consumer and Other. Our consumer and other loan portfolio is made up of loans made to individuals for personal purposes and deferred fees and costs on all loan types. Our consumer and other loan portfolio increased due to core loan growth partially offset by the impact of the deferred fees and costs recorded on PPP loans during 2021.

“At-Risk” Industry Loan Exposure due to Economic Stress Resulting from COVID-19 Impacts. While all industries have and are expected to continue to experience adverse impacts as a result of the COVID-19 pandemic, we have exposure in the following loan categories considered to be more “at-risk” of significant impact.

Hotel. Our hotel loans, excluding PPP loans, at September 30, 2021 totaled $135.5 million, or 3.4% of total loans, $6.0 million of which were on nonaccrual status. At September 30, 2021, our allowance for credit losses on loans allocated to our total hotel loan portfolio totaled 3.8% of total hotel loans.

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Restaurant and Bar. Our restaurant and bar loans, excluding PPP loans, at September 30, 2021 totaled $112.5 million, or 2.8% of total loans, $289 thousand of which were on nonaccrual status. At September 30, 2021, our allowance for credit losses on loans allocated to our total restaurant and bar loan portfolio was 1.3% of total restaurant and bar loans.

Oil and Gas. Our oil and gas loans, excluding PPP loans, at September 30, 2021 totaled $67.8 million, or 1.7% of total loans, of which $746 thousand were on nonaccrual status. At September 30, 2021, our allowance for credit losses on loans allocated to our total oil and gas loan portfolio was 1.3% of total oil and gas loans. At September 30, 2021, we did not have exposure to exploration and production or reserve-based lending and only had minimal exposure to the industry.

Asset Quality

Nonperforming Assets

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

We had $28.4 million and $28.9 million in nonperforming loans as of September 30, 2021 and December 31, 2020, respectively.

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


	As of September 30, 2021			As of December 31, 2020
	(Dollars in thousands)
Nonaccrual loans:
Commercial and industrial	$	10,247		$	10,747
Paycheck Protection Program (PPP)	—			—
Real estate:
Commercial real estate (including multi-family residential)	14,629			10,081
Commercial real estate construction and land development	53			3,011
1-4 family residential (including home equity)	3,224			4,525
Residential construction	—			—
Consumer and other	216			529
Total nonaccrual loans	28,369			28,893
Accruing loans 90 or more days past due	—			—
Total nonperforming loans	28,369			28,893
Other real estate	1,397			9,196
Other repossessed assets	—			—
Total nonperforming assets	$	29,766		$	38,089
Restructured loans(1)	$	11,312		$	12,448
Nonperforming assets to total assets	0.44		%	0.63		%
Nonperforming loans to total loans	0.66		%	0.64		%

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

Potential problem loans are included in the loans that are accruing, restructured and impaired that are performing in accordance with contractual terms but for which management has concerns about the ability of an obligor to continue to comply with repayment terms because of the obligor’s potential operating or financial difficulties. Management monitors these loans closely and reviews their performance on a regular basis. Potential problem loans contain potential weaknesses that could improve, persist or further deteriorate. At September 30, 2021 and December 31, 2020, we had $54.4 million and $32.6 million, respectively, in loans of this type which are not included in any of the nonaccrual or 90 days past due loan categories. At September 30, 2021, potential problem loans consisted of 36 credit relationships. Of the total outstanding balance at September 30, 2021, 57.0% to seven customers in the hotel industry, 10.0% to three customers in the consumer services industry, 7.2% to two customers in the commercial real estate

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investment industry, 7.2% to four customers in the construction services industry, 6.9% to three customers in the residential rental real estate industry, 6.0% to six customers in the energy industry, 1.5% to one customer in the RV park industry, 1.5% to four customers in the commercial services industry, 1.3% to three customers in the homestead industry, 1.1% to two customers in the medical industry and 0.3% to one customer in the wholesale industry. Weakness in these organizations’ operating performance, financial condition and borrowing base deficits for certain energy-related credits, among other factors, have caused us to heighten the attention given to these credits.

The Company granted initial principal and interest deferrals on outstanding loan balances to borrowers in connection with the COVID-19 relief provided by the CARES Act and subsequent deferrals upon request and after meeting certain conditions. These deferrals were generally no more than 90 days in duration. As of September 30, 2021, 37 loans with outstanding loan balances of $37.4 million remained on deferral. If the impact of COVID-19 persists, borrower operations do not improve or if other negative events occur, such modified loans could transition to potential problem loans or into problem loans.

The following table presents information regarding principal and/or interest deferrals as of September 30, 2021 associated with loan modifications related to COVID-19:


	Outstanding Loan Balance		Inside of Deferral Period				Outside of Deferral Period				Total Loans That Have Had a Deferral
			Loan Balance		Percent		Loan Balance		Percent		Loan Balance		Percent
	(Dollars in thousands)
Commercial and industrial	$	728,897	$	979	2.6	%	$	78,871	10.1	%	$	79,850	9.7	%
Paycheck Protection Program (PPP)	290,028		—		—	%	—		—	%	—		—	%
Real estate:
Commercial real estate (including multi-family residential)	2,073,521		32,780		87.6	%	587,195		75.0	%	619,975		75.7	%
Commercial real estate construction and land development	382,610		1,987		5.3	%	40,294		5.2	%	42,281		5.1	%
1-4 family residential (including home equity)	683,919		1,688		4.5	%	73,530		9.4	%	75,218		9.2	%
Residential construction	104,638		—		—	%	1,321		0.2	%	1,321		0.2	%
Consumer and other	25,856		—		—	%	522		0.1	%	522		0.1	%
Total loans	$	4,289,469	$	37,434	100.0	%	$	781,733	100.0	%	$	819,167	100.0	%

We have also actively participated in assisting with applications for resources through the PPP. PPP loans have a two-year or five-year term and earn interest at 1%. We believe that the majority of these loans will ultimately be forgiven by the SBA in accordance with the terms of the program. As of September 30, 2021, we have funded over $1.08 billion in PPP loans. The balance of the PPP loans decreased to $290.0 million at September 30, 2021 as a result of loan forgiveness. It is our understanding that loans funded through the PPP are fully guaranteed by the U.S. government. Should those circumstances change, we could be required to establish additional allowance for credit loss through additional provision expense charged to earnings.

Allowance for Credit Losses

The allowance for credit losses is a valuation allowance that is established through charges to earnings in the form of a provision for credit losses calculated in accordance with ASC 326 that is deducted from the amortized cost basis of certain assets to present the net amount expected to be collected. The amount of each allowance account represents management's best estimate of CECL on these financial instruments considering available information, from internal and external sources, relevant to assessing exposure to credit loss over the contractual term of the instrument. Relevant available information includes historical credit loss experience, current conditions and reasonable and supportable forecasts. While historical credit loss experience provides the basis for the estimation of expected credit losses, adjustments to historical loss information may be made for differences in current portfolio-specific risk characteristics, environmental conditions or other relevant factors. While management utilizes its best judgment and information available, the ultimate adequacy of our allowance accounts is dependent upon a variety of factors beyond our control, including the performance of our portfolios, the economy, changes in interest rates and the view of the regulatory authorities toward classification of assets. For additional information regarding critical accounting policies, refer to Note 1 – Nature of Operations and Summary of Significant Accounting and Reporting Policies and Note 4 – Loans and Allowance for Credit Losses in the accompanying notes to consolidated financial statements.

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Allowance for Credit Losses on Loans

The allowance for credit losses on loans represents management’s estimates of current expected credit losses in the Company’s loan portfolio. Pools of loans with similar risk characteristics are collectively evaluated, while loans that no longer share risk characteristics with loan pools are evaluated individually.

The Company retroactively adopted ASC Topic 326 effective January 1, 2020 during the fourth quarter of 2020. Upon adoption of CECL, the Company recognized an increase in allowance for credit losses on loans of $3.1 million with a corresponding decrease in retained earnings (pre-tax). Additionally, the Company recognized an increase in the allowance for credit losses on loans of $2.1 million related to loans acquired from the acquisition of Post Oak Bancshares, Inc., due to the reclassification of PCD discounts as a result of adopting CECL. At September 30, 2021, our allowance for credit losses on loans amounted to $50.5 million, or 1.18% of total loans, compared with $53.2 million, or 1.18%, of total loans as of December 31, 2020. The decrease in the allowance for credit losses on loans during 2021 reflected improvements in economic factors compared to increased expected losses during 2020 resulting from a deterioration in forecasted economic conditions and the current and uncertain future impacts associated with the COVID-19 pandemic and recent volatility in crude oil prices.

Collective loss estimates are determined by applying reserve factors, designed to estimate current expected credit losses, to amortized cost balances over the remaining contractual life of the collectively evaluated portfolio. Loans with similar risk characteristics are aggregated into homogeneous pools. The allowance for credit losses on loans also includes qualitative adjustments to bring the allowance to the level management believes is appropriate based on factors that have not otherwise been fully accounted for, including adjustments for foresight risk, input imprecisions and model imprecision. Credit losses for loans that no longer share risk characteristics with the loan pools are estimated on an individual basis. Individual credit loss estimates are typically performed for nonaccrual loans and modified loans classified as TDRs and are based on one of several methods, including the estimated fair value of the underlying collateral, observable market value of similar debt or the present value of expected cash flows.

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


	As of and for the Nine Months Ended September 30,
	2021			2020
	(Dollars in thousands)
Average loans outstanding	$	4,482,684		$	4,318,564
Gross loans outstanding at end of period	4,289,469			4,592,362
Allowance for credit losses on loans at beginning of period	53,173			29,438
(Recapture of) provision for loan losses	(1,725)			23,006
Charge-offs:
Commercial and industrial loans	(609)			(1,442)
Real estate:
Commercial real estate (including multi-family residential)	(457)			(137)
Commercial real estate construction and land development	—			(2,341)
1-4 family residential (including home equity)	(21)			(215)
Residential construction	—			—
Consumer and other	(24)			—
Total charge-offs for all loan types	(1,111)			(4,135)
Recoveries:
Commercial and industrial loans	147			381
Real estate:
Commercial real estate (including multi-family residential)	—			8
Commercial real estate construction and land development	—			—
1-4 family residential (including home equity)	—			—
Residential construction	—			—
Consumer and other	7			—
Total recoveries for all loan types	154			389
Net charge-offs	(957)			(3,746)
Allowance for credit losses on loans at end of period	$	50,491		$	48,698
Allowance for credit losses on loans to total loans	1.18		%	1.06		%
Net charge-offs to average loans(1)	0.03		%	0.12		%
Allowance for credit losses on loans to nonperforming loans	177.98		%	128.40		%

(1)Interim periods annualized.

Available for Sale Securities

We use our securities portfolio to provide a source of liquidity, to provide an appropriate return on funds invested, to manage interest rate risk and to meet pledging and regulatory capital requirements. As of September 30, 2021, the carrying amount of investment securities totaled $1.21 billion, an increase of $438.6 million, or 56.7%, compared with $772.9 million as of December 31, 2020. Securities represented 17.9% of total assets as of September 30, 2021 and 12.8% as of December 31, 2020.

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

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


	September 30, 2021
	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses		Fair Value
	(Dollars in thousands)
Available for Sale
U.S. government and agency securities	$	132,434	$	487	$	(928)	$	131,993
Municipal securities	455,816		28,142		(1,686)		482,272
Agency mortgage-backed pass-through securities	250,913		2,585		(3,651)		249,847
Agency collateralized mortgage obligations	230,273		2,585		(2,111)		230,747
Corporate bonds and other	113,598		3,420		(401)		116,617
Total	$	1,183,034	$	37,219	$	(8,777)	$	1,211,476


	December 31, 2020
	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses		Fair Value
	(Dollars in thousands)
Available for Sale
U.S. government and agency securities	$	25,545	$	654	$	—	$	26,199
Municipal securities	392,586		35,079		(60)		427,605
Agency mortgage-backed pass-through securities	167,606		3,829		(146)		171,289
Agency collateralized mortgage obligations	80,182		4,263		(75)		84,370
Corporate bonds and other	62,124		1,352		(49)		63,427
Total	$	728,043	$	45,177	$	(330)	$	772,890

Investment securities classified as available for sale or held to maturity are evaluated for expected credit losses under ASC Topic 326, “Financial Instruments – Credit Losses.” As of September 30, 2021, we did not expect to sell any securities classified as available for sale with unrealized losses, and management believes that we more likely than not will not be required to sell any securities before their anticipated recovery at which time we will receive full value for the securities. The unrealized losses are largely due to increases in market interest rates over the yields available at the time the underlying securities were purchased.

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


	September 30, 2021
	Within One Year				After One Year but Within Five Years				After Five Years but Within Ten Years				After Ten Years				Total
	Amount		Yield		Amount		Yield		Amount		Yield		Amount		Yield		Total		Yield
	(Dollars in thousands)
Available for Sale
U.S. government and agency securities	$	1486	3.10	%	$	4,089	3.37	%	$	23,978	1.28	%	$	102,881	0.90	%	$	132,434	1.07	%
Municipal securities	2,392		3.16	%	4,312		3.54	%	72,720		2.96	%	376,392		3.08	%	455,816		3.06	%
Agency mortgage-backed pass-through securities	—		0.00	%	2,990		2.87	%	5,256		3.23	%	242,667		1.32	%	250,913		1.38	%
Agency collateralized mortgage obligations	—		0.00	%	6,079		2.80	%	19,184		2.74	%	205,010		1.19	%	230,273		1.36	%
Corporate bonds and other	—		0.00	%	4,965		4.70	%	40,000		5.50	%	68,633		2.14	%	113,598		3.44	%
Total	$	3,878	3.14	%	$	22,435	3.48	%	$	161,138	3.32	%	$	995,583	1.97	%	$	1,183,034	2.19	%

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	December 31, 2020
	Within One Year				After One Year but Within Five Years				After Five Years but Within Ten Years				After Ten Years				Total
	Amount		Yield		Amount		Yield		Amount		Yield		Amount		Yield		Total		Yield
	(Dollars in thousands)
Available for Sale
U.S. government and agency securities	$	—	0.00	%	$	5,526	3.30	%	$	18,536	1.62	%	$	1,483	2.74	%	$	25,545	2.05	%
Municipal securities	110		4.40	%	4,323		3.34	%	51,703		3.12	%	336,450		3.27	%	392,586		3.26	%
Agency mortgage-backed pass-through securities	—		0.00	%	5,378		2.99	%	6,681		3.31	%	155,547		1.65	%	167,606		1.76	%
Agency collateralized mortgage obligations	—		0.00	%	—		—	%	25,354		2.79	%	54,828		1.66	%	80,182		2.01	%
Corporate bonds and other	—		0.00	%	3,000		5.75	%	35,000		5.72	%	24,124		3.10	%	62,124		4.70	%
Total	$	110	4.40	%	$	18,227	3.62	%	$	137,274	3.53	%	$	572,432	2.67	%	$	728,043	2.86	%

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

As of September 30, 2021 and December 31, 2020, we did not own securities of any one issuer (other than the U.S. government and its agencies or sponsored entities) for which the aggregate adjusted cost exceeded 10% of our consolidated shareholders’ equity.

The average yield of our securities portfolio was 2.25% during the nine months ended September 30, 2021 compared with 2.67% for the nine months ended September 30, 2020. The decrease in average yield during 2021 compared to the same period in 2020 was primarily due to the lower interest rate environment over the prior year partially offset by the growth in the portfolio.

Goodwill and Core Deposit Intangible Assets

Our goodwill was $223.6 million as of September 30, 2021 and December 31, 2020. Goodwill resulting from business combinations represents the excess of the consideration paid over the fair value of the net assets acquired and liabilities assumed. Goodwill is assessed annually for impairment or when events or changes in circumstances indicate that the carrying amount of the asset may not be recoverable.

Our core deposit intangible assets, net as of September 30, 2021 and December 31, 2020, was $15.5 million and $18.0 million, respectively. Core deposit intangible assets are amortized over their estimated useful life of seven to ten years.

Premises and Equipment, net

Premises and equipment, net was $65.1 million and $70.7 million at September 30, 2021 and December 31, 2020, respectively.

Deposits

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

Total deposits at September 30, 2021 were $5.67 billion, an increase of $678.4 million, or 13.6%, compared with $4.99 billion at December 31, 2020. Noninterest-bearing deposits at September 30, 2021 were $2.09 billion, an increase of $382.1 million, or 22.4%, compared with $1.70 billion at December 31, 2020 partially due to funds from government stimulus programs such as the PPP and consumer economic impact payments received. Interest-bearing deposits at September 30, 2021 were $3.58 billion, an

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increase of $296.3 million, or 9.0%, compared with $3.28 billion at December 31, 2020 due in part to funds from government stimulus programs such as the PPP and consumer economic impact payments received.

Borrowings

We have an available line of credit with the Federal Home Loan Bank ("FHLB") of Dallas, which allows us to borrow on a collateralized basis. FHLB advances are used to manage liquidity as needed. The advances are secured by a blanket lien on certain loans. Maturing advances are replaced by drawing on available cash, making additional borrowings or through increased customer deposits. At September 30, 2021, we had a total borrowing capacity of $1.91 billion, of which $1.15 billion was available and $761.8 million was outstanding. FHLB advances of $140.0 million were outstanding at September 30, 2021, at a weighted average interest rate of 1.19%. Letters of credit were $621.8 million at September 30, 2021, of which $70.7 million will expire during the remaining months of 2021, $423.3 million will expire in 2022, $60.9 million will expire in 2023, $55.9 million will expire in 2024 and $11.0 million will expire in 2025.

Credit Agreement

At September 30, 2021, the balance of the revolving credit agreement was zero. The interest rate on the debt is the Prime Rate minus 25 basis points, or 3.00%, at September 30, 2021, and is paid quarterly. On December 28, 2018, we amended our revolving credit agreement to increase the maximum commitment to advance funds to $45.0 million which reduces annually by $7.5 million beginning in December 2020 and on December 22nd of each year thereafter. We are required to repay any outstanding balance in excess of the then-current maximum commitment amount. The revised agreement will mature in December 2025 and is secured by 100% of the capital stock of the Bank.

Our credit agreement contains certain restrictive covenants, including limitations on our ability to incur additional indebtedness or engage in certain fundamental corporate transactions, such as mergers, reorganizations and recapitalizations. Additionally, the Bank is required to maintain a “well-capitalized” rating, a minimum return on assets of 0.65%, measured quarterly, a ratio of loan loss reserve to nonperforming loans equal to or greater than 75%, measured quarterly, and a ratio of nonperforming assets to aggregate equity plus loan loss reserves minus intangible assets of less than 35%, measured quarterly. As of September 30, 2021, we believe we were in compliance with all such debt covenants.

Off-Balance Sheet Items

In the normal course of business, we enter into various transactions, which, in accordance with accounting principles generally accepted in the United States, are not included in our consolidated balance sheets. We enter into these transactions to meet the financing needs of our customers. These transactions include commitments to extend credit and standby and commercial letters of credit, which involve, to varying degrees, elements of credit risk and interest rate risk in excess of the amounts recognized in our consolidated balance sheets.

Commitments to Extend Credit. We enter into contractual commitments to extend credit, normally with fixed expiration dates or termination clauses, at specified rates and for specific purposes. Substantially all of our commitments to extend credit are contingent upon customers maintaining specific credit standards at the time of loan funding. We minimize our exposure to loss under these commitments by subjecting them to credit approval and monitoring procedures. The amount and type of collateral obtained, if considered necessary by us, upon extension of credit, is based on management’s credit evaluation of the customer. Management assesses the credit risk associated with certain commitments to extend credit in determining the level of the allowance for credit losses.

Standby Letters of Credit. Standby letters of credit are conditional commitments issued by us to guarantee the performance of a customer to a third party. If the customer does not perform in accordance with the terms of the agreement with the third party, we would be required to fund the commitment and we would have the rights to the underlying collateral. The maximum potential amount of future payments we could be required to make is represented by the contractual amount of the commitment. Our policies generally require that standby letter of credit arrangements contain security and debt covenants similar to those contained in loan agreements.

As of September 30, 2021 and December 31, 2020, we had outstanding $1.63 billion and $1.24 billion, respectively, in commitments to extend credit and $22.8 million and $17.3 million, respectively, in commitments associated with outstanding letters of credit. Since commitments associated with letters of credit and commitments to extend credit may expire unused, the total outstanding may not necessarily reflect the actual future cash funding requirements.

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Liquidity and Capital Resources

Liquidity

Liquidity is the measure of our ability to meet the cash flow requirements of depositors and borrowers, while at the same time meeting our operating, capital, strategic cash flow needs and to maintain reserve requirements to operate on an ongoing basis and manage unexpected events, all at a reasonable cost. During the nine months ended September 30, 2021 and the year ended December 31, 2020, our liquidity needs have been primarily met by deposits, borrowed funds, security and loan maturities and amortizing investment and loan portfolios. The Bank has access to purchased funds from correspondent banks, and advances from the FHLB are available under a security and pledge agreement to take advantage of investment opportunities.

Our largest source of funds is deposits, and our largest use of funds is loans. Our average deposits increased $938.5 million, or 21.2%, and our average loans increased $164.1 million, or 3.8%, for the nine months ended September 30, 2021 compared with the nine months ended September 30, 2020. We predominantly invest excess deposits in Federal Reserve Bank of Dallas balances, securities, interest-bearing deposits at other banks or other short-term liquid investments until the funds are needed to fund loan growth. Our securities portfolio had a weighted average life of 7.3 years and modified duration of 5.2 years at September 30, 2021, and a weighted average life of 7.9 years and modified duration of 6.2 years at December 31, 2020.

As of September 30, 2021 and December 31, 2020, we had no exposure to future cash requirements associated with known uncertainties or capital expenditures of a material nature.

Capital Resources

Capital management consists of providing equity to support our current and future operations. We are subject to capital adequacy requirements imposed by the Federal Reserve, and the Bank is subject to capital adequacy requirements imposed by the FDIC. Both the Federal Reserve and the FDIC have adopted risk-based capital requirements for assessing bank holding company and bank capital adequacy. These standards define capital and establish minimum capital requirements in relation to assets and off-balance sheet exposure, adjusted for credit risk. The risk-based capital standards currently in effect are designed to make regulatory capital requirements more sensitive to differences in risk profiles among bank holding companies and banks, to account for off-balance sheet exposure and to minimize disincentives for holding liquid assets. Assets and off-balance sheet items are assigned to broad risk categories, each with appropriate relative risk weights. The resulting capital ratios represent capital as a percentage of total risk-weighted assets and off-balance sheet items.

Under current guidelines, the minimum ratio of total capital to risk-weighted assets (which are primarily the credit risk equivalents of balance sheet assets and certain off-balance sheet items such as standby letters of credit) is 8.0%. At least half of total capital must be composed of tier 1 capital, which includes common shareholders’ equity (including retained earnings), less goodwill, other disallowed intangible assets, and disallowed deferred tax assets, among other items. The Federal Reserve also has adopted a minimum leverage ratio, requiring tier 1 capital of at least 4.0% of average quarterly total consolidated assets, net of goodwill and certain other intangible assets, for all but the most highly rated bank holding companies. The federal banking agencies have also established risk-based and leverage capital guidelines that FDIC-insured depository institutions are required to meet. These regulations are generally similar to those established by the Federal Reserve for bank holding companies.

Under the Federal Deposit Insurance Act, the federal bank regulatory agencies must take “prompt corrective action” against undercapitalized U.S. depository institutions. U.S. depository institutions are assigned one of five capital categories: “well-capitalized,” “adequately capitalized,” “undercapitalized,” “significantly undercapitalized” and “critically undercapitalized,” and are subjected to different regulation corresponding to the capital category within which the institution falls. A depository institution is deemed to be “well-capitalized” if the banking institution has a total risk-based capital ratio of 10.0% or greater, a tier 1 risk-based capital ratio of 8.0% or greater, a common equity tier 1 capital ratio of 6.5% and a leverage ratio of 5.0% or greater, and the institution is not subject to an order, written agreement, capital directive or prompt corrective action directive to meet and maintain a specific level for any capital measure. Under certain circumstances, a well-capitalized, adequately capitalized or undercapitalized institution may be treated as if the institution were in the next lower capital category.

Failure to meet capital guidelines could subject the institution to a variety of enforcement remedies by federal bank regulatory agencies, including: termination of deposit insurance by the FDIC, restrictions on certain business activities and appointment of the FDIC as conservator or receiver.

As of September 30, 2021 and December 31, 2020, the Bank was well-capitalized. Total shareholder’s equity was $798.6 million at September 30, 2021, compared with $758.7 million at December 31, 2020, an increase of $39.9 million. This increase was

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primarily due to net income of $60.0 million partially offset by the decrease in accumulated other comprehensive income of $12.0 million along with the $0.36 per common share dividend paid during the nine months ended September 30, 2021.

The following table provides a comparison of our leverage and risk-weighted capital ratios as of the dates indicated to the minimum and well-capitalized regulatory standards, as well as with the capital conservation buffer:


	Actual Ratio		Minimum Required For Capital Adequacy Purposes		Minimum Required Plus Capital Conservation Buffer		To Be Categorized As Well-Capitalized Under Prompt Corrective Action Provisions
Allegiance Bancshares, Inc. (Consolidated)
As of September 30, 2021
Total capital (to risk weighted assets)	16.13	%	8.00	%	10.50	%	N/A
Common equity Tier 1 capital (to risk weighted assets)	12.37	%	4.50	%	7.00	%	N/A
Tier 1 capital (to risk weighted assets)	12.60	%	6.00	%	8.50	%	N/A
Tier 1 capital (to average assets)	8.76	%	4.00	%	4.00	%	N/A
As of December 31, 2020
Total capital (to risk weighted assets)	15.71	%	8.00	%	10.50	%	N/A
Common equity Tier 1 capital (to risk weighted assets)	11.80	%	4.50	%	7.00	%	N/A
Tier 1 capital (to risk weighted assets)	12.04	%	6.00	%	8.50	%	N/A
Tier 1 capital (to average tangible assets)	8.51	%	4.00	%	4.00	%	N/A
Allegiance Bank
As of September 30, 2021
Total capital (to risk weighted assets)	14.98	%	8.00	%	10.50	%	10.00	%
Common equity Tier 1 capital (to risk weighted assets)	12.81	%	4.50	%	7.00	%	6.50	%
Tier 1 capital (to risk weighted assets)	12.81	%	6.00	%	8.50	%	8.00	%
Tier 1 capital (to average tangible assets)	8.91	%	4.00	%	4.00	%	5.00	%
As of December 31, 2020
Total capital (to risk weighted assets)	15.55	%	8.00	%	10.50	%	10.00	%
Common equity Tier 1 capital (to risk weighted assets)	13.32	%	4.50	%	7.00	%	6.50	%
Tier 1 capital (to risk weighted assets)	13.32	%	6.00	%	8.50	%	8.00	%
Tier 1 capital (to average tangible assets)	9.41	%	4.00	%	4.00	%	5.00	%

GAAP Reconciliation and Management’s Explanation of Non-GAAP Financial Measures

We identify certain financial measures discussed in this Quarterly Report on Form 10-Q as being “non-GAAP financial measures.” In accordance with the SEC’s rules, we classify a financial measure as being a non-GAAP financial measure if that financial measure excludes or includes amounts, or is subject to adjustments that have the effect of excluding or including amounts, that are included or excluded, as the case may be, in the most directly comparable measure calculated and presented in accordance with GAAP as in effect from time to time in the United States in our statements of income, balance sheet or statements of cash flows. Non-GAAP financial measures do not include operating and other statistical measures or ratios or statistical measures calculated using exclusively either financial measures calculated in accordance with GAAP, operating measures or other measures that are not non-GAAP financial measures or both.

The non-GAAP financial measures that we discuss in this Quarterly Report on Form 10-Q should not be considered in isolation or as a substitute for the most directly comparable or other financial measures calculated in accordance with GAAP. Moreover, the manner in which we calculate the non-GAAP financial measures that we discuss in this Quarterly Report on Form 10-Q may differ from that of other companies reporting measures with similar names. You should understand how such other banking organizations calculate their financial measures similar or with names similar to the non-GAAP financial measures we have discussed in this Quarterly Report on Form 10-Q when comparing such non-GAAP financial measures.

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Our management, financial analysts and investment bankers use the non-GAAP financial measure “Return on Average Tangible Shareholders’ Equity” in their analysis of our performance. Return on average tangible shareholders’ equity is computed by dividing net earnings by average total shareholders’ equity reduced by average goodwill and core deposit intangibles, net of accumulated amortization. For return on average tangible shareholders’ equity, the most directly comparable financial measure calculated in accordance with GAAP is return on average shareholders’ equity. This measure is important to investors because it measures the performance of the business consistently, exclusive of changes in intangible assets.

We believe this non-GAAP financial measure provides useful information to management and investors that is supplementary to our financial condition, results of operations and cash flows computed in accordance with GAAP; however, we acknowledge that non-GAAP financial measures have a number of limitations. As such, you should not view these disclosures as a substitute for results determined in accordance with GAAP, and they are not necessarily comparable to non-GAAP financial measures that other companies use. The following reconciliation tables provide a more detailed analysis of this non-GAAP financial measure:


	Three Months Ended September 30,						Nine Months Ended September 30,
	2021			2020			2021			2020
	(Dollars in thousands)
Net income	$	19,060		$	16,170		$	59,995		$	29,593

Average shareholders' equity	$	800,146		$	748,647		$	778,991		$	728,502
Less: Average goodwill and core deposit intangibles, net	239,497			243,015			240,325			244,007
Average tangible shareholders’ equity	$	560,649		$	505,632		$	538,666		$	484,495

Return on average tangible shareholders' equity(1)	13.49		%	12.72		%	14.89		%	8.16		%

(1)Annualized.

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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Asset/Liability Management and Interest Rate Risk

Our asset liability and interest rate risk policy provides management with the guidelines for effective balance sheet management. We have established a measurement system for monitoring our net interest rate sensitivity position. We manage our sensitivity position within our established guidelines.

As a financial institution, a component of the market risk that we face is interest rate volatility. Fluctuations in interest rates will ultimately impact both the level of income and expense recorded on most of our assets and liabilities, and the market value of all interest-earning assets and interest-bearing liabilities, other than those which have a short term to maturity. Interest rate risk is the potential for economic losses due to future interest rate changes. These economic losses can be reflected as a loss of future net interest income and/or a loss of current fair market values. The objective is to measure the effect on net interest income and to adjust the balance sheet to minimize the inherent risk while at the same time maximizing income.

During the second quarter 2021, we terminated an interest rate swap entered into for the purpose of reducing interest rate risk. See Note 8 – Derivative Instruments. Based upon the nature of our operations, we are not subject to foreign exchange rate or commodity price risk. We do not own any trading assets. We manage our exposure to interest rates by structuring our balance sheet in the ordinary course of a community banking business.

Our exposure to interest rate risk is managed by our Asset Liability Committee (“ALCO”), which is composed of certain members of our Board of Directors and Bank management. The ALCO formulates strategies based on appropriate levels of interest rate risk. In determining the appropriate level of interest rate risk, the ALCO considers the impact on earnings and capital of the current outlook on interest rates, potential changes in interest rates, regional economies, liquidity, business strategies and other factors. The ALCO meets regularly to review, among other things, the sensitivity of assets and liabilities to interest rate changes, the book and market values of assets and liabilities, unrealized gains and losses, purchase and sale activities, commitments to originate loans and the maturities of investments and borrowings. Additionally, the ALCO reviews liquidity, cash flow flexibility, maturities of deposits and consumer and commercial deposit activity.

We use an interest rate risk simulation model and shock analysis to test the interest rate sensitivity of net interest income and the balance sheet, respectively. All instruments on the balance sheet are modeled at the instrument level, incorporating all relevant attributes such as next reset date, reset frequency and call dates, as well as prepayment assumptions for loans and securities and decay rates for nonmaturity deposits. Assumptions based on past experience are incorporated into the model for nonmaturity deposit account decay rates. The assumptions used are inherently uncertain and, as a result, the model cannot precisely measure future net interest income or precisely predict the impact of fluctuations in market interest rates on net interest income. Actual results will differ from the model’s simulated results due to timing, magnitude and frequency of interest rate changes as well as changes in market conditions and the application and timing of various management strategies.

We utilize static balance sheet rate shocks to estimate the potential impact on net interest income of changes in interest rates under various rate scenarios. This analysis estimates a percentage of change in the metric from the stable rate base scenario versus alternative scenarios of rising and falling market interest rates by instantaneously shocking a static balance sheet.

The following table summarizes the simulated change in net interest income over a 12-month horizon and the economic value of equity as of the dates indicated:


Change in Interest Rates (Basis Points)	Percent Change in Net Interest Income		Percent Change in Economic Value of Equity
	As of September 30, 2021	As of December 31, 2020	As of September 30, 2021	As of December 31, 2020
+300	5.2%	(3.9)%	9.6%	10.8%
+200	2.9%	(3.1)%	8.2%	8.8%
+100	1.1%	(1.9)%	5.1%	5.2%
Base	0.0%	0.0%	0.0%	0.0%
-100	(4.1)%	(3.7)%	(8.4)%	(12.9)%

These results are primarily due to the size of our cash position, the size and duration of our loan and securities portfolio, the duration of our borrowings and the expected behavior of demand, money market and savings deposits during such rate fluctuations.

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ITEM 4. CONTROLS AND PROCEDURES

Evaluation of disclosure controls and procedures. As of the end of the period covered by this Quarterly Report on Form 10-Q, the Company carried out an evaluation, under the supervision and with the participation of its management, including its Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of its disclosure controls and procedures. In designing and evaluating the disclosure controls and procedures, management recognizes that controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and management was required to apply judgment in evaluating its controls and procedures. Based on this evaluation, the Company’s Chief Executive Officer and Chief Financial Officer concluded that the Company’s disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)) were effective as of the end of the period covered by this report. See Exhibits 31.1 and 31.2 for the Certification statements issued by the Company’s Chief Executive Officer and Chief Financial Officer, respectively.

Changes in internal control over financial reporting. There were no changes in the Company’s internal control over financial reporting (as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) during the quarter ended September 30, 2021 that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

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PART II—OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

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

ITEM 1A. RISK FACTORS

In evaluating an investment in any of the Company’s securities, investors should consider carefully, among other things, information under the heading “Cautionary Notice Regarding Forward-Looking Statements” in this Form 10-Q and in the Company’s Annual Report on Form 10-K for the year ended December 31, 2020, and such other risk factors as the Company may disclose or has disclosed in other reports and statements filed with the Securities and Exchange Commission. As of September 30, 2021, there were no material changes to the risk factors disclosed in the Company’s Annual Report on Form 10-K for the year ended December 31, 2020.

ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

Information regarding shares of common stock we repurchased during the three months ended September 30, 2021 is as follows:


Period	Total Number of Shares Purchased(1)	Average Price Paid Per Share
July 1, 2021 to July 31, 2021	—	$	—
August 1, 2021 to August 31, 2021	132	$	36.47
September 1, 2021 to September 30, 2021	—	$	—

(1)The Company acquired 132 shares from employees for tax withholding purposes related to vesting of restricted stock grants.

ITEM 3. DEFAULTS UPON SENIOR SECURITIES

None.

ITEM 4. MINE SAFETY DISCLOSURES

Not applicable.

ITEM 5. OTHER INFORMATION

None.

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ITEM 6. EXHIBITS


Exhibit Number						Description

3.1						Amended and Restated Certificate of Formation of Allegiance Bancshares, Inc. (incorporated herein by reference to Exhibit 3.1 to the Company’s Quarterly Report on Form 10-Q filed on August 1, 2019)

3.2						Amended and Restated Bylaws of Allegiance Bancshares, Inc. (incorporated herein by reference to the Company’s Registration Statement on Form S-1 (Registration No. 333-206536) (the “Registration Statement”))

31.1*						Certification of the Chief Executive Officer pursuant to Rule 13a-14(a) of the Securities Exchange Act of 1934, as amended

31.2*						Certification of the Chief Financial Officer pursuant to Rule 13a-14(a) of the Securities Exchange Act of 1934, as amended

32.1**						Certification of the Chief Executive Officer pursuant to 18 U.S.C. Section 1350, adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

32.2**						Certification of the Chief Financial Officer pursuant to 18 U.S.C. Section 1350, adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

101.INS*						Inline XBRL Instance Document – the instance document does not appear in the Interactive Data File because XBRL tags are embedded within the Inline XBRL document.

101.SCH*						Inline XBRL Taxonomy Extension Schema Document

101.CAL*						Inline XBRL Taxonomy Extension Calculation Linkbase Document

101.DEF*						Inline XBRL Taxonomy Extension Definition Linkbase Document

101.LAB*						Inline XBRL Taxonomy Extension Label Linkbase Document

101.PRE*						Inline XBRL Taxonomy Extension Presentation Linkbase Document

104						Cover Page Interactive Data File (embedded within the Inline XBRL document)

* Filed with this Quarterly Report on Form 10-Q.

** Furnished with this Quarterly Report on Form 10-Q.

Table of Contents

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.


			Allegiance Bancshares, Inc. (Registrant)

Date: October 28, 2021			/s/ Steven F. Retzloff
			Steven F. Retzloff
			Chief Executive Officer

Date: October 28, 2021			/s/ Paul P. Egge
			Paul P. Egge
			Chief Financial Officer