FIRST FINANCIAL BANKSHARES INC - Quarter Report: 2019 September (Form 10-Q)

Large accelerated filer

Accelerated filer

Non-accelerated
filer

Smaller reporting company

Emerging growth company

Table of Contents

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM

10-Q

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)

THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2019

Commission file number

0-7674

FIRST FINANCIAL BANKSHARES, INC.

(Exact name of registrant as specified in its charter)


Texas		75-0944023
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)

400 Pine Street, Abilene, Texas		79601
(Address of principal executive offices)		(Zip Code)

(325)

627-7155

(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, $0.01 par value	FFIN	NASDAQ Global Select Market

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

☒

☐

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

☒

☐

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a

non-accelerated

filer, a smaller reporting company or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company” and “emerging growth company” in Rule

12b-2

of the Exchange Act.

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

☐

Indicate by check mark whether the registrant is a shell company (as defined in Rule

12b-2

of the Act). Yes

☐

☒

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date:


Class		Outstanding at October 29, 2019
Common Stock, $0.01 par value per share		135,844,644

Table of Contents

TABLE OF

CONTENTS


PART I

FINANCIAL INFORMATION
Item		Page
1.	Financial Statements		2
	Consolidated Balance Sheets – Unaudited		3
	Consolidated Statements of Earnings – Unaudited		4
	Consolidated Statements of Comprehensive Earnings – Unaudited		5
	Consolidated Statements of Shareholders’ Equity – Unaudited		6
	Consolidated Statements of Cash Flows – Unaudited		8
	Notes to Consolidated Financial Statements – Unaudited		9

2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations		36

3.	Quantitative and Qualitative Disclosures About Market Risk		56

4.	Controls and Procedures		56

PART II

OTHER INFORMATION

1.	Legal Proceedings		57

1A.	Risk Factors		57

2.	Unregistered Sales of Equity Securities and Use of Proceeds		57

3.	Defaults Upon Senior Securities		57

4.	Mine Safety Disclosures		57

5.	Other Information		57

6.	Exhibits		58

	Signatures		59

Table of Contents

PART I

FINANCIAL INFORMATION

Item 1. Financial Statements.

The consolidated balance sheets of First Financial Bankshares, Inc. (the “Company” or “we”) at September 30, 2019 and 2018 and December 31, 2018, and the consolidated statements of earnings, comprehensive earnings and shareholders’ equity for the three and nine months ended September 30, 2019 and 2018, and the consolidated statements of cash flows for the nine months ended September 30, 2019 and 2018, follow on pages

through

Table of Contents

FIRST FINANCIAL BANKSHARES, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(Dollars in thousands, except per share amounts)


	September 30,						December 31,
	2019			2018			2018
ASSETS	(Unaudited)
CASH AND DUE FROM BANKS	$	198,855		$	164,998		$	207,835
INTEREST-BEARING DEPOSITS IN BANKS		31,410			34,511			40,812

Total cash and cash equivalents		230,265			199,509			248,647
INTEREST-BEARING TIME DEPOSITS IN BANKS		—			1,458			1,458
SECURITIES AVAILABLE-FOR-SALE, at fair value		3,397,156			3,144,367			3,158,777
LOANS:
Held for investment		4,100,316			3,867,040			3,953,636
Less - allowance for loan losses		(51,889	)		(50,871	)		(51,202	)

Net loans held for investment		4,048,427			3,816,169			3,902,434
Held-for-sale ($39,735, $15,955 and $19,185 at fair value at September 30, 2019 and 2018 and December 31, 2018, respectively)		40,499			18,496			21,672

Net loans		4,088,926			3,834,665			3,924,106
BANK PREMISES AND EQUIPMENT, net		132,367			130,815			133,421
INTANGIBLE ASSETS		173,905			174,907			174,683
OTHER ASSETS		91,220			85,510			90,762

Total assets	$	8,113,839		$	7,571,231		$	7,731,854

LIABILITIES AND SHAREHOLDERS’ EQUITY
NONINTEREST-BEARING DEPOSITS	$	2,210,997		$	2,146,984		$	2,116,107
INTEREST-BEARING DEPOSITS		4,186,686			3,998,298			4,064,282

Total deposits		6,397,683			6,145,282			6,180,389
DIVIDENDS PAYABLE		16,299			14,216			14,227
BORROWINGS		400,155			380,760			468,706
OTHER LIABILITIES		94,604			35,234			15,237

Total liabilities		6,908,741			6,575,492			6,678,559

COMMITMENTS AND CONTINGENCIES
SHAREHOLDERS’ EQUITY:
C ommon stock—($ 0.01 par value, authorized 200,000,000 shares; 135,822,456, 67,693,586 and 67,753,133 shares issued at September 30, 2019 and 2018 and December 31, 2018, respectively)		1,358			677			678
Capital surplus		448,968			440,589			443,114
Retained earnings		682,575			582,449			606,658
Treasury stock (shares at cost: 928,287, 471,070 and 467,811 at September 30, 2019 and 2018 and December 31, 2018, respectively)		(8,042	)		(7,512	)		(7,507	)
Deferred compensation		8,042			7,512			7,507
Accumulated other comprehensive earnings (loss)		72,197			(27,976	)		2,845

Total shareholders’ equity		1,205,098			995,739			1,053,295

Total liabilities and shareholders’ equity	$	8,113,839		$	7,571,231		$	7,731,854

See notes to consolidated financial statements.

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FIRST FINANCIAL BANKSHARES, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF EARNINGS - (UNAUDITED)

(Dollars in thousands, except per share amounts)


	Three Months Ended September 30,					Nine Months Ended September 30,
	2019		2018			2019		2018
INTEREST INCOME:
Interest and fees on loans	$	57,123	$	51,428		$	166,095	$	147,279
Interest on investment securities:
Taxable		14,292		12,593			41,505		36,666
Exempt from federal income tax		8,795		9,558			27,801		29,882
Interest on federal funds sold and interest-bearing deposits in banks		381		470			1,668		1,382

Total interest income		80,591		74,049			237,069		215,209
INTEREST EXPENSE:
Interest on deposits		7,123		4,330			21,070		11,854
Other		830		293			2,231		869

Total interest expense		7,953		4,623			23,301		12,723

Net interest income		72,638		69,426			213,768		202,486
PROVISION FOR LOAN LOSSES		450		1,450			2,015		3,865

Net interest income after provision for loan losses		72,188		67,976			211,753		198,621

NONINTEREST INCOME:
Trust fees		7,051		7,291			21,057		21,265
Service charges on deposit accounts		5,629		5,690			16,179		15,950
ATM, interchange and credit card fees		7,728		7,533			21,920		21,570
Real estate mortgage operations		5,733		4,834			13,928		11,718
Net gain on sale of available-for-sale securities (includes $52 and $58 for the three months ended September 30, 2019 and 2018, respectively, and $728 and $1,346 for the nine months ended September 30, 2019 and 2018, respectively, related to accumulated other comprehensive earnings reclassifications)		52		58			728		1,346
Net gain on sale of foreclosed assets		71		84			193		201
Net gain (loss) on sale of assets		235		(61	)		241		(152	)
Interest on loan recoveries		575		199			1,815		607
Other		1,595		1,427			5,020		4,461

Total noninterest income		28,669		27,055			81,081		76,966
NONINTEREST EXPENSE:
Salaries and employee benefits		28,550		26,377			82,468		79,442
Loss from partial settlement of pension plan		—		—			900		—
Net occupancy expense		2,830		2,900			8,372		8,589
Equipment expense		2,225		2,629			7,009		7,548
FDIC insurance premiums		15		570			1,091		1,768
ATM, interchange and credit card expenses		2,627		2,344			7,437		6,692
Professional and service fees		1,902		2,174			5,721		6,613
Printing, stationery and supplies		480		387			1,348		1,485
Operational and other losses		507		981			1,253		1,852
Software amortization and expense		1,767		1,393			5,147		4,433
Amortization of intangible assets		246		279			778		1,049
Other		7,761		7,472			23,059		22,977

Total noninterest expense		48,910		47,506			144,583		142,448

EARNINGS BEFORE INCOME TAXES		51,947		47,525			148,251		133,139
INCOME TAX EXPENSE (includes $11 and $12 for the three months ended September 30, 2019 and 2018, respectively, and $153 and $283 for the nine months ended September 30, 2019 and 2018, respectively, related to income tax expense from reclassification items)		8,867		7,475			24,827		20,937

NET EARNINGS	$	43,080	$	40,050		$	123,424	$	112,202
EARNINGS PER SHARE, BASIC	$	0.32	$	0.30		$	0.91	$	0.83
EARNINGS PER SHARE, ASSUMING DILUTION	$	0.32	$	0.29		$	0.91	$	0.83
DIVIDENDS PER SHARE	$	0.12	$	0.11		$	0.35	$	0.31

See notes to consolidated financial statements.

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FIRST FINANCIAL BANKSHARES, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF COMPREHENSIVE EARNINGS - (UNAUDITED)

(Dollars in thousands)


	Three Months Ended September 30,						Nine Months Ended September 30,
	2019			2018			2019			2018
NET EARNINGS	$	43,080		$	40,050		$	123,424		$	112,202
OTHER ITEMS OF COMPREHENSIVE EARNINGS (LOSS):
C hange in unrealized gain (loss) on investment securities available-for-sale, before income taxes		16,446			(20,930	)		88,517			(75,236	)
Reclassification adjustment for realized gains on investment securities included in net earnings, before income tax		(52	)		(58	)		(728	)		(1,346	)

Total other items of comprehensive earnings		16,394			(20,988	)		87,789			(76,582	)
Income tax benefit (expense) related to other items of comprehensive earnings		(3,444	)		4,407			(18,437	)		16,082
Reclassification of certain income tax effects related to the change in the U.S. statutory federal incoem tax rate under the Tax Cuts and Jobs Act to retained earnings .		—			—			—			5,759

COMPREHENSIVE EARNINGS	$	56,030		$	23,469		$	192,776		$	57,461

See notes to consolidated financial statements.

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FIRST FINANCIAL BANKSHARES, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY

(Dollars in thousands, except per share amounts)


																		Accumulated
																		Other			Total
	Common Stock				Capital		Retained			Treasury Stock						Deferred		Comprehensive			Shareholders’
	Shares		Amount		Surplus		Earnings			Shares			Amounts			Compensation		Earnings			Equity
Balances at June 30, 2018 (unaudited)		67,669,658	$	677	$	439,731	$	556,615			(491,170	)	$	(7,419	)	$	7,419	$	(11,395	)	$	985,628
Net earnings (unaudited)		—		—		—		40,050			—			—			—		—			40,050
Stock option exercises (unaudited)		23,928		—		481		—			—			—			—		—			481
Cash dividends declared, $0.11 per share (unaudited)		—		—		—		(14,216	)		—			—			—		—			(14,216	)
Change in unrealized loss in investment securities available-for-sale, net of related income taxes (unaudited)		—		—		—		—			—			—			—		(16,581	)		(16,581	)
Shares purchased (redeemed) in connection with directors’ deferred compensation plan, net (unaudited)		—		—		—		—			20,100			(93	)		93		—			—
Stock option expense (unaudited)		—		—		377		—			—			—			—		—			377
Balances at September 30, 2018 (unaudited)		67,693,586	$	677	$	440,589	$	582,449			(471,070	)	$	(7,512	)	$	7,512	$	(27,976	)	$	995,739
Balances at June 30, 2019 (unaudited)		135,809,224	$	1,358	$	448,349	$	655,794			(929,441	)	$	(7,823	)	$	7,823	$	59,247		$	1,164,748
Net earnings (unaudited)		—		—		—		43,080			—			—			—		—			43,080
Stock option exercises (unaudited)		13,232		—		188		—			—			—			—		—			188
Cash dividends declared, $0.12 per share (unaudited)		—		—		—		(16,299	)		—			—			—		—			(16,299	)
Change in unrealized gain in investment securities available-for-sale, net of related income taxes (unaudited)		—		—		—		—			—			—			—		12,950			12,950
Shares purchased (redeemed) in connection with directors’ deferred compensation plan, net (unaudited)		—		—		—		—			1,154			(219	)		219		—			—
Stock option expense (unaudited)		—		—		431		—			—			—			—		—			431
Balances at September 30, 2019 (unaudited)		135,822,456	$	1,358	$	448,968	$	682,575			(928,287	)	$	(8,042	)	$	8,042	$	72,197		$	1,205,098


		6		(continued)

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FIRST FINANCIAL BANKSHARES, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY

(Dollars in thousands, except per share amounts)


																		Accumulated
																		Other			Total
	Common Stock				Capital		Retained			Treasury Stock						Deferred		Comprehensive			Shareholders’
	Shares		Amount		Surplus		Earnings			Shares			Amounts			Compensation		Earnings			Equity
Balances at December 31, 2017		66,260,444	$	663	$	378,062	$	517,257			(495,964	)	$	(7,148	)	$	7,148	$	26,786		$	922,768
Net earnings (unaudited)		—		—		—		112,202			—			—			—		—			112,202
Stock option exercises (unaudited)		133,061		1		2,799		—			—			—			—		—			2,800
Restricted stock grant (unaudited)		10,710		—		523		—			—			—			—		—			523
Cash dividends declared, $0.31 per share (unaudited)		—		—		—		(41,272	)		—			—			—		—			(41,272	)
Stock issued in acquisition of Commercial Bancshares, Inc.		1,289,371		13		58,074		—			—			—			—		—			58,087
Change in unrealized loss in investment securities available-for-sale, net of related income taxes (unaudited)		—		—		—		—			—			—			—		(60,500	)		(60,500	)
Shares purchased (redeemed) in connection with directors’ deferred compensation plan, net (unaudited)		—		—		—		—			24,894			(364	)		364		—			—
Stock option expense (unaudited)		—		—		1,131		—			—			—			—		—			1,131
Reclassification of certain income tax effects related to the change in the U.S. statutory federal income tax rate under the Tax Cuts and Jobs Act to retained earnings		—		—		—		(5,759	)		—			—			—		5,759			—
Reclassification of unrealized gain in equity securities at December 31, 2017 from accumulated other comprehensive earnings to retained earnings (unaudited)		—		—		—		21			—			—			—		(21	)		—

Balances at September 30 , 2018 (unaudited)		67,693,586	$	677	$	440,589	$	582,449			(471,070	)	$	(7,512	)	$	7,512	$	(27,976	)	$	995,739

Balances at December 31, 2018		67,753,133	$	678	$	443,114	$	606,658			(467,811	)	$	(7,507	)	$	7,507	$	2,845		$	1,053,295
Net earnings (unaudited)		—		—		—		123,424			—			—			—		—			123,424
Stock option exercises (unaudited)		185,779		2		3,491		—			—			—			—		—			3,493
Restricted stock grant (unaudited)		43,334		—		1,307		—			—			—			—		—			1,307
Cash dividends declared, $0.35 per share (unaudited)		—		—		—		(46,829	)		—			—			—		—			(46,829	)
Change in unrealized gain in investment securities available-for-sale, net of related income taxes (unaudited)		—		—		—		—			—			—			—		69,352			69,352
Shares purchased (redeemed) in connection with directors’ deferred compensation plan, net (unaudited)		—		—		—		—			3,863			(535	)		535		—			—
Stock option expense (unaudited)		—		—		1,056		—			—			—			—		—			1,056
Two-for-one stock spllit in the form of a 100% stock dividend (unaudited)		67,840,210		678		—		(678	)		(464,339	)		—			—		—			—

Balances at September 30, 2019 (unaudited)		135,822,456	$	1,358	$	448,968	$	682,575			(928,287	)	$	(8,042	)	$	8,042	$	72,197		$	1,205,098

See notes to consolidated financial statements.

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FIRST FINANCIAL BANKSHARES, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS - (UNAUDITED)

(Dollars in thousands)


	Nine Months Ended September 30,
	2019			2018
CASH FLOWS FROM OPERATING ACTIVITIES:
Net earnings	$	123,424		$	112,202
Adjustments to reconcile net earnings to net cash provided by operating activities:
Depreciation and amortization		8,730			9,554
Provision for loan losses		2,015			3,865
Securities premium amortization (discount accretion), net		18,690			21,005
Gain on sale of assets, net		(1,312	)		(1,254	)
Deferred federal income tax benefit		1,720			8,107
Change in loans held-for-sale		(18,491	)		(2,928	)
Change in other assets		1,789			2,699
Change in other liabilities		9,097			5,653

Total adjustments		22,238			46,701

Net cash provided by operating activities		145,662			158,903

CASH FLOWS FROM INVESTING ACTIVITIES:
Cash received in acquisition of Commercial Bancshares, Inc.		—			18,653
Net decrease in interest-bearing time deposits in banks		1,458			—
Activity in available-for-sale securities:
Sales		67,404			220,259
Maturities		4,342,074			3,354,571
Purchases		(4,526,709	)		(3,650,127	)
Net increase in loans		(149,553	)		(116,860	)
Purchases of bank premises and equipment and other assets		(7,541	)		(12,381	)
Proceeds from sale of bank premises and equipment and other assets		1,344			810

Net cash used in investing activities		(271,523	)		(185,075	)

CASH FLOWS FROM FINANCING ACTIVITIES:
Net increase (decrease) in noninterest-bearing deposits		94,890			(56,706	)
Net increase (decrease) in interest-bearing deposits		122,404			(102,875	)
Net increase (decrease) in borrowings		(68,551	)		49,760
Common stock transactions:
Proceeds from stock issuances		3,493			2,800
Dividends paid		(44,757	)		(39,645	)

Net cash provided by (used in) financing activities		107,479			(146,666	)

NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS		(18,382	)		(172,838	)
CASH AND CASH EQUIVALENTS, beginning of period		248,647			372,347

CASH AND CASH EQUIVALENTS, end of period	$	230,265		$	199,509

SUPPLEMENTAL INFORMATION AND NONCASH TRANSACTIONS:
Interest paid	$	22,963		$	12,617
Federal income taxes paid		22,141			20,351
Transfer of loans and bank premises to other real estate		1,208			126
Investment securities purchased but not settled		51,181			13,453
Restricted stock grant to officers and directors		1,307			523
Stocks issued in acquisition of Commercial Bancshares, Inc.		—			58,087

See notes to consolidated financial statements.

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FIRST FINANCIAL BANKSHARES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

Note 1

—

Basis of Presentation

The unaudited interim consolidated financial statements include the accounts of the Company, a Texas corporation and a financial holding company registered under the Bank Holding Company Act of 1956, as amended, or BHCA, and its wholly-owned subsidiaries: First Financial Bank, National Association, Abilene, Texas; First Technology Services, Inc.; First Financial Trust & Asset Management Company, National Association; First Financial Investments, Inc.; and First Financial Insurance Agency, Inc.

Through our subsidiary bank, we conduct a full-service commercial banking business. Our banking centers are located primarily in Central, North Central, Southeast and West Texas. As of September 30, 2019, we had 73 financial centers across Texas, with eleven locations in Abilene, three locations in Weatherford, two locations in Cleburne, Conroe, San Angelo, Stephenville and Granbury, and one location each in Acton, Albany, Aledo, Alvarado, Beaumont, Boyd, Bridgeport, Brock, Burleson, Cisco, Clyde, Cut and Shoot, Decatur, Eastland, El Campo, Fort Worth, Fulshear, Glen Rose, Grapevine, Hereford, Huntsville, Keller, Kingwood, Magnolia, Mauriceville, Merkel, Midlothian, Mineral Wells, Montgomery, Moran, New Waverly, Newton, Odessa, Orange, Palacios, Port Arthur, Ranger, Rising Star, Roby, Southlake, Spring, Sweetwater, Tomball, Trent, Trophy Club, Vidor, Waxahachie, Willis and Willow Park, all in Texas. Our trust subsidiary has eight locations which are located in Abilene, Fort Worth, Houston, Odessa, Beaumont, San Angelo, Stephenville and Sweetwater.

In the opinion of management, the unaudited interim consolidated financial statements reflect all adjustments necessary for a fair presentation of the Company’s financial position and unaudited results of operations and should be read in conjunction with the Company’s audited consolidated financial statements and notes thereto in the Company’s Annual Report on Form

10-K,

for the year ended December 31, 2018. All adjustments were of a normal recurring nature. However, the results of operations for the three and nine months ended September 30, 2019, are not necessarily indicative of the results to be expected for the year ending December 31, 2019, due to seasonality, changes in economic conditions and loan credit quality, interest rate fluctuations, regulatory and legislative changes and other factors. The preparation of financial statements in conformity with United States generally accepted accounting principles (“GAAP”) requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the financial statement date. Actual results could vary. Certain information and footnote disclosures normally included in financial statements prepared in accordance with GAAP have been condensed or omitted under U.S. Securities and Exchange Commission (“SEC”) rules and regulations.

In addition, certain reclassifications have been made to the 2018 statements of earnings to conform to the 2019 presentation.

The Company evaluated subsequent events for potential recognition and/or disclosure through the date the consolidated financial statements were issued.

Goodwill and other intangible assets are evaluated annually for impairment as of the end of the second quarter. No such impairment has been noted in connection with the current or any prior evaluations.

Note 2

–

Stock Split and Stock Repurchase

On April 23, 2019, the Company’s Board of Directors declared a two-for-one stock split

of a the Company’s outstanding common shares with

a record date of May 15, 2019 that was distributed on June 3, 2019. All per share amounts in this report have been restated to reflect this stock split. An amount equal to the par value of the additional common shares to be issued pursuant to the stock split was reflected as a transfer from retained earnings to common stock in the consolidated financial statements as of and for the three months ended March 31, 2019 and as of and for the nine months ended September 30, 2019.

On July 25, 2017, the Company’s Board of Directors authorized the repurchase of up to 2,000,000 common shares through September 30, 2020. The shares buyback plan authorizes management to repurchase the shares at such time as repurchases are considered beneficial to shareholders. Any repurchase of shares will be made through the open market, block trades or in privately negotiated transactions in accordance with applicable laws and regulations. Under the repurchase plan, there is no minimum number of shares that the Company is required to repurchase. Through September 30, 2019, no shares were repurchased under this authorization.

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Note 3—Earnings Per Share

Basic earnings per common share is computed by dividing net income available to common shareholders by the weighted average number of shares outstanding during the periods presented. In computing diluted earnings per common share for the three months ended September 30, 2019 and 2018, the Company assumes that all dilutive outstanding options to purchase common shares have been exercised at the beginning of the period (or the time of issuance, if later). The dilutive effect of these outstanding options and the restricted shares is reflected by application of the treasury stock method, whereby the proceeds from exercised options and restricted shares are assumed to be used to purchase common shares at the average market price during the respective periods. The weighted average common shares outstanding used in computing basic earnings per common share for the three months ended September 30, 2019 and 2018 were 135,693,901 and 135,270,116 shares, respectively. The weighted average common shares outstanding used in computing basic earnings per common share for the nine months ended September 30, 2019 and 2018 were 135,613,646 and 135,173,686. The weighted average common shares outstanding used in computing fully diluted earnings per common share for the three months ended September 30, 2019 and 2018 were 136,369,328 and 136,107,448 shares, respectively. The weighted average common shares outstanding used in computing fully diluted earnings per common share for the nine months ended September 30, 2019 and 2018 were 136,274,342 and 135,896,840. For the three and nine months ended September 30, 2019 and 2018, there were no stock options that were anti-dilutive that have been excluded from the EPS calculation.

Note 4—Interest-bearing Time Deposits in Banks and Securities

Interest-bearing time deposits in banks totaled $

1,458

,000 at both September 30, 2018 and December 31, 2018,

respectively, and had original maturities ranging from one to six months. At September 30, 2019, all interest-bearing time deposits in banks have matured.

Management classifies debt and equity securities as

held-to-maturity,

available-for-sale,

or trading based on its intent. Debt securities that management has the positive intent and ability to hold to maturity are classified as

held-to-maturity

and recorded at cost, adjusted for amortization of premiums and accretion of discounts, which are recognized as adjustments to interest income using the interest method. Debt securities not classified as

held-to-maturity

or trading are classified as

available-for-sale

and recorded at fair value, with all unrealized gains and unrealized losses judged to be temporary, net of deferred income taxes, excluded from earnings and reported in the consolidated statements of comprehensive earnings.

Available-for-sale

debt securities that have unrealized gains and losses are excluded from earnings and reported net of tax in accumulated other comprehensive income until realized. Declines in the fair value of

available-for-sale

debt securities below their cost that are deemed to be other-than-temporary are reflected in earnings as a realized loss if there is no ability or intent to hold to recovery. If the Company does not intend to sell and will not be required to sell prior to recovery of its amortized cost basis, only the credit component of the impairment is reflected in earnings as a realized loss with the noncredit portion recognized in other comprehensive income. In estimating other-than-temporary impairment losses, we consider (1) the length of time and the extent to which the fair value has been less than cost, (2) the financial condition and near-term prospects of the issuer, and (3) our intent and ability to retain our investment in the issuer for a period of time sufficient to allow for any anticipated recovery in fair value.

Effective January 1, 2018, in accordance with ASU

2016-01

(see note 13), increases or decreases in the fair value of equity securities are recorded in earnings. Prior to January 1, 2018, such increases or decreases were recorded similar to increases or decreases in debt securities.

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The Company records its

available-for-sale

and equity securities portfolio at fair value. Fair values of these securities are determined based on methodologies in accordance with current authoritative accounting guidance. Fair values are volatile and may be influenced by a number of factors, including market interest rates, prepayment speeds, discount rates, credit ratings and yield curves. Fair values for investment securities are based on quoted market prices, where available. If quoted market prices are not available, fair values are based on the quoted prices of similar instruments or an estimate of fair value by using a range of fair value estimates in the market place as a result of the illiquid market specific to the type of security.

When the fair value of a debt security is below its amortized cost, and depending on the length of time the condition exists and the extent the fair value is below amortized cost, additional analysis is performed to determine whether an other-than-temporary impairment condition exists. Often, the information available to conduct these assessments is limited and rapidly changing, making estimates of fair value subject to judgment. If actual information or conditions are different than estimated, the extent of the impairment of the debt security may be different than previously estimated, which could have a material effect on the Company’s results of operations and financial condition.

The Company’s investment portfolio consists of U.S. Treasury securities, obligations of state and political subdivisions, mortgage pass-through securities, corporate bonds and general obligation or revenue based municipal bonds. Pricing for such securities is generally readily available and transparent in the market. The Company utilizes independent third-party pricing services to value its investment securities, which the Company reviews as well as the underlying pricing methodologies for reasonableness and to ensure such prices are aligned with pricing matrices. The Company validates prices supplied by the independent pricing services by comparison to prices obtained from other third-party sources on a quarterly basis.

A summary of the Company’s

available-for-sale

securities follows (in thousands):


	September 30, 2019
			Gross		Gross
	Amortized		Unrealized		Unrealized			Estimated
	Cost Basis		Holding Gains		Holding Losses			Fair Value
U.S. Treasury securities	$	9,990	$	31	$	—		$	10,021
Obligations of states and political subdivisions		1,182,549		59,734		(86	)		1,242,197
Corporate bonds and other		4,643		87		—			4,730
Residential mortgage-backed securities		1,597,807		27,001		(1,428	)		1,623,380
Commercial mortgage-backed securities		509,019		8,069		(260	)		516,828

Total securities available-for-sale	$	3,304,008	$	94,922	$	(1,774	)	$	3,397,156

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	September 30, 2018
			Gross		Gross
	Amortized		Unrealized		Unrealized			Estimated
	Cost Basis		Holding Gains		Holding Losses			Fair Value
U.S. Treasury securities	$	9,964	$	—	$	(35	)	$	9,929
Obligations of U.S. government sponsored enterprises and agencies		303		—		(1	)		302
Obligations of states and political subdivisions		1,174,320		21,664		(4,097	)		1,191,887
Corporate bonds and other		4,860		—		(121	)		4,739
Residential mortgage-backed securities		1,533,302		912		(39,908	)		1,494,306
Commercial mortgage-backed securities		453,495		8		(10,299	)		443,204

Total securities available-for-sale	$	3,176,244	$	22,584	$	(54,461	)	$	3,144,367


	December 31, 2018
			Gross		Gross
	Amortized		Unrealized		Unrealized			Estimated
	Cost Basis		Holding Gains		Holding Losses			Fair Value
U.S. Treasury securities	$	9,970	$	—	$	(8	)	$	9,962
Obligations of U.S. government sponsored enterprises and agencies		301		—		—			301
Obligations of states and political subdivisions		1,229,828		30,013		(1,970	)		1,257,871
Corporate bonds and other		4,875		—		(77	)		4,798
Residential mortgage-backed securities		1,472,228		3,928		(21,611	)		1,454,545
Commercial mortgage-backed securities		436,366		670		(5,736	)		431,300

Total securities available-for-sale	$	3,153,568	$	34,611	$	(29,402	)	$	3,158,777

The Company invests in mortgage-backed securities that have expected maturities that differ from their contractual maturities. These differences arise because borrowers may have the right to call or prepay obligations with or without a prepayment penalty. These securities include collateralized mortgage obligations (CMOs) and other asset backed securities. The expected maturities of these securities at September 30, 2019 were computed by using scheduled amortization of balances and historical prepayment rates. At September 30, 2019 and 2018, and December 31, 2018, the Company did not hold CMOs that entail higher risks than standard mortgage-backed securities.

The amortized cost and estimated fair value of

available-for-sale

securities at September 30, 2019 by contractual and expected maturity, are shown below (in thousands):


	Amortized		Estimated
	Cost Basis		Fair Value
Due within one year	$	207,121	$	208,899
Due after one year through five years		494,764		520,494
Due after five years through ten years		493,565		525,301
Due after ten years		1,732		2,254
Mortgage-backed securities		2,106,826		2,140,208
Total	$	3,304,008	$	3,397,156

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The following tables disclose the Company’s investment securities that have been in a continuous

unrealized-loss

position for less than 12 months and for 12 or more months (in thousands):


	Less than 12 Months				12 Months or Longer				Total
September 30, 2019	Fair Value		Unrealized Loss		Fair Value		Unrealized Loss		Fair Value		Unrealized Loss
Obligations of states and political subdivisions	$	11,140	$	86	$	828	$	—	$	11,968	$	86
Residential mortgage-backed securities		91,850		75		146,449		1,353		238,299		1,428
Commercial mortgage-backed securities		42,310		115		74,873		145		117,183		260

Total	$	145,300	$	276	$	222,150	$	1,498	$	367,450	$	1,774


	Less than 12 Months				12 Months or Longer				Total
September 30, 2018	Fair Value		Unrealized Loss		Fair Value		Unrealized Loss		Fair Value		Unrealized Loss
U.S. Treasury Securities	$	9,929	$	35	$	—	$	—	$	9,929	$	35
Obligations of U.S. government sponsored enterprises and agencies		302		1		—		—		302		1
Obligations of states and political subdivisions		184,265		2,165		44,750		1,932		229,015		4,097
Corporate bonds and other		4,399		110		449		11		4,848		121
Residential mortgage-backed securities		962,320		20,850		461,227		19,058		1,423,547		39,908
Commercial mortgage-backed securities		270,375		5,908		167,368		4,391		437,743		10,299

Total	$	1,431,590	$	29,069	$	673,794	$	25,392	$	2,105,384	$	54,461


	Less than 12 Months				12 Months or Longer				Total
December 31, 2018	Fair Value		Unrealized Loss		Fair Value		Unrealized Loss		Fair Value		Unrealized Loss
U.S. Treasury securities	$	9,962	$	8	$	—	$	—	$	9,962	$	8
Obligations of U.S. government sponsored enterprises and agencies		—		—		301		—		301		—
Obligations of state and political subdivisions		27,489		107		114,461		1,863		141,950		1,970
Corporate bonds and other		4,348		68		450		9		4,798		77
Residential mortgage-backed securities		119,584		483		922,289		21,128		1,041,873		21,611
Commercial mortgage-backed securities		1,994		5		343,015		5,731		345,009		5,736

Total	$	163,377	$	671	$	1,380,516	$	28,731	$	1,543,893	$	29,402

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The number of investments in an unrealized loss position totaled 77 at September 30, 2019. We do not believe these unrealized losses are “other-than-temporary” as (i) we do not have the intent to sell our securities prior to recovery and/or maturity and (ii) it is more likely than not that we will not have to sell our securities prior to recovery and/or maturity. In making this determination, we also consider the length of time and extent to which fair value has been less than cost and the financial condition of the issuer. The unrealized losses noted are interest rate related due to the level of interest rates at September 30, 2019 compared to the time of purchase. We have reviewed the ratings of the issuers and have not identified any issues related to the ultimate repayment of principal as a result of credit concerns on these securities. Our mortgage related securities are backed by GNMA, FNMA and FHLMC or are collateralized by securities backed by these agencies. At September 30, 2019, 85.33% of our

available-for-sale

securities that are obligations of states and political subdivisions were issued within the State of Texas, of which 36.22% are guaranteed by the Texas Permanent School Fund.

At September 30, 2019, $2,112,193,000 of the Company’s securities were pledged as collateral for public or trust fund deposits, repurchase agreements and for other purposes required or permitted by law.

During the three months ended September 30, 2019 and 2018, sales of investment securities that were classified as

available-for-sale

totaled $1,352,000 and $71,134,000, respectively. Gross realized gains from security sales during the third quarter of 2019 and 2018 totaled $54,000 and $348,000, respectively. Gross realized losses from security sales during third quarter of 2019 and 2018 totaled $2,000 and $290,000, respectively.

During the nine months ended September 30, 2019 and 2018, sales of investment securities classified as

available-for-sale

totaled $67,404,000 and $220,259,000, respectively. Gross realized gains from security sales during the nine-month periods ended September 30, 2019 and 2018 totaled $747,000 and $1,877,000, respectively. Gross realized losses from security sales during the nine-month periods ended September 30, 2019 and 2018 totaled $19,000 and $531,000, respectively.

The specific identification method was used to determine cost in order to compute the realized gains and losses.

Note 5 – Loans Held for Investment and Allowance for Loan Losses

Loans held for investment are stated at the amount of unpaid principal, reduced by unearned income and an allowance for loan losses. Interest on loans is calculated by using the simple interest method on daily balances of the principal amounts outstanding. The Company defers and amortizes net loan origination fees and costs as an adjustment to yield. The allowance for loan losses is established through a provision for loan losses charged to expense. Loans are charged against the allowance for loan losses when management believes the collectability of the principal is unlikely.

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

Commercial loans are underwritten after evaluating and understanding the borrower’s ability to operate profitably and effectively. Underwriting standards are designed to determine whether the borrower possesses sound business ethics and practices and to evaluate current and projected cash flows to determine the ability of the borrower to repay their obligations as agreed. Commercial loans are primarily made based on the identified cash flows of the borrower and, secondarily, on the underlying collateral provided by the borrower. Most commercial loans are secured by the assets being financed or other business assets, such as accounts receivable or inventory, and include personal guarantees.

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Agricultural loans are subject to underwriting standards and processes similar to commercial loans. These agricultural loans are based primarily on the identified cash flows of the borrower and secondarily on the underlying collateral provided by the borrower. Most agricultural loans are secured by the agriculture related assets being financed, such as farm land, cattle or equipment, and include personal guarantees.

Real estate loans are also subject to underwriting standards and processes similar to commercial and agricultural loans. These loans are underwritten primarily based on projected cash flows and, secondarily, as loans secured by real estate. The repayment of real estate loans is generally largely dependent on the successful operation of the property securing the loans or the business conducted on the property securing the loan. Real estate loans may be more adversely affected by conditions in the real estate markets or in the general economy. The properties securing the Company’s real estate portfolio are generally diverse in terms of type and geographic location within Texas. This diversity helps reduce the exposure to adverse economic events that affect any single market or industry. Generally, real estate loans are owner occupied which further reduces the Company’s risk.

Consumer loan underwriting utilizes methodical credit standards and analysis to supplement the Company’s underwriting policies and procedures. The Company’s loan policy addresses types of consumer loans that may be originated and the collateral, if secured, which must be perfected. The relatively smaller individual dollar amounts of consumer loans that are spread over numerous individual borrowers also minimize the Company’s risk.

The allowance for loan losses is an amount which represents management’s best estimate of probable losses that are inherent in the Company’s loan portfolio as of the balance sheet date. The allowance for loan losses is comprised of three elements: (i) specific reserves determined based on probable losses on specific classified loans; (ii) a historical valuation reserve component that considers historical loss rates and estimated loss emergence periods; and (iii) qualitative reserves based upon general economic conditions and other qualitative risk factors both internal and external to the Company. The allowance for loan losses is increased by charges to income and decreased by

charge-offs

(net of recoveries). Management’s periodic evaluation of the appropriateness of the allowance is based on general economic conditions, the financial condition of borrowers, the value and liquidity of collateral, delinquency, prior loan loss experience, and the results of periodic reviews of the portfolio. For purposes of determining our historical valuation reserve, the loan portfolio, less cash secured loans, government guaranteed loans and classified loans, is multiplied by the Company’s historical loss rate adjusted for the estimated loss emergence period. Specific allocations are increased or decreased in accordance with deterioration or improvement in credit quality and a corresponding increase or decrease in risk of loss on a particular loan. In addition, we adjust our allowance for qualitative factors such as current local economic conditions and trends, including, without limitations, unemployment, oil and gas prices, drought conditions, changes in lending staff, policies and procedures, changes in credit concentrations, changes in the trends and severity of problem loans and changes in trends in volume and terms of loans. This qualitative reserve serves to estimate for additional areas of losses inherent in our portfolio that are not reflected in our historic loss factors.

Although we believe we use the best information available to make loan loss allowance determinations, future adjustments could be necessary if circumstances or economic conditions differ substantially from the assumptions used in making our initial determinations. A decline in the economy could result in increased levels of

non-performing

assets and charge-offs, increased loan provisions and reductions in income. Additionally, bank regulatory agencies periodically review our allowance for loan losses and methodology and could require, in accordance with U.S. GAAP, additional provisions to the allowance for loan losses based on their judgment of information available to them at the time of their examination as well as changes to our methodology.

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Accrual of interest is discontinued on a loan and payments are applied to principal when management believes, after considering economic and business conditions and collection efforts, the borrower’s financial condition is such that collection of interest is doubtful. Except consumer loans, generally all loans past due greater than 90 days, based on contractual terms, are placed on

non-accrual.

Loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured. Consumer loans are generally

charged-off

when a loan becomes past due 90 days. For other loans in the portfolio, facts and circumstances are evaluated in making

charge-off

decisions.

Loans are considered impaired when, based on current information and events, management determines that it is probable we will be unable to collect all amounts due in accordance with the loan agreement, including scheduled principal and interest payments. If a loan is impaired, a specific valuation allowance is allocated, if necessary. Interest payments on impaired loans are typically applied to principal unless collectability of the principal amount is reasonably assured, in which case interest is recognized on a cash basis. Impaired loans, or portions thereof, are charged off when deemed uncollectable.

The Company’s policy requires measurement of the allowance for an impaired, collateral dependent loan based on the fair value of the collateral less cost to sell. Other loan impairments for

non-collateral

dependent loans are measured based on the present value of expected future cash flows or the loan’s observable market price. At September 30, 2019 and 2018, and December 31, 2018, all significant impaired loans have been determined to be collateral dependent and the allowance for loss has been measured utilizing the estimated fair value of the collateral less cost to sell.

From time to time, the Company modifies its loan agreement with a borrower. A modified loan is considered a troubled debt restructuring when two conditions are met: (i) the borrower is experiencing financial difficulty and (ii) concessions are made by the Company that would not otherwise be considered for a borrower with similar credit risk characteristics. Modifications to loan terms may include a lower interest rate, a reduction of principal, or a longer term to maturity. For all impaired loans, including the Company’s troubled debt restructurings, the Company performs a periodic, well-documented credit evaluation of the borrower’s financial condition and prospects for repayment to assess the likelihood that all principal and interest payments required under the terms of the agreement will be collected in full. When doubt exists about the ultimate collectability of principal and interest, the troubled debt restructuring remains on

non-accrual

status and payments received are applied to reduce principal to the extent necessary to eliminate such doubt. This determination of accrual status is judgmental and is based on facts and circumstances related to each troubled debt restructuring. Each of these loans is individually evaluated for impairment and a specific reserve is recorded based on probable losses, taking into consideration the related collateral, modified loan terms and cash flow. As of September 30, 2019 and 2018 and December 31, 2018, substantially all of the Company’s troubled debt restructured loans are included in the

non-accrual

totals.

Loans acquired, including loans acquired in a business combination, are initially recorded at fair value with no valuation allowance. Acquired loans are segregated between those considered to be credit impaired and those deemed performing. To make this determination, management considers such factors as past due status,

non-accrual

status and credit risk ratings. The fair value of acquired performing loans is determined by discounting expected cash flows, both principal and interest, at prevailing market interest rates. The difference between the fair value and principal balances at acquisition date, the fair value discount, is accreted into interest income over the estimated life of the acquired portfolio.

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Purchased credit impaired loans are those loans that showed evidence of deterioration of credit quality since origination and for which it is probable, at acquisition, that the Company will be unable to collect all amounts contractually owed. Their acquisition fair value, which includes a credit component at the acquisition date, was based on the estimate of cash flows, both principal and interest, expected to be collected or estimated collateral values if cash flows are not estimable, discounted at prevailing market rates of interest. The difference between the discounted cash flows expected at acquisition and the investment in the loan is recognized as interest income on a level-yield method over the life of the loan, unless management was unable to reasonably forecast cash flows in which case the loans were placed on nonaccrual. Subsequent to the acquisition date, increases in expected cash flows will generally result in a recovery of any previously recorded allowance for loan loss, to the extent applicable, and/or a reclassification from the nonaccretable difference to accretable yield, which will be recognized prospectively. Decreases in expected cash flows subsequent to acquisition are

recognized as impairment. Valuation allowances on these impaired loans reflect only losses incurred after the acquisition. The carrying amount of purchased credit impaired loans at September 30, 2019 and 2018 and December 31, 2018 were $342,000, $2,947,000 and $827,000, respectively, compared to a contractual balance of $605,000, $3,898,000 and $1,157,000, respectively. Other purchased credit impaired loan disclosures were omitted due to immateriality.

Loans

held-for-investment

by class of financing receivables are as follows (in thousands):


	September 30,				December 31,
	2019		2018		2018
Commercial	$	836,644	$	773,924	$	844,953
Agricultural		102,054		93,953		96,677
Real estate		2,749,552		2,614,929		2,639,346
Consumer		412,066		384,234		372,660

Total loans held-for-investment	$	4,100,316	$	3,867,040	$	3,953,636

The Company’s

non-accrual

loans, loans still accruing and past due 90 days or more and restructured loans are as follows (in thousands):


	September 30,				December 31,
	2019		2018		2018
Non-accrual loans*	$	25,717	$	25,587	$	27,534
Loans still accruing and past due 90 days or more		104		88		1,008
Troubled debt restructured loans**		27		513		513

Total	$	25,848	$	26,188	$	29,055

*	Includes $342,000, $2,947,000 and $827,000 of purchased credit impaired loans as of September 30, 2019 and 2018, and December 31, 2018, respectively.

**	Troubled debt restructured loans of $3,983,000, $4,577,000 and $3,840,000, whose interest collection, after considering economic and business conditions and collection efforts, is doubtful are included in non-accrual loans at September 30, 2019 and 2018, and December 31, 2018, respectively.

The Company’s recorded investment in impaired loans and the related valuation allowance are as follows (in thousands):


September 30, 2019				September 30, 2018				December 31, 2018
Re corded Investment		Valuation Allowance		Recorded Investment		Valuation Allowance		Recorded Investment		Valuation Allowance
$	25,717	$	4,194	$	25,587	$	4,988	$	27,534	$	4,069

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The Company had $27,212,000, $26,859,000 and $29,632,000 in

non-accrual,

past due 90 days or more and still accruing, restructured loans and foreclosed assets at September 30, 2019 and 2018, and December 31, 2018, respectively.

Non-accrual

loans at September 30, 2019 and 2018, and December 31, 2018, consisted of the following by class of financing receivables (in thousands):


	September 30,				December 31,
	2019		2018		2018
Commercial	$	8,802	$	6,961	$	9,334
Agricultural		1,502		1,046		759
Real estate		15,095		16,682		16,714
Consumer		318		898		727

Total	$	25,717	$	25,587	$	27,534

No significant additional funds are committed to be advanced in connection with impaired loans as of September 30, 2019.

The Company’s impaired loans and related allowance are summarized in the following tables by class of financing receivables (in thousands). No interest income was recognized on impaired loans subsequent to their classification as impaired.


September 30, 2019	Unpaid Contractual Principal Balance		Recorded Investment With No Allowance*		Recorded Investment With Allowance		Total Recorded Investment		Related Allowance		Year –to- D ate Average Recorded Investment		Three- Month Average Recorded Investment
Commercial	$	10,250	$	5,885	$	2,917	$	8,802	$	1,448	$	9,586	$	9,263
Agricultural		1,701		406		1,096		1,502		247		1,707		1,609
Real Estate		22,535		4,143		10,952		15,095		2,314		16,739		15,577
Consumer		444		9		309		318		185		416		346

Total	$	34,930	$	10,443	$	15,274	$	25,717	$	4,194	$	28,448	$	26,795

*	Includes $342,000 of purchased credit impaired loans.


September 30, 201 8	Unpaid Contractual Principal Balance		Recorded Investment With No Allowance*		Recorded Investment With Allowance		Total Recorded Investment		Related Allowance		Year –to-Date Average Recorded Investment		Three- Month Average Recorded Investment
Commercial	$	9,276	$	3,467	$	3,494	$	6,961	$	1,412	$	8,339	$	7,669
Agricultural		1,062		—		1,046		1,046		528		1,506		1,101
Real Estate		22,513		4,215		12,467		16,682		2,652		18,688		17,762
Consumer		1,088		50		848		898		396		1,012		942

Total	$	33,939	$	7,732	$	17,855	$	25,587	$	4,988	$	29,545	$	27,474

*	Includes $2,947,000 of purchased credit impaired loans.


December 31, 2018	Unpaid Contractual Principal Balance		Recorded Investment With No Allowance*		Recorded Investment With Allowance		Total Recorded Investment		Related Allowance		12 Month Average Recorded Investment
Commercial	$	10,808	$	6,728	$	2,606	$	9,334	$	1,133	$	7,986
Agricultural		799		213		546		759		170		842
Real Estate		24,072		6,699		10,015		16,714		2,409		16,042
Consumer		935		101		626		727		357		914

Total	$	36,614	$	13,741	$	13,793	$	27,534	$	4,069	$	25,784

*	Includes $827,000 of purchased credit impaired loans.

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The Company recognized interest income on impaired loans prior to being recognized as impaired of approximately $948,000 during the year ended December 31, 2018. Such amounts for the three-month and nine-month periods ended September 30, 2019 and 2018 were not significant.

From a credit risk standpoint, the Company rates its loans in one of four categories: (i) pass, (ii) special mention, (iii) substandard or (iv) doubtful. Loans rated as loss are

charged-off.

The ratings of loans reflect a judgment about the risks of default and loss associated with the loan. The Company reviews the ratings on our credits as part of our

on-going

monitoring of the credit quality of our loan portfolio. Ratings are adjusted to reflect the degree of risk and loss that are felt to be inherent in each credit as of each reporting period. Our methodology is structured so that specific allocations are increased in accordance with deterioration in credit quality (and a corresponding increase in risk and loss) or decreased in accordance with improvement in credit quality (and a corresponding decrease in risk and loss).

Credits rated special mention show clear signs of financial weaknesses or deterioration in credit worthiness, however, such concerns are not so pronounced that the Company generally expects to experience significant loss within the short-term. Such credits typically maintain the ability to perform within standard credit terms and credit exposure is not as prominent as credits rated more harshly.

Credits rated substandard are those in which the normal repayment of principal and interest may be, or has been, jeopardized by reason of adverse trends or developments of a financial, managerial, economic or political nature, or important weaknesses exist in collateral. A protracted workout on these credits is a distinct possibility. Prompt corrective action is therefore required to strengthen the Company’s position, and/or to reduce exposure and to assure that adequate remedial measures are taken by the borrower. Credit exposure becomes more likely in such credits and a serious evaluation of the secondary support to the credit is performed.

Credits rated doubtful are those in which full collection of principal appears highly questionable, and which some degree of loss is anticipated, even though the ultimate amount of loss may not yet be certain and/or other factors exist which could affect collection of debt. Based upon available information, positive action by the Company is required to avert or minimize loss. Credits rated doubtful are generally also placed on

non-accrual.

The following summarizes the Company’s internal ratings of its loans

held-for-investment

by class of financing receivables and portfolio segments, which are the same (in thousands):


September 30, 2019	Pass		Special Mention		Substandard		Doubtful		Total
Commercial	$	797,444	$	24,836	$	14,364	$	—	$	836,644
Agricultural		99,586		61		2,407		—		102,054
Real Estate		2,673,591		21,171		54,790		—		2,749,552
Consumer		410,491		232		1,343		—		412,066

Total	$	3,981,112	$	46,300	$	72,904	$	—	$	4,100,316


September 30, 2018	Pass		Special Mention		Substandard		Doubtful		Total
Commercial	$	747,758	$	8,817	$	17,349	$	—	$	773,924
Agricultural		89,314		68		4,571		—		93,953
Real Estate		2,530,673		27,241		57,015		—		2,614,929
Consumer		381,772		324		2,138		—		384,234

Total	$	3,749,517	$	36,450	$	81,073	$	—	$	3,867,040

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December 31, 2018	Pass		Special Mention		Substandard		Doubtful		Total
Commercial	$	804,584	$	23,392	$	16,977	$	—	$	844,953
Agricultural		92,864		46		3,767		—		96,677
Real Estate		2,559,379		26,626		53,341		—		2,639,346
Consumer		370,510		315		1,835		—		372,660

Total	$	3,827,337	$	50,379	$	75,920	$	—	$	3,953,636

The Company’s past due loans are as follows (in thousands):


September 30, 2019	15-59 Days Past Due*		60-89 Days Past Due		Greater Than 90 Days		Total Past Due		Current		Total Loans		90 Days Past Due Still Accruing
Commercial	$	2,740	$	815	$	619	$	4,174	$	832,470	$	836,644	$	—
Agricultural		605		232		202		1,039		101,015		102,054		—
Real Estate		14,216		1,563		239		16,018		2,733,534		2,749,552		69
Consumer		595		164		40		799		411,267		412,066		35

Total	$	18,156	$	2,774	$	1,100	$	22,030	$	4,078,286	$	4,100,316	$	104


September 30, 2018	15-59 Days Past Due*		60-89 Days Past Due		Greater Than 90 Days		Total Past Due		Current		Total Loans		90 Days Past Due Still Accruing
Commercial	$	3,850	$	420	$	3,331	$	7,601	$	766,323	$	773,924	$	—
Agricultural		442		—		287		729		93,224		93,953		—
Real Estate		15,542		2,583		661		18,786		2,596,143		2,614,929		—
Consumer		749		173		145		1,067		383,167		384,234		88

Total	$	20,583	$	3,176	$	4,424	$	28,183	$	3,838,857	$	3,867,040	$	88


December 31, 2018	15-59 Days Past Due*		60-89 Days Past Due		Greater Than 90 Days		Total Past Due		Current		Total Loans		Total 90 Days Past Due Still Accruing
Commercial	$	3,546	$	682	$	677	$	4,905	$	840,048	$	844,953	$	—
Agricultural		791		19		26		836		95,841		96,677		—
Real Estate		13,185		881		2,020		16,086		2,623,260		2,639,346		960
Consumer		782		263		54		1,099		371,561		372,660		48

Total	$	18,304	$	1,845	$	2,777	$	22,926	$	3,930,710	$	3,953,636	$	1,008

*	The Company monitors commercial, agricultural and real estate loans after such loans are 15 days past due. Consumer loans are monitored after such loans are 30 days past due.

The following table details the allowance for loan losses by portfolio segment (in thousands). There were no allowances for purchased credit impaired loans at September 30, 2019 and 2018, and December 31, 2018. Allocation of a portion of the allowance to one category of loans does not preclude its availability to absorb losses in other categories.


September 30, 2019	Commercial		Agricultural		Real Estate		Consumer		Total
Loans individually evaluated for impairment	$	1,448	$	247	$	2,314	$	185	$	4,194
Loans collectively evaluated for impairment		11,018		1,000		30,022		5,655		47,695

Total	$	12,466	$	1,247	$	32,336	$	5,840	$	51,889

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September 30, 2018	Commercial		Agricultural		Real Estate		Consumer		Total
Loans individually evaluated for impairment	$	1,412	$	528	$	2,652	$	396	$	4,988
Loans collectively evaluated for impairment		7,549		1,106		31,713		5,515		45,883

Total	$	8,961	$	1,634	$	34,365	$	5,911	$	50,871


December 31, 2018	Commercial		Agricultural		Real Estate		Consumer		Total
Loans individually evaluated for impairment	$	1,133	$	170	$	2,409	$	357	$	4,069
Loans collectively evaluated for impairment		10,815		1,276		29,933		5,109		47,133

Total	$	11,948	$	1,446	$	32,342	$	5,466	$	51,202

Changes in the allowance for loan losses are summarized as follows by portfolio segment (in thousands):

Three months ended September 30, 2019	Commercial			Agricultural			Real Estate			Consumer			Total
Beginning balance	$	13,899		$	1,360		$	30,799		$	5,762		$	51,820
Provision for loan losses		(1,174	)		(32	)		1,531			125			450
Recoveries		90			85			100			111			386
Charge-offs		(349	)		(166	)		(94	)		(158	)		(767	)

Ending balance	$	12,466		$	1,247		$	32,336		$	5,840		$	51,889


Three months ended September 30, 2018	Commercial			Agricultural			Real Estate			Consumer			Total
Beginning balance	$	9,218		$	1,402		$	33,243		$	6,088		$	49,951
Provision for loan losses		(24	)		229			1,091			154			1,450
Recoveries		192			3			85			135			415
Charge-offs		(425	)		—			(54	)		(466	)		(945	)

Ending balance	$	8,961		$	1,634		$	34,365		$	5,911		$	50,871


Nine months ended September 30, 2019	Commercial			Agricultural			Real Estate			Consumer			Total
Beginning balance	$	11,948		$	1,446		$	32,342		$	5,466		$	51,202
Provision for loan losses		439			10			998			568			2,015
Recoveries		1,163			92			250			459			1,964
Charge-offs		(1,084	)		(301	)		(1,254	)		(653	)		(3,292	)

Ending balance	$	12,466		$	1,247		$	32,336		$	5,840		$	51,889


Nine months ended September 30, 2018	Commercial			Agricultural			Real Estate			Consumer			Total
Beginning balance	$	10,865		$	1,305		$	29,896		$	6,090		$	48,156
Provision for loan losses		(1,316	)		317			4,325			539			3,865
Recoveries		476			12			345			382			1,215
Charge-offs		(1,064	)		—			(201	)		(1,100	)		(2,365	)

Ending balance	$	8,961		$	1,634		$	34,365		$	5,911		$	50,871

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The Company’s recorded investment in loans related to the balance in the allowance for loan losses on the basis of the Company’s impairment methodology is as follows (in thousands). Purchased credit impaired loans of $342,000, $2,947,000 and $827,000 at September 30, 2019 and 2018, and December 31, 2018, respectively, are included in loans individually evaluated for impairment.


September 30, 2019	Commercial		Agricultural		Real Estate		Consumer		Total
Loans individually evaluated for impairment	$	8,802	$	1,502	$	15,095	$	318	$	25,717
Loans collectively evaluated for impairment		827,842		100,552		2,734,457		411,748		4,074,599

Total	$	836,644	$	102,054	$	2,749,552	$	412,066	$	4,100,316


September 30, 2018	Commercial		Agricultural		Real Estate		Consumer		Total
Loans individually evaluated for impairment	$	6,961	$	1,046	$	16,682	$	898	$	25,587
Loans collectively evaluated for impairment		766,963		92,907		2,598,247		383,336		3,841,453

Total	$	773,924	$	93,953	$	2,614,929	$	384,234	$	3,867,040


December 31, 2018	Commercial		Agricultural		Real Estate		Consumer		Total
Loans individually evaluated for impairment	$	9,334	$	759	$	16,714	$	727	$	27,534
Loan collectively evaluated for impairment		835,619		95,918		2,622,632		371,933		3,926,102

Total	$	844,953	$	96,677	$	2,639,346	$	372,660	$	3,953,636

The Company’s loans that were modified and considered troubled debt restructurings are as follows (in thousands):


	Three Months Ended September 30, 2019						Nine Months Ended September 30, 2019
			Pre-Modification		Post- Modification				Pre-Modification		Post- Modification
			Recorded		Recorded				Recorded		Recorded
	Number		Investment		Investment		Number		Investment		Investment
Commercial		2	$	100	$	100		5	$	379	$	379
Agricultural		—		—		—		10		619		619
Real Estate		1		42		42		5		692		692
Consumer		—		—		—		—		—		—

Total		3	$	142	$	142		20	$	1,690	$	1,690


	Three Months Ended September 30, 2018						Nine Months Ended September 30, 2018
			Pre-Modification		Post- Modification				Pre-Modification		Post- Modification
			Recorded		Recorded				Recorded		Recorded
	Number		Investment		Investment		Number		Investment		Investment
Commercial		2	$	547	$	547		3	$	826	$	826
Agricultural		—		—		—		1		4		4
Real Estate		1		117		117		5		642		642
Consumer		—		—		—		6		113		113

Total		3	$	664	$	664		15	$	1,585	$	1,585

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The balances below provide information as to how the loans were modified as troubled debt restructured loans (in thousands):


	Three Months Ended September 30, 2019						Nine Months Ended September 30, 2019
	Adjusted Interest Rate		Extended Maturity		Combined Rate and Maturity		Adjusted Interest Rate		Extended Maturity		Combined Rate and Maturity
Commercial	$	—	$	—	$	100	$	—	$	279	$	100
Agricultural		—		—		—		—		354		265
Real Estate		—		—		42		—		202		490
Consumer		—		—		—		—		—		—

Total	$	—	$	—	$	142	$	—	$	835	$	855


	Three Months Ended September 30, 2018						Nine Months Ended September 30, 2018
	Adjusted Interest Rate		Extended Maturity		Combined Rate and Maturity		Adjusted Interest Rate		Extended Maturity		Combined Rate and Maturity
Commercial	$	—	$	491	$	56	$	—	$	491	$	335
Agricultural		—		—		—		—		—		4
Real Estate		—		117		—		—		279		363
Consumer		—		—		—		—		—		113

Total	$	—	$	608	$	56	$	—	$	770	$	815

During the three and nine months ended September 30, 2019, two loans

totaling $28,000

were modified as a troubled debt restructured loan within the previous 12 months and for which there was a payment default. During the three and nine months ended September 30, 2018, no loans were modified as a troubled debt restricted during loan within the previous 12 months and for which there was a payment default. A default for purposes of this disclosure is a troubled debt restructured loan in which the borrower is 90 days past due or more or results in the foreclosure and repossession of the applicable collateral.

As of September 30, 2019, the Company has no commitments to lend additional funds to loan customers whose terms have been modified in troubled debt restructurings.

Our subsidiary bank has established a line of credit with the Federal Home Loan Bank of Dallas (FHLB) to provide liquidity and meet pledging requirements for those customers eligible to have securities pledged to secure certain uninsured deposits. At September 30, 2019, $2,616,319,000 in loans held by our bank subsidiary were subject to blanket liens as security for this line of credit. At September 30, 2019, there

was $35,000,000

outstanding under this line of credit.

Note 6 - Loans Held for Sale

The Company originates certain mortgage loans for sale in the secondary market. The mortgage loan sales contracts contain indemnification clauses should the loans default, generally in the first three to nine months, or if documentation is determined not to be in compliance with regulations. The Company’s historic losses as a result of these indemnities have been insignificant.

Loans held for sale totaled $

40,499

,000, $

18,496

,000 and $

21,672

,000 at September 30, 2019 and 2018, and December 31, 2018, respectively. At September 30, 2019 and 2018, and December 31, 2018, $764,000, $2,541,000 and $2,487,000 are valued at the lower of cost or fair value, and the remaining amounts are valued under the fair value option. The change to the fair value option for loans held for sale was effective at June 30, 2018 and was done in conjunction with the Company’s move to mandatory delivery in the secondary market and the purchase of forward mortgage-backed securities to manage the changes in fair value (see note 7 for additional information).

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These loans, which are sold on a servicing released basis, are valued using a market approach by utilizing either: (i) the fair value of the securities backed by similar mortgage loans, adjusted for certain factors to approximate the fair value of a whole mortgage loan, including the value attributable to mortgage servicing and credit risk, (ii) current commitments to purchase loans or (iii) recent observable market trades for similar loans, adjusted for credit risk and other individual loan characteristics. As these prices are derived from market observable inputs, the Company classifies these valuations as Level 2 in the fair value disclosures (see note 12). Interest income on mortgage loans held for sale is recognized based on the contractual rates and reflected in interest income on loans in the consolidated statements of earnings. The Company has no continuing ownership in any residential mortgage loans sold.

Note 7 - Derivative Financial Instruments

The Company enters into interest rate lock commitments (“IRLCs”) with customers to originate residential mortgage loans at a specific interest rate that are ultimately sold in the secondary market. These commitments, which contain fixed expiration dates, offer the borrower an interest rate guarantee provided the loan meets underwriting guidelines and closes within the timeframe established by the Company.

Beginning in the second quarter of 2018, the Company purchased forward mortgage-backed securities contracts to manage the changes in fair value associated with changes in interest rates related to a portion of the IRLCs. These instruments are typically entered into at the time the IRLC is made.

These financial instruments are not designated as hedging instruments and are used for asset and liability management needs. All derivatives are carried at fair value in either other assets or other liabilities.

The fair values of IRLCs are based on current secondary market prices for underlying loans and estimated servicing value with similar coupons, maturity and credit quality, subject to the anticipated loan funding probability (pull-through rate). The fair value of IRLCs is subject to change primarily due to changes in interest rates and the estimated pull-through rate. These commitments are classified as Level 2 in the fair value disclosures (see note 12), as the valuations are based on observable market inputs.

Forward mortgage-backed securities contracts are exchange-traded or traded within highly active dealer markets. In order to determine the fair value of these instruments, the Company utilizes the exchange price or dealer market price for the particular derivative contract and these instruments are therefore classified as Level 2 in the fair value disclosures (see note 12). The estimated fair values are subject to change primarily due to changes in interest rates.

The following table provides the outstanding notional balances and fair values of outstanding derivative positions (dollars in thousands):


September 30, 2019:	Outstanding Notional Balance		Asset Derivative Fair Value		Liability Derivative Fair Value
IRLCs	$	82,330	$	1,320	$	—
Forward mortgage-backed securities trades		126,500		41		—

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September 30, 2018:	Outstanding Notional Balance		Asset Derivative Fair Value		Liability Derivative Fair Value
IRLCs	$	48,311	$	715	$	—
Forward mortgage-backed securities trades		42,500		143		—

December 31, 2018:	Outstanding Notional Balance		Asset Derivative Fair Value		Liability Derivative Fair Value
IRLCs	$	37,088	$	765	$	—
Forward mortgage-backed securities trades		45,500		—		403

Note 8 – Borrowings

Borrowings consisted of the following (dollars in thousands):


	September 30,				December 31,
	2019		2018		2018
Securities sold under agreements with customers to repurchase	$	358,155	$	378,460	$	409,631
Federal funds purchased		7,000		2,300		4,075
Advances from Federal Home Loan Bank of Dallas		35,000		—		55,000

Total	$	400,155	$	380,760	$	468,706

Securities sold under repurchase agreements are generally with significant customers of the Company that require short-term liquidity for their funds for which the Company pledges certain securities that have a fair value equal to at least the amount of the borrowings. The agreements mature daily and therefore the risk arising from a decline in the fair value of the collateral pledged is minimal. The securities pledged are mortgage-backed securities. These agreements do not include “right of

set-off”

provisions and therefore the Company does not offset such agreements for financial reporting purposes.

Note 9 - Income Taxes

Income tax expense was $

8,867

,000 for the third quarter of 2019 as compared to $

7,475

,000 for the same period in 2018. The Company’s effective tax rates on pretax income were 17.07% and 15.73% for the third quarters of 2019 and 2018, respectively. Income tax expense was $

24,827

,000 for the nine months ended September 30, 2019 as compared to $

20,937

,000 for the same period in 2018. The Company’s effective tax rates on pretax income were 16.75% and 15.73% for the nine months ended September

30,

2019 and 2018, respectively. The effective tax rates differ from the statutory federal tax rate of 21% primarily due to tax exempt interest income earned on certain investment securities and loans, the deductibility of dividends paid to our employee stock ownership plan and excess tax benefits related to our directors’ deferred compensation plan.

Note 10 - Stock Option Plan and Restricted Stock Plan

The Company grants incentive stock options for a fixed number of shares with an exercise price equal to the fair value of the shares at the date of grant to employees. On June 26, 2019, the Company granted 398,850 incentive stock options with an exercise price of $29.70 per share. The fair value of the options was $7.31 per share and was estimated using the Black-Scholes options pricing model with the following weighted average assumptions: risk free interest rate of 1.83%; expected dividend yield of 1.62%; expected life of 6.64 years; and expected volatility of 26.69%. No options were granted in 2018.

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The Company recorded stock option expense totaling $431,000 and $377,000 for the three-month periods ended September 30, 2019 and 2018, respectively. The Company recorded stock option expense totaling $1,056,000 and $1,131,000 for the nine months ended September 30, 2019 and 2018, respectively. The additional disclosure requirements under authoritative accounting guidance have been omitted due to the amounts being insignificant.

On April 25, 2017, upon

re-election

of existing directors, 29,300 restricted shares with a total value of $600,000 were granted to the ten

non-employee

directors and were expensed over the period from the grant date to April 24, 2018, the date of the next annual shareholders’ meeting at which these directors’ term expired. On April 24, 2018, upon

re-election

of nine of the existing directors, 21,420 restricted shares with a total value of $523,000 were granted to these

non-employee

directors and were expensed over the period from grant date to April 23, 2019, the date of the next annual shareholders’ meeting at which the directors’ term expired. On April 23, 2019, upon

re-election

of nine of the existing directors and two new directors, 21,714 restricted shares with a total value of $660,000 were granted to these

non-employee

directors and will be expensed over the period from the grant date to April 28, 2020, the Company’s next annual shareholders’ meeting at which the directors’ term expires. The Company recorded director expense related to these restricted share grants of $185,000 and $135,000 for the three-month periods ended September 30, 2019 and 2018, respectively. The Company recorded director expense related to these restricted stock grants of $455,000 and $425,000 for the nine months ended September 30, 2019 and 2018, respectively.

On October 27, 2015, the Company granted 62,546 restricted shares with a total value of $1,060,000 to certain officers that

were

expensed over the vesting period of three years. On October 25, 2016, the Company granted 30,810 restricted stock shares with a total value of $560,000 to certain officers that

are

being expensed over the vesting period of three years. On October 24, 2017, the Company granted 28,382 restricted shares with a total value of $655,000 to certain officers that

are

being expensed over the vesting period of one to three years. On October 23, 2018, the Company granted 52,042 restricted shares with a total value of $1,440,000 to certain officers that

are

being

expensed over a three-year vesting period. On June 26, 2019, the Company granted 23,428 restricted shares with a total value of $695,000 to certain officers tha

t are b

eing expensed over the vesting period of three years. On October 22, 2019, the Company granted 22,188 restricted shares with a total value of $785,000 to certain officers that

will be

expensed over a three-year vesting period. The Company recorded restricted stock expense for officers of $248,000 and $175,000 for the three-month periods ended September 30, 2019 and 2018, respectively. The Company recorded restricted stock expense for officers of $661,000 and $501,000 for the nine-month periods ended September 30, 2019 and 2018, respectively.

Note 11 - Pension Plan

The Company’s defined benefit pension plan was frozen effective January 1, 2004, whereby no new participants were added to the plan and no additional years of service were accrued to participants. The pension plan covered substantially all of the Company’s employees at the time. The benefits for each employee were based on years of service and a percentage of the employee’s qualifying compensation during the final years of employment. The Company’s funding policy was and is to contribute annually the amount necessary to satisfy the Internal Revenue Service’s funding standards. As a result of its evaluation of its funding status, the Company made no contribution in 2018, and has not made a contribution through September 30, 2019.

In December 2018, due to the rising interest rate environment, the Company determined it was in the best interest of its shareholders to settle its pension obligation to its retiree group in payout, approximately 53% of the pension benefit obligation on that date, and recorded a loss on settlement totaling $1,546,000 for the year ended December 31, 2018. In 2019, the Company made a decision to terminate and settle the remaining obligation in its pension plan with an effective termination date of

June

30, 2019, following which date the Company is obligated to settle the Company’s remaining obligations of the plan upon receipt of regulatory approval. Final settlement of the Company’s remaining obligation under the plan is expected to be made in the fourth quarter of 2019 or first quarter of 2020, subject to regulatory approval.

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In addition, the Company had a multiple employer pension plan related to its acquisition of Orange Savings Bank in 2013. This plan was likewise frozen. During the first quarter of 2019, the Company made a decision to remove this plan from the multiple employer plan and merge it into the Company’s existing pension plan. The Company recorded $900,000 in pension merger expense for the three months ended March 31, 2019 in connection with this merger of the Orange pension plan. In May 2019, the Company assumed the Orange pension obligation of $2,740,000 and received related assets totaling $1,829,000.

Net periodic benefit costs totaling $31,000 and $65,000 were recorded for the three months ended September 30, 2019 and 2018, respectively. Net periodic benefit costs totaling $973,000 and $177,000 were recorded for the nine months ended September 30, 2019 and 2018, respectively, which includes the Orange pension merger costs discussed above.

Note 12 - Fair Value Disclosures

The authoritative accounting guidance for fair value measurements defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants. A fair value measurement assumes that the transaction to sell the asset or transfer the liability occurs in the principal market for the asset or liability or, in the absence of a principal market, the most advantageous market for the asset or liability. The price in the principal (or most advantageous) market used to measure the fair value of the asset or liability shall not be adjusted for transaction costs. An orderly transaction is a transaction that assumes exposure to the market for a period prior to the measurement date to allow for marketing activities that are usual and customary for transactions involving such assets and liabilities; it is not a forced transaction. Market participants are buyers and sellers in the principal market that are (i) independent, (ii) knowledgeable, (iii) able to transact, and (iv) willing to transact.

The authoritative accounting guidance requires the use of valuation techniques that are consistent with the market approach, the income approach and/or the cost approach. The market approach uses prices and other relevant information generated by market transactions involving identical or comparable assets and liabilities. The income approach uses valuation techniques to convert future amounts, such as cash flows or earnings, to a single present amount on a discounted basis. The cost approach is based on the amount that currently would be required to replace the service capacity of an asset (replacement costs). Valuation techniques should be consistently applied. Inputs to valuation techniques refer to the assumptions that market participants would use in pricing the asset or liability. Inputs may be observable, meaning those that reflect the assumptions market participants would use in pricing the asset or liability developed based on market data obtained from independent sources, or unobservable, meaning those that reflect the reporting entity’s own assumptions about the assumptions market participants would use in pricing the

asset or liability developed based on the best information available in the circumstances. In that regard, the authoritative guidance establishes a fair value hierarchy for valuation inputs that gives the highest priority to quoted prices in active markets for identical assets or liabilities and the lowest priority to unobservable inputs. The fair value hierarchy is as follows:

•	Level 1 Inputs – Unadjusted quoted prices in active markets for identical assets or liabilities that the reporting entity has the ability to access at the measurement date.

•

Level 2 Inputs – Inputs other than quoted prices included in Level 1 that are observable for the asset or liability, either directly or indirectly. These include quoted prices for similar assets or liabilities in active markets, quoted prices for identical or similar assets or liabilities in markets that are not active, inputs other than quoted prices that are observable for the asset or liability (for example, interest rates, volatilities, prepayment speeds, loss severities, credit risks and default rates) or inputs that are derived principally from or corroborated by observable market data by correlation or other means.

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•	Level 3 Inputs – Significant unobservable inputs that reflect an entity’s own assumptions that market participants would use in pricing the assets or liabilities.

A description of the valuation methodologies used for assets and liabilities measured at fair value, as well as the general classification of such instruments pursuant to the valuation hierarchy, is set forth below.

In general, fair value is based upon quoted market prices, where available. If such quoted market prices are not available, fair value is based upon internally developed models that primarily use, as inputs, observable market-based parameters. Valuation adjustments may be made to ensure that financial instruments are recorded at fair value. While management believes the Company’s valuation methodologies are appropriate and consistent with other market participants, the use of different methodologies or assumptions to determine the fair value of certain financial instruments could result in a different estimate of fair value at the reporting date.

Securities classified as

available-for-sale

and trading are reported at fair value utilizing Level 1 and Level 2 inputs. For these securities, the Company obtains fair value measurements from an independent pricing service. The fair value measurements consider observable data that may include market spreads, cash flows, the United States Treasury yield curve, live trading levels, trade execution data, dealer quotes, market consensus prepayments speeds, credit information and the security’s terms and conditions, among other items.

See notes 6 and 7 related to the determination of fair value for loans

held-for-sale,

IRLCs and forward mortgage-backed securities trades.

There were no transfers between Level 1 and Level 2 or Level 2 and Level 3 during the three and nine months ended September 30, 2019 and 2018, and the year ended December 31, 2018.

The following table summarizes the Company’s

available-for-sale

securities which are measured at fair value on a recurring basis, segregated by the level of the valuation inputs within the fair value hierarchy utilized to measure fair value (dollars in thousands):

September 30, 2019


	Level 1 Inputs		Level 2 Inputs		Level 3 Inputs		Total Fair Value
Available-for-sale investment securities:
U.S. Treasury securities	$	10,021	$	—	$	—	$	10,021
Obligations of states and political subdivisions		—		1,242,197		—		1,242,197
Corporate bonds		—		229		—		229
Residential mortgage-backed securities		—		1,623,380		—		1,623,380
Commercial mortgage-backed securities		—		516,828		—		516,828
Other securities		4,501		—		—		4,501

Total	$	14,522	$	3,382,634	$	—	$	3,397,156
Loans held-for-sale	$	—	$	39,735	$	—	$	39,735
IRLCs	$	—	$	1,320	$	—	$	1,320
Forward mortgage-backed securities trades	$	—	$	41	$	—	$	41

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September 30, 2018


	Level 1 Inputs		Level 2 Inputs		Level 3 Inputs		Total Fair Value
U.S. Treasury securities	$	9,929	$	—	$	—	$	9,929
Obligations of U. S. government sponsored enterprises and agencies		—		302		—		302
Obligations of states and political subdivisions		—		1,191,887		—		1,191,887
Corporate bonds		—		450		—		450
Residential mortgage-backed securities		—		1,494,306		—		1,494,306
Commercial mortgage-backed securities		—		443,204		—		443,204
Other securities		4,289		—		—		4,289

Total	$	14,218	$	3,130,149	$	—	$	3,144,367

Loans held-for-sale	$	—	$	15,955	$	—	$	15,955

IRLCs	$	—	$	715	$	—	$	715

Forward mortgage-backed securities trades	$	—	$	143	$	—	$	143

December 31, 2018


	Level 1 Inputs		Level 2 Inputs			Level 3 Inputs		Total Fair Value
Available-for-sale investment securities:
U.S. Treasury securities	$	9,962	$	—		$	—	$	9,962
Obligations of U. S. government sponsored enterprises and agencies		—		301			—		301
Obligations of states and political subdivisions		—		1,257,871			—		1,257,871
Corporate bonds		—		450			—		450
Residential mortgage-backed securities		—		1,454,545			—		1,454,545
Commercial mortgage-backed securities		—		431,300			—		431,300
Other securities		4,348		—			—		4,348

Total	$	14,310	$	3,144,467		$	—	$	3,158,777

Loans held-for-sale	$	—	$	19,185		$	—	$	19,185

IRLCs	$	—	$	765		$	—	$	765

Forward mortgage-backed securities trades	$	—	$	(403	)	$	—	$	(403	)

Certain financial assets and financial liabilities are measured at fair value on a nonrecurring basis, that is, the instruments are not measured at fair value on an ongoing basis but are subject to fair value adjustments in certain circumstances (for example, when there is evidence of impairment).

Impaired loans are reported at the fair value of the underlying collateral less selling costs if repayment is expected solely from the collateral. Collateral values are estimated using Level 2 inputs based on observable market data. At September 30, 2019, impaired loans with a carrying value of $15,274,000 were reduced by specific valuation reserves totaling $4,194,000 resulting in a net fair value of $11,080,000. The Company also had impaired loans of $

10,443

,000 with no specific valuation reserve at September 30, 2019, due to the loans carrying value generally being lower than the value of the collateral associated with the loan.

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Certain

non-financial

assets and

non-financial

liabilities measured at fair value on a

non-recurring

basis include other real estate owned, goodwill and other intangible assets and other

non-financial

long-lived assets.

Non-financial

assets measured at fair value on a

non-recurring

basis during the three months and nine months ended September 30, 2019 and 2018 include other real estate owned which, subsequent to their initial transfer to other real estate owned from loans, were

re-measured

at fair value through a write-down included in gain (loss) on sale of foreclosed assets. During the reported periods, all fair value measurements for foreclosed assets utilized Level 2 inputs based on observable market data, generally third-party appraisals, or Level 3 inputs based on customized discounting criteria. These appraisals are evaluated individually and discounted as necessary due to the age of the appraisal, lack of comparable sales, expected holding periods of property or special use type of the property. Such discounts vary by appraisal based on the above factors but generally range from 5% to 25% of the appraised value.

Re-evaluation

of other real estate owned is performed at least annually as required by regulatory guidelines or more often if particular circumstances arise.

The following table presents other real estate owned that were

re-measured

subsequent to their initial transfer to other real estate owned (dollars in thousands):


	Three Months Ended September 30,
	2019		2018
Carrying value of other real estate owned prior to re-measurement	$	—	$	—
Write-downs included in gain (loss) on sale of other real estate owned		—		—

Fair value	$	—	$	—


	Nine Months Ended September 30,
	2019		2018
Carrying value of other real estate owned prior to re-measurement	$	—	$	526
Write-downs included in gain (loss) on sale of other real estate owned		—		(126	)

Fair value	$	—	$	400

At September 30, 2019 and 2018, and December 31, 2018, other real estate owned totaled $1,329,000, $593,000

and $448,000,

respectively.

The Company is required under current authoritative accounting guidance to disclose the estimated fair value of their financial instrument assets and liabilities including those subject to the requirements discussed above. For the Company, as for most financial institutions, substantially all of its assets and liabilities are considered financial instruments. Many of the Company’s financial instruments, however, lack an available trading market as characterized by a willing buyer and willing seller engaging in an exchange transaction.

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The estimated fair value amounts of financial instruments have been determined by the Company using available market information and appropriate valuation methodologies. However, considerable judgment is required to interpret data to develop the estimates of fair value. Accordingly, the estimates presented herein are not necessarily indicative of the amounts the Company could realize in a current market exchange. The use of different market assumptions and/or estimation methodologies may have a material effect on the estimated fair value amounts.

In addition, reasonable comparability between financial institutions may not be likely due to the wide range of permitted valuation techniques and numerous estimates that must be made given the absence of active secondary markets for many of the financial instruments. This lack of uniform valuation methodologies also introduces a greater degree of subjectivity to these estimated fair values.

Cash and due from banks, federal funds sold, interest-bearing deposits and time deposits in banks and accrued interest receivable and payable are liquid in nature and considered Levels 1 or 2 of the fair value hierarchy.

Financial instruments with stated maturities have been valued using a present value discounted cash flow with a discount rate approximating current market for similar assets and liabilities and are considered Levels 2 and 3 of the fair value hierarchy. Financial instrument liabilities with no stated maturities have an estimated fair value equal to both the amount payable on demand and the carrying value and are considered Level 1 of the fair value hierarchy.

The carrying value and the estimated fair value of the Company’s contractual

off-balance-sheet

unfunded lines of credit, loan commitments and letters of credit, which are generally priced at market at the time of funding, are not material.

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The estimated fair values and carrying values of all financial instruments under current authoritative guidance were as follows (in thousands).


	September 30,								December 31,
	2019				2018				2018
	Carrying Value		Estimated Fair Value		Carrying Value		Estimated Fair Value		Carrying Value			Estimated Fair Value			Fair Value Hierarchy
Cash and due from banks	$	198,855	$	198,855	$	164,998	$	164,998	$	207,835		$	207,835			Level 1
Interest-bearing deposits in banks		31,410		31,410		34,511		34,511		40,812			40,812			Level 1
Interest-bearing time deposits in banks		—		—		1,458		1,458		1,458			1,458			Level 2
Available-for-sale securities		3,397,156		3,397,156		3,144,367		3,144,367		3,158,777			3,158,777			Levels 1 and 2
Loans held for investment		4,048,427		4,068,755		3,816,169		3,857,059		3,902,434			3,947,391			Level 3
Loans held for sale		40,499		40,542		18,496		18,517		21,672			21,779			Level 2
Accrued interest receivable		29,606		29,606		28,990		28,990		36,765			36,765			Level 2
Deposits with stated maturities		428,192		429,522		450,667		450,409		442,161			441,727			Level 2
Deposits with no stated maturities		5,969,491		5,969,491		5,694,615		5,694,615		5,738,228			5,738,228			Level 1
Borrowings		400,155		400,155		380,760		380,760		468,706			468,706			Level 2
Accrued interest payable		746		746		303		303		408			408			Level 2
IRLCs		1,320		1,320		715		715		765			765			Level 2
Forward mortgage backed securities trades		41		41		143		143		(403	)		(403	)		Level 2

Note 13—Recently Issued Authoritative Accounting Guidance

Accounting Standards Update (“ASU”) 2014-09, “Revenue from Contracts with Customers

.” ASU

2014-09

implemented a comprehensive new revenue recognition standard that supersedes substantially all existing revenue recognition guidance. The new standard’s core principle is that a company will recognize revenue when it transfers promised goods or services to customers in an amount that reflects the consideration to which the company expects to be entitled in exchange for those goods or services. To achieve that core principle, an entity applies the following steps: (i) identify the contract(s) with a customer, (ii) identify the performance obligations in the contract, (iii) determine the transaction price, (iv) allocate the transaction price to the performance obligations in the contract and (v) recognize revenue when (or as) the entity satisfies a performance obligation. ASU

2015-4

“Revenue from Contracts with Customers – Deferral of the Effective Date” deferred the effective date of ASU

2014-09

by one year and as a result, the new standard became effective in the first quarter of 2018. The Company’s revenue is comprised of net interest income on financial assets and financial liabilities, which is explicitly excluded from the scope of ASU

2014-09,

and

non-interest

income. The adoption of the new standard in the first quarter of 2018 did not have a significant impact on the Company’s financial statements and no adjustment to opening retained earnings was recorded.

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ASU 2016-01, ASU 2016-01 “Financial Instruments – Overall: Recognition and Measurement of Financial Assets and Financial Liabilities

.” ASU

2016-01,

among other things, (i) requires equity investments, with certain exceptions, to be measured at fair value with changes in fair value recognized in net income, (ii) simplified the impairment assessment of equity investments without readily determinable fair values by requiring a qualitative assessment to identify impairment, (iii) eliminated the requirement for public business entities to disclose the methods and significant assumptions used to estimate the fair value that is required to be disclosed for financial instruments measured at amortized cost on the balance sheet, (iv) required public business entities to use the exit price notion when measuring the fair value of financial instruments for disclosure purposes, (v) required an entity to present separately in other comprehensive income the portion of the total change in the fair value of a liability resulting from a change in the instrument-specific credit risk when the entity has elected to measure the liability at fair value in accordance with the fair value option for financial instruments, (vi) required separate presentation of financial assets and financial liabilities by measurement category and form of financial asset on the balance sheet or the accompanying notes to the financial statements and (vii) clarified that an entity should evaluate the need for a valuation allowance on a deferred tax asset related to

available-for-sale

securities. ASU

2016-1

became effective for the Company on January 1, 2018 and did not have a significant impact on the Company’s financial statements.

ASU 2016-02, “Leases

.” ASU

2016-02

amended current lease accounting to require lessees to recognize (i) a lease liability, which is a lessee’s obligation to make lease payments arising from a lease, measured on a discounted basis, and (ii) a

right-of-use

asset, which is an asset that represents the lessee’s right to use, or control the use of, a specified asset for the lease term. ASU

2016-02

does not significantly change lease accounting requirements applicable to lessors; however, certain changes were made to align, where necessary, lessor accounting with the lessee accounting model. The amended guidance became effective in the first quarter of 2019 and required transition using a modified retrospective approach for leases existing at, or entered into after, the beginning of the earliest comparative period presented in the financial statements. The Company evaluated the provisions of the new lease standard and, due to the small dollar amounts and number of lease agreements, the effect for the Company on January 1, 2019 was not significant.

ASU 2016-13, “Financial Instruments – Credit Losses

.” ASU

2016-13

implements a comprehensive change in estimating the allowances for loan losses from the current model of losses inherent in the loan portfolio to a current expected credit loss model that generally is expected to result in earlier recognition of allowances for losses. ASU

2016-13

requires the measurement of all expected credit losses for financial assets held at the reporting date based on historical experience, current conditions, and reasonable and supportable forecasts and requires enhanced disclosures related to the significant estimates and judgments used in estimating credit losses, as well as the credit quality and underwriting standards of an organization’s portfolio. In addition, ASU

2016-13

amends the accounting for credit losses on

available-for-sale

debt securities and purchased financial assets with credit deterioration. ASU

2016-13

will be effective for the Company as of January 1, 2020. The Company has formed a working group comprised of individuals from various functional areas including credit, risk management, finance and information technology, among others to assist in the implementation of ASU

2016-13.

The Company is completing its implementation plan that includes assessment of processes, portfolio segmentation, data validation, model development and internal controls. Additionally, the Company is working with a third-party vendor to assist with implementation and model development. The Company continues to evaluate the potential impact of ASU

2016-13

on the Company’s financial statements, but expects that the impact of adoption will be significantly influenced by the composition, characteristics and quality of our loan and securities portfolios as well as the prevailing economic conditions and forecasts as of the adoption date.

ASU 2017-04, “Intangibles – Goodwill and Other

.” ASU

2017-04

will amend and simplify current goodwill impairment testing to eliminate Step 2 from the current provisions. Under the new guidance, an entity should perform the goodwill impairment test by comparing the fair value of a reporting unit with its carrying value and recognize an impairment charge for the amount by which the carrying amount exceeds the reporting unit’s fair value. An entity still has the option to perform the qualitative assessment for a reporting unit to determine if a quantitative impairment test is necessary. ASU

2017-04

will be effective for the Company on January 1, 2020 and is not expected to have a significant impact on the Company’s financial statements.

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ASU 2018-02, “Income Statement – Reporting Comprehensive Income: Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income.”

ASU

2018-02

was issued to address the income tax accounting treatment of the stranded tax effects within other comprehensive income due to the prohibition of backward tracing due to an income tax rate change that was initially recorded in other comprehensive income. This issue came about from the enactment of the Tax Cuts and Jobs Act on December 22, 2017 that changed the Company’s income tax rate from 35% to 21%. The ASU changed current accounting whereby an entity may elect to reclassify the stranded tax effect from accumulated other comprehensive income to retained earnings. The ASU was effective for periods beginning after December 15, 2018 although early adoption was permitted. The Company early adopted ASU

2018-02

in the first quarter of 2018 and reclassified its stranded tax debit of $5,759,000 within accumulated other comprehensive income to retained earnings.

ASU 2018-13, “Fair Value Measurement – Changes to the Disclosure Requirements for Fair Value Measurement

” eliminates the requirements to disclose the amount and reason for transfers between Level 1 and Level 2 fair value methodology, the policy for the timing of transfers between levels and the valuation process for Level 3 fair value measurements. ASU

2018-13

requires an entity to disclose relevant quantitative information used to develop Level 3 fair value measurements. ASU

2018-13

will become effective for the Company on January 1, 2020 and is not expected to have a significant impact on the Company’s financial statements.

Note 14

–

Acquisition and Proposed Acquisition

At closing, Commercial Bancshares, Inc. was merged into the Company and Commercial State Bank, Kingwood, Texas, was merged into First Financial Bank, National Association, Abilene, Texas, a wholly owned subsidiary of the Company. The primary purpose of the acquisition was to expand the Company’s market share around Houston. Factors that contributed to a purchase price resulting in goodwill include Commercial State Bank’s record of earnings, strong management and board of directors, strong local economic environment and opportunity for growth. The results of operations from this acquisition are included in the consolidated earnings of the Company commencing January 1, 2018.

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The following table presents the amounts recorded on the consolidated balance sheet on the acquisition date (dollars in thousands):


Fair value of consideration paid:
Common stock issued (1,289,371 shares)	$	58,087

Fair value of identifiable assets acquired:
Cash and cash equivalents		18,653
Securities available-for-sale		64,501
Loans		266,327
Identifiable intangible assets		3,167
Other assets		15,375

Total identifiable assets acquired		368,023

Fair value of liabilities assumed:
Deposits		341,902
Other liabilities		(373	)

Total liabilities assumed		341,529

Fair value of net identifiable assets acquired		26,494

Goodwill resulting from acquisition	$	31,593

Goodwill recorded in the acquisition was accounted for in accordance with the authoritative business combination guidance. Accordingly, goodwill will not be amortized but will be tested for impairment annually. The goodwill recorded is not deductible for federal income tax purposes.

The fair value of total loans acquired was $266,327,000 at acquisition compared to contractual amounts of $271,714,000. The fair value of purchased credit impaired loans at acquisition was $3,013,000 compared to contractual amounts of $3,806,000. Additional purchased credit impaired loan disclosures were omitted due to immateriality. All other acquired loans were considered performing loans.

On September 19, 2019, we entered into an agreement

and

plan of reorganization to acquire TB&T Bancshares, Inc. and its wholly owned bank subsidiary, The Bank & Trust of Bryan/College Station. Pursuant to the agreement, we will issue 6,275,806 shares of the Company’s common stock in exchange for all of the outstanding shares of TB&T Bancshares, Inc. At June 30, 2019, The Bank & Trust of Bryan/College Station had gross loans totaling

$445,600,000, total deposits of $538,200,000 and total assets of $624,500,000. Pending regulatory and shareholder

approvals,

the acquisition is expected to close in the first quarter of 2020.

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Item 2.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

Forward-Looking Statements

This Form

10-Q

contains certain forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. When used in this Form

10-Q,

words such as “anticipate,” “believe,” “estimate,” “expect,” “intend,” “predict,” “project,” and similar expressions, as they relate to us or our management, identify forward-looking statements. These forward-looking statements are based on information currently available to our management. Actual results could differ materially from those contemplated by the forward-looking statements as a result of certain factors, including, but not limited, to those listed in “Item

1A-

Risk Factors” in our Annual Report on Form

10-K

and the following:

•

general economic conditions, including local, state, national and international, and the impact they may have on us and our customers;

•

effect of severe weather conditions, including hurricanes, tornadoes, flooding and droughts;

•

volatility and disruption in national and international financial and commodity markets;

•

government intervention in the U.S. financial system including the effects of recent legislative, tax, accounting and regulatory actions and reforms, including the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”), the Jumpstart Our Business Startups Act, the Consumer Financial Protection Bureau, the capital ratios of Basel III as adopted by the federal banking authorities and the Tax Cuts and Jobs Act;

•

political instability;

•

the ability of the Federal government to address the national economy;

•

changes in our competitive environment from other financial institutions and financial service providers;

•

the effects of and changes in trade, monetary and fiscal policies and laws, including interest rate policies of the Board of Governors of the Federal Reserve System (the “Federal Reserve Board”);

•

the effect of changes in accounting policies and practices, as may be adopted by the regulatory agencies, as well as the Public Company Accounting Oversight Board, the Financial Accounting Standards Board and other accounting standard setters;

•

the effect on our financial positions and results of operations from the change in accounting practices from the implementation of ASU 2016-13, “Financial Instruments – Credit Losses as it relates to our allowance for loan losses;

•

the effect of changes in laws and regulations (including laws and regulations concerning taxes, banking, securities and insurance) with which we and our subsidiaries must comply;

•

changes in the demand for loans;

•

fluctuations in the value of collateral securing our loan portfolio and in the level of the allowance for loan losses;

•

potential risk of environmental liability associated with lending activities;

•

the accuracy of our estimates of future loan losses;

•

the accuracy of our estimates and assumptions regarding the performance of our securities portfolio;

•

soundness of other financial institutions with which we have transactions;

•

inflation, interest rate, market and monetary fluctuations;

•

changes in consumer spending, borrowing and savings habits;

•

changes in commodity prices (e.g., oil and gas, cattle and wind energy);

•

our ability to attract deposits and increase market share;

•

changes in our liquidity position;

•

changes in the reliability of our vendors, internal control system or information systems;

•

cyber attacks on our technology information systems, including fraud from our customers and external third party vendors;

•

our ability to attract and retain qualified employees;

•

acquisitions and integration of acquired businesses;

•

the possible impairment of goodwill associated with our acquisitions;

•

consequences of continued bank mergers and acquisitions in our market area, resulting in fewer but much larger and stronger competitors;

•

greater than expected costs or difficulties related to expansion of operations, including branch openings, new product offerings and expansion into new markets;

•

changes in our organization, compensation and benefit plans;

•

acts of God or of war or terrorism; and

•

our success at managing the risk involved in the foregoing items.

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Such forward-looking statements reflect the current views of our management with respect to future events and are subject to these and other risks, uncertainties and assumptions relating to our operations, results of operations, growth strategy and liquidity. All subsequent written and oral forward-looking statements attributable to us or persons acting on our behalf are expressly qualified in their entirety by this paragraph. We undertake no obligation to publicly update or otherwise revise any forward-looking statements, whether as a result of new information, future events or otherwise (except as required by law).

Introduction

As a financial holding company, we generate most of our revenue from interest on loans and investments, trust fees, and service charges. Our primary source of funding for our loans and investments are deposits held by our subsidiary, First Financial Bank, National Association, Abilene, Texas. Our largest expense is salaries and related employee benefits. We usually measure our performance by calculating our return on average assets, return on average equity, our regulatory leverage and risk-based capital ratios and our efficiency ratio, which is calculated by dividing noninterest expense by the sum of net interest income on a tax equivalent basis and noninterest income.

The following discussion and analysis of operations and financial condition should be read in conjunction with the financial statements and accompanying footnotes included in Item 1 of this Form

10-Q

as well as those included in the Company’s 2018 Annual Report on Form

10-K.

Critical Accounting Policies

We prepare consolidated financial statements based on GAAP and customary practices in the banking industry. These policies, in certain areas, require us to make significant estimates and assumptions.

We deem a policy critical if (1) the accounting estimate required us to make assumptions about matters that are highly uncertain at the time we make the accounting estimate; and (2) different estimates that reasonably could have been used in the current period, or changes in the accounting estimate that are reasonably likely to occur from period to period, would have a material impact on the financial statements.

We deem our most critical accounting policies to be (1) our allowance for loan losses and our provision for loan losses and (2) our valuation of securities. We have other significant accounting policies and continue to evaluate the materiality of their impact on our consolidated financial statements, but we believe these other policies either do not generally require us to make estimates and judgments that are difficult or subjective, or it is less likely they would have a material impact on our reported results for a given period. A discussion of (1) our allowance for loan losses and our provision for loan losses and (2) our valuation of securities is included in note 5 and note 4, respectively, to our notes to consolidated financial statements (unaudited) which begins on page 11.

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Stock Split

On April 23, 2019, the Company’s Board of Directors declared a

two-for-one

stock split in the form of a 100% stock dividend with a record date of May 15, 2019 that was distributed on June 3, 2019. All per share amounts in this report have been restated to reflect this stock split. An amount equal to the par value of the additional common shares to be issued pursuant to the stock split was reflected as a transfer from retained earnings to common shares in the consolidated financial statements as of and for the three months ended March 31, 2019 and as of and for the nine months ended September 30, 2019.

Acquisition and Proposed Acquisition

On October 12, 2017, we entered into an agreement and plan of reorganization to acquire Commercial Bancshares, Inc. and its wholly owned bank subsidiary, Commercial State Bank, Kingwood, Texas. On January 1, 2018, the transaction closed. Pursuant to the agreement, we issued 1.29 million shares of the Company’s common stock in exchange for all of the outstanding shares of Commercial Bancshares, Inc. In addition, in accordance with the plan of reorganization, Commercial Bancshares, Inc. paid a special dividend totaling $22.08 million to its shareholders prior to the closing of this transaction. At the closing, Kingwood Merger Sub., Inc., a wholly-owned subsidiary of the Company, merged into Commercial Bancshares Inc., with Commercial Bancshares, Inc. surviving as a wholly-owned subsidiary of the Company. Immediately following such merger, Commercial Bancshares, Inc. was merged into the Company and Commercial State Bank, Kingwood, Texas was merged into First Financial Bank, National Association, Abilene, Texas, a wholly owned subsidiary of the Company. The total purchase price exceeded the estimated fair value net of assets acquired by approximately $31.59 million and the Company recorded such excess as goodwill. The balance sheet and results of operations of Commercial Bancshares, Inc. have been included in the financial statements of the Company effective January 1, 2018. See note 14 to the consolidated financial statements on page 34 for additional information and disclosure.

On September 19, 2019, the we entered into an agreement and plan of reorganization to acquire TB&T Bancshares, Inc. and its wholly owned bank subsidiary, The Bank & Trust of Bryan/College Station. Pursuant to the agreement, we will issue 6.28 million shares of the Company’s common stock in exchange for all of the outstanding shares of TB&T Bancshares, Inc. At June 30, 2019, The Bank & Trust of Bryan/College Station had gross loans totaling $445.60 million, total deposits of $538.20 million and total assets of $624.50 million. Pending regulatory and shareholder approvals, the acquisition is expected to close in the first quarter of 2020.

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Results of Operations

Performance Summary

. Net earnings for the third quarter of 2019 were $43.08 million, up $3.03 million when compared with earnings of $40.05 million in the same quarter last year. Basic earnings per share were $0.32 for the third quarter of 2019 compared with $0.30 in the same quarter a year ago.

The return on average assets was 2.15% for the third quarter of 2019, as compared to 2.10% for the third quarter of 2018. The return on average equity was 14.46% for the third quarter of 2019 as compared to 16.00% for the third quarter of 2018.

Net earnings for the nine-month period ended September 30, 2019 were $123.42 million compared to $112.20 million for the same period in 2018. Basic earnings per share for the first nine months of 2019 were $0.91 compared to $0.83 for the same period in 2018.

The return on average assets was 2.10% for the first nine months of 2019, as compared to 1.97% for the same period a year ago. The return on average equity was 14.67% for the first nine months of 2019 as compared to 15.43% for the first nine months of 2018.

Net Interest Income

. Net interest income is the difference between interest income on earning assets and interest expense on liabilities incurred to fund those assets. Our earning assets consist primarily of loans and investment securities. Our liabilities to fund those assets consist primarily of noninterest-bearing and interest-bearing deposits.

Tax-equivalent

net interest income was $74.21 million for the third quarter of 2019, as compared to $71.67 million for the same period last year. The increase in 2019 compared to 2018 was largely attributable to the increase in interest earning assets. Average earning assets increased $381.25 million for the third quarter of 2019 over the same period in 2018. Average loans and taxable securities increased $248.40 million and $240.81 million, respectively, for the third quarter of 2019 over the same quarter of 2018.

Average

tax-exempt

securities decreased $80.93 million for the third quarter of 2019 compared to the same period in 2018, primarily due to the Company’s gradual shift away from

tax-exempt

securities due to the change in corporate tax rate to 21% from 35%. Average interest-bearing liabilities increased $110.89 million for the third quarter of 2019, as compared to the same period in 2018. The yield on earning assets increased nine basis points while the rate paid on interest-bearing liabilities increased 28 basis points for the third quarter of 2019 compared to the third quarter of 2018.

Tax-equivalent

net interest income was $218.83 million for the first nine months of 2019, as compared to $209.48 million for the same period last year. The increase in 2019 compared to 2018 was largely attributable to the increase in interest earning assets. Average earning assets increased $253.45 million for the first nine months of 2019 over the same period in 2018. Average loans and

tax-exempt

securities increased $239.64 million and $132.13 million, respectively, for the first nine months of 2019 over the first nine months of 2018.

Average

tax-exempt

securities decreased $106.03 million for the first nine months of 2019 compared to the same period in 2018, primarily due to the Company’s gradual shift away from

tax-exempt

securities due to the change in corporate tax rate to 21% from 35%. Average interest-bearing liabilities increased $77.08 million for the first nine months of 2019, as compared to the same period in 2018. The yield on earning assets increased 22 basis points while the rate paid on interest-bearing liabilities increased 30 basis points for the first nine months of 2019 compared to the first nine months of 2018.

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Table 1 allocates the change in

tax-equivalent

net interest income between the amount of change attributable to volume and to rate.

Table 1 - Changes in Interest Income and Interest Expense (in thousands):


	Three Months Ended September 30, 2019 Compared to Three Months Ended September 30, 2018									Nine Months Ended September 30, 2019 Compared to Nine Months Ended September 30, 2018
	Change Attributable to						Total Change			Change Attributable to						Total Change
	Volume			Rate			Total Change			Volume			Rate			Total Change
Short-term investments	$	(138	)	$	51		$	(87	)	$	(157	)	$	443		$	286
Taxable investment securities		1,560			138			1,698			2,515			2,324			4,839
Tax-exempt investment securities (1)		(764	)		(620	)		(1,384	)		(2,979	)		(1,072	)		(4,051	)
Loans (1) (2)		3,343			2,305			5,648			9,348			9,499			18,847

Interest income		4,001			1,874			5,875			8,727			11,194			19,921
Interest-bearing deposits		131			2,663			2,794			239			8,978			9,217
Short-term borrowings		(8	)		544			536			(12	)		1,373			1,361

Interest expense		123			3,207			3,330			227			10,351			10,578

Net interest income	$	3,878		$	(1,333	)	$	2,545		$	8,500		$	843		$	9,343

(1)	Computed on a tax-equivalent basis assuming a marginal tax rate of 21%.

(2)	Non-accrual loans are included in loans.

The net interest margin for the third quarter of 2019 was

3.94%, a decrease of seven basis points from the same period in 2018. The net interest margin for the first nine months of 2019 was 3.97%, an increase of three basis points from the same period in 2018. We continue to experience downward pressures on our net interest margin in 2019 and 2018 primarily due to (i) the change in the income tax rate from 35% to 21% from the Tax Cuts and Jobs Act and its effect on our tax free municipal bonds and tax free loans, (ii) an extended period of fluctuating historically low levels of short-term interest rates, and (iii) flat to inverted yield curve currently being experienced in the bond market. We have been able to somewhat mitigate the impact of these lower short-term interest rates and the flat/inverted yield curve by establishing minimum interest rates on certain of our loans, improving the pricing for loan risk, and minimizing rates paid on interest bearing liabilities. The Federal Reserve increased rates 100 basis points in 2018, 75 basis points in 2017 and 25 basis points in 2016 and 2015 but has recently decreased rates by 50 basis points during the third quarter of 2019.

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The net interest margin, which measures

tax-equivalent

net interest income as a percentage of average earning assets, is illustrated in Table 2.

Table 2 - Average Balances and Average Yields and Rates (in thousands, except percentages):


	Three Months Ended September 30,
	2019								2018
	Average Balance			Income/ Expense		Yield/ Rate			Average Balance			Income/ Expense		Yield/ Rate
Assets
Short-term investments (1)	$	64,471		$	382		2.35	%	$	91,495		$	469		2.03	%
Taxable investment securities (2)		2,183,930			14,292		2.62			1,943,125			12,594		2.59
Tax-exempt investment securities (2)(3)		1,132,279			10,075		3.56			1,213,212			11,459		3.78
Loans (3)(4)		4,094,235			57,417		5.56			3,845,836			51,769		5.34

Total earning assets		7,474,915		$	82,166		4.36	%		7,093,668		$	76,291		4.27	%
Cash and due from banks		165,868								171,498
Bank premises and equipment, net		133,191								130,898
Other assets		68,519								63,094
Goodwill and other intangible assets, net		174,005								175,048
Allowance for loan losses		(52,137	)							(50,383	)

Total assets	$	7,964,361							$	7,583,823

Liabilities and Shareholders’ Equity
Interest-bearing deposits	$	4,156,850		$	7,123		0.68	%	$	4,035,174		$	4,329		0.43	%
Short-term borrowings		388,235			830		0.85			399,026			294		0.29

Total interest-bearing liabilities		4,545,085		$	7,953		0.69	%		4,434,200		$	4,623		0.41	%
Noninterest-bearing deposits		2,180,200								2,123,612
Other liabilities		57,262								32,646

Total liabilities		6,782,547								6,590,458
Shareholders’ equity		1,181,814								993,365

Total liabilities and shareholders’ equity	$	7,964,361							$	7,583,823

Net interest income				$	74,213							$	71,668

Rate Analysis:
Interest income/earning assets							4.36	%							4.27	%
Interest expense/earning assets							0.42								0.26

Net interest margin							3.94	%							4.01	%

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	Nine Months Ended September 30,
	2019								2018
	Average Balance			Income/ Expense		Yield/ Rate			Average Balance			Income/ Expense		Yield/ Rate
Assets
Short-term investments (1)	$	93,997		$	1,667		2.37	%	$	106,294		$	1,381		1.74	%
Taxable investment securities (2)		2,058,380			41,505		2.69			1,926,249			36,666		2.54
Tax-exempt investment securities (2)(3)		1,175,863			31,968		3.62			1,281,892			36,019		3.75
Loans (3)(4)		4,037,243			166,987		5.53			3,797,602			148,140		5.22

Total earning assets		7,365,483			242,127		4.40	%		7,112,037		$	222,206		4.18	%
Cash and due from banks		173,647								177,190
Bank premises and equipment, net		133,886								128,863
Other assets		65,525								61,941
Goodwill and other intangible assets, net		174,264								171,623
Allowance for loan losses		(52,143	)							(49,992	)

Total assets	$	7,860,662							$	7,601,662

Liabilities and Shareholders’ Equity
Interest-bearing deposits	$	4,165,735		$	21,071		0.68	%	$	4,083,292		$	11,854		0.39	%
Short-term borrowings		391,680			2,230		0.76			397,045			869		0.29

Total interest-bearing liabilities		4,557,415			23,301		0.68	%		4,480,337		$	12,723		0.38	%
Noninterest-bearing deposits		2,133,418								2,119,208
Other liabilities		44,994								30,063

Total liabilities		6,735,827								6,629,608
Shareholders’ equity		1,124,835								972,054

Total liabilities and shareholders’ equity	$	7,860,662							$	7,601,662

Net interest income				$	218,826							$	209,483

Rate Analysis:
Interest income/earning assets							4.40	%							4.18	%
Interest expense/earning assets							0.43								0.24

Net interest margin							3.97	%							3.94	%

(1)	Short-term investments are comprised of Fed Funds sold, interest-bearing deposits in banks and interest-bearing time deposits in banks.

(2)	Average balances include unrealized gains and losses on available-for-sale securities.

(3)	Computed on a tax-equivalent basis assuming a marginal tax rate of 21%.

(4)	Non-accrual loans are included in loans.

Noninterest Income

. Noninterest income for the third quarter of 2019 increased to $28.67 million compared to $27.06 million in same period in 2018. Trust fees were $7.05 million in the third quarter of 2019 compared with $7.29 million in the same quarter last year. The fair value of trust assets managed increased to $6.36 billion from $5.75 billion a year ago; however, the income from the growth in assets was offset by a decrease of $447 thousand in Trust mineral fee and lease bonus income when compared to the same period a year ago primarily due to a decline in oil and gas volume. Real estate mortgage fees increased in the third quarter of 2019 to $5.73 million from $4.83 million in the same quarter a year ago due to an increase in the volume of loans originated. ATM, interchange and credit card fees increased 2.59% to $7.73 million compared with $7.53 million in the same quarter last year due to continued growth in debit cards. Additionally, interest on loan recoveries totaled $575 thousand for the third quarter of 2019 compared to $199 thousand for the same period in 2018 due to the collection of a larger loan that had previously been on non-accrual and gains on the sale of assets totaled $235 thousand for the third quarter of 2019 compared to a $61 thousand loss in the same quarter in 2018.

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oninterest income for the nine-month period ended September 30, 2019 was $81.08 million, an increase of $4.12 million compared to the same period in 2018. Trust fees were $21.06 million in the first nine months of 2019 compared with $21.27 million in the same period in 2018. The fair value of trust assets managed increased to $6.36 billion from $5.75 billion a year ago; however, the income from the growth in assets was offset by a decrease of $896 thousand in Trust mineral fee and lease bonus income when compared to the same period a year ago primarily due to a decline in oil and gas volumes. Service charges on deposits increased to $16.18 million compared with $15.95 million in the same period last year primarily due to the continued growth in net new accounts. Real estate mortgage fees increased in the first nine months of 2019 to $13.93 million compared to $11.72 million in the same period a year ago due to an increase in the volume of loans originated and additional income from the change to mandatory delivery (see notes 6 and 7 to the consolidated financial statements (unaudited) on pages 23 to 25). ATM, interchange and credit card fees increased to $21.92 million compared with $21.57 million in the same period last year due to continued growth in debit cards. Additionally, interest on loan recoveries totaled $1.82 million for the first nine months of 2019 compared to $607 thousand in the same period in 2018 due to the collection of certain larger loans that had previously been on non-accrual. Offsetting these increases was a decrease in gains on the sale of securities which totaled $728 thousand for the first nine months of 2019 compared to $1.35 million in the same period a year ago

ATM and interchange fees are charges that merchants pay to us and other card-issuing banks for processing electronic payment transactions. ATM and interchange fees consist of income from debit card usage, point of sale income for debit card transactions and ATM service fees. Federal Reserve rules applicable to financial institutions that have assets of $10 billion or more provide that the maximum permissible interchange fee for an electronic debit transaction is the sum of 21 cents per transaction and 5 basis points multiplied by the value of the transaction. While we currently have assets under $10 billion, we are monitoring the effect of this reduction in per transaction fee income as we approach the $10 billion asset level.

Table 3 - Noninterest Income (in thousands):


	Three Months Ended September 30,								Nine Months Ended September 30,
	2019		Increase (Decrease)			2018			2019		Increase (Decrease)			2018
Trust fees	$	7,051	$	(240	)	$	7,291		$	21,057	$	(208	)	$	21,265
Service charges on deposit accounts		5,629		(61	)		5,690			16,179		229			15,950
ATM, interchange and credit card fees		7,728		195			7,533			21,920		350			21,570
Real estate mortgage operations		5,733		899			4,834			13,928		2,210			11,718
Net gain on sale of available-for-sale securities		52		(6	)		58			728		(618	)		1,346
Net gain (loss) on sale of foreclosed assets		71		(13	)		84			193		(8	)		201
Net gain (loss) on sale of assets		235		296			(61	)		241		393			(152	)
Interest on loan recoveries		575		376			199			1,815		1,208			607
Other:
Check printing fees		55		1			54			143		(7	)		150
Safe deposit rental fees		115		3			112			429		(7	)		436
Credit life fees		184		63			121			798		189			609
Brokerage commissions		406		(16	)		422			1,169		(117	)		1,286
Miscellaneous income		835		117			718			2,481		501			1,980

Total other		1,595		168			1,427			5,020		559			4,461

Total Noninterest Income	$	28,669	$	1,614		$	27,055		$	81,081	$	4,115		$	76,966

Noninterest Expense

. Total noninterest expense for the third quarter of 2019 was $48.91 million, an increase of $1.40 million compared to $47.51 million in the same period of 2018. An important measure in determining whether a financial institution effectively manages noninterest expense is the efficiency ratio, which is calculated by dividing noninterest expense by the sum of net interest income on a

tax-equivalent

basis and noninterest income. Lower ratios indicate better efficiency since more income is generated with a lower noninterest expense total. Our efficiency ratio for the third quarter of 2019 was 47.54% compared to 48.12% for the same quarter in 2018.

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Salaries and employee benefits expense for the third quarter of 2019 totaled $28.55 million, an increase of $2.17 million compared to the same period in 2018. The increase was primarily driven by annual merit-based pay increases that were effective March 1, 2019. All other categories of noninterest expense for the third quarter of 2019 totaled $20.36 million, down from $21.13 million in the same quarter a year ago primarily due to a reduction of $555 thousand in FDIC insurance premiums resulting from credits from prior premiums paid.

Total noninterest expense for the first nine months of 2019 was $144.58 million, an increase of $2.14 million when compared to $142.45 million in the same period in 2018. Our efficiency ratio for the first nine months of 2019 was 48.21%, compared to 49.73% from the same period in 2018.

Salaries and employee benefits expense for the first nine months of 2019 totaled $83.37 million, an increase of $3.93 million when compared to the same period in 2018. The increase was primarily driven by annual merit-based pay increases that were effective March 1, 2019 and the recognition of $900 thousand in pension expense resulting from the Company’s continued efforts to terminate its frozen defined benefits pension plan.

All other categories of noninterest expense for the first nine months of 2019 totaled $61.22 million, a decrease of $1.79 million when compared to the same period in 2018. Included in noninterest expense in the first nine months period of 2018 were technology contract termination and conversion related costs totaling $1.55 million related to the Commercial State Bank acquisition.

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Table 4 - Noninterest Expense (in thousands):


	Three Months Ended September 30,							Nine Months Ended September 30,
	2019		Increase (Decrease)			2018		2019		Increase (Decrease)			2018
Salaries	$	22,197	$	2,123		$	20,074	$	62,440	$	2,807		$	59,633
Medical		2,101		19			2,082		6,884		290			6,594
Profit sharing		1,520		(164	)		1,684		4,895		(315	)		5,210
Pension		31		(34	)		65		73		(104	)		177
401(k) match expense		668		20			648		2,094		102			1,992
Payroll taxes		1,354		82			1,272		4,365		161			4,204
Stock option and stock grant expense		679		127			552		1,717		85			1,632

Total salaries and employee benefits		28,550		2,173			26,377		82,468		3,026			79,442
Loss from partial settlement of pension plan		—		—			—		900		900			—
Net occupancy expense		2,830		(70	)		2,900		8,372		(217	)		8,589
Equipment expense		2,225		(404	)		2,629		7,009		(539	)		7,548
FDIC assessment fees		15		(555	)		570		1,091		(677	)		1,768
ATM, interchange and credit card expense		2,627		283			2,344		7,437		745			6,692
Professional and service fees		1,902		(272	)		2,174		5,721		(892	)		6,613
Printing, stationery and supplies		480		93			387		1,348		(137	)		1,485
Operational and other losses		507		(474	)		981		1,253		(599	)		1,852
Software amortization and expense		1,767		374			1,393		5,147		714			4,433
Amortization of intangible assets		246		(33	)		279		778		(271	)		1,049
Other:
Data processing fees		406		(34	)		440		1,174		143			1,031
Postage		407		(31	)		438		1,248		(29	)		1,277
Advertising		907		(36	)		943		2,669		(13	)		2,682
Correspondent bank service charges		171		(20	)		191		518		(71	)		589
Telephone		918		40			878		2,841		125			2,716
Public relations and business development		838		72			766		2,353		175			2,178
Directors’ fees		524		100			424		1,469		156			1,313
Audit and accounting fees		357		(56	)		413		1,282		(46	)		1,328
Legal fees		356		144			212		938		113			825
Regulatory exam fees		298		(23	)		321		881		(73	)		954
Travel		364		54			310		1,239		164			1,075
Courier expense		221		15			206		611		(20	)		631
Other real estate owned		37		17			20		109		3			106
Other miscellaneous expense		1,957		47			1,910		5,727		(545	)		6,272

Total other		7,761		289			7,472		23,059		82			22,977

Total Noninterest Expense	$	48,910	$	1,404		$	47,506	$	144,583	$	2,135		$	142,448

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Balance Sheet Review

Loans

. Our portfolio is comprised of loans made to businesses, professionals, individuals, and farm and ranch operations located in the primary trade areas served by our subsidiary bank. Real estate loans represent loans primarily for

1-4

family residences and commercial real estate. The structure of loans in the real estate mortgage area generally provides

re-pricing

intervals to minimize the interest rate risk inherent in long-term fixed rate loans. As of September 30, 2019, total loans held for investment were $4.10 billion, an increase of $146.68 million, as compared to December 31, 2018 balances. As compared to December 31, 2018, commercial loans decreased $8.31 million, agricultural loans increased $5.38 million, real estate loans increased $110.21 million and consumer loans increased $39.41 million. Loans averaged $4.09 billion during the third quarter of 2019, an increase of $248.40 million from the prior year third quarter average balances. Loans averaged $4.04 billion during the first nine months of 2019, an increase of $239.64 million from the prior year nine-month period average balances.

Table 5 - Composition of Loans (in thousands):


	September 30,				December 31,
	2019		2018		2018
Commercial	$	836,644	$	773,924	$	844,953
Agricultural		102,054		93,953		96,677
Real estate		2,749,552		2,614,929		2,639,346
Consumer		412,066		384,234		372,660

Total loans held-for-investment	$	4,100,316	$	3,867,040	$	3,953,636

At September 30, 2019, our real estate loans represent approximately 67.06% of our loan portfolio and are comprised of (i)

1-4

family residence loans of 41.76%, (ii) commercial real estate loans of 29.46%, generally owner occupied, (iii) other loans, which includes ranches, hospitals and universities, of 12.66%, (iv) residential development and construction loans of 9.83%, which includes our custom and speculative home construction loans and (v) commercial development and construction loans of 6.29%.

Loans held for sale, consisting of secondary market mortgage loans, totaled $40.50 million, $18.50 million, and $21.67 million at September 30, 2019 and 2018, and December 31, 2018, respectively. At September 30, 2019 and 2018 and December 31, 2018, $764 thousand, $2.54 million and $2.49 million, respectively, are valued using the lower of cost or fair value method and the remaining amounts are valued under the fair value option method. See notes 6 and 7 to the consolidated financial statements (unaudited) related to the change to mandatory delivery for sales in the secondary mortgage market on pages 23 through 25.

Asset Quality

. Our loan portfolio is subject to periodic reviews by our centralized independent loan review group as well as periodic examinations by bank regulatory agencies. Loans are placed on nonaccrual status when, in the judgment of management, the collectability of principal or interest under the original terms becomes doubtful. Nonaccrual, past due 90 days or more and still accruing, and restructured loans plus foreclosed assets were $27.21 million at September 30, 2019, as compared to $26.86 million at September 30, 2018 and $29.63 million at December 31, 2018. As a percent of loans and foreclosed assets, these assets were 0.66% at September 30, 2019, as compared to 0.69% at September 30, 2018 and 0.75% at December 31, 2018. As a percent of total assets, these assets were 0.34% at September 30, 2019, as compared to 0.35% at September 30, 2018 and 0.38% at December 31, 2018. We believe the level of these assets to be manageable and are not aware of any material classified credits not properly disclosed as nonperforming at September 30, 2019.

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Supplemental Oil and Gas Information

. As of September 30, 2019, the Company’s exposure to the oil and gas industry totaled 2.97% of gross loans, or $122.91 million, up $9.37 million from December 31, 2018

year-end

levels, and consisted (based on collateral supporting the loan) of (i) development and production loans of 11.27%, (ii) oil and gas field servicing loans of 14.97%, (iii) real estate loans of 38.10%, (iv) accounts receivable and inventory of 2.33%, (v) automobile of 26.09% and (vi) other of 7.24%. The following oil and gas information is as of and for the quarters ended September 30, 2019 and 2018, and December 31, 2018:


	September 30,						December 31,
	2019			2018			2018
Oil and gas related loans	$	122,908		$	112,039		$	113,536
Oil and gas related loans as a % of total loans		2.97	%		2.88	%		2.86	%
Classified oil and gas related loans	$	7,953		$	4,861		$	3,894
Non-accrual oil and gas related loans	$	519		$	1,825		$	1,048
Net charge-offs for oil and gas related loans	$	—		$	—		$	—
Allowance for oil and gas related loans as a % of oil and gas loans		2.87	%		3.28	%		3.23	%

Table 6 –

Non-accrual,

Past Due 90 Days or More and Still Accruing, Restructured Loans and Foreclosed Assets (in thousands, except percentages):


	September 30,						December 31,
	2019			2018			2018
Non-accrual loans*	$	25,717		$	25,587		$	27,534
Loans still accruing and past due 90 days or more		104			88			1,008
Troubled debt restructured loans**		27			513			513

Nonperforming Loans		25,848			26,188			29,055
Foreclosed assets		1,364			671			577

Total nonperforming assets		27,212		$	26,859		$	29,632

As a % of loans and foreclosed assets		0.66	%		0.69	%		0.75	%
As a % of total assets		0.34	%		0.35	%		0.38	%

*	Includes $342 thousand, $2.95 million and $827 thousand of purchased credit impaired loans as of September 30, 2019 and 2018, and December 31, 2018, respectively.

Other troubled debt restructured loans of $3.98 million, $4.58 million and $3.84 million, whose interest collection, after considering economic and business conditions and collection efforts, is doubtful are included in

non-accrual

loans at September 30, 2019 and 2018, and December 31, 2018, respectively.

We record interest payments received on

non-accrual

loans as reductions of principal. Prior to the loans being placed on

non-accrual,

we recognized interest income on impaired loans of approximately $395 thousand for the year ended December 31, 2018. If interest on these impaired loans had been recognized on a full accrual basis during the year ended December 31, 2018, such income would have approximated $2.57 million. Such amounts for the 2019 and 2018 interim periods were not significant.

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Provision and Allowance for Loan Losses

. The allowance for loan losses is the amount we determine as of a specific date to be appropriate to absorb probable losses on existing loans in which full collectability is unlikely based on our review and evaluation of the loan portfolio. For a discussion of our methodology, see note 5 to our notes to the consolidated financial statements (unaudited). The provision for loan losses was $450 thousand for the third quarter of 2019, as compared to $1.45 million for the third quarter of 2018. The provision for loan losses was $2.02 million for the nine-month period ended September 30, 2019 as compared to $3.87 million for the same period in 2018. The continued provision for loan losses in 2019 and 2018 reflects primarily the growth in the loan portfolio. As a percent of average loans, net loan charge-offs were 0.04% for the third quarter of 2019, as compared to 0.05% for the third quarter of 2018. As a percentage of average loans, net loan charge-offs were 0.04% for the first nine months of 2019, as compared to 0.04% for the first nine months of 2018. The allowance for loan losses as a percent of loans was 1.25% as of September 30, 2019, as compared to 1.31% as of September 30, 2018 and 1.29% as of December 31, 2018. Included in Table 7 is further analysis of our allowance for loan losses.

Table 7 - Loan Loss Experience and Allowance for Loan Losses (in thousands, except percentages):


	Three Months Ended September 30,						Nine Months Ended September 30,
	2019			2018			2019			2018
Allowance for loan losses at period-end	$	51,889		$	50,871		$	51,889		$	50,871
Loans held for investment at period-end	$	4,100,316		$	3,867,040		$	4,100,316		$	3,867,040
Average loans for period	$	4,094,235		$	3,845,836		$	4,037,243		$	3,797,602
Net charge-offs/average loans (annualized)		0.04	%		0.05	%		0.04	%		0.04	%
Allowance for loan losses/period-end loans		1.25	%		1.31	%		1.25	%		1.31	%
Allowance for loan losses/non-accrual loans, past due 90 days still accruing and restructured loans		200.75	%		194.25	%		200.75	%		194.25	%

Interest-Bearing Deposits in Banks.

At September 30, 2019, our interest-bearing deposits in banks were $31.41 million compared to $35.97 million at September 30, 2018 and $42.27 million at December 31, 2018, respectively. At September 30, 2019, interest-bearing deposits in banks included $30.97 million maintained at the Federal Reserve Bank of Dallas and $437 thousand on deposit with the Federal Home Loan Bank of Dallas (“FHLB”).

Available-for-Sale and Held-to-Maturity Securities

. At September 30, 2019, securities with a fair value of $3.40 billion were classified as securities

available-for-sale.

As compared to December 31, 2018, the

available-for-sale

portfolio at September 30, 2019

reflected (i) an increase in U.S. Treasury securities of $59 thousand, (ii) a decrease of $301 thousand in obligations of U.S. government sponsored enterprises and agencies, (iii) a decrease of $15.67 million in obligations of states and political subdivisions, (iv) a decrease of $68 thousand in corporate bonds and other, and (v) an increase of $254.36 million in mortgage-backed securities. The shift to mortgage-backed securities from obligations of state and political subdivisions was due to the change in the federal income tax rate of 21% from 35% effective January 1, 2018. Our mortgage related securities are backed by GNMA, FNMA or FHLMC or are collateralized by securities backed by these agencies.

See note 4 to the consolidated financial statements (unaudited) for additional disclosures relating to the investment portfolio at September 30, 2019 and 2018, and December 31, 2018.

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Table 8 - Maturities and Yields of

Available-for-Sale

Securities Held at September 30, 2019 (in thousands, except percentages):


	Maturing
	One Year or Less					After One Year Through Five Years					After Five Years Through Ten Years					After Ten Years					Total
Available-for-Sale:	Amount		Yield			Amount		Yield			Amount		Yield			Amount		Yield			Amount		Yield
U.S. Treasury securities	$	10,021		2.52	%	$	—		—	%	$	—		—	%	$	—		—	%	$	10,021		2.52	%
Obligations of states and political subdivisions		194,379		4.61			520,263		4.26			525,301		3.80			2,254		5.66			1,242,197		4.13
Corporate bonds and other securities		4,499		2.40			231		2.63			—		—			—		—			4,730		2.41
Mortgage-backed securities		47,657		1.76			1,663,037		2.64			403,751		2.88			25,763		3.06			2,140,208		2.67

Total	$	256,556		3.96	%	$	2,183,531		3.03	%	$	929,052		3.39	%	$	28,017		3.27	%	$	3,397,156		3.20	%

All yields are computed on a

tax-equivalent

basis assuming a marginal tax rate of 21%. Yields on

available-for-sale

securities are based on amortized cost. Maturities of mortgage-backed securities are based on contractual maturities and could differ due to prepayments of underlying mortgages. Maturities of other securities are reported at the earlier of maturity date or call date.

As of September 30, 2019, the investment portfolio had an overall tax equivalent yield of 3.20%, a weighted average life of 4.12 years and modified duration of 3.68 years.

Deposits

. Deposits held by our subsidiary bank represent our primary source of funding. Total deposits were $6.40 billion as of September 30, 2019, as compared to $6.15 billion as of September 30, 2018 and $6.18 billion as of December 31, 2018. Table 9 provides a breakdown of average deposits and rates paid for the three and nine-month periods ended September 30, 2019 and 2018, respectively.

Table 9 — Composition of Average Deposits (in thousands, except percentages):


	Three Months Ended September 30,
	2019					2018
	Average Balance		Average Rate			Average Balance		Average Rate
Noninterest-bearing deposits	$	2,180,200		—	%	$	2,123,612		—	%
Interest-bearing deposits:
Interest-bearing checking		2,046,792		0.69			1,987,884		0.54
Savings and money market accounts		1,679,684		0.58			1,582,698		0.29
Time deposits under $100,000		184,843		0.79			197,713		0.24
Time deposits of $100,000 or more		245,531		1.15			266,879		0.52

Total interest-bearing deposits		4,156,850		0.68	%		4,035,174		0.43	%

Total average deposits	$	6,337,050				$	6,158,786

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	Nine Months Ended September 30,
	2019					2018
	Average Balance		Average Rate			Average Balance		Average Rate
Noninterest-bearing deposits	$	2,133,418		—	%	$	2,119,208		—	%
Interest-bearing deposits:
Interest-bearing checking		2,052,943		0.73			2,058,071		0.52
Savings and money market accounts		1,677,181		0.57			1,550,428		0.23
Time deposits under $100,000		188,210		0.68			211,418		0.21
Time deposits of $100,000 or more		247,401		1.01			263,375		0.43

Total interest-bearing deposits		4,165,735		0.68	%		4,083,292		0.39	%

Total average deposits	$	6,299,153				$	6,202,500

Borrowings.

Included in borrowings were federal funds purchased, securities sold under repurchase agreements and advances from the FHLB of $400.16 million, $380.76 million and $468.71 million at September 30, 2019 and 2018 and December 31, 2018, respectively. Securities sold under repurchase agreements are generally with significant customers of the Company that require short-term liquidity for their funds for which we pledge certain securities that have a fair value equal to at least the amount of the borrowings. The average balance of federal funds purchased, securities sold under repurchase agreements and advances from the FHLB were $388.24 million and $399.03 million in the third quarter of 2019 and 2018, respectively. The weighted average interest rates paid on these borrowings were 0.85% and 0.29% for the third quarters of 2019 and 2018, respectively. The average balances of federal funds purchased, securities sold under repurchase agreements and advances from the FHLB was $391.68 million and $397.05 million for the nine-month periods ended September 30, 2019 and 2018, respectively. The weighted average interest rate on these short-term borrowings was 0.76% and 0.29% for the first nine months of 2019 and 2018, respectively.

Capital Resources

We evaluate capital resources by our ability to maintain adequate regulatory capital ratios to do business in the banking industry. Issues related to capital resources arise primarily when we are growing at an accelerated rate but not retaining a significant amount of our profits or when we experience significant asset quality deterioration.

Total shareholders’ equity was $1.21 billion, or 14.85% of total assets at September 30, 2019, as compared to $995.74 million or 13.15% of total assets at September 30, 2018 and $1.05 billion, or 13.62% of total assets at December 31, 2018. Included in shareholders’ equity at September 30, 2019 and 2018 and December 31, 2018, were $73.52 million, ($25.10) million and $4.17 million, respectively, in unrealized gains (losses) on investment securities

available-for-sale,

net of related income taxes. For the third quarter of 2019, total shareholders’ equity averaged $1.18 billion, or 14.84% of average assets, as compared to $993.37 million, or 13.10% of average assets, during the same period in 2018. For the nine months ended September 30, 2019, total shareholders’ equity averaged $1.12 billion or 14.31%, as compared to $972.06 million or 12.79% of total assets during the same period in 2018.

Banking regulators measure capital adequacy by means of the risk-based capital ratios and the leverage ratio under the Basel III regulatory capital framework and prompt corrective action regulations. The risk-based capital rules provide for the weighting of assets and

off-balance-sheet

commitments and contingencies according to prescribed risk categories. Regulatory capital is then divided by risk-weighted assets to determine the risk-adjusted capital ratios. The leverage ratio is computed by dividing shareholders’ equity less intangible assets by

quarter-to-date

average assets less intangible assets.

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Beginning in January 2016, under the Basel III regulatory capital framework, the implementation of the capital conservation buffer was effective for the Company starting at the 0.625% level and increasing 0.625% each year thereafter, until it reached 2.50% on January 1, 2019. The capital conservation buffer is designed to absorb losses during periods of economic stress and requires increased capital levels for the purpose of capital distributions and other payments. Failure to meet the amount of the buffer will result in restrictions on the Company’s ability to make capital distributions, including dividend payments and stock repurchases, and to pay discretionary bonuses to executive officers.

As of September 30, 2019 and 2018, and December 31, 2018, we had a total capital to risk-weighted assets ratio of 21.14%, 20.34% and 20.61%, a Tier 1 capital to risk-weighted assets ratio of 20.05%, 19.19% and 19.47%; a common equity Tier 1 to risk-weighted assets ratio of 20.05%, 19.19% and 19.47% and a leverage ratio of 12.58%, 11.57% and 11.85%, respectively. The regulatory capital ratios as of September 30, 2019 and 2018, and December 31, 2018 were calculated under Basel III rules. There is no threshold for well-capitalized status for bank holding companies.

The regulatory capital ratios of the Company and Bank under the Basel III regulatory capital framework are as follows:


	Actual					Minimum Capital Required-Basel III Fully Phased-In*					Required to be Considered Well- Capitalized
As of September 30, 2019:	Amount		Ratio			Amount		Ratio			Amount		Ratio
Total Capital to Risk-Weighted Assets:
Consolidated	$	1,023,229		21.14	%	$	508,149		10.50	%		—		N/A
First Financial Bank, N.A	$	905,495		18.75	%	$	506,957		10.50	%	$	482,816		10.00	%
Tier 1 Capital to Risk-Weighted Assets:
Consolidated	$	970,532		20.05	%	$	411,359		8.50	%		—		N/A
First Financial Bank, N.A	$	852,798		17.66	%	$	410,394		8.50	%	$	386,253		8.00	%
Common Equity Tier 1 Capital to Risk-Weighted Assets:
Consolidated	$	970,532		20.05	%	$	338,766		7.00	%		—		N/A
First Financial Bank, N.A	$	852,798		17.66	%	$	337,971		7.00	%	$	313,830		6.50	%
Leverage Ratio:
Consolidated	$	970,532		12.58	%	$	308,675		4.00	%		—		N/A
First Financial Bank, N.A	$	852,798		11.10	%	$	307,442		4.00	%	$	384,302		5.00	%

*	At September 30, 2019, the capital conservation buffer under Basel III has been fully phased-in.

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	Actual					Minimum Capital Required Under Basel III Phase-In					Minimum Capital Required-Basel III Fully Phased-In					Required to be Considered Well- Capitalized
As of September 30, 2018:	Amount		Ratio			Amount		Ratio			Amount		Ratio			Amount		Ratio
Total Capital to Risk-Weighted Assets:
Consolidated	$	912,453		20.34	%	$	442,997		9.875	%	$	471,035		10.50	%		—		N/A
First Financial Bank, N.A	$	819,222		18.31	%	$	441,850		9.875	%	$	469,815		10.50	%	$	447,443		10.00	%
Tier 1 Capital to Risk-Weighted Assets:
Consolidated	$	860,848		19.19	%	$	353,276		7.875	%	$	381,314		8.50	%		—		N/A
First Financial Bank, N.A	$	767,617		17.16	%	$	352,362		7.875	%	$	380,327		8.50	%	$	357,955		8.00	%
Common Equity Tier 1 Capital to Risk-Weighted Assets:
Consolidated	$	860,848		19.19	%	$	285,985		6.375	%	$	314,023		7.00	%		—		N/A
First Financial Bank, N.A	$	767,617		17.16	%	$	285,245		6.375	%	$	313,210		7.00	%	$	290,838		6.50	%
Leverage Ratio:
Consolidated	$	860,848		11.57	%	$	297,516		4.000	%	$	297,516		4.00	%		—		N/A
First Financial Bank, N.A	$	767,617		10.36	%	$	296,444		4.000	%	$	296,444		4.00	%	$	370,554		5.00	%


	Actual					Minimum Capital Required Under Basel III Phase-In					Minimum Capital Required-Basel III Fully Phased-In					Required to be Considered Well- Capitalized
As of December 31, 2018:	Amount		Ratio			Amount		Ratio			Amount		Ratio			Amount		Ratio
Total Capital to Risk-Weighted Assets:
Consolidated	$	940,026		20.61	%	$	450,459		9.875	%	$	478,969		10.50	%		—		N/A
First Financial Bank, N.A	$	824,428		18.12	%	$	449,350		9.875	%	$	477,790		10.50	%	$	455,038		10.00	%
Tier 1 Capital to Risk-Weighted Assets:
Consolidated	$	888,015		19.47	%	$	359,226		7.875	%	$	387,737		8.50	%		—		N/A
First Financial Bank, N.A	$	772,417		16.97	%	$	358,342		7.875	%	$	386,782		8.50	%	$	364,030		8.00	%
Common Equity Tier 1 Capital to Risk-Weighted Assets:
Consolidated	$	888,015		19.47	%	$	290,802		6.375	%	$	319,312		7.00	%		—		N/A
First Financial Bank, N.A	$	772,417		16.97	%	$	290,087		6.375	%	$	318,526		7.00	%	$	295,775		6.50	%
Leverage Ratio:
Consolidated	$	888,015		11.85	%	$	299,682		4.00	%	$	299,682		4.00	%		—		N/A
First Financial Bank, N.A	$	772,417		10.35	%	$	298,576		4.00	%	$	298,576		4.00	%	$	373,220		5.00	%

In connection with the adoption of the Basel III regulatory capital framework, our subsidiary bank made the election to continue to exclude most accumulated other comprehensive income (“AOCI”) from capital in connection with its quarterly financial filing and, in effect, to retain the AOCI treatment under the prior capital rules.

Interest Rate Risk

Interest rate risk results when the maturity or repricing intervals of interest-earning assets and interest-bearing liabilities are different. Our exposure to interest rate risk is managed primarily through our strategy of selecting the types and terms of interest-earning assets and interest-bearing liabilities that generate favorable earnings while limiting the potential negative effects of changes in market interest rates. We use no

off-balance

sheet financial instruments to manage interest rate risk.

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Our subsidiary bank has an asset liability management committee that monitors interest rate risk and compliance with investment policies. The subsidiary bank utilizes an earnings simulation model as the primary quantitative tool in measuring the amount of interest rate risk associated with changing market rates. The model quantifies the effects of various interest rate scenarios on projected net interest income and net income over the next twelve months. The model measures the impact on net interest income relative to a base case scenario of hypothetical fluctuations in interest rates over the next twelve months. These simulations incorporate assumptions regarding balance sheet growth and mix, pricing and the

re-pricing

and maturity characteristics of the existing and projected balance sheet.

As of September 30, 2019, the model simulations projected that 100 and 200 basis point increases in interest rates would result in positive variances in net interest income of 2.69% and 4.43%, respectively, relative to the current financial statement structure over the next twelve months, while a decrease in interest rates of 100 and 200 basis points would result in a negative variance in net interest income of 2.84% and 5.67%, respectively, relative to the current financial statement structure over the next twelve months. Our model simulation as of September 30, 2019 indicates that our balance sheet is relatively asset/liability neutral. These are good faith estimates and assume that the composition of our interest sensitive assets and liabilities existing at each

year-end

will remain constant over the relevant twelve-month measurement period and that changes in market interest rates are instantaneous and sustained across the yield curve regardless of duration of pricing characteristics on specific assets or liabilities. Also, this analysis does not contemplate any actions that we might undertake in response to changes in market interest rates. We believe these estimates are not necessarily indicative of what actually could occur in the event of immediate interest rate increases or decreases of this magnitude. As interest-bearing assets and liabilities

re-price

in different time frames and proportions to market interest rate movements, various assumptions must be made based on historical relationships of these variables in reaching any conclusion. Since these correlations are based on competitive and market conditions, we anticipate that our future results will likely be different from the foregoing estimates, and such differences could be material.

Should we be unable to maintain a reasonable balance of maturities and repricing of our interest-earning assets and our interest-bearing liabilities, we could be required to dispose of our assets in an unfavorable manner or pay a higher than market rate to fund our activities. Our asset liability committee oversees and monitors this risk.

Liquidity

Liquidity is our ability to meet cash demands as they arise. Such needs can develop from loan demand, deposit withdrawals or acquisition opportunities. Potential obligations resulting from the issuance of standby letters of credit and commitments to fund future borrowings to our loan customers are other factors affecting our liquidity needs. Many of these obligations and commitments are expected to expire without being drawn upon; therefore the total commitment amounts do not necessarily represent future cash requirements affecting our liquidity position. The potential need for liquidity arising from these types of financial instruments is represented by the contractual notional amount of the instrument. Asset liquidity is provided by cash and assets which are readily marketable or which will mature in the near future. Liquid assets include cash, federal funds sold, and short-term investments in time deposits in banks. Liquidity is also provided by access to funding sources, which include core depositors and correspondent banks that maintain accounts with and sell federal funds to our subsidiary bank. Other sources of funds include our ability to borrow from short-term sources, such as purchasing federal funds from correspondent banks, sales of securities under agreements to repurchase and advances from the FHLB (see below) and an unfunded $25.00 million revolving line of credit established with Frost Bank, a nonaffiliated bank, which matures in June 2021 (see next paragraph).

Our subsidiary bank also has federal funds purchased lines of credit with two

non-affiliated

banks totaling $130.00 million. At September 30, 2019, no amounts were drawn on these lines of credit. Our subsidiary bank also has available a line of credit with the FHLB totaling $1.24 billion at September 30, 2019, secured by portions of our loan portfolio and certain investment securities. At September 30, 2019, the Company had $35.00 million outstanding under this line of credit.

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The Company renewed its loan agreement, effective June 30, 2019, with Frost Bank. Under the loan agreement, as renewed and amended, we are permitted to draw up to $25.00 million on a revolving line of credit. Prior to June 30, 2021, interest is paid quarterly at

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Prime Rate and the line of credit matures June 30, 2021. If a balance exists at June 30, 2021, the principal balance converts to a term facility payable quarterly over five years and interest is paid quarterly at

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Prime Rate. The line of credit is unsecured. Among other provisions in the credit agreement, we must satisfy certain financial covenants during the term of the loan agreement, including, without limitation, covenants that require us to maintain certain capital, tangible net worth, loan loss reserve,

non-performing

asset and cash flow coverage ratios. In addition, the credit agreement contains certain operational covenants, which among others, restricts the payment of dividends above 55% of consolidated net income, limits the incurrence of debt (excluding any amounts acquired in an acquisition) and prohibits the disposal of assets except in the ordinary course of business. Since 1995, we have historically declared dividends as a percentage of our consolidated net income in a range of 37% (low) in 1995 to 53% (high) in 2003 and 2006. The Company was in compliance with the financial and operational covenants at September 30, 2019. There was no outstanding balance under the line of credit as of September 30, 2019 or December 31, 2018.

In addition, we anticipate that future acquisitions of financial institutions, expansion of branch locations or offerings of new products could also place a demand on our cash resources. Available cash and cash equivalents at our parent company which totaled $101.77 million at September 30, 2019, investment securities which totaled $6.35 million at September 30, 2019 and mature over 9 to 12 years, available dividends from our subsidiaries which totaled $257.67 million at September 30, 2019, utilization of available lines of credit, and future debt or equity offerings are expected to be the source of funding for these potential acquisitions or expansions.

Our liquidity position is continuously monitored and adjustments are made to the balance between sources and uses of funds as deemed appropriate. Liquidity risk management is an important element in our asset/liability management process. We regularly model liquidity stress scenarios to assess potential liquidity outflows or funding problems resulting from economic disruptions, volatility in the financial markets, unexpected credit events or other significant occurrences deemed potentially problematic by management. These scenarios are incorporated into our contingency funding plan, which provides the basis for the identification of our liquidity needs. As of September 30, 2019, management is not aware of any events that are reasonably likely to have a material adverse effect on our liquidity, capital resources or operations. Given the strong core deposit base and relatively low loan to deposit ratios maintained at our subsidiary bank, we consider our current liquidity position to be adequate to meet our short-term and long-term liquidity needs. In addition, management is not aware of any regulatory recommendations regarding liquidity that would have a material adverse effect on us.

Off-Balance Sheet Arrangements.

We are a party to financial instruments with

off-balance

sheet risk in the normal course of business to meet the financing needs of our customers. These financial instruments include unfunded lines of credit, commitments to extend credit and federal funds sold to correspondent banks and standby letters of credit. Those instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in our consolidated balance sheets.

Our exposure to credit loss in the event of nonperformance by the counterparty to the financial instrument for unfunded lines of credit, commitments to extend credit and standby letters of credit is represented by the contractual notional amount of these instruments. We generally use the same credit policies in making commitments and conditional obligations as we do for

on-balance

sheet instruments.

Unfunded lines of credit and commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. These commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. We evaluate each customer’s creditworthiness on a

case-by-case

basis. The amount of collateral obtained, as we deem necessary upon extension of credit, is based on our credit evaluation of the counterparty. Collateral held varies but may include accounts receivable, inventory, property, plant, and equipment and income-producing commercial properties.

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Standby letters of credit are conditional commitments we issue to guarantee the performance of a customer to a third party. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. The average collateral value held on letters of credit usually exceeds the contract amount.

Table 10 – Commitments as of September 30, 2019 (in thousands):


	Total Notional Amounts Committed
Unfunded lines of credit	$	695,669
Unfunded commitments to extend credit		377,790
Standby letters of credit		35,913

Total commercial commitments	$	1,109,372

We believe we have no other

off-balance

sheet arrangements or transactions with unconsolidated, special purpose entities that would expose us to liability that is not reflected on the face of the financial statements.

Parent Company Funding

. Our ability to fund various operating expenses, dividends, and cash acquisitions is generally dependent on our own earnings (without giving effect to our subsidiaries), cash reserves and funds derived from our subsidiaries. These funds historically have been produced by intercompany dividends and management fees that are limited to reimbursement of actual expenses. We anticipate that our recurring cash sources will continue to include dividends and management fees from our subsidiaries. At September 30, 2019, approximately $257.67 million was available for the payment of intercompany dividends by our subsidiaries without the prior approval of regulatory agencies. Our subsidiaries paid aggregate dividends of $44.50 million and $38.95 million for the nine-month periods ended September 30, 2019 and 2018, respectively.

Dividends

. Our long-term dividend policy is to pay cash dividends to our shareholders of approximately 40% of annual net earnings while maintaining adequate capital to support growth. We are also restricted by a loan covenant within our line of credit agreement with Frost Bank to dividend no greater than 55% of net income, as defined in such loan agreement. The cash dividend payout ratios have amounted to 37.94% and 36.79% of net earnings for the first nine months of 2019 and 2018, respectively. Given our current capital position and projected earnings and asset growth rates, we do not anticipate any significant change in our current dividend policy.

We last increased our dividend paid per share in April 2019 when the Board of Directors declared a $0.12 per share cash dividend (post stock split) for the second quarter of 2019, a 14.3% increase over 2018

Our bank subsidiary, which is a national banking association and a member of the Federal Reserve System, is required by federal law to obtain the prior approval of the OCC to declare and pay dividends if the total of all dividends declared in any calendar year would exceed the total of (1) such bank’s net profits (as defined and interpreted by regulation) for that year plus (2) its retained net profits (as defined and interpreted by regulation) for the preceding two calendar years, less any required transfers to surplus.

To pay dividends, we and our subsidiary bank must maintain adequate capital above regulatory guidelines. In addition, if the applicable regulatory authority believes that a bank under its jurisdiction is engaged in or is about to engage in an unsafe or unsound practice (which, depending on the financial condition of the bank, could include the payment of dividends), the authority may require, after notice and hearing, that such bank cease and desist from the unsafe practice. The Federal Reserve, the FDIC and the OCC have each indicated that paying dividends that deplete a bank’s capital base to an inadequate level would be an unsafe and unsound banking practice. The Federal Reserve, the OCC and the FDIC have issued policy statements that recommend that bank holding companies and insured banks should generally only pay dividends out of current operating earnings.

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Item 3.

Quantitative and Qualitative Disclosures About Market Risk

Management considers interest rate risk to be a significant market risk for the Company. See “Item 2—Management’s Discussion and Analysis of Financial Condition and Results of Operations – Capital Resources—Interest Rate Risk” for disclosure regarding this market risk.

Item 4.

Controls and Procedures

As of September 30, 2019, we carried out an evaluation, under the supervision and with the participation of our management, including our principal executive officer and principal financial officer, of the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rule

13a-15(e)

15d-15(e)

of the Securities Exchange Act of 1934). Our management, which includes our principal executive officer and our principal financial officer, does not expect that our disclosure controls and procedures will prevent all errors and all fraud.

A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the Company have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty and that breakdowns can occur because of simple error or mistake. Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the control. The design of any system of controls also is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions; over time, controls may become inadequate because of changes in conditions or the degree of compliance with the policies or procedures may deteriorate. Because of the inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and not be detected. Our principal executive officer and principal financial officer have concluded, based on our evaluation of our disclosure controls and procedures, that our disclosure controls and procedures were effective at the reasonable assurance level as of September 30, 2019.

Subsequent to our evaluation, there were no significant changes in internal controls over financial reporting or other factors that have materially affected, or are reasonably likely to materially affect, these internal controls.

Table of Contents

PART II

OTHER INFORMATION

Item 1.

Legal Proceedings

From time to time we and our subsidiaries are parties to lawsuits arising in the ordinary course of our banking business. However, there are no material pending legal proceedings to which we, our subsidiaries, or any of their properties, are currently subject. Other than regular, routine examinations by state and federal banking authorities, there are no proceedings pending or known to be contemplated by any governmental authorities.

Item 1A.

Risk Factors

There has been no material change in the risk factors previously disclosed under Item 1A. of the Company’s 2018 Annual Report on Form

10-K.

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

None

Item 3.

Defaults Upon Senior Securities

Not Applicable

Item 4.

Mine Safety Disclosures

Not Applicable

Item 5.

Other Information

None

Table of Contents

Item 6.

Exhibits



2.1	—	Agreement and Plan of Reorganization, dated October 12, 2017, by and among First Financial Bankshares, Inc., Kingwood Merger Sub, Inc., and Commercial Bancshares, Inc. (schedules have been omitted pursuant to Item 601(b)(2) of Regulation S-K) (incorporated by reference from Exhibit 2.1 to Registrant’s Form 8-K filed October 12, 2017).

2.2	—	Agreement and Plan of Reorganization, dated September 19, 2019, by and among First Financial Bankshares, Inc., Brazos Merger Sub, Inc., and TB&T Bancshares, Inc. (schedules have been omitted pursuant to Item 601(b)(2) of Regulation S-K) (incorporated by reference from Exhibit 2.1 to Registrant’s Form 8-K filed September 20, 2019).

3.1	—	Amended and Restated Certificate of Formation (incorporated by reference from Exhibit 3.1 of the Registrant’s Form 10-Q filed on July 30, 2019).

3.2	—	Amended and Restated Bylaws of the Registrant (incorporated by reference from Exhibit 99.1 of the Registrant’s Form 8-K filed January 24, 2012).

4.1	—	Specimen certificate of First Financial Common Stock (incorporated by reference from Exhibit 3 of the Registrant’s Amendment No. 1 to Form 8-A filed on Form 8-A/A No. 1 on January 7, 1994).

10.1	—	2002 Incentive Stock Option Plan (incorporated by reference from Exhibit 10.3 of the Registrant’s Form 10-Q filed May 4, 2010).++

10.2	—	2012 Incentive Stock Option Plan (incorporated by reference from Appendix A of the Registrant’s Definitive Proxy Statement Pursuant to Section 14(a) of the Securities Exchange Act of 1934 filed March 1, 2012).++

10.3	—	Loan agreement dated June 30, 2013, between First Financial Bankshares, Inc. and Frost Bank (incorporated by reference from Exhibit 10.1 of the Registrant’s Form 8-K filed July 1, 2013).

10.4	—	First Amendment to Loan Agreement, dated June 30, 2015, between First Financial Bankshares, Inc. and Frost Bank (incorporated by reference from Exhibit 10.1 of the Registrant’s Form 8-K filed June 30, 2015).

10.5	—	Second Amendment to Loan Agreement, dated June 30, 2017, between First Financial Bankshares, Inc. and Frost Bank (incorporated by reference from Exhibit 10.1 of the Registrant’s Form 8-K filed June 30, 2017).

10.6	—	Third Amendment to Loan Agreement, dated June 30, 2019, between First Financial Bankshares, Inc. and Frost Bank (incorporated by reference from Exhibit 10.1 of the Registrant’s Form 8-K filed July 1, 2019).

10.7	—	2015 Restricted Stock Plan (incorporated by reference from Appendix A of the Registrant’s Definitive Proxy Statement Pursuant to Section 14(a) of the Securities Exchange Act of 1934 filed March 2, 2015).++

10.8	—	Form of Executive Recognition Agreement (incorporated by reference from Exhibit 10.1 of the Registrant’s Form 8-K filed June 29, 2018).++

31.1	—	Rule 13a-14(a) / 15(d)-14(a) Certification of Chief Executive Officer of First Financial Bankshares, Inc.*

31.2	—	Rule 13a-14(a) / 15(d)-14(a) Certification of Chief Financial Officer of First Financial Bankshares, Inc.*

32.1	—	Section 1350 Certification of Chief Executive Officer of First Financial Bankshares, Inc.+

32.2	—	Section 1350 Certification of Chief Financial Officer of First Financial Bankshares, Inc.+

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

101.SCH	—	XBRL Taxonomy Extension Schema Document.*

101.CAL	—	XBRL Taxonomy Extension Calculation Linkbase Document.*

101.DEF	—	XBRL Taxonomy Extension Definition Linkbase Document.*

101.LAB	—	XBRL Taxonomy Extension Label Linkbase Document.*

101.PRE	—	XBRL Taxonomy Extension Presentation Linkbase Document.*

*	Filed herewith

Furnished herewith. This Exhibit shall not be deemed “filed” for purposes of Section 18 of the Securities Exchange Act of 1934, or otherwise subject to the liability of that section, and shall not be deemed to be incorporated into any filing under the Securities Act of 1933 or the Securities Exchange Act of 1934.

++	Management contract or compensatory plan on arrangement.

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.


	FIRST FINANCIAL BANKSHARES, INC.

Date: October 29, 2019	By:	/s/ F. Scott Dueser
		F. Scott Dueser
		President and Chief Executive Officer

Date: October 29, 2019	By:	/s/ J. Bruce Hildebrand
		J. Bruce Hildebrand
		Executive Vice President and
		Chief Financial Officer