SOUTHSIDE BANCSHARES INC - Quarter Report: 2022 September (Form 10-Q)

Table of Contents

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)


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

For the quarterly period ended September 30, 2022


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

For the transition period from ____________ to ____________

Commission file number: 000-12247

SOUTHSIDE BANCSHARES, INC.

(Exact name of registrant as specified in its charter)

Texas

75-1848732

(State or Other Jurisdiction of

Incorporation or Organization)

(I.R.S. Employer

Identification No.)

1201 S. Beckham Avenue,

Tyler,

Texas

75701

(Address of Principal Executive Offices)

(Zip Code)

903-531-7111

(Registrant’s telephone number, including area code)

Securities Registered Pursuant to Section 12(b) of the Act:

Title of each class

Trading Symbol

Name of each exchange on which registered

Common Stock, $1.25 par value

SBSI

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 ☒ No ☐

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

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


Large Accelerated Filer	☒	Accelerated filer	☐
Non-accelerated filer	☐	Smaller reporting company	☐
		Emerging growth company	☐
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐

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

The number of shares of the issuer’s common stock, par value $1.25, outstanding as of October 27, 2022 was 32,105,020 shares.

TABLE OF CONTENTS


GLOSSARY OF ACRONYMS, ABBREVIATIONS AND TERMS			1
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS			3
ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS			42
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK			67
ITEM 4. CONTROLS AND PROCEDURES			68
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS			68
ITEM 1A. RISK FACTORS			68
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS			69
ITEM 3. DEFAULTS UPON SENIOR SECURITIES			69
ITEM 4. MINE SAFETY DISCLOSURES			69
ITEM 5. OTHER INFORMATION			69
ITEM 6. EXHIBITS			70
EXHIBIT INDEX			70
SIGNATURES			71

Table of Contents

SOUTHSIDE BANCSHARES, INC.

Glossary of Acronyms, Abbreviations and Terms

The acronyms, abbreviations and terms listed below are used in various sections of this Form 10-Q, including "Item 1. Financial Statements" and "Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations."


Entities:
Southside Bancshares, Inc.						Bank holding company for Southside Bank
Southside Bank						Texas state bank and wholly owned subsidiary of Southside Bancshares, Inc.
Company						Combined entities of Southside Bancshares, Inc. and its subsidiaries, including Southside Bank
Bank						Southside Bank
Southside						Southside Bancshares, Inc.

Other Acronyms, Abbreviations and Terms:
2021 Form 10-K						Company’s Annual Report on Form 10-K for the year ended December 31, 2021
401(k) Plan						401(k) Defined Contribution Plan
Acquired Retirement Plan						OmniAmerican Bank defined benefit pension plan
AFS						Available for sale
ALCO						Asset/Liability Committee
AOCI						Accumulated other comprehensive income or loss
ASC						Accounting Standards Codification
ASU						Accounting Standards Update issued by the FASB
ATM						Automated teller machines
Basel Committee						Basel Committee on Banking Supervision
BOLI						Bank owned life insurance
CARES Act						Coronavirus Aid, Relief, and Economic Security Act
CDs						Certificates of deposit
CECL						ASU No. 2016-13, Financial Instruments- Credit Losses, also known as Current Expected Credit Losses
CET1						Common Equity Tier 1
CMOs						Collateralized mortgage obligations
COVID-19						Novel strain of coronavirus
Dodd-Frank Act						Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010
Economic Aid Act						Economic Aid to Hard-Hit Small Business, Nonprofits and Venues Act
ESOP						Employee Stock Ownership Plan
ETR						Effective tax rate
Exchange Act						Securities Exchange Act of 1934
FASB						Financial Accounting Standards Board
FDIC						Federal Deposit Insurance Corporation
Federal Reserve						The Board of Governors of the Federal Reserve System
FHLB						Federal Home Loan Bank
FRBNY						Federal Reserve Bank of New York
FRDW						Federal Reserve Discount Window
FTE						Fully-taxable equivalents measurements
GAAP						United States generally accepted accounting principles
GSEs						U.S. government-sponsored enterprises

Southside Bancshares, Inc. |1

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Guidelines						Interagency Guidelines Prescribing Standards for Safety and Soundness adopted by federal banking agencies
HTM						Held to maturity
ITM						Interactive teller machines
LIBOR						London Interbank Offered Rate
MBS						Mortgage-backed securities
MVPE						Market value of portfolio equity
OREO						Other real estate owned
PCD						Purchased financial assets with credit deterioration under CECL
PCI						Financial assets purchased credit impaired under ASC 310-30 prior to CECL
PPP						Paycheck Protection Program
PPP Facility						Paycheck Protection Program Lending Facility
Repurchase agreements						Securities sold under agreements to repurchase
Restoration Plan						Nonfunded supplemental retirement plan
Retirement Plan						Defined benefit pension plan
ROU						Right-of-use
SBA						Small Business Administration
SEC						Securities and Exchange Commission
SOFR						Secured Overnight Financing Rate provided by the Federal Reserve Bank of New York
TDR						Troubled debt restructurings
U.S.						United States

Southside Bancshares, Inc. |2

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PART I. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

SOUTHSIDE BANCSHARES, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS

(UNAUDITED)
(in thousands, except share amounts)


	September 30, 2022		December 31, 2021

ASSETS
Cash and due from banks	$	110,620	$	91,120
Interest earning deposits	3,476		110,633
Federal funds sold	81,031		—
Total cash and cash equivalents	195,127		201,753
Securities:
Securities AFS, at estimated fair value (amortized cost of $1,592,891 and $2,655,594, respectively)	1,424,562		2,764,325
Securities HTM (estimated fair value of $943,322 and $95,235, respectively)	1,151,205		90,780
FHLB stock, at cost	12,887		14,375
Equity investments	11,052		11,841
Loans held for sale	421		1,684
Loans:
Loans	4,063,495		3,645,162
Less: Allowance for loan losses	(36,506)		(35,273)
Net loans	4,026,989		3,609,889
Premises and equipment, net	142,653		142,509
Operating lease ROU assets	15,610		15,073
Goodwill	201,116		201,116
Other intangible assets, net	5,137		6,895
Interest receivable	32,914		39,145
Deferred tax asset, net	45,991		—

Unsettled issuances of brokered CDs	28,481		—
BOLI	133,394		131,232
Other assets	26,208		28,985
Total assets	$	7,453,747	$	7,259,602

LIABILITIES AND SHAREHOLDERS’ EQUITY
Deposits:
Noninterest bearing	$	1,759,959	$	1,644,775
Interest bearing	4,421,200		4,077,552
Total deposits	6,181,159		5,722,327
Other borrowings	74,721		23,219
FHLB borrowings	243,531		344,038
Subordinated notes, net of unamortized debt issuance costs	98,639		98,534
Trust preferred subordinated debentures, net of unamortized debt issuance costs	60,264		60,260
Deferred tax liability, net	—		17,808
Unsettled trades to purchase securities	—		18,995
Operating lease liabilities	17,337		16,676
Other liabilities	70,460		45,573
Total liabilities	6,746,111		6,347,430

Off-balance-sheet arrangements, commitments and contingencies (Note 12)

Shareholders’ equity:
Common stock: ($1.25 par value, 80,000,000 shares authorized, 37,991,729 shares issued at September 30, 2022 and 37,968,969 shares issued at December 31, 2021)	47,490		47,461
Paid-in capital	783,803		780,501
Retained earnings	224,142		179,813
Treasury stock: (shares at cost, 5,864,774 at September 30, 2022 and 5,616,917 at December 31, 2021)	(167,109)		(155,308)
AOCI	(180,690)		59,705
Total shareholders’ equity	707,636		912,172
Total liabilities and shareholders’ equity	$	7,453,747	$	7,259,602

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

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SOUTHSIDE BANCSHARES, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF INCOME

(UNAUDITED)

(in thousands, except per share data)


	Three Months Ended				Nine Months Ended
	September 30,				September 30,
	2022		2021		2022		2021
Interest income:
Loans	$	45,257	$	37,034	$	118,489	$	108,792
Taxable investment securities	4,896		3,853		14,136		9,097
Tax-exempt investment securities	11,482		9,649		32,306		27,787
MBS	4,770		4,405		12,025		15,140
FHLB stock and equity investments	101		111		291		355
Other interest earning assets	374		24		606		56
Total interest income	66,880		55,076		177,853		161,227
Interest expense:
Deposits	7,887		2,234		15,388		7,170
FHLB borrowings	1,078		1,865		1,668		5,590
Subordinated notes	1,004		2,417		3,002		7,235
Trust preferred subordinated debentures	669		345		1,496		1,045
Other borrowings	727		9		800		31
Total interest expense	11,365		6,870		22,354		21,071
Net interest income	55,515		48,206		155,499		140,156
Provision for (reversal of) credit losses	1,494		(5,071)		1,155		(13,543)
Net interest income after provision for credit losses	54,021		53,277		154,344		153,699
Noninterest income:
Deposit services	6,241		6,779		19,365		19,513
Net gain (loss) on sale of securities AFS	(99)		1,381		(3,819)		3,399
Gain on sale of loans	109		299		495		1,285
Trust fees	1,407		1,494		4,421		4,373
BOLI	720		637		2,131		1,908
Brokerage services	701		846		2,608		2,476
Other	1,190		1,333		4,890		4,371
Total noninterest income	10,269		12,769		30,091		37,325
Noninterest expense:
Salaries and employee benefits	21,368		19,777		61,666		59,825
Net occupancy	3,847		3,532		11,157		10,698

Advertising, travel & entertainment	789		579		2,242		1,491
ATM expense	317		311		954		821
Professional fees	1,412		1,135		3,486		3,166
Software and data processing	1,736		1,503		5,106		4,221
Communications	497		552		1,509		1,689
FDIC insurance	485		454		1,434		1,343
Amortization of intangibles	550		695		1,758		2,191
Loss on redemption of subordinated notes	—		1,118		—		1,118
Other	2,463		2,107		7,453		7,133
Total noninterest expense	33,464		31,763		96,765		93,696
Income before income tax expense	30,826		34,283		87,670		97,328
Income tax expense	3,875		4,977		10,318		12,614
Net income	$	26,951	$	29,306	$	77,352	$	84,714

Earnings per common share – basic	$	0.84	$	0.90	$	2.40	$	2.60
Earnings per common share – diluted	$	0.84	$	0.90	$	2.39	$	2.59
Cash dividends paid per common share	$	0.34	$	0.33	$	1.02	$	0.98

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

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SOUTHSIDE BANCSHARES, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(UNAUDITED)

(in thousands)


	Three Months Ended				Nine Months Ended
	September 30,				September 30,
	2022		2021		2022		2021
Net income	$	26,951	$	29,306	$	77,352	$	84,714
Other comprehensive income (loss):
Securities AFS and transferred securities:
Change in unrealized holding gain (loss) on AFS securities during the period	(61,354)		(27,714)		(256,778)		(43,527)

Change in net unrealized loss on securities transferred from AFS to HTM	(6,367)		—		(97,871)		—


Reclassification adjustment for amortization related to AFS and HTM debt securities	1,396		312		2,949		1,118

Reclassification adjustment for net (gain) loss on sale of AFS securities, included in net income	99		(1,381)		3,819		(3,399)

Derivatives:
Change in net unrealized gain (loss) on effective cash flow hedge interest rate swap derivatives	15,226		377		42,819		8,296

Reclassification adjustment of net (gain) loss related to derivatives designated as cash flow hedges	(1,572)		1,617		94		4,784

Pension plans:
Amortization of net actuarial loss, included in net periodic benefit cost	224		316		671		948


Other comprehensive income (loss), before tax	(52,348)		(26,473)		(304,297)		(31,780)
Income tax (expense) benefit related to items of other comprehensive income (loss)	10,993		5,560		63,902		6,674
Other comprehensive income (loss), net of tax	(41,355)		(20,913)		(240,395)		(25,106)
Comprehensive income (loss)	$	(14,404)	$	8,393	$	(163,043)	$	59,608

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

Southside Bancshares, Inc. |5

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SOUTHSIDE BANCSHARES, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY

(UNAUDITED)

(in thousands, except share and per share data)


	Common Stock		Paid In Capital		Retained Earnings		Treasury Stock		Accumulated Other Comprehensive Income (Loss)		Total Shareholders’ Equity
Balance at December 31, 2021	$	47,461	$	780,501	$	179,813	$	(155,308)	$	59,705	$	912,172


Net income	—		—		24,996		—		—		24,996
Other comprehensive income (loss)	—		—		—		—		(139,976)		(139,976)
Issuance of common stock for dividend reinvestment plan (7,671 shares)	10		312		—		—		—		322
Purchase of common stock (82,285 shares)	—		—		—		(3,358)		—		(3,358)
Stock compensation expense	—		819		—		—		—		819
Net issuance of common stock under employee stock plans (16,551 shares)	—		182		(67)		154		—		269
Cash dividends paid on common stock ($0.34 per share)	—		—		(11,003)		—		—		(11,003)



Balance at March 31, 2022	47,471		781,814		193,739		(158,512)		(80,271)		784,241
Net income	—		—		25,405		—		—		25,405
Other comprehensive income (loss)	—		—		—		—		(59,064)		(59,064)
Issuance of common stock for dividend reinvestment plan (7,717 shares)	10		303		—		—		—		313
Purchase of common stock (223,901 shares)	—		—		—		(8,842)		—		(8,842)
Stock compensation expense	—		847		—		—		—		847
Net issuance of common stock under employee stock plans (30,162 shares)	—		(453)		(67)		308		—		(212)
Cash dividends paid on common stock ($0.34 per share)	—		—		(10,906)		—		—		(10,906)



Balance at June 30, 2022	47,481		782,511		208,171		(167,046)		(139,335)		731,782
Net income	—		—		26,951		—		—		26,951
Other comprehensive loss	—		—		—		—		(41,355)		(41,355)
Issuance of common stock for dividend reinvestment plan (7,372 shares)	9		269		—		—		—		278
Purchase of common stock (8,613 shares)	—		—		—		(309)		—		(309)
Stock compensation expense	—		760		—		—		—		760
Net issuance of common stock under employee stock plans (20,229 shares)	—		263		(61)		246		—		448
Cash dividends paid on common stock ($0.34 per share)	—		—		(10,919)		—		—		(10,919)
Balance at September 30, 2022	$	47,490	$	783,803	$	224,142	$	(167,109)	$	(180,690)	$	707,636

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SOUTHSIDE BANCSHARES, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY (continued)

(UNAUDITED)

(in thousands, except share and per share data)


	Common Stock		Paid In Capital		Retained Earnings		Treasury Stock		Accumulated Other Comprehensive Income (Loss)		Total Shareholders’ Equity
Balance at December 31, 2020	$	47,419	$	771,511	$	111,208	$	(123,921)	$	69,080	$	875,297


Net income	—		—		34,091		—		—		34,091
Other comprehensive income (loss)	—		—		—		—		(29,494)		(29,494)
Issuance of common stock for dividend reinvestment plan (8,918 shares)	11		321		—		—		—		332
Purchase of common stock (427,396 shares)	—		—		—		(15,213)		—		(15,213)
Stock compensation expense	—		674		—		—		—		674
Net issuance of common stock under employee stock plans (126,260 shares)	—		2,309		(41)		1,118		—		3,386
Cash dividends paid on common stock ($0.32 per share)	—		—		(10,476)		—		—		(10,476)


Balance at March 31, 2021	47,430		774,815		134,782		(138,016)		39,586		858,597
Net income	—		—		21,317		—		—		21,317
Other comprehensive income	—		—		—		—		25,301		25,301
Issuance of common stock for dividend reinvestment plan (7,780 shares)	9		321		—		—		—		330
Purchase of common stock (90,884 shares)	—		—		—		(3,497)		—		(3,497)
Stock compensation expense	—		686		—		—		—		686
Net issuance of common stock under employee stock plans (99,217 shares)	—		1,591		(47)		897		—		2,441
Cash dividends paid on common stock ($0.33 per share)	—		—		(10,775)		—		—		(10,775)


Balance at June 30, 2021	47,439		777,413		145,277		(140,616)		64,887		894,400
Net income	—		—		29,306		—		—		29,306
Other comprehensive income	—		—		—		—		(20,913)		(20,913)
Issuance of common stock for dividend reinvestment plan (8,631 shares)	11		313		—		—		—		324
Purchase of common stock (420,204 shares)	—		—		—		(15,438)		—		(15,438)
Stock compensation expense	—		829		—		—		—		829
Net issuance of common stock under employee stock plans (9,426 shares)	—		45		(68)		87		—		64
Cash dividends paid on common stock ($0.33 per share)	—		—		(10,706)		—		—		(10,706)
Balance at September 30, 2021	$	47,450	$	778,600	$	163,809	$	(155,967)	$	43,974	$	877,866

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

Southside Bancshares, Inc. |7

SOUTHSIDE BANCSHARES, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(UNAUDITED)

(in thousands)


	Nine Months Ended
	September 30,
	2022		2021
OPERATING ACTIVITIES:
Net income	$	77,352	$	84,714
Adjustments to reconcile net income to net cash provided by operations:
Depreciation and net amortization	8,332		8,634
Securities premium amortization (discount accretion), net	13,861		17,709
Loan (discount accretion) premium amortization, net	(267)		(649)
Provision for (reversal of) credit losses	1,155		(13,543)
Stock compensation expense	2,426		2,189
Deferred tax expense (benefit)	103		3,612

Net (gain) loss on sale of AFS securities	3,819		(3,399)
Loss on impairment of investments	38		—
Net loss on premises and equipment	435		315
Gross proceeds from sales of loans held for sale	20,195		36,961
Gross originations of loans held for sale	(18,932)		(34,397)
Net (gain) loss on OREO	(12)		(180)

Loss on redemption of subordinated notes	—		1,118
Net change in:
Interest receivable	6,231		9,611
Other assets	76,432		(2,803)
Interest payable	925		(1,223)
Other liabilities	16,271		19,981
Net cash provided by (used in) operating activities	208,364		128,650

INVESTING ACTIVITIES:
Securities AFS:
Purchases	(697,393)		(569,807)
Sales	460,765		104,728
Maturities, calls and principal repayments	98,046		243,507
Securities HTM:
Purchases	(1,632)		—
Maturities, calls and principal repayments	11,020		16,602
Proceeds from redemption of FHLB stock and equity investments	26,623		19,240
Purchases of FHLB stock and equity investments	(24,346)		(21,113)
Net loan paydowns (originations)	(418,546)		9,314

Purchases of premises and equipment	(8,370)		(6,491)
Purchases of BOLI	—		(13,000)
Proceeds from sales of premises and equipment	1,365		1,853
Net proceeds from sales of OREO	34		797
Proceeds from sales of repossessed assets	47		247
Net cash provided by (used in) investing activities	(552,387)		(214,123)

(continued)

Southside Bancshares, Inc. | 8






SOUTHSIDE BANCSHARES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (continued)
(UNAUDITED)
(in thousands)
	Nine Months Ended
	September 30,
	2022		2021
FINANCING ACTIVITIES:
Net change in deposits	430,321		399,303
Net change in other borrowings	51,502		(2,448)
Proceeds from FHLB borrowings	2,501,000		11,648,180
Repayment of FHLB borrowings	(2,601,507)		(11,821,503)
Net proceeds from issuance of subordinated notes	—		(95)
Redemption of subordinated notes	—		(100,011)
Proceeds from stock option exercises	912		6,108
Cash paid to tax authority related to tax withholding on share-based awards	(407)		(217)
Purchase of common stock	(12,509)		(34,148)
Proceeds from the issuance of common stock for dividend reinvestment plan	913		986

Cash dividends paid	(32,828)		(31,957)
Net cash provided by (used in) financing activities	337,397		64,198

Net increase (decrease) in cash and cash equivalents	(6,626)		(21,275)
Cash and cash equivalents at beginning of period	201,753		108,408
Cash and cash equivalents at end of period	$	195,127	$	87,133

SUPPLEMENTAL DISCLOSURES FOR CASH FLOW INFORMATION:

Interest paid	$	21,428	$	22,295
Income taxes paid	$	8,200	$	8,750

SUPPLEMENTAL DISCLOSURES OF NONCASH INVESTING AND FINANCING ACTIVITIES:

Loans transferred to other repossessed assets and real estate through foreclosure	$	266	$	740


Transfer of AFS to HTM securities	$	1,166,550	$	—


Unsettled trades to purchase securities	$	—	$	4,433


Unsettled issuances of brokered CDs	$	28,481	$	—

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

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SOUTHSIDE BANCSHARES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

1. Summary of Significant Accounting and Reporting Policies

Basis of Presentation

In this report, the words “the Company,” “we,” “us,” and “our” refer to the combined entities of Southside Bancshares, Inc. and its subsidiaries, including Southside Bank. The words “Southside” and “Southside Bancshares” refer to Southside Bancshares, Inc. The words “Southside Bank” and “the Bank” refer to Southside Bank.

The accompanying unaudited consolidated financial statements have been prepared in accordance with U.S. GAAP for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, not all information required by GAAP for complete financial statements is included in these interim statements. In the opinion of management, all adjustments necessary for a fair presentation of such financial statements have been included. Such adjustments consisted only of normal recurring items. The preparation of these consolidated financial statements in accordance with GAAP requires the use of management’s estimates. These estimates are subjective in nature and involve matters of judgment. Actual amounts could differ from these estimates.

Interim results are not necessarily indicative of results for a full year. These financial statements should be read in conjunction with the financial statements and notes thereto in our Annual Report on Form 10-K for the year ended December 31, 2021.

Accounting Changes and Reclassifications

Certain prior period amounts may be reclassified to conform to current year presentation.

Accounting Pronouncements

In March 2020, the FASB issued ASU 2020-04, “Reference Rate Reform (Topic 848): Facilitation of the Effects of Reference Rate Reform on Financial Reporting.” ASU 2020-04 is intended to provide relief for companies preparing for discontinuation of interest rates based on LIBOR. The ASU provides optional expedients and exceptions for applying GAAP to contract modifications and hedging relationships, subject to meeting certain criteria, that reference LIBOR or other reference rates expected to be discontinued. ASU 2020-04 also provides for a one-time sale and/or transfer to AFS or trading to be made for HTM debt securities that both reference an eligible reference rate and were classified as HTM before January 1, 2020. ASU 2020-04 was effective for all entities as of March 12, 2020 and through December 31, 2022. Companies can apply the ASU as of the beginning of the interim period that includes March 12, 2020 or any date thereafter. The guidance requires companies to apply the guidance prospectively to contract modifications and hedging relationships while the one-time election to sell and/or transfer debt securities classified as HTM may be made any time after March 12, 2020. Additionally, in January 2021, the FASB issued ASU 2021-01, “Reference Rate Reform (Topic 848): Scope,” which provided additional clarification that certain optional expedients and exceptions noted above apply to derivative instruments that use an interest rate for margining, discounting or contract price alignment that is modified as a result of reference rate reform. We established an officer level committee to guide our transition from LIBOR in October 2019 and are transitioning to alternative rates consistent with industry timelines. We continue to evaluate our LIBOR exposure, and note that we have the option to have certain of our interest rate swaps fall back to an adjusted SOFR index. Additionally, we anticipate the trust preferred subordinated debentures will transition to a SOFR index once the Federal Reserve completes the relevant rule. We have identified our products that utilize LIBOR and have implemented enhanced fallback language to facilitate the transition to alternative reference rates. We are evaluating existing systems and have begun offering alternative rates. We are no longer offering LIBOR indexed rates on newly originated loans. ASU 2020-04 and ASU 2021-01 are not expected to have a material impact on our consolidated financial statements.

In March 2022, the FASB issued ASU 2022-02, “Financial Instruments - Credit Losses (Topic 326): Troubled Debt Restructurings and Vintage Disclosures.” ASU 2022-02 eliminates the accounting guidance for TDRs, while enhancing disclosure requirements for certain loan refinancings and restructurings by creditors when a borrower is experiencing financial difficulty. Specifically, rather than applying the recognition and measurement guidance for TDRs, an entity must apply the loan refinancing and restructuring guidance to determine whether a modification results in a new loan or a continuation of an existing loan. Additionally, ASU 2022-02 requires an entity to disclose current-period gross write-offs by year of origination for financing receivables within the scope of Subtopic 326-20, Financial Instruments—Credit Losses—Measured at Amortized Cost. ASU 2022-02 is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2022 for companies that have adopted CECL, which we adopted on January 1, 2020. Early adoption is permitted. The guidance should be applied prospectively with the option to use a modified retrospective transition method for the recognition

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and measurement of TDRs, resulting in a cumulative-effect adjustment to retained earnings. ASU 2022-02 is not expected to have a material impact on our consolidated financial statements.

In June 2022, the FASB issued ASU 2022-03, “Fair Value Measurement (Topic 820): Fair Value Measurement of Equity Securities Subject to Contractual Sale Restrictions.” ASU 2022-03 clarifies that a contractual restriction on the sale of an equity security should not be considered in measuring fair value. It also requires the following disclosures for equity securities subject to the contractual sale restrictions: 1) the fair value of equity securities subject to contractual sale restrictions reflected in the balance sheet; 2) the nature and remaining duration of the restriction(s); and 3) the circumstances that could cause a lapse in the restriction(s). ASU 2022-03 is effective for the fiscal years and interim periods within those fiscal years, beginning after December 15, 2023. Early adoption is permitted. The guidance should be applied prospectively. ASU 2022-04 is not expected to have a material impact on our consolidated financial statements.

2. Earnings Per Share

Earnings per share on a basic and diluted basis are calculated as follows (in thousands, except per share amounts):


	Three Months Ended September 30,				Nine Months Ended September 30,
	2022		2021		2022		2021
Basic and Diluted Earnings:
Net income	$	26,951	$	29,306	$	77,352	$	84,714
Basic weighted-average shares outstanding	32,112		32,465		32,195		32,641
Add: Stock awards	109		91		146		118
Diluted weighted-average shares outstanding	32,221		32,556		32,341		32,759
Basic earnings per share:
Net income	$	0.84	$	0.90	$	2.40	$	2.60
Diluted earnings per share:
Net income	$	0.84	$	0.90	$	2.39	$	2.59

For the three months ended September 30, 2022, there were approximately 22,000 anti-dilutive shares. For the nine months ended September 30, 2022, there were no anti-dilutive shares. For the three and nine months ended September 30, 2021, there were approximately 462,000 and 288,000 anti-dilutive shares, respectively.

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3. Accumulated Other Comprehensive Income (Loss)

The changes in accumulated other comprehensive income (loss) by component are as follows (in thousands):


	Three Months Ended September 30, 2022

	Unrealized Gains (Losses) on Securities		Unrealized Gains (Losses) on Derivatives		Retirement Plans		Total
Beginning balance, net of tax	$	(137,792)	$	21,857	$	(23,400)	$	(139,335)
Other comprehensive income (loss):
Other comprehensive income (loss) before reclassifications	(67,721)		15,226		—		(52,495)
Reclassification adjustments included in net income	1,495		(1,572)		224		147
Income tax (expense) benefit	13,908		(2,868)		(47)		10,993
Net current-period other comprehensive income (loss), net of tax	(52,318)		10,786		177		(41,355)
Ending balance, net of tax	$	(190,110)	$	32,643	$	(23,223)	$	(180,690)

	Nine Months Ended September 30, 2022

	Unrealized Gains (Losses) on Securities		Unrealized Gains (Losses) on Derivatives		Retirement Plans		Total
Beginning balance, net of tax	$	84,716	$	(1,257)	$	(23,754)	$	59,705
Other comprehensive income (loss):
Other comprehensive (loss) income before reclassifications	(354,649)		42,819		—		(311,830)
Reclassification adjustments included in net income	6,768		94		671		7,533

Income tax (expense) benefit	73,055		(9,013)		(140)		63,902
Net current-period other comprehensive income (loss), net of tax	(274,826)		33,900		531		(240,395)

Ending balance, net of tax	$	(190,110)	$	32,643	$	(23,223)	$	(180,690)

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	Three Months Ended September 30, 2021

	Unrealized Gains (Losses) on Securities		Unrealized Gains (Losses) on Derivatives		Retirement Plans		Total
Beginning balance, net of tax	$	102,628	$	(8,334)	$	(29,407)	$	64,887
Other comprehensive income (loss):
Other comprehensive income (loss) before reclassifications	(27,714)		377		—		(27,337)
Reclassification adjustments included in net income	(1,069)		1,617		316		864
Income tax (expense) benefit	6,045		(418)		(67)		5,560
Net current-period other comprehensive income (loss), net of tax	(22,738)		1,576		249		(20,913)
Ending balance, net of tax	$	79,890	$	(6,758)	$	(29,158)	$	43,974

	Nine Months Ended September 30, 2021

	Unrealized Gains (Losses) on Securities		Unrealized Gains (Losses) on Derivatives		Retirement Plans		Total
Beginning balance, net of tax	$	116,078	$	(17,091)	$	(29,907)	$	69,080


Other comprehensive income (loss):
Other comprehensive income (loss) before reclassifications	(43,527)		8,296		—		(35,231)
Reclassification adjustments included in net income	(2,281)		4,784		948		3,451
Income tax (expense) benefit	9,620		(2,747)		(199)		6,674
Net current-period other comprehensive income (loss), net of tax	(36,188)		10,333		749		(25,106)
Ending balance, net of tax	$	79,890	$	(6,758)	$	(29,158)	$	43,974

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The reclassification adjustments out of accumulated other comprehensive income (loss) included in net income are presented below (in thousands):


	Three Months Ended September 30,				Nine Months Ended September 30,
	2022		2021		2022		2021






Unrealized gains and losses on securities transferred:
Amortization of unrealized gains and losses (1)	$	(1,396)	$	(312)	$	(2,949)	$	(1,118)
Tax benefit	293		66		619		235
Net of tax	(1,103)		(246)		(2,330)		(883)

Unrealized gains and losses on available for sale securities:
Realized net gain (loss) on sale of securities (2)	(99)		1,381		(3,819)		3,399


Tax (expense) benefit	21		(290)		802		(714)
Net of tax	(78)		1,091		(3,017)		2,685

Derivatives:
Realized net gain (loss) on interest rate swap derivatives (3)	1,572		(1,617)		(94)		(4,784)
Tax benefit	(330)		340		20		1,005
Net of tax	1,242		(1,277)		(74)		(3,779)





Amortization of pension plan:
Net actuarial loss (4)	(224)		(316)		(671)		(948)


Tax benefit	47		67		140		199
Net of tax	(177)		(249)		(531)		(749)
Total reclassifications for the period, net of tax	$	(116)	$	(681)	$	(5,952)	$	(2,726)

(1) Included in interest income on the consolidated statements of income.

(2) Listed as net gain (loss) on sale of securities AFS on the consolidated statements of income.

(3) Included in interest expense for FHLB borrowings and deposits on the consolidated statements of income.

(4) These AOCI components are included in the computation of net periodic pension cost (income) presented in “Note 8 – Employee Benefit Plans.”

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4. Securities

Debt securities

The amortized cost, gross unrealized gains and losses and estimated fair value of investment and mortgage-backed AFS and HTM securities as of September 30, 2022 and December 31, 2021 are reflected in the tables below (in thousands):


	September 30, 2022
	Amortized		Gross Unrealized		Gross Unrealized		Estimated
AVAILABLE FOR SALE	Cost		Gains		Losses		Fair Value
Investment securities:


State and political subdivisions	$	1,186,010	$	26	$	147,704	$	1,038,332
Corporate bonds and other	60,144		67		2,794		57,417

MBS: (1)
Residential	337,189		263		17,084		320,368
Commercial	9,548		—		1,103		8,445
Total	$	1,592,891	$	356	$	168,685	$	1,424,562




HELD TO MATURITY
Investment securities:
State and political subdivisions	$	918,216	$	—	$	190,841	$	727,375
Corporate bonds and other	95,458		—		6,077		89,381
MBS: (1)
Residential	94,539		22		8,383		86,178
Commercial	42,992		—		2,604		40,388
Total	$	1,151,205	$	22	$	207,905	$	943,322


	December 31, 2021
	Amortized		Gross Unrealized		Gross Unrealized		Estimated
AVAILABLE FOR SALE	Cost		Gains		Losses		Fair Value
Investment securities:
U.S. Treasury	$	58,084	$	843	$	50	$	58,877

State and political subdivisions	1,962,257		93,893		4,214		2,051,936
Corporate bonds and other	133,333		2,408		209		135,532

MBS: (1)
Residential	411,727		14,895		272		426,350
Commercial	90,193		1,642		205		91,630
Total	$	2,655,594	$	113,681	$	4,950	$	2,764,325





HELD TO MATURITY
Investment securities:
State and political subdivisions	$	788	$	3	$	—	$	791
MBS: (1)
Residential	38,644		2,103		—		40,747
Commercial	51,348		2,349		—		53,697
Total	$	90,780	$	4,455	$	—	$	95,235

(1) All MBS are issued and/or guaranteed by U.S. government agencies or U.S. GSEs.

From time to time, we transfer securities from AFS to HTM due to overall balance sheet strategies. We transferred securities from AFS to HTM with an estimated fair value of $1.07 billion during the nine months ended September 30, 2022. There were no securities transferred from AFS to HTM during the year ended December 31, 2021. The remaining net unamortized, unrealized loss on the transferred securities included in AOCI in the accompanying balance sheets totaled $96.2 million ($76.0 million, net of tax) at September 30, 2022 and $1.5 million ($1.2 million, net of tax) at December 31, 2021. Any net unrealized gain or loss on the transferred securities included in AOCI at the time of transfer will be amortized over the remaining life of the underlying security as an adjustment to the yield on those securities. Securities transferred with losses included in AOCI continue to be included in management’s assessment for impairment for each individual security. We transferred these securities

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due to overall balance sheet strategies, and our management has the current intent and ability to hold these securities until maturity.

Investment securities and MBS with carrying values of $1.58 billion and $1.61 billion were pledged as of September 30, 2022 and December 31, 2021, respectively, to collateralize FHLB borrowings, borrowings from the FRDW, repurchase agreements and public fund deposits, for potential liquidity needs or other purposes as required by law.

The following tables present the fair value and unrealized losses on AFS and HTM investment securities and MBS, if applicable, for which an allowance for credit losses has not been recorded as of September 30, 2022 and December 31, 2021, segregated by major security type and length of time in a continuous loss position (in thousands):


	September 30, 2022
	Less Than 12 Months				More Than 12 Months				Total
	Fair Value		Unrealized Loss		Fair Value		Unrealized Loss		Fair Value		Unrealized Loss
AVAILABLE FOR SALE
Investment securities:


State and political subdivisions	$	1,026,787	$	146,634	$	3,862	$	1,070	$	1,030,649	$	147,704
Corporate bonds and other	53,381		2,794		—		—		53,381		2,794

MBS:
Residential	307,521		17,084		—		—		307,521		17,084
Commercial	5,666		344		2,779		759		8,445		1,103
Total	$	1,393,355	$	166,856	$	6,641	$	1,829	$	1,399,996	$	168,685

HELD TO MATURITY
Investment securities:
State and political subdivisions	$	644,238	$	161,326	$	83,137	$	29,515	$	727,375	$	190,841
Corporate bonds and other	87,630		5,939		1,751		138		89,381		6,077
MBS:
Residential	81,422		7,809		3,935		574		85,357		8,383
Commercial	40,388		2,604		—		—		40,388		2,604
Total	$	853,678	$	177,678	$	88,823	$	30,227	$	942,501	$	207,905

	December 31, 2021
	Less Than 12 Months				More Than 12 Months				Total
	Fair Value		Unrealized Loss		Fair Value		Unrealized Loss		Fair Value		Unrealized Loss
AVAILABLE FOR SALE
Investment securities:
U.S. Treasury	$	9,947	$	50	$	—	$	—	$	9,947	$	50

State and political subdivisions	260,509		3,622		7,608		592		268,117		4,214
Corporate bonds and other	35,597		209		—		—		35,597		209

MBS:
Residential	1,225		3		5,168		269		6,393		272
Commercial	4,274		7		4,674		198		8,948		205
Total	$	311,552	$	3,891	$	17,450	$	1,059	$	329,002	$	4,950

For those AFS debt securities in an unrealized loss position where management (i) has the intent to sell or (ii) where it will more-likely-than-not be required to sell the security before the recovery of its amortized cost basis, we recognize the loss in earnings. For those AFS debt securities in an unrealized loss position that do not meet either of these criteria, management assesses whether the decline in fair value has resulted from credit-related factors, using both qualitative and quantitative criteria. Determining the allowance under the credit loss method requires the use of a discounted cash flow method to assess the credit losses. Any credit-related impairment will be recognized in allowance for credit losses on the balance sheet with a corresponding adjustment to earnings. Noncredit-related temporary impairment, the portion of the impairment relating to factors other than credit (such as changes in market interest rates), is recognized in other comprehensive income, net of tax.

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As of September 30, 2022 and December 31, 2021, we did not have an allowance for credit losses on our AFS securities, based on our consideration of the qualitative factors associated with each security type in our AFS portfolio. The unrealized losses on our investment and MBS are due to changes in interest rates and spreads and other market conditions. At September 30, 2022, we had 811 AFS debt securities in an unrealized loss position. Our state and political subdivisions are highly rated municipal securities with a long history of no credit losses. Our AFS MBS are highly rated securities which are either explicitly or implicitly backed by the U.S. Government through its agencies which are highly rated by major ratings agencies and also have a long history of no credit losses. Our corporate bonds and other investment securities consist of highly rated investment grade bonds.

We assess the likelihood of default and the potential amount of default when assessing our HTM securities for credit losses. We utilize term structures and, due to no prior loss exposure on our state and political subdivision securities or our corporate securities, we currently apply a third-party average loss given default rate to model these securities. Due to a relatively small number of HTM securities in our portfolio as of September 30, 2022 and 2021, we elected to use the specific identification method to model these securities which aligns with our third-party fair value measurement process. The model determined any expected credit loss over the life of these securities to be insignificant. Management further evaluated the remote expectation of loss along with the qualitative factors associated with these securities and concluded that, due to the securities being highly rated municipals and investment grade corporates with a long history of no credit losses, no credit loss should be recognized for these securities for the three and nine months ended September 30, 2022 or 2021.

The accrued interest receivable on our debt securities is excluded from the credit loss estimate and is included in interest receivable on our consolidated balance sheets. As of September 30, 2022, accrued interest receivable on AFS and HTM debt securities totaled $11.8 million and $6.3 million, respectively. As of December 31, 2021, accrued interest receivable on AFS and HTM debt securities totaled $25.6 million and $244,000, respectively. No HTM debt securities were past-due or on nonaccrual status as of September 30, 2022 or December 31, 2021.

The following table reflects interest income recognized on securities for the periods presented (in thousands):



	Three Months Ended September 30,
	2022		2021
U.S. Treasury	$	44	$	182

State and political subdivisions	14,666		12,223

Corporate bonds and other	1,668		1,097
MBS	4,770		4,405
Total interest income on securities	$	21,148	$	17,907



	Nine Months Ended September 30,
	2022		2021
U.S. Treasury	$	271	$	388

State and political subdivisions	41,786		33,568
Corporate bonds and other	4,385		2,928
MBS	12,025		15,140
Total interest income on securities	$	58,467	$	52,024

There was a $3.8 million net realized loss from the sale of AFS securities for the nine months ended September 30, 2022, which consisted of $4.4 million in realized losses and $584,000 in realized gains. There was a $3.4 million net realized gain from the sale of AFS securities for the nine months ended September 30, 2021, which consisted of $3.5 million in realized gains and $71,000 in realized losses. There were no sales from the HTM portfolio during the nine months ended September 30, 2022 or 2021. We calculate realized gains and losses on sales of securities under the specific identification method.

Expected maturities on our securities may differ from contractual maturities because issuers may have the right to call or prepay obligations. MBS are presented in total by category since MBS are typically issued with stated principal amounts and are backed by pools of mortgages that have loans with varying maturities. The characteristics of the underlying pool of mortgages, such as fixed-rate or adjustable-rate, as well as prepayment risk, are passed on to the security holder. The term of a mortgage-backed pass-through security thus approximates the term of the underlying mortgages and can vary significantly due to prepayments.

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The amortized cost and estimated fair value of AFS and HTM securities at September 30, 2022, are presented below by contractual maturity (in thousands):


	September 30, 2022
	Amortized Cost		Fair Value
AVAILABLE FOR SALE
Investment securities:
Due in one year or less	$	528	$	529
Due after one year through five years	21,668		21,154
Due after five years through ten years	96,779		93,415
Due after ten years	1,127,179		980,651
	1,246,154		1,095,749
MBS:	346,737		328,813
Total	$	1,592,891	$	1,424,562


	September 30, 2022
	Amortized Cost		Fair Value
HELD TO MATURITY
Investment securities:
Due in one year or less	$	125	$	123
Due after one year through five years	1,039		1,016
Due after five years through ten years	100,463		94,140
Due after ten years	912,047		721,477
	1,013,674		816,756
MBS:	137,531		126,566
Total	$	1,151,205	$	943,322

Equity Investments

Equity investments on our consolidated balance sheets include Community Reinvestment Act funds with a readily determinable fair value as well as equity investments without readily determinable fair values. At September 30, 2022 and December 31, 2021, we had equity investments recorded in our consolidated balance sheets of $11.1 million and $11.8 million, respectively.

Any realized and unrealized gains and losses on equity investments are reported in income. Equity investments without readily determinable fair values are recorded at cost less impairment, if any.

The following is a summary of unrealized and realized gains and losses on equity investments recognized in other noninterest income in the consolidated statements of income during the periods presented (in thousands):


	Three Months Ended September 30,				Nine Months Ended September 30,
	2022		2021		2022		2021
Net gains (losses) recognized during the period on equity investments	$	(230)	$	(28)	$	(696)	$	(118)
Less: Net gains recognized during the period on equity investments sold during the period	—		—		—		—
Unrealized gains (losses) recognized during the reporting period on equity investments held at the reporting date	$	(230)	$	(28)	$	(696)	$	(118)

Equity investments are assessed quarterly for other-than-temporary impairment. Based upon that evaluation, management does not consider any of our equity investments to be other-than-temporarily impaired at September 30, 2022.

FHLB Stock

Our FHLB stock, which has limited marketability, is carried at cost and is assessed quarterly for other-than-temporary impairment. Based upon evaluation by management at September 30, 2022, our FHLB stock was not impaired and thus was not considered to be other-than-temporarily impaired.

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5. Loans and Allowance for Loan Losses

Loans in the accompanying consolidated balance sheets are classified as follows (in thousands):


	September 30, 2022		December 31, 2021
Real estate loans:
Construction	$	554,345	$	447,860
1-4 family residential	646,692		651,140
Commercial	1,901,921		1,598,172
Commercial loans	433,538		418,998
Municipal loans	449,219		443,078
Loans to individuals	77,780		85,914
Total loans	4,063,495		3,645,162
Less: Allowance for loan losses	36,506		35,273
Net loans	$	4,026,989	$	3,609,889

Paycheck Protection Program Loans

In April 2020, we began originating loans to qualified small businesses under the PPP administered by the SBA under the provisions of the CARES Act. Loans covered by the PPP may be eligible for loan forgiveness for certain costs incurred related to payroll, group health care benefit costs and qualifying mortgage, rent and utility payments. The remaining loan balance after forgiveness of any amount is still fully guaranteed by the SBA. On December 27, 2020, the Economic Aid Act was signed into law. This second coronavirus relief package granted additional funds for a new round of PPP loans. Additionally, it expanded the eligibility for loans and allowed certain businesses to request a second loan. In return for processing and booking a PPP loan, the SBA paid lenders a processing fee tiered by the size of the loan. These loans are included in commercial loans with an amortized cost basis at September 30, 2022 and December 31, 2021 of $306,000 and $31.0 million, respectively.

Construction Real Estate Loans

Our construction loans are collateralized by property located primarily in or near the market areas we serve. A number of our construction loans will be owner occupied upon completion. Construction loans for non-owner occupied projects are financed, but these typically have cash flows from leases with tenants, secondary sources of repayment, and in some cases, additional collateral. Our construction loans have both adjustable and fixed interest rates during the construction period. Construction loans to individuals are typically priced and made with the intention of granting the permanent loan on the completed property. Commercial construction loans are subject to underwriting standards similar to that of the commercial portfolio. Owner occupied 1-4 family residential construction loans are subject to the underwriting standards of the permanent loan.

1-4 Family Residential Real Estate Loans

Residential loan originations are generated by our loan officers, in-house origination staff, marketing efforts, present customers, walk-in customers and referrals from real estate agents and builders. We focus our lending efforts primarily on the origination of loans secured by first mortgages on owner occupied 1-4 family residences. Substantially all of our 1-4 family residential originations are secured by properties located in or near our market areas.

Our 1-4 family residential loans generally have maturities ranging from 15 to 30 years. These loans are typically fully amortizing with monthly payments sufficient to repay the total amount of the loan. Our 1-4 family residential loans are made at both fixed and adjustable interest rates.

Underwriting for 1-4 family residential loans includes debt-to-income analysis, credit history analysis, appraised value and down payment considerations. Changes in the market value of real estate can affect the potential losses in the residential portfolio.

Commercial Real Estate Loans

Commercial real estate loans as of September 30, 2022 consisted of $1.57 billion of owner and non-owner occupied real estate, $307.1 million of loans secured by multi-family properties and $24.8 million of loans secured by farmland. Commercial real estate loans primarily include loans collateralized by retail, commercial office buildings, multi-family residential buildings, medical facilities and offices, senior living, assisted living and skilled nursing facilities, warehouse facilities, hotels and churches. In determining whether to originate commercial real estate loans, we generally consider such factors as the financial condition of the borrower and the debt service coverage of the property. Commercial real estate loans are made at both fixed and adjustable interest rates for terms generally up to 20 years.

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Commercial Loans

Our commercial loans are diversified loan types including short-term working capital loans for inventory and accounts receivable and short- and medium-term loans for equipment or other business capital expansion. In our commercial loan underwriting, we assess the creditworthiness, ability to repay and the value and liquidity of the collateral being offered. Terms of commercial loans are generally commensurate with the useful life of the collateral offered.

Municipal Loans

We make loans to municipalities and school districts primarily throughout the state of Texas, with a small percentage originating outside of the state. The majority of the loans to municipalities and school districts have tax or revenue pledges and in some cases are additionally supported by collateral. Municipal loans made without a direct pledge of taxes or revenues are usually made based on some type of collateral that represents an essential service. Lending money directly to these municipalities allows us to earn a higher yield than we could if we purchased municipal securities for similar durations.

Loans to Individuals

Substantially all originations of our loans to individuals are made to consumers in our market areas. The majority of loans to individuals are collateralized by titled equipment, which are primarily automobiles. Loan terms vary according to the type and value of collateral, length of contract and creditworthiness of the borrower. The underwriting standards we employ for consumer loans include an application, a determination of the applicant’s payment history on other debts, with the greatest weight being given to payment history with us and an assessment of the borrower’s ability to meet existing obligations and payments on the proposed loan. Although creditworthiness of the applicant is a primary consideration, the underwriting process also includes a comparison of the value of the collateral, if any, in relation to the proposed loan amount. Most of our loans to individuals are collateralized, which management believes assists in limiting our exposure.

Credit Quality Indicators

We categorize loans into risk categories on an ongoing basis based on relevant information about the ability of borrowers to service their debt such as: current financial information, historical payment experience, credit documentation, public information and current economic trends, among other factors. We use the following definitions for risk ratings:

•Pass (Rating 1 – 4) – This rating is assigned to all satisfactory loans. This category, by definition, consists of acceptable credit. Credit and collateral exceptions should not be present, although their presence would not necessarily prohibit a loan from being rated Pass, if deficiencies are in the process of correction. These loans are not included in the Watch List.

•Pass Watch (Rating 5) – These loans require some degree of special treatment, but not due to credit quality. This category does not include loans specially mentioned or adversely classified; however, particular attention is warranted to characteristics such as:

▪A lack of, or abnormally extended payment program;

▪A heavy degree of concentration of collateral without sufficient margin;

▪A vulnerability to competition through lesser or extensive financial leverage; and

▪A dependence on a single or few customers or sources of supply and materials without suitable substitutes or alternatives.

•Special Mention (Rating 6) – A Special Mention loan has potential weaknesses that deserve management’s close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the loan or in our credit position at some future date. Special Mention loans are not adversely classified and do not expose us to sufficient risk to warrant adverse classification.

•Substandard (Rating 7) – Substandard loans are inadequately protected by the current sound worth and paying capacity of the obligor or of the collateral pledged, if any. Loans so classified must have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt. They are characterized by the distinct possibility that the Bank will sustain some loss if the deficiencies are not corrected.

•Doubtful (Rating 8) – Loans classified as Doubtful have all the weaknesses inherent in those classified Substandard with the added characteristic that the weaknesses make collection or liquidation, in full, on the basis of currently known facts, conditions and values, highly questionable and improbable.

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The following tables set forth the amortized cost basis by class of financing receivable and credit quality indicator for the periods presented (in thousands):


September 30, 2022	Term Loans Amortized Cost Basis by Origination Year												Revolving Loans Amortized Cost Basis		Total
	2022		2021		2020		2019		2018		Prior
Construction real estate:
Pass	$	127,074	$	200,310	$	40,301	$	9,256	$	1,918	$	6,813	$	165,829	$	551,501
Pass watch	—		—		—		—		—		—		—		—
Special mention	1,830		305		—		—		—		—		—		2,135
Substandard	—		—		—		389		45		229		—		663
Doubtful	—		46		—		—		—		—		—		46
Total construction real estate	$	128,904	$	200,661	$	40,301	$	9,645	$	1,963	$	7,042	$	165,829	$	554,345

1-4 family residential real estate:
Pass	$	91,723	$	127,248	$	112,796	$	68,045	$	37,349	$	202,116	$	2,190	$	641,467
Pass watch	—		—		—		—		—		—		—		—
Special mention	—		—		80		—		1,414		—		—		1,494
Substandard	4		—		396		160		184		2,531		42		3,317
Doubtful	—		—		—		—		178		236		—		414
Total 1-4 family residential real estate	$	91,727	$	127,248	$	113,272	$	68,205	$	39,125	$	204,883	$	2,232	$	646,692

Commercial real estate:
Pass	$	664,538	$	579,040	$	170,699	$	138,748	$	56,168	$	241,718	$	11,944	$	1,862,855
Pass watch	—		9,434		—		—		—		1,771		—		11,205
Special mention	—		—		1,844		333		116		1,898		—		4,191
Substandard	596		—		285		14,699		263		7,620		—		23,463
Doubtful	—		—		—		78		—		129		—		207
Total commercial real estate	$	665,134	$	588,474	$	172,828	$	153,858	$	56,547	$	253,136	$	11,944	$	1,901,921

Commercial loans:
Pass	$	105,247	$	76,210	$	20,852	$	9,369	$	5,792	$	3,680	$	164,967	$	386,117
Pass watch	217		6		—		247		—		—		27,452		27,922
Special mention	—		5,183		34		—		307		—		12,742		18,266
Substandard	—		16		72		122		37		9		74		330
Doubtful	68		328		17		195		240		55		—		903
Total commercial loans	$	105,532	$	81,743	$	20,975	$	9,933	$	6,376	$	3,744	$	205,235	$	433,538

Municipal loans:
Pass	$	49,215	$	75,567	$	58,288	$	56,151	$	26,141	$	183,857	$	—	$	449,219
Pass watch	—		—		—		—		—		—		—		—
Special mention	—		—		—		—		—		—		—		—
Substandard	—		—		—		—		—		—		—		—
Doubtful	—		—		—		—		—		—		—		—
Total municipal loans	$	49,215	$	75,567	$	58,288	$	56,151	$	26,141	$	183,857	$	—	$	449,219

Loans to individuals:
Pass	$	25,795	$	24,290	$	15,004	$	6,515	$	1,994	$	1,285	$	2,838	$	77,721
Pass watch	—		—		—		—		—		—		—		—
Special mention	—		—		—		—		—		—		—		—
Substandard	—		1		—		10		40		4		1		56
Doubtful	—		—		—		—		—		3		—		3
Total loans to individuals	$	25,795	$	24,291	$	15,004	$	6,525	$	2,034	$	1,292	$	2,839	$	77,780
Total loans	$	1,066,307	$	1,097,984	$	420,668	$	304,317	$	132,186	$	653,954	$	388,079	$	4,063,495

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December 31, 2021	Term Loans Amortized Cost Basis by Origination Year												Revolving Loans Amortized Cost Basis		Total
	2021		2020		2019		2018		2017		Prior
Construction real estate:
Pass	$	179,521	$	82,862	$	38,788	$	5,666	$	2,126	$	6,080	$	132,592	$	447,635
Pass watch	—		—		—		—		—		—		—		—
Special mention	—		—		—		—		—		—		—		—
Substandard	—		—		—		—		—		175		—		175
Doubtful	—		—		—		50		—		—		—		50
Total construction real estate	$	179,521	$	82,862	$	38,788	$	5,716	$	2,126	$	6,255	$	132,592	$	447,860

1-4 family residential real estate:
Pass	$	141,058	$	129,681	$	81,607	$	47,566	$	34,236	$	209,470	$	2,238	$	645,856
Pass watch	—		—		—		—		—		777		—		777
Special mention	—		82		—		—		—		—		—		82
Substandard	57		403		55		—		295		3,257		88		4,155
Doubtful	—		—		—		—		—		270		—		270
Total 1-4 family residential real estate	$	141,115	$	130,166	$	81,662	$	47,566	$	34,531	$	213,774	$	2,326	$	651,140

Commercial real estate:
Pass	$	648,002	$	207,370	$	209,923	$	114,788	$	143,350	$	209,368	$	7,566	$	1,540,367
Pass watch	21,669		—		2,163		3,074		374		—		—		27,280
Special mention	—		2,062		2,217		119		163		1,877		—		6,438
Substandard	3,299		667		10,830		1,480		—		7,691		—		23,967
Doubtful	—		—		—		—		—		120		—		120
Total commercial real estate	$	672,970	$	210,099	$	225,133	$	119,461	$	143,887	$	219,056	$	7,566	$	1,598,172

Commercial loans:
Pass	$	140,628	$	51,866	$	24,688	$	13,204	$	2,516	$	4,062	$	178,263	$	415,227
Pass watch	—		—		280		22		—		—		—		302
Special mention	—		57		78		363		—		157		—		655
Substandard	—		283		296		174		16		—		1,457		2,226
Doubtful	7		26		124		359		—		72		—		588
Total commercial loans	$	140,635	$	52,232	$	25,466	$	14,122	$	2,532	$	4,291	$	179,720	$	418,998

Municipal loans:
Pass	$	80,167	$	64,803	$	61,348	$	29,168	$	56,274	$	151,318	$	—	$	443,078
Pass watch	—		—		—		—		—		—		—		—
Special mention	—		—		—		—		—		—		—		—
Substandard	—		—		—		—		—		—		—		—
Doubtful	—		—		—		—		—		—		—		—
Total municipal loans	$	80,167	$	64,803	$	61,348	$	29,168	$	56,274	$	151,318	$	—	$	443,078

Loans to individuals:
Pass	$	40,252	$	24,028	$	11,813	$	4,121	$	1,684	$	849	$	3,052	$	85,799
Pass watch	—		—		—		—		—		—		—		—
Special mention	—		—		—		36		—		—		—		36
Substandard	—		1		24		4		23		10		2		64
Doubtful	—		—		1		7		3		4		—		15
Total loans to individuals	$	40,252	$	24,029	$	11,838	$	4,168	$	1,710	$	863	$	3,054	$	85,914
Total loans	$	1,254,660	$	564,191	$	444,235	$	220,201	$	241,060	$	595,557	$	325,258	$	3,645,162

Watchlisted loans reported as 2022 originations as of September 30, 2022 and watchlisted loans reported as 2021 originations as of December 31, 2021 were, for the majority, first originated in various years prior to 2022 and 2021, respectively, but were renewed in the respective year.

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The following tables present the aging of the amortized cost basis in past due loans by class of loans (in thousands):


	September 30, 2022
	30-59 Days Past Due		60-89 Days Past Due		Greater than 90 Days Past Due		Total Past Due		Current		Total
Real estate loans:
Construction	$	160	$	410	$	46	$	616	$	553,729	$	554,345
1-4 family residential	1,367		547		516		2,430		644,262		646,692
Commercial	243		422		—		665		1,901,256		1,901,921
Commercial loans	1,094		794		434		2,322		431,216		433,538
Municipal loans	—		—		—		—		449,219		449,219
Loans to individuals	208		—		—		208		77,572		77,780
Total	$	3,072	$	2,173	$	996	$	6,241	$	4,057,254	$	4,063,495


	December 31, 2021
	30-59 Days Past Due		60-89 Days Past Due		Greater than 90 Days Past Due		Total Past Due		Current		Total
Real estate loans:
Construction	$	82	$	58	$	—	$	140	$	447,720	$	447,860
1-4 family residential	3,226		606		227		4,059		647,081		651,140
Commercial	1,191		—		99		1,290		1,596,882		1,598,172
Commercial loans	1,523		251		537		2,311		416,687		418,998
Municipal loans	170		—		—		170		442,908		443,078
Loans to individuals	315		41		8		364		85,550		85,914
Total	$	6,507	$	956	$	871	$	8,334	$	3,636,828	$	3,645,162

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The following table sets forth the amortized cost basis of nonperforming assets for the periods presented (in thousands):


	September 30, 2022		December 31, 2021
Nonaccrual loans:
Real estate loans:
Construction	$	77	$	57
1-4 family residential	1,183		969
Commercial	696		668
Commercial loans	1,071		815

Loans to individuals	12		27
Total nonaccrual loans (1)	3,039		2,536

Accruing loans past due more than 90 days	—		—
TDR loans	8,481		9,073
OREO	162		—
Repossessed assets	35		—
Total nonperforming assets	$	11,717	$	11,609

(1) Includes $950,000 and $1.1 million of TDR loans as of September 30, 2022 and December 31, 2021, respectively.

We reversed $10,000 and $33,000 of interest income on nonaccrual loans during the three and nine months ended September 30, 2022, and $5,000 and $13,000 for the three and nine months ended September 30, 2021, respectively. We had $1.0 million and $1.2 million of loans on nonaccrual for which there was no related allowance for credit losses as of September 30, 2022 and December 31, 2021, respectively.

Collateral-dependent loans are loans that we expect the repayment to be provided substantially through the operation or sale of the collateral of the loan and we have determined that the borrower is experiencing financial difficulty. In such cases, expected credit losses are based on the fair value of the collateral at the measurement date, adjusted for selling costs. As of September 30, 2022 and December 31, 2021, we had $8.7 million and $8.5 million, respectively, of collateral-dependent loans, secured mainly by real estate and equipment. There have been no significant changes to the collateral that secures the collateral-dependent assets. Foreclosed assets include OREO and repossessed assets. For 1-4 family residential real estate properties, a loan is recognized as a foreclosed property once legal title to the real estate property has been received upon completion of foreclosure or the borrower has conveyed all interest in the residential property through a deed in lieu of foreclosure. There were $171,000 and $21,000 loans secured by 1-4 family residential properties for which formal foreclosure proceedings were in process as of September 30, 2022 and December 31, 2021, respectively.

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Troubled Debt Restructurings

The restructuring of a loan is considered a TDR if both (i) the borrower is experiencing financial difficulties and (ii) the creditor has granted a concession. Concessions may include interest rate reductions or below market interest rates, restructuring amortization schedules and other actions intended to minimize potential losses. We may provide a combination of concessions which may include an extension of the amortization period, interest rate reduction and/or converting the loan to interest-only for a limited period of time.

The following tables set forth the recorded balance of loans considered to be TDRs that were restructured and the type of concession by class of loans during the periods presented (dollars in thousands):



	Nine Months Ended September 30, 2022
	Extend Amortization Period		Interest Rate Reductions		Combination		Total Modifications		Number of Loans
Real estate loans:

1-4 family residential	$	—	$	—	$	307	$	307	4

Commercial loans	—		—		5		5		1

Loans to individuals	—		—		9		9		2
Total	$	—	$	—	$	321	$	321	7



	Three Months Ended September 30, 2021
	Extend Amortization Period		Interest Rate Reductions		Combination		Total Modifications		Number of Loans
Real estate loans:

1-4 family residential	$	—	$	—	$	219	$	219	3
Commercial	—		—		453		453		1



Total	$	—	$	—	$	672	$	672	4


	Nine Months Ended September 30, 2021
	Extend Amortization Period		Interest Rate Reductions		Combination		Total Modifications		Number of Loans
Real estate loans:

1-4 family residential	$	—	$	—	$	344	$	344	5
Commercial	—		—		453		453		1
Commercial loans	—		16		94		110		3


Total	$	—	$	16	$	891	$	907	9

There were no TDRs restructured during the three months ended September 30, 2022.

Interest continues to be charged on principal balances outstanding during the extended term. Therefore, the financial effects of the recorded investment of loans restructured as TDRs during the nine months ended September 30, 2022 and 2021 were not significant.

On an ongoing basis, the performance of the TDRs is monitored for subsequent payment default. Payment default for TDRs is recognized when the borrower is 90 days or more past due. As of September 30, 2022 and 2021, the amount of TDRs in default was not significant. Payment defaults for TDRs did not significantly impact the determination of the allowance for loan losses in the periods presented. At September 30, 2022 and 2021, there were no commitments to lend additional funds to borrowers whose terms had been modified in TDRs.

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Allowance for Loan Losses

The following tables detail activity in the allowance for loan losses by portfolio segment for the periods presented (in thousands):



	Three Months Ended September 30, 2022
	Real Estate
	Construction		1-4 Family Residential		Commercial		Commercial Loans		Municipal Loans		Loans to Individuals		Total
Balance at beginning of period	$	3,399	$	2,024	$	27,221	$	2,558	$	46	$	201	$	35,449
Loans charged-off	—		(66)		—		(192)		—		(428)		(686)
Recoveries of loans charged-off	—		4		—		139		—		306		449
Net loans (charged-off) recovered	—		(62)		—		(53)		—		(122)		(237)
Provision for (reversal of) loan losses	136		44		1,273		(272)		(2)		115		1,294
Balance at end of period	$	3,535	$	2,006	$	28,494	$	2,233	$	44	$	194	$	36,506



	Nine Months Ended September 30, 2022
	Real Estate
	Construction		1-4 Family Residential		Commercial		Commercial Loans		Municipal Loans		Loans to Individuals		Total
Balance at beginning of period	$	3,787	$	1,866	$	26,980	$	2,397	$	47	$	196	$	35,273
Loans charged-off	—		(66)		—		(369)		—		(1,285)		(1,720)
Recoveries of loans charged-off	1		96		81		469		—		858		1,505
Net loans (charged-off) recovered	1		30		81		100		—		(427)		(215)
Provision for (reversal of) loan losses	(253)		110		1,433		(264)		(3)		425		1,448
Balance at end of period	$	3,535	$	2,006	$	28,494	$	2,233	$	44	$	194	$	36,506



	Three Months Ended September 30, 2021
	Real Estate
	Construction		1-4 Family Residential		Commercial		Commercial Loans		Municipal Loans		Loans to Individuals		Total
Balance at beginning of period	$	8,018	$	2,520	$	28,930	$	3,097	$	47	$	301	$	42,913


Loans charged-off	—		(35)		—		(508)		—		(397)		(940)
Recoveries of loans charged-off	1		4		12		74		—		346		437
Net loans (charged-off) recovered	1		(31)		12		(434)		—		(51)		(503)
Provision for (reversal of) loan losses	(3,036)		(543)		(684)		(103)		(1)		(21)		(4,388)
Balance at end of period	$	4,983	$	1,946	$	28,258	$	2,560	$	46	$	229	$	38,022

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	Nine Months Ended September 30, 2021
	Real Estate
	Construction		1-4 Family Residential		Commercial		Commercial Loans		Municipal Loans		Loans to Individuals		Total
Balance at beginning of period	$	6,490	$	2,270	$	35,709	$	4,107	$	46	$	384	$	49,006


Loans charged-off	—		(136)		—		(943)		—		(1,183)		(2,262)
Recoveries of loans charged-off	2		71		13		535		—		904		1,525
Net loans (charged-off) recovered	2		(65)		13		(408)		—		(279)		(737)
Provision for (reversal of) loan losses	(1,509)		(259)		(7,464)		(1,139)		—		124		(10,247)
Balance at end of period	$	4,983	$	1,946	$	28,258	$	2,560	$	46	$	229	$	38,022

The accrued interest receivable on our loan receivables is excluded from the allowance for credit loss estimate and is included in interest receivable on our consolidated balance sheets. As of September 30, 2022 and December 31, 2021, the accrued interest on our loan portfolio was $14.8 million and $13.3 million, respectively.

6. Borrowing Arrangements

Information related to borrowings is provided in the table below (dollars in thousands):


	September 30, 2022			December 31, 2021
Other borrowings:
Balance at end of period	$	74,721		$	23,219
Average amount outstanding during the period (1)	62,814			22,257
Maximum amount outstanding during the period (2)	248,592			24,549
Weighted average interest rate during the period (3)	1.7		%	0.2		%
Interest rate at end of period (4)	2.1		%	0.2		%

FHLB borrowings:
Balance at end of period	$	243,531		$	344,038
Average amount outstanding during the period (1)	117,724			665,384
Maximum amount outstanding during the period (2)	423,645			723,584
Weighted average interest rate during the period (3)	1.9		%	1.1		%
Interest rate at end of period (5)	3.1		%	1.3		%

(1)The average amount outstanding during the period was computed by dividing the total daily outstanding principal balances by the number of days in the period.

(2)The maximum amount outstanding at any month-end during the period.

(3)The weighted average interest rate during the period was computed by dividing the actual interest expense (annualized for interim periods) by the average amount outstanding during the period. The weighted average interest rate on the FHLB borrowings includes the effect of interest rate swaps.

(4)Stated rate.

(5)As of December 31, 2021, the interest rate on the FHLB borrowings includes the effect of interest rate swaps.

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Maturities of the obligations associated with our borrowing arrangements based on scheduled repayments at September 30, 2022 are as follows (in thousands):


	Payments Due by Period
	Less than 1 Year		1-2 Years		2-3 Years		3-4 Years		4-5 Years		Thereafter		Total
Other borrowings	$	72,021	$	2,700	$	—	$	—	$	—	$	—	$	74,721
FHLB borrowings	240,702		733		764		582		401		349		243,531
Total obligations	$	312,723	$	3,433	$	764	$	582	$	401	$	349	$	318,252

Other borrowings may include federal funds purchased, repurchase agreements and borrowings from the FRDW. Southside Bank has three unsecured lines of credit for the purchase of overnight federal funds at prevailing rates with Frost Bank, TIB – The Independent Bankers Bank and Comerica Bank for $40.0 million, $15.0 million and $7.5 million, respectively. There were no federal funds purchased at September 30, 2022 or December 31, 2021. To provide more liquidity in response to the economic impact of the COVID-19 pandemic, the Federal Reserve took steps to encourage broader use of the discount window. At September 30, 2022, the amount of additional funding the Bank could obtain from the FRDW, collateralized by securities, was approximately $505.8 million. There were $34.0 million in borrowings from the FRDW at September 30, 2022. There were no borrowings from the FRDW at December 31, 2021. Southside Bank has a $5.0 million line of credit with Frost Bank to be used to issue letters of credit, and at September 30, 2022, the line had one outstanding letter of credit for $155,000. Southside Bank currently has no outstanding letters of credit from FHLB held as collateral for its public fund deposits.

Southside Bank enters into sales of securities under repurchase agreements. These repurchase agreements totaled $40.7 million at September 30, 2022 and $23.2 million at December 31, 2021, and had maturities of less than 1.4 years. Repurchase agreements are secured by investment and MBS securities and are stated at the amount of cash received in connection with the transaction.

FHLB borrowings represent borrowings with fixed interest rates ranging from 2.73% to 4.799% and with remaining maturities of 6 days to 5.8 years at September 30, 2022. FHLB borrowings may be collateralized by FHLB stock, nonspecified loans and/or securities. At September 30, 2022, the amount of additional funding Southside Bank could obtain from FHLB, collateralized by securities, FHLB stock and nonspecified loans and securities, was approximately $1.62 billion, net of FHLB stock purchases required.

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7. Long-term Debt

Information related to our long-term debt is summarized as follows for the periods presented (in thousands):


	September 30, 2022		December 31, 2021

Subordinated notes: (1)
3.875% Subordinated notes, net of unamortized debt issuance costs (2)	$	98,639	$	98,534

Total Subordinated notes	98,639		98,534
Trust preferred subordinated debentures: (3)
Southside Statutory Trust III, net of unamortized debt issuance costs (4)	20,572		20,568
Southside Statutory Trust IV	23,196		23,196
Southside Statutory Trust V	12,887		12,887
Magnolia Trust Company I	3,609		3,609
Total Trust preferred subordinated debentures	60,264		60,260




Total Long-term debt	$	158,903	$	158,794

(1)This debt consists of subordinated notes with a remaining maturity greater than one year that qualify under the risk-based capital guidelines as Tier 2 capital, subject to certain limitations.

(2)The unamortized discount and debt issuance costs reflected in the carrying amount of the subordinated notes totaled approximately $1.4 million at September 30, 2022 and $1.5 million at December 31, 2021.

(3)This debt consists of trust preferred securities that qualify under the risk-based capital guidelines as Tier 1 capital, subject to certain limitations.

(4)The unamortized debt issuance costs reflected in the carrying amount of the Southside Statutory Trust III junior subordinated debentures totaled $47,000 at September 30, 2022 and $51,000 at December 31, 2021.

As of September 30, 2022, the details of the subordinated notes and the trust preferred subordinated debentures are summarized below (dollars in thousands):

Date Issued

Amount Issued

Fixed or Floating Rate

Interest Rate

Maturity Date

3.875% Subordinated Notes

November 6, 2020

100,000

Fixed-to-Floating

3.875%

November 15, 2030

Southside Statutory Trust III

September 4, 2003

20,619

Floating

3 month LIBOR + 2.94%

September 4, 2033

Southside Statutory Trust IV

August 8, 2007

23,196

Floating

3 month LIBOR + 1.30%

October 30, 2037

Southside Statutory Trust V

August 10, 2007

12,887

Floating

3 month LIBOR + 2.25%

September 15, 2037

Magnolia Trust Company I (1)

May 20, 2005

3,609

Floating

3 month LIBOR + 1.80%

November 23, 2035

(1)On October 10, 2007, as part of an acquisition we assumed $3.6 million of floating rate junior subordinated debentures issued in 2005 to Magnolia Trust Company I.

On November 6, 2020, the Company issued $100.0 million in aggregate principal amount of fixed-to-floating rate subordinated notes that mature on November 15, 2030. This debt initially bears interest at a fixed rate of 3.875% per year through November 14, 2025 and thereafter, adjusts quarterly at a floating rate equal to the then current three-month term SOFR, as published by the FRBNY, plus 366 basis points. The proceeds from the sale of the subordinated notes were used for general corporate purposes.

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8. Employee Benefit Plans

The components of net periodic benefit cost (income) related to our employee benefit plans are as follows (in thousands):



	Three Months Ended September 30,
	Retirement Plan				Acquired Retirement Plan				Restoration Plan
	2022		2021		2022		2021		2022		2021

Interest cost	$	685	$	642	$	25	$	23	$	144	$	130
Expected return on assets	(1,461)		(1,355)		(58)		(53)		—		—
Net loss amortization	160		251		—		1		64		64


Net periodic benefit cost (income)	$	(616)	$	(462)	$	(33)	$	(29)	$	208	$	194



	Nine Months Ended September 30,
	Defined Benefit Pension Plan				Defined Benefit Pension Plan Acquired				Restoration Plan
	2022		2021		2022		2021		2022		2021

Interest cost	$	2,056	$	1,927	$	76	$	69	$	433	$	390
Expected return on assets	(4,384)		(4,065)		(174)		(158)		—		—
Net loss amortization	480		752		—		4		191		192


Net periodic benefit cost (income)	$	(1,848)	$	(1,386)	$	(98)	$	(85)	$	624	$	582

At June 30, 2021, we updated our expected long-term rate of return on plan assets for the Retirement Plan and the Acquired Retirement Plan from 6.50% to 6.125%. This assumption is reviewed, at a minimum, on an annual basis.

The noncash adjustment to the employee benefit plan liabilities, consisting of changes in net loss, was $671,000 and $948,000 for the nine months ended September 30, 2022 and 2021, respectively.

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9. Derivative Financial Instruments and Hedging Activities

Our hedging policy allows the use of interest rate derivative instruments to manage our exposure to interest rate risk or hedge specified assets and liabilities. These instruments may include interest rate swaps and interest rate caps and floors. All derivative instruments are carried on the balance sheet at their estimated fair value and are recorded in other assets or other liabilities, as appropriate.

Derivative instruments may be designated as cash flow hedges of variable rate assets or liabilities, cash flow hedges of forecasted transactions, fair value hedges of a recognized asset or liability or as non-hedging instruments. Gains and losses on derivative instruments designated as cash flow hedges are recorded in AOCI to the extent they are effective. If the hedge is effective, the amount recorded in other comprehensive income is reclassified to earnings in the same periods that the hedged cash flows impact earnings. The ineffective portion of changes in fair value is reported in current earnings. Gains and losses on derivative instruments designated as fair value hedges, as well as the change in fair value on the hedged item, are recorded in interest income in the consolidated statements of income. Gains and losses due to changes in fair value of the interest rate swap agreements completely offset changes in the fair value of the hedged portion of the hedged item. For derivative instruments not designated as hedging instruments, the gain or loss is recognized in current earnings during the period of change.

We have entered into certain interest rate swap contracts on specific variable rate agreements and fixed rate short-term pay agreements with third-parties. These interest rate swap contracts were designated as hedging instruments in cash flow hedges under ASC Topic 815. The objective of the interest rate swap contracts is to manage the expected future cash flows on $575.0 million of Bank liabilities. The cash flows from the swap contracts are expected to be effective in hedging the variability in future cash flows attributable to fluctuations in the underlying LIBOR interest rate.

During the second and third quarters of 2022, we entered into partial term fair value hedges, as allowed under ASU 2017-12, for certain of our fixed rate callable AFS municipal securities. The instruments are designated as fair value hedges as the changes in the fair value of the interest rate swap are expected to offset changes in the fair value of the hedged item attributable to changes in the SOFR swap rate, the designated benchmark interest rate. As of September 30, 2022, hedged securities with a carrying amount of $708.9 million are included in our AFS securities portfolio in our consolidated balance sheets. These derivative contracts involve the receipt of floating rate interest from a counterparty in exchange for us making fixed-rate payments over the life of the agreement, without the exchange of the underlying notional value. The change in the fair value of these hedging instruments is recorded in AOCI and is subsequently reclassified into earnings in the period that the hedged transactions affects earnings.

In accordance with ASC Topic 815, if a hedging item is terminated prior to maturity for a cash settlement, the existing gain or loss within AOCI will continue to be reclassified into earnings during the period or periods in which the hedged forecasted transaction affects earnings unless it is probable the forecasted transaction will not occur by the end of the originally specified time period. These transactions are reevaluated on a monthly basis to determine if the hedged forecasted transactions are still probable of occurring. If at a subsequent evaluation, it is determined that the transactions will not occur, any related gains or losses recorded in AOCI are immediately recognized in earnings.

From time to time, we may enter into certain interest rate swaps, cap and floor contracts that are not designated as hedging instruments. These interest rate derivative contracts relate to transactions in which we enter into an interest rate swap, cap or floor with a customer while concurrently entering into an offsetting interest rate swap, cap or floor with a third party financial institution. We agree to pay interest to the customer on a notional amount at a variable rate and receive interest from the customer on a similar notional amount at a fixed interest rate. At the same time, we agree to pay a third party financial institution the same fixed interest rate on the same notional amount and receive the same variable interest rate on the same notional amount. These interest rate derivative contracts allow our customers to effectively convert a variable rate loan to a fixed rate loan. The changes in the fair value of the underlying derivative contracts primarily offset each other and do not significantly impact our results of operations. We recognized swap fee income associated with these derivative contracts immediately based upon the difference in the bid/ask spread of the underlying transactions with the customer and the third party financial institution. The swap fee income is included in other noninterest income in our consolidated statements of income.

At September 30, 2022, net derivative asset included $81.0 million of cash collateral received from counterparties under master netting agreements. At December 31, 2021, net derivative liabilities included $12.8 million, of cash collateral held by counterparties subject to master netting agreements.

The notional amounts of the derivative instruments represent the contractual cash flows pertaining to the underlying agreements. These amounts are not exchanged and are not reflected in the consolidated balance sheets. The fair value of the interest rate swaps are presented at net in other assets and other liabilities and in the net change in each of these financial statement line items in the accompanying consolidated statements of cash flows when a right of offset exists, based on transactions with a single counterparty that are subject to a legally enforceable master netting agreement.

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The following tables present the notional and estimated fair value amount of derivative positions outstanding (in thousands):


	September 30, 2022						December 31, 2021
			Estimated Fair Value						Estimated Fair Value
	Notional Amount (1)		Asset Derivative		Liability Derivative		Notional Amount (1)		Asset Derivative		Liability Derivative
Derivatives designated as hedging instruments
Interest rate contracts:
Swaps-Cash Flow Hedge-Financial institution counterparties	$	575,000	$	41,320	$	—	$	605,000	$	4,274	$	5,866
Swaps-Fair Value Hedge-Financial institution counterparties	742,675		23,956		18		—		—		—
Derivatives designated as non-hedging instruments
Interest rate contracts:
Swaps-Financial institution counterparties	229,199		22,804		—		214,379		545		13,412
Swaps-Customer counterparties	229,199		—		22,804		214,379		13,412		545
Gross derivatives			88,080		22,822				18,231		19,823
Offsetting derivative assets/liabilities			(18)		(18)				(4,819)		(4,819)
Cash collateral received/posted			(81,030)		—				—		(12,810)
Net derivatives included in the consolidated balance sheets (2)			$	7,032	$	22,804			$	13,412	$	2,194

(1) Notional amounts, which represent the extent of involvement in the derivatives market, are used to determine the contractual cash flows required in accordance with the terms of the agreement. These amounts are typically not exchanged, significantly exceed amounts subject to credit or market risk and are not reflected in the consolidated balance sheets.

(2) Net derivative assets are included in other assets and net derivative liabilities are included in other liabilities on the consolidated balance sheets. Included in the fair value of net derivative assets and net derivative liabilities are credit valuation adjustments reflecting counterparty credit risk and our credit risk. We had $7.0 million credit exposure related to interest rate swaps with financial institutions and none related to interest rate swaps with customers at September 30, 2022. We had no credit exposure related to interest rate swaps with financial institutions and $13.4 million related to interest rate swaps with customers at December 31, 2021. The credit risk associated with customer transactions is partially mitigated as these are generally secured by the non-cash collateral securing the underlying transaction being hedged.

The summarized expected weighted average remaining maturity of the notional amount of interest rate swaps and the weighted average interest rates associated with the amounts expected to be received or paid on interest rate swap agreements are presented below (dollars in thousands). Variable rates received on fixed pay swaps are based on one-month or three-month LIBOR or overnight SOFR rates in effect at September 30, 2022 and December 31, 2021:


	September 30, 2022							December 31, 2021
			Weighted Average							Weighted Average
	Notional Amount		Remaining Maturity (in years)	Receive Rate		Pay Rate		Notional Amount		Remaining Maturity (in years)	Receive Rate		Pay Rate
Swaps-Cash Flow hedge
Financial institution counterparties	$	575,000	2.6	2.94	%	1.13	%	$	605,000	3.2	0.13	%	1.10	%
Swaps-Fair Value hedge
Financial institution counterparties	742,675		6.5	2.58	%	3.21	%	—		—	—		—
Swaps-Non-hedging
Financial institution counterparties	229,199		9.1	3.37	%	2.68	%	214,379		10.3	0.47	%	2.42	%
Customer counterparties	229,199		9.1	2.68	%	3.37	%	214,379		10.3	2.42	%	0.47	%

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10. Fair Value Measurement

Fair value is the price that would be received upon the sale of an asset or paid to transfer a liability (exit price) in an orderly transaction between market participants. A fair value measurement assumes 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 is not 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.

Valuation techniques including the market approach, the income approach and/or the cost approach are utilized to determine fair value. Inputs to valuation techniques refer to the assumptions market participants would use in pricing the asset or liability. Valuation policies and procedures are determined by our investment department and reported to our ALCO for review. An entity must consider all aspects of nonperforming risk, including the entity’s own credit standing, when measuring fair value of a 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. A fair value hierarchy for valuation inputs 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 might 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 (such as interest rates, volatilities, prepayment speeds, credit risks, etc.) or inputs that are derived principally from or corroborated by market data by correlation or other means.

Level 3 Inputs - Unobservable inputs for determining the fair values of assets or liabilities that reflect an entity’s own assumptions about the assumptions that market participants would use in pricing the assets or liabilities.

Certain financial assets are measured at fair value in accordance with GAAP. Adjustments to the fair value of these assets usually result from the application of fair value accounting or write-downs of individual assets. 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.

Securities AFS and Equity Investments with readily determinable fair values – U.S. Treasury securities and equity investments with readily determinable fair values are reported at fair value utilizing Level 1 inputs. Other securities classified as AFS are reported at fair value utilizing Level 2 inputs. For these securities, we obtain fair value measurements from independent pricing services and obtain an understanding of the pricing methodologies used by these independent pricing services. The fair value measurements consider observable data that may include dealer quotes, market spreads, cash flows, the U.S. Treasury yield curve, live trading levels, trade execution data, market consensus prepayment speeds, credit information and the bond’s terms and conditions, among other things, as stated in the pricing methodologies of the independent pricing services.

We review and validate the prices supplied by the independent pricing services for reasonableness by comparison to prices obtained from, in some cases, two additional third-party sources. For securities where prices are outside a reasonable range, we further review those securities, based on internal ALCO approved procedures, to determine what a reasonable fair value measurement is for those securities, given available data.

Derivatives – Derivatives are reported at fair value utilizing Level 2 inputs. We obtain fair value measurements from two sources including an independent pricing service and the counterparty to the derivatives designated as hedges. The fair value measurements consider observable data that may include dealer quotes, market spreads, the U.S. Treasury yield curve, live trading levels, trade execution data, credit information and the derivatives’ terms and conditions, among other things. We review the prices supplied by the sources for reasonableness. In addition, we obtain a basic understanding of their underlying pricing methodology. We validate prices supplied by the sources by comparison to one another.

Certain nonfinancial assets and nonfinancial liabilities measured at fair value on a recurring basis include reporting units measured at fair value and tested for goodwill impairment.

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Certain financial assets and financial liabilities are measured at fair value on a nonrecurring basis, which means that 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). Financial assets and financial liabilities measured at fair value on a nonrecurring basis included foreclosed assets and collateral-dependent loans at September 30, 2022 and December 31, 2021.

Foreclosed Assets – Foreclosed assets are initially recorded at fair value less costs to sell. The fair value measurements of foreclosed assets can include Level 2 measurement inputs such as real estate appraisals and comparable real estate sales information, in conjunction with Level 3 measurement inputs such as cash flow projections, qualitative adjustments and sales cost estimates. As a result, the categorization of foreclosed assets is Level 3 of the fair value hierarchy. In connection with the measurement and initial recognition of certain foreclosed assets, we may recognize charge-offs through the allowance for credit losses.

Collateral-Dependent Loans – Certain loans may be reported at the fair value of the underlying collateral if repayment is expected substantially from the operation or sale of the collateral. Collateral values are estimated using Level 3 inputs based on customized discounting criteria or appraisals. At September 30, 2022 and December 31, 2021, the impact of the fair value of collateral-dependent loans was reflected in our allowance for loan losses.

The fair value estimate of financial instruments for which quoted market prices are unavailable is dependent upon the assumptions used. Consequently, those estimates cannot be substantiated by comparison to independent markets and, in many cases, could not be realized in immediate settlement of the instruments. Accordingly, the aggregate fair value amounts presented in the fair value tables do not necessarily represent their underlying value.

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The following tables summarize assets measured at fair value on a recurring and nonrecurring basis segregated by the level of the valuation inputs within the fair value hierarchy utilized to measure fair value (in thousands):



			Fair Value Measurements at the End of the Reporting Period Using
September 30, 2022	Carrying Amount		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Recurring fair value measurements
Investment securities:


State and political subdivisions	$	1,038,332	$	—	$	1,038,332	$	—
Corporate bonds and other	57,417		—		57,417		—
MBS: (1)
Residential	320,368		—		320,368		—
Commercial	8,445		—		8,445		—
Equity investments:
Equity investments	5,224		5,224		—		—
Derivative assets:
Interest rate swaps	88,080		—		88,080		—
Total asset recurring fair value measurements	$	1,517,866	$	5,224	$	1,512,642	$	—

Derivative liabilities:
Interest rate swaps	$	22,822	$	—	$	22,822	$	—
Total liability recurring fair value measurements	$	22,822	$	—	$	22,822	$	—

Nonrecurring fair value measurements
Foreclosed assets	$	197	$	—	$	—	$	197
Collateral-dependent loans (2)	8,224		—		—		8,224
Total asset nonrecurring fair value measurements	$	8,421	$	—	$	—	$	8,421

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			Fair Value Measurements at the End of the Reporting Period Using
December 31, 2021	Carrying Amount		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Recurring fair value measurements
Investment securities:
U.S. Treasury	$	58,877	$	58,877	$	—	$	—

State and political subdivisions	2,051,936		—		2,051,936		—
Corporate bonds and other	135,532		—		135,532		—
MBS: (1)
Residential	426,350		—		426,350		—
Commercial	91,630		—		91,630		—
Equity investments:
Equity investments	5,920		5,920		—		—
Derivative assets:
Interest rate swaps	18,231		—		18,231		—
Total asset recurring fair value measurements	$	2,788,476	$	64,797	$	2,723,679	$	—

Derivative liabilities:
Interest rate swaps	$	19,823	$	—	$	19,823	$	—
Total liability recurring fair value measurements	$	19,823	$	—	$	19,823	$	—

Nonrecurring fair value measurements

Collateral-dependent loans (2)	$	8,458	$	—	$	—	$	8,458

Total asset nonrecurring fair value measurements	$	8,458	$	—	$	—	$	8,458

(1)All MBS are issued and/or guaranteed by U.S. government agencies or U.S. GSEs.

(2)Consists of individually evaluated loans. Loans for which the fair value of the collateral and commercial real estate fair value of the properties is less than cost basis are presented net of allowance. Losses on these loans represent charge-offs which are netted against the allowance for loan losses.

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Disclosure of fair value information about financial instruments, whether or not recognized in the balance sheet, is required when it is practicable to estimate that value. In cases where quoted market prices are not available, fair values are based on estimates using present value or other estimation techniques. Those techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. Such techniques and assumptions, as they apply to individual categories of our financial instruments, are as follows:

Cash and cash equivalents – The carrying amount for cash and cash equivalents is a reasonable estimate of those assets’ fair value.

Investment and MBS HTM – Fair values for these securities are based on quoted market prices, where available. If quoted market prices are not available, fair values are based on quoted market prices for similar securities or estimates from independent pricing services.

FHLB stock – The carrying amount of FHLB stock is a reasonable estimate of the fair value of those assets.

Equity investments – The carrying value of equity investments without readily determinable fair values are measured at cost less impairment, if any, adjusted for observable price changes for an identical or similar investment of the same issuer. This carrying value is a reasonable estimate of the fair value of those assets.

Loans receivable – We estimate the fair value of our loan portfolio to an exit price notion with adjustments for liquidity, credit and prepayment factors. Nonperforming loans continue to be estimated using discounted cash flow analyses or the underlying value of the collateral where applicable.

Loans held for sale – The fair value of loans held for sale is determined based on expected proceeds, which are based on sales contracts and commitments.

Deposit liabilities – The fair value of demand deposits, savings accounts and certain money market deposits is the amount on demand at the reporting date, which is the carrying value. Fair values for fixed rate CDs are estimated using a discounted cash flow calculation that applies interest rates currently being offered for deposits of similar remaining maturities.

Other borrowings – Federal funds purchased generally have original terms to maturity of one day and repurchase agreements generally have terms of less than one year, and therefore both are considered short-term borrowings. Consequently, their carrying value is a reasonable estimate of fair value.

FHLB borrowings – The fair value of these borrowings is estimated by discounting the future cash flows using rates at which borrowings would be made to borrowers with similar credit ratings and for the same remaining maturities.

Subordinated notes – The fair value of the subordinated notes is estimated by discounting future cash flows using estimated rates at which long-term debt would be made to borrowers with similar credit ratings and for the remaining maturities.

Trust preferred subordinated debentures – The fair value of the long-term debt is estimated by discounting future cash flows using estimated rates at which long-term debt would be made to borrowers with similar credit ratings and for the remaining maturities.

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The following tables present our financial assets and financial liabilities measured on a nonrecurring basis at both their respective carrying amounts and estimated fair value (in thousands):


			Estimated Fair Value
September 30, 2022	Carrying Amount		Total		Level 1		Level 2		Level 3
Financial assets:
Cash and cash equivalents	$	195,127	$	195,127	$	195,127	$	—	$	—
Investment securities:
HTM, at carrying value	1,013,674		816,756		—		816,756		—
MBS:
HTM, at carrying value	137,531		126,566		—		126,566		—
FHLB stock, at cost	12,887		12,887		—		12,887		—
Equity investments	5,828		5,828		—		5,828		—
Loans, net of allowance for loan losses	4,026,989		3,793,430		—		—		3,793,430
Loans held for sale	421		421		—		421		—
Financial liabilities:
Deposits	$	6,181,159	$	6,126,861	$	—	$	6,126,861	$	—
Other borrowings	74,721		74,721		—		74,721		—
FHLB borrowings	243,531		243,512		—		243,512		—
Subordinated notes, net of unamortized debt issuance costs	98,639		89,214		—		89,214		—
Trust preferred subordinated debentures, net of unamortized debt issuance costs	60,264		57,598		—		57,598		—


			Estimated Fair Value
December 31, 2021	Carrying Amount		Total		Level 1		Level 2		Level 3
Financial assets:
Cash and cash equivalents	$	201,753	$	201,753	$	201,753	$	—	$	—
Investment securities:
HTM, at carrying value	788		791		—		791		—
Mortgage-backed securities:
HTM, at carrying value	89,992		94,444		—		94,444		—
FHLB stock, at cost	14,375		14,375		—		14,375		—
Equity investments	5,921		5,921		—		5,921		—
Loans, net of allowance for loan losses	3,609,889		3,748,116		—		—		3,748,116
Loans held for sale	1,684		1,684		—		1,684		—
Financial liabilities:
Deposits	$	5,722,327	$	5,721,694	$	—	$	5,721,694	$	—
Other borrowings	23,219		23,219		—		23,219		—
FHLB borrowings	344,038		346,604		—		346,604		—
Subordinated notes, net of unamortized debt issuance costs	98,534		98,642		—		98,642		—
Trust preferred subordinated debentures, net of unamortized debt issuance costs	60,260		48,480		—		48,480		—

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11. Income Taxes

The income tax expense included in the accompanying consolidated statements of income consists of the following (in thousands):


	Three Months Ended September 30,				Nine Months Ended September 30,
	2022		2021		2022		2021
Current income tax expense	$	4,415	$	3,387	$	10,215	$	9,002
Deferred income tax expense (benefit)	(540)		1,590		103		3,612
Income tax expense	$	3,875	$	4,977	$	10,318	$	12,614

The net deferred tax asset totaled $46.0 million at September 30, 2022 as compared to a net deferred tax liability of $17.8 million at December 31, 2021. The increase in the net deferred tax asset is primarily the result of an increase in unrealized losses in the AFS securities portfolio. No valuation allowance was recorded at September 30, 2022 or December 31, 2021, as management believes it is more likely than not that all of the deferred tax asset items will be realized in future years. Unrecognized tax benefits were not material at September 30, 2022 or December 31, 2021.

We recognized income tax expense of $3.9 million and $10.3 million, for an ETR of 12.6% and 11.8% for the three and nine months ended September 30, 2022, respectively, compared to income tax expense of $5.0 million and $12.6 million, for an ETR of 14.5% and 13.0%, for the three and nine months ended September 30, 2021, respectively. The lower ETR for the three and nine months ended September 30, 2022 was primarily due to an increase in tax-exempt income as a percentage of pre-tax income as compared to the same periods in 2021. The ETR differs from the statutory rate of 21% for the three and nine months ended September 30, 2022 and 2021 primarily due to the effect of tax-exempt income from municipal loans and securities, as well as BOLI. We file income tax returns in the U.S. federal jurisdictions and in certain states. We are no longer subject to U.S. federal income tax examinations by tax authorities for years before 2018 or Texas state tax examinations by tax authorities for years before 2017.

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12. Off-Balance-Sheet Arrangements, Commitments and Contingencies

Financial Instruments with Off-Balance-Sheet Risk. In the normal course of business, we are a party to certain financial instruments with off-balance-sheet risk to meet the financing needs of our customers. These off-balance-sheet instruments include commitments to extend credit and standby letters of credit. These instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount reflected in the financial statements. The contract or notional amounts of these instruments reflect the extent of involvement and exposure to credit loss that we have in these particular classes of financial instruments. The allowance for credit losses on these off-balance-sheet credit exposures is calculated using the same methodology as loans including a conversion or usage factor to anticipate ultimate exposure and expected losses and is included in other liabilities on our consolidated balance sheets.

Allowance for off-balance-sheet credit exposures were as follows (in thousands):


	Three Months Ended September 30,				Nine Months Ended September 30,
	2022		2021		2022		2021

Balance at beginning of period	$	1,891	$	3,773	$	2,384	$	6,386

Provision for (reversal of) off-balance-sheet credit exposures	200		(683)		(293)		(3,296)
Balance at end of period	$	2,091	$	3,090	$	2,091	$	3,090

Contractual commitments to extend credit are agreements to lend to a customer provided the terms established in the contract are met. Commitments to extend credit generally have fixed expiration dates and may require the payment of fees. Since some commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. Standby letters of credit are conditional commitments issued to guarantee the performance of a customer to a third party. These guarantees are primarily issued to support public and private borrowing arrangements. The credit risk involved in issuing letters of credit is essentially the same as that involved in commitments to extend credit and similarly do not necessarily represent future cash obligations.

Financial instruments with off-balance-sheet risk were as follows (in thousands):


	September 30, 2022		December 31, 2021

Commitments to extend credit	$	1,223,284	$	1,053,002
Standby letters of credit	14,719		12,708
Total	$	1,238,003	$	1,065,710

We apply the same credit policies in making commitments to extend credit and standby letters of credit as we do for on-balance-sheet instruments. We evaluate each customer’s creditworthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary, upon extension of credit is based on management’s credit evaluation of the borrower. Collateral held varies but may include cash or cash equivalents, negotiable instruments, real estate, accounts receivable, inventory, oil, gas and mineral interests, property, plant and equipment.

Leases. During both the three and nine months ended September 30, 2022, there were $1.5 million operating lease ROU assets obtained in exchange for new operating lease liabilities. During the three and nine months ended September 30, 2021, there were $240,000 and $1.3 million, respectively, of operating lease ROU assets obtained in exchange for new operating lease liabilities, primarily due to one lease that commenced in January 2021 with an initial ROU asset of $1.1 million.

Securities. In the normal course of business we buy and sell securities. At September 30, 2022, there were no unsettled trades to purchase securities and no unsettled trades to sell securities. At December 31, 2021, there were $19.0 million unsettled trades to purchase securities and no unsettled trades to sell securities.

Deposits. There were $28.5 million unsettled issuances of brokered CDs at September 30, 2022. There were no unsettled issuances of brokered CDs at December 31, 2021.

Litigation. We are involved with various litigation in the normal course of business. Management, after consulting with our legal counsel, believes that any liability resulting from litigation will not have a material effect on our financial position, results of operations or liquidity.

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13. Subsequent Events

Subsequent to September 30, 2022, on October 27, 2022, we purchased 21,935 shares of common stock at an average price of $33.37 pursuant to the Stock Repurchase Plan.

Subsequent to September 30, 2022, on October 4, 2022, we transferred municipal securities and corporate bonds with fair values of approximately $118.9 million and $56.9 million, respectively, to HTM. All transfers from AFS to HTM were at the fair market value on the date of transfer. There was no impact to the income statement as a result of these transfers.

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

The following is a discussion of our consolidated financial condition, changes in our financial condition and results of our operations, and should be read and reviewed in conjunction with the financial statements, and the notes thereto, in this Quarterly Report on Form 10-Q and in our 2021 Form 10-K. Certain risks, uncertainties and other factors, including those set forth under "Risk Factors" in Part I, Item 1A. of the 2021 Form 10-K and elsewhere in this Quarterly Report on Form 10-Q, may cause actual results to differ materially from the results discussed in the forward-looking statements appearing in this discussion and analysis.

Forward-Looking Statements

Certain statements of other than historical fact that are contained in this report may be considered to be “forward-looking statements” within the meaning of and subject to the safe harbor protections of the Private Securities Litigation Reform Act of 1995. These forward-looking statements are not guarantees of future performance, nor should they be relied upon as representing management’s views as of any subsequent date. These statements may include words such as “expect,” “estimate,” “project,” “anticipate,” “appear,” “believe,” “could,” “should,” “may,” “might,” “will,” “would,” “seek,” “intend,” “probability,” “risk,” “goal,” “target,” “objective,” “plans,” “potential,” and similar expressions. Forward-looking statements are statements with respect to our beliefs, plans, expectations, objectives, goals, anticipations, assumptions, estimates, intentions and future performance and are subject to significant known and unknown risks and uncertainties, which could cause our actual results to differ materially from the results discussed in the forward-looking statements. For example, discussions of the effect of our expansion, benefits of the Share Repurchase Plan, trends in asset quality, capital, liquidity, our ability to sell nonperforming assets, expense reductions, planned operational efficiencies and earnings from growth and certain market risk disclosures, including the impact of interest rates, tax reform, inflation, the impacts related to or resulting from other economic factors are based upon information presently available to management and are dependent on choices about key model characteristics and assumptions and are subject to various limitations. By their nature, certain of the market risk disclosures are only estimates and could be materially different from what actually occurs in the future. Accordingly, our results could materially differ from those that have been estimated. The most significant factor that could cause future results to differ materially from those anticipated by our forward-looking statements include the ongoing impact of higher inflation levels, higher interest rates and general economic and recessionary concerns, all of which could impact economic growth and could cause a reduction in financial transactions and business activities, including decreased deposits and reduced loan originations, our ability to manage liquidity in a rapidly changing and unpredictable market, supply chain disruptions, labor shortages and additional interest rate increases by the Federal Reserve. Other factors that could cause actual results to differ materially from those indicated by forward-looking statements include, but are not limited to, the following:

•general (i) political conditions, including, without limitation, governmental action and uncertainty resulting from U.S. and global political trends and (ii) economic conditions, either globally, nationally, in the State of Texas, or in the specific markets in which we operate, including, without limitation, the deterioration of the commercial real estate, residential real estate, construction and development, energy, oil and gas, credit or liquidity markets, which could cause an adverse change in our net interest margin, or a decline in the value of our assets, which could result in realized losses, as well as the risk of an economic slowdown or recession;

•current or future legislation, regulatory changes or changes in monetary or fiscal policy that adversely affect the businesses in which we or our customers or our borrowers are engaged, including the impact of the Dodd-Frank Act, the Federal Reserve’s actions to increase interest rates, the capital requirements promulgated by the Basel Committee, the CARES Act, the Economic Aid Act, the discontinuation of interest rates based on LIBOR and other regulatory responses to economic conditions;

•economic or other disruptions caused by acts of terrorism, war or other conflicts, including the Russia-Ukraine conflict, natural disasters, such as hurricanes, freezes, flooding and other man-made disasters, such as oil spills or power outages, health emergencies, epidemics or pandemics or other catastrophic events;

•technological changes, including potential cyber-security incidents and other disruptions, or innovations to the financial services industry, including as a result of the increased telework environment;

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•our ability to identify and address cyber-security risks such as data security breaches, malware, “denial of service” attacks, “hacking” and identity theft, which could disrupt our business and result in the disclosure of and/or misuse or misappropriation of confidential or proprietary information, disruption or damage of our systems, increased costs, significant losses, or adverse effects to our reputation;

•changes in the interest rate yield curve such as flat, inverted or steep yield curves, or changes in the interest rate environment that impact net interest margins and may impact prepayments on our MBS portfolio;

•the ongoing impact of the COVID-19 pandemic and related variants on our future consolidated financial condition and results of operations and the financial condition of our customers;

•the risk that our enterprise risk management framework, compliance program or our corporate governance and supervisory oversight functions may not identify or address risks adequately, which may result in unexpected losses;

•the effect of compliance with legislation or regulatory changes;

•credit risks of borrowers, including any increase in those risks due to changing economic conditions, inflation and interest rates;

•increases in our nonperforming assets;

•risks related to environmental liability as a result of certain lending activity;

•our ability to maintain adequate liquidity to fund operations and growth;

•our ability to monitor interest rate risk;

•any applicable regulatory limits or other restrictions on the Bank and its ability to pay dividends to us;

•the failure of our assumptions underlying our allowance for credit losses and other estimates;

•the failure to maintain an effective system of controls and procedures, including internal control over financial reporting;

•the effectiveness of our derivative financial instruments and hedging activities to manage risk;

•unexpected outcomes of, and the costs associated with, existing or new litigation involving us;

•potential claims, damages, penalties, fines and reputational damage resulting from pending or future litigation, regulatory proceedings and enforcement actions;

•changes impacting our balance sheet and leverage strategy;

•risks related to actual mortgage prepayments diverging from projections;

•risks related to fluctuations in the price per barrel of crude oil;

•significant increases in competition in the banking and financial services industry;

•changes in consumer spending, borrowing and saving habits, including as a result of rising inflation and the economic impact of COVID-19;

•execution of future acquisitions, reorganization or disposition transactions, including the risk that the anticipated benefits of such transactions are not realized;

•our ability to increase market share and control expenses;

•our ability to develop competitive new products and services in a timely manner and the acceptance of such products and services by our customers;

•the effect of changes in federal or state tax laws;

•the effect of changes in accounting policies and practices;

•adverse changes in the status or financial condition of the GSEs which impact the GSEs’ guarantees or ability to pay or issue debt;

•adverse changes in the credit portfolios of other U.S. financial institutions relative to the performance of certain of our investment securities;

•risks related to actual U.S. agency MBS prepayments exceeding projected prepayment levels;

•risks related to U.S. agency MBS prepayments increasing due to U.S. government programs designed to assist homeowners to refinance their mortgage that might not otherwise have qualified;

•risks related to loans secured by real estate, including the risk that the value and marketability of collateral could decline;

•risks associated with our common stock and our other securities, including fluctuations in our stock price and general volatility in the stock market; and

•other risks and uncertainties discussed in “Part I - Item 1A. Risk Factors” in the 2021 Form 10-K.

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All written or oral forward-looking statements made by us or attributable to us are expressly qualified by this cautionary notice. We disclaim any obligation to update any factors or to announce publicly the result of revisions to any of the forward-looking statements included herein to reflect future events or developments, unless otherwise required by law.

Critical Accounting Estimates

Our accounting and reporting estimates conform with U.S. GAAP and general practices within the financial services industry. The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. We consider accounting estimates that can (1) be replaced by other reasonable estimates and/or (2) changes to an estimate from period to period that have a material impact on the presentation of our financial condition, changes in financial condition or results of operations as well as (3) those estimates that require significant and complex assumptions about matters that are highly uncertain to be critical accounting estimates. We consider our critical accounting policies to include allowance for credit losses on loans and off-balance-sheet credit exposure.

Critical accounting estimates include a high degree of uncertainty in the underlying assumptions. Management bases its estimates on historical experience, current information and other factors deemed relevant. The development, selection and disclosure of our critical accounting estimates are reviewed with the Audit Committee of the Company's Board of Directors. Actual results could differ from these estimates. For additional information regarding critical accounting policies, refer to “Part II - Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations - Critical Accounting Estimates,,” “Part II - Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations - Allowance for Credit Losses - Loans and Allowance for Credit Losses - Off-Balance-Sheet Credit Exposures,” “Note 1 – Summary of Significant Accounting and Reporting Policies,” “Note 5 – Loans and Allowance for Loan Losses” and “Note 17 - Off-Balance-Sheet Arrangements, Commitments and Contingencies” in the 2021 Form 10-K. As of September 30, 2022, there have been no significant changes to our critical accounting estimates.

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Non-GAAP Financial Measures

Certain non-GAAP measures are used by management to supplement the evaluation of our performance. These include the following fully taxable-equivalent measures: Net interest income (FTE), net interest margin (FTE) and net interest spread (FTE), which include the effects of taxable-equivalent adjustments using a federal income tax rate of 21% to increase tax-exempt interest income to a tax-equivalent basis. Interest income earned on certain assets is completely or partially exempt from federal income tax. As such, these tax-exempt instruments typically yield lower returns than taxable investments.

Net interest income (FTE), net interest margin (FTE) and net interest spread (FTE). Net interest income (FTE) is a non-GAAP measure that adjusts for the tax-favored status of net interest income from certain loans and investments and is not permitted under GAAP in the consolidated statements of income. We believe this measure to be the preferred industry measurement of net interest income, and that it enhances comparability of net interest income arising from taxable and tax-exempt sources. The most directly comparable financial measure calculated in accordance with GAAP is our net interest income. Net interest margin (FTE) is the ratio of net interest income (FTE) to average earning assets. The most directly comparable financial measure calculated in accordance with GAAP is our net interest margin. Net interest spread (FTE) is the difference in the average yield on average earning assets on a tax-equivalent basis and the average rate paid on average interest bearing liabilities. The most directly comparable financial measure calculated in accordance with GAAP is our net interest spread.

These non-GAAP financial measures should not be considered alternatives to GAAP-basis financial statements and other bank holding companies may define or calculate these non-GAAP measures or similar measures differently. Whenever we present a non-GAAP financial measure in an SEC filing, we are also required to present the most directly comparable financial measure calculated and presented in accordance with GAAP and reconcile the differences between the non-GAAP financial measure and such comparable GAAP measure.

In the following table we present the reconciliation of net interest income to net interest income adjusted to a fully taxable-equivalent basis assuming a 21% marginal tax rate for interest earned on tax-exempt assets such as municipal loans and investment securities (dollars in thousands), along with the calculation of net interest margin (FTE) and net interest spread (FTE).


Non-GAAP Reconciliations
	Three Months Ended September 30,						Nine Months Ended September 30,
	2022			2021			2022			2021
Net interest income (GAAP)	$	55,515		$	48,206		$	155,499		$	140,156
Tax equivalent adjustments:
Loans	742			722			2,249			2,180
Tax-exempt investment securities	2,973			2,666			8,431			7,289
Net interest income (FTE) (1)	$	59,230		$	51,594		$	166,179		$	149,625

Average earning assets	$	6,999,525		$	6,467,545		$	6,742,985		$	6,368,906

Net interest margin	3.15		%	2.96		%	3.08		%	2.94		%
Net interest margin (FTE) (1)	3.36		%	3.16		%	3.29		%	3.14		%

Net interest spread	2.87		%	2.79		%	2.90		%	2.77		%
Net interest spread (FTE) (1)	3.08		%	3.00		%	3.11		%	2.97		%

(1) These amounts are presented on a fully taxable-equivalent basis and are non-GAAP measures.

Management believes adjusting net interest income, net interest margin and net interest spread to a fully taxable-equivalent basis is a standard practice in the banking industry as these measures provide useful information to make peer comparisons. Tax-equivalent adjustments are reported in the respective earning asset categories as listed in the “Average Balances with Average Yields and Rates” tables under Results of Operations.

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OVERVIEW

COVID-19

COVID-19 significantly impacted local, national and global economies due to stay-at-home orders and social distancing guidelines. In compliance with social distancing guidelines issued by federal, state and local governments, we implemented a number of precautionary actions to safeguard our business and our employees from COVID-19. Additionally, COVID-19 significantly disrupted supply chains, business activity and the overall economic and financial markets globally and in our footprint.

Since the implementation of the PPP in 2020, we originated over $420 million of loans in this program, of which $306,000 were still outstanding as of September 30, 2022. Additionally, we assisted both our consumer and commercial borrowers that experienced financial hardship due to COVID-19 related challenges.

We continue to monitor and assess the impacts of the COVID-19 pandemic on our employees and customers. The ongoing pandemic could continue to adversely impact the markets in which we operate and our business, operations and financial condition.

ECONOMIC CONDITIONS

The economic conditions and growth prospects for our markets, even against the headwinds of inflation and recessionary concerns, continue to reflect a solid and positive overall outlook with economic activity close to pre-pandemic levels. Increasing interest rates and high building costs have caused a slowdown in what was a robust single family housing market, however there continues to be a shortage of housing in several Texas markets. Worker shortages, especially in the restaurant, hospitality and retail industries, combined with supply chain disruptions impacting numerous industries and inflationary conditions, has had some impact on the level of economic growth. Ongoing higher inflation levels and higher interest rates could have a negative impact on both our consumer and commercial borrowers. Despite these conditions, overall, Texas continues to experience economic growth due to company relocations and expansions, combined with overall population growth.

Operating Results

Net income decreased $2.4 million, or 8.0%, for the three months ended September 30, 2022, to $27.0 million compared to the same period in 2021. The decrease in net income was primarily a result of an increase in the provision for credit losses, a $2.5 million decrease in noninterest income and the $1.7 million increase in noninterest expense, partially offset by the $7.3 million increase in net interest income and the $1.1 million decrease in income tax expense. For the three months ended September 30, 2022, we recorded a provision for credit losses of $1.5 million, compared to a reversal of provision for credit losses of $5.1 million for the same period in 2021. Earnings per diluted common share decreased $0.06, or 6.7%, to $0.84 for the three months ended September 30, 2022, compared to $0.90 for the three months ended September 30, 2021.

During the nine months ended September 30, 2022, our net income decreased $7.4 million, or 8.7%, to $77.4 million from $84.7 million for the same period in 2021. The decrease in net income was largely driven by the increase in the provision for credit losses, the $7.2 million decrease in noninterest income, and the $3.1 million increase in noninterest expense, partially offset by the $15.3 million increase in net interest income and the $2.3 million decrease in income tax expense. For the nine months ended September 30, 2022, we recorded a provision for credit losses of $1.2 million compared to a reversal of provision for credit losses of $13.5 million for the same period in 2021. Earnings per diluted common share decreased $0.20, or 7.7%, to $2.39 for the nine months ended September 30, 2022, from $2.59 for the same period in 2021.

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Financial Condition

Our total assets increased $194.1 million, or 2.7%, to $7.45 billion at September 30, 2022 from $7.26 billion at December 31, 2021. Our securities portfolio decreased by $279.3 million, or 9.8%, to $2.58 billion, compared to $2.86 billion at December 31, 2021. The decrease in the securities portfolio was due to the increase in the unrealized loss in the portfolio, sales of securities, and principal payments, which more than offset the securities purchased during the nine months ended September 30, 2022. Our FHLB stock decreased $1.5 million, or 10.4%, to $12.9 million from $14.4 million at December 31, 2021, due to the decline in our FHLB borrowings during the nine months ended September 30, 2022, reducing the amount of FHLB stock we are required to hold.

Loans at September 30, 2022 were $4.06 billion, an increase of $418.3 million, or 11.5%, compared to $3.65 billion at December 31, 2021. Our PPP loans, a component of the commercial loan category, decreased $30.7 million, or 99.0%, during the nine months ended September 30, 2022 due to forgiveness payments received for loans funded under the CARES Act. Excluding PPP loans, total loans increased $449.1 million, or 12.4%, due to increases of $303.7 million in commercial real estate loans, $106.5 million in construction loans, $45.3 million in commercial loans (excluding PPP loans) and $6.1 million in municipal loans. The increases were partially offset by decreases of $8.1 million in loans to individuals and $4.4 million in 1-4 family residential loans. Loans held for sale decreased $1.3 million, or 75.0%, to $421,000 at September 30, 2022 from $1.7 million at December 31, 2021.

Our nonperforming assets at September 30, 2022 increased $108,000, or 0.9%, to $11.7 million and represented 0.16% of total assets, compared to $11.6 million, or 0.16% of total assets, at December 31, 2021. Nonaccruing loans increased $503,000, or 19.8%, to $3.0 million, and the ratio of nonaccruing loans to total loans remained at 0.07% for September 30, 2022 and December 31, 2021. TDR loans were $8.5 million and $9.1 million at September 30, 2022 and December 31, 2021, respectively. There was $162,000 of OREO at September 30, 2022 and none at December 31, 2021.

Our deposits increased $458.8 million, or 8.0%, to $6.18 billion at September 30, 2022 from $5.72 billion at December 31, 2021. The increase was primarily due to the increase in our brokered deposits of $467.2 million, or 158.5%, associated with funding our cash flow hedge swaps in place of the FHLB advances to obtain lower cost funding.

Total FHLB borrowings decreased $100.5 million, or 29.2%, to $243.5 million at September 30, 2022 from $344.0 million at December 31, 2021.

Our total shareholders’ equity at September 30, 2022 decreased 22.4%, or $204.5 million, to $707.6 million, or 9.5% of total assets, compared to $912.2 million, or 12.6% of total assets, at December 31, 2021. The primary decrease in shareholders’ equity was the result of other comprehensive loss of $240.4 million, a direct result of the impact of rising interest rates on the AFS securities portfolio. Additional decreases to shareholders’ equity included cash dividends paid of $32.8 million and the repurchase of $12.5 million of our common stock. These decreases were partially offset by net income of $77.4 million, stock compensation expense of $2.4 million, common stock issued under our dividend reinvestment plan of $913,000 and net issuance of common stock under employee stock plans of $505,000.

Key financial indicators management follows include, but are not limited to, numerous interest rate sensitivity and interest rate risk indicators, credit risk, operations risk, liquidity risk, capital risk, regulatory risk, inflation risk, competition risk, yield curve risk, U.S. agency MBS prepayment risk and economic risk indicators.

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Balance Sheet Strategy

Determining the appropriate size of the balance sheet is one of the critical decisions any bank makes. Our balance sheet is not merely the result of a series of micro-decisions, but rather the size is controlled based on the economics of assets compared to the economics of funding and funding sources. Changing interest rate environments and economic conditions require that we monitor the interest rate sensitivity of the assets, the funding driving our growth and closely align ALCO objectives accordingly.

During the first quarter of 2022, we replaced $310 million of FHLB advances with lower cost brokered deposits as the funding source of our cash flow hedge swaps to lower this expense. Over the past two years, management used the significant increase in non-maturity deposits, net of brokered deposits, to reduce dependence on more interest rate sensitive wholesale funding. At September 30, 2022, the securities portfolio is currently funded primarily by non-maturity deposits with wholesale funding accounting for approximately 38% of the funding source, of which approximately 55% is swapped at a fixed rate, providing protection from rising interest rates.

We utilize wholesale funding and securities to enhance overall profitability by maximizing the use of our capital, determining acceptable levels of credit, interest rate and liquidity risk consistent with prudent capital management. This balance sheet strategy currently consists of borrowing funds from the brokered funds market, FHLB and FRDW. These funds are invested primarily in U.S. agency MBS and long-term municipal securities. Although U.S. agency MBS often carry lower yields than loans we make, these securities generally (i) increase the overall quality of our assets because of either the implicit or explicit guarantees of the U.S. Government, (ii) are more liquid than individual loans and (iii) may be used to collateralize our borrowings or other obligations.

Risks associated with this asset structure include a potentially lower net interest rate spread and margin when compared to our peers, changes in the slope of the yield curve, increased interest rate risk, the length of interest rate cycles, changes in volatility or spreads associated with the MBS and municipal securities, the unpredictable nature of MBS prepayments and credit risks associated with the municipal securities. See “Part I - Item 1A. Risk Factors – Risks Related to Our Business” in the 2021 Form 10-K for a discussion of risks related to interest rates. An additional risk is significant increases in interest rates, especially long-term interest rates, which could adversely impact the fair value of the AFS securities portfolio and could also impact our equity capital. Due to the unpredictable nature of MBS prepayments, the length of interest rate cycles and the slope of the interest rate yield curve, net interest income could fluctuate more than simulated under the scenarios modeled by our ALCO and described under “Item 3. Quantitative and Qualitative Disclosures about Market Risk” in this Quarterly Report on Form 10-Q.

Our securities portfolio decreased from $2.86 billion at December 31, 2021 to $2.58 billion at September 30, 2022. The decrease in the securities portfolio was due to the increase in the unrealized loss in the portfolio, sales of securities, and principal payments, which more than offset the securities purchased during the nine months ended September 30, 2022.

During the nine months ended September 30, 2022, the composition of the securities portfolio continued to change as corporate bonds increased while the remaining categories in the portfolio decreased. The decrease in MBS was attributable to the sales of U.S. Agency MBS and regular principal payments, partially offset by MBS purchases during the second and third quarter. During the nine months ended September 30, 2022, we purchased $303 million in highly rated primarily Texas municipal securities, $41.2 million of which were taxable, $49.4 million in U.S. Treasury Notes, $320.3 million in MBS and $26.4 million in investment grade subordinated debt. Sales during the nine months ended September 30, 2022, included $107.5 million in U.S. Treasury Notes due to the rising rate environment, $28.1 million in municipal securities and $328.8 million in MBS to align the investment portfolio with the current balance sheet strategy. Sales of AFS securities for the three and nine months ended September 30, 2022, resulted in a net realized loss of $99,000 and $3.8 million, respectively.

During the three and nine months ended September 30, 2022, management transferred to HTM, long duration AFS municipal securities with fair values of approximately $41.8 million and $916.7 million, respectively. Management also transferred to HTM, MBS with fair values of approximately $28.4 million and $56.7 million during the three and nine months ended September 30, 2022, respectively. Additionally, during the nine months ended September 30, 2022, management transferred to HTM, $95.3 million in corporate bonds. Long duration securities experience greater fair value volatility when interest rates either rise or fall. These transfers reduce any future volatility reflected in AOCI, resulting from unrealized gains or losses. These transfers were made to align the investment portfolio with the current balance sheet strategy, and management has the intent and ability to hold these securities to maturity.

At September 30, 2022, securities as a percentage of assets totaled 34.6%, compared to 39.3% at December 31, 2021, due to an increase in total assets of $194.1 million and the $279.3 million, or 9.8%, decrease in the securities portfolio. Our balance sheet management strategy is dynamic and is continually evaluated as market conditions warrant.

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During the second and third quarters of 2022, we entered into partial term fair value hedges for certain of our fixed rate callable AFS municipal securities. The instruments are designated as fair value hedges as the changes in the fair value of the interest rate swap are expected to offset changes in the fair value of the hedged item attributable to changes in the SOFR swap rate, the designated benchmark interest rate. As of September 30, 2022, hedged securities with a carrying amount of $708.9 million are included in our AFS securities portfolio in our consolidated balance sheets. These derivative contracts involve the receipt of floating rate interest from a counterparty in exchange for us making fixed-rate payments over the life of the agreement, without the exchange of the underlying notional value. The change in the fair value of these hedging instruments is recorded in AOCI and is subsequently reclassified into earnings in the period that the hedged transactions affects earnings. A pre-tax unrealized gain of $23.9 million was recognized in other comprehensive income as of September 30, 2022 and there was no ineffective portion of these hedges.

With respect to funding sources, we primarily utilize deposits and to a lesser extent wholesale funding to achieve our strategy of minimizing cost while achieving overall interest rate risk objectives as well as the liability management objectives of the ALCO. Our primary wholesale funding sources are brokered deposits, FHLB and FRDW borrowings. Our FHLB borrowings decreased 29.2%, or $100.5 million, to $243.5 million at September 30, 2022 from $344.0 million at December 31, 2021.

For the nine months ended September 30, 2022, our total wholesale funding as a percentage of deposits, not including brokered deposits, increased to 19.2%, from 11.8% at December 31, 2021, and 14.8% at September 30, 2021.

Our brokered deposits consist of CDs and non-maturity deposits. Our brokered CDs increased $137.7 million, or 557.6%, from $24.7 million at December 31, 2021 to $162.4 million at September 30, 2022. At September 30, 2022, our brokered CDs had a weighted average cost of 239 basis points and remaining maturities of less than 7 months. Our brokered non-maturity deposits increased to $599.6 million at September 30, 2022, of which $575.0 million are related to our cash flow hedges, from $270.1 million at December 31, 2021, with a weighted average cost of 107 basis points and 91 basis points, respectively. Our wholesale funding policy currently allows for maximum brokered deposits of $1.10 billion, with an additional $50 million of flexibility for deposits maturing within 30 days. Potential higher interest expense and lack of customer loyalty are risks associated with the use of brokered deposits.

In connection with most of our wholesale funds, the Bank has entered into various variable rate agreements and fixed or variable rate short-term pay agreements with an interest rate tied to three-month LIBOR or to one-month LIBOR. In connection with $575.0 million and $605.0 million of the agreements outstanding at September 30, 2022 and December 31, 2021, respectively, the Bank also entered into various interest rate swap contracts that are treated as cash flow hedges under ASC Topic 815, “Derivatives and Hedging” that are expected to be effective in hedging the variability in future cash flows attributable to fluctuations in the underlying LIBOR interest rate. The interest rate swap contracts had an average interest rate of 1.13% with a remaining average weighted maturity of 2.6 years at September 30, 2022. Refer to “Note 11 – Derivative Financial Instruments and Hedging Activities” in our consolidated financial statements included in this report for a detailed description of our hedging policy and methodology related to derivative instruments.

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Results of Operations

Our results of operations are dependent primarily on net interest income, which is the difference between the interest income earned on assets (loans and investments) and interest expense due on our funding sources (deposits and borrowings) during a particular period. Results of operations are also affected by our noninterest income, provision for credit losses, noninterest expenses and income tax expense. General economic and competitive conditions, particularly changes in interest rates, changes in interest rate yield curves, prepayment rates of MBS and loans, repricing of loan relationships, government policies and actions of regulatory authorities also significantly affect our results of operations. Future changes in applicable law, regulations or government policies may also have a material impact on us.

The following table presents net interest income for the periods presented (in thousands):


	Three Months Ended				Nine Months Ended
	September 30,				September 30,
	2022		2021		2022		2021
Interest income:
Loans	$	45,257	$	37,034	$	118,489	$	108,792
Taxable investment securities	4,896		3,853		14,136		9,097
Tax-exempt investment securities	11,482		9,649		32,306		27,787
MBS	4,770		4,405		12,025		15,140
FHLB stock and equity investments	101		111		291		355
Other interest earning assets	374		24		606		56
Total interest income	66,880		55,076		177,853		161,227
Interest expense:
Deposits	7,887		2,234		15,388		7,170
FHLB borrowings	1,078		1,865		1,668		5,590
Subordinated notes	1,004		2,417		3,002		7,235
Trust preferred subordinated debentures	669		345		1,496		1,045
Repurchase agreements	54		9		82		31
Other borrowings	673		—		718		—
Total interest expense	11,365		6,870		22,354		21,071
Net interest income	$	55,515	$	48,206	$	155,499	$	140,156

Net Interest Income

Net interest income is one of the principal sources of a financial institution’s earnings stream and represents the difference or spread between interest and fee income generated from interest earning assets and the interest expense paid on interest bearing liabilities. Fluctuations in interest rates or interest rate yield curves, as well as repricing characteristics and volume and changes in the mix of interest earning assets and interest bearing liabilities, materially impact net interest income. During the nine months ended September 30, 2022, the Federal Reserve increased the target federal funds rate by 300 basis points to 325 basis points and has indicated it anticipates additional rate increases during the remainder of 2022. The increase in the federal funds rate to date has increased our net interest income. However, as the federal funds rate increases further and the yield curve remains flat, it may be less beneficial to our net interest income.

Net interest income for the three months ended September 30, 2022 increased $7.3 million, or 15.2%, compared to the same period in 2021. The increase in net interest income for the three months ended September 30, 2022 was due to the increase in interest income, a result of a combined increase in the average yield as well as the average balance of interest earning assets, partially offset by an increase in interest expense on our interest bearing liabilities due to higher interest rates and the change in the mix of our interest bearing liabilities. Total interest income increased $11.8 million, or 21.4%, to $66.9 million for the three months ended September 30, 2022, compared to $55.1 million during the same period in 2021. Total interest expense increased $4.5 million, or 65.4%, to $11.4 million for the three months ended September 30, 2022, compared to $6.9 million for the same period in 2021. Our net interest margin and net interest margin (FTE), a non-GAAP measure, increased to 3.15% and 3.36%, respectively, for the three months ended September 30, 2022, compared to 2.96% and 3.16%, respectively, for the same period in 2021, and our net interest spread and net interest spread (FTE), also a non-GAAP measure, increased to 2.87% and 3.08%, respectively, compared to 2.79% and 3.00%, respectively, for the same period in 2021.

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Net interest income was $155.5 million for the nine months ended September 30, 2022 compared to $140.2 million for the same period in 2021, an increase of $15.3 million, or 10.9%. The increase in net interest income for the nine months ended September 30, 2022 was due to a result of a combined increase in the average balance as well as the average yield of interest earning assets, partially offset by the increase in interest expense on our interest bearing liabilities due to the increase in interest rates and the change in the mix of our interest bearing liabilities. Total interest income increased $16.6 million, or 10.3%, to $177.9 million for the nine months ended September 30, 2022, compared to $161.2 million for the same period in 2021. Total interest expense increased $1.3 million, or 6.1%, to $22.4 million for the nine months ended September 30, 2022, compared to $21.1 million for the same period in 2021. Our net interest margin and net interest margin (FTE), a non-GAAP measure, increased to 3.08% and 3.29%, respectively, for the nine months ended September 30, 2022, compared to 2.94% and 3.14%, respectively, for the same period in 2021, and our net interest spread and net interest spread (FTE), also a non-GAAP measure, increased to 2.90% and 3.11%, respectively, compared to 2.77% and 2.97%, respectively, for the same period in 2021. See “Non-GAAP Financial Measures” for more information and for a reconciliation to GAAP.

Quarterly Analysis of Changes in Interest Income and Interest Expense

The following table presents on a fully taxable-equivalent basis, a non-GAAP measure, the net change in net interest income and sets forth the dollar amount of increase (decrease) in the average volume of interest earning assets and interest bearing liabilities and from changes in yields/rates. Volume/Yield/Rate variances (change in volume times change in yield/rate) have been allocated to amounts attributable to changes in volumes and to changes in yields/rates in proportion to the amounts directly attributable to those changes (in thousands):


	Three Months Ended September 30, 2022 Compared to 2021
	Change Attributable to				Total
Fully Taxable-Equivalent Basis:	Average Volume		Average Yield/Rate		Change
Interest income on:
Loans (1)	$	3,794	$	4,454	$	8,248
Loans held for sale	(10)		5		(5)
Taxable investment securities	713		330		1,043
Tax-exempt investment securities (1)	2,465		(325)		2,140
Mortgage-backed and related securities	(1,547)		1,912		365
FHLB stock, at cost, and equity investments	(54)		44		(10)
Interest earning deposits	(19)		100		81
Federal funds sold	269		—		269
Total earning assets	5,611		6,520		12,131
Interest expense on:
Savings accounts	41		191		232
CDs	(55)		718		663
Interest bearing demand accounts	399		4,359		4,758
FHLB borrowings	(1,993)		1,206		(787)
Subordinated notes, net of unamortized debt issuance costs	(1,039)		(374)		(1,413)
Trust preferred subordinated debentures, net of unamortized debt issuance costs	—		324		324
Repurchase agreements	5		40		45
Other borrowings	673		—		673
Total interest bearing liabilities	(1,969)		6,464		4,495
Net change	$	7,580	$	56	$	7,636

(1)Interest yields on loans and securities that are nontaxable for federal income tax purposes are presented on a fully taxable-equivalent basis. See “Non-GAAP Financial Measures” for more information and for a reconciliation to GAAP.

The increase in total interest income was primarily attributable to an increase in the average yield on interest earning assets to 4.00% from 3.59% for the same period in 2021, as well as an increase in the average balance of interest earning assets of $532.0 million, or 8.2%, for the three months ended September 30, 2022 compared to the same period in 2021. The increase in total interest expense for the three months ended September 30, 2022 was primarily attributable to the increase in interest rates on our interest bearing liabilities for the three months ended September 30, 2022, when compared to the same period in 2021.

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The “Average Balances with Average Yields and Rates” table that follows shows average earning assets and interest bearing liabilities together with the average yield on the earning assets and the average rate of the interest bearing liabilities (dollars in thousands) for the three months ended September 30, 2022 and 2021. The interest and related yields presented are on a fully taxable-equivalent basis and are therefore non-GAAP measures. See “Non-GAAP Financial Measures” for more information, and for a reconciliation to GAAP.


	Average Balances with Average Yields and Rates (Annualized)
	(unaudited)
	Three Months Ended
	September 30, 2022						September 30, 2021
	Average Balance		Interest		Average Yield/Rate		Average Balance		Interest		Average Yield/Rate
ASSETS
Loans (1)	$	4,012,547	$	45,992	4.55	%	$	3,662,496	$	37,744	4.09	%
Loans held for sale	606		7		4.58	%	1,640		12		2.90	%
Securities:
Taxable investment securities (2)	626,136		4,896		3.10	%	532,679		3,853		2.87	%
Tax-exempt investment securities (2)	1,750,952		14,455		3.28	%	1,453,275		12,315		3.36	%
Mortgage-backed and related securities (2)	520,501		4,770		3.64	%	738,287		4,405		2.37	%
Total securities	2,897,589		24,121		3.30	%	2,724,241		20,573		3.00	%
FHLB stock, at cost, and equity investments	24,013		101		1.67	%	39,786		111		1.11	%
Interest earning deposits	18,664		105		2.23	%	39,382		24		0.24	%
Federal funds sold	46,106		269		2.31	%	—		—		—
Total earning assets	6,999,525		70,595		4.00	%	6,467,545		58,464		3.59	%
Cash and due from banks	102,840						99,113
Accrued interest and other assets	433,532						684,917
Less: Allowance for loan losses	(35,706)						(43,052)
Total assets	$	7,500,191					$	7,208,523
LIABILITIES AND SHAREHOLDERS’ EQUITY
Savings accounts	$	685,947	481		0.28	%	$	598,118	249		0.17	%
CDs	588,212		1,452		0.98	%	629,718		789		0.50	%
Interest bearing demand accounts	3,164,961		5,954		0.75	%	2,496,037		1,196		0.19	%
Total interest bearing deposits	4,439,120		7,887		0.70	%	3,723,873		2,234		0.24	%
FHLB borrowings	173,838		1,078		2.46	%	656,474		1,865		1.13	%
Subordinated notes, net of unamortized debt issuance costs	98,621		1,004		4.04	%	195,204		2,417		4.91	%
Trust preferred subordinated debentures, net of unamortized debt issuance costs	60,263		669		4.40	%	60,258		345		2.27	%
Repurchase agreements	30,530		54		0.70	%	21,634		9		0.17	%
Other borrowings	98,174		673		2.72	%	—		—		—
Total interest bearing liabilities	4,900,546		11,365		0.92	%	4,657,443		6,870		0.59	%
Noninterest bearing deposits	1,746,245						1,551,298
Accrued expenses and other liabilities	101,881						97,954
Total liabilities	6,748,672						6,306,695
Shareholders’ equity	751,519						901,828
Total liabilities and shareholders’ equity	$	7,500,191					$	7,208,523
Net interest income (FTE)			$	59,230					$	51,594
Net interest margin (FTE)					3.36	%					3.16	%
Net interest spread (FTE)					3.08	%					3.00	%

(1)Interest on loans includes net fees on loans that are not material in amount.

(2)For the purpose of calculating the average yield, the average balance of securities is presented at historical cost.

Note: As of September 30, 2022 and 2021, loans totaling $3.0 million were on nonaccrual status. Our policy is to reverse previously accrued but unpaid interest on nonaccrual loans; thereafter, interest income is recorded to the extent received when appropriate.

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Year-to-Date Analysis of Changes in Interest Income and Interest Expense


	Nine Months Ended September 30, 2022 Compared to 2021
	Change Attributable to				Total
Fully Taxable-Equivalent Basis:	Average Volume		Average Yield/Rate		Change
Interest income on:
Loans (1)	$	5,801	$	3,977	$	9,778
Loans held for sale	(26)		14		(12)
Taxable investment securities	4,944		95		5,039
Tax-exempt investment securities (1)	7,012		(1,351)		5,661
Mortgage-backed and related securities	(7,236)		4,121		(3,115)
Federal Home Loan Bank stock, at cost, and equity investments	(191)		127		(64)
Interest earning deposits	16		182		198
Federal funds sold	352		—		352
Total earning assets	10,672		7,165		17,837
Interest expense on:
Savings accounts	146		245		391
CDs	(543)		213		(330)
Interest bearing demand accounts	1,289		6,868		8,157
FHLB borrowings	(6,430)		2,508		(3,922)
Subordinated notes, net of unamortized debt issuance costs	(3,144)		(1,089)		(4,233)
Trust preferred subordinated debentures, net of unamortized debt issuance costs	—		451		451
Repurchase agreements	8		43		51
Other borrowings	718		—		718
Total interest bearing liabilities	(7,956)		9,239		1,283
Net change	$	18,628	$	(2,074)	$	16,554

The increase in total interest income was attributable to the increase in average earning assets of $374.1 million, or 5.9%, for the nine months ended September 30, 2022, compared to the same period in 2021, as well as an increase in the average yield on earning assets to 3.74% from 3.58% for the same period in 2021. The increase in total interest expense for the nine months ended September 30, 2022 was primarily attributable to the increase in interest rates on our interest bearing liabilities when compared to the same period in 2021.

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The “Average Balances with Average Yields and Rates” table that follows shows average earning assets and interest bearing liabilities together with the average yield on the earning assets and the average rate of the interest bearing liabilities (dollars in thousands) for the nine months ended September 30, 2022 and 2021. The interest and related yields presented are on a fully taxable-equivalent basis and are therefore non-GAAP measures. See “Non-GAAP Financial Measures” for more information, and for a reconciliation to GAAP.


	Average Balances with Average Yields and Rates (Annualized)
	(unaudited)
	Nine Months Ended
	September 30, 2022						September 30, 2021
	Average Balance		Interest		Average Yield/Rate		Average Balance		Interest		Average Yield/Rate
ASSETS
Loans (1)	$	3,855,844	$	120,705	4.19	%	$	3,667,941	$	110,927	4.04	%
Loans held for sale	1,102		33		4.00	%	2,092		45		2.88	%
Securities:
Taxable investment securities (2)	629,413		14,136		3.00	%	409,251		9,097		2.97	%
Tax-exempt investment securities (2)	1,656,691		40,737		3.29	%	1,373,206		35,076		3.42	%
Mortgage-backed and related securities (2)	501,330		12,025		3.21	%	841,361		15,140		2.41	%
Total securities	2,787,434		66,898		3.21	%	2,623,818		59,313		3.02	%
FHLB stock, at cost, and equity investments	20,796		291		1.87	%	37,116		355		1.28	%
Interest earning deposits	46,972		254		0.72	%	37,939		56		0.20	%
Federal funds sold	30,837		352		1.53	%	—		—		—
Total earning assets	6,742,985		188,533		3.74	%	6,368,906		170,696		3.58	%
Cash and due from banks	103,390						92,206
Accrued interest and other assets	492,173						672,558
Less: Allowance for loan losses	(35,746)						(44,664)
Total assets	$	7,302,802					$	7,089,006
LIABILITIES AND SHAREHOLDERS’ EQUITY
Savings accounts	$	669,632	1,080		0.22	%	$	562,699	689		0.16	%
CDs	556,728		2,624		0.63	%	674,452		2,954		0.59	%
Interest bearing demand accounts	3,146,350		11,684		0.50	%	2,433,120		3,527		0.19	%
Total interest bearing deposits	4,372,710		15,388		0.47	%	3,670,271		7,170		0.26	%
FHLB borrowings	117,724		1,668		1.89	%	684,280		5,590		1.09	%
Subordinated notes, net of unamortized debt issuance costs	98,587		3,002		4.07	%	196,572		7,235		4.92	%
Trust preferred subordinated debentures, net of unamortized debt issuance costs	60,262		1,496		3.32	%	60,257		1,045		2.32	%
Repurchase agreements	27,393		82		0.40	%	22,387		31		0.19	%
Other borrowings	35,421		718		2.71	%	—		—		—
Total interest bearing liabilities	4,712,097		22,354		0.63	%	4,633,767		21,071		0.61	%
Noninterest bearing deposits	1,697,779						1,475,828
Accrued expenses and other liabilities	92,161						94,536
Total liabilities	6,502,037						6,204,131
Shareholders’ equity	800,765						884,875
Total liabilities and shareholders’ equity	$	7,302,802					$	7,089,006
Net interest income (FTE)			$	166,179					$	149,625
Net interest margin (FTE)					3.29	%					3.14	%
Net interest spread (FTE)					3.11	%					2.97	%

(1)Interest on loans includes net fees on loans that are not material in amount.

(2)For the purpose of calculating the average yield, the average balance of securities is presented at historical cost.

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Noninterest Income

Noninterest income consists of revenue generated from a broad range of financial services and activities and other fee generating services that we either provide or in which we participate.

The following table details the categories included in noninterest income (dollars in thousands):


	Three Months Ended September 30,				2022
					Change From
	2022		2021		2021
Deposit services	$	6,241	$	6,779	$	(538)	(7.9)	%
Net gain (loss) on sale of securities AFS	(99)		1,381		(1,480)		(107.2)	%
Gain on sale of loans	109		299		(190)		(63.5)	%
Trust fees	1,407		1,494		(87)		(5.8)	%
BOLI	720		637		83		13.0	%
Brokerage services	701		846		(145)		(17.1)	%
Other noninterest income	1,190		1,333		(143)		(10.7)	%
Total noninterest income	$	10,269	$	12,769	$	(2,500)	(19.6)	%



	Nine Months Ended September 30,			2022
			Change From
		2022		2021		2021
Deposit services				$	19,365	$	19,513	$	(148)	(0.8)	%
Net gain (loss) on sale of securities AFS				(3,819)		3,399		(7,218)		(212.4)	%
Gain on sale of loans				495		1,285		(790)		(61.5)	%
Trust fees				4,421		4,373		48		1.1	%
BOLI				2,131		1,908		223		11.7	%
Brokerage services				2,608		2,476		132		5.3	%
Other noninterest income				4,890		4,371		519		11.9	%
Total noninterest income				$	30,091	$	37,325	$	(7,234)	(19.4)	%

The 19.6% decrease in noninterest income for the three months ended September 30, 2022, when compared to the same period in 2021, was due primarily to a net loss on sale of securities AFS and decreases in deposit services income, gain on sale of loans, brokerage services income and other noninterest income. The 19.4% decrease in noninterest income for the nine months ended September 30, 2022, when compared to the same period in 2021, was due to a net loss on sale of securities AFS and a decrease in gain on sale of loans, partially offset by an increase in other noninterest income.

The decrease in deposit services income for the three months ended September 30, 2022, when compared to the same period in 2021, was due to a decrease in overdraft and non-sufficient fund fees and debit card income.

During the three and nine months ended September 30, 2022, we sold U.S. Treasury securities, MBS and municipal securities that resulted in a net loss on sale of AFS securities of $99,000 and $3.8 million, respectively.

Gain on sale of loans decreased for the three and nine months ended September 30, 2022, when compared to the same period in 2021, due to a decrease in the volume of loans sold.

The increase in BOLI income for the three and nine months ended September 30, 2022, when compared to the same periods in 2021, was due to $13.0 million in additional BOLI purchased during the third quarter of 2021.

Brokerage services income decreased for the three months ended September 30, 2022, when compared to the same period in 2021, due to a decrease in production and the downturn in the market.

Other noninterest income decreased for the three months ended September 30, 2022, when compared to the same period in 2021, due to a decrease in equity investment income. For the nine months ended September 30, 2022, noninterest income increased when compared to same period in 2021, primarily due to increases in investment income, mortgage servicing fee income, mortgage derivative income and credit card fee income, partially offset by decreases in swap fee income and equity investment income.

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Noninterest Expense

We incur certain types of noninterest expenses associated with the operation of our various business activities. The following table details the categories included in noninterest expense (dollars in thousands):


	Three Months Ended September 30,				2022
					Change From
	2022		2021		2021
Salaries and employee benefits	$	21,368	$	19,777	$	1,591	8.0	%
Net occupancy	3,847		3,532		315		8.9	%

Advertising, travel & entertainment	789		579		210		36.3	%
ATM expense	317		311		6		1.9	%
Professional fees	1,412		1,135		277		24.4	%
Software and data processing	1,736		1,503		233		15.5	%
Communications	497		552		(55)		(10.0)	%
FDIC insurance	485		454		31		6.8	%
Amortization of intangibles	550		695		(145)		(20.9)	%
Loss on redemption of subordinated notes	—		1,118		(1,118)		(100.0)	%
Other noninterest expense	2,463		2,107		356		16.9	%
Total noninterest expense	$	33,464	$	31,763	$	1,701	5.4	%



	Nine Months Ended September 30,			2022
			Change From
		2022		2021		2021
Salaries and employee benefits				$	61,666	$	59,825	$	1,841	3.1	%
Net occupancy				11,157		10,698		459		4.3	%

Advertising, travel & entertainment				2,242		1,491		751		50.4	%
ATM expense				954		821		133		16.2	%
Professional fees				3,486		3,166		320		10.1	%
Software and data processing				5,106		4,221		885		21.0	%
Communications				1,509		1,689		(180)		(10.7)	%
FDIC insurance				1,434		1,343		91		6.8	%
Amortization of intangibles				1,758		2,191		(433)		(19.8)	%
Loss on redemption of subordinated notes				—		1,118		(1,118)		(100.0)	%
Other noninterest expense				7,453		7,133		320		4.5	%
Total noninterest expense				$	96,765	$	93,696	$	3,069	3.3	%

The primary increase in noninterest expense for the three and nine months ended September 30, 2022, when compared to the same periods in 2021, was in salaries and employee benefits. Several additional expense categories increased during the three months ended September 30, 2022, including other noninterest expense, net occupancy expense, professional fees, software and data processing expense and advertising, travel and entertainment expense, however when combined, such expenses were partially offset by the loss on the redemption of subordinated notes recorded in the third quarter of 2021. Several additional expense categories also increased during the nine months ended September 30, 2022, including software and data processing expense, advertising, travel and entertainment expense and net occupancy expense, however when combined, such expenses were partially offset by the loss on the redemption of subordinated notes recorded in the third quarter of 2021.

Salaries and employee benefits increased for the three months ended September 30, 2022, when compared to the same period in 2021, due to an increase in direct salary expense and health insurance expense, partially offset by a decrease in retirement expense. Salaries and employee benefits increased for the nine months ended September 30, 2022, when compared to the same period in 2021, due to an increase in direct salary expense, partially offset by decreases in retirement expense and health insurance expense.

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For the three and nine months ended September 30, 2022, direct salary expense increased $1.6 million, or 9.6%, and $3.0 million, or 6.0%, respectively, when compared to the same periods in 2021, primarily due to normal salary increases effective in the first quarter of 2022 and market increases in the second quarter of 2022.

Health and life insurance expense, included in salaries and employee benefits, increased $229,000, or 10.0%, and decreased $507,000, or 7.6%, for the three and nine months ended September 30, 2022, respectively, when compared to the same periods in 2021. We have a self-insured health plan which is supplemented with a stop loss insurance policy.

Retirement expense, included in salaries and employee benefits, decreased $203,000, or 18.5%, and $654,000, or 20.7%, for the three and nine months ended September 30, 2022, respectively, when compared to the same periods in 2021. This decrease was primarily due to a decrease in our split dollar agreement expense and deferred compensation expense.

Net occupancy expense increased for the three and nine months ended September 30, 2022, when compared to the same periods in 2021, due to increased depreciation, rent expense and other occupancy related expenses.

Advertising, travel and entertainment expense increased for the three and nine months ended September 30, 2022, when compared to the same periods in 2021, primarily due to increases in donations, travel related expenses and media advertising.

ATM expense increased for the nine months ended September 30, 2022, when compared to the same period in 2021, due primarily to higher armored car expense.

Professional fees increased for the three and nine months ended September 30, 2022, when compared to the same period in 2021, due to an increase in consulting fees.

Software and data processing expense increased for the three and nine months ended September 30, 2022, when compared to the same periods in 2021, due to new software contracts and increases in existing contract renewal costs.

Communications expense decreased for the three and nine months ended September 30, 2022, when compared to the same periods in 2021, driven by a decrease in phone and internet costs.

Amortization of intangibles decreased for the three and nine months ended September 30, 2022, when compared to the same periods in 2021, due primarily to a decrease in core deposit intangible amortization which is recognized on an accelerated method resulting in a decline in expense over the amortization period.

Loss on redemption of subordinated notes consisted of the remaining unamortized discount of $856,000 and debt issuance costs of $251,000 associated with the notes at the time of redemption on September 30, 2021.

Other noninterest expense increased for the three months ended September 30, 2022, when compared to the same period in 2021, primarily due to increases in losses on other real estate owned and losses on retired assets.

Income Taxes

Pre-tax income for the three and nine months ended September 30, 2022 was $30.8 million and $87.7 million, respectively, a decrease of 10.1% and 9.9%, compared to $34.3 million and $97.3 million for the same periods in 2021. We recorded income tax expense of $3.9 million and $10.3 million, for the three and nine months ended September 30, 2022, respectively, compared to income tax expense of $5.0 million and $12.6 million for the same periods in 2021. The ETR as a percentage of pre-tax income was 12.6% and 11.8% for the three and nine months ended September 30, 2022, compared to an ETR as a percentage of pre-tax income of 14.5% and 13.0% for the same periods in 2021. The decrease in the income tax expense for the three and nine months ended September 30, 2022 was a result of a decrease in pre-tax income and the ETR. The decrease in the ETR for the three and nine months ended September 30, 2022 is primarily due to an increase in tax-exempt income as a percentage of pre-tax income as compared to the same periods in 2021.

The ETR differs from the statutory rate of 21% primarily due to the effect of tax-exempt income from municipal loans and securities, as well as BOLI. The net deferred tax asset totaled $46.0 million at September 30, 2022 as compared to a net deferred tax liability of $17.8 million at December 31, 2021. The increase in the net deferred tax asset is primarily the result of an increase in unrealized losses in the AFS securities portfolio.

See “Note 11 – Income Taxes” to our consolidated financial statements included in this report. No valuation allowance was recorded at September 30, 2022 or December 31, 2021, as management believes it is more likely than not that all of the deferred tax asset items will be realized in future years.

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Composition of Loans

One of our main objectives is to seek attractive lending opportunities in Texas, primarily in the market areas in which we operate. Refer to “Part I - Item 1. Business - Market Area” in the 2021 Form 10-K for a discussion of our primary market area and the geographic concentration of our loan portfolio as of December 31, 2021. There were no substantial changes in these concentrations during the nine months ended September 30, 2022. The majority of our loan originations are made to borrowers who live in and/or conduct business in the market areas of Texas in which we operate or adjoin, with the exception of municipal loans, which are made primarily throughout the state of Texas. Municipal loans are made to municipalities, counties, school districts and colleges.

The following table sets forth loan totals by class as of the dates presented (dollars in thousands):


							Compared to
							December 31, 2021		September 30, 2021
	September 30, 2022		December 31, 2021		September 30, 2021		Change (%)		Change (%)

Real estate loans:
Construction	$	554,345	$	447,860	$	422,095	23.8	%	31.3	%
1-4 family residential	646,692		651,140		660,689		(0.7)	%	(2.1)	%
Commercial	1,901,921		1,598,172		1,605,132		19.0	%	18.5	%
Commercial loans	433,538		418,998		443,708		3.5	%	(2.3)	%
Municipal loans	449,219		443,078		427,259		1.4	%	5.1	%
Loans to individuals	77,780		85,914		88,702		(9.5)	%	(12.3)	%
Total loans	$	4,063,495	$	3,645,162	$	3,647,585	11.5	%	11.4	%

Our total loan portfolio increased $418.3 million, or 11.5%, at September 30, 2022 compared to December 31, 2021. For the nine months ended September 30, 2022, our PPP loans decreased $30.7 million, or 99.0%, from $31.0 million at December 31, 2021, primarily due to forgiveness payments received from loans funded under the CARES Act. Excluding PPP loans, total loans increased $449.1 million, or 12.4%, with increases in commercial real estate loans, construction loans, commercial loans and municipal loans, partially offset by decreases in loans to individuals and 1-4 family residential loans.

Excluding a $67.2 million year-over-year decrease in PPP loans, total loans increased $483.1 million, or 13.5%, compared to September 30, 2021, with increases in commercial real estate loans, construction loans, commercial loans and municipal loans, partially offset by decreases in 1-4 family residential loans and loans to individuals.

At September 30, 2022, our real estate loans represented 76.4% of our loan portfolio and were comprised of commercial real estate loans of 61.3%, 1-4 family residential loans of 20.8% and construction loans of 17.9%. Commercial real estate loans primarily include loans collateralized by retail, commercial office buildings, multi-family residential buildings, medical facilities and offices, senior living, assisted living and skilled nursing facilities, warehouse facilities, hotels and churches. Our 1-4 family residential loans consist primarily of loans secured by first mortgages on owner occupied 1-4 family residences. Our construction loans are collateralized by property located primarily in or near the market areas we serve. A number of our construction loans will be owner occupied upon completion. Construction loans for non-owner occupied projects are financed, but these typically have cash flows from leases with tenants, secondary sources of repayment, and in some cases, additional collateral.

Loan Portfolios Most at Risk due to Economic Stress

The banking industry is affected by general economic conditions such as interest rates, inflation, recession, unemployment and other factors beyond our control, including the ongoing impact of the COVID-19 pandemic. During the last 30 years, the Texas economy has continued to diversify, decreasing the overall impact of fluctuations in oil and gas prices; however, the oil and gas industry is still a significant component of the Texas economy. Oil prices have increased significantly during 2022 as a result of strong demand, global supply disruptions and the Ukraine/Russia conflict. We cannot predict whether current economic conditions or oil prices will improve, remain the same or decline.

As of September 30, 2022, the Company’s exposure to the oil and gas industry totaled $117.5 million, or 2.89% of gross loans, an increase of $47.8 million, or 68.7%, from December 31, 2021, and consisted primarily of (i) support/service loans of 2.28%, (ii) upstream of 0.45%, (iii) midstream of 0.12% and (iv) downstream of 0.04%. Expanded monitoring and analysis of these loans has been implemented to address the uncertainty in oil and gas prices as needed.

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The following table sets forth our oil and gas information for the periods presented (dollars in thousands):


	September 30, 2022			December 31, 2021			September 30, 2021
Oil and gas related loans	$	117,529		$	69,688		$	70,685
Oil and gas related loans as a % of loans	2.89		%	1.91		%	1.94		%
Classified oil and gas related loans	$	389		$	4,104		$	4,418
Classified oil and gas related loans as a % of oil and gas related loans	0.33		%	5.89		%	6.25		%
Nonaccrual oil and gas related loans	$	231		$	334		$	342
Net (recoveries) charge-offs for oil and gas related loans	$	—		$	(7)		$	(7)
Allowance for oil and gas related loans as a % of oil and gas loans	0.57		%	1.19		%	1.24		%

As of September 30, 2022, while elevated inflation and recessionary concerns persist, overall economic activity in Texas has returned close to pre-pandemic levels. Commercial activity has resumed to levels close to those existing prior to the outbreak of the pandemic. When the pandemic occurred, in addition to the oil and gas industry, we considered the sectors set forth in the table below to be most vulnerable to financial risks from business disruptions caused by the pandemic mitigation efforts based on North American Industry Classification System categories as of September 30, 2022 (dollars in thousands). At September 30, 2022, the percent of loans classified in the hotel sector increased to 34.78%, from 14.33% compared to December 31, 2021, a direct result of payoffs in this category of approximately 58.8%, reducing the remaining balance of loans held in the hotel sector. No additional loans in the hotel sector have been classified since December 31, 2021. As of September 30, 2022, our customers in these industries have not experienced long-term business disruptions initially thought possible. We are, however, continuing to monitor these customers closely.


	September 30, 2022
	Loans		Percent of Total Loans		Percent Classified (1)
Retail commercial real estate (2)	$	527,126	12.97	%	—
Retail goods and services	46,113		1.13	%	0.14	%
Hotels	25,535		0.63	%	34.78	%
Food services	52,897		1.30	%	6.77	%
Arts, entertainment and recreation	7,642		0.19	%	1.72	%
Total	$	659,313	16.22	%	1.92	%


	December 31, 2021
	Loans		Percent of Total Loans		Percent Classified (1)
Retail commercial real estate (2)	$	384,381	10.54	%	—
Retail goods and services	72,650		1.99	%	0.20	%
Hotels	61,992		1.70	%	14.33	%
Food services	45,019		1.24	%	4.33	%
Arts, entertainment and recreation	6,039		0.17	%	2.95	%
Total	$	570,081	15.64	%	1.96	%


	September 30, 2021
	Loans		Percent of Total Loans		Percent Classified (1)
Retail commercial real estate (2)	$	338,123	9.27	%	—
Retail goods and services	72,166		1.98	%	0.27	%
Hotels	62,677		1.72	%	14.17	%
Food services	46,731		1.28	%	—
Arts, entertainment and recreation	6,480		0.18	%	2.88	%
Total	$	526,177	14.43	%	1.76	%

(1) Sector classified loans as a percentage of sector total loans.

(2) Loans in the retail commercial real estate sector are included in our commercial real estate portfolio.

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PCD Loans

We have purchased certain loans that as of the date of purchase have experienced more-than-insignificant deterioration in credit quality since origination. Management evaluates these loans against a probability threshold to determine if substantially all of the contractually required payments will be received. PCD loans are recorded at the purchase price plus an allowance for credit losses which becomes the PCD loan's initial amortized cost. The non-credit related discount or premium, the difference between the initial amortized cost and the par value, will be amortized into interest income over the life of the loan. Any further changes to the allowance for credit losses are recorded through provision expense. In accordance with the adoption of ASU 2016-13, management did not reassess whether PCI assets met the criteria of PCD assets and elected to not maintain pools of loans as of the date of adoption. All PCD loans are evaluated based upon product type within the underlying segment.

Nonperforming Assets

Nonperforming assets consist of delinquent loans 90 days or more past due, nonaccrual loans, OREO, repossessed assets and TDR loans. Nonaccrual loans are loans 90 days or more delinquent and collection in full of both the principal and interest is not expected. Additionally, some loans that are not delinquent or that are delinquent less than 90 days may be placed on nonaccrual status if it is probable that we will not receive contractual principal and interest payments in accordance with the terms of the respective loan agreements. When a loan is categorized as nonaccrual, the accrual of interest is discontinued and any accrued balance is reversed for financial statement purposes. OREO represents real estate taken in full or partial satisfaction of debts previously contracted. The dollar amount of OREO is based on a current evaluation of the OREO at the time it is recorded on our books, net of estimated selling costs. Updated valuations are obtained as needed and any additional impairments are recognized. Restructured loans represent loans that have been renegotiated to provide a below market interest rate or deferral of interest or principal because of deterioration in the financial position of the borrowers. The restructuring of a loan is considered a TDR if both (i) the borrower is experiencing financial difficulties and (ii) the creditor has granted a concession. Concessions may include interest rate reductions or below market interest rates, restructuring amortization schedules and other actions intended to minimize potential losses. Categorization of a loan as nonperforming is not in itself a reliable indicator of potential loan loss. Other factors, such as the value of collateral securing the loan and the financial condition of the borrower are considered in judgments as to potential loan loss.

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The following table sets forth nonperforming assets for the periods presented (dollars in thousands):


							Compared to
							December 31, 2021		September 30, 2021
	September 30, 2022		December 31, 2021		September 30, 2021		Change (%)		Change (%)







Nonaccrual loans	$	3,039	$	2,536	$	3,013	19.8	%	0.9	%
Accruing loans past due more than 90 days	—		—		—		—		—
TDR loans	8,481		9,073		9,371		(6.5)	%	(9.5)	%
OREO	162		—		25		100.0	%	548.0	%
Repossessed assets	35		—		15		100.0	%	133.3	%
Total nonperforming assets	$	11,717	$	11,609	$	12,424	0.9	%	(5.7)	%

Total loans	$	4,063,495	$	3,645,162	$	3,647,585
Allowance for loan losses at end of period	36,506		35,273		38,022


Ratio of nonaccruing loans to:
Total loans	0.07	%	0.07	%	0.08	%
Ratio of nonperforming assets to:
Total assets	0.16	%	0.16	%	0.17	%
Total loans	0.29	%	0.32	%	0.34	%
Total loans and OREO	0.29	%	0.32	%	0.34	%
Total loans, excluding PPP loans, and OREO	0.29	%	0.32	%	0.35	%
Ratio of allowance for loan losses to:
Nonaccruing loans	1,201.25	%	1,390.89	%	1,261.93	%
Nonperforming assets	311.56	%	303.84	%	306.04	%
Total loans	0.90	%	0.97	%	1.04	%
Total loans, excluding PPP loans	0.90	%	0.98	%	1.06	%
Net charge-offs to average loans outstanding	0.01	%	0.02	%	0.03	%

We actively market all OREO properties and do not hold them for investment purposes.

Allowance for Credit Losses - Loans

In accordance with ASC 326, the allowance for credit losses on loans is estimated and recognized upon origination of the loan based on expected credit losses. The CECL model uses historical experience and current conditions for homogeneous pools of loans, and reasonable and supportable forecasts about future events. The impact of varying economic conditions and portfolio stress factors are a component of the credit loss models applied to each portfolio. Reserve factors are specific to the loan segments that share similar risk characteristics based on the probability of default assumptions and loss given default assumptions, over the contractual term. The forecasted periods gradually mean-revert the economic inputs to their long-run historical trends. Management evaluates the economic data points used in the Moody’s forecasting scenarios on a quarterly basis to determine the most appropriate impact to the various portfolio characteristics based on management’s view and applies weighting to various forecasting scenarios as deemed appropriate based on known and expected economic activities. Management also considers and may apply relevant qualitative factors, not previously considered, to determine the appropriate allowance level. The use of the CECL model includes significant judgment by management and may differ from those of our peers due to different historical loss patterns, economic forecasts, and the length of time of the reasonable and supportable forecast period and reversion period.

We utilize Moody’s Analytics economic forecast scenarios and assign probability weighting to those scenarios which best reflect management’s views on the economic forecast. The probability weighting and scenarios utilized for the estimate of the allowance were generally reflective of improved asset quality, offset slightly by continued economic uncertainty related to inflation and recessionary concerns, as based on known and knowable information as of September 30, 2022.

When determining the appropriate allowance for credit losses on our loan portfolio, our commercial construction and real estate loans, commercial loans and municipal loans utilize the probability of default/loss given default discounted cash flow approach.

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Reserves on these loans are based upon risk factors including the loan type and structure, collateral type, leverage ratio, refinancing risk and origination quality, among others. Our consumer construction real estate loans, 1-4 family residential loans and our loans to individuals use a loss rate based upon risk factors including loan types, origination year and credit scores. Loans covered by the PPP may be eligible for loan forgiveness. The remaining loan balance after forgiveness of any amount is still fully guaranteed by the SBA and therefore does not have an associated allowance.

Loans evaluated collectively in a pool are monitored to ensure they continue to exhibit similar risk characteristics with other loans in the pool. If a loan does not share similar risk characteristics with other loans, expected credit losses for that loan are evaluated individually.

As of September 30, 2022, our review of the loan portfolio indicated that an allowance for loan losses of $36.5 million was appropriate to cover expected losses in the portfolio. Changes in economic and other conditions, including the application of the CECL model, rising interest rates and heightened inflation, may require future adjustments to the allowance for loan losses.

During the nine months ended September 30, 2022, the allowance for loan losses increased $1.2 million, or 3.5%, to $36.5 million, or 0.90% of total loans, when compared to $35.3 million, or 0.97% of total loans at December 31, 2021.

For the three and nine months ended September 30, 2022, loan charge-offs were $686,000 and $1.7 million, respectively, and recoveries were $449,000 and $1.5 million, respectively. For the three and nine months ended September 30, 2021, loan charge-offs were $940,000 and $2.3 million, respectively, and recoveries were $437,000 and $1.5 million, respectively. For the three and nine months ended September 30, 2022, we recorded a provision for credit losses for loans of $1.3 million and $1.4 million, respectively. For the three and nine months ended September 30, 2021, we recorded a reversal of provision for credit losses for loans of $4.4 million and $10.2 million, respectively.

Allowance for Credit Losses - Off-Balance-Sheet Credit Exposures

Allowance for off-balance-sheet credit exposures were as follows (in thousands):


	Three Months Ended September 30,				Nine Months Ended September 30,
	2022		2021		2022		2021

Balance at beginning of period	$	1,891	$	3,773	$	2,384	$	6,386

Provision for (reversal of) off-balance-sheet credit exposures	200		(683)		(293)		(3,296)
Balance at end of period	$	2,091	$	3,090	$	2,091	$	3,090

Our off-balance-sheet credit exposures include contractual commitments to extend credit and standby letters of credit. For these credit exposures we evaluate the expected credit losses using usage given defaults and credit conversion factors depending on the type of commitment and based upon historical usage rates. These assumptions are reevaluated on an annual basis and adjusted if necessary. For the three and nine months ended September 30, 2022, we recorded a provision for credit losses for off-balance-sheet exposures of $200,000 and a reversal of provision of $293,000, respectively, compared to a reversal of $683,000 and $3.3 million, for the three and nine months ended September 30, 2021, respectively. For additional information regarding our methodology used to estimate the allowance for credit losses on off-balance-sheet credit exposures, see “Note 12 - Off-Balance-Sheet Arrangements, Commitments and Contingencies” to our consolidated financial statements included in this report.

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Capital Resources and Liquidity

The Company’s Common Equity Tier 1 capital includes common stock and related paid-in capital, net of treasury stock, and retained earnings. The Bank’s Common Equity Tier 1 capital includes common stock and related paid-in capital, and retained earnings. In connection with the adoption of the Basel III Capital Rules, we elected to opt-out of the requirement to include accumulated other comprehensive income in Common Equity Tier 1. We also elected, for a five-year transitional period, the effects of credit loss accounting under CECL from Common Equity Tier 1, as further discussed below. Common Equity Tier 1 for both the Company and the Bank is reduced by goodwill and other intangible assets, net of associated deferred tax liabilities.

Tier 1 capital includes Common Equity Tier 1 capital and additional Tier 1 capital. For the Company, additional Tier 1 capital at September 30, 2022 included $58.5 million of trust preferred securities. For bank holding companies that had assets of less than $15 billion as of December 31, 2009, trust preferred securities issued prior to May 19, 2010 can be treated as Tier 1 capital to the extent that they do not exceed 25% of Tier 1 capital after the application of capital deductions and adjustments. The Bank did not have any additional Tier 1 capital beyond Common Equity Tier 1 at September 30, 2022.

Total capital includes Tier 1 capital and Tier 2 capital. Tier 2 capital for both the Company and the Bank includes a permissible portion of the allowance for credit losses on loans and off-balance sheet exposures. Tier 2 capital for the Company also includes $98.6 million of qualified subordinated debt as of September 30, 2022. The permissible portion of qualified subordinated notes decreases 20% per year during the final five years of the term of the notes.

In April 2020, the FDIC, Federal Reserve, and the Office of the Comptroller of the Currency issued supplemental instructions allowing banking organizations that implement CECL before the end of 2020, the option to delay for two years an estimate of the CECL methodologies’ effect on regulatory capital, relative to the incurred loss methodologies effect on capital, followed by a three-year transition period. We elected to adopt the five-year transition option. In accordance with CECL guidance, a CECL transitional amount totaling $6.1 million has been added back to CET1 as of September 30, 2022, representing 75% of the $8.2 million transitional amount at December 31, 2021.

Also in April 2020, we began originating loans to qualified small businesses under the PPP administered by the SBA. Federal bank regulatory agencies have issued an interim final rule that permits banks to neutralize the regulatory capital effects of participating in the Paycheck Protection Program Lending Facility and clarify that PPP loans have a zero percent risk weight under applicable risk-based capital rules. Specifically, a bank may exclude all PPP loans pledged as collateral to the PPP Facility from its average total consolidated assets for the purposes of calculating its leverage ratio, while PPP loans that are not pledged as collateral to the PPP Facility will be included. Our PPP loans are included in the calculation of our leverage ratio as of September 30, 2022, as we did not utilize the PPP Facility for funding purposes.

Management believes that, as of September 30, 2022, we met all capital adequacy requirements to which we were subject. It is management’s intention to maintain our capital at a level acceptable to all regulatory authorities and future dividend payments will be determined accordingly. Regulatory authorities require that any dividend payments made by either us or the Bank not exceed earnings for that year. Accordingly, shareholders should not anticipate a continuation of the cash dividend payments simply because of the existence of a dividend reinvestment program. The payment of dividends will depend upon future earnings, our financial condition and other related factors including the discretion of the board of directors.

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To be categorized as well capitalized we must maintain minimum Common Equity Tier 1 risk-based, Tier 1 risk-based, Total capital risk-based and Tier 1 leverage ratios as set forth in the following table (dollars in thousands):


	Actual				For Capital Adequacy Purposes				To Be Well Capitalized Under Prompt Corrective Actions Provisions
September 30, 2022	Amount		Ratio		Amount		Ratio		Amount		Amount
Common Equity Tier 1 (to Risk-Weighted Assets)
Consolidated	$	692,139	12.98	%	$	239,985	4.50	%	N/A		N/A
Bank Only	$	837,461	15.71	%	$	239,953	4.50	%	$	346,599	6.50	%

Tier 1 Capital (to Risk-Weighted Assets)
Consolidated	$	750,592	14.07	%	$	319,980	6.00	%	N/A		N/A
Bank Only	$	837,461	15.71	%	$	319,937	6.00	%	$	426,583	8.00	%

Total Capital (to Risk-Weighted Assets)
Consolidated	$	880,090	16.50	%	$	426,640	8.00	%	N/A		N/A
Bank Only	$	868,320	16.28	%	$	426,583	8.00	%	$	533,229	10.00	%

Tier 1 Capital (to Average Assets) (1)
Consolidated	$	750,592	10.09	%	$	297,635	4.00	%	N/A		N/A
Bank Only	$	837,461	11.26	%	$	297,524	4.00	%	$	371,905	5.00	%


	Actual				For Capital Adequacy Purposes				To Be Well Capitalized Under Prompt Corrective Actions Provisions
December 31, 2021	Amount		Ratio		Amount		Ratio		Amount		Ratio










Common Equity Tier 1 (to Risk-Weighted Assets)
Consolidated	$	657,043	14.17	%	$	208,616	4.50	%	N/A		N/A
Bank Only	$	793,271	17.11	%	$	208,576	4.50	%	$	301,277	6.50	%

Tier 1 Capital (to Risk-Weighted Assets)
Consolidated	$	715,492	15.43	%	$	278,155	6.00	%	N/A		N/A
Bank Only	$	793,271	17.11	%	$	278,102	6.00	%	$	370,803	8.00	%

Total Capital (to Risk-Weighted Assets)
Consolidated	$	841,300	18.15	%	$	370,874	8.00	%	N/A		N/A
Bank Only	$	820,545	17.70	%	$	370,803	8.00	%	$	463,503	10.00	%

Tier 1 Capital (to Average Assets) (1)
Consolidated	$	715,492	10.33	%	$	277,065	4.00	%	N/A		N/A
Bank Only	$	793,271	11.46	%	$	276,932	4.00	%	$	346,165	5.00	%

(1)Refers to quarterly average assets as calculated in accordance with policies established by bank regulatory agencies.

As of September 30, 2022, Southside Bancshares and Southside Bank met all capital adequacy requirements under the Basel III Capital Rules that became fully phased-in as of January 1, 2019. Refer to the Supervision and Regulation section in the 2021 Form 10-K for further discussion of our capital requirements.

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The table below summarizes our key equity ratios for the periods presented:


	Three Months Ended September 30,
	2022		2021
Return on average assets	1.43	%	1.61	%
Return on average shareholders’ equity	14.23	%	12.89	%
Dividend payout ratio – Basic	40.48	%	36.67	%
Dividend payout ratio – Diluted	40.48	%	36.67	%
Average shareholders’ equity to average total assets	10.02	%	12.51	%
	Nine Months Ended September 30,
	2022		2021
Return on average assets	1.42	%	1.60	%
Return on average shareholders’ equity	12.92	%	12.80	%
Dividend payout ratio – Basic	42.50	%	37.69	%
Dividend payout ratio – Diluted	42.68	%	37.84	%
Average shareholders’ equity to average total assets	10.97	%	12.48	%

Management of Liquidity

Liquidity management involves our ability to convert assets to cash with minimum risk of loss while enabling us to meet our current and future obligations to our customers at any time. This means addressing (1) the immediate cash withdrawal requirements of depositors and other fund providers; (2) the funding requirements of lines and letters of credit; and (3) the short-term credit needs of customers. Liquidity is provided by cash, interest earning deposits and short-term investments that can be readily liquidated with a minimum risk of loss. At September 30, 2022, these investments were 2.6% of total assets, as compared with 5.9% for December 31, 2021 and 4.8% for September 30, 2021. The decrease to 2.6% at September 30, 2022 as compared to December 31, 2021 and September 30, 2021, is reflective of the increase in total assets combined with decreases in the short-term investment portfolio and interest earning deposits. Liquidity is further provided through the matching, by time period, of rate sensitive interest earning assets with rate sensitive interest bearing liabilities. The Bank has three unsecured lines of credit for the purchase of overnight federal funds at prevailing rates with Frost Bank, TIB – The Independent Bankers Bank and Comerica Bank for $40.0 million, $15.0 million and $7.5 million, respectively. There were no federal funds purchased at September 30, 2022 or December 31, 2021. To provide more liquidity in response to the economic impact of the COVID-19 pandemic, the Federal Reserve took steps to encourage broader use of the discount window. At September 30, 2022, the amount of additional funding the Bank could obtain from the FRDW, collateralized by securities, was approximately $505.8 million. There were $34.0 million in borrowings from the FRDW at September 30, 2022. There were no borrowings from the FRDW at December 31, 2021. At September 30, 2022, the amount of additional funding Southside Bank could obtain from FHLB, collateralized by securities, FHLB stock and nonspecified loans and securities, was approximately $1.62 billion, net of FHLB stock purchases required. The Bank has a $5.0 million line of credit with Frost Bank to be used to issue letters of credit, and at September 30, 2022, the line had one outstanding letter of credit for $155,000. The Bank currently has no outstanding letters of credit from FHLB held as collateral for its public fund deposits.

Interest rate sensitivity management seeks to avoid fluctuating net interest margins and to enhance consistent growth of net interest income through periods of changing interest rates. The ALCO closely monitors various liquidity ratios and interest rate spreads and margins. The ALCO utilizes a simulation model to perform interest rate simulation tests that apply various interest rate scenarios including immediate shocks and MVPE to assist in determining our overall interest rate risk and the adequacy of our liquidity position. In addition, the ALCO utilizes this simulation model to determine the impact on net interest income of various interest rate scenarios. By utilizing this technology, we can determine changes that need to be made to the asset and liability mix to minimize the change in net interest income under these various interest rate scenarios.

Management continually evaluates our liquidity position and currently believes the Company has adequate funding to meet our financial needs.

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Branch Closure

In September 2022, we announced our plans to close one traditional branch location in Lufkin on January 6, 2023, due to close proximity to another Southside branch and a shift in customer preferences and their transition from in-branch banking to digital banking.

Recent Accounting Pronouncements

See “Note 1 – Summary of Significant Accounting and Reporting Policies” in our consolidated financial statements included in this Quarterly Report on Form 10-Q.

Subsequent Events

Subsequent to September 30, 2022 on October 27, 2022, we purchased 21,935 shares of common stock at an average price of $33.37 pursuant to the Stock Repurchase Plan.

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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

The disclosures set forth in this item are qualified by the section captioned “Forward-Looking Statements” included in “Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations” of this report and other cautionary statements set forth elsewhere in this Quarterly Report on Form 10-Q.

Refer to the discussion of market risks included in “Item 7A. Quantitative and Qualitative Disclosures About Market Risk” in the 2021 Form 10-K.

In the banking industry, a major risk exposure is changing interest rates. The primary objective of monitoring our interest rate sensitivity, or risk, is to provide management the tools necessary to manage the balance sheet to minimize adverse changes in net interest income as a result of changes in the direction and level of interest rates. Federal Reserve monetary control efforts, the effects of deregulation, economic uncertainty and legislative changes have been significant factors affecting the task of managing interest rate sensitivity positions in recent years.

In an attempt to manage our exposure to changes in interest rates, management closely monitors our exposure to interest rate risk through our ALCO. Our ALCO meets regularly and reviews our interest rate risk position and makes recommendations to our board for adjusting this position. In addition, our board regularly reviews our asset/liability position. We primarily use two methods for measuring and analyzing interest rate risk: net income simulation analysis and MVPE modeling. We utilize the net income simulation model as the primary quantitative tool in measuring the amount of interest rate risk associated with changing market rates. This model quantifies the effects of various interest rate scenarios on projected net interest income and net income over the next 12 months. The model is used to measure the impact on net interest income relative to a base case scenario of rates immediately increasing 100 and 200 basis points or decreasing 50, 100 and 200 basis points over the next 12 months. These simulations incorporate assumptions regarding balance sheet growth and mix, pricing and the repricing and maturity characteristics of the existing and projected balance sheet. The impact of interest rate-related risks such as prepayment, basis and option risk are also considered. The model has interest rate floors and no interest rates are assumed to go negative. The interest rate environment in 2020 and much of 2021 was at a point where most treasury terms were under 100 basis points; therefore, we did not believe an analysis of an assumed decrease in interest rates beyond 50 basis points would provide meaningful results. We have resumed the simulation of rates decreasing 100 and 200 basis points. We are continuing to monitor interest rates and anticipate additional rate increases during the remainder of 2022.

The following table reflects the noted increases and decreases in interest rates under the model simulations and the anticipated impact on net interest income relative to the base case over the next 12 months for the periods presented.


	Anticipated impact over the next 12 months
	September 30,
Rate projections:	2022		2021
Increase:
100 basis points	4.26	%	2.03	%
200 basis points	7.19	%	4.58	%

Decrease:
50 basis points	(2.13)	%	(1.47)	%
100 basis points	(4.54)	%	N/A
200 basis points	(10.28)	%	N/A

As part of the overall assumptions, certain assets and liabilities are given reasonable floors. This type of simulation analysis requires numerous assumptions including but not limited to changes in balance sheet mix, prepayment rates on mortgage-related assets and fixed rate loans, cash flows and repricing of all financial instruments, changes in volumes and pricing, future shapes of the yield curve, relationship of market interest rates to each other (basis risk), credit spread and deposit sensitivity. Assumptions are based on management’s best estimates but may not accurately reflect actual results under certain changes in interest rates.

Economic conditions and growth prospects are currently impacted by record inflation and recessionary concerns. Increasing interest rates and high building costs have caused a slowdown in the single family housing market. Furthermore, worker shortages, especially in the restaurant, hospitality and retail industries, combined with supply chain disruptions impacting numerous industries and inflationary conditions, has had some impact on the level of economic growth. Ongoing higher inflation levels and higher interest rates could have a negative impact on both our consumer and commercial borrowers.

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The ALCO monitors various liquidity ratios to ensure a satisfactory liquidity position for us. Management continually evaluates the condition of the economy, the pattern of market interest rates and other economic data to determine the types of investments that should be made and at what maturities. Using this analysis, management from time to time assumes calculated interest sensitivity gap positions to maximize net interest income based upon anticipated movements in the general level of interest rates. Regulatory authorities also monitor our gap position along with other liquidity ratios. In addition, as described above, we utilize a simulation model to determine the impact of net interest income under several different interest rate scenarios. By utilizing this model, we can determine changes that need to be made to the asset and liability mixes to mitigate the change in net interest income under these various interest rate scenarios.

ITEM 4. CONTROLS AND PROCEDURES

Evaluation of Disclosure Controls and Procedures

Management, including our Chief Executive Officer (“CEO”) and our Chief Financial Officer (“CFO”), undertook an evaluation of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”)) as of the end of the period covered by this report, and, based on that evaluation, our CEO and CFO concluded that our disclosure controls and procedures were effective as of the end of the period covered by this report, in recording, processing, summarizing and reporting in a timely manner the information that the Company is required to disclose in its reports under the Exchange Act and in accumulating and communicating to the Company’s management, including the Company’s CEO and CFO, such information as appropriate to allow timely decisions regarding required disclosure.

Changes in Internal Control Over Financial Reporting

No changes were made to our internal control over financial reporting (as defined in Rule 13a-15(f) under the Exchange Act) during the quarter ended September 30, 2022 that materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

PART II. OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

We are a party to various litigation in the normal course of business. Management, after consulting with our legal counsel, believes that any liability resulting from litigation will not have a material effect on our financial position, results of operations or liquidity.

ITEM 1A. RISK FACTORS

There have been no material changes in the risk factors previously disclosed in the 2021 Form 10-K.

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

Issuer Purchases of Equity Securities

On March 1, 2022, our board of directors approved a Stock Repurchase Plan, authorizing the repurchase, from time to time, of up to 1.0 million shares of the Company’s outstanding common stock. Repurchases may be carried out in open market purchases, privately negotiated transactions or pursuant to any trading plan that might be adopted in accordance with Rule 10b5-1 of the Exchange Act. The Company has no obligation to repurchase any shares under the Stock Repurchase Plan and may suspend or discontinue the plan at any time.

The following table provides information with respect to purchases made by or on behalf of any “affiliated purchaser” (as defined in Rule 10b-18(a)(3) under the Exchange Act), of our common stock during the three months ended September 30, 2022:


Period	Total Number of Shares Purchased	Average Price Paid Per Share		Total Number of Shares Purchased as Part of Publicly Announced Plan	Maximum Number of Shares That May Yet Be Purchased Under the Stock Repurchase Plan at the End of the Period
July 1, 2022 - July 31, 2022	8,613	$	35.93	8,613	685,201
August 1, 2022 - August 31, 2022	—	—		—	685,201
September 1, 2022 - September 30, 2022	—	—		—	685,201
Total	8,613	$	35.93	8,613

Subsequent to September 30, 2022, on October 27, 2022, we purchased 21,935 shares of common stock at an average price of $33.37 pursuant to the Stock Repurchase Plan.

ITEM 3. DEFAULTS UPON SENIOR SECURITIES

None.

ITEM 4. MINE SAFETY DISCLOSURES

None.

ITEM 5. OTHER INFORMATION

None.

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ITEM 6. EXHIBITS

Exhibit Index

Incorporated by Reference

Exhibit Number

Exhibit Description

Filed Herewith

Exhibit

Form

Filing Date

File No.

(3)

Articles of Incorporation and Bylaws

3.1

Restated Certificate of Formation of Southside Bancshares, Inc.

3.1

8-K

05/14/2018

0-12247

3.2

Amended and Restated Bylaws of Southside Bancshares, Inc.

3.1

8-K

02/22/2018

0-12247

(31)

Rule 13a-14(a)/15d-14(a) Certifications

31.1

Certification of Chief Executive Officer

31.2

Certification of Chief Financial Officer

(32)

Section 1350 Certification

†32

Certification of Executive Officer and Chief Financial Officer

(101)

Interactive Date File

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

Inline XBRL Taxonomy Extension Schema Document.

101.CAL

Inline XBRL Taxonomy Extension Calculation Linkbase Document.

101.LAB

Inline XBRL Taxonomy Extension Label Linkbase Document.

101.PRE

Inline XBRL Taxonomy Extension Presentation Linkbase Document.

101.DEF

Inline XBRL Taxonomy Extension Definition Linkbase Document.

104

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

† The certification attached as Exhibit 32 accompanies this Quarterly Report on Form 10-Q and is “furnished” to the Commission pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 and shall not be deemed “filed” by us for purposes of Section 18 of the Securities Exchange Act of 1934, as amended.

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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.


		SOUTHSIDE BANCSHARES, INC.

DATE:	October 28, 2022	BY:	/s/ Lee R. Gibson
			Lee R. Gibson, CPA
			President and Chief Executive Officer
			(Principal Executive Officer)




DATE:	October 28, 2022	BY:	/s/ Julie N. Shamburger
			Julie N. Shamburger, CPA
			Chief Financial Officer
			(Principal Financial and Accounting Officer)

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